2013 Results Announcement

 

Not for release, publication or distribution, directly or indirectly, in whole or in part in or into the United States or any jurisdiction other than the United Kingdom and Bermuda where to do so would constitute a contravention of the relevant laws or regulations of such jurisdiction.  This announcement (and the information contained herein) does not contain or constitute an offer to sell or the solicitation of an offer to purchase, nor shall there be any sale of securities in any jurisdiction where such offer, solicitation or sale would constitute a contravention of the relevant laws or regulations of such jurisdiction.

 

 

27 March 2014

Gulf Keystone Petroleum Ltd. (LSE: GKP)

("Gulf Keystone" or "the Company")

 

2013 Results Announcement

Gulf Keystone, an independent oil and gas exploration, development and production company with operations in the Kurdistan Region of Iraq, today announces its results for the year ended 31 December 2013.

HIGHLIGHTS

 

Operational - in the year to 31 December 2013 and post year end

 

Kurdistan reserves and resources

 

·          Publication of the Competent Person's Report ("CPR"), the first third-party evaluation of the Company's Reserves, Contingent Resources and Prospective Resources across the Company's portfolio in the Kurdistan Region of Iraq, comprising the Shaikan, Sheikh Adi, Ber Bahr and Akri-Bijeel blocks, identifying 12.5 billion barrels of gross oil in place and 1.2 billion barrels of combined gross 2P and 2C recoverable oil reserves and resources, of which 680 million barrels of net 2P and 2C oil reserves and resources are attributable to Gulf Keystone

 

Shaikan Block (75% working interest; Operator)

·           Approval of the Shaikan Field Development Plan ("FDP") by the Ministry of Natural Resources of the Kurdistan Regional Government ("MNR" and "KRG") in June 2013

·           Commencement of commercial production from the first Shaikan production facility ("PF-1"), with expected production capacity of 20,000 barrels of oil per day ("bopd"), in July 2013, and ramp-up of production to stable levels of about 10,000 bopd in early 2014 with 16,000 bopd achieved in March 2014

·           Gross production from Shaikan to 31 December 2013 totalled 496,921 barrels, with gross sales of 304,680 barrels

·           Beginning of Shaikan crude export deliveries by truck to Turkey in December 2013 in line with the Company's marketing strategy developed in co-operation with the MNR

·           189,746 gross barrels of Shaikan crude export deliveries to 31 December 2013 and approximately 690,000 gross barrels by mid-March 2014 with the expectation to receive payment of the Company's full entitlement for Shaikan crude export deliveries

·           Commissioning of the second Shaikan production facility ("PF-2") is ongoing with first initial production of 10,000 bopd expected in Q2 2014; full production capacity of 20,000 bopd expected by the end of Q4 2014

·           Shaikan-7, the first deep exploration well, targeting previously undrilled mid to lower Triassic and Permian horizons, spudded in June 2013 with drilling ongoing in the Triassic; potential to add to already discovered resources with first results expected in Q2 2014

·           Completion of the regional independent export pipeline from the Kurdistan Region of Iraq to Turkey

 

Sheikh Adi Block (80% working interest; Operator)

·           Approval and commencement of the appraisal programme

·           Sheikh Adi-3, the first appraisal well, spudded in December 2013 to appraise Jurassic targets and evaluate the Triassic upside; the well is currently drilling below 2,240 metres in the Jurassic

·           Acquisition of 111km of additional 2D seismic data has been completed

 

Ber Bahr Block (40% working interest)

·           The successful side-track of the original Ber Bahr-1 exploration well in May 2013 confirmed the existence of a commercial Jurassic discovery

·           A 3D seismic survey is underway, planned for completion by mid-year 2014

·           The first appraisal well is planned to spud in Q4 2014

 

Akri-Bijeel Block (20% working interest)

·           The new Triassic oil discovery made on the Bakrman structure with the Bakrman-1 exploration well in February 2013

·           The block declared commercial in October 2013 based on the Bijell-1 Jurassic discovery and the Bakrman-1 Triassic discovery

·           Bijell extended well test ("EWT") facility was completed and became operational in early 2014 with initial flow rates of about 3,500 bopd from the Bijell-1B well; the facility is expected to reach its full production capacity of 10,000 bopd by the end of 2014

·           Drilling of two additional appraisal wells Bijell-2 and Bijell-4 is ongoing; both are expected to be tied to the EWT facility

 

Financial - as at 31 December 2013

 

·           Loss after tax: $32.0 million (2012: $81.8 million)

·           Loss per share: 3.69 cents (2012: 9.61 cents)

·           As at 31 December 2013, cash, cash equivalents and liquid investments: $82.0 million (2012: $262.3 million). As at 1 March 2014, cash, cash equivalents and liquid investments: $76.0 million

 

Corporate Developments - to 30 December 2013 and post period end

·           Simon Murray, C.B.E. was appointed Non-Executive Chairman of the Board in July 2013

·           Five additional Non-Executive Directors were appointed to the Company's Board

·           Successful transition from AIM, a market operated by the London Stock Exchange plc. ("LSE"), to the Official List, by way of a Standard Listing, and to trading on the Main Market of the LSE

·           Successful "tap issue" of the unsecured convertible bonds in the amount of US$50 million, consolidated with the US$275,000,000 convertible bonds issued in October 2012 and due October 2017

·           Completion of the trial in the English Commercial Court in London of all the claims asserted by Excalibur Ventures LLC ("Excalibur") against Gulf Keystone, two of its subsidiaries (together the "Companies") and Texas Keystone Inc. with all claims dismissed and all issues ruled in favour of and costs awarded to the Companies and Texas Keystone Inc.

·           In January 2014, the Company received £17.5 million of litigation costs incurred by the Companies and Texas Keystone Inc. and commenced proceedings to recover additional £5.61 million of the litigation costs from Excalibur's funders

 

OUTLOOK

·           Increase Shaikan production capacity to 40,000 bopd by the end of Q4 2014 and 66,000 bopd by Q1 2016 before progressing to the medium-term target of 100,000 bopd in line with the approved Phase 1 of Shaikan FDP

·           Expand export sales and generate steady revenues

·           Utilise cash generated from increasing oil sales, in addition to the available debt financing, to initiate the next stage of the Shaikan project execution, drilling development wells and constructing and commissioning PF-3

·           Obtain and evaluate results of the Shaikan-7 exploration well, currently targeting deeper Triassic and Permian horizons in the Shaikan block and potentially providing further upside to reserves and resources beyond the recent CPR

·           Side-track the original Shaikan-6 appraisal well to obtain better understanding of the oil water contact levels in Shaikan, again providing potentially significant further upside to reserves and resources beyond the recent CPR

·           Prepare a review of the Shaikan FDP to include Cretaceous, Triassic and potentially Permian developments, subject to the results of Shaikan-7

·           Conclude discussions with the MNR on a connection of the Shaikan field to the regional oil export pipeline infrastructure

·           Appraise the Sheikh Adi discovery, continue to target additional exploration prospects on the block and make decision regarding early production and development

 

 

Todd F Kozel, Chief Executive Officer of Gulf Keystone, commented:

 

"2013 was another successful year for Gulf Keystone as we transitioned from a pure exploration play to an exploration, development and production company, heading in 2014 towards our target of 40,000 bopd of production capacity from the world class Shaikan field. We continuously improve our operational performance having recently achieved a record loading of nearly 20,000 barrels of Shaikan crude in one single day at our production facility, which will be delivered to the international market in line with our marketing strategy developed in cooperation with the Ministry of Natural Resources.

 

"We have recently passed an important milestone with our successful listing on the Main Market of the London Stock Exchange, a further demonstration of how Gulf Keystone continues to develop. This important move followed the recent publication of the Competent Person's Report which has set a solid initial baseline of reserves and resources, from which we expect to build.  

 

"We continue to be encouraged by the recent positive political developments in the Kurdistan Region of Iraq, where the fast pace of economic development was maintained in 2013, not solely but largely due to the burgeoning O&G sector. Against this background, with a number of funding options open to us and a clear path to significantly ramping up production, we are focused on delivering the Company's strategy for 2014 and beyond."

 

The management team will host a conference call for analysts at 11am today. A live audio webcast of the call will be available on the Company's website www.gulfkeystone.com.

 

Enquiries:

 

Gulf Keystone Petroleum:	+44 (0) 20 7514 1400
Simon Murray, Non-Executive Chairman
Todd Kozel, Chief Executive Officer
Anastasia Vvedenskaya, Investor Relations
Mirabaud Securities LLP	+44 (0) 20 7878 3362
Peter Krens
Bell Pottinger	+44 (0) 20 7861 3232
Mark Antelme / Henry Lerwill

 

or visit: www.gulfkeystone.com

 

 

Notes to Editors:

·           Gulf Keystone Petroleum Ltd. (LSE: GKP) is an independent oil and gas exploration, development and production company focused on exploration in the Kurdistan Region of Iraq.

·           Gulf Keystone Petroleum International (GKPI) holds Production Sharing Contracts for four exploration blocks in Kurdistan, the Shaikan, Sheikh Adi, Ber Bahr and Akri-Bijeel blocks.

·           GKPI is the Operator of the Shaikan Block, which is a major commercial discovery, with a working interest of 75% and is partnered with Kalegran Ltd. (a 100% subsidiary of MOL Hungarian Oil and Gas plc.) and Texas Keystone Inc., which have working interests of 20% and 5% respectively.  Texas Keystone Inc. holds its interest in trust for Gulf Keystone, pending transfer of its interest to the Company.

·           Gulf Keystone is moving into the large-scale phased development of the Shaikan field targeting 100,000 bopd of production capacity during Phase 1 of the Shaikan Field Development Plan following its approval in June 2013.

 

 

Disclaimer

 

This announcement contains certain forward-looking statements.  These statements are made by the Company's Directors in good faith based on the information available to them up to the time of their approval of this announcement but such statements should be treated with caution due to inherent uncertainties, including both economic and business factors, underlying such forward-looking information.  This announcement has been prepared solely to provide additional information to shareholders to assess the Group's strategies and the potential for those strategies to succeed.  This announcement should not be relied on by any other party or for any other purpose.

 

This communication and the information contained herein is not an offer of securities for sale in the United States. Securities may not be offered or sold in the United States unless they are registered or are exempt from registration. Any public offering of securities to be made in the United States would be made by means of a prospectus that would contain detailed information about the company and its management, as well as financial statements. The company does not intend to register any portion of this offering in the United States or to conduct a public offering in the United States or any other jurisdiction. Any public offering of securities to be made in the United States would be made by means of a prospectus that would contain detailed information about the Company and its management, as well as financial statements. Copies of this communication are not being, and should not be, distributed in or sent into the United States.

 

This communication is directed only at (i) persons who are outside the United Kingdom or (ii) persons who have professional experience in matters relating to investments falling within Article 19(2) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended from time to time (the Order) or (iii) high net worth entities, and other persons to whom it may lawfully be communicated, falling within Article 49(2) of the Order or (iv) certified high net worth individuals and certified and self-certified sophisticated investors as described in Articles 48, 50, and 50A respectively of the Order or (v) persons to whom this communication may otherwise be lawfully communicated (all such persons together being referred to as relevant persons). Any investment activity to which this communication relates will only be available to and will only be engaged with, relevant persons. Any person who is not a relevant person should not act or rely on this document or any of its contents.

 

This communication is distributed in any member state of the European Economic Area which applies Directive 2003/71/EC (this Directive together with any implementing measures in any member state, the Prospectus Directive) only to those persons who are qualified investors for the purposes of the Prospectus Directive in such member state, and such other persons as this document may be addressed on legal grounds, and no person that is not a relevant person or qualified investor may act or rely on this document or any of its contents.

 

 

 

GULF KEYSTONE PETROLEUM LIMITED

 

Statement of Non-Executive Chairman

 

It is a great privilege to address shareholders of Gulf Keystone in this, my first Chairman's Statement since joining the company in July 2013.

 

In the past twelve months, Gulf Keystone has continued its remarkable journey and has further consolidated its position as one of the leading independent exploration companies in the Kurdistan Region of Iraq.  Most significantly, however, your company has successfully transitioned from a pure exploration player into being a meaningful development and production company with a clear path to producing 100,000 bopd.  The approval in June 2013 of the Field Development Plan ("FDP") for the world-class Shaikan commercial discovery, the first among the Production Sharing Contracts awarded in or after 2007 in the region, is a clear highlight of the reporting period and a resounding endorsement of the Company by the Kurdistan Regional Government's Ministry of Natural Resources ("KRG" and "MNR") . 

 

I am acutely conscious that since the time when commercial production from the Shaikan field began in late July we have not achieved the levels of oil sales that we had hoped to achieve during 2013, despite having a higher level of production capacity available since the summer. However, since December 2013, when Shaikan crude oil deliveries by truck commenced to export markets, our ramp-up in production has been increasing steadily and we are determined to continue in the same vein in 2014.

 

As one of the genuine early movers into the Kurdistan Region of Iraq, Gulf Keystone is a trusted and long standing partner of the KRG and people of the Kurdistan Region of Iraq.  Not only are we playing a key part in the development of Kurdistan's considerable oil wealth, but we continue to make a significant contribution to the economic and social fabric of the region through our community relations programme.  As you will read in this report, this includes a number of sustainable initiatives primarily focused around training, education and healthcare, designed to not only improve the standard of living of those closest to our areas of operations, but to ensure that the region's hugely talented population have the opportunities to fulfil their potential, including in future generations having the requisite skillset to develop their extensive natural resources for the long term good of the country. In 2013, in consultation with the MNR, we commenced the work on the Company's long-term Corporate Social Responsibility Plan, encompassing all aspects of our operations. We are pleased to report that this work has now been completed and the plan has been submitted to the MNR for final approval.

 

In addition, in response to the MNR's request to support its activities to alleviate the plight of hundreds of thousands of Syrian refugees fleeing their homeland and crossing the border into the Kurdistan Region of Iraq, we made an industry leading pledge to support the KRG and to help avoid a humanitarian crisis.

 

 

In preparation for our transition from AIM to the Standard Segment of the Official List and admission to trading on the Main Market of the London Stock Exchange ("LSE"), which was successfully accomplished in March 2014, considerable progress was made to ensure that the business was structured accordingly. Part of that preparation included the commissioning of a Competent Person's Report ("CPR"), which established an important and understandably conservative initial baseline for Gulf Keystone's Reserves and Resources and which we can build on going forward. AIM has been a very good home for Gulf Keystone since our IPO in 2004, but as we continue to grow and realise the potential of our world class acreage, we felt it was the appropriate moment to move up.  With the support of our advisers (we were pleased to welcome Deutsche Bank AG, London Branch into the team during the year), a considerable amount of endeavour has gone into preparing for life as a Main Market company.

 

One key work stream has been ensuring the highest standards of corporate governance, a review which started with the splitting of the Chairman and Chief Executive roles. I joined in July and thereafter we welcomed five new Non-Executive Directors during the year. In 2013 and the year to date we have made good progress towards many of our objectives, even though we have a great deal further to go in the year ahead. Among our achievements I would like to underline the establishment of a new remuneration policy in line with the advice of external advisors and a general tightening of internal and external procedures consistent with the move to the Main Market. I should also mention that our executive directors volunteered directly to forego any short term bonuses in respect of 2013.

 

On behalf of everyone at Gulf Keystone, I would again like to thank Ali Al-Qabandi, the co-founder of the Company, and Mehdi Varzi, a long-standing non-executive director, for all of their input and contributions in helping to build Gulf Keystone into the company it is today.    

 

I am pleased to report that the Board and its various committees, including the most recent addition of the HSSE and CSR Committee, are functioning well and, in advance of the move to the Main Market of the LSE, we have adopted the practices and standards befitting of a Main Market company.

 

Personally, I am extremely excited about the future. The business is uniquely well placed to build upon its leading position in the region.  With the full support of our hosts, our world class asset base and the right team in place, including our 250-strong workforce in-country, we are well positioned to create more value for all of our stakeholders. 

 

On behalf of the Board I would like to thank the KRG and people of the Kurdistan Region of Iraq for their ongoing faith in us.  I would also like to thank all our partners and investors, as well as everyone within the Company for their unswerving commitment to continuing to help Gulf Keystone on its remarkable journey. 

 

 

Simon Murray

Non-Executive Chairman

 

 

 

Statement of Chief Executive Officer

 

2013 was another year of important operational progress for Gulf Keystone, as the Company completed the transition from explorer to producer with the commencement of commercial oil production at our flagship Shaikan field in the Kurdistan Region of Iraq. I would like to thank the Government of the Kurdistan Region of Iraq for their support as we move towards our vision of being a significant independent exploration, development and production company listed on the Main Market of the London Stock Exchange.

 

In 2013, the Company continued to appraise the Sheikh Adi discovery, while two additional discoveries were made by our partners on the Akri-Bijeel and Ber Bahr blocks. This remarkable exploration success means that today Gulf Keystone has a share in four contiguous blocks with five discoveries with one of them already being at an early stage of commercial production. 

 

The commencement of commercial oil production from the Shaikan field followed approval in June of the Shaikan FDP by the MNR. This was a historic moment for Gulf Keystone, and we are proud to be working with the MNR and our partner MOL to continue to develop the field.  We have been a pioneer in the region from the outset and this milestone reconfirmed our goal to become a key player in the upstream oil industry in Kurdistan.

 

The first Shaikan production facility (PF-1), capable of producing 20,000 barrels of oil per day, was fully commissioned in July with domestic sales achieved shortly after in August. The Company continued to monetize its production through domestic sales until December when crude oil export deliveries by truck to Turkey commenced, in line with the Company's marketing strategy developed in co-operation with the MNR. Total production from Shaikan, since the early production operations began in late 2010, is now rapidly approaching 2.6 million barrels, out of which three cargoes totalling approximately 690,000 barrels have already been trucked to Turkey and loaded for delivery to international markets with the fourth cargo expected to be loaded by the end of March 2014.    

 

Three wells are currently tied to the facility, namely Shaikan-1, -3 and -4. Production from PF-1 has recently increased from 10,000 bopd to approximately 16,000 bopd and we plan to reach 20,000 bopd of production in the near term. The second Shaikan production facility ("PF-2") is currently being commissioned with two wells, Shaikan-2 and -5, already tied into the facility. Production from PF-2, which ultimately will be capable of producing 20,000 bopd, will commence in Q2 2014. Our immediate focus remains on achieving the target of 40,000 bopd of production capacity by the end of 2014.

 

These operational highlights were followed early in 2014 by the first third party evaluation of the Company's Reserves, Contingent Resources and Prospective Resources of our interests in the Kurdistan Region of Iraq. The CPR, prepared by ERC Equipoise Limited, identified 12.5 billion barrels of gross oil in place and 1.2 billion barrels of oil of combined gross 2P and 2C recoverable reserves and resources across the Company's portfolio, comprising the Shaikan, Sheikh Adi, Ber Bahr and Akri-Bijeel blocks. It is an important step in the growth of Gulf Keystone, demonstrating the size of our assets and significant potential for future increases in the existing numbers of reserves and resources. Shaikan is a significant industry asset with 2P value of US$1 billion, as indicated in the CPR, which does not take into account our extensive contingent resources. It is important to remember that we have not yet appraised the full potential of the field. As we drill more wells and increase production we will get a fuller understanding of its geology and the recovery factor assumptions are expected to increase. 

 

Shaikan is a phased development and the Company today is at an important juncture in this process. We have achieved several months of stable production and exports record, following which we are on a clear path to ramp up production from Shaikan, while fully expecting to receive the first payment for Shaikan crude export deliveries in line with the terms of the Shaikan Production Sharing Contract. The increase of production from 20,000 bopd to 40,000 bopd will enable us to generate substantial cash flow and help us progress to the full implementation of Phase 1 of the Shaikan FDP. Being operator of Shaikan means that we control the pace of development and capital expenditure and we will continue to seek funding at an appropriate cost of capital and a structure for the continued development of the Shaikan field and activities related to other fields in which the Company has participating interests. Financing decisions in order to fund the Shaikan Phase 1 activities will be made in conjunction with an anticipated increase in production capacity and sales of up to 40,000 bopd in 2014 and the recurring revenues this will provide. As Gulf Keystone matures as a producer, an increasingly diversified base of funding opportunities will become available.

 

In December, we were extremely pleased to have reached the end of the trial of the claims asserted by Excalibur against the Company, its two subsidiaries and Texas Keystone Inc. After a three year long process, which required a lot of time and effort from the Company and created unfortunate and significant uncertainty for our shareholders, the English Commercial Court ruled in our favour in the most unequivocal manner, acknowledging the speculative nature of Excalibur's claims, all of which have been dismissed. We worked hard to defend our position in the interests of our shareholders and the Court ruled all issues in favour of and awarded costs to the Companies and Texas Keystone Inc.  In January 2014, the Company received £16.9 million of litigation costs incurred by the Companies and Texas Keystone Inc. and commenced proceedings to recover additional £5.61 million of the litigation costs from Excalibur's funders.

 

I strongly believe that the Company's move to the Main Market in March 2014 has been an important and necessary hurdle for us to demonstrate the Company's increased size and maturity as an E&P player, as well as our desire to target a broader institutional investor audience. Having now passed this hurdle, the Board and the management team are aligned and focused on delivering the Company's strategy. 

 

I would like to take this opportunity to thank my fellow Board members, my management team and all the Company's employees for their commitment, dedication and hard work over the past twelve months. 2013 was another year of growth and delivery for Gulf Keystone and this is down to the efforts of our team.

 

Finally, at the end of 2013, important political momentum was gained with the completion of the Kurdistan-Turkey export oil pipeline, which became fully operational early in 2014. It is a major achievement for the Kurdistan Region of Iraq and, having made the significant leap from explorer to producer, Gulf Keystone will continue to progress with the development of the Shaikan field in 2014, making an increasing contribution to Kurdistan's production and exports. We look forward to continuing to work for the benefit of the Kurdistan Region of Iraq and all our stakeholders.

 

Todd F Kozel

Chief Executive Officer

 

 

 

Operational Review

 

Gulf Keystone achieved a number of significant milestones in its operations in the Kurdistan Region of Iraq in 2013. After the MNR approved the FDP for the Shaikan field, which the Company operates, commercial production from this key asset began in late July 2013. Against the backdrop of the significant progress being made on the independent pipeline infrastructure from Kurdistan to Turkey, the Company achieved its goal of having Shaikan crude delivered to the export market ahead of 2014. In December 2013, oil crude trucking operations commenced from Shaikan PF-1 with approximately 690,000 barrels delivered by truck to Turkey by mid-March 2014.

 

Last year, we commenced the implementation of the approved Phase 1 of the staged large-scale development of Shaikan with the drilling of Shaikan-10, our first development well, and achieving stable production levels of 10,000 from PF-1 by early 2014, which are expected to increase to 20,000 in Q2 2014. Shaikan PF-2 is being commissioned and our target is to reach cumulative production capacity of 40,000 bopd by the end of 2014.  

 

In an important step in Gulf Keystone's transition from an oil and gas exploration company to a production company and as part of our move from AIM to the Main Market of the LSE, in March 2014 we released the CPR prepared by ERC Equipoise Limited. This report provided the Company and the market with the first baseline indication of reserves and resources across our portfolio in the Kurdistan Region of Iraq, against which we will now be measuring our future progress.

 

Elsewhere across our portfolio, we began appraising the Jurassic discovery on the Sheikh Adi block with the Sheikh Adi-3 well, which spudded in December 2013. Subject to the outcome of the appraisal programme, decision will be made regarding early development and production from Sheikh Adi, which we operate.

 

In May 2013, Genel Energy, the operator of the Ber Bahr block, announced that Ber Bahr-1, the first exploration well on the block, confirmed existence of a Jurassic commercial discovery. A 3D seismic survey is ongoing and the first appraisal well is expected to be spud by the end of 2014. Earlier in 2013, MOL Hungarian Oil and Gas plc, the operator of the Akri-Bijeel block, announced a new Triassic discovery made with the Bakrman-1 exploration well, before declaring the block commercial in October 2013, based on the Bijell-1 and Bakrman-1 discoveries. Finally, early production from the Bijell Extended Well Test facility commenced with initial flow rates of 3,500 bopd, while the operator is planning to submit an FDP for the Bijell and Bakrman discoveries in Q2 2014.

 

Reserves and Resources

 

The CPR identified 12.5 billion barrels of gross oil in place and 1.2 billion barrels of oil of combined gross 2P and 2C recoverable reserves and resources across the Shaikan, Sheikh Adi, Ber Bahr and Akri-Bijeel blocks. All 2P reserves and the majority of 2C contingent resources have been identified within the Company-operated assets of Shaikan and Sheikh Adi, and most of these reserves and resources, based on current information, are in the Jurassic formation. 299 million barrels of gross 2P oil reserves in the Jurassic formation of the Shaikan field, with 163 million barrels of net 2P reserves to Gulf Keystone, have been assigned on the basis of the planned 26 development wells of the Shaikan FDP Phase 1. These wells, which will mainly target the Sargelu, Alan and Mus formations only in the Jurassic, represent fewer than 25% of approximately 109 wells currently envisaged for the Shaikan full field development. The CPR establishes an NPV valuation using a 10% discount rate of US$1,004 million nominal based on the Company's net entitlement and a 'base case' oil price scenario. The assumptions dealing with the derivation of the 2P valuation are contained in the CPR Section 9 'Shaikan Fiscal Terms' and should be referred to in order to understand the basis of calculation. The CPR is available on Gulf Keystone's website at http://www.gulfkeystone.com/investor-centre/presentations-and-technical-reports.

 

The CPR is an important baseline indication of resources and reserves, with potential for future increases through the full implementation of Phase 1 of the Shaikan Field Development Plan and its further project phases, which will include the drilling of a substantial number of development wells, acquisition of additional production data from the existing and additional production facilities and further exploration drilling in and development of the Cretaceous, Triassic and potentially Permian formations. The CPR does not take into account undrilled and untested horizons, which are currently being targeted by our first deep exploration well on Shaikan, and we see a clear route for unlocking the upside to these initial 2P and 2C numbers through drilling more wells and thus obtaining a better understanding of the oil water contact levels and the actual fracture porosity. We also anticipate that our 2C contingent resources will be converted to 2P reserves as the next phase of the Shaikan development gets approved.

 

 

Production and Development

 

Shaikan (75% working interest; Operator)

 

Further to the MNR's approval of the Shaikan FDP, Gulf Keystone obtained the right to commence commercial production from the field in June 2013. The approved Phase 1 of the Shaikan FDP envisages the first initial stage with production building from 20,000 bopd to 40,000 bopd and then progressing to 100,000 bopd. The Company's immediate target is to reach 40,000 bopd of production capacity by the end of 2014, before initiating the next stage of the Shaikan project execution and increasing production capacity from 40,000 bopd to 66,000 bopd by Q1 2016.

 

Shaikan PF-1 became operational in late July and achieved a steady ramp-up of production resulting in total gross production of 183,000 barrels as at 1 September 2013, at which point production had increased to 12,400 bopd. By late December production operations and sales from PF-1 stabilised and continued in January, February and March 2014 at the level of approximately 10,000 bopd (gross) with total cumulative production from late 2010 to early 2014 from the early Jurassic Sargelu producers Shaikan-1 and -3 having surpassed 2.1 million barrels. In addition to the Shaikan-1 and Shaikan-3 wells, Shaikan-4, also a Jurassic Sargelu producer, was tied into PF-1 in March 2014, increasing total PF-1 output to about 16,000 bopd with a further increase to 20,000 bopd anticipated in Q2 2014. With the addition of Shaikan-4, our cumulative production from the field to date is approaching 2.6 million barrels.

 

The Shaikan-2 and Shaikan-5 wells are tied into PF-2 and the production facility is currently being commissioned with first Jurassic production, initially of approximately 10,000 bopd, expected in Q2 2014. The connection of Shaikan-10 to PF-2 will be completed in Q2 2014, increasing PF-2 production capacity. In order to achieve 40,000 bopd of production capacity from PF-1 and PF-2 in 2014, the Company intends to  re-configure Shaikan-8, initially drilled as a gas injection well, into a fourth producer tied into PF-1, as well as to tie in the deep exploration well Shaikan-7, which is currently being drilled, to become the fifth producing well at PF-1. Additionally, productivity of the Shaikan-1 and Shaikan-3 wells will be enhanced through the replacement of the existing 3 ½" tubing by 4 ½" tubing. An additional production well will be drilled and connected to PF-2, alongside Shaikan-2, -5 and -10, the latter being  our first development well drilled and completed as a producer in October 2013.

 

Since Shaikan crude oil export deliveries commenced in December 2013, three cargoes totalling in excess of 105,000 tonnes (690,000 barrels) of oil have been delivered from PF-1 to Turkey by truck and loaded at the port of Dortyol. The fourth cargo of approximately 33,000 tonnes (215,000 barrels) of Shaikan crude is expected to be loaded by the end of March 2014. The move to 40,000 bopd of production capacity will allow further expansion of export crude oil sales and the additional cash generated, in addition to the Company's near term debt financing options, will facilitate the move to the next stage of the Shaikan project execution. This next stage envisages a further 60,000 bopd of additional production capacity in order to reach the medium-term target of 100,000 bopd, which will require construction of additional production facilities with gas injection and water handling capabilities, as well as the drilling of a substantial number of development and production wells.

 

Akri-Bijeel (20% working interest)

 

In November 2013, MOL Hungarian Oil and Gas plc, the operator of the Akri-Bijeel block, declared the block commercial based on the discoveries made by the Bijell-1 well in the Jurassic in 2010 and the Bakrman-1 well in the Triassic in February 2013.  While appraisal drilling continues, the operator is in the process of preparing the Field Development Plan for the Bijell and Bakrman discoveries, which is expected to be submitted to the MNR in Q2 2014 and approved later in 2014.

In early 2014, following the successful side-tracking and testing of the Bijell-1B well and the completion and commissioning of the Bijell Extended Well Test ("EWT") facility, early production operations began from the Bijell field. Early flow rates from the Bijell-1B well are around 3,500 bopd with an anticipated increase to the facility's full capacity of 10,000 bopd by the end of 2014.

Exploration & Appraisal

 

Shaikan (75% working interest; Operator)

 

Shaikan-7, the first deep exploration well on the Shaikan block, spudded in June 2013 to evaluate the previously undrilled mid to lower Triassic and Permian horizons. The well is being drilled with the Weatherford Rig 319 (3,000HP) close to the crest of the Shaikan structure, approximately 1km east of the Shaikan-1 discovery well. Exploring this potential exploration upside may provide significant additions to reserves and resources beyond the recent CPR.

 

Following a number of side-tracks and after setting casing at the bottom of Kurre Chine B formation below 2,600 metres in the upper Triassic, Shaikan-7 will drill into the deep Triassic and is then expected to penetrate the Permian. This vertical well is planned to reach a total depth below 4,500m in the Permian with the first results expected in Q2 2014. 

 

Sheikh Adi (80% working interest; Operator)

 

After making the Jurassic discovery with the Sheikh Adi-2 well in November 2012, the Company and the KRG, our partner in the block, unanimously agreed to move to an appraisal programme for the Sheikh Adi field to appraise Jurassic targets and evaluate the Triassic upside. Sheikh Adi-3, the first well to appraise the Sheikh Adi discovery, spudded in December 2013, and is currently drilling below 2,240 metres in the Alan formation in the Jurassic. A well testing programme to evaluate the potential of the Jurassic reservoirs in the Sheikh Adi footwall is currently being designed, before the well enters the Triassic. Subject to the outcome of the appraisal programme, decision will be made regarding early development and production from Sheikh Adi.

 

Approximately 111 km of new 2D seismic data acquired in the north of the block during 2013, has been processed to evaluate potential new structures.

 

Ber Bahr (40% working interest)

 

The Ber Bahr-1 exploration well was successfully side-tracked in the first half of 2013 and tested 2,100 bopd of 15 degree API oil from the Jurassic Sargelu formation. Genel Energy, the operator of the block, stated in May that the results of the Ber Bahr-1 well confirmed the existence of a commercial oil discovery. A 3D seismic survey is underway, planned for completion by mid-year 2014. The operator plans to spud an appraisal well in the fourth quarter of 2014.

 

Akri-Bijeel (20% working interest)

 

In 2013, the operator was progressing its extensive exploration and appraisal programme on the block. In addition to the already mentioned Bijell-1B side-track, the Bijell-2 appraisal well was drilled and tested in the Jurassic. Once it has been drilled into and tested in the Triassic, Bijell-2 is expected to be tied in to the Bijell EWT facility in H2 2014. Bijell-4, the third appraisal well, is currently drilling and Bijell-6 is expected to spud early in Q2 2014. Both wells are envisaged to be tied into the Bijell EWT facility, subject to the well testing results.

 

Following the Bakrman-1 Triassic oil discovery in January 2013, the operator plans to start an appraisal programme, consisting of two wells, in April 2014. Bakrman-2, which will target Triassic horizons, will be followed by Bakrman-3 in Q4 2014. Acquisition of 200 km² of 3D data is ongoing and the operator plans to commence early production from the field in 2015.

 

In line with the Company's decision to undertake a gradual strategic exit from Algeria, our remaining limited activities in Algeria will continue to focus on an orderly exit from the small GKN/GKS oil fields in the Ferkane area.

 

John Gerstenlauer

Chief Operating Officer

 

Financial Review

 

Results for the Year

 

Operating Results

 

2013 was a landmark year for Gulf Keystone Petroleum. Following the approval of the Shaikan FDP in June 2013, the Group has entered a critical phase in its development as it transitions from pure explorer to oil producer. The approval of the FDP, together with the commissioning of the PF-1 production facility in the summer of 2013, has led to the Group recognising commercial production from the Shaikan block in July 2013 and commercial sales thereafter.  Commercial production and sales have been shortly followed by the commencement of the export of crude oil in December 2013. 

 

Gross production for the year totalled 496,921 barrels of oil (2012: 832,859 barrels of oil) and gross sales were 304,680 barrels of oil (2012: 825,485 barrels of oil). These sales, all of which came from domestic sales from the Shaikan block, generated $6.7 million of revenue in 2013 (2012: $32.2 million). Revenue for sales from commercial production was recognised in line with the terms of Shaikan PSC, with the price achieved on domestic sales in 2013 being $41.2/bbl.  For all commercial production during 2013, the point of delivery to the customer is considered to be the metering point at the Shaikan field.

 

Trucking of Shaikan crude to the export market commenced in December 2013 with a total of 189,746 barrels (gross) leaving the Shaikan facility by 31 December 2013.  Given the payment mechanism for sales to the export market is currently developing within the Kurdistan Region of Iraq, and the fact that the Group is in the early stages of producing oil for this market, revenue is being recognised on the basis of cash receipt, consistent with our producing peers in the region.  The Group expects to receive its full entitlement for Shaikan crude trucked to international markets and estimates that the value of the production sent during 2013, net to the Group, is approximately $7 million, gross of royalty.  Further details of sales revenues and the assumptions associated with their recognition and measurement can be found in the Summary of Significant Accounting Policies, Critical accounting estimates and judgements and note 2 to the consolidated financial statements. 

 

The recognition of commercial sales has resulted in the Group recognising a gross profit margin associated with Shaikan block production for the first time in 2013.  In contrast, during 2012, all $32.2 million of revenue related to test production, where test production revenue is recognised with an equal and offsetting amount against cost of sales.  This resulted in an amount equal to revenue being credited to intangible assets against exploration and evaluation costs, reducing the net book value in the balance sheet and showing a $nil gross profit.

 

Operating costs on a per barrel basis, excluding royalty, inventory movements, production payments due under the PSC terms to the KRG, depreciation, depletion and amortisation costs and share-based payment charges were $44.00 per barrel on an entitlement basis reflecting the lack of consistent production achieved throughout 2013 (2012: $28.31 per barrel) and the production sent to the export market, for which no entitlement has been recognised until the associated cash is received.  Adjusting for the production sent to the export market, operating costs would be $27.20 per barrel net to the Group. 

 

At 30 June 2013, the Shaikan block assets, with a carrying value at time of transfer of $443.5 million (31 December 2012: $357.7 million), were transferred from intangible assets to property, plant and equipment.  This reflects the fact that assets in this block are now considered developing and producing assets following the Group's criteria for the transfer being met with the approval of the FDP.  The Group's internal determination of commercial reserves has been supplemented by the CPR report from ERC Equipoise, which was finalised during the first quarter of 2014 (see Operational Review for further details).  The property, plant and equipment balance for the Shaikan block is now being depreciated using the unit of production method based on entitlement production and reserves.  The depreciation charge relating to these assets for 2013 was $2.4 million (2012: $nil), and is recorded within cost of sales; see notes 3, 10 and 11 to the consolidated financial statements for further details.

 

Non-Operating Results

 

General and administrative expenses for 2013 were $15.8 million (2012: $82.1 million), a reduction of $66.3 million. This can be attributed to a number of factors as discussed below.

 

On 13 December 2013, the English Commercial Court (the "Court") handed down its full judgment dismissing all the claims asserted by Excalibur Ventures LLC ("Excalibur") and deciding all issues in favour of the Group and Texas Keystone (the "Defendants") (see Excalibur Claims section for further details).  The Court ordered that the full sum paid into the Court as security for the Defendant's costs be paid out to the Defendants and the amount received by the Company (£17.5 million, net of outstanding legal fees of £0.6 million) has been credited against 2013 administrative expenses (see note 4 to the consolidated financial statements).  The Company received this amount in January 2014. The Company was awarded a further £3.2 million, and Texas Keystone, an additional £2.4 million to be recovered from Excalibur and their financial backers, following an assessment of costs on an indemnity basis.  As at the date of this report, these funds have not yet been received, and while the Company intends to pursue these claims, it cannot be certain that any further amounts will be paid by Excalibur and its financial backers.  For further details of the claim, and the circumstances of its resolution, please refer to note 23 to the consolidated financial statements.  This refund of legal costs has resulted in a reduction of administrative expenses of $45.8 million (2013: $19.0 million net credit to costs incurred in relation to the Excalibur litigation; 2012: $26.8 million costs incurred).

 

The costs associated with the share bonus awards and the options awarded under the Company Share Options Plan and Long Term Incentive Plan decreased from $25.9 million in 2012 to $12.6 million, reflecting no new grants during the year.  Of these costs, $2.9 million has been included within intangible assets and property plant and equipment (2012: $6.0 million), as these employment costs are directly attributable to technical staff working on capital oil and gas projects.  In addition, cash bonuses for senior management have reduced by $6.4 million to $7.6 million (2012: $14.0 million), in line with Group remuneration policy and no new awards granted to Executive Management for the year ended 31 December 2013.

 

Other losses of $1.2 million (2012: other gains of $5.2 million) comprise foreign exchange losses of $1.2 million (2012: $6.4 million gain), with the Group holding no derivative financial instruments at year end requiring mark-to-market valuation (2012: $1.2 million mark-to-market valuation loss). The currency and interest rate hedges which the Company entered into to partially mitigate the risk associated with converting U.S. dollars to sterling were all held to maturity.

 

Interest revenue remains low in accordance with prevailing interest rates and has reduced from 2012 due to a lower average cash balance (2013: $0.8 million; 2012: $1.2 million).  Finance costs of $10.4 million (2012: $4.5 million) are made up of the accretion charge on the decommissioning provision of $0.4 million (2012: $0.3 million) and interest payable in respect of the Convertible Bonds of $23.4 million (2012: $4.6 million) out of which $13.4 million (2012: $0.5 million) was capitalised within intangible assets. The increase in convertible bond interest expense is due to the fact that the original $275.0 million issue was in place for the whole of 2013, compared to the last two months of 2012, and a "tap" issue of $50 million was completed during November 2013 (see Convertible Bonds section).

 

The tax cost for 2013 is $0.1 million (2012: $1.6 million) and arises on UK activities.

 

The results for 2013 show a decreased loss after tax of $32.0 million (2012: $81.8 million) reflecting the reduction in administrative expenses discussed previously, offset by a gross operating loss of $5.3 million and increased finance costs.

 

Cash Flow

 

Net cash outflow from oil and gas operations after operational and administrative expenses was $25.1 million (2012: $59.0 million). The loss from operations of $21.1 million (2012: $82.1 million) was adjusted for non-cash expenditure of $13.0 million (2012: $25.4 million), that includes share-based payments and depreciation, depletion and amortisation costs. Non-cash expenditure was reduced by a decrease in share-based payment expense from $20.0 million to $9.8 million, there being no change to the value of the Algeria decommissioning provision (2012: $3.5 million) but offset by an increase in depreciation to $3.0 million (2012: $0.6 million), including the charge to the Shaikan oil and gas assets. See note 21 to the consolidated financial statements for further details. 
 

Working capital adjustments result in a $17.0 million cash outflow (2012: $2.2 million outflow) increasing operational cash outflow relative to accounting loss from operations.  The increases in inventories and payables are in line with the level of increase in the Company's activities during the year, while the significant increase in receivables results from the outstanding Court costs receivable, which was paid shortly after year end.

 

Convertible bond coupon payments of $17.2 million were made during 2013 (2012: $nil) and are included within cash used in operating activities.

 

Tax paid in 2013 was $0.7 million (2012: $1.7 million) and interest received was $0.8 million (2012: $1.2 million). Net cash outflow from operating activities after tax and interest was $42.1 million (2012: $59.4 million).

 

Cash used in investing activities totalled $182.3 million (2012: $172.3 million), which comprises $131.8 million spent on intangible assets (2012: $191.9 million) and $59.0 million (2012: $1.3 million) spent on property, plant and equipment offset by a reduction in liquid investments of $8.6 million (2012: $20.9 million decrease).  The spend on property, plant and equipment has increased following the transfer of the Shaikan assets from intangible assets to property, plant and equipment at 30 June 2013. All Shaikan block capitalised spend during the second half of the year has been recorded as property, plant and equipment. The majority of the $131.8 million cash spent on intangible assets relates to the Company's exploration activities in the Kurdistan Region of Iraq, including the drilling, testing and workovers of wells on the Sheikh Adi, Ber Bahr and Akri-Bijeel blocks, Akri-Bijeel surface facility construction and the acquisition and processing of seismic data as well as additions to the Shaikan block in the first half of 2013.  Overall, cash spend on intangible assets and property plant and equipment was comparable to 2012 (2013: $190.9 million; 2012: $193.2 million).

 

Cash generated by financing activities amounted to $53.9 million (2012: $270.2 million) and primarily results from the "tap" issue of the $50 million convertible bonds during November 2013.  In 2012, significant funds were raised through the $275.0 million convertible bonds in October 2012 to fund the Group's capital work programme throughout 2013. A further $4.7 million was raised in 2013 through the funds received following the exercises of the warrants previously granted and options under the Company's share option plan (2012: $1.3 million).

 

The net overall decrease in cash and cash equivalents during the period was $170.4 million (2012: $38.5 million increase).  Foreign exchange losses on cash balances were $1.3 million (2012: $7.1 million gain).

 

Cash and cash equivalents totalled $82.0 million at 31 December 2013 (31 December 2012: $253.7 million). Cash, cash equivalents and liquid investments totalled $82.0 million at 31 December 2013 and $141.1 million at 30 June 2013 (31 December 2012: $262.3 million).

 

Excalibur Claims

 

On 13 December 2013, the English Commercial Court handed down its full judgment dismissing all of the claims asserted by Excalibur against the Defendants. Excalibur has announced that it does not intend to appeal this judgment. Up until the date of the judgment, Excalibur had paid £17.5 million into the court as security for costs, comprising £10.7 million for Gulf Keystone and £6.8 million for Texas Keystone. The court ordered that the defendants should receive the £17.5 million in its entirety, in addition to a further £5.6 million indemnity costs recoverable from Excalibur and its backers.  To date, the £5.6 million has not been recovered and the Company is launching legal proceedings to recover the balance.  Further details of the claim and its resolution are given in note 23 to the consolidated financial statements.

 

Convertible Bonds and Capital Structure

 

In October 2012, in order to fund the Company's ongoing work programme through 2013, the Company completed an oversubscribed offering of Convertible Bonds, raising $275.0 million gross proceeds.  These Convertible Bonds were admitted to the Official List of the Luxembourg Stock Exchange in January 2013. In November 2013, the Company completed an additional offering of Convertible Bonds (the "tap" issue), raising a further $50.0 million gross proceeds. The bonds issued in 2013 have been consolidated with those issued in 2012 to form a single series. All of the Convertible Bonds are due to mature on the fifth anniversary of the initial bond issue in October 2017; see note 17 to the consolidated financial statements for further details.

 

Funds raised via the offering of the Convertible Bonds enhanced the Company's liquidity position and have contributed to the Company's strategy of developing the production capabilities of the Shaikan block to the level where future development will be funded by ongoing, stable production and export sales.

 

This is the second time Gulf Keystone has accessed the debt capital markets, with an equity-linked product, and the success of the offering demonstrates investors' confidence in the Company's continuing development of the Shaikan block and other opportunities.

 

No changes were made to the authorised share capital during 2013.  At the date of this report, 888,933,057 common shares are in issue.

 

During February 2013, 7.1 million common shares were issued including 6.5 million to the Employee Benefit Trust ("EBT"), to satisfy awards made under the 2010 and 2011 Executive Bonus Scheme that were deemed to have vested.  Further details of the awards granted and vested are given in the Directors' Report and notes 20 and 24 to the consolidated financial statements.  These issues were reported in the 2012 Annual Report and Accounts.

 

During 2013, 4.6 million common shares were issued in response to option exercises by the Company's employees and directors.

 

The common shares issued during 2013 to satisfy awards under the Company's bonus and option incentive schemes represent 1.32% of the Company's share capital as at the date of this report.  There were no additional share bonuses or LTIP options granted in 2013.

 

Corporate Activities

 

During 2013, the Company continued to work towards obtaining admission to trading on the London Stock Exchange plc's ("LSE") Main Market for listed securities. The late 2013 resolution of the Excalibur case in the Company's favour removed a significant amount of uncertainty that had previously held the Company back from applying for admission to the Official List of the United Kingdom Listing Authority ("UKLA"). The Competent Person's Report ("CPR"), prepared by ERC Equipoise and released on 14 March 2014 was an important step towards admission to the Official List.  The admission to the Official List occurred at 8.00am on 25 March 2014, just prior to the date of this report.  Trading in the Company's common shares on AIM was simultaneously cancelled.

 

Other and Further Events

 

The Company continues to explore options for the disposal of its 20% working interest in the Akri-Bijeel block together with its appointed corporate advisers, whom are responsible for coordination of, and advice on, the process. The disposal process remains ongoing at the date of this report, with the Group continuing to actively market its interest.  The block was declared commercial in October 2013 by the operator, MOL. Early production has recently commenced from the Extended Well Test ("EWT") facility following the tie-in of Bijell-1B, with initial production at around 3,500 barrels per day.  These developments, together with the Bakrman discovery in 2013, all enhance the prospect of a successful conclusion to the disposal process.  The Akri-Bijeel intangible asset (2013: $103.1 million; 2012: $64.6 million), including the associated working capital balances, continues to be classified as an asset held for sale. Further details of this asset, and the facts and circumstances of the proposed sale, are given in note 12 to the consolidated financial statements.

 

The Company continues to effect an orderly exit from its Algerian operations and continues the discussions with Sonatrach regarding the exit from Block 126a (GKN and GKS oilfields under the Ferkane Permit).

 

Financial Strategy and Outlook for 2014

 

2013 has been a year of significant progress for Gulf Keystone, a year in which the Company achieved important operational and financial milestones. These milestones include the $50 million "tap" issue follow-up to the highly successful 2012 Convertible Bonds issue, the approval of the Shaikan FDP and the commencement of commercial production from this block.

 

The Group's current committed capital work programme and immediate focus remains on achieving its target of 40,000 bopd of production capacity from the Shaikan block's PF-1 and PF-2 by the end of 2014, which will allow further expansion of export crude oil sales.  The first Shaikan production facility is already producing oil for commercial sale and the second is due to produce "first oil" in the second quarter of 2014.  Gulf Keystone, together with its partners, continues to carry on its exploration and appraisal programmes on the prospects identified in the Sheikh Adi, Akri-Bijeel and Ber Bahr blocks aimed at unlocking significant value and increasing reserves and resources across all of the Company's licence interests.

 

The Group's business is highly capital intensive and on 20 March 2014, the Company included a statement in its announcement of the publication of its prospectus in connection with the admission to the Official List, that it was of the opinion that the Group does not have sufficient working capital for its present requirements, representing a material uncertainty over the going concern assumption (see the Directors' Report for further details). 

 

Existing cash resources at 1 March 2014 were $76.0 million.  It is expected that these may be enhanced over the next 12 months by:

·      achieving further consistent oil production and domestic and export sales from Shaikan increasing up to 40,000 bopd;

·      the exercise of the Shaikan Government Option, the Shaikan Third Party Option, the Akri-Bijeel Government Option and/or the Akri-Bijeel Third Party Option under the terms of the Shaikan and Akri-Bijeel PSCs;

·      any proceeds from the potential sale of the Group's interest in the Akri-Bijeel Block; and/or

·      reimbursement of the additional £5.6 million litigation costs by Excalibur.

 

With reference to the above, under the terms of the Shaikan and the Akri-Bijeel PSCs, the KRG has the option (the "Government Option") to participate in an undivided interest in the petroleum operations of the relevant block. In addition to the Government Option, the KRG also has the option to nominate a third party to have an undivided interest in the petroleum operations of the Shaikan block and the Akri-Bijeel block (the "Third Party Option").

 

However, in order to address a potential shortfall in working capital, the Company is currently seeking additional, cost-effective financing in the form of high yield bonds.  Prior to this report, on 19 March 2014, the Company announced that it has mandated Deutsche Bank and Pareto Securities to arrange a series of fixed income investor meetings in the US, Europe and Asia commencing 20 March 2014. A debt offering of up to US$250 million in accordance with Reg S/144A is expected to follow, subject to market conditions; investor meetings are on-going at the date of this report.

 

The Company expects to utilise cash generated from increasing oil sales, in addition to the funds from the contemplated raising of up to US$250 million in debt financing, to initiate the next stage of the Shaikan project execution and increase production capacity to 66,000 bopd by Q1 2016.  The increase of Shaikan production capacity to 66,000 bopd is the Company's next step towards reaching the medium-term target of 100,000 bopd set for Phase 1 of the approved Shaikan FDP.

 

 

 

KE Ainsworth

Finance Director

 

 

Management of Principal Risks and Uncertainties

 

Getting risk management right is an essential component of business success.  It supports the achievement of our strategic objectives and protects our business, our people and our reputation.  Identifying, understanding and mitigating the risks we face, whilst being able to maximise the value from business opportunities, supports effective decision making.  Responding quickly when risks crystallise to mitigate their impact is a key element of our risk management process which underpins the safe delivery of our business plans and strategic objectives, protects our licence to operate, and helps to create a long-term competitive advantage. 

 

The Board, its Committees and the senior management team are actively engaged in monitoring and limiting, where possible, the risks to which the Company and its subsidiaries (together "the Group") are exposed.  During 2013, we have regularly considered our risk profile and updated the Group risk register.  The following table indicates the key risks the Group faces, their potential impact and the mitigation measures that we have in place.  The list is not exhaustive or in priority order, and may change at any time.

 

Key Risk Factor	Potential Impact	Mitigation
Strategic Risks
Meeting shareholder expectations, particularly with regard to the Group's long-term strategy, production profile and funding	Ineffective or poorly executed strategy fails to create shareholder value and to meet shareholder expectations.  It may lead to loss of investor confidence and reduction in the Company's share price, which reduces the Company's ability to access finance and increases vulnerability to a hostile takeover.	The Company maintains a regular dialogue with the Company's shareholder base and the general public. A website is maintained to disseminate information widely and in a timely manner. Gulf Keystone employs an investor relations team. All key developments are released to the market through the Regulatory Information Service, also available on the Company's website.
Organisational capability	With the Group's transition from exploration to development and production, it is of utmost importance to ensure that the capability of the organisation is adequate to deliver plans for growth. Organisational capability is a function of both the strength of the Group's human resources and internal controls. Inability of the Group to recruit and retain staff with the right skills and to implement succession plans may lead to a loss of knowledge and skills to the Group and other short- and long-term disruption to the business. Weak controls or lack of compliance may lead to loss of value and failure to achieve growth targets.	Gulf Keystone has created competitive remuneration packages including bonus, share options and long-term incentive plans that are reviewed regularly to ensure key executives and senior management are appropriately compensated. Executive and senior management turnover rate in the Group continues to remain at low levels. The Group's internal audit function performed by PricewaterhouseCoopers ('PwC') carries out a variety of internal control procedures audits with a risk based focus. The areas of focus for the internal audit reviews are determined by the Audit Committee, who also monitor timely and adequate implementation of the recommendations made.  For further details on the reviews carried out in 2013, please refer to the Audit Committee Report section of the Corporate Governance Report.
Political and regional risk, including risks relating to disputes regarding title and exploration and production rights	Unfavourable developments in politics, laws and regulations can affect our operations, earnings and our ability to deliver the strategy. The Group has the right to explore its assets in the Kurdistan Region of Iraq and, to the best of its knowledge, those rights are in good standing.  However, The Iraq Oil Ministry has publicly stated that the PSCs entered into by the KRG are not valid.  If the validity of the PSCs was successfully challenged, the Group could be required by the KRG to accept contractor entitlements that are materially less favourable than the current PSCs. Consequences may include limits on production or cost recovery, import and export restrictions, price controls, uncertainty over payment mechanisms for the export sales, tax increases and other retroactive tax claims, expropriation of property, cancellation of contract rights and increase in regulatory burden.	The history of political and social instability of Iraq, including the Kurdistan Region of Iraq where the majority of the Group's operations are concentrated, is noted by the Board who mitigate the political risk as far as possible.  While the Group cannot control or completely mitigate the risks of disputes between the Kurdistan Region of Iraq and the Republic of Iraq in relation to the Kurdistan PSCs, it maintains continuous dialogue with appropriate government departments and closely monitors the local situation for emerging risks to the business and has business continuity plans in place. Gulf Keystone strives to be a good corporate citizen globally, and fosters reputation by strong and positive relationships with the governments and communities where we do business.  The Group has a number of ongoing corporate social responsibility initiatives.
Risks associated with infrastructure and export market	The Group's ability to export oil may be curtailed by current uncertainty relating to the export market and the payment mechanism for export oil in the Kurdistan Region of Iraq. The construction of a pipeline connecting the Company's blocks to the export market is critical to the future operations of the Group as transportation by truck has limited capacity, is costly and carries inherent risk relating to potential safety and environmental concerns in the event of any accidents.	The Group continues to have a regular dialogue with the KRG as part of its engagement with stakeholders. Gulf Keystone has been selling into the local market in the Kurdistan Region of Iraq, which has provided a reliable revenue stream for the Group to date.  The export of crude oil by the KRG via truck from the Shaikan Block in December 2013 and, to date, three exports totalling in excess of 105,000 tonnes (690,000 barrels) have been delivered from Shaikan PF-1.  The Group monitors the developments in the Kurdistan Region of Iraq infrastructure and availability of transport options. As a short-term solution, Gulf Keystone can rely on transportation by truck pending the Group's anticipated access to the regional pipeline infrastructure from Kurdistan to Turkey in 2015. However, the Group recognises all the limitations associated with trucking.
Business conduct and bribery act	Due to the nature of the industry sector and the regions in which Gulf Keystone operates, the Group is potentially exposed to accusations of poor practice when it comes to the requirements introduced by the UK Bribery Act in 2010. Violations of this Act, by the Group or those acting on its behalf, may result in a criminal case against Gulf Keystone and/or our employees, leading to reputational damage, possible imprisonment and fines.	The Audit Committee designated a senior executive as the anti-Bribery Officer for the Group. His role is to ensure that the Group has appropriate procedures in place to mitigate the risk of bribery and that all employees, agents and other associated persons are made fully aware of the Group's policies and procedures with regard to ethical behaviour, business conduct and transparency. PwC performed an independent Bribery Act compliance review in 2013.  The Audit Committee is monitoring the timely implementation of PwC's recommendations. A detailed bribery risk assessment has been performed by management and reviewed by the Board.
Operational Risks
Field delivery risk	Field delivery risk applies to all phases of the exploration and production ("E&P") cycle from seismic acquisition through to production operations. At each phase the mitigating measures will be different, however, failure to control risks will manifest itself as project delays, cost overruns, high production costs, early field decommissioning and, ultimately, lower than expected reserves.	Technical, financial and Board approvals are required for all projects, and for all dedicated project teams. The technical team analyse results from appraisal wells and determine the appropriate course of action in terms of drilling programme and facility design. All projects are closely monitored to ensure the project delivers against plan and to enable actions to be taken to maintain progress. Project finances are monitored against budget to minimise overruns.
Health, safety, security and environment (HSSE)	The Group may be exposed to specific risks in relation to social and environmental factors as well as health and safety matters. The security risk is addressed in additional detail below. Identified risk areas include H2S leaks at the production facilities, road traffic accidents and other accidents at production facilities and well sites.  Consequences may include accidents resulting in loss of life, injury and/or significant pollution of the local environment, destruction of facilities, disruption to business activities, risk of litigation and reputational damage, with an associated financial loss.	The Group has established a Health, Safety, Security and Environment and Corporate Social Responsibility ("HSSE and CSR") Committee in September 2013, ensuring that HSSE strategy is directed from the Board level, in order to warrant accountability and commitment throughout the organisation. Gulf Keystone has put in place comprehensive HSSE and operations management procedures including emergency and incident response plans. The Group actively engages with local communities and governments using specialist consultants. PwC performed an independent HSSE procedures review in 2013. Management is continuously working on the improvements to the HSSE procedures including the implementation of the recommendations that arose from PwC's review.
Security	The Group is exposed, by virtue of the location of its operations, to a number of security risks. These include the threat of terrorist attack and local protests and unrest at Gulf Keystone sites. Both of these threats may lead to death or injury to personnel, disruption to operations, costs to repair facilities and reputational damage to the Group.	The Group has employed external consultants to assess the security risks, monitor the threat level and advise on security procedures and contingency plans. Good relations with local communities are also considered essential as they provide intelligence about the nature, severity and likelihood of any threat.
Prohibition on flaring and undeveloped options for monetising natural gas discoveries	Under the terms of the Kurdistan PSCs, to the extent that the Group is unable to re-inject or sweeten natural gas, prior authorisation is required for the prolonged flaring of natural gas.  The Group currently has all necessary flaring permits but these are due to expire in August 2014. Expiration of the flaring permit will result in the suspension of production and sales.	The Group maintains active dialogue with the regional authorities to ensure that it complies with the existing regulations.  Harmful gases emissions are closely monitored by the HSSE department with any variances outside the norms investigated and reported to the executive management. The Group is currently discussing the terms of a possible extension to the flaring permits and has no reason to believe that the permits will not be extended. However, there can be no assurance that these permits will be renewed by the Kurdistan Ministry of Natural Resources.
Financial Risks
Capital availability and expenditure control	Access to financing to maintain the ongoing operations of the business is critical. If the Group's financial performance and access to funding do not match the capital requirements, it will be impossible for Gulf Keystone to fulfil commitments and deliver the exploration and development programme. In the extreme case, this could impact the Group's ability to continue as a going concern.	Finances are controlled through a comprehensive annual budgeting process and periodic forecast updates, including sensitivity reviews.  The projected cash balance is reviewed on an ongoing basis. All significant expenditure is approved by the Board. Short-term and long-term cash forecasts are monitored and reported regularly to senior management and the Board. Active dialogue is maintained with financial institutions and investors and potential sources of funding the Group's ongoing work programme are considered. Gulf Keystone's management have a strong track record of successful fundraisings.
Liquidity and credit risk	The Group's required capital expenditures exceed the currently available working capital. The Directors believe that a material uncertainty exists around the Group's ability to continue as a going concern. As a result of the shortfall in working capital, the Group may not be able to pay liabilities as they fall due and, in extreme cases, this may lead to insolvency. The Group also has convertible bonds in issue, thereby increasing its exposure to credit risk.	In order to address this potential shortfall in working capital, the Group is currently seeking to raise additional debt financing by the end of April 2014.  The Group has mandated Deutsche Bank and Pareto Securities to arrange a series of fixed income investor meetings in the US, Europe and Asia, which commenced on 20 March 2014.  A debt offering of up to US$250 million in accordance with Reg S/144A is expected to follow, subject to market conditions. The Group also has a number of other potential sources of cash inflows which are detailed in the "Going Concern" section of the Directors' Report. The Group has a strong track record of fundraising and the Directors have a reasonable expectation of securing the necessary funds to fulfil the Group's working programme.

 

 

 

Directors' Report

 

The Directors are pleased to present their report on the affairs of the Group, together with the consolidated financial statements of the Company and auditor's report, for the year ended 31 December 2013.  A review of the business is set out in the preceding sections of this Annual Report, including the Statement of Non-Executive Chairman and Statement of Chief Executive Officer, Operational Review and Financial Review, which are incorporated into this report by reference.  The Corporate Governance statement also forms part of this report. 

 

Results and Dividends

 

The Group's financial results for the year ended 31 December 2013 are set out in the consolidated financial statements.  The Group made a net loss after taxation for the year of $32.0 million (2012: $81.8 million loss) and the Directors do not recommend a dividend for the year (2012: $nil).  Future payments of dividends are expected to depend on the earnings and financial condition of the Company and such factors as the Board of Directors consider are appropriate.

 

Capital Structure

 

Details of the authorised and issued share capital, together with movements in the Company's issued share capital during the year, are shown in note 20 to the consolidated financial statements.  The business is financed by means of debt (see note 17 to the consolidated financial statements), internally generated funds and external share capital. 

 

There are no specific restrictions on the size of a holding nor on the transfer of common shares, both of which are governed by the general provisions of the Company's Bye-laws and prevailing legislation.  The Directors are not aware of any agreements between holders of the Company's common shares that may result in restrictions on the transfer of securities or on voting rights.  No person has any special rights of control over the Company's share capital and all issued common shares are fully paid.

 

Details of the employee share schemes are set out in note 24 to the consolidated financial statements and details of the Directors' awards are included in the Report of the Remuneration Committee.

 

Voting Rights and Bye-Law Amendments

 

The Company's Bye-laws may only be revoked or amended by the shareholders of the Company by resolution passed by a majority of not less than three-fourths of such shareholders as vote in person or, where proxies are allowed, by proxy at a general meeting.  Resolutions put to the vote of any general meeting are decided on a show of hands unless a poll is demanded in accordance with the Company's Bye-laws.

 

Directors

 

With regard to the appointment and replacement of Directors, the Company is governed by its Bye-laws, the Companies Act (Bermuda) and related legislation.  In accordance with the Bye-Laws, one-third of all the Directors are required to retire by rotation every year at the Annual General Meeting. 

 

The following Directors have held office during the year:

 

Todd Kozel -Chief Executive Officer⁽³⁾

Simon Murray - Non-Executive Chairman (joined the Board in July 2013)⁽²⁾⁽³⁾

John Gerstenlauer - Chief Operating Officer⁽⁴⁾

Ewen Ainsworth - Finance Director

Lord Guthrie - Non-Executive Director⁽³⁾

Mark Hanson - Non-Executive Director^(1)(2)(3)

Jeremy Asher - Non-Executive Deputy Chairman (joined the Board in July 2013)⁽¹⁾⁽³⁾

John Bell - Independent Non-Executive Director (joined the Board in July 2013)^(1)(2)(3)

Philip Dimmock - Independent Non-Executive Director (joined the Board in July 2013)^(1)(3)(4)

Thomas Shull - Independent Non-Executive Director (joined the Board in July 2013)⁽³⁾⁽⁴⁾

Andrew Simon - Non-Executive Director and Senior Independent Director (joined the Board in September 2013)^(1)(2)(3)

Ali Al Qabandi - Business Development Director (retired by rotation in June 2013)

Mehdi Varzi - Non-Executive Director (retired by rotation in June 2013)

 

⁽¹⁾     Member of the Audit Committee

⁽²⁾     Member of the Remuneration Committee

⁽³⁾     Member of the Nominations Committee

⁽⁴⁾     Member of Health, Safety, Security and Environment Committee

 

Directors' indemnities

 

The Company has made qualifying third party indemnity provisions for the benefit of its Directors which were made during the year and remain in force at the date of this report.

 

Directors' Interests in Shares

 

The Directors who held office at 31 December 2013 had the following interests in the common shares of the Company, including family interests:

 

	Number of common shares(1)
Name of Director	At 1 January 2013	Shares issued/ purchased in 2013	Shares sold/  transferred in 2013	At 31 December 2013	Shares issued post year end	Shares sold/ transferred post year end	At date of report
Todd Kozel	5,307,503	5,947,501	(11,000,000)	255,004	-	-	255,004
John Gerstenlauer	1,154,611	589,500	-	1,744,111	-	-	1,744,111
Ewen Ainsworth	2,160,131	589,500	(11,000)	2,738,631	-	-	2,738,631
Simon Murray	-	160,000	-	160,000	-	-	160,000
Lord Guthrie	-	-	-	-	-	-	-
Mark Hanson	-	-	-	-	-	-	-
Jeremy Asher	15,200,000	-	-	15,200,000	-	-	15,200,000
Thomas Shull	-	-	-	-	-	-	-
John Bell	-	72,200	-	72,200	-	-	72,200
Philip Dimmock	-	-	-	-	-	-	-
Andrew Simon	-	-	-	-	-	-

 

⁽¹⁾Includes common shares held directly, by family members and through the Gulf Keystone EBT which are held subject to the discretion of the EBT Trustee.

 

At the date of this report, the EBT held 9,402,442 common shares of the Company.  A further 10,000,000 common shares are held by the Exit Event Trustee in relation to the Exit Event Award (see note 24 to the consolidated financial statements). 

 

Directors' interests in share options of the Company and the Company's bonus scheme grants, including family interests, as at 31 December 2013 are disclosed in the Report of the Remuneration Committee.

 

 

Significant Shareholdings

 

The Company has been notified of the following significant shareholdings as at 18 March 2014:

 

 

	Number of common shares	Percentage of issued share capital
TD Waterhouse	61,631,833	6.93%
Barclays Wealth	57,038,914	6.42%
Capital Research Global Investors	49,596,975	5.58%
M&G Investment Mgt	47,973,877	5.40%
Hargreaves Lansdown Asset Management	45,738,815	5.15%
Halifax Share Dealing	43,440,591	4.89%

 

 

 

 

Going Concern

 

The Group's business activities, together with the factors likely to affect its future development, performance and position are set out in the Chairman's Statement, Strategic Review by the Chief Executive Officer and Operational Review.  The financial position of the Group at the year end, its cash flows and liquidity position are included in the Financial Review.  In addition, note 26 to the consolidated financial statements includes the Group's objectives, policies and processes for managing its capital, its financial risk management objectives and details of its financial instruments and hedging activities.  Note 26 also describes exposures to credit risk and liquidity risk.

 

Following commencement of first commercial production in July 2013 and sales thereafter along with the commencement of the export of crude oil in December 2013 from the Shaikan Block, the Group has entered a critical phase in its development as it transitions from pure explorer to oil producer.  The Group's business requires substantial capital expenditures for the foreseeable future, being at least the next 12 months, to finance the exploration, development and production of its existing oil reserves and resources. 

 

The Group is dependent on existing cash resources, which totalled $76.0 million at 1 March 2014, together with production revenues from its interest in the Shaikan Block in order to meet its future working capital requirements.  Existing cash resources may be enhanced over the next 12 months from the date of this report by achieving further consistent oil production and domestic and export sales from Shaikan, increasing up to 40,000 bopd; the exercise of the Shaikan Government Option, the Shaikan Third Party Option, the Akri-Bijeel Government Option and/or the Akri-Bijeel Third Party Option under the terms of the Shaikan and Akri-Bijeel PSCs; any proceeds from the potential sale of the Group's interest in the Akri-Bijeel Block and/or the reimbursement of an additional £5.6 million of litigation costs by Excalibur Ventures LLC (see note 23 to the financial statements). 

 

Whilst the Group believes that one or more of the above events are likely to occur, if none of these events occur, and the Group is unable to otherwise enhance its existing cash resources, then the Directors would expect the Group to require additional working capital by the end of May 2014.  If only one of these events occurs in the next 12 months from the date of this document, this would reduce any potential working capital shortfall and, depending on the final proceeds from the event, potentially remove it completely.

 

In order to address this potential shortfall in working capital, the Group is currently seeking to raise additional debt financing by the end of April 2014.  The Group has mandated Deutsche Bank and Pareto Securities to arrange a series of fixed income investor meetings in the US, Europe and Asia, which commenced on 20 March 2014.  A debt offering of up to $250 million in accordance with Reg S/144A is expected to follow, subject to market conditions.

 

Whilst there can be no certainty that a debt transaction will follow the Group's investor meetings, any debt raised will enhance the Group's liquidity position and support the Group's on-going capital work programmes, including increasing sales to up to 40,000 bopd by the completion and commissioning of Shaikan PF-1 and PF-2.  If such debt financing is not available or not available on appropriate terms, the Group would also look to achieve funding via a further equity-linked or equity financing. 

 

The Directors have concluded that the early stage of fundraising and the insufficiency of the current working capital to fulfil the Group's current working programme create a material uncertainty that casts significant doubt upon the Group's ability to continue as a going concern.  Nevertheless, based on the forecasts and projections prepared at the time of preparation of this annual report and after making enquiries, and considering the uncertainties described above, the Directors have a reasonable expectation that the Group has adequate resources to continue in operational existence for the foreseeable future. For these reasons, they continue to adopt the going concern basis in preparing this annual report and financial statements.

 

Significant Agreements - Change of Control

 

There are a number of agreements that take effect, alter or terminate upon a change of control of the Group including employee share plans and the Convertible Bonds.  None of these are considered to be significant in terms of their likely impact on the business of the Group as a whole.  Furthermore, the Directors are not aware of any agreements between the Group and its Directors or employees that provide for compensation for loss of office or employment that occurs because of a takeover bid.

 

Auditor

 

Each of the persons who is a Director at the date of approval of this annual report confirms that:

 

-			so far as the Director is aware, there is no relevant audit information of which the Group's auditor is unaware; and
-			the Director has taken all the steps that he ought to have taken as a Director in order to make himself aware of any relevant audit information and to establish that the Group's auditor is aware of that information.

 

 

 

By order of the Board

 

 

 

Todd F Kozel

Chief Executive Officer

 

26 March 2014

 

 

 

 

Chairman's introduction into the Corporate Governance section

 

Dear Shareholder

 

In my first year as Chairman, we have made progress towards strengthening our governance arrangements.   On 25 March 2014, the Company's common shares were admitted to the standard segment of the Official List.  As a consequence of a standard listing the Company is not subject to the UK Corporate Governance Code (the "Code"), as amended in September 2012.  However the Board recognises the importance of good governance and has considered the principles and provisions set out in the Code.   In anticipation of a standard listing and in order to strengthen the governance framework of the Group, the Board resolved in December 2013 to follow all the requirements of the Code voluntarily.  Therefore, I am pleased to confirm to you that the reporting in this annual report follows the requirements of the Code, except as set out in the "Statement of compliance with the UK Corporate Governance Code" section of the Corporate Governance Report.

 

The Board is ultimately responsible to shareholders for all the Group's activities, its strategy and financial performance, for the efficient use of the Group's resources and for social, environmental and ethical matters.  The Board, with the assistance of the Audit Committee, approves the Group's governance framework and reviews its risk management and internal control processes.

 

 

The most significant reporting changes have been to our Directors' Remuneration Report together with the introduction of the advisory vote on our remuneration policy and annual report on remuneration at the 2014 AGM.  The 2013 Report consists of the Remuneration Committee Chairman's introduction regarding the work performed by the Committee during the year, a policy report stating the Company's revised policy on remuneration as well as an annual remuneration report detailing the elements of Directors' remuneration for the year.

 

The additional reporting required by the Code also includes the statement made by the Directors in the Directors' Responsibilities Statement that they consider the annual report and accounts, taken as a whole, to be fair, balanced and understandable.  The processes which underpin and support the Directors' confidence in making this statement are long established and embedded into our business and include the review of the narrative sections of the annual report and accounts by our external advisers who verify its accuracy and consider the tonality and balance of approach. In addition, our external Auditors read the narrative sections of the Annual Report and Accounts to identify any material inconsistences with the financial statements.  Our Board members receive drafts of the Annual Report and Accounts in sufficient time to facilitate their review and input.

 

Additional disclosures in respect of how the Audit Committee addresses the key issues it has considered during the year can be found in the Audit Committee Report. A separate Nominations Committee report also forms part of this year's Corporate Governance Report.  The Nominations Committee Report describes the work of this Committee during the year and the principles applied in determining the most appropriate structure and suitable candidates for the Board.

 

In 2013, our Board was further strengthened with five new Non-Executive Directors who come from a variety of backgrounds and bring a range of skills and experience to the Board.   The Board has taken the opportunity to review and enhance the composition of the Bard Committing by co-opting these new Directors.  Furthermore, a new Health Safety Security Environment and Corporate Social Responsibility Committee ("HSSE and CSR Committee")was established in September 2013 to enhance Board oversight on the management of safety and security issues at GKP.

 

With this new stronger Board we will continue to implement sound principles of good governance in the way we run the Company and build upon the high standards that we have implemented to date.

 

 

Simon Murray

Chairman

 

 

 

Governance: Corporate Governance Report

 

Introduction

 

One of the Board's primary responsibilities is to ensure that the Company is run in the best long-term interests of our shareholders and wider stakeholders.  This is achieved through the Board's commitment to maintain high standards of governance and to aim to create a culture which demands the same commitment and performance from all of our employees and contractors and in all our business activities.   The governance processes applied across the Group are illustrated below and in the individual Committee reports.

 

Statement of Compliance with the UK Corporate Governance Code

 

Although Gulf Keystone, as a Bermuda incorporated Company, is not required to comply with the UK Corporate Governance Code, the Board resolved that, in the view of the Company's recent move from AIM to the Standard Segment of the Official List of the United Kingdom Listing Authority of The London Stock Exchange(the "Main Market"), the principles and provisions of the UK Corporate Governance Code will be applied and followed across the Group.

 

The version of the Corporate Governance Code applicable to the current reporting period is the September 2012 UK Corporate Governance Code (the "Code").  As at the date of this report, the Board considers that it and the Company have complied with the provisions of the Code, except for the following matters:

 

-       In 2014, the Company undertook a rigorous review of the Non-Executive Directors' independence in line with the Listing Rules' guidance.  It was concluded that, excluding the Chairman, four Non-Executive Directors out of ten Board members are independent, i.e. less than half of the Board (B.1.2).  In addition, requirements D.2.1 and B.2.1 of the Code regarding the number of independent members were not met for the Remuneration and Nominations Committees. 

 

The non-compliance is the result of the limited time the Company had, between the adoption of the Code and the date of this report, to address this issue.  The Company is seeking to appoint at least one additional Independent Non-Executive Director which will improve the Board balance.

 

-       The Company does not have Non-Executive Directors' contracts available for inspection at the registered office in Bermuda as it was deemed impracticable to do so, but will make these contracts available at the AGM.

 

-       Given the recent changes to the Board composition and the voluntary adoption of the Code, the Board are looking into the most appropriate ways of conducting a formal Board evaluation (B.6).  For further details please refer to the "Performance evaluation of the Board and its Committees" section of the Corporate Governance Report.

 

The Code is issued by the Financial Reporting Council and is available for review on the Financial Reporting Council's (FRC's) website http://www.frc.org.uk/Our-Work/Publications/Corporate-Governance/UK-Corporate-Governance-Code-September-2012.aspx.

 

Matters reserved for the Board

 

The Board has a formal schedule of matters specifically reserved to it for decision.  They cover the key strategic, financial and operational issues facing the Group and include:

·     the Group's strategic aims and objectives;

·     changes to the Company's capital, management or control structures;

·     dividend policy and dividend recommendation;

·     half-yearly reports, interim management statements, final results, annual report and accounts;

·     the overall system of internal control and risk management;

·     major capital projects, corporate actions and investment;

·     communication policy; and

·     changes to the structure, size and composition of the Board.

 

The Board is responsible to shareholders for the proper management of the Group. In 2013, the Board has continued to focus its efforts on strategic objectives that will create shareholder value and ensuring that these are properly pursued. 

 

The Gulf Keystone Board and its Committees               

 

As at the time of this report, the Board comprised three Executive Directors and eight Non-Executive Directors (including the Chairman).  The Company regards four of the Non-Executive Directors (excluding the Chairman) as independent. The Company's Executive and Non-Executive Directors come from a variety of backgrounds and bring different ideas and perspectives to the table ensuring that the Company's Directors have the right experience to meet the needs of the business.  The Company places high importance on having an appropriate Board composition with the eight Non-Executive Directors, ensuring that the strategies proposed by the Executive Directors are fully considered and appropriately challenged.

 

Currently, the Board has four Committees: Audit and Risk Committee (the "Audit Committee"), Remuneration Committee, Nominations Committee and Health, Safety, Security and Environment and Corporate Social Responsibility ("HSSE and CSR") Committee. Each standing Board Committee has specific written terms of reference issued by the Board and adopted by the relevant Committee, updated most recently in December 2013 in anticipation of the move up to the Main Market.  All Committee Chairmen report orally on the proceedings of their Committees at the meetings of the Board.  Where appropriate the Committee Chairmen also make recommendations to the Board in accordance with their relevant terms of reference.  In addition the minutes of the Committee meetings are included in the papers distributed to all Board members in advance of Board meetings.

 

To ensure Directors are kept up-to-date on developing issues and to support the overall effectiveness of the Board and its Committees, the Non-Executive Chairman and Committee Chairmen communicate regularly with the Chief Executive and other Executive Directors.  The key governance mandates of the Board's four main Committees are shown below.

 

Board Committees

 

Audit Committee

 

The Audit Committee comprises four Non-Executive Directors. As at 31 December 2013, the Audit Committee members were Mark Hanson (Chairman), Andrew Simon, Jeremy Asher and John Bell.  Mark Hanson has served as the Chairman of the Committee throughout the year. In March 2014, Philip Dimmock was appointed to the Committee and Mark Hanson stepped down as Chairman of the Audit Committee to be replaced by Philip Dimmock.  The Committee members have been selected to provide the wide range of financial and commercial expertise necessary to fulfil the Committee's duties.  The Board considers each Committee member's experience to be recent and relevant for the purposes of the Code.  This Committee meets at least three times per year and, during the year ended 31 December 2013 the Committee met three times.

 

The terms of reference of the Audit Committee are documented and agreed by the Board and are available in the corporate governance section of Gulf Keystone's corporate website www.gulfkeystone.com.  The Audit Committee report is set out in a separate section of the Corporate Governance report.

 

Nominations Committee

 

As at 31 December 2013, the Nominations Committee members were Field Marshal the Lord Guthrie of Craigiebank (Chairman) and Mark Hanson, who served on the Committee for the full year joined by Simon Murray, Todd Kozel, Philip Dimmock and Thomas Schull in September 2013. In March 2014, Jeremy Asher, John Bell and Andrew Simon, were appointed to the Committee and Lord Guthrie stepped down as Chairman of the Nominations Committee to be replaced by Simon Murray.  The Nominations Committee formally met once during the year.  In addition to the formal meetings, Lord Guthrie and Mark Hanson were actively involved in the search for the Non-Executive Chairman and Non-Executive Directors with the assistance of Odgers Berndtson, one of the UK's pre-eminent executive search firms. The terms of reference of the Nominations Committee are documented and agreed by the Board and are available in the corporate governance section of Gulf Keystone's corporate website www.gulfkeystone.com. The Nominations Committee report is set out in a separate section of the Corporate Governance report.

 

Remuneration Committee

 

As at 31 December 2013, the Remuneration Committee comprised four Non-Executive Directors: Andrew Simon (Chairman), Simon Murray, John Bell and Mark Hanson.  This Committee, which meets at least twice per year, is responsible for making recommendations to the Board concerning the compensation of the Executive Directors and the Chairman, as well as the level and structure of remuneration for senior management. PricewaterhouseCoopers ("PwC") was appointed as Gulf Keystone's remuneration consultant in March 2014.  The Remuneration Committee has met four times during the year. The Committee is also responsible for the determination of the Group's remuneration policy.  The details of the policy as well as the activities undertaken by the Committee during the year can be found in the Directors' Remuneration Report.  The terms of reference for the Remuneration Committee are available in the corporate governance section of Gulf Keystone's corporate website www.gulfkeystone.com.

 

HSSE & CSR Committee

 

The HSSE & CSR Committee was set up in September 2013 to ensure that appropriate systems are in place to maintain health, safety, security and environmental risk and the corporate social responsibility of the Group.  The Committee comprises two Non-Executive Directors, Philip Dimmock (Chairman) and Thomas Shull and the Group's COO, John Gerstenlauer.  The Committee meets at least four times a year. In 2013, the Committee met two times as it was in existence for less than half of the year.  The primary function of the Committee is to oversee the development of the Group's policies and guidelines for the management of HSSE and social risks, evaluate the effectiveness of these policies and their ability to ensure compliance with applicable legal and regulatory requirements, evaluate and oversee the quality and integrity of reporting to external stakeholders concerning HSSE and CSR, and review the results of any independent audits of the Group's performance in regard to HSSE and CSR making recommendations, where appropriate, to the Board concerning the same. The Committee also examines specific safety issues as requested by the Board.

 

Since its constitution, the Committee has reviewed a range of safety-related matters. This included consideration of the recommendations that arose from the internal audit of the Group's HSSE arrangements carried out by PwC as part of their internal audit function and the development of an action plan to address these recommendations. Shortly after its creation, the Committee carried out a site visit to the Shaikan block in order to observe and assess the safety measures in place. The Committee did not note any violations of the Group's HSSE policy during the visit. During 2013, the HSSE policy was reviewed to ensure it remained adequate and up-to-date.  It was requested that a management report on the Group's safety matters was produced and provided to the Committee on a monthly basis. The Committee will also consider the engagement of a specialist HSSE firm to perform any future reviews if required.  The terms of reference of the HSSE and CSR Committee are documented and agreed by the Board and are available in the corporate governance section of Gulf Keystone's corporate website www.gulfkeystone.com.

 

Division of Responsibilities of Chairman and Chief Executive

 

In May 2013, the Board resolved that, as part of the move from AIM to the Main Market, and in keeping with the best practice of the Official List, the roles of Chairman and Chief Executive Officer, previously fulfilled by Todd Kozel, would be split.  On 4 July 2013, Simon Murray was appointed to the Board of Gulf Keystone as Non-Executive Chairman.  This appointment represented a significant step forward for the Company as it expanded and strengthened its Board in advance of its recent admission to the Official List of the London Stock Exchange.

 

Whilst retaining a close working relationship, the Chairman and Chief Executive have clearly defined and separate responsibilities divided between running the Board and the business. They meet regularly between Board meetings to ensure a full understanding of evolving issues and to facilitate effective decision making.  They are responsible to the Company's shareholders for the successful delivery of the strategy.

 

The Role of the Chairman

 

In running the Board, the Chairman is responsible for creating an environment which facilitates robust and constructive challenge and debate. In creating this environment the Chairman encourages open communications and aims to ensure that the Non-Executive Directors' constructive challenge and suggestions are considered by the Executive Directors dispassionately and on their merits. The Chairman is responsible for setting the Board's agenda and ensuring that adequate time is available for discussion of all agenda items, in particular strategic issues.

 

In 2013, the Board evaluated the Chairman's external commitments. The Board is satisfied that the Chairman committed sufficient time to his duties in relation to the Company.

 

The Role of the Chief Executive

 

Supported by the Executive Directors and senior management team, the Chief Executive, within the authority delegated by the Board, has day to day management responsibility for implementing the Group's strategy and running the Group.

 

The Role of the Senior Independent Director

 

Andrew Simon holds the role of the Senior Independent Director, having been appointed to this position in March 2014.  He is responsible for assisting the Chairman with effective communications to Gulf Keystone's shareholders and is available to shareholders should they have any concerns which have not been resolved through the normal channels of the Chairman, Executive Directors or our Investor Relations Department or if these channels are not appropriate.

 

He is also available to our Non-Executive Directors should they have any concerns which are not appropriate to raise with the Chairman or which have not been satisfactorily resolved by the Chairman.

 

Changes to the Board

 

In 2013, the Company welcomed five new Non-Executive Directors and a Non-Executive Chairman to the Board. Simon Murray was appointed to the Board as Non-Executive Chairman in July 2013.  Jeremy Asher, John Bell, Philip Dimmock and Thomas Shull were each elected as a Non-Executive Director at the 2013 Annual General Meeting, having been proposed by a major shareholder in accordance with Bye-Law 94.2 of the Company's Bye-Laws. Andrew Simon was appointed as a Non-Executive Director in September 2013.

The search, selection and appointment process for Non-Executive Directors is described in the section on the Nominations Committee.

 

Mehdi Varzi and Ali Al-Qabandi retired from the Board by rotation in July 2013.

 

Board meetings and attendance

 

Board meetings are held on a regular basis, outside the UK, and no decision of any consequence is made other than by the Directors. The Directors' attendance record at the scheduled Board meetings and Board Committee meetings for the year ended 31 December 2013 is shown in the table below.  For Board and Board Committee meetings, attendance is expressed as the number of meetings that each Director attended out of the number that they were eligible to attend. In addition to those scheduled meetings, ad hoc meetings and Board administration calls were arranged to deal with matters between scheduled meetings as appropriate.

 

	Full Board meetings	Audit Committee	Remuneration Committee	Nomination Committee	HSSE and CSR Committee (established September 2013)
Simon Murray(1)	5(5)		2(2)	1(1)
Todd Kozel	10(10)			1(1)
John Gerstenlauer	10(10)				2(2)
Ewen Ainsworth	9(10)
Mark Hanson	10(10)	3(3)	3(3)	1(1)
Lord Guthrie	10(10)	2(2)	1(1)	1(1)
Jeremy Asher(2)	3(3)	1(1)
John Bell(2)	3(3)	1(1)	2(2)
Philip Dimmock(2)	3(3)			1(1)	2(2)
Thomas Shull(2)	3(3)			1(1)	1(2)
Andrew Simon(3)	3(3)	1(1)	2(2)

 

⁽¹⁾ Appointed as a Director with effect from 4 July 2013

⁽²⁾ Appointed as a Director with effect from 25 July 2013

⁽³⁾ Appointed as a Director with effect from 1 September 2013

 

Directors' independence

 

The independence of each of the Non-Executive Directors is considered upon appointment, annually and at any other time a Director's circumstances change in a way that warrants reconsideration. The Board considers whether the Director is independent of management and any business or other relationship that could materially interfere with the exercise of objective and independent judgement by the Director or the Director's ability to act in the best interests of the shareholders.  In particular, the Board has considered each Non-Executive Director's interest in share compensation schemes, including the Company Share Options Plan and Executive Bonus Schemes, and any positions which the Director holds, or held, in companies with which Gulf Keystone has commercial relationships. The Board has concluded that, four out of seven Non-Executive Directors (excluding the Chairman) are independent. Where compensation arrangements in the form of shares exist, the Non-Executive Director was deemed not to be independent

 

Information and support

 

The Group is committed to supply the Board and its Committees with full and timely information, including detailed financial, operational and corporate information, to enable Directors to discharge their responsibilities.  The Committees are provided with sufficient resources to undertake their duties.  All Directors have access to the advice of senior management and, where appropriate, the services of other employees for all governance and regulatory matters.  Independent professional advice is also available to Directors in appropriate circumstances, at the Company's expense.

 

The Board also keep up to date with developments in relevant law, regulation and best practice to maintain their skills and knowledge. Monthly reports are produced by management of the Group to ensure that the Board are well informed on the Group's latest operational, financial, corporate and investor relations updates.

 

A wealth of papers and reports are prepared by management prior to all Board and Committee meetings allowing the Board to effectively address all of the items on the relevant meeting's agenda. These papers are provided to the Board in a timely manner allowing for sufficient time to review the information prior to the meeting and raise questions where necessary.

 

Re-Election of Directors

 

The Company's Bye-laws provide for each Director to be re-elected by shareholders at least once every three years.  The Board believes that continuity is essential for a business like Gulf Keystone and that allowing each Director to serve a three-year term prior to standing for re-election facilitates the retention of experienced and appropriately skilled individuals.

 

Performance evaluation of the Board and its Committees

 

The Board and its Committees are satisfied that they are operating effectively and that each Director has performed well in respect of his individual role on the Board.  The Board believes that the performance of all the Directors continues to be effective and that they each demonstrate commitment to the role. The Board is satisfied that the individuals currently fulfilling key senior management positions in the organisation have the requisite depth and breadth of skills, knowledge and experience.

 

Given the recent changes to the Board's composition and the Company's recently stated intent to comply with all aspects of the Code, the Board has been considering the most appropriate methodology for formal evaluation of the Board and its Committees' effectiveness with a view to implementation in 2014-2015. As a start of the process, the Audit Committee performed internal evaluation of its effectiveness at its December meeting.

 

Risk management and internal Control

 

The Board acknowledges its responsibility for establishing and monitoring the Group's systems of internal control.  Although no system of internal control can provide absolute assurance against material misstatement or loss, the Group's systems are designed to provide the Directors with reasonable assurance that problems are identified on a timely basis and dealt with appropriately.  The Board regularly reviews the effectiveness of the systems of internal control and considers the major business risks and the control environment.  The Board is accordingly satisfied that effective controls are in place and that risks have been mitigated to an acceptable level. 

 

The Company is subject to a variety of risks which derive from the nature of the oil and gas exploration and production business and relate to the countries in which it conducts its activities.  The key procedures that have been established and which are designed to provide effective control are as follows:

 

-    regular meetings between the executive management and the Board to discuss all issues affecting the Group;

-    a clearly defined framework for investment appraisal, with Board approval required as appropriate; and -    an internal audit function.

 

The Board also believes that the ability to recognise the value of working as a partnership with host governments is a critical ingredient in managing risk successfully. 

 

The Directors have derived assurance over the control environment from the following internal and external controls during 2013:

 

-       implementation of policies and procedures for key business activities;

-       an appropriate organisational structure;

-       control over non-operated activities through delegated representatives;

-       specific delegations of authority for all financial and other transactions;

-       segregation of duties where appropriate and cost effective;

-       business and financial reporting, including KPIs;

-       reports from the Group Audit Committee;

-       reports and findings from the Group's internal auditors on the areas identified and recommended for review by the Audit Committee; and

-       reports from the Group's external auditor on matters identified during its audit.

 

The above procedures and controls have been in place in respect of the Group for the 2013 accounting period and up to the date of approval of the Annual Report and Accounts.  There were no significant weaknesses or material failings in the risk management and internal control system identified in any of the above reviews and reports.

 

Relations with investors

 

Regular communications with the Company's diverse shareholder base, including institutional and retail equity investors, as well as debt investors, are given high priority by the Board.  The Chairman, Chief Executive Officer, Chief Operating Officer, Finance Director, Legal and Commercial Director and Head of Investor Relations are the Company's principal spokespersons, engaging with investors, fund managers, analysts, the press and other interested parties. 

 

The Company is committed to maintaining a constructive dialogue with all its investors, including through providing regular updates on its operations and corporate developments. The Company has an established practice of issuing regulatory announcements on the Company's operations and/or any new price sensitive information. The Company's website at http://www.gulfkeystone.com/, which is regularly updated, contains a wide range of information on the Company, including a dedicated investor section where investors can find share price and financial information, regulatory announcements, investor presentations, technical reports, corporate webcasts, videos and photos, interviews with the Company's management, etc. 

 

Gulf Keystone seeks to respond to all correspondence from shareholders as far as is applicable and proactively seeks to provide quarterly updates to the Company's major investors, as well as regular update meetings and calls with fund managers. Each of the Non-Executive Directors are available to attend meetings with major shareholders (without the Executive Directors present), if requested by such major shareholders.  A list of the Company's major shareholders can be found in the Directors' Report. Further to the Company's issue of convertible bonds in October 2012 and a subsequent tap issue of such bonds in November 2013, the Company's Investor Relations today encompass communications with both equity and debt investors.

 

The Executive Directors of the Board regularly present at public conferences and investor meetings. Throughout 2013, the Company has given a number of investor presentations, which are available to view on the Company's website. Since the Annual General Meeting in 2013 was held in Bermuda, the Board and management hosted a dedicated shareholder event in London on 4 July 2013 particularly tailored for private investors. At the Investor Day, the Board and management presented to shareholders on all aspects of the Company's business and corporate strategy and took questions from the audience. The Investor Day was recorded and a webcast was made available on the Company's website at http://www.gulfkeystone.com/investor-centre/webcasts.

 

In accordance with its Bye-Laws, last year the Company  implemented the provisions of the Bermuda Companies Act 1981, in accordance with the AIM rules, regarding electronic communications with its shareholders in order to give shareholders more choice and flexibility in how they receive information from the Company.  The number of communications sent by post has been reduced, resulting not only in cost savings for the Company but also speeding up the provision of information to shareholders.

 

A list of the Company's significant shareholders can be found in the Directors' Report.

 

Annual General Meeting

 

The Board uses the AGM to communicate with private and institutional investors and welcomes their participation.  It is policy for all Directors to attend the AGM if possible. 

 

 

 

 

Audit Committee Report

 

Role

 

The Board has delegated to the Committee responsibility for overseeing the financial reporting, internal risk management and control functions, internal audit and for making recommendations to the Board in relation to the appointment of the Group's internal and external auditors.

 

In accordance with its terms of reference, the Audit Committee, which reports its findings to the Board, is authorised to:

 

-       review the integrity of the Group's financial reporting and significant financial accounting estimates and judgements;

-       monitor the effectiveness of the Group's risk management framework and internal controls;

-       monitor and review the effectiveness of the Group's internal audit function;

-       advise the Board on the appointment of the external auditor and on the remuneration for both audit and non-audit work;

-       discuss the nature and scope of the audit with the external auditor; and

-       assess the performance, independence and objectivity of the external auditor and any supply of non-audit services.

 

Composition

 

The Audit Committee currently comprises four Non-Executive Directors, two of whom are considered to be independent.  The members of the Audit Committee during the year were as follows:

 

-       Mark Hanson (Chairman)⁽¹⁾

-       John Bell (joined the Audit Committee 17 September 2013)

-       Andrew Simon (joined the Audit Committee 17 September 2013)

-       Jeremy Asher (joined the Audit Committee 17 September 2013)

-       Philip Dimmock (joined the Audit Committee 18 March 2014)

-       Lord Guthrie (retired from the Audit Committee 17 September 2013)

-       Mehdi Varzi (retired from the Board by rotation 20 June 2013)

 

⁽¹⁾       Mark Hanson stepped down as Chairman of Audit Committee to be replaced by Philip Dimmock in March 2014.  Mark Hanson remains a member of the Committee.  

 

Meetings

 

Four Audit Committee meetings were held in the financial year and to-date, at key times within the Group's reporting and audit calendar.  The Committee discussed, among others, the following matters:

 

Month	Key issues considered
April 2013	·    2012 full year results;  ·    principal judgemental accounting matters affecting the Group based on reports from both the Group's management and the external auditors; ·    review of internal audit progress; and considerations of areas and timings for future reviews.
September 2013	·    2013 half year results; ·    review of principal accounting judgements and estimates; ·    update on the ongoing internal audit reviews, including: ·      IT strategic review; ·      Health and Safety review; ·      UK Bribery Act 2010 review; ·    Consideration of potential conflict of interest or issues associated with auditor independence and objectivity arising from engaging Deloitte to provide one off remuneration advisory services. No such conflict or issues were deemed to arise.
December 2013	·    external audit planning and reports for 2013 annual report; ·    internal audit plans and reports, including: ·     key internal audit reports; ·     follow up of internal audit recommendations; ·     internal financial control assessments; ·     future areas of review; ·    consideration and roll out of Anti-Bribery Action Plan; ·    risk profile and mitigation; ·    external audit effectiveness, independence ·    and reappointment; ·    Audit Committee annual evaluation.
March 2014	●   2013 full year results;  ●   assessment of the implications of the voluntary compliance with the revised Corporate Governance Code; ●   update on internal audit progress.

 

The meetings were also regularly attended by Ewen Ainsworth (Finance Director), Tony Peart (Legal and Commercial Director), senior finance management, Deloitte LLP (external auditor) and PricewaterhouseCoopers LLP ("PwC") (internal auditor).

 

Principal activities during the year

 

During the year, the main focus of the Audit Committee has been to support and oversee the Group's ongoing review and evaluation of its risk management systems and internal controls, ensure the robustness and integrity of the Group's financial reporting, and assess the effectiveness of both the internal and external audit processes.

 

The Committee has devoted significant time to reviewing these areas, which are integral to the Group's core management and financial processes, as well as engaging regularly with management, internal audit function and the external auditor.  On the instruction of the Audit Committee, the internal audit function, undertook a number of reviews.  The Committee worked closely with the management team to ensure the recommendations of the internal audit function are actioned in an efficient and timely manner.  The creation of the internal audit function in 2012 has led to a number of improvements in the Group's controls and processes.  For example, the establishment of HSSE and CSR Committee and an IT management group were a result of internal audit recommendations, among others.  The Group also undertook anti-bribery policies and procedures review as bribery was determined as one of the principal risks given the nature of the business and the region in which the Group operates.  The audit did not raise any significant areas of concern and indicated that the Group have appropriate processes in place. 

 

The Committee has, where necessary, taken initiative in requesting information in order to provide the appropriate constructive challenge for its role.  During the course of the year, the information that the Committee has received has been timely and clear and has enabled the Committee to discharge its duties effectively.

 

Significant issues considered by the Audit Committee in 2013 and early 2014

 

The Committee assesses whether suitable accounting policies have been adopted and whether management have made appropriate estimates and judgements.  The Committee reviews accounting papers prepared by management which provide details on the main financial reporting judgements.  The Committee also reviews reports by the external auditor on the full year and half year results which highlight any issues with respect to the work undertaken on the audit and provide further insights into the judgements used by management.  The significant issues considered in the year are detailed below:

 

Significant issue	How the issue was addressed by the Committee
Going Concern: The appropriateness of preparing the Group financial statements for the half year and full year on a going concern basis.	The Committee considered papers prepared by management, taking into account the external auditors' review of these papers and their observations.  The Committee also reviewed the working capital models and statement as part of the move up to the Main Market.  The Committee concluded that management's recommendation to prepare the accounts on a going concern basis was appropriate, notwithstanding the existence of material uncertainties in this regard as further outlined in the Directors' Report
Accounting policy and measurement of depreciation, depletion and amortisation ("DD&A"): the charge is recognised for the first time in 2013 following the commencement of commercial production from Shaikan	The Committee reviewed the Group's accounting policy for DD&A and carefully considered the appropriateness of the key assumptions used by management in determining the DD&A charge for 2013.  The Committee was satisfied that the charge recognised in 2013 was appropriate
Revenue: review of the policy for recognition of revenue from commercial production for both domestic and export sales	The Committee considered whether recognition of revenue in relation to both domestic and export sales was appropriate.  The Committee reviewed and discussed the key judgements with management and thoroughly assessed the facts presented.  The Committee also considered detailed reports from, and had discussions with, the external Auditor in respect of revenue recognition. Based on these reviews and discussions, the Committee concluded that, in the absence of any cash receipts to date, it was not appropriate to recognise revenue in relation to oil sent for export during the year.  They were satisfied that the revenue balance recognised for domestic oil sales for the year ended 31 December 2013 was appropriate
Carrying value of exploration and evaluation ("E&E") assets: an annual assessment of E&E assets for impairment is required under International Financial Reporting Standards. Such assessment involves management making a number of judgements and assumptions	The Committee considered reports from management ensuring the assumptions used are within an acceptable range.  The views of the external auditor were also taken into account.  The Committee concurred with the management's conclusion that there was no impairment of E&E assets for 2013
Classification of Akri-Bijeel as an asset held for sale: Akri-Bijeel was classified as asset held for sale in both the 31 December 2011 and 2012 accounts. The appropriateness of retaining such a classification in the current year was assessed by the Committee	The Committee reviewed the management paper that considers the appropriateness of continuing to classify Akri-Bijeel as an asset held for sale.  In particular, the Committee assessed the likelihood of the sale taking place in the next 12 months and concluded that it remained appropriate to treat Akri-Bijeel as an asset held for sale

 

Internal audit

 

The Audit Committee has oversight responsibilities for the internal audit function.  The internal audit annual plan is reviewed and approved and all reports arising therefrom are reviewed and assessed, along with management's actions on findings and recommendations.  PwC are invited to and attend Audit Committee meetings where appropriate and is also given the opportunity to meet privately with the Audit Committee without any members of management present.  Where PwC's attendance of the Audit Committee's meeting is not practicable, a report on the progress of the reviews and findings is prepared for the Committee's consideration.

 

From its establishment in 2012 to the date of this report, the internal audit function has carried out the following reviews:

 

-     Budgeting for capital expenditure

A review of the design and operating effectiveness of key controls in place relating to the capital expenditure budgeting process, monitoring of spend against budget and authorisation of capital expenditure.

 

-     Procurement and tendering

A review of the design and operating effectiveness of key controls in place relating to the procurement tendering process during the last 12 months.

 

-     Financial controls

A review of the design and operating effectiveness of the Group's financial controls around month-end reporting, payroll and reconciliations of major accounts.

 

-     Selected administrative expenses

A review of the design and operating effectiveness of key controls in place relating to a number of selected administrative expenses.

 

-     Health and safety

A review of the Group's controls around ensuring the compliance with various operational health and safety regulations, information maintenance and reporting of health and safety matters to executive management.

 

-     IT strategy

A review of the design and operating effectiveness of key controls in place relating to the IT infrastructure.

 

-     Bribery Act compliance

A review of Group's response to the UK Bribery Act, the overall bribery risk assessment, training, communication and ongoing compliance reporting protocols in place in the areas of Group's operations.

 

The findings of the internal audit reviews were communicated to management who, based on the recommendations, prepared an action plan for addressing the issues raised. A report on the progress made on each action point is presented to the Audit Committee at each committee meeting.

 

External Auditor

 

The Audit Committee is responsible for the development, implementation and monitoring of the Group's policy on external audit including ensuring that the auditor remains objective and independent.  To fulfil its responsibility regarding independence, the Audit Committee considered:

 

-               the external auditor's plan for the current year, noting the role of the audit partner, who signs the audit report and who, in accordance with professional rules, has not held office for more than five years, and any changes in the key audit staff;

-               the overall extent of non-audit services provided by the external auditor, in addition to its case-by-case approval of the provision of non-audit services by the external auditor;

-               the external auditor's written confirmation of independence to the Audit Committee; and

-               the past service of the auditor who was first appointed in 2006.

 

Audit tendering

 

The Audit Committee has noted the changes to the Code, the recent findings of the Competition

Commission and the Guidance for Audit Committees issued by the Financial Reporting Council, each in the context of tendering for the external audit contract at least every ten years.  The Group's external audit was last tendered in 2011, resulting in a decision to retain Deloitte LLP as the Group's auditor.  Since the appointment of Deloitte LLP in 2006, there have been two different senior statutory auditors in line with the required rotation timetable. Having previously conducted a full tender exercise and considered retendering in subsequent years, the Committee will continue to give consideration to the timing of the next formal tender in light of the regulatory requirements and any further changes in the regulatory framework.  There are no contractual obligations that restrict the choice of external auditors.

 

Effectiveness of external auditor

 

To assess the effectiveness of the external audit process, the auditors are asked on an annual basis to articulate the steps that they have taken to ensure objectivity and independence, including where the auditor provides non-audit services. Gulf Keystone monitors the auditors' performance, behaviour and effectiveness during the exercise of their duties, which informs the Audit Committee's decision to recommend reappointment on an annual basis. The external auditor's fulfilment of the agreed audit plan and any variations from the plan and the robustness and perceptiveness of the auditor in its handling of the key accounting and audit judgements are also considered when making a judgement on auditor effectiveness. The Committee also held discussions with the management team regarding the efficiency of the audit process.

 

Following the above, the Audit Committee has recommended to the Board that Deloitte LLP be reappointed.

 

Non-audit services

 

As a safeguard to help to avoid the objectivity and independence of the external auditor becoming compromised, the Committee has a formal policy governing the supply of non-audit services by the external auditor.  The Group engages external advisers to provide non-audit services based on the skills and experience required for the work, and cost.  The Group may engage the external auditor to provide a limited range of non-audit services where this is the most effective and efficient way of procuring such services as long as the Group is satisfied that the auditor's objectivity and independence will not be compromised as a result. 

 

In 2013, Deloitte LLP provided the following services to the Group:

 

-       advisory services to the Remuneration Committee (see "Remuneration Committee Report" for details);

-       corporate finance services in relation to the move up to the Standard Segment of the London Stock Exchange; and

-       advisory services in relation to the assessment of operational efficiencies in Kurdistan.

 

A breakdown of the fees paid to the external auditor in respect of audit and non-audit work is included in note 4 to the consolidated financial statements.

 

The Committee considered the potential threats that engagement of Deloitte LLP to perform non-audit services may pose to auditor independence. Deloitte LLP ensured that necessary safeguards were put in place to reduce the independence threats to an acceptable level. The Committee was satisfied that, given the nature of the work and the safeguards in place, the provision of non-audit services did not undermine auditor objectivity and independence.

 

Committee Evaluation

 

During the year, a review of the Audit Committee's effectiveness was completed. This was conducted by reference to the Committee's responsibilities as stated in the Audit Committee's Terms of Reference.  The assessment concluded that the Audit Committee was effective in carrying out its duties.

 

 

 

 

Nominations Committee Report

 

Role

 

The Board has delegated to the Nominations Committee the responsibility for ensuring the Board has the right balance of experience and skills to support our strategy.

 

In accordance with its terms of reference, the Committee, which reports its findings to the Board, is authorised to:

 

·        review the structure, size and composition required of the Board and the balance of skills, experience, independence and knowledge;

·        oversee executive succession planning taking into account challenges and opportunities facing the Group;

·        identify and nominate for the approval of the Board candidates to fill Board vacancies as and when they arise;

·        make recommendations  to the Board concerning the continuation in office of any Director, including suspension and termination of service;

·        appoint external search consultants to assist with appointments as required; and

·        determine skills and capabilities required for new appointments.

Composition

 

The Nominations Committee currently comprises four Non-Executive Directors, the Non-Executive Chairman and the CEO.  The members of the Nominations Committee during the year were as follows:

 

-       Lord Guthrie  (Chairman)⁽¹⁾

-       Mark Hanson

-       Simon Murray (joined the Nominations Committee 17 September 2013)

-       Philip Dimmock (joined the Nominations Committee 17 September 2013)

-       Thomas Shull (joined the Nominations Committee 17 September 2013)

-       Todd Kozel (joined the Nominations Committee 17 September 2013)

-       Jeremy Asher (joined the Nominations Committee 18 March 2014)

-       John Bell (joined the Nominations Committee 18 March 2014)

-       Andrew Simon (joined the Nominations Committee 18 March 2014)

-       Mehdi Varzi (retired from the Board by rotation 20 June 2013)

 

⁽¹⁾       In March 2014, Lord Guthrie stepped down as Chairman of Nominations Committee to be replaced by Simon Murray.  Lord Guthrie remains a member of the Committee.

 

Process used for board appointments

 

In appointing Non-Executive Directors, the Board's practice is to use external recruitment consultants where appropriate.  During the year, terms were negotiated with Odgers Berndtson, one of the UK's pre-eminent executive search firms, to act as recruitment consultants for the Board.  Other than providing recruitment consultancy services, Odgers Berndtson has no other connection with the Group.

 

The Committee adopts a formal, rigorous and transparent procedure for the appointment of new directors to the Board.  In May 2013, the Board decided to split the roles of Chairman and Chief Executive Officer.  Following this decision, a search for a Non-Executive Chairman and at least one other Independent Non-Executive Director was initiated and led by the Nominations Committee. Odgers Berndston were provided with a detailed brief of the desired candidate profile based on merit and against objective criteria (including an assessment of the time commitment expected) and their services were used to conduct a thorough search to identify suitable candidates for both Chairman and Senior Independent Non-Executive Director positions.  The Nominations Committee considered a list of potential candidates and the balance of skills, knowledge, independence, diversity and experience on the Board to ensure that a suitable balance was maintained.  Those shortlisted were interviewed by members of the Board including the Nominations Committee and the Legal and Commercial Director.  Following this process, Simon Murray and Andrew Simon were invited to join the Board and to become Gulf Keystone's Chairman and Senior Independent Non-Executive Director.  Mr Murray's and Mr Simon's other significant commitments were disclosed to the Board before their respective appointments and can be found in their biographies on the Gulf Keystone's corporate website www.gulfkeystone.com.  The Board was and continues to be satisfied that Mr Murray and Mr Simon would allocate sufficient time to the Company to discharge their responsibilities effectively.  Mr Murray's and Mr Simon's wealth of public company board experience, valuable commercial expertise, knowledge of capital markets and strong network of contacts, both globally and across the Far East, were the main factors taken into account in the Board's decision. 

 

In addition to the appointments of Chairman and Senior Independent Non-Executive Director, Jeremy Asher, Thomas Shull, John Bell and Philip Dimmock were each elected as a Non-Executive Director of the Company at the 2013 Annual General Meeting, having been proposed by a major shareholder in accordance with Bye-Law 94.2 of the Company's Bye-Laws.

 

There are no arrangements or understandings between any Director or executive officer and any other person pursuant to which any Director or executive officer was selected to serve.  There are no family relationships between the Directors.

 

Other matters considered by the Nominations Committee

 

During the year, other matters considered by the Nominations Committee included the consideration of succession planning for the Board and the key skills and experience required for future recruits.  The Company is continuing the search process, with the assistance of Odgers Berndtson, one of the UK's pre-eminent executive search firms, for at least one other independent non-executive director, and a further announcement on that process will be made in due course.  The assessment of succession planning will be further developed during the course of next year.

 

The Committee recognises the benefits of having diversity across all areas of the Group and believes that this adds to Gulf Keystone's continued success and advantage.  When considering the optimum make-up of the Board, the benefits of diversity of the Board are appropriately reviewed and balanced where possible, including in terms of differences in skills, industry experience, business model experiences, gender, race, disability, age, nationality, background and other contributions that individuals may bring.  The Committee continues to focus on encouraging diversity of business skills and experience across the Board.  In identifying suitable candidates to fill the Non-Executive Director position, the Committee will seek candidates from a range of backgrounds, with the final decision being based on merit against objective criteria. The Committee notes that the Company has no female Directors on its Board at present and therefore is looking to address this in the future Board appointments. 

 

 

 

Remuneration Committee Report

 

Introduction

 

This report is on the activities of the Remuneration Committee for the period to 31 December 2013 and early 2014. It sets out the remuneration policy and remuneration details for the Executive and Non-Executive Directors of the Company. The Company is incorporated in Bermuda and therefore is exempt from the required disclosures under  Schedule 8 of The Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 as amended in August 2013 (the "Regulations) but the Directors have decided to provide such disclosures insofar as they are still compliant with the Company's Bye-Laws. The report is split into three main areas:

-       the statement by the Chairman of the Remuneration Committee,

-       the policy report, and

-       the annual report on remuneration.

 

 

 

 

Remuneration Committee Chairman's statement

 

Dear Shareholder,

 

On behalf of the Board, I am pleased to present the Directors' remuneration report for the year ended 31 December 2013.

 

I hope that 2013 will be seen as a turning point in the way Gulf Keystone approaches remuneration. There has in the past been some investor concern about certain aspects of executive remuneration.  On my appointment as Chair of the Remuneration Committee, we agreed to undertake a detailed review of past and future remuneration policies, with the objective of developing a forward looking remuneration policy which satisfies best practice standards of corporate governance, whilst keeping the ability to attract and retain top quality executives to deliver the Company's business strategy.

 

During the last quarter of 2013, the Committee engaged Deloitte's remuneration practice on a one off basis to provide a thorough analysis of the Company's historical remuneration practice and payments to Executive Directors together with an external market context.  Deloitte were asked to comment on the current remuneration framework and remuneration policy in the light of this review.  The results of their work were taken into account by the Committee when developing the new remuneration policy.  On an ongoing basis PricewaterhouseCoopers LLP ('PwC') will be the independent remuneration advisor to the Committee.

 

As a Bermudan domiciled company we are not under an obligation to follow the Regulations.  However, we have elected to seek an advisory vote at the 2014 AGM on the Company's remuneration policy report and the annual report on remuneration.  It is not currently possible under the Company's bye-laws to have a binding vote on the policy report as required under the Regulations.  We will also include a resolution to change the Company's Bye-Laws to enable future votes on the policy to be binding with effect from the 2015 AGM.

 

Whilst basic salary levels have been kept low in the past, the benchmarking exercise carried out by Deloitte helped us to conclude that the level of long-term incentives and short-term bonuses were notably above the market range. It should be noted that there are ongoing obligations in respect of awards already granted.  In this context, deferred cash and share bonus awards will vest in 2014 and the remaining outstanding Long Term Incentive Plan ("LTIP") options will vest on satisfaction of the applicable performance conditions.  In addition, the Executive Directors decided on their own initiative that no short term bonuses were to be paid for 2013 given the performance of the business.

 

Gulf Keystone is an entrepreneurial company operating in one of the last and most challenging frontiers of the oil exploration industry. The Company is moving from exploration to production, with significant future  capital expenditure to move production from 10,000 bopd towards 40,000 bopd by the end of 2014, with a target of 100,000  bopd set for Phase 1 of the Shaikan FDP in the medium term. Our ability to achieve these targets and move to even greater production levels will be dependent not only on the significant investment in infrastructure required both by Gulf Keystone and the KRG, but also on the complex regional geopolitical situation. Consequently we will always need to retain a considerable element of flexibility in ensuring the right level of fairness for all of our stakeholders.

 

In designing the new policy, we have benchmarked ourselves against a group of oil and exploration companies of similar size on the London market, recognising the entrepreneurial nature of the business, whilst seeking to establish a remuneration policy which is compatible with the Code and which demonstrates clearly how the Directors have been and will be paid and how this relates to the Company's performance.

 

The work done by the Remuneration Committee has resulted in the following proposals.

 

1.     Basic salaries will not increase significantly in 2014 and will be reviewed annually.

                                                     

2.     Pension provision.

 

Historically there has been no provision for pension benefits and it is proposed to make a 15 percent cash allowance for this effective from 1st January 2014.

 

3.     Annual Bonus (short-term)

 

The maximum bonus potential for the CEO would be 200 percent of salary and for the other executive directors 150 percent of salary, with a set of demanding quantified metric targets.

 

4.     LTIP

 

Since the existing scheme is due to mature in August 2014, we will be introducing a new LTIP, which will be subject to shareholder approval at the next AGM and will be effective from July 2014. As with the Short-term Bonus, the maximum entitlement for the CEO will be an LTIP award of 200 percent of salary, with 150 percent of salary for the other executive directors.

 

In designing the new annual bonus and LTIP arrangements, the metrics were selected to reflect the Company's strategic objectives. For the annual bonus, it was decided that, the metric most likely to generate shareholder value and cash flow at this stage of the company's development is production based on bopd.  In addition to production, a number of qualitative objectives will be set for each of the Executive Directors.  For the LTIP, the performance metrics will be based on comparative total shareholder return ("TSR"), production and increase in contingent resources, which are considered the best basis for generating shareholder value over the medium term.

 

Furthermore, I will be undertaking a consultation with our major shareholders prior to the 2014 AGM to seek their feedback on the revised remuneration policy.

 

We believe that the new policy will make it easier for shareholders to understand what directors are paid and will be paid, whilst ensuring that pay is linked to performance and the executive team is rewarded at an appropriate level for delivering the Company's strategic objectives.

 

 

Andrew Simon

Remuneration Committee Chairman

 

 

 

Policy

 

Introduction

 

In light of the change to the Corporate Governance approach, the Directors' Remuneration Policy (the '"Policy'") as set out below will operate from 1 January 2014 and be put to an advisory shareholders vote.  It will become formally effective at the 2014 Annual General Meeting and will apply for the period of 3 years from the date of approval.

 

Summary

 

The Company's policy is to attract, motivate and retain individuals of the calibre necessary to achieve the strategic priorities of the Group. Furthermore, our new policy is constructed to offer packages that are significantly weighted towards performance based elements with measures that reflect corporate and operational performance. The aim is to set targets that are stretching yet achievable.

 

Differences in policy from the wider employee population

 

Our remuneration policy is not unique to our directors. The same principles underpin how we reward and compensate all our colleagues. We aim to provide base pay to all colleagues that is market competitive and to offer them the opportunity to share in our success through a variety of bonuses and incentive schemes. 
 

Discretion

 

The Committee has discretion in several areas of policy as set out in this report. The Committee may also exercise operational and administrative discretions under relevant plan rules approved by shareholders as set out in those rules. In addition, the Committee has the discretion to amend policy with regard to minor or administrative matters where it would be, in the opinion of the Committee, disproportionate to seek or await shareholder approval.

 

It is the Committee's intention that commitments made in line with its policies prior to the date of the 2014 AGM will be honoured, even if satisfaction of such commitments is made post the AGM and may be inconsistent with the remuneration policies. This includes the exit event awards set out below.

 

Exit Event Awards

 

In March 2012, the Company made Exit Event Awards to certain Executive Directors and employees equivalent to the value of up to 2.0 million common shares. Exit Event Awards are cash settled awards which are conditional on the occurrence of an Exit Event which envisages a sale of either the Company or a substantial proportion (i.e. more than 50%) of its assets. A further award of 0.9 million common shares was made in December 2013 to the employees with no additional Exit Event Awards made to directors. The Exit Event Awards made in 2012 expire in March 2017 and the additional awards expire in December 2018. The purpose of the Award was to encourage employee retention in the event of any corporate transaction up to the point of Exit Event completion as well as align the interests of the Company's employees and key management personnel with shareholders.

                                                                                                                                                                   

The Company appointed a trustee (the "Exit Event Trustee") to hold and, subject to the occurrence of an Exit Event, to sell sufficient common shares to satisfy the Exit Event Awards. In total 10.0 million common shares were issued to the Exit Event Trustee to satisfy the initial, additional and any future Exit Event Awards to full-time employees of the Company and subsidiary companies, subject to the occurrence of an Exit Event, with such beneficiaries to be determined in due course.  The preparation of the Exit Event Awards involved detailed discussions with a number of the Company's leading institutional and other shareholders who held, in aggregate, in excess of 35 per cent of the issued share capital of the Company, as well as consultation with the Company's advisers.  The Company will not grant any further Exit Events Awards to the directors of the Company and its subsidiaries.

 

A summary of the remuneration components is detailed below.

 

Policy table (for determination of Executive Directors' pay)