Kazmunaigaz Exploration Regulatory News (KMG)

30 Apr 2010 13:59



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

KazMunaiGas Exploration Production releases its Annual Report for 2009

 

Astana, 30 April 2010. JSC KazMunaiGas Exploration Production has published today its Annual Report for 2009. The report is posted on the Company's website at www.kmgep.kz.

Further, the Company provides below the extracts from its Annual Report in unedited full text as required in accordance with DTR 6.3.5 (1)

 

 

 

 

COMPANY OVERVIEW

 

KMG EP is among the top three oil and gas exploration and production companies in Kazakhstan. The Company, JSC KazMunaiGas Exploration Production (KMG EP) was created through the merger of JSC Uzenmunaigas (UMG) and JSC Embamunaigas (EMG) in March 2004.

The total volume of 2P reserves at the UMG and EMG fields is 1.7 billion barrels (over 234 million tonnes). Today the Company operates 41 fields (excluding acquisitions made in 2007-2009). When the recent acquisitions are included, the total volume of proved and probable reserves is about 2.2 billion barrels.

The Company's shares are listed on the Kazakhstan Stock Exchange (KASE) and its GDRs are listed on the London Stock Exchange (LSE).

KMG EP has many years' experience of oil production in Kazakhstan and expert knowledge of the geology.

Financial and Operational Highlights

 

 

 

Letter to shareholders from the Chairman of the Board of Directors

 

It is my pleasure to report another strong year for KMG EP. Despite deteriorating financial market conditions in 2009, against the backdrop of the global economic downturn, KMG EP made a profit of 209.7bn Tenge (US$1,422m) and earnings per share of 2,871Tenge (US$3.2 per GDR). 

In June 2009, Mr Kenzhebek Ibrashev was appointed as KMG EP's new Chief Executive to lead the Company through the next stage of its development. Mr Ibrashev has been on the Company's Board of Directors for several years and brings with him deep knowledge and experience of the markets in which we operate. I would also like to express my gratitude to the previous Chief Executive, Mr Askar Balzhanov, for his excellent contribution to the Company.

In line with our strategy, at the end of 2009 we successfully completed the acquisition of a 33% stake in PetroKazakhstan Inc. This acquisition contributes to the expansion of our reserve and resource base and serves as an extension of our sustainable growth strategy. In the coming year we expect this acquisition to add approximately 17% to the Company's consolidated production.

We are happy to note that previous acquisitions, notably a 50% interest in Kazgermunai and CCEL, also played a positive role in 2009. We are looking to continue our efforts to consolidate our onshore assets in Kazakhstan as well as to expand internationally in line with the general strategy of the "KazMunaiGas" group of companies. Participating in off-shore projects in Kazakhstan and abroad is one of the additional long-term strategies of KMG EP.

We remain confident that even at distressed oil prices we are capable of funding the growing expenditure required to complete our exploration projects from our existing liquid resources and internal cash generation.

In 2010 the Company is planning to spend 95bn Tenge (US$633m) on capital expenditure, to fund maintenance and exploration drilling, as well as the implementation of the associated gas utilisation programme. 

We continue to be focused on maintaining production levels at our core fields, Uzen and Emba, mainly by using effective oil recovery methods to optimise the performance of our key assets.

We are exceptionally well positioned to withstand these times of economic upheaval and uncertainty due to our strong balance sheet and clear vision. We maintain a balanced approach to our growth strategy and aim to ensure a strong flow of investment into our projects, ensuring their future effectiveness and good financial returns.

The international investment community's continuing interest in KMG EP shows that our strengths are widely recognised. A good example of this is the speedy recovery of our share price in 2009 and the purchase of 11% of our shares by China Investment Corporation announced in September2009. 

From time to time oil companies experience difficulties related to global economic trends, oil price volatility, severe weather conditions, industrial disputes and issues connected to state regulation of the oil and gas sector in general. However, we are growing stronger and are fully equipped to continue growing for the benefit of our shareholders and Kazakhstan.

We also recognise that today the Company's reputation is not only judged by its financial and operating performance but also by its standards of corporate responsibility. We believe that  corporate governance and the way we deal with social matters is as important for us as meeting our production targets and financial goals.

 This commitment stems from a clear understanding that acting responsibly is essential to building long-term shareholder value. We deem it unacceptable to fall short of our obligations towards employees, local communities and the environment. Our people are our most valuable resource. The Company is proud to employ highly qualified professionals and we are determined to provide them with good working conditions. The Company is always ready for a constructive dialogue with its workers. It takes their concerns very seriously and tries hard to resolve outstanding issues to mutual satisfaction.

I would like to thank the Board and Independent Non-Executive Directors for their effective leadership and support. I would especially like to thank Mr. Christopher Mackenzie who stepped down as an Independent Director and as Chairman of the Remuneration Committee in 2010 for his important input to the Company's performance. I also would like to thank all employees of KMG EP for their daily contribution to our joint success.

 

Kairgeldy Kabyldin,

Chairman of the Board of Directors

 

 

 

 Letter to shareholders from the Chief Executive Officer

 

I took over as the CEO of KazMunaiGas Exploration Production in the middle of 2009 from Askar Balzhanov who brought the Company to a successful IPO in 2006 and helped to build a very strong base for future growth. The operations and activities of KMG EP were very familiar to me as previously I worked as Vice President of Exploration and Production at our parent company, NC KazMunayGas. Since 2007 I have been a member of the Board of Directors of KMG EP and have a very clear idea of the Company's potential, its projects, and its prospects.

 

Since its inception, the Company has achieved remarkable success and has firmly established itself as an important player and strong force in the international oil market. The Company remains in a very advantageous position to overcome challenges related to the global economic downturn, as well as those stemming from fluctuating oil prices and other external and internal influences.

 

As you know, the New Tax Code of the Republic of Kazakhstan took effect on 1 January, 2009. The financial effect of the new Code on the Company largely depends on the fluctuating oil price. However the new system is transparent and allows profitable operation at different oil prices while providing a fair level of tax revenue for the government.

 

The current cash balance of KMG EP is a very healthy US$4bn. Looking at our strategy, the funds are intended for long-term investment projects such as acquisitions, maintaining production at the core assets, receiving exploration licenses and conducting exploration activities. We will continue exploiting the advantages of our close relationship with the NC KMG in accordance with earlier agreements.

 

In line with its core development strategy, in December 2009 the Company added a 33% stake in PKZ Inc to the list of completed acquisitions. PetroKazakhstan is involved in the exploration, development, production and sale of hydrocarbons. PetroKazakhstan produced 6,294 thousand tonnes of crude oil in 2009 (134kbopd). It is an attractive asset and we look forward to benefiting from it in 2010.

 

Continuing the process of consolidating onshore producing assets in Kazakhstan, the Company is also moving closer to acquiring a 50% interest in Kazakhoil Aktobe and 51% in Kazakhturkmunai as well as a 50% stake in Mangistaumunaigas. We are always prepared to consider any other attractive prospect both in Kazakhstan and abroad, provided that it expands our resource base and brings value to our shareholders and to our country.

 

KMG EP maintains its position as one of the top three oil producers in Kazakhstan. In 2009 we produced 11,497 thousand tonnes of crude oil (232kbopd), which includes the Company's stakes in both JV Kazgermunai LLP ("Kazgermunai") and CCEL ("Karazhanbasmunai"). This is 3.8% less than in 2008 but it is important to note that despite severe weather conditions and occasional disruptions in power supplies, the decrease in output was insignificant to planned production levels. We aim to sustain optimal production levels from existing assets and continue the use of cost-effective enhanced oil recovery techniques. In 2010 we plan to increase capital expenditure on our main assets and expand our resource base in order to maintain output from the core fields and achieve overall growth in production. This increase in capital expenditure is a positive step towards normalizing working conditions, following the economic downturn. Our cash resources allow us to invest in the Company's future, particularly in exploration where the budget increased threefold in 2010, and in the utilization of associated gas.

 

KMG EP considers high standards of corporate governance, efficiency of management procedures and reporting systems as its top priorities and every year shows further improvements in these areas. In July 2009, the international rating agency Standard & Poor's (S&P) confirmed KMG EP's "BB+" corporate credit rating and assigned the Company a"GAMMA-6" rating. The GAMMA score is a comprehensive assessment of governance structures and practices which includes the enterprise risk management system and the strategic process. The agency based its decision on the overall strength of corporate government practices at KMG EP including formalised and transparent mutual obligations with the parent company, competent auditing systems, effective communication with shareholders and the role of independent non-executive directors, among others. Another example of the growing international reputation of the Company was the purchase of 11% of KMG EP's shares by the China Investment Corporation at the end of September 2009.

 

Human outreach and attention to the social and living conditions of oil industry employees is a matter of high importance for KMG EP. Wherever we operate, every effort is made to improve the quality of life of local communities and all those who contribute to the Company's success. Our achievements are due to the hard work and professionalism of all our staff. To this end we encourage our management teams to act in a socially responsible manner in all their activities.

 

I would like to express gratitude to all colleagues and partners of the Company whose expertise and competence contribute to our success and improve our ability to find timely and strong solutions to any difficult questions and situations.

 

Special thanks should go to the National Company KazMunayGas for their full support, to the Board and the Independent Non-Executive Directors whose leadership and dedication to KMG EP's success continues to build long-term shareholder value.

 

Kenzhebek Ibrashev,

Chief Execurive Officer

 

 

   

 

2009 MILESTONES

 

1Q 2009

·; A new Tax Code for the Republic of Kazakhstan came into force. Taxation of all subsoil users was changed to a single transparent system. As a whole, the new tax legislation meets the economic fundamentals and facilitates the development of the Company.

·; The National Bank of the Republic of Kazakhstan implemented a one-step 23% devaluation of the national currency (the Tenge) against the US Dollar. Since most of the cash, cash equivalents and other financial assets of the Company were denominated in US Dollars, a considerable profit was gained from the exchange rate difference resulting from the devaluation.

·; In the first three months of 2009 KMG EP produced 2,743 thousand tonnes of crude oil (224kbopd), which includes the Company's stakes in both Kazgermunai and CCEL. This was 150 thousand tonnes, or 5%, less than first quarter 2008. The drop in production below the planned level at Uzen and Emba was due to unusually tough weather conditions in Western Kazakhstan.

·; According to consolidated interim financial results for the first three months of 2009 KMG EP's net profit was 108bn Tenge (US$778m), including a significant foreign exchange gain. Earnings per share were 1,464 Tenge (US$1.8 per GDR). Operating profit declined by 79% to 20bn Tenge (US$144m) compared to the first three months of 2008 on lower oil prices.

 

2Q 2009

·; As decided by shareholders, the dividend per share (ordinary and preferred) for 2008 was KZT656 (including taxes withheld in accordance with RK laws). The total dividend for 2008 was about KZT48bn (US$319m). Dividends paid during 2009 were KZT46bn (US$313m).

·; Kenzhebek Ibrashev was appointed CEO of the Company. Askar Balzhanov who previously headed the Company, moved to the position of Vice-President for Exploration and Production at NC KMG.

·; Taking into account its stakes in JV Kazgermunai LLP and CCEL, KMG EP produced 5,673 thousand tonnes of oil (230kbopd) in the first half of 2009, that is 225 thousand tonnes less than for the same period of 2008 (4% decrease).

·; According to unaudited interim financial results net profit for the first half of 2009 was KZT128.8bn (US$890m) and profit per share was KZT1,752 (US$2.0 per GDR) including a considerable foreign exchange gain amounting to KZT97.9bn (US$677m). Owing to a fall in oil prices, operating profit declined to KZT57bn (US$394m), or 74% less than first half 2008.

 

3Q 2009

·; The KMG EP Board of Directors approved changes in the Management Board. Due to personnel changes in the management of production branches, two new members of the Management Board were approved. They were Dovulbai Abilkhanov Director of UMG and Isturgan Baimukhanov Director of EMG. Kairbek Eleusinov left the Management Board.

·; Fitch, the International rating agency, confirmed KMG EP's long-term credit rating in Tenge and foreign currency at BBB-. The agency noted that the ratings of KMG EP reflect the Company's strong financial position.

·; The 110th anniversary of Kazakh oil was celebrated by festive events in the Atyrau and Mangistau regions. New social facilities built with KMG EP funds were presented to the residents of these regions.

·; The state investment fund of the People's Republic of China, China Investment Corporation (CIC), announced its purchase of 11% of the Company shares in the form of the Company's global depositary receipts, for US$939m. The market responded with an 11% increase in KMG EP's share price.

·; In the first 9 months of 2009 KMG EP produced 8,644 thousand tonnes of crude oil (233kbopd), including the Company's share of production from JV Kazgermunai LLP ("Kazgermunai") and CCEL ("Karazhanbasmunai"). This is 265 thousand tonnes, or 3%, less than the same period of 2008.

·; According to unaudited interim financial results, net profit for the first nine months of 2009 was KZT180.6bn (US$1,231m) to give a profit per share of KZT2,467 (US$2.8 per GDR), including a KZT99.9bn (US$681m) profit from the exchange rate gain, received in the first quarter of 2009. Mostly due to a decrease in oil prices, operating profit declined to KZT107bn (US$730m), 67% less than the corresponding period of 2008.

 

4Q 2009

·; Completion of the share buyback programme that began on 24 November 2008. Since the start of the programme, the Company has bought back 8,699,697 GDRs and 110,632 ordinary shares on the Kazakhstan Stock Exchange (KASE) and London Stock Exchange (LSE) for the total amount of KZT22bn (US$148m).

·; A protest action was held November 15-17 in the town of Zhanaozen in which about 30 UMG employees took part. Their main demands were for a wage increase, that UMG should be spun out into a separate legal entity and that the central office of KMG EP should move from Astana to Zhanaozen. Employment issues were also on the agenda. Through negotiation, the management of KMG EP and protesters came to a constructive agreement and the protest was stopped.

·; The KMG EP Board of Directors approved the Company's 2010 budget based on the annual average Brent price of US$50 per barrel. The Company's capital investments in 2010 are expected to rise to KZT95.0bn (US$633m). The increase as compared to 2009 of approximately KZT51.6bn or US$339m is connected with increased expenses for production and exploration drilling and the gas utilisation project at EMG's Prorva group of oil and gas fields. Planned 2010 production volumes from the main assets (UMG and EMG) will be around 9,200 thousand tonnes (186kbopd).

·; KMG EP completed the purchase of a 33% stake in PetroKazakhstan Inc. It is expected that the deal will allow KMG EP to step up production volumes in 2010 by about 17%.

·; The International rating agency Standard & Poor's (S&P) awarded KMG EP a GAMMA corporate governance rating at GAMMA-6 level.

·; In the full year ended 31 December 2009 KMG EP produced 11,497 thousand tonnes of crude oil (232kbopd), which includes the Company's stakes in both JV Kazgermunai LLP ("Kazgermunai") and CCEL ("Karazhanbasmunai"). This is 458 thousand tonnes, or 3.8% less than 2008. The decline was mainly due to KMG EP's planned reduction in drilling and production in 2009 in a lower oil price environment.

·; In 2009 KMG EP made a profit of 209.7bn Tenge (US$1,422m) and earnings per share were 2,871 Tenge (US$3.2 per GDR). This includes a significant foreign exchange gain of approximately 89.5bn Tenge (US$607m). Operating profit declined by 50% to 155bn Tenge (US$1,050m) compared to 2008, mainly due to lower oil prices and the introduction of the new Tax Code in January 2009.

·; According to a report by the independent energy consulting firm Gaffney, Cline & Associates, proved plus probable (2P) reserves were 234 million tonnes (1,725 million barrels), covering KMG EP's interests in Uzen and Emba fields. Proved oil reserves (1P) were 88 million tonnes (646 million barrels). Proved, probable and possible (3P) reserves were 270 million tonnes (1,989 million barrels).

 

 

 

Evaluation of KMG EP activity by independent experts

 

In July 2009, the international rating agency Standard & Poor's confirmed KMG EP's long-term credit rating at BB+. The 'stable' outlook for this rating reflects the changes in rating of its parent company NC KMG and the expectations of S&P analysts that KMG EP is capable of maintaining its creditworthiness at the BB level, taking into account the moderate level of debt and substantial expected cash flows.

In December 2009, the international rating agency Fitch Ratings confirmed the long-term foreign and local currency issuer default ratings of KMG EP at BBB-, and the short-term Issuer Default Rating (IDR) at F3.

In July 2009 Moody's Investors Service international rating agency confirmed the credit rating of KMG EP at Âàà2 level.

In addition, independent experts positively rated the KMG EP's corporate governance. International rating agencyStandard & Poor's (S&P) awarded to the Company GAMMA-6 corporate governance rating (CGR).

The GAMMA rating replaces the CGR awarded to KMG EP on 1 October 2007. For awarding GAMMA rating, an improved CGR methodology is used, including two new elements of corporate governance analysis: the risk management system and the strategic planning process. In S&P's opinion, the GAMMA rating provides more complete assessment of corporate governance structure and practice.

S&P analysts note that in 2009 the Company's corporate governance mechanisms showed definite progress; the most significant improvements were observed in the areas of internal audit, risk management and strategic planning.

The following were determined as the strengths of KMG EP corporate governance: effective work by independent non-executive directors in balancing the main shareholder's influence and thorough monitoring of management; transparent and legally secured mutual obligations with the NC KMG parent company; high level of transparency in the Company's operations; competent independent audit; efficient interaction with shareholders, who have a wide range of rights; efficient procedures for preparing and holding shareholder meetings.

Moreover, in 2009 KMG EP was recognized by Standard & Poor's as the most transparent company in Kazakhstan. The S&P report states that the Company showed a high level of information disclosure on its financial and operating activities, shareholder procedures and corporate governance.

KMG EP also won the nomination as 'Best Anti-crisis instrument' by the Cbonds Awards 2009 for implementation of the share buyback programme that has been run by the Company since November 2008.

Cbonds Awards 2009 is a Kazakh stock market award designed to single out and encourage the most exemplary companies, which develop and actively implement effective and attractive projects in all areas of stock market development.

 

KMG EP share price dynamics

 

Table of share price and Brent crude oil price

Source: Bloomberg

 

In 2009, the fluctuation of commodity prices had a determining influence on KMG EP's share price. Recovery started in March, when the first positive signs of investor confidence appeared in global markets. The single-step devaluation of the Tenge in February 2009 also had a positive effect.

In the last quarter of 2009, KMG EP's share price on KASE was KZT 21,784, and the GDR price on LSE was US$24.46. Throughout the year, a number of equity analysts evaluated KMG EP shares as one of the most attractive for long-term investment of the sector.

On 30 September 2009, the Chinese state investment fund China Investment Corporation (CIC) announced its purchase of an 11% stake in the Company in the form of global depositary receipts for a total of US$939m. The purchase of shares by CIC was well received by the market as it served as a positive signal for other investors. KMG EP's share price rose 11% following the news.

 

 

 

 

OPERATIONAL ACTIVITY

 

Crude oil production and sales

In 2009, KMG EP (including shares in Kazgermunai and CCEL) produced 11,497 thousand tonnes of crude (232kbopd), 458 thousand tonnes (3.8%) less than in 2008.

At the core assets (Uzenmunaigas and Embamunaigas), 8,962 thousand tonnes of crude were produced (181kbopd), some 508 thousand tonnes less than 2008. The decrease reflected the planned reduction in the 2009 production plan due to the significant fall in global oil prices. KMG EP reduced planned production from core assets by approximately 3.5% compared to 2008 in order to preserve production cost efficiency at the lower oil price of US$40 per barrel. Drilling and well workover volumes were also reduced.

Adverse weather conditions in early 2009 and power supply interruptions also had a negative impact on production at Uzenmunaigas in the first and third quarters of 2009. In addition, it was not possible to fully offset the impact of the aforementioned negative factors, owing to labor disputes at UMG in the fourth quarter of 2009.

At the same time, the Company has done everything necessary to maintain production facilities for the long-term, and to retain the staff and principle contractors.

In 2010, the production volume in UMG and EMG is planned at the level of 9,200 thousand tonnes (186kbopd).

 

UMG and EMG data as at 2009 year-end

 

In 2009 (excluding the oil from Kazgermunai and CCEL), 8,966 thousand tonnes of oil were sold (181kbopd), including 6,946 thousand tonnes of export sales (140kbopd). The CPC pipeline was a more profitable route in 2009.

In 2009, KMG EP's share of Kazgermunai and CCEL sales comprised 2,452 thousand tonnes of oil (49kbopd), including 2,054 thousand tonnes (41kbopd) of export sales.

 

 

Key financial and operational indicators of JV Kazgermunai LLP

 

Key financial and operational indicators of CCEL

 

Oil reserves

According to the report by Gaffney, Cline & Associates (GCA), as of 31 December 2009, the total proved and probable (2P) reserves of KMG EP were 234 million tonnes (1,725 million barrels), covering KMG EP's interests in Uzen and Emba fields.

The reserves replacement ratio was 25% as 2.2 million tonnes (16 million barrels) were added to reserves against production of nearly 9 million tonnes (66 million barrels). The reserves-to-production ratio at the end of 2009 was 26 years.

Proved oil reserves (1P) are 88 million tonnes (646 million barrels). Proved, probable and possible (3P) reserves stand at 270 million tonnes (1,989 million barrels).

 

 

  

COMPANY DEVELOPMENT

 

KMG EP continues to pursue its strategic goal of strengthening its position as one of the leading oil and gas companies in Kazakhstan. The Company coped well with the global economic crisis and the fall in oil prices, which negatively impacted all oil and gas companies.

The key points of KMG EP strategy include increasing total production volume and replenishing the Company's hydrocarbon reserves through the acquisition of new assets, as well as geological exploration and optimisation of production in the core fields.

The Company's accumulated funds are first of all intended for long-term investment projects aimed at increasing the Company's capitalisation.

One of the key strategic goals of the Company's development is to enter international hydrocarbons markets. The geographical spread of KMG EP's interests extends to neighbouring countries, particularly Turkmenistan and the Russian Federation. Other attractive regions for extending the Company's activities include the Middle East, North Africa and other regions. Broadening the geographical scope of KMG EP's activities will allow the Company to enter international markets; gain work experience in potentially beneficial oil and gas projects, including offshore projects; gain access to modern oil and gas exploration and production technologies; and occupy those business niches in which the Company is competitive.

 

Acquisition of 33% shares of PetroKazakhstan Inc.

 

On 23 December 2009, KMG EP completed a transaction to acquire 33% of the shares of PetroKazakhstan Inc. (PKI) from its parent company JSC National Company KazMunayGas (NC KMG). This deal confirms that the Company is systematically following the acquisition plan announced during its IPO in 2006.

Thanks to this acquisition, KMG EP will be able not only to increase 2010 production by around 17%, but also to expand the geographical spread of its business, which is currently concentrated mainly in Western Kazakhstan. Moreover, KMG EP will gain access to the development of PKI's new licensed blocks, whose promising potential has been identified by preliminary exploration results.

The PetroKazakhstan Inc. group of companies is involved in hydrocarbon exploration and production as well as in the sale of oil and petroleum products. PKI has a share in 16 fields, 11 of which are in various stages of development. In 2009 PKI produced 6,294 thousand tonnes of oil (134kbopd).

The majority shareholder in PKI is the Chinese oil and gas company, CNPC Exploration and Development Company Ltd. (CNPC E&D), which holds 67% of the shares.

PKI's production is stable and no substantial changes are expected in output. This asset is able to generate stable cash flows without large capital expenditures. In addition, PKI holds a number of licences for the exploration of promising areas that will allow the Company to increase its resource base and ensure stable production for years ahead.

PKI's exploration targets have relatively plain mining and geological conditions (insignificant depth, absence of various aggressive components in the geological section) and a possibility of rapid linkage with the existing infrastructure and development in case of positive exploration results. This should have a favourable effect on costs.

According to experts, the basin of PKI's operations contain 450-500 million tonnes of geological resources. Currently, the most studied and developed part is the Upper Jurassic-Cretaceous part of the section. Data obtained in recent years in several licensed blocks of the South Torgai basin suggests considerable potential in the lower, unexplored part of the section connected with the Paleozoic zone. This is considered as a prerequisite for increasing the resource base of PKI and the basin as a whole.

 

Acquisition of new assets 

 

KMG EP has expressed interest in acquiring a 50% stake in JSC Mangistaumunaigas (MMG). On 25 November 2009, NC KMG and CNPC Exploration and Development Company Ltd (CNPC E&D) completed the acquisition of 100% of the ordinary shares of MMG from Central Asia Petroleum Ltd.

The acquisition of MMG shares was carried out through public trades on the Kazakhstan Stock Exchange (KASE) via Mangistau Investments B.V. - a joint venture owned equally by KMG EP and CNPC E&D.

MMG is one of the major oil producing companies in Kazakhstan. The company owns 36 oil and gas fields, 15 of which are being developed. The largest fields of the company in terms of reserves are Kalamkas and Zhetybai

It is anticipated that negotiations concerning KMG EP's acquisition of a 50% stake in Mangistaumunaigas from NC KMG will result in specific solutions in 2010.

KMG EP is also considering acquisition of the 50% shares in Kazakhoil-Aktobe and 51% shares in Kazakhturkmunai from its parent company.

The close cooperation and partnership with the National Company KazMunayGas and the Government of Kazakhstan play a key role in the implementation of KMG EP's acquisition strategy and give considerable advantages to the Company with respect to new business development opportunities.

Being a national oil and gas company of Kazakhstan, NC KMG has the pre-emptive right to receive contracts for subsoil use, in accordance with Kazakhstan legislation, as well as the pre-emptive right to unlicensed territories in Kazakhstan. As a subsidiary of NC KMG, KMG EP can acquire assets using these rights on mutually agreed terms. Active collaboration with the National Company in implementation of joint projects will continue.

 

Exploration

Expansion of its resource base is one of KMG EP's strategic development goals, and geological exploration plays a key role in this process. This is an investment in the Company's future, which builds up its potential and creates opportunities that are in the interests of both the Company's employees and its shareholders.

Since mid-2009, KMG EP has been systematically increasing its capital expenditure. Capex is expected to rise to KZT95bn (US$633m) in 2010 and focused on stabilising oil production levels through increased well drilling, implementation of the associated petroleum gas utilisation programme and increased expenditure on exploration drilling.

The Company continues its exploration work in the search for hydrocarbons in post-salt and sub-salt deposits. In 2009 the work on processing and analysis of 3D seismic data on R-9 block gained in 2008 were completed. Recommendations were obtained with regard to promising block structures, and an Exploration Programme for post-salt and subsalt megalithic complexes of the contract area has been agreed and approved.

An analysis has been made of the 2D seismic exploration results for the Liman block in 2008. The work results were approved and recommendations obtained for the continuation of geological exploration works. Due to tight deadlines, the previously planned 3D seismic exploration works on the Tegen - East Tegen structure, as well as the drilling of a post-salt well and the start of drilling a subsalt well, have been postponed until 2010.

At the Taisoigan field, trial production has continued in the Uaz and Kondybai sites. There were 15 wells involved, producing 24 thousand tonnes in 2009. Consent has been obtained from the Russian army command for the possibility of excluding the Uaz and Kondybai field sites from the territory of a military range previously leased by the RK Government to the Russian Ministry of Defence on a long-term basis.

At the S. Nurzhanov field, drilling and development works were performed at four wells with a projected depth of 3500m. . The works resulted in oil inflow and production has started.

The Company, in liaison with NC KazMunayGas, is actively looking to expand its exploration portfolio. KMG EP is currently developing an exploration programme, with a view to obtaining new blocks in Kazakhstan (including the Temir block, the area adjacent to the Uzen and Karamandybas fields; and the Karaton-Sarkamys and Teresken blocks) and is also considering various strategic partnership options with international companies for the joint development of future projects.

 

 

SOCIAL RESPONSIBILITY

 

Social responsibility is one of the key features of KMG EP's operations. The Company's activity in this area is aimed at creating safe and comfortable work conditions, providing social protection for employees and their family members, continuous professional staff development, and facilitating the sustainable development of areas where the Company operates.

In order to organise KMG EP's activities under social programmes and partnership with local executive bodies, trade unions and public organisations, the Company's Board of Directors approved the main principles of social policy in 2009. These clearly set out the aims of social policy with regard to the Company's employees and residents in the regions where it operates..

 

 

Social projects in the Mangistau region

 

Starting from 2008, KMG EP has allocated KZT900m (US$6.1m) each year to fulfil its contractual obligations, in accordance with the Social Infrastructure Development Programme for the town of Zhanaozen and Karakiya district.

Taking into account the complex social climate that formed in the region as a result of the economic crisis in Kazakhstan, KMG EP and the Administration (Akimat) of the Mangistau Region have jointly concluded a Memorandum regarding additional financing of the region's social projects. According to the Memorandum, in 2009-2010 the Company allocated over KZT970m (US$6.6m) for municipal needs, on top of the funds specified by the contractual obligations. These funds are being used in Zhanaozen to create 1000 social jobs, to build a 200-apartment communal residential house, to expand the subsidiary plot in the Tenirekshin area up to 500 hectares for part-time farm purposes, to install playgrounds in 63 residential yards and sports grounds at 10 of the town's schools, and to pay utility bills for veterans of the World War II and other socially vulnerable population groups.

The Company also helps to provide potable water in the Senek settlement and provides financial assistance to disabled children, families with many children and needy families, war and labour veterans, and single pensioners who were left without means of subsistence.

In the period of 2010-2012 it plans to build a medical treatment centre with an in-patient department in Zhanaozen, at an estimated cost of KZT1.3bn (US$8.8m), and a children's holiday camp for 250 people, costing over KZT250m (US$1.7m) The Company will also convert one of the dormitory blocks of the Kenderly recreation zone into a medical rehabilitation centre. These projects will require KZT1.2bn (US$8.1m).

The Company pays special attention to the development of sports and the promotuion of a healthy lifestyle in the region. To honour the 110th anniversary of the discovery of oil in Kazakhstan, a multifunctional sports and leisure complex was opened in Zhanaozen in September 2009. The cost of the complex exceeds KZT2bn (US$13.6m). Construction was funded by KMG EP. The new modern sports complex, unique in the region, was named after Rakhmet Utesinov, a famous oilman. The sports complex includes halls for boxing, judo, aikido, basketball, volleyball, football and rhythmic sportive gymnastics. There also is a 25-metre swimming pool, a 50-metre shooting gallery and a weight-lifting room.

Since 2008, a 3000-seat stadium, also funded by KMG EP, has been successfully functioning in Zhanaozen.

 

Social projects in the Atyrau region

 

Financial allocations by KMG EP to support the social infrastructure of the Atyrau Region are growing year by year. In 2009, under its contractual obligations, the Company paid out KZT271.5m (US$1.8m). These funds were used to build a 220-pupil school in the Gran settlement of Isatai district and for the construction, reconstruction and complete overhaul of water service facilities in the Makat settlement of Makat district; and other projects.

In 2010, pursuant to its contractual obligations, KMG EP will allocate KZT276m (US$1.9m) for reconstruction of the Akkistau-Balgimbayevo road in Isatai district; for the construction and overhaul of water service facilities in Makat settlement; for the construction of a kindergarten for 140 children in Sagiz settlement and a community centre in Mukur settlement (both in Kyzylkogin district); and for other social projects.

Under the social partnership programme implemented jointly with the Akimat of Atyrau Region, KMG EP allocated KZT165.5m (US$1.1m) in 2009. These funds were used in Akkistau settlement to build a sports and recreation complex, to improve a playground and install outdoor amenities, and to repair a boiler room in the Munaishy neighbourhood of Munaishy settlement. In Makat settlement, conversion of the former administration building of Makatmunaigas into a pre-school has commenced and the utility systems and equipment of Baichunas settlement boiler room have been repaired. KMG EP plans to implement similar social projects in other regions of Western Kazakhstan in future years.

Joint collaboration with the regional Akimat will continue in 2010. The Company will allocate KZT420m (US$2.8m) for social projects in Makat, Kyzylkugin, Zhylyoy and Makhambet districts of Atyrau Region. The Company allocated funds of KZT200m (US$1.4m) for moving the people of Komsomol, Koshkar, Bek-bike settlements. As a result, social infrastructure facilities requiring total overhaul will be reconstructed in all these districts.I; n Makat district, a rehabilitation centre will be opened for patients of the local tuberculosis hospital, and in Miyaly settlement, a sports and leisure complex will be built and equipped. Moreover, the Company will continue to provide fuel oil for home heating in Baichunas, Koshkar, Komsomol and Iskene settlements (all in Makat district).

Between 2004 and 2009, the Company paid over KZT3.8bn (US$25.8m) in sponsorship for the implementation of social projects in Atyrau Region.

KMG EP renders annual sponsorship and charitable help to Ak-Bota orphanage, an orphan home for the disabled children; to the Association of Mothers of the Disabled, the Association for the Disabled and Association for the Blind; to large families and needy families in Atyrau and to the city sports organisations, as well as providing financial assistance to World War II veterans and those who worked on the home front. In 2009, about KZT119m (US$0.8m) was allocated for these purposes. In 2010, it is planned to spend KZT125m (US$0.8m).

 

Improvement of working conditions

 

The management of KMG EP considers the creation of appropriate working conditions for the Company's employees to be one of the most important aspects of increasing productivity.

KMG EP has developed a Programme for the improvement of social and living conditions in the structural divisions of UMG for 2009-2012. In 2009, over KZT1.3bn (US$8.8m) was allocated in the budget for this purpose, and in 2010 the sum will reach KZT1.6bn (US$10.7m). These funds are being used for building new canteens and amenity blocks for the personnel of structural divisions and for the acquisition and installation of modular units for operators who work on group units. First-aid points are also being built and the Company has purchased ambulance cars and special vehicles for delivery of hot food. The fleet of buses for personnel transportation has been renewed.

The Company allocates funds each year for the improvement of social and living conditions in the structural divisions of Embamunaigas (EMG) production branch. Pursuant to the spending budget for 2009-2010, about KZT700m (US$4.7m) has been allocated for the renovation of functioning dormitories and canteens on oilfields and the construction of new ones, as well as for the replacement of household equipment, reconstruction of the sports and recreation complex in Dossor settlement, the acquisition of eight ambulance cars, and construction of a sports complex in Kenbai shift camp.

 

Personnel Policy

 

The Company pays particular attention to ensuring an objective and transparent hiring process. Currently, assessment of a candidate for a position is a multi-stage process consisting of several levels of interviews and tests of professional knowledge and skills. Since 2009, this system operates both in the Company's head office and in its branches. Local HR committees include heads of structural divisions, trade union representatives and local professionals with many years of work experience.

The competence of KMG EP staff is continuously evaluated, and not only during the hiring process. An appraisal of all Company employees is carried out annually. This allows an objective judgment of every manager's level of professionalism; a focusing of his/her efforts on the factors, objectives and areas of operation that will lead to increasing the efficacy of his/her own work and the Company as a whole; and a full evaluation of the manager's work over the reporting period and his/her contribution to achieving the Company's goals.

Currently, the Company employs high-class professionals, many of whom have many years' experience of working in the Kazakhstan oil and gas industry, as well as young professionals who studied abroad and had internships in foreign companies.

Constant improvement of employee qualifications is a necessity in the current market environment. It is impossible to achieve higher personal performance and economic indicators without training personnel in new work methods and the use of new equipment and technology, or without the improvement of working skills and techniques.

During 2009, 5,649 employees of UMG and EMG, the Engineering Centre branch and the head office underwent training under special programmes. About KZT399m (US$2.7m) was allocated for training.

Despite the economic crisis in the country, KMG EP has managed to avoid staff reductions and preserved jobs, not only in production divisions but in all subsidiary service companies. Salaries have also been increased to compensate for inflation. 

Nevertheless, on 15-17 November 2009, about 30 employees of UMG took part in a protest action in the town of Zhanaozen (Mangistau Region). Their demands were a further wage increase, the spinning out of UMG into a separate legal entity and the removal of the central office of KMG EP from Astana to Zhanaozen..Issues of employment for the town's unemployed were also on the agenda. The remaining employees of the 8-thousand UMG workforce continued to work as usual.

The prosecutor's office in Zhanaozen declared this protest action unlawful, a ruling of which all its participants were informed. No significant break in the main production activity occurred at UMG.

A reconciliation commission was formed for resolving the labour dispute. It included the Company management, representatives of Zhanaozen Administration (Akimat), the local trade union leaders and the protesters. All the conflict issues were considered in the course of the commission's work.

In December 2009, an operating management group was created for UMG operating division in Aktau (Mangistau Region). It will ensure implementation of social projects within the terms of social partnership with the local executive authorities, including social obligations under subsurface use contracts. The Group is entrusted with constant monitoring of the division's operations, including work and production discipline, work quota setting, personnel management, labour protection, observance of environmental protection standards, health and safety, procurement and fulfilment of obligations under the subsurface use contracts, etc.

 

 

HEALTH, SAFETY AND ENVIRONMENT

 

Occupational health and safety

 

Occupational health and safety is one of the main priorities for management at KMG EP. The Company personnel and top managers of structural divisions are personally liable for observance of the standards and requirements of the labour and environmental protection laws during the production process. The implemented measures are aimed at improving working conditions, accident prevention, readiness to localise and eliminate the consequences of accidents and guarantee indemnity of damage inflicted upon third parties and the environment. All measures are supported financially and are performed in full, year after year.

According to the Republic of Kazakhstan's Labour Code and the Industrial Safety Law, managers and executives of industrial organisations who are responsible for the provision of occupational health and safety have to undergo training and test their knowledge at advanced training courses once every three years.

All members of the permanent commission and permanent examination commission of the Company's head office completed regular training in September 2009 by a specialised training organisation at the Ministry of Labour and Social Protection of the Republic of Kazakhstan. State monitoring and control bodies' representatives also took part. Upon completion of the training course, all participants passed an exam and obtained positive marks.

The permanent commission carries out thorough inspections and analyses of occupational safety and environmental conditions. It also checks that protective and other equipment, and the whole work environment, conforms to the rules, safety requirements and international standards. Certification of production facilities with regard to working conditions in UMG and EMG were also carried out in 2009 by independent organisations. Safety declarations of production facilities at UMG and EMG were reviewed and positive expert reports by the state monitoring and control bodies were obtained. The risk management system in the area of industrial and fire safety is well-developed in the projects, considerably reducing the risk of accident and emergencies at production sites and giving an objective estimate of hazards which likewise plays its part in risk reduction.

The production branches of KMG EP, like other enterprises, take an active part in nation-wide official emergency training exercises. The goal of such exercises is to prepare for and undertake rescue and other emergency work when dealing with natural and man-made disasters.

To prevent and reduce occupational diseases, the staff of KMG EP head office and branches has to pass an annual medical check-up while drivers and other personnel must pass a medical check-up before their shifts.

The production sites of oil companies are inherently hazardous, so KMG EP is actively working to reduce risks that pose a threat to health and safety. Analysis of the last few years clearly shows stabilisation of the level of industrial injuries. Nevertheless, accidents in the workplace are still a real issue. 2009 has seen two hazard-related incidents in the Company's production facilities.

The injury rate and frequency of accidents was reduced by around 70 per cent as compared to the last year. The accident frequency rate was reduced nearly 80 per cent since 2004.

 

Environmental protection

 

Taking into account that the natural environment and biodiversity are assets for all future generations to enjoy, the Company implements a balanced policy of sustainable development of the economic, social and ecological aspects of its operations.

KMG EP implements the most effective and ecologically sound projects in order to restore and stabilise the quality of the environment.

The Company allocates considerable funds annually for implementation of these projects, rising from KZT7.9bn (US$53.6m) in 2009 to a planned KZT10bn (US$66.7m) in 2010.

The bulk of this investment is allocated to eliminating past pollution. Lately the Company has intensively implemented the technology of zeolite biological remediation of polluted land. Considerable areas of previously polluted land are returned to use every year. In 2009 alone, 77 hectares were restored. Moreover, the Company also uses traditional technical means of regenerating polluted lands. The total area of regenerated lands so far is 156 hectares.

To reduce the volume of historically accumulated waste, especially the overspill oil which formed into a shallow lake at Uzen in Soviet times, the Company uses two facilities for processing soil polluted with crude oil and re-cycle it for Company use. As of today these facilities have passed the test of industrial use and have all the necessary state licences and certificates. In order to increase the capacity of waste recycling, KMG EP involves contractors with special equipment. In the past year, the Company recycled 121 thousand tonnes of waste and plans to recycle another 121 thousand tonnes in 2010.

In 2009, KZT1.3bn (US$8.8m) was allocated for removing an old oil processing and pumping facility at UMG, reducing its size from 85 to 29 hectares.

Increasing the rate of associated gas utilisation is another aspect to which the Company pays serious attention. KMG EP has constructed 64.6km of new gas pipelines and increased its own associated gas consumption by installing additional heating furnaces in Kisimbai, Akingen and B. Zholamanov fields. In this way it has reduced gas flaring by 5.6 cubic metres per year and increased utilisation of associated gas to 65%.

To implement the associated gas recovery programme, the Company invested KZT577m (US$3.9m). Work on raising gas utilisation continues.

Since 2005 JV Kazgermunai LP has been implementing a gas disposition project to provide the people of Kyzylorda with low-cost natural gas. By 2011 the project will increase capacity of the UPG-2 gas treatment facility by up to 500 cubic meters annually; An oil processing facility is also being built at the Nuraly oilfield with a booster compressor station which allows for the further injection of associated gas into the new system. The construction of a gas turbine power station at Akshabulak oilfield will also supply power to Kyzylorda of which 62 MW will be used by the city and 25 MW will be for the Company's needs.

A number of the Company's current ecological projects are related to preventing the pollution of the Caspian Sea offshore area. For this, the shoreline is fenced off from the Company's production infrastructure by dams to prevent oil pollution of the sea when the level of the Caspian fluctuates. Every year, after sea levels subside, the dams are repaired and reconstructed.

Lately, the Company has been using a totally new technology to protect fields from flooding. It is a multi-step metal structure with a special filler which protects the shoreline from landslides and erosion. This technology is more wave-resistant than previous methods. It is planned ito fully replace the filling dams with the new structures in future.

In order to continuously control the state of the environment, the Company has formed an onshore ecological monitoring network. This is centred on physical and chemical laboratories which trace the impact of KMG EP's production activity on every component of the environment: air, underground waters, soil, flora and fauna.

The Company then evaluates the soundness and efficiency of the technological processes on the basis of the results obtained. Should the technological processes be broken off or disrupted, steps are promptly taken to identify the source of pollution. The operability of the monitoring network is maintained and developed year by year.

 

Main social policy principles of JSC KazMunaiGas Exploration Production:

 

·; to act in accordance with labour legislation and its contractual obligations under subsoil use contracts;

·; to actively cooperate with state bodies, including local authorities, within the framework of social partnership programmes;

·; to cooperate with trade unions within the framework of obligations undertaken in terms of the Collective Labour Agreement;

·; to inform openly shareholders, clients and employees about its operations, within the limits of legislation;

·; to meet ecological standards in order to prevent environmental pollution;

·; to cooperate with Nur-Otan People's Democratic Party and other public associations.

 

 

 

1. Aims of the Company's social policy with regard to its employees:

·; Provision of social benefits and guarantees in accordance with the terms of the Collective Agreement;

·; Provision of voluntary medical insurance;

·; Health and safety;

·; Improvement of living conditions;

·; Support of retired pensioners, war and labour veterans;

·; Support of young professionals;

·; Creation of a work culture within strict observance of the standards of labour legislation and corporate ethics, observance of bilateral obligations under the Collective Agreement, taking steps to minimise occasions for social conflict or social protest.

Primary areas of social programmes:

- improvement of work conditions

·; Qualitative improvement of social and living conditions for Company employees;

·; Creation of comfortable catering conditions, improving the quality of service;

·; Provision of quality potable water;

·; Provision of quality transport services.

 

 

 - improvement of living conditions and provision of quality medical services

·; Allocation of concessionary housing loans through placing of deposits at second-tier banks;

·; Assistance in the relocation of residents from regions affected by the closure of low-profit or unprofitable fields;

·; Using other opportunities to provide housing for Company employees;

·; Provision of quality medical services at work;

·; Provision of voluntary medical insurance;

- interaction with trade unions

·; Control of performance of social obligations;

·; Monitoring fulfilment of the terms of the Collective Agreement and informing work teams about the results;

·; Work to improve social and living conditions for employees;

·; Organising therapeutic resort treatment and recreation for employees and their family members;

·; Organising cultural, mass and sports events;

·; Strict compliance with the achieved agreements and arrangements.

 

 

2. Aims of the company's social policy in the regions of operation:

·; Strengthening cooperation with local executive authorities within the social partnership framework;

·; Improvement and landscaping population centres in the regions of operation;

·; Development of physical culture and sports, creation of a healthy lifestyle;

·; Support of young people;

·; Support of the socially vulnerable population;

Primary areas of social programmes:

·; Taking part in the development of social infrastructure in towns and settlements in the areas where the Company operates;

·; Repairing and equipping sports grounds and playgrounds in schools and residential areas;

·; Sponsorship and charity for orphanages, disabled children and orphans, families with many children;

·; Support for war and labour veterans, repatriates, needy families living below the poverty line, people with socially significant diseases (tuberculosis, etc.);

·; Taking part in implementation of the state programmes 'Road map' and 'Cultural Heritage - Madeni Mura';

·; Modernisation and construction of social facilities.

 

 

 

 

Corporate governance information

 

 

COMBINED CODE COMPLIANCE

 

This section of the Annual Report has been prepared in compliance with the requirements of the United Kingdom Listing Authority's ("UKLA") Disclosure and Transparency Rule ("DTR") 7.2 (Corporate Governance Statements).

 

As an overseas company with GDRs admitted to the Official List of the United Kingdom Listing Authority, the Company is not required to comply with the provisions of the UK Combined Code on Corporate Governance (Combined Code). However in accordance with DTR 7.2 it is required to disclose in its Annual Report whether or not it complies with the corporate governance code of the Republic of Kazakhstan and the significant ways in which its actual governance practices differ from those set out in the Combined Code. In addition, the Directors view corporate governance as very important, support the development of high standards of corporate governance in the Company.

 

Differences between Kazakhstan Corporate Governance Code and Combined Code provisions

 

Corporate governance best practice in Kazakhstan is set out in the Kazakhstan Corporate Governance Code. This Code is based on existing international best practice in the area of corporate governance and the recommendations for applying the principles of corporate governance by Kazakhstan joint-stock companies, approved by the Expert Council for Securities Market Matters under the National Bank of the Republic of Kazakhstan in September 2002. The Code was approved by the Association of Financial experts of Kazakhstan in March 2005 and by the Board of Issuers in February 2005.

 

Throughout 2009 the Company complied with the provisions of the Kazakhstan Corporate Governance Code in all material respects.

 

KazMunaiGas Exploration and Production Joint-Stock Company (KMG EP) has adopted the Kazakhstan Corporate Governance Code, modified to include certain provisions from the Combined Code, as its Corporate Governance Code. The modifications adopted by the Company impose additional corporate governance obligations on KMG EP. The Company believes that these additional modifications significantly strengthen the corporate governance regime adopted by the Company. KMG EP also takes into consideration other provisions of the Combined Code and will seek to improve its standards of corporate governance in the future.

The copy of the Company's Corporate Governance Code and a description of the Company's corporate governance practices is available on the Company's website.

 

Below are described the main differences between the Corporate Governance Code, adopted by the Company and the Combined Code

 

·; The Combined Code provides that the Non-Executive Directors should meet without the Chairman of the Board of Directors present at least annually to appraise the Chairman's performance and on such other occasions as are deemed appropriate. On the other hand, the Company's Corporate Governance Code doesn't include such a requirement.

 

Throughout 2009 Independent Non-Executive Directors met eight times without a Chairman of the Board, where the following issues were discussed: the position with regard to interested party transactions with JSC National Company KazMunayGas (NC KMG) or companies of NC KMG Group, including purchase of a stake in PetroKazakstan Inc.; measures for bringing the Treasury Policy in compliance with regulations; internal audit and internal control issues; the Company development strategy; election of the Management Board members and other changes in the Company's management; issues related to workforce; and personnel appointments.

Although no official evaluation of the activity of the Chairman of the Board of Directors was made by the Non-Executive Directors; the Board's activities was evaluated by an external independent consultant in March 2010. More detailed information on the Board of Directors evaluation may be found on page 37 of this report.

 

·; In accordance with the provisions of the Combined Code, following his appointment, the Chairman of the Board of Directors shall meet the criteria of independence defined in the Combined Code.

 

The provision for appointment of the Chairman of the Board of Directors is not included in the Company's Corporate Governance Code, and, in the opinion of the Directors, the Chairman of the Board of Directors would not meet the criteria of independence stated in the relevant provision of the Combined Code.

The Audit Committee Provision stipulates that the Chairman of the Board of Directors must not be a member of the Audit Committee, despite the existence of such an option in the Combined Code. This difference is intentionally stipulated in the Audit Committee Provision on the ground that the Chairman of the Board of Directors is a representative of a major shareholder.

·; The Combined Code stipulates that not less than half of the Board of Directors members, except for the Chairman, shall be Independent Non-Executive Directors.

On the other hand, the Company's Corporate Governance Code and Charter stipulate that not less than one third of the Board of Directors members shall be Independent Non-Executive Directors.

 

During 2009 the Board of Directors included three Independent Non-Executive Directors: Christopher Mackenzie, Paul Manduca and Edward Walshe, and thus the number of independent directors comprised more than one third of the Board of Directors. In addition, according to the Company's Charter, a number of key issues are required to be approved by the majority of Independent Non-Executive Directors. 

 

In connection with the expiration of the term of appointment to the Board of Directors, Christopher Mackenzie decided to withdraw from the Board reappointment process on EGM on March 26, 2010. According to the Company's Charter; the number of Board of Directors' members must comprise not less than eight Directors (in the absence of temporary vacancies) including not less than one third of INEDs. Therefore, one position for Independent Non-Executive Director is temporarily vacant. As a result, on May 25, 2010 during the AGM, the Board of Directors acting on the recommendation of the Nomination Committee, will propose a candidate Independent Non-Executive Director for election to the Board.

 

·; The Combined Code also states that the Board shall appoint one of the independent directors as a Senior Non-Executive Director.

 

The Board of Directors did not appoint a Senior Non-Executive Director in view of the current shareholder structure. The requirement concerning the appointment of a Senior Non-Executive Director will be considered from time to time.

 

 

 

DIRECTORS' RESPONSIBILITY STATEMENT

 

In accordance with the Company's Corporate Governance Code, the Board of Directors and the Management Board shall bear responsibility for the credibility of the Company's annual report and financial statements.

 

In compliance with the UKLA's Disclosure and Transparency Rules, each of the Directors, whose names and functions appear on pages 6-7 of this Annual Report, confirms that to the best of his or her knowledge:

 

·; the financial statements, prepared in accordance with IFRS, give a true and fair account of the Company's assets, liabilities and financial position, the results of its financial and economic activities and those of the subsidiary enterprises included in the consolidated Company balance sheet taken as a whole; and 

 

·; the management report includes a fair review of the development and performance of the business and the financial position of the Company and its joint obligations in the matter of subsidiary enterprises, together with a description of the principal risks and uncertainties that these face.

 

THE BOARD OF DIRECTORS STRUCTURE

 

As of December 31, 2009 the Board comprised the following eight members:  

 

In connection with the expiration of the term of appointment, pursuant to clause 2 article 12.2 of the Company Charter, Board of Directors resolved to call an EGM on March 26, 2010 where the following changes were approved:

 

·; Kairgeldy Kabyldin, the Chairman of the Board of Directors and Christopher Mackenzie, the independent director decided to withdraw from the Board reappointment process.

·; In accordance with the proposal of a major shareholder (NC KMG) Assiya Syrgabekova was elected as a member of the Board of Directors.

·; Under Article 12.16 of KMG EP Charter, the Chairman of the Board is elected from among its members by a simple majority of votes. Hereby on March 30, 2010 Askar Balzhanov was elected as the new Chairman of the Board.

 

In compliance with the Corporate Governance Code, the Board of Directors established the independence of the Directors and considers that Christopher Mackenzie, Paul Manduca and Edward Walshe are independent by nature and in decision-making. The Board of Directors determined that there exist no relations or circumstances that affect or may significantly affect the independent decisions made by these Directors.

 

THE MANAGEMENT BOARD STRUCTURE

 

The Company's Management Board comprises senior executives of the Company, including the CEO and his deputies.

 

Members of the Management Board as of December 31, 2009:

Following a resolution of the Company's Board of Directors, the following changes were made in the composition of the Management Board over the course of 2009-2010:

·; On May 29, 2009 Askar Balzhanov, CEO (Chairman of the Management Board) resigned from his position, and on June 1, 2009 Kenzhebek Ibrashev was elected as the Chairman of the Management Board.

·; On June 30, 2009 the BoD decided on Kairbek Eleusinov's resignation from the Management Board. Dovulbai Abilkhanov (Director of UMG) and Isturgan Baimukhanov (Director of EMG) were elected to the Management Board.

·; On October 5, 2009 Askar Aubakirov took a position of Deputy CEO for Corporate Development and Asset Management and was elected to the Management Board on December 1, 2009.

·; On January 26, 2009 the BoD decided on the resignation of Dovulbai Abilkhanov and Kairolla Yerezhepov from the Management Board. Bagitkali Biseken (as a Director of UMG) was elected to the Management Board.

·; On March 30, 2010 BoD decided on the resignation of Bagitkali Biseken who has been transferred from the position of Director of UMG, and Kiikbai Yeshmanov was elected to the Management Board.

 

RESPONSIBILITY OF THE BOARD OF DIRECTORS AND MANAGEMENT BOARD

 

The distribution of authority between the Board of Directors, Management Board and the CEO of the Company is set out in articles 12 and 13 of the Company's Charter.

 

The Board of Directors is responsible to shareholders for effective management and control of the Company and acts in compliance with the approved decision-making system. The most important functions of the Board of Directors are to determine the main directions of the Company's strategic development and policy, to consider potential acquisitions, and to review other essential issues.

 

In turn, the Management Board is responsible for developing an action plan for implementation of these functions and for the current operating activity of the Company. The Management Board reports to the Board of Directors on progress made in achieving the Company's goals.

 

The Board of Directors holds meetings on a regular basis and as required. 

 

In 2009, the Board of Directors held 35 meetings, including seven meetings held by voting in person, two meetings held by voting in person by a conference call, and 26 meetings held by proxy voting.

 

Throughout the year, the Board of Directors reviewed such issues as:

 

·; preliminary approval of the Company's consolidated financial statements for 2008;

·; the final results of the key performance indicators (KPI) of the Management Board, Head of Internal Audit and Corporate Secretary of the Company;

·; the report on the performance of the Board of Directors and the Management Board in 2008;

·; the report on performance evaluation of the Board of Directors in 2008.

·; a recommendation to review at the Annual General Meeting of shareholders the order of distribution of the Company's net income and the dividend amount per ordinary and preferred shares of the Company, based on the 2008 results.

 

In 2009, the Board of Directors business activities included the regular hearing of information on the results of the Company's financial and economic activity and on environmental protection, health and safety and of reports on the implementation of the previous decisions of the Board of Directors.

As a result, during 2009, the Board of Directors considered and made decisions on two interested party transactions

·; a contract of acquisition of a 100% stake in KazMunaiGas PKI Finance BV.,

·; agreement on assignment of rights and undertaking obligations with regard to the purchase of 33% shares in PetroKazakhstan Inc.

 

The Board of Directors approved the following documents in 2009:

·; Company principles;

·; Procurement Policy for the Company and legal entities in which KMG EP owns 100% of voting shares (equity stakes);

·; the list of information constituting an official, commercial or other secret of KMG EP and other information protected by law.  

 

The Board of Directors also made decisions on personnel issues, such as the appointment and resignation of the Management Board members, employees of the Internal Audit Service and the Corporate Secretary of the Company.

 

 

Directors' Attendance at the Meetings of the Board of Directors and Committees

 

 

The Management Board is the executive body and manages the current activities of the Company. In 2009 the Management Board held 38 meetings on a regular basis and as required.

 

During 2009 the Management Board reviewed and approved a number of key issues related to the Company's operating activity:

 

·; a number of regulatory technical documents with regard to industrial safety during drilling, well workover, labour and environmental protection; to improve the work safety and environmental protection system;

·; amendments to the collective agreement with regard to work remuneration, social relationships, health and safety in the workplace;

·; allocation of funds for the creation of over 1,000 social jobs in Zhanaozen, related to social protection and population support in the regions of Company's operations, in 2010;

·; the Company's internal procedures in compliance with the Integrated Management Standards;

·; creation of an operating management group in Aktau;

·; a medium-term production programme for 2009-2011 of KMG EP;

·; the Company's medium-term budget for 2009-2011;

·; the measures for implementation of the investment project 'Production of road bitumen in the Aktau Plastic Plant';

·; a number of projects for the potential acquisition of oil and gas assets located both in the Republic of Kazakhstan and abroad;

·; the Regulation on quarterly bonuses for production units of the Company based on the positive results of business and production activity.

 

The Management Board also decides on other issues of the Company's operations that are not referred to the exclusive competence of the general meeting of shareholders, the Board of Directors or the Company's officials.

 

 

 

Performance Evaluation of the Board of Directors

 

The Company Board has made a comprehensive assessment of its performance and of its committees in 2009. The assessment has been made by outside independent consultant. Such criteria as implementation of top-priority goals by the Board, professional balance, independence of the Board, its interaction with the management, the quality of key procedures of the Board's performance were used for the assessment. Certain recommendations given by the Board following this assessment, including INED's opinion, were discussed at the Board meeting on March 31, 2010. An action plan to improve the Board performance has been developed following the discussion.

 

According to the assessment, in 2009 the Board performed consistently and efficiently. The strategic planning committee contributed significantly to the Board to help it find optimal solutions.

 

Further efforts of the Board were aimed at strengthening risk management, improvement of internal controls within the Company. It was noted that Information support of the Board should be improved further.

 

 

AUDIT COMMITTEE

 

Membership

 

In 2009 the Audit Committee included only Independent Non-Executive Directors: Paul Manduca (Chairman of the Committee), Christopher Mackenzie and Edward Walshe. Appointments to the Audit Committee are made for a period of up to three years, extendable by no more than two additional three-year periods by resolution of the Board of Directors, as long as the members of the Audit Committee continue to be independent.

 

Number of Meetings 

 

During 2009 the Audit Committee held 11 meetings. The Chairman of the Audit Committee decides the frequency and timing of the Committee's meetings. A certain number of meetings shall be decided on in compliance with the requirements for the roles and responsibilities of the Committee. However, there are not less than four meetings in the course of a year, coinciding with key dates in the Company's financial statements preparation and audit cycle (when internal and external audit plans are available for review and when interim financial statements, preliminary announcements and the annual report are close to being completed).

 

Role and Responsibilities of the Audit Committee

 

The Audit Committee bears responsibility, among other things, for any statements containing financial information on the Company, for monitoring of the risk management system and internal controls system, and for involving the Company's auditors in this process. Also, it receives information from the Company's Internal Audit Department that monitors compliance with internal control procedures. In particular, the Committee deals with the issues of complying with the requirements of legislation, accounting standards and applicable UKLA and Kazakhstan Stock Exchange (KASE) rules, ensuring an effective internal controls system. The Board of Directors is responsible for preliminary approval of the annual financial report.

 

The Audit Committee reviews from time to time major acquisition and disposal transactions and any other issues which the Board of Directors may address to the Audit Committee.

 

Annually, at the general shareholders' meeting, the Chairman of the Audit Committee through the Chairman of the Board of Directors reports on the Audit Committee's performance and answers questions related to the Audit Committee's activity.

 

Activity of the Audit Committee in 2009

 

Ø Financial Reporting 

o Review of the preparation of financial statements in compliance with IFRS;

o Approval of quarterly and annual financial statements for disclosure to the Kazakhstan and London Stock Exchanges;

Ø Internal Controls and Risk Management System

o Assessment of the effectiveness of the internal controls and Risk Management system;

o Self-assessment of the Audit Committee;

Ø Internal Audit 

o Review and approval of the three-year Internal Audit Service plans;

o Assessment of the effectiveness of the internal audit;

o Review and approval of the report on the Audit Committee operation for 2008;

Ø External Audit 

o Recommendation of Ernst & Young Kazakhstan LLP as an external auditor of the Company.

 

 

REMUNERATION COMMITTEE

 

Membership

 

During 2009 this Committee comprised only Independent Non-Executive Directors. Its members were Christopher Mackenzie (Chairman of the Committee), Paul Manduca and Edward Walshe. The terms of office of the Committee members coincide with their terms of office as members of the Board of Directors.

 

Roles and Responsibilities of the Remuneration Committee

 

The Remuneration Committee bears responsibility for monitoring the Company's existing remuneration system for members of the Board of Directors, the CEO, members of the Management Board and other employees of the Company, including analysis of remuneration policy relative to that of other companies.

 

Further, the Remuneration Committee is responsible for developing and making recommendations to the Board of Directors on the principles and criteria for deciding the amount and terms of remuneration and compensation payments to members of the Board of Directors, the CEO and members of the Management Board. It is also responsible for approval of the terms and conditions of the Company's option plans; and other long-term employee incentive programmes for encouraging members of the Company's bodies and other Company employees.

 

The Remuneration Committee checks that the Company's remuneration policy and existing remuneration system are consistent with the Company's strategy and financial position and also with the labour market situation.

 

The Remuneration Committee monitors appropriate information disclosure with regard to the remuneration and compensation of members of the Company's Management Board and the Board of Directors, as required by the legislation of the Republic of Kazakhstan and by the Listing Rules and internal documents of the Company.

 

In addition, the Remuneration Committee exercises control over implementation of the decisions of the shareholders' general meeting in terms of determining the amount and procedure of remuneration payment to members of the Board of Directors.

 

The Remuneration Committee reports regularly to the Board of Directors on a regular basis and submits to the Board an annual analysis of the compliance of the Committee's activities with its Terms of Reference.

 

Activity of the Remuneration Committee in 2009

 

During 2009 the Remuneration Committee held eight meetings. Meetings of the Committee are held as required but not less than once every six months. Meetings may be convened on the initiative of the Chairman or members of the Committee or as decided by the Board of Directors.

In 2009 the Remuneration Committee reviewed issues such as:

 

o Creation of a working group for analysis of the Company's remuneration policy;

o Offering options to the Company's management and employees.

o Remuneration and approval of KPI for the Corporate Secretary of the Company;

o Salary indexation for members of the Management Board, the Corporate Secretary of the Company and employees of Internal Audit Department, taking inflation into account;

o Review of the results according to KPI for members of the Company's Management Board for 2008;

o Review of draft KPI charts for members of the Company's Management Board for 2009;

o Payment of annual remuneration for 2008 to the Company employees;

o Remuneration of the Company management, i.e. members of the Management Board;

o Succession of official positions held by foreign employees;

o Payment of advance annual remuneration for 2009 to members of the Management Board and the Corporate Secretary.

 

The total amount of remuneration accrued to Independent Non-Executive Directors for the year ending December 31, 2009 is presented in the table below:

 

 

Other members of the Board of Directors do not receive any remuneration as members of the Board but are entitled to reimbursement for the costs related to such appointment.

 

The total amount of remuneration accrued to members of the Management Board for the year ending December 31, 2009 is presented in the tables below:

 

 

 

\* The total amount for 2009 excludes a part of annual payment for 2008 paid to Kurbanbayev M. in the amount of KZT 4,445,000; Mr. Kurbanbayev has worked as a Director of UMG and was member of Management Board until October 8, 2009.

 

Directors and members of the Management Board were granted KMG EP's GDR Options in accordance with the Provisions of the Company Option Programme. The table below represents GDR options which were granted but not exercised yet.

 

 

NOMINATIONS COMMITTEE

 

In 2009 the Nominations Committee comprised Independent Non-Executive Directors Christopher Mackenzie, Edward Walshe and Chairman of the Board of Directors Kairgeldy Kabyldin, who was also the Chairman of the Committee.

During 2009 the Nominations Committee held six meetings.

The main purpose of the Committee's activity is to improve the effectiveness and quality of work of the Board of Directors in the selection of specialists for substitute positions in the Company's bodies. It also ensures continuity despite replacement of the Company's personnel, and determines criteria for the selection of candidates for the positions of the Board of Directors, CEO, members of the Management Board and Corporate Secretary of the Company.

The Nominations Committee reviews issues related to changes in membership of the Board of Directors and the Management Board, the resignation and appointment of the Corporate Secretary, and the retirement and appointment of additional and substituting directors.

 

 

STRATEGIC PLANNING COMMITTEE

 

In 2009 the Committee comprised members of the Board of Directors Kenzhebek Ibrashev, Askar Balzhanov and Independent Non-Executive Director Edward Walshe, who was the Chairman of the Committee.

 

The main purpose of the Committee's activity is to develop and advise the Company's Board of Directors on the prioritisation and direction of the Company's operations and development strategy.

 

Activity of the Strategic Planning Committee in 2009

 

During 2009 the Committee held four meetings where the following issues were reviewed:

 

·; The Company's development strategy;

·; Approval of participation of the Company and its 100% subsidiary in creating a subsidiary entity;

·; Approval of interested party transaction - a contract of 100% acquisition stake in KazMunaiGas PKI Finance BV;

·; New oil and gas asset acquisition projects in the Republic of Kazakhstan and abroad;

·; Prospective exploration projects;

·; Oil price forecast scenario for 2010-2014;

·; Operational issues and further development of UMG fields;

·; Analysis of lifting costs and capital expenditure;

·; Entering new projects and the degree of support from NC KMG in these issues;

·; Petrochemical issues.

 

Interests of the Directors and Members of the Management Board 

 

The interests of the Directors and Management Board members in ordinary, preference shares and GDRs, according to the information provided by the Board of Directors and the Management Board members as of December 31, 2009:

 

 

PRINCIPAL SHAREHOLDERS AND/OR GDR HOLDERS

 

Below is shown a list of shareholders as of December 31, 2009 which is Company must disclose in accordance with the legislation of the Republic of Kazakhstan.

This requirement is not applicable to GDR holders, however the Company is aware that on September 30, 2009 the state investment fund of the People's Republic of China, China Investment Corporation (CIC), announced its purchase of Company's GDRs equivalent to 11% of the Company's shares.

 

(1) Including GDRs purchased to implement the Company's Option Program and held in trust (as of December 31, 2009 - 1,419,656 GDRs), and the shares and GDRs purchased in accordance with own share buyback programme (as of December 31, 2009 - 8,699,697 GDRs and 110,632 shares).

 

 

DIRECTORS' EMPLOYMENT CONTRACTS AND LETTERS OF APPOINTMENT AND EMPLOYMENT CONTRACTS OF THE MEMBERS OF THE MANAGEMENT BOARD

 

Employment Contracts with Directors

 

In connection with the expiration of the Board of Directors' term of appointment on March 26, 2010 the term of office of the existing Board of Directors of the Company was extended for three years. Kairgeldy Kabyldin, the Chairman of the Board of Directors and Christopher Mackenzie, the independent director decided to withdraw from the Board reappointment process.

 

During 2009 Kairgeldy Kabyldin was Chairman of the Board of Directors. He was appointed a Director at the extraordinary general shareholders' meeting on September 24, 2008. The Board of Directors elected Mr. Kabyldin as its Chairman on October 8, 2008. 

 

In 2009 Kenzhebek Ibrashev was a member of the Board of Directors and CEO of the Company. He was elected a member of the Board of Directors at the general shareholders' meeting on October 30, 2007 and appointed CEO of the Company at the meeting of the Board of Directors on May 28, 2009. 

 

During 2009 Askar Balzhanov was a member of the Board of Directors of the Company. He was elected a member of the Board of Directors at the general shareholders' meeting on June 12, 2006. As per the Board of Directors' decision on March 30, 2010 Askar Balzhanov was elected as the new Chairman of the Board.

 

In 2009 Yerzhan Zhangaulov was a member of the Board of Directors of the Company. He was elected a member of the Board of Directors at the general shareholders' meeting on June 12, 2006.

 

In 2009 Tolegen Bozzhanov was a member of the Board of Directors of the Company. He was elected a member of the Board of Directors at the general shareholders' meeting on September 24, 2008.

 

Christopher Mackenzie was appointed an Independent Non-Executive Director of the Company on August 28, 2006. In connection with his term appointment expiration in 2010, Christopher Mackenzie decided to withdraw from the Board reappointment process.

 

Paul Manduca was appointed an Independent Non-Executive Director of the Company on August 28, 2006. In connection with the expiry of his term of appointment, his term of office was extended for three years by resolution of the general shareholders' meeting of the Company dated March 26, 2010

 

Edward Walshe was appointed an Independent Non-Executive Director of the Company on August 28, 2006. In connection with the expiry of his term of appointment, his term of office was also extended for three years by resolution of the general shareholders' meeting of the Company dated March 26, 2010

 

Employment Contracts of Members of the Management Board

 

All members of the Management Board have entered into employment contracts with the Company that generally provide for business travel insurance and reimbursement of costs incurred during business trips on the Company's behalf, in accordance with the Company's internal regulations. Other than those set out above, no employment contracts exist, or are anticipated to be entered into, between the Company and members of the Board of Directors or Management Board.

 

INTERNAL CONTROL AND RISK MANAGEMENT

 

The Company has a system of internal control and risk management. This system is designed to identify, evaluate and manage the significant risks associated with the Company's achievement of its business objectives, with a view to safeguarding shareholders' investments in the Company.

 

The Directors confirm that, throughout the year ended December 31, 2009 there have been processes in place for identifying, evaluating and managing the significant risks faced by the Company. In addition the Directors adopt a risk-based approach in establishing the system of internal control and in reviewing its effectiveness.

 

Key elements of the Company's system of internal control are:

 

·; The Company's internal documentation, such as financial, treasury, operating and administrative policies and other procedures;

 

·; Continuous review of safety, operating and financial performance of the Company;

 

·; The Company's Internal Audit provides Board of Directors with assurance that the management processes are adequate to identify and monitor significant risks; confirms the effectiveness of operations of the established internal control systems; ensures processes for feedback on risks management and assurance are credible; and provides with objective confirmation that the Board of Directors receives the right quality of assurance and information from management and this information is reliable.

 

In addition, information in respect of financial risk management can be found in the Financial Review commencing on page 45, overall information on Company's risk profile can be found in section Risk Factors on page 56 and initiatives in the area of health, safety and the environment can be found in the Corporate Responsibility Section commencing on page 32.

 

In relation to risk management, the Management Board has established a Risk Management Committee, more details on its operation can be found below.

 

RISK MANAGEMENT COMMITTEE

 

During 2009 the Risk Management Committee was chaired by CEO Kenzhebek Ibrashev. It comprised the first deputy CEO for Production - Head of Operating Management Group in Aktau, CFO, Deputy CEO for Corporate Development and Asset Management, Managing Director - Financial Controller, Managing Director on Economics and Finance, Managing Director of Business Development, Managing Director on Legal Issues, Managing Director on Information Technologies, Managing Director on Human Resources and Social Policy, Managing Director of HSE, and Corporate Secretary. The Head of Internal Audit participated in the Committee's meetings as an observer.

 

The primary goal of the Committee is the timely consideration of issues related to risk management, the preparation of recommendations to the Management Board to support decision-making on such issues, and monitoring of the risk management system's performance. It is also concerned with formulating recommendations to structural divisions of the Company on improving the risk management system in order to increase the effectiveness of business processes and reach the Company's strategic goals.

In the new version of the Provision for the Risk Management Committee approved by the Management Board in 2009, the Committee's functions were broadened, particularly in the area of strategic planning and investment project analysis.

 

In 2009 the Risk Management Committee met three times and made decisions on the following:

 

·; Planning the development of a risk management system;

·; Review of a standard procedural document on risk management;

·; Consideration of the report on identification and evaluation of the Company's risk portfolio;

·; Issues of implementing the risk management system in the operational divisions;

·; Consideration of the renewal terms of the corporate insurance programme for 2010;

·; Improvement of corporate governance;

·; Development prospects for a training system;

·; Issues of developing a Business Continuity Plan;

·; Consideration of amendments to the Provision for the Risk Management Committee;

·; Consideration of current situations arising from the normal operations of the structural divisions of the Company in 2009.

 

 

UNITED KINGDOM TAX CONSIDERATIONS

 

The comments below are of a general nature and are based on current United Kingdom law and HM Revenue & Customs practice at the date of this document, both of which are subject to change, possibly with retrospective effect. Except where otherwise stated, the summary discusses only certain UK tax consequences for absolute beneficial owners of the shares or GDRs who are (1) resident in the UK for tax purposes; (2) not resident for tax purposes in any other jurisdiction; and (3) not in possession of a permanent residence or fixed base in Kazakhstan with which the holding of the shares or GDRs is connected (''UK Holders'').

 

In addition, the summary (1) addresses only the tax consequences for UK Holders who hold the shares and GDRs as capital assets, and does not address the tax consequences that may apply to certain other categories of UK holders, e.g. dealers; (2) assumes that the UK Holder does not either directly or indirectly control 10% or more of the voting power of the company; (3) assumes that a holder of the GDRs is beneficially entitled to the underlying shares and to the dividends on those shares; and (4) does not address the tax consequences for UK Holders that are insurance companies, investment companies or pension funds connected with the Company.

 

The following is intended only as a general guide and is not intended to be, nor should be considered to be, legal or tax advice to any particular UK Holder. Accordingly, potential investors should satisfy themselves as to the overall tax consequences, including, specifically, the consequences under UK law and HM Revenue & Customs practice, of the acquisition, ownership and disposal of the shares or the GDRs in their own particular circumstances.

 

Withholding Tax

 

Assuming that the income received under the GDRs does not have a United Kingdom source, there should be no United Kingdom withholding tax on payment of any such income. Dividend payments in respect of the shares will not be subject to UK withholding tax.

 

Taxation of Dividends

 

A UK Holder receiving a dividend on the shares or the GDRs may be subject to UK income tax or corporation tax, as the case may be, on the gross amount of any dividend paid before the deduction of any Kazakhstan withholding taxes, subject to the availability of any credit for Kazakhstan tax withheld. A UK Holder who is an individual resident and domiciled in the UK will be subject to UK income tax on the dividend paid on the shares or the GDRs and is entitled to a non-refundable tax credit equal to one ninth of the dividend received. A UK Holder who is an individual resident but not domiciled in the UK and who is entitled to be taxed in the UK on the remittance basis will be subject to UK income tax on the dividend paid on the shares or the GDRs to the extent that the dividend is remitted, or treated as remitted, to the UK and will also be entitled to a non-refundable tax credit equal to one ninth of the dividend received.

 

A UK Holder who is a company resident in the UK will with effect from July 1, 2009 not be subject to UK corporation tax on a dividend paid on the shares or the GDRs unless it falls within certain specific anti-avoidance rules.

 

Taxation of Disposals or Deemed Disposals

 

The disposal by a UK Holder of interests in the shares or the GDRs may give rise to a chargeable gain or allowable loss for the purposes of UK taxation of chargeable gains, depending on the UK Holder's circumstances and subject to any available exemption or relief. A UK Holder who is an individual and domiciled in the UK will generally be liable to UK capital gains tax on chargeable gains made on the disposal of an interest in the shares or the GDRs. A UK Holder who is an individual but not domiciled in the UK and who is entitled to be taxed in the UK on the remittance basis will generally be liable to UK capital gains tax to the extent that the chargeable gains made on the disposal of an interest in the shares or the GDRs are remitted or treated as remitted to the UK. In particular, dealings in the GDRs on the London Stock Exchange may give rise to remitted profits that would, therefore, give rise to UK capital gains tax liability.

 

An individual holder of the shares or the GDRs who ceases to be resident or ordinarily resident in the UK for UK tax purposes for a period of less than five years and who disposes of such shares or GDRs during that period may also be liable on returning to the UK to UK tax on capital gains, even though the individual may not be resident or ordinarily resident in the UK at the time of the disposal.

 

A corporate UK Holder will generally be subject to UK corporation tax on any chargeable gain arising from a disposal of the shares or the GDRs.

 

Effect of Kazakhstan Withholding Taxes

 

Dividend payments in respect of the shares and the GDRs will be subject to Kazakhstan withholding taxes. A UK Holder who is an individual resident should generally be entitled to a credit for Kazakhstan tax properly withheld from such payments against such investor's liability to income tax on such amounts, subject to UK tax rules for calculation of such a credit. From July 1, 2009 a UK Holder who is a UK resident company will not be subject to UK corporation tax on a dividend payment and so will not be able to claim credit for any Kazakhstan tax.

 

Stamp Duty and Stamp Duty Reserve Tax (''SDRT'')

 

Assuming that any document effecting a transfer of, or containing an agreement to transfer, one or more of the shares or the GDRs is neither (i) executed in the UK nor (ii) relates to any property situate, or to any matter or thing done or to be done, in the UK (which may include involvement of UK bank accounts in payment mechanics), then no UK ad valorem stamp duty should be payable on such a document.

 

Even if a document effecting a transfer of, or containing an agreement to transfer, one or more of the shares or the GDRs is (i) executed in the UK and/or (ii) relates to any property situate, or to any matter or thing done or to be done, in the UK, in practice it should not be necessary to pay any UK ad valorem stamp duty on such a document unless the document is required for any purposes in the UK. If it is necessary to pay UK ad valorem stamp duty, it may also be necessary to pay interest and penalties.

 

As the GDRs relate to stock expressed in a currency other than sterling, no ''bearer instrument'' stamp duty should be payable on either the issue of the GDRs or any transfer of stock transferable by means of the GDRs.

 

Assuming that the shares are neither (i) registered in a register kept in the UK nor (ii) paired with shares issued by a company incorporated in the UK, no SDRT should be payable in respect of any agreement to transfer the shares or the GDRs.

 

 

 

 

 

YEAR 2009 OPERATING AND FINANCIAL REVIEW

 

The following document is intended to assist the understanding and assessment of trends and significant changes in the Group's results and financial condition. In this document, the consolidated financial statements presented are those of the Company. This review is based on the consolidated financial statements of the Company and should be read in conjunction with those statements and the accompanying notes. All the financial data and discussions thereof are based upon financial statements prepared in accordance with IFRS.

 

 

KazMunaiGas Exploration Production Joint Stock Company (hereinafter - the Company or KMG EP) is engaged in the acquisition, exploration, development, production, processing and export of hydrocarbons, its core operations being oil and gas properties located in the Pre-Caspian and Mangistau basins of western Kazakhstan. The Company's majority shareholder is Joint Stock Company National Company KazMunaiGas, which represents the state's interests in the Kazakh oil and gas industry. The Company conducts its core production activities at 41 oil and gas fields, including the production branch "Uzenmunaigas" (hereinafter - UMG), consisting of 2 fields, and the production branch "Emb amunaigas" (hereinafter - EMG), consisting of 39 fields. The Company has a 50% interest in the oil and gas production joint ventures Kazgermunai LLP and CCEL, and a 33% interest in PetroKazakhstan Inc.

 

As of December 22, 2009 KMG EP finalized the acquisition of a 33% stake in PetroKazakhstan Inc ("PKI"). PetroKazakhstan Inc. ("PetroKazakhstan") is involved in exploration, development and production of hydrocarbons as well as sales of oil and oil products. PetroKazakhstan also has stakes in 16 oil fields, 11 of which are at different stages of development. The second shareholder in PetroKazakhstan is CNPC Exploration and Development Company Ltd. (CNPC E&D), which owns 67% of the company.

 

The total oil production of the Company and its associates, based on the Company's working interest (50% share in JV Kazgermunai LLP and 50% share in CCEL), was approximately 11.497,000 tonnes or 232 kbopd (UMG and EMG - 181 kbopd, JV Kazgermunai LLP - 34 kbopd and CCEL - 17 kbopd) for 2009.

 

Further details of the above three associates are given in the section: Overview of Associates' Operations. Elsewhere in this Operating and Financial Review, the discussion is limited to the core assets of the Company unless indicated otherwise.

 

 

Economic factors affecting the Company's financial performance during the year under review include movements in crude oil prices, foreign exchange, particularly the tenge-US dollar rate, and domestic inflation rates.

 

Business Environment in 2009

 

The price of Brent averaged US$61.67 per barrel for 2009, a decrease of US$35.41 per barrel from the average price in the previous year.

 

Most of the Company's revenues, financial assets and borrowings are denominated in US dollars, while most of the Company's operating expenses are denominated in tenge. The impact of foreign currency fluctuations on the Company's results depends on its net foreign currency position and the magnitude and direction of any fluctuation in foreign exchange rates.

 

Tenge-US dollar exchange rates and domestic inflation, as measured by the consumer price index ("CPI") for the periods presented, were as follows:

 

The tenge depreciated against the US dollar from 120.29 KZT/US$ in 2008 to 147.5 KZT/US$ in 2009. The inflation rate in 2009 was 6.2% compared to 9.5% in 2008.

 

 

The Company almost achieved its target production goals for 2009 with oil production of 8,962K tonnes, which was 5% lower than the 2008 actual oil production and 37,852K tonnes below the 2009 oil production plan. The non-fulfillment of the production plan was due to the reduction by 49.192K tonnes in the UMG and over-fulfillment of the EMG plan by 11.340K tonnes.

 

 

The main reasons for the non-fulfillment of the UMG production plan were the abnormal winter of 2009, with its abundant snowfall and frost and weather-related power supply problems.

 

Severe weather conditions caused an increase in the quantity of non-operating well stock and the number of wells working below optimal operating conditions. Flow lines were frozen, well-service brigades experienced production time losses, personnel was unable to access fields, etc. Company losses on this account are estimated as 62K tonnes.

 

Power supply cut-off caused emergency production shutdown, water injection shutdown, and underground equipment failures. Company losses on this account are estimated as 13K tonnes.

 

As of December 31, 2009, the well stock of the Company includes 5,853 production and 1,658 injection wells.

 

The majority of the Company's existing oil fields are at the mature stage of development, characterized by high water cut and declining oil production. The Company performed production drilling, work-over operations and enhanced recovery in order to mitigate natural production decline and achieve its oil production plan for 2009.

 

In 2009, the Company plugged in 95 wells compared to 149 wells in 2008. Oil production generated by new wells was 122.1K tonnes compared to 216.4K tonnes in 2008. The work-over of 206 wells provided an incremental production of 601.57 tonnes. The Company applies enhanced recovery techniques, including hydro-fracturing and polymer systems. As a result of 235 enhanced recovery operations, an additional 324.31K tonnes were produced.

 

During 2009, the Company carried out exploration works in the R-9, Liman blocks and appraisal works in the S. Nurzhanov oilfield. Wells #503-504 were spudded in 2008 and two 2009 wells on Nurzhanov field, #505-506, were completed. As of December 31, 2009 construction of exploration well #1 in the salt structure of the Karashungul (R-9 block), with a depth of 2,100m, was in progress.

 

In 2009, 3D seismic data processing and interpretation works begun in 2008 in R-9 block were completed. 2D field exploration seismology works of 400 running km (Shokat, Akshi and Imankara) were carried out. An exploration project (above-salt and subsalt complexes) was considered and aligned with the MTD "Zapkaznedra" on June 25, 2009. The project covers drilling of wells in the Buiyrgyn (subsalt), Karashungul and Kyzylkuduk (above-salt) structures. On the basis of this project, the development wells construction project is being prepared.

 

At the beginning of 2009, 2D exploration seismology results (700 running km) for 2008 and 2D exploration seismology reinterpretation works of 800 running km on the Liman block were considered. Recommendations of further G&G works were received. An exploration project (above-salt and subsalt complexes) on Liman block was prepared. The project is in the process of alignment with the MTD "Zapkaznedra".

 

 

 

It is expected that crude oil production in 2010 will be 9.20 million tonnes, which is 3% more than in 2009. Because of this increase, and to compensate for the natural decrease in production in 2010, the Company is planning the drilling of 113 production wells, 83 injection and 4 appraisal well in addition to well work-overs, bottomhole treatment and the sealing off of productive wells from the inactive ones.

For 2010, the Company is planning exploratory works on the prospective blocks to specify the geological structure further and justify the objectives of exploratory drilling. In particular, on R-9 block the Company is planning to carry out 3D field works of 400 square kilometers on the South-Eastern Koschagyl structure, drilling of a subsalt well on Buiyrgyn structure with a project depth of 7,000m, and drilling of an above-salt well on the Karashungul structure with a project depth of 2,500m.

 

On Liman block, 3D seismic research is planned for the Saraishyk structure of 360 square kilometres. Drilling of exploratory wells with depths of 7,000m and 2,000m is expected to determine oil and gas content. Exploratory drilling of 3,000m is planned on Liman block. This includes 2,000m of work on the above-salt complex and a 1,000m work on the subsalt complex.

 

The results of drilling at well #502 in the Southern Nurzhanov field confirmed an extension of the oil deposits spread square of the separate south block. For the further specifications of the potential drilling, two project wells, #507 and #508, with a depth of 3,500m, are planned for 2010. Drilling of one exploratory well to a depth of 2,000m is planned in the top part of the field cross-section. The total expected volume of all three wells is 9,000m. Drilling of one exploratory well with a project depth of 1,500m is planned on the Eastern Makat field in order to assess the geological structure and identify the prospects of productive density. Drilling of one exploratory well with a depth of 3,200m is planned on the south wing of the Western Prorva field in 2010. The previously planned drilling of an exploratory well with a project depth of 2,900m in the Botakhan field was postponed from 2010 to 2011. Owing to the poor quality of the data from seismic exploration of the Kenbay field, 3D seismic exploration of an area of 128 square-kilometers is planned on the Eastern Moldabek and the Northern Kotyrtas sites. In order to prepare for drilling of the exploratory wells, 3D seismic exploration over an area of 300 square kilometers is planned in Zhanatalap field. Reprocessing and reinterpretation of 3D seismic data is planned in Kisimbay field in 2010 on account of significant differences from the data obtained from drilling.

 

In 2010, the capital expenditure of the Company is expected to be KZT95 billion. The Company's budget will be periodically reviewed to reflect changes in oil price, exchange and inflation rates, among other factors.

 

In 2010, KMG EP intends to continue its acquisition strategy, targeting assets both in Kazakhstan and abroad.

 

 

Amounts shown in US dollars are included solely for the convenience of the reader, at the average rate over the applicable period. This rate is based on information derived from the consolidated income statements and consolidated cash flow statements and the end of the period rate for information derived from the consolidated balance sheets. See "Business Environment and Outlook".

Key Indexes

 

(1) Converted at 7.36 barrels per tonne of crude oil.

(2) Operating expenses net of export customs duty and rental tax.

(3) Net income for the period

(4) Oil production and other costs represent an aggregate of the following operating expenses line items (as presented in the Company's consolidated financial statement for the year ending December 31, 2009 (see Company website for a copy): employee benefits, materials, repairs, maintenance and other services, energy and other costs. These include costs related to gas producing and processing activities, oil processing activities and general and administrative costs which are not directly related to oil production and which increased the US dollar cost per barrel by approximately US$1.55 and US$2.04 for the years 2009 and 2008 respectively (US$1.58 è 1.79 for the quarters ending December 31, 2009 and December 31, 2008 respectively).

 

Transport Routes

The Company delivers its crude oil through three principal routes: export markets via the pipeline owned by Caspian Pipeline Consortium (CPC), the Uzen-Atyrau-Samara pipeline (UAS) owned by JSC KazTransOil (in Kazakhstan) and the domestic market, as outlined in the following table:

 

The relative profitability of the two export routes depends on the quality of oil in the pipeline, the prevailing international market prices and the relevant pipeline tariffs. Specifically, CPC tends to be more advantageous owing to the higher quality of crude oil in the CPC pipeline in a higher price oil environment, even after taking into account quality bank payments. However, in 2009, the CPC route was less attractive than the UAS for several reasons. The first is the difference between the actual average realisation price and the average market price for 2009 (US$58.32 and US$61.02 per bbl accordingly), due to the volatility of the price of crude oil. The second factor is excess of quality bank expenses over the premium from bbl factor (5.68 and 4.93 US dollars per barrel accordingly). The premium from bbl factor resulted from a bbl coefficient increase from 7.23 to 7.84 for the transport through CPC (in 2009).

It should be noted that KMG EP has obligations to provide crude oil for domestic market. In addition, the Kazakh Ministry for Energy and Mineral Resources sets the quotas for export volumes.

 

Revenue

The following table shows sales volumes and realised prices for Q3 2009, Q4 2009, Q4 2008, 12m 2009 and 12m 2008:

 

(1) Average sales price under financial statement (realised price), converted at 7.23 barrels per tonne of crude oil.

 

Crude Oil Sales in 2009

Total sales of crude oil in 2009, in comparison with 2008, decreased by 20% to KZT473 billion, primarily owing to the 33% decrease in the average sales price and the decrease in the sales volume by 2% (or 174K tonnes). The sales volume decrease was caused by a limited oil receptionat Atyrau refinery. It should be noted that the rate of the 33% average sales price decrease was lower than the 36% world price decrease because the domestic sales volume reduction and the export sales volume increase had a positive impact on the average sales price.

 

Export - UAS Pipeline

Sales of crude oil exported via the UAS pipeline in 2009 decreased by 18% to KZT313 billion owing to the decrease of the average sales price by 19% to KZT63,293 per tonne and was partially adjusted by the increase of volume exported via the UAS by 50 thousand tonnes or 1%.

Revenue from export sales through the UAS pipeline in Q4 2009 in comparison with Q4 2008 increased by 76% owing to the increase of the average sales price by 83% to KZT77,654 per tonne. This effect was partially adjusted by the 4% decrease by 47 thousand tonnes in sales volume.

 

Export - CPC Pipeline

Sales of exported crude oil via the CPC pipeline in 2009 decreased by 27% to KZT123 billion compared to 2008. The decrease was due to an average realisation price decrease by 23% to KZT61,389 per tonne and the 5% decrease of volume exported via the CPC. The negative impact on sales was caused by the fact that benefits from the bbl premium happened to be 13% lower than quality bank expenses, whereas in 2008 the difference was 9%.

Revenue from export sales through the CPC pipeline in Q4 2009 by comparison with Q4 2008 increased by 45% owing to the increase of average sales price by 115% and the 33% decrease of sales volume. Because of this, benefits from the bbl factor exceeded quality bank expenses.

Domestic Market - Sales of Crude Oil

Domestic sales of crude oil in 2009 were on a par with those of 2008. In Q4 2009 domestic sales increased by 64% compared to Q4 2008, helped by an increase of sales volume by 52% and an increase of average sales price by 8%. 

 

 

The following table shows the Company's realised sales prices adjusted for crude oil transport and other expenses for the periods ending September 30, 2009 and December 31, 2009 and 2008:

 

 

 

(1) The following quoted prices are used as benchmarks: for Q4 and 12m 2008 Urals (RCMB) through the UAS and CPC blend (CIF) the

CPC pipeline; for the 1H 2009 Urals NOVO 80KT through the UAS and CPC FOB 80kt through the CPC; for 2H 2009 Brent (DTD).

 (2) Average realised price by financial report converted at 7.23 barrels per tonne of crude oil

 

The difference between the benchmark quote and the realised price of sales through the CPC mainly comprises freight expenses, port charges, customs fees, certain sales commissions and averaging effects. Averaging effects usually appear because of the difference between the average mean of quoted price on the sale date and the average published price over the whole period; this difference may be significant on account of the high volatility of oil prices. The price received for domestic sales of crude oil is determined primarily by the agreement with NC KMG (production cost + 3%).

 

Operating Expenses

The Company's operating expenses relate primarily to the cost of producing crude oil. The following table presents a breakdown of the Company's operating expenses:

 

Operating expenses in 2009 increased by 11% or KZT33 billion, compared to 2008. This is primarily due to the increased mineral extraction tax resulting from an accrual of tax provisions in the results of a tax audit from 2004-2005, an increase of employee benefits, and changes in crude oil balance.

 

In accordance with the new tax code, royalty was replaced by the mineral extraction tax (MET) starting in January 1, 2009. The increase of MET expenses compared to royalty is due to the fact that MET is calculated on the basis of oil market price while royalty is calculated from the sales price.

 

Employee benefits expenses for 2009 increased by 18% compared to 2008, owing to the 80% payroll increase and the increase in average expenses per employee by 19%. The increase of headcount was due to changing labour demands. Average salary increased owing to adjustments in the basic tariffs of production personnel salary, increase of bonuses to production personnel and the growth of the EMG regional salary coefficient to the UMG coefficient level.

 

Expenses on depreciation, depletion, and amortization decreased and losses on disposals of fixed assets increased in the reported period compared to 2008, owing to the fact that in the previous year a total of 215 wells were liquidated, compared to 320 in 2009. In addition, amortization of the Liman block licence was accrued for 12 months in 2008, while in the reporting period it was accrued only till February 19, 2009 owing to expiry of the licence term.

 

Repairs, maintenance and other service expenses decreased by 13% compared to 2008 owing to a decrease in well work-overs and the volume of 2D and 3D research works according to the production plan for 2009. In addition, in 2008 2D research expenses on Liman block were written-off. 

 

Energy expenses have increased by 12% owing to an increase in power tariffs and power transmission tariffs. The effect of this was partly mitigated by a decrease in energy and technical water consumption.

 

The Company used its own oil products processed at the Atyrau refinery, resulting in a 20% decrease in material expenses.

 

Management fees and commissions are paid according to the management services agreement with NC KazMunaiGas. A 9% decrease in expenses is due to a reduction of the annual management fee by 10%.

The increase in "Fines and Penalties" category by KZT6.3 billion was due to accrual of tax provisions resulting from the tax audit for 2004-2005. The Tax Committee of the Finance Ministry made a complete audit for the period of 2004-2005. As a result of the tax audit, commenced in 2007 and completed on August 5, 2009, additional accruals to the amount of KZT32 billion were provided, including tax deficiencies totalling KZT16.2 billion, made up of a KZT8.0 billion administrative penalty (due to tax law violation) and KZT7.8 billion in late payment interest. The main reasons for the previous shortfall are transport and other service expenses, treated by the tax authority as CAPEX, and income from fixed assets revaluation not recognized by the Company for tax purposes.

The Company's management believes that its interpretations of the tax legislation were appropriate and that the Company has strong arguments in support of its tax position. The Company will dispute the tax assessment to the fullest extent possible under the law of the Republic of Kazakhstan. However, given the uncertainty of the outcome of the dispute because of ambiguity, varying interpretations and inconsistencies of opinion on the part of the tax authorities, the management recognized the need to accrue certain amounts. As of December 31, 2009, on account of similar violations in 2004-2005, provisions amounting to KZT9.1 billion, including fines and penalties, are also accrued.

 

Taxes other than those on income decreased by 12% in 2009 compared to 2008. The main reasons for this decrease are remission of road tax and production bonus, reduction of environmental pollution charges and their basis (the list of emissions), while the decrease in average social tax rates was partly offset by the growth in the property tax rate.

 

In 2009, joint ventures investments, totaling KZT3,0 billion, were higher by 27% than in the previous year. This was because on October 1, 2009, KMG EP paid off its remaining contributions to charter capital of LLP KPI Inc. At the balance sheet date, EP KMG has fully paid in shares of LLP KPI Inc., equivalent to KZT4.9 billion.

 

The increase in expenses on social infrastructure projects was due to the provision of sponsorship for the development of the infrastructure of Zhana-Ozen and the impairment of social facilities.

 

As of December 31, 2009, expenses listed under "Change in crude oil balance" are connected to the increase of the inventory balance. These accounts were carried forward to 2010 due to unfavourable weather conditions at the end of the reported period.

 

 

Finance Income (Cost) and Exchange Rate Difference (Net Finance Income/Expense)

 

The Company's financial income in each of the periods relates mainly to interest on deposits, and, when the tenge depreciates, foreign exchange gains. The Company's financial expense in each of the periods comprises mainly of interest on borrowings and the termination of a discount related to asset retirement obligations and historical obligations.

 

The net financial income for 2009 was KZT133.1 billion and exceeded the net financial income for 2008 by KZT90.1 billion. This was due to the growth in a net foreign exchange gain by KZT88.8 billion, resulting from devaluation of the tenge in February 2009 and an increase of interest income by KZT1.3 billion. Interest income increases resulted from an increased rate of the USD deposits under the terms of tenge depreciation.

 

Share of Earnings by Associates and Joint Ventures

The Company's loss from its share in associates and joint ventures in 2009 was KZT2.5 billion compared to KZT57.6 billion income in 2008. The main reason for this change is the decrease of income from the share in JV Kazgermunai LLP by KZT61.2 billion.

Income Tax Expense

 

The income tax expenses in 2009 decreased by KZT91.3billion, or 55%, due to the decrease of income before tax by 19% and a 21% decrease of income tax.

 

 

The decrease in the overall income tax rate in 2009, compared to 2008, resulted from the new tax code adopted on January 1, 2009. The new tax code introduced a decrease of CIT rates from 30% to 20%, which is a significant decrease in effective excess profit tax rate. The proportion of EPT in the total amount of income tax is increased in 2009 from 2008. In accordance with EPT calculation method, the progressive rates scale proportional to income is used. During the period, the EPT marginal rate for each individual oilfield increased by 1.25-2 times.

 

 

Profit for the Period

As a result of the factors mentioned above, in 2009 the Company's profit for the period decreased by 13% to KZT209.7 billion compared to 2008.

 

 

 

JV Kazgermunai LLP

 

JV Kazgermunai LLP's (Kazgermunai) key financial and operational indicators are shown below:

 

 

The Company's share (50%) in Kazgermunai oil production in 2009 was 1,601 thousand tonnes. Capital expenditure is US$99.7 million. The company's share in income of the joint venture in accordance with consolidated financial statements of the Company in 2009 is KZT2.4 billion. The Company received dividends in the amount of US$25 million from Kazgermunai LLP in 2009 (it was US$325 million in year 2008). This significant decrease in dividends took place because of the 69% reduction in the net income of Kazgermunai LLP compared to 2008. The decrease of net income was due to the 34% reduction of revenue, the introduction of a new tax code in 2009, accrual of environmental fines for excessive gas flaring and a change in revenue recognition.

 

In 2010, Kazgermunai plans to produce 3 million tonnes of crude oil and to drill 15 development wells. Capital expenditure of KZT15.1 billion in 2010 is planned.

 

 

Karazhanbasmunai JCS

 

Karazhanbasmunai JCS's key financial and operational indicators are shown below:

 

 

For the year 2009, the Company recognized finance income from its investment in Karazhanbasmunai JCS (50% share) as US$16.3 million. Capital expenses for 2009 are US$110.0 million or 52% less than for 2008. The decrease in net income in 2009 is due to the increased tax burden compared to 2008.

 

In 2010 Karazhanbasmunai JCS planned to produce 1.9 million tonnes of crude oil. Capital expenditure in 2010 is expected to be KZT23.0 billion (US$153 million).

 

PetroKazakhstan Inc.

 

In 2009, it produced 6.292K tonnes as against 6.390K tonnes in 2008.

The share of results of the joint venture included in the consolidated financial statements of the KMG EP is as follows:

 

Liquidity and Capital Resources

 

Summary of Cash Flows

 

The Company's liquidity requirements arise principally from the need to finance its existing operations (working capital), the need to finance investment (capital expenditure) and realise its growth targets via acquisitions. The management believes that the Company has adequate liquidity to meet its short-term obligations and pursue investment opportunities.

 

 

In 2009, net cash generated from operating activities was KZT149.2 billion, decreasing by KZT14.7 billion compared to 2008. This decrease in profit is due to export revenue reductions and a decrease of the share in the income of joint ventures.

 

Net cash used in investment activities increased by KZT393.2 billion in 2009. This increase was mainly due to growth in net cash outflows from financial asset operations of KZT340.8 billion. This effect was partly mitigated by a decrease of dividends received from joint ventures by KZT35.4 billion and a KZT18.7 billion decrease of interest received.

 

In 2009 and 2008, the Company's capital expenditure, calculated on a cash basis, was KZT43.3 billion and KZT41.9 billion respectively.

 

Net cash outflows from financing activities increased by KZT33.0 billon in 2009 compared to 2008. The change in cash outflows was mainly due to the repurchase of treasury shares valued at KZT21.4 billion, increasing dividends payment by KZT6.6 billion and the repayment of borrowings by KZT6.0 billion.

 

Borrowings and Cash Position

The following table below shows the Company's net cash for the periods ended December 31, 2009, December 31, 2008 and September 30, 2009:

 

 

The Company's borrowings are denominated in US dollars. The increase in the borrowings by the end of 2009 compared to the previous period is due to the acquisition of debt securities of PKI Finance for the amount of US$129 billion issued in 2005 for the acquisition of a 33% share in PetroKazakhstan Inc.

The increase in financial assets denominated in US dollars was due to the opening of long-term deposits as a result of monetary policy and tenge devaluation in February 2009.

 

Esomet Arrangement. On August 16, 2004, the Company entered into a crude oil sale agreement with Esomet and received a US$600 million long-term advance with interest at Libor plus 1.75% per annum. On July 24, 2006, Esomet and the Company amended the Esomet Arrangement to include an additional payment of US$50.0 million, a reduction of the interest margin from 1.75% to 1.1% and the release of the existing NC KMG guarantee. As of September 30, 2009, the Company had performed all its obligations.

 

***

 

Risk factors

 

The Company's activity involves many risks and uncertainties in the economic, political, legislative, social and financial spheres. In making decisions, stakeholders should take into consideration the risk factors that may affect the financial and operational success of the Company.

 

In order to increase efficiency, maximise value and ensure sustainable development, a risk management system has been introduced into the Company.

 

The risk management system forms an integral part of the Company's management system and is a constantly evolving process; in following this process, the Company systematically identifies, evaluates and manages its risk portfolio, analysing its past, present and future development.

 

The Company's risk management system includes a system for monitoring the tasks in hand, a procedure for evaluating the efficacy of measures undertaken, and a system for developing strategic and tactical solutions after taking the risk analysis into account.

 

The risk management procedure is carried out by the Board of Directors, the Management Board, the Risk Management Committee, the divisional heads and all employees of the Company. The sharing of responsibility and roles in the risk management process is set out in the Risk Management Policy.

 

The Company's risk portfolio was formed on the basis of an annual survey and evaluation of risks by the Risk Management Committee.

 

 

Risks from external and internal sources account for respectively 18% and 69% of the Company's risk portfolio.

 

 

Internal source risks are fully within the Company's management and control and are directly connected with the efficacy of management and of the internal control system.

External source risks are outside the Company's management and control, but the Company undertakes all possible measures to minimise and reduce such risks.

 

Some risk information is contained in the Offering Memorandum for Ordinary Shares and GDR, published 29 September 2006; analysis of key financial risks is also contained in annual audited statements.

 

An additional, less than exhaustive list of the main risks is presented below.

 

Exploration

 

During geological exploratory work, there is always a risk of non-commercial discovery of hydrocarbon deposits and/or of drilling a 'dry' well. To reduce the risk involved in geological exploration, a set of geoscience tests is carried out. Apart from traditional seismic testing, it includes geochemical testing and high-resolution electrical exploration, as well as special methods of processing seismic and gravity data. Geological risk analysis is the final stage of geological exploration.

 

Production

One of the key aims of the Company is to sustain an optimum production level at its own fields, most of which are at advanced stage of production. To this end, the Company uses modern methods and technologies to impact the oil beds and wellbore zones.

The Company carries out a detailed analysis of production risks in order to increase the efficiency of the production process by timely risk identification and management and by ensuring communication, coordination and cross-checking between various levels of production personnel.

 

Key factors influencing the Company's operations:

• State of the firm wells;

• Electrical supply;

• Weather conditions;

• Punctual procurement and supply of equipment;

• Quality of equipment supplied;

• Punctuality and quality of service by contractors;

• Strikes by the Company's production personnel;

• Safety of the production personnel;

• Effective planning;

• Ecological safety;

• Observance of state regulatory requirements.

 

At the same time, the Company's operations are subject to the risk of incidents and breakdowns of the main production equipment. To mitigate these risks, the Company carries out a set of preventive measures and a programme of equipment replacement and overhaul. The main production equipment is insured against loss due to fire, explosion, natural and other hazards; the risk of a well going out of control is also insured.

 

Labour protection, work safety and environmental protection

The Company's operational activity involves a wide range of health and environmental risks. These may include non-compliance with work safety rules, incidents at work, harm to the environment, ecological pollution and natural disasters. The consequences of these can be most severe, including a fatal accident at work, atmospheric, soil and water pollution, fires, and temporary suspension or complete cessation of business. Depending on the cause of these events, the consequences may negatively affect the Company's reputation, finances and operations. The Company undertakes various measures to prevent the occurrence of such threats, including health and safety checks at work, hazard identification and personnel training. The labour protection, occupational safety and environmental protection systems in the Company are implemented and function in accordance with ISO 14001 and OHSAS 18001 standards.

 

Volatility of the price of crude oil and petroleum products

The price of crude and petroleum products is affected by the state of the global economy, political instability or conflicts, actions by the main oil-exporting states, weather and natural disasters. Changes in the price of oil and petroleum products may affect the level of expected profits, investment decision-making and operational activity. Therefore the Company prepares annual budgets and regular forecasts, including sensitivity analysis with regard to various levels of crude oil prices in the future. A certain amount of crude oil is hedged.

 

Strikes

Exacerbation of social problems in Kazakhstan, including in the Company's regions of operation, may negatively affect the business continuity and cause protests and strikes. As a result, wildcat strikes may have a significant adverse impact on the Company's reputation, operations and finances.

To prevent strikes, it has been explained to the teams in the various departments that any labour disputes must be resolved constructively, via the trade unions. Special conciliatory commissions are formed for resolving labour disputes, with local authorities, trade unions and protesters represented.

 

Partners

The Company collaborates with and involves foreign and domestic companies in various areas if its activity. The Company has a limited ability to exert influence on the behaviour or operational activities of its partners, which may affect the Company's operations or finances. Therefore, the Company is developing long-term and mutually beneficial partner relationships. To minimise the breach or non-performance of obligations, the Company stipulates serious penalties in its contracts and keeps a database of unscrupulous contractors.

 

Changes in legislation, taxation and regulations

Changes of legislation on sub-soil use or in tax and customs regulations may lead to an increase of the Company's fiscal burden, a decrease in its profits, operational difficulties and a reduction of its available investment resources. In response to changes in the tax and customs burden, the Company intends to revise its production and investment plans and amend them as required.

 

Personnel Risk

Highly qualified personnel are a competitive advantage and a foundation for achieving the Company's strategic goals. Every year, the Company faces the problem of attracting suitably qualified personnel: a problem chiefly due to a shortage of the required experts on the labour market. On the evidence of certain reviews, the Company's current salary level is lower than the market indicators of salary level for comparably financed and operating companies. To reduce this risk, the Company has undertaken to implement an employee incentive scheme to bring salary levels to the level of market indicators in order to attract and retain highly qualified personnel. In 2009, by resolution of the Company's Management Board, salaries were recalculated to allow for the level of inflation.

 

Information Technology

The Company is exposed to risks in the area of information technology through its dependence on a variety of high-technology hardware and software to maintain effective operations. There may be problems in adaptating the new hardware and software and providing for the safe storage of confidential business data. In order to ensure effective work in this area, the Company carries out an annual examination of the technology used and takes care to purchase only the most adaptable and reputable information technology, while ensuring reliable control of access to databases.

 

 

 

Key operating and financial indicators of KMG EP for the year ended 31 December 2009

 

Tenge thousands

Tenge thousands

 

Tenge thousands

 

The following tables show the Company's realised sales prices adjusted for oil and oil products transportation and other expenses for the year ended December 31, 2009 and 2008.

 

 

 

 

 

 

 

- ENDS -

 

 

REFERENCE INFORMATION

 

CCEL

CCEL (CITIC Canada Energy Limited, 100% owner of CCPL, previously Nations Energy Company Ltd, develops Karazhanbas field).

 

Gaffney, Cline & Associates

Independent international consulting company specialising in evaluating hydrocarbon reserves.

 

KASE

Kazakhstan Stock Exchange

 

LSE

London Stock Exchange

 

Kazgermunai (KGM)

Kazakhstani oil company, sixth largest in terms of production volume. Proved and probable reserves (2P) of KGM as at the end of 2009, according to preliminary data, were about 30 million tonnes (232 million barrels), production in 2009 was about 3.2 million tonnes (68 kbopd). The second member of KGM is PKI (through PetroKazakhstan Kumkol Resources).

 

Karazhanbasmunai (KBM)

JSC Karazhanbasmunai owns 100% of the rights to develop the Karazhanbas oil and gas field in Western Kazakhstan till 2020. The proved and probable (2P) reserves of the KBM as at the end of 2009, according to preliminary data, were 73 million tonnes.

 

Caspian Pipeline Consortium (CPC)

This pipeline connects Tengiz field in Kazakhstan with Novorossiysk, Russian port on the Black Sea. It is an important route of oil transportation from the Caspian shores to the international market.

 

 

Chinese Investment Corporation (CIC) - State investment fund of the People's Republic of China. The main mission of CIC is long-term investment in order to reduce financial risks for its shareholders.

 

JSC Mangistaumunaigas (MMG)

One of the largest oil and gas production companies in Kazakhstan. The main areas of MMG operation: oil prospecting, development, production and processing.

 

National Company KazMunayGas (NC KMG)

A state oil and gas company of the Republic of Kazakhstan, in the form of a joint-stock company with 100% of its shares held in Samruk-Kazyna National Wealth Fund.

 

Uzenmunaigas (UMG)

One of two production branches of KMG EP, operating in 2 main fields in Mangistau Region.

 

PetroKazakhstan Inc. (PKI)

The PetroKazakhstan Inc. group of companies is involved in hydrocarbon exploration and production as well as in sales of oil and petroleum products. PetroKazakhstan has a share in 16 fields, 11 of which are in various development stages.

 

Uzen - Atyrau - Samara (UAS) 

An oil pipeline, a 1,500lm-long link over the territory of Atyrau and Mangistau Regions to Russia.

 

Samruk-Kazyna Fund

National Prosperity Fund, managing state assets, shares of national companies and financial institutions for Kazakhstan development.

 

Embamunaigas (EMG)

One of two production branches of KMG EP, operating in 37 main fields in Atyrau Region in Western Kazakhstan.

 

 

 

 

Shareholder information

 

Annual general SHAREHOLDERS' meeting

 

The AGM will be held at 10:00 am, on May 25, 2010, at

Duman Hotel, Kurgalzhinskoye Shosse 2A,,

Astana, 010000,

Republic of Kazakhstan

 

Website

A wide range of information on the Company is available at www.kmgep.kz including details of activities, press releases and annual and interim reports.

 

shareholders' enquries

For information about proxy voting, dividends and to report changes in personal details, shareholders should contact the Company's registrar/ depositary:

 

·; Holders of ordinary and preferred shares: JSC "Fondovyi Tsentr", 79 «À», Zheltoksan Street, Almaty, Republic of Kazakhstan, Tel.: +7 (727) 250 89 61, 250 89 60, Fax: +7 (727) 250 16 96.

 

·; Holders of GDRs: The Bank of New York Mellon, Shareholder Services, PO Box 358516, Pittsburgh PA 15252-8516, United States of America, Telephone +1 888 269 2377 (toll free within the USA), Telephone +1 201 680 6825 (outside USA), Email: shrrelations@bnymellon.com , www.adrbnymellon.com.

 

Number of shares in issue: 

	Common	Preferred	Total Share
	Shares	Shares	Capital (2)
Total number of shares issued (1)	70,220,935	4,136,107	74,357,042

 

(1) Including GDRs purchased to implement the Company's Option Program and held in trust (as of December 31, 2009 - 1,419,656 GDRs), and the shares and GDRs purchased in accordance with own share buyback programme (as of December 31, 2009- 8,699,697 GDRs and 110,632 shares)

(2) The Company's shares are listed on Kazakhstan Stock Exchange and the GDRs are listed on the London Stock Exchange. Each GDR corresponds to one sixth of an ordinary share.

 

 

ENDFR KKKDBBBKDNQN