NOT FOR DISTRIBUTION TO U.S. NEWSWIRE SERVICES OR DISSEMINATION IN THE UNITED STATES
WesternZagros Resources Ltd. (TSX VENTURE:WZR) ("WesternZagros" or "the
Corporation") announced today its operating and financial results for the fourth
quarter and year ended December 31, 2010 and an operational update.
WesternZagros' highlights and activities for the year ended December 31, 2010
and up to and including April 11, 2011 include:
Operations
On March 29, 2011, the Corporation re-entered the Sarqala-1 well bore with the
intent to drill a 100-metre sidetrack to evaluate and test the Miocene Jeribe
Formation ("Jeribe") which is the primary reservoir target in the Sarqala-1
well. Sidetracking operations have drilled down to 3,873 metres. The Corporation
is currently completing the remaining sidetrack drilling before wireline logging
and testing. The Corporation originally drilled Sarqala-1 in 2008 and early
2009, suspending the well after equipment problems prevented logging. Subsequent
analysis of the drilling cuttings from, and mud gas chromatograph data across,
the Jeribe showed good oil potential and led to the decision to re-enter the
well bore and to undertake the current sidetrack operation.
In the fall of 2009, the Corporation confirmed the presence of the Oligocene
reservoir and the completed high rate gas and condensate tests from the upper
Oligocene of Kurdamir-1 (the Corporation's second exploration well). During the
year ended December 31, 2010, the following operational activities were
completed at Kurdamir-1:
During the first quarter of 2010, the well was drilled through the Eocene and
Cretaceous formations to a total depth of 4,077 metres and encountered numerous
oil and gas shows. Upon encountering high formation pressures at 4,077 metres,
WesternZagros commenced well control operations that were completed in March
2010. The Corporation then began sidetracking the well.
During the second quarter of 2010, the well was sidetracked through the Eocene
formation into the Aaliji Seal above the Cretaceous formations to a depth of
3,214 metres. At this depth, the well unexpectedly encountered a high pressure,
hydrogen sulfide (H2S) bearing, hydrocarbon zone. The well was shut in while
attempting to stabilize this zone.
On May 15, 2010, while attempting to stabilize the well, the drill string parted
and the Corporation activated its Emergency Response Plan and began well control
operations. As a precaution, the Corporation moved non-essential personnel and
local inhabitants to locations outside of its Emergency Planning Zone ("EPZ").
The Corporation safely and successfully secured the well on May 31, 2010 and the
local residents who had been evacuated were able to return to their homes in
early June.
A hydraulic workover rig, known as a snubbing unit and which enables
intervention to be performed safely while the well is under pressure, was
installed in June in order to recover the drill string from the well and
complete well kill operations. Approximately 2,105 metres of the drill string
was recovered through successful snubbing operations, and the Corporation
subsequently removed the snubbing unit and abandoned the sidetrack.
On October 14, 2010, the open hole was plugged and cemented to approximately
2,500 metres, thus concluding well control operations. Although the Contractor
Group decided not to pursue further drilling, it was decided to conduct further
testing of the Oligocene formation, in its lower part, through the 9 5/8 inches
casing.
In November and December 2010, WesternZagros successfully concluded two cased
hole tests of the lower Oligocene formation. The first cased hole test was
conducted between 2,365 metres and 2,415 metres. The test achieved a maximum
flow rate, after acidization, of 18.3 million cubic feet of gas per day at a
flowing wellhead pressure of 1,960 pounds per square inch with a maximum yield
of 86 barrels of high quality, 62 degrees API natural gas liquids (condensate)
per million cubic feet of gas. No formation water was recovered during the
testing. In addition, a mixture of light crude oil and condensate was recovered
during the test prior to acidizing the formation. Subsequently, a second deeper
cased hole test was conducted between 2,455 metres and 2,469 metres which proved
an oil column in the Oligocene reservoir.
Proving an oil column in the Oligocene reservoir beneath the gas cap resulted in
an increase in the gross contingent resource estimates for this reservoir. The
Corporation's best estimate of gross contingent gas, gas condensate, and oil
resources for the Oligocene reservoir at Kurdamir as of December 14, 2010
increased to 850 billion cubic feet (BCF), 33 million barrels (MMBBL) and
6.5MMBBL, respectively. These contingent resource numbers do not include any of
the potential in the, as yet undrilled, downdip flanks of the Kurdamir structure
in the Tertiary Oligocene reservoir. In the case where the oil column
potentially extends below into the flanks, the Corporation's best estimate of
gross unrisked prospective oil resources for this reservoir effective as of
December 14, 2010 increased to 260 MMBBL.
The gross costs for the Kurdamir-1 well were approximately $76 million ($46
million net to WesternZagros), including $14 million ($8 million net to
WesternZagros) of costs associated with the cased hole tests. These gross costs
exclude approximately $70 million of incremental costs associated with well
control and sidetrack activities ($42 million net to WesternZagros) which are
subject to the insurance claim being pursued by the Contractor Group.
HSE&S
WesternZagros has operated in Kurdistan with few safety or security incidents
since 2004. During the course of its operations, the Corporation has achieved a
maximum total of four million person hours without any Lost Time Incidents
("LTI's"). This milestone was reached in December 2009, and subsequently, on
March 2, 2010, the Corporation achieved another milestone of 1,000 days of
operations without any LTI's. Unfortunately, on May 15, 2010, the Corporation
experienced its first serious situation while undertaking well control
operations in order to stabilize a zone of high pressure in the sidetrack well
when the drill string parted and part of the drill string became stuck in the
Blow Out Preventer ("BOP") at the wellhead. This resulted in a potentially
dangerous situation and caused the Corporation to activate its Emergency
Response Plan and begin various additional well control operations. As a
precaution, the Corporation moved non-essential personnel and local inhabitants
outside of its Emergency Planning Zone ("EPZ"). The Corporation was successful
in safely securing the well on May 31, 2010 and the local residents who had been
evacuated were able to return to their homes in early June. All of these
achievements demonstrate the commitment of the Corporation's Board of Directors,
Executive Management, employees and contractors to the safety and security of
the local residents and to the staff and contractors involved in its operations.
Exploration
During the year ended December 31, 2010, WesternZagros undertook a range of
exploration activities to further its understanding of the geology on its PSC
Lands. Focusing on its lowest risk prospect areas at Kurdamir, Sarqala, Mil
Qasim, Qulijan and Baran, the Corporation's exploration work included:
Completion of geochemical and basin modeling studies which indicate that the
Aaliji Formation (the "Aaliji") is likely the source rock for the hydrocarbons
on the PSC Lands. This is significant, because the Aaliji is both oil prone and
likely to be generating oil at the present time, and this increases the
probability that WesternZagros' exploration prospects contain oil and reduces
the probability that they contain only natural gas. The specific studies
undertaken include a geochemical study of the drill cuttings and hydrocarbons
recovered from the Kurdamir-1 and Sarqala-1 wells, and analyses of oil from the
natural oil seep at Aj Dagh (approximately nine kilometres from Kurdamir-1).
Completion of a re-analysis of the prospectivity of the Miocene Jeribe Formation
(the "Jeribe") in the Sarqala structure. This consisted of detailed
petrophysical analysis of the wireline logs obtained from Sarqala-1 in 2008/2009
and detailed analysis of the cuttings captured while drilling. This analysis
suggests good oil potential in the Jeribe as it is analogous to the same
formation in the nearby Qamar-1 well, which flowed 2,200 barrels of oil per day.
Completion of the evaluation of the high quality light oil shows (35 degree API
gravity) that were encountered while drilling the Upper Fars interval at
Sarqala-1. This evaluation indicated the prospectivity of the adjacent structure
at Mil Qasim. The crestal location at Mil Qasim-1 is just three kilometres from
the Sarqala-1 well.
Completion of the evaluation of the Oligocene, Eocene and Cretaceous formations
of two additional prospects in the vicinity of the Kurdamir structure, i.e.
Qulijan and Baran. Both Qulijan and Baran are anticline structures with upside
potential extending to the fault that separates them from Kurdamir.
Integration of the encouraging test results from the Kurdamir-1 well and
determination of the optimum location for Kurdamir-2.
WesternZagros also continues to compile seismic data and information from wells
adjacent to its PSC Lands and to integrate the data, together with the
reprocessed seismic data on its PSC Lands, into its seismic interpretations to
further define and update its prospects and leads inventory. The Corporation's
efforts include re-evaluating the hydrocarbon potential beneath the Kalar thrust
fault as part of its overall prospective resource re-assessment of its PSC
Lands.
All of the above exploration work in 2010 refined the Corporation's
understanding of the regional geology, and reinforced management's view of the
excellent prospects for significant oil discoveries on the Corporation's PSC
Lands.
Financial
As at December 31, 2010, WesternZagros had $37.5 million in working capital.
For the year ended December 31, 2010, WesternZagros' share of capital
expenditures associated with its PSC activities and other capitalized costs was
$67.2 million. Expenditures for 2010 included $62.6 million of drilling-related
costs; $1.0 million of geological and geosciences related work; $2.5 million of
supervision and local office costs; $0.2 million of PSC related expenditures;
and $0.9 million of corporate related expenditures.
Insurance
WesternZagros initiated a control of well insurance claim in the first quarter
of 2010 related to the events at Kurdamir-1, which began when the well was
drilled into a high pressure formation in the Gulneri Seal. These operations
continued after a subsequent additional high pressure zone was encountered in
the Aaliji Seal and continued until October 14, 2010, when the open hole was
plugged and cemented up to approximately 2,500 metres, thus concluding well
control operations.
The control of well insurance policy covering these claims has a net aggregate
limit to the Corporation of $45 million, with a $0.4 million deductible. Under
the terms of the insurance policy, the Corporation submits claims for these
costs as they are incurred and paid and these claims are then subject to the
review and approval of an adjuster appointed by the insurers. WesternZagros
submitted its initial claim in the first quarter of 2010 and received initial
confirmation of coverage from the insurers during the second quarter of 2010.
For the year ended December 31, 2010, WesternZagros credited $42.0 million of
insurance recoveries, net of the $0.4 million deductible, related to the well
control and recovery operations at Kurdamir-1 against the Kurdistan Region
Exploration Project.
During the year ended December 31, 2010, the Corporation received $24.4 million
of insurance proceeds from the insurers. Subsequent to December 31, 2010,
further insurance proceeds of $11.5 million were received related to further
approved interim claims. The Corporation has submitted the remaining costs
incurred and continues to pursue the required approval for these amounts.
Corporate
During the first quarter of 2010, WesternZagros announced the appointment of Mr.
Ian McIntosh to the new position of Vice President, Kurdistan Business Unit, to
be resident in the Kurdistan Region. Mr. McIntosh brings to the Corporation over
30 years of international oil and gas experience, encompassing development and
production engineering, in-country management and business development. This
appointment was a reflection of the Corporation's desire to have additional
executive ability in-country. Subsequently, during the second quarter of 2010,
WesternZagros announced that Mr. Ian McIntosh had assumed the position of acting
Senior Vice President, Engineering and Operations on an interim basis following
the departure of Mr. Robert Theriault.
Given the difficulties encountered during drilling operations, in the second
quarter of 2010 WesternZagros undertook a comprehensive review of its operations
to determine how to achieve better performance. The Corporation's Board of
Directors and an external expert led this review, and the resulting
recommendations were implemented. These recommendations included shifting
certain technical roles from the head office to both the rig site and to the
Corporation's office in Sulaymaniyah, increasing the technical resources
available for planning and design for future wells, and working with our
suppliers to improve the equipment and services available to the Corporation in
the Kurdistan Region.
Political
The first fully democratic federal election, with all parties participating, was
held in Iraq on March 7, 2010, with no one party winning a clear majority.
During the fourth quarter of 2010, an agreement was reached to form a new
coalition federal government with Nouri Al-Maliki and Jalal Talabani reappointed
to their respective posts as Prime Minister and President. Prime Minister Maliki
subsequently appointed Abdul Karim Luaibi as the new Minister of Oil.
In late 2010 and early 2011, Prime Minister Maliki and Minister of Oil Luaibi
were both quoted as voicing their support for the Kurdistan Region's PSC's in
their current form. Further to this, an agreement was reached to resume exports
from the Kurdistan Region from both the Taq Taq field and the Tawke field with a
goal to export 100,000 barrels per day by the end of 2011. In March 2011, both
of these fields were reported to be on production at a collective rate of
approximately 85,000 bbls/day and the oil was being exported from the Kurdistan
Region.
Corporate Social Responsibility
In 2010, WesternZagros and its co-venturers continued to focus on three key
corporate social responsibility initiatives in the Garmian region of Kurdistan -
water supply, education and health care. Activities included:
Providing road tanker services for the local delivery of water;
Providing low cost methods of obtaining water through extensive earthworks
projects for over 40 villages;
Implementing a partnership project with Mercy Corp, an international NGO, and
the local government in order to improve water access to two additional rural
villages;
Providing training to the local communities to maintain the biosand water filter
project that was completed in partnership with the Kurdistan Village
Reconstruction Association, a local NGO;
Supporting the Garmian Sports Directorate's Youth Activity Festival, a seven-day
event attended by 1,400 children, through the donation of uniforms, trophies,
medals and equipment. Children learned and played various sports including
football, volleyball, bicycling, and basketball;
Partnering with Project Cure, an international NGO committed to donating medical
equipment, in order to supply and distribute beds, examination tables, crutches,
wheelchairs and IV stands to three local clinics and one hospital.
MANAGEMENT'S DISCUSSION AND ANALYSIS
This Management's Discussion and Analysis ("MD & A") of the financial and
operating results for WesternZagros Resources Ltd. ("WesternZagros" or the
"Corporation") should be read in conjunction with the Corporation's audited
consolidated financial statements (the "Annual Financial Statements") and
related notes for the years ended December 31, 2010 and 2009.
Additional information relating to the Corporation, including its quarterly MD &
A for the year is available on SEDAR at www.sedar.com
This MD & A is dated April 11, 2011.
Forward-Looking Information
This discussion offers management's analysis of the financial and operating
results of WesternZagros and contains certain forward-looking statements
relating to, but not limited to, operational information, future drilling plans
and testing programs and the timing associated therewith, estimated Production
Sharing Contract ("PSC") commitments, expected outcomes of ongoing PSC
negotiations, anticipated capital and operating budgets, anticipated insurance
recoveries, anticipated working capital and estimated costs. Forward-looking
information typically contains statements with words such as "anticipate",
"estimate", "expect", "potential", "could", or similar words suggesting future
outcomes. The Corporation cautions readers and prospective investors in the
Corporation's securities to not place undue reliance on forward-looking
information as, by its nature, it is based on current expectations regarding
future events that involve a number of assumptions, inherent risks and
uncertainties, which could cause actual results to differ materially from those
anticipated by WesternZagros. Readers are also cautioned that disclosed test
rates may not be indicative of ultimate production levels.
Forward looking information is not based on historical facts but rather on
management's current expectations and assumptions regarding, among other things,
outcomes of future well operations, plans for and results of drilling activity,
future capital and other expenditures (including the amount, nature and sources
of funding thereof), future economic conditions, future currency and exchange
rates, continued political stability, timely receipt of any necessary government
or regulatory approvals, the Corporation's continued ability to employ qualified
staff and to obtain equipment in a timely and cost efficient manner, the
resolution of PSC negotiations, the continued participation of the Corporation's
co-venture partners in exploration activities and the timely receipt of
insurance proceeds. In addition, budgets are based upon WesternZagros' current
exploration plans and anticipated costs, both of which are subject to change
based on, among other things, the actual outcomes of well operations and the
results of drilling activity, the outcome of PSC negotiations or of the
Corporation's force majeure claim, unexpected delays, availability of future
financing and changes in market conditions. Although the Corporation believes
the expectations and assumptions reflected in such forward-looking information
are reasonable, they may prove to be incorrect. Forward-looking information
involves significant known and unknown risks and uncertainties. A number of
factors could cause actual results to differ materially from those anticipated
by WesternZagros including, but not limited to, risks associated with the oil
and gas industry (e.g. operational risks in exploration; inherent uncertainties
in interpreting geological data; changes in plans with respect to exploration or
capital expenditures; interruptions in operations together with any associated
insurance proceedings; denial of any portion of the insurance claims; the
uncertainty of estimates and projections in relation to costs and expenses and
health, safety and environmental risks), the risk of commodity price and foreign
exchange rate fluctuations, the uncertainty associated with negotiating with
foreign governments, the risk of rejection of the Corporation's force majeure
claim and risk associated with international activity.
In addition, statements relating to "resources" contained herein are deemed to
be forward-looking statements, as they involve the implied assessment, based on
certain estimates and assumptions that the resources described can be
economically produced in the future. Terms related to resource classifications
referred to herein are based on the definitions and guidelines in the Canadian
Oil and Gas Evaluation Handbook which are as follows. "Contingent resources" are
those quantities of petroleum estimated, as of a given date, to be potentially
recoverable from known accumulations using established technology or technology
under development, but which are not currently considered to be commercially
recoverable due to one or more contingencies. Contingent resources have an
associated chance of development (economic, regulatory, market and facility,
corporate commitment or political risks). The estimates referred to herein have
not been risked for the chance of development. There is no certainty that the
contingent resources will be developed and, if developed, there is no certainty
as to the timing of such development or that it will be commercially viable to
produce any portion of the contingent resources. "Prospective resources" are
those quantities of petroleum estimated, as of a given date, to be potentially
recoverable from undiscovered accumulations by application of future development
projects. Prospective resources have both an associated chance of discovery
(geological chance of success) and a chance of development (economic,
regulatory, market, facility, corporate commitment or political risks). The
chance of commerciality is the product of these two risk components. The
estimates referred to herein have not been risked for either the chance of
discovery or the chance of development. There is no certainty that any portion
of the prospective resources will be discovered. If a discovery is made, there
is no certainty that it will be developed or, if it is developed, there is no
certainty as to the timing of such development or that it will be commercially
viable to produce any portion of the prospective resources. All resource
estimates presented are gross volumes for the indicated reservoirs, without any
adjustment for working interest or encumbrances. A barrel of oil equivalent
(BOE) is determined by converting a volume of natural gas to barrels using the
ratio of 6 million cubic feet (Mcf) to one barrel. BOEs may be misleading,
particularly if used in isolation. A BOE conversion ratio of 6 Mcf:1 BOE is
based on an energy equivalency conversion method primarily applicable at the
burner tip and does not represent a value equivalency at the wellhead.
The Corporation's material change reports filed on SEDAR at www.sedar.com and
dated December 16, 2010, January 17, 2011 and February 22, 2011 contain
additional detail on the information used in the resource assessments and
include the risks and level of uncertainty associated with the recovery and
development of the resources, the significant positive and negative factors
relevant to the estimates and, in respect of contingent resources, the specific
contingencies which prevent the classification of the resources as reserves.
Readers are cautioned that the foregoing list of important factors is not
exhaustive. The forward-looking statements contained in this MD&A are made as of
the date of this MD&A and, except as required by law, WesternZagros does not
undertake any obligation to update publicly or to revise any of the included
forward-looking statements, whether as a result of new information, future
events or otherwise. The forward-looking statements contained in this MD&A are
expressly qualified by this cautionary statement. See the Risk Factors section
of this MD&A for a further description of these risks and uncertainties facing
WesternZagros. Additional information relating to WesternZagros is also
available on SEDAR at www.sedar.com, including the Corporation's Annual
Information Form.
Overview
WesternZagros is a publicly-traded, Calgary-based, international oil and gas
company engaged in acquiring properties and exploring for, developing and
producing crude oil and natural gas in Iraq. WesternZagros holds a PSC with the
Kurdistan Regional Government ("KRG") which covers a 2,120 square kilometre
exploration block (the "Kalar-Bawanoor Block" or "PSC Lands") in the Kurdistan
Region of Iraq and it is on trend with, and adjacent to, a number of prolific
historic oil and gas discoveries. WesternZagros (operator) holds a 40 percent
working interest, the KRG holds a 20 percent working interest (the costs of
which are carried by WesternZagros) and a wholly-owned subsidiary of Talisman
Energy Inc. ("Talisman") holds the remaining 40 percent working interest
(collectively the "Contractor Group").
Basis of Presentation
Reporting and Functional Currency
The reporting and functional currency of the Corporation is the United States
("U.S.") dollar. All references herein to US$ or to $ are to United States
dollars and references herein to Cdn$ are to Canadian dollars.
Going Concern Uncertainty
The financial data presented below has been prepared in accordance with Canadian
generally accepted accounting principles ("GAAP") on the basis that the
Corporation will continue to operate as a going concern, which implies the
realization of assets and the settlement of liabilities and commitments in the
normal course of business for the foreseeable future. In assessing whether the
going concern assumption is appropriate, management takes into account all
available information about the future, which is at least, but is not limited
to, twelve months from December 31, 2010.
Since inception and typical with development stage companies, the Corporation
has incurred losses from operations and negative cash flows from operating
activities, and has an accumulated deficit at December 31, 2010. During the year
ended December 31, 2010, the Corporation had expenditures of $3.4 million,
before net change in non-cash working capital, for operating activities and
$67.2 million for oil and gas property expenditures, and an overall decrease in
non-cash working capital of $1.0 million. The Corporation will require
additional funding over time to maintain ongoing exploration programs and
property commitments, as well as for administration expenses. This requirement
for funding will occur during the fiscal year ending December 31, 2011, with the
amount dependent on the level of exploration activities pursued by
WesternZagros.
There are material uncertainties that could raise significant doubt about the
Corporation's ability to continue as a going concern, as outlined below:
Availability of Future Financing
Subsequent to December 31, 2010, the Corporation successfully obtained
additional equity financing of Cdn$43 million, by way of a brokered private
placement of common shares that closed on March 10, 2011, which provided funds
for planned operations at both Sarqala-1 and Mil Qasim-1 in 2011. The
Corporation will require additional financing to re-drill the Kurdamir structure
and to test the Oligocene, Eocene and Cretaceous formations that were originally
encountered, but only partially evaluated, in Kurdamir-1.
In general, the Corporation's ability to continue operations and exploration
activities as a going concern is dependent upon its ability to obtain additional
funding over time. While the Corporation has been successful in obtaining its
required funding in the past, there is no assurance that sufficient funds will
be available to the Corporation in the future, or if available, available on
favourable terms. Factors that could affect the availability of financing
include, but are not limited to: the continued support of its shareholders;
resolution of the PSC negotiations (see the "Future PSC Operations" section in
this MD&A for further information); the results of its exploration activities;
meeting all commitments under the PSC; the resolution of remaining political
disputes in Iraq; progress on the Federal Petroleum Law and the ability to
export oil and natural gas from the Kurdistan Region of Iraq in accordance with
the economic terms under the PSC; the state of the capital markets and the
ability of the Corporation to obtain financing to develop reserves; and the
timely receipt of the remaining anticipated proceeds from the current insurance
claim associated with the Kurdamir-1 well control operations.
Insurance Claim Related To Well Control Operations
The Corporation experienced two well control operations while drilling
Kurdamir-1. The first of these began in the first quarter of 2010 and the second
ended in the fourth quarter of 2010. Both were subject to an insurance claim.
The Corporation received confirmation of coverage for the additional costs of
these operations from the insurers during the second quarter of 2010. Subsequent
to the conclusion of well control operations, the Corporation successfully
completed and tested a portion of the well.
The insurance claim provides coverage for the Corporation's share of allowable
costs up to a maximum of $45 million. The Corporation has submitted claims for
$45.9 million and has received $35.9 million (both net to the Corporation) in
insurance proceeds as at April 11, 2011. The Corporation continues to pursue
payment for the remainder of the claim. However, any change in the determination
of insurance coverage or delay in payment could impair the Corporation's ability
to fund ongoing activities under the PSC.
Continued Participation of the Corporation's Co-Venturers in the PSC
WesternZagros is involved in ongoing discussions with both Talisman and the
Kurdistan Regional Government ("KRG") regarding the optimal contractual
arrangement for conducting future activities on the PSC Lands, see the "Future
PSC Operations" section of this MD&A for further information. As a consequence
of these discussions, it is likely that Talisman will continue to participate in
the funding of their working interest share of the costs of drilling Kurdamir-2,
but it is unlikely that Talisman will participate in activities on the remaining
PSC Lands and that the Corporation will likely be required to initially, or
entirely, fund 100% of the costs associated with the third commitment well at
Mil Qasim-1. In addition, due to these ongoing discussions between the
Contractor Group and the KRG, Talisman has elected not to participate in the
Sarqala-1 re-entry operations.
The consolidated financial statements, and associated disclosures in this MD&A,
do not reflect adjustments in the carrying values of assets and liabilities
reported, revenue or expenses, nor the balance sheet classification used that
would be necessary if the going concern assumption was not appropriate. Such
adjustments could be material.
Strategy
WesternZagros' main focus is the exploration and development of its PSC Lands in
the Kurdistan Region of Iraq. WesternZagros' objective is to be recognized,
through consistently superior business performance and operations excellence, as
one of the leading junior oil and gas companies active in Iraq. The Corporation
is committed to apply the lessons learned from its operations and from
operations occurring elsewhere within the Kurdistan Region to improve our
operating performance. The Corporation is committed to operating in Iraq in a
safe and secure manner. In executing its strategy, WesternZagros has made it a
priority to recruit and retain local personnel and to actively participate in,
and contribute to, community development projects. WesternZagros believes it has
developed a relationship with government authorities, local communities and the
business community in the Kurdistan Region that has enabled access to
opportunities and facilitated the cooperation needed to successfully execute
projects.
Highlights
WesternZagros is currently exploring for crude oil and natural gas in the
Kurdistan Region of Iraq and the Corporation currently has no reserves or
production. WesternZagros' revenue is comprised entirely of interest earned on
cash and cash equivalent balances and short-term investments. WesternZagros'
highlights and activities to April 11, 2011 include the following.
HSE&S
-- WesternZagros has operated in Kurdistan with few safety or security
incidents since 2004. During the course of its operations, the
Corporation has achieved a maximum total of four million person hours
without any Lost Time Incidents ("LTI's"). This milestone was reached in
December 2009, and subsequently, on March 2, 2010, the Corporation
achieved another milestone of 1,000 days of operations without any
LTI's. Unfortunately, on May 15, 2010, the Corporation experienced its
first serious situation while undertaking well control operations in
order to stabilize a zone of high pressure in the sidetrack well when
the drill string parted and part of the drill string became stuck in the
Blow Out Preventer ("BOP") at the wellhead. This resulted in a
potentially dangerous situation and caused the Corporation to activate
its Emergency Response Plan and begin various additional well control
operations. As a precaution, the Corporation moved non-essential
personnel and local inhabitants outside of its Emergency Planning Zone
("EPZ"). The Corporation was successful in safely securing the well on
May 31, 2010 and the local residents who had been evacuated were able to
return to their homes in early June. All of these achievements
demonstrate the commitment of the Corporation's Board of Directors,
Executive Mangement, employees and contractors to the safety and
security of the local residents and to the staff and contractors
involved in its operations.
Operations
-- On March 29, 2011, the Corporation re-entered the Sarqala-1 well bore
with the intent to drill a 100-metre sidetrack to evaluate and test the
Miocene Jeribe Formation ("Jeribe") which is the primary reservoir
target in the Sarqala-1 well. Sidetracking operations have drilled down
to 3,873 metres. The Corporation is currently completing the remaining
sidetrack drilling before wireline logging and testing. The Corporation
originally drilled Sarqala-1 in 2008 and early 2009, suspending the well
after equipment problems prevented logging. Subsequent analysis of the
drilling cuttings from, and mud gas chromatograph data across, the
Jeribe showed good oil potential and led to the decision to re-enter the
well bore and to undertake the current sidetrack operation.
-- During the year ended December 31, 2010, and following the confirmation
of the presence of the Oligocene reservoir and the completion of high
rate gas and condensate tests, from the upper Oligocene, in the fall of
2009, the following operational activities were completed in respect to
Kurdamir-1, the Corporation's second exploration well:
-- During the first quarter of 2010, the well was drilled through the
Eocene and Cretaceous formations to a total depth of 4,077 metres
and encountered numerous oil and gas shows. Upon encountering high
formation pressures at 4,077 metres, WesternZagros commenced well
control operations that were completed in March 2010. The
Corporation then began sidetracking the well.
-- During the second quarter of 2010, the well was sidetracked through
the Eocene formation into the Aaliji Seal above the Cretaceous
formations to a depth of 3,214 metres. At this depth, the well
unexpectedly encountered a high pressure, hydrogen sulfide (H2S)
bearing, hydrocarbon zone. The well was shut in while attempting to
stabilize this zone.
-- On May 15, 2010, while attempting to stabilize the well, the drill
string parted and the Corporation activated its Emergency Response
Plan and began well control operations. As a precaution, the
Corporation moved non-essential personnel and local inhabitants to
locations outside of its Emergency Planning Zone ("EPZ"). The
Corporation safely and successfully secured the well on May 31, 2010
and the local residents who had been evacuated were able to return
to their homes in early June.
-- A hydraulic workover rig, known as a snubbing unit and which enables
intervention to be performed safely while the well is under
pressure, was installed in June in order to recover the drill string
from the well and complete well kill operations. Approximately 2,105
metres of the drill string was recovered through successful snubbing
operations, and the Corporation subsequently removed the snubbing
unit and abandoned the sidetrack.
-- On October 14, 2010, the open hole was plugged and cemented to
approximately 2,500 metres, thus concluding well control operations.
Although the Contractor Group decided not to pursue further
drilling, it was decided to conduct further testing of the Oligocene
formation, in its lower part, through the 9 5/8 inches casing.
-- In November and December 2010, WesternZagros successfully concluded
two cased hole tests of the lower Oligocene formation. The first
cased hole test was conducted between 2,365 metres and 2,415 metres.
The test achieved a maximum flow rate, after acidization, of 18.3
million cubic feet of gas per day at a flowing wellhead pressure of
1,960 pounds per square inch with a maximum yield of 86 barrels of
high quality, 62 degrees API natural gas liquids (condensate) per
million cubic feet of gas. No formation water was recovered during
the testing. In addition, a mixture of light crude oil and
condensate was recovered during the test prior to acidizing the
formation. Subsequently, a second deeper cased hole test was
conducted between 2,455 metres and 2,469 metres which proved an oil
column in the Oligocene reservoir.
-- Proving an oil column in the Oligocene reservoir beneath the gas cap
resulted in an increase in the gross contingent resource estimates
for this reservoir. The Corporation's best estimate, as audited by
Sproule International Limited, of gross contingent gas, gas
condensate, and oil resources for the Oligocene reservoir at
Kurdamir as of December 14, 2010 increased to 850 billion cubic feet
(BCF), 33 million barrels (MMBBL) and 6.5MMBBL, respectively. These
contingent resource numbers do not include any of the potential in
the, as yet undrilled, downdip flanks of the Kurdamir structure in
the Tertiary Oligocene reservoir. In the case where the oil column
potentially extends below into the flanks, the Corporation's best
estimate, as audited by Sproule International Limited, of gross
unrisked prospective oil resources for this reservoir effective as
of December 14, 2010 increased to 260 MMBBL.
-- The gross costs for the Kurdamir-1 well were approximately $76
million ($46 million net to WesternZagros), including $14 million
($8 million net to WesternZagros) of costs associated with the cased
hole tests. These gross costs exclude approximately $70 million of
incremental costs associated with well control and sidetrack
activities ($42 million net to WesternZagros) which are subject to
the insurance claim being pursued by the Contractor Group.
Exploration
-- During the year ended December 31, 2010, WesternZagros undertook a range
of exploration activities to further its understanding of the geology on
its PSC Lands. Focusing on its lowest risk prospect areas at Kurdamir,
Sarqala, Mil Qasim, Qulijan and Baran, the Corporation's exploration
work included:
-- Completion of geochemical and basin modeling studies which indicate
that the Aaliji Formation (the "Aaliji") is likely the source rock
for the hydrocarbons on the PSC Lands. This is significant, because
the Aaliji is both oil prone and likely to be generating oil at the
present time, and this increases the probability that WesternZagros'
exploration prospects contain oil and reduces the probability that
they contain only natural gas. The specific studies undertaken
include a geochemical study of the drill cuttings and hydrocarbons
recovered from the Kurdamir-1 and Sarqala-1 wells, and analyses of
oil from the natural oil seep at Aj Dagh (approximately nine
kilometres from Kurdamir-1).
-- Completion of a re-analysis of the prospectivity of the Miocene
Jeribe Formation (the "Jeribe") in the Sarqala structure. This
consisted of detailed petrophysical analysis of the wireline logs
obtained from Sarqala-1 in 2008/2009 and detailed analysis of the
cuttings captured while drilling. This analysis suggests good oil
potential in the Jeribe as it is analogous to the same formation in
the nearby Qamar-1 well, which flowed 2,200 barrels of oil per day.
-- Completion of the evaluation of the high quality light oil shows (35
degree API gravity) that were encountered while drilling the Upper
Fars interval at Sarqala-1. This evaluation indicated the
prospectivity of the adjacent structure at Mil Qasim. The crestal
location at Mil Qasim-1 is just three kilometres from the Sarqala-1
well.
-- Completion of the evaluation of the Oligocene, Eocene and Cretaceous
formations of two additional prospects in the vicinity of the
Kurdamir structure, i.e. Qulijan and Baran. Both Qulijan and Baran
are anticline structures with upside potential extending to the
fault that separates them from Kurdamir.
-- Integration of the encouraging test results from the Kurdamir-1 well
and determination of the optimum location for Kurdamir-2.
-- WesternZagros also continues to compile seismic data and information
from wells adjacent to its PSC Lands and to integrate the data, together
with the reprocessed seismic data on its PSC Lands, into its seismic
interpretations to further define and update its prospects and leads
inventory. The Corporation's efforts include re-evaluating the
hydrocarbon potential beneath the Kalar thrust fault as part of its
overall prospective resource re-assessment of its PSC Lands.
-- All of the above exploration work in 2010 refined the Corporation's
understanding of the regional geology, and reinforced management's view
of the excellent prospects for significant oil discoveries on the
Corporation's PSC Lands.
Financial
-- As at December 31, 2010, WesternZagros had $37.5 million in working
capital.
-- For the year ended December 31, 2010, WesternZagros' share of capital
expenditures associated with its PSC activities and other capitalized
costs was $67.2 million. Expenditures for 2010 included $62.6 million of
drilling-related costs; $1.0 million of geological and geosciences
related work; $2.5 million of supervision and local office costs; $0.2
million of PSC related expenditures; and $0.9 million of corporate
related expenditures.
Insurance
-- WesternZagros initiated a control of well insurance claim in the first
quarter of 2010 related to the events at Kurdamir-1, which began when
the well was drilled into a high pressure formation in the Gulneri Seal.
These operations continued after a subsequent additional high pressure
zone was encountered in the Aaliji Seal and continued until October 14,
2010, when the open hole was plugged and cemented up to approximately
2,500 metres, thus concluding well control operations.
-- The control of well insurance policy covering these claims has a net
aggregate limit to the Corporation of $45 million, with a $0.4 million
deductible. Under the terms of the insurance policy, the Corporation
submits claims for these costs as they are incurred and paid and these
claims are then subject to the review and approval of an adjuster
appointed by the insurers. WesternZagros submitted its initial claim in
the first quarter of 2010 and received initial confirmation of coverage
from the insurers during the second quarter of 2010.
-- For the year ended December 31, 2010, WesternZagros credited $42.0
million of insurance recoveries, net of the $0.4 million deductible,
related to the well control and recovery operations at Kurdamir-1
against the Kurdistan Region Exploration Project.
-- During the year ended December 31, 2010, the Corporation received $24.4
million of insurance proceeds from the insurers. Subsequent to December
31, 2010, further insurance proceeds of $11.5 million were received
related to further approved interim claims. The Corporation has
submitted the remaining costs incurred and continues to pursue the
required approval for these amounts.
Corporate
-- During the first quarter of 2010, WesternZagros announced the
appointment of Mr. Ian McIntosh to the new position of Vice President,
Kurdistan Business Unit, to be resident in the Kurdistan Region. Mr.
McIntosh brings to the Corporation over 30 years of international oil
and gas experience, encompassing development and production engineering,
in-country management and business development. This appointment was a
reflection of the Corporation's desire to have additional executive
ability in-country. Subsequently, during the second quarter of 2010,
WesternZagros announced that Mr. Ian McIntosh had assumed the position
of acting Senior Vice President, Engineering and Operations on an
interim basis following the departure of Mr. Robert Theriault.
-- Given the difficulties encountered during drilling operations, in the
second quarter of 2010 WesternZagros undertook a comprehensive review of
its operations to determine how to achieve better performance. The
Corporation's Board of Directors and an external expert led this review,
and the resulting recommendations were implemented. These
recommendations included shifting certain technical roles from the head
office to both the rig site and to the Corporation's office in
Sulaymaniyah, increasing the technical resources available for planning
and design for future wells, and working with our suppliers to improve
the equipment and services available to the Corporation in the Kurdistan
Region.
Political
-- The first fully democratic federal election, with all parties
participating, was held in Iraq on March 7, 2010, with no one party
winning a clear majority. During the fourth quarter of 2010, an
agreement was reached to form a new coalition federal government with
Nouri Al-Maliki and Jalal Talabani reappointed to their respective posts
as Prime Minister and President. Prime Minister Maliki subsequently
appointed Abdul Karim Luaibi as the new Minister of Oil.
-- In late 2010 and early 2011, Prime Minister Maliki and Minister of Oil
Luaibi were both quoted as voicing their support for the Kurdistan
Region's PSC's in their current form. Further to this, an agreement was
reached to resume exports from the Kurdistan Region from both the Taq
Taq field and the Tawke field with a goal to export 100,000 barrels per
day by the end of 2011. In March 2011, both of these fields were
reported to be on production at a collective rate of approximately
85,000 bbls/day and the oil was being exported from the Kurdistan
Region.
Corporate Social Responsibility
-- In 2010, WesternZagros and its co-venturers continued to focus on three
key corporate social responsibility initiatives in the Garmian region of
Kurdistan - water supply, education and health care. Activities
included:
-- Providing road tanker services for the local delivery of water;
-- Providing low cost methods of obtaining water through extensive
earthworks projects for over 40 villages;
-- Implementing a partnership project with Mercy Corp, an international
NGO, and the local government in order to improve water access to
two additional rural villages;
-- Providing training to the local communities to maintain the biosand
water filter project that was completed in partnership with the
Kurdistan Village Reconstruction Association, a local NGO;
-- Supporting the Garmian Sports Directorate's Youth Activity Festival,
a seven-day event attended by 1,400 children, through the donation
of uniforms, trophies, medals and equipment. Children learned and
played various sports including football, volleyball, bicycling, and
basketball;
-- Partnering with Project Cure, an international NGO committed to
donating medical equipment, in order to supply and distribute beds,
examination tables, crutches, wheelchairs and IV stands to three
local clinics and one hospital.
FINANCIAL PERFORMANCE
----------------------------------------------------------------------------
Selected Annual Information
US$(000's), unless otherwise
specified 2010 2009 2008
----------------------------------------------------------------------------
Total Revenue 87 184 2,959
Net Loss 5,748 5,491 10,100
Net Loss Per Share (US$ Per
Share)
(Basic and Diluted) 0.03 0.03 0.05
Capital Expenditures 67,162 54,356 95,102
Total Assets 241,231 241,077 243,697
Total Long-term Liabilities 245 175 69
Dividends (US$ Per Share) Nil Nil Nil
----------------------------------------------------------------------------
General and Administrative Expenses
For the year ended December 31, 2010, WesternZagros expensed $6.4 million in
general and administrative expenses ("G&A"), compared to $6.3 million for the
prior year, and capitalized $3.0 million of G&A compared to $3.2 million in
2009. The amounts capitalized are directly related to the supervision of the
Corporation's drilling and geological capital programs. Total G&A costs were
relatively consistent between 2010 and 2009, as the increase in US$ costs
incurred resulting from a stronger Canadian dollar in 2010, which impacts a
large portion of the Corporation's G&A expenditures, was mostly offset by lower
stock-based compensation expense as compared to the prior year.
Depreciation, Depletion and Amortization (DD&A)
For the year ended December 31, 2010, WesternZagros had $0.6 million
depreciation related to certain administrative assets, compared to $0.7 million
for the year ended December 31, 2009. No depletion, which is calculated on a
unit-of-production basis based on proved reserves, has been recorded on oil and
gas related assets because there has been no production to date. Furthermore,
WesternZagros has yet to determine whether proved reserves are attributable to
the PSC Lands.
Stock Based Compensation
The Corporation recognized stock based compensation expense for all stock
options granted. For the year ended December 31, 2010, WesternZagros recorded
$1.6 million in stock based compensation expense and $1.0 million as part of
capitalized G&A, with a corresponding increase to contributed surplus, for stock
options granted. For the year ended December 31, 2009, WesternZagros recorded
$1.9 million in stock-based compensation expense, and $0.5 million in
capitalized G&A.
Foreign Exchange
WesternZagros adopted the U.S. dollar as its measurement and reporting currency
since the majority of its expenditures are or will be directly or indirectly
denominated in U.S. dollars and to facilitate a more direct comparison to other
international crude oil and natural gas exploration and development companies.
As at December 31, 2010, WesternZagros held over 95 percent of its cash and cash
equivalents in U.S. dollar accounts and U.S. dollar overnight term deposits. The
Corporation also has certain assets and liabilities in currencies other than the
U.S. dollar (mainly Canadian dollars). For financial statement presentation
purposes, WesternZagros converts other currencies to U.S. dollars at the end of
each period resulting in foreign exchange gains and losses. Canadian dollar
balances are held for the purpose of funding WesternZagros' Canadian dollar
expenditures, which are mainly related to the costs associated with general and
administrative costs for its head office and certain drilling-related services
and tangible equipment procured from Canadian suppliers. For the year ended
December 31, 2010, WesternZagros recorded a foreign exchange loss of $0.06
million relating to these conversions, compared to a $0.01 million foreign
exchange loss for the year ended December 31, 2009.
Income Taxes
For the year ended December 31, 2010, WesternZagros had a net income tax
recovery of $1.2 million (2009: $1.3 million recovery), comprised of $1.3
million of current income tax recovery (2009: $1.8 million recovery) and reduced
by $0.1 million of future income tax expense (2009: $0.4 million expense). The
current tax recovery relates to the expected recovery of taxes incurred in 2008
on realized foreign exchange gains and losses in WesternZagros' wholly-owned
Canadian subsidiary through the utilization of loss carry forwards and the
associated G&A costs incurred by the subsidiary.
The Corporation received proceeds of $2.2 million for prior year tax recoveries
during the year ended December 31, 2010 (2009: $4.7 million taxes paid).
Revenue
WesternZagros' revenue is comprised entirely of interest earned on cash and cash
equivalents and short-term investment balances. Interest of $0.09 million was
earned for the year ended December 31, 2010 compared to $0.18 million for the
year ended December 31, 2009. The decrease in revenue resulted mainly from a
decrease in cash and cash equivalents as the Corporation expended funds for
exploration activities during the year.
Net Loss
For the year ended December 31, 2009, WesternZagros recorded a net loss of $5.7
million compared to $5.5 million for the year ended December 31, 2009.
WesternZagros is an early stage exploration enterprise and, apart from its
working interest in the PSC and cash and cash equivalents, the Corporation has
no other significant assets. The increased net loss in 2010 resulted mainly from
reduced tax recoveries as compared to 2009.
Capital Expenditures
For the year ended December 31, 2010, total capital expenditures, prior to any
insurance recoveries, related to the Kalar-Bawanoor Block were $107.3 million,
including $100.1 million of drilling-related costs, $1.3 million of
geosciences-related work (reprocessing and interpretation of seismic data), $5.7
million of supervision and local office costs in support of drilling operations,
and $0.2 million of PSC-related expenditures. Included in the drilling costs
were $93.3 million for operations at Kurdamir-1, $4.8 million for planning and
site preparation for Qulijan-1, $1.3 million for planning costs related to the
Sarqala-1 re-entry, and $0.7 million for planning costs related to the Mil Qasim
prospect.
By comparison, for the year ended December 31, 2009, total capital expenditures
related to the Kalar-Bawanoor Block were $73.3 million, including $65.1 million
of drilling-related costs, $1.1 million of geosciences-related work
(reprocessing and interpretation of seismic data), $5.7 million of supervision
and local office costs in support of drilling operations and $1.4 million of
PSC-related expenditures. Included in the drilling costs were $46.6 million for
operations at Kurdamir-1, $11.5 million for operations at Sarqala-1, and $7.0
million for long lead items, consumables and pre spud costs for subsequent
wells.
WesternZagros' share of capital expenditures, prior to any insurance recoveries,
for the year ended December 31, 2010 associated with its PSC activities and
other capitalized costs was $67.2 million. Capital expenditures for 2010
included $62.6 million of drilling-related costs; $1.0 million of
geosciences-related work; $2.5 million of related field office and supervision
costs; $0.2 million for PSC-related costs, and $0.9 million of corporate-related
expenditures.
For the year ended December 31, 2010, the costs for Kurdamir-1 have been
credited by approximately $42.0 million, net to WesternZagros, for estimated
claimable costs under the current insurance claim. This amount is net of
deductibles.
By comparison, WesternZagros' share of capital expenditures for the year ended
December 31, 2009 associated with its PSC activities and other capitalized costs
was $54.4 million. Capital expenditures for 2009 included $39.1 million of
drilling-related costs; $0.7 million of geological and geosciences-related work;
$3.4 million of related field office and supervision costs; $10.8 million for
PSC-related costs and the remaining amounts owing under the capacity building
bonus, which WesternZagros completed paying in April 2009; and $0.4 million of
corporate- related expenditures.
The Corporation's share of 2010 capital expenditures, net of the insurance
recoveries, decreased in 2010 in comparison to 2009 as the costs associated with
the Kurdamir-1 operations were mostly offset by the estimated claimable costs
under the insurance claim. In addition, the PSC-related costs were lower in 2010
as the capacity building bonus payments were completed in 2009
WesternZagros capitalized $3.0 million of G&A expenses, including $1.0 million
of stock-based compensation, for the year ended December 31, 2010, compared to
$3.2 million of G&A expenses, including $0.5 million of stock-based
compensation, for the year ended December 31, 2009.
Quarterly Information
The following table summarizes key financial information on a quarterly basis
for the 2010 and 2009 fiscal periods:
----------------------------------------------------------------------------
(US$ thousands, unless Year
otherwise specified) Ended Three Month Periods Ended
----------------------------------------------------------------------------
Dec 31, Dec 31 Sep 30 June 30 March 31
2010 2010 2010 2010 2010
----------------------------------------------------------------------------
Revenue 87 13 38 17 19
----------------------------------------------------------------------------
Net Loss 5,748 1,924 1,098 1,720 1,006
----------------------------------------------------------------------------
Net Loss Per Share (US$
Per Share)
(Basic and Fully Diluted) 0.027 0.009 0.005 0.008 0.005
----------------------------------------------------------------------------
Capital Expenditures 67,162 17,332 20,455 16,041 13,334
----------------------------------------------------------------------------
Total Assets 241,231 241,231 234,555 236,006 235,977
----------------------------------------------------------------------------
Total Long-term
Liabilities 245 245 228 207 178
----------------------------------------------------------------------------
Dividend (US$ per Share) Nil Nil Nil Nil Nil
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Year
Ended Three Month Periods Ended
----------------------------------------------------------------------------
Dec 31, Dec 31 Sep 30 June 30 March 31
2009 2009 2009 2009 2009
----------------------------------------------------------------------------
Revenue 184 32 36 35 81
----------------------------------------------------------------------------
Net Loss 5,491 1,035 2,712 1,404 340
----------------------------------------------------------------------------
Net Loss Per Share (US$
Per Share)
(Basic and Fully Diluted) 0.026 0.005 0.013 0.006 0.002
----------------------------------------------------------------------------
Capital Expenditures 54,356 11,250 11,456 14,796 16,854
----------------------------------------------------------------------------
Total Assets 241,077 241,077 241,600 241,171 239,288
----------------------------------------------------------------------------
Total Long-term
Liabilities 175 175 171 197 71
----------------------------------------------------------------------------
Dividend (US$ per Share) Nil Nil Nil Nil Nil
----------------------------------------------------------------------------
Fourth Quarter
In the fourth quarter of 2010, WesternZagros had a net loss of $1.9 million
compared to a net loss of $1.0 million in the fourth quarter of 2009. The
increased fourth quarter net loss in 2010 is mainly due to reduced income tax
recoveries as well as increased professional and legal fees incurred as compared
to the fourth quarter of 2009.
WesternZagros' capital expenditures totaled $17.3 million, prior to insurance
recoveries, in the fourth quarter of 2010 compared to $11.5 million in the
fourth quarter of 2009. This increase in 2010 is primarily due to the ongoing
Kurdamir-1 operations, including completing and testing a portion of the well
during the fourth quarter of 2010.
Production Sharing Contract - Summary
Under the terms of its PSC, WesternZagros has a 40 percent working interest and
the KRG has a 20 percent working interest which is carried by WesternZagros. The
remaining 40 percent working interest is held by Talisman, which was allocated
the interest in June 2008 by the KRG. WesternZagros, the KRG and Talisman are
collectively the "Contractor Group" under the PSC. WesternZagros is the operator
of the PSC Lands until the end of the first exploration sub-period of the PSC,
when a joint operating company may be established if so elected by the
Contractor Group.
Production Sharing Contract - Commercial Terms
Under the PSC, the sharing of oil occurs as follows: of the total oil produced,
operations oil is available to WesternZagros for use in carrying out its
obligations under the PSC; the remaining oil is subject to a 10 percent royalty
payable to the KRG (the residual is considered to be "net available oil"). The
net available oil is determined on a development by development basis. Up to 45
percent of the net available oil is available for cost recovery with the
remainder as "profit oil". Costs subject to cost recovery include all costs and
expenditures incurred by the Contractor Group for exploration, development,
production and decommissioning operations, as well as any other costs and
expenditures incurred directly or indirectly with these activities. The portion
of profit oil available to the Contractor Group is based on a sliding scale from
35 percent to 16 percent depending on a calculated R-Factor. The R-Factor is
established by reference to the ratio of cumulative revenues over cumulative
costs. When the ratio is below one, the Contractor Group is entitled to 35
percent of the profit oil. The percentage is then reduced on a linear sliding
scale to a minimum of 16 percent at an R-Factor ratio of two or greater.
The production sharing terms for natural gas are the same as the oil production
share terms except that the net available gas available for cost recovery is 55
percent and the profit sharing component is on a different scale. For natural
gas, the portion of profit natural gas available for the Contractor Group is
based on a sliding scale from 40 percent to 20 percent depending on a calculated
R-factor. The R-Factor is established by reference to the ratio of the
Contractor Group's cumulative revenue over cumulative costs. When the R-Factor
is below one, the Contractor Group is entitled to 40 percent of the profit oil.
The Contractor Group's percentage is then reduced on a linear scale to a minimum
of 20 percent at a ratio of 2.75 or greater.
Production
The PSC provides the Contractor Group with the exclusive right to develop and
produce any commercial discoveries. The development period for producing a
commercial discovery is an initial term of 20 years from the date of declaring a
commercial discovery with a further automatic right to a five year extension. If
commercial production is possible at the end of the last period then the
Contractor Group shall be entitled to an extension of a further five years under
the same terms as in the PSC if a request is made by the Contractor Group at
least six months before the end of the first five year extension.
Pursuant to the terms of the PSC, WesternZagros maintains the right to market
its share of oil on the world market. There is an obligation under the PSC to
make oil production available to meet regional market demand. The price of such
oil is a market-based oil price based on a basket of crudes. The price for
natural gas is based on local commercial value and Iraq tariffs. Currently, no
markets exist for natural gas within Iraq and there is no infrastructure for
export.
Contract Obligations and Commitments
The PSC contemplates two exploration sub-periods of three years and two years,
respectively, with two possible one-year extensions. The first exploration
sub-period ended December 31, 2010, subject to an extension under a force
majeure claim described below. During such time the Contractor Group is required
to complete a minimum of 1,150 kilometres of seismic surveying (which has been
completed), to drill three exploration wells (two of which have been drilled),
and to commit a minimum of $75 million in the aggregate on these activities
(which has been completed). The PSC also includes capacity building support
payments (which concluded in April 2009) and annual funding for certain
technological, logistical, recruitment and training support during the
exploration sub-periods.
During the drilling of the Kurdamir-1 well, certain situations occurred which
caused additional time to be spent on well control and repair operations under
conditions of force majeure. Under the terms of the PSC, when a force majeure
event occurs, the timing resulting from any such delay and the time necessary to
repair any damage resulting from the delay is to be added to any time period
provided under the PSC, including the first exploration sub-period. The period
of force majeure started on January 22, 2010 and continued until October 14,
2010, a period of 265 days. The Corporation, on behalf of the Contractor Group,
has notified the KRG of a force majeure event under the terms of the PSC and
claimed a corresponding 265 day extension of the first exploration sub-period,
i.e. until September 22, 2011.
Following the submission of the force majeure claim to the KRG, the KRG proposed
certain contractual amendments in order to resolve the timing issues created by
the force majeure event and other commercial concerns. Negotiations between the
Contractor Group are ongoing with respect to these proposed amendments. See the
"Future PSC Operations" section in this MD&A for further information.
At the end of the first exploration sub-period, WesternZagros and the other
parties to the PSC may relinquish the entire contract area (other than any
discovery or development areas), or continue further exploration operations by
entering into the second exploration sub-period, or request a one-year extension
for further exploration and appraisal activities prior to deciding to enter into
the second exploration sub-period.
To meet its remaining commitments for the first exploration sub-period,
WesternZagros estimates expenditures of approximately $20 million to $25
million, prior to the costs of any testing, if required, and assuming that the
Corporation will be required to fund 100% of for the remaining exploration
commitment well (see "Future PSC Operations" section in this MD&A for further
information). This estimate includes the remaining costs associated with
drilling this additional exploration commitment well by the end of the first
exploration sub-period, and providing the associated supervision and local
office costs in support of drilling operations.
During the second exploration sub-period, the Contractor Group, or those parties
that have elected to participate in further exploration, is required to complete
a minimum of 575 kilometres of seismic surveying, drill at least two exploration
wells and commit a minimum of $35 million to these activities. At the end of the
second exploration sub-period, WesternZagros, and the other parties to the PSC
who have elected to participate in the second exploration sub-period, may
relinquish the entire contract area (other than any discovery or development
areas) or continue further exploration and appraisal operations into the
extension periods subject to the following relinquishment requirements. At the
end of the second exploration sub-period, and at the end of each subsequent
extension period, the PSC requires WesternZagros, and other parties who have
elected to participate, to relinquish 25 percent of the remaining undeveloped
area within the PSC Lands or the entire contract area (other than any discovery
or development areas).
WesternZagros has entered into various exploration-related contracts, including
contracts for drilling equipment, services and tangibles. The following table
summarizes the commitments WesternZagros has under these exploration-related
contracts and other contractual obligations at December 31, 2010:
For the year ended December 31
($ 000's) 2011 2012 2013 2014 2015+ Total
----------------------------------------------------------------------------
Exploration 2,335 - - - - 2,335
Offices 614 234 - - - 848
----------------------------------------------------------------------------
Total 2,949 234 - - - 3,183
----------------------------------------------------------------------------
Future PSC Operations
In parallel with, and as an alternative to the force majeure claim,
WesternZagros remains involved in ongoing negotiations with both Talisman and
the KRG regarding the optimal contractual arrangements for conducting future
activities on the PSC Lands. Proposals discussed to date include, but are not
limited to:
-- A one-year extension, to December 31, 2011, for drilling the third
exploration commitment well;
-- A requirement to complete the drilling of Kurdamir-2 prior to June 30,
2012, and subsequent to Talisman drilling the Topkhana-1 well on its
adjacent Block 39;
-- Talisman becoming operator for all future activity on the Kurdamir
structure, with WesternZagros continuing as operator for all future
activity on the remainder of the PSC Lands; and
-- Talisman's future participation in activities on the PSC Lands being
limited to the Kurdamir prospect, with the expectation that the KRG
would assign Talisman's prior 40% interest in the remaining PSC Lands to
a new third party participant following completion of the third
exploration commitment well, which would be located on those remaining
PSC Lands. As such, this would require the Corporation to initially, or
entirely, fund 100% of the costs associated with the third commitment
well.
While these negotiations proceed, WesternZagros continues to work toward
drilling the third exploration commitment well under the terms of the force
majeure provision in the PSC in order to ensure that it meets the current
requirements of the PSC in the event that these negotiations are not
successfully concluded.
Third Party Consulting Services Agreements
In 2003, WesternZagros entered into a consulting service agreement that provides
for a three percent right to participate indirectly in the future profits the
Corporation may earn in respect to the PSC, in exchange for consulting services
provided since that date. In the determination of profits under this agreement,
WesternZagros is entitled to deduct the consultant's proportional share of all
costs associated with acquiring the PSC and the exploration, appraisal,
development and production expenditures incurred by the Corporation ("eligible
costs"), together with interest on such percentage of eligible costs at LIBOR
plus three percent. The Corporation is currently in negotiations to terminate
this right.
Further, in 2004, WesternZagros entered into a consulting service agreement that
provides for a two percent right to indirectly participate in the future profits
the Corporation may earn in respect to the PSC, in exchange for the provision of
consulting services during the period 2004 to 2006. In the determination of
profits under this agreement, WesternZagros is entitled to deduct one percent of
all eligible costs, together with interest on such percentage of eligible costs
at LIBOR plus ten percent. The consultant is required to fund the additional one
percent of all eligible costs. The Corporation is currently in negotiations to
terminate this right.
Off Balance Sheet Arrangements
The Corporation does not presently utilize any off-balance sheet arrangements to
enhance its liquidity and capital resource positions, or for any other purpose.
During the period ended December 31, 2010, WesternZagros did not enter into any
off-balance sheet transactions.
Insurance Claim Update
WesternZagros initiated a control of well insurance claim in the first quarter
of 2010 in relation to certain events at Kurdamir-1 which commenced when the
well was drilled into a high pressure formation in the Gulneri Seal. These
operations continued after a subsequent additional high pressure zone was
encountered in the Aaliji Seal and continued until October 14, 2010, when the
open hole in the Kurdami-1 well was plugged and cemented to approximately 2,500
metres, concluding well control operations.
The control of well insurance policy covering these claims has a net aggregate
limit to the Corporation of $45 million, with a $0.4 million deductible. Under
the terms of the insurance policy, the Corporation submits claims for these
costs as they are incurred and paid and these claims are then subject to the
review and approval by the adjuster appointed by the insurers. WesternZagros
submitted its initial claim in the first quarter of 2010 and received initial
confirmation of coverage from the insurers during the second quarter of 2010.
For the year ended December 31, 2010, WesternZagros credited $42.0 million of
insurance recoveries, net of the $0.4 million deductible, related to the well
control and recovery operations at Kurdamir-1 against the Kurdistan Region
Exploration Project. During the year ended December 31, 2010, the Corporation
received $24.4 million of insurance proceeds from the insurers. Subsequent to
December 31, 2010, further insurance proceeds of $11.5 million have been
received related to further approved interim claims. The Corporation has
submitted the remaining costs incurred and continues to pursue the required
approval for these amounts.
Outlook for 2011
In 2011 and early 2012, WesternZagros plans to focus on a program of drilling
and testing to evaluate the highly prospective formations discovered through the
Sarqala-1 and Kurdamir-1 wells. This program will test the approximately one
billion barrels of oil equivalent of mean gross un-risked prospective resources
that these formations are estimated to contain as of December 14, 2010 and
January 14, 2011, as audited by Sproule International Limited.
On March 29, 2011, the Corporation began the first of these operations by
re-entering the Sarqala-1 well bore with the intent to drill a 100-metre
sidetrack to evaluate and test the Miocene Jeribe Formation ("Jeribe") which is
the primary reservoir target in the Sarqala-1 well. Sidetracking operations have
drilled down to 3,873 metres. The Corporation is currently completing the
remaining sidetrack drilling before wireline logging and testing. The
Corporation originally drilled Sarqala-1 in 2008 and early 2009, suspending the
well after equipment problems prevented logging. Subsequent analysis of the
drilling cuttings from, and mud gas across, the Jeribe showed good oil potential
and led to the decision to re-enter the well bore and to undertake the current
sidetrack operation.
Following completion of the Sarqala sidetrack, WesternZagros plans to drill the
third commitment well at Mil Qasim-1, located only three kilometres from
Sarqala-1, in order to target potential oil-bearing sandstones in the Upper Fars
reservoir. The Upper Fars reservoir is shallower than the Jeribe Formation and
exhibited oil shows when penetrated in Sarqala-1. With a proposed total depth of
2,000 to 2,400 metres, Mil Qasim-1 will be a shallower well with less technical
risk than either Sarqala-1 or Kurdamir-2.
Concurrent with the Corporation's drilling operations at Sarqala-1 and Mil
Qasim-1, Talisman will be drilling the Topkhana prospect on its adjacent Block
39, where operations commenced on January 31, 2011. Topkhana-1 will be drilled
to evaluate and test the Oligocene reservoir. Although WesternZagros has no
working interest in Topkhana-1, results from the well could provide information
confirming the potential coalescing of the Kurdamir and Topkhana structures into
one large structure. The Contractor Group plans to drill the Kurdamir-2 well
after Topkhana-1, with Talisman as operator. WesternZagros and Talisman are
currently preparing the drilling plan for Kurdamir-2, including acquiring and
preparing the drilling location lands and acquiring the long lead time
materials.
With the objective of maximizing its options and flexibility to increase the
likelihood of success, WesternZagros' priorities for 2011 are as follows:
-- Re-enter the Sarqala-1 well in order to test the Miocene Jeribe
Formation;
-- Conclude PSC negotiations with the KRG and Talisman in a manner that
gives flexibility around the timing of the third commitment well and
provides for an orderly progression of drilling and other exploration
activities to maximize the efficient use of capital;
-- Drill Mil Qasim-1 to test the Upper Fars Formation;
-- Begin drilling Kurdamir-2 to test the Oligocene, Eocene and Cretaceous
formations; and
-- Evaluate the commercial potential and design an appraisal program for
the natural gas, gas condensate and oil discovered at Kurdamir, and
evaluate the commercial potential for any discoveries from the Sarqala-1
re-entry and Mil Qasim-1.
WesternZagros estimates its 2011 capital and operating budget, including the
likely requirement for the Corporation to fully fund the Sarqala-1 re-entry and
Mil Qasim-1 and to fund its share of the costs of Kurdamir-2 well to be incurred
in the fourth quarter of 2011, to be approximately $95 million. This includes
approximately $80 million for drilling and related costs, with the remainder of
the budget comprised of funds for certain annual PSC payments, initial technical
studies as part of the Kurdamir Discovery appraisal program, in-country
operational support and corporate general and administrative costs.
Liquidity and Capital Resources
WesternZagros is currently exploring for crude oil and natural gas in the
Kurdistan Region of Iraq and currently has no reserves, production or
operational cash flows. WesternZagros' revenue is comprised entirely of interest
earned on cash and cash equivalent balances and short-term investments.
WesternZagros invests its cash and cash equivalents with major Canadian
financial institutions with investment grade credit ratings and in Government of
Canada instruments. This is in accordance with an Investment Policy approved by
the Board of Directors. WesternZagros had no outstanding bank debt or other
interest bearing indebtedness as at December 31, 2010.
At December 31, 2010, WesternZagros had $37.5 million in working capital. On
March 10, 2011, WesternZagros successfully completed a brokered private
placement for gross proceeds of approximately Cdn$43 million (net proceeds of
approximately Cdn$41 million after fees). The working capital and the proceeds
of this private placement will be used to fund a portion of the future capital
expenditures as described in the "Outlook" section, specifically both the
drilling operations for the Sarqala-1 re-entry and Mil Qasim-1 which the
Corporation anticipates funding 100 percent. WesternZagros will be required to
access further funding in 2011, in particular as it relates to the drilling of
Kurdamir-2, and ultimately to fund any appraisal programs and future development
programs from successful exploration activities. In considering the proper
timing to access further financial resources, the Corporation will assess the
following factors:
-- The conclusion of discussions with both the KRG and Talisman as it
relates to the PSC and associated timing of work commitments;
-- The exploration results of both Sarqala-1 re-entry and Mil Qasim-1;
-- The timing for settlement for all outstanding amounts under the control
of well insurance claim;
-- Participation of the Corporation's co-venturers in the PSC activities;
-- The ability to export oil and natural gas from the Kurdistan Region of
Iraq in accordance with the economic terms under the PSC, likely
following the promulgation of the new Federal Petroleum Law of Iraq; and
-- The current conditions in the financial markets, including the potential
for further market instability.
Outstanding Share Data
As at December 31, 2010, there were 207,464,320 shares issued and outstanding.
The number of common shares reserved for issuance pursuant to options granted
will not exceed 10 percent of the issued and outstanding common shares.
Subsequent to December 31, 2010, WesternZagros completed a private placement of
common shares in which 89,665,352 common shares were issued. As at April 11,
2011, the total number of shares outstanding was 297,129,672.
For the year ended December 31, 2010, there were 9,764,900 stock options granted
to employees and 2,417,334 forfeited by employees, bringing the total stock
options outstanding as of December 31, 2010 to 20,354,900. Subsequent to
December 31, 2010, there were 27,000 stock options granted to employees and
605,400 forfeited by employees, bringing the total stock options outstanding as
of April 11, 2011 to 19,776,500.
RISK FACTORS
The oil and gas industry is very competitive and is subject to many risks. Many
of these risks are outside of WesternZagros' control. Since inception and
typical with development stage companies, WesternZagros has incurred losses from
operations and negative cash flows from operating activities, and has an
accumulated deficit at December 31, 2010. The ability of WesternZagros to
successfully carry out its business plan beyond exploration is primarily
dependent upon the continued support of its shareholders, resolution of the PSC
negotiations referred to under the "Future PSC Operations" section of this MD&A,
the discovery of economically recoverable reserves, meeting all commitments
under the PSC, the resolution of remaining political disputes in Iraq, progress
on the Federal Petroleum Law and the ability to export oil and natural gas from
the Kurdistan Region of Iraq in accordance with the economic terms under the
PSC, the state of the capital markets, the ability of WesternZagros to obtain
financing to develop reserves, and the timely receipt of the remaining
anticipated insurance proceeds from the current insurance claim associated with
the Kurdamir-1 well control and recovery operations. Management of WesternZagros
has identified certain key risks and their potential impact on WesternZagros'
operations.
Additional Funding Requirements
In general, the Corporation's ability to continue operations and exploration
activities as a going concern is dependent upon its ability to obtain additional
funding when required. WesternZagros anticipates making substantial capital
expenditures for the acquisition, exploration, appraisal, development and
production of oil and natural gas reserves in the future. These expenditures
also include WesternZagros' requirement to carry the KRG's 20 percent interest
under the PSC. In addition, any change in the continued participation of
Talisman under the PSC could increase the Corporation's capital requirements
(see "Future PSC Operations").
WesternZagros' cash balances may not be sufficient to fund its ongoing
activities at all times and to carry the KRG's 20 percent interest. From time to
time, WesternZagros may require additional financing in order to carry out its
oil and gas acquisition, exploration and development activities. While the
Corporation has been successful in obtaining its required funding in the past,
there is no assurance that debt or equity financing, or future cash generated by
operations (if any), would be available or sufficient to meet these requirements
or, if debt or equity financing is available, that it will be on terms
acceptable to WesternZagros.
Financial market instability in the past few years has impacted WesternZagros'
ability, and that of other exploration and development companies, to access
equity or debt markets at all or on acceptable terms. Future global economic
events and conditions may result in further volatility in the financial markets
which, in turn, could negatively impact WesternZagros' ability to access equity
or debt markets over time. In addition, the results of the Corporation's
exploration activities or any prolonged delay in the resolution of remaining
political disputes in Iraq, progress on the Federal Petroleum Law or in the
export of oil from Kurdistan in accordance with the economic terms under the PSC
could negatively impact the future ability of the Corporation to access equity
or debt markets.
The inability of WesternZagros to access sufficient capital for its operations
on a timely basis could have a material adverse effect on WesternZagros'
financial condition, results of operations and prospects and its ability to
continue as a going concern and could cause WesternZagros to forfeit its
interest in certain properties, miss certain acquisition opportunities and
reduce or terminate its operations.
Foreign Activities
All of WesternZagros' assets are located in Kurdistan. As such, WesternZagros is
subject to political, economic, and other uncertainties, including, but not
limited to, the uncertainty of negotiating with foreign governments (including
e.g. the Corporation's force majeure claim under the PSC), expropriation of
property without fair compensation, adverse determinations or rulings by
governmental authorities, changes in energy policies or in the personnel
administering them, nationalization, currency fluctuations and devaluations,
disputes between various levels of authorities, arbitrating and enforcing claims
against entities that may claim sovereignty, authorities claiming jurisdiction,
potential implementation of exchange controls and royalty and government take
increases and other risks arising out of foreign governmental sovereignty over
the areas in which WesternZagros' operations are conducted, as well as risks of
loss due to civil strife, acts of war, guerrilla activities, and insurrections.
WesternZagros' operations may be adversely affected by changes in government
policies and legislation or social instability and other factors which are not
within the control of WesternZagros including, among other things, adverse
legislation in Iraq and/or Kurdistan, a change in crude oil or natural gas
pricing policy, the risks of war, terrorism, abduction, expropriation,
nationalization, renegotiation or nullification of existing concessions and
contracts, taxation policies, economic sanctions, the imposition of specific
drilling obligations, and the development and abandonment of fields.
Continued Participation of the Corporation's Co-Venturers
WesternZagros' ability to execute its exploration and development strategies in
the manner in which the Corporation considers optimal may be affected by the
continued participation of the Corporation's co-venturers and the conclusion of
discussions related to PSC activities, the resulting timing of work commitments
therefrom and the Corporation's percentage share of costs relating thereto. Any
change in the continued participation of Talisman under the PSC could increase
the Corporation's capital requirements, see "PSC Overview and Commitments" and
"Future PSC Operations".
Political Issues
The political and security situation in Iraq (outside Kurdistan) is unsettled
and volatile. Kurdistan is the only Region that is constitutionally established
pursuant to the Iraq Constitution. The political issues of federalism and the
autonomy of Regions in Iraq are matters about which there are major differences
between the various political factions in Iraq. These differences could
adversely impact WesternZagros' interests in Kurdistan and the PSC.
Legislative Issues
No federal Iraq legislation has yet been agreed to or enacted by the Iraq
Council of Ministers (Cabinet) and Council of Representatives (Parliament) to
address the future organization of Iraq's petroleum industry or the sharing of
petroleum and other revenues within Iraq. Failure to enact legislation or the
enactment of federal legislation contradictory to Kurdistan legislation could
materially adversely impact WesternZagros' interest in Kurdistan and the PSC.
Exploration, Development and Production Risks
Oil and natural gas operations involve many risks which even a combination of
experience, knowledge and careful evaluation may not be able to overcome. The
long-term commercial success of WesternZagros depends on its ability to find,
appraise, develop and commercially produce oil and natural gas resources and
reserves, which will depend not only on its ability to explore and develop any
properties it may have from time to time, but also on its ability to select and
acquire additional producing properties or prospects. No assurance can be given
that WesternZagros will be able to locate satisfactory properties for
acquisition or participation. Moreover, if such acquisitions or participations
are identified, WesternZagros may determine that current markets, terms of
acquisition and participation or pricing conditions make such acquisitions or
participations uneconomic. There is no assurance that commercial quantities of
oil and natural gas will be discovered or acquired by WesternZagros.
Future oil and natural gas exploration may involve unprofitable efforts, not
only from dry wells, but from wells that are productive but do not produce
sufficient petroleum substances to return a profit after drilling, operating and
other costs. Completion of a well does not assure a profit on the investment or
recovery of drilling, completion and operating costs. In addition, drilling
hazards or environmental damage could greatly increase the cost of operations,
and various field operating conditions may adversely affect the production from
successful wells. These conditions include delays in obtaining governmental
approvals or consents, shut-ins of connected wells resulting from extreme
weather conditions, insufficient storage or transportation capacity or other
geological and mechanical conditions. While diligent well supervision and
effective maintenance operations can contribute to maximizing production rates
over time, production delays and declines from normal field operating conditions
cannot be eliminated and can be expected to adversely affect revenue and cash
flow levels to varying degrees.
Oil and natural gas exploration, development and production operations are
subject to all the risks and hazards typically associated with such operations,
including hazards such as fire, explosion, blowouts, cratering, sour gas
releases and spills, each of which could result in substantial damage to oil and
natural gas wells, production facilities, other property and the environment or
personal injury. In accordance with industry practice, WesternZagros is not
fully insured against all of these risks, nor are all such risks insurable.
Although WesternZagros maintains liability insurance in an amount that it
considers consistent with industry practice, the nature of these risks is such
that liabilities could exceed policy limits, in which event WesternZagros could
incur significant costs that could have a material adverse effect upon its
financial condition. Oil and natural gas exploration, development and production
operations are also subject to all the risks typically associated with such
operations, including encountering unexpected formations or pressures, premature
decline of reservoirs and the invasion of water into producing formations.
Losses resulting from the occurrence of any of these risks could have a material
adverse effect on WesternZagros.
Resources Estimates
Resource estimates contained herein are only estimates and the ultimate
resources may prove to be significantly less than the mean estimates. Estimates
of resources depend in large part upon the reliability of available geological
and engineering data. Geological and engineering data are used to determine the
probability that a reservoir of oil and/or natural gas exists at a particular
location, and whether, and to the extent to which, such hydrocarbons are
recoverable from the reservoir.
Basic reservoir parameters will vary within the reservoir of interest and some
of these parameters such as porosity, net hydrocarbon pay thickness and water
saturation may affect the volume of hydrocarbon estimated to be present.
Additional reservoir parameters such as permeability, the presence or absence of
bottom water and the specific mineralogy of the reservoir rock may affect the
effectiveness of the recovery process. Recovery of the resources may also be
affected by the availability and quality of source water, availability of fuel
gas, and well and plant equipment malfunction or failure. There is no certainty
that certain mineral interests are not affected by ownership considerations that
have not yet come to light.
The Corporation has engaged professional geologists and engineers to evaluate
the reservoir and prepare development and depletion plans, however
implementation risk remains. This risk is related to factors such as the
operational capacity and reliability of wells and facilities, the vertical and
areal homogeneity of the reservoir, and the effectiveness of the drainage of oil
in the reservoir to the vicinity of the production wells where it can be
captured.
Ability to Execute Exploration, Appraisal and Development Program
It may not always be possible for WesternZagros to execute its exploration,
appraisal and development strategies in the manner in which WesternZagros
considers optimal. WesternZagros' exploration and development programs in Iraq
involve the need to obtain approvals from the relevant authorities, which may
require conditions to be satisfied or the exercise of discretion by the relevant
authorities. It may not be possible for such conditions to be satisfied.
Project Risks
WesternZagros' ability to execute projects and market oil and natural gas will
depend upon, or be impacted by, numerous factors beyond WesternZagros' complete
control, including:
-- the availability and proximity of pipeline capacity and sales markets;
-- security issues;
-- the supply of and demand for oil and natural gas;
-- the effects of inclement weather;
-- the availability of drilling, production and related equipment and
supplies, as well as services, all of which may be disrupted for a
number of reasons;
-- the hazards related to drilling and associated operations;
-- unexpected cost increases;
-- the continued participation of its co-venturers in the PSC activities;
-- accidental events;
-- currency fluctuations;
-- the availability and productivity of skilled labour;
-- adverse legislation in Kurdistan and/or Iraq; and
-- the regulation of the oil and natural gas industry by various levels of
government and governmental agencies in Kurdistan and/or Iraq.
Because of these factors, WesternZagros could be unable to execute projects on
time, on budget or at all, and may not be able to effectively market the oil and
natural gas that it may produce.
Operational Experience
The management and directors of WesternZagros have significant international
experience in the oil and gas industry; however, given the fact that
WesternZagros was incorporated recently in 2007, the team has not, as a group,
developed a conventional oil and gas project.
Competition
The petroleum industry is competitive in all its phases. WesternZagros competes
with numerous other organizations in the search for, and the acquisition of, oil
and natural gas properties and in the marketing of oil and natural gas.
WesternZagros' competitors include oil and natural gas companies that have
substantially greater financial resources, staff and facilities than
WesternZagros. WesternZagros' ability to acquire or increase reserves in the
future will depend not only on its ability to explore and develop its present
properties, but also on its ability to select and acquire other suitable
producing properties or prospects for exploratory drilling. Competitive factors
in the distribution and marketing of oil and natural gas include price and
methods and reliability of delivery.
Management of Growth
WesternZagros may be subject to growth-related risks, including capacity
constraints and pressure on its internal systems and controls. The ability of
WesternZagros to manage growth effectively will require it to continue to
implement and improve its operational and financial systems and to expand, train
and manage its employee base. The inability of WesternZagros to deal with this
growth could have a material adverse impact on its business, operations and
prospects.
Reliance on Key Personnel
WesternZagros' success depends in large measure on certain key personnel. The
loss of the services of such key personnel could have a material adverse affect
on WesternZagros. WesternZagros does not have any key person insurance in effect
for management. The contributions of the existing management team to the
immediate and near term operations of WesternZagros are likely to be of central
importance. In addition, the competition for qualified personnel in the oil and
natural gas industry can be intense and there can be no assurance that
WesternZagros will be able to attract and retain all personnel necessary for the
development and operation of its business. Investors must rely upon the ability,
expertise, judgment, discretion, integrity and good faith of the management of
WesternZagros.
Access to Export Infrastructure
WesternZagros' ability to export production from any potential oil and gas
discoveries may depend on its ability to secure transportation. WesternZagros
may also be affected by deliverability uncertainties related to the proximity of
its potential production to pipelines and processing facilities and operational
problems affecting such pipelines and facilities.
Prices, Markets and Marketing
The marketability and price of oil and natural gas that may be acquired or
discovered by WesternZagros is, and will continue to be, affected by numerous
factors beyond its control including the impact that the various levels of
government may have on the ultimate price received for oil and gas sales.
WesternZagros' ability to market its oil and natural gas may depend upon its
ability to secure transportation. WesternZagros may also be affected by
potential government regulation relating to price, the export of oil and natural
gas and other aspects of the oil and natural gas business.
Both oil and natural gas prices are subject to wide fluctuation. During 2010,
both oil and gas prices remained volatile as West Texas Intermediate ranging
from US$64 to US$91 per barrel. WesternZagros originally negotiated the economic
terms of its PSC in 2007 in a $50 per barrel crude oil price environment and any
significant and sustained decline in crude oil prices from this price may impact
the feasibility of WesternZagros' business plan.
Foreign Exchange
WesternZagros operations costs are generally incurred in U.S. dollars, while the
funds it will have available to it may be in other currencies. There is a
possibility that operations and development costs may increase as a result of
currency fluctuation.
Third Party Credit Risk
WesternZagros is exposed to third party credit risk through its contractual
arrangements with any potential joint venture partners, marketers of its
petroleum and natural gas production, suppliers, contractors, and other parties.
In the event such entities fail to meet their contractual obligations to
WesternZagros or determine not to continue to participate in the PSC activities,
such events could have a material adverse effect on WesternZagros and its cash
flow from operations. In addition, poor credit conditions in the industry may
impact a joint venture partner's willingness to participate in a future
WesternZagros' capital program.
Conflicts of Interest
Certain directors of WesternZagros are also directors of other oil and gas
companies and as such may, in certain circumstances, have a conflict of interest
requiring them to abstain from certain decisions. Conflicts, if any, will be
subject to the procedures and remedies of the ABCA.
Dilution
WesternZagros may make future acquisitions or enter into financings or other
transactions involving the issuance of securities of WesternZagros which may be
dilutive.
Issuance of Debt
From time to time, WesternZagros may enter into transactions to acquire assets
or the shares of other organizations. These transactions may be financed in
whole or in part with debt, which may increase WesternZagros' debt levels above
industry standards for oil and natural gas companies of similar size. Neither
WesternZagros' articles nor its by-laws limit the amount of indebtedness
WesternZagros may incur. The level of WesternZagros' indebtedness from time to
time, could impair WesternZagros' ability to obtain additional financing on a
timely basis to take advantage of business opportunities that may arise.
Hedging
From time to time, WesternZagros may enter into agreements to receive fixed
prices on any future oil and natural gas production to offset the risk of
revenue losses if commodity prices decline; however, if commodity prices
increase beyond the levels set in such agreements, WesternZagros would not
benefit from such increases. Similarly, from time to time, WesternZagros may
enter into agreements to fix the exchange rate of various currencies used in its
business in order to offset the risk of revenue or cost related losses in the
event of currency fluctuations. There is no certainty that any such currency
hedges which may be entered into will benefit WesternZagros.
Availability of Drilling Equipment and Access
Oil and natural gas exploration and development activities are dependent on the
availability of drilling and related equipment and supplies (typically leased
from third parties) in the particular areas where such activities will be
conducted. Demand for such limited equipment or access restrictions may affect
the availability of such equipment and supplies to WesternZagros and may delay
exploration and development activities.
Insurance and Liability
WesternZagros' involvement in the exploration for and development of oil and
natural gas properties may result in WesternZagros becoming subject to liability
for pollution, blow outs, property damage, personal injury or other hazards.
Although WesternZagros maintains insurance in accordance with industry standards
to address certain of these risks, such insurance has limitations on liability
and may not be sufficient to cover the full extent of such liabilities. In
addition, such risks are not, in all circumstances, insurable or, in certain
circumstances, WesternZagros may elect not to obtain insurance to deal with
specific risks due to the high premiums associated with such insurance or other
reasons. The payment of any uninsured liabilities would reduce the funds
available to WesternZagros. The occurrence of a significant event that
WesternZagros is not fully insured against, or the insolvency of the insurer of
such event, could have a material adverse effect on WesternZagros.
CRITICAL ACCOUNTING ESTIMATES
WesternZagros' critical accounting estimates are defined as those estimates that
have a significant impact on the portrayal of its financial position and
operations and that require management to make judgments, assumptions and
estimates in the application of Canadian GAAP. Judgments, assumptions and
estimates are based on historical experience and other factors that management
believes to be reasonable under current conditions. As events occur and
additional information is obtained, these judgments, assumptions and estimates
may be subject to change. WesternZagros believes the following are the critical
accounting estimates used in the preparation of its consolidated financial
statements. WesternZagros' significant accounting estimates can be found in note
3 to its Annual Financial Statements.
Use of Estimates
The preparation of the consolidated financial statements in conformity with
Canadian GAAP requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities as at the date of the consolidated financial statements,
and the reported amounts of revenues and expenses during the reporting period.
Such estimates relate to unsettled transactions and events as of the date of the
consolidated financial statements. Accordingly, actual results may differ from
these estimated amounts as future confirming events occur. Significant estimates
used in the preparation of the consolidated financial statements include, but
are not limited to, recovery of exploration costs capitalized in accordance with
full cost accounting, insurance recoveries receivable, asset retirement
obligations, future incomes taxes, and fair value of stock-based compensation.
Insurance Recoveries Receivable
WesternZagros has recognized an insurance recoveries receivable as at December
31, 2010. This receivable has been recognized on the basis of the acceptance of
the insurance claim by the insurers (see the "Insurance Claim Update" section of
this MD&A) and requires management to estimate the amount of the remaining claim
that it believes it has virtual certainty in recovering.
Property, Plant and Equipment ("PP&E")
WesternZagros capitalizes costs related to crude oil and natural gas properties
in accordance with the full cost method, whereby all costs associated with the
acquisition of, exploration for and the development of crude oil and natural
gas, including asset retirement obligations are capitalized and accumulated
within cost centres on a country-by-country basis. Such costs include land
acquisition, geological and geophysical activity, drilling and testing of
productive and non-productive wells, carrying costs directly related to unproved
properties, major development projects and administrative costs directly related
to exploration and development activities.
Depletion on crude oil properties is anticipated to be provided over the life of
proved reserves (assuming such reserves are established) on a unit of production
basis and commences when the facilities are substantially complete and after
commercial production has begun. Other PP&E assets are depreciated on a
straight-line basis over their useful lives, except for lease acquisition costs,
which are amortized and depreciated over the life of proved and probable
reserves once established.
PP&E assets are reviewed for impairment whenever events or conditions indicate
that their net carrying amount may not be recoverable from estimated future cash
flows. If an impairment is identified the assets are written down to the
estimated fair market value. The calculation of these future cash flows are
dependent on a number of estimates, which include reserves, timing of
production, crude oil price, operating cost estimates and foreign exchange
rates. As a result, future cash flows are subject to significant management
judgment.
Asset Retirement Obligation
WesternZagros recognizes an asset and a liability for asset retirement
obligations in the period in which they are incurred by estimating the fair
value of the obligation. The Corporation determines the fair value by first
estimating the expected timing and amount of cash flow, using third-party costs
that will be required for future dismantlement and site restoration, and then
calculating the present value of these future expenditures using a credit
adjusted risk free rate appropriate for WesternZagros. Any change in timing or
amount of the cash flow subsequent to initial recognition results in a change in
the asset and liability, which then impacts the depletion on the asset and the
accretion charged on the liability. Estimating the timing and amount of cash
outflow to settle this obligation is inherently difficult and is based on
management's current experience.
Stock Based Compensation
WesternZagros uses fair value accounting for stock-based compensation. Under
this method, all equity instruments awarded to employees and the cost of the
service received as considerations are measured and recognized based on the fair
value of the equity instruments issued. Compensation expense is recognized over
the period of related employee service, usually the vesting period of the equity
instrument awarded.
Income Tax
WesternZagros follows the liability method of accounting for income taxes
whereby future income taxes are recognized based on the differences between the
carrying values of assets and liabilities reported in the Annual Financial
Statements and their respective tax basis. Future income tax assets and
liabilities are recognized at the tax rates at which management expects the
temporary differences to reverse. Management bases this expectation on future
earnings, which requires estimates for reserves, timing of production, crude oil
price, operating cost estimates and foreign exchange rates. Management assesses,
based on all available evidence, the likelihood that the future income tax
assets will be recovered from future taxable income and a valuation allowance is
provided to the extent that it is more than likely that future income tax assets
will not be realized. As a result, future earnings are subject to significant
management judgment as well as future economic and legislative changes.
CHANGES IN ACCOUNTING POLICIES AND PRACTICES AND FUTURE ACCOUNTING PRONOUNCEMENTS
Changes in Accounting Policies
WesternZagros adopted the following new accounting standards effective January
1, 2010:
-- Amendments to CICA Handbook Section 1506, Accounting Changes. These
amendments to the standard resulted in excluding changes in accounting
policies due to a complete replacement of an entity's primary basis of
accounting. The implementation of these amendments had no significant
impact on the Corporation's financial statements.
Future Accounting Pronouncements
Convergence to International Financial Reporting Standards ("IFRS")
In February 2008, the Accounting Standards Board confirmed that all Canadian
publicly accountable enterprises will be required to adopt IFRS for interim and
annual reporting purposes for fiscal years beginning on or after January 1,
2011. Companies will also be required to provide IFRS comparable information for
the previous fiscal year. The transition date of January 1, 2010, will require
WesternZagros to restate the 2010 comparative information for the 2011 financial
statements to be prepared in accordance with IFRS.
In early 2010 the project team developed an IFRS implementation plan and
performed preliminary assessments on the accounting policy choices for
conversion to IFRS. During the second quarter of 2010 the project team focused
on key IFRS transition issues and alternatives and commenced an analysis of IFRS
financial statement presentation and disclosure requirements. A detailed
implementation plan and timeline was also developed at that time. During the
third quarter of 2010 the project team drafted IFRS accounting policies for
Steering Committee review and completed an initial analysis on the opening
balance sheet adjustments required upon conversion to IFRS. Since that time, the
draft IFRS accounting policies have been formalized and the project team
continues to execute the implementation phase under the IFRS conversion plan.
WesternZagros currently continues to review the required adjustments for the
January 1, 2010 opening IFRS balance sheet. While still subject to change, the
most significant impacts from conversion to IFRS are as follows:
IFRS 1, "First-Adoption of International Reporting Standards" ("IFRS 1")
WesternZagros currently utilizes the full cost method for accounting for its
exploration activities in the Kurdistan Region of Iraq under Canadian GAAP.
Under the full cost method, all costs associated with the acquisition of,
exploration for, and development of crude oil and natural gas, including asset
retirement obligations, are capitalized and accumulated within cost centres on a
country-by-country basis. Such costs include land acquisition, geological and
geophysical activity, drilling and testing of productive and non-productive
wells, carrying costs directly related to unproved properties, major development
projects and administrative costs directly related to exploration and
development activities. As WesternZagros is only currently operating in the
Kurdistan Region of Iraq and has only one PSC in that region, it has capitalized
all costs associated with those exploration activities, including certain costs
incurred prior to entering into the PSC.
IFRS 1 sets out the procedures that an entity must follow when adopting IFRS as
the basis for preparing financial statements. IFRS provides entities with a
number of optional exemptions upon conversion to IFRS, the most significant of
which that WesternZagros currently intends to utilize is the exemption that
allows the December 31, 2009 full cost pool under previous GAAP to be
reclassified as intangible exploration and evaluation assets under IFRS.
WesternZagros currently estimates that upon transition to IFRS, approximately
$154 million in costs will be reclassified from property, plant, and equipment
to intangible evaluation and exploration assets on a deemed cost basis as at
January 1, 2010.
IFRS 6, "Exploration for and Evaluation of Mineral Resources", ("IFRS 6")
Upon conversion to IFRS, WesternZagros will be required to adopt IFRS 6, which
is the standard that deals with accounting for exploration and evaluation
("E&E") assets for extractive industries.
Typical costs included in the E&E assets are acquisition of rights to explore,
topographical, geological, geochemical and geophysical studies, exploratory
drilling, trenching, sampling, and activities in relation to evaluating the
technical feasibility and commercial viability of extracting mineral resources.
Under IFRS 6, costs incurred prior to the legal rights to explore an area being
obtained may no longer be capitalized within E&E assets.
After transition to IFRS on January 1, 2010, WesternZagros currently expects
that E&E assets will continue to increase, during the E&E phase, due to ongoing
expenditures related to its PSC Lands.
WesternZagros will also be required to complete an impairment test of
exploration and evaluation assets as at January 1, 2010. For the purposes of
completing an impairment test under IFRS 6, the E&E assets must be allocated to
specific cash-generating units (CGUs). Due to the sizeable prospective resource
estimates associated with its PSC Lands, WesternZagros does not currently expect
to record any impairment of E&E assets upon transition to IFRS.
IFRS 2, "Share Based Payment", ("IFRS 2")
The valuation and expensing of share-based payments will be done using a graded
vesting under IFRS, whereas under previous GAAP, entire stock option issuances
were valued as a whole and expensed on a straight line over the expected lives
of the options. This results in an accelerated expensing of the share-based
payments as the fair value is weighted more heavily toward the periods closer to
the date of issuance of the stock options but is partially offset by the impact
of estimated forfeitures. WesternZagros currently estimates that at transition
on January 1, 2010, contributed surplus will increase between $1 million to $2
million, with a corresponding increase in the accumulated deficit, due to the
accelerated expensing associated with share based payments under IFRS.
IAS 37, "Provisions, Contingent Liabilities and Contingent Assets", ("IAS 37")
The provisions for decommissioning obligations under IFRS are treated similarly
to Canadian GAAP, which are currently disclosed as asset retirement obligations
("ARO"). However, IAS 37 requires that a risk-free discount rate, that is not
credit risk adjusted, be applied to the present value calculation of estimated
future abandonment costs. It is anticipated that the change in the discount rate
will result in an increased provision for decommissioning obligations of between
$0.2 million to $0.5 million upon transition to IFRS as at January 1, 2010.
Other IFRS Considerations
In addition to accounting policy changes necessary upon transition to IFRS,
WesternZagros continues to work on the development of processes and systems to
ensure that IFRS comparative data is captured, and to position the Corporation
for reporting under IFRS in 2011. WesternZagros does not currently anticipate
significant system modifications or significant changes in internal controls
upon transition to IFRS.
Overall, WesternZagros continues to make progress on the convergence with IFRS.
Presentation and disclosures requirements for each policy continue to be
addressed. The project team also continues to work on the implementation phase,
which includes determining the specific qualitative and quantitative impacts for
each IFRS requirement that is relevant to the Corporation and anticipates
completion of this phase in April 2011. The final determination of IFRS policy
choices discussed in this MD&A, as well as the discussion of the optional
exemptions that may be utilized, are still subject to final approval of the
Audit Committee and the Board of Directors and the concurrence of WesternZagros'
auditors.
WESTERNZAGROS RESOURCES LTD.
CONSOLIDATED BALANCE SHEETS
(United States dollars thousands)
As At December 31 2010 2009
----------------------------------------------------------------------------
Assets
Current Assets
Cash and Cash Equivalents $ 31,482 $ 76,708
Accounts Receivable(note 5) 8,648 6,880
Insurance Recoveries Receivable (note 6) 17,597 -
Deposits held in trust (note 7) 420 -
Prepaid Expenses 39 183
Income Tax Recoverable 887 1,738
Future Income Taxes (note 9) 102 231
----------------------------------------------------------------------------
59,175 85,740
Long-term Assets
Property, Plant and Equipment (note 6) 182,056 154,911
Deposits held in trust (note 7) - 420
Future Income Taxes (note 9) - 6
----------------------------------------------------------------------------
182,056 155,337
----------------------------------------------------------------------------
$ 241,231 $ 241,077
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Liabilities
Current Liabilities
Accounts Payable and Accrued Liabilities $ 21,525 $ 18,297
----------------------------------------------------------------------------
21,525 18,297
Long-term Liabilities
Asset Retirement Obligation (note 8) 189 175
Future Income Taxes (note 9) 56 -
----------------------------------------------------------------------------
21,770 18,472
----------------------------------------------------------------------------
Shareholders' Equity
Share Capital (note 10) 253,583 253,583
Contributed Surplus (note 12) 11,353 8,749
Deficit (45,475) (39,727)
----------------------------------------------------------------------------
219,461 222,605
----------------------------------------------------------------------------
$ 241,231 $ 241,077
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Going Concern Uncertainty (note 1)
Commitments and Contingencies (note 16)
Subsequent Events (note 20)
See Accompanying Notes to the Consolidated Financial Statements
Approved by the Board of Directors
(Signed) "Fred J. Dyment" (Signed) "Randall Oliphant"
Director Director
CONSOLIDATED STATEMENTS OF OPERATIONS,
COMPREHENSIVE LOSS AND DEFICIT
(United States dollars thousands, except per share amounts)
For the Years Ended December 31 2010 2009
----------------------------------------------------------------------------
Revenues
Interest Income $ 87 $ 184
Expenses
General and Administrative 6,362 6,260
Depreciation 553 737
Accretion on Asset Retirement Obligation 14 11
Foreign Exchange Loss 62 12
----------------------------------------------------------------------------
6,991 7,020
----------------------------------------------------------------------------
Loss Before Income Taxes 6,904 6,836
Income Tax Recovery (note 9) (1,156) (1,345)
----------------------------------------------------------------------------
Net Loss and Other Comprehensive Loss 5,748 5,491
Deficit, Beginning of Year 39,727 34,236
----------------------------------------------------------------------------
Deficit, End of Year $ 45,475 $ 39,727
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Net Loss Per Share
- Basic and Diluted(note 13) $ 0.03 $ 0.03
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Going Concern Uncertainty (note 1)
See Accompanying Notes to the Consolidated Financial Statements
CONSOLIDATED STATEMENTS OF CASH FLOWS
(United States dollars thousands)
For the Years Ended December 31 2010 2009
----------------------------------------------------------------------------
Cash Provided By (Used In)
Cash From (For) Operating Activities
Net Loss $ (5,748) $ (5,491)
Non-cash Items
Depreciation 553 737
Accretion on Asset Retirement Obligation
(note 8) 14 11
Stock-based Compensation 1,568 1,938
Future Income Tax Expense (note 9) 191 404
----------------------------------------------------------------------------
(3,422) (2,401)
Decrease (Increase)in Non-Cash Working
Capital (note 15) 728 (6,440)
----------------------------------------------------------------------------
(2,694) (8,841)
----------------------------------------------------------------------------
Cash From (for) Financing Activities
None - -
----------------------------------------------------------------------------
- -
----------------------------------------------------------------------------
Cash From (For) Investing Activities
Short-term Investments - 39,967
Capital Expenditures (67,162) (54,356)
Insurance Recoveries (note 6) 24,403 -
Deposits Held in Trust - (420)
Decrease in Non-cash Working Capital (note
15) 227 10,342
----------------------------------------------------------------------------
(42,532) (4,467)
----------------------------------------------------------------------------
Decrease in Cash and Cash Equivalents (45,226) (13,308)
Cash and Cash Equivalents at Beginning of Year 76,708 90,016
----------------------------------------------------------------------------
Cash and Cash Equivalents at End of Year $ 31,482 $ 76,708
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Supplemental cash flow information:
Income Taxes Recovered (Paid) $ 2,198 $ (4,669)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Going Concern Uncertainty (note 1)
See Accompanying Notes to the Consolidated Financial Statements
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2010 and 2009
(Tabular amounts in United States dollars thousands)
1. GOING CONCERN UNCERTAINTY AND BASIS OF PRESENTATION
These consolidated financial statements have been prepared in accordance with
Canadian generally accepted accounting principles ("GAAP") on the basis that
WesternZagros Resources Ltd. (the "Corporation" or "WesternZagros") will
continue to operate as a going concern, which implies the realization of assets
and the settlement of liabilities and commitments in the normal course of
business for the foreseeable future.
Since inception and typical with development stage companies, the Corporation
has incurred losses from operations and negative cash flows from operating
activities, and has an accumulated deficit at December 31, 2010. During the year
ended December 31, 2010, the Corporation had expenditures of $3.4 million,
before net change in non-cash working capital, for operating activities and
$67.2 million for oil and gas property expenditures, as well as an overall
decrease in non-cash working capital of $1.0 million. The Corporation will
require additional funding over time to maintain ongoing exploration programs
and property commitments, as well as for administration expenses. This
requirement for funding will occur during the fiscal year ending December 31,
2011, with the amount dependant on the level and timing of exploration
activities pursued by the Corporation.
There are material uncertainties that could raise significant doubt about the
Corporation's ability to continue as a going concern, as further outlined below:
Availability of Future Financing
Subsequent to December 31, 2010, the Corporation successfully obtained
additional equity financing of Cdn$43 million, by way of a brokered private
placement of common shares that closed on March 10, 2011, which provided funds
for planned operations at both Sarqala-1 and Mil Qasim-1 in 2011. The
Corporation will require additional financing to re-drill the Kurdamir structure
(Kurdamir-2) and to test the Oligocene, Eocene and Cretaceous formations that
were originally encountered, but only partially evaluated, in Kurdamir-1.
In general, the Corporation's ability to continue operations and exploration
activities as a going concern is dependent upon its ability to obtain additional
funding over time. While the Corporation has been successful in obtaining its
required funding in the past, there is no assurance that sufficient funds will
be available to the Corporation in the future, or if available, available on
favourable terms. Factors that could affect the availability of financing
include, but are not limited to: the continued support of its shareholders;
resolution of the negotiations in respect of the Corporation's Production
Sharing Contract ("PSC") referred to in Note 16(a); the results of its
exploration activities; meeting all commitments under the PSC; the resolution of
remaining political disputes in Iraq; progress on the Federal Petroleum Law and
the ability to export oil and natural gas from the Kurdistan Region of Iraq in
accordance with the economic terms under the PSC; the state of the capital
markets and the ability of the Corporation to obtain financing to develop
reserves; and the timely receipt of the remaining anticipated proceeds from the
current insurance claim associated with the Kurdamir-1 well control operations.
Insurance Claim Related To Well Control Operations:
The Corporation experienced two well control operations while drilling
Kurdamir-1. The first of these began in the first quarter of 2010 and the second
ended in the fourth quarter of 2010. Both were subject to an insurance claim.
The Corporation received confirmation of coverage for the additional costs of
these operations from the insurers during the second quarter of 2010. Subsequent
to the conclusion of well control operations, the Corporation successfully
completed and tested a portion of the well.
The insurance claim provides coverage for the Corporation's share of allowable
costs up to a maximum of $45 million. The Corporation has submitted claims for
$45.9 million and has received $35.9 million (both net to the Corporation) in
insurance proceeds as at April 11, 2011. The Corporation continues to pursue
payment for the remainder of the claim. However, any change in the determination
of insurance coverage or delay in payment could impair the Corporation's ability
to fund ongoing activities under the PSC.
Continued Participation of the Corporation's Co-Venturers in the PSC:
The Corporation is involved in ongoing discussions with both Talisman (Block 44)
B.V., a wholly owned subsidiary of Talisman Energy Inc. ("Talisman"), and the
Kurdistan Regional Government ("KRG") regarding the optimal contractual
arrangement for conducting future activities on the PSC lands as described in
Note 16(a). As a consequence of these discussions, it is likely that Talisman
will continue to participate in the funding of its working interest share of the
costs of drilling Kurdamir-2, but it is unlikely that Talisman will participate
in activities on the remaining PSC Lands and that the Corporation will likely be
required to initially, or entirely, fund 100% of the costs associated with the
third exploration commitment well under the PSC at Mil Qasim-1. In addition, due
to these ongoing discussions among the Corporation, Talisman and the KRG,
Talisman has elected not to participate in the Sarqala-1 re-entry operations.
These consolidated financial statements do not reflect adjustments in the
carrying values of assets and liabilities reported, revenue or expenses, nor the
balance sheet classification used that would be necessary if the going concern
assumption was not appropriate. Such adjustments could be material.
2. NATURE OF OPERATIONS
WesternZagros Resources Ltd. (the "Corporation") was incorporated on August 22,
2007 under the laws of the Province of Alberta. The Corporation, an
international oil and gas company, is engaged in acquiring properties and
exploring for, developing and in due course producing crude oil and natural gas
in Iraq and is in the developmental stage. Through its subsidiaries, the
Corporation's operations are related to its interest in a Production Sharing
Contract with the Kurdistan Regional Government ("KRG") in respect of an
exploration project area in the Kurdistan Region of Iraq.
3. SIGNIFICANT ACCOUNTING POLICIES
In these Consolidated Financial Statements, unless otherwise indicated, all
dollar amounts are expressed in United States ("U.S.") dollars. The Corporation
has determined the U.S. dollar to be its functional and reporting currency since
most of its expenditures are directly or indirectly denominated in U.S. dollars.
When revenues are realized, it is expected that U.S. dollars will be received.
In addition, the U.S. dollar facilitates a more direct comparison to other
international crude oil and natural gas exploration and development companies.
All references herein to U.S. $ or to $ are to United States dollars and
references herein to Cdn $ are to Canadian dollars.
i. Principles of Consolidation
The Consolidated Financial Statements have been prepared in accordance with
Canadian generally accepted accounting principles and include the accounts of
the Corporation and its wholly-owned subsidiaries.
ii. Measurement Uncertainty
The preparation of the Consolidated Financial Statements in conformity with
Canadian generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the Consolidated Financial Statements and the reported amounts of revenues and
expenses during the reporting period. Such estimates relate to unsettled
transactions and events as of the date of the Consolidated Financial Statements.
Accordingly, actual results may differ from these estimated amounts as future
confirming events occur. Significant estimates used in the preparation of the
Consolidated Financial Statements include, but are not limited to, recovery of
exploration costs capitalized in accordance with full-cost accounting, insurance
recoveries receivable, asset retirement obligation, future income taxes, and
fair value of stock-based compensation.
iii. Foreign Currency Translation
Monetary assets and liabilities denominated in foreign currencies are translated
to U.S. dollars at rates of exchange in effect at the end of the period, while
non-monetary assets and liabilities are translated into U.S. dollars at
historical rates. Foreign currency transactions are translated into the
functional currency using the exchange rates prevailing at the dates of the
transactions. Foreign exchange gains and losses resulting from the settlement of
such transactions and from the translation at year-end exchange rates of
monetary assets and liabilities denominated in foreign currencies are recognized
in the income statement.
iv. Cash and Cash Equivalents
Cash and cash equivalents consist of cash in the bank, less outstanding cheques,
and short-term deposits with a maturity of three months or less.
v. Revenue
The Corporation recognizes revenue, which is related to the interest income
earned on the Corporation's cash and cash equivalents and short-term
investments, on an accrual basis.
vi. Property, Plant and Equipment ("PP&E")
a) Petroleum and natural gas assets.
The Corporation accounts for its petroleum and natural gas operations in
accordance with the Canadian Institute of Chartered Accountants' ("CICA")
guideline on full-cost accounting in the oil and gas industry. Under this
method, all exploration and development costs, including asset retirement
obligations, are capitalized and accumulated within cost centres on a
country-by-country basis. Such costs include land acquisition, geological and
geophysical activity, drilling and testing of productive and non-productive
wells, carrying costs directly related to unproved properties, major development
projects and administrative costs directly related to exploration and
development activities.
If the Corporation commences commercial production from the cost centres,
capitalized costs accumulated within each cost centre will be depleted,
depreciated and amortized on the unit-of-production method based on the
estimated proved reserves of that country using estimated future prices and
costs.
Proceeds from the disposal of properties are normally deducted from the
full-cost pool without recognition of a gain or loss, unless that deduction
would result in a change to the depletion rate by 20 percent or more, in which
case a gain or loss is recorded.
In determining the depletion base, the Corporation will include estimated future
costs to be incurred in developing proved reserves and will exclude the cost of
unproved properties and major development projects. Costs of major development
projects and costs of acquiring and evaluating significant unproved properties
are excluded, on a cost centre basis, from costs subject to depletion until it
is determined whether or not proved reserves are attributable to the properties
or impairment has occurred. To date, no depletion related to the Corporation's
properties has been recorded as commercial operations have not commenced.
The Corporation reviews the carrying amount of its properties relative to their
recoverable amount (the "ceiling test") for each cost centre at each annual
balance sheet date or more frequently if circumstances or events indicate
impairment has occurred. The recoverable amount is calculated as the sum of:
-- the undiscounted cash flow from proved reserves using expected future
prices and costs;
-- the cost of unproved properties; and
-- the costs of major development projects less impairment.
If the carrying amount of the properties exceeds their recoverable amount, an
impairment loss is recognized in depletion equal to the amount by which the
carrying amount of the properties exceeds their fair value. Fair value is
calculated as the sum of:
-- the cash flows from proved and probable reserves using expected future
prices and costs, discounted at a risk-free interest rate; and
-- the cost, less impairment, of unproved reserves and major development
projects that do not have probable reserves attributable to them.
The Corporation is currently engaged in the Kurdistan Region Exploration
Project, as described in Note 6, which is in the development stage. The
Corporation has no proven or probable reserves to form the basis for an estimate
of future net cash flow from the properties. The Corporation has considered the
conditions in CICA Accounting Guideline 11 for impairment which includes
significant unfavorable economic, legal, regulatory, environmental, political
and other factors. In addition, the Corporation's continued execution of its'
business plan is a key factor considered as part of the assessment of the
recoverability of the carrying amount of the properties. Whenever events or
changes in circumstances indicate that the carrying amount of a property in the
development stage may be impaired, capitalized costs are written down to the
estimated recoverable amount. As at December 31, 2010, $181.8 million has been
capitalized to date related to this project. No revenues have been generated
from this project to date and no impairment was identified at December 31, 2010.
b) Corporate PP&E assets
Corporate PP&E assets are stated at historical cost less accumulated
depreciation. Corporate assets are depreciated on a straight-line basis over
their useful lives ranging from two to three years. The assets' residual values
and useful lives are reviewed and adjusted, if required, at each balance sheet
date.
vii. Asset Retirement Obligation
The Corporation recognizes an asset and a liability for asset retirement
obligations in the period in which they are incurred by estimating the fair
value of the obligation. The fair value is determined by the Corporation by
first estimating the expected timing and amount of cash flows, using third-party
costs, that will be required for future dismantlement and site restoration, and
then calculating the present value of these future expenditures using a credit
adjusted risk-free interest rate that Management of the Corporation deems
appropriate. Any change in timing or amount of the cash flows subsequent to
initial recognition results in a change in the asset and liability. The
Corporation recognizes the accretion expense on the liability and depletion on
the asset over the estimated life of the asset and liability. Actual
expenditures, when incurred, will be charged against the accumulated obligation.
viii. Income Taxes
The Corporation follows the liability method of income tax allocation. Under
this method, future tax assets and liabilities are determined based on
differences between the carrying values and tax bases of assets and liabilities
and are measured using the substantially enacted tax rates and laws that will be
in effect when the differences are expected to reverse. The Corporation
assesses, based on all available evidence, the likelihood that the future income
tax assets will be recovered from future taxable income. A valuation allowance
is provided to the extent that it is more likely than not that future income tax
assets will not be realized.
ix. Stock-Based Compensation
For the Corporation's stock option plan, compensation expense is recorded in the
Consolidated Statements of Operations as general and administrative expenses
with a corresponding increase in contributed surplus in the Consolidated Balance
Sheets for all common share options granted. Compensation costs directly related
to exploration activities are capitalized. The expense is based on the fair
values of the options at the time of grant and is recognized in the Consolidated
Statements of Operations over the requisite service period of the respective
options on a straight-line basis. Fair values are determined, at the grant date,
using the Black-Scholes option-pricing model. When stock options are exercised,
the cash proceeds together with the amount previously recorded as contributed
surplus is recorded as share capital. When stock options are forfeited, the
previously recognized expense associated with non-vested stock options is
reversed in the period in which the stock options were forfeited, while
previously recognized expense associated with vested stock options is not
reversed.
x. Financial instruments
Financial assets and liabilities, including derivative instruments, are
initially recognized and subsequently measured based on their classification as
"held-for-trading", "available-for-sale" financial assets, "held-to-maturity",
"loans and receivables", or "other" financial liabilities. Held-for-trading
financial instruments are measured at their fair value with changes in fair
value recognized in net income for the period. Available-for-sale financial
assets are measured at their fair value and changes in fair value are included
in other comprehensive income until the asset is removed from the balance sheet.
Held-to-maturity investments, loans and receivables and other financial
liabilities are measured at amortized cost using the effective interest rate
method. Derivative instruments, including embedded derivatives, are measured at
their fair value with changes in fair value recognized in net income for the
period, unless the instrument is a cash flow hedge and hedge accounting applies,
in which case changes in fair value are recognized in other comprehensive
income. The Corporation has not identified any material embedded derivatives in
any of its financial instruments. The Corporation has not designated any its
derivatives as hedges.
The Corporation classifies fair value measurements using a fair value hierarchy
that reflects the significance of the inputs used in making the measurements.
The Corporation's fair value hierarchy has the following levels:
-- Quoted prices (unadjusted) in active markets for identical assets and
liabilities (Level I); and
-- Inputs other than quoted prices included in Level I that are observable
for the asset or liability, either directly or indirectly (Level II).
-- Valuation techniques with significant unobservable market inputs. (Level
III).
4. CHANGES IN ACCOUNTING POLICIES AND FUTURE ACCOUNTING PRONOUNCEMENTS
Changes in Accounting Policies
i) Accounting Changes
As of January 1, 2010, the Corporation adopted recent amendments to CICA
Handbook Section 1506, "Accounting Changes", which now excludes from its scope
changes in accounting policies upon the complete replacement of an entity's
primary basis of accounting. These amendments apply to interim and annual
financial statements related to years beginning on or after July 1, 2009 and did
not have a material impact on the Corporation's financial statements.
Future Accounting Pronouncements
i) Convergence to International Financial Reporting Standards ("IFRS")
In February 2008, the Accounting Standards Board confirmed that all Canadian
publicly accountable enterprises will be required to adopt IFRS for interim and
annual reporting purposes for fiscal years beginning on or after January 1,
2011. Companies will also be required to provide IFRS comparable information for
the previous fiscal year. The transition date of January 1, 2010, will require
WesternZagros to restate the 2010 comparative information for the 2011 financial
statements to be prepared in accordance with IFRS.
5. RELATED PARTY TRANSACTIONS
As at December 31, 2009, there was a loan to a senior officer of $0.2 million
included in accounts receivable. The loan was non-interest bearing and was
subsequently repaid during the year ended December 31, 2010.
6. PROPERTY, PLANT AND EQUIPMENT
Accumulated
Depletion and Net
As at December 31, 2010 Cost Depreciation Book Value
----------------------------------------------------------------------------
Kurdistan Region Exploration
Project $ 181,795 $ - $ 181,795
Corporate 1,831 (1,570) 261
----------------------------------------------------------------------------
$ 183,626 $ (1,570) $ 182,056
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Accumulated
Depletion and Net
As at December 31, 2009 Cost Depreciation Book Value
----------------------------------------------------------------------------
Kurdistan Region Exploration
Project $ 154,244 $ - $ 154,244
Corporate 1,684 (1,017) 667
----------------------------------------------------------------------------
$ 155,928 $ (1,017) $ 154,911
----------------------------------------------------------------------------
----------------------------------------------------------------------------
All costs included in the Kurdistan Region Exploration Project are excluded from
depletion as they represent costs incurred related to properties in cost centres
that are considered to be in the development stage. Currently, there are no
proved reserves. All costs, net of associated recoveries, have been capitalized.
For the year ended December 31, 2010, the Corporation capitalized $3.0 million
of general and administrative costs (2009: $3.2 million), including $1.0 million
of stock-based compensation (2009: $0.5million), directly related to exploration
activities.
The Corporation initiated an insurance claim related to the cost of the well
control and recovery operations at Kurdamir-1. The control of well insurance
policy covering these claims has a net aggregate limit to the Corporation of $45
million, with a $0.4 million deductible. Under the terms of the insurance
policy, the Corporation submits claims for these costs as they are incurred and
paid and these claims are then subject to the review and approval of an adjuster
appointed by the insurers. For the year ended December 31, 2010, the Corporation
credited $42.0 million of insurance recoveries, net of the $0.4 million
deductible, related to these well control and recovery operations at Kurdamir-1
against the Kurdistan Region Exploration Project. During the year ended December
31, 2010, the Corporation received $24.4 million of insurance proceeds from the
insurers. Subsequent to December 31, 2010, further insurance proceeds of $11.5
million were received related to further approved interim claims. The
Corporation has submitted the remaining costs incurred and continues to pursue
the required approval for these amounts, and approval of an adjustor appointed
by the insurers.
As at December 31, 2010, the Corporation had approximately $157 million, net to
WesternZagros, of cost pools available that may ultimately be recovered from
future oil or natural gas sales in accordance with the terms of the PSC.
7. DEPOSITS HELD IN TRUST
As of December 31, 2010, the Corporation had a $0.4 million deposit held in
trust for a supplier to be utilized to fund certain expenditures for drilling
operations. Subsequent to December 31, 2010, the funds held in trust were
subsequently recovered.
8. ASSET RETIREMENT OBLIGATION
The Corporation records the fair value of legal obligations associated with the
retirement and reclamation of tangible long-lived assets when incurred. The
asset retirement cost, equal to the estimated fair value of the asset retirement
obligation, is capitalized as part of the cost of the related long-lived asset.
The estimation of this cost is based on engineering estimates using current
costs and technology and in accordance with industry practice. The Corporation's
share of total undiscounted amount of estimated cash flow required to settle the
obligations is $1.2 million. The asset retirement obligations are calculated
based on a weighted-average approach under the assumption that the cash
out-flows required to settle the obligations are incurred either two years after
inception or 25 years after inception, with the most likely case that the
obligations are paid in the years 2033 and 2034. The Corporation used a credit
risk adjusted risk-free rate of 10 percent and an inflation factor of 4 percent
to calculate the net present value of the future retirement obligation.
The following table presents the reconciliation of the Corporation's asset
retirement obligation for the years ended December 31, 2010 and 2009:
For the Years Ended December 31 2010 2009
----------------------------------------------------------------------------
Balance, beginning of year 175 69
Liabilities incurred $ - $ 95
Accretion expense 14 11
----------------------------------------------------------------------------
Balance at end of year $ 189 $ 175
9. INCOME TAXES
For the Years Ended December 31 2010 2009
----------------------------------------------------------------------------
Current Income Tax Recovery $ (1,347) $ (1,749)
Future Income Tax Expense 191 404
----------------------------------------------------------------------------
Income Tax (Recovery) Expense $ (1,156) $ (1,345)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
The Future Income Tax assets are comprised of:
As at December 31 2010 2009
----------------------------------------------------------------------------
Current Future Income Tax Asset:
Non-Capital Loss Carryforwards $ - $ 27
Share Issue Costs 102 204
----------------------------------------------------------------------------
$ 102 $ 231
----------------------------------------------------------------------------
----------------------------------------------------------------------------
As at December 31 2010 2009
----------------------------------------------------------------------------
Long-term Future Income Tax Asset (Liability):
Share Issue Costs $ 275 $ 387
Book Values in Excess of Tax Values (158) (198)
Valuation Allowance (173) (183)
----------------------------------------------------------------------------
$ (56) $ 6
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Income tax expense differs from that which would be expected from applying
the effective Canadian federal and provincial tax rates of 28% (2009 - 29%)
due to the following:
For the Years Ended December 31 2010 2009
----------------------------------------------------------------------------
Net Loss Before Income Taxes (6,904) (6,836)
Income Tax Recovery at Statutory Rate (1,933) (1,982)
Losses in Foreign Jurisdictions With No Tax
Benefit 968 808
Stock-based Compensation 439 717
Valuation Allowance (10) 183
Effect of Tax Planning and Provision to Actual (631) (859)
Effect of Timing of Use (37) (154)
Other 48 (58)
----------------------------------------------------------------------------
Income Tax Recovery (1,156) (1,345)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
10. SHARE CAPITAL
a. Authorized
The Corporation is authorized to issue an unlimited number of common and
preferred shares. The common shares are without nominal or par value.
b. Common Shares Issued and Outstanding
Number of Amount
Shares (000's)
----------------------------------------------------------------------------
Balance as at December 31, 2009 and
December 31, 2010 207,464,320 $ 253,583
----------------------------------------------------------------------------
----------------------------------------------------------------------------
11. STOCK OPTIONS AND STOCK-BASED COMPENSATION
Pursuant to the stock option plan, the Board of Directors may grant options to
directors, officers, employees, consultants and other service providers. The
aggregate number of shares that may be reserved for issuance pursuant to stock
options may not exceed 10 per cent of the issued and outstanding common shares
on a non-diluted basis of the Corporation at the time of granting. Stock options
expire not more than five years from the date of grant, or earlier if the
individual ceases to be associated with the Corporation, and vest at the
discretion of the Board of Directors.
During 2010 the Corporation granted 9,764,900 options exercisable for voting
common shares of the Corporation, while 2,417,334 options were forfeited. The
following table presents the reconciliation of stock options granted for the
years ended December 31, 2010 and 2009:
December 31, 2010 December 31, 2009
Weighted Weighted
Average Average
Number of Exercise Number of exercise
Options Price (Cdn$) Options price ($Cdn)
----------------------------------------------------------------------------
Outstanding, beginning
of year 13,007,334 $ 1.50 12,305,667 $ 1.62
Granted 9,764,900 0.49 1,990,000 0.80
Forfeited (2,417,334) 1.67 (1,288,333) 1.55
----------------------------------------------------------------------------
Outstanding, end of year 20,354,900 $ 1.00 13,007,334 $ 1.50
----------------------------------------------------------------------------
----------------------------------------------------------------------------
The following table summarizes Stock Options outstanding and exercisable
under the Stock Option Plan at December 31, 2010:
Options Outstanding
---------------------------------------------------------------------------
Weighted
Average Weighted
Remaining Average
Number of Contractual Exercise
Range of Exercise Price Options Life Price
Cdn$ Outstanding (years) Cdn$
----------------------------------------------------------------------------
$ 0.38 - $0.49 9,739,900 4.97 0.49
$ 0.50 - $1.00 4,756,667 3.10 0.63
$ 1.01 - $2.00 435,000 2.85 1.37
$ 2.01 - $3.28 5,423,333 2.12 2.19
----------------------------------------------------------------------------
20,354,900 3.73 1.00
----------------------------------------------------------------------------
Options Exercisable
----------------------------------------------------------------------------
Weighted
Average Weighted
Remaining Average
Number of Contractual Exercise
Range of Exercise Price Options Life Price
Cdn$ Exercisable (years) Cdn$
----------------------------------------------------------------------------
$ 0.38 - $0.49 3,226,634 4.97 0.49
$ 0.50 - $1.00 3,275,664 3.09 0.65
$ 1.01 - $2.00 263,334 2.79 1.34
$ 2.01 - $3.28 5,378,333 2.12 2.19
----------------------------------------------------------------------------
12,143,965 3.15 1.30
----------------------------------------------------------------------------
The fair value of all options granted have been estimated at the grant date
using the Black-Scholes option pricing model and are summarized in the
following table:
Year Ended December 31 2010 2009
----------------------------------------------------------------------------
Weighted average fair value of stock
options granted $0.29 $0.79
Risk Free Interest Rate 1.62% to 2.01% 1.64% to 1.73%
Expected Life 2 - 3 years 1 - 3 years
Expected Volatility 120% 80%
Dividend Per Share Nil Nil
----------------------------------------------------------------------------
----------------------------------------------------------------------------
During the year ended December 31, 2010, the Corporation recognized $1.6
million (2009: $1.9 million) of stock-based compensation as general and
administrative expense and capitalized $1.0 million (2009: $0.5 million).
12. CONTRIBUTED SURPLUS
The following table presents the reconciliation of Contributed Surplus:
Year Ended December 31 2010 2009
----------------------------------------------------------------------------
Balance, beginning of year $ 8,749 $ 6,276
Stock-based Compensation 2,604 2,473
----------------------------------------------------------------------------
Balance, end of year $ 11,353 $ 8,749
----------------------------------------------------------------------------
----------------------------------------------------------------------------
13. LOSS PER SHARE
The net loss per share has been calculated based on the basic weighted average
number of common shares outstanding for the year of 207,464,320 (2009:
207,464,320). In computing diluted per share amounts, the Corporation's options
totaling 20,354,900 (2009:13,007,334) have been excluded as anti-dilutive.
Accordingly, no additional common shares were added to the basic weighted
average shares outstanding to account for dilution.
14. SHAREHOLDER RIGHTS PLAN
On October 18, 2007, the Corporation adopted a shareholder rights plan (the
"Plan"). Under the Plan, one right has been issued in respect of each currently
issued common share and one right will be issued with each additional common
share which is issued. The rights remain attached to the common shares and are
not exercisable or separable unless one or more of certain specified events
occur. If a person or group acting in concert acquires 20 per cent or more of
the common shares of the Corporation, the rights will entitle the holders
thereof (other than the acquiring person or group) to purchase common shares at
a substantial discount from the then market price. The rights are not triggered
by a "Permitted Bid" as defined in the Plan. The Plan will remain in effect
until termination of the annual meeting of shareholders in 2013, unless extended
by resolution of the shareholders at such meeting.
15. CHANGES IN NON-CASH WORKING CAPITAL
For the Years Ended December 31 2010 2009
----------------------------------------------------------------------------
Operating Activities
Accounts Receivable $ (270) $ (68)
Prepaid Expenses 144 67
Income Tax Receivable 851 (1,738)
Accounts Payable and Accrued Liabilities 3 (22)
Income Tax Payable - (4,679)
----------------------------------------------------------------------------
$ 728 $ (6,440)
----------------------------------------------------------------------------
Investing Activities
Accounts Receivable $ (1,498) $ 5,349
Accounts Payable and Accrued Liabilities 1,725 4,993
----------------------------------------------------------------------------
$ 227 $ 10,342
----------------------------------------------------------------------------
----------------------------------------------------------------------------
16. COMMITMENTS AND CONTINGENCIES
Commitments
a. Production Sharing Contract
Under the terms of its PSC, the Corporation has a 40 percent working interest
and the KRG has a 20 percent working interest which is carried by the
Corporation. The remaining 40 percent working interest is held by Talisman,
which was allocated the interest by the KRG, as announced on June 23, 2008. The
Corporation, the KRG and Talisman are collectively the "Contractor Group" under
the PSC. WesternZagros is the operator of the PSC Lands until the end of the
first exploration sub-period of the PSC, when a joint operating company may be
established if so elected by the Contractor Group.
The PSC contemplates two exploration sub-periods of three years and two years,
respectively, with two possible one-year extensions. The first exploration
sub-period ended December 31, 2010, subject to an extension under a force
majeure claim described below. During such time, the Contractor Group was
required to complete a minimum of 1,150 kilometres of seismic surveying (which
has been completed), to drill three exploration wells (two of which have been
drilled), and to commit a minimum of $75 million in the aggregate on these
activities (which has been completed). The PSC also includes capacity building
support payments (which concluded in April 2009) and annual funding for certain
technological, logistical, recruitment and training support during the
exploration sub-periods.
During the drilling of the Kurdamir-1 well, certain situations occurred which
caused additional time to be spent on well control and repair operations under
conditions of force majeure. Under the terms of the PSC, when a force majeure
event occurs, the time resulting from any such delay and the time necessary to
repair any damage resulting from the delay is to be added to any time period
provided under the PSC, including the first exploration sub-period. The period
of force majeure started on January 22, 2010 and continued until October 14,
2010, a period of 265 days. The Corporation, on behalf of the Contractor Group,
has notified the KRG of a force majeure event under the terms of the PSC and
claimed a corresponding 265 day extension of the first exploration sub-period,
i.e. until September 22, 2011.
Following the submission of the force majeure claim to the KRG, the KRG proposed
certain contractual amendments in order to resolve the timing issues created by
the force majeure event and other commercial concerns. Negotiations among the
Contractor Group are ongoing with respect to these proposed amendments. See
"Future PSC Operations".
At the end of the first exploration sub-period, the Corporation and the other
parties to the PSC may relinquish the entire contract area (other than any
discovery or development areas), or continue further exploration operations by
entering into the second exploration sub-period, or request a one-year extension
for further exploration and appraisal activities prior to deciding to enter into
the second exploration sub-period.
To meet its remaining commitments for the first exploration sub-period, the
Corporation estimates expenditures of approximately $20 million to $25 million,
prior to the costs of any testing, if required, and assuming that the
Corporation will be required to fund 100% for the remaining exploration
commitment well (see "Future PSC Operations"). This estimate includes the
remaining costs associated with drilling this additional exploration commitment
well by the end of the first exploration sub-period, and providing associated
supervision and local office support in support of drilling operations.
During the second exploration sub-period under the original PSC Agreement, the
Contractor Group, or those parties who elected to participate in further
exploration, is required to complete a minimum of 575 kilometres of seismic
surveying, drill at least two exploration wells and commit a minimum of $35
million to these activities. At the end of the second exploration sub-period,
the Corporation and the other parties to the PSC who elected to participate in
the second exploration sub-period, may relinquish the entire contract area
(other than any discovery or development areas) or continue further exploration
and appraisal operations into the extension periods subject to the following
relinquishment requirements. At the end of the second exploration sub-period,
and at the end of each subsequent extension period, the PSC requires the
Corporation, and other parties who elected to participate, to relinquish 25
percent of the remaining undeveloped area within the PSC Lands or the entire
contract area (other than any discovery or development areas).
Future PSC Operations
In parallel with, and as an alternative to the force majeure claim,
WesternZagros remains involved in ongoing negotiation with both Talisman and the
KRG regarding the optimal contractual arrangements for conducting future
activities on the PSC Lands. Proposals discussed to date include, but are not
limited to:
-- A one-year extension, to December 31, 2011, for drilling the third
exploration commitment well;
-- A requirement to complete the drilling of Kurdamir-2 prior to June 30,
2012, and subsequent to Talisman drilling the Topkhana-1 well on its
adjacent Block 39;
-- Talisman becoming operator for all future activity on the Kurdamir
structure, with WesternZagros continuing as operator for all future
activity on the remainder of the PSC Lands; and
-- Talisman's future participation in activities on the PSC Lands being
limited to the Kurdamir prospect, with the expectation that the KRG
would assign Talisman's prior 40% interest in the remaining PSC Lands to
a new third party participant following completion of the third
exploration commitment well, which would be located on these remaining
PSC Lands. As such, this would require the Corporation to initially, or
entirely, fund 100% of the costs associated with the third commitment
well.
While these negotiations proceed, WesternZagros continues to work toward
drilling the third exploration commitment well under the terms of the force
majeure provision in the PSC in order to ensure that it meets the current
requirements of the PSC in the event these negotiations are not successfully
concluded.
b. Consulting Services Agreements
In 2003 the Corporation entered into a consulting service agreement that
provides for a three percent right to participate indirectly in the future
profits the Corporation may earn in respect to the PSC, in exchange for
consulting services provided since that date. In the determination of profits
under this agreement, the Corporation is entitled to deduct the consultant's
proportional share of all costs associated with acquiring the PSC and the
exploration, appraisal, development and production expenditures incurred by the
Corporation ("eligible costs"), together with interest on such percentage of
eligible costs at LIBOR plus three percent. The Corporation is currently in
negotiations to terminate this right.
Further, in 2004 the Corporation entered into a consulting service agreement
that provides for a two percent right to indirectly participate in the future
profits the Corporation may earn in respect to the PSC, in exchange for the
provision of consulting services during the period 2004 to 2006. In
determination of profits under this agreement, the Corporation is entitled to
deduct one percent of all eligible costs, together with interest on such
percentage of eligible costs at LIBOR plus ten percent. The consultant is
required to fund the additional one percent of all eligible costs. The
Corporation is currently in negotiations to terminate this right.
c. Other
The Corporation has entered into various exploration-related contracts,
including contracts for drilling equipment, services and tangibles. The
following table summarizes the commitments the Corporation has under these
exploration-related contracts and other contractual obligations at December 31,
2010:
For the Years Ending December 31,
2011 2012 2013 2014 2015+ Total
----------------------------------------------------------------------------
Exploration 2,335 - - - - 2,335
Offices 614 234 - - - 848
----------------------------------------------------------------------------
2,949 234 - - - 3,183
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Contingencies
a. Litigation
From time to time the Corporation may become involved in legal or administrative
proceedings in the normal conduct of business. Amounts involved in such matters
are not reasonably estimable due to uncertainty as to the final outcome. The
Corporation 's assessment of the likely outcome of these matters is based on its
judgment of a number of factors, including precedents and facts specific to the
matters. The Corporation does not believe these matters, individually or in
aggregate will have a material adverse effect on its consolidated financial
position or results of operations.
b. Regulatory
Oil and gas operations are subject to extensive controls and regulations imposed
by various levels of government that may be amended from time to time. The
Corporation's operations may require licenses and permits from various
governmental authorities in the countries in which it operates. Under the PSC,
the KRG is obligated to assist in obtaining all permits and licenses from any
government agencies in the Kurdistan Region and from any other government
administration in Iraq. There can be no assurance that the Corporation will be
able to obtain all necessary licenses and permits that may be required to carry
out exploration and development of its projects.
The political and security situation in Iraq is unsettled and volatile. The
Kurdistan Region is the only "Region" of Iraq that is constitutionally
established pursuant to the Iraq Constitution, which expressly recognizes the
Kurdistan Region. The political issues of federalism and the autonomy of the
Regions of Iraq are matters about which there are major differences between the
various political factions in Iraq. These differences could adversely impact the
Corporation's interest in the Kurdistan Region including the ability to export
any hydrocarbons as a result of our activities.
17. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT
Financial instruments of the Corporation consist of cash and cash equivalents,
accounts receivable, accounts payable and accrued liabilities. The Corporation's
cash and cash equivalents are designated as held-for-trading and are measured at
fair value, which approximates carrying value due to the short-term nature of
these instruments. The fair value of cash and cash equivalents is classified as
Level II fair value measurement. Accounts receivable are designated as loans and
receivables and recorded at amortized cost, which approximates fair value due to
the short term nature of the instrument. Accounts payable and accrued
liabilities are designated as other liabilities and are recorded at amortized
cost. The fair value of accounts payable and accrued liabilities approximate
their carrying values due to the short term nature of these instruments.
The Corporation is exposed to credit risk, interest rate risk, market risk,
liquidity and funding risk. The following is a description of those risks and
how the Corporation manages exposure to them:
Credit Risk
Credit risk is the risk of loss associated with counterparty's inability to
fulfill its payment obligations. The Corporation is currently exposed to credit
risk on its cash and cash equivalents, to the extent that these balances are
invested with various institutions. The Board of Directors of the Corporation
has approved an Investment Policy to dictate the various types of instruments
and institutions that can be invested in and monitors these against this policy
on a regular basis. Currently, the Corporation has entered into transactions for
cash equivalents with major Canadian financial institutions with investment
grade credit ratings.
Under the terms of the PSC, as described in Note 16, the KRG elected a
wholly-owned subsidiary of Talisman as the Third Party Participant under the
PSC. The Corporation is subject to credit risk associated with Talisman's 40
percent interest in the PSC and its share of related expenditures. As at
December 31, 2010, the Corporation had $8.6 million of receivables outstanding
mostly from Talisman under the credit terms defined by the PSC, including
penalty provisions for any amount in default.
Market and Interest Rate Risk
Market risk is the risk of loss that may arise from changes in market factors
such as interest rate, foreign exchange rates and equity or commodity prices.
The Corporation is exposed to interest rate risk to the extent that changes in
market interest rates will impact any interest earned on the Corporation's cash
and cash equivalent. The Corporation is also exposed to foreign exchange risk,
as the majority of costs are anticipated to be incurred in U.S. dollars and the
funds it will have available to it may be in other currencies.
The Corporation's Investment Policy dictates the various types of instruments
and institutions that can be invested in and monitors these against this policy
on a regular basis. The Board of Directors has also approved a Foreign Exchange
Policy to dictate the currencies held by the Corporation and the instruments
that can be utilized by the Corporation to meet day to day needs. This Foreign
Exchange Policy requires the Corporation to hold the majority of its cash and
cash equivalents in U.S. dollars and sets out the type and duration of
instruments that can be used to meet the Corporation's day to day foreign
exchange needs. The Foreign Exchange Policy does allow the Corporation to hold
other balances, mainly Canadian dollars, to meet the requirements to fund
ongoing general and administrative and other spending requirements in these
currencies. Neither policy permits the Corporation to enter into any economic
hedging as it relates to interest or foreign exchange risks. As at December 31,
2010, had the U.S. Dollar changed by one percent against the Canadian dollar,
with all other variables held constant, the Corporation's foreign exchange gain
or loss would have been affected by approximately $11,000.
The marketability and price of oil and natural gas that may be acquired or
discovered by the Corporation is, and will continue to be, affected by numerous
factors beyond its control including the impact that the various levels of
government may have on the ultimate price received for oil and gas sales. The
Corporation's ability to market its oil and natural gas may depend upon its
ability to secure transportation. The Corporation may also be affected by
deliverability uncertainties related to the proximity of its potential
production to pipelines and processing facilities and operational problems
affecting such pipelines and facilities as well as potential government
regulation relating to price, the export of oil and natural gas and other
aspects of the oil and natural gas business.
Both oil and natural gas prices are subject to wide fluctuation. During 2010,
both oil and gas prices remained somewhat volatile with West Texas Intermediate
ranging from $68 to $91 per barrel. WesternZagros originally negotiated the
economic terms of its PSC in 2007 in a $50 per bbl crude oil price environment
and any significant and sustained decline in crude oil prices from this price
may impact the feasibility of WesternZagros' business plan.
Liquidity and Funding Risks
Liquidity and funding risk is the risk that the Corporation may be unable to
generate or obtain sufficient cash or its equivalent in a timely and
cost-effective manner to meet its commitments as they come due. As the
Corporation is engaged in acquiring properties and exploring for crude oil and
natural gas and is in the developmental stage, it currently does not have a
revenue source outside of interest on its cash and cash equivalent and
short-term investment balances. The Corporation is therefore required to fund
its share of all commitments from existing balances or access additional sources
of cash from the equity markets. The Board of Directors reviews the
Corporation's cash and cash equivalent balances against the Corporation's
commitments and assesses the timing and need for additional equity financing on
a regular basis. However, the Corporation's results will impact its ability to
access the capital necessary to meet these commitments. There can be no
assurance that debt or equity financing will be available or sufficient to meet
these requirements or for other corporate purposes or, if debt or equity
financing is available, that it will be on terms acceptable to the Corporation.
In recent years, the capital markets have seen a period of significant market
instability. The Corporation's ability to access the capital markets in the
future may be affected by any prolonged period of market instability. The
inability of Corporation to access sufficient capital for its operations could
have a material adverse effect on the Corporation's financial condition, results
of operations and prospects. Additionally, the Corporation currently expects to
re-drill the Kurdamir structure in the future after first drilling the third
commitment well required under the PSC. The Corporation will have to raise funds
in order to be able to complete the Kurdamir re-drill.
18. CAPITAL STRUCTURE
The Corporation's capital consists of shareholder's equity and working capital.
The Corporation will adjust its capital structure to manage its drilling program
through the issuance of shares and adjustments to capital spending.
The Corporation's objectives when managing its capital structure are to:
i) Ensure adequate levels of available cash and cash equivalents and short-term
investments to meet the Corporation's commitments under the PSC.
ii) To prudently fund expenditures related to the acquisition of properties, and
for exploration, appraisal and development of crude oil and natural gas
resources.
The Corporation funds its share of expenditures of all commitments from existing
cash and cash equivalent balances received primarily from issuances of
shareholders' equity. The Corporation has not entered into any debt financing
arrangements at the balance sheet date and is not subject to any externally
imposed capital requirements.
The Board of Directors regularly reviews the Corporation's cash and cash
equivalents against the Corporation's expenditure commitments and assesses the
timing and need for additional equity financing. The Corporation's results will
impact its access the capital necessary to meet these expenditure commitments.
There can be no assurance that equity financing will be available or sufficient
to meet those commitments, or for other corporate purposes, or if equity
financing is available, that it will be on terms acceptable to the Corporation.
The inability of the Corporation to access sufficient capital for its operations
could have a material adverse impact on the Corporation's financial condition,
results of operations and prospects. During 2010 the capital markets have
continued to see a period of market instability. The Corporation's ability to
access the capital markets in the future may be affected by any prolonged period
of market instability.
19. CHANGE IN FINANCIAL STATEMENT PRESENTATION
Certain comparative information has been changed in conformity to the current
year financial statement presentation.
20. EVENTS SUBSEQUENT TO THE BALANCE SHEET DATE
Subsequent to December 31, 2010, WesternZagros completed a private placement of
common shares in which 89,665,352 common shares were issued at a price of
Cdn$0.48 per share. Total gross proceeds received were Cdn$43 million.
About WesternZagros Resources Ltd.
WesternZagros is an international natural resources company engaged in acquiring
properties and exploring for, developing and producing crude oil and natural gas
in Iraq. WesternZagros, through its wholly-owned subsidiaries, holds a
Production Sharing Contract with the Kurdistan Regional Government in the
Kurdistan Region of Iraq. WesternZagros' shares trade in Canada on the TSX
Venture Exchange under the symbol "WZR".
This news release contains certain forward-looking information relating, but not
limited, to operational information, future drilling plans and testing programs
and the timing and costs associated therewith. Forward-looking information
typically contains statements with words such as "anticipate", "estimate",
"expect", "potential", "could", or similar words suggesting future outcomes. The
Corporation cautions readers not to place undue reliance on forward-looking
information as by its nature, it is based on current expectations regarding
future events that involve a number of assumptions, inherent risks and
uncertainties, which could cause actual results to differ materially from those
anticipated by WesternZagros. Readers are also cautioned that disclosed test
rates and potential production rates may not be indicative of ultimate
production levels. In addition, the forward-looking information is made as of
the date hereof, and the Corporation assumes no obligation to update or revise
such to reflect new events or circumstances, except as required by law.
Forward-looking information is not based on historical facts but rather on
management's current expectations and assumptions regarding, among other things,
plans for and results of drilling activity, future capital and other
expenditures (including the amount, nature and sources of funding thereof),
continued political stability, timely receipt of any necessary government or
regulatory approvals, the continued participation of the Corporations's
co-venturers in exploration activities and the timely receipt of any insurance
proceeds due to the Corporation. Although the Corporation believes the
expectations and assumptions reflected in such forward-looking information are
reasonable, they may prove to be incorrect. Forward-looking information involves
significant known and unknown risks and uncertainties. A number of factors could
cause actual results to differ materially from those anticipated by
WesternZagros including, but not limited to, risks associated with the oil and
gas industry (e.g. operational risks in exploration; inherent uncertainties in
interpreting geological data; changes in plans with respect to exploration or
capital expenditures; interruptions in operations together with any associated
insurance proceedings; the uncertainty of estimates and projections in relation
to costs and expenses and health, safety and environmental risks), risks
associated with resource estimates, the risk of commodity price and foreign
exchange rate fluctuations, the uncertainty associated with negotiating with
foreign governments and risk associated with international activity. For further
information on WesternZagros and the risks associated with its business, please
see the Corporation's Annual Information Form dated March 24, 2010, which is
available on SEDAR at www.sedar.com.
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