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NELSON RESOURCES LIMITED - Final Results 31 March 2005 NELSON RESOURCES LIMITED REPORTS ANNUAL RESULTS, SUBSTANTIAL INCREASES IN PRODUCTION, REVENUE AND RESERVES Nelson Resources Limited ("Nelson" or the "Company", TSX / AIM: NLG), a leading independent oil exploration and production company operating in Kazakhstan, today reports its final results for the twelve months ending December 31, 2004. All amounts are expressed in U.S. dollars unless otherwise indicated. Production amounts are expressed net to Nelson's equity interest in the fields unless otherwise indicated. HIGHLIGHTS ========== Financial --------- - Oil Revenue up 497% year-on-year to $242.4 million (2003 $40.6 million) - Profit from operations of $61.7 million, compared with a loss of $7.0 million in 2003 - Net profit of $3.7 million, which has been impacted by hedging costs and non-cash compensation charges, compared with a loss of $11.0 million in 2003 - Net cash flow increases thirty-fold to $84.9 million (2003 $2.9 million) - Average price per barrel sold $32.62 (2003 $26.51) - Successful $110.8 million placing and admission to trading on London Stock Exchange's AIM Operational ----------- - Total annual production of 6.1 million barrels net to Nelson - an increase of 277% (1.6 million bbls in 2003) - End of year production rate net to Nelson increasing 205% to 22,213 bopd (End 2003 7,279 bopd) - Nelson's net Proved plus Probable Reserves increased 25% to 234.9 million barrels (independently assessed by McDaniel & Associates) - Ambitious field development with 51 new wells drilled and 129 producing wells at end of year - KOA - Strong growth in production at Alibekmola field, initiation of pilot production at Kozhasai field - North Buzachi - 50% acquisition completed in February 2004, accelerated development plan approved - Karakuduk - acquisition of a net 36% stake in the field in May and a further 40% stake in December 2004 - Arman - acquisition of a 50% stake in this mature producing field after year end, in February 2005 Nick Zana, Nelson's Chief Executive Officer, commented: "I am proud of the achievements of our Company and its subsidiaries during 2004. Operationally, we have dramatically increased production and proved ourselves as an effective operator in Kazakhstan. Strategically, we have demonstrated our ability to complete acquisitions on a commercially prudent basis. Financially, we have achieved successful equity and debt capital market fundings, which provide the Company with a solid base to build upon. While net profit continues to be impacted by non-cash other compensation charges and hedging costs, revenue and cash flow grew significantly and the Company is in a strong position to finance continued growth in 2005 and beyond. I look forward to creating further shareholder value through capitalising on opportunities offered in Kazakhstan and the Caspian." FINANCIAL REVIEW ================ ================================================================================ (in thousands of U.S. dollars, Year Ended except per barrel amounts) December 31 2004 2003 -------------------------------------------------------------------------------- Crude oil revenue $ 242,394 $ 40,591 Revenue per barrel 32.62 26.51 Profit/(loss) from operations 61,705 (6,962) Net Profit/(loss) 3,695 (11,011) Basic profit/(loss) per share 0.0046 (0.019) Diluted profit/(loss) per share 0.0045 (0.019) Net effect of operating activities on cash flows 84,884 2,864 ================================================================================ All figures are for 50% of KOA, 50% of North Buzachi and 100% of Chaparral. Revenue, Expense and Income --------------------------- Revenue and profit from operations in 2004 have increased dramatically compared with the previous year, due to a combination of substantial increases in crude oil production - the result of both acquisitions and rapid field development - and higher oil export prices. Average revenue per barrel sold during the year was $32.62 compared with $26.51 in 2003. Unit costs of production increased from $2.91/bbl to $3.79/bbl year on year. This increase is due to the acquisition of North Buzachi, where unit production costs are higher than those at Kazakhoil Aktobe (KOA) and Karakudukmunai (KKM). Sales and transportation costs decreased from $6.68/bbl to $5.55/bbl year on year, due to lower unit costs at newly acquired fields. Per barrel general and administration (G&A) costs of Nelson's oil and gas operations decreased from $1.72/bbl to $1.50/bbl, reflecting the achievement of internal growth objectives of the Company, while corporate G&A increased due to greater administrative costs of managing an expanded group as well as extraordinary accounting and legal expenses relating primarily to acquisitions. While Net Profit after tax increased to $3.7 million in 2004 from a loss of $11.0 million in 2003, reported profit for the year was significantly reduced by the following factors: - Other Compensation Costs of $27.4 million arising from the intrinsic valuation method of accounting for stock options. Under this method, the difference between market price of the company's stock and the exercise price of the options are recorded in the profit and loss account, resulting in an increased expense as stock price rises. On a cumulative basis, options have been granted equal to 6% of shares outstanding and charges to earnings occur as the stock price rises. These accounting charges are non-cash. - Derivative instrument charges of $23.0 million attributable to oil price hedging contracts, $10.4 million of which arise from the fair value accounting for the underlying derivative value of the contracts and are non-cash. These contracts were entered into by KOA in November 2003 to mitigate price risk, cover 270,000 barrels per month (32% of KOA's year end production) at a strike price of approximately $30/bbl, and expire in August 2006. - Income tax expense of $31.4 million as compared to $4.2 million in 2003. The increase in income tax arises from the increasing profitability of the company's oil field production. Tax liabilities in the country of operation are not offset by the non-cash flow element in the above cited accounting charges. Taxable income in Kazakhstan for Nelson's operating companies was approximately $77.4 million. Reported tax expense includes the 30% Kazakh income tax plus other taxes including use taxes, property taxes, withholding taxes and other similar charges. Investing Activities -------------------- In February 2004, Nelson completed the acquisition of a 50% interest in North Buzachi, paying $32.3 million in addition to the $58.0 million paid in December 2003. This represents an acquisition cost of $1.07 per barrel of proved plus probable (2P) reserves. In May 2004, Nelson acquired a 60% interest in Chaparral, giving the company an indirect 36% interest in KKM, for $16.9 million or $0.76 per barrel of 2P reserves. This was followed in December by a 40% direct interest in KKM for $34.6 million or $1.41 per barrel of 2P reserves. Capital expenditures increased significantly year on year to $98.3 million, due to increased investment in field development, in particular drilling new wells and expanding field processing facilities. Financing Activities -------------------- In July 2004, Nelson issued 112 million shares at a subscription price of Cdn$1.40 (�0.57) per share on the London Stock Exchange's Alternative Investment Market. The new issue was subscribed to by both North American and European institutional investors, with net proceeds of $110.8 million. Also in 2004, Nelson significantly expanded its finance portfolio to include expanded availability from European and Kazakh banks, various advance payment arrangements from the major international independent trading companies aggregating more than $70 million, $10 million of medium term financing from the ECGD (the British government's export credit agency), increased vendor financing, and acquisition financing arranged by a major international investment bank. At year end 2004, financing arranged by Nelson from these sources for Nelson companies aggregated approximately $187.2 million. Restated Quarterly Information ------------------------------ Information previously reported in quarterly statements for the first three quarters of 2004 has been restated due to a number of changes, notably the retrospective adoption of the U.S. dollar as functional currency at KOA (previously using the Kazakh Tenge) from January 1, 2004, a revision of the marked-to-market valuation of derivative instruments, and a recalculation of minority interest. A detailed analysis of these charges is in the Management Discussion and Analysis document (see below). ================================================================================ (in thousands of As previously reported Restated U.S. dollars) Total Net Total Net Revenue Profit/(loss) Revenue Profit/(loss) -------------------------------------------------------------------------------- 2004, quarter ended March 31 26,398 (4,725) 26,398 (9,845) June 30 49,994 668 49,994 3,262 September 30 81,491 20,202 77,683 16,766 December 31 - - 88,319 (6,488) ================================================================================ MANAGEMENT DISCUSSION AND ANALYSIS ================================== A full Management Discussion and Analysis document, along with the Company's Annual Information Form, is available on SEDAR, www.sedar.com, and on the Company's website, www.nelsonresources.com, as part of the Company's annual filings. These documents can also be obtained on application from the Company. REVIEW OF OPERATIONS ==================== In 2004 the Company had interests in four onshore producing fields in western Kazakhstan, with a 50% interest in the Arman field acquired after year end. During 2004, Nelson's share of production from its three operating entities KOA, North Buzachi and KKM continued to grow. Production of crude oil net to Nelson's share in the fields increased from 7,279 bopd at the end of 2003 to 22,213 bopd at the end of 2004, an increase of 205%. Nelson is pursuing ambitious development programmes for all its operating properties. During 2004, 51 new wells were drilled across all fields, bringing the total number of producing wells to 129 at the end of the year. Work to increase oil processing capacities and to improve field facilities has also been undertaken, including de-bottlenecking of existing facilities at Alibekmola to 38,000 bopd. Field development will continue throughout 2005, including a new accelerated drilling programme now in place at North Buzachi and expected further development of pilot production at Kozhasai. According to independent estimates from McDaniel & Associates for the year 2005, production net to Nelson's equity interest in its fields (excluding the recent Arman acquisition) will be approximately 11 million barrels. Production and sales for 2004 are summarised in the following table: ===================================================== (in bbls) Year Ended December 31 2004 2003 ----------------------------------------------------- Production KOA 3,820,664 1,569,407 North Buzachi 1,556,243 41,896 Chaparral 1,883,005 - --------- --------- Total 7,259,912 1,611,303 ----------------------------------------------------- Sales KOA 3,956,033 1,498,525 North Buzachi 1,639,989 - Chaparral 1,834,576 - --------- --------- Total 7,430,598 1,498,525 ===================================================== All figures are for 50% of KOA, 50% of North Buzachi and 100% of Chaparral. Reserves -------- Remaining oil reserves at each of Nelson's fields are assessed by independent auditors McDaniel & Associates Ltd., Calgary, at the end of each year. Between the end of 2003 and the end of 2004, Nelson saw a 32% increase in its share of proved reserves, increasing from 123.4 to 163.4 million barrels. Proved plus probable reserves increased by 25% from 187.2 to 234.9 million barrels. This increase is predominantly attributable to the acquisitions of an additional 15% interest in North Buzachi and a net 76% interest in KKM during 2004. The acquisition of a 50% stake in the Arman field in February 2005 has increased proved plus probable reserves net to Nelson further by an estimated 5.4 million barrels (Kazmunaigas estimate as at 1 January 2004). ================================================================================ (in thousands of McDaniel & Associates Independent Reserves Report barrels) December 31, 2004 Proved Total Proved + Producing Proved Probable Probable -------------------------------------------------------------------------------- Gross Reserves Alibekmola 60,405 138,425 57,804 196,229 Kozhasai 1,300 2,885 7,755 10,640 North Buzachi 13,369 118,192 49,946 168,138 Karakuduk 11,685 44,274 18,034 62,308 ------- ------- ------- ------- Total 86,759 303,777 133,538 437,315 -------------------------------------------------------------------------------- Nelson Net Reserves Alibekmola 30,202 69,213 28,902 98,114 Kozhasai 650 1,443 3,877 5,320 North Buzachi 6,684 59,096 24,973 84,069 Karakuduk 8,881 33,648 13,706 47,354 ------- ------- ------- ------- Total 46,418 163,400 71,458 234,858 ================================================================================ Nelson Net figures are for 50% of Alibekmola and Kozhasai, 50% of North Buzachi and 76% of Karakuduk. More detailed information on independent reserves disclosure can be found in the Company's Annual Information Form available on SEDAR, www.sedar.com. Kazakhoil Aktobe (KOA) ---------------------- KOA has licences to develop the Alibekmola and Kozhasai oil fields located in the Aktiubinsk region in northwest Kazakhstan, 200km south of the city of Aktobe. During 2004, 18 new wells were drilled at Alibekmola, including one exploratory well in the northern area of the field which confirmed the presence of economically viable reserves. Four drilling rigs were in use at Alibekmola, and a fifth rig started drilling in the Kozhasai field during the fourth quarter. In addition, two work-over rigs were providing completion and re-entry services in both fields. KOA plans to drill 16 new wells at Alibekmola and four at Kozhasai during 2005. Production at Alibekmola increased steadily for most of the year, reaching more than 26,000 bopd (gross) by December. Kozhasai pilot production was maintained at an average 835 bopd throughout the year. Oil produced at Kozhasai is currently trucked to Alibekmola for processing. Oil from Alibekmola is transported by pipeline direct from the field to Atyrau and the CPC export pipeline. Exports via this route are expected to continue in 2005. Other activities during 2004 include: - Processing facilities: Existing facilities at Alibekmola debottlenecked to 38,000 bopd during 2004. Work is currently underway to further increase capacity to 42,000 bopd. Work has also started on the construction of an additional central processing facility (CPF) with a capacity of 30,000 bopd. - Water injection: A programme to maintain reservoir pressure through water injection at Alibekmola started in June 2004. At the end of 2004, two wells were injecting water. - Field infrastructure: A field camp to house 350 people is being constructed at Alibekmola and is expected to be complete in early 2005. At Kozhasai, a field camp was constructed in 2004, as well as new roads, processing facilities and gathering systems. Activities planned for 2005 include: - Drilling: Plans to drill 16 new wells at Alibekmola and four at Kozhasai. - Water injection: Four further wells expected to be transferred to water injection. North Buzachi ------------- The North Buzachi oil field is located in the Mangistau region of western Kazakhstan, approximately 180km north of the Caspian Sea port of Aktau. In July 2004, the government approved an accelerated development plan for the field, with the numbers of wells planned to be drilled by the end of 2005 increasing to 115 (of which 20 are horizontal). Drilling started during the latter half of 2004, with 15 new wells being drilled by year end by one rig. Production increased steadily during the second half of 2004 as new wells were brought online, reaching 10,800 by the end of the year. Oil from North Buzachi was transported via a number of different routes during 2004, including via the Russian Transneft pipeline system and by sea from Aktau. Nelson maximises netbacks from oil sales through efficient marketing of production, which includes flexible arrangements regarding offtakers and transportation routes. Other activities during 2004 include: - Processing facilities: Facilities at the nearby Arman oil field, in which Nelson acquired a 50% interest in February 2005, was used throughout 2004 to process oil from North Buzachi, with processing capacity reaching 13,000 bopd by February 2005. - Water injection: Two wells were used continuously as injectors throughout 2004, with a third added in November. Four more wells are currently being converted. Activities planned for 2005 include: - Drilling: Mobilisation of up to four further rigs by mid-2005 to meet the accelerated drilling schedule. - Processing facilities: Upgrading the processing capacities at North Buzachi itself to 20,000 bopd, and construction of a new export pipeline from the field. These projects are expected to be complete by third quarter 2005. - Water injection: Plans for a further 31 water injecting wells by the end of the year. Karakudukmunai (KKM) -------------------- The Karakuduk field is located in the Mangistau region of western Kazakhstan, approximately 340km northeast of Aktau. During 2004, 17 new wells were drilled at the field by one rig. In addition, three workover rigs were maintaining and re-completing wells, several wells were converted to artificial lift, and a hydraulic fracturing programme was started. With each new well currently adding 150 bopd to field production, significant development is now taking place at the field to increase production rates since Nelson's acquisition of a controlling interest in May 2004. The field is directly connected via the Kaztransoil system to the Transneft export pipeline. During 2004, this route was used to transport the field's oil. As KKM is not currently compensated for the positive quality differential between its oil and the pipeline's Russian Export Blend, KKM plans to commission a rail terminal at the field allowing export by ship from Aktau. This is expected to be operational by mid-2006, and will allow the field to market its own crude thus achieving better netbacks on sales. Other activities during 2004 include: - Processing facilities: In 2004, expansions to the processing facilities were made to meet anticipated production increases. Work has also been completed to boost throughput on the field export pipeline. - Water injection: At the end of 2004, six wells were being used to inject water into the reservoir. Producing wells in the vicinity of injectors have shown increased production rates and well head pressure. - Gas utilisation: During the year, the first phase of development allowing KKM to use gas produced at the field to meet its own fuel needs was started. Activities planned for 2005 include: - Drilling and workovers: KKM expects to drill 18 new wells in 2005, including two horizontal wells, and convert 16 wells to artificial lift using sucker rod pumps. - Processing facilities: Further upgrades to existing facilities will be made during the year. Upgrading the processing capacities at North Buzachi itself to 20,000 bopd, and construction of a new export pipeline from the field. These projects are expected to be complete by third quarter 2005. - Water injection: Number of injecting wells is expected to reach 18 by the end of the year. OUTLOOK ======= Nelson has maintained a stated strategy of growth through the aggressive development of its existing assets and through acquisition of new onshore and offshore assets, when such acquisitions can be made on commercially attractive terms. In 2004, the company has been able to execute this strategy and is optimistic that its presence in Kazakhstan will provide continued opportunities for further growth consistent with this strategy. For further information, please contact: ---------------------------------------- Nick Greene, Chief Financial Officer Tel: 020 7495 8908 Nelson Resources Limited ngreene@nelsonresources.co.uk Fred Hodder, Senior Vice President Tel: 020 7495 8908 Nelson Resources Limited fhodder@nelsonresources.co.uk Investor Relations: Ann-marie Wilkinson / Nick Lambert Tel: 020 7861 3232 Bell Pottinger Corporate & Financial (London) Conference Call --------------- The Annual Results Conference Call and Web Presentation will take place on Monday 4 April 2005 at 2:30pm BST (9:30am EDT), and will be hosted by Nick Zana, Chief Executive Officer. To participate, please dial one of the following numbers: From the UK 0845 245 0248 From North America 1-866-220-1452 From abroad +44 1452 556 620 If you would like to ask a question following the presentation, or require operator assistance at any time during the call, please dial *1. The results presentation will be given online during the call. To view it, please go to www.meetingcentre.net (please note the European spelling!) and click on 'Attend a Meeting'. Then enter the meeting number 701 979 301. Alternatively, the results presentation will be available for download from Nelson's website, www.nelsonresources.com, at 7:00am BST on 4 April. The lines will be open 15 minutes before the meeting, so please join early to ensure you have everything working before the start time. If you have difficulty in setting up the software required for the online presentation, you can contact technical support on +44 (0) 1452 556 226. Notes ----- Nelson Resources Limited is an oil exploration and production company with operations in the Republic of Kazakhstan. The Company established its presence in the Kazakhstan oil sector in 2000 and its management team, comprising both international and Kazakh executives, has extensive experience of the Kazakh operating and regulatory environment. The Company owns 50% of Kazakhoil Aktobe LLP (KOA), a 50/50 joint venture between Nelson and Kazmunaigas, the national oil company of Kazakhstan, which is developing the Alibekmola and Kozhasai fields. The Company owns a 50% participatory interest in the North Buzachi oil field located in western Kazakhstan (50% Nelson, 50% CNPC International (Buzachi) Inc.). In May 2004, Nelson purchased 60% of Chaparral Resources Inc., which has a 60% interest in the joint stock company Karakudukmunai, operator of and owner of a 60% interest in the Karakuduk field. In January of 2005, Nelson acquired the 40% interest in this field previously owned by Kazmunaigas, bringing the Company's aggregate ownership interest in the field to 76%. In February 2005, the Company also acquired a 50% interest in the Arman field, with the other 50% held by Shell. The Company also holds an option to acquire a minimum 25% participatory interest in two Caspian Sea offshore blocks, Zhambai South and South Zaburunye. The Company maintains its operational office in Almaty, Kazakhstan, which oversees the field joint ventures in western Kazakhstan. Nelson and its affiliated companies employ approximately 800 people. Common shares of Nelson are listed on the Toronto Stock Exchange and London's Alternative Investment Market under the symbol NLG. Readers are cautioned that the preceding statements and information may include certain estimates, assumptions and other forward-looking information. The actual future performance, developments and/or results of the Company may differ materially from any or all of the forward-looking statements, which include current expectations, estimates and projections, in all or part attributable to general economic conditions and other risks, uncertainties and circumstances partly or totally outside the control of the Company, including oil prices, imprecision of reserve estimates, drilling risks, future production of gas and oil, rates of inflation, changes in future costs and expenses related to the activities involving the exploration, development, production and transportation of oil, hedging, financing availability and other risks related to financial activities, and environmental and geopolitical risks. Discussion of the various factors that may affect future results is contained in the Company's recent filings with Canadian securities regulatory authorities. The Company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. The following financial statements should be read in conjunction with the full financial statements and accompanying notes as filed on SEDAR, www.sedar.com. The statements can also be found on the Company's website, www.nelsonresources.com. **** ================================================================================ NELSON RESOURCES LIMITED Consolidated Statements of Operations -------------------------------------------------------------------------------- Expressed in thousands of Year Ended U.S. dollars December 31 2004 2003 -------------------------------------------------------------------------------- Revenues Crude oil $ 242,394 $ 40,591 Expenses Cost of production 28,166 4,452 Sales and transportation 41,233 10,227 Depreciation and amortisation 34,592 5,537 General and administration 26,362 14,681 Derivative instruments 22,955 3,887 Other compensation costs 27,381 8,769 -------- -------- 180,689 47,553 -------------------------------------------------------------------------------- Profit/(loss) from operations 61,705 (6,962) -------------------------------------------------------------------------------- Other income/(expenses) Foreign exchange (loss)/gain (1,550) 3,555 Interest and financing costs (20,396) (8,783) Profit on sale of investment - 2,731 Interest and other income 4,673 2,683 Minority interest (9,372) - -------- -------- (26,645) 186 -------------------------------------------------------------------------------- Profit/(loss) from continuing operations before income taxes 35,060 (6,776) -------------------------------------------------------------------------------- Income taxes (31,365) (4,235) -------------------------------------------------------------------------------- Net profit/(loss) $ 3,695 $ (11,011) -------------------------------------------------------------------------------- Basic profit/(loss) per share 0.0046 (0.019) Diluted profit/(loss) per share 0.0045 (0.019) ================================================================================ **** ================================================================================ NELSON RESOURCES LIMITED Consolidated Balance Sheets -------------------------------------------------------------------------------- Expressed in thousands of December 31 December 31 U.S. dollars 2004 2003 -------------------------------------------------------------------------------- Assets Current assets Cash and cash equivalents $ 56,486 $ 43,246 Accounts receivable and prepaid expenses 57,693 19,546 Inventory 15,175 2,242 -------- -------- Total current assets 129,354 65,034 Oil and gas properties, full cost 297,879 108,963 Property, plant and equipment 20,119 11,750 Advances to oil and gas limited partnership 26,646 23,318 Deferred tax 9,359 - Other non-current assets 3,871 384 -------------------------------------------------------------------------------- Total assets $ 487,228 $ 209,449 -------------------------------------------------------------------------------- Liabilities Current liabilities Accounts payable $ 31,471 $ 18,765 Accrued liabilities 21,638 6,295 Income taxes payable 5,398 924 Derivative instruments 29,638 3,887 Bank loan - 58,000 Note payable to affiliate 23,912 - Current portion of long-term debt 41,523 3,550 -------- -------- Total current liabilities 153,580 91,421 Long-term debt 121,776 66,923 Deferred tax 3,258 - Other provisions and creditors 1,972 192 Minority interest 21,877 - -------------------------------------------------------------------------------- Total liabilities 302,463 158,536 -------------------------------------------------------------------------------- Shareholders' equity Share Capital 8,620 7,392 Additional paid in capital 294,462 176,247 Other compensation costs 31,221 9,161 -------- -------- 334,303 192,800 Accumulated deficit (136,960) (140,655) Other comprehensive loss (12,578) (1,232) -------------------------------------------------------------------------------- Total shareholders' equity 184,765 50,913 -------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 487,228 $ 209,449 -------------------------------------------------------------------------------- ================================================================================ **** ================================================================================ NELSON RESOURCES LIMITED Consolidated Statements of Cash Flows -------------------------------------------------------------------------------- Expressed in thousands of Year Ended U.S. dollars December 31 2004 2003 -------------------------------------------------------------------------------- Cash Flows from continuing operations Net profit $ 3,695 $ (11,011) Adjustments to reconcile net profit/(loss) to net cash provided by operating activities: Deferred tax (2,633) - Profit on sale of investment - (2,731) Interest income (3,328) (2,933) Other compensation costs 27,381 8,769 Exchange rate loss/(gain) 2,073 (610) Depreciation and amortisation 34,592 5,537 Discount accretion 1,370 1,211 Derivative instruments 10,444 3,887 Retirement obligation accretion 106 20 Amortisation of note discount 327 - Interest on shareholders' equity advance - 431 Loan arrangement fee amortised 1,485 177 Debenture cost amortised - 117 Minority interest 9,372 - -------- -------- Net effect on cash flows 84,884 2,864 (Increase)/decrease in working capital (23,075) (2,692) -------------------------------------------------------------------------------- Net cash provided by operating activities 61,809 172 -------------------------------------------------------------------------------- Cash flows from investing activities Capital expenditure on oil and gas properties (93,415) (28,876) Acquisition of subsidiary - (58,348) Acquisition of participatory interest in North Buzachi (32,250) - Acquisition of KKM (34,611) - Acquisition of Chaparral (net of cash acquired) 3,153 - Proceeds from sale of investment - 6,337 Purchase of property, plant and equipment (4,934) (7,294) -------------------------------------------------------------------------------- Net cash used in investing activities (162,057) (88,181) -------------------------------------------------------------------------------- Cash flows from financing activities Proceeds from exercise of stock options 3,299 2,505 Proceeds from private placement/rights offerings 110,814 37,074 Net proceeds from exercise of warrants less shareholders equity advances - 6,661 Bank loans received 190,215 78,000 Bank loans paid (189,259) - Other non-current assets (1,581) (492) -------------------------------------------------------------------------------- Net cash provided by financing activities 113,488 123,748 -------------------------------------------------------------------------------- Net increase in cash and cash equivalents 13,240 35,739 Cash and cash equivalents at beginning of year 43,246 7,507 -------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 56,486 $ 43,246 ================================================================================ Movements in respect of advances to oil and gas limited partnership in 2003 have been reclassified to conform with current year presentation. **** ================================================================================ NELSON RESOURCES LIMITED Consolidated Statements of Cash Flows (cont.) -------------------------------------------------------------------------------- Expressed in thousands of Year Ended U.S. dollars December 31 2004 2003 -------------------------------------------------------------------------------- Changes in components of working capital Accounts receivable and prepaid expenses (30,545) (16,025) Inventory (9,685) (1,685) Accounts payable 861 14,967 Accrued liabilities 9,108 (545) Income taxes payable 7,186 596 -------- -------- Increase in working capital (23,075) (2,692) -------------------------------------------------------------------------------- Supplemental information Taxes paid during the year (29,524) (3,639) Interest paid during the year (14,941) (6,287) ================================================================================ During 2004, the Company acquired a 60% controlling interest in Chaparral Resources, Inc. This was a non-cash acquisition in 2004. **** ================================================================================ NELSON RESOURCES LIMITED Consolidated Statements of Shareholders' Equity -------------------------------------------------------------------------------- Expressed in thousands of Other U.S. dollars, except Additional Compen- share amounts Number of Common Paid in sation Common Shares Shares Capital Costs Total -------------------------------------------------------------------------------- Balance December 31, 2002 446,659,860 4,467 115,358 817 120,642 Exercise of stock options 12,620,000 126 2,957 - 3,083 Debentures converted 9,979,558 100 2,755 - 2,855 Exercise of warrants 196,062,000 1,961 18,841 - 20,802 Rights offering 73,839,417 738 36,336 - 37,074 Movement in other compensation costs - - - 8,344 8,344 ----------- ------- ------- ------- ------- Balance December 31, 2003 739,160,835 7,392 176,247 9,161 192,800 Exercise of stock options 10,731,132 107 8,522 - 8,629 Private placement 112,144,128 1,121 109,693 - 110,814 Movement in other compensation costs - - - 22,060 22,060 ----------- ------- ------- ------- ------- Balance December 31, 2004 862,036,095 8,620 294,462 31,221 334,303 -------------------------------------------------------------------------------- Share- Other Total holders Accum- Compre- Share- Equity ulated hensive holders Total Advance deficit Income Equity -------------------------------------------------------------------------------- Balance December 31, 2002 120,642 13,710 (129,644) 2,506 7,214 Exercise of stock options 3,083 - - - 3,083 Debentures converted 2,855 - - - 2,855 Exercise of warrants 20,802 (14,141) - - 6,661 Rights offering 37,074 - - - 37,074 Movement in other compensation costs 8,344 - - - 8,344 Interest on shareholders' equity advance - 431 - - 431 Net loss for the year (11,011) - (11,011) Release of revaluation of investment held for sale - - - (2,705) (2,705) Cumulative translation adjustments - - - (1,033) (1,033) ------- ------- ------- ------- ------- Balance December 31, 2003 192,800 - (140,655) (1,232) 50,913 Exercise of stock options 8,629 - - - 8,629 Private placement 110,814 - - - 110,814 Movement in other compensation costs 22,060 - - - 22,060 Net profit for the year - - 3,695 - 3,695 Unrealised losses on oil and gas cash flow hedges, after tax - - - (10,715) (10,715) Cumulative translation adjustments - - - (631) (631) ------- ------- ------- ------- ------- Balance December 31, 2004 334,303 - (136,960) (12,578) 184,765 ================================================================================ **** NELSON RESOURCES LIMITED Selected Notes To Consolidated Financial Statements December 31, 2004 and 2003 Tabular amounts are expressed in thousands of U.S. dollars, except share amounts These notes should be read in conjunction with the full financial statements and accompanying notes as filed on SEDAR, www.sedar.com. 1. Organisation and Basis of Presentation Nelson Resources Limited (the "Company" or "Nelson") was incorporated as an exempted company under the laws of Bermuda on March 31, 1993. The Company is involved in oil & gas exploration, development and production in Kazakhstan. The consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP"). All amounts are stated in U.S. dollars thousands unless otherwise indicated. 10. Bank Loan On December 15, 2003, NPB BV entered into a credit facility agreement with CSFB ("Credit Suisse First Boston"). The maximum principal amount available under the facility was $90 million, of which $58 million was drawn down in 2003 in connection with the purchase of NPBH BV and the first 35% interest in the licence to develop the North Buzachi field in Kazakhstan. The remaining $32 million was drawn down in February 2004 when the transfer of the additional 15% interest in the licence to NPB BV was approved by the Kazakh government. Loans under the facility bore an annual interest of 8% payable on the termination date. The facility terminated on June 4, 2004. Repayment of the facility was partly financed by the new financing obtained under the crude oil advance payment agreement with Vitol (see Note 13 e) and existing cash funds. The obligations of NPB BV under the facility were guaranteed by a security interest over the issued share capital of NBHL, NBL and NPBH BV. In addition, CSFB had a security interest over the rights under the North Buzachi Hydrocarbon Contract. HSBK had guaranteed the obligations of NPB BV under the facility up to $45 million. 11. Note Payable to Related Party On May 17, 2004, the Company bought a 60% controlling interest in Chaparral. In consideration for the Chaparral Shares, the Warrant and the CAIH Note (see Note 4), Nelson has issued a promissory note in the principal amount of $23.912 million payable to CAIH a related party to Nelson (see Note 23). The Nelson Note has a term of one year and bears interest at 10.5% per annum, payable at maturity. 14. Deferred Tax Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's net deferred income taxes are as follows: 2004 2003 $'000 $'000 -------------------------------------------------------------------------------- Deferred tax assets: Oil and gas assets 1,279 708 Sales of assets 25 - Obsolete inventory 82 - Compensation and accrued expenses 517 - Capital loss on transfer of net profits interest 1,529 - Net operating loss carry-forwards 8,528 - Derivative instruments 9,894 - Other 958 - ------- ------- Total deferred tax assets 22,812 708 Valuation allowance (13,453) (708) ------- ------- Total deferred tax assets 9,359 - Deferred tax liabilities: Depreciation and other basis differences (3,258) - ======= ======= Net deferred tax assets/(liabilities) 6,101 - ======= ======= According to FAS No. 109, deferred tax assets are only reported if it is more likely than not that some portion or all of the deferred tax assets will be realised. After consideration of all the evidence, both positive and negative, management has determined that a $13.453 million valuation allowance at December 31, 2004 (December 31, 2003 $0.708 million) is necessary to reduce the deferred tax assets to the amount that will more likely than not be realised. The change in the valuation allowance for the current year is $12.745 million. As of December 31, 2004, the Company has estimated tax loss carry-forwards of $24.766 million. These carry-forwards will expire at various times between 2005 and 2022. 1 Year 2-3 Years 4-5 Years Later Years Total -------------------------------------------------------------------------------- Tax loss carry-forward 433 520 1,137 22,676 24,766 17. Stock Options The Company maintains a stock option plan (the "Plan") pursuant to which the Company may grant options to directors, officers and employees. Share options are exercisable at prices not less than the closing market value of the shares on the date of grant and are permitted to have a maximum term of ten years. The maximum number of shares reserved for issuance under the Plan is 70,000,000 common shares. The following table summarises stock option activity during 2003 and 2004 under the Plan: Weighted Weighted Average Average Number Cost Cdn$ Cost US$ -------------------------------------------------------------------------------- Outstanding at December 31, 2002 17,270,000 0.41 0.26 Options granted 13,286,465 0.67 0.52 Options exercised (6,080,000) 0.36 0.28 Options lapsed (450,000) 0.33 0.25 ---------- Outstanding at December 31, 2003 24,026,465 0.57 0.44 Options granted 30,787,541 2.03 1.68 Options exercised (6,153,132) 0.54 0.45 ---------- Outstanding at December 31, 2004 48,660,874 1.50 1.25 ================================================================================ Exercisable at December 31, 2004 26,407,000 0.88 0.73 ================================================================================ The following table summarises information about the Plan's stock options outstanding at December 31, 2004: Exercise Weighted average Price Number of options Remaining Life Number of options Cdn$ outstanding (years) exercisable -------------------------------------------------------------------------------- 0.30 50,000 1.30 50,000 0.40 2,330,000 2.83 2,330,000 0.45 2,330,000 2.83 2,330,000 0.50 2,330,000 2.83 2,330,000 0.63 1,333,333 3.63 666,667 0.67 9,500,000 3.32 9,500,000 1.45 11,867,000 4.63 9,200,333 2.40 12,930,541 5.00 - 2.40 5,990,000 4.88 - ----------- ----------- 48,660,874 26,407,000 -------------------------------------------------------------------------------- From December 31, 2004 to date, the Company has granted 900,000 options to key employees or directors of the Company. The Company accounts for the stock options issued under the Plan under APB No. 25. Had compensation cost for these plans been determined consistent with FAS No. 123, net income attributable to common stock and earnings per share would have been reduced to the following pro forma amounts: (in thousands, except per share amounts) 2004 2003 -------------------------------------------------------------------------------- Net profit/(loss) As reported 3,695 (11,011) Reverse other compensation costs per the intrinsic method 27,381 8,769 Other compensation costs per the fair value method (38,956) (2,663) ------- ------- Pro Forma loss (7,880) (4,905) Basic earnings/(loss) As reported 0.0046 (0.019) per share Pro Forma (0.0099) (0.008) Diluted earnings(loss) As reported 0.0045 (0.019) per share Pro Forma (0.0099) (0.008) -------------------------------------------------------------------------------- The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 2004 and 2003, respectively: average risk-free interest rates of 3.45 and 1.29 percent; average expected lives of 4.84 and 1.02 years; average expected volatility factors of 96.39 and 102.12 percent; and no dividend yield. The estimated weighted average fair value of options to purchase one share of common stock issued under the Plan was Cdn $1.52 in 2004 and Cdn $0.26 in 2003. The exercise price of all stock options granted under the scheme is denominated in Canadian Dollars. Canadian dollars are neither the reporting currency of the Company nor the currency in which the employees are paid. As such, on the date of the grant the exercise price is not fixed and the plan is deemed to be a variable plan under APB No. 25. Compensation cost is re-measured for each reporting period using the intrinsic value method. The cost is reported as a charge in earnings over the periods the service is provided by the employee. The additional compensation cost, net of taxes, included in the net loss for 2004 and 2003 was $27,381,393 and $8,768,567 respectively. In March 2003, as part of the settlement with Mr. Teck Soon Kong, a former director of Nelson, 13,080,000 options at Cdn$0.21 was granted to him outside the option plan. Mr. Kong exercised 4,578,000 options during 2004 and 6,540,000 options during 2003. As at December 31, 2004 and 2003, the remaining options outside the plan were 1,962,000 and 6,540,000 respectively. 18. Income Taxes The components of the income tax provision/(benefit) are as follows: 2004 2003 $'000 $'000 -------------------------------------------------------------------------------- Withholding tax 25 694 Kazakh tax 33,824 3,275 UK tax charge 149 266 ------- ------- Total current tax 33,998 4,235 Deferred tax (2,633) - ------- ------- Total provision for income taxes 31,365 4,235 -------------------------------------------------------------------------------- The Company has income tax expense relating to withholding tax paid in Kazakhstan on interest repayment and corporation tax paid in Kazakhstan and the United Kingdom. A reconciliation of the Company's expected tax benefit to the income tax expense as reported in the consolidated statement of operations is as follows: 2004 2003 $'000 $'000 -------------------------------------------------------------------------------- Profit/(loss) from continuing operations before income taxes 35,060 (6,776) Statutory tax rate 0%, 30%, 0%, 30%, 34.5% and 50% and 34.5% Income taxes computed at statutory rate per individual companies* 25,106 3,553 Foreign exchange differences (136) (582) Minority interest 1,694 - Non deductible expenses 2,488 353 Increase in valuation allowance 2,592 - Losses brought forward - 76 Withholding tax 25 694 Unrecognised deferred tax asset 103 124 Adjustment in respect of prior year (507) 17 ------- ------- 31,365 4,235 -------------------------------------------------------------------------------- * The income taxes calculated on a statutory basis is a charge rather than a credit due to the taxable profits in Kazakhstan. These taxable profits cannot be offset against losses elsewhere in the group. The Company operates in various tax jurisdictions having varying statutory tax rates. In Kazakhstan the tax rate is 30%. In the United Kingdom the corporate tax rate is 30% (30% in 2003) and in the Netherlands the corporate tax rate is 34.5%. By agreement with the Bermudian tax authorities the Company's Bermudian tax rate is nil in Bermuda, where the Company incurs corporate expenses and significant compensation costs. These factors influence the Company's effective tax rate. According to the Contract between the Kazakh tax authorities and KOA, the Company is liable to pay taxes under the tax regime existing as of the date of signing the Contract, August 10, 1999. The Company calculates its tax liabilities in accordance with the Contract; however, Kazakhstan currently has a number of laws related to various taxes imposed by both state and regional tax authorities. Applicable taxes include value added tax, corporate income tax (profits tax), a number of turnover based taxes, and payroll (social) taxes, together with others. Laws related to these taxes have not been in force for significant periods, in contrast to more developed market economies; therefore, regulations are often unclear or nonexistent. Accordingly, few precedents with regard to issues have been established. Often, differing opinions regarding legal interpretation exist both among and within government ministries and organisations; thus creating uncertainties and areas of conflict. Tax declarations, together with other legal compliance areas (as examples, customs and currency control matters) are subject to review and investigation by a number of authorities, who are enabled by law to impose extremely severe fines, penalties and interest charges. These facts create tax risks in Kazakhstan substantially more significant than typically found in countries with more developed tax systems. The liability for income tax is provided for in the accrued liabilities in these financial statements. Management believes that it has adequately provided for tax liabilities in the accompanying consolidated financial statements. However, the risk remains that relevant government ministries and organisations could take differing positions with regard to interpretive issues and the application of the provisions contained in the Contract and the resulting effect of such positions on the Company's tax liability could be significant. 19. Basic and Diluted Profit/Loss per Share The earnings/loss per share calculations are based on the weighted average common shares outstanding during the periods as follows: 2004 2003 -------------------------------------------------------------------------------- Weighted average number of common shares outstanding 795,948,498 589,703,797 Weighted average diluted number of common shares outstanding 813,635,450 589,703,797 Net income/(loss) ($'000) 3,695 (11,011) Basic profit/(loss) per common share ($) 0.0046 (0.019) Diluted profit/(loss) per common share ($) 0.0045 (0.019) -------------------------------------------------------------------------------- The inclusion of unexercised options of 23,810,000 in 2003 would be anti-dilutive. 21. Financial Instruments, Hedging and Trading Activities The Company accounts for derivative financial instruments in accordance with FAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". This statement requires that the Company recognise all derivatives on the balance sheet at fair value and those derivatives not accounted for as hedges, are reported in the statement of operations. Commodity trading KOA has entered into a risk management program where it is utilising derivative instruments to manage the exposure to fluctuations in the price of crude oil. KOA has entered into the following contracts with BNP Paribas: Price Price Contract amount Floor Ceiling (bbls per month) Contract period Contract Type ($/bbl)* ($/bbl)* -------------------------------------------------------------------------------- 120,000 Sep 2003 - Aug 2006 Zero cost collar 18.00 30.00 150,000 Dec 2003 - Aug 2006 Zero cost collar 18.00 29.50 -------------------------------------------------------------------------------- *Brent price If crude oil sales price falls below $18/bbl, the decline in value of revenue is offset by gains in the value of the zero cost collars. Conversely, when crude oil sales price exceeds $30/bbl and $29.5/bbl, the increase in the value of revenues is offset by losses in the value of the zero cost collars. Effective July 1, 2004 these derivative contracts were designated, and qualified, as cash flow hedges under FAS No. 133. Prior to this date of designation, changes in the fair value of these derivative instruments were reported in earnings in the "Derivative instruments" line. The Company recognised a charge of $16.286 million in current year earnings for the period prior to this designation. As a result of the instruments having an aggregate liability fair value on the date of designation of $16.910 million, the Company has determined that this represents an embedded financing element that gives rise to ineffectiveness. This liability will be unwound over the remaining contract period of the derivative instruments. The Company has recognised a reduction in fair value of this financing element of $3.902 million through current year earnings, in the 'Derivative instruments' line, representing ineffectiveness. Following designation, the effective portion of changes in the fair value of these derivative instruments is reported as a component of other comprehensive income. These changes are reclassified into earnings in the 'Derivative instruments' line in the same periods during which the hedged revenues affect earnings. The change in fair value of the derivative instruments recorded through other comprehensive income amounted to $10.715 million, after tax effect, for the year ended December 31, 2004. Based on the assumptions used in the December 31, 2004 fair value assessment of the derivative instruments, the estimated net amount expected to be reclassified from other comprehensive income within the next twelve months would be $17 million as actual sales occur. The cumulative derivative loss taken to other comprehensive income is $10.715 million, after tax effect, as at December 31, 2004 (December 31, 2003 $nil). Financial Instruments The Company does not use foreign currency contracts. Fair Value Disclosure The carrying amounts of cash and cash equivalents approximate fair value. The Company estimates the fair value of its short-term and long-term debt generally using discounted cash flow analysis based on current interest rates for instruments with similar maturities. The year-end fair values of short-term and long-term debt approximate their recorded values as they carry interest rates that either are, or that approximate market rates. See note 12 and 13 for the carrying value of debts at December 31, 2004 and 2003. Market and Credit Risks The Company has significant credit risk exposure due to concentration of its crude oil receivables with several significant customers. Three purchasers of oil production accounted for all of the Company's total crude oil export sales revenues in 2004. The capabilities of these oil trading companies are assessed on a regular basis and the contractual arrangements can be changed as required. The Company does not generally require collateral. The Company's oil operations are exposed to oil price fluctuations. The Company has begun to use price risk management contracts to limit its exposure to oil price fluctuations, by protecting against the potential down side in oil prices. Due to Kazakh regulations, there is a possibility, that the Company may be required to sell some portion of its crude oil production to local markets at prices lower than those achieved on the international market. There is currently no requirement to make these sales to the local market, but the Ministry of Energy can enforce them by controlling export pipeline access quotas. The price realised for these sales was substantially lower than world market prices. Government directed deliveries may disrupt customer relationships, lead to delays in payments for crude oil or result in sale at below market prices. Local market sales accounted for 2.3% of the total sales revenues in 2004. In addition, there is a concentration of risk in Kazakhstan, where all of the Company's operations are located. 27. Subsequent Events a) On December 23, 2004, the Company entered into a definitive sale and purchase agreement to acquire a 50% participating interest in Arman Joint Enterprise LLP ("Arman") from the Kazakh state oil company Kazmunaigas. Arman holds the licence in the Arman field. Nelson paid a purchase price of $10.8 million from existing cash resources. The government and regulatory approval was obtained on February 14, 2005 from which date the acquisition becomes effective and the results of operations will be included. The allocation of purchase price to the net assets acquired is not practicable at the date of these financial statements. b) On January 5, 2005 NPB BV entered into a structured oil pre-export facility with a principal amount of up to $40 million through the Commodity Structured Finance Group of BNP Paribas. Proceeds of this financing have been used in part to refinance the Vitol facility. The financing is structured as a $40 million revolving credit line available for two years. Thereafter, the facility converts to an amortising term loan, with regular repayments being made until the final repayment date 54 months after the initial advance. Repayments are secured by offtake agreements under which NPB BV sells crude oil from the North Buzachi field to one or several offtakers. Interest on the facility will be paid on a monthly basis, at a rate of one month LIBOR plus a 3.25% per annum, margin, increasing to a 4.25% per annum margin after 12 months. Nelson serves as financial guarantor of the facility. c) On March 24, 2005, KKM signed a $40 million Structured Crude Oil Pre-export Credit Facility Agreement with BNP Paribas (Suisse) SA and others (the "BNP Credit Facility"). Subject to meeting conditions precedent within 30 days of signing, funds from this facility will be available for use to cover any short-term working capital deficiencies and to pay down the existing loan with Kazkommertsbank. Amounts borrowed under the BNP Credit Facility are repayable in 36 equal monthly installments commencing between six and seven months after the signing date. The interest rate is LIBOR plus 3.25% for the first 12 months and LIBOR plus 4.00% thereafter. The lenders also require that KKM implement a crude oil price hedging program, in a form satisfactory to the lenders. **** END DATASOURCE: NELSON RESOURCES LIMITED

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