68
the unit of production method, spread over the life of the field based on the 2P net entitlement reserves in that field. The
level of depletion expenses have been and will remain a material factor affecting the Group’s results of operations.
Under the unit of production method, the amount of depletion recognised in any given period is determined according to
the barrels produced in that period, as a proportion of the total 2P net entitlement reserves for that field.
As a result, the Group’s depletion expenses is any given period will increase in proportion to the volume of oil and gas
produced, and will also fluctuate in line with changes in the Group’s estimated 2P net entitlement reserves. Factors
which increase the Group’s estimate of its 2P net entitlement reserves will spread the Group’s depletion expenses over a
larger quantity of reserves, significantly decreasing the cost per unit and therefore reducing the Group’s cost of sales in a
period. Conversely, a significant decrease in the Group’s estimated 2P net entitlement reserves will decrease the
denominator and therefore raise the Group’s depletion expenses and total cost of sales. If the assumptions used to
generate a given depletion charge later prove wrong, the depletion expense in the next period includes a correction to
make up for the difference.
Impairment of capitalised costs
Impairment of capitalised costs can have a significant impact on the Group’s business. Such impairment may be a result
of a decrease in the fair market value of 2P net entitlement reserves, which in turn is dependent on oil prices. See “
—
Critical accounting policies subject to significant judgments, estimates and assumptions—Impairment of property, plant
and equipment
.” In 2013, for example, the Group recognised a net impairment loss of $1.8 million, primarily relating to
Blocks 5 and 43 in Yemen, as a result of a downward adjustment in the Group’s assessment of its commercially
recoverable reserves from these assets. Upon a disposal of assets in the future, the Group may be required to similarly
impair capitalised costs relating to the disposed asset if the disposal price is below the Group’s recorded book value of
that asset.
Changes in regulatory, tax and royalty regimes or to material terms in production sharing contracts
The Group’s oil and gas exploration, appraisal and production are currently subject to varying fiscal regimes. The
Group’s operations in Egypt and Yemen are on PSCs, and Egypt, Iraq and Oman on service agreements. See
“The
Group’s business—The Group’s operations
”. The Group would face substantially lower operating profits if one of the
Group’s governmental counterparties decides to significantly increase the taxes or fees payable by the Group, decrease
the level of the Group’s profit oil percentage, cost recovery percentage or otherwise challenge the Group’s recoverable
costs, or otherwise significantly alter material contract terms at some date in the future. Any such increases or changes
could increase the Group’s costs and adversely affect its results of operations. See
“Risk factors—Risks relating to the
jurisdictions in which the Group operates—Changes in oil and gas regulation or other government policy in any of the
Group’s operating jurisdictions could have a negative impact on the Group’s business.
”
In July 2014, the Egyptian government announced a 10% withholding tax payable on dividends and other cash
distributions to shareholders. At present, the Group’s only Egyptian subsidiary, Kuwait Energy (Eastern Desert)
Petroleum Services SAE, which holds the Group’s interest in Area A in Egypt, distributes cash to the Issuer as
repayment of intercompany loan arrangements, which are not treated as dividends and therefore will not be subject to
10% withholding. Once the intercompany loan balances have been repaid, however, any further distributions from
Kuwait Energy (Eastern Desert) Petroleum Services SAE to the Issuer will be characterised as dividends and subject to
this 10% withholding tax. The Egyptian government also announced a temporary 5% income tax effective for the next
three years on any profits above one million Egyptian pounds, in addition to the already existing income tax regime,
applied at progressive rates up to 25%. Kuwait Energy (Eastern Desert) Petroleum Services SAE will be subject to this
additional 5% income tax. Either or both of these changes in Egyptian tax law could have an effect on our financial
results in Egypt, which could render our Area A operations unprofitable and otherwise have a material adverse effect on
our business, prospects, financial condition and results of operations. See
“Risk factors—Risks relating to the
jurisdictions in which the Group operates—The Group’s operations in Egypt may be disrupted by political and economic
developments
.”
Disposals and farm outs
In July 2013, the Group resolved to dispose of its operations in Russia and Ukraine, classifying them as discontinued
operations in the Group’s financial statements. Starting in July 2013, the Group ceased to pursue new projects in Russia,
Ukraine, Pakistan and Latvia as well as in Mansuriya in Iraq. In respect of its assets in Russia and Ukraine, in order to
assist comparability the Group has classified these as discontinued operations in its financial statements back to 1
January 2011. These assets, which at the time of classification were expected to be sold within 12 months, were
classified as held for sale and presented separately in the Group’s 31 March 2014 consolidated balance sheet. The
Group’s loss for the year from discontinued operations in 2013 includes an impairment loss of $236.9 million, of which
$89.0 million arose in Russia and $147.9 million in Ukraine. As at 31 December 2013, the assets and liabilities held for
sale for these discontinued operations were written down to their estimated fair value less cost to sell of $15.0 million,
