Empire Oil & Gas NL : Half Year Results & Update

W E B w w w . e m p i r e o i l . c o m . a u

S T R A L I A

12 March 2014

Empire Oil & Gas (ASX: EGO) provides the following commentary to accompany its financial results for the half-year ended 31 December 2013, which have been lodged with the ASX today.
Empire's half-year results, the first since the Red Gully Facility was commissioned, compared to the previous corresponding period (pcp), are:
• Gas sales of 653.4 TJ, total to date 688.0 TJ (pcp nil)
• Condensate sales of 34,201 bbls, total to date 34,201 bbls (pcp nil);
• Total revenue for gas and condensate sales of $5.4m (pcp $nil);
• Net loss from continuing operations decreased to $0.25m from $1.0m in the pcp;
• Empire's share of the amount outstanding on the pre-payment from Alcoa has reduced by
$3.25m for the period ($3.44m since gas was first delivered, based on 68.75% share, refer note 8 in the Half-Year Accounts for further information). The outstanding amount of
$13.75m represents the gas for which Alcoa has pre-paid but is yet to receive.

Red Gully Joint Venture

The Red Gully Joint Venture, in which Empire has a 76.39% per cent interest (including its share of the deemed default of Wharf Resources plc, 68.75% excluding Wharf's stake), is currently supplying gas to Alcoa under Tranche One of its two-tranche Gas Supply Agreement (GSA).
The Red Gully Joint Venture parties received from Alcoa total upfront payments of $25 million over the period January 2012 to April 2013 (Empire received $17.2m) for the gas required to be delivered under Tranche One of the GSA. This money was used to help fund the ~$39m million construction cost of the Red Gully Facility which has been significantly over budget, being originally costed at
$21.6m and provided to the Joint Venture by the previous management of Empire, as Operator.
The condensate produced in association with the gas is being sold to BP Kwinana refinery, which pays Empire monthly in arrears. Empire's share (68.75% excluding its share of the deemed default of Wharf Resources plc) of this condensate revenue actually received in the six months to December 31,
2013 was $2.7m (excluding GST).
This condensate revenue is currently Empire's sole income and is being used to meet its share of operating costs and provisional royalty payments. Importantly, these costs include the cost of producing the gas and associated royalties for Tranche One gas which has already been paid for by Alcoa. This condensate revenue is also being used to meet Empire's corporate costs. At present, condensate revenue (excluding the impact of significant plant downtime) is considered sufficient to
fund these costs but does not yet provide surplus cashflow to fund future drilling, exploration or development programs.
Red Gully's performance has also been hampered by continuing design and operational commissioning issues, lack of redundancy and related unexpected downtime. Production interruptions have lasted for between a few hours and up to a day pending resolution of the particular issue.

A review has been conducted of the Red Gully Plant by an external party, including its design and operations, and the issues that have been encountered to date. The joint venture is currently awaiting their final report. The joint venture will then review the report and recommendations and seek to implement a program to establish a cost effective way of implementing any proposed actions while ensuring and improving the reliability of the plant.
This under-performance, much of which is still due to commissioning-related difficulties and limited redundancy built into the plant, has reduced the production of gas and condensate, with flow-on consequences for Empire's revenue.
Gas deliveries under Tranche Two will begin once gas deliveries under Tranche One are completed. Alcoa will pay for the Tranche Two gas as it is delivered. The total volume of gas under the GSA for Tranches One and Two is 15 petajoules.

The Red Gully-1 Perforation and Test program and the associated Environmental Management Plan and Safety Plans were submitted to the Department of Mines and Petroleum (DMP) for approval in the first week of March 2014. Subject to obtaining these approvals and finalisation of the contract with the sub-contractor, the work program is expected to commence in the last week of April 2014.
The objective of this program is to:
• perforate and test the B-sands of Red Gully-1 and determine their flow potential and gas and condensate composition and the potential combined flow of the B and D-sands together (none of which has been done before);
• based on the initial flow results, determine how much additional gas, if any, may potentially be there for future sales; and
• production flow-test the D-sands of both wells and the B-sands of the Red Gully-1 well to gain reserve certification for these wells. It is expected that between 6-9 months of production flow rates will be required before reserves can be certified.
Red Gully currently has no reserves as defined under the Australian JORC code. The Company has
previously referred to its gas inventory as "potential recoverable resources".
The Red Gully Well Perforation and Test Program is expected to take approximately 10 to 15 days to complete. It will be necessary to shut down both the Red Gully-1 well and Gingin West-1 well (due to the close proximity of the work) and therefore the Red Gully Facility will also be shut down during this time to ensure safe work operations.
The budget estimates indicate that the cost of this program to the Joint Venture will be in the order of $1 to $1.2 million (Empire share 76.39%).
Empire intends to fund its share of the cost of the program and deferred condensate revenue during this shut-down period by drawing down $1m on the credit facility provided to the Company by major shareholder ERM Power.

In order for the Red Gully Joint Venture to enter into further gas sales agreements, additional gas over and above the 15 petajoules required to fulfil the Alcoa GSA will be needed.
The Red Gully-1 Well Perforation and Test program is the first step in order to define what additional gas may be available from the current wells for future GSAs. Additionally, the Wannamal 3D Seismic results, the evaluation and interpretation of which is expected to be completed this quarter, will identify the second step, being new drilling prospects in the adjacent areas to Red Gully.

Moderate exploration success would potentially increase the life of the Red Gully project beyond the end of the current Alcoa contract, though the impact on its current day-to-day operations and cashflow would be minimal due to the facilities limited production capacity (10 TJ per day in total). To generate a substantial increase in the performance and operating cashflow of the facility, sufficient additional gas would need to be identified to justify the investment needed to increase the capacity of the current Red Gully Facility.
The Red Gully joint venture parties will continue to review the growth prospects of the Red Gully Facility and will await the initial results of the Red Gully B-sand Well Perforation and Test program and the Wannamal drilling prospects, along with a better understanding of both technical and economic factors, before making any decisions on expanding the facility.
The Empire Board believes that while the financial performance of Red Gully is suffering from ongoing production problems, there is potential to improve its results. The commissioning problems, while not yet totally resolved, are gradually being overcome. At the same time, steps are being taken to reduce operating costs.
The Board believes that these measures should improve Red Gully's financial performance in the near term and provide the joint venture with the opportunity to expand its production and cashflow through exploration.

The legal proceedings against some of the former directors of Empire, relating to the payment by Empire of their legal costs in certain defamation actions against Empire's shareholders continues. The statement of claim has been filed by Empire, with programming orders made by the court at a status conference, and with a defence filed on 6 March 2014 by the defendants. The defence includes the argument that the directors acted on the advice of their lawyer at the time and were entitled to act as they did.
The proceedings brought in relation to the deemed withdrawal of Wharf Resources plc from EP 389 and PL 96 under the relevant joint operating agreement continue with the matter set down for early trial in May 2014. The court-ordered mediation in late February 2014 was cancelled by the court and is now currently scheduled for 2 April 2014.

$2M Credit Facility

On 27 February 2014, Empire drew-down the first $1m on this facility to assist in paying some of its outstanding suppliers, particularly in relation to commissioning costs from the second half of last year. Following the proposed drawdown of $1m for the Red Gully-1 Perforation and Well Test program, this facility will be fully drawn down.

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