Pantone 541 background

Recommend a sealer coat or a lamination with an open window around the embossed logo.

Heritage Oil Limited is an independent Heritage Logo oil and gas explorationSilver Foil Embossed and production company with a primary listing on the Main Market of the London Stock Exchange (symbol HOIL) and Exchangeable Shares listed on the Toronto Stock Exchange

Heritage Oil Limited Annual Report & Accounts 2008 (symbol HOC) and London Stock Exchange Heritage Oil Limited Annual Report & Accounts 2008 (symbol HOX). The Company currently focuses on operations in Africa, the Middle East and Russia.

Overview Financial Review Financial Statements 01 Highlights 28 Committed to Generating Value 53 Consolidated Income Statement 02 Chairman’s Statement 54 Consolidated Statement 04 Chief Executive’s Review Corporate Social of Recognised Income 08 Chief Executive’s Q&A Responsibility and Expense 10 Operations Review 32 Co-operative Relationships 55 Consolidated Balance Sheet 10 Uganda 56 Consolidated Cash Flow 14 Kurdistan Region of Iraq Board of Directors Statement 16 Tanzania 57 Notes to Consolidated Financial 34 Board of Directors 18 Democratic Republic Statements of Congo Corporate Governance 20 Mali Other 36 Corporate Governance Report 22 Malta 81 Glossary of Technical Terms 41 Remuneration Report 24 Pakistan and Definitions 47 Directors’ Report 26 Russia 82 List of Advisers 51 Responsibility Statement of the 83 Financial Calendar Directors 52 Independent Auditors’ Report to the Members of Heritage www.heritageoilltd.com Oil Limited

Head Office and Directors’ Business Address: Fourth Floor, Windward House La Route de la Liberation Jersey JE1 1BG Channel Islands

Tel +44 1534 873000 Fax +44 1534 873344

Cover page shows Miran Block in Kurdistan Region of Iraq Pantone 541 background

Recommend a sealer coat or a lamination with an open window around the embossed logo.

Heritage Oil Limited is an independent Heritage Logo oil and gas explorationSilver Foil Embossed and production company with a primary listing on the Main Market of the London Stock Exchange (symbol HOIL) and Exchangeable Shares listed on the Toronto Stock Exchange

Heritage Oil Limited Annual Report & Accounts 2008 (symbol HOC) and London Stock Exchange Heritage Oil Limited Annual Report & Accounts 2008 (symbol HOX). The Company currently focuses on operations in Africa, the Middle East and Russia.

Overview Financial Review Financial Statements 01 Highlights 28 Committed to Generating Value 53 Consolidated Income Statement 02 Chairman’s Statement 54 Consolidated Statement 04 Chief Executive’s Review Corporate Social of Recognised Income 08 Chief Executive’s Q&A Responsibility and Expense 10 Operations Review 32 Co-operative Relationships 55 Consolidated Balance Sheet 10 Uganda 56 Consolidated Cash Flow 14 Kurdistan Region of Iraq Board of Directors Statement 16 Tanzania 57 Notes to Consolidated Financial 34 Board of Directors 18 Democratic Republic Statements of Congo Corporate Governance 20 Mali Other 36 Corporate Governance Report 22 Malta 81 Glossary of Technical Terms 41 Remuneration Report 24 Pakistan and Definitions 47 Directors’ Report 26 Russia 82 List of Advisers 51 Responsibility Statement of the 83 Financial Calendar Directors 52 Independent Auditors’ Report to the Members of Heritage www.heritageoilltd.com Oil Limited

Head Office and Directors’ Business Address: Fourth Floor, Windward House La Route de la Liberation Jersey JE1 1BG Channel Islands

Tel +44 1534 873000 Fax +44 1534 873344

Cover page shows Miran Block in Kurdistan Region of Iraq Where we operate

Exploration ( Operated) Democratic Republic of Congo (“DRC”) Kurdistan Region of Iraq Mali Malta Pakistan Tanzania Uganda

Production ( Operated) Russia

A Balanced Portfolio Experienced Proven Track-Record Strategic Positioning of Diverse Assets Management

>> Near term focus on the core activity areas >> Solid understanding of local geology and >> Discovered the M’Boundi field in the >> Focus on high impact exploration plays of Uganda and Kurdistan politics in all areas of operations Republic of Congo in 2001 >> First mover advantage – as demonstrated >> High impact exploration plays which can >> Track-record of finding valuable world-class >> Raised approximately $100 million from by success with significant holdings in transform the Company discoveries the sale of assets in the Republic of Congo Uganda and the Kurdistan Region of Iraq >> Sufficient oil volumes have been found in >> Extensive network of contacts between 2002 and 2006 >> Core areas are Africa, Middle East the Albert Basin, Uganda, to justify a major >> Strong oil and gas experience >> Funds re-invested to acquire current and Russia commercial development portfolio >> Medium and longer term focus is Tanzania, >> Pioneering entry into the Albert Basin, where seismic acquisition has recently Uganda, in 1997 – we have now unlocked been completed, the DRC, Malta, Mali a multi-billion barrel basin and Pakistan >> Sold Oman holdings in April 2009 for >> Production asset in Russia $28 million to fund acceleration of work programmes in core areas Where we operate

Exploration ( Operated) Democratic Republic of Congo (“DRC”) Kurdistan Region of Iraq Mali Malta Pakistan Tanzania Uganda

Production ( Operated) Russia

A Balanced Portfolio Experienced Proven Track-Record Strategic Positioning of Diverse Assets Management

>> Near term focus on the core activity areas >> Solid understanding of local geology and >> Discovered the M’Boundi field in the >> Focus on high impact exploration plays of Uganda and Kurdistan politics in all areas of operations Republic of Congo in 2001 >> First mover advantage – as demonstrated >> High impact exploration plays which can >> Track-record of finding valuable world-class >> Raised approximately $100 million from by success with significant holdings in transform the Company discoveries the sale of assets in the Republic of Congo Uganda and the Kurdistan Region of Iraq >> Sufficient oil volumes have been found in >> Extensive network of contacts between 2002 and 2006 >> Core areas are Africa, Middle East the Albert Basin, Uganda, to justify a major >> Strong oil and gas experience >> Funds re-invested to acquire current and Russia commercial development portfolio >> Medium and longer term focus is Tanzania, >> Pioneering entry into the Albert Basin, where seismic acquisition has recently Uganda, in 1997 – we have now unlocked been completed, the DRC, Malta, Mali a multi-billion barrel basin and Pakistan >> Sold Oman holdings in April 2009 for >> Production asset in Russia $28 million to fund acceleration of work programmes in core areas Highlights Financial >>Primary listing on the Main Market of the London Stock Exchange completed on 31 March 2008 >>Joined the FTSE 250 Index on Operational 23 June 2008 >>Sufficient oil volumes have been >>Net production increased by 26% discovered in the Albert Basin, year-on-year Uganda, to exceed the commercial >Strong balance sheet with cash threshold for development > position of $91 million as at >>Discovered the world-class 31 December 2008 Buffalo-Giraffe field in Block 1, >Sale of holdings in Oman, Uganda > subsequent to the year end, >>Kingfisher-3 well, Block 3A, realised cash of $28 million to fund Uganda, discovered oil in the three acceleration of work programmes main reservoirs structurally higher in core activity areas than anticipated, increasing the >In April 2009, third party back-in areal extent of the field > rights for 25% were exercised on >>Miran West-1 well in the Kurdistan the Miran Licence in the Kurdistan Region of Iraq encountered oil Region of Iraq. Heritage received over an interval of 1,100 metres in $6.7 million (25% of back costs) 2009 and is currently being tested >>Termination of a refinery >>Collected 2D seismic over the commitment for over $140 million Kimbiji and Kisangire Blocks in in return for making payments out Tanzania, where Heritage farmed- of future oil and gas sales from in earlier in the year the Miran Licence in the Kurdistan >>Expanded the portfolio of Region of Iraq properties: Farmed-in to two >>Independent research analyst licences in Mali; four blocks coverage increased from one in Tanzania and one licence in party to twelve Pakistan

Outlook >>Testing of the Miran West-1 well in the Kurdistan Region of Iraq is being undertaken during April 2009 >>Further drilling on the Miran Licence in 2009 will be considered following test results from the Miran West-1 well >>A further exploration and appraisal drilling programme is planned to commence in Block 1, Uganda, in the second half of 2009

All dollars are US$ unless otherwise stated Chairman’s Statement

Potential for Growth

I am pleased to report that 2008 was another year of very strong progress for Heritage both operationally and in terms of positioning the Company for steady near- and long-term growth in shareholder value.

Our strategy of seeking out and investing reported that the exploration success rate in in exploration and early development Iraq has historically averaged over 80%. opportunities with high-impact potential, while Heritage has been active in Kurdistan since also expanding our exposure to European 2004 and we are strongly committed to the capital markets and the international oil and region. We were the second of 21 companies gas sector, is proving to be effective. that have been awarded Production Sharing Contracts (“PSCs”) by the Kurdistan Regional Operations Government (“KRG”) since their petroleum Operating highlights include world-class law was passed in August 2007. discoveries in the Albert Basin, Uganda, and commencement of drilling of the Miran West-1 On 25 March 2009 we announced drilling well in the Kurdistan Region of Iraq, which is now of the Miran West-1 well had completed and in the process of being tested. had reached a total depth of 2,935 metres. The well encountered oil shows over an interval Our considerable achievements in Uganda of 1,100 metres with excellent oil shows in include continued drilling success in Block 3A, the three principal known productive reservoir highlighted by Kingfisher-2 testing at a formations in the region. We are in the process combined rate of 14,364 bopd, and successful of undertaking a series of drill stem tests over drilling in Block 1. Our discovery of the a gross interval of approximately 500 metres. Buffalo-Giraffe field in Block 1, Uganda, is We believe our operations in this region also Michael J. Hibberd believed, by management, to be the largest have the potential to transform the Company. Chairman onshore oil field discovered in Sub-Saharan Our commitment and enthusiasm for the Africa in the last 20 years. Exceptional results Kurdistan Region of Iraq is reflected in the from Uganda drilling have established a gross acceleration of our programmes. resource of approximately 600 million barrels. This is above the volume considered necessary London Listing for major infrastructure development for the Our most significant corporate achievement Albert Basin. Our Albert Basin results indicate of 2008 was the primary listing of our shares the outstanding potential of this region. This on the Main Market of the London Stock could transform the Company, especially as Exchange, which was completed at the end we continue with further exploration and of March, a move that was overwhelmingly development. Having operated in Uganda since supported by our shareholders. This 1997, Heritage, as operator with a 50% equity listing initiative was undertaken to increase interest in Blocks 1 and 3A, is strongly liquidity, unlock additional value creation positioned to be a major participant in the for shareholders and also to enhance the future development of this world-class resource. Company’s status and profile among European investors and within the international oil and Another notable highlight of 2008 was the gas sector as a whole. excellent progress made in the Kurdistan Region of Iraq, a highly prospective, and as The London listing, which was followed by yet under-developed, oil-prone region. The the Company’s inclusion as a member of the undiscovered potential of the region has been prestigious FTSE 250 Index, was accompanied estimated at 40 billion barrels of oil and 60 by a reorganisation that saw the establishment trillion cubic feet of natural gas, ranking it as of a new parent company, Heritage Oil Limited, one of the most highly prospective untapped in Jersey. Given the geographic spread of energy resource regions in the world. It is Heritage’s operational activities and licences,

02 Heritage Oil Limited Annual Report & Accounts 2008 >>Workers at the Miran West-1 well, in the Kurdistan Region of Iraq

2008 was a year of exceptional progress for Heritage, and the outlook for 2009 and beyond is very encouraging.

we believed that it was appropriate for the to undertake similar projects in our other Company to be domiciled in the British Isles, core interest areas as our operational Milestones where a substantial number of investors activities expand. >>April 2009 Sale of Oman holdings and the Company’s management reside. >>April 2009 Commenced testing the Board of Directors Miran West-1 well in the Kurdistan Region Also, as part of the corporate reorganisation, During 2008 we were delighted to welcome of Iraq the Company’s shares were effectively split Salim Hassan Macki and General Sir Michael >>April 2009 Termination of a refinery on a ten-for-one basis. This was designed to Wilkes KCB, CBE to the Group as Non- commitment in the Kurdistan Region further enhance trading volumes and liquidity Executive Directors. Both appointments are of Iraq of our shares for the benefit of all shareholders. outstanding additions to the Board and both >>January 2009 Successful completion are already making valuable contributions to of the Kingfisher-3A well, Uganda the Company. Financial > Successful Giraffe-1 After the Company’s success in raising > January 2009 exploration well in Block 1, Uganda – significant amounts of capital in 2007, no Outlook a world class discovery additional financing was required in 2008. As always, I am very grateful to our talented Heritage finished the year with a strong balance management team and employees for their >>December 2008 Commenced drilling sheet and cash to finance planned operations dedication and contribution to the remarkable the Miran West-1 well in the Kurdistan in 2009. Nevertheless, our recent exceptional growth Heritage has enjoyed this past year. Region of Iraq success means that we now intend to 2008 was a year of exceptional progress >>December 2008 Successful accelerate work programmes in Uganda and for Heritage and the outlook for 2009 and completion of the Kingfisher-3 well Kurdistan. With this in mind, we made a beyond is highly encouraging. Operations in >>December 2008 Successful Buffalo-1 decision to dispose of our non-core interests in Uganda and the Kurdistan Region of Iraq are well in Block 1, Uganda Oman. Oman disposal proceeds of $28 million, particularly promising and we continue to look >>October 2008 Successful Warthog-1 plus $400,000 in working capital adjustments, for further strong results from investments and exploration well in Block 1, Uganda are to be used to fund accelerated programmes activities in other operating areas. I would add > Commenced three in our core areas. In regard to financing > September 2008 that in the future, as in the past, our overriding well exploration programme in Block 1, large-scale infrastructure programmes in objective is to create real and lasting value for Uganda Uganda, I am pleased to report that we have our shareholders. been approached by a number of parties. Initial >>September 2008 Commenced drilling proposals involve terms that would significantly Kingfisher-3 and -3A wells in Block 3A, reduce our financing requirements. Uganda >>September 2008 Obtained Social Responsibility government approval and completed As a company that operates in remote and farm-in documentation in Tanzania comparatively undeveloped regions of the Michael J. Hibberd >>August 2008 Reported record test world, we recognise that our responsibilities to Chairman results in Uganda with the Kingfisher-2 well local communities go beyond simply providing >>June 2008 FTSE 250 Index Inclusion funds and local employment. We are committed > Commenced drilling the to implementing community programmes > April 2008 Kingfisher-2 well in Uganda in health, education, public facility and environmental awareness, and we work actively >>March 2008 Dealings commenced with local communities to secure trust and on the London Stock Exchange mutual co-operation. Over the course of the last >>February 2008 Completion of the Mali 18 months we have undertaken a significant farm-in documentation for two licences investment in the Carl Nefdt Memorial Primary >>February 2008 Announced corporate School, in Block 3A, Uganda. We intend reorganisation

Heritage Oil Limited Annual Report & Accounts 2008 03 Chief Executive’s Review

First Mover Advantage

Operational success has dramatically transformed Heritage. Our outstanding drilling successes in Blocks 1 and 3A in the Albert Basin, Uganda, mean we are now confident that sufficient volumes have been discovered to justify a major development.

The work programme on the Miran Block in The combination of aggressive investment, the Kurdistan Region of Iraq was accelerated prudent risk management and operating following the completion of a seismic survey excellence has yielded exceptional results in the second quarter of 2008. The Miran throughout 2008 and into 2009. This includes West-1 well, which commenced drilling on our discovery of the world-class Buffalo-Giraffe 21 December 2008, reached a total depth field in Block 1, Uganda where we are the of 2,935 metres on 25 March 2009. This operator with a 50% interest. well encountered oil shows over an interval of 1,100 metres with excellent oil shows over Africa the three targeted reservoir intervals. A series Uganda of tests is being performed over a gross The world-class Kingfisher field in Block 3A interval of approximately 500 metres. These was discovered in 2007. This significant achievements, coupled with listing on the Main discovery was surpassed with the discovery Market of the London Stock Exchange and of the large Buffalo-Giraffe field, in Block 1, the corporate reorganisation that raised the in January 2009. On current estimates, the Company’s profile as a significant player in Buffalo-Giraffe field has an area of approximately the international oil and gas industry, puts 48 square kilometres and an oil column of 140 us in excellent shape for the achievement metres. The structure may extend even further of near- and long-term growth in production to include the Buffalo East prospect, creating a and reserves and also in shareholder value. very large structure of up to 90 square Anthony Buckingham kilometres. Initial estimates for the Buffalo- Chief Executive Officer 2008 was a year of extreme volatility in Giraffe field are recoverable resources of international crude oil markets, with price approximately 350 million barrels (gross), fluctuations of a magnitude never seen before. which is not only a major field in itself, but also Fortunately, as primarily an exploration significantly de-risks the many other potential company with international projects in proven targets in the block. light oil basins, Heritage was not dramatically affected by short-term price volatility and we Operations in this basin have continued to remain confident that the longer-term outlook achieve a 100% success rate as, to date, for oil and gas is positive. The world will 21 successful exploration and appraisal continue to need hydrocarbons which will wells have been drilled with all encountering require new production from remote and hydrocarbons. Further appraisal work on the challenging regions. At Heritage we remain Kingfisher discovery produced some exciting committed to seeking out such opportunities results in 2008 with a record production test, and managing political and operational risk for any well drilled in Uganda, of 14,364 bopd. with a diverse portfolio and a prudent mix of Additionally, the same three reservoir intervals exploration, development and production. were encountered in all of the wells and, significantly, the areal extent of the field Our long-standing strategy of being an early was increased as oil was found structurally entrant in prospective regions, demonstrating higher than anticipated in the Kingfisher-3 our management and technical expertise, appraisal well. and our commitment to building working relationships with local and international The Albert Basin will remain a high corporate companies and governments, gives us priority in coming years as the recent drilling the flexibility to react quickly to changing successes have raised the estimated circumstances.

04 Heritage Oil Limited Annual Report & Accounts 2008 >>Drilling operations at Buffalo site, Block 1, Uganda

resources of the basin above the threshold required for commercial development. This is transformational for Heritage. With a gross licence area in Uganda and the DRC in excess of 12,000 square kilometres – equivalent to approximately 55 North Sea blocks – the Albert Basin is now estimated to have multi-billion barrel reserve potential. We are considering a number of fast-track development scenarios for the Albert Basin, including the possibility of a phased development with first production in 2011 by utilising the existing railway network in East Africa. We are also considering an export pipeline to the coast as well as a scheme to service local markets.

In addition to the Kingfisher drilling activity, mapping of recent seismic data has identified a number of prospects offshore in Lake Albert within the Heritage operated Block 3A, including the structurally attractive Pelican potential to contain billions of barrels of oil in Heritage management believes that any prospect and the large Crane prospect. An place from multiple potential reservoir targets. outstanding issues between the government of offshore drilling programme that will include Drilling of the Miran West-1 well began in Iraq and the Kurdistan Regional Government the Crane and Pelican prospects is currently December 2008, a significant accomplishment will be resolved satisfactorily. To that end, expected to begin in the first half of 2010. given that Heritage was awarded the licence the two parties formed a series of committees less than 15 months prior, in October 2007. to resolve issues. There has been considerable Tanzania progress recently with the likelihood that first Heritage farmed-in to four licence areas in In March 2009, we announced drilling of oil from Kurdistan will be exported this year. Tanzania in mid-2008, with a total area of the Miran West-1 well had completed and approximately 25,000 square kilometres. reached a total depth of 2,935 metres. The Oman In early 2009, Heritage completed the well encountered oil shows over an interval Following our exceptional success in Uganda acquisition of 2D seismic in-fill data on two of 1,100 metres, with excellent oil shows in and very encouraging drilling results in the blocks in Tanzania. Future drilling locations the three principal proven reservoir formations Kurdistan Region of Iraq, we decided to sell will be identified once the data has been in the region (the Shiranish, Kometan and our non-core 10% interest in Block 8 in Oman processed and interpreted. Qamchuqua). Good quality light sweet oil was for $28 million, plus $400,000 in working recovered to surface as part of the drilling capital adjustments. We believe that greater The Middle East operations. A series of drill stem tests over a value can be generated by using this cash to Kurdistan Region of Iraq gross interval of approximately 500 metres are finance accelerated work programmes in The Kurdistan Region of Iraq is another being conducted during April 2009. A further Uganda and the Kurdistan Region of Iraq. primary focus area for Heritage, with the announcement will be made when all tests potential to find multi-billion barrels of have been completed. oil. Based on excellent quality seismic data acquired by Heritage during 2008, The operating environment for oil and gas management has confirmed that the Miran companies in the Kurdistan Region of Iraq Block contains two anticlines that have the remains relatively stable and secure, and

Heritage Oil Limited Annual Report & Accounts 2008 05 Chief Executive’s Review continued

First Mover Advantage

Pakistan In summary, Heritage has achieved In December 2008, Heritage received tremendous operating success during 2008 government approval for a farm-in to the and early 2009, leading to a world-class oil Zamzama North Block in the Sindh Zone discovery in Uganda and very encouraging Recent drilling successes (Zone lll) in southern Pakistan. Heritage is the results from the Miran West-1 well in the operator and was awarded a 48% participating Kurdistan Region of Iraq, which is currently have raised the estimated interest in the block. This has extended being tested. We also achieved increases in Heritage’s operations in Pakistan, which also production and expanded our portfolio of resources of the Albert include a 54% interest in, and operatorship of, properties. Looking ahead, we believe we have Basin, Uganda, above the the Sanjawi Block in the Baluchistan Zone the financial and technical capability, combined (Zone II) in Pakistan. This block contains a with the management flexibility, to pursue threshold required for number of large anticlinal structures which opportunities to enhance the interests of our could be potentially significant drilling targets. shareholders. We look forward to making commercial development. substantial further progress and increasing Russia shareholder value in both the near- and the Development of the Zapadno Chumpasskoye long-term. Licence in western Siberia, in which Heritage holds a 95% equity interest, continued during I would like to thank our staff, my fellow 2008. A third exploration and appraisal well Directors and our shareholders for their was completed in the first half of 2008, and continuing support. average daily oil production increased to 379 bopd in 2008. Peak production of 900 bopd was achieved but the field was shut-in between December 2008 and February 2009 following a temporary reduction in the domestic oil price in Russia. Production has since recommenced at a level of approximately Anthony Buckingham 150 bopd but we expect this to increase over Chief Executive Officer the year.

06 Heritage Oil Limited Annual Report & Accounts 2008 >>Kingfisher-3 drill site, Block 3A, Uganda

The Group aims to continue to generate growth in shareholder value by focusing on high- impact international plays.

Strategy Strengths

The Group aims to continue to generate The Company’s competitive strengths growth in shareholder value by focusing include: on high-impact international plays that provide multiple targets with >>Our ability to expand a portfolio of high- the potential to discover substantial impact international plays; in 2008 hydrocarbon reserves. The Group’s we extended our portfolio to include growth strategy is to acquire and invest assets in Tanzania, Mali and Pakistan in exploration and early development opportunities throughout the world, with >>Experienced management and a particular emphasis on its core areas technical teams with a track-record of Africa, the Middle East and Russia. of finding valuable oil discoveries; we announced in January 2009 the world- To be successful, the Group has class Buffalo-Giraffe discovery developed a highly effective network of influential industry, political and >>Our position in the Albert Basin of institutional relationships. These enable Uganda is considered by management the Group to gain access to a wide to have the potential to contain over variety of new oil and gas business two billion barrels of oil reserves opportunities. >>Our demonstrated success as a first- mover in acquiring assets in territories such as Uganda and the Kurdistan Region of Iraq

>>Our proven record of realising value through asset sales; $28 million was raised in April 2009 through the sale of Eagle Energy (Oman) Limited, a wholly-owned subsidiary of Heritage

Heritage Oil Limited Annual Report & Accounts 2008 07 Chief Executive’s Q&A

What, for you, were the highlights How does the Company engage of 2008? with shareholders? 2008 was a year of tremendous achievements One of the aims of moving to the Main Market for Heritage, both operationally and corporately. of the London Stock Exchange was to Heritage remains Operationally, we continued with the 100% enhance the Company’s status and profile success rate in Uganda where we discovered among European investors and within the committed to generating the Buffalo-Giraffe field which management international oil and gas sector as a whole. considers to be the largest onshore discovery Communication with shareholders is given shareholder value by in Sub-Saharan Africa for 20 years. This a high priority and we ensure there is regular focusing on high-impact discovery, in our operated Block 1, pushed dialogue with institutional investors, as well as the Albert Basin over the threshold required general presentations to analysts. As a result exploration. for a commercial development. we have broadened our investor base and increased the research coverage, giving In the Kurdistan Region of Iraq we accelerated Heritage an increased profile. We have also our work programme and within only 15 redesigned our website which is continually months of signing our licence we commenced updated to keep investors informed of drilling the prospective Miran West-1 well – a our activities. We also employed a full remarkable achievement highlighting the time investor relations specialist for the technical and managerial capabilities of first time who has coordinated an effective Heritage. investor relations programme. What does 2009 hold for Heritage? 2009 will be another exciting year for Heritage Corporately, Heritage listed on the Main Market What values define Heritage? as we continue with high-impact exploration in of the London Stock Exchange in March 2008 Heritage has many core values that run our focus areas of Uganda and Kurdistan. We and joined the FTSE 250 Index. This has been through all our activities. These include: are planning on returning to Block 1 in Uganda very advantageous for the Company, increasing • respecting the laws and customs of later in the year with an exciting exploration the visibility of the Company and the liquidity of the countries in which we operate; and appraisal programme in this prolific basin. our shares. • supporting the communities in areas The Kurdistan Region of Iraq will also feature where we operate; prominently in 2009 as we are currently testing How has your strategy evolved over • promoting long-term relationships with the Miran West-1 well. the last year? stakeholders; Heritage remains committed to generating • encouraging and supporting employees Do you have a message for shareholders? shareholder value by focusing on high-impact to play their part in creating a better Exceptional exploration success has begun exploration with the potential to discover environment; to transform the Company within the last year substantial hydrocarbon reserves. Our strategy • motivating staff to retain and attract and we have delivered on promises made in of realising value for shareholders within our experienced employees; and our Annual Report last year. Namely, we have own portfolio has recently been demonstrated • the belief that shareholders’ long-term exceeded the volume threshold required to by the sale of our Oman holdings for $28 interests are best served by the pursuit justify development in Uganda and we have million. With this asset, Heritage had a minority of businesses with high standards of commenced a high-impact drilling campaign interest in a non-operated licence with responsibility. in the Kurdistan Region of Iraq. Heritage negligible reserves which was no longer has the ability to grow significantly over the considered integral to the portfolio. We believe What distinguishes Heritage from coming years and we believe that we have the that the proceeds will generate greater value other companies within the sector? management, technical expertise and strategy through reinvestment in our core activity areas The Company has many competitive to achieve this. of Uganda and the Kurdistan Region of Iraq. strengths, including: • experienced management and technical team with a track-record of finding valuable oil discoveries; • a geographically diversified portfolio of high-impact exploration plays; • our demonstrated success as a first-mover in being awarded assets in territories such as Uganda and the Kurdistan Region of Iraq; and • our proven track-record of realising value through asset sales.

08 Heritage Oil Limited Annual Report & Accounts 2008 Heritage has the ability to grow significantly over the coming years.

Heritage Oil Limited Annual Report & Accounts 2008 09 Operations Review: Exploration

Uganda

In 2008 the Buffalo-Giraffe field was discovered – this is the largest discovery in Uganda to date

10 Heritage Oil Limited Annual Report & Accounts 2008 >>Map of licences in Uganda

In 1997, the Group became the first oil and gas company to actively explore in Uganda in almost 60 years after being awarded a licence covering the original Block 3 in the Albert Basin of western Uganda. In 2001, the Group farmed out 50% of the licence to Energy Africa, which was subsequently acquired by Tullow Oil plc (“Tullow”). Heritage is one of only two international oil companies with licences in the vast Albert Basin, which has an area in Uganda of over 9,000 square kilometres.

A total of 21 wells have been drilled in the Albert Basin since the beginning of 2006 and The more extensive oil accumulation and the Block 3A. These will be explored in a lake all have found hydrocarbons. greater structural elevation of the reservoir drilling programme scheduled to commence in in the south-west part of the field gives 2010. 550 kilometres of 2D seismic, which was Block 3A confidence the discovery is larger than initially acquired in mid-2007, was further interpreted The original Block 3 was reconfigured and estimated. The Kingfisher-3A sidetrack, during 2008 and identified a number of re-licenced in 2004, as Block 3A, for a term of which was drilled as a development well and additional prospects in the lake including six years. Block 3A is located in the southern completed in February 2009, encountered a the large Crane prospect. The Front End portion of the Albert Basin and covers an area gross vertical oil-bearing interval of 90 metres Engineering and Design (“FEED”) study for an of 2,024 square kilometres. Heritage holds a with net vertical oil pay of 22 metres. offshore drilling programme commenced last 50% interest in Block 3A, is the operator and year following completion of feasibility and drilled two successful appraisal wells during The discovered oil in Block 3A is good quality, pre-FEED studies and is expected to be 2008 in this block. light (between 30º and 32º API) and sweet completed in the first half of 2009. with a low gas-oil ratio and some associated The Kingfisher-2 well was drilled to a total wax. The reservoirs are highly permeable Block 1 measured depth of 3,906 metres (3,197 metres sandstones with an estimated permeability Heritage holds a 50% interest in and is the true vertical depth) in 2008. Three reservoir of up to 3,000 miliDarcies. The same three operator of Block 1, which was awarded in intervals were encountered which had a sandstone reservoir intervals were encountered 2004. Block 1 is located at the northern end cumulative test rate of 14,364 bopd, surpassing in all of the Kingfisher wells highlighting the of Lake Albert, and encompasses an area of the rate from the same three intervals continuity and the large lateral extent of 3,659 square kilometres. A successful 2008 encountered in Kingfisher-1A, which flowed at the reservoirs. All three Kingfisher wells have drilling campaign discovered the Warthog a combined rate of 9,773 bopd, in 2007. been suspended as future producers. accumulation and the Buffalo-Giraffe field, which is considered by management The Kingfisher-3 well, located three kilometres Management believes that successful drilling of to be the largest onshore oil discovery in south of Kingfisher-2, commenced drilling the Kingfisher field has lowered the exploration Sub-Saharan Africa in over 20 years. in September 2008. This well was drilled risk of other exploration targets identified within to evaluate the south-west portion of the Kingfisher structure and encountered a gross Area Date Heritage vertical hydrocarbon bearing interval of 123 Licence (sq km) Awarded Equity Partners Operator metres, with net vertical pay of 41 metres, 1 based on evaluation of the wireline log data. In Block 1 3,659 July 2004 50% Tullow Heritage addition to finding oil, the well also confirmed Block 3A 2,024 September 2004 50%1 Tullow Heritage that this part of the field was approximately 100 metres structurally higher than expected. 1 Third party back-in rights exist which, if exercised fully, could result in a minimum holding of 42.5%.

Heritage Oil Limited Annual Report & Accounts 2008 11 Operations Review: Exploration

Uganda continued

12 Heritage Oil Limited Annual Report & Accounts 2008 A seismic survey comprising approximately Pressure and seismic data indicate that the Potential Development 670 kilometres of 2D data was completed on Giraffe discovery is structurally connected The exceptional results from recent drilling Block 1 in February 2008 which identified to the Buffalo discovery, creating the Buffalo- programmes in Blocks 1 and 3A mean that many encouraging Direct Hydrocarbon Giraffe field covering approximately 48 square management now believes that a gross Indicators (“DHIs”). A three well exploration kilometres with an oil column of approximately recoverable resource of approximately 600 programme commenced in September 140 metres. Based on current mapping, the million barrels has been proved up. This is 2008 targeting the Warthog, Buffalo and Company’s initial estimate of gross recoverable significantly greater than the threshold Giraffe prospects. resources for the Buffalo-Giraffe field is over considered necessary for major infrastructure 350 million barrels. The Buffalo-Giraffe field development in the Albert Basin. Other The Warthog-1 well commenced drilling in may extend into the Buffalo-East prospect leads and prospects have the potential to September 2008 and encountered 46 metres which would result in one very large structure, significantly add to these estimates. of net hydrocarbon pay. Wireline logging covering up to 90 square kilometres. and formation pressure measurements Development studies are currently being indicated 31 metres of net oil pay in the All the wells drilled in Block 1 were relatively undertaken to optimise and fast-track principal oil-bearing section, overlain by shallow with target depths between 600 and development of the basin. Options include 15 metres of additional net hydrocarbon 920 metres. Downhole pressure testing and using the existing rail infrastructure which will pay comprising, most probably, volatile oil, sampling and the recovery of oil to surface enable commercial production to begin as condensate and liquids rich gas. In addition have confirmed the presence of moveable early as 2011, as well as an export pipeline to to the oil discovered, further potential for oil oil in the Block 1 discoveries. Log interpretation the coast. It is planned to present these plans exists in the overlying reservoir section and core analysis has confirmed excellent to the government of Uganda in late 2009. downdip of the Warthog well location and reservoir quality with porosities of up to 35%. The costs of a pipeline will be significant, but there is additional potential in the adjacent Recent testing of the Kasamene-1 well, close Heritage has been approached by a number Warthog North prospect. by in neighbouring Block 2, gives further of parties who are interested in financing confidence as a maximum flow rate of 3,500 and building the pipeline, as well as other The Buffalo-1 well commenced drilling in bopd was achieved. All three wells in Block 1 infrastructure. Discussions with these parties November 2008 and encountered 43 metres have been suspended as future producers. are ongoing. of net hydrocarbon pay with 28 metres of net oil pay. In December 2008, the Giraffe-1 Management estimates that there is potentially well commenced drilling 5.5 kilometres from a billion barrels of oil recoverable from Block 1 Buffalo-1 and encountered a gross oil-bearing as many other prospects and leads have interval of 89 metres with 38 metres of net been mapped and exploration risk has been oil pay. significantly reduced by the recent drilling success. All these prospects and leads are characterised by encouraging seismic DHIs similar to those seen over the successful Warthog, Buffalo and Giraffe discoveries. Heritage plans to undertake further drilling in Block 1 in the second half of 2009.

Heritage Oil Limited Annual Report & Accounts 2008 13 Operations Review: Exploration

Kurdistan Region of Iraq

Heritage drilled its first well in Kurdistan in 2008, less than 15 months after being awarded the licence

14 Heritage Oil Limited Annual Report & Accounts 2008 >>Map showing the Miran Block in the Kurdistan Region of Iraq

In October 2007, the Group signed a PSC with Kometan and Qamchuqua. Both the Miran the Kurdistan Regional Government (“KRG”) structures have the potential to contain billions covering the Miran Block in the southern part of barrels of oil from multiple potential zones. of the Kurdistan Region of Iraq. The Kurdistan Heritage has demonstrated its operational Region of Iraq is an autonomous northern efficiency and commitment to the region region in federal Iraq bordering Syria, Iran and by completing the seismic survey and Turkey. Since the passing of the Petroleum commencing a drilling programme less than Law in Kurdistan, in August 2007, the KRG has 15 months after the licence was awarded for awarded 21 PSCs with Heritage’s PSC being a previously unexplored block. the second awarded. Being an early entrant in this region, the Group is strongly positioned In March 2009, the Company announced that to benefit from development of this significant drilling of the Miran West-1 well had been hydrocarbon-prone region especially as the completed and reached a total depth of 2,935 already-stable security situation continues to metres. The well encountered oil shows over improve. Other oil and gas companies have an interval of 1,100 metres, with excellent oil been operating in this area for several years shows in the three principal proven reservoir without major interruption. There is believed to formations in the region. Good quality, light be huge undiscovered potential in the region, sweet oil was recovered to surface. We are estimated, by the US Geological Survey, in the process of undertaking a series of at approximately 40 billion barrels of oil and drill stem tests over a gross interval of 60 trillion cubic feet of gas. Additionally, it has approximately 500 metres. been reported that 80% of all wells drilled in Iraq have encountered hydrocarbons. Based on the encouraging seismic evaluation and drilling results of the Miran West-1 well, The Miran Block covers an area of 1,015 Heritage is formulating plans for further drilling square kilometres and is located approximately on Miran in 2009 in order to plan for a fast 65 kilometres from the Kirkuk oil field where track development. remaining reserves are estimated to be in excess of 10 billion barrels. The Miran structures are on trend with the Taq Taq field.

In the second quarter of 2008, Heritage acquired 332 kilometres of good quality 2D seismic which showed two very large anticlines, Miran West and Miran East, which together cover an area of approximately 330 square kilometres. The seismic data also indicates that the reservoirs are fractured in a radial pattern which appears similar to the neighbouring Taq Taq field. Area Date Heritage After interpreting the seismic data, Heritage Licence (sq km) Awarded Equity Partners Operator accelerated the Miran work programme and Miran 1,015 October 2007 75%1, 2 Genel Energy Heritage contracted a rig in October 2008. Drilling commenced on Miran West-1 in December 2008, targeting the three main known 1 Third party back-in rights exist which, if exercised fully, could result in a minimum holding of 56.25% producing reservoirs in the region; Shiranish, 2 Heritage equity reduced from 100% following exercise of back-in rights in April 2009

Heritage Oil Limited Annual Report & Accounts 2008 15 Operations Review: Exploration

Tanzania

Seismic data, combined with encouraging hydrocarbon shows, identify the licences as being within a highly desirable exploration province

16 Heritage Oil Limited Annual Report & Accounts 2008 >>Map showing licences in Tanzania

Heritage farmed-in to four blocks in Tanzania in East Africa in 2008 and has already completed two seismic acquisition programmes.

In April 2008, Heritage entered into farm-in agreements on two licences in eastern Tanzania, comprising four blocks (Latham, Kimbiji, Kisangire and Lukuliro Areas). 2006 with an exploration period of four years, has applied for an extension to the initial Government approval for the farm-ins was followed by two extensions of four years and exploration period, which the government has received in the second half of 2008. The four three years, respectively, with the right to a advised it is favourably considering. This is blocks are located in eastern Tanzania and development licence with a term of 25 years. followed by one extension of four years, a cover a total area of approximately 25,000 further extension of three years and the right to square kilometres. The Kimbiji and Latham Under the terms of the farm-in agreement with a development licence with a term of 25 years. Areas cover approximately 9,300 square Petrodel, the Group has the right to earn a kilometres and are held under one Production 70% working interest in the Kimbiji licence Under the terms of the farm-in agreement with Sharing Agreement (“PSA”), whilst the area, and a 29.9% working interest in the Dominion, the Group has the right to initially Kisangire and Lukuliro Areas cover Latham licence area, by funding all seismic earn a working interest of 55% in both the approximately 16,100 square kilometres and costs of the required work programmes on Kisangire and Lukuliro licences. In order to are held under a second PSA. both blocks, comprising the acquisition of both earn the working interests, Heritage will fund all 2D and 3D seismic data, and the drilling of two costs to acquire a minimum of 150 kilometres All four licences are close to the Mkuranga-1 exploration wells within the Kimbiji Area. of 2D seismic data and the costs of the first gas discovery which was drilled in 2007 and Heritage is initially acting as contract operator, commitment well. The Group also has an reportedly flowed gas at a rate of 20 mmcf/d being responsible for all technical and option to earn an additional working interest from an Upper Cretaceous reservoir. This well operational aspects of the work programmes, of 15%, thereby increasing its participating is located approximately 25 kilometres to the and will be appointed operator upon drilling the interest to 70%, by funding 87.5% of the costs east of the Kisangire licence area. The large second exploration well in the Kimbiji Area. of a second well. Songo Songo producing gas field is located to the south-east of the licence areas. The Kisangire and Lukuliro The acquisition of 198 kilometres of 2D seismic Wingayongo oil seep is present in the Kisangire The onshore Kisangire and Lukuliro licences commenced in the Kisangire licence area in licence area, indicating the presence in the cover an area of 7,280 square kilometres and September 2008 and was followed by the region of a working hydrocarbon system that 8,828 square kilometres, respectively. The PSA acquisition of 207 kilometres of 2D seismic in has generated both oil and gas. Previous was originally awarded to Dominion Oil & Gas the onshore part of the Kimbiji licence area. seismic data acquired in these licence areas, Limited (“Dominion”) in May 2005, with an The data is currently being analysed after combined with encouraging hydrocarbon exploration period of four years. The Company which drilling locations will be determined. shows in wells drilled in the licences, identify them as highly desirable exploration licences. Area Date Heritage Latham and Kimbiji Licence (sq km) Awarded Equity Partners Operator The Latham and Kimbiji licence areas, covering 5,056 square kilometres and 4,298 square Kisangire 7,280 May 2005 55% Dominion Heritage kilometres respectively, encompass onshore Lukuliro 8,828 May 2005 55% Dominion Heritage (1,882 square kilometres), near shore (2,981 Kimbiji 4,298 September 2006 70% Petrodel Heritage1 square kilometres) and deep water (4,491 square kilometres) areas. The PSA was Latham 5,056 September 2006 29.9% Petrodel Heritage1 awarded to Petrodel Resources Ltd (“Petrodel”) by the Tanzanian government in September 1 Heritage is operator of the work programme.

Heritage Oil Limited Annual Report & Accounts 2008 17 Operations Review: Exploration

Democratic Republic of Congo

Blocks I and II cover more than 6,000 square kilometres in the highly prospective Albert Basin

18 Heritage Oil Limited Annual Report & Accounts 2008 >>Map showing licences in the Democratic Republic of Congo

In addition to its licences in Uganda, Heritage holds a 39.5% non-operated interest in two blocks in the Albert Basin on the DRC side of Lake Albert – Blocks I and II. These blocks, which include the entire DRC side of Lake Albert, cover more than 6,000 square kilometres and are adjacent to Block 3A and Block 2 in Uganda. The combination of licences in both the DRC and Uganda gives the Group a very strong acreage position in this highly prolific sedimentary basin.

In 2006 the Group, with its partners in these licences, executed a PSA with the government of the DRC. The initial exploration term is five years, during which seismic data will be acquired and exploration wells drilled. However, work will only commence following the receipt of a Presidential Decree, the timing of which is still uncertain. The validity of the licences was disputed during 2008, however, Heritage and the operator are working closely with the government of the DRC and both continue to be confident that title will be confirmed.

Given the proximity of the DRC licences to the Ugandan licences in the Albert Basin, management anticipates being able to realise cost benefits in operating, capital and infrastructure development costs.

Area Date Heritage Licence (sq km) Awarded Equity Partners Block I 3,825 Signed July 2006 39.5% Tullow Oil1, (awaiting presidential decree) COHYDRO Block II 2,634 Signed July 2006 39.5% Tullow Oil1, (awaiting presidential decree) COHYDRO

1 Operator

Heritage Oil Limited Annual Report & Accounts 2008 19 Operations Review: Exploration

Mali

The two licences have a gross area of over 72,000 square kilometres

20 Heritage Oil Limited Annual Report & Accounts 2008 >>Map showing licence areas in Mali

Heritage announced in March 2008 that the Previous drilling in the Gao Graben has government of Mali had approved a farm-in encountered oil and gas shows. The Tin on two exploration licences. The two licences Bergoui water well, which lies approximately have a gross area of over 72,000 square 30 kilometres to the west of Block 11, kilometres. Heritage has been appointed was drilled to a depth of 350 metres and operator with the right to earn a 75% working encountered oil and gas shows in a number interest in each of Blocks 7 and 11 by financing of horizons, indicating the potential for a 100% of the minimum work programme of working hydrocarbon system. seismic acquisition and the drilling of one exploration well. The Group’s partner is Mali A two year extension to the licences on both Oil Development SARL, a wholly-owned blocks was awarded in January 2009 giving subsidiary of Centric Energy Corporation. the Group a better opportunity to refine the work programme. Over the next couple Blocks 7 and 11 are located in the east of of years, the Group will proceed with a the country and include the Gao Graben, a programme of seismic acquisition and Mesozoic basin that management considers reprocessing to support the selection of geologically similar to other Mesozoic initial drilling locations. interior-rift basins within North Africa, such as the Muglad Basin of Sudan and the Doba Basin of Chad. The Graben has been delineated by various surveys conducted since the early 1970s, including over 2,000 kilometres of 2D seismic and a comprehensive gravity and magnetic survey. The data shows the presence of tilted fault-blocks and indicate the possible presence of up to 4,000 metres of sediments above basement.

Area Date Heritage Licence (sq km) Awarded Equity Partners Operator Block 7 39,804 July 2006 75% Centric Energy Heritage Block 11 32,810 June 2005 75% Centric Energy Heritage

Heritage Oil Limited Annual Report & Accounts 2008 21 Operations Review: Exploration

Malta

Areas 2 and 7 are considered, by management, to be similar play types to producing fields in the western Mediterranean

22 Heritage Oil Limited Annual Report & Accounts 2008 >>Map showing licence areas in Malta

In December 2007, the Group entered into a The licences are under-explored with only one PSC with the Maltese government for a 100% well previously drilled in Area 2; the Medina interest in Areas 2 and 7 in the south-eastern Bank 1 in 1980. The well was drilled to a offshore region of Malta. The licences cover depth of 1,225 metres, but failed to reach almost 18,000 square kilometres and are the target horizons, estimated to be between situated approximately 80 kilometres and 140 1,500 and 4,500 metres. The well did, kilometres, for Area 2 and Area 7, respectively, however, encounter gas shows in porous, from the south eastern Maltese coast in water fractured carbonates. depths of approximately 300 metres. The two areas are considered, by management, Heritage has agreed to a minimum contractual to be similar play types to producing fields work programme comprising the acquisition in the western Mediterranean. Initial seismic of a further 1,000 kilometres of seismic data interpretation, based on the current extensive and the drilling of an exploration well. The data set of almost 3,500 kilometres acquired work programme has commenced with the in 2000, indicates the presence of a variety reinterpretation of existing seismic which will of potential prospects. Primary targets are be followed by the acquisition of a 2D seismic Lower Eocene and Cretaceous carbonates programme in either 2009 or 2010. that are already recognised as major hydrocarbon producing plays in the western part of the Mediterranean.

Area Date Heritage Licence (sq km) Awarded Equity Area 2 9,190 December 2007 100% Area 7 8,778 December 2007 100%

Heritage Oil Limited Annual Report & Accounts 2008 23 Operations Review: Exploration

Pakistan

The licences cover a total area of 3,487 square kilometres

24 Heritage Oil Limited Annual Report & Accounts 2008 >>Map showing licence areas in Pakistan

Pakistan covers approximately 800,000 square kilometres and has proved reserves reported to be in the region of 289 million barrels of oil and 760 billion cubic metres of gas.

The Sanjawi Block (number 3067–2) in Zone II (Baluchistan) was awarded in November 2007. Heritage has a 54% interest and is the operator. This onshore exploration licence covers a gross area of 2,258 square kilometres and encompasses a variety of terrains ranging from relatively flat desert and cultivated valley floors to a series of rugged hills. The block Any discovered hydrocarbons could be readily is considered highly prospective due to the connected to the existing infrastructure as presence of oil seeps to the south of the the main Sui-Karachi pipeline is situated only licence. The block is dominated by a series about six kilometres to the east of the block. of broad east-west trending surface features To the immediate south of this block is the including the Dabbar and Warkan Shah large Zamzama gas field. anticlines. These are large structures with the Dabbar anticline alone being some 300 square Initial interpretation of seismic has identified kilometres in area. several prospects and leads.

In December 2008, Heritage obtained a 48% interest in the Zamzama North Block (number 2667–8) and has been appointed operator. The Zamzama North Block is located in the south of Pakistan in the western part of Sindh Province approximately 200 kilometres northwest of Hyderabad and has an area of 1,229 square kilometres. The block is situated only 10 kilometres from the eastern flanks of the Kirthar Fold Belt and forms part of the associated compressive foreland. The eastern portion of the block is composed of the riverine, rich, flat, low lying and intensively cultivated flood plain of the Southern Indus Area Date Heritage Basin, whilst the western area is uncultivated Licence (sq km) Awarded Equity Partners Operator and covered by the low, flat alluvial outwash Sanjawi Permit 2,258 November 54% Hycarbex Heritage from the Kirthar Hills. The current seismic 2007 American Energy, database used to map the Zamzama North Sprint Energy, Block comprises some 750 kilometres of fair Trakker Energy to good quality, recent 2D seismic. Zamzama North 1,229 December 48% Hycarbex Heritage 2008 American Energy, Sprint Energy, Trakker Energy

Heritage Oil Limited Annual Report & Accounts 2008 25 Operations Review: Production

Russia

This licence is in the hydrocarbon-rich Western Siberian province of Khanty- Mansiysk, accessible to existing infrastructure and facilities

26 Heritage Oil Limited Annual Report & Accounts 2008 >>Map showing licence area in Russia

Zapadno Chumpasskoye, located within the Western Siberian province of Russia which accounts for approximately 60% of Russia’s total crude oil production, is an example of the Group’s strategy of acquiring assets in both highly-prospective and established hydrocarbon-prone parts of the world.

Since 2005, the Group has held a 95% equity and sweet, 42º API crude oil, with moderate interest in ChumpassNefteDobycha Limited, gas-to-oil ratios. a Russian Company whose sole asset is the Zapadno Chumpasskoye Licence. This RPS Energy independently estimated that licence, which expires in 2024, is in the Zapadno Chumpasskoye contains proved plus hydrocarbon-rich Western Siberian province probable reserves of 60.4 million barrels of oil, of Khanty-Mansiysk, approximately 100 net to the Group, with a Net Present Value, kilometres from the city of Nizhnevartovsk and discounted at 10%, of $234.9 million as at in the area of the region’s prolific Samotlor oil 31 December 2007. During 2008 another field, which makes it accessible to existing independent review was undertaken by production infrastructure and facilities. The Sibtechneft, a noted Russian reserves agency, licence covers an area of about 200 square as a requirement of the licence following kilometres and contains the Zapadno completion of work commitments. The C1+C2 Chumpasskoye field, discovered in 1997. A reserves were determined to be closely in line total of nine wells were drilled on the licence with those estimated by RPS Energy; 63.4 prior to 2005, and the Group has drilled a million barrels gross or 60.2 million barrels further three wells. The producing reservoir net to the Group. The review was accepted is a late Jurassic sandstone, at a depth of by the Ministry of Natural Resources of the approximately 2,700 metres, and is the same Russian Federation in November 2008. producing horizon present in a number of neighbouring fields. Independent Reserves at Zapadno Since 2006 the Company has acquired 200 Chumpasskoye RPS Energy, an independent geoscience kilometres of seismic data, began constructing consultancy, estimated Zapadno pilot production facilities and re-entered Chumpasskoye’s net working and entitlement existing well #226. Production facilities were interest reserves and value to the Group as at commissioned and production commenced 31 December 2007, using money of the day in May 2007. Three additional exploration and prices, discounted at 10%, to be as follows: appraisal wells were drilled by Heritage and the third well was completed in the first half of Net Working Net Net 2008. A fracture stimulation was completed Interest Entitlement Present and artificial lift installed on one well. In 2008, Reserves Interest Value production peaked at over 900 bopd and MMboe MMboe $ millions averaged 379 bopd which was an increase of 80% on 2007 levels. The field was shut-in Proved 23.1 23.1 20.7 between December 2008 and February Probable Additional 37.3 37.3 214.2 2009 following a temporary reduction in the Total Proved + Probable 60.4 60.4 234.9 domestic oil price in Russia. The crude is light

Heritage Oil Limited Annual Report & Accounts 2008 27 Financial Review

Committed to Generating Value

Selected Operational and Financial Data

2008 2007 Change Production bopd 450 356 26% Sales volume bopd 435 333 31% Average realised price $/bbl 32.1 30.5 5% Petroleum and natural gas revenue $ million 5.1 3.7 38% Net loss $ million (41.3) (83.2) 50% Net loss per share – basic and diluted $ (0.16) (0.37) 57% Total cash capital expenditures $ million (103.2) (75.3) Year end cash balance $ million 90.6 230.1

Corporate Performance The average realised price of $32.1 per barrel in Paul Atherton Production 2008 was 5% higher than in 2007, attributable Chief Financial Officer Average daily production increased by 26% to higher average commodity prices in Russia, from 356 bopd in 2007 to 450 bopd in 2008. offset by lower average condensate and LPG The increase in production was attributable sales prices in Oman. to higher levels of production from Zapadno Chumpasskoye in Russia despite being shut-in Operating Results during December 2008. This was offset by a Petroleum and natural gas operating costs 51% decline in production of condensate and increased by 22% to $2.3 million in 2008, due LPG in Oman due to the temporary cessation of to almost a full year of production in Russia production in the second half of 2008. This was compared to only seven and a half months of in part due to upgrading the Bukha platform to production in 2007. The increase is in line with handle new production from the West Bukha the higher sales volumes but additionally some field. The West Bukha field commenced volume efficiencies were achieved. Average production in February 2009. operating costs per barrel sold declined by $0.69 to $14.18 in 2008, compared to $14.87 Revenue in 2007. Petroleum and natural gas revenue increased by 38% to $5.1 million, due to higher sales Production tax in Russia increased from volumes in Russia offset by lower condensate $1.1 million in 2007 to $2.3 million in 2008. and LPG sales from the Bukha field in Oman. This increase was due to an increase in Condensate sales from the Bukha field in volumes of oil production in Russia and Oman decreased by 38% to $1 million due to higher average commodity prices in 2008 the shut-in of Bukha production in the second used in the calculation of production tax. half of 2008. Revenue from oil production in Russia increased by 124% to $3.8 million.

28 Heritage Oil Limited Annual Report & Accounts 2008 General and administrative expenses million) in November 2007 and the issue of decreased from $41.3 million in 2007 $165 million of 8% unsecured convertible to $30.7 million in 2008, due principally to bonds in February 2007. lower non-cash share-based compensation expenses arising from stock options granted or Convertible bonds are separated into liability approved in 2007. General and administrative and derivative liability components (being expenses in 2008 were also inflated by one- the bondholders’ conversion option) and off expenses of $9.7 million relating to the each component is recognised separately. corporate reorganisation and subsequent The change in the fair value of the convertible listing on the London Stock Exchange. bonds’ conversion options, which is primarily due to the performance of Heritage’s share If share-based compensation and the one-off price, resulted in a gain of $11 million in 2008 corporate reorganisation and subsequent compared to a loss of $21.3 million in 2007. listing expenses are excluded, net general and administrative expenses increased from Other finance costs decreased from $12.0 $12.2 million in 2007 to $13.6 million in 2008. million in 2007 to $11.3 million in 2008. These This 11% increase resulted from the Group costs are mainly comprised of interest and employing additional staff and incurring accretion expenses relating to the issue of increased expenses to support higher levels of $165 million of 8% unsecured convertible exploration and development activities in the bonds in February 2007. Group’s activity areas. The Group had foreign exchange losses In 2008, the Group capitalised $6.3 million (2007 of $5.6 million in 2008, primarily related to – $10.3 million) of directly attributable general and an intercompany US dollar denominated Work programmes administrative costs relating to exploration and loan provided by the Group to the Russian continued to be development activities, including stock-based subsidiary for the development of Zapadno compensation of $4.6 million (2007 – $9.0 million). Chumpasskoye. The revaluation of this loan accelerated in Uganda in Russian roubles (the functional currency of Depletion, depreciation and amortisation the Russian subsidiary) created the foreign with five exploration expenses increased by 24% to $2.3 million in exchange loss due to the weakening of the wells drilled. 2008, primarily due to higher oil and liquids Russian rouble against the US dollar during sales volumes. 2008. In accordance with the Group’s accounting policy, the revaluation loss was Exploration expenditures expensed and not recognised in the financial statements of the capitalised in the year decreased by 85% from Russian subsidiary in Russian roubles and $5.4 million in 2007 to $0.8 million in 2008. translated into US dollars at consolidation and Exploration expenditures in 2008 related recognised in the income statement. principally to potential new ventures in Russia ($0.3 million) and activities in Tanzania ($0.2 Heritage recognised an unrealised loss of $1.7 million). Exploration expenditures in 2007 million in 2008 (2007 – $0.9 million gain), in the related mainly to activities in the Kurdistan fair value of its investment in Afren Plc (“Afren”) Region of Iraq ($2.3 million) and potential new warrants. The gain or loss is determined by ventures in Russia ($1.5 million). the performance of the share price of Afren. Heritage holds 1,500,000 warrants in Afren In 2008, the Group recognised an impairment with an exercise price of £0.60 per warrant, write-down of property, plant and equipment received as partial consideration from the of $4 million (2007 – $1.8 million) comprised sale of Heritage Congo in 2006. The warrants of two elements; the disposal of the Oman have a term until 22 December 2011. At holdings and the write-down of a drilling rig. 31 December 2008, Afren’s share price was Subsequent to year end, the entire share £0.26 per share. capital of the Oman holdings was sold for $28 million in cash and a working capital Heritage’s net loss in 2008 was $41.3 million, adjustment of approximately $0.4 million. The compared to $83.2 million in 2007. The Group wrote down the carrying value of adjusted net loss in 2008 was $23.7 million interest in Oman to its year end fair value compared to $29.7 million in the previous resulting in a charge of $3.2 million. The year if certain non-cash items (share-based carrying value of the Group’s 50% interest in a compensation expense, gain/loss on derivative drilling rig was written down to nil, resulting in a financial liability, property, plant and equipment charge of $0.7 million (2007 – $1.8 million). impairment write-down, foreign exchange loss/ gain and unrealised loss/gain on revaluation of In 2008, interest income was $4.0 million (2007 Afren warrants) and the one-off reorganisation – $4.0 million). Cash and cash equivalents are costs are excluded. In 2008 the basic and typically held in interest bearing treasury diluted loss per share was $0.16, compared accounts. Cash generating this income was to basic and diluted loss per share of $0.37 raised by a private placement of shares for in 2007. gross proceeds of $186.4 million (Cdn$181.5

Heritage Oil Limited Annual Report & Accounts 2008 29 Financial Review continued

>>Miran Block in the Kurdistan Region of Iraq

Cash Flow and Capital Expenditures Heritage commenced acquiring 2D seismic Cash used in operating activities was $32.8 in the Kimbiji and Kisangire blocks in million in 2008 compared to $2.5 million in 2007. September 2008 and the programmes were Production in Russia Total cash capital expenditures in 2008 were completed in February 2009. The data is $103.2 million compared to $75.3 million in 2007. currently being processed. peaked at 900 bopd and The following work was undertaken in 2008: • Work programmes continued to be The net decrease in cash and cash equivalents averaged 379 bopd for accelerated in Uganda with five exploration during 2008 was $139.5 million for a year end the year. wells drilled at a total net cost of approximately cash balance of $90.6 million. $45.3 million ($8.8 million in 2007); • The successful Kingfisher-2 and -3 appraisal Financial Position wells were drilled in Block 3A, Uganda, with Liquidity the successful Kingfisher-3A sidetracked At 31 December 2008, Heritage had a working over the year end and completed in capital surplus of $43.2 million, including cash February 2009; and cash equivalents of $90.6 million. As for • A three well exploration programme was most oil and gas exploration companies, undertaken in Block 1, Uganda. The Heritage raises financing for its activities from Warthog-1 well spud on 30 September time to time using a variety of sources. Based 2008, followed by the Buffalo-1 well in on its current plans and knowledge and its December 2008 and the Giraffe-1 well at projected capital expenditure and operating the end of December. The programme was cash requirements, the Group has sufficient completed in January 2009 and all three cash to finance its current plans for at least wells discovered oil; 12 months from the date of approval of the • A 2D seismic programme of approximately financial statements, but further financings are 330 kilometres was acquired over the likely to be required to meet expenditures Miran Block, in the Kurdistan Region of planned for the second half of 2010. Sources Iraq, between April and June 2008 and of funding for future exploration and the Miran West-1 exploration well spud development programmes will be derived from, on 22 December 2008; inter alia, new credit facilities, reinvesting funds • Development of the West Bukha field in from operations, using existing treasury Oman continued. Production commenced resources, disposal proceeds from the sale of in February 2009 at a rate of 15,000 boepd. non-core assets, such as the sale of the The West Bukha-3 development well was Company’s holdings in Oman in 2009, drilled in 2008, the existing West Bukha-2 farm-outs and, when considered appropriate, well was deepened, the platform was issuing debt and additional equity. Accordingly installed and the sub-sea pipeline the Group has a number of different sources completed; of finance available and the Directors are • The drilling of Heritage’s third exploration and confident that additional finance will be raised appraisal well in the Zapadno Chumpasskoye as and when needed. In addition, development field in Russia was completed in the first half of the Group’s successful exploration projects of 2008. This well was brought into may be financed separately. production later in the year. Production in Russia increased to a peak of 900 bopd and Capital Structure averaged 379 bopd for the year; and Heritage’s financial strategy has been to fund • Heritage farmed-in to two licences, covering its capital expenditure programmes and any four exploration blocks, in Tanzania in 2008. potential acquisitions by selling non-core

30 Heritage Oil Limited Annual Report & Accounts 2008 assets, reinvesting funds from operations, Group’s previous independent reserves administrative expenses or to comply with using existing treasury resources, finding report effective at 31 December 2007 is not local currency regulations. new credit facilities and, when considered considered to have changed significantly appropriate, either issuing unsecured due to the relatively small production during The Board will continue to review its approach convertible bonds or equity. Heritage raised 2008. Additionally, the Group was undertaking to commodity prices, interest rates and cash of over $350 million in 2007. $165 million significant work programmes in Uganda and currency fluctuations in light of the Company’s was raised in February 2007 by the issue of 8% Kurdistan at the year end, which would not have future capital commitments and ongoing unsecured convertible bonds, of which $82.5 been incorporated in a report at that date. obligations. Heritage may use derivative million plus interest was used to redeem Management is planning to update the reserve instruments to mitigate against its exposure existing 10% convertible bonds and the report in the second half of 2009 when the to volatility in oil prices and foreign currency remainder was available for general corporate results from the recent drilling programmes in movements. In 2007 and 2008 the Group funding purposes. Gross proceeds of $186.4 Uganda and the Kurdistan Region of Iraq have did not enter into any hedging arrangements. million (Cdn$181.5 million) were received in been completed and results analysed and November 2007 from an issue of 3,000,000 interpreted. There is further information on the risks facing Common Shares by Heritage Oil Corporation the Company in the Directors’ Report on (“HOC”) at a price of Cdn$60.50 per share. Risk and Internal Controls pages 47 to 50 and also in note 3 of the financial statements on pages 64 and 65. In October 2007, Heritage received a loan of Primary Risks and Uncertainties Facing $9.5 million to refinance the acquisition of a the Business corporate jet. Interest on the loan is at a rate of Internal Controls The primary risks and uncertainties facing the A system of internal controls was designed and London Interbank Offered Rate (“LIBOR”) plus business which could have a material adverse 1.6%. In January 2005, the Company received tailored to ensure key risks are appropriately impact on the Group include: addressed and to provide assurance regarding a sterling denominated loan of £4.5 million to • Exploration and development expenditure the reliability of financial reporting and preparation refinance the acquisition of a corporate office. and success rates – the Company has of financial statements. Risk and internal controls Interest on the loan is fixed at 6.515% for the experienced management and technical are continually assessed. One possible weakness first five years and is then variable at a rate of teams with a track-record of finding has been identified, concerning accounting for LIBOR plus 1.35%. Heritage had net debt attractive oil discoveries and has a complex transactions, although the Company of $146.8 million and gearing of 47% at diversified portfolio of exploration, seeks third party advice to mitigate against 31 December 2008 compared with net cash of development and production assets; this weakness. $13.7 million and nil gearing at 31 December • Factors associated with operating in 2007. Net debt and gearing are defined in note developing countries, political and As part of the Company’s internal controls, any 3b to the financial statements on page 65. regulatory instability – the Company transactions with related parties are identified, maintains close contact with governments scrutinised and appropriately disclosed in the Important Events Since the Year End in the areas within which it operates and financial statements. Following a strategic review the entire share where appropriate gets involved in capital of Eagle Energy (Oman) Limited, a community projects; Heritage maintains insurance policies in wholly-owned subsidiary that owned a 10% • Heritage cannot completely protect itself accordance with industry standards. Heritage working interest in Block 8, Oman, was sold against title disputes – in many of the believes that the level of insurance cover it to RAK Petroleum for $28 million, plus $0.4 countries in which the Group operates, land maintains is adequate based on various factors million in working capital adjustments, on title systems are not developed to the extent such as the cost of the policies, industry 7 April 2009. found in many industrialised countries. standard practice and the risks associated Notwithstanding potential challenges in with the exploration and development of oil In April 2009, in accordance with the option the DRC, the Kurdistan Region of Iraq and and gas properties in the countries in which outlined in the PSC in the Kurdistan Region of Malta, the Group believes that it has good it operates. Heritage does not insure against Iraq the KRG nominated a third party title to its oil and gas properties. However, political risk and, therefore, provides participant in the Miran Licence. Additionally, it cannot control or completely protect shareholders with full exposure to the risks the KRG has released the Company from the itself against the risk of title disputes or and rewards of investing in its territories. obligation to build a refinery in exchange for challenges and there can be no assurance making payments totalling $35 million from that claims or challenges by third parties Heritage maintains a detailed financial model future oil and gas sales from the licence. against the Group’s properties will not be which allows the Company to plan future The minimum financial commitment for the asserted at a future date; operating and capital activities in the most Company for building the refinery was $140 • Oil and gas sales volumes and prices – efficient manner. million. The Company remains the operator whilst not under the direct control of the with a 75% working interest in the Miran Company a material movement could Licence and will receive the pro-rata share of impact on the Group; 25% of all past work programme expenditures. • Loss of key employees – remuneration The transaction was completed upon the packages are regularly reviewed to ensure Paul Atherton receipt of approximately $6.7 million in costs key executives and senior management Chief Financial Officer incurred by the Company to 31 January 2009. are properly remunerated; and The third party participant is responsible for • Generally, it is the Company’s policy to funding its share of all work programme conduct and manage its business in US expenditures. dollars, which is its reporting currency. Cash balances in Group subsidiaries The Group is not required to obtain a reserve are primarily held in US dollars but small report annually or to publish reserves data amounts may be held in other currencies under the listing rules. No reserves report in order to meet immediate operating or at 31 December 2008 was obtained as the

Heritage Oil Limited Annual Report & Accounts 2008 31 Corporate Social Responsibility

Co-operative Relationships

Heritage has always been committed to Heritage is committed to integrating CSR into responsible and respectful conduct towards everything it does – from being a great place the diverse communities affected by our to work, investing in local communities, activities. Heritage’s Corporate Social minimising environmental impacts and working Heritage’s objective is to Responsibility (“CSR”) encompasses the closely with partners and contractors. minimise its impact on management of relationships with shareholders, employees, contractors and Environment the environment and to most importantly the communities in areas There were no environmental issues where we work, together with the impact on encountered by Heritage during 2008. support development in society and the environment, especially where Heritage is aware that many parts of our local communities. we are the operator. We recognise we have business could potentially impact upon the specific responsibilities in each of these areas environment and ecosystems within which we and consider adherence to CSR values to be operate. We pledge to restore sites where we a key factor in securing long-term success. operate to their original state and to comply with conditions imposed by bodies such as the Heritage today faces a wide range of both National Environment Management Authority opportunities and challenges in the area of (“NEMA”) in Uganda. Before any well is drilled CSR. This is particularly so given the nature we conduct a seismic survey which uses of the industry and the geographic location reflected sound waves to generate data. This of our operations, many of which are in information, together with other geological countries with complex social, political and data, enables our technical team to establish economic challenges and/or particular where to drill for the best chance of a environmental sensitivities. discovery. In 2008, five wells were drilled in Uganda and all encountered hydrocarbons. Heritage’s objective is to minimise our The drill sites are all in the process of being impact on the environment and to support restored under government supervision. development in local communities. We Heritage adheres to a strict clean environment recognise the importance of engaging with philosophy with a comprehensive waste local stakeholders and take seriously their management practice. We contain site drilling concerns regarding oil and gas development. effluents which are disposed of in dedicated Heritage believes that by working closely with environmentally accepted areas. our host communities we are better enabled to meet potential challenges. Heritage works with Heritage provides support to the Ugandan the communities within which we operate to Wildlife Authority (“UWA”) and has recently ensure their needs are fully considered when financed a major overhaul of a ferry which is projects are being planned. used to transport both vehicles and people in the Block 1 area in Uganda. We have also Effective management of CSR allows Heritage provided scrambler motorcycles for UWA to identify potential risks and respond to areas rangers and a vehicle for UWA nature wardens. of performance where improvement is needed. Effective CSR can help in attracting and Society retaining the best staff, making us a partner Our community development strategies in all of choice and realising value for shareholders. areas are designed and implemented through The CSR agenda is to inspire, challenge and consulting and working with local communities empower staff to make a positive contribution and local governments. This is done from an to local communities and the environment. early stage to ensure that the community has a

32 Heritage Oil Limited Annual Report & Accounts 2008 >>Opening of the Carl Nedft Memorial Primary School in Buhuka, Uganda

sense of ownership of the project and is able Training contractors in health and safety career development for all employees and with to continue the implementation of the project matters was a priority in 2008. Our personnel a geographically diversified portfolio we on a sustainable basis. in Uganda, the Kurdistan Region of Iraq and believe that the workforce should reflect Russia attended, or were offered, courses on the communities in which we operate. It is In Block 3A, Uganda, the inauguration safety issues such as oil spill and HAZMAT important that our employees create and ceremony of the Carl Nedft Memorial Primary (Hazardous Materials) operational training maintain our business culture within the School at Buhuka was organised by Heritage. and fire fighting training. In both the Kurdistan communities where our operations impact. This was a major project for which we made Region of Iraq and Uganda, Heritage provides Heritage employs local resources wherever available $500,000 and will endow the school nearby villagers with medical checks and possible and also encourages all seismic for many years to come with teaching facilities access to the site clinic. A senior member of contractors to do the same and to run a and learning opportunities for the children of staff is directly responsible for health and safety programme of training for those with potential the remote Buhuka area. matters and refers any issues to the Board. to take on technical roles within future surveys.

Other community work in which we lead Malaria remains the biggest health care issue Government and Partners programmes includes: in Uganda and Heritage is determined to help Relationships are key to the development • paving or mending roads providing better address this risk. A total of 42 workers were of any business and our success would access for villagers to local markets; treated for Malaria in Block 1 and 115 in Block not be possible without the support of all • providing fresh water by drilling water wells; 3A, out of total of 786 patients seen which stakeholders including governments and • supplying carpets to a local mosque in included residents from the local communities. regulators. We work hard to continuously the Kurdistan Region of Iraq; None of the patients progressed to complicated engage with these groups to generate support • providing tremendous opportunities for Malaria and no Malaria related deaths were and understanding of our operations. employment for the local population; reported, showing that the current Malaria • sponsoring pupils to attend university. We prevention and treatment programme is working. The Tanzanian National Environmental are currently sponsoring 12 in Uganda; Management Council twice made visits to the • sponsoring various community aid and In Uganda we have appointed an HIV and AIDS crew’s seismic operations in both the Kimbiji womens’ projects, including a community Co-ordinator who leads related training on the and Kisangire licence areas and senior officers radio station and the Watoto Child Care project locations. fed back a report which is detailed in our Project in Uganda; and separate CSR report on page 5. • sponsoring civil servants in Uganda to In 2008 we sponsored two local Ugandan attend courses on oil legislation and students to attend the Basic Life Support Business Ethics contract terms. Paramedical Course in Rustenburg, South The Group encourages the highest standards Africa. Both of these students passed the of integrity and honesty in all business dealings. Health and Safety course and are now employed on projects as The objective is to maintain and enhance Heritage is committed to achieving and part of the internal training programmes to the reputation of the Company and enforce maintaining the highest standards of safety obtain further paramedical qualifications. ethical dealings within our areas of operation. for its employees and the communities within The Board has established a “whistleblowing” which we operate. In line with our policy, Employees policy which has been distributed to employees Heritage is committed to: We aim to attract, develop and retain talented and is available in all offices. The policy • championing safety to everyone our and committed people in order to maintain the details procedures for any employee to raise activities touch; capability to deliver our business objectives in confidence any concerns they may have • playing a role in promoting best practice and make Heritage an employer of choice. We about possible improprieties with either the in our industry; ensure that all of our employees understand Chairman or the Chief Executive Officer. • sharing openly information on our health and appreciate our business strategy, goals and safety performance; and and values. It is important to Heritage that • managing health and safety matters our staff feel valued, safe and free to raise any as a critical business activity. concerns. There are equal opportunities in

Heritage Oil Limited Annual Report & Accounts 2008 33 Board of Directors

1. Michael J. Hibberd 4. Salim Hassan Macki 6. Gregory Turnbull Chairman and Non-Executive Director Non-Executive Director Non-Executive Director Mr. Hibberd has extensive international Mr. Macki was a Member of the State Mr. Turnbull is the Regional Managing energy project planning and capital markets Council, Former Ambassador, Government of Partner of the Calgary office of the law firm experience. He has been President and CEO Sultanate of Oman and has been a Director of McCarthy Tétrault LLP. Mr. Turnbull has of MJH Services Inc., a corporate finance of Oman Oil (a wholly owned Government extensive knowledge of corporate governance advisory company, since 1995, prior to which Company) since 1996. Mr. Macki holds issues and has acted for many boards of he spent 12 years with ScotiaMcLeod in a Master’s degree in Petrochemical directors and special committees in that corporate finance and held the position of Engineering and has spent most of his regard. Mr. Turnbull started his career with Director and Senior Vice President, Corporate working life in the oil industry, where he is the law firm of MacKimmie Matthews in 1979. Finance. He is Co-Chairman of Sunshine highly regarded internationally. He holds, or From 1987 to 2001, he was a partner with Oilsands Ltd. and currently serves on the has previously held, many senior executive Gowlings LLP (formerly Code Hunter LLP). In boards of directors of AltaCanada Energy positions in various private and state owned 2001 and 2002, he was a partner with the law Corp., Canacol Energy Ltd., Challenger entities in Oman and internationally. He joined firm of Donahue LLP. Mr. Turnbull has been a Energy Corp., Iteration Energy Ltd., Pan the Group on 12 August 2008. partner with the law firm of McCarthy Tétrault Orient Energy Corp., Ramtelecom Inc. and LLP since July 2002. He joined the Group in Zapata Energy Corporation. Mr. Hibberd also 5. General Sir Michael Wilkes KCB, CBE 19 97. served as a Director of Rally Energy Corp. Non-Executive Director until October 2007 and as a Director of Deer General Sir Michael Wilkes retired from 7. John McLeod Creek Energy Limited until December 2005. the British Army in 1995 as Adjutant Non-Executive Director Mr. Hibberd joined the Group in March 2006. General and Middle East Adviser to the Mr. McLeod is a Professional Engineer British Government on defence matters. with over 38 years of varied domestic and 2. Anthony Buckingham As Adjutant General, Sir Michael was the international oil and gas experience. He is the Chief Executive Officer most senior administrative officer within the President of McLeod Petroleum Consulting Mr. Buckingham is the founder of the Army and a member of the Army Board. Limited, President, CEO and a Director of Group. He commenced his involvement During his distinguished career, he has seen Tuscany Energy Ltd., Paris Energy Inc. and in the oil industry as a North Sea diver active service across the world while also California Oil and Gas Corporation. He has and subsequently became a concession commanding at every level from Platoon to held positions and served on various boards negotiator acting for several companies Field Army including commanding the 22 including Constellation Oil & Gas Ltd. and including Ranger Oil Limited and Premier Oil Special Air Service Regiment and serving as CanArgo Energy Inc., as President and CEO of plc. He was previously a security adviser to the Director of Special Forces. Sir Michael is a Arakis Energy Company, as VP, Operations of various governments. Non-Executive Director of AIM listed Stanley Pengrowth Gas Company, CEO and director Gibbons Group. In addition he holds non- of Rally Energy Corp. and Canoro Resources. 3. Paul Atherton executive positions on a number of private Currently, Mr. McLeod serves as a director of Chief Financial Officer companies including Britam Defence and Diaz Resources Ltd. and March Resources Mr. Atherton is a qualified accountant, Trico Ltd and chairs the Advisory Board of Ltd. He is immediate Past-President of having qualified with Deloitte & Touche, and PegasusBridge Fund Management Limited, the Association of Professional Engineers, holds a degree in geology from Imperial a homeland security Company. He joined the Geologists and Geophysicists of Alberta. College London. He has a corporate finance Group on 18 March 2008. He joined the Group in 1998. background with specific experience in the international mining and resource sectors. He joined the Group in 2000 and joined the Board of Directors in 2005.

34 Heritage Oil Limited Annual Report & Accounts 2008 1 4 7

2 5

3 6

Heritage Oil Limited Annual Report & Accounts 2008 35 Corporate Governance Report

The Directors recognise the importance of maintaining good • Code Provision A.5.1: A formal induction process was not corporate governance practices and are committed to applying the in place during the period. However, it is considered more highest industry standards of business ethics, health and safety, appropriate that the induction of an individual Director is environment, risk management and corporate and social tailor made to suit the needs and experience of that Director; responsibility throughout the Group. • Code Provision A.6.1: Board evaluation has not yet been undertaken due to the short time elapsed since Listing. The To this end, the Board is continuing to put in place policies and Board believes that a meaningful evaluation can only take place procedures within which it will conduct its activities along with once the Board has had a reasonable amount of time to work working practices and a business culture to ensure openness together. A Board evaluation process will be developed and and full accountability. implemented during the next year; • Code Provision B.1.6: Notice periods for the Executive Directors As described below, the Company intends in due course to comply are 24 months. The contracts for the Executive Directors were with the new June 2008 Combined Code on Corporate Governance in place before the Listing of the Company. There is no current as issued by the UK Financial Reporting Council (the “Code”) in all intention to amend the notice periods but this will be kept under material respects. review by the Remuneration Committee; and • Code Provision C.3.1: The Chairman of the Company, Michael Compliance with the Code Hibberd, is a Non-Executive Director and Chairman of the Audit The Company was incorporated on 6 February 2008 and listed on Committee. However, the Board believes that his recent and the main market of the London Stock Exchange on 31 March 2008 relevant financial experience, including his experience on (the “Listing”). corporate financial matters, is invaluable in supporting the Audit Committee to perform its role. This report describes the extent to which the Company has complied with the principles set out in Section 1 of the Code and Board of Directors how it intends to apply those principles (to the extent relevant to The initial Board was composed of six Directors which included a the June 2008 code) going forward. Non-Executive Chairman, two Executive Directors and a further three Non-Executive Directors (as noted below). The Board is now Prior to the Listing, the Board took a number of steps, and continues comprised of seven Directors, a further independent Non-Executive to do so, to comply with the Code. The majority of the Board Director being appointed during the year. The Chairman and three of previously served as Directors of Heritage Oil Corporation (“HOC”) the Non-Executive Directors are deemed to be independent under whose shares were listed on the Toronto Stock Exchange. The the terms of the Code. All of the Directors bring either extensive Board is, therefore, already accustomed to operating in a highly experience of the oil industry or a broad range of business, regulated corporate governance environment and as a result has commercial and corporate governance experience to the Board. adopted a number of its processes. It is the Board’s intention to The Executive Directors have close involvement with the operations work towards full compliance with the Code in all material respects. of the business through their operational roles. The Board is However, in light of its recent Listing, certain principles of the Code supported by a strong and experienced senior management team. have not been applied during the reporting period, either because it The biographies of the Board are set out on page 34. is not appropriate to do so at this stage in the Company’s development or because of the short period of time that has The Board is accountable to shareholders for the creation and elapsed since Listing. delivery of strong sustainable financial performance, guidance, perspective and long-term shareholder value. The Board is Between 31 March and 31 December 2008, the Board considers responsible for ensuring the effectiveness of the system of internal that the Company complied with Section 1 of the Code, save in the controls including effectively managing and considering the following respects: commercial risks and financing needs, the disposal of businesses • Code Provision A.1.3: The Chairman’s performance has not yet and assessing the most appropriate balance between acquisition been appraised due to the short time elapsed since listing. It is led growth and organic growth. Individual Directors constantly anticipated that the Chairman’s performance will be appraised evaluate and challenge the Company’s business strategy to ensure for the first time as part of the Board evaluation process during they identify areas where improvements can be made or where the second half of 2009; new opportunities exist so that the strategies remain appropriate • Code Provision A.2.1: The division of responsibilities between the and relevant to the Company’s business. In order to ensure that Chairman and Chief Executive Officer were agreed in writing after the Company complies with its obligations as a listed Company, the the end of the reporting period; Board also has responsibility for communications with shareholders, • Code Provision A.3.2: For part of the year until the appointment health and safety policy and the review of the Company’s of Salim Hassan Macki in August 2008 at least half the Board management and financial performance. Further details of (excluding the Chairman) were not considered to be independent compliance with these obligations are set out below. Non-Executive Directors; • Code Provision A.3.3: The Board has yet to appoint a Senior The Board was formed early in 2008 and met five times between independent Non-Executive Director. Communication between the Listing on 31 March 2008 and 31 December 2008. The Board the Chairman, Executive and Non-Executive Directors is open will continue to meet sufficiently regularly to discharge its duties and frank and the Board believes that little would be added by the by way of formal Board meetings as well as ad-hoc meetings. appointment of a Senior Independent Director at this stage. In The Board intends to meet at least four times a year. A formal addition, shareholders have access to all of the Directors to raise schedule detailing matters specifically reserved for its decision concerns. The appointment of a Senior Independent Director has been agreed. will be kept under review;

36 Heritage Oil Limited Annual Report & Accounts 2008 The Board has delegated some of its responsibilities to certain committees in line with recommendations of the Code and to facilitate the business of the Company. These are the Audit, Remuneration and Nomination Committees. Further details of these committees and their activities can be found later in this report and also in the Remuneration Report on pages 41 to 46.

A table of attendance of members of the Board and Board Committees at meetings between 31 March 2008 and 31 December 2008 is set out below:

Audit Remuneration Nomination Board Committee Committee Committee (5 meetings) (3 meetings) (3 meetings) (1 meeting) Michael Hibberd 5/5 3/3 3/31 1/1 Anthony Buckingham 4/5 – – 1/1 Paul Atherton 5/5 – – – John McLeod 5/5 3/3 3/3 – Salim Hassan Macki 2/22 –4 1/33 – Gregory Turnbull 5/5 – – – General Sir Michael Wilkes 5/5 3/3 3/3 1/1

1 Mr. Hibberd resigned from the Remuneration Committee in December 2008. 2 Mr. Macki was appointed to the Board in August 2008. 3 Mr. Macki was appointed to the Remuneration Committee in December 2008. 4 Mr. Macki was appointed to the Audit Committee in April 2009.

The Company Secretary is a corporate entity based in Jersey that Chairman and Chief Executive Officer deals with the normal statutory compliance for the Company. The There is a clear division of responsibility between the Chairman Board and its Committees are, therefore, serviced by the Company and Chief Executive Officer to ensure an appropriate balance of Secretary or its nominee. The other duties that would normally be responsibility and accountability. These responsibilities have been carried out by the Company Secretary such as the provision of formalised in writing and approved by the Board. information flows to the Board are dealt with by either the Chairman or Chief Financial Officer or their nominee. In terms of corporate The Chairman’s role is to ensure the effective running of the Board governance issues, the Board is advised by McCarthy Tétrault, in all aspects of its roles and setting its agenda. His other key Registered Foreign Lawyers & Solicitors, in London. The Board responsibilities include leading the Board, overseeing effective will monitor the provision of Company Secretarial duties and take communication with shareholders, ensuring constructive relations any action as appropriate to ensure its requirements are met. The between all Directors and that all Directors are encouraged to appointment or removal of the Company Secretary is a matter for participate fully in the activities and decision making processes of the Board as a whole. the Board. The Chairman also ensures that the Directors receive accurate, timely and clear information with all Board and Committee The Board shall ensure that all Directors and Committee members meeting information being issued to members in advance. At each have access to independent professional advice whenever it is meeting there is an update on operational and financial performance required and at the Company’s expense. including a review of the performance and future potential of all material assets. The Chairman’s other significant appointments are Non-Executive Directors have executed letters of appointment disclosed to the Board and may be found in the Directors’ setting out their respective terms of appointment including the biographies on page 34. expected time commitment which has been agreed and confirmed with them. Further details can be found in the Remuneration Report The Chief Executive Officer is responsible for managing the Group’s on pages 41 to 46. business, proposing and developing the Group’s strategy and overall commercial objectives in consultation with the Board and, The Directors are aware of their responsibilities and feel able to raise as leader of the executive team, implementing the decisions of the any concerns at Board meetings which are minuted accurately in Board and its Committees. the Board meeting minutes.

As required by the Code, the Company maintains Directors’ and Officers’ liability insurance cover, in respect of any legal action taken against the Directors, which is reviewed annually.

Heritage Oil Limited Annual Report & Accounts 2008 37 Corporate Governance Report continued

Board Balance and Independence responsibilities which are set out in its terms of reference and The Board is comprised of the following Directors: include responsibility for: Michael Hibberd Chairman and Non-Executive Director • integrity of financial statements, including annual and interim Anthony Buckingham Chief Executive Officer reports, results announcements and any other formal Paul Atherton Chief Financial Officer announcement relating to its financial performance; Salim Hassan Macki Non-Executive Director • considering the establishment of an internal audit function; General Sir Michael Wilkes Non-Executive Director • making recommendations to the Board on the appointment, Gregory Turnbull Non-Executive Director review and removal of external auditors; John McLeod Non-Executive Director • monitoring external auditors’ independence; and • policy on external auditors’ non-audit services. The Board is satisfied that its composition will ensure that no individual or group of individuals will dominate the decision-making The Audit Committee also oversees the Company’s relationship with process and that there is a strong presence on the Board of both its external auditors and reviews the effectiveness of the external Executive and Non-Executive Directors. audit process. The Audit Committee pre-approves all audit and non- audit services undertaken by the external auditor, to ensure that the The Board considers John McLeod, Salim Hassan Macki and independence of the external auditors is not impaired. The Audit General Sir Michael Wilkes are independent in character and Committee was satisfied throughout the year that the objectivity and judgement and free from relationships or circumstances which may independence of the external auditor were not in any way impaired affect their judgement. On appointment, the Chairman was also by either the nature of the non-audit work undertaken by the considered to be independent. external auditor during the year, the level of non-audit fees charged for such work or any other facts or circumstances. The split Gregory Turnbull does not meet the independence criteria set between audit and non-audit fees is shown on page 49 of the out by the Code as he is a partner of McCarthy Tétrault LLP, the Directors’ Report. Canadian legal advisers to the Company. In fulfilling its responsibility of monitoring the integrity of financial Albion Energy Limited (“Albion”), the Company’s largest shareholder, reports to shareholders, the Audit Committee reviews the and Anthony Buckingham entered into a relationship agreement with accounting principles, policies and practices adopted in the the Company on 28 March 2008 (the “Relationship Agreement”) as preparation of public financial information and will examine part of the Listing. The ultimate owner of Albion Energy Limited is documentation in relation to the Annual Report and annual financial Anthony Buckingham. The purpose of the Relationship Agreement is report announcements. The ultimate responsibility for reviewing and to ensure that transactions and relationships between the Group, approving the interim and annual financial statements remains with Albion and Anthony Buckingham are at arm’s length and on normal the Board. commercial terms. The Relationship Agreement prescribes that at all times, the Board shall comprise of a majority of Directors who are all During the year the Audit Committee considered the following main independent of Anthony Buckingham. items of business: • review of operations; Board Committees • review and approval of corporate budgeting; As mentioned above, the Board has three committees, being the • review of the integrity of the financial statements and formal Remuneration, Audit and Nomination Committees. The duties of announcements relating to the Group’s financial performance; these Committees are set out in formal terms of reference that were • report of the external auditors, KPMG Audit Plc; adopted by the Board on 18 March 2008 and are available on the • review of interim financial statements; Company website. Membership of the Committees was reviewed • review of the effectiveness of internal controls; during the year. • review of whistleblowing policy; • management representation letters; Audit Committee and Internal Controls • audit engagement letter; and Audit Committee Report • 2008 audit plan and key audit risks. The members of the Audit Committee are Michael Hibberd (Chairman), John McLeod, General Sir Michael Wilkes and Salim At present there is no internal audit function. The Board believes Hassan Macki who was appointed on 7 April 2009. All members, that the current control systems in place and management oversight including the Chairman, are independent Non-Executive Directors. are sufficient to highlight any areas of weaknesses in the financial Other members of the Board may also be invited to attend as and reporting systems. The need for an internal audit function is kept when appropriate. The auditors are also invited to attend regularly. under review.

The Chairman of the Company, Michael Hibberd, is a member of Internal Controls the Audit Committee which is not in line with the recommendations The Audit Committee has responsibility for reviewing the made in the Smith Guidance on the Combined Code. However, effectiveness of the Company’s system of internal controls and risk the Board believes that his recent and relevant financial experience, management systems. The Board has taken into account the including his experience on corporate financial matters, is invaluable relevant provisions of the Code in formulating the systems and in supporting the Audit Committee to perform its role. procedures in operation in the Company. It currently maintains the existing system of internal controls based on that used by HOC The Audit Committee engages in numerous ad-hoc discussions which was subject to compliance with relevant rules and regulations and formally meets at least twice a year to discharge its in Canada. The Audit Committee considers the system to be effective.

38 Heritage Oil Limited Annual Report & Accounts 2008 The system of internal controls is designed to manage, rather than Following his appointment to the Board Salim Hassan Macki eliminate, the risk of failure to achieve business objectives and can replaced Michael Hibberd as a member on the Remuneration only provide reasonable and not absolute assurance against Committee. All the members are independent Non-Executive material misstatement or loss. The Board will continue to review Directors. The Chief Executive Officer, Chief Financial Officer and and improve its system of internal controls. external advisers may also be invited to attend. Further information on the Committee can be found in the Remuneration Report on The Board recognises the need for effective internal controls and for pages 41 to 46. evaluating and managing the risks of the Company. Such matters are brought to the attention of the Board at its formal Board The Remuneration Committee engages in numerous ad-hoc meetings, ad-hoc discussions or via the whistleblowing policy. discussions and formally meets at least once a year and has responsibility for making recommendations to the Board on the High level controls in operation include: framework, or broad Company policy, for the remuneration of the • review of management accounts with comparison of actual Chairman and the specific remuneration packages including performance against prior periods and budget; pension rights and any compensation payments for each of the • approval of orders, authorisation of invoices and two signatories Executive Directors, the senior management and such other required to make a transfer on the principal bank accounts; members of the executive management as it is designated to • quarterly reconciliation of all control accounts; consider. The Committee will also ensure compliance with the • approval by the Board for major investments; and Code and Companies Act 2006 in this respect. No Director may • segregation of duties between relevant functions and be involved in any decisions as to their own remuneration. departments. Nomination Committee Report The Company has implemented a whistleblowing policy and The members of the Nomination Committee are Michael Hibberd information has been sent to all employees advising them that they (Chairman), General Sir Michael Wilkes and Anthony Buckingham. can raise concerns in confidence about possible wrong doing by The majority of the members are independent Non-Executive contacting the Chairman of the Audit Committee. In addition, Directors and Anthony Buckingham is the Chief Executive Officer. whistleblowing is an agenda item at Board and Audit Committee External advisers may also be invited to attend meetings as and meetings with procedures established for appropriate action to be when required. taken as required. The Nomination Committee engages in numerous ad-hoc The Board is aware of the need to conduct regular risk assessments discussions and formally meets at least once a year and has to identify any deficiencies in the controls currently operating over responsibility for making recommendations to the Board on its all aspects of the Company. A formal risk assessment is conducted composition (including the skills, knowledge and experience), periodically during the year on internal controls to cover material structure and size and that of its Committees, as well as on controls, both financial and operational, and risk management retirements and appointments of additional and replacement systems. Directors taking into account the challenges and opportunities facing the Company. In due course, as the Company develops, The risk assessment and a review of the effectiveness of the the Nomination Committee will review requirements to formalise Group’s system of internal controls are performed in accordance succession planning and the process for new appointments. with the Turnbull guidance and they were in place for the year end review process. During the year the Nomination Committee considered the following items of business: Financial reporting procedures were reviewed as part of the Listing • terms of reference; process and a Board memorandum prepared. Having considered • board structure and committees; the findings, the Directors were able to confirm that the financial • succession planning; and reporting procedures established provided them with a reasonable • process for new appointments. basis on which to make proper judgements on the financial position and prospects of the Company on an ongoing basis. However, one The majority of the Board have previously served as Directors of main weakness was noted, concerning accounting for complex HOC and they were judged on their merit before being appointed transactions, although the Company seeks third party advice to to the Board. Future re-elections of Directors will be subject to mitigate against this weakness. satisfactory performance reviews and refreshing of the Board.

The Directors recognise the need to maintain financial reporting Two new Non-Executive Directors, Salim Hassan Macki and procedures, to review them on an ongoing basis and to adapt them General Sir Michael Wilkes, were appointed during 2008. An to changing circumstances and will use the Board memorandum external consultancy was not used in the appointment process as a basis for further developing the Board processes. as this was not felt appropriate to the circumstances of the recruitments. Both appointments are an outstanding addition to Details of other principal risks and uncertainties are discussed in the the Board providing a wealth of corporate experience and Mr Macki Financial Review on page 31. is highly regarded internationally in the oil industry. The Board approved the appointments recognising that their knowledge Remuneration Committee Report will be invaluable in assisting the Company to achieve its planned The members of the Remuneration Committee are John McLeod goals in its core areas. (Chairman), Salim Hassan Macki and General Sir Michael Wilkes.

Heritage Oil Limited Annual Report & Accounts 2008 39 Corporate Governance Report continued

Information and Professional Development The Board believes that the Directors possess a wealth of diverse experience and business skills. Non-Executive Directors are actively encouraged to take up opportunities for questioning, examining and reviewing the Group’s businesses and to undertake training applicable to their roles.

The Directors who were members of the Board at the time of Listing received a full and tailored induction from the Company’s lawyers as part of the Listing process.

The Company will make the necessary resources available for any Director’s development needs including access to independent professional advice, services and any other resources including Company Secretarial services as may be necessary to discharge their responsibilities.

Re-Election All Directors appointed, other than by shareholders, are subject to election by shareholders at the first Annual General Meeting (“AGM”) following their appointment.

One-third or the nearest to one-third of the Directors shall retire at subsequent AGMs. Details of Directors retiring, but subject to re-appointment, at the forthcoming AGM will be detailed in the AGM circular.

Shareholder Relations and Constructive Use of the AGM The Chairman is responsible for ensuring effective communication of shareholders’ views to the Board as a whole and will update the rest of the Board accordingly. Board members will use their best endeavours to attend meetings with a broad range of shareholders or otherwise keep in touch with shareholder opinion and discuss strategy and corporate governance issues with them as time progresses. In addition, the Company has appointed an investor relations specialist who has co-ordinated an investor relations programme to meet with major shareholders and analysts.

The Chairman will also ensure that the respective chairmen of the Remuneration, Audit and Nomination Committees attend the AGM to answer questions and that the other Directors also attend.

Corporate information including the Annual Report and other financial presentations and announcements (including the Prospectus) are available on the Company’s website at www.heritageoilltd.com.

Michael J. Hibberd Chairman 28 April 2009

40 Heritage Oil Limited Annual Report & Accounts 2008 Remuneration Report

Introduction The central conclusion of the review was that the current executive This report has been prepared having regard to The Directors’ reward policy and long-term incentive arrangements were Remuneration Report Regulations 2002 (the “regulations”) and inappropriate for the UK marketplace. The market benchmarking meets the relevant requirements of the Financial Services Authority’s exercise conducted by the Hay Group also indicated that overall Listing Rules. levels of reward were low compared to the international marketplace and that performance-related reward would need to increase if the In preparing this report consideration has also been given to the Company were to maintain the emphasis on the performance- Combined Code on Corporate Governance and the Guidelines related components of reward appropriate for the UK. of the Association of British Insurers on Executive Remuneration Policies and Practices. Furthermore the review found that the legacy share option arrangement, approved by shareholders of HOC in 2004, was A resolution to approve the report will be put to shareholders inappropriate for the UK marketplace because it allowed for at the AGM on 18 June 2009. annual vesting of a proportion of the option grant, did not have a performance condition determining vesting and did not reflect Remuneration Committee current market practice in the UK. The Remuneration Committee The members of the Remuneration Committee during the year were has determined that no further options will be issued, although John McLeod (Chairman), General Sir Michael Wilkes and Michael existing arrangements will be honoured. Hibberd who was replaced by Salim Hassan Macki in December 2008. Independent advisers, the Chief Executive and the Chief New Executive Reward Policy Financial Officer may also attend meetings at the Remuneration The Remuneration Committee has addressed the findings of this Committee’s invitation except where matters associated with their review by ensuring that the levels of total reward are competitive own remuneration are being discussed. and that the balance between fixed (base package and benefits) and variable reward (short- and long-term incentives) is appropriate The Remuneration Committee’s main responsibilities are to: (see chart overleaf). • advise on remuneration policy for the Chairman, Executive Directors and Senior Executives; It is the Remuneration Committee’s opinion that an upper quartile • assess and determine total compensation packages available level of reward is appropriate in light of the areas where the to the Executive and Non-Executive Directors; Company operates, the relatively small number of Executive • determine policy and scope for pension rights and any Directors at the Company and the roles conducted by the Executive compensation payments and ensure compliance with the Directors. However, upper quartile levels of reward are only available Combined Code in this respect; and (mainly through participation in the Long Term Incentive Plan • make recommendations to the Board for its approval, and that (“LTIP”)) for truly exceptional levels of performance. of shareholders, on the design of long-term incentive plans and make recommendations for the grant of awards to executives Overall levels of reward are benchmarked against three relevant under such plans. comparator groups: • UK listed oil and gas companies (excluding those significantly The Remuneration Committee has clearly defined terms of reference larger than the Company); which are available on the Company’s website. No Director is • an international comparator group comprising companies of involved in deciding his own remuneration. a similar size and scale to Heritage; and • the FTSE 250 Index. During the year the Remuneration Committee appointed independent executive reward consultants, the Hay Group, to The Remuneration Committee determined that the current annual advise on executive reward arrangements with particular reference bonus structure for Executive Directors was appropriate for the to the UK marketplace and UK best practice. No other services business and has also implemented a two year base package were provided to the Company by the Hay Group during the year. freeze for Executive Directors with effect from 31 March 2008. In addition, a new LTIP was proposed by the Remuneration Executive Reward Policy Review Committee and approved by shareholders at the Company’s AGM In conjunction with its independent executive reward consultants, on 19 June 2008 (see page 42). the Hay Group, specifically appointed for the purpose, the Remuneration Committee conducted a review of the executive reward policy during the year. The objectives of the review were: • to ensure that the Company has an executive reward framework to help drive future value growth; • to ensure the Company retains and, when necessary, recruits management talent of the required ability and experience; • to ensure that the overall levels of reward were appropriate for the Company given its listing in London, international operations and the global nature of the oil and gas industry; and • to ensure that any new arrangements required were in line with UK as well as Canadian standards of corporate governance in as much as that such standards support and enhance the Company’s ability to generate value for shareholders.

Heritage Oil Limited Annual Report & Accounts 2008 41 Remuneration Report continued

Balance Between Fixed and Performance-Related Reward • none of the awards will vest until comparative TSR performance The charts below show the balance between fixed (base package is close to the upper quartile level of the comparator group and benefits) and variable (bonus and long-term incentives) detailed on page 43; and elements of reward for each of the Executive Directors. • there is an additional holding period of one year following the vesting of the awards.

Awards vest according to the following schedule:

CEO 36% 64% Proportion of award vesting Typical UK TSR performance vs comparator group of 18 companies Heritage practice 3rd place (the Upper Decile) and above 100% 100% 4th place 80% 100% 5th place (the Upper Quartile) 50% 100% CFO 43% 57% 6th place 30% 85% 7th place 0% 70% 8th place 0% 55% 9th place 0% 40% Fixed Reward Variable Reward 10th place (the Median) 0% 25% Fixed Reward includes 2008 base package and value of benefits Below 10th place 0% 0% (including pension). Long-term incentive award levels have been set with reference to Variable Reward includes 2008 bonus and the annualised fair value the upper quartile of the Company’s comparator groups. However, of long-term incentive awards (apportioned over the life of the LTIP). the vesting schedule is designed to only deliver the whole value of the award for truly exceptional performance, at a standard higher Components of Executive Directors’ Reward than that which is normal for the UK. The additional performance Base Package condition, requiring the share price to increase by 20% or more, The table below shows the annual base packages of the Executive is also above and beyond what is common in both the UK Directors on listing on the main market of the London Stock and Canada. Exchange. Following the introduction of the LTIP the Remuneration Committee has implemented a two year base package freeze for In light of the performance conditions described above, the the Executive Directors and therefore salaries will not be increased Remuneration Committee believes that the award levels, which in 2009. reflect the equivalent of three years’ annual awards, are appropriate for the Executive Directors because: Name 2008 2009 Increase • a one-off award provides better alignment of the Executive Anthony Buckingham £675,000 £675,000 0% Directors with current and potential shareholders following the Paul Atherton £500,000 £500,000 0% Company’s reorganisation and listing on the main market of the London Stock Exchange than annual rolling awards; Annual bonus • a one-off award encourages sustained performance over the Executive Directors are entitled to an annual performance related next three key years for the Company. Annual awards can have bonus, determined by the Remuneration Committee. In determining the effect of encouraging “staggered” or “delayed” performance the appropriate bonus level, the Remuneration Committee takes into e.g. not maximising investments and performance as soon as account progress made towards the Company’s long-term goals, possible in any given year so as to ensure that new awards the level of commitment of the Chief Executive Officer and Chief benefit from any uplift such investments and performance will Financial Officer in advancing the interests of the Company and create. The Remuneration Committee believes that it is in the share performance. best possible interest of shareholders for maximum value to be accrued as soon as possible; Long Term Incentives • a one-off award to cover three years of annual grant provides a 2008 Long Term Incentive Plan (“LTIP”) greater retentive effect than annual grants and ensures continuity The LTIP was approved by shareholders in June 2008. The main in management following the Company’s listing in London; and features of the awards to Executive Directors are: • whilst the Remuneration Committee is keen to move to UK • one-off awards of performance shares reflecting the equivalent of standard annual grant patterns as soon as practicable, provided three years of award; to do so is in the best interests of shareholders, providing a • a face value of 1,200% of base package for the CEO and 800% one-off award equivalent to three years of annual awards of base package for the CFO, reflecting the equivalent of three counterbalances the Remuneration Committee’s decision to years’ annual awards; remove annual vesting for long-term incentives, replacing it • the performance conditions, measured over the three-year with a three-year vesting period and an additional one year period starting with the date of the award, are relative total holding period. shareholder return (“TSR”) versus a group of international oil companies and a requirement for the share-price to increase by at least 20% between the date of the award and the end of the vesting period;

42 Heritage Oil Limited Annual Report & Accounts 2008 The comparator group of companies was selected on the basis of their size and scale of operations, market capitalisation and geographic spread. The comparator group comprises:

Aminex plc Imperial Energy plc Premier Oil plc BowLeven plc JKX Oil & Gas plc SOCO International plc Dana Petroleum plc Mariner Energy Inc. Stone Energy Corp. Dominion Petroleum Ltd. McMoran Exploration Co Swift Energy Co. Gulf Keystone Petroleum Ltd. Melrose Resources plc Tullow Oil plc Hunting plc Oilexco Inc. Venture Production plc

It is not planned to make any further awards to existing members of the LTIP scheme before 2011, although awards may be made to new senior members of staff between 2009 and 2011.

2008 Replacement Share Option Scheme HOC implemented The Heritage Oil Corporation Plan (the “Original Plan”) following approval by its shareholders in 2004 and granted options under the Original Plan to its Executive and Non-Executive Directors and other employees and consultants at that time. The grant of options included all the then current Executive and Non-Executive Board members which excluded General Sir Michael Wilkes and Salim Hassan Macki. As a result of the Group reorganisation and subsequent listing on the main market of the London Stock Exchange, all the Board members were entitled to retain their options under the Original Plan and exchange them for options to acquire 10 Ordinary Shares of the Company for every one Common Share they held under option consistent with the Company’s 10-for-1 share split. The Original Plan was then cancelled and on 18 March 2008, the Company adopted The Heritage Oil Limited 2008 Replacement Share Option Scheme (“Replacement Scheme”) which is substantially in the same form as the Original Plan. The purpose of the Replacement Scheme is to act as a replacement to the Original Plan and to honour the options granted under it by granting holders the option to purchase Ordinary Shares. The Replacement Scheme is administered by the Board and no further options will be granted under it.

The maximum number of Ordinary Shares that may be issued under the Replacement Scheme was 24,545,340, being the equivalent number of shares required to replace the options granted under the Original Plan that were still in existence prior to their cancellation.

The Company will not grant any further options under this share scheme.

Pensions Executive Directors receive pension contributions of an annual amount equal to 10% of their base package into a personal pension scheme nominated by the executive.

Other Benefits The Company’s policy is to provide Executive Directors with certain benefits in kind including private medical insurance and life assurance. In addition, both Executive Directors are entitled to allowances of £100,000 (Anthony Buckingham) and £77,500 (Paul Atherton) to cover their living expenses.

Service Agreements The Executive Directors’ service agreements with the Company are for no fixed term. In normal circumstances, the agreements may be terminated by the Company giving no less than 24 months’ notice and the Executive Director giving six months’ notice. These arrangements were in place during their time as Executive Directors of HOC and were inherited by the Company on listing in London. The Board feels that these notice periods were appropriate to recruit and retain the Executive Directors, and whilst it has no present intention of changing them, it will continue to keep them under review.

Executive Director Date of contract Unexpired term Notice period by Company Notice period by Director Anthony Buckingham 28 March 2008 Rolling Contract 24 months 6 months Paul Atherton 28 March 2008 Rolling Contract 24 months 6 months

In the event of a change of control of the Company, if the Executive Directors resign or the Company terminates their appointment within 24 months of such an event, they will each be entitled to an immediate payment in lieu of notice of a sum equivalent to three times their annual base package. In addition, they will be entitled to a payment of $75,000 in the event they are asked to resign from the Board of HOC in any event other than as a result of a change of control. The Company also may terminate the agreements and make payments in lieu of notice.

Currently the Executive Directors’ service contracts do not provide for mitigation in the event of early termination. The Executive Directors do not have service contracts with any Group subsidiary.

Heritage Oil Limited Annual Report & Accounts 2008 43 Remuneration Report continued

Non-Executive Directors The remuneration of Non-Executive Directors is a matter for the Remuneration Committee. The Company’s policy is to set levels for Non-Executive Directors’ remuneration so as to ensure that they are sufficient to attract, retain and motivate high quality Directors.

Non-Executive Directors’ annual fee levels for 2008 and 2009 are set out below. Fees were paid from 28 March 2008, the date of the Company’s reorganisation and listing on the Main Market of the London Stock Exchange, or the date of appointment if later. Actual fees paid or accrued for the year ended 31 December 2008 are shown in the Directors’ Emoluments table on page 45.

2008 2009 Michael Hibberd £80,000 £80,000 Salim Hassan Macki £80,000 £80,000 General Sir Michael Wilkes £80,000 £80,000 Gregory Turnbull £50,000 £50,000 John McLeod £50,000 £50,000 Additional fee for each day worked in excess of the agreed 20 days per annum £2,000 £2,000

Michael Hibberd, Gregory Turnbull and John McLeod also receive fees of Cdn$22,500 per annum from HOC for acting as Directors of that company.

Messrs. Hibberd, Turnbull, McLeod and Wilkes are entitled to additional fees of £20,000 in 2008 for the work they undertook in connection with the Company’s reorganisation and listing on the London Stock Exchange.

The Non-Executive Directors’ terms of appointment may be terminated by each party giving three months’ notice in writing. Michael Hibberd and Gregory Turnbull will be entitled to a change of control bonus of $75,000 plus a pro-rata amount of their previous year’s bonus multiplied by a stock price performance factor in the event that HOC changes control.

With the exception of General Sir Michael Wilkes and Salim Hassan Macki all the Non-Executive Directors will be entitled to a payment of $75,000 in the event they are asked to resign from the Board of HOC in any event other than as a result of a change of control. General Sir Michael Wilkes received a payment of £50,000 on joining the Board of the Company. No other Director received this form of payment on joining the Board of the Company. Initial term of Subsequent term Non-Executive Director Date of contract Notice period appointment of appointment Michael Hibberd 28 March 2008 3 months 2010 AGM 3 years Gregory Turnbull 28 March 2008 3 months 2009 AGM 3 years John McLeod 28 March 2008 3 months 2009 AGM 3 years General Sir Michael Wilkes 28 March 2008 3 months 2011 AGM 3 years Salim Hassan Macki 12 August 2008 3 months 2009 AGM 3 years

Non-Executive Directors do not participate in the Company’s pension arrangements. Although some of these Directors have previously received grants of options, they will not receive any further grants or participate in any other long-term incentive arrangements.

44 Heritage Oil Limited Annual Report & Accounts 2008 Performance Graph The following graph shows the Company’s TSR since trading of the Company’s shares began on the London Stock Exchange on 31 March 2008 against the FTSE 250 Index. The Remuneration Committee has selected the FTSE 250 Index as it represents a broad equity market index which includes the Company and therefore provides a good indication of the Company’s general performance.

Cumulative TSR rebased to 100 130.00

120.00

110.00

100.00

90.00

80.00

70.00

60.00

50.00

40.00 March 2008 June 2008 September 2008 December 2008

Heritage Oil Ltd FTSE 250 Index

Directors’ Emoluments for the Year Ended 31 December 2008 Base Annual Package/ bonus/ 20082 2008 20072 Fees Benefits1 other Total Pensions Total £000 £000 £000 £000 £000 £000 Executive Directors Anthony Buckingham 675.0 134.8 300.0 1,109.8 50.6 1,038.3 Paul Atherton 495.37 119.6 262.5 877.4 37.5 808.0 Non-Executive Directors Michael Hibberd3 74.9 – 20.06 94.9 58.5 Gregory Turnbull3 46.4 – 20.06 66.4 27.7 John McLeod3 47.4 – 20.06 67.4 27.7 General Sir Michael Wilkes4 96.7 – 20.06 116.7 – Salim Hassan Macki5 31.8 – – 31.8 – Total 1,467.5 254.4 642.5 2,364.4 88.1 1,960.2

1 Shows the taxable value of benefits, comprising private medical insurance, school fees for Paul Atherton’s children and life insurance. The figures also include living allowances of £100,000 (Anthony Buckingham) and £77,500 (Paul Atherton) but exclude pension contributions. 2 The Directors became entitled to emoluments payable by the Company from 28 March 2008. Prior to this date the Directors were only entitled to emoluments payable by HOC which was then the parent company of the Group. 3 Michael Hibberd, Gregory Turnbull and John McLeod receive fees of Cdn$22,500 per annum paid by HOC as Directors of that company. These fees have been included in the above table. 4 General Sir Michael Wilkes received a payment of £50,000 on joining the board in 2008. 5 Mr. Macki was appointed on 12 August 2008. 6 Michael Hibberd, Gregory Turnbull, John McLeod and General Sir Michael Wilkes are entitled to an additional fee of £20,000 in 2008 for the work they undertook in connection with the Company’s reorganisation and listing on the London Stock Exchange. 7 The difference from the base package of £500,000 mentioned above is due to the foreign exchange differences.

Heritage Oil Limited Annual Report & Accounts 2008 45 Remuneration Report continued

Performance Shares Conditional awards of Performance Shares were granted to Executive Directors on 19 June 2008 under the LTIP, subsequent to the Plan’s approval at the Company’s AGM, as shown below.

Executive Directors’ Interests in Performance Shares As at 31 December 2008 (Audited information) Number Earliest Share price at Director of shares vesting date date of grant Anthony Buckingham 2,347,826 18 June 2011 345p Paul Atherton 1,159,420 18 June 2011 345p

Executive Directors’ Interests in Share Options Held Under the Replacement Scheme As at 31 December 2008 (Audited information) Options Exercise Director Date of grant At 31/03/08 exercised At 31/12/08 prices Vesting periods Expiry date Michael Hibberd 23 Jun 06 150,000 150,000 £0.81 23 Jun 06–23 Jun 08 23 Jun 11 14 Dec 06 750,000 750,000 £1.43 14 Dec 06–14 Dec 08 14 Dec 11 21 Dec 06 250,000 250,000 £2.45 21 Dec 07–21 Dec 09 21 Dec 12 Anthony Buckingham 20 May 05 500,000 500,000 £0.48 20 May 05–20 May 07 20 May 10 14 Dec 06 9,129,510 9,129,510 £1.43 14 Dec 06–14 Dec 08 14 Dec 11 21 Dec 07 500,000 500,000 £2.45 21 Dec 07–21 Dec 09 21 Dec 12 Paul Atherton 20 May 05 1,250,000 1,250,000 £0.48 20 May 05–20 May 07 20 May 10 14 Dec 06 1,125,000 1,125,000 £1.43 14 Dec 06–14 Dec 08 14 Dec 11 21 Dec 06 500,000 500,000 £2.45 21 Dec 07–21 Dec 09 21 Dec 12 Gregory Turnbull 20 May 05 150,000 150,000 £0.48 20 May 05–20 May 07 20 May 10 14 Dec 06 300,000 300,000 £1.43 14 Dec 06–14 Dec 08 14 Dec 11 21 Dec 07 150,000 150,000 £2.45 21 Dec 07–21 Dec 09 21 Dec 12 John McLeod 20 May 05 100,000 100,0001 0 £0.48 20 May 05–20 May 07 20 May 10 14 Dec 06 300,000 300,000 £1.43 14 Dec 06–14 Dec 08 14 Dec 11 21 Dec 07 150,000 150,000 £2.45 21 Dec 07–21 Dec 09 21 Dec 12

Note: The final exercise prices were converted into pounds sterling on the Company’s reorganisation and listing on the main market of the London Stock Exchange using the exchange rate in effect on that date.

1 The share price on the date of exercise was £1.72.

No options were granted or lapsed during 2008.

The closing share price on 31 December 2008 was £2.05. During the period the highest share price was £3.50 and the lowest was £1.38.

This report was approved by the Board on 28 April 2009 and signed on its behalf by:

John McLeod Chairman of the Remuneration Committee 28 April 2009

46 Heritage Oil Limited Annual Report & Accounts 2008 Directors’ Report

The Directors of Heritage Oil Limited (the “Company”) submit their Key Performance Indicators report together with the consolidated audited financial statements Heritage uses a number of financial and operating Key Performance for the year ended 31 December 2008 for the Company and its Indicators (“KPIs”) against which it monitors performance. Due to subsidiaries (the “Group”). being listed on the LSE for less than one year there are no year-on- year comparisons but comparative data will be built up and reported The Company was incorporated on 6 February 2008 in Jersey on in future years. Additionally the KPIs will also be developed as the under the Companies (Jersey) Law 1991, as amended (the “Jersey Company’s operations evolve. Companies Law”) to become the ultimate holding company of the Year to Group. It changed its status to a public company on 25 February 31 December 2008 2008 in preparation for the listing of its ordinary shares on the Main LTIFR1 0.03 Market of the London Stock Exchange (the “LSE”) on 31 March Staff turnover 3% 2008 (the “Listing”). The Company’s registered office is in Jersey. Production from continuing operations (%)2 +80% Reserves and Resources Additions (%)3 +272% Prior to the Listing, the holding company of the Group was HOC, a Average realised price +5% Canadian registered company whose common shares (“Common Shares”) were traded on the Toronto Stock Exchange (“TSX”). As 1 Lost Time Injury Frequency Rate per 10,000 hours worked. part of the Listing, the Group was reorganised and HOC became an 2 Excludes production from Block 8, Oman which was sold in April 2009. 3 Management estimates. indirect wholly-owned subsidiary of the Company (the “Reorganisation”). The Reorganisation culminated in the Common Results and Dividends Shares being de-listed from the TSX and a new class of The Group’s financial statements for the year ended 31 December exchangeable shares being created and issued by HOC 2008 are set out on pages 53 to 56. (“Exchangeable Shares”). Subject to the terms of the reorganisation, holders of Common Shares could exchange their Common Shares The Company and HOC have not declared or paid any dividends for either Ordinary Shares of the Company (“Ordinary Shares”) since their incorporation and do not intend to pay dividends in the which are traded on the LSE or for Exchangeable Shares that are foreseeable future. The future payment of dividends will depend traded on both the LSE and the TSX. Further details of the Listing on the earnings and financial condition of the Company and and Reorganisation can be found in the prospectus dated 28 March such other factors as the Board of Directors of the Company 2008 (the “Prospectus”) available on the Company’s website at consider appropriate. www.heritgageoilltd.com. Capital Structure Principal Activities and Business Review The Company has two classes of shares, namely the Ordinary The Group is an independent, international oil and gas exploration, Shares and a special voting share of HOC (the “Special Voting development and production Group with a focus on Africa, the Share”). As described previously, the Company’s indirect subsidiary, Middle East, Russia and South Asia. It has exploration projects in HOC, has Exchangeable Shares outstanding that are convertible Uganda, the Kurdistan Region of Iraq, the DRC, Malta, Pakistan, into Ordinary Shares of the Company. Tanzania and Mali, and a producing property in Russia. Producing assets in Oman were sold on 7 April 2009. The Group operates The Ordinary Shares and the Special Voting Share carry no right to through a number of subsidiaries which are set out on page 57. fixed income. A review of the business including future developments and The Ordinary Shares have a right to one vote for every share at performance of the Group is contained in: general meetings whilst the holders of Exchangeable Shares have • the Chairman’s Statement on pages 2 to 3; rights through the Special Voting Share held by the trustee of the • the Chief Executive’s Review on pages 4 to 6; Voting and Exchange Trust to one vote at general meetings for every • the Operations Review on pages 10 to 27; Exchangeable Share on the same basis as if they had exchanged • the Financial Review on pages 28 to 31; and them for Ordinary Shares. For clarity, the Voting and Exchange Trust • the Corporate Social Responsibility report on pages 32 to 33. is a Canadian trust that holds the Special Voting Share for the benefit of the registered holders of the Exchangeable Shares In addition, the Company has published a separate Corporate pursuant to the terms of a Voting and Exchange Trust Agreement Social Responsibility report to be sent to shareholders with this dated 27 February 2008. Annual Report. Details of how to vote and deadlines for exercising voting rights will A description of the significant risk factors and uncertainties facing be set out in the Notice of AGM. the Group is set out in the Financial Review on page 31 and also in the Directors’ Report on page 49. Subject to the Articles, any member may transfer certificated shares by an instrument of transfer in writing in any usual form or in any other form acceptable to the Directors. The Directors may refuse to register any transfer of certificated shares which are not fully paid or where the register of transfer is not in the acceptable form.

Heritage Oil Limited Annual Report & Accounts 2008 47 Directors’ Report continued

The issued share capital of the Company and total voting rights Directors’ Election and Rotation of the Company as at 31 March 2009 are as follows: With regard to retirement and re-election of Directors, the Company • 252,083,374 Ordinary Shares of the Company are issued and is governed by its Articles of Association (the “Articles”), the outstanding, which constitutes 98.8% of the total voting rights Combined Code of Corporate Governance and the Jersey of the Company. Companies Law. The Directors have the power to appoint a Director • 3,024,108 Exchangeable Shares of HOC each carrying one during the year but any person so appointed must stand for election voting right in the Company, are issued and outstanding, which at the next AGM. One-third of the Directors must retire from office at constitutes 1.2% of the total voting rights of the Company. each AGM. A retiring Director is eligible to stand for re-election.

Directors’ interests in the Ordinary Shares, Exchangeable Shares, In accordance with the above provisions, Salim Hassan Macki, options granted under the employee share scheme and interests having been appointed since the last AGM, will retire, and being in the LTIP are set out in the Directors’ Remuneration Report on eligible, offer himself for election at the forthcoming AGM. In page 46. addition, Gregory Turnbull and John McLeod will retire and, being eligible, offer themselves for re‑election. The Company did not purchase any of its own shares during the year. Powers of the Directors After Listing, in the period between 31 March 2008 and Subject to the Company’s Articles, relevant statutory law and any 31 December 2008, a total of 1,182,012 Exchangeable Shares direction that may be given by the Company in general meeting, were exchanged into Ordinary Shares. the business of the Company is managed by the Directors who may exercise all powers of the Company. Major Shareholders In accordance with Rule 5 of the Disclosure and Transparency Directors’ Indemnity Provisions Rules, the shareholders listed below have notified the Company Under the Company’s Articles the Directors are indemnified out of of their interests in the Ordinary Shares of the Company as at the assets of the Company against any loss or liability incurred by 31 March 2009: reasons of having been a Director of the Company. Ordinary Shares Name held % Held1 Albion Energy Limited3 84,540,3402 33.14 Annual General Meeting The AGM will be held at 22 Grenville Street, St Helier, Jersey Capital Research and Management on 18 June 2009. Formal notice of the Annual General Meeting Company 18,683,814 7.32 including details of special business will be set out in the Notice Lansdowne Partners Limited 17,901,624 7.02 of the Annual General Meeting and on the Company’s website at Firebird Global Master Fund, Ltd 14,384,000 5.64 www.heritageoilltd.com. Harrier Holdings Ltd re LCAM 12,241,395 4.80 Registrar 1 Includes voting rights attaching to the Special Voting Share as well as the The Company’s share registrar is Computershare Investor Services Ordinary Shares. 2 Number of Ordinary Shares held by both Albion Energy Limited and (Channel Islands) Limited, Ordnance House, 31 Pier Road, St Helier, Anthony Buckingham. Jersey, JE4 8PW, Channel Islands. 3 The ultimate owner of Albion Energy Limited is Anthony Buckingham. Creditors’ Payment Policy Albion Energy Limited (“Albion”) and Anthony Buckingham entered It is the Company and Group’s policy to settle all debts with into a relationship agreement with the Company on 28 March 2008 creditors on a timely basis and in accordance with the terms of (the “Relationship Agreement”) as part of the Listing. The purpose credit agreed with each supplier. Average creditor payment days of the Relationship Agreement is to ensure that transactions and for the period under review were approximately 45 days. relationships between the Group, Albion and Anthony Buckingham are at arm’s length and on normal commercial terms. Employees As at 31 December 2008, the Group had 132 employees (including Directors full-time contractors, consultants and Directors) based in the The following Directors held office during the reporting period: following locations:

Appointment dates Jersey 2 Michael Hibberd (Chairman) 18 March 2008 Canada 5 Anthony Buckingham (CEO) 25 February 2008 Russia 40 Paul Atherton (CFO) 6 February 2008 Europe 27 Gregory Turnbull 18 March 2008 Uganda 28 Salim Hassan Macki 12 August 2008 Kurdistan Region of Iraq 14 John McLeod 18 March 2008 Tanzania 10 General Sir Michael Wilkes 18 March 2008 South Africa 6 Total 132 Biographical details of all directors can be found on page 34.

With the exception of General Sir Michael Wilkes and Salim Hassan Macki, all the Directors were previously, and continue to be, Directors of HOC.

48 Heritage Oil Limited Annual Report & Accounts 2008 Significant Risk Factors and Uncertainties In April 2009, bondholders with $5.9 million of bonds gave notice of A variety of material risk factors have been identified that could have the exercise of 59 bonds. These bondholders received 1,255,317 an impact on the Company, including risks relating to operations, Ordinary Shares. countries in which the Group operates, the Group structure and risks relating to the Ordinary Shares and the Exchangeable Shares. Important Events Since the Year End The most significant risk factors impacting on the Group are Events since the balance sheet date are summarised in note 26 to considered to be: the financial statements on page 80. • exploration and development expenditure and success rates; • factors associated with operating in developing countries, Audit and Auditors political and regulatory instability; The Directors who held office at the date of approval of this • title disputes; Directors’ Report confirm that, so far as they are each aware, there • oil and gas sales volumes and prices; and is no relevant audit information of which the Company’s auditors are • reliance on key employees. unaware; and each Director has taken all the steps that they ought to have taken as a Director to make themselves aware of any The above risk factors could adversely affect the cash flows to a relevant audit information and to establish that the Company’s material extent that the Group may, in certain circumstances, need auditors are aware of that information. to obtain further debt or equity financing in the future. A resolution to reappoint KPMG Audit Plc as auditors of the Further information on risks and internal controls can be found in the Company will be proposed at the upcoming AGM. Financial Review on page 31. Fees billed by KPMG, the Company’s auditors and its associates, Financial Risks and Financial Instruments during 2007 and 2008, may be summarised as follows: Information on financial risk management, including credit and liquidity risks and information about financial instruments are set out 2008 2007 US$ US$ in the note to the financial statements on pages 64 to 65 and page 66, respectively. Audit and audit related services: Group audit of annual and review of Political and Charitable Donations interim statements 276,900 456,135 The Group has undertaken a wide range of community schemes, Prospectus and information circular 97,087 – including public health, education, environment, public facility and 373,987 456,135 community relations based programmes, further details of which can Non-audit services: be found in the Corporate Social Responsibility Report on pages 34 Tax compliance and advisory 110,124 8,704 to 35. The Group did not make any political donations during 2008. Transaction services 537,900 – 648,024 8,704 Change of Control Agreements The Company confirms that there are no significant agreements to which it is party that would take effect, alter or terminate upon Statement of Directors’ Responsibilities a change of control following a takeover bid except those The Directors are responsible for preparing the Annual Report and disclosed below: the financial statements for the Group in accordance with applicable • the Executive Directors’ service contracts contain certain law and regulations. provisions in relation to change of control as disclosed in the Remuneration Report; Company law requires the Directors to prepare Group financial • the Long Term Incentive Plan rules contain a provision whereby statements for each financial year. Under that law they are required in the event of a change of control all awards will vest in their to prepare the Group financial statements in accordance with entirety subject to the achievement or otherwise of the International Financial Reporting Standards (“IFRS”) as adopted by performance conditions; and the EU and applicable law. • on 16 February 2007, HOC issued 1,650 $100,000 convertible bonds at par to raise $165,000,000 by way of a private The Group financial statements are required by law and IFRS as placement. Issue costs amounted to $6,979,268 resulting in net adopted by the EU to present fairly the financial position of the proceeds of $158,020,732. The bonds have a maturity of five Group and the performance for that period. years and one day and an annual coupon of 8.00%. Bondholders have the right to convert bonds into Ordinary Shares at a price In preparing the financial statements the Directors are required to: of $4.70 per share. $9,900,000 of bonds have been converted, • select suitable accounting policies and then apply them leaving 1,551 $100,000 bonds outstanding. Bondholders have consistently; a put option requiring the Company to redeem the bonds at par, • present information, including accounting policies, in a manner plus accrued interest, in the event of a change of control of the that provides relevant, reliable, comparable and understandable Company, together with a cash payment of up to $19,700 on information; each bond will be made to the bondholder, the amount of which • provide additional disclosures when compliance with the specific depends upon the date of redemption and market value at the requirements in IFRS is insufficient to enable users to understand date of any change of control event. the impact of particular transactions, other events and conditions on the entity’s financial position and financial performance; • state whether they have been prepared in accordance with IFRS as adopted by the EU; and

Heritage Oil Limited Annual Report & Accounts 2008 49 Directors’ Report continued

• prepare the financial statements on a going concern basis unless, having assessed the ability of the Company to continue as a going concern, it is inappropriate to presume the Company will continue in business.

The Directors are responsible for keeping proper accounting records which disclose with reasonable accuracy at any time the financial position of the Group and enable them to ensure that its financial statements comply with the Companies (Jersey) Law 1991. They have general responsibility for taking such steps as are reasonably open to them for safeguarding the assets of the Group and to prevent and detect fraud and other irregularities.

Under applicable law and regulations, the Directors are also responsible for the preparation of a Directors’ Report, Remuneration Report and Corporate Governance Statement.

The Directors are responsible for the maintenance and integrity of the statutory and audited information on the Company’s website. Jersey legislation and United Kingdom regulation, governing the preparation and dissemination of financial statements, may differ from requirements in other jurisdictions.

Going Concern After making due enquiries, the Directors have made an informed judgement at the time of approving the financial statements, that there is a reasonable expectation that the Group has adequate resources to continue in operational existence for the foreseeable future. For this reason, the Directors continue to adopt the going concern basis in preparing the financial statements.

Approved by the Board on 28 April 2009.

Anthony Buckingham Chief Executive Officer 28 April 2009

50 Heritage Oil Limited Annual Report & Accounts 2008 Responsibility Statement of the Directors

We confirm on behalf of the Board that to the best of our knowledge: (a) the financial statements prepared in accordance with the applicable set of accounting standards give a true and fair view of the assets, liabilities, financial position and profit and loss of the Company and the undertakings included in the consolidation taken as a whole; and (b) the management report, comprising the Chairman’s Statement, Chief Executive’s Review, Operations Review, Financial Review and Corporate Social Responsibility report on pages 2 to 33, includes a fair review of the development and performance of the business, and the principal risks and uncertainties that it faces.

For and on behalf of the Board.

Michael J. Hibberd Paul Atherton Chairman Chief Financial Officer 28 April 2009 28 April 2009

Heritage Oil Limited Annual Report & Accounts 2008 51 Independent Auditors’ Report to the Members of Heritage Oil Limited

We have audited the Group financial statements of Heritage Oil Basis of Audit Opinion Limited for the year ended 31 December 2008 which comprise the We conducted our audit in accordance with International Standards consolidated income statement, consolidated statement of on Auditing (UK and Ireland) issued by the Auditing Practices recognised income and expense, consolidated balance sheet, Board. An audit includes examination, on a test basis, of evidence consolidated cash flow statement and related notes. These financial relevant to the amounts and disclosures in the financial statements. statements have been prepared under the accounting policies set It also includes an assessment of the significant estimates and out therein. judgements made by the Directors in the preparation of the financial statements, and of whether the accounting policies are appropriate This report is made solely to the Company’s members, as a body, to the Company’s circumstances, consistently applied and in accordance with Article 110 of the Companies (Jersey) Law 1991 adequately disclosed. and, in respect of our work on the Corporate Governance Report, on terms that have been agreed with the Company. Our audit work We planned and performed our audit so as to obtain all the has been undertaken so that we might state to the Company’s information and explanations which we considered necessary in members those matters we are required to state in an auditors’ order to provide us with sufficient evidence to give reasonable report and, in respect of our work on the Corporate Governance assurance that the financial statements are free from material Report, those matters that we have agreed to state to them in our misstatement, whether caused by fraud or other irregularity or error. report, and for no other purpose. To the fullest extent permitted by In forming our opinion we also evaluated the overall adequacy of law, we do not accept or assume responsibility to anyone other than the presentation of information in the financial statements. the Company and the Company’s members as a body, for our audit work, for this report, or for the opinions we have formed. Opinion In our opinion: Respective Responsibilities of Directors and Auditors • the Group’s financial statements give a true and fair view, in As described in the Statement of Directors’ Responsibilities on accordance with IFRS as adopted by the European Union, pages 49 to 50, the Company’s Directors are responsible for of the state of the Group’s affairs as at 31 December 2008 preparation of the financial statements in accordance with and of its loss for the year then ended; and applicable law and International Financial Reporting Standards • the financial statements have been properly prepared in (“IFRS”) as adopted by the European Union. accordance with the Companies (Jersey) Law 1991.

Our responsibility is to audit the financial statements in accordance with the relevant legal and regulatory requirements and International Standards on Auditing (UK and Ireland).

We report to you our opinion as to whether the financial statements KPMG Audit Plc give a true and fair view and are properly prepared in accordance Chartered Accountants with the Companies (Jersey) Law 1991. We also report to you if, in 8 Salisbury Square our opinion, the Company has not kept proper accounting records London EC4Y 8BB or if we have not received all the information and explanations we United Kingdom require for our audit. 28 April 2009

We read the Directors’ Report accompanying the financial statements and consider the implications for our report if we become aware of any apparent misstatements within it.

We review whether the Corporate Governance Report reflects the Company’s compliance with the nine provisions of the 2006 Combined Code specified for our review by the Listing Rules of the Financial Services Authority, and we report if it does not. We are not required to consider whether the Board’s statements on internal control cover all risks and controls, or form an opinion on the effectiveness of the Group’s corporate governance procedures or its risk and control procedures.

52 Heritage Oil Limited Annual Report & Accounts 2008 Consolidated Income Statement Years Ended 31 December 2008 and 2007

2008 2007 $ $ Revenue Petroleum and natural gas 5,095,808 3,709,503 Expenses Petroleum and natural gas operating (2,250,771) (1,843,540) Production tax (2,618,806) (1,092,423) General and administrative (30,686,764) (41,271,960) Depletion, depreciation and amortisation (2,349,484) (1,892,290) Exploration expenditures (note 2e) (786,398) (5,415,696) Impairment of property, plant and equipment (note 11) (3,997,033) (1,799,762) Operating loss (37,593,448) (49,606,168) Gain on disposal of subsidiaries (note 9) – 1,077,132 Finance income (costs) Interest income 3,954,749 3,958,219 Loss on redemption of liability component of convertible bonds – ( 7,155,622) Gain/(loss) on derivative financial liability relating to convertible bonds (note 2q) 10,954,514 (21,279,964) Other finance costs (note 6) (11,257,187) (11,9 97,74 8) Foreign exchange (losses)/gains (5,648,179) 931,913 Unrealised (loss)/gain on other financial assets (note 12) (1,713,700) 906,643 (3,709,803) (34,636,559) Net loss for the year attributable to equity holders of the Company (41,303,251) (83,165,595) Net loss per share Basic and diluted (note 20) (0.16) (0.37)

The notes are an integral part of these consolidated financial statements.

Heritage Oil Limited Annual Report & Accounts 2008 53 Consolidated Statement of Recognised Income and Expense Years Ended 31 December 2008 and 2007

2008 2007 $ $ Changes in the fair value of available-for-sale financial assets (note 19) – 168,000 Exchange differences on translation of foreign operations (note 19) (651,364) 434,583 Net (expense)/income recognised directly in equity (651,364) 602,583 Net loss for the year (41,303,251) (83,165,595) Total recognised loss for the year (41,954,615) (82,563,012)

The notes are an integral part of these consolidated financial statements.

54 Heritage Oil Limited Annual Report & Accounts 2008 Consolidated Balance Sheet As at 31 December 2008 and 2007

2008 2007 $ $ ASSETS Non-current assets Intangible exploration assets (note 10) 211,346,037 102,862,754 Property, plant and equipment (note 11) 88,039,218 64,225,918 Other financial assets (note 12) 3,330,501 5,044,201 302,715,756 172,132,873 Current assets Inventories 395,110 199,465 Prepaid expenses 664,759 4 47, 271 Trade and other receivables (note 13) 6,901,511 6,759,261 Cash and cash equivalents (note 14) 90,620,385 230,089,323 98,581,765 237,49 5,320 401,297,521 409,628,193 LIABILITIES Current liabilities Trade and other payables (note 15) 54,751,768 24,646,531 Borrowings (note 16) 595,418 623,640 55,347,186 25,270,171 Non-current liabilities Borrowings (note 16) 155,609,982 154,253,701 Derivative financial liability (note 22) 25,785,476 36,739,990 Provisions (note 17) 719,808 170,899 182,115,266 191,164,590 237,462,452 216,434,761 Net assets 163,835,069 193,193,432 SHAREHOLDERS’ EQUITY ATTRIBUTABLE TO EQUITY HOLDERS OF THE COMPANY Share capital (note 18) 218,283,881 217,672, 24 3 Reserves (note 19) 54,511,609 43,178,359 Retained deficit (note 19) (108,960,421) (67,6 57,170) 163,835,069 193,193,432

The notes are an integral part of these consolidated financial statements.

Heritage Oil Limited Annual Report & Accounts 2008 55 Consolidated Cash Flow Statement Years Ended 31 December 2008 and 2007

2008 2007 $ $ Cash provided by (used in) operating activities Net loss from operations for the year (41,303,251) (83,165,595) Items not affecting cash Depletion, depreciation and amortisation 2,349,484 1,892,290 Finance costs – accretion expenses 4,183,874 3,619,198 Foreign exchange losses/(gains) 320,580 (153,174) Share-based compensation 7,595,542 31,300,295 Loss on redemption of convertible bonds – 7,155,622 (Gain)/loss on derivative financial liability (10,954,514) 21,279,964 Gain on disposal of subsidiaries – (1,077,132) Loss/(gain) on other financial assets 1,713,700 (906,643) Impairment of property, plant and equipment 3,997,033 1,799,762 Decrease in trade and other receivables 1,136,624 5,195,888 (Increase)/decrease in prepaid expenses (217,488) 84,002 Increase in inventory (195,645) (100,544) (Decrease)/increase in trade and other payables (1,432,138) 10,585,162 (32,806,199) (2,490,905) Investing activities Property, plant and equipment expenditures (29,610,908) (27, 23 6,018) Intangible exploration expenditures (73,608,271) (48,095,422) Intangible development expenditures – (64,931) Investment in shares – (200,000) (103,219,179) (75,596,371) Financing activities Shares issued for cash 361,537 187,10 6,476 Share issue costs – (10,473,386) Convertible bonds – 165,000,000 Convertible bonds issue costs – (6,979,268) Redemption of convertible bonds – (83,022,752) Long-term debt – 9,450,000 Long-term debt issue costs – (314,897) Repayment of long-term debt (616,118) (155,537) (254,581) 260,610,636 (Decrease)/increase in cash and cash equivalents (136,279,959) 182,523,360 Cash and cash equivalents – beginning of year 230,089,323 46,861,146 Foreign exchange (loss)/gain on cash held in foreign currency (3,188,979) 704,817 Cash and cash equivalents – end of year 90,620,385 230,089,323 Non-cash investing and financing activities (note 25) Supplementary information The following have been included within cash flows for the year under operating activities Interest received 4,477,227 3,504,866 Interest paid 13,636,178 8,546,840

The notes are an integral part of these consolidated financial statements.

56 Heritage Oil Limited Annual Report & Accounts 2008 Notes to Consolidated Financial Statements

1 Reporting Entity Heritage Oil Limited (the “Company”) was incorporated under the Companies (Jersey) Law 1991 (as amended) on 6 February 2008. Its primary business activity is the exploration, development and production of petroleum and natural gas in Africa, the Middle East, Russia and South Asia. The Company was established in order to implement a corporate reorganisation of Heritage Oil Corporation (“HOC”, the “Corporation”).

On 24 March 2008, HOC entered into a corporate reorganisation (the “Reorganisation”) which resulted in the Company becoming the parent company of HOC and its subsidiaries. The Company’s corporate head office is now located in the Channel Islands. In connection with the Reorganisation, the Company listed its Ordinary Shares (“Ordinary Shares”) on the Official List of the United Kingdom Listing Authority (the “UKLA”) and trades on the Main Market of the London Stock Exchange plc (the “LSE”) (collectively, “Admission”). HOC delisted its existing Common Shares (“Heritage Shares”) from the Toronto Stock Exchange (the “TSX”) and obtained a listing for a new class of Exchangeable Shares (the “Exchangeable Shares”) on the TSX. As part of the Reorganisation, implemented by way of a court-approved plan of arrangement (the “Arrangement”) under the Business Corporations Act (Alberta), HOC split its stock such that each existing HOC Share was exchanged for either ten Ordinary Shares or 10 Exchangeable Shares in accordance with the terms of the Arrangement.

On 2 April 2008, HOC and the Company collectively, together with their subsidiaries and affiliates, announced that Articles of Arrangement implementing the previously announced Arrangement involving HOC and the Company had been filed with the Registrar of Corporations for the Province of Alberta with an effective date of 31 March 2008. As a result, former holders of Common Shares of HOC were entitled to either 10 Ordinary Shares of the Company or ten Exchangeable Shares of HOC for each Common Share held depending on the elections previously made by such shareholders. Effective at the opening of business on 3 April 2008, the Exchangeable Shares were listed and posted for trading in substitution for the previously listed Common Shares of HOC which were delisted at that time. The Exchangeable Shares were also admitted to trading on the Main Market of the LSE on 2 April 2008. Trading of Ordinary Shares commenced on the LSE on 31 March 2008.

The Exchangeable Shares are designed to have rights as near as possible equivalent to the Ordinary Shares of the Company. Each Exchangeable Share is exchangeable on a one-for-one basis for an Ordinary Share. The holders of Exchangeable Shares are entitled to Voting Rights equivalent to Ordinary Shares through the Special Voting Share (see below). Dividends to Ordinary Shareholders can only be declared or paid simultaneously with the declaration or payment of an identical dividend to Exchangeable Shareholders. On liquidation, dissolution or winding-up of HOC, the Exchangeable Shareholders will be given one Ordinary Share per Exchangeable Share held.

The Company has issued one Special Voting Share. The Special Voting Share has the number of votes, which may be cast at any meeting at which holders of Ordinary Shares are entitled to vote, equal to the number of Exchangeable Shares of HOC outstanding at the relevant time. The holders of Exchangeable Shares are entitled to Voting Rights through the Special Voting Share held by the trustee of the Voting and Exchange Trust by the Company, and have the right to receive notice of, speak and vote at the general meetings of the Company (on the basis of one vote for every Exchangeable Share) on the same basis as if they had exchanged their Exchangeable Shares for Ordinary Shares.

In connection with this Reorganisation the Company has agreed that the 2007 convertible bonds outstanding were convertible into Ordinary Shares of the Company rather than Common Shares of HOC.

These consolidated financial statements include the results of the Company and all subsidiaries over which the Company exercises control. The Company together with its subsidiaries are referred to as the Group. The subsidiaries consolidated within these financial statements include, inter alia, Heritage Oil Corporation, Heritage Oil & Gas Limited, Eagle Energy (Oman) Limited, Heritage Oil and Gas (U) Limited, Heritage Energy Middle East Limited, Heritage DRC Limited, Coatbridge Estates Limited, ChumpassNefteDobycha, Neftyanaya Geologicheskaya Kompaniya, Heritage Oil & Gas (Austria) GesmbH, Heritage Mali Block 7 Limited, Heritage Mali Block 11 Limited, Heritage Energy Holding GesmbH, Heritage Oil & Gas (Gibraltar) Limited, TISE Heritage Neftegaz, Begal Air Limited, Heritage International Holding GesmbH, Heritage Oil & Gas Holdings Limited, Eagle Drill Limited, Heritage Oil (Barbados) Limited, Heritage Oil & Gas (Switzerland) SA, Heritage Oil International Malta Limited, 1381890 Alberta ULC, Heritage Oil Cooperatief U.A, Heritage Oil Holdings Limited, Heritage International VOF, Heritage (International) Holding (Gibraltar) Limited, Heritage Tanzania Kimbiji-Latham Limited and Heritage Tanzania Kisangire Limited.

The Company’s consolidated financial statements are presented in US dollars, which is the Company’s functional and presentation currency.

The financial statements were approved by the Board and authorised for issuance on 28 April 2009.

2 Significant Accounting Policies The principal accounting policies applied in the preparation of these consolidated financial statements are set out below. These policies have been consistently applied to all the years presented, unless otherwise stated.

Heritage Oil Limited Annual Report & Accounts 2008 57 Notes to Consolidated Financial Statements continued

2 Significant Accounting Policies continued a) Basis of Preparation The consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as adopted by the European Union.

The Reorganisation, which is not a business combination, was accounted for with reference to the principles of reverse acquisition accounting as in accounting terms, the substance of the Reorganisation is that the underlying economics of the business have remained unchanged. Accordingly, the Reorganisation has been accounted for on a carry over basis of the historical cost of assets and liabilities of HOC and the consolidated financial history of HOC becomes that of the Company.

Certain prior year balances have been reclassified to conform to the current year’s presentation.

The consolidated financial statements have been prepared under the historical cost convention, as modified by the revaluation of certain financial assets and liabilities at fair value.

As for most oil and gas exploration companies, the Company raises financing for its activities from time to time using a variety of sources. Based on its current plans and knowledge, its projected capital expenditure and operating cash requirements, the Group has sufficient cash to finance its current plans for at least 12 months from the date of approval of the financial statements, but further finance is likely to be required to meet expenditure planned for the second half of 2010. Sources of funding for future exploration and development programmes will be derived from, inter alia, new credit facilities, reinvesting funds from operations, using existing treasury resources, disposal proceeds from the sale of non-core assets, farm-outs and, when considered appropriate, issuing debt and additional equity. Accordingly, the Group has a number of different sources of finance available and the Directors are confident that additional finance will be raised as and when needed.

After making enquiries, the Directors have a reasonable expectation that the Group has adequate resources to continue in operational existence for the foreseeable future. Accordingly, they continue to adopt the going concern basis in preparing the annual report and accounts.

The Group’s business activities, together with the factors likely to affect its future development, performance and position are set out in the Operations Review of the Annual Report on pages 10 to 27. The financial position of the Group, its cash flows and liquidity position are described in the Chief Financial Officer’s Financial Review on pages 28 to 31. In addition, note 3 to the financial statements includes the Group’s policies and processes for managing its capital, its financial risk management, and its exposure to foreign exchange risk, commodity price risk, credit risk and liquidity risk.

The preparation of financial statements in conformity with IFRS requires the use of certain critical accounting estimates. It also requires management to exercise its judgement in the process of applying the Company’s accounting policies. The areas involving a higher degree of judgement or complexity, or areas where assumptions and estimates are significant to the consolidated financial statements are disclosed in note 4. b) Consolidation The consolidated financial statements incorporate the assets and liabilities of all subsidiaries of the Company as at 31 December 2008 and 2007 and the results of all subsidiaries for the years then ended.

Subsidiaries are all entities (including special purpose entities) over which the Company has the power to govern the financial and operating policies, so as to obtain benefits from its activities, generally accompanying a shareholding of more than one half of the voting rights. The existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing whether the Company controls another entity. Subsidiaries are fully consolidated from the date on which control is transferred to the Company. They are de-consolidated from the date that control ceases.

The purchase method of accounting is used to account for the acquisition of subsidiaries by the Group. The cost of an acquisition is measured as the fair value of the assets given, equity instruments issued and liabilities incurred or assumed at the date of exchange, plus costs directly attributable to the acquisition. Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date, irrespective of the extent of any minority interest. The excess of the cost of acquisition over the fair value of the Group’s share of the net fair value of the identifiable assets, liabilities and contingent liabilities acquired is recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognised immediately in the income statement.

Inter-company transactions, balances and unrealised gains on transactions between Group entities (the Company and its subsidiaries) are eliminated. For the purposes of consolidation, the accounting policies of subsidiaries have been changed where necessary to ensure consistency with the policies adopted by the Company.

58 Heritage Oil Limited Annual Report & Accounts 2008 2 Significant Accounting Policies continued c) Segment Reporting The Company’s primary segment reporting format is geographical. A geographical segment is engaged in providing products or services within a particular economic environment, that are subject to risks and returns, that are different from those of segments operating in other economic environments. d) Joint Arrangements The majority of exploration, development and production activities are conducted jointly with others under contractual arrangement and, accordingly, the Group only reflects its proportionate interest in such assets, liabilities, revenues and expenses. e) Exploration and Evaluation Expenditures The Group applies a modified full cost method of accounting for exploration and evaluation (“E&E”) costs, having regard to the requirements of IFRS 6 “Exploration for and Evaluation of Mineral Resources”. Under the modified full cost method of accounting, costs of exploring for and evaluating oil and gas properties are capitalised on a licence or prospect basis and the resulting assets are tested for impairment by reference to appropriate cost pools. Such cost pools are based on geographic areas and are not larger than a segment. The Group had nine cost pools in 2007 and 2008: Uganda, Kurdistan Region of Iraq, Russia, Oman, DRC, Pakistan, Malta, Mali and Tanzania.

E&E costs related to each licence/prospect are initially capitalised within “Intangible exploration assets”. Such E&E costs may include costs of licence acquisition, technical services and studies, seismic acquisition, exploration drilling and testing, the projected costs of retiring the assets (if any) and directly attributable general and administrative expenses, but do not include costs incurred prior to having obtained the legal rights to explore an area, which are expensed directly to the income statement as they are incurred.

Where the Company farms-in to licences and incurs costs in excess of its own share of licence costs as consideration, these costs are capitalised as its own share.

Tangible assets acquired for use in E&E activities are classified as property, plant and equipment; however, to the extent that such a tangible asset is consumed in developing an intangible E&E asset, the amount reflecting that consumption is recorded as part of the cost of the intangible asset.

Intangible E&E assets related to each exploration licence/prospect are not depreciated and are carried forward until the existence (or otherwise) of commercial reserves has been determined. The Group’s definition of commercial reserves for such purpose is proved and probable reserves on an entitlement basis.

Proved and probable reserves are the estimated quantities of crude oil, natural gas and natural gas liquids which geological, geophysical and engineering data demonstrate with a specified degree of certainty (see below) to be recoverable in future years from known reservoirs and which are considered commercially producible. There should be a 50% statistical probability that the actual quantity of recoverable reserves will be more than the amount estimated as proved and probable and a 50% statistical probability that it will be less. The equivalent statistical probabilities for the proved component of proved and probable reserves are 90% and 10%, respectively.

Such reserves may be considered commercially producible if management has the intention of developing and producing them and such intention is based upon: • a reasonable assessment of the future economics of such production; • a reasonable expectation that there is a market for all or substantially all the expected hydrocarbon production; and • evidence that the necessary production, transmission and transportation facilities are available or can be made available.

Furthermore: (i) Reserves may only be considered proved and probable if producibility is supported by either actual production or a conclusive formation test. The area of reservoir considered proved includes: (a) that portion delineated by drilling and defined by gas-oil and/or oil-water contacts, if any, or both: and (b) the immediately adjoining portions not yet drilled, but which can be reasonably judged as economically productive on the basis of available geophysical, geological and engineering data. In the absence of information on fluid contacts, the lowest known structural occurrence of hydrocarbons controls the lower proved limit of the reservoir; and (ii) Reserves which can be produced economically through application of improved recovery techniques (such as fluid injection) are only included in the proved and probable classification when successful testing by a pilot project, the operation of an installed programme in the reservoir, or other reasonable evidence (such as, experience of the same techniques on similar reservoirs or reservoir simulation studies) provides support for the engineering analysis on which the project or programme was based.

If commercial reserves have been discovered, the related E&E assets are assessed for impairment on a cost pool basis as set out below and any impairment loss is recognised in the income statement. The carrying value, after any impairment loss, of the relevant E&E assets is then reclassified as development and production assets within property, plant and equipment.

Heritage Oil Limited Annual Report & Accounts 2008 59 Notes to Consolidated Financial Statements continued

2 Significant Accounting Policies continued E&E assets are assessed for impairment when facts and circumstances suggest that the carrying amount may exceed its recoverable amount. Such indicators include the point at which a determination is made as to whether or not commercial reserves exist. Where the E&E assets concerned fall within the scope of an established full cost pool, the E&E assets are tested for impairment together with all development and production assets associated with that cost pool, as a single cash generating unit. The aggregate carrying value is compared against the expected recoverable amount of the pool, generally by reference to the present value of the future net cash flows expected to be derived from production of commercial reserves. Where the E&E assets to be tested fall outside the scope of any established cost pool, there will generally be no commercial reserves and the E&E assets concerned will be written-off in full. f) Property, Plant and Equipment i) Development and Production Assets The Group had two interests at the development and production stage during the years covered by these financial statements; Russia and Oman.

Development and production assets are accumulated on a field-by-field basis and represent the cost of developing the commercial reserves discovered and bringing them into production, together with the E&E expenditures incurred in finding commercial reserves transferred from intangible E&E assets as outlined above, the projected cost of retiring the assets and directly attributable general and administrative expenses.

The net book values of producing assets are depleted on a field-by-field basis using the unit of production method by reference to the ratio of production in the year to the related proved plus probable reserves of the field, taking into account estimated future development expenditures necessary to bring those reserves into production.

An impairment test is performed whenever events and circumstances arising during the development or production phase indicate that the carrying value of a development or production asset may exceed its recoverable amount. The aggregate carrying value is compared against the expected recoverable amount of the cash generating unit, generally by reference to the present value of the future net cash flows expected to be derived from the production of commercial reserves. The cash generating unit applied for impairment test purposes is generally the field, except that a number of field interests may be grouped as a single cash generating unit where the cash flows generated by the fields are interdependent. ii) Other Assets Other property, plant and equipment are stated at cost less accumulated depreciation and any impairment in value. The assets’ useful lives and residual values are assessed on an annual basis.

Furniture and fittings are depreciated using the reducing balance method at 20% per year.

Land is not subject to depreciation.

Drilling rig equipment is depreciated using the unit-of-production method based on 2,740 drilling days with a 20% residual value.

The corporate jet is depreciated over its expected useful life of 69 months. Depreciation is charged so as to write-off the cost, less estimated residual value of corporate jet on a straight-line basis.

Corporate capital assets are depreciated on a straight-line basis over their estimated useful lives. The building is depreciated on a straight- line basis over 40 years with nil residual value. The land is not depreciated. g) Cash and Cash Equivalents Cash and cash equivalents include cash on hand, deposits held at call with banks and other short-term highly liquid investments with original maturities of three months or less. Cash and cash equivalents are stated at amortised cost using the effective interest rate method. h) Trade and Other Receivables Trade and other receivables are recognised initially at fair value and subsequently measured at amortised cost using the effective interest method, less provision for impairment. A provision for impairment of trade receivables is established when there is objective evidence that the Group will not be able to collect all amounts due according to the original terms of the receivables. i) Inventories Inventories consist of petroleum, condensate, liquid petroleum gas and materials that are recorded at the lower of weighted average cost and net realisable value. Cost comprises direct materials, direct labour, depletion and those overheads that have been incurred in bringing the inventories to their present location and condition. Net realisable value is the estimated selling price in the ordinary course of business, less applicable variable selling expenses. Provision is made for obsolete, slow-moving or defective items where appropriate.

60 Heritage Oil Limited Annual Report & Accounts 2008 2 Significant Accounting Policies continued j) Intangible Development Costs Development costs are recognised as intangible assets when it is probable that the project will, after considering its commercial and technical feasibility, be completed and generate future economic benefits and its costs can be measured reliably. All other research and development costs are charged to earnings in the year incurred. k) Investments The Group classifies its investments in the following categories: financial assets at fair value through the income statement and available- for-sale financial assets. The classification depends on the purpose for which the investments were acquired. Management determines the classification of its investments at initial recognition. During the years covered by these financial statements the Group did not have any investments classified as “loans and receivables” or “held to maturity investments”. i) Financial Assets at Fair Value Through the Income Statement Financial assets held for trading are carried at fair value with changes in fair value recognised in the income statement. A financial asset is classified in this category if acquired principally for the purpose of selling in the short term. Derivatives are classified as held for trading unless they are designated as hedges.

Gains or losses arising from changes in the fair value of the “financial assets at fair value through the income statement” category are presented in the income statement within “Unrealised gain/(loss) on other financial assets” in the year in which they arise. ii) Available-For-Sale Financial Assets Available-for-sale financial assets, comprising principally marketable equity securities, are non-derivatives that are either designated in this category or not classified. They are included in non-current assets unless management intends to dispose of the investment within 12 months of the balance sheet date.

Changes in the fair value of monetary and non-monetary securities classified as available-for-sale (other than impairment losses and foreign exchange gains and losses which are recognised in the income statement) are recognised in equity. Upon sale of a security classified as available-for-sale, the cumulative gain or loss previously recognised in equity is recognised in the income statement.

The Group assesses at each balance sheet date whether there is objective evidence that a financial asset or a group of financial assets is impaired. Measurement is assessed by reference to the fair value of the financial asset or group of financial assets. l) Non-Current Assets Held for Sale Non-current assets (or disposal groups) are classified as assets held for sale and stated at the lower of their carrying amount and fair value less costs to sell if their carrying amount will be recovered principally through a sale transaction rather than through continuing use.

Non-current assets (including those that are part of a disposal group) are not depreciated or amortised while they are classified as held for sale. Interest and other expenses attributable to the liabilities of a disposal group classified as held for sale continue to be recognised.

Non-current assets classified as held for sale and the assets of a disposal group classified as assets held for sale are presented separately, as current assets, from the other assets in the balance sheet. The liabilities of a disposal group classified as held for sale are presented separately, as current liabilities, from other liabilities in the balance sheet. m) Trade and Other Payables These amounts represent liabilities for goods and services provided to the Group prior to the end of the financial year which are unpaid. n) Borrowings Borrowings are initially recognised at fair value, net of transaction costs incurred. Borrowings are subsequently measured at amortised cost. Any difference between the proceeds (net of transaction costs) and the redemption amount is recognised in the income statement over the period of the borrowings using the effective interest method.

Convertible bonds are separated into liability and derivative liability components (being the bondholders’ conversion option) and each component is recognised separately. On initial recognition, the fair value of the liability component of a convertible bond is determined using a market interest rate for an equivalent non-convertible bond. This amount is recorded as a liability on an amortised cost basis using the effective interest method until extinguished on conversion or maturity of the bonds. The fair value of the derivative liability component (see note 2q) is determined using a Black-Scholes option pricing model, and this amount is recorded as a liability.

Borrowings are removed from the balance sheet when the obligation specified in the contract is discharged, cancelled or expired. The difference between the carrying amount of a financial liability that has been extinguished or transferred to another party and the consideration paid, including any non-cash assets transferred or liabilities assumed, is recognised in finance income or costs.

Borrowings are classified as current liabilities unless the Group has an unconditional right to defer settlement of the liability for at least 12 months after the balance sheet date.

Heritage Oil Limited Annual Report & Accounts 2008 61 Notes to Consolidated Financial Statements continued

2 Significant Accounting Policies continued o) Borrowing Costs Borrowing costs incurred for the construction of any qualifying asset are capitalised during the period of time that is required to complete and prepare the asset for its intended use or sale. Other borrowing costs are expensed.

The capitalisation rate used to determine the amount of borrowing costs to be capitalised is the weighted average interest rate applicable to the Group’s outstanding borrowings during the year. For the year ended 31 December 2008, this was 12.01% (31 December 2007 – 10.70%). p) Provisions Asset Retirement Obligations Provision is made for the estimated cost of any asset retirement obligations when the Group has a present legal or constructive obligation as a result of past events, it is probable that an outflow of resources will be required to settle the obligation and the amount has been reliably estimated. Provisions are not recognised for future operating losses. Asset retirement obligation expense is capitalised in the relevant asset category unless it arises from the normal course of production activities.

Provisions are measured at the present value of management’s best estimate of expenditure required to settle the present obligation at the balance sheet date. The discount rate used to determine the present value reflects current market assessments of the time value of money and the risks specific to the liability.

Subsequent to the initial measurement of the asset retirement obligation, the obligation is adjusted at the end of each year to reflect the passage of time and changes in the estimated future cash flows underlying the obligation. The increase in the provision due to the passage of time is recognised as finance costs whereas increase due to changes in the estimated future cash flows are capitalised. q) Derivative Financial Liabilities Derivatives are initially recognised at fair value on the date a derivative contract is entered into and are subsequently remeasured to their fair value at each reporting date. Changes in the fair value are recognised immediately in the income statement. r) Revenue Recognition Revenue from the sale of petroleum and natural gas is recognised at the fair value received or receivable and is recorded when the significant risks and rewards of ownership of the product are transferred to the buyer. For sales of oil and gas this is usually when legal title passes to the external party which occurs on shipment of oil and gas to the buyer. Interest income is recognised on a time proportion basis using the effective interest method. s) Income Taxes Current income tax is based on taxable profit for the year. Taxable profit differs from profit as reported in the income statement because it excludes items that are never taxable or deductible. The Group’s current tax assets and liabilities are calculated using tax rates that have been enacted or substantively enacted by the balance sheet date.

Deferred income tax is provided in full, using the balance sheet method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated financial statements. Deferred income tax is determined using tax rates (and laws) that have been enacted or substantively enacted by the balance sheet date and are expected to apply when the related deferred income tax asset is realised or the deferred income tax liability is settled.

Deferred tax assets are recognised for deductible temporary differences and unused tax losses only if it is probable that future taxable amounts will be available to utilise those temporary differences and losses.

Deferred tax assets and liabilities are offset when there is a legally enforceable right to offset current tax assets and liabilities and when the deferred tax balances relate to the same taxation authority. t) Foreign Currency Translation Items included in the financial statements of each of the Company’s consolidated subsidiaries are measured using the currency of the primary economic environment in which the subsidiary operates (“the functional currency”). The Company’s consolidated financial statements are presented in US dollars, which is the Company’s functional and presentation currency.

Foreign currency transactions are translated into the respective functional currencies of Group entities 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 recognised in the income statement.

62 Heritage Oil Limited Annual Report & Accounts 2008 2 Significant Accounting Policies continued The results and financial position of all the Company’s consolidated subsidiaries (none of which has a functional currency that is the currency of a hyperinflationary economy) that have a functional currency different from the presentation currency are translated into the presentation currency as follows: i) assets and liabilities for each balance sheet presented are translated at the closing rate at the date of that balance sheet; ii) income and expenses for each year are translated at average exchange rates (unless this is not a reasonable approximation of the cumulative effect of the rates prevailing on the transaction dates, in which case income and expenses are translated at the dates of the transactions); and iii) all resulting exchange differences are recognised as either income or expense in a separate component of equity.

Foreign currency loans and overdrafts are designated as, and are considered to be, hedges of the exchange rate exposure inherent in foreign currency net investments and, to the extent that the hedge is effective, exchange differences giving rise to changes in the carrying value of foreign currency loans are also recognised as income or expense directly in equity. All other exchange differences giving rise to changes in the carrying value of foreign currency loans and overdrafts are recognised in the income statement.

When a foreign operation is sold, a proportionate share of the cumulative exchange differences previously recognised in equity are recognised in the income statement, as part of the gain or loss on sale where applicable. u) Share-Based Compensation Plans The Group applies the fair value method of accounting to all equity classified share-based compensation arrangements for both employees and non-employees. Compensation cost of equity classified awards to employees are measured at fair value of the awards at the time when the services are rendered at the grant date and recognised over the periods during which the employees become unconditionally entitled to the options. The compensation cost is charged to the income statement with a corresponding increase in equity. The amount recognised as an expense is adjusted to reflect the actual number of share options that vest.

The compensation cost of equity classified awards to non-employees is initially measured at fair value, and periodically remeasured to fair value until the non-employees’ performance is complete, and recognised over their vesting period with a corresponding increase to share-based payment reserve. Upon the exercise of the award, consideration received is recognised in equity. See note 21. v) Share Capital Ordinary and Exchangeable Shares are classified as share capital. Incremental costs directly attributable to the issue of new shares or options are shown in equity as a deduction, net of tax, from the proceeds.

If the Company re-acquires its own equity instruments the cost is deducted from equity and the associated shares are cancelled. w) Earnings per Share Basic earnings per share is calculated by dividing the profit attributable to equity holders of the Company by the weighted average number of Ordinary Shares outstanding during the financial period. The rights of different classes of shares are the same and therefore economically equivalent. As such, Ordinary and Exchangeable Shares are treated as one class of shares for the earnings per share calculation.

Diluted earnings per share adjusts the figures used in the determination of basic earnings per share to take into account the after income tax effect of interest and other financing costs associated with dilutive potential Ordinary Shares and the weighted average number of shares assumed to have been issued for no consideration in relation to dilutive potential Ordinary Shares.

The if-converted method used in the calculation of diluted earnings per share assumes the conversion of convertible securities at the later of the beginning of the reported period or issuance date, if dilutive. In all cases, the weighted average number of shares used has been adjusted to reflect the effective one for ten share split that took place as part of the corporate reorganisation described in note 1. x) New Accounting Standards and Interpretations Certain new accounting standards and interpretations have been published that are not mandatory for the year ended 31 December 2008. The Company’s assessment of the impact of these new standards and interpretations which have not been adopted is set out below. i) IFRS 8, “Operating segments” (effective from 1 January 2009), replaces International Accounting Standard (“IAS”) 14 and aligns segment reporting with the requirements of the US standard Statement of Financial Accounting Standards (“SFAS”) 131, “Disclosures about segments of an enterprise and related information”. The new standard requires a “management approach”, under which segment information is presented on the same basis as that used for internal reporting purposes. The expected impact is still being assessed by management, but is expected to only impact the disclosures of the Group.

The following standard is assessed not to have any impact on the Company’s financial statements: i) IAS 23 (Amendment), “Borrowing costs” (effective from 1 January 2009), requires the Group to capitalise borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset (one that takes a substantial period of time to get ready for use or sale) as part of the cost of that asset. The Group currently applies the capitalisation approach to borrowing costs.

Heritage Oil Limited Annual Report & Accounts 2008 63 Notes to Consolidated Financial Statements continued

2 Significant Accounting Policies continued The following amendments have been published, but have not been applied in these financial statements: i) IFRS 2 (Amendment), Share-based payment – Vesting Conditions and Cancellations: effective for accounting periods commencing on or after 1 January 2009; i) IFRS 3 (Amendment) Business Combinations: effective for accounting periods commencing on or after 1 July 2009; iii) IAS 1 (Amendment), Presentation of Financial Statements: effective for accounting periods commencing on or after 1 January 2009; and iv) IAS 27 (Amendment), Consolidated and Separate Financial Statements: effective for accounting periods commencing on or after 1 July 2009.

The Directors do not anticipate that the adoption of these amendments will have a material impact on the Group’s financial statements in the period of initial application.

3 Risk Management The Group’s activities expose it to a variety of financial risks that arise as a result of its exploration, development, production, and financing activities. The Group’s overall risk management programme focuses on the unpredictability of financial markets and seeks to minimise potential adverse effects on the Group’s financial performance. a) Financial Risk Management i) Foreign Exchange Risk Foreign exchange risk arises when transactions and recognised assets and liabilities of the Group entity concerned are denominated in a currency that is not the Company’s functional currency. The Group operates internationally and is exposed to foreign exchange risk arising from currency exposures to the US dollar.

There are no forward exchange rate contracts in place at, or subsequent to, 31 December 2008.

At 31 December 2008, if the Canadian dollar had strengthened/weakened by 10% against the US dollar with all other variables held constant, the loss for the year would have been $122,403 (31 December 2007 – $2,978,702) higher/(lower), mainly as a result of foreign exchange gains/losses on translation of Canadian dollar denominated general and administrative expenses and cash in bank. Profit is more sensitive to movement of Canadian/US dollar exchange rates in 2007 than 2008 because of significantly higher general and administrative expenses in 2007 in comparison with 2008.

At 31 December 2008, if the Russian rouble had strengthened/weakened by 10% against the US dollar with all other variables held constant, the loss for the year would have been $(513,633) (31 December 2007 – $(329,361)) higher/(lower), mainly as a result of foreign exchange gains/losses on translation of Russian rouble denominated cash in bank and monetary assets and liabilities.

At 31 December 2008, if the Pounds Sterling had strengthened/weakened by 10% against the US dollar with all other variables held constant, the loss for the year would have been $605,907 (31 December 2007 – $343,011) higher/(lower), mainly as a result of Pounds Sterling denominated general and administrative expenses and foreign exchange gains/losses on translation of Pounds Sterling denominated long-term loan.

At 31 December 2008, if the Swiss franc had strengthened/weakened by 10% against the US dollar with all other variables held constant, the loss for the year would have been $(299,806) (31 December 2007 – $(420,274)) higher/(lower), mainly as a result of foreign exchange gains/losses on translation of Swiss franc denominated cash at bank. ii) Commodity Price Risk The Company is exposed to commodity price risk to the extent that it sells its entitlement to petroleum, condensate and liquid petroleum gas production on a floating price basis. The Company may consider partly mitigating this risk in the future.

The table below summarises the impact of increases/decreases of the relevant oil/condensate/LPG benchmark on the Company’s loss for the year. The analysis is based on the assumption that commodity prices had increased/decreased by 5% with all other variables held constant: Year ended 31 December 2008 2007 $ $ Brent light crude 191,850 85,886 Condensate 48,190 77,8 31 LPG 14,751 21,759 254,791 185,476

The loss for the year would increase/decrease as a result of commodity revenues received.

64 Heritage Oil Limited Annual Report & Accounts 2008 3 Risk Management continued iii) Interest Rate Risk The Group had fixed rate long-term debt and fixed rate convertible bonds in the years under review, therefore, it was not exposed to interest rate risk with respect to these fixed-rate borrowings. In October 2007, a wholly-owned subsidiary of the Company received a long-term loan of $9,450,000 with a variable rate of LIBOR plus 1.6% (note 16). An increase/decrease of LIBOR by 1% would result in an increase/decrease of the Company’s loss for the year by $73,375 (31 December 2007 – $17,325). iv) Credit Risk All of the Company’s production was derived from Russia and Oman. In 2007 and 2008, the Company made all of its production sales, at any point in time, in each country to a single customer for each commodity. Accordingly, substantially all the Company’s accounts receivables from petroleum and natural gas sales were from a maximum of three customers during these years.

Trade debtors of the Company are subject to internal credit review to minimise the risk of non-payment. The Company does not anticipate any defaults as it transacts with creditworthy counterparties. No credit limits were exceeded during the reporting years and management does not expect any losses from non-performance by these counterparties.

The Company is also exposed to credit risk in relation to regular joint venture billings which are typically outstanding for one month and in relation to its cash balances held with the reputable banks. v) Liquidity Risk Liquidity risk is the risk that the Group will not have sufficient funds to meet liabilities. Cash forecasts identifying liquidity requirements of the Group are produced quarterly. These are reviewed regularly to ensure sufficient funds exist to finance the Company’s current operational and investment cash flow requirements.

Management monitors rolling forecasts of the Company’s cash position on the basis of expected cash flow.

The Group had available cash of $91 million at 31 December 2008. Based on its current plans and knowledge, its projected capital expenditure and operating cash requirements, the Group has sufficient cash to finance its current plans for at least 12 months from the date of approval of the financial statements, but further financing is likely to be required to meet expenditures planned for the second half of 2010.

The Company’s financial liabilities consist of trade and other payables and borrowings. Trade and other payables are due within 12 months, and borrowings fall due as outlined in note 24. b) Capital Risk Management The Company’s objectives when managing capital are to safeguard the Company’s ability to continue as a going concern in order to provide returns for shareholders and benefits for other stakeholders and to maintain an optimal capital structure to reduce the cost of capital. In accordance with the terms of the convertible bonds, the Company shall not, over the life of the convertible bonds (note 16), make any dividend payment or share repurchase.

The Company monitors capital on the basis of the gearing ratio. This ratio is calculated as net debt divided by total capital. Net debt is calculated as total borrowings (including “borrowings” and “trade and other payables” as shown in the consolidated balance sheet) less cash and cash equivalents. Total capital is calculated as ‘equity’ as shown in the consolidated balance sheet plus net debt.

As at 31 December 2008 2007 $ $ Total borrowings 237,462,452 216,434,761 Less cash and cash equivalents (note 14) (90,620,385) (230,089,323) Net debt (cash) 146,842,067 (13,654,562) Total equity 163,835,069 193,193,432 Total capital 310,677,136 193,193,432 Gearing ratio 47% 0%

This increase in the gearing ratio during 2008 resulted primarily from an increase in accounts payable at 31 December 2008 due to the significant exploration activities at the end of the year and a decrease in equity due to the net loss incurred during 2008.

Heritage Oil Limited Annual Report & Accounts 2008 65 Notes to Consolidated Financial Statements continued

4 Critical Accounting Estimates, Assumptions and Judgements In the process of applying the Company’s accounting policies, which are described in note 2, management makes estimates and assumptions concerning the future. The resulting accounting estimates will, by definition, seldom equal the related actual results. The estimates and assumptions that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year are discussed below: a) Recoverability of Exploration and Evaluation Costs Under the modified full cost method of accounting for E&E costs, certain costs are capitalised as intangible assets by reference to appropriate cost pools, and are assessed for impairment when circumstances suggest that the carrying amount may exceed its recoverable value.

Such circumstances include, but are not limited to: i) the period for which the entity has the right to explore in the specific area has expired during the period, or will expire in the near future, and is not expected to be renewed; ii) substantive expenditure on further exploration for and evaluation of mineral resources in the specific area is neither budgeted nor planned; iii) exploration for, and evaluation of, mineral resources in the specific area have not led to the discovery of commercially viable quantities of mineral resources and the entity has decided to discontinue such activities in the specific area; and iv) sufficient data exist to indicate that, although a development in the specific area is likely to proceed, the carrying amount of the exploration and evaluation asset is unlikely to be recovered in full from successful development or by sale.

This assessment involves judgement as to: (i) the likely future commerciality of the asset and when such commerciality should be determined; (ii) future revenues and costs pertaining to any wider cost pool with which the asset in question is associated; and (iii) the discount rate to be applied to such revenues and costs for the purpose of deriving a recoverable value. Note 10 discloses the carrying amounts of the Group’s E&E assets. Consequently, major uncertainties affect the recoverability of these costs which is dependent on the Group achieving commercial production or the sale of the assets. Note 24 discloses contingencies relating to the title risks. The Company assessed whether these risks are contingencies or indicators of impairment and concluded that they are contingencies. b) Reserve Estimates Estimates of recoverable quantities of proven and probable reserves include assumptions regarding commodity prices, exchange rates, discount rates, production and transportation costs for future cash flows. It also requires interpretation of complex and difficult geological and geophysical models in order to make an assessment of the size, shape, depth, and quality of reservoirs and their anticipated recoveries. The economic, geological and technical factors used to estimate reserves may change from period to period. Changes in reported reserves can impact asset carrying values and the asset retirement obligation due to changes in expected future cash flows. Reserves are integral to the amount of depletion charged to the income statement and the calculation of inventory.

The level of estimated commercial reserves is also a key determinant in assessing whether the carrying value of any of the Group’s development and production assets has been impaired. c) Fair Value of Financial Instruments The Group’s accounting policies and disclosures require the determination of the fair value of financial instruments. Fair values have been determined for measurement and/or disclosure purposes based on the following methods: i) Non-Derivative Financial Instruments These comprise investments in equity and debt securities, trade and other receivables, cash and cash equivalents, loans and borrowings and trade and other payables. Non-derivative financial instruments are recognised initially at fair value plus, for instruments not at fair value through the income statement, any directly attributable transaction costs.

Fair value is calculated based on the present value of future principal and interest cash flows, discounted at the applicable market rate of interest at the reporting date. ii) Derivatives Derivatives are recognised initially at fair value; attributable transaction costs are recognised in the income statement when incurred. Subsequent to initial recognition, derivatives are measured at fair value. Embedded derivatives are separated from the host contract and accounted for separately if the economic characteristics and risks of the host contract and the embedded derivative are not closely related, a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative, and the combined instrument is not measured at fair value through the income statement.

The fair value of derivative financial instruments is based on their listed market prices, if available. If a listed market price is not available, then fair value is estimated by discounting the difference between the contractual forward price and the current forward price for the residual maturity of the contract using a risk-free interest rate (based on government bonds).

66 Heritage Oil Limited Annual Report & Accounts 2008 4 Critical Accounting Estimates, Assumptions and Judgements continued iii) Compound Financial Instruments Compound financial instruments issued by the Group comprise convertible bonds that can be converted to share capital at the option of the holder, and the number of shares to be issued does not vary with changes in their fair value.

The convertible bonds are separated into liability and derivative liability components (being the bondholders’ conversion option). The liability component of a compound financial instrument is recognised initially at fair value, determined by reference to market interest rates for equivalent bonds which do not contain conversion features. Subsequent to initial recognition, the liability component is measured at amortised cost using the effective interest method. The fair value of the derivative liability component is determined using a Black-Scholes option-pricing model and this amount is recorded as a liability. The Black-Scholes model contains assumptions and determinations pertaining to volatility, risk-free interest rates, and the terms of the options (see note 22).

5 Segment Information The Group has a single class of business which is international exploration, development and production of petroleum oil and natural gas.

In 2007 and 2008, the Group operated in a number of geographical areas based on the location of operations and assets; Russia, Oman, Uganda, DRC, Kurdistan Region of Iraq, Pakistan, Tanzania, Malta and Mali.

Year ended 31 December 2008 Depreciation, External Segment Total Total Capital depletion and revenue result assets liabilities additions amortisation $ $ $ $ $ $ Russia 3,836,991 (7,643,812) 48,123,180 446,935 4,674,969 1,070,410 Oman 1,258,817 (2,850,270) 28,065,282 3,279,402 17,983,358 264,003 Uganda – – 154,684,138 30,485,069 55,791,804 – DRC – – 1,606,765 – 760,545 – Kurdistan Region of Iraq – – 43,774,646 6,467,567 41,781,416 – Pakistan – – 1,560,330 – 607,924 – Tanzania – (204,515) 13,785,019 659,604 13,129,738 – Mali – – 1,682,381 – 1,012,320 – Malta – (14,831) 8,685,637 3,469 2,052,831 – Unallocated – Corporate – (30,589,823) 99,330,143 196,120,406 870,924 1,015,071 5,095,808 (41,303,251) 401,297,521 237,462,452 138,665,829 2,349,484

Year ended 31 December 2007 Depreciation, External Segment Total Total Capital depletion and revenue result assets liabilities additions amortisation $ $ $ $ $ $ Russia 1,717,717 (2,653,941) 46,384,681 2,874,575 24,306,477 558,604 Oman 1,991,786 1,027,069 13,817,039 331,379 4,408,453 370,868 Uganda1 – (38,359) 92,398,347 6,036,508 32,993,911 – DRC – – 1,296,220 – 710,751 – Kurdistan Region of Iraq2 – (2,273,220) 1,622,934 – 1,622,934 – Pakistan – (311,778) 952,406 – 952,406 – Mali – (159,947) 213,145 – 213,146 – Malta – (32,846) 6,517,779 – 6,517,779 – Unallocated – Corporate – (78,722,573) 246,425,642 207,192,299 11,765,343 962,818 3,709,503 (83,165,595) 409,628,193 216,434,761 83,491,200 1,892,290

1 Uganda includes exploration activity as well as operating expenses relating to drilling services. 2 Kurdistan Region of Iraq information was not a separate geographic segment as defined in note 2c until October 2007. However, information is presented to conform with the current year presentation.

Exploration expenditures in respect of E&E assets relate to pre-licence costs which are expensed in accordance with IFRS 6.

Heritage Oil Limited Annual Report & Accounts 2008 67 Notes to Consolidated Financial Statements continued

6 Other Finance Costs Year ended 31 December 2008 2007 $ $ Interest on long-term debt 963,965 678,199 Interest on convertible bonds 12,640,000 12,573,959 Accretion of convertible debt 4,161,215 3,601,636 Accretion of asset retirement obligation 22,659 7,6 3 6 17,787,839 16,861,430 Amount capitalised (6,530,652) (4,863,682) Finance costs expensed 11,257,187 11,9 97,74 8

Finance costs are capitalised in various balance sheet categories.

7 Income Tax Expense The Group is subject to income taxes in Canada, Uganda and Russia. All of the Group’s operating activities are outside of Jersey.

In Oman, the tax rate applicable to the Group’s operations is considered to be nil as in this jurisdiction the Group is subject to a production sharing agreement.

In Canada, Uganda and Russia, the Group has available tax deductions of $31,438,808 (31 December 2007 – $37,624,932) and tax losses of $93,531,776 (31 December 2007 – $77,749,022), of which $50,915,869 expires from 2009 to 2028, and the remaining $42,615,907 does not have an expiry period. No deferred tax assets have been recognised for the benefit of tax deductions and tax losses because realisation of the deferred tax assets in the foreseeable future is not sufficiently likely.

Factors affecting current tax charge for the year: Year ended 31 December 2008 2007 $ $ Net loss before tax (41,303,251) (83,165,595) Standard tax rate 0% 32.12% Tax on loss at standard rate – (26,712,789) Effect of (higher)/lower tax rates in foreign jurisdiction (5,436,526) 215,472 Effective weighted average tax rate 13.16% 31.86% Change in statutory tax rate 626,190 1,165,447 Expenses not deductible for tax purposes 117,112 22,010,883 Foreign exchange gains/(losses) 2,055,325 (687,333) Effect of tax losses not recognised 2,637,899 4,008,320 Current tax charge – –

As at 31 December 2008 2007 $ $ The balance comprises temporary differences attributable to: Available tax losses and deductions 26,649,554 24,011,654 Deferred tax asset (unrecognised) 26,649,554 24,011,654

68 Heritage Oil Limited Annual Report & Accounts 2008 8 Staff Costs The average number of employees (including Directors) and consultants employed/contracted by the Group during the year, analysed by category was: Year ended 31 December 2008 2007 Jersey 2 – Canada 5 5 Switzerland – 3 Russia 40 41 Europe 27 14 Uganda 28 21 Kurdistan Region of Iraq 14 5 Tanzania 10 – South Africa 6 4 Total 132 93

The aggregate payroll expenses of those employees were as follows: Year ended 31 December 2008 2007 $ $ Salaries and other short-term benefits 15,573,451 12,871,099 Share-based compensation 12,080,813 39,001,420 Total employee remuneration 27,654,264 51,872,519 Capitalised portion of total remuneration 11,435,283 14, 217,49 5

Key management compensation was: Year ended 31 December 2008 2007 $ $ Salaries and other short-term benefits 4,448,302 4,263,647 Share-based compensation 7,498,703 28,313,954 11,947,005 32,577,601

9 Disposals On 9 March 2007, the Group disposed of its previously consolidated 65% interests in Natural Pipelay Worldwide Limited (“NPWL”) and Naturalay Technologies Limited (“Naturalay”) in consideration for 605,000 Common Shares in a private company named SeaDragon. The fair value of the Common Shares consideration received of $2,420,000, which was based on the most recent private placement by SeaDragon in October 2006, resulted in a gain of $1,077,132 on the disposal. The Group’s CFO is a director and CFO of SeaDragon.

Below is an analysis of the assets and liabilities of NPWL and Naturalay as at 9 March 2007, the date of sale completion: 9 March 2007 $ Assets Intangible development costs 1,642,868 Liabilities Trade and other payables 300,000 Net assets 1,342,868

The gain on disposal of the previously consolidated subsidiary has been derived as follows: $ Consideration received Fair value of shares 2,420,000 Total disposal consideration 2,420,000 Less: carrying amount of net assets sold 1,342,868 Gain on disposal of subsidiaries 1,077,132

Heritage Oil Limited Annual Report & Accounts 2008 69 Notes to Consolidated Financial Statements continued

10 Intangible Exploration Assets 31 December 2008 2007 $ $ Balance – beginning of year 102,862,754 5 4,767,3 32 Exchange differences (1,448,654) 251,338 Additions 115,136,798 57,3 37,19 0 Assets transferred to property, plant and equipment (note 11) (5,204,861) (9,493,106) Balance – end of year 211,346,037 102,862,754

No assets have been pledged as security.

The balances at the end of the years are as follows: 31 December 2008 2007 $ $ Russia 11,365,662 18,019,174 Oman 551,083 550,867 Uganda 130,032,034 74,240,229 DRC 1,506,765 746,219 Kurdistan Region of Iraq 43,404,350 1,622,934 Pakistan 1,560,330 952,406 Malta 8,570,610 6,517,779 Mali 1,225,465 213,146 Tanzania 13,129,738 – Balance – end of year 211,346,037 102,862,754

In many of the countries in which the Group operates, land title systems are not developed to the extent found in many industrial countries and there may be no concept of registered title. The risk of title disputes associated with the Kurdistan Region of Iraq, the DRC and Malta is described in note 24.

70 Heritage Oil Limited Annual Report & Accounts 2008 11 Property, Plant and Equipment 31 December 2008 2007 $ $ Petroleum and natural gas interests 68,121,295 42,056,745 Drilling and barge equipment 3,544,969 3,544,969 Land and building 11,984,701 11,984,701 Other 15,323,857 14,452,933 Property, plant and equipment, at cost 98,974,822 72,039,348 Accumulated depletion, depreciation and amortisation (10,935,604) (7,813,430) Net book amount 88,039,218 64,225,918 Reconciliation of movements during the year Petroleum and natural gas interests Cost – beginning of year 42,056,745 18,091,216 Accumulated depletion and depreciation – beginning of year (3,981,438) (3,051,966) Net book amount – beginning of year 38,075,307 15,039,250 Net book value – beginning of year 38,075,307 15,039,250 Exchange differences (3,426,524) 335,094 Additions 27,533,291 14,137,329 Assets transferred from intangible exploration (note 10) 5,204,861 9,493,106 Depletion and depreciation (1,290,992) (929,472) Write-down of proved petroleum and natural gas interests (3,247,078) – Net book amount – end of year 62,848,865 38,075,307 Cost – end of year 68,121,295 42,056,745 Accumulated depletion and depreciation – end of year (5,272,430) (3,981,438) Net book amount – end of year 62,848,865 38,075,307 Drilling and barge equipment Cost – beginning of year 3,544,969 3,544,969 Accumulated depletion and depreciation – beginning of year (2,147,503) (3 47,741) Net book amount – beginning of year 1,397,466 3,197, 228 Net book amount – beginning of year 1,397,466 3,197, 228 Additions – – Depletion and depreciation – – Impairment (749,955) (1,799,762) Net book amount – end of year 647,511 1,3 97,46 6 Cost – end of year 3,544,969 3,544,969 Accumulated depletion and depreciation – end of year (2,897,458) (2,147,50 3) Net book amount – end of year 647,511 1,3 97,46 6 Land and building Cost – beginning of year 11,984,701 11,984,701 Accumulated depletion and depreciation – beginning of year (452,329) (313,151) Net book amount – beginning of year 11,532,372 11,671,550 Net book amount – beginning of year 11,532,372 11,671,550 Depletion and depreciation (139,178) (139,178) Net book amount – end of year 11,393,194 11,532,372 Cost – end of year 11,984,701 11,984,701 Accumulated depletion and depreciation – end of year (591,507) (452,329) Net book amount – end of year 11,393,194 11,532,372 Other Cost – beginning of year 14,452,933 2,687,590 Accumulated depletion and depreciation – beginning of year (1,232,160) (408,520) Net book amount – beginning of year 13,220,773 2,279,070

Heritage Oil Limited Annual Report & Accounts 2008 71 Notes to Consolidated Financial Statements continued

11 Property, Plant and Equipment continued 31 December 2008 2007 $ $ Net book amount – beginning of year 13,220,773 2,279,070 Additions 870,924 11,765,343 Depletion and depreciation (942,049) (823,640) Net book amount – end of year 13,149,648 13,220,773 Cost – end of year 15,323,857 14,452,933 Accumulated depletion and depreciation – end of year (2,174,209) (1,232,160) Net book amount – end of year 13,149,648 13,220,773

The corporate office which represents the land and building category and the corporate jet included in the other category serve as security for long-term loans (note 16).

The carrying value of the drilling rig was written down to nil because management does not expect that there will be significant drilling services revenues generated from the use of the drilling rig. This resulted in an impairment write-down of $749,955 (2007 – $1,799,762) recognised in the income statement during the year ended 31 December 2008. Impairment tests were performed for development and producing assets for a variety of scenarios using after tax discount rates in the range from 10% to 15%. The trigger for the impairment tests was a decline in oil and gas prices during 2008. As a result of the impairment test, the carrying value of the petroleum and natural gas interest in Oman was written down to its fair value of $28 million. This resulted in an impairment write-down of $3,247,078 (2007 – nil) recognised in the income statement during the year ended 31 December 2008. The impairment tests indicated that the fair value of the Company’s development and producing assets in Russia significantly exceeds its book value.

12 Other Financial Assets 31 December 2008 2007 $ $ Investment in warrants 107,501 1,821,201 Investment in unlisted securities (note 9) 3,223,000 3,223,000 3,330,501 5,044,201

The investment in Afren Plc warrants is classified as held for trading. The investment in unlisted securities represents common shares in a private company named SeaDragon, which is classified as available-for-sale.

There were no other disposals or impairment losses on held for trading or available-for-sale financial assets in the reporting years under these financial statements.

The Company owns 805,832 of the unlisted shares of SeaDragon, representing approximately 15% of the shares outstanding. These are carried at a value of $4 per share, based on the most recent private placement of SeaDragon on 26 October 2006. At year end, the value of the shares could not be measured reliably as SeaDragon is in the process of financial reorganisation and there is a wide range of possible values for the shares and the resulting outcome of the alternatives cannot be determined. Management of the Company has no reason to believe that the value of the investment in the shares of SeaDragon is lower than the carrying value and, therefore, there is no need for an impairment write-down of the Company’s investment in the shares of SeaDragon. The Company does not plan to dispose of its investment in shares of SeaDragon in the forseeable future.

13 Trade and Other Receivables 31 December 2008 2007 $ $ Trade receivables 3,087 318,417 Other receivables 6,898,424 6,440,844 6,901,511 6,759,261

Trade receivables are due within 30 days from the invoice date. Joint ventures billings are typically paid within 30 days from the invoice date. No interest is charged on the receivables. The carrying amount of trade and other receivables approximates to their fair value.

The maximum exposure to credit risk at the reporting date is the fair value of each class of receivable.

72 Heritage Oil Limited Annual Report & Accounts 2008 13 Trade and Other Receivables continued As of 31 December 2008, trade and other receivables of $6,901,511 (31 December 2007 – $6,759,261) were neither past due nor impaired. Trade and receivables relate to independent customers and joint ventures partners for whom there is no recent history of default. The ageing analysis of these trade and other receivables is as follows: 31 December 2008 2007 $ $ Up to 3 months 5,978,468 4,964,480 3 to 6 months 704,588 1,794,781 6 to 12 months 218,455 – 6,901,511 6,759,261

Trade and other receivables analysed by category are as follows: 31 December 2008 2007 $ $ US dollars 6,185,267 4,050,828 Russian roubles 567,052 2,064,084 Swiss francs 109,968 528,035 Canadian dollars 5,073 100,032 GB pounds sterling 9,987 16,282 Euros 24,164 – 6,901,511 6,759,261

14 Cash and Cash Equivalents 31 December 2008 2007 $ $ Cash at bank and in hand 90,620,385 230,089,323

Cash at bank and in hand includes cash held in interest-bearing accounts.

15 Trade and Other Payables Due Within One Year 31 December 2008 2007 $ $ Trade payables 45,714,400 14,055,027 Other payables and accrued liabilities 9,037,368 10,591,504 54,751,768 24,646,531

Trade and other payables and accrued liabilities comprise current amounts outstanding for trade purchases and ongoing costs. The carrying amount of trade and other payables approximates to their fair value.

16 Borrowings 31 December 2008 2007 $ $ Non-current borrowings Convertible bonds – unsecured 141,319,489 137,213,274 Non-current portion of long-term debt 14,290,493 17,0 4 0,427 155,609,982 154,253,701 Long-term debt – secured Current 595,418 623,640 Non-current 14,290,493 17,0 4 0,427 14,885,911 17,664,067

Heritage Oil Limited Annual Report & Accounts 2008 73 Notes to Consolidated Financial Statements continued

16 Borrowings continued 2007 Convertible Bonds On 16 February 2007, the Company raised $165,000,000 by completing a private placement of convertible bonds. Issue costs amounted to $6,979,268 resulting in net proceeds of $158,020,732. The Company issued 1,650 unsecured convertible bonds at par, which have a maturity of five years and one day and an annual coupon of 8% payable semi-annually on 17 August and 17 February of each year. Bondholders have the right to convert the bonds into Ordinary Shares at a price of $4.70 per share (after one for ten split (note 1)) at any time. The number of Ordinary Shares receivable on conversion of the bonds is fixed. The Company had the right to redeem, in whole or part, the bonds for cash at any time on or before 16 February 2008, at 150% of par value. This right was not exercised. Proceeds were used to finance the redemption of all outstanding 10% convertible bonds issued on 26 March 2006, at a premium of 150% and for general corporate funding purposes.

Bondholders have a put option requiring the Company to redeem the bonds at par, plus accrued interest, in the event of a change of control of the Company or revocation or surrender of the Zapadno Chumpasskoye Licence in Russia. In the event of a change of control and redemption of the bonds or exercise of the conversion rights, a cash payment of up to $19,700 on each $100,000 bond will be made to the bondholder, the amount of which depends upon the date of redemption and market value of shares at the date of any change of control event. The bonds included conversion features which in certain circumstances could be settled in cash and so these features represent a derivative financial instrument which is classified as a liability.

The fair value of the liability component of the bonds (net of issue costs) was estimated at $140,154,215. The fair value of the derivative financial liability representing the bondholders’ conversion feature (note 22) (net of issue costs) was estimated at $17,866,517 on 16 February 2007. The difference between the $165,000,000 due on maturity and the initial liability component is accreted using the effective interest method and is recorded as finance costs. The derivative financial instrument is recorded at fair value with resulting gains and losses recorded in finance income and costs.

In July 2007, a bondholder with $7 million of bonds gave notice of the exercise of 70 bonds and received 148,937 Common Shares in August 2007. As a result of this conversion, $8,944,487 was transferred to Share Capital from convertible bonds, derivative liability component of convertible bonds and accrued liabilities.

In April 2009, bondholders with $5.9 million of bonds gave notices of the exercise of 59 bonds. These bondholders received 1,255,317 Ordinary Shares (see note 26).

Long-Term Debt In January 2005, a wholly-owned subsidiary of the Company received a sterling denominated loan of £4.5 million to refinance the acquisition of a corporate office. Interest on the loan is fixed at 6.515% for the first five years and is then variable at a rate of London Interbank Offered Rate (“LIBOR”) plus 1.35%. The loan, which is secured on the property, is scheduled to be repaid by 240 instalments of capital and interest at monthly intervals, subject to a residual debt at the end of the term of the loan of $3.5 million (£1,860,000). The current principal balance outstanding as at 31 December 2008 was $6,155,882 (£4.2 million) (31 December 2007 – $8,519,037 (£4.3 million)).

In October 2007, a wholly-owned subsidiary of the Company received a loan of $9,450,000 to refinance the acquisition of the corporate jet. Interest on the loan is variable at a rate of LIBOR plus 1.6% The loan, which is secured on the corporate jet, is scheduled to be repaid by 19 consecutive quarterly installments of principal. Each installment equals to $117,500 with the final installment being $7,217,500. The Corporation provided a corporate guarantee to the lender.

Fair Values At 31 December 2007 and 31 December 2008, the fair values of borrowings are approximately equal to their carrying amounts as the facilities bear interest at market rates of interest.

17 Provisions The Group’s asset retirement obligation results from net ownership interests in petroleum and natural gas assets including well sites and gathering systems. The Group estimates the total undiscounted inflation adjusted amount of cash flows required to settle its asset retirement obligation to be approximately $1,331,359, which is expected to be incurred in the period between 2012 and 2024. A cost pool specific discount rate, related to the liability, of 9% was used to calculate the fair value of the asset retirement obligation in Uganda and Russia (2007 – 9%) and 10% in the Kurdistan Region of Iraq in 2008 (2007 – N/A).

A reconciliation of the asset retirement obligation is provided below: 31 December 2008 2007 $ $ Balance – beginning of year 170,899 62,322 Additions 526,250 97,737 Revision (due to change in discount rate) – 3,204 Accretion expense (note 6) 22,659 7,6 3 6 Balance – end of year 719,808 170,899

74 Heritage Oil Limited Annual Report & Accounts 2008 18 Share Capital The Company was incorporated under the Companies (Jersey) Law 1991 (as amended) on 6 February 2008. The Company’s authorised share capital is an unlimited number of Ordinary Shares without par value. At incorporation, there was one Ordinary Share issued at $42. On 22 February 2008, a second Ordinary Share was issued at $41.

As part of the Reorganisation (note 1), the Corporation split its stock such that each existing Common Share of the Corporation was exchanged for either ten Ordinary Shares or ten Exchangeable Shares. The Corporation was a US dollar functional currency entity as is the Company and therefore the balance of Share Capital was carried forward at its historical amount into the financial statements of the Company. The rights of different classes of shares are the same and therefore economically equivalent. As such, Ordinary and Exchangeable Shares were treated as one class of shares for loss per share calculation.

Information about movements in share capital issued before the Reorganisation is presented in the table below on the after split basis, i.e. taking into account, the one for ten split.

Ordinary Shares Year ended Year ended 31 December 2008 | 31 December 2007 Number Amount Number Amount $ $ Balance – beginning of year 254,877,480 217,672,243 220,090,330 24,580,984 Issue of shares 2 83 30,000,000 175,963,414 Exchange of the Common Shares for Exchangeable Shares (4,431,120) (3,784,296) – – Exchange of the Exchangeable Shares for Ordinary Shares 1,182,012 1,009,470 – – Issued on exercise of stock options (note 21) 230,000 611,555 520,000 1,079,031 Issued on conversion of bonds – – 4, 267,150 16,0 4 8,814 Balance – end of year 251,858,374 215,509,055 25 4,877,4 8 0 217,672, 24 3

Special Voting Share Year ended Year ended 31 December 2008 | 31 December 2007 Number Amount Number Amount $ $ Balance – beginning of year – – – – Issued during the year 1 – – – Balance – end of year 1 – – –

Exchangeable Shares of Heritage Oil Corporation each carrying one voting right in the Company

Year ended Year ended 31 December 2008 | 31 December 2007 Number Amount Number Amount $ $ Balance – beginning of year – – – – Exchange of Common Shares for Exchangeable Shares 4,431,120 3,784,296 – – Exchange of Exchangeable Shares for Ordinary Shares (1,182,012) (1,009,470) – – Balance – end of year 3,249,108 2,774,826 – –

Balance of Ordinary Shares of the Company and Exchangeable Shares of HOC – end of year 255,107,482 218,283,881 25 4,877,4 8 0 217,672, 24 3

Heritage Oil Limited Annual Report & Accounts 2008 75 Notes to Consolidated Financial Statements continued

19 Reserves and Retained Earnings/(Deficit) (a) Reserves 31 December 2008 2007 $ $ Available-for-sale investments revaluation reserve 168,000 168,000 Foreign currency translation reserve (220,784) 430,580 (52,784) 598,580 Share-based payments reserve 54,564,393 42,579,779 54,511,609 43,178,359 Movements Available-for-sale investments revaluation reserve Balance – beginning of year 168,000 – Revaluation – 168,000 Balance – end of year 168,000 168,000 Foreign currency translation reserve Balance – beginning of year 430,580 (4,003) Currency translation differences arising during year (651,364) 434,583 Balance – end of year (220,784) 430,580 Share-based payments reserve Balance – beginning of year 42,579,779 2,641,061 Compensation costs – options issued 12,234,715 40,491,888 Transfer to share capital on exercise of options (250,101) (409,363) Options forfeited – (143,807) Balance – end of year 54,564,393 42,579,779

(b) Retained Earnings/(Deficit) 31 December 2008 2007 $ $ Balance – beginning of year (67,657,170) 15,508,425 Net loss for the year (41,303,251) (83,165,595) Balance – end of year (108,960,421) (67,6 57,170)

(c) Nature and Purpose of Reserves i) Available-for-Sale Investments Revaluation Reserve Changes in the fair value and exchange differences arising on translation of available-for-sale investments such as equities, classified as available-for-sale financial assets, are taken to the available-for-sale investments revaluation reserve, as described in note 2k. Amounts are recognised in the income statement when the associated assets are sold or impaired. ii) Foreign Currency Translation Reserve Exchange differences arising on translation of the foreign controlled entity are taken to the foreign currency translation reserve, as described in note 2t. The reserve will be recognised in the income statement when the net investment is disposed. iii) Share-Based Payments Reserve The share-based payments reserve, as described in note 2u, is used to recognise the fair value of options and LTIP awards issued, but not exercised, to employees.

20 Loss per Share The following table summarises the weighted average Ordinary and Exchangeable Shares used in calculating net earnings per share:

Year ended 31 December 2008 2007 Weighted average Ordinary and Exchangeable Shares Basic 254,969,021 227,504,282 Diluted 256,257,622 237,562,9 82

76 Heritage Oil Limited Annual Report & Accounts 2008 20 Loss per Share continued The weighted average number of shares has been adjusted to reflect the effective one for ten share split that took place as part of the corporate reorganisation described in note 18. The reconciling item between basic and diluted weighted average number of Ordinary Shares is the dilutive effect of stock options. A total of 22,232,010 options (31 December 2007 – nil), 4,926,429 of shares relating to the LTIP (31 December 2007 – nil) and 33,617,020 of shares relating to the convertible bonds (31 December 2007 – 33,617,020) were excluded from the above calculation, as they were anti-dilutive.

21 Share-Based Payments Stock Options The Company had a stock option plan whereby certain Directors, officers, employees and consultants of the Group have been granted options to purchase Ordinary Shares. Under the terms of the plan, options granted normally vest one-third immediately and one-third in each of the years following the date granted and have a life of 5 years.

As part of the Reorganisation (note 1) the 2008 Replacement Share Option Scheme (the “2008 Scheme”) was adopted. The 2008 Scheme served as a replacement of the Stock Option Plan of HOC which was cancelled just after the Reorganisation of HOC and its subsidiaries companies which occurred on 31 March 2008. Pursuant to the Reorganisation, the HOC optionholders exchanged each outstanding option to acquire a Common Share in the capital of HOC for ten options to acquire ten Ordinary Shares in the capital of the Company. The HOC optionholders were put in substantially the same economic position in the Company that they were in prior to the Reorganisation. The exercise prices of the options to acquire Ordinary Shares in the capital of the Company are expressed in Pounds Sterling and represent the exercise prices of the HOC’s options, expressed in Canadian dollars, translated at the exchange rate at 31 March 2008.

Information about stock options granted before the Reorganisation is presented in the tables below on the same basis as it is stipulated by the 2008 Scheme, i.e. after taking into account the one for ten exchange and translation of exercise prices to Pounds Sterling.

Ordinary Share options outstanding and exercisable: Year ended Year ended 31 December 2008 | 31 December 2007 Average Average exercise exercise Number price Number price of options (GBP) £ of options (GBP) £ Balance – beginning of year 24,612,010 1.51 8,316,670 1.06 Granted – – 17, 232,010 1.4 3 Exercised (note 18) (230,000) 0.89 (520,000) 0.65 Forfeited – – (416,670) 0.48 Balance – end of year 24,382,010 1.51 24,612,010 1.51 Exercisable – end of year 23,040,343 1.45 15,693,010 1.38

Number of options Remaining Exercise price (GBP) Outstanding Exercisable life (years) £0.48 2,000,000 2,000,000 1.39 £0.81 150,000 150,000 2.48 £1.08–£1.43 18,207,010 18,207,010 2.95 £2.45–£2.51 4,025,000 2,683,333 3.93 24,382,010 23,040,343 2.98

The share-based payment recognised with respect to the stock options in the period ended 31 December 2008 was $9,805,167 (2007 – $40,344,181) out of which $3,671,537 (2007 – $9,043,886) was capitalised.

Long Term Incentive Plan (“LTIP”) On 19 June 2008, the AGM of the Company approved the 2008 LTIP. Under the terms of the plan, the LTIP awards will be in the form of full-value shares (Performance Shares), subject to performance and time-vesting conditions. Eligible employees will normally be considered by the Remuneration Committee for an award once each year. Awards, made, to the Executive Directors of the Company under the LTIP are called First Awards. Participants in the First Award, however, will not be entitled to any further awards until the 2011 financial year. Awards will normally be made during the period of 42 days following the announcement of year end or half-year financial results. Exceptionally, the First Awards under the plan, on 19 June 2008, were permitted to be made within 42 days following approval of the LTIP at the June 2008 AGM.

The plan is intended to apply to Executive Directors and other employees in senior management or leadership roles. By exception, other higher performing and high potential employees may be considered for awards. Participants in the LTIP will not be entitled to any further awards under the 2008 Scheme.

Heritage Oil Limited Annual Report & Accounts 2008 77 Notes to Consolidated Financial Statements continued

21 Share-Based Payments continued The vesting of shares under award are subject to performance conditions agreed by the Remuneration Committee when the award is made. For the First Awards made in 2008 the performance conditions are relative TSR (capital gain plus dividends) performance of the Company versus that of a comparator group of international oil companies and a requirement for the share price of the Company to have increased by 20% over the vesting period of three years. Furthermore there is an additional holding period of one year following the awards vesting.

The Remuneration Committee in consultation with executive reward consultants, approved grants of shares to Executive Directors, senior management and other employees in leadership roles under the LTIP. The maximum annual, individual award for participants who are not executive directors is 250% of base package (expressed as the “face value” of the shares). The First Award to executive directors is 1,200% of base package for the CEO and 800% of base package for the CFO.

The First Awards vest after three years provided that the performance conditions are met. The awards granted to senior management and other employees in leadership roles are in three tranches that vest after three, four and five years respectively, provided that the performance condition is met at that time.

The award would vest in line with the following schedule: Senior management and other First Awards employees in leadership role TSR Performance vs Comparator Group of 18 companies proportion vesting award proportion vesting 3rd place and above 100% of the award 100% of the award 4th place 80% 100% 5th place 50% 100% 6th place 30% 100% 7th place and below 0% 100% 9th place (median) 0% 100% 10th place and below 0% 0%

TSR is measured in comparison to a peer group of 18 oil companies selected based on one of, or a combination of, size (market capitalisation, revenue, turnover, cash expenditure or a combination thereof), area of operations and country of domicile. The TSR measurement is conducted by independent consultants in discussion with the Remuneration Committee.

Since there are market-related conditions the awards of the shares under LTIP were fair valued using the Monte Carlo model which takes into account the market-based performance conditions which effectively estimate the number of shares expected to vest. No subsequent adjustment is made to the fair value charge for shares that do not vest in the event that these performance conditions are not met. Adjustments are, however, made for leavers. The fair value of the awards is recognised as an employee expense with the corresponding increase in equity. The total amount to be expensed is spread over the vesting period during which the employees become unconditionally entitled to the shares and options.

The table below summarises the main assumptions used to fair value the awards made under the above LTIP and the fair values of the shares granted. First Awards Award date 19 June 2008 19 June 2008 19 June 2008 19 June 2008 Vesting period 3 3 4 5 Exercise price nil nil nil nil Share price at date of grant £3.45 £3.45 £3.45 £3.45 Expected volatility 40% 40% 40% 40% Expected dividend yield 0% 0% 0% 0% Fair value as at grant date £1.55 £2.49 £2.61 £2.70 Number of shares granted 3,507,246 473,061 473,061 473,061

The share-based payment recognised with respect to the awards granted in the period ended 31 December 2008 was $2,429,547 out of which $967,632 was capitalised.

78 Heritage Oil Limited Annual Report & Accounts 2008 22 Derivative Financial Liability 31 December 2008 2007 $ $ Convertible bond – conversion option 25,785,476 36,739,990

For details of the convertible bonds, refer to note 16.

The fair value of the convertible bonds conversion option has been estimated using the Black-Scholes option-pricing model at each period end, with changes in the fair value of the conversion option recognised in income during the period. The volatility used in the fair value calculation is 56.13% (31 December 2007 – 53.85%).

23 Related Party Transactions During the year ended 31 December 2008, the Company incurred transportation costs of $134,978 (31 December 2007 – nil) with respect to the services provided by a company indirectly owned by Mr. Anthony Buckingham, CEO and a Director of the Company.

Mr. Atherton, a Director and CFO of the Company, is also a Director and CFO of SeaDragon. The Group acquired 605,000 Common Shares of SeaDragon on 9 March 2007 through the sale of its 65% interest in Pipelay and Naturalay Technologies.

24 Commitments and Contingencies Heritage’s net share of outstanding contractual commitments at 31 December 2008 was estimated at:

Less than After Total 1 year 1-3 years 4-5 years 5 years $000 $000 $000 $000 $000 Long-term debt 15,136 595 1,190 7,820 5,531 Convertible bonds3 158,000 – – 158,000 – Total repayments of borrowings 173,136 595 1,190 165,820 5,531 Operating leases 8,782 406 649 649 7,078 Other long-term obligations1 140,000 – 140,000 – – Work programme obligations2 166,053 17,446 116,863 31,744 – Total contractual obligations 314,835 17,852 257,512 32,393 7,078

1 Other long-term obligations represent the minimum financial commitment for the Group to build a refinery in the Kurdistan Region of Iraq in accordance with the PSC in the Kurdistan Region of Iraq. On 19 April 2009, the Group was released from the obligation to build a refinery (note 26). 2 Work programme obligation includes minimum required financial commitment for the Group to fulfill the requirements of licences and production sharing contracts. A two year extension to the licences on two blocks in Mali was awarded in January 2009. The Company has applied for an extension to the initial exploration period for two blocks in Tanzania, which the Tanzanian government has advised it is favourably considering. The Company included $58.8 million relating to Tanzania work programme obligations in column “1–3 years”. 3 In April 2009, bondholders with $5.9 million of bonds gave notice of the exercise of 59 bonds. These bondholders received 1,255,317 Ordinary Shares (note 26).

The Company may have a potential residual obligation to satisfy any shortfall in officers’ and former officers’ secured real estate borrowings in the event of default, a shortfall on the proceeds from the disposal of the properties and the individuals being unable to repay the balance. The value of the residual obligation was estimated as insignificant.

In many of the countries in which the Group operates, land title systems are not developed to the extent found in many industrial countries and there may be no concept of registered title. Although the Group believes that it has title to its oil and gas properties, it cannot control or completely protect itself against the risk of title disputes or challenges. There can be no assurance that claims or challenges by third parties against the Group’s properties will not be asserted at a future date. The Group received a letter from the Iraq Ministry of Oil dated 17 December 2007 stating that the PSC signed with the KRG without the prior approval of the Iraqi government is considered to be void by the Iraqi government as they have stated it violates the “prevailing Iraqi law”. The Directors believe that the PSC is valid and effective pursuant to the applicable laws.

In addition, the DRC work programme pursuant to the PSC cannot be commenced prior to the grant of a Presidential Decree from the DRC government. There can be no assurance that final approval or ratification will ever be received in respect of the PSC or that the pre-agreed fiscal terms will not be re-negotiated at a later date by the DRC government. The Directors are confident that title will be confirmed.

Furthermore, the Group received a letter from the chairman of the Management Committee of the National Oil Company of Libya dated 28 February 2008 stating that the Block 7 licence area lies within the Libyan continental shelf and a portion of this area has already been licenced to Sirte Oil Company. This letter also demands that the Group refrain from any activities over, or concerning, the Block 7 licence area and asserts the Libyan government’s right to invoke Libyan and international law to protect its rights in the Block 7 licence area. The Directors believe that the Libyan government’s claims are unfounded.

Heritage Oil Limited Annual Report & Accounts 2008 79 Notes to Consolidated Financial Statements continued

25 Non-Cash Investing and Financing Activities Supplementary Information Year ended 31 December 2008 2007 $ $ Capitalised portion of share-based compensation (4,639,169) (9,043,886) Non-cash property, plant and equipment additions relating to the capitalised portion of share-based compensation 4,639,169 9,043,886 Disposal of subsidiaries (note 9) – (1,342,868) Gain on disposal of subsidiaries (note 9) – (1,077,132) Receipt of SeaDragon shares as a proceeds for disposal of subsidiaries (note 9) – 2,420,000 Receipt of SeaDragon shares as a result of the issuance of the Company’s guarantee for a third party’s debt – 435,000 Accrual of payable representing the fair value of the Company’s guarantee issued for a third party’s debt – (435,000)

26 Subsequent Events On 7 April 2009, the Company entered into an agreement to sell Eagle Energy (Oman) Limited which held a 10% interest in Block 8, Oman, for approximately $28 million plus a working capital adjustment. Cash was received on 7 April 2009 and the transaction was completed on that day.

In April 2009, in accordance with the option outlined in the PSC in the Kurdistan Region of Iraq the KRG nominated a third party participant in the Miran Licence. The Company remains the operator with a 75% working interest in the Miran Licence and will receive the pro-rata share of 25% of all past work programme expenditures and the third party is responsible for paying its share of future costs. The transaction was completed upon the receipt of approximately $6.7 million in costs incurred by the Company to 31 January 2009. Additionally, the KRG has released the Company from the obligation to build a refinery in exchange for making a payment of $35 million from future oil and gas sales from the licence. The minimum financial commitment for the Company was $140 million.

In April 2009, bondholders with $5.9 million of bonds gave notice of the exercise of 59 bonds. These bondholders received 1,255,317 Ordinary Shares.

80 Heritage Oil Limited Annual Report & Accounts 2008 Glossary of Technical Terms and Definitions

$ US dollars unless otherwise stated NGLs natural gas liquids API a specific gravity scale developed by the Petroleum any mineral, oil or relative hydrocarbon American Petroleum Institute for measuring (including condensate and natural gas the relative density of various petroleum liquids) and natural gas existing in its natural liquids, expressed in degrees condition in strata (but not including coal or bituminous shale or other stratified deposits bbl/bbls barrel/barrels from which oil can be extracted by bopd barrels of oil per day destructive distillation) Bcf billion cubic feet Possible Reserves those additional reserves that are less certain to be recovered than Probable Reserves. It is 1 boe barrels of oil equivalent unlikely that the actual remaining quantities boe/d or boepd barrels of oil equivalent per day recovered will exceed the sum of the estimated Proved plus Probable plus Company or Heritage Oil Limited a company incorporated Possible Reserves Heritage in Jersey on 6 February 2008 and the ultimate holding company of HOC and the Probable Reserves those additional reserves that are less certain other group subsidiaries to be recovered than Proved Reserves. It is equally likely that the actual remaining condensate low density, high API hydrocarbon liquids quantities recovered will be greater or less that are present in natural gas fields where than the sum of the estimated Proved plus it condensates out of the raw gas if the Probable Reserves temperature is reduced to below the hydrocarbon dew point temperature of Prospect Potential drilling target that is well defined, the raw gas usually by seismic data DRC the Democratic Republic of Congo Proved Reserves those reserves that can be estimated with a high degree of certainty to be recoverable. FEED Front End Engineering and Design It is likely that the actual remaining quantities Gj gigajoules recovered will exceed the estimated Proved Reserves Group the Company and all of its subsidiaries PSC or PSA production sharing contract or production HOC or Heritage Oil Corporation, incorporated in sharing agreement Corporation Canada and a wholly-owned subsidiary of the Company psi pounds per square inch KRG Kurdistan Regional Government psia pounds per square inch absolute Lead Potential drilling target that is less well SPE Society of Petroleum Engineers defined than a prospect and requires further WTI West Texas Intermediate data before being considered a prospect for drilling 1. Boes may be misleading, particularly if used in isolation. A boe conversion ratio of LPG liquid petroleum gas 6 Mcf:1 Bbl is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead. LSE London Stock Exchange Conversion m3 cubic metres The following table sets forth standard conversions from Standard Mbbls thousand barrels Imperial Units to the International System of Units (or metric units).

MMbbls million barrels To convert from To Multiply by Mboe thousands of barrels of oil equivalent boes Mcfs 6 3 MMboe millions of barrels of oil equivalent Mcf m 28.174 m3 Cubic feet 35.494 Mcf thousand cubic feet bbls m3 0.159 m3 bbls oil 6.290 Mcf/d thousand cubic feet per day Feet Metres 0.305 MMBtu million British thermal units Metres Feet 3.281 Miles Kilometres 1.609 MMcf million cubic feet Kilometres Miles 0.621 MMcf/d million cubic feet per day Acres Hectares 0.405 MMstb million stock tank barrels N/A not applicable

Heritage Oil Limited Annual Report & Accounts 2008 81 List of Advisers

Company Secretary Woodbourne Secretaries Jersey Legal Advisers Mourant du Feu & Jeune (Jersey) Limited to the Company 22 Grenville Street Ordnance House St. Helier 31 Pier Road Jersey JE4 8PX St. Helier Channel Islands Jersey JE4 8PW Channel Islands Auditors of the Company KPMG Audit Plc 8 Salisbury Square Registered Office Ordnance House London EC4Y 8BB of the Company 31 Pier Road United Kingdom St. Helier Jersey JE4 8PW Registrars of the Computershare Investor Services Channel Islands Company (Channel Islands) Limited Ordnance House Head Office and Fourth Floor 31 Pier Road Directors’ Windward House St. Helier Business Address La Route de la Liberation Jersey JE4 8PW Jersey JE1 1BG Channel Islands Channel Islands Principal Bankers Standard Bank (Europe) UK Office 34 Park Street of the Company Bank of Scotland (Europe) of the Company London W1K 2JD Barclays Bank United Kingdom Independent Petroleum RPS Energy Financial Advisers JP Morgan Cazenove Limited Engineering Consultants Goldsworth House 20 Moorgate to the Company Denton Way London EC2R 6DA Goldsworth Park United Kingdom Woking, Surrey GU21 3LG English Legal Advisers McCarthy Tétrault United Kingdom to the Company Registered Foreign Lawyers & Solicitors 2nd Floor Press Agents Bell Pottinger Group 5 Old Bailey 6th Floor, Holborn Gate London EC4M 7BA 330 High Holborn United Kingdom London WC1V 7QD United Kingdom Canadian Legal Advisers McCarthy Tétrault LLP to the Company Suite 3300 421-7th Avenue SW Calgary, Alberta T2P 4K9 Canada

82 Heritage Oil Limited Annual Report & Accounts 2008 Financial Calendar

Group results for the year to 31 December are announced in April. The AGM is held during the second quarter. Half year results to 30 June are announced in August. Additionally, the Group will issue an Interim Management Statement between 10 weeks after the beginning and six weeks before the end of each half year period. www.heritageoilltd.com

Heritage Oil Limited Annual Report & Accounts 2008 83 Notes

84 Heritage Oil Limited Annual Report & Accounts 2008 Where we operate

Exploration ( Operated) Democratic Republic of Congo (“DRC”) Kurdistan Region of Iraq Mali Malta Pakistan Tanzania Uganda

Production ( Operated) Russia

A Balanced Portfolio Experienced Proven Track-Record Strategic Positioning of Diverse Assets Management

>> Near term focus on the core activity areas >> Solid understanding of local geology and >> Discovered the M’Boundi field in the >> Focus on high impact exploration plays of Uganda and Kurdistan politics in all areas of operations Republic of Congo in 2001 >> First mover advantage – as demonstrated >> High impact exploration plays which can >> Track-record of finding valuable world-class >> Raised approximately $100 million from by success with significant holdings in transform the Company discoveries the sale of assets in the Republic of Congo Uganda and the Kurdistan Region of Iraq >> Sufficient oil volumes have been found in >> Extensive network of contacts between 2002 and 2006 >> Core areas are Africa, Middle East the Albert Basin, Uganda, to justify a major >> Strong oil and gas experience >> Funds re-invested to acquire current and Russia commercial development portfolio >> Medium and longer term focus is Tanzania, >> Pioneering entry into the Albert Basin, where seismic acquisition has recently Uganda, in 1997 – we have now unlocked been completed, the DRC, Malta, Mali a multi-billion barrel basin and Pakistan >> Sold Oman holdings in April 2009 for >> Production asset in Russia $28 million to fund acceleration of work programmes in core areas Pantone 541 background

Recommend a sealer coat or a lamination with an open window around the embossed logo.

Heritage Oil Limited is an independent Heritage Logo oil and gas explorationSilver Foil Embossed and production company with a primary listing on the Main Market of the London Stock Exchange (symbol HOIL) and Exchangeable Shares listed on the Toronto Stock Exchange

Heritage Oil Limited Annual Report & Accounts 2008 (symbol HOC) and London Stock Exchange Heritage Oil Limited Annual Report & Accounts 2008 (symbol HOX). The Company currently focuses on operations in Africa, the Middle East and Russia.

Overview Financial Review Financial Statements 01 Highlights 28 Committed to Generating Value 53 Consolidated Income Statement 02 Chairman’s Statement 54 Consolidated Statement 04 Chief Executive’s Review Corporate Social of Recognised Income 08 Chief Executive’s Q&A Responsibility and Expense 10 Operations Review 32 Co-operative Relationships 55 Consolidated Balance Sheet 10 Uganda 56 Consolidated Cash Flow 14 Kurdistan Region of Iraq Board of Directors Statement 16 Tanzania 57 Notes to Consolidated Financial 34 Board of Directors 18 Democratic Republic Statements of Congo Corporate Governance 20 Mali Other 36 Corporate Governance Report 22 Malta 81 Glossary of Technical Terms 41 Remuneration Report 24 Pakistan and Definitions 47 Directors’ Report 26 Russia 82 List of Advisers 51 Responsibility Statement of the 83 Financial Calendar Directors 52 Independent Auditors’ Report to the Members of Heritage www.heritageoilltd.com Oil Limited

Head Office and Directors’ Business Address: Fourth Floor, Windward House La Route de la Liberation Jersey JE1 1BG Channel Islands

Tel +44 1534 873000 Fax +44 1534 873344

Cover page shows Miran Block in Kurdistan Region of Iraq