Annual Report 2010

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NOTES TO THE FINANCIAL STATEMENTS OF THE GROUP Transaction exposure Lundin Petroleum’s policy on currency rate hedging is, in case of currency exposure, to consider setting the rate of exchange for known costs in non-US Dollar currencies to US Dollars in advance so that future US Dollar cost levels can be forecasted with a reasonable degree of certainty. The Group will take into account the current rates of exchange and market expectations in comparison to historic trends and volatility in making the decision to hedge. Price of oil and natural gas Price of oil and natural gas are aﬀected by the normal economic drivers of supply and demand as well as the ﬁnancial investors and market uncertainty. Factors that inﬂuence these include operational decisions, natural disasters, economic conditions, political instability or conﬂicts or actions by major oil exporting countries. Price ﬂuctuations can aﬀect Lundin Petroleums ﬁnancial position. The table below summarises the eﬀect a shift in the oil price would have had on the net result at 31 December 2010: Net result in the financial statements (MUSD) Possible shift (USD/boe) Total effect on net result (MUSD) 498.5 -5 -20.0 498.5 5 20.0 Lundin Petroleum has, through its subsidiary Lundin Malaysia BV, entered into four Production Sharing Contracts (PSC) with Petroliam Nasional Berhad, the oil and gas company of the Government of Malaysia (“Petronas”), in respect of the licences PM308A, PM308B, SB307 and SB308, and SB303 in Malaysia. BNP Paribas, on behalf of Lundin Malaysia BV has issued bank guarantees in support of the work commitments in relation to these PSCs amounting to MUSD 86.3. In addition, BNP Paribas have issued additional bank guarantees to cover work commitments in Indonesia amounting to MUSD 15.9. It is expected that the Group’s ongoing development and exploration expenditure requirements will be funded by the Group’s operating cash ﬂows and loan facility. No loan repayments are required for the credit facility in 2011. Financial instruments by category The accounting principles for ﬁnancial instruments have been applied to the line items below: Financial Loan liabilities receivables Derivatives valued at 31 December 2010 and other Availableused for amortised TUSD receivables for-sale hedging cost Assets Other shares and participations Long-term receivables Trade receivables Short-term loan receivable Cash and cash equivalents – 23,791 94,190 74,527 48,703 241,211 Liabilities 68,613 – – – – 68,613 – – – – – – – – – – – – Lundin Petroleum’s policy is to adopt a ﬂexible approach towards oil price hedging, based on an assessment of the beneﬁts of the hedge contract in speciﬁc circumstances. Based on analysis of the circumstances Lundin Petroleum will assess the beneﬁts of forward hedging monthly sales contracts for the purpose of establishing cash ﬂow. If it believes that the hedging contract will provide an enhanced cash ﬂow then it may choose to enter into an oil price hedge. For the year ended 31 December 2010, the Group did not enter into oil price hedging contracts. There are no oil price hedging contracts outstanding as at 31 December 2010. Interest rate risk Interest rate risk is risk to the earnings due to uncertain future interest rates. Lundin Petroleum is exposed to interest rate risk through the credit facility (see also liquidity risk below). Lundin Petroleum will assess the beneﬁts of interest rate hedging on borrowings on a continuous basis. If the hedging contract provides a reduction in the interest rate risk at a price that is deemed acceptable to the Group, then Lundin Petroleum may choose to enter into an interest hedge. The table below summarises the eﬀect an increase/decrease in the interest rate for the credit facility would have had on the net result for the year ended 31 December 2010: Net result in the financial statements (MUSD) Possible shift (%) Total effect on net result (MUSD) 498.5 -10 0.9 498.5 10 -0.9 Trade Payables Bank loans Other non-current liabilities Derivative instruments Short-term debt – – – – – – – – – – – – – – – 6,866 – 6,866 16,031 458,835 17,836 – 450 493,152 31 December 2009 TUSD Assets Other shares and participations Long-term receivables Trade receivables Short-term loan receivable Derivative instruments Cash and cash equivalents Loan receivables and other receivables Available -for-sale Derivatives used for hedging Financial liabilities valued at amortised cost In January 2008, the Group entered into an interest hedging contract ﬁxing the LIBOR rate of interest at 3.75% p.a. on MUSD 200 of the Group’s USD borrowings for the period January 2008 to January 2012. Credit risk Lundin Petroleum’s policy is to limit credit risk by limiting the counter-parties to major banks and oil companies. Where it is determined that there is a credit risk for oil and gas sales, the policy is to require an irrevocable letter of credit for the full value of the sale. The policy on joint venture parties is to rely on the provisions of the underlying joint operating agreements to take possession of the licence or the joint venture partner’s share of production for non-payment of cash calls or other amounts due. As at 31 December 2010 the Group’s trade receivables amounted to MUSD 94.2 (MUSD 80.7). There is no recent history of default. Other long-term and short-term receivables are considered recoverable. The provision for bad debt as at 31 December 2010 amounted to MUSD – (MUSD –). Cash and cash equivalents are maintained with banks having strong long-term credit ratings. Liquidity risk Liquidity risk is deﬁned as the risk that the Group could not be able to settle or meet its obligations on time or at a reasonable price. Group treasury is responsible for liquidity, funding as well as settlement management. In addition, liquidity and funding risks and related processes and policies are overseen by management. Lundin Petroleum has a secured revolving borrowing base facility of MUSD 850, of which MUSD 459 had been drawn in cash as at 31 December 2010. The MUSD 850 facility is a revolving borrowing base facility secured against certain cash ﬂows generated by the Company. The amount available under the facility is recalculated every six months based upon the calculated cash ﬂow generated by certain producing ﬁelds at an oil price and economic assumptions agreed with the banking syndicate providing the facility. As part of the semi-annual redetermination process under the facility, a new borrowing base amount of approximately MUSD 867 was calculated eﬀective 1 January 2011. See also Note 33. – 24,239 80,721 33,907 – 77,338 216,205 32,369 – – – – – 32,369 – – – – 231 – 231 – – – – – – – Liabilities Trade Payables Bank loans Other non-current liabilities Derivative instruments Short-term debt – – – – – – – – – – – – – – – 10,196 – 10,196 20,487 545,729 12,598 – 32,400 611,214 For ﬁnancial instruments measured at fair value in the balance sheet, the following fair value measurement hierarchy is used: - Level 1: based on quoted prices in active markets; - Level 2: based on inputs other than quoted prices as within level 1, that are either directly or indirectly observable; - Level 3: based on inputs which are not based on observable market data. 85

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