Introduction
DNO International ASA (DNO) is an independent international upstream oil and gas company. The Company currently holds oil and gas assets in Yemen, the Kurdistan region of Iraq, the UK North Sea, Mozambique and Equatorial Guinea. As of 31 December 2010, DNO has an 11.66% ownership share in Det norske oljeselskap ASA (DETNOR), operating on the Norwegian Continental Shelf (NCS).
Strategy focused on growth
DNO has a proven record of value creation through smart exploration, fast track/low cost development and cost efficient operations of petroleum assets. During the past years, the Company has focused on organic growth of reserves, restructuring the Company’s Norwegian offshore portfolio, tight capital discipline and preparations for increased production. After a limited period focused on consolidation and cash generation, we are now entering a new cycle with the overall objective of delivering further growth and shareholder values.
Developing operations and diversifying the portfolio. New growth shall come from a more diversified portfolio of petroleum assets, as well as a restructuring of the asset portfolio. The Company´s producing assets today are in Yemen, using facilities built from DNO´s entry in 1998, and in Kurdistan using facilities developed over the last seven years. DNO has gained solid competence and track records through these operations and shall actively pursue new opportunities within the Middle East and Africa with the view of developing at least one new core area of operations.
DNO’s operational focus shall be onshore exploration and production activities. The Company shall preferably operate its licenses or alternatively act as an active partner in licenses we participate. DNO will pursue and assess various opportunities for increased shareholder value creation through legal re-restructuring of the group and through asset restructuring or optimization.
Maintaining a solid financial platform. DNO shall maintain a solid financial position, providing sufficient resources to reach its operational and financial goals. The Company shall maintain maximum access to relevant financial markets and secure funding at competitive terms. DNO shall seek to cover exploration investments from cash flow and equity, while development CAPEX shall preferably be covered from cash flow and debt financing.
A focused organization. DNO’s organization shall be ”lean and mean”, and utilize the advantages created by the strong in-house competence combined with a well established external network. DNO shall seek to outperform on key competence such as all sub-surface disciplines, drilling and well technology and field development in order to deliver new reserves and resources at low costs, and execute fast track/low cost field developments. DNO shall be perceived as open, honest and reliable through professional investor relations activities and trustful and open communication.
Highlights 2010
2010 was a positive year for DNO, with increased production and improved financial results. Increased production from the Kurdistan region of Iraq and increase of oil prices in Yemen contributed to a 44% increase in operating revenues for 2010 compared with 2009. The Company has increased its cash position during 2010 through solid operations and new equity proceeds in addition to divestment of treasury shares. Provisions of special items have affected the net result for 2010 negatively by NOK 525 million, and the net loss for 2010 was NOK 283 million compared to a loss of NOK 270 million in 2009. Adjusted for these provisions the net profit for 2010 would have been NOK 242 million.
Operational review 2010
Exploration. Drilling of the Bastora exploration well commenced in September and hydrocarbons have been observed while drilling through several of the prospective intervals. An extensive test program with six production tests in various intervals have been undertaken in the well, with an oil flow of 500-600 bopd achieved in the most productive intervals. Drilling of a horizontal section into the most productive test interval with the objective of achieving increased production rates in this zone commenced in March 2011. This information will be essential for the further evaluations of the development plans for the Benenan/Bastora discoveries in the Erbil license, and a commerciality plan will be submitted to the authorities by 25 June 2011.
In the Dohuk PSC area in the Kurdistan region of Iraq, technical studies related to maturing the Summail prospect continued during the year. The rig which was seconded to another operator throughout 2010, was returned to DNO in January 2011. The rig will commence drilling of the Summail-1 well in April 2011, as part of the commitment work program of the license. Following drilling of this commitment well, the rig will be moved to the Tawke PSC area to drill the exploration well Peshkabir-1. A 2D seismic campaign was acquired during the year and has assisted in selecting the well site.
In Yemen, three exploration wells were drilled during the year. Ansas-1 in Block 52 was drilled as the last well in the committed program in the block and the targeted Qishn reservoir was found water-bearing. The block has now been relinquished and handed back to the authorities. The Safa-1 exploration well in Block 32 tested a small closure west of the Godah field. The Qishn reservoir was found dry and the well plugged and abandoned, but the well costs are recoverable under the cost oil in Block 32. In Block 72, the drilling of the Gabdain-1 well commenced 19 November. The well encountered hydrocarbons in the Kohlan/Basement formations. The well was immediately followed by Gabdain-2 (spudded in February 2011) which targeted a Qishn reservoir prospect, but was found dry. The oil discovery in Gabdain-1 will now be further analyzed prior to any further appraisal plan.
A Memorandum of Understanding (MoU) for the new Block 48 was signed in October, and a first draft of a PSA has now been received. The negotiations started in the first quarter of 2011. In Mozambique, DNO completed a farm-out process assigning a 5% interest to Harmattan Uruguay S.A. and a 41% interest to New Age (African Global Energy) in the Inhaminga Block. The Chite-1 exploration well was spudded on 19 November. No hydrocarbons were detected in the well. The second well, on the Inhaminga High location, was spudded on 13 February 2011. No commercial discoveries were made in this well. DNO was awarded the rights to negotiate an EPC for the Block “Lower Zambesi” in the fourth licensing round in Mozambique. The Lower Zambesi Block is located north of the Inhaminga Block in a previously unexplored area. Negotiations of Lower Zambesi will commence in 2011. Screening of new opportunities has continued during the year with regional geological studies and monitoring of the transaction markets, targeting Middle East and Africa regions. These are considered as high potential onshore areas that fit well with the DNO strategy of achieving new fast track developments at low cost.
Appraisal and field development. At the Tawke field in the Kurdistan region of Iraq, construction of flow lines to connect the T3 and T12 wells with the Central Processing Facility (CPF) were completed during the year. In the Erbil PSC in Kurdistan, testing of Erbil-2 appraisal well was completed with preliminary results confirming oil in the Najmeh reservoir.
In Block 47 in Yemen, drilling of the Yaalen-3 well was undertaken in the second quarter and was successfully tested in two Qishn intervals. It is anticipated that the combined flow capacity of these two intervals would reach 8,000 -10,000 bopd. Further on, the drilling of the Sharnah-2 well which took place in June/July penetrated the reservoir 20 meters deeper than prognosis, and the reservoir sands were water bearing. Based on the results of these two wells together with the Yaalen-1 and Sharnah-1 wells, in addition to engineering and feasibility studies, the partners have now agreed and approved to develop the Yaalen/Sharnah discoveries. Phase 1 of the Yaalen development will be based on the concept of local processing facilities with capacity of 5,000 bopd and trucking of oil to the Nabrajah installations in the neighbouring Block 43 for further export into the existing pipeline system. The project schedule indicates that first oil will be exported in the first quarter of 2012. Sharnah is planned to be connected to the facilities at a later stage.
In Block 43, a gas injection pilot project in the Nabrajah-10S well was undertaken. The results together with reservoir simulation studies indicated potential for further drilling in the Nabrajah Qishn oil accumulation and a new well is planned in 2011. Costs saving projects in Block 43 in Yemen were commenced during the year. Gas engines are sceduled to be installed at the power generators to use produced gas for fuel and reduce the consumption of diesel. This will contribute to operational cost savings in addition to positive environmental effects.
Production. DNO’s total average working interest production increased in 2010 by more than 40% from the previous year (17,381 bopd versus 12,285 bopd). There was no export of crude oil from the Tawke field during the year and the comparable figures are excluding export in 2009. The Tawke field delivered crude oil to the local market and the Tawke refinery, with a total working interest production of 10,661 bopd in 2010. The local sales have been based on short term contracts, with significant fluctuations in lifted quantities depending domestic demands. Truck loading from the loading station at Fishkhabour commenced in September, whilst previously the lifting took place at the Tawke oil field. This new arrangement enables increased loading capacity and shorter distance to the local market without passing through the city of Zakho. On 2 February 2011, export of crude oil from Tawke recommenced with gradual ramp-up of production to more than 50,000 bopd by 12 February. The facilities have been tested at 65,000 bopd.
DNO has been advised by the KRG that there will be an interim period until a Federal Petroleum Law for Iraq has passed the Iraqi parliament later this year. All crude oil exported by DNO via the North Oil Company (NOC) operated export pipe line facilities is subject to fiscal metering and all quantities are monitored by NOC, KRG and DNO. DNO has been advised that these quantities will form the basis for payment instructions to be submitted by the KRG to the Ministry of Finance in Baghdad for processing as per the payment mechanism as agreed between the KRG and the Federal Government.
In Yemen, there is an overall decline in production as expected, but production is maintained at a higher level than forecasted. On an average yearly basis, the WI production from Yemen was 6,156 bopd – a reduction from 7,749 bopd last year. In Block 32, the Godah-11 and Godah-12 infill wells improved production from the Godah field. In Block 53, three new infill wells in the Bayoot field contributed to an increase in production from the Basement formation.
Reserves. DNO’s total remaining oil reserves (P50) are estimated to 194.2 million barrels of oil equivalents at the end of 2010, compared to 149.4 mboe the year before. Including contingent resources, the volumes are 211.2 mboe versus 172.8 mboe in 2009, with all produced reserves in Yemen being more than replaced, partly from new discoveries in Block 47 and revisions of previous estimates in Block 32. The recovery factor at Tawke has increased from 16.6% to 21.3% primarily based on updated geological and reservoir technical evaluations which have resulted in improved reservoir properties. Based on the increased recovery factor, the gross ultimate recoverable P50 reserves at Tawke is estimated at 306 mboe. The reserves in Tawke are confirmed by a third party reserves audit.
Financial performance 2010
Total operating revenues for 2010 were NOK 1,252 million. This represents a 44% increase from the NOK 869 million reported for 2009. The increase is a result of higher production and higher achieved oil prices. Achieved oil prices for 2010, averaged 51.49 USD/bbl (net entitlement), up from 47.37 USD/bbl in 2009. As previously reported, DNO Iraq AS, a subsidiary of DNO International ASA, was involved in arbitration proceedings related to certain third party interests in Kurdistan. A preliminary arbitration ruling was received in October 2010 and a total provision of USD 65 million plus provisions for legal expenses have been recorded in the financial statements for 2010. The arbitration case has now been settled outside of the arbitration process, with no additional material effect to the financial statements for 2010 or future accounts.
Provision for arbitration costs of NOK 330 million and impairment of the investment in Det norske oljeselskap ASA of NOK 195 million have negatively affected this year’s result. Without the arbitration costs and the impairment charge the net profit for 2010 would have been NOK 242 million. DNO has shown a strong net cash flow in 2010. The net cash flow from operating activities for 2010 was NOK 525 million (2009: -53 million) and cash flow after tax, as shown by netback, was NOK 380 million (2009: NOK 30 million). Total investments in 2010 were NOK 152 million, mainly related to the completion of infill wells in Block 32 and Block 53, and drilling of the Gabdain-1 well in Block 72, the Sharnah-2 and Yaalen-3 in Block 47 in Yemen.
DNO’s cash balances increased during 2010 through solid operational cash flow and proceeds from new equity. In addition, DNO sold its treasury shares in 2010. Cash at year-end was NOK 1,385 million, which together with financial assets are considered sufficient for the investment program planned for 2011. All DNO’s assets have been reviewed for impairment at year-end 2010. No impairment is required for the producing assets in Yemen or Kurdistan or for any other block. Impairment of NOK 204 million for the financial assets has been recorded for 2010. This relates to the investments in Det norske oljeselskap ASA (NOK 195 million), Petrolia ASA (NOK 6 million) and Rocksource ASA (NOK 3 million) and reflects the significant decrease in share prices during 2010 compared to the cost prices.
Total assets were NOK 5,393 million at year-end. The equity ratio was 39% and the ratio between current assets and current liabilities was 213%. Net interest bearing debt was NOK 428 million. DNO’s current bond loans mature mainly in 2012. In March 2011, the loan maturity was extended by 5 years through the completion of a new bond issue of approximately USD 240 million. The new bond issue has a five year tenor and carries a floating interest rate of LIBOR/NIBOR + 7.50%. DNO agreed in connection with the bond issue to purchase the aggregate of USD 170 million and NOK 308 million of its various outstanding bond issues. The Board of Directors confirms that the annual financial statements have been prepared based on the going concern assumption, in accordance with § 3-3a of the Norwegian Accounting Act.
Corporate Governance
DNO’s corporate governance is based on the principles in the Norwegian Code of Practice for Corporate Governance (NUES). Good corporate governance is a responsible interaction between shareholders, Board of Directors and executive management in order to develop long-term value. DNO acknowledge the role corporate governance plays in growing shareholder value, retaining the confidence of investors and maintaining a low cost of capital. The Corporate Governance statement, included in this annual report and also posted on our website, outlines key principles and guidelines for DNO’s corporate governance, approved by the Board of Directors. The statement is reviewed annually or more often if deemed necessary.
Work of the Board. In 2010, the Board of Directors engaged in frequent meetings and discussions to handle several key strategic and operational issues, including:
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Close monitoring of QS-HSE, operational and financial performance of the group.
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Strategies to position the Company to engage in new opportunities in the oil and gas sector.
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Progress and results of development investments and exploration expenditures in DNO’s key projects.
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Measures to strengthen the Company’s financial flexibility, including completion of a private placement of new equity and divestment of treasury shares
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Changes in the composition of the Board of Directors, through resignation of two Directors and election of one new Director.
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Arbitration proceedings in the London Court of International Arbitration
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Supervision of risk management processes and internal control reporting
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Communication policy, including recruitment of a Communication Director
In all, the Board of Directors convened for 23 meetings in 2010. The Board has two subcommittees. The audit committee consists of two Board Members and held three meetings in 2010. The audit committee reviewed quarterly and annual reports, risk management and reporting and internal and external audit work. In addition, the audit committee evaluated the internal control related to the financial reporting. DNO’s compensation committee is nominated by the Board and consists of two Board Members. The committee considers questions related to compensation to the Managing Director including key management and prepares and presents this to the Board. The work of the committee is described in a mandate approved by the Board. The remuneration committee held one meeting in 2010.
Risk management. DNO has established an integrated system for risk management throughout the group of companies, which is described in a risk management policy approved by the Board of Directors. The principles for risk management are based on the framework in COSO (Committee of Sponsoring Organizations of the Treadway Commission) and recognized international industry standards within the area of internal control and risk management. Risk management and internal control systems, development and implementation is a continuous process and it is the Company’s view that an effective risk management and internal control systems contribute to safeguarding the Company’s assets and the shareholders’ interests. Due to the nature of DNO’s business some of the identified risks are outside of the Company’s direct control. This is mainly related to political and contractual issues (controlled by governments) in the Kurdistan region of Iraq, and the security situation in Yemen.
Financial risk. Risks related to oil price, interest rates and currency constitute financial risks to the Group. Financial risk management is carried out by a central treasury function and seeks to minimize the potential adverse effects on the Group’s financial performance. Derivative financial instruments are used to hedge certain risk exposures.
Political risk. The stability in parts of the Middle East has deteriorated due to political protests starting in the latter part of 2010 and are continuing into 2011. DNO operates in the Middle East, in the Kurdistan region of Iraq, in Yemen and in Dubai. In the Kurdistan region of Iraq, the political situation and general stability has remained good and the security is maintained at a satisfactory level. The head office is located in Dubai, which has remained stable and unaffected by the political protests experienced in other parts of the region. In Yemen, there has been severe unrest, mainly located in the capital Sana´a, but also other cities. DNO has taken several measures to improve security for DNO employees in Yemen, e.g. temporarily transfering expats from Sana´a to Dubai. DNO has managed to maintain production and continue the exploration and development projects in Yemen according to plan. The security developments are closely monitored, both at business unit and corporate level. At present, the situation is manageable for DNO in Yemen. Further information about the financial risk management objectives and policies and other risks, see Note 9 in the consolidated accounts and the section on risk on page 29.
CR – Corporate Responsibility
DNO has throughout 2010 continued the development of every aspect within CR. General risk-focused approach towards key CR-issues sits well with the new recommendations from NUES and also the suggested additions in the Norwegian Accounting Law set forth by the Ministry of Finance in 2010. The Board believes that to be fully effective, corporate responsibility must go beyond the formulation of policies and procedures and be an integral part of the corporate culture. As the company spent 2009 developing and refining policies and systems, the focus for 2010 was implementation and dialogue with stakeholders. In particular we chose to work with business ethics and anti-corruption, where we developed and implemented a competence building program involving corporate functions as well as all Business Units. Relevant policies and related management systems, as well as status and future targets, are further described on DNO’s web page.
The program, which was based on Norwegian anti corruption and penal laws, set the direction for our five focus areas for 2010:
The program involved top and middle management and was verified by a third party. In order to further improve the management of CR, we established a CR plan at the corporate level of the Company with and interface to the Company’s systems on Corporate Governance and Risk Management.
Key factors in our progression have been:
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Competence development
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Consider and agree on the formal acknowledgement of Global Compact which will commence in 2011
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Consider and agree on the formal acknowledgement and dialogue with EITI and TI
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Alignment with the GRI index on reporting and development
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Management of third parties/contractors
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Develop consistency in the interface between CR, Corporate Governance, Risk Management, business monitoring and reporting
Our people - diversity and equal opportunities. DNO acknowledges international law and standards for human rights, including the OECD guidelines. Our policies are aimed at supporting the belief that all employees and job applicants shall be treated equally, regardless of age, gender, religion or any other factor. DNO values cultural diversity and a high degree of responsibility amongst staff. The Company fosters a “no blame” culture and stimulates people to learn and utilize their skill base. Our policy is to attract talented people through exposure to a challenging however rewarding environment that motivate each individual. DNO aims at employing local staff and focuses on competence development. The Company has a strong cultural and national diversity amongst the workforce at the head office in Oslo. Our equal opportunity statistics show that women accounted for 26% of the overall workforce in Norway. At the end of 2010, two of the four board members were women.
Organisation and Personnel. At the end of 2010, DNO had a total workforce of 565 people: 43 are based in Norway and 522 in our international operations. This compares with a total workforce of 513 at the end of 2009.
Quality, Health, Safety and Environment (QHse)
DNO has during 2010 worked systematically to produce results in accordance with our goals for the year. Efforts have been made to move competence and knowledge out to the sharp end of our operations in order to produce expected results. In order to succeed in implementation of systems, techniques and knowledge we have established arenas where we discuss and share best practice. DNO has furthermore developed staff exchange programs that enable us to capitalize on learning and experience across the group. Being professional in all aspects of the work is key in the process of achieving business continuity and high regularity. Every effort is therefore made to identify and mitigate risk. DNO has managed to get representation of HSE competence within all Business Units, which is of importance in the process. We realize and acknowledge that the nature of the business expose certain risk to the environment. However, we believe that the control environment, commercial and legal framework in combination with our Business Management System makes it possible for us to manage these risks in line with industry expectations.
DNO has registered 26 environmental incidents during 2010, of which none were of a serious character by volume or toxicity. DNO has continuously and in line with the formalized Production Sharing Contracts developed Environmental Impact Assessments (EIA) for all licenses. The EIA’s produced comply with the standard developed by the World Trade Bank, and identify sensitivities and risks relevant to the license. The risks identified are mitigated through environmental programs governed by an Environmental Plan. DNO report environmental performance in accordance with local regulations, GRI and rating agencies like CDP.
Our Management system has been reviewed by a third party and allowed for an improved understanding of possible improvement points on the quality side. Initiatives have been made to initiate a step change on how to improve the quality and effect of our systems. We use international standards like ISO 9001:2008 to pursue this issue.
At year-end 2010, the status within the HSE performance was as follows (incident frequency per one million man-hours):
Lost time incident frequency
(LTIF goal 1.0): 1.04
Total recordable incident frequency
(TRIF goal 3.0): 2.58
Vehicle incident frequency
(VIF goal 3.0): 0.93
Sickness absence in DNO was 3% in 2010, up 0.5% compared to 2009, mainly due to long term sick leave.
Technical and operational quality. The Company has established a strict operational standard that effectively supports business regularity and business continuity. DNO has a continued strong focus on operational regularity and technical integrity as key success factors. Our QHSE network and resources has become most efficient in their way of supporting these objectives and outstanding results have in this way been achieved. Quality of the work performed at all levels of the organization are in focus to avoid any type of incidents; that being damage to plant equipment which potentially could result in injuries to personnel, health issues, and/or negative effects to the environment. Security. The stability in parts of the Middle East has deteriorated due to political protests starting in the last part of 2010 and continuing into 2011. DNO has a good intelligence system enabling the development and implementation of effective plans and mitigating measures. These plans allow us to minimize the exposure to staff and assets and secure business continuity. We continuously monitor, analyze and report in order to tailor and improve our plans and procedures.
Main events since year end
The main events affecting Company since year-end have been:
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In February 2011, export of crude oil from the Tawke field commenced.
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In March 2011, DNO completed new bond issue of approximately USD 240 million.
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An extraordinary general meeting in March 2011 elected Bijan Mossavar-Rahmani as new Board Member in DNO.
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The arbitration was settled outside of the arbitration process in March/April 2011
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On 18 April 2011, DNO filed the Annual Statement of Reserves, disclosing the hydrocarbon reserves as of 31 December 2010.
Outlook
In 2011 DNO expects to see increased production from the Tawke field in the Kurdistan region of Iraq. Work will also be undertaken to evaluate options to increase the production capacity through fine-tuning and modifications of our current facilities once full scale production is achieved for a sustainable period. Our key priority going forward is to fully utilize and sustain our current production capacity, and also to seek to further increase the capacity through optimization of current facilities as well as from fast-track development of new discoveries.
Our production in Yemen is expected to continue to decline somewhat until we add new production from the Yaalen development. This project is planned to be completed during 2011 and with first oil in 2012. The recent oil discoveries made in the Erbil license in Kurdistan and in Yemen will be further evaluated to conclude possible commerciality, which in turn could initiate new development projects. The exploration drilling program for 2011 includes at least 6 wells, of which 2 wells in Kurdistan, 3 wells in Yemen and 1 well in Mozambique. Our investment program for 2011 include NOK 450 million in committed investments and NOK 420 million in contingent investments. Increased exploration efforts will be maintained going forward with the objective to add new reserves and resources at low cost.
Our financial position was strengthened during 2010 and we expect to cover our committed investments for 2011 from operating cash flow. To further position the Company for future growth, DNO will pursue various re-financing options in 2011, and completed a new bond issue in March 2011 of USD 240 million. DNO will seek to diversify its portfolio and assess onshore opportunities through new entries primarily in the Middle East and Africa regions. DNO recommenced export from the Tawke field on 2 February 2011 at an initial gross rate of 10,000 bopd, increasing to approximately 50,000 bopd in 10 days. We expect that a payment mechanism and settlement for the export of crude oil from the Tawke field will be in place during the first half of 2011.
Parent company
The Parent Company’s net loss for 2010 was NOK 60 million, compared to a loss of NOK 101 million for 2009. Total assets as of 31 December 2010 were NOK 4,878 million, up 24% from 2009 mainly due to an increased cash balance. The long-term intercompany receivables were NOK 2,074 million at year end 2010. The long-term intercompany receivables at the end of 2009 were at the same level. The Company’s cash balance at year-end 2010 was NOK 1,328 million compared to NOK 267 million for 2009, mainly increased by strong operational cash flow, proceeds from new equity and divestment of treasury shares. Total shareholders’ equity at 31 December 2010 was NOK 2,219 million compared to NOK 1,563 at the end of 2009. The equity ratio increased to 45% from 39% in 2009. No ordinary dividend is proposed for 2010 as the Board believes that investment in the Company’s exploration and development program will deliver increased shareholder returns in the future.
The Company’s unrestricted equity as of 31 December 2010 totaled NOK 1,612 million. The Board proposes that the annual loss of NOK 60 million is transferred from other equity.
Responsibility statement
We confirm to the best of our knowledge that the consolidated financial statements for the period 1 January to 31 December 2010 have been prepared in accordance with IFRS and give a fair view of DNO’s and the Group’s assets, liabilities, financial position and results for the period viewed in their entirety, and that the Board of Directors report includes a fair review of any significant events that arose during the period and their effect on the financial report, any significant related parties’ transactions, and a description of the significant risks and uncertainties for the Group.