KMG EP website

CHAIRMAN’S AND CHIEF EXECUTIVE’S STATEMENT

Last year was a difficult one for JSC KazMunaiGas Exploration Production. A series of complex events in 2011 led us to make adjustments to the Company’s short term operations while remaining true to the previously defined longer term development strategy through to 2020.

Lyazzat Kiinov
Chairman of the Board of Directors

Alik Aidarbayev
Chief Executive Officer (Chairman of the Management Board)

In terms of profitability the Company completed 2011 with good results, earning around 1.4 billion U.S. dollars for shareholders. Earnings per share however declined by 9% compared to 2010. The doubling of export customs duty rates from January 2011 was one of the factors which adversely affected the profitability of the Company. The key factor, however, was the decline in oil production and consequently in exports. Consolidated production by KMG EP in 2011 amounted to just over 12.3 million tonnes (250 thousand barrels per day), which was 7% less than in 2010.

The main factor influencing the decline in production was labour unrest at the Uzenmunaigas (UMG) production facility. The protest began in May 2011 with several people going on hunger strike and a few hundred workers stopping work in their support. The strikers’ demands for higher wages were not endorsed by the trade union, as they contradicted the Collective Labour Agreement signed in March 2011. Official government and judicial bodies repeatedly confirmed the illegal status of the strike.

This led to a prolonged confrontation between the Company’s management and the striking workers, and increased social tensions in the region, especially in the town of Zhanaozen. The situation was complicated by the fact that a similar protest was taking place at JSC Karazhanbasmunai (KBM).

Early in 2012, in response to the government’s suggestion to re-employ workers laid-off at UMG and KBM, the Board of Directors of KMG EP decided to create two new service companies – for transportation and drilling – with a total staff of about 2,000 people. These will provide services to KMG EP and other companies operating in the Mangistau region. The two new companies created in January 2012 are «Drilling Operations Management,» based in Zhanaozen and «Managing Technological Ttransport and Wells Maintenance” formed in the city of Aktau.

The new management of the Company has revised its approach to its operating activities in the field to take into account the new circumstances. Recognizing the key role of staff relations, management intends to carry out a systematic awareness-raising programme, and create a system of non-material motivation. The aim is to make the payment system more transparent and to involve employees more actively in the process of improving the Company’s performance. In addition, management intends to use a more systematic approach to improving occupational safety, health and environmental protection programmes.

Considerable effort will also be focused on the modernization of production facilities. At Uzenmunaigas, for example, the Company plans to start building a new service center to service 1,000 machines and two new units for preparing the special liquids needed for shutting down wells. It also plans a diagnostics and repair centre for underground equipment.

The new, modern service centers and workshops are expected to improve service quality for the fleet of special vehicles and equipment and improve the quality of well sealing liquid. This should lengthen the operating time between servicing of wells, raise the level of industrial and environmental safety, and help to stabilize and even increase oil production.

In order to give the new production facilities a certain autonomy in the conduct of their industrial and economic activities they have been organized as joint stock companies, 100% owned by KMG. This will provide for the necessary management responsibility on the ground, increase the level of transparency in corporate activities and comply with modern standards of corporate governance.

The Company’s main medium and long term priorities remain those set out in its Strategy-2020 document. The Board of Directors and management remain committed to this Strategy and the objectives that were outlined at the time of the IPO in 2006. In the course of 2011, the Company took several steps towards achieving these goals.

The Company significantly expanded its exploration portfolio in 2011, for example. It acquired a 50% stake in development of the Fedorovsky unit whose hydrocarbon reserves are estimated at 133.6 million barrels. Last year the Company also bought the right to explore the Karpovsky North block, which is located near Fedorovsky in Western Kazakhstan. Prospective recoverable resources of the Karpovsky North block are estimated at 240 million barrels of oil equivalent. The geographical proximity of these two blocks will enable the Company to create and utilise a joint infrastructure.

KMG EP also purchased four exploration contracts from the National Company KazMunayGas in 2011. These are the Temir block, Teresken, Karaton - Sarkamys and territory adjacent to Uzen and Karamandybas. Total geological resources of all the blocks are about 1.5 bn barrels of oil equivalent. In the event of successful exploration, they will increase the recoverable reserves of the company in the medium term, including the Uzen and Emba groups of fields.

The acquisition of these assets has increased the quality of the Company’s exploration portfolio. This is consistent with the Company’s overall development strategy, which is focused on organic reserves growth through active exploration.

In addition, KMG EP has signed a memorandum with the parent company on its possible involvement in several offshore blocks in the Caspian Sea. In this way the Company gained access to the geological, physical, financial and economic data on a number of oil and gas projects. These include marine blocks Zhambyl, Ustyurt (Dead Kultuk) Zhenis, Godin, C-1 and C-2, as well as Urikhtau. The company has conducted a feasibility study of these projects and their commercial attractiveness and made a relevant proposal to the National Company KazMunaiGas.

At the end of 2011 the Company also completed the preferred shares buy out program, whereby it acquired more than two million shares worth over 37 billion tenge. This program has considerably stimulated the stock market in Kazakhstan, accounting for a significant share of transactions. In addition, KMG has started buying back common shares on the Kazakhstan Stock Exchange and GDRs on the London Stock Exchange. By doing this the management has demonstrated its confidence in the value and future prospects of the Company.

KMG EP is strongly placed to continue implementing its development strategy through exploration, acquisitions and investments in oil and gas assets. The Company’s financial stability is reinforced by its high standards of corporate governance. Among the major strengths of the Company’s corporate governance analysts note the experience of its independent directors in balancing the influence of the majority shareholder, and monitoring of management. Analysts also note the Company’s high level of transparency, active investor relations work and the significant amount of voting rights held by KMG EP’s shareholders.

Despite some existing difficulties, the Company looks to the future with confidence. Through establishing a close and continuing dialogue with the workforce of the newly created joint stock companies, the management, with the support of the Board of Directors, expects to continue to ensure efficient operation of the Company for the benefit of all shareholders.

Lyazzat Kiinov
Chairman of the Board of Directors

Alik Aidarbayev
Chief Executive Officer (Chairman of the Management Board)