Audit Committee Report

Role and responsibilities of the Audit Committee

The primary role of the committee is to assist the Board in achieving the Group’s strategic objectives whilst protecting stakeholder interests.
The key areas of responsibility of the committee are categorised below and are described in more detail in the committee terms of reference which are available on the Group’s website at www.nog.co.uk:

  • review the Group’s annual and interim reports including financial statements, formal announcements of financial results and other related announcements;
  • review the effectiveness of the Group’s internal control and risk management systems;
  • monitor compliance with applicable regulatory and legal requirements and the Group’s Code of Conduct;
  • monitor and review the effectiveness of the Group’s internal audit function;
  • maintain the relationship with the Company’s external auditor and oversee its appointment, remuneration and terms of engagement whilst continually assessing its independence and objectivity; and
  • review audit findings and assess the standard and effectiveness of the external audit.

Membership
Sir Christopher Codrington, Bt. Member since 19 May 2014,
Chairman since 8 May 2017
Mark Martin Member since 31 December 2016
Kaat van Hecke Member since 8 May 2017
Martin Cocker Member since 16 November 2017


The members of the Audit Committee were selected with the aim of providing a wide range of financial, commercial and industry expertise necessary to meet the role and responsibilities of the committee. Details of the qualifications of each member of the committee can be found in their biographies which can be found here: http://nostrumoilandgas.com/en/board-of-directors

Meetings

In addition to its scheduled quarterly meetings, the committee also meets when it is necessary. The chief financial officer, the chief legal officer and company secretary, the internal audit manager and the external auditor are invited to the meetings. The committee held seven meetings during 2017.

The committee also receives monthly management updates covering key issues including financial and operational performance and the status of key initiatives.

Interaction with the Financial Reporting Council (“FRC”)

As part of the communication by the FRC to audit committee chairs, the committee chairman received a letter from the FRC describing the FRC’s perspective on aspects of annual reports that companies should aim to improve and highlighting changes to UK reporting requirements covering areas like new accounting standards, non-financial reporting, performance reporting, risk reporting and viability statements, UK referendum results, various aspects of financial statement disclosures, and audit quality and effectiveness.

Audit Committee Report

Respectively, the Audit Committee considered the applicability of those recommendations to the Group and took following steps to ensure adherence to recommendations and expectations as much as possible:

  • reviewed the disclosures related to IFRS 9 ‘Financial Instruments’, IFRS 15 ‘Revenue from contracts with customers’ and IFRS 16 ‘Leases’ and discussed with management the plans on adopting these standards in 2018 and 2019.
  • when reviewing the disclosures related to anti-bribery and corruption policies and diversity policies, as well as policies related to environmental, social and employee related matters, the committee focused its attention on the description of the policies, a due diligence processes implemented and the outcome of implementation of these policies, and assessment of the principle relevant risks in these non-financial areas;
  • where information was not provided on a specified non-financial matter, the committee requested for a reasoned explanation of why it was not provided;
  • the committee also reviewed the Non-Financial Information Statement, which provides a picture of the company'scompany’s performance and impact;
  • when reviewing the annual report, the committee also paid attention to the definitions, explanations, reconciliations, prominence and consistency of alternative performance measurements like EBITDA, etc.;
  • in the process of the review of the viability assessment and statement, the committee challenged the factors considered when determining the period covered as well as significant assumptions and qualifications used.
  • the committee also gave due consideration to the Brexit impact, even though there has previously been an assessment and it was concluded to have an insignificant influence on the Group;
  • finally, the committee members critically reviewed the accounting policies, critical judgements and estimates and statement of cashflows within the consolidated financial statements.

Self-assessment

The committee undertakes an periodic evaluation of its performance and effectiveness. In June 2016, there was an evaluation of the Board’s performance conducted with the support of an external independent consulting company. Among other areas, the survey examined the committee’s role in external reporting, external audit, internal audit, risk strategy and framework, risk exposures, overall engagement externally and internally, as well as roles and responsibilities.

In March 2018, the Board performed an update based on that evaluation to re-assess whether developments have been made since the last evaluation and if any further actions need to be taken.

Based on the updated evaluation, the committee concluded that its focus should be kept on risk management and internal audit. Aside from this observation, the committee concluded that its mandate and oversight performance were appropriate.

Appointment of external auditor

Ernst & Young LLP (Kazakhstan) was the auditor of the predecessor group of companies since 2007, and continued auditing Zhaikmunai LLP in 2015, while Ernst & Young LLP (UK) was first appointed as an auditor of the Group on 19 May 2014 based on the recommendation of the committee and upon approval by the Company’s shareholders and re-appointed as an auditor of the Group on 19 May 2015. Mr Richard Addison was appointed as lead audit engagement partner on 19 May 2014 and continued in this role for the 2015 Group audit.

Given guidance contained under provision C.3.7 of the UK Corporate Governance Code that provides that companies should put their external audit contract out to tender at least once every ten years together with sustained low oil prices the committee decided to initiate a tender process for the external audit arrangements for the year ending 31 December 2016 to ensure that the Group is receiving high quality audit services at the best available price. Several Big4 audit firms as well as one Tier2 audit firm participated in the tender process as a result of which it was concluded that it would be in the best interests of shareholders to continue engaging Ernst & Young LLP (UK) as the Group’s external auditor and on that basis the Board, on the recommendation of the committee, will ask shareholders to approve the re-appointment of Ernst & Young LLP (UK) as the Group’s auditor at the Company’s 2016 annual general meeting.

Activities during the year

In 2017 the committee continued to use the annual planner, which summarizes various topics requiring the committee’s attention, and which were accumulated based on the requirements of the UK Corporate Governance Code 2016 (“2016 Code”), the FRC’s Guidance on Audit Committees dated April 2016, the committee’s terms of reference and other relevant sources.

In accordance with its responsibilities outlined above, the committee’s activities can be summarised into the following four main areas:

  • Financial reporting
  • Risk management and internal controls
  • Compliance
  • External audit

Each of these four categories is dealt with in more detail in Sections 1 to 4 below.

Internal audit

The committee periodically receives reports from the Group’s internal audit manager throughout the year. The reports summarise internal audit findings and any action to be taken by management as a result.

In 2014 the Group developed its internal audit function and hired an internal audit manager. In connection with this an internal audit charter has been adopted, which sets out the responsibilities of the internal audit function, and a three-year internal audit plan has been developed. The primary role of the internal audit function is to help the Board and executive management to protect the assets, reputation and sustainability of the organisation. This is intended to be achieved through:

  • building strong and effective rist awareness within the Group;
  • continuously improving risk management and control processes so that they operate effectively and efficiently and reflect leading practice; and
  • sharing best practice with regard to risk management and assurance across the Group.

The Group aims to further develop its ongoing process for identifying, evaluating and managing the significant risks faced by the Group in accordance with the FRC’s Internal Control: Revised Guidance for Directors on the Combined Code (formerly, the “Turnbull Guidance”). The system is intended to manage rather than eliminate the risk of failure to achieve business objectives and can only provide reasonable and not absolute assurance against material misstatement or loss.

The Group plans to enhance the internal audit function by assigning internal resources to support the function (provided that all necessary safeguards are considered) and refining the terms of the internal audit charter in consultation with the committee to ensure that it is effective and meets the requirements of the business.

1. Financial reporting

In reviewing the quarterly and annual financial statements as well as the Annual Report, the committee focused on challenging:

  • compliance of the applied accounting policies and disclosures with financial reporting standards and relevant corporate governance requirements;
  • significant judgements and estimates applied by management; and
  • whether the Annual Report, taken as a whole, is fair, balanced and understandable and provides the information necessary for the shareholders to assess the Group’s performance, business model and strategy.

Any questions and comments from the committee or the external auditor were discussed with management. Subsequently, based on its overall assessment the committee recommended that the Board approve the financial statements and the Annual Report.

The committee continuously provides feedback to management on ways to improve the effectiveness and clarity of the Group’s corporate reporting and works closely with management to ensure that any new regulatory requirements, for example the reporting of payments to governments, are fully complied with.

Significant judgements and estimates

Significant judgements and estimates applied by management when preparing the financial statements are closely related to the principal risks and uncertainties faced by the Group, which are subject to constant monitoring by the Board and the committee. The table below summarizes the key areas where significant judgements and estimates are applied and the corresponding actions taken by the committee to address them.

Significant judgements and estimates

Significant judgements and estimates applied by management when preparing the financial statements are closely related to the principal risks and uncertainties faced by the Group, which are subject to constant monitoring by the Board and the committee. The table below summarizes the key areas where significant judgements and estimates are applied and the corresponding actions taken by the committee to address them.

Oil and gas reserves estimation and accounting

Oil and gas reserves are estimated by the Group’s reserve engineers and audited byreviewed independent reserve engineers. These are used to calculate the depletion of oil and gas assets and as input data for impairment testing models.

The committee reviewed assumptions and judgements made in the reserve estimation report and examined developments in relevant regulations.

Recoverability of non-current assets' carrying values

The Group performs impairment testing of goodwill on an annual basis as required by IFRS. The impairment testing is subject to application of management judgement and various assumptions underlying the calculation of the value-in-use of the Company’s single cash generating unit. The applied judgements and estimates rely on geological, technical and economic assumptions.

The committee reviewed the detailed reports on impairment testing prepared by management and challenged the appropriateness of the assumptions. Areas of particular focus were the assumed oil prices and discount rates particularly in light of recent oil price developments and related volatility risk. Special consideration was also given to the sensitivity analysis in relation to these assumptions.

Other significant judgements and estimates

The decommissioning of oil and gas assets at the end of their economic lives, the provisioning for contingent and other liabilities, current and deferred income tax and fair value of financial instruments are all areas that require the management to use judgement and estimates.

The committee examined each of these issues and sought clarifications as and when necessary.

Significant matters communicated by the external auditors

Significant risks identified by the external auditor were related to the above-mentioned areas involving judgments and estimates as well as following areas which additionally by the committee:

  • Revenue recognition – the committee believes that Group’s policy and internal controls in relation to revenue recognition adequately respond to this risk.
  • Related party transactions and disclosures - the committee has been monitoring procedures for identification of related parties to ensure that pre-approvals are obtained before entering into any such contracts.
  • Risk of management override – in the committee’s view a set of internal controls, as described below in the section “internal control system”, sufficiently minimizes the risks related to management’s ability to manipulate accounting records or to misappropriate assets.

2. Risk management and internal controls

The committee continuously monitored risk management system, further information on which can be found in the Risk Management section of the Annual Report.

In accordance with requirements of the 2016 Code relating to the viability statement, the committee reviewed the impact and sensitivity analysis of such risks on the Group’s long-term viability. The principal areas of risk management assessed by the committee are described in the table below.

Key areas of the committee’s focus in relation to principal risks

GTU3 construction and well drilling

Construction of GTU3 and the drilling programme continued to be a key focus for the committee, particularly in light of low oil prices. The committee reviewed progress reports and met regularly with management to discuss potential problems and to provide recommendations on future steps to be taken by management.

Oil and gas production rates

Oil and gas production volumes, being one of the strategic indicators of the Group’s performance, are subject to risks and uncertainties of a geological and technological nature. The committee has been constantly monitoring forecast production rates in comparison to actual rates. Any material variances were discussed and explanations sought either during committee meetings or dedicated presentations given by management.

Health, safety and environment

As part of the monthly management reports the committee reviewed the Group’s activities to ensure an appropriate level of protection for health, safety and the environment. The committee has also reviewed the annual report prepared by the independent environmental auditor outlining the Group’s compliance and related recommendations for improvement.

Cyber security

The committee examined cyber security matters and discussed with management past and planned actions directed at addressing the recommendations from external consultants. Also, the chairman of the committee received timely updates on the risks and responses in the context of the Cyber Governance Health Check carried out by the UK authorities.

Financial reporting

The committee seeks to ensure the accurate maintenance of accounting records and related transactions. In light of the volatility of oil prices, the committee focused on the review of impairment testing, going concern and the viability statement.

Internal control system

The Group’s internal control system is aimed at mitigating risks and improving efficiency. These include:

  • corporate governance: segregation of authorities and duties at various levels;
  • policies and procedures covering directors’ remuneration, compliance, accounting and reporting, health, safety and environment as described in the relevant sections of the Annual Report;
  • training and internal communications;
  • continuous monitoring by senior management and the Board of short-term, medium-term and long-term planning and decision-making processes;
  • internal audit work and any remedial action taken by management in response to findings.

In the committee’s view, the Group maintained robust and defensible systems of risk management and internal control, and the committee made recommendations to senior management on further improvements as and when considered necessary.

The primary role of the internal audit function is to assist the Board and senior management to protect the assets, reputation and sustainability of the organisation. This is achieved through:

  • building strong and effective risk awareness within the Group;
  • continuously improving risk management and control processes so that they operate effectively and efficiently and reflect leading practice; and
  • sharing best practice with regard to risk management and assurance across the Group.

The committee reviewed findings and recommended actions from the Group’s internal audit manager. Based on its assessment of the internal audit’s competence, resourcing, delivery, findings and reporting, the committee was satisfied that the quality, experience and expertise of the function is appropriate for the business.

3. Compliance with laws and regulations

The chief legal officer and company secretary attends the committee’s quarterly meetings which allow the committee to raise any concerns related to legal, compliance, whistle-blowing and the status of any on-going litigation.

UK Corporate Governance Code

In relation to the work of the committee, as of 31 December 2017, Nostrum had complied with all the principles and provisions of the UK Corporate Governance Code 2014.

Whistle-blowing arrangements

Nostrum has a Group Whistle-blowing Policy and to ensure that all Group employees have access to someone who can provide them with support and guidance. The Group has two compliance liaison officers; one Russian-speaking officer based in Kazakhstan and another Dutch and English-speaking officer based in Brussels. The Audit Committee maintained close contact with the compliance liaison officers. In the beginning of 2017 the committee was aware of one whistle-blowing case, which was investigated and nothing was revealed that would substantiate the allegations.

Corporate Bonds Covenants

At its quarterly meetings, the committee is updated by management on the Group’s compliance with covenants contained in the 2012, 2014, 2017 and 2018 Corporate Bonds.

4. External audit

Appointment of external auditor

Since 2007, Ernst & Young LLP (Kazakhstan) has been the auditor of the predecessor group of companies and continued auditing Zhaikmunai LLP during 2016. On the recommendation of the committee and subsequent approval by the Company’s shareholders, Ernst & Young LLP (UK) was first appointed as an auditor of the Group on 19 May 2014.

In accordance with The Statutory Audit Services for Large Companies Market Investigation (Mandatory Use of Competitive Tender Processes and Audit Committee Responsibilities) Order 2014 (the “CMA Order 2014”) companies should put their external audit contract out to tender at least once every ten years. The committee carried out a tender for the external audit arrangements in 2015 to ensure that the Group was receiving the highest possible quality audit services commensurate with the best available price. As a result of the tender it was concluded that it would be in the best interests of the stakeholders to continue engaging Ernst & Young LLP (UK) as the Group’s external auditor.

Following a recommendation to that effect from the Board, the shareholders approved the re appointment of Ernst & Young LLP (UK) at the Annual General Meeting held on 26 June 2017.

Mr Richard Addison was appointed as lead audit engagement partner on 19 May 2014 and has to-date continued in this role.

Throughout 2017 the Group was in compliance with the provisions of the CMA Order 2014.

NostrumOil&GasPLC AnnualReport2017 Nostrum Oil & Gas PLC Annual Report 2017

2017 audit

During Q4 2017 the Audit Committee reviewed and discussed the detailed audit plan prepared by Ernst & Young LLP (UK) which identified the audit scope and its assessment of significant risks. The key risks monitored by the committee corresponded with those identified and assessed by management and the external auditor. All members of the committee supported the application of professional scepticism by the Group’s external auditor.

During 2017, the members of the committee held private meetings with the external auditor, which provided a mutual opportunity for open dialogue and feedback without management being present. Topics covered at such meetings included: the external auditor’s assessment of significant risks and related management actions, confirmation that there had been no restriction in the scope placed on it by management, the adequacy of the audit fees, the independence of its audit and how the auditor had exercised professional scepticism.

The committee reviewed the 2017 H1 interim and 2017 annual auditor’s reports giving particular consideration to the audit procedures and findings in the areas of significant judgements and estimates. The committee also reviewed the letter of representations in respect of both the interim review and the annual audit, which were subsequently signed by management.

The committee evaluated the effectiveness of the external audit process by completing a questionnaire, which addressed areas such
as processes, audit team, audit scope, communications, technical expertise, audit governance and independence and audit fees. On the basis of such evaluation the committee concluded that the performance of the external auditor remains at an appropriately high level.

Non-audit services

In 2016, the Group’s “Policy on the provision of non-audit services by the external auditor” was revised based on the requirements of the FRC Revised Ethical Standards dated June 2016 and the FRC’s Guidance on Audit Committees dated April 2016. There were no significant changes made to the policy during 2017.

The main principle of the policy is that non-audit services may only be provided by the external auditor where the external auditor maintains the necessary degree of independence and objectivity and standard supplier selection procedures are carried out. Committee pre-approval is required before the external auditor is engaged to provide any permitted non-audit services (as defined in the policy) in addition to any other approvals required by the Board and management pursuant to powers delegated by the Board or Nostrum’s internal approvals policies. The committee monitors the external auditor to ensure that it does not provide non-audit services that are prohibited by the FRC and limits such services to due diligence services and other assurance services. The revised policy is available on the Group’s website at www.nog.co.uk. and will be reviewed and amended as and when required.

The detailed breakdown of audit and non-audit fees can be found in the 2017 annual report. The ratio of audit fees to non-audit fees in 2017 was 0.77 (2016: 1.84). A significant proportion of non-audit fees was attributable to quarterly reviews of interim financial statements and assurance services related to the bond refinancing project. Considering the assurance nature of these services, the committee concluded that it was in the best interest of the Group that such services were provided by the external auditor.

By operating in accordance with the above policy and other practices established within the Group, the committee was satisfied that adequate safeguards were in place to ensure the objectivity and independence of the external auditor.

Audit and non-audit fees (US$ thousands)

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