Heritage Oil

Oil & Gas Producers

Initiation of Coverage A Play on Kurdistan
In terms of catalysts going forward, appraisal and exploration drilling is expected to continue in Kurdistan but drilling elsewhere is likely to be in H2 2012 so the only real short term driver would appear to be corporate/take over speculation. Progress with the Nabucco pipeline, alliances with other gas players in the area and/or an improving political environment in Iraq/Kurdistan could act as catalysts and make Heritage more appealing as a takeover candidate. These are perhaps medium to long term events on which a potential acquirer may take a view on in the shorter term but this would be pure conjecture. The only other short term driver we could foresee would be further strategic acquisitions/new country entries (given cash resources to utilise). We initiate with a Hold recommendation and 213p/share PT. Portfolio Overview - Heritage has booked 2P reserves of c. 60 MMbbls in Russia but the current focus is on Kurdistan where it has discovered what management believe to be the largest gas field in the last 30 years (the original expectation was that it was oil). More recently, it has gone into Libya via the acquisition of 51% of Sahara Oil Services which holds permits and licenses to provide oil field services in Libya. Heritage has also just been awarded additional acreage in Tanzania via a PSA covering 18,920km (almost the entire Rukwa Rift Basin). It also has exploration acreage elsewhere in Malta, Mali, the DRC, Pakistan and Tanzania. A warrant on Kurdistan Kurdistan is believed to potentially hold over 50 bn boe of oil and gas. With recent drilling success, despite political uncertainty overhanging, we believe both drilling and corporate activity will continue at an increasing rate. From initial in-place estimates provided by HOIL, and applying a gas recovery factor of 60% and a liquids recovery factory of 30% we estimate net contingent resources of c. 400 MMboe (95% gas) in its Miran West (MW) field. We estimate additional prospective resources of 146 MMboe at MW and c. 38 MMboe at Miran East (ME). Whilst Heritage continues to make all the right noises in regards to development options we believe it is likely gearing up for an asset sale. From HOIL's perspective the optimum time to divest may be on the back of its Miran West-3 well & further seismic processing, i.e. mid-2012. The Nabucco pipeline offers longer term value upside potential. Financials & NAV - A strong balance sheet with net cash of $468m, an additional $284m of cash in escrow relating to its Ugandan dispute (which we risk at 50% in our RNAV) and c. $122m on deposit with the URA (BD risked @ 25%). Our Core NAV (comprising Russia & risked BS items) is 130p/share, including appraisal & development our Total NAV is 206p/share and incorporating risked upside from the exploration portfolio our RNAV is 266p/share. Our PT is set at a P/RNAV of 0.8x = 213p/share. Feasible outcomes We think it is worthwhile to look at how the rating may behave under various scenarios. Unlike many of its peers, the combination of a significant net cash position, additional restricted cash and the likelihood of an asset divestment should provide investors with non-drilling related downside risk cushioning. We have a risk-reward spread of -23%-+101% with our base case suggesting only 6% upside (See scenario analysis for more detail). BD View A relatively attractive risk reward but lacking in ST catalysts. Key risks would be political set backs in Kurdistan and/or an unsuccessful resolution on its Ugandan tax dispute.
Year End Dec 2010(A) 2011(E) 2012(E) 2013(E)

HOLD
New

Date
Share Price: 12m Price Target: Upside: Fundamental View:

11th November 2011

199.9p 213p 6% Positive 3 259.8m 519.3m 220.8m 298.5m
Absolute Relative

Forecast Sensitivity: Shares in Issue:

Market Cap:
Forecast Cash/(Debt): Enterprise Value:
600

500 400

300 200

100 0 Nov-09

Nov-10 Source: Datastream

Reserves & Production Metrics 2010 2P Actual Reserves (WI) Total (MMboe) 2010 Actual Production (WI) Total (boepd) 2011 Forecast Production (WI) Total (boepd) Reuters: Analysts:

60.0 542 637

HOIL.L

Tracy Mackenzie/Jack Allardyce 0845 213 4220/2067

This document is a Marketing Communication and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. Please refer to important disclosures at the end of this document.

Production boepd
542 637 1,621 2,395

Sales $m
5.0 13.2 29.7 43.9

PBT* $m
-30.5 -18.3 -17.3 -21.2

EPS p
-10.0 -6.0 -5.7 -7.0

PE Ratio x
-

EV/EBITDAX x
-

FCF p
-24.3 -23.1 -25.3 -75.4

P/RNAV
x

0.8

*Figures pre-exceptionals and goodwill amortisation, Fully diluted, Source: Company Accounts/BD Forecasts

Heritage Oil

NAV Summary & Outcome Scenarios

NAV Summary
Country/Fields Work Int (%) Russia Zapadno Total assets Net (Debt)/cash 2010A Cash in Escrow URA deposit PV of overheads CNAV Country/Fields Work Int (%) Russia Zapadno Kurdistan Miran West Cont. (P50) A&D Value TNAV Well/Prospect Work Int (%) Kurdistan Miran West (P10 upside) Miran East Malta Areas 2 & 7 Tanzania Kimbiji Kisangire EMV Value (Exploration) RNAV (TNAV+EMV) 70% 55% 10% 10% 35.0 27.5 581.1 660.4 350.0 275.0 1616.9 3910.6 93.3 73.3 850.5 1312.2 466.7 366.7 2586.4 3534.3 5.0 5.0 3.0 2.7 46.7 36.7 291.4 1296.1 0.5 0.5 0.3 1.0 9.6 7.5 59.8 266.1 0.8 95.8 75.3 531.0 882.3 212.9 100% 10% 500.0 0.0 500.0 1500.0 3.0 150.0 0.3 30.8 307.9 CoS (%) Oil (MMbbl) 56% 50% 18.4 59.0 79.4 2293.7 2293.7 2293.7 Net Gas (bcf) Total (MMboe) 400.7 441.2 461.7 644.8 846.4 948.0 1.6 1.9 2.1 322.4 372.8 1004.6 0.8 0.8 2.2 Risked Value NAV ($m) NAV ($/boe) NAV (p) 66.2 76.5 206.2 132.4 173.8 351.3 Unrisked NAV (p) 95% 25% 40.6 0.0 40.6 201.6 5.0 50.4 1.2 10.3 41.4 CoS (%) Oil (MMbbl) Net Gas (bcf) Total (MMboe) 20.4 50% 25% 95% 80% 20.4 20.4 0.0 0.0 20.4 20.4 101.6 101.6 463.9 283.6 121.5 -85.4 885.1 43.3 5.0 5.0 81.2 81.2 463.9 141.8 30.4 -85.4 631.8 4.0 Risked Value NAV ($m) NAV ($/boe) NAV (p) 4.0 4.0 16.7 16.7 95.2 29.1 6.2 -17.5 129.7 20.8 16.7 95.2 58.2 24.9 -17.5 177.5 Unrisked NAV (p) CoS (%) Oil (MMbbl) Net Gas (bcf) Total (MMboe) Unrisked NAV ($m) NAV ($/boe) NAV ($m) Risked Value NAV ($/boe) NAV (p) Unrisked NAV (p)

Unrisked NAV ($m) NAV ($/boe)

Unrisked NAV ($m) NAV ($/boe)

56% 56%

25% 15%

8.9 9.6

824.9 167.1

146.4 37.5

201.5 51.6

1.4 1.4

50.4 7.7

0.3 0.2

10.3 1.6

41.4 10.6

P/RNAV Source: BD Analysis, Company Data

Heritage Oil

Scenario Analysis
Scenario Bull Case - 403p Bull Case (ex expl.) 320p Corporate Event - 277p Events/Assumptions Bull case with exploration success: as below but HOIL also discover c. 200 MMboe from its drilling programme pending (ex. Kurdistan). Bull case excl. exploration success: risks MW cont. res. risked @ 75% CoS & all prosp. resources @ 50%, cash in escrow released, same BD risked value for Russia & risked NAV of exploration prospects. Corporate Event: If we assume a corporate acquirer risks MW cont. res. at a 75% CoS & all prosp. resources @ 50% we get a value of 125p/share (equivalent to $610m or $1.5/boe of cont. resources or $1.0/boe of cont & pros. resources). Expected y/e 2012 net cash plus risking cash in escrow at 50% yields 102p/share. Thus valuing Kurdistan on the basis of an expected sale & assuming cash in escrow has even odds of being released we would have a valuation of 227p/share. As above this ignores all other balance sheet items (BD risked: -11p/share), Russian reserves (BD risked: 27p/share) and the balance of the exploration programme (BD risked: 48p/share). Base case: Work continues but no immediate corporate or drilling catalysts. We set our PT at a P/RNAV of 0.8x. Bear case: If we risk Miran West cont. & prosp. resources @ 25% and Miran East at 15% CoS we get a value of 45p/share. Russian 2P reserves aggressively risked. Expected y/e 2012 net cash plus risking cash in escrow at 25% yields 102p/share. Thus with an aggressively valued Kurdistan & potential cash value we would have a backstop valuation of 155p/share. Implied % 101% 60%

38%

Base Case - 227p Bear Case - 155p

13% -23%

Source: BD Analysis, Company Data

Heritage Oil

BD Company Summary
Cheat Sheet

Source: BD Analysis, Company Data

Heritage Oil

(B) Denotes Brewin Dolphin acts as broker to the company

(A) Denotes AIM listing

Brewin Dolphin Research - Recommendation Definition (expects absolute performance over next 12 months). Buy - 20%+ upside to BD 12m Price Target Add - 10% - 20% upside to BD 12m Price Target Hold - minus 10% to +10% to BD 12m Price Target Reduce minus 10% to 20% downside to BD 12m Price Target Sell - minus 20% or more downside to BD 12m Price Target Fundamental View: Positive - quality company, strong management, strong fundamentals, focussed strategy. Neutral - ambivalent over the company's strategy, market place, management. Negative - BD believes company has fundamental flaws and is not a long term investment. Forecast Sensitivity: 1 = highly likely downgrade upgrade

2 = likely downgrade

3 = neutral

4 = likely upgrade

5 = highly likely

Prices of other securities mentioned: None

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