OIL & GAS RESEARCH

Heritage Oil 585p SUSPENDED

Explorer Extraordinaire 03 June 2009 ANALYST
Our note on Heritage Oil has been overtaken by events. Whilst we intended to re- David Hart
+44 (0)20 7601 6124
iterate our BUY recommendation, events today, when the company asked for its shares
david.hart@hansonwesthouse.com
to be suspended due to discussions with a third party regarding a possible reverse
takeover, have made a Buy un-actionable. Peter Bassett
Yet there are no guarantees regarding the outcome of current discussions, as such we believe + 44 (0)20 7601 6125
peter.bassett@hansonwesthouse.com
there is merit in releasing our note illustrating the value we believe resides within Heritage and
which will still be of interest to potential buyers of the company in the weeks ahead as events
unfold. SPECIALST SALES
Malcolm Graham-Wood
Key Financial data +44 (0)20 7601 6138
malcolm.graham-wood@hansonwesthouse.com
Year Revenue Operating Income EPS
2007 $3.7m -$49.6m -$0.16 COMPANY DESCRIPTION
2008 $5.1m -$37.6m -$0.37 Mid-cap oil & gas explorer and
2009E $8.4m -$46.4m -$0.15 producer
2010E $153.5m $4.8m $0.02
Market Cap £1,482m EV/Bbl1 £22.74 INVESTMENT DATA
Cash2 $120m Net debt to equity3 Net Cash Ticker HOIL
1. Based on reserves at end of 2007 Listing LSE
No. of shares 253.3m
2. As per management in May 2009 following Oman sale and Genel back-in right in KRI
Market cap £1,482m
3. Assumes convertible bonds are converted into shares Enterprise value £1,414m
Heritage produced a mere 450 barrels of oil per day last year and yet the market cap stood at
nearly £1.5bn prior to the suspension of shares on 3 June. As the table above suggests, this value SHAREHOLDERS Holding
is not based on current operational status, rather it is the huge potential upside in Uganda and the Albion Energy 32.50%
Kurdistan Region of Iraq. On a sum of the parts valuation of the group’s asset base, we Lansdowne Partners 7.30%
value Heritage at 890p per share. Capital World Investors 5.71%
Heritage has enjoyed exceptional success in drilling campaigns in Uganda and the Kurdistan Region London & Capital 3.81%
of Iraq. So much so, that we anticipate the group’s interests will yield implied recoverable Firebird Management 3.61%
reserves in excess of 2 billion barrels. Blackrock Group 2.48%

In our view, these resources will prove to be too enticing for either a national oil company or an
12M SHARE PRICE PERFORMANCE
international oil company (IOC) to resist. While yesterday’s events have not taken the exact shape
we anticipated, corporate activity involving Heritage was in our view inevitable given a litany of
reasons not least of which are:
• the move away from exploration to capital intensive development,
• a track record of realising value through asset sales,
• the large scale of its discoveries and
• the need for IOCs to replace resources when access to new exploration areas is limited.
Although Heritage’s share price has been a strong performer in 2009, we believe that
there is significant additional upside. What follows is our analysis to arrive at this
conclusion and our target sum of the parts valuation of 890p per share. This does not For important regulatory disclosures,
include any premium in the event of a still possible corporate takeover, which we would expect please refer to the information on page
to be significant. 17 of this report.

1
 Company overview
History
Heritage was formed in 1992 by the current Chief Executive, Anthony Buckingham. It was originally
called Land and Marine Hydrocarbons Development Limited but the name was changed to Heritage Oil
& Gas Limited in 1993. Until 1996, operations were confined to Angola when the group acquired a 10%
interest in Block 8, offshore Oman. This interest was sold earlier this year for $28 million and $400,000
in working capital adjustments.
In 1997, Heritage expanded into both the Congo and Uganda. In 2004, the company sold out completely
from the Kouilou licence area in the Congo and later sold the Kouakouala licences to Maurel et Prom, a
French exploration company, and Burren Energy in 2007. We believe that these sales demonstrate a
trait of realising value through asset sales that remains today. In Uganda, Block 3 would later be
reconfigured and a portion re-awarded (Block 3A) to the group in 2004.
Another asset in the Congo, the Noumbi licence, where Heritage established a position in 2004, was
also sold to Afren (Symbol: AFR; Mkt Cap: £378m) for a combination of cash and warrants in 2006.
In 2005, Heritage obtained Russian assets when it acquired a 95% interest in the Zapadno
Chumpasskoye licence in West Siberia. This was followed by the establishment of a presence in the
Democratic Republic of Congo (formerly Zaire), the Kurdistan Region of Iraq (KRI) , Mali, Pakistan,
Malta and most recently Tanzania.
Although Heritage listed on the TSX in 1999, it was not listed in London until the first quarter of 2008.
The company’s shares are now a component of the FTSE 250 Index. At the same time as listing in
London, a new parent company, Heritage Oil Limited, was established in Jersey and the company's
shares were split on a ten-for-one basis.
Throughout this period, founder and Chief Executive, Anthony Buckingham has been a constant feature
behind the group’s development. His experience in the industry dates back to 1972 when he began
work as a saturation diver. His biography and a full list of the board and key managers leading Heritage
today is in Appendix 1.

Strategy
Heritage operates a straightforward strategy. Primarily, the group sets out to identify and establish early
positions in high potential hydrocarbon basins utilising internal expertise and a well developed network
of industry contacts. The company then attempts to upgrade these assets through exploration, appraisal
and development depending on its stage of entry.
As with any strategy which sounds good in theory, it is the execution in practice that sets ultimate
performance apart. Here, we believe that Heritage has excelled as recent exploration success can attest.
This is testament to savvy management and bold decision making. When unsuccessful, these attributes
can lead to accusations of excessive risk taking. However, in the case of Heritage, we believe that major
discoveries in Uganda and the Kurdistan Region of Iraq have vindicated the group’s strategy.

2
Investment Case
For an E&P company with a market cap exceeding £1 billion and with output measured in the hundreds of
barrels per day, Heritage does not have a typical production driven cash flow with which to value the
shares. However, it is not difficult to understand how the development of star assets in Uganda and the
KRI would lead to substantial levels of positive cash flow.
As such, the investment case for Heritage can be distilled down to the undervalued assets in Uganda and
the KRI. That is not to say that there is no value in the group’s other exploration interests or the Russian
assets which are in production. However, we believe that the tremendous upside we see in the value of
Heritage comes from these two regions.
At this stage of development there are two straightforward ways for Heritage to recognise and monetise
the value of its existing assets for the benefit of shareholders. First, developing the assets in Uganda and
the KRI itself would take the longest and expose shareholders to the most risk. On the other hand, an
acquisition by a large international oil company (IOC) or national oil company (NOC) could be
accomplished relatively quickly with the added benefit of crystallising a portion of future returns
immediately through what we would anticipate to be a significant takeover premium.
Of these two options we believe a full takeover is the most probable. Several reasons support this
conclusion:
• Realising value from Heritage’s relative strength as an explorer rather than development company
• Heritage has a proven track record of selling assets to realise value
• Acquirer would gain operatorship of both primary assets whilst retaining partnership with existing
parties to share risk and cost
• Additional capex requirements for full development of assets in Uganda and the KRI
• Avoid execution risk associated with large scale development of discoveries
• The share price has already incorporated a portion of exploration upside – incremental increases
from here will be forthcoming but in smaller percentage gains
• Need for IOCs to expand dwindling reserve bases in environment of limited access to other large
hydrocarbon basins
• A key metric for an acquisitive oil major is the price it must pay for new reserves. In the case of
Heritage, we believe its enterprise value per barrel of implied recoverable oil below £1.00 makes
it attractive in this sense.
• Large field size with exceptional remaining upside will be attractive to IOCs and NOCs as the
fields can materially impact reserve and production figures. Operationally, the risk of full field
development remains, however the need to develop 10-20 smaller fields for equivalent
production is avoided.
• Exploration to date has significantly de-risked the company’s portfolio and also highlighted
significant remaining upside.
• Ability of net saving nations such as China to put foreign exchange reserves (sovereign wealth
funds) as well as industrial output (steel industry) to work.
• Incorporate field development with other investment and development programmes.
In the case of NOCs:
• Ability of nations to secure energy resources
• Expand outside of home market
• Foster closer ties between acquiring nation and region.

3
 Other mitigating factor
Finally, Heritage’s corporate structure is such that a sale of assets in the KRI and Uganda individually rather
than the full company would appear unlikely. This is due to the company’s Canadian corporate structure
and the subsequent tax liability that would arise from making this type of disposal.

Conclusion
In all, the rationale behind a takeover is compelling but that does not necessarily mean that one will
happen. The problem for any buyer, in our view, will be to offer a price that Heritage would find
acceptable.
The bottom line is Heritage can afford to wait. Funds on hand adequately support financial commitments
over the next twelve months. Subsequent to this period, we believe that Heritage would have little
difficulty in raising additional funding should the need arise.
Yet the longer a buyer takes to arrive the more time Heritage has to drill and evaluate its growing volume
of data in relation to existing asset discoveries. This will in our view inevitably lead to resources being
upgraded and assigned a higher valuation per barrel as well as increasing the total amount of resources a
potential buyer will need to factor into its acquisition price. As such, Heritage will clearly feel very
confident should talks leading to a takeover begin.
Interested parties will no doubt be aware of this dynamic, which makes the likelihood of a substantial
premium in our view a very high probability as well as the need to act quickly. By acting now, a potential
buyer will at least benefit from residual weakness in the sector driven by short term oil price weakness.

Potential acquirers
National oil companies
National oil companies are natural choices as interested parties in a potential takeover of Heritage. We
believe that many of these companies would see Heritage as an ideal way to diversify out of their home
market. In addition, the vast accumulations of US dollars could be put to use by respective sovereign
wealth funds to aid in the funding of an acquisition not to mention the step up in spending that full field
development will require in Uganda and the KRI.
In countries such as China, where the State has involvement at multiple levels, there is a viable argument
for even deeper levels of participation that a Heritage takeover could act as a springboard. For example,
the steel required for the Ugandan pipeline would provide a convenient source of demand during a period
when export and domestic demand is flagging and when output must be maintained in order to keep civil
order.

International oil majors

International oil companies also have strong claims to be considered in this potential scenario. For
instance, Total and ENI, two European heavyweights, are both active in Africa and the Middle East but
with no operations in Uganda or Iraq. As such, an acquisition of Heritage would offer either of these
substantial new areas of interest in regions in which they are already operating. This also highlights
perhaps the greatest attraction of these assets, at a time of very limited access for oil majors the world
round, when finds of over 100 million barrels attract interest, Heritage offers access to two potential
multi-billion barrel discoveries.

4
TNK-BP steps up?
Another candidate we see as a potential acquirer is TNK-BP. Last year, the group went through a period
of turmoil as the relationship between BP and the group’s Russian shareholders; Mikhail Fridman, Viktor
Vekselberg, German Khan and Len Blavatnik (referred to as Alfa Access Renova or AAR), fell to a
regrettable low. Among the disagreements between the two JV partners was the desire by AAR to have
TNK-BP operate as an international oil company rather than simply what was perceived to be BP’s
strategy for Russia. International diversification it would seem is therefore on the company’s agenda. This
was one reason we failed to see the logic in TNK-BP’s half-hearted approach for Sibir Energy earlier this
month (except perhaps to lay down a marker for Gazprom to come in and beat).
In May, we learned that BP’s proposed new chief executive of the TNK-BP joint venture has both an
investment and diplomatic service background. This makes TNK-BP an even more likely potential buyer in
our view as this combination may mean the new CEO is just as, if not more, inclined to search for oil on
today’s depressed stock markets than in the field. Given his diplomatic experience included a six year stint
as Soviet vice-consul in Uganda, his knowledge of the country would also make him an ideal candidate to
help lead the development process Heritage’s operations will soon be entering.

5
 Operations
Although Heritage operates in the E&P sector, the company’s focus and value resides squarely in its
exploration activities, specifically in Uganda and the Kurdistan Region of Iraq. This focus is even more
pronounced following the recent sale of producing assets in Oman. Below is a brief overview of Heritage’s
operations.

Map of Heritage’s exploration interests

Source: Company

Uganda
Heritage has been involved in Uganda since 1997 when it was awarded the licence to explore the area
originally covered by Block 3. Block 3 was later reconfigured and in 2004, the company was awarded a
50% interest and operatorship of Block 3A and Block 1. The assets are located in the Albert Lake basin
which straddles the border with the Democratic Republic of Congo. The company’s partner in the Blocks
is Tullow Oil (Symbol: TLW; Mkt Cap: £8.1bn), also with a 50% interest. The government of Uganda,
under the terms of the production sharing contract (PSC), has a 15% back in right that, if exercised,
would reduce Heritage’s interest to 42.5%.
Initially, Block 3A was generating most of the headlines for Heritage in Uganda following the successful
Kingfisher exploration well towards the end of 2006. However, drilling in Block 1 has yielded an even
larger discovery with the world class Buffalo-Giraffe field last year. Both blocks still contain multiple high
potential targets that offer significant upside.

6
Kurdistan Region of Iraq (KRI)
Following the fall of Saddam Hussein in Iraq, Heritage arrived in the KRI early relative to its peers. As a
result of this first mover advantage, the company was able to target the Miran block following the advice
of amongst others, the current Kurdistan Regional Government (KRG) Energy Minister, Ashti Hawrami.
In October 2007, the KRG awarded Heritage a PSC for the Miran Block. This structure, containing
multiple reservoirs, extends over an area of over 500 km2. Drilling results, which are still subject to longer
term testing in the weeks ahead, have exceeded pre-drill expectations.
Heritage’s interest in the block is now 75% following the KRG’s nomination of Genel Energy International
Ltd as the third party participant in the licence pursuant to the PSC’s terms. The KRG has additional back-
in rights which if exercised, will further reduce Heritage’s interest to 56.2%.

Russia
The Zapadno Chumpasskoye licence in Russia’s West Siberian Basin is Heritage’s only producing asset in
its portfolio. The company acquired a 95% interest in the oil field from TNK-BP in 2005. In 2008,
production averaged a meagre 379 barrels of oil per day (bopd), although peak production of 900 bopd
was achieved during the year.
Net proven and probable reserves at Zapadno Chumpasskoye stood at 60.4 million barrels at the end of
2007. Given the low level of production, these were not updated at the end of 2008. While we anticipate
production to rise in 2009 following a brief shut-in period between December 2008 and February 2009,
we do not believe Russia will be a significant value creator in the group relative to the exploration plays in
Uganda and the Kurdistan Region of Iraq.

Other regions of operation

Tanzania
In September 2008, Heritage received government approval for farm-ins to four exploration licences
covering 25,000 km2 in East Tanzania.
The Kisangire and Lukuliro licence areas are covered by a single PSA. Heritage is the operator and will
earn a 55% working interest in both licences by funding a minimum of 150 kms of 2D seismic and one
commitment well. An additional 15% interest can be earned by funding 87.5% of the costs of a second
well. As the initial exploration period is due to expire shortly, Heritage has applied for an extension which,
according to the company, is receiving a favourable hearing from the government.
The Kimbiji and Latham licences areas are also covered by a single PSA. Here, Heritage can earn a 70%
working interest in Kimbiji and a 29.9% working interest in Latham by funding all seismic costs required
for the initial exploration period on both licences and drilling two exploration wells in Kimbiji. Heritage
will act initially as contract operator. However, after drilling the second exploration well in the Kimbiji
licence, the group will be appointed operator.

Mali
Heritage farmed into two Blocks 7 and 11 in November 2007, receiving government approval in Q1 2008.
The company has the right to earn a 75% interest in the blocks by funding a $14-15 million, two year
work programme which includes the acquisition of seismic and drilling one exploration well. A two year
extension to both licences was awarded in January 2009.

7
 Malta
In December 2007, Heritage entered into a PSC for a 100% interest in offshore Blocks 2 and 7. The two
blocks cover an area of almost 18,000 km2 to the south east of Malta. Past seismic surveys have identified
several potential targets. However, only one well, back in 1980, has ever been drilled on the licences.
Under the agreed three year work programme, current commitments costing $22 million call for an
additional 1,000 km2 of seismic and an exploration well. Legal wrangles may lie ahead however as the
Libyan state oil company has contacted Heritage disputing the rights over portions of the southernmost
Block 7.

Pakistan
Heritage was awarded a 54% interest in the Sanjawi Block, in the Baluchistan Zone, in November 2007.
The license covers an area of 2,258 km2. More recently the group farmed into a 48% interest in the
Zamzama North Block. Existing seismic and regional infrastructure will help promote exploration and any
subsequent development. Both blocks are onshore.

Democratic Republic of Congo (DRC)

In the DRC, Heritage holds a 39.5% interest in Blocks 1 and 2 which lie on the border with Uganda and
are adjacent to the group’s Block 3A and Tullow’s Block 2 in Uganda in the Lake Albert basin. The initial
exploration term is for five years during which time seismic data will be collected and exploration wells
drilled. However, this work programme will not begin until a presidential decree is received. In addition,
there is an ongoing dispute regarding the validity of Heritage’s licences which the company is confident of
resolving in its favour.

Future drilling plans

The following table shows the wells we anticipate Heritage will drill (exploration and appraisal) in 2009
and 2010 after the short break while the extended test on Miran West-1 is completed. We believe this
illustrates the short time frame in which Heritage can upgrade its resource base and cost to a potential
suitor to wait.

2009 and 2010 drilling

Prospect Location Block Timing
Miran West-2 Kurdistan Region of Iraq Miran 3Q 2009
Miran East-1 Kurdistan Region of Iraq Miran 4Q 2009
Buffalo Uganda Block 1 3Q 2009
Buffalo East Uganda Block 1 3Q 2009
Crocodile Uganda Block 1 4Q 2009
Pelican Uganda Block 3A 2Q 2010
Crane Uganda Block 3A 3Q 2010
TBA Tanzania Kimbiji 3Q 2010
TBA Tanzania Kisangire 4Q 2010

Reserves
Heritage’s reserves are difficult to define. In April’s preliminary earnings release, the figures were not
updated given the small amount of production from Russia and the data from recent success in Uganda
and the KRI not being available at year end. As such, total official reserves are a misleading 60.4 million
barrels.
Heritage is preparing a reserve report for the second half of 2009 incorporating recent drilling success, at
which time this figure from the end of 2007 will be immaterial to the group’s activity.

8
The Discoveries
As we stated in our Operations review, Heritage is focused on Uganda and the KRI. It is in these two
countries that the company has made transformational discoveries.

Uganda
Map of Albert Basin (including Ugandan and DRC interests)

Source: Company

Block 3A
Block 3A covers the southernmost half of Lake Albert on the Ugandan side of the border with the DRC.
The Kingfisher-1 (and sidetrack 1A) well discovered the Kingfisher field in 2006. Since then, Heritage has
drilled the Kingfisher-2, 3 (and sidetrack 3A) wells on the structure.
The wells have encountered three reservoir intervals. The best flow test result was the Kingfisher-2 which
flowed at an impressive 14,364 barrels of oil per day (bopd). The oil in the Block is light and sweet
(between 30 and 32 degree API), with a low gas-oil ratio. There is also some associated wax. Heritage
estimates gross recoverable resources to be 200 million barrels of oil although there remains, in our view,
tremendous upside in the Block. All the wells have been suspended as future producers.
The Kingfisher field itself is nearly completely underneath Lake Albert although drilling until now has all
taken place on the shoreline. This will change in 2010 when Heritage plans to incorporate a barge in the
drilling programme to allow for “offshore” drilling in landlocked Uganda. Potential targets include the very
large Crane and Pelican prospects.

9
 Block 1
Block 1 is north of Block 3A and covers an area of 3,659 km2. This acreage was the news maker for
Heritage in the second half of 2008. Successful results with Warthog-1 and later Buffalo -1, set the stage
for what management is calling the largest onshore discovery in sub-Saharan Africa for 20 years. This
occurred when the Giraffe-1 well confirmed that the Buffalo and Giraffe fields were structurally
connected. The initial estimate of gross recoverable resources from the field is 350 million barrels and
Warthog adds an additional 45 million barrels.
The wells drilled were shallow (between 600m and 920m), making further exploration and appraisal
relatively cost effective. Moveable oil has been confirmed through downhole testing and the recovery of
oil at the surface. In addition, Tullow Oil has tested Kasamene-1 in the adjacent Block 2 at a maximum
flow rate of 3,500 bopd.
Later this year, Heritage intends to continue drilling in Block 1. Among the prospects to be targeted are
Buffalo East and Crocodile (see map). This drilling campaign is targeting an additional 400 million barrels of
gross recoverable resources although the ultimate upside in the Block is substantially higher, potentially
surpassing 1 billion in our view.

Development in Uganda
It is just as well the discoveries in Uganda are large as the domestic market is quite small and the cost of
developing an export solution made a significant discovery necessary. Heritage (along with partner
Tullow) certainly has achieved the required hurdle level.

Map of pipeline extension in Uganda

Source: Company

10
A pipeline is necessary for full scale development, this much is known. The waxy nature of the crude
would also require a heated pipeline or the addition of pump stations. Initial estimates are that a pipeline
will cost $2 billion to build. Heritage is not in a position to fund this development currently but has,
according to management, received multiple approaches from interested parties to either finance or build
the pipeline.
In the shorter term, Heritage believes it will be able to phase in development for local needs and low
export volumes via trucking and rail while the larger capacity pipeline is being built alongside an existing
product pipeline.

The Kurdistan Region of Iraq (KRI)

The Miran Block
In October 2007, Heritage was awarded the licence and operatorship of the Miran Block, a 1,015 km2
licence area located west of the city of Suleimaniah in the KRI and close to one of Iraq's major export
pipelines. The licence is located around 65 kms from the massive Kirkuk field and lies on trend with the
Taq Taq oil field. The licence contains two structures, Miran West and Miran East. Between April and June
2008, Heritage mapped the structures from 332 kms of 2D seismic data.

Map of Miran licence in the Kurdistan Region of Iraq

Source: Company

11
 Recent work programme
Having gained encouragement from the quality of the seismic, Heritage accelerated the work programme
and by December 2008 was drilling the first ever well, Miran West-1, on the licence. The well targeted
three principal proven reservoir formations - the Shiranish, Kometan and Qamchuqua and was expected
to take three months to reach a target depth of between 2,500m and 3,000m.
On 25 March 2009, the company announced the well had reached a total depth of 2,935m and
encountered oil shows over a 1,100m interval. Testing was anticipated to take one month to complete
and would include a series of drill stem tests over a gross interval of approximately 500m including all
three reservoir formations.

Discovery of significant reserves

Anticipating a large discovery, we were not disappointed on 6 May 2009 when Heritage released the
results of the initial testing programme. Oil in place in the Miran West structure was estimated between
2.3 and 4.2 billion barrels. The oil was of medium gravity, with low sulphur, a low gas-oil ratio and no
water. Due to the highly fractured nature of the reservoirs, the company also estimated an impressive
recovery factor between 50% and 70%.
The only slight disappointment was the low initial flow rates from the well. The company has put this
down to the use and significant loss of heavy mud when drilling due to the expectation of encountering
large quantities of gas which did not occur, a cased rather than open bore hole and limitations of the
surface testing equipment. As a result, an extended test is currently being undertaken which should lend
added credibility to management flow rate estimates of between 10,000 to 15,000 bopd per well.
Following this test programme, Heritage intends to drill a second well on Miran West in July and later in
the year at Miran East. We anticipate a second similar sized discovery at Miran East given the proximity to
Miran West and similar seismic data.

Development options
The announcement that Norwegian oil company DNO and Addax Petroleum (Symbol: AXC; Mkt Cap:
£3.3bn) will be able to export oil from the KRI starting in June 2009 is a significant event for all interested
parties in the region and has to some degree de-risked the future development of Miran. Heritage has
gone as far as saying it may begin trucking some production for sale by the end of this year. Full field
development will eventually require the installation of a pipeline to tap into local existing infrastructure.
The construction of a mini-refinery with an estimated price tag of $140m is no longer an issue for Heritage
after receiving a “waiver” from the KRG to no longer build the facility as per the terms of the PSC. In
return, Heritage will pay $35m from future revenue for the dropping of the condition.

12
 Valuation
As we stated earlier, Heritage does not have a typical cash flow to use to determine its value. Given
existing information, estimating cash flow would require broad estimates which would reveal a value that
suggests a level of precision we do not believe is available at present. This situation may improve in the
coming months when the company updates its reserve estimates in mid-year as mentioned in the
preliminary results announcement on 30 April 2009.

Asset based valuation criteria

Until such time, our valuation will be asset based utilising both the company’s and our own resource
estimates in the ground, recovery guidance and a conservative per barrel valuation of implied reserves.
Our valuation also assumes that the group’s convertible bonds are converted into 33.6 million shares as
they are already “in the money”.
Our base case does not include any value for the exploration portfolio in Tanzania, Mali, Malta, Pakistan or
the DRC. Although there is no doubt that there is substantial upside potential in these assets, we believe
the early stage of exploration, consisting in most cases of historical and company acquired seismic and the
clear focus of management elsewhere within the group renders their value nominal at present.
A planned drilling programme in Tanzania could change this. However, we now expect this to be
postponed until 2010 given Heritage’s desire to focus on the high value creation potential in Uganda and
the KRI.

The KRI
Recently completed drilling at the Miran West structure has resulted in initial estimates of 2.3 to 4.2 billion
barrels of oil in place. While this is impressive, company guidance of a 50-70% recovery factor is equally
exciting. This indicates a high quality reservoir despite the uninspiring initial DST which Heritage believes
can be put right in future drilling.
The oil itself tested at 27 degrees API which, when in production, supports an oil price discount of 5% to
Brent. In the meantime, we are assuming a conservative $2.50 per barrel in the ground. We also assume
that the government exercises its back in right thereby reducing Heritage’s interest from 75% today to
56.25%.

Miran West

Mean bbls HOIL Net bbls of Recovery Net Implied Unrisked Risked Diluted Value per
of oil in interest oil in place rate Recovery Implied value 75% shares share
place at $2.5/bbl

3.25 bn 56.25% 1.83 bn 60% 1.10 bn $2,742m $2,057m 290 m 458p

Following further tests on the initial Miran West well, a second well is planned around August and should
provide tighter parameters for our valuation. Drilling on Miran East is then planned for later in 2009 and
will be targeting a structure similar to Miran West. We believe, given the proximity of Miran West and the
similar seismic data, attributing a value to this on a higher risked basis is acceptable.

Miran East

Mean bbls HOIL Net bbls of Recovery Net Implied Unrisked Risked Diluted Value per
of oil in interest oil in place rate Recovery Implied value 25% shares share
place at $2.5/bbl

2.0 bn 56.25% 1.13 bn 60% 0.68 bn $1,688m $633m 290 m 141p

13
 Uganda
Heritage has had a string of successful wells in Uganda. The Kingfisher field is believed to contain 200
million barrels of gross recoverable resources following the drilling of Kingfisher-1, 2, 3 and horizontal 3A
wells. Another 3 well programme is planned later this year targeting 400 million barrels of recoverable
resources.
Our table below is similar to that for the KRI. However, in this case, the starting point is from company
guided gross recoverable resources. We have applied a conservative value of $4.00 per barrel to these
resources and kept the risk weighting the same between drilled (75%) and undrilled (25%) estimates. We
also assume the Ugandan government exercises its back in right thereby reducing Heritage’s interest from
50% today to 42.5%.

Kingfisher, Buffalo-Giraffe and Warthog

Gross HOIL Net Unrisked Risked Diluted Value per

Recoverable interest recoverable Implied value 80% shares share
resources bbls at $4/bbl

0.6 bn 42.5% 0.25 bn $1,012 $809m 290 m 180p

Second half 2009 drilling programme

Gross HOIL Net Unrisked Risked Diluted Value per

Recoverable interest recoverable Implied value 40% shares share
resources bbls at $4/bbl

0.4 bn 42.5% 0.17 bn $680 $272m 290 m 61p

Conclusion
In addition to the amounts above, we have included 27p per share for Heritage’s Russian assets and 23p
for the net cash position (assuming convertible bonds are converted). The result is our target
valuation of 890p. This does not include any premium which we would expect to be significant in the
event of a corporate takeover.

Sensitivity analysis
Given Heritage’s high recovery guidance, we have included a table below to show the significant upside in
the Miran structure which Heritage can unlock with further drilling and testing. We have varied the
recovery factor from a low of 30% to Heritage’s high estimate of 70% and the implied value of reserves
in the ground ranging from $1.50 to $4.50. The analysis includes the whole Miran structure, i.e. West and
East.

Miran Sensitivity Analysis

Recovery rate Implied net barrels $1.5/bbl $2.5/bbl $3.5/bbl $4.5/bbl
to HOIL
30% 0.89 bn 180p 299p 419p 539p
40% 1.18 bn 239p 399p 559p 718p
50% 1.48 bn 299p 499p 698p 898p
60% 1.77 bn 359p 599p 838p 1077p
70% 2.07 bn 419p 698p 978p 1257p

14
The table below performs a sensitivity analysis for Heritage’s Ugandan assets in which the value per barrel
in the ground is changed. We believe this value is closer to $6.00. However, in our valuation above we
used $4.00 in order to keep our estimate conservative. As such, we believe that there is not only
additional upside on offer from higher resource estimates but also assumptions regarding those resources
undeveloped value.

Ugandan Sensitivity Analysis

Implied net barrels to $3/bbl $4/bbl $5/bbl $6/bbl
HOIL
0.43 bn 180p 241p 301p 361p

Financials
Our analysis and conclusion that Heritage warrants a BUY recommendation does not rely on the strength
of its income statement. With production in Russia not set to rise significantly in the foreseeable future,
profitability at Heritage is dependent of the development of assets in Uganda and the KRI.
The near term potential of production being trucked for export in the KRI means that although losses are
expected to continue in 2009, the revenue from Iraq could enable operating profits as soon as 2010. We
have assumed a modest production level of 10,000 bopd from Miran to arrive at the figures in the table
below. We recognise that given the region is still unsettled and the company’s time table remains fluid, this
estimate is likely to undergo substantial revision in the future.

Key financial data

Year Revenue Operating Income EPS
2007 $3.7m -$49.6m -$0.37
2008 $5.1m -$37.6m -$0.16
2009E $8.4m -$46.4m -$0.15
2010E $153.5m $4.7m $0.02
Market Cap £1,482m EV/Bbl1 £22.74
Cash2 $120m Net debt to equity3 Net Cash
1. Based on reserves at end of 2007
2. As per management in May 2009 following Oman sale and Genel back-in right in KRI
3. Assumes convertible bonds are converted into shares

Given the group negative cash flow in 2009, we should note that existing resources on hand are, according
to management, sufficient to see the group through April 2010. Further financing would be necessary to
satisfy work programme commitments and planned expenditure in the second half of 2010.

15
 Appendix 1 – Board and Management
Michael Hibberd, Chairman and Non-Executive Director
Mr. Hibberd has extensive international energy project planning and capital markets experience. He has
been President and CEO of MJH Services Inc., a corporate finance advisory company, since 1995, prior to
which he spent 12 years with ScotiaMcLeod in corporate finance and held the position of director and
Senior Vice President, Corporate Finance. He is Co-Chairman of Sunshine Oilsands Ltd. and currently
serves on the boards of directors of AltaCanada Energy Corp., Canacol Energy Ltd., Challenger Energy
Corp., Iteration Energy Ltd., Pan Orient Energy Corp., Ramtelecom Inc. and Zapata Energy Corporation.
Mr. Hibberd also served as a director of Rally Energy Corp. until October 2007 and as a director of Deer
Creek Energy Limited until December 2005. Mr. Hibberd joined the Group in March 2006.

Tony Buckingham, Chief Executive Officer

Mr. Buckingham is the founder of the Group. Mr. Buckingham commenced his involvement in the oil
industry as a North Sea diver and subsequently became a concession negotiator acting for several
companies including Ranger Oil Limited and Premier Oil plc. He was previously a security adviser to
various governments.

Paul Atherton, Chief Financial Officer

Mr. Atherton is a qualified accountant, having qualified with Deloitte & Touche, and holds a degree in
geology from Imperial College London. He has a corporate finance background with specific experience in
the international mining and resource sectors. He joined the Group in 2000 and joined the Board of
Directors in 2005.

Salim Hassan Macki, Non-Executive Director

Mr. Macki was a Member of the State Council, Former Ambassador, Government of Sultanate of Oman
and has been a Director of Oman Oil since 1996. Mr. Macki holds a Master’s degree in Petrochemical
Engineering and has spent most of his working life in the oil industry, where he is highly regarded
internationally. He holds, or has previously held, many senior executive positions in various private and
state owned entities in Oman and internationally. He joined the Group on 13 August 2008.

General Sir Michael Wilkes KCB, CBE, Non-Executive Director

General Sir Michael Wilkes retired from the British Army in 1995 as Adjutant General and Middle East
Adviser to the British Government on defence matters. As Adjutant General, Sir Michael was the most
senior administrative officer within the Army and a member of the Army Board. Sir Michael is a non-
executive director of AIM listed Stanley Gibbons Group. In addition he holds non-executive positions on a
number of private companies including Britam Defence and Trico Ltd and chairs the Advisory Board of
PegasusBridge Fund Management Limited, a homeland security Company. He joined the Group on 18
March 2008.

John McLeod, Non-Executive Director

Mr. McLeod is a Professional Engineer with over 38 years of varied domestic and international oil and gas
experience. He is the President of McLeod Petroleum Consulting Limited, President, CEO and a Director
of Tuscany Energy Ltd., Paris Energy Inc. and California Oil and Gas Corporation. He has held positions
and served on various boards including Constellation Oil & Gas Ltd. and CanArgo Energy Inc., as President
and CEO of Arakis Energy Company, as VP, Operations of Pengrowth Gas Company, CEO and director
of Rally Energy Corp. and Canoro Resources. Currently, Mr. McLeod serves as a director of Diaz
Resources Ltd. and March Resources Ltd. He is immediate Past-President of the Association of
Professional Engineers, Geologists and Geophysicists of Alberta. He joined the Group in 1998.

16
Gregory Turnbull, Non-Executive Director
Mr. Turnbull is the Regional Managing Partner of the Calgary office of the law firm of McCarthy Tetrault
LLP. Mr. Turnbull has extensive knowledge of corporate governance issues and has acted for many boards
of directors and special committees in that regard. Mr. Turnbull started his career with the law firm of
MacKimmie Matthews in 1979. From 1987 to 2001, he was a partner with Gowlings LLP (formerly Code
Hunter LLP). In 2001 and 2002, he was a partner with the law firm of Donahue LLP. Mr. Turnbull has
been a partner with the law firm of McCarthy Tetrault LLP since July 2002. He joined the Group in 1997.

Brian Smith - VP Exploration

Mr. Smith has 30 years experience in the oil industry. He initially worked as an exploration geologist for
Exxon in the North Sea and Gulf of Mexico. Later he joined Enterprise Oil where he managed various
exploration projects in the Far East and Eastern Europe/FSU. He joined Heritage as Vice President,
Exploration in 1997.

Stephen Kobak - VP Production Russia and CIS

Stephen Kobak, a qualified engineer, has 27 years of experience in oil and gas production operations,
reservoir studies and asset development. The companies he has worked for include ESSO, Shell
International and Khanty Mansiysk Oil Corporation in Western Siberia where he held senior management
positions guiding technical and operations activities. He has extensive international experience working in
Russia, the Far East, Middle East and Canada. Mr. Kobak joined Heritage in 2007.

James Baban - General Manager, Kurdistan

Mr. Baban has over 30 years experience in the upstream oil and gas industry. He is a Chartered Engineer
and a Fellow of The Energy Institute in the United Kingdom and has previously worked for Petro-Canada,
Burlington Resources, Veba Oil, BP & BG. Mr. Baban has extensive skills in the development and
management of international offshore and onshore projects, having worked in the Middle East, Far East
and North Africa. Mr. Baban joined Heritage in 2005.

Appendix 2 - Risks
Many of the risks facing Heritage are the same as those facing any other E&P company. As such, we have
attempted to limit our comments on general sector risk and focused instead on those specifically
associated with Heritage.

Exploration risk
Whilst Heritage is still actively engaged in exploration, we believe this risk has largely been overtaken by
recent discoveries. Clearly, there is potential in our view for exploration to further bolster resources at
Heritage. However, given the scale of discoveries to date, the company does not require further success
to justify commercial development in its regions of interest in Uganda and the Kurdistan Region of Iraq.
Elsewhere, the company remains exposed to exploration risk outside its core regions of activity, however
these other areas are not key drivers of value.

Appraisal risk
Having made the initial discoveries in Uganda and the KRI, Heritage will begin ramping up appraisal
activity. This will now add risk associated with the potential upside of said discoveries, the condition of the
reservoir or the quality of oil being materially different from initial estimates.

Development risk:
This is an operational risk inherent in any large project. Heritage’s exposure is somewhat heightened given
the jurisdictions in which the company operates.

17
 Political risk
Political stability is not something that Heritage can take for granted. Although there have been elections,
there has not been a transition in power in Uganda since the current President, Yoweri Museveni, took
power in 1986. Equally, the politics of Iraq offer even greater challenges, not least due to the acrimony
between the central Iraqi authorities and the KRG. Elsewhere, political risk in the DRC renders those
assets in particular valueless, in our opinion, until there is meaningful improvement in the country’s
political outlook.

Geopolitical risk
Here is one of the major risks associated with Heritage and given its nature one which the company
exerts no control. That said, this is a risk that nearly all diversified oil and gas companies face. In the case
of Heritage however, there is no ‘rock’ or low risk base from which to operate and support riskier
international operations. As a result, while this risk is common to the sector, we believe Heritage has an
elevated exposure to it.

Capital risk
We said we would skip the basic risks yet we have included access to capital. However, in the case of
Heritage we believe this only becomes elevated to risk in the event a takeover is not forthcoming. In this
scenario, our expectations of a near term takeover do not eventuate and Heritage must progress to the
next stage of development which will require additional capital. While it is a risk, we believe that should
this occur, the project economics would ensure that the company would find sources of capital with
which to progress its projects.

Liquidity risk
We believe this is potential risk. For instance, the financing referred to
above cannot be assumed to be 100% safe in the case it is need. Also, there
is a risk that the $165 million convertible bond becomes payable in the
event of a share price collapse.

18
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19
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20
CONTACTS
SALES:
Sanjiv Pandya
+44 (0)20 7601 6130
sanjiv.pandya@hansonwesthouse.com

Simon Hodges
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SALES TRADING:
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