JKX Warns of Ukrainian Litigation Risk, Declining Output

Promising a new era of transparency, new-look JKX sees “significant scope for improvement in capital investments” and “areas to realize both cost savings and production gains,” it said in an operations update February 29. This would allow it to deliver “significant improvements to the value,” said the new CEO, Tom Reed, after a month spent going through the company’s books. But he also said there was litigation risk, and “many challenges facing the company, not all of them easily understood from previous communication.”

Unlike conventional takeovers where the buyer can do due diligence, the new board took control of JKX by calling for an extraordinary general meeting, where the vote to remove the existing board succeeded.

Among the unwelcome discoveries the new board made as it went through the financial records was some $2.5mn in pay-offs which the previous board approved and paid to themselves in the last 24 hours before the final general meeting on January 28.

There was also another $6.9mn in legal fees: the previous board spent $3.9mn in attempts to stop two shareholders, Eclairs and Glengary, from voting at general meetings, notably on January 28; and it had to pay legal costs of about $3mn more when the UK Supreme Court found in favour of the challenge that these two shareholders brought.

Reed also warned of tax losses, or “legacy risk,” relating to changes in Ukrainian legislation, and which the company warned investors of before the change of management at the end of January. The government almost doubled rental payments on production from 28% to 55%, leading JKX to sue Ukraine for breaches of various treaties. The percentage has been lowered to 28% once more but the company has already spent $3.5mn in legal fees on this case.

The company was awarded an interim payment of some $180mn until final judgement is rendered on the main case, plus damages. The arbitration hearing is expected to take place in July 2016 and will result in additional legal costs for JKX although it might recover the full sum.

The former board of JKX warned that if the board were swept out of office this payment would be forfeit as there would be nobody to represent the company in the July hearing.

But on top of that, Reed warned, JKX has several potential near-term contingent liabilities arising from three separate court proceedings over the amount of rental fees paid in Ukraine for certain periods since 2007, which in total amount to a potential liability of about $41mn, including interest and penalties. “We believe that these claims are without merit under Ukrainian law and we will continue to contest them vigorously. There are several hearings scheduled in the coming months on these proceedings and we will update shareholders in due course,” he said.

In January 2016, it produced 10,553 boe/d of which 9,863 boe/d were gas. Of the total, 6,581 boe/d were produced in Russia and the remainder in Ukraine.  This compares with January 2015 production of 8,126 boe/d of which 7,284 boe/d was gas. Production growth came primarily from the restoration of production from well-27 in Russia. However unless last year’s capex freeze is lifted, and Reed did not say it would be, output will be likely to decline this year.

William Powell