CALGARY, March 12 /CNW/ - Petrolifera Petroleum Limited (PDP - TSX) today announced solid financial and operating results for the year ended December 31, 2008. Stable production was accompanied by favorable commodity pricing in the fourth quarter 2008 and resulted in the company's twelfth successive quarter of positive cash flow from operations before changes in working capital ("cash flow") and net earnings since becoming a public company in late 2005.
These Year End results will be the subject of a Conference Call at 9:00 a.m. MST on March 13, 2009. To listen to or participate in the live conference call please dial either (416) 644.3414 or (800) 733.7560. A replay of the event will be available from Friday, March 13, 2009 at 11:00 a.m. MST until 23:59 (11:59 p.m.) MST on Friday, March 20, 2009. To listen to the replay please dial either (416) 640-1917 or Toll Free at (877) 289-8525 and enter the passcode 21294036 followed by the number sign.
Summary Results are as follows:
For the years ended December 31,
2008 2007 % Change
FINANCIAL ($000 except per share amounts)
Total revenue 130,326 134,223 (3)
Cash flow from operations before
working capital changes(1) 62,802 68,445 (8)
Per share, basic(1) 1.19 1.43 (17)
Per share, diluted(1) 1.17 1.33 (12)
Net earnings 11,554 29,301 (61)
Per share, basic 0.22 0.61 (64)
Per share, diluted 0.22 0.57 (61)
Capital expenditures 116,751 111,025 5
Cash and cash equivalents 30,701 13,052 135
Working capital 19,956 (31,779) 163
Long-term debt 77,150 - -
Shareholders' equity 202,347 120,303 68
Total assets 355,658 204,227 74
OPERATING
Daily sales volumes
Crude oil - bbl/d 6,891 7,919 (13)
Natural gas - mcf/d 5,942 2,157 175
Barrels of oil equivalent - boe/d(2) 7,881 8,279 (5)
Reserves (mboe)(3)
Total Proved (1P) 13,049 17,782 (27)
Total Proved plus probable (2P) 20,035 25,566 (22)
Total Proved plus probable
plus possible (3P) 29,458 39,037 (25)
Prices
Oil - $/bbl 49.46 45.51 9
Natural gas - $/Mcf 2.49 1.55 61
Barrels of oil equivalent - $/boe 45.12 43.94 3
Common shares outstanding (000s)
Weighted average - Basic 52,648 47,990 10
Weighted average - Diluted 53,573 51,435 4
End of period 54,948 50,127 10
(1) Cash flow from operations before non-cash working capital changes
("cash flow") and cash flow per share do not have standardized
meanings prescribed by Canadian generally accepted accounting
principles ("GAAP") and therefore may not be comparable to similar
measures used by other companies. Cash flow from operations before
non-cash working capital changes includes all cash flow from
operating activities and is calculated before changes in non-cash
working capital. The most comparable measure calculated in accordance
with GAAP would be net earnings. Cash flow from operations before
working capital changes is reconciled with net earnings on the
Consolidated Statements of Cash Flows and in the accompanying
Management's Discussion & Analysis. Management uses these non-GAAP
measurements for its own performance measures and to provide its
shareholders and investors with a measurement of the company's
efficiency and its ability to fund a portion of its future growth
expenditures.
(2) All references to barrels of oil equivalent (boe) are calculated on
the basis of 6 Mcf : 1bbl. Boes may be misleading, particularly if
used in isolation. This conversion is based on an energy equivalency
conversion method primarily applicable at the burner tip and does not
represent a value equivalency at the wellhead.
(3) The reserve estimates for 2008 and 2007 were prepared by an
independent professional petroleum engineering firm in accordance
with National Instrument 51-101 (NI 51-101) and the Canadian Oil and
Gas Handbook. Under NI 51-101, proved reserves are those reserves
that can be estimated with a high degree of certainty to be
recoverable. There is at least a 90 percent probability that the
quantities actually recovered will equal or exceed the estimated
proved reserves. Probable reserves are those additional reserves that
are less certain to be recovered than proved reserves. It is equally
likely that the actual remaining quantities recovered will be greater
or less than the sum of the estimated proved plus probable reserves.
Possible reserves are those additional reserves that are less certain
to be recovered than probable reserves. There is at least a 10
percent probability that the quantities actually recovered will equal
or exceed the sum of proved plus probable plus possible reserves.
Review of 2008
Petrolifera Petroleum Limited (PDP - TSX) maintained a relatively steady level of production, sales revenue and cash flow during 2008. The steady sales volume levels reflect the continuing impact of the company's water flood at Puesto Morales Norte Field ("PMN") and some modest contributions from new pool discoveries in Argentina during the year. Consistent production, higher commodity pricing and healthy cash flow, combined with new borrowings and proceeds from a successful equity financing during the year, enabled the company to conduct an active capital program throughout 2008. Petrolifera ended the period with healthy cash balances, unutilized credit capacity and sustainable cash flow available to finance its anticipated share of capital programs throughout 2009. Commencement of Petrolifera's high impact drilling program began in January 2009 on the Sierra Nevada License in the Lower Magdalena Basin in Colombia; this license offsets and is contiguous with the Sierra Nevada II Technical Evaluation Agreement ("TEA") which is anticipated to be converted into the Magdalena License shortly. In early 2009, Petrolifera also anticipates being awarded Peruvian Block 133, which offsets and is contiguous with Block 107 in the Ucayali Basin. We also anticipate the commencement of drilling on Block 107 later in 2009, upon receipt of approval of a drilling Environmental Impact Assessment ("EIA") from Peruvian authorities. This drilling is anticipated to be conducted using the same helicopter-transportable rig presently active for Petrolifera in Colombia, a requisite for jungle drilling.
Highlights of 2008 were as follows:
- Stable crude oil and natural gas sales were achieved, buoyed in part
by the water flood program at PMN and contributions from new pool
Argentinean discoveries.
- Cash flow was $62.8 million ($1.19 per share) and profitability
continued, despite provision for ABCP impairment during the year.
- Improved commodity pricing was realized throughout 2008, despite the
precipitous drop in world crude oil prices.
- Long-term reserve backed credit facility was expanded to US$70.0
million.
- Balance sheet was strengthened with a successful $40.0 million bought
deal equity financing, completed in June 2008.
- Long overdue resolution of our asset-backed commercial paper
investments was achieved; subsequent to year-end 2008, anticipated
expansion of the related line-of-credit to $28.2 million, with a term
out, will improve working capital.
- Prepared for high potential drilling to be initiated in Colombia in
early 2009.
Subsequent Events
On March 2, 2009 we issued a press release which summarized the results contained in our year end reserve report, as prepared for the company by GLJ Petroleum Consultants ("GLJ 2008 Report" and "GLJ", respectively) We ended the year with a healthy reserve base, despite the reductions arising from technical revisions and production during the year. The technical revisions are largely associated with lower anticipated recovery due to complications with our water flood in the northern part of the Puesto Morales Norte ("PMN") Field in Argentina. We are investigating the problems which have arisen and if warranted will undertake remediation of the problem. GLJ assigned Total Proved and Probable reserves ("2P") to Petrolifera's interests in Argentina and Colombia of just over 20 million barrels of oil equivalent ('boe"), with an estimated 10 percent pre-tax net present value ("10% PV"), using forecast prices, of $328 million. Including Total Possible reserves estimated at 9.4 million boe, Petrolifera's Total Proved, Probable and Possible reserves ("3P") were estimated to be 29.5 million boe with a pre-tax 10% PV of $505 million.
A boe conversion ratio of 6 mcf of natural gas to one bbl of crude oil (6:1) was used in determining the company's oil equivalent volume of reserves. The conversion is based on an energy equivalency conversion method primarily applicable to the burner tip and does not represent a value equivalency at the wellhead. Boe may be misleading, particularly if used in isolation.
In conjunction with the release of our reserve report results, we also announced that we had reached a decision to begin a divestiture process with respect to our producing and non-producing interests in Argentina. This was a difficult decision, but one arrived at having regard for current capital and credit market conditions, an increasing emphasis on liquidity and the desirability of lowered debt levels and perhaps most importantly, because we are embarked on a higher cost, higher potential series of wells and activity in Colombia and Peru. To that end, we have engaged Tristone Capital Inc. to assist us in the process and hope to complete it before the end of the second quarter of 2009, subject to approvals as may be required. This action was not taken at the direction of or request of any bank or lender.
Our La Pinta well in Colombia is proceeding favorably. As we announced, we have now set intermediate casing in the wellbore and are drilling ahead below approximately 8,200 feet. A log run of the wellbore, conducted prior to the installation of the intermediate casing, was completed several days ago following extensive hydrocarbon shows recorded during drilling over a fairly wide interval, well above the primary objective of the well for oil in the Lower Porquero Formation. We are encouraged by both the shows during drilling and by the results of the logs. Further evaluation will await the outcome of the results from lower intervals and may require a separate wellbore or wellbores. GLJ assigned 1P, 2P and 3P crude oil reserves to the La Pinta prospect based on test results from the offsetting Guamito-1 well, which tested light gravity crude oil when drilled by a major company in 1975.
We were also pleased to announce that we have commenced our drilling program on our 100 percent-owned Gobernador Ayala II Concession in the Province of La Pampa, Argentina. This block has been subjected to 3D seismic and the selected locations were based on the interpretation of this recently-completed program. Our objective is to find shallow heavy oil on the block similar to that being developed by another Canadian company on lands situated to the west of the Concession.
Petrolifera Petroleum is preparing for active drilling and evaluation work on its Peruvian and Colombian acreage over the next several years. Our seismic program on Block 106 in the Maranon Basin onshore northern Peru is proceeding favorably. Our preparations for drilling on Block 107 in the Ucayali Basin in southern Peru are also advancing. We are in active discussions with numerous industry companies, which are examining our data, plays and prospects under confidentiality agreements with a view to finalizing a joint venture or farm-out arrangement. This will spread risks and costs associated with the high cost of exploration in both Peru and Colombia. We remain optimistic we can complete one or more such transactions, to further strengthen the balance between our potential and our financial capacity in these types of activities.
While the successful sale of our Argentinean interests will modify the makeup of the company, our focus will also be on identifying and, if prudent, acquiring production in either Colombia or Peru to reinstate a model of having cash flow in those jurisdictions where we intend to continue operations. We are also examining other ground floor opportunities being developed internally in other lower cost, but higher potential jurisdictions.
Fourth Quarter 2008
Petrolifera maintained a steady level of activity, consistent with its production and sales in the fourth quarter of 2008. When combined with the company's realized crude oil and natural gas liquids prices, growth was achieved in revenue and cash flow relative to the third quarter in 2008 and compared to the fourth quarter in 2007. Petrolifera's crude oil and natural gas liquids sales during the fourth quarter of 2008 was 6,877 bbl/d, which was marginally above sales volumes during the third quarter of 2008 and an increase of five percent from the fourth quarter of 2007. On an equivalent basis, sales volumes for the fourth quarter of 2008 averaged 7,786 boe/d, an increase of 11 percent over the same period in 2007 and steady from the third quarter of 2008. The increase and the relatively consistent sales volume levels relative to the fourth quarter of 2007 and third quarter of 2008, respectively, reflect the continuing impact of the company's water flood program at the PMN Field and contributions from new pool discoveries during the year. December 2008 sales were positively impacted by incremental inventory sales, which are anticipated to develop and occur from time to time during 2009, as market conditions evolve in response to changing economic circumstances in Argentina.
Total revenue in the fourth quarter of 2008 was $37.4 million compared to $32.1 million in the third quarter of 2008 and $27.3 million in the fourth quarter of 2007, reflecting generally higher sales volumes and higher realized commodity prices. The average price received for crude oil and natural gas liquids sales in the fourth quarter of 2008 was $56.76 per barrel and on an equivalent barrel basis was $52.15 per boe. This was the highest realized equivalent pricing experienced in the company's history. Despite the precipitous drop in world crude oil prices, Petrolifera's financial results were not as adversely affected in a relative sense due to the historic regulated commodity pricing regime in Argentina. The complexities of the regulated commodity pricing regime were highlighted in December 2008, when the company received US$47.00 per barrel for its crude oil. This was a 13 percent premium relative to US$41.53, the December average price reported for WTI. The fourth quarter commodity prices also reflect the strengthening of the U.S. dollar, which appreciated approximately 24 percent against the Canadian dollar during 2008.
Net earnings in the fourth quarter of 2008 were $2.7 million ($0.05 per share), compared to $3.6 million ($0.06 per share) in the previous quarter of 2008 and $4.9 million ($0.10 per share) in 2007, decreases in net earnings of 25 and 45 percent, respectively. These decreases in comparable net earnings reflect a higher depletion expense resulting from higher estimated cost of production additions and a year-end reserve adjustment partially offset by increases in sales volumes, higher realized commodity prices and a reduction in the current tax provision.
Cash flow of $21.7 million ($0.39 per share) was recorded during the fourth quarter 2008, compared to $15.7 million ($0.29 per share) in the previous quarter of 2008 and $10.7 million ($0.21 per share) in the fourth quarter of 2007. These represent increases in cash flow of 38 and 103 percent, respectively, and reflect improved operating results and realized commodity pricing, combined with a favorable change to the company's current tax provision.
Capital spending of $35.5 million during the fourth quarter of 2008 reflects the company's preparations for increased activity in Colombia and Peru offset by a prudent and cautious approach in Argentina. The capital spending in the current reporting period reflected the company's drilling preparations and surface location preparations for the La Pinta well, which spudded in January, 2009 on the Sierra Nevada Concession in Colombia. Also extensive 2D seismic was shot on the Peruvian Block 106 and the company also had outlays related to data processing and interpretation of the data.
Petrolifera is a Calgary-based crude oil, natural gas liquids and natural gas producer engaged in exploration and exploitation activity in Argentina, Colombia and Peru. The company is a large land holder in all three jurisdictions and anticipates an active and aggressive exploratory drilling program, primarily in Colombia and Peru, in the next several years. Petrolifera recently announced its intention to embark on a divestiture of its Argentinean interests, to focus on its other areas of operation.
FORWARD LOOKING INFORMATION
This press release contains forward-looking information, including but not limited to estimated reserves and future net revenues, future exploration and development plans and the anticipated timing associated therewith, anticipated capital expenditures and sources of funding in respect thereof, future drilling plans in Argentina, Colombia and Peru, planned divestiture program with respect to producing and non-producing interests in Argentina and the anticipated timing associated therewith, planned farm-out and/or joint venture arrangements, the anticipated award of Block 133 in Peru and the Magdalena License in Colombia and potential acquisition activities. This information is based on current expectations that involve a number of risks and uncertainties, which could cause actual results to differ materially from those anticipated. These risks include, but are not limited to risks associated with the oil and gas industry (e.g. operational risks in development, exploration and production, delays or changes in plans with respect to exploration or development projects or capital expenditures; the uncertainty of reserve estimates; the uncertainty of estimates and projections in relation to production, costs and expenses and health, safety and environmental risks), the risk of commodity price and foreign exchange rate fluctuations, the uncertainty associated with negotiating with foreign governments and third parties located in foreign jurisdictions and risk associated with international activity. In addition, the current financial crisis has resulted in severe economic uncertainty and resulting illiquidity in credit and capital markets which increases the risk that actual results will vary from forward looking expectations and these variations may be material. The planned divestiture program in Argentina and farm-out and joint venture arrangements in Colombia and Peru are highly dependent on economic conditions. There can be no assurance that Petrolifera will be able to complete the sale of its Argentinean interests on terms and conditions that are acceptable or at all. Petrolifera may have to bring participants into its acreage holdings and planned evaluation activities on less attractive terms than might otherwise have been the case due to the combination of tighter economic conditions and the influence of contractual commitments and deadlines on the terms of trade. There can be no assurance that the company will be successful in its efforts to secure planned farm-outs and/or joint venture arrangements. Failure to secure these arrangements could result in adjustments to the company's capital expenditure program. Additional risks and uncertainties are described in the company's Annual Information Form which is filed on SEDAR at www.sedar.com.
The reserves and future net revenue in this press release represent estimates only. The reserves and future net revenue from the company's properties have been independently evaluated by GLJ with effective dates of December 31, 2008 and December 31, 2007. These evaluations include a number of assumptions relating to factors such as initial production rates, production decline rates, ultimate recovery of reserves, timing and amount of capital expenditures, marketability of production, future prices of crude oil and natural gas, operating costs, well abandonment and salvage values, royalties and other government levies that may be imposed during the producing life of the reserves. These assumptions were based on price forecasts in use at December 31, 2008 and December 31, 2007 and many of these assumptions are subject to change and are beyond the control of the company. Actual production, sales and cash flows derived therefrom will vary from the evaluations and such variations could be material. The present value of estimated future net cash flows referred to herein should not be construed as the current market value of estimated crude oil and natural gas reserves attributable to the company's properties. Reference is made to the Company's Annual Information Form for a detailed description of the assumptions utilized in the reserves report prepared by GLJ.
Due to the risks, uncertainties and assumptions inherent in forward- looking information, prospective investors in the company's securities should not place undue reliance on this forward-looking information. Readers should review the risk-factors set forth in the company's Annual Information Form, available at www.sedar.com, for a detailed description of the risks and uncertainties facing the company. Forward looking information contained in this press release is made as of the date hereof and are subject to change. The company assumes no obligation to revise or update forward looking information to reflect new circumstances, except as required by law.
MANAGEMENT'S DISCUSSION AND ANALYSIS ("MD&A")
The following is dated as of March 11, 2009 and should be read in conjunction with the consolidated financial statements of Petrolifera Petroleum Limited ("Petrolifera" or the "company") for the years ended December 31, 2008 and 2007 as contained in this annual report. The consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles ("GAAP") and are presented in Canadian dollars. This MD&A provides management's view of the financial condition of the company and the results of its operations for the reporting periods indicated.
Information in this report, including the letter to shareholders, contains forward-looking information including but not limited to future exploration and development plans, strategies for reducing the company's financial exposure to high cost exploration and drilling activities, planned sale of interests in Argentina, future drilling plans and the anticipated timing associated therewith, anticipated capital expenditures and sources of funding in respect thereof, anticipated production growth from planned capital programs, current production and the company's waterflood program, reserves and future net revenues attributable thereto and potential recovery of investments in the non- bank Asset-Backed Commercial Paper ("ABCP"). See "Forward-Looking Information" for a discussion of the forward-looking information contained in this MD&A and the risks and uncertainties associated therewith. Throughout this MD&A, per barrel of oil equivalent ("boe") amounts have been calculated using a conversion rate of six thousand cubic feet of natural gas to one barrel of crude oil (6:1). The conversion is based on an energy equivalency conversion method primarily applicable to the burner tip and does not represent a value equivalency at the wellhead. Boe may be misleading, particularly if used in isolation.
SELECTED FINANCIAL INFORMATION
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As at and for the
Year Ended
December 31(1) 2008 2007 2006 2005 2004
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($000, except
per share amounts)
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Total revenue $130,326 $134,223 $105,583 $ 2,864 $ 123
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Net earnings (loss) 11,554 29,301 37,312 (415) (26)
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Per share, basic 0.22 0.61 0.95 (0.02) -
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Per share, diluted 0.22 0.57 0.75 (0.02) -
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Total assets 355,658 204,227 118,517 31,581 3,884
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Long-term
liabilities 99,306 10,259 2,347 467 3,172
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(1) No cash dividends have been declared by the company since
incorporation.
Since incorporation, Petrolifera's management has concentrated on building a financially strong crude oil and natural gas exploration and production company with a focus on South America. To this end, the company completed four equity financings, two by way of private placement while a private company, one by way of the initial public offering, pursuant to a prospectus dated October 17, 2005 and one by way of a "bought deal" prospectus offering. The latest equity financing in June, 2008 raised approximately $40.0 million at $9.00 per common share. The company's common shares trade on the Toronto Stock Exchange under the symbol PDP.
Petrolifera conducts its business in Argentina, Colombia and Peru, in South America and it is examining activity in Central America. Growth to date has been organic, derived from successful exploration and development drilling programs.
Sales during 2008 have remained relatively stable in comparison to 2007. Petroleum and natural gas sales and cash flows from operations before changes in non-cash working capital ("cash flow") have been supplemented by bank borrowings and proceeds from equity sales from treasury. This minimal dilution approach has enabled the company to conduct active capital programs since its formation while maintaining its financial integrity, as it prepares for a prudent and cautious approach to its 2009 capital program in Argentina and increased capital spending activity in Colombia and Peru.
FINANCIAL AND OPERATING REVIEW SALES VOLUMES, PRICING AND REVENUE ------------------------------------------------------------------------- Year Ended December 31 2008 2007 % ------------------------------------------------------------------------- DAILY SALES VOLUMES Crude oil and natural gas liquids - bbl/d 6,891 7,919 (13) Natural gas - mcf/d 5,942 2,157 175 Total - boe/d 7,881 8,279 (5) ------------------------------------------------------------------------- AVERAGE SELLING PRICES Crude oil and natural gas liquids - $ per bbl $ 49.46 $ 45.51 9 Natural gas - $ per mcf 2.49 1.55 61 Revenue per boe $ 45.12 $ 43.94 3 ------------------------------------------------------------------------- Petroleum and natural gas sales ($000) $ 130,148 $ 132,779 (2) Interest income ($000) 178 1,444 (88) ------------------------------------------------------------------------- Total revenue ($000) $ 130,326 $ 134,223 (3) ------------------------------------------------------------------------- -------------------------------------------------------------------------
Petroleum and natural gas revenues for 2008 were $130.1 million (2007 - $132.8 million) on sales volumes of 7,881 boe/d (2007 - 8,279 boe/d), a slight year-over-year decrease of two percent for revenue and five percent for sales volumes. The relatively flat sales revenue and volumes reflect the continuing positive effect of the company's waterflood program to repressurize the reservoir and optimize the ultimate recovery of crude oil reserves from the Puesto Morales Norte ("PMN") Field. The average 2008 crude oil and natural gas liquids sales volumes of 6,891 bbl/d decreased 13 percent from 2007, when flush production was still being experienced in certain wells in the PMN Field, immediately following their drilling and completions. In the company's opinion, the full impact of the waterflood program remains to be realized. We anticipate resolution of certain related challenges, including evidence of rising water cuts which appear to be related to the heterogeneity of the reservoir, including the presence of highly permeable conglomerate zones which act as a conduit for the water to preferentially flow compared to the crude oil present in the reservoir. Remedial measures are being evaluated and will be introduced upon resolution of the source and locale of the problematic zones following tracer analysis. New discoveries further contributed to the stable sales revenues and volumes recorded in 2008. These included a new pool discovery at Puesto Morales Este and the new pool discovery by the 1082 well under the Rio Colorado Embalse. The waterflood program and new discoveries contributed to 2008 exit production levels above that of 2007. They also offset the ongoing impact of normal declines in well productivity and short- term declines due to optimization programs and adjustments being made to the pumping systems in the PMN Field. All of Petrolifera's sales were from its Puesto Morales/Rinconada and Puesto Morales Este Concessions in Argentina and all of its production is sold to the domestic market in Argentina.
For 2008, sales of crude oil and natural gas liquids represented 87 percent of the company's sales volumes compared to 96 percent for 2007. The company's realized crude oil price was up nine percent to average $49.46 per barrel for 2008 (2007 - $45.51 per barrel). Argentinean crude oil selling prices reflect world prices for the respective quality of oil, adjusted for the impact of Argentinean export taxes on domestic sales prices, which effectively capped the 2008 realized crude oil price at US$42.00 per barrel (2007 - US$42.00 per barrel). However, during 2008 Petrolifera was able to negotiate a US$5.00 per barrel improvement in prices retroactive to November 2007, from purchasers of its crude oil. Because the realized crude oil price was already well below that being recorded in world markets throughout most of 2008, Petrolifera has been somewhat insulated from the adverse impact of the significant decline which occurred in world crude oil markets in 2008. It should also be noted that as the Canadian dollar weakened relative to the US dollar and Argentinean peso during the latter half of 2008, Petrolifera's realized price, as expressed in Canadian dollars, increased.
Natural gas prices increased 61 percent over 2007 levels to average $2.49 per mcf for 2008, reflecting some relaxation of regulated Argentinean natural gas prices in industrial markets. These are still substantially below prices prevalent in North American markets. The company successfully negotiated an increase to US$2.40 per mmbtu for winter sales volumes sold to a local gas marketing company. Natural gas prices have the potential of further improvement in the longer term due to market conditions and new policy initiatives aimed at further market deregulation for industrial sales, including for power generation.
Interest income was $0.2 million for 2008 (2007 - $1.4 million), related to interest earned on short-term cash deposits and interest on the company's investments. Interest on the investment in ABCP, with a face value of $37.7 million, has not been recognized since August 2007, due to the lack of this investment's liquidity. See long term investments for additional details including estimates of valuation. Subsequent to year end, Petrolifera received an interest payment on its ABCP holdings of $1.1 million.
ROYALTIES
Royalties represent charges against production or revenue, levied by governments and landowners. Included in royalties are revenue taxes imposed by provincial jurisdictions. Royalties in 2008 were $18.4 million ($6.37 per boe) or 14 percent of oil and natural gas revenue, compared to $17.5 million ($5.79 per boe), or 13 percent, in 2007. The increase, on a boe basis, is attributable primarily to higher 2008 realized commodities pricing relative to 2007.
OPERATING EXPENSES AND NETBACKS
Company Netbacks(1)
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Year ended December 31 2008 2007
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Total Per boe Total Per boe
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($000, except per unit amounts)
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Average daily sales (boe/d) 7,881 8,279
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Petroleum and natural
gas sales $130,148 $ 45.12 $132,779 $ 43.94
Interest income 178 0.06 1,444 0.48
Royalties (18,381) (6.37) (17,500) (5.79)
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Net revenue 111,945 38.81 116,723 38.63
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Operating costs (26,040) (9.03) (18,267) (6.05)
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Corporate netback $ 85,905 $ 29.78 $ 98,456 $ 32.58
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(1) Calculated by dividing related revenue and costs by total boe sold,
resulting in an overall company netback. Netbacks do not have a
standardized meaning prescribed by GAAP and therefore is unlikely to
be comparable to similar measures used by other companies.
The most comparable measure calculated in accordance with GAAP would
be net earnings. Nevertheless, Petrolifera's management uses netbacks
as a performance measurement of operating efficiency and the
prevailing royalty regime. A high ratio of netback to selling price
is a positive indicator. A reconciliation of netback to net income
can be found in the Net Earnings table.
Petrolifera's corporate netback per boe decreased by 13 percent over that recorded in the 2007. The year-over-year change primarily reflects higher operating expenses and lower interest income. Petrolifera's calculated unit netback at $29.78 per boe remained healthy at 66 percent of the selling price per boe (2007 - 74 percent). Operating costs in 2008 increased 43 percent in total and 49 percent on a per boe basis from 2007 levels. The company's facilities at PMN operated effectively throughout 2008 and operating costs have remained at acceptable, albeit, higher levels, even with additional fluid handling associated with the waterflood program, the additional number of wells being operated, the number of wells on pump or that require servicing on a more frequent basis in addition to the effect of inflationary pressures and start-up costs related to new field facilities. Every effort will be undertaken to control and if possible reduce operating costs going forward, reflecting more challenging economic conditions and the possibility of weaker crude oil prices which may emerge in 2009.
GENERAL & ADMINISTRATIVE AND STOCK BASED COMPENSATION EXPENSES
General and administrative ("G&A") expenses were $8.4 million in 2008 compared to $6.4 million during 2007. These costs primarily consist of management and administrative salaries, legal and professional fees, insurance, travel and other administrative expenses. The increase from 2007 is primarily attributable to increased staffing levels to handle the expanded nature of the company's operations, especially in Colombia and increased legal costs associated with a dispute that was subject to an arbitration proceeding. The dispute was resolved during 2008.
On a per boe basis, G&A was $2.92 per boe of sales for 2008 compared to $2.11 per boe for 2007. The increase in G&A per boe for the year, relative to 2007, was due to the reasons previously mentioned, combined with modestly lower sales volumes. G&A of $5.1 million was capitalized in 2008 (2007 - $2.4 million), primarily related to further exploration and evaluation of the prospects in Colombia and Peru and the level of drilling activity in Argentina.
Non-cash stock-based compensation costs of $5.1 million was recorded in 2008 (2007 - $6.8 million), reflecting the amortization over the vesting period of the fair value of stock options granted during 2008 or during a previous year, less the recognized fair value of unvested options that were forfeited during 2008. The reduction in stock-based compensation from 2007 is mainly attributable to a lower average fair value per option, partially offset by an increase in grants. The company has generally granted stock options on an annual basis to existing employees and to new hires when employed.
An additional stock-based compensation expense of $0.7 million was recorded related to certain non-managerial employees electing to forfeit certain options in exchange for cash consideration of $0.2 million. Upon such elections to forfeit certain options, any of the forfeited options that were unvested at the time of election were deemed to have vested, resulting in previously unrecognized stock-based compensation being recognized. None of the optionees who were offered or made this election were Directors or Officers of the company.
FINANCE CHARGES
Included in the finance charges of $5.4 million in 2008 (2007 - $0.4 million) is interest paid and accrued, on the company's outstanding short-term and long-term bank debt and the pro-rata portion of the deferred financing charges that are being allocated over the life of the reserve-based credit facility.
FOREIGN EXCHANGE
The impact of fluctuations in the Argentinean peso and the US dollar relative to the Canadian dollar, arising from settling foreign-denominated transactions and from translating foreign denominated financial statements and operating results of its integrated foreign operations, resulted in a foreign exchange charge of $0.2 million in 2008 (2007 - $2.3 million charge). The company's main exposure to foreign currency risk relates to the pricing of crude oil sales, operating costs and capital expenditures which are mainly denominated in US dollars and Argentinean pesos, partially mitigated by draws on the reserve-based credit facility which is denominated in US dollars.
FAIR VALUE IMPAIRMENT - ABCP
In recognition of the loss of liquidity in the company's ABCP investment, a provision was made in the financial statements for a non-cash fair value impairment charge of $8.9 million for 2008 (2007 - $6.1 million). The cumulative effect of the current year and 2007 impairments represents approximately 40 percent of the face value of the investment at the time of the loss of liquidity in the Canadian commercial paper market. Subsequent to year-end, a court-approved plan for restructuring the ABCP was implemented and the company has received longer-term notes in exchange for its ABCP holdings. The maturities of the new notes generally match those of the assets previously contained in the underlying conduits. If these replacement notes were to become liquid, the company would be able to substantially reduce its net indebtedness incurred due to lack of access to these amounts. The basis for the impairment provision is explained under "Long-Term Investments."
DEPLETION, DEPRECIATION AND ACCRETION ("DD&A")
DD&A is calculated using the unit-of-production method based on total estimated proved reserves. DD&A in 2008 was $29.0 million (2007 - $16.9 million) or $10.05 per boe (2007 - $5.59 per boe). Accretion expense for 2008, which is included in DD&A expense, was $0.4 million (2007 - $0.1 million) to accrete the company's estimated asset retirement obligation. These charges will continue at appropriate levels in the future to accrete the currently booked discounted liability of $10.1 million (2007 - $5.6 million) over the estimated remaining economic life of the company's oil and gas properties. Capital costs of $14.5 million (2007 - $3.3 million) incurred for unevaluated properties in Argentina and $48.6 million (2007 - $15.4 million) and $13.8 million (2007 - $0.6 million) for major development projects and other assets in the pre-production stage located in Peru and Colombia, respectively, have been excluded from the depletion and depreciation expense. The increase in DD&A in 2008 relative to 2007 was mainly due to the higher estimated cost of production additions and the cost of infrastructure related to the Argentina production together with a year-end reserve adjustment.
CEILING TEST
Oil and gas companies are required to compare the recoverable value of their oil and gas assets to their recorded carrying value at the end of each reporting period. Excess carrying values over fair value are to be written off against earnings. No write-down was required in 2008 or for 2007. The following benchmark prices were applied in determining the recoverable value of the company's oil and gas assets:
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Crude Oil Price ($US/bbl) Natural Gas Price ($US/mcf)
-------------------------------------------------------------------------
2009 $ 44.91 $ 2.76
2010 46.72 2.81
2011 47.00 2.87
2012 47.94 2.92
2013 $ 48.90 $ 2.98
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+ approximately 2% thereafter + approximately 2% thereafter
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TAXES
The current income tax provision of $7.9 million in 2008 (2007 - $21.1 million) primarily relates to income taxes payable in Argentina. Additionally, a future income tax provision of $6.5 million in 2008 (2007 - $6.9 million) was recorded to recognize the differences, at the statutory rate, between the tax pool and accounting carrying values. The implied effective tax rate on earnings before income taxes of $26.0 million (2007 - $57.3 million) was 56 percent for 2008 and 49 percent for 2007. The 2008 and 2007 effective tax rates are very high due partially to not being able to recognize the tax benefit of the impairment recorded on the company's investment in ABCP. Management does not anticipate the implied effective tax rate during 2008 and 2007 to continue, due to the court-approved resolution of the ABCP controversy in Canada. Taxes other than income taxes of $2.2 million (2007 - $2.1 million) represent taxes charged on all banking transactions in Argentina during 2008.
NET EARNINGS AND SHARES OUTSTANDING ------------------------------------------------------------------------- Year ended December 31 2008 2007 ------------------------------------------------------------------------- ($000, except per unit amounts) Total Per boe Total Per boe ------------------------------------------------------------------------- Corporate netback $ 85,905 $ 29.78 $ 98,456 $ 32.58 General and administrative (8,425) (2.92) (6,369) (2.11) Stock-based compensation (5,847) (2.03) (6,833) (2.26) Finance charges (5,417) (1.88) (421) (0.14) Foreign exchange loss (180) (0.06) (2,331) (0.77) Fair value adjustments - ABCP (8,882) (3.07) (6,169) (2.04) Depletion, depreciation and accretion (28,984) (10.05) (16,890) (5.59) Income tax provision (14,431) (5.00) (28,004) (9.27) Taxes other than income taxes (2,185) (0.76) (2,138) (0.71) ------------------------------------------------------------------------- Net earnings $ 11,554 $ 4.01 $ 29,301 $ 9.69 -------------------------------------------------------------------------
In 2008, the company reported net earnings of $11.6 million (2007 - $29.3 million), which equates to $0.22 per weighted average basic and diluted share, compared to $0.61 per weighted average basic and $0.57 per weighted average diluted share for 2007. Net earnings for 2008 were lower than in 2007, mainly due to slightly lower sales volumes, cost inflation, the higher cost of estimated production additions, the cost of infrastructure related to the Argentina production, a year-end reserve adjustment, recognition of non-cash ABCP impairment and increased financing costs.
In 2008, the weighted average number of common shares outstanding was 52.6 million (2007 - 48.0 million). In 2008 there were 0.9 million additional shares (2007 - 3.4 million) included in the diluted earnings per share calculations related to the weighted average dilutive effect of "in-the-money" options and warrants.
As at the close of business on March 11, 2009, the company had the following securities issued and outstanding:
- 54,948,010 common shares; and - 2,785,167 stock options
Details of the exercise rights and terms of the options are noted in the Consolidated Financial Statements, included in this Annual Report.
CAPITAL RESOURCES, CAPITAL EXPENDITURES AND LIQUIDITY
During the latter half of 2008, anticipation of a prolonged recession, triggered by excessive worldwide leverage and emerging restrictions in access to credit and capital markets, triggered a sell off in commodity prices, including crude oil. Investors sought refuge from stock, bond and commodity markets and aggressively sold equities during the latter half of 2008. Along with other international junior oil companies, Petrolifera's share price weakened substantially from this selling pressure. The company has adopted a very conservative approach to its 2009 capital programs in South America, until it can determine with greater confidence a sense of direction for worldwide stock, credit and crude oil markets. Accordingly the company would as necessary curtail, defer or sell down, through joint venture or farmout activity, its participation in various higher risk projects. This approach was adopted in recognition of the limitations on being able to access new or alternative capital sources until markets exhibit discernible and restored equilibrium.
CASH FLOW
Cash flow and cash flow per share do not have standardized meanings prescribed by GAAP and therefore may not be comparable to similar measures used by other companies. Cash flow includes all cash flow from operating activities and is calculated before changes in non-cash working capital. The most comparable measure calculated in accordance with GAAP would be net earnings. Cash flow is reconciled with net earnings on the Consolidated Statements of Cash Flows and below. Cash flow per share is calculated by dividing cash flow by the weighted average shares outstanding. Management uses these non-GAAP measurements for its own performance measures and to provide its shareholders and investors with a measurement of the company's efficiency and its ability to fund a portion of its future growth expenditures.
Reconciliation of net earnings to cash flow: ------------------------------------------------------------------------- Year ended December 31 2008 2007 ------------------------------------------------------------------------- ($000) NET EARNINGS $ 11,554 $ 29,301 Add non-cash charges: Depletion, depreciation and accretion 28,984 16,890 Fair value adjustments - ABCP 8,882 6,169 Future income tax provision 6,526 6,921 Stock-based compensation 5,847 6,833 ------------------------------------------------------------------------- Amortization of deferred finance charges 829 - Foreign exchange loss 180 2,331 ------------------------------------------------------------------------- Cash flow $ 62,802 $ 68,445 ------------------------------------------------------------------------- Per share, basic 1.19 1.43 ------------------------------------------------------------------------- Per share, diluted 1.17 1.33 -------------------------------------------------------------------------
Cash flow in 2008 was $62.8 million (2007 - $68.4 million) or $1.19 per weighted average basic and $1.17 per weighted average diluted share, (2007 - $1.43 per weighted average basic and $1.33 per weighted average diluted share). Although cash flow remained strong, there was an overall decrease by eight percent due to slightly lower crude oil production, cost inflation and increased financing costs. At current realized commodity pricing, the company's Argentina cash flows are anticipated to be sufficient and can be used to partially discharge outstanding long-term indebtedness or to partially finance the high-potential exploration activities in Colombia and Peru.
The GAAP measure cash flow from operations for the year ended December 31, 2008 of $50.3 million were unfavorably impacted by an increase in non-cash working capital of $12.5 million. This increase in non-cash working capital is partially the result of an increase in accounts receivable attributable to the timing of billing and a reduction in accounts payable attributable to timing of payments.
EQUITY FINANCING
On June 11, 2008 the company announced that it entered into a financing agreement with a syndicate of underwriters to issue, on a "bought deal" basis, 4,445,000 common shares ("Common Shares") at $9.00 per Common Share for gross proceeds of approximately $40.0 million. The underwriters were granted an over- allotment option to purchase up to an additional 666,750 Common Shares on the same terms and conditions, exercisable in whole or in part up to 30 days following closing. This financing was closed on June 27, 2008 and the over- allotment option was not exercised.
During 2008, the net proceeds were used to fund a portion of Petrolifera's 2008 capital expenditure programs in Argentina, Colombia and Peru as described under "Capital Expenditures". Prior to Petrolifera applying all of the net proceeds of the financing to its remaining 2008 capital expenditure programs, a portion of the net proceeds were used to repay $11.5 million of indebtedness incurred outside of Argentina pursuant to the reserve- based credit facility. This reserve-based credit facility had previously been utilized to fund a portion of the capital expenditures and general working capital, arising from the temporary loss of liquidity experienced in connection with the investment in ABCP (see "Long-Term Investments").
Proceeds of the financing are summarized as follows:
-------------------------------------------------------------------------
($000s)
Proceeeds
as Disclosed Proceeeds
in Short-form as Received
Prospectus or Applied
-------------------------------------------------------------------------
Gross proceeds $ 40,005 $ 40,005
Underwriter's commissions and issue costs (2,300) (2,217)
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Net funds available for capital
expenditure program $ 37,705 $ 37,788
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Proceeds of financing funding of
capital expenditures:
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Argentina $ 17,234
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Colombia 12,677
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Peru 7,877
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Net funding of capital expenditures $ 37,705(1) $ 37,788
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(1) Proceeds were intended to fund the company's remaining capital
expenditure program of $58.0 million, with the funds to be deployed
in Argentina, Columbia and Peru in the manner determined by
management.
CAPITAL EXPENDITURES
-------------------------------------------------------------------------
Year ended December 31 2008 2007
-------------------------------------------------------------------------
($000)
Argentina $ 70,792 $ 97,465
Peru 33,306 12,931
Colombia 12,610 594
Corporate 43 35
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Total capital expenditures $116,751 $111,025
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Capital spending in 2008 exceeded cash flow and was financed through the use of proceeds from the bought deal equity financing and partially from an increase in long-term bank debt. During 2008 production levels remained relatively stable and associated revenue and cash flows enabled the company to conduct an active capital program throughout 2008. With a fully developed Argentinean field, an operative waterflood program and either self-financed or partner financed future exploration programs, Petrolifera anticipates a prudent and cautious approach to its overall 2009 capital spending program. Some commitments may be reduced through anticipated farm-outs and joint ventures. The company only anticipates an actual cash outlay approaching $30 million, out of a total anticipated capital program on its properties which may exceed $80 million, if it is successful in completing certain farmout arrangements on terms offered to the industry. These arrangements include some recovery of sunk costs and disproportionate spending by a joint venturer to thereby earn an interest in Petrolifera's properties upon completion of certain earning programs with Petrolifera continuing as the operator of the properties.
Capital expenditures in 2008 totaled $116.8 million (2007 - $111.0 million). In Argentina, the company drilled 33 wells (including two wells started in 2007 and completed in 2008) in 2008. The drilling program resulted in 20 oil wells, two natural gas wells, three injectors, three wells abandoned, four wells shut-in or suspended and one well awaiting completion as at December 31, 2008.
The company conducted an extensive seismic data acquisition program on Block 107 in the Ucayali Basin onshore Peru. Subsequent interpretation of this seismic data has resulted in the definition of a variety of prospects and leads, with potential for both crude oil and natural gas accumulations. The company is conducting a series of data room reviews in early 2009 with a number of qualified and interested third parties, with a view to farming-out an interest in this concession. Drilling base-camp preparations for Block 107 are already underway.
On Block 106, in the Maranon Basin, a 476 km 2D seismic acquisition program is underway. A number of approaches have been made to Petrolifera by third parties interested in farming-in on this acreage block.
Petrolifera also anticipates being awarded a new license over the approximate one million acre Block 133, which offsets and is contiguous with Block 107 to the west. The Block 133 License will, if awarded as scheduled in 2009, provide Petrolifera with additional protection acreage in relation to prospects, leads and planned drilling activity on Block 107. The work commitments on this license, considered reasonable and appropriate considering its location and degree of risk, will be made public when the official award is confirmed by Presidential Decree in Peru.
During 2008, the company continued preparations and expenditures for the La Pinta exploration well that was spudded in Colombia on our Sierra Nevada License in the onshore Lower Magdalena Basin. The 100-percent owned well spudded on January 23, 2009 and has an anticipated total depth of approximately 13,000 feet. Early drilling results have been encouraging although drilling time is longer than the prognosis. Petrolifera is also in the late stages of completing 2D and 3D seismic programs over its Turpial License in the Middle Magdalena Basin onshore Colombia.
As earlier mentioned, Petrolifera anticipates participating in a capital expenditure program that could be excess of $80.0 million during 2009, although net cash outlays by the company are anticipated to approximate $30.0 million if planned farm-outs can be achieved during these difficult market conditions. With current production levels and prices plus proceeds from third party farm-ins, the company anticipates an increase in year-end cash balances during 2009, with a view to accomplishing a debt reduction program, if there is no change in its current banking relationships and market conditions do not deteriorate further. Petrolifera may have to negotiate to defer certain expenditures if economic conditions deteriorate during 2009. Also, the company is well positioned to defer certain expenditures, especially in Peru and still maintain its properties in good standing. Consistent with the company's strategy of achieving positive leveraging for its shareholders and stakeholders from the significant value-added impact of its early stage geological and geophysical activity, it will still be important to seek out and find industry participants to join with Petrolifera to achieve success in this regard. The much tightened capital market conditions may make this process more challenging and time consuming than under more buoyant economic circumstances of worldwide economic growth and demand by the industry for viable drilling prospects with significant reserve potential. Petrolifera may have to bring participants into its acreage holdings and planned evaluation activities on less attractive terms than might otherwise have been the case due to the combination of tighter economic conditions and the influence of contractual commitments and deadlines on the terms of trade.
The company anticipates it has sufficient cash balances, cash flow and available credit to fund the anticipated net 2009 capital expenditures. Should credit conditions be altered, there may be circumstances where the company would have to reassess its capital programs in favour of debt reduction. Subsequent to year-end, the company announced the sale of its Argentinean productive and exploratory assets through the sale of its subsidiary active in Argentina in order to realize on a more mature asset at an opportune time.
Required funds are being moved among Argentina, Barbados, Canada, Colombia and Peru as needed. The company's only financial instruments are cash, accounts receivable, long-term investments, accounts payable, bank debt and long-term bank debt. It maintains no off-balance sheet financial instruments.
CREDIT FACILITIES
In 2007 the company entered into a US$100.0 million reserve-based revolving credit facility with an initial availability of US$60.0 million that was increased during the second quarter of 2008 to US$70.0 million, based on crude oil and natural gas reserves as at December 31, 2007. This facility is scheduled to expire on September 5, 2010, bears interest at LIBOR plus a margin, is secured by the pledge of the shares of Petrolifera's subsidiaries and parent company guarantees and has a provision for a borrowing base adjustment every six months, with the next adjustment to be calculated based on information as at January 1, 2009. Changes in the availability of the reserve-based credit facility are anticipated to occur, from time-to-time, through significant reserve additions, disposals or revisions. Deferred financing costs of $1.6 million related to this facility are being amortized over the remaining term of the facility.
In late 2007, the company established an $18.0 million line of credit with a Canadian chartered bank. The line of credit bears interest at a floating rate and is secured by the ABCP investments. The company is in final stages of negotiating a revised line of credit to $28.2 million with a Canadian chartered bank. The revised facility is primarily secured by the longer term notes, exchanged for the ABCP, and allows the company to categorize any such advances under this facility as long-term. The line of credit bears interest at a floating rate.
As at December 31, 2008, the reserve-based facility had $77.2 million (US$63.0 million) outstanding and classified as long-term debt. The line of credit facility had $16.6 million outstanding classified as current bank debt. Interest expense on the facilities for the year ended December 31, 2008 was $4.3 million (2007 - $0.4 million). The effective interest rate on the company's interest bearing debt was 8.8 percent for the year ended December 31, 2008. Unused credit facilities as at December 31, 2008 were $9.9 million.
The company is subject to external restrictions on its reserves-based revolving credit facility. Bank debt and long-term bank debt outstanding cannot exceed two times the 12 month trailing EBITDA. EBITDA is a non-GAAP measure as defined by the credit facility agreement as net earnings prior to deduction of finance charges, income taxes, depletion, depreciation and accretion expense, stock-based compensation and unrealized foreign exchange losses. As at December, 2008, bank debt and long-term bank debt outstanding was $93.8 million and two times EBITDA was $151.3 million, for a ratio of 0.6:1, which is below the imposed limit. With existing realized commodity pricing combined with the company's low-cost structure, Petrolifera anticipates that it will be in compliance with the financial debt to EBITDA ratio covenant during 2009.
Reconciliation of net earnings to EBITDA is as follows: ------------------------------------------------------------------------- Year ended December 31 2008 ------------------------------------------------------------------------- ($000) Net earnings $ 11,554 Add Stock-based compensation 5,847 Depletion, depreciation, and accretion 28,984 Future income tax provision 6,526 Fair value adjustments - ABCP 8,882 Foreign exchange loss 180 Current income tax provision 7,905 Finance Charges 5,417 ------------------------------------------------------------------------- EBITDA 75,295 ------------------------------------------------------------------------- -------------------------------------------------------------------------
LONG-TERM INVESTMENTS
As at December 31, 2008, included in long-term investments were ABCP with a face value of $37.7 million (2007 - $37.7 million) and a carrying value of $22.5 million (2007 - $31.5 million) and collateral to support issued letters of credit of $2.9 million (2007 - $1.9 million). These investments are classified as held for trading and are carried at fair value which is assessed each reporting date.
In August 2007 the Canadian third-party ABCP market experienced a severe shortage of liquidity. Shortly thereafter, a panel of banks, asset providers and major investors formed the Pan-Canadian Investors Committee for Third-Party Structured Asset-Backed Commercial Paper to oversee the restructuring process with the principal objective of preserving value for the benefit of investors through the exchange of ABCP for longer-term notes that are designed to match the maturities of the underlying assets. Because of the large number of participants, the complexity of the required documentation involved in the process and the recent volatility in the global financial markets, the restructuring process had not been completed by December 31, 2008.
In January, 2009, the Pan-Canadian Investors Committee for Third-Party Structured Asset-Backed Commercial Paper announced that the Superior Court of Ontario approved the Plan Implementation Order and that, accordingly, the plan for restructuring ABCP has subsequently been fully implemented. Subsequent to year-end, the company received the longer term notes, whose maturities match those of the assets previously contained in the underlying conduits, in exchange for the shorter-term ABCP. Assuming these replacement notes become liquid, the company would be able to substantially reduce its net indebtedness incurred from lack of access to these amounts.
Subsequent to year-end, the company recently received $1.1 million, which is the first payment to be received on its longer term notes representing interest that has accrued on the previous holdings in ABCP between mid-August 2007 and August 31, 2008, net of its pro-rata portion of expenses, calculated after deducting legal costs associated with the resolution agreed and approved under the Canada Business Corporations Act and the Company Creditors' Arrangement Act. It is expected that substantially all of the restructuring costs and reserves were deducted from this first payment and are not expected to have any further impact on future payments to the company.
With the delay in the restructuring process, management has estimated the fair value of the company's investment in ABCP based on a probabilistic recovery of principal and interest taking into account all available information. Under this valuation method, several different outcomes of the recovery of the principal and interest are estimated considering the information available as at December 31, 2008. A weighted average recovery is then calculated. This weighted average recovery is used to determine the discounted cash flows that are expected from these investments. The discount rate used to discount the expected cash flows from the ABCP is an approximation of the risk-free rate for the expected life of the ABCP notes to be received. As the rate used for discounting is an approximation of the risk-free rate, all other risks have been incorporated in the estimated probability adjusted expected outcomes. This methodology applies all risking information into the various scenarios and discounts the fully risked cash flow stream only for the time value of money. The recovery factors used were as follows:
-------------------------------------------------------------------------
Risk- Risk-
Face Risk- Risk- adjusted adjusted
Value adjusted adjusted Capital Interest
Class of Notes Capital Interest Weighted Weighted Risk-free
of Expected Recovery Recovery Average Average Term Discount
Note (i)($000s) Range Range Recovery Recovery (years) Rate
-------------------------------------------------------------------------
A-1 $14,014 0 - 80% 0 - 70% 75% 64% 5 - 8 3.55%
-------------------------------------------------------------------------
A-2 13,543 0 - 70% 0 - 50% 65% 46% 8 3.55%
-------------------------------------------------------------------------
B 2,459 0 - 30% 0% 27% 0% 8 3.55%
-------------------------------------------------------------------------
C 928 0% 0% 0% 0% 8 3.55%
-------------------------------------------------------------------------
IA
Tracking 6,613 0 - 40% 0% 36% 0% 8 3.55%
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Total $37,557
-------------------------------------------------------------------------
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(i) The $37.7 million face value of ABCP was purchased at a discount with
the difference between the face value and the amount paid
representing the interest component. The face value of notes
expected, per the above table, of $37.6 million approximates the
original amount paid to acquire the ABCP.
Based on the above approach the fair value of the investment in ABCP is estimated to be $22.5 million (2007 - $31.4 million) which is an impairment of $8.9 million (2007 - $6.2 million ) for the year ended December 31, 2008. This impairment brings the total impairment of the ABCP recorded to date to approximately 40 percent (2007 - 16 percent) of the original cost of the investment.
The theoretical fair value of the company's ABCP could range from $19.2 million to $31.1 million using the valuation methodology described above with reasonably possible alternative assumptions. The outcome of the actual timing and amount ultimately recoverable from these notes may differ materially from this estimate which would impact the company's earnings.
RELATED PARTY TRANSACTIONS AND SIGNIFICANT TRANSACTIONS
Under the terms of an Administrative Agreement with Connacher Oil and Gas Limited ("Connacher"), in effect from January 1, 2008, Connacher will provide certain administrative services necessary or appropriate upon the direction of the company. Petrolifera paid Connacher $0.2 million in 2008 under the management agreement which has been renewed on the same terms for 2009. From time to time Connacher also paid bills on behalf of Petrolifera, for which it is reimbursed. Connacher also provided certain support and services to Petrolifera in its pursuit of exploration opportunities in Colombia, for which it will be indemnified and reimbursed without further economic interest in the secured opportunities. Connacher also retains a convertible 10 percent carried working interest through one well on Block 107 and Block 106 in Peru. The Executive Chairman of the company is the President and Chief Executive Officer of Connacher.
There were no significant transactions in 2008.
SIGNIFICANT ACCOUNTING POLICIES AND APPLICATION OF CRITICAL ACCOUNTING ESTIMATES
Certain accounting policies require that management make appropriate decisions with respect to the formulation of estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Changes in these judgments and estimates may have a material impact on the company's financial results and condition. The following accounts, although not exhaustive, that are most likely to be impacted by critical accounting estimates include long-term investments and impairments, property and equipment and depletion expense, asset retirement obligations and accretion expense, future income tax liabilities and future tax expense and contributed surplus and stock-based compensation expense. The following discusses such accounting policies and is included in the MD&A to aid the reader in assessing the significant accounting policies and practices of the company and the likelihood of materially different results being reported. Management reviews its estimates regularly. The emergence of new information and changed circumstances may result in changes to estimates which could be material and the company might realize different results from the application of new accounting standards promulgated, from time to time, by various rule-making bodies. The following assessment of significant accounting polices is not meant to be exhaustive:
OIL AND GAS RESERVES
Under Canadian Securities Regulators' "National Instrument 51-101-Standards of Disclosure for Oil and Gas Activities" ("NI 51-101") proved reserves are those reserves that can be estimated with a high degree of certainty to be recoverable. In accordance with this definition, the level of certainty should result in at least a 90 percent probability that the quantities actually recovered will equal or exceed the estimated proved reserves. In the case of probable reserves, which are less certain to be recovered than proved reserves, NI 51-101 states that it must be equally likely that the actual remaining quantities recovered will be greater or less than the sum of the estimated proved plus probable reserves. Possible reserves are those reserves less certain to be recovered than probable reserves. There is at least a 10 percent probability that the quantities actually recovered will exceed the sum of proved plus probable plus possible reserves.
The company's oil and gas reserve estimates are made by independent reservoir engineers using all available geological and reservoir data as well as historical production data. Estimates are reviewed and revised as appropriate. Revisions occur as a result of changes in prices, costs, fiscal regimes, reservoir performance or a change in the company's plans. The reserve estimates are also used in determining the company's borrowing base for its credit facilities and may impact the same upon revision or changes to the reserve estimates. The effect of changes in proved oil and gas reserves on the financial results and position of the company is described under the heading "Full Cost Accounting for Oil and Gas Activities".
FULL COST ACCOUNTING FOR OIL AND GAS ACTIVITIES
The company uses the full cost method of accounting for exploration and development activities. In accordance with this method of accounting, all costs associated with exploration and development are capitalized whether successful or not. The aggregate of net capitalized costs and estimated future development costs is amortized using the unit-of-production method based on estimated proved oil and gas reserves.
MAJOR DEVELOPMENT PROJECTS AND UNPROVED PROPERTIES
Certain costs related to major development projects and unproved properties are excluded from net capitalized costs subject to depletion until proved reserves have been determined, the project becomes commercial, or their value is impaired. These costs are reviewed quarterly and any impairment is transferred to the costs being depleted or, if the properties are located in a cost centre where there is no reserve base, the impairment is charged directly to income.
FULL COST ACCOUNTING CEILING TEST
The company is required to review the carrying value of all property, plant and equipment, including the carrying value of oil and gas assets, for potential impairment. Impairment is indicated if the carrying value of the long-lived asset or oil and gas cost centre is not recoverable from the future undiscounted cash flows. If impairment is indicated, the amount by which the carrying value exceeds the estimated fair value of the long-lived asset is charged to earnings.
The ceiling test is based on estimates of reserves, production rate, petroleum and natural gas prices, future costs and other relevant assumptions. By their nature these estimates are subject to measurement uncertainty and the impact on the consolidated financial statements could be material.
ASSET RETIREMENT OBLIGATIONS
The company is required to provide for future removal and site restoration costs by estimating these costs in accordance with existing laws, contracts or other policies. These estimated costs are charged to earnings and the appropriate liability account over the expected service life of the asset. When the future removal and site restoration costs cannot be reasonably determined, a contingent liability may exist. Contingent liabilities are charged to earnings only when management is able to determine the amount and the likelihood of the future obligation. The company estimates future retirement costs based on current estimates adjusted for inflation and credit risk. These estimates are subject to measurement uncertainty.
INCOME TAXES
The company follows the liability method of accounting for income taxes. Under this method tax assets are recognized when it is more than likely realization will occur. Tax liabilities are recognized for temporary differences between recorded book values and underlying tax values. Rates used to determine income tax asset and liability amounts are enacted rates expected to be used in future periods when the timing differences change. The period in which a timing difference reverses are impacted by future income and capital expenditures. Rates are also affected by legislation changes.
STOCK-BASED COMPENSATION
The company uses the fair value method to account for stock options. The determination of the amounts for stock-based compensation is based on assumptions of stock volatility, interest rates and the term of the option. These assumptions by their nature are subject to measurement uncertainty.
LEGAL, ENVIRONMENT REMEDIATION AND OTHER CONTINGENT MATTERS
In respect of these matters, the company is required to determine whether a loss is probable based on judgment and interpretation of laws and regulations and determine if such a loss can be estimated. When any such loss is determined, it is charged to earnings. Management continually monitors known and potential contingent matters and makes appropriate provisions by charges to earnings when warranted by circumstance.
FOREIGN CURRENCY TRANSLATION
Colombia, Peru, Barbados and the U.S. subsidiaries are considered to be "integrated foreign operations" for accounting purposes and, therefore, these foreign operations' financial statements are translated into Canadian dollars using the temporal method. Under the temporal method, the company translates foreign denominated monetary assets and liabilities at the exchange rate prevailing at year end; non-monetary assets, liabilities and related depletion and depreciation are translated at historic rates; revenues and expenses are translated at the average rate of exchange for the period; and any resulting foreign exchange gains or losses are included in operations.
As a self-sustaining foreign operation, the Argentinean financial statements are translated into Canadian dollars using the current rate method, whereby assets and liabilities are translated at the rate of exchange in effect at the balance sheet date; revenues and expenses are translated at the average monthly rates of exchange during the period and gains or losses on translation are included as a foreign currency translation adjustment in the consolidated statements of comprehensive income and accumulated other comprehensive income (loss).
IMPACT OF NEW AND PROPOSED ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2008, the company adopted CICA Handbook sections 1535, 3031, 3862 and 3863 relating to Capital Disclosures, Inventories, Financial Instruments - Disclosures and Financial Instruments - Presentation, respectively. Under section 1535, the company is required to disclose its objectives, policies and processes for managing capital, and in addition, whether the entity has complied with any externally imposed capital requirements. Note 6 to the 2008 Notes to the Consolidated Financial Statements contains further disclosures with respect to this standard.
Under section 3031, the measurement of cost and cost formulas for inventories have been revised, along with additional disclosure requirements. The adoption of this section has had no impact on the company's Consolidated Financial Statements, as inventory was already being measured in a manner permitted under the new standard.
Under section 3862, the company is required to disclose the significance of financial instruments to an entity's financial statements, the risks associated with the financial instruments and how those risks are managed. Note 6 to the 2008 Notes to the Consolidated Financial Statements contains further disclosures with respect to this standard.
Under section 3863, further guidance is provided on the classification of financial instruments as liabilities vs. equity and when netting of financial assets and financial liabilities is appropriate. The adoption of this section had no impact on the company's consolidated financial statements as the company does not have any financial instruments that contain both a liability and an equity element and was already offsetting a financial asset and financial liability only when it had a legally enforceable right to set off the recognized amounts and intended to settle simultaneously.
As of January 1, 2009, the company will be required to adopt CICA Handbook section 3064, Goodwill and Intangible Assets, replacing section 3062, Goodwill and Other Intangible Assets and section 3450, Research and Development Costs. Various changes have been made to other sections of the CICA Handbook for consistency purposes. The new standard establishes standards for the recognition, measurement, presentation and disclosure of goodwill subsequent to its initial recognition and of intangible assets by profit-oriented enterprises. Standards concerning goodwill are unchanged from the standards included in the previous section 3062. The company is currently evaluating the impact of the adoption of this new section but does not anticipate any material changes.
INTERNATIONAL FINANCIAL REPORTING STANDARDS
In February 2008, the Canadian Accounting Standards Board confirmed that publicly accountable enterprises will be required to adopt International Financial Reporting Standards ("IFRS") in place of GAAP for interim and annual reporting purposes for fiscal years beginning on or after January 1, 2011.
Management has commenced its IFRS conversion project which consists of several phases commencing with a review of the company's significant accounting policies relative to current and proposed IFRS. During this preliminary phase, management determined that the differences most likely to have the greatest impact on the company's consolidated financial statements are the accounting for exploration and development activities, assessment of impairment of property and equipment, calculation of asset retirement obligations and the foreign currency translation method of the company's foreign operations. At the present time, the financial impacts of these preliminarily identified accounting policy differences on the company's current financial position and results of operations have yet to be quantified. The impact on the company's disclosure controls, internal controls over financial reporting, contracts and lending agreements will also be determined but have not yet been quantified.
In September, 2008, the International Accounting Standards Board issued an exposure draft that provides first-time adopters with additional exemptions from the retrospective application of IFRS. This exposure draft, if adopted, would allow full cost oil and gas companies to elect, at the date of transition to IFRS, to measure exploration and evaluation assets at the amount determined under GAAP and to measure oil and gas assets in the development or production phases by allocating the amount determined under GAAP to the underlying assets pro-rata using reserve volumes or reserve values as of that date. Management will consider if this exemption should be applied if the exposure draft is adopted as it continues to monitor the IFRS adoption efforts of the company's peers.
COMMITMENTS, CONTINGENCIES, GUARANTEES, CONTRACTUAL OBLIGATIONS AND OFF BALANCE SHEET ARRANGEMENTS Work Commitments
In 2005, Petrolifera acquired two significant oil and gas exploration licenses in Peru. The licenses have a total US$51.9 million financial commitment to complete negotiated work programs on the two licenses over seven years. The company has the right to withdraw from the licenses at the end of each period associated with the term of the licenses. The first license term for Block 106 ended in 2007 and the company has met its commitment and is currently in the second license term with a commitment to invest a minimum of US$1.6 million in this next term. In Block 107, the company has completed three terms of the license with a commitment to invest a minimum of US$10.0 million in the next term.
In 2007, the company was granted three concessions comprised of one license and two technical evaluation agreements ("TEA") in Colombia. Petrolifera has converted the Turpial TEA into a license and has requested that the Sierra Nevada II TEA also be converted into a license. Petrolifera is drilling the La Pinta well on the Sierra Nevada I License which will complete the first phase work commitments on the License.
In Argentina the company has total work commitments of gross US$11.0 million over the next three years related to the Vaca Mahuida, Puesto Guevara and Gobernador Ayalla II blocks. A portion of the Argentinean work commitments related to the Vaca Mahuida block has been farmed out to a third party.
Contractual Commitments
The company's annual commitments under service contracts for drilling,
leases for office premises and other equipment and an administrative services
agreement are as follows:
-------------------------------------------------------------------------
Subsequent
2009 2010 2011 to 2011 Total
-------------------------------------------------------------------------
($000)
-------------------------------------------------------------------------
Drilling service
contracts and
other leases $ 25.5 $ 22.5 $ 1.5 $ 0.2 $ 49.7
-------------------------------------------------------------------------
Contingencies
The company has various guarantees and indemnifications in place in the ordinary course of business, none of which are expected to have a significant impact on the company's financial statements or operations.
Guarantees
The company has issued letters of credit in the total amount of $2.3 million to secure the capital expenditure requirements associated with the two exploration licenses in Peru and $0.6 million in support of the Colombian work commitments as well as a remaining $0.9 million in a trust account in Colombia to meet certain of the work obligations.
Off Balance Sheet Arrangements The company has no off balance sheet financing arrangements. SUBSEQUENT EVENT
Petrolifera announced on March 2, 2009 that its Board of Directors has authorized the company to enter in to an engagement agreement with Tristone Capital Inc. ("Tristone") to immediately establish a data room, which will be made available to qualifying companies. Tristone will assist Petrolifera in the sale of Petrolifera's interests in Argentina, which are primarily held, indirectly, by a wholly-owned Barbadian subsidiary. Petrolifera's Argentina interests represent all of its current production and related revenues and substantially all of its reserves. It would be Petrolifera's intention to redeploy the proceeds in its high-potential exploration activities in Colombia and Peru, after discharging related outstanding long-term indebtedness. While Petrolifera recognizes continuing potential associated with its extensive Argentinean assets, both from an exploratory and exploitation perspective, it is the opinion of management and the company's Board of Directors that the company's holdings in Colombia and Peru have greater identified growth potential. Petrolifera's desire is to sell its Barbadian subsidiary and related assets as a going concern, with view to the purchaser providing continuing employment to the company's managerial, technical and operating staff to the fullest extent possible. Arrangements are contemplated to ensure fair and appropriate treatment under prevailing employment law to both continuing and redundant employees and contractors, should the prospective purchaser not require all of Petrolifera's current Argentinean employees and contractors on a continuing basis.
DISCLOSURE CONTROLS AND PROCEDURES AND INTERNAL CONTROL OVER FINANCIAL REPORTING
Disclosure controls and procedures have been designed to ensure that information required to be disclosed by the company is accumulated, recorded, processed, summarized and reported to the company's management as appropriate to allow timely decisions regarding required disclosure. The company's Executive Chairman, President and Chief Operating Officer and Chief Financial Officer have concluded, based on their evaluation as of the end of the year covered by this MD&A, that the company's disclosure controls and procedures as of the end of such period are effective to provide reasonable assurance that material information related to the company, including its consolidated subsidiaries, is communicated to them as appropriate to allow timely decisions regarding required disclosure.
Management of the company is responsible for designing and testing the effectiveness of internal controls over the company's financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP The design of the company's internal controls over financial reporting was based upon the Committee of Sponsoring Organizations of the Treadway Commission control framework. The testing of the effectiveness of the internal controls over financial reporting did not reveal any material weaknesses related to their design. There were no changes in the company's system of internal controls over financial reporting during 2008 that would materially affect, or is reasonably likely to materially affect, the company's internal controls over financial reporting.
It should be noted that while the company's Executive Chairman, President and Chief Operating Officer and Chief Financial Officer believe that the company's disclosure controls and procedures provide a reasonable level of assurance that they are effective and that the internal controls over financial reporting are adequately designed and are effective, they do not expect that the financial disclosure controls and procedures or internal control over financial reporting will prevent all errors and fraud. In reaching a reasonable level of assurance, management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. A control system, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.
BUSINESS RISKS
Petrolifera is exposed to certain risks and uncertainties inherent in the oil and gas business. Furthermore, being a smaller independent company, it is exposed to financing and other risks which may impair its ability to realize on its assets or to capitalize on opportunities which might become available to it. Additionally, Petrolifera operates in various foreign jurisdictions and is exposed to other risks including currency fluctuations, political risk, price controls and varying forms of fiscal regimes or changes thereto which may impair Petrolifera's ability to conduct profitable operations.
The risks arising in the oil and gas industry include price fluctuations for both crude oil and natural gas over which the company has limited control; risks arising from exploration and development activities; production risks associated with the depletion of reservoirs and the ability to market production. Additional risks include environmental and health and safety concerns.
The success of the company's capital programs as embodied in its productivity and reserve base could also impact its prospective liquidity and pace of future activities. Control of finding, development, operating and overhead costs per boe is an important criterion in determining company growth, success and access to new capital sources.
To date, the company has utilized debt and equity financing and has had a bias towards conservatively financing its operations under normal industry conditions to offset the inherent risks of international oil and gas exploration, development and production activities. From time to time, the company may have to access capital markets for new equity to supplement internally generated cash flow and bank borrowings to finance its growth plans. Periodically, these markets may not be receptive to offerings of new equity from treasury, whether by way of private placement or public offerings.
Access to financing has been impacted by sub-prime mortgage defaults, the liquidity crisis affecting the ABCP and collateralized debt obligation markets and a deterioration in the global economy. Banks have been adversely affected by the worldwide economic crisis and have severely curtailed existing liquidity lines, increased pricing and introduced new and tighter borrowing restrictions to corporate borrowers, with extremely limited access to new facilities or for new borrowers. These factors may impact Petrolifera's ability to obtain equity, debt or bank financing on terms that are commercially reasonable, or at all, and could negatively impact its ability to access liquidity needed for its operations in the longer term. This may be further complicated by the limited market liquidity for shares of smaller companies, restricting access to some institutional investors.
Periodic fluctuations in energy prices may also affect lending policies of the company's banker for new borrowings in addition to the semi-annual review of exisiting availability of indebtedness. This in turn could limit growth prospects over the short run or may even require the company to dedicate cash flow, dispose of properties or raise new equity to reduce bank borrowings under circumstances of declining energy prices or disappointing drilling results.
While hedging activities may have opportunity costs when realized prices exceed hedged pricing, such transactions are not meant to be speculative and are considered within the broader framework of financial stability and flexibility. Management continuously reviews the need to utilize such financing techniques.
The company attempts to mitigate its business and operational risk exposures by maintaining comprehensive insurance coverage on its assets and operations, by employing or contracting competent technicians and professionals, by instituting and maintaining operational health, safety and environmental standards and procedures and by maintaining a prudent approach to exploration and development activities. The company also addresses and regularly reports on the impact of risks to its shareholders, writing down the carrying values of assets that may not be recoverable.
FOURTH QUARTER 2008
Petrolifera maintained a steady level of activity, consistent with its production and sales in the fourth quarter of 2008. When combined with the company's realized crude oil and natural gas liquids prices, growth was achieved in revenue and cash flow relative to the third quarter in 2008 and compared to the fourth quarter in 2007. Petrolifera's crude oil and natural gas liquids sales during the fourth quarter of 2008 was 6,877 bbl/d, which was marginally above sales volumes during the third quarter of 2008 and an increase of five percent from the fourth quarter of 2007. On an equivalent basis, sales volumes for the fourth quarter of 2008 averaged 7,786 boe/d, an increase of 11 percent over the same period in 2007 and steady from the third quarter of 2008. The increase and the relatively consistent sales volume levels relative to the fourth quarter of 2007 and third quarter of 2008, respectively, reflect the continuing impact of the company's waterflood program at the PMN Field and contributions from new pool discoveries during the year. December 2008 sales were positively impacted by incremental inventory sales, which are anticipated to develop and occur from time to time during 2009, as market conditions evolve in response to changing economic circumstances in Argentina.
Total revenue in the fourth quarter of 2008 was $37.4 million compared to $32.1 million in the third quarter of 2008 and $27.3 million in the fourth quarter of 2007, reflecting generally higher sales volumes and higher realized commodity prices. The average price received for crude oil and natural gas liquids sales in the fourth quarter of 2008 was $56.76 per barrel and on an equivalent barrel basis was $52.15 per boe. This was the highest realized equivalent pricing experienced in the company's history. Despite the precipitous drop in world crude oil prices, Petrolifera's financial results were not as adversely affected in a relative sense due to the historic regulated commodity pricing regime in Argentina. The complexities of the regulated commodity pricing regime were highlighted in December 2008, when the company received US$47.00 per barrel for its crude oil. This was a 13 percent premium relative to US$41.53, the December average price reported for WTI. The fourth quarter commodity prices also reflect the strengthening of the U.S. dollar, which appreciated approximately 24 percent against the Canadian dollar during 2008.
Net earnings in the fourth quarter of 2008 were $2.7 million ($0.05 per share), compared to $3.6 million ($0.06 per share) in the previous quarter of 2008 and $4.9 million ($0.10 per share) in 2007. These represent decreases in net earnings of 25 and 45 percent, respectively, primarily due to higher depletion expense resulting from higher estimated cost of production additions and a year-end reserve adjustment partially offset by improved sales volumes, higher realized commodity prices and a reduction in the current tax provision.
Cash flow of $21.7 million ($0.39 per share) was recorded during the fourth quarter 2008, compared to $15.7 million ($0.29 per share) in the previous quarter of 2008 and $10.7 million ($0.21 per share) in the fourth quarter of 2007. These represent increases in cash flow of 38 and 103 percent, respectively, and reflect improved operating results and realized commodity pricing, combined with a favourable change to the company's current tax provision.
Reconciliation of net earnings to cash flows as follows:
-------------------------------------------------------------------------
Three months ended December September December
31, 2008 30, 2008 31, 2007
-------------------------------------------------------------------------
($000)
Net earnings $ 2,662 $ 3,564 $ 4,863
Add (deduct) non-cash charges:
Stock-based compensation 1,595 1,123 1,414
Depletion, depreciation,
and accretion 11,328 6,599 4,470
Future income tax provision 3,166 2,573 534
Amortization of deferred finance charges 222 221 -
Foreign exchange gain (789) (239) (3,956)
Fair value adjustments - ABCP 3,505 1,885 3,382
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Cash flow $21,689 $15,726 $10,707
-------------------------------------------------------------------------
Per share, basic 0.39 0.29 0.21
-------------------------------------------------------------------------
Per share, diluted 0.39 0.28 0.21
-------------------------------------------------------------------------
Capital spending of $35.5 million during the fourth quarter of 2008 reflects the company's preparations for increased activity in Colombia and Peru offset by a prudent and cautious approach in Argentina. The capital spending in the current reporting period reflected the company's drilling preparations and surface location preparations for the La Pinta well, which spudded in January, 2009 on the Sierra Nevada Concession in Colombia. Also extensive 2D seismic was shot on the Peruvian Block 106 and the company also had outlays related to data processing and interpretation of the data.
OUTLOOK
Petrolifera's outlook remains exciting and favourable although clouded by the overall weakness in world economies, commodity pricing, economic activity, credit markets and capital markets. As a consequence, there is little short-term optimism of a significant recovery in crude oil prices, although the reduction in commodity prices is setting the groundwork for rapid and steep increases when demand destruction ends and growth is restored through the world. The company did experience some reserve reductions in 2008, which arose primarily from the impact of increased water cuts arising during production in conjunction with its waterflood program. This could affect short-term and possibly long term productivity from PMN, until it is determined if there is a remedy for increased water incursion. Petrolifera is also headed into a period of higher risk, higher reward drilling activity, if it can secure available industry participation through farmouts. If these cannot be secured on favourable terms, the company may have to reduce its participation in its blocks through farmouts without disproportionate spending by joint venture partners or outright sales to the benefit of the company shareholders.
The company announced the initiation of a process for the sale of our Argentinean assets. The company intends to focus on new areas with greater potential or fewer complications related to economic and fiscal policies such as now characterize Argentina.
FORWARD-LOOKING INFORMATION
This MD&A contains forward-looking information including, but not limited to, future exploration and development opportunities in Argentina, Colombia and Peru, current drilling, testing and completion plans in Colombia, future drilling plans in Argentina, Colombia and Peru, anticipated timing of the full impact of the company's waterflood program, anticipated pricing relative to world pricing and historical pricing for the company's crude oil and natural gas, planned 2009 capital expenditures (including sources of funding and timing thereof), planned farmout and/or joint ventures arrangements, anticipated award of Block 133 in Peru and the Magdalena License in Colombia, planned sale of interests in Argentina, reserves and future net revenue attributable thereto, recovery of the company's investment in and anticipated improvements in the company's financial condition throughout 2009. Forward looking information is not based on historical facts but rather on Management's expectations regarding the company's future growth, results of operations, production, future capital and other expenditures (including the amount, nature and sources of finding thereof), competitive advantages, plans for and results of drilling activity, environmental matters, business prospects and opportunities and expectations with respect to general economic conditions. Such forward looking information reflects Management's current beliefs and assumptions and is based on information currently available to Management. Forward looking information involves significant known and unknown risks and uncertainties. A number of factors could cause actual results to differ materially from the results discussed in the forward looking information, including but not limited to, risks associated with the oil and gas industry (e.g. operational risks in development, exploration and production, delays or changes to plans with respect to exploration or development projects or capital expenditures; the uncertainty of reserve estimates; the uncertainty of estimates and projections in relation to production, costs and expenses and health, safety and environment risks), the risk of commodity price and foreign exchange rate fluctuations, the uncertainty associated with negotiating with foreign governments and third parties located in foreign jurisdictions and the risk associated with international activity. The company's ability to complete its capital program is dependant upon completion of planned farm-out arrangements, access to required credit and capital and access to services, drilling rigs and equipment. In addition, the current financial crisis has resulted in severe economic uncertainty and resulting illiquidity in credit and capital markets which increases the risk that actual results will vary from forward looking expectations in this report and these variations may be material. Petrolifera may have to bring participants into its acerage holdings and planned evaluation activities on less attractive terms than might otherwise have been the case due to the combination of tighter economic conditions and the influence of contractual commitments and deadlines on the terms of trade. There can be no assurance that the company will be successful in its efforts to secure planned farm-outs and/or joint venture arrangements. Information relating to "reserves" and "future net revenues" associated therewith are deemed to be foward-looking information, as they involve the implied assessment, based on certain estimates and assumptions, that the reserves described exist in the quantities predicted or estimated, and can be profitably produced in the future to achieve the future net revenue calculated in accordance with certain assuptions. The assumptions relating to the reserves and assoiacted future net revenues reported herein are contained in the GLJ 2008 Report and are summarized in Petrolifera's Annual Information Form for the year ended December 31, 2008. Future net revenues associated with reserves do not necessarily represent fair market value. Although the forward looking information contained herein is based upon assumptions which Management believes to be reasonable, the company cannot assure investors that actual results will be consistent with this forward looking information. This forward looking information is made as of the date hereof and the company assumes no obligation to update or revise this information to reflect new events or circumstances, except as required by law. Because of the risks, uncertainties and assumptions inherent in forward looking information, prospective investors in the company's securities should not place undue reliance on this forward looking information. Additionally, readers are reminded that cash flow from operations and EBITDA do not have standardized meanings prescribed by Canadian generally accepted accounting principles ("GAAP") and therefore may not be comparable to similar measures used by other companies. Cash flow from operations and EBITDA are reconciled to net earnings when provided by the company.
QUARTERLY RESULTS(4)
-------------------------------------------------------------------------
For the three months ended
--------------------------------------
2007
-------------------------------------------------------------------------
Mar 31 June 30 Sept 30 Dec 31
-------------------------------------------------------------------------
FINANCIAL RESULTS
($000 except per share
amounts) - unaudited
-------------------------------------------------------------------------
Total revenue 47,122 28,105 31,730 27,266
-------------------------------------------------------------------------
Cash flow from operations
before working capital changes(1) 24,615 14,504 18,619 10,707
-------------------------------------------------------------------------
Basic, per share(1) 0.56 0.30 0.37 0.21
-------------------------------------------------------------------------
Diluted, per share(1) 0.49 0.28 0.36 0.21
-------------------------------------------------------------------------
Net earnings 15,069 4,450 4,919 4,863
-------------------------------------------------------------------------
Basic, per share 0.34 0.09 0.10 0.10
-------------------------------------------------------------------------
Diluted, per share 0.30 0.09 0.10 0.09
-------------------------------------------------------------------------
Capital expenditures 7,514 19,842 26,061 57,608
-------------------------------------------------------------------------
Cash or cash equivalents 59,155 66,535 11,368 13,052
-------------------------------------------------------------------------
Working capital 58,811 69,690 22,742 (31,779)
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Long-term bank debt - - - -
-------------------------------------------------------------------------
Shareholders' equity 98,124 120,236 121,727 120,303
-------------------------------------------------------------------------
Total assets 137,840 139,054 144,016 204,227
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OPERATING RESULTS
-------------------------------------------------------------------------
Sales volumes
-------------------------------------------------------------------------
Crude oil and natural gas
liquids-bbl/d 11,333 6,644 7,195 6,565
-------------------------------------------------------------------------
Natural gas - mcf/d 1,858 1,726 2,169 2,860
-------------------------------------------------------------------------
Equivalent - boe/d(2) 11,643 6,932 7,557 7,042
-------------------------------------------------------------------------
Pricing
-------------------------------------------------------------------------
Crude oil and natural gas
liquids-$/bbl 45.43 45.17 46.99 44.36
-------------------------------------------------------------------------
Natural gas - $/mcf 1.53 1.42 1.41 1.76
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Selected highlights - $/boe(2)
-------------------------------------------------------------------------
Weighted average selling
price per boe 44.47 43.65 45.15 42.07
-------------------------------------------------------------------------
Interest and other income 0.50 0.90 0.49 0.01
-------------------------------------------------------------------------
Royalties 5.59 6.19 5.77 5.76
-------------------------------------------------------------------------
Operating costs 4.40 5.56 6.96 8.20
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Corporate netback(3) 34.98 32.80 32.91 28.12
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COMMON SHARE INFORMATION
(000, except share price)
-------------------------------------------------------------------------
Shares outstanding at
end of period 44,029 50,084 50,119 50,127
-------------------------------------------------------------------------
Weighted average shares
outstanding for the period
-------------------------------------------------------------------------
Basic 43,800 47,816 50,107 50,123
-------------------------------------------------------------------------
Diluted 50,635 51,303 51,800 51,689
-------------------------------------------------------------------------
Volume traded during quarter 7,202 6,211 10,921 12,223
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Common share price ($)
-------------------------------------------------------------------------
High 20.20 19.29 22.35 17.10
-------------------------------------------------------------------------
Low 16.05 16.60 13.18 9.14
-------------------------------------------------------------------------
Close (end of period) 19.14 17.04 15.20 9.87
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-------------------------------------------------------------------------
For the three months ended
--------------------------------------
2008
-------------------------------------------------------------------------
Mar 31 June 30 Sept 30 Dec 31
-------------------------------------------------------------------------
FINANCIAL RESULTS
($000 except per share
amounts) - unaudited
-------------------------------------------------------------------------
Total revenue 27,167 33,622 32,126 37,411
-------------------------------------------------------------------------
Cash flow from operations
before working capital changes(1) 11,902 13,485 15,726 21,689
-------------------------------------------------------------------------
Basic, per share(1) 0.24 0.27 0.29 0.39
-------------------------------------------------------------------------
Diluted, per share(1) 0.23 0.26 0.28 0.39
-------------------------------------------------------------------------
Net earnings 1,738 3,590 3,564 2,662
-------------------------------------------------------------------------
Basic, per share 0.04 0.07 0.06 0.05
-------------------------------------------------------------------------
Diluted, per share 0.03 0.07 0.06 0.05
-------------------------------------------------------------------------
Capital expenditures 31,056 29,110 21,046 35,539
-------------------------------------------------------------------------
Cash or cash equivalents 11 41,039 14,865 30,701
-------------------------------------------------------------------------
Working capital (51,546) 13,295 8,148 19,956
-------------------------------------------------------------------------
Long-term bank debt - 43,800 45,576 77,150
-------------------------------------------------------------------------
Shareholders' equity 127,225 168,735 178,069 202,347
-------------------------------------------------------------------------
Total assets 231,278 292,882 279,174 355,658
-------------------------------------------------------------------------
OPERATING RESULTS
-------------------------------------------------------------------------
Sales volumes
-------------------------------------------------------------------------
Crude oil and natural gas
liquids-bbl/d 6,726 7,111 6,850 6,877
-------------------------------------------------------------------------
Natural gas - mcf/d 7,044 5,922 5,363 5,451
-------------------------------------------------------------------------
Equivalent - boe/d(2) 7,900 8,098 7,744 7,786
-------------------------------------------------------------------------
Pricing
-------------------------------------------------------------------------
Crude oil and natural gas
liquids-$/bbl 41.99 49.90 48.93 56.76
-------------------------------------------------------------------------
Natural gas - $/mcf 2.20 2.38 2.58 2.88
-------------------------------------------------------------------------
Selected highlights - $/boe(2)
-------------------------------------------------------------------------
Weighted average selling
price per boe 37.72 45.56 45.07 52.15
-------------------------------------------------------------------------
Interest and other income 0.07 0.07 0.02 0.08
-------------------------------------------------------------------------
Royalties 4.71 6.33 6.80 7.66
-------------------------------------------------------------------------
Operating costs 8.24 8.60 9.00 10.28
-------------------------------------------------------------------------
Corporate netback(3) 24.84 30.69 29.29 34.29
-------------------------------------------------------------------------
COMMON SHARE INFORMATION
(000, except share price)
-------------------------------------------------------------------------
Shares outstanding at
end of period 50,353 54,798 54,948 54,948
-------------------------------------------------------------------------
Weighted average shares
outstanding for the period
-------------------------------------------------------------------------
Basic 50,212 50,500 54,884 54,948
-------------------------------------------------------------------------
Diluted 51,562 51,735 55,897 55,043
-------------------------------------------------------------------------
Volume traded during quarter 7,721 4,590 7,884 8,826
-------------------------------------------------------------------------
Common share price ($)
-------------------------------------------------------------------------
High 11.96 11.25 8.72 3.99
-------------------------------------------------------------------------
Low 6.61 8.25 3.16 0.75
-------------------------------------------------------------------------
Close (end of period) 9.10 8.69 3.37 1.05
-------------------------------------------------------------------------
(1) Cash flow from operations before non-cash working capital changes
("cash flow") and cash flow per share do not have standardized
meanings prescribed by Canadian generally accepted accounting
principles ("GAAP") and therefore are unlikely to be comparable to
similar measures used by other companies. Cash flow includes all cash
flow from operating activities and is calculated before changes in
non-cash working capital. The most comparable measure calculated in
accordance with GAAP would be net earnings. Cash flow is reconciled
with net earnings on the Consolidated Statement of Cash Flows and in
the accompanying Management's Discussion & Analysis ("MD&A").
Management uses these non-GAAP measurements for its own performance
measures and to provide its shareholders and investors with a
measurement of the company's efficiency and its ability to internally
fund a portion of its future growth expenditures.
(2) All references to barrels of oil equivalent (boe) are calculated on
the basis of 6 mcf : 1 bbl. Boe may be misleading particularly if
used in isolation. This conversion is based on an energy equivalency
conversion method primarily applicable at the burner tip and does not
represent a value equivalent at the wellhead.
(3) Corporate netback is a non-GAAP measure used by management as a
measure of operating efficiency and profitability. It is calculated
as petroleum and natural gas revenue and other income less royalties
and operating costs. For a reconciliation of net backs to net
earnings, see "MD&A".
(4) Fluctuations in results over the previous eight quarters are due
principally to variations in oil and gas prices and production
volumes. Attributing to fluctuations in working capital is the
classification of debt as either current or long-term.
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
Petrolifera Petroleum Limited
December 31
-------------------------------------------------------------------------
2008 2007
-------------------------------------------------------------------------
($000)
-------------------------------------------------------------------------
ASSETS
Current
Cash 30,701 13,052
Accounts receivable 37,331 27,512
Income taxes receivable 4,736 -
Prepaid expenses 535 468
Inventory (Note 4) 658 854
-------------------------------------------------------------------------
73,961 41,886
-------------------------------------------------------------------------
Long-term investments (Note 5) 25,428 33,378
Property and equipment (Note 7) 254,644 126,874
Deferred financing costs (Note 8) 1,625 2,089
-------------------------------------------------------------------------
$355,658 $204,227
-------------------------------------------------------------------------
LIABILITIES
Current
Accounts payable and accrued liabilities $35,882 $37,963
Income taxes payable 1,444 6,090
Bank debt (Note 8) 16,637 29,612
-------------------------------------------------------------------------
Due to a related company (Note 10) 42 -
-------------------------------------------------------------------------
54,005 73,665
Long-term bank debt (Note 8) 77,150 -
Asset retirement obligations (Note 11) 10,106 5,639
Future income taxes (Note 9) 12,050 4,620
-------------------------------------------------------------------------
153,311 83,924
-------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Share capital, warrants and contributed surplus
(Note 12) 108,254 64,544
Accumulated other comprehensive income (loss) 16,106 (10,674)
Retained earnings 77,987 66,433
-------------------------------------------------------------------------
202,347 120,303
-------------------------------------------------------------------------
$355,658 $204,227
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Commitments, contingencies and guarantees (Note 15)
Subsequent events (Note 16)
Approved by the board
Signed, Signed,
"C.J. Smith" "D.D. Barkwell"
Director Director
CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS
Petrolifera Petroleum Limited
Years Ended December 31
-------------------------------------------------------------------------
2008 2007
-------------------------------------------------------------------------
$000 (except per share amounts)
-------------------------------------------------------------------------
Revenue
Petroleum and natural gas sales $130,148 $132,779
Interest income 178 1,444
-------------------------------------------------------------------------
130,326 134,223
Royalties (18,381) (17,500)
-------------------------------------------------------------------------
111,945 116,723
-------------------------------------------------------------------------
Expenses
Operating 26,040 18,267
General and administrative 8,425 6,369
Fair value impairment - ABCP (Note 5) 8,882 6,169
Stock-based compensation (Note 12) 5,847 6,833
Finance charges (Note 8) 5,417 421
Taxes other than income taxes 2,185 2,138
Foreign exchange loss 180 2,331
Depletion, depreciation and accretion (Note 7) 28,984 16,890
-------------------------------------------------------------------------
85,960 59,418
-------------------------------------------------------------------------
Earnings before income taxes 25,985 57,305
Current income tax provision (Note 9) 7,905 21,083
Future income tax provision (Note 9) 6,526 6,921
-------------------------------------------------------------------------
14,431 28,004
-------------------------------------------------------------------------
Net earnings 11,554 29,301
Retained earnings, beginning of year 66,433 37,132
-------------------------------------------------------------------------
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Retained earning, end of year $77,987 $66,433
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Net earnings per share (Note 14)
Basic $0.22 $0.61
Diluted $0.22 $0.57
-------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Petrolifera Petroleum Limited
Years Ended December 31
-------------------------------------------------------------------------
2008 2007
-------------------------------------------------------------------------
($000)
-------------------------------------------------------------------------
Net earnings $11,554 $29,301
Foreign currency translation adjustment 26,780 (12,341)
-------------------------------------------------------------------------
Comprehensive income $38,334 $16,960
-------------------------------------------------------------------------
-------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Petrolifera Petroleum Limited
Years Ended December 31
-------------------------------------------------------------------------
2008 2007
-------------------------------------------------------------------------
($000)
-------------------------------------------------------------------------
Balance, beginning of year $(10,674) $1,667
Foreign currency translation adjustment 26,780 (12,341)
-------------------------------------------------------------------------
Balance, end of year $16,106 $(10,674)
-------------------------------------------------------------------------
-------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
Petrolifera Petroleum Limited
Years Ended December 31
-------------------------------------------------------------------------
2008 2007
-------------------------------------------------------------------------
($000)
-------------------------------------------------------------------------
Cash provided by (used in) the following activities:
Operating
Net earnings $11,554 $29,301
Items not involving cash:
Depletion, depreciation and accretion (Note 7) 28,984 16,890
Future income tax provision 6,526 6,921
Stock-based compensation (Note 12) 5,847 6,833
Fair value impairment - ABCP (Note 5) 8,882 6,169
Amortization of deferred charges (Note 8) 829 -
Foreign exchange loss 180 2,331
-------------------------------------------------------------------------
Cash flow from operations before non-cash working
capital changes 62,802 68,445
Changes in non-cash working capital (Note 14) (12,482) (19,604)
-------------------------------------------------------------------------
50,320 48,841
-------------------------------------------------------------------------
Financing
Proceeds from bank debt or long-term bank debt 69,507 29,612
Repayment of bank debt or long-term bank debt (15,825) -
Issue of common shares, net of share issue costs
(Note 12) 38,013 18,435
Deferred financing costs (153) (2,089)
-------------------------------------------------------------------------
91,542 45,958
-------------------------------------------------------------------------
Investing
Development of oil and gas properties (116,751) (111,025)
Reclassification to long-term investments (Note 5) (324) (39,633)
Changes in non-cash working capital (Note 14) (6,540) 24,271
-------------------------------------------------------------------------
(123,615) (126,387)
-------------------------------------------------------------------------
Increase (decrease) in cash 18,247 (31,588)
-------------------------------------------------------------------------
Cash, beginning of year 13,052 51,008
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Impact of foreign exchange on foreign currency
denominated cash balances (598) (6,368)
-------------------------------------------------------------------------
Cash, end of year $30,701 $13,052
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Supplementary cash flow information (Note 14)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Petrolifera Petroleum Limited
For the year ended December 31, 2008
1. INCORPORATION
Petrolifera Petroleum Limited was incorporated on November 9, 2004.
Through subsidiaries and foreign branches (collectively "Petrolifera" or
the "company"), it is engaged in petroleum and natural gas exploration,
development and production activities in South America.
2. FINANCIAL STATEMENT PRESENTATION
The financial statements include the accounts of the company and are
presented in Canadian dollars and in accordance with Canadian generally
accepted accounting principles.
3. SIGNIFICANT ACCOUNTING POLICIES
Inventory
Crude oil inventory is measured at the lower of cost (on a weighted
average cost basis) and net realizable value.
Income taxes
The company follows the liability method of accounting for income taxes.
Under this method, income tax liabilities and assets are recognized for
the estimated tax consequences attributed to differences between the
amounts reported in the financial statements and their respective tax
bases, using substantively enacted income tax rates. The effect of a
change in income tax rates on future income tax liabilities and assets is
recognized in income in the period that the change occurs. Future tax
assets are assessed by management at each balance sheet date and
recognized when realization is more likely than not.
Petroleum and natural gas operations
The company follows the full cost method of accounting whereby all costs
relating to the exploration for and development of crude oil and natural
gas reserves are capitalized on a country by country cost centre basis.
Capitalized costs of petroleum and natural gas properties and related
equipment within a cost centre are depleted and depreciated using the
unit-of-production method based on estimated proved crude oil and natural
gas reserves, as determined by independent consulting engineers. For the
purpose of this calculation, production and reserves of natural gas are
converted to equivalent units of crude oil based on relative energy
content (6:1).
The company applies a "ceiling test" to the net book value of petroleum
and natural gas properties for each cost centre to ensure that such
carrying value does not exceed the estimated fair value of the
properties. The carrying value is assessed to be recoverable when the sum
of the undiscounted cash flows expected from the production of proved
reserves and the cost, less impairment, of unproved properties exceeds
the carrying value. If the carrying value is assessed to not be
recoverable, the calculation compares the carrying value to the sum of
the discounted cash flows expected from the production of proved and
probable reserves and the cost, less impairment, of unproved properties.
Should the carrying value exceed this sum, an impairment loss is
recognized. The cash flows are estimated using projected future product
prices and costs and are discounted using the risk-free interest rate.
Costs of acquiring and evaluating unproved properties and major
development projects are excluded from costs subject to depletion and
depreciation until it is determined whether or not proved reserves are
attributable to the properties, the project becomes commercial, or
impairment occurs. These costs are reviewed quarterly and any impairment
is transferred to the costs being depleted or, if the properties are
located in a cost centre where there is no reserve base, the impairment
is charged directly to earnings.
Gains or losses on sales of properties are recognized only when crediting
the proceeds to cost would result in a change of 20 percent or more in
the depletion and depreciation rate.
Asset retirement obligations
The company provides for the costs of retirement obligations associated
with long-lived assets, including the abandonment of oil and natural gas
wells, related facilities, compressors and gas plants, removal of
equipment from leased acreage and returning such land to its original
condition. The estimated fair value of each asset retirement obligation
is recorded in the period a well or related asset is drilled, constructed
or acquired. Fair value is estimated using the present value of the
estimated future cash outflows to abandon the asset using the company's
credit adjusted risk-free interest rate and expected inflation rate. The
obligation is reviewed regularly by management based upon current
regulations, costs, technologies and industry standards. The discounted
obligation is initially capitalized as part of the carrying amount of the
related oil and natural gas properties and a corresponding liability is
recognized. The liability is accreted against income until it is settled
or the property is sold and is included as a component of depletion and
depreciation expense. The increase in oil and natural gas properties is
depleted and depreciated on the same basis as the remainder of the oil
and natural gas properties. Actual restoration expenditures are charged
against the accumulated obligation as incurred.
Revenue recognition
Crude oil, natural gas liquids and natural gas sales are recognized as
revenue at the time the respective commodities are delivered to
purchasers at the point of sale.
Stock-based compensation
The company uses the fair value method for valuing stock option grants.
Compensation costs attributed to share options granted are measured at
fair value at the grant date and expensed over the vesting period with a
corresponding increase to contributed surplus. Upon exercise of the stock
options, consideration paid by the option holder together with the amount
previously recognized in contributed surplus is recorded as an increase
to share capital.
Financial instruments
Financial instruments are recognized initially at fair value on the
balance sheet, and include cash, accounts receivable, long-term
investments, accounts payable and accrued liabilities, due to/from a
related company, bank debt and long-term bank debt. The company has
classified all of its financial instruments as held for trading, with
the exception of the bank debt and long-term bank debt, which are
classified as other liabilities. Held for trading instruments are
measured at fair value, while other liabilities are measured at
amortized cost.
The company has not entered into any financial derivative contracts, does
not enter into these contracts for speculative purposes, and has not
recorded any assets or liabilities as a result of embedded derivatives.
The carrying value of held for trading instruments is their fair value
due to the short term nature of these instruments, except for long term
investments, which is discussed in Note 5. The fair value of the bank
debt and long-term bank debt approximates the carrying value as the debt
has a floating market rate of interest.
Deferred financing costs
Deferred financing costs include amounts incurred in relation to the
company's revolving credit facility and are recognized against earnings
over the life of the associated credit facility.
Measurement uncertainty
The timely preparation of the financial statements in conformity with
Canadian generally accepted accounting principles requires that
management make estimates and assumptions and use judgment regarding the
reported amounts of assets and liabilities at the date of the
consolidated financial statements and the reported amounts of revenues
and expenses during the period. Such estimates primarily relate to
unsettled transactions and events as of the date of the consolidated
financial statements. Accordingly, actual results may differ from
estimated amounts as future confirming events occur.
Amounts recorded for depreciation, depletion and accretion, amounts used
for ceiling test and impairment calculations and amounts used in the
determination of the future tax liability are based, in part, on
estimates of natural gas and crude oil reserves and future costs required
to develop those reserves. By their nature, these estimates of reserves,
including the estimates of future prices and costs and the related future
cash flows are subject to measurement uncertainty. Asset retirement
obligations is based, in part, on estimates of future costs to settle the
obligation, in addition to estimates of the useful lives of the
underlying assets, the rate of inflation and the credit adjusted risk-
free interest rate. Stock-based compensation is based upon volatility,
expected lives and risk-free interest rates. Actual results could differ
materially from estimated amounts.
Per share amounts
Basic per share amounts are calculated using the weighted average number
of common shares outstanding for the period. The company follows the
treasury stock method to calculate diluted per share amounts. The
treasury stock method assumes that any proceeds from the exercise of in-
the-money share options, stock purchase warrants and other dilutive
instruments, in addition to stock-based compensation not yet recognized,
would be used to purchase common shares at the average market price
during the period.
Foreign currency translation
Colombia, Peru, Barbados and the U.S. subsidiaries are considered to be
"integrated foreign operations" for accounting purposes and, therefore,
these foreign operations' financial statements are translated into
Canadian dollars using the temporal method. Under the temporal method,
the company translates foreign denominated monetary assets and
liabilities at the exchange rate prevailing at year end; non-monetary
assets, liabilities and related depletion and depreciation are translated
at historic rates; revenues and expenses are translated at the average
rate of exchange for the period; and any resulting foreign exchange gains
or losses are included in earnings.
As a "self-sustaining foreign operation", the Argentinean financial
statements are translated into Canadian dollars using the current rate
method, whereby assets and liabilities are translated at the rate of
exchange in effect at the balance sheet date; revenues and expenses are
translated at the average monthly rates of exchange during the period;
and gains or losses on translation are included as a foreign currency
translation adjustment in the consolidated statements of comprehensive
income and accumulated other comprehensive income (loss).
Impact of New Accounting Pronouncements and Standards
Effective January 1, 2008, the company adopted CICA Handbook sections
1535, 3031, 3862 and 3863 relating to Capital Disclosures, Inventories,
Financial Instruments - Disclosures and Financial Instruments -
Presentation, respectively. Under section 1535, the company is required
to disclose its objectives, policies and processes for managing capital,
and in addition, whether the entity has complied with any externally
imposed capital requirements. Note 6 contains further disclosures with
respect to this standard.
Under section 3031, the measurement of cost and cost formulas for
inventories have been revised, along with additional disclosure
requirements. The adoption of this section has had no impact on the
company's Consolidated Financial Statements, as inventories were already
being measured in a manner permitted under the new standard.
Under section 3862, the company is required to disclose the significance
of financial instruments to its financial statements, the risks
associated with the financial instruments, and how those risks are
managed. Note 6 contains further disclosures with respect to this
standard.
Under section 3863, further guidance is provided on the classification of
financial instruments as liabilities vs. equity, and when netting of
financial assets and financial liabilities is appropriate. The adoption
of this section had no impact on the company's consolidated financial
statements as the company does not have any financial instruments that
contain both a liability and an equity element and was already offsetting
a financial asset and financial liability only when it had a legally
enforceable right to set off the recognized amounts and intended to
settle simultaneously.
As of January 1, 2009, the company will be required to adopt CICA
Handbook section 3064, Goodwill and Intangible Assets, replacing section
3062, Goodwill and Other Intangible Assets and section 3450, Research and
Development Costs. Various changes have been made to other sections of
the CICA Handbook for consistency purposes. The new standard establishes
standards for the recognition, measurement, presentation and disclosure
of goodwill subsequent to its initial recognition and of intangible
assets by profit-oriented enterprises. Standards concerning goodwill are
unchanged from the standards included in the previous section 3062. The
company is currently evaluating the impact of the adoption of this new
section.
International Financial Reporting Standards
In February, 2008, the Canadian Accounting Standards Board confirmed that
publicly accountable enterprises will be required to adopt International
Financial Reporting Standards ("IFRS") in place of Canadian generally
accepted accounting policies ("GAAP") for interim and annual reporting
purposes for fiscal years beginning on or after January 1, 2011.
4. INVENTORY
-------------------------------------------------------------------------
Years ended December 31 2008 2007
-------------------------------------------------------------------------
($000)
-------------------------------------------------------------------------
Crude oil $ 658 $ 854
-------------------------------------------------------------------------
The company maintains inventory as a consequence of the sales process for
crude oil which has been produced and not delivered to customers for
periods of up to several days, during which time it must be stored. Crude
oil inventory was measured at December 31, 2008 and 2007 using a weighted
average cost basis.
At December 31, 2008 and 2007, inventory is composed of crude oil held in
storage at the company's facilities and in transportation pipelines.
Crude oil is carried at the lower of cost and net realizable value.
5. LONG-TERM INVESTMENTS
As at December 31, 2008, included in long-term investments were Asset
Backed Commercial Paper ("ABCP") with a face value of $37.7 million
(2007 - $37.7 million) and a carrying value of $22.5 million (2007 -
$31.4 million) and collateral to support issued letters of credit of
$2.9 million (2007 - $1.9 million) (Note 15). These investments are
classified as held for trading and are carried at fair value which is
assessed each reporting date.
In August 2007 the Canadian third-party ABCP market experienced a severe
shortage of liquidity. Shortly thereafter, a panel of banks, asset
providers, and major investors formed the Pan-Canadian Investors
Committee for Third-Party Structured Asset-Backed Commercial Paper to
oversee the restructuring process with the principal objective of
preserving value for the benefit of investors through the exchange of
ABCP for longer-term notes that are designed to match the maturities of
the underlying assets. Because of the large number of participants, the
complexity of the required documentation involved in the process and the
recent volatility in the global financial markets, the restructuring
process had not been completed by December 31, 2008.
With the delay in the restructuring process, management has estimated the
fair value of the company's investment in ABCP based on a probabilistic
recovery of principal and interest taking into account all available
information. Under this valuation method, several different outcomes of
the recovery of the principal and interest are estimated considering the
information available as at December 31, 2008. A weighted average
recovery is then calculated. This weighted average recovery is used to
determine the discounted cash flows that are expected from these
investments. The discount rate used to discount the expected cash flows
from the ABCP is an approximation of the risk-free rate for the expected
life of the ABCP notes to be received. As the rate used for discounting
is an approximation of the risk-free rate, all other risks have been
incorporated in the estimated probability adjusted expected outcomes.
This methodology applies all risking information into the various
scenarios and discounts the fully risked cash flow stream only for the
time value of money. The recovery factors used were as follows:
-------------------------------------------------------------------------
Risk- Risk-
Face Value adjusted adjusted Capital Interest Risk-
of Notes Capital Interest Weighted Weighted free
Class Expected(i) Recovery Recovery Average Average Term Discount
of Note ($000s) Range Range Recovery Recovery (years) Rate
-------------------------------------------------------------------------
A-1 $14,014 0 - 80% 0 - 70% 75% 64% 5 - 8 3.55%
-------------------------------------------------------------------------
A-2 13,543 0 - 70% 0 - 50% 65% 46% 8 3.55%
-------------------------------------------------------------------------
B 2,459 0 - 30% 0% 27% 0% 8 3.55%
-------------------------------------------------------------------------
C 928 0% 0% 0% 0% 8 3.55%
-------------------------------------------------------------------------
IA
Tracking 6,613 0 - 40% 0% 36% 0% 8 3.55%
-------------------------------------------------------------------------
Total $37,557
-------------------------------------------------------------------------
(i) The $37.7 million face value of ABCP was purchased at a discount with
the difference between the face value and the amount paid
representing the interest component. The face value of notes
expected, per the above table, of $37.6 million approximates the
amount paid to acquire the ABCP.
Based on the above approach the fair value of the investment in ABCP is
estimated to be $22.5 million (2007 - $31.4 million) which is an
impairment of $8.9 million (2007 - $6.2 million) for the year ended
December 31, 2008. This impairment brings the total impairment of the
ABCP recorded to date to approximately 40 percent (2007 - 16 percent) of
the original cost of the investment.
The theoretical fair value of the company's ABCP could range from
$19.2 million to $31.1 million using the valuation methodology described
above with reasonably possible alternative assumptions. The outcome of
the actual timing and amount ultimately recoverable from these notes may
differ materially from this estimate which would impact the company's
earnings.
6. FINANCIAL RISK MANAGEMENT
Summary
The company is exposed to various risks that arise from its business
environment and the financial instruments it holds. The Audit Committee
of the Board of Directors assists the Board in the discharge of its
responsibility for overseeing the process that management has in place to
identify, assess and manage business risks. The following outlines the
company's risk exposures, quantifies these risks, and explains how these
risks and its capital structure are managed.
Capital Management
The company's objective is to maintain a strong capital position in order
to execute its business plans and maximize value to shareholders. The
company defines its capital as shareholders' equity, bank debt and long-
term bank debt. Changes to the relative weighting of the capital
structure is driven by the company's business plans, changes in economic
conditions and risks inherent in the global oil and gas industry.
Although, during the year ended December 31, 2008, there were changes in
the relative weighting of capital, there have been no material changes to
the company's processes and objectives related to capital management
compared to prior periods. Methods to adjust the company's capital
structure could include any or all of the following activities:
- Repurchase shares pursuant to a normal course issuer bid;
- Issue new shares through a public offering or private placement; such
as occurred in the second quarter of 2008 (Note 12);
- Raise fixed or floating rate debt; and
- Refinance existing debt facilities to change amounts or terms
(Note 8).
The company periodically reviews certain quantitative measures of its
capital structure, in order to understand its position relative to
industry peers. These measures include calculations such as return on
equity, return on capital employed and the debt to equity ratio. The
company does not set certain limits or ranges with respect to these
quantitative measures.
The company is subject to external restrictions on its reserves-based
revolving credit facility. The facility has an overall limit of US$100
million and the current available limit is US$70 million, which is
subject to semi-annual review. Bank debt and long-term bank debt
outstanding cannot exceed two times the 12 month trailing EBITDA. EBITDA
as defined by the credit facility agreement as net earnings prior to
deduction of interest, income taxes, depletion, depreciation and
accretion expense and other non-cash expenses (a reconciliation to the
nearest GAAP measure is provided in the Managerial Discussion and
Analysis). As at December, 2008, bank debt and long-term bank debt
outstanding was $93.8 million and two times EBITDA was $151.3 million,
for a ratio of 0.6:1, which is below the imposed limit.
Credit Risk
The Company is exposed to credit risk in relation to its cash, accounts
receivable and long-term investments. Cash is held with highly rated
international banks and therefore the company considers these assets to
have negligible credit risk. Refer to Note 5 for further discussion
regarding the credit risk of long-term investments.
The company's accounts receivable are primarily with joint venture
partners, multinational purchasers, oil and gas marketers and local
government agencies. The company conducts a small minority of its
business through joint ventures, so its overall exposure to credit risk
from joint venture partners is considered to be low. The company's
production base is entirely located in Argentina, and is heavily weighted
to oil. The company sold $123.6 million of crude oil production to a
multinational purchaser. Gas production is sold to a reputable local gas
marketing company. Receivables with local governments mainly pertain to
input taxes paid on certain expenditures.
The company has not experienced any collection problems with its
counterparties and does not currently have any overdue amounts.
The carrying amounts of cash, accounts receivable and long-term
investments represent the company's maximum credit exposure. The company
does not have an allowance for doubtful accounts, and did not write off
any receivables in the twelve months ended December 31, 2008.
Liquidity Risk
The company manages its risk of not meeting its financial obligations
through management of its capital structure, annual budgeting of its
revenues, expenditures and cash flows, cash flow forecasting and
maintaining unused credit facilities where practicable.
Accounts payable, as disclosed on the Consolidated Balance Sheet, falls
due within the next reporting period. The revolving debt facility has a
current available limit of US$70.0 million, of which US$7.0 million is
undrawn at December 31, 2008, and is reserve-based. Changes in the
availability of the reserve-based credit facility are anticipated to
occur, from time-to-time, through significant reserve additions,
disposals or revisions. This facility expires on September 5, 2010. The
company also holds an $18.0 million line of credit, of which $1.4 million
is undrawn at December 31, 2008, that is partially secured by the
company's long-term investments. This line of credit is due on demand.
Market Risk
Changes in commodity prices, interest rates and foreign currency exchange
rates can expose the company to fluctuations in its net earnings and in
the fair value of its financial assets and liabilities.
Commodity Price Risk
Price fluctuations for crude oil, natural gas liquids and natural gas are
a risk to the company over which the company has little influence. Due to
pricing controls present in Argentina and a domestic crude oil sales
agreement with a multinational purchaser, crude oil selling prices
reflect both current market conditions in Argentina and the movement of
crude oil prices in international markets. Natural gas prices are
impacted by the Argentine government and local demand with historic
prices at low levels compared to world prices.
Interest Rate Risk
Floating rate debt exposes the company to fluctuations in cash flows and
net earnings due to changes in market interest rates. Based on the
existing debt balance, a one percent increase (decrease) in the
underlying market interest rates would have decreased (increased) after
tax earnings by approximately $0.8 million for the year. The company may
enter into derivative interest rate swap contracts to manage this risk,
but has not done so to date.
Foreign Currency Exchange Rate Risk
Substantially all of the company's operations are conducted in foreign
jurisdictions, so the company is exposed to foreign currency exchange
rate risk on most of its activities as reported in Canadian Dollars
(CAD). Oil and natural gas sales contracts are denominated in US Dollars
(USD) and settled in Argentine Pesos (ARS). Operating and capital
expenditures are incurred in US Dollars and Argentine Pesos, and to a
lesser extent in Peruvian Nuevos Soles (PEN) and Colombian Pesos (COP).
The revolving credit facility is denominated in US Dollars, which
partially limits the company's exposure in terms of cash outflows
(interest expense) being inversely correlated to cash inflows (oil and
gas revenues). The company may enter into derivative forward exchange
rate contracts to manage this risk, but has not done so to date.
The table below shows the company's financial instruments exposure to
foreign currencies:
-------------------------------------------------------------------------
Per
Balance
Sheet CAD USD ARS PEN COP
-------------------------------------------------
($000) CAD $ equivalent amounts
-------------------------------------------------------------------------
Cash $ 30,701 $ 253 $ 25,164 $ 4,354 $ 36 $ 894
Accounts
receivable 37,331 111 18,510 10,726 6,591 1,393
Long-term
investments 25,428 22,582 2,846 - - -
Accounts
payable and
accrued
liabilities (35,882) (582) (20,901) (8.594) (15) (5,790)
Bank debt (16,637) (16,637) - - - -
Long term
bank debt (77,150) - (77,150) - - -
-------------------------------------------------------------------------
Net financial
assets (lia-
bilities) $(36,209) $ 5,727 $(51,531) $ 6,486 $ 6,612 $ (3,503)
-------------------------------------------------------------------------
The company estimates a 20 percent change in the Canadian Dollar against
the above foreign currencies could be reasonably possible over a twelve
month period.
A 20 percent strengthening in the Canadian Dollar would result in a
change to earnings before taxes and other comprehensive income as follows
(an equal but opposite impact to earnings before taxes and other
comprehensive income would result if the Canadian Dollar weakened by 20
percent):
-------------------------------------------------------------------------
USD ARS PEN COP
($000) ---------------------------------------
CAD $ equivalent amounts
-------------------------------------------------------------------------
Increase (decrease) in earnings
before taxes 1,819 - (1,102) 585
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Increase in other comprehensive
income 5,069 - - -
-------------------------------------------------------------------------
7. PROPERTY AND EQUIPMENT
-------------------------------------------------------------------------
Accumulated
Depletion and Net
($000) Cost Depreciation Book Value
-------------------------------------------------------------------------
As at December 31, 2008
Petroleum and natural gas
properties and equipment $ 315,349 $ 62,143 $ 253,206
Furniture, equipment and
leaseholds 2,186 748 1,438
-------------------------------------------------------------------------
$ 317,535 $ 62,891 $ 254,644
-------------------------------------------------------------------------
As at December 31, 2007
Petroleum and natural gas
properties and equipment $ 150,152 $ 24,096 $ 126,056
Furniture, equipment and
leaseholds 1,094 276 818
-------------------------------------------------------------------------
$ 151,246 $ 24,372 $ 126,874
-------------------------------------------------------------------------
Included in property and equipment are estimated future asset retirement
costs of $9.5 million (2007 - $5.4 million). In 2008, the company
capitalized $5.1 million (2007 - $2.4 million) of general and
administrative expenses related to exploration and development
activities.
Depletion, depreciation and accretion expense includes a charge of
$0.4 million (2007 - $0.1 million) to accrete the company's estimated
asset retirement obligations (Note 11).
Capital costs of $14.5 million (2007 - $3.3 million) incurred for
unevaluated properties in Argentina and $48.6 million (2007 -
$15.4 million) and $13.8 million (2007 - $0.6 million) for major
development projects and other assets in a pre-production stage located
in Peru and Colombia, respectively, have been excluded from the depletion
and depreciation expense. No proved reserves have been assigned to these
projects. These costs have been separately evaluated by management for
impairment. No impairment has been recorded at December 31, 2008 or 2007.
Based on the ceiling test as at December 31, 2008, which excludes the
above costs incurred for unevaluated properties, no impairment has been
recorded at December 31, 2008 or 2007.
Petrolifera's petroleum and natural gas reserves, as used in the ceiling
test, were evaluated by independent reservoir engineers as at
December 31, 2008 in a report dated February 23, 2009. The evaluation was
conducted in accordance with Canadian Securities Administrators' National
Instrument 51-101 and the Canadian Oil and Gas Evaluation Handbook, using
the following price assumptions:
-------------------------------------------------------------------------
Crude Oil Natural Gas
Price Price
($USD/bbl) ($USD/mcf)
-------------------------------------------------------------------------
2009 $ 44.91 $ 2.76
2010 46.72 2.81
2011 47.00 2.87
2012 47.94 2.92
2013 $ 48.90 $ 2.98
-------------------------------------------------------------------------
+ +
approximately approximately
2% thereafter 2% thereafter
-------------------------------------------------------------------------
8. CREDIT FACILITIES
In 2007 the company entered into a US$100.0 million reserve-based
revolving credit facility with an initial availability of US$60.0 million
that was increased during the second quarter of 2008 to US$70.0 million
based on reserves as at December 31, 2007. This facility expires on
September 5, 2010, bears interest at LIBOR plus a margin, is secured by
the pledge of the shares of Petrolifera's subsidiaries and has a
provision for a borrowing base adjustment every six months, with the next
adjustment to be calculated based on information as at January 1, 2009.
Deferred financing costs of $1.6 million related to this facility are
being amortized over the remaining term of the facility (2007 -
$2.1 million).
In late 2007, the company established an $18.0 million line of credit
with a Canadian chartered bank. The line of credit bears interest at a
floating rate and is partially secured by the ABCP investments (note 5).
As at December 31, 2008 the reserve-based facility had $77.2 million
(US$63.0 million) outstanding classified as long-term debt. As at
December 31, 2007, the reserve-based facility had $19.7 million
(US$20 million) outstanding classified as current bank debt.The line of
credit facility had $16.6 million outstanding classified as current bank
debt (2007 - $9.9 million). Interest expense on the facilities for the
year ended December 31, 2008 was $4.3 million (2007 - $0.4 million). The
effective interest rate on the company's interest bearing debt was
8.8 percent for the year ended December 31, 2008 (2007 - 11.4 percent).
Unused credit facilities as at December 31, 2008 were $9.9 million.
9. INCOME TAXES
The following table reconciles income taxes calculated at the Canadian
statutory rate with recorded income taxes:
-------------------------------------------------------------------------
Years ended December 31 2008 2007
-------------------------------------------------------------------------
($000)
-------------------------------------------------------------------------
Earnings before income taxes $ 25,985 $ 57,305
-------------------------------------------------------------------------
Statutory income tax rate 29.50% 32.12%
-------------------------------------------------------------------------
Expected income tax $ 7,666 $ 18,406
-------------------------------------------------------------------------
Non deductible expenditures and foreign taxes 6,369 4,842
-------------------------------------------------------------------------
Stock compensation 1,725 2,195
-------------------------------------------------------------------------
Rate adjustment and other (1,329) 2,561
-------------------------------------------------------------------------
Tax expense $ 14,431 $ 28,004
-------------------------------------------------------------------------
Future income taxes relate to the following temporary timing differences:
-------------------------------------------------------------------------
Years ended December 31 2008 2007
-------------------------------------------------------------------------
($000)
-------------------------------------------------------------------------
Property and equipment $ 4,513 $ 611
-------------------------------------------------------------------------
Net operating loss carryforwards (5,141) (182)
-------------------------------------------------------------------------
Future foreign tax credit 11,014 4,115
-------------------------------------------------------------------------
Asset retirement obligation (22) (12)
-------------------------------------------------------------------------
Valuation allowance 637 102
-------------------------------------------------------------------------
Other 1,049 (14)
-------------------------------------------------------------------------
Future income tax liability $ 12,050 $ 4,620
-------------------------------------------------------------------------
10. RELATED PARTY TRANSACTIONS
Under the terms of an Administrative Agreement with Connacher Oil and Gas
Limited ("Connacher"), in effect from January 1, 2008, Connacher provided
certain administrative services necessary or appropriate upon the
direction of the company. The fee for this service was $180,000 for the
years ended December 31, 2008 and 2007. From time to time Connacher also
paid bills on behalf of Petrolifera, for which it is reimbursed.
Connacher also provided certain support and services to Petrolifera in
its pursuit of exploration opportunities in Colombia, for which it will
be indemnified and reimbursed without further economic interest in the
secured opportunities. The Executive Chairman of the company is the
President and Chief Executive Officer of Connacher.
In 2008 the company paid professional legal fees and common share issue
costs totaling $0.9 million (2007 - $0.2 million) to a law firm in which
an officer of the company is a related party. Transactions with the
related party occurred within the normal course of business and have been
measured at the exchange amount on normal business terms. The exchange
amount is the amount of consideration established and agreed with the
related parties.
11. ASSET RETIREMENT OBLIGATIONS
At December 31, 2008 the estimated total undiscounted amount required to
settle the asset retirement obligations was $19.2 million (December 31,
2007 - $11.3 million). These obligations are expected to be settled over
the useful lives of the underlying assets, which currently extend up to
19 years into the future. This amount has been discounted using a
credit-adjusted risk-free interest rate of six percent and an annual
inflation rate of two percent. Changes to asset retirement obligations
were as follows:
-------------------------------------------------------------------------
Years ended December 31 2008 2007
-------------------------------------------------------------------------
Asset retirement obligations, beginning of year $ 5,639 $ 2,347
Liabilities incurred 2,102 3,103
Changes to estimate 384 497
Cumulative translation adjustment 1,587 (432)
Accretion expense 394 124
-------------------------------------------------------------------------
Asset retirement obligations, end of year $ 10,106 $ 5,639
-------------------------------------------------------------------------
12. SHARE CAPITAL, WARRANTS AND CONTRIBUTED SURPLUS
Authorized:
The authorized share capital is comprised of an unlimited number of
common shares.
Issued:
-------------------------------------------------------------------------
Number Amount
Share capital and warrants: of Shares ($000)
-------------------------------------------------------------------------
Balance, share capital and warrants,
December 31, 2006 43,612,503 $ 35,662
Issued upon exercise of warrants in 2007(a) 6,031,507 17,822
Issued upon exercise of options in 2007(c) 482,500 614
Assigned value of options exercised 258
-------------------------------------------------------------------------
Balance, share capital and warrants,
December 31, 2007 50,126,510 $ 54,356
Issued upon exercise of options and warrants
in 2008(a)(c) 376,500 225
Assigned value of options exercised in 2008 - 39
Issuance of common shares (net of tax-effected
issue costs)(b) 4,445,000 37,788
-------------------------------------------------------------------------
Balance, share capital and warrants,
December 31, 2008 54,948,010 $ 92,408
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Contributed surplus:
-------------------------------------------------------------------------
Balance, contributed surplus, December 31, 2006 $ 3,613
Assigned fair value of options exercised in 2007 (258)
Assigned fair value of stock options vesting
in 2007 6,833
-------------------------------------------------------------------------
Balance, contributed surplus, December 31, 2007 $ 10,188
Cash consideration on cancellation of options
in 2008(c) (150)
Assigned value of options exercised in 2008 (39)
Stock-based compensation expensed in 2008(c) 5,847
-------------------------------------------------------------------------
Balance, contributed surplus, December 31, 2008 15,846
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Total share capital, warrants and contributed surplus:
-------------------------------------------------------------------------
December 31, 2007 $ 64,544
December 31, 2008 $ 108,254
-------------------------------------------------------------------------
(a) Common Share Purchase Warrants
-------------------------------------------------------------------------
Number of Warrants 2008 2007
-------------------------------------------------------------------------
Outstanding, beginning of year 160,000 6,194,672
Exercised (150,000) (6,031,507)
-------------------------------------------------------------------------
Expired (10,000) (3,165)
-------------------------------------------------------------------------
Outstanding, end of year - 160,000
-------------------------------------------------------------------------
For the year ended December 31, 2008 there were 150,000 Common Share
Purchase Warrants ("warrants"), exercised for proceeds of $0.1 million.
For the year ended December 31, 2007 there were 6,031,507 warrants
exercised for proceeds of $17.8 million. As at December 31, 2008, there
were no warrants outstanding.
(b) Equity Financing
On June 11, 2008 the company announced that it entered into a financing
agreement with a syndicate of underwriters to issue 4,445,000 common
shares ("Common Shares") at $9.00 per Common Share, on a "bought deal"
basis, for gross proceeds of approximately $40.0 million. The
underwriters had an over-allotment option to purchase up to an additional
666,750 Common Shares on the same terms and conditions, exercisable in
whole or in part up to 30 days following closing. This financing was
closed on June 27, 2008 and the over-allotment option was not exercised
subsequent to the closing.
For the year ended December 31, 2008, the net proceeds of the financing
have been used to fund a portion of Petrolifera's 2008 capital
expenditure programs in Argentina, Colombia and Peru.
Proceeds of the financing were as follows:
-------------------------------------------------------------------------
($000s)
-------------------------------------------------------------------------
Gross proceeds $ 40,005
Underwriters' commissions and issue costs (net of tax-effect) (2,217)
-------------------------------------------------------------------------
Net proceeds $ 37,788
-------------------------------------------------------------------------
(c) Stock Options
As at December 31, 2008 and 2007, the company had stock options
outstanding to acquire common shares, as follows:
-------------------------------------------------------------------------
As at December 31 2008 2007
-------------------------------------------------------------------------
Weighted Weighted
Average Average
Number of Exercise Number of Exercise
Options Price Options Price
-------------------------------------------------------------------------
Outstanding,
beginning of year 3,228,867 8.71 2,896,667 4.86
Granted 2,162,000 4.92 824,700 18.34
Exercised (226,500) 0.73 (482,500) (1.27)
Cancelled (588,040) 12.89 (10,000) (13.23)
-------------------------------------------------------------------------
Outstanding,
end of year 4,576,327 6.85 3,228,867 8.71
-------------------------------------------------------------------------
Exercisable,
end of year 2,557,914 7.69 1,911,499 6.32
-------------------------------------------------------------------------
Options granted under the plan are generally fully exercisable after two
or three years and expire five years after the date granted. The table
below summarizes unexercised stock options as at December 31, 2008 and
2007:
-------------------------------------------------------------------------
Range of Exercise Prices 2008 2007
-------------------------------------------------------------------------
Weighted Weighted
Average Average
Remaining Remaining
Number Contractual Number Contractual
Outstanding Life Outstanding Life
-------------------------------------------------------------------------
$0.50 - $1.00 787,667 1.4 996,667 2.4
-------------------------------------------------------------------------
$1.70 - $1.80 418,000 1.9 445,500 2.9
-------------------------------------------------------------------------
$2.00 - $3.40 1,332,000 4.9 - -
-------------------------------------------------------------------------
$5.40 - $9.94 662,660 3.9 100,000 3.1
-------------------------------------------------------------------------
$10.70 - $20.95 1,376,000 2.7 1,686,700 3.8
-------------------------------------------------------------------------
Total 4,576,327 3.2 3,228,867 2.9
-------------------------------------------------------------------------
During 2008 a compensatory non-cash expense of $5.1 million (2007 -
$6.8 million) was recorded as stock-based compensation, reflecting the
amortization of the fair value of stock options over the vesting period.
Additionally, during 2008 the company paid $0.2 million to certain
optionees resulting in the cancellation of 350,000 options. None of these
optionees included Directors or Officers of the company. As a result of
these optionees electing to have certain of their options cancelled, any
unvested options were deemed to have become vested resulting in the
recognition of an additional non-cash stock-based compensation expense of
$0.7 million.
The fair value of each option granted in 2008 is estimated on the date of
grant using the Black-Scholes option-pricing model with assumptions for
grants as follows:
-------------------------------------------------------------------------
Risk free Expected Expected
interest rate life Volatility
-------------------------------------------------------------------------
2008 2.48% - 3.35% 4 years 73.4% - 93.6%
-------------------------------------------------------------------------
2007 4.14% - 4.73% 4 years 70.3% - 75.9%
-------------------------------------------------------------------------
The weighted average fair value at the date of grant of all options
granted in 2008 was $2.85 per option (2007 - $10.38 per option).
13. SEGMENTED INFORMATION
The company has corporate offices in Canada, the U.S. and Barbados
(combined to comprise the corporate segment), petroleum and natural gas
operations in Argentina and exploration activities in Peru and Colombia.
Financial information pertaining to these operating segments is presented
below.
-------------------------------------------------------------------------
Corporate Argentina Peru Colombia Total
-------------------------------------------------------------------------
($000)
-------------------------------------------------------------------------
Year ended
December 31, 2008
Revenue, gross $ 70 $130,256 $ - $ - $130,326
Net earnings (loss) (17,401) 28,998 (36) (7) 11,554
Property and
equipment 267 192,179 48,599 13,963 255,008
Capital expenditures 43 70,792 33,306 12,610 116,751
Total assets $ 48,104 $235,839 $ 55,449 $ 16,266 $355,658
-------------------------------------------------------------------------
Year ended
December 31, 2007
Revenue, gross $ 750 $133,473 $ - $ - $134,223
Net earnings (loss) (18,411) 47,791 (43) (36) 29,301
Property and
equipment 302 110,605 15,373 594 126,874
Capital expenditures 35 97,465 12,931 594 111,025
Total assets $ 46,258 $139,192 $ 18,170 $ 607 $204,227
-------------------------------------------------------------------------
Crude oil sales totaling $123.6 million (2007 - $131.6 million) was made
to one large international oil company (2007 - two large international
oil companies) during the year ended December 31, 2008.
14. SUPPLEMENTARY INFORMATION
(a) Per share amounts
The following table summarizes the common shares used in the per share
calculations:
-------------------------------------------------------------------------
For the years ended December 31 2008 2007
-------------------------------------------------------------------------
Weighted average common shares outstanding 52,648,485 47,990,246
Dilutive effect of all stock options and all
stock purchase warrants 924,118 3,444,904
-------------------------------------------------------------------------
Weighted average common shares outstanding -
diluted 53,572,603 51,435,150
-------------------------------------------------------------------------
(b) Net change in non-cash working capital
-------------------------------------------------------------------------
For the years ended December 31 2008 2007
-------------------------------------------------------------------------
($000)
-------------------------------------------------------------------------
Accounts receivable $ (3,664) $ (644)
Income taxes receivable (4,592) -
Prepaid expenses 10 (166)
Crude oil inventory 527 (480)
Accounts payable and accrued liabilities (6,138) 23,897
Income taxes payable (5,207) (17,908)
Due to a related company 42 (32)
-------------------------------------------------------------------------
$(19,022) $ 4,667
-------------------------------------------------------------------------
Operating $(12,482) $(19,604)
Investing (6,540) 24,271
-------------------------------------------------------------------------
$(19,022) $ 4,667
-------------------------------------------------------------------------
(c) Supplementary cash flow information
-------------------------------------------------------------------------
For the years ended December 31 2008 2007
-------------------------------------------------------------------------
($000)
-------------------------------------------------------------------------
Interest paid $ 4,261 $ 25
Income taxes paid $ 12,434 $ 31,400
-------------------------------------------------------------------------
15. COMMITMENTS, CONTINGENCIES AND GUARANTEES
Work Commitments
In 2005 Petrolifera acquired two significant oil and gas exploration
licenses in Peru. The licenses have a total US$51.9 million financial
commitment to complete negotiated work programs on the two licenses over
seven years. The company has the right to withdraw from the licenses at
the end of each period associated with the term of the licenses. The
first license term for Block 106 ended in 2007 and the company has met
its commitment and is currently in the second license term with a
commitment to invest a minimum of US$1.6 million in this next term. In
Block 107, the company has completed three terms of the license with a
commitment to invest a minimum of US$10.0 million in the next term.
In 2007, the company was granted three concessions comprised of one
license and two technical evaluation agreements ("TEA") in Colombia.
Petrolifera has converted the Turpial TEA into a license and has
requested that the Sierra Nevada II TEA also be converted into a license.
Petrolifera is drilling the La Pinta well on the Sierra Nevada I License
which will complete the first phase work commitments on the License.
In Argentina the company has total work commitments of gross
US$11.0 million over the next three years related to the Vaca Mahuida,
Puesto Guevara and Gobernador Ayalla II blocks. A portion of the
Argentinean work commitments related to the Vaca Mahuida block has been
farmed out to a third party.
Contractual Commitments
The company's annual commitments under service contracts for drilling,
leases for office premises and other equipment and an administrative
services agreement are as follows:
-------------------------------------------------------------------------
Subsequent
2009 2010 2011 to 2011 Total
-------------------------------------------------------------------------
($000)
-------------------------------------------------------------------------
Drilling service
contracts and
other leases $25.5 $22.5 $1.5 $0.2 $49.7
-------------------------------------------------------------------------
Contingencies
The company has various guarantees and indemnifications in place in the
ordinary course of business, none of which are expected to have a
significant impact on the company's financial statements or operations.
Guarantees
The company has issued letters of credit in the total amount of
$2.3 million to secure the capital expenditure requirements associated
with the two exploration licenses in Peru and $0.6 million in support of
the Colombian work commitments as well as depositing $0.9 million in a
trust account in Colombia to meet certain of the work obligations as they
occur.
16. SUBSEQUENT EVENTS
i) Long-term investments
In January, 2009, the Pan-Canadian Investors Committee for Third-Party
Structured Asset-Backed Commercial Paper announced that the Superior
Court of Ontario granted the Plan Implementation Order and that,
accordingly, the plan for restructuring ABCP has now been fully
implemented. The company has received the longer term notes, whose
maturities match those of the assets previously contained in the
underlying conduits, in exchange for the shorter-term ABCP. Assuming
these replacement notes become liquid, the company would be able to
substantially reduce its net indebtedness incurred from lack of access to
these amounts.
The company recently received $1.1 million in the first payment to be
received on its longer term notes representing interest that has accrued
on the previous holdings in ABCP between mid-August 2007 and August 31,
2008, net of its pro-rata portion of expenses, calculated after deducting
legal costs associated with the resolution agreed and approved under the
Canada Business Corporations Act and the Company Creditors' Arrangement
Act. It is expected that substantially all of the restructuring costs and
reserves were deducted from this first payment and are not expected to
have any further impact on future payments to the company.
ii) Discontinued operations
On March 2, 2009, Petrolifera announced that its Board of Directors
authorized the sale of the company's interests in Argentina, which are
primarily held, indirectly through a wholly-owned Barbadian subsidiary.
Petrolifera has engaged Tristone Capital Inc. to actively market and
solicit offers from qualifying companies. It would be Petrolifera's
intention to redeploy the proceeds towards its exploration activities in
Colombia and Peru, after discharging related outstanding long-term bank
debt. The anticipated timing of the sale of the company's interest in
Argentina is not yet determinable.
As the discontinued operation may have pervasive effect on the future
activities of Petrolifera, a pro forma consolidated balance sheet and
consolidated statement of operations incorporating the effect of the
discontinued operation on the pro forma consolidated balance sheet as if
it had occurred as at December 31, 2008 and on the pro forma statement of
operations as if it had occurred for the year ended December 31, 2008 are
provided below:
Pro forma consolidated balance sheet:
-------------------------------------------------------------------------
As at December 31, 2008
-------------------------------------------------------------------------
Consolidated Pro forma
Balance Pro forma Balance
($000) Sheet Adjustments Sheet
-------------------------------------------------------------------------
ASSETS
-------------------------------------------------------------------------
Current
-------------------------------------------------------------------------
Cash $ 30,701 $ (7,595) (a) $ 23,106
-------------------------------------------------------------------------
Accounts receivable 37,331 (29,186) (a) 8,145
-------------------------------------------------------------------------
Income taxes receivable 4,736 (4,682) 54
-------------------------------------------------------------------------
Prepaid expenses 535 (278) (a) 257
-------------------------------------------------------------------------
Inventory 658 (658) (a) -
-------------------------------------------------------------------------
Discontinued operations - 42,399 (a) 42,399
-------------------------------------------------------------------------
73,961 - 73,961
-------------------------------------------------------------------------
Long-term investments 25,428 - 25,428
-------------------------------------------------------------------------
Property and equipment 254,644 (191,815) (a) 62,829
-------------------------------------------------------------------------
Deferred financing costs 1,625 (1,625) (a) -
-------------------------------------------------------------------------
Discontinued operations - 193,440 (a) 193,440
-------------------------------------------------------------------------
$ 355,658 $ - $ 355,658
-------------------------------------------------------------------------
-------------------------------------------------------------------------
LIABILITIES
-------------------------------------------------------------------------
Current
-------------------------------------------------------------------------
Accounts payable and
accrued liabilities $ 35,882 $ (16,304) (a) $ 19,578
-------------------------------------------------------------------------
Income taxes payable 1,444 (1,439) 5
-------------------------------------------------------------------------
Bank debt 16,637 - 16,637
-------------------------------------------------------------------------
Due to a related company 42 - 42
-------------------------------------------------------------------------
Discontinued operations - 17,743 (a) 17,743
-------------------------------------------------------------------------
54,005 - 54,005
-------------------------------------------------------------------------
Long-term bank debt 77,150 (77,150) (a)(b) -
-------------------------------------------------------------------------
Asset retirement obligations 10,106 (10,106) (a) -
-------------------------------------------------------------------------
Future income taxes 12,050 (12,050) (a) -
-------------------------------------------------------------------------
Discontinued operations - 99,306 (a) 99,306
-------------------------------------------------------------------------
153,311 - 153,311
-------------------------------------------------------------------------
-------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
-------------------------------------------------------------------------
Share capital, warrants and
contributed surplus 108,254 - 108,254
-------------------------------------------------------------------------
Accumulated other
comprehensive income 16,106 - 16,106
-------------------------------------------------------------------------
Retained earnings 77,987 - 77,987
-------------------------------------------------------------------------
202,347 - 202,347
-------------------------------------------------------------------------
$ 355,658 - $ 355,658
-------------------------------------------------------------------------
Pro forma consolidated statement of operations:
-------------------------------------------------------------------------
For the year ended December 31, 2008
-------------------------------------------------------------------------
Consolidated Pro forma
Statement of Pro forma Statement of
($000) Operations Adjustments Operations
-------------------------------------------------------------------------
REVENUE
-------------------------------------------------------------------------
Petroleum and natural
gas sales $ 130,148 $ (130,148) (a) $ -
-------------------------------------------------------------------------
Interest and other income 178 (108) (a) 70
-------------------------------------------------------------------------
130,326 (130,256) 70
-------------------------------------------------------------------------
Royalties (18,381) 18,381 (a) -
-------------------------------------------------------------------------
111,945 (111,875) 70
-------------------------------------------------------------------------
EXPENSES
-------------------------------------------------------------------------
Operating 26,040 (26,040) (a) -
-------------------------------------------------------------------------
General and administrative 8,425 (4,010) (a) 4,415
-------------------------------------------------------------------------
Stock-based compensation 5,847 - 5,847
-------------------------------------------------------------------------
Finance charges 5,417 (3,991) (a) 1,426
-------------------------------------------------------------------------
Fair value impairment - ABCP 8,882 - 8,882
-------------------------------------------------------------------------
Taxes other than income taxes 2,185 (2,185) (a) -
-------------------------------------------------------------------------
Foreign exchange loss 180 (2,560) (a) (2,380)
-------------------------------------------------------------------------
Depletion, depreciation
and accretion 28,984 (28,984) (a) -
-------------------------------------------------------------------------
85,960 (67,770) 18,190
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Earnings (losses) before
income taxes 25,985 (44,105) (18,120)
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Current income tax
provision (recovery) 7,905 (8,581) (a) (676)
-------------------------------------------------------------------------
Future income tax
provision (recovery) 6,526 (6,526) (a) -
-------------------------------------------------------------------------
14,431 (15,107) (676)
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Net earnings (losses) before
discontinued operations 11,554 (28,998) (17,444)
-------------------------------------------------------------------------
Net earnings of
discontinued operations - 28,998 28,998
-------------------------------------------------------------------------
Net earnings $ 11,554 $ - $ 11,554
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Accompanying notes to the pro forma consolidated balance sheet and
statement of operations:
(a) Balances that are held for sale have been reclassified as
discontinued operations.
(b) As the majority of the company's proved reserves are associated with
its Argentina operations, the reserve-based long term debt has also
been reclassified as a component of discontinued operations as at
December 31, 2008.