CALGARY, ALBERTA - (Marketwire - May 13, 2008) - Accrete Energy Inc. (TSX:GZ) (the "Corporation") is pleased to announce results of its operations for the first quarter ended March 31, 2008.
Highlights
Three Months Three Months
$ Thousands except production/day Ending Ending
and common shares information March 31, 2008 March 31, 2007 % Change
----------------------------------------------------------------------------
Funds flow (1) 7,551 4,415 71
Per share basic 0.46 0.27 72
Net income 1,992 930 114
Per share basic 0.12 0.06 100
Per share diluted 0.11 0.05 120
Common shares outstanding 16,271,802 16,497,902 (1)
Debt, including working
capital deficiency 57,134 55,032 4
Operational :
Sales 14,007 10,647 32
Royalties 3,393 3,327 2
Operating and transportation costs 1,402 1,485 (6)
Net Back (2) 9,212 5,835 58
Net Back/ bbl (2) 34.50 24.31 42
General and administrative 868 864 -
General and administrative $/bbl 3.25 3.60 (10)
Volumes :
Natural gas (mcf/d) 11,286 9,345 21
Oil (bbl/d) 108 140 (23)
NGL's (bbl/d) 946 970 (2)
Total Boe/d 2,935 2,667 10
Wells Drilled (Gross) :
Oil - 1 (.9 net)
Gas 5 (3.2 net) 5(4.6 net)
D&A - -
Total 5 (3.2 net) 6 (5.5)
Capital Expenditures 5,606 19,092
Notes:
(1)(2) Accrete's definition of funds flow from operations and/or netbacks
may not be comparable to that reported by other companies. See the
caption Non GAAP Measures.
President's Message
Accrete Energy is pleased to announce its first Quarter 2008 financial and operational results.
Natural gas producers, who were adversely affected by low commodity pricing throughout 2007, welcomed a return to normal winter temperatures in the first quarter. Natural gas prices increased by 25% over the previous quarter as storage inventories were depleted to more normal levels. Increased pricing had a significant impact on cash flow, resulting in an increase of 34% compared to the previous quarter. Production levels remained comparable to those volumes produced on average throughout 2007. Although five wells were drilled in the quarter, the Company was delayed bringing all those volumes to market.
The Company now plans to focus its attention on acquiring strategic land positions in core areas and refining its geological and geophysical models.
Claresholm accounted for the majority of capital expenditures in the first Quarter and will continue to command the majority of Accrete's capital budget for the balance of 2008. Four wells were drilled and an additional 3-D seismic program was shot in this area. One of the four wells encountered a light oil bearing sand which the company has completed and plans to place on production in the next few weeks. Additional lands have been acquired along a fairway that extends over 20 miles to the southeast of this well and connects to an existing oil accumulation. The company is optimistic that this well may be the northwest extension of this existing oil pool. To further consolidate its position in Claresholm, the Company has entered into an agreement to acquire additional land interests in the area. This transaction is expected to close mid May, 2008.
There has been a lot of discussion recently about the potential of the Montney formation in Northern Alberta and Northeastern British Columbia. The Company's land position, comprising 25 3/4 sections, at Saxon was acquired with the view to exploit this resource. A Montney target was tested by the Company based on bypassed pay in an abandoned competitor well. Although this well tested marginally economic quantities of natural gas, a subsequent 3-D seismic survey conducted by the company in December, 2007 supports a strong Montney anomaly adjacent to this well on 100% Company lands. The Company has plans to test this opportunity next winter with a program designed to temper risk by drilling wells which penetrate both the prolific lower Mannville section and the Montney.
One well was drilled and tied into production facilities in the Harmattan area in the first quarter of 2008. The Company will continue to backfill production in this area with development drilling and has plans to test a new prospect on its extensive land base.
In contrast to the acquisitions planned for the Claresholm area, the Company has agreed to sell its Pouce Coupe assets for $4.3 MM. This transaction, which closed on May 9, 2008, follows the Company's strategy of focusing on core assets with low operating costs and capital control.
The Company's operational activities have been hectic over the last three months as the Company continues to refine its mandate to a longer term, focused, growth oriented exploration company. We expect this mandate and the capital programs for the balance of 2008 and beyond will continue to create value for our shareholders.
Respectfully,
Peter Salamon, President
Management Discussion and Analysis
The following discussion and analysis was prepared on May 6, 2008 and is management's assessment of Accrete's historical financial and operating results and should be read in conjunction with the audited financial statements and related notes for the years ended, December 31, 2007 and 2006.
The financial data presented has been prepared in accordance with Canadian Generally Accepted Accounting Principles ("GAAP"). The reporting and measurement currency is the Canadian dollar.
Additional information may be found on the Company's web site at www.accrete-energy.com and on the SEDAR web site at www.sedar.ca.
Accrete was established on June 1, 2004 and is a Calgary based, natural gas focused exploitation and development company that operates exclusively in Alberta.
Accrete has production and a focused inventory of drilling prospects primarily in the Harmattan, Claresholm and Saxon areas.
Accrete's shares trade on the Toronto Stock Exchange ("TSX") under the symbol GZ.
Forward-Looking Statements
Some of the statements contained herein including, without limitation, financial and business prospects and financial outlooks may be forward-looking statements which reflect management's expectations regarding future plans and intentions, growth, results of operations, performance and business prospects and opportunities. Words such as "may", "will", "should", "could", "anticipate", "believe", "expect", "intend", "plan", "potential", "continue" and similar expressions have been used to identify these forward-looking statements. These statements reflect management's current beliefs and are based on information currently available to management. Forward-looking statements involve significant risk and uncertainties. A number of factors could cause actual results to differ materially from the results discussed in the forward-looking statements. Readers should refer to the section entitled "Risks" in this Management Discussion and Analysis for further information with regards to operational and business risks that may affect the company's results.
Although the forward-looking statements contained herein are based upon what management believes to be reasonable assumptions, management cannot assure that actual results will be consistent with these forward-looking statements. Investors should not place undue reliance on forward-looking statements. These forward-looking statements are made as of the date hereof and we assume no obligation to update or revise them to reflect new events or circumstances.
Forward-looking statements and other information contained herein concerning the oil and gas industry and Accrete's general expectations concerning this industry are based on estimates prepared by management using data from publicly available industry sources as well as from reserve reports, market research and industry analysis and on assumptions based on data and knowledge of this industry which Accrete believes to be reasonable. However, this data is inherently imprecise, although generally indicative of relative market positions, market shares and performance characteristics. While Accrete is not aware of any misstatements regarding any industry data presented herein, the industry involves risks and uncertainties and is subject to change based on various factors.
Non GAAP Measures
The forgoing contains the term "cash flow from operations" and "netbacks" which should not be considered an alternative to, or more meaningful than cash flow from operating activities as determined in accordance with Canadian Generally Accepted Accounting Principles ("GAAP") as an indicator of the Company's performance. Accrete's definition of cash flow from operations and/or netbacks may not be comparable to that reported by other companies.
The Company evaluates its performance based on net earnings, net back and cash flow. The Company considers cash flow a key measure as it illustrates the Company's ability to meet obligations necessary to repay debt and fund future growth through capital investment. Cash flow per share is presented in this discussion using the weighted average shares outstanding in a manner consistent with that used to calculate earnings per share.
The following reconciles cash flow from operating activities, the most comparable GAAP measure to cash flow used in this MD&A:
Three Months Ended
$ Thousands March 31, 2008 March 31, 2007
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Cash flow provided by operating
activities 7,707 6,520
Net changes in non-cash working capital 156 2,105
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Cash flow 7,551 4,415
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The following table reconciles field and corporate netback to income before
taxes the most comparable GAAP measure:
Three Months Ended
$ Thousands March 31, 2008 March 31, 2007
----------------------------------------------------------------------------
Income before income taxes 2,661 961
Depletion, depreciation and accretion 3,775 3,120
Stock based compensation cost 101 100
Unrealized loss on derivative instruments 996 234
Interest expense 811 556
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Corporate netback 8,344 4,971
General and administrative expenses 868 864
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Field netback 9,212 5,835
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The reader is cautioned that the use of the term boe's ("barrels of oil equivalent") may be misleading particularly when used in isolation. A boe conversion of 6 mcf to 1 boe may not represent a value equivalency at the wellhead.
As the determination of many assets, liabilities, revenues and expenses is dependent upon future events, the preparation of these financial statements requires the use of estimates and assumptions which have been made using careful judgment. In the opinion of management, the unaudited interim financial statements have been properly prepared within reasonable limits of materiality and within the framework of the significant accounting policies summarized in the financial statements.
Business Environment
The level of natural gas in storage had risen in 2007 so that record levels had been achieved by year end. The fear of a resultant oversupply caused the sales price for natural gas to decrease. Exploration and development activities had slowed down somewhat by year end because of the low prices and because of uncertainty surrounding the introduction of a new Crown Royalty regime in Alberta. High natural gas prices overseas on the other hand, caused LNG shipments to be diverted away from North America and that, in turn, further exacerbated the effect on the diminishing North American natural gas supply.
Cold weather in the consuming regions during the first quarter of 2008 resulted in large withdrawals from storage to feed the increased demand for natural gas for heating and power generation. This, together with reduced supply, resulted in an increase in the price of natural gas. Natural gas prices were also affected by the volatility of oil prices and moved upward in concert with them.
Oil prices remained volatile because of geopolitical tension overseas but trended upward as a result of strong world wide demand and a weakening US dollar.
The effect of a strong Canadian dollar negatively affected pricing of all commodities somewhat because they are customarily priced in US dollars.
In the 4th quarter of 2007, the government of Alberta introduced a new Crown Royalty regime that is scheduled to be implemented in 2009. Uncertainty still surrounds the treatment of natural gas.
Financial Information
Total Revenue Net Income Net Income Net Income
($ thousands) ($ thousands) Basic $/Share Diluted $/Share
----------------------------------------------------------------------------
2008
First Quarter 14,007 1,992 0.12 0.11
2007
First Quarter 10,647 930 0.06 0.05
Second Quarter 11,149 1,789 0.11 0.11
Third Quarter 11,499 677 0.04 0.04
Fourth Quarter 11,876 2,359 0.14 0.12
Total 45,171 5,755 0.35 0.32
2006
First Quarter 9,821 1,585 0.10 0.10
Second Quarter 9,182 1,390 0.09 0.08
Third Quarter 9,583 743 0.05 0.05
Fourth Quarter 10,736 257 0.02 0.01
Total 39,322 3,975 0.26 0.24
Commodity prices had declined from record highs following the hurricane season late in 2005 until the 4th quarter of 2007. They did pick up slightly in the 4th quarter of 2007 but the increases in the 1st quarter of 2008 really reversed the trend. In fact, the Company realized $8.31/mcf for natural gas in the 1st quarter 2008 versus $6.62/mcf for the final quarter of 2007. This provided the largest impetus for the growth in total revenue from the 4th quarter of 2007 to the 1st quarter of 2008.
Costs however surged forward relentlessly until the fall of 2007 when the combination of lower commodity prices and uncertainty over the new Alberta royalty scheme caused industry activity to slacken somewhat. This, in turn lead to a stabilization of input costs.
The Company has financed its capital programs with a combination of debt and cash flow over the last 2 years.
Debt levels have steadily grown which have lead to an increase in interest expense.
Net income for the 4th quarter of 2006 was adversely affected by adjustments but was positively affected in the 2nd and 4th quarter of 2007 by reductions in corporate tax rates.
Net income for the 3rd quarter 2007 was negatively impacted the payment of property taxes.
The Company estimates that at March 31, 2008 that it has 500 net barrels of oil equivalent per day behind pipe. This is comprised of 150 barrels at Harmattan, 190 barrels at Claresholm, 90 barrels at Edson and 70 barrels at Ansell.
Operational Activities
Production
3 Months Ended 3 Months Ended
March 31, 2008 March 31, 2007
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Oil (bbl/d) 108 140
NGL (bbl/d) 946 970
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Total Oil/NGL (bbl/d) 1,054 1,110
Gas (mcf/d) 11,286 9,345
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Total (boe/d) 2,935 2,667
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Natural Gas Production (mcf/d)
3 Months Ended 3 Months Ended
March 31, 2008 March 31, 2007
----------------------------------------------------------------------------
Area
Atlee-Buffalo 39 22
Claresholm 4,165 2,216
Harmattan 6,006 6,518
Edson 517 458
Pouce Coupe 366 131
Saxon 193 -
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Total 11,286 9,345
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Crude Oil Sales (bbl/d)
3 Months Ended 3 Months Ended
March 31, 2008 March 31, 2007
----------------------------------------------------------------------------
Area
Atlee-Buffalo - -
Claresholm - -
Harmattan 108 139
Edson - 1
Pouce Coupe - -
Saxon - -
----------------------------------------------------------------------------
Total 108 140
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Natural Gas Liquids Sales (bbl/d)
3 Months Ended 3 Months Ended
March 31, 2008 March 31, 2007
----------------------------------------------------------------------------
Area
Atlee-Buffalo - -
Claresholm 74 16
Harmattan 845 942
Edson 25 10
Pouce Coupe 1 2
Saxon 1 -
----------------------------------------------------------------------------
Total 946 970
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Production at Harmattan decreased from an average of 6,518 mcf/d of natural gas and 139 bbls/d of oil for the 1st quarter 2007 to 6,006 mcf/d of natural gas and 108 bbl/d of oil for the 1st quarter of 2008 as a result of normal production declines offset, in part by drilling activity. The average natural gas liquids production rate remained relatively constant for the same periods.
At Claresholm, 2007 drilling and the addition of a liquids storage facility at the Claresholm plant had boosted natural gas and liquids production from 1st quarter 2007 averages of 2,216 mcf/d and 16 bbls/d respectively to an average of 4,165 mcf/d of natural gas and 74 bbls/d for the 1st quarter 2008. Four wells were drilled in the area in 2008. None of these have been tied in due to adverse field conditions. The decrease from the 4th quarter average production figures at Claresholm were as a result of normal production declines.
Natural gas production at Edson, Saxon and Pouce Coupe was higher in the 1st quarter of 2008 due to the addition of wells drilled in 2007 that were tied in later in the year.
Product Prices
Natural Gas Prices ($/mcf)
3 Months Ended 3 Months Ended
March 31, 2008 March 31, 2007
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Area
Atlee-Buffalo 8.40 7.66
Claresholm 8.72 7.89
Harmattan 8.00 7.44
Edson 8.51 7.84
Pouce Coupe 7.99 7.32
Saxon 9.18 -
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Average Price 8.31 7.56
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The average price that the Company realized for natural gas production for the 4th quarter 2007 was $6.62/mcf. Cold weather in the consuming regions during the first quarter of 2008 resulted in large withdrawals from storage to feed the increased demand for natural gas for heating and power generation. This, together with reduced supply, resulted in an increase in the market price of natural gas.
It should be noted that the price received for Claresholm, Saxon and Edson natural gas is higher than from the other areas because liquids are recombined prior to sale giving the gas a higher heating content.
Crude Oil Sales Prices ($/bbl)
3 Months Ended 3 Months Ended
March 31, 2008 March 31, 2007
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Area
Atlee-Buffalo - -
Boltan - -
Claresholm - -
Harmattan 94.29 64.45
Edson - 63.08
Pouce Coupe - -
Saxon - -
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Average Price 94.29 64.44
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Crude oil prices received by the Company moved upwards with world oil prices.
Natural Gas Liquids (NGL) Sales Prices ($/bbl)
3 Months Ended 3 Months Ended
March 31, 2008 March 31, 2007
----------------------------------------------------------------------------
Area
Atlee-Buffalo - -
Claresholm 82.44 111.94
Harmattan 47.20 37.76
Edson 85.31 49.73
Pouce Coupe 94.57 52.28
Saxon 109.71 -
----------------------------------------------------------------------------
Average Price 51.12 39.11
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Natural gas liquid prices moved in tune with natural gas and oil prices. Harmattan natural gas liquids include a significant amount of ethane, which does not receive a very high price relative to other liquids produced.
Revenue
Total Sales
($ thousands)
3 Months Ended 3 Months Ended
March 31, 2008 March 31, 2007
----------------------------------------------------------------------------
Oil 927 813
NGL 4,400 3,413
Gas 8,538 6,361
Processing 142 60
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Total 14,007 10,647
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Natural Gas Sales Revenue
($ thousands)
3 Months Ended 3 Months Ended
March 31, 2008 March 31, 2007
----------------------------------------------------------------------------
Area
Atlee-Buffalo 30 15
Claresholm 3,305 1,573
Harmattan 4,375 4,364
Edson 401 323
Pouce Coupe 266 86
Saxon 161 -
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Total 8,538 6,361
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Crude Oil Sales Revenue
($ thousands)
3 Months Ended 3 Months Ended
March 31, 2008 March 31, 2007
----------------------------------------------------------------------------
Area
Atlee-Buffalo - -
Boltan - -
Claresholm - -
Harmattan 927 809
Edson - 4
Pouce Coupe - -
Saxon - -
----------------------------------------------------------------------------
Total 927 813
----------------------------------------------------------------------------
Natural Gas Liquids (NGL) Sales Revenue
($ thousands)
3 Months Ended 3 Months Ended
March 31, 2008 March 31, 2007
----------------------------------------------------------------------------
Area
Atlee-Buffalo - -
Claresholm 555 158
Harmattan 3,626 3,202
Edson 197 43
Pouce Coupe 8 10
Saxon 14 -
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Total 4,400 3,413
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Revenues increased because of increased volumes and increased commodity
prices.
Processing Revenue
($ thousands)
3 Months Ended 3 Months Ended
March 31, 2008 March 31, 2007
----------------------------------------------------------------------------
Area
Atlee-Buffalo - -
Boltan - -
Claresholm 65 -
Harmattan 77 60
Edson - -
Pouce Coupe - -
Saxon - -
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Total 142 60
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Processing fees are charged to third parties utilizing Accrete facilities.
Royalties
($ thousands)
3 Months Ended 3 Months Ended
March 31, 2008 March 31, 2007
----------------------------------------------------------------------------
Area Total $ Rate Total $ Rate
----------------------------------------------------------------------------
Atlee-Buffalo 1 1% (6) -41%
Claresholm 821 21% 409 24%
Harmattan 2,401 27% 2,766 33%
Edson 58 10% 135 37%
Pouce Coupe 85 31% 23 24%
Saxon 27 15% - -
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Total 3,393 24% 3,327 31%
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For the 1st quarter 2008, Crown royalties were $2,557,000 ($2,492,000 in 2007), total gross overriding royalties were $720,000 ($724,000 in 2007), and freehold royalties totaled $116,000 ($110,000 in 2007). Harmattan royalties for the 1st quarter 2007 are relatively high due to adjustments for prior period gas cost allowance that were processed in that period. Variations in royalties for the other areas are generally as a result of relatively minor adjustments.
Production and Transportation Expenses
($ thousands except per boe information)
3 Months Ended 3 Months Ended
March 31, 2008 March 31, 2007
----------------------------------------------------------------------------
Area $ $/boe $ $/boe
----------------------------------------------------------------------------
Atlee-Buffalo 4 7.07 2 5.60
Claresholm 216 3.07 122 3.50
Harmattan 947 5.32 1,266 6.49
Edson 109 10.63 75 9.62
Pouce Coupe 100 17.81 20 9.40
Saxon 26 8.40 - -
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Total 1,402 5.24 1,485 6.19
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The downturn in activity experienced in the 4th quarter 2007 and 1st quarter 2008 had the effect of lowering the costs of some operating materials and supplies, but the greatest impact on costs at Claresholm and Harmattan came from careful management of field activities.
The Company operates the Claresholm gas facility and therefore is able to manage its processing costs for that area. On the other hand, Harmattan gas is processed by a 3rd party processor therefore costs are higher.
Edson, Pouce Coupe and Saxon have relatively few wells and, as such, the Company can not realize economies of scale that it can at Claresholm and Harmattan. Atlee-Buffalo accounts for minor production volumes and is a property that is not operated by the Company.
Field and Corporate Netbacks
Field Netback
($/boe)
3 Months Ended 3 Months Ended
Area March 31, 2008 March 31, 2007
----------------------------------------------------------------------------
Atlee-Buffalo 42.87 59.14
Claresholm 41.34 34.66
Harmattan 31.83 22.56
Edson 42.56 20.46
Pouce Coupe 15.68 24.48
Saxon 40.00 -
----------------------------------------------------------------------------
Field Netback 34.50 24.31
----------------------------------------------------------------------------
Field netbacks for the first quarter increased largely because of higher
product prices and lower operating expenses.
Corporate Netback
($ thousands)
3 Months Ended 3 Months Ended
March 31, 2008 March 31, 2007
----------------------------------------------------------------------------
Field Netback 9,212 5,835
General and Administrative 868 864
----------------------------------------------------------------------------
Corporate Netback 8,344 4,971
----------------------------------------------------------------------------
Corporate netbacks for the first quarter increased because of higher field
net backs, along with constant general and administrative costs.
General and Administrative Expense
($ thousands)
3 Months Ended 3 Months Ended
March 31, 2008 March 31, 2007
----------------------------------------------------------------------------
Salary & Benefits 641 632
General Office Expenses 377 440
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1,018 1,072
Recoveries (150) (208)
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Total 868 864
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Staffing levels remained constant with 2007. General and administrative expenses are recovered through billings to participants in company operated projects in accordance with standard industry practice. The decrease in recoveries relates to the amount and type activity incurred in the respective quarters.
Interest Expense
Accrete used its operating line of credit and funds flow to fund its 2008 capital program. At March 31, 2008, Accrete's bank indebtedness was $53 million compared to $41 million at March 31, 2007. As a result, interest expense for the first quarter of 2008 was $811,000 versus $556,000 in the equivalent period in 2007 even though interest rates were slightly lower.
Stock-Based Compensation
The Company has accounted for its employee stock options granted using the fair value method. The fair value of all options granted to March 31, 2008 was estimated to be $4,486,000 ($2.43 per option granted). This value is charged to stock based compensation cost over the vesting period. A total of $101,000 was charged to expense in the 1st quarter 2008 ($100,000 in the 1st quarter 2007, all expensed) and $18,000 was capitalized for a total of $119,000.
No employee stock options were granted during the 1st quarter of 2008.
50,000 options were granted with an exercise price of $5.26/share and 380,000 options were granted with an exercise price of $5.20/share during the 1st quarter of 2007.
An estimated fair value of $2.14/share was calculated for the $5.26 options and an estimated fair value of $1.88/share was calculated for the $5.20 options as at the dates of the respective grants using the Black-Scholes model.
Depletion Depreciation & Accretion
Depletion, depreciation and accretion of the asset retirement obligation for the three month period ended March 31, 2008 totaled $3,775,000 or $14.14/Boe. This compares to charges of $3,120,000 or $13.00/boe for the equivalent 3 month period in 2007. The increase resulted from relatively minor revisions to reserves.
Costs of $9,587,000 relating to unproved properties have been excluded from costs subject to depletion for the 3 month period ended March 31, 2008. This included the costs of undeveloped land such as that at Ansell, Saxon and Pouce Coupe that has been purchased at land sales for future exploitation.
Income Taxes
In the first quarter of 2008, the company recorded an income tax provision of $669,000 as compared to an income tax provision of $31,000 for the same period last year. The income tax provision for the 1st quarter 2007 was relatively small relative to that recorded in 2008 due to the effect of rate reductions booked in the period.
Accrete has approximately $82 million of income tax pools at March 31, 2008 and does not anticipate being cash taxable in 2008.
Funds Flow
Funds flow from operations for the three months ended March 31, 2008 was $7,551,000 ($0.46 per share) versus $4,415,000 ($0.27 per share) for the equivalent period last year.
Capital Expenditures
Capital expenditures for the three months ending March 31, 2008:
3 Months Ended
March 31, 2008
($ thousands) $
----------------------------------------------------------------------------
Drilling and Completions 4,606
Geology and Geophysical 322
Equipping and Tie-Ins 309
Land 359
Property Acquisitions and Dispositions (net) -
Office Equipment 10
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Total Cash Expenditures 5,606
Capitalized stock based compensation 18
Allowance for future restoration expenditures 79
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Total 5,703
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During the first quarter the Company drilled 5 wells (3.2 net), comprising 5
(3.2 net) gas wells. A success rate of 100% was achieved.
Liquidity and Capital Resources
$ (thousands)
--------------
2008 Exploration and development program funding
Cash, Beginning of Year -
Cash flow from operations 7,552
Change in non-cash working capital 903
Decrease in Bank Debt (2,849)
Cash, end of period -
----------------------------------------------------------------------------
Net capital expenditures 5,606
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Accrete intends to fund its capital expenditure program from internally generated cash flow, debt, sales of non core property and new equity on favorable terms.
At March 31, 2008 the Company's credit facility comprises a Revolving Operating Demand Loan facility with a credit limit of $70,000,000.
This facility bears interest at bank prime plus one eighth percent and has no specific terms of repayment aside from the bank's right of demand and periodic review.
Success in its focus areas means that additional funds will be raised through additional bank debt, sale of non-core properties or additional share issuances or all of these measures to expedite or expand the drilling program.
Commodity prices and production volumes have a large impact on the ability of the Company to generate adequate cash flow. A prolonged decrease in commodity prices would negatively affect cash flow from operations and would also likely result in a reduction in the amount of cash flow and bank loan available for investment. This condition may also affect the availability of funds through the public equity market which may be accessed if funds are available on favorable terms.
See the caption entitled "Risks" for further items that could affect liquidity.
Risk Management
The Company adopted the provisions of CICA Sections 3855, Financial Instruments - Recognition and Measurement, 3861, Financial Instruments - Presentation and Disclosure, 3865 Hedges and 1530 Comprehensive Income, on January 1, 2007. These sections address the classification, recognition and measurement of financial instruments and hedges in the financial statements and the inclusion of other comprehensive income. These sections were adopted on a prospective basis without retrospective restatement of prior periods and there was no material impact on the Company's financial statements on adoption.
Currently, the Company does not use hedge accounting, and, as a result, the adoption of CICA Section 3865 has no material impact on the financial statements.
The Company has used financial instruments that are derivative contracts classified as "held for trading" to manage volatility of natural gas prices. The Company had no such contracts at December 31, 2006 but entered into two "costless collars" during the first quarter of 2007. The contracts expired on October 31, 2007 and a gain of $209,000 was recorded.
There were no such contracts open at December 31, 2007 but subsequent to that, the Company entered into a financial costless collar based 3,000 Gj/d of natural gas for the period from April 1, 2008 to October 31, 2008 with a put price of $6.635/Gj and a call price of $7.365/Gj. This financial instrument derivative contract has been classified as "held for trading". The Company elected to mark-to-market its financial contracts which resulted in an unrealized pre tax loss of $996,000 being recorded in the 1st quarter 2008.
Outlook
The Company will continue to seek opportunities in new areas so as to provide future development opportunities.
Accrete has assessed its prospects in the Ansell, Edson and Pouce Coupe areas, and has concluded that they rank secondary to those at Claresholm and Saxon and its interests there will most likely be rationalized. To that end, subsequent to the end of the 1st quarter 2008, the Company accepted an offer to purchase its interests in the Pouce Coupe area for proceeds of approximately $4.3 million. The sale will close later in May 2008 with an effective date of April 1, 2008 and is subject to due diligence on the part of the purchaser and normal industry post sale adjustments. In addition, the Company has made an offer to purchase additional working interests in the Claresholm area of Alberta from an industry partner for approximately $5.6 million. Such purchase is subject to the completion of formal documentation, due diligence and post closing adjustments and is expected to close later in May with an effective date of April 1, 2008. Since the production volumes that will be purchased approximates that which will be sold, the redeployment of capital should have minimal immediate effect on gross revenues but should enable the Company to take advantage of the economy that should be gleaned from wells that it already operates.
The Company will maintain sufficient activity to stabilize production at Harmattan and will utilize the cash flow generated to develop its inventory of prospects at Claresholm and Saxon.
The Company received notice from the 3rd party processor of natural gas for the Harmattan area that the gas plant would be shut down for maintenance and modification from April 19 to May 9, 2008. During that period, Harmattan production will be shut in.
Sensitivities
The Company's performance is affected by factors such as changes in production volumes, commodity prices and interest rates.
The following table illustrates the impact on cash flows and net earnings as a result of changes in commodity prices and interest rates based on forecast cash flows and capital expenditures of between $26 and $30 Million for 2008:
$ Thousand Cash Flow Pre Tax Earnings
----------------------------------------------------------------------------
Impact on the year ended December 31, 2008
Change in Canadian crude oil by $1/ bbl 35 25
Change in field gate price of Natural Gas
by $1/ mcf 4,718 3,303
Change in Natural Gas Liquids price by $1/ bbl 223 156
Change of 1% in prime interest rates 645 452
Critical Accounting Estimates
There are no changes from those described in the Management's Discussion and Analysis for the year ended December 31, 2007.
Risks
There are no changes to the risks to which the Company is exposed from those disclosed in the Management's Discussion and Analysis for the year ended December 31, 2007.
Changes in Legislation
Alberta Royalty Review
On October 25, 2007, the Government of Alberta released its New Royalty Framework ("NRF") which is to be the basis of royalty regulations that are to become effective on January 1, 2009. The NRF proposes a regime that would have Alberta Crown Royalty rates based on production rates, well depths and commodity prices. At this time, the detailed and specific information that is necessary to calculate the impact of the proposed regulations on natural gas royalties is not available and accordingly, the Company cannot thoroughly evaluate the impact on the Company's operations.
Greenhouse Gas and Air Emissions Legislation
The Federal Government released on April 26, 2007, its Action Plan to Reduce Greenhouse Gases and Air Pollution (the "Action Plan"), also known as ecoACTION and which includes the Regulatory Framework for Air Emissions. This Action Plan covers not only large industry, but regulates the fuel efficiency of vehicles and the strengthening of energy standards for a number of energy-using products. Regarding large industry and industry related projects, the Government's Action Plan intends to achieve the following: (i) an absolute reduction of 150 megatonnes in greenhouse gas emissions by 2020 by imposing mandatory targets; and (ii) air pollution from industry is to be cut in half by 2015 by setting certain targets. New facilities using cleaner fuels and technologies will have a grace period of three years. In order to facilitate companies' compliance with the Action Plan's requirements, while at the same time allowing them to be cost-effective, innovative and adopt cleaner technologies, certain options are provided. These are: (i) in-house reductions; (ii) contributions to technology funds; (iii) trading of emissions with below-target emission companies; (iv) offsets; and (v) access to Kyoto's Clean Development Mechanism.
On March 8, 2007, the Alberta Government introduced Bill 3, the Climate Change and Emissions Management Amendment Act, which intends to reduce greenhouse gas emission intensity from large industries. Bill 3 states that facilities emitting more than 100,000 tonnes of greenhouse gases a year must reduce their emissions intensity by 12% starting July 1, 2007; if such reduction is not initially possible the companies owning the large emitting facilities will be required to pay $15 per tonne for every tonne above the 12% target. These payments will be deposited into an Alberta-based technology fund that will be used to develop infrastructure to reduce emissions or to support research into innovative climate change solutions. As an alternate option, large emitters can invest in projects outside of their operations that reduce or offset emissions on their behalf, provided that these projects are based in Alberta. Prior to investing, the offset reductions offered by a prospective operation must be verified by a third party to ensure that the emission reductions are real. Given the evolving nature of the debate related to climate change and the control of greenhouse gases and resulting requirements, it is not possible to predict the impact of those requirements on the Company and its operations and financial condition. Bill 3 does not currently have an impact on the Company as it does not own any facilities emitting in excess of 100,000 tonnes per year.
Disclosure Controls and Internal Controls Over Financial Reporting
Disclosure controls and procedures have been designed to ensure that information required to be disclosed by the Company is accumulated and communicated to Accrete's management as appropriate to allow timely decisions regarding required disclosure. Accrete's Chief Executive Officer and Chief Financial Officer have concluded, based on their evaluation as of the end of the period covered by the interim filings, that the Company's disclosure controls and procedures are effective to provide reasonable assurance that material information related to the Company is made known to them by others within the Company. It should be noted that while the Company's Chief Executive Officer and Chief Financial Officer believe that the Company's disclosure controls and procedures provide a reasonable level of assurance that they are effective, they do not expect that the disclosure controls and procedures or internal control over financial reporting will prevent all errors and fraud. A control system, no matter how well conceived or operated, can provide only reasonable assurance that the objective of the control system is met.
Management acknowledges that there is a lack of segregation of duties within several of the Company's processes due to its small size. Management has identified the specific functions with the potential to compromise the Company's overall control objectives. Appropriate compensating controls have been implemented to management's satisfaction in response to the identified risks.
Accrete's Chief Executive Officer and Chief Financial Officer are required to cause the Company to disclose herein any change in the Company's internal controls over financial reporting that occurred during the Company's most recent interim period that has materially affected, or is reasonably likely to affect, the Company's internal controls over financial reporting. During 2006, 2007 and 2008, Accrete engaged external consultants to assist in documenting and assessing the Company's internal controls over financial reporting.
No material changes in the Company's internal controls were identified during the year ended December 31, 2007 or during the interim period ending March 31, 2008 that have materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting.
Contractual Obligations
The Company has committed to a term drilling program with a major drilling contractor. The Company is obligated to utilize the contractor's rig for a period of 200 days for a one year period that commenced August 15, 2007.
The Company rents a compressor for $26,495 per month on a month to month basis.
The Company has entered into various commitments related to the leasing of office premises and office equipment. The payments due under such leases are as follows:
Contractual obligations 2008 2009 2010 2011 2012 Thereafter
($ thousands) $ $ $ $ $ $
----------------------------------------------------------------------------
Office Premises 562 708 708 741 808 879
Office equipment 9 2 1 - - -
----------------------------------------------------------------------------
571 710 709 741 808 879
----------------------------------------------------------------------------
The current office lease expired early in 2008. Accordingly, the Company negotiated leases for new office space. The increase in the commitment for office premises reflects the dramatic increase in prices for suitable office space.
At December 31, 2007 the Company's credit facility comprises a revolving Operating Demand Loan facility with a credit limit of $70,000,000 that bears interest at bank prime plus one eighth percent.
This facility has no specific terms of repayment aside from the bank's right of demand and periodic review and is secured by a general assignment of book debts, a $100,000,000 debenture with a first floating charge over all assets with a negative pledge and an undertaking to provide fixed charges on the Company's major producing reserves at the request of the bank.
New Accounting Standards
The Company adopted the Canadian Institute of Chartered Accountants ("CICA") Handbook Section 3031 "Inventories", Section 3863 "Financial Instruments - Disclosures" and Section 1535 "Capital Disclosures" on January 1, 2008. The adoption of these standards has had no material impact on the Company's Net Earnings or Cash Flows. Additional information on the effects of the implementation can be found in the notes to the Company's interim financial statements.
As of January 1, 2009, the Company will be required to adopt CICA Handbook Section 3064 "Goodwill and Intangible Assets", which defines the criteria for the recognition of intangible assets. The adoption of this standard should have no material impact on the Company's financial statements.
On February 13, 2008, Canada's Accounting Standards Board confirmed January 1, 2011 as the effective date for the convergence of Canadian GAAP to International Financial Reporting Standards. The Canadian Securities Administrators are in the process of examining changes to securities rules that may occur. Accrete Energy Inc. has not determined the impact of this initiative because it is still in its early stages.
Transactions With Related Parties
The Corporation has not entered into any transactions with related parties, nor did it have any balances outstanding with related parties at year end.
Off Balance Sheet Arrangements
The Corporation has not entered into any off-balance sheet transactions.
Additional Information
Additional information regarding the Company and its business operations, including the annual information form ("AIF") is available on the Company's web site at accrete-energy.com and on SEDAR.com. Copies of such information may also obtained by contacting the Company at Accrete Energy Inc., 2100, 500 - 4th Avenue S.W., Calgary, Alberta T2P 2V6 or by e-mail at investor@accrete-energy.com.
Accrete Energy Inc.
Balance Sheets
(Unaudited)
March 31, December 31,
($ Thousands) 2008 2007
----------------------------------------------------------------------------
ASSETS
Current assets
Accounts receivable 6,738 6,912
Prepaid expenses 1,718 1,796
Future income tax (Note 7) 294 -
----------------------------------------------------------------------------
8,750 8,708
Property and equipment (note 3) 121,703 119,742
----------------------------------------------------------------------------
130,453 128,450
----------------------------------------------------------------------------
----------------------------------------------------------------------------
LIABILITIES
Current liabilities
Accounts payable and accrued liabilities 11,809 11,139
Fair value of derivative financial instruments
(notes 2 and 8) 996 -
Bank indebtedness (note 4) 53,079 55,928
----------------------------------------------------------------------------
65,884 67,067
Asset retirement obligation (note 6) 2,094 1,982
Future income tax (note 7) 9,143 8,181
----------------------------------------------------------------------------
77,121 77,230
----------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Share capital (note 5) 36,142 36,142
Contributed surplus (note 5) 3,701 3,581
Retained Earnings 13,489 11,497
----------------------------------------------------------------------------
53,332 51,220
----------------------------------------------------------------------------
130,453 128,450
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Commitments (note 10)
See accompanying notes to financial statements
Accrete Energy Inc.
Statements of Income and Comprehensive Income
(Unaudited)
Three Months Three Months
Ended Ended
($ Thousands) March 31, 2008 March 31,2007
----------------------------------------------------------------------------
Revenue
Petroleum and natural gas revenue 14,007 10,647
Royalties (3,393) (3,327)
Unrealized loss on derivative instruments (996) (234)
----------------------------------------------------------------------------
9,618 7,086
----------------------------------------------------------------------------
Expenses
Production expenses 1,245 1,375
Transportation expenses 157 110
General and administrative, net of recoveries 868 864
Interest Expense 811 556
Stock based compensation cost (note 5) 101 100
Depletion, depreciation and accretion 3,775 3,120
----------------------------------------------------------------------------
6,957 6,125
----------------------------------------------------------------------------
Income before income taxes 2,661 961
Future income taxes (note 7) (669) (31)
----------------------------------------------------------------------------
Net income and comprehensive income 1,992 930
----------------------------------------------------------------------------
Income per share:
Basic 0.12 0.06
Diluted 0.11 0.05
See accompanying notes to financial statements
Accrete Energy Inc.
Statements of Retained Earnings, Comprehensive Income and Accumulated Other
Comprehensive Income
(Unaudited)
Three Months Three Months
Ended Ended
($ Thousands) March 31, 2008 March 31,2007
----------------------------------------------------------------------------
Retained Earnings:
Retained Earnings, beginning of year 11,497 5,742
Net income for the period 1,992 930
-------------------------------
Retained Earnings, end of year 13,489 6,672
-------------------------------
-------------------------------
Comprehensive Income:
Net income for the period 1,992 930
Other comprehensive income - -
-------------------------------
Comprehensive income 1,992 930
-------------------------------
-------------------------------
Accumulated other comprehensive income:
Accumulated other comprehensive income,
beginning of year - -
Effect of adoption of new accounting standards
(Note 2) - -
Changes during the period - -
-------------------------------
-------------------------------
Accumulated other comprehensive income, end
of year - -
-------------------------------
-------------------------------
See accompanying notes to financial statements
Accrete Energy Inc.
Statements of Cash Flows
(Unaudited)
Three Months Three Months
Ended Ended
($ Thousands) March 31, 2008 March 31, 2007
----------------------------------------------------------------------------
Cash provided by (used in):
Operating Activities
Net income for the period 1,992 930
Items not affecting cash:
Stock based compensation cost 119 100
Future income taxes 669 31
Unrealized loss on derivative financial
instruments 996 234
Depletion, depreciation and accretion 3,775 3,120
----------------------------------------------------------------------------
7,551 4,415
Change in non-cash working capital (note 9) 156 2,105
----------------------------------------------------------------------------
7,707 6,520
----------------------------------------------------------------------------
Investing Activities
Property and equipment additions (5,624) (19,092)
Change in non-cash working capital (note 9) 766 8,382
----------------------------------------------------------------------------
(4,858) (10,710)
----------------------------------------------------------------------------
Financing Activities
Bank debt 2,849 4,190
----------------------------------------------------------------------------
2,849 4,190
Increase (decrease) in cash - -
Cash - beginning of year - -
----------------------------------------------------------------------------
Cash - end of year - -
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Supplemental Information :
Interest Paid 811 556
----------------------------------------------------------------------------
----------------------------------------------------------------------------
See accompanying notes to financial statements
Accrete Energy Inc.
Notes to the Financial Statements
For the period ended March 31, 2008
(Unaudited)
1. Significant Accounting Policies
Accrete Energy Inc. ("Accrete") is engaged in the exploration, development and production of petroleum and natural gas in Alberta.
The unaudited interim financial statements of the Company have been prepared by Management in accordance with Canadian generally accepted accounting principles, following the same accounting policies and methods of computation as the audited financial statements of Accrete Energy Inc. for the year ended December 31, 2007 except as disclosed in Note 2. These unaudited interim financial statements should be read in conjunction with the audited financial statements of Accrete Energy Inc. for the year ended December 31, 2007.
2. Change In Accounting Policies
Effective January 1, 2008, the Company adopted CICA Handbook Section 3862, Financial Instruments - Disclosure, CICA Handbook Section 3863, Financial Instruments - Presentation and CICA Handbook Section 3031, Inventories and CICA Handbook Section 1535 "Capital Disclosures".
The adoption of Handbook Sections 3862, 3863 and 3031 had no impact on the Company's financial results. The new disclosure as required by Handbook Sections 1535 and 3062 is presented in the notes to the interim financial statements.
3. Property and Equipment
As at
As at March December 31,
31, 2008 2007
($ thousands) $ $
----------------------------------------------------------------------------
Petroleum and natural gas properties and
equipment 158,323 152,631
Furniture, fixtures and other 139 129
----------------------------------------------------------------------------
158,462 152,760
Less: Accumulated depletion and depreciation 36,759 33,018
----------------------------------------------------------------------------
121,703 119,742
----------------------------------------------------------------------------
At March 31, 2008 costs of $9,587,000 ($9,509,000 at December 31, 2007) with respect to unproved properties have been excluded from costs subject to depletion. At March 31, 2008 a total of $2,700,000 of future development costs were included in the depletion calculation (2007 - $2,700,000). Direct salary costs related to geological and geophysical personnel in the amount of $70,000 ($60,000 in 2007) have been charged to petroleum and gas properties. No other salary or overhead charges have been capitalized.
4. Bank Indebtedness
At March 31, 2008 the Company's credit facility comprises a Revolving Operating Demand Loan facility with a credit limit of $70,000,000 that bears interest at bank prime plus one eighth percent.
This facility has no specific terms of repayment aside from the bank's right of demand and periodic review and is secured by a general assignment of book debts, a $100,000,000 debenture with a first floating charge over all assets with a negative pledge and an undertaking to provide fixed charges on the Company's major producing reserves at the request of the bank.
A covenant to the Revolving Operating Demand Loan facility requires that the Company maintain a working capital ratio of at least 1 to 1. For purposes of this calculation, the undrawn availability under the facility is added to current assets.
5. Share Capital
Authorized:
An unlimited number of common voting shares and an unlimited number of preferred shares issuable in series for which the directors may fix, among other things, the rights, privileges, restrictions, conditions, voting rights, rates, method of calculation and dates of payment of dividends and terms of redemption, purchase and conversion if any, and any other provisions.
Issued and outstanding:
Number of
Common Voting Shares Shares $ Thousands
----------------------------------------------------------------------------
Balance, December 31, 2005 15,232,936 29,618
Exercise of Stock Options 16,666 74
Issued on private placement - flow through shares 1,248,300 10,486
Share issuance costs, net of tax (460)
----------------------------------------------------------------------------
Balance, December 31, 2006 16,497,902 39,718
Normal Course Issuer Bid (226,100) (544)
Tax effect of flow through shares (3,041)
Share issuance costs, net of tax 9
----------------------------------------------------------------------------
Balance, December 31, 2007 16,271,802 36,142
----------------------------------------------------------------------------
Balance March 31, 2008 16,271,802 36,142
----------------------------------------------------------------------------
The tax deductions related to the $10,486,000 of flow through shares issued in 2006 were renounced to flow through shareholders and booked to the accounts in February 2007.
The following reconciles the common shares used in calculating net earnings
per common share:
March 31,
2008 2007
----------------------------------------------------------------------------
Weighted average common voting shares outstanding
- basic 16,271,802 16,497,902
Effect of dilutive stock options 1,360,910 1,018,011
----------------------------------------------------------------------------
Weighted average common shares outstanding -
diluted 17,632,712 17,515,913
----------------------------------------------------------------------------
Stock Options
Under the terms of the Accrete Energy Inc. 2004 Incentive Stock Option Plan, as amended, (the "plan"), directors, officers, employees and consultants (the "Participant(s)") are eligible to be granted options to purchase common shares. The plan provides for granting up to 1,926,394 common shares. The maximum number of option shares that may be reserved for issuance to any one Participant under the plan cannot exceed 5% of the issued and outstanding common shares. The exercise price under the plan is defined by the plan to be the closing price on the principal stock exchange on which the common shares are traded on the last business date preceding the date of grant or if the common shares did not trade on that date, the weighted average price for the five trading days preceding the date of grant.
The vesting of stock options is determined by the board of directors and the term, as also determined by the board of directors cannot exceed five years from the date of grant of such options. A Participant's entitlement under the plan ceases upon ceasing to be a Participant. If such cessation is involuntary, then the vested and unvested options can be exercised for a period of ninety days after such date. Where a Participant is terminated for cause, the Participant may only exercise those options that have become vested. Where a Participant is terminated by the company without cause, the Participant is entitled to exercise stock options that have vested during the notice period or in the event of compensation being paid in lieu of notice, for 21 days after ceasing to be a Participant. Options granted under the plan are not assignable and no financial assistance is extended to optionees. The board of directors is empowered to amend the plan. Any amendment to the plan is subject to the receipt of necessary regulatory approvals and any amendment required by applicable law or regulatory policy to be approved by shareholders does not become effective until so approved.
The following table summarizes information about stock options outstanding
at March 31, 2008:
Weighted
Average
Remaining Number Exercise
Options Contractual Exercisable Price
Grant Price Outstanding Life (Vested) ($/Share)
----------------------------------------------------------------------------
$1.00(1) 926,845 1.2 Years 926,845 .50
$2.30(2) 40,000 1.6 Years 40,000 .05
$2.60(2) 395,000 1.7 Years 395,000 .56
$2.89(2) 5,000 1.7 Years 5,000 .01
$3.12(2) 40,000 1.7 Years 40,000 .07
$5.20(1) 375,000 3.9 Years 253,334 1.05
$5.26(1) 50,000 3.8 Years 16,667 .14
$6.91(2) 10,000 3.5 Years 3,333 .04
$7.01(2) 5,000 2.2 Years 3,333 .02
----------------------------------------------------------------------------
1,846,845 2.3 Years 1,683,512 2.44
----------------------------------------------------------------------------
(1) Five year term, vest equally over a three year period commencing on the
date of grant.
(2) Five year term, vest equally over a three year period commencing on the
first anniversary of the date of grant.
Options outstanding:
Balance, December 31, 2005 1,465,845
Granted 10,000
Exercised and Forfeited (50,000)
----------------------------------------------------------------------------
Balance, December 31, 2006 1,425,845
Granted 430,000
Forfeited (9,000)
----------------------------------------------------------------------------
Balance, December 31, 2007 1,846,845
----------------------------------------------------------------------------
Balance, March 31, 2008 1,846,845
----------------------------------------------------------------------------
The Company has accounted for its employee stock options granted using the fair value method. The fair value of all options granted to March 31, 2008 was estimated to be $4,486,000 ($2.43 per option granted). This value is charged to stock based compensation cost over the vesting period. A total of $101,000 (2007, $100,000) was charged to expense in the first quarter, and a total of $18,000 was capitalized for a total stock based compensation charge of $119,000 for the quarter.
The assumptions used in calculating the fair value include a volatility factor ranging from 31% to 52%, a weighted average risk free interest rate of 3.7% to 4.5%, and a weighted average expected life of the options of 4 to 5 years.
Contributed Surplus
3 Months Year Ended
Ended March December 31,
($ thousands) 31, 2008 2007
----------------------------------------------------------------------------
Balance, beginning of year 3,582 3,414
Stock Based Compensation 119 707
Normal Course Issuer Bid - (540)
----------------------------------------------------------------------------
Balance, end of year 3,701 3,581
----------------------------------------------------------------------------
Normal Course Issuer Bid
On March 27, 2007, the Company announced that the Toronto Stock Exchange had approved a normal course issuer bid (the "NCIB) whereby the Company may acquire a maximum of 1,000,000 common voting shares by way of the NCIB prior to its expiry on March 22, 2008.
A total of 226,100 common voting shares have been acquired during 2007 at prices ranging from $3.90 to $5.05 per share. Shares purchased pursuant to the NCIB have been cancelled and returned to treasury.
6. Asset Retirement Obligation
Asset retirement obligation comprises:
Three Months Year Ended
Ended March December 31,
($ thousands) 31, 2008 2007
----------------------------------------------------------------------------
Balance, beginning of year 1,982 1,663
Liabilities incurred 78 197
Liabilities settled - -
Dispositions - -
Accretion expense 34 122
----------------------------------------------------------------------------
Balance, end of year 2,094 1,982
----------------------------------------------------------------------------
The total future asset retirement obligation was estimated based on the Company's net ownership interest in all wells and facilities, the estimated costs to abandon and reclaim the wells and facilities and the estimated timing of the costs to be incurred in future periods. The total undiscounted amount of the estimated cash flows to settle the asset retirement obligation is approximately $3,956,000(2007 $3,501,000) which will be incurred over the next twenty five years. A credit adjusted risk-free rate of 7% (2007 7%) and an inflation rate of 2% (2007 2%) was used to calculate the fair value of the obligations.
7. Income Taxes
At March 31, 2008, the Company's exploration and development expenditures and undepreciated capital costs total $81,785,000. These costs may be carried forward indefinitely to reduce future taxable income.
The following reconciles the difference between income tax recorded and the expected income tax expense obtained by applying the expected income tax rate to earnings before taxes:
Three Months Ended March 31,
($ thousands) 2008 2007
----------------------------------------------------------------------------
Income/(Loss) before income taxes 2,661 961
Statutory Rate 29.5% 32.12%
Expected income tax expense at the combined
federal and provincial statutory rate 785 309
Stock based compensation cost 30 32
Tax-rate adjustments (152) (309)
Other 6 (1)
----------------------------
Future income tax expense 669 31
----------------------------
The following table summarizes the tax effect of temporary differences:
($ thousands)
March 31, 2008 December 31,
2007
----------------------------------------------------------------------------
Future income tax assets (liabilities):
Carrying value of capital assets in excess of
tax basis (9,980) (9,112)
Asset retirement obligation 524 495
Share issue costs 140 263
Attributed crown royalty income 173 173
Unrealized loss on derivative financial
instruments 294 -
----------------------------------------------------------------------------
(8,849) (8,181)
----------------------------------------------------------------------------
Current future tax asset 294 -
Non-current future income tax liability (9,143) (8,181)
----------------------------------------------------------------------------
(8,849) (8,181)
----------------------------------------------------------------------------
8. Financial Instruments
Financial instruments consist primarily of accounts receivable, accounts payable and accrued liabilities and bank debt. There are no significant differences between the carrying value of these instruments and their estimated fair value.
A portion of the Company's accounts receivable are from joint venture partners in the oil and gas business and are subject to normal industry credit risk. Purchasers of the Company's petroleum and natural gas products are subject to an internal credit review designed to mitigate the risk of non-payment and the carrying value reflects management's assessment of the associated credit risks.
The Company is exposed to fluctuations in commodity prices that are based in foreign currency.
The Company did not enter into any such contracts that would have mitigated its exposure to foreign currency but it did enter into various contracts that were intended to reduce its exposure to fluctuations in commodity prices during 2007. These were derivative contracts classified as "held for trading".
These contracts expired on October 31, 2007. The realized gain for 2007 from these collars was $209,000.
There were no such contracts open at December 31, 2007 but subsequent to that, the Company entered into a financial costless collar based 3,000 Gj/d of natural gas for the period from April 1, 2008 to October 31, 2008 with a put price of $6.635/Gj and a call price of $7.365/Gj.
9. Supplemental Cash Flow Information
Change in non-cash working capital comprises:
March 31, December 31,
($ thousands) 2008 2007
----------------------------------------------------------------------------
Accounts receivable 174 (881)
Prepaid expenses 78 (275)
Accounts payable and accrued liabilities 670 (186)
----------------------------------------------------------------------------
Change in non-cash working capital 922 (1,342)
----------------------------------------------------------------------------
Relating to:
Investing activities 766 (2,236)
Operating activities 156 894
----------------------------------------------------------------------------
922 (1,342)
----------------------------------------------------------------------------
10. Commitments
The Company has entered into an agreement with a major drilling contractor. The Company is obligated to utilize the contractor's rig for a period of 200 days during the one year term of the agreement that commenced August 15, 2007.
The Company has entered into various commitments related to the leasing of office premises and office equipment. The payments due under such leases are as follows:
Contractual obligations
($ thousands) 2008 2009 2010 2011 2012 Thereafter
----------------------------------------------------------------------------
Office Premises 562 708 708 741 808 879
Office equipment 9 2 1 - - -
----------------------------------------------------------------------------
571 710 709 741 808 879
----------------------------------------------------------------------------
11. Capital Structure
The Company's objective is to maintain a strong capital base so as to maintain investor, creditor and market confidence and to sustain the future development of the business.
The Company manages its capital structure and makes adjustments to it in the light of changes in economic conditions and the risk characteristics of the underlying petroleum and natural gas assets.
The Company's capital structure is comprised of shareholder's equity, bank indebtedness and working capital. In order to maintain or adjust the capital structure, the Company may from time to time issue shares and adjust its capital spending to manage its current and projected debt levels.
The Company monitors capital based on the ratio of net debt to annualized funds flow. This ratio is calculated as net debt, defined as outstanding bank indebtedness plus or minus working capital, divided by funds flow from operations before changes in non cash working capital for the most recent calendar quarter, annualized (i.e. multiplied by four). The Company's strategy is to maintain a ratio that is in keeping with that of its industry peer group. The ratio may increase at certain times as a result of acquisitions or extremely low commodity prices. The Company prepares annual capital expenditure budgets, which are updated as necessary depending on varying factors including current and forecast prices, successful capital deployment and general industry conditions in order to manage the ratio. The annual and updated budgets are approved by the Company's Board of Directors.
The Company's share capital is not subject to external restrictions, however the bank debt facility is based on petroleum and natural gas reserves. The Company has not paid or declared any dividends since the date of incorporation, nor are any contemplated in the foreseeable future. There were no changes in the Company's approach to capital management during the year.
12. Fair value of Financial Instruments
The Company's financial instruments as at March 31, 2008 and December 31, 2007 include cash and cash equivalents, accounts receivable, derivative contracts, accounts payable and accrued liabilities and bank indebtedness. The fair value of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate their carrying amounts due to their short-terms to maturity.
The fair value of derivative contracts is determined by reference to market information provided by the Company's bank.
Bank debt bears interest at a floating market rate and accordingly the fair market value approximates the carrying value.
13. Financial Risk Management
The Company has exposure to the following risks from its use of financial instruments:
- Credit risk
- Liquidity risk
- Market risk
This note presents information about the Company's exposure to each of the above risks, the Company's objectives, policies and processes for measuring and managing risk, and the Company's management of capital. Further quantitative disclosures are included throughout these financial statements. The Board of Directors has overall responsibility for the establishment and oversight of the Company's risk management framework. The Board has implemented and monitors compliance with risk management policies. The Company's risk management policies are established to identify and analyze the risks faced by the Company, to set appropriate risk limits and controls, and to monitor risks and adherence to market conditions and the Company's activities.
Credit risk
Credit risk is the risk of financial loss to the Company if a customer or counterparty to a financial instrument fails to meet its contractual obligations, and arises principally from the Company's receivables from joint venture partners and petroleum and natural gas marketers. As at December 31, 2007 the Company's receivables consisted of $554,000 (2007 - $651,000) from joint venture partners, $5,535,000 (2007 - $3,657,000) of receivables from petroleum and natural gas marketers and $649,000 (2007 - $197,000) of other trade receivables.
Receivables from petroleum and natural gas marketers are normally collected on the 25th day of the month following production. The Company's policy to mitigate credit risk associated with these balances is to establish marketing relationships with large purchasers. The Company historically has not experienced any collection issues with its petroleum and natural gas marketers. Joint venture receivables are typically collected within one to three months of the joint venture bill being issued to the partner. The Company attempts to mitigate the risk from joint venture receivables by obtaining partner approval of significant capital expenditures prior to expenditure. However, the receivables are from participants in the petroleum and natural gas sector, and collection of the outstanding balances is dependent on industry factors such as commodity price fluctuations, escalating costs and the risk of unsuccessful drilling, in addition further risk exists with joint venture partners as disagreements occasionally arise that increase the potential for non-collection. The Company does not typically obtain collateral from petroleum and natural gas marketers or joint venture partners. The Company collects cash advances from joint venture partners to the extent possible and it does have the ability to withhold production from them in certain cases in the event of non-payment.
The carrying amount of accounts receivable represents the maximum credit exposure. The Company does not have an allowance for doubtful accounts as at March 31, 2008 and December 31, 2007 and did not provide for any doubtful accounts nor was it required to write-off any receivables during the period ended March 31 or the year ended December 31, 2008.
As at December 31, 2007 the Company considers it receivables to be all current as it has no material accounts receivables over 90 days.
Liquidity risk
Liquidity risk is the risk that the Company will not be able to meet its financial obligations as they are due. The Company's approach to managing liquidity is to ensure, as far as possible, that it will have sufficient liquidity to meet its liabilities when due, under both normal and stressed conditions without incurring unacceptable losses or risking harm to the Company's reputation.
The Company prepares annual capital expenditure budgets, which are regularly monitored and updated as considered necessary. Further, the Company utilizes authorizations for expenditures on both operated and non-operated projects to further manage capital expenditures. To facilitate the capital expenditure program, the Company has a revolving operating demand loan facility, as outlined in note 4 that is at least reviewed annually by the lender. The Company also attempts to match its payment cycle with collection of petroleum natural gas revenues on the 25th of each month.
Market risk
Market risk is the risk that changes in market prices, such as foreign exchange rrates, commodity prices, and interest rates will affect the Company's net earnings or the value of financial instruments. The objective of market risk management is to manage and control market risk exposures within acceptable limits, while maximizing returns. The Company utilizes both financial derivatives and physical delivery sales contracts to manage market risks. All such transactions are conducted in accordance with the risk management policy that has been approved by the Board of Directors.
Commodity price risk
Commodity price risk is the risk that the fair value or future funds flow will fluctuate as a result of changes in commodity prices. Commodity prices for petroleum and natural gas are impacted by not only the relationship between the Canadian and United States dollar, as outlined above, but also world economic events that dictate the levels of supply and demand. The Company has attempted to mitigate commodity price risk through the use of various financial derivative and physical delivery sales contracts. The Company's banking agreement limits the volumes that the Company can contract by way of commodity contracts to 50% of the Company's production.
The Company entered into various contracts that were intended to reduce its exposure to fluctuations in commodity prices during 2007. These were derivative contracts classified as "held for trading". These contracts expired on October 31, 2007. The realized gain for 2007 from these collars was $209,000.
There were no such contracts open at December 31, 2007 but subsequent to that, the Company entered into a financial costless collar based 3,000 Gj/d of natural gas for the period from April 1, 2008 to October 31, 2008 with a put price of $6.635/Gj and a call price of $7.365/Gj. This financial instrument derivative contract has been classified as "held for trading". The Company elected to mark-to-market its financial contracts which resulted in an unrealized before tax loss of $996,000 being recorded in the 1st quarter 2008.
The unrealized gain or loss from financial contracts has been included on the income statement with changes in the fair value included in petroleum and natural gas sales.
Interest rate risk
Interest rate risk is the risk that future funds flow will fluctuate as a result of changes in market interest rates. The Company is exposed to interest rate fluctuations on its bank debt which bears a floating rate of interest As at March 31, 2007, if interest rates had been 1% lower with all other variables held constant, pre tax net earnings for the period would have been $136,000 (2007 4Q - $136,000) higher, due to lower interest expense offset by higher average debt. An equal an opposite impact would have occurred to pre tax earnings had interest rates been 1% higher. The sensitivity is lower / higher in 2007 as compared to 2006 because of a reduction / increase in outstanding bank debt.
14. Subsequent Events
Subsequent to the end of the 1st quarter 2008, the Company accepted an offer to purchase its interests in the Pouce Coupe area for proceeds of approximately $4.3 million. The sale will close later in May 2008 with an effective date of April 1, 2008 and is subject to due diligence on the part of the purchaser and normal industry post sale adjustments. In addition, the Company has made an offer to purchase additional working interests in the Claresholm area of Alberta from an industry partner for approximately $5.6 million. Such purchase is subject to the completion of formal documentation, due diligence and post closing adjustments and is expected to close later in May with an effective date of April 1, 2008.
Website: www.accrete-energy.com
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