CALGARY, Nov. 6 /CNW/ - Petrolifera Petroleum Limited (TSX: PDP) reports its sales growth was restored during the third quarter ("Q3") of 2007. As a consequence, successive period cash flow from operations before changes in working capital ("cash flow")(1) rose 28 percent to $18.6 million and year-to-date 2007 cash flow of $57.7 million was 85 percent higher than a year ago. Higher volumes of both crude oil and natural gas sales were the principal contributing factors. The company continued to expand its overall exploratory holdings in both Argentina and Colombia and commenced its seismic program in Peru.
<< Highlights are as follows:
- Crude oil sales increased eight percent over the second quarter 2007
("Q2"), while equivalent volumes rose nine percent as natural gas
sales rose 26 percent.
- Year-over-year crude oil sales rose 91 percent to 8,376 bbl/d while
equivalent sales rose 90 percent to 8,696 boe/d.
- Cash flow was $18.6 million or $0.37 per common share in Q3 2007
($18.4 million in 2006) while net earnings declined to $4.9 million
($0.10 per common share), from $15.7 million ($0.39 per common
share), fuelled by the impact of a strong Canadian dollar.
- Year-over-year cash flow increased 85 percent to $57.7 million
($1.22 per common share) while earnings decreased two percent to
$24.4 million or $0.52 per common share.
- Self-financed capital expenditures thus far in 2007 were
$53.4 million, primarily for drilling new wells and constructing
facilities and infrastructure in Argentina.
- Working capital was $22.7 million at the end of the reporting period
as short-term investments were reclassified to long-term after an
impairment provision.
- New concessions were acquired in Argentina and Colombia.
- A new US$60 million credit facility was established, ensuring strong
liquidity.
Summary Results
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Three months ended Nine months ended
September 30 September 30
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2007 2006 % Change 2007 2006 % Change
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FINANCIAL ($000
except per share
amounts)
Total revenue 31,730 33,157 (4) 106,956 60,430 77
Cash flow from
operations before
working capital
changes(1) 18,619 18,384 1 57,738 31,289 85
Per share,
basic(1) 0.37 0.46 (20) 1.22 0.82 49
Per share,
diluted(1) 0.36 0.38 (5) 1.13 0.69 64
Net earnings (loss)
for the period 4,919 15,683 (69) 24,438 24,911 (2)
Per share, basic 0.10 0.39 (74) 0.52 0.65 (20)
Per share, diluted 0.10 0.32 (69) 0.48 0.55 (13)
Capital
expenditures 26,061 9,738 168 53,417 14,368 272
Cash on hand 11,368 36,206 (69)
Working capital 22,742 41,361 (45)
Indebtedness - -
Shareholders' equity 121,727 61,440 98
Total assets 144,016 81,226 77
OPERATING
Daily sales volumes
Crude oil - bbl/d 7,195 7,202 0 8,376 4,374 91
Natural gas
- mcf/d 2,169 1,259 72 1,919 1,223 57
Barrels of oil
equivalent
- boe/d(2) 7,557 7,412 2 8,696 4,578 90
Average selling
prices
Oil - $/bbl 46.99 49.49 (5) 45.82 49.78 (8)
Natural gas - $/mcf 1.41 1.44 (2) 1.45 1.31 11
Barrels of oil
equivalent
- $/boe(2) 45.15 48.33 (7) 44.45 47.91 (7)
Common shares
outstanding (000s)
Weighted average
Basic 50,107 40,442 24 47,285 37,975 25
Diluted 51,800 48,594 7 51,309 45,531 13
End of period
Issued 50,119 42,817 17
Fully diluted 51,803 52,671 (2)
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(1) Cash flow from operations before 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 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 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 portio n 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.
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LETTER TO SHAREHOLDERS
Your company experienced the restoration of sales growth in Argentina during the third quarter of 2007, as work continued on completion of infrastructure and facilities. This should impact on production, reserves and recovery factors as they are commissioned and activated. Included in work in progress, or completed, are the company's waterflood program for pressure maintenance, its water and crude oil treatment facilities and a new high pressure natural gas pipeline to transport anticipated growth in volumes to available industrial markets north of its Puesto Morales operations.
During the reporting period, the company was able to arrange and secure additional drilling and service rigs to advance its appraisal of the Puesto Morales and Rinconada Blocks in Neuquén Province, Argentina. A total of 20 wells were drilled and completed or were drilling at the end of the quarter and an additional drilling rig with greater depth capacity is now on location and drilling. This will enable Petrolifera to evaluate some higher potential projects which have been deferred until the rig's arrival in the region. This rig will enable the company to drill deviated and deeper wells on prospects located near the water reservoir which bisects Rinconada and is proximate to the Puesto Morales area. In large measure, this is required to move the surface locations away from areas which might be flooded during high water or rainy periods in the region.
We continue to be pleased with the overall results of our drilling program and believe the full impact of our successful drilling will become more apparent once the waterflood or pressure maintenance program is underway. We had been attempting to drill injector wells for the northern and central lobe at Puesto Morales yet continued to encounter considerable oil pay in certain locations. As a result, we completed these wells as producers to recover related reserves. This, then, required new injectors to be drilled and the completed oil wells exhibited lower productivity than is anticipated once the waterflood is operational. Nevertheless, new drilling enabled Petrolifera to offset continuing primary declines and grow our production and sales until our facilities are completed, which will help sustain this improvement.
At Rinconada, we have now drilled a total of five wells and have confirmed a thick hydrocarbon column in the order of 150 feet, without yet having encountered the regional oil/water contact in the Sierras Blancas Formation. Rinconada wells are shallower than at Puesto Morales, exhibit lower comparable permeability and productivity, but still provide attractive economic returns. It appears the main prospect at Rinconada extends over a broad area, including onto the Vaca Mahuida Block and possibly onto the recently confirmed but still informally-awarded Puesto Guevara Block in Rio Negro Province, Argentina. This play could provide us a long-term project with continuous drilling, leading to the prospect of associated reserve and production enhancement over several years. To assist in spreading risk in the area, Petrolifera farmed out one half of its work obligations on the Vaca Mahuida Block to a third party in exchange for a 25 percent interest therein. This is viewed as an attractive way to leverage shareholder's participation at lower cost.
We continue to await final negotiations to secure our 50 percent interest in the Salinas Grande I concession in La Pampa Province, Argentina. As our prospective partners have been unwilling to complete the agreed-upon transaction to bring Petrolifera in as a 50 percent partner, we have served notice of our intention to proceed with arbitration to secure our interest in this large exploratory concession. This is an unfortunate development brought about by the inaction of our joint venture partners, to the detriment of all parties, including the government of La Pampa, Argentina.
In Colombia, Petrolifera was awarded the Sierra Nevada II Technical Evaluation Agreement over a large land spread offsetting our Sierra Nevada I License, on which we plan to drill at least one well during 2008. Petrolifera now holds a 100 percent interest in over one million acres of exploratory rights in Colombia, which has emerged as one of the most competitive and attractive regions of South America.
In Peru, we received approval of our Environmental Impact Assessment ("EIA") for the Ucayali Block 107 situated northwest of the giant Camisea natural gas and condensate field. Accordingly, we are proceeding with our 2D seismic program over a number of large structures as identified by our geological work and extensive and densely-gridded aeromagnetic and gravity survey of the three million acre license area. We anticipate completing our seismic acquisition and processing by year end 2007 and Petrolifera is actively investigating suitable equipment alternatives to be in a position to commence a multi-well drilling program on the block during the second half of 2008. We remain very enthusiastic about Block 107 and its potential for natural gas, associated liquids and crude oil accumulations of considerable size.
We are completing our EIA for Maranon Block 106 and have decided to expand our 2D program over a number of attractive prospects and leads on this two million acre block. Again, we will require approval of our EIA by the regulators before proceeding with this program, which will likely be undertaken after the seismic program on Block 107 is completed. Accordingly, drilling on Block 106 will likely occur later in 2008 or in 2009.
Petrolifera now holds interests in over seven million acres of lands in three countries in South America. As its production and sales expand later this year and into 2008, with continuous drilling and the impact of new facilities, the company is well positioned to aggressively evaluate its holdings due to its strong financial condition and liquidity. It appears we will be able to self-finance our programs this year and will endeavor to do so next year as well. Our total outlays for 2007 will be lower than originally anticipated, in part due to the late arrival of newly-constructed rigs. Nevertheless, we still have an extensive inventory of prospects, plays and locations to drill for several years and remain optimistic about our growth prospects.
As announced during the quarter, Petrolifera has been impacted by the recent problems in the Canadian asset backed commercial paper ("ABCP") market. We had invested funds (largely our IPO proceeds from 2005 and our warrant exercise proceeds from this year) on the advice of our Canadian banker and through its money market facilities. We made investments in what was rated by a Canadian bond-rating agency as R-1 High commercial paper. The key message of this rating was the implied assurance of principal recovery, with limited or virtually minimal likelihood of default, as liquidity for the issuers was represented to be supported by access to lender backstop arrangements to assure the issuers of continuing liquidity even with a mismatch of the maturities of their assets and liabilities. We were, then, investing prudently to earn a respectable return but with a primary emphasis on certainty of capital, until we needed the funds for our programs. Unfortunately, virtually the entire $35 billion Canadian ABCP market has fallen into a state of illiquidity or default since August 2007. At that time, Petrolifera had approximately $37.7 million of its cash invested in ABCP.
We are awaiting resolution of this situation. Initial efforts are focused on clearly identifying the assets in the various conduit trusts which issued the commercial paper. There will then be a determination of the "fair market value" of the underlying assets held by the conduit trusts who issued the ABCP. The next step would apparently be to monetize or otherwise securitize the assets and return all or a portion of the invested funds as cash or securities. We are also examining all of the legal options which could be required or exercised to ensure we recover our funds in as timely a manner as possible, without impairment if possible. At this writing, there can be no assurance we will be successful in our efforts. We have been verbally assured by our banker that we will be made "whole" once the valuation process is completed, but again there can be no assurance this outcome will be obtained.
In the meantime, we have adequate cash flow and other cash balances to carry on with our capital programs without delay. Unrelated to the ABCP developments, we also completed the establishment of an initial US$100 million revolving reserve-backed credit facility with Standard Bank during the period, which provides the company with an initial access to $US60 million of available funds to supplement our internal liquidity. Accordingly, while we continue to pursue full recovery of our ABCP funds, we can proceed in an uninhibited manner with our activity due to the preplanning in establishing this credit facility.
As previously mentioned, our capital expenditures for the nine months ended September 20, 2007 were only $53.4 million. We had originally anticipated an outlay of $76.0 million by this time in our previously announced plans. As a consequence, we now expect our full year 2007 capital expenditures will reach $106.5 million, compared to our previous estimate of $145 million. Some of these expenditures will now occur in 2008.
Our Board of Directors recently approved a $140 million capital budget for 2008. We have provided for total outlays by country of $76 million for Argentina, $56 million in Peru and $8 million in Colombia. We anticipate drilling 69 wells in Argentina on our Puesto Morales/Rinconada, Vaca Mahuida, Puesto Guevara and Gobernador Ayala I blocks. One well is anticipated on Block 107 in Peru and we anticipate at least one well in Colombia on our Sierra Nevada License. The capital program includes approximately $36 million to be invested in new seismic in all three countries.
Our company and its shareholders will be exposed to a broad range of opportunities with our planned 2008 capital program, ranging from infill deliverability and exploratory wells in Argentina to very high potential exploratory wells in Peru and Colombia. We believe this cross section of opportunities balances risk and reward and affords our shareholders the opportunity to participate in a growing production profile with the potential for high returns.
The company's year end results are scheduled to be reported on March 14, 2008. In the interim we will provide timely updates on well results and other events of consequence as they evolve.
On October 19, 2007 the Company relocated its head office to Suite 900, 332 - 6 Avenue SW, Calgary AB, T2P 0B2. There is no change to the company's phone and fax numbers.
MANAGEMENT'S DISCUSSION AND ANALYSIS ("MD&A")
The following is dated as of November 6, 2007 and should be read in conjunction with the unaudited consolidated financial statements of Petrolifera Petroleum Limited ("Petrolifera" or the "company") for the three and nine months ended September 30, 2007 as contained in this interim report and the MD&A and audited financial statements for the years ended December 31, 2006 and 2005 as contained in the company's 2006 Annual Report. Additional information relating to Petrolifera, including its Annual Information Form for the year ended December 31, 2006 is on SEDAR at www.sedar.com. 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 contains forward-looking information based on current expectations, estimates and projections of future production, capital expenditures, cash flow, working capital, available sources of financing, the anticipated impact to the company of the market disruption on short term asset backed commercial paper ("ABCP") and third party initiatives to support and resolve ABCP issues. It should be noted forward-looking information involves a number of risks and uncertainties and actual results may vary materially from those anticipated by the company. These risks and uncertainties include, but are not limited to, political and economic conditions in the countries in which the company operates, changes in market conditions, law or governing policy, operating conditions and costs, operating performance, demand for crude oil and natural gas, foreign currency exchange rate fluctuations, currency controls, commercial negotiations, technical and economic factors and access to services, equipment and facilities. In addition, there can be no assurance that the proposals relating to ABCP will be implemented or restore liquidity to the ABCP market to facilitate repayment. The timing of repayment and amount available to satisfy outstanding obligations to the company is uncertain. Readers should review Petrolifera's Annual Information Form for the year ended December 31, 2006 for a description of the risk factors affecting Petrolifera. Throughout the 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. Boes may be misleading, particularly if used in isolation.
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Petroleum and natural gas revenues for the nine months ended September 30, 2007 were $105.5 million (nine months ended September 30, 2006 - $60.0 million) on sales of 8,696 boe/d (2006 - 4,578 boe/day), a year-over-year increase of 76 percent. Petroleum and natural gas revenues for the third quarter of 2007 were $31.4 million on sales of 7,557 boe/d, a decrease of five percent compared to the third quarter of 2006 revenues of $33.0 million (7,412 boe/d). The substantial increases in revenue resulted from higher oil and natural gas production and resultant sales volumes arising from the company's successful drilling program. All sales were from the company's Puesto Morales/Rinconada block in Argentina. Petroleum and natural gas revenues in the third quarter 2007 were up 14 percent from the second quarter of 2007, due to the continued successful results from the company's ongoing drilling campaign. Lower oil prices were prevalent for both reporting periods in 2007, compared to 2006 levels, but were up modestly on a successive basis.
Crude oil sales volumes increased substantially from the first nine months of 2006. New discoveries resulted in oil sales volumes rising to an average of 8,376 bbl/d for the first nine months of the year compared to 4,374 bbl/d for the same period in 2006. For the nine months ended September 30, 2007 and September 30, 2006 sales of crude oil represented 96 percent of the company's sales volumes. The company's realized crude oil price was down eight percent to average $45.82 per barrel for the nine months ended September 30, 2007 (2006 - $49.78 per barrel). Third quarter average realized crude oil prices were also down five percent compared to the third quarter of 2006. Natural gas prices increased 11 percent to average $1.45 per mcf for the first nine months of 2007, reflecting some relaxation of regulated Argentinean natural gas prices, which are still substantially below prices prevailing in North American markets. Third quarter natural gas prices were essentially flat at a decrease of two percent compared the third quarter of 2006.
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. All of Petrolifera's production is sold in domestic markets. Natural gas prices have been improving and are expected to continue improving due to market conditions and new policy initiatives aimed at market deregulation for industrial sales. The effect of this improved pricing has been somewhat offset by the strengthening of the Canadian dollar relative to the Argentine peso, which reduces the reported realization expressed in Canadian dollar terms.
Interest earned on short-term investments and other income was $1.4 million in the nine months ended September 30, 2007 (2006 - $0.6 million) and $0.3 million for the three months ended September 30, 2007 (2006 - $0.2 million).
ROYALTIES
Royalties represent charges against production or revenue by governments and landowners. Included in royalties are revenue taxes levied by provincial jurisdictions. Royalties in the first nine months of 2007 were $13.8 million ($5.80 per boe) or 13 percent of oil and natural gas revenue, compared to $8.4 million ($6.72 per boe) or 14 percent in the first nine months of 2006. Royalties for the third quarter of 2007 were $4.0 million ($5.77 per boe) or 13 percent of oil and natural gas revenue compared to $4.6 million ($6.73 per boe) or 14 percent in the third quarter of 2006. Lower 2007 unit costs for royalties essentially reflects lower crude oil prices than in 2006.
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Petrolifera's corporate netbacks per boe were down eight percent over those recorded in the first nine months of 2006 and were down ten percent for the third quarter of 2007 compared to the third quarter of 2006. This primarily reflects a decrease in the selling price of crude oil and higher operating expenses, offset by lower royalties and higher interest income. Petrolifera's calculated unit netback for the first nine months of 2007 at $33.79 per boe was a healthy 76 percent of selling price in 2007 and was 73 percent for the third quarter of 2007 at $32.91 per boe. Total netbacks in 2007 were higher due to significant sales volume growth.
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Operating costs in the year to date in 2007 increased on a per unit basis from 2006 reflecting increased staffing levels needed to operate the larger field operations compared to the prior year. Petrolifera anticipates some operating cost efficiencies when its new crude oil processing facilities are fully functional and its crude oil pipeline is increasingly utilized. Also, with the passage of time, more of the company's Argentinean wells require artificial lift with attendant higher associated costs.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative ("G&A") expenses were $4.7 million in the first nine months of 2007 compared to $2.9 million for the first nine months of 2006. G&A was $1.5 million in the third quarter of 2007 compared to $0.8 million for the third quarter of 2006. These costs primarily consist of salaries, insurance, the cost of independent reserve reports, travel and other administrative expenses incurred in Canada, Argentina, Peru and Colombia. The increase from 2006 is primarily attributable to increased staffing related to expanded activity levels. On a per boe basis, G&A was reduced by 14% to $1.99 per boe of sales for the first nine months of 2007 compared to $2.31 per boe in 2006. G&A of $1.8 million was capitalized in the first nine months of 2007 (2006 - $0.2 million).
Non-cash stock-based compensation (a non-cash charge) costs of $5.4 million were recorded in the first nine months of 2007 (2006 - $2.8 million), reflecting the company's increased share price and its consequent effect on the determination of the fair value of all stock options granted and vested in the periods. The company grants stock options on an annual basis to existing employees and to new hires when employed.
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 $6.3 million in the first nine months of 2007 (2006 - $0.5 million charge) and a charge of $2.3 million for the third quarter of 2007 (third quarter 2006 - $0.1 million charge). The company's main exposure to foreign currency risk relates to the pricing of crude oil sales, costs and capital expenditures which are denominated in US dollars and Argentinean pesos. This is a non-cash charge.
DEPLETION, DEPRECIATION AND ACCRETION ("DD&A")
DD&A is a non-cash charge and calculated using the unit-of-production method based on total estimated proved reserves. DD&A in the first nine months of 2007 was $12.4 million (2006 - $3.6 million) or $5.23 per boe (2006 - $2.86 per boe). DD&A was $3.6 million or $5.16 per boe for the third quarter of 2007 (third quarter 2006 - $1.9 million or $2.74 per boe). Accretion expense for the first nine months of 2007 which is included in DD&A expense was $0.1 million (2006 - $0.02 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 $2.7 million to the estimated total undiscounted liability of $7.5 million over the estimated remaining economic life of the company's oil and gas properties. Capital costs of $10.1 million related to unevaluated properties in Argentina and for major development projects and other assets in the pre-production stage, principally related to Peruvian assets, have been excluded from depletable costs (2006 - $1.7 million). The increase in both the three and nine month charges in 2007 is mainly due to the increased cost of additions and infrastructure related to the Argentina production.
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 the first nine months of 2007 or for 2006 as the company has a significant surplus.
TAXES
The current income tax provision of $16.4 million for the first nine months of 2007 (2006 - $11.8 million) primarily relates to income taxes in Argentina. Additionally, a future income tax provision (another non-cash charge) of $6.4 million for the nine month period (2006 - recovery of $0.5 million) was recorded to recognize changes in tax pool balances. Taxes other than income taxes of $1.3 million (2006 - nil) represent taxes charged on all banking transactions in Argentina for the nine month periods.
The current income tax provision for the third quarter of 2007 was $2.4 million (2006 - $5.8 million) and future income tax provision was $3.8 million (2006 - nil) for a total income tax provision in the third quarter of $6.2 million (third quarter of 2006 - $5.8 million). Taxes other than income taxes were $400,000 (2006 - nil) for the third quarter of 2007.
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Cash flow in the first nine months of 2007 was $57.7 million (2006 - $31.3 million) or $1.22 per weighted average basic share and $1.13 per weighted average diluted share, (2006 - $0.82 per weighted average basic share and $0.69 per weighted average diluted share). Cash flow in the third quarter was $18.6 million (2006 - $18.4 million) which equates to $0.37 per weighted average basic share and $0.36 per weighted average fully diluted share (2006 - $0.46 per weighted average basic share and $0.38 per weighted average fully diluted share). There were more shares outstanding in 2007 than in 2006.
Capital expenditures in the nine months of 2007 totaled $53.4 million (2006 - $14.4 million). Of the total, $47.4 million was invested in Argentina, mainly for costs to drill wells, constructing a crude oil treating facility, construction of secondary recovery facilities and construction of a high pressure natural gas sales pipeline in Argentina. In Peru, $5.6 million was invested on EIA advancement and the preparation for field seismic activity in the second half of 2007 and in Colombia, $0.4 million was invested in the establishment of a small startup office and the incurrence of costs related to the acquisition of concessions. Capital expenditures for the three months ended September 30, 2007 were $26.1 million (2006 - $19.8 million). All capital spending year to date 2007 was internally financed from cash flow which exceeded outlays.
Petrolifera was in a strong financial position at September 30, 2007 with robust cash flow, $22.7 million of working capital and no debt.
The company's 2007 capital program includes expenditures to satisfy work commitments related to the Peruvian license blocks. The company is ahead of schedule in meeting these requirements and in 2007 expects to complete geophysical work prior to drilling wells on each block. Remaining 2007 capital expenditures are discretionary. The company has sufficient working capital and cash flow is being generated in Argentina to fund these planned capital expenditures. Required funds are being moved among Argentina, Barbados, Canada, Colombia and Peru. The company had originally anticipated an outlay of $76.0 million for capital expenditures by this time in our previously announced plans. The company now expects our full year 2007 capital expenditures will be approximately $106.5 million.
As previously announced the company has completed the establishment of a reserve-based US$100 million revolving credit facility, with initial available draws established at US$60 million. This further enhances Petrolifera's liquidity and financial capacity to take advantage of new investment opportunities.
The company's only financial instruments are cash and cash equivalents, short-term investments, accounts receivable, accounts payable and income taxes payable. It maintains no off-balance sheet financial instruments.
LONG-TERM INVESTMENTS
As at September 30, 2007, included in long-term investments were third party sponsored asset backed commercial paper ("ABCP") with a par value of $37.7 million. These investments are carried at management's estimate of fair value of $34.9 million. During the quarter the third party ABCP market in Canada experienced severe liquidity problems causing several third party ABCP conduits to default on redemptions of maturing notes. There is currently a proposal which calls for the notes to be converted into longer term floating rate notes which match the maturities of the underlying assets. Petrolifera had maturities originally scheduled for the ABCP between August 14th and August 15th, 2007 which were not repaid.
Petrolifera has recorded an impairment charge on the Canadian ABCP of $2.8 million based on the expected recovery of these notes. As there has been no market data available, management has estimated the fair value of these notes based on the probabilistic recovery of principal and interest. The actual timing and amount ultimately recovered from these notes may differ materially from this estimate which would impact the company's earnings.
SUBSEQUENT EVENTS
Subsequent to the end of the quarter Petrolifera commenced an arbitration procedure with respect to securing its 50 percent interest in the Salinas Grande I concession in La Pampa Province, Argentina. The designated partners have been reluctant to complete the transaction as agreed, necessitating this action.
Also, subsequent to the end of the quarter the former contract operator of the Puesto Morales/Rinconada Concession commenced an arbitration procedure against Petrolifera and others claiming wrongful dismissal and seeking financial compensation, including costs and general damages. Petrolifera is of the opinion the action is without merit and intends to respond and counterclaim. Potential damages, if any, are not quantifiable at this time, but in any event are not anticipated to be material to the company.
RELATED PARTY TRANSACTIONS AND SIGNIFICANT TRANSACTIONS
Under the terms of a Management Services Agreement with Connacher Oil and Gas Limited ("Connacher"), which originally expired in May 2007, Connacher provided all management, operational, accounting and general and administrative services necessary or appropriate to manage and administer the company. The fee for this service was $15,000 per month. From time to time Connacher also paid bills on behalf of Petrolifera, for which it is reimbursed. During the second quarter of 2007 this agreement was extended on a month-to-month basis and will be reassessed as Petrolifera achieves increasing independence and managerial capabilities. 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.
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 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 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 there is a 50 percent probability that the actual remaining quantities recovered will be equal to or greater 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 be equal to or 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.
IMPACT OF NEW AND PROPOSED ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2007 the company adopted CICA Handbook sections 1530, 3251, 3855, 3861, and 3865 relating to Comprehensive Income, Equity, Financial Instruments - Recognition and Measurement, Financial Statements - Disclosure and Presentation and Hedges, respectively. Under the new standards, additional financial statement disclosure, namely Consolidated Statements of Other Comprehensive Income, has been introduced. This statement identifies certain gains and losses, which in the company's case at this time, include only foreign currency translation adjustments arising from translation of the company's Argentinean business units which are considered to be self-sustaining, that are recorded outside the income statement. Additionally, a separate component of equity, Accumulated Other Comprehensive Income, has been introduced to disclose comprehensive income balances on a cumulative basis. Finally, all financial instruments, including derivatives, are recorded in the company's consolidated balance sheet and measured at their fair values.
Under section 3855, the company is required to classify its financial instruments into one of five categories. The company has classified all of its financial instruments as Held for Trading, which requires measurement on the balance sheet at fair value with any changes in fair value recorded in income. This classification has been chosen due to the nature of the company's financial instruments. Transaction costs related to financial instruments classified as held for trading are recorded in income in accordance with the new standards.
The adoption of section 3865, "Hedges", has had no effect on the company's consolidated financial statements as the company has no hedging transactions in place at this time.
Over the next five years the CICA will adopt its new strategic plan for the direction of accounting standards in Canada, which was ratified in January 2006. As part of the plan, Canadian GAAP for public companies will converge with International Financial Reporting Standards ("IFRS") over the next five years. The company continues to monitor and assess the impact of the convergence of Canadian GAAP with IFRS.
The CICA has issued new Canadian accounting recommendations for additional disclosures about financial instruments and capital which will require disclosure and presentation of financial instruments about the nature and extent of risks arising from financial instruments to which the company is exposed. These recommendations are effective beginning January 1, 2008.
DISCLOSURE CONTROLS AND PROCEDURES
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 and Chief Financial Officer have concluded, based on their evaluation as of the end of the period 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.
INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of the company is responsible for designing adequate 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 Canadian GAAP. There have been no changes in the company's system of internal controls over financial reporting 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 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, 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 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 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. 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. 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. To date, none have been employed.
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.
OUTLOOK
The company's business plan contemplates continued aggressive growth. To accomplish this, the company expects an active capital program of oil and gas exploration and development drilling in 2007 and 2008 with capital spending for the full year 2007 reaching $106.5 million and capital spending for 2008 being budgeted at $140 million. The company no longer plans to publicly issue formal guidance for operating results due to the difficulties and challenges in forecasting drilling outcomes and timing at its current stage of development. Material drilling results and developments will continue to be reported in our customary manner.
The company holds $37.7 million face value of ABCP. This was previously held as a short-term investment but has now been reclassified as a long-term investment (after provision for impairment) on the company's balance sheet. These investments were made in accordance with the company's short-term investment policies which placed a primary emphasis on a high credit rating for the issuer and certainty of capital recovery. Despite the current problems in the Canadian ABCP market, which has become illiquid, the company believes it will recover its investment and is exerting all reasonable efforts to achieve this outcome. Regardless of the outcome of the company's efforts to recover its investment, in the interim, the company has sufficient liquidity derived from its current and anticipated production operations and its remaining financial resources, including other cash balances and a revolving reserve-based credit facility, to fund its planned activities. While efforts will continue to recover the value of the company's original investment in ABCP, there is no assurance of success in this regard.
All estimates and statements which are not statements of historical facts are forward-looking statements. These statements involve inherent risks and uncertainties where actual results will differ and such differences could be material. There can be no assurance that Petrolifera will achieve the drilling results, levels of production, sales, cash flow or working capital, it might assume in developing its internal capital budget and financial plan. In addition, oil and gas prices and foreign exchange are subject to fluctuation and there can be no assurance that the prices assumed for the company's internal plan, or any variation thereof, will be attained. Estimated production, cash flow and working capital are dependant on access to required services and equipment on a timely basis.
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FORWARD LOOKING STATEMENTS
This press release contains forward-looking statements, including but not limited to future drilling plans, anticipated capital expenditures, forecast production, Cash-flow and working capital, available sources of funding, recovery of investments as short term asset-backed commercial paper and results of certain arbitration matters. These statements are 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 commercial parties, risk associated with international activity and the uncertainties associated with timing and amount of recovery of investments in short-term asset backed commercial paper. Additional risks and uncertainties are described in the company's Annual Information Form which is filed on SEDAR at www.sedar.com.
The company's ability to complete its capital program and potentially increase production volumes and reserves is dependent on access to services, drilling rigs and equipment. Similarly, the company's ability to increase sales of oil and natural gas is dependent on sustained productivity of new and existing wells, maintenance (or reduction) of water cuts and completion of certain infrastructure and transportation systems that are currently under construction. There can be no assurance that the flow rates of newly drilled wells will result in stabilized production at these levels or that the company's new or existing high productivity wells will not incur higher water cuts than that previously reported or reductions in reservoir pressures, resulting in a decision to curtail production pending implementation of the proposed pressure maintenance program or other remedial measures. The timing and amount of recovery of the company's investment in short term asset backed commercial paper is dependent on the creditworthiness of the underlying assets held in such trusts and/or re-establishment of liquidity to the asset backed commercial paper market. These matters are outside of the control of the company and there can be no assurance as to such timing or resolution. Due to the risks, uncertainties and assumptions inherent in forward-looking statements, prospective investors in the company's securities should not place undue reliance on these forward-looking statements. Forward looking statements contained in this press release are made as of the date hereof and are subject to change. The company assumes no obligation to revise or update forward looking statements to reflect new circumstances, except as required by law.
A barrel of oil equivalent (boe), derived by converting gas to oil in the
ratio of six thousand cubic feet of gas to one barrel of oil, may be
misleading, particularly if used in isolation. A boe 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.
For further information: Richard A Gusella, Executive Chairman, Petrolifera Petroleum Limited, Phone: (403) 538-6202, Fax: (403) 538-6225, inquiries@petrolifera.ca, www.petrolifera.ca
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