(Unaudited)
(tabular amounts in millions of US dollars, except as noted)
1. CORPORATE INFORMATION
Talisman Energy Inc. (‘Talisman’ or ‘the Company’) is a public company incorporated pursuant to the laws of Canada and domiciled in Alberta, Canada, with common shares listed on the Toronto Stock Exchange and the New York Stock Exchange under the symbol ‘TLM’. The registered office is located at Suite 2000, 888 – 3rd Street SW, Calgary, Alberta, T2P 5C5.
The Company is in the business of exploration, development, production and marketing of crude oil, natural gas and natural gas liquids (NGLs).
The interim condensed Consolidated Financial Statements as at and for the three month period ended March 31, 2012 were approved by the Audit Committee on April 30, 2012.
2. BASIS OF PREPARATION
These interim condensed Consolidated Financial Statements have been prepared in accordance with International Accounting Standard (IAS) 34, Interim Financial Reporting as issued by the International Accounting Standards Board (IASB). Certain information and disclosures required to be included in notes to Annual Consolidated Financial Statements prepared in accordance with International Financial Reporting Standards (IFRS) and interpretations of the International Financial Reporting Interpretations Committee (IFRIC), as issued by the IASB, have been condensed or omitted.
The interim condensed Consolidated Financial Statements should be read in conjunction with the audited annual Consolidated Financial Statements as at and for the year ended December 31, 2011 and the notes thereto included in Talisman’s 2011 Annual Report.
These interim condensed Consolidated Financial Statements were prepared on a going concern basis, under the historical cost convention, except for certain financial assets and liabilities measured at fair value through the Consolidated Statement of Income (Loss).
3. SIGNIFICANT ACCOUNTING POLICIES
a) Accounting Policies Used
The interim condensed Consolidated Financial Statements have been prepared following the same accounting policies and methods of computation as the 2011 Annual Consolidated Financial Statements.
b) Accounting Pronouncements Not Yet Adopted
The Company continues to assess the impact of adopting the pronouncements from the IASB as described in the 2011 Annual Consolidated Financial Statements.
4. ASSETS SOLD AND HELD FOR SALE
Assets Held for Sale
The assets and liabilities of properties held for sale at March 31, 2012 have been classified separately on the Consolidated Balance Sheet and comprise the following:
| | | March 31, 2012 | |
| Assets | | | |
| Property, plant and equipment | | | 202 | |
| Exploration and evaluation assets | | | 15 | |
| Accounts receivable | | | 10 | |
| Goodwill | | | 9 | |
| Deferred tax assets | | | 16 | |
| Assets held for sale | | | 252 | |
| Liabilities | | | | |
| Accounts payable and accrued liabilities | | | 22 | |
| Decommissioning liabilities | | | 26 | |
| Deferred tax liabilities | | | 68 | |
| Liabilities associated with assets held for sale | | | 116 | |
In North America, Talisman has entered into two agreements to sell oil and gas producing assets in Western Canada. These transactions are expected to close in the second quarter of 2012. The Company has recorded an impairment of $60 million in relation to one of these transactions, which represents the expected pre-tax loss on sale. The second transaction is expected to result in a gain, which will be recorded upon closing.
In the North Sea, Talisman has classified exploration and evaluation assets with a carrying value of $15 million as held for sale. This transaction is expected to close in the second quarter of 2012.
Sale of Non-Core Coal Assets
In March 2012, Talisman sold non-core coal assets in northern British Columbia for cash consideration of $496 million after transaction costs. The carrying value of these assets was $nil and a gain of $372 million was recorded, net of tax of $124 million.
Sale of Farrell Creek interests to Sasol Limited (Sasol)
In March 2011, Talisman created a strategic partnership with Sasol to develop the Farrell Creek assets in Talisman’s Montney shale play in British Columbia. Talisman sold 50% of its working interests in the Farrell Creek assets for total consideration of approximately $1 billion, comprising $238 million in cash and approximately $800 million of certain future development costs. The transaction resulted in a pre-tax gain of $89 million, which is included in ‘Gain on asset disposals’ on the Consolidated Statement of Loss.
5. BUSINESS COMBINATIONS
Equión Energía Limited
On January 24, 2011, Talisman, together with Ecopetrol, completed the acquisition of BP Exploration Company (Colombia) Limited, renamed Equión Energía Limited (Equión). Talisman acquired a 49% interest in Equión for cash consideration of $785 million. Since Equión is a jointly controlled entity, the Company is proportionately consolidating its interest, which is reported in the Other segment.
The assets acquired through this transaction include interests in producing properties and investments in companies having interests in oil and gas pipelines in Colombia.
This acquisition, which builds on the Company’s acreage position in Colombia, was accounted for using the acquisition method. The fair values of the identifiable assets acquired and liabilities assumed by Talisman, after working capital and other adjustments, were as follows:
| Fair value of net assets acquired | | | |
| Property, plant and equipment | | | 559 | |
| Cash | | | 16 | |
| Accounts receivable | | | 81 | |
| Inventories | | | 16 | |
| Investments | | | 350 | |
| Indemnification asset | | | 52 | |
| Accounts payable | | | (113 | ) |
| Other current liabilities | | | (52 | ) |
| Decommissioning liability | | | (25 | ) |
| Provisions | | | (52 | ) |
| Deferred tax liability | | | (209 | ) |
| Total identifiable net assets at fair value | | | 623 | |
| Goodwill arising on acquisition (note 7) | | | 162 | |
| Total cost of acquisition | | | 785 | |
| Satisfied by: | | | | |
| Cash paid in 2010 | | | 613 | |
| Cash paid in 2011 | | | 172 | |
| Total cash paid | | | 785 | |
The fair value of the acquired trade accounts receivable approximates the carrying value due to their short term nature. None of the accounts receivable were impaired and the full contractual amount was collected.
The goodwill arising on acquisition is attributable to the difference between the accounting fair value and the tax basis of the net assets acquired, and is not expected to be deductible for income tax purposes.
From the date of acquisition, Equión contributed revenue of $50 million and net income of $26 million to the Company’s Consolidated Statement of Loss for the three month period ended March 31, 2011. Had the transaction closed on January 1, 2011, the incremental revenue and net income reported by Talisman would have been immaterial.
As part of the purchase transaction, Talisman assumed provisions of $52 million for which the vendor has indemnified the Company. Accordingly, a non-current asset has been recorded in the same amount.
No contingent consideration arose from this transaction.
6. JOINTLY CONTROLLED ENTITIES
Talisman accounts for jointly controlled entities using proportionate consolidation. Summarized financial information for the Company’s jointly controlled entities, comprising Equión and Talisman Sasol Montney Partnership, is as follows:
| | | March 31, 2012 | | | December 31, 2011 | |
| Current assets | | | 370 | | | | 367 | |
| Non-current assets | | | 1,684 | | | | 1,740 | |
| Total assets | | | 2,054 | | | | 2,107 | |
| Current liabilities | | | 259 | | | | 287 | |
| Non-current liabilities | | | 205 | | | | 260 | |
| Total liabilities | | | 464 | | | | 547 | |
| | | Three months ended March 31 | |
| | | 2012 | | | 2011 | |
| Total revenue and other income | | | 125 | | | | 290 | |
| Total expenses (including income taxes) | | | (85 | ) | | | (179 | ) |
| Net income | | | 40 | | | | 111 | |
7. GOODWILL
Changes in the carrying amount of the Company’s goodwill are as follows:
| | | Three months ended March 31, 2012 | | | Year ended December 31, 2011 | |
| Balance, beginning of period | | | 1,317 | | | | 1,164 | |
| Acquisitions (note 5) | | | - | | | | 162 | |
| Reclassified to assets held for sale (note 4) | | | (9 | ) | | | - | |
| Disposals | | | - | | | | (9 | ) |
| Balance, end of period | | | 1,308 | | | | 1,317 | |
Goodwill has no tax basis.
8. OTHER ASSETS
| | | March 31, 2012 | | | December 31, 2011 | |
| Accrued pension asset | | | 2 | | | | 1 | |
| Decommissioning sinking fund | | | 41 | | | | 38 | |
| Indemnification asset | | | 52 | | | | 52 | |
| Other | | | 17 | | | | 10 | |
| Total | | | 112 | | | | 101 | |
9. OIL AND GAS ASSETS
The cost and accumulated depreciation, depletion and amortization (DD&A) of the Company’s property, plant and equipment (PP&E), including corporate assets, and exploration and evaluation (E&E) assets are as follows:
| | | PP&E | | | E&E assets | | | Total | |
| | | | | | | | | | |
| Cost | | | | | | | | | |
| At December 31, 2010 | | | 25,217 | | | | 3,758 | | | | 28,975 | |
| | | | | | | | | | | | | |
| Acquisitions through business combinations (note 5) | | | 559 | | | | - | | | | 559 | |
| Other additions | | | 3,491 | | | | 1,527 | | | | 5,018 | |
| Disposals and derecognition | | | (384 | ) | | | (192 | ) | | | (576 | ) |
| Transfers from E&E assets to PP&E | | | 654 | | | | (654 | ) | | | - | |
| Change in decommissioning liabilities | | | 363 | | | | - | | | | 363 | |
| Expensed to dry hole | | | - | | | | (241 | ) | | | (241 | ) |
| | | | | | | | | | | | | |
| At December 31, 2011 | | | 29,900 | | | | 4,198 | | | | 34,098 | |
| | | | | | | | | | | | | |
| Additions | | | 885 | | | | 125 | | | | 1,010 | |
| Disposals and derecognition | | | (7 | ) | | | (7 | ) | | | (14 | ) |
| Transfers from E&E assets to PP&E | | | 145 | | | | (145 | ) | | | - | |
| Change in decommissioning liabilities | | | (50 | ) | | | - | | | | (50 | ) |
| Expensed to dry hole | | | - | | | | (60 | ) | | | (60 | ) |
| Reclassified to assets held for sale | | | (625 | ) | | | (15 | ) | | | (640 | ) |
| | | | | | | | | | | | | |
| At March 31, 2012 | | | 30,248 | | | | 4,096 | | | | 34,344 | |
| | | | | | | | | | | | | |
| Accumulated DD&A | | | | | | | | | | | | |
| At December 31, 2010 | | | 11,951 | | | | 316 | | | | 12,267 | |
| | | | | | | | | | | | | |
| Charge for the year | | | 1,949 | | | | - | | | | 1,949 | |
| Disposals and derecognition | | | (88 | ) | | | (119 | ) | | | (207 | ) |
| Impairment losses | | | 313 | | | | 47 | | | | 360 | |
| Impairment reversal | | | (134 | ) | | | - | | | | (134 | ) |
| | | | | | | | | | | | | |
| At December 31, 2011 | | | 13,991 | | | | 244 | | | | 14,235 | |
| | | | | | | | | | | | | |
| Charge for the period | | | 614 | | | | - | | | | 614 | |
| Disposals and derecognition | | | - | | | | - | | | | - | |
| Impairment losses | | | 1,053 | | | | - | | | | 1,053 | |
| Reclassified to assets held for sale | | | (423 | ) | | | - | | | | (423 | ) |
| | | | | | | | | | | | | |
| At March 31, 2012 | | | 15,235 | | | | 244 | | | | 15,479 | |
| | | | | | | | | | | | | |
| Net book value | | | | | | | | | | | | |
| At March 31, 2012 | | | 15,013 | | | | 3,852 | | | | 18,865 | |
| At December 31, 2011 | | | 15,909 | | | | 3,954 | | | | 19,863 | |
| At December 31, 2010 | | | 13,266 | | | | 3,442 | | | | 16,708 | |
10. IMPAIRMENT
| | | Three months ended March 31 | |
| | | 2012 | | | 2011 | |
| Impairment losses | | | | | | |
| Exploration and evaluation assets | | | - | | | | 47 | |
| Property, plant and equipment | | | 1,053 | | | | 55 | |
| | | | 1,053 | | | | 102 | |
The Yme project in Norway has experienced significant delays and cost overruns and is subject to arbitration with the platform contractor. The Company has considered further internal and external engineering studies of the Yme facility completed in April 2012 and updated estimates of project costs and completion dates. It is clear that considerable work remains to be completed in order for the facility to comply with Norwegian offshore safety and environmental standards and be ready for first oil. While management remains committed to the development of the Yme project with the primary focus being the completion of the facility by the contractor, the Company is considering alternative solutions that assume cost and start up estimates that differ from those used in the preparation of the December 31, 2011 Consolidated Financial Statements. Assumptions with respect to the price of oil and the Company’s post-tax discount rate are consistent with those used at December 31, 2011. The estimated recoverable amount of the Yme at March 31, 2012 has declined since December 31, 2011 and is less than its carrying value. Accordingly, the Company recorded impairment of $248 million after-tax ($978 million pre-tax) for the three month period ended March 31, 2012. The remaining book value associated with the Company’s investment in the Yme project is $630 million. Management’s evaluation of options is expected to continue throughout 2012.
During the three month period ended March 31, 2012, the Company also recorded impairment of $75 million in North America, of which $60 million relates to the estimated loss on sale as described in note 4, and $15 million related to a non-core natural gas property in North America resulting from a reduction in near-term natural gas price assumptions.
During the three month period ended March 31, 2011, the Company recorded impairment of $102 million in the North Sea in respect of PP&E and E&E assets as a result of a change in tax legislation announced by the UK Government in March 2011.
11. DECOMMISSIONING LIABILITIES
| | Three months ended March 31, 2012 | | | Year ended December 31, 2011 | |
| Balance, beginning of period | | 3,035 | | | | 2,610 | |
| Liabilities incurred during the period | | 1 | | | | 115 | |
| Liabilities settled during the period | | (14 | ) | | | (44 | ) |
| Accretion expense (note 12) | | 21 | | | | 76 | |
| Revisions in estimated cash flows | | 1 | | | | 204 | |
| Change in discount rate | | (52 | ) | | | 74 | |
| Reclassified to liabilities associated with assets held for sale (note 4) | | (26 | ) | | | - | |
| Balance, end of period | | 2,966 | | | | 3,035 | |
| Expected to be settled within one year | | 49 | | | | 53 | |
| Expected to be settled in more than one year | | 2,917 | | | | 2,982 | |
| | | 2,966 | | | | 3,035 | |
Decommissioning liabilities have been discounted using a weighted average credit-adjusted risk free rate of 5.3% at March 31, 2012 (December 31, 2011 – 5.1%).
12. FINANCE COSTS
| | | Three months ended March 31 | |
| | | 2012 | | | 2011 | |
| Interest on long-term debt | | | 60 | | | | 61 | |
| Miscellaneous interest expense and other fees | | | 15 | | | | 14 | |
| Accretion expense (note 11) | | | 21 | | | | 19 | |
| Less: interest capitalized | | | (25 | ) | | | (18 | ) |
| | | | 71 | | | | 76 | |
13. LONG-TERM DEBT
| | | March 31, 2012 | | | December 31, 2011 | |
| Bank Credit Facilities | | | 225 | | | | 648 | |
| Commercial Paper | | | 660 | | | | 402 | |
| Tangguh Project Financing | | | 97 | | | | 97 | |
| Debentures and Notes (Unsecured): | | | | | | | | |
| US$ denominated | | | 3,364 | | | | 3,363 | |
| UK£ denominated (UK£250 million) | | | 395 | | | | 385 | |
| | | | 4,741 | | | | 4,895 | |
| Less: current portion | | | (892 | ) | | | (410 | ) |
| | | | 3,849 | | | | 4,485 | |
During the three month period ended March 31, 2012, Talisman issued $258 million of commercial paper, and repaid $429 million (2011 - $308 million repayment) of debt from cash on hand.
At March 31, 2012, $225 million in the form of C$ bankers’ acceptances was drawn on the Company’s $4.1 billion bank lines that are fully committed through 2014. In addition, $660 million of commercial paper was outstanding, the amount of which is limited to the availability of backup funds under the Company’s bank credit facilities.
14. OTHER LONG-TERM OBLIGATIONS
| | | March 31, 2012 | | | December 31, 2011 | |
| Accrued pension and other post-employment benefits liability | | | 157 | | | | 163 | |
| Deferred credits | | | 21 | | | | 25 | |
| Long-term portion of discounted obligations under finance leases | | | 64 | | | | 66 | |
| Long-term portion of share-based payments liability (note 15) | | | 17 | | | | 14 | |
| Acquired provisions (note 5) | | | 52 | | | | 52 | |
| Other | | | 30 | | | | 26 | |
| | | | 341 | | | | 346 | |
15. SHARE CAPITAL AND SHARE-BASED PAYMENTS1
Authorized
Talisman's authorized share capital consists of an unlimited number of common shares without nominal or par value and an unlimited number of first and second preferred shares.
Common Shares Issued
| Continuity of common shares | | Three months ended March 31, 2012 | | | Year ended December 31, 2011 | |
| | | Shares | | | Amount | | | Shares | | | Amount | |
| Balance, beginning of period | | | 1,021,422,470 | | | | 1,561 | | | | 1,019,290,939 | | | | 1,480 | |
| Issued on exercise of stock options | | | 471,260 | | | | 5 | | | | 7,500,131 | | | | 175 | |
| Shares purchased and held in trust for long-term PSU plan | | | (320,000 | ) | | | (4 | ) | | | (5,368,600 | ) | | | (94 | ) |
| Shares released from trust for long-term PSU plan | | | 4,859,037 | | | | 88 | | | | - | | | | - | |
Balance, end of period2 | | | 1,026,432,767 | | | | 1,650 | | | | 1,021,422,470 | | | | 1,561 | |
Subsequent to March 31, 2012, 21,992 common shares were issued pursuant to the exercise of stock options resulting in 1,026,454,759 common shares being outstanding at April 26, 2012.
Preferred Shares Issued
| Continuity of preferred shares | | Three months ended March 31, 2012 | | | Year ended December 31, 2011 | |
| | | Shares | | | Amount | | | Shares | | | Amount | |
Cumulative Redeemable Rate Reset First Preferred Shares, 4.2% Series 1: | | | | | | | | | | | | |
| Balance, beginning of period | | | 8,000,000 | | | | 191 | | | | - | | | | - | |
| Issued | | | - | | | | - | | | | 8,000,000 | | | | 191 | |
| Balance, end of period | | | 8,000,000 | | | | 191 | | | | 8,000,000 | | | | 191 | |
On December 5, 2011, Talisman issued 8,000,000 Cumulative Redeemable Rate Reset First Preferred Shares, Series 1 at a price of C$25 per share for aggregate gross proceeds of C$200 million. Net proceeds, after deducting underwriting fees, were C$194 million ($191 million).
During the three month period ended March 31, 2012, Talisman declared a preferred share dividend of $0.3136 per share for an aggregate dividend of $3 million, which was paid on April 2, 2012.
Stock Option Plans
Talisman has stock option plans that govern the granting of options to employees and directors. No options have been issued to non-executive directors since 2003. All options issued by the Company permit the holder to purchase a specified number of common shares of the Company at the stated exercise price or to receive a cash payment equal to the appreciated value of the shares underlying the stock option.
1. Dollar amounts in share-based payments tables are provided in C$
2. Excluding aggregate shares held in trust for long-term PSU plan
| Continuity of stock options | | Three months ended March 31, 2012 | | | Year ended December 31, 2011 | |
| | | Number of shares underlying options | | | Weighted average
exercise price (C$) | | | Number of shares
underlying options | | | Weighted average exercise price (C$) | |
| Outstanding, beginning of period | | | 59,092,044 | | | | 16.82 | | | | 62,959,223 | | | | 15.89 | |
| Granted | | | 61,520 | | | | 14.21 | | | | 6,686,170 | | | | 23.29 | |
| Exercised for common shares | | | (471,260 | ) | | | 7.81 | | | | (7,500,131 | ) | | | 14.54 | |
| Surrendered for cash | | | (13,583 | ) | | | 9.51 | | | | (642,889 | ) | | | 15.62 | |
| Forfeited | | | (1,120,583 | ) | | | 18.29 | | | | (2,410,329 | ) | | | 17.40 | |
| Outstanding, end of period | | | 57,548,138 | | | | 16.86 | | | | 59,092,044 | | | | 16.82 | |
| Exercisable, end of period | | | 38,841,905 | | | | 16.39 | | | | 39,242,566 | | | | 16.33 | |
The fair value of the liability for stock options at March 31, 2012 was $179 million (December 31, 2011 – $209 million) of which $164 million (December 31, 2011 - $196 million) is included in accounts payable and accrued liabilities on the Consolidated Balance Sheets.
Subsequent to March 31, 2012, 8,117,130 options were granted, 21,992 were exercised for shares, 1,467 were surrendered for cash and 381,095 were forfeited, with 65,260,714 stock options outstanding at April 26, 2012.
Cash Unit Plans
In addition to the Company's stock option plans, various subsidiaries of the Company issue stock appreciation rights under cash unit plans. Cash units are similar to stock options except that the holder does not have a right to purchase the underlying shares of the Company.
Continuity of cash units | | Three months ended March 31, 2012 | | | Year ended December 31, 2011 | |
| | | Number of units | | | Weighted average exercise price (C$) | | | Number of units | | | Weighted average exercise price (C$) | |
| Outstanding, beginning of period | | | 9,461,164 | | | | 17.35 | | | | 10,112,792 | | | | 16.64 | |
| Granted | | | 92,240 | | | | 14.19 | | | | 1,547,670 | | | | 22.34 | |
| Exercised | | | (12,284 | ) | | | 9.81 | | | | (1,636,458 | ) | | | 17.42 | |
| Forfeited | | | (118,045 | ) | | | 17.73 | | | | (562,840 | ) | | | 18.33 | |
| Outstanding, end of period | | | 9,423,075 | | | | 17.28 | | | | 9,461,164 | | | | 17.35 | |
| Exercisable, end of period | | | 6,217,771 | | | | 16.94 | | | | 6,234,650 | | | | 16.90 | |
The fair value of the liability for the cash unit plans at March 31, 2012 was $29 million (December 31, 2011 – $28 million), of which $27 million (December 31, 2011 - $27 million) is included in accounts payable and accrued liabilities on the Consolidated Balance Sheets.
Subsequent to March 31, 2012, 2,226,990 cash units were granted, 9,270 were exercised and 114,660 were forfeited, with 11,526,135 cash units outstanding at April 26, 2012.
Long-Term Performance Share Unit (PSU) Plan
In 2009, the Company implemented a long-term PSU plan that allows for the granting of PSUs to employees and vesting to varying degrees (0–150%) subject to predetermined performance measures being achieved. Each PSU represents the right, subject to performance metrics and vesting conditions, to receive one common share of the Company. Participants in the PSU plan are credited with additional PSUs corresponding to any associated dividend payments (referred to as “dividend equivalent PSUs”).
Continuity of long-term PSU plan | | Three months ended
March 31, 2012 | | | Year ended December 31, 2011 | |
| | | Number of Units | | | Number of Units | |
| Outstanding, beginning of period | | | 11,219,027 | | | | 8,173,762 | |
| Granted | | | 64,453 | | | | 3,450,930 | |
| Settled | | | (4,672,151 | ) | | | - | |
| Forfeited | | | (155,562 | ) | | | (605,949 | ) |
| Dividend equivalent PSUs | | | - | | | | 200,284 | |
| Outstanding, end of period | | | 6,455,767 | | | | 11,219,027 | |
To satisfy the Company’s obligation to deliver common shares to settle the PSUs, Talisman has arranged for a third party trustee to hold common shares which were purchased on the open market. During the three month period ended March 31, 2012, the Company purchased 320,000 common shares on the open market for $4 million.
The 2009 long-term PSU grant vested on December 31, 2011 and the obligation was settled in March 2012. Based on the Company’s performance relative to the predetermined performance measures, the Board of Directors approved the vesting of 104% of the PSUs granted. 4,859,037 shares were released from trust in order to settle the obligation.
Subsequent to March 31, 2012, 10,394,024 long-term PSUs were granted and 92,753 were forfeited with 16,757,038 outstanding at April 26, 2012. During this period, the Company did not purchase any further common shares on the open market to settle the PSUs.
Deferred Share Unit (DSU) Plan
Talisman issues DSUs to directors in lieu of cash compensation. Each DSU represents the right to receive a cash payment on retirement equal to the market value of the Company’s shares at the time of surrender. Dividends are credited as additional DSUs when paid. At March 31, 2012, there were 394,655 (December 31, 2011 – 394,655) units outstanding and the fair value of the liability was $5 million (December 31, 2011 – $5 million), which is included in accounts payable and accrued liabilities on the Consolidated Balance Sheets. Expense related to the DSUs is recognized in general and administrative expenses on the Consolidated Statements of Income (Loss).
Restricted Share Unit (RSU) Plan
Talisman has a RSU plan that grants RSUs to eligible employees. All RSUs issued by the Company permit the holder to receive a cash payment equal to the market value of the stock. Participants are also credited with additional RSUs corresponding to any associated notional dividend payments (referred to as “dividend equivalent RSUs”). Typically, RSUs granted under the plan are paid three years after the grant date. At March 31, 2012, there were 334,399 (December 31, 2011 – 404,683) units outstanding (including dividend equivalent RSUs) and the fair value of the liability was $2 million (December 31, 2011 – $2 million), which is included in accounts payable and accrued liabilities on the Consolidated Balance Sheets.
Share-Based Payments Expense
The Black-Scholes option pricing model is used to estimate the fair value of share-based payment plans, with the following assumptions:
| | | March 31, 2012 | | | December 31, 2011 | |
| Expected volatility | | | 48 | % | | | 45 | % |
| Risk free interest rate | | | 1.6 | % | | | 1.3 | % |
| Expected term (years) | | | 5 | | | | 5 | |
| Expected forfeiture rate | | | 3.8 | % | | | 3.5 | % |
| Expected annual dividend yield | | | 1.4 | % | | | 1.2 | % |
During the three month period ended March 31, 2012, the Company recorded a share-based payments recovery of $41 million (2011 - $116 million expense) in respect of the plans described above as follows: stock options - $28 million recovery, cash units - $1 million expense, long-term PSUs - $14 million recovery. The share-based payments expense includes a cash payment of $1 million (2011 - $7 million) to employees in settlement of fully accrued share-based payments liabilities for stock options and cash units exercised in the period.
The Company recorded a net decrease in contributed surplus of $99 million during the three month period ended March 31, 2012, relating to its long-term PSU plan net of applicable equity tax deductions, compared to a net increase of $25 million during the three month period ended March 31, 2011.
Of the combined obligation for cash-settled stock option, cash unit, DSU and RSU plans of $215 million (December 31, 2011 – $244 million), $198 million (December 31, 2011 – $230 million) is included in accounts payable and accrued liabilities on the Consolidated Balance Sheets and $17 million (December 31, 2011 – $14 million) is included in other long-term obligations.
16. FINANCIAL INSTRUMENTS
Talisman’s financial assets and liabilities at March 31, 2012 comprise cash and cash equivalents, accounts receivable, investments, accounts payable and accrued liabilities, long-term debt (including the current portion) and risk management assets and liabilities arising from the use of derivative financial instruments.
Fair Value of Financial Assets and Liabilities
The fair value of public debentures and notes is based on market quotations, which reflect the discounted present value of the principal and interest payments using the effective yield for instruments having the same term and risk characteristics. The fair value of Talisman’s long-term debt at March 31, 2012 was $5.3 billion (December 31, 2011 – $5.5 billion) while the carrying value was $4.7 billion (December 31, 2011 - $4.9 billion). The fair values of all other financial assets and liabilities approximate their carrying values.
Talisman’s processes for estimating and classifying the fair value of financial instruments are consistent with those in place at December 31, 2011. The following table presents the Company’s risk management assets and liabilities measured at fair value for each hierarchy level as at March 31, 2012:
| | | Fair value measurements using | |
| | | Level 1 inputs | | | Level 2 inputs | | | Level 3 inputs | | | Total fair value | |
| Assets | | | | | | | | | | | | |
| Interest rate swaps | | | - | | | | 40 | | | | - | | | | 40 | |
| Liabilities | | | | | | | | | | | | | | | | |
| Commodity collars | | | - | | | | 20 | | | | - | | | | 20 | |
There were no changes in level 3 inputs during the three month period ended March 31, 2012.
Risk Management Assets, Liabilities, Gains and Losses
| Derivative instrument | Balance sheet presentation | | March 31, 2012 | | | December 31, 2011 | |
| Interest rate swaps | Current assets | | | 13 | | | | 12 | |
| Interest rate swaps | Non-current assets | | | 27 | | | | 24 | |
| Commodity contracts | Current assets | | | - | | | | 30 | |
| Risk management assets | | | | 40 | | | | 66 | |
| | | | | | | | | | |
| Commodity contracts | Current liabilities | | | 20 | | | | - | |
The Company recorded a loss on held-for-trading financial instruments of $47 million during the three month period ended March 31, 2012 (2011 - $319 million).
Currency Risk
Talisman operates internationally and is therefore exposed to foreign exchange risk. Talisman’s primary exposures are from fluctuations in the US$ relative to the C$, UK£ and NOK.
Talisman manages its foreign exchange exposure in a number of ways. By denominating most of its borrowings in US$, the Company is able to reduce some of its economic exposure to currency fluctuations. Talisman also manages its translation exposure by generally matching internal borrowings with its subsidiaries’ functional currencies. The Company purchases foreign currencies, mostly at spot value, to meet its current foreign currency obligations as they come due. Talisman had no material outstanding foreign exchange forward contracts at March 31, 2012.
In respect of financial instruments existing at March 31, 2012, a 1% strengthening of the US$ against the other currencies to which the Company is exposed (C$, UK£ and NOK), with all other variables assumed constant, would have resulted in an increase of $11 million in the net income for the three month period ended March 31, 2012. A similar weakening of the US$ would have had the opposite impact.
In conjunction with the issuance of the 4.44% C$350 million medium term notes, the Company entered into a cross currency swap in order to hedge the foreign exchange exposure on this C$ denominated liability. As a result, the Company was effectively paying interest semi-annually in US$ at a rate of 5.05% on a notional amount of US$304 million. The cross currency swap was designated as a cash flow hedge. The notes were repaid in January 2011 and the hedge was settled.
Interest Rate Risk
Talisman is exposed to interest rate risk principally by virtue of its borrowings. Borrowing in floating rates exposes Talisman to short-term movements in interest rates. Borrowing at fixed rates exposes Talisman to reset risk (i.e. at debt maturity).
In order to mitigate its exposure to interest rate changes, Talisman enters into interest rate swaps from time to time to manage the ratio of fixed rate debt to floating rate debt. At March 31, 2012, the Company had fixed-to-floating interest rate swap contracts with a total notional amount of $300 million that expire on May 15, 2015. For the three month period ended March 31, 2012, the fair value of the fixed-to-floating interest rate swaps increased by $4 million.
In respect of financial instruments existing at March 31, 2012, a 1% increase in interest rates would have resulted in a $13 million decrease in the net income for the three month period ended March 31, 2012, principally related to the fair value of the interest rate swap. A similar decrease in interest rates would have had the opposite effect.
Credit Risk
A significant proportion of Talisman’s accounts receivable balance is with customers in the oil and gas industry and is subject to normal industry credit risks. At March 31, 2012, approximately 96% of the Company's trade accounts receivable were current and the largest single counterparty exposure, accounting for 17% of the total, was with a very highly rated counterparty. Concentration of credit risk is mitigated by having a broad domestic and international customer base of highly rated counterparties. The maximum credit exposure associated with accounts receivable is the carrying value.
Liquidity Risk
Talisman is exposed to liquidity risk, which is the risk that the Company may be unable to generate or obtain sufficient cash to meet its commitments as they come due. Talisman mitigates this risk through its management of cash, debt, committed credit capacity and its capital program.
Talisman maintains appropriate undrawn capacity in its revolving credit facilities to meet short-term fluctuations from forecasted results. Talisman manages its liquidity requirements by use of both short-term and long-term cash forecasts, and by maintaining appropriate undrawn capacity under committed bank credit facilities. The Company has in place a total of $4.1 billion bank lines that are fully committed through 2014. At March 31, 2012, $225 million in the form of C$ bankers’ acceptances was drawn and $660 million of the available capacity was used to backstop commercial paper issued. Available borrowing capacity was $3.2 billion at March 31, 2012.
In addition, the Company utilizes letters of credit pursuant to letter of credit facilities, most of which are uncommitted. At March 31, 2012, letters of credit totaling $1.6 billion had been issued under these facilities.
With the exception of commercial paper and bankers’ acceptances, the Company has no significant debt maturities until 2014.
Except for commodity price derivative contracts that mature as noted below, long-term debt detailed in note 13 and other long-term obligations detailed in note 14, all of the Company’s financial liabilities are due within one year.
Commodity Price Risk
Talisman is exposed to commodity price risk since its revenues are dependent on the price of crude oil, natural gas, and natural gas liquids. Talisman enters into derivative instruments from time to time to mitigate commodity price risk volatility under guidelines approved by the Board of Directors. The Company may hedge a portion of its future production to protect cash flows to allow it to meet its strategic objectives.
The Company had the following commodity price derivative contracts not designated as hedges outstanding at March 31, 2012:
| | | | | | Floor/ceiling | | | | |
| Two-way collars | Term | | bbls/d | | US$/bbl | | | Fair value | |
| Dated Brent oil index | Apr-Dec 2012 | | | 20,000 | | | 90.00/148.36 | | | | (1 | ) |
| Dated Brent oil index | Apr-Jun 2012 | | | 9,000 | | | 90.00/126.93 | | | | (2 | ) |
| Dated Brent oil index | Apr-Jun 2012 | | | 11,000 | | | 90.00/155.16 | | | | - | |
| Dated Brent oil index | Apr-Jun 2012 | | | 10,000 | | | 90.00/123.08 | | | | (3 | ) |
| Dated Brent oil index | Jul-Dec 2012 | | | 10,000 | | | 90.00/119.26 | | | | (14 | ) |
| | | | | | | | | | | | (20 | ) |
In respect of outstanding financial instruments and assuming forward commodity prices in existence at March 31, 2012, an increase of US$1/bbl in the price of oil would have reduced the net fair value of commodity derivatives, thereby resulting in a decrease in net income of approximately $3 million for the three month period ended March 31, 2012. A similar decrease in commodity prices would result in an increase in net income of approximately $3 million for the three month period ended March 31, 2012. However, the net income would also be impacted by the effect of the change in the commodity price on underlying transactions and taxes.
17. CONTINGENCIES AND COMMITMENTS
Contingencies
From time to time, Talisman is the subject of litigation arising out of the Company’s operations. Damages claimed under such litigation may be material or may be indeterminate and the outcome of such litigation may materially impact the Company’s financial condition or results of operations. While Talisman assesses the merits of each lawsuit and defends itself accordingly, the Company may be required to incur significant expenses or devote significant resources to defend itself against such litigation. These claims are not currently expected to have a material impact on the Company’s financial position.
The New York Attorney General has commenced an investigation, pursuant to the Martin Act, into the disclosure practices of companies engaged in hydraulic fracturing in the New York State area. The Martin Act provides broad authority to commence and conduct investigations, whether upon receipt of a complaint, or on the Attorney General’s own initiative. Subpoenas have been issued to a number of companies, including Talisman. The Company has been cooperating with the New York Attorney General in the investigation. No enforcement action has been taken against Talisman, nor has the Company been advised that any enforcement action is imminent.
Commitments
During the three month period ended March 31, 2012, the Company entered into contracts to secure long-term transportation and processing capacity in the Eagle Ford. The total commitment associated with these contracts is approximately $450 million over 15 years, of which approximately $190 million is expected to be incurred within the next five years. There have been no other significant changes in the Company’s expected future payment commitments, and the timing of those payments, since December 31, 2011. Refer to note 23 to the 2011 audited Consolidated Financial Statements for details of the Company’s commitments.
18. OTHER EXPENSES, NET
| | | Three months ended March 31 | |
| | | 2012 | | | 2011 | |
| Foreign exchange loss | | | 31 | | | | 40 | |
| Derecognition | | | 6 | | | | 6 | |
| Rig cancellation fees | | | 9 | | | | - | |
| Other | | | 31 | | | | 12 | |
| | | | 77 | | | | 58 | |
19. INCOME TAXES
Current Tax Expense (Recovery)
| | | Three months ended March 31 | |
| | | 2012 | | | 2011 | |
| North America | | | (3 | ) | | | 2 | |
| North Sea | | | 213 | | | | 321 | |
| Southeast Asia | | | 175 | | | | 97 | |
| Other | | | 48 | | | | 23 | |
| Total | | | 433 | | | | 443 | |
Deferred Tax Expense (Recovery)
| | | Three months ended March 31 | |
| | | 2012 | | | 2011 | |
| North America | | | (8 | ) | | | (91 | ) |
| North Sea | | | (742 | ) | | | 122 | |
| Southeast Asia | | | (13 | ) | | | (11 | ) |
| Other | | | (24 | ) | | | (7 | ) |
| Total | | | (787 | ) | | | 13 | |
The $730 million tax effect of the Yme impairment has resulted in a net deferred tax asset in Norway of $560 million, which is expected to be recoverable through the generation of future taxable income from the Company’s Norwegian assets and under existing tax legislation.
In March 2011, the UK government announced that, from March 24, 2011, the rate of supplementary charge levied on ring fence profits increased from 20% to 32%. Supplementary charge is levied on ring fence profits in addition to the ring fence corporation tax rate of 30%, which remains unchanged. Consequently, there is now a combined UK corporation tax and supplementary charge rate of 62% for oil and gas companies with fields not subject to PRT and 75% to 81% with fields subject to PRT. If the price of oil falls below a certain level (currently expected to be $75/bbl) for a sustained period of time, the UK government has indicated that it will reduce the supplementary charge rate back towards 20% on a “staged and affordable basis” while prices remain low. As a result of this legislative change, the Company recorded additional current income tax expense of $27 million and additional deferred tax expense of $225 million in the North Sea during the three month period ended March 31, 2011.
20. SUPPLEMENTAL CASH FLOW INFORMATION
Items Not Involving Cash
| | | Three months ended March 31 | |
| | | 2012 | | | 2011 | |
| Depreciation, depletion and amortization | | | 603 | | | | 469 | |
| Impairment | | | 1,053 | | | | 102 | |
| Dry hole | | | 60 | | | | 104 | |
| Share-based payments expense (recovery) | | | (42 | ) | | | 109 | |
| Gain on asset disposals | | | (505 | ) | | | (92 | ) |
| Unrealized loss on held-for-trading financial instruments | | | 38 | | | | 272 | |
| Deferred income tax (recovery) | | | (787 | ) | | | 13 | |
| Other | | | 44 | | | | 29 | |
| | | | 464 | | | | 1,006 | |
Other Cash Flow Information
| | | Three months ended March 31 | |
| | | 2012 | | | 2011 | |
| Cash interest paid | | | 64 | | | | 57 | |
| Cash interest received | | | 4 | | | | 2 | |
| Cash income taxes paid | | | 424 | | | | 344 | |
21. CASH AND CASH EQUIVALENTS
Of the cash and cash equivalents balance of $732 million, $322 million has been invested in bank deposits and the remainder in highly rated marketable securities with maturities of less than three months.
22. SEGMENTED INFORMATION
Talisman's activities are conducted in four geographic segments: North America, the North Sea, Southeast Asia and Other. The North America segment includes operations in Canada and the US. The North Sea segment includes operations and exploration activities in the UK and Norway. The Southeast Asia segment includes operations and exploration activities in Indonesia, Malaysia, Vietnam and Papua New Guinea and operations in Australia/Timor-Leste. The Company also conducts operations in Algeria, operations and exploration activities in Colombia, and exploration activities in Peru, Poland, Sierra Leone and the Kurdistan region of northern Iraq. For ease of reference, the activities in Algeria, Colombia, Peru, Poland, Sierra Leone and the Kurdistan region of northern Iraq are referred to collectively as the Other geographic segment. All activities relate to the exploration, development, production and transportation of oil, liquids and natural gas.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | North America1 | | North Sea2 | | | Southeast Asia3 | | | Other4 | | Total | |
| | | Three months ended March 31 | | Three months ended March 31 | | Three months ended March 31 | | | Three months ended March 31 | | | Three months ended March 31 | |
| (millions of US$) | | 2012 | | | 2011 | | | 2012 | | | 2011 | | | 2012 | | | 2011 | | | 2012 | | | 2011 | | | 2012 | | | 2011 | |
| Revenue | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Sales | | | 363 | | | | 404 | | | | 945 | | | | 1,088 | | | | 614 | | | | 386 | | | | 167 | | | | 94 | | | | 2,089 | | | | 1,972 | |
| Other income | | | 21 | | | | 23 | | | | 3 | | | | 5 | | | | - | | | | - | | | | 2 | | | | - | | | | 26 | | | | 28 | |
| Total revenue and other income | | | 384 | | | | 427 | | | | 948 | | | | 1,093 | | | | 614 | | | | 386 | | | | 169 | | | | 94 | | | | 2,115 | | | | 2,000 | |
| Segmented expenses | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Operating | | | 149 | | | | 111 | | | | 312 | | | | 260 | | | | 98 | | | | 72 | | | | 18 | | | | 9 | | | | 577 | | | | 452 | |
| Transportation | | | 23 | | | | 16 | | | | 20 | | | | 23 | | | | 14 | | | | 15 | | | | 2 | | | | 2 | | | | 59 | | | | 56 | |
| DD&A | | | 273 | | | | 201 | | | | 174 | | | | 186 | | | | 118 | | | | 62 | | | | 38 | | | | 20 | | | | 603 | | | | 469 | |
| Impairment | | | 75 | | | | - | | | | 978 | | | | 102 | | | | - | | | | - | | | | - | | | | - | | | | 1,053 | | | | 102 | |
| Dry hole | | | 11 | | | | 2 | | | | (1 | ) | | | 75 | | | | 3 | | | | 24 | | | | 47 | | | | 3 | | | | 60 | | | | 104 | |
| Exploration | | | 1 | | | | 29 | | | | 14 | | | | 11 | | | | 18 | | | | 52 | | | | 23 | | | | 20 | | | | 56 | | | | 112 | |
| Other | | | 29 | | | | 7 | | | | 10 | | | | 9 | | | | 1 | | | | 3 | | | | 6 | | | | - | | | | 46 | | | | 19 | |
| Total segmented expenses | | | 561 | | | | 366 | | | | 1,507 | | | | 666 | | | | 252 | | | | 228 | | | | 134 | | | | 54 | | | | 2,454 | | | | 1,314 | |
| Segmented income (loss) before taxes | | | (177 | ) | | | 61 | | | | (559 | ) | | | 427 | | | | 362 | | | | 158 | | | | 35 | | | | 40 | | | | (339 | ) | | | 686 | |
| Non-segmented expenses | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| General and administrative | | | | | | | | | | | | | | | | | | | | | | | | | | | | 121 | | | | 98 | |
| Finance costs | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 71 | | | | 76 | |
| Share-based payments (recovery) | | | | | | | | | | | | | | | | | | | | | | | | | | | (41 | ) | | | 116 | |
| Currency translation | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 31 | | | | 39 | |
| Loss on held-for-trading | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| financial instruments | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 47 | | | | 319 | |
| Gain on asset disposals | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (505 | ) | | | (92 | ) |
| Total non-segmented expenses | | | | | | | | | | | | | | | | | | | | | | | | | | | | (276 | ) | | | 556 | |
| Income (loss) before taxes | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (63 | ) | | | 130 | |
| Capital expenditure | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Exploration | | | 33 | | | | 83 | | | | - | | | | 51 | | | | 13 | | | | 49 | | | | 56 | | | | 16 | | | | 102 | | | | 199 | |
| Development | | | 561 | | | | 351 | | | | 229 | | | | 245 | | | | 70 | | | | 71 | | | | 15 | | | | 28 | | | | 875 | | | | 695 | |
| Exploration and development | | | 594 | | | | 434 | | | | 229 | | | | 296 | | | | 83 | | | | 120 | | | | 71 | | | | 44 | | | | 977 | | | | 894 | |
| Acquisitions | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 2 | | | | 793 | |
| Proceeds on dispositions | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (502 | ) | | | (249 | ) |
| Other non-segmented | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 31 | | | | 16 | |
| Net capital expenditures | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 508 | | | | 1,454 | |
| Property, plant and equipment | | | 6,884 | | | | 6,740 | | | | 4,821 | | | | 5,809 | | | | 2,466 | | | | 2,501 | | | | 842 | | | | 859 | | | | 15,013 | | | | 15,909 | |
| Exploration and evaluation assets | 2,265 | | | | 2,370 | | | | 537 | | | | 538 | | | | 497 | | | | 498 | | | | 553 | | | | 548 | | | | 3,852 | | | | 3,954 | |
| Goodwill | | | 131 | | | | 140 | | | | 866 | | | | 866 | | | | 149 | | | | 149 | | | | 162 | | | | 162 | | | | 1,308 | | | | 1,317 | |
| Other | | | 1,127 | | | | 987 | | | | 1,379 | | | | 645 | | | | 568 | | | | 560 | | | | 789 | | | | 788 | | | | 3,863 | | | | 2,980 | |
| Assets held for sale | | | 237 | | | | - | | | | 15 | | | | - | | | | - | | | | - | | | | - | | | | - | | | | 252 | | | | - | |
| Segmented assets | | | 10,644 | | | | 10,237 | | | | 7,618 | | | | 7,858 | | | | 3,680 | | | | 3,708 | | | | 2,346 | | | | 2,357 | | | | 24,288 | | | | 24,160 | |
| Non-segmented assets | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 40 | | | | 66 | |
Total assets5 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 24,328 | | | | 24,226 | |
Decommissioning liabilities5 | | | 333 | | | | 394 | | | | 2,379 | | | | 2,390 | | | | 210 | | | | 208 | | | | 44 | | | | 43 | | | | 2,966 | | | | 3,035 | |
