EXHIBIT 99.3
------------
- --------------------------------------------------------------------------------
Consolidated Financial Statements of
HARVEST ENERGY TRUST
December 31, 2004 and 2003
- --------------------------------------------------------------------------------
HARVEST ENERGY TRUST
Consolidated Balance Sheets
As at December 31,
(thousands of canadian dollars) (restated, note 3)
- ------------------------------------------------------------------------------------------------------------
2004 2003
- ------------------------------------------------------------------------------------------------------------
Unaudited Audited
ASSETS
Current assets
Accounts receivable $ 44,028 $ 19,168
Current portion of derivative contracts [NOTE 16] 8,861 -
Prepaid expenses and deposits 3,014 12,131
- ------------------------------------------------------------------------------------------------------------
55,903 31,299
Deferred charges [NOTE 16] 24,507 1,989
Long term portion of derivative contracts [NOTE 16] 3,710 -
Capital assets [NOTES 4 AND 5] 918,397 210,543
Future income tax [NOTE 15] - 12,609
Goodwill [NOTE 4] 43,832 -
- ------------------------------------------------------------------------------------------------------------
$ 1,046,349 $ 256,440
============================================================================================================
LIABILITIES AND UNITHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued liabilities [NOTE 6] $ 76,251 $ 18,083
Cash distribution payable 8,358 3,422
Current portion of derivative contracts [NOTE 16] 27,927 -
Bank debt [NOTE 8] 75,519 63,349
- ------------------------------------------------------------------------------------------------------------
188,055 84,854
Deferred gains [NOTE 16] 2,177 -
Senior notes [NOTE 9] 300,500 -
Asset retirement obligation [NOTES 3 AND 7] 90,085 42,009
Future income tax [NOTE 15] 34,671 -
- ------------------------------------------------------------------------------------------------------------
615,488 126,863
Unitholders' equity
Unitholders' capital [NOTE 11] 465,131 117,407
Exchangeable shares [NOTE 13] 6,728 -
Equity bridge notes [NOTES 10 AND 17] - 25,000
Convertible debentures [NOTE 14] 24,696 -
Accumulated income 31,416 19,478
Contributed surplus - 239
Accumulated distributions (97,110) (32,547)
- ------------------------------------------------------------------------------------------------------------
430,861 129,577
- ------------------------------------------------------------------------------------------------------------
$ 1,046,349 $ 256,440
============================================================================================================
COMMITMENTS, CONTINGENCIES AND GUARANTEES [NOTE 19]
See accompanying notes to these consolidated financial statements.
2
HARVEST ENERGY TRUST
Consolidated Statements of Income and Accumulated Income
For the years ended December 31,
(thousands of canadian dollars, except per trust unit amounts) (restated, note 3)
- ------------------------------------------------------------------------------------------------------------
2004 2003
- ------------------------------------------------------------------------------------------------------------
Unaudited Audited
REVENUE
Oil and natural gas sales $ 331,331 $ 119,351
Royalty expense, net (54,236) (16,412)
- ------------------------------------------------------------------------------------------------------------
277,095 102,939
EXPENSES
Operating 73,442 36,045
General and administrative 8,621 4,101
Unit right compensation expense 11,359 239
Interest on short term debt 9,445 5,582
Interest on long term debt 5,488 -
Depletion, depreciation and accretion 102,776 35,727
Foreign exchange gain (7,111) (4,374)
Gains and losses on derivative contracts 63,701 18,924
- ------------------------------------------------------------------------------------------------------------
267,721 96,244
- ------------------------------------------------------------------------------------------------------------
Income before taxes 9,374 6,695
TAXES
Large corporations tax 1,505 157
Future income tax recovery [NOTE 15] (10,362) (8,978)
- ------------------------------------------------------------------------------------------------------------
NET INCOME FOR THE YEAR $ 18,231 $ 15,516
============================================================================================================
Interest on equity bridge notes [NOTES 10 AND 17] (1,070) (870)
Interest on convertible debentures [NOTE 14] (5,223) -
Accumulated income, beginning of year 19,478 5,136
Retroactive application of change in accounting policy [NOTE 3] - (304)
ACCUMULATED INCOME, END OF YEAR $ 31,416 $ 19,478
============================================================================================================
Net income per trust unit, basic [NOTE 11] $ 0.47 $ 1.16
Net income per trust unit, diluted [NOTE 11] $ 0.45 $ 1.13
See accompanying notes to these consolidated financial statements.
3
HARVEST ENERGY TRUST
Consolidated Statements of Cash Flows
For the years ended December 31,
(thousands of canadian dollars, except per trust unit amounts) (restated, note 3)
- -------------------------------------------------------------------------------------------------------------
2004 2003
- -------------------------------------------------------------------------------------------------------------
Unaudited Audited
CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES
Net income for the year $ 18,231 $ 15,516
Items not requiring cash
Depletion, depreciation and accretion 102,776 35,727
Unrealized foreign exchange (gain) loss (5,537) 1,432
Amortization of deferred finance charges 4,086 2,556
Unrealized loss on derivative contracts [NOTE 16] 11,274 -
Future tax recovery (10,362) (8,978)
Non-cash unit right compensation expense 9,535 239
- -------------------------------------------------------------------------------------------------------------
130,003 46,492
Settlement of asset retirement obligations (929) (577)
Change in non-cash working capital (11,103) (12,290)
- -------------------------------------------------------------------------------------------------------------
117,971 33,625
FINANCING ACTIVITIES
Issue of trust units, net of issue costs 164,743 61,691
Issue of bridge note payable - 25,000
Repayment of bridge notes - (25,000)
Issue of equity bridge notes [NOTES 10 AND 17] 30,000 33,500
Repayment of equity bridge notes [NOTES 10 AND 17] (55,000) (8,500)
Interest on equity bridge notes (1,070) (870)
Issuance of convertible debentures [NOTE 14] 160,000 -
Issue costs for convertible debentures (7,201) -
Interest on convertible debentures (5,223) -
Issue of senior notes 311,951 -
Repayment of bank debt, net (44,661) 15,263
Repayment of promissory note payable - (850)
Financing costs (13,770) (2,334)
Cash distributions (47,074) (18,488)
Change in non-cash working capital 5,097 2,889
- -------------------------------------------------------------------------------------------------------------
497,792 82,301
INVESTING ACTIVITIES
Additions to capital assets (42,662) (27,209)
Acquisition of Storm Energy Ltd. (75,783) -
Property acquisitions (513,865) (93,549)
Change in non-cash working capital 16,547 329
- -------------------------------------------------------------------------------------------------------------
(615,763) (120,429)
Decrease in cash and short-term investments - (4,503)
Cash and short term investments, beginning of year - 4,503
- -------------------------------------------------------------------------------------------------------------
Cash and short term investments, end of year $ - $ -
- -------------------------------------------------------------------------------------------------------------
Cash interest payments $ 5,521 $ 2,866
Cash tax payments $ 2,298 $ 157
Cash distributions declared per trust unit $ 2.40 $ 2.40
=============================================================================================================
See accompanying notes to these consolidated financial statements.
4
HARVEST ENERGY TRUST
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(tabular amounts in
thousands of canadian dollars, except trust unit, and per trust unit amounts)
- --------------------------------------------------------------------------------
1. STRUCTURE OF THE TRUST
Harvest Energy Trust (the "Trust") is an open-ended, unincorporated
investment trust formed under the laws of Alberta. Pursuant to its trust
indenture and an administration agreement, the Trust is managed by its
wholly owned subsidiary, Harvest Operations Corp. ("Harvest Operations").
The Trust acquires and holds net profit interests in oil and natural gas
properties in Alberta, Saskatchewan and British Columbia held by Harvest
Operations and other operating subsidiaries of the Trust. All properties
under the Trust are operated by Harvest Operations.
The beneficiaries of the Trust are the holders of trust units. The Trust
makes monthly distributions of its distributable cash to unitholders of
record on the last business day of each calendar month.
2. SIGNIFICANT ACCOUNTING POLICIES
These consolidated financial statements of Harvest Energy Trust have been
prepared by management in accordance with Canadian generally accepted
accounting principles ("Canadian GAAP"). Certain comparative figures have
been reclassified to conform to the current period's presentation.
(a) CONSOLIDATION
These consolidated financial statements include the accounts of the
Trust, its wholly-owned subsidiaries and its 60% interest in a
partnership with a third party. All inter-entity transactions and
balances have been eliminated upon consolidation. The Trust's
proportionate interest in the partnership has been reflected in the
consolidated financial statements.
(b) USE OF ESTIMATES
The preparation of financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosures of contingencies, if any, as at the
date of the financial statements and the reported amounts of revenues
and expenses during the period. Specifically, amounts recorded for
depletion, depreciation and accretion expense, asset retirement
obligations and amounts used in the impairment tests for goodwill and
capital assets are based on estimates of oil and natural gas reserves
and future costs required to develop those reserves. By their nature,
these estimates are subject to measurement uncertainty. In the opinion
of management, these consolidated financial statements have been
prepared within reasonable limits of materiality.
(c) REVENUE RECOGNITION
Revenues associated with the sale of crude oil, natural gas and
natural gas liquids are recognized when title passes to customers.
(d) JOINT VENTURE ACCOUNTING
The subsidiaries of the Trust conduct substantially all of their oil
and natural gas production activities through joint ventures and the
consolidated financial statements reflect only their proportionate
interest in such activities.
1
HARVEST ENERGY TRUST
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(tabular amounts in
thousands of canadian dollars, except trust unit, and per trust unit amounts)
- --------------------------------------------------------------------------------
(e) CAPITAL ASSETS
OIL AND NATURAL GAS ACTIVITIES
The Trust follows the full cost method of accounting for its oil and
natural gas activities. All costs of acquiring oil and natural gas
properties and related development costs, including overhead charges
directly related to these activities, are capitalized and accumulated
in one cost center. Maintenance and repairs are charged against
income. Renewals and enhancements that extend the economic life of the
capital assets are capitalized.
Gains and losses are not recognized on disposition of oil and natural
gas properties unless that disposition would alter the rate of
depletion by 20 percent or more.
Provision for depletion and depreciation of oil and natural gas assets
is calculated on the unit-of-production method, based on proved
reserves net of royalties as estimated by independent petroleum
engineers. The basis used for the calculation of the provision is the
capitalized costs of oil and natural gas assets plus the estimated
future development costs of proved undeveloped reserves. Reserves are
converted to equivalent units on the basis of six thousand cubic feet
of natural gas to one barrel of oil.
The Trust places a limit on the aggregate carrying value of capital
assets associated with oil and natural gas activities, which may be
amortized against revenues of future periods. Impairment is recognized
if the carrying amount of the capital assets exceeds the sum of the
undiscounted cash flows expected to result from the Trust's proved
reserves. Cash flows are calculated based on third-party quoted
forward prices, adjusted for the Trust's contract prices and quality
differentials.
Upon recognition of impairment, the Trust would then measure the
amount of impairment by comparing the carrying amounts of the capital
assets to an amount equal to the estimated net present value of future
cash flows from proved plus probable reserves. The Trust's risk-free
interest rate is used to arrive at the net present value of the future
cash flows. Any excess carrying value above the net present value of
the Trust's future cash flows would be a permanent impairment and
reflected in net income for the relevant period.
The cost of unproved properties is excluded from the impairment test
calculation described above and subject to a separate impairment test.
OFFICE FURNITURE AND EQUIPMENT
Depreciation and amortization of office furniture and equipment is
provided for at rates ranging from 20 percent to 50 percent per annum.
2
HARVEST ENERGY TRUST
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(tabular amounts in
thousands of canadian dollars, except trust unit, and per trust unit amounts)
- --------------------------------------------------------------------------------
(f) GOODWILL
Goodwill is the residual amount that results when the purchase price
of an acquired business exceeds the fair value for accounting purposes
of the net identifiable assets and liabilities of the acquired
BUSINESS. The goodwill balance is assessed for impairment annually at
year-end, or more frequently if events or changes in circumstances
occur that more likely than not reduce the fair value of the acquired
business below its carrying amount. The test for impairment is carried
out by comparing the carrying amount of the reporting entity to its
fair value. If the fair value of the Trust's equity is less than the
book value, impairment is measured by allocating the fair value of the
consolidated Trust to its identifiable assets and liabilities at their
fair values. The excess of this allocation is the fair value of
goodwill. Any excess of the book value of goodwill over this implied
fair value is the impairment amount. Impairment is charged to income
in the period in which it occurs. Goodwill is stated at cost less
impairment and is not amortized.
(g) ASSET RETIREMENT OBLIGATION
The Trust records the fair value of an asset retirement obligation as
a liability in the period in which it incurs a legal obligation
associated with the retirement of tangible long-lived assets that
result from the acquisition, construction, development, and normal use
of the assets. The Trust uses a credit-adjusted risk-free discount
rate to estimate this fair value. The associated asset retirement
costs are capitalized as part of the carrying amount of the long-lived
asset and depleted and depreciated using the unit of production method
over estimated net proved reserves. Subsequent to the initial
measurement of the asset retirement obligation, the obligation is
adjusted at the end of each period to reflect the passage of time and
changes in the estimated future cash flows underlying the obligation.
(h) INCOME TAXES
The Trust and its trust subsidiaries are taxable entities under the
Income Tax Act (Canada) and are taxable only on income that is not
distributed or distributable to their unitholders. As both the Trust
and its trust subsidiaries distribute all of their taxable income to
their respective unitholders pursuant to the requirements of the
Income Tax Act (Canada), neither the Trust nor its trust subsidiaries
make provisions for future income taxes.
Harvest Operations and the corporate subsidiaries of the Trust follow
the liability method of accounting for income taxes. Under this
method, income tax liabilities and assets are recognized for the
estimated tax consequences attributable to differences between the
amounts reported in its financial statements and its respective tax
base, using enacted or substantively enacted income tax rates. The
effect of a change in income tax rates on future tax liabilities and
assets is recognized in income in the period in which the change
occurs.
(i) UNIT-BASED COMPENSATION
The Trust determines compensation expense for the trust unit incentive
plan and the unit award incentive plan [NOTE 12] by estimating the
intrinsic value of the rights at each period end and recognizing the
amount in income over the vesting period. After the rights have
vested, further changes in the intrinsic value are recognized in
income in the period of change.
3
HARVEST ENERGY TRUST
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(tabular amounts in
thousands of canadian dollars, except trust unit, and per trust unit amounts)
- --------------------------------------------------------------------------------
The intrinsic value is the difference between market value of the
units and the exercise price of the right. The intrinsic value is used
to determine compensation expense as participants in the plan have the
option to either purchase the units at the exercise price or to
receive a cash payment equal to the excess of the market value over
the exercise price. As the expense is determined based on the period
end price, large fluctuations, even recoveries, in compensation
expense may occur. As the unit rights are exercised, cash payments are
reflected against the liability previously recorded and any unit
issuances are reflected as increases to unitholders' capital.
Under the terms of the plan, the exercise price of rights granted may
be reduced in future periods based on the distributions made to Trust
unitholders.
The Trust previously used the fair value method of accounting for the
trust unit incentive plan.
(j) EXCHANGEABLE SHARES
Exchangeable shares are presented as equity of the Trust as their
features make them economically equivalent to trust units.
(k) DEFERRED FINANCING CHARGES
Deferred financing charges relate to costs incurred on the issuance of
debt and are amortized on a straight-line basis over the term of the
debt and included in interest expense.
(l) FINANCIAL INSTRUMENTS
Derivative financial instruments are utilized by the Trust in the
management of its commodity price, foreign currency and interest rate
exposures. The Trust uses a variety of derivative instruments to
manage these exposures including swaps, options and collars. The Trust
may elect to use hedge accounting when there is a high degree of
correlation between the price movements in the derivative financial
instruments and the items designated as being hedged. The Trust
documents all relationships between hedging instruments and hedged
items as well as its risk management objective and strategy for
undertaking various hedge transactions. Gains and losses are
recognized on the derivative financial instruments in the same period
in which the gains and losses on the hedged item are recognized. If
the price movements in the derivative instrument and the hedged item
cease to be highly correlated, hedge accounting is terminated and the
fair value of the derivative financial instrument at such time is
recognized on the balance sheet as a deferred charge and recognized in
income in the period in which the underlying hedged transaction is
recognized. Future changes in the market value of the derivative
financial instrument are then recognized in income as they occur. At
December 31, 2004, the Trust has not designated any of its outstanding
derivative instruments as hedges.
For derivative transactions where hedge accounting is not applied, the
Trust applies a fair value method of accounting by initially recording
an asset or liability, and recognizing changes in the fair value of
the derivative instrument in income as an unrealized gain or loss on
derivative contracts. Any realized gains or losses on derivative
contracts that are not designated as hedges are recognized in income
in the period they occur.
4
HARVEST ENERGY TRUST
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(tabular amounts in
thousands of canadian dollars, except trust unit, and per trust unit amounts)
- --------------------------------------------------------------------------------
(m) FOREIGN CURRENCY TRANSLATION
Monetary assets and liabilities denominated in a foreign currency are
translated at the rate of exchange in effect at the balance sheet
date. Revenues and expenses are translated at the monthly average rate
of exchange. Translation gains and losses are included in income in
the period in which they arise.
3. CHANGES IN ACCOUNTING POLICY
(a) FULL COST ACCOUNTING GUIDELINE
Effective January 1, 2004, the Trust adopted the Canadian Institute of
Chartered Accountants ("CICA") Handbook Accounting Guideline 16 "OIL AND
GAS ACCOUNTING - FULL COST". The changes under the new guideline include
modifications to the ceiling test and depletion and depreciation
calculations. There were no changes to previously reported net income,
capital assets or any other financial statement amounts as a result of the
implementation of this guideline.
(b) ASSET RETIREMENT OBLIGATION
Effective January 1, 2004, the Trust adopted CICA Handbook Section 3110
"ASSET RETIREMENT OBLIGATIONS" in accounting for its asset retirement
obligation.
The effect of this change in accounting policy has been recorded
retroactively with restatement of prior periods as follows:
--------------------------------------------------------------------------
BALANCE SHEET As at December 31,
2003
--------------------------------------------------------------------------
Asset retirement costs, included in capital assets $ 35,166
Asset retirement obligation 42,009
Site restoration provision (4,321)
Future income tax asset 1,024
Accumulated income (1,498)
--------------------------------------------------------------------------
--------------------------------------------------------------------------
INCOME STATEMENT Year ended December
31, 2003
--------------------------------------------------------------------------
Accretion expense $ 1,845
Depletion and depreciation on asset retirement costs 4,520
Site restoration and reclamation (4,355)
Future tax recovery (816)
Net income change (1,194)
Basic net income change per trust unit (0.10)
Diluted net income change per trust unit (0.09)
--------------------------------------------------------------------------
(c) FINANCIAL INSTRUMENTS
Effective January 1, 2004, the Trust implemented CICA Accounting Guideline
13 "HEDGING RELATIONSHIPS" ("AcG-13"). This guideline addresses the
identification, designation and effectiveness of financial contracts for
the purpose of applying hedge accounting. Under this guideline, financial
derivative
5
HARVEST ENERGY TRUST
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(tabular amounts in
thousands of canadian dollars, except trust unit, and per trust unit amounts)
- --------------------------------------------------------------------------------
contracts must be designated to the underlying revenue or expense stream
that they are intended to hedge, and tested to ensure they remain
sufficiently effective. For transactions that do not qualify as designated
hedges, the Trust applies a fair value method of accounting by initially
recording an asset or liability, and recognizing changes in the fair value
of the derivative instrument in income.
Upon implementation of this new accounting policy, the Trust recorded a
liability and a corresponding asset of $5.5 million related to the fair
value of the derivative financial instruments that did not qualify for
hedge accounting. This amount has been fully recognized in income for the
year ended December 31, 2004.
4. CORPORATE ACQUISITIONS
On June 30, 2004, the Trust completed a Plan of Arrangement with Storm
Energy Ltd. ("Storm"). Under this plan, the Trust acquired certain oil and
natural gas producing properties for total consideration of approximately
$192.2 million. This amount consisted of the issuance of 2,720,837 trust
units [NOTE 11] and the issuance of 600,587 exchangeable shares each at
$14.77 [NOTE 13], $75 million in cash, the assumption of approximately
$67.3 million in debt and working capital deficiency and acquisition costs
of $0.8 million. This transaction has been accounted for using the purchase
price method.
The following summarizes the estimated fair value of the assets acquired
and liabilities assumed at the date of acquisition.
--------------------------------------------------------------------------
ALLOCATION OF PURCHASE PRICE: AMOUNT
--------------------------------------------------------------------------
Working capital deficiency $ (10,488)
Bank debt (56,831)
Capital assets 213,455
Derivative contract 863
Goodwill 43,832
Asset retirement obligation (8,353)
Future income tax (57,642)
--------------------------------------------------------------------------
$ 124,836
--------------------------------------------------------------------------
CONSIDERATION FOR THE ACQUISITION:
Cash $ 75,000
Issuance of trust units 40,183
Issuance of exchangeable shares 8,870
Acquisition costs 783
--------------------------------------------------------------------------
$ 124,836
--------------------------------------------------------------------------
On June 1, 2003, the Trust acquired all of the common shares and the Net
Profit Interest of a private company. Total consideration paid by the Trust
was $10.1 million, and consisted of the issuance of 625,000 trust units at
a price of $10.00 per trust unit, $3 million in cash and $850,000 unsecured
demand promissory note bearing an interest rate of 10% per annum effective
June 27, 2003. The trust assumed $2.5 million of working capital, $2.8
million of bank debt and acquired $15.4 million in capital assets as part
of this acquisition.
6
HARVEST ENERGY TRUST
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(tabular amounts in
thousands of canadian dollars, except trust unit, and per trust unit amounts)
- --------------------------------------------------------------------------------
5. CAPITAL ASSETS
-------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2004 COST ACCUMULATED DEPLETION
AND DEPRECIATION NET BOOK VALUE
-------------------------------------------------------------------------------------------------------------
Oil and natural gas properties $ 845,396 $ (110,077) $ 735,319
Production facilities and equipment 209,984 (27,817) 182,167
Office furniture and equipment 1,337 (426) 911
-------------------------------------------------------------------------------------------------------------
Total $ 1,056,717 $ (138,320) $ 918,397
=============================================================================================================
-------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2003 COST ACCUMULATED DEPLETION
AND DEPRECIATION NET BOOK VALUE
-------------------------------------------------------------------------------------------------------------
Oil and natural gas properties $ 202,529 $ (31,262) $ 171,267
Production facilities and equipment 47,071 (8,346) 38,725
Office furniture and equipment 708 (157) 551
-------------------------------------------------------------------------------------------------------------
Total $ 250,308 $ (39,765) $ 210,543
=============================================================================================================
On September 2, 2004, the Trust purchased oil and natural gas producing
properties from a senior producer for cash consideration of approximately
$526 million before final working capital adjustments. Final adjustments
reduced the Trust's purchase price to $511.4 million. In conjunction with
the acquisition of these properties, the Trust issued approximately $175.2
million in subscription receipts which were converted into 12,166,666 trust
units upon completion of the purchase [NOTE 11], and $100 million in 8%
convertible unsecured subordinated debentures [NOTE 14]. The balance of the
acquisition cost was funded with a new credit facility arrangement [NOTE
8].
On October 16, 2003, the Trust acquired the Carlyle Properties in
southeastern Saskatchewan for total consideration of approximately $79.5
million before costs and purchase price adjustments. The acquisition was
partially financed by the issue of trust units on October 16, 2003, with
the balance being funded by the bank facility.
General and administrative costs of $3.6 million (2003 - $1.3 million) have
been capitalized during the year ended December 31, 2004.
All costs are subject to depletion and depreciation at December 31, 2004
including future development costs of $83.3 million (2003 - $15.2 million).
$28.6 million (2003 - nil) of undeveloped properties were excluded from the
asset base subject to depletion at December 31, 2004.
In accordance with Canadian GAAP, the Trust performed an impairment test as
at December 31, 2004 and 2003. The crude oil and natural gas future prices
used in the impairment test were obtained from third parties and were
adjusted for commodity price differentials specific to the Trust. Based on
these assumptions, the undiscounted future net revenue from the Trust's
proved reserves exceed the carrying value of the Trust's oil and natural
gas assets as at December 31, 2004, and therefore no impairment was
recorded.
7
HARVEST ENERGY TRUST
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(tabular amounts in
thousands of canadian dollars, except trust unit, and per trust unit amounts)
- --------------------------------------------------------------------------------
Benchmark Prices:
----------------------------------------------------------------------------------------------------------
WTI OIL FOREIGN EDMONTON LIGHT CRUDE AECO GAS
YEAR (US$/BBL) EXCHANGE RATE OIL (CDN$BBL) (CDN$/GJ)
----------------------------------------------------------------------------------------------------------
2005 42.00 0.83 49.60 6.45
2006 39.50 0.83 46.60 6.20
2007 37.00 0.83 43.50 6.05
2008 35.00 0.83 41.10 5.80
2009 34.50 0.83 40.50 5.70
Thereafter (escalation) 2.0% 0% 2.0% 2.0%
----------------------------------------------------------------------------------------------------------
6. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
----------------------------------------------------------------------------------------------------
AS AT DECEMBER 31, 2004 2003
----------------------------------------------------------------------------------------------------
Trade accounts payable $ 13,697 $ 9,524
Accrued interest 5,993 897
Trust unit incentive plan [NOTE 12] 9,774 -
Premium on derivative contracts 4,500 -
Accrued closing adjustments on asset acquisition 13,546 -
Other accrued liabilities 27,139 7,629
Large corporation taxes payable 1,602 33
----------------------------------------------------------------------------------------------------
$ 76,251 $ 18,083
----------------------------------------------------------------------------------------------------
7. ASSET RETIREMENT OBLIGATION
The Trust's asset retirement obligation results from its net ownership
interest in oil and natural gas assets including well sites, gathering
systems and processing facilities and the estimated costs and timing to
reclaim and abandon them. The Trust estimates the total undiscounted amount
required to settle its asset retirement obligation to be approximately
$334.8 million which will be incurred between 2004 and 2023. The majority
of the costs will be incurred between 2015 and 2021. A credit-adjusted
risk-free rate of 10 percent was used to calculate the fair value of the
asset retirement obligation.
8
HARVEST ENERGY TRUST
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(tabular amounts in
thousands of canadian dollars, except trust unit, and per trust unit amounts)
- --------------------------------------------------------------------------------
A reconciliation of the asset retirement obligation is provided below:
-------------------------------------------------------------------------
YEAR ENDED DECEMBER 31 2004
-------------------------------------------------------------------------
Balance, beginning of year $ 42,009 $ 15,566
Liabilities incurred 53,488 25,175
Revision of estimates (8,704) -
Liabilities settled (929) (577)
Accretion expense 4,221 1,845
-------------------------------------------------------------------------
Balance, end of year $ 90,085 $ 42,009
-------------------------------------------------------------------------
8. BANK DEBT
As at December 31, 2004, Harvest Operations has a senior borrowing base
credit facility with a syndicate of lenders. This facility consists of a
$310 million production loan, a $15 million operating loan, and a U.S.
$21.3 million mark to market credit to be used for financial instrument
hedging. The term of the facility is to June 29, 2005. Availability under
the facility is subject to a borrowing base calculation performed by the
lenders at least on a semi-annual basis. The facility permits drawings in
Canadian or U.S. dollars, and includes banker's acceptances, LIBOR loans
and letters of credit. Outstanding balances bear interest at rates ranging
from 0% to 2.25% above the applicable Canadian or U.S. prime rate depending
upon the type of borrowing and the debt to annualized cash flow ratio. The
debt is secured by a $750 million debenture with a fixed and floating
charge over all of the assets of the Corporation, and a guarantee by the
Trust and its subsidiaries.
A bridge facility of $70 million was provided by the Trust's lenders to
assist in the closing of the significant property acquisition in September
2004 [NOTE 5]. This facility was due to mature on June 1, 2005, and
outstanding balances under this facility accrued interest at progressive
rates of 3% to 8% above the applicable Canadian prime rate. The bridge
facility was repaid in full with the net proceeds of the senior note
issuance [NOTE 9].
9. SENIOR NOTES
On October 14, 2004, Harvest Operations closed an agreement to sell, on a
private placement basis in the United States, US$250 million of senior
notes due October 15, 2011. The senior notes are unsecured and bear
interest at an annual rate of 7 7/8% and were sold at a price of 99.3392%
of their principal amount. A discount of $2.1 million on the senior notes
is recorded in deferred charges and amortized into interest expense over
the term of the notes. Interest is payable semi-annually on April 15 and
October 15. The senior notes are unconditionally guaranteed by the Trust
and all of its wholly-owned subsidiaries. The Trust used the net proceeds
of the offering to repay in full Harvest's bank bridge facility and
partially repay outstanding balances under Harvest's senior credit
facility. The fair value of the senior notes at December 31, 2004 was
US$250.6 million (Cdn$301.2 million).
9
HARVEST ENERGY TRUST
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(tabular amounts in
thousands of canadian dollars, except trust unit, and per trust unit amounts)
- --------------------------------------------------------------------------------
10. EQUITY BRIDGE NOTES
A director of Harvest Operations and a corporation controlled by that
director had advanced $25 million pursuant to the equity bridge notes as at
December 31, 2003. On January 2, 2004 Harvest Operations paid $665,068 in
accrued interest on these notes. On January 26 and 29, 2004, Harvest
Operations repaid the principal amount and paid $185,232 of interest
accrued since December 31, 2003. The notes were amended on June 29, July 7
and July 9, 2004. These notes were drawn by $30 million and repaid as to
$20 million on August 11, 2004 and $10 million on December 30, 2004. The
notes accrued interest at 10% per annum, were secured by a fixed and
floating charge on the assets of the Trust and were subordinate to the
interest of the senior secured lenders pursuant to Harvest Operations'
credit facility.
The Trust had the option to settle the quarterly interest payments under
the equity bridge notes with cash or the issue of trust units. If the Trust
elected to issue trust units, the number of trust units to be issued to
settle a quarterly interest payment would have been the equivalent of the
quarterly payment amount divided by 90% of the most recent ten-day weighted
average trading price. The Trust had the option at maturity of the notes to
settle the principal obligation with cash or with the issue of trust units.
The terms to settle principal with units is the same as with the interest
option described above.
11. UNITHOLDERS' CAPITAL
(a) Authorized
The authorized capital consists of an unlimited number of trust units.
(b) Issued
--------------------------------------------------------------------------
NUMBER OF UNITS
(000S) AMOUNT
--------------------------------------------------------------------------
AS AT DECEMBER 31, 2002 9,312 $ 36,728
Exercise of warrants 150 150
Special warrant exercise 1,500 15,000
Acquisitions 825 8,350
Trust unit issue 4,313 48,645
Distribution reinvestment plan issuance 1,009 10,638
Trust unit issue costs - (2,104)
--------------------------------------------------------------------------
AS AT DECEMBER 31, 2003 17,109 $ 117,407
Storm Plan of Arrangement [NOTE 4] 2,721 40,183
Conversion of subscription receipts [NOTE 5] 12,167 175,200
Convertible debenture conversions-9% series 3,521 49,300
Convertible debenture conversions-8% series 5,221 84,841
Exchangeable share retraction 152 2,142
Distribution reinvestment plan issuance 752 12,553
Unit appreciation rights exercise 145 721
Trust unit issue costs - (17,216)
--------------------------------------------------------------------------
AS AT DECEMBER 31, 2004 41,788 $ 465,131
--------------------------------------------------------------------------
10
HARVEST ENERGY TRUST
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(tabular amounts in
thousands of canadian dollars, except trust unit, and per trust unit amounts)
- --------------------------------------------------------------------------------
(c) Per trust unit information
The following table summarizes the net income and trust unit amounts used
in calculating income per trust unit:
- -------------------------------------------------------------------------------
2004 2003
- -------------------------------------------------------------------------------
NET INCOME ADJUSTMENTS
- -------------------------------------------------------------------------------
Net income $ 18,231 $ 15,516
Interest on equity bridge notes (1,070) (870)
Interest on convertible debentures (5,223) -
- -------------------------------------------------------------------------------
Net income available to Trust unitholders $ 11,938 $ 14,646
- -------------------------------------------------------------------------------
WEIGHTED AVERAGE TRUST UNITS ADJUSTMENTS
- -------------------------------------------------------------------------------
Weighted average trust units outstanding 25,033,567 12,590,937
Weighted average exchangeable shares outstanding(1) 290,090 -
- -------------------------------------------------------------------------------
Weighted average trust units outstanding, basic 25,323,657 12,590,937
Effect of trust unit appreciation rights 1,140,738 411,868
- -------------------------------------------------------------------------------
Weighted average trust units outstanding, diluted(2) 26,464,395 13,002,805
- -------------------------------------------------------------------------------
(1) Reflects the weighted average of exchangeable shares outstanding based on
the conversion ratio at December 31, 2004
(2) Weighted average Trust Units outstanding diluted for 2004 does not include
the impact of the conversion of the debentures as the impact would be
anti-dilutive. Total units excluded amount to 6,004,145.
12. TRUST UNIT INCENTIVE PLANS
The Trust unit plan was established in 2002. In December 2004, the plan was
modified such that the ability to settle a unit right with cash is now
solely at the option of the holder and not subject to the discretion of the
Board of Directors. The Trust is authorized to grant non-transferable
rights to purchase trust units to directors, officers, consultants,
employees and other service providers to an aggregate of 1,487,250 trust
units, of which 1,371,475 were granted as of December 31, 2004. The initial
exercise price of rights granted under the plan is equal to the market
price of the trust units at the time of grant and the maximum term of each
right is five years. The rights vest equally over four years commencing on
the first anniversary of the grant date. The exercise price of the rights
may be reduced by an amount up to the amount of cash distributions made on
the trust units subsequent to the date of grant of the respective right,
provided that the trust's net operating cash flow (on an annualized basis)
exceeds 10% of the trust's recorded cost of capital assets less all debt,
working capital deficiency (surplus) or debt equivalent instruments,
accumulated depletion, depreciation and amortization charges, asset
retirement obligations, and any future income tax liability associated with
such capital assets. Any portion of a distribution that does not reduce the
exercise price on vested rights is paid to the holder in cash on a
semi-annual basis.
As a result of the modification of the trust unit incentive plan, the Trust
is required to recognize an obligation for all of the units reserved under
the plan. This obligation represents the difference between the market
value of the trust units and the exercise price of the unit rights
outstanding under the plan. As such, an obligation of $9.8 million has been
recorded in accounts payable and accrued liabilities for the graded vested
portion of the 1,117,725 trust units outstanding under the plan at December
31, 2004. A one time charge of $8.2 million has been included in unit right
compensation expense to reflect the
11
HARVEST ENERGY TRUST
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(tabular amounts in
thousands of canadian dollars, except trust unit, and per trust unit amounts)
- --------------------------------------------------------------------------------
additional expense resulting from the change in accounting from the fair
value method previously used to the intrinsic method. The amount previously
expensed has been removed from contributed surplus and reflected in
accounts payable and accrued liabilities.
The following summarizes the trust units reserved for issuance under the
trust unit incentive plan:
2004 2003
----------------------------------------------------------------------------------------------------------------
UNIT UNIT
APPRECIATION WEIGHTED AVERAGE APPRECIATION WEIGHTED AVERAGE
RIGHTS EXERCISE PRICE RIGHTS EXERCISE PRICE(a)
----------------------------------------------------------------------------------------------------------------
Outstanding beginning of year 1,065,150 $ 9.04 787,500 $ 8.00
Granted 445,600 16.47 277,650 11.94
Exercised (253,750) 8.30 - -
Cancelled (139,275) 10.91 - -
----------------------------------------------------------------------------------------------------------------
Outstanding before exercise price
reductions 1,117,725 11.92 1,065,150 9.04
Exercise price reductions - (1.83) - (1.11)
----------------------------------------------------------------------------------------------------------------
Outstanding, end of year 1,117,725 $ 10.09 1,065,150 $ 7.93
================================================================================================================
Exercisable before exercise price
reductions 206,688 $ 8.89 196,875 $ 8.00
Exercise price reductions - (2.64) - (1.30)
----------------------------------------------------------------------------------------------------------------
Exercisable, end of year 206,688 $ 6.25 196,875 $ 6.70
================================================================================================================
(a) adjusted to retroactively reflect modifications to the plan made
in 2004.
The following table summarizes information about unit appreciation rights
outstanding at December 31, 2004.
----------------------------------------------------------------------------------------------------------------------------
OUTSTANDING EXERCISABLE
----------------------------------------------------------------------------------------------------------------------------
EXERCISE PRICE EXERCISE PRICE OUTSTANDING AT PRICE NET OF REMAINING EXERCISABLE EXERCISE PRICE
BEFORE PRICE NET OF PRICE DECEMBER 31, PRICE CONTRACTUAL AT DECEMBER, NET OF PRICE
REDUCTIONS REDUCTIONS 2004 REDUCTIONS(a) LIFE (a) 31, 2004 REDUCTIONS (a)
$ 8.00 - $10.21 $ 5.18 - $7.86 509,625 $ 5.27 2.9 163,375 $ 5.23
----------------------------------------------------------------------------------------------------------------------------
$10.30 - $13.35 $ 7.98 - $11.97 214,700 10.31 3.7 43,313 10.11
$13.75 - $18.90 $ 12.37 -$18.50 308,400 14.92 4.5 - n/a
$19.90 - $23.70 $19.50 - $23.30 85,000 20.92 4.8 - n/a
----------------------------------------------------------------------------------------------------------------------------
$ 8.00 - $23.70 $ 5.18 - $23.30 1,117,725 $ 10.09 3.7 206,688 $ 6.25
----------------------------------------------------------------------------------------------------------------------------
(a) based on weighted average unit appreciation rights outstanding
When the Trust adopted the fair value method of accounting for its trust
unit incentive plan on January 1, 2003, it was required to calculate the
pro forma impact of having adopted that method from the date all rights
were initially granted.
12
For purposes of those calculations, the fair value of each trust unit right
has been estimated on the grant date using the following.
---------------------------------------------------------------------------
December 31
2003
---------------------------------------------------------------------------
Expected volatility 23.3%
Risk free interest rate 4.1%
Expected life of the trust unit rights 4 years
Estimated annual distributions per unit $2.40
---------------------------------------------------------------------------
As at December 31, 2003 for the purposes of pro forma disclosures, the
expense related to all of the trust unit rights issued prior to December
31, 2002 is reflected in pro forma net income as shown below:
---------------------------------------------------------------------------
(RESTATED NOTE 3)
2003
---------------------------------------------------------------------------
Net income As reported $15,516
Pro forma $14,228
Income (loss) per unit - basic As reported $1.16
Pro forma $1.06
Income (loss) per unit - diluted As reported $1.13
Pro forma $1.03
---------------------------------------------------------------------------
During the years ended December 31, the Trust has recognized non-cash
compensation expense of $9.5 million in 2004 and $239,000 in 2003 related
to trust unit rights and included it in general and administrative expense
in the consolidated statement of income.
UNIT AWARD INCENTIVE PLAN
In the year ended December 31, 2004, the trust has implemented a Unit Award
Incentive Plan ("Unit Award Plan"). The Unit Award Plan authorizes the
trust to grant awards of trust units to directors, officers, employees and
consultants of the trust and its affiliates. Subject to the Board of
Directors' discretion, awards vest annually over a four year period and,
upon vesting, entitle the holder to receive the number of trust units
subject to the award or the equivalent cash amount. The number of units to
be issued is adjusted at each distribution date for an amount approximately
equal to the foregone distributions. The fair value associated with the
trust units granted under the Unit Award Plan is expensed in the statement
of income over the vesting period. The Trust recorded compensation expense
of $56,000 in 2004 related to this plan. The trust may issue up to a
maximum of 150,000 trust units under the Unit Award Plan. In 2004, 15,000
trust units were issued under this plan, of which 5,000 were subsequently
cancelled.
13
HARVEST ENERGY TRUST
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(tabular amounts in
thousands of canadian dollars, except trust unit, and per trust unit amounts)
- --------------------------------------------------------------------------------
13. EXCHANGEABLE SHARES
(a) Authorized
Harvest Operations is authorized to issue an unlimited number of
exchangeable shares without nominal or par value.
(b) Issued
EXCHANGEABLE SHARES, SERIES 1
---------------------------------------------------------------------
NUMBER AMOUNT
---------------------------------------------------------------------
Storm Plan of Arrangement 600,587 $ 8,870
Shareholder retractions (145,040) (2,142)
---------------------------------------------------------------------
As at December 31, 2004 455,547 $ 6,728
---------------------------------------------------------------------
On June 30, 2004, 600,587 exchangeable shares, series 1 were issued at
$14.77 each as partial consideration under the Plan of Arrangement
with Storm [NOTE 4]. The exchangeable shares, series 1 can be
converted at the option of the holder at any time into trust units.
The number of trust units issued to the holder upon conversion is
based upon the applicable exchange ratio at that time. The exchange
ratio is calculated monthly and adjusts to account for distributions
paid to unitholders during the period that the exchangeable shares are
outstanding. The exchangeable shares are not eligible to receive
distributions. The exchangeable shares that have not been converted by
the holder may be redeemed in part or in their entirety by Harvest
Operations at any date until June 30, 2009, at which time all
remaining exchangeable shares in this series will be redeemed for
trust units. The exchangeable shares had an exchange ratio of
1:1.06466 as at December 31, 2004.
14. CONVERTIBLE DEBENTURES
On January 29, 2004, the Trust issued $60 million of 9% convertible
unsecured subordinated debentures due May 31, 2009. Interest on the
debentures is payable semi-annually in arrears in equal installments on May
31 and November 30 in each year, commencing May 31, 2004. The debentures
are convertible into fully paid and non-assessable trust units at the
option of the holder at any time prior to the close of business on the
earlier of May 31, 2009 and the business day immediately preceding the date
specified by the Trust for redemption of the debentures, at a conversion
price of $14.00 per trust unit plus a cash payment for accrued interest and
in lieu of any fractional trust units resulting on the conversion. The
debentures may be redeemed by the Trust at its option in whole or in part
subsequent to May 31, 2007, at a price equal to $1,050 per debenture
between June 1, 2007 and May 31, 2008 and at $1,025 per debenture between
June 1, 2008 and May 31, 2009. Any redemption will include accrued and
unpaid interest at such time. Under both redemption options, the Trust may
elect to pay both the principal and accrued interest in the form of trust
units at a price equal to 95% of the weighted average trading price for the
preceding 20 consecutive trading days, 5 days prior to settlement date.
On August 10, 2004, the Trust issued $100 million of 8% convertible
unsecured subordinated debentures due September 30, 2009. Interest on the
debentures is payable semi-annually in arrears in equal installments on
March 31 and September 30 in each year, commencing March 31, 2005. The
debentures
14
HARVEST ENERGY TRUST
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(tabular amounts in
thousands of canadian dollars, except trust unit, and per trust unit amounts)
- --------------------------------------------------------------------------------
are convertible into fully paid and non-assessable trust units at the
option of the holder at any time prior to the close of business on the
earlier of September 30, 2009 and the business day immediately preceding
the date specified by the Trust for redemption of the debentures, at a
conversion price of $16.25 per trust unit plus a cash payment for accrued
interest and in lieu of any fractional trust units resulting on the
conversion. The debentures may be redeemed by the Trust at its option in
whole or in part subsequent to September 30, 2007, at a price equal to
$1,050 per debenture between October 1, 2007 and September 30, 2008 and at
$1,025 per debenture between October 1, 2008 and September 30, 2009. Any
redemption will include accrued and unpaid interest at such time. Under
both redemption options, the Trust may elect to pay both the principal and
accrued interest in the form of trust units at a price equal to 95% of the
weighted average trading price for the preceding 20 consecutive trading
days, 5 days prior to settlement date. This series of convertible
debentures ranks pari-passu with the outstanding debentures issued on
January 29, 2004.
The following table summarizes the issuance and subsequent conversions of
the convertible debentures:
9% SERIES 8% SERIES TOTAL
- ------------------------------------------------------------------------------------------------------------------
NUMBER OF NUMBER OF
DEBENTURES AMOUNT DEBENTURES AMOUNT AMOUNT
- ------------------------------------------------------------------------------------------------------------------
January 29, 2004 issuance 60,000 $60,000 - - $60,000
August 10, 2004 issuance - - 100,000 $100,000 100,000
Converted for trust units (49,300) (49,300) (84,841) (84,841) (134,141)
Convertible debenture issue costs (2,667) (4,534) (7,201)
-------------------------------------------------------------------------
Convertible debenture issue costs
related to the converted debentures 2,184 3,854 6,038
- ------------------------------------------------------------------------------------------------------------------
As at December 31, 2004 10,700 $10,217 15,159 $14,479 $24,696
- ------------------------------------------------------------------------------------------------------------------
Fair value at December 31, 2004 $17,441 $21,223 $38,664
- ------------------------------------------------------------------------------------------------------------------
15. INCOME TAXES
Future income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities of Harvest
Operations and the Trust's other corporate subsidiaries and their
corresponding income tax bases. The legislated reductions in the Federal
and Provincial income tax rates were implemented as expected in 2004.
Federal rates are expected to decline further until 2007, resulting in an
effective tax rate of approximately 34% for the Trust, which is the rate
applied to the temporary differences in the future income tax calculation.
15
HARVEST ENERGY TRUST
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(tabular amounts in
thousands of canadian dollars, except trust unit, and per trust unit amounts)
- --------------------------------------------------------------------------------
The provision for future income taxes varies from the amount that would be
computed by applying the combined Canadian Federal and Provincial income
tax rates to the reported income before taxes as follows:
- -----------------------------------------------------------------------------------------------
2004 2003
- -----------------------------------------------------------------------------------------------
Income before taxes $ 9,374 $ 6,695
Multiplied by tax rate 38.9% 40.6%
- -----------------------------------------------------------------------------------------------
Computed income tax expense at statutory rates 3,646 2,718
Amount included in Trust income (17,433) (13,293)
- -----------------------------------------------------------------------------------------------
(13,787) (10,575)
Increase (decrease) resulting from the following:
Non-deductible crown charges 1,278 (61)
Resource allowance (1,731) 2,062
Non-tax portion of capital gain 2,633 (1,282)
Unit appreciation rights expense 560 99
Rate change 549 794
Other 136 (15)
- -----------------------------------------------------------------------------------------------
Future income tax recovery $ (10,362) $ (8,978)
- -----------------------------------------------------------------------------------------------
The components of the future income tax liability (asset) are as follows:
- -----------------------------------------------------------------------------------------------
2004 2003
- -----------------------------------------------------------------------------------------------
Net book value of oil and natural gas assets in excess of tax pools $ 46,333 $ (1,085)
Asset retirement obligation (9,691) (9,468)
Net unrealized gains on derivative contracts and foreign exchange 2,293 -
Tax loss carry forwards (1,172) (1,649)
Deferral of taxable income in partnership 2,339 -
Working capital and other items (5,431) (407)
- -----------------------------------------------------------------------------------------------
Future income tax liability (asset) $ 34,671 $(12,609)
- -----------------------------------------------------------------------------------------------
The non-capital losses described above expire in the years 2009 and 2010.
16. FINANCIAL INSTRUMENTS
The Trust is exposed to market risks resulting from fluctuations in
commodity prices, foreign exchange rates and interest rates in the normal
course of operations.
a. FAIR VALUES
Financial instruments of the Trust consist mainly of accounts
receivable, deposits, accounts payable and accrued liabilities, cash
distributions payable, bank debt, convertible debentures and senior
notes. Other than as disclosed in the related notes to the convertible
debentures and the senior notes, there were no significant differences
between the carrying values of these financial instruments reported on
the balance sheet and their estimated fair values due to their short
term to maturity.
16
HARVEST ENERGY TRUST
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(tabular amounts in
thousands of canadian dollars, except trust unit, and per trust unit amounts)
- --------------------------------------------------------------------------------
b. INTEREST RATE RISK
The Trust is exposed to interest rate risk on its bank debt. All of
the Trust's other debt has fixed interest rates.
c. CREDIT RISK
Substantially all accounts receivable are due from customers in the
oil and natural gas industry and are subject to normal industry credit
risks. Concentration of credit risk is mitigated by having a broad
customer base, which includes a significant number of companies
engaged in joint operations with the Trust. The Trust periodically
assesses the financial strength of its partners and customers,
including parties involved in marketing or other commodity
arrangements. The carrying value of accounts receivable reflects
management's assessment of the associated credit risks.
d. FOREIGN EXCHANGE RATE RISK
The Trust is exposed to the risk of changes in the Canadian/US dollar
exchange rate on sales of commodities that are denominated in US
dollars or directly influenced by US dollar benchmark prices. In
addition, the Trust's senior notes are denominated in US dollars
(US$250 million). These notes act as an economic hedge to help offset
the impact of exchange rate movements on commodity sales during the
year. As at December 31, 2004 the full balance of the notes is still
outstanding and is not repayable until October 15, 2011. Interest is
payable semi-annually on the notes in US dollars.
e. COMMODITY RISK MANAGEMENT
The Trust uses fixed price oil sales contracts and derivative
financial instruments to manage its commodity price exposure. Under
the terms of some of the derivative instruments, Harvest Operations is
required to provide security from time to time based on the underlying
market value of those contracts. The Trust is also exposed to
counterparty risk for these derivative contracts. This risk is managed
by diversifying the Trust's derivative portfolio among a number of
counterparties and by dealing with large investment grade
institutions.
The following is a summary of the oil sales price derivative contracts
as at December 31, 2004, that have fixed future sales prices:
17
HARVEST ENERGY TRUST
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(tabular amounts in
thousands of canadian dollars, except trust unit, and per trust unit amounts)
- --------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Oil price swap contracts based on West Texas Intermediate
----------------------------------------------------------------------------------------------------------------
Mark to Market
Daily Quantity Term Price per Barrel Gain (Loss)
----------------------------------------------------------------------------------------------------------------
500 Bbls/d January through December 2005 U.S. $24.00 $ (4,107)
1,100 Bbls/d January through March 2005 U.S. $22.38 (2,535)
1,030 Bbls/d April through June 2005 U.S. $22.18 (2,358)
50% Participating swap contracts based on West Texas Intermediate
----------------------------------------------------------------------------------------------------------------
8,750 Bbls/d Jan - Dec 2006 U.S. $38.16 (b) $ 3,710
Oil price collar contracts based on West Texas Intermediate
----------------------------------------------------------------------------------------------------------------
2,500 Bbls/d January through June 2005 U.S. $28.40 - 32.25 ($21.80) $ (6,032) (a)
1,500 Bbls/d July through December 2005 U.S. $28.17 - 32.10 ($22.33) (3,296) (a)
2,000 Bbls/d January through December 2005 U.S. $28.00 - 42.00 (529)
----------------------------------------------------------------------------------------------------------------
Note: (a) Harvest has sold put options at the average price denoted in
parenthesis, for the same volumes as the associated commodity
contracts. The counterparty may exercise these options if the
respective index falls below the specified price on a monthly
settlement basis.
(b) This price is a floor. The Trust realizes this price plus 50%
of the difference between spot price and this price.
-----------------------------------------------------------------------------------------------------------
Daily Mark to Market Gain
Quantity Term Type Price per Bbl (Loss)
-----------------------------------------------------------------------------------------------------------
4,000 bbls/d Jan - Dec 2005 Long Put $30.00 $ 937
1,972 bbls/d Jan - Dec 2005 Short Call $30.00 (11,261)
1,972 bbl/d Jan - Dec 2005 Long Call $40.00 4,642
7,000 bbl/d Jan - Dec 2005 Long Put $35.00 $ 4,050
2,380 bbl/d Jan - Dec 2005 Short Call $35.00 (9,239)
2,380 bbl/d Jan - Dec 2005 Long Call $45.00 3,090
7,500 bbl/d Jan - Dec 2005 Long Put $40.00 $ 9,142
3,675 bbl/d Jan - Dec 2005 Short Call $40.00 (8,651)
3,675 bbl/d Jan - Dec 2005 Long Call $50.00 2,678
7,500 bbl/d Jan - June 2006 Long Put $34.00 $ 2,989
3,750 bbl/d Jan - June 2006 Short Call $34.00 (7,252)
3,750 bbl/d Jan - June 2006 Long Call $44.00 3,170
-----------------------------------------------------------------------------------------------------------
(1) Each group of a long put, short call and a long call reflect an
"indexed put option". These series of puts and calls serve to fix a floor
price while retaining upward price exposure on a portion of price movements
above the floor price.
18
HARVEST ENERGY TRUST
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(tabular amounts in
thousands of canadian dollars, except trust unit, and per trust unit amounts)
- --------------------------------------------------------------------------------
The following is a summary of electricity price physical and financial swap
contracts entered into by Harvest Operations to fix the cost of future
electricity usage as well as a put option related to the US/Canadian dollar
exchange rate as at December 31, 2004:
------------------------------------------------------------------------------------------------------------
Swap contracts based on electricity prices
------------------------------------------------------------------------------------------------------------
Weighted Average Term Average Price Mark to Market
Quantity per Megawatt Gain (Loss)
------------------------------------------------------------------------------------------------------------
24.8 MWH January through December 2005 Cdn $47.43 $ 1,272
29.9 MWH January through December 2006 Cdn $47.51 (196)
Swap contracts based on electricity heat rate
------------------------------------------------------------------------------------------------------------
Quantity Term Heat Rate Mark to Market
(Loss)
------------------------------------------------------------------------------------------------------------
5 MW January through December 2005 8.40 GJ/MWh $ (80)
------------------------------------------------------------------------------------------------------------
Foreign currency contracts
------------------------------------------------------------------------------------------------------------
Mark to Market
Monthly Contract Amount Term Contract Rate Gain
------------------------------------------------------------------------------------------------------------
U.S. $8.33 million January through December 2005 1.20 Cdn / U.S. $ 4,500(1)
19
HARVEST ENERGY TRUST
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(tabular amounts in
thousands of canadian dollars, except trust unit, and per trust unit amounts)
- --------------------------------------------------------------------------------
(1) Represents the premium paid on this contract.
At December 31, 2004, the net unrealized loss position reflected on the
balance sheet for all the financial derivative contracts outstanding at
that date was approximately $15.4 million. Harvest Operations has provided
deposits to some counterparties for a portion of its financial derivative
contracts, based on the fair value of those contracts at the end of the
trading day. As at December 31, 2004, the amounts deposited totaled $1.3
million and are recorded in the prepaid expenses and deposits balance.
For the year ended December 31, 2004, the total unrealized loss recognized
in the statement of income was $11.3 million. The realized losses on all
derivative contracts are included in the period in which they are incurred.
Both of these amounts are reflected in Gains and Losses on Derivative
Contracts on the statement of income.
At October 1, 2004, the Trust discontinued hedge accounting for all of its
derivative financial instruments. For those contracts where hedge
accounting had previously been applied, a deferred charge or gain was
recorded equal to the fair value of the contracts at the time hedge
accounting was discontinued with a corresponding amount recorded in the
derivative contracts balance. The deferred charge or gain is recognized in
income in the period in which the underlying transaction is recognized.
For the year ended December 31, 2004, $14.9 million of the deferred charge
and $350,000 of the deferred gain has been amortized and recorded in gains
and losses on derivative contracts in the statement of income. At December
31, 2004, $10.8 million and $2.2 million has been recorded as a deferred
charge and a deferred gain, respectively on the balance sheet.
20
HARVEST ENERGY TRUST
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(tabular amounts in
thousands of canadian dollars, except trust unit, and per trust unit amounts)
- --------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------
DECEMBER 31
DEFERRED CHARGES - ASSET 2004 2003
---------------------------------------------------------------------------------------------
Balance, beginning of year $ 1,989 $ 2,210
Deferred charge related to derivative contracts
recorded upon adoption of AcG-13 5,490 -
Deferred charge related to derivative contracts
recorded upon discontinuing hedge accounting 20,215 -
Discount on senior notes [NOTE 9] 2,075
Financing costs incurred 13,770 2,335
Amortization of deferred charge related to derivative
contracts(1) (14,946) -
Amortization of deferred financing costs(2) (4,086) (2,556)
---------------------------------------------------------------------------------------------
Balance, end of year $ 24,507 $ 1,989
---------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------
DECEMBER 31
DEFERRED GAINS - LIABILITY 2004 2003
---------------------------------------------------------------------------------------------
Balance, beginning of year $ - $ -
Deferred gains related to derivative contracts
recorded upon discontinuing hedge accounting 2,527 -
Amortization of deferred gains related to derivative
contracts(1) (350) -
---------------------------------------------------------------------------------------------
Balance, end of year $ 2,177 $ -
---------------------------------------------------------------------------------------------
(1) Recorded within gains and losses on derivative contracts
(2) Recorded within interest expense
17. RELATED PARTY TRANSACTIONS
Refer to Note 10 regarding equity bridge notes received from a director of
Harvest Operations and a corporation controlled by that director.
A corporation controlled by a director of Harvest Operations sublets office
space and is provided administrative services by Harvest Operations on a
cost recovery basis.
21
HARVEST ENERGY TRUST
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
(tabular amounts in
thousands of canadian dollars, except trust unit, and per trust unit amounts)
- --------------------------------------------------------------------------------
18. CHANGE IN NON-CASH WORKING CAPITAL
-------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31
2004 2003
-------------------------------------------------------------------------------------------
Changes in non-cash working capital items:
Accounts receivable $ (24,860) $ (5,590)
Prepaid expenses and deposits 9,117 (11,596)
Current portion of derivative contracts assets (8,861) -
Accounts payable and accrued liabilities 58,168 12,154
Cash distributions payable 4,936 1,559
Current portion of derivative contracts liability 27,927 -
-------------------------------------------------------------------------------------------
$ 66,427 $ (3,473)
-------------------------------------------------------------------------------------------
Changes relating to operating activities $ (11,103) $ (12,290)
Changes relating to financing activities 5,097 2,889
Changes relating to investing activities 16,547 329
Add: Non cash changes 55,886 5,599
-------------------------------------------------------------------------------------------
$ 66,427 $ (3,473)
-------------------------------------------------------------------------------------------
19. COMMITMENTS, CONTINGENCIES AND GUARANTEES
From time to time, the Trust is involved in litigation or has claims
brought against it in the normal course of business operations. Management
of the Trust is not currently aware of any claims or actions that would
materially affect the Trust's reported financial position or results from
operations.
In the normal course of operations, management may also enter into certain
types of contracts that require the Trust to indemnify parties against
possible third party claims, particularly when these contracts relate to
purchase and sale agreements. The terms of such contracts vary and
generally a maximum is not explicitly stated; as such the overall maximum
amount of the obligations cannot be reasonably estimated. Management does
not believe payments, if any, related to such contracts would have a
material affect on the Trust's reported financial position or results from
operations.
The Trust has letters of credit outstanding in the amount of approximately
$5 million related to electricity infrastructure usage. These letters are
provided by Harvest Operations' lenders pursuant to the credit agreement
[Note 8]. These letters expire throughout 2004 and 2005, and are expected
to be renewed as required.
Following is a summary of the Trust's contractual obligations and
commitments as at December 31, 2004:
- ----------------------------------------------------------------------------------------------------------------------
PAYMENTS DUE BY PERIOD
- ----------------------------------------------------------------------------------------------------------------------
($000'S) 2005 2006 - 2007 2008 - 2009 THEREAFTER TOTAL
- ----------------------------------------------------------------------------------------------------------------------
Debt repayments (1) 75,519 - - 300,500 376,019
Capital commitments 700 - - - 700
Operating leases 400 2,869 2,869 956 7,094
- ----------------------------------------------------------------------------------------------------------------------
Total contractual obligations 76,619 2,869 2,869 301,456 383,813
- ----------------------------------------------------------------------------------------------------------------------
(1) Includes long-term and short-term debt. Assumes that the outstanding
convertible debentures either exchange at holders' option for units or are
redeemed for units at the Trust's option.
22