EXHIBIT 99.2
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[GRAPHIC OMITTED]
V E R M I L L I O N
ENERGY TRUST
2005 ANNUAL MANAGEMENT'S DISCUSSION AND ANALYSIS
AMENDED NOVEMBER 15, 2006
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MANAGEMENT'S DISCUSSION AND ANALYSIS
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The following management's discussion and analysis (MD&A) has been amended to
enhance the disclosure relating to the assessment of the Trust's disclosure
controls and procedures by Vermilion's officers as of the end of the period
covered by this MD&A. Please see Disclosure Controls and Procedures on page 13
of this MD&A.
Although the MD&A has been updated to reflect material events that occurred
subsequent to the original filing date of March 20, 2006, readers should review
Vermilion's subsequent public filings available through SEDAR including the
MD&A documents filed for the first, second and third quarters of 2006.
The following MD&A is dated February 15, 2006 and relates to Vermilion's
operating and financial results for the years ended December 31, 2005 and 2004.
This discussion should be read in conjunction with the Trust's audited
consolidated financial statements for the years ended December 31, 2005 and
2004, together with accompanying notes.
NON-GAAP MEASURES
Included in this report are references to terms commonly used in the oil and
gas industry, such as cash flow and cash flow per unit and funds from
operations which are expressed before changes in non-cash working capital and
is used by the Trust to analyze operating performance, leverage and liquidity.
These terms are not defined by Generally Accepted Accounting Principles
("GAAP"). Consequently, these are referred to as non-GAAP measures. Cash flow,
as discussed in this report, appears as a separate caption on the Trust's cash
flow statement as "funds from operations" and is reconciled to net earnings.
FORWARD-LOOKING INFORMATION
This report contains forward-looking financial and operational information
including earnings, cash flow, production and capital expenditure projections.
These projections are based on the Trust's expectations and are subject to a
number of risks and uncertainties that could materially affect the results.
These risks include, but are not limited to, future commodity prices, exchange
rates, interest rates, geological risk, reserves risk, political risk, product
demand and transportation restrictions.
HIGHLIGHTS ($M EXCEPT PER UNIT AMOUNTS) 2005 2004* 2003*
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Revenues $ 529,938 $ 354,525 $ 314,146
Net earnings from continuing operations 158,471 66,010 44,962
Net earnings 158,471 127,513 43,477
Per unit basic 2.57 2.12 0.82
Per unit diluted 2.49 2.07 0.81
Funds from operations 278,165 170,179 144,761
Per unit 4.50 2.83 2.73
Return on equity (%) 37.4 34.0 12.0
Total assets 1,111,739 844,602 780,589
WTI (US$/bbl) 56.56 41.40 31.04
AECO (CDN$/mcf) 8.77 6.56 6.69
Realized price ($/boe) 53.48 39.48 37.52
Cash flow netback ($/boe) (1) $ 30.15 $ 20.19 $ 17.29
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(1) 2003 netbacks are calculated including the impact of $25.6 million of
reorganization costs
2005 SUMMARY OF QUARTERLY RESULTS ($M EXCEPT PER UNIT AMOUNTS) Q1 Q2 Q3 Q4
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Revenue $ 108,715 $ 117,360 $ 149,877 $ 153,986
Net earnings 25,990 32,585 50,118 49,778
Per unit basic 0.43 0.53 0.81 0.80
Per unit diluted $ 0.41 $ 0.53 $ 0.79 $ 0.78
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2004 SUMMARY OF QUARTERLY RESULTS ($M EXCEPT PER UNIT AMOUNTS) Q1 Q2 Q3 Q4
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Revenue $ 77,610 $ 87,420 $ 96,260 $ 93,235
Net earnings from continuing operations* 10,797 19,309 14,902 21,002
Net earnings* 11,625 78,184 14,902 22,802
Per unit basic* 0.20 1.31 0.25 0.38
Per unit diluted* $ 0.19 $ 1.28 $ 0.24 $ 0.37
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* Restated stock compensation expense (Note 11)
2005 AMENDED ANNUAL MD&A - VERMILLION ENERGY TRUST 2
QUARTERLY RESULTS
Quarterly results in 2005 have improved due to the Australia acquisition which
was completed at the end of the first quarter of 2005. In addition, WTI prices
in the last half of 2005 were approximately US$10.00 per barrel higher than the
first half of 2005. The increase in earnings in the three months ended June 30,
2004 relates to the sale of Aventura for a net gain of $68.0 million.
FOURTH QUARTER 2005
Revenue for the three months ended December 31, 2005 increased 65% over the
three months ended December 31, 2004. This increase is due to an increase in
production resulting from the acquisition of assets in Australia as well as
increased prices received. WTI increased 24% quarter over quarter and AECO
increased 74% in the same period. Earnings increased significantly due mostly
to the increase in revenues. In December 2005, the Trust's ownership in Verenex
was decreased to approximately 49% and the Trust discontinued consolidating
Verenex effective December 15, 2005. Prior periods have not been restated.
OPERATIONAL ACTIVITIES
CANADA
In Canada, the Trust participated in the drilling of 66 wells (30.4 net)
resulting in 19 gas wells (10.7 net), 1 oil well (0.5 net), 2 abandoned wells
(0.6 net) and 44 standing wells (18.6 net) awaiting further evaluation,
completion or tie-in. Of the total wells drilled in 2005, 55 (24.0 net) were
related to the CBM / shallow gas program, which achieved a 100% success rate.
In addition to the Trust's drilling operations, an additional 21 wells were
drilled on Vermilion lands by third party operators through farm-out
arrangements. Vermilion maintained an overriding royalty of small working
interest in these wells.
FRANCE
Vermilion drilled and completed three new La Torche wells and re-entered and
completed the Champotran 23 well which was temporarily abandoned in 2004, all
in the Paris Basin. Average production rates from these wells were
approximately 180 boe/d per well, with each well adding approximately 400,000
bbls of reserves on a proved plus probable basis.
NETHERLANDS
The Trust installed 16 small diameter tubing strings to improve the
deliverability of these gas wells. Vermilion completed major plant inspections
and turn-arounds at its Harlingen and Garijp facilities and installed a new
canal crossing for one of its delivery pipelines.
AUSTRALIA
Vermilion applied for and received government approval to operate the offshore
Wandoo facilities. A modest debottlenecking of the topside facilities on the
Wandoo B platform was successfully completed during the summer, which combined
with a modified cycling program of these wells increased production by
approximately 200 boe/d. Vermilion undertook a geological modeling study and a
reservoir study to explore different avenues to increase production from this
field.
PRODUCTION
Production in Canada during 2005 averaged 4,870 bbls/d of oil and NGL's and
38.4 mmcf/d of natural gas compared to 5,723 bbls/d of oil and NGL's and 46.4
mmcf/d of natural gas in 2004. Fourth quarter production averaged 4,522 bbls/d
of oil and NGL's and 39.1 mmcf/d of natural gas, representing an annual decline
of approximately 11% compared to fourth quarter 2004 volumes.
Production in France averaged 5,695 boe/d in 2005 a 5% decline compared to
6,018 boe/d production in 2004. Fourth quarter production averaged 6,096 boe/d
and benefited from a recent recompletion and tie-in of new wells in the
Champotran/La Torche field.
Production in the Netherlands, acquired in May 2004, averaged 4,812 boe/d for
the year compared to 3,519 boe/d in 2004. Fourth quarter production from the
Netherlands averaged 5,214 boe/d, representing an annual decline of
approximately 7% compared to fourth quarter 2004 volumes.
Production in Australia, acquired in March 2005, averaged 3,391 boe/d for the
year. Fourth quarter production in Australia averaged 4,294 boe/d.
2005 AMENDED ANNUAL MD&A - VERMILLION ENERGY TRUST 3
Total Trust production averaged 25,166 boe/d in 2005, compared to 22,990 boe/d
in 2004. Production declines in Canada and France were offset with the
acquisition of production in Australia and the full year of production in the
Netherlands.
YEAR ENDED DECEMBER 31, 2005 YEAR ENDED DECEMBER 31, 2004 YEAR ENDED DECEMBER 31, 2003
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OIL & NATURAL OIL & NATURAL OIL & NATURAL
NGLS GAS TOTAL NGLS GAS TOTAL NGLS GAS TOTAL
(bbls/d) (mmcf/d) (boe/d) (bbls/d) (mmcf/d) (boe/d) (bbls/d) (mmcf/d) (boe/d)
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Vermilion Energy Trust
Canada 4,870 38.39 11,268 5,723 46.38 13,453 6,678 59.96 16,671
France 5,478 1.30 5,695 5,763 1.53 6,018 6,018 1.51 6,271
Netherlands (1) 28 28.70 4,812 13 21.03 3,519 - - -
Australia (2) 3,391 - 3,391 - - - - - -
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Total 13,767 68.39 25,166 11,499 68.94 22,990 12,696 61.47 22,942
=================================================================================================================================
(1) Effective from May 19th, 2004
(2) Effective from March 31, 2005
2005 QUARTERLY PRODUCTION (BOE/D) Q1 Q2 Q3 Q4
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Canada 11,978 10,996 11,075 11,035
France 5,559 5,260 5,856 6,096
Netherlands 5,225 3,789 5,018 5,214
Australia (1) - 4,498 4,710 4,294
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Total 22,762 24,543 26,659 26,639
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(1) Effective from March 31, 2005
2004 QUARTERLY PRODUCTION (BOE/D) Q1 Q2 Q3 Q4
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Canada 15,055 13,502 12,875 12,398
France 6,262 5,991 5,869 5,954
Netherlands (1) - 2,882 5,553 5,593
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Total 21,317 22,375 24,297 23,945
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(1) Effective from May 19th, 2004
CAPITAL EXPENDITURES
Capital spending for the year totalled $300.1 million compared to $161.2
million spent in 2004. Of this total, approximately $95.0 million relates to
the acquisition in Australia, $91.6 million relates to the Glacier acquisition
with the remainder spent on drilling and development activities.
CAPITAL EXPENDITURES ($M) 2005 2004 2003
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Land $ 2,233 $ 493 $ 1,520
Seismic 12,116 787 1,272
Drilling and completion 43,929 34,469 47,440
Production equipment and facilities 25,111 15,757 11,887
Recompletions 21,163 9,999 12,861
Capitalized exploration administration 267 1,670 2,061
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Drilling and development expenditures 104,819 63,175 77,041
Property acquisitions (dispositions) 94,967 93,990 (1,294)
Corporate acquisitions 91,613 - -
Other 8,711 4,084 3,819
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$300,110 $161,249 $ 79,566
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CAPITAL EXPENDITURES BY COUNTRY ($M) 2005 2004 2003
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Canada $141,022 $ 31,722 $ 33,511
France 50,649 35,028 30,469
Netherlands 12,434 94,499 -
Australia 96,005 - -
Trinidad - - 15,586
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$300,110 $161,249 $ 79,566
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2005 AMENDED ANNUAL MD&A - VERMILLION ENERGY TRUST 4
FINANCIAL REVIEW
The Trust (excluding Verenex Energy Inc. "Verenex") generated funds from
operations of $87.9 million ($1.29 per unit) in the fourth quarter of 2005,
compared to $47.5 million ($0.72 per unit) in the fourth quarter of 2004. The
Trust's distributions in the fourth quarter totaled $31.8 million ($0.51 per
unit) for a payout ratio of 36%. Cash flow (excluding Verenex) for the twelve
months ended December 31, 2005 totaled $277.2 million ($4.07 per unit) compared
to $169.8 million ($2.57 per unit) in the prior year. The full year
distributions in 2005 totaled $126.2 million compared to $122.6 million in
2004. This represents a payout ratio of approximately 45% of total cash flow.
Development capital expenditures during the fourth quarter of 2005 (excluding
Verenex) were $27.2 million bringing the full year total to $102.6 million
($50.7 million in 2004). Vermilion took advantage of strong cash flow driven by
high commodity prices to inject a further $25.2 million into the Trust's
reclamation fund, increasing the fund to $42.2 million. Vermilion is committed
to maintaining a source of funds available for abandonment and reclamation
activities, such that future distribution and capital program decisions will
not be impacted by these liabilities.
Vermilion's net debt as of December 31, 2005 was $244.9 million, less than 0.9
times trailing cash flow. Financial derivatives put in place by the Trust late
in 2002 to protect against a fall in oil prices expired at the end of 2005. In
2005, Vermilion recorded a cash cost of approximately $41 million related to
these financial instruments. Vermilion has changed its approach in its use of
financial instruments and is currently using a combination of puts and collars
to provide downside commodity price protection.
CASH FLOW NETBACKS
Cash flow was $278.2 million in 2005, up from $170.2 million in 2004. A higher
average wellhead price was recorded in 2005 as a result of a 34% increase in
AECO pricing and a 37% increase in average WTI pricing compared with 2004.
2005 CASH FLOW ($/BOE) Q1 Q2 Q3 Q4 2005 2004 2003
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Oil and gas revenues $53.36 $52.90 $61.42 $62.87 $57.94 $43.21 $39.90
Realized hedging losses (3.98) (4.29) (5.13) (4.36) (4.46) (3.73) (2.38)
Royalties (net) (7.01) (9.40) (10.37) (10.94) (9.54) (7.54) (8.92)
Transportation (1.43) (0.96) (0.82) (0.81) (0.99) (1.17) (1.24)
Lifting costs (7.52) (8.52) (7.54) (7.99) (7.89) (6.63) (6.11)
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Operating netbacks 33.42 29.73 37.56 38.77 35.06 24.14 21.25
General and administration (1.58) (1.65) (1.16) (1.39) (1.43) (1.59) (1.24)
Reorganization costs - - - - - - (1.05)
Interest (0.47) (0.54) (0.78) (0.90) (0.69) (0.37) (1.05)
Current and capital taxes (3.40) (3.12) (3.95) (0.52) (2.71) (2.03) (0.59)
Foreign exchange (0.08) (0.06) (0.13) (0.05) (0.08) 0.04 (0.03)
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Cash flow netbacks $27.89 $24.36 $31.54 $35.91 $30.15 $20.19 $17.29
======================================================================================================================
2004 CASH FLOW ($/BOE) Q1 Q2 Q3 Q4
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Oil and gas revenues $41.71 $44.21 $43.79 $43.04
Realized hedging losses (2.84) (3.34) (4.35) (4.23)
Royalties (net) (9.67) (8.33) (6.74) (5.75)
Transportation (1.43) (1.35) (0.99) (0.97)
Lifting costs (6.16) (6.72) (6.86) (6.74)
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Operating netbacks 21.61 24.47 24.85 25.35
General and administration (1.58) (1.67) (1.59) (1.53)
Interest (0.69) (0.39) (0.17) (0.26)
Current and capital taxes (1.24) (1.99) (2.81) (1.97)
Foreign exchange - 0.05 0.09 -
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Cash flow netbacks $18.10 $20.47 $20.37 $21.59
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REVENUE
Total revenues in 2005 were $529.9 million compared to $354.5 million in 2004.
Vermilion's combined crude oil & NGL price was $64.79 per bbl for 2005, an
increase of 37% over the $47.26 per bbl reported in 2004. The natural gas price
realized in 2005 was $8.28 per mcf compared to $6.53 per mcf realized a year
ago, a 27% year-over-year increase.
2005 AMENDED ANNUAL MD&A - VERMILLION ENERGY TRUST 5
In the following chart, "Derivative instruments" is the amortization of the
fair value loss of Vermilion's hedges in place as of January 1, 2004.
YEAR ENDED DECEMBER 31
($000'S EXCEPT PER BOE) 2005 2004
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Crude oil & NGL's $326,754 $199,060
Per boe $64.79 $47.26
Natural gas 207,902 165,174
Per mcf $8.28 $6.53
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Combined 534,656 364,234
Derivative instruments (4,718) (9,709)
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Petroleum and natural gas revenue $529,938 $354,525
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DERIVATIVE INSTRUMENTS
Vermilion continues to manage its risk exposure through prudent commodity and
currency economic hedging strategies. Vermilion has the following collars and
puts in place at the end of 2005:
RISK MANAGEMENT: OIL FUNDED COST BBLS/D US$/BBL
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Collar - WTI
Q1 2006 US$0.50-$1.00/bbl 1,250 $53.00 - $72.75
Q2 2006 US$1.50/bbl 250 $53.00 - $73.90
Collar - BRENT
2006 US$1.00/bbl 1,000 $53.00 - $67.70
Q3 2006 US$1.00/bbl 250 $52.00 - $68.50
Q4 2006 US$1.50/BBL 250 $53.00 - $69.80
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RISK MANAGEMENT: NATURAL GAS FUNDED COST GJ/D C$/GJ
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Collar
Q1 2006 $0.25/GJ 2,500 $9.50 - $16.00
Feb-Mar 2006 costless 2,500 $11.00 - $20.74
Apr-Oct 2006 $0.25/GJ 2,500 $8.00 - $15.00
Put
Q1 2006 $0.23/GJ 5,000 $10.50
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The impact of Vermilion's hedging program reduced cash netbacks by $4.46 per
boe on a combined basis for the year ended 2005 compared to an economic hedging
loss of $3.73 per boe in 2004. Oil hedging resulted in a $41.6 million cost for
the year or $4.51 per boe. For 2004, oil hedging resulted in a $34.1 million
cost for the year or $4.04 per boe. For the year the Trust recorded a net gain
from its power hedges totalling $0.5 million or $0.05 per boe. In 2004 a
currency hedge gain of $3.3 million or $0.39 per boe was recorded.
ROYALTIES
Total royalties, net of ARTC, increased to $9.54 per boe in 2005 or 16% of
sales compared with $7.54 per boe or 17% of sales in 2004. The increase on a
per boe basis is due to the impact of higher commodity prices. The decrease on
a percentage basis is due to the fact there are no royalties paid in the
Netherlands offset somewhat by a higher royalty rate in Australia. Contributing
to the lower percentage is the fact that gas royalties in Canada have reached a
plateau as prices have increased beyond the maximum royalty calculation. In
France, royalties for the most part are calculated on a unit of production
basis and rates do not react to price changes, therefore as prices increase,
the royalties, as a percentage of sales, decline. In Australia, royalties are
reduced by capital reinvestment in the country. For 2005, Vermilion's capital
program in Australia was minimal resulting in the Trust paying royalties at or
near the maximum rate.
YEAR ENDED DECEMBER 31
($000'S EXCEPT PER BOE) 2005 2004
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Crude oil & NGL's $ 61,322 $ 31,105
Per boe $ 12.16 $ 7.39
Natural gas $ 26,679 $ 32,450
Per mcf $ 1.06 $ 1.28
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Combined $ 88,001 $ 63,555
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Per boe $ 9.54 $ 7.54
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2005 AMENDED ANNUAL MD&A - VERMILLION ENERGY TRUST 6
OPERATING COSTS
Operating costs increased to $7.89 per boe in 2005 from $6.63 per boe in 2004.
The increase in the dollar amount of operating costs over 2004 was due to the
acquisition of higher cost assets in Australia. In Canada, the significant
activity levels in the industry combined with increased energy costs, have
placed upward pressure on costs across the board. When combined with a
reduction in production volumes due primarily to plant turnarounds, year over
year increases in costs per boe have been experienced. In France, operating
costs are down due to a reclassification of certain expenses in the fourth
quarter of 2005. In the Netherlands, operating costs are up due primarily to a
reduction in production volumes and extensive plant maintenance in the second
quarter of 2005. Cost of operations in Australia averaged $9.09 per boe of
production since acquiring the assets at the end of the first quarter.
YEAR ENDED DECEMBER 31
($000'S EXCEPT PER BOE) 2005 2004
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Crude oil & NGL's $ 39,060 $ 30,632
Per boe $ 7.75 $ 7.27
Natural gas $ 33,796 $ 25,285
Per mcf $ 1.35 $ 1.00
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Combined $ 72,856 $ 55,917
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Per boe $ 7.89 $ 6.63
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TRANSPORTATION
Transportation costs, as presented in the statement of earnings, are defined by
the point of legal transfer of the product. Transportation costs are dependent
upon where the product is sold, product split, location of properties, and
industry transportation rates that are driven by supply and demand of available
transport capacity. For Canadian gas production, legal title transfers at the
intersection of major pipelines (referred to as "the Hub") whereas the majority
of Vermilion's Canadian oil production is sold at the wellhead. The majority of
Vermilion's transportation costs are made up of boat charges incurred in the
Aquitaine Basin in France where oil production is transported by tanker from
Ambes shipping terminal in Bordeaux to Donges, France. In Australia, oil is
sold at the Wandoo B platform and in the Netherlands gas is sold at the plant
gate, resulting in no transportation costs relating to Vermilion's production
in these countries.
YEAR ENDED DECEMBER 31
($000'S EXCEPT PER BOE) 2005 2004
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Transportation $9,136 $9,865
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Per boe $ 0.99 $ 1.17
===============================================================================
GENERAL AND ADMINISTRATION EXPENSES
General and administration expenses for the year decreased to $1.43 per boe
from $1.59 per boe in 2004. The decrease per boe is a result of the higher
production volumes experienced in 2005.
YEAR ENDED DECEMBER 31
($000'S EXCEPT PER BOE) 2005 2004
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General and administration $13,241 $13,410
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Per boe $ 1.43 $ $1.59
===============================================================================
UNIT COMPENSATION EXPENSE
A non-cash trust unit compensation expense of $1.52 per boe was recorded in
2005 compared to $0.80 per boe for 2004. This non-cash amount relates to the
value attributable to rights granted to officers, directors and employees under
the Trust Unit Rights Incentive Plan ("Unit Rights Plan") and the Trust Unit
Award Plan ("Award Plan").
From inception of the unit rights incentive plan until January 1, 2005, the
Trust applied the intrinsic value methodology based on the initial asessment
that the number of uncertainties regarding the reduction in the strike price of
the rights precluded a reasonable estimate of the fair value of the rights on
the date of grant.
Effective on January 1, 2005, the Trust prospectively applied the fair value
based method of accounting for the rights plan.
2005 AMENDED ANNUAL MD&A - VERMILLION ENERGY TRUST 7
In the fourth quarter of 2005 however, it has been determined that, in the
circumstances, the fair value methodology could be applied since inception of
the plan rather than the intrinsic value methodology. The Trust has therefore
computed a fair value estimate of the rights at the respective dates of grant
and has retroactively restated its unit compensation expense back to the
inception of the plan in 2003.
In March 2005, the Board of Directors established the new Award Plan to replace
the existing Unit Rights Plan. The new Award Plan will result in directors,
officers, employees and consultants of the Trust and its Affiliates being
awarded a specified number of Restricted Units and the Units shall be
designated as either a Restricted Time Based Award ("RTBA's") for which the
number of awards is fixed or a Performance Based Award ("PBA's") for which the
number of awards is variable. Payment in respect of Restricted Units that have
vested shall be made by delivering Units or corresponding cash value to the
Grantee. The fair value of the Awards will be recognized in earnings over the
vesting period of the Awards outstanding.
YEAR ENDED DECEMBER 31
($000'S EXCEPT PER BOE) 2005 2004
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(Restated)
Unit compensation expense $ 14,000 $ 6,738
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Per boe $ 1.52 $ $0.80
===============================================================================
INTEREST EXPENSE
Interest expense increased to $0.69 per boe in 2005 from $0.37 per boe in 2004
as a result of higher average debt levels in 2005 stemming from the purchase of
the assets in the Netherlands in May of 2004, the Australia assets in the first
quarter of 2005 and the Glacier acquisition in December 2005. The Trust's
interest rates have remained steady over the year.
YEAR ENDED DECEMBER 31
($000'S EXCEPT PER BOE) 2005 2004
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Interest $ 6,331 $ 3,086
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Per boe $ 0.69 $ 0.37
===============================================================================
DEPLETION, DEPRECIATION AND ACCRETION EXPENSES
Depletion, depreciation and accretion expense increased to $13.23 per boe in
2005 from $11.57 per boe in 2004. The increase is due mainly to the increase of
finding and development costs in Canada and the increase in the asset
retirement obligation, resulting primarily from the Australia acquisition.
YEAR ENDED DECEMBER 31
($000'S EXCEPT PER BOE) 2005 2004
- -------------------------------------------------------------------------------
Depletion, depreciation and accretion $ 122,098 $ 97,540
- -------------------------------------------------------------------------------
Per boe $ 13.23 $ 11.57
===============================================================================
TAXES
The Trust's current tax provision has increased to $2.71 per boe in 2005 from
$2.03 per boe in 2004 and is due primarily to the increase in earnings
generated by strong commodity prices. The current provision is based on an
approximate $13.4 million tax liability in France, an approximate $3.6 million
tax liability in the Netherlands and an approximate $7.4 million tax liability
in Australia. The tax liability in Australia was allocated to the purchase
price for the period from January 1 to March 31, 2005 in accordance with the
allocation of revenues and expenses related to the Australia assets for that
same time period. The Netherlands acquisition closed on May 19, 2004 resulting
in only a partial tax payment in 2004 compared to a full period assessment this
year. In Canada, it is anticipated that there will be no current taxes due with
the exception of capital taxes which are assessed on an annual basis. The
recovery in future income taxes is a result of the taxable portion of
distribution payments made to unitholders. In the Trust's structure, payments
are made between the operating company and the Trust transferring both income
and future income tax liability to the unitholder. Therefore it is the opinion
of management that no cash income taxes in Canada are expected to be paid by
the operating company in the future, and as such, the future income tax
liability recorded on the balance sheet related to Canadian operations will be
recovered through earnings over time.
YEAR ENDED DECEMBER 31
($000'S EXCEPT PER BOE) 2005 2004
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Current and capital tax $ 25,007 $ 17,108
- -------------------------------------------------------------------------------
Per boe $ $2.71 $ 2.03
===============================================================================
2005 AMENDED ANNUAL MD&A - VERMILLION ENERGY TRUST 8
FOREIGN EXCHANGE
A combined realized and unrealized foreign exchange loss of $0.12 per boe was
recorded in 2005 with a gain of $0.16 per boe in 2004. The loss is mostly
unrealized and relates to the impact of the strengthening Canadian dollar
compared to the Euro on the foreign working capital.
YEAR ENDED DECEMBER 31
($000'S EXCEPT PER BOE) 2005 2004
- -------------------------------------------------------------------------------
Foreign exchange loss (gain) $ 1,083 $ (1,285)
- -------------------------------------------------------------------------------
Per boe $ 0.12 $ (0.16)
===============================================================================
EARNINGS
Net earnings from continuing operations in the year increased to $158.5 million
or $2.57 per unit from $66.0 million or $1.10 per unit in 2004. The increase in
earnings is due mainly to the record commodity prices realized in the year as
well as the full year impact of the Netherlands operations and the impact of
the operations in Australia acquired in 2005.
LIQUIDITY AND CAPITAL RESOURCES
Vermilion's debt (net of working capital) on December 31, 2005 was $244.9
million. Vermilion entered into an unsecured covenant based credit facility
with a syndicate of chartered banks in July 2005. This $410 million facility is
comprised of a one year revolving period with a one year term to follow with a
final settlement payment required at the end of the second year. In July 2006
this facility was increased to $500 million as a result of the reserves
purchased in France (See Proposed Transaction).
LIQUIDITY AND CAPITAL RESOURCES 2005 2004 2003
- -------------------------------------------------------------------------------
Debt and working capital ($m) $244,889 $ 84,686 $131,498
Bank facility ($m) $410,000 $240,000 $240,000
Unused bank facility ($m) $165,111 $155,314 $108,502
Debt-to-cash-flow ratio (1) 0.88 0.50 0.87
Debt-to-equity ratio (1) 0.53 0.22 0.38
===============================================================================
(1) Debt includes working capital
Vermilion has a long-term and short-term need for capital. Short-term working
capital will be required to finance accounts receivable, crude oil inventory
and other similar short-term assets. Short-term capital may also be used from
time to time to fund cash distributions to maintain consistent monthly cash
distributions to unitholders of the Trust. However, the acquisition and
development of petroleum and natural gas properties requires large amounts of
long-term capital. There are essentially three components in financing the
capital needs of Vermilion: debt, equity and internally generated cash.
There is currently an active market for the equity financing of Canadian
resource trusts. Accordingly, any future significant acquisition of producing
properties is expected to be financed through additional bank debt combined
with the issuance of trust units.
Internally generated cash is used primarily for distributions, internal capital
requirements and contributions to the Trust's reclamation fund. Internal cash
flow is significantly influenced by commodity prices. Other risks include
exchange rates, interest rates and marketing opportunities, among others. For a
thorough discussion of these risks and how they are managed by Vermilion,
please see the section on Risk Management.
RECLAMATION FUND
Vermilion has established a reclamation fund for the ultimate payment of
environmental and site restoration costs on its asset base. The reclamation
fund will be funded by Vermilion Resources Ltd. and/or its operating
subsidiaries. Contributions in 2005 totalled $25.2 million. Contributions are
currently made on a barrel of oil equivalent of production basis in Canada,
France the Netherlands, and Australia and are occasionally supplemented with
lump sum contributions. Contribution levels to the reclamation fund will be
reviewed on a regular basis and will be adjusted when necessary to ensure
reclamation obligations associated with the Trust's assets will be
substantially funded when the costs are forecast to be incurred.
2005 AMENDED ANNUAL MD&A - VERMILLION ENERGY TRUST 9
ASSET RETIREMENT OBLIGATION
At December 31, 2005, Vermilion had recorded an asset retirement obligation of
$70.2 million for future abandonment and reclamation of its properties compared
to $51.7 million in 2004. The increase is due to the liabilities recorded as a
function of the asset acquisition in Australia.
DISTRIBUTIONS
Vermilion maintained monthly distributions at $0.17 per unit for the year
distributing a total of $126.2 million compared to $122.6 million in 2004
before the impact of the Trust's DRIP program. Vermilion has maintained its
distributions at $0.17 per month since its conversion to a trust, resulting in
35 continuous months of distributions at this level. Of the distributions paid
in the year, approximately 86% will be taxed in the hands of taxable Canadian
unitholders' as other income. The balance, considered to be a return of
capital, is tax deferred and will reduce the adjusted cost base of trust units
held by unitholders'.
The Trust defines distributable income as funds from operations. For 2005, the
Trust has paid out 45% of its distributable income (72% in 2004).
UNITHOLDERS' EQUITY
During the year approximately 1.8 million units were issued on conversion of
exchangeable shares, unit rights exercised, issued pursuant to the terms of the
Trust's bonus plan and unitholders' participation in the distribution
reinvestment plan. Unitholders' capital increased during the year by $26.6
million as a result of the issuance of those units and $4.2 million as a result
of contributed surplus transfer on exercise of unit rights. This increase in
equity was offset by cash distributions of $126.2 million in the year.
NON-CONTROLLING INTEREST - EXCHANGEABLE SHARES
The Trust has recorded non-controlling interest attributed to the issued and
outstanding exchangeable shares in accordance with accounting requirements
pursuant to EIC-151 (see Note 2 of the consolidated financial statements for
further discussion). The intent of the new standard is that exchangeable shares
of a subsidiary which are transferable to third parties, outside of the
consolidated entity, represent a non-controlling interest in the subsidiary.
The exchangeable shares are transferable to third parties. In all
circumstances, including in the event of liquidation or insolvency, holders of
exchangeable shares will receive trust units in exchange for their exchangeable
shares and as a result the exchangeable shares and trust units are considered
to be economically equivalent. Therefore, the Trust does not believe that there
is a permanent non-controlling interest as all exchangeable shares will
ultimately be exchanged for trust units by passage of time whereby the
exchangeable shares will be redeemed for trust units. Consequently, as the
exchangeable shares are exchanged for trust units over time, the
non-controlling interest will decrease and eventually will be nil when all
exchangeable shares have been exchanged for trust units on or before January
22, 2013.
The non-controlling interest in 2005 of $38.8 million ($24.7 million in 2004)
on the consolidated balance sheet represents the book value of exchangeable
shares plus accumulated earnings attributable to the outstanding exchangeable
shares. The reduction in 2005 and 2004 net income, respectively, of $14.4
million and $10.1 million, represents the net income attributable to the
exchangeable shareholders for 2005 and 2004. As the exchangeable shares are
converted to trust units, Unitholders' capital is increased for the fair value
of the trust units issued.
As at December 31, 2005 there were 4.6 million exchangeable shares outstanding
at exchange ratio of 1.37836 whereby 6.4 million trust units would be issuable
upon conversion. The exchangeable shares can be converted into trust units or
redeemed by the exchangeable share holder for trust units at any time.
Vermilion may redeem all outstanding exchangeable shares on or before January
22, 2013 and may redeem the exchangeable shares at any time if the number of
exchangeable shares outstanding falls below 500,000 shares. Vermilion may issue
cash or trust units upon redemption of exchangeable shares and it is the
intention to issue trust units upon redemption.
2005 AMENDED ANNUAL MD&A - VERMILLION ENERGY TRUST 10
PROPOSED TRANSACTION
On October 18, 2005, Vermilion announced that a wholly-owned subsidiary entered
into an exclusive arrangement with a French subsidiary of Exxon Mobil
Corporation, to negotiate the purchase of its 89.886% shareholding in Esso Rep.
On July 10, 2006, the Trust, through its France subsidiary completed the
acquisition of the 89.886% interest in Esso Rep and on July 12, 2006 the
remaining 10.114% interest in Esso Rep was acquired from another party
resulting in an ownership interest of 100%. Please refer to Vermilion's MD&A
and interim financial statements for the period ended September 30, 2006 as
filed on SEDAR for additional information.
DISCONTINUED OPERATIONS
The Trust made a strategic decision to sell its interest in the Trinidad
operations. On May 6, 2004, the Trust completed the sale of the shares of its
subsidiary, Aventura, for gross proceeds of $164.6 million. As a result, the
Trust realized an estimated $68.0 million (net of tax) gain on the sale of
shares, which was recorded in the second quarter.
RISK MANAGEMENT
Crude oil and natural gas exploration, production, acquisition and marketing
operations involve a number of risks. These risks include operational
fluctuations in commodity prices, exchange rates, interest rates, exploration
uncertainties, product demand, transportation restrictions and governmental
regulatory changes.
Vermilion considers its commodity price risk management program as a form of
insurance that protects its cash flow and rate of return. The primary objective
of the risk management program is to support Vermilion's distributions and its
internal capital development program. Maintenance of a strong financial
position and a stable cash flow stream through the development of long-life
reserves is key to mitigating business risks.
To manage the adverse impact of significant movements in commodity prices,
exchange rates and interest rates, Vermilion uses over-the-counter financial
structures as well as fixed/collar structures as a part of physical natural gas
sales. Vermilion has strict controls and guidelines in place and enacts
transactions only with counter parties that have high credit ratings.
Vermilion maintains an insurance program consistent with industry practice to
protect against losses from accidental destruction of assets, well blowouts,
pollution and other potential business interruptions.
CURRENCY RISK
Vermilion's primary exposure to currency risk comes from a revenue stream that
is denominated in U.S. dollars. Vermilion's exposure to fluctuations in the
Euro and Australian dollar is limited primarily to reinvestment and
repatriation of funds and forward-sale contracts can be used to mitigate these
risks. The remaining cash flow from Vermilion's international operations is
reinvested in each country, creating a natural hedge to the working capital and
cash flow stream when they are converted to Euros and Australian dollars.
CRITICAL ACCOUNTING ESTIMATES
The amounts recorded for depletion and depreciation of property, plant and
equipment and the provision for future asset retirement obligations are based
on estimates. The ceiling test calculation is based on estimates of proved
reserves, production rates, oil and natural gas prices, future costs and other
relevant assumptions. By their nature, these estimates are subject to
measurement uncertainty and the effect on the consolidated financial statements
from changes in such estimates in future years could be significant.
2005 AMENDED ANNUAL MD&A - VERMILLION ENERGY TRUST 11
SENSITIVITIES
Crude oil and natural gas prices may change significantly because of factors
Vermilion cannot control. The following table provides a summary of estimated
sensitivities to price fluctuations for pro-forma production levels and
expenses for the year ended December 31, 2006.
CASH AVAILABLE FOR DISTRIBUTIONS CASH AVAILABLE
PER UNIT AND EXCHANGEABLE SHARES FOR DISTRIBUTIONS
- ---------------------------------------------------------------------------------------------------------------------
Change in crude oil price by Cdn$1.00/bbl $ 0.05 $ 3.2 million
Change in natural gas price by Cdn$0.10/mcf $ 0.02 $ 1.3 million
Change in interest rate by one point $ 0.03 $ 2.0 million
Change in Cdn/U.S. foreign exchange rate by one point $ 0.05 $ 3.5 million
Change in cdn/euro foreign exchange rate by one point $ 0.01 $ 0.8 million
- ---------------------------------------------------------------------------------------------------------------------
OFF BALANCE SHEET ARRANGEMENTS
The Trust has certain lease agreements that are entered into in the normal
course of operations. All leases are treated as operating leases whereby the
lease payments are included in operating expenses or G&A expenses depending on
the nature of the lease. No asset or liability value has been assigned to these
leases in the balance sheet as of December 31, 2005.
The Trust has not entered into any guarantee or off balance sheet arrangements
that would adversely impact the Trust's financial position or results of
operations.
ENVIRONMENT, HEALTH AND SAFETY
Vermilion remains committed to conducting its activities in an environmentally
responsible manner, protecting the health and safety of its employees and the
public in every country in which it operates. It is a condition of employment
that Vermilion personnel work safely and in accordance with established
regulations and procedures.
In 2005, Vermilion remained committed to the principles of the Environment,
Health and Safety Stewardship Program set out by the Canadian Association of
Petroleum Producers (CAPP). This voluntary initiative promotes continual
improvement in the areas of environment, health and safety performance,
supplemented by progress reports to stakeholders.
Vermilion continued its commitment to protect land, water and air, as policies
and procedures, demonstrating leadership in these areas, were maintained and
further developed in 2005. Examples of accomplishments during the year
included:
- - Reducing long-term environmental liabilities through decommissioning,
abandoning and reclaiming well leases and facilities;
- - Monitoring long-term liabilities through regular inspections;
- - Continuing reductions in flaring and greenhouse gas emissions;
- - Minimizing waste products by reducing, recycling and recovering; and
- - Continuing risk management efforts with detailed emergency-response
planning.
Vermilion is a member of several organizations concerned with environment,
health and safety, including the Western Canadian Air Shed and numerous area
co-operatives.
In the area of stakeholder relations, Vermilion works to build long-term
relationships with environmental stakeholders and communities.
CORPORATE GOVERNANCE
Vermilion is committed to a high standard of corporate governance practices, a
dedication that begins at Board level and extends throughout the Trust. We
believe good corporate governance is in the best interest of our unitholders,
and that successful companies are those that deliver growth and a competitive
return along with a commitment to the environment, to the communities where
they operate and to their employees. We comply with the objectives and
guidelines relating to corporate governance adopted by the Toronto Stock
Exchange. In addition, the Board monitors and considers the implementation of
corporate governance standards proposed by various regulatory and
non-regulatory authorities in Canada. A full examination of our corporate
governance policies will be provided in our annual Information Circular, which
will be filed on SEDAR (www.sedar.com) and mailed to all unitholders on or
before March 31, 2006.
2005 AMENDED ANNUAL MD&A - VERMILLION ENERGY TRUST 12
SARBANES OXLEY UPDATE
On July 31, 2002, the United States Congress enacted the Sarbanes Oxley Act
("SOX") that applies to all companies registered with the Securities and
Exchange Commission ("SEC"). On March 2, 2005, the Securities and Exchange
Commission ("SEC") announced a one year extension of the compliance date for
all foreign private issuers. As a result of this extension, Vermilion is
currently required to comply with section 404 of the SOX legislation on
December 31, 2006. Section 404 of the SOX legislation "Internal Controls Over
Financial Reporting" requires that management identify, document, assess and
remediate internal controls and issue an opinion on the effectiveness of
internal controls surrounding the financial reporting process. The Trust
currently has a comprehensive plan and a dedicated team of individuals in place
to execute the plan of meeting the SOX Section 404 compliance date.
DISCLOSURE CONTROLS AND PROCEDURES
Vermilion's officers, including the Chief Executive Officer and the Chief
Financial Officer, have established and maintained disclosure controls and
procedures which are designed to provide reasonable assurance that all relevant
information is gathered and reported to senior management, including the
Trust's Chief Executive Officer and Chief Financial Officer, on a timely basis
so that appropriate decisions can be made regarding public disclosure.
As of the period covered by this MD&A, Vermilion's officers, including the
Chief Executive Officer and the Chief Financial Officer, have evaluated and
concluded that the Trust's disclosure controls and procedures were effective to
provide reasonable assurance that information required to be disclosed in the
Trust's annual and interim filings (as such terms are defined under
Multilateral Instrument 52-109, Certification of Disclosure in Issuers' Annual
and Interim Filings) and other reports filed or submitted under Canadian
securities laws is recorded, processed, summarized and reported within the time
periods specified by those laws and that material information is accumulated
and communicated to management of the Trust, including the Chief Executive
Officer and the Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure.
2005 AMENDED ANNUAL MD&A - VERMILLION ENERGY TRUST 13