EXHIBIT 99.3
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MANAGEMENT'S DISCUSSION & ANALYSIS
The following Management's Discussion and Analysis ("MD&A"), dated as of March
21, 2007, provides a detailed explanation of the financial and operating
results of Advantage Energy Income Fund ("Advantage", the "Fund", "us", "we" or
"our") for the quarter and year ended December 31, 2006 and should be read in
conjunction with the audited consolidated financial statements. The
consolidated financial statements have been prepared in accordance with
Canadian generally accepted accounting principles ("GAAP") and all references
are to Canadian dollars unless otherwise indicated. All per barrel of oil
equivalent ("boe") amounts are stated at a conversion rate of six thousand
cubic feet of natural gas being equal to one barrel of oil or liquids.
NON-GAAP MEASURES
The Fund discloses several financial measures in the MD&A that do not have any
standardized meaning prescribed under GAAP. These financial measures include
funds from operations and per Trust Unit, cash netbacks, and payout ratio.
Management believes that these financial measures are useful supplemental
information to analyze operating performance, leverage and provide an
indication of the results generated by the Fund's principal business activities
prior to the consideration of how those activities are financed or how the
results are taxed. Investors should be cautioned that these measures should not
be construed as an alternative to net income, cash provided by operating
activities or other measures of financial performance as determined in
accordance with GAAP. Advantage's method of calculating these measures may
differ from other companies, and accordingly, they may not be comparable to
similar measures used by other companies.
Funds from operations, as presented, is based on cash provided by operating
activities before expenditures on asset retirement and changes in non-cash
working capital. Funds from operations per Trust Unit is based on the number of
Trust Units outstanding at each cash distribution record date. Both cash
netbacks and payout ratio are dependent on the determination of funds from
operations. Cash netbacks include the primary cash revenues and expenses on a
per boe basis that comprise funds from operations. Payout ratio represents the
cash distributions declared for the period as a percentage of funds from
operations. Funds from operations reconciled to cash provided by operating
activities is as follows:
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
($000) 2006 2005 % CHANGE 2006 2005 % CHANGE
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Cash provided by operating activities $ 65,495 $ 70,117 (7)% $229,087 $ 186,606 23%
Expenditures on asset retirement 3,462 445 678% 5,974 2,025 195%
Changes in non-cash working capital (6,220) (9,656) (36)% (20,303) 22,910 (189)%
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FUNDS FROM OPERATIONS $ 62,737 $ 60,906 3% $214,758 $ 211,541 2%
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FORWARD-LOOKING INFORMATION
The information in this report contains certain forward-looking statements.
These statements relate to future events or our future performance. All
statements other than statements of historical fact may be forward-looking
statements. Forward-looking statements are often, but not always, identified by
the use of words such as "seek", "anticipate", "plan", "continue", "estimate",
"expect", "may", "will", "project", "predict", "potential", "targeting",
"intend", "could", "might", "should", "believe", "would" and similar
expressions. These statements involve substantial known and unknown risks and
uncertainties, certain of which are beyond Advantage's control, including: the
impact of general economic conditions; industry conditions; changes in laws and
regulations including the adoption of new environmental laws and regulations
and changes in how they are interpreted and enforced; fluctuations in commodity
prices and foreign exchange and interest rates; stock market volatility and
market valuations; volatility in market prices for oil and natural gas;
liabilities inherent in oil and natural gas operations; uncertainties
associated with estimating oil and natural gas reserves; competition for, among
other things, capital, acquisitions of reserves, undeveloped lands and skilled
personnel; incorrect assessments of the value of acquisitions; changes in
income tax laws or changes in tax laws and incentive programs relating to the
oil and gas industry and income trusts; geological, technical, drilling and
processing problems and other difficulties in producing petroleum reserves;
obtaining required approvals of regulatory authorities and other risk factors
set forth in Advantage's Annual Information Form which is available at
www.advantageincome.com or www.sedar.com. Advantage's actual results,
performance or achievement could differ materially from those expressed in, or
implied by, such forward-looking statements and, accordingly, no assurances can
be given that any of the events anticipated by the forward-looking statements
will transpire or occur or, if any of them do, what benefits that Advantage
will derive from them. Except as required by law, Advantage undertakes no
obligation to publicly update or revise any forward-looking statements.
Advantage Energy Income Fund - 1
MERGER WITH KETCH RESOURCES TRUST
On June 22, 2006, the previously announced merger of Advantage and Ketch
Resources Trust ("Ketch") was approved by 96.6% of the votes cast at the
Advantage Unitholder meeting and 88.4% of the votes cast at the Ketch
Unitholder meeting. Court approval was received on June 22, 2006 with closing
of the Arrangement and the successful merger of the two trusts occurring the
following day. The financial and operational information for the year ended
December 31, 2006 reflect operations from the Ketch properties effective the
closing date, June 23, 2006. The combined trust is managed by an experienced
senior management team which includes key management, technical personnel and
administrative employees from both Advantage and Ketch. The merger was
accomplished through the exchange of each Ketch Unit for 0.565 of an Advantage
Unit and upon completion, Advantage Unitholders owned approximately 65% of the
combined trust and Ketch Unitholders owned approximately 35%.
The merger was conditional on Advantage internalizing the external management
contract structure and eliminating all related fees. The Fund reached an
agreement with Advantage Investment Management Ltd. ("AIM" or the "Manager") to
purchase all of the outstanding shares of AIM pursuant to the terms of the Plan
of Arrangement for total original consideration of 1,933,208 Advantage Trust
Units initially valued at $39.1 million using the weighted average trading
value for June 22, 2006 of $20.23 per Advantage Trust Unit. The Trust Unit
consideration was placed in escrow for a 3-year period ensuring Advantage
Unitholders will receive continued benefit and commitment of the existing
management team and employees. The Fund paid final management fees and
performance fees for the period January 1 to March 31, 2006 in the amount of
$3.3 million. The consideration to settle the fees consisted of $0.9 million in
cash and 117,662 Trust Units. AIM agreed to forego fees for the period April 1,
2006 to the closing of the Arrangement.
OVERVIEW
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2006 2005 % CHANGE 2006 2005 % CHANGE
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Funds from operations ($000) $ 62,737 $ 60,906 3% $ 214,758 $ 211,541 2%
per Trust Unit(1) $ 0.59 $ 1.06 (44)% $ 2.63 $ 3.72 (29)%
Net income ($000) $ 8,736 $ 25,846 (66)% $ 49,814 $ 75,072 (34)%
per Trust Unit - Basic $ 0.08 $ 0.45 (82)% $ 0.62 $ 1.33 (53)%
- Diluted $ 0.08 $ 0.45 (82)% $ 0.61 $ 1.32 (54)%
(1) Based on Trust Units outstanding at each cash distribution record date.
Funds from operations increased 3% for the three months and 2% for the year
ended December 31, 2006, as compared to the same periods of 2005. Funds from
operations per Trust Unit decreased 44% and 29% respectively. The slight
increase in funds from operations has been primarily due to the Ketch merger.
However, both funds from operations and funds from operations per Trust Unit
have been negatively impacted by significantly lower natural gas prices
throughout 2006. Weak natural gas prices have been partially offset by a
successful hedging program that was implemented in November 2006. Net income
decreased 66% for the three months ended December 31, 2006, as compared to 2005
and 34% for the year ended December 31, 2006. Net income per basic Trust Unit
decreased 82% for the three months and 53% for the year ended December 31,
2006. The lower net income has been primarily due to the lower natural gas
prices realized during the periods, amortization of the management
internalization consideration, and increased depletion and depreciation
expense. The primary factor that causes significant variability of Advantage's
funds from operations, cash flows and net income is commodity prices. Refer to
the section "Commodity Prices and Marketing" for a more detailed discussion of
commodity prices and our price risk management.
CASH DISTRIBUTIONS
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2006 2005 % CHANGE 2006 2005 % CHANGE
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Cash distributions declared ($000) $ 58,791 $ 43,265 36% $ 217,246 $ 177,366 22%
per Trust Unit(1) $ 0.56 $ 0.75 (25)% $ 2.66 $ 3.12 (15)%
Payout ratio (%) 94% 71% 23% 101% 84% 17%
(1) Based on Trust Units outstanding at each cash distribution record date.
Total distributions increased 36% for the three months and 22% for the year
ended December 31, 2006. The higher total distributions reflect the increased
Trust Units outstanding from the continued growth and development of the Fund,
especially due to the Ketch acquisition. Natural gas prices were very weak
during the fourth quarter and year resulting in reduced funds from
Advantage Energy Income Fund - 2
operations and a higher payout ratio of 94% and 101%, respectively. As a
result, we reduced the distribution level during the last half of 2006 to more
appropriately reflect the current commodity price environment. Cash
distributions per Trust Unit were $0.56 for the three months and $2.66 for the
year ended December 31, 2006 representing decreases of 25% and 15%
respectively, as compared to the same periods of 2005. In January 2007, the
monthly distribution was further decreased to $0.15 as natural gas prices
continued to show prolonged weakness throughout the winter. To mitigate the
persisting risk associated with lower natural gas prices and the resulting
negative impact on distributions, the Fund implemented a hedging program in
2006 with 58% of natural gas hedged for January to March 2007 and 54% hedged
for April to October 2007. See "Commodity Price Risk" section for a more
detailed discussion of our price risk management. It is also important to note
that the timing of the Ketch merger negatively impacted the payout ratio for
the year ended December 31, 2006 as the arrangement closed prior to the June
record date resulting in the payment of a full month distribution to Ketch
Unitholders; however funds from operations for June only included eight days of
cash flows from the Ketch properties. We believe the Fund has taken the
necessary action and is now well-positioned with the objective of providing
long-term distribution sustainability to Unitholders.
Cash distributions are determined by Management and the Board of Directors. We
closely monitor our distribution policy considering forecasted cash flows,
optimal debt levels, capital spending activity, taxability to Unitholders,
working capital requirements, and other potential cash expenditures. Cash
distributions are announced monthly and are based on the cash available after
retaining a portion to meet such spending requirements. The level of cash
distributions are primarily determined by cash flows received from the
production of oil and natural gas from existing Canadian resource properties
and will be susceptible to the risks and uncertainties associated with the oil
and natural gas industry generally. If the oil and natural gas reserves
associated with the Canadian resource properties are not supplemented through
additional development or the acquisition of additional oil and natural gas
properties, our cash distributions will decline over time in a manner
consistent with declining production from typical oil and natural gas reserves.
Therefore, cash distributions are highly dependent upon our success in
exploiting the current reserve base and acquiring additional reserves.
Furthermore, monthly cash distributions we pay to Unitholders are highly
dependent upon the prices received for oil and natural gas production. Oil and
natural gas prices can fluctuate widely on a month-to-month basis in response
to a variety of factors that are beyond our control. Declines in oil or natural
gas prices will have an adverse effect upon our operations, financial
condition, reserves and ultimately on our ability to pay distributions to
Unitholders. The Fund attempts to mitigate the volatility in commodity prices
through our hedging program. It is our long-term objective to provide stable
and sustainable cash distributions to the Unitholders, while continuing to grow
the Fund. However, given that funds from operations can vary significantly from
month-to-month due to these factors, the Fund may utilize various financing
alternatives as an interim measure to maintain stable distributions.
For Canadian holders of Advantage Trust Units, the distributions paid for 2006
were 50% non-taxable return of capital and 50% taxable. For U.S. unitholders,
distributions paid during 2006 were 47% non-taxable return of capital and 53%
taxable. All Unitholders of the Fund are encouraged to consult their tax
advisors as to the proper treatment of Advantage distributions for income tax
purposes.
REVENUE
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
($000) 2006 2005 % CHANGE 2006 2005 % CHANGE
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Natural gas excluding hedging $ 74,309 $ 78,001 (5)% $ 231,548 $ 238,902 (3)%
Realized hedging gains (losses) 4,046 (6,749) (160)% 4,164 (10,063) (141)%
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Natural gas including hedging $ 78,355 $ 71,252 10% $ 235,712 $ 228,839 3%
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Crude oil and NGLs excluding hedging $ 48,051 $ 39,318 22% $ 182,882 $ 151,639 21%
Realized hedging gains (losses) 1,133 (398) (385)% 1,133 (3,906) (129)%
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Crude oil and NGLs including hedging $ 49,184 $ 38,920 26% $ 184,015 $ 147,733 25%
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TOTAL REVENUE $ 127,539 $110,172 16% $ 419,727 $ 376,572 11%
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Natural gas revenues, excluding hedging, have decreased 5% for the three months
and 3% for the year ended December 31, 2006, compared to 2005. Natural gas
revenues have increased due to additional production from the Ketch merger but
have been more than offset by weak natural gas prices. However, due to the
Fund's hedge positions that were in place for the latter part of 2006, natural
gas revenues, including hedging, have increased 10% for the three months and 3%
for the year ended December 31, 2006. Crude oil and NGL revenues, excluding
hedging, have increased by 22% for the three months and 21% for the year ended
December 31, 2006 compared to 2005 due to a combination of continued strong oil
prices and increased production levels from Ketch. The Fund had several oil
hedges that came into effect in October 2006, further increasing crude oil and
NGL revenues 26% for the three months and 25% for the year ended December 31,
2006, as compared to 2005.
Advantage Energy Income Fund - 3
PRODUCTION
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2006 2005 % CHANGE 2006 2005 % CHANGE
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Natural gas (mcf/d) 117,134 72,587 61% 94,074 78,561 20%
Crude oil (bbls/d) 7,148 5,900 21% 6,273 5,854 7%
NGLs (bbls/d) 2,422 1,206 101% 1,802 1,175 53%
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TOTAL (BOE/D) 29,092 19,204 51% 23,754 20,123 18%
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Natural gas (%) 67% 63% 66% 65%
Crude oil (%) 25% 31% 26% 29%
NGLs (%) 8% 6% 8% 6%
The Fund's total daily production averaged 29,092 boe/d for the fourth quarter
of 2006, an increase of 51% compared with the same period of 2005. Natural gas
production increased 61%, crude oil production increased 21%, and NGLs
production increased 101%. Average daily production for the year ended December
31, 2006 was 23,754 boe/d, an increase of 18% compared with December 31, 2005.
During this same period natural gas production increased 20%, crude oil
production increased 7% and NGLs production increased 53%.
The increase in production during the quarter and year has been primarily
attributed to the Ketch acquisition, which closed June 23, 2006. Other key
production additions included light oil production from our Nevis and Sunset
properties located in Central Alberta of 500 boe/d and gas additions of 3.5
mmcf/d realized from our Sweetgrass and Chigwell properties. An additional 5.0
mmcf/d was placed onstream in July from the Westerose-Battle Lake area. The
additions have been offset somewhat by further capacity constraints at third
party facilities, a one-time adjustment recognizing the impact of several wells
that had paid out whereby partners had elected to convert to working interest
positions and pipeline curtailments. The curtailment on the main northern leg
of the Trans Canada Pipeline system impacted most of our Northern Alberta areas
and resulted in a loss of 150 boe/d for the year. In addition, significant
adverse production impacts occurred in November and December due to the extreme
cold weather conditions at Fontas and Martin Creek, a compressor failure at
Worsley, battery outages at Nevis and Westerose, and high declines at our
Hamelin Creek property. Production has also been impacted by maximum rate
limitations ("MRL") initiated on our Chip Lake and Nevis properties beginning
January 1, 2006. At the close of 2006 our Chigwell North coal bed methane joint
venture and our new gas pool at Sweetgrass were placed onstream. The Chigwell
North and Sweetgrass wells were delayed primarily due to regulatory delays in
each respective area, but the regulations have since been satisfied and
production began in late December.
COMMODITY PRICES AND MARKETING
NATURAL GAS
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
($/MCF) 2006 2005 % CHANGE 2006 2005 % CHANGE
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Realized natural gas prices
Excluding hedging $ 6.90 $11.68 (41)% $ 6.74 $ 8.33 (19)%
Including hedging $ 7.27 $10.67 (32)% $ 6.86 $ 7.98 (14)%
AECO monthly index $ 6.36 $11.68 (46)% $ 6.98 $ 8.49 (18)%
Realized natural gas prices, excluding hedging, decreased 41% for the three
months and 19% for the year ended December 31, 2006, as compared to the same
periods of 2005. The price of natural gas is primarily based on supply and
demand fundamentals in the North American marketplace. Natural gas prices began
to weaken near the end of 2005 as North America recorded one of the mildest
winters on record, thereby reducing demand. This weakness has continued through
2006 with relatively uneventful weather resulting in natural gas inventories
that swelled to historic levels. The 2006/2007 winter has also been mild, with
inventory levels remaining high, causing significant downward pressure on
commodity prices. However, February 2007 brought sustained colder weather and
inventory levels decreased below 2006 levels but are still ample compared to
demand. The withdrawals from inventories resulted in a modest rebound in
natural gas prices but overall the prices still remain low due to weather
uncertainty. We continue to believe that the long-term pricing fundamentals for
natural gas remain strong. These fundamentals include (i) the continued
strength of crude oil prices, which has eliminated the economic advantage of
fuel switching away from natural gas, (ii) long-term tightness in
Advantage Energy Income Fund - 4
supply that has resulted from persistent demand and the decline in North
American natural gas production levels and (iii) ongoing weather related
factors such as hot summers, cold winters and annual hurricane season in the
Gulf of Mexico, all of which have an impact on the delicate supply/demand
balance that exists.
CRUDE OIL AND NGLS
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
($/BBL) 2006 2005 % CHANGE 2006 2005 % CHANGE
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Realized crude oil prices
Excluding hedging $ 56.10 $ 61.11 (8)% $ 63.85 $ 61.02 5%
Including hedging $ 57.82 $ 60.37 (4)% $ 64.34 $ 59.20 9%
Realized NGLs prices
Excluding hedging $ 50.09 $ 55.42 (10)% $ 55.81 $ 49.54 13%
Realized crude oil and NGLs prices
Excluding hedging $ 54.58 $ 60.14 (9)% $ 62.05 $ 59.10 5%
Including hedging $ 55.86 $ 59.53 (6)% $ 62.44 $ 57.58 8%
WTI ($US/bbl) $ 60.21 $ 60.04 0% $ 66.35 $ 56.61 17%
$US/$Canadian exchange rate $ 0.88 $ 0.85 4% $ 0.88 $ 0.83 6%
Realized crude oil and NGLs prices, excluding hedging, decreased 9% for the
three months and increased 5% for the year ended December 31, 2006, as compared
to the same periods of 2005. Advantage's crude oil prices are based on the
benchmark pricing of West Texas Intermediate Crude ("WTI") adjusted for
quality, transportation costs and $US/$Canadian exchange rates. Advantage's
realized crude oil price has not changed to the same extent as WTI due to
strengthening of the Canadian dollar and the widening of Canadian crude oil
differentials relative to WTI. The price of WTI fluctuates based on worldwide
supply and demand fundamentals. There has been significant price volatility
experienced over the last several years whereby WTI has reached historic high
levels. For the three months ended December 31, 2006 WTI has remained
relatively stable and increased 17% for the year ended December 31, 2006,
compared to 2005. Many developments have resulted in the current price levels,
including significant geopolitical and weather related issues. Early in 2006,
prices remained strong due to concerns regarding the lack of North American
refining capacity, and the continued strength of global demand. However, the
mild 2005/2006 winter and the surge in crude imports to North America have
resulted in significantly higher inventories, which prompted the relative price
decrease towards the end of 2006. These key issues persist and will continue to
impact overall commodity prices. With the current softening of crude price
levels, it is notable that production restrictions are frequently being
considered by the OPEC cartel and that inventory levels can quickly decline. We
believe that the pricing fundamentals for crude oil remain strong with many
factors affecting the continued strength including (i) supply management and
supply restrictions by the OPEC cartel, (ii) ongoing civil unrest in Venezuela,
Nigeria, and the Middle East, (iii) strong world wide demand, particularly in
China, India and the United States and (iv) North American refinery capacity
constraints.
COMMODITY PRICE RISK
The Fund's operational results and financial condition will be dependent on the
prices received for oil and natural gas production. Oil and natural gas prices
have fluctuated widely during recent years and are determined by economic and,
in the case of oil prices, political factors. Supply and demand factors,
including weather and general economic conditions as well as conditions in
other oil and natural gas regions impact prices. Any movement in oil and
natural gas prices could have an effect on the Fund's financial condition and
therefore on the cash distributions to holders of Advantage Trust Units. As
current and future practice, Advantage has established a financial hedging
strategy and may manage the risk associated with changes in commodity prices by
entering into financial derivatives. These commodity risk management activities
could expose Advantage to losses or gains. To the extent that Advantage engages
in risk management activities related to commodity prices, it will be subject
to credit risk associated with counterparties with which it contracts. Credit
risk is mitigated by entering into contracts with only stable, creditworthy
parties and through frequent reviews of exposures to individual entities.
Advantage Energy Income Fund - 5
Currently, the Fund has the following financial derivatives in place:
DESCRIPTION OF FINANCIAL DERIVATIVE TERM VOLUME AVERAGE PRICE
- -----------------------------------------------------------------------------------------------------------------------------
NATURAL GAS - AECO
Fixed price November 2006 to March 2007 5,687 mcf/d Cdn$8.70/mcf
Fixed price November 2006 to March 2007 3,791 mcf/d Cdn$10.02/mcf
Fixed price April 2007 to October 2007 9,478 mcf/d Cdn$7.16/mcf
Fixed price April 2007 to October 2007 9,478 mcf/d Cdn$7.55/mcf
Collar November 2006 to March 2007 9,478 mcf/d Floor Cdn$8.18/mcf
Ceiling Cdn$11.24/mcf
Collar November 2006 to March 2007 4,739 mcf/d Floor Cdn$8.44/mcf
Ceiling Cdn$12.40/mcf
Collar November 2006 to March 2007 4,739 mcf/d Floor Cdn$8.18/mcf
Ceiling Cdn$11.66/mcf
Collar November 2006 to March 2007 4,739 mcf/d Floor Cdn$8.44/mcf
Ceiling Cdn$12.29/mcf
Collar November 2006 to March 2007 5,687 mcf/d Floor Cdn$7.91/mcf
Ceiling Cdn$9.81/mcf
Collar November 2006 to March 2007 9,478 mcf/d Floor Cdn$8.44/mcf
Ceiling Cdn$13.82/mcf
Collar November 2007 to March 2008 9,478 mcf/d Floor Cdn$8.44/mcf
Ceiling Cdn$10.29/mcf
CRUDE OIL - WTI
Collar October 2006 to March 2007 1,250 bbls/d Floor US$65.00/bbl
Ceiling US$87.40/bbl
Collar October 2006 to September 2007 1,000 bbls/d Floor US$65.00/bbl
Ceiling US$90.00/bbl
In addition, the Fund has the following physical natural gas contracts in place:
DESCRIPTION OF PHYSICAL CONTRACT TERM VOLUME AVERAGE PRICE
- -----------------------------------------------------------------------------------------------------------------------------
NATURAL GAS - AECO
Collar November 2006 to March 2007 4,739 mcf/d Floor Cdn$8.07/mcf
Ceiling Cdn$11.61/mcf
Collar April 2007 to October 2007 4,739 mcf/d Floor Cdn$7.12/mcf
Ceiling Cdn$8.67/mcf
Collar April 2007 to October 2007 4,739 mcf/d Floor Cdn$6.86/mcf
Ceiling Cdn$9.13/mcf
Collar April 2007 to October 2007 9,478 mcf/d Floor Cdn$7.39/mcf
Ceiling Cdn$9.63/mcf
Collar April 2007 to October 2007 9,478 mcf/d Floor Cdn$6.33/mcf
Ceiling Cdn$7.20/mcf
As at December 31, 2006 the settlement amount of the financial derivatives
outstanding was an asset of approximately $10,433,000. For the year ended
December 31, 2006, $10,242,000 was recognized in income as an unrealized
derivative gain. As a result of the Ketch merger, we assumed several of these
contracts which had an estimated fair value of $191,000 on closing. Recorded in
revenue are realized hedging gains of $5.2 million for the three months and
$5.3 million for the year ended December 31, 2006, which partially alleviated
lower revenue from reduced commodity prices. The Fund does not apply hedge
accounting and current accounting standards require changes in the fair value
to be included in the income statement as an unrealized derivative gain or loss
with a corresponding derivative asset or liability recorded on the balance
sheet. The valuation is the estimated fair value to settle the financial
contracts as at December 31, 2006 and is based on pricing models, estimates,
assumptions and market data available at that time. The actual gain or loss
realized on cash settlement can vary materially due to subsequent fluctuations
in commodity prices as compared to the valuation assumptions.
Advantage Energy Income Fund - 6
The Fund has fixed the commodity price on anticipated production as follows:
APPROXIMATE PRODUCTION
COMMODITY HEDGED, NET OF ROYALTIES MINIMUM PRICE MAXIMUM PRICE
- --------------------------------------------------------------------------------------------------------------------------
NATURAL GAS - AECO
Winter 2006/2007 58% Cdn$8.42/mcf Cdn$11.46/mcf
Summer 2007 54% Cdn$7.08/mcf Cdn$8.09/mcf
Winter 2007/2008 11% Cdn$8.44/mcf Cdn$10.29/mcf
CRUDE OIL - WTI
Winter 2006/2007 30% US$65.00/bbl US$88.56/bbl
Summer 2007 14% US$65.00/bbl US$90.00/bbl
ROYALTIES
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2006 2005 % CHANGE 2006 2005 % CHANGE
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Royalties, net of Alberta Royalty Credit ($000) $ 23,349 $ 23,281 0% $ 76,456 $ 74,290 3%
per boe $ 8.72 $ 13.18 (34)% $ 8.82 $ 10.11 (13)%
As a percentage of revenue,
excluding hedging 19.1% 19.8% (0.7)% 18.4% 19.0% (0.6)%
Advantage pays royalties to the owners of mineral rights from which we have
leases. The Fund currently has mineral leases with provincial governments,
individuals and other companies. Royalties are shown net of Alberta Royalty
Credit which is a royalty rebate provided by the Alberta government to certain
producers and was eliminated effective January 1, 2007. Royalties have
increased in total due to the increase in revenue from higher production but
have decreased on a per boe basis due to the significantly reduced natural gas
prices. Royalties as a percentage of revenue, excluding hedging, have remained
relatively consistent with comparable periods and we expect the royalty rate to
continue as such.
On February 13, 2007, the Alberta provincial government announced it will begin
an oil and gas royalty and tax system review expected to conclude by August 31,
2007. The review will concentrate on the oil sands royalty structure initially,
followed by an analysis of the conventional oil and gas and coal bed methane
levies. The panel in charge will perform a comparison to other oil and
gas-producing jurisdictions, ensure the system is sufficiently sensitive to
market conditions, examine the tax treatment compared to other sectors, assess
the impacts of potential changes to the structure and determine the treatment
of existing resource development if changes are made to the system. The review
may result in imposed modifications that affect the Fund's royalties in the
future.
OPERATING COSTS
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2006 2005 % CHANGE 2006 2005 % CHANGE
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Operating costs ($000) $ 27,803 $ 17,381 60% $ 82,911 $ 57,941 43%
per boe $ 10.39 $ 9.84 6% $ 9.56 $ 7.89 21%
Total operating costs increased 60% for the three months ended and 43% for the
year ended December 31, 2006 as compared to 2005 mainly due to the Ketch
acquisition and service costs that have escalated in 2006. Operating costs per
boe increased 6% for the three months and 21% for the year ended December 31,
2006. In the fourth quarter of 2006, crude oil pipeline restrictions in
Southeast Saskatchewan resulted in additional trucking, increasing operating
costs per boe for the quarter. In addition, operating costs per boe for the
quarter and year ended December 31, 2006 have increased due to significantly
higher costs associated with the shortage of supplies and services in the
field. However, there has been recent evidence of reduced demand on the current
available support and service resources as drilling rig utilization rates have
decreased. The impact on operating costs is uncertain but we will be
opportunistic and proactive in pursuing alternatives that will improve our
operating cost structure. A significant operating cost that Advantage has been
successful in stabilizing is electricity costs associated with field
operations. The Fund has been active in preserving the price of power by
hedging 3.5 MW at $56.68/MWh for 2007 and 3.0 MW at $54.00/MWh for 2008.
Management of operating costs will be a persistent challenge in the current
environment and we expect operating costs per boe to average between $9.50 to
$10.50 for 2007.
Advantage Energy Income Fund - 7
GENERAL AND ADMINISTRATIVE
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2006 2005 % CHANGE 2006 2005 % CHANGE
- -----------------------------------------------------------------------------------------------------------------------------------
General and administrative expense ($000) $ 4,586 $ 1,521 202% $ 13,738 $ 5,452 152%
per boe $ 1.71 $ 0. 86 99% $ 1.58 $ 0.74 114%
Employees at December 31 135 80 69%
General and administrative ("G&A") expense has increased 202% for the three
months and 152% for the year ended December 31, 2006, as compared to 2005. G&A
per boe increased 99% for the three months and 114% for the year when compared
to the same periods of 2005. G&A expense has increased overall and per boe
primarily due to an increase in staff levels that have resulted from the Ketch
acquisition and growth of the Fund. Additionally, the Ketch acquisition was
conditional on Advantage internalizing the external management contract
structure and eliminating all related fees for a more typical employee
compensation arrangement. The new employee compensation plan has resulted in
higher G&A expense that is offset by the elimination of future management fees
and performance incentive. Prior to elimination of the management contract, the
quarterly management fee and annual performance incentive were not included
within G&A.
Current employee compensation includes salary, benefits, a short-term incentive
plan and a long-term incentive plan. The long-term incentive plan consists of
Restricted Trust Unit ("RTU") grants based on the Fund's individual Trust Unit
performance from June 23 to December 31, 2006, adjusted for each monthly
distribution, and compared to a peer group approved by the Board of Directors.
The RTU grants vest over two years and are not available to previous AIM
management for a period of three years following the Ketch acquisition. As the
Fund did not meet the 2006 grant thresholds, there was no RTU grant made for
the 2006 year.
MANAGEMENT FEE, PERFORMANCE INCENTIVE, AND MANAGEMENT INTERNALIZATION
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2006 2005 % CHANGE 2006 2005 % CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Management fee ($000) $ - $ 1,043 (100)% $ 887 $ 3,665 (76)%
per boe $ - $ 0.59 (100)% $ 0.10 $ 0.50 (80)%
Performance incentive ($000) $ - $ 10,544 (100)% $ 2,380 $ 10,544 (77)%
Management internalization ($000) $ 5,497 $ - - $ 13,449 $ - -
Prior to the Ketch merger, the Manager received both a management fee and a
performance incentive fee as compensation pursuant to the Management Agreement
approved by the Board of Directors. Management fees were calculated based on
1.5% of operating cash flow defined as revenues less royalties and operating
costs.
The Manager was entitled to earn an annual performance incentive fee when the
Fund's total annual return exceeded 8%. The total annual return was calculated
at the end of the year by dividing the year-over-year change in Unit price plus
cash distributions by the opening Unit price, as defined in the Management
Agreement. Ten percent of the amount of the total annual return in excess of 8%
was multiplied by the market capitalization (defined as the opening Unit price
multiplied by the weighted average number of Trust Units outstanding during the
year) to determine the performance incentive fee. The Management Agreement
provided an option to the Manager to receive the performance incentive fee in
equivalent Trust Units. The Manager did not receive any form of compensation in
respect of acquisition or divestiture activities nor were there any form of
stock option or bonus plan for the Manager or the employees of Advantage
outside of the management and performance fees. The management fees and
performance fees were shared amongst all management and employees.
As a condition of the merger with Ketch, the Fund and the Manager reached an
agreement to internalize the management contract arrangement. As part of the
agreement, Advantage agreed to purchase all of the outstanding shares of the
Manager pursuant to the terms of the Arrangement for total original
consideration of 1,933,208 Advantage Trust Units initially valued at $39.1
million using the weighted average trading value for June 22, 2006 of $20.23
per Advantage Trust Unit. The Trust Unit consideration was placed in escrow for
a 3-year period and is being deferred and amortized into income as management
internalization expense over the specific vesting periods during which employee
services are provided. The Fund paid final management fees and performance fees
for the period January 1 to March 31, 2006 in the amount of $3.3 million,
representing $0.9 million in management fees and $2.4 million in performance
fees. The performance fees were settled through the issuance of 117,662 Trust
Units of the Fund. The Manager agreed to forego fees for the period April 1,
2006 to the closing of the Arrangement.
Advantage Energy Income Fund - 8
INTEREST
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2006 2005 % CHANGE 2006 2005 % CHANGE
- -----------------------------------------------------------------------------------------------------------------------------------
Interest expense ($000) $ 5,414 $ 2,865 89% $ 18,258 $ 10,275 78%
per boe $ 2.02 $ 1.62 25% $ 2.11 $ 1.40 51%
Average effective interest rate 5.5% 4.4% 1.1% 5.1% 4.3% 0.8%
Bank indebtedness at December 31 ($000) $ 410,574 $ 252,476 63%
Interest expense has increased 89% for the three months and 78% for the year
ended December 31, 2006, as compared to 2005. The increase in interest expense
is primarily attributable to a higher average debt level associated with the
growth of the Fund, an increase in the average effective interest rates, and
the merger with Ketch which included the assumption of Ketch's additional bank
indebtedness. The increased debt has been used in financing continued
development activities and pursuit of expansion opportunities. We monitor the
debt level to ensure an optimal mix of financing and cost of capital that will
provide a maximum return to Unitholders. Our current credit facilities have
been a favorable financing alternative with an effective interest rate of
approximately 5.5% for the three months and 5.1% for the year ended December
31, 2006. The Fund's interest rates are primarily based on short term Bankers
Acceptance rates plus a stamping fee.
INTEREST AND ACCRETION ON CONVERTIBLE DEBENTURES
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2006 2005 % CHANGE 2006 2005 % CHANGE
- ----------------------------------------------------------------------------------------------------------------------------------
Interest on convertible debentures ($000) $ 3,289 $ 2,727 21% $ 11,210 $ 11,210 0%
per boe $ 1.23 $ 1.54 (20)% $ 1.29 $ 1.53 (16)%
Accretion on convertible debentures ($000) $ 604 $ 532 14% $ 2,106 $ 2,182 (3)%
per boe $ 0.23 $ 0.30 (23)% $ 0.24 $ 0.30 (20)%
Convertible debentures maturity
value at December 31 ($000) $ 180,730 $ 135,111 34%
Interest on convertible debentures has increased 21% for the three months and
was unchanged for the year ended December 31, 2006 compared to the same periods
of 2005. Accretion on convertible debentures has increased 14% for the three
months and decreased 3% for the year ended December 31, 2006 as compared to
2005. The increases in total interest and accretion for the quarter as well as
the increased convertible debentures maturity value are due to Advantage
assuming Ketch's 6.50% convertible debentures in the merger. The increased
interest and accretion from the additional debentures has been offset for the
year due to the continual exchange of convertible debentures to Trust Units
that will pay distributions rather than interest. During the year ended
December 31, 2006, $24.3 million of convertible debentures were converted
resulting in the issuance of 1,286,901 Trust Units.
Advantage Energy Income Fund - 9
CASH NETBACKS
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2006 2005 2006 2005
- --------------------------------------------------------------------------------------------------------------------------------
$000 PER BOE $000 PER BOE $000 PER BOE $000 PER BOE
- --------------------------------------------------------------------------------------------------------------------------------
Revenue $122,360 $ 45.72 $117,319 $ 66.40 $ 414,430 $ 47.80 $ 390,541 $ 53.17
Realized hedging gains (losses) 5,179 1.93 (7,147) (4.05) 5,297 0.61 (13,969) (1.90)
Royalties (23,349) (8.72) (23,281) (13.18) (76,456) (8.82) (74,290) (10.11)
Operating costs (27,803) (10.39) (17,381) (9.84) (82,911) (9.56) (57,941) (7.89)
- --------------------------------------------------------------------------------------------------------------------------------
OPERATING $ 76,387 $ 28.54 $ 69,510 $ 39.33 $ 260,360 $ 30.03 $ 244,341 $ 33.27
General and administrative (4,586) (1.71) (1,521) (0.86) (13,738) (1.58) (5,452) (0.74)
Management fee - - (1,043) (0.59) (887) (0.10) (3,665) (0.50)
Interest (5,414) (2.02) (2,865) (1.62) (18,258) (2.11) (10,275) (1.40)
Interest on convertible debentures (3,289) (1.23) (2,727) (1.54) (11,210) (1.29) (11,210) (1.53)
Taxes (361) (0.13) (448) (0.25) (1,509) (0.17) (2,198) (0.30)
- --------------------------------------------------------------------------------------------------------------------------------
FUNDS FROM OPERATIONS $ 62,737 $ 23.45 $ 60,906 $ 34.47 $ 214,758 $ 24.78 $ 211,541 $ 28.80
- --------------------------------------------------------------------------------------------------------------------------------
Funds from operations per boe have decreased from $28.80 per boe in the prior
year to $24.78 per boe for the year ended December 31, 2006. The lower cash
netback per boe is primarily due to lower revenues resulting from soft natural
gas prices as well as higher operating costs, general and administrative
expenses and interest. Operating costs per boe for the year ended December 31,
2006 were $9.56, an increase of 21% from the $7.89 experienced in 2005.
Operating costs have steadily increased over the past year due to significantly
higher field costs associated with the shortage of supplies and services that
has resulted from the high level of industry activity. General and
administrative expenses per boe for the 2006 year have increased 114% over the
prior year period due to the additional employees from the growth of the Fund
and the Ketch merger, which also resulted in internalization of the management
arrangement and a new employee compensation plan. Interest expense per boe on
bank indebtedness for the year ended December 31, 2006 has increased 51% over
the prior year due to the assumption of debt in the Ketch merger, higher
average effective interest rates and the general growth of the Fund.
DEPLETION, DEPRECIATION AND ACCRETION
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2006 2005 % CHANGE 2006 2005 % CHANGE
- ----------------------------------------------------------------------------------------------------------------------------------
Depletion, depreciation & accretion ($000) $ 63,521 $ 32,581 95% $194,309 $ 135,096 44%
per boe $ 23.73 $ 18.44 29% $ 22.41 $ 18.39 22%
Depletion and depreciation of property and equipment is provided on the
"unit-of-production" method based on total proved reserves. The depletion,
depreciation and accretion ("DD&A") provision has increased by 95% for the
three months and 44% for the year ended December 31, 2006. The DD&A per boe has
increased by 29% for the three months and 22% for the year ended December 31,
2006 compared to prior years. The higher DD&A is primarily due to increased
production from the Ketch acquisition while the DD&A per boe increase was
caused by a higher valuation for the Ketch reserves than accumulated from prior
acquisitions and development activities.
TAXES
Current taxes paid or payable for the quarter ended December 31, 2006 amounted
to $0.4 million, compared to $0.4 million expensed for the same period of 2005.
For the year ended December 31, 2006, current taxes paid or payable were $1.5
million, compared to $2.2 million for the comparative period. Current taxes
primarily represent Federal large corporations tax and Saskatchewan resource
surcharge. Federal large corporations tax was based on debt and equity levels
of the Fund and has been eliminated effective January 1, 2006 due to government
legislation. Saskatchewan resource surcharge is based on the petroleum and
natural gas revenues within the province of Saskatchewan.
Advantage Energy Income Fund - 10
Future income taxes arise from differences between the accounting and tax bases
of the operating company's assets and liabilities. For the year ended December
31, 2006, the Fund recognized an income tax reduction of $37.1 million compared
to a reduction of $11.4 million for 2005.
Under the Fund's current structure, payments are made between the operating
company and the Fund transferring income tax obligations to the Unitholders.
Therefore, based on the current structure and existing legislation, no cash
income taxes are to be paid by the operating company or the Fund, and as such,
the future income tax liability recorded on the balance sheet will be recovered
through earnings over time. As at December 31, 2006, the operating company had
a future income tax liability balance of $61.9 million. Canadian generally
accepted accounting principles require that a future income tax liability be
recorded when the book value of assets exceeds the balance of tax pools.
On October 31, 2006, the Federal Government proposed changes to Canada's tax
system that include altering the tax treatment of income trusts. The government
proposed a two-tier tax structure, similar to that of corporations, whereby
distributions paid by trusts that represent a return on capital will be subject
to tax at the trust level in addition to personal tax as if they were dividends
from a taxable Canadian corporation. The changes are proposed to take effect in
2011 for existing publicly-traded trusts. If enacted, the proposal could affect
the Fund in several ways, and Advantage is currently assessing several options
for the future. The Fund may allocate a portion of cash flows to additional tax
on distributions, resulting in less cash flow available for distribution or the
Fund may determine strategic alternatives such as increasing cash flow
allocated to capital spending, conversion to a corporation, or paying a higher
percentage of distributions on a return of capital basis, all of which could
result in a decrease or elimination of distributions. The following is a table
provided by the Federal Government showing a simplified comparison of the
effects of the proposed changes to investor tax rates in 2011:
CURRENT SYSTEM ENACTED SYSTEM (2011)
- ----------------------------------------------------------------------------------------------------------------------------------
INCOME PORTION OF LARGE CORPORATION INCOME PORTION OF LARGE CORPORATION
- ----------------------------------------------------------------------------------------------------------------------------------
TRUST DISTRIBUTIONS (DIVIDEND) TRUST DISTRIBUTIONS (DIVIDEND)
- ----------------------------------------------------------------------------------------------------------------------------------
Taxable Canadian individuals(1) 46% 46% 45.5% 45.5%
Canadian tax-exempt investors 0% 32% 31.5% 31.5%
Taxable U.S. investors(2) 15% 42% 41.5% 41.5%
- ----------------------------------------------------------------------------------------------------------------------------------
(1) All rates in the table are as of 2011, and include both entity- and
investor-level tax (as applicable). Rates for "Taxable Canadian
individuals" assume that top personal income tax rates apply and that
provincial governments increase their dividend tax credit for dividends of
large corporations.
(2) Canadian taxes only. U.S. tax will also apply in most cases, net of any
foreign tax credits.
The Fund has approximately $1.2 billion in tax pools and deductions at December
31, 2006, which can be used to declare a higher percentage of distributions as
a return of capital and thus reduce the amount of taxes paid by Unitholders.
The Fund and AOG had the following estimated tax pools in place at December 31,
2006:
DECEMBER 31, 2006
ESTIMATED TAX POOLS
($ MILLIONS)
-------------------
Undepreciated Capital Cost $ 453
Canadian Oil and Gas Property Expenses 333
Canadian Development Expenses 303
Canadian Exploration Expenses 44
Non capital losses 29
Other 22
--------
$ 1,184
NON-CONTROLLING INTEREST
Non-controlling interest expense for the year ended December 31, 2006 was
$29,000, a decrease of 88% from the $232,000 recognized during the same period
of 2005. Non-controlling interest expense represents the net income
attributable to Exchangeable Share ownership interests. The non-controlling
interest was created when Advantage Oil & Gas Ltd. ("AOG"), a subsidiary of the
Fund, issued Exchangeable Shares as partial consideration for the acquisition
of Defiant Energy Corporation ("Defiant") that occurred at the end of 2004. The
decrease in non-controlling interest expense is directly attributable to the
continued conversion of Exchangeable Shares to Trust Units since the original
issuance. On March 8, 2006, AOG elected to exercise its redemption right to
Advantage Energy Income Fund - 11
redeem all of the Exchangeable Shares outstanding. The redemption price per
Exchangeable Share was satisfied by delivering that number of Advantage Trust
Units equal to the Exchange Ratio of 1.22138 in effect on May 9, 2006. As such,
there is no non-controlling interest expense recorded in the quarter and no
exchangeable shares remain outstanding.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The Fund has contractual obligations in the normal course of operations
including purchases of assets and services, operating agreements,
transportation commitments, sales contracts and convertible debentures. These
obligations are of a recurring and consistent nature and impact cash flow in an
ongoing manner. The following table is a summary of the Fund's remaining
contractual obligations and commitments. Advantage has no guarantees or
off-balance sheet arrangements other than as disclosed.
PAYMENTS DUE BY PERIOD
($ MILLIONS) TOTAL 2007 2008 2009 2010 2011
- -------------------------------------------------------------------------------------------------------------------------------
Building leases $ 5.4 $ 2.2 $ 1.4 $ 0.8 $ 0.8 $ 0.2
Capital leases 2.9 2.6 0.3 - - -
Pipeline/transportation 5.9 4.2 1.4 0.3 - -
Convertible debentures (1) 180.7 1.4 5.4 57.1 70.0 46.8
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL CONTRACTUAL OBLIGATIONS $ 194.9 $ 10.4 $ 8.5 $ 58.2 $ 70.8 $ 47.0
- -------------------------------------------------------------------------------------------------------------------------------
(1) As at December 31, 2006, Advantage had $180.7 million convertible
debentures outstanding. Each series of convertible debentures are
convertible to Trust Units based on an established conversion price. The
Fund expects that the obligations related to convertible debentures will
be settled through the issuance of Trust Units.
(2) Bank indebtedness of $410.6 million has been excluded from the contractual
obligations table as the credit facilities constitute a revolving facility
for a 364 day term which is extendible annually for a further 364 day
revolving period at the option of the syndicate. If not extended, the
revolving credit facility is converted to a two year term facility with
the first payment due one year and one day after commencement of the term.
LIQUIDITY AND CAPITAL RESOURCES
The following table is a summary of the Fund's capitalization structure:
($000, EXCEPT AS OTHERWISE INDICATED) DECEMBER 31, 2006
- ------------------------------------------------------------------------------
Bank indebtedness (long-term) $ 410,574
Working capital deficit (1) 42,655
- ------------------------------------------------------------------------------
Net debt $ 453,229
- ------------------------------------------------------------------------------
Trust Units outstanding (000) 105,390
Trust Unit closing market price ($/Trust Unit) $ 12.43
- ------------------------------------------------------------------------------
Market value $ 1,309,998
- ------------------------------------------------------------------------------
Capital lease obligation (long-term) $ 305
Convertible debentures maturity value (long-term) 179,245
- ------------------------------------------------------------------------------
TOTAL CAPITALIZATION $ 1,942,777
- ------------------------------------------------------------------------------
(1) Working capital deficit includes accounts receivable, prepaid expenses and
deposits, accounts payable and accrued liabilities, cash distributions
payable, and the current portion of capital lease obligations and
convertible debentures.
UNITHOLDERS' EQUITY, EXCHANGEABLE SHARES AND CONVERTIBLE DEBENTURES
Advantage has utilized a combination of Trust Units, Exchangeable Shares,
convertible debentures and bank debt to finance acquisitions and development
activities.
As at December 31, 2006, the Fund had 105.4 million Trust Units outstanding. On
January 20, 2006, Advantage issued 475,263 Trust Units to satisfy $10.5 million
of the performance incentive fee obligation related to the 2005 year. On June
23, 2006, Advantage issued 32,870,465 Trust Units as consideration for the
acquisition of Ketch, 1,933,208 Trust Units as consideration for all of the
outstanding shares of AIM to internalize the external management contract, and
117,662 Trust Units to satisfy the final obligation related to the 2006 first
quarter performance fee. The Trust Units issued as consideration for the
external management contract are subject to escrow provisions and 19,366 Trust
Units were forfeited during the year ended December 31, 2006. On August 1, 2006
Advantage Energy Income Fund - 12
Advantage issued 7,500,000 Trust Units, plus an additional 1,125,000 Trust
Units upon full exercise of the Underwriters' over-allotment option on August
4, 2006, at $17.30 per Trust Unit for net proceeds of $141.4 million (net of
Underwriters' fees and other issue costs of $7.8 million). The net proceeds of
the offering were used to pay down bank indebtedness and to subsequently fund
capital and general corporate expenditures. As at March 21, 2007, Advantage had
115.0 million Trust Units issued and outstanding.
Exchangeable Shares issued and outstanding were exchangeable for Advantage
Trust Units at any time on the basis of the applicable exchange ratio in effect
at that time. On March 8, 2006, AOG elected to exercise its redemption right to
redeem all of the Exchangeable Shares outstanding. The redemption price per
Exchangeable Share was satisfied by delivering that number of Advantage Trust
Units equal to the Exchange Ratio of 1.22138 in effect on May 9, 2006. During
2006, the Fund issued 127,014 Trust Units for the remaining Exchangeable
Shares.
Effective June 25, 2002, a Trust Units Rights Incentive Plan for external
directors of the Fund was established and approved by the Unitholders of
Advantage. A total of 500,000 Trust Units have been reserved for issuance under
the plan with an aggregate of 400,000 rights granted since inception. The
initial exercise price of rights granted under the plan may not be less than
the current market price of the Trust Units as of the date of the grant and the
maximum term of each right is not to exceed ten years with all rights vesting
immediately upon grant. At the option of the rights holder, the exercise price
of the rights can be adjusted downwards over time based upon distributions paid
by the Fund to Unitholders. In exchange for an equivalent number of Trust
Units, all of the remaining 85,000 Series A Trust Units Rights were exercised
in the third quarter and 37,500 Series B Trust Unit Rights were exercised in
the second quarter of 2006. As at March 21, 2007, 187,500 Series B Trust Unit
Rights remain outstanding.
As at December 31, 2006, the Fund had $180.7 million convertible debentures
outstanding that were convertible to 8.3 million Trust Units based on the
applicable conversion prices. During the year ended December 31, 2006, $24.3
million convertible debentures were exchanged for the issuance of 1.3 million
Trust Units. As at March 21, 2007, the convertible debentures outstanding have
not changed from December 31, 2006.
On July 24, 2006, Advantage announced that it adopted a Premium
Distribution(TM), Distribution Reinvestment and Optional Trust Unit Purchase
Plan (the "Plan"). The Plan commenced with the monthly cash distribution
payable on August 15, 2006 to Unitholders of record on July 31, 2006. For
Unitholders that elect to participate in the Plan, Advantage will settle the
monthly distribution obligation through the issuance of additional Trust Units
at 95% of the Average Market Price (as defined in the Plan). Unitholder
enrollment in the Premium Distribution(TM) component of the Plan effectively
authorizes the subsequent disposal of the issued Trust Units in exchange for a
cash payment equal to 102% of the cash distributions that the Unitholder would
otherwise have received if they did not participate in the Plan. During the
year ended December 31, 2006, 2,005,499 Trust Units were issued as a result of
the Plan, generating $27.7 million reinvested in the Fund and representing an
approximate 26% participation rate.
On February 14, 2007 Advantage issued 7,800,000 Trust Units, plus an additional
800,000 Trust Units upon exercise of the Underwriters' over-allotment option on
March 7, 2007, at $12.80 per Trust Unit for approximate net proceeds of $104.2
million (net of Underwriters' fees and other issue costs of $5.9 million). The
net proceeds of the offering will be used to pay down bank indebtedness and to
subsequently fund capital and general corporate expenditures.
In the October 31, 2006 proposal to tax distributions at the income trust level
as well as the existing Unitholder level, the Federal Government warned against
income trusts incurring "undue expansion" during the period between the
proposal announcement and 2011 when the tax rules will effectively change. On
December 15, 2006 the Federal Government clarified "undue expansion" by
providing a set of guidelines for "normal growth". An income trust is permitted
to double its market capitalization as it stands on October 31, 2006 by growing
a maximum of 40% in 2007 and 20% for the years 2008 to 2010. Any unused
expansion from the prior year can be brought forward into the following year
until the new tax rules take effect. In addition, an income trust may replace
debt that was outstanding as of October 31, 2006 with new equity or issue new,
non-convertible debt without affecting the normal growth percentage. An income
trust may also merge with another income trust without a change to their normal
growth percentage, provided there is no net addition to equity as a result of
the merger. As of October 31, 2006, the Fund had an approximate market
capitalization of $1.6 billion and bank indebtedness of $0.4 billion.
Therefore, as a result of the "normal growth" guidelines, the Fund is permitted
to issue $2.0 billion of new equity over the next four years, which we believe
is adequate for any growth we expect to incur.
BANK INDEBTEDNESS, CREDIT FACILITY AND OTHER OBLIGATIONS
At December 31, 2006, Advantage had bank indebtedness outstanding of $410.6
million. Advantage assumed net bank indebtedness of approximately $188 million
in the Ketch merger. The Fund has a $600 million credit facility agreement
consisting of a $580 million extendible revolving loan facility and a $20
million operating loan facility. The current credit facilities are secured by a
$1 billion floating charge demand debenture, a general security agreement and a
subordination agreement from the Fund covering all assets and cash flows.
At December 31, 2006, Advantage had a working capital deficiency of $42.7
million that has remained relatively consistent with the previous year end. Our
working capital includes items expected for normal operations such as trade
receivables, prepaids, deposits,
Advantage Energy Income Fund - 13
trade payables and accruals. Working capital varies primarily due to the timing
of such items, the current level of business activity including our capital
program, commodity price volatility, and seasonal fluctuations. Advantage has
no unusual working capital requirements. We do not anticipate any problems in
meeting future obligations as they become due given the strength of our funds
from operations. It is also important to note that working capital is
effectively integrated with Advantage's operating credit facility, which
assists with the timing of cash flows as required.
Advantage generally does not make use of capital leases to finance development
expenditures. However, Advantage currently has two capital leases outstanding
at December 31, 2006 for $2.8 million that were both assumed from corporate
acquisitions.
CAPITAL EXPENDITURES
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
($000) 2006 2005 2006 2005
- -------------------------------------------------------------------------------------------------------------------------------
Land and seismic $ 522 $ 609 $ 5,261 $ 3,860
Drilling, completions and workovers 42,612 24,293 113,146 77,794
Well equipping and facilities 17,690 2,758 39,437 20,322
Other 285 300 1,643 1,253
- -------------------------------------------------------------------------------------------------------------------------------
$ 61,109 $ 27,960 $ 159,487 $ 103,229
Purchase adjustment of Defiant acquisition - 98 - 98
Property acquisitions 46 (3) 244 210
Property dispositions - 76 (8,727) (3,379)
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL CAPITAL EXPENDITURES $ 61,155 $ 28,131 $ 151,004 $ 100,158
- -------------------------------------------------------------------------------------------------------------------------------
Advantage's growth strategy has been to acquire properties in or near areas
where we have large land positions, shallow to medium depth drilling
opportunities, and preserve a balance of year round access. We focus on areas
where past activity has yielded long-life reserves with high cash netbacks.
With the integration of the Ketch assets, Advantage is very well positioned to
selectively exploit the highest value-generating drilling opportunities given
the size, strength and diversity of our asset base. As a result, the Fund has
shifted its remaining capital program to further oil development due to
superior project economics. Our preference is to operate a high percentage of
our properties such that we can maintain control of capital expenditures,
operations and cash flows.
For the three month period ended December 31, 2006, the Fund spent a net $61.2
million on capital expenditures. Approximately $42.6 million was expended on
drilling and completion operations where the Fund drilled a total of 25.1 net
(44 gross) wells. During the quarter we drilled 4.4 net (13 gross) gas wells at
Chigwell, two 100% working interest gas wells at Black, five 70% working
interest oil wells at Sunset, three oil wells and one gas well with 100%
working interests at Nevis and several wells at other minor properties. Total
capital spending in the quarter included $13.8 million at Nevis, $7.5 million
at Sunset, $5.4 million at Chigwell, $2.7 million at Hardy, $2.6 million at
Worsley, $2.6 million at Westerose, $2.5 million at Martin Creek, $2.4 million
at Conroy Creek, and $2.4 million at Willesden Green.
For the year ended December 31, 2006, the Fund spent a net $151.0 million on
capital expenditures. The Fund drilled a total of 90.2 net (147 gross) wells as
a result of spending approximately $113.1 million on drilling and completion
operations. During the year, Advantage drilled 10.4 net (25 gross) gas wells at
Chigwell, 15 gas wells with 100% working interest at Medicine Hat, 2.3 net (4
gross) gas wells at Worsley, 9.8 net (14 gross) oil wells at Sunset, 4.2 net (6
gross) gas wells and 11 oil wells with 100% working interest at Nevis, and 3
100% working interest gas wells at Shouldice, along with numerous wells at
other minor properties. The Fund experienced a 95% success rate on wells
drilled in 2006. Total capital spending for the year included $36.5 million at
Nevis, $17.4 million at Sunset, $8.0 million at Chigwell, $7.8 million at
Willesden Green, and $6.5 million at Worsley. The majority of capital spending
was used for drilling and facilities throughout the year as well as some
residual development activity remaining from the end of 2005. Activity
occurring late in the year included three new oil wells at the Westerose Banff
"C" unit adding a net 200 boe/d, two new oil wells at Little Bow in Southern
Alberta adding a net 150 boe/d, the Chigwell North coal bed methane joint
venture and new gas pool at Sweetgrass.
Advantage Energy Income Fund - 14
The following table summarizes the various funding requirements during the year
ended December 31, 2006 and the sources of funding to meet those requirements.
SOURCES AND USES OF FUNDS
YEAR ENDED
($000) DECEMBER 31, 2006
- ------------------------------------------------------------------------------
SOURCES OF FUNDS
Funds from operations $ 214,758
Units issued, net of costs 169,631
Property dispositions 8,727
Decrease in working capital 27,222
- ------------------------------------------------------------------------------
$ 420,338
- ------------------------------------------------------------------------------
USES OF FUNDS
Cash distributions to Unitholders $ 212,738
Expenditures on property and equipment 159,487
Decrease in bank indebtedness 30,767
Acquisition costs of Ketch Resources Trust 10,109
Expenditures on asset retirement 5,974
Reduction of capital lease obligations 1,019
Property acquisitions 244
- ------------------------------------------------------------------------------
$ 420,338
- ------------------------------------------------------------------------------
ANNUAL FINANCIAL INFORMATION
The following is a summary of selected financial information of the Fund for
the periods indicated.
YEAR ENDED YEAR ENDED YEAR ENDED
DEC. 31, 2006 DEC. 31, 2005 DEC. 31, 2004
- --------------------------------------------------------------------------------------------------------------------
Total revenue (before royalties) ($000) $ 419,727 $ 376,572 $ 241,481
Net income ($000) $ 49,814 $ 75,072 $ 24,038
per Trust Unit - Basic $ 0.62 $ 1.33 $ 0.59
- Diluted $ 0.61 $ 1.32 $ 0.58
Total assets ($000) $ 1,981,587 $ 1,012,847 $1,033,251
Long term financial liabilities ($000) ((1)) $ 581,698 $ 379,903 $ 144,039
Cash distributions declared per Trust Unit $ 2.66 $ 3.12 $ 2.82
(1) Given amendments made in 2005 to the credit facility repayment terms, the
bank indebtedness is classified as a long-term liability while in 2004
bank indebtedness was shown as a current liability. Long term financial
liabilities also exclude asset retirement obligations and future income
taxes.
Advantage Energy Income Fund - 15
QUARTERLY PERFORMANCE
2006 2005
($000, EXCEPT AS OTHERWISE INDICATED) Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1
- --------------------------------------------------------------------------------------------------------------------------------
Daily production
Natural gas (mcf/d) 117,134 122,227 70,293 65,768 72,587 75,994 79,492 86,350
Crude oil and NGLs (bbls/d) 9,570 9,330 6,593 6,760 7,106 7,340 6,772 6,892
Total (boe/d) 29,092 29,701 18,309 17,721 19,204 20,006 20,021 21,284
Average prices
Natural gas ($/mcf)
Excluding hedging $ 6.90 $ 5.89 $ 6.18 $ 8.69 $ 11.68 $ 8.25 $ 7.27 $ 6.52
Including hedging $ 7.27 $ 5.90 $ 6.18 $ 8.69 $ 10.67 $ 7.79 $ 7.30 $ 6.47
AECO monthly index $ 6.36 $ 6.03 $ 6.28 $ 9.31 $ 11.68 $ 8.15 $ 7.38 $ 6.70
Crude oil and NGLs ($/bbl)
Excluding hedging $ 54.58 $ 67.77 $ 68.69 $ 58.26 $ 60.14 $ 66.00 $ 56.57 $ 53.02
Including hedging $ 55.86 $ 67.77 $ 68.69 $ 58.26 $ 59.53 $ 61.10 $ 56.24 $ 53.02
WTI (US$/bbl) $ 60.21 $ 70.55 $ 70.75 $ 63.88 $ 60.04 $ 63.17 $ 53.13 $ 49.90
Total revenues (before royalties) $ 127,539 $124,521 $ 80,766 $ 86,901 $110,172 $ 95,715 $ 87,476 $ 83,209
Net income $ 8,736 $ 1,209 $ 23,905 $ 15,964 $ 25,846 $ 18,674 $ 26,537 $ 4,015
per Trust Unit - basic $ 0.08 $ 0.01 $ 0.38 $ 0.27 $ 0.45 $ 0.33 $ 0.46 $ 0.07
- diluted $ 0.08 $ 0.01 $ 0.38 $ 0.27 $ 0.45 $ 0.32 $ 0.46 $ 0.07
Funds from operations $ 62,737 $ 63,110 $ 42,281 $ 46,630 $ 60,906 $ 55,575 $ 49,705 $ 45,355
Cash distributions declared $ 58,791 $ 60,498 $ 53,498 $ 44,459 $ 43,265 $ 43,069 $ 44,693 $ 46,339
Payout ratio (%) 94% 96% 127% 95% 71% 77% 90% 102%
The table above highlights the Fund's performance for the fourth quarter of
2006 and also for the preceding seven quarters. During 2005, production
continued to experience normal declines until a more significant decrease
occurred in the first quarter of 2006 due to a one-time adjustment for several
payout wells, restricted production on wells in Chip Lake and Nevis, and some
minor non-core property dispositions that occurred in 2005. Production
increased in the second quarter of 2006 with the addition of eight days of
production from the Ketch properties and further increased in the third quarter
of 2006 as the acquisition was fully integrated with Advantage. Production in
the fourth quarter of 2006 was significantly impacted by freezing problems at
several properties due to extreme cold in Alberta during the latter part of
November. Advantage's revenues and funds from operations for the third and
fourth quarters of 2006 are higher primarily due to the production from the
merger with Ketch, offset by significantly lower natural gas prices. Net income
has been lower during the last two quarters due to reduced natural gas prices
realized during the periods, amortization of the management internalization
consideration, and increased depletion and depreciation expense due to the
Ketch merger. During 2006, the payout ratio has been higher relative to prior
quarters as a result of considerably weak natural gas prices. Additionally, the
timing of the Ketch merger has also increased the payout ratio for the second
quarter of 2006 as the arrangement closed prior to the June record date
resulting in the payment of a full month distribution to Ketch Unitholders
whereas funds from operations for June only included eight days of cash flows
from the Ketch properties.
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in accordance with GAAP requires
Management to make certain judgments and estimates. Changes in these judgments
and estimates could have a material impact on the Fund's financial results and
financial condition. Management relies on the estimate of reserves as prepared
by the Fund's independent qualified reserves evaluator. The process of
estimating reserves is critical to several accounting estimates. The process of
estimating reserves is complex and requires significant judgments and decisions
based on available geological, geophysical, engineering and economic data.
These estimates may change substantially as additional data from ongoing
development and production activities becomes available and as economic
conditions impact crude oil and natural gas prices, operating costs, royalty
burden changes, and future development costs. Reserve estimates impact net
income through depletion and depreciation of property and equipment, the
provision for asset retirement costs and related accretion expense, and
impairment calculations for property and equipment and goodwill. The reserve
estimates are also used
Advantage Energy Income Fund - 16
to assess the borrowing base for the Fund's credit facilities. Revision or
changes in the reserve estimates can have either a positive or a negative
impact on net income and the borrowing base of the Fund.
FINANCIAL REPORTING UPDATE
CONVERGENCE OF CANADIAN GAAP WITH INTERNATIONAL FINANCIAL REPORTING STANDARDS
In 2006, Canada's Accounting Standards Board ("AcSB") issued a strategic plan
that will result in Canadian GAAP, as it applies to publicly accountable
entities, being converged with International Financial Reporting Standards over
a transitional period, initially indicated to be five years. The AcSB is
expected to develop and release a detailed implementation plan and the Fund
will consider the effect that this implementation plan might have on the
consolidated financial statements during the transition period.
FINANCIAL INSTRUMENTS RECOGNITION AND MEASUREMENT
In April 2005, a series of new accounting standards were released which
established guidance for the recognition and measurement of financial
instruments. These new standards include Section 1530 "Comprehensive Income",
Section 3855 "Financial Instruments -- Recognition and Measurement", and
Section 3865 "Hedges". The new standards also resulted in a number of
significant consequential amendments to other accounting standards to
accommodate the new sections. The standards require all applicable financial
instruments to be classified into one of several categories including:
financial assets and financial liabilities held for trading, held-to-maturity
investments, loans and receivables, available-for-sale financial assets, or
other financial liabilities. The financial instruments are then included on a
company's balance sheet and measured at fair value, cost or amortized value,
depending on the classification. Subsequent measurement and recognition of
changes in value of the financial instruments also depends on the initial
classification. These standards are effective for interim and annual financial
statements for fiscal years beginning on or after October 1, 2006 and must be
implemented simultaneously. Advantage has adopted the new standards as of
January 1, 2007 and there are no significant changes in the recognition and
measurement of the Fund's financial instruments.
In December 2006, new accounting standards were released which provided further
guidance on the presentation and disclosure of financial instruments and were
intended to better align the Canadian standards with international accounting
standards. The new standards are effective for interim and annual financial
statements related to fiscal years beginning on or after October 1, 2007.
Advantage has chosen to early adopt the new standards Section 3862 "Financial
Instruments - Presentation" and Section 3863 "Financial Instruments -
Disclosure" as issued by the CICA effective January 1, 2007. As a result, there
will be several additional disclosures relating to financial instruments in
2007, but no significant changes to presentation.
CONTROLS AND PROCEDURES
The Fund has established procedures and internal control systems to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
GAAP. Management of the Fund is committed to providing timely, accurate and
balanced disclosure of all material information about the Fund. Disclosure
controls and procedures are in place to ensure all ongoing reporting
requirements are met and material information is disclosed on a timely basis.
The Chief Executive Officer and Vice-President Finance and Chief Financial
Officer, individually, sign certifications that the financial statements,
together with the other financial information included in the regular filings,
fairly present in all material respects the financial condition, results of
operation, and cash flows as of the dates and for the periods presented in the
filings. The certifications further acknowledge that the filings do not contain
any untrue statement of a material fact or omit to state a material fact
required to be stated or that is necessary to make a statement not misleading
in light of the circumstances under which it was made, with respect to the
period covered by the filings. As well, during 2006, Management conducted an
evaluation of the effectiveness of our internal control over financial
reporting and concluded that as of December 31, 2006, our internal control over
financial reporting was effective and there were no significant changes during
2006 that would materially affect, or are reasonably likely to materially
affect, the internal controls over financial reporting.
Because of inherent limitations, internal control over financial reporting may
not prevent or detect misstatements and even those systems determined to be
effective can provide only reasonable assurance with respect to the financial
statement preparation and presentation. Further, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
Advantage Energy Income Fund - 17
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Fund has established a Disclosure Committee consisting of seven executive
members with the responsibility of overseeing the Fund's disclosure practices
and designing disclosure controls and procedures to ensure that all material
information is communicated to the Disclosure Committee. All written public
disclosures are reviewed and approved by at least one member of the Disclosure
Committee prior to issuance. Additionally, the Disclosure Committee assists the
Chief Executive Officer and Chief Financial Officer of the Fund in making
certifications with respect to the disclosure controls of the Fund required
under applicable regulations and ensures that the Board of Directors is
promptly and fully informed regarding potential disclosure issues facing the
Fund.
The Fund's Management is responsible for establishing and maintaining effective
internal control over financial reporting. Management of Advantage, including
our Chief Executive Officer and Vice-President, Finance and Chief Financial
Officer, has evaluated the effectiveness of the design and operation of the
disclosure controls and procedures as of December 31, 2006. Based on that
evaluation, Management has concluded that the disclosure controls and
procedures are effective as of the end of the period, in all material respects.
It should be noted that while the Chief Executive Officer and Chief Financial
Officer believe that the Fund's design of disclosure controls and procedures
provide a reasonable level of assurance that they are effective, they do not
expect that the disclosure controls and procedures or internal control over
financial reporting will prevent all errors and fraud. A control system does
not provide absolute, but rather is designed to provide reasonable, assurance
that the objective of the control system is met.
CORPORATE GOVERNANCE
The Board of Directors' mandate is to supervise the management of the business
and affairs of the Fund including the business and affairs of the Fund
delegated to AOG. In particular, all decisions relating to: (i) the acquisition
and disposition of properties for a purchase price or proceeds in excess of $5
million; (ii) the approval of annual operating and capital expenditure budgets;
and (iii) the establishment of credit facilities and the issuance of additional
Trust Units, will be made by the Board.
Computershare Trust Company of Canada, the Trustee of the Fund, has delegated
certain matters to the Board of Directors. These include all decisions relating
to issuance of additional Trust Units and the determination of the amount of
distributions. Any amendment to any material contract to which the Fund is a
party will require the approval of the Board of Directors and, in some cases,
Unitholder approval.
The Board of Directors meets regularly to review the business and affairs of
the Fund and AOG and to make any required decisions. The Board of Directors
consists of ten members, seven of whom are unrelated to the Fund. The
Independent Reserve Evaluation Committee has three members, all of whom are
independent. The Human Resources, Compensation and Corporate Governance
Committee and Audit Committee each have four members, all of whom are
independent. One member of the Audit Committee has been designated a "Financial
Expert" as defined in applicable regulatory guidance. In addition, the Chairman
of the Board is not related and is not an executive officer of the Fund.
The Board of Directors approved and Management implemented a Code of Business
Conduct and Ethics. The purpose of the code is to lay out the expectation for
the highest standards of professional and ethical conduct from our directors,
officers and employees. The code reflects our commitment to a culture of
honesty, integrity and accountability and outlines the basic principles and
policies with which all employees are expected to comply. Our Code of Business
Conduct and Ethics is available on our website at www.advantageincome.com.
As a Canadian issuer listed on the New York Stock Exchange (the "NYSE"),
Advantage is not required to comply with most of the NYSE rules and listing
standards and instead may comply with domestic requirements. As a foreign
private issuer, Advantage is only required to comply with four of the NYSE
Rules: (i) have an audit committee that satisfies the requirements of the
United States Securities Exchange Act of 1934; (ii) the Chief Executive Officer
must promptly notify the NYSE in writing after an executive officer becomes
aware of any material non-compliance with the applicable NYSE Rules; (iii)
submit an executed annual written affirmation as well as an interim affirmation
each time a change occurs to the audit committe; and (iv) provide a brief
description of any significant differences between its corporate governance
practices and those followed by U.S. companies listed under the NYSE. Advantage
has reviewed the NYSE listing standards and confirms that its corporate
governance practices do not differ significantly from such standards.
A further discussion of the Fund's corporate governance practices can be found
in the Management Proxy Circular.
OUTLOOK
The Fund has established a 2007 Budget, as approved by the Board of Directors,
that retains a high degree of activity and will focus on drilling in many of
our key properties where a high level of success was realized through 2006.
Capital will also be directed to accommodate facility expansions and further
develop enhanced recovery schemes as necessary. New drill bit additions are
expected to be more effective in replacing production as corporate declines
have continued to subside through 2006. Advantage's production now contains
very little flush production from high impact wells and concentrated drilling
programs (from 2004 and 2005 activities) creating a balanced and predictable
platform. During the second and third quarters of 2007, we expect two major
third party plant
Advantage Energy Income Fund - 18
turnarounds to occur which will significantly affect our Lookout Butte and
Westerose properties. These two turnarounds combined with well payouts are
expected to result in an impact of approximately 400 boe/d to the 2007 annual
average production. Overall, we expect production in 2007 to average between
27,500 to 29,500 boe/d.
Advantage's 2007 capital expenditures budget of $120 to $145 million includes
the drilling, completion and tie-in of 107 gross wells (64 net) weighted
approximately 50% toward light oil and 50% to natural gas. In Northeast B.C., a
17 well (14 net) natural gas drilling program is being substantially completed
in the first quarter of 2007 at Martin Creek. This program exploits the
northern portions of the Field where a successful drilling program was
conducted in 2006 which extended pool boundaries. At this time, the 17 well
drilling program has been completed and final facilities work and tie-ins are
in progress. Results to date indicate a very successful program with tested
well deliverability in excess of facilities capacity and budget assumptions.
Combined with Advantage's already commanding position of facilities
infrastructure and operatorship, we estimate three years of drilling inventory
in this property. At Sunset, in Northern Alberta, four wells are planned to
follow-up the successful 2006 development drilling program and capital will
also be required to expand water flood facilities in this light oil pool. In
Central Alberta, a 12 well (12 net) program is planned at Nevis for 40 degree
light oil where horizontal drilling in 2006 showed excellent results. A net 15
sections of land were added through deals with industry third parties in 2006
bringing the total land under control to 37.5 net sections in this property. A
second development drilling program in the western portion of the Nevis
property is underway and facilities will be constructed to accommodate
production additions. Additional gas opportunities will be pursued in the
Central Alberta areas targeting down spacing and follow-up to successes. In
Southern Alberta and S.E. Saskatchewan, 13 wells (10 net) will be drilled for
oil targets in 2007.
Operating costs are forecasted to be closer to the $9.50 to $10.50/boe range as
higher gas prices indicated by the current strip price through the summer of
2007 suggest higher power costs than what was realized in 2006. In addition,
higher property taxes, surface rentals and additional trucking costs due to
continued pipeline restrictions in Southeast Saskatchewan are expected to occur
in 2007. Advantage is undertaking several operating cost reduction initiatives
through 2007 to help offset these increases.
Advantage's funds from operations in 2007 will continue to be impacted by the
volatility of crude oil and natural gas prices and the $US/$Canadian exchange
rate. Advantage will continue to follow its strategy of acquiring properties
that provide low risk development opportunities and enhance long term cash
flow. Advantage will also continue to focus on low cost production and reserve
additions through low to medium risk development drilling opportunities that
have arisen as a result of the acquisitions completed in prior years and from
the significant inventory of drilling opportunities that has resulted from the
Ketch merger. The synergy of larger size and the complementary winter/summer
drilling programs with the Ketch merger is providing benefits in terms of
securing services, flexibility and quality of our capital program.
Looking forward, Advantage's high quality assets, three year drilling
inventory, hedging program and excellent tax pools provides many options for
the Fund and we are committed to maximizing value generation for our
Unitholders.
The following table indicates our funds from operations sensitivity to changes
in prices and production of natural gas, crude oil and NGLs, exchange rates and
interest rates for 2007 based on production of 28,000 boe/d comprised of 110.4
mmcf/d of natural gas and 9,600 bbls/d of crude oil and NGLs. Advantage is
considerably more sensitive to changes in natural gas prices as compared to oil
due to the Fund's higher natural gas weighting.
SENSITIVITIES ANNUAL
ANNUAL FUNDS FROM OPERATIONS
FUNDS FROM OPERATIONS PER TRUST UNIT
($000) ($/TRUST UNIT)
- -----------------------------------------------------------------------------------------------------------------
Natural gas
AECO monthly price change of $0.25/mcf $ 5,500 $ 0.05
Production change of 1,000 mcf/d $ 1,800 $ 0.02
Crude oil and NGLs
WTI price change of US$1.00/bbl $ 2,900 $ 0.03
Production change of 200 bbls/d $ 2,800 $ 0.03
$US/$Canadian exchange rate change of $0.01 $ 5,800 $ 0.04
Interest rate change of 1% $ 3,800 $ 0.03
ADDITIONAL INFORMATION
Additional information relating to Advantage can be found on SEDAR at
www.sedar.com and the Fund's website at www.advantageincome.com. Such other
information includes the annual information form, the annual information
circular - proxy statement, press releases, material contracts and agreements,
and other financial reports. The annual information form will be of particular
interest for current and potential Unitholders as it discusses a variety of
subject matter including the nature of the business, structure of the Fund,
description of our operations, general and recent business developments, risk
factors, reserves data and other oil and gas information.
Advantage Energy Income Fund - 19