EXHIBIT 99.3
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[GRAPHIC OMITTED -- LOGO]
ADVANTAGE ENERGY INCOME FUND
2007 MANAGEMENT'S DISCUSSION & ANALYSIS
The following Management's Discussion and Analysis ("MD&A"), dated as of March
5, 2008, 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, 2007 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, funds from operations per Trust Unit and cash netbacks.
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 distribution record date. Cash netbacks are
dependent on the determination of funds from operations and include the primary
cash revenues and expenses on a per boe basis that comprise 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) 2007 2006 % CHANGE 2007 2006 % CHANGE
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Cash provided by operating activities $ 83,366 $ 65,495 27% $ 249,132 $229,087 9%
Expenditures on asset retirement 2,116 3,462 (39)% 6,951 5,974 16%
Changes in non-cash working capital (4,963) (6,220) (20)% 15,060 (20,303) (174)%
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FUNDS FROM OPERATIONS $ 80,519 $ 62,737 28% $ 271,143 $214,758 26%
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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, royalty regimes 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,
Advantage Energy Income Fund - 1
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.
ACQUISITION OF SOUND ENERGY TRUST
On September 5, 2007, the previously announced acquisition of Sound Energy
Trust ("Sound") was completed. The financial and operational information for
the quarter and year ended December 31, 2007 reflects operations from the Sound
properties effective from the closing date, September 5, 2007.
The acquisition was accomplished through a Plan of Arrangement (the
"Arrangement") by the exchange of each Sound Trust Unit for 0.30 of an
Advantage Trust Unit or, at the election of the holder of Sound Trust Units,
$0.66 in cash and 0.2557 of an Advantage Trust Unit. In addition, all Sound
Exchangeable Shares were exchanged for Advantage Trust Units on the same ratio
based on the conversion ratio in effect at the effective date of the
Arrangement. Advantage issued 16,977,184 Trust Units and paid $21.4 million
cash as consideration to acquire Sound. The transaction is accretive to
Advantage's Unitholders on a production, cash flow, reserves and net asset
value basis and has significantly increased Advantage's tax pool position to a
total of approximately $1.7 billion, and Safe Harbour expansion room to
approximately $2.0 billion. Sound's higher oil weighting, synergy with many of
Advantage's core properties and significant undeveloped land holdings of
approximately 400,000 net undeveloped acres will further enhance the operating
platform of Advantage.
OVERVIEW
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2007 2006 % CHANGE 2007 2006 % CHANGE
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Cash provided by operating activities ($000) $ 83,366 $ 65,495 27% $ 249,132 $ 229,087 9%
Funds from operations ($000) $ 80,519 $ 62,737 28% $ 271,143 $ 214,758 26%
per Trust Unit (1) $ 0.58 $ 0.59 (2)% $ 2.22 $ 2.63 (16)%
Net income (loss) ($000) $ 13,795 $ 8,736 58% $ (7,535) $ 49,814 (115)%
per Trust Unit - Basic $ 0.10 $ 0.08 25% $ (0.06) $ 0.62 (110)%
- Diluted $ 0.10 $ 0.08 25% $ (0.06) $ 0.61 (110)%
(1) Based on Trust Units outstanding at each distribution record date.
Cash provided by operating activities increased 27%, funds from operations
increased 28%, and funds from operations per Trust Unit modestly decreased 2%
for the three months ended December 31, 2007, as compared to the same period of
2006. For the year ended December 31, 2007, cash provided by operating
activities increased 9%, funds from operations increased 26%, and funds from
operations per Trust Unit decreased 16%. Cash provided by operating activities
and funds from operations for the quarter and year were positively impacted by
increased revenues due to additional production from the Sound acquisition and
the year was further impacted by a full year of production from the Ketch
acquisition that closed in 2006. Funds from operations per Trust Unit decreased
during the periods due to a higher average number of Trust Units outstanding.
The weighted average number of Trust Units has increased 32% for the three
months and 48% for the year ended in 2007 compared to 2006, mainly due to the
Sound acquisition, the Trust Unit financing in the first quarter of 2007 and
the distribution reinvestment plan. When compared to the third quarter of 2007,
funds from operations increased 29% due to production increases of 17% from the
acquisition of Sound and stronger commodity prices. Natural gas prices,
excluding hedging, increased 11% and crude oil and NGL prices, excluding
hedging, increased 6% for the fourth quarter of 2007 as compared to the prior
quarter. The Fund also realized net derivative gains of $5.2 million in the
three months and $18.6 million for the year ended December 31, 2007 which also
helped to strengthen cash provided by operating activities and funds from
operations.
Net income for the quarter increased 58% over prior year due to higher crude
oil prices and higher production from the Sound acquisition, offset somewhat by
higher costs from the acquisition and general growth of the Fund. Net income
for the year decreased to a net loss for the twelve months ended December 31,
2007 primarily due to higher operating costs, as well as non-cash expenses such
as amortization of the management contract internalization and higher depletion
and depreciation expense. The primary factor that causes significant
variability of Advantage's cash provided by operating activities, funds from
operations, and net income is
Advantage Energy Income Fund - 2
commodity prices. Refer to the section "Commodity
Prices and Marketing" for a more detailed discussion of commodity prices and
our price risk management.
DISTRIBUTIONS
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2007 2006 % CHANGE 2007 2006 % CHANGE
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Distributions declared ($000) $ 57,875 $ 58,791 (2)% $ 215,194 $ 217,246 (1)%
per Trust Unit (1) $ 0.42 $ 0.56 (25)% $ 1.77 $ 2.66 (33)%
(1) Based on Trust Units outstanding at each distribution record date.
Total distributions declared decreased 2% for the three months and 1% for the
year ended December 31, 2007 when compared to the same periods in 2006. Total
distributions declared are slightly lower as a result of the decreases in the
distribution per Trust Unit in January and December 2007. The decreases in per
Trust Unit distributions are offset by additional distributions due to the
increased Trust Units outstanding from the continued growth and development of
the Fund. Since natural gas prices were very weak during the 2006/2007 winter
season, we reduced the distribution level in January 2007 and as natural gas
prices continued to show prolonged weakness throughout 2007, we decreased the
distribution level further in December 2007 to more appropriately reflect the
current commodity price environment. Distributions per Trust Unit were $0.42
for the three months and $1.77 for the year ended December 31, 2007,
representing a decrease of 25% and 33% from same periods in 2006. The monthly
distribution is currently $0.12 per Trust Unit. To mitigate the persisting risk
associated with lower commodity prices and the resulting negative impact on
cash flows, the Fund implemented a hedging program with 51% of natural gas
production and 38% of crude oil production, net of royalties, hedged for 2008.
See "Commodity Price Risk" section for a more detailed discussion of our price
risk management.
Distributions from the Fund to Unitholders are entirely discretionary and 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. Distributions are
announced monthly and are based on the cash available after retaining a portion
to meet such spending requirements. The level of 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 distributions
will decline over time in a manner consistent with declining production from
typical oil and natural gas reserves. Therefore, distributions are highly
dependent upon our success in exploiting the current reserve base and acquiring
additional reserves. Furthermore, monthly distributions we pay to Unitholders
are highly dependent upon the prices received for such 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 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 and U.S. holders of Advantage Trust Units, the distributions paid
for 2007 were 100% 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.
Advantage Energy Income Fund - 3
REVENUE
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
($000) 2007 2006 % CHANGE 2007 2006 % CHANGE
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Natural gas excluding hedging $ 73,662 $ 74,309 (1)% $ 286,777 $ 231,548 24%
Realized hedging gains 8,762 4,046 117% 20,933 4,164 403%
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Natural gas including hedging $ 82,424 $ 78,355 5% $ 307,710 $ 235,712 31%
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Crude oil and NGLs excluding hedging $ 87,079 $ 48,051 81% $ 251,987 $ 182,882 38%
Realized hedging gains (losses) (3,552) 1,133 (414)% (2,339) 1,133 (306)%
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Crude oil and NGLs including hedging $ 83,527 $ 49,184 70% $ 249,648 $ 184,015 36%
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TOTAL REVENUE $ 165,951 $ 127,539 30% $ 557,358 $419,727 33%
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Natural gas revenues, excluding hedging, have decreased 1% for the three months
and increased 24% for the year ended December 31, 2007, compared to 2006. The
decrease in natural gas revenues for the three months is mainly due to a 10%
decrease in natural gas prices, excluding hedging, offset by an equivalent 10%
increase in production, primarily from the Sound acquisition. Conversely, the
increase in natural gas revenues for the 2007 year is mainly due to the
inclusion of a full year of production from the Ketch merger that closed in
2006 and production from the Sound acquisition since September 5, 2007, while
natural gas prices remained fairly constant. Crude oil and NGL revenues,
excluding hedging, have increased by 81% for the three months and 38% for the
year ended December 31, 2007, compared to 2006. Crude oil and NGL revenue
increased due to additional production from the Sound acquisition and the
inclusion of a full year of production from the Ketch merger combined with an
increase in crude oil and NGL prices of 34% for the three months and 6% for the
year ended December 31, 2007. For the three months and year ended December 31,
2007, the Fund recognized natural gas and crude oil net hedging gains of $5.2
million and $18.6 million primarily due to derivative contracts in place that
offset commodity prices fluctuations which can jeopardize revenues and
corresponding distributions.
PRODUCTION
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2007 2006 % CHANGE 2007 2006 % CHANGE
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Natural gas (mcf/d) 128,556 117,134 10% 116,998 94,074 24%
Crude oil (bbls/d) 10,410 7,148 46% 8,090 6,273 29%
NGLs (bbls/d) 2,485 2,422 3% 2,372 1,802 32%
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TOTAL (BOE/D) 34,321 29,092 18% 29,962 23,754 26%
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Natural gas (%) 63% 67% 65% 66%
Crude oil (%) 30% 25% 27% 26%
NGLs (%) 7% 8% 8% 8%
The Fund's total daily production averaged 34,321 boe/d for the three months
and 29,962 boe/d for the year ended December 31, 2007, an increase of 18% and
26%, respectively, compared with the same periods of 2006. Natural gas
production increased 10%, crude oil production increased 46%, and NGLs
production increased 3% for the fourth quarter of 2007. For the year ended
December 31, 2007, natural gas production increased 24%, crude oil production
increased 29%, and NGLs production increased 32%. Production for the quarter
increased due to the additional properties from the Sound acquisition. The
increase in production for the year ended December 31, 2007 has been primarily
attributed to a full year of production from the Ketch acquisition which closed
June 23, 2006 and production from the Sound acquisition which closed September
5, 2007. Production for the fourth quarter increased 17% from the third quarter
of 2007 also due to a full quarter of production from the acquisition of Sound.
Our successful first quarter 2007 drilling program at Martin Creek, followed by
continued success at Sunset, Nevis, Willesden Green, as well as other areas in
Southern Alberta and Saskatchewan throughout the year has helped offset natural
declines. In addition, our flattening production platform, resulting from our
continued focus on long life assets, is contributing to a stable operating
foundation. For 2008 we expect production to average approximately 32,000 to
34,000 boe/d, weighted 62% to natural gas.
Advantage Energy Income Fund - 4
Approximately 55% of our capital spending will be directed to natural gas and
45% toward light oil projects which will enable us to increase our crude oil
production and capitalize on the stronger crude oil pricing environment.
COMMODITY PRICES AND MARKETING
NATURAL GAS
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
($/MCF) 2007 2006 % CHANGE 2007 2006 % CHANGE
- -------------------------------------------------------------------------------------------------------------------------------
Realized natural gas prices
Excluding hedging $ 6.23 $ 6.90 (10)% $ 6.72 $ 6.74 -
Including hedging $ 6.97 $ 7.27 (4)% $ 7.21 $ 6.86 5%
AECO monthly index $ 6.00 $ 6.36 (6)% $ 6.61 $ 6.98 (5)%
Realized natural gas prices, excluding hedging, decreased 10% for the three
months and remained constant for the year ended December 31, 2007, as compared
to 2006. The price of natural gas is primarily based on supply and demand
fundamentals in the North American marketplace; however market speculation
activity has increased price volatility. Natural gas prices declined for the
current quarter and continued to remain weak for the entire 2007 year, as in
2006, due to exceedingly high storage levels, mild summer and winter weather
and a lack of storm activity in the Gulf of Mexico. Fourth quarter natural gas
inventory levels remained well above average, causing continued downward
pressure on commodity prices. However, early 2008 has brought colder weather
and significant inventory withdrawals have been experienced, resulting in a
rebound of natural gas prices. Natural gas storage levels are now closer to
expectation and only slightly above the five-year average. In addition, there
has been a tighter supply of natural gas, putting further upward pressure on
prices. These developments have been encouraging and 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
evidenced by the increase in proposed gas fired electrical generation
facilities, (ii) significantly less natural gas drilling in Canada projected
for 2008, which will reduce productivity to offset declines, (iii) the
increasing focus on resource style natural gas wells, which have high initial
declines and require a higher threshold economic price than conventional gas
drilling and (iv) the demand for natural gas for the Canadian oil sands
projects.
CRUDE OIL AND NGLS
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
($/BBL) 2007 2006 % CHANGE 2007 2006 % CHANGE
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Realized crude oil prices
Excluding hedging $ 74.19 $ 56.10 32% $67.71 $ 63.85 6%
Including hedging $ 70.48 $ 57.82 22% $66.92 $ 64.34 4%
Realized NGLs prices
Excluding hedging $ 70.09 $ 50.09 40% $60.12 $ 55.81 8%
Realized crude oil and NGLs prices
Excluding hedging $ 73.40 $ 54.58 34% $65.99 $ 62.05 6%
Including hedging $ 70.40 $ 55.86 26% $65.38 $ 62.44 5%
WTI ($US/bbl) $ 90.63 $ 60.21 51% $72.37 $ 66.35 9%
$US/$Canadian exchange rate $ 1.02 $ 0.88 16% $ 0.94 $ 0.88 7%
Realized crude oil and NGLs prices, excluding hedging, increased 34% for the
three months and 6% for the year ended December 31, 2007, as compared to the
same periods of 2006. 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. For the three months and
year ended December 31, 2007, WTI increased 51% and 9%, respectively, with
momentous increases experienced in the fourth quarter of 2007. Advantage's
realized crude oil price has not changed to the same extent as WTI due to the
strengthening of the Canadian dollar relative to the US dollar and widened
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. Many developments have resulted in the current
price levels, including significant continuing geopolitical issues and general
market speculation. In fact, the impact of market fundamentals has diminished
Advantage Energy Income Fund - 5
as geopolitical events and speculation has prevailed. As a result, prices have
remained strong throughout 2007 and into early 2008. With the current high
price levels, it is notable that demand has remained resilient even as the
United States, the world's largest crude oil consumer, experiences an economic
slowdown. Regardless whether the current price level is sustainable or just a
short-term anomaly, 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 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 derivatives. These commodity price 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.
We have been active in entering new financial contracts to protect future cash
flows and currently the Fund has the following derivatives in place:
DESCRIPTION OF DERIVATIVE TERM VOLUME AVERAGE PRICE
- -------------------------------------------------------------------------------------------------------------------------------
NATURAL GAS - AECO
Fixed price November 2007 to March 2008 7,109 mcf/d Cdn$9.54/mcf
Fixed price April 2008 to October 2008 14,217 mcf/d Cdn$6.85/mcf
Fixed price April 2008 to October 2008 9,478 mcf/d Cdn$7.25/mcf
Fixed price April 2008 to October 2008 14,217 mcf/d Cdn$7.83/mcf
Fixed price April 2008 to March 2009 14,217 mcf/d Cdn$7.10/mcf
Fixed price April 2008 to March 2009 14,217 mcf/d Cdn$7.06/mcf
Fixed price November 2008 to March 2009 14,217 mcf/d Cdn$7.77/mcf
Fixed price November 2008 to March 2009 4,739 mcf/d Cdn$8.10/mcf
Collar November 2007 to March 2008 9,478 mcf/d Floor Cdn$8.44/mcf
Ceiling Cdn$10.29/mcf
Collar November 2007 to March 2008 7,109 mcf/d Floor Cdn$8.70/mcf
Ceiling Cdn$10.71/mcf
CRUDE OIL - WTI
Fixed price February 2008 to January 2009 2,000 bbls/d Cdn$90.93/bbl
Fixed price April 2008 to March 2009 2,500 bbls/d Cdn$97.15/bbl
Collar February 2008 to January 2009 2,000 bbls/d Sold put Cdn$70.00/bbl
Purchased call Cdn$105.00/bbl
Cost Cdn$1.52/bbl
As at December 31, 2007 the fair value of the derivatives outstanding was a net
asset of approximately $2.2 million. For the year ended December 31, 2007,
$11.0 million was recognized in income as an unrealized derivative loss due to
changes in the fair value and settlement of such contracts since December 31,
2006. For the same period we recognized in income a realized derivative gain of
$18.6 million upon the settlement of these financial contracts, which partially
alleviated lower revenue from continued weak natural gas prices. As a result of
the Sound acquisition, the Fund assumed several derivatives which had an
estimated net fair value on closing of $2.8 million. The change in fair value
of these derivatives since acquisition to the end of the period has been
recognized in income as an unrealized derivative gain or loss. The valuation of
the derivatives is the estimated fair value to settle the contracts as at
December 31, 2007 and is based on pricing models, estimates, assumptions and
market data available at that time. The actual gain or loss realized on
eventual cash settlement can vary materially due to subsequent fluctuations in
commodity prices as compared to the valuation assumptions. The Fund does not
apply hedge accounting and current accounting standards require changes in the
fair value
Advantage Energy Income Fund - 6
to be included in the consolidated statement of income and comprehensive income
as an unrealized derivative gain or loss with a corresponding derivative asset
and liability recorded on the balance sheet. The Fund has fixed the commodity
price on anticipated production as follows:
APPROXIMATE PRODUCTION AVERAGE AVERAGE
COMMODITY HEDGED, NET OF ROYALTIES FLOOR PRICE CEILING PRICE
- -------------------------------------------------------------------------------------------------------------------------------
NATURAL GAS - AECO
January to March 2008 22% Cdn$8.85/mcf Cdn$10.19/mcf
April to June 2008 66% Cdn$7.22/mcf Cdn$7.22/mcf
July to September 2008 64% Cdn$7.22/mcf Cdn$7.22/mcf
October to December 2008 53% Cdn$7.32/mcf Cdn$7.32/mcf
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL 2008 51% CDN$7.43/MCF CDN$7.58/MCF
- -------------------------------------------------------------------------------------------------------------------------------
January to March 2009 46% Cdn$7.39/mcf Cdn$7.39/mcf
CRUDE OIL - WTI
January to March 2008 13% Cdn$90.93/bbl Cdn$90.93/bbl
April to June 2008 47% Cdn$94.39/bbl Cdn$94.39/bbl
July to September 2008 46% Cdn$94.39/bbl Cdn$94.39/bbl
October to December 2008 46% Cdn$94.39/bbl Cdn$94.39/bbl
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL 2008 38% CDN$94.07/BBL CDN$94.07/BBL
- -------------------------------------------------------------------------------------------------------------------------------
January to March 2009 32% Cdn$95.84/bbl Cdn$95.84/bbl
ROYALTIES
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2007 2006 % CHANGE 2007 2006 % CHANGE
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Royalties, net of Alberta Royalty Credit ($000) $27,099 $ 23,349 16% $ 98,614 $76,456 29%
per boe $ 8.58 $ 8.72 (2)% $ 9.02 $ 8.82 2%
As a percentage of revenue, excluding hedging 16.9% 19.1% (2.2)% 18.3% 18.4% (0.1)%
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 for 2006 are shown net of the
Alberta Royalty Credit, which was a royalty rebate provided by the Alberta
government to certain producers and was eliminated effective January 1, 2007.
Royalties have increased in total for the 2007 periods due to the increase in
revenue from higher production related to acquisitions but remains comparable
on a per boe basis. Royalties as a percentage of revenue, excluding hedging,
remained consistent for the year as compared to 2006 but decreased in the
fourth quarter of 2007 due to the lower natural gas prices experienced by
Advantage during the last six months of the year. We expect the royalty rate to
be in the range of 17% to 19% for 2008 given the current environment.
On October 25, 2007, the Alberta Provincial Government announced changes to
royalties for conventional oil, natural gas and oil sands that will become
effective January 1, 2009. Given the methodology used in the new royalty
regime, royalties and as a result, cash flows will be affected by depths and
productivity of wells. In addition, royalties are price sensitive with higher
royalty levels applying when commodity prices are higher. A review of the
initial information released by the Alberta Provincial Government indicates
that lower rate natural gas wells will see a benefit of lower royalties while
conventional oil will be subject to an increase in royalties but is again less
punitive at lower rates. Commodity prices and individual well production rates
are both key factors in the calculation. The majority of Advantage's production
in Alberta comes from lower rate wells due to well-established large, long life
properties. In addition, we have a significant presence in British Columbia and
Saskatchewan. Therefore, early indications are that the impact may not be
significant based on our current production and the current commodity price
environment. Advantage continues to analyze the impact of the decision and will
take the new royalty regime into consideration in preparing future development
projects. Project economics are evaluated taking into consideration all
relevant factors including the new royalty regime given the commodity pricing
environment anticipated. Those projects that maximize return to Advantage
Unitholders will continue to be selected for development.
Advantage Energy Income Fund - 7
OPERATING COSTS
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2007 2006 % CHANGE 2007 2006 % CHANGE
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Operating costs ($000) $39,330 $ 27,803 41% $127,309 $82,911 54%
per boe $ 12.46 $ 10.39 20% $ 11.64 $ 9.56 22%
Total operating costs increased 41% for the three months and 54% for the year
ended December 31, 2007 as compared to 2006, mainly due to increased production
from the Ketch acquisition which was completed June 23, 2006 and the Sound
acquisition, which closed on September 5, 2007. Operating costs per boe
increased 20% for the three months and 22% for the year ended December 31,
2007, mainly due to lower production levels related to third party turnaround
activity, an extended spring break-up, increased service and supply costs as
the industry experienced overall cost increases, and higher relative operating
costs from recent acquisitions. However, fourth quarter 2007 per boe operating
costs came in modestly lower than our expectation of $12.50 to $13.50, due to
optimization initiatives put in place by the Fund in 2007. We will continue to
be opportunistic and proactive in pursuing programs that will improve our
operating cost structure. Consistent with this strategy, the Fund entered
hedges for power costs, one of our more significant operating costs, of 3.0 MW
at $54.00/MWh for 2008. We expect that operating costs per boe will be in the
range of $12.50 to $13.30 for the 2008 year.
GENERAL AND ADMINISTRATIVE
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2007 2006 % CHANGE 2007 2006 % CHANGE
- --------------------------------------------------------------------------------------------------------------------------------
General and administrative expense ($000) $ 7,173 $ 4,586 56% $ 21,449 $ 13,738 56%
per boe $ 2.27 $ 1.71 33% $ 1.96 $ 1.58 24%
Employees at December 31 172 135 27%
General and administrative ("G&A") expense has increased 56% for the three
months and year ended December 31, 2007, as compared to 2006. G&A per boe
increased 33% for the three months and 24% for the year when compared to the
same periods of 2006. G&A expense for the year ended December 31, 2007 has
increased overall and per boe primarily due to an increase in staff levels that
have resulted from the Ketch and Sound acquisitions and general 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, including
unit-based compensation, which 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 a
Restricted Trust Unit Plan (the "Plan"), as approved by the Unitholders on June
23, 2006, and Trust Units issuable for the retention of certain employees of
the Fund. The purpose of the long-term compensation plans is to retain and
attract employees, to reward and encourage performance, and to focus employees
on operating and financial performance that results in lasting Unitholder
return.
The Plan authorizes the Board of Directors to grant Restricted Trust Units
("RTUs") to directors, officers, or employees of the Fund. The number of RTUs
granted is based on the Fund's Trust Unit return for a calendar year and
compared to a peer group approved by the Board of Directors. The Trust Unit
return is calculated at the end of the year and is primarily based on the
year-over-year change in the Trust Unit price plus distributions. The RTU
grants vest one third immediately on grant date, with the remaining two thirds
vesting evenly on the following two yearly anniversary dates. The holders of
RTUs may elect to receive cash upon vesting in lieu of the number of Trust
Units to be issued, subject to consent of the Fund. Compensation cost related
to the Plan is based on the "fair value" of the RTUs at the grant date and is
recognized as compensation expense over the service period. This valuation
incorporates the period end Trust Unit price, the estimated number of RTUs to
vest, and certain management estimates. The maximum fair value of RTUs granted
in any one calendar year is limited to 175% of the base salaries of those
individuals participating in the Plan for such period. As the Fund did not meet
the 2007 or 2006 grant thresholds, there were no RTU grants made during these
years and no related compensation expense has been recognized.
Advantage Energy Income Fund - 8
For the year ended December 31, 2007, the Fund has accrued unit-based
compensation expense of $0.9 million in general and administrative expense and
has capitalized $0.3 million related to Trust Units issuable for the retention
of certain employees of the Fund.
MANAGEMENT FEE, PERFORMANCE INCENTIVE, AND MANAGEMENT INTERNALIZATION
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2007 2006 % CHANGE 2007 2006 % CHANGE
- --------------------------------------------------------------------------------------------------------------------------------
Management fee ($000) $ - $ - - $ - $ 887 (100)%
per boe $ - $ - - $ - $ 0.10 (100)%
Performance incentive ($000) $ - $ - - $ - $ 2,380 (100)%
Management internalization ($000) $ 2,534 $ 5,497 (54)% $ 15,708 $13,449 17%
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. 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, thereby eliminating the management fee and performance incentive
effective April 1, 2006. The Trust Unit consideration issued in exchange for
the outstanding shares of the Manager 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 management internalization is lower for the quarter since one
third vested and was paid in June 2007 while two thirds remains outstanding.
INTEREST
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2007 2006 % CHANGE 2007 2006 % CHANGE
- --------------------------------------------------------------------------------------------------------------------------------
Interest expense ($000) $ 7,917 $ 5,414 46% $ 24,351 $ 18,258 33%
per boe $ 2.51 $ 2.02 24% $ 2.23 $ 2.11 6%
Average effective interest rate 6.2% 5.5% 0.7% 5.7% 5.1% 0.6%
Bank indebtedness at December 31 ($000) $547,426 $410,574 33%
Interest expense has increased 46% for the three months and 33% for the year
ended December 31, 2007, as compared to 2006. Interest expense per boe has
increased 24% for the three months and 6% for the year ended December 31, 2007.
The increase in total 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 increased bank indebtedness assumed on the
Ketch and Sound acquisitions. 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 only 5.7% for the year ended
December 31, 2007. 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
2007 2006 % CHANGE 2007 2006 % CHANGE
- --------------------------------------------------------------------------------------------------------------------------------
Interest on convertible debentures ($000) $ 4,426 $ 3,289 35% $ 14,867 $11,210 33%
per boe $ 1.40 $ 1.23 14% $ 1.36 $ 1.29 5%
Accretion on convertible debentures ($000) $ 721 $ 604 19% $ 2,569 $ 2,106 22%
per boe $ 0.23 $ 0.23 - $ 0.23 $ 0.24 (4)%
Convertible debentures maturity
value at December 31 ($000) $224,612 $180,730 24%
Interest on convertible debentures has increased 35% for the three months and
33% for the year ended December 31, 2007, as compared to 2006. Accretion on
convertible debentures has increased 19% for the three months and 22% for the
year ended December 31, 2007. The increases in total interest and accretion are
due to Advantage assuming Sound's 8.75% and 8.00% convertible debentures and
Ketch's 6.50% convertible debentures in the 2006 merger. The increased interest
and accretion from the additional debentures has been slightly offset due to
the exchange of convertible debentures to Trust Units during 2006 that pay
distributions rather than interest. Interest per boe for the quarter is higher
as our convertible debentures outstanding have slightly increased relative to
our level of production.
Advantage Energy Income Fund - 9
CASH NETBACKS
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2007 2006 2007 2006
- -------------------------------------------------------------------------------------------------------------------------------
$000 PER BOE $000 PER BOE $000 PER BOE $000 PER BOE
- -------------------------------------------------------------------------------------------------------------------------------
Revenue $ 160,741 $ 50.91 $ 122,360 $ 45.72 $ 538,764 $ 49.27 $ 414,430 $ 47.80
Realized gain on derivatives 5,210 1.65 5,179 1.93 18,594 1.70 5,297 0.61
Royalties, net of Alberta Royalty Credit (27,099) (8.58) (23,349) (8.72) (98,614) (9.02) (76,456) (8.82)
Operating costs (39,330) (12.46) (27,803) (10.39) (127,309) (11.64) (82,911) (9.56)
- -------------------------------------------------------------------------------------------------------------------------------
OPERATING $ 99,522 $ 31.52 $ 76,387 $ 28.54 $ 331,435 $ 30.31 $ 260,360 $ 30.03
General and administrative (1) (7,029) (2.23) (4,586) (1.71) (20,520) (1.88) (13,738) (1.58)
Management fee - - - - - - (887) (0.10)
Interest (7,917) (2.51) (5,414) (2.02) (24,351) (2.23) (18,258) (2.11)
Interest on convertible debentures (1) (3,536) (1.12) (3,289) (1.23) (13,977) (1.28) (11,210) (1.29)
Income and capital taxes (521) (0.16) (361) (0.13) (1,444) (0.13) (1,509) (0.17)
- -------------------------------------------------------------------------------------------------------------------------------
FUNDS FROM OPERATIONS $ 80,519 $ 25.50 $ 62,737 $ 23.45 $ 271,143 $ 24.79 $ 214,758 $ 24.78
- -------------------------------------------------------------------------------------------------------------------------------
(1) General and administrative expense and interest on convertible debentures
exclude unit-based compensation and non-cash interest expense.
Funds from operations of Advantage for the quarter ended December 31, 2007
increased to $80.5 million from $62.7 million in the prior year. Funds from
operations for the year ended December 31, 2007 increased to $271.1 million
from $214.8 million compared to 2006. The cash netback per boe for the three
months ended December 31, 2007 increased 9% from $23.45 to $25.50 for the
quarter, but remained comparable for the year ended December 31, 2007. The
higher cash netback per boe for the three months ended December 31, 2007 is
primarily due to higher revenues, resulting from additional production from the
accretive Sound acquisition and strong oil prices offset somewhat by lower
natural gas prices as well as higher operating and general and administrative
costs. Operating costs have steadily increased over the past year due to
significantly higher field costs associated with supplies and services that
have resulted from the high level of industry activity, an overall industry
labour cost increase, and higher relative operating costs from recent
acquisitions. However, it is noteworthy that due to several of our initiatives
this year, operating costs for the quarter were less than anticipated. The
increased general and administrative costs are due to higher staff levels and
general growth of the Fund. When compared to the third quarter of 2007, funds
from operations per boe increased 10%, again mainly due to the acquisition of
Sound.
DEPLETION, DEPRECIATION AND ACCRETION
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
2007 2006 % CHANGE 2007 2006 % CHANGE
- --------------------------------------------------------------------------------------------------------------------------------
Depletion, depreciation & accretion ($000) $78,149 $ 63,521 23% $272,175 $194,309 40%
per boe $ 24.75 $ 23.73 4% $ 24.89 $ 22.41 11%
Depletion and depreciation of fixed assets is provided on the
"unit-of-production" method based on total proved reserves. Accretion
represents the increase in the asset retirement obligation liability each
reporting period due to the passage of time. The depletion, depreciation and
accretion ("DD&A") provision has increased 23% for the three months and 40% for
the year ended December 31, 2007. The higher DD&A is due to considerable
increases in daily production volumes, mainly from the Ketch and Sound
acquisitions and the increase in the DD&A rate per boe compared to the prior
year. The increased DD&A rate per boe was due to a higher valuation assigned
for reserves from recent acquisitions than accumulated from prior acquisitions
and development activities. We evaluate the recoverability of our petroleum and
natural gas assets each reporting period to ensure the carrying amount does not
Advantage Energy Income Fund - 10
exceed the fair value. When the carrying amount is not assessed to be
recoverable, an impairment loss is recognized. There has been no impairment of
the Fund's petroleum and natural gas properties under Canadian GAAP since
inception.
TAXES
Current taxes paid or payable for the quarter ended December 31, 2007 amounted
to $0.5 million, comparable to the $0.4 million expensed for the same period of
2006. The higher current taxes are due to the increased Saskatchewan properties
and activity within these properties from the Ketch and Sound acquisitions.
Current taxes primarily represent Saskatchewan resource surcharge, which is
based on the petroleum and natural gas revenues within the province of
Saskatchewan.
Future income taxes arise from differences between the accounting and tax bases
of the assets and liabilities. For the year ended December 31, 2007, the Fund
recognized a future income tax reduction of $24.6 million compared to $37.1
million for 2006. Under the Fund's current structure, payments are made between
the operating company and the Fund transferring income tax obligations to
Unitholders and as a result no cash income taxes would be paid by the operating
company or the Fund prior to 2011. However, the Specified Investment
Flow-Through Entity ("SIFT") tax legislation was enacted on June 22, 2007
altering the tax treatment by subjecting income trusts to a two-tier tax
structure, similar to that of corporations, whereby the taxable portion of
distributions paid by trusts will be subject to tax at the trust level and at
the Unitholder level. The rules are effective for tax years beginning in 2011
for existing publicly-traded trusts. The impact of the new tax law is reflected
in 2007 and resulted in an additional future income tax expense of $42.9
million. As at December 31, 2007, we had a future income tax liability balance
of $66.7 million, compared to $61.9 million at December 31, 2006. 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. It further requires that a future tax liability be recorded on an
acquisition when a corporation acquires assets with associated tax pools that
are less than the purchase price. As a result of the Sound acquisition,
Advantage recorded a future tax liability of $29.4 million.
On December 14, 2007, the Federal government enacted legislation phasing in
corporate income tax rate reductions which will reduce federal tax rates from
22.1% to 15.0% by 2012. Rate reductions will also apply to the new tax on
distributions of income trusts and other specified investment flow-through
entities as of 2011, reducing the tax rate in 2011 to 29.5% and in 2012 to
28.0%. These rates include a deemed provincial rate of 13%.
The Fund has approximately $1.7 billion in tax pools and deductions at December
31, 2007, which can be used to reduce the amount of taxes paid by Advantage.
The Fund and Advantage Oil & Gas Ltd. ("AOG") had the following estimated tax
pools in place at December 31, 2007:
DECEMBER 31, 2007
ESTIMATED TAX POOLS
($ MILLIONS)
------------
Undepreciated Capital Cost $ 641
Canadian Oil and Gas Property Expenses 462
Canadian Development Expenses 435
Canadian Exploration Expenses 65
Non-capital losses 76
Other 25
--------
$ 1,704
Advantage Energy Income Fund - 11
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 2008 2009 2010 2011 2012
- -------------------------------------------------------------------------------------------------------------------------------
Building leases $ 16.6 $ 5.3 $ 4.1 $ 4.1 $ 1.8 $ 1.3
Capital leases 8.1 1.9 2.1 2.2 1.9 -
Pipeline/transportation 6.0 4.4 1.3 0.3 - -
Convertible debentures (1) 224.6 5.4 87.0 69.9 62.3 -
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL CONTRACTUAL OBLIGATIONS $ 255.3 $ 17.0 $ 94.5 $ 76.5 $ 66.0 $ 1.3
- -------------------------------------------------------------------------------------------------------------------------------
(1) As at December 31, 2007, Advantage had $224.6 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 either directly or indirectly through the issuance of Trust
Units.
(2) Bank indebtedness of $547.4 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, 2007
- --------------------------------------------------------------------------------
Bank indebtedness (long-term) $ 547,426
Working capital deficit (1) 28,087
- --------------------------------------------------------------------------------
Net debt $ 575,513
- --------------------------------------------------------------------------------
Trust Units outstanding (000) 138,269
Trust Unit closing market price ($/Trust Unit) $ 8.73
- --------------------------------------------------------------------------------
Market value $ 1,207,088
- --------------------------------------------------------------------------------
Capital lease obligations (long-term) $ 5,653
Convertible debentures maturity value (long-term) 219,220
- --------------------------------------------------------------------------------
TOTAL CAPITALIZATION $ 2,007,474
- --------------------------------------------------------------------------------
(1) Working capital deficit includes accounts receivable, prepaid expenses and
deposits, accounts payable and accrued liabilities, distributions payable,
and the current portion of capital lease obligations and convertible
debentures.
UNITHOLDERS' EQUITY AND CONVERTIBLE DEBENTURES
Advantage has utilized a combination of Trust Units, convertible debentures and
bank debt to finance acquisitions and development activities.
As at December 31, 2007, the Fund had 138.3 million Trust Units outstanding. 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 $104.1
million (net of Underwriters' fees and other issue costs of $6.0 million). The
net proceeds of the offering were used to pay down bank indebtedness and to
subsequently fund capital and general corporate expenditures. On September 5,
2007, Advantage issued 16,977,184 Trust Units as partial consideration for the
acquisition of Sound. As at March 5, 2008, Advantage had 139.0 million Trust
Units issued and outstanding.
On July 24, 2006, Advantage adopted a Premium Distribution(TM), Distribution
Reinvestment and Optional Trust Unit Purchase Plan (the "Plan"). For
Unitholders that elect to participate in the Plan, Advantage will settle the
monthly distribution obligation through
Advantage Energy Income Fund - 12
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, 2007, 4,028,252
Trust Units were issued as a result of the Plan, generating $46.7 million
reinvested in the Fund and representing an approximate 18% participation rate.
As at December 31, 2007, the Fund had $224.6 million convertible debentures
outstanding that were convertible to 9.8 million Trust Units based on the
applicable conversion prices. During the year ended December 31, 2007, $24,000
debentures were converted resulting in the issuance of 1,386 Trust Units and
all of the remaining $1,470,000 10% convertible debentures matured on November
1, 2007 and were settled with the issuance of 127,493 Trust Units.
Due to the acquisition of Sound, $59,513,000 8.75% and $41,035,000 8.00%
convertible debentures were assumed by Advantage on September 5, 2007. As a
result of the change in control of Sound, the Fund was required by the
debenture indentures to make an offer to purchase all of the outstanding
convertible debentures assumed from Sound as at a price equal to 101% of the
principal amount plus accrued and unpaid interest. On October 17, 2007, the
expiry date of the offer, 911,709 Trust Units were issued and $19.9 million in
total cash consideration was paid in exchange for $29,665,000 8.75% convertible
debentures and 2,220,289 Trust Units were issued in exchange for $25,507,000
8.00% convertible debentures. As at March 5, 2008, the convertible debentures
have not changed from December 31, 2007.
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, 37,500 Series B Trust Unit Rights were exercised in the second quarter
of 2007. As at March 5, 2008, 150,000 Series B Trust Unit Rights remain
outstanding.
As a result of the new SIFT tax legislation, 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 from October 31, 2006 to January 1, 2011,
which we believe is adequate for any growth we expect to incur.
BANK INDEBTEDNESS, CREDIT FACILITY AND OTHER OBLIGATIONS
At December 31, 2007, Advantage had bank indebtedness outstanding of $547.4
million. The Fund has a $710 million credit facility agreement consisting of a
$690 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, 2007, Advantage had a working capital deficiency of $28.1
million. Our working capital includes items expected for normal operations such
as trade receivables, prepaids, deposits, trade payables and accruals as well
as the current portion of capital lease obligations and convertible debentures.
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.
In the second quarter of 2007, Advantage entered a new lease arrangement that
resulted in the recognition of a fixed asset addition and capital lease
obligation of $4.1 million. The lease obligation bears interest at 5.8% and is
secured by the related equipment. The lease term expires June 2011 with a final
purchase obligation of $1.5 million at which time ownership of the equipment
will transfer to Advantage. We entered a second lease arrangement during the
third quarter of 2007 that resulted in the recognition of a fixed asset
addition and capital lease obligation of $1.8 million. This lease obligation
bears interest at 6.7% and is also secured by the related equipment. The lease
term expires August 2010 with a final payment obligation of $0.7 million.
Distributions to Unitholders are not permitted if the Fund is in default of
this capital lease.
Advantage Energy Income Fund - 13
On September 5, 2007, Advantage assumed two capital lease obligations in the
acquisition of Sound resulting in the recognition of capital lease obligations
of $1.6 million. Both of the assumed lease obligations bear interest at 5.6%
and are secured by the related equipment. The lease terms expire December 2009
and April 2010 with a total final payment obligation of $0.9 million.
CAPITAL EXPENDITURES
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31 DECEMBER 31
($000) 2007 2006 2007 2006
- --------------------------------------------------------------------------------------------------------------
Land and seismic $ 64 $ 522 $ 3,270 $ 5,261
Drilling, completions and workovers 30,020 42,612 94,786 113,146
Well equipping and facilities 9,971 17,690 48,296 39,437
Other 878 285 2,373 1,643
- --------------------------------------------------------------------------------------------------------------
$ 40,933 $ 61,109 $ 148,725 $159,487
Acquisition of Sound Energy Trust (67) - 22,307 -
Property acquisitions 3,200 46 16,051 244
Property dispositions (610) - (1,037) (8,727)
- --------------------------------------------------------------------------------------------------------------
TOTAL CAPITAL EXPENDITURES $ 43,456 $ 61,155 $ 186,046 $151,004
- --------------------------------------------------------------------------------------------------------------
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 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 and Sound 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 a
high level of flexibility to distribute its capital program and ensure a
risk-balanced platform of projects. 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, 2007, the Fund spent a net $40.9
million and drilled a total of 16.6 net (32 gross) wells at a 100% success
rate. Total capital spending in the quarter included $7.1 million at Nevis,
$5.7 million at Chip Lake, $5.3 million at Martin Creek, $3.9 million at
Southeast Saskatchewan and $3.4 million at Willesden Green. For the year ended
December 31, 2007, the Fund spent a net $148.7 million and drilled a total of
64.8 net (112 gross) wells at a 99% success rate. Total capital spending for
the year included $33.6 million at Martin Creek, $26.2 million at Nevis, $17.5
million at Willesden Green, $10.5 million in Southeast Saskatchewan, $8.5
million at Chip Lake, and $7.2 million at Sunset.
Property acquisitions year to date include a $12.9 million property acquisition
in the first quarter for producing properties and undeveloped land at the
Fund's core area, Nevis, and a $3.2 million property acquisition in the
Boundary Lake area during the fourth quarter. Costs of $22.3 million were
incurred related to the Sound acquisition representing the cash portion paid
due to the exercise of the cash option offered to Sound Unitholders and other
costs.
Advantage Energy Income Fund - 14
The following table summarizes the various funding requirements during the
years ended December 31, 2007 and 2006 and the sources of funding to meet those
requirements.
SOURCES AND USES OF FUNDS
YEAR ENDED
DECEMBER 31
($000) 2007 2006
- --------------------------------------------------------------------------------
SOURCES OF FUNDS
Funds from operations $ 271,143 $ 214,758
Units issued, net of costs 104,215 141,908
Increase in bank indebtedness 28,893 -
Property dispositions 1,037 8,727
Decrease in working capital - 27,222
- --------------------------------------------------------------------------------
$ 405,288 $ 392,615
- --------------------------------------------------------------------------------
USES OF FUNDS
Distributions to Unitholders $ 170,915 $ 185,015
Expenditures on property and equipment 148,725 159,487
Acquisition of Sound Energy Trust 22,307 -
Debentures redeemed 19,406 -
Increase in working capital 17,749 -
Property acquisitions 16,051 244
Expenditures on asset retirement 6,951 5,974
Reduction of capital lease obligations 3,184 1,019
Decrease in bank indebtedness - 30,767
Acquisition of Ketch Resources Trust - 10,109
- --------------------------------------------------------------------------------
$ 405,288 $ 392,615
- --------------------------------------------------------------------------------
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, 2007 DEC. 31, 2006 DEC. 31, 2005
- ------------------------------------------------------------------------------------------------------------
Total revenue (before royalties) ($000) $ 557,358 $ 419,727 $ 376,572
Net income (loss) ($000) $ (7,535) $ 49,814 $ 75,072
per Trust Unit - Basic $ (0.06) $ 0.62 $ 1.33
- Diluted $ (0.06) $ 0.61 $ 1.32
Total assets ($000) $ 2,422,280 $ 1,981,587 $1,012,847
Long term financial liabilities ($000) ((1)) $ 768,060 $ 581,698 $ 379,903
Distributions declared per Trust Unit $ 1.77 $ 2.66 $ 3.12
(1) Long term financial liabilities exclude asset retirement obligations and
future income taxes.
Advantage Energy Income Fund - 15
QUARTERLY PERFORMANCE
2007 2006
($000, EXCEPT AS OTHERWISE INDICATED) Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1
- ----------------------------------------------------------------------------------- -----------------------------------------
Daily production
Natural gas (mcf/d) 128,556 115,991 108,978 114,324 117,134 122,227 70,293 65,768
Crude oil and NGLs (bbls/d) 12,895 10,014 8,952 9,958 9,570 9,330 6,593 6,760
Total (boe/d) 34,321 29,346 27,115 29,012 29,092 29,701 18,309 17,721
Average prices
Natural gas ($/mcf)
Excluding hedging $ 6.23 $ 5.62 $ 7.54 $ 7.61 $ 6.90 $ 5.89 $ 6.18 $ 8.69
Including hedging $ 6.97 $ 6.35 $ 7.52 $ 8.06 $ 7.27 $ 5.90 $ 6.18 $ 8.69
AECO monthly index $ 6.00 $ 5.62 $ 7.37 $ 7.46 $ 6.36 $ 6.03 $ 6.28 $ 9.31
Crude oil and NGLs ($/bbl)
Excluding hedging $ 73.40 $ 69.03 $ 61.84 $ 56.84 $ 54.58 $ 67.77 $ 68.69 $ 58.26
Including hedging $ 70.40 $ 68.51 $ 61.93 $ 58.64 $ 55.86 $ 67.77 $ 68.69 $ 58.26
WTI (US$/bbl) $ 90.63 $ 75.33 $ 65.02 $ 58.12 $ 60.21 $ 70.55 $ 70.75 $ 63.88
Total revenues (before royalties) $ 165,951 $130,830 $125,075 $135,502 $127,539 $124,521 $ 80,766 $ 86,901
Net income (loss) $ 13,795 $(26,202) $ 4,531 $ 341 $ 8,736 $ 1,209 $ 23,905 $ 15,964
per Trust Unit - basic $ 0.10 $ (0.22) $ 0.04 $ 0.00 $ 0.08 $ 0.01 $ 0.38 $ 0.27
- diluted $ 0.10 $ (0.22) $ 0.04 $ 0.00 $ 0.08 $ 0.01 $ 0.38 $ 0.27
Funds from operations $ 80,519 $ 62,345 $ 62,634 $ 65,645 $ 62,737 $ 63,110 $ 42,281 $ 46,630
Distributions declared $ 57,875 $ 55,017 $ 52,096 $ 50,206 $ 58,791 $ 60,498 $ 53,498 $ 44,459
The table above highlights the Fund's performance for the fourth quarter of
2007 and also for the preceding seven quarters. Production significantly
increased in the third quarter of 2006 as the Ketch acquisition that closed on
June 23, 2006 was fully integrated with Advantage. The second quarter of 2007
encountered a temporary production decrease as expected due to several facility
turnarounds that had been planned for that period. The third quarter of 2007
includes the financial and operating results from the acquired Sound properties
for 26 days, and fourth quarter of 2007 includes the full integration of the
Sound properties. Advantage's revenues and funds from operations increased
significantly beginning in the third quarter of 2006 primarily due to the
production from the merger with Ketch and surged again in the fourth quarter of
2007 due to the Sound acquisition, partially offset by lower natural gas
prices. Net income was lower in the first three quarters of 2007 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 and Sound mergers. Net income increased in the fourth quarter
of 2007 due to the full integration of the Sound acquisition and stronger crude
oil prices.
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 fixed assets, the provision for asset retirement costs and
related accretion expense, and impairment calculations for fixed assets and
goodwill. The reserve estimates are also used 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.
Management's process of determining the provision for future income taxes, the
provision for asset retirement obligation costs and related accretion expense,
and the fair values assigned to any acquired company's assets and liabilities
in a business combination is based on estimates. These estimates are
significant and can include reserves, future production rates, future crude oil
and natural gas
Advantage Energy Income Fund - 16
prices, future costs, future interest rates, future tax rates and other
relevant assumptions. Revisions or changes in any of these estimates can have
either a positive or a negative impact on asset and liability values and net
income.
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 released
a detailed implementation plan in May 2007 and the Fund will consider the
effects that this implementation plan might have on the consolidated financial
statements during the transition period.
CAPITAL DISCLOSURES
The CICA has issued section 1535 "Capital Disclosures", which will be effective
January 1, 2008 for the Fund. Section 1535 will require the Fund to provide
additional disclosures relating to capital and how it is managed. It is not
anticipated that the adoption of section 1535 will impact the amounts reported
in the Fund's financial statements as they primarily relate to disclosure.
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
operations, 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. During 2007, there were no significant changes
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.
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, 2007. 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
Advantage Energy Income Fund - 17
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 and Audit Committee each have three
members, all of whom are independent. The Human Resources, Compensation and
Corporate Governance Committee has 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 committee; 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's 2008 Budget, as approved by the Board of Directors, retains a high
degree of activity and focus on drilling in many of our key properties where a
high level of success was realized through 2007. Capital has also been directed
to delineate a natural gas resource play at Glacier in Northwest Alberta and to
accommodate facility expansions and 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 throughout 2007. 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 fourth quarter of 2007, production was on-track and operating costs
were lower than expected. We realized some impact to our production due to
third party related facilities outages in December, however, continued efforts
in operating cost optimization is providing efficiency gains. For 2008, we are
forecasting production to be in the range of 32,000 to 34,000 boe/d.
Advantage's 2008 capital expenditures budget is estimated to be approximately
$125 to $145 million with approximately 143 gross (88 net) wells. An active
winter program at Martin Creek, Glacier, Nevis and Willesden Green will be
followed by a relatively even paced program in Q3 and Q4 of 2008. Capital
spending is estimated to be split evenly between oil and gas activities.
Per unit operating costs on an annual basis are expected to range between the
$12.50 to $13.30/boe range. Advantage is continuing with several operating cost
reduction initiatives throughout 2008 to help offset these increases and we
have begun to realize some key achievements in this area. We expect industry
servicing and maintenance costs to generally remain stable in 2008 with some
potential for natural gas related costs to increase during the latter part of
2008 if natural gas prices strengthen at that time.
On October 25, 2007, the Alberta Provincial Government announced changes to
royalties for conventional oil, natural gas and oil sands that will become
effective January 1, 2009. Preliminary indications are that the changes will
have a negligible impact on Advantage since we have a significant number of
lower rate wells within our long life properties producing in Alberta.
Advantage also has a significant Horseshoe Canyon coal bed methane drilling
inventory that can be pursued which will also have a favorable royalty
treatment due to lower rate per well characteristics. Our exposure in Northeast
British Columbia and Saskatchewan also affords us further flexibility with
mitigating the royalty impact in our capital program. We expect our royalty
rates to range from 17% to 19% in 2008.
Advantage Energy Income Fund - 18
Advantage's funds from operations in 2008 will continue to be impacted by the
volatility of crude oil and natural gas prices and the $US/$Canadian exchange
rate. Additional hedging has been completed for 2008 to i) stabilize cash flows
and ii) ensure that the Fund's capital program is substantially funded out of
cash flow. Approximately 51% of our natural gas production, net of royalties,
is now hedged for the 2008 calendar year at a floor of $7.43/mcf. Advantage has
also hedged 38% of its 2008 crude oil production, net of royalties, at an
average price of $94.07/bbl.
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 and Sound mergers.
Looking forward, Advantage's high quality assets combined with a greater than
five 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.
SENSITIVITIES
The following table displays the current estimated sensitivity on funds from
operations and funds from operations per Trust Unit to changes in production,
commodity prices, exchange rates and interest rates for 2008.
ANNUAL
ANNUAL FUNDS FROM OPERATIONS
FUNDS FROM OPERATIONS PER TRUST UNIT
($000) ($/TRUST UNIT)
- -------------------------------------------------------------------------------------------------------
Natural gas
AECO monthly price change of $1.00/mcf $ 17,800 $ 0.12
Production change of 6.0 mmcf/d $ 7,200 $ 0.05
Crude oil and NGLs
WTI price change of US$10.00/bbl $ 27,900 $ 0.20
Production change of 1,000 bbls/d $ 22,200 $ 0.16
$US/$Canadian exchange rate change of $0.01 $ 5,900 $ 0.04
Interest rate change of 1% $ 5,600 $ 0.04
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