Zargon Energy Trust Announces 2009 Third Quarter Results
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CALGARY, ALBERTA--(Marketwire - Nov. 11, 2009) - Zargon Energy Trust (TSX: ZAR.UN) (TSX: ZOG.B)
FINANCIAL & OPERATING HIGHLIGHTS
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------------------------------------------------
Percent Percent
(unaudited) 2009 2008 Change 2009 2008 Change
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Financial
Income and Investments
($ millions)
Petroleum and natural gas
revenue 40.96 66.35 (38) 108.77 188.25 (42)
Funds flow from operating
activities 22.84 29.75 (23) 61.61 86.51 (29)
Cash flows from operating
activities 23.30 33.58 (31) 60.97 85.29 (29)
Cash distributions 12.22 9.87 24 33.51 29.13 15
Net earnings 4.47 40.05 (89) 2.28 40.09 (94)
Net capital expenditures 29.32 17.47 68 91.72 103.36 (11)
Per Unit, Diluted
Funds flow from operating
activities ($/unit) 0.90 1.42 (37) 2.67 4.21 (37)
Cash flows from operating
activities ($/unit) 0.92 1.60 (43) 2.64 4.15 (36)
Net earnings ($/unit) 0.20 2.20 (91) 0.11 2.24 (95)
Cash Distributions ($/trust
unit) 0.54 0.54 - 1.62 1.62 -
Balance Sheet at Period End
($ millions)
Property and equipment, net 431.72 385.37 12
Bank debt 77.05 74.95 3
Unitholders' equity 258.05 203.00 27
Total Units Outstanding at
Period End (millions) 25.93 21.05 23
Operating
Average Daily Production
Oil and liquids (bbl/d) 5,382 4,367 23 4,911 4,263 15
Natural gas (mmcf/d) 28.23 29.84 (5) 28.20 29.61 (5)
Equivalent (boe/d) 10,088 9,340 8 9,610 9,198 4
Equivalent per million trust
units (boe/d) 398 445 (11) 413 446 (7)
Average Selling Price (before
the impact of financial risk
management contracts)
Oil and liquids ($/bbl) 64.72 109.34 (41) 56.51 102.15 (45)
Natural gas ($/mcf) 3.43 8.17 (58) 4.29 8.50 (50)
Wells Drilled, Net 10.3 7.7 34 20.7 22.0 (6)
Undeveloped Land at Period End
(thousand net acres) 594 464 28
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Notes:
Throughout this report, the calculation of barrels of oil equivalent ("boe")
is based on the conversion ratio that six thousand cubic feet of natural gas
is equivalent to one barrel of oil. For a further discussion about this
term, refer to the Management's Discussion and Analysis section in this
report.
For net capital expenditures, amounts include capital expenditures acquired
for cash, equity issuances, acquisition costs and net debt assumed on
corporate acquisitions.
Funds flow from operating activities is a non-GAAP term that represents net
earnings/losses and asset retirement expenditures except for non-cash items.
For a further discussion about this term, refer to the Management's
Discussion and Analysis section in this report.
Total units outstanding include trust units plus exchangeable shares
outstanding at period end. The exchangeable shares are converted at the
exchange ratio at the end of the period.
Average daily production per million trust units is calculated using the
weighted average number of units outstanding during the period plus the
weighted average number of exchangeable shares outstanding for the period
converted at the average exchange ratio for the period.
FINANCIAL & OPERATING HIGHLIGHTS
Zargon Energy Trust is pleased to report its financial results for the third quarter of 2009. Highlights from the three and nine months ended September 30, 2009, are noted below:
- Funds flow from operating activities was $22.84 million ($0.90 per diluted trust unit) in the 2009 third quarter compared to $20.92 million ($0.91 per diluted trust unit) in the 2009 second quarter and $29.75 million ($1.42 per diluted trust unit) in the 2008 third quarter.
- Third quarter 2009 production averaged 10,088 barrels of oil equivalent per day, six percent above the preceding quarter and eight percent above the corresponding quarter of 2008. Higher third quarter production volumes were primarily due to a full quarter of additional volumes provided by the acquisition of Masters Energy Inc. ("Masters") and flush production volumes from this summer's Williston Basin horizontal drilling program. For the 2009 third quarter, Zargon's production averaged 398 barrels of oil equivalent per day per million trust units outstanding compared to 413 barrels of oil equivalent per day per million trust units outstanding for the prior quarter and 445 barrels of oil equivalent per day per million trust units outstanding in the corresponding quarter of 2008.
- The Trust declared three monthly cash distributions of $0.18 per trust unit in the 2009 third quarter for a total of $12.22 million. These cash distributions were equivalent to a payout ratio of 60 percent of the Trust's third quarter funds flow from operating activities on a diluted trust unit basis and, after considering the effect of the exchangeable shares not receiving distributions, the distributions amounted to 53 percent of funds flow from operating activities.
- Reflecting a now expanded 2009 field related capital program of $48 million, the Trust's third quarter exploration and development capital expenditures (excluding corporate and property acquisitions and dispositions) increased 49 percent from the prior quarter to $12.75 million primarily as a result of increased drilling, completions and equipping of wells. For the first nine months of 2009, Zargon spent $34.09 million on field related capital expenditures and drilled a total of 20.7 net wells.
- On September 23, 2009, Zargon closed the acquisition of Churchill Energy Inc. ("Churchill") for a total consideration of approximately 0.555 million Zargon trust units, $0.11 million in cash and the assumption of approximately $6.85 million of net debt (including adjustments and transactions costs) for a total transaction value of approximately $16.31 million.
- Debt net of working capital (excluding unrealized risk management assets/liabilities and future income taxes) increased 12 percent from the prior quarter to $87.14 million at September 30, 2009, which represents approximately 48 percent of the Trust's available credit facilities at September 30, 2009. The Trust's balance sheet remains strong with a debt net of working capital to annualized funds flow from operating activities ratio of 1.06 times.
Production (1)
Oil and liquids production averaged 5,382 barrels per day in the 2009 third quarter, a 13 percent increase from the preceding quarter and a 23 percent increase from the corresponding 2008 quarter. The increase in production volumes was primarily due to a full quarter's contribution from the Masters corporate acquisition that was closed on April 29, 2009, as well as the completion and tie-in of five horizontal oil exploitation wells drilled over the summer primarily in the Williston Basin. In particular, the drilling results from our horizontal drilling program exploiting Frobisher ridges at Steelman, Saskatchewan have been particularly strong (with initial flush rates of more than 100 barrels of oil per day per well) and should provide further oil production gains during the balance of 2009.
Natural gas production volumes in the 2009 third quarter averaged 28.23 million cubic feet per day, a one percent decrease from the previous quarter and a five percent decrease from the corresponding period of 2008. The 2009 third quarter natural gas production decreased primarily due to natural declines and the shut-in of selected high cost natural gas properties during a period of exceptionally low natural gas prices. For the remainder of the year, we anticipate that the Trust's natural gas production volumes will remain relatively flat as natural declines are offset by production volumes from the Churchill acquisition and from recent tie-ins at the Kakut property in the Peace River Arch region of our West Central Alberta core area.
Over the last two years, Zargon has made a concerted effort to increase its oil volumes through a series of oil-weighted corporate acquisitions and related oil exploitation projects. Specifically, in the two year period since the 2007 third quarter, Zargon has successfully grown its oil volumes by 50 percent and has increased its oil production weighting from 42 percent to 53 percent.
Capital Expenditures (1)
Zargon's third quarter field capital program totalled $12.75 million, a 22 percent decrease from the 2008 third quarter field capital expenditures and a 49 percent increase from the prior quarter. During the quarter, Zargon drilled 12 gross wells (10.3 net) that resulted in 6.0 net oil wells and 4.3 net gas wells for a 100 percent success ratio. This oil exploitation focused drilling program included one Taber horizontal well in the Alberta Plains and three Steelman horizontal wells along with one horizontal well at Elswick in the Williston Basin. Also, during the quarter, Zargon drilled three Jarrow natural gas wells in the Alberta Plains, one step-out natural gas well at Kakut in the Peace River Arch area and one Pembina natural gas exploration well in West Central Alberta.
For the remainder of 2009, Zargon is planning on drilling three oil exploitation horizontal wells with two additional Frobisher ridge targets at Steelman in the Williston Basin and one Sunburst target at Taber in the Alberta Plains. Natural gas drilling will be limited to one Alberta Plains Jarrow natural gas development well.
Throughout 2009, Zargon has successfully redirected its business to emphasize the exploitation of oil-in-place or gas-in-place resources as enabled by periodic accretive acquisitions and focused reservoir management. Specifically, we have made good progress with our oil exploitation initiatives in the Williston Basin and Taber, Alberta properties along with last year's corporate acquisitions of Rival Energy Ltd. and Newpact Energy Corp. and this year's corporate acquisitions of Masters and Churchill. Furthermore, we continue to advance our detailed technical review of our Little Bow Alkaline Surfactant Polymer ("ASP") tertiary oil recovery initiative and look forward to making our final decision regarding project implementation for this Southern Alberta opportunity by the end of the first quarter of 2010.
In the third quarter of 2009, the purchase of 21 thousand net acres of Crown lands at an average price of $39 per acre and the addition of approximately 60 thousand net acres from the Churchill acquisition, allowed Zargon to increase its quarter end undeveloped land inventory to 594 thousand net acres, up 61 thousand net acres from the balance reported at the end of the 2009 second quarter. For the remainder of the year, Zargon will continue to be an active participant at Alberta Crown land sales during this period of low Crown land sale costs.
Zargon continues to take advantage of the industry's current lower property and corporate acquisition costs with the announcement and closing of the Masters and Churchill acquisitions. During this period of opportunity, Zargon will continue to use its strong balance sheet and solid cash flows augmented by substantial hedge gains to pursue additional property and corporate acquisitions.
Guidance (1)
In the August 12, 2009 press release announcing the 2009 second quarter results, Zargon provided updated production guidance of 9,800 barrels of oil equivalent per day for the remainder of 2009 (not including volumes from the pending acquisition of Churchill). This previous guidance had been premised on a 2009 capital budget of $37 million. Due to the combination of improved field and service costs, strong oil production netbacks and promising oil exploitation drilling results, Zargon elected to expand its Williston Basin and Taber horizontal drilling programs in addition to proceeding with an enhanced facility upgrade and modification program, thereby taking the 2009 field capital budget to $48 million. Supported by flush production volumes coming from our Steelman Frobisher ridge initiative, Zargon's third quarter production exceeded guidance by three percent and averaged 10,088 barrels of oil equivalent per day. With the addition of the late September Churchill acquisition, production volumes for the fourth quarter of this year are now anticipated to average (with approximately 400 barrels of oil equivalent per day of flush production) in excess of 10,400 barrels of oil equivalent per day.
For 2010, Zargon is providing preliminary guidance of 10,400 barrels of oil equivalent per day, which is based on a 2010 field capital program of $58 million that includes the drilling of 44 net wells. This field capital budget continues to emphasize oil exploitation projects in the Williston Basin and the Alberta Plains (South) as well as natural gas directed exploitation drilling in the West Central Alberta and Alberta Plains (North), which will be designed to take advantage of the improved economics provided by the Alberta Crown drilling incentives. On a preliminary basis, the field capital program will be allocated $26 million to the Williston Basin, $11 million to the West Central Alberta and $21 million to the Alberta Plains core areas. Finally, this budget and related guidance level does not include the potential ASP tertiary recovery project initiation expenditures, that may be authorized at the end of the 2010 first quarter, nor does it include any allowance for additional corporate or property acquisitions.
Zargon continues to be well positioned with a strong balance sheet, positive production growth momentum and an inventory of promising opportunities that has recently been augmented by corporate acquisitions. We are pleased that our historical conservative hedging, debt and distribution policies have enabled our organization to maintain the current monthly $0.18 per unit distribution for 48 consecutive months. To date, during this commodity price downturn, we have been able to maintain distributions primarily due to our substantial positive hedges and the strength of the forward commodity price strip, which indicates improved pre-hedge cash flows in 2010. Going forward we will continue to carefully balance our projected cash flows with the competing uses for our cash resources, while remaining committed to a 50 percent cash flow distributing model before the trust sunset date. Post December 2010, we remain committed to a partial distribution model that will evolve into a corporate structure that targets a stable dividend representing approximately 35 percent of cash flow in addition to providing our equity holders a modest level of per unit growth.
(1) Please see comments on "Forward-Looking Statements" in the Management's Discussion and Analysis section in this report.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Management's discussion and analysis ("MD&A") is a review of Zargon Energy Trust's 2009 third quarter financial results and should be read in conjunction with the unaudited interim consolidated financial statements for the three and nine months ended September 30, 2009 and the audited consolidated financial statements and related notes for the year ended December 31, 2008. The consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles ("GAAP"). All amounts are in Canadian dollars unless otherwise noted. All references to "Zargon" or the "Trust" refer to Zargon Energy Trust and all references to the "Company" refer to Zargon Oil & Gas Ltd.
In the MD&A, reserves and production are commonly stated in barrels of oil equivalent ("boe") on the basis that six thousand cubic feet of natural gas is equivalent to one barrel of oil. Boes may be misleading, particularly if used in isolation. A boe conversion ratio of six thousand cubic feet of natural gas to one barrel of oil is based on an energy equivalent conversion method primarily applicable to the burner tip and does not represent a value equivalent at the wellhead.
The following are descriptions of non-GAAP measures used in this MD&A:
- The MD&A contains the term "funds flow from operating activities" ("funds flow"), which should not be considered an alternative to, or more meaningful than, "cash flows from operating activities" as determined in accordance with Canadian GAAP as an indicator of the Trust's financial performance. This term does not have any standardized meaning as prescribed by GAAP and, therefore, the Trust's determination of funds flow from operating activities may not be comparable to that reported by other trusts. The reconciliation between cash flows from operating activities and funds flow from operating activities can be found in the table below and in the consolidated statements of cash flows in the consolidated financial statements. The Trust evaluates its performance based on net earnings and funds flow from operating activities. The Trust considers funds flow from operating activities to be a key measure as it demonstrates the Trust's ability to generate the cash necessary to pay distributions, repay debt and to fund future capital investment. It is also used by research analysts to value and compare oil and gas trusts, and it is frequently included in published research when providing investment recommendations. Funds flow from operating activities per unit is calculated using the diluted weighted average number of units for the period.
Funds Flow from Operating Activities Reconciliation
Three Months Ended Nine Months Ended
September 30, September 30,
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($ millions) 2009 2008 2009 2008
----------------------------------------------------------------------------
Cash flows from operating activities 23.30 33.58 60.97 85.29
Changes in non-cash operating
working capital (0.46) (3.83) 0.64 1.22
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Funds flow from operating activities 22.84 29.75 61.61 86.51
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- The Trust also uses the term "debt net of working capital" or "net debt". Debt net of working capital, as presented, does not have any standardized meaning prescribed by Canadian GAAP and may not be comparable with the calculation of similar measures for other entities. Debt net of working capital, as used by the Trust, is calculated as bank debt and any working capital deficit excluding unrealized risk management assets/liabilities and future income taxes.
- Operating netbacks per boe equal total petroleum and natural gas revenue per boe adjusted for realized risk management gains and/or losses per boe, royalties per boe and production costs per boe. Operating netbacks are a useful measure to compare the Trust's operations with those of its peers.
- Funds flow netbacks per boe are calculated as operating netbacks less general and administrative expenses per boe, interest and financing charges per boe, asset retirement expenditures per boe and current income taxes per boe. Funds flow netbacks are a useful measure to compare the Trust's operations with those of its peers.
References to "production volumes" or "production" in this document refer to sales volumes.
Forward-Looking Statements - This document offers our assessment of Zargon's future plans and operations as at November 11, 2009, and contains forward-looking statements including:
- our expectations for production referred to under the heading "Financial & Operating Highlights";
- our expectations for capital expenditures referred to under the heading "Financial & Operating Highlights";
- our expectations for royalties referred to under the heading "Financial Analysis";
- our expectations for production costs referred to under the heading "Financial Analysis";
- our expectations for interest expenses referred to under the heading "Financial Analysis";
- our expectations for current taxes referred to under the headings "Financial Analysis";
- our distribution policy referred to under the headings "Financial & Operating Highlights" and "Liquidity and Capital Resources";
- our expected sources of funds for distributions and capital expenditures referred to under the headings "Liquidity and Capital Resources" and "Financial & Operating Highlights";
- our expectations for future commodity pricing and operating results referred to under the headings "Financial & Operating Highlights" and "Outlook"; and
- our expectations for designing and implementing International Financial Reporting Standards referred to under the heading "Changes in Accounting Policies".
Such statements are generally identified by the use of words such as "anticipate", "continue", "estimate", "expect", "forecast", "may", "will", "project", "should", "plan", "intend", "believe" and similar expressions (including the negatives thereof). By their nature, forward-looking statements are subject to numerous risks and uncertainties, some of which are beyond our control, including such as those relating to results of operations and financial condition, general economic conditions, industry conditions, changes in regulatory and taxation regimes, volatility of commodity prices, escalation of operating and capital costs, currency fluctuations, the availability of services, imprecision of reserve estimates, geological, technical, drilling and processing problems, environmental risks, weather, the lack of availability of qualified personnel or management, stock market volatility, the ability to access sufficient capital from internal and external sources and competition from other industry participants for, among other things, capital, services, acquisitions of reserves, undeveloped lands and skilled personnel. Risks are described in more detail in our Annual Information Form, which is available on our website and at www.sedar.com. Forward-looking statements are provided to allow investors to have a greater understanding of our business.
You are cautioned that the assumptions, including among other things, future oil and natural gas prices; future capital expenditure levels; future production levels; future exchange rates; the cost of developing and expanding our assets; our ability to obtain equipment in a timely manner to carry out development activities; our ability to market our oil and natural gas successfully to current and new customers; the impact of increasing competition, our ability to obtain financing on acceptable terms; and our ability to add production and reserves through our development and acquisition activities used in the preparation of such information, although considered reasonable at the time of preparation, may prove to be imprecise and, as such, undue reliance should not be placed on forward-looking statements. Our actual results, performance, or achievement could differ materially from those expressed in, or implied by, these forward-looking statements. We can give no assurance that any of the events anticipated will transpire or occur, or if any of them do, what benefits we will derive from them. The forward-looking information contained in this document is expressly qualified by this cautionary statement. Our policy for updating forward-looking statements is that Zargon disclaims, except as required by law, any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
This MD&A has been prepared as of November 11, 2009.
SUMMARY OF SIGNIFICANT EVENTS IN THE THIRD QUARTER
- During the third quarter of 2009, the Trust realized funds flow from operating activities of $22.84 million ($0.90 per diluted trust unit) and declared total distributions of $12.22 million ($0.54 per trust unit) to unitholders. For Canadian income tax purposes, the distributions are currently estimated to be 100 percent taxable income to unitholders.
- Average field prices received (before the impact of financial risk management contracts) for oil and liquids and for natural gas increased eight percent to $64.72 per barrel and decreased nine percent to $3.43 per thousand cubic feet, respectively, compared to the second quarter of 2009.
- Third quarter production volumes were 10,088 barrels of oil equivalent per day, a six percent increase from the second quarter 2009 production levels.
- During the third quarter of 2009, the Trust drilled 12 gross wells (10.3 net) with a 100 percent success rate. Total field exploration and development capital expenditures (excluding property acquisitions and dispositions) were $12.75 million for the quarter compared to $8.56 million for the prior quarter.
- The Trust continues to maintain a strong balance sheet with a combined debt net of working capital (excluding unrealized risk management assets/liabilities and future income taxes) of $87.14 million, which represents approximately 48 percent of the Trust's available credit facilities at September 30, 2009.
- On September 23, 2009, Zargon closed the Arrangement Agreement to acquire all the issued and outstanding common shares of Churchill Energy Inc. ("Churchill") for a total consideration of approximately 0.555 million Zargon trust units, $0.11 million in cash and the assumption of approximately $6.85 million of net debt (including adjustments and transactions costs) for a total transaction value of approximately $16.31 million. This acquisition brought oil exploitation opportunities at Grand Forks and Brazeau, Alberta along with significant tax pools.
- On July 27, 2009, the Trust amended and renewed its syndicated committed credit facilities of $180 million. These facilities are available for general corporate purposes and the acquisition of oil and natural gas properties.
FINANCIAL ANALYSIS
Third quarter 2009 revenue of $40.96 million was 14 percent above the $35.84 million in the second quarter of 2009 and 38 percent below the $66.35 million in the third quarter of 2008. An eight percent increase in oil and liquids prices received and a six percent increase in production volumes were the primary reasons for the increased revenues when compared to the prior quarter amounts. Third quarter 2009 realized oil and liquids field prices averaged $64.72 per barrel before the impact of financial risk management contracts and were eight percent higher than the preceding quarter's $59.95 per barrel and were 41 percent lower than the $109.34 per barrel recorded in the 2008 third quarter. Zargon's crude oil field price differential from the Edmonton par price increased to $6.78 per barrel in the third quarter of 2009 compared to $5.95 per barrel in the second quarter of 2009. Natural gas field prices received averaged $3.43 per thousand cubic feet before the impact of financial risk management contracts in the third quarter of 2009 ($2.83 per thousand cubic feet before the impact of physical and financial risk management contracts), a nine percent decrease from the preceding quarter levels and 58 percent below the 2008 third quarter prices. Zargon's realized field prices differ from the benchmark AECO average daily price due to a combination of fixed price physical contracts (see note 11 to the interim unaudited consolidated financial statements) and from the impact of Zargon receiving AECO monthly index pricing for a portion of its natural gas production.
Pricing
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------------------------------------------------
Percent Percent
Average for the period 2009 2008 Change 2009 2008 Change
----------------------------------------------------------------------------
Natural Gas:
NYMEX average daily spot
price ($US/mmbtu) 3.16 9.00 (65) 3.81 9.68 (61)
AECO average daily spot
price ($Cdn/mmbtu) 2.94 7.73 (62) 3.78 8.64 (56)
Zargon realized field price
before the impact of
financial risk
management contracts
($Cdn/mcf) 3.43 8.17 (58) 4.29 8.50 (50)
Zargon realized field price
before the impact of
physical and financial
risk management contracts
($Cdn/mcf) 2.83 7.80 (64) 3.62 8.53 (58)
Zargon realized field price
after the impact of
physical and financial
risk management contracts
($Cdn/mcf) 3.91 7.77 (50) 4.80 8.33 (42)
Zargon realized natural
gas field price
differential/(premium) (1) (0.49) (0.44) (0.51) 0.14
Zargon realized natural
gas field price
differential/(premium)
before the impact of
physical and financial risk
management contracts 0.11 (0.07) 0.16 0.11
Crude Oil:
WTI ($US/bbl) 68.30 117.98 (42) 57.00 113.27 (50)
Edmonton par price
($Cdn/bbl) 71.50 121.85 (41) 62.31 115.14 (46)
Zargon realized field
price before the impact
of financial risk
management contracts
($Cdn/bbl) 64.72 109.34 (41) 56.51 102.15 (45)
Zargon realized field price
after the impact of
financial risk management
contracts ($Cdn/bbl) 76.00 92.07 (17) 69.92 86.29 (19)
Zargon realized oil field
price differential (2) 6.78 12.51 5.80 12.99
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(1) Calculated as Zargon's realized field price before the impact of
financial risk management contracts ($Cdn/mcf) as compared to AECO
average daily spot price ($Cdn/mmbtu). Note: premiums may occur as a
result of the realization of fixed price physical contracts and the
impact of Zargon receiving AECO monthly index pricing for a portion of
its natural gas production.
(2) Calculated as Zargon's realized field price before the impact of
financial risk management contracts ($Cdn/bbl) as compared to Edmonton
par price ($Cdn/bbl).
Natural gas production volumes decreased by one percent in the third quarter of 2009 to 28.23 million cubic feet per day from 28.44 million cubic feet per day in the second quarter of 2009 and were five percent lower than the 2008 third quarter. When compared to the prior quarter, the 2009 third quarter decrease in natural gas production volumes were primarily a result of reduced production from the shut-in of high cost natural gas properties, facility and processing plant maintenance related outages and natural production declines, which did not offset production volume additions from the April 29, 2009 acquisition of Masters and the September 23, 2009 acquisition of Churchill. Oil and liquids production during the third quarter of 2009 was 5,382 barrels per day, which is 13 percent above the 2009 second quarter rate of 4,780 barrels per day and 23 percent above the third quarter of 2008 level. The year-over-year increase in oil and liquids production volumes was primarily due to an active oil exploitation drilling program and the post acquisition contribution of production volume additions coming from the Masters properties. On a barrel of oil equivalent basis, Zargon produced 10,088 barrels of oil equivalent per day in the third quarter of 2009, which represents a six percent increase from the 9,520 barrels of oil equivalent per day in the second quarter of 2009 and an eight percent increase when compared to the third quarter of 2008.
Production by Core Area
Three Months
Ended
September 30, 2009 2008
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Oil and Natural Oil and Natural
Liquids Gas Equivalents Liquids Gas Equivalents
(bbl/d) (mmcf/d) (boe/d) (bbl/d) (mmcf/d) (boe/d)
----------------------------------------------------------------------------
Alberta Plains 2,115 16.42 4,853 1,313 19.44 4,554
West Central
Alberta 424 11.37 2,319 328 9.93 1,983
Williston
Basin 2,843 0.44 2,916 2,726 0.47 2,803
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5,382 28.23 10,088 4,367 29.84 9,340
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Nine Months
Ended
September 30, 2009 2008
----------------------------------------------------------------------------
Oil and Natural Oil and Natural
Liquids Gas Equivalents Liquids Gas Equivalents
(bbl/d) (mmcf/d) (boe/d) (bbl/d) (mmcf/d) (boe/d)
----------------------------------------------------------------------------
Alberta Plains 1,759 16.89 4,573 1,240 19.68 4,521
West Central
Alberta 390 10.82 2,194 278 9.44 1,851
Williston
Basin 2,762 0.49 2,843 2,745 0.49 2,826
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4,911 28.20 9,610 4,263 29.61 9,198
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Zargon's commodity price risk management policy, which is approved by the Board of Directors, allows the use of forward sales, costless collars and other instruments up to a 24 month term and approximately 30 percent of the combined oil and natural gas working interest production in order to partially offset the effects of commodity price fluctuations. Zargon's management considers financial risk management contracts to be effective on an economic basis, but has decided not to designate these contracts as hedges for accounting purposes and, accordingly, for these contracts, an unrealized gain or loss is recorded based on the fair value (mark-to-market) of the contracts at the period end.
Specifically, in the 2009 third quarter, relatively higher oil and natural gas prices brought about a smaller net realized financial risk management gain totalling $6.83 million, consisting of a $1.24 million gain on natural gas contracts and a $5.59 million gain on oil contracts (foreign exchange contracts are considered in conjunction with the oil contracts), that compares to a $7.45 million realized net gain in the second quarter of 2009 and a $8.02 million realized net loss in the third quarter of 2008.
The 2009 third quarter unrealized risk management loss resulted from oil contract (including related foreign exchange contract) losses of $2.49 million, and unrealized risk management natural gas contract losses of $1.11 million resulting in a total loss of $3.60 million for the quarter, which compares to a net $13.65 million loss for the 2009 second quarter and a net $46.58 million gain in the third quarter of 2008. These non-cash unrealized risk management gains or losses are generated by the change over the reporting period in the mark-to-market valuation of Zargon's risk management contracts. Recent volatility in commodity prices has resulted in significant fluctuations in the mark-to-market amount of unrealized risk management assets and liabilities. The period-over-period changes in these valuations directly impact net earnings/losses. Zargon's commodity risk management positions are fully described in note 11 to the unaudited consolidated interim financial statements.
Royalties, inclusive of the Saskatchewan Resource Surcharge, totalled $7.57 million for the third quarter of 2009, an increase of 26 percent from the $5.99 million preceding quarter expense and a decrease of 44 percent from $13.46 million in the third quarter of 2008. The variations in royalty rates generally track changes in production volumes and prices. As a percentage of petroleum and natural gas revenue, royalty rates in 2008 tended to move in a relatively narrow range from 20 to 21 percent and were 20.3 percent in the third quarter of 2008. Commencing in 2009, the oil and natural gas royalty structure changed for Alberta production volumes (as disclosed in our 2008 Annual Financial Report). Reflecting the 2009 relatively lower commodity prices and the modified royalty structure, on a consolidated basis, the third quarter of 2009 royalties resulted in a rate of 18.5 percent (19.2 percent excluding revenue that does not attract royalty expenses) which compared to 16.7 percent (17.4 percent excluding revenue that does not attract royalty expenses) in the second quarter of 2009. For the remainder of 2009 and for calendar 2010 Zargon expects that its royalty rate will range from 18 to 20 percent, but will ultimately depend on the actual price received for our production.
On a unit of production basis, production costs of $13.18 per barrel of oil equivalent in the third quarter of 2009 compares with $13.08 per barrel of oil equivalent in the preceding quarter and $12.10 per barrel of oil equivalent in the third quarter of 2008. The increase in the 2009 third quarter costs (on a unit of production basis) primarily relates to seasonal repairs and annual maintenance programs and the relatively higher operating cost properties acquired in recent corporate acquisitions. Despite the impact of these higher cost oil-weighted properties, Zargon anticipates that its production costs can be maintained in the $13.00 to $13.50 range for the remainder of the 2009 year. For 2010, Zargon anticipates a moderation in the upward cost pressures, and anticipates maintaining operating costs in the $13.50 to $14.00 per barrel of oil equivalent range.
Operating Netbacks
Three Months Ended September 30, 2009 2008
----------------------------------------------------------------------------
Oil and Natural Oil and Natural
Liquids Gas Liquids Gas
($/bbl) ($/mcf) ($/bbl) ($/mcf)
----------------------------------------------------------------------------
Production revenue 64.72 3.43 109.34 8.17
Realized risk management gain/(loss) 11.29 0.48 (17.27) (0.39)
Royalties (13.54) (0.33) (22.82) (1.56)
Production costs (13.65) (2.11) (16.02) (1.44)
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Operating netbacks 48.82 1.47 53.23 4.78
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Nine Months Ended September 30, 2009 2008
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Oil and Natural Oil and Natural
Liquids Gas Liquids Gas
($/bbl) ($/mcf) ($/bbl) ($/mcf)
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Production revenue 56.51 4.29 102.15 8.50
Realized risk management gain/(loss) 13.41 0.51 (15.86) (0.16)
Royalties (11.41) (0.50) (21.00) (1.69)
Production costs (14.28) (2.04) (14.54) (1.48)
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Operating netbacks 44.23 2.26 50.75 5.17
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Measured on a unit of production basis, third quarter 2009 general and administrative expenses (net of recoveries) of $2.96 million were $3.19 per barrel of oil equivalent which compared to $4.29 in the prior quarter and $3.06 in the third quarter of 2008. The year-over-year increase in general and administrative expenses on a per unit of production basis is primarily due to additional office lease costs and the costs related to the expansion of Zargon's technical staff and consultants, as Zargon repositions itself for its expanded exploitation and acquisition initiatives. The second quarter 2009 costs included $0.53 per barrel of oil equivalent of one-time employment related charges.
Unit-based compensation in the third quarter of 2009 was $0.39 million, a 23 percent increase from the third quarter of 2008 and a 40 percent increase from the prior quarter. The increase is a result of unit rights granted late in the prior quarter pursuant to the Trust's new unit rights incentive plan as approved at Zargon's Annual and Special meeting of Unitholders held on April 22, 2009.
Zargon's borrowings are through its syndicated bank credit facilities. Interest and financing charges on these facilities in the 2009 third quarter were $0.80 million, $0.31 million higher than the previous quarter amount of $0.49 million and a decrease of $0.45 million from $1.25 million in the third quarter of 2008. This year-over-year decrease is primarily due to a slight decrease in average bank debt levels and lower average borrowing costs. In particular, bank debt levels were decreased in June 2009, when the Trust closed an offering of 2.365 million trust units on a bought deal basis at $15.00 per unit for total gross proceeds of $35.48 million ($33.44 million net of equity issuance expenses). Zargon's current available syndicated committed credit facilities and borrowing base are $180 million, with approximately 57 percent unutilized at September 30, 2009.
On July 27, 2009, Zargon amended and renewed its syndicated committed credit facilities of $180 million. The next renewal date is June 29, 2010. These facilities continue to be available for general corporate purposes and the potential acquisition of oil and natural gas properties. For the remainder of 2009 through to the 2010 renewal, it is anticipated that Zargon's borrowing costs will be higher as general debt pricing, standby fees and extension fees have risen considerably in the current economic environment. Interest rates fluctuate under the syndicated facilities with Canadian prime, US prime, and US base rates plus an applicable margin between 125 basis points and 275 basis points (2008 - zero and 32.5 basis points, respectively), as well as with Canadian banker's acceptance and LIBOR rates plus an applicable margin between 275 basis points and 425 basis points (2008 - 97.5 and 157.5 basis points, respectively).
Current income taxes for the 2009 third quarter were $0.68 million, and related primarily to the United States operations. When compared to prior periods, current income taxes increased $0.25 million from the 2009 second quarter and decreased $0.01 million relative to the third quarter of 2008. The decreased 2009 taxable income is primarily due to reduced oil prices. Total corporate tax pools and future tax benefits as at September 30, 2009, are approximately $295 million, which represents an increase of 57 percent from the comparable $188 million of tax pools available to Zargon at December 31, 2008, primarily a result of the tax pools acquired as part of the recent Masters and Churchill corporate acquisitions.
Trust Netbacks
Three Months Ended Nine Months Ended
September 30, September 30,
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($/boe) 2009 2008 2009 2008
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Petroleum and natural gas revenue 44.13 77.22 41.46 74.69
Realized risk management gain/(loss) 7.35 (9.34) 8.35 (7.87)
Royalties (8.15) (15.66) (7.30) (15.16)
Production costs (13.18) (12.10) (13.27) (11.50)
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Operating netbacks 30.15 40.12 29.24 40.16
General and administrative (3.19) (3.06) (3.83) (2.96)
Interest and financing charges (0.86) (1.46) (0.73) (1.56)
Asset retirement expenditures (0.75) (0.17) (0.60) (0.27)
Current income taxes (0.74) (0.81) (0.60) (1.05)
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Funds flow netbacks 24.61 34.62 23.48 34.32
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Reflecting higher production volumes and the impact of recent corporate acquisitions, depletion and depreciation expense for the third quarter of 2009 increased seven percent to $16.82 million compared to the $15.68 million prior quarter expense and increased 10 percent from the $15.30 million 2008 third quarter expense. On a per barrel of oil equivalent basis, the depletion and depreciation rates were $18.12, $18.09 and $17.80 for the third and second quarters of 2009 and the third quarter of 2008, respectively. The 2008 calendar year depletion and depreciation rate was $17.61 per barrel of oil equivalent.
The provision for accretion of asset retirement obligations for the first nine months of 2009 was $1.99 million, a 24 percent increase compared to the first nine months of 2008. The year-over-year increase is due to changes in the estimated future liability for asset retirement obligations as a result of wells added through Zargon's drilling program inclusive of wells acquired/disposed of in the current year and wells acquired with the recent corporate acquisitions.
The recovery of future taxes for the third quarter of 2009 was $3.13 million compared to a recovery of $6.11 million in the prior quarter and an expense of $14.27 million in the third quarter of 2008. The 2009 third quarter recovery is primarily related to the quarter's unrealized risk management losses.
On October 31, 2006, the Federal Government announced tax proposals pertaining to taxation of distributions paid by trusts and the personal tax treatment of trust distributions. Currently, the Trust does not pay tax on distributions as tax is paid by the unitholders. On June 12, 2007, the Federal Government enacted these tax proposals, which would have resulted in taxation of distributions at the Trust level at a rate of 31.5 percent effective January 1, 2011. Subsequent 2007 fourth quarter legislation lowered this tax rate to 29.5 percent in 2011 and 28.0 percent beyond 2011. Prior to June 2007, the Trust estimated the future income tax on certain temporary differences between amounts recorded on its balance sheet for book and tax purposes to have a nil effective tax rate. On February 26, 2008, the Federal Government, in its Federal Budget, announced further changes to the specified investment flow through ("SIFT") tax rules. The provincial component of the SIFT tax will be based on the provincial rates where the SIFT has a permanent establishment rather than using a 13.0 percent flat rate. During the 2009 first quarter this tax rate change had been substantively enacted, and the future income tax impact has been recorded in the financial statements. Under the legislation, the Trust now estimates the effective tax rate on the post 2010 reversal of these temporary differences to be approximately 26.5 percent for 2011 and 25.0 percent thereafter. Until 2011, Zargon's future tax obligations are reduced as distributions are made from the Trust and, consequently, it is anticipated that Zargon's effective tax rate will continue to be low until that time.
On December 15, 2006, the Canadian Federal Department of Finance stated its intention to allow conversions of SIFT income trusts to a corporation without any adverse tax consequences to investors. On July 14, 2008, the Department of Finance released the draft legislative proposals to allow the conversion of these SIFT trusts into corporations. Zargon is currently reviewing and assessing this recent legislation and is considering its potential impact on the organization while Zargon's management develops its strategic plan beyond December 2010, which is the effective date of the new SIFT tax rules.
According to the January 19, 2005 CICA pronouncement, EIC-151 "Exchangeable Securities Issued by Subsidiaries of Income Trusts", Zargon Energy Trust must reflect the exchangeable securities issued by its subsidiary (Zargon Oil & Gas Ltd.) as a non-controlling interest. Prior to 2005, these exchangeable shares were reflected as a component of unitholders' equity. Accordingly, the Trust has reflected a non-controlling interest of $27.63 million on the Trust's consolidated balance sheet as at September 30, 2009. Consolidated net earnings have been reduced for net earnings attributable to the non-controlling interest of $0.57 million in the third quarter of 2009. In accordance with EIC-151 and given the circumstances in Zargon's case, each exchangeable share redemption is accounted for as a step-purchase, which, in the third quarter of 2009, resulted in an increase in property and equipment of $0.01 million, an increase in unitholders' equity and non-controlling interest of $0.58 million and a nominal increase in future income tax liability. Funds flow was not impacted by this change. The cumulative impact to date of the application of EIC-151 has been to increase property and equipment by $55.24 million, unitholders' equity and non-controlling interest by $66.22 million, increase future income tax liability by $18.21 million and allocate net earnings of $29.19 million to exchangeable shareholders.
Funds flow from operating activities in the 2009 third quarter of $22.84 million was $1.92 million, or nine percent higher than the preceding quarter and $6.91 million or 23 percent lower than the prior year third quarter. The increase in funds flow from the preceding quarter was primarily due to increased revenues (net of related royalties) as a result of higher oil prices and higher oil production volumes. Compared to the prior year third quarter, an eight percent increase in production volumes were more than offset by the 43 percent decline in commodity prices and rising production costs and general and administrative expenses. Funds flow on a per diluted trust unit basis was $0.90 for the third quarter of 2009, a one percent decrease from the prior quarter and a 37 percent decrease from the 2008 third quarter.
Net earnings were $4.47 million for the 2009 third quarter compared to $2.55 million of net losses in the preceding quarter and $40.05 million of net earnings in the third quarter of 2008. The net earnings track the funds flow from operating activities for the respective periods modified by asset retirement expenditures and non-cash charges, which include depletion and depreciation, unrealized risk management gains/losses, future income taxes/recoveries and non-controlling interest.
Capital Expenditures
Three Months Ended Nine Months Ended
September 30, September 30,
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($ millions) 2009 2008 2009 2008
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Undeveloped land 1.47 1.67 4.00 6.05
Geological and geophysical (seismic) 0.63 0.43 2.22 2.93
Drilling and completion of wells 6.08 10.09 16.07 19.59
Well equipment and facilities 4.57 4.14 11.80 8.61
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Exploration and development 12.75 16.33 34.09 37.18
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Property acquisitions (1) 0.11 1.14 0.81 6.35
Property dispositions (0.11) - (0.11) (0.17)
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Net property acquisitions (1) - 1.14 0.70 6.18
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Corporate acquisitions assigned to
property and equipment (2) 16.31 - 56.34 59.85
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Total net capital expenditures
excluding administrative
assets (1) (2) 29.06 17.47 91.13 103.21
Administrative assets 0.26 - 0.59 0.15
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Total net capital expenditures (1) (2) 29.32 17.47 91.72 103.36
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(1) Amounts include capital expenditures acquired for cash and equity
issuances.
(2) Amounts include capital expenditures acquired for cash, equity
issuances, acquisition costs and net debt assumed on corporate
acquisitions.
CORPORATE ACQUISITIONS
On September 23, 2009, Zargon closed the Arrangement Agreement to acquire all the issued and outstanding common shares of Churchill Energy Inc. for a total consideration of approximately 0.555 million Zargon trust units, $0.11 million in cash and the assumption of approximately $6.85 million of net debt (including adjustments and transactions costs) for a total transaction value of approximately $16.31 million. This acquisition brought oil exploitation opportunities at Grand Forks and Brazeau, Alberta along with significant tax pools.
The results of operations of Churchill have been included in the consolidated financial statements since September 23, 2009. In relation to the third quarter 2009 results, the Churchill acquisition has contributed approximately 27 barrels of oil equivalent per day of production volumes to Zargon's total quarterly production volumes of 10,088 barrels of oil equivalent per day.
On April 29, 2009, Zargon closed the Arrangement Agreement to acquire all the issued and outstanding common shares of Masters Energy Inc. for a total consideration of approximately 1.475 million Zargon trust units, $5.70 million in cash and the assumption of approximately $13.29 million of net debt (including adjustments and transactions costs) for a total transaction value of approximately $40.03 million. This acquisition brought approximately 1,230 barrels of oil equivalent per day of production along with a significant Alkaline Surfactant Polymer (ASP) tertiary oil recovery opportunity at the Little Bow oil property in Southern Alberta. The results of operations of Masters have been included in the consolidated financial statements since April 29, 2009.
LIQUIDITY AND CAPITAL RESOURCES
Total net capital expenditures (including net property acquisitions and consideration and net debt assumed for corporate acquisitions) of $91.72 million in the first nine months of 2009 were 11 percent lower than the first nine months of 2008 which included the Rival Energy Ltd. and Newpact Energy Corp. acquisitions. Field expenditures of $34.09 million for the 2009 first nine months reflected a reduced exploration and development field program when compared to $37.18 million for the 2008 first nine months, representing an eight percent decrease. Drilling and completion expenses of $16.07 million were 18 percent lower than the prior year's first nine months amount of $19.59 million. During the first nine months of 2009, 20.7 net wells were drilled compared to 22.0 net wells in the first nine months of 2008. Field capital expenditures (excluding net property acquisitions) for the first nine months of 2009 were allocated to Alberta Plains - $13.25 million, West Central Alberta - $7.48 million and Williston Basin - $13.36 million. Field capital expenditures for the nine months ended September 30, 2009 are net of $1.44 million and $0.31 million in Alberta drilling credits in the respective Alberta Plains and West Central Alberta core areas. Alberta drilling credits are designed to encourage the execution of new drilling projects in Alberta and were announced in response to the slow down in drilling throughout the province of Alberta. The drilling credit is based on $200 per metre credit on total metres drilled with a cap based on production levels and Alberta Crown royalties paid.
On June 5, 2009, the Trust closed an offering of 2.365 million trust units on a bought deal basis at $15.00 per unit for total gross proceeds of $35.48 million ($33.44 million net of equity issuance costs). The net proceeds of the offering were used to reduce outstanding borrowings under existing credit facilities, and in turn will also be used to partially fund the 2009 capital expenditure program and for general corporate purposes.
Funds flow from operating activities in the 2009 first nine months of $61.61 million and proceeds from the issuance of trust units of $65.11 million (due to the acquisition of Masters and Churchill, the equity issuance and unit right exercises) funded the capital program including corporate and property acquisitions, the decrease in bank debt, the changes in working capital and the cash distributions to the unitholders.
At September 30, 2009, the Trust continues to maintain a strong balance sheet with a combined debt net of working capital (excluding unrealized risk management assets and liabilities and future income taxes) of $87.14 million, compared to $77.47 million at the end of the 2009 second quarter, which represents approximately 48 percent of the Trust's available credit facilities at September 30, 2009.
The volatility of oil and natural gas prices, the changes relating to Alberta royalties and Canadian income trust tax rules and recent global economic concerns have partially restricted the oil and natural gas industry's ability to attract new capital from debt and equity markets. Zargon's historically conservative strategy of maintaining a relatively low cash distribution to funds flow ratio and conservative debt levels should enable Zargon to maintain modified capital and distribution programs during periods of limited access to debt and equity capital.
Cash Distributions Analysis
Three Months Ended Nine Months Ended
September 30, September 30,
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($ millions) 2009 2008 2009 2008
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Cash flows from operating activities 23.30 33.58 60.97 85.29
Net earnings 4.47 40.05 2.28 40.09
Actual cash distributions paid or
payable relating to the period (12.22) (9.87) (33.51) (29.13)
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Excess of cash flows from operating
activities over cash distributions
paid 11.08 23.71 27.46 56.16
Excess (shortfall) of net earnings
over cash distributions paid (7.75) 30.18 (31.23) 10.96
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During the first nine months of 2009, Zargon has maintained a base monthly distribution of $0.18 per trust unit. Management monitors the Trust's distribution policy with respect to forecasted net cash flows, debt levels and capital expenditures. Zargon's cash distributions are discretionary to the extent that these distributions do not cause a breach of the financial covenants under Zargon's credit facilities and to the extent the Trust (non-consolidated) is not taxable. As a crude oil and natural gas Trust, Zargon's reserve base is depleted with production and Zargon, therefore, relies on ongoing exploration, development and acquisition activities to replace reserves and to offset production declines. The success of these exploration, development and acquisition capital programs, along with commodity price fluctuations and the Trust's ability to manage costs, are the main factors influencing the sustainability of the Trust's distributions.
For the three and nine months ended September 30, 2009, cash flows from operating activities (after changes in non-cash working capital) of $23.30 million and $60.97 million, respectively, exceeded cash distributions of $12.22 million and $33.51 million, respectively. For the three months and nine months ended September 30, 2008, cash flows from operating activities (after changes in non-cash working capital) of $33.58 million and $85.29 million, respectively, exceeded cash distributions of $9.87 million and $29.13 million, respectively.
For the three and nine months ended September 30, 2009, cash distributions of $12.22 and $33.51 million, exceeded net earnings of $4.47 and $2.28 million, respectively. For the three and nine months ended September 30, 2008, net earnings of $40.05 million and $40.09 million, respectively, exceeded cash distributions of $9.87 million and $29.13 million, respectively. Net earnings include significant non-cash charges, which were $19.06 million for the 2009 third quarter and $60.88 million for the nine months ended September 30, 2009, that do not impact cash flow. Net earnings also include fluctuations in future income taxes due to changes in tax rates and tax rules. In the instances where distributions exceed net earnings, a portion of the cash distri
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