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Form 6-K ARC RESOURCES LTD. For: Dec 31

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February 12, 2015 6:03 AM EST


UNITED STATES
 
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 6-K
 
REPORT OF FOREIGN PRIVATE ISSUER
Pursuant to Section 13a-16 or 15d-16 of the
Securities Exchange Act of 1934
 
For the month of February 2015
 
Commission File Number: 000-30514
 
ARC RESOURCES LTD.
______________________________________________________________________________________________________
(Exact name of registrant as specified in its charter)
 
Suite 1200, 308 - 4th Avenue S.W., Calgary, Alberta T2P 0H7
______________________________________________________________________________________________________
(Address of principal executive offices)
 
Indicate by check mark whether the registrant files or will file annual reports under cover Form 20-F or Form 40-F.
 
Form 20-F o
Form 40-F x
 
Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(1). o
 
Note: Regulation S-T Rule 101(b)(1) only permits the submission in paper of a Form 6-K if submitted solely to provide an attached annual report to security holders.
 
Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(7): o
 
Note: Regulation S-T Rule 101(b)(7) only permits the submission in paper of a Form 6-K if submitted to furnish a report or other document that the registrant foreign private issuer must furnish and make public under the laws of the jurisdiction in which the registrant is incorporated, domiciled or legally organized (the registrant’s “home country”), or under the rules of the home country exchange on which the registrant’s securities are traded, as long as the report or other document is not a press release, is not required to be and has not been distributed to the registrant’s security holders, and, if discussing a material event, has already been the subject of a Form 6-K submission or other Commission filing on EDGAR.
 
Indicate by check mark whether the registrant by furnishing the information contained in this Form is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934.
 
Yes o
No x
 
If “Yes” is marked, indicate below the file number assigned to the registrant in connection with Rule 12g3-2(b):  82-     




SIGNATURE
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
Dated: February 11, 2015
ARC Resources Ltd.
 
(Registrant)
 
 
 
 
 
 
 
By:
/s/“David Carey”
 
 
David Carey
 
 
Senior Vice President, Capital Markets
INDEX TO EXHIBITS
 
EXHIBIT NUMBER
 
TITLE
 
 
 
99.1
 
Consolidated Financial Statements and Management's Discussion and Analysis and Results of Operations for the fiscal year ended December 31, 2014.



MANAGEMENT’S DISCUSSION AND ANALYSIS
This management’s discussion and analysis (“MD&A”) of ARC Resources Ltd. (“ARC” or the “Company”) is Management’s analysis of the financial performance and significant trends or external factors that may affect future performance. It is dated February 11, 2015 and should be read in conjunction with the audited consolidated financial statements (the "financial statements") as at and for the year ended December 31, 2014, and the MD&A and unaudited condensed interim consolidated financial statements for the periods ended March 31, 2014, June 30, 2014 and September 30, 2014 as well as ARC’s Annual Information Form that is filed on SEDAR at www.sedar.com. All financial information is reported in Canadian dollars, unless otherwise noted.
This MD&A contains additional generally accepted accounting principles ("GAAP") measures, non-GAAP measures and forward-looking statements. Readers are cautioned that the MD&A should be read in conjunction with ARC’s disclosure under the headings “Non-GAAP Measures,” “Additional GAAP Measures,” “Forward-looking Information and Statements” and "Glossary" included at the end of this MD&A.
ABOUT ARC RESOURCES LTD.
ARC is a dividend-paying Canadian oil and gas company headquartered in Calgary, Alberta. ARC’s activities relate to the exploration, development and production of conventional oil and natural gas in Canada with an emphasis on the development of properties with a large volume of hydrocarbons in place commonly referred to as “resource plays.”
ARC’s vision is to be a leading energy producer, focused on delivering results through its strategy of risk-managed value creation. ARC is committed to providing superior long-term financial returns for its shareholders, creating a culture where respect for the individual is paramount and action and passion are rewarded. ARC runs its business in a manner that protects the safety of employees, communities and the environment. ARC’s vision is realized through the four pillars of its strategy:
1.
High quality, long-life assets – ARC’s unique suite of assets include both growth and base assets. ARC’s growth assets consist of world-class resource play properties, primarily concentrated in the Montney geological formation in northeast British Columbia and northern Alberta, and the Cardium formation in the Pembina area of Alberta. These assets provide substantial growth opportunities, which ARC will pursue to create value through long-term profitable development. ARC’s base assets consist of core properties located throughout Alberta, Saskatchewan and Manitoba. The base assets deliver stable production and contribute significant cash flow to fund future development and support ARC's dividend.
2.
Operational excellence – ARC is focused on capital discipline and cost management to extract the maximum return on its investments while operating in a safe and environmentally responsible manner. Production from individual oil and natural gas wells naturally declines over time. In any one year, ARC approves a budget to drill new wells with the intent to first replace production declines and second to potentially increase production volumes. At times, ARC may also acquire strategic producing or undeveloped properties to enhance current production and reserves or to provide potential future drilling locations. Alternatively, it may strategically dispose of non-core assets that no longer meet its investment criteria.
3.
Financial flexibility – ARC provides returns to shareholders through a combination of a monthly dividend, currently $0.10 per share per month, and a potential for capital appreciation. ARC’s goal is to fund capital expenditures necessary to replace production declines and dividend payments using funds from operations (1). ARC will finance value creating activities through a combination of sources including funds from operations, proceeds from ARC’s Dividend Reinvestment Program (“DRIP”), reduced funding required under the Stock Dividend Program ("SDP"), proceeds from property dispositions, debt capacity, and if necessary, equity issuance. ARC chooses to maintain prudent debt levels, targeting its net debt to be one to 1.5 times annualized funds from operations and less than 20 per cent of total capitalization over the long-term (1).
4.
Top talent and strong leadership culture – ARC is committed to the attraction, retention and development of the best and brightest people in the industry. ARC’s employees conduct business every day in a culture of trust, respect, integrity and accountability. Building leadership talent at all levels of the organization is a key focus. ARC is also committed to corporate leadership through community investment, environmental reporting practices and open communication with all stakeholders. As of the end of December 2014, ARC had approximately 603 employees with 346 professional, technical and support staff in the Calgary office, and 257 individuals located across ARC’s operating areas in western Canada.
(1)
Funds from operations, net debt, and total capitalization are additional GAAP measures which may not be comparable to similar additional GAAP measures used by other entities. Refer to the section entitled “Additional GAAP Measures” contained within this MD&A. Also refer to the "Funds from Operations" section within this MD&A for a reconciliation of ARC’s net income to funds from operations and cash flow from operating activities.


ARC Resources Ltd.
1

Total Return to Shareholders
ARC's business plan has resulted in significant operational success and has contributed to a trailing five year annualized total return per share of 9.9 per cent (Table 1).
Table 1
Total Returns (1)
Trailing One Year

Trailing Three Year

Trailing Five Year

Dividends per share ($)
1.20

3.60

6.00

Capital appreciation (depreciation) per share ($)
(4.41
)
0.06

5.22

Total return per share (%)
(11.4
)
14.9

60.4

Annualized total return per share (%)
(11.4
)
4.7

9.9

S&P/TSX Exploration & Producers Index annualized total return (%)
(22.1
)
(7.7
)
(6.2
)
(1)
Non-GAAP measure which may not be comparable to similar non-GAAP measures used by other entities. Refer to the section entitled "Non-GAAP Measures" contained within this MD&A. Calculated as at December 31, 2014.
Since 2010, ARC’s production has grown by 38,433 boe per day, or 52 per cent, while its proved plus probable reserves have grown by 187.6 million boe, or 39 per cent. Table 2 highlights ARC’s production and reserves for the last five years:
Table 2
 
2014

2013

2012

2011

2010

Production (boe/d)
112,387

96,087

93,546

83,416

73,954

Daily production per thousand shares (1)
0.35

0.31

0.31

0.29

0.28

Proved plus probable reserves (mmboe) (2)(3)(4)
672.7

633.9

607.0

572.4

485.1

Proved plus probable reserves per share (boe) (5)
2.1

2.0

2.0

2.0

1.8

(1)
Daily production per thousand shares represents annual average daily production divided by the diluted weighted average common shares for the respective years ending December 31.
(2)
As determined by ARC’s independent reserve evaluator solely at December 31.
(3)
ARC has also disclosed contingent resources associated with interests in certain of its properties located in northeastern British Columbia in ARC’s Annual Information Form as filed on SEDAR at www.sedar.com.
(4)
Company gross reserves. For more information, see ARC’s Annual Information Form as filed on SEDAR at www.sedar.com and the news release entitled “ARC Resources Ltd. Announces 210 Per Cent Produced Reserves Replacement in 2014” dated February 11, 2015.
(5)
Per share amounts are based on weighted average shares, diluted.
ECONOMIC ENVIRONMENT
ARC’s 2014 financial and operating results were impacted by commodity prices and foreign exchange rates which are outlined in Table 3 below:
Table 3
Selected Benchmark Prices and Exchange Rates (1)
Three Months Ended
Twelve Months Ended
 
December 31
December 31
 
2014

2013

% Change

2014

2013

% Change

Brent (US$/bbl)
77.07

109.35

(30
)
99.45

108.70

(9
)
WTI oil (US$/bbl)
73.20

97.61

(25
)
92.91

98.05

(5
)
Edmonton Par (Cdn$/bbl)
75.65

86.64

(13
)
94.46

93.16

1

Henry Hub NYMEX (US$/mmbtu) (2)
4.00

3.60

11

4.41

3.65

21

AECO natural gas (Cdn$/mcf)
4.01

3.15

27

4.42

3.16

40

Cdn$/US$ exchange rate
1.14

1.05

9

1.10

1.03

7

(1)
The benchmark prices do not reflect ARC's realized sales prices. For average realized sales prices, refer to Table 13 in this MD&A. Prices and exchange rates presented above represent averages for the respective periods.
(2)
NYMEX Henry Hub "Last Day" Settlement.
In the first six months of 2014, North American crude oil and natural gas prices reached their highest level on average since 2008. Strong prices contributed to significant drilling activity in North America, resulting in supply growth of both crude oil and natural gas. Increased supply led to a supply-demand imbalance, which resulted in price deterioration for both crude oil and natural gas markets late in 2014.


ARC Resources Ltd.
Page 2

The over-supplied nature of the oil market became more apparent late in 2014, with the continued production growth from shale plays in the United States, slower than expected global demand growth, and sustained production levels by OPEC. As a result, there is currently a crude oil supply-demand imbalance. The sell-off in global oil prices was a market reaction to restore the supply-demand balance, given that OPEC did not reduce production.
Current oil prices are below marginal supply costs for new production from many areas; the current depressed prices have resulted in a significant reduction in 2015 budgeted capital spending for the global energy sector. Reduced drilling activity is expected to slow supply growth and re-balance markets, however there is a lag between drilling activity levels and resultant oil production due to the life cycle of well completions and tie-ins. In addition to re-balancing supply and demand, it is expected that the decrease in drilling activity will result in a meaningful decrease in oilfield service costs which should result in improved rates of return at lower commodity prices and a more efficient energy sector.

For natural gas, 2014 started with a cold winter that established record-setting demand. Depleted inventory levels supported both NYMEX Henry Hub and AECO prices above US$4 per mmbtu and Cdn$4 per GJ, respectively, for the first six months of the year. In the later part of 2014, US natural gas supply levels increased and inventory reached levels that are currently viewed as being adequate to satisfy the expected level of demand through the winter and into 2015.
In addition to volatile commodity prices, foreign exchange rates have also changed significantly over the past year. The US dollar has been particularly strong, reflecting the strength of the broad economic recovery in the United States. The Cdn$/US$ exchange rate has been further impacted by weaker Canadian exports resulting from low energy prices. The devaluation of the Canadian dollar relative to the US dollar partially offset the impact of lower US dollar-denominated crude oil and natural gas prices.


ARC Resources Ltd.
Page 3

Annual Guidance and Financial Highlights
Table 4 is a summary of ARC’s 2015 and 2014 guidance and a review of 2014 actual results. The 2015 guidance outlined below is under review and will be updated with ARC's first quarter 2015 results to incorporate reduced capital spending that includes cost savings from the service sector in response to reduced activity levels and reflects spending on only those projects that are profitable under current market conditions. ARC expects to spend approximately $150 million in the first quarter of 2015 and has a great deal of flexibility to adjust its capital budget as required. At this time, ARC's 2015 guidance estimates are unchanged from the original guidance announced on November 5, 2014 with the exception of 2015 capital expenditures, current income taxes and weighted average shares outstanding. Capital expenditures were reduced from $875 million to $750 million and current income taxes were revised to a range of zero to eight percent of funds from operations from three to eight percent of funds from operations due to lower expected commodity prices in 2015. Guidance for 2015 weighted average shares outstanding was increased to 339 million shares from 321 million shares to reflect the impact of ARC's equity offering of 17.9 million shares that closed on January 29, 2015.
Table 4
 
2015 Guidance (3)(4)
2014 Guidance

2014 YTD

% Variance

Production
 
 
 
 
Crude oil (bbl/d)
37,000 - 39,000
35,000 - 37,000

36,525

—

Condensate (bbl/d)
3,800 - 4,300
3,500 - 3,800

3,667

—

Natural gas (mmcf/d)
445 - 460
405 - 415

406.1

—

NGLs (bbl/d)
4,700 - 5,100
4,200 - 4,500

4,518

—

Total (boe/d)
120,000 - 125,000
110,000 - 114,000

112,387

—

Expenses ($/boe)
 
 
 
 
Operating
8.80 - 9.30
9.00 - 9.40

8.88

(1
)
Transportation
2.00 - 2.20
2.00 - 2.20

2.23

1

G&A (1)
2.00 - 2.30
2.20 - 2.40

2.06

(6
)
Interest
1.10 - 1.30
1.10 - 1.20

1.15

—

Current income tax (per cent of funds from operations) (2)
0 - 8
6 - 8

6

—

Capital expenditures before land purchases and net property acquisitions ($ millions)
750
975

945.5

(3
)
Land purchases and net property acquisitions ($ millions)
—
—

96.5

N/A

Weighted average shares, diluted (millions)
339
317

317

—

(1)
The 2014 guidance for G&A expenses per boe was based on a range of $1.45 - $1.55 prior to the recognition of any expense associated with ARC’s long-term incentive plans and $0.75 - $0.85 per boe associated with ARC’s long-term incentive plans. Actual per boe costs for each of these components for the year ended December 31, 2014 were $1.44 and $0.62 per boe, respectively.
(2)
The 2014 and 2015 corporate tax estimates will vary depending on level of commodity prices. Current income tax is quoted as a percentage of funds from operations before tax.
(3)
2015 production guidance does not take into account the impact of any dispositions that may occur during the year.
(4)
2015 guidance is under review and will be updated for reduced capital spending with ARC's first quarter 2015 results.

ARC’s 2014 production was 112,387 boe per day, falling into the middle of the guidance range. Crude oil and liquids production was just above the mid-point of the guidance range while natural gas production averaged toward the lower end of the range.
On a per boe basis, operating expenses were below the guidance range during 2014, as ARC has continued to increase its production from properties with lower operating costs while divesting of non-core assets with historically higher operating costs. Transportation expenses are slightly outside of the guidance range as ARC incurred additional trucking costs throughout 2014 to transport liquids to market. As ARC manages the transportation and marketing of its products itself rather than working through a third-party marketer, it typically incurs additional transport costs that are recouped in the price it receives upon delivery. G&A expenses were below guidance in 2014, primarily reflecting a reduction to the estimated payment obligation under ARC's long-term incentive plans at December 31, 2014. G&A expenses before any impact of ARC's long-term incentive plans is just below the guidance range.
ARC incurred $945.5 million of capital expenditures during 2014. In addition, ARC spent $134 million on land purchases and "tuck-in" acquisitions of land and facilities and infrastructure during the year. In response to the deterioration of commodity prices late in 2014, ARC announced a reduction to its 2015 capital program from $875 million to $750 million (see January 7, 2015 new release "ARC Resources Ltd. Announces Bought Deal Financing and Reduced 2015 Capital


ARC Resources Ltd.
Page 4

Program"). Since that date, there has been a continued decline in commodity prices and as such ARC is re-evaluating its 2015 spending to ensure it is creating long-term value for its shareholders. This includes working with all service providers to find additional cost savings as ARC believes that such costs will come down as activity levels decline. ARC will only execute capital projects that meet appropriate hurdle rates of return and as such it is expected that the 2015 capital development program will be less than the $750 million currently approved. This reduction will have a modest impact on full year 2015 production volumes, particularly on the oil side. Updated guidance will be provided with the release of first quarter 2015 results.
The guidance information presented is intended to provide shareholders with information on Management’s expectations for results of operations. Readers are cautioned that the guidance may not be appropriate for other purposes.
2014 FOURTH QUARTER FINANCIAL AND OPERATING RESULTS
Financial Highlights
Table 5
 
Three Months Ended
Twelve Months Ended
 
December 31
December 31
($ millions, except per share and volume data)
2014

2013

% Change
2014

2013

% Change
Funds from operations (1)
251.7

237.8

6
1,124.0

861.8

30
Funds from operations per share (1)(2)
0.79

0.76

4
3.54

2.76

28
Net income and comprehensive income
113.7

13.6

736
380.8

240.7

58
Operating income (3)
64.5

50.0

29
390.3

224.9

74
Dividends per share (2)
0.30

0.30

—
1.20

1.20

—
Average daily production (boe/d) (4)
117,986

100,883

17
112,387

96,087

17
(1)
Refer to the sections entitled "Funds from Operations" and “Additional GAAP Measures” contained within this MD&A.
(2)
Per share amounts (with the exception of dividends per share, which are based on the number of shares outstanding at each dividend record date) are based on weighted average shares, diluted.
(3)
Non-GAAP measure which may not be comparable to similar non-GAAP measures used by other entities. Refer to the section entitled "Non-GAAP Measures" contained within this MD&A. Also refer to the "Operating Income" section within this MD&A for the definition of operating income and a reconciliation of ARC’s net income to operating income.
(4)
Reported production amount is based on company interest before royalty burdens.


ARC Resources Ltd.
Page 5

Funds from Operations
ARC reports funds from operations in total and on a per share basis. Funds from operations does not have a standardized meaning prescribed by Canadian GAAP. Refer to the section entitled “Additional GAAP Measures” contained within this MD&A.
Table 6 is a reconciliation of ARC’s net income to funds from operations and cash flow from operating activities:
Table 6
 
Three Months Ended
Twelve Months Ended
 
December 31
December 31
($ millions)
2014

2013

2014

2013

Net income
113.7

13.6

380.8

240.7

Adjusted for the following non-cash items:
 
 
 
 
DD&A and impairment
279.4

157.0

758.5

551.9

Accretion of ARO
3.7

3.1

14.9

12.5

Intangible E&E expenses
9.5

1.3

39.4

1.3

Deferred tax expense
23.5

15.1

59.1

77.9

Unrealized loss (gain) on risk management contracts
(212.6
)
27.8

(205.3
)
(30.6
)
Unrealized gain on risk management contracts recognized in previous quarters (1)
—

(5.0
)
—

—

Unrealized loss on foreign exchange
32.7

24.8

73.8

48.9

Loss (gain) on disposal of petroleum and natural gas properties
(0.1
)
0.4

1.8

(38.9
)
Other
1.9

(0.3
)
1.0

(1.9
)
Funds from operations
251.7

237.8

1,124.0

861.8

Unrealized gain on risk management contracts recognized in previous quarters (1)
—

5.0

—

—

Net change in other liabilities
0.4

(2.3
)
(20.4
)
(16.6
)
Change in non-cash working capital
39.1

(19.6
)
49.4

(43.5
)
Cash flow from operating activities
291.2

220.9

1,153.0

801.7

(1) ARC enters into certain commodity price risk management contracts that pertain to production periods spanning the entire calendar year but that are settled at the end of the year on an annual average benchmark commodity price.Throughout the year, ARC has applied the portion of gains or losses associated with these contracts to the funds from operations calculation in the production period to which they relate to more appropriately reflect the funds from operations generated during the period after any effects of contracts used for economic hedging. At December 31, all gains and losses associated with these contracts have been realized, and in the fourth quarter gains or losses previously applied to all prior quarters are reversed.


ARC Resources Ltd.
Page 6

Details of the change in funds from operations from the three and twelve months ended December 31, 2013 to the three and twelve months ended December 31, 2014 are included in Table 7 below:
Table 7
 
Three Months Ended
Twelve Months Ended
 
December 31
December 31
 
$ millions

$/Share (1)

$ millions

$/Share (1)

Funds from operations – 2013
237.8

0.76

861.8

2.76

Volume variance
 
 
 
 
Crude oil and liquids
37.1

0.12

214.8

0.69

Natural gas
24.2

0.08

71.4

0.23

Price variance
 
 
 
 
Crude oil and liquids
(53.5
)
(0.18
)
3.2

0.01

Natural gas
21.3

0.07

194.0

0.62

Realized gain or loss on risk management contracts
15.9

0.05

(44.8
)
(0.14
)
Unrealized gain on risk management contracts recognized in previous quarters (2)
5.0

0.02

—

—

Royalties
(3.2
)
(0.01
)
(74.9
)
(0.24
)
Expenses
 
 
 
 
Transportation
(10.3
)
(0.03
)
(31.4
)
(0.10
)
Operating
(7.3
)
(0.02
)
(25.5
)
(0.08
)
G&A
(1.4
)
(0.01
)
13.8

0.04

Interest
(1.6
)
(0.01
)
(4.8
)
(0.02
)
Current tax
(12.7
)
(0.04
)
(54.0
)
(0.17
)
Realized gain or loss on foreign exchange
0.4

—

0.4

—

Diluted shares
—

(0.01
)
—

(0.06
)
Funds from operations – 2014
251.7

0.79

1,124.0

3.54

(1)
Per share amounts are based on weighted average shares, diluted.
(2)
ARC enters into certain commodity price risk management contracts that pertain to production periods spanning the entire calendar year but that are settled at the end of the year on an annual average benchmark commodity price.Throughout the year, ARC has applied the portion of gains or losses associated with these contracts to the funds from operations calculation in the production period to which they relate to more appropriately reflect the funds from operations generated during the period after any effects of contracts used for economic hedging. At December 31, all gains and losses associated with these contracts have been realized, and in the fourth quarter gains or losses previously applied to all prior quarters are reversed.

Funds from operations increased by six per cent in the fourth quarter of 2014 to $251.7 million from $237.8 million generated in the fourth quarter of 2013. The increase reflects increased revenue associated with higher crude oil and liquids and natural gas production coupled with higher natural gas prices, partially offset by lower crude oil and liquids pricing. Increased realized gains on risk management contracts also served to increase fourth quarter funds from operations which was partially offset by increased royalties, transportation and operating expenses and higher current taxes.
For the year ended December 31, 2014, funds from operations increased by $262.2 million or 30 per cent as compared to the same period in 2013. Increased production volumes and higher crude oil, natural gas and NGLs prices as well as lower G&A expenses contributed to the year-over-year increase in funds from operations, offset by higher royalties, increased realized losses on risk management contracts and higher current income taxes, transportation, and operating expenses.



ARC Resources Ltd.
Page 7

2014 Funds from Operations Sensitivity
Table 8 illustrates sensitivities of pre-hedged operating items to operational and business environment changes and the resulting impact on funds from operations per share:
Table 8
 
Impact on Annual Funds from Operations (6)

 
Assumption

Change

$/Share

Business Environment (1)
 
 
 
Crude oil price (US$ WTI/bbl) (2)(3)
92.91

1.00

0.033

Natural gas price (Cdn$ AECO/mcf) (2)(3)
4.42

0.10

0.029

Cdn$/US$ exchange rate (2)(3)(4)
1.10

0.01

0.026

Interest rate on floating-rate debt (2)
2.7
%
1.0
%
0.003

Operational
 
 
 
Crude oil and liquids production volumes (bbl/d) (5)
44,710

1.0
%
0.027

Natural gas production volumes (mmcf/d) (5)
406.1

1.0
%
0.013

Operating expenses ($/boe) (5)
8.88

1.0
%
0.009

G&A expenses ($/boe) (5)
2.06

10.0
%
0.023

(1)
Calculations are performed independently and may not be indicative of actual results that would occur when multiple variables change at the same time.
(2)
Prices and rates are indicative of published prices for the year ended December 31, 2014. See Table 13 of this MD&A for additional details. The calculated impact on funds from operations would only be applicable within a limited range of these amounts.
(3)
Analysis does not include the effect of risk management contracts.
(4)
Includes impact of foreign exchange on crude oil, condensate, and NGLs prices that are presented in US dollars.
(5)
Operational assumptions are based upon results for the year ended December 31, 2014.
(6)
Refer to the sections entitled "Funds from Operations" and “Additional GAAP Measures” contained within this MD&A.
Net Income
Net income of $113.7 million ($0.36 per share, diluted) was earned in the fourth quarter of 2014, a $100.1 million increase compared to net income of $13.6 million ($0.04 per share, diluted) in the fourth quarter of 2013. ARC recorded increased revenue net of royalties of $25.9 million and higher gains on risk management contracts of $256.3 million. The increased revenue is a reflection of increased production volumes and higher realized natural gas prices during the fourth quarter of 2014 relative to the fourth quarter of 2013, partially offset by lower realized crude oil and liquids pricing, while the increase in gains on risk management contracts reflects lower forward commodity prices at the end of the fourth quarter as compared to the average of prices identified in ARC's risk management contracts. Increased activity has led to higher transportation and operating expenses by $10.3 million and $7.3 million, respectively. ARC's DD&A expense increased by $122.4 million, of which $103 million is related to impairment charges recognized by ARC in the fourth quarter of 2014 on assets in its Northern Alberta district due to reduced forward pricing estimates. Increased income tax expense of $21.1 million also served to offset the increase in net income.
For the year ended December 31, 2014, net income was $380.8 million ($1.20 per share, diluted) as compared to $240.7 million ($0.77 per share, diluted) in 2013 resulting in a year-over-year increase of $140.1 million. Revenue after royalties increased by $408.5 million for the year ended December 31, 2014 as compared to the prior year, and gains on risk management contracts increased by $129.9 million during the same period. Consistent with the fourth quarter, ARC recognized increased transportation and operating expenses of $31.4 million and $25.5 million, respectively, during 2014 as compared to 2013 reflecting higher production levels, while increased DD&A and impairment charges of $206.6 million relate to increased production levels and lower forward commodity prices and include $103 million of impairment charges recognized in the fourth quarter. Reduced G&A expenses of $12.8 million served to increase net income, while increased intangible exploration and evaluation expenses of $38.1 million and increased losses on foreign exchange of $24.5 million during 2014 offset some of the increases to net income. Additionally, a $38.9 million gain on disposal of petroleum and natural gas properties was recorded during 2013 when a loss of $1.8 million was recorded during the same period of the current year.


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Operating Income
Operating income is a non-GAAP financial measure that does not have standardized meaning, and is therefore unlikely to be comparable to similar measures presented by other issuers. Operating income is defined by ARC as net income excluding the impact of after-tax unrealized gains and losses on risk management contracts, after-tax unrealized gains and losses on foreign exchange, after-tax gains on disposal of petroleum and natural gas properties, after-tax impairment on PP&E, after-tax E&E expense, after-tax unrealized gains and losses on short-term investments, and is further adjusted to include any after-tax portion of unrealized gains or losses on risk management contracts settled annually that relate to current period production. ARC believes that adjusting net income for these non-operating items presents a measure of “full cycle” financial performance that is more comparable between periods than net income. The most directly comparable GAAP measure to operating income is net income. Refer to the section entitled "Non-GAAP Measures" at the end of this MD&A.
ARC's operating income was $64.5 million in the fourth quarter of 2014, up $14.5 million compared to operating income of $50 million in the fourth quarter of 2013. For the year ended December 31, 2014, operating income was $390.3 million, up $165.4 million from $224.9 million from the same period in 2013.
Table 9
 
Three Months Ended
Twelve Months Ended
 
December 31
December 31
Operating Income
($ millions, except per share amounts)
2014

2013

2014

2013

Net income
113.7

13.6

380.8

240.7

Add (deduct) non-operating items:
 
 
 
 
Unrealized loss (gain) on risk management contracts
(212.6
)
27.8

(205.3
)
(30.6
)
Unrealized gain on risk management contracts recognized in previous quarters (1)
—

(5.0
)
—

—

Intangible E&E expenses
9.5

1.3

39.4

1.3

Unrealized loss on foreign exchange
32.7

24.8

73.8

48.9

Loss (gain) on disposal of petroleum and natural gas properties
(0.1
)
0.4

1.8

(38.9
)
Impairment on PP&E
103.0

—

103.0

—

Gain (loss) on short-term investment
1.5

(0.4
)
—

(1.9
)
Income tax associated with non-operating items
16.8

(12.5
)
(3.2
)
5.4

Operating income
64.5

50.0

390.3

224.9

Operating income per share, diluted
0.20

0.16

1.23

0.72

(1) ARC enters into certain commodity price risk management contracts that pertain to production periods spanning the entire calendar year but that are settled at the end of the year on an annual average benchmark commodity price.Throughout the year, ARC has applied the portion of gains or losses associated with these contracts to the funds from operations calculation in the production period to which they relate to more appropriately reflect the funds from operations generated during the period after any effects of contracts used for economic hedging. At December 31, all gains and losses associated with these contracts have been realized, and in the fourth quarter gains or losses previously applied to all prior quarters are reversed.


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Production
Table 10
 
Three Months Ended
Twelve Months Ended
 
December 31
December 31
Production
2014

2013

% Change

2014

2013

% Change

Light and medium crude oil (bbl/d)
36,276

34,556

5

35,467

31,929

11

Heavy oil (bbl/d)
1,166

986

18

1,058

855

24

Condensate (bbl/d)
3,448

2,580

34

3,667

2,251

63

Natural gas (mmcf/d)
432.1

359.4

20

406.1

349.4

16

NGLs (bbl/d)
5,075

2,868

77

4,518

2,811

61

Total production (boe/d)
117,986

100,883

17

112,387

96,087

17

% Natural gas production
61

59

3

60

61

(2
)
% Crude oil and liquids production
39

41

(5
)
40

39

3

ARC’s crude oil production consists predominantly of light and medium crude oil while heavy oil accounts for approximately three per cent of total oil production. During the fourth quarter of 2014, crude oil and liquids production increased 12 per cent from the fourth quarter of the prior year. Increased crude oil and liquids production is mainly the result of positive drilling results from new wells in Tower in northeastern British Columbia and Ante Creek in northern Alberta.
For the year ended December 31, 2014, ARC's total crude oil and liquids production increased by 6,864 barrels per day or 18 per cent as compared to the same period in 2013, also a result of production from new wells brought on-stream throughout 2014.
Natural gas production was 432.1 mmcf per day in the fourth quarter of 2014, an increase of 20 per cent from the 359.4 mmcf per day produced in the fourth quarter of 2013. The increase is mainly attributed to new production in Sunrise as new wells were brought on to fill increased capacity at a third-party facility as well as at Parkland and Attachie in northeastern British Columbia. Higher volumes at Sunrise were partially offset by shut-ins of existing production to accommodate fraccing in the area as well as minor facility issues. Additionally, the disposition of non-core assets early in the second quarter of 2014 producing approximately 2,400 boe per day served as a partial offset to gains in production.
ARC produced 406.1 mmcf per day of natural gas during the year ended December 31, 2014, a 16 per cent increase from the prior year, reflecting strong production results from new wells drilled primarily in northeastern British Columbia.
During the fourth quarter of 2014, ARC drilled 34 gross wells (31 net wells) on operated properties consisting of 30 gross (27 net) oil wells, one gross (one net) natural gas wells, and three gross (three net) liquids-rich natural gas wells. Total wells drilled to December 31, 2014 were 187 gross wells (177 net wells) on operated properties consisting of 139 gross (129 net) oil wells, 26 gross (26 net) natural gas wells, and 22 gross (22 net) liquids-rich natural gas wells.


ARC Resources Ltd.
Page 10

Table 11 summarizes ARC’s production by core area for the fourth quarter of 2014 and 2013:
Table 11
 
Three Months Ended December 31, 2014
Production
Total

Crude Oil

Condensate

Natural Gas

NGLs

Core Area (1)
(boe/d)

(bbl/d)

(bbl/d)

(mmcf/d)

(bbl/d)

Northeast BC
63,675

4,372

2,420

325.0

2,704

Northern AB
22,583

8,496

748

70.3

1,626

Pembina
12,068

9,331

167

12.8

444

South Central AB (2)
8,645

4,542

60

23.0

213

Southeast SK & MB
11,015

10,701

53

1.0

88

Total
117,986

37,442

3,448

432.1

5,075

 
Three Months Ended December 31, 2013
Production
Total

Crude Oil

Condensate

Natural Gas

NGLs

Core Area (1)
(boe/d)

(bbl/d)

(bbl/d)

(mmcf/d)

(bbl/d)

Northeast BC
44,131

1,232

1,535

243.0

879

Northern AB
21,605

9,100

709

63.1

1,278

Pembina
12,427

9,698

177

12.8

420

South Central AB (2)
11,120

4,233

96

39.3

235

Southeast SK & MB
11,600

11,279

63

1.2

56

Total
100,883

35,542

2,580

359.4

2,868

(1)
Provincial references: "AB" is Alberta, "BC" is British Columbia, "SK" is Saskatchewan, "MB" is Manitoba.
(2) During the second quarter of 2014, ARC disposed of certain non-core assets in this district. These assets had been producing approximately 2,400 boe per day prior to disposal.
Table 11a summarizes ARC’s production by core area for the twelve months ended December 31, 2014 and 2013:
Table 11a
 
Twelve Months Ended December 31, 2014
Production
Total

Crude Oil

Condensate

Natural Gas

NGLs

Core Area (1)
(boe/d)

(bbl/d)

(bbl/d)

(mmcf/d)

(bbl/d)

Northeast BC
57,669

3,384

2,580

296.4

2,302

Northern AB
23,339

9,547

811

68.8

1,511

Pembina
11,391

8,779

163

12.3

405

South Central AB (2)
9,190

4,321

70

27.5

220

Southeast SK & MB
10,798

10,494

43

1.1

80

Total
112,387

36,525

3,667

406.1

4,518

 
Twelve Months Ended December 31, 2013
Production
Total

Crude Oil

Condensate

Natural Gas

NGLs

Core Area (1)
(boe/d)

(bbl/d)

(bbl/d)

(mmcf/d)

(bbl/d)

Northeast BC
42,189

934

1,224

235.6

774

Northern AB
18,274

7,005

640

56.8

1,156

Pembina
12,319

8,878

263

15.8

545

South Central AB (2)
11,698

4,648

90

40.1

273

Southeast SK & MB
11,607

11,319

34

1.1

63

Total
96,087

32,784

2,251

349.4

2,811

(1)
Provincial references: "AB" is Alberta, "BC" is British Columbia, "SK" is Saskatchewan, "MB" is Manitoba.
(2)
During the second quarter of 2014, ARC disposed of certain non-core assets in this district. These assets had been producing approximately 2,400 boe per day prior to disposal.


ARC Resources Ltd.
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Sales of Crude Oil, Natural Gas, Condensate, NGLs and Other Income
Sales revenue from crude oil, natural gas, condensate, NGLs and other income was $454.1 million in the fourth quarter of 2014, an increase of $29.1 million from $425 million for the same period in the prior year, reflecting increased production volumes that contributed additional revenue of $61.3 million, partially offset by a decrease in average commodity pricing which lowered revenue by $32.2 million. Crude oil, condensate and NGLs revenue accounted for $288.5 million or 64 per cent of fourth quarter sales revenue.
For the year ended December 31, 2014, sales revenue from crude oil, natural gas, condensate, NGLs and other income was $2,107.7 million, an increase of $483.4 million from $1,624.3 million compared to the prior year, reflecting an increase in 2014 average pricing which contributed additional revenue of $197.2 million and increased production volumes that contributed an additional $286.2 million.
A breakdown of sales revenue by product is outlined in Table 12:
Table 12
 
Three Months Ended
Twelve Months Ended
 
December 31
December 31
Sales revenue by product
($ millions)
2014

2013

% Change

2014

2013

% Change

Crude oil
249.7

270.9

(8
)
1,208.4

1,063.8

14

Condensate
23.5

21.0

12

125.6

77.3

62

Natural gas
165.0

119.5

38

705.6

440.2

60

NGLs
15.3

10.9

40

65.1

37.2

75

Total sales revenue from crude oil, natural gas, condensate and NGLs
453.5

422.3

7

2,104.7

1,618.5

30

Other income
0.6

2.7

(78
)
3.0

5.8

(48
)
Total sales revenue
454.1

425.0

7

2,107.7

1,624.3

30

Commodity Prices Prior to Hedging
Table 13
 
Three Months Ended
Twelve Months Ended
 
December 31
December 31
 
2014

2013

% Change

2014

2013

% Change

Average Benchmark Prices
 
 
 
 
 
 
AECO natural gas (Cdn$/mcf) (1)
4.01

3.15

27

4.42

3.16

40

WTI oil (US$/bbl)
73.20

97.61

(25
)
92.91

98.05

(5
)
Cdn$/US$ exchange rate
1.14

1.05

9

1.10

1.03

7

WTI oil (Cdn$/bbl)
83.45

102.49

(19
)
102.20

100.99

1

Edmonton par (Cdn$/bbl)
75.65

86.64

(13
)
94.46

93.16

1

ARC Realized Prices Prior to Hedging
 
 
 
 
 
 
Crude oil ($/bbl)
72.49

82.85

(13
)
90.64

88.90

2

Condensate ($/bbl)
74.04

88.72

(17
)
93.81

94.13

—

Natural gas ($/mcf)
4.15

3.61

15

4.76

3.45

38

NGLs ($/bbl)
32.69

41.47

(21
)
39.45

36.25

9

Total commodity price prior to other income and hedging ($/boe)
41.78

45.51

(8
)
51.31

46.15

11

Other income ($/boe)
0.05

0.29

(83
)
0.07

0.16

(56
)
Total commodity price prior to hedging ($/boe)
41.83

45.80

(9
)
51.38

46.31

11

(1)
Represents the AECO Monthly (7a) index.
In the fourth quarter of 2014, WTI (US$/bbl) decreased 25 per cent as compared to the same period in 2013. Similarly, ARC’s realized crude oil price also decreased by 13 per cent during the same time period. During the fourth quarter of 2014, the differential between WTI and Edmonton posted prices narrowed to an average discount of US$6.51 per barrel compared to US$14.97 per barrel in the same period in 2013 and during the same period, the average exchange rate


ARC Resources Ltd.
Page 12

for the Canadian dollar as compared to the US dollar weakened from $1.05 to $1.14, lessening the overall impact of the decrease in WTI.
ARC's average realized oil price for the twelve months ended December 31, 2014 of $90.64 per barrel was two per cent higher than in 2013. Although WTI decreased five per cent during 2014 as compared to 2013, the average differential between WTI and Edmonton posted prices narrowed slightly in 2014 when compared to 2013 from an average of US$7.57 to US$7.41, respectively. Additionally, the value of the Canadian dollar weakened in comparison to the US dollar, from an average of $1.03 in 2013 to $1.10 in 2014, which increased the Canadian dollar price that ARC ultimately received for its oil.
Natural gas prices increased in the fourth quarter of 2014 as compared to 2013 as natural gas inventory levels remained lower compared to the previous year. ARC's fourth quarter 2014 average realized price of $4.15 per mcf was higher than the average AECO monthly index price during the same period due in part to ARC's higher than average heat content in its natural gas. Additionally, ARC maintains a diversified sales portfolio that allows some flexibility on a portion of its natural gas sales between monthly average and daily spot pricing at sales hubs in western Canada and the mid-western United States.
During the year ended December 31, 2014, ARC's average realized natural gas price of $4.76 per mcf increased by 38 per cent over the same period of the prior year and reflects the 40 per cent increase in the average AECO monthly posting in 2014 as compared to 2013.
While ARC’s production mix on a per boe basis is weighted more heavily to natural gas than to oil, ARC's revenue contribution is more heavily weighted to crude oil and liquids production as shown by the table below:
Table 14
Revenue by Product Type
Three Months Ended
Year Ended
 
December 31
December 31
($ millions)
2014
2013
2014
2013
 
Revenue

% of Total
Revenue

% of Total
Revenue

% of Total
Revenue

% of Total
Crude oil and liquids
288.5

64
302.8

71
1,399.1

66
1,178.3

73
Natural gas
165.0

36
119.5

28
705.6

34
440.2

27
Total sales revenue from crude oil, natural gas, condensate and NGLs
453.5

100
422.3

99
2,104.7

100
1,618.5

100
Other income
0.6

—
2.7

1
3.0

—
5.8

—
Total sales revenue
454.1

100
425.0

100
2,107.7

100
1,624.3

100
Risk Management
ARC maintains a risk management program to reduce the volatility of revenues, increase the certainty of funds from operations, and to protect acquisition and development economics. ARC’s risk management program is governed by certain guidelines approved by the Board of Directors (the "Board"). These guidelines currently restrict risk management contracts to a maximum of 55 per cent of total forecast production whereby a specific commodity (crude oil or natural gas) cannot exceed a maximum of 70 per cent of forecast production for that commodity over the next two years, and with a maximum of 25 percent of forecast natural gas production in risk management contracts beyond two years and up to five years. ARC’s risk management program guidelines allow for further risk management contracts on anticipated volumes associated with new production arising from specific capital projects and acquisitions or to further protect cash flows for a specific period with approval of the Board.
Gains and losses on risk management contracts are composed of both realized gains and losses, representing the portion of risk management contracts that have settled in cash during the period, and unrealized gains or losses that represent the change in the mark-to-market position of those contracts throughout the period. ARC does not employ hedge accounting for any of its risk management contracts currently in place. ARC considers all of its risk management contracts to be effective economic hedges of its underlying business transactions.
Table 15 summarizes the total gain or loss on risk management contracts for the fourth quarter of 2014 compared to the same period in 2013:
Table 15
Risk Management Contracts
($ millions)
Crude Oil & Liquids

Natural
 Gas

Foreign Currency

Power

Q4 2014 Total

Q4 2013 Total

Realized gain (loss) on contracts (1)
29.9

3.5

(7.7
)
(0.9
)
24.8

8.9

Unrealized gain on contracts recognized in previous quarters (2)
—

—

—

—

—

(5.0
)
Impact of risk management contracts on funds from operations
29.9

3.5

(7.7
)
(0.9
)
24.8

3.9

Unrealized gain (loss) on contracts related to future production periods (3)
23.2

183.8

3.9

1.7

212.6

(22.8
)
Gain (loss) on risk management contracts
53.1

187.3

(3.8
)
0.8

237.4

(18.9
)
(1)
Represents actual cash settlements or receipts under the respective contracts.
(2)
ARC enters into certain commodity price risk management contracts that pertain to production periods spanning the entire calendar year but that are settled at the end of the year on an annual average benchmark commodity price.
(3)
Represents the change in fair value of the contracts during the period.
Table 15a summarizes the total gain or loss on risk management contracts for the year ended December 31, 2014 compared to the same period in 2013:
Table 15a
Risk Management Contracts
($ millions)
Crude Oil & Liquids

Natural
 Gas

Foreign Currency

Power

2014 YTD Total

2013 YTD Total

Realized gain (loss) on contracts (1)
12.0

(23.5
)
(15.9
)
(1.7
)
(29.1
)
15.7

Unrealized gain (loss) on contracts related to future production periods (2)
40.9

165.7

(0.9
)
(0.4
)
205.3

30.6

Gain (loss) on risk management contracts
52.9

142.2

(16.8
)
(2.1
)
176.2

46.3

(1)
Represents actual cash settlements or receipts under the respective contracts.
(2)
Represents the change in fair value of the contracts during the period.
During the fourth quarter of 2014, ARC recorded a gain of $237.4 million on its risk management contracts comprising realized gains of $24.8 million and unrealized gains of $212.6 million. The realized gains related to crude oil and natural gas, offset by realized losses on foreign exchange and electricity contracts.
For the year ended December 31, 2014, ARC has recognized a gain on its risk management contracts of $176.2 million comprising a realized loss of $29.1 million and an unrealized gain of $205.3 million. The realized losses are related to natural gas, foreign exchange and electricity contracts, offset by gains on crude oil contracts.
ARC's fourth quarter 2014 net unrealized gains related primarily to natural gas contracts and to a lesser extent, crude oil contracts. Gains on natural gas contracts reflect lower NYMEX prices and wider basis through 2019 while gains on crude oil contracts reflect contract gains from lower crude oil prices through the first half of 2015.
ARC’s risk management contracts provide protection from natural gas prices falling lower than an average floor price of US$3.94 per mmbtu on approximately 219,900 mmbtu per day for 2015. In addition, they provide upside participation to a price of US$4.56 per mmbtu on approximately 219,900 mmbtu per day for 2015. ARC has also executed long-term natural gas hedge contracts on 145,000 mmbtu per day for the period 2016 through 2017, 90,000 mmbtu per day for 2018 and 40,000 mmbtu per day for 2019.
ARC also has AECO basis swap contracts in place, fixing the AECO price received to approximately 90 per cent of the Henry Hub NYMEX price on a portion of its natural gas volume throughout 2015 and into 2019. As at December 31, 2014, the net fair value of these basis swap contracts was an asset of $67.7 million.
ARC has protected the selling price on a portion of crude oil production by establishing crude oil floor and ceiling prices for 2015. Approximately 6,000 barrels per day of crude oil production has been hedged at floor prices of US$90 per barrel for the first six months of 2015. ARC has also sold floors on these positions at an average price of US$65 per barrel which limit downside protection and reduce ARC’s overall hedging transaction costs. These contracts allow ARC to participate in crude oil prices up to approximately US$101 per barrel on 6,000 barrels per day for the first half of 2015. Additionally, ARC has hedged approximately 5,000 barrels per day of crude oil production throughout the second and


ARC Resources Ltd.
Page 13

third quarters of 2015 at an average floor price of Cdn$60 per barrel. These contracts allow ARC to participate in crude oil prices up to Cdn$80 per barrel on 5,000 barrels per day of production throughout the second and third quarters of 2015.
Table 16 summarizes ARC’s average crude oil and natural gas hedged volumes for 2015 through 2019 as at the date of this MD&A. For a complete listing and terms of ARC’s hedging contracts at December 31, 2014, see Note 15 “Financial Instruments and Market Risk Management” in the financial statements as at and for the year ended December 31, 2014. Updates to the following table are posted to ARC’s website at www.arcresources.com.
Table 16
Hedge Positions Summary (1)
 
 
 
 
 
 
 
 
 
 
As at February 11, 2015
2015
2016
2017
2018
2019
Crude Oil (2)
US$/bbl

bbl/day

US$/bbl

bbl/day

US$/bbl

bbl/day

US$/bbl

bbl/day

US$/bbl

bbl/day

Ceiling
100.83

2,975

—

—

—

—

—

—

—

—

Floor
90.00

2,975

—

—

—

—

—

—

—

—

Sold Floor
65.00

2,975

—

—

—

—

—

—

—

—

Crude Oil (2)
Cdn$/bbl

bbl/day

Cdn$/bbl

bbl/day

Cdn$/bbl

bbl/day

Cdn$/bbl

bbl/day

Cdn$/bbl

bbl/day

Ceiling
80.00

2,507

—

—

—

—

—

—

—

—

Floor
60.00

2,507

—

—

—

—

—

—

—

—

Natural Gas (3)
US$/mmbtu

mmbtu/day

US$/mmbtu

mmbtu/day

US$/mmbtu

mmbtu/day

US$/mmbtu

mmbtu/day

US$/mmbtu

mmbtu/day

Ceiling
4.56

219,932

4.81

145,000

4.81

145,000

4.92

90,000

5.00

40,000

Floor
3.94

219,932

4.00

145,000

4.00

145,000

4.00

90,000

4.00

40,000

Natural Gas - AECO Basis (4)
AECO/NYMEX

mmbtu/day

AECO/NYMEX

mmbtu/day

AECO/NYMEX

mmbtu/day

AECO/NYMEX

mmbtu/day

AECO/NYMEX

mmbtu/day

Swap (percentage of NYMEX)
89.9

145,123

90.3

140,000

90.2

140,000

88.2

55,000

90.8

9,918

Foreign Exchange
Cdn$/
US$

US$ Total

Cdn$/
US$

US$ Total

Cdn$/
US$

US$ Total

Cdn$/
US$

US$ Total

Cdn$/
US$

US$ Total

Ceiling
1.0725

48,000

—

—

—

—

—

—

—

—

Floor
1.0463

48,000

—

—

—

—

—

—

—

—

(1)
The prices and volumes in this table represent averages for several contracts representing different periods. The average price for the portfolio of options listed above does not have the same payoff profile as the individual option contracts. Viewing the average price of a group of options is purely for indicative purposes. All positions are financially settled against the benchmark prices disclosed in Note 15 “Financial Instruments and Market Risk Management” in the financial statements for the year ended December 31, 2014.
(2)
The crude oil prices in this table are referenced to WTI.
(3) The natural gas prices in this table are referenced to NYMEX at Henry Hub.
(4)
ARC sells the majority of its natural gas production based on AECO pricing. To reduce the risk of weak basis pricing (AECO relative to NYMEX) ARC has hedged a portion of production by tying ARC's price to a percentage of the NYMEX natural gas price.
“Floors” represent the lower price limits on hedged volumes and consist of put and swap prices. “Ceilings” provide an upper limit to the prices ARC may receive for hedged volumes and are the result of combined call and swap prices. ARC has also sold puts that limit the downside protection at an average of the disclosed “Sold Floor” price. These “Sold Floors” do not eliminate the floor, but merely limit the downside protection. The purpose of these sold puts is to reduce ARC’s overall hedging transaction costs.
To accurately analyze ARC’s hedge position, contracts need to be modeled separately as using average prices and volumes may be misleading. The following provides examples of how Table 16 can be interpreted for approximate current year values (all in US dollars):
•
If the market price is above $100.83 per barrel, ARC will receive $100.83 per barrel on 2,975 barrels per day.
•
If the market price is between $90.00 and $100.83 per barrel, ARC will receive the market price on 2,975 barrels per day.
•
If the market price is between $65.00 and $90.00 per barrel, ARC will receive $90.00 per barrel on 2,975 barrels per day.


ARC Resources Ltd.
Page 14

•
If the market price is below $65.00 per barrel, ARC will receive $90.00 per barrel less the difference between $65.00 per barrel and the market price on 2,975 barrels per day. For example, if the market price is at $55.00 per barrel, ARC will receive $80.00 per barrel on 2,975 barrels per day.
The net fair value of ARC’s risk management contracts at December 31, 2014 was a net asset of $257.8 million, representing the expected market price to buy out ARC’s contracts at the balance sheet date after any adjustments for credit risk. This may differ from what will eventually be settled in future periods.
Operating Netbacks
ARC’s operating netback prior to hedging was $25.00 per boe in the fourth quarter of 2014 ($33.01 for the year ended December 31, 2014) as compared to $28.34 per boe in the same period of 2013 ($28.57 for the year ended December 31, 2013).
ARC’s fourth quarter and 2014 netbacks, including realized hedging gains and losses, were $27.29 per boe and $32.36 per boe, respectively, representing a decrease of five per cent and an increase of 12 per cent as compared to the same periods in 2013.
The components of operating netbacks for the fourth quarter of 2014 compared to the same period in 2013 are summarized in Table 17:
Table 17
Netbacks (1)
Crude Oil

Heavy Oil

Condensate

Natural Gas

NGLs

Q4 2014 Total

Q4 2013 Total

 
($/bbl)

($/bbl)

($/bbl)

($/mcf)

($/bbl)

($/boe)

($/boe)

Average sales price
72.90

59.71

74.04

4.15

32.69

41.78

45.51

Other income
—

—

—

—

—

0.05

0.29

Total sales
72.90

59.71

74.04

4.15

32.69

41.83

45.80

Royalties
(11.97
)
(4.32
)
(13.72
)
(0.39
)
(4.85
)
(5.77
)
(6.42
)
Transportation
(3.39
)
(0.62
)
(4.59
)
(0.27
)
(8.17
)
(2.51
)
(1.83
)
Operating expenses (2)
(14.46
)
(13.27
)
(6.18
)
(0.96
)
(6.05
)
(8.55
)
(9.21
)
Netback prior to hedging
43.08

41.50

49.55

2.53

13.62

25.00

28.34

Hedging gain (3)
7.24

—

—

0.02

—

2.29

0.41

Netback after hedging
50.32

41.50

49.55

2.55

13.62

27.29

28.75

% of total netback
57

2

5

34

2

100

100

(1)
Non-GAAP measure which may not be comparable to similar non-GAAP measures used by other entities. Refer to the section entitled "Non-GAAP Measures" contained within this MD&A.
(2)
Composed of direct costs incurred to operate crude oil and natural gas wells. A number of assumptions have been made in allocating these costs between crude oil, heavy oil, condensate, natural gas and NGLs production.
(3)
Includes realized cash gains and losses on commodity risk management contracts, plus a reversal for unrealized gains and losses on risk management contracts that relate to current year production that have been recognized in netback calculations in prior quarters.


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The components of operating netbacks for the year ended December 31, 2014 compared to the same period in 2013 are summarized in Table 17a:
Table 17a
Netbacks (1)
Crude Oil

Heavy Oil

Condensate

Natural Gas

NGLs

2014 YTD Total

2013 YTD Total

 
($/bbl)

($/bbl)

($/bbl)

($/mcf)

($/bbl)

($/boe)

($/boe)

Average sales price
91.17

72.95

93.81

4.76

39.45

51.31

46.15

Other income
—

—

—

—

—

0.07

0.16

Total sales
91.17

72.95

93.81

4.76

39.45

51.38

46.31

Royalties
(14.65
)
(4.99
)
(14.20
)
(0.52
)
(6.08
)
(7.26
)
(6.36
)
Transportation
(2.97
)
(0.71
)
(3.36
)
(0.25
)
(6.82
)
(2.23
)
(1.72
)
Operating expenses (2)
(14.94
)
(15.54
)
(6.58
)
(0.97
)
(6.98
)
(8.88
)
(9.66
)
Netback prior to hedging
58.61

51.71

69.67

3.02

19.57

33.01

28.57

Hedging gain (loss) (3)
0.12

—

—

(0.19
)
—

(0.65
)
0.45

Netback after hedging
58.73

51.71

69.67

2.83

19.57

32.36

29.02

% of total netback
57

2

7

32

2

100

100

(1)
Non-GAAP measure which may not be comparable to similar non-GAAP measures used by other entities. Refer to the section entitled "Non-GAAP Measures" contained within this MD&A.
(2)
Composed of direct costs incurred to operate crude oil and natural gas wells. A number of assumptions have been made in allocating these costs between crude oil, heavy oil, condensate, natural gas and NGLs production.
(3)
Includes realized cash gains and losses on commodity risk management contracts.
Royalties
ARC pays royalties to the respective provincial governments and landowners of the four western Canadian provinces in which it operates. Approximately 85 per cent of these royalties are Crown royalties. Each province that ARC operates in has established a separate and distinct royalty regime which impacts ARC’s average corporate royalty rate.
In British Columbia, the majority of ARC’s royalty expense stems from production of natural gas and associated liquids. While condensate and NGLs have a flat royalty rate of 20 per cent of sales revenue, the royalty rates for natural gas are based on the drill date of a well and a producer price. In Alberta, the majority of ARC’s royalties are related to oil production where royalty rates are based on reference prices, production levels and well depths. Similarly, most royalties remitted in Saskatchewan and Manitoba relate to oil production. Royalty calculations in these provinces are based on the classification of the oil product and well productivity.
Each province has various incentive programs in place to promote drilling by reducing the overall royalty expense for producers and offsetting gathering and processing costs. In most cases, the incentive period lasts for a finite period of time (usually 12 months upon commencement of production), after which point the royalty rate usually increases depending on the production rate of the well and prevailing market commodity prices.
In the first quarter of 2013, the British Columbia government announced a three per cent minimum royalty for all natural gas wells that qualify for the Deep Well Royalty Credit as well as the termination of the Summer Drilling Credit Program. These changes were effective April 1, 2013 and had a minimal impact on natural gas royalties for the balance of 2013. During the first quarter of 2014, the provincial government of British Columbia announced further changes to its royalty program, whereby the three per cent minimum royalty was replaced by a six per cent minimum and additional royalty credits will be made available for horizontal wells drilled to depths greater than 1,900 meters. These changes apply to wells spud on or after April 1, 2014.
Total royalties as a percentage of pre-hedged commodity product sales revenue decreased from 14 per cent ($6.42 per boe) in the fourth quarter of 2013 to 13.8 per cent ($5.77 per boe) in the fourth quarter of 2014 reflecting the decrease to average commodity prices during that time period. Total royalties increased from $59.5 million in the fourth quarter of 2013 to $62.7 million in the fourth quarter of 2014 as a result of increased sales volumes. For the year ended December 31, 2014, total royalties represented 14.1 per cent of pre-hedged commodity product sales ($7.26 per boe) as compared to 13.7 per cent ($6.36 per boe) for the same period in 2013. The increase is primarily attributed to higher average commodity prices year-over-year.


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Page 16

Operating and Transportation Expenses
Operating expenses decreased to $8.55 per boe in the fourth quarter of 2014 ($8.88 per boe for the year ended December 31, 2014) compared to $9.21 per boe in the fourth quarter of 2013 ($9.66 per boe for the year ended December 31, 2013). On an absolute dollar basis, operating expenses have increased by $7.3 million or nine per cent for the fourth quarter of 2014 as compared to the fourth quarter of 2013, reflecting additional costs associated with increased production volumes. On a per boe basis, ARC's operating costs were lower for the fourth quarter of 2014 and the year compared to the same periods of 2013 as additional production volumes were brought on in areas having lower average operating costs. Additionally, electricity costs were lower in 2014 than 2013 with an average Alberta Power Pool Rate of $49.63 per megawatt hour in 2014 as compared to an average of $79.95 per megawatt hour in 2013, further reducing operating costs year-over-year.
ARC hedges a portion of its electricity costs using financial risk management contracts that do not qualify for hedge accounting. The gains and losses associated with these contracts are included within gains and losses on risk management contracts on the consolidated statements of income (the "statements of income"). Had these contracts been recognized within operating expenses, ARC’s operating expenses would have been increased by $0.08 per boe for the three months ended December 31, 2014 (increased by $0.04 per boe for the year ended December 31, 2014) as a result of a realized loss of $0.9 million during the period (realized loss of $1.7 million for the year ended December 31, 2014).
Transportation expense was $2.51 per boe during the fourth quarter of 2014 ($2.23 per boe for the year ended December 31, 2014) as compared to $1.83 per boe in the fourth quarter of 2013 ($1.72 per boe for the year ended December 31, 2013). This increase in transportation charges during both the fourth quarter of 2014 relative to the fourth quarter of 2013, as well as 2014 relative to 2013, is primarily related to increased production volumes in the Parkland and Tower areas where the majority of liquids volumes are currently transported by truck. ARC chooses to control its own transportation arrangements in order to move its product most efficiently to market. ARC has entered into additional pipeline transportation contracts in order to secure transportation of its products in future years. These contracts are included in Table 28 "Contractual Obligations and Commitments" in this MD&A and in Note 19 "Commitments and Contingencies" of ARC's financial statements for the year ended December 31, 2014.
G&A Expenses and Long-Term Incentive Compensation
G&A, prior to long-term incentive compensation expense and net of capitalized G&A and overhead recoveries on operated properties, increased by three per cent to $14.8 million in the fourth quarter of 2014 from $14.4 million in the fourth quarter of 2013. While G&A expenses before the impact of recoveries and capitalized G&A remained flat from the fourth quarter of 2013 to the fourth quarter of 2014, there was a three per cent reduction in capitalized G&A and overhead recoveries during the same period. This reduction is related to fewer operating recoveries from partners following a disposition of non-core assets in the second quarter of 2014.
For the year ended December 31, 2014, ARC's G&A, prior to long-term compensation expense and net of capitalized G&A and overhead recoveries on operated properties, was $59 million, a $0.5 million increase from the same period in 2013. The increase reflects increased staffing costs offset by higher capitalized G&A and recoveries from partners associated with higher capital spending.


ARC Resources Ltd.
Page 17

Table 18 is a breakdown of G&A and long-term incentive compensation expenses:
Table 18
 
Three Months Ended
Twelve Months Ended
 
December 31
December 31
G&A and Long-term Incentive Compensation
2014

2013

% Change

2014

2013

% Change

($ millions, except per boe)
G&A expenses (1)
27.1

27.1

—

107.1

104.8

2

Capitalized G&A and overhead recoveries
(12.3
)
(12.7
)
(3
)
(48.1
)
(46.3
)
4

G&A expenses before long-term incentive plans
14.8

14.4

3

59.0

58.5

1

G&A – long-term incentive plans (2)
11.2

9.9

13

25.3

38.6

(34
)
Total G&A and long-term incentive compensation expenses
26.0

24.3

7

84.3

97.1

(13
)
Total G&A and long-term incentive compensation expenses per boe
2.40

2.62

(8
)
2.06

2.77

(26
)
(1)
Includes expenses recognized under the DSU Plan.
(2)
Comprised of expenses recognized under the RSU, PSU and Stock Option Plans.
Long-Term Incentive Plans – Restricted Share Unit & Performance Share Unit Plan, Share Option Plan, and Deferred Share Unit Plan
Restricted Share Unit and Performance Share Unit Plan
The RSU and PSU Plan is designed to offer each eligible employee and officer (the “plan participants”) cash compensation in relation to the underlying value of a specified number of share units. The RSU and PSU Plan consists of RSUs for which the number of units is fixed and will vest over a period of three years and PSUs for which the number of units is variable and will vest at the end of three years.
Upon vesting, the plan participant is entitled to receive a cash payment based on the underlying value of the share units plus accrued dividends. The cash compensation issued upon vesting of the PSUs is dependent upon the total return performance of ARC compared to its peers. Total return is calculated as a sum of the change in the market price of the common shares in the period plus the amount of dividends in the period. A performance multiplier is applied to the PSUs based on the percentile rank of ARC’s total shareholder return compared to its peers. The performance multiplier ranges from zero if ARC’s performance ranks in the bottom quartile, to two for top quartile performance.
ARC recorded G&A expenses of $10.4 million during the fourth quarter of 2014 in accordance with the RSU and PSU Plan, as compared to $9.3 million during the fourth quarter of 2013. During the fourth quarter of 2014, ARC recognized additional compensation charges associated with a higher estimated performance multiplier for its PSU awards relative to what ARC had been estimating earlier in the year. The additional compensation charges associated with a higher performance multiplier estimate were partially offset by a reduction to the valuation of awards at December 31, 2014, as ARC's share price decreased to $25.16 per share at December 31, 2014 as compared to $29.55 at September 30, 2014.
For the year ended December 31, 2014, ARC recorded expenses related to the RSU and PSU Plan of $22.6 million, a decrease of $14.1 million or 38 per cent from the year ended December 31, 2013.This decrease reflects a decrease in ARC's share price from December 31, 2013 of $29.57 per share to $25.16 per share at December 31, 2014, which served to decrease the value of accrued awards.
During the year ended December 31, 2014, ARC made cash payments of $39.4 million in respect of the RSU and PSU Plan ($33.7 million for the year ended December 31, 2013). Of these payments, $28.9 million were in respect of amounts recorded to G&A expenses ($25 million for the year ended December 31, 2013) and $10.5 million were in respect of amounts recorded to operating expenses and capitalized as PP&E and E&E assets ($8.7 million for the year ended December 31, 2013). These amounts were accrued in prior periods.


ARC Resources Ltd.
Page 18

Table 19 shows the changes to the RSU and PSU Plan during 2014:
Table 19
RSU and PSU Plan
(number of units, thousands)

RSUs
PSUs (1)
Total
RSUs and PSUs
Balance, December 31, 2013
638
1,492
2,130
Granted
327
494
821
Distributed
(299)
(435)
(734)
Forfeited
(41)
(38)
(79)
Balance, December 31, 2014
625
1,513
2,138
(1)
Based on underlying units before performance multiplier.
The liability associated with the RSUs and PSUs granted is recognized in the statements of income over the vesting period while being adjusted each period for changes in the underlying share price, accrued dividends and the number of PSUs expected to be issued on vesting. In periods where substantial share price fluctuation occurs, ARC’s G&A expenses are subject to greater volatility.
Due to the variability in the future payments under the plan, ARC estimates that between $16.3 million and $96.3 million will be paid out in 2015 through 2017 based on the current share price, accrued dividends, and ARC’s market performance relative to its peers. Table 20 is a summary of the range of future expected payments under the RSU and PSU Plan based on variability of the performance multiplier and units outstanding under the RSU and PSU Plan as at December 31, 2014:
Table 20
Value of RSU and PSU Plan as at
 
 
 
December 31, 2014
Performance multiplier
(units thousands and $ millions, except per share)
—

1.0

2.0

Estimated units to vest
 
 
 
RSUs
648

648

648

PSUs
—

1,590

3,180

Total units (1)
648

2,238

3,828

Share price (2)
25.16

25.16

25.16

Value of RSU and PSU Plan upon vesting (3)
16.3

56.3

96.3

2015
8.2

22.1

36.1

2016
5.4

19.2

33.0

2017
2.7

15.0

27.2

(1)
Includes additional estimated units to be issued under the RSU and PSU Plan for dividends accrued to date.
(2)
Values will fluctuate over the vesting period based on the volatility of the underlying share price. Assumes a future share price of $25.16, which is based on the closing share price at December 31, 2014.
(3)
Upon vesting, a cash payment is made for the value of the share units, equivalent to the current market price of the underlying common shares plus accrued dividends.
Share Option Plan
Share options are granted to employees and consultants of ARC, vesting evenly on the fourth and fifth anniversaries of their respective grant dates, and have a maximum term of seven years. The option holder has the right to exercise the options at the original exercise price or at a reduced exercise price, equal to the exercise price at grant date less all dividends paid subsequent to the grant date and prior to the exercise date. On June 19, 2014, ARC granted 568,538 options to officers and certain employees at ARC.
At December 31, 2014, ARC had 2.5 million share options outstanding under this plan, representing less than one per cent of outstanding shares, with a weighted average exercise price of $23.43 per share. Compensation expense of $0.8 million has been recorded during the fourth quarter of 2014 ($2.7 million for the year ended December 31, 2014) compared to $0.6 million for the fourth quarter of 2013 ($1.9 million for the year ended December 31, 2013), and is included within G&A expenses.


ARC Resources Ltd.
Page 19

Deferred Share Unit Plan
ARC has a DSU Plan for its non-employee directors under which each director receives a minimum of 60 per cent of their total annual remuneration in the form of DSUs. Each DSU fully vests on the date of grant but is settled in cash only when the director has ceased to be a member of the Board. For the three and twelve months ended December 31, 2014, a G&A recovery of $0.5 million and a G&A expense of $0.8 million were recorded in relation to the DSU Plan, respectively (G&A expenses of $0.9 million and $2.4 million in 2013).
Interest and Financing Charges
Interest and financing charges increased 14 per cent to $12.9 million in the fourth quarter of 2014 from $11.3 million in the fourth quarter of 2013. For the year ended December 31, 2014, interest and financing charges were $47.3 million as compared to $42.5 million in 2013, an increase of 11 per cent. The increase in interest charges primarily reflects a higher average debt level held by ARC during the 2014 as compared to 2013. Average debt levels were lower in 2013 following an equity offering completed during the latter half of 2012 which served to finance a portion of ARC's 2013 capital program.
At December 31, 2014, ARC had $1,074.8 million of long-term debt outstanding, including a current portion of $49.5 million that is due for repayment within the next 12 months. Of the total debt balance, $991 million is fixed at a weighted average interest rate of 4.51 per cent, while the remaining $83.8 million incurs a floating interest rate based on market rates plus a current credit spread of 150 basis points. Approximately 87 per cent (US$809.7 million) of ARC’s debt outstanding is denominated in US dollars.
Foreign Exchange Gains and Losses
ARC recorded a foreign exchange loss of $32.3 million in the fourth quarter of 2014 compared to a loss of $24.8 million in the fourth quarter of 2013. The loss is a result of the revaluation of ARC’s US dollar denominated debt outstanding from the period of September 30, 2014 to December 31, 2014 and reflects the change in value of the US dollar relative to the Canadian dollar from $1.1208 to $1.1601.
For the year ended December 31, 2014, ARC recorded a foreign exchange loss of $73.7 million compared to a loss of $49.2 million for the same period in the prior year. During 2014, the value of the US dollar relative to the Canadian dollar increased from $1.0636 at December 31, 2013 to $1.1601 at December 31, 2014 which ultimately increased the Canadian dollar equivalent of ARC's US dollar debt obligation. In 2013, the value of the US dollar relative to the Canadian dollar increased to a lesser extent, increasing from $0.9949 at December 31, 2012 to $1.0636 at December 31, 2013. Additionally, as ARC's average debt balance was higher in 2014 than in 2013, a larger foreign exchange loss was recognized in 2014.
Table 21 shows the various components of foreign exchange losses:
Table 21
 
Three Months Ended
Twelve Months Ended
 
December 31
December 31
Foreign Exchange Gains and Losses
($ millions)
2014

2013

% Change
2014

2013

% Change

Unrealized loss on US denominated debt
(32.7
)
(24.8
)
32
(73.8
)
(48.9
)
51

Realized gain (loss) on US denominated transactions
0.4

—

—
0.1

(0.3
)
(133
)
Total foreign exchange loss
(32.3
)
(24.8
)
30
(73.7
)
(49.2
)
50

Taxes
ARC recorded a current income tax expense of $6.3 million in the fourth quarter of 2014 ($70.3 million expense for the year ended December 31, 2014) compared to a current tax recovery of $6.4 million during the fourth quarter of 2013 ($16.3 million expense for the year ended December 31, 2013). The increases in current taxes for both the fourth quarter and the year ended December 31, 2014 compared to the same periods in 2013 reflect higher annual taxable income for 2014 related to increased average commodity prices and production volumes.


ARC Resources Ltd.
Page 20

During the fourth quarter of 2014, a deferred income tax expense of $23.5 million was recorded ($59.1 million expense for the year ended December 31, 2014) compared to an expense of $15.1 million in the fourth quarter of 2013 ($77.9 million expense for the year ended December 31, 2013). For the three months ended December 31, 2014 as compared to the three months ended December 31, 2013, ARC’s increase in deferred tax expense is related primarily to an increase in unrealized gains on risk management contracts partially offset by temporary differences arising from the book basis of ARC's PP&E relative to its tax basis. For the year ended December 31, 2014 as compared to the year ended December 31, 2013, ARC’s decrease in deferred tax expense is related primarily to a net increase in the ARO liability and temporary differences arising from the book basis of ARC's PP&E relative to its tax basis, partially offset by an increase in unrealized gains on risk management contracts.
The income tax pools (detailed in Table 22) are deductible at various rates and annual deductions associated with the initial tax pools will decline over time.
Table 22
Income Tax Pool Type
($ millions)
December 31, 2014


Annual Deductibility

Canadian oil and gas property expense
710.9

10% declining balance

Canadian development expense
974.6

30% declining balance

Canadian exploration expense
—

100
%
Undepreciated capital cost
834.5

Primarily 25% declining balance

Other
10.8

Various rates, 7% declining balance to 20%

Total federal tax pools
2,530.8

 
Additional Alberta tax pools
19.9

Various rates, 25% declining balance to 100%


DD&A Expense and Impairment Charges
ARC records DD&A expense on its PP&E over the individual useful lives of the assets employing the unit of production method using proved plus probable reserves and associated estimated future development capital required for its oil and natural gas assets, and a straight-line method for its corporate administrative assets. Assets in the E&E phase are not amortized. For the three and twelve months ended December 31, 2014, ARC recorded DD&A expense prior to any impairment of $176.4 million and $655.5 million as compared to $157 million and $551.9 million for three and twelve months ended December 31, 2013, reflecting increased production volumes as well as increased capital spending on infrastructure as ARC continues to develop its own infrastructure to facilitate production in high-growth areas.
Impairment is recognized when the carrying value of an asset or group of assets exceeds its recoverable amount, defined as the higher of its value in use or fair value less cost to sell. Any asset impairment that is recorded is recoverable to its original value less any associated DD&A expense should there be indicators that the recoverable amount of the asset has increased in value since the time of recording the initial impairment. At December 31, 2014, an impairment charge of $103 million was recognized associated with assets located in the northern Alberta area as a result of lower forward commodity pricing. There were no impairment charges or recoveries recorded in 2013. See Note 5 "Management Judgments and Estimation Uncertainty" to ARC's financial statements for the year ended December 31, 2014 for further information regarding the estimation of recoverability of asset carrying values at December 31, 2014. As future commodity prices remain volatile, impairment charges or recoveries could be recorded in future periods.
A breakdown of DD&A expense is summarized in Table 23:
Table 23
 
Three Months Ended
Twelve Months Ended
 
December 31
December 31
DD&A Expense
($ millions, except per boe amounts)
2014

2013

% Change

2014

2013

% Change

Depletion of oil and gas assets
174.7

155.5

12

649.2

545.4

19

Depreciation of administrative assets
1.7

1.5

13

6.3

6.5

(3
)
Impairment charges
103.0

—

100

103.0

—

100

Total DD&A expense and impairment charges
279.4

157.0

78

758.5

551.9

37

DD&A rate before impairment per boe
16.25

16.92

(4
)
15.98

15.74

17

DD&A and impairment rate per boe

25.74

16.92

52

18.49

15.74

17



ARC Resources Ltd.
Page 21

For the year ended December 31, 2014, ARC recorded an impairment of $28.2 million on a Southeast Saskatchewan E&E project prior to its transfer to PP&E, based on a recoverable amount of $9 million as at September 30, 2014. The impairment charge was recorded as part of intangible E&E expenses in the statements of income.
Capital Expenditures, Acquisitions and Dispositions
Capital expenditures before acquisitions, dispositions or purchases of undeveloped land totaled $249.3 million in the fourth quarter of 2014 as compared to $207.7 million during the fourth quarter of 2013. This total includes development and production additions to PP&E of $245.6 million and additions to E&E assets of $3.7 million. PP&E expenditures include additions to oil and gas development and production assets and administrative assets. E&E expenditures include asset additions in areas that have been determined by Management to be in the E&E stage.
A breakdown of capital expenditures, acquisitions and dispositions is shown in Table 24 and 24a:
Table 24
 
Three Months Ended December 31
 
2014
2013
 
Capital Expenditures
($ millions)
E&E

PP&E

Total

E&E

PP&E

Total

% Change

Geological and geophysical
—

4.7

4.7

0.2

6.4

6.6

(29
)
Drilling and completions
2.5

161.9

164.4

9.1

131.8

140.9

17

Plant and facilities
1.2

77.0

78.2

1.3

57.5

58.8

33

Administrative assets
—

2.0

2.0

—

1.4

1.4

43

Total capital expenditures
3.7

245.6

249.3

10.6

197.1

207.7

20

Undeveloped land purchased at Crown land sales
0.6

17.4

18.0

—

3.5

3.5

414

Total capital expenditures including undeveloped land purchases
4.3

263.0

267.3

10.6

200.6

211.2

27

Acquisitions (1)
—

—

—

8.6

3.8

12.4

(100
)
Dispositions (2)
—

(2.4
)
(2.4
)
—

0.5

0.5

(580
)
Total capital expenditures, land purchases and net acquisitions and dispositions
4.3

260.6

264.9

19.2

204.9

224.1

18

(1)
Value is net of post-closing adjustments.
(2)
Represents proceeds and adjustments to proceeds from divestitures.
For the year ended December 31, 2014, capital expenditures before property acquisitions, dispositions or purchases of undeveloped land totaled $945.5 million as compared to $859.9 million during the same period of 2013. This total includes development and production additions to PP&E of $897.5 million (2013 - $845.1 million) and additions to E&E assets of $48 million (2013 - $14.8 million).


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Table 24a
 
Twelve Months Ended December 31
 
2014
2013
 
Capital Expenditures
($ millions)
E&E

PP&E

Total

E&E

PP&E

Total

% Change

Geological and geophysical
1.4

16.2

17.6

0.3

18.9

19.2

(8
)
Drilling and completions
30.8

629.2

660.0

12.9

555.5

568.4

16

Plant and facilities
15.8

245.6

261.4

1.6

266.1

267.7

(2
)
Administrative assets
—

6.5

6.5

—

4.6

4.6

41

Total capital expenditures
48.0

897.5

945.5

14.8

845.1

859.9

10

Undeveloped land purchased at Crown land sales
1.4

60.9

62.3

0.2

14.1

14.3

336

Total capital expenditures including undeveloped land purchases
49.4

958.4

1,007.8

15.0

859.2

874.2

15

Acquisitions (1)
1.8

71.7

73.5

13.6

22.8

36.4

102

Dispositions (2)
(1.8
)
(37.5
)
(39.3
)
—

(89.8
)
(89.8
)
(56
)
Total capital expenditures, land purchases and net acquisitions and dispositions
49.4

992.6

1,042.0

28.6

792.2

820.8

27

(1)
Value is net of post-closing adjustments.
(2)
Represents proceeds and adjustments to proceeds from divestitures.
ARC finances its capital expenditures with funds from operations that are available after deducting current period expenditures on site restoration and reclamation, net reclamation fund contributions, and dividends declared in the current period. Further funding is obtained by contributions from DRIP, SDP, and debt. ARC financed 70 per cent of the $267.3 million fourth quarter capital program with funds from operations and contributions from DRIP and SDP (80 per cent in the fourth quarter of 2013).
Table 25
 
Three Months Ended December 31
 
2014
2013
Source of Funding of Capital Expenditures and Net Acquisitions and Dispositions
($ millions)
Capital Expenditures including Land Purchases

Net Acquisitions

Total Expenditures

Capital Expenditures including Land Purchases

Net Dispositions

Total Expenditures

Expenditures (1)
267.3

(2.4
)
264.9

211.2

12.9

224.1

Funds from operations,
net (%) (2)
55

—

55

64

—

60

Contributions from DRIP and SDP (%)
15

—

15

16

—

15

Debt (%)
30

100

30

20

100

25

Total (%)
100

100

100

100

100

100

(1)
Excludes capital expenditures attributable to non-cash stock options.
(2)
Refer to the sections entitled "Funds from Operations" and “Additional GAAP Measures” contained within this MD&A. The percentage of capital expenditures that have been funded by funds from operations is determined as funds from operations that are available after deducting current period expenditures on site restoration and reclamation, net reclamation fund contributions, and dividends declared in the current period.


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Table 25a
 
Twelve Months Ended December 31
 
2014
2013
Source of Funding of Capital Expenditures and Net Acquisitions and Dispositions
($ millions)
Capital Expenditures including Land Purchases

Net Acquisitions

Total Expenditures

Capital Expenditures including Land Purchases

Net Dispositions

Total Expenditures

Expenditures (1)
1,007.6

34.2

1,041.8

874.2

(53.4
)
820.8

Funds from operations,
net (%) (2)
71

—

69

53

—

57

Contributions from DRIP and SDP (%)
15

—

14

15

—

16

Debt (%)
14

100

17

32

100

27

Total (%)
100

100

100

100

100

100

(1)
Excludes capital expenditures attributable to non-cash stock options.
(2)
Refer to the sections entitled "Funds from Operations" and “Additional GAAP Measures” contained within this MD&A. The percentage of capital expenditures that have been funded by funds from operations is determined as funds from operations that are available after deducting current period expenditures on site restoration and reclamation, net reclamation fund contributions, and dividends declared in the current period.
Asset Retirement Obligations and Reclamation Fund
At December 31, 2014, ARC has recorded an ARO liability of $616.1 million ($475.4 million at December 31, 2013) for the future abandonment and reclamation of ARC’s properties. The estimated ARO liability includes assumptions in respect of actual costs to abandon wells or reclaim the property, the time frame in which such costs will be incurred, as well as annual inflation factors in order to calculate the undiscounted total future liability. The future liability has been discounted at a liability-specific risk-free interest rate of 2.3 per cent (3.2 per cent at December 31, 2013).
Accretion charges of $3.7 million and $14.9 million for the three and twelve months ended December 31, 2014 ($3.1 million and $12.5 million for 2013), respectively, have been recognized in the statements of income to reflect the increase in the ARO liability associated with the passage of time.
Actual spending under ARC’s abandonment and reclamation program for the three and twelve months ended December 31, 2014 was $8.7 million and $23 million ($8 million and $18.5 million for 2013), respectively.
In 2005, ARC established a restricted reclamation fund to finance obligations specifically associated with its Redwater property. Minimum contributions to this fund will be approximately $64 million in total over the next 41 years. The balance of this fund totaled $35.2 million at December 31, 2014, compared to $32.6 million at December 31, 2013. Under the terms of ARC’s investment policy, cash in the reclamation fund can only be invested in certain securities and require a minimum credit rating for investments of A or higher.
Environmental stewardship is a core value at ARC and abandonment and reclamation activities continue to be made in a prudent, responsible manner with the oversight of the Health, Safety and Environment Committee of the Board. Ongoing abandonment expenditures for all of ARC’s assets including contributions to the Redwater reclamation fund are funded entirely out of funds from operations.


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Capitalization, Financial Resources and Liquidity
A breakdown of ARC’s capital structure as at December 31, 2014 and December 31, 2013 is outlined in Table 26:
Table 26
Capital Structure and Liquidity
($ millions, except per cent and ratio amounts)
December 31, 2014

December 31, 2013

Long-term debt (1)
1,074.8

901.3

Working capital deficit (2)
181.1

110.2

Net debt obligations (3)
1,255.9

1,011.5

Market value of common shares (4)
8,036.1

9,287.9

Total capitalization (3)
9,292.0

10,299.4

Net debt as a percentage of total capitalization
13.5

9.8

Net debt to annual funds from operations (3)
1.1

1.2

(1)
Includes a current portion of long-term debt of $49.5 million at December 31, 2014 and $42.1 million at December 31, 2013.
(2)
Working capital deficit is calculated as current liabilities less current assets as they appear on the consolidated balance sheets (the "balance sheets"), and excludes current unrealized amounts pertaining to risk management contracts, assets held for sale and ARO contained within liabilities associated with assets held for sale, as well as the current portion of long-term debt and current portion of ARO.
(3)
Refer to the section entitled "Additional GAAP Measures” contained within this MD&A.
(4)
Calculated using the total common shares outstanding at December 31, 2014 multiplied by the closing share price of $25.16 at December 31, 2014 (closing share price of $29.57 at December 31, 2013).
At December 31, 2014, ARC had total available credit facilities of approximately $2.2 billion with debt of $1,074.8 million currently drawn. After its $181.1 million working capital deficit, ARC has available credit of $916.4 million. ARC’s long-term debt balance includes a current portion of $49.5 million at December 31, 2014 ($42.1 million at December 31, 2013), reflecting principal payments that are due to be paid within the next 12 months. ARC intends to finance these obligations by drawing on its syndicated credit facility at the time the payments are due.
On September 25, 2014, ARC issued US$150 million of long-term fixed-rate notes through a private placement. Proceeds from the notes were used to pay down indebtedness under ARC's credit facility. The notes have a 12 year amortization term with a 10 year average life and a fixed-rate coupon of 3.72 per cent. Concurrently, ARC increased the Master Shelf Agreement from a maximum of US$225 million to US$350 million and extended the term for an additional three years commencing September 25, 2014.
On January 29, 2015, ARC issued 17.9 million common shares for aggregate gross proceeds of approximately $402 million (net proceeds of approximately $385 million) on a bought deal basis. The proceeds from this offering will be used to temporarily reduce bank indebtedness, increase working capital and to fund ongoing capital expenditure programs.
ARC’s debt agreements contain a number of covenants, all of which were met as at December 31, 2014. These agreements are available at www.sedar.com. ARC calculates its covenants four times annually. The major financial covenants are described below:
Table 27
Covenant description
Estimated Position at
December 31, 2014 (1)
Long-term debt and letters of credit not to exceed three and a quarter times annualized net income before non-cash items, income taxes and interest expense
0.9
Long-term debt, letters of credit, and subordinated debt not to exceed four times annualized net income before non-cash items, income taxes and interest expense
0.9
Long-term debt and letters of credit not to exceed 50 per cent of the book value of shareholders’ equity and long-term debt, letters of credit and subordinated debt
0.2
(1)
Estimated position, subject to final approval.
ARC’s long-term strategy is to target net debt between one and 1.5 times funds from operations and less than 20 per cent of total capitalization. This strategy has resulted in manageable debt levels to date and has positioned ARC to remain well within its debt covenants.
ARC typically uses three markets to raise capital: equity, bank debt and long-term notes. Long-term notes are issued to large institutional investors normally with an average term of five to 12 years. The cost of this debt is based upon two


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factors: the current rate of long-term government bonds and ARC’s credit spread. ARC’s weighted average interest rate on its outstanding long-term notes is currently 4.51 per cent.
Shareholders’ Equity
At December 31, 2014, there were 319.4 million shares outstanding, an increase of 5.3 million shares over the balance of shares issued at December 31, 2013. The increase was attributable to shares issued to participants in the DRIP and SDP.
At December 31, 2014, ARC had 2.5 million share options outstanding under its Share Option Plan, representing less than one per cent of outstanding shares, with a weighted average exercise price of $23.43 per share. These options vest in equal parts on the fourth and fifth anniversaries of the grant date. The first tranche will vest on March 24, 2015.
Dividends
In the fourth quarter of 2014, ARC declared dividends totaling $95.7 million ($0.30 per share) compared to $94 million ($0.30 per share) during the fourth quarter of 2013.
As a dividend-paying corporation, ARC declares monthly dividends to its shareholders. ARC continually assesses dividend levels in light of commodity prices, capital expenditure programs, and production volumes to ensure that dividends are in line with the long-term strategy and objectives of ARC as per the following guidelines:
•
To maintain a dividend policy that, in normal times, in the opinion of Management and the Board, is sustainable after factoring in the impact of current commodity prices on funds from operations. ARC’s objective is to normalize the effect of volatility of commodity prices rather than to pass that volatility onto shareholders in the form of fluctuating monthly dividends.
•
To maintain ARC’s financial flexibility, by reviewing ARC’s level of debt to equity and debt to funds from operations. The use of funds from operations and proceeds from equity offerings to fund capital development activities reduces the need to use debt to finance these expenditures.
ARC is focused on value creation, with the dividend being a key component of its business strategy. ARC believes that it is positioned to sustain current dividend levels despite the volatile commodity price environment. ARC’s fourth quarter dividend was 38 per cent of funds from operations (34 per cent of funds from operations for the year ended December 31, 2014).
ARC's Board of Directors approved a modification to the DRIP and SDP wherein the discount applicable to common shares acquired or issued under both plans was reduced to three per cent from five per cent. The change took effect for the September 15, 2014 dividend payment for shareholders on record as of August 29, 2014.
The actual amount of future monthly dividends is proposed by Management and is subject to the approval and discretion of the Board. The Board reviews future dividends in conjunction with their review of quarterly financial and operating results. Dividends are taxable to the shareholder irrespective of whether payment is received in cash or shares via the DRIP. In the case of shares issued via the SDP, dividends received are converted to a future capital gain to the recipient. Shareholders should consult their own tax advisors with respect to tax implications of dividends received in cash or via the DRIP or SDP in their particular circumstances.
On January 16, 2015, ARC confirmed that a dividend of $0.10 per common share designated as an eligible dividend will be paid on February 17, 2015 to shareholders of record on January 30, 2015 with an ex-dividend date of January 28, 2015.
Please refer to ARC’s website at www.arcresources.com for details of the estimated monthly dividend amounts and dividend dates for 2014.
Environmental Initiatives Impacting ARC
There are no new material environmental initiatives impacting ARC at this time.


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Contractual Obligations and Commitments
Table 28 discloses ARC's contractual obligations and commitments at December 31, 2014 and the associated minimum future payments:
Table 28
 
Payments Due by Period
Contractual Obligations and Commitments
($ millions)

1 Year


2-3 Years


4-5 Years

Beyond 5 Years


Total

Debt repayments (1)
49.5

94.0

220.7

710.6

1,074.8

Interest payments (2)
43.5

78.8

66.4

88.7

277.4

Reclamation fund contributions (3)
3.4

6.4

6.0

48.4

64.2

Purchase commitments
27.0

19.4

13.6

8.2

68.2

Transportation commitments
67.2

137.7

113.6

260.7

579.2

Operating leases
15.8

29.4

27.1

58.6

130.9

Risk management contract premiums (4)
0.8

9.6

0.5

—

10.9

Total contractual obligations and commitments
207.2

375.3

447.9

1,175.2

2,205.6

(1)
Long-term and current portion of long-term debt.
(2)
Fixed interest payments on senior notes.
(3)
Contribution commitments to a restricted reclamation fund associated with the Redwater property.
(4)
Fixed premiums to be paid in future periods on certain commodity price risk management contracts.
In addition to the above risk management contract premiums, ARC has commitments related to its risk management program (see Note 15 "Financial Instruments and Market Risk Management" of the financial statements). As the premiums are related to the underlying risk management contract, they have been recorded at fair market value at December 31, 2014 on the balance sheet as part of risk management contracts.
ARC enters into commitments for capital expenditures in advance of the expenditures being made. At any given point in time, it is estimated that ARC has committed to capital expenditures equal to approximately one quarter of its capital budget by means of giving the necessary authorizations to incur the capital expenditures in a future period.
ARC is involved in litigation and claims arising in the normal course of operations. Management is of the opinion that pending litigation will not have a material impact on ARC’s financial position or results of operations and therefore Table 28 does not include any commitments for outstanding litigation and claims.
Off-Balance Sheet Arrangements
ARC has certain lease agreements, all of which are reflected in the Contractual Obligations and Commitments table (Table 28), which were entered into in the normal course of operations. All leases have been treated as operating leases whereby the lease payments are included in operating expenses or G&A expenses depending on the nature of the lease. No asset or liability value has been assigned to these leases on the balance sheet as of December 31, 2014.
Critical Accounting Estimates
ARC has continuously refined and documented its management and internal reporting systems to ensure that accurate, timely, internal and external information is gathered and disseminated.
ARC’s financial and operating results incorporate certain estimates including:
•
estimated revenues, royalties and operating expenses on production as at a specific reporting date but for which actual revenues and costs have not yet been received;
•
estimated capital expenditures on projects that are in progress;
•
estimated DD&A charges that are based on estimates of oil and gas reserves that ARC expects to recover in the future;
•
estimated fair values of financial instruments that are subject to fluctuation depending upon the underlying commodity prices, foreign exchange rates and interest rates, volatility curves and the risk of non-performance;
•
estimated value of asset retirement obligations that are dependent upon estimates of future costs and timing of expenditures;


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•
estimated future recoverable value of PP&E and goodwill and any associated impairment charges or recoveries; and
•
estimated compensation expense under ARC’s share-based compensation plans including the PSU Plan that is based on an adjustment to the final number of PSU awards that eventually vest based on a performance multiplier.
ARC has hired individuals and consultants who have the skills required to make such estimates and ensures that individuals or departments with the most knowledge of the activity are responsible for the estimates. Further, past estimates are reviewed and compared to actual results, and actual results are compared to budgets in order to make more informed decisions on future estimates. For further information on the determination of certain estimates inherent in the financial statements, refer to Note 5 “Management Judgments and Estimation Uncertainty” in the audited consolidated financial statements for the years ended December 31, 2014 and 2013.
ARC’s leadership team’s mandate includes ongoing development of procedures, standards and systems to allow ARC staff to make the best decisions possible and ensuring those decisions are in compliance with ARC’s environmental, health and safety policies.
ASSESSMENT OF BUSINESS RISKS
The ARC management team is focused on long-term strategic planning and has identified the key risks, uncertainties and opportunities associated with ARC’s business that can impact the financial results. They include, but are not limited to:
Volatility of Oil and Natural Gas Prices
ARC’s operational results and financial condition, and therefore the amount of capital expenditures and future dividend payments made to shareholders, are dependent on the prices received for crude oil and natural gas production. Decreasing crude oil and natural gas prices will affect ARC’s cash flow, impacting ARC’s level of capital expenditures and may result in the shut-in of certain producing properties. Differentials on Canadian crude oil have also shown significant volatility throughout recent years due to pipeline and infrastructure constraints. Any movement in crude oil and natural gas prices will have an effect on ARC’s ability to continue with its capital expenditure program and its ability to pay dividends. Future declines in crude oil and natural gas prices may result in future declines in, or elimination of, any future dividends. Crude oil and natural gas prices are determined by economic and, in some circumstances, political factors. Supply and demand factors, including weather and general economic conditions as well as conditions in other crude oil and natural gas regions, impact prices. ARC may manage the risk associated with changes in commodity prices by entering into crude oil or natural gas price derivative contracts. If ARC engages in activities to manage its commodity price exposure, it may forego the benefits it would otherwise experience if commodity prices were to increase. In addition, commodity derivative contracts activities could expose ARC to losses. To the extent that ARC engages in risk management activities related to commodity prices, it will be subject to credit risks associated with counterparties with which it contracts.
Refinancing and Debt Service
ARC currently has a $1 billion financial covenant-based syndicated credit facility with 12 banks. At the request of ARC, the lenders will review the credit facility each year and determine if they will extend for another year. In the event that the facility is not extended before November 6, 2018, indebtedness under the facility will become repayable at that date. There is also a risk that the credit facility will not be renewed for the same amount or on the same terms. Any of these events could affect ARC’s ability to fund ongoing operations and make future dividend payments.
ARC currently has $991 million of long-term, fixed interest rate debt outstanding which requires principal repayments in 2015 through 2026. ARC intends to fund these principal repayments with existing credit facilities. In the event ARC is unable to fund future principal repayments, it may impact ARC’s ability to fund its ongoing operations and make future dividend payments.
ARC is required to comply with covenants under the credit facility. In the event that ARC does not comply with covenants under the credit facility, ARC’s access to capital could be restricted or repayment could be required. ARC routinely reviews the covenants based on actual and forecast results and has the ability to make changes to its development plans and/or dividend policy to comply with covenants under the credit facility. If ARC becomes unable to pay its debt service charges or otherwise commits an event of default such as bankruptcy, the lender may foreclose on such assets of ARC or sell the working interests.


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Access to Capital Markets
ARC's capital expenditures are financed from funds from operations, borrowings, proceeds from property divestments and possible future equity issuances. ARC's ability to issue equity is dependent upon, among other factors, the overall state of capital markets and investor appetite for investments in the energy industry and ARC securities. Further, if revenues or reserves decline ARC may not have access to the capital necessary to undertake or complete future drilling programs.
Additionally, ARC may issue additional common shares from treasury at prices which may result in a decline in production per common share and reserves per common share.
To the extent that external sources of capital become limited or unavailable or available on onerous terms, ARC's ability to make capital investments and maintain or expand existing assets and reserves may be impaired and ARC's assets, liabilities, business, financial condition, results of operations and dividend payments may be materially or adversely affected as a result.
Retention of Key Personnel
A loss in the key personnel of ARC could delay the completion of certain projects or otherwise have a material adverse effect on the Company. Shareholders are dependent on ARC's management and staff in respect of the administration and management of all manners relating to ARC's assets. Any deterioration of ARC's corporate culture could adversely affect ARC's long-term success.
Operational Matters
The operation of oil and gas wells involves a number of operating and natural hazards that may result in blowouts, environmental damage and other unexpected or dangerous conditions resulting in damage to operating subsidiaries of ARC and possible liability to third parties. ARC maintains liability insurance, where available, in amounts consistent with industry standards. Business interruption insurance may also be purchased for selected facilities, to the extent that such insurance is available. ARC may become liable for damages arising from such events against which it cannot insure or against which it may elect not to insure because of high premium costs or other reasons. Costs incurred to repair such damage or pay such liabilities may reduce dividend payments to shareholders.
Continuing production from a property, and to some extent the marketing of production therefrom, are largely dependent upon the ability of the operator of the property. Approximately nine per cent of ARC’s production is operated by third parties. ARC has limited ability to influence costs on partner operated properties. Operating costs on most properties operated by third parties have increased steadily over recent years. To the extent the operator fails to perform these functions properly, ARC’s revenue from such property may be reduced. Payments from production generally flow through the operator and there is a risk of delayed payment, or non-payment and additional expense in recovering such revenues if the operator becomes insolvent. To mitigate this risk, all significant non-operated production is taken in kind and marketed by ARC. Although satisfactory title reviews are generally conducted in accordance with industry standards, such reviews do not guarantee or certify that a defect in the chain of title may not arise to defeat the claim of ARC to certain properties. A reduction of future dividend payments to shareholders could result under such circumstances.
Reserves and Resources Estimates
The reserves and recovery information contained in ARC’s independent reserves evaluation is only an estimate. The actual production and ultimate reserves from the properties may be greater or less than the estimates prepared by the independent reserves evaluator. The reserves report was prepared using certain commodity price assumptions. If lower prices for crude oil, natural gas, condensate and NGLs are realized by ARC and substituted for the price assumptions utilized in those reserves reports, the present value of estimated future net cash flows for ARC’s reserves as well as the amount of ARC’s reserves would be reduced and the reduction could be significant.
Depletion of Reserves and Maintenance of Dividend
ARC’s future crude oil and natural gas reserves and production, and therefore its cash flows, will be highly dependent on ARC’s success in exploiting its reserves base and acquiring additional reserves. Without reserves additions through acquisition or development activities, ARC’s reserves and production will decline over time as the oil and natural gas reserves are produced out. There can be no assurance that ARC will make sufficient capital expenditures to maintain production at current levels nor, as a consequence, that the amount of dividends by ARC to shareholders can be maintained at current levels. There can be no assurance that ARC will be successful in developing or acquiring additional reserves on terms that meet ARC’s investment objectives.


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Counterparty Risk
ARC assumes customer credit risk associated with oil and gas sales, financial hedging transactions and joint arrangement participants. In the event that ARC’s counterparties default on payments to ARC, cash flows will be impacted and dividend payments to shareholders may be impacted. ARC has established credit policies and controls designed to mitigate the risk of default or non-payment with respect to oil and gas sales, financial hedging transactions and joint arrangement participants. A diversified sales customer base is maintained and exposure to individual entities is reviewed on a regular basis.
Variations in Interest Rates and Foreign Exchange Rates
Variations in interest rates could result in an increase in the amount ARC pays to service debt. World oil prices are quoted in US dollars and the price received by Canadian producers is therefore affected by the Canadian/US dollar exchange rate that may fluctuate over time. A material increase in the value of the Canadian dollar may negatively impact ARC’s net production revenue. Volatility in interest rates and the Canadian dollar may affect future cash flow from operations and reduce funds available for both dividends and capital expenditures. ARC may initiate certain derivative contracts to attempt to mitigate these risks. To the extent that ARC engages in risk management activities related to foreign exchange rates, it will be subject to credit risk associated with counterparties with which it contracts. An increase in Canadian/US exchange rates may impact future dividend payments to shareholders and the value of ARC’s reserves as determined by independent evaluators.
Changes in Income Tax Legislation
In the future, income tax laws or other laws may be changed or interpreted in a manner that adversely affects ARC or its shareholders. Tax authorities having jurisdiction over ARC or its shareholders may disagree with how ARC calculates its income for tax purposes to the detriment of ARC and its shareholders.
Changes in Government Royalty Legislation
Provincial programs related to the crude oil and natural gas industry may change in a manner that adversely impacts shareholders. ARC currently operates in British Columbia, Alberta, Saskatchewan and Manitoba, all of which have different royalty programs that could be revised at any time. Future amendments to royalty programs in any of ARC’s operating jurisdictions could result in reduced cash flow and reduced dividend payments to shareholders.
Acquisitions
The price paid for acquisitions is based on engineering and economic estimates of the potential reserves made by independent engineers modified to reflect the technical views of Management. These assessments include a number of material assumptions regarding such factors as recoverability and marketability of crude oil, natural gas, condensate and NGLs, future prices of crude oil, natural gas, condensate and NGLs, and operating costs, future capital expenditures and royalties and other government levies that will be imposed over the producing life of the reserves. Many of these factors are subject to change and are beyond the control of the operators of the working interests, Management and ARC. In particular, changes in the prices of and markets for crude oil, natural gas, condensate and NGLs from those anticipated at the time of making such assessments will affect the amount of future dividends and the value of the shares. In addition, all such estimates involve a measure of geological and engineering uncertainty that could result in lower production and reserves than attributed to the working interests. Actual reserves could vary materially from these estimates. Consequently, the reserves acquired may be less than expected, which could adversely impact cash flow and dividends to shareholders.
Environmental Concerns
The oil and natural gas industry is subject to environmental regulation pursuant to local, provincial and federal legislation. A breach of such legislation may result in the imposition of fines or issuance of clean-up orders in respect of ARC or its working interests. Such legislation may be changed to impose higher standards and potentially more costly obligations to ARC. Furthermore, Management believes the federal government appears to favor new programs for environmental laws and regulation, particularly in relation to the reduction of emissions, and there is no assurance that any such programs, laws or regulations, if proposed and enacted, will not contain emission reduction targets which ARC cannot meet. Financial penalties or charges could be incurred as a result of the failure to meet such targets. In particular there is uncertainty regarding the Federal Government’s Regulatory Framework for Air Emissions (“Framework”), as issued under the Canadian Environmental Protection Act.
The use of fracture stimulations has been ongoing safely in an environmentally responsible manner in western Canada for decades. With the increase in the use of fracture stimulations in horizontal wells there is increased communication between the oil and natural gas industry and a wider variety of stakeholders regarding the responsible use of this


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technology. This increased attention to fracture stimulations may result in increased regulation or changes of law which may make the conduct of ARC’s business more expensive or prevent ARC from conducting its business as currently conducted. ARC focuses on conducting transparent, safe and responsible operations in the communities in which its people live and work.
PROJECT RISKS
ARC manages a variety of small and large projects and plans to continue with the development of several capital projects throughout 2015. Project delays may impact expected revenues from operations. Significant project cost overruns could make a project uneconomic. ARC's ability to execute projects and market oil and natural gas depends upon numerous factors beyond its control, including:
•
availability of processing capacity;
•
availability and proximity of pipeline capacity;
•
availability of storage capacity;
•
supply of and demand for oil and natural gas;
•
availability of alternative fuel sources;
•
effects of inclement weather;
•
availability of drilling and related equipment;
•
unexpected cost increases;
•
accidental events;
•
changes in regulations; and
•
availability and productivity of skilled labour.
Because of these factors, ARC could be unable to execute projects on time, on budget or at all, and may not be able to effectively market the oil and natural gas that ARC produces.
Disclosure Controls and Procedures
As of December 31, 2014, an internal evaluation was carried out of the effectiveness of ARC’s disclosure controls and procedures as defined in Rule 13a-15 under the US Securities Exchange Act of 1934 and as defined in Canada by National Instrument 52-109, Certification of Disclosure in Issuers’ Annual and Interim Filings. Based on that evaluation, the President and Chief Executive Officer and the Senior Vice President and Chief Financial Officer concluded that the disclosure controls and procedures are effective to ensure that the information required to be disclosed in the reports that ARC files or submits under the Exchange Act or under Canadian Securities legislation is recorded, processed, summarized and reported, within the time periods specified in the rules and forms therein. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that the information required to be disclosed by ARC in the reports that it files or submits under the Exchange Act or under Canadian Securities Legislation is accumulated and communicated to ARC’s Management, including the senior executive and financial officers, as appropriate to allow timely decisions regarding the required disclosure.
Internal Control over Financial Reporting
Internal control over financial reporting is a process designed to provide reasonable assurance that all assets are safeguarded, transactions are appropriately authorized and to facilitate the preparation of relevant, reliable and timely information. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Management has assessed the effectiveness of ARC’s internal control over financial reporting as defined in Rule 13a-15 under the US Securities Exchange Act of 1934 and as defined in Canada by National Instrument 52-109, Certification of Disclosure in Issuers’ Annual and Interim Filings. The assessment was based on the framework in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management concluded that ARC’s internal control over financial reporting was effective as of December 31, 2014. The effectiveness of ARC’s internal control over financial reporting as of December 31, 2014 has been audited


ARC Resources Ltd.
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by Deloitte LLP, as reflected in their report for 2014. No changes were made to ARC’s internal control over financial reporting during the year ended December 31, 2014 that have materially affected, or are reasonably likely to materially affect, the internal controls over financial reporting.
FINANCIAL REPORTING UPDATE
Changes in Accounting Policies
As of January 1, 2014, the Company adopted several new IFRS interpretations and amendments in accordance with the transitional provisions of each standard. A brief description of each new accounting policy and its impact on the Company's financial statements follows below:
•
IAS 36 "Impairment of Assets" has been amended to reduce the circumstances in which the recoverable amount of cash generating units "CGUs" is required to be disclosed and clarify the disclosures required when an impairment loss has been recognized or reversed in the period. The retrospective adoption of these amendments impact ARC's disclosures in the notes to the financial statements in periods when an impairment loss or impairment reversal is recognized.
•
IAS 39 "Financial Instruments: Recognition and Measurement" has been amended to clarify that there would be no requirement to discontinue hedge accounting if a hedging derivative was novated, provided certain criteria are met. The retrospective adoption of the amendments does not have any impact on ARC's financial statements.
•
IFRIC 21 "Levies" was developed by the IFRS Interpretations Committee ("IFRIC") and is applicable to all levies imposed by governments under legislation, other than outflows that are within the scope of other standards (e.g., IAS 12 "Income Taxes") and fines or other penalties for breaches of legislation. The interpretation clarifies that an entity recognizes a liability for a levy when the activity that triggers payment, as identified by the relevant legislation, occurs. It also clarifies that a levy liability is accrued progressively only if the activity that triggers payment occurs over a period of time, in accordance with the relevant legislation. Lastly, the interpretation clarifies that a liability should not be recognized before the specified minimum threshold to trigger that levy is reached. The retrospective adoption of this interpretation does not have any impact on ARC's financial statements.
Future Accounting Policy Changes
In May 2014, the IASB issued IFRS 15 "Revenue from Contracts with Customers," which replaces IAS 18 "Revenue," IAS 11 "Construction Contracts," and related interpretations. The standard is required to be adopted either retrospectively or using a modified transition approach for fiscal years beginning on or after January 1, 2017, with earlier adoption permitted. IFRS 15 will be applied by ARC on January 1, 2017 and the Company is currently evaluating the impact of the standard on ARC's financial statements.
In July 2014, the IASB completed the final elements of IFRS 9 "Financial Instruments." The Standard supersedes earlier versions of IFRS 9 and completes the IASB’s project to replace IAS 39 "Financial Instruments: Recognition and Measurement." IFRS 9, as amended, includes a principle-based approach for classification and measurement of financial assets, a single 'expected loss’ impairment model and a substantially-reformed approach to hedge accounting. The Standard will come into effect for annual periods beginning on or after January 1, 2018, with earlier adoption permitted. IFRS 9 will be applied by ARC on January 1, 2018 and the Company is currently evaluating the impact of the standard on ARC's financial statements.
Non-GAAP Measures
Management uses certain key performance indicators (“KPIs”) and industry benchmarks such as operating netbacks (“netbacks”), operating income, finding, development and acquisition costs, net asset value, and total returns to analyze financial and operating performance. Management feels that these KPIs and benchmarks are key measures of profitability for ARC and provide investors with information that is commonly used by other oil and gas companies. These KPIs and benchmarks as presented do not have any standardized meaning prescribed by GAAP and therefore may not be comparable with the calculation of similar measures for other entities.


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Additional GAAP Measures
All additional GAAP Measures described below do not have a standardized meaning prescribed by GAAP and therefore may not be comparable with the calculation of similar measures for other entities.

Funds from Operations
Funds from operations is defined as net income excluding the impact of non-cash DD&A and impairment charges, accretion of ARO, E&E expense, deferred tax expense and recovery, unrealized gains and losses on risk management contracts, unrealized gains and losses on foreign exchange, gains on disposal of petroleum and natural gas properties, unrealized gains and losses on short-term investments, non-cash lease inducement charges, share option expense, and is further adjusted to include any portion of unrealized gains and losses on risk management contracts settled annually that relate to current period production. ARC considers funds from operations to be a key measure of operating performance as it demonstrates ARC’s ability to generate the necessary funds to fund future growth through capital investment and to repay debt. Management believes that such a measure provides a better assessment of ARC’s operations on a continuing basis by eliminating certain non-cash charges and charges that are nonrecurring, while respecting that certain risk management contracts that are settled on an annual basis are intended to protect prices on product sales occurring throughout the year. From a business perspective, the most directly comparable measure of funds from operations calculated in accordance with GAAP is net income.
Net Debt
Net debt is defined as long-term debt plus working capital surplus or deficit. Working capital surplus or deficit is calculated as current liabilities less current assets as they appear on the balance sheets, and excludes current unrealized amounts pertaining to risk management contracts, assets held for sale and ARO contained within liabilities associated with assets held for sale, as well as the current portion of long-term debt and current portion of ARO.
Total Capitalization
Total capitalization is defined as total shares outstanding multiplied by the closing share price on the Toronto Stock Exchange plus net debt outstanding. Total capitalization is used by ARC in analyzing its balance sheet strength and liquidity.
Forward-looking Information and Statements
This MD&A contains certain forward-looking information and statements within the meaning of applicable securities laws. The use of any of the words "expect," "anticipate," "continue," "estimate," "objective," "ongoing," "may," "will," "project," "should," "believe," "plans," "intends," "strategy," and similar expressions are intended to identify forward-looking information or statements. In particular, but without limiting the foregoing, this MD&A contains forward-looking information and statements pertaining to the following: ARC’s financial goals under the heading “About ARC Resources Ltd.," ARC’s view of future crude oil, natural gas, condensate and NGLs pricing under the heading “Economic Environment,” ARC’s guidance for 2015 under the heading “2014 Annual Guidance and Financial Highlights,” ARC’s intentions in the future regarding hedging under the heading “Risk Management,” ARC’s view as to the increased transportation costs under the heading “Operating and Transportation Expenses,” the estimated future payments under the RSU and PSU Plan under the heading “Long-Term Incentive Plans – Restricted Share Unit & Performance Share Unit Plan, Share Option Plan, and Deferred Share Unit Plan,” the information relating to the 2015 capital program under the heading “Capital Expenditures, Acquisitions and Dispositions,” the financing information relating to raising capital under the heading "Capitalization, Financial Resources and Liquidity," ARC's belief in relation to maintaining current dividend levels under the heading "Dividends," ARC’s estimates of normal course obligations under the heading “Contractual Obligations and Commitments,” and a number of other matters, including the amount of future asset retirement obligations, future liquidity and financial capacity, future results from operations and operating metrics, future costs, expenses and royalty rates, future interest costs, and future development, exploration, acquisition and development activities (including drilling plans) and related capital expenditures.
The forward-looking information and statements contained in this MD&A reflect several material factors and expectations and assumptions of ARC including, without limitation: that ARC will continue to conduct its operations in a manner consistent with past operations; the general continuance of current industry conditions; the continuance of existing (and in certain circumstances, the implementation of proposed) tax, royalty and regulatory regimes; the accuracy of the estimates of ARC's reserves and resource volumes; certain commodity price and other cost assumptions; and the continued availability of adequate debt and equity financing and cash flow to fund its planned expenditures. ARC believes the material factors, expectations and assumptions reflected in the forward-looking information and statements are reasonable, but no assurance can be given that these factors, expectations and assumptions will prove to be correct.
The forward-looking information and statements included in this MD&A are not guarantees of future performance and should not be unduly relied upon. Such information and statements involve known and unknown risks, uncertainties and


ARC Resources Ltd.
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other factors that may cause actual results or events to differ materially from those anticipated in such forward-looking information or statements including, without limitation: changes in commodity prices; changes in the demand for or supply of ARC's products; unanticipated operating results or production declines; changes in tax or environmental laws, royalty rates or other regulatory matters; changes in development plans of ARC or by third-party operators of ARC's properties, increased debt levels or debt service requirements; inaccurate estimation of ARC's oil and gas reserve and resource volumes; limited, unfavorable or a lack of access to capital markets; increased costs; a lack of adequate insurance coverage; the impact of competitors; and certain other risks detailed from time to time in ARC's public disclosure documents (including, without limitation, those risks identified in this MD&A and in ARC's Annual Information Form).
The forward-looking information and statements contained in this MD&A speak only as of the date of this MD&A, and none of ARC or its subsidiaries assumes any obligation to publicly update or revise them to reflect new events or circumstances, except as may be required pursuant to applicable laws.


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Glossary
The following is a list of abbreviations that may be used in this MD&A:
Measurement
bbl        barrel
bbl/d        barrels per day
mbbls        thousand barrels
mmbbls        million barrels

boe (1)        barrels of oil equivalent
boe/d (1)        barrels of oil equivalent per day
mboe (1)        thousands of barrels of oil equivalent
mmboe (1)    millions of barrels of oil equivalent

mcf        thousand cubic feet
mcf/d        thousand cubic feet per day
mmcf        million cubic feet
mmcf/d        million cubic feet per day
bcf        billion cubic feet

mmbtu        million British Thermal Units
GJ        gigajoule

(1) Where applicable in this MD&A natural gas has been converted to boe based on a conversion ratio of six mcf to one bbl. The boe rate is based on an energy equivalent conversion method primarily applicable at the burner tip. Given that the value ratio based on the current price of crude oil as compared to natural gas is significantly different than the energy equivalency of the conversion ratio, utilizing a conversion ratio of 6:1 may be misleading as an indication of value.

Financial and Business Environment
ARO        asset retirement obligations
DD&A        depreciation, depletion and amortization
DRIP        Dividend Reinvestment Program
DSU        Deferred Share Unit
E&E        intangible exploration and evaluation
GAAP        generally accepted accounting principles
G&A        general and administrative
IFRS        International Financial Reporting Standards
MSW        Mixed Sweet Blend
NGLs        natural gas liquids
NYMEX        New York Mercantile Exchange
PP&E        property, plant and equipment
PSU        Performance Share Unit
RSU        Restricted Share Unit
SDP        Stock Dividend Program
WTI        West Texas Intermediate



ARC Resources Ltd.
Page 35

ANNUAL HISTORICAL REVIEW
 
 
 
 
 
For the year ended December 31
 
 
 
 
 
($ millions, except per share amounts)
2014
2013
2012
2011
2010
FINANCIAL
 
 
 
 
 
Sales of crude oil, natural gas, condensate and NGLs
2,107.7

1,624.3

1,389.4

1,438.2

1,213.7

Per share (1)
6.66

5.21

4.67

5.02

4.67

Per share, diluted (1)
6.64

5.21

4.67

5.02

4.59

Funds from operations (2)
1,124.0

861.8

719.8

844.3

667.0

Per share (1)
3.55

2.77

2.42

2.95

2.57

Per share, diluted (1)
3.54

2.76

2.42

2.95

2.52

Net income and comprehensive income
380.8

240.7

139.2

287.0

212.2

Per share (1)
1.20

0.77

0.47

1.00

0.82

Per share, diluted (1)
1.20

0.77

0.47

1.00

0.80

Operating income (3)
390.3

224.9

163.1

293.5

235.6

Per share (1)
1.23

0.72

0.55

1.02

0.91

Per share, diluted (1)
1.23

0.72

0.55

1.02

0.88

Dividends declared
380.2

374.0

357.4

344.0

313.5

Per share (1)
1.20

1.20

1.20

1.20

1.20

Total assets
6,325.5

5,736.0

5,627.1

5,323.9

5,060.1

Total liabilities
2,773.7

2,339.9

2,230.4

2,162.1

1,947.7

Net debt outstanding (4)
1,255.9

1,011.5

745.6

909.7

871.0

Weighted average shares outstanding
316.6

311.5

297.2

286.6

259.9

Weighted average shares outstanding, diluted
317.2

311.9

297.2

286.6

264.2

Shares outstanding, end of period
319.4

314.1

308.9

288.9

284.4

CAPITAL EXPENDITURES
 
 
 
 
 
Geological and geophysical
17.6

19.2

31.8

25.9

16.0

Drilling and completions
660.0

568.4

429.8

456.5

358.5

Plant and facilities
261.4

267.7

131.6

165.1

131.4

Other
6.5

4.6

5.3

3.6

24.1

Total capital expenditures
945.5

859.9

598.5

651.1

530.0

Undeveloped land purchased at Crown land sales
62.3

14.3

9.5

74.9

60.9

Total capital expenditures including undeveloped land purchases
1,007.8

874.2

608.0

726.0

590.9

Acquisitions
73.5

36.4

36.5

57.1

8.9

Dispositions
(39.3
)
(89.8
)
(4.1
)
(168.4
)
(3.9
)
Corporate acquisitions
—

—

—

—

652.1

Total capital expenditures and net acquisitions
1,042.0

820.8

640.4

614.7

1,248.0

OPERATING
 
 
 
 
 
Production
 
 
 
 
 
Crude oil (bbl/d)
36,525

32,784

31,454

27,158

27,341

Condensate (bbl/d)
3,667

2,251

2,217

2,052

1,617

Natural gas (mmcf/d)
406.1

349.4

342.9

310.6

254.2

NGLs (bbl/d)
4,518

2,811

2,728

2,444

2,628

Total (boe/d)
112,387

96,087

93,546

83,416

73,954

Average realized prices, prior to hedging
 
 
 
 
 
Crude oil ($/bbl)
90.64

88.90

82.03

89.51

73.85

Condensate ($/bbl)
93.81

94.13

92.63

96.07

77.40

Natural gas ($/mcf)
4.76

3.45

2.62

3.83

4.21

NGLs ($/bbl)
39.45

36.25

38.11

47.53

39.57

Oil equivalent ($/boe)
51.31

46.31

40.50

47.15

44.88

RESERVES (company gross) (5)
 
 
 
 
 
Proved plus probable reserves
 
 
 
 
 
Crude oil and NGLs (mbbl)
192,489

194,064

185,548

170,153

165,963

Natural gas (bcf)
2,881.6

2,638.8

2,528.6

2,413.3

1,914.9

Total (mboe)
672,748

633,864

606,982

572,374

485,121

TRADING STATISTICS ($, based on intra-day trading)
 
 
 
 
 
High
33.68

29.95

26.25

28.67

26.04

Low
22.70

23.12

18.36

19.40

18.77

Close
25.16

29.57

24.44

25.10

25.41

Average daily volume (thousands)
1,344

1,064

1,356

1,251

1,197

(1)
Per share amounts (with the exception of dividends per share which are based on the number of shares outstanding at each dividend record date) are based on weighted average shares outstanding during the period.
(2)
Refer to the sections entitled "Funds from Operations" and “Additional GAAP Measures” contained within this MD&A.
(3)
Refer to the sections entitled "Operating Income" and “Non-GAAP Measures” contained within this MD&A.
(4)
Refer to the sections entitled "Capitalization, Financial Resources and Liquidity" and “Additional GAAP Measures” contained within this MD&A.
(5)
Company gross reserves are the gross interest reserves prior to the deduction of royalty burdens.



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Page 36

QUARTERLY HISTORICAL REVIEW
($ millions, except per share amounts)
2014
2013
FINANCIAL
Q4

Q3

Q2

Q1

Q4

Q3

Q2

Q1

Sales of crude oil, natural gas, condensate, NGLs and other income
454.1

535.2

567.0

551.4

425.0

417.4

403.4

378.5

Per share, basic (1)
1.43

1.69

1.79

1.75

1.36

1.34

1.30

1.22

Per share, diluted (1)
1.42

1.68

1.79

1.75

1.35

1.34

1.30

1.22

Funds from operations (2)
251.7

284.2

295.8

292.3

237.8

220.4

201.2

202.4

Per share, basic (1)
0.79

0.90

0.94

0.93

0.76

0.71

0.65

0.65

Per share, diluted (1)
0.79

0.89

0.93

0.93

0.76

0.71

0.65

0.65

Net income and comprehensive income
113.7

90.3

147.4

29.4

13.6

86.9

93.3

46.9

Per share, basic (1)
0.36

0.28

0.47

0.09

0.04

0.28

0.30

0.15

Per share, diluted (1)
0.36

0.28

0.47

0.09

0.04

0.28

0.30

0.15

Operating income (3)
64.5

90.1

118.7

117.0

50.0

73.3

53.9

47.6

Per share, basic (1)
0.20

0.28

0.37

0.37

0.16

0.23

0.17

0.15

Per share, diluted (1)
0.20

0.28

0.37

0.37

0.16

0.23

0.17

0.15

Dividends declared
95.7

95.2

94.8

94.5

94.0

93.7

93.4

92.9

Per share (1)
0.30

0.30

0.30

0.30

0.30

0.30

0.30

0.30

Total assets
6,325.5

6,095.5

5,988.7

5,949.5

5,736.0

5,599.2

5,548.1

5,612.7

Total liabilities
2,773.7

2,603.5

2,531.1

2,580.7

2,339.9

2,156.6

2,132.6

2,229.9

Net debt outstanding (4)
1,255.9

1,152.8

1,061.9

1,096.0

1,011.5

936.5

883.7

855.1

Weighted average shares outstanding
318.6

317.2

315.9

314.7

313.5

312.2

310.9

309.6

Weighted average shares outstanding, diluted
319.1

317.8

316.6

315.2

313.9

312.5

311.2

309.8

Shares outstanding, end of period
319.4

317.8

316.5

315.3

314.1

312.8

311.5

310.2

CAPITAL EXPENDITURES
 
 
 
 
 
 
 
 
Geological and geophysical
4.7

3.5

3.5

5.9

6.6

4.5

3.1

5.0

Drilling and completions
164.4

154.9

181.6

159.1

140.9

179.2

106.7

141.6

Plant and facilities
78.2

58.8

49.4

75.0

58.8

65.6

59.8

83.5

Administrative assets
2.0

1.0

1.6

2.0

1.4

1.0

1.1

1.1

Total capital expenditures
249.3

218.2

236.1

242.0

207.7

250.3

170.7

231.2

Undeveloped land purchased at Crown land sales
18.0

21.9

16.6

5.8

3.5

8.9

0.7

1.2

Total capital expenditures including undeveloped land purchases
267.3

240.1

252.7

247.8

211.2

259.2

171.4

232.4

Acquisitions
—

37.3

5.5

30.7

12.4

12.6

2.4

9.0

Dispositions
(2.4
)
(5.1
)
(31.8
)
—

0.5

(53.6
)
(28.2
)
(8.5
)
Total capital expenditures, land purchases and net acquisitions and dispositions
264.9

272.3

226.4

278.5

224.1

218.2

145.6

232.9

OPERATING
 
 
 
 
 
 
 
 
Production
 
 
 
 
 
 
 
 
Crude oil (bbl/d)
37,442

35,871

35,317

37,478

35,542

31,438

31,635

32,505

Condensate (bbl/d)
3,448

3,862

4,462

2,887

2,580

2,235

2,150

2,032

Natural gas (mmcf/d)
432.1

424.5

397.2

369.6

359.4

348.9

340.8

348.6

NGLs (bbl/d)
5,075

5,056

4,179

3,743

2,868

2,687

2,859

2,831

Total (boe/d)
117,986

115,530

110,165

105,699

100,883

94,515

93,436

95,472

Average realized prices, prior to hedging
 
 
 
 
 
 
 
 
Crude oil ($/bbl)
72.49

93.34

102.14

95.58

82.85

101.43

89.18

83.00

Condensate ($/bbl)
74.04

95.55

103.72

100.11

88.72

96.70

91.08

101.53

Natural gas ($/mcf)
4.15

4.46

4.99

5.60

3.61

2.94

3.89

3.37

NGLs ($/bbl)
32.69

39.61

39.51

48.54

41.47

36.80

29.25

37.48

Oil equivalent ($/boe)
41.78

50.28

56.44

57.91

45.51

47.94

47.36

43.84

TRADING STATISTICS
 
 
 
 
 
 
 
 
($, based on intra-day trading)
 
 
 
 
 
 
 
 
High
29.85

32.60

33.68

30.66

29.95

28.65

28.90

27.64

Low
22.70

28.54

30.30

27.52

25.68

24.71

25.73

23.12

Close
25.16

29.55

32.49

30.45

29.57

26.27

27.53

26.84

Average daily volume (thousands)
1,886

1,205

1,037

1,248

1,030

1,004

1,074

1,151

(1)
Per share amounts (with the exception of dividends per share which are based on the number of shares outstanding at each dividend record date) are based on weighted average shares outstanding during the period.
(2)
Refer to the sections entitled "Funds from Operations" and “Additional GAAP Measures” contained within this MD&A.
(3)
Refer to the sections entitled "Operating Income" and “Non-GAAP Measures” contained within this MD&A.
(4)
Refer to the sections entitled "Capitalization, Financial Resources and Liquidity" and “Additional GAAP Measures” contained within this MD&A.


ARC Resources Ltd.
Page 37


Management’s Report

Management’s Responsibility on Financial Statements
Management is responsible for the preparation of the accompanying consolidated financial statements and for the consistency therewith of all other financial and operating data presented in this annual report. The consolidated financial statements have been prepared in accordance with the accounting policies detailed in the notes thereto. In Management’s opinion, the consolidated financial statements are in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board, have been prepared within acceptable limits of materiality, and have utilized supportable, reasonable estimates.
To ensure the integrity of our financial statements, we carefully select and train qualified personnel. We also ensure our organizational structure provides appropriate delegation of authority and division of responsibilities. Our policies and procedures are communicated throughout the organization including a written ethics and integrity policy that applies to all employees including the chief executive officer and chief financial officer.
The Board of Directors approves the consolidated financial statements. Their financial statement related responsibilities are fulfilled mainly through the Audit Committee. The Audit Committee is composed entirely of independent directors, and includes at least one director with financial expertise. The Audit Committee meets regularly with Management and the external auditors to discuss reporting and control issues and ensures each party is properly discharging its responsibilities. The Audit Committee also considers the independence of the external auditors and reviews their fees.
The consolidated financial statements have been audited by Deloitte LLP, Chartered Accountants, in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States) on behalf of the shareholders.

Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining an adequate system of internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance that all assets are safeguarded, transactions are appropriately authorized and to facilitate the preparation of relevant, reliable and timely information. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Management has assessed the effectiveness of the Company’s internal control over financial reporting as defined in Rule 13a-15 under the US Securities Exchange Act of 1934. The assessment was based on the framework in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2014. The Company’s internal control over financial reporting as of December 31, 2014 has been audited by Deloitte LLP, the Company’s Chartered Accountants, who also audited the Company’s consolidated financial statements for the year ended December 31, 2014.
    

(signed) (signed)     
Myron M. Stadnyk             P. Van R. Dafoe
President and Chief Executive Officer    Senior Vice-President and Chief Financial Officer
Calgary, Alberta
February 11, 2015



ARC Resources Ltd.
Page 38

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of ARC Resources Ltd.

We have audited the accompanying consolidated financial statements of ARC Resources Ltd. and subsidiaries (the "Company"), which comprise the consolidated balance sheets as at December 31, 2014 and 2013 and the consolidated statements of income and comprehensive income, statements of changes in shareholders’ equity and statements of cash flows for the years then ended, and a summary of significant accounting policies and other explanatory information.

Management's Responsibility for the Consolidated Financial Statements

Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.

Auditor's Responsibility

Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by Management, as well as evaluating the overall presentation of the consolidated financial statements.

We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion.

Opinion

In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as at December 31, 2014 and 2013 and its financial performance and cash flows for the years then ended in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board.

Other Matter

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2014, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 11, 2015 expressed an unqualified opinion on the Company’s internal control over financial reporting.


(signed) “Deloitte LLP”
Chartered Accountants
February 11, 2015
Calgary, Canada





ARC Resources Ltd.
Page 39

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of ARC Resources Ltd.

We have audited the internal control over financial reporting of ARC Resources Ltd. and subsidiaries (the “Company”) as of December 31, 2014, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's Management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2014 of the Company and our report dated February 11, 2015 expressed an unqualified opinion on those financial statements.


(signed) “Deloitte LLP”
Chartered Accountants
February 11, 2015
Calgary, Canada



ARC Resources Ltd.
Page 40

ARC RESOURCES LTD.
 
 
 
CONSOLIDATED BALANCE SHEETS
 
 
 
 
 
 
 
(Cdn$ millions)
December 31, 2014

 
December 31, 2013

 
 
 
 
ASSETS
 
 
 
Current assets
 
 
 
Cash and cash equivalents (Note 6)
7.1

 
—

Short-term investment
3.6

 
3.6

Accounts receivable
165.0

 
176.5

Prepaid expenses
14.3

 
15.6

Risk management contracts (Note 15)
131.8

 
4.4

Assets held for sale (Note 10)
5.8

 
—

 
327.6

 
200.1

Reclamation fund (Note 8)
35.2

 
32.6

Risk management contracts (Note 15)
128.0

 
61.2

Intangible exploration and evaluation assets (Note 9)
266.4

 
265.4

Property, plant and equipment (Note 10)
5,320.1

 
4,928.5

Goodwill
248.2

 
248.2

Total assets
6,325.5

 
5,736.0

 
 
 
 
LIABILITIES
 
 
 
Current liabilities
 
 
 
Accounts payable and accrued liabilities
339.1

 
274.5

Current portion of long-term debt (Note 12)
49.5

 
42.1

Current portion of asset retirement obligations (Note 13)
13.0

 
25.1

Dividends payable
32.0

 
31.4

Risk management contracts (Note 15)
1.0

 
12.9

Liabilities associated with assets held for sale (Note 13)
5.5

 
—

 
440.1

 
386.0

Risk management contracts (Note 15)
1.0

 
0.6

Long-term debt (Note 12)
1,025.3

 
859.2

Long-term incentive compensation liability (Note 18)
29.1

 
26.1

Other deferred liabilities
15.8

 
17.5

Asset retirement obligations (Note 13)
603.1

 
450.3

Deferred taxes (Note 16)
659.3

 
600.2

Total liabilities
2,773.7

 
2,339.9

Commitments and contingencies (Note 19)
 
 
 
 
 
 
 
SHAREHOLDERS’ EQUITY
 
 
 
Shareholders’ capital
3,951.1

 
3,800.8

Contributed surplus
8.6

 
3.8

Deficit
(407.9
)
 
(408.5
)
Total shareholders’ equity
3,551.8

 
3,396.1

Total liabilities and shareholders’ equity
6,325.5

 
5,736.0

See accompanying notes to the consolidated financial statements.
Approved by the Board of Directors


(signed)                            (signed)
Mac H. Van Wielingen
Kathleen M. O’Neill
Chairman of the Board of Directors and Director        Chair of the Audit Committee and Director


ARC Resources Ltd.
Page 41

ARC RESOURCES LTD.
 
 
 
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
For the years ended December 31
 
 
(Cdn$ millions, except per share amounts)
2014

 
2013

 
 
 
 
REVENUE
 
 
 
Sales of crude oil, natural gas, condensate, natural gas liquids and other income
2,107.7

 
1,624.3

Royalties
(298.0
)
 
(223.1
)
 
1,809.7

 
1,401.2

 
 
 
 
Gain on risk management contracts (Note 15)
176.2

 
46.3

 
1,985.9

 
1,447.5

 
 
 
 
EXPENSES
 
 
 
Transportation
91.6

 
60.2

Operating
364.2

 
338.7

Intangible exploration and evaluation expenses (Note 9)
39.4

 
1.3

General and administrative
84.3

 
97.1

Interest and financing charges
47.3

 
42.5

Accretion of asset retirement obligations (Note 13)
14.9

 
12.5

Depletion, depreciation, amortization and impairment (Note 10)
758.5

 
551.9

Loss on foreign exchange
73.7

 
49.2

Gain on short-term investment
—

 
(1.9
)
Loss (gain) on disposal of petroleum and natural gas properties
1.8

 
(38.9
)
 
1,475.7

 
1,112.6

Provision for income taxes (Note 16)
 
 
 
Current
70.3

 
16.3

Deferred
59.1

 
77.9

 
129.4

 
94.2

 
 
 
 
Net income and comprehensive income
380.8

 
240.7

 
 
 
 
Net income per share (Note 17)
 
 
 
Basic
1.20

 
0.77

Diluted
1.20

 
0.77

See accompanying notes to the consolidated financial statements.


ARC Resources Ltd.
Page 42

ARC RESOURCES LTD.
 
 
 
 
 
 
 
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the years ended December 31
(Cdn$ millions)
Shareholders’ Capital

 
Contributed
Surplus

 
Deficit

 
Total Shareholders’ Equity

December 31, 2012
3,670.2

 
1.7

 
(275.2
)
 
3,396.7

Shares issued for cash
0.5

 
—

 
—

 
0.5

Shares issued pursuant to the dividend reinvestment program
115.4

 
—

 
—

 
115.4

Shares issued pursuant to the stock dividend program
14.7

 
—

 
—

 
14.7

Share option expense (Note 18)
—

 
2.1

 
—

 
2.1

Comprehensive income
—

 
—

 
240.7

 
240.7

Dividends declared
—

 
—

 
(374.0
)
 
(374.0
)
December 31, 2013
3,800.8

 
3.8

 
(408.5
)
 
3,396.1

Shares issued pursuant to the dividend reinvestment program
115.9

 
—

 
—

 
115.9

Shares issued pursuant to the stock dividend program
35.1

 
—

 
—

 
35.1

Cancellation of shares and return of accrued dividends
(0.7
)
 
1.9

 
—

 
1.2

Share option expense (Note 18)
—

 
2.9

 
—

 
2.9

Comprehensive income
—

 
—

 
380.8

 
380.8

Dividends declared
—

 
—

 
(380.2
)
 
(380.2
)
December 31, 2014
3,951.1

 
8.6

 
(407.9
)
 
3,551.8

See accompanying notes to the consolidated financial statements.


ARC Resources Ltd.
Page 43

ARC RESOURCES LTD.
 
 
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
 
For the years ended December 31
 
 
(Cdn$ millions)
2014

 
2013

CASH FLOW FROM OPERATING ACTIVITIES
 
 
 
Net income and comprehensive income
380.8

 
240.7

Add items not involving cash:
 
 
 
Unrealized gain on risk management contracts
(205.3
)
 
(30.6
)
Accretion of asset retirement obligations
14.9

 
12.5

Depletion, depreciation, amortization and impairment
758.5

 
551.9

Intangible exploration and evaluation expenses
39.4

 
1.3

Unrealized loss on foreign exchange
73.8

 
48.9

Loss (gain) on disposal of petroleum and natural gas properties
1.8

 
(38.9
)
Deferred tax expense
59.1

 
77.9

Other (Note 21)
1.0

 
(1.9
)
Net change in other liabilities (Note 21)
(20.4
)
 
(16.6
)
Change in non-cash working capital (Note 21)
49.4

 
(43.5
)
 
1,153.0

 
801.7

CASH FLOW FROM FINANCING ACTIVITIES
 
 
 
Issuance (repayment) of long-term debt under revolving credit facilities, net
(22.1
)
 
105.9

Issue of senior notes
166.6

 
—

Repayment of senior notes
(43.9
)
 
(40.9
)
Issue of common shares
—

 
0.5

Cash dividends paid
(228.6
)
 
(243.4
)
 
(128.0
)
 
(177.9
)
CASH FLOW FROM INVESTING ACTIVITIES
 
 
 
Acquisition of petroleum and natural gas properties (Note 10)
(71.7
)
 
(36.4
)
Disposal of petroleum and natural gas properties
37.5

 
89.8

Property, plant and equipment development expenditures (Note 10)
(958.2
)
 
(859.2
)
Intangible exploration and evaluation asset expenditures (Note 9)
(49.4
)
 
(15.0
)
Net reclamation fund contributions
(2.6
)
 
(2.8
)
Change in non-cash working capital (Note 21)
26.5

 
5.2

 
(1,017.9
)
 
(818.4
)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
7.1

 
(194.6
)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
—

 
194.6

CASH AND CASH EQUIVALENTS, END OF PERIOD
7.1

 
—

The following are included in cash flow from operating activities:
 
 
 
Income taxes paid in cash
30.4

 
43.6

Interest paid in cash
46.3

 
42.5

See accompanying notes to the consolidated financial statements.


ARC Resources Ltd.
Page 44

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
1.
STRUCTURE OF THE BUSINESS
The principal undertakings of ARC Resources Ltd. and its subsidiaries (collectively the “Company” or “ARC”) are to carry on the business of acquiring, developing and holding interests in petroleum and natural gas properties and assets.
ARC was incorporated in Canada and the Company’s registered office and principal place of business is located at 1200, 308 – 4th Avenue SW, Calgary, Alberta, Canada T2P 0H7.
2.
BASIS OF PREPARATION
These consolidated financial statements (the “financial statements”) have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board ("IASB"). All financial information is reported in millions of Canadian dollars ("Cdn$"), unless otherwise noted. References to “US$” are to United States dollars.
The financial statements have been prepared on a historical cost basis, except for ARC's cash and cash equivalents, short-term investment, reclamation fund assets, and risk management contracts which are presented at fair value, as detailed in the accounting policies disclosed in Note 3.
The financial statements include the accounts of ARC and its wholly owned subsidiaries, ARC Resources General Partnership (the "partnership") and 1504793 Alberta Ltd. All inter-entity transactions have been eliminated.
The preparation of the financial statements requires Management to use judgments, estimates and assumptions that affect the reported amounts of assets, liabilities and the disclosure of contingencies at the date of the financial statements, and revenues and expenses during the reporting period. Accordingly, actual results could differ from those estimated. Significant estimates and judgments used in the preparation of the financial statements are detailed in Note 5.
These financial statements were authorized for issue by the Board of Directors on February 11, 2015.
3.
SUMMARY OF ACCOUNTING POLICIES
Revenue Recognition
Revenue associated with the sale of crude oil, natural gas, condensate and natural gas liquids (“NGLs”) owned by ARC is recognized when title is transferred from ARC to its customers. Revenue is measured at the fair value of the consideration received or receivable. Revenue from the sale of crude oil, natural gas, condensate and NGLs (prior to deduction of transportation costs) is recognized when all of the following conditions have been satisfied:
•
ARC has transferred the significant risks and rewards of ownership of the goods to the buyer;
•
ARC retains no continuing managerial involvement to the degree usually associated with ownership or effective control over the goods sold;
•
the amount of revenue can be measured reliably;
•
it is probable that the economic benefits associated with the transaction will flow to ARC; and
•
the costs incurred or to be incurred in respect of the transaction can be measured reliably.
Transportation
Costs paid by ARC for the transportation of crude oil, natural gas, condensate and NGLs to the point of title transfer are recognized when the transportation is provided.
Joint Arrangements
ARC conducts many of its oil and gas production activities through jointly controlled operations and the financial statements reflect only ARC’s proportionate interest in such activities. Joint control exists for contractual arrangements governing ARC's assets whereby ARC has less than 100 per cent working interest, all of the partners have control of the arrangement collectively, and spending on the project requires unanimous consent of all parties


ARC Resources Ltd.
Page 45

that collectively control the arrangement and share the associated risks. ARC does not have any joint arrangements that are individually material to the Company or that are structured through joint venture arrangements.
Long-Term Incentive Plans
Restricted Share Unit & Performance Share Unit and Deferred Share Unit Plans
ARC has established a cash-settled Restricted Share Unit & Performance Share Unit Plan (“RSU & PSU Plan”) for employees and independent directors who otherwise meet the definition of an employee of ARC, as well as a Deferred Share Unit Plan (“DSU Plan”) for non-employee directors. Compensation expense associated with the RSU & PSU Plan and the DSU Plan is granted in the form of Restricted Share Units (“RSUs”), Performance Share Units (“PSUs”) and Deferred Share Units (“DSUs”) and is determined based on the fair value of the share units at grant date and is subsequently adjusted to reflect the fair value of the share units at each period end. This valuation incorporates the period-end share price, the number of RSUs, PSUs and DSUs outstanding at each period end, and certain management estimates. Compensation expense is recognized in earnings over the relevant service period of the RSU & PSU Plan and DSU Plan with a corresponding increase or decrease in liabilities. Classification of the associated short-term and long-term liabilities is dependent on the expected payout dates.
Share Option Plan
ARC has established a share option plan for certain employees. The fair value of share options issued to employees is determined on their grant date using a valuation model and recorded as compensation expense over the period that the share options vest, with a corresponding increase to contributed surplus. The exercise price of the share options granted may be reduced by the amount of dividends declared in future periods in accordance with the terms of the plan. Forfeitures are estimated through the vesting period based on past experience and future expectations, and adjusted upon actual vesting. When share options are exercised, the proceeds, together with the amounts recorded in contributed surplus, are recorded in shareholders’ capital.
A portion of total compensation costs associated with both the RSU & PSU Plan and the Share Option Plan is charged to property, plant and equipment ("PP&E") to reflect those costs that are directly attributable to capital projects. A portion is also charged to operating expenses to reflect the awards that are attributable to certain individuals working in field operations, and the remainder is charged to general and administrative expense.
Cash Equivalents
Cash equivalents include market deposits and similar type instruments, with an original maturity of three months or less when purchased.
Reclamation Fund
ARC's reclamation fund holds investment grade assets and cash and cash equivalents. Investments are categorized as available-for-sale assets. Available-for-sale assets are initially measured at fair value with subsequent changes in fair value recognized in other comprehensive income ("OCI"), net of tax.
Goodwill
ARC records goodwill relating to a business combination when the total purchase price exceeds the fair value of the identifiable assets and liabilities of the acquired company. Goodwill is stated at cost less any accumulated impairment losses. Goodwill is evaluated for impairment on an annual basis, or more frequently if potential indicators of impairment exist.
Intangible Exploration and Evaluation (“E&E”) Assets
Intangible E&E costs are capitalized until the technical feasibility and commercial viability, or otherwise, of the relevant projects have been determined. Technical feasibility and commercial viability of E&E assets is dependent upon the existence of economically recoverable reserves and obtaining the appropriate internal and external approvals. E&E costs may include costs of license acquisition, technical services and studies, and exploration drilling and testing. Tangible assets acquired which are consumed in developing an intangible exploration asset are recorded as part of the cost of the intangible exploration asset. Costs incurred prior to obtaining the legal right to explore are expensed as incurred. Net revenues from test production associated with assets classified as E&E is recognized as earned. Assets classified as E&E are not amortized.
If a project classified as E&E is determined to be technically feasible and commercially viable, the relevant cost is transferred from E&E to development and production assets which are classified as PP&E on the consolidated balance sheets (the "balance sheets"). Assets are assessed for impairment prior to any such transfer. If an E&E project is determined to be unsuccessful, all associated costs are charged to the consolidated statements of income (the "statements of income") at that time.


ARC Resources Ltd.
Page 46

Property, Plant and Equipment ("PP&E")
Items of PP&E, which include oil and gas development and production assets and administrative assets, are measured at cost less accumulated depletion, depreciation and amortization and accumulated impairment losses.
Gains and losses on disposal of an item of PP&E are determined by comparing the proceeds from disposal with the carrying amount of PP&E and are recognized separately in the statements of income.
Exchanges of properties are measured at fair value, unless the transaction lacks commercial substance or fair value cannot be reasonably measured. Where the exchange is measured at fair value, a gain or loss is recognized in the statements of income.
Overhead costs which are directly attributable to bringing an asset to the location and condition necessary for it to be capable of use in the manner intended by Management are capitalized. These costs include compensation costs paid to ARC personnel dedicated to capital projects.
Depletion, Depreciation and Amortization
Development and production assets are componentized into groups of assets with similar useful lives for the purposes of performing depletion calculations. Depletion expense is calculated on the unit-of-production basis based on:
(a)
total estimated proved and probable reserves calculated in accordance with Ontario Securities Commission’s National Instrument 51-101, Standards of Disclosure for Oil and Gas Activities;
(b)
total capitalized costs plus estimated future development costs of proved and probable reserves, including future estimated asset retirement costs; and
(c)
relative volumes of petroleum and natural gas reserves and production, before royalties, converted at the energy equivalent conversion ratio of six thousand cubic feet of natural gas to one barrel of oil.
Depreciation of corporate assets is calculated on a straight-line basis over the estimated useful lives of the related assets, which range from three to fourteen years.
Impairment of Non-Financial Assets
Development and Production Assets
ARC’s development and production assets are grouped into cash generating units (“CGUs”) for the purpose of assessing impairment. A CGU is a grouping of assets that generate cash inflows independently of other assets held by the Company. Geological formation, product type, geography and internal management are key factors considered when grouping ARC’s petroleum and natural gas assets into CGUs.
CGUs are reviewed at each reporting date for indicators of potential impairment. If such indicators exist, an impairment test is performed by comparing the CGU’s carrying value to its recoverable amount, defined as the greater of a CGU’s fair value less cost to sell and its current value in use. Any excess of carrying value over recoverable amount is recognized in the statements of income as an impairment charge.
If there is an indicator that a previously recognized impairment charge may no longer be valid, the recoverable amount of the relevant CGU is calculated and compared against the carrying amount. An impairment charge is reversed to the extent that the asset’s carrying amount does not exceed the carrying amount that would have been determined, net of depletion, if no impairment loss had been recognized.
E&E Assets, Administrative Assets and Goodwill
E&E assets, administrative assets and goodwill are assessed for impairment at the operating segment level. Goodwill has not been attributed to individual CGUs as ARC believes the goodwill it has acquired enhances the value of all of its pre-existing CGUs through enhanced operating efficiencies. Impairment tests are carried out when E&E assets are transferred to be included as development and production assets following the declaration of commercial reserves, and any time that circumstances arise which could indicate a potential impairment. Irrespective of whether there is any indication of impairment, goodwill balances are tested for impairment annually. An impairment loss is recognized if the total carrying values of E&E, administrative assets and goodwill exceed the aggregate impairment cushions calculated for each of ARC’s CGUs and is applied first to reduce the carrying amount of goodwill and then to E&E and administrative assets on a pro-rata basis. Impairment of goodwill and administrative assets is recognized in depletion, depreciation, amortization and impairment and impairment of E&E assets is recognized in intangible E&E expenses. Any impairment loss of goodwill is not reversed.
If E&E assets, administrative assets and goodwill are subject to impairment testing in the same period in which there is an indication of impairment in one of ARC’s CGUs, that CGU is first tested for impairment and any resulting impairment loss is recorded prior to conducting impairment tests on assets at the operating segment level.


ARC Resources Ltd.
Page 47

Assets Held for Sale
Non-current assets are classified as held for sale if their carrying amounts will be recovered through a sale transaction rather than through continuing use. This condition is met when the sale is highly probable and the asset is available for immediate sale in its present condition. For the sale to be highly probable, Management must be committed to a plan to sell the asset and an active program to locate a buyer and complete the plan must have been initiated. The asset must be actively marketed for sale at a price that is reasonable in relation to its current fair value and the sale should be expected to be completed within one year from the date of classification.
Non-current assets classified as held for sale are measured at the lower of the carrying amount and fair value less cost to sell, with impairments recognized in the statements of income in the period measured. Non-current assets held for sale are classified and presented in current assets and liabilities within the balance sheet. Assets held for sale are not depleted, depreciated or amortized.
Government Grants
Government grants are recognized when there is reasonable assurance that ARC will comply with the conditions attached to them and the grants will be received. If a grant is received before it is certain whether compliance with all conditions will be achieved, the grant is recognized as a deferred liability until such conditions are fulfilled and then amortized into earnings on a systematic basis over the useful life of the asset. When a grant relates to an expense item, it is recognized in the statements of income in the period in which the costs are incurred. When a grant relates to an asset, it is recognized as a reduction to the carrying amount of the related asset and amortized into income on a systematic basis over the expected useful life of the underlying asset through reduced depletion, depreciation and amortization charges.
Asset Retirement Obligations ("ARO")
ARC recognizes an ARO liability in the period in which it has a present legal or constructive liability and a reasonable estimate of the amount can be made. On a periodic basis, Management reviews these estimates and changes, if any, are applied prospectively. The change in fair value of the estimated ARO is recorded as a liability, with a corresponding increase to the carrying amount of the related asset. The capitalized amount is depreciated on a unit-of-production basis over the life of the associated proved and probable reserves. The long-term liability is increased each reporting period with the passage of time and the associated accretion charge is recognized in earnings. Periodic revisions to the liability-specific discount rate, estimated timing of cash flows or to the original estimated undiscounted cost can also result in an increase or decrease to the ARO. Actual costs incurred upon settlement of the obligation are recorded against the ARO to the extent of the liability recorded.
Income Taxes
Deferred tax is recognized using the balance sheet method, providing for temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. Deferred tax is measured at the tax rates that are expected to be applied to temporary differences when they reverse, based on the laws that have been substantively enacted by the reporting date.
Deferred income tax expense is recognized in the statements of income except to the extent that it relates to items recognized directly in equity, in which case it is recognized in equity. Deferred tax assets and tax liabilities are offset to the extent there is a legally enforceable right to set off the recognized amounts and the intent is to either settle on a net basis or to realize the asset and settle the liability simultaneously. Claims made for scientific research and experimental development tax credits are offset against income tax expense.
Financial Instruments
Financial assets, financial liabilities and derivatives are measured at fair value on initial recognition. Measurement in subsequent periods depends on the financial instrument’s classification, as described below. ARC does not employ hedge accounting for its risk management contracts currently in place.
•
Fair value through profit or loss
Financial assets and liabilities classified as held-for-trading or designated as at fair value through profit or loss are initially recognized and subsequently measured at fair value with changes in those fair values charged immediately to earnings. ARC classifies its cash and cash equivalents, short-term investment, and risk management contracts as held-for-trading.
•
Held-to-maturity investments, loans and receivables and other financial liabilities
Held-to-maturity investments, loans and receivables, and other financial liabilities are initially recognized at fair value, net of directly attributable transaction costs, and are subsequently measured at amortized cost using the effective interest method. ARC classifies accounts receivable as loans and receivables, and classifies accounts payable and accrued liabilities, dividends payable, long-term debt, and long-term incentive compensation liability as other financial liabilities.


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•
Available-for-sale financial assets
Non-derivative financial assets may be designated as available for sale so long as they are not classified in another category above. Available-for-sale financial assets are initially recognized at fair value, net of directly attributable transaction costs, and are subsequently measured at fair value with changes in fair value recognized in OCI, net of tax. Transaction costs related to the purchase of available-for-sale assets are recognized in the statements of income. Amounts recognized in OCI for available-for-sale financial assets are charged to earnings when the asset is derecognized or when there is a significant or prolonged decrease in the value of the asset. ARC classifies its reclamation fund assets as available-for-sale assets.
Fair Value Measurement
ARC measures cash and cash equivalents, short-term investment, risk management contracts, and reclamation fund assets at fair value at each reporting date. Fair value less cost to sell is also calculated at each reporting date to determine the recoverable amount of non-financial assets that are tested for impairment. In addition, the fair value of long-term debt is disclosed in Note 12.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in its principal or most advantageous market at the reporting date. To estimate the fair value of its financial instruments, ARC uses quoted market prices when available, or third-party models and valuation methodologies that use observable market data. Fair value is measured using the assumptions that market participants would use, including transaction-specific details and non-performance risk.
All financial assets and liabilities for which fair value is measured or disclosed in the financial statements are further categorized using a three-level hierarchy that reflects the significance of the lowest level of inputs used in determining fair value:
•
Level 1 – Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions occur in sufficient frequency and volume to provide pricing information on an ongoing basis.
•
Level 2 – Pricing inputs are other than quoted prices in active markets included in Level 1. Prices in Level 2 are either directly or indirectly observable as of the reporting date. Level 2 valuations are based on inputs, including quoted forward prices for commodities, time value and volatility factors, which can be substantially observed or corroborated in the marketplace.
•
Level 3 – Valuations in this level are those with inputs for the asset or liability that are not based on observable market data.
At each reporting date, ARC determines whether transfers have occurred between levels in the hierarchy by reassessing the level of classification for each financial asset and financial liability measured or disclosed at fair value in the financial statements based on the lowest level input that is significant to the fair value measurement as a whole. Assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the placement within the fair value hierarchy.
ARC's risk management contracts are subject to master netting agreements that create a legally enforceable right to offset by counterparty the related financial assets and financial liabilities on the Company's balance sheets in all circumstances. ARC manages these contracts on the basis of its net exposure to market risks and therefore measures their fair value consistently with how market participants would price the net risk exposure at the reporting date under current market conditions.
Impairment of Financial Assets
The Company assesses whether there is objective evidence that indicates a financial asset or group of financial assets is impaired at each reporting date. Objective evidence exists if one or more loss events occur after initial recognition of the financial asset which have an impact on the estimated future cash flows of the financial asset and that impact can be reliably measured. Objective evidence of impairment may include indications that a debtor is experiencing significant financial difficulty, that a debtor has breached certain contracts, the probability that a debtor will enter bankruptcy or other financial reorganization, and changes in economic conditions that correlate with defaults.
If a receivable or group of receivables carried at amortized cost is impaired, the amount of the loss is measured as the difference between the amortized cost of the receivable and its recoverable amount. The carrying amount of the asset is reduced through the use of an allowance account and the loss is recognized in general and administrative expenses. If the amount of the impairment loss decreases in a subsequent period because of a specific event, the


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impairment loss is reversed through the allowance account. Receivables and the associated allowance balance are written off when there is no longer a probability of future recovery.
When a decline in the fair value of an available-for-sale financial asset has been recognized in OCI and there is objective evidence that the asset is impaired, the cumulative loss is measured as the difference between the acquisition cost of the financial asset and its fair value and is reclassified from equity to general and administrative expenses.
Foreign Currency Translation
Monetary assets and liabilities denominated in a foreign currency are translated at the rate of exchange in effect at the balance sheet date. Revenues and expenses are translated at the period average rates of exchange. Translation gains and losses are included in earnings in the period in which they arise.
ARC’s functional and presentation currency is Canadian dollars.
4.
CHANGES IN ACCOUNTING POLICIES
As of January 1, 2014, the Company adopted several new IFRS interpretations and amendments in accordance with the transitional provisions of each standard. A brief description of each new accounting policy and its impact on the Company's financial statements follows below:
•
IAS 36 "Impairment of Assets" has been amended to reduce the circumstances in which the recoverable amount of cash generating units "CGUs" is required to be disclosed and clarify the disclosures required when an impairment loss has been recognized or reversed in the period. The retrospective adoption of these amendments impact ARC's disclosures in the notes to the financial statements in periods when an impairment loss or impairment reversal is recognized.
•
IAS 39 "Financial Instruments: Recognition and Measurement" has been amended to clarify that there would be no requirement to discontinue hedge accounting if a hedging derivative was novated, provided certain criteria are met. The retrospective adoption of the amendments does not have any impact on ARC's financial statements.
•
IFRIC 21 "Levies" was developed by the IFRS Interpretations Committee ("IFRIC") and is applicable to all levies imposed by governments under legislation, other than outflows that are within the scope of other standards (e.g., IAS 12 "Income Taxes") and fines or other penalties for breaches of legislation. The interpretation clarifies that an entity recognizes a liability for a levy when the activity that triggers payment, as identified by the relevant legislation, occurs. It also clarifies that a levy liability is accrued progressively only if the activity that triggers payment occurs over a period of time, in accordance with the relevant legislation. Lastly, the interpretation clarifies that a liability should not be recognized before the specified minimum threshold to trigger that levy is reached. The retrospective adoption of this interpretation does not have any impact on ARC's financial statements.
Future Accounting Policy Changes
In May 2014, the IASB issued IFRS 15 "Revenue from Contracts with Customers," which replaces IAS 18 "Revenue," IAS 11 "Construction Contracts," and related interpretations. The standard is required to be adopted either retrospectively or using a modified transition approach for fiscal years beginning on or after January 1, 2017, with earlier adoption permitted. IFRS 15 will be applied by ARC on January 1, 2017 and the Company is currently evaluating the impact of the standard on ARC's financial statements.
In July 2014, the IASB completed the final elements of IFRS 9 "Financial Instruments." The Standard supersedes earlier versions of IFRS 9 and completes the IASB’s project to replace IAS 39 "Financial Instruments: Recognition and Measurement." IFRS 9, as amended, includes a principle-based approach for classification and measurement of financial assets, a single 'expected loss’ impairment model and a substantially-reformed approach to hedge accounting. The Standard will come into effect for annual periods beginning on or after January 1, 2018, with earlier adoption permitted. IFRS 9 will be applied by ARC on January 1, 2018 and the Company is currently evaluating the impact of the standard on ARC's financial statements.
5.
MANAGEMENT JUDGMENTS AND ESTIMATION UNCERTAINTY
The timely preparation of financial statements in accordance with IFRS requires Management to use judgments, estimates and assumptions. These estimates and judgments are subject to change and actual results could differ from those estimated. The key sources of estimation uncertainty that have a significant risk of causing material


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adjustment to the reported amounts of assets, liabilities, revenues, expenses, and the disclosure of contingencies are discussed below.
Joint Control
Judgment is required to determine when ARC has joint control over an arrangement, which requires an assessment of the capital and operating activities of the projects it undertakes with partners and when the decisions in relation to those activities require unanimous consent.
Recoverability of Asset Carrying Values
The recoverability of development and production asset carrying values are assessed at the CGU level. Determination of what constitutes a CGU is subject to management judgment. The asset composition of a CGU can directly impact the recoverability of the assets included therein. In assessing the recoverability of oil and gas properties, each CGU’s carrying value is compared to its recoverable amount, defined as the greater of its fair value less cost to sell and value in use.
For the year ended December 31, 2014, ARC performed an impairment test prior to the transfer of a project in Southeast Saskatchewan from E&E assets to PP&E on the balance sheets. At December 31, 2014, ARC evaluated its CGUs for indicators of any potential impairment or related recovery. In making these evaluations, ARC used the following information:
i)
the net present value of the after-tax cash flows from oil and gas reserves of each CGU based on reserves estimated by ARC’s independent reserve evaluator; and
ii)
the fair value of undeveloped land based on estimates provided by ARC’s independent land evaluator with consideration given to acquisition metrics of recent transactions completed on similar assets to those contained within the relevant CGU
with consideration given to acquisition metrics of recent transactions completed on similar assets to those contained within the relevant CGU.
Key input estimates used in the determination of cash flows from oil and gas reserves include the following:
a)
Reserves – Assumptions that are valid at the time of reserve estimation may change significantly when new information becomes available. Changes in forward price estimates, production costs or recovery rates may change the economic status of reserves and may ultimately result in reserves being restated.
b)
Crude oil and natural gas prices – Forward price estimates of the crude oil and natural gas prices are used in the cash flow model. Commodity prices have fluctuated widely in recent years due to global and regional factors including supply and demand fundamentals, inventory levels, exchange rates, weather, economic and geopolitical factors.
c)
Discount rate – The discount rate used to calculate the net present value of cash flows is based on estimates of an approximate industry peer group weighted average cost of capital. Changes in the general economic environment could result in significant changes to this estimate.
As a result of declining forward commodity prices for natural gas and crude oil, impairment tests were carried out at December 31, 2014 on each of ARC's CGUs. The estimated recoverable amounts were based on fair value less costs of disposal calculations using after-tax discount rates that are based on an estimated industry weighted cost of capital ranging from nine to 9.5 per cent depending on the resource composition of the assets in the CGU and the following forward commodity price estimates:


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Edmonton Light
Crude Oil

WTI Oil

AECO Gas

Cdn$/US$

Year
(Cdn$/bbl) (1)

(US$/bbl) (1)

(Cdn$/mmbtu) (1)

Exchange Rates (1)

2015
64.71

62.50

3.31

0.85

2016
80.00

75.00

3.77

0.88

2017
85.71

80.00

4.02

0.88

2018
91.43

85.00

4.27

0.88

2019
97.14

90.00

4.53

0.88

2020
102.86

95.00

4.78

0.88

2021
106.18

98.54

5.03

0.88

2022
108.31

100.51

5.28

0.88

2023
110.47

102.52

5.53

0.88

2024
112.67

104.57

5.71

0.88

Remainder
+2.0% per year

+2.0% per year

+2.0% per year

0.88

(1)
Source: GLJ Petroleum Consultants price forecast, effective December 31, 2014.
For the year ended December 31, 2014, ARC recorded an impairment of $28.2 million on a Southeast Saskatchewan E&E project prior to its transfer to PP&E upon determination that the carrying amount of the project assets was unlikely to be recovered by successful development or sale. The recoverable amount of $9 million as at the date of transfer on September 30, 2014 was determined using an after-tax discount rate of 10 per cent. The impairment charge was recorded as part of intangible E&E expenses in the statements of income.
For the year ended December 31, 2014, ARC recorded an impairment of $103 million on its Northern Alberta CGU, which was recognized in depletion, depreciation, amortization and impairment in the statements of income. The recoverable amount of $991 million was determined using an after-tax discount rate of nine per cent.
The fair value less cost to sell values used to determine the recoverable amounts of the impaired E&E and PP&E assets are classified as Level 2 fair value measurements. Refer to Note 3 for information on fair value hierarchy classifications.
The carrying value of goodwill at December 31, 2014 is $248.2 million. This value is supported by the combined excess recoverable amount over the current carrying value of ARC’s operating segment.
Depletion of Oil and Gas Assets
Depletion of oil and gas assets is determined based on total proved and probable reserve values as well as future development costs as estimated by ARC’s external reserve evaluator. See (a) above for discussion of estimates and judgments involved in reserve estimation.
Oil and Gas Activities
The Company applies judgment when classifying the nature of oil and gas activities as E&E or PP&E, and when determining whether capitalization of the initial costs of these activities is appropriate. The Company uses historical drilling results, project economics, resource quantities, production technology expectations, production costs and future development costs to make judgments about future events and circumstances. See (a) above for discussion of estimates and judgments involved in reserve estimation.
Asset Retirement Obligations
The provision for site restoration and abandonment is based on current legal and constructive requirements, technology, price levels and expected plans for remediation. Actual costs and cash outflows can differ from estimates because of changes in laws and regulations, public expectations, market conditions, discovery and analysis of site conditions and changes in technology.
Fair Value Measurement
The estimated fair value of financial instruments is reliant upon a number of estimated variables including forward commodity prices, foreign exchange rates and interest rates, volatility curves and risk of non-performance. A change in any one of these factors could result in a change to the overall estimated valuation of the instrument.


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Employee Compensation Costs
Compensation expense accrued for ARC’s PSU Plan is dependent on an adjustment to the final number of PSU awards that eventually vest based on a performance multiplier that is estimated by Management. Large fluctuations in compensation expense may occur due to changes in the underlying share price or revised management estimates of relevant performance factors.
Compensation expense recorded for ARC’s Share Option Plan is based on a binomial-lattice option pricing model. The inputs to this model rely on management judgment.
Income Taxes
Tax regulations and legislation are subject to change and differing interpretations requiring management judgment. Deferred tax liabilities are recognized when it is considered probable that temporary differences will be payable to tax authorities in future periods. Income tax filings are subject to audits and re-assessments and changes in facts, circumstances and interpretations of the standards may result in a material increase or decrease in the Company’s provision for income taxes.
6.
CASH AND CASH EQUIVALENTS
ARC's cash balance was $7.1 million at December 31, 2014 and was held in investment grade assets. The cash balance was nil at December 31, 2013.
7.
FINANCIAL ASSETS AND CREDIT RISK
Credit risk is the risk of financial loss to ARC if a partner or counterparty to a product sales contract or financial instrument fails to meet its contractual obligations. ARC is exposed to credit risk with respect to its accounts receivable, reclamation fund assets, and risk management contracts. Most of ARC’s accounts receivable relate to crude oil and natural gas sales and are subject to typical industry credit risks. Refer to Note 14 which discusses ARC's capital management objectives and policies. ARC manages its credit risk as follows:
•
by entering into sales contracts with only established, creditworthy counterparties as verified by a third-party rating agency, through internal evaluation or by requiring security such as letters of credit or parental guarantees;
•
by limiting exposure to any one counterparty in accordance with ARC’s credit policy; and
•
by restricting cash equivalent investments, reclamation fund investments, and risk management transactions to counterparties that are not less than investment grade.
The majority of the credit exposure on accounts receivable at December 31, 2014 pertains to accrued revenue for December 2014 production volumes. ARC transacts with a number of crude oil and natural gas marketing companies and commodity end users (“commodity purchasers”). Commodity purchasers and marketing companies typically remit amounts to ARC by the 25th day of the month following production. Joint interest receivables are typically collected within one to three months following production. At December 31, 2014, no one counterparty accounted for more than 10 per cent of total revenue.
ARC’s allowance for doubtful accounts was $0.6 million as at December 31, 2014 (nil as at December 31, 2013). During the year ended December 31, 2014, ARC recorded a $0.6 million provision for non-collectible accounts receivable (nil for the year ended December 31, 2013).
When determining whether amounts that are past due are collectible, Management assesses the creditworthiness and past payment history of the counterparty, as well as the nature of the past due amount. ARC considers all amounts greater than 90 days to be past due. At December 31, 2014, $2.6 million of accounts receivable are past due, all of which are considered to be collectible ($5 million at December 31, 2013).


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ARC's accounts receivable was aged as follows at December 31, 2014:
Accounts Receivable Aging
December 31, 2014

Current (less than 30 days)
159.8

31 - 60 days
1.8

61 - 90 days
0.8

Past due (more than 90 days)
2.6

Balance, December 31, 2014
165.0

Maximum credit risk is calculated as the total recorded value of accounts receivable, reclamation fund assets, and risk management contracts at the balance sheet date. The carrying value of ARC's accounts receivable approximates the fair value of the underlying financial assets.
8.
RECLAMATION FUND
In 2005, ARC established a restricted reclamation fund to finance obligations specifically associated with its Redwater property. Minimum contributions to this fund will be approximately $64.2 million in total over the next 41 years. Under the terms of ARC’s investment policy, cash in the reclamation fund can only be invested in Canadian or US Government securities, investment grade corporate bonds, or investment-grade short-term money market securities.
 
Year Ended December 31, 2014

 
Year Ended December 31, 2013

Balance, beginning of period
32.6

 
29.8

Contributions
3.7

 
3.9

Reimbursed expenditures (1)
(1.8
)
 
(1.5
)
Interest earned on funds
0.7

 
0.4

Balance, end of period
35.2

 
32.6

(1)Amount differs from actual expenditures incurred by ARC due to timing differences and discretionary reimbursements.
Required contributions to this fund will vary over time and have been disclosed as commitments in Note 19. Interest earned on the respective investments is retained within the fund.
9.
INTANGIBLE EXPLORATION AND EVALUATION ASSETS
Carrying amount
Balance, January 1, 2013
238.1

Additions
15.0

Acquisitions
13.6

Intangible exploration and evaluation expenses
(1.3
)
Balance, December 31, 2013
265.4

Additions
49.4

Transfers to property, plant and equipment
(9.0
)
Intangible exploration and evaluation expenses
(39.4
)
Balance, December 31, 2014
266.4

ARC has certain E&E properties that have sales of petroleum products associated with production from test wells. For the year ended December 31, 2014, these operating results have been recognized in the statements of income and comprised sales of crude oil, natural gas, condensate and natural gas liquids of $19.3 million, royalties of $1 million, operating expenses of $6.9 million, and transportation expenses of $1.6 million. All cash flows associated with E&E assets are reflected in cash flow from operating activities.


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10.
PROPERTY, PLANT AND EQUIPMENT
Cost
Development and Production Assets

 
Administrative Assets

 
Total

Balance, January 1, 2013
6,129.3

 
50.3

 
6,179.6

Additions
862.8

 
4.6

 
867.4

Acquisitions
22.8

 
—

 
22.8

Change in asset retirement cost
(40.6
)
 
—

 
(40.6
)
Assets reclassified as held for sale
(115.8
)
 
—

 
(115.8
)
Balance, December 31, 2013
6,858.5

 
54.9

 
6,913.4

Additions
951.9

 
6.5

 
958.4

Acquisitions
71.7

 
—

 
71.7

Transfers from exploration and evaluation
9.0

 
—

 
9.0

Change in asset retirement cost
182.8

 
—

 
182.8

Dispositions
(140.9
)
 
—

 
(140.9
)
Assets reclassified as held for sale
(15.9
)
 
—

 
(15.9
)
Balance, December 31, 2014
7,917.1

 
61.4

 
7,978.5

 
 
 
Accumulated depletion, depreciation, amortization and impairment
Balance, January 1, 2013
(1,459.9
)
 
(15.3
)
 
(1,475.2
)
Depletion, depreciation and amortization
(545.4
)
 
(6.5
)
 
(551.9
)
Accumulated depletion reclassified as held for sale
42.2

 
—

 
42.2

Balance, December 31, 2013
(1,963.1
)
 
(21.8
)
 
(1,984.9
)
Depletion, depreciation and amortization
(649.2
)
 
(6.3
)
 
(655.5
)
Impairment (Note 5)
(103.0
)
 
—

 
(103.0
)
Accumulated depletion and impairment associated with dispositions
74.9

 
—

 
74.9

Accumulated depletion and impairment reclassified as held for sale

10.1

 
—

 
10.1

Balance, December 31, 2014
(2,630.3
)
 
(28.1
)
 
(2,658.4
)
 
 
 
 
 
 
Carrying amounts
 
 
 
 
 
Balance, December 31, 2013
4,895.4

 
33.1

 
4,928.5

Balance, December 31, 2014
5,286.8

 
33.3

 
5,320.1

For the year ended December 31, 2014, $39.9 million of direct and incremental general and administrative expenses were capitalized to PP&E ($38 million for the year ended December 31, 2013). During the year ended December 31, 2014, ARC completed minor acquisitions of non-producing properties for consideration of $29.8 million.
Assets held for sale
Balance, January 1, 2013
0.3

Additions
73.6

Disposals
(73.9
)
Balance, December 31, 2013
—

Additions
66.0

Disposals
(60.2
)
Balance, December 31, 2014
5.8

In the year ended December 31, 2014, ARC entered into an agreement to dispose of certain non-core shallow gas assets located in southwestern Saskatchewan for proceeds of $32.7 million. The liabilities associated with the assets held for sale were asset retirement obligations with a book value of $28.5 million. The transaction closed on April 15, 2014.


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11.
FINANCIAL LIABILITIES AND LIQUIDITY RISK
Liquidity risk is the risk that ARC will not be able to meet its financial obligations as they become due. ARC actively manages its liquidity at a reasonable cost through strategies such as continuously monitoring forecast and actual cash flows from operating, financing and investing activities, available credit and working capital facilities under existing banking arrangements, and opportunities to issue additional equity. Management believes that future cash flows generated from these sources will be adequate to settle ARC’s financial liabilities. Refer to Note 12 for further details on available amounts under existing banking arrangements and Note 14 for further details on ARC's capital management objectives and policies.
The following table details the contractual maturities of ARC’s financial liabilities as at December 31, 2014:
 
Carrying Amount

1 Year

2-3 Years

4-5 Years

Beyond 5 Years

Accounts payable and accrued liabilities (1)
339.1

339.1

—

—

—

Dividends payable
32.0

32.0

—

—

—

Risk management contracts (2)
2.0

1.0

1.0

—

—

Long-term debt
1,074.8

49.5

94.0

220.7

710.6

Long-term incentive compensation liability
29.1

—

29.1

—

—

Total financial liabilities
1,477.0

421.6

124.1

220.7

710.6

(1)
Includes the portion of the cash obligations associated with the RSU & PSU Plans that will be settled within one year.
(2)
Risk management contracts are derivatives. All other financial liabilities contained in this table are non-derivative liabilities.
The carrying values of ARC's accounts payable and accrued liabilities, dividends payable, and long-term incentive compensation liability approximate their fair values.


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12.
LONG-TERM DEBT
 
December 31, 2014

 
December 31, 2013

Syndicated credit facilities
 
 
 
Cdn$ denominated
83.8

 
99.8

Working capital facility
—

 
6.1

Senior notes
 
 
 
Master Shelf Agreement
 
 
 
5.42% US$ note
32.6

 
39.9

4.98% US$ note
58.0

 
53.2

3.72% US$ note
174.0


—

2004 Note Issuance
 
 
 
4.62% US$ note
—

 
6.8

5.10% US$ note
11.1

 
15.3

2009 note issuance
 
 
 
7.19% US$ note
31.3

 
43.1

8.21% US$ note
40.6

 
37.2

6.50% Cdn$ note
11.6

 
17.4

2010 note issuance
 
 
 
5.36% US$ note
174.0

 
159.5

2012 note issuance
 
 
 
3.31% US$ note
69.7

 
63.8

3.81% US$ note
348.1

 
319.2

4.49% Cdn$ note
40.0

 
40.0

Total long-term debt outstanding
1,074.8

 
901.3

Long-term debt due within one year
49.5

 
42.1

Long-term debt due beyond one year
1,025.3

 
859.2

Credit Facility
ARC has a $1 billion, annually extendable, financial covenant-based syndicated credit facility (“the facility”). The current maturity date of the facility is November 6, 2018. ARC also has in place a $40 million demand working capital facility and letter of credit facilities from two lenders totaling $40 million. Both the working capital facility and the letter of credit facilities are subject to the same covenants as the syndicated credit facility.
Borrowings under the facility bear interest at Canadian bank prime (three per cent at both December 31, 2014 and 2013) or US base rate, or, at ARC’s option, Canadian dollar bankers’ acceptances or US dollar LIBOR loan rates, plus applicable margin and stamping fees. The total stamping fees range between 50 basis points and 215 basis points on Canadian bank prime and US base rate borrowings and between 150 basis points and 315 basis points on Canadian dollar bankers’ acceptance and US dollar LIBOR borrowings. The undrawn portion of the facility is subject to a standby fee in the range of 30 to 63 basis points.
The weighted average interest rate under the credit facility was three per cent for the year ended December 31, 2014 (two per cent for the year ended December 31, 2013).
Senior Notes Issued Under a Master Shelf Agreement
These senior notes were issued in three separate tranches pursuant to an uncommitted master shelf agreement. The terms and rates of these senior notes are summarized below:
Issue Date
Remaining Principal
Coupon Rate
Maturity Date
Principal Payment Terms
December 15, 2005
US$28.1 million
5.42%
December 15, 2017
Eight equal installments beginning December 15, 2010
March 5, 2010
US$50 million
4.98%
March 5, 2019
Five equal installments beginning March 5, 2015
September 25, 2014
US$150 million
3.72%
September 25, 2026
Five equal installments beginning September 25, 2022


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Senior Notes Not Subject to the Master Shelf Agreement
The senior notes not subject to the Master Shelf Agreement were issued by way of private placements. The terms and rates of these senior notes are summarized below:
Issue Date
Remaining Principal
Coupon Rate
Maturity Date
Principal Payment Terms
April 27, 2004
US$9.6 million
5.10%
April 27, 2016
Five equal installments beginning April 27, 2012
April 14, 2009
US$27 million
7.19%
April 14, 2016
Five equal installments beginning April 14, 2012
April 14, 2009
US$35 million
8.21%
April 14, 2021
Five equal installments beginning April 14, 2017
April 14, 2009
Cdn$11.6 million
6.50%
April 14, 2016
Five equal installments beginning April 14, 2012
May 27, 2010
US$150 million
5.36%
May 27, 2022
Five equal installments beginning May 27, 2018
August 23, 2012
US$60 million
3.31%
August 23, 2021
Five equal installments beginning August 23, 2017
August 23, 2012
US$300 million
3.81%
August 23, 2024
Five equal installments beginning August 23, 2020
August 23, 2012
Cdn$40 million
4.49%
August 23, 2024
Five equal installments beginning August 23, 2020
Credit Capacity
The following table summarizes ARC’s available credit capacity and the current amounts drawn as at December 31, 2014:
 
Credit Capacity

 
Drawn

 
Remaining

Syndicated credit facility
1,000.0

 
83.8

 
916.2

Working capital facility
40.0

 
—

 
40.0

Senior Notes subject to a Master Shelf Agreement (1)
406.0

 
264.6

 
141.4

Senior Notes not subject to a Master Shelf Agreement
726.4

 
726.4

 
—

Total
2,172.4

 
1,074.8

 
1,097.6

(1)
Total credit capacity is US$350 million.
Debt Covenants
The following are the significant financial covenants governing the revolving credit facilities:
•
long-term debt and letters of credit not to exceed three and a quarter times trailing twelve month net income before non-cash items, income taxes and interest expense;
•
long-term debt, letters of credit, and subordinated debt not to exceed four times trailing twelve month net income before non-cash items, income taxes and interest expense; and
•
long-term debt and letters of credit not to exceed 50 per cent of the book value of shareholders’ equity and long-term debt, letters of credit, and subordinated debt.
In the event that ARC enters into a material acquisition whereby the purchase price exceeds 10 per cent of the book value of ARC’s assets, the ratio in the first covenant is increased to 3.5 times, while the third covenant is increased to 55 per cent for the subsequent six month period. As at December 31, 2014, ARC had $15.5 million in letters of credit ($14.9 million at December 31, 2013), no subordinated debt, and was in compliance with all covenants.
On September 25, 2014, ARC issued US$150 million of senior unsecured notes under its Master Shelf Agreement by way of a private placement. The notes have a 12 year amortization term with a 10 year average life and a fixed-rate coupon of 3.72 per cent. The notes are unsecured and rank equally with ARC's bank credit facility and other outstanding senior notes. Concurrently, ARC increased the Master Shelf Agreement from a maximum of US$225 million to US$350 million and extended the term for an additional three years commencing September 25, 2014.
As at December 31, 2014, the fair value of all senior notes is $974.4 million ($785.9 million as at December 31, 2013), compared to a carrying value of $991 million ($795.4 million as at December 31, 2013).


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13.
ASSET RETIREMENT OBLIGATIONS
The total future ARO liability was estimated by Management based on ARC’s net ownership interest in all wells and facilities, estimated costs to reclaim and abandon the wells and facilities, and the estimated timing of the costs to be incurred in future periods. ARC has estimated the net present value of its total ARO to be $616.1 million as at December 31, 2014 ($475.4 million at December 31, 2013) based on a total future undiscounted liability of $1.6 billion ($1.7 billion at December 31, 2013). At December 31, 2014, Management estimates that these payments are expected to be made over the next 60 years with the majority of payments being made in years 2063 to 2074. The Bank of Canada's long-term risk-free bond rate of 2.3 per cent (3.2 per cent at December 31, 2013) and an inflation rate of two per cent (two per cent at December 31, 2013) were used to calculate the present value of the ARO liability at December 31, 2014.
The following table reconciles ARC’s provision for ARO:
 
Year Ended December 31, 2014

 
Year Ended December 31, 2013

Balance, beginning of period
475.4

 
532.9

Increase in liabilities relating to development activities
12.6

 
12.8

Increase (decrease) in liabilities relating to change in estimate and discount rate
174.2

 
(53.4
)
Settlement of reclamation liabilities
(23.0
)
 
(18.5
)
Accretion
14.9

 
12.5

Dispositions
(32.5
)
 
(10.9
)
Reclassified as liabilities associated with assets held for sale
(5.5
)
 
—

Balance, end of period
616.1

 
475.4

Expected to be incurred within one year
13.0

 
25.1

Expected to be incurred beyond one year
603.1

 
450.3

14.
CAPITAL MANAGEMENT
ARC’s objective when managing its capital is to maintain a conservative structure that will allow it to:
•
fund its development and exploration program;
•
provide financial flexibility to execute on strategic opportunities; and
•
maintain a dividend policy that, in normal times, in the opinion of Management and the Board of Directors, is sustainable.
ARC manages the following capital:
•
common shares and
•
net debt, which includes long-term debt and working capital deficit (surplus), if any. Working capital deficit (surplus) is calculated as current liabilities less current assets, and excludes current unrealized amounts pertaining to risk management contracts, assets held for sale and ARO contained within liabilities associated with assets held for sale, as well as the current portion of long-term debt and current portion of ARO.
When evaluating ARC’s capital structure, Management’s objective is to target net debt between one to 1.5 times annualized funds from operations and less than 20 per cent of total market capitalization. As at December 31, 2014 ARC’s net debt to funds from operations ratio is 1.1 and its net debt to total market capitalization ratio is 13.5 per cent.


ARC Resources Ltd.
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Year Ended December 31, 2014

 
Year Ended December 31, 2013

Cash flow from operating activities
1,153.0

 
801.7

Net change in other liabilities (Note 21)
20.4

 
16.6

Change in non-cash working capital (Note 21)
(49.4
)
 
43.5

Funds from operations
1,124.0

 
861.8

 
December 31, 2014

 
December 31, 2013

Long-term debt (1)
1,074.8

 
901.3

Accounts payable and accrued liabilities
339.1

 
274.5

Dividends payable
32.0

 
31.4

Cash and cash equivalents, accounts receivable, prepaid expenses and short-term investment
(190.0
)
 
(195.7
)
Net debt obligations
1,255.9

 
1,011.5

 
 
 
 
Shares outstanding (millions)
319.4

 
314.1

Share price ($) (2)
25.16

 
29.57

Market capitalization
8,036.1

 
9,287.9

Net debt obligations
1,255.9

 
1,011.5

Total capitalization
9,292.0

 
10,299.4

 
 
 
 
Net debt as a percentage of total capitalization (%)
13.5

 
9.8

Net debt to funds from operations (ratio)
1.1

 
1.2

(1)
Includes current portion of long-term debt at December 31, 2014 and 2013 of $49.5 million and $42.1 million, respectively.
(2)
TSX closing price as at December 31, 2014 and 2013, respectively.
ARC manages its capital structure and makes adjustments to it in response to changes in economic conditions and the risk characteristics of the underlying assets. ARC is able to change its capital structure by issuing new shares, new debt or changing its dividend policy.
15.
FINANCIAL INSTRUMENTS AND MARKET RISK MANAGEMENT
Fair Value Hierarchy
All of ARC’s financial instruments carried at fair value are transacted in active markets. ARC’s cash and cash equivalents, short-term investment, and reclamation fund assets are classified as Level 1 measurements in the three-level fair value measurement hierarchy and its bank debt and risk management contracts are classified as Level 2 measurements. ARC does not have any fair value measurements classified as Level 3 and there were no transfers between levels in the hierarchy in the year ended December 31, 2014.
Short-term Investment
ARC holds an equity investment in a publicly traded petroleum and natural gas producing company that had an initial cost of $2.9 million. At December 31, 2014, the fair value of ARC's investment was $3.6 million ($3.6 million at December 31, 2013). An unrealized gain of $1.9 million was recorded for the year ended December 31, 2013, where no gains or losses were recorded for the year ended December 31, 2014.


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Financial Assets and Financial Liabilities Subject to Offsetting
The following is a summary of ARC's financial assets and financial liabilities that are subject to offsetting as at December 31, 2014 and December 31, 2013:
 
Gross Amounts of Recognized Financial Assets (Liabilities)

Gross Amounts of Recognized Financial Assets (Liabilities) Offset in Balance Sheet

Net Amounts of Financial Assets (Liabilities) Recognized in Balance Sheet Prior to Credit Risk Adjustment

Credit Risk Adjustment

Net Amounts of Financial Assets (Liabilities) Recognized in Balance Sheet

As at December 31, 2014
 
 
 
 
 
Risk management contracts
 
 
 
 
Current asset
151.0

(18.2
)
132.8

(1.0
)
131.8

Long-term asset
132.1

(3.1
)
129.0

(1.0
)
128.0

Current liability
(19.2
)
18.2

(1.0
)
—

(1.0
)
Long-term liability
(4.1
)
3.1

(1.0
)
—

(1.0
)
Net position
259.8

—

259.8

(2.0
)
257.8

 
 
 
 
 
 
As at December 31, 2013
 
 
 
 
 
Risk management contracts
 
 
 
 
Current asset
13.7

(9.2
)
4.5

(0.1
)
4.4

Long-term asset
63.3

(1.6
)
61.7

(0.5
)
61.2

Current liability
(22.6
)
9.2

(13.4
)
0.5

(12.9
)
Long-term liability
(2.3
)
1.6

(0.7
)
0.1

(0.6
)
Net position
52.1

—

52.1

—

52.1

Market Risk Management
ARC is exposed to a number of market risks that are part of its normal course of business. Market risks that could adversely affect the value of the Company’s financial assets, liabilities and expected future cash flows include commodity price risk, interest rate risk, and foreign exchange risk. ARC has a risk management program in place that includes financial instruments as disclosed in the risk management contracts section of this note.
ARC’s senior Management oversees the Company’s risk management program and the program is governed by certain guidelines approved by the Risk Committee of the Board of Directors. The objective of the risk management program is to support ARC’s business plan by mitigating adverse changes in commodity prices, interest rates and foreign exchange rates in order to reduce the volatility of revenues, increase the certainty of funds from operations, and to protect acquisition and development economics. All risk management activities are performed by specialist teams that have the appropriate skills, experience and supervision.
ARC has prepared sensitivity analyses in an attempt to demonstrate the hypothetical effect of changes in these market risk factors on ARC’s net income. For the purposes of the sensitivity analyses, the effect of a variation in a particular variable is calculated independently of any change in another variable. In reality, changes in one factor may contribute to changes in another, which may magnify or counteract the sensitivities. The assumptions made to derive the changes in the relevant risk variables in each sensitivity analysis are based on Management’s assessment of reasonably possible changes that could occur at December 31, 2014. The results of the sensitivity analyses should not be considered to be predictive of future performance.
Commodity Price Risk
ARC’s operational results and financial condition are largely dependent on the commodity prices received for its crude oil and natural gas production. Commodity prices have fluctuated widely during recent years due to global and regional factors including supply and demand fundamentals, inventory levels, weather, economic, and geopolitical factors. Movement in commodity prices could have a significant positive or negative impact on ARC’s net income.
The guidelines for ARC’s risk management program currently restrict the amount of risk management contracts to a maximum of 55 per cent of total forecast production whereby a specific commodity (crude oil or natural gas) cannot exceed a maximum of 70 per cent of forecast production for that commodity over the next two years, and with a maximum of 25 percent of forecast natural gas production in risk management contracts beyond two years and up to five years. ARC’s risk management program guidelines allow for further risk management contracts on anticipated


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volumes associated with new production arising from specific capital projects and acquisitions or to further protect cash flows for a specific period with approval of the Board.
ARC manages the risks associated with changes in commodity prices by entering into a variety of risk management contracts (see Risk Management Contracts section below). The following table illustrates the effects of movement in commodity prices on net income due to changes in the fair value of risk management contracts in place at December 31, 2014. The sensitivity is based on a US$10 increase and decrease in the price of West Texas Intermediate ("WTI"), a US$0.50 increase and decrease in the price of New York Mercantile Exchange ("NYMEX") natural gas, a five per cent increase and 10 per cent decrease in the Alberta natural gas trading price ("AECO") basis relative to NYMEX, and a Cdn$20 increase and Cdn$10 decrease in the Alberta Electric System Operator ("AESO") power price.
Sensitivity of Commodity Price Risk Management Contracts
 
Increase in Commodity Price
Decrease in Commodity Price
 
Crude Oil

Natural Gas

Electricity

Crude Oil

Natural Gas

Electricity

Net income increase (decrease)
(3.8
)
(104.8
)
8.8

1.0

135.6

(4.0
)
ARC enters into physical commodity contracts in the normal course of business. These contracts are not derivatives and are treated as executory contracts, which are recognized at cost at the time of transaction.
Interest Rate Risk
ARC's policy is to manage its interest cost using a mix of both fixed and variable interest rates on its debt. Changes in interest rates could result in an increase or decrease in the amount ARC pays to service variable interest rate debt. Changes in interest rates could also result in fair value risk on ARC’s fixed rate senior notes. Fair value risk of the senior notes is mitigated due to the fact that ARC generally does not intend to settle its fixed rate debt prior to maturity.
If interest rates applicable to variable rate debt increased or decreased by one per cent, it is estimated that ARC's net income would change by approximately $1.2 million for the year ended December 31, 2014. This assumes that the change in interest rates would be effective from the beginning of the year, while maintaining the same amount and proportion of variable interest rate debt that was outstanding as at December 31, 2014.
Foreign Exchange Risk
North American crude oil and natural gas prices are based upon US dollar denominated commodity prices. As a result, the price received by Canadian producers is affected by the Cdn$/US$ foreign exchange rate that may fluctuate over time. In addition, ARC has US dollar denominated debt and interest obligations of which future cash repayments are directly impacted by the exchange rate in effect on the repayment date.
The following table demonstrates the effect of exchange rate movements on net income due to changes in the fair value of risk management contracts in place at December 31, 2014 as well as the unrealized gain or loss on revaluation of outstanding US dollar denominated debt. The sensitivity is based on a $0.04 increase and $0.04 decrease in the Cdn$/US$ foreign exchange rate.
Sensitivity of Foreign Exchange Exposure
Increase in Cdn$/US$ rate

 
Decrease in Cdn$/US$ rate

Risk management contracts
7.0

 
(8.3
)
US dollar denominated debt
(28.3
)
 
28.3

Net income increase (decrease)
(21.3
)
 
20.0

Increases and decreases in foreign exchange rates applicable to US dollar denominated payables and receivables would have a nominal impact on ARC’s net income for the year ended December 31, 2014.


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Risk Management Contracts
The following is a summary of all risk management contracts in place, excluding premiums, as at December 31, 2014. Risk management contract premiums have been disclosed as commitments in Note 19.
Financial WTI Crude Oil Contracts (1)
 
 
Volume
Bought Put
Sold Put

Sold Call
Term
Contract
bbl/d
US$/bbl
US$/bbl

US$/bbl
1-Jan-15
30-Jun-15
3-Way
4,000
90.00
65.00

100.00
1-Jan-15
30-Jun-15
3-Way
2,000
90.00
65.00

102.50
(1)
Settled on the monthly average price.
Financial NYMEX Natural Gas Contracts (2)
 
 
 
 
Volume
Bought Put

Sold Call

Term
Contract
mmbtu/d
US$/mmbtu

US$/mmbtu

1-Jan-15
31-Mar-15
Collar
75,000
4.00

4.50

1-Jan-15
31-Mar-15
Collar
20,000
4.00

5.25

1-Jan-15
30-Apr-15
Collar
30,000
3.75

4.25

1-Jan-15
31-Dec-15
Collar
20,000
3.75

4.25

1-Jan-15
31-Dec-15
Collar
30,000
4.00

4.75

1-Jan-15
31-Dec-15
Collar
60,000
4.00

5.00

1-Apr-15
31-Dec-15
Collar
65,000
4.00

4.25

1-May-15
31-Dec-15
Collar
30,000
3.75

4.00

1-Apr-15
31-Dec-17
Collar
10,000
4.00

4.50

1-Jan-16
31-Dec-17
Collar
45,000
4.00

4.50

1-Jan-16
31-Dec-17
Collar
90,000
4.00

5.00

1-Jan-18
31-Dec-18
Collar
30,000
4.00

4.75

1-Jan-18
31-Dec-18
Collar
60,000
4.00

5.00

1-Jan-19
31-Dec-19
Collar
40,000
4.00

5.00

(2)
NYMEX Henry Hub "Last Day" Settlement.
Financial AECO Basis Swap Contracts (3)
 
 
Volume
Ratio Sold Swap %
Term
Contract
mmbtu/d
AECO/NYMEX
1-Jan-15
31-Dec-15
Swap
130,000
90.5
1-Jul-15
31-Dec-15
Swap
30,000
85.2
1-Jan-16
31-Dec-16
Swap
140,000
90.3
1-Jan-17
31-Dec-17
Swap
140,000
90.2
1-Jan-18
30-Jun-18
Swap
20,000
89.9
1-Jan-18
31-Dec-18
Swap
35,000
88.5
1-Jul-18
31-Dec-18
Swap
20,000
85.4
1-Jan-19
30-Jun-19
Swap
20,000
90.8
(3)
ARC receives NYMEX price based on Last Day settlement multiplied by AECO/NYMEX US$/mmbtu ratio; ARC pays AECO (7a) monthly index US$/mmbtu.
Financial Electricity Heat Rate Contracts (4)
 
 
Volume
Heat Rate
Term
Contract
MWh
GJ/MWh
1-Jan-15
31-Dec-17
Heat Rate Swap
20
13.71
(4)
ARC pays AECO Monthly (5a) x Heat Rate; ARC receives floating AESO Power Price.


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Financial Electricity Contracts (5)
 
 
Volume
Bought Swap
Term
Contract
MWh
Cdn$/MWh
1-Jan-15
31-Dec-16
Fixed Rate Swap
5
51.00
(5)
Alberta Power Pool (monthly average 24x7).
Foreign Exchange Contracts (6)
 
 
Volume

Bought Put
Sold Call
Term
Contract
US$ millions/month

Cdn$/US$
Cdn$/US$
1-Jan-15
31-Dec-15
Collar
2.0

1.0400
1.0925
(6)
Bank of Canada monthly average noon day rate settlement.
Foreign Exchange Swap Contracts (7)
 
 
 
Volume
Sold Swap
Limit Price
Term
Contract
US$ millions/month
Cdn$/US$
Cdn$/US$ (8)
1-Jan-15
31-Dec-15
Limit Swap
2.0
1.0525
1.1350
(7)
Bank of Canada monthly average noon day rate settlement.
(8)
Swap with upside participation up to the limit; above which, settlement will occur at swap price.
At December 31, 2014, the net fair value associated with ARC’s risk management contracts was a net asset of $257.8 million ($52.1 million net asset at December 31, 2013). ARC recorded gains on its risk management contracts of $176.2 million for the year ended December 31, 2014 in its statements of income (gains of $46.3 million for the year ended December 31, 2013).
16.
INCOME TAXES
The major components of income tax expense for the years ended December 31, 2014 and 2013 were as follows:
 
December 31, 2014

 
December 31, 2013

Current:
 
 
 
Current year
87.1

 
24.7

Adjustments for prior years
(16.8
)
 
(8.4
)
 
70.3

 
16.3

Deferred:
 
 
 
Origination and reversal of temporary differences
53.0

 
55.5

Adjustments for prior years
7.4

 
10.7

Changes in tax rates and legislation
(1.3
)
 
11.7

 
59.1

 
77.9

Total provision for income taxes
129.4

 
94.2



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The tax provision differs from the amount computed by applying the combined Canadian federal and provincial statutory income tax rates to income before deferred income tax expense as follows:
 
December 31, 2014

 
December 31, 2013

Income before tax
510.2

 
334.9

Canadian statutory rate (1)
25.4
%
 
25.5
%
Expected income tax expense at statutory rates
129.8

 
85.3

Effect on income tax of:
 
 
 
Effect of change in corporate tax rate
(1.3
)
 
11.7

Non-deductible portion of unrealized loss on foreign exchange
10.0

 
7.2

Change in estimated pool balances
(9.4
)
 
(8.2
)
Other
0.3

 
(1.8
)
Total provision for income taxes
129.4

 
94.2

(1)
The tax rate consists of the combined federal and provincial statutory tax rates for the Company and its subsidiaries for the years ended December 31, 2014 and December 31, 2013.
 
December 31, 2014

 
December 31, 2013

Deferred tax liabilities:
 
 
 
PP&E in excess of tax basis
780.6

 
731.3

Risk management contracts
66.2

 
16.8

 
 
 
 
Deferred tax assets:
 
 
 
Asset retirement obligations
(158.4
)
 
(121.5
)
Long-term debt
(10.8
)
 
(0.9
)
Risk management contracts
(0.5
)
 
(3.4
)
Long-term incentive compensation expense
(15.2
)
 
(17.4
)
Other
(2.6
)
 
(4.7
)
Deferred taxes
659.3

 
600.2

At December 31, 2014, the petroleum and natural gas properties and facilities owned by ARC have an approximate federal tax basis of $2.5 billion ($2.3 billion in 2013) available for future use as deductions from taxable income.
The following is a summary of the estimated ARC tax pools:
 
December 31, 2014

 
December 31, 2013

Canadian oil and gas property expense
710.9

 
718.2

Canadian development expense
974.6

 
862.5

Canadian exploration expense
—

 
—

Undepreciated capital cost
834.5

 
740.0

Other
10.8

 
18.8

Total federal tax pools
2,530.8

 
2,339.5

Additional Alberta tax pools
19.9

 
23.3

A deferred tax liability has not been recognized in respect of temporary differences associated with the investment in the partnership, as it is not likely that such temporary differences will reverse in the foreseeable future as ARC currently has no intention to dispose of its investment in the partnership. The taxable temporary differences associated with the investment in the partnership at December 31, 2014 are approximately $3 billion ($3 billion at December 31, 2013).
17.
SHAREHOLDERS’ CAPITAL
ARC is authorized to issue an unlimited number of no par value common shares and 50 million preferred shares without nominal or par value. Common shares carry one vote per share and the right to dividends. Preferred shares


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may be issued in series with rights and conditions to be determined by ARC's Board of Directors prior to issuance and subject to the Company’s articles. There are no outstanding preferred shares as at December 31, 2014 or 2013.
(thousands of shares)
Year Ended December 31, 2014

 
Year Ended December 31, 2013

Common shares, beginning of period
314,067

 
308,888

Cancelled shares
(47
)
 
—

Dividend reinvestment program
4,159

 
4,611

Stock dividend program
1,260

 
568

Common shares, end of period
319,439

 
314,067

Net income per common share has been determined based on the following:
(thousands of shares)
Year Ended December 31, 2014

 
Year Ended December 31, 2013

Weighted average common shares
316,621

 
311,537

Dilutive impact of share options
587

 
361

Weighted average common shares - diluted
317,208

 
311,898

Dividends declared for the years ended December 31, 2014 and 2013 were $1.20 per common share.
On January 16, 2015, the Board of Directors declared a dividend of $0.10 per common share, payable in cash or common shares under the Stock Dividend Program, to shareholders of record on January 30, 2015. The dividend payment date is February 17, 2015. Of the $32 million in dividends payable at December 31, 2014, $4.2 million is payable in common shares under the Stock Dividend Program ($2.6 million at December 31, 2013).
18.
LONG-TERM INCENTIVE PLANS
RSU & PSU Plan
ARC’s share-based long-term incentive plan results in employees, officers and directors (the “plan participants”) receiving cash compensation in relation to the value of a specified number of underlying notional share units. The RSU & PSU Plan consists of RSUs for which the number of share units is fixed and will vest evenly over a period of three years and PSUs for which the number of share units is variable and will vest at the end of three years.
Upon vesting of the RSUs, the plan participant receives a cash payment based on the fair value of the underlying share units plus all dividends accrued since the grant date. The cash compensation of the PSUs issued upon vesting is further dependent upon an adjustment to the final number of PSU awards that eventually vest based on a performance multiplier. The performance multiplier is calculated at the time of payment using the percentile rank of ARC’s total shareholder return relative to its peers and can result in cash compensation issued upon vesting of the PSUs ranging from zero to two times the value of the PSUs originally granted.
DSU Plan
ARC offers a DSU Plan to non-employee directors, under which each director receives a minimum of 60 per cent of their total annual remuneration in the form of DSUs. Each DSU fully vests on the date of grant, but is distributed only when the director has ceased to be a member of the Board of Directors of the Company. Compensation expense associated with the DSU Plan is based on the fair value of DSUs at the date of grant, adjusted to the current fair value of outstanding awards at each period end. Units are settled in cash based on the common share price plus accrued dividends.
The following table summarizes the Restricted Share Unit ("RSU"), Performance Share Unit ("PSU") and Deferred Share Unit ("DSU") movement for the years ended December 31, 2014 and 2013:


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Page 66

(number of units, thousands)
RSUs

 
PSUs (1)

 
DSUs

Balance, January 1, 2013
696

 
1,401

 
134

Granted
346

 
577

 
57

Distributed
(349
)
 
(379
)
 
(32
)
Forfeited
(55
)
 
(107
)
 
—

Balance, December 31, 2013
638

 
1,492

 
159

Granted
327

 
494

 
61

Distributed
(299
)
 
(435
)
 
—

Forfeited
(41
)
 
(38
)
 
—

Balance, December 31, 2014
625

 
1,513

 
220

(1)
Based on underlying units before performance multiplier.
Compensation charges relating to the RSU, PSU and DSU Plans can be reconciled as follows:
 
Year Ended December 31, 2014

 
Year Ended December 31, 2013

General and administrative expense
22.7

 
38.7

Operating expense
3.8

 
5.3

PP&E
4.3

 
6.5

Total compensation charges
30.8

 
50.5

Cash payments
39.4

 
33.7

At December 31, 2014, $30.9 million of compensation amounts payable were included in accounts payable and accrued liabilities on the balance sheet ($42.6 million at December 31, 2013) and $29.1 million was included in long-term incentive compensation liability ($26.1 million at December 31, 2013). A recoverable amount of $0.5 million was included in accounts receivable at December 31, 2014 ($0.6 million at December 31, 2013).
Share Option Plan
Share options are granted to officers and certain employees of ARC which vest evenly on the fourth and fifth anniversary of their grant date and have a maximum term of seven years. The option holder has the right to exercise the options and purchase common shares at the original grant price or at a reduced exercise price, equal to the grant price less all dividends paid subsequent to the grant date and prior to the exercise date.
ARC estimates the fair value of share options granted using a binomial-lattice option pricing model. The grant date fair values were $3.6 million, or $8.40 per option outstanding for the 2011 grant, $5.5 million, or $5.25 per option outstanding for the 2012 grant, $5.6 million, or $7.87 per option outstanding for the 2013 grant, and $5.8 million, or $10.21 per option outstanding for the 2014 grant. The first vesting is expected to occur on March 24, 2015. The following assumptions were used to arrive at the estimated fair value at the date of the options grants:
 
Year Ended December 31, 2014

 
Year Ended December 31, 2013
Grant date share price ($)
20.20 - 32.94

 
20.20 - 27.15
Exercise price ($) (1)
17.20 - 32.34

 
18.40 - 26.55
Expected annual dividends ($)
1.20

 
1.20
Expected volatility (%) (2)
37.00 - 38.00

 
37.00 - 38.00
Risk-free interest rate (%)
1.39 - 2.61

 
1.39 - 2.61
Expected life of share option (3)
5.5 to 6 years

 
5.5 to 6 years
(1)
Exercise price is reduced monthly by the amount of dividend declared.
(2)
Expected volatility is determined by the average price volatility of the common shares/trust units over the past seven years.
(3)
Expected life of the share option is calculated as the mid-point between vesting date and expiry.
ARC recorded compensation expense of $2.7 million relating to the share option plan for the year ended December 31, 2014 ($1.9 million for the year ended December 31, 2013). During the year ended December 31, 2014, $0.2 million of direct and incremental share option expenses were capitalized to PP&E ($0.2 million for the year ended December 31, 2013).


ARC Resources Ltd.
Page 67

The changes in total share options outstanding and related weighted average exercise prices for the years ended December 31, 2014 and 2013 were as follows:
 
Share Options
(number of units, thousands)

 
Weighted Average Exercise Price ($)

Balance, January 1, 2013
1,420

 
21.06

Granted
713

 
27.15

Forfeited
(111
)
 
22.13

Balance, December 31, 2013
2,022

 
22.12

Granted
569

 
32.94

Forfeited
(86
)
 
23.85

Balance, December 31, 2014
2,505

 
23.43

Exercisable, December 31, 2014
—

 
—



ARC Resources Ltd.
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19.
COMMITMENTS AND CONTINGENCIES
The following is a summary of ARC’s contractual obligations and commitments as at December 31, 2014:
 
Payments Due by Period
 
1 Year

2-3 Years

4-5 Years

Beyond 5 Years

Total

Debt repayments (1)
49.5

94.0

220.7

710.6

1,074.8

Interest payments (2)
43.5

78.8

66.4

88.7

277.4

Reclamation fund contributions (3)
3.4

6.4

6.0

48.4

64.2

Purchase commitments
27.0

19.4

13.6

8.2

68.2

Transportation commitments
67.2

137.7

113.6

260.7

579.2

Operating leases
15.8

29.4

27.1

58.6

130.9

Risk management contract premiums (4)
0.8

9.6

0.5

—

10.9

Total contractual obligations and commitments
207.2

375.3

447.9

1,175.2

2,205.6

(1)
Long-term and current portion of long-term debt.
(2)
Fixed interest payments on senior notes.
(3)
Contribution commitments to a restricted reclamation fund associated with the Redwater property.
(4)
Fixed premiums to be paid in future periods on certain commodity price risk management contracts.
In addition to the above risk management contract premiums, ARC has commitments related to its risk management program (see Note 15). As the premiums are related to the underlying risk management contracts, they have been recorded at fair market value at December 31, 2014 on the balance sheet as part of risk management contracts.
ARC enters into commitments for capital expenditures in advance of the expenditures being made. At a given point in time, it is estimated that ARC has committed to capital expenditures equal to approximately one quarter of its capital budget by means of giving the necessary authorizations to incur the expenditures in a future period.
ARC is involved in litigation and claims arising in the normal course of operations. Such claims are not expected to have a material impact on ARC’s results of operations or cash flows.
20.
RELATED PARTIES
Interest in Partnership
ARC owns a 99.99% interest in the ARC Resources General Partnership. The other 0.01% of the partnership is owned by 1504793 Alberta Ltd, a 100% owned subsidiary of ARC. ARC’s oil and gas properties are owned and administered by the partnership. ARC is also the sole beneficiary of the Redwater A&R Trust, which administers the reclamation fund on ARC’s behalf.
Key Management Personnel Compensation
ARC has determined that the key management personnel of ARC consists of its officers and directors. Short-term benefits are comprised of salaries and directors' fees, annual bonuses, and other benefits. In addition, the Company provides share-based compensation to its key management personnel under the long-term incentive plans and the officers participate in ARC’s share option plan. The compensation included in general and administrative expenses relating to key management personnel for the year is as follows:
 
Year Ended December 31, 2014

 
Year Ended December 31, 2013

Short-term benefits
8.0

 
9.8

Share-based payments
15.6

 
26.0

Total key management personnel compensation
23.6

 
35.8



ARC Resources Ltd.
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21.
SUPPLEMENTAL DISCLOSURES
Presentation in the Statements of Income
ARC’s statements of income are prepared primarily by nature of item, with the exception of employee compensation expenses which are included in both the operating and general and administrative expense line items.
The following table details the amount of total employee compensation expenses included in the operating and general and administrative expense line items in the statements of income:
 
Year Ended

 
Year Ended

 
December 31, 2014

 
December 31, 2013

Operating
35.3

 
33.0

General and administrative
84.4

 
95.6

Total employee compensation expenses
119.7

 
128.6

Cash Flow Statement Presentation
The following tables provide a detailed breakdown of certain line items contained within cash flow from operating activities:
 
Year Ended

 
Year Ended

Change in Non-Cash Working Capital
December 31, 2014

 
December 31, 2013

Accounts receivable
12.5

 
(12.2
)
Accounts payable and accrued liabilities
62.1

 
(23.6
)
Prepaid expenses
1.3

 
(2.5
)
Total
75.9

 
(38.3
)
Relating to:
 
 
 
Operating activities
49.4

 
(43.5
)
Investing activities
26.5

 
5.2

Total change in non-cash working capital
75.9

 
(38.3
)
 
Year Ended

 
Year Ended

Other Non-Cash Items
December 31, 2014

 
December 31, 2013

Non-cash lease inducement
(1.7
)
 
(1.9
)
Gain on short-term investment
—

 
(1.9
)
Share option expense
2.7

 
1.9

Total other non-cash items
1.0

 
(1.9
)
 
Year Ended

 
Year Ended

Net Change in Other Liabilities
December 31, 2014

 
December 31, 2013

Long-term incentive compensation liability
3.0

 
1.6

Risk management contracts
(0.4
)
 
0.3

Asset retirement obligations
(23.0
)
 
(18.5
)
Total net change in other liabilities
(20.4
)
 
(16.6
)
22.
SUBSEQUENT EVENT
On January 29, 2015, ARC issued 17.9 million common shares at a price of $22.55 per share for aggregate gross proceeds of approximately $402 million (net proceeds of approximately $385 million) on a bought deal basis.


ARC Resources Ltd.
Page 70

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