Pearl Exploration and Production Ltd. ("Pearl" or the "Company") (TSX:PXX)(FIRST
NORTH:PXXS) is pleased to announce the results for the third quarter ended
September 30, 2008.
FINANCIAL AND OPERATING HIGHLIGHTS
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Three months ended Nine months ended
September 30 September 30
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2008 2007 2008 2007
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FINANCIAL ($000's,
except per share data)
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Total revenue 33,638 24,916 123,146 67,859
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Cash flow from
operations before
working capital
changes (2) 21,021 6,268 68,496 11,468
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Per common share
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Basic and diluted ($) 0.11 0.04 0.36 0.08
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Net income (loss) 1,926 (13,683) 4,823 (38,536)
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Per common share
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Basic and diluted ($) 0.01 (0.09) 0.03 (0.28)
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Capital expenditures 39,480 47,446 74,597 140,787
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Total assets 554,956 654,543 554,956 654,543
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Total long-term
financial
liabilities 13,499 14,512 13,499 14,512
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Working capital
(deficiency) 36,147 (87,588) 36,147 (87,588)
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Shareholders' equity 496,400 500,882 496,400 500,882
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OPERATIONAL
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Daily Production
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Oil - net production
(bbls/d) 4,401 6,973 6,578 5,852
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Gas - net production
(mcf/d) 8,156 12,608 9,434 12,758
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Total net production
(boe/d) 5,776 9,093 8,166 7,998
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Product Pricing
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Oil - average selling
price per bbl ($/) 95.85 41.94 77.68 40.26
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Gas - average selling
price per mcf ($) 8.08 5.01 8.54 6.40
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Weighted average sales
price per boe ($) 85.02 39.17 72.78 39.87
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Royalties ($/boe) 22.51 9.43 18.26 8.93
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Operating costs
(including
transportation
expenses) ($/boe) 18.74 15.23 18.99 16.44
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Petroleum and Natural
Gas ("PNG") Netback
(3) ($/boe) 43.77 14.51 35.53 14.50
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Common Share Information
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Weighted average
shares outstanding
(basic) 189,241,716 145,615,529 189,241,716 137,389,099
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Weighted average
shares outstanding
(diluted) 189,241,716 145,880,287 189,242,004 137,741,368
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Shares outstanding
at end of period 189,241,716 147,434,697 189,241,716 147,434,697
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Volume traded during
the quarter 17,442,292 26,011,475 91,897,535 78,023,421
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Share price ($)
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High 2.48 5.30 2.80 5.93
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Low 0.91 3.30 0.91 3.30
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Close (end of period) 1.30 3.94 1.30 3.94
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(1) Barrel of oil equivalent (or "BOE") amounts referenced have been
calculated using a conversion rate of six thousand cubic feet of
natural gas to one barrel of oil. BOEs may be misleading, particularly
if used in isolation. A BOE conversion ratio of 6 mcf:1 bbl is based on
an energy equivalency.
(2) Cash flow from operations before working capital changes and cash flow
per share do not have standardized meanings prescribed by Canadian
Generally Accepted Accounting Principles ("GAAP") and therefore may
not be comparable to similar measures used by other companies. Cash
flow from operations before working capital changes includes all cash
flow from operating activities and is calculated before changes in
non-cash working capital. Cash flow from operations before working
capital changes is reconciled with net loss on the Consolidated
Statement of Cash. Management uses these non-GAAP measurements for its
own performance measures and to provide its shareholders and investors
with a measurement of the Company's efficiency and its ability to fund
a portion of its future growth expenditures.
(3) PNG netback is a non-GAAP measure used by management as a measure of
operating efficiency and profitability and may not be comparable to
similar measures used by other companies. It is calculated by deducting
royalties, operating costs and transportation costs from petroleum and
natural gas revenues.
Letter to Shareholders
The third quarter of 2008 represented a major shift in the market conditions
impacting the business model of the Company. July saw the highest wellhead
pricing and wellhead netbacks in our history, $94.01 and $53.08 respectively
which declined throughout the period to an average of $71.32 and $32.90 in
September. These values have continued to decline into the fourth quarter as
overall market conditions also continued to deteriorate. This fall was partially
offset by a historic weakening of the Canadian dollar which fell from
approximately par at the beginning of July to under $0.80 at times during
October. As essentially all of our product sales trade in reference to US
dollars, a falling Canadian dollar helps mitigate the impact of falling oil and
natural gas prices as the majority of our costs are in Canadian dollars. While
our long term outlook on commodity prices and in particular heavy oil prices
remains highly positive, we have adjusted our budget and financial outlooks to
reflect the difficult pricing environment we are currently experiencing.
The Company remains dedicated to our capital budget philosophy, which is to fund
capital programs based on available cash flow from operations and proceeds from
non-core asset sales. As such, as a result of the dramatic decrease in current
commodity prices we have deferred several of the projects in our recently
announced budget to result in a firm budget of approximately $110 million for
2008. As a result, some anticipated production increases and pilot advancement
activities will be delayed. It is the Company's intention to re-instate these
deferred projects when the prices for oil and natural gas return to more normal
levels.
On the positive front, the Company has a very strong balance sheet and is well
positioned to weather the current financial crisis. Due to the sale of $79
million in non-core producing assets and cash flow from operations of
approximately $68.5 million, to the end of Q3, including a strong quarterly cash
flow performance of $21 million in the third quarter, we find ourselves in the
enviable position of having a $36 million working capital surplus, a $47 million
un-drawn credit facility with Alberta Treasury Branch ("ATB") and have no
requirements to raise additional financing through either debt or equity,
despite an aggressive 2008 capital spending program being undertaken on our four
core assets.
We have made good progress on all four core assets with each of them making
significant strides down the path to adding value in terms of our core strategy
of converting resources first to reserves and then ultimately to production and
cash flow. We have production pilots up and running at three of these core
assets (Mooney, Onion Lake and San Miguel) and have increased our ownership
interests and are working towards pilot implementation on our Blackrod project.
At Mooney, the most significant events were the initiation of the water flood
and the commencement of injection of polymer at the pilot project. The water
flood includes the drilling of 7 additional wells and will essentially be
completed by the end of the year. Implementation of the water flood is critical
for maintaining reservoir pressure and should help check the current declines in
the field. Polymer injection commenced on October 30th and results are expected
to be observed in the next three to six months. Polymer flooding has the
potential to significantly increase both production rates and recoveries in the
field if successful.
At Onion Lake, the cyclic steam stimulation ("CSS") pilot project continued to
produce positive results. The first well (Z1) had sustained flow rates of over
150 barrels of oil per day in the first production cycle, approximately 3 times
greater than our modeled expectations. The second well (Z2) encountered some
mechanical issues, but still achieved a rate of over 70 barrels of oil per day.
Z1 is currently undergoing the second injection cycle with the second production
cycle at Z1 expected to commence in mid-November. The Z2 well should begin the
second steam injection cycle in the next couple of weeks. Based on the positive
results to date, up to 3 additional CSS wells are being planned in order to
better quantify the reservoir distribution and performance. It is expected that
a decision on whether to go ahead with the first phase of a commercial steam
development will be made by mid-year 2009.
At San Miguel, the Chittum Steam Assisted Gravity Drainage ("SAGD") pilot, in
the central portion of the field, was put on full SAGD mode in September and we
have seen the first production start to ramp-up in the producing well. It will
likely take several months for the steam chamber to build to sufficient size to
allow the well to achieve full production rates, but initial results are
encouraging. The Saner pilot, in the northern portion of the field, utilizes the
Fracture Assisted Steam Technology ("FAST") used by Conoco in their original
pilot and is currently injecting steam in the pre-heating phase. This pilot will
use horizontal wells in a portion of the pilot area, as opposed to all vertical
wells used by Conoco. In parallel with these pilots, numerous commercial
optimization studies including the fuel source selection for steam generation
and the marketing of the very heavy oil in this project are being investigated.
It is expected that both the pilot and the commercial study results will be
completed by mid-year 2009 and thus a commercial development decision can be
made at that time.
At Blackrod, we are awaiting approvals from the Alberta and Canadian Federal
regulatory agencies for our SAGD pilot project. The winter season in 2008 / 2009
will be used to gather additional essential information including cores, water
source and disposal information and oil viscosity data. We are targeting a
startup date for the Blackrod pilot in the first quarter of 2010. As previously
announced we acquired an additional 30% working interest in the Blackrod project
on August 20, 2008. In addition, in September and early October, we acquired
approximately net 36 sections of crown lands in the area and very recently we
have entered into an agreement with our remaining partner Serrano Energy Ltd.
("Serrano") to swap our equity interests in Serrano for a 15% increased interest
in the Blackrod project and a carried work commitment of $5 million. We expect
to close this transaction prior to year end. We have the right and we intend to
become operator of the Blackrod project as soon as reasonably practicable.
Our production averaged 5,776 Boed per day during the third quarter down from
8,246 Boed day in the second quarter. The three primary reasons for this drop
were the aforementioned sale of non-core producing properties, the forced
shut-in of approximately 700 Boed from our Mooney Field due to CO2 content in
the gas greater than permitted on the pipeline and natural declines. We have
solved the CO2 issues through the installation of an amine plant to remove
excess CO2 from our solution gas. Productive capacity is now over 6000 Boed. We
expect to exit the year at between 6000 and 7000 Boed. This production is not
only vital to our cash flow for development activities but will also be helpful
in our resource to reserves strategy.
Despite the current impact of low oil and natural gas prices on our near term
cash flow, we remain very encouraged on the value and viability of our large
scale heavy oil fields. Our strong balance sheet will allow us to emerge from
this crisis in a very favorable position at a time when reserves will hopefully
be at a premium as more and more projects are put on hold or delayed. Existing
announced refinery upgrade and heavy oil pipeline projects appear to remain on
track and will require significant supplies of heavy oil in the future. Our
primary goal is to keep our projects moving forward at the best possible speed
without exposing the Company to financial leverage or risk until the market
recovers.
Keith Hill, President and CEO
PEARL EXPLORATION AND PRODUCTION LTD.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Three months ended September 30, 2008 and 2007
Management's discussion and analysis ("MD&A") of Pearl Exploration and
Production Ltd.'s (the "Company" or "Pearl") financial condition and results of
operations should be read in conjunction with the unaudited consolidated
financial statements for the three and nine months ended September 30, 2008 and
2007 as contained in this interim report and the MD&A and audited financial
statements for the fifteen months ended December 31, 2007 and twelve months
ended September 30, 2006 contained in the Company's 2007 Financial Report. The
consolidated financial statements have been prepared in accordance with Canadian
generally accepted accounting principles ("GAAP") and are presented in Canadian
dollars unless otherwise indicated. The effective date of this MD&A is November
13th, 2008.
Additional information relating to the Company is available on SEDAR at
www.sedar.com and on the Company's web-site at www.pearleandp.com.
Forward-Looking Statements
Forward-looking statements: This document contains statements about expected or
anticipated future events and financial results that are forward-looking in
nature and, as a result, are subject to certain risks and uncertainties, such as
general economic, market and business conditions, the regulatory process and
actions, technical issues, new legislation, competitive and general economic
factors and conditions, the uncertainties resulting from potential delays or
changes in plans, the occurrence of unexpected events, and the Company's
capability to execute and implement its future plans. Actual results may differ
materially from those projected by management. Although the Company has
attempted to identify important factors that could cause the actual events or
results to differ materially from those described in forward-looking statements,
readers are cautioned that the foregoing list of risks and factors is not
exhaustive and there may be other factors that cause events or results not to be
as anticipated, estimated or intended. Forward-looking statements are based on
management's estimates, beliefs and opinions on the date the statements are
made. Although the Company believes that the expectations represented by such
forward-looking statements and the assumptions of the Company upon which they
are based are reasonable, there can be no assurance that such expectations will
prove to be correct. The Company assumes no obligation except as outlined by
regulatory requirements to update forward-looking statements if circumstances of
management's estimates, beliefs or opinions should change. Additional
information on these and other potential factors that could affect the Company's
financial results are detailed in documents filed from time to time with the
Alberta, British Columbia and Ontario Securities Commissions. Accordingly,
readers should not place undue reliance on forward-looking statements. For such
statements, we claim the safe harbour for forward-looking statements within the
meaning of the Private Securities Legislation Reform Act of 1995.
All references to BOEs are based on a 6 to 1 conversion ratio. BOEs may be
misleading, particularly if used in isolation. A BOE conversion of 6 Mcf: 1 bbl
is based on an energy equivalency conversion method primarily applicable at the
burner tip and does not represent a value equivalency at the wellhead.
OVERVIEW
Pearl is a Canadian-based oil and gas company whose common shares are traded on
the TSX Exchange under the symbol "PXX". Pearl's main focus is large, heavy oil
projects in Canada and the USA. The Company also holds interests in a number of
natural gas properties.
Pearl's core properties include:
- Onion Lake, Saskatchewan - heavy oil;
- Mooney, Alberta - heavy oil;
- Blackrod, Alberta - heavy oil;
- San Miguel, Texas - heavy oil
OPERATIONS UPDATE
Mooney Heavy Oil Project - Alberta
As of the end Q3 2008 Pearl has drilled ten net horizontal wells in our Mooney
area thus far in 2008. Four of the eight wells were drilled as part of the
polymer pilot which will consist of two polymer injection wells and two
producers. Regulatory approval has been obtained for the polymer pilot and
polymer injection began in late October of 2008. Preliminary results from the
pilot are expected by Q1 2009. Plans for a field wide polymer flood
implementation are expected to be finalized by Q2 2009 with the initiation of
full field implementation targeted as early as Q4 2009.
In addition we have continued to advance the conversion of the field to a water
flood project. During Q3 an additional 1.5 sections were approved for water
flood with water injection expected to commence in late Q4 2008 and early Q1
2009. In addition, one additional section is awaiting waterflood approval which
is expected to commence water injection in Q1 2009. The water flood will
ultimately assist in both maintaining production levels and increasing reserves
as recoveries are expected to increase with the demonstration of pressure
maintenance, a decreasing gas/oil ratio ("GOR") and sustained production. In the
event that the polymer pilot is successful the investment in the infrastructure
implemented for the water flood will be used as base infrastructure for the
polymer flood. While the Company expects that the implementation of the water
flood will result in both sustained production and higher reserve recovery, in
the short term as the field is converted there will be intermittent production
disruption in Mooney.
The Company was successful at a crown land sale acquiring 6 sections (1536
hectares) of land at 100% working interest in the Mooney core area.
The Mooney field produced approximately 1,650 Boed during Q3. Production from
Mooney was curtailed significantly for approximately nine weeks, beginning at
the end of June by approximately 700 Boed. This shut-in was a result of our
pipeline provider, on short notice, terminating our ability to ship solution gas
that contained higher than permitted CO2 on their system. To rectify the
situation we procured, installed and commissioned an amine plant in less than 10
weeks. As a result we now have the capability to remove excess CO2 from our gas
stream which allows us to ship our gas production to market without interruption
to service.
Onion Lake Heavy Oil Project - Saskatchewan
In Onion Lake the Cyclic Steam Stimulation (CSS) thermal pilot continues. The
first well ("Z1") has completed the first steam and production cycles, with a
peak rate of over 150 Bopd being achieved. The Z1 well began its second
injection cycle September 21/08. Steam injection on the second well ("Z2") began
on June 20th and the first production cycle commenced on August 11, 2008.
Mechanical issues were experienced during the steam cycle on the Z2 well
resulting in a small amount of steam entering the reservoir. As a result, the
first production cycle of the Z2 well was lower than expected. It is anticipated
that the Z2 well will perform similarly to the Z1 well when similar amounts of
steam have been injected into the reservoir. We are currently preparing to begin
the second steam cycle in the Z2 well.
During Q3 production from Onion Lake average approximately 2,300 Boed; this
excludes production from the CSS thermal pilot as net revenue from the pilot is
captured as an offset to the net capital costs for that project.
Blackrod Heavy Oil Project - Alberta
At Blackrod, as previously announced the Company closed a transaction on August
20th to acquire an additional 30% working interest in the Blackrod project area.
The company paid $4.5 million in cash and, if successful, will be required to
make additional payments totaling up to $11 million, based on pre-set criteria
of success. In September and early October the Company was also successful at 2
separate crown land sales and acquired an additional 36 sections (9,216 net
hectares) of oil sands leases contiguous to our project area. Subsequent to the
end of Q3 the Company entered into an agreement with Serrano to increase our
working interest in the original project area from 65% to 80% in return for the
disposal of our interests in Serrano and a carried work program of net $5 mm
over the next twelve months.
Pearl intends to continue its plan to drill 10 to 15 stratigraphic core wells in
the 2008/2009 winter to further delineate this deposit and gather additional
petrophysical and reservoir fluid characteristic data. The application for the
required governmental approvals of the thermal SAGD pilot project was submitted
in May of 2008 and is expected to be approved in the next 6 to 12 months.
There is currently no production at Blackrod and we do not anticipate any
production coming from Blackrod until our pilot project is operational. We
currently anticipate the pilot being operational in 2010.
San Miguel Heavy Oil Project - Maverick Basin, South Texas
At San Miguel, Pearl and its 50% partner TXCO continued steam injection at the
Steam Assisted Gravity Drainage ("SAGD") pilot located within the Chittim "B"
Lease. Production, temperature, and pressure monitoring of the well pair
continue to confirm that the well pair has entered SAGD mode with initial oil
flows being observed.
At Saner Ranch, the pilot facility construction is proceeding on schedule with
mechanical completion still expected to be completed in early December. The
Saner Ranch pilot includes a vertical inverted five spot well pattern and a
horizontal three well pattern that both utilize a modified Fracture Assisted
Steamflood Technology ("FAST") process. Steam injection into the vertical
inverted five spot pattern commenced on August 28 as part of the reservoir
warm-up phase with initial indications of connectivity being observed within the
inverted 5 spot pattern. The three horizontal wells were completed in September
and achieved first steam injection / reservoir warm-up phase as scheduled on
October 8, 2008. Preliminary performance results from both patterns are
anticipated during the first half of 2009.
By the end of the second quarter of 2009, Pearl expects to be in a position to
select which of the three recovery techniques will be used to form the basis of
a commercial development project, SAGD or one of the two modified FAST
techniques. In addition, work continues on the commercial aspects of a
successful project in San Miguel including the method in which the JV will
generate energy to produce steam and the markets and value of the production
from the project.
The is currently no commercial production in San Miguel and we do not anticipate
any commercial production originating from San Miguel until the JV moves into a
commercial development of this resource. We have begun to see early production
in the Chittum pilot in October.
Other Properties - Alberta, Saskatchewan
In order to enhance the value of certain non-core assets, Pearl initiated a 9
well drilling program at Ear Lake, Salt Lake and Druid in Q3, which is now
complete. All of these wells will initiate production in Q4. Overall, the
production increase from this program is expected to reach between 400 and 500
bopd by year end.
Production from other non-core Canadian properties averaged 1,800 Boe/d in Q3.
It is still the intention to sell these properties once market conditions
improve.
Other Properties - U.S.
The Company also holds interests in several other areas in the United States,
including Queen City gas fields, the West Rozel and Gunnison Wedge in Utah,
Promised Land and Fiddler Creek in Montana and Queen City gas field in Texas.
There is limited or no production from these areas and there are only minor
evaluation plans contemplated for these lands in 2008. However, the Company
believes certain of these lands contain large resource potential and may, based
upon further evaluation, be developed in the future.
In September, we agreed to dispose of our land and tangible interests in the
Palo Duro basin to Tyner Resources Ltd. ("Tyner") in exchange for an equity
interest in Tyner. This transaction is consistent with our strategy to focus on
our 4 core areas and is expected to close prior to year-end.
Production
Q3 production averaged 5,776 boed in line with expectations given that volumes
were curtailed in Mooney due to the previously discussed CO2 issue. That
situation has now been addressed and full production in Mooney has been
restored. We maintain our previous guidance of 6,000 to 7,000 boed for the
remainder of the year.
RESULTS OF OPERATIONS
Oil and Gas Production, Pricing and Revenue
Three months ended Nine months ended
September 30 September 30
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2008 2007 2008 2007
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Daily production / sales
volumes (1)
Oil (bbl/d) 4,401 6,973 6,578 5,852
Natural gas (mcf/d) 8,156 12,608 9,434 12,758
Combined (1) (boe/d) 5,776 9,093 8,166 7,998
Product pricing ($)
Crude oil - per bbl 95.85 41.94 77.68 40.26
Natural gas - per mcf 8.08 5.01 8.54 6.40
Combined - per boe 85.02 39.17 72.78 39.87
Revenue (000's)
PNG revenue - gross 45,180 32,786 162,849 87,052
Royalties (11,962) (7,889) (40,849) (19,495)
PNG revenue - net 33,218 24,898 122,000 67,557
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- gas production converted at 6:1
(1) Includes small amounts of NGLs not separately identified in the table
For the three months ended September 30, 2008 production has decreased from the
prior year three-months ended September 30, 2007 due to the company disposing of
non-core properties during the prior quarter representing approximately thirty
percent of daily production, natural decline and the unscheduled shut-in of
approximately 700 Boed of production in Mooney due to the requirement to install
and an amine facility to decrease the CO2 in our associated gas production. In
addition during the current quarter, wells were taken offline in order to
complete some drilling in Mooney.
The significant increase in revenue for both the three and nine months ended
September 30, 2008 is primarily due to the higher market pricing for heavy oil
and natural gas in 2008.
Royalties
Three months ended Nine months ended
September 30 September 30
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2008 2007 2008 2007
--------------------------------------------------------------------------
Royalties 11,962 7,889 40,849 19,495
as a percentage of PNG revenue 26% 24% 25% 22%
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Royalties represent charges against production or revenue by governments and
landowners. Royalties for the three and nine months ended September 30, 2008
increased over the comparable periods of 2007. This increase is consistent with
the increase in revenues during the period.
As expected royalties as a percentage of revenue are consistent between 2008 and
2007.
PNG Operating Expenses and Netbacks
Three months ended September 30 Nine months ended September 30
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2008 2007 2008 2007
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Total Per boe Total Per boe Total Per boe Total Per boe
--------------------------------------------------------------------------
Average
daily
produc-
tion 5,776 9,093 8,166 7,998
Gross
PNG
revenue 45,180 85.02 32,786 39.17 162,849 72.78 87,052 39.87
Royal-
ties (11,962) (22.51) (7,889) (9.43) (40,849) (18.26) (19,495) (8.93)
--------------------------------------------------------------------------
Net PNG
revenue 33,218 62.51 24,897 29.74 122,000 54.52 67,557 30.94
Operating
costs (9,272) (17.45) (12,245) (14.64) (39,609) (17.70) (33,327) (15.26)
Transport-
ation (686) (1.29) (498) (0.59) (2,886) (1.29) (2,571) (1.18)
--------------------------------------------------------------------------
PNG
netback 23,260 43.77 12,154 14.51 79,505 35.53 31,659 14.50
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Operating Expenses
Third quarter operating costs on a per boe basis were higher when compared to
the same period in 2007, averaging $17.45 for the three months ended September
30, 2008 in comparison to $14.64 per boe in 2007. For the nine months ended
September 30, 2008 operating costs were $17.70 per boe as compared to $15.26 for
the nine months ended September 30, 2007. The increase in per unit operating
costs for the nine month period is principally due to several factors including:
(i) high cost of propane incurred in Q1; (ii) timing of focusing resources on
developing efficiencies with regards to operating costs; and (iii) $2.2 million
or $1.02 per boe of underestimated 3rd party costs that related to prior periods
that was recognized in the first quarter. Installation of a fuel gas system has
helped to alleviate the high cost of propane in the second and third quarters.
PNG netbacks are significantly higher in both the three and nine months ended
September 30, 2008 when compared to 2007 results. The increase is due to the
higher price of oil and gas in 2008.
General and Administrative Expenses ("G&A")
General and administrative expenses were $3.6 million in the third quarter of
2008 compared to $4.3 million in 2007. On a per unit basis, G&A was $6.71 per
boe compared to $5.10 per boe in 2007. General and administrative costs have
increased by $1.61 per boe from the same period in 2007 due to a decrease in
production. The gross costs have decreased by $0.7 million due to a corporate
focus on decreasing administrative costs and an overall decrease in corporate
acquisition activities but offset slightly by higher exchange related costs
associated with moving our shares from the Toronto venture exchange (TSX-V) to
the main exchange (TSX).
G&A for the nine months ended September 30, 2008 was $10.0 million or $4.46 per
boe compared to $10.8 million or $4.94 per boe in 2007. The decrease of $0.48
per boe from 2007 is again principally due to the same reasons noted for the
above three months ended September 30, 2008.
Depletion, Depreciation and Accretion ("DD&A")
DD&A expense was $13.7 million or $25.73 per boe for the three months ended
September 30, 2008 in comparison to $23.4 million or $27.98 per boe for the
three months ended September 30, 2007. For the nine months ended September 30,
2008 DD&A expense was $57.7 million or $25.79 per boe in comparison to $63.3
million or $28.98 for the same period of 2007. The lower rate in 2008 is due to
increased proved reserves as a result of the significant drilling and
acquisition activity in 2007.
Interest Expense
Interest expense for the three months ended September 30, 2008 was $0.03 million
in comparison to $1.2 million for the three months ended September 30, 2007.
Interest expense relates to the Company's bank debt. The Company had an average
debt level of $0.4 million and an effective interest rate of 6.24% for the three
months ended September 30, 2008. Lower interest expense is due to a lower
dependence on debt financing during the period.
For the nine months ended September 30, 2008 interest expense was $0.8 million
in comparison to $2.9 million for the same period in 2007. The Company's average
debt balance was $14.9 million with an effective interest rate of 5.42% for the
nine months ended September 30, 2008. Lower interest expense is due to a lower
dependence on debt financing during the period.
Change in unrealized loss on gas pricing contracts
The change in unrealized loss on gas pricing contracts for the nine months ended
September 30, 2007 relates to gas contracts acquired as part of the Atlas
acquisition in December, 2006.
Other items
For the three and nine months ended September 30, 2008 there was a dilution gain
of $2.3 million recorded on the investment in Serrano and a $2.6 million
writedown of the investment in Asset-backed commercial paper ("ABCP"). Both of
these items are discussed in more detail in note 5 of the financial statements.
For the nine months ended September 30, 2007 a $13.3 million gain was recorded
on the sale of of its Gulf of Mexico leases in exchange for shares of Bayou Bend
Petroleum Ltd.
Income Taxes
The provision for future income taxes for the quarter ended September 30, 2008
was $2.6 million compared to a recovery of $5.4 million for the three months
ended September 30, 2007. As at September 30, 2008, the Company has recognized a
future tax liability of $1.9 million due to the decrease of our tax pool
balances as a result of our asset sales during 2008 and due to the high revenues
we have realized thus far in 2008.
For the nine months ended September 30, 2008, future income taxes were $2.6
million in comparison to a recovery of $5.0 million for the comparable period in
2007. Reasons for the significant change year to year are noted above for the
three month period.
Current tax of $1.9 million for the nine months ended September 30, 2008 is
comprised of Saskatchewan capital tax and resource surcharge. The $8.3 million
tax expense for the same period of 2007 was a result of the sale of certain
assets in the United States.
Net Income (Loss)
Net income for the quarter ended September 30, 2008 was $1.9 million in
comparison to a net loss of $13.7 million for the quarter ended September 30,
2007. Earnings for the nine months ended September 30, 2008 were $4.8 million, a
$43.4 million improvement over the nine months ended September 30, 2007 reported
net loss of $38.5 million. The significant increase in 2008 net income is
principally due to increased revenues caused by the high market price for heavy
oil and natural gas in the first nine months of 2008.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2008, the Company had $47.0 million of remaining credit
capacity available under its $37.0 million extendible term credit facility and
$10.0 million demand revolving credit facility.
At September 30, 2008, the Company had working capital surplus of $36.2 million
compared to a working capital deficit of $34.2 million at December 31, 2007.
Funds from operations were $21.0 million for the three months ended September
30, 2008 compared to funds from operations of $6.3 million for the three months
ended September 30, 2007. For the nine months ended September 30, 2008 funds
from operations were $68.5 million as compared to $11.5 million for the nine
months ended September 30, 2007. The improvement in funds from operations is
principally due to higher commodity prices and to a lesser extent higher average
production and lower G&A expenses.
Net cash used in financing activities for the quarter ended September 30, 2008
was $5.0 million compared to net cash from financing activities of $44.4 million
for the quarter ended September 30, 2007. During the current quarter the Company
repaid $5.0 million on its credit facility. Significant financing activities
from the quarter ended September 30, 2007 included (i) the net repayment of
$14.0 million of debt, and (ii) the net proceeds of $58.4 million from an equity
financing.
Net cash from financing activities was $nil for the nine months ended September
30, 2008 in comparison to net cash from financing activities of $24.3 million
for the nine months ended September 30, 2007. The repayment of $5.0 million on
the Company's bank loan was the only financing activity for the current period.
Significant financing activities from the nine months ended September 30, 2007
included (i) a net repayment of $34.7 million of the Company's debt, and (ii)
net proceeds of $58.4 million from equity financing, and (iii) $0.6 million from
the exercise of stock options.
Net cash used in investing activities was $22.0 million for the three months
ended September 30, 2008 compared to net cash used in investing activities of
$42.8 million for the three months ended September 30, 2007. During the current
quarter, the Company sold certain non-core heavy oil producing assets for $3.8
million and spent $39.5 million on exploration, development and lease
acquisition activities. Investing activities during the quarter ended September
30, 2007 included $47.4 million spent on exploration, development and lease
acquisition activities.
Net cash used in investing activities for the nine months ended September 30,
2008 was $13.9 million compared to net cash used in investing activities of
$113.4 million in the same period of 2007. In addition to the $79 million from
the sale of assets, the Company spent $74.6 million on exploration, development
and lease acquisition activities during the first nine months of 2008. During
the nine months ended September 30, 2007 the Company's exploration, development
and lease acquisition activities totaled $140.8 million, corporate acquisition
costs totaled $11.3 million and the sale of Bayou Bend shares generated $10.0
million.
During Q3 the Company announced that it had increased its capital budget for
2008 to approximately $135 million, up from the original budget of $61.0
million. Since the time of our announcement to expand our budget, the world
price of oil and the North American price of natural gas have declined
dramatically. In-turn the prices that we receive for our products have also been
dramatically impacted by the decreasing broader market values for these
commodities.
The Company remains dedicated to our capital budget philosophy; which is to fund
capital budgets based on available cash flow from operations, non-core asset
sales and to limit the timing of our capital expenditures such that we will only
ever use a maximum of 50% of our current borrowing base. As such, as a result of
the dramatic decrease in current commodity prices we have deferred several of
the projects in our recently announced budget increase to $135 million to result
in a firm budget of approximately $110 million for 2008. This decreased budget
is still principally focused on Mooney: accelerating the polymer pilot,
expansion of the water flood and related infrastructure and delineation drilling
in the western portion of the eastern field. However, some production increases
and pilot advancement activities will be delayed by this capital budget cut. It
is the intention of the Company to re-instate these deferred projects when the
price of oil and natural gas increase, resulting in increased cash flow from
operations that is available for capital investment.
While there are no current plans to raise additional funds in the form of either
debt or equity, in the future as our projects move from pilot projects to
development projects, the Company may consider additional issuances of common
shares or debt instruments to assist with financing these developments to the
extent that sufficient cash flow from operations is inadequate. The Company may
consider divesting additional non-core oil and gas assets or farming out
interests in oil and gas properties to finance its operations. Accordingly, the
Company's consolidated financial statements are presented on a going-concern
basis.
CAPITAL EXPENDITURES
Capital expenditures for the three and nine months ended September 30, 2008 and
2007 are as follows:
--------------------------------------------------------------------------
2008 2007 2008 2007
--------------------------------------------------------------------------
Land 1,207,620 812,108 2,071,613 1,616,811
Seismic 407,647 218,122 968,861 1,227,589
Drilling and
completion 27,830,145 35,186,887 41,335,656 103,390,831
Equipment 5,236,987 5,576,523 24,424,744 23,277,153
Other - 700,423 561,003 1,967,417
--------------------------------------------------------------------------
Total exploration
and development 34,682,399 42,494,063 69,361,877 131,479,801
Corporate
acquisition - - - 8,809,049
Property
acquisitions 4,797,608 11,678,057 5,235,356 17,381,053
Property
dispositions (3,760,800) (6,726,454) (79,097,031) (15,573,771)
--------------------------------------------------------------------------
Total capital
expenditures 35,719,207 47,445,666 4,499,798 142,096,132
--------------------------------------------------------------------------
RELATED PARTY TRANSACTIONS
Tanganyika Oil Company Ltd. ("Tanganyika") provides administrative and technical
services to the Company from time to time based upon time and expenses incurred
by Tanganyika. For the nine months ended September 30, 2008, Tanganyika charged
the Company $58,643 (2007 - $127,773). Tanganyika and Pearl have certain
directors and officers in common.
Namdo Management Services Ltd. ("Namdo") provides executive and support services
to the Company. For the nine months ended September 30, 2008, the Company paid
Namdo $135,000 (2007 - $78,000). Namdo is a private corporation owned by Lukas
H. Lundin, a director of the Company.
RISKS AND UNCERTAINTIES
The Company is exposed to a number of risks and uncertainties inherent in
exploring for, developing and producing crude oil and natural gas. These risks
and uncertainties include, but are not limited to, the following:
- risk of finding and producing reserves economically;
- uncertainty associated with obtaining drilling licenses and other regulatory
consents and approvals;
- production risks associated with sour hydrocarbons;
- marketing reserves at acceptable prices;
- cost of capital risk associated with securing the needed capital to carry out
the Company's operations;
- risk of fluctuating oil and natural gas prices;
- risk of fluctuating foreign currency exchange rates;
- risk of governmental policies, social instability or other political, economic
or diplomatic developments in its operations;
- market risks associated with investing the Company's cash reserves in interest
bearing depository instruments; and
- environmental risks related to its oil and gas properties.
Many of the previously mentioned risks are beyond the Company's control, and it
is impossible to ensure that any exploration drilling program or piloting
program will ultimately result in commercial operations. The Company does not
currently utilize derivative instruments to hedge its commodity price, foreign
currency exchange or interest rate risks.
Pearl strives to minimize and manage these risks in a number of ways, including:
- Employing qualified professional and technical staff;
- Communicating openly with members of the public regarding its activities;
- Concentrating in a limited number of areas;
- Utilizing the latest technology for finding and developing reserves;
- Constructing high-quality, environmentally sensitive, safe production
facilities; and
- Maximizing operational control of drilling and producing operations.
ENVIRONMENTAL RISKS
All phases of the oil and natural gas business present environmental risks and
hazards and are subject to environmental regulation pursuant to a variety of
federal, provincial and local laws and regulations. Compliance with such
legislation can require significant expenditures and a breach may result in the
imposition of fines and penalties, some of which may be material. Environmental
legislation is evolving in a manner expected to result in stricter standards and
enforcement, larger fines and liability and potentially increased capital
expenditures and operating costs. In 2002, the Government of Canada ratified the
Kyoto Protocol (the "Protocol"), which calls for Canada to reduce its greenhouse
gas emissions to specified levels. There has been much public debate with
respect to Canada's ability to meet these targets and the government's strategy
or alternative strategies with respect to climate change and the control of
greenhouse gases. Implementation of strategies for reducing greenhouse gases,
whether to meet the limits required by the Protocol or as otherwise determined,
could have a material impact on the nature of oil and natural gas operations,
including those of the Company. Given the evolving nature of the debate related
to climate change and the control of greenhouse gases and resulting
requirements, it is not possible to predict either the nature of those
requirements or the impact on the Company and its operations and financial
condition.
NEW ACCOUNTING STANDARDS ADOPTED
As disclosed in the December 31, 2007 annual audited consolidated financial
statements, on January 1, 2008, the Company adopted the new CICA Handbook
Sections 3862 "Financial Instruments - Disclosures", 3863 "Financial Instruments
- Presentation", and 1535 "Capital Disclosures". The adoption of these standards
has had no material impact on the Company's net income or cash flows. Additional
information on the implementation of these new standards can be found in Note 3
to the Interim Consolidated Financial Statements.
RECENT ACCOUNTING PRONOUNCEMENTS
Goodwill and Intangible Assets
As of January 1, 2009, Pearl will be required to adopt Section 3064 "Goodwill
and Intangible Assets," which revises the requirement for recognition,
measurement, presentation and disclosure of intangible assets and replaces the
existing Goodwill and Intangible Asset standard. The adoption of this standard
should not have a material impact on the Company's consolidated financial
statements.
International Financial Reporting Standards
In January 2006, the CICA Accounting Standards Board ("AcSB") adopted a
strategic plan for the direction of accounting standards in Canada. As part of
that plan, the Accounting Standards Board confirmed in February, 2008 that
International Reporting Standards ("IFRS") will replace Canadian GAAP for
profit-oriented Canadian publicly accountable enterprises in 2011. Pearl is
assessing the potential impact of this change and developing a plan accordingly.
INTERNAL CONTROLS OVER FINANCIAL REPORTING
The Company has, under the supervision of its chief financial officer, designed
a process for internal control over financial reporting, which process has been
effected by the Company's board of directors and management. The process was
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with GAAP and incorporates policies and procedures as described
above. There have been no changes in the Company's systems of internal control
over financial reporting that would materially affect, or is reasonably likely
to materially affect, the company's internal controls over financial reporting.
It should be noted that a control system, including the Company's disclosure and
internal controls and procedures, no matter how well conceived can provide only
reasonable, but not absolute, assurance that the objectives of the control
system will be met and it should not be expected that the disclosure and
internal controls and procedures will prevent all errors or fraud.
OUTLOOK
The Company plans to continue pursuing large North American heavy oil resource
opportunities to add to its portfolio, to seek to rationalize non-core assets,
and to focus on conversion of resources to reserves and development of its
existing interests in the USA and Canada.
BOES
Throughout this MD&A the calculation of barrels of oil equivalent (boe) is
calculated at a conversion rate of six thousand cubic feet (mcf) of natural gas
for one barrel of oil and is based on an energy equivalence conversion method.
BOEs may be misleading, particularly if used in isolation. A boe conversion
ratio of 6 mcf:1 bbl is based on an energy equivalence conversion method
primarily applicable at the burner tip and does not represent a value
equivalence at the wellhead.
NON-GAAP MEASURES
Included in this report are references to terms commonly used in the oil and gas
industry, such as, cash flow and funds from operations which represent cash flow
from operating activities expressed before changes in non-cash working capital,
long-term receivable and asset retirement costs incurred and are used by the
Company to analyze operating performance, leverage and liquidity. These terms do
not have standardized meanings prescribed by GAAP and therefore may not be
comparable with the calculations of similar measures for other entities.
Consequently, these are referred to as non-GAAP measures.
PEARL EXPLORATION AND PRODUCTION LTD.
Consolidated Balance Sheet
(unaudited)
--------------------------------------------------------------------------
September 30, December 31,
2008 2007
--------------------------------------------------------------------------
Assets
Current assets
Cash $ 52,288,900 $ 4,799,186
Accounts receivable 24,707,344 25,134,435
Income taxes and capital taxes receivable 2,817,446 2,618,015
Prepaid expenses and deposits 1,390,011 3,195,770
-------------------------------
81,203,701 35,747,406
-------------------------------
Investments (note 5) 9,056,027 9,362,895
Petroleum and natural gas properties
(note 6) 464,695,831 528,352,540
Future income tax - 2,402,532
-------------------------------
$ 554,955,559 $ 575,865,373
-------------------------------
-------------------------------
Liabilities
Current liabilities
Accounts payable and accrued liabilities 45,056,965 69,899,310
-------------------------------
45,056,965 69,899,310
-------------------------------
Long-term liabilities
Asset retirement obligation (note 8) 11,525,869 16,586,030
Future income tax 1,972,876 -
-------------------------------
58,555,710 86,485,340
-------------------------------
Shareholders' equity
Share capital (note 10) 723,121,821 723,121,821
Contributed surplus (note 11) 10,974,502 8,778,124
Deficit (237,696,474) (242,519,912)
-------------------------------
496,399,849 489,380,033
-------------------------------
$ 554,955,559 $ 575,865,373
-------------------------------
-------------------------------
Commitments (note 13)
Contingencies (note 16)
See accompanying notes to consolidated financial statements.
PEARL EXPLORATION AND PRODUCTION LTD.
Consolidated Statement of Operations and Deficit
(unaudited)
--------------------------------------------------------------------------
Three months ended Nine months ended
September 30 September 30
--------------------------------------------------------
2008 2007 2008 2007
------------- ------------ ------------ -------------
Revenue
Oil and gas
sales $ 45,180,194 $ 32,786,237 162,848,816 $ 87,051,517
Interest income 420,090 18,802 1,146,227 302,342
Royalties (11,961,858) (7,888,734) (40,848,856) (19,495,302)
------------- ------------ ------------ -------------
33,638,426 24,916,305 123,146,187 67,858,557
------------- ------------ ------------ -------------
Expenses
Production
costs 9,272,258 12,245,376 39,609,214 33,326,783
Transportation
costs 685,605 497,724 2,886,210 2,570,874
General and
administrative 3,566,000 4,268,083 9,979,160 10,779,543
Depletion,
depreciation
and accretion 13,670,991 23,406,095 57,706,350 63,265,388
Stock-based
compensation 775,293 777,877 2,196,377 2,653,273
Interest 27,143 1,246,596 808,868 2,885,179
Change in
unrealized loss
of gas pricing
contracts - - - 487,760
Foreign
currency
exchange loss
(gain) 260,152 118,534 223,441 386,756
------------- ------------ ------------ -------------
28,257,442 42,560,285 113,409,620 116,355,556
------------- ------------ ------------ -------------
Other items
Gain on
investment (2,268,028) - (2,268,028) -
Gain on sale of
assets - - - (13,270,044)
Writedown of
ABCP 2,574,896 - 2,574,896 -
------------- ------------ ------------ -------------
306,868 - 306,868 (13,270,044)
------------- ------------ ------------ -------------
Income (loss)
before income
taxes 5,074,116 (17,643,980) 9,429,699 (35,226,955)
------------- ------------ ------------ -------------
Income taxes
Future income
taxes
(recovery) 2,650,137 (5,400,712) 2,663,958 (5,007,942)
Income taxes
and capital
taxes 498,059 1,439,267 1,942,303 8,316,938
------------- ------------ ------------ -------------
3,148,196 (3,961,445) 4,606,261 3,308,996
------------- ------------ ------------ -------------
------------- ------------ ------------ -------------
Net income
(loss) for the
period 1,925,920 (13,682,535) 4,823,438 (38,535,951)
------------- ------------ ------------ -------------
Deficit,
beginning of
period (239,622,394) (45,430,584) (242,519,912) (20,577,168)
------------- ------------ ------------ -------------
Deficit, end of
period $(237,696,474) $(59,113,119) (237,696,474) $ (59,113,119)
------------- ------------ ------------ -------------
------------- ------------ ------------ -------------
Basic and
diluted income
(loss) per
share $ 0.01 $ (0.09) 0.03 $ (0.28)
Weighted
average number
of common
shares
used in
computing
earnings per
share:
basic 189,241,716 145,615,529 189,241,716 137,389,099
diluted 189,241,716 145,880,287 189,242,004 137,741,368
See accompanying notes to consolidated financial statements.
Consolidated Statement of Comprehensive Income (Loss) and Accumulated Other
Comprehensive Income
(unaudited)
--------------------------------------------------------------------------
Three months ended Nine months ended
September 30 September 30
-----------------------------------------------------
2008 2007 2008 2007
---------- ------------ ----------- -------------
Net income (loss) $1,925,920 $(13,682,535) $ 4,823,438 $ (38,535,951)
Other comprehensive
income, net of tax
Items affecting
comprehensive income - (5,300,000) - (4,550,000)
---------- ------------ ----------- -------------
Comprehensive income
(loss) $1,925,920 $(18,982,535) $ 4,823,438 $ (43,085,951)
---------- ------------ ----------- -------------
---------- ------------ ----------- -------------
Accumulated other
comprehensive
income, beginning
of period $ - $ 750,000 $ - $ -
Other comprehensive
income, net of taxes - (5,300,000) - (4,550,000)
---------- ------------ ----------- -------------
Accumulated other
comprehensive
income, end of
period $ - $ (4,550,000) $ - $ (4,550,000)
---------- ------------ ----------- -------------
---------- ------------ ----------- -------------
See accompanying notes to consolidated financial statements.
PEARL EXPLORATION AND PRODUCTION LTD.
Consolidated Statements of Cash Flows
(unaudited)
--------------------------------------------------------------------------
Three months ended Nine months ended
September 30 September 30
--------------------------------------------------------
2008 2007 2008 2007
------------- ------------ ------------ -------------
Operating
activities
Income (loss) $ 1,925,920 $(18,982,535) $ 4,823,438 $ (43,085,951)
Items not
involving
cash:
Mark to market
gain on
available-for-
sale financial
asset - 5,300,000 - 4,550,000
Writedown of
accounts
receivable 1,014,252 1,285,098 824,655 2,537,098
Writedown of
ABCP 2,574,896 - 2,574,896 -
Gain on sale
of assets - - - (13,270,044)
Gain on
investment (2,268,028) - (2,268,028) -
Depletion,
depreciation
and accretion 13,670,991 23,406,095 57,706,350 63,265,388
Stock-based
compensation 775,293 777,877 2,196,377 2,653,273
Future income
tax (recovery) 2,650,137 (5,400,712) 2,663,958 (5,007,942)
Change in
unrealized
loss of gas
pricing
contracts - - - 487,760
Foreign
exchange loss
(gain) 260,152 118,534 223,441 386,756
Abandonment
costs 416,904 (236,612) (249,225) (1,047,950)
------------- ------------ ------------ -------------
21,020,517 6,267,745 68,495,862 11,468,388
------------- ------------ ------------ -------------
Changes in
non-cash
working
capital
balances
related to
operations 3,501,052 (3,100,923) (7,057,885) (5,246,993)
Long term
accounts
receivable - - - 1,066,758
------------- ------------ ------------ -------------
24,521,569 3,166,822 61,437,977 7,288,153
------------- ------------ ------------ -------------
Financing
activities
Advances of
bank loan - 10,000,000 25,000,000 75,000,000
Repayments of
bank loan (5,000,000) (24,000,000) (25,000,000) (109,670,719)
Proceeds from
equity
financings,
net of issue
costs - 58,364,871 - 58,364,870
Exercise of
stock options - 34,100 - 605,325
------------- ------------ ------------ -------------
(5,000,000) 44,398,971 - 24,299,476
------------- ------------ ------------ -------------
Investing
activities
Acquisition of
Cipher
Exploration
Inc. - - - (8,809,049)
Acquisition of
Serrano shares - - - (2,500,000)
Proceeds from
sale of
investments - - - 10,000,000
Proceeds from
sale of assets 3,760,800 - 79,097,031 -
Additions to
petroleum and
natural gas
properties (39,480,007) (47,445,666) (74,597,233) (140,787,082)
Changes in
non-cash
working
capital from
investing 13,737,291 4,673,781 (18,448,061) 28,709,600
------------- ------------ ------------ -------------
(21,981,916) (42,771,885) (13,948,263) (113,386,531)
------------- ------------ ------------ -------------
Net increase
(decrease) in
cash (2,460,347) 4,793,908 47,489,714 (81,798,902)
Cash,
beginning of
period 54,749,247 4,465,393 4,799,186 91,058,203
------------- ------------ ------------ -------------
Cash, end of
period $ 52,288,900 $ 9,259,301 $ 52,288,900 $ 9,259,301
------------- ------------ ------------ -------------
------------- ------------ ------------ -------------
Supplementary
Information
Interest paid $ 27,143 $ 1,245,596 $ 808,868 $ 2,847,956
Capital taxes
paid $ - $ - $ 1,009,957 $ -
See accompanying notes to consolidated financial statements.
PEARL EXPLORATION AND PRODUCTION LTD.
Notes to the Consolidated Financial Statements
(unaudited)
1. NATURE OF OPERATIONS
Pearl Exploration and Production Ltd. (collectively with its subsidiaries, the
"Company" or "Pearl") is listed and traded on the TSX Exchange under the trading
symbol "PXX". The Company is engaged in the business of oil and gas exploration
and development in North America.
2. BASIS OF PRESENTATION
The interim consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries: Pearl E&P Canada Ltd., CODA Holdings
Corp., Pearl Exploration and Production USA Ltd., Pearl Exploration and
Production Montana Ltd., Newmex Energy (USA) Inc., Valkyries Texas Corp., and
Valkyries Texas Gas Ltd. Both Cipher Exploration Inc. and Watch Resources Ltd.
were amalgamated with Pearl E & P Canada Ltd. on January 1, 2008.
The interim consolidated financial statements for the Company have been prepared
in accordance with accounting principles generally accepted in Canada, using the
same accounting policies and methods of computation as set out in note 3 to the
audited consolidated financial statements in the Company's Financial Report for
the fifteen months ended December 31, 2007. The disclosures provided herein are
incremental to those included with the audited consolidated financial
statements. The interim consolidated financial statements should be read in
conjunction with the audited consolidated financial statements for the fifteen
months ended December 31, 2007 and the interim consolidated financial statements
for the quarters ended March 31 and June 30, 2008.
3. CHANGES IN ACCOUNTING POLICIES
As disclosed in the December 31, 2007 annual audited Consolidated Financial
Statements, on January 1, 2008, the Company adopted the following Canadian
Institute of Chartered Accountants ("CICA") Handbook Sections:
- Section 3862 "Financial Instruments - Disclosures" and Section 3863 "Financial
Instruments - Presentation", which replace Section 3861 "Financial Instruments -
Disclosure and Presentation". The new disclosure standard increases the emphasis
on the risks associated with financial instruments and how those risks are
managed (See Note 14). The new presentation standard carries forward the former
presentation requirements.
- Section 1535 "Capital Disclosures", The new standard requires the Company to
disclose its objectives, policies and processes for managing its capital
structure (See Note 12).
4. RECENT ACCOUNTING PRONOUNCEMENTS
As of January 1, 2009, the Company will be required to adopt the CICA Handbook
Section 3064, "Goodwill and Intangible Assets", which will replace the existing
Goodwill and Intangible Assets standard. The new standard revises the
requirement for recognition, measurement, presentation and disclosure of
intangible assets. The adoption of this standard should not have a material
impact on the Company's Consolidated Financial Statements.
In January 2006, the CICA Accounting Standards Board ("AcSB") adopted a
strategic plan for the direction of accounting standards in Canada. As part of
that plan, accounting standards in Canada for public companies are expected to
converge with International Financial Reporting Standards ("IFRS") for fiscal
periods commencing on or after January 1, 2011. The Company is assessing the
potential impacts of this changeover and developing a plan for the conversion.
5. INVESTMENTS
-------------------------------
September 30, December 31,
2008 2007
-------------------------------
Investment in Serrano Energy Ltd.
("Serrano") $ 7,768,028 $ 5,500,000
Asset-backed commercial paper ("ABCP") 1,287,999 3,862,895
-------------------------------
$ 9,056,027 $ 9,362,895
-------------------------------
The Company owns approximately 4.0 million shares of Serrano. On August 20,
2008, a third party participated in a private placement of common shares in
Serrano for an amount of $55.0 million. However, the terms of the placement were
such that the Company's ownership position, formerly 37 percent was reduced to
approximately 18 percent. As the shares issued under the placement were sold at
a per share price greater than the per share price of the Company's initial
investment, the Company recognized a dilution gain of $2.3 million. As the
Company's ownership position is now below the threshold applicable to equity
accounting, it accounts for this investment using the cost method;
correspondingly, gains or losses will only be recognized upon disposal of the
shares held.
The Company holds an investment in ABCP as part of the Watch acquisition on
October 19, 2007. Prior to the acquisition of Watch major participants in the
third party sponsored ABCP market announced a proposed solution to the liquidity
problem in the ABCP market. A restructuring plan was ultimately submitted to the
Ontario Superior Court of Justice under the Companies Creditors Arrangement Act
(CCAA) which was sanctioned on June 5, 2008. On June 18, 2008 proceedings were
taken by a number of corporate noteholders to the Ontario Court of Appeal
seeking to challenge the Courts decision that sanctioned the restructuring plan.
On August 18, 2008, the Ontario Court of Appeal dismissed the appeal. On
September 2, 2008, a number of unsuccessful appellants sought leave to appeal
the decision to the Supreme Court of Canada. On September 19, 2008 the Supreme
Court announced that it would not grant leave to hear the appeal. The Committee
has now commenced the process for implementation of the restructuring with a
view of completing implementation by the end of November 2008. The ABCP
investment will be converted into notes with maturities matching the underlying
assets. The notes will bear interest rates commensurate with the nature of the
underlying assets including the cost of a margin funding facility.
At the time of the acquisition of Watch the Company determined that the
estimated fair value of the ABCP was $1.1 million less than the face value. The
valuation technique used by the Company to estimate the fair value of its
investments in ABCP incorporates probability - weighted discounted cash flows
considering the best available public information regarding market conditions
and other factors that a market participant would consider for such investments.
As at September 30, 2008 the Company determined that a further downward
adjustment of $2.6 million was required at this time. The historical decrease
that has affected all the capital markets provides significant uncertainties
regarding the value of the assets which underlie the ABCP, the potential
development of a liquid market for the replacement notes and as a result the
amount and timing of cash flows and the outcome of the restructuring process all
give rise to a further decrease in the value of the Company's investment in
ABCP.
6. PETROLEUM AND NATURAL GAS PROPERTIES
-----------------------------------------------
September 30, 2008
-----------------------------------------------
Accumulated
depreciation
and Net book
Cost depletion value
Petroleum and natural gas
properties $ 616,248,746 $ 153,279,238 $ 462,969,508
Office equipment 2,401,745 675,422 1,726,323
-----------------------------------------------
$ 618,650,491 $ 153,954,660 $ 464,695,831
-----------------------------------------------
-----------------------------------------------
December 31, 2007
-----------------------------------------------
Accumulated
depreciation
and Net book
Cost depletion value
Petroleum and natural gas
properties $ 623,916,051 $ 96,763,951 $ 527,152,100
Office equipment 1,520,287 319,847 1,200,440
-----------------------------------------------
$ 625,436,338 $ 97,083,798 $ 528,352,540
-----------------------------------------------
The depletion and ceiling test calculations have excluded the cost of unproved
properties of $66.3 million (December 31, 2007 - $61.0 million) and included the
cost of future development costs of $82.1 million (December 31, 2007 - $145.0
million).
7. BANK CREDIT FACILITY
The Company has a credit facility with a Canadian chartered bank which is
comprised of a $37 million revolving 364-day extendible term facility, and a $10
million demand revolving operating facility. The Company may borrow, repay and
re-borrow advances with the aggregated outstanding not to exceed the total
credit facility. The facility bears interest at the bank prime rate payable
monthly and is secured by a general securities agreement.
The facility is subject to annual reviews. The next scheduled review will take
place on May 31, 2009.
8. ASSET RETIREMENT OBLIGATION
The total future asset retirement obligation was estimated based on the
Company's net ownership interest in all wells and facilities, the estimated
costs to abandon and reclaim the wells and facilities and the estimated timing
of the costs to be incurred in future periods. The total undiscounted amount of
the estimated cash flows required to settle the asset retirement obligations is
approximately $27.6 million which will be incurred over the next 48 years with
the majority of costs incurred between 2008 and 2025.
A credit adjusted risk-free rate of 8 percent and an inflation factor of 1.5
percent was used to calculate the fair value of the asset retirement obligation.
Changes to the asset retirement obligation were as follows:
--------------------------------------------------------------------------
September 30, December 31,
2008 2007
--------------------------------------------------------------------------
Asset retirement obligation at beginning
of period $ 16,586,030 $ 3,772,479
--------------------------------------------------------------------------
Liabilities acquired through acquisitions,
of net dispositions (6,404,132) 9,822,642
--------------------------------------------------------------------------
Liabilities incurred during the period 757,708 2,987,539
--------------------------------------------------------------------------
Actual remediation expenses (249,225) (1,164,822)
--------------------------------------------------------------------------
Accretion 835,488 1,168,192
--------------------------------------------------------------------------
Asset retirement obligation at end of
period $ 11,525,869 $ 16,586,030
--------------------------------------------------------------------------
9. RELATED PARTY TRANSACTIONS
During the nine months ended September 30, 2008 the Company entered into the
following transactions with related parties in the normal course of business,
which are recorded at the exchange amount established and agreed to by the
related parties:
(a) The Company paid $58,643 (2007 - $127,773) to Tanganyika Oil Company Ltd.
("Tanganyika") for administrative and other services. The Company and Tanganyika
have certain officers and directors in common.
(b) The Company paid $135,000 (2007 - $78,000) to Namdo Management Services Ltd.
("Namdo") for executive and support services pursuant to a services agreement.
Namdo is a private corporation owned by Lukas H. Lundin, a director of the
Company.
10. SHARE CAPITAL
(a) Authorized:
The Company is authorized to issue an unlimited number of common shares.
(b) Common Shares Issued:
Number Attributed
of Shares Value
----------- -------------
Balance as at September 30, 2008 and December
31, 2007 189,241,716 $ 723,121,821
----------- -------------
(c) Warrants Outstanding:
--------------------------------------------------------------------------
Weighted average
Number of whole exercise price
warrants per share
--------------------------------------------------------------------------
Outstanding at December 31, 2007 4,091,800 $ 0.98
--------------------------------------------------------------------------
Cancelled (91,800)
--------------------------------------------------------------------------
Outstanding at September 30, 2008 4,000,000 1.00
--------------------------------------------------------------------------
(i) Four million warrants were issued pursuant to the San Miguel acquisition in
November 2005. Each warrant entitles the holder thereof to purchase an
additional common share of the Company at a price of $1.00, exercisable from the
date the San Miguel heavy oil project achieves an average daily producing rate
of 5,000 barrels of oil per day, averaged over 30 consecutive days, until
November 18, 2008.
(ii) In connection with the December, 2005 Palo Duro acquisition, the Company
issued 270,000 warrants. This number was subsequently reduced by 66% to 91,800
when the vendor exercised a back-in right on March 3, 2006. Each remaining
warrant provides the warrant holder with the right to receive an additional
common share of the Company, within 75 days of September 15, 2008, for no
additional consideration, if the average production rate per well drilled in the
Palo Duro shale gas project is at least 1.5 million cubic feet equivalent per
day, based on the initial 60 days of production. The number of warrants
ultimately issued will be reduced pro rata to the actual average production rate
if the actual average production rate per well drilled by September 15, 2008 is
less than 1.5 million cubic feet equivalent per day. There was no production by
September 15, 2008 and the warrants accordingly have now expired.
11. STOCK-BASED COMPENSATION
The Company has a stock option plan (the "plan") for directors, officers,
consultants and employees of the Company and its subsidiaries. A total of
18,924,172 stock options are authorized to be issued under the plan. Stock
options have terms of two to five years, vest over periods of up to three years
and are exercisable at the market prices of the shares on the dates that the
options were granted. All of the options are subject to a four-month "hold"
period.
The continuity of stock options issued and outstanding is as follows:
Weighted Average
Number of Options Exercise Price $
-----------------------------------
Outstanding December 31, 2007 7,726,357 3.98
Granted 1,460,500 1.77
Cancelled (1,445,254) 4.22
Expired (1,401,667) 4.19
----------------- ----------------
Outstanding at September 30, 2008 6,339,936 3.36
----------------- ----------------
The following stock options were outstanding at September 30, 2008:
Options Outstanding Options Exercisable
---------------------------------------------------------------
Weighted- Weighted- Weighted- Weighted-
Range of Average Average Average Average
Exercise Exercise Life Exercise Life
Prices ($) Number Price ($) (Years) Number Price ($) (Years)
--------------------------------------------------------------------------
1.43-3.00 3,228,000 2.19 4.47 -
3.01-4.50 1,250,936 3.83 3.07 634,269 4.14 2.16
4.51-5.28 1,861,000 5.09 3.20 663,666 5.08 3.04
--------------------------------------------------------------------------
6,339,936 3.37 3.82 1,297,935 4.62 2.61
--------------------------------------------------------------------------
Compensation expense of $2,703,818, net of recovery of $507,440 for cancelled
stock options, has been recorded in the Consolidated Statements of Operations
and Deficit for the nine months ended September 30, 2008 (2007 - $2,653,273).
The fair value of common share options granted is estimated on the date of grant
using the Black-Scholes option pricing model. The weighted average fair value of
options granted during 2008 and the assumptions used in their determination are
as noted below:
Nine Months Ended
September 30, 2008
------------------
Weighted average fair value of stock
options granted (per option) $ 0.79
Expected life of stock options (years) 3.00
Volatility (weighted average) 64%
Risk free rate of return (weighted average) 3.26%
Expected dividend yield 0%
Contributed surplus continuity September 30, 2008 December 31, 2007
-------------------------------------
Balance, beginning of the period $ 8,778,124 $ 4,791,060
Stock-based compensation 2,703,818 4,636,916
Stock-based compensation allocated
to contributed surplus
as part of Watch acquisition - 575,448
Recovery of expense on
cancelled stock options (507,440) (590,137)
Transfer to share capital on
exercise of options - (635,163)
------------------ -----------------
Balance, end of period $ 10,974,502 $ 8,778,124
------------------ -----------------
12. CAPITAL MANAGEMENT
The Company's capital management strategy is designed to minimize the use of
long term debt and maintaining positive working capital. This strategy should
provide the financial flexibility to fund the Company's capital program and
profitable growth opportunities.
Financial covenants associated with the Company's credit facility are reviewed
regularly and controls are in place to maintain compliance with these covenants.
The Company complied with all covenants for the nine months ended September 30,
2008.
13. COMMITMENTS AND CONTRACTUAL OBLIGATIONS
The Company enters into commitments and contractual obligations in the normal
course of business, including the purchase of services, farm-in agreements,
royalty agreements, operating agreements, transportation agreements, processing
agreements, right of way agreements and lease agreements for vehicles.
The Company has a nine-year operating lease for office space.
--------------------------------------------------------------------------
Subsequent
2008 2009 2010 2011 2012 to 2012
--------------------------------------------------------------------------
Office
rent $ 271,190 $1,084,760 $1,084,760 $1,152,557 $1,220,355 $4,576,331
--------------------------------------------------------------------------
The Company has contracted drilling rig services over the next two years In the
event that the Company does not utilize the minimum contracted days, the Company
would be obligated to pay the rig operators a variable rate based on days not
utilized under the contracts. The maximum commitment at September 30, 2008
related to these contracts is approximately $3.1 million, which can be reduced
by farm-outs to other operators.
14. FINANCIAL INSTRUMENTS
The Company does not utilize derivative instruments to manage risks. The Company
is exposed to the following risks related to financial assets and liabilities:
(a) Commodity price risk
The Company is exposed to risks associated with fluctuating commodity prices. At
this time, the Company does not use derivative financial instruments to manage
its exposure to this risk.
(b) Foreign currency exchange risk
The Company is exposed to risks arising from fluctuations in foreign currency
exchange rates and the volatility of those rates. This exposure primarily
relates to: (i) certain expenditure commitments, deposits, accounts receivable,
and accounts payable which are denominated in US dollars, and (ii) its
operations in the United States.
(c) Fair values
The carrying amounts of financial instruments comprising cash, accounts
receivable and accounts payable approximate their fair value due to the
immediate or short-term nature of these financial instruments.
(d) Credit Risk
The Company's accounts receivable are with customers and joint venture partners
in the petroleum and natural gas business and are subject to normal credit
risks. Management believes that there is no unusual exposure associated with the
collection of the receivables due to the size and reputation of the companies
and to the continuing joint venture relationship.
(e) Interest Rate Risk
The Company is exposed to interest rate risk in relation to interest expense on
its revolving credit facility.
15. SEGMENTED INFORMATION
The Company presently has one reportable business segment, that being oil and
gas exploration and development. The Company's operations are carried on in the
following geographic locations:
Three Months Ended September 30, 2008
--------------------------------------------------------------------------
--------------------------------------------------------------------------
Canada USA Consolidated
--------------------------------------------------------------------------
Total revenues, net of royalties 33,042,578 595,848 33,638,426
Expenses 27,617,604 379,686 27,997,290
Foreign currency loss (gain) 297,841 (37,689) 260,152
Write-downs 2,574,896 - 2,574,896
Gain on investment (2,268,028) - (2,268,028)
----------------------------------------
Net income before income taxes 4,820,265 253,851 5,074,116
Income taxes 3,116,269 31,927 3,148,196
----------------------------------------
Net income 1,703,996 221,924 1,925,920
----------------------------------------
----------------------------------------
Segment assets 484,802,365 70,153,194 554,955,559
----------------------------------------
Segment petroleum and natural
gas properties 404,317,798 60,378,033 464,695,831
----------------------------------------
Capital additions 34,367,037 5,112,970 39,480,007
----------------------------------------
Nine Months Ended September 30, 2008
--------------------------------------------------------------------------
--------------------------------------------------------------------------
Canada USA Consolidated
--------------------------------------------------------------------------
Total revenues, net of royalties 121,887,757 1,258,430 123,146,187
Expenses 112,009,762 1,176,417 113,186,179
Foreign currency loss (gain) 286,553 (63,112) 223,441
Write-downs 2,574,896 - 2,574,896
Gain on investment (2,268,028) - (2,268,028)
----------------------------------------
Net income before income taxes 9,284,574 145,125 9,429,699
Income taxes 4,557,258 29,003 4,606,261
----------------------------------------
Net income 4,727,316 116,122 4,823,438
----------------------------------------
----------------------------------------
Segment assets 484,802,365 70,153,195 554,955,559
----------------------------------------
Segment petroleum and natural
gas properties 404,317,798 60,378,033 464,695,831
----------------------------------------
Capital additions 59,475,701 15,121,532 74,597,233
----------------------------------------
Three Months Ended September 30, 2007
--------------------------------------------------------------------------
--------------------------------------------------------------------------
Canada USA Consolidated
--------------------------------------------------------------------------
Total revenues, net of royalties 24,679,954 236,351 24,916,305
Expenses 42,322,872 118,879 42,441,751
Foreign currency loss (8,623) 127,157 118,534
Gain on sale of assets - - -
----------------------------------------
Loss before income taxes (17,634,296) (9,685) (17,643,981)
Income taxes (recovery) (4,796,159) 834,714 (3,961,445)
----------------------------------------
Net loss (12,838,137) (844,399) (13,682,536)
----------------------------------------
----------------------------------------
Segment assets 618,850,780 35,692,662 654,543,442
----------------------------------------
Goodwill 159,863,578 - 159,863,578
----------------------------------------
Segment petroleum and natural
gas properties 418,180,234 28,163,838 446,344,072
----------------------------------------
Capital additions 45,640,603 1,805,063 47,445,666
----------------------------------------
Nine Months Ended September 30, 2007
--------------------------------------------------------------------------
--------------------------------------------------------------------------
Canada USA Consolidated
--------------------------------------------------------------------------
Total revenues, net of royalties 67,099,849 758,708 67,858,557
Expenses 114,891,668 1,077,132 115,968,800
Foreign currency loss 259,599 127,157 386,756
Gain on sale of assets - (13,270,044) (13,270,044)
----------------------------------------
Income (loss) before income taxes (48,051,418) 12,824,463 (35,226,955)
Income taxes (recovery) (3,977,344) 7,286,340 3,308,996
----------------------------------------
Net income (loss) (40,074,074) 5,538,123 (38,535,951)
----------------------------------------
----------------------------------------
Segment assets 618,850,780 35,692,662 654,543,442
----------------------------------------
Goodwill 159,863,578 - 159,863,578
----------------------------------------
Segment petroleum and natural
gas properties 418,180,234 28,163,838 446,344,072
----------------------------------------
Capital additions 134,493,536 7,602,596 142,096,132
----------------------------------------
16. CONTINGENCIES
(a) In connection with the November, 2007 property acquisition from PetroHunter,
the Company may be required to pay a performance payment of US $9.8 million in
cash at such time as either: (i) production from the assets reaches 5,000 bopd;
or (ii) proven reserves from the assets is greater than 50 million barrels of
oil, if either condition is met prior to November 6th, 2010. As noted in Q2, the
Company did not reach an agreement with a third party and therefore the
previously stated performance payment was reduced and the contingent shares were
not issued.
(b) Four million warrants were issued pursuant to the San Miguel property
acquisition in November 2005. Each warrant entitles the holder thereof to
purchase an additional common share of the Company at a price of $1.00,
exercisable from the date the San Miguel heavy oil project achieves an average
daily producing rate of 5,000 barrels of oil per day, averaged over 30
consecutive days, until November 18, 2008.
(c) In connection with the August, 2008 Blackrod property acquisition, the
Company may be required to pay additional payments of (i) $4.0 million in cash
at such time as the pilot project achieving gross accumulated production of
100,000 barrels of oil and (ii) $4.0 million in cash at such time as commercial
project achieving 5,000 Bbl/d of production for the duration of one month, and
(iii) $3.0 million in cash at such time as commercial project achieving 10,000
Bbl/d of production for the duration of one month.
17. SUBSEQUENT EVENTS
The Company has entered into an agreement with Serrano Energy Ltd. ("Serrano")
to swap our equity interests in Serrano for a 15% increased interest in the
Blackrod project and a carried work commitment of $5 million. We expect to close
this transaction prior to year end. We have the right and we intend to become
operator of the Blackrod project as soon as reasonably practicable.
18. COMPARATIVE FIGURES
Certain comparative figures have been reclassified to conform to the
presentation adopted in 2008.
Pearl Exploration and Production Ltd. is a public company focused on converting
its captured resources into reserves and becoming a substantial North American
heavy oil project development company. Additional information, including an
updated corporate presentation, is available on the Company's website at
www.pearleandp.com.
Pearl's Certified Advisor on First North is E. Ohman J:or Fondkommission AB.
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