Source: Birchcliff Energy Ltd.
Birchcliff Energy Ltd. Announces Audited 2010 Financial Statements and Operations Update
CALGARY, ALBERTA--(Marketwire - March 17, 2011) -
NOT FOR DISTRIBUTION TO THE UNITED STATES NEWSWIRE SERVICES OR FOR DISSEMINATION IN THE UNITED STATES OF AMERICA
Birchcliff Energy Ltd. ("Birchcliff")(TSX:BIR) is pleased to announce its audited financial statements for 2010 and provide a 2011 operations update. These audited financial statements are consistent with the unaudited financial results announced in the news release issued by Birchcliff on February 16, 2011.
The full text of the 2010 audited financial statements and the related Management's Discussion and Analysis are set forth below.
It is with great pleasure that we effectively repeat and confirm the information contained in our press release dated February 16, 2011.
For an overview of Birchcliff's 2010 activities including reserve additions, finding and development costs, developments on Birchcliff's Montney/Doig Natural Gas Resource Play and its Worsley Light Oil Resource Play, please refer to the news release issued by Birchcliff on February 16, 2011.
Jeff Tonken, President and Chief Executive Officer of Birchcliff stated "At the bottom end of the natural gas price cycle, Birchcliff had significant per share growth, in terms of annual average production per share (10%), proved plus probable reserves per share (26.5%), earnings per share and reduced operating costs per boe (13%). We added material reserves at extremely low finding and development costs. We have established significant scale to both our unconventional resource plays which will allow us to continue to grow in the future by developing our existing asset base.
We are investing our shareholders' money in 2 prolific resource plays and we expect to create significant value for them in the future."
Key points from our 2010 results are as follows:
1. Production averaged 16,375 boe per day in the fourth quarter a 56% increase from the fourth quarter of 2009.
2. Significant reserve additions, to 201.1 mmboe on a proved plus probable basis at year-end 2010, a 28% gain over year-end 2009 and a 50% gain on a proved developed producing basis to 30.8 mmboe.
3. Low finding, development and acquisition costs, $4.49 per boe excluding future development capital and $8.34 per boe including future development capital (both on a proved plus probable basis).
4. Cash flow of $100 million ($0.81 per share) a 49% increase from 2009.
5. Earnings of $5.9 million ($0.05 per share), as compared to a loss of $24.3 million in 2009, notwithstanding Birchcliff was unhedged, and AECO spot natural gas prices averaged $3.80 per GJ in 2010.
6. Operating costs per boe were reduced by 13.4% from 2009, to $7.70 per boe (excluding transportation and marketing expense).
7. Expansion of its unconventional resource plays including the Montney/Doig Natural Gas Resource Play and the Worsley Light Oil Resource Play, in terms of reserves, production, drilling operations, depth of opportunities, undeveloped land and technical expertise.
2011 Operations Update
Birchcliff's drilling results to date in 2011 include the drilling of 11 (9.8 net) wells. Of these wells, 5 (3.8 net) were Montney/Doig horizontal natural gas wells in our Pouce Coupe area and6 (6.0 net) wells were horizontal wells at Worsley on our light oil resource play.
As we wind up a very active winter drilling program, Birchcliff currently has 1 drilling rig at work on a pad location in Pouce Coupe, drilling Montney/Doig horizontal natural gas wells. This pad location will allow us to continue to drill up to 4 horizontal wells which will permit continuous drilling through breakup. Multi-well pad drilling reduces drilling costs and improves operational efficiencies.
2011 Production
Birchcliff re-affirms that it expects production to average 18,500 boe per day in 2011. Birchcliff expects to average 17,500 boe per day in the first half of 2011 and 19,500 boe per day during the second half of 2011.
January 2011 average production was 18,160 boe per day. February 2011 average production is estimated at 17,810 boe per day based on field estimates.
Resource Assessment
To better quantify our potential on the Montney/Doig Natural Gas Resource Play, Birchcliff has commissioned AJM Petroleum Consultants to conduct an independent resource assessment for our Montney/Doiglands in the Pouce Coupe region of Alberta.
We expect to receive and make public the results of this resource assessment in the second quarter of 2011.
Science and Technology
Over the last several years, Birchcliff has invested substantial time and money to develop an integrated science and technology team based approach to the way we explore for and develop shale/tight oil and gas resource plays in the Peace River Arch. This investment is based on the understanding that resource plays are complex and require in-depth scientific knowledge to identify gas or oil saturated and geo-mechanically favourable sweet spots. Integrating geology, petrophysics, geophysics, hydrodynamics, reservoir engineering, microseismic and geo-mechanics with our drilling, completion and production practices has helped Birchcliff significantly de-risk the Montney/Doig Natural Gas Resource Play and the Worsley Light Oil Resource Play while enabling more precise identification and ranking of our growing portfolio of opportunities.
Birchcliff's experienced and talented team of geoscientists and engineers are now applying an integrated science and technology methodology to new shale/tight oil and gas resource plays in the Peace River Arch.
As part of Birchcliff's commitment to the scientific study of resource plays, we participated in two industry consortiums initiated by Core Laboratories. The "North American Shale Gas Study" is a multi-company, geo-engineering study of gas shales conducted by the Integrated Reservoir Solutions division of Core Laboratories. To date, over 70 companies have participated in the project, which involves the characterization and evaluation of numerous conventional cores taken from multiple gas shale formations in a variety of North American Basins. Specifically, the gas shale reservoirs are analyzed for their geological, petrophysical, geo-mechanical, geo-chemical and production properties. This data is then integrated with well logs, stimulation designs and production test information. This large and searchable database provides Birchcliff with valuable information not only on its own wells in a particular gas shale play, but also on other operators' wells in other gas shale formations. The second industry consortium in which Birchcliff has participated is the "Montney Shale Gas Study" conducted by Core Laboratories, which is similar to the North American Shale Gas Study, but focused specifically on the Montney formation of the Western Canadian Sedimentary Basin.
Utilizing this science, significant time and expertise has been invested into the modeling and design of various hydraulic fracture stimulation treatments, fluids, geometry and stimulated rock volume simulations so that the optimal fracture density, well length and inter-well spacing can be better determined in various reservoirs on our lands. This will be key to effectively exploiting our lands at an optimal well spacing while maximizing our production profiles and ultimate reserve capture. Our proven operational experience and expertise is also applied in real time during our fracture stimulations treatments which has resulted in the repeated successful placement of our fracture stimulations. Overall, the application of this science and technology will allow us to maximize gas recovery while minimizing capital expenditures resulting in greater value for our shareholders.
Shareholder Support
We thank Mr. Seymour Schulich who continues to provide his sage advice and support to our executive team. Recently, Mr. Schulich, again, demonstrated his commitment to Birchcliff when he increased his share position to 33 million shares representing 26.3% of the current issued and outstanding shares.
/T/
2010 FINANCIAL AND OPERATIONAL HIGHLIGHTS
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Three Three Twelve Twelve
months months months months
ended ended ended ended
December December December December
31, 31, 31, 31,
2010 2009 2010 2009
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OPERATING
Average daily production
Light oil - barrels 3,486 3,045 3,135 2,934
Natural gas - thousands of
cubic feet 73,978 43,170 56,970 47,805
NGLs - barrels 559 274 448 314
Total - barrels of oil
equivalent (6:1) 16,375 10,515 13,079 11,216
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Average sales price
($ Canadian)
Light oil - per barrel 81.89 75.01 78.76 64.35
Natural gas - per thousand
cubic feet 3.94 4.81 4.21 4.28
NGLs - per barrel 76.14 67.94 72.82 55.52
Total - barrels of oil
equivalent (6:1) 37.83 43.23 39.72 36.65
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Undeveloped land
Gross (acres) 500,069 398,308 500,069 398,308
Net (acres) 456,952 353,150 456,952 353,150
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NETBACK AND COST
($ per barrel of oil
equivalent at 6:1)
Petroleum and natural gas
revenue 37.88 43.32 39.80 36.80
Royalties (2.91) (5.35) (3.55) (3.75)
Operating expense (6.92) (7.64) (7.70) (8.89)
Transportation and
marketing expense (2.56) (2.47) (2.59) (2.39)
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Netback 25.49 27.86 25.96 21.77
General and administrative
expense, net (3.25) (3.54) (2.12) (2.77)
Interest expense (2.60) (2.72) (2.82) (2.52)
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Cash Flow Netback 19.64 21.60 21.02 16.48
Depletion and depreciation
expense (14.51) (15.80) (15.64) (20.40)
Accretion expense (0.33) (0.60) (0.38) (0.43)
Stock-based compensation
expense (1.67) (1.84) (2.22) (2.40)
Amortization of deferred
financing fees (0.17) (0.51) (0.34) (0.29)
Future income tax recovery
(expense) (1.23) (1.18) (1.20) 1.12
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Net Income (Loss) 1.73 1.67 1.24 (5.92)
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FINANCIAL
Petroleum and natural gas
revenue ($000) 57,072 41,908 189,978 150,669
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Cash flow from operations
($000) 29,592 20,900 100,351 67,476
Per share - basic ($) 0.24 0.17 0.81 0.57
Per share - diluted ($) 0.23 0.17 0.79 0.56
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Net income (loss) ($000) 2,612 1,616 5,902 (24,252)
Per share - basic ($) 0.02 0.01 0.05 (0.21)
Per share - diluted ($) 0.02 0.01 0.05 (0.21)
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Daily production per
weighted average million
basic share (boe/d) 131.01 85.12 104.94 95.06
Proved reserves per basic
share - end of period (boe/d) 0.91 0.73 0.91 0.73
Proved plus probable
reserves per basic share
- end of period (boe/d) 1.61 1.27 1.61 1.27
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Common shares outstanding
End of period - basic 125,129,234 123,815,002 125,129,234 123,815,002
End of period - diluted 137,316,486 134,464,987 137,316,486 134,464,987
Weighted average shares for
period - basic 124,994,761 123,538,213 124,629,761 117,993,314
Weighted average shares for
period - diluted 129,264,791 126,358,921 127,662,373 117,993,314
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Capital expenditures, net
($000)(1)(2) 47,456 44,368 220,034 101,690
Working capital deficiency
($000) 3,956 20,291 3,956 20,291
Revolving credit facilities
($000) 333,468 201,230 333,468 201,230
Total debt ($000) 337,424 221,521 337,424 221,521
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(1) Included as a reduction of net capital expenditures in the twelve months
ended December 31, 2010 are proceeds of $17.5 million relating to the
sale of a minor asset.
(2) Included as a reduction of net capital expenditures in the twelve months
ended December 31, 2010 is an expected recovery of $9.9 million
(December 31, 2009 - $6.3 million) relating to the Alberta Drilling
Royalty Credit Program.
/T/
2010 Audited Financial Statements and related Management's Discussion and Analysis
Hereafter follows the full text of the 2010 audited financial statements and the related Management's Discussion and Analysis.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Birchcliff Energy Ltd. ("Birchcliff" or the "Corporation") is an intermediate oil and gas exploration, development and production company based in Calgary, Alberta. Additional information relating to the Corporation, including its Annual Information Form, is available on the SEDAR website at www.sedar.com. Birchcliff's common shares are listed for trading on the Toronto Stock Exchange ("TSX") under the symbol "BIR" and are included in the Standard and Poor's S&P/TSX Composite Index.
The following Management's Discussion and Analysis ("MD&A") is dated March 17, 2011. The annual financial statements with respect to the three and twelve months ended December 31, 2010 (the "Reporting Periods") as compared to the three and twelve months ended December 31, 2009 (the "Comparable Prior Periods") and this MD&A have been prepared by management and approved by the Corporation's Audit Committee and Board of Directors. This MD&A should be read in conjunction with the unaudited interim financial statements of the Corporation and related notes for the Reporting Periods and Comparable Prior Periods, and the audited financial statements and related notes as at and for the years ended December 31, 2010 and 2009. All financial information has been prepared in accordance with Canadian Generally Accepted Accounting Principles ("GAAP") and all amounts are expressed in Canadian dollars unless otherwise stated.
/T/
SELECTED ANNUAL INFORMATION
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Year ended December 31,
($000's, except for production and share information) 2010 2009
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Average daily production (boe at 6 mcf:1 bbl) 13,079 11,216
Petroleum and natural gas revenue 189,978 150,669
Total revenue, net royalties 173,045 135,327
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Cash flow from operations 100,351 67,476
Per share - basic ($) 0.81 0.57
Per share - diluted ($) 0.79 0.56
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Net income (loss) 5,902 (24,252)
Per share - basic ($) 0.05 (0.21)
Per share - diluted ($) 0.05 (0.21)
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Capital expenditures, net(1)(2) 220,034 101,690
Total assets 995,391 837,108
Working capital deficit 3,956 20,291
Revolving credit facilities 333,468 201,230
Total debt 337,424 221,521
Shareholders' equity 577,123 554,561
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Common shares outstanding
End of period - basic 125,129,234 123,815,002
End of period - diluted 137,316,486 134,464,987
Weighted average shares for period - basic 124,629,761 117,993,314
Weighted average shares for period - diluted 127,662,373 117,993,314
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(1) Included as a reduction of net capital expenditures in the year ended
December 31, 2010 are proceeds of $17.5 million relating to the sale of
a minor asset.
(2) Included as a reduction of net capital expenditures in the year ended
December 31, 2010 is an expected recovery of $9.9 million (2009 - $6.3
million) relating to the Alberta Drilling Royalty Credit Program.
/T/
2010 OVERALL PERFORMANCE
Production
Production in 2010 averaged 13,079 boe per day. This is a 17% increase from the 11,216 boe per day the Corporation averaged in 2009. Production in the fourth quarter of 2010 averaged 16,375 boe per day, a 56% increase from the 10,515 boe per day the Corporation averaged in the fourth quarter of 2009. These increases were achieved through the success of Birchcliff's capital drilling program and the processing of natural gas through Phases I and II of Birchcliff's 100% owned and operated Pouce Coupe South Natural Gas Plant ("PCS Gas Plant"), which commenced operation in March and November of 2010, respectively. Birchcliff's average daily production for December 2010 was 19,102 boe per day.
Production consisted of approximately 75% natural gas and 25% crude oil and natural gas liquids in the fourth quarter of 2010.
Commodity Prices
Oil sales prices at the wellhead averaged $78.76 per barrel in 2010, a 22% increase from $64.35 per barrel in 2009. Natural gas sales prices at the wellhead averaged $4.21 per mcf in 2010, a 2% decrease from $4.28 per mcf in 2009. The prices received for Birchcliff's petroleum and natural gas sales are impacted by world events that dictate the level of supply and demand for oil and natural gas. Birchcliff currently does not have any commodity hedges in place and therefore is subject to fluctuations in commodity prices.
Canadian Edmonton Par oil prices averaged $77.50per barrel in 2010 as compared to $65.90 per barrel in 2009. The AECO daily natural gas spot prices averaged $4.01 per mcf in 2010 as compared to $3.96 per mcf in 2009.
Capital Expenditures
Total capital expenditures (excluding dispositions) in 2010 were $237.5 million as compared to $101.7 million in 2009. Birchcliff disposed of a minor non-producing asset in the first quarter of 2010 for $17.5 million. As a result of this asset sale, net capital expenditures in 2010 were $220.0 million. Of the $237.5 million in total capital spent during 2010, approximately $39.2 million (17%)was directed to the construction of Phases I and II of the PCS Gas Plant and related infrastructure, and $91.9 million (39%) on the drilling and completion of Montney/Doig horizontal natural gas wells used to fill the plant in order to utilize the total design capacity of 60 mmcf per day. The remaining $106.4 million in capital was spent acquiring land; expanding the Montney/Doig Natural Gas Resource Play and Worsley Light Oil Resource Play and related infrastructure; on minor acquisitions; and on other exploration and development projects. Further details of the Corporation's capital expenditures in 2010 are set forth in the table entitled "Capital Expenditures".
Construction of both Phases I and II of the PCS Gas Plant was completed ahead of schedule and on budget, with a combined design capacity of 60 mmcf per day.
Cash Flow and Earnings
Cash flow was $100.4 million ($0.81 per share) in 2010 as compared to $67.5 million ($0.57 per share) in 2009. The 49% increase in cash flow from 2009 resulted from a combination of factors, including increased average daily production; higher average petroleum prices realized at the wellhead and decreased net general and administrative expenses, offset by higher interest expense.
Cash flow netback was $21.02 per boe in 2010,a 28% increase from 2009. Despite the low natural gas price environment, a significant factor in this increase was a 13% reduction in operating costs per boe to $7.70 per boe (excluding transportation and marketing expense) during 2010. This reduction was mainly achieved through greater proportion of Birchcliff's natural gas being processed through the new PCS Gas Plant and increased cost recoveries.
Birchcliff recorded net income of $5.9 million ($0.05 per share) in 2010 as compared to a net loss of $24.3 million ($0.21 loss per share) in 2009. The increase in net income from 2009 was mainly attributable to higher cash flow and lower depletion expense, and was offset by increases in stock-based compensation expense and future income tax expense reported in 2010.
OUTLOOK
Production
Birchcliff's 2011 average daily production is expected to be 18,500 boe per day, which represents average annual production growth of approximately 41% from 2010. Birchcliff expects to average 17,500 boe per day during the first half of 2011 and19,500 boe per day during the second half of 2011.The 2011 production forecast assumes that no unexpected outages occur in the infrastructure that Birchcliff relies on to produce its wells and that existing and future wells continue to meet production expectations.
Birchcliff is focused on utilizing the full capacity of the PCS Gas Plant and providing sustainable average daily production rates in 2011.
Capital Expenditures
The Board of Directors recently approved Birchcliff's 2011 capital spending program in the amount of $159 million. Of the $159 million, approximately $73 million is budgeted for drilling and development of the Montney/Doig Natural Gas Resource Play; approximately $34 million is allocated to the Worsley Light Oil Resource Play; and approximately $52 million is planned for infrastructure, land acquisitions, sustaining capital and seed capital for new growth opportunities and other projects.
The Corporation's operating cash flow and revolving credit facilities will be used to fund the capital spending program in 2011.
Cash Flow and Bank Debt
Birchcliff's bank syndicate approved an increase of the revolving credit facilities to an aggregate limit of $375 million in November 2010. The $375 million of credit facilities will provide Birchcliff with greater liquidity and financial flexibility to further develop its Montney/Doig Natural Gas Resource Play and the Worsley Light Oil Resource Play. Birchcliff expects that its bank credit facilities will be increased during its normal credit review in May 2011. The review of the Corporation's borrowing base limit will depend largely on the bank syndicate's expectation of future commodity prices.
Despite the current low natural gas price environment, the Corporation does not foresee any liquidity issues with respect to the operation of its petroleum and natural gas business in 2011. Birchcliff expects to meet all its future obligations as they become due. Management expects that Birchcliff's average working capital deficiency will be similar in 2011 as compared to 2010 as a result of reduced capital spending.
The Corporation intends to finance its oil and natural gas business primarily through cash generated from operations, working capital, minor asset dispositions and available credit from its revolving facilities. Should commodity prices deteriorate materially, Birchcliff may adjust its capital spending accordingly to ensure that it does not exceed its anticipated cash flow. Birchcliff is now at a size that it anticipates it will not require additional equity except to fund a significant acquisition or to significantly increase its capital spending beyond its cash flow. Management expects to be able to obtain debt financing, and should the need arise, raise additional equity sufficient to meet both its short term and long term growth requirements.
Resource Plays and Infrastructure
The 100% owned and operated PCS Gas Plant has enhanced the value of the Montney/Doig Natural Gas Resource Play in 2010 by allowing for production growth, reducing operating costs per boe and increasing Birchcliff's strategic control over the Pouce Coupe area. Birchcliff expects to achieve the full operating and processing benefits of Phases I and II of the PCS Gas Plant in 2011. This assumes that no unexpected outages occur at the PCS Gas Plant that Birchcliff relies on to produce a significant portion of its natural gas and that existing and future Montney/Doig horizontal natural gas wells continue to meet production expectations.
Birchcliff received Energy Resources Conservation Board approval for construction of Phase III of its PCS Gas Plant, subject to normal industry conditions, which will add up to another 60 mmcf per day of processing capacity, bringing total processing capacity to 120 mmcf per day. The decision to proceed with construction of Phase III will be made in the second quarter of 2011 and is primarily dependent on the outlook for natural gas prices.
Birchcliff has a very strong asset base with its two main resource plays, the Montney/Doig Natural Gas Resource Play and the Worsley Light Oil Resource Play. The extensive portfolio of development opportunities on these resource plays will provide low risk, long life future production and reserves additions that are readily available with the investment of additional capital. Birchcliff expects to be able to manage its lease expiries so that minimal lands will be lost.
These properties provide the Corporation with a long term and operationally reliable cash flow base, the level of which is primarily dependent on commodity prices. Commodity prices affect cash flow, thus dictating the pace at which Birchcliff invests in its resource plays and the rate at which its production will grow. Birchcliff has a long term view of the development of its resource plays and therefore short term commodity prices do not affect the quality or long term value of the Corporation's asset base.
MAJOR TRANSACTIONS AFFECTING FINANCIAL RESULTS
On November 30, 2010, the Corporation's bank syndicate approved an increase of the revolving credit facilities to an aggregate limit of $375 million from $350 million. The amended revolving credit facilities included an increased credit limit for the extendible revolving term credit facility (the "Syndicated Credit Facility") of $345 million from $320 million.
On May 21, 2010, the Corporation's bank syndicate approved an increase of the revolving credit facilities to an aggregate limit of $350 million from $255 million and extended the conversion date of those facilities from May 21, 2010 to May 20, 2011. In conjunction with these changes, the $50 million term credit facility was repaid and cancelled. The amended revolving credit facilities included an increased credit limit for the Syndicated Credit Facility of $320 million from $235 million and an increased credit limit for the extendible revolving working capital facility (the "Working Capital Facility") of $30 million from $20 million.
LIQUIDITY
Working Capital
The Corporation's working capital deficit (current assets minus current liabilities) decreased to $4.0 million at December 31, 2010 from $20.3 million at December 31, 2009. The deficit at the end of 2010 was mainly comprised of costs incurred from the construction of the Phase II expansion of the PCS Gas Plant and related infrastructure, and the drilling and completion of new Montney/Doig horizontal wells during the fourth quarter of 2010.
At December 31, 2010, the major components of Birchcliff's current assets were: cash on hand (10%); joint venture billings (39%) to be received from its partners; and revenue (44%) to be received from its marketers in respect of December 2010 production, which was subsequently received in January 2011. In contrast, current liabilities largely consisted of trade payables (65%)and accrued capital and operating costs (28%).Cash on hand at the end of 2010 was used in full to reduce trade payables in January 2011.
Birchcliff manages its working capital deficit using its cash flow and advances under its revolving credit facilities. The Corporation's working capital deficit does not reduce the amount available under the Corporation's revolving facilities, which have a combined limit of $375 million at December 31, 2010. The Corporation did not have any liquidity issues with respect to the operation of its petroleum and natural gas business during 2010 and 2009.
Total Debt and Bank Debt
Total debt (including working capital deficit) increased to $337.4 million at December 31, 2010 from $221.5 million at December 31, 2009. The increase in total debt from 2009 was primarily a result of $137.2 million in total capital (before dispositions) expended during 2010 in excess of cash flow during that same period, offset by proceeds of $17.5 million from the sale of a minor asset in March 2010.
The amount outstanding on Birchcliff's revolving credit facilities at December 31, 2010 was $333.5 million (2009 - $201.2 million), which is net of $5.7 million (2009 - $5.2 million) in unamortized interest and fees.
The amount drawn under the Corporation's revolving credit facilities increased to $339.2 million at December 31, 2010, with an aggregate limit of $375 million compared with $206.4 million drawn at December 31, 2009, when the aggregate limit was $305 million. The drawn amount is not reduced for unamortized costs and excludes letters of credit that have not been drawn upon. A significant portion of the funds drawn under the Corporation's bank credit facilities in 2010 was directed towards the construction of Phases I and II of the PCS Gas Plant, related infrastructure and Montney/Doig horizontal natural gas wells.
The following table shows the Corporation's total available credit at the end of 2010 and 2009.
/T/
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($000's) December 31, 2010 December 31, 2009
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Maximum borrowing base limit(1) :
Revolving credit facilities 375,000 255,000
Non-revolving term credit facility(2) - 50,000
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375,000 305,000
Principal amount utilized:
Drawn revolving credit facilities (339,176) (206,387)
Outstanding letters of credit(3) (3,014) (2,739)
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(342,190) (209,126)
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Total unused credit 32,810 95,874
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(1) The Corporation's credit facilities are subject to a semi-annual review
of the borrowing base limit, which is directly impacted by the value of
its oil and natural gas reserves.
(2) Effective May 21, 2010, the Corporation repaid in full and cancelled
the $50 million non-revolving term credit facility.
(3) Letters of credit are issued to various service providers. No amounts
were drawn on the letters of credit as at and during the years ended
December 31, 2010 and 2009.
/T/
The financial covenants applicable to the Corporation's credit facilities include a quarterly interest coverage ratio test, which is calculated as earnings before interest, taxes, stock-based compensation, depletion, depreciation and amortization ("EBITDA") over interest expense. The following table shows the interest coverage ratios at December 31, 2010 and 2009:
/T/
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December 31, 2010 December 31, 2009
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Required Actual Required Actual
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Annualized EBITDA to interest greater greater
coverage(1) than 3.5 8.4 than 3.5 7.6
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(1) Interest coverage ratio is calculated on a trailing four quarter basis.
/T/
The Corporation was compliant with all financial covenants applicable under its credit facilities as at and during the periods ended December 31, 2010 and 2009 and continues to be compliant with such covenants at the date hereof.
Contractual Obligations
The Corporation enters into contractual obligations in the course of conducting its day-to-day business. The following table lists Birchcliff's estimated material contractual obligations at December 31, 2010:
/T/
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less than 1 1 - 2 3 - 5
($000's) Year Years Years Thereafter
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Accounts payable and accrued
liabilities 50,721 - - -
Drawn revolving credit
facilities (1) - - 339,176 -
Office leases (2) 3,108 3,118 9,675 6,182
Transportation and processing 10,143 9,201 17,531 -
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Total estimated contractual
obligations (3) 63,972 12,319 366,382 6,182
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(1) The revolving facilities consist of approximately $5.2 million drawn on
the Working Capital Facility and $334 million drawn on the Syndicated
Credit Facility at December 31, 2010.
(2) The Corporation is committed under an operating lease relating to its
office premises, beginning December 1, 2007 and expiring on November 30,
2017. Birchcliff does not presently use all of the leased premises and
has sublet approximately 24% of the excess space to an arms' length
party on a basis that recovers all of the rental costs for the first
five years. The Corporation is also committed to March 29, 2011 under
an operating lease for another office premises that it does not use and
has sublet to an arm's length party on a basis that recovers all of its
rental costs.
(3) Contractual commitments that are routine in nature and form part of the
normal course of operations for Birchcliff are not included in the above
table.
/T/
OUTSTANDING SHARE DATA
The common shares of Birchcliff are the only class of shares outstanding. Birchcliff's common shares began trading on the TSX on July 21, 2005 under the symbol "BIR" and were at the same time de-listed from the TSX Venture Exchange where they were trading under the same symbol prior to such time. Birchcliff's common shares are included in the Standard and Poor's S&P/TSX Composite Index. The following table summarizes the common shares issued in 2010 and 2009:
/T/
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Common Shares
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Balance at December 31, 2008 112,395,970
Issue of common shares 10,000,000
Issue of common shares upon exercise of options 1,419,032
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Balance at December 31, 2009 123,815,002
Issue of common shares upon exercise of options 1,314,232
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Balance at December 31, 2010 125,129,234
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/T/
At March 11, 2011, there were outstanding 125,578,411 common shares, 11,457,009 stock options to purchase an equivalent number of common shares and 2,939,732 performance warrants to purchase an equivalent number of common shares.
RESULTS OF OPERATIONS
Petroleum and Natural Gas Revenues
Petroleum and Natural Gas ("P&NG") revenues totaled $57.1 million ($37.88 per boe) for the three month Reporting Period and $190.0 million ($39.80 per boe) for the twelve month Reporting Period as compared to $41.9 million ($43.32 per boe) and $150.7 million ($36.80 per boe) for the Comparable Prior Periods. The increase in aggregate P&NG revenues was largely a result of increased average daily production during the Reporting Periods. The following table details Birchcliff's P&NG revenues, production and sales prices by category for the Reporting Periods and Comparable Prior Periods:
/T/
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Three months ended Three months ended
December 31, 2010 December 31, 2009
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Total Average Total Average
Revenue Daily Average Revenue Daily Average
($000's) Production % ($/unit) ($000's) Production % ($/unit)
----------------------------------------------------------------------------
Light oil
(bbls) 26,263 3,486 21 81.89 21,015 3,045 29 75.01
Natural
gas (mcf) 26,806 73,978 75 3.94 19,092 43,170 68 4.81
Natural
gas liquids
(bbls) 3,916 559 4 76.14 1,716 274 3 67.94
----------------------------------------------------------------------------
Total P&NG
sales 56,985 16,375 100 37.83 41,823 10,515 100 43.23
Royalty
revenue 87 0.5 85 0.09
----------------------------------------------------------------------------
Total P&NG
revenue 57,072 37.88 41,908 43.32
----------------------------------------------------------------------------
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Twelve months ended Twelve months ended
December 31, 2010 December 31, 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Total Average Total Average
Revenue Daily Average Revenue Daily Average
($000's) Production % ($/unit) ($000's) Production % ($/unit)
----------------------------------------------------------------------------
Light oil
(bbls) 90,125 3,135 24 78.76 68,916 2,934 26 64.35
Natural
gas (mcf) 87,576 56,970 73 4.21 74,754 47,805 71 4.28
Natural
gas liquids
(bbls) 11,919 448 3 72.82 6,369 314 3 55.52
----------------------------------------------------------------------------
Total P&NG
sales 189,620 13,079 100 39.72 150,039 11,216 100 36.65
Royalty
revenue 358 0.08 630 0.15
----------------------------------------------------------------------------
Total P&NG
revenue 189,978 39.80 150,669 36.80
----------------------------------------------------------------------------
----------------------------------------------------------------------------
/T/
Commodity Prices
Birchcliff sells all of its crude oil on a spot basis and virtually all of its natural gas production for prices based on the AECO daily spot price. Birchcliff receives premium pricing for its natural gas due to its high heat content. The following table details the average sales price and differential received by Birchcliff for natural gas during the Reporting Periods and Comparable Prior Periods:
/T/
----------------------------------------------------------------------------
Three Three Twelve Twelve
months months months months
ended ended ended ended
December December December December
31, 31, 31, 31,
2010 2009 2010 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Average natural gas sales price ($/mcf) 3.94 4.81 4.21 4.28
Average AECO daily spot price
($/mmbtu) (1) 3.64 4.49 4.01 3.96
----------------------------------------------------------------------------
Positive differential 0.30 0.32 0.20 0.32
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) $1.00/mmbtu = $1.00/mcf based on a standard heat value mcf.
/T/
The price the Corporation receives for its production depends on a number of factors, including AECO Canadian dollar spot market prices for natural gas, Canadian dollar Edmonton Par oil prices, US dollar oil prices, the US-Canadian dollar exchange rate and transportation and product quality differentials. Birchcliff had no financial derivatives such as commodity price risk management contracts, forward exchange rate contracts and interest rate swaps in place during the Reporting Periods and Comparable Prior Periods, but it actively monitors the market to determine if any are required. The Corporation has no current intention to enter into any such contracts at the date hereof.
Royalties
Birchcliff recorded a royalty expense of $4.4 million ($2.91 per boe) for the three month Reporting Period and $16.9 million ($3.55 per boe) for the twelve month Reporting Period as compared to a royalty expense of $5.2 million ($5.35 per boe) and $15.3 million ($3.75 per boe) for the Comparable Prior Periods. Royalties are paid to the Alberta Government and other land and mineral rights owners. The following table illustrates the Corporation's royalty expense for the Reporting Periods and Comparable Prior Periods:
/T/
----------------------------------------------------------------------------
Three Three Twelve Twelve
months months months months
ended ended ended ended
December December December December
31, 31, 31, 31,
2010 2009 2010 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Oil & natural gas royalties ($000's) 4,388 5,172 16,933 15,342
Oil & natural gas royalties ($/boe) 2.91 5.35 3.55 3.75
Effective royalty rate (%)(1) 8% 12% 9% 10%
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) The effective royalty rate is calculated by dividing the total aggregate
royalties into petroleum and natural gas sales for the period.
/T/
The decrease in the effective royalty rates from the Comparable Prior Periods is largely due to production royalty incentives for a number of new Montney/Doig horizontal natural gas wells and Worsley horizontal oil wells brought on production during the Reporting Periods that are receiving a 5% royalty rate.
New Royalty and Drilling Incentives
On July 9, 2009, the Government of Alberta approved an incentive royalty rate of 5% for the first year of production from each new conventional oil or gas well brought on production after April 1, 2009 and before March 31, 2011, up to a maximum of 50,000 barrels of oil or 500 million cubic feet of natural gas per well.
On September 15, 2009, the Government of Alberta approved a Drilling Royalty Credit ("DRC") incentive for new conventional oil and natural gas wells spud on or after April 1, 2009 and rig released before April 1, 2011. Birchcliff is entitled to a DRC of $200 per meter drilled, up to a maximum of 50% of the aggregate Crown royalties paid by the Corporation during the incentive period. Included as a reduction of net capital in the twelve month Reporting Period is an expected recovery of $9.9 million in DRC related to this incentive program. The recovery of DRC is dependent on future commodity prices and the effect these prices have on the aggregate royalties paid by Birchcliff during the incentive period. Due to the low natural gas price environment, the Corporation may not be able to recover in full all the DRC earned from its capital drilling program during the incentive period.
On March 11, 2010, the Alberta Government announced certain changes to the existing royalty framework based on the recommendations from the Investment Competiveness Review. As a result of the competiveness review, the existing Alberta Royalty Framework ("ARF") will be adjusted to better reflect current industry conditions. The adjusted ARF will be effective for the January 2011 production month. Some of the highlights include:
- The current 5% front-end royalty rate on natural gas and conventional oil will become a permanent feature of the royalty system with the current time and volume limits as described above.
- The $200 per meter drilling royalty credit program will continue to remain in place as legislated until March 31, 2011. Credits not used prior to January 1, 2011 and credits established by drilling on or after that date until March 31, 2011 will be offset from net royalties calculated using adjusted ARF rates.
- The maximum royalty rate for conventional and unconventional natural gas will be reduced from 50% to 36%. For conventional oil, the maximum royalty will be reduced from 50% to 40%.
- The transitional royalty framework for oil and gas introduced in November 2008 will continue until December 31, 2013. Effective January 1, 2011, the government will not allow any new wells to elect the transitional royalty rates, but it will allow an operator of wells for which transitional royalty rates have already been elected an option to switch to the new rates effective January 1, 2011.
On May 27, 2010, the Alberta Government finalized the new royalty curves for oil and natural gas wells. A number of new incentive programs were also introduced for unconventional resource exploration and the use of high-cost technologies. Some of the highlights include:
- Wells defined as a "horizontal gas well" will receive a lower upfront maximum royalty rate of 5% to account for the high cost of horizontal drilling. This horizontal gas new well royalty rate will apply for 18 producing months up to a maximum of 500 million cubic feet of gas equivalent production per well, and is retroactive for wells that were spud on or after May 1, 2010.
- Wells defined as a "horizontal oil well" will receive a lower upfront maximum royalty rate of 5% at the start of production to facilitate the recovery of investment costs prior to imposing a higher royalty rate. This horizontal oil new well royalty rate will apply to all products, with varying volume and production month limits set according to depth of the well, and is retroactive to wells that were spud on or after May 1, 2010.
- The Natural Gas Deep Drilling Program ("NGDDP") will become an ongoing feature of Alberta's royalty regime. Vertical depth requirements under this program were adjusted from 2,500 meters to 2,000 meters and will be applied retroactively for wells that were spud on or after May 1, 2010. Wells that have producing intervals that exceed 2,000 meters of true vertical depth are eligible for a royalty credit adjustment. The royalty credit ranges from $625 per meter to $3,750 per meter drilled and depends on the type of well drilled and the depth ranges specified under the program.
These royalty incentive programs will create a lower cost structure for Birchcliff. Projects will have better economics under the new royalty framework as compared to the prior framework and therefore are more likely to be approved for capital spending during this current low natural gas commodity cycle. Birchcliff intends to focus its capital spending program in large part on its Montney/Doig Natural Gas Resource Play and Worsley Light Oil Resource Play to maximize the return available from these new Alberta incentive programs.
Operating Costs
Operating costs were $10.4 million ($6.92 per boe) for the three month Reporting Period and $36.7 million ($7.70 per boe) for the twelve month Reporting Period as compared to $7.4 million ($7.64 per boe) and $36.4 million ($8.89 per boe) for the Comparable Prior Periods. The following table compares operating costs for the Reporting Periods and Comparable Prior Periods:
/T/
----------------------------------------------------------------------------
Three months ended Three months ended
December 31, 2010 December 31, 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
($000's) $/boe ($000's) $/boe
----------------------------------------------------------------------------
Field operating costs 12,084 8.02 7,866 8.13
Recoveries (2,123) (1.41) (789) (0.81)
----------------------------------------------------------------------------
Field operating costs, net of
recoveries 9,961 6.61 7,077 7.32
Expensed workovers and other 467 0.31 316 0.32
----------------------------------------------------------------------------
Total operating costs 10,428 6.92 7,393 7.64
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Twelve months ended Twelve months ended
December 31, 2010 December 31, 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
($000's) $/boe ($000's) $/boe
----------------------------------------------------------------------------
Field operating costs 41,212 8.63 39,432 9.63
Recoveries (6,105) (1.28) (3,830) (0.93)
----------------------------------------------------------------------------
Field operating costs, net of
recoveries 35,107 7.35 35,602 8.70
Expensed workovers and other 1,638 0.35 786 0.19
----------------------------------------------------------------------------
Total operating costs 36,745 7.70 36,388 8.89
----------------------------------------------------------------------------
----------------------------------------------------------------------------
/T/
Operating costs per boe decreased by 9% and 13% from the three and twelve months ended December 31, 2009 largely due to the operating benefits achieved from Phases I and II of the PCS Gas Plant, which commenced processing natural gas in March and November 2010 respectively, and increased recoveries.
Birchcliff continues to focus on controlling and reducing operating costs on a per boe basis.
Transportation and Marketing Expenses
Transportation and marketing expenses were $3.9 million ($2.56 per boe) for the three month Reporting Period and $12.4 million ($2.59 per boe) for the twelve month Reporting Period as compared to $2.4 million ($2.47 per boe) and $9.8 million ($2.39 per boe) for the Comparable Prior Periods. These costs consist primarily of transportation costs.
General and Administrative Expenses
Net General and Administrative ("G&A") expenses were $4.9 million ($3.25 per boe) for the three month Reporting Period and $10.1 million ($2.12 per boe) for the twelve month Reporting Period as compared to $3.4 million ($3.54 per boe) and $11.4 million ($2.77 per boe) for the Comparable Prior Periods. The components of G&A for the Reporting Periods and Comparable Prior Periods are as follows:
/T/
----------------------------------------------------------------------------
Three months ended Three months ended
December 31, 2010 December 31, 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
($000's) % ($000's) %
----------------------------------------------------------------------------
Salaries, benefits and consultants 6,403 76 4,513 77
Other 1,999 24 1,362 23
----------------------------------------------------------------------------
G & A expense, gross 8,402 100 5,875 100
Overhead recoveries (2,461) (29) (1,701) (29)
Capitalized overhead (1,044) (13) (752) (13)
----------------------------------------------------------------------------
G & A expense, net 4,897 58 3,422 58
----------------------------------------------------------------------------
G & A expense, net per boe $ 3.25 $ 3.54
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Twelve months ended Twelve months ended
December 31, 2010 December 31, 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
($000's) % ($000's) %
----------------------------------------------------------------------------
Salaries, benefits and consultants 14,143 64 11,849 67
Other 7,792 36 5,945 33
----------------------------------------------------------------------------
G & A expense, gross 21,935 100 17,794 100
Overhead recoveries (9,510) (43) (4,540) (26)
Capitalized overhead (2,288) (11) (1,901) (11)
----------------------------------------------------------------------------
G & A expense, net 10,137 46 11,353 63
----------------------------------------------------------------------------
G & A expense, net per boe $ 2.12 $ 2.77
----------------------------------------------------------------------------
----------------------------------------------------------------------------
/T/
Gross G&A expenses increased on an aggregate basis in the Reporting Periods largely as a result of the increased company growth year over year.Net G&A expenses decreased on a per boe basis from 2009 mainly due to additional volumes added from Phases I and II of the PCS Gas Plant and due to the significant increases in overhead recoveries, which are directly attributable to the increased capital spent in 2010. Capital expenditures during the twelve months ended December 31, 2010 increased by 116% from the same period in 2009.
The capitalization of costs in the "overhead recoveries" category reflects an industry standard charge per Authorization For Expenditure to capitalize engineering, land, accounting and operations time related to overhead costs spent on capital projects, whereas the "capitalized overhead" category reflects a portion of costs relating to Birchcliff's exploration and geology department.
Interest Expenses
Interest expense was $3.9 million ($2.60 per boe) for the three month Reporting Period and $13.5 million ($2.82 per boe) for the twelve month Reporting Period as compared to $2.6 million ($2.72 per boe) and $10.3 million ($2.52 per boe) for the Comparable Prior Periods. The aggregate interest expense from the Comparable Prior Periods increased mainly due to higher average balance on the outstanding credit facilities during the Reporting Periods. The Corporation's average outstanding credit facilities balance was approximately $306.9 million in the three month Reporting Period and $249.0 million in the twelve month Reporting Period as compared to $191.9 million and $208.3 million in the Comparable Prior Periods, calculated as the simple average of the month end amounts. Funds drawn from Birchcliff's credit facilities during the Reporting Periods were largely directed towards the PCS Gas Plant, related infrastructure and Montney/Doig horizontal wells.
The aggregate interest expense is impacted by the pricing margins that are used to determine Birchcliff's average effective interest rate under its bank credit facilities. During the twelve month Reporting Period, the Corporation withdrew the full $50 million term credit facility which had higher pricing margins than the revolving credit facilities and was outstanding for most of the first quarter of 2010. No amounts were drawn or outstanding on the term credit facility during 2009. In May 2010, Birchcliff repaid and cancelled the term credit facility. New lower pricing margins became applicable when the Corporation increased its revolving credit facilities limit to $350 million in May 2010.
The effective rate applicable to the Working Capital Facility was 5.8% at the end of the Reporting Period as compared to 4.8% at the end of the Comparable Prior Period. The overall effective interest rates applicable to the bankers' acceptances issued under the Syndicated Credit Facility was 5.4% and 5.9% in the three and twelve month Reporting Periods as compared to 5.7% and 5.7% in the Comparable Prior Periods. The effective interest rate applicable to the bankers' acceptances issued under the term credit facility was 5.9% in the twelve month Reporting Period.
Depletion, Depreciation and Accretion Expenses
Depletion, Depreciation and Accretion ("DD&A") expenses were $22.4 million ($14.84 per boe) for the three month Reporting Period and $76.5 million ($16.02 per boe) for the twelve month Reporting Period as compared to $15.9 million ($16.40 per boe) and $85.3 million ($20.83 per boe) for the Comparable Prior Periods. DD&A expenses increased on an aggregate basis quarter over quarter mainly due to increased average daily production in the fourth quarter of 2010, notwithstanding increased proved reserve additions in the current quarter. DD&A expenses decreased on a per boe basis from the Comparable Prior Periods mainly due to the reduced cost of adding significant proved reserves recorded during the fourth quarter of 2010. The components of DD&A for the Reporting Periods and Comparable Prior Periods are as follows:
/T/
----------------------------------------------------------------------------
Three months ended Three months ended
December 31, 2010 December 31, 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
($000's) $/boe ($000's) $/boe
----------------------------------------------------------------------------
Depletion & depreciation 21,865 14.51 15,289 15.80
Accretion on asset retirement
obligations 495 0.33 584 0.60
----------------------------------------------------------------------------
Total DD&A 22,360 14.84 15,873 16.40
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Twelve months ended Twelve months ended
December 31, 2010 December 31, 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
($000's) $/boe ($000's) $/boe
----------------------------------------------------------------------------
Depletion & depreciation 74,636 15.64 83,495 20.40
Accretion on asset retirement
obligations 1,833 0.38 1,758 0.43
----------------------------------------------------------------------------
Total DD&A 76,469 16.02 85,253 20.83
----------------------------------------------------------------------------
----------------------------------------------------------------------------
/T/
DD&A is a function of the estimated proved reserve additions, the associated future development capital required to recover those proved reserves, the cost of petroleum and natural gas properties in the full cost pool attributable to those proved reserves and production in the period. At December 31, 2010, the Corporation excluded $60.5 million (2009 - $44.9 million) from its full cost pool for undeveloped land acquired by Birchcliff.
Petroleum and Natural Gas Properties Impairment Test
The Corporation follows the full cost method of accounting, which requires periodic review of capitalized costs to ensure that they do not exceed the recoverable value of the petroleum and natural gas properties and the fair value of the Corporation's assets.
Birchcliff performed an impairment test on its petroleum and natural gas assets at December 31, 2010 and determined its petroleum and natural gas assets were not impaired at that time.
Stock-Based Compensation Expenses
Birchcliff accounts for its stock-based compensation awards, namely stock options and performance warrants, using the fair value method. The related expense is recorded in the income statement over the vesting period.
The Corporation recorded a total stock-based compensation expense of $2.5 million ($1.67 per boe) for the three month Reporting Period and $10.6 million ($2.22 per boe) for the twelve month Reporting Period as compared to $1.8 million ($1.84 per boe) and $9.8 million ($2.40 per boe) for the Comparable Prior Periods. Included in total stock-based compensation expense in the twelve month Comparable Prior Period was $3.1 million relating to the extension of the performance warrants on May 28, 2009 as discussed below. Excluding the impact of the extension of the performance warrants, the stock-based compensation expense related to stock options was $1.8 million and $6.7 million in the three and twelve month Comparable Prior Periods.
The increase in stock option expense from the Comparable Prior Periods was largely due to the issuance of 2,311,300 options to directors, officers, and employees of Birchcliff at an exercise price of $9.72 per common share in January 2010 as a result of Birchcliff's annual compensation review.
A summary of the Corporation's outstanding stock options at December 31, 2010 is presented below:
/T/
----------------------------------------------------------------------------
Weighted Average
Number Exercise Price ($)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Outstanding, December 31, 2008 6,324,221 5.58
Granted 3,959,900 5.53
Exercised (1,419,032) (3.74)
Forfeited (1,154,836) (6.18)
----------------------------------------------------------------------------
Outstanding, December 31, 2009 7,710,253 5.81
Granted 3,350,300 9.61
Exercised (1,314,232) (4.63)
Forfeited (498,801) (7.41)
----------------------------------------------------------------------------
Outstanding, December 31, 2010 9,247,520 7.26
----------------------------------------------------------------------------
----------------------------------------------------------------------------
/T/
On January 14, 2005, the Corporation issued 4,049,665 performance warrants with an exercise price of $3.00 and an expiration date of January 31, 2010 to members of its executive team. On May 28, 2009, the outstanding performance warrants were amended following receipt of shareholder approval to extend the expiration date from January 31, 2010 to January 31, 2015. There remained 2,939,732 outstanding and exercisable performance warrants at December 31, 2010. Each stock option and performance warrant entitles the holder to purchase one common share at the exercise price.
Deferred Financing Fees
In May 2009, the Corporation paid $625,000 in financing fees to establish the one year non-revolving $50 million term credit facility, and $1.35 million to increase the aggregate limit of the revolving credit facilities to $255 million and extend the conversion date of the revolving facilities from May 22, 2009 to May 21, 2010. In January 2010, the Corporation paid an additional $250,000 in financing fees to extend the maturity date of the term credit facility from May 21, 2010 to May 21, 2011.In May 2010, the Corporation paid approximately $1.0 million in financing fees to increase the aggregate limit of the revolving credit facilities to $350 million and extend the conversion date of those facilities from May 21, 2010 to May 20, 2011. In November 2010, the Corporation paid an additional $75,000 in fees to increase the aggregate limit of the revolving facilities to $375 million.
The Corporation amortized to income approximately $0.3 million ($0.17 per boe) in deferred financing fees during the three month Reporting Period and $1.6 million ($0.34 per boe) for the twelve month Reporting Period as compared to $0.5 million ($0.51 per boe) and $1.2 million ($0.29 per boe) for the Comparable Prior Periods.
Income Taxes
Birchcliff recorded a future income tax expense of approximately $1.9 million ($1.23 per boe) for the three month Reporting Period and $5.8 million ($1.20per boe) for the twelve month Reporting Period as compared to a future income tax expense of $1.1 million ($1.18 per boe) and a recovery of $4.6 million ($1.12 per boe) for the Comparable Prior Periods. A future income tax expense was recorded in the Reporting Periods largely due to higher reported net income in those periods.
/T/
CAPITAL EXPENDITURES AND CAPITAL RESOURCES
Capital Expenditures
The following table sets forth a summary of the Corporation's capital
expenditures incurred for the Reporting Periods and Comparable Prior
Periods:
----------------------------------------------------------------------------
Three months ended December 31, ($000's) 2010 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Land 1,312 2,768
Seismic 1,384 796
Workovers and other 2,273 2,732
Drilling and completions 25,087 16,043
Well equipment and facilities 15,547 20,902
Capitalized general and administrative expenses 1,045 752
----------------------------------------------------------------------------
Total finding and development costs (F&D) 46,648 43,993
Acquisitions and Dispositions - 285
----------------------------------------------------------------------------
Total finding, development and acquisition costs
(FD&A) 46,648 44,278
Administrative assets 808 90
----------------------------------------------------------------------------
Total capital expenditures 47,456 44,368
----------------------------------------------------------------------------
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Twelve months ended December 31, ($000's) 2010 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Land 19,050 4,452
Seismic 2,755 1,551
Workovers and other 9,749 6,333
Drilling and completions(1) 127,814 37,985
Well equipment and facilities 72,300 45,498
Capitalized general and administrative expenses 2,289 1,902
----------------------------------------------------------------------------
Total finding and development costs (F&D) 233,957 97,721
Acquisitions and Dispositions(2) (15,460) 3,334
----------------------------------------------------------------------------
Total finding, development and acquisition costs
(FD&A) 218,497 101,055
Administrative assets 1,537 635
----------------------------------------------------------------------------
Total capital expenditures 220,034 101,690
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Included in drilling and completions for the twelve months ended
December 31, 2010 is an expected recovery of $9.9 million (2009 - $6.3
million) related to the Alberta Drilling Royalty Credit Program.
(2) On March 3, 2010, the Corporation sold a minor non-producing asset in
the Kakut area of Alberta for $17.5 million.
Capital Resources
The following table sets forth a summary of the Corporation's capital
resources for the Reporting Periods and Comparable Prior Periods:
----------------------------------------------------------------------------
Three months ended December 31, ($000's) 2010 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Cash generated by operations 29,592 20,900
Changes in non-cash working capital from operations 5,345 (7,780)
Asset retirement expenditures (571) (297)
Equity issues 1,186 1,929
Increase in revolving credit facilities 52,042 18,303
Changes in non-cash working capital from investing (35,415) 11,313
----------------------------------------------------------------------------
Total capital resources 52,179 44,368
----------------------------------------------------------------------------
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Twelve months ended December 31, ($000's) 2010 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Cash generated by operations 100,351 67,476
Changes in non-cash working capital from operations 1,429 (10,051)
Asset retirement expenditures (902) (606)
Equity issues, net of issue costs 6,083 64,605
Increase (decrease) in revolving credit facilities 132,105 (9,826)
Deferred financing fees paid (1,268) (1,975)
Changes in non-cash working capital from investing (13,041) (7,858)
----------------------------------------------------------------------------
Total capital resources 224,757 101,765
----------------------------------------------------------------------------
----------------------------------------------------------------------------
SUMMARY OF QUARTERLY RESULTS
The following are the quarterly results of the Corporation for the eight
most recently completed quarters:
----------------------------------------------------------------------------
Quarters Ended
($000's, except for
production, share
and per share December 31, September 30, June 30, March 31,
amounts) 2010 2010 2010 2010
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Petroleum and natural
gas production
(boe per day) 16,375 13,109 12,357 10,407
Petroleum and natural
gas commodity price at
wellhead ($ per boe) 37.83 36.60 39.45 47.12
Natural gas commodity
price at wellhead ($ per
mcf) 3.94 3.79 4.16 5.34
Petroleum commodity
price at wellhead ($
per bbl) 81.89 76.44 76.24 80.03
Total petroleum and
natural gas revenue 57,072 44,125 44,546 44,235
Total royalties (4,388) (3,561) (3,621) (5,363)
Total revenues, net 52,684 40,564 40,925 38,872
Total capital expenditures,
net 47,456 93,792 43,083 35,703
Net income (loss) 2,612 422 215 2,653
Per share basic $ 0.02 - - $ 0.02
Per share diluted $ 0.02 - - $ 0.02
Cash generated by
operations 29,592 24,022 23,825 22,912
Per share basic $ 0.24 $ 0.19 $ 0.19 $ 0.18
Per share diluted $ 0.23 $ 0.19 $ 0.19 $ 0.18
Book value of total
assets 995,391 961,592 883,279 860,180
Non-revolving term credit
facility - - - 49,661
Revolving credit
facilities 333,468 281,172 235,993 158,614
Total debt 337,424 319,921 250,370 232,287
Shareholders' equity 577,123 570,813 566,943 562,019
Common shares
outstanding -
end of period
basic 125,129,234 124,912,134 124,792,136 124,358,735
diluted 137,316,486 137,364,386 137,255,386 137,190,886
Weighted average common
shares outstanding
basic 124,994,761 124,872,806 124,548,932 124,095,074
diluted 129,264,791 127,253,296 126,816,143 127,094,837
----------------------------------------------------------------------------
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Quarters Ended
($000's, except for
production, share
and per share December 31, September 30, June 30, March 31,
amounts) 2009 2009 2009 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Petroleum and natural gas
production (boe per day) 10,515 10,552 11,313 12,513
Petroleum and natural gas
commodity price at wellhead
($ per boe) 43.23 33.32 33.79 36.48
Natural gas commodity
price at wellhead ($ per
mcf) 4.81 3.20 3.75 5.27
Petroleum commodity
price at wellhead ($ per
bbl) 75.01 70.00 63.84 49.33
Total petroleum and
natural gas revenue 41,908 32,446 34,917 41,398
Total royalties (5,172) (3,644) 2,118 (8,644)
Total revenues, net 36,736 28,802 37,035 32,754
Total capital expenditures,
net 44,368 33,442 5,485 18,395
Net income (loss) 1,616 (9,039) (7,128) (9,701)
Per share basic $ 0.01 ($0.07) ($0.06) ($0.09)
Per share diluted $ 0.01 ($0.07) ($0.06) ($0.09)
Cash generated by
operations 20,900 12,196 20,026 14,354
Per share basic $ 0.17 $ 0.10 $ 0.18 $ 0.13
Per share diluted $ 0.17 $ 0.10 $ 0.18 $ 0.13
Book value of total
assets 837,108 796,338 819,142 800,959
Revolving credit
facilities 201,230 182,589 219,361 228,867
Total debt 221,521 199,346 179,649 253,544
Shareholders' equity 554,561 549,239 535,917 496,276
Common shares outstanding -
end of period
basic 123,815,002 123,267,436 122,807,637 112,542,635
diluted 134,464,987 134,049,987 134,732,322 124,618,156
Weighted average common
shares outstanding
basic 123,538,213 122,914,069 112,887,812 112,457,321
diluted 126,358,921 122,914,069 112,887,812 112,457,321
----------------------------------------------------------------------------
----------------------------------------------------------------------------
/T/
Discussion of Quarterly Results
Birchcliff's average production in the fourth quarter of 2010 was 16,375 boe per day, a 25% increase from 13,109 boe per day in the third quarter of 2010 and a 56% increase from 10,515 boe per day in the fourth quarter of 2009. These production gains were achieved through the success of Birchcliff's capital drilling program in 2010 and processing of natural gas through Phases I and II of the PCS Gas Plant, which commenced operations in March and November 2010, respectively.
Total capital expenditures in the fourth quarter of 2010 were $47.5 million as compared to $93.8 million in the third quarter of 2010 and $44.4 million in the fourth quarter of 2009. Of the $47.5 million in capital expended in the current quarter, approximately $5.6 million (12%) was spent on the expansion of Phase II of the PCS Gas Plant and related infrastructure, and approximately $12.2 million (26%) on the drilling and completion of new Montney/Doig horizontal natural gas wells to be tied into the PCS Gas Plant. The remaining $29.7 million in capital was spent on acquiring land; expanding the existing Montney/Doig Natural Gas Resource Play and Worsley Light Oil Resource Play and related infrastructure; and other projects. Further details of the Corporation's capital expenditures for the fourth quarter of 2010 are set forth in the table entitled "Capital Expenditures".
Cash flow generated by the Corporation in the fourth quarter of 2010 was $29.6 million as compared to $24.0million in the third quarter of 2010 and $20.9 million in the fourth quarter of 2009. Cash flow was higher than the previous quarter mainly due to increased average daily production; slightly higher average petroleum and natural gas prices realized at the wellhead offset by increased net G&A expenses and higher interest expense. The increase in cash flow as compared to the fourth quarter of 2009 was mainly attributed to higher average daily production notwithstanding higher interest expenses and net G&A expenses and lower petroleum and natural gas prices realized at the wellhead in the current quarter as compared to the fourth quarter of 2009.
Canadian Edmonton Par oil prices averaged $80.33per barrel in the fourth quarter of 2010 as compared to $74.43 per barrel in the third quarter of 2010 and $76.56 per barrel in the fourth quarter of 2009. The AECO daily natural gas spot prices averaged $3.64 per mcf in the fourth quarter of 2010 as compared to $3.54 per mcf in the third quarter of 2010 and $4.49 per mcf in the fourth quarter of 2009.
Despite weak natural gas prices, Birchcliff has reported net income in each of its five recently completed quarters. Birchcliff recorded net income of $2.6 million in the fourth quarter of 2010 as compared to net income of $0.4 million in the third quarter of 2010 and $1.6 million in the fourth quarter of 2009. The increase in net income from the comparative quarters was mainly a result of higher cash flow, notwithstanding higher DD&A expenses reported during the fourth quarter of 2010.
Total debt (including working capital deficit) increased to $337.4 million at December 31, 2010 from $319.9 million at September 30, 2010 and $221.5 million at December 31, 2009. The increase in total debt was largely due to $17.9 million and $119.7 million in net capital expended during the three and twelve months ended December 31, 2010 in excess of cash flow during those same periods. Birchcliff's 2010 cash flow and bank credit facilities were used to fund the PCS Gas Plant project.
MERGERS & ACQUISITIONS
Within its focus area, the Corporation is always reviewing potential property acquisitions and corporate mergers and acquisitions for the purposes of determining whether any such potential transaction is of interest to the Corporation and the terms on which such a potential transaction would be available. As a result, the Corporation may from time to time be involved in discussions or negotiations with other parties or their agents in respect of potential property acquisitions and corporate merger and acquisition opportunities, but the Corporation is not committed to any such potential transaction and cannot be reasonably confident that it can complete any such potential transaction until appropriate legal documentation has been signed by relevant parties.
CONTROLS AND PROCEDURES
Disclosure Controls
The Corporation has established and maintains disclosure controls and procedures that have been designed by, or under the supervision of, the Corporation's Chief Executive Officer and the Chief Financial Officer ("Certifying Officers") to provide reasonable assurance that information required to be disclosed by the Corporation in its annual filings, interim filings or other reports filed or submitted by it under securities legislation is recorded, processed, summarized and reported within the time periods specified in the securities legislation and to ensure that information required to be disclosed by an issuer in its annual filings, interim filings or other reports filed or submitted under securities legislation is accumulated and communicated to the Corporation's management, including its Certifying Officers, as appropriate to allow timely decisions regarding required disclosure. Such disclosure controls and procedures are referred to as the "Disclosure Controls and Procedures".
The Certifying Officers have evaluated, or caused to be evaluated under their supervision, the effectiveness of the Corporation's Disclosure Controls and Procedures as at December 31, 2010 and have concluded that such Disclosure Controls and Procedures were effective as at that date to provide reasonable assurance that information required to be disclosed by the Corporation in its annual filings, interim filings or other reports filed or submitted by it under securities legislation is recorded, processed, summarized, and reported within the time periods specified in the securities legislation and that information required to be disclosed by the Corporation in its annual filings, interim filings or other reports filed or submitted under securities legislation is accumulated and communicated to the Corporation's management, including the Certifying Officers, as appropriate to allow timely decisions regarding required disclosure.
While the Certifying Officers believe that the Corporation's Disclosure Controls and Procedures are effective to provide a reasonable level of assurance, they do not expect that the Disclosure Controls and Procedures will provide an absolute level of assurance or prevent all errors and fraud. A control system, no matter how well conceived, maintained and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are achieved.
Internal Controls over Financial Reporting
The Corporation has established and maintains internal controls over financial reporting that have been designed by, or under the supervision of, the Corporation's Certifying Officers to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP applicable to the Corporation and reasonable assurance that all assets are safeguarded and transactions are appropriately authorized and recorded to facilitate the preparation of relevant, reliable and timely information. Such internal controls over financial reporting are herein referred to as "ICFR". The Certifying Officers have evaluated, or caused to be evaluated under their supervision, the effectiveness of the Corporation's ICFR as required by National Instrument 52-109, Certification of Disclosure in Issuers' Annual and Interim Filings. Based on that evaluation, the Certifying Officers concluded that the Corporation's ICFR was effective at December 31, 2010 for the purposes described above. It should be noted that a control system, including the Corporation's, no matter how well conceived, maintained and operated, 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 ICFR will prevent all errors and fraud.
NEW ACCOUNTING PRONOUNCEMENTS
Transition to International Financial Reporting Standards
Effective January 1, 2011, Canadian public companies are required to adopt International Financial Reporting Standards ("IFRS"). The Corporation has developed a plan to complete the transition to IFRS by January 1, 2011, including the preparation of 2010 required comparative information. Birchcliff's transition plan includes training and development throughout the organization, and three key phases:
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- Phase 1 - Scoping and diagnostics
Phase 1 involves performing a high level diagnostic analysis to identify
areas that may be affected by the transition to IFRS. The results of this
analysis are priority ranked according to complexity and the amount of
time required to assess the impact of changes in transitioning to IFRS.
- Phase 2 - Impact analysis and evaluation
During Phase 2, items identified in Phase 1 are addressed according to
the priority levels assigned to them. This phase involves analysis of
policy choices allowed under IFRS and their impact on the financial
statements. In addition, certain potential differences are further
investigated to assess whether there may be a broader impact to
Birchcliff's debt agreements, business processes or management reporting
systems. The conclusion of the impact analysis and evaluation phase
requires the Audit Committee of the Board of Directors to review and
approve all accounting policy choices as proposed by management.
- Phase 3 - Implementation
Phase 3 involves implementation of all changes approved in Phase 2 and
will include changes to information systems, business processes,
modification of agreements and training of all staff who are impacted by
the conversion.
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In 2009, Birchcliff made significant progress on its transition plan, completing Phase 1 and moving into Phase 2, and conducting preliminary impact analysis of accounting policy alternatives. In 2010, Birchcliff focused its efforts primarily on Phases 2 and 3 of the transition plan. Management has essentially finalized its IFRS accounting policies for significant impact areas (excluding income tax) and has quantified the expected financial impact of these policies on the IFRS opening balance sheet at January 1, 2010 ("Transition Date"). Birchcliff has also implemented necessary changes to its business processes and information systems for significant areas of impact, with internal control requirements taken into account.
IFRS Accounting Policies
Birchcliff has evaluated all significant accounting policy differences between IFRS and Canadian GAAP. Each of these differences and the expected financial impact on the IFRS opening balance sheet is discussed in more detail below. All chosen IFRS accounting policies have been reviewed and approved by the Audit Committee of the Board of Directors in the fourth quarter of 2010. Birchcliff's analysis of the chosen IFRS accounting policies specifically considers the current IFRSs that are in effect. As a result, any new or amended accounting standards that are issued by the International Accounting Standards Board ("IASB") in future periods may impact our current assessment of the chosen IFRS accounting policies and the expected financial impact on transition to IFRS.
Property, Plant & Equipment
Property, Plant and Equipment ("PP&E") is the most significant area impacted by the adoption of IFRS. Birchcliff currently follows the Canadian GAAP guidelines on full cost accounting for oil and gas companies. IFRS has no equivalent guideline. In order to facilitate the transition to IFRS by full cost oil and gas companies, the IASB issued amendments to IFRS 1First-time adoption of IFRS allowing additional exemptions for first-time adopters of IFRS. Under these amendments, full cost oil and gas companies can elect to use the recorded amount under Canadian GAAP as the "deemed cost" for oil and gas assets on the transition date to IFRS. Companies that elect to use this IFRS 1 exemption on transition will need to decide whether to allocate based on reserve volumes or values using either proved or proved plus probable reserves. Without this exemption, the Corporation would have been required to retrospectively determine the carrying amount of oil and gas assets at the date of transition, or use the fair value or revaluation amount as the new deemed cost under IFRS. Birchcliff will use this exemption on transition to IFRS and allocate the existing net book value of its oil and gas full cost pool at the area level using proved plus probable reserve volumes. By using the exemption, the net book value of Birchcliff's PP&E at the date of transition to IFRS will be the same as it was under Canadian GAAP.
In moving to IFRS, Birchcliff will be required to adopt different accounting policies for pre-exploration activities, Exploration and Evaluation ("E&E"), DD&A, and accounting for gains and losses on property dispositions, significant components of PP&E and other material non-monetary transactions.
Pre-exploration costs are costs incurred before the Corporation obtains the legal right to explore an area. Under Canadian GAAP, these costs are capitalized, while under IFRS, these costs must be expensed. At this time, Birchcliff does not anticipate that this accounting policy difference will have a significant impact on the Corporation's IFRS financial statements.
During the E&E phase, Birchcliff capitalizes costs incurred for these projects under Canadian GAAP. Under IFRS, the Corporation has the choice to either continue capitalizing E&E costs until technical feasibility and commercial viability of the project is determined or to expense these costs as incurred. Once technical feasibility and commercial viability of an E&E project is determined, the related costs (net of any impairment) are transferred to the Developing and Producing ("D&P") category. If Birchcliff's policy choice is to continue capitalizing E&E project costs under IFRS, the Corporation has the alternative to either begin depleting the related costs when in the E&E phase or to deplete the costs once the project has demonstrated technical feasibility and commercial viability and is in the D&P phase. Birchcliff has estimated its E&E assets at the date of transition to be immaterial. Birchcliff will capitalize E&E project costs as incurred and begin depleting the related costs once technical feasibility and commercial viability of an E&E project is established and related costs are transferred to the D&P category. Technical feasibility and commercial viability of an E&E project is established when proved reserves are identified.
Under Canadian GAAP, Birchcliff calculates its DD&A rate at the country cost centre level. Under IFRS, this rate will be calculated at a lower unit of account. Under IFRS, the Corporation has the alternative to either continue depleting its assets over proved reserves (same as Canadian GAAP) or use another basis which more accurately reflects the useful life of Birchcliff's oil and gas assets. Birchcliff will calculate its DD&A rate at the area level and deplete its oil and gas assets over proved plus probable reserves on transition to IFRS.
Full cost oil and gas accounting under Canadian GAAP requires that gains or losses on divestitures of properties are only recognized when the disposal would affect the DD&A rate by 20% or more. Under IFRS, there is no such exemption, and therefore Birchcliff will be required to recognize all gains and losses on property divestitures and from disposal of significant components of PP&E. There is no impact of adopting this IFRS accounting policy at January 1, 2010.
As a result of the additional IFRS 1 exemptions released by the IASB in July 2009, the Corporation anticipates that all changes to its PP&E accounting policies will be adopted prospectively at date of transition.
Impairment Testing
Under Canadian GAAP, the recoverable amount of Birchcliff's oil and gas assets under the first step of the impairment test is determined using undiscounted future cash flow from proved reserves. Under IFRS, the recoverable amount is calculated using discounted future cash flow from proved or proved plus probable reserves. In addition, impairment testing under Canadian GAAP is performed at the country cost centre level, while under IFRS it will be performed at a lower level referred to as a cash-generating unit. Canadian GAAP prohibits reversal of impairment losses. Under IFRS, if the conditions giving rise to impairment have reversed, impairment losses previously recorded would be partially or fully reversed to eliminate write-downs recorded. Birchcliff expects to adopt these changes in accounting policy prospectively.
Birchcliff has identified a single cash-generating unit at the date of transition. Birchcliff did not have an impairment of its petroleum and natural gas assets under IFRS at January 1, 2010. The impairment calculation was performed using an after-tax discount rate of 12% on cash flow from proved plus probable reserves. Birchcliff also expects that its petroleum and natural gas assets will not be impaired at December 31, 2010 under IFRS.
Asset retirement obligation
Under Canadian GAAP, the Corporation recognizes a liability for the estimated fair value of future asset retirement obligations associated with PP&E. The fair value is capitalized and amortized over the same period as the underlying asset. Birchcliff estimates the liability based on the estimated costs to abandon and reclaim its net ownership interest in wells and facilities, including an estimate for the timing of the costs to be incurred in future periods. These cash outflows are discounted using a credit-adjusted risk free rate of 8% under Canadian GAAP. Changes in the net present value of the future retirement obligation are expensed through accretion as part of DD&A (same as IFRS).
Under IFRS, asset retirement obligations are calculated at each reporting period by estimating the risk-adjusted future cash outflows which are discounted using a risk-free rate. Due to the change in the discount rate from a credit-adjusted rate to a risk-free rate, Birchcliff will record a $12.0 million increase in discounted future asset retirement obligation with the offset to retained earnings on transition at January 1, 2010. Birchcliff's risk-adjusted future cash outflows were discounted using a risk-free rate of 4% on transition to IFRS.
Stock-based Compensation
IFRS 2 Share-Based Payments requires the expense related to share-based payments to be recognized as the options vest. For options with different vesting periods, each vesting tranche must be treated as a separate option grant which accelerates the expense recognition ("Graded Vesting Amortization") in comparison to Canadian GAAP, which allows the expense to be recognized on a straight-line basis over the period the options vest. Birchcliff must also apply an estimated forfeiture rate at the initial grant date for each option tranche. The forfeiture rate is taken into account by adjusting the number of stock options expected to vest under each tranche and subsequently revising this estimate throughout the vesting period, as necessary. When determining the fair value of each vesting tranche, Birchcliff will apply an estimated option tranche life which reflects historical experiences in comparison to GAAP, which allows the life of the option to equal the five year expiry period. Birchcliff expects total aggregate stock-based compensation expense to be lower under IFRS as compared to Canadian GAAP as a result of using a lower estimated option life when calculating the fair value of an option tranche under IFRS. However, because of the graded vesting requirements, stock based compensation expense will be higher in earlier vesting periods for an option tranche under IFRS as compared to GAAP.
As a result of adopting IFRS 2, Birchcliff will record a $2.5 million increase to contributed surplus with the offset to retained earnings at January 1, 2010. The increase is largely due to the accelerated expense recognition for vesting tranches under IFRS.
Income Tax
In transitioning to IFRS, the carrying amount of Birchcliff's deferred tax balances will be directly impacted by the tax effects resulting from changes required by the above IFRS accounting policy differences. Birchcliff is still determining the impact of the revised standard on its IFRS transition. Therefore, at this time the income tax impacts of the differences are not reasonably determinable.
Changes to IFRS Accounting Standards
Birchcliff's analysis of accounting policy differences specifically considers the current IFRS standards that are in effect. The Corporation will continue to monitor any new or amended accounting standards that are issued by the IASB in future periods.
Internal Controls over Financial Reporting
The transition to IFRS is not expected to have a significant impact on its internal controls over financial reporting. Birchcliff has reviewed its internal controls over financial reporting and has implemented all significant changes in accounting policies, including the appropriate additional business controls and procedures for future IFRS reporting requirements.
Disclosure Controls and Procedures
The transition to IFRS is not expected to have a significant impact on its disclosure controls and procedures. Birchcliff will continue to assess stakeholders' information requirements and will ensure that adequate and timely information is provided so that all stakeholders remain apprised throughout the transition.
Education and Training
All of the key individuals that are involved in financial reporting under Canadian GAAP have received IFRS training and are actively involved in the IFRS transition project. Birchcliff will continue to involve senior financial reporting personnel in the IFRS transition throughout 2011. External advisors have been retained and will continue to assist management with the IFRS project on an as needed basis. The Corporation's auditors are involved throughout the process to ensure that Birchcliff's accounting policies are in accordance with the new standards.
Information Systems
Birchcliff has evaluated and implemented necessary changes to its information systems for significant areas of impact. While Birchcliff's system updates were minimal, they were critical to allow for reporting of both Canadian GAAP and IFRS statements in 2010 as well as the updates required to track capital expenditures at a granular level for IFRS reporting in 2011 and thereafter.
Impacts to our Business
Birchcliff does not expect that the adoption of IFRS in 2011 will have a significant impact or influence on its business activities, operations or strategies going forward. Management will continue to closely monitor the impact of IFRS on its business activities during 2011.
RISK FACTORS & RISK MANAGEMENT
Commodity Price Risk
Birchcliff's liquidity and cash flow are largely impacted by petroleum and natural gas commodity prices. Birchcliff has not hedged any of its oil and natural gas production at the date hereof and although it does monitor the hedge market, its strategy is to continue to sell its oil and natural gas production at the spot market rate. Management remains bullish about future commodity prices and believes Birchcliff is well positioned to take advantage of a rising oil and natural gas price environment. If there is a significant deterioration in the price it receives for oil and natural gas, Birchcliff will consider reducing its capital spending or access alternate sources of capital.
Foreign Currency Exchange Risk
The Corporation is exposed to foreign currency fluctuations because its Canadian revenues are strongly linked to United States dollar denominated benchmark prices. Birchcliff has not hedged any of its foreign exchange risk at the date hereof.
Production Risk
Birchcliff believes it has a stable production base from a large number of producing wells and that an adverse event affecting production at any single well would not cause a liquidity issue. Nonetheless, Birchcliff remains subject to the risk that production rates of its most significant wells may decrease in an unpredictable and uncontrollable manner, which could result in a material decrease in the Corporation's overall production and associated cash flows.
The majority of Birchcliff's production passes through owned or third party infrastructure prior to it being ready for transfer at designated commodity sales points. There is a risk that should this infrastructure fail and cause a significant portion of Birchcliff's production to be shut-in and unable to be sold, this could have a material adverse effect on Birchcliff's available cash flow. The Corporation mitigates this risk by purchasing business interruption and property insurance policies for its significant owned infrastructure and contingent business interruption insurance policies for its significant third party infrastructure.
Reserve Replacement Risk
Oil and natural gas reserves naturally deplete as they are produced over time. The success of the Corporation's business is highly dependent on its ability to acquire and/or discover new reserves in a cost efficient manner. Substantially all of the Corporation's cash flow is derived from the sale of the petroleum and natural gas reserves it accumulates and develops. In order to remain financially viable, the Corporation must be able to replace reserves over time at a lesser cost on a per unit basis than its cash flow on a per unit basis. The reserves and costs used in this determination are estimated each year based on numerous assumptions and these estimates and costs may vary materially from the actual reserves produced or from the costs required to produce those reserves. In order to mitigate this risk, the Corporation employs a competent and experienced team of petroleum and natural gas professionals and closely monitors the capital expenditures made for the purposes of increasing its petroleum and natural gas reserves. Historically, Birchcliff's finding, development and acquisition costs and reserve replacement on a proved and probable basis have remained competitive compared to industry peers.
Health, Safety & Environmental Risk
Health, safety and environment risks influence the workforce, operating costs and the establishment of regulatory standards. Birchcliff provides staff with the training and resources they need to complete work safely and effectively; incorporates hazard assessment and risk management as an integral part of everyday operations; monitors performance to ensure its operations comply with legal obligations and internal standards; and identifies and manages environmental liabilities associated with its existing asset base. The Corporation has a site inspection program and a corrosion risk management program designed to ensure compliance with environmental laws and regulations. Birchcliff carries insurance to cover a portion of property losses, liability to others and business interruption resulting from unusual events.
Birchcliff is subject to the risk that the unexpected failure of its equipment used in drilling, completing or producing wells or in transporting production could result in release of fluid substances that pollute or contaminate lands at or near its facilities which could result in significant liability to the Corporation for costs of clean up, remediation and reclamation of contaminated lands. Birchcliff conducts its operations with due regard for the potential impact on the environment. This includes hiring skilled personnel, providing adequate training to all staff involved with operations, and by retaining expert advice and assistance to deal with environmental remediation and reclamation work where such expertise is needed.
Regulatory Risk
Government royalties, income tax laws, environmental laws and regulatory requirements can have a significant financial and operational impact on the Corporation. As an oil and natural gas producer, Birchcliff is subject to a broad range of regulatory requirements. Birchcliff hires and retains skilled personnel that are knowledgeable regarding changes to the regulatory regime under which it operates.
All of Birchcliff's properties are currently located within the province of Alberta. There is a risk that although the Corporation believes it is making an economic investment at the time all of the upfront capital is invested in facilities or drilling, completing and equipping an oil or natural gas well, the Government may at any point in the economic life of that project, expropriate without compensation a portion of the expected profit under a new royalty/tax regulation or regime with no grandfathering provisions. This may cause a particular project to become uneconomic once the new royalties or taxes take effect. This type of possible future government action is unpredictable and cannot be forecast by the Corporation.
Counterparty Risk
Birchcliff assumes customer credit risk associated with oil and gas sales and joint venture participants. To mitigate this risk, the Corporation performs regular reviews of receivables to minimize default or non-payment and takes the majority of its production in kind. The Corporation also puts in place security arrangements with respect to amounts owed to it by others when reviews indicate it is appropriate to do so.
Access to Credit Markets
Due to the nature of the Corporation's business it is necessary from time to time for the Corporation to access other sources of capital beyond its internally generated cash flow in order to fund the development and acquisition of its long term asset base. As part of this strategy the Corporation obtains some of this necessary capital by incurring debt and therefore the Corporation is dependent to a certain extent on continued availability of the credit markets.
The continued availability of the credit markets for Birchcliff is primarily dependent on the state of the economy and the health of the banking industry in Canada and the United States. There is risk that if the economy and banking industry experience unexpected and/or prolonged deterioration, then Birchcliff's access to credit markets may contract or disappear altogether. The Corporation tries to mitigate this risk by dealing with reputable lenders and tries to structure its lending agreements to give it the most flexibility possible should these situations arise. However, the situations that may give rise to credit markets tightening or disappearing are beyond Birchcliff's control.
Birchcliff is also dependent to a certain extent on continued access to equity capital markets. The Corporation is listed on the Toronto Stock Exchange and maintains an active investor relations program. Continued access to capital is dependent on Birchcliff's ability to continue to perform at a level that meets market expectations.
Climate Change Risks
North American climate change policy is evolving at both regional and national levels and recent political and economic events may significantly affect the scope and timing of new climate change measures that are ultimately put in place. Although it is not the case today, the Corporation expects that some of its significant facilities may ultimately be subject to future regional, provincial and/or federal climate change regulations to manage greenhouse gas ("GHG") emissions.
The Specified Gas Emitters Regulation, which came into effect in Alberta in 2007, requires large industrial facility emitters of GHG to reduce GHG emissions intensities by 12% below a baseline based on 2003-2005 emissions. Each of Birchcliff's facilities is below the 100,000 tonnes per year threshold that this regulation applies to.
The Government of Alberta released its climate change strategy which sets a target to reduce GHG emissions in Alberta by 200 megatonnes or 50% by 2050. Implementing carbon capture and storage technology across industrial sectors is a large component of the strategy, along with energy-efficiency measures, clean energy technologies, and expanding the use of renewable sources of energy.
The Canadian government has expressed interest in pursuing the development of a North American cap and trade system for GHG emissions. In April 2007, the Government of Canada released the Regulatory Framework for Air Emissions ("Framework"). The Framework outlines short, medium and long-term objectives for managing both GHG emissions and air pollutants in Canada. It is uncertain how the Framework will fit within a North American cap and trade system and what the specific requirements for industrial emitters such as Birchcliff will be. Proposed regulations have not yet been released and therefore it is uncertain whether the impacts from such future regulations will be material to the Corporation.
ADVISORIES
BOE Conversions
Barrels of oil equivalent ("boe") amounts may be misleading, particularly if used in isolation. A boe conversion ratio of six thousand cubic feet (6 mcf) of natural gas to one barrel of oil (1 bbl) is based on an energy equivalent conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.
Non-GAAP Measures
This MD&A and the Corporation's Quarterly and Annual Reports uses the terms "cash flow", "netback", "cash flow netback", "operating netback", "cash flow per share", and "EBITDA", which do not have standardized meanings prescribed by GAAP and therefore may not be comparable to measures by other companies where similar terminology is used. Cash flow appears as a separate line on the Corporation's Statements of Cash Flows above "changes in non-cash working capital" and is reconciled to net income (loss) and comprehensive income (loss). Netback denotes petroleum and natural gas revenue less royalties, less operating expenses and less transportation and marketing expenses. Cash flow netback denotes net earnings plus non-cash items including future income tax expense (less any recovery), depletion, depreciation and accretion expense, unrealized losses from risk management contracts and foreign exchange (less unrealized gains), non-cash stock-based compensation expense and amortization of deferred financing fees. EBITDA denotes earnings before interest, taxes, stock-based compensation, depletion, depreciation and amortization.
Forward Looking Information
This MD&A contains certain forward-looking statements and forward-looking information (hereinafter collectively referred to as "forward-looking information") within the meaning of applicable Canadian securities laws. These statements relate to future events or future performance and are based upon the Corporation's current internal expectations, estimates, projections, assumptions and beliefs. All statements other than statements of historical fact are forward-looking statements. In some cases, words such as "plan", "expect", "project", "intend", "believe", "anticipate", "estimate", "may", "will", "potential", "proposed" and other similar words, or statements that certain events or conditions "may" or "will" occur, are intended to identify forward-looking statements.
In particular, this MD&A contains forward-looking information, including among other places, under the headings "Outlook" and "International Financial Reporting Standards". This forward-looking information includes but is not limited to statements regarding: expected processing capacity of the PCS Gas Plant and its future expansion; overall production; planned drilling, exploration and development; planned 2010 capital spending and sources of funding; expected results from the Corporation's portfolio of oil and gas assets; the quantity and development of oil and gas reserves; future net cash flows and discounted cash flows; expected operating, general administrative, services, environmental compliance costs and expenses; royalty rates and incentives; treatment under tax laws; expected ability to transition to new accounting standards and other expectations, beliefs, plans, goals, objectives, assumptions, information and statements about possible future events, conditions, results of operations or performance. The Corporation cannot guarantee future results, levels of activity, performance or achievements. Consequently, there is no representation by the Corporation that actual results achieved will be the same in whole or in part as those set out in the forward-looking information.
With respect to such forward-looking information the key assumptions on which the Corporation relies are: that future prices for crude oil and natural gas, future currency exchange rates and interest rates, and future availability of debt and equity financing will be at levels and costs that allow the Corporation to manage, operate and finance its business and develop its properties and meet its future obligations; that the regulatory framework in respect of royalties, taxes and environmental matters applicable to the Corporation will not become so onerous as to preclude the Corporation from viably managing, operating and financing its business and the development of its properties; that the Corporation will continue to be able to identify, attract and employ qualified staff and obtain the outside expertise and specialized and other equipment it requires to manage, operate and finance its business and develop its properties; and various assumptions as to future prices for crude oil and natural gas, currency exchange rates, inflation rates, future well production rates, well drainage areas, success rates of future well drilling and future costs and availability of labour and services. With respect to estimates of reserves volumes and associated future net revenues and numbers of future wells to be drilled, a key assumption is the validity of the commodity prices, currency exchange rates, future capital and operating costs and well production rates forecast by the Corporation's independent reserves evaluator. With respect to the number of future wells to be drilled, a key assumption is the validity of the geological and other technical interpretations that have been performed by Birchcliff's technical staff and that indicate that commercially economic reserves can be recovered from Birchcliff's lands as a result of drilling such future wells.
Undue reliance should not be placed on forward-looking information, as there can be no assurance that the plans, intentions or expectations upon which they are based will occur. Forward-looking information involves numerous assumptions, uncertainties and both known and unknown risks. There is a risk that such predictions, forecasts, and projections may not occur. Although the Corporation believes that the expectations reflected in the forward-looking statements are reasonable, there can be no assurance that such expectations will prove to be correct. Some of those risks include: risks inherent in the oil and gas industry, such as operational risks in exploring for, developing and producing crude oil and nature gas, market demand and unpredictable facilities outages; risks and uncertainties involving geology of oil and gas deposits; uncertainty of reserves and resources estimates, reserves life and underlying reservoir risk; general economic conditions in Canada, the United States and globally; changes in governmental regulation of the oil and gas industry, including environmental regulation; fluctuations in foreign exchange rates or interest rates; adverse conditions in the debt and equity markets; and competition from others for scarce resources.
The foregoing list of risk factors is not exhaustive. The forward-looking information contained in this MD&A is expressly qualified by this cautionary statement. Additional information on these and other risk factors that could affect operations or financial results are included in the Corporation's most recent Annual Information Form. In addition, information is available in the Corporation's other reports filed with Canadian securities regulatory authorities. Forward-looking information is based on estimates and opinions of management at the time the information is presented. The Corporation is not under any duty to update the forward-looking information after the date of this MD&A to conform such information to actual results or to changes in the Corporation's plans or expectations, except as otherwise required by applicable securities laws.
MANAGEMENT'S REPORT
To the Shareholders of Birchcliff Energy Ltd.
The financial statements of Birchcliff Energy Ltd. were prepared by management within the acceptable limits of materiality and are in accordance with accounting principles generally accepted in Canada. Management is responsible for ensuring that the financial and operating information presented in this annual report is consistent with that shown in the financial statements.
The financial statements have been prepared by management in accordance with the accounting policies as described in the notes to the financial statements. Timely release of financial information sometimes necessitates the use of estimates when transactions affecting the current accounting period cannot be finalized until future periods. When necessary, such estimates are based on informed judgments made by management.
Management has designed and maintains an appropriate system of internal controls to provide reasonable assurance that all assets are safeguarded and financial records properly maintained to facilitate the preparation of financial statements for reporting purposes.
Deloitte & Touche LLP, an independent firm of Chartered Accountants appointed by shareholders, have conducted an examination of the corporate and accounting records in order to express their opinion on the financial statements.
The Audit Committee, consisting of non-management directors, has met with representatives of Deloitte & Touche LLP and management in order to determine if management has fulfilled its responsibilities in the preparation of the financial statements. The Board of Directors has approved the financial statements on the recommendation of the Audit Committee.
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(signed) "A. Jeffery Tonken" (signed) "Bruno P. Geremia"
A. Jeffery Tonken, Bruno P.Geremia,
President and Chief Executive Officer Vice President and Chief Financial
Officer
March 17, 2011
/T/
INDEPENDENT AUDITOR'S REPORT
To the Shareholders of Birchcliff Energy Ltd.:
We have audited the accompanying financial statements of Birchcliff Energy Ltd., which are comprised of the balance sheet as at December 31, 2010 and 2009, and the statements of net income (loss), comprehensive income (loss) and retained earnings (deficit) and cash flows for the years then ended, and the notes to the financial statements.
Management's Responsibility for the Financial Statements
Management is responsible for the preparation and fair presentation of these financial statements in accordance with Canadian generally accepted accounting principles, and for such internal control as management determines is necessary to enable the preparation of 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 financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audits to obtain reasonable assurance about whether the financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the 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 financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. 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 financial statements.
We believe that the audit evidence we have obtained in our audit is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the financial statements present fairly, in all material respects, the financial position of Birchcliff Energy Ltd. as at December 31, 2010 and 2009, the results of its operations and its financial performance and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles.
"Deloitte & Touche LLP"
Chartered Accountants
Calgary, Alberta
March 17, 2011
/T/
BIRCHCLIFF ENERGY LTD.
BALANCE SHEETS
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As at December 31, (000's) 2010 2009
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ASSETS
CURRENT
Cash 4,863 140
Accounts receivable (Note 8) 39,241 29,665
Prepaid and other 2,661 4,635
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46,765 34,440
Deferred financing fees (Note 5) - 245
Petroleum and natural gas properties and equipment
(Note 4) 948,626 802,423
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995,391 837,108
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LIABILITIES
CURRENT
Accounts payable and accrued liabilities 50,721 54,731
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50,721 54,731
Revolving credit facilities (Note 6) 333,468 201,230
Asset retirement obligations (Note 9) 26,448 24,713
Future income taxes (Note 10) 7,631 1,873
Commitments (Note 14)
SHAREHOLDERS' EQUITY
Share capital (Note 11) 550,472 541,593
Contributed surplus (Note 12) 28,096 20,315
Deficit (1,445) (7,347)
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577,123 554,561
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995,391 837,108
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See accompanying notes to the financial statements.
APPROVED BY THE BOARD
(signed) "Larry A. Shaw"
Larry A. Shaw, Director
(signed) "A. Jeffery Tonken"
A. Jeffery Tonken, Director
BIRCHCLIFF ENERGY LTD.
STATEMENTS OF NET INCOME (LOSS), COMPREHENSIVE INCOME (LOSS) AND RETAINED
EARNINGS (DEFICIT)
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For the years ended December 31, (000's) 2010 2009
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----------------------------------------------------------------------------
REVENUE
Petroleum and natural gas 189,978 150,669
Royalties (16,933) (15,342)
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173,045 135,327
EXPENSES
Production(Note 16) 36,745 36,388
Transportation and marketing 12,359 9,799
General and administrative, net (Note 4) 10,137 11,353
Stock-based compensation (Note 12) 10,577 9,844
Depletion, depreciation and accretion (Notes 4
and 9) 76,469 85,253
Amortization of deferred financing fees (Notes
5 and 6) 1,646 1,200
Interest on non - revolving term credit
facility (Note 5) 700 -
Interest on revolving credit facilities
(Note 6) 12,753 10,311
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161,386 164,148
INCOME (LOSS) BEFORE TAXES 11,659 (28,821)
TAXES
Future income tax expense (recovery) (Note 10) 5,757 (4,569)
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5,757 (4,569)
NET INCOME (LOSS) AND COMPREHENSIVE INCOME
(LOSS) 5,902 (24,252)
RETAINED EARNINGS (DEFICIT), BEGINNING OF YEAR (7,347) 16,905
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DEFICIT, END OF YEAR (1,445) (7,347)
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Net income (loss) per common share (Note 13)
basic $0.05 $(0.21)
diluted $0.05 $(0.21)
Weighted average common shares (Note 13)
basic 124,629,761 117,993,314
diluted 127,662,373 117,993,314
See accompanying notes to the financial statements.
BIRCHCLIFF ENERGY LTD.
STATEMENTS OF CASH FLOWS
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For the years ended December 31, (000's) 2010 2009
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OPERATING
Net income (loss) 5,902 (24,252)
Adjustments for items not affecting cash:
Depletion, depreciation and accretion 76,469 85,253
Stock-based compensation 10,577 9,844
Amortization of deferred financing fees 1,646 1,200
Future income tax expense (recovery) 5,757 (4,569)
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100,351 67,476
Changes in non-cash working capital (Note 15) 1,429 (10,051)
Asset retirement expenditures (902) (606)
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100,878 56,819
FINANCING
Increase (decrease) in revolving credit facilities 132,105 (9,826)
Deferred financing fees paid (1,268) (1,975)
Issuance of share capital (Note 11) 6,083 67,300
Share issue costs (Note 11) - (2,695)
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136,920 52,804
INVESTING
Purchase of petroleum and natural gas properties
and equipment (2,051) (3,334)
Sale of petroleum and natural gas properties and
equipment (Note 4) 17,511 -
Development of petroleum and natural gas properties
and equipment (235,494) (98,356)
Changes in non-cash investing working capital (Note
15) (13,041) (7,858)
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(233,075) (109,548)
NET INCREASE IN CASH 4,723 75
CASH, BEGINNING OF YEAR 140 65
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CASH, END OF YEAR 4,863 140
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Cash interest paid 13,453 10,311
Cash taxes paid - -
See accompanying notes to the financial statements.
/T/
BIRCHCLIFF ENERGY LTD.
Notes to the Financial Statements
For the years ended December 31, 2010 and 2009
1. NATURE OF OPERATIONS
Birchcliff Energy Ltd. ("Birchcliff" or the "Corporation") was a private company, incorporated under the Business Corporations Act (Alberta) on July 6, 2004 as 1116463 Alberta Ltd. The name was changed from 1116463 Alberta Ltd. to Birchcliff Energy Ltd. on September 10, 2004. The address of the Corporation's registered office is 500, 630 - 4th Avenue, S.W., Calgary, Alberta, Canada T2P 0J9.
The Corporation is engaged in the exploration for and the development, production and acquisition of, petroleum and natural gas reserves in Western Canada. Birchcliff trades on the Toronto Stock Exchange under the symbol "BIR". Birchcliff's financial year end is December 31.
2. SIGNIFICANT ACCOUNTING POLICIES
The annual Financial Statements have been prepared by management in accordance with Canadian Generally Accepted Accounting Principles ("GAAP"), within an acceptable level of materiality, utilizing the framework of the accounting policies below. The Financial Statements are expressed in Canadian ("CDN") dollars.
a) Basis of accounting
The Corporation's Financial Statements include the accounts of Birchcliff. There are no subsidiary companies.
b) Revenue recognition
Revenue associated with sales of petroleum and natural gas are recorded when the commodities are delivered and title passes to the purchaser. Revenue associated with petroleum and natural gas sales are recorded gross of royalties and transportation and marketing charges.
c) Joint venture activities
Substantially all of the Corporation's exploration and production activities are conducted jointly with others and, accordingly, the accounts reflect only the Corporation's proportionate interest in such activities.
d) Measurement uncertainty
The preparation of timely Financial Statements necessitates the use of estimates when transactions affecting the current accounting period cannot be finalized until future periods. These estimates will affect assets, liabilities and the disclosure of contingent assets and liabilities at the date of the Financial Statements, as well as revenues and expenses during the reporting periods. Such estimates are based on informed judgments made by management. Actual results could differ materially from those estimated.
Amounts recorded for depletion, depreciation and accretion and amounts used for impairment test calculations are based on estimates of petroleum and natural gas reserves which include estimates of future commodity prices, future capital costs and other relevant assumptions. The Corporation's reserves are estimated and evaluated, at a minimum, annually by an independent engineering firm. The provision for income taxes is based on judgments in applying income tax law and estimates on the timing, likelihood and reversal of temporary differences between the accounting and tax bases of assets and liabilities. By their nature, these estimates are subject to measurement uncertainty and the impact of changes in such estimates on the Financial Statements of future periods could be material.
e) Cash
Cash consists of cash on deposit, less outstanding cheques, and deposits with a maturity at the time of investment of less than three months.
(f) Property, plant and equipment
Capitalized costs
The Corporation follows the full cost method of accounting whereby all costs relating to the exploration, acquisition and development of petroleum and natural gas reserves are capitalized. Such costs include land acquisition costs, geological and geophysical expenses, production equipment, carrying charges of non-producing properties, costs of drilling both productive and non-productive wells and corporate charges directly related to acquisition, exploration and development activities. Proceeds from the sale of properties are applied against capitalized costs, with no gain or loss recognized, unless such a sale would alter the rate of depletion and depreciation by 20% or more.
Depletion and depreciation
Depletion and depreciation of petroleum and natural gas properties and equipment, together with the estimated future costs to be incurred in developing proved reserves, are depleted or depreciated using the unit-of-production method based on the proved reserves before royalties as estimated by independent engineers. Petroleum and natural gas reserves and production are converted into equivalent units based upon estimated relative energy content of six thousand cubic feet of natural gas to one barrel of oil. The costs of undeveloped properties are excluded from the costs subject to depletion and depreciation until it is determined whether proved reserves are attributable to the properties.
Impairment
Petroleum and natural gas properties are evaluated each reporting period through an impairment test to determine the recoverability of capitalized costs. The carrying amount is assessed as recoverable when the sum of the undiscounted cash flows expected from proved reserves plus the cost of unproved interests, net of impairments, exceeds the carrying amount. When the carrying amount is assessed as non-recoverable, an impairment loss is recognized to the extent that the carrying amount exceeds the sum of the discounted cash flows from proved and probable reserves plus the cost of unproved interests, net of impairments. Reserves are determined pursuant to National Instrument 51-101, Standards of Disclosures for Oil and Gas Activities. Unproved properties are assessed at least annually to determine whether impairment has occurred.
Administrative assets
The Corporation records depreciation on its office furniture and equipment, which includes computer equipment, on a straight-line basis using an expected useful life of four years.
(g) Asset retirement obligations
The Corporation recognizes the estimated liability associated with future site reclamation costs in the Financial Statements when a well or related asset is drilled, constructed or acquired including facilities. Costs are estimated by management in consultation with the Corporation's engineers based on current costs and technology in accordance with current legislation and industry practices. The obligation is initially measured at fair value, and subsequently adjusted for the accretion of discount and any changes to the underlying cash flows. The asset retirement cost is capitalized to petroleum and natural gas properties and equipment and amortized into earnings in depletion expense on a basis consistent with depletion and depreciation. Actual site restoration and abandonment expenditures are applied directly against the asset retirement obligation. The Corporation reviews the obligation regularly such that revisions to the estimated timing of cash flows, discount rates and estimated costs will result in an increase or decrease to the asset retirement obligation.
(h) Future income taxes
The Corporation accounts for its income taxes using the liability method. Under this method, future income tax assets and liabilities are determined based on the differences between the accounting and tax bases of assets and liabilities using substantively enacted tax rates anticipated to apply in relevant future periods. The effect of a change in income tax rates on future income tax assets and liabilities is recognized in the period of substantive enactment.
(i) Stock-based compensation
The Corporation accounts for its stock-based compensation plans using the fair value method to value stock options and performance warrants granted to officers, directors, employees and consultants. Under this method, compensation cost attributed to stock options and performance warrants ("stock awards") granted is measured at fair value at the grant date and expensed over the vesting period with a corresponding increase to contributed surplus. Upon the exercise of stock awards, consideration paid together with the amount previously recognized in contributed surplus is recorded as an increase to share capital. The Corporation does not incorporate an estimated forfeiture rate for stock awards that will not vest, but instead accounts for forfeitures as a change in estimate in the period in which they occur. In the event that vested stock awards expire without being exercised, previously recognized compensation costs associated with such awards are not reversed.
(j) Flow-through shares
The resource expenditure deductions for income tax purposes related to exploratory and development activities funded by flow-through share arrangements are renounced to investors in accordance with tax legislation. The Corporation records the carrying value of the expenditures in property, plant and equipment as incurred and records the future income taxes associated with the renunciation of expenditures with a corresponding reduction to share capital.
(k) Financial instruments
All financial instruments are initially recognized at fair value on the balance sheet. The Corporation has classified each financial instrument into the following categories: "held for trading" financial assets and financial liabilities; "loans or receivables"; and "other financial liabilities". Subsequent measurement of the financial instruments is based on their classification. The Corporation has made the following classifications:
- Cash and cash equivalents are classified as financial assets held for trading and are measured at fair value. Gains and losses from revaluation are recognized in net income.
- Accounts receivable are classified as loans and receivables and are initially measured at fair value.
- Revolving credit facilities, accounts payable and accrued liabilities are classified as other liabilities and are initially measured at fair value.
(l) Derivative financial instruments
Derivative financial instruments are used by the Corporation to manage economic exposure to market risks relating to commodity prices. Birchcliff's policy is not to utilize derivative financial instruments for speculative purposes.
Derivative financial instruments that do not qualify as hedges, or are not designated as hedges, are classified as held-for-trading and are recorded using the mark-to-market method of accounting whereby instruments are recorded in the Balance Sheet as either an asset or liability with changes in fair value recognized in net income.
(m) Per share information
Per share information is computed using the weighted average number of common shares outstanding during the period. Diluted per share information is calculated using the treasury stock method, which assumes that any proceeds from the exercise of "in-the-money" stock options or performance warrants plus the unamortized stock based compensation expense amounts would be used to purchase common shares at the average market price during the period. No adjustment to diluted income per share is made if the result of these calculations is anti-dilutive.
(n) Foreign currency translations
Monetary assets and liabilities of the Corporation that are denominated in foreign currencies are translated into its reporting currency at the rates of exchange in effect at the period end date. Any gains or losses are recorded in net income.
3. TRANSITION TO INTERNATIONAL FINANCIAL REPORTING STANDARDS
In 2006, the Accounting Standards Board ("AcSB") ratified a strategic plan to converge Canadian GAAP with International Financial Reporting Standards ("IFRS") by 2011 for public reporting entities. On February 13, 2008 the AcSB confirmed that IFRS will replace Canadian GAAP for public companies beginning January 1, 2011. The adoption date of January 1, 2011 will require the restatement, for comparative purposes, of amounts reported by Birchcliff for the year ended December 31, 2010, including the opening balance sheet as at January 1, 2010.
/T/
4. PETROLEUM AND NATURAL GAS PROPERTIES AND EQUIPMENT
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($000's) December 31, 2010
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Accumulated Depletion
Cost and Depreciation Net Book Value
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Petroleum and natural
gas assets 1,318,722 (372,530) 946,192
Office furniture,
equipment & other 4,952 (2,518) 2,434
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1,323,674 (375,048) 948,626
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----------------------------------------------------------------------------
($000's) December 31, 2009
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Accumulated Depletion
Cost and Depreciation Net Book Value
----------------------------------------------------------------------------
Petroleum and natural
gas assets 1,099,420 (298,560) 800,860
Office furniture,
equipment & other 3,415 (1,852) 1,563
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1,102,835 (300,412) 802,423
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/T/
At December 31, 2010, the cost of petroleum and natural gas assets includes $60.5 million (2009 - $44.9 million) relating to unproved properties which have been excluded from costs subject to depletion and depreciation. Birchcliff capitalized general and administrative costs directly related to exploration and development activities of approximately $2.3 million in the year ended December 31, 2010 (2009 - $1.9 million).
On March 3, 2010, the Corporation completed and closed the sale of a non-producing asset in the Kakut area of Alberta for $17.5 million. The proceeds from the sale were used to reduce the cost of petroleum and natural gas assets at December 31, 2010. No gain or loss was recorded on the sale.
On September 15, 2009, the Government of Alberta approved a drilling royalty incentive for new conventional oil and natural gas wells drilled on or after April 1, 2009, but before April 1, 2011. Included as a reduction of petroleum and natural gas assets at December 31, 2010 is an expected recovery of $9.9 million (2009 - $6.3 million) related to the Alberta Drilling Royalty Credit Program.
The Corporation performed an impairment test at December 31, 2010 to ensure the carrying value of its petroleum and natural gas properties and equipment is recoverable and does not exceed fair value. The petroleum and natural gas future prices are based on December 31, 2010 commodity price forecasts of the Corporation's independent reserve evaluators. The following table summarizes the estimated crude oil and natural gas prices used in the impairment test:
/T/
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Edmonton Light
WTI Oil(1) Foreign Exchange Crude Oil(1) ECO Gas(1)
Year ($US/bbl) Rate ($CDN/bbl) ($CDN/mcf)
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2011 85.00 1.00 82.80 4.10
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2012 89.25 0.950 88.80 4.60
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2013 91.55 0.950 94.05 5.20
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2014 95.50 0.950 98.15 5.50
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2015 102.85 0.950 105.80 5.75
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2016 110.40 0.950 113.70 6.20
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2017 112.60 0.950 116.05 6.55
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2018 114.85 0.950 118.35 7.00
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2019 117.15 0.950 120.75 7.30
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2020 119.50 0.950 123.15 7.45
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2021 121.90 0.950 125.60 7.60
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2022 124.35 0.950 128.15 7.75
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2023 126.80 0.950 130.70 7.95
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2024 129.35 0.950 133.30 8.10
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2025 131.95 0.950 135.95 8.25
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2026 134.60 0.950 138.70 8.40
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2027 137.30 0.950 141.45 8.60
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2028 140.00 0.950 144.30 8.75
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2029 142.80 0.950 147.20 8.95
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2030 145.70 0.950 150.10 9.10
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Thereafter 2% 2% 2% 2%
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(1) Estimated prices used in the impairment test were adjusted for crude oil
and natural gas differentials and transportation and marketing costs
specific to the Corporation's operations.
/T/
Birchcliff's petroleum and natural gas properties and equipment were not impaired at December 31, 2010 and 2009.
5. NON-REVOLVING TERM CREDIT FACILITY
On May 21, 2009, the Corporation entered into a $50 million non-revolving one year term credit facility (the "Term Facility"). The Term Facility was provided by a syndicate of banks (the "Syndicate"). The Corporation paid approximately $625,000 in financing fees to the Syndicate to establish the one year Term Facility. In January 2010, the Corporation paid an additional $250,000 in financing fees to extend the maturity date of this facility from May 21, 2010 to May 21, 2011. As no amounts were drawn or outstanding on the Term Facility at December 31, 2009, approximately $245,000 in unamortized fees was shown as a non-current asset on the balance sheet. Effective May 21, 2010, the Corporation repaid and cancelled the Term Facility. The increased funds available from the revolving credit facilities as described in Note 6 were used to repay the full $50 million outstanding under the Term Facility. No amounts are outstanding on the Term Facility at December 31, 2010.
During the year ended December 31, 2010, the Corporation fully amortized to income approximately$0.5 million (2009 -$0.4 million) in deferred financing fees applicable to the Term Facility. The overall effective interest rate applicable to the bankers' acceptances issued under this facility was 5.9%during the year ended December 31, 2010.
/T/
6. REVOLVING CREDIT FACILITIES
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December 31, December 31,
($000's) 2010 2009
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Syndicated credit facility 334,000 192,000
Working capital facility 5,176 14,387
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Drawn revolving credit facilities 339,176 206,387
Unamortized prepaid interest on
bankers' acceptances (5,311) (4,627)
Unamortized deferred financing fees (397) (530)
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Revolving credit facilities, net 333,468 201,230
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/T/
Effective May 21, 2010, Birchcliff amended its agreement with its bank syndicate, which increased the Corporation's revolving credit facilities limit from $255 million to an aggregate limit of $350 million. On November 30, 2010, Birchcliff's bank syndicate approved an increase of the revolving credit facilities limit from $350 million to an aggregate limit of $375 million. At December 31, 2010, the revolving credit facilities consist of an extendible revolving term credit facility with an authorized limit of $345 million (the "Syndicated Credit Facility") and an extendible revolving working capital facility with an authorized limit of $30 million (the "Working Capital Facility"). The Corporation paid approximately $1.0 million in financing fees to the Syndicate to extend the conversion date of the revolving credit facilities from May 21, 2010 to May 20, 2011. These fees have been deferred and netted against the amounts drawn under this facility and are being amortized to income over the one year extension period. During the year ended December 31, 2010, the Corporation amortized to income approximately $1.2 million (2009 -$0.8 million) in deferred fees applicable to this facility.
At December 31, 2010, the effective interest rate applicable to the Working Capital Facility was 5.8% (2009 - 4.8%). The overall effective interest rates applicable to the bankers' acceptances issued under the Syndicated Credit Facility was 5.9%during the year ended December 31, 2010 (2009 - 5.7%).
The revolving credit facilities allow for prime rate loans, US base rate loans, bankers' acceptances, letters of credit and LIBOR loans. The interest rates applicable to the drawn loans are based on a pricing grid and will increase as a result of the increased ratio of outstanding indebtedness to earnings before interest, taxes, depreciation and amortization. The revolving credit facilities are subject to the Syndicate's redetermination of the borrowing base twice each year as of November 15 and the conversion date. Upon any change in or redetermination of the borrowing base limit which results in a borrowing base shortfall, Birchcliff must eliminate the borrowing base shortfall amount. The revolving credit facilities are secured by a fixed and floating charge debenture, an instrument of pledge and a general security agreement encompassing all of the Corporation's assets.
Syndicated Credit Facility
The Syndicated Credit Facility has a conversion date of May 20, 2011 and a maturity date which is two years after the conversion date. Birchcliff may request an extension of the conversion date with such an extension not exceeding 364days, in order to maintain the revolving Syndicated Credit Facility. If the conversion date of the Syndicated Credit Facility is not extended, then on the conversion date, the revolving Syndicated Credit Facility will convert to a term loan whereby all principal and interest will be required to be repaid at the maturity date.
Working Capital Facility
The Working Capital Facility has a conversion date of May 20, 2011 and a maturity date which is two years after the conversion date. Birchcliff may request an extension of the conversion date with such an extension not exceeding 364 days, in order to maintain the revolving Working Capital Facility. If the Syndicate does not grant an extension of the conversion date, then upon four months after the expiry of the conversion date, the revolving Working Capital Facility will convert to a term loan whereby all principal and interest will be required to be repaid at the maturity date.
7. CAPITAL MANAGEMENT
The Corporation's general policy is to maintain a sufficient capital base in order to manage its business in the most effective manner with the goal of increasing the value of its assets and thus its underlying share value. The Corporation's objectives when managing capital are to maintain financial flexibility in order to preserve its ability to meet financial obligations, including potential obligations arising from additional acquisitions; to maintain a capital structure that allows Birchcliff to favour the financing of its growth strategy using primarily internally-generated cash flow and its available debt capacity; and to optimize the use of its capital to provide an appropriate investment return to its shareholders.
There were no changes in the Corporation's approach to capital management throughout 2010 and 2009. The following table shows the Corporation's total available credit at the end of 2010 and 2009.
/T/
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December 31, December 31,
($000's) 2010 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Maximum borrowing base limit(1) :
Revolving credit facilities 375,000 255,000
Non-revolving term credit facility(2) - 50,000
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375,000 305,000
Principal amount utilized:
Drawn revolving credit facilities (339,176) (206,387)
Outstanding letters of credit(3) (3,014) (2,739)
----------------------------------------------------------------------------
(342,190) (209,126)
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Total unused credit 32,810 95,874
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(1) The Corporation's credit facilities are subject to a semi-annual review
of the borrowing base limit which is directly impacted by the value of
oil and natural gas reserves.
(2) Effective May 21, 2010, the Corporation repaid in full and cancelled
the $50 million non-revolving term credit facility.
(3) Letters of credit are issued to various service providers. No amounts
were drawn on the letters of credit as at or during the years ended
December 31, 2010 and 2009.
/T/
The financial covenants applicable to the Corporation's bank credit facilities include a quarterly interest coverage ratio test, which is calculated as earnings before interest, taxes, stock-based compensation, depletion, depreciation and amortization ("EBITDA") over interest expense. The following table shows the interest coverage ratios at December 31, 2010 and 2009:
/T/
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December 31, 2010 December 31, 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Required Actual Required Actual
----------------------------------------------------------------------------
Annualized EBITDA to greater
interest coverage(1) greater than 3.5 8.4 than 3.5 7.6
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----------------------------------------------------------------------------
(1) Interest coverage ratio is calculated on a trailing four quarter basis.
/T/
The Corporation was compliant with all financial covenants under its credit facilities as at and during the years ended December 31, 2010 and 2009.
The capital structure of the Corporation is as follows:
/T/
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December December
($000's) 31, 2010 31, 2009 Change %
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Total shareholders' equity(1) 577,123 554,561 4%
----------------------------------------------------------------------------
Total shareholders' equity as a % of total
capital 63% 71%
Working capital deficit (2) 3,956 20,291
Drawn revolving credit facilities 339,176 206,387
----------------------------------------------------------------------------
Total drawn debt 343,132 226,678 51%
Total drawn debt as a % of total capital 37% 29%
----------------------------------------------------------------------------
Total capital 920,255 781,239 18%
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Shareholders' equity is defined as share capital plus contributed
surplus plus retained earnings, less any deficit.
(2) Working capital
deficit is defined as current assets less current liabilities.
/T/
During the year ended December 31, 2010, total shareholders' equity increased due to the exercise of options (Note 12) and an increase in reported net income for the period. Total debt increased during the year ended December 31, 2010 largely due to $119.7 million of net capital spent in excess of cash flow during that year.
8. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT CONTRACTS
Birchcliff is exposed to credit risk, liquidity risk and market risk as part of its normal course of business. The Board of Directors has overall responsibility for the establishment and oversight of the Corporation's financial risk management framework and periodically reviews the results of all risk management activities and all outstanding positions. Management has implemented and monitors compliance with risk management guidelines as outlined by the Board of Directors. The Corporation's risk management guidelines are established to identify and analyze the risks faced by the Corporation, to set appropriate risk limits and controls, and to monitor risks and adherence to market conditions and the Corporation's activities.
Credit Risk
Cash is comprised of bank balances. Historically, the Corporation has not carried short term investments. Should this change in the future, counterparties will be selected based on credit ratings and management will monitor all investments to ensure a stable return, and complex investment vehicles with higher risk will be avoided. The Corporation's exposure to cash credit risk at the balance sheet date is very low.
A substantial portion of the Corporation's accounts receivable are with marketers and joint venture partners in the oil and natural gas industry and are subject to normal industry credit risks. The carrying amount of accounts receivable reflects management's assessment of the credit risk associated with these customers.
The following table illustrates the Corporation's maximum exposure for receivables:
/T/
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December December
($000's) 31, 2010 31, 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Marketers 20,800 16,607
Joint venture partners 18,118 12,984
Other 323 74
----------------------------------------------------------------------------
Total receivables 39,241 29,665
----------------------------------------------------------------------------
----------------------------------------------------------------------------
/T/
At December 31, 2010, approximately 22% of the Corporation's significant individual accounts receivable was due from one marketer (2009 - 18%, one marketer). For the year ended December 31, 2010, the Corporation received 14%, 43%, 14%, and 14% of its revenue, respectively, from four core marketers. The Corporation received the majority of its revenue for the year ended December 31, 2009 from four marketers, who individually accounted for 39%, 10%, 11% and 23%, respectively. Typically, Birchcliff's maximum credit exposure from its marketers is revenue from two months of commodity sales. Receivables from marketers are normally collected on the 25th day of the month following production. Birchcliff mitigates the credit risk associated with these by establishing marketing relationships with credit worthy purchasers, obtaining guarantees from their ultimate parent companies and obtaining letters of credit as appropriate. The Corporation historically has not experienced any material collection issues with its marketers.
At December 31, 2010, approximately $0.4 million or 1% of Birchcliff's total accounts receivable are aged over 120 days and considered past due. The majority of these accounts are due from various joint venture partners. Birchcliff attempts to mitigate the credit risk from joint venture receivables by obtaining pre-approval of significant capital expenditures. However, the receivables are from participants in the oil and natural gas sector, and collection of the outstanding balances is dependent on industry factors such as commodity price fluctuations, escalating costs and the risk of unsuccessful drilling. In addition, further risk exists with joint venturers' as disagreements occasionally arise that increase the potential for non-collection. The Corporation does not typically obtain collateral from oil and natural gas marketers or joint venturers', however, the Corporation does have the ability to withhold production from joint venturers' in the event of non-payment.
Should Birchcliff determine that the ultimate collection of a receivable is in doubt, it will provide the necessary provision in its allowance for doubtful accounts with a corresponding charge to income. If the Corporation subsequently determines an account is uncollectible, the account is written off with a corresponding charge to the allowance for doubtful accounts. Birchcliff did not have an allowance for doubtful accounts balance at December 31, 2010 and 2009.
Liquidity Risk
Liquidity risk is the risk that the Corporation will not be able to meet its obligations associated with financial liabilities that are settled by cash as they become due. Birchcliff's approach to managing liquidity is to ensure, as much as possible, that it will have sufficient liquidity to meet its short term and long term financial obligations when due, under both normal and unusual conditions without incurring unacceptable losses or risking harm to the Corporation's reputation.
All of the Corporation's contractual financial liabilities are to be settled in cash. Typically, the Corporation ensures that it has sufficient cash on demand to meet expected operational expenses, including the servicing of financial obligations. To achieve this objective, the Corporation prepares annual capital expenditure budgets, which are approved by the Board of Directors and are regularly reviewed and updated as considered necessary. Petroleum and natural gas production is monitored weekly and is used to provide monthly cash flow estimates. Further, the Corporation utilizes authorizations for expenditures on both operated and non operated projects to manage capital expenditure. The Corporation also attempts to match its payment cycle with collection of oil and natural gas revenue on the 25th of each month.
To facilitate the capital expenditure program, the Corporation has reserve-based bank credit facilities which are reviewed semi-annually by the lender. The principal amount utilized under the Corporation's credit facilities at December 31, 2010 was $342.2 million (2009 - $209.1 million) and $32.8 million (2009 - $95.9 million) in unused credit was available at the end of the period to fund future obligations.
The following table lists the contractual obligations of the Corporation's financial liabilities at December 31, 2010:
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less than 1 - 2 3 - 5
($000's) 1 Year Years Years Thereafter
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Accounts payable and accrued
liabilities 50,721 - - -
Drawn revolving credit facilities - - 339,176 -
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Total financial liabilities 50,721 - 339,176 -
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Market Risk
Market risk is the risk that changes in market conditions, such as commodity prices, exchange rates and interest rates, will affect the Corporation's net income or the value of its financial instruments, if any. The objective of market risk management is to manage and control exposures within acceptable limits, while maximizing returns. These risks are consistent with prior years. All risk management transactions are conducted within risk management tolerances that are reviewed by the Board of Directors.
Commodity Price Risk
Commodity price risk is the risk that the fair value of future cash flows will fluctuate as a result of changes in commodity prices. Significant changes in commodity prices can materially impact the Corporation's borrowing base limit. Lower commodity prices can also reduce the Corporation's ability to raise capital. Commodity prices for crude oil and natural gas are not only influenced by Canadian ("CDN") and United States ("US") demand, but also by world events that dictate the levels of supply and demand.
The Corporation may attempt to mitigate commodity price risk through the use of financial derivatives such as commodity price risk management contracts. Birchcliff had no risk management contracts in place as at or during the years ended December 31, 2010 and 2009. The Corporation actively monitors the market to determine whether any additional commodity price risk management contracts are warranted.
Foreign Currency Risk
Foreign currency risk is the risk that future cash flows will fluctuate as a result of changes in foreign currency exchange rates. The exchange rate effect cannot be quantified but generally an increase in the value of the CDN dollar as compared to the US dollar will reduce the prices received by Birchcliff for its petroleum and natural gas sales. The Corporation had no forward exchange rate contracts in place as at or during the year ended December 31, 2010 and 2009.
Interest Rate Risk
Interest rate risk is the risk that future cash flows will fluctuate as a result of changes in market interest rates. The Corporation's credit facilities are exposed to interest rate cash flow risk on a floating interest rate due to fluctuations in market interest rates. The remainder of Birchcliff's financial assets and liabilities are not exposed directly to interest rate risk.
A 1% change in the CDN prime interest rate during the year ended December 31, 2010 would have increased (decreased) net income (loss) and comprehensive income (loss) by approximately $2.5 million (2009 - $2.1 million), assuming that all other variables remain constant. A sensitivity of 1% is considered reasonable given the current level of the bank prime rate and market expectations for future movements. The Corporation considers this risk to be limited and thus does not hedge its interest rate risk.
The Corporation had no interest rate swap contracts in place as at or during the years ended December 31, 2010 and 2009.
Fair Value of Financial Instruments
Birchcliff's financial instruments include cash, accounts receivable, accounts payable and accrued liabilities, and credit facilities. All of Birchcliff's financial instruments are transacted in active markets. Financial instruments carried at fair value are assessed using the following hierarchy based on the amount of observable inputs used to value the instrument.
- 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.
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 level. The carrying value and fair value of financial instruments at December 31, 2010 is disclosed below by financial instrument category, as well as any related loss or interest expense for the period:
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Carrying Fair Interest
($000's) Value Value Loss Expense
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Assets Held for Trading
Cash(1) 4,863 4,863 - -
Loans and Receivables
Accounts receivable(2) 39,241 39,241 - -
Other Liabilities
Accounts payable and accrued
liabilities(2) 50,721 50,721 - -
Drawn revolving credit facilities(3) 339,176 339,176 - 12,753
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(1) Cash is reported at fair value, based on a Level 1 designation.
(2) Accounts receivable and accounts payable and accrued liabilities are
reported at amortized cost. Due to the short term nature of accounts
receivable and accounts payable and accrued liabilities, their carrying
values approximate their fair values.
(3) The Corporation's revolving facilities bear interest at a floating rate
and accordingly the fair market value approximates the carrying value
before the carrying value is reduced for any remaining unamortized costs
as described in Note 6.
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9. ASSET RETIREMENT OBLIGATIONS
The Corporation's asset retirement obligations result from net ownership interests in petroleum and natural gas properties and equipment including well sites, gathering systems and processing facilities. Birchcliff estimates the total undiscounted amount of cash flows required to settle its asset retirement obligations at December 31, 2010 to be approximately $91.5 million (2009 - $70.1 million) which will be incurred between 2011 and 2062. A credit-adjusted risk-free interest rate of 8% and an inflation rate of 2% were used to calculate the fair value of the asset retirement obligation.
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A reconciliation of the asset retirement obligations is provided below:
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December December
($000's) 31, 2010 31, 2009
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Balance, January 1 24,713 21,223
Obligations incurred 1,350 475
Obligations acquired, net 92 17
Changes in estimate (638) 1,846
Accretion expense 1,833 1,758
Actual expenditures (902) (606)
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Ending balance 26,448 24,713
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10. FUTURE INCOME TAX
The provision for income taxes differs from the result that would be obtained by applying the combined current year Canadian federal and provincial income tax rates in 2010 of 28% (2009 - 29%). The difference results from the following items:
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December December
($000's) 31, 2010 31, 2009
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Net income (loss) before taxes 11,659 (28,821)
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Computed expected income tax expense (recovery) 3,265 (8,358)
Increase (decrease) in taxes resulting from:
Non-deductible stock-based compensation 2,962 2,855
Non-deductible expenses 69 50
Changes in tax rate and other (539) 884
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Future income tax expense (recovery) 5,757 (4,569)
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The components of the future income tax assets and liabilities at December
31 are as follows:
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December December
($000's) 31, 2010 31, 2009
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Future tax liabilities:
Property, plant and equipment (59,595) (42,198)
Deferred financing fees (105) (217)
Future tax assets:
Asset retirement obligations 6,636 6,237
Share issue costs 1,465 2,357
NCL's, SR&ED's & ITC's(1) 43,968 31,948
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Net future tax liability (7,631) (1,873)
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(1) "NCL" = Non Capital Losses; "SR&ED" = Scientific Research & Experimental
Development; "ITC" = Investment Tax Credits
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At December 31, 2010, the Corporation's estimated non-capital losses for income tax purposes is approximately $157.2 million (2009 - $109.1 million) available to shelter future taxable income. Management expects that future taxable income will be available to utilize non-capital losses.
The following table shows a breakdown of the Corporation's non-capital losses at the end of 2010 by year of expiry:
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Year of Expiry Amount ($000's)
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2015 71
2026 388
2028 18,098
2029 28,463
2030 58,376
2031 51,758
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Total non-capital losses 157,154
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SHARE CAPITAL
(a) Authorized:
Unlimited number of voting common shares
Unlimited number of non-voting preferred shares
The preferred shares may be issued in one or more series and the directors are authorized to fix the number of shares in each series and to determine the designation, rights, privileges, restrictions and conditions attached to the shares of each series.
(b) Issued:
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Number of Amount
Common Shares ($000's)
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Balance, December 31, 2008 112,395,970 477,482
Issued upon exercise of stock options 1,419,032 7,813
Tax effect of flow through shares (Note (c)) - (3,750)
Issued, net of costs (Note (d)) 10,000,000 59,305
Tax effect of share issue costs (Note (d)) - 743
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Balance, December 31, 2009 123,815,002 541,593
Issued upon exercise of stock options 1,314,232 8,879
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Balance, December 31, 2010 125,129,234 550,472
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(c) Birchcliff recognized a future income tax liability of $3,750,000 with respect to the renunciation of $15 million of qualified 100% deductible flow-through shares.
(d) On June 30, 2009, Birchcliff issued 10,000,000 common shares at a price of $6.20 per share for total net proceeds of $59,304,600.Birchcliff recognized a future income tax benefit of $743,000 in respect of share issue costs of $2,695,400 incurred with respect to the issuance of 10,000,000 common shares.
12. STOCK-BASED COMPENSATION
Stock Options
The Corporation has established a stock-based compensation plan whereby officers, directors, employees, and consultants may be granted options to purchase common shares at a fixed price not less than the fair market value of the stock at the time of grant, subject to certain conditions. Stock options granted under this plan vest over a three year period at the rate of one-third on each anniversary date of the stock option grant. All stock options granted are for a five year term. The Corporation is authorized to issue stock options for a maximum of 10% of the issued and outstanding common shares pursuant to the Amended and Restated Stock Option Plan. In order to calculate the compensation expense, the fair value of the stock options is estimated using the Black-Scholes option-pricing model that takes into account, as of the grant date: exercise price, expected life, current stock price, expected volatility, expected dividends and risk-free interest rates.
During the year ended December 31, 2010, the Corporation recorded $10.6 million (2009 - $9.8 million) of stock-based compensation expense and a corresponding increase to contributed surplus related to stock options issued and outstanding during the period.
At December 31, 2010, the Corporation's Amended and Restated Stock Option Plan permitted the grant of options in respect of a maximum 12,512,923(2009 - 12,381,500) common shares. At December 31, 2010, there remained available for issuance options in respect of 3,265,403 (2009 - 4,671,247)common shares. A summary of the Corporation's outstanding stock options for the years ended December 31, 2010 and 2009 is presented below:
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Weighted
Average
Exercise
Number Price ($)
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Outstanding, December 31, 2008 6,324,221 5.58
Granted 3,959,900 5.53
Exercised (1,419,032) (3.74)
Forfeited (1,154,836) (6.18)
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Outstanding, December 31, 2009 7,710,253 5.81
Granted 3,350,300 9.61
Exercised (1,314,232) (4.63)
Forfeited (498,801) (7.41)
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Outstanding, December 31, 2010 9,247,520 7.26
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The weighted average assumptions used in calculating the fair values are set
forth below:
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December December
31, 2010 31, 2009
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Risk-free interest rate 2.5% 2.0%
Expected maturity (years) 5.0 5.0
Expected volatility 60.5% 63.5%
Dividend yield - -
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A summary of the stock options outstanding and exercisable under the plan at December 31, 2010 is presented below:
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Exercise Price Awards Outstanding Awards Exercisable
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Weighted Weighted
Average Weighted Average Weighted
Remaining Average Remaining Average
Contractual Exercise Contractual Exercise
Low High Quantity Life Price Quantity Life Price
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$3.87 $6.00 3,793,120 2.45 $ 4.76 2,073,295 1.95 $ 4.52
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$6.01 $9.00 2,111,200 2.73 $ 7.61 1,072,765 2.37 $ 7.49
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$9.01 $12.00 3,155,400 4.07 $ 9.70 99,399 2.59 $10.74
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$12.01 $14.25 187,800 2.53 $13.07 125,200 2.53 $13.07
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9,247,520 3.07 $ 7.26 3,370,659 2.12 $ 5.97
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Performance Warrants
On January 14, 2005, as part of the Corporation's initial restructuring to become a public entity, the Corporation issued 4,049,665 performance warrants with an exercise price of $3.00 and an expiration date of January 31, 2010 to members of its executive team. Each performance warrant entitles the holder to purchase one common share at the exercise price. Because the performance conditions were fulfilled in 2005, resulting in the performance warrants vesting, the full amount of the related compensation expense was recorded in net income in that year. The fair value of each performance warrant was determined on the date of the grant using the Black-Scholes option-pricing model. On May 28, 2009, the Corporation's outstanding performance warrants were amended to extend the expiration date from January 31, 2010 to January 31, 2015. The Corporation recorded stock-based compensation expense of $3.1 million relating to the extension of the performance warrants for the year ended December 31, 2009.
No performance warrants were issued or exercised during the years ended December 31, 2010 and 2009. At December 31, 2010, there remained outstanding and exercisable 2,939,732 performance warrants.
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Contributed Surplus Continuity
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Amount ($000's)
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Balance, December 31, 2008 12,984
Stock-based compensation expense - stock options (1) 6,784
Stock-based compensation expense - performance warrants 3,060
Exercise of stock options (2,513)
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Balance, December 31, 2009 20,315
Stock-based compensation expense - stock options (1) 10,577
Exercise of stock options (2,796)
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Balance, December 31, 2010 28,096
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(1) Included in the stock-based compensation expense is the non-cash impact
of forfeitures during the period.
13. PER SHARE INFORMATION
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December 31, December 31,
2010 2009
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Basic Net income (loss) per share $ 0.05 $ (0.21)
Weighted average shares outstanding 124,629,761 117,993,314
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Diluted Net income (loss) per share $ 0.05 $ (0.21)
Weighted average shares outstanding 127,662,373 117,993,314
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The weighted average diluted common shares outstanding for the year ended December 31, 2010 excludes 2,886,200 of stock options that are anti-dilutive. The average market value of the Corporation's shares for the purpose of calculating the dilutive effect of stock options and performance warrants was based on average quoted market prices for the period that the options and warrants were outstanding.
The basic and diluted weighted average common shares outstanding are the same for the year ended December 31, 2009 as the Corporation reported a net loss during that period.
14. COMMITMENTS
The Corporation is committed under an operating lease relating to its office premises beginning December 1, 2007 which expires on November 30, 2017. Birchcliff does not use all of the leased space and has sublet approximately 24% of the excess space to an arms' length party on a basis that recovers all of the rental costs for the first five years. The Corporation is committed to the following aggregate minimum lease payments (not reduced by rents receivable by the Corporation):
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Year Amount ($000's)
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2011 3,108
2012 3,118
2013 3,225
2014 3,225
2015 3,225
Thereafter 6,182
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The Corporation is also committed to March 29, 2011 under an operating lease for another office premises that it does not use and has sublet to an arm's length party on a basis that recovers all of its rental costs.
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15. SUPPLEMENTARY CASH FLOW INFORMATION
The following table details the components of non-cash working capital:
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December December
($000's) 31, 2010 31, 2009
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Provided by (used in)
Accounts receivable (9,577) 172
Prepaid and other 1,974 (1,604)
Accounts payable and accrued liabilities (4,009) (16,477)
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(11,612) (17,909)
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Provided by (used in)
Operating 1,429 (10,051)
Investing (13,041) (7,858)
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(11,612) (17,909)
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16. PRODUCTION EXPENSES
The Corporation's production expenses include all costs with respect to day-to-day well and facility operations. Processing recoveries related to joint venture and third party natural gas reduces production expenses.
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December December
For the years ended, ($000's) 31, 2010 31, 2009
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Field production costs 41,212 39,432
Processing recoveries (6,105) (3,830)
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Field production costs, net of recoveries 35,107 35,602
Expensed workovers and other 1,638 786
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Total production expenses 36,745 36,388
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END OF AUDITED FINANCIAL STATEMENTS
Advisory Regarding Reserves Data and Other Oil and Gas Information
Reserves Data: All estimates of reserves volumes and future net revenues disclosed herein are derived from the reserves evaluation dated February 9, 2011 which was prepared effective December 31, 2010 in accordance with National Instrument 51-101 by AJM Petroleum Consultants, an independent reserves evaluator.
Finding and Development Costs: With respect to disclosure of finding and development costs disclosed above:
(a) The amounts of finding and development and/or acquisition costs herein are calculated by dividing the total of the particular costs noted incurred during such year by the amounts of additions to proved reserves and proved and probable reserves during such year that resulted from the expenditure of such costs.
(b) In calculating the amounts of finding and development and/or acquisition costs for a year, the changes during the year in estimated future development costs and in estimated reserves are based upon the evaluation of Birchcliff's reserves prepared by AJM Petroleum Consultants effective December 31 of such year.
(c) National Instrument 51-101 requires the inclusion of the following warning statement:
The aggregate of the exploration and development costs incurred in the most recent financial year and any change during that year in estimated future development costs generally will not reflect total finding and development costs related to reserves additions for that year.
(d) The Press Release issued by Birchcliff on February 16, 2011 contains the required disclosure relating to the calculation of finding and development costs disclosed herein and the three year history of Birchcliff's finding and development costs.
Reserves For Portion of Properties: With respect to the disclosure of reserves contained herein relating to portions of Birchcliff's properties, the estimates of reserves and future net revenue for individual properties may not reflect the same confidence level as estimates of reserves and future net revenues for all properties due to the effects of aggregation.
Calculation of Net Present Values: Each of the net present value amounts disclosed herein is calculated using the pre-tax present value of the reserves estimated by AJM discounted at 10% without including any additional value for Birchcliff's substantial high working interest, undeveloped land base.
BOE Conversions: The term barrels of oil equivalent ("boe") may be misleading, particularly if used in isolation. Per barrel of oil equivalent ("boe") amounts have been calculated using a conversion rate of six thousand cubic feet of natural gas to one barrel of oil equivalent ("6:1"). A boe conversion ratio of 6:1 is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.
Forward Looking Statements: This document contains forward-looking statements regarding the business and operations of Birchcliff Energy Ltd. Please see the information and warnings regarding such forward looking statements set forth above in Management's Discussion and Analysis.
Birchcliff is a publicly traded company that trades on the TSX Exchange under the symbol "BIR".
This press release is not for distribution to United States Newswire Services or for dissemination in the United States.
Contact Information: Birchcliff Energy Ltd. Jeff Tonken President and CEO (403) 261-6401 (403) 261-6424 (FAX) or Birchcliff Energy Ltd. Bruno Geremia Vice President and CFO (403) 261-6401 (403) 261-6424 (FAX) or Birchcliff Energy Ltd. Jim Surbey Vice President, Corporate Development (403) 261-6401 (403) 261-6424 (FAX)