2010 A
Annual
l Repo
ort
Financial ($00
indicated)
00, except as ot
therwise
e royalties (1)
Revenue befor
(2)
per share (
per boe
Funds from op
perations
(2)
per share (
per boe
Net income (lo
oss)
(2)
per share (
Expenditures o
on fixed assets
al deficit(3)
ness
bentures (face v
ding at end of ye
d average shares
Working capita
Bank indebtedn
Convertible de
Shares outstand
Basic weighted
Operating
Daily Productio
on
as (mcf/d)
Natural ga
and NGLs (bbl
Crude oil
/d @ 6:1
Total boe
g (including hed
Average pricing
as ($/mcf)
Natural ga
and NGLs ($/b
Crude oil
Proved plus pr
robable reserves
as (bcf)
Natural ga
& NGLs (mbbl
Crude oil
oe
Total mbo
fe index (years)
Reserve li
ls)
(4)
value)
ear (000)
(000)
s/d)
dging)
bbl)
2010
ecember 31
Year ended De
Y
8
2008
7
2007
2009
06
200
364,
501
2.23
2
41
1.38
139
175,
1
1.07
19
9.88
(44,2
208)
0.27)
(0
223,3
308
64,4
290,6
148,5
164,0
163,4
452
657
544
092
467
101,5
7,2
24,
562
202
129
5
5.45
61
1.85
1,24
36,7
244,
45.2
760
291
27.5
2
429,
,492
2.80
2
3.70
43
,675
197,
1.29
0.11
20
,426)
(86,
(0
0.56)
,066
169,
48,
250,
218,
162,
153,
,809
,262
,471
,746
,140
104,
,527
,508
9,
,929
26,
6.24
6
5.16
55
1,14
43,
233,
40.2
,266
,292
28.2
2
741
1,962
5.32
6
62.82
361
1,087
2.59
30.58
3
(20
0,577)
(
(0.15)
255
5,591
62
587
219
142
139
2,959
7,404
9,195
2,825
9,483
122
11
32
2,878
1,793
2,273
8.14
87.08
8
7
704.3
57
7,386
174
4,767
15.2
557
7,358
19,727
41
5.18
4.66
48.41
50.97
5
14,758
21
1,143
271
2.65
2.22
24.78
24.79
2
49,814
4
7,535)
(7
(0.06)
8,725
148
2,754
22
7,426
547
4,612
224
8,269
138
9,604
119
0.62
59,487
15
41,191
4
41
10,574
18
80,730
10
05,390
80,958
8
94,074
9
6,998
116
8,075
0,462
10
23,754
2
9,962
29
7.21
65.38
6
6.86
62.44
442.7
546.4
5
4
47,524
61
1,131
21,317
12
2,203
152
12.1
11.4
(1) includes realiz
ed derivative gains
and losses
(2) based on basic
c weighted average
g
shares outstanding
(3) working capita
al deficit includes a
accounts receivable
, prepaid expenses
and
deposits, accou
unts payable and ac
ccrued liabilities, di
istributions payable
e, and
the current po
ortion of capital leas
se obligations
(4) based on fourt
th quarter average
production rates
CONTENTS
Message to Shareholders ........................................................................................................................................................................................... 3
Reserves ....................................................................................................................................................................................................................... 6
Management’s Discussion & Analysis ................................................................................................................................................................... 10
Consolidated Financial Statements ........................................................................................................................................................................ 34
Consolidated Balance Sheets .......................................................................................................................................................................... 37
Consolidated Statements of Loss, Comprehensive Loss and Deficit ....................................................................................................... 38
Consolidated Statements of Cash Flows ....................................................................................................................................................... 39
Notes To Consolidated Financial Statements .............................................................................................................................................. 40
ANNUAL GENERAL MEETING
Advantage Oil & Gas Ltd. is pleased to invite its shareholders and other interested parties to its Annual General Meeting to be held
in the Lecture Theatre Room at the Metropolitan Centre, 333 – 4th Avenue SW, Calgary, Alberta on Wednesday, May 25, 2011
commencing at 10:00 a.m. We ask those shareholders unable to attend the meeting to please complete and return your Form of
Proxy.
Advantage Oil & Gas Ltd. - 2
MESSAGE TO SHAREHOLDERS
Production Growth, Hedging and Reduced Costs Deliver Solid Financial and Operating Results
(cid:190) Production for the fourth quarter of 2010 averaged 24,308 boe/d, an increase of 18% as compared to the fourth quarter of
2009, after adjusting for non-core asset dispositions. Advantage’s daily production for 2010 exited at approximately 25,000
boe/d, exceeding our guidance of 24,000 boe/d due to stronger than expected well performance at Glacier. The Glacier gas
plant expansion is now completed with production exceeding 100 mmcf/d and corporate production at approximately
30,000 boe/d.
(cid:190) Funds from operations for the fourth quarter of 2010 increased 6% to $40.7 million or $0.25 per share, as compared to the
$38.5 million or $0.23 per share for the third quarter of 2010. For the year ended December 31, 2010, funds from operations
was $175.1 million or $1.07 per share, a decrease from $197.7 million or $1.29 per share during 2009 attributed primarily to
asset dispositions completed during the last two years.
(cid:190) For the three months and year ended December 31, 2010, our hedging program contributed a net gain of $9.8 million and
$45.1 million to funds from operations, respectively. Advantage’s hedging program has helped to stabilize and enhance our
cash flow for capital reinvestment requirements.
(cid:190) Operating costs for the fourth quarter of 2010 were $10.64/boe, a decrease of 3% as compared to $11.01/boe during the
fourth quarter of 2009. Operating costs per boe for 2010 was $10.66/boe, a decrease of 12% as compared to $12.11/boe
during 2009. Operating costs per boe have decreased considerably over the last several years as a result of the increasing
contribution of low cost production from Glacier, the disposition of higher cost non-core assets, and the continued
optimization of our other properties. We anticipate corporate operating costs will decline further in 2011 as a result of
increased production at Glacier.
(cid:190) The royalty rate for 2010 as a percentage of revenue was 14.0% as compared to 14.3% in 2009. For the fourth quarter of
2010, Advantage’s royalty rate was 12.2% as compared to 13.8% for the fourth quarter of 2009. We anticipate that our
corporate royalty rate will decline further due to increased production from Glacier where the effective royalty rate for a new
Glacier Montney well is anticipated to be approximately 5% over the life of the well.
(cid:190) Significant reductions in the average bank indebtedness during the last twelve months have led to a 31% decrease in total
interest expense as compared to the prior year.
(cid:190) As at December 31, 2010, Advantage’s bank debt was $290.7 million on a credit facility of $525 million with an unutilized
capacity of approximately $231.4 million. A total of $148.5 million of convertible debentures remain outstanding of which
$62.3 million will mature in December 2011 and the balance of $86.2 million will mature in January 2015.
(cid:190) Capital expenditures during the fourth quarter of 2010 amounted to $68.9 million for a total of $223.3 million for the year
ended December 31, 2010. Approximately 86% of our 2010 capital program has been invested at Glacier where we
successfully completed Phase II of our development program in the second quarter of 2010. The second half 2010 capital
spending has been focused on our Phase III development program at Glacier which consisted of drilling 28 net (28 gross)
horizontal wells and expanding our Glacier gas plant and gathering system capacity to 100 mmcf/d.
(cid:190) Additional capital activities during 2010 included 3 net (3 gross) oil wells at Eyehill, 2.8 net (3 gross) oil and gas wells at
Nevis, and 2.1 net (3 gross) oils wells at Sunset.
Glacier Production Exceeding 100 mmcf/d with Additional 100 mmcf/d of Production Capacity
(cid:190) Production performance at Glacier has been higher than anticipated with natural gas production averaging 53.3 mmcf/d for
the fourth quarter of 2010 and exiting 2010 at 60 mmcf/d (10,000 boe/d), which exceeded our guidance.
(cid:190) Phase III activities at Glacier are now substantially complete and production is exceeding 100 mmcf/d, which has progressed
ahead of schedule and on-budget.
(cid:190) An additional 100 mmcf/d (16,667 boe/d) of production capacity currently exists and additional wells will be brought on-
stream as required to offset declines and maintain production.
(cid:190) Optimization of drilling and completion practices combined with improved geological knowledge at Glacier has significantly
increased the horizontal well test rates through each of our development phases. The average test rate of the Upper Montney
wells for Phase III was 8.4 mmcf/d with an average of 13 fracs per well, surpassing our expectations.
Advantage Oil & Gas Ltd. - 3
Impressive Glacier Netbacks Enhanced by Low Cost Structure
(cid:190) Operating costs at Glacier are forecast to decrease from the $2.85/boe ($0.48/mcf) during the fourth quarter of 2010 to
$1.80/boe ($0.30/mcf) at 100 mmcf/d due to efficiencies created by increasing the production rate through Advantage’s
100% owned Glacier gas plant and the utilization of multi-well production well pads on our contiguous land block which
simplifies field operations.
(cid:190) All Montney horizontal wells drilled at Glacier after May 1, 2010 qualify for a royalty incentive of $2.7 to $3.4 million based
on a typical Glacier Montney horizontal well (total length of 4,200 to 4,500 metres). As a result, the effective royalty rate for
a new Glacier Montney well is anticipated to be approximately 5% over the life of the well.
(cid:190) The attractive royalty rates and low operating costs significantly enhances the netback and drilling economics of all of our
Glacier Montney drilling locations as indicated below:
Revenue (realized price)
Royalties (5% royalty rate)
Operating costs
Netback*
$/mcf
$4.00
(0.20)
(0.30)
$3.50
$/mcf
$5.00
(0.25)
(0.30)
$4.45
Operating netbacks
exceed 87% of
revenue
Well Drilling Economics pre-tax rate of return *
>39%
*Note: assumes 4.5 mmcf/d IP, 5 Bcf reserves & $5.5 million per well with total Glacier production of 100 mmcf/d
>66%
(cid:190) Based on netbacks of $3.50/mcf and $4.45/mcf, annualized cash flows are projected to be approximately $128 million and
$162 million respectively, which are in excess of estimated capital requirements to maintain a 100 mmcf/d production rate at
Glacier.
(cid:190) In summary, Glacier is a unique asset which provides the opportunity for Advantage to develop a large, scalable natural gas
resource play which contains decades of drilling inventory and with one of the lowest cost structures in the Western
Canadian Sedimentary Basin.
Commodity Hedging Program
(cid:190) Advantage’s hedging program includes 25% of our forecast net natural gas production for 2011 hedged at an average price
of Cdn$6.30 AECO per mcf and 34% of forecast net crude oil production for 2011 at Cdn$88.90 per bbl.
(cid:190) Additional details on our hedging program are available at our website at www.advantageog.com.
Creation of Longview Oil Corp.
(cid:190) On March 7, 2011, Advantage announced that Longview Oil Corp. (“Longview”), a wholly-owned subsidiary of the
Corporation, filed a preliminary prospectus on March 4, 2011 for an initial public offering (the “Offering”), which is targeted
to raise gross proceeds of $150 million prior to an over-allotment option of up to 15% of the base offering size, exercisable
30 days following the closing of the Offering. The closing of the Offering is expected to occur in April, 2011. Concurrent
with closing of the Offering, Longview will purchase certain oil-weighted assets from Advantage with fourth quarter 2010
average production of 6,220 boe/d (74% oil & NGLs), proved reserves of 20.1 mmboe and proved plus probable reserves
of 36.9 mmboe.
(cid:190) Advantage will receive consideration comprised of the net proceeds of the Offering, common shares of Longview and
proceeds of $100 million to be drawn from an independent Longview credit facility to be established at closing. Advantage
plans to use the cash proceeds from the transaction to reduce outstanding bank indebtedness. Advantage will retain an equity
ownership interest of approximately 68% of the common shares of Longview (approximately 63% if the over-allotment
option is exercised in full). The transaction is conditional upon customary industry conditions including the approval of the
Board of Directors of Advantage. As a result of the successful completion of the transaction, historical financial and
operating performance as well as forward-looking information may not be indicative of actual future performance.
(cid:190) For further details, please refer to the press release issued by Advantage on March 7, 2011 and the preliminary prospectus
filed by Longview on March 4, 2011, which are available at www.sedar.com and Advantage’s website www.advantageog.com.
Advantage Oil & Gas Ltd. - 4
Looking Forward
(cid:190) Drilling results at our cornerstone Glacier property have demonstrated that our Montney development is among the top tier
natural gas resource developments in North America. The attractive cost structure at Glacier which includes low operating
costs and low royalty rates combined with a multi-decade drilling inventory provides a strong foundation to drive future
development beyond 100 mmcf/d of production.
(cid:190) With the expansion of Glacier to 100 mmcf/d now completed, a review of well performance, facility capacity and actual
costs will be undertaken by Advantage to assess the timing and capital requirements for the next phase of growth at Glacier.
(cid:190) Advantage will provide additional corporate guidance and communicate future development plans on or about mid-year
2011.
Advantage Oil & Gas Ltd. - 5
Reserves
Advantage engaged our independent qualified reserves evaluator Sproule Associates Ltd. (“Sproule”) to update the reserves
analysis for the Company in accordance with National Instrument 51-101 and the COGE Handbook.
Reserves and production information included herein is stated on a Company Interest basis (before royalty burdens and including
royalty interests receivable) unless noted otherwise. This report contains several cautionary statements that are specifically required by
NI 51-101. In addition to the detailed information disclosed in this press release, more detailed information on a net interest basis
(after royalty burdens and including royalty interests) and on a gross interest basis (before royalty burdens and excluding royalty
interests) will be included in Advantage's Annual Information Form ("AIF") and will be available at www.advantageog.com and
www.sedar.com in the coming weeks.
Highlights - Company Interest Reserves (Working Interests plus Royalty Interests Receivable)
December 31, 2010
December 31, 2009
Proved plus probable reserves (mboe)
Present Value of 2P reserves discounted at 10%, before tax ($000)(1)
Net Asset Value per Share discounted at 10%, before tax (2)
Reserve Life Index (proved plus probable - years) (3)
Reserves per Share (proved plus probable) (2)
Bank debt per boe of reserves (4)
Convertible debentures per boe of reserves (4)
244,291
$2,515,972
$13.63
27.5
1.48
$1.18
$0.61
233,292
$2,773,428
$15.07
28.2
1.43
$1.06
$0.94
(1) Assumes that development of each property will occur, without regard to the likely availability to the Company of funding required for that
development.
(2) Based on 164.092 million Shares outstanding at December 31, 2010, and 162.746 million Shares outstanding as December 31, 2009.
(3) Based on Q4 average production and company interest reserves.
(4) Using boe's may be misleading, particularly if used in isolation. In accordance with NI 51-101, a boe conversion ratio for natural gas of 6 mcf: 1 bbl
has been used which is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value
equivalency at the wellhead.
Company Interest Reserves (Working Interests plus Royalty Interests Receivable)
Summary as at December 31, 2010
Proved
Developed Producing
Developed Non-producing
Undeveloped
Total Proved
Probable
Total Proved + Probable
Light & Medium Oil Heavy Oil
(mbbl)
(mbbl)
Natural
Gas Liquids
(mbbl)
Natural Gas
(mmcf)
Oil
Equivalent
(mboe)
10,540
751
2,795
14,086
10,289
24,375
1,447
150
95
1,692
2,853
4,545
4,464
129
621
5,214
2,626
7,840
208,206
28,672
499,788
736,666
508,519
1,245,185
51,152
5,809
86,809
143,770
100,521
244,291
Advantage Oil & Gas Ltd. - 6
Gross Working Interest Reserves (Working Interest only)
Summary as at December 31, 2010
Proved
Developed Producing
Developed Non-producing
Undeveloped
Total Proved
Probable
Total Proved + Probable
Light & Medium Oil Heavy Oil
(mbbl)
(mbbl)
Natural
Gas Liquids
(mbbl)
Natural Gas
(mmcf)
Oil
Equivalent
(mboe)
10,319
749
2,795
13,862
10,182
24,044
1,417
147
90
1,654
2,833
4,487
4,432
129
621
5,181
2,615
7,796
207,695
28,562
499,783
736,040
507,929
1,243,969
50,783
5,785
86,803
143,371
100,285
243,656
Present Value of Future Net Revenue using Sproule price and cost forecasts (1)(2)
($000)
Proved
Developed Producing
Developed Non-producing
Undeveloped
Total Proved
Probable
Total Proved + Probable
0%
$ 1,408,498
158,270
1,653,020
3,219,789
3,410,239
$ 6,630,028
Before Income Taxes Discounted at
10%
$ 819,727
89,107
525,190
1,434,024
1,081,948
$ 2,515,972
15%
$ 690,677
73,543
304,641
1,068,861
741,772
$ 1,810,633
(1) Advantage’s crude oil, natural gas and natural gas liquid reserves were evaluated using Sproule’s product price forecast effective December 31, 2010
prior to the provision for income taxes, interests, debt services charges and general and administrative expenses. It should not be assumed that the
discounted future revenue estimated by Sproule represents the fair market value of the reserves.
(2) Assumes that development of each property will occur, without regard to the likely availability to the Company of funding required for that
development.
Sproule Price Forecasts
The present value of future net revenue at December 31, 2010 was based upon crude oil and natural gas pricing assumptions prepared
by Sproule effective December 31, 2010. These forecasts are adjusted for reserve quality, transportation charges and the provision of
any applicable sales contracts. The price assumptions used over the next seven years are summarized in the table below:
Year
2011
2012
2013
2014
2015
2016
2017
WTI
Crude Oil
($US/bbl)
88.40
89.14
88.77
88.88
90.22
91.57
92.94
Edmonton Light Alberta AECO-C
Crude Oil
($Cdn/bbl)
93.08
93.85
93.43
93.54
94.95
96.38
97.84
Natural Gas
($Cdn/mmbtu)
4.04
4.66
4.99
6.58
6.69
6.80
6.91
Henry Hub
Natural Gas
($US/mmbtu)
4.44
5.01
5.32
6.80
6.90
7.00
7.11
Exchange
Rate
($US/$Cdn)
0.932
0.932
0.932
0.932
0.932
0.932
0.932
Advantage Oil & Gas Ltd. - 7
Net Asset Value using Sproule price and cost forecasts (Before Income Taxes)
The following net asset value ("NAV") table shows what is normally referred to as a "produce-out" NAV calculation under which the
current value of the Company’s reserves would be produced at forecast future prices and costs. The value is a snapshot in time and is
based on various assumptions including commodity prices and foreign exchange rates that vary over time.
($000, except per Share amounts)
Net asset value per Share (1) - December 31, 2009
Present value proved and probable reserves
Undeveloped acreage and seismic (2)
Working capital (deficit) and other
Convertible debentures
Bank debt
Net asset value - December 31, 2010
Net asset value per Share (1) - December 31, 2010
Before Income Taxes Discounted at
0%
$ 45.55
6,630,028
199,800
(41,839)
(148,544)
(288,852)
6,350,593
38.70
$
$
$
10%
$ 15.07
2,515,972
199,800
(41,839)
(148,544)
(288,852)
2,236,537
13.63
$
$
$
15%
$ 10.09
1,810,633
199,800
(41,839)
(148,544)
(288,852)
1,531,198
9.33
$
$
$
(1) Based on 164.092 million Shares outstanding at December 31, 2010, and 162.746 million Shares outstanding at December 31, 2009.
(2) Internal estimate
Gross Working Interest Reserves Reconciliation
Proved
Opening balance Dec. 31, 2009
Extensions
Improved recovery
Infill Drilling
Discoveries
Economic factors
Technical revisions
Acquisitions
Dispositions
Production
Light &
Medium Oil
(mbbl)
15,602
345
-
176
-
(93)
(430)
-
(167)
(1,570)
Heavy
Oil
(mbbl)
2,466
3
-
233
-
(8)
(49)
-
(709)
(282)
Natural Gas
Liquids
(mbbl)
5,266
42
-
91
-
(67)
678
16
(68)
(776)
Natural
Gas
(mmcf)
507,206
141,744
-
5,916
-
(40,732)
178,521
213
(19,758)
(37,070)
Oil
Equivalent
(mboe)
107,868
24,014
-
1,485
-
(6,957)
29,952
52
(4,237)
(8,807)
Closing balance at Dec. 31, 2010
13,862
1,654
5,181
736,040
143,371
Proved + Probable
Opening balance Dec. 31, 2009
Extensions
Improved recovery
Infill Drilling
Discoveries
Economic factors
Technical revisions
Acquisitions
Dispositions
Production
Light &
Medium Oil
(mbbl)
29,125
795
-
230
-
(154)
(4,121)
-
(260)
(1,570)
Heavy
Oil
(mbbl)
5,836
4
-
-
-
(13)
(41)
-
(1,017)
(282)
Natural Gas
Liquids
(mbbl)
7,749
46
-
138
-
(89)
802
25
(99)
(776)
Natural
Gas
(mmcf)
1,137,322
209,799
-
7,959
-
(33,158)
(11,766)
331
(29,448)
(37,070)
Oil
Equivalent
(mboe)
232,264
35,811
-
1,694
-
(5,782)
(5,321)
80
(6,284)
(8,807)
Closing balance at Dec. 31, 2010
24,044
4,487
7,796
1,243,969
243,656
Advantage Oil & Gas Ltd. - 8
Finding, Development & Acquisitions Costs (“FD&A”) (1)(2)(3)
2010 FD&A Costs – Gross Working Interest Reserves excluding Future Development Capital
Capital expenditures ($000)
Acquisitions net of dispositions ($000)
Total capital ($000)
Total mboe, end of year
Total mboe, beginning of year
Production, mboe
Reserve additions, mboe
FD&A costs ($/boe)
2010
2009
Three year average
F&D costs ($/boe)
2010
2009
Three year average
Proved
$
223,308
(69,676)
153,632
$
143,371
107,868
8,807
44,310
$
$
$
$
$
$
3.47
(4.55)
4.32
4.60
10.46
6.42
Proved + Probable
$
$
223,308
(69,676)
153,632
243,656
232,264
8,807
20,199
$
$
$
$
$
$
7.61
(1.08)
2.78
8.46
2.49
4.17
NI 51-101
2010 FD&A Costs – Gross Working Interest Reserves including Future Development Capital
Capital expenditures ($000)
Alberta Drilling Incentives ($000)
Acquisitions net of dispositions ($000)
Net change in Future Development Capital ($000)
Total capital ($000)
Reserve additions, mboe
FD&A costs ($/boe)
2010
2009
Three year average
F&D costs ($/boe)
2010
2009
Three year average
Proved
$
223,308
(3,258)
(69,676)
339,907
490,281
44,310
11.06
22.50
17.13
11.55
10.58
16.43
$
$
$
$
$
$
$
Proved + Probable
$
$
$
$
$
$
$
$
223,308
(3,258)
(69,676)
69,493
219,867
20,199
10.89
10.14
13.24
10.97
9.82
12.43
(1) Under NI 51-101, the methodology to be used to calculate FD&A costs includes incorporating changes in future development capital ("FDC")
required to bring the proved undeveloped and probable reserves to production. For continuity, Advantage has presented herein FD&A costs
calculated both excluding and including FDC.
(2) The aggregate of the exploration and development costs incurred in the most recent financial year and the 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. Changes in
forecast FDC occur annually as a result of development activities, acquisition and disposition activities and capital cost estimates that reflect
Sproule’s best estimate of what it will cost to bring the proved undeveloped and probable reserves on production.
(3) In all cases, the FD&A number is calculated by dividing the identified capital expenditures by the applicable reserve additions. Boes may be
misleading, particularly if used in isolation. A boe conversion ratio of 6 MCF:1 BBL is based on an energy equivalency conversion method primarily
applicable at the burner tip and does not represent a value equivalency at the wellhead.
Advantage Oil & Gas Ltd. - 9
Management’s Discussion & Analysis
The following Management’s Discussion and Analysis (“MD&A”), dated as of March 22, 2011, provides a detailed explanation of the
financial and operating results of Advantage Oil & Gas Ltd. (“Advantage”, the “Corporation”, “us”, “we” or “our”) for the three
months and year ended December 31, 2010 and should be read in conjunction with the audited consolidated financial statements. The
consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles (“GAAP”)
and all references are to Canadian dollars unless otherwise indicated. All per barrel of oil equivalent (“boe”) amounts are stated at a
conversion rate of six thousand cubic feet of natural gas being equal to one barrel of oil or liquids, based on an energy equivalency
conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead. Boes maybe
misleading, particularly if used in isolation.
Forward-Looking Information
This MD&A contains certain forward-looking statements, which are based on our current internal expectations, estimates, projections,
assumptions and beliefs. These statements relate to future events or our future performance. All statements other than statements of
historical fact may be forward-looking statements. Forward-looking statements are often, but not always, identified by the use of
words such as "seek", "anticipate", "plan", "continue", "estimate", "expect", "may", "will", "project", "predict", "potential", "targeting",
"intend", "could", "might", "should", "believe", "would" and similar or related expressions. These statements are not guarantees of
future performance.
In particular, forward-looking statements included in this MD&A include, but are not limited to, statements with respect to spending
and capital budgets; capital expenditure programs; the focus of capital expenditures; availability of funds for our capital program; effect
of asset dispositions in 2010 on financial performance; effect on production once current facilities and infrastructure expansion work
in Glacier, Alberta have been completed; expected production from Phase III of the Glacier development project; our future operating
and financial results; supply and demand for oil and natural gas; effect of natural gas prices on drilling activity and supply levels;
projections of market prices and costs; effect of natural gas and oil prices on the Corporation's financial performance; the size of, and
future net revenues from, reserves; the performance characteristics of our properties; effect on revenue of the Corporation's derivative
and hedging activities; the Corporation's hedging strategy; effect of the Corporation's risk management activities; projected royalty
rates; average royalty rates; plans to improve operating cost structure and effect on corporate operating costs; the amount of general
and administrative expenses; terms of the Corporation's credit facility; estimated tax pools; terms of the transaction with Longview Oil
Corp., including the timing of completion thereof; and the effect of implementation of International Financial Reporting Standards on
financial results and the timing of implementation. In addition, statements relating to "reserves" or "resources" are deemed to be
forward-looking statements, as they involve the implied assessment, based on certain estimates and assumptions, that the resources
and reserves described can be profitably produced in the future.
These forward-looking statements involve substantial known and unknown risks and uncertainties, many of which are beyond our
control, including changes in general economic, market and business conditions; stock market volatility; changes to legislation and
regulations and how they are interpreted and enforced; changes to investment eligibility or investment criteria; our ability to comply
with current and future environmental or other laws; actions by governmental or regulatory authorities including increasing taxes,
changes in investment or other regulations; changes in tax laws, royalty regimes and incentive programs relating to the oil and gas
industry; the effect of acquisitions; our success at acquisition, exploitation and development of reserves; unexpected drilling results,
changes in commodity prices, currency exchange rates, capital expenditures, reserves or reserves estimates and debt service
requirements; the occurrence of unexpected events involved in the exploration for, and the operation and development of, oil and gas
properties; hazards such as fire, explosion, blowouts, cratering, and spills, each of which could result in substantial damage to wells,
production facilities, other property and the environment or in personal injury; changes or fluctuations in production levels;
competition from other producers; the lack of availability of qualified personnel or management; individual well productivity; ability to
access sufficient capital from internal and external sources; credit risk; failure to complete the transaction with Longview Oil Corp.;
and failure to receive all required regulatory approvals for the transaction with Longview Oil Corp. Many of these risks and
uncertainties are described
is available at www.sedar.com and
www.advantageog.com. Readers are also referred to risk factors described in other documents Advantage files with Canadian securities
authorities.
in the Corporation’s Annual Information Form which
With respect to forward-looking statements contained in this MD&A, Advantage has made assumptions regarding: conditions in
general economic and financial markets; effects of regulation by governmental agencies; current commodity prices and royalty regimes;
future exchange rates; royalty rates; future operating costs; availability of skilled labour; availability of drilling and related equipment;
timing and amount of capital expenditures; the impact of increasing competition; and receipt of all required regulatory approvals for
the transaction with Longview Oil Corp.
Advantage Oil & Gas Ltd. - 10
Management has included the above summary of assumptions and risks related to forward-looking information provided in this
MD&A in order to provide shareholders with a more complete perspective on Advantage's future operations and such information
may not be appropriate for other purposes. Advantage’s actual results, performance or achievement could differ materially from those
expressed in, or implied by, these forward-looking statements and, accordingly, no assurance can be given that any of the events
anticipated by the forward-looking statements will transpire or occur, or if any of them do so, what benefits that Advantage will derive
there from. Readers are cautioned that the foregoing lists of factors are not exhaustive. These forward-looking statements are made as
of the date of this MD&A and Advantage disclaims any intent or obligation to update publicly any forward-looking statements,
whether as a result of new information, future events or results or otherwise, other than as required by applicable securities laws.
This MD&A discusses historical financial and operating performance as well as forward-looking information for the Corporation
excluding any potential impacts that may occur due to the successful completion of the transaction with Longview Oil Corp. (see
section “Creation of Longview Oil Corp.”). As a result, historical financial and operating performance as well as forward-looking
information may not be indicative of actual future performance.
Non-GAAP Measures
The Corporation discloses several financial measures in the MD&A that do not have any standardized meaning prescribed under
GAAP. These financial measures include funds from operations and cash netbacks. Management believes that these financial measures
are useful supplemental information to analyze operating performance and provide an indication of the results generated by the
Corporation’s principal business activities prior to the consideration of how those activities are financed or how the results are taxed.
Investors should be cautioned that these measures should not be construed as an alternative to net income, cash provided by operating
activities or other measures of financial performance as determined in accordance with GAAP. Advantage’s method of calculating
these measures may differ from other companies, and accordingly, they may not be comparable to similar measures used by other
companies.
Funds from operations, as presented, is based on cash provided by operating activities before expenditures on asset retirement and
changes in non-cash working capital. Cash netbacks are dependent on the determination of funds from operations and include the
primary cash revenues and expenses on a per boe basis that comprise funds from operations. Funds from operations reconciled to
cash provided by operating activities is as follows:
Three months ended
December 31
Year ended
December 31
($000)
Cash provided by operating activities
Expenditures on asset retirement
Changes in non-cash working capital
Funds from operations
2010
55,268
1,811
(16,335)
40,744
$
$
$
$
2009
39,383
947
7,951
48,281
% change
40
%
91
%
(305) %
(16) %
2010
202,494
6,275
(33,630)
175,139
$
$
2009
170,889
5,437
21,349
197,675
$
$
% change
18 %
15 %
(258) %
(11) %
Advantage Oil & Gas Ltd. - 11
Overview
Cash provided by operating
activities ($000)
Funds from operations ($000)
per share (1)
per boe
Three months ended
December 31
Year ended
December 31
2010
2009
% change
2010
2009
% change
$
$
$
$
55,268
40,744
0.25
18.21
$
$
$
$
39,383
48,281
0.29
23.24
%
40
%
(16)
%
(14)
%
(22)
$
$
$
$
202,494
175,139
1.07
19.88
$
$
$
$
170,889
197,675
1.29
20.11
%
18
%
(11)
(17)
%
%
(1)
(1) Based on basic weighted average shares outstanding.
Our financial and operating results during 2009 and 2010 have been impacted by dispositions completed during these years. In July
2009 we closed two major asset dispositions for net proceeds of $242.1 million representing production of approximately 8,100 boe/d.
On May 31 and June 3, 2010, we closed two additional asset dispositions of non-core natural gas weighted properties for net proceeds
of $66.5 million and representing production of approximately 1,700 boe/d. The net proceeds from the various dispositions were
utilized to reduce outstanding debt. As a result of the dispositions, total funds from operations decreased for the three months and
year ended December 31, 2010 compared to the same periods of 2009 with all revenues and expenses generally impacted.
For the year ended December 31, 2010 we continued to realize significant gains on derivatives which amounted to $45.1 million that
has helped to offset the continued weak natural gas prices and positively impact funds from operations. Hedging gains in 2010 were
lower than 2009 as we had a lower percentage of natural gas production hedged at lower average prices. Funds from operations has
also benefited during this year from higher crude oil prices and continued cost reductions, such as operating costs and interest
expense. Unfortunately, natural gas prices still remain weak and pose a continuing challenge to the entire natural gas industry. When
comparing the current quarter to the third quarter of 2010, our funds from operations per boe increased 6% to $18.21/boe from
$17.19/boe as both production and crude oil prices increased, partially offset by the impact of lower natural gas prices. Funds from
operations per share decreased from 2009 due to the decrease in total funds from operations and the increase in shares outstanding
attributable to 17 million shares issued in July 2009 as a result of an equity offering. Cash provided by operating activities has increased
during 2010 as compared to the prior year due to the decrease in funds from operations being more than offset by increases in
working capital deficit.
As a result of asset dispositions completed in 2009 and 2010 and changes in commodity prices, historical financial and
operating performance may not be indicative of actual future performance.
The primary factor that causes significant variability of the Corporation’s cash provided by operating activities, funds from operations,
and net income is commodity prices. Refer to the section “Commodity Prices and Marketing” for a more detailed discussion of
commodity prices and our price risk management.
Revenue
Three months ended
December 31
Year ended
December 31
2010
$
34,081
12,871
46,952
($000)
Natural gas excluding hedging
Realized hedging gains
Natural gas including hedging
Crude oil and NGLs
excluding hedging
Realized hedging gains (losses)
Crude oil and NGLs
39,060
including hedging
Total revenue (1)
86,012
(1) Total revenue excludes unrealized derivative gains and losses.
$
$
42,140
(3,080)
$
$
2009
$
$
33,281
20,325
53,606
% change
%
2
%
(37)
%
(12)
2010
146,572
55,360
201,932
$
$
2009
154,889
83,162
238,051
$
$
% change
%
(5)
%
(33)
%
(15)
$
49,229
(4,053)
(14)
(24)
%
%
$
172,796
(10,227)
$
188,116
3,325
%
(8)
%
(408)
$
$
45,176
98,782
(14)
(13)
%
%
$
$
162,569
364,501
$
$
191,441
429,492
(15)
%
%
(15)
Revenue, excluding hedging, was negatively impacted for the three months and year ended December 31, 2010, as compared to 2009,
primarily due to lower production attributable to our asset dispositions that closed in the third quarter of 2009 and the second quarter
of 2010. Production net of asset dispositions increased 16% for the year ended December 31, 2010 as compared to 2009 as a result of
Advantage Oil & Gas Ltd. - 12
our successful exploration and development activities. Natural gas revenue for 2010 benefited from significant increases to production
at our Montney natural gas resource play at Glacier, Alberta where we have increased production capacity by 140% since December
31, 2009. Additional increases in production have been realized now that our facilities and infrastructure expansion work have been
completed in the first quarter of 2011. Total revenue was also positively impacted by crude oil and NGLs prices, excluding hedging,
that have been higher for 2010 as compared to 2009 and partially offset reduced production from asset dispositions. However,
revenue has continued to be adversely impacted by natural gas prices that have been weak during the last two years due to many
factors, including the recession in the North American economy that has generally reduced energy demand and higher North
American natural gas production, both of which have maintained relatively high natural gas inventory levels.
Given the low natural gas price environment, our commodity price risk management program has delivered realized natural gas
hedging gains of $12.9 million and $55.4 million for the three months and year ended December 31, 2010, respectively. As crude oil
prices continued to strengthen throughout 2010, we realized crude oil hedging losses of $3.1 million and $10.2 million for the three
months and year ended December 31, 2010, respectively. The Corporation enters derivative contracts whereby realized hedging gains
and losses partially offset commodity price fluctuations, which can positively or negatively impact revenue. The realized natural gas
hedging gains have been significant and helped us stabilize cash flows and ensure that our capital expenditure program is substantially
funded by such cash flows.
Production
Natural gas (mcf/d)
Crude oil (bbls/d)
NGLs (bbls/d)
Total (boe/d)
Natural gas (%)
Crude oil (%)
NGLs (%)
Three months ended
December 31
Year ended
December 31
2010
106,125
4,886
1,734
24,308
73%
20%
7%
% change
26
%
%
(18)
%
(31)
%
8
2009
84,466
5,985
2,503
22,566
62%
27%
11%
2010
101,562
5,076
2,126
24,129
70%
21%
9%
% change
%
(3)
%
(30)
%
(7)
%
(10)
2009
104,527
7,225
2,283
26,929
65%
27%
8%
Average daily production during the fourth quarter of 2010 increased 8% above the same period of 2009, with natural gas production
increasing 26% while being offset by decreases in crude oil and NGLs production. Production from the fourth quarter of 2009 also
included approximately 1,990 boe/d related to assets disposed in 2010. After excluding production from these asset dispositions,
Advantage’s average daily production for the fourth quarter of 2010 increased approximately 18%, as compared to the same period of
2009. Average daily production for the fourth quarter of 2010 was comparable to the 24,287 boe/d reported in the third quarter of
2010 and our exit daily production rate for December 31, 2010 was approximately 25,000 boe/d, exceeding our guidance of exiting the
year at 24,000 boe/d. Average annual production for 2010 was lower than 2009 due to the impact of asset dispositions which was
partially offset by production growth at Glacier, Alberta. During the second quarter of 2010 our new 100% working interest gas plant
(“Glacier gas plant”) was brought on-stream ahead of schedule with production rates exceeding 50 mmcf/d (8,300 boe/d). Due to
stronger than expected well performance, we were able to further increase Glacier production ending the year exceeding 60 mmcf/d
(10,000 boe/d). This year represented another milestone in the development of our significant Montney reserves and resource
potential at Glacier by increasing production capacity 140%.
Phase III of our Glacier development project has progressed ahead of schedule and on-budget with production now exceeding 100
mmcf/d (16,667 boe/d). We have been very active in drilling, testing and completing wells at Glacier during the last half of 2010 and
into 2011. An additional 100 mmcf/d (16,667 boe/d) of production capacity currently exists and additional wells will be brought on-
stream as required to offset declines and maintain production. We expect corporate production to average approximately 26,600 to
27,200 boe/d for the first half of 2011 since completing the 100 mmcf/d Glacier gas plant expansion.
Advantage Oil & Gas Ltd. - 13
Commodity Prices and Marketing
Natural Gas
($/mcf)
Realized natural gas prices
Excluding hedging
Including hedging
AECO monthly index
Three months ended
December 31
Year ended
December 31
2010
2009
% change
2010
2009
% change
$
$
$
3.49
4.81
3.58
$
$
$
4.28
6.90
4.18
(18)
(30)
(14)
%
%
%
$
$
$
3.95
5.45
4.12
$
$
$
4.06
6.24
4.12
%
(3)
(13)
%
%
-
Realized natural gas prices, excluding hedging, were 18% lower for the three months ended and 3% lower for the year ended
December 31, 2010 as compared to the same periods of 2009. Our realized natural gas prices, excluding hedging, for this quarter
decreased 1% from the $3.51/mcf realized during the third quarter of 2010. Although natural gas prices have continued to remain
weak, our commodity hedging strategy has resulted in realized natural gas prices, including hedging, that well exceed current market
prices. Our realized natural gas prices, including hedging, have decreased during 2010 as compared to 2009 as we have less natural gas
production hedged for this year at lower average prices. Nevertheless, our hedging program has significantly mitigated the negative
impact from lower natural gas prices and has reduced the volatility of our cash flows.
During 2009 and 2010, natural gas prices have remained low from continued high US domestic natural gas production that has
increased supply and the ongoing weaker North American economy that has negatively impacted demand. These factors have resulted
in generally higher inventory during these years and has placed considerable downward pressure on natural gas prices. Heading into
the 2009/2010 winter season, we saw strong inventory withdraws which helped to modestly strengthen prices relative to the prior lows
experienced during the majority of 2009. However, as we exited the winter, natural gas prices significantly decreased and have
remained weak throughout 2010. During the 2010/2011 winter we have seen respectable storage withdraws that has helped to reduce
natural gas inventory to approximately the five-year average. Nevertheless, natural gas prices continue to remain weak as we exit the
winter. We continue to believe in the longer-term price support for natural gas as reduced drilling for new resource based natural gas
supplies and conventional natural gas will eventually reduce the supply levels. We continue to monitor these market developments
closely and will be proactive in implementing an appropriate hedging strategy to mitigate the volatility in our cash flow as a result of
fluctuations in natural gas prices.
Crude Oil and NGLs
($/bbl)
Realized crude oil prices
Excluding hedging
Including hedging
Realized NGLs prices
Excluding hedging
Realized crude oil and NGLs prices
Excluding hedging
Including hedging
WTI ($US/bbl)
$US/$Canadian exchange rate
Three months ended
December 31
Year ended
December 31
2010
2009
% change
2010
2009
% change
$
$
74.76
67.91
$
$
70.86
63.50
%
%
6
7
$
$
72.80
67.28
$
$
59.29
60.55
23 %
11 %
$
53.50
$
44.34
%
21
$
48.88
$
38.10
28 %
$
$
$
$
69.19
64.14
85.18
0.99
$
$
$
$
63.04
57.85
76.17
0.95
%
10
%
11
%
12
%
4
$
$
$
$
65.74
61.85
79.55
0.97
$
$
$
$
54.20
55.16
61.93
0.88
21 %
12 %
28 %
10 %
Realized crude oil and NGLs prices, excluding hedging, increased 10% and 21% for the three months and year ended December 31,
2010, as compared to the same periods of 2009. As compared to the third quarter of 2010, realized crude oil and NGLs prices,
excluding hedging, have increased 12% for the fourth quarter of 2010. Advantage’s realized crude oil price may not change to the
same extent as West Texas Intermediate (“WTI”), due to changes in the $US/$Canadian exchange rate and changes in Canadian crude
oil differentials relative to WTI.
The price of WTI fluctuates based on worldwide supply and demand fundamentals. There has been significant price volatility
experienced over the last several years whereby WTI reached historic high levels in the first half of 2008, followed by a record decline
in the latter half of the year and into early 2009, the result of demand destruction brought on by the global recession. There was
Advantage Oil & Gas Ltd. - 14
improvement during the last half of 2009 which continued during 2010 and significantly escalated into 2011 primarily influenced by
middle-east civil unrest, with WTI currently trading at approximately US$104/bbl. However, we have also seen a constant
strengthening of the $US/$Canadian exchange rate during these years such that our increase in realized price has been less than the
improvement in WTI. We continue to believe that the long-term pricing fundamentals for crude oil will remain strong with supply
management by the OPEC cartel and strong relative demand from many developing countries, such as China and India.
Commodity Price Risk
The Corporation’s financial results and condition will be dependent on the prices received for oil and natural gas production. Oil and
natural gas prices have fluctuated widely and are determined by economic and political factors. Supply and demand factors, including
weather and general economic conditions as well as conditions in other oil and natural gas regions, impact prices. Any movement in oil
and natural gas prices could have an effect on the Corporation’s financial condition and performance. Advantage has an established
financial hedging strategy and may manage the risk associated with changes in commodity prices by entering into derivative contracts.
Although these commodity price risk management activities could expose Advantage to losses or gains, entering derivative contracts
helps us to stabilize cash flows and ensures that our capital expenditure program is substantially funded by such cash flows. To the
extent that Advantage engages in risk management activities related to commodity prices, it will be subject to credit risk associated
with counterparties with which it contracts. Credit risk is mitigated by entering into contracts with only stable, creditworthy parties and
through frequent reviews of exposures to individual entities. In addition, the Corporation only enters into derivative contracts with
major banks that are members of our credit facility syndicate and international energy firms to further mitigate associated credit risk.
Our credit facilities also prohibit the Corporation from entering into any derivative contract where the term of such contract exceeds
three years. Further, the aggregate of such contracts cannot hedge greater than 60% of total estimated petroleum and natural gas
production over two years and 50% over the third year.
We have historically been active in entering financial contracts to protect future cash flows and currently the Corporation has the
following derivatives in place:
Description of Derivative
Term
Volume
Average Price
Natural gas - AECO
Fixed price
Fixed price
Fixed price
Fixed price
Crude oil – WTI
Fixed price
Fixed price
April 2010 to January 2011
January 2011 to December 2011
January 2011 to December 2011
January 2011 to December 2011
18,956 mcf/d
9,478 mcf/d
9,478 mcf/d
9,478 mcf/d
Cdn$7.25/mcf
Cdn$6.24/mcf
Cdn$6.24/mcf
Cdn$6.26/mcf
April 2010 to January 2011
January 2011 to December 2011
2,000 bbls/d
1,500 bbls/d
Cdn$69.50/bbl
Cdn$91.05/bbl
Advantage Oil & Gas Ltd. - 15
The derivative contracts have allowed us to fix the commodity price on anticipated production, net of royalties, as follows:
Commodity
Natural gas - AECO
January to March 2011
April to June 2011
July to September 2011
October to December 2011
Total 2011
Crude Oil - WTI
January to March 2011
April to June 2011
July to September 2011
October to December 2011
Total 2011
Approximate Production
Hedged, Net of Royalties (1)
Average
Price
34%
22%
21%
22%
25%
41%
30%
32%
32%
34%
Cdn$6.43/mcf
Cdn$6.24/mcf
Cdn$6.24/mcf
Cdn$6.24/mcf
Cdn$6.30/mcf
Cdn$84.42/bbl
Cdn$91.05/bbl
Cdn$91.05/bbl
Cdn$91.05/bbl
Cdn$88.90/bbl
(1) Approximate production hedged is based on our estimated average production by quarter, net of estimated royalty
payments.
For the year ended December 31, 2010, we recognized in income a net realized derivative gain of $45.1 million (December 31, 2009 -
$86.5 million net realized derivative gain) on settled derivative contracts as a result of average market prices decreasing below our
established average hedge prices. Our net realized derivative gain has decreased during 2010 as compared to 2009 as we have less
natural gas production hedged for this year at lower average prices and we realized losses on our crude oil hedges as WTI prices
increased. However, our successful commodity price risk management program continued to realize significant gains on derivatives for
the year ended December 31, 2010 that has helped to offset the continued weak natural gas prices and positively impact funds from
operations. As at December 31, 2010, the fair value of the derivative contracts outstanding and to be settled was a net asset of
approximately $22.6 million, an increase of $5.4 million from the $17.2 million net asset recognized as at December 31, 2009. For the
year ended December 31, 2010, this $5.4 million increase was recognized in income as an unrealized derivative gain (December 31,
2009 – $23.7 million unrealized derivative loss). The valuation of the derivatives is the estimated fair value to settle the contracts as at
December 31, 2010 and is based on pricing models, estimates, assumptions and market data available at that time. As such, the
recognized amounts are not cash and the actual gains or losses realized on eventual cash settlement can vary materially due to
subsequent fluctuations in commodity prices and foreign exchange rates as compared to the valuation assumptions. The Corporation
does not apply hedge accounting and current accounting standards require changes in the fair value to be included in the consolidated
statements of income (loss) and comprehensive income (loss) as an unrealized derivative gain or loss with a corresponding derivative
asset and liability recorded on the balance sheet. These derivative contracts will settle in 2011 corresponding to when the Corporation
will receive revenues from production.
Advantage Oil & Gas Ltd. - 16
Royalties
Royalties ($000)
per boe
As a percentage of revenue,
excluding hedging
Three months ended
December 31
Year ended
December 31
2010
$
$
9,313
4.16
12.2%
2009
$
$
11,390
5.49
13.8%
% change
(18)
(24)
(1.6)
%
%
%
2010
$
$
44,640
5.07
14.0%
2009
$
$
49,010
4.99
14.3%
% change
%
(9)
%
2
%
(0.3)
Advantage pays royalties to the owners of mineral rights from which we have leases. The Corporation currently has mineral leases with
provincial governments, individuals and other companies. Royalty expense includes the impact of gas cost allowance (“GCA”), which
is a reduction of royalties payable to the Alberta Provincial Government to recognize capital and operating expenditures incurred in
the gathering and processing of their share of natural gas production and does not generally fluctuate with natural gas prices. Total
royalties paid and royalties as a percentage of revenue decreased for the three months ended December 31, 2010 compared to the
same period of 2009 due to lower natural gas prices. For the year ended December 31, 2010, total royalties paid decreased due to
lower revenue from reduced production attributable to our asset dispositions while royalties as a percentage of revenue was
comparable.
Our average corporate royalty rates are significantly impacted by the Alberta Provincial Government’s royalty framework that was
revised effective January 1, 2009 for conventional oil, natural gas and oil sands whereby Alberta royalties are affected by depths, well
production rates, and commodity prices. Additionally, the Alberta Provincial Government implemented a number of drilling incentive
programs with reduced royalty rates over a period of time for qualifying wells. The majority of our wells brought on production since
April 1, 2009 qualify and benefit from a 5% royalty rate on the first 500 mmcf produced or one-year, whichever occurs first, and a
drilling credit of $200 per metre drilled that reduces capital spending. The drilling credit incentives are effective for qualifying wells
drilled and brought on production from April 1, 2009 to March 31, 2011 while the reduced 5% royalty rate program was made a
permanent incentive as of May 1, 2010. The Alberta Provincial Government also made changes in the Natural Gas Deep Drilling
Program (“NGDDP”) which reduces the vertical depth requirement to 2,000 metres (from 2,500 metres) and makes the program
permanent. As a result, all of our Montney horizontal wells at Glacier drilled after May 1, 2010 will qualify for the NGDDP which is
estimated to provide an additional royalty incentive of $2.7 to $3.4 million for a typical horizontal well (a typical Advantage horizontal
well at Glacier is 4,200 to 4,500 metres in total length). This royalty incentive results in an estimated 5 to 7% royalty rate for all
Montney horizontal wells for the life of the well. This significantly lowers the natural gas price threshold required to drill economic
wells and substantially improves the value of future reserves and upside potential at Glacier.
We expect our corporate royalty rate to be in the range of 13% to 15% for the first half of 2011. Alberta royalty rates will continue to
fluctuate based on commodity prices, individual well productivity, and our ongoing capital development plans.
Operating Costs
Operating costs ($000)
per boe
Three months ended
December 31
Year ended
December 31
2010
$
$
23,787
10.64
2009
$
$
22,847
11.01
% change
%
%
4
(3)
2010
$
$
93,875
10.66
2009
119,022
12.11
$
$
% change
(21)
(12)
%
%
Total operating costs increased 4% for the three months ended December 31, 2010 and decreased 21% for the year ended December
31, 2010 as compared to the same periods of 2009. The reduction in total operating costs for 2010 has been primarily due to the sale
of higher cost assets, increased production from Glacier and benefits of our ongoing optimization program. Total operating costs
increased modestly during the fourth quarter of 2010 as compared to the same period of 2009 due to an 8% increase in corporate
production and the impact of cold weather operations. Operating costs per boe decreased 12% from 2009 to 2010 and we anticipate
corporate operating costs will decline further in 2011 as a result of increasing production at Glacier. Operating costs at Glacier during
the fourth quarter of 2010 decreased to approximately $2.85/boe ($0.48/mcf) which has significantly improved the netbacks realized
from our Montney gas production. We estimate that operating costs at Glacier will be further reduced to a target of approximately
$1.80/boe ($0.30/mcf) at 100 mmcf/d due to the efficiencies created by increasing the production rate through our 100% owned
Glacier gas plant. We will seek further opportunities to improve our operating cost structure and expect corporate operating costs for
the first half of 2011 to be between $8.50 and $9.00/boe.
Advantage Oil & Gas Ltd. - 17
General and Administrative
General and administrative
Cash expense ($000)
per boe
Non-cash expense ($000)
per boe
Employees at December 31
Three months ended
December 31
Year ended
December 31
2010
2009
% change
2010
2009
% change
$
$
$
$
6,141
2.75
2,039
0.91
$
$
$
$
8,613
4.15
2,270
1.09
(29)
(34)
(10)
(17)
%
%
%
%
$
$
$
$
24,701
2.80
12,877
1.46
128
$
$
$
$
29,162
2.97
10,173
1.03
129
(15)
%
%
(6)
%
27
42
%
%
(1)
Cash general and administrative (“G&A”) expense for the three months and year ended December 31, 2010 has decreased as
compared to the same periods of 2009 due to incremental costs incurred in 2009 associated with the asset dispositions (approximately
$1.8 million for severance costs) and costs incurred for our corporate conversion and reorganization (approximately $2.5 million).
Non-cash G&A expense for the three months ended December 31, 2010 decreased 10% but increased 27% for the year ended
December 31, 2010, as compared to the same periods of 2009. Non-cash G&A expense is primarily comprised of Advantage’s
Restricted Share Performance Incentive Plan (“RSPIP” or the “Plan”) as approved by the shareholders with the purpose to retain and
attract employees, to reward and encourage performance, and to focus employees on operating and financial performance that results
in lasting shareholder return. The Plan authorizes the Board of Directors to grant restricted shares to service providers of the
Corporation, including directors, officers, employees and consultants. The number of restricted shares granted is based on the
Corporation’s share price return for a twelve-month period and compared to the performance of a peer group approved by the Board
of Directors. The share price return is calculated at the end of each and every quarter and is primarily based on the twelve-month
change in the share price. If the share price return for a twelve-month period is positive, a restricted share grant will be calculated
based on the return. If the share price return for a twelve-month period is negative, but the return is still within the top two-thirds of
the approved peer group performance, the Board of Directors may grant a discretionary restricted share award. Compensation cost
related to the Plan is recognized as equity-based compensation expense within G&A expense over the service period and incorporates
the share grant price, the estimated number of restricted shares to vest, and certain management estimates. For the year ended
December 31, 2010, we granted 2,547,020 restricted shares at an average grant price of $6.93 per restricted share and recognized $16.1
million of equity-based compensation expense, including a non-cash amount of $13.4 million, related to restricted shares granted to
service providers. During the year ended December 31, 2010 we issued 1,346,481 shares to service providers in accordance with the
vesting provisions of the Plan. As at December 31, 2010, 2,925,868 restricted shares remain unvested and will vest to service providers
over the next two years with a total of $8.1 million in compensation cost to be recognized over the future service periods.
Management Internalization
Three months ended
December 31
Year ended
December 31
Management internalization ($000)
per boe
2010
$
-
$
-
2009
$
-
$
-
% change
%
%
-
-
2010
$
-
$
-
2009
$
$
1,724
0.18
% change
(100)
(100)
%
%
In 2006, Advantage Energy Income Fund (the “Fund”) and Advantage Investment Management Ltd. (the “Manager”) reached an
agreement to internalize a pre-existing management contract arrangement. As part of the agreement, the Fund agreed to purchase all
of the outstanding shares of the Manager pursuant to the terms of the arrangement, thereby eliminating the management fee and
performance incentive effective April 1, 2006. The Trust Unit consideration issued in exchange for the outstanding shares of the
Manager was placed in escrow for a three-year period and was deferred and amortized into income as management internalization
expense over the specific vesting periods. As of June 23, 2009, the final Trust Units held in escrow vested and there is no subsequent
management internalization expense recognized.
Advantage Oil & Gas Ltd. - 18
Interest on Bank Indebtedness
Interest expense ($000)
per boe
Average effective interest rate
Bank indebtedness
at December 31 ($000)
Three months ended
December 31
2010
$
$
3,414
1.53
4.9%
2009
$
$
5,066
2.44
4.5%
% change
(33)
(37)
0.4
%
%
%
Year ended
December 31
2010
2009
$
$
13,545
1.54
5.0%
290,657
$
$
$
19,752
2.01
4.9%
250,262
$
% change
(31)
(23)
0.1
16
%
%
%
%
Total interest expense decreased 33% for the three months and 31% for the year ended December 31, 2010 as compared to 2009.
During the first half of 2009, Advantage experienced significantly lower average interest rates as bank lending rates declined in
response to rate reductions enacted by central banks to stimulate the economy. This reduced interest expense was partially offset by
additional interest expense on a higher average debt balance during that period. In June 2009 our credit facility was renewed and was
subject to generally higher basis point and stamping fee adjustments as was typically applied by financial institutions at that time.
Therefore, our average effective interest rate during 2010 has been slightly higher than 2009; however, this was significantly offset by
lower interest expense on the reduced average bank indebtedness that resulted from proceeds on various asset dispositions and both
the equity financing and convertible debenture issuance during the periods. Bank indebtedness has increased in the fourth quarter of
2010 as expected due to progress of the Phase III capital expenditure program at Glacier. Our revolving credit facility was renewed in
June 2010 and is subject to basis point and stamping fee adjustments ranging from 1.25% to 3.75%, depending on the Corporation’s
debt to cash flow ratio. The Corporation’s interest rates are primarily based on short term bankers acceptance rates plus a stamping
fee. We monitor the debt level to ensure an optimal mix of financing and cost of capital that will provide a maximum return to our
shareholders. Our current credit facilities have been a favorable financing alternative with an effective interest rate of 5.0% for the year
ended December 31, 2010.
Interest and Accretion on Convertible Debentures
Interest on convertible
debentures ($000)
per boe
Accretion on convertible
debentures ($000)
per boe
Convertible debentures maturity
value at December 31 ($000)
Three months ended
December 31
Year ended
December 31
2010
2009
% change
2010
2009
% change
$
$
2,303
1.03
$
$
2,344
1.13
%
%
(2)
(9)
$
$
11,486
1.30
$
$
13,676
1.39
(16)
%
%
(6)
$
$
939
0.42
$
$
379
0.18
148
133
%
%
$
$
4,097
0.47
$
$
2,354
0.24
74
96
%
%
$
148,544
$
218,471
(32)
%
Interest on convertible debentures for the three months and year ended December 31, 2010 has decreased compared to 2009 due to
the maturity of the 8.25% debentures on February 1, 2009, the 8.75% debentures on June 30, 2009, the 7.50% debentures on October
1, 2009, and the 6.50% debentures on June 30, 2010. The reduced interest has been partially offset by additional interest on our 5.00%
convertible debentures that were issued on December 31, 2009. Accretion on convertible debentures has increased for the three
months and year ended December 31, 2010 as compared to the same periods of 2009 due to the higher accretion expense on the
5.00% convertible debentures as a result of the greater value assigned to the equity component of the debenture representing the
conversion option available to debentureholders.
Advantage Oil & Gas Ltd. - 19
Depletion, Depreciation and Accretion
Depletion, depreciation
and accretion ($000)
per boe
Three months ended
December 31
Year ended
December 31
2010
2009
% change
2010
2009
% change
$
$
46,762
20.91
$
$
52,284
25.18
(11)
(17)
%
%
$
$
215,780
24.50
$
$
256,882
26.13
(16)
%
%
(6)
Depletion and depreciation of petroleum and natural gas properties is provided on the “unit-of–production” method based on total
proved reserves. Accretion represents the increase in the asset retirement obligation liability each reporting period due to the passage
of time. The depletion, depreciation and accretion (“DD&A”) provision has decreased for the three months and year ended December
31, 2010 compared to 2009 due to reduced production from the asset dispositions that closed during the periods and a lower average
rate of DD&A per boe. Our DD&A rate per boe has decreased considerably during 2010 as compared to 2009 due to a higher
proportion of proved reserves as compared to capital expenditures and future development capital. This change has occurred primarily
due to our successful exploration and development activities, particularly at Glacier, that contributed to a 33% increase in corporate
proved reserves.
Taxes
Current taxes paid or payable for the year ended December 31, 2010 amounted to $1.3 million, comparable to the expense for the
same period of 2009. Current taxes primarily represent Saskatchewan resource surcharge, which is based on the petroleum and natural
gas revenues earned within the province of Saskatchewan.
Future income taxes arise from differences between the accounting and tax bases of our assets and liabilities. For the year ended
December 31, 2010, the Corporation recognized a total future income tax reduction of $8.2 million compared to a future income tax
reduction of $10.9 million for the same period of 2009. The future income tax reduction for 2010 is comparable to 2009, although the
loss before taxes for the prior year was significantly higher, due to a $23.0 million future income tax expense impact recognized in the
third quarter of 2009 related to the corporate conversion that was completed during that period. As at December 31, 2010, the
Corporation had a total future income tax liability balance of $35.3 million, compared to $43.5 million at December 31, 2009.
Canadian generally accepted accounting principles require that a future income tax liability be recorded when the book value of assets
exceeds the balance of tax pools.
The Corporation has approximately $1.6 billion in tax pools and deductions at December 31, 2010, which can be used to reduce the
amount of taxes payable by Advantage. The estimated tax pools in place at December 31, 2010 are as follows:
December 31, 2010
Estimated Tax Pools
($ millions)
Undepreciated Capital Cost
Canadian Oil and Gas Property Expenses
Canadian Development Expenses
Canadian Exploration Expenses
Non-capital losses
Other
$
413
138
331
44
633
11
1,570
$
Advantage has a federal non-capital loss carry forward balance of approximately $633 million (December 31, 2009 - $508 million).
These losses expire between 2023 and 2030.
Advantage Oil & Gas Ltd. - 20
Net Loss
Three months ended
December 31
Year ended
December 31
Net loss ($000)
per share - basic and diluted
2010
(18,169)
(0.11)
$
$
2009
(14,213)
(0.09)
$
$
% change
28
22
%
%
2010
(44,208)
(0.27)
$
$
2009
(86,426)
(0.56)
$
$
% change
(49)
(52)
%
%
Net loss and net loss per share increased for the three months ended December 31, 2010 but decreased for the year ended December
31, 2010, as compared to the same periods of 2009. During the third quarter of 2009 and the second quarter of 2010 we completed
several asset dispositions that generally reduced all revenues and expenses as compared to the prior year. However, with our new
100% working interest Glacier gas plant that came on-stream during the second quarter of 2010, our corporate natural gas production
has increased 26% as compared to the fourth quarter of 2009 thereby exceeding disposed production. Revenue for 2010 was positively
impacted by higher crude oil prices as compared to 2009 but our major challenge continues to be the natural gas price environment
that has remained weak and adversely impacts revenue, which generally results in our recognized net loss regardless of other significant
positive accomplishments during the year. Low revenues were partially mitigated by our commodity hedging program that resulted in a
net realized derivative gain of $45.1 million for the year ended December 31, 2010 and a non-cash unrealized derivative gain of $5.4
million relating to the valuation of commodity hedging contracts outstanding as at December 31, 2010 that will not settle until 2011.
Our realized derivative gain has decreased during 2010 as compared to 2009 as we have less natural gas production hedged for this
year at lower average prices and we realized losses on our crude oil hedges as WTI prices increased. We continue to experience low
royalty rates due to weak natural gas prices and Alberta Provincial royalty reduction incentive plans relative to our capital development
program. Operating costs have continued to improve through increased production volumes at Glacier, divestment of higher cost
non-core assets and an aggressive optimization program that continues to demonstrate positive benefits. We anticipate that corporate
operating costs will further improve as a result of lower cost production from our Glacier property that is currently producing in
excess of 100 mmcf/d. Our net loss for 2010 is also lower relative to 2009 due to significant costs incurred during the third quarter of
2009 attributed to the corporate conversion, including the recognition of several one-time costs in G&A expense and a future income
tax expense of $23.0 million.
Cash Netbacks
Revenue
Realized gain on derivatives
Royalties
Operating costs
Operating
General and administrative (1)
Interest (2)
Interest on convertible debentures (2)
Income and capital taxes
Funds from operations and
cash netbacks
Three months ended
December 31
Year ended
December 31
2010
2009
2010
2009
$
$
$000
76,221
9,791
(9,313)
(23,787)
52,912
(6,141)
(3,376)
(2,303)
(348)
40,744
$
$
per boe
34.08
$
4.38
(4.16)
(10.64)
23.66
(2.75)
(1.51)
(1.03)
(0.16)
18.21
$
$
$
$000
82,510
16,272
(11,390)
(22,847)
64,545
(8,613)
(5,003)
(2,344)
(304)
48,281
$
$
per boe
39.74
$
7.84
(5.49)
(11.01)
31.08
(4.15)
(2.41)
(1.13)
(0.15)
23.24
$
$
$
$000
319,368
45,133
(44,640)
(93,875)
225,986
(24,701)
(13,346)
(11,486)
(1,314)
175,139
$
$
per boe
36.26
$
5.12
(5.07)
(10.66)
25.65
(2.80)
(1.52)
(1.30)
(0.15)
19.88
$
$
$
$000
343,005
86,487
(49,010)
(119,022)
261,460
(29,162)
(19,667)
(13,676)
(1,280)
197,675
$
$
per boe
34.90
$
8.80
(4.99)
(12.11)
26.60
(2.97)
(2.00)
(1.39)
(0.13)
20.11
$
(1) General and administrative expense excludes non-cash G&A and non-cash equity-based compensation expense.
(2) Interest excludes non-cash accretion expense.
Funds from operations decreased in total for the three months and year ended December 31, 2010 compared to the same periods of
2009 primarily due to our asset dispositions completed in the third quarter of 2009 and the second quarter of 2010 that generally
impacted all revenues and expenses. However, funds from operations have been positively impacted during 2010 due to completion of
the Glacier gas plant whereby we have realized production rates exceeding 50 mmcf/d (8,300 boe/d). Due to stronger than expected
well performance, we were able to exit 2010 with Glacier production exceeding 60 mmcf/d (10,000 boe/d). Funds from operations
per boe or cash netbacks decreased when compared to 2009 primarily due to lower realized derivative gains as we have less natural gas
production hedged for 2010 at lower average prices. However, our successful commodity price risk management program has still
enabled us to realize significant gains on derivatives of $45.1 million for the year ended December 31, 2010 that has helped to offset
Advantage Oil & Gas Ltd. - 21
the continued weak natural gas prices and positively impact funds from operations. Funds from operations has also benefited during
this year from higher crude oil prices and continued cost reductions. Unfortunately, natural gas prices still remain weak and pose a
continuing challenge to the entire natural gas industry. Operating costs per boe decreased as we continue to realize benefits from our
divestment of higher cost assets and the addition of lower cost production due to the completion of our Glacier gas plant. Interest
expense has also continued to decrease as we utilized proceeds from the various asset dispositions and both the equity financing and
convertible debenture issuance during the periods to repay bank indebtedness and maturing convertible debentures. When comparing
the current quarter to the third quarter of 2010, our funds from operations per boe increased 6% to $18.21/boe from $17.19/boe as
both production and crude oil prices increased, partially offset by the impact of lower natural gas prices.
Contractual Obligations and Commitments
The Corporation has contractual obligations in the normal course of operations including purchases of assets and services, operating
agreements, transportation commitments, sales contracts, bank indebtedness and convertible debentures. These obligations are of a
recurring and consistent nature and impact cash flow in an ongoing manner. The following table is a summary of the Corporation’s
remaining contractual obligations and commitments. Advantage has no guarantees or off-balance sheet arrangements other than as
disclosed.
($ millions)
Building leases
Pipeline/transportation
Capital lease obligations
Bank indebtedness (1)
Convertible debentures (2)
Total contractual obligations
$
$
$
Total
10.8
34.2
0.8
290.7
148.5
485.0
$
$
Payments due by period
2013
2.5
8.1
-
-
-
10.6
2012
3.4
8.4
-
290.7
-
302.5
$
$
2011
3.5
8.3
0.8
-
62.3
74.9
$
$
$
2014
1.4
7.3
-
-
-
8.7
2015
$
-
2.1
-
-
86.2
88.3
$
(1) The Corporation’s bank indebtedness does not have specific maturity dates. It is governed by a credit facility agreement with a syndicate of financial institutions.
Under the terms of the agreement, the facility is reviewed annually, with the next review scheduled in June 2011. The facility is revolving, and is extendible at each
annual review for a further 364 day period at the option of the syndicate. If not extended, the credit facility is converted at that time into a one-year term facility,
with the principal payable at the end of such one-year term. Management fully expects that the facility will be extended at each annual review.
(2) As at December 31, 2010, Advantage had $148.5 million convertible debentures outstanding (excluding interest payable during the various debenture terms). Each
series of convertible debentures are convertible to shares based on an established conversion price. All remaining obligations related to convertible debentures can
be settled through the payment of cash or issuance of shares at Advantage’s option.
Liquidity and Capital Resources
The following table is a summary of the Corporation’s capitalization structure.
($000, except as otherwise indicated)
Bank indebtedness (long-term)
Working capital deficit (1)
Net debt
Shares outstanding, representing shareholders' equity
Shares closing market price ($/share)
Market capitalization (2)
Convertible debentures maturity value (current and long-term)
Total capitalization
$
$
December 31, 2010
290,657
64,452
355,109
164,092,009
6.76
1,109,262
148,544
1,612,915
$
$
$
$
(1) Working capital deficit includes accounts receivable, prepaid expenses and deposits, accounts payable and
accrued liabilities, and the current portion of capital lease obligations.
(2) Market capitalization is a non-GAAP measure.
Advantage Oil & Gas Ltd. - 22
Advantage monitors its capital structure and makes adjustments according to market conditions in an effort to meet its objectives
given the current outlook of the business and industry in general. The capital structure of the Corporation is composed of working
capital, bank indebtedness, convertible debentures, capital lease obligations and shareholders’ equity. Advantage may manage its capital
structure by issuing new shares, repurchasing outstanding shares, obtaining additional financing either through bank indebtedness or
convertible debenture issuances, refinancing current debt, issuing other financial or equity-based instruments, declaring a dividend,
implementing a dividend reinvestment plan, adjusting capital spending, or disposing of assets. The capital structure is reviewed by
Management and the Board of Directors on an ongoing basis.
Management of the Corporation’s capital structure is facilitated through its financial and operational forecasting processes. The
forecast of the Corporation’s future cash flows is based on estimates of production, commodity prices, forecast capital and operating
expenditures, and other investing and financing activities. The forecast is regularly updated based on new commodity prices and other
changes, which the Corporation views as critical in the current environment. Selected forecast information is frequently provided to
the Board of Directors. This continual financial assessment process further enables the Corporation to mitigate risks. The Corporation
continues to satisfy all liabilities and commitments as they come due.
The current economic situation has placed considerable pressure on commodity prices. Natural gas prices have remained weak
throughout 2009 and 2010 due to the ailing economy as well as high inventory levels with AECO gas presently trading at
approximately $3.80/mcf. Crude oil has improved since early 2009 and has continued to increase with WTI at approximately
US$104/bbl. The outlook for the Corporation from prolonged weak natural gas prices would be reductions in operating netbacks and
funds from operations. Management has partially mitigated this risk through our commodity hedging program but the lower natural
gas price environment has still had a significant negative impact. In order to strengthen our financial position and balance our cash
flows, in 2009 we completed an equity financing, two asset dispositions, and issued 5.00% convertible debentures and in 2010 we
completed two additional asset dispositions. These steps have allowed us to repay significant bank indebtedness and maturing
convertible debentures and also enabled us to focus capital spending on our Glacier Montney natural gas resource play. However, we
continue to be very cognizant of improving our financial flexibility in the current environment and have initiated a process to sell
certain oil-weighted assets to Longview with an anticipated closing date in April, 2011. The net proceeds from the Transaction will be
utilized to further repay bank indebtedness.
We believe that Advantage has implemented strategies to protect our business as much as possible in the current industry and
economic environment. We have implemented a strategy to balance funds from operations and our capital program expenditure
requirements. A successful hedging program was also executed to help reduce the volatility of funds from operations. However, we are
still exposed to risks as a result of the current economic situation. We continue to closely monitor the possible impact on our business
and strategy, and will make adjustments as necessary with prudent management.
Shareholders’ Equity and Convertible Debentures
Advantage has utilized a combination of equity, convertible debentures and bank debt to finance acquisitions and development
activities.
As at December 31, 2010, the Corporation had 164.1 million shares outstanding. During 2010 we have issued 1,346,481 shares to
employees in accordance with the vesting provisions of the RSPIP. As at March 22, 2011, shares outstanding have increased to 164.5
million.
The Corporation had $148.5 million convertible debentures outstanding at December 31, 2010 that were immediately convertible to
13.0 million shares based on the applicable conversion prices (December 31, 2009 - $218.5 million outstanding and convertible to 15.8
million shares). During the year ended December 31, 2010, there were no conversions of debentures. The principal amount of 6.50%
convertible debentures matured on June 30, 2010 and was settled with $69.9 million in cash. As at March 22, 2011, the convertible
debentures outstanding have not changed from December 31, 2010. We have $62.3 million of 7.75% and 8.00% debentures that
mature in December 2011 and $86.2 million of 5.00% debentures that mature in January 2015. These obligations can be settled
through the payment of cash or issuance of shares at Advantage’s option.
Bank Indebtedness, Credit Facility and Other Obligations
At December 31, 2010, Advantage had bank indebtedness outstanding of $290.7 million. Bank indebtedness has increased $40.4
million since December 31, 2009, primarily the result of our significant capital expenditure program during this year. The
Corporation’s credit facility is $525 million, comprised of a $20 million extendible revolving operating loan facility and a $505 million
extendible revolving loan facility (the “Credit Facilities”). The Credit Facilities are collateralized by a $1 billion floating charge demand
debenture covering all assets of the Corporation. As well, the borrowing base for the Corporation’s credit facilities is determined
through utilizing our regular reserve estimates. The banking syndicate thoroughly evaluates the reserve estimates based upon their own
commodity price expectations to determine the amount of the borrowing base. Revisions or changes in the reserve estimates and
Advantage Oil & Gas Ltd. - 23
commodity prices can have either a positive or a negative impact on the borrowing base of the Corporation. The next annual review is
scheduled to occur in June 2011. There can be no assurance that the $525 million credit facility will be renewed at the current
borrowing base level at that time.
Advantage had a working capital deficiency of $64.5 million as at December 31, 2010. Our working capital includes items expected for
normal operations such as trade receivables, prepaids, deposits, trade payables and accruals as well as the current portion of capital
lease obligations. Working capital varies primarily due to the timing of such items, the current level of business activity including our
capital expenditure program, commodity price volatility, and seasonal fluctuations. Our working capital deficiency is usually higher at
the end of the year, as would be expected, due to accounts payable and accrued liabilities associated with our capital expenditure
program. We do not anticipate any problems in meeting future obligations as they become due given the level of our funds from
operations. It is also important to note that working capital is effectively integrated with Advantage’s revolving operating loan facility,
which assists with the timing of cash flows as required. Advantage has a capital lease obligation on various equipment used in its
operations. The total amount of principal obligation outstanding at December 31, 2010 is $0.8 million, bearing interest at an effective
rate of 5.8%, and is collateralized by the related equipment. The lease expires in 2011 at which time title of the equipment will transfer
to Advantage.
Capital Expenditures
($000)
Land and seismic
Drilling, completions and workovers
Well equipping and facilities
Other
Property dispositions
Net capital expenditures
Three months ended
December 31
2010
$
2009
$
1,023
55,902
11,896
97
68,918
(226)
68,692
$
$
(186)
33,566
24,615
51
58,046
34
58,080
$
$
Year ended
December 31
2010
2009
$
$
4,309
169,814
48,782
403
223,308
(69,676)
153,632
$
$
2,080
105,618
61,155
213
169,066
(245,150)
(76,084)
$
$
Advantage’s exploitation and development program is focused primarily at Glacier, Alberta where we are developing a significant
natural gas resource play. Our preference is to operate a high percentage of our properties such that we can maintain control of capital
expenditures, operations and cash flows. Advantage’s acquisition strategy has been to acquire long-life properties with strong drilling
opportunities while retaining a balance of year round access and risk.
For the year ended December 31, 2010, the Corporation spent a net $153.6 million and drilled a total of 50.2 net (63 gross) wells at a
98% success rate. Total capital spending included $192.4 million at Glacier, $5.3 million at Sunset, $3.9 million at Nevis, $4.5 million in
Saskatchewan, and the remaining balance at other areas. However, we continue to focus on development of our Montney natural gas
resource play at Glacier where Advantage will continue to employ a phased development approach. Phase II was completed during the
second quarter of 2010 and costs incurred were lower than anticipated due to our successful drilling program which demonstrated well
productivities that exceeded internal expectations and reduced drilling and completion costs. Construction of our facilities and gas
gathering system expansions were completed ahead of schedule and on-budget leading to an earlier than anticipated commissioning of
Advantage’s 100% working interest gas plant in March 2010. The Glacier gas plant has been operating at its design capacity with
throughput rates between 50 and 55 mmcf/d. Due to stronger than expected well performance, we were able to further increase
Glacier production ending the year exceeding 60 mmcf/d (10,000 boe/d). Our Phase III expansion began at the end of the second
quarter of 2010 and included the drilling of 28 net (28 gross) horizontal wells and the fabrication of a new processing train to facilitate
expansion of our Glacier gas plant to its current production capacity of 100 mmcf/d. In addition to the current production rate of 100
mmcf/d, we currently have an incremental 100 mmcf/d (16,667 boe/d) of production capacity available and additional wells will be
brought on-stream as required to offset declines and maintain production. The amount of excess field production capacity above our
current plant capacity is a result of our successful drilling program which demonstrated well test rates that exceeded expectations and
proved up a large portion of our undrilled acreage at Glacier.
On May 31 and June 3, 2010, we closed two additional asset dispositions of non-core natural gas weighted properties for net proceeds
of $66.5 million and representing production of approximately 1,700 boe/d. During 2010 we had a number of other minor
dispositions that were successfully completed. The net proceeds from the dispositions were utilized to reduce outstanding debt.
Advantage Oil & Gas Ltd. - 24
Sources and Uses of Funds
The following table summarizes the various funding requirements during the year ended December 31, 2010 and 2009 and the sources
of funding to meet those requirements:
($000)
Sources of funds
Funds from operations
Property dispositions
Increase in bank indebtedness
Decrease in working capital
Units issued, net of costs
Convertible debentures issued, less costs
Uses of funds
Expenditures on fixed assets
Convertible debenture maturities
Expenditures on asset retirement
Reduction of capital lease obligations
Decrease in bank indebtedness
Distributions to Unitholders
Increase in working capital
Year ended
December 31
2010
2009
$
$
175,139
69,676
41,068
15,002
-
-
300,885
223,308
69,927
6,275
1,375
-
-
-
300,885
$
$
$
$
$
$
197,675
245,150
-
-
96,770
82,515
622,110
169,066
82,107
5,437
2,299
336,933
23,481
2,787
622,110
Funds from operations decreased during the year ended December 31, 2010 compared to 2009, due to reduced production attributed
to asset dispositions and lower realized derivative gains from less natural gas production hedged for this year at lower average prices.
However, funds from operations were positively impacted during 2010 from an improvement in crude oil prices and continued cost
reduction efforts. Significant asset dispositions were completed in both 2010 and 2009 with proceeds utilized to generally repay bank
indebtedness and convertible debenture maturities. During the second quarter of 2010 our 6.50% convertible debentures matured and
were settled with $69.9 million in cash. Bank indebtedness increased in 2010 as would be expected due to our very active capital
expenditure program that included finalizing our Glacier Phase II program and commencing Phase III that comprised expanding the
Glacier gas plant to 100 mmcf/d and drilling 28 wells. We have focused on balancing our funds from operations and expenditures on
fixed assets to maintain a strong balance sheet and preserve financial flexibility.
Advantage Oil & Gas Ltd. - 25
Annual Financial Information
The following is a summary of selected financial information of the Corporation and the Fund for the years indicated.
Total revenue (before royalties) ($000)
Net loss ($000)
per share - basic and diluted
Total assets ($000)
Long term financial liabilities ($000) (1)
Distributions declared per Trust Unit (2)
Year ended
Dec. 31, 2010
$
364,501
$
(44,208)
$
(0.27)
$
1,842,571
$
363,675
$
-
Year ended
Year ended
Dec. 31, 2009 Dec. 31, 2008
741,962
$
(20,577)
$
$
(0.15)
2,302,746
$
718,511
$
1.40
$
$
$
$
$
$
$
429,492
(86,426)
(0.56)
1,927,241
383,797
0.08
(1) Long term financial liabilities exclude asset retirement obligations and future income taxes.
(2) On March 18, 2009 Advantage annouced the discontinuance of distributions.
Total revenue (before royalties) was significantly higher in 2008 as compared to 2009 and 2010 due to much stronger commodity
prices and higher production. However, a net loss was still experienced in 2008 as we recognized a $120.3 million impairment of
goodwill. For 2009 and 2010, total revenue (before royalties) decreased significantly as a result of considerably reduced commodity
prices and lower production resulting from various asset dispositions completed in these years. The lower commodity prices also
primarily contributed to the net losses recognized. Total assets have continually decreased from 2008 through 2010 due to the asset
dispositions and depletion, depreciation and accretion expense that has exceeded capital spending activity. From 2008 to 2010 we have
also experienced significant decreases in long term financial liabilities due to our concerted efforts to reduce debt, including utilizing
net proceeds from significant asset dispositions, an equity financing, and a convertible debenture issuance. We also suspended all
distributions in March 2009 and completed our conversion to a corporation in July 2009.
Quarterly Performance
($000, except as otherwise
indicated)
Daily production
2010
2009
Q4
Q3
Q2
Q1
Q4
Q3
Q2
Q1
Natural gas (mcf/d)
Crude oil and NGLs (bbls/d)
Total (boe/d)
106,125
6,620
24,308
104,714
6,835
24,287
107,821
7,395
25,365
87,346
7,975
22,533
84,466
8,488
22,566
91,200
8,431
23,631
124,990
10,212
31,044
117,968
10,942
30,603
Average prices
Natural gas ($/mcf)
Excluding hedging
Including hedging
AECO monthly index
Crude oil and NGLs ($/bbl)
Excluding hedging
Including hedging
WTI ($US/bbl)
Total revenues (before royalties)
Net income (loss)
per share - basic
- diluted
Funds from operations
Distributions declared
$
$
$
3.49
4.81
3.58
$
$
$
3.51
4.80
3.72
$
$
$
3.81
5.58
3.86
$
$
$
5.26
6.87
5.35
$
$
$
4.28
6.90
4.18
$
$
$
2.89
6.10
3.03
$
$
$
3.56
5.63
3.66
$
$
$
5.36
6.52
5.64
$
69.19
$
64.14
$
85.18
$
86,012
$
(18,169)
$
(0.11)
$
(0.11)
$
40,744
$
-
$
61.84
$
59.01
$
76.21
$
83,335
$
(16,915)
$
(0.10)
$
(0.10)
38,450
$
$
-
$
64.66
$
61.80
$
77.98
$
96,377
$
(22,279)
$
(0.14)
$
(0.14)
45,605
$
$
-
$
67.23
$
62.42
$
78.79
$
98,777
13,155
$
$
0.08
$
0.08
50,340
$
$
-
$
63.04
$
57.85
$
76.17
$
98,782
$
(14,213)
$
(0.09)
$
(0.09)
50,083
$
$
-
$
56.99
$
54.02
$
68.29
$
93,101
$
(53,293)
$
(0.33)
$
(0.33)
42,213
$
$
-
$
55.89
$
54.51
$
59.62
$
114,659
$
(37,810)
$
(0.26)
$
(0.26)
51,590
$
$
-
$
$
$
$
$
$
$
$
$
43.41
54.54
43.21
122,950
18,890
0.13
0.13
55,591
17,266
The table above highlights the Corporation’s and Fund’s performance for the fourth quarter of 2010 and also for the preceding seven
quarters. Production decreased modestly in the first quarter of 2009 as we experienced freezing conditions from early cold weather.
Production increased in the second quarter of 2009 due to recovery from these cold weather conditions and additional production
from a number of wells drilled during the first quarter of 2009 but delayed until after March 31, 2009 such that we could benefit from
the 5% Alberta Provincial royalty rate available on such wells. We experienced a significant decrease in production during the third
Advantage Oil & Gas Ltd. - 26
quarter of 2009 as we completed asset dispositions that closed in July 2009. The disposed properties represented approximately 8,100
boe/d of production. As the third quarter of 2009 still included 1,725 boe/d from the disposed properties, production in the fourth
quarter of 2009 actually increased 3% from the prior quarter due to a few new wells, partially offset by some natural declines and cold
weather conditions that typically cause production interruptions. An extended third party facility outage at our Lookout Butte property
that began in 2008 resulted in 1,100 boe/d of reduced production that continued through much of 2009 but was completed and our
production came back on in November 2009. Production for the first quarter of 2010 was comparable to the fourth quarter of 2009
but increased dramatically during the second quarter of 2010 as our new gas plant was completed and production from Glacier was
increased to between 50 and 55 mmcf/d. We completed two additional asset dispositions during the end of the second quarter of 2010
representing approximately 1,700 boe/d that resulted in modestly lower production. The full impact of these recent dispositions
resulted in the decrease in production for the third quarter of 2010 with our production remaining consistent during the fourth quarter
of 2010. Our financial results, particularly revenues and funds from operations, have declined since 2008, as commodity prices
decreased in response to the financial crisis that materialized in the fall of 2008 and commodity prices continued on a downward trend
through to the third quarter of 2009. We experienced improvements in commodity prices during the fourth quarter of 2009 and the
first quarter of 2010 that increased our revenues and funds from operations; however, natural gas prices still remained low. During the
remainder 2010, natural gas prices weakened again, which has decreased our corresponding revenues and funds from operations. Weak
commodity prices, particularly natural gas, have generally resulted in the recognized net losses for 2009 through 2010. Advantage did
report net income in the first quarter of 2009 as we recognized both significant realized and unrealized gains on our derivative
contracts and moderately lower expenses, including operating costs. Natural gas prices worsen during the second and third quarters of
2009 resulting in the recognition of net losses for the periods. The third quarter 2009 net loss was also impacted by additional costs
incurred related to the corporate conversion, including a $23.0 million future income tax expense, and increased depletion and
depreciation expense from a higher DD&A rate per boe that resulted from the asset dispositions. The net loss decreased during the
fourth quarter of 2009 as commodity prices marginally improved. Partially offsetting the net losses experienced during 2009 has been
the continuing reduction in costs including royalties and operating costs. We recognized net income during the first quarter of 2010
with improved crude oil prices and realized and unrealized gains on our derivative contracts associated with weak natural gas prices.
Natural gas prices worsened during the remainder of 2010, resulting in the continued net losses during these quarters.
Critical Accounting Estimates
The preparation of financial statements in accordance with GAAP requires Management to make certain judgments and estimates.
Changes in these judgments and estimates could have a material impact on the Corporation’s financial results and financial condition.
Management relies on the estimate of reserves as prepared by the Corporation’s independent qualified reserves evaluator. The process
of estimating reserves is critical to several accounting estimates. The process of estimating reserves is complex and requires significant
judgments and decisions based on available geological, geophysical, engineering and economic data. These estimates may change
substantially as additional data from ongoing development and production activities becomes available and as economic conditions
impact crude oil and natural gas prices, operating costs, royalty burden changes, and future development costs. Reserve estimates
impact net income through depletion and depreciation and impairment of petroleum and natural gas properties. The reserve estimates
are also used to assess the borrowing base for the Corporation’s credit facilities. Revision or changes in the reserve estimates can have
either a positive or a negative impact on net income and the borrowing base of the Corporation.
Management’s process of determining the provision for future income taxes, the provision for asset retirement obligation costs and
related accretion expense, the fair values initially assigned to the convertible debentures liability and equity components, and the fair
values assigned to any acquired company’s assets and liabilities in a business combination is based on estimates. These estimates are
significant and can include proved and probable reserves, future production rates, future petroleum and natural gas prices, future
costs, future interest rates, future tax rates and other relevant assumptions. Revisions or changes in any of these estimates can have
either a positive or a negative impact on asset and liability values and net income.
In accordance with GAAP, derivative assets and liabilities are recorded at their fair values at the reporting date, with unrealized gains
and losses recognized directly into net income and comprehensive income in the same period. The fair value of derivatives outstanding
is an estimate based on pricing models, estimates, assumptions and market data available at that time. As such, the recognized amounts
are non-cash items and the actual gains or losses realized on eventual cash settlement can vary materially due to subsequent
fluctuations in commodity prices and foreign exchange rates as compared to the valuation assumptions.
Advantage Oil & Gas Ltd. - 27
International Financial Reporting Standards
In February 2008, the Canadian Institute of Chartered Accountants (“CICA”) confirmed that Canadian GAAP for publicly
accountable enterprises will be replaced by International Financial Reporting Standards (“IFRS”) for the fiscal years beginning on or
after January 1, 2011. Accordingly, the conversion from Canadian GAAP to IFRS will be applicable to the Corporation’s reporting for
the first quarter 2011, for which the current and comparative information will be prepared under IFRS. We expect the transition to
IFRS will impact accounting, financial reporting, processes, internal controls over financial reporting, taxes, and information systems.
Management has engaged its key personnel responsible and developed an overall plan to address IFRS implementation. We anticipate
no impact on the Corporations operations or business strategy from conversion to IFRS.
Phase one of our plan consisted of a high level assessment to identify key areas of Canadian GAAP versus IFRS differences that
would most likely impact the Corporation. This assessment was completed in early 2009.
Phase two commenced in the third quarter of 2009 and involved the detailed assessment, from an accounting, financial reporting and
business perspective, of the changes that would be caused by the conversion to IFRS. Specific accounting processes and policy review
included: property, plant and equipment, exploration and evaluation costs, depreciation, impairment of assets, decommissioning
liabilities and provisions, deferred income taxes, financial reporting and information systems. The deliverables for this phase include
specific accounting policies for the above mentioned topics and also includes IFRS transitional choices. This phase is currently still in
progress but is being finalized. The most significant change identified for Advantage, as with many companies in the oil and gas
industry, will be associated with accounting for property, plant and equipment (“PP&E”). During the early stages of this phase, we had
concentrated on the accounting for PP&E and have now primarily completed our assessments with key policy choices to be approved
and finalized. We have now also evaluated most other accounting issues identified whereby differences between Canadian GAAP and
IFRS exist for Advantage and have completed preliminary assessments and developed draft accounting policies.
Phase three involves the execution of the work completed in phase two, by making changes to business and accounting processes and
supporting information systems, as well as the formal documentation of the final approved accounting policies and procedures
compliant with IFRS. This phase is progressing well and is expected to be completed in early 2011. Details surrounding the collection
of comparative financial and other data in 2010 are currently being finalized in this phase. We are also in the process of finalizing our
accounting policies and determining the financial impacts. We have completed our initial draft IFRS transitional balance sheet as of
January 1, 2010 and our first three quarters of 2010 financial statements based on preliminary selected accounting policies. Our
external auditors have been conducting their audit work of our transitional balance sheet and review of our first and second quarters
of 2010 financial statements. Their work is not yet completed and we will have ongoing discussions with them through the entire
process. We have now started to prepare draft IFRS financial statements for the fourth quarter of 2010 and believe we are on schedule
to complete the conversion within the required deadline. The draft transitional balance sheet and quarterly financial statements are
subject to change depending upon the finalization and approval of accounting policies.
Education and training of key financial employees has been primarily completed. Training of other staff, management, and the Board
is ongoing throughout the conversion project. Advantage views education and training as critical to our financial reporting controls
and is a permanent process that we will continue. We will begin an education program for key stakeholders upon finalizing the impacts
of the IFRS conversion project.
The Corporation has identified the following areas as having the greatest potential impact on the accounting policies, financial
reporting and information systems requirements upon conversion to IFRS. Differences between IFRS and Canadian GAAP in
addition to those referred to below, may still be identified based on further detailed analysis and other changes in IFRS prior to
conversion in 2011. Advantage has not yet finalized all of its accounting policies or transitional choices and as such is unable to
quantify all of the impacts on the financial statements of adopting IFRS at this time. Any accounting policy selections or potential
impacts referred to below are preliminary and are not finalized until all policies have been selected, approved by the Board of
Directors, and completion of the corresponding audit and reviews by our external auditors. We continue to monitor other IFRS
developments that may impact our choice of accounting policies.
a) Property, plant and equipment
The Corporation, like many Canadian oil and gas reporting issuers, applies the “full cost” concept in accounting for its oil and gas
assets. Under full cost, capital expenditures are maintained in a single cost centre for each country, and the cost centre is subject to a
single depletion and depreciation calculation and impairment test. IFRS will require the Corporation to make a much more detailed
assessment of its oil and gas assets that will impact depreciation and impairment calculations. Included in this assessment is an ongoing
appraisal of exploration and evaluation expenditures (“E&E”). Under Canadian GAAP, it is necessary to track costs associated with
unproved properties that would be excluded from depletion and depreciation calculations. Under IFRS, a company may choose to
expense E&E associated costs or capitalize such costs without recording depreciation expense until the expenditures are determined to
Advantage Oil & Gas Ltd. - 28
represent technically feasible and commercially viable projects at which time the costs are moved to development properties.
Advantage currently anticipates that it will select to capitalize E&E costs except for costs incurred before the acquisition of rights to
explore, and to begin depreciating when technically feasible and commercially viable. We do not anticipate this to have a material
impact on our financial results other than to the extent that expenditures may be incurred related to unsuccessful wells or projects that
will be expensed in the period incurred.
b) Depreciation
For Canadian GAAP purposes, the full cost method of accounting for oil and gas properties requires a single calculation of depletion
and depreciation of the carrying value of PP&E based on proved reserves. However, IFRS requires an allocation of the amount
recognized as PP&E to each significant identified component and each component depreciated separately, utilizing an appropriate
method of depreciation. This component depreciation of PP&E will result in an increased number of calculations of depreciation
expense and may impact the amount of depreciation expense recognized. IFRS also permits the option of using either proved or
proved and probable reserves in the depreciation calculation. Advantage has tentatively concluded at this time to utilize proved and
probable reserves which we would expect to decrease annual depreciation expense between $90 and $110 million.
c)
Impairment of Assets
Under Canadian GAAP, impairment calculations are prepared according to a two-step test generally conducted at a country level. Step
one involves a comparison of the PP&E carrying value to the undiscounted net cash flows of proved reserves. If a company should
fail step one, step two is completed to measure the amount of impairment whereby the PP&E carrying value is compared to a
calculated fair value with any excess carrying value above the fair value recognized as an impairment loss. Impairment losses
recognized under Canadian GAAP are not subsequently reversed. Under IFRS, impairment testing is completed at an individual asset
group or “Cash Generating Unit” level (“CGU”) when indicators suggest there may be impairment. A CGU is defined as the smallest
group of assets that produce independent cash flows. Impairment of assets at a CGU level use a one-step approach for testing and
measuring asset impairment, with asset carrying values compared to the higher of “Value in Use” and “Fair Value less Costs to Sell”.
The IFRS methodology may result in the possibility of more frequent impairments in the carrying value of PP&E. However, under
IFRS previous impairment losses (except for goodwill) must be reversed where circumstances change such that the previously
recognized impairment has been reduced. Advantage has completed an initial assessment of CGU’s as of the transition date and has
determined there to be 12 CGU’s. The number of CGU’s is subject to change as Advantage’s portfolio of assets may change through
development activities, acquisitions or dispositions.
d) Decommissioning Liabilities
Both Canadian GAAP and IFRS require a company to provide for a liability related to decommissioning PP&E. Both methodologies
are similar and we have determined there to be no significant difference for Advantage, other than a potential difference related to
discount rates. Canadian GAAP requires that the decommissioning liability be discounted at a credit-adjusted risk-free rate while IFRS
requires that the decommissioning liability be discounted at an appropriate rate with either the cash flows or rate adjusted for risks. As
a result, there currently is the possibility of using a risk-free rate or a credit-adjusted risk-free rate. Advantage has tentatively selected to
use the risk-free rate for discounting purposes, currently determined to be approximately 4%, and we expect this would increase the
decommissioning liability at transition date between $100 and $110 million.
e) Deferred Income Taxes
Future income taxes under Canadian GAAP and deferred income taxes under IFRS are similar for Advantage and we are continuing
to evaluate this complex area. However, any differences in decommissioning liabilities and PP&E, including depreciation, will impact
the carrying value as reported on the balance sheet and therefore result in a difference in the balance of deferred taxes reported under
IFRS.
f) First Time Adoption of International Financial Reporting Standards
IFRS 1 provides the framework for the first time adoption of IFRS and specifies that an entity shall apply the principles under IFRS
retrospectively. IFRS 1 also specifies that the adjustments that arise on retrospective conversion to IFRS from other GAAP should be
directly recognized in retained earnings. Certain optional exemptions and mandatory exceptions to retrospective application are
provided under IFRS 1. Advantage has chosen to apply an exemption that allows an entity that used full cost accounting, at adoption
of IFRS, to measure exploration and evaluation assets at the amount measured under its previous GAAP for those assets. The entity
may also measure its oil and gas assets in the development and production phases, by allocating the amount determined under the
entities previous GAAP to the underlying assets and areas pro rata using reserve volumes or reserve values as of that date. Advantage
has made a preliminary allocation based on proved and probable reserves values discounted at 10%. The allocation process had no
impact on Advantage’s carrying value of PP&E. As a result of applying this exemption, Advantage will also be required to complete an
Advantage Oil & Gas Ltd. - 29
impairment test under IFRS on the transition date. A preliminary impairment test has been completed for the tentatively determined
CGU’s and there is currently no impairment at transition date.
Advantage has also elected not to reevaluate prior completed business combinations under Canadian GAAP and has simply reviewed
such prior business combinations accounting to ensure that no assets were recognized that would be inappropriate under IFRS. We
have not found any such items and there will be no impact from choosing this exemption.
g) Financial Reporting
The adoption of IFRS will result in different presentation and additional disclosure requirements in the financial statements. Draft
IFRS financial statements including notes have been prepared and are being reviewed with our external auditors and Board of
Directors. We anticipate that review and discussion of the presentation and disclosures will continue until the first interim financial
statements are released for the quarter ended March 31, 2011.
h)
Information Systems
The adoption of IFRS will have an impact on information systems requirements. We have evaluated our financial reporting systems
and have made current changes to accommodate IFRS. We will continue assessing the need for additional system upgrades or
modifications to ensure an efficient conversion to IFRS and to improve ongoing processes.
i)
Internal Controls
In accordance with the Corporations approach to certification of internal controls required under Canadian Securities Administrators’
National instrument 52-109 and SOX 302 and 404, all entity level, information technology, disclosures and business process controls
will require updating and testing to reflect changes arising from our conversion to IFRS. Upon review with internal audit, we have
determined there to be minimal updating of processes, controls and documentation required. We will work on updating our processes,
controls and documentation during the final phase of IFRS conversion.
Controls and Procedures
The Corporation has established procedures and internal control systems to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Management of the
Corporation is committed to providing timely, accurate and balanced disclosure of all material information about the Corporation.
Disclosure controls and procedures are in place to ensure all ongoing reporting requirements are met and material information is
disclosed on a timely basis. The Chief Executive Officer and President and Chief Financial Officer, individually, sign certifications that
the financial statements, together with the other financial information included in the regular filings, fairly present in all material
respects the financial condition, results of operations, and cash flows as of the dates and for the periods presented in the filings. The
certifications further acknowledge that the filings do not contain any untrue statement of a material fact or omit to state a material fact
required to be stated or that is necessary to make a statement not misleading in light of the circumstances under which it was made,
with respect to the period covered by the filings.
Evaluation of Disclosure Controls and Procedures
The Corporation has established a Disclosure Committee consisting of the executive members with the responsibility of overseeing
the Corporation’s disclosure practices and designing disclosure controls and procedures, as specified under Canadian and US securities
law, 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 the Corporation under applicable securities legislation is recorded, processed, summarized and
reported within the time periods specified in applicable securities legislation and that all material information relating to the
Corporation is made known to them by others, particularly during the period in which the Corporation’s annual and interim filings are
being prepared. All written public disclosures are reviewed and approved by at least one member of the Disclosure Committee prior to
issuance. Additionally, the Disclosure Committee assists the Chief Executive Officer and President and Chief Financial Officer of the
Corporation in making certifications with respect to the disclosure controls of the Corporation required under applicable regulations
and ensures that the Board of Directors is promptly and fully informed regarding potential disclosure issues facing the Corporation.
Management of Advantage, including our Chief Executive Officer and President and Chief Financial Officer, has evaluated the
effectiveness of the design and operation of the disclosure controls and procedures as of December 31, 2010. Based on that
evaluation, our Chief Executive Officer and President and Chief Financial Officer have concluded that the disclosure controls and
procedures are effective as of the end of the period, in all material respects. It should be noted that while the Chief Executive Officer
and President and Chief Financial Officer believe that the Corporation’s design of disclosure controls and procedures provide a
reasonable level of assurance that they are effective, they do not expect that the disclosure controls and procedures or internal control
Advantage Oil & Gas Ltd. - 30
over financial reporting will prevent all errors and fraud. A control system does not provide absolute, but rather is designed to provide
reasonable assurance that the objective of the control system is met.
Management’s Report on Internal Controls over Financial Reporting
The Corporation’s Management is responsible for establishing and maintaining adequate internal control over financial reporting as
such term is defined in the rules of the United States Securities and Exchange Commission and the Canadian Securities
Administrators. The Corporation’s internal control over financial reporting is a process designed, under the supervision and with the
participation of executive and financial officers of the Corporation, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of the Corporation’s financial statements for external reporting purposes in accordance with
GAAP.
The Corporation’s internal control over financial reporting includes policies and procedures that: (i) pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets of the Corporation; (ii) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with
GAAP; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition
of the Corporation’s assets that could have a material effect on the financial statements.
The Corporation’s internal control over financial reporting may not prevent or detect all misstatements because of inherent limitations.
Additionally, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions or deterioration in the degree of compliance with the Corporation’s policies and
procedures.
The Corporation’s management assessed the design and effectiveness of the internal control over financial reporting as of December
31, 2010, based on the framework established in Internal Control – Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this assessment, the Chief Executive Officer and President and Chief Financial
Officer concluded that the Corporation maintained effective internal control over financial reporting as of December 31, 2010.
During the year ended December 31, 2010, there has been no change in the Corporation’s internal control over financial reporting that
has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
Corporate Governance
The Board of Directors’ mandate is to supervise the management of the business and affairs of the Corporation. In particular, all
decisions relating to: (i) the acquisition and disposition of properties for a purchase price or proceeds in excess of $5 million; (ii) the
approval of annual operating and capital expenditure budgets; and (iii) the establishment of credit facilities and the issuance of
additional shares, will be made by the Board.
The Board of Directors meets regularly to review the business and affairs of the Corporation to make any required decisions. The
Board of Directors consists of nine members, seven of whom are unrelated to the Corporation. The Independent Reserve Evaluation
Committee has four members, the Audit Committee has four members, and the Human Resources, Compensation and Corporate
Governance Committee has three members. All members of the various committees are independent. One member of the Audit
Committee has been designated a “Financial Expert” as defined in applicable regulatory guidance. In addition, the Chairman of the
Board is not related and is not an executive officer of the Corporation.
The Board of Directors approved and Management implemented a Code of Business Conduct and Ethics. The purpose of the code is
to lay out the expectation for the highest standards of professional and ethical conduct from our directors, officers and employees.
The code reflects our commitment to a culture of honesty, integrity and accountability and outlines the basic principles and policies
with which all employees are expected to comply. Our Code of Business Conduct and Ethics is available on our website at
www.advantageog.com.
As a foreign private issuer listed on the New York Stock Exchange (the "NYSE"), Advantage is not required to comply with most of
the NYSE rules and listing standards and instead may comply with domestic Canadian requirements. Advantage is, however, required
to comply with the following NYSE Rules: (i) Advantage must have an audit committee that satisfies the requirements of Rule 10A-3
under the United States Securities Exchange Act of 1934, as amended; (ii) the Chief Executive Officer must promptly notify the
NYSE in writing after an executive officer becomes aware of any material non-compliance with the applicable NYSE Rules; (iii)
submit an executed annual written affirmation to the NYSE, as well as an interim affirmation each time certain changes occurs to the
audit committee; and (iv) provide a brief description of any significant differences between its corporate governance practices and
those followed by U.S. domestic issuers listed under the NYSE. Advantage has reviewed the NYSE listing standards and confirms that
its corporate governance practices do not differ significantly from such standards.
A further discussion of the Corporation’s corporate governance practices can be found in the Management Proxy Circular.
Advantage Oil & Gas Ltd. - 31
Creation of Longview Oil Corp.
On March 7, 2011 Advantage announced that Longview Oil Corp. (“Longview”), a wholly-owned subsidiary of the Corporation, filed
a preliminary prospectus on March 4, 2011 for an initial public offering (the “Offering”), which is targeted to raise gross proceeds of
$150 million prior to an over-allotment option of up to 15% of the base offering size, exercisable 30 days following the closing of the
Offering. The closing of the Offering is expected to occur in April, 2011.
Longview was created to acquire certain oil-weighted assets (the “Acquired Assets”) located in West Central Alberta, Southeast
Saskatchewan and the Lloydminster area of Saskatchewan with fourth quarter 2010 average production of 6,220 boe/d (74% crude oil
and NGLs, proved reserves of 20.1 mmboe and proved plus probable reserves of 36.9 mmboe, based on a report prepared by Sproule
& Associates Limited on the Acquired Assets for Advantage and Longview with an effective date of December 31, 2010. Longview’s
business strategy is to provide shareholders with attractive long-term returns that combine both growth and yield by exploiting the
Acquired Assets in a financially disciplined manner, acquiring additional long-life oil and gas assets of a similar nature and through the
payment of a monthly dividend.
Concurrent with closing of the Offering, Longview will purchase the Acquired Assets from Advantage (the “Transaction”), with
consideration comprised of the net proceeds of the Offering, common shares of Longview and proceeds of $100 million to be drawn
from an independent Longview credit facility (which is anticipated to be $200 million) to be established at closing. Advantage plans to
use the cash proceeds from the Transaction to reduce outstanding bank indebtedness. The Transaction is conditional upon customary
industry conditions including the approval of the Board of Directors of Advantage.
Advantage will retain an equity ownership interest of approximately 67% of the common shares of Longview (approximately 62% if
the over-allotment option is exercised in full). Concurrent with closing of the Offering, Advantage will enter into a Technical Services
Agreement (the “TSA”) with Longview. Under the TSA, Advantage will provide the necessary personnel and technical services to
manage Longview's business and Longview will reimburse Advantage on a monthly basis for its share of administrative charges based
on respective levels of production. Longview will have an independent board of directors with three initial members. The officers of
Longview will provide services to Longview under the TSA but will remain as employees of Advantage.
As a result of the successful completion of the Transaction, historical financial and operating performance as well as
forward-looking information may not be indicative of actual future performance.
Outlook
During the first half of 2010, we successfully completed our Phase II Montney development program at Glacier which involved
drilling horizontal wells to build production inventory and delineate our land block. Construction on Advantage’s 100% working
interest gas plant and gathering system expansion was completed ahead of schedule and on-budget leading to an earlier than
anticipated commissioning during March 2010. The Glacier gas plant has since been operating at its design capacity with throughput
rates between 50 and 55 mmcf/d. Due to stronger than expected well performance, we were able to further increase Glacier
production ending the year exceeding 60 mmcf/d (10,000 boe/d).
Phase III of our Glacier development project began at the end of the second quarter of 2010 and included the drilling of 28 net (28
gross) horizontal wells and the fabrication of a new processing train to facilitate expansion of our Glacier gas plant to a production
capacity of 100 mmcf/d. At this time, in addition to the 100 mmcf/d of current production, we have an incremental 100 mmcf/d
(16,667 boe/d) of production capacity available and additional wells will be brought on-stream as required to offset declines and
maintain production. The amount of excess field production capacity above our current plant capacity is a result of our successful
drilling program which demonstrated well test rates that exceeded expectations and proved up a large portion of our undrilled acreage
at Glacier.
Drilling results at our cornerstone Glacier property have demonstrated that our Montney development is among the top tier natural
gas resource developments in North America. The attractive cost structure at Glacier which includes low operating costs and low
royalty rates combined with a multi-decade drilling inventory provides a strong foundation to drive future development beyond 100
mmcf/d of production. With the expansion of Glacier to 100 mmcf/d now completed, a review of well performance, facility capacity
and actual costs will be undertaken by Advantage to assess the timing and capital requirements for the next phase of growth at Glacier.
Advantage will provide additional corporate guidance and communicate future development plans on or about mid-year 2011.
Advantage Oil & Gas Ltd. - 32
Sensitivities
The following table displays the current estimated sensitivity on funds from operations and funds from operations per share to
changes in production, commodity prices, exchange rates and interest rates for 2011 including our hedging activities.
Impact on Annual Funds from Operations
$000
per share
Natural gas
AECO monthly price change of $1.00/Mcf
Production change of 6.0 mmcf/d
Crude oil and NGLs
WTI price change of US$10.00/bbl
Production change of 1,000 bbls/d
$US/$Canadian exchange rate change of $0.01
Interest rate change of 1%
$31,400
$7,500
$13,100
$24,800
$2,700
$3,400
$0.19
$0.05
$0.08
$0.15
$0.02
$0.02
Additional Information
Additional information relating to Advantage can be found on SEDAR at www.sedar.com and the Corporation’s website at
www.advantageog.com. Such other information includes the annual information form, the annual information circular – proxy
statement, press releases, material contracts and agreements, and other financial reports. The annual information form will be of
particular interest for current and potential shareholders as it discusses a variety of subject matter including the nature of the business,
description of our operations, general and recent business developments, risk factors, reserves data and other oil and gas information.
March 22, 2011
Advantage Oil & Gas Ltd. - 33
Ma
anagement’s
Responsibi
lity for Finan
ncial Stateme
ents
Consolidated
C
Financial St
tatements
The
con
con
prin
info
e Management
nsolidated finan
nsolidated finan
nciples and util
ormation conta
t of Advantage
ncial statement
ncial statement
lize the best es
ained throughou
e Oil & Gas L
s together with
ts have been p
stimates and ca
ut the annual re
Ltd. (the “Corp
h all operationa
repared by Ma
areful judgmen
eport is consiste
poration”) is r
al and other fin
anagement in a
nts of Managem
ent with that pr
responsible for
nancial inform
accordance wit
ment, where ap
rovided in the c
r the preparatio
mation contained
th Canadian ge
ppropriate. Ope
consolidated fin
on and presen
d in the annua
enerally accepte
erational and o
nancial stateme
ntation of the
al report. The
ed accounting
other financial
nts.
Ma
are
fina
tha
anagement has d
accurately and
ancial results w
t the Corporati
developed and
d reliably recor
within acceptabl
ion’s assets are
maintains a sys
rded, that the
le limits of mat
properly safegu
stem of interna
consolidated f
teriality, that al
uarded.
al controls desig
financial statem
ll other operatio
gned to provid
ments accuratel
onal and finan
de reasonable as
ly report the C
ncial informatio
ssurance that al
Corporation’s o
n presented is
ll transactions
operating and
accurate, and
The
fulf
Ma
mat
Ma
the
e Audit Comm
fills its financia
anagement, the
tters and vario
anagement and
se consolidated
mittee, comprise
al reporting an
external audito
ous aspects of
the external au
d financial state
d of non-mana
nd internal con
ors, and the int
f financial repo
uditors, and rec
ments.
agement directo
ntrol responsibi
ternal auditors
orting. The A
commended app
ors, acts on beh
ilities. The Aud
to discuss inte
udit Committe
proval to the B
half of the Boar
dit Committee
ernal controls o
ee reviewed th
Board of Direct
rd of Directors
is responsible
over financial r
he consolidated
tors. The Board
s to ensure that
e for meeting r
reporting proce
d financial sta
d of Directors
t Management
regularly with
esses, auditing
atements with
has approved
Pric
of t
loss
acc
cewaterhouseC
the Corporation
s, comprehensi
cordance with C
Coopers LLP, an
n, has audited t
ive loss and d
Canadian genera
n independent
the consolidate
deficit and cash
ally accepted au
firm of Charte
d balance sheet
h flows for the
uditing standard
ered Accountan
ts as at Decemb
e years then e
ds and have unl
nts, appointed b
ber 31, 2010 an
ended. The ex
limited and unr
by the shareho
nd 2009 and the
xternal auditor
restricted access
olders as the ex
e consolidated
s conducted th
s to the Audit C
xternal auditor
statements of
heir audits in
Committee.
An
CE
Ma
dy J. Mah
EO
arch 22, 2011
Kelly I. Drader
K
Pr
resident and CF
FO
Ma
anagement’s
Report on In
nternal Cont
rol over Fina
ancial Repor
The
con
as a
the
Com
as o
Bec
syst
pre
inad
Pric
aud
fina
opi
e Management
ntrol over finan
amended. Unde
effectiveness o
mmittee of Spo
of December 3
cause of inhere
tems determine
esentation. Furt
dequate becaus
cewaterhouseC
dit and provide
ancial reporting
inion.
of Advantage
ncial reporting f
er the supervisi
of our internal
onsoring Organ
1, 2010, our int
ent limitations,
ed to be effect
ther, projection
se of changes in
Coopers LLP, th
an independen
g as at Decem
Oil & Gas Ltd
for the Corpora
ion of our Chi
control over f
nizations of the
ternal control o
internal contr
tive can provid
s of any evalua
n conditions, or
he Corporation
nt opinion on b
ber 31, 2010, a
d. (the “Corpor
ation as such te
ef Executive O
financial report
e Treadway Com
over financial re
ol over financi
de only reasona
ation of effectiv
r that the degree
n’s independent
both the conso
as stated in th
ration”) is respo
erm is defined i
Officer and Chie
ting based on t
mmission (“CO
eporting was eff
ial reporting m
able assurance
veness to future
e of compliance
t firm of Chart
olidated financia
eir Auditor’s R
rting
onsible for esta
in Rule 13a-15
ef Financial Of
the Internal Co
OSO”). Based o
ffective.
may not preven
with respect t
e periods are su
e with the polic
tered Accounta
al statements a
Report. Pricewa
ablishing and m
(f) of the Secur
fficer, we have
ontrol-Integrate
on our assessm
maintaining ade
rities Exchange
conducted an
ed Framework
ment, we have co
quate internal
e Act of 1934,
evaluation of
issued by the
oncluded that
nt or detect mi
to the financial
ubject to the ris
cies or procedu
ants, was appoi
and the Corpor
aterhouseCoop
isstatements an
l statement pre
sk that controls
ures may deterio
inted by the sh
ration’s internal
pers LLP has p
nd even those
eparation and
s may become
orate.
hareholders to
l control over
provided such
An
CE
Ma
dy J. Mah
EO
arch 22, 2011
Kelly I. Drader
K
Pr
resident and CF
FO
Advantage
e Oil & Gas Ltd
d. - 34
March 22, 2011
Independent Auditor’s Report
To the Shareholders
of Advantage Oil & Gas Ltd.
PricewaterhouseCoopers LLP
Chartered Accountants
111 5 Avenue SW, Suite 3100
Calgary, Alberta
Canada T2P 5L3
Telephone +1 403 509 7500
Facsimile +1 403 781 1825
www.pwc.com/ca
We have completed integrated audits of Advantage Oil & Gas Ltd.’s 2010 and 2009
consolidated financial statements and its internal control over financial reporting as at December 31, 2010. Our
opinions, based on our audits, are presented below.
Report on the consolidated financial statements
We have audited the accompanying consolidated financial statements of Advantage Oil & Gas Ltd., which
comprise the consolidated balance sheets as at December 31, 2010 and 2009 and the consolidated statements of
loss, comprehensive loss and deficit and cash flows for the years then ended, and the related notes including a
summary of significant accounting policies.
Management’s responsibility for the consolidated financial statements
Management is responsible for the preparation and fair presentation of these consolidated financial statements in
accordance with Canadian generally accepted accounting principles and for such internal control as management
determines is necessary to enable the preparation of consolidated financial statements that are free from material
misstatement, whether due to fraud or error.
Auditor’s responsibility
Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We
conducted our audits in accordance with Canadian generally accepted auditing standards and the standards of the
Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform
an audit to obtain reasonable assurance about whether the consolidated financial statements are free from
material misstatement. Canadian generally accepted auditing standards require that we comply with ethical
requirements.
An audit involves performing procedures to obtain audit evidence, on a test basis, about the amounts and
disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgment,
including the assessment of the risks of material misstatement of the consolidated financial statements, whether
due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the
company’s preparation and fair presentation of the consolidated financial statements in order to design audit
procedures that are appropriate in the circumstances. An audit also includes evaluating the appropriateness of
accounting principles and policies used and the reasonableness of accounting estimates made by management,
as well as evaluating the overall presentation of the consolidated financial statements.
We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis
for our audit opinion on the consolidated financial statements.
Opinion
In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of
Advantage Oil & Gas Ltd. as at December 31, 2010 and 2009 and the results of its operations and cash flows for
the years then ended in accordance with Canadian generally accepted accounting principles.
Advantage Oil & Gas Ltd. - 35
Report on in
nternal contr
rol over finan
ncial reportin
ng
We have also
based on crit
Organization
o audited Adv
teria establish
ns of the Trea
vantage Oil &
hed in Interna
dway Commi
& Gas Ltd.’s in
al Control - Int
ssion (COSO
nternal contro
tegrated Fram
O).
ol over financi
mework, issue
al reporting a
ed by the Com
as at Decemb
mmittee of Sp
er 31, 2010
ponsoring
Managemen
Managemen
of the effectiv
on Internal C
nt’s responsi
t is responsib
veness of inte
Control over F
ibility for inte
ble for maintai
ernal control o
inancial Repo
ernal control
ining effective
over financial
orting.
l over financ
e internal con
reporting, inc
g
cial reporting
ncial reporting
ntrol over finan
accompanyin
cluded in the
g and for its a
ng Manageme
assessment
ent’s Report
Auditor’s re
Our respons
audit. We co
Public Comp
the audit to o
maintained in
sponsibility
ibility is to exp
nducted our a
pany Accounti
obtain reason
n all material
press an opin
audit of intern
ing Oversight
able assuran
respects.
nion on the co
nal control ove
t Board (Unite
ce about whe
ompany’s inte
er financial re
ed States). Th
ether effective
ernal control o
eporting in acc
hose standard
e internal cont
over financial
cordance with
ds require tha
trol over finan
reporting bas
h the standard
at we plan and
ncial reporting
sed on our
ds of the
d perform
g was
An audit of in
financial repo
operating eff
we consider
nternal contro
orting, assess
fectiveness of
necessary in
ol over financi
sing the risk th
f internal cont
the circumsta
al reporting in
hat a materia
trol based on
ances.
ncludes obtain
l weakness e
the assessed
ning an unde
exists, testing
d risk, and pe
rstanding of i
and evaluatin
erforming such
nternal contro
ng the design
h other proce
ol over
n and
edures as
We believe th
financial repo
hat our audit
orting.
provides a re
easonable bas
sis for our aud
dit opinion on
n the company
y’s internal co
ontrol over
Definition of
A company’s
regarding the
accordance w
includes thos
accurately an
assurance th
with generall
only in accor
assurance re
company’s a
f internal con
s internal cont
e reliability of
with generally
se policies an
nd fairly reflec
hat transaction
y accepted a
rdance with au
egarding prev
ssets that cou
ntrol over fin
trol over finan
financial repo
y accepted ac
nd procedures
ct the transac
ns are record
ccounting prin
uthorizations
vention or time
uld have a ma
nancial repor
ncial reporting
orting and the
ccounting prin
s that (i) perta
ctions and dis
ed as necess
nciples, and t
of managem
ely detection
aterial effect o
rting
g is a process
e preparation
nciples. A com
ain to the main
positions of th
sary to permit
that receipts a
ent and direc
of unauthoriz
on the financ
s designed to
of financial st
mpany’s intern
ntenance of r
he assets of t
t preparation o
and expenditu
ctors of the co
zed acquisition
ial statements
provide reaso
tatements for
nal control ov
records that, i
the company;
of financial st
ures of the co
ompany; and
n, use, or dis
s.
ance
onable assura
poses in
r external pur
eporting
ver financial re
e detail,
n reasonable
reasonable
; (ii) provide r
accordance
tatements in a
being made
ompany are b
(iii) provide re
easonable
e
position of the
mitations
ts inherent lim
nts. Also, proje
y become inad
rocedures ma
mitations, inte
rnal control o
ections of any
y evaluation o
ause of chang
dequate beca
.
ay deteriorate
over financial
of effectivenes
ges in conditio
reporting may
ss to future p
ons or that the
y not prevent
periods are su
e degree of c
t or detect
ubject to the ri
ompliance wi
isk that
ith the
n, Advantage
orting as at D
ssued by CO
e Oil & Gas Lt
ecember 31,
SO.
td. maintained
2010 based o
d, in all mater
on criteria est
rial respects,
tablished in In
effective inter
nternal Contro
ver
rnal control ov
d
ol - Integrated
Inherent lim
Because of it
misstatemen
controls may
policies or pr
Opinion
In our opinion
financial repo
Framework is
Chartered A
Accountants
Advantage
e Oil & Gas Ltd
d. - 36
Consolidated Balance Sheets
(thousands of dollars)
Assets
Current assets
Accounts receivable
Prepaid expenses and deposits
Derivative asset (note 11)
Derivative asset (note 11)
Fixed assets (note 3)
Liabilities
Current liabilities
Accounts payable and accrued liabilities
Current portion of capital lease obligations (note 4)
Current portion of convertible debentures (note 5)
Derivative liability (note 11)
Future income taxes (note 8)
Derivative liability (note 11)
Capital lease obligations
Bank indebtedness (note 6)
Convertible debentures (note 5)
Asset retirement obligations (note 7)
Future income taxes (note 8)
Other liability (note 9)
Shareholders' Equity
Share capital (note 10)
Convertible debentures equity component (note 5)
Contributed surplus (note 10)
Deficit
Commitments (note 13)
Subsequent events (note 14)
see accompanying Notes to Consolidated Financial Statements
On behalf of the Board of Directors of Advantage Oil & Gas Ltd:
December 31, 2010
December 31, 2009
$
$
42,276
6,488
25,157
73,921
-
1,768,650
1,842,571
54,531
9,936
30,829
95,296
323
1,831,622
1,927,241
$
$
$
112,457
759
61,570
2,367
5,876
183,029
177
-
288,852
72,811
58,281
29,399
1,835
634,384
2,199,491
15,896
17,754
(1,024,954)
1,208,187
1,842,571
$
$
111,901
1,375
69,553
12,755
4,704
200,288
1,165
759
247,784
130,658
68,555
38,796
3,431
691,436
2,190,409
18,867
7,275
(980,746)
1,235,805
1,927,241
$
__________________
Paul G. Haggis, Director
______________
Andy J. Mah, Director
Advantage Oil & Gas Ltd. - 37
Consolidated Statements of Loss,
Comprehensive Loss and Deficit
(thousands of dollars, except for per share amounts)
Revenue
Petroleum and natural gas
Realized gain on derivatives (note 11)
Unrealized gain (loss) on derivatives (note 11)
Royalties
Expenses
Operating
General and administrative
Management internalization (note 10)
Interest
Interest and accretion on convertible debentures
Depletion, depreciation and accretion
Loss before taxes
Future income tax reduction (note 8)
Income and capital taxes (note 8)
Net loss and comprehensive loss
Deficit, beginning of year
Distributions declared
Deficit, end of year
Net loss per share (note 10)
Basic and diluted
see accompanying Notes to Consolidated Financial Statements
Year ended
December 31, 2010
Year ended
December 31, 2009
$
319,368
45,133
5,381
(44,640)
325,242
93,875
37,578
-
13,545
15,583
215,780
376,361
(51,119)
(8,225)
1,314
(6,911)
(44,208)
(980,746)
-
(1,024,954)
$
$
343,005
86,487
(23,738)
(49,010)
356,744
119,022
39,335
1,724
19,752
16,030
256,882
452,745
(96,001)
(10,855)
1,280
(9,575)
(86,426)
(877,054)
(17,266)
(980,746)
$
$
(0.27)
$
(0.56)
Advantage Oil & Gas Ltd. - 38
Consolidated Statements of Cash Flows
(thousands of dollars)
Operating Activities
Net loss
Add (deduct) items not requiring cash:
Unrealized loss (gain) on derivatives
Equity-based compensation (note 10)
Non-cash general and administrative (note 9)
Management internalization
Accretion on other liability (note 9)
Accretion on convertible debentures
Depletion, depreciation and accretion
Future income tax reduction
Expenditures on asset retirement (note 7)
Changes in non-cash working capital
Cash provided by operating activities
Financing Activities
Convertible debenture maturities (note 5)
Increase (decrease) in bank indebtedness
Reduction of capital lease obligations
Units issued, less costs (note 10)
Convertible debentures issued, less costs (note 5)
Distributions to Unitholders
Changes in non-cash working capital
Cash used in financing activities
Investing Activities
Expenditures on fixed assets
Property dispositions (note 3)
Changes in non-cash working capital
Cash provided by (used in) investing activities
Net change in cash
Cash, beginning of year
Cash, end of year
Supplementary Cash Flow Information
Interest paid
Taxes paid
see accompanying Notes to Consolidated Financial Statements
Year ended
December 31, 2010
Year ended
December 31, 2009
$
(44,208)
$
(86,426)
(5,381)
13,415
(538)
-
199
4,097
215,780
(8,225)
(6,275)
33,630
202,494
(69,927)
41,068
(1,375)
-
-
-
(310)
(30,544)
(223,308)
69,676
(18,318)
(171,950)
-
-
$
-
$
$
21,533
1,200
23,738
6,392
3,781
1,724
85
2,354
256,882
(10,855)
(5,437)
(21,349)
170,889
(82,107)
(336,933)
(2,299)
96,770
82,515
(23,481)
500
(265,035)
(169,066)
245,150
18,062
94,146
-
-
$
-
$
$
31,335
1,410
Advantage Oil & Gas Ltd. - 39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010 and 2009
All tabular amounts in thousands except as otherwise indicated.
1.
Business and Structure of Advantage Oil & Gas Ltd.
Advantage Oil & Gas Ltd. (“Advantage” or the “Corporation”) is an intermediate oil and natural gas exploration and production
corporation with properties located in Western Canada. Advantage was created on July 9, 2009, through the completion of a plan
of arrangement pursuant to an information circular dated June 5, 2009. Advantage Energy Income Fund (the “Fund”) was
dissolved and converted into the corporation, Advantage Oil and Gas Ltd., with each Trust Unit converted into one Common
Share.
2.
Summary of Significant Accounting Policies
The Management of the Corporation prepares its consolidated financial statements in accordance with Canadian generally
accepted accounting principles (“Canadian GAAP”) and all amounts are stated in Canadian dollars. The preparation of
consolidated financial statements requires Management to make estimates and assumptions that affect the reported amount of
assets, liabilities and equity and disclosures of contingencies at the date of the consolidated financial statements and the reported
amounts of revenues and expenses during the periods. The following significant accounting policies are presented to assist the
reader in evaluating these consolidated financial statements and, together with the notes, should be considered an integral part of
the consolidated financial statements.
(a) Consolidation and joint operations
These consolidated financial statements include the accounts of the Corporation and all subsidiaries. All intercompany balances
and transactions have been eliminated.
The Corporation conducts exploration and production activities jointly with other participants. The accounts of the Corporation
reflect its proportionate interest in such joint operations.
(b) Fixed assets
(i) Petroleum and natural gas properties
The Corporation follows the “full cost” method of accounting in accordance with the guideline issued by the Canadian
Institute of Chartered Accountants (“CICA”) whereby all costs associated with the acquisition of and the exploration for and
development of petroleum and natural gas reserves, whether productive or unproductive, are capitalized in a Canadian cost
centre and charged to income as set out below. Such costs include lease acquisition, drilling and completion, production
facilities, asset retirement costs, geological and geophysical costs and overhead expenses related to exploration and
development activities, net of any government incentive programs.
Gains or losses are not recognized upon disposition of petroleum and natural gas properties unless crediting the proceeds
against accumulated costs would result in a change in the rate of depletion and depreciation of 20% or more.
Depletion of petroleum and natural gas properties and depreciation of lease, well equipment and production facilities is
provided on accumulated costs using the “unit-of-production” method based on estimated proved petroleum and natural gas
reserves, before royalties, as determined by independent engineers. For purposes of the depletion and depreciation calculation,
proved petroleum and natural gas reserves are converted to a common unit-of-measure on the basis of one barrel of oil or
liquids being equal to six thousand cubic feet of natural gas.
The depletion and depreciation cost base includes total capitalized costs, less costs of unproved properties, plus an estimate of
future development costs of proved undeveloped reserves. Costs of acquiring and evaluating unproved properties are
excluded from depletion calculations until it is determined whether or not proved reserves are attributable to the properties or
impairment occurs.
Petroleum and natural gas properties are evaluated in each reporting period to determine that the carrying amount in a cost
centre is recoverable and does not exceed the fair value of the properties in the cost centre (the “ceiling test”). The carrying
amounts are assessed to be recoverable when the sum of the undiscounted net cash flows expected from the production of
Advantage Oil & Gas Ltd. - 40
(i) Petroleum and natural gas properties (continued)
proved reserves, the lower of cost and market of unproved properties and the cost of major development projects exceeds the
carrying amount of the cost centre. When the carrying amount is not assessed to be recoverable, an impairment loss is
recognized to the extent that the carrying amount of the cost centre exceeds the sum of the discounted net cash flows
expected from the production of proved and probable reserves, the lower of cost and market of unproved properties and the
cost of major development projects of the cost centre. The net cash flows are estimated using expected future product prices
and costs and are discounted using a risk-free interest rate.
(ii) Furniture and equipment
The Corporation records furniture and equipment at cost and provides depreciation on the declining balance method at a rate
of 20% per annum which is designed to amortize the cost of the assets over their estimated useful lives. The Corporation
records leasehold improvements at cost and provides depreciation on the straight-line method over the term of the lease.
(c) Distributions
Distributions previously declared by the Fund were reported on an accrual basis.
(d) Financial instruments
The Corporation’s financial instruments consist of financial assets, financial liabilities, and non-financial derivatives. All financial
instruments are initially recognized at fair value on the balance sheet. Measurement of financial instruments subsequent to the
initial recognition, as well as resulting gains and losses, is based on how each financial instrument was initially classified. The
Corporation has classified each identified financial instrument into the following categories: held for trading, loans and
receivables, held to maturity investments, available for sale financial assets, and other financial liabilities. Held for trading financial
instruments are measured at fair value with gains and losses recognized in earnings immediately. Available for sale financial assets
are measured at fair value with gains and losses, other than impairment losses, recognized in other comprehensive income and
transferred to earnings when the asset is derecognized. Loans and receivables, held to maturity investments and other financial
liabilities are recognized at amortized cost using the effective interest method and impairment losses are recorded in earnings
when incurred. With all new financial instruments, an election is available that allows entities to classify any financial instrument as
held for trading. Only those financial assets and liabilities that must be classified as held for trading are classified as such by the
Corporation.
Derivative instruments executed by the Corporation to manage market risk associated with volatile commodity prices are
classified as held for trading and recorded on the balance sheet at fair value as derivative assets and liabilities. Gains and losses on
these instruments are recorded as unrealized gains and losses on derivatives in the consolidated statement of loss, comprehensive
loss and deficit in the period they occur and as realized gains and losses on derivatives when the contracts are settled. Since
unrealized gains and losses on derivatives are non-cash items, there is no impact on cash provided by operating activities as a
result of their recognition.
Transaction costs are frequently attributed to the acquisition or issue of a financial asset or liability. Such costs incurred on held
for trading financial instruments are expensed immediately. For other financial instruments, an entity can adopt an accounting
policy of either expensing transaction costs as they occur or adding such transaction costs to the fair value of the financial
instrument. The Corporation has chosen a policy of adding transaction costs to the fair value initially recognized for financial
assets and liabilities that are not classified as held for trading.
(e) Comprehensive income
Comprehensive income consists of net income and other comprehensive income (“OCI”) with amounts included in OCI shown
net of tax. Accumulated other comprehensive income is comprised of the cumulative amounts of OCI. To date, the Corporation
does not have any adjustments in OCI and therefore comprehensive loss is currently equal to net loss.
(f) Convertible debentures
The Corporation’s convertible debentures are financial liabilities consisting of a liability with an embedded conversion feature. As
such, the debentures are segregated between liabilities and equity based on the residual value method, where the liability is first
measured using a discount rate without the conversion feature and the remaining amount is allocated to equity. Therefore, the
debenture liabilities are presented at less than their eventual maturity values. The liability and equity components are further
reduced for issuance costs initially incurred. The discount of the liability component as compared to maturity value is accreted by
the “effective interest” method over the debenture term and expensed accordingly. As debentures are converted to shares, an
appropriate portion of the liability and equity components are transferred to share capital.
Advantage Oil & Gas Ltd. - 41
(g) Asset retirement obligations
The Corporation records the future cost associated with removal, site restoration and asset retirement costs. The fair value of the
liability for the Corporation’s asset retirement obligations is recorded in the period in which it is incurred, discounted to its
present value using the Corporation’s credit adjusted risk-free interest rate and the corresponding amount recognized by
increasing the carrying amount of fixed assets. The asset recorded is depleted on a “unit-of-production” basis over the life of the
reserves consistent with the Corporation’s depletion and depreciation policy for petroleum and natural gas properties. The liability
amount is increased each reporting period due to the passage of time and the amount of accretion is charged to income in the
period. Revisions to the estimated timing of cash flows or to the original estimated undiscounted cost could also result in an
increase or decrease to the obligation. Actual costs incurred upon settlement of the retirement obligations are charged against the
obligation to the extent of the liability recorded.
(h) Income taxes
The Corporation follows the “liability” method of accounting for future income taxes. Under this method future income tax
assets and liabilities are determined based on differences between the carrying value of an asset or liability and its tax basis using
substantively enacted tax rates and laws expected to apply when the differences reverse. The effect a change in income tax rates
has on future tax assets and liabilities is recognized in net income in the period in which the change is substantively enacted.
(i) Equity-based compensation
Advantage accounts for compensation expense based on the “fair value” of rights granted under its equity-based compensation
plans. Prior to converting to a corporation, the Fund had Trust Units held in escrow relating to management internalization (note
10) and a Restricted Trust Unit Plan. Subsequent to converting to a corporation, Advantage has a Restricted Share Performance
Incentive Plan (note 10).
The escrowed Trust Units relating to the management internalization vested equally over three years, the period during which
employees were required to provide service to receive the Trust Units. Therefore, the management internalization consideration
was being deferred and amortized into income as management internalization expense over the specific vesting periods during
which employee services were provided, including an estimate of future Trust Unit forfeitures.
Advantage’s Restricted Share Performance Incentive Plan (“RSPIP” or the “Plan”), authorizes the Board of Directors to grant
restricted shares to service providers of the Corporation, including directors, officers, employees, and consultants. The restricted
share grants generally vest one-third immediately on grant date, with the remaining two-thirds vesting evenly on the following two
yearly anniversary dates. Compensation cost related to the Plan is recognized as compensation expense within general and
administrative expense over the service period and incorporates the share grant price, the estimated number of restricted shares to
vest, and certain management estimates. As compensation expense is recognized, contributed surplus is recorded until the
restricted shares vest at which time the appropriate shares are then issued to the services providers and the contributed surplus is
transferred to share capital. The Plan replaced the previous Restricted Trust Unit (“RTU”) plan that was in place prior to the
conversion to a corporation and for which the accounting was the same.
(j) Revenue recognition
Revenue associated with the sale of petroleum, natural gas and natural gas liquids is recognized when the title and risks pass to the
purchaser, normally at the pipeline delivery point for natural gas and at the wellhead for crude oil.
(k) Per share amounts
Net loss per share is calculated using the weighted average number of shares outstanding during the year. Diluted net loss per
share is calculated using the “if-converted” method to determine the dilutive effect of convertible debentures and the “treasury
stock” method for equity-based compensation.
(l) Measurement uncertainty
The amounts recorded for depletion and depreciation of fixed assets, the provision for asset retirement obligation costs and
related accretion expense, impairment calculations for fixed assets, derivative fair value calculations, future income tax provisions,
fair values initially assigned to convertible debentures liability and equity components, as well as fair values assigned to any
identifiable assets and liabilities in business combinations are based on estimates. These estimates are significant and include
proved and probable reserves, future production rates, future petroleum and natural gas prices, future costs, future interest rates,
future tax rates, fair value assessments, and other relevant assumptions. By their nature, these estimates are subject to
measurement uncertainty and the effect on the consolidated financial statements of changes in such estimates in future years
could be material.
Advantage Oil & Gas Ltd. - 42
(m) Recent accounting pronouncements issued but not implemented
(i) International Financial Reporting Standards (“IFRS”)
Effective January 1, 2011, Advantage will adopt IFRS.
(n) Comparative figures
Certain comparative figures have been reclassified to conform to the current year presentation.
3.
Fixed Assets
December 31, 2010
Petroleum and natural gas properties
Furniture and equipment
December 31, 2009
Petroleum and natural gas properties
Furniture and equipment
Cost
3,366,697
12,188
3,378,885
$
$
Cost
3,218,785
11,785
3,230,570
$
$
Accumulated
Depletion and Depreciation
$
$
1,600,839
9,396
1,610,235
Accumulated
Depletion and Depreciation
$
$
1,390,784
8,164
1,398,948
$
Net Book
Value
1,765,858
2,792
1,768,650
$
$
Net Book
Value
1,828,001
3,621
1,831,622
$
In May and June 2010, Advantage closed two asset dispositions for net cash proceeds of $66.5 million, and other minor
dispositions of $3.2 million (December 31, 2009 - $245.2 million). As these dispositions did not result in a change of more than
20% in the rate of depletion and depreciation, no gain or loss was recognized.
During the year ended December 31, 2010, Advantage capitalized general and administrative expenditures directly related to
exploration and development activities of $9.6 million (December 31, 2009 - $10.2 million).
Costs of $30.7 million (December 31, 2009 - $38.2 million) for unproved properties have been excluded from the calculation of
depletion expense, and future development costs of $1.2 billion (December 31, 2009 - $845.3 million) have been included in costs
subject to depletion.
The Corporation performed a ceiling test calculation at December 31, 2010 to assess the recoverable value of fixed assets. Based
on the calculation, there has been no impairment of the Corporation’s petroleum and natural gas properties. The carrying
amounts are recoverable as compared to the sum of the undiscounted net cash flows expected from the production of proved
reserves based on the following benchmark prices:
Year
2011
2012
2013
2014
2015
2016
Approximate escalation rate after 2016
WTI Crude Oil
($US/bbl)
Exchange Rate
($US/$Cdn)
AECO Gas
($Cdn/mmbtu)
$ 88.40
$ 89.14
$ 88.77
$ 88.88
$ 90.22
$ 91.57
1.5%
$ 0.932
$ 0.932
$ 0.932
$ 0.932
$ 0.932
$ 0.932
-
$4.04
$4.66
$4.99
$6.58
$6.69
$6.80
1.5%
Benchmark prices are adjusted for a variety of factors, such as quality differentials, to determine the expected price to be realized
by the Corporation when performing the ceiling test calculation.
Advantage Oil & Gas Ltd. - 43
4.
Capital Lease Obligations
The Corporation has capital leases on a variety of fixed assets. Future minimum lease payments at December 31, 2010 consist of
the following:
2011
Less amounts representing interest
Current portion
$
779
(20)
759
(759)
$
-
Fixed assets subject to capital leases are depreciated on a “unit-of-production” basis over the life of the reserves consistent with
the Corporation’s depletion and depreciation policy for petroleum and natural gas properties and is included in depletion,
depreciation and accretion expense.
5.
Convertible Debentures
The convertible unsecured subordinated debentures pay interest semi-annually and are convertible at the option of the holder into
shares of Advantage at the applicable conversion price per share plus accrued and unpaid interest. The details of the convertible
debentures including fair market values initially assigned and issuance costs are as follows:
7.75%
8.00%
5.00%
Trading symbol
Issue date
Maturity date
Conversion price
Liability component
Equity component
Gross proceeds
Issuance costs
Net proceeds
AAV.DBD
AAV.DBG
Sep. 15, 2004 Nov. 13, 2006 Dec. 31, 2009
Jan. 30, 2015
Dec. 1, 2011 Dec. 31, 2011
20.33
$
$
AAV.DBH
$
21.00
8.60
$
47,444
2,556
$
14,884
26,561
$
73,019
13,231
50,000
(2,190)
41,445
-
86,250
(3,735)
$
47,810
$
41,445
$
82,515
The convertible debentures are redeemable prior to their maturity dates, at the option of the Corporation, upon providing
appropriate advance notification as per the debenture indentures. The redemption prices for the various debentures, plus accrued
and unpaid interest, is dependent on the redemption periods and are as follows:
Convertible
Debenture
Redemption Periods
7.75%
8.00%
5.00%
After December 1, 2009 and before December 1, 2011
After December 31, 2010 and before December 31, 2011
After January 31, 2013 and on or before January 30, 2015
Provided that Current Market Price exceeds 125% of Conversion Price
Redemption
Price
$
$
$
1,000
1,025
1,000
Advantage Oil & Gas Ltd. - 44
5.
Convertible Debentures (continued)
The balance of debentures outstanding at December 31, 2010 and changes in the liability and equity components during the years
ended December 31, 2010 and 2009 are as follows:
Trading symbol
Debentures outstanding
Liability component:
8.25%
AVN.DBB
$
-
8.75%
AVN.DBF
$
-
7.50%
AAV.DBC
$
-
6.50%
AAV.DBE
$
-
Balance at December 31, 2008
Accretion of discount
Matured
Balance at December 31, 2009
Accretion of discount
Matured
Balance at December 31, 2010
$
4,859
8
(4,867)
-
$
-
-
$
-
$
29,687
152
(29,839)
-
$
-
-
$
-
$
51,579
689
(52,268)
-
$
-
-
$
-
$
$
68,807
746
-
69,553
374
(69,927)
$
-
Equity component:
Balance at December 31, 2008
Expired
Balance at December 31, 2009
Expired
Balance at December 31, 2010
Trading symbol
Debentures outstanding
Liability component:
Balance at December 31, 2008
Issued
Accretion of discount
Matured
Balance at December 31, 2009
Accretion of discount
Matured
Balance at December 31, 2010
Equity component:
Balance at December 31, 2008
Issued
Expired
Balance at December 31, 2009
Expired
Balance at December 31, 2010
$
248
(248)
-
$
-
$
-
$
852
(852)
-
$
-
$
-
$
2,248
(2,248)
-
$
-
$
-
$
$
2,971
-
2,971
(2,971)
$
-
7.75%
AAV.DBD
46,766
$
8.00%
AAV.DBG
15,528
$
5.00%
AAV.DBH
86,250
$
Total
$
148,544
$
$
44,964
-
610
-
45,574
619
-
46,193
2,286
-
-
2,286
-
2,286
$
$
$
$
$
$
$
$
$
$
15,078
-
149
-
15,227
150
-
15,377
798
-
-
798
-
798
-
$
69,857
-
-
69,857
2,954
-
72,811
$
$
-
$
12,812
-
12,812
-
12,812
$
$
$
$
214,974
69,857
2,354
(86,974)
200,211
4,097
(69,927)
134,381
$
$
9,403
12,812
(3,348)
18,867
(2,971)
15,896
$
$
Advantage Oil & Gas Ltd. - 45
5.
Convertible Debentures (continued)
The principal amount of 8.25% convertible debentures matured on February 1, 2009 and were settled by issuing 946,887 Trust
Units. The 8.75% convertible debentures matured and were settled with $29.8 million in cash on June 30, 2009. The 7.50%
convertible debentures matured and were settled with $52.3 million in cash on September 30, 2009.
The principal amount of 6.50% convertible debentures matured and were settled with $69.9 million in cash on June 30, 2010.
On December 31, 2009, 5.00% convertible debentures were issued for net proceeds of $82.5 million. The debentures have a face
value of $1,000 per debenture, mature on January 30, 2015 and are convertible into shares of the Corporation at the option of the
holder at a conversion price of $8.60. The debentures pay interest semi-annually in arrears on January 31 and July 31 of each year,
commencing on July 31, 2010. The debentures will not be redeemable by the Corporation prior to January 31, 2013. On and after
January 31, 2013 and prior to January 30, 2015, the debentures may be redeemed by the Corporation in whole or in part from
time to time at the option of the Corporation at a redemption price equal to their principal amount plus accrued and unpaid
interest, provided that the Current Market Price is at least 125% of the Conversion Price. In the event that a holder of debentures
exercises their conversion right following a notice of redemption by the Corporation, such holder shall be entitled to receive
accrued and unpaid interest, in addition to the applicable number of shares to be received on conversion.
During the years ended December 31, 2010 and 2009, there were no convertible debenture conversions.
6.
Bank Indebtedness
Revolving credit facility
Discount on Bankers Acceptances and other fees
Balance, end of year
December 31, 2010
$
290,657
(1,805)
288,852
$
December 31, 2009
$
250,262
(2,478)
247,784
$
Advantage’s credit facilities of $525 million is comprised of a $20 million extendible revolving operating loan facility from one
financial institution and a $505 million extendible revolving loan facility from a syndicate of financial institutions (the "Credit
Facilities"). Amounts borrowed under the Credit Facilities bear interest at a floating rate based on the applicable Canadian prime
rate, US base rate, LIBOR rate or bankers' acceptance rate plus between 1.25% and 3.75% depending on the type of borrowing
and the Corporation’s debt to cash flow ratio. The Credit Facilities are collateralized by a $1 billion floating charge demand
debenture covering all assets of the Corporation. The amounts available to Advantage from time to time under the Credit
Facilities are based upon the borrowing base determined semi-annually by the lenders. The revolving period for the Credit
Facilities will end in June 2011 unless extended at the option of the syndicate for a further 364 day period. If the Credit Facilities
are not extended, they will convert to non-revolving term facilities due 365 days after the last day of the revolving period. The
credit facilities prohibit the Corporation from entering into any derivative contract where the term of such contract exceeds three
years. Further, the aggregate of such contracts cannot hedge greater than 60% of total estimated petroleum and natural gas
production over two years and 50% over the third year. The Credit Facilities contain standard commercial covenants for credit
facilities of this nature. The only financial covenant is a requirement for Advantage to maintain a minimum cash flow to interest
expense ratio of 3.5:1, determined on a rolling four-quarter basis. This covenant was met at December 31, 2010 and 2009. Breach
of any covenant will result in an event of default in which case Advantage has 20 days to remedy such default. If the default is not
remedied or waived, and if required by the lenders, the administrative agent of the lenders has the option to declare all obligations
under the credit facilities to be immediately due and payable without further demand, presentation, protest, days of grace, or
notice of any kind. Interest payments under the debentures are subordinated to the repayment of any amounts owing under the
credit facilities and are not permitted if the Corporation is in default of such credit facilities or if the amount of outstanding
indebtedness under such facilities exceeds the then existing current borrowing base. For the year ended December 31, 2010, the
average effective interest rate on the outstanding amounts under the facility was 5.0% (December 31, 2009 – 4.9%). Advantage
also has issued letters of credit totaling $2.9 million at December 31, 2010 (December 31, 2009 – $1.3 million).
Advantage Oil & Gas Ltd. - 46
7.
Asset Retirement Obligations
The Corporation’s asset retirement obligations result from net ownership interests in petroleum and natural gas properties
including well sites, gathering systems and processing facilities. The Corporation estimates the total undiscounted amount of cash
flows required to settle its asset retirement obligations is approximately $320 million which will be incurred between 2011 and
2070. A credit-adjusted risk-free rate of 7% and an inflation factor of 2% were used to calculate the fair value of the asset
retirement obligations.
A reconciliation of the asset retirement obligations is provided below:
Balance, beginning of year
Accretion expense
Liabilities incurred
Change in estimates
Property dispositions
Liabilities settled
Balance, end of year
8.
Income Taxes
Year ended
December 31, 2010
68,555
$
4,493
1,370
4,107
(13,969)
(6,275)
58,281
$
Year ended
December 31, 2009
73,852
$
5,297
699
16,419
(22,275)
(5,437)
68,555
$
The provision for income taxes varies from the amount that would be computed by applying the combined Canadian federal and
provincial income tax rates for the following reasons:
Loss before taxes
Canadian combined federal and provincial income tax rates
Expected income tax recovery at statutory rates
Increase (decrease) in income taxes resulting from:
Amounts included in trust income
Conversion to a corporation
Management internalization
Change in estimated pool balances
Equity-based compensation
Difference between current and expected tax rates
Other
Future income tax reduction
Income and capital taxes
Year ended
December 31, 2010
Year ended
December 31, 2009
$
(51,119)
28.17%
(14,400)
$
(96,001)
29.20%
(28,032)
-
-
-
-
4,674
696
805
(8,225)
1,314
(6,911)
$
(5,042)
22,637
503
(4,682)
2,393
-
1,368
(10,855)
1,280
(9,575)
$
Advantage Oil & Gas Ltd. - 47
8.
Income Taxes (continued)
The components of the future income tax liability are as follows:
December 31, 2010
December 31, 2009
Fixed assets in excess of tax basis
Asset retirement obligations
Non-capital tax loss carry forward
Net derivative assets
Other
Future income tax liability
Current future income tax liability
Long-term future income tax liability
$
$
211,355
(14,828)
(159,358)
6,034
(7,928)
35,275
5,876
29,399
35,275
$
$
$
$
$
$
193,821
(17,418)
(127,941)
4,867
(9,829)
43,500
4,704
38,796
43,500
Advantage has a federal non-capital loss carry forward balance of approximately $633 million (December 31, 2009 - $508 million).
These losses expire between 2023 and 2030.
The estimated tax pools in place at December 31, 2010 are as follows:
December 31, 2010
Estimated Tax Pools
($ millions)
Undepreciated Capital Cost
Canadian Oil and Gas Property Expenses
Canadian Development Expenses
Canadian Exploration Expenses
Non-capital losses
Other
$
413
138
331
44
633
11
1,570
$
9.
Other Liability
In August 2009, Advantage vacated an office location as the space was no longer required. Advantage is obligated to make lease
payments for the remainder of the life of the lease, which terminates in November 2012. As a result, the full fair value of future
scheduled lease payments was recognized as general and administrative expense in 2009 with a corresponding liability. Fair value
was determined on a present value basis, using a credit-adjusted risk free rate of 7%. In November 2010, Advantage subleased a
portion of the space to a subtenant, and accordingly recognized a reduction in the liability and a corresponding recovery of
general and administrative expense.
A reconciliation of the other liability is as follows:
Year ended
Year ended
Balance, beginning of year
Office lease liability incurred
Accretion expense
Reduction of liability by subleasing space
Liability settled
Balance, end of year
December 31, 2010 December 31, 2009
$
3,431
-
199
(538)
(1,257)
1,835
$
-
3,781
85
-
(435)
3,431
$
$
Advantage Oil & Gas Ltd. - 48
10.
Shareholders’ Equity
(a) Share capital
(i) Authorized
The Corporation is authorized to issue an unlimited number of shares without nominal or par value.
(ii) Issued
Balance at July 9, 2009
Issued on conversion to a corporation
Issued pursuant to Restricted Share Performance Incentive Plan
Balance at December 31, 2009
Issued pursuant to Restricted Share Performance Incentive Plan
Balance at December 31, 2010
Number of Shares
-
162,197,790
547,738
162,745,528
1,346,481
164,092,009
Amount
-
$
2,186,802
3,607
2,190,409
9,082
2,199,491
$
$
On July 9, 2009, the Fund successfully completed the plan of arrangement pursuant to an information circular dated June 5, 2009.
The Fund was dissolved and converted into the Corporation, with each Trust Unit converted into one Common Share.
(b) Unit capital
Balance at December 31, 2008
Distribution reinvestment plan
Issued on maturity of debentures
Issued pursuant to Restricted Trust Unit Plan
Management internalization forfeitures
Issued, less costs net of future taxes
Purchased from dissenting Unitholders
Cancelled on conversion to a corporation
Balance at July 9, 2009
Number of Units
142,824,854
1,263,158
946,887
171,093
(7,862)
17,000,000
(340)
(162,197,790)
-
Amount
$
2,077,760
5,211
4,867
939
(159)
98,185
(1)
(2,186,802)
-
Concurrent with the acquisition of Ketch Resources Trust on June 23, 2006, the Fund internalized the external management
contract structure and eliminated all related fees for total original consideration of 1,933,208 Trust Units initially valued at $39.1
million. These Trust Units were subject to escrow provisions over a three-year period, vesting one-third each year beginning in
2007. The management internalization consideration was deferred and amortized into income as management internalization
expense over the specific vesting periods during which employee services were provided. For the year ended December 31, 2009,
a total of 7,862 Trust Units issued for the management internalization were forfeited and $1.7 million was recognized as
management internalization expense. At December 31, 2010 and 2009, all Trust Units in respect of management internalization
were issued and none remained held in escrow.
Prior to converting to a corporation on July 9, 2009, 1,263,158 Trust Units were issued under the Premium Distribution(TM),
Distribution Reinvestment and Optional Trust Unit Purchase Plan, generating $5.2 million reinvested in the Fund during the year
ended December 31, 2009. The Premium Distribution(TM), Distribution Reinvestment and Optional Trust Unit Purchase Plan
was discontinued on March 18, 2009, concurrent with the discontinuation of cash distributions.
The principal amount of 8.25% convertible debentures matured on February 1, 2009 and were settled by issuing 946,887 Trust
Units.
On July 7, 2009, the Fund closed a bought deal financing with 17 million Trust Units issued at $6.00 each, for gross proceeds of
$102 million, less $3.8 million related to $5.2 million of issuance costs net $1.4 million of related future taxes.
Advantage Oil & Gas Ltd. - 49
10.
Shareholders’ Equity (continued)
(c) Contributed surplus
The changes in contributed surplus during the years ended December 31, 2010 and 2009 are as follows:
Balance, beginning of year
Equity-based compensation
Expiration of convertible debentures equity component (note 5)
Balance, end of year
The components of contributed surplus are as follows:
Expired convertible debentures equity component
Equity-based compensation
Balance, end of year
(d) Equity-based compensation
Year ended
December 31, 2010
$
7,275
7,508
2,971
17,754
$
December 31, 2010
$
6,606
11,148
17,754
$
Year ended
December 31, 2009
287
$
3,640
3,348
7,275
$
December 31, 2009
$
3,635
3,640
7,275
$
Advantage has a Restricted Share Performance Incentive Plan (“RSPIP” or the “Plan”) as approved by the shareholders on July 9,
2009, concurrent with the conversion to a corporation. The Plan authorizes the Board of Directors to grant restricted shares to
service providers of the Corporation, including directors, officers, employees, and consultants. The number of restricted shares
granted is based on the Corporation’s share price return for a twelve-month period and compared to the performance of a peer
group approved by the Board of Directors. The share price return is calculated at the end of each and every quarter and is
primarily based on the twelve-month change in the share price. If the share price return for a twelve-month period is positive, a
restricted share grant will be calculated based on the return. If the share price return for a twelve-month period is negative, but
the return is still within the top two-thirds of the approved peer group performance, the Board of Directors may grant a
discretionary restricted share award. The restricted share grants generally vest one-third immediately on grant date, with the
remaining two-thirds vesting evenly on the following two yearly anniversary dates. The holders of restricted shares may elect to
receive cash upon vesting in lieu of the number of shares to be issued, subject to consent of the Corporation. However, it is the
intent to settle unvested amounts with shares. The Plan replaced the previous Restricted Trust Unit (“RTU”) plan that was in
place prior to the conversion to a corporation and outstanding grants under the RTU are now subject to the RSPIP.
In conjunction with the corporate conversion, a transitional award of restricted shares to service providers was approved by
shareholders valued at $5.80 per share or $8.4 million and to be issued in shares. The restricted shares were granted on September
2, 2009 with the first one-quarter of the grant vesting immediately and the remaining three-quarters of the grant that will vest over
the subsequent three anniversary dates.
Total equity-based compensation recorded in general and administrative expenses during the year ended December 31, 2010 was
$16.1 million, including a non-cash amount of $13.4 million (December 31, 2009 - $8.1 million, including a non-cash amount of
$6.4 million). During the year ended December 31, 2010, 1,346,481 shares were issued in satisfaction of grants vesting under the
RSPIP. For the year ended December 31, 2009, 547,738 shares were issued subsequent to the corporate conversion in
satisfaction of grants vesting under the RSPIP, and prior to the corporate conversion, 171,093 Trust Units were issued in
satisfaction of grants vesting under the previous RTU plan.
Advantage Oil & Gas Ltd. - 50
10.
Shareholders’ Equity (continued)
The details of restricted shares granted and outstanding at December 31, 2010 are as follows:
Date Granted
January 15, 2009
September 2, 2009
October 15, 2009
January 12, 2010
April 12, 2010
July 12, 2010
Total
Restricted
Shares
Granted
Restricted
Shares
Vested
Restricted
Shares
Forfeited
691,178
1,453,609
1,153,314
779,013
979,915
788,092
5,845,121
487,427
741,842
775,367
269,544
332,973
262,689
2,869,842
22,268
9,172
6,299
4,623
5,975
1,074
49,411
Restricted
Shares
Outstanding
181,483
702,595
371,648
504,846
640,967
524,329
2,925,868
Weighted
average fair
value at
grant date
$5.49
$5.80
$7.51
$7.27
$6.97
$6.53
$6.59
In January 2011, an RSPIP grant was made to service providers valued at $6.95 per share or $0.5 million and is to be issued in
shares. No compensation expense was included in general and administrative expense as this grant occurred after December 31,
2010.
(e) Net loss per share
The calculations of basic and diluted net loss per share are derived from both net loss and weighted average shares outstanding,
calculated as follows:
Net loss
Basic and diluted
Weighted average shares outstanding
Basic and diluted
Year ended
December 31, 2010
Year ended
December 31, 2009
$
(44,208)
$
(86,426)
163,467,225
153,139,829
The calculation of diluted net loss per share excludes all series of convertible debentures for the years ended December 31, 2010
and 2009 as the impact would be anti-dilutive. Total weighted average shares issuable in exchange for the convertible debentures
and excluded from the diluted net loss per share calculation for the year ended December 31, 2010 was 14,401,412 shares
(December 31, 2009 – 8,165,575 shares). As at December 31, 2010, the total convertible debentures outstanding were immediately
convertible to 13,019,819 shares (December 31, 2009 – 15,821,382 shares).
Restricted shares granted have been excluded from the calculation of diluted net loss per share for the years ended December 31,
2010 and 2009, as the impact would have been anti-dilutive. Total weighted average shares issuable in exchange for the restricted
shares and excluded from the diluted net loss per share calculation for the year ended December 31, 2010 was 1,094,135
(December 31, 2009 – 331,281).
Management internalization escrowed Trust Units have been excluded from the calculations of diluted net loss per share for the
year ended December 31, 2009 as the impact would be anti-dilutive. Total weighted average Trust Units issuable in exchange for
the management internalization escrowed Trust Units and excluded from the diluted net loss per share calculation for the year
ended December 31, 2009 was 207,018.
Advantage Oil & Gas Ltd. - 51
11.
Financial Instruments
Financial instruments of the Corporation include accounts receivable, deposits, accounts payable and accrued liabilities, bank
indebtedness, convertible debentures, other liabilities and derivative assets and liabilities.
Accounts receivable and deposits are classified as loans and receivables and measured at amortized cost. Accounts payable and
accrued liabilities, bank indebtedness and other liabilities are all classified as other liabilities and similarly measured at amortized
cost. As at December 31, 2010, there were no significant differences between the carrying amounts reported on the balance sheet
and the estimated fair values of these financial instruments due to the short terms to maturity and the floating interest rate on the
bank indebtedness.
The Corporation has convertible debenture obligations outstanding, of which the liability component has been classified as other
liabilities and measured at amortized cost. The convertible debentures have different fixed terms and interest rates (note 5)
resulting in fair values that will vary over time as market conditions change. As at December 31, 2010, the estimated fair value of
the total outstanding convertible debenture obligation was $153.2 million (December 31, 2009 - $207.9 million). The fair value of
the convertible debentures was determined by a Level 2 valuation model, based on discounted cash flows assuming no future
conversions and continuation of current interest and principal payments as well as taking into consideration the current public
trading activity of such debentures. The Corporation applied discount rates of between 5% and 7% considering current available
market information, assumed credit adjustments, and various terms to maturity.
Advantage has an established strategy to manage the risk associated with changes in commodity prices by entering into
derivatives, which are recorded at fair value as derivative assets and liabilities with gains and losses recognized through earnings.
As the fair value of the contracts varies with commodity prices, they give rise to financial assets and liabilities. The fair values of
the derivatives are determined by a Level 2 valuation model, where pricing inputs other than quoted prices in an active market are
used. These pricing inputs include quoted forward prices for commodities, foreign exchange rates, volatility and risk-free rate
discounting, all of which can be observed or corroborated in the marketplace. The actual gains and losses realized on eventual
cash settlement can vary materially due to subsequent fluctuations in commodity prices and foreign exchange rates as compared
to the valuation assumptions.
Credit Risk
Accounts receivable, deposits, and derivative assets are subject to credit risk exposure and the total carrying value of $70.4 million
(December 31, 2009 - $92.0 million) reflects Management’s assessment of the associated maximum exposure to such credit risk.
Advantage mitigates such credit risk by closely monitoring significant counterparties and dealing with a broad selection of
partners that diversify risk within the sector. The Corporation’s deposits are primarily due from the Alberta Provincial
government and are viewed by Management as having minimal associated credit risk. To the extent that Advantage enters
derivatives to manage commodity price risk, it may be subject to credit risk associated with counterparties with which it contracts.
Credit risk is mitigated by entering into contracts with only stable, creditworthy parties and through frequent reviews of exposures
to individual entities. In addition, the Corporation only enters into derivative contracts with major banks and international energy
firms to further mitigate associated credit risk.
Substantially all of the Corporation’s accounts receivable are due from customers and joint operation partners concentrated in the
Canadian oil and gas industry. As such, accounts receivable have been subject to normal industry credit risks. As at December 31,
2010, $2.3 million or 5.4% of accounts receivable have been outstanding for 90 days or more (December 31, 2009 - $6.9 million
or 12.6% of accounts receivable). The Corporation believes that the entire balance is collectible, and in some instances the
Corporation has the ability to mitigate risk through withholding production or offsetting payables with the same parties.
Management has provided for an allowance for doubtful accounts of $0.2 million at December 31, 2010 (December 31, 2009 –
$0.5 million).
Advantage Oil & Gas Ltd. - 52
11.
Financial Instruments (continued)
Liquidity Risk
The Corporation is subject to liquidity risk attributed from accounts payable and accrued liabilities, bank indebtedness, convertible
debentures, other liabilities, and derivative liabilities. Accounts payable and accrued liabilities, and derivative liabilities are primarily
due within one year of the balance sheet date and Advantage does not anticipate any problems in satisfying the obligations from
cash provided by operating activities and the existing credit facility. The Corporation’s bank indebtedness is subject to a $525
million credit facility agreement (note 6) and does not have specific maturity dates. Under the terms of the agreement, the facility
is reviewed annually, with the next review scheduled in June 2011. The credit facility constitutes a revolving facility for a 364 day
term which is extendible annually for a further 364 day revolving period at the option of the syndicate. If not extended, the
revolving credit facility is converted to a one year term facility with the principal payable at the end of such one year term.
Management fully expects that the facility will be extended at each annual review. Although the credit facility is a source of
liquidity risk, the facility also mitigates liquidity risk by enabling Advantage to manage interim cash flow fluctuations. The terms of
the credit facility are such that it provides Advantage adequate flexibility to evaluate and assess liquidity issues if and when they
arise. Additionally, the Corporation regularly monitors liquidity related to obligations by evaluating forecasted cash flows, optimal
debt levels, capital spending activity, working capital requirements, and other potential cash expenditures. This continual financial
assessment process further enables the Corporation to mitigate liquidity risk.
Advantage has several series of convertible debentures outstanding that mature in 2011 and 2015 (note 5). Interest payments are
made semi-annually with excess cash provided by operating activities. As the debentures become due, the Corporation can satisfy
the obligations in cash or issue shares at a price determined in the applicable debenture indentures. This settlement alternative
allows the Corporation to adequately manage liquidity, plan available cash resources and implement an optimal capital structure.
To the extent that Advantage enters derivatives to manage commodity price risk, it may be subject to liquidity risk as derivative
liabilities become due. While the Corporation has elected not to follow hedge accounting, derivative instruments are not entered
for speculative purposes and Management closely monitors existing commodity risk exposures. As such, liquidity risk is mitigated
since any losses actually realized are subsidized by increased cash flows realized from the higher commodity price environment.
The timing of cash outflows relating to financial liabilities as at December 31, 2010 are as follows:
Accounts payable and accrued liabilities
Capital lease obligations
Derivative liabilities
Bank indebtedness
- principal
- interest
- principal
- interest
Convertible debentures
Other liability
$
Less than
one year
112,457
779
2,367
-
13,717
62,294
9,179
-
200,793
$
One to
three years
$
-
-
177
290,657
6,577
-
8,625
1,966
308,002
$
Four to five
years
$
-
-
-
-
-
86,250
6,469
-
92,719
$
Thereafter
$
-
-
-
-
-
-
-
-
$
-
$
Total
112,457
779
2,544
290,657
20,294
148,544
24,273
1,966
601,514
$
Interest on bank indebtedness was calculated assuming conversion of the revolving credit facility to a one-year term facility.
Advantage Oil & Gas Ltd. - 53
11.
Financial Instruments (continued)
The timing of cash outflows relating to financial liabilities as at December 31, 2009 are as follows:
Accounts payable and accrued liabilities
Capital lease obligations
Derivative liabilities
Bank indebtedness
- principal
- interest
- principal
- interest
Convertible debentures
Other liability
$
Less than
one year
111,901
1,459
12,755
-
12,008
69,927
9,679
-
217,729
$
One to
three years
$
-
779
1,165
250,262
6,004
62,294
13,492
3,803
337,799
$
Four to five
years
-
$
-
-
-
-
-
8,625
-
8,625
$
Thereafter
-
$
-
-
-
-
86,250
2,156
-
88,406
$
$
Total
111,901
2,238
13,920
250,262
18,012
218,471
33,952
3,803
652,559
$
Interest on bank indebtedness was calculated assuming conversion of the revolving credit facility to a one-year term facility.
Interest Rate Risk
The Corporation is exposed to interest rate risk to the extent that bank indebtedness is at a floating rate of interest and the
Corporation’s maximum exposure to interest rate risk is based on the effective interest rate and the current carrying value of the
bank indebtedness. The Corporation monitors the interest rate markets to ensure that appropriate steps can be taken if interest
rate volatility compromises the Corporation’s cash flows. A 1% increase in interest rates for the year ended December 31, 2010
could have increased net loss for the year by approximately $1.9 million (December 31, 2009 - $3.4 million).
Price and Currency Risk
Advantage’s derivative assets and liabilities are subject to both price and currency risks as their fair values are based on
assumptions including forward commodity prices and foreign exchange rates. The Corporation enters derivative financial
instruments to manage commodity price risk exposure relative to actual commodity production and does not utilize derivative
instruments for speculative purposes. Changes in the price assumptions can have a significant effect on the fair value of the
derivative assets and liabilities and thereby impact net loss. It is estimated that a 10% increase in the forward natural gas prices
used to calculate the fair value of the natural gas derivatives at December 31, 2010 could increase net loss for the year ended
December 31, 2010 by approximately $2.7 million (December 31, 2009 - $7.1 million). As well, an increase of 10% in the forward
crude oil prices used to calculate the fair value of the crude oil derivatives at December 31, 2010 could increase net loss for the
year ended December 31, 2010 by $4.0 million (December 31, 2009 - $4.7 million). A similar magnitude increase in the forward
currency rate assumption underlying the derivatives fair value does not materially increase net loss.
As at December 31, 2010 the Corporation had the following derivatives in place:
Description of Derivative
Term
Volume
Average Price
Natural gas - AECO
Fixed price
Fixed price
Fixed price
Fixed price
Crude oil – WTI
Fixed price
Fixed price
April 2010 to January 2011
January 2011 to December 2011
January 2011 to December 2011
January 2011 to December 2011
18,956 mcf/d
9,478 mcf/d
9,478 mcf/d
9,478 mcf/d
Cdn$7.25/mcf
Cdn$6.24/mcf
Cdn$6.24/mcf
Cdn$6.26/mcf
April 2010 to January 2011
January 2011 to December 2011
2,000 bbls/d
1,500 bbls/d
Cdn$69.50/bbl
Cdn $91.05/bbl
As at December 31, 2010, the fair value of the derivatives outstanding resulted in an asset of approximately $25.2 million
(December 31, 2009 – $31.1 million) and a liability of approximately $2.5 million (December 31, 2009 – $13.9 million). For the
year ended December 31, 2010, $5.4 million was recognized in net loss as an unrealized derivative gain (December 31, 2009 -
$23.7 million unrealized derivative loss) and $45.1 million was recognized in net loss as a realized derivative gain (December 31,
2009 – $86.5 million realized derivative gain).
Advantage Oil & Gas Ltd. - 54
12.
Capital Management
The Corporation manages its capital with the following objectives:
• To ensure sufficient financial flexibility to achieve the ongoing business objectives including replacement of production,
funding of future growth opportunities, and pursuit of accretive acquisitions; and
• To maximize shareholder return through enhancing the share value.
Advantage monitors its capital structure and makes adjustments according to market conditions in an effort to meet its objectives
given the current outlook of the business and industry in general. The capital structure of the Corporation is composed of
working capital (excluding derivative assets and liabilities), bank indebtedness, convertible debentures, capital lease obligations and
shareholders’ equity. Advantage may manage its capital structure by issuing new shares, repurchasing outstanding shares,
obtaining additional financing either through bank indebtedness or convertible debenture issuances, refinancing current debt,
issuing other financial or equity-based instruments, declaring a dividend, implementing a dividend reinvestment plan, adjusting
capital spending, or disposing of assets. The capital structure is reviewed by Management and the Board of Directors on an
ongoing basis. Advantage’s capital structure is as follows:
December 31, 2010
December 31, 2009
Bank indebtedness (long-term)
Working capital deficit (1)
Net debt
Shares outstanding, representing shareholders' equity
Shares closing market price ($/share)
Market capitalization (2)
Convertible debentures maturity value (current and long-term)
Capital lease obligations (long-term)
Total capitalization
$
$
290,657
64,452
355,109
164,092,009
6.76
1,109,262
148,544
-
1,612,915
$
$
$
$
$
250,262
48,809
299,071
162,745,528
6.90
1,122,944
218,471
759
1,641,245
$
$
$
(1) Working capital deficit includes accounts receivable, prepaid expenses and deposits, accounts payable and
accrued liabilities, and the current portion of capital lease obligations.
(2) Market capitalization is a non-GAAP measure
The Corporation’s bank indebtedness is governed by a $525 million credit facility agreement (note 6) that contains standard
commercial covenants for facilities of this nature. The only financial covenant is a requirement for Advantage to maintain a
minimum cash flow to interest expense ratio of 3.5:1, determined on a rolling four quarter basis. This covenant was met at
December 31, 2010 and 2009. As well, the borrowing base for the Corporation’s credit facilities is determined through utilizing
Advantage’s regular reserve estimates. The banking syndicate thoroughly evaluates the reserve estimates based upon their own
commodity price expectations to determine the amount of the borrowing base. Revision or changes in the reserve estimates and
commodity prices can have either a positive or a negative impact on the borrowing base of the Corporation.
Management of the Corporation’s capital structure is facilitated through its financial and operational forecasting processes. The
forecast of the Corporation’s future cash flows is based on estimates of production, commodity prices, forecast capital and
operating expenditures, and other investing and financing activities. The forecast is regularly updated based on new commodity
prices and other changes, which the Corporation views as critical in the current environment. Selected forecast information is
frequently provided to the Board of Directors.
The Corporation’s capital management objectives, policies and processes have remained unchanged during the year ended
December 31, 2010.
Advantage Oil & Gas Ltd. - 55
13.
Commitments
Advantage has several lease commitments relating to office buildings and transportation. The estimated remaining annual
minimum operating lease payments are as follows, of which $1.8 million is recognized in other liabilities:
2011
2012
2013
2014
2015
$
11,756
11,791
10,576
8,723
2,108
44,954
$
14.
Subsequent Events
On March 7, 2011, Advantage announced that Longview Oil Corp. (“Longview”), a wholly-owned subsidiary of the Corporation,
filed a preliminary prospectus on March 4, 2011 for an initial public offering (the “Offering”), which is targeted to raise gross
proceeds of $150 million prior to an over-allotment option. The closing of the Offering is expected to occur in April, 2011.
Concurrent with closing of the Offering, Longview will purchase certain oil-weighted assets from Advantage (the “Transaction”),
with consideration comprised of the net proceeds of the Offering, an equity ownership interest of approximately 68%
(approximately 63% if the over-allotment option is exercised in full) of the common shares of Longview and proceeds of $100
million to be drawn from an independent Longview credit facility. Advantage plans to use the cash proceeds from the Transaction
to reduce outstanding bank indebtedness. The Transaction is conditional upon customary industry conditions including the
approval of the Board of Directors of Advantage.
15.
Reconciliation of Financial Statements to United States Generally Accepted Accounting Principles
The consolidated financial statements of Advantage have been prepared in accordance with accounting principles generally
accepted in Canada. Canadian GAAP, in most respects, conforms to generally accepted accounting principles in the United States
(“US GAAP”). Significant differences in accounting principles between Canadian GAAP and US GAAP, as they apply to
Advantage, are as described below.
(a) Equity-based compensation
Advantage accounts for compensation expense based on the fair value of the equity awards on the grant date and the initial fair
value is not subsequently remeasured. Prior to converting to a corporation, the Fund’s equity-based compensation consisted of a
Restricted Trust Unit Plan and Trust Units held in escrow subject to service requirement provisions. Advantage’s current equity-
based compensation consists of a Restricted Share Performance Incentive Plan. The initial fair value is expensed over the vesting
period of the grants.
Under US GAAP, the Corporation adopted ASC 718 “Stock compensation” on January 1, 2006 using the modified prospective
approach and applies the fair value method of accounting for all equity-based compensation granted after January 1, 2006. Prior
to converting to a corporation, a US GAAP difference existed as grants of Trust Unit compensation were considered liability
awards for US GAAP and equity awards for Canadian GAAP. Under US GAAP, the fair value of a liability award is measured at
the grant date and is subsequently remeasured at each reporting period. When the Trust Unit grants vested, the amount recorded
as a liability was recognized as temporary equity. Upon conversion to a corporation, all equity-based compensation are now
considered equity awards under both US and Canadian GAAP. Accordingly, there is no US GAAP difference with respect to
equity-based compensation awards granted subsequent to conversion to a corporation.
(b) Convertible debentures and issuance costs
The Corporation applies CICA 3863 “Financial Instruments – Presentation” in accounting for convertible debentures which
results in their classification as liabilities. The convertible debentures also have an embedded conversion feature which must be
segregated between liabilities and equity, based on the residual value method, where the liability is first measured using a discount
rate without the conversion feature and the remaining amount is allocated to equity. Therefore, the debenture liabilities are
presented at less than their eventual maturity values. The liability and equity components are further reduced for issuance costs
initially incurred. The discount of the liability component, net of issuance costs, as compared to maturity value is accreted by the
effective interest method over the debenture term. As debentures are converted to shares, an appropriate portion of the liability
and equity components are transferred to share capital. Interest and accretion expense on the convertible debentures are shown
on the Consolidated Statements of Loss.
Advantage Oil & Gas Ltd. - 56
Under US GAAP, convertible debentures issued after the corporate conversion are shown as a liability. The embedded
conversion feature is not accounted for separately as a component of equity. Given that the convertible debentures are carried at
maturity value, it is not necessary to accrete the balance over the term of the debentures which results in an expense reduction as
compared to Canadian GAAP. For the year ended December 31, 2009, the Corporation implemented retrospectively changes
prescribed by ASC 470 “Debt” which became effective for years beginning after December 15, 2008. As a result, for all
convertible debentures that existed prior to the corporate conversion, the instruments were divided into a liability and an equity
component, similar to Canadian GAAP treatment, and opening Shareholders’ Equity was increased $3.5 million.
Additionally, under US GAAP, issuance costs related to liabilities are generally shown as a deferred charge rather than netted from
the carrying value and are amortized to interest expense over the term of the liability.
(c) Depletion and depreciation
For Canadian GAAP, depletion of petroleum and natural gas properties and depreciation of lease and well equipment is provided
on accumulated costs using the unit-of-production method based on estimated proved petroleum and natural gas reserves, before
royalties, based on forecast prices and costs.
US GAAP provides for a similar accounting methodology except that estimated proved petroleum and natural gas reserves are net
of royalties and based on the first-day-of-month average prices for the prior twelve months (“constant prices”). Therefore,
depletion and depreciation under US GAAP will be different since changes to royalty rates will impact both proved reserves and
production and differences between constant prices as compared to forecast prices will impact proved reserve volumes.
Additionally, differences in depletion and depreciation will result in divergence of net book value for Canadian GAAP and US
GAAP from year-to-year and impact future depletion and depreciation expense as well as the net book value utilized for future
impairment calculations.
(d) Impairment of Petroleum and Natural Gas Properties
Under Canadian GAAP, petroleum and natural gas properties are evaluated each reporting period to determine that the carrying
amount is recoverable and does not exceed the fair value of the properties in the cost centre (the “ceiling test”). The carrying
amounts are assessed to be recoverable when the sum of the undiscounted net cash flows expected from the production of
proved reserves, the lower of cost and market of unproved properties and the cost of major development projects exceeds the
carrying amount of the cost centre. When the carrying amount is not assessed to be recoverable, an impairment loss is recognized
to the extent that the carrying amount of the cost centre exceeds the sum of the discounted net cash flows expected from the
production of proved and probable reserves, the lower of cost and market of unproved properties and the cost of major
development projects of the cost centre. The cash flows are estimated using expected future product prices and costs and are
discounted using a risk-free interest rate. For Canadian GAAP purposes, Advantage has not recognized an impairment loss since
inception.
Under US GAAP, the carrying amounts of petroleum and natural gas properties, net of deferred income taxes, shall not exceed an
amount equal to the sum of the present value of estimated net future after-tax cash flows of proved reserves at constant prices
and costs computed using a discount factor of ten percent plus the lower of cost or estimated fair value of unproved properties.
Any excess is charged to expense as an impairment loss through depletion, depreciation and accretion expense. Under US GAAP,
Advantage recognized impairment losses of $49.5 million in 2001 ($28.3 million net of tax), $535.4 million in 2006 ($477.8 million
net of tax), $1,047.5 million in 2008 ($770.8 million net of tax), and $303.9 million in 2009 ($227.4 million net of tax). Impairment
losses decrease net book value of petroleum and natural gas properties which reduces depletion and depreciation expense
subsequently recorded as well as future potential impairment calculations.
(e) Income tax
The future income tax accounting standard under Canadian GAAP is substantially similar to the deferred income tax approach as
required by US GAAP. Pursuant to Canadian GAAP, substantively enacted tax rates are used to calculate future income tax,
whereas US GAAP applies enacted tax rates. However, there were no tax rate differences for the years ended December 31, 2010
and 2009. The differences between Canadian GAAP and US GAAP relate to future income tax impacts on other GAAP
differences.
Under Canadian GAAP as at December 31, 2010, the Corporation’s carrying value of its net assets exceeded its tax bases and
resulted in a future income tax liability. Adjustments under US GAAP result in a large future income tax recovery and a future
income tax asset, as the impairment significantly lowered the Corporation’s fixed assets carrying value under US GAAP.
Advantage Oil & Gas Ltd. - 57
(f) Goodwill
Under Canadian and US GAAP, the Corporation is required to test the carrying amount of goodwill at each balance sheet
reporting date and the methodologies are substantially the same. However, the carrying value of the reporting unit (the
Corporation) under US GAAP is much lower due to the impairments to fixed assets required under US GAAP (note 15(d)). For
the year ended December 31, 2008, goodwill was determined to be fully impaired, and was therefore written down to Nil under
Canadian GAAP. However, under US GAAP, the fair value of the reporting unit (the Corporation) was in excess of its carrying
values and no impairment of goodwill was recorded for the year ended December 31, 2008. For the years ended December 31,
2010 and 2009, the fair value of the reporting unit continued to be in excess of carrying values as determined under US GAAP
and no impairment of goodwill was recorded.
(g) Shareholders’ equity
Since converting to a corporation on July 9, 2009, Shareholders’ Equity of Advantage consists primarily of shares. For both
Canadian and US GAAP, the shares are considered permanent equity and presented as a component of Shareholders’ equity.
Prior to conversion to a corporation, the Trust Units of the Fund were redeemable at any time on demand by the holders, which
was required for the Fund to retain its Canadian mutual fund trust status. The holders were entitled to receive a price per Trust
Unit equal to the lesser of: (i) 85% of the simple average of the closing market prices of the Trust Units, on the principal market
on which the Trust Units were quoted for trading, during the 10 trading-day period commencing immediately after the date on
which the Trust Units were surrendered for redemption; and (ii) the closing market price on the principal market on which the
Trust Units were quoted for trading on the redemption date. For Canadian GAAP purposes, the Trust Units were considered
permanent equity and were presented as a component of Unitholders’ equity.
Under US GAAP, it is required that equity with a redemption feature be presented as temporary equity between the liability and
equity sections of the balance sheet. Therefore, prior to the corporate conversion temporary equity was shown at an amount equal
to the redemption value based on the terms of the Trust Units and all components of Unitholders’ equity related to Trust Units
was eliminated. Changes in the redemption value from year-to-year was charged to deficit. For the year ended December 31, 2009,
shareholders’ equity was increased by $130.8 million corresponding to changes in the Trust Units redemption value from January
1, 2009 to July 8, 2009. On July 9, 2009, the entire recorded value of temporary equity of $660.1 million was transferred to
permanent equity concurrent with the corporate conversion.
A continuity schedule of significant equity accounts for each reporting period is required disclosure under US GAAP. The
following table is a continuity of shareholders’ equity, the Corporation’s only significant equity account:
Shareholders' Equity
(thousands of Canadian dollars)
Year ended
December 31, 2010
Year ended
December 31, 2009
$
$
115,469
-
115,469
65,050
-
-
-
9,082
7,508
197,109
$
$
(451,946)
3,494
(448,452)
(216,595)
(17,266)
130,751
660,145
3,607
3,279
115,469
$
$
Balance, beginning of year (previously reported)
Effect on opening Shareholders' Equity of implementation of ASC 470 - note 15(b)
Balance, beginning of year (restated)
Net income (loss) and comprehensive income (loss)
Distributions declared
Change in redemption value of temporary equity
Temporary equity transferred to share capital
Shares issued pursuant to Restricted Share Performance Incentive Plan
Equity-based compensation
Balance, end of year
Advantage Oil & Gas Ltd. - 58
(h) Balance Sheet Disclosure
US GAAP requires disclosure of certain line items for balances that would be aggregated in the Canadian GAAP financials. The
following are the additional line items to be disclosed for accounts receivable and accounts payable:
(thousands of Canadian dollars)
Accounts receivable
Trade receivables
Other receivables
Total accounts receivable
Accounts payable and accrued liabilities
Accounts payable
Accrued liabilities
Other payables
Total accounts payable and accrued liabilities
December 31, 2010
December 31, 2009
42,276
-
42,276
$
$
$
42,340
70,117
-
112,457
$
$
$
54,531
-
54,531
17,202
94,699
-
111,901
$
$
(i) Statements of cash flow
The differences between Canadian GAAP and US GAAP have not resulted in any significant variances concerning the statements
of cash flows as reported.
The application of US GAAP would have the following effect on net income (loss) as reported:
Consolidated Statements of Income (Loss) and Comprehensive
Income (Loss)
(thousands of Canadian dollars)
Net loss - Canadian GAAP, as reported
US GAAP Adjustments:
General and administrative - note 15 (a)
Management internalization - note 15 (a)
Interest and accretion on convertible debentures - note 15 (b)
Depletion, depreciation and accretion - notes 15 (c) and (d)
Future income tax - note 15 (e)
Net income (loss) and comprehensive income (loss) - US GAAP
Year ended
December 31, 2010
$
(44,208)
Year ended
December 31, 2009
$
(86,426)
-
-
2,191
143,043
(35,976)
65,050
$
358
1,026
-
(153,711)
22,158
(216,595)
$
The application of US GAAP would have the following effect on the balance sheets as reported:
Consolidated Balance Sheets
(thousands of Canadian dollars)
Assets
Deferred charge - note 15 (b)
Fixed assets, net - notes 15 (c) and (d)
Future income taxes - note 15 (e)
Goodwill - note 15 (f)
Liabilities and Shareholders' Equity
Current portion of convertible debentures
- note 15 (b)
Bank indebtedness - note 15 (b)
Convertible debentures - note 15 (b)
Future income taxes - note 15 (e)
Shareholders' equity - note 15 (g)
December 31, 2010
US
GAAP
Canadian
GAAP
December 31, 2009
US
GAAP
Canadian
GAAP
$
-
1,768,650
-
-
$
3,851
270,727
347,642
120,271
$
-
1,831,622
-
-
$
5,310
190,656
374,221
120,271
61,570
61,847
69,553
69,553
288,852
72,811
29,399
1,208,187
289,454
86,250
-
197,109
247,784
130,658
38,796
1,235,805
248,808
147,602
-
115,469
Advantage Oil & Gas Ltd. - 59
Corporate Information
Directors
Stephen E. Balog (1)(2)
Kelly I. Drader
Paul G. Haggis(1)
John A. Howard (2)(3)
Andy J. Mah
Ronald A. McIntosh (1)(2)
Sheila H. O’Brien (2)(3)
Carol D. Pennycook (1)(3)
Steven Sharpe
(1) Member of Audit Committee
(2) Member of Reserve Evaluation Committee
(3) Member of Human Resources, Compensation & Corporate Governance
Committee
Officers
Andy J. Mah, CEO
Kelly I. Drader, President and CFO
Patrick J. Cairns, Senior Vice President
Craig Blackwood, Vice President, Finance
Weldon M. Kary, Vice President, Geosciences and Land
Neil Bokenfohr, Vice President, Exploitation
Corporate Secretary
Jay P. Reid, Partner
Burnet, Duckworth and Palmer LLP
Auditors
PricewaterhouseCoopers LLP
Bankers
The Bank of Nova Scotia
National Bank of Canada
Bank of Montreal
Royal Bank of Canada
Canadian Imperial Bank of Commerce
Union Bank, Canada Branch
Alberta Treasury Branches
HSBC Bank Canada
BNP Paribas (Canada)
Independent Reserve Evaluators
Sproule Associates Limited
Legal Counsel
Burnet, Duckworth and Palmer LLP
Transfer Agent
Computershare Trust Company of Canada
Abbreviations
- barrels
bbls
- barrels per day
bbls/d
- barrels of oil equivalent (6 mcf = 1 bbl)
boe
- barrels of oil equivalent per day
boe/d
- thousand cubic feet
mcf
- thousand cubic feet per day
mcf/d
mmcf
- million cubic feet
mmcf/d - million cubic feet per day
- billion cubic feet
bcf
- trillion cubic feet
tcf
- gigajoules
gj
- natural gas liquids
NGLs
- West Texas Intermediate
WTI
Corporate Office
700, 400 – 3 Avenue SW
Calgary, Alberta T2P 4H2
(403) 718-8000
Contact Us
Toll free: 1-866-393-0393
Email: ir@advantageog.com
Visit our website at www.advantageog.com
Toronto Stock Exchange Trading Symbols
Shares: AAV
7.75% Convertible Debentures: AAV.DBD
8.00% Convertible Debentures: AAV.DBG
5.00% Convertible Debentures: AAV.DBH
New York Stock Exchange Trading Symbol
Shares: AAV
Advantage Oil & Gas Ltd. - 60