Advantage Oil & Gas Ltd.
Annual Report 2013

Plain-text annual report

2013 Annual Report Non-Consolidated Financial and Operating Highlights (1) Three months ended December 31 Year ended December 31 2013 2012 2013 2012 $ $ $ 34,304 20.57 23,822 $ $ $ $ $ $ $ $ 0.14 14.30 2,961 0.02 69,512 49,034 153,697 86,250 168,383 168,383 $ $ $ 36,556 19.15 16,890 $ $ $ $ $ $ $ $ 0.10 8.85 3,172 0.02 35,849 35,467 161,630 86,250 168,383 168,383 $ $ $ 142,943 20.08 85,310 $ $ $ $ $ $ $ $ 0.51 11.98 12,479 0.07 155,370 49,034 153,697 86,250 168,383 168,383 $ $ $ 126,749 15.97 47,046 $ $ $ $ $ $ $ $ 0.28 5.94 14,350 0.09 130,570 35,467 161,630 86,250 168,383 167,509 108,260 79 108,734 18,122 116,929 1,261 124,495 20,749 113,947 507 116,989 19,498 122,069 1,337 130,091 21,682 Financial ($000, except as otherwise indicated) Sales including realized hedging per boe Funds from operations per share (2) per boe Dividends received from Longview per share (2) Total capital expenditures Working capital deficit (3) Bank indebtedness Convertible debentures (face value) Shares outstanding at end of period (000) Basic weighted average shares (000) Operating Daily Production Natural gas (mcf/d) Crude oil and NGLs (bbls/d) Total mcfe/d (4) Total boe/d (4) Average prices (including hedging) Natural gas ($/mcf) Crude oil and NGLs ($/bbl) 2.70 65.21 (1) Non-consolidated financial and operating highlights for Advantage excluding Longview. (2) Based on weighted average shares outstanding (3) Working capital deficit includes trade and other receivables, prepaid expenses and deposits, $ $ $ $ 3.39 77.01 and trade and other accrued liabilities (4) A boe and mcfe conversion ratio has been calculated using a conversion rate of six thousand cubic feet of natural gas equivalent to one barrel of oil. $ $ 3.10 76.01 $ $ 2.09 68.35 CONTENTS Message to Shareholders ................................................................................................................................................................................................ 3 Reserves ............................................................................................................................................................................................................................ 6 Consolidated Management’s Discussion & Analysis .............................................................................................................................................. 11 Consolidated Financial Statements ............................................................................................................................................................................ 36 Consolidated Statement of Financial Position ................................................................................................................................................. 41 Consolidated Statement of Comprehensive Loss ........................................................................................................................................... 42 Consolidated Statement of Changes in Shareholders’ Equity ....................................................................................................................... 43 Consolidated Statement of Cash Flows ............................................................................................................................................................ 44 Notes To The Consolidated Financial Statements ......................................................................................................................................... 45 Advantage Oil & Gas Ltd. - 2 The following Message to Shareholders discusses the non-consolidated financial and operating results for Advantage, excluding Longview. MESSAGE TO SHAREHOLDERS Increased Funds from Operations driven by Glacier Production, Low Cost Structure and Improved Gas Prices (cid:1) Funds from operations for the fourth quarter of 2013, excluding dividends from Longview Oil Corp. (“Longview”), increased 41% to $23.8 million or $0.14 per share as compared to the fourth quarter of 2012. Funds from operations during 2013 increased 81% to $85.3 million or $0.51 per share as compared to 2012. The increase in funds from operations was supported by a continued reduction in Advantage’s cost structure due to development at Glacier and an increase in realized natural gas prices for the quarter and year. (cid:1) The tax free dividend income received from Longview amounted to $3.0 million ($0.02/share) during the fourth quarter of 2013 and $12.5 million ($0.07/share) for 2013 due to Advantage’s 45.1% ownership in the common shares of Longview in 2013. (cid:1) Glacier production increased to 135 mmcfe/d (22,500 boe/d) in early March, approximately one month ahead of our Phase VI budget schedule. Production averaged 117.0 mmcfe/d (19,498 boe/d) for 2013 and averaged 108.7 mmcfe/d (18,122 boe/d) during the fourth quarter of 2013. The 2013 average production rate included the non-core assets from January 1 to April 30, 2013. Production during the fourth quarter of 2013 was impacted by minor facility outages at Glacier to accommodate field gathering system work in preparation for the eventual tie-in of new Phase VI Montney wells. (cid:1) The royalty rate in 2013 was 5.4% as compared to 5.7% during 2012. The reduction in royalty rate reflects the disposition of the non-core assets and increased production from Glacier where royalty rates of approximately 5% are realized on our Montney wells. (cid:1) Operating costs decreased 68% to $0.28/mcfe ($1.66/boe) in the fourth quarter of 2013 compared to the same period in 2012. The decrease in operating costs was due to the divestment of the higher cost non-core assets and the continued improvement in operating efficiencies achieved through our Glacier Montney development. Advantage’s operating costs for 2013 which included the non-core assets to April 30, 2013 decreased 47% to $0.48/mcfe ($2.88/boe) compared to 2012. (cid:1) Advantage’s operating netback during the fourth quarter of 2013 was $3.00/mcfe which is 93% of our realized natural gas price of $3.21/mcfe. This strong cash margin is due to the industry leading low cost structure at Glacier and is a key success factor in our go forward three year development plan which is targeted to deliver 190% cash flow per share growth at an average natural gas price of $3.75/GJ. (cid:1) Total capital expenditures in the fourth quarter of 2013 were $69.5 million and $155.4 million for the 2013 year which resulted from ongoing activities in our Glacier Phase VI development program. (cid:1) On a pro forma basis after giving consideration to net proceeds of $90 million received from the sale of the Longview common shares, Advantage’s bank debt was $63.7 million and total debt was $199.0 million as of December 31, 2013. (cid:1) Advantage’s estimated tax pools as of December 31, 2013 are approximately $1.1 billion of which $0.8 billion are categorized as immediately deductible at a rate of 100%. Advantage Oil & Gas Ltd. - 3 Glacier Operations On-Track with Three Year Development Plan Advantage’s Glacier three year development plan is targeted to deliver 100% production per share growth and 190% cash flow per share growth. Production is expected to grow to 183 mmcfe/d in 2015, 205 mmcfe/d in 2016 and 245 mmcfe/d in 2017. The three year development plan is supported by continuing strong operational results and a solid financial strategy which includes an improved balance sheet and hedging program. The three year development plan is designed to maintain an average total debt to forward cash flow ratio of 1.5x based on an average natural gas price of AECO Cdn $3.75/GJ. Advantage has hedged an average of 47% of its forecast production through to Q1 2016 at an average price of $3.86/mcf. Strong Initial Production from New Phase VI Glacier Wells (cid:1) Only nine of the 22 new Phase VI Montney wells were required to ramp production to our 135 mmcfe/d Phase VI target which was achieved approximately one month ahead of schedule. The remaining Phase VI wells will be brought on stream as required to maintain the 135 mmcfe/d production rate through the balance of 2014. (cid:1) Advantage’s record Upper Montney well at 05-20-76-12W6 which demonstrated a final production test rate of 21 mmcf/d was initially brought on production at rates of up to 21 mmcf/d and then restricted to approximately 10 mmcf/d for the last 80 days. The production rate has been restricted to manage the flow back of frac sand through well site equipment which is typical in most higher rate Montney wells. The 05-20-76-12W6 well is still producing at a strong flowing wellhead pressure of 7,620 kpa compared to our average gas gathering system pressure of 3,000 kpa. During the first 80 days of production, the 05-20-76-12W6 well has produced 0.7 bcf. (cid:1) Two Lower Montney wells located at 15-31-75-13W6 and 10-31-75-13W6 were initially brought on production at rates of up to 15 mmcf/d and 11 mmcf/d and then restricted to a rate of 8.0 mmcf/d for each well. The wells have produced for an average of 125 days and each well has produced approximately 1 bcf during this period. These wells, which were completed with slickwater and modified completion techniques, are demonstrating significantly improved performance compared to older Lower Montney wells. (cid:1) Since the winter of 2012, a total of 15 Upper and Lower Montney wells that were completed with slickwater and brought on production are demonstrating performance which is trending at or above our Phase VII budget type curve (based on an average initial 30 day production rate of 6.9 mmcf/d). (cid:1) Advantage’s record Middle Montney well located at 12-02-76-12W6 which demonstrated a final production test rate of 13 mmcf/d, including 20 bbl/mmcf of free condensate, was initially brought on production at restricted rates of up to 9.5 mmcf/d. This well has been further rate restricted to approximately 6.0 mmcf/d for the last 20 days to manage the flow back of frac sand and to control the amount of free condensate that our facilities can handle at this time since our Glacier gas plant does not currently have liquid extraction or condensate stabilization processes installed. The 12-02-76- 12W6 well is still producing at a strong wellhead pressure of 10,100 kPa compared to our average gas gathering system pressure of 3,000 kpa. Advantage Oil & Gas Ltd. - 4 Glacier Phase VII Glacier Development Program Underway (cid:1) The Glacier Phase VII drilling program was accelerated during the first quarter of 2014 due to lower than anticipated capital expenditures in our Phase VI program. The lower capital spending resulted from improved drilling and well completion efficiencies which reduced well costs below our original budget estimates. (cid:1) To date, four new Phase VII wells have been rig released. One drilling rig is currently situated on a six well pad that will continue drilling through spring breakup. Two additional rigs will be deployed once weather conditions permit access to new drilling sites. A total of 33 wells are included in our Phase VII drilling program. (cid:1) Engineering design is nearing completion for the expansion of our 100% owned Glacier gas plant. The expansion work is targeted for completion during the second quarter of 2015 and includes the installation of a shallow cut liquids extraction process and increased natural gas processing capacity to accommodate our Phase VII production target of 183 mmcfe/d. The engineering design will allow our Glacier gas plant to ultimately provide 245 mmcfe/d of processing capacity to accommodate our three year development plan through to 2017. (cid:1) Design plans are also underway for increasing the transportation capacity of the sales gas lateral which connects the Glacier gas plant to TransCanada Pipeline’s main sales pipeline to accommodate our three year development plan and beyond. Advantage’s strong operating and financial achievements during 2013 combined with simplification of the Corporate structure have positioned the company as an industry leading low cost Montney producer with strong growth. We look forward to reporting results on our progress as we execute Advantage’s Glacier three year development plan. 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 (the “Sproule Report”) in accordance with National Instrument 51-101 (“NI 51-101”) and the COGE Handbook. The Sproule Report includes only Advantage’s “stand-alone” reserves and excludes the assets in Longview Oil Corp. Reserves and production information included herein is stated on a Gross Working Interest basis (before royalty burdens and excluding royalty interests) unless noted otherwise. This summary contains several cautionary statements that are specifically required by NI 51-101. In addition to the detailed information disclosed in this annual report more detailed information on a net interest basis (after royalty burdens and including royalty interests) is included in Advantage's Annual Information Form ("AIF") and is available at www.advantageog.com and www.sedar.com. Highlights – Gross Working Interest Reserves December 31, 2013 December 31, 2012 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) 282,847 2,118,740 $11.44 42.8 1.68 $0.54 $0.30 268,020 $1,694,555 $9.26 35.4 1.59 $0.60 $0.32 (1) Assumes that development will occur, without regard to the likely availability to the Company of funding required for that development. (2) Based on 168.383 million Shares outstanding at December 31, 2013 and 2012. (3) Based on Q4 average production and working 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. Given that the value ratio based on the current price of crude oil as compared to natural gas is significantly different from the energy equivalency of 6:1, utilizing a conversion on a 6:1 basis may be misleading as an indication of value. Gross Working Interest Reserves Summary as at December 31, 2013 Light & Medium Oil (mbbl) Heavy Oil (mbbl) Natural Gas Liquids (mbbl) Oil Natural Gas Equivalent (mboe) (mmcf) Proved Developed Producing Developed Non-producing Undeveloped Total Proved Probable Total Proved + Probable 6 - - 6 1 7 - - - - - - 758 243 6,084 7,085 5,949 13,034 205,253 27,648 759,424 992,325 626,509 1,618,834 34,973 4,851 132,655 172,479 110,368 282,847 Advantage Oil & Gas Ltd. - 6 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% $786,135 117,613 2,604,490 3,508,238 3,140,500 $6,648,738 Before Income Taxes Discounted at 10% 15% $465,720 69,208 692,264 1,227,192 891,548 $2,118,740 $395,466 58,238 398,953 852,657 591,703 $1,444,360 (1) Advantage’s crude oil, natural gas and natural gas liquid reserves were evaluated using Sproule’s product price forecast effective December 31, 2013 prior to the provision for income taxes, interests, debt services charges and general and administrative expenses. It should not be assumed that the discounted future revenue estimated by Sproule represents the fair market value of the reserves. (2) Assumes that development will occur, without regard to the likely availability to the Company of funding required for that development. Sproule Price Forecasts The present value of future net revenue at December 31, 2013 was based upon crude oil and natural gas pricing assumptions prepared by Sproule effective December 31, 2013. These forecasts are adjusted for reserve quality, transportation charges and the provision of any applicable sales contracts. The price assumptions used over the next seven years are summarized in the table below: Year 2014 2015 2016 2017 2018 2019 2020 WTI Edmonton Light Alberta AECO-C Natural Gas ($Cdn/mmbtu) 4.00 3.99 4.00 4.93 5.01 5.09 5.18 Crude Oil ($Cdn/bbl) 92.64 89.31 89.63 101.62 103.14 104.69 106.26 Crude Oil ($US/bbl) 94.65 88.37 84.25 95.52 96.96 98.41 99.89 Henry Hub Exchange Rate Natural Gas ($US/mmbtu)($US/$Cdn) 4.17 4.15 4.17 5.04 5.12 5.19 5.27 0.94 0.94 0.94 0.94 0.94 0.94 0.94 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. Before Income Taxes Discounted at ($000, except per Share amounts) Net asset value per Share (1) - December 31, 2012 Present value proved and probable reserves Undeveloped land (2) Working capital (deficit) and other Convertible debentures Bank debt Longview shares (3) Net asset value - December 31, 2013 Net asset value per Share (1) - December 31, 2013 0% $34.58 $6,648,738 6,831 (50,264) (86,250) (153,697) 90,353 $6,455,711 $38.34 10% $9.26 15% $5.80 $2,118,740 6,831 (50,264) (86,250) (153,697) 90,353 $1,444,360 6,831 (50,264) (86,250) (153,697) 90,353 $1,925,713 $1,251,333 $11.44 $7.43 (1) Based on 168.383 million Shares outstanding at December 31, 2013 and 2012. (2) Represents amount paid for new 27,680 net acres of undeveloped land at Glacier. (3) Represents the net proceeds from the sale of Longiew shares that closed February 28, 2014. Gross Working Interest Reserves Reconciliation Proved Opening balance Dec. 31, 2012 Extensions Improved recovery Infill Drilling Discoveries Economic factors Technical revisions Acquisitions Dispositions Production Light & Medium Oil (mbbl) 1,363 - - - - 6 30 - (1,302) (91) Heavy Oil (mbbl) 3 - - - - - - - (3) - Natural Gas Liquids (mbbl) 4,430 2,927 - - - (16) 2,315 - (2,477) (94) Natural Oil Gas Equivalent (mboe) 170,187 18,997 - - - (258) 11,477 - (20,807) (7,117) (mmcf) 986,344 96,420 - - - (1,489) 54,793 - (102,152) (41,591) Closing balance at Dec. 31, 2013 6 - 7,085 992,325 172,479 Advantage Oil & Gas Ltd. - 8 Gross Working Interest Reserves Reconciliation (continued) Proved + Probable Opening balance Dec. 31, 2012 Extensions Improved recovery Infill Drilling Discoveries Economic factors Technical revisions Acquisitions Dispositions Production Light & Medium Oil (mbbl) 2,190 - - - - 11 30 - (2,133) (91) Heavy Oil (mbbl) 9 - - - - 1 (1) - (9) - Natural Gas Liquids (mbbl) 6,413 6,599 - - - (15) 3,723 - (3,591) (94) Natural Oil Gas Equivalent (mboe) 268,020 39,940 - - - (355) 13,195 - (30,836) (7,117) (mmcf) 1,556,450 200,043 - - - (2,110) 56,656 - (150,615) (41,591) Closing balance at Dec. 31, 2013 7 - 13,035 1,618,833 282,847 Finding, Development & Acquisitions Costs (“FD&A”) (1)(2)(3) 2013 FD&A Costs – Gross Working Interest Reserves excluding Future Development Capital Capital expenditures ($000) Acquisitions net of dispositions ($000) Total capital ($000) Total mboe, end of year Total mboe, beginning of year Production, mboe Reserve additions, mboe 2013 FD&A costs ($/boe) 2012 FD&A costs ($/boe) Three year average FD&A costs ($/boe) 2013 F&D costs ($/boe) 2012 F&D costs ($/boe) Three year average F&D costs ($/boe) Proved $155,370 (70,403) (4) $84,967 172,479 170,187 (7,117) 9,409 $9.03 $3.09 $(2.75) $5.14 $3.44 $5.25 Proved + Probable $155,370 (70,403) (4) $84,967 282,847 268,020 (7,117) 21,944 $3.87 $2.01 $(2.31) $2.94 $2.24 $3.76 Advantage Oil & Gas Ltd. - 9 NI 51-101 2013 FD&A Costs – Gross Working Interest Reserves including Future Development Capital Capital expenditures ($000) Acquisitions net of dispositions ($000) Net change in Future Development Capital ($000) Total capital ($000) Reserve additions, mboe 2013 FD&A costs ($/boe) 2012 FD&A costs ($/boe) Three year average FD&A costs ($/boe) 2013 F&D costs ($/boe) 2012 F&D costs ($/boe) Three year average F&D costs ($/boe) Proved $155,370 (70,403) (4) 152,889 $237,856 9,409 $25.28 $6.58 $3.52 $10.20 $6.91 $8.77 Proved + Probable $155,370 (70,403) (4) 272,189 $357,156 21,944 $16.28 $4.29 $3.60 $8.10 $4.51 $6.59 (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. Given that the value ratio based on the current price of crude oil as compared to natural gas is significantly different from the energy equivalency of 6:1, utilizing a conversion on a 6:1 basis may be misleading as an indication of value. (4) Includes net cash proceeds from dispositions closed in 2013 and $17.5 million of estimated net cash proceeds from the sale of investments in Questfire expected to close in 2014. Advantage Oil & Gas Ltd. - 10 CONSOLIDATED MANAGEMENT’S DISCUSSION & ANALYSIS The following Management’s Discussion and Analysis (“MD&A”), dated as of March 27, 2014, provides a detailed explanation of the consolidated 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, 2013 and should be read in conjunction with the December 31, 2013 audited consolidated financial statements. The consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”), representing generally accepted accounting principles (“GAAP”) for publicly accountable enterprises in Canada. All references in the MD&A and consolidated financial statements are to Canadian dollars unless otherwise indicated. The term “boe” or barrels of oil equivalent and “mcfe” or thousand cubic feet equivalent may be misleading, particularly if used in isolation. A boe or mcfe conversion ratio of six thousand cubic feet of natural gas equivalent to one barrel of oil (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. As the value ratio between natural gas and crude oil based on the current prices of natural gas and crude oil is significantly different from the energy equivalency of 6:1, utilizing a conversion on a 6:1 basis may be misleading as an indication of value. 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, effect of commodity prices on the Corporation's financial results, condition and performance; effect of changes in the $US/$Canadian exchange rate, changes in Canadian crude oil differentials between WTI and Canadian realized pricing, and quality and transportation adjustments on Advantage’s realized prices; industry conditions, including effect of changes in commodity prices on the crude oil and natural gas industry and demand for crude oil and natural gas; the Corporation's hedging strategy, including its anticipated effect on the volatility of Advantage's future cash flows and the funding of its capital expenditure program and on the volatility of Longview Oil Corp.'s (“Longview”) sales and stability of funds from operations; effect of commodity price risk management activities on the Corporation, including on cash flows, sales and credit risk; the Corporation's plans to mitigate credit risk; terms of the Corporation's and Longview's derivative contracts, including the timing of settlement of such contracts; effect of fluctuations in commodity prices and foreign exchange rates as compared to valuation assumptions on actual gains or losses realized on cash settlement of derivatives; average royalty rates and the impact of well depths, well production rates and commodity prices on average corporate royalty rates; projected royalty rates, including the estimated royalty rate for the life of a Glacier Montney horizontal well; Advantage's estimated operating costs at Glacier for the first quarter of 2014; Advantage's expectations regarding decreased general and administrative expenses through 2014, including the estimated amount of such expenses, as a result of the termination of the TSA (as defined herein) with Longview; terms of the Corporation's and Longview's equity compensation plans; the Corporation's intentions to monitor debt levels to ensure an optimal mix of financing and cost of capital to provide return to the Corporation's shareholders; terms of the Corporation's and Longview's credit facilities, including timing of next review of the credit facilities; the Corporation's expectations regarding extension of Advantage's credit facilities at each annual review, effect of revisions or changes in reserve estimates and commodity prices on the borrowing base, and limitations on the utilization of hedging contracts; terms of the Corporation's convertible debentures; the ability of the Corporation to manage its capital structure, the Corporation's strategy for managing its capital structure, including the use of financial and operational forecasting processes, and the timing of reviews of capital structure and forecast information by management and the Board; future commitments and contractual obligations; effect of the Corporation's continual financial assessment processes on the Corporation's ability to mitigate risks; the Corporation's ability to satisfy all liabilities and commitments, including a working capital deficit, and meet future obligations as they become due; Advantage's focus on development of the natural gas resource play at Glacier; the Corporation's expectations as to its ability to maintain and increase production, as applicable, from Glacier at the levels and for the periods disclosed herein; the focus of each of the Corporation's and Longview's capital drilling program; the Corporation's drilling plans at Glacier; the Corporation's beliefs regarding the potential for Middle Montney natural gas liquids on certain recently acquired assets located southeast of Glacier and the terms of the licenses for such assets; Longview's plans to advance their waterflood projects in Alberta; and anticipated changes in accounting standards. 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. Advantage Oil & Gas Ltd. - 11 These forward-looking statements involve substantial known and unknown risks and uncertainties, many of which are beyond our control, including, but not limited to, 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; individual well productivity; delays in anticipated timing of drilling and completion of wells; failure to extend the credit facilities at each annual review; competition from other producers; the lack of availability of qualified personnel or management; ability to access sufficient capital from internal and external sources; credit risk; and the risks and uncertainties described in the Corporation’s Annual Information Form which 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. With respect to forward-looking statements contained in this MD&A, in addition to other assumptions identified herein, Advantage has made assumptions regarding, but not limited to: 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; the price of crude oil and natural gas; that the Corporation will have sufficient cash flow, debt or equity sources or other financial resources required to fund its capital and operating expenditures and requirements as needed; that the Corporation’s conduct and results of operations will be consistent with its expectations; that the Corporation will have the ability to develop the Corporation’s crude oil and natural gas properties in the manner currently contemplated; that current or, where applicable, proposed assumed industry conditions, laws and regulations will continue in effect or as anticipated as described herein; and that the estimates of the Corporation’s production, reserves and resources volumes and the assumptions related thereto (including commodity prices and development costs) are accurate in all material respects. 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. Advantage Oil & Gas Ltd. - 12 Consolidation of Longview Oil Corp. At December 31, 2013, Advantage owned 21,150,010 common shares of Longview, representing an interest of approximately 45.1% in Longview. As Advantage held the single largest ownership interest of Longview and other ownership interests were comparatively dispersed, Advantage was considered to control Longview. Accordingly, the financial and operating results of Longview were consolidated 100% within Advantage and non-controlling interest was recognized which represented Longview’s independent shareholders 54.9% ownership interest in the net assets and income of Longview. Refer to the MD&A section “Supplementary Financial and Operating Information for Advantage and Longview” which provides detailed financial and operational information with respect to the separate legal entities. On February 4, 2014, Advantage entered into an agreement to sell its remaining 21,150,010 common shares of Longview at a price of $4.45 per share. The offering closed on February 28, 2014 and Advantage received net proceeds of $90.0 million, all of which were used to reduce existing bank indebtedness. Concurrent with closing, Advantage ceased to consolidate Longview. A Technical Services Agreement (“TSA”) existed between Advantage and Longview whereby Advantage provided the necessary personnel and technical services to manage Longview's business and Longview reimbursed Advantage on a monthly basis for its share of administrative charges based on respective levels of production. The officers of Longview provided services to Longview under the TSA but remained employees of Advantage. On February 1, 2014, Advantage and Longview terminated the TSA and Advantage has no future obligations to Longview for the provision of personnel and services. Appropriate staffing and systems are now in place to enable both organizations to run independently following termination of the TSA. Non-core Asset Sales The Advantage legal entity has systematically disposed of substantially all non-core assets since the third quarter of 2012 to focus on continued development of Advantage's core Glacier Montney natural gas asset. In accordance with the requirements of IFRS, Advantage ceased recognizing depreciation on property, plant and equipment effective when classified as held for sale. The carrying amounts of exploration and evaluation assets, property, plant and equipment, decommissioning liabilities and derivative liabilities associated with assets held for sale were presented separately on the statement of financial position and reflected at the lesser of fair value less costs to sell and carrying amount. Net cash proceeds from all disposition transactions were used to reduce outstanding bank indebtedness. The disposition transactions have had a pervasive impact on the financial and operating results and financial position of the Advantage legal entity such that historical financial and operating performance may not be indicative of actual future performance. Advantage is now a pure play company focused on our signature Glacier Montney property. At December 31, 2013, Advantage’s other assets included investments in Questfire Energy Corp. (“Questfire”) including a $32.6 million Convertible Senior Secured Debenture (the “Questfire Debenture”) and 1.5 million Class B Shares of Questfire (the “Class B Shares”), which were received as partial consideration for certain asset dispositions. On March 26, 2014, Advantage entered an agreement for Questfire to repurchase the Questfire Debenture at an aggregate purchase price of $13.6 million. Questfire also agreed that it would make an offer to purchase by way of issuer bid, all of the Class B Shares at a purchase price of $2.60 per share. Advantage expects to receive total proceeds of $17.5 million on the disposition of its investments in Questfire. Advantage Oil & Gas Ltd. - 13 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. Investors should be cautioned that these measures should not be construed as an alternative to net income, comprehensive income, and 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 decommissioning liability and changes in non-cash working capital, reduced for finance expense excluding accretion. Cash netbacks are dependent on the determination of funds from operations and include the primary cash sales and expenses on a per boe or mcfe 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 decommissioning liability Changes in non-cash working capital Finance expense (1) Funds from operations (1) Finance expense excludes non-cash accretion expense. $ $ $ $ 2013 57,355 1,533 (16,818) (4,508) 37,562 2012 43,675 252 (7,152) (4,246) 32,529 % change 31 % 508 % 135 % 6 % 15 % 2013 165,017 5,158 (4,052) (17,618) 148,505 2012 106,956 2,395 14,864 (16,749) 107,466 % change 54 % 115 % (127) % 5 % 38 % $ $ $ $ Advantage Oil & Gas Ltd. - 14 Supplementary Financial and Operating Information for Advantage and Longview The following information has been presented to provide additional information with respect to the legal entity financial and operating information for each of Advantage and Longview. Production Natural gas (mcf/d) Crude oil (bbls/d) NGLs (bbls/d) Total (boe/d) Natural gas (%) Crude oil (%) NGLs (%) Natural Gas Prices ($/mcf) Realized natural gas prices Excluding hedging Including hedging Crude Oil and NGLs Prices ($/bbl) Realized crude oil prices Excluding hedging Including hedging Realized NGLs prices Excluding hedging Realized crude oil and NGLs prices Excluding hedging Including hedging Cash netbacks ($/boe) Petroleum and natural gas sales Royalties Realized gain (loss) on derivatives Operating expense Operating income General and administrative expense (1) Finance expense (2) Other income (3) Cash netbacks Three months ended December 31, 2013 Year ended December 31, 2013 Advantage Longview Consolidated Advantage Longview Consolidated 108,260 63 16 18,122 100% -% -% 6,503 4,226 506 5,816 18% 73% 9% 114,763 4,289 522 23,938 80% 18% 2% 113,947 249 258 19,498 98% 1% 1% 7,232 4,226 522 5,953 20% 71% 9% 121,179 4,475 780 25,452 79% 18% 3% $ $ 3.21 3.39 $ $ 3.81 3.81 $ $ 3.25 3.41 $ $ 3.03 3.10 $ $ 3.35 3.35 $ $ 3.05 3.11 $ $ 77.79 77.79 $ $ 79.15 74.09 $ $ 79.13 74.15 $ $ 84.23 84.40 $ $ 84.70 80.30 $ $ 84.67 80.52 $ 73.87 $ 56.66 $ 57.19 $ 67.89 $ 53.34 $ 58.15 $ $ 77.01 77.01 $ $ 76.74 72.23 $ $ 76.75 72.31 $ $ 75.92 76.01 $ $ 81.25 77.33 $ $ 80.74 77.21 $ $ $ $ $ $ 19.52 (0.91) 1.05 (1.66) 18.00 (2.36) (1.90) 0.56 14.30 66.70 (11.97) (3.67) (21.56) 29.50 (1.33) (2.49) - 25.68 30.98 (3.60) (0.09) (6.50) 20.79 (2.11) (2.04) 0.41 17.05 19.68 (1.06) 0.40 (2.88) 16.14 (2.70) (1.70) 0.24 11.98 68.87 (12.10) (3.12) (21.08) 32.57 (1.25) (2.54) 0.30 29.08 31.19 (3.64) (0.42) (7.14) 19.99 (2.36) (1.89) 0.26 16.00 $ $ $ $ $ $ (1) General and administrative expense excludes non-cash G&A. (2) Finance expense excludes non-cash accretion expense. (3) Other income excludes non-cash other income. Advantage Oil & Gas Ltd. - 15 ($000, except as otherwise indicated) Sales including realized hedging Natural gas sales Realized hedging gains Natural gas sales including hedging Crude oil and NGLs sales Realized hedging gains (losses) Crude oil and NGLs sales including hedging Total per boe Royalties per boe Royalty Rate (percentage of petroluem and natural gas sales) Operating expense per boe General and administrative expense (1) per boe Three months ended December 31, 2013 Year ended December 31, 2013 Advantage Longview Consolidated Advantage Longview Consolidated $ 31,984 1,758 33,742 562 - $ 2,280 - 2,280 33,407 (1,966) $ 34,264 1,758 36,022 33,969 (1,966) $ 126,038 2,837 128,875 14,052 16 $ 8,840 - 8,840 140,812 (6,789) $ 134,878 2,837 137,715 154,864 (6,773) 562 34,304 20.57 $ $ 31,441 33,721 63.03 $ $ 32,003 68,025 30.89 $ $ 14,068 142,943 20.08 $ $ 134,023 142,863 65.75 $ $ 148,091 285,806 30.77 $ $ $ $ 1,523 0.91 4.7% $ $ 6,405 11.97 17.9% $ $ 7,928 3.60 11.6% $ $ 7,534 1.06 5.4% $ $ 26,297 12.10 17.6% $ $ 33,831 3.64 11.7% $ $ 2,772 1.66 $ $ 11,533 21.56 $ $ 14,305 6.50 $ $ 20,515 2.88 $ $ 45,799 21.08 $ $ 66,314 7.14 $ $ 3,932 2.36 $ $ 709 1.33 $ $ 4,641 2.11 $ $ 19,246 2.70 $ $ 2,706 1.25 $ $ 21,952 2.36 Interest on bank indebtedness per boe $ $ 2,087 1.25 $ $ 1,334 2.49 $ $ 3,421 1.55 $ $ 7,784 1.09 $ $ 5,521 2.54 $ $ 13,305 1.43 Interest on convertible debentures per boe Other income (2) per boe Funds from operations per boe per share (3) (4) Dividends from Longview (declared by Longview) $ $ 1,087 0.65 $ - $ - $ $ 1,087 0.49 $ $ 4,313 0.61 $ - $ - $ $ 4,313 0.46 $ $ 919 0.56 2% $ - - $ 3% $ $ 919 0.41 $ $ 1,759 0.24 $ $ 655 0.30 $ $ 2,414 0.26 $ $ $ 23,822 14.30 0.14 $ $ $ 13,740 25.68 0.29 $ $ $ 37,562 17.05 0.18 $ $ $ 85,310 11.98 0.51 $ $ $ 63,195 29.08 1.35 $ $ $ 148,505 16.00 0.68 $ 2,961 $ (6,570) $ (3,609) $ 12,479 $ (27,670) $ (15,191) Expenditures on property, plant and $ 69,470 $ 10,674 $ 80,144 $ 148,539 $ 40,502 $ 189,041 equipment Expenditures on exploration and 42 146 188 6,831 146 6,977 evaluation assets Total capital spending Debt and working capital Bank indebtedness Convertible debentures Working capital deficit $ 69,512 $ 10,820 $ 80,332 $ 155,370 $ 40,648 $ 196,018 $ $ $ 153,697 86,250 49,034 117,642 $ $ - $ 9,486 $ $ $ 271,339 86,250 58,520 (1) General and administrative expense excludes non-cash G&A. (2) Other income excludes non-cash other income. (3) Based on basic weighted average shares outstanding applicable to each legal entity. (4) Consolidated funds from operations per share excludes funds from operations attributable to the non-controlling interest of Longview. Advantage Oil & Gas Ltd. - 16 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 2013 2012 % change 2013 2012 % change $ $ $ $ 57,355 37,562 0.18 17.05 $ $ $ $ 43,675 32,529 0.14 13.05 31 15 29 31 % % % % $ $ $ $ 165,017 148,505 0.68 16.00 $ $ $ $ 106,956 107,466 0.47 10.53 54 38 45 52 % % % % (1) Based on basic weighted average shares outstanding and excludes funds from operations attributable to the non-controlling interest of Longview. For the three months ended December 31, 2013, Advantage realized an increase of 15% in funds from operations to $37.6 million and an increase of 31% in cash netbacks to $17.05 per boe, as compared to the fourth quarter of 2012. For the year ended December 31, 2013, Advantage realized an increase of 38% in funds from operations to $148.5 million and an increase of 52% in cash netbacks to $16.00 per boe, as compared to 2012. The increased funds from operations and cash netbacks have been primarily attributable to significantly improved commodity prices and partially offset by lower production due to non-core asset dispositions. Realized natural gas prices, excluding hedging, increased 9% for the three months and 41% for the year ended December 31, 2013, as compared to the same periods of 2012. Realized crude oil and NGLs prices, excluding hedging, increased 8% for the three months and 9% for the year ended December 31, 2013 when compared to 2012. Management has been proactive in mitigating commodity price risk and has entered numerous hedging contracts to March 31, 2016 (refer to the section “Commodity Price Risk”). Average daily production during the three months and year ended December 31, 2013 decreased as compared to the same periods of 2012 primarily attributable to significant non-core property dispositions, which was finalized on April 30, 2013, to create a pure play company focused on our signature Glacier Montney property. As a result of our continued focus at Glacier, Advantage has achieved an industry leading cost structure comprised of low royalty rates and operating expense with continued general and administrative cost reductions. The primary factor that causes significant variability of the Corporation’s cash provided by operating activities, funds from operations, net income and comprehensive 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. As a result of asset dispositions, disposition of our ownership interest of Longview, and changes in commodity prices, historical financial and operating performance may not be indicative of actual future performance. Petroleum and Natural Gas Sales and Hedging ($000) Natural gas sales Realized hedging gains (losses) Natural gas sales including hedging Crude oil and NGLs sales Realized hedging gains (losses) Crude oil and NGLs sales including hedging Total (1) (1) Total excludes unrealized derivative gains and losses. Three months ended December 31 Year ended December 31 $ 2013 34,264 1,758 36,022 33,969 (1,966) $ 2012 34,310 (2,619) 31,691 40,122 1,131 % change % - % (167) % 14 % (15) % (274) $ 2013 134,878 2,837 137,715 154,864 (6,773) $ 2012 104,045 (2,382) 101,663 164,860 1,412 % change % % % % % 30 (219) 35 (6) (580) 32,003 68,025 $ 41,253 72,944 $ (22) % % (7) 148,091 285,806 $ 166,272 267,935 $ % % (11) 7 Total sales excluding hedging during the fourth quarter of 2013 was $68.2 million, a decrease of $6.2 million or 8% when compared to the same period of 2012 attributable to lower production due to non-core asset dispositions, partially offset by increased commodity prices. However, for the year ended December 31, 2013, total sales excluding hedging was $289.7 million, an increase of $20.8 million or 8% when compared to the same period of 2012 as increased commodity prices more than offset lower production from non-core asset dispositions. Realized natural gas prices, excluding hedging, increased 9% for the three months and 41% for the Advantage Oil & Gas Ltd. - 17 year ended December 31, 2013, as compared to the same periods of 2012. Realized crude oil and NGLs prices, excluding hedging, increased 8% for the three months and 9% for the year ended December 31, 2013 when compared to 2012. The Corporation’s financial results and condition will be dependent on the prices received for crude oil and natural gas production. As such, the Corporation enters derivative contracts whereby realized hedging gains and losses partially offset commodity price fluctuations, which can positively or negatively impact sales. Management has been proactive in mitigating commodity price risk and has entered numerous hedging contracts to March 31, 2016 (refer to the section “Commodity Price Risk”). For the three months and year ended December 31, 2013, we recognized net realized derivative losses on settled derivative contracts as a result of higher crude oil prices, partially offset by realized derivative gains attributed from lower natural gas prices, as compared to our average hedge prices. 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 2013 114,763 4,289 522 23,938 80% 18% 2% % change % (9) % (12) (59) % % (12) 2012 125,455 4,883 1,265 27,057 77% 18% 5% Year ended December 31 2013 121,179 4,475 780 25,452 79% 18% 3% % change (8) % (7) % (39) % % (9) 2012 131,007 4,799 1,283 27,917 78% 17% 5% Average daily production during the three months and year ended December 31, 2013 decreased as compared to the same periods of 2012 primarily attributable to significant non-core property dispositions by Advantage. Advantage’s stand-alone production averaged 108.7 mmcfe/d for the fourth quarter of 2013, as compared to 124.5 mmcfe/d for the fourth quarter of 2012 due to several significant non-core gas weighted property dispositions from the third quarter of 2012 through to the second quarter of 2013 (exceeding 6,000 boe/d) to create a pure play company focused on our signature Glacier Montney property. Average daily production in 2013 from Glacier was 105 mmcfe/d, an increase of 14% from the prior year due to continued strong well performance and development. In early March 2014 Glacier production reached the 135 mmcfe/d Phase VI target approximately one month ahead of schedule. Nine new wells from Advantage’s Glacier Phase VI program were brought on production to initially ramp production to 135 mmcfe/d with the remaining 13 new wells from our Phase VI program expected to provide sufficient production inventory to maintain production at 135 mmcfe/d through to the end of 2014. At Longview, daily production averaged 5,816 boe/d for the fourth quarter of 2013 with 82% from crude oil and NGLs, an 8% decrease from the 6,308 boe/d realized during the fourth quarter of 2012. The majority of production declines related to natural gas which fell by 24% compared to the fourth quarter of 2012 while higher value crude oil production remained comparable to the same period of the prior year. On a year to date basis, total production averaged 5,953 boe/d versus 6,235 boe/d in 2012. The decrease in total production occurred as natural gas and NGL volumes declined by 19% and 9%, respectively, due to normal production declines, more than offsetting the 1% increase in crude oil production. Advantage Oil & Gas Ltd. - 18 Commodity Prices and Marketing Natural Gas ($/mcf, except where indicated) Realized natural gas prices Excluding hedging Including hedging AECO daily index NYMEX ($US/mmbtu) Three months ended December 31 Year ended December 31 2013 2012 % change 2013 2012 % change $ $ $ $ 3.25 3.41 3.52 3.63 $ $ $ $ 2.97 2.75 3.22 3.36 % 9 % 24 % 9 % 8 $ $ $ $ 3.05 3.11 3.18 3.67 $ $ $ $ 2.17 2.12 2.40 2.80 41 % 47 % 32 % % 31 Realized natural gas prices, excluding hedging, have increased significantly as compared to 2012 corresponding to increases in AECO prices. Natural gas prices declined dramatically throughout 2012 due to decreased demand caused by the mild 2011/2012 winter and increasing U.S. domestic natural gas production, particularly from non-conventional natural gas resource plays, that resulted in historic high inventory levels. Massive switching by electrical utilities from coal to natural gas during the 2012 summer combined with the 2012/2013 prolonged winter reduced the inventory levels to a more balanced market and a significant improvement in pricing during 2013. Advantage’s realized natural gas prices include deductions for unutilized sales gas pipeline fees associated with TransCanada pipeline firm service commitments of approximately 125 mmcf/d at Glacier for calendar 2013. We incur charges of approximately $0.25/mcf on these service commitments and since Glacier production has averaged less than the commitments, the unutilized firm service costs reduced our realized natural gas prices in comparison to AECO prices. Advantage has been successful is partially mitigating such transportation commitments by assignment to third parties resulting in less unutilized firm service and lower deductions for 2013 as compared to 2012. Crude Oil and NGLs ($/bbl, except where indicated) 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 Edmonton Light ($/bbl) WTI/Edmonton Light Differential ($/bbl) Three months ended December 31 Year ended December 31 2013 2012 % change 2013 2012 % change $ $ 79.13 74.15 $ $ 75.78 78.30 % % 4 (5) $ $ 84.67 80.52 $ $ 78.88 79.68 % % 7 1 $ 57.19 $ 52.28 % 9 $ 58.15 $ 55.99 % 4 $ $ $ $ $ $ 76.75 72.31 97.50 0.95 86.88 (15.75) $ $ $ $ $ $ 70.94 72.94 88.20 1.01 84.55 (2.78) % 8 % (1) % 11 % (6) % 3 % 467 $ $ $ $ $ $ 80.74 77.21 98.00 0.97 93.43 (7.60) $ $ $ $ $ $ 74.05 74.69 94.19 1.00 86.73 (7.46) % % % % % % 9 3 4 (3) 8 2 Realized crude oil and NGLs prices, excluding hedging, have increased as compared to 2012 due to modestly stronger Canadian realized pricing. The West Texas Intermediate benchmark price (“WTI”) fluctuates based on regional and worldwide supply and demand fundamentals with significant price volatility experienced over the last several years. Advantage’s realized prices may not change to the same extent as WTI due to changes in Canadian crude oil differentials between WTI and Canadian realized pricing, the $US/$Canadian exchange rate, and quality and transportation adjustments. Although differentials continue to remain volatile, the WTI/Edmonton Light differential during the year ended December 31, 2013 approximated that for the same period of 2012. Advantage Oil & Gas Ltd. - 19 Commodity Price Risk The Corporation’s financial results and condition will be dependent on the prices received for crude oil and natural gas production. Crude 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 crude oil and natural gas regions, impact prices. 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 and international energy firms to further mitigate associated credit risk. Our Credit Facilities also separately limit the utilization of derivative contracts for each of Advantage and Longview. Advantage is allowed to hedge up to 65% of total estimated crude oil and natural gas production over the first three years and 50% over the fourth year. Longview is allowed to hedge up to 60% of total estimated crude oil and natural gas production over the first two years and 50% over the third year. Advantage has entered into a number of natural gas hedges in support of our Glacier multi-year development plan. Our natural gas hedges will reduce the volatility of future cash flows through to March 2016. Our current hedging positions are summarized as follows: Period Q1 2014 to Q4 2014 Q1 2015 to Q4 2015 Q1 2016 Average Production Hedged 60.2 mmcf/d 75.8 mmcf/d 52.1 mmcf/d Forecast Production Hedged (net of royalties) 48% 51% 31% Average Price AECO ($Cdn.) $3.81/mcf $3.90/mcf $3.88/mcf Longview has entered into a number of crude oil hedges to reduce the volatility of sales to provide a measure of stability to their funds from operations that will fund capital expenditures and dividend payments. Longview’s current hedging positions are summarized as follows: Period Q1 2014 to Q4 2014 Average Production Hedged 2,000 bbls/d Average Price WTI ($Cdn.) $94.84/bbl A summary of realized and unrealized hedging gains and losses for the years ended December 31, 2013 and 2012 are as follows: ($000) Realized gains (losses) on derivatives Natural gas Crude oil Total realized losses on derivatives Unrealized gains (losses) on derivatives Natural gas Crude oil Total unrealized gains (losses) on derivatives Total gains (losses) on derivatives Three months ended December 31 Year ended December 31 2013 2012 % change 2013 2012 % change $ 1,758 (1,966) (208) $ (2,619) 1,131 (1,488) (167) (274) (86) % % % $ 2,837 (6,773) (3,936) $ (2,382) 1,412 (970) (11,472) 1,133 (10,339) (10,547) $ 4,058 (1,777) 2,281 793 $ (383) (164) (553) (1,430) % % % % (6,043) (4,769) (10,812) (14,748) $ 2,142 1,686 3,828 2,858 $ (219) (580) 306 % % % (382) (383) (382) (616) % % % % For the three months and year ended December 31, 2013, we recognized net realized derivative losses on settled derivative contracts as a result of higher crude oil prices, partially offset by realized derivative gains attributed from lower natural gas prices, as compared to our average hedge prices. As at December 31, 2013, the fair value of the derivative contracts outstanding and to be settled was a net liability of approximately $7.0 million, a change of $8.1 million from the $1.1 million net asset at December 31, 2012 due to generally stronger commodity prices. For the year ended December 31, 2013, this $8.1 million loss due to the change in the fair value of the derivative contracts was recognized in income as an unrealized derivative loss (December 31, 2012 – $3.8 million unrealized Advantage Oil & Gas Ltd. - 20 derivative gain) together with the recognition of a $2.7 million unrealized derivative loss associated with the net liability of derivative contracts outstanding that were subsequently assigned to Questfire upon disposition of corresponding assets. The valuation of the derivatives is the estimated fair value to settle the contracts as at December 31, 2013 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 statement of comprehensive income as a derivative gain or loss with a corresponding derivative asset and liability recorded on the statement of financial position. These derivative contracts will settle from January 1, 2014 to March 31, 2016 corresponding to when the Corporation will recognize sales from production. Royalties Royalties ($000) per boe Royalty Rate (percentage of petroleum and natural gas sales) Three months ended December 31 Year ended December 31 2013 $ $ 7,928 3.60 2012 $ $ 7,915 3.18 % change % - % 13 2013 33,831 3.64 $ $ 2012 34,126 3.34 $ $ % change % % (1) 9 11.6% 10.6% 1.0 % 11.7% 12.7% (1.0) % 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. Royalties include payments for Saskatchewan Resource Surcharge which is based on the petroleum and natural gas sales earned within the Province of Saskatchewan. Royalties also include 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. Our average corporate royalty rates are impacted by well depths, well production rates, and commodity prices. Royalties for the three months and year ended December 31, 2013 are generally comparable to the same periods of 2012 whereby reduced royalties from disposed non-core properties that generally attracted higher royalty rates were offset by additional royalties attributed from stronger commodity prices. On a stand-alone basis, the royalty rate realized by each of Advantage and Longview for the current quarter was 4.7% and 17.9%, respectively. Advantage’s royalty rates are predominately based on our significant natural gas development at Glacier where the royalty rate for the life of a Glacier Montney horizontal well is approximately 5% due to industry provincial incentive programs. As production from Glacier has become a larger proportion of total production, we have experienced a continual reduction in our realized royalty rate. Operating Expense Operating expense ($000) per boe Three months ended December 31 Year ended December 31 2013 14,305 6.50 $ $ 2012 22,196 8.92 $ $ % change (36) (27) % % 2013 66,314 7.14 $ $ 2012 89,229 8.73 $ $ % change (26) (18) % % Operating expense for the three months and year ended December 31, 2013 decreased as compared to the same periods of 2012 attributable to significant non-core property dispositions. Operating expense per boe realized by Advantage on a stand-alone basis for the fourth quarter of 2013 was $1.66/boe ($0.28/mcfe), compared to $5.23/boe ($0.87/mcfe) for the fourth quarter of 2012. Advantage operating costs have decreased with disposition of higher cost non-core assets from the third quarter of 2012 through to the second quarter of 2013. In the first quarter of 2014, Advantage estimates operating expenses at Glacier are $0.27/mcfe due to the continued efficiencies created by processing our natural gas through our 100% owned Glacier gas plant. Advantage Oil & Gas Ltd. - 21 At Longview, total operating expenses for the three months and year ended December 31, 2013 were comparable to the same periods of 2012. Although total operating costs have remained relatively stable, operating costs per boe for the year ended December 31, 2013 increased by 4% to $21.08/boe, due to the variation of production during these periods. Additionally, to help stabilize fluctuating power costs, Longview has fixed the price of 0.8 MW at $55.41/MWh for the period from January 2013 to December 2014. General and Administrative Expense General and administrative expense Cash expense ($000) per boe Non-cash expense ($000) per boe Total general and administrative expense ($000) per boe Employees at December 31 Three months ended December 31 Year ended December 31 2013 2012 % change 2013 2012 % change $ $ $ $ 4,641 2.11 677 0.31 $ $ $ $ 6,067 2.44 2,423 0.97 $ $ 5,318 2.42 $ $ 8,490 3.41 (24) (14) (72) (68) (37) (29) % % % % % % $ $ $ $ 21,952 2.36 5,456 0.59 $ $ 27,408 2.95 80 $ $ $ $ 20,960 2.05 7,220 0.71 % 5 % 15 % (24) % (17) $ $ 28,180 2.76 121 % (3) % 7 % (34) Cash general and administrative (“G&A”) expense decreased for the three months ended December 31, 2013 as Advantage began to realize cost efficiencies associated with the non-core asset dispositions which was finalized on April 30, 2013. Cash G&A increased slightly for the year ended December 31, 2013 compared to 2012 due to one-time costs including retention and staff rationalization associated with the asset dispositions and costs incurred during Advantage’s strategic alternatives review process that commenced in early 2013 and was concluded on February 4, 2014. On February 1, 2014, Advantage and Longview terminated the TSA and Advantage has no future obligations to Longview for the provision of personnel and services. Appropriate staffing and systems are now in place to enable both organizations to run independently following termination of the TSA. As a result, Advantage currently has 25 full time employees and expects to incur significantly lower cash G&A that will continue to decrease through 2014 to approximately $1.20/boe ($0.20/mcfe). Non-cash G&A expense is comprised of share based compensation. Advantage had a restricted share performance incentive plan that expired during the third quarter of 2012 and no Advantage restricted shares were granted during 2012. On September 13, 2012, shareholders of Advantage approved a new stock option plan, to continue providing for long term equity based compensation for service providers. Stock options are granted subject to Board of Directors approval and on vesting can be exercised at the option of the service providers in exchange for common shares. Compensation cost related to share based compensation is recognized as non- cash G&A expense over the vesting period based on the determination of fair value on grant date, the estimated number of restricted shares or stock options to vest, and certain management estimates. The fair value of share based compensation is the estimated fair value on grant date calculated utilizing option pricing models, including estimates, assumptions and available market data. As such, the fair value determined on grant date and recognized as expense over the vesting period is not cash and the actual gains or losses realized on eventual vesting and exercise can vary materially from the fair value. For the year ended December 31, 2013, 2.0 million stock options expired unexercised, 2.0 million stock options were exercised for cash consideration of approximately $40,000, and 3.8 million new stock options were granted. Advantage stand-alone recognized $5.2 million of compensation cost as non-cash G&A expense related to the amortization of the fair value of stock options granted over the vesting period. Longview non-cash G&A expense is comprised of restricted shares and for the year ended December 31, 2013, no restricted shares were granted and $0.3 million of compensation cost was recognized as non-cash G&A expense. Advantage Oil & Gas Ltd. - 22 Depreciation Expense Depreciation expense ($000) per boe Three months ended December 31 Year ended December 31 2013 27,882 12.66 $ $ 2012 26,453 10.63 $ $ % change % 5 % 19 2013 111,188 11.97 $ $ 2012 132,175 12.94 $ $ % change (16) % % (7) Depreciation of oil and gas properties is provided on the unit-of–production method based on total proved and probable reserves, including future development costs, on a component basis. For the year ended December 31, 2013, depreciation expense has decreased compared to 2012 due to the reduced rate of depreciation per boe and lower production attributable to significant non- core property dispositions. The rate of depreciation per boe has decreased as Advantage ceased depreciation of assets held for sale in accordance with the requirements of IFRS (refer to the section “Non-core Asset Sales”). Impairment of Assets Held for Sale Impairment of assets held for sale ($000) 2013 $ - 2012 $ 73,000 % change (100) % 2013 $ - 2012 $ 73,000 % change (100) % Three months ended December 31 Year ended December 31 The carrying amounts of exploration and evaluation assets, property, plant and equipment and decommissioning liabilities associated with the Advantage assets held for sale were presented separately on the statement of financial position at December 31, 2012 and reflected at the lesser of fair value less costs to sell and carrying amount, which resulted in an impairment recognition of $73 million during the year ended December 31, 2012. The sale of these assets has been completed (refer to the section “Non-core Asset Sales”). Impairment of Oil and Gas Properties Three months ended December 31 Year ended December 31 2013 2012 % change 2013 2012 % change Impairment of oil and gas properties ($000) $ - $ 31,865 (100) % $ - $ 31,865 (100) % As at December 31, 2012, Longview determined that the reduction in crude oil prices recognized within their year-end independent reserves evaluation was an indicator of impairment. As a result, they completed an impairment assessment and calculated an estimated recoverable amount for their CGUs, primarily based upon the net present value after tax of their year-end proved plus probable reserves discounted at 10% and adjusted for a number of other estimates and assumptions. Based upon these calculations, Longview recognized an impairment loss of $31.9 million related to one CGU located in Alberta that had suffered a significant deterioration in value due to the reduction in crude oil prices and decreased reserves. The decrease in Alberta reserves was more than offset by increased reserves from Saskatchewan CGUs resulting in a total increase in Longview reserves for the year ended December 31, 2012. No impairment losses were recognized for any other CGUs. An impairment loss is reversed if there is subsequently an objective change in the estimates used to determine the recoverable amount. Exploration and Evaluation Expense ($000) Exploration and evaluation expense 2013 $ 59 2012 $ 41 % change 44 % 2013 $ 195 2012 $ 181 % change % 8 Three months ended December 31 Year ended December 31 Exploration and evaluation expense represents exploration and evaluation costs related to undeveloped land that expired during the periods. Advantage Oil & Gas Ltd. - 23 Interest on Bank Indebtedness Interest on bank indebtedness ($000) per boe Average effective interest rate Three months ended December 31 Year ended December 31 2013 $ $ 3,421 1.55 5.1% 2012 $ $ 3,159 1.27 4.5% % change % % % 8 22 0.6 $ $ 2013 13,305 1.43 5.0% $ $ 2012 12,436 1.22 4.9% % change % 7 % 17 % 0.1 Interest on bank indebtedness for 2013 has been slightly higher as compared to 2012 with a modest increase in effective interest rates and average bank indebtedness. Our consolidated bank indebtedness outstanding at the end of December 31, 2013 was $271.3 million, a decrease of $1.2 million from December 31, 2012, consisting of $153.7 million and $117.6 million for each of the legal entities Advantage and Longview, respectively. The Corporation’s interest rates have increased due to the moderately higher debt to cash flow ratio as calculated pursuant to our Credit Facilities and 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. Interest and Accretion on Convertible Debentures Interest on convertible debentures ($000) per boe Accretion on convertible debentures ($000) per boe Three months ended December 31 Year ended December 31 2013 2012 % change 2013 2012 % change $ $ 1,087 0.49 $ $ 1,087 0.44 % - % 11 $ $ 4,313 0.46 $ $ 4,313 0.42 % - % 10 $ $ 843 0.38 $ $ 808 0.32 % 4 % 19 $ $ 3,346 0.36 $ $ 3,218 0.31 % 4 % 16 Interest and accretion on convertible debentures for 2013 are comparable to 2012 as there have been no changes in our convertible debentures outstanding. We have $86.2 million of 5% convertible debentures outstanding that are due to mature January 30, 2015. Accretion on Decommissioning Liability Accretion on decommissioning liability ($000) per boe Three months ended December 31 Year ended December 31 2013 2012 % change 2013 2012 % change $ $ 840 0.38 $ $ 1,613 0.65 (48) (42) % % $ $ 5,169 0.56 $ $ 6,300 0.62 (18) (10) % % Decommissioning liabilities are determined by discounting at a risk-free rate the expected future cash flows required to decommission all petroleum and natural gas assets. Accretion on decommissioning liability represents the increase in the decommissioning liability each reporting period due to the passage of time and is currently calculated at an annualized rate of 3.20% of the liability. The decommissioning liability has decreased significantly during 2013 primarily due to $125.0 million derecognized attributable to non- core property dispositions and a $37.9 million decrease in the net present value of the decommissioning liability due to an increase in the risk-free rate. Advantage Oil & Gas Ltd. - 24 Other Income (Expense) ($000) Gain (loss) on sale of assets held for sale Gain (loss) on sale of property, plant and equipment Interest income - Questfire Debenture Accretion income - Questfire Debenture Unrealized loss - Questfire Class B Shares Miscellaneous income Three months ended December 31 Year ended December 31 2013 $ 505 2012 $ 5,476 % change (91) % 2013 (6,354) $ 2012 $ - % change 100 % (1,800) 492 569 (750) 427 (557) $ - - - - 9 5,485 $ 100 100 100 100 4,644 (110) % % % % % % (1,800) 1,312 1,516 (900) 1,102 (5,124) $ 16,964 - - - 595 17,559 $ (111) 100 100 100 85 (129) % % % % % % On April 30, 2013, Advantage closed a disposition transaction with Questfire and consideration consisted of $40.2 million of cash, the Questfire Debenture with a face value of $32.6 million and 1.5 million Class B Shares of Questfire. As a result, Advantage has recognized a $6.4 million loss on disposition as the fair value assigned to the consideration received was less than the carrying value of the assets held for sale. Advantage recognized $1.3 million of interest income earned at a 6% interest rate on the Questfire Debenture. The fair value of the Questfire Debenture was based on a discounted cash flow model at a discount rate of 18% such that the fair value assigned of $25.4 million was less than the face value. Advantage records accretion income each reporting period to increase the carrying value to the fair value by the maturity date and therefore recognized $1.5 million of accretion income. The Class B Shares are recognized at fair value based on quoted trading prices and we recognized an unrealized loss of $0.9 million associated with a decrease in the fair value since acquired. During the fourth quarter of 2013, Longview disposed of a non-core property and recognized a loss of $1.8 million as the consideration received was less than the carrying value of the assets. Taxes Deferred income taxes arise from differences between the accounting and tax bases of our assets and liabilities. For the year ended December 31, 2013, the Corporation recognized a deferred income tax expense of $2.2 million as a result of the $4.8 million net income before taxes and non-controlling interest. As at December 31, 2013, the Corporation had a deferred income tax asset balance of $39.1 million and a deferred income tax liability balance of $3.0 million. Canadian Development Expenses Canadian Exploration Expenses Canadian Oil and Gas Property Expenses Non-capital losses Undepreciated Capital Cost Other $ Estimated Tax Pools December 31, 2013 ($ millions) Longview Consolidated 190 66 295 860 223 25 1,659 50 - 295 108 62 4 519 $ $ $ Advantage 140 $ 66 - 752 161 21 1,140 $ Advantage Oil & Gas Ltd. - 25 Net Income Attributable to Non-Controlling Interest At December 31, 2013, Advantage had a 45.1% ownership interest in Longview with the remaining 54.9% held by outside interests or non-controlling interests. As Advantage held the single largest ownership interest of Longview and other ownership interests were comparatively dispersed, Advantage was considered to control Longview. Accordingly, Advantage’s consolidated financial statements include 100% of Longview’s accounts. To determine the net income or loss attributable to the Advantage shareholders, it is necessary to deduct or add that portion of the net income or loss related to Longview that is consolidated within Advantage’s financial results but is attributable to the non-controlling interests. Therefore, for the year ended December 31, 2013, Advantage recognized a $6.0 million decrease to net income related to Longview’s net income consolidated within Advantage’s financial results but attributable to the non-controlling interests (December 31, 2012 – $8.0 million increase to net income related to Longview’s net loss consolidated within Advantage’s financial results). On February 4, 2014, Advantage entered into an agreement to sell its remaining 21,150,010 common shares of Longview at a price of $4.45 per share. The offering closed on February 28, 2014 and Advantage received net proceeds of $90.0 million, all of which were used to reduce existing bank indebtedness. Concurrent with closing, Advantage ceased to consolidate Longview. As a result, historical consolidated financial and operating performance may not be indicative of actual future performance. Net Loss and Comprehensive Loss Three months ended December 31 Year ended December 31 2013 2012 % change 2013 2012 % change Net loss and comprehensive loss ($000) per share - basic and diluted $ $ (5,403) (0.03) $ $ (60,218) (0.36) (91) (91) % % $ $ (3,382) (0.02) $ $ (89,125) (0.53) (96) (96) % % Advantage’s realized net loss for the year ended December 31, 2013, decreased $85.7 million as compared to the same period of 2012. This improvement was primarily due to significantly higher funds from operations, less depreciation expense and no impairment losses, partially offset by losses recognized on non-core asset dispositions. Funds from operations have improved considerably during 2013 due to increases in commodity prices and continued lower royalties and operating costs. Depreciation expense has decreased due to the significant non-core gas weighted property dispositions that closed during the year. However, Advantage also recognized an $8.2 million loss on the property dispositions as the fair value assigned to the consideration received was less than the carrying value of the assets. Advantage did not recognize any impairment losses during 2013, while in 2012 both Advantage and Longview recognized impairments that totaled $104.9 million. Advantage Oil & Gas Ltd. - 26 Cash Netbacks Petroleum and natural gas sales Royalties Realized loss on derivatives Operating expense Operating income General and administrative (1) Finance expense (2) Other income (3) Funds from operations and cash netbacks $ $ $ $ $ Three months ended December 31 2013 per boe 2012 per boe $ 29.90 (3.18) (0.60) (8.92) 17.20 (2.44) (1.71) - 13.05 $ $000 74,432 (7,915) (1,488) (22,196) 42,833 (6,067) (4,246) 9 32,529 30.98 (3.60) (0.09) (6.50) 20.79 (2.11) (2.04) 0.41 17.05 $000 68,233 (7,928) (208) (14,305) 45,792 (4,641) (4,508) 919 37,562 Year ended December 31 2013 2012 $000 289,742 (33,831) (3,936) (66,314) 185,661 (21,952) (17,618) 2,414 148,505 per boe $ 31.19 (3.64) (0.42) (7.14) 19.99 (2.36) (1.89) 0.26 16.00 $ $000 268,905 (34,126) (970) (89,229) 144,580 (20,960) (16,749) 595 107,466 per boe $ 26.32 (3.34) (0.09) (8.73) 14.16 (2.05) (1.64) 0.06 10.53 $ $ $ $ $ $ (1) General and administrative expense excludes non-cash G&A. (2) Finance expense excludes non-cash accretion expense. (3) Other income excludes non-cash other income. For the three months ended December 31, 2013, Advantage realized an increase of 15% in funds from operations to $37.6 million and an increase of 31% in cash netbacks to $17.05 per boe, as compared to the fourth quarter of 2012. For the year ended December 31, 2013, Advantage realized an increase of 38% in funds from operations to $148.5 million and an increase of 52% in cash netbacks to $16.00 per boe, as compared to 2012. The increased funds from operations and cash netbacks have been primarily attributable to significantly improved commodity prices and partially offset by lower production due to non-core asset dispositions. Realized natural gas prices, excluding hedging, increased 9% for the three months and 41% for the year ended December 31, 2013, as compared to the same periods of 2012. Advantage Oil & Gas Ltd. - 27 Contractual Obligations and Commitments The Corporation has contractual obligations in the normal course of operations including purchases of assets and services, operating agreements, transportation commitments, sales contracts, bank indebtedness and convertible debentures. These obligations are of a recurring and consistent nature and impact cash flow in an ongoing manner. The following table is a summary of the Corporation’s remaining contractual obligations and commitments. Advantage has no guarantees or off-balance sheet arrangements other than as disclosed. ($ millions) Building leases Pipeline/transportation Bank indebtedness (1) Convertible debentures (2) - principal - interest - principal - interest Total contractual obligations Payments due by period Total 1.5 13.1 2014 1.5 11.8 $ 2015 $ - 1.3 $ 272.5 20.1 - 13.6 272.5 6.5 86.2 6.4 399.8 $ - 4.3 31.2 $ 86.2 2.1 368.6 $ (1) As at December 31, 2013, the Corporation’s bank indebtedness was governed by credit facility agreements for each of Advantage and Longview with a syndicate of financial institutions. Under the terms of the agreements, the facilities are reviewed annually, with the next reviews scheduled in June 2014. The facilities are revolving, and extendible at each annual review for a further 364 day period at the option of the syndicate. If not extended, the credit facilities are converted at that time into one-year term facilities, with the principal payable at the end of such one-year terms. Management fully expects that the facilities will be extended at each annual review. On disposition of Advantage’s investment in Longview on February 28, 2014, there is only one credit facility agreement remaining for Advantage (refer to the section “Consolidation of Longview Oil Corp”). (2) As at December 31, 2013, Advantage had $86.2 million convertible debentures outstanding. The convertible debentures are convertible to common 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 common shares at Advantage’s option. Liquidity and Capital Resources The following table is a summary of the Corporation’s capitalization structure: ($000, except as otherwise indicated) Bank indebtedness (non-current) Working capital deficit (1) Net debt Convertible debentures maturity value (non-current) Total debt Shares outstanding Shares closing market price ($/share) Market capitalization (2) $ Advantage 153,697 49,034 202,731 86,250 288,981 168,382,838 4.61 776,245 $ $ $ December 31, 2013 Longview $ 117,642 9,486 127,128 - 127,128 46,928,094 4.81 225,724 $ $ $ Consolidated $ 271,339 58,520 329,859 86,250 416,109 $ (1) Working capital deficit is a non-GAAP measure that includes trade and other receivables, prepaid expenses and deposits, and trade and other accrued liabilities. (2) Market capitalization is a non-GAAP measure calculated by multiplying shares outstanding by the closing market share price on the applicable date for each legal entity. 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 and share capital. Advantage may manage its capital structure by issuing new common shares, repurchasing outstanding common shares, obtaining additional financing either through bank indebtedness or convertible debenture issuances, refinancing current debt, issuing other financial or equity-based Advantage Oil & Gas Ltd. - 28 instruments, declaring a dividend, implementing a dividend reinvestment plan, adjusting capital spending, or disposing of assets or its investments. The capital structure is reviewed by Management and the Board 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. 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. In order to strengthen our financial position and balance our cash flows, Advantage has systematically disposed of substantially all non-core assets including its investment in the common shares of Longview. The net cash proceeds from all disposition transactions were used to reduce outstanding bank indebtedness. Advantage is now a pure play company focused on our signature Glacier Montney property. We will continue to be very cognizant of improving our financial flexibility in the current environment. Shareholders’ Equity and Convertible Debentures Advantage utilizes a combination of equity, convertible debentures, bank indebtedness and funds from operations to finance acquisitions and development activities. As at December 31, 2013, Advantage had 168.4 million common shares outstanding and there were no changes in share capital during the year ended December 31, 2013. As at March 27, 2014, Advantage had 169.1 million common shares outstanding. The Corporation had $86.2 million of 5.00% convertible debentures outstanding at December 31, 2013 that were convertible to 10.0 million common shares based on the applicable conversion price and will mature in January 2015 (December 31, 2012 - $86.2 million outstanding and convertible to 10.0 million common shares). Our convertible debenture obligation can be settled through the payment of cash or issuance of common shares at Advantage’s option. Bank Indebtedness, Credit Facilities and Other Obligations At December 31, 2013, Advantage had consolidated bank indebtedness outstanding of $271.3 million consisting of $153.7 million and $117.6 million for each of the legal entities Advantage and Longview, respectively. Bank indebtedness has decreased $1.2 million since December 31, 2012. On October 24, 2013, Advantage announced an increase in the credit facility borrowing base from $230 million to $300 million which combined with Longview’s existing $200 million borrowing base resulted in a consolidated borrowing base of $500 million as at December 31, 2013 (the “Credit Facilities”). Advantage’s credit facilities are each collateralized by a $1 billion floating charge demand debenture covering all assets of the legal entities. As well, the borrowing bases for the credit facilities are determined through utilizing the legal entities 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 bases. Revisions or changes in the reserve estimates and commodity prices can have either a positive or a negative impact on the borrowing bases. The next annual reviews are scheduled to occur in June 2014. There can be no assurance that the credit facilities will be renewed at the current borrowing base levels at that time. On disposition of Advantage’s investment in Longview on February 28, 2014, Advantage received net proceeds of $90.0 million that was used to reduce existing bank indebtedness, and there is only one credit facility agreement remaining for Advantage (refer to the section “Consolidation of Longview Oil Corp”) Advantage had a consolidated working capital deficiency of $58.5 million as at December 31, 2013. Our working capital includes items expected for normal operations such as trade receivables, prepaids, deposits, and trade payables and accruals. 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 is normally in a deficit position due to our continuing capital development activities. The working capital deficit has increased as at December 31, 2013 in conjunction with commencement of our Phase VI capital development program at Glacier to increase production to 135 mmcfe/d. We do not anticipate any problems in satisfying working capital deficit and meeting future obligations as they become due as they can be satisfied with funds from operations, our available Credit Facilities, or proceeds from sale of investments. Advantage Oil & Gas Ltd. - 29 Non-Controlling Interest On completion of Longview’s initial public offering on April 14, 2011, Advantage owned 29,450,010 common shares of Longview representing a 63% equity ownership with the remaining 37% equity ownership held by outside interests or non-controlling interests. On May 22, 2012, Advantage sold 8,300,000 Longview common shares to a syndicate of underwriters at a price of $9.00 per common share for gross proceeds of $74.7 million. At December 31, 2013, Advantage owned 21,150,010 common shares of Longview, representing an interest of approximately 45.1% in Longview. As Advantage held the single largest ownership interest of Longview at December 31, 2013 and other ownership interests were comparatively dispersed, Advantage was considered to control Longview. As such, Advantage’s consolidated financial statements at December 31, 2013 include 100% of Longview’s accounts and non-controlling interest was recognized which represented Longview’s independent shareholders ownership interest in the net assets of Longview. Non-controlling interest on the statement of financial position was continually adjusted for the independent shareholders’ share of Longview’s net income or loss that was consolidated within Advantage’s financial results and reduced for dividends declared by Longview to the independent shareholders. Therefore, for the year ended December 31, 2013, Advantage recognized a $6.0 million decrease to net income related to Longview’s net income consolidated within Advantage’s financial results but attributable to the non-controlling interests. This $6.0 million increased non-controlling interest on the statement of financial position with a decrease of $15.2 million related to dividends declared by Longview to the non-controlling interest ownership. On February 4, 2014, Advantage entered into an agreement to sell its remaining 21,150,010 common shares of Longview at a price of $4.45 per share. The offering closed on February 28, 2014 and Advantage received net proceeds of $90.0 million, all of which were used to reduce existing bank indebtedness. Concurrent with closing, Advantage ceased to consolidate Longview. Capital Expenditures ($000) Drilling, completions and workovers Well equipping and facilities Land and seismic Other Expenditures on property, plant and equipment Expenditures on exploration and evaluation assets Proceeds from property dispositions (1) Net capital expenditures (2) Three months ended December 31 2013 2012 Year ended December 31 $ $ $ $ 72,043 7,991 31 79 80,144 188 (2,457) 77,875 40,792 6,508 (65) - 47,235 377 (2,996) 44,616 2013 162,703 26,204 55 79 189,041 6,977 (54,855) 141,163 2012 134,630 39,281 - 773 174,684 377 (13,967) 161,094 $ $ $ $ (1) Proceeds from property dispositons represents the net cash proceeds and excludes all other forms of consideration. (2) Net capital expenditures excludes changes in non-cash working capital and change in decommissioning liability. The Advantage legal entity spent $148.5 million on property, plant and equipment for the year ended December 31, 2013, substantially all of which was incurred at Glacier. Advantage continues to focus on development of our Montney natural gas resource play at Glacier, Alberta where we will continue to employ a phased development approach. During the first quarter of 2013, we finished our Phase V capital program with an inventory of wells that maintained average daily production from Glacier for the 2013 year at 105 mmcfe/d, an increase of 14% from the prior year due to continued strong well performance and development. Our Phase VI Glacier capital program commenced in the third quarter of 2013 with three drilling rigs and in early March 2014 Glacier production reached the 135 mmcfe/d target approximately one month ahead of schedule. Nine new wells from Advantage’s Glacier Phase VI program were brought on production to initially ramp production to 135 mmcfe/d with the remaining 13 new wells from our Phase VI program expected to provide sufficient production inventory to maintain production at 135 mmcfe/d through to the end of 2014. Additionally, Advantage has spent $6.7 million on exploration and evaluation assets to acquire an additional 43.25 sections (27,680 acres) of 100% working interest Montney lands. These lands are located southeast of Glacier in a fairway that we believe is prospective for Middle Montney natural gas liquids. These land parcels are held under licenses which will not expire until September 2017 and can be extended for an additional five years with the drilling of two horizontal wells. These lands can also be continued indefinitely under production. Our total acreage position in the Montney has increased to 125.65 gross (120.35 net) sections. Advantage Oil & Gas Ltd. - 30 For the year ended December 31, 2013, Longview spent $40.6 million on property, plant and equipment and exploration and evaluation assets which included $27.0 million in Saskatchewan, $5.8 million at Sunset, $3.2 million at Nevis, and $1.7 million at Westerose, with the remaining spending for miscellaneous projects. Longview drilled a total of 18.1 net (24 gross) wells at a 95% success rate, adding production of 1,738 boe/d (89% light oil). Consistent with their business strategy, Longview developed and executed a sustainable and balanced 2013 budget that preserved a strong balance sheet and utilized funds from operations to maintain their dividend policy and fund substantially all of their capital expenditures. Longview’s 2014 capital drilling program is primarily focused on further development of their Midale and Frobisher plays within Southeast Saskatchewan where they have an extensive land base, high working interests, fee title ownership and existing infrastructure. In addition, they plan on continuing to advance their waterflood projects in Alberta through further enhancement of injection facilities in preparation for future in-fill drilling programs. Sources and Uses of Funds The following table summarizes the various funding requirements during the years ended December 31, 2013 and 2012 and the sources of funding to meet those requirements: ($000) Sources of funds Funds from operations Property dispositions Change in non-cash working capital and other Proceeds from Longview financing Increase in bank indebtedness Uses of funds Expenditures on property, plant and equipment Dividends declared by Longview to non-controlling interest Expenditures on exploration and evaluation assets Expenditures on decommissioning liability Decrease in bank indebtedness Change in non-cash working capital and other Year ended December 31 2013 2012 $ $ $ $ 148,505 54,855 14,657 - - 218,017 189,041 15,191 6,977 5,158 1,650 - 218,017 $ $ 107,466 13,967 - 71,563 40,268 233,264 174,684 13,735 377 2,395 - 42,073 233,264 $ $ Funds from operations have increased primarily attributable to significantly improved commodity prices and partially offset by lower production due to non-core asset dispositions. The funds from operations and $54.9 million in net cash proceeds from the non-core asset dispositions were primarily used to fund capital expenditures during the current year. Bank indebtedness was relatively unchanged during 2013 and 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. Annual Financial Information The following is a summary of selected financial information of the Corporation for the years indicated. Total sales (before royalties) ($000) Net loss ($000) per share - basic and diluted Total assets ($000) Long term financial liabilities ($000) (1) Year ended Dec. 31, 2013 $ 289,742 $ (3,382) $ (0.02) $ 1,765,244 $ 353,793 Year ended Dec. 31, 2012 $ 268,905 $ (89,125) $ (0.53) $ 1,913,796 $ 351,619 Year ended Dec. 31, 2011 $ 355,288 $ (152,772) $ (0.92) $ 1,972,789 $ 308,574 (1) Long term financial liabilities exclude derivative liability, decommissioning liability and deferred income tax liability. Advantage Oil & Gas Ltd. - 31 Quarterly Performance ($000, except as otherwise indicated) Daily production 2013 2012 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Natural gas (mcf/d) Crude oil and NGLs (bbls/d) Total (boe/d) 114,763 4,811 23,938 118,875 4,738 24,551 123,843 5,366 26,007 127,398 6,127 27,360 125,455 6,148 27,057 126,606 5,724 26,825 132,411 5,880 27,949 139,664 6,582 29,859 Average prices Natural gas ($/mcf) Excluding hedging Including hedging AECO daily index Crude oil and NGLs ($/bbl) Excluding hedging Including hedging WTI ($US/bbl) Total sales including realized hedging Net income (loss) per share - basic - diluted Funds from operations $ $ $ 3.25 3.41 3.52 $ $ $ 2.47 2.62 2.45 $ $ $ 3.48 3.37 3.55 $ $ $ 3.00 3.05 3.20 $ $ $ 2.97 2.75 3.22 $ $ $ 2.07 2.07 2.28 $ $ $ 1.65 1.67 1.90 $ $ $ 2.02 2.02 2.17 $ $ $ $ $ $ $ $ 76.75 72.31 97.50 68,025 (5,403) (0.03) (0.03) 37,562 $ $ $ $ $ $ $ $ 93.52 85.82 105.82 66,091 (1,342) (0.01) (0.01) 34,475 $ $ $ $ $ $ $ $ 80.35 78.57 94.23 76,363 8,342 0.05 0.05 40,171 $ $ $ $ $ $ $ $ 74.18 73.12 94.34 75,327 (4,979) (0.03) (0.03) 36,297 $ $ $ $ $ $ $ $ 70.94 72.94 88.20 72,944 (60,218) (0.36) (0.36) 32,529 $ $ $ $ $ $ $ $ 72.07 73.06 92.19 62,615 (2,769) (0.02) (0.02) 24,703 $ $ $ $ $ $ $ $ 70.97 71.73 93.51 58,526 (15,579) (0.10) (0.10) 18,243 $ $ $ $ $ $ $ $ 81.48 80.41 102.94 73,850 (10,559) (0.06) (0.06) 31,991 The table above highlights the Corporation’s performance for the fourth quarter of 2013 and also for the preceding seven quarters. Production decreased in the second and third quarters of 2012 as a result of numerous facilities outages due to annual turnaround maintenance, facility construction activities, and prolonged spring break-up and other related weather conditions that caused lease access restrictions. Wet weather delayed our Glacier capital program that resumed in September 2012 to maintain production at between 90 and 100 mmcf/d. Production was also impacted as production from our Lookout Butte property (1,000 boe/d) in southern Alberta was curtailed in June 2012 due to maintenance and a fire that occurred at a third party processing facility. With Lookout Butte back on production in early November 2012 and the resumption of our capital programs, we experienced an improvement in our fourth quarter 2012 and first quarter 2013 production. Production decreased in the second and third quarters of 2013 as we completed our final significant non-core asset disposition on April 30, 2013. During the third quarter of 2013, sales and funds from operations decreased due to a temporary collapse in AECO prices that impacted the entire Alberta natural gas industry attributable to a significant increase in the TransCanada interruptible tolls for the transportation of natural gas from Alberta. This situation improved in the fourth quarter of 2013 with higher AECO prices for the new natural gas contract year that began November 1, 2013. Advantage has generally recognized net losses primary driven by weak natural gas prices, although we have also continued to achieve cost reductions and lower expenses. During the fourth quarter of 2012 our assets held for sale were reflected at the lesser of fair value less costs to sell and carrying amount, which resulted in an impairment recognition of $73 million. Additionally, in the fourth quarter of 2012 Longview recognized an impairment loss of $31.9 million related to one CGU located in Alberta that had suffered a significant deterioration in value due to the reduction in crude oil prices and decreased reserves. Critical Accounting Estimates The preparation of financial statements in accordance with IFRS 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 expense, royalty burden changes, and future development costs. Reserve estimates impact net income and comprehensive income through depreciation and impairment of oil and gas properties. The reserve estimates are also used to assess the borrowing bases for the Corporation’s credit facilities. Revision or changes in the reserve estimates can Advantage Oil & Gas Ltd. - 32 have either a positive or a negative impact on asset values, net income, comprehensive income and the borrowing bases of the Corporation. Management’s process of determining the provision for deferred income taxes, the provision for decommissioning liability 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 are based on estimates. These estimates are significant and can include proved and probable reserves, future production rates, future commodity 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, net income and comprehensive income. In accordance with IFRS, derivative assets and liabilities are recorded at their fair values at the reporting date, with gains and losses recognized directly into 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 as compared to the valuation assumptions. Changes in Accounting Policies The Corporation has adopted, as required, the following new and revised standards along with any consequential amendments, effective January 1, 2013. IFRS 10 Consolidated Financial Statements IFRS 10 is a new standard that has replaced SIC 12, “Consolidation – Special Purpose Entities” and IAS 27 “Consolidated and Separate Financial Statements”. The new standard eliminates the risks and rewards approach and establishes control as the single basis for determining the consolidation of an entity. We have determined that the new standard has no effect on the accounting methodology with respect to Longview Oil Corp. We will continue to control Longview Oil Corp. under IFRS 10 as we did under IAS 27, and as such will consolidate Longview Oil Corp. as a subsidiary of Advantage. IFRS 11 – Joint Arrangements, IAS 28 – Investments in Associates and Joint Ventures IFRS 11 supersedes IAS 31, Interests in Joint Ventures and SIC-13, Jointly Controlled Entities, Non-Monetary Contributions by Ventures and requires a venture to classify its interest in a joint arrangement as a joint venture or joint operation depending on the contractual rights and obligations of the parties that jointly controls the arrangement. Joint ventures will be accounted for using the equity method of accounting as set out in IAS 28 whereas for a joint operation, the venture will recognize its share of the assets, liabilities, revenue and expenses. The Corporation determined all of its joint arrangements to be joint operations as defined in IFRS 11 and that the adoption and application of these standards did not result in any changes in the accounting for joint arrangements. IFRS 12 Disclosure of Interests in Other Entities IFRS 12 provides the required disclosures for interests in subsidiaries, investees and joint arrangements. These disclosures require information that will assist users of financial statements to evaluate the nature, risks and financial effects associated with an entity’s interests in subsidiaries and joint arrangements. The adoption of this standard did not result in any changes or additions to existing disclosures with respect to Questfire Energy Corp, an investee, or the Corporations interests in joint arrangements. With respect to Longview Oil Corp., a subsidiary, the Corporation has disclosed dividends paid to non-controlling interests as well as summarized information about the assets, liabilities, profit or loss and cash flows of Longview Oil Corp., in order to assist readers in understanding the interest that non-controlling interests have in the Corporation’s activities and cash flows in note 27 of the consolidated financial statements. IFRS 13 – Fair Value Measurement IFRS 13 is a comprehensive standard for fair value measurement and disclosure requirements for use across all IFRS standards. The new standard clarifies that fair value is the price that would be received to sell an asset, or paid to transfer a liability in an orderly transaction between market participants, at the measurement date. It also establishes disclosures about fair value measurement. The adoption of this standard did not require any adjustments to the valuation techniques used by the Corporation to measure fair value and did not result in any measurement adjustments as at January 1, 2013. IAS 28 – Investments in Associates and Joint Ventures IAS 28 has been amended to include joint ventures in its scope and to address the changes in IFRS 10 to 13. The adoption of this standard did not result in any changes or additions to existing disclosures. Advantage Oil & Gas Ltd. - 33 IAS 36 Impairment of Assets In May 2013, the IASB issued an amendment to IAS 36, Impairment of Assets. The amendment removes certain disclosures of the recoverable amount of a CGU. The amendment is effective retrospectively for annual periods beginning on or after January 1, 2014. As allowed by the standard, the Corporation early adopted the amendment in the current period. No additional disclosures were required as a result of this early adoption. Accounting Pronouncements not yet Adopted Standards issued but not yet effective up to the date of issuance of the Corporation’s financial statements are listed below. This listing is of standards and interpretations issued which the Corporation reasonably expects to be applicable at a future date. The Corporation intends to adopt those standards when they become effective. IFRS 9 Financial Instruments: Classification and Measurement IFRS 9 is intended to supersede IAS 39, Financial Instruments: Recognition and Measurement and will be published in three phases, of which the first phase has been published. The first phase addresses the accounting for financial assets and financial liabilities. The second phase will address the impairment of financial instruments, and the third phase will address hedge accounting. For financial assets, IFRS 9 uses a single approach to determine whether a financial asset is measured at amortized cost or fair value, and replaces the multiple rules in IAS 39. The approach in IFRS 9 is based on how an entity manages its financial instruments in the context of its business model and the contractual cash flow characteristics of the financial assets. The new standard also requires a single impairment method to be used, replacing the multiple impairment methods in IAS 39. For financial liabilities, although the classification criteria for financial liabilities will not change under IFRS 9, the approach to the fair value option for financial liabilities may require different accounting for changes to the fair value of a financial liability as a result of changes to an entity’s own credit risk. This standard is not applicable until January 1, 2015. Evaluation of Disclosure Controls and Procedures Advantage’s Chief Executive Officer and Chief Financial Officer have designed disclosure controls and procedures (“DC&P”), or caused it to be designed under their supervision, to provide reasonable assurance that material information relating to the Corporation is made known to them by others, particularly during the period in which the annual filings are being prepared, and information required to be disclosed by the Corporation in its annual filings, interim filings or other reports filed or submitted by it under securities legislation is recorded, processed, summarized and reported within the time periods specified in securities legislation. Management of Advantage, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Corporation’s DC&P as at December 31, 2013. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that the DC&P are effective as of the end of the year, in all material respects. Evaluation of Internal Controls over Financial Reporting Advantage’s Chief Executive Officer and Chief Financial Officer are responsible for establishing and maintaining internal control over financial reporting (“ICFR”). They have as at the financial year end December 31, 2013, designed ICFR, or caused it to be designed under their supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with IFRS. The control framework Advantage’s officers used to design the Corporation’s ICFR is the Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations. Management of Advantage, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Corporation’s ICFR as at December 31, 2013. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that the ICFR are effective as of the end of the year, in all material respects. Advantage’s Chief Executive Officer and Chief Financial Officer are required to disclose any change in the ICFR that occurred during our most recent interim period that has materially affected, or is reasonably likely to materially affect, the Corporation’s ICFR. No material changes in the ICFR were identified during the interim period ended December 31, 2013 that have materially affected, or are reasonably likely to materially affect, our ICFR. It should be noted that while the Chief Executive Officer and Chief Financial Officer believe that the Corporation’s design of DC&P and ICFR provide a reasonable level of assurance that they are effective, they do not expect that the control system will prevent all errors and fraud. A control system, no matter how well conceived or operated, does not provide absolute, but rather is designed to provide reasonable assurance that the objective of the control system is met. The Corporation’s ICFR 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. Advantage Oil & Gas Ltd. - 34 Corporate Governance The Corporation’s corporate governance practices can be found in the Management Information Circular. 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 non-compliance with the applicable NYSE Rules; (iii) submit an executed section 303A annual written affirmation to the NYSE, as well as a Section 303A 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 under NYSE listing standards. Advantage has reviewed the NYSE listing standards followed by U.S. domestic issuers listed under the NYSE and confirms that its corporate governance practices do not differ significantly from such standards. 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 management information circular, press releases, material change reports, 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 27, 2014 Advantage Oil & Gas Ltd. - 35 Management’s Responsibility for Financial Statements Consolidated Financial Statements The Management of Advantage Oil & Gas Ltd. (the “Corporation”) is responsible for the preparation and presentation of the consolidated financial statements together with all operational and other financial information contained in the annual report. The consolidated financial statements have been prepared by Management in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board and utilize the best estimates and careful judgments of Management, where appropriate. Operational and other financial information contained throughout the annual report is consistent with that provided in the consolidated financial statements. Management has developed and maintains a system of internal controls designed to provide reasonable assurance that all transactions are accurately and reliably recorded, that the consolidated financial statements accurately report the Corporation’s operating and financial results within acceptable limits of materiality, that all other operational and financial information presented is accurate, and that the Corporation’s assets are properly safeguarded. The Audit Committee, comprised of non-management directors, acts on behalf of the Board of Directors to ensure that Management fulfills its financial reporting and internal control responsibilities. The Audit Committee is responsible for meeting regularly with Management, the external auditors, and the internal auditors to discuss internal controls over financial reporting processes, auditing matters and various aspects of financial reporting. The Audit Committee reviewed the consolidated financial statements with Management and the external auditors, and recommended approval to the Board of Directors. The Board of Directors has approved these consolidated financial statements. PricewaterhouseCoopers LLP, an independent firm of Chartered Accountants, appointed by the shareholders as the external auditor of the Corporation, has audited the consolidated statement of financial position as at December 31, 2013 and 2012, and the consolidated statements of comprehensive loss, changes in shareholders’ equity and cash flows for the years ended December 31, 2013 and 2012. The external auditors conducted their audits in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States) and have unlimited and unrestricted access to the Audit Committee. Andy J. Mah President and Chief Executive Officer March 27, 2014 Craig Blackwood Vice President Finance and Chief Financial Officer Advantage Oil & Gas Ltd. - 36 Management’s Report on Internal Control over Financial Reporting The Management of Advantage Oil & Gas Ltd. (the “Corporation”) is responsible for establishing and maintaining adequate internal control over financial reporting for the Corporation as such term is defined in Rule 13a-15(f) of the Securities Exchange Act of 1934, as amended. Under the supervision of our Chief Executive Officer and Chief Financial Officer, we have conducted an evaluation of the effectiveness of our internal control over financial reporting based on the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our assessment, we have concluded that as of December 31, 2013, our internal control over financial reporting was effective. Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements and even those systems determined to be effective can provide only reasonable assurance with respect to the financial statement preparation and presentation. Further, 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 that the degree of compliance with the policies or procedures may deteriorate. PricewaterhouseCoopers LLP, the Corporation’s independent firm of Chartered Accountants, was appointed by the shareholders to audit and provide an independent opinion on both the consolidated financial statements and the Corporation’s internal control over financial reporting as at December 31, 2013, as stated in their Auditor’s Report. PricewaterhouseCoopers LLP has provided such opinion. Andy J. Mah President and Chief Executive Officer March 27, 2014 Craig Blackwood Vice President Finance and Chief Financial Officer Advantage Oil & Gas Ltd. - 37 March 27, 2014 Independent Auditor’s Report To the Shareholders of Advantage Oil & Gas Ltd. We have completed integrated audits of Advantage Oil & Gas Ltd.’s 2013 and 2012 consolidated financial statements and its internal control over financial reporting as at December 31, 2013. 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 statement of financial position as at December 31, 2013 and December 31, 2012 and the consolidated statements of comprehensive loss, changes in shareholders’ equity, and cash flows for the years then ended, and the related notes, which comprise a summary of significant accounting policies and other explanatory information. Management’s responsibility for the consolidated financial statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor’s responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. Canadian generally accepted auditing standards also 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. Advantage Oil & Gas Ltd. - 38 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, 2013 and December 31, 2012 and its financial performance and its cash flows for the years then ended in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board. Report on internal control over financial reporting We have also audited Advantage Oil & Gas Ltd.’s internal control over financial reporting as at December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992), issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Management’s responsibility for internal control over financial reporting Management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Auditor’s responsibility Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control, based on the assessed risk, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our audit opinion on the company’s internal control over financial reporting. Definition of internal control over financial reporting A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Advantage Oil & Gas Ltd. - 39 Inherent limitations Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, 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 that the degree of compliance with the policies or procedures may deteriorate. Opinion In our opinion, Advantage Oil & Gas Ltd. maintained, in all material respects, effective internal control over financial reporting as at December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by COSO. Chartered Accountants Calgary, Alberta March 27, 2014 Advantage Oil & Gas Ltd. - 40 Consolidated Statement of Financial Position (thousands of Canadian dollars) Notes December 31, 2013 December 31, 2012 ASSETS Current assets Trade and other receivables Prepaid expenses and deposits Derivative asset Assets held for sale Total current assets Non-current assets Derivative asset Investment - Questfire Class B Shares Investment - Questfire Debenture Exploration and evaluation assets Property, plant and equipment Deferred income tax asset Total non-current assets Total assets LIABILITIES Current liabilities Trade and other accrued liabilities Derivative liability Liabilities associated with assets held for sale Total current liabilities Non-current liabilities Derivative liability Bank indebtedness Convertible debenture Decommissioning liability Deferred income tax liability Total non-current liabilities Total liabilities SHAREHOLDERS' EQUITY Share capital Convertible debentures equity component Contributed surplus Deficit Total shareholders' equity attributable to Advantage shareholders Non-controlling interest Total shareholders' equity 6 12 5 12 8 9 7 10 16 12 5 12 13 14 15 16 17 14 $ 32,016 $ 32,657 3,357 143 - 35,516 2,329 3,750 26,876 10,270 1,647,434 39,069 1,729,728 5,143 2,186 222,877 262,863 - - - 2,381 1,605,659 42,893 1,650,933 $ 1,765,244 $ 1,913,796 $ 93,893 $ 84,979 8,340 - 102,233 1,183 271,339 82,454 100,616 3,006 458,598 560,831 2,229,598 8,348 92,276 (1,255,588) 1,074,634 129,779 1,204,413 1,096 136,540 222,615 - 272,511 79,108 126,224 4,628 482,471 705,086 2,229,598 8,348 84,962 (1,252,206) 1,070,702 138,008 1,208,710 Total liabilities and shareholders' equity $ 1,765,244 $ 1,913,796 Commitments (note 25) Subsequent events (note 27) See accompanying Notes to the Consolidated Financial Statements On behalf of the Board of Directors of Advantage Oil & Gas Ltd.: ___________________ Paul G. Haggis, Director _________________ Andy J. Mah, Director Advantage Oil & Gas Ltd. - 41 Consolidated Statement of Comprehensive Loss (thousands of Canadian dollars, except for per share amounts) Notes Year ended December 31, 2013 Year ended December 31, 2012 Petroleum and natural gas sales Less: royalties Petroleum and natural gas revenue Operating expense General and administrative expense Depreciation expense Impairment of assets held for sale Impairment of oil and gas properties Exploration and evaluation expense Finance expense Gains (losses) on derivatives Other income (expenses) Income (loss) before taxes and non-controlling interest Income tax recovery (expense) Net income (loss) and comprehensive income (loss) before non-controlling interest Net (income) loss attributable to non-controlling interest Net loss and comprehensive loss attributable to Advantage shareholders 20 21 10 5 10 7 22 12 23 16 Net loss per share attributable to Advantage shareholders Basic Diluted 19 See accompanying Notes to the Consolidated Financial Statements $ 289,742 (33,831) 255,911 $ 268,905 (34,126) 234,779 (66,314) (27,408) (111,188) - - (195) (26,133) (14,748) (5,124) 4,801 (2,202) 2,599 (5,981) (89,229) (28,180) (132,175) (73,000) (31,865) (181) (26,299) 2,858 17,559 (125,733) 28,605 (97,128) 8,003 $ (3,382) $ (89,125) $ $ (0.02) (0.02) $ $ (0.53) (0.53) Advantage Oil & Gas Ltd. - 42 Consolidated Statement of Changes in Shareholders' Equity (thousands of Canadian dollars) Notes Share capital Convertible debentures equity component Contributed surplus Deficit Total shareholders' equity attributable to Advantage shareholders Non- controlling interest Total shareholders' equity Balance, December 31, 2012 Net loss and comprehensive loss Share based compensation Change in ownership interest, share based compensation Dividends declared by Longview ($0.59 per Longview share) Balance, December 31, 2013 Balance, December 31, 2011 Net loss and comprehensive loss Share based compensation Change in ownership interest, sale of 8,300,000 shares of Longview Change in ownership interest, share based compensation Dividends declared by Longview ($0.60 per Longview share) Balance, December 31, 2012 $ 2,229,598 - - $ 8,348 - - $ 84,962 - 7,314 $ (1,252,206) (3,382) - $ 1,070,702 (3,382) 7,314 $ 138,008 5,981 - $ 1,208,710 2,599 7,314 17, 18 - - - - - 981 981 - 2,229,598 $ - 8,348 $ - 92,276 $ - (1,255,588) $ - 1,074,634 $ (15,191) 129,779 $ (15,191) 1,204,413 $ $ 2,214,784 - 14,814 $ 8,348 - - $ 71,762 - (6,671) $ (1,163,081) (89,125) - $ 1,131,813 (89,125) 8,143 $ 107,118 (8,003) - $ 1,238,931 (97,128) 8,143 17, 18 - - - - 19,871 - - - 19,871 51,692 71,563 - 936 936 - 2,229,598 $ - 8,348 $ - 84,962 $ - (1,252,206) $ - 1,070,702 $ (13,735) 138,008 $ (13,735) 1,208,710 $ See accompanying Notes to the Consolidated Financial Statements Advantage Oil & Gas Ltd. - 43 Consolidated Statement of Cash Flows (thousands of Canadian dollars) Operating Activities Income (loss) before taxes and non-controlling interest Add (deduct) items not requiring cash: Share based compensation Depreciation expense Impairment of assets held for sale Impairment of oil and gas properties Exploration and evaluation expense Unrealized loss (gain) on derivatives (Gain) loss on sale of property, plant and equipment Loss on sale of assets held for sale Unrealized loss - Questfire Class B Shares Accretion income - Questfire Debenture Finance expense Expenditures on decommissioning liability Changes in non-cash working capital Cash provided by operating activities Financing Activities Proceeds from sale of shares in Longview Increase (decrease) in bank indebtedness Dividends paid by Longview Interest paid Cash provided by (used in) financing activities Investing Activities Expenditures on property, plant and equipment Expenditures on exploration and evaluation assets Property dispositions Cash used in investing activities Net change in cash Cash, beginning of year Cash, end of year Notes Year ended December 31, 2013 Year ended December 31, 2012 $ 4,801 $ (125,733) 18 10 5 10 7 12 10, 23 5, 23 8, 23 9, 23 22 5, 15 24 13 10, 24 7 5,456 111,188 - - 195 10,812 1,800 6,354 900 (1,516) 26,133 (5,158) 4,052 165,017 - (1,650) (15,443) (17,140) (34,233) 7,220 132,175 73,000 31,865 181 (3,828) (16,964) - - - 26,299 (2,395) (14,864) 106,956 71,563 40,268 (13,318) (17,190) 81,323 (179,265) (6,977) 55,458 (130,784) - - $ - (201,429) (377) 13,527 (188,279) - - $ - See accompanying Notes to the Consolidated Financial Statements Advantage Oil & Gas Ltd. - 44 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS For the years ended December 31, 2013 and 2012 All tabular amounts are in thousands of Canadian dollars except as otherwise indicated. 1. Business and structure of Advantage Oil & Gas Ltd. Advantage Oil & Gas Ltd. and its subsidiaries (together “Advantage” or the “Corporation”) is an intermediate oil and natural gas development and production corporation with properties located in Western Canada. Advantage is domiciled and incorporated in Canada under the Business Corporations Act (Alberta). Advantage’s head office address is 300, 440 – 2nd Avenue SW, Calgary, Alberta, Canada. The Corporation’s primary listing is on the Toronto Stock Exchange and is also traded on the New York Stock Exchange as a Foreign Private Issuer, under the symbol “AAV”. 2. Basis of preparation (a) Statement of compliance The Corporation prepares its consolidated financial statements in accordance with Canadian generally accepted accounting principles (“GAAP”) as defined in the Handbook of the Canadian Institute of Chartered Accountants (“CICA Handbook”). The CICA Handbook incorporates International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board. Publicly accountable enterprises, such as the Corporation, are required to apply these standards. Accordingly, these consolidated financial statements are prepared and issued under IFRS. The accounting policies applied in these consolidated financial statements are based on IFRS issued and outstanding as of March 27, 2014, the date the Board of Directors approved the statements. (b) Basis of measurement The consolidated financial statements have been prepared on the historical cost basis, except as detailed in the Corporation’s accounting policies in note 3. The methods used to measure fair values of derivative instruments are discussed in note 12. (c) Functional and presentation currency These consolidated financial statements are presented in Canadian dollars, which is the Corporation’s functional currency. (d) Basis of consolidation These consolidated financial statements include the accounts of the Corporation and all subsidiaries over which it has control. The only significant operating subsidiary is Longview Oil Corp. (“Longview”), a public Canadian corporation that is a junior oil-focused development and production company with properties located in Western Canada. Advantage owns 45.1% of the common shares of Longview at December 31, 2013. Because the remaining ownership is dispersed, Advantage is considered to control Longview. Therefore, Longview is accounted for on a consolidated basis in these financial statements. The remaining 54.9% ownership is disclosed as non-controlling interest. All inter- corporate balances, income and expenses resulting from inter-corporate transactions are eliminated. Advantage Oil & Gas Ltd. - 45 3. Significant accounting policies The accounting policies set out below have been applied consistently to all years presented in these financial statements. (a) Cash and cash equivalents Cash consists of balances held with banks, and other short-term highly liquid investments with original maturities of three months or less from inception. (b) Basis of consolidation (i) Subsidiaries Subsidiaries are entities controlled by the Corporation. Control exists when the Corporation is exposed, or has rights to variable returns from its involvement with the entity and has the ability to affect those returns through its power over the entity. In assessing control, potential voting rights that currently are exercisable are taken into account. The financial statements of subsidiaries are included in the consolidated financial statements from the date that control commences until the date that control ceases. (ii) Non-controlling interests The Corporation treats transactions with non-controlling interests as transactions with equity owners of the Corporation. For purchases of shares from non-controlling interests, the difference between any consideration paid and the relevant ownership acquired of the carrying value of net assets of the subsidiary is recorded in equity. Gains or losses on disposals of shares to non-controlling interests are also recorded in equity, unless the disposal results in the Corporation’s loss of control of the subsidiary, in which case the gain or loss is recognized in the Consolidated Statement of Comprehensive Income (Loss). (iii) Joint arrangements A significant portion of the Corporation’s oil and natural gas activities involve joint operations. The consolidated financial statements include the Corporation’s share of these joint operations and a proportionate share of the relevant revenue and related costs. (c) Financial instruments All financial instruments are initially recognized at fair value on the Consolidated Statement of Financial Position. 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: fair value through profit or loss, loans and receivables, held to maturity investments, available for sale financial assets, and financial assets and liabilities at amortized cost. Fair value through profit or loss financial instruments are measured at fair value with gains and losses recognized in income 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 income when the asset is derecognized. Loans and receivables, held to maturity investments and financial liabilities at amortized cost, are recognized at amortized cost using the effective interest method and impairment losses are recorded in income when incurred. Derivative instruments executed by the Corporation to manage market risk associated with volatile commodity prices are classified as fair value through profit or loss and recorded on the Consolidated Statement of Financial Position at fair value as derivative assets and liabilities. Gains and losses on these instruments are recorded as gains and losses on derivatives in the Consolidated Statement of Comprehensive Income (Loss) in the period they occur. Gains and losses on derivative instruments are comprised of cash receipts and payments associated with periodic settlement that occurs over the life of the instrument, and non-cash gains and losses associated with changes in the fair values of the instruments, which are remeasured at each reporting date and recorded on the Consolidated Statement of Financial Position. On April 30, 2013, Advantage completed the sale of substantially all non-core assets (see note 5). Proceeds received consisted of cash and non-cash consideration. The Questfire Class B Shares have been classified as financial assets at fair value through profit or loss. The Questfire Debenture has been classified as financial assets at amortized cost. Advantage Oil & Gas Ltd. - 46 3. Significant accounting policies (continued) (c) Financial instruments (continued) Transaction costs are frequently attributed to the acquisition or issue of a financial asset or liability. Such costs incurred on fair value through profit or loss financial instruments are expensed immediately. For other financial instruments, transaction costs are added to the fair value initially recognized for financial assets and liabilities. Embedded derivatives are separated from the host contract and accounted for separately if the economic characteristics and risks of the host contract and the embedded derivative are not closely related, a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative, and the combined instrument is not measured at fair value through profit or loss. Changes in the fair value of separable embedded derivatives are recognized immediately in income. Equity instruments issued by the Corporation are recorded at the proceeds received, with direct issue costs as a deduction therefrom, net of any associated tax benefit. (d) Property, plant and equipment and exploration and evaluation assets (i) Recognition and measurement a) Exploration and evaluation costs Pre-license costs are recognized in the Consolidated Statement of Comprehensive Income (Loss) as incurred. All exploratory costs incurred subsequent to acquiring the right to explore for oil and natural gas and before technical feasibility and commercial viability of the area have been established are capitalized. Such costs can typically include costs to acquire land rights, geological and geophysical costs and exploration well costs. Exploration and evaluation costs are not depreciated and are accumulated in cost centers by well, field or exploration area and carried forward pending determination of technical feasibility and commercial viability. The technical feasibility and commercial viability of extracting a mineral resource from exploration and evaluation assets is considered to be generally determinable when proved or probable reserves are determined to exist. Upon determination of proved or probable reserves, exploration and evaluation assets attributable to those reserves are first tested for impairment and then reclassified from exploration and evaluation assets to development and production assets, net of any impairment loss. Management reviews and assesses exploration and evaluation assets to determine if technical feasibility and commercial viability exist. If Management decides not to continue the exploration and evaluation activity, the unrecoverable costs are charged to exploration and evaluation expense in the period in which the determination occurs. b) Development and production costs Items of property, plant and equipment, which include oil and gas development and production assets, are measured at cost less accumulated depreciation and accumulated impairment losses. Costs include lease acquisition, drilling and completion, production facilities, decommissioning costs, geological and geophysical costs and directly attributable general and administrative costs related to development and production activities, net of any government incentive programs. When significant parts of an item of property, plant and equipment, including oil and natural gas interests, have different useful lives, they are accounted for as separate items (major components). Advantage Oil & Gas Ltd. - 47 3. Significant accounting policies (continued) (d) Property, plant and equipment and exploration and evaluation assets (continued) (ii) Subsequent costs Costs incurred subsequent to development and production that are significant are recognized as oil and gas property only when they increase the future economic benefits embodied in the specific asset to which they relate. All other expenditures are recognized in comprehensive income as incurred. Such capitalized oil and natural gas costs generally represent costs incurred in developing proved and probable reserves and bringing in or enhancing production from such reserves, and are accumulated on a field or area basis. The carrying amount of any replaced or sold component is derecognized in accordance with our policies. The costs of the day-to-day servicing of property, plant and equipment are recognized in the Consolidated Statement of Comprehensive Income (Loss) as incurred. (iii) Depreciation The net carrying value of oil and gas properties is depreciated using the unit-of-production (“UOP”) method by reference to the ratio of production in the period to the related proved and probable reserves, taking into account estimated future development costs necessary to bring those reserves into production. Future development costs are estimated taking into account the level of development required to produce the reserves. These estimates are reviewed by independent reserve engineers at least annually. (e) Assets held for sale Assets are classified as held for sale if their carrying amounts will be recovered through a sale transaction rather than through continuing use. Assets held for sale are measured at the lower of carrying amount and fair value less costs to sell and presented as a current asset on the Consolidated Statement of Financial Position. This condition is regarded as met only when the sale is highly probable and the asset is available for immediate sale in its present condition. Management must be committed to the sale, which should be expected to qualify for recognition as a completed sale within one year from the date of classification. (f) Asset swaps and dispositions Exchanges of development and production assets are measured at fair value unless the exchange transaction lacks commercial substance or the fair value of neither the asset received nor the asset given up is reliably measurable. The cost of the acquired asset is measured at the fair value of the asset given up, unless the fair value of the asset received is more clearly evident. Where fair value is not used, the cost of the acquired asset is measured at the carrying amount of the asset given up. Any gain or loss on derecognition of the asset given up is recognised in the Consolidated Statement of Comprehensive Income (Loss). For exchanges or parts of exchanges that involve only exploration and evaluation assets, the exchange is accounted for at carrying value. Gains and losses on disposal of an item of property, plant and equipment, including oil and natural gas interests, are determined by comparing the proceeds from disposition with the carrying amount of property, plant and equipment and are recognized net within “other income” or “other expenses” in the Consolidated Statement of Comprehensive Income (Loss). (g) Impairment (i) Financial assets At each reporting date, the Corporation assesses whether there is objective evidence that a financial asset is impaired. If a financial asset carried at amortized cost is impaired, the amount of the loss is measured as the difference between the amortized cost of the loan or receivable and the present value of the estimated future cash flows, discounted using the instrument’s original effective interest rate. The loss is recognized in other expenses in the period incurred. Advantage Oil & Gas Ltd. - 48 3. Significant accounting policies (continued) (g) Impairment (continued) (ii) Property, plant and equipment and exploration and evaluation assets The carrying amounts of the Corporation’s property, plant and equipment are reviewed at each reporting date to determine whether there is any indication of impairment. If any such indication exists, the asset’s recoverable amount is estimated. For the purpose of impairment testing of property, plant and equipment, assets are grouped together into the smallest group of assets that generates cash inflows from continuing use that are largely independent of the cash inflows of other assets or groups of assets (the “cash-generating unit” or “CGU”). Exploration and evaluation assets are assessed for impairment if sufficient data exists to determine technical feasibility and commercial viability, and facts and circumstances suggest that the carrying amount exceeds the recoverable amount. Exploration and evaluation assets are allocated to CGU’s or groups of CGU’s for the purposes of assessing such assets for impairment. The recoverable amount of an asset or a CGU is the greater of its value in use and its fair value less costs to sell. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. Value in use is generally computed by reference to the present value of the future cash flows expected to be derived from production of proved and probable reserves. Fair value less costs to sell is assessed utilizing market valuation based on an arm’s length transaction between active participants. In the absence of any such transactions, fair value less costs to sell is estimated by discounting the expected after-tax cash flows of the cash generating unit at an after-tax discount rate that reflects the risk of the properties in the cash generating unit. The discounted cash flow calculation is then increased by a tax-shield calculation, which is an estimate of the amount that a prospective buyer of the cash generating unit would be entitled. The carrying value of the cash generating unit is reduced by the deferred tax liability associated with its property, plant and equipment. Impairment losses on property, plant and equipment are recognized in the Consolidated Statement of Comprehensive Income (Loss) as impairment of oil and gas properties and are separately disclosed. An impairment of exploration and evaluation assets is recognized as exploration and evaluation expense in the Consolidated Statement of Comprehensive Income (Loss). Impairment losses recognized in prior years are assessed at each reporting date for any indications that the loss has decreased or no longer exists. An impairment loss is reversed if there has been a change in the estimates used to determine the recoverable amount. An impairment loss is reversed only to the extent that the asset’s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation, if no impairment loss had been recognized. (h) Decommissioning liability A decommissioning liability is recognized if, as a result of a past event, the Corporation has a present legal or constructive obligation that can be estimated reliably, and it is probable that an outflow of economic benefits will be required to settle the obligation. Decommissioning liabilities are determined by discounting the expected future cash flows at a risk-free rate. Advantage Oil & Gas Ltd. - 49 3. Significant accounting policies (continued) (i) Share based compensation Advantage accounts for share based compensation expense based on the fair value of rights granted under its share based compensation plans. Advantage’s and Longview’s Restricted Share Performance Incentive Plan (“RSPIP”), authorizes each respective Board of Directors to grant restricted shares to service providers, including directors, officers, employees, and consultants of Advantage and Longview. The restricted share grants generally vest one-third immediately on grant date, with the remaining two-thirds vesting on each of the two subsequent anniversary dates. Compensation cost related to the RSPIP is recognized as share based compensation expense within general and administrative expense over the service period of the service providers and incorporates the fair value at grant date, the estimated number of restricted shares to vest, and certain management estimates. Advantage’s Stock Option Plan (“Stock Option Plan”) authorizes the Board of Directors to grant stock options to service providers, including directors, officers, employees and consultants of Advantage. Compensation cost related to the Stock Option Plan is recognized as share based compensation expense within general and administrative expense over the vesting period at fair value. As compensation expense is recognized, contributed surplus is recorded until the restricted shares vest or stock options are exercised, at which time the appropriate common shares are then issued to the service providers and the contributed surplus is transferred to share capital. (j) Common-control transaction Business combinations involving entities under common control are outside the scope of IFRS 3 Business Combinations. IFRS provides no guidance on the accounting for these types of transactions and an entity is required to develop an accounting policy. The three most common methods utilized are the purchase method, the predecessor values since inception method, and the predecessor values from date of transaction method. A business combination involving entities under common control is a business combination in which all of the combining entities are ultimately controlled by the same party, both before and after the business combination, and control is not transitory. Management has determined the predecessor values from the date of transaction method to be most appropriate. This method requires the financial statements to be prepared using the predecessor carrying values without any step up to fair value. The difference between any consideration and the aggregate carrying value of the assets and liabilities are recorded in shareholders’ equity. (k) Revenue Revenue from the sale of petroleum and natural gas is recorded when the significant risks and rewards of ownership of the product is transferred to the buyer which is usually when legal title passes to the external party. For natural gas, this is generally at the time product enters the pipeline. For crude oil, this is generally at the time the product reaches a trucking terminal. For natural gas liquids, this is generally at the time the product reaches a gas plant. Revenue is measured net of discounts, customs, duties and royalties. Royalty income is recognized as it accrues in accordance with the terms of the royalty agreements. (l) Finance expense Finance expense comprises interest expense on bank indebtedness and convertible debentures, and accretion of the discount on the decommissioning liability and convertible debentures. (m) Income tax Income tax expense or recovery comprises current and deferred income tax. Income tax expense or recovery is recognized in income or loss except to the extent that it relates to items recognized directly in shareholders’ equity. Current income tax is the expected tax payable on the taxable income for the year, using tax rates enacted or substantively enacted at the reporting date, and any adjustment to income tax payable in respect of previous years. Deferred income tax is recognized using the liability method, providing for temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. Deferred income tax is not recognized on the initial recognition of assets or liabilities in a transaction that is not a business combination, and at the time of the transaction, affects neither accounting income nor taxable income. Deferred Advantage Oil & Gas Ltd. - 50 3. Significant accounting policies (continued) (m) Income tax (continued) income tax is measured at the tax rates that are expected to be applied to temporary differences when they reverse, based on the laws that have been enacted or substantively enacted by the reporting date. A deferred income tax asset is recognized to the extent that it is probable that future taxable profits will be available against which the temporary difference can be utilized. Deferred income tax assets are reviewed at each reporting date and are reduced to the extent that it is no longer probable that the related tax benefit will be realized. Deferred income tax assets and liabilities are only offset when they are within the same legal entity and same tax jurisdiction. Deferred income tax assets and liabilities are presented as non-current. (n) Net income (loss) per share Basic net income (loss) per share is calculated by dividing the net income (loss) attributable to common shareholders of the Corporation by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is determined by adjusting the net income (loss) attributable to common shareholders and the weighted average number of common shares outstanding for the effects of dilutive instruments such as restricted shares and stock options granted to service providers and convertible debentures, using the treasury stock method. (o) Segmented information The Corporation has determined that it has two reportable operating segments, being the legal entities Advantage and Longview. These segments were determined on the basis of their different economic characteristics. Advantage is a natural gas focused producer and Longview is an oil and natural gas liquids focused producer. Furthermore, each legal entity’s Board of Directors decides how to allocate resources and assess performance. Advantage Oil & Gas Ltd. - 51 3. Significant accounting policies (continued) (p) Changes in accounting policies The Corporation has adopted, as required, the following new and revised standards along with any consequential amendments, effective January 1, 2013. IFRS 10 Consolidated Financial Statements IFRS 10 is a new standard that has replaced SIC 12, “Consolidation – Special Purpose Entities” and IAS 27 “Consolidated and Separate Financial Statements”. The new standard eliminates the risks and rewards approach and establishes control as the single basis for determining the consolidation of an entity. We have determined that the new standard has no effect on the accounting methodology with respect to Longview Oil Corp. We will continue to control Longview Oil Corp. under IFRS 10 as we did under IAS 27, and as such will consolidate Longview Oil Corp. as a subsidiary of Advantage. IFRS 11 – Joint Arrangements, IAS 28 – Investments in Associates and Joint Ventures IFRS 11 supersedes IAS 31, Interests in Joint Ventures and SIC-13, Jointly Controlled Entities, Non-Monetary Contributions by Ventures and requires a venture to classify its interest in a joint arrangement as a joint venture or joint operation depending on the contractual rights and obligations of the parties that jointly controls the arrangement. Joint ventures will be accounted for using the equity method of accounting as set out in IAS 28 whereas for a joint operation, the venture will recognize its share of the assets, liabilities, revenue and expenses. The Corporation determined all of its joint arrangements to be joint operations as defined in IFRS 11 and that the adoption and application of these standards did not result in any changes in the accounting for joint arrangements. IFRS 12 Disclosure of Interests in Other Entities IFRS 12 provides the required disclosures for interests in subsidiaries, investees and joint arrangements. These disclosures require information that will assist users of financial statements to evaluate the nature, risks and financial effects associated with an entity’s interests in subsidiaries and joint arrangements. The adoption of this standard did not result in any changes or additions to existing disclosures with respect to Questfire Energy Corp, an investee, or the Corporations interests in joint arrangements. With respect to Longview Oil Corp., a subsidiary, the Corporation has disclosed dividends paid to non-controlling interests as well as summarized information about the assets, liabilities, profit or loss and cash flows of Longview Oil Corp., in order to assist readers in understanding the interest that non- controlling interests have in the Corporation’s activities and cash flows in note 26. IFRS 13 – Fair Value Measurement IFRS 13 is a comprehensive standard for fair value measurement and disclosure requirements for use across all IFRS standards. The new standard clarifies that fair value is the price that would be received to sell an asset, or paid to transfer a liability in an orderly transaction between market participants, at the measurement date. It also establishes disclosures about fair value measurement. The adoption of this standard did not require any adjustments to the valuation techniques used by the Corporation to measure fair value and did not result in any measurement adjustments as at January 1, 2013. IAS 28 – Investments in Associates and Joint Ventures IAS 28 has been amended to include joint ventures in its scope and to address the changes in IFRS 10 to 13. The adoption of this standard did not result in any changes or additions to existing disclosures. IAS 36 Impairment of Assets In May 2013, the IASB issued an amendment to IAS 36, Impairment of Assets. The amendment removes certain disclosures of the recoverable amount of a CGU. The amendment is effective retrospectively for annual periods beginning on or after January 1, 2014. As allowed by the standard, the Corporation early adopted the amendment in the current period. No additional disclosures were required as a result of this early adoption. Advantage Oil & Gas Ltd. - 52 3. Significant accounting policies (continued) (q) New standards and interpretations not yet adopted Standards issued but not yet effective up to the date of issuance of the Corporation’s financial statements are listed below. This listing is of standards and interpretations issued which the Corporation reasonably expects to be applicable at a future date. The Corporation intends to adopt those standards when they become effective. IFRS 9 Financial Instruments: Classification and Measurement IFRS 9 is intended to supersede IAS 39, Financial Instruments: Recognition and Measurement and will be published in three phases, of which the first phase has been published. The first phase addresses the accounting for financial assets and financial liabilities. The second phase will address the impairment of financial instruments, and the third phase will address hedge accounting. For financial assets, IFRS 9 uses a single approach to determine whether a financial asset is measured at amortized cost or fair value, and replaces the multiple rules in IAS 39. The approach in IFRS 9 is based on how an entity manages its financial instruments in the context of its business model and the contractual cash flow characteristics of the financial assets. The new standard also requires a single impairment method to be used, replacing the multiple impairment methods in IAS 39. For financial liabilities, although the classification criteria for financial liabilities will not change under IFRS 9, the approach to the fair value option for financial liabilities may require different accounting for changes to the fair value of a financial liability as a result of changes to an entity’s own credit risk. This standard is not applicable until January 1, 2015. Advantage Oil & Gas Ltd. - 53 4. Significant accounting judgments, estimates and assumptions The preparation of financial statements in conformity with IFRS requires management to make judgments, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, income and expenses. Actual results may differ from these estimates, and differences could be material. Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the year in which the estimates are revised and in any future years affected. Estimates and assumptions Information about significant areas of estimation uncertainty in applying accounting policies that have the most significant effect on the amounts recognized in the consolidated financial statements is included in the following notes: • Note 12 – valuation of financial instruments; • Note 5 – valuation and impairment of assets held for sale; • Note 10 – valuation of property, plant and equipment; • Note 7 & 10 – impairment of exploration and evaluation assets and property, plant and equipment; • Note 9, 12 & 14 – valuation of convertible debentures; • Note 15 – measurement of decommissioning liability; • Note 16 – measurement of deferred income tax; and • Note 18 – measurement of share based compensation. Judgments In the process of applying the Corporation’s accounting policies, management has made the following judgments, apart from those involving estimates, which may have the most significant effect on the amounts recognized in the consolidated financial statements. (a) Consolidation At December 31, 2013, Advantage controls 45.1% of the voting rights of Longview. Although this is below 50%, management has determined that Advantage has the power to govern the financial and operating policies of Longview so as to obtain benefits from its activities, due to the comparatively dispersed ownership among the non-controlling interest. (b) Exploration and evaluation assets Costs incurred to acquire rights to explore for oil and natural gas may be grouped into either exploration and evaluation or development and production, depending on facts and circumstances. Costs incurred in respect of properties that have been determined to have proved or probable reserves, are classified as development and production properties. In such circumstances, technical feasibility and commercial viability are considered to be established. Costs incurred in respect of new prospects with no nearby established development past or present and no proved or probable reserves assigned are classified as exploration and evaluation assets (note 7). (c) Reserves base The oil and gas development and production properties are depreciated on a unit-of-production (“UOP”) basis at a rate calculated by reference to proved and probable reserves determined in accordance with National Instrument 51-101 “Standards of Disclosure for Oil and Gas Activities” and incorporating the estimated future cost of developing and extracting those reserves. Proved plus probable reserves are determined using estimates of oil and natural gas in place, recovery factors and future oil and natural gas prices. Future development costs are estimated using assumptions as to number of wells required to produce the reserves, the cost of such wells and associated production facilities and other capital costs. Advantage Oil & Gas Ltd. - 54 4. Significant accounting judgments, estimates and assumptions (continued) (d) Depreciation of oil and gas assets Oil and gas properties are depreciated using the UOP method over proved plus probable reserves. The calculation of the UOP rate of depreciation could be impacted to the extent that actual production in the future is different from current forecast production based on proved plus probable reserves (note 10). (e) Determination of cash generating units Oil and gas properties are grouped into cash generating units for purposes of impairment testing. Management has evaluated the oil and gas properties of the Corporation, and grouped the properties into cash generating units on the basis of their ability to generate independent cash flows, similar reserve characteristics, geographical location, and shared infrastructure. (f) Impairment indicators and calculation of impairment At each reporting date, Advantage assesses whether or not there are circumstances that indicate a possibility that the carrying values of exploration and evaluation assets and property, plant and equipment are not recoverable, or impaired. Such circumstances include incidents of physical damage, deterioration of commodity prices, changes in the regulatory environment, or a reduction in estimates of proved and probable reserves. When management judges that circumstances indicate potential impairment, property, plant and equipment are tested for impairment by comparing the carrying values to their recoverable amounts. The recoverable amounts of cash generating units are determined based on the higher of value-in-use calculations and fair values less costs to sell. These calculations require the use of estimates and assumptions, that are subject to change as new information becomes available including information on future commodity prices, expected production volumes, quantities of reserves, discount rates, future development costs and operating costs (note 7 & 10). (g) Decommissioning liability Decommissioning costs will be incurred by the Corporation at the end of the operating life of some of the Corporation’s facilities and properties. The ultimate decommissioning liability is uncertain and can vary in response to many factors including changes to relevant legal requirements, the emergence of new restoration techniques, experience at other production sites, or changes in the risk-free discount rate. The expected timing and amount of expenditure can also change in response to changes in reserves or changes in laws and regulations or their interpretation. As a result, there could be significant adjustments to the provisions established which would affect future financial results. (h) Income taxes The Corporation recognizes deferred income tax assets to the extent that it is probable that taxable profit will be available to allow the benefit of that deferred income tax asset to be utilized. Assessing the recoverability of deferred income tax assets requires the Corporation to make significant estimates related to expectations of future taxable income. Estimates of future taxable income are based on forecast cash flows from operations and the application of existing tax laws. To the extent that future cash flows and taxable income differ significantly from estimates, the ability of the Corporation to realize the deferred income tax assets recorded at the reporting date could be impacted. Additionally, future changes in tax laws in the jurisdictions in which the Corporation operates could limit the ability of the Corporation to obtain tax deductions in future periods. Advantage Oil & Gas Ltd. - 55 5. Assets held for sale On February 5, 2013, Advantage announced that it had signed a definitive agreement (the “Transaction”) with Questfire Energy Corp. (“Questfire”) for the sale of certain oil and gas properties. The Transaction closed on April 30, 2013. The Transaction, along with another minor sale that closed in January 2013, constituted the sale of substantially all of the non- core assets of the Advantage legal entity. All Advantage legal entity assets and associated liabilities presented as held for sale at December 31, 2012 have been derecognized from the Consolidated Statement of Financial Position. Consideration received by Advantage from Questfire consisted of $40.2 million of cash, a Convertible Senior Secured Debenture (“Questfire Debenture”) with a face value of $32.6 million and a fair value of $25.4 million at closing based on an 18% discount rate applied to future cash flows, and 1.5 million Class B Shares of Questfire (“Questfire Class B Shares”) with a fair value of $4.7 million at closing. The following table provides detail of the assets and liabilities classified as held for sale as at December 31, 2013: Assets held for sale Balance at December 31, 2011 Transferred from property, plant and equipment - cost (note 10) Transferred from property, plant and equipment - accumulated depreciation and impairment losses (note 10) Transferred from exploration and evaluation assets (note 7) Impairment of assets held for sale Balance at December 31, 2012 Additions Change in decommissioning liability Disposals Transferred to exploration and evaluation assets (note 7) Balance at December 31, 2013 Liabilities associated with assets held for sale Balance at December 31, 2011 Transferred from decommissioning liability (note 15) Balance at December 31, 2012 Change in decommissioning liability Accretion - decommissioning liability Expenditures on decommissioning liability Transferred from derivative liability Disposals - decommissioning liability and derivative liability Transferred to decommissioning liability (note 15) Balance at December 31, 2013 $ $ - 581,444 (288,694) 3,127 (73,000) 222,877 590 (5,483) (216,731) (1,253) $ - $ $ - 136,540 136,540 (5,483) 582 (2,060) 2,671 (127,541) (4,709) $ - For the year ended December 31, 2013, Advantage realized a loss on sale of assets held for sale of $6.4 million. Advantage Oil & Gas Ltd. - 56 6. Trade and other receivables Trade receivables Receivables from joint venture partners Other 7. Exploration and evaluation assets Balance at December 31, 2011 Additions Dispositions Exploration and evaluation expense Transferred to property, plant and equipment (note 10) Transferred to assets held for sale (note 5) Balance at December 31, 2012 Additions Dispositions Exploration and evaluation expense Transferred from assets held for sale (note 5) Transferred to property, plant and equipment (note 10) Balance at December 31, 2013 December 31, 2013 26,317 $ 4,204 1,495 32,016 $ December 31, 2012 26,154 $ 5,708 795 32,657 $ $ 7,730 377 (113) (181) (2,305) (3,127) 2,381 6,977 - (195) 1,253 (146) 10,270 $ $ 8. Investment – Questfire Energy Corp. – Class B Shares Advantage received as proceeds of the Transaction (note 5), 1,500,000 Questfire Class B Shares. The Questfire Class B Shares are convertible at the option of Questfire any time after September 30, 2014, into a number of Class A Shares of Questfire (“Questfire Class A Shares”) equal to $10.00 divided by the greater of $1.00 and the then current market price of Questfire Class A Shares. The Questfire Class B Shares are convertible at the option of Advantage any time after November 30, 2016 on the same basis. 9. Investment – Questfire Energy Corp. – Convertible Senior Secured Debenture Advantage received as proceeds of the Transaction (note 5), a Convertible Senior Secured Debenture of Questfire with a face value of $32.6 million. The terms of the Questfire Debenture are defined in the Indenture Agreement (the “Indenture”): The Debenture bears interest at a rate of 6.0% per annum from April 30, 2013 to April 30, 2014, 7% per annum from May 1, 2014 to April 30, 2015, and 9% per annum from May 1, 2015 to maturity on April 30, 2016. The Questfire Debenture only becomes convertible at the option of Advantage for 30 days after any of the following events: October 31, 2015; April 1, 2016; a default by Questfire as defined in the Indenture; any conversion of Questfire Class B Shares into Questfire Class A Shares effected by Questfire; a change of control of Questfire as defined in the Indenture; the election by Questfire to satisfy an interest payment in Questfire Class A Shares in accordance with terms defined in the Indenture. If converted, the Questfire Debenture will be converted into Questfire Class A Shares at the then current market price of the latter. Advantage Oil & Gas Ltd. - 57 10. Property, plant and equipment Cost Balance at December 31, 2011 Additions Change in decommissioning liability (note 15) Disposals Transferred from exploration and evaluation assets (note 7) Transferred to assets held for sale (note 5) Balance at December 31, 2012 Additions Change in decommissioning liability (note 15) Disposals Transferred from exploration and evaluation assets (note 7) Balance at December 31, 2013 Accumulated depreciation and impairment losses Balance at December 31, 2011 Depreciation Impairment of oil and gas properties Disposals Transferred to assets held for sale (note 5) Balance at December 31, 2012 Depreciation Disposals Balance at December 31, 2013 $ $ Oil & gas properties $ 2,352,639 173,911 11,095 (6,443) 2,305 (581,444) 1,952,063 188,451 (30,387) (5,876) 146 2,104,397 $ Oil & gas properties $ 477,939 131,503 31,865 (3,521) (288,694) 349,092 110,650 (629) 459,113 $ $ Furniture and equipment 4,467 $ 773 - - - - 5,240 - - - - 5,240 $ $ Furniture and equipment 1,880 $ 672 - - - 2,552 538 - 3,090 $ $ Total $ 2,357,106 174,684 11,095 (6,443) 2,305 (581,444) 1,957,303 188,451 (30,387) (5,876) 146 2,109,637 $ Total $ 479,819 132,175 31,865 (3,521) (288,694) 351,644 111,188 (629) 462,203 $ $ Net book value At December 31, 2012 At December 31, 2013 Oil & gas properties $ $ 1,602,971 1,645,284 Furniture and equipment $ 2,688 $ 2,150 Total $ $ 1,605,659 1,647,434 During the year ended December 31, 2013, Advantage capitalized general and administrative expenditures directly related to development activities of $11.7 million (December 31, 2012 - $6.7 million). Advantage included future development costs of $2.1 billion (December 31, 2012 – $1.8 billion) in property, plant and equipment costs subject to depreciation. Impairment of oil and gas properties occur when management determines that indicators of impairment are present in specific cash generating units. Recorded impairments are the amount by which carrying amounts of the cash generating units exceed their respective recoverable amount based on a fair value less costs to sell determination. Fair value less costs to sell is based on discounted after-tax future net cash flows of proved and probable reserves using forecast prices and costs, discounted at 10%. For the year ended December 31, 2012, Longview recognized an impairment of oil and gas properties of $31.9 million. The impairment of oil and gas properties recognized relates to crude oil and natural gas producing assets in West Central Alberta. The decline in the price of crude oil and discounted after-tax future net cash flows were considered to be indicators of impairment. Advantage Oil & Gas Ltd. - 58 10. Property, plant and equipment (continued) Forecast crude oil prices used in the calculation of impairment of oil and gas properties for the year ended December 31, 2012 are as follows: Year 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 (1) Edmonton Par ($Cdn/bbl) 84.55 89.84 88.21 95.43 96.87 98.32 99.79 101.29 102.81 104.35 105.92 (1) Escalation of 1.5% thereafter 11. Related party transactions Transactions between Advantage and Longview At December 31, 2013 and 2012, Advantage and Longview were bound by a Technical Services Agreement (“TSA”). Under the TSA, Advantage provides the necessary personnel and technical services to manage Longview’s business and Longview reimburses Advantage on a monthly basis for its share of administrative charges based on respective levels of production. All amounts paid are recorded as general and administrative expenses and measured at the fair value, which is the amount agreed upon by the transacting parties. At December 31, 2013, amounts due from Longview totaled $1.4 million (December 31, 2012 - $2.2 million). Advantage charged Longview $5.2 million during the year ended December 31, 2013 (December 31, 2012 - $5.3 million) under the Technical Services Agreement (“TSA”). Dividends declared and paid or payable from Longview to Advantage during the year ended December 31, 2013 totaled $12.5 million (December 31, 2012 - $14.4 million). All amounts due to and from Longview are non-interest bearing in nature, settled monthly and were incurred within the normal course of business. All inter-corporate balances, income and expenses resulting from inter-corporate transactions are eliminated on consolidation. Key management compensation The compensation paid or payable to officers and directors is as follows: Salaries, director fees and short-term benefits Share based compensation (1) December 31, 2013 5,916 $ 1,180 7,096 $ December 31, 2012 3,881 $ 5,088 8,969 $ (1) Represents the grant date fair value of restricted shares and stock options granted for the respective years. As at December 31, 2013, there is a $1.9 million commitment (December 31, 2012 - $3.5 million) related to change of control or termination of employment of officers. Advantage Oil & Gas Ltd. - 59 12. Financial risk management Financial instruments of the Corporation include trade and other receivables, deposits, investment in Questfire Class B Shares, investment in Questfire Debenture, trade and other accrued liabilities, bank indebtedness, convertible debentures and derivative assets and liabilities. Trade and other receivables and deposits are classified as loans and receivables and measured at amortized cost. Trade and other accrued liabilities and bank indebtedness are all classified as financial liabilities at amortized cost. As at December 31, 2013, there were no significant differences between the carrying amounts reported on the Consolidated Statement of Financial Position 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 Questfire Debenture has been classified as a financial asset at amortized cost. As at December 31, 2013, there was no significant difference between the carrying amount reported on the Consolidated Statement of Financial Position and the estimated fair value of the financial asset. No value was assigned to the conversion option, due to its restrictions and short term to maturity. The Corporation has a convertible debenture obligation outstanding, of which the liability component has been classified as a financial liability at amortized cost. The convertible debenture has fixed terms and interest rates resulting in fair values that will vary over time as market conditions change. As at December 31, 2013, the estimated fair value of the outstanding convertible debenture obligation was $86.7 million (December 31, 2012 - $86.0 million). The fair value of the liability component of convertible debentures was determined based on the current public trading activity of the debenture. Fair value is determined following a three level hierarchy: Level 1: Quoted prices in active markets for identical assets and liabilities. Financial assets measured at fair value based on a level 1 input consist solely of the investment in Questfire Class B Shares, using a quoted market price. The Corporation does not have any financial liabilities that require level 1 inputs. Level 2: Inputs other than quoted prices included within Level 1 that are observable, either directly or indirectly. Such inputs can be corroborated with other observable inputs for substantially the complete term of the contract. For assets and liabilities measured at fair value on a recurring basis, such as derivative assets and liabilities, 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 as compared to the valuation assumptions. Level 3: Under this level, fair value is determined using inputs that are not observable. Advantage has no assets or liabilities that use level 3 inputs. Advantage Oil & Gas Ltd. - 60 12. Financial risk management (continued) The Corporation’s activities expose it to a variety of financial risks that arise as a result of its exploration, development, production, and financing activities such as: • • • • credit risk; liquidity risk; price and currency risk; and interest rate risk. (a) Credit risk Credit risk is the risk of financial loss to the Corporation if a customer or counterparty to a financial instrument fails to meet its contractual obligations, and arises principally from the Corporation’s receivables from joint venture partners, oil and natural gas marketers, companies with whom we enter into hedging contracts, and Questfire. The maximum exposure to credit risk is as follows: Trade and other receivables Deposits Derivative asset Questfire debenture $ December 31, 2013 32,016 1,548 2,472 26,876 62,912 $ $ December 31, 2012 32,657 2,780 2,186 - 37,623 $ Trade and other receivables, deposits, and derivative assets are subject to credit risk exposure and the carrying values reflect 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 trade and other receivables are due from customers and joint operation partners concentrated in the Canadian oil and gas industry. As such, trade and other receivables are subject to normal industry credit risks. As at December 31, 2013, $0.9 million or 2.9% of trade and other receivables are outstanding for 90 days or more (December 31, 2012 - $0.7 million or 2.2% of trade and other receivables). The Corporation believes the entire balance is collectible, and in some instances has the ability to mitigate risk through withholding production or offsetting payables with the same parties. Management has not provided an allowance for doubtful accounts at December 31, 2013 or 2012. The Corporation’s most significant customer, a Canadian oil and natural gas marketer, accounts for $13.0 million of the trade and other receivables at December 31, 2013 (December 31, 2012 - $12.6 million). Advantage Oil & Gas Ltd. - 61 12. Financial risk management (continued) (b) Liquidity risk The Corporation is subject to liquidity risk attributed from trade and other accrued liabilities, bank indebtedness, convertible debentures, and derivative liabilities. Trade and other accrued liabilities and derivative liabilities are primarily due within one year of the Consolidated Statement of Financial Position date and Advantage does not anticipate any problems in satisfying the obligations from cash provided by operating activities and the existing credit facilities. The Corporation’s bank indebtedness is subject to $500 million credit facility agreements. Although the credit facilities are a source of liquidity risk, the facilities also mitigates liquidity risk by enabling Advantage to manage interim cash flow fluctuations. The terms of the credit facilities are such that they provide 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 a convertible debenture outstanding that matures in 2015 (note 14). Interest payments are made semi- annually with excess cash provided by operating activities. As the debenture becomes due, the Corporation can satisfy the obligation in cash or issue shares at a price determined in the applicable debenture agreement. 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, 2013 and 2012 are as follows: December 31, 2013 Trade and other accrued liabilities Derivative liability Bank indebtedness Convertible debentures - principal - interest - principal - interest $ Less than one year 93,893 8,340 - 13,626 - 4,313 120,172 $ One to three years - $ 1,183 272,521 6,496 86,250 2,156 368,606 $ Three to five years Thereafter - - $ $ - - - - - - - - - - $ - $ - Total $ 93,893 9,523 272,521 20,122 86,250 6,469 488,778 $ Interest on bank indebtedness was calculated assuming conversion of the revolving credit facility to a one-year term facility. December 31, 2012 Trade and other accrued liabilities Derivative liability Bank indebtedness Convertible debentures - principal - interest - principal - interest $ Less than one year 84,979 1,096 - 13,338 - 4,313 103,726 $ One to three years - $ - 274,171 6,358 86,250 6,469 373,248 $ Three to five years Thereafter - - $ $ - - - - - - - - - - $ - $ - Total $ 84,979 1,096 274,171 19,696 86,250 10,782 476,974 $ Interest on bank indebtedness was calculated assuming conversion of the revolving credit facility to a one-year term facility. Advantage Oil & Gas Ltd. - 62 12. Financial risk management (continued) (b) Liquidity risk (continued) The Corporation’s bank indebtedness does not have specific maturity dates. It is governed by credit facility agreements with a syndicate of financial institutions (note 13). Under the terms of the agreements, the facilities are reviewed annually, with the next reviews scheduled in June 2014. The facilities are revolving and are extendible at each annual review for a further 364 day period at the option of the syndicate. If not extended, the credit facilities are converted at that time into one year term facilities, with the principal payable at the end of such one year terms. Management fully expects that the facilities will be extended at each annual review. (c) 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 into non- financial derivatives 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 earnings. It is estimated that a 10% change in the forward crude oil prices used to calculate the fair value of the crude oil derivatives at December 31, 2013 would result in a $2.5 million change in net loss for the year ended December 31, 2013. It is estimated that a 10% change in the forward natural gas prices used to calculate the fair value of the natural gas derivatives at December 31, 2013 would result in a $13.6 million change in net loss for the year ended December 31, 2013. As at December 31, 2013, the Corporation’s hedging positions are summarized as follows: Natural gas - AECO Period Q1 2014 to Q4 2014 Q1 2015 to Q4 2015 Q1 2016 Average Production Hedged 60.2 mmcf/d 59.2 mmcf/d 42.7 mmcf/d Average Price AECO - $Cdn. $3.81/mcf $3.86/mcf $3.90/mcf Crude oil – WTI Period Q1 2014 to Q4 2014 Average Production Hedged 2,000 bbls/d Average Price WTI - $Cdn. $94.84/bbl Advantage Oil & Gas Ltd. - 63 12. Financial risk management (continued) (c) Price and currency risk (continued) As at December 31, 2013, the fair value of the derivatives outstanding resulted in an asset of $2.5 million (December 31, 2012 – $2.2 million) and a liability of $9.5 million (December 31, 2012 – $1.1 million). The fair value of the commodity risk management derivatives have been allocated to current assets and liabilities on the basis of expected timing of cash settlement. For the year ended December 31, 2013, $14.7 million was recognized in net loss as a derivative loss (December 31, 2012 - $2.9 million derivative gain). The table below summarizes the realized and unrealized gains (losses) on derivatives. Realized loss on derivatives Unrealized gain (loss) on derivatives (d) Interest rate risk Year ended December 31, 2013 $ Year ended December 31, 2012 $ (3,936) (10,812) (14,748) (970) 3,828 2,858 $ $ Interest rate risk is the risk that future cash flows will fluctuate as a result of changes in market interest rates. The interest charged on the outstanding bank indebtedness fluctuates with the interest rates posted by the lenders. The Corporation is exposed to interest rate risk and has not entered into any mitigating interest rate hedges or swaps. Had the borrowing rate been different by 100 basis points throughout the year ended December 31, 2013, net income (loss) and comprehensive income (loss) would have changed by $2.0 million (December 31, 2012 - $2.8 million) based on the average debt balance outstanding during the year. (e) Capital management The Corporation manages its capital with the following objectives: • To ensure sufficient financial flexibility to achieve the ongoing business objectives including replacement of production, funding of future growth opportunities, and pursuit of accretive acquisitions; and • To maximize shareholder return through enhancing the share value. Advantage monitors its capital structure and makes adjustments according to market conditions in an effort to meet its objectives given the current outlook of the business and industry in general. The capital structure of the Corporation is composed of working capital (excluding derivative assets and liabilities), bank indebtedness, convertible debentures, and share capital. Advantage may manage its capital structure by issuing new shares, repurchasing outstanding shares, obtaining additional financing either through bank indebtedness or convertible debenture issuances, refinancing current debt, issuing other financial or equity-based instruments, declaring a dividend, implementing a dividend reinvestment plan, adjusting capital spending, or disposing of assets or its investments. The capital structure is reviewed by Management and the Board of Directors on an ongoing basis. Advantage Oil & Gas Ltd. - 64 12. Financial risk management (continued) (e) Capital management (continued) Advantage’s capital structure as at December 31, 2013 and 2012 is as follows: Bank indebtedness (non-current) (note 13) Working capital deficit (1) Net debt Convertible debentures maturity value (non-current) Total debt Shares outstanding (note 17) Share closing market price ($/share) Market capitalization (2) Total capitalization December 31, 2013 $ 271,339 58,520 329,859 86,250 416,109 168,382,838 4.61 776,245 1,192,354 $ $ $ December 31, 2012 $ 272,511 47,179 319,690 86,250 405,940 168,382,838 3.20 538,825 944,765 $ $ $ (1) Working capital deficit is a non-GAAP measure that includes trade and other receivables, prepaid expenses and deposits and trade and other accrued liabilities. (2) Market capitalization is a non-GAAP measure calculated by multiplying shares outstanding by the closing market share price on the applicable date. 13. Bank indebtedness Revolving credit facility: Advantage Longview Discount on Bankers Acceptances and other fees Balance, end of year December 31, 2013 December 31, 2012 $ $ 154,370 118,151 (1,182) 271,339 161,630 112,541 (1,660) 272,511 $ $ As at December 31, 2013, the Corporation had credit facilities (the "Credit Facilities") of $500 million, comprised of $300 million held by Advantage and $200 million held by Longview. The Credit Facilities are comprised of $40 million extendible revolving operating loan facilities from one financial institution and $460 million of extendible revolving loan facilities from a syndicate of financial institutions. 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 1.00% and 3.50% depending on the type of borrowing and the Corporations’ debt to cash flow ratio. The Credit Facilities are each collateralized by a $1 billion floating charge demand debenture covering all assets. The amounts available to the Corporation 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 2014 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 four years. Further, the aggregate of such contracts cannot hedge greater than 65% of total estimated petroleum and natural gas production over three years and 50% over the fourth year, in the Advantage legal entity, and cannot hedge greater than 60% of total estimated petroleum and natural gas production over two years and 50% over the third year in the Longview legal entity. The Credit Facilities contain standard commercial covenants for credit facilities of this nature. The only financial covenant is a requirement for each entity to maintain a minimum cash flow to interest expense ratio of 3.5:1, determined on a rolling four-quarter basis. These covenants were met at December 31, 2013 and 2012. Breach of any covenant will result in an event of default in which case the Corporation 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 Advantage Oil & Gas Ltd. - 65 13. Bank indebtedness (continued) 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, 2013, the average effective interest rate on the outstanding amounts under the facilities was approximately 5.0% (December 31, 2012 – 4.9%). Advantage has no letters of credit issued and outstanding at December 31, 2013 or December 31, 2012. 14. Convertible debenture The convertible unsecured subordinated debenture pays an annual coupon of 5%, paid semi-annually on January 31st and July 31st of each year and is 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 debenture including fair market values initially assigned and issuance costs are as follows: Trading symbol Issue date Maturity date Conversion price Liability component Equity component Gross proceeds Issuance costs Net proceeds AAV.DBH Dec. 31, 2009 Jan. 30, 2015 8.60 $ $ 73,019 13,231 86,250 (3,735) $ 82,515 The convertible debenture is redeemable at the option of the Corporation, upon providing appropriate advance notification as per the debenture indenture: Redemption can only occur during the period after January 31, 2013 and on or before January 30, 2015, provided that the Current Market Price exceeds 125% of the Conversion Price. The redemption price is $1,000 per debenture, plus accrued and unpaid interest. The balance of the convertible debenture outstanding at December 31, 2013 and changes in the liability and equity components during the years ended December 31, 2013 and 2012 are as follows: Trading symbol Debentures outstanding Liability component: Balance at December 31, 2011 Accretion of discount Balance at December 31, 2012 Accretion of discount Balance at December 31, 2013 Equity component: Balance at December 31, 2012 Balance at December 31, 2013 5.00% AAV.DBH 86,250 $ 75,890 3,218 79,108 3,346 82,454 $ $ $ $ 8,348 8,348 There were no conversions of convertible debentures during the years ended December 31, 2013 and 2012. Advantage Oil & Gas Ltd. - 66 15. Decommissioning liability The Corporation’s decommissioning liability results from net ownership interests in petroleum and natural gas assets including well sites, gathering systems and processing facilities, all of which will require future costs of decommissioning under environmental legislation. These costs are expected to be incurred between 2014 and 2073. A risk-free rate of 3.20% (December 31, 2012 – 2.37%) and an inflation factor of 2% (December 31, 2012 – 2%) were used to calculate the fair value of the decommissioning liability at December 31, 2013. A reconciliation of the decommissioning liability is provided below: Balance, beginning of year Accretion expense Liabilities incurred Change in estimates Effect of change in risk-free rate Property dispositions Liabilities settled Transferred from (to) assets held for sale (note 5) Balance, end of year 16. Income taxes The provision for income taxes is as follows: Current income tax expense Deferred income tax expense (recovery) Income tax expense (recovery) Year ended December 31, 2013 126,224 $ 4,587 3,908 1,335 (35,630) (1,419) (3,098) 95,907 4,709 100,616 $ Year ended December 31, 2012 253,796 $ 6,300 3,637 (6,252) 13,710 (6,032) (2,395) 262,764 (136,540) 126,224 $ Year ended December 31, 2013 - $ 2,202 2,202 $ Year ended December 31, 2012 $ - (28,605) (28,605) $ The provision for income taxes varies from the amount that would be computed by applying the combined federal and provincial income tax rates for the following reasons: Income (loss) before taxes and non-controlling interest Combined federal and provincial income tax rates Expected income tax expense (recovery) Increase (decrease) in income taxes resulting from: Non-deductible share based compensation Change in estimated pool balances Difference between current and expected tax rates Effective tax rate $ Year ended December 31, 2013 4,801 25.00% 1,200 Year ended December 31, 2012 $ (125,733) 25.00% (31,433) 2,094 (2,350) 1,258 2,202 45.87% $ 2,281 1,022 (475) (28,605) 22.75% $ The Canadian combined statutory tax rate remained unchanged at 25.00% for 2013 and 2012. Advantage Oil & Gas Ltd. - 67 16. Income taxes (continued) The movement in deferred income tax liabilities and assets without taking into consideration the offsetting of balances within the same tax jurisdiction is as follows: Deferred income tax liability Balance at December 31, 2011 Charged (credited) to income Balance at December 31, 2012 Charged (credited) to income Balance at December 31, 2013 Deferred income tax asset Balance at December 31, 2011 Charged (credited) to income Balance at December 31, 2012 Charged (credited) to income Balance at December 31, 2013 Net deferred income tax liability (asset) Balance at December 31, 2011 Charged (credited) to income Balance at December 31, 2012 Charged (credited) to income Balance at December 31, 2013 Property, plant and equipment $ Derivative asset/liability $ 238,341 (1,095) 237,246 (18,807) 218,439 (704) 971 267 (2,058) (1,791) Total $ 237,637 (124) 237,513 (20,865) 216,648 $ $ $ Decommissioning liability $ Non-capital losses $ Other $ Total $ (63,935) (2,282) (66,217) 40,594 (25,623) (176,419) (27,728) (204,147) (11,422) (215,569) (6,943) 1,529 (5,414) (6,105) (11,519) (247,297) (28,481) (275,778) 23,067 (252,711) $ $ $ $ Longview $ Advantage $ Total $ (39,383) (3,510) (42,893) 3,824 (39,069) 29,723 (25,095) 4,628 (1,622) 3,006 (9,660) (28,605) (38,265) 2,202 (36,063) $ $ $ At December 31, 2013, Advantage has a $100 million outside basis difference related to its investment in Longview. It is not probable that Advantage can utilize the capital loss that would be generated when the temporary difference reverses. Accordingly, Advantage has not recognized a deferred income tax asset of $12.5 million relating to its investment in Longview. The estimated tax pools available at December 31, 2013 are as follows: Longview Advantage Total Canadian development expenses Canadian exploration expenses Canadian oil and gas property expenses Non-capital losses Undepreciated capital cost Other $ $ $ 50,349 - 295,479 108,033 61,910 3,365 519,136 139,553 65,945 - 752,108 160,791 21,701 1,140,098 189,902 65,945 295,479 860,141 222,701 25,066 1,659,234 $ $ $ The non-capital loss carry forward balances above expire no earlier than 2023. Advantage Oil & Gas Ltd. - 68 17. Share capital (a) Authorized The Corporation is authorized to issue an unlimited number of shares without nominal or par value. (b) Issued Balance at December 31, 2011 Share based compensation (note 18) Balance at December 31, 2012 and 2013 Common Shares 166,304,040 2,078,798 168,382,838 18. Share based compensation (a) Restricted share performance incentive plan Amount 2,214,784 14,814 2,229,598 $ $ Advantage had a Restricted Share Performance Incentive Plan (“RSPIP”) as approved by the shareholders. The RSPIP authorized the Board of Directors to grant restricted shares to service providers, including directors, officers, employees, and consultants of Advantage. The number of restricted shares granted was 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. On vesting, common shares were issued to the service providers in exchange for the restricted shares outstanding. On July 9, 2012, Advantage’s Restricted Share Performance Incentive Plan expired and no new Advantage restricted shares were granted during 2012 or 2013. During the year ended December 31, 2012, Advantage issued 2,078,798 common shares to service providers in exchange for vested restricted shares. The following table is a continuity of restricted shares: Balance at December 31, 2011 Granted Vested (note 17) Forfeited Balance at December 31, 2012 and 2013 Restricted Shares 2,117,710 - (2,078,798) (38,912) - Advantage Oil & Gas Ltd. - 69 18. Share based compensation (continued) (b) Stock option plan On September 13, 2012, shareholders of Advantage approved a new Stock Option Plan, to provide for long term equity based compensation for service providers. Options are granted with exercise prices that approximate the market price of common shares at the date of grant. Share based compensation costs of the Stock Option Plan are determined using a Black-Scholes-Merton valuation model, using weighted average assumptions as follows: Volatility Expected forfeiture rate Dividend rate Risk-free rate 42% 0.25% 0% 1.04% Volatility is based on historical stock prices at the close-of-trade-day over a historical time period. The following tables summarize information about changes in stock options outstanding at December 31, 2013: Balance at December 31, 2011 Granted Forfeited Balance at December 31, 2012 Expired Exercised Granted Forfeited/cancelled Balance at December 31, 2013 Stock Options - 15,996,366 (18,483) 15,977,883 (1,994,658) (1,994,641) 3,804,675 (2,732,416) 13,060,843 Weighted-Average Exercise Price $ $ - 3.67 3.67 3.67 3.67 3.67 3.69 3.68 3.68 $ Stock Options Outstanding Stock Options Exercisable Range of Exercise Price $3.67 - $3.69 Number of Stock Options Outstanding 13,060,843 Weighted Average Remaining Contractual Life 0.50 Weighted Average Exercise Price $ 3.68 Number of Stock Options Exercisable - $ - Weighted Average Exercise Price Share based compensation recognized by plan for the years ended December 31, 2013 and 2012 are as follows: RSPIP Stock Option Plan Total share based compensation (note 21) Capitalized Net share based compensation expense Year ended December 31, 2013 420 $ 7,874 8,294 (2,838) Year ended December 31, 2012 6,200 $ 2,878 9,078 (1,858) $ 5,456 $ 7,220 Advantage Oil & Gas Ltd. - 70 19. Net loss per share attributable to Advantage shareholders The calculations of basic and diluted net loss per share are derived from both net loss attributable to Advantage common shareholders and weighted average shares outstanding, calculated as follows: Net loss attributable to Advantage shareholders Basic and diluted Weighted average shares outstanding Basic and diluted Year ended December 31, 2013 Year ended December 31, 2012 $ (3,382) $ (89,125) 168,382,838 167,509,131 The calculation of diluted net loss per share for the years ended December 31, 2013 and 2012 excludes convertible debentures, as their impact would be anti-dilutive. Total weighted average shares issuable in exchange for the series of convertible debentures excluded from the diluted net loss per share calculation for the years ended December 31, 2013 and 2012 was 10,029,070 shares. As at December 31, 2013 and 2012, the total convertible debentures outstanding were convertible to 10,029,070 shares. The calculation of diluted net loss per share for the year ended December 31, 2013 excluded stock options, as their impact would have been anti-dilutive. Total weighted average shares issuable in exchange for outstanding stock options for the year ended December 31, 2013 was 1,445,884 shares (December 31, 2012 – nil). Restricted shares have been excluded from the calculation of diluted net loss per share, as there were no restricted shares outstanding at December 31, 2013 and 2012. 20. Petroleum and natural gas sales Crude oil and natural gas liquid sales Natural gas sales Total petroleum and natural gas sales Year ended December 31, 2013 154,864 $ 134,878 289,742 $ Year ended December 31, 2012 164,860 $ 104,045 268,905 $ Advantage Oil & Gas Ltd. - 71 21. General and administrative expense (“G&A”) Salaries and benefits Share based compensation (note 18) Office rent Other Total G&A Capitalized (note 10) Net G&A 22. Finance expense Interest on bank indebtedness (note 13) Interest on convertible debentures (note 14) Accretion on convertible debentures (note 14) Accretion of decomissioning liability (note 15) Accretion of other liability Total finance expense 23. Other income (expenses) Loss on sale of assets held for sale Gain (loss) on sale of property, plant and equipment Interest income - Questfire Debenture Accretion income - Questfire Debenture Unrealized loss - Questfire Class B Shares Miscellaneous income Total other income (expenses) 24. Supplemented cash flow information Changes in non-cash working capital is comprised of: Source (use) of cash: Trade and other receivables Prepaid expenses and deposits Trade and other accrued liabilities Related to operating activities Related to financing activities Related to investing activities Advantage Oil & Gas Ltd. - 72 Year ended December 31, 2013 22,877 $ 8,294 2,109 5,863 39,143 (11,735) 27,408 $ Year ended December 31, 2012 19,650 $ 9,078 2,540 3,568 34,836 (6,656) 28,180 $ Year ended December 31, 2013 13,305 $ 4,313 3,346 5,169 - 26,133 $ Year ended December 31, 2012 12,436 $ 4,313 3,218 6,300 32 26,299 $ Year ended December 31, 2013 $ Year ended December 31, 2012 - $ 16,964 - - - 595 17,559 $ (6,354) (1,800) 1,312 1,516 (900) 1,102 (5,124) $ Year ended December 31, 2013 Year ended December 31, 2012 $ $ 641 1,786 8,914 11,341 4,052 (259) 7,548 11,341 $ $ $ $ $ $ 9,687 902 (53,140) (42,551) (14,864) 916 (28,603) (42,551) 25. Commitments Advantage has several lease commitments relating to office buildings and transportation. The estimated remaining annual minimum operating lease payments are as follows: 2013 2014 2015 Total commitments December 31, 2013 - 13,260 4,305 17,565 $ December 31, 2012 15,280 12,499 2,371 30,150 $ Advantage Oil & Gas Ltd. - 73 26. Segmented information The Corporation is comprised of two operating segments: Advantage Oil & Gas Ltd. (“Advantage”) and Longview Oil Corp. (“Longview”). Advantage develops and operates natural gas focused properties in Alberta. Longview develops and operates primarily conventional oil and natural gas liquids focused properties in Alberta and Saskatchewan. Results by operating segment for the year ended December 31, 2013 and 2012 are as follows: Year ended December 31, 2013 Year ended December 31, 2012 (thousands of Canadian dollars) Advantage Longview Consolidated Advantage Longview Consolidated Petroleum and natural gas sales Less: royalties Petroleum and natural gas revenue $ 140,090 (7,534) 132,556 $ 149,652 (26,297) 123,355 $ 289,742 (33,831) 255,911 $ 129,131 (7,401) 121,730 $ 139,774 (26,725) 113,049 $ 268,905 (34,126) 234,779 Operating expense General and administrative expense Depreciation expense Impairment of assets held for sale Impairment of oil and gas properties Exploration and evaluation expense Finance expense Gains (losses) on derivatives Other income (expenses) Income (loss) before taxes and non- controlling interest Income tax recovery (expense) Net income (loss) and comprehensive income (loss) before non-controlling interest Net (income) loss attributable to non- controlling interest (20,515) (24,426) (72,140) - - - (18,225) (3,190) (3,979) (45,799) (2,982) (39,048) - - (195) (7,908) (11,558) (1,145) (66,314) (27,408) (111,188) - - (195) (26,133) (14,748) (5,124) (42,796) (24,250) (90,376) (73,000) - (140) (19,316) (240) 17,527 (46,433) (3,930) (41,799) - (31,865) (41) (6,983) 3,098 32 (89,229) (28,180) (132,175) (73,000) (31,865) (181) (26,299) 2,858 17,559 (9,919) 1,622 14,720 (3,824) 4,801 (2,202) (110,861) 25,095 (14,872) 3,510 (125,733) 28,605 (8,297) 10,896 2,599 (85,766) (11,362) (97,128) - (5,981) (5,981) - 8,003 8,003 Net loss and comprehensive loss attributable to Advantage shareholders Total assets Total liabilities Cash flows from operating activities Expenditures on property, plant and equipment Dividends received (paid) (1) These items are presented before inter-company eliminations. (2) Consolidated figure represents dividends paid to non-controlling interests. (8,297) 1,309,543 346,416 99,366 $ $ $ $ 147,949 12,479 $ $ $ $ $ $ $ $ 4,915 455,701 214,415 65,651 40,502 (27,670) (1) (1) $ $ $ $ (3,382) 1,765,244 560,831 165,017 $ $ $ $ (85,766) 1,424,010 470,647 40,560 $ $ $ $ (3,359) 489,786 234,439 66,396 (1) (1) $ $ $ $ (89,125) 1,913,796 705,086 106,956 $ $ 188,451 (15,191) (2) $ $ 130,490 14,350 $ $ 44,194 (28,085) $ $ 174,684 (13,735) (2) Advantage Oil & Gas Ltd. - 74 27. Subsequent events On February 4, 2014 the Corporation announced the following: That its strategic alternatives review process was completed and did not result in an acceptable proposal; that the Technical Services Agreement (“TSA”) between the Corporation and Longview was terminated; and that the Corporation had entered into an agreement to sell the 21.15 million Longview common shares owned by Advantage at a price of $4.45 per share for net proceeds of $90.0 million. The offering closed on February 28, 2014. As at December 31, 2013, the carrying value of Advantage’s investment in Longview was $111.5 million. On March 26, 2014, Advantage entered an agreement for Questfire to repurchase the Questfire Debenture at an aggregate purchase price of $13.6 million. Questfire also agreed that it would make an offer to purchase by way of issuer bid, all of the Class B Shares at a purchase price of $2.60 per share. Advantage expects to receive total proceeds of $17.5 million on the disposition of its investments in Questfire. Advantage Oil & Gas Ltd. - 75 Directors Stephen E. Balog (1)(2)(3) Paul G. Haggis (1)(2)(3) Andy J. Mah Ronald A. McIntosh (1)(2)(3) (1) Member of Audit Committee (2) Member of Reserve Evaluation Committee (3) Member of Human Resources, Compensation & Corporate Governance Committee Officers Andy J. Mah, President and CEO Craig Blackwood, Vice President, Finance and CFO Neil Bokenfohr, Senior Vice President Corporate Secretary Jay P. Reid, Partner Burnet, Duckworth and Palmer LLP Auditors PricewaterhouseCoopers LLP Bankers The Bank of Nova Scotia National Bank of Canada Royal Bank of Canada Canadian Imperial Bank of Commerce Union Bank, Canada Branch Alberta Treasury Branches Wells Fargo Bank N.A., /Canada Branch 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 - million cubic feet mmcf 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 300, 440 – 2nd Avenue SW Calgary, Alberta T2P 5E9 (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 5.00% Convertible Debentures: AAV.DBH New York Stock Exchange Trading Symbol Shares: AAV Advantage Oil & Gas Ltd. - 76 

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