Advantage Oil & Gas Ltd.
Annual Report 2018

Plain-text annual report

2018 Annual Report Financial and Operating Highlights (1) Non-GAAP Measure which may not be comparable to similar non-GAAP measures used by other entities. Please see "Non-GAAP Measures". (2) Based on basic weighted average shares outstanding. (3) Excludes net sales of natural gas purchased from third parties. Financial Highlights($000, except as otherwise indicated)2018201720182017Financial Statement Highlights73,979$ 65,779$ 250,604$ 259,611$ Net income and comprehensive income25,162$ 21,425$ 11,119$ 95,039$ per basic share (2)0.14$ 0.12$ 0.06$ 0.51$ Cash provided by operating activities44,790$ 29,848$ 160,162$ 186,401$ Cash provided by financing activities8,576$ 50,659$ 53,015$ 48,945$ Cash used in investing activities50,723$ 73,591$ 213,734$ 228,430$ Basic weighted average shares (000)185,942 185,963 186,040 185,641 Other Financial HighlightsAdjusted funds flow (1)46,301$ 43,883$ 150,378$ 183,202$ per mcfe1.84$ 1.94$ 1.65$ 2.13$ per basic share (2)0.25$ 0.24$ 0.81$ 0.99$ Net capital expenditures (1)52,000$ 73,723$ 203,834$ 248,774$ Working capital deficit1,912$ 13,808$ 1,912$ 13,808$ Bank indebtedness270,918$ 208,978$ 270,918$ 208,978$ Total debt (1)272,830$ 222,786$ 272,830$ 222,786$ Three months endedYear endedDecember 31December 31Sales including realized hedging (3)OperatingDaily ProductionNatural gas (mcf/d)262,269 237,780 240,959 228,583 Liquids (bbls/d)1,974 1,227 1,491 1,218 Total mcfe/d274,113 245,142 249,905 235,891 Total boe/d45,686 40,857 41,651 39,315 Average prices (including realized hedging)Natural gas ($/mcf) (3)2.70$ 2.69$ 2.47$ 2.82$ Liquids ($/bbl)49.23$ 60.48$ 62.12$ 54.28$ Operating Netback ($/mcfe)Sales of natural gas and liquids from production2.81$ 2.38$ 2.44$ 2.69$ Net sales of natural gas purchased from third parties (1)- - 0.01 - Realized gains on derivatives0.12 0.53 0.31 0.32 Royalty expense(0.07) (0.07) (0.03) (0.07) Operating expense(0.29) (0.26) (0.30) (0.25) Transportation expense(0.53) (0.50) (0.56) (0.40) Operating netback (1)2.04$ 2.08$ 1.87$ 2.29$ CONTENTS Message to Shareholders………………………………………………………………… ………………….3 Reserves…………………………………………………………………………………… ……………......5 Consolidated Management’s Discussion & Analysis…………………………………………… ……….......10 Independent Auditor’s Report………………………………………………………………… …………...32 Consolidated Financial Statements……………………………………………………………… …………35 Consolidated Statement of Financial Position………………………………………………….…… ....35 Consolidated Statement of Comprehensive Income…………………………………………………. ...36 Consolidated Statement of Changes in Shareholders’ Equity…………………………………….….….37 Consolidated Statement of Cash Flows……………………………………………… ………………...38 Notes to the Consolidated Financial Statements……………………………………… ……………….39 Advisory……………………………………………………………………………………………………65 Advantage Oil & Gas Ltd. - 2 MESSAGE TO SHAREHOLDERS Liquids Growth, Market Diversification & Operational Excellence Advantage Oil & Gas Ltd. (“Advantage” or the “Corporation”) is pleased to announce its 2018 results, culminating in increased liquids development, successful revenue diversification, and operational excellence. These accomplishments, combined with an emphasis on capital and financial discipline, will continue to strengthen the Corporation’s solid business and advance its multi -year liquids development plan. Highlights from our 2018 accomplishments include: • Record annual production of 41,651 boe/d including a 22% increase in liquids; • $59 million gain through marketing diversification initiatives; • Low operating expenses of $1.80/boe; • Year-end total debt(a) to adjusted funds flow(a) ratio of 1.8; • 3 year capital efficiency(a) of $13,400/boe/d; • Increased Montney holdings by acquiring 17 net sections (10,880 acres) of complimentary lands for $2 million resulting in total land ownership of 206 net sections (131,840 acres); • 30% improvement in the liquids-rich Montney productivity per well through frac design enhancements; • Completed Glacier plant expansion and new Valhalla liquids hub to accommodate liquids development strategy; • Increased CO2e sequestration credits by 59% to 90,500 tonnes; and • Participated in several industry advocacy initiatives and continued to explore marketing opportunities. We are proud of our Team’s 2018 achievements and thank Advantage’s Board of Directors and our shareholders for their support. We look forward to reporting on our progress as our Team continues to advance Advantage’s multi-year liquids development plan. 2018 Operating and Financial Results Summary • Record annual and fourth quarter production of 41,651 boe/d (249.9 mmcfe/d) and 45,686 boe/d (274.1 mmcfe/d), respectively, representing increases of 6% and 12% compared to the same periods of 2017. • Annual liquids production increased 22% to 1,491 bbls/d and generated a 40% increase in liquids revenue over 2017. • Achieved low annual 2018 costs including royalty costs of $0.18/boe, operating costs of $1.80/boe, transportation expenses of $3.36/boe, general and administrative costs of $0.60/boe and finance costs of $0.72/boe. • Annual 2018 cash provided by operating activities of $160 million and adjusted funds flow(a) of $150 million was supported by $59 million market diversification gains (includes realized gains on derivatives and revenue less transportation realized from physical sales arrangements involving Advantage Oil & Gas Ltd. - 3 markets outside of AECO). Advantage’s revenue exposure to AECO daily prices was 22% in 2018 and is anticipated to be 20% in 2019. • Year-end total debt(a) was $273 million resulting in a total debt(a) to adjusted funds flow(a) ratio of 1.8 and an undrawn bank credit facility of $120 million. Strengthened Market Diversification and Hedging On November 1, 2018, Advantage began receiving Midwest U.S. prices on 20,000 mcf/d, increasing to 40,000 mcf/d in April 2019. This arrangement complements our Dawn, Ontario market where we delivered 52,700 mcf/d in 2018. For 2019, Advantage has fixed price hedges on 45% of our estimated natural gas production at an average price of Cdn $2.46/mcf, with 29% of production remaining exposed to AECO. In the summer when prices are anticipated to be more volatile, 52% of estimated natural gas production is hedged at an average price of Cdn $2.13/mcf, with only 19% of production remaining exposed to AECO. Looking Forward As previously communicated (see Advantage press release February 11, 2019) the Corporation’s 2019 net capital expenditures(a) guidance range was reduced to $185 to $215 million from $210 to $240 million as a result of accelerated spending. Our 2019 production guidance range remains between 43,500 and 46,500 boe/d (261 and 279 mmcfe/d). Advantage is planning to invest approximately $65 million through the first quarter of 2019 which is expected to substantially provide the well productivity to achieve our 2019 annual production guidance. Liquids production is forecast to begin increasing through the second quarter as we tie -in new wells at east Glacier and Valhalla. Production from our Pipestone/Wembley asset is target ed to be brought on-stream during the third quarter when third party processing capacity is available. Investment for the remainder of 2019 will be reviewed during the second quarter of 2019. The Corporation has identified capital projects of up to $100 million which could be deferred from our 2019 plan with minimal 2019 production impact. Capital deferrals will be prioritized to minimize impact on the highest-return liquids projects. Advantage will remain diligent in monitoring commodity and industry trend s and respond accordingly to retain a strong balance sheet while advancing our multi-year strategy to increase liquids development. (a) Non-GAAP Measure which may not be comparable to similar non-GAAP measures used by other entities. Please see Advisory for reconciliations to the nearest measure calculated in accordance with GAAP. Advantage Oil & Gas Ltd. - 4 RESERVES Advantage engaged our independent qualified reserves evaluator Sproule Associates Ltd. (“Sproule”) to evaluate our year-end reserves as of December 31, 2018 in accordance with National Instrument 51-101 and the Canadian Oil and Gas Evaluation Handbook. Reserves and production information included herein is stated on a gross working interest basis (before royalty burdens and excluding royalty interests) unless noted otherwise. Certain tables may not add due to rounding. In addition to the information disclosed in this annual report, more detailed information on our oil and gas reserves, including our reserves on a net interest basis (after royalty burdens and including royalty interests) is included in Advantage's Annual Information Form dated February 28, 2019 and is available at www.advantageog.com and www.sedar.com. Highlights – Gross Working Interest Reserves Proved plus probable reserves (mboe) Net Present Value of future net revenue 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 - boe)(2) Bank debt per boe of reserves (proved plus probable) December 31, 2018 432,186 December 31, 2017 413,819 $ 2,169,187 $ 10.54 25.9 2.32 $ 0.63 $ 2,549,991 $ 12.91 27.7 2.23 $ 0.50 (1) Assumes that development of each property will occur, without regard to the likely availability to the Corporation of funding required for that development. (2) Based on 185.942 million Shares outstanding at December 31, 2018 and 185.963 million at December 31, 2017. (3) Based on fourth quarter average production and Corporation interest reserves. Corporation Gross (before royalties) Working Interest Reserves Summary as at December 31, 2018 Light & Medium Crude Oil (mbbl) - 266 2,745 3,011 1,393 4,404 Conventional Natural Gas (mmcf) Natural Gas Liquids (mbbl) Total Oil Equivalent (mboe) 490,850 52,097 1,234,075 1,777,022 583,135 2,360,157 5,974 871 19,038 25,884 8,539 34,423 87,782 9,821 227,462 325,065 107,121 432,186 Proved Developed Producing Developed Non-producing Undeveloped Total Proved Probable Total Proved + Probable (1) Tables may not add due to rounding Advantage Oil & Gas Ltd. - 5 Corporation Net Present Value of Future Net Revenue using Sproule price and cost forecasts(1)(2)(3) ($000) Proved Developed Producing Developed Non-producing Undeveloped Total Proved Probable Total Proved Plus Probable Before Income Taxes Discounted at 0% 10% 15% $ 1,206,385 167,849 2,712,159 4,086,393 2,044,535 $ 6,130,928 $ 778,999 86,014 652,328 1,517,341 651,846 $ 2,169,187 $ 653,677 68,431 336,103 1,058,212 441,686 $ 1,499,898 (1) Advantage's light crude oil and medium crude oil, conventional natural gas and NGL reserves were evaluated using Sproule's product price forecast effective December 31, 2018 prior to interests, debt service charges and general and administrative expenses. It should not be assumed that the future net revenue estimated by Sproule represents the fair market value of the reserves. (2) Assumes that development of each property will occur, without regard to the likely availability to the Corporation of funding required for that development. (3) Future net revenue incorporates management's estimates of required abandonment and reclamation costs, including expected timing such costs will be incurred, associated with all wells (including undrilled wells that have been attributed reserves), facilities and infrastructure. No abandonment and reclamation costs have been excluded. (4) Tables may not add due to rounding Sproule Price Forecasts The net present value of future net revenue at December 31, 2018 was based upon oil, natural gas and natural gas liquids pricing assumptions prepared by Sproule effective December 31, 2018. These forecasts are adjusted for reserves 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: Canadian Light Sweet Crude 40o API ($Cdn/bbl) Alberta AECO-C Natural Gas ($Cdn/mmbtu) Year Henry Hub Natural Gas ($US/mmbtu) Edmonton Propane ($Cdn/bbl) Edmonton Butane ($Cdn/bbl) Edmonton Pentanes Plus ($Cdn/bbl) Exchange Rate ($US/$Cdn) ____________________ ______________________________________________ ____________________________________________________________ _______________________________________________________ __________________________________________________ __________________________________________________ ________________________________________________ _________________________________________________ 2019 2020 2021 2022 2023 2024 2025 75.27 77.89 82.25 84.79 87.39 89.14 90.92 1.95 2.44 3.00 3.21 3.30 3.39 3.49 3.00 3.25 3.50 3.57 3.64 3.71 3.79 30.27 34.51 38.15 39.64 40.62 41.62 42.64 40.91 50.25 56.88 58.01 59.17 60.36 61.56 75.32 80.00 83.75 85.50 87.29 89.11 90.96 0.77 0.80 0.80 0.80 0.80 0.80 0.80 Advantage Oil & Gas Ltd. - 6 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 Corporation’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) 0% 10% 15% Net asset value per Share (1) - December 31, 2017 $ 36.14 $ 12.91 $ 8.82 Present value proved and probable reserves Undeveloped land(2) Working capital and other(3) Bank debt Net asset value - December 31, 2018 $ 6,130,928 22,613 $ 2,169,187 22,613 $ 1,499,898 22,613 39,708 (270,918) 39,708 (270,918) 1,960,590 1,291,301 39,708 (270,918) 5,922,331 Net asset value per Share (1) - December 31, 2018 $ 31.85 $ 10.54 $ 6.94 (1) Based on 185.942 million Shares outstanding at December 31, 2018 and 185.963 million at December 31, 2017. (2) The value of undeveloped land is based on book value. (3) Other is calculated as current and non-current derivative asset less current and non-current derivative liability. Corporation Gross (before royalties) Working Interest Reserves Reconciliation (1) Proved Opening balance December 31, 2017 Extensions Infill Drilling Improved recovery Technical revisions Discoveries Acquisitions Economic factors Production Light & Medium Crude Oil (mbbl) 4 3,011 - - (4) - - - - Conventional Natural Gas (mmcf) 1,698,002 37,170 66,715 - 85,997 - - (22,907) (87,955) Natural Gas Liquids (mbbl) 23,057 1,956 1,304 - 287 - - (176) (544) Total Oil Equivalent (mboe) 306,062 11,162 12,423 - 14,616 - - (3,994) (15,204) Closing balance at December 31, 2018 3,011 1,777,022 25,884 325,065 Advantage Oil & Gas Ltd. - 7 Corporation Gross (before royalties) Working Interest Reserves Reconciliation (continued) Proved Plus Probable Opening balance December 31, 2017 Extensions Infill Drilling Improved recovery Technical revisions Discoveries Acquisitions Economic factors Production Light & Medium Crude Oil (mbbl) 6 4,404 - - (5) - - - - Conventional Natural Gas (mmcf) 2,292,273 51,000 85,127 - 47,473 - - (27,761) (87,955) Natural Gas Liquids (mbbl) 31,768 2,755 1,644 - (1,009) - - (191) (544) Total Oil Equivalent (mboe) 413,819 15,659 15,832 - 6,897 - - (4,817) (15,204) Closing balance at December 31, 2018 4,404 2,360,157 34,423 432,186 (1) Technical revisions accounted for 43% of the total proved reserve additions and 21% of the total proved plus probable reserve additions. Percentage of each category calculated by dividing the technical revisions in the category by the total reserve additions in the same category before production. The technical revisions were a result of stronger well performance than forecasted in the prior year and reserve category changes. Extensions and infill drilling changes were the result of wells drilled in 2018 and economic factor changes were primarily related to lower forecasted prices for natural gas and associated liquids. (2) Tables may not add due to rounding Advantage Oil & Gas Ltd. - 8 Corporation Finding and Development Cost (“F&D”) Corporation 2018 F&D Cost – Gross (before royalties) Working Interest Reserves Including Future Development Capital(1)(2)(3) Capital expenditures ($000) Net change in Future Development Capital ($000) Total capital ($000) Proved $ 203,834 81,206 285,040 Proved Plus Probable $ 203,834 66,049 269,883 Total mboe, end of year Total mboe, beginning of year Production, mboe Reserve additions, mboe 2018 F&D cost ($/boe) 2017 F&D cost ($/boe) Three-year average F&D cost ($/boe) 325,065 306,062 15,204 34,207 $ 8.33 $ 5.88 $ 4.88 432,186 413,819 15,204 33,571 $ 8.04 $ 5.01 $ 3.88 (1) F&D cost is calculated by dividing total capital by reserve additions during the applicable period. Total capital includes both capital expenditures incurred and changes in FDC required to bring the proved undeveloped and probable reserves to production during the applicable period. Reserve additions is calculated as the change in reserves from the beginning to the ending of the applicable period excluding production. (2) The aggregate of the exploration and development costs incurred in the most recent financial year and the change during that year in estimated FDC 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) The change in FDC is primarily from incremental undeveloped locations. Advantage Oil & Gas Ltd. - 9 CONSOLIDATED MANAGEMENT’S DISCUSSION & ANALYSIS The following Management’s Discussion and Analysis (“MD&A”), dated as of February 28, 2019, 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, 2018 and should be read in conjunction with the December 31, 2018 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. This MD&A contains non-GAAP measures and forward-looking information. Readers are advised to read this MD&A in conjunction with both the “Non-GAAP Measures” and “Forward-looking Information and Other Advisories” sections found at the end of this MD&A. Advantage Oil & Gas Ltd. - 10 Financial Highlights($000, except as otherwise indicated)2018201720182017Financial Statement Highlights73,979$ 65,779$ 250,604$ 259,611$ Net income and comprehensive income25,162$ 21,425$ 11,119$ 95,039$ per basic share (2)0.14$ 0.12$ 0.06$ 0.51$ Cash provided by operating activities44,790$ 29,848$ 160,162$ 186,401$ Cash provided by financing activities8,576$ 50,659$ 53,015$ 48,945$ Cash used in investing activities50,723$ 73,591$ 213,734$ 228,430$ Basic weighted average shares (000)185,942 185,963 186,040 185,641 Other Financial HighlightsAdjusted funds flow (1)46,301$ 43,883$ 150,378$ 183,202$ per mcfe1.84$ 1.94$ 1.65$ 2.13$ per basic share (2)0.25$ 0.24$ 0.81$ 0.99$ Net capital expenditures (1)52,000$ 73,723$ 203,834$ 248,774$ Working capital deficit1,912$ 13,808$ 1,912$ 13,808$ Bank indebtedness270,918$ 208,978$ 270,918$ 208,978$ Total debt (1)272,830$ 222,786$ 272,830$ 222,786$ (1) (2) (3) Excludes net sales of natural gas purchased from third parties.Three months endedYear endedDecember 31December 31Based on basic weighted average shares outstanding.Non-GAAP Measure which may not be comparable to similar non-GAAP measures used by other entities. Please see "Non-GAAP Measures". Sales including realized hedging (3) Advantage Oil & Gas Ltd. - 11 Operating Highlights2018201720182017OperatingDaily ProductionNatural gas (mcf/d)262,269 237,780 240,959 228,583 Liquids (bbls/d)1,974 1,227 1,491 1,218 Total mcfe/d274,113 245,142 249,905 235,891 Total boe/d45,686 40,857 41,651 39,315 Average prices (including realized hedging)Natural gas ($/mcf) (2)2.70$ 2.69$ 2.47$ 2.82$ Liquids ($/bbl)49.23$ 60.48$ 62.12$ 54.28$ Operating Netback ($/mcfe)Sales of natural gas and liquids from production2.81$ 2.38$ 2.44$ 2.69$ Net sales of natural gas purchased from third parties (1)- - 0.01 - Realized gains on derivatives0.12 0.53 0.31 0.32 Royalty expense(0.07) (0.07) (0.03) (0.07) Operating expense(0.29) (0.26) (0.30) (0.25) Transportation expense(0.53) (0.50) (0.56) (0.40) Operating netback (1)2.04$ 2.08$ 1.87$ 2.29$ (1) (2) Excludes net sales of natural gas purchased from third parties.Three months endedYear endedDecember 31December 31Non-GAAP Measure which may not be comparable to similar non-GAAP measures used by other entities. Please see "Non-GAAP Measures". Natural Gas and Liquids Sales Higher natural gas production and stronger realized prices resulted in an increase of $15.0 million or 32% to natural gas sales between the three months ended December 31, 2018 and 2017. Liquids sales increased by $2.1 million or 31% over the same period as a result of a 61% increase in production, slightly offset by weaker realized prices. The higher natural gas and liquids sales was offset by lower realized gains on derivatives, resulting in an increase of $8.2 million or 12% to total sales between the three months ended December 31, 2018 and 2017. For the year ended December 31, 2018, Advantage realized a slight decrease of $9.0 million or 3% to total sales compared to the year ended December 31, 2017. The decrease in total sales resulted from lower natural gas sales due to weaker realized prices which were partially offset by higher production. While total sales for 2018 were lower overall, liquids sales and realized gains on derivatives both increased. Liquids production increased 22% and was in conjunction with our increased focus on liquids-rich development. Variances in realized gains on derivatives between the year ended December 31, 2018 and 2017 were due to differences in natural gas prices and the pricing terms of contracts realized during each period (see “Commodity Price Risk Management and Market Diversification”). Production Advantage ramped up production following the completion of our Glacier gas plant expansion project to 400 mmcf/d of raw gas processing capacity including 6,800 bbls/d of liquids extraction capacity, resulting in higher natural gas and liquids production for the three months and year ended December 31, 2018 as compared to 2017. Advantage’s current development plan continues our increased focus on liquids-rich development. Advantage Oil & Gas Ltd. - 12 ($000)2018201720182017Natural gas sales61,917$ 46,950$ 32 %188,528$ 207,623$ (9) %Realized gains on derivatives3,121 12,002 (74) %28,269 27,847 2 %Natural gas sales including derivatives65,038 58,952 10 %216,797 235,470 (8) %Liquids sales8,941 6,827 31 %33,807 24,141 40 %Total (1)73,979$ 65,779$ 12 %250,604$ 259,611$ (3) %(1) Total excludes unrealized gains and losses on derivatives.% change% changeThree months endedDecember 31Year endedDecember 312018201720182017Natural gas (mcf/d)262,269 237,780 10 %240,959 228,583 5 %Liquids (bbls/d)1,974 1,227 61 %1,491 1,218 22 %Total- mcfe/d274,113 245,142 12 %249,905 235,891 6 %- boe/d45,686 40,857 12 %41,651 39,315 6 %Natural gas (%)96%97%96%97%Liquids (%)4%3%4%3%% change% changeThree months endedDecember 31Year endedDecember 31 Commodity Prices and Marketing Weak AECO natural gas prices were realized during the three months and year ended December 31, 2018 due to excess natural gas supply and pipeline constraints within Alberta. In order to offset weak AECO natural gas pricing, Advantage maintains a strategy of physical and financial natural gas price diversification. As part of these diversification efforts, Advantage sold natural gas into the Dawn, Ontario market and the Chicago market, both of which generated higher realized prices as compared to AECO. Advantage’s firm transportation service to Dawn of 52,700 mcf/d is a ten-year commitment that began November 1, 2017 and represents approximately 20% of our natural gas production. The Dawn market has provided the Corporation with additional physical market diversification and exposure to higher prices net of transportation costs since this commitment began. Starting November 1, 2018, Advantage entered into sales arrangements for 20,000 mcf/d at Chicago Citygate prices, net of a fixed differential. Beginning April 2019, Chicago Citygate based sales will increase to 40,000 mcf/d. While Advantage’s realized liquids prices normally trend with fluctuations in WTI oil prices, during the fourth quarter of 2018 our realized liquids prices were significantly impacted by variations in differentials that were experienced by the Canadian industry. Advantage’s current liquids mix is comprised of 68% pentanes and condensate, which have historically attracted higher market prices than other natural gas liquids. Commodity Price Risk Management and Market Diversification The Corporation’s financial results and condition are impacted primarily by the prices received for natural gas and liquids production. Natural gas and liquids prices have fluctuated widely and are determined by supply and demand factors, including available access to pipelines and markets, weather, general economic conditions in natural gas consuming and producing regions throughout North America and political factors. Management has been proactive in entering into derivative contracts for the purposes of reducing cash flow volatility and diversifying price realizations to multiple markets in support of our Montney development plans. Advantage’s Credit Facilities (as defined herein) allow us to enter fixed price derivative contracts up to 75% of total estimated natural gas and liquids production over the first three years and up to 50% over the fourth and fifth years. In addition, the Credit Facilities allow us to enter into basis swap arrangements to any natural gas price point in North America for up to 100,000 MMbtu/day with a maximum term of seven years. Basis swap arrangements do not count against the limitations on hedged production. Advantage Oil & Gas Ltd. - 13 2018201720182017Average Realized PricesNatural gas, excluding hedging ($/mcf)(1)2.57$ 2.15$ 20 %2.14$ 2.49$ (14) %Natural gas, including hedging ($/mcf)(1)2.70$ 2.69$ - %2.47$ 2.82$ (12) %Liquids, excluding and including hedging ($/bbl)49.23$ 60.48$ (19) %62.12$ 54.28$ 14 %Benchmark PricesAECO daily ($/mcf)1.56$ 1.69$ (8) %1.50$ 2.15$ (30) %AECO monthly ($/mcf)1.90$ 1.95$ (3) %1.53$ 2.43$ (37) %Dawn daily ($US/mmbtu)3.78$ 2.87$ 32 %3.13$ 3.10$ 1 %Chicago Citygate ($US/mmbtu)3.62$ 2.92$ 24 %3.05$ 3.04$ - %Henry Hub ($US/mmbtu)3.65$ 2.94$ 24 %3.08$ 3.11$ (1) %WTI ($US/bbl)59.10$ 55.35$ 7 %64.96$ 50.87$ 28 %Exchange rate (US$/CDN$)0.7569 0.7865 (4) %0.7717 0.7712 - %(1) Excludes sales of natural gas purchased from third parties. % change% changeThree months endedDecember 31Year endedDecember 31 Our natural gas production and corresponding derivative contracts resulted in the realization of the following fixed market prices and variable market exposures for 2018: Our natural gas production and corresponding derivative contracts are expected to result in the realization of the following fixed market prices and variable market exposures for 2019: Advantage Oil & Gas Ltd. - 14 Volumes Contracted% of(mmcf/d)(1)Average Minimum PriceProductionAECO fixed price swaps61.1$2.99/mcf25%AECO put option bought20.6$1.42/mcf9%Dawn fixed price swaps33.3US$2.86/mcf14%115.048%AECO physical92.9AECO39%Dawn physical19.4Dawn8%Chicago physical3.3Chicago less US$1.19/mcf1%AECO / Henry Hub basis swaps10.4Henry Hub less US$0.95/mcf4%126.052%Total Natural Gas241.0100%(1)All volumes contracted converted to mcf on the basis of 1 mcf = 1.055056 GJ and 1 mcf = 1 mmbtuJanuary 1 to December 31, 2018Fixed PriceVariable PriceVolumes Contracted% of(mmcf/d)(1)Average Minimum PriceEstimated ProductionAECO fixed price swaps89.0$2.10/mcf35%Dawn fixed price swaps22.9US$2.94/mcf9%111.944%AECO physical75.3AECO30%Dawn physical29.8Dawn12%Chicago physical35.0Chicago less US$1.19/mcf14%140.156%Total Natural Gas (2)252.0100%(1)All volumes contracted converted to mcf on the basis of 1 mcf = 1.055056 GJ and 1 mcf = 1 mmbtu(2)Represents the midpoint of our Guidance for 2019 natural gas volumes (see News Release dated November 1, 2018)January 1 to December 31, 2019Fixed PriceVariable Price A summary of realized and unrealized gains and losses on derivatives for the three months and years ended December 31, 2018 and 2017 are as follows: For the three months and year ended December 31, 2018 and 2017, Advantage recognized realized gains on derivatives due to the settlement of contracts with average derivative contract prices that were above average market prices during the periods. For the three months ended December 31, 2018, Advantage recognized unrealized gains on derivatives resulting from an increase in the fair value of our derivative contracts to a net asset of $41.6 million at December 31, 2018, as compared to a net asset of $18.9 million at September 30, 2018. For the year ended December 31, 2018, Advantage recognized unrealized losses on derivatives resulting from a decrease in the fair value of our derivative contracts to a net asset of $41.6 million at December 31, 2018, as compared to a net asset of $50.8 million at December 31, 2017. The changes to the fair value of our outstanding derivative contracts was primarily attributable to actual cash received from derivative settlements and changes in commodity price assumptions during the periods. The fair value of the net derivative asset or liability is the estimated value to settle the outstanding contracts as at a point in time. As such, unrealized derivative gains and losses do not impact adjusted funds flow 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. Remaining derivative contracts will settle between January 1, 2019 and December 31, 2024. Sales of Natural Gas Purchased from Third Parties Due to a scheduled plant shutdown during the second quarter of 2018, the Corporation purchased natural gas volumes from third parties to satisfy physical delivery commitments. Advantage realized $5.1 million of revenue from the sale of purchased natural gas while the natural gas volumes were purchased for a total of $4.0 million. Transportation expense related to sales of natural gas purchased from third parties is included in transportation expense. Royalty Expense Advantage pays royalties to the owners of mineral rights from which we have leases. The Corporation has mineral leases with provincial governments, individuals and other companies. Our current average royalty rates are determined by various royalty regimes that incorporate factors including well depths, well production rates, and commodity prices. Royalties also include the impact of gas cost allowance (“GCA”) which is a reduction of royalties payable to the Alberta Provincial Government (the “Crown”) to recognize capital and operating expenditures incurred by Advantage in the gathering and Advantage Oil & Gas Ltd. - 15 ($000s)2018201720182017Realized gains on derivatives3,121$ 12,002$ 28,269$ 27,847$ Unrealized gains (losses) on derivatives22,722 17,200 (9,139) 73,305 Gains on derivatives25,843$ 29,202$ 19,130$ 101,152$ Year ended Three months ended December 31December 31($000s)2018201720182017Sales of natural gas purchased from third parties-$ -$ 5,078$ -$ Natural gas purchased from third parties- - (3,967) - Net sales of natural gas purchased from third parties-$ -$ 1,111$ -$ Year ended Three months ended December 31December 312018201720182017Royalty expense ($000)1,654$ 1,575$ 5 %2,583$ 6,387$ (60) % per mcfe0.07$ 0.07$ - %0.03$ 0.07$ (57) %Royalty Rate (percentage of sales of natural gas and liquids from production)2.3 %2.9 %(0.6) %1.2 %2.8 %(1.6) %% change% changeThree months endedDecember 31Year endedDecember 31 processing of the Crown’s share of our natural gas production. The lower royalty expense for the year ended December 31, 2018 compared to the year ended December 31, 2017 was due to lower natural gas prices as well as a $1.1 million refund received during 2018 due to GCA adjustments. Operating Expense Operating expense for the three months and year ended December 31, 2018 increased by 22% to $7.3 million and by 27% to $27.6 million compared to the respective periods of 2017. Higher operating expense incurred during the 2018 periods resulted from increased production and incremental operating costs related to process design changes required for the expansion of our 100% owned Glacier gas plant from 250 to 400 mmcf/d raw gas capability including 6,800 bbls/d of liquids. The expansion increased gas, water and hydrocarbon processing capacity which was made possible by adding additional equipment and plant processes. Additional municipal taxes and carbon tax accounted for 20% of the increase in operating costs. Operating expense per mcfe for the three months and year ended December 31, 2018 was $0.29 and $0.30, respectively. The higher operating costs per mcfe incurred in the 2018 periods were in-line with Advantage’s expectations of cost structure following the commissioning of the Glacier gas plant expansion. Transportation Expense Transportation expense represents the cost of transporting our natural gas and liquids to the sales points, including associated fuel costs. Natural gas transportation expense for 2018 increased in conjunction with Advantage’s participation in TCPL’s Long-Term, Fixed Price service from Empress, Alberta to the Dawn market, which commenced November 1, 2017. Transportation under our firm commitment from AECO to Dawn is approximately $1.10/mcf. Liquids transportation expense increased for the three months and year ended December 31, 2018 predominantly due to higher liquids production. Liquids transportation expense per bbl may vary between periods attributable to local area constraints that can impact the delivery of liquids to a sales point. Advantage Oil & Gas Ltd. - 16 2018201720182017Operating expense ($000)7,262$ 5,967$ 22 %27,593$ 21,729$ 27 % per mcfe0.29$ 0.26$ 12 %0.30$ 0.25$ 20 %% change% changeThree months endedDecember 31Year endedDecember 312018201720182017Transportation expenseNatural gas ($000)11,805$ 10,316$ 14 %45,930$ 30,770$ 49 % per mcf0.49$ 0.29$ 69 %0.52$ 0.37$ 41 %Liquids ($000)1,545$ 1,034$ 49 %4,764$ 3,747$ 27 % per bbl8.51$ 5.92$ 44 %8.75$ 8.43$ 4 %Total transportation expense ($000)13,350$ 11,350$ 18 %50,694$ 34,517$ 47 % per mcfe0.53$ 0.50$ 6 %0.56$ 0.40$ 40 %% change% changeThree months endedDecember 31Year endedDecember 31 Operating Netback Operating netback for the three months ended December 31, 2018 was $51.7 million or $2.04/mcfe. Operating netback per mcfe was comparable to the same period of 2017 with stronger realized natural gas prices primarily offset by lower realized gains on derivatives associated with Advantage’s commodity price risk management program (see “Commodity Price Risk Management and Market Diversification”). Operating netback for the year ended December 31, 2018 was $170.8 million or $1.87/mcfe. Operating netback per mcfe decreased compared to 2017 due to overall weaker AECO realized natural gas prices, partially offset by premium prices realized from delivering production to the Dawn and Chicago markets, although resulting in higher transportation expense associated with accessing the Dawn market (see “Transportation Expense”). General and Administrative Expense General and administrative (“G&A”) expense increased for the three months and year ended December 31, 2018 compared to the same periods in 2017. For 2018, higher costs were due to external consulting costs associated with evaluating marketing and business development opportunities and an increased number of staff. Advantage Oil & Gas Ltd. - 17 $000per mcfe$000per mcfe$000per mcfe$000per mcfe70,858$ 2.81$ 53,777$ 2.38$ 222,335$ 2.44$ 231,764$ 2.69$ - - - - 1,111 0.01 - - 3,121 0.12 12,002 0.53 28,269 0.31 27,847 0.32 (1,654) (0.07) (1,575) (0.07) (2,583) (0.03) (6,387) (0.07) (7,262) (0.29) (5,967) (0.26) (27,593) (0.30) (21,729) (0.25) (13,350) (0.53) (11,350) (0.50) (50,694) (0.56) (34,517) (0.40) 51,713$ 2.04$ 46,887$ 2.08$ 170,845$ 1.87$ 196,978$ 2.29$ (1)Sales of natural gas and liquids from productionRoyalty expenseOperating expenseTransportation expenseOperating netback (1)Net sales of natural gas purchased from third parties (1)Non-GAAP measure which may not be comparable to similar non-GAAP measures used by other entities. Please see "Non-GAAP Measures".Three months endedDecember 31Year endedDecember 312018201720172018Realized gains on derivatives2018201720182017General and administrative expense2,083$ 1,052$ 98 %8,873$ 7,165$ 24 % per mcfe0.08$ 0.05$ 60 %0.10$ 0.08$ 25 % Employees at December 3132 29 10 %% change% changeThree months endedDecember 31Year endedDecember 31 Share Based Compensation Share based compensation represents the expense associated with Advantage’s stock option plan and restricted and performance incentive plan that are designed to provide for long-term compensation to employees and contractors and to align the interests of these individuals with those of shareholders. Share based compensation for the three months and year ended December 31, 2018 was consistent with the comparative periods of 2017. During April 2018, 136,631 Performance Awards matured and were settled with the issuance of 239,791 common shares, while 112,057 Performance Awards matured and were net settled for $0.5 million of cash consideration. As at December 31, 2018, a total of 2.0 million Stock Options and 2.9 million Performance Awards are unexercised which represents 2.7% of Advantage’s total outstanding common shares. Finance Expense Advantage realized higher cash finance expense during the three months and year ended December 31, 2018 compared to the same periods of 2017 primarily due to higher average outstanding bank indebtedness due to lower cash provided by operating activities. Advantage’s interest rates are primarily based on short-term bankers’ acceptance rates plus a stamping fee and determined by total debt to the trailing four quarters Earnings before Interest, Taxes, Depreciation and Amortization (“EBITDA”) ratio as calculated pursuant to our Credit Facilities. During 2018, we expected higher cash finance expense resulting from the higher average bank indebtedness and interest rates as determined by our total debt to EBITDA ratio. Depreciation Expense Depreciation of natural gas and liquids properties is provided on the units-of–production method based on total proved and probable reserves, including future development costs, on a component basis. Depreciation expense for the year ended Advantage Oil & Gas Ltd. - 18 2018201720182017Total share based compensation2,190$ 2,040$ 7 %8,208$ 8,364$ (2) %Capitalized(813) (791) 3 %(3,046) (3,245) (6) %Net share based compensation1,377$ 1,249$ 10 %5,162$ 5,119$ 1 % per mcfe0.05$ 0.06$ (17) %0.06$ 0.06$ - %% change% changeThree months endedDecember 31Year endedDecember 312018201720182017Finance expenseCash expense ($000)3,163$ 1,968$ 61 %10,922$ 6,931$ 58 % per mcfe0.13$ 0.09$ 44 %0.12$ 0.08$ 50 %Accretion expense ($000)236$ 223$ 6 %1,030$ 951$ 8 % per mcfe0.01$ 0.01$ - %0.01$ 0.01$ - %Total finance expense ($000)3,399$ 2,191$ 55 %11,952$ 7,882$ 52 % per mcfe0.14$ 0.10$ 40 %0.13$ 0.09$ 44 %% change% changeThree months endedDecember 31Year endedDecember 312018201720182017Depreciation expense ($000)33,065$ 29,394$ 12 %119,042$ 117,945$ 1 % per mcfe1.31$ 1.30$ 1 %1.31$ 1.37$ (4) %% change% changeThree months endedDecember 31Year endedDecember 31 December 31, 2018 increased as compared to 2017 due to higher production volumes, partially offset by a slightly reduced rate of depreciation expense. Taxes Deferred income taxes arise from differences between the accounting and tax bases of our assets and liabilities. For the three months and year ended December 31, 2018, the Corporation recognized deferred income tax expenses of $9.6 million and $5.8 million as a result of $34.8 million and $17.0 million income before taxes, respectively. As at December 31, 2018, the Corporation had a deferred income tax liability of $78.3 million. Estimated tax pools at December 31, 2018, are as follows: Net Income and Comprehensive Income Advantage recognized net income of $11.1 million for the year ended December 31, 2018. Net income was significantly lower as compared to the year ended December 31, 2017 due primarily to lower realized natural gas prices and an $82.4 million decrease in unrealized gains on derivatives as compared to 2017. Advantage recognized net income of $25.2 million for the three months ended December 31, 2018. Net income was modestly higher during the three months ended December 31, 2018 as compared to the same period of 2017 due to primarily increased production while stronger realized natural gas prices were predominately offset by a reduction in gains on derivatives. Unrealized gains and losses on derivatives are non- cash and can fluctuate greatly between periods from changes to the estimated value to settle outstanding contracts (see “Commodity Price Risk Management and Market Diversification”). Advantage Oil & Gas Ltd. - 19 2018201720182017Deferred income tax expense ($000)9,632$ 8,624$ 12 %5,841$ 37,285$ (84) % per mcfe0.38$ 0.38$ - %0.06$ 0.43$ (86) %% change% changeThree months endedDecember 31Year endedDecember 31($ millions)Canadian Development Expenses210$ Canadian Exploration Expenses66 Canadian Oil and Gas Property Expenses14 Non-capital losses715 Undepreciated Capital Cost284 Capital losses158 Scientific Research and Experimental Development Expenditures33 Other8 1,488$ 2018201720182017Net income and comprehensive income ($000)25,162$ 21,425$ 17 %11,119$ 95,039$ (88) % per share - basic0.14$ 0.12$ 17 %0.06$ 0.51$ (88) % per share - diluted0.13$ 0.11$ 18 %0.06$ 0.50$ (88) %% change% changeThree months endedDecember 31Year endedDecember 31 Cash Provided by Operating Activities and Adjusted Funds Flow For the year ended December 31, 2018, cash provided by operating activities was $160.2 million, a reduction as compared to 2017 due to lower adjusted funds flow as noted below. For the three months ended December 31, 2018, cash provided by operating activities was $44.8 million, an increase as compared to the same 2017 period due to stronger adjusted funds flow as noted below and a reduction in the change in non-cash operating working capital. Advantage’s non-cash working capital can vary significantly depending on the timing and amount of trade payable settlements. For the year ended December 31, 2018, Advantage realized adjusted funds flow of $150.4 million or $0.81/share. Adjusted funds flow for the year ended December 31, 2018 was lower as compared to 2017 primarily due to reduced natural gas sales resulting from weaker AECO natural gas prices. For the three months ended December 31, 2018, Advantage realized adjusted funds flow of $46.3 million or $0.25/share. Advantage realized slightly higher adjusted funds flow for the three months ended December 31, 2018 as compared to the same period of 2017 due to increased production while stronger realized natural gas prices were predominately offset by a reduction in realized gains on derivatives. During 2018, adjusted funds flow has also been positively impacted by our increased focus on liquids-rich development that has increased liquids sales from both higher liquids production and stronger realized liquids prices. Advantage Oil & Gas Ltd. - 20 ($000, except as otherwise indicated)201820172018201744,790$ 29,848$ 160,162$ 186,401$ Expenditures on decommissioning liability1,045 370 1,782 1,190 Changes in non-cash working capital3,629 15,633 (644) 2,542 Finance expense (1)(3,163) (1,968) (10,922) (6,931) 46,301$ 43,883$ 150,378$ 183,202$ Adjusted funds flow per share (2)0.25$ 0.24$ 0.81$ 0.99$ (1)(2)Non-GAAP measure which may not be comparable to similar non-GAAP measures used by other entities. Please see "Non-GAAP Measures".Cash provided by operating activitiesThree months endedDecember 31Year endedDecember 31Finance expense excludes non-cash accretion expense.Adjusted funds flow (2) Contractual Obligations and Commitments The Corporation has contractual obligations in the normal course of operations including purchases of assets and services, operating agreements, transportation and processing commitments, sales contracts and bank indebtedness. 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. Liquidity and Capital Resources The following table is a summary of the Corporation’s capitalization structure: Advantage has a $400 million credit facility of which $120.2 million or 30% was available at December 31, 2018 after deducting letters of credit of US$5 million outstanding (see “Bank Indebtedness, Credit Facilities and Other Obligations”). The Corporation’s adjusted funds flow and bank indebtedness was utilized to fund our capital expenditure program of $203.8 million for the year ended December 31, 2018. With major facilities expenditures in 2018 including the Glacier gas plant expansion and the substantial completion of a new compression and liquids handling hub at Valhalla, Advantage still maintained a strong balance sheet with a total debt to twelve-month trailing adjusted funds flow ratio of 1.8 times as at December 31, 2018. Advantage continues to be focused on maintaining a strong balance sheet, a disciplined commodity Advantage Oil & Gas Ltd. - 21 Total20192020202120222023After 20236.4$ 0.8$ 0.7$ 0.7$ 0.7$ 0.7$ 2.8$ Transportation and processing370.9 49.4 49.3 48.2 46.9 40.4 136.7 - principal273.0 - 273.0 - - - - - interest17.2 11.6 5.6 - - - - 667.5$ 61.8$ 328.6$ 48.9$ 47.6$ 41.1$ 139.5$ (1)AsatDecember31,2018,theCorporation’sbankindebtednesswasgovernedbyacreditfacilityagreementwithasyndicateoffinancialinstitutions.Underthetermsoftheagreement,thefacilityisreviewedsemi-annually,withthenextreviewscheduledinJune2019.Thefacilityisrevolvingandextendibleateachannualreviewforafurther364dayperiodattheoptionofthesyndicate.Ifnotextended,thecreditfacilityisconvertedatthattimeintoaone-yeartermfacility,withtheprincipalpayableattheendofsuchone-yearterm.Managementfullyexpectsthatthefacilitywill be extended at each annual review. Payments due by period($ millions)Building leasesBank indebtedness (1)Total contractual obligationsDecember 31, 2018December 31, 2017270,918$ 208,978$ 1,912 13,808 272,830$ 222,786$ 185,942,141 185,963,186 1.98$ 5.40$ 368,165$ 1,004,201$ 640,995$ 1,226,987$ 1.8 1.2 (1)Total debt is a non-GAAP measure that includes bank indebtedness and working capital deficit. (2)Market capitalizationTotal capitalizationTotal debt to adjusted funds flow (2)Total debt to adjusted funds flow is calculated by dividing total debt by adjusted funds flow for the previous four quarters.Bank indebtedness (non-current)($000, except as otherwise indicated)Working capital deficit Total debt (1)Shares outstandingShares closing market price ($/share) risk management program, a low-cost structure, and substantial available liquidity such that it is well positioned to continue successfully executing our multi-year development plan. Advantage monitors its capital structure and makes adjustments according to market conditions and to meet its objectives given the current outlook of the business and industry in general. The capital structure of the Corporation is composed of working capital, bank indebtedness, and share capital. Advantage may manage its capital structure by issuing new common shares, repurchasing outstanding common shares, obtaining additional financing through bank indebtedness, refinancing current debt, issuing other financial or equity-based instruments, declaring a dividend, or adjusting capital spending. The capital structure is reviewed by Management and the Board of Directors on an ongoing basis. Management of the Corporation’s capital structure is facilitated through its financial and operational forecasting processes. Selected forecast information is frequently provided to the Board of Directors. This continual financial assessment process further enables the Corporation to mitigate risks. The Corporation continues to satisfy all liabilities and commitments as they come due. Shareholders’ Equity Advantage’s common shares are publicly traded on the Toronto Stock Exchange. Advantage voluntarily de-listed its common shares from the New York Stock Exchange effective September 21, 2018 to simplify administrative processes and recognize cost savings. During August 2018, in accordance with sunset clauses associated with past common share conversions, 256,387 common shares were cancelled and $2.0 million of proceeds were recognized as a reduction to deficit. As at December 31, 2018, a total of 2.0 million Stock Options and 2.9 million Performance Awards were unexercised, which represents 2.7% of Advantage’s total outstanding common shares. No Stock Options were exercised during the year ended December 31, 2018. During April 2018, 136,631 Performance Awards matured and were settled with the issuance of 239,791 common shares while 112,057 Performance Awards matured and were net settled for $0.5 million of cash consideration. As at February 28, 2019, Advantage had 185.9 million common shares outstanding. Bank Indebtedness, Credit Facilities and Other Obligations At December 31, 2018, Advantage had bank indebtedness outstanding of $270.9 million, an increase of $61.9 million since December 31, 2017. The increase in bank indebtedness was consistent with the timing and execution of Advantage’s 2018 capital expenditure program. Advantage’s credit facilities have a borrowing base of $400 million that is collateralized by a $1 billion floating charge demand debenture covering all assets of the Corporation and has no financial covenants (the “Credit Facilities”). The borrowing base for the Credit Facilities is determined by the banking syndicate through an evaluation of our reserve estimates based upon their own commodity price assumptions. Revisions or changes in the reserve estimates and commodity prices can have either a positive or a negative impact on the borrowing base. In October 2018, the semi-annual redetermination of the Credit Facilities borrowing base was completed, with no changes to the borrowing base of $400 million, comprised of a $20 million extendible revolving operating loan facility from one financial institution and a $380 million extendible revolving loan facility from a syndicate of financial institutions. The next annual review is scheduled to occur in June 2019. There can be no assurance that the Credit Facilities will be renewed at the current borrowing base level at that time. Advantage’s working capital deficit of $1.9 million as at December 31, 2018 was lower than the working capital deficit at December 31, 2017 due to differences in the timing of capital expenditures and related payments. Our working capital includes items expected for normal operations such as cash and cash equivalents, trade receivables, prepaid expenses, 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 capital development activities. We do not anticipate any problems in meeting future obligations as they become due as they can be satisfied with adjusted funds flow and our available Credit Facilities. Advantage Oil & Gas Ltd. - 22 Cash Used in Investing Activities and Net Capital Expenditures Advantage invested $52.0 million and $203.8 million on property, plant, equipment and exploration and evaluation assets purchases during the three months and year ended December 31, 2018, respectively. For the year ended December 31, 2018 approximately 45% of expenditures were related to infrastructure projects including finishing construction and commissioning of the expansion of our 100% owned Glacier gas plant from 250 to 400 mmcf/d raw gas capability including 6,800 bbls/d of liquids extraction capacity; the construction of our first compressor and liquids handling facility at Valhalla; the installation of a meter station connection to the Alliance Pipeline and the construction of power lines that will allow electricity sales from the Glacier gas plant. The expanded and newly constructed facilities provide current excess capacity for our drilling programs or third-party processing. Advantage’s strategy of owning and operating our own infrastructure has helped us achieve a low cost structure and provides opportunities to diversify our revenue streams. During the year, Advantage drilled 15 wells (including 1 service well) focusing on liquid-rich Montney opportunities across our acreage position. Glacier During the first quarter of 2018, Advantage completed an eight well pad with six of the wells being in the liquids-rich Middle Montney. The six wells delineated all three layers within the Middle Montney and had an average per well test rate and average flowing pressure of 86% and 126%, respectively, higher compared to all of our previously drilled Glacier Middle Montney wells. Average frac count was increased to 34 stages per well which represents a 76% increase over our previous Middle Montney wells. The two Lower Montney wells drilled off of the same pad were flow tested at an average rate that is consistent with the exceptional Lower Montney results that have been achieved in the western portion of Glacier over the past number of drilling programs. In the second half of 2018 completion operations focused on a separate and previously drilled 10 well pad at Glacier which includes 5 liquids-rich Middle Montney wells. Test results from the pad were strong with all wells expected to be on production by the end of the first quarter of 2019. At Glacier, our 2018 completed wells are out-performing Advantage’s average well type curve by 35% after more than 150 days of production. Drilling activity took place in the second half of 2018 and focused on a 10 well Middle Montney pad on the eastern side of Glacier where liquid yields are as high as 80 bbls/mmcf. These wells will be completed in the first quarter of 2019. Advantage Oil & Gas Ltd. - 23 201820172018201729,793$ 44,781$ 97,208$ 143,797$ 20,488 29,272 104,370 97,652 159 (5) 159 118 50,440 74,048 201,737 241,567 1,560 (325) 2,097 7,207 52,000$ 73,723$ 203,834$ 248,774$ Changes in non-cash working capital(464) 661 12,648 (17,098) Capitalized non-cash stock-based compensation(813) (791) (2,748) (3,245) 50,723$ 73,593$ 213,734$ 228,431$ (1)(2)Net capital expenditures excludes change in decommissioning liability.Three months endedDecember 31Year endedDecember 31($000)Drilling, completions and workoversWell equipping and facilitiesOtherExpenditures on property, plant and equipmentExpenditures on exploration and evaluation assetsNet capital expenditures (1)(2)Non-GAAP measure which may not be comparable to similar non-GAAP measures used by other entities. Please see "Non-GAAP Measures".Cash used in investing activities Wembley The Corporation’s Pipestone/Wembley land block consists of 31 net sections (19,840 acres) and is located in a prolific condensate fairway where significant industry drilling successes in multiple layers has occurred. Industry drilling adjacent to our lands have targeted multiple Montney layers with results demonstrating liquids-rich gas accumulations in all layers to date. In 2018, Advantage’s first well in this land block was tested at an average flow rate of 1,312 boe/d consisting of 2.9 mmcf/d of gas and 819 bbls/d of condensate and NGLs. This well is expected to be on-production by the fourth quarter of 2019. Front-end engineering and design work is ongoing for a compressor/liquid handling hub and associated gathering system. Stakeholder consultations is underway in anticipation of securing regulatory approvals later in 2019 with construction planned for the first half of 2020. Valhalla At Valhalla, our new compressor station and liquids hub was constructed and has been commissioned. The facility will increase drawdown of existing wells and provide capacity for future liquids-rich wells, including seven wells that make up our current winter Valhalla program. The facility was designed to handle 40 mmcf/d of raw gas and 2,000 bbls/d of free liquids and is expandable to accommodate future liquids-rich production growth at Valhalla. The majority of major equipment was sourced from surplus equipment resulting from the Glacier gas plant expansion project. Corporate Advantage’s current standing well inventory consists of nineteen total wells. Of these wells, four are tied-in waiting on production; ten are completed; and five are cased waiting to be completed. During 2018, Advantage acquired 17 additional sections of Doig/Montney rights proximal to our existing land holdings. We now hold a total of 206 net sections (131,840 net acres) of Doig/Montney rights with 116 of those net sections outside of Glacier in the Valhalla/Progress/Wembley areas that have potential for liquids-rich and multi-layer development. Advantage Oil & Gas Ltd. - 24 Guidance and Estimates 2018 Guidance Major facilities expenditures in 2018 included the Glacier gas plant expansion to 400 mmcf/d and 6,800 bbls/d of liquids, and the substantial completion of a new compression and liquids handling hub at Valhalla. In addition, certain liquids-rich well operations and capital expenditures that were previously planned for January 2019 were accelerated to December 2018 to capitalize on temporary service discounts and reinforce our production outlook. This resulted in higher net capital expenditures of $204 million for 2018 as compared to our original guidance of $175 million. Adjusted funds flow of $150 million for 2018 was lower than our original guidance range of $175 to $200 million due to weaker natural gas prices than our original guidance estimates. The combination of accelerated capital spending and lower adjusted funds flow resulted in a higher total debt to adjusted funds flow ratio of 1.8 as compared to our original guidance of 1.0 to 1.3. 2019 Guidance With the exception of cash used in investing activities and net capital expenditures for 2019, Advantage’s guidance has not materially changed from the November 1, 2018 Press Release. Advantage’s 2019 cash used in investing activities and net capital expenditures guidance range has been reduced to $185 to $215 million from $210 to $240 million as a result of certain liquids-rich well operations and capital expenditures that were previously planned for January 2019 being accelerated to December 2018. Advantage is planning to invest approximately $65 million through the first quarter of 2019 which is expected to substantially provide the well productivity to achieve our 2019 annual production guidance. Investment for the remainder of 2019 will be reviewed during the second quarter of 2019. The Corporation has identified additional capital projects of up to $100 million which could be deferred from our 2019 plan with minimal 2019 production impacts. Capital deferrals will be prioritized to minimize impact on the highest-return liquids projects. Advantage will remain diligent in monitoring commodity and industry trends and respond accordingly to retain a strong balance sheet while advancing our multi-year strategy to increase liquids development. The Corporation has made no changes to the 2020 and 2021 guidance. Please refer to the “Development Plan Summary Table” per the November 1, 2018 Press Release. Annual Financial Information The following is a summary of selected financial information of the Corporation for the years indicated. Advantage Oil & Gas Ltd. - 25 Year endedYear endedYear endedDec. 31, 2018Dec. 31, 2017Dec. 31, 2016222,335$ 231,764$ 161,933$ Net income (loss) ($000)11,119$ 95,039$ (15,734)$ per share - basic0.06$ 0.51$ (0.09)$ per share - diluted0.06$ 0.50$ (0.09)$ Total assets1,771,197$ 1,691,182$ 1,496,459$ Long term financial liabilities ($000) (2)270,918$ 208,978$ 153,102$ (1)Before royalties and excludes sales of natural gas purchased from third parties.(2)Long term financial liabilities exclude derivative liability, decommissioning liability and deferred income tax liability.Total sales ($000) (1) Quarterly Performance The table above highlights the Corporation’s performance for the fourth quarter of 2018 and for the preceding seven quarters. In the first and second quarters of 2017, Advantage continued to increase production thereby substantially filling the Glacier gas plant processing capacity, consistent with our development plan. Production for the third quarter of 2017 was slightly impacted by TCPL capacity restrictions and planned production decreases due to the ongoing expansion of the Glacier gas plant. Production increased during the fourth quarter of 2017, filling the Glacier gas plant capacity and achieving record production for Advantage at that time. Advantage’s production volumes were reduced during the first and second quarter of 2018 as a result of Glacier gas plant expansion activities, with production increasing significantly in the third and fourth quarters of 2018 following the completion of the expansion to 400 mmcf/d with Advantage achieving a new record production level. Sales and adjusted funds flow were strong during early 2017 in conjunction with continued production growth, low cash costs and gains realized from our commodity risk management program. Sales and adjusted funds flow were weaker in the second half of 2017 as operational achievements were offset by a decline in natural gas prices. As commodity prices strengthened in the first quarter of 2018, both sales and adjusted funds flow recovered briefly but was subsequently followed by weak natural gas prices in the second quarter of 2018, associated with NGTL system maintenance, resulting in a considerable reduction in both sales and adjusted funds flow. Both sales and adjusted funds flow improved during the third and fourth quarters of 2018 largely as a result of higher production, especially increased liquids production with stronger realized prices. From early 2017 to the end of 2018, cash provided by operating activities experienced greater fluctuations than adjusted funds flow due to changes in non-cash working capital, which primarily resulted from the amount and timing of trade payable settlements and accounts receivable collections. Advantage Oil & Gas Ltd. - 26 ($000, except as otherwiseQ4Q3Q2Q1Q4Q3Q2Q1indicated)Daily productionNatural gas (mcf/d)262,269 262,841 205,712 232,456 237,780 219,812 225,844 230,906 Liquids (bbls/d)1,974 1,804 1,067 1,105 1,227 1,395 1,098 1,151 Total (mcfe/d)274,113 273,665 212,114 239,086 245,142 228,182 232,432 237,812 Total (boe/d)45,686 45,611 35,352 39,848 40,857 38,030 38,739 39,635 Average pricesNatural gas ($/mcf)Excluding hedging2.57$ 1.85$ 1.63$ 2.46$ 2.15$ 1.84$ 2.98$ 2.99$ Including realized hedging (2)2.70$ 1.93$ 2.05$ 3.19$ 2.69$ 2.26$ 3.09$ 3.24$ AECO daily1.56$ 1.19$ 1.18$ 2.08$ 1.69$ 1.46$ 2.79$ 2.70$ AECO monthly1.90$ 1.55$ 1.03$ 1.85$ 1.95$ 2.04$ 2.77$ 2.95$ Liquids ($/bbl)Excluding and including hedging49.23$ 67.90$ 72.32$ 66.11$ 60.48$ 46.95$ 57.27$ 53.73$ WTI ($US/bbl)59.10$ 69.75$ 68.05$ 62.91$ 55.35$ 48.15$ 48.24$ 51.71$ 73,979$ 57,928$ 45,319$ 73,378$ 65,779$ 51,706$ 69,169$ 72,957$ Net income (loss)25,162$ (8,852)$ (15,294)$ 10,103$ 21,425$ 13,026$ 18,339$ 42,249$ per share - basic0.14$ (0.05)$ (0.08)$ 0.05$ 0.12$ 0.07$ 0.10$ 0.23$ per share - diluted0.14$ (0.05)$ (0.08)$ 0.05$ 0.11$ 0.07$ 0.10$ 0.22$ 44,790$ 30,786$ 23,681$ 60,905$ 29,848$ 56,661$ 44,382$ 55,510$ 46,301$ 32,035$ 23,160$ 48,882$ 43,883$ 36,722$ 48,625$ 53,972$ (1)Excludes net sales of natural gas purchased from third parties.(2)Excludes unrealized hedging.(3)2017Total sales including realized hedging (1)(2)Cash provided by operating activites2018Adjusted funds flow (3)Non-GAAP measure which may not be comparable to similar non-GAAP measures used by other entities. Please see "Non-GAAP Measures". Although Advantage has generally reported net income, the net losses reported in the second and third quarters of 2018 were primarily due to the recognition of unrealized derivative losses that are non-cash and can fluctuate greatly between periods from changes to the estimated value to settle outstanding contracts (see “Commodity Price Risk Management and Market Diversification”). Net income generated through 2017, the first quarter of 2018 and the fourth quarter of 2018 has been attributable to increased production with strong adjusted funds flow as well as the recognition of unrealized derivative gains resulting from an increase in the fair value of our outstanding derivative contracts (see “Commodity Price Risk Management and Market Diversification”). Despite periods of weak Alberta natural gas prices, Advantage has maintained a strong balance sheet. Advantage’s production growth, low cash costs, strong capital efficiencies and commodity risk management program have achieved long-term profitability despite the natural gas price volatility. 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 natural gas and liquids prices, operating expense, royalty burden changes, and future development costs. Reserve estimates impact net income and comprehensive income through depreciation and impairment of natural gas and liquids properties. The reserve estimates are also used to assess the borrowing base for the Corporation’s Credit Facilities. Revision or changes in the reserve estimates can have either a positive or a negative impact on asset values, net income, comprehensive income and the borrowing base of the Corporation. Management has determined there to be a single cash-generating unit (“CGU”), the Glacier Area, on the basis of its ability to generate independent cash flows, similar reserve characteristics, geographical location, and shared infrastructure, namely a single processing plant owned by Advantage. For purposes of assessment of impairment, Management has allocated all exploration and evaluation assets to the Glacier Area CGU, on the basis of their geographic proximity. Management’s process of determining the provision for deferred income taxes and the provision for decommissioning liability costs and related accretion expense are based on estimates. Estimates used in the determination of deferred income taxes provisions are significant and can include expected future tax rates, expectations regarding the realization or settlement of the carrying amount of assets and liabilities and other relevant assumptions. Estimates used in the determination of decommissioning liability cost provisions and accretion expense are significant and can include proved and probable reserves, future production rates, future commodity prices, future costs, future interest 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 During the year ended December 31, 2018, the Corporation adopted IFRS 9 and IFRS 15. Additional information regarding the adoption of the standards and their impact can be found in the Consolidated Financial Statements for the year ended December 31, 2018. Advantage Oil & Gas Ltd. - 27 Accounting Pronouncements not yet Adopted IFRS 16 Leases applies to annual periods beginning on or after January 1, 2019. Under IFRS 16, lease assets and liabilities will be required to be recognized on the balance sheet for many leases, where the entity is acting as a lessee. The Corporation intends to adopt IFRS 16 using the modified retrospective method. Under this method, comparative asset and liability balances will not be restated as any cumulative effect of applying the standard to prior periods would be adjusted in opening retained earnings. The value of the lease liability at January 1, 2019 will be based on the present value of lease payments remaining to be made as of January 1, 2019 and the lease asset recognized will be equal to the lease liability at the date of transition. The Corporation intends to apply the following adoption expedients: (i) Exemption of short-term leases. A lease is considered to be short term if, at its commencement date, it has a term of 12 months or less. (ii) Exemption of low-value leases. A lease is considered to be low value if the value of its underlying asset(s), when new, is equal to US $5,000 or less. (iii) Application of IFRS 16 to a portfolio of leases with similar characteristics. The Corporation has identified leases and arrangements qualifying as leases under IFRS 16 in which the Corporation is currently a party and which will be subject to the recognition requirements of IFRS 16. The Corporation anticipates the value of lease assets and equivalent lease liabilities to be recognized upon adoption of IFRS 16 to be between $2.5 million and $3.5 million. 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, 2018. 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, 2018, 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 (2013) 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, 2018. 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, 2018 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 Advantage Oil & Gas Ltd. - 28 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. Non-GAAP Measures The Corporation discloses several financial and performance measures in the MD&A that do not have any standardized meaning prescribed under GAAP. These financial and performance measures include “net capital expenditures”, “adjusted funds flow”, “operating netback”, “total debt”, and “net sales of natural gas purchased from third parties”, which should not be considered as alternatives to, or more meaningful than “net income”, “comprehensive income”, “cash provided by operating activities”, “cash used in investing activities”, or individual expenses presented within the consolidated statement of comprehensive income as determined in accordance with GAAP. Management believes that these measures provide an indication of the results generated by the Corporation’s principal business activities and provide useful supplemental information for analysis of the Corporation’s operating performance and liquidity. 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. Net Capital Expenditures Net capital expenditures include total capital expenditures related to property, plant and equipment and exploration and evaluation assets. Management considers this measure reflective of actual capital activity for the period as it excludes changes in working capital related to other periods. Please see the section “Cash Used in Investing Activities and Net Capital Expenditures” for a reconciliation to the nearest measure calculated in accordance with GAAP, cash used in investing activities. Adjusted Funds Flow The Corporation considers adjusted funds flow to be a useful measure of Advantage’s ability to generate cash from the production of natural gas and liquids, which may be used to settle outstanding debt and obligations, and to support future capital expenditures plans. Changes in non-cash working capital are excluded from adjusted funds flow as they may vary significantly between periods and are not considered to be indicative of the Corporation’s operating performance as they are a function of the timeliness of collecting receivables or paying payables. Expenditures on decommissioning liabilities are excluded from the calculation as the amount and timing of these expenditures are unrelated to current production, highly variable and discretionary. Please see the section “Cash Provided by Operating Activities and Adjusted Funds Flow” for a reconciliation to the nearest measure calculated in accordance with GAAP, cash provided by operating activities. Adjusted Funds Flow Per Share Adjusted funds flow per share is comprised of adjusted funds flow descried above, over the Corporation’s total outstanding common shares. Please see the section “Cash Provided by Operating Activities and Adjusted Funds Flow” for a reconciliation to the nearest measure calculated in accordance with GAAP, cash provided by operating activities. Total Debt Total debt is comprised of bank indebtedness and working capital deficit. Total debt provides Management and users with a measure of the Corporation’s indebtedness and expected settlement of net liabilities in the next year. Please see the section “Liquidity and Capital Resources”. Operating Netback Operating netback is comprised of sales revenue, realized gains on derivatives and net sales of natural gas purchased from third parties, net of expenses resulting from field operations, including royalty expense, operating expense and transportation expense. Operating netback provides Management and users with a measure to compare the profitability of field operations between companies, development areas and specific wells. Please see the section “Operating Netback”. Net Sales of Natural Gas Purchased from Third Parties Net sales of natural gas purchased from third parties represents the revenue or loss generated from the sale of natural gas volumes purchased from third parties, after deducting the cost to purchase the volumes. The purchase and sale transactions are non-routine and are considered by Management to be related for performance purposes. Advantage Oil & Gas Ltd. - 29 Conversion Ratio 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 and Other Advisories This MD&A contains certain forward-looking statements and forward-looking information (collectively, "forward-looking statements"), which are based on our current internal expectations, estimates, projections, assumptions and beliefs. These forward-looking statements relate to future events or our future performance. All statements other than statements of historical fact may be forward-looking statements. Forward-looking statements are often, but not always, identified by the use of words such as "seek", "anticipate", "plan", "continue", "estimate", "expect", "may", "will", "project", "predict", "potential", "targeting", "intend", "could", "might", "should", "believe", "would" and similar or related expressions. These statements are not guarantees of future performance. In particular, forward-looking statements included in this MD&A include, but are not limited to, statements about our strategy, plans, objectives, priorities and focus; Corporation's focus on liquids-rich development; the Corporation's hedging activities; terms of the Corporation's derivative contracts, including the timing of settlement of such contracts; effect of fluctuations in commodity prices as compared to valuation assumptions on actual gains or losses realized on cash settlement of derivatives; expectation that carbon tax will be less in subsequent years and the Corporation will benefit from the new methodology going forward; variation of liquids transportation expense and reasons therefor; estimated tax pools; variation in Corporation's non-cash working capital and reasons therefor; future commitments and contractual obligations; terms of the Corporation's credit facilities, including timing of the next review of the credit facilities, the Corporation's expectations regarding extension of Advantage's credit facilities at each annual review; the Corporation’s belief that it is well positioned to successfully execute its multi-year development plan; the Corporation's strategy for managing its capital structure, including the use of equity financing arrangements, share repurchases, obtaining additional financing through bank indebtedness, refinancing current debt, issuing other financial or equity-based instruments, declaring a dividend or adjusting capital spending; the benefits to be derived by the Corporation over the next number of years from the expanded and newly constructed facilities; the Corporation's ability to satisfy all liabilities and commitments and meet future obligations as they become due; the Corporation's drilling and completion plans; the status of stakeholder communications, regulatory approvals and commencing construction, of the compressor/liquid handling hub and associated gathering system at Wembley; the benefits to be derived from the compressor and liquids handling facility at Valhalla; expected 2019 net capital expenditures; the estimated amount of planned investment in the first quarter of 2019 and the results therefrom; timing to review remainder of investment in 2019; ability to defer some capital projects in 2019; the statements under "critical accounting estimates" in this MD&A; and other matters. These forward-looking statements involve substantial known and unknown risks and uncertainties, many of which are beyond our control, including, but not limited to, risks related to changes in general economic, market and business conditions; continued volatility in market prices for oil and natural gas; the impact of significant declines in market prices for oil and natural gas; stock market volatility; changes to legislation and regulations and how they are interpreted and enforced; our ability to comply with current and future environmental or other laws; actions by governmental or regulatory authorities including increasing taxes, regulatory approvals, 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; failure to achieve production targets on timelines anticipated or at all; 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; lack of available capacity on pipelines; delays in timing of completion of the Corporation's Advantage Oil & Gas Ltd. - 30 facility installation at Valhalla and Wembley; delays in obtaining stakeholder and regulatory approvals; the 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: current and future prices of oil and natural gas; that the current commodity price and foreign exchange environment will continue or improve; conditions in general economic and financial markets; effects of regulation by governmental agencies; receipt of required stakeholder and regulatory approvals; 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; availability of pipeline capacity; 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. References in this MD&A to production test rates are useful in confirming the presence of hydrocarbons, however such rates are not determinative of the rates at which such wells will commence production and decline thereafter and are not indicative of long-term performance or of ultimate recovery. Additionally, such rates may also include recovered “load oil” fluids used in well completion stimulation. While encouraging, readers are cautioned not to place reliance on such rates in calculating the aggregate production for Advantage. A pressure-transient analysis or well-test interpretation has not been carried out in respect of all wells. Accordingly, the Corporation cautions that the test results should be considered preliminary. 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. February 28, 2019 Advantage Oil & Gas Ltd. - 31 Independent auditor’s report To the Shareholders of Advantage Oil & Gas Ltd. Our opinion In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, the financial position of Advantage Oil & Gas Ltd. and its subsidiaries (together, the “Company”) as at December 31, 2018 and 2017, and its financial performance and its cash flows for the years then ended in accordance with International Financial Reporting Standards (“IFRS”). What we have audited The Company’s consolidated financial statements comprise:      the consolidated statement of financial position as at December 31, 2018 and 2017; the consolidated statement of comprehensive income for the years then ended; the consolidated statement of changes in shareholders’ equity for the years then ended; the consolidated statement of cash flows for the years then ended; and the notes to the consolidated financial statements, which include a summary of significant accounting policies. Basis for opinion We conducted our audit in accordance with Canadian generally accepted auditing standards. Our responsibilities under those standards are further described in the Auditor’s responsibilities for the audit of the consolidated financial statements section of our report. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Independence We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the consolidated financial statements in Canada. We have fulfilled our other ethical responsibilities in accordance with these requirements. Other information Management is responsible for the other information. The other information comprises the Management’s Discussion and Analysis, which we obtained prior to the date of this auditor’s report and the information, other than the consolidated financial statements and our auditor’s report thereon, included in the annual report, which is expected to be made available to us after that date. Our opinion on the consolidated financial statements does not cover the other information and we do not and will not express an opinion or any form of assurance conclusion thereon. PricewaterhouseCoopers LLP 111-5th Avenue S.W., Suite 3100, Calgary, Alberta, Canada T2P 5L3 T: +1 403 509 7500, F: +1 403 781 1825 “PwC” refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership. In connection with our audit of the consolidated financial statements, our responsibility is to read the other information identified above and, in doing so, consider whether the other information is materially inconsistent with the consolidated financial statements or our knowledge obtained in the audit, or otherwise appears to be materially misstated. If, based on the work we have performed on the other information that we obtained prior to the date of this auditor’s report, we conclude that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report in this regard. When we read the information, other than the consolidated financial statements and our auditor’s report thereon, included in the annual report, if we conclude that there is a material misstatement therein, we are required to communicate the matter to those charged with governance. Responsibilities of management and those charged with governance for the consolidated financial statements Management is responsible for the preparation and fair presentation of the consolidated financial statements in accordance with IFRS, 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. In preparing the consolidated financial statements, management is responsible for assessing the Company’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless management either intends to liquidate the Company or to cease operations, or has no realistic alternative but to do so. Those charged with governance are responsible for overseeing the Company’s financial reporting process. Auditor’s responsibilities for the audit of the consolidated financial statements Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with Canadian generally accepted auditing standards will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these consolidated financial statements. As part of an audit in accordance with Canadian generally accepted auditing standards, we exercise professional judgment and maintain professional skepticism throughout the audit. We also:  Identify and assess the risks of material misstatement of the consolidated financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control. Advantage Oil & Gas Ltd. - 33      Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control. Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management. Conclude on the appropriateness of management’s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Company’s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report to the related disclosures in the consolidated financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause the Company to cease to continue as a going concern. Evaluate the overall presentation, structure and content of the consolidated financial statements, including the disclosures, and whether the consolidated financial statements represent the underlying transactions and events in a manner that achieves fair presentation. Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the Company to express an opinion on the consolidated financial statements. We are responsible for the direction, supervision and performance of the group audit. We remain solely responsible for our audit opinion. We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit. We also provide those charged with governance with a statement that we have complied with relevant ethical requirements regarding independence, and to communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards. The engagement partner on the audit resulting in this independent auditor’s report is Ryan Lundeen. Chartered Professional Accountants Calgary, Alberta February 28, 2019 Advantage Oil & Gas Ltd. - 34 CONSOLIDATED FINANCIAL STATEMENTS Commitments (note 22) 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. - 35 Consolidated Statement of Financial Position(thousands of Canadian dollars)NotesDecember 31, 2018December 31, 2017ASSETSCurrent assetsCash and cash equivalents56,359$ 6,916$ Trade and other receivables628,350 28,678 Prepaid expenses and deposits2,178 1,602 Derivative asset929,593 33,093 Total current assets66,480 70,289 Non-current assetsDerivative asset912,943 17,777 Exploration and evaluation assets722,613 22,143 Property, plant and equipment 81,669,161 1,580,973 Total non-current assets1,704,717 1,620,893 Total assets1,771,197$ 1,691,182$ LIABILITIESCurrent liabilitiesTrade and other accrued liabilities38,799$ 51,004$ Derivative liability994 111 Total current liabilities38,893 51,115 Non-current liabilitiesDerivative liability9822 - Bank indebtedness 10270,918 208,978 Decommissioning liability1150,028 46,913 Deferred income tax liability1278,341 72,500 Total non-current liabilities400,109 328,391 Total liabilities439,002 379,506 SHAREHOLDERS' EQUITYShare capital 132,342,689 2,340,801 Contributed surplus 115,574 110,077 Deficit(1,126,068) (1,139,202) Total shareholders' equity1,332,195 1,311,676 Total liabilities and shareholders' equity1,771,197$ 1,691,182$ See accompanying Notes to the Consolidated Financial Statements Advantage Oil & Gas Ltd. - 36 Consolidated Statement of Comprehensive IncomeNotes20182017RevenuesSales of natural gas and liquids from production16222,335$ 231,764$ Sales of natural gas purchased from third parties175,078 - Royalty expense(2,583) (6,387) Natural gas and liquids revenue224,830 225,377 Gains on derivatives919,130 101,152 Other income188 320 244,148 326,849 ExpensesOperating expense(27,593) (21,729) Transportation expense(50,694) (34,517) Natural gas purchased from third parties17(3,967) - General and administrative expense18(8,873) (7,165) Share based compensation15(5,162) (5,119) Depreciation expense8(119,042) (117,945) Exploration and evaluation expense7- (168) Finance expense19(11,952) (7,882) Gains on foreign exchange95 - (227,188) (194,525) 16,960 132,324 Income tax expense12(5,841) (37,285) 11,119$ 95,039$ 14Basic0.06$ 0.51$ Diluted0.06$ 0.50$ Net income and comprehensive incomeNet income per share(thousands of Canadian dollars, except for per share amounts) Total revenues and other incomeYear endedDecember 31Total expensesIncome before taxes See accompanying Notes to the Consolidated Financial Statements Advantage Oil & Gas Ltd. - 37 Consolidated Statement of Changes in Shareholders' Equity(thousands of Canadian dollars)NotesShare capitalContributed surplusDeficitTotal shareholders' equityBalance, December 31, 20172,340,801$ 110,077$ (1,139,202)$ 1,311,676$ Net income and comprehensive income- - 11,119 11,119 Share based compensation15- 8,208 - 8,208 Settlement of Performance Awards13, 15(b)1,906 (2,711) - (805) Proceeds on share cancellations13- - 2,015 2,015 Share repurchases13(18) - - (18) Balance, December 31, 20182,342,689$ 115,574$ (1,126,068)$ 1,332,195$ (thousands of Canadian dollars)NotesShare capitalContributed surplusDeficitTotal shareholders' equityBalance, December 31, 20162,334,199$ 108,315$ (1,234,241)$ 1,208,273$ Net income and comprehensive income- - 95,039 95,039 Share based compensation15- 8,364 - 8,364 Settlement of Performance Awards13, 15(b)5,374 (5,374) - - Exercise of Stock Options13, 15(a)1,228 (1,228) - - Balance, December 31, 20172,340,801$ 110,077$ (1,139,202)$ 1,311,676$ See accompanying Notes to the Consolidated Financial Statements Advantage Oil & Gas Ltd. - 38 Consolidated Statement of Cash Flows(thousands of Canadian dollars)Notes20182017Operating Activities16,960$ 132,324$ Add (deduct) items not requiring cash:Share based compensation155,162 5,119 Exploration and evaluation expense7- 168 Depreciation expense8119,042 117,945 Unrealized (gains) losses on derivatives99,139 (73,305) Unrealized gains on foreign exchange(449) - Finance expense1911,952 7,882 Settlement of Performance Awards15(b)(506) - Expenditures on decommissioning liability11(1,782) (1,190) Changes in non-cash working capital21644 (2,542) Cash provided by operating activities160,162 186,401 Financing ActivitiesIncrease in bank indebtedness1062,999 56,189 Interest paid(11,981) (7,244) Proceeds on share cancellations132,015 - Share repurchases13(18) - Cash provided by financing activities53,015 48,945 Investing ActivitiesPayments on property, plant and equipment8, 21(211,637) (221,223) Payments on exploration and evaluation assets7(2,097) (7,207) Cash used in investing activities(213,734) (228,430) Net change in cash and cash equivalents(557) 6,916 Cash and cash equivalents, beginning of year6,916 - Cash and cash equivalents, end of year6,359$ 6,916$ Income before taxesYear endedDecember 31 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2018 AND 2017 (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 natural gas and liquids development and production corporation with a significant position in the Montney resource play 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 common shares are listed on the Toronto Stock Exchange under the symbol “AAV”. 2. Basis of preparation (a) Statement of compliance The Corporation prepares its consolidated financial statements in accordance with International Financial Reporting Standards (“IFRS”). The accounting policies applied in these consolidated financial statements are based on IFRS issued and outstanding as of February 28, 2019, 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 9. (c) Functional and presentation currency These consolidated financial statements are presented in Canadian dollars, which is the Corporation’s functional currency. 3. Significant accounting policies The accounting policies set out below have been applied consistently to all years presented in these financial statements and notes. (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. Advantage Oil & Gas Ltd. - 39 3. Significant accounting policies (continued) (b) Basis of consolidation (i) Subsidiaries Subsidiaries are entities controlled by the Corporation. Control exists when the Corporation has power to govern the financial and operating policies of the entity so as to obtain benefits from its activities. 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) Joint arrangements A portion of the Corporation’s natural gas and liquids 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 costs. (c) Financial instruments The Corporation adopted IFRS 9, Financial Instruments, effective January 1, 2018 and the standard was applied retrospectively. Comparative figures have not been restated, in accordance with transitional provisions. The Corporation’s consolidated financial statements were substantially unchanged by the adoption of IFRS 9. On January 1, 2018, the Corporation determined the appropriate classification category and measurement for each of its financial assets and financial liabilities under IFRS 9 and compared each to their original classification and measurement under IAS 39. Under IFRS 9, financial instruments are classified as amortized cost, fair value through other comprehensive income or fair value through profit and loss. No adjustments were made to the carrying amounts of financial instruments as a result of the adoption of IFRS 9. Accounting policy prior to the adoption of IFRS 9 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 assets and 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 as derivatives assets and liabilities measured at fair value. Gains and losses on these instruments are recorded as gains and losses on derivatives in the Consolidated Statement of Comprehensive Income 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. Advantage Oil & Gas Ltd. - 40 3. Significant accounting policies (continued) (c) Financial instruments (continued) Accounting policy after the adoption of IFRS 9 Financial instruments are classified as amortized cost, fair value through other comprehensive income or fair value through profit and loss. A comparison of the Corporation’s classification of each identified financial instrument under IAS 39 and IFRS 9 is provided below: Financial Instrument Measurement Category (IAS 39) Measurement Category (IFRS 9) Cash and cash equivalents Loans and receivables (measured at Amortized cost amortized cost) Trade and other receivables Loans and receivables (measured at amortized cost) Amortized cost Prepaid expenses and deposits Loans and receivables (measured at amortized cost) Amortized cost Derivative asset Fair value through profit and loss Fair value through profit and loss Trade and other accrued liabilities Financial liabilities (measured at amortized cost) Amortized cost Derivative liability Fair value through profit and loss Fair value through profit and loss Bank indebtedness Financial liabilities (measured at amortized cost) Amortized cost Derivative assets and liabilities Derivative instruments executed by the Corporation to manage market risk are classified as fair value through profit and loss and are recorded on the Consolidated Statement of Financial Position as derivatives assets and liabilities measured at fair value. Gains and losses on these instruments are recorded as gains and losses on derivatives in the Consolidated Statement of Comprehensive Income 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. Impairment of Financial Assets IFRS 9 requires the application of an expected credit loss (“ECL”) model to financial assets measured at amortized cost, contract assets and debt investments measured at fair value through other comprehensive income. For the Corporation’s financial assets measured at amortized cost, loss allowances are determined based on the expected credit loss over the asset’s lifetime. ECLs are a probability-weighted estimate of credit losses, considering possible default events over the expected life of a financial asset. ECLs are measured as the present value of all cash shortfalls (i.e. the difference between the cash flows due to the Corporation in accordance with the contract and the cash flows that the Corporation expects to receive) over the life of the financial asset, discounted at the effective interest rate specific to the financial asset. Substantially all of the Corporation’s trade and other receivables are with counterparties with high credit ratings. At December 31, 2018, the average expected credit loss for trade and other receivables was 0.03% and no expected credit loss was recognized. Advantage Oil & Gas Ltd. - 41 3. Significant accounting policies (continued) (d) Property, plant and equipment and exploration and evaluation assets (i) Recognition and measurement Exploration and evaluation costs Pre-license costs are recognized in the Consolidated Statement of Comprehensive Income as incurred. All exploratory costs incurred subsequent to acquiring the right to explore for natural gas and liquids 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 property, plant and equipment, 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. Property, plant and equipment Items of property, plant and equipment, which include natural gas and liquids properties, 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 and share based compensation related to development and production activities, net of any government incentive programs. When significant parts of an item of property, plant and equipment, including natural gas and liquids properties, have different useful lives, they are accounted for as separate items (major components). (ii) Subsequent costs Costs incurred subsequent to development and production that are significant are recognized as natural gas and liquids 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 natural gas and liquids costs generally represent costs incurred in developing proved and probable reserves and producing 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 as incurred. Advantage Oil & Gas Ltd. - 42 3. Significant accounting policies (continued) (d) Property, plant and equipment and exploration and evaluation assets (continued) (iii) Depreciation The net carrying value of natural gas and liquids properties is depreciated using the units-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. (iv) Dispositions Gains and losses on disposal of an item of property, plant and equipment are determined by comparing the proceeds from disposition with the carrying amount of property, plant and equipment and are recognized net within other income (expenses) in the Consolidated Statement of Comprehensive Income. (v) Impairment 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 of disposition. 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 of disposition 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 of disposition is estimated by discounting the expected after-tax cash flows of the CGU at an after-tax discount rate that reflects the risk of the properties in the CGU. 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 CGU 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 as impairment of natural gas and liquids 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. Advantage Oil & Gas Ltd. - 43 3. Significant accounting policies (continued) (d) 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. (e) 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 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 costs related to the Stock Options are recognized as share based compensation expense over the vesting period at fair value. Advantage’s Restricted and Performance Award Incentive Plan provides share based compensation for service providers. Awards granted under this plan may be settled in cash or in shares. As the Corporation generally intends to settle the Awards in shares, the plan is considered and accounted for as “equity-settled”. As compensation expense is recognized, contributed surplus is recorded until the Performance Awards 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. (f) Revenue IFRS 15, Revenue from Contracts with Customers Adoption The Corporation adopted IFRS 15, Revenue from contracts with customers, effective January 1, 2018 and the standard was adopted using the Modified Retrospective approach. The Corporation elected to apply IFRS 15 retrospectively only to contracts that were not completed as at January 1, 2018 and, for modified contracts, elected to evaluate the original contract together with any contract modifications at the date of initial application. The Corporation’s revenue recognition was substantially unchanged by the adoption of IFRS 15 and did not result in an adjustment to the Deficit balance at January 1, 2018. Accounting policy prior to the adoption of IFRS 15 Revenue from the sale of natural gas and liquids is recorded when the significant risks and rewards of ownership of the product is substantially transferred to the buyer. Accounting policy after to the adoption of IFRS 15 The Corporation’s revenue is comprised of natural gas and liquids sales to customers under fixed and variable volume contracts. Revenue is recognized when the Corporation has satisfied its performance obligations which occurs upon the delivery of volumes to the customer. The transaction price used to determine revenue from natural gas and liquids sales is the market price, net of any marketing and fractionation fees for liquids sales as specified in the contract. Payments are normally received from customers within 30 days following the end of the production month. The Corporation’s revenue transactions do not include any financing components. The Corporation does not have any long-term contracts with unfulfilled performance obligations and does not disclose information about remaining performance obligations with an original expected duration of 12 months or less. Advantage Oil & Gas Ltd. - 44 3. Significant accounting policies (continued) (g) Finance expense Finance expense comprises interest expense on bank indebtedness and accretion of the discount on the decommissioning liability. (h) 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 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. (i) Net income per share Basic net income per share is calculated by dividing the net income attributable to common shareholders of the Corporation by the weighted average number of common shares outstanding during the period. Diluted net income per share is determined by adjusting the net income attributable to common shareholders and the weighted average number of common shares outstanding for the effects of dilutive instruments such as Performance Awards and Stock Options granted to service providers using the treasury stock method. (j) Investment tax credits Investment tax credits relating to Scientific Research and Experimental Development claims are considered an income tax credit and are offset against our income tax expense when they become probable of realization. Advantage Oil & Gas Ltd. - 45 3. Significant accounting policies (continued) (k) Accounting Pronouncement not yet Adopted IFRS 16 Leases applies to annual periods beginning on or after January 1, 2019. Under IFRS 16, lease assets and liabilities will be required to be recognized on the balance sheet for many leases, where the entity is acting as a lessee. The Corporation intends to adopt IFRS 16 using the modified retrospective method. Under this method, comparative asset and liability balances will not be restated as any cumulative effect of applying the standard to prior periods would be adjusted in opening retained earnings. The value of the lease liability at January 1, 2019 will be based on the present value of lease payments remaining to be made as of January 1, 2019 and the lease asset recognized will be equal to the lease liability at the date of transition. The Corporation intends to apply the following adoption expedients: (iv) Exemption of short-term leases. A lease is considered to be short term if, at its commencement date, it has a term of 12 months or less. (v) Exemption of low-value leases. A lease is considered to be low value if the value of its underlying asset(s), when new, is equal to US $5,000 or less. (vi) Application of IFRS 16 to a portfolio of leases with similar characteristics. The Corporation has identified leases and arrangements qualifying as leases under IFRS 16 in which the Corporation is currently a party and which will be subject to the recognition requirements of IFRS 16. The Corporation anticipates the value of lease assets and equivalent lease liabilities to be recognized upon adoption of IFRS 16 to be between $2.5 million and $3.5 million. 4. Significant accounting judgments, estimates and assumptions The preparation of consolidated 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. Significant estimates and judgments made in the preparation of the consolidated financial statements are outlined below. (a) Reserves base The natural gas and liquids properties are depreciated on a 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 natural gas and liquids in place, recovery factors and future natural gas and liquids prices. Future development costs are estimated using assumptions as to the number of wells required to produce the reserves, the cost of such wells and associated production facilities and other capital costs. (b) Determination of cash generating unit Management has determined there to be a single CGU (the “Glacier Area”) on the basis of its ability to generate independent cash flows, similar reserve characteristics, geographical location, and shared infrastructure, namely a single processing plant owned by Advantage. For purposes of assessment of impairment, management has allocated all exploration and evaluation assets to the Glacier Area CGU, on the basis of their geographic proximity. Advantage Oil & Gas Ltd. - 46 4. Significant accounting judgements, estimates and assumptions (continued) (c) 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, but are not limited to, incidents of physical damage, deterioration of commodity prices, changes in the regulatory environment, a reduction in estimates of proved and probable reserves, or significant increases to expected costs to produce and transport 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 of disposition. 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. (d) Derivative assets and liabilities 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 market prices as compared to the valuation assumptions. (e) Decommissioning liability Decommissioning costs will be incurred by the Corporation at the end of the operating life 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. (f) Income taxes Income tax laws and regulations are subject to change. Deferred tax liabilities that arise from temporary differences between recorded amounts on the statement of financial position and their respective tax bases will be payable in future periods. The amount of a deferred tax liability is subject to management’s best estimate of when a temporary difference will reverse and expected changes in income tax rates. These estimates by nature involve significant measurement uncertainty. Advantage Oil & Gas Ltd. - 47 5. Cash and cash equivalents Cash at financial institutions earns interest at floating rates based on daily deposit rates. As at December 31, 2018, cash at financial institutions included US$1.9 million (December 31, 2017: US$0.1 million). The Corporation only deposits cash with major financial institutions of high quality credit ratings. 6. Trade and other receivables 7. Exploration and evaluation assets Advantage Oil & Gas Ltd. - 48 December 31, 2018December 31, 2017Cash at financial institutions6,359$ 6,916$ December 31, 2018December 31, 2017Trade receivables25,955$ 25,384$ Receivables from joint venture partners524 1,425 Other1,871 1,869 28,350$ 28,678$ Balance at December 31, 201616,012$ Additions7,207 Lease expiries(168) Transferred to property, plant and equipment (note 8)(908) Balance at December 31, 201722,143$ Additions2,097 Transferred to property, plant and equipment (note 8)(1,627) Balance at December 31, 201822,613$ 8. Property, plant and equipment During the year ended December 31, 2018, Advantage capitalized general and administrative expenditures directly related to development activities of $4.2 million (year ended December 31, 2017 - $4.1 million) and capitalized share based compensation directly related to development activities of $3.0 million (year ended December 31, 2017 - $3.2 million). At December 31, 2018, Advantage included future development costs of $1.7 billion (December 31, 2017 – $1.7 billion) in property, plant and equipment costs subject to depreciation. Advantage Oil & Gas Ltd. - 49 CostNatural gas and liquids propertiesFurniture and equipmentTotalBalance at December 31, 20161,993,684$ 5,648$ 1,999,332$ Additions241,449 118 241,567 Change in decommissioning liability (note 11)6,160 - 6,160 Transferred from exploration and evaluation assets (note 7)908 - 908 Balance at December 31, 20172,242,201$ 5,766$ 2,247,967$ Additions201,577 159 201,736 Change in decommissioning liability (note 11)3,867 - 3,867 Transferred from exploration and evaluation assets (note 7)1,627 - 1,627 Balance at December 31, 20182,449,272$ 5,925$ 2,455,197$ Accumulated depreciationNatural gas and liquids propertiesFurniture and equipmentTotalBalance at December 31, 2016544,790$ 4,259$ 549,049$ Depreciation117,643 302 117,945 Balance at December 31, 2017662,433$ 4,561$ 666,994$ Depreciation118,801 241 119,042 Balance at December 31, 2018781,234$ 4,802$ 786,036$ Net book valueNatural gas and liquids propertiesFurniture and equipmentTotalAt December 31, 20171,579,768$ 1,205$ 1,580,973$ At December 31, 20181,668,038$ 1,123$ 1,669,161$ 9. Financial risk management Financial instruments of the Corporation include cash and cash equivalents, trade and other receivables, prepaid expenses and deposits, trade and other accrued liabilities, bank indebtedness, and derivative assets and liabilities. Cash and cash equivalents, trade and other receivables, prepaid expenses and deposits, trade and other accrued liabilities and bank indebtedness are classified as ‘amortized cost’. As at December 31, 2018, 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. Fair value is determined following a three level hierarchy: Level 1: Quoted prices in active markets for identical assets and liabilities. The Corporation does not have any financial assets or 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. Derivative assets and liabilities are measured at fair value on a recurring basis. For 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 market prices as compared to the valuation assumptions. Level 3: Fair value is determined using inputs that are not observable. Advantage has no assets or liabilities that use level 3 inputs. 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 risk; and • interest rate risk. Advantage Oil & Gas Ltd. - 50 9. Financial risk management (continued) (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 natural gas and liquids marketers and companies with whom we enter into derivative contracts. The maximum exposure to credit risk is as follows: 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 counterparties that diversify risk within the sector. The Corporation’s deposits are 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 market 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 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, 2018, $0.2 million or 0.9% of trade and other receivables are outstanding for 90 days or more (December 31, 2017 - $0.2 million or 0.8% 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. At December 31, 2018 no expected credit loss was recognized. The Corporation’s most significant customer, a Canadian oil and natural gas marketer, accounts for $10.2 million of the trade and other receivables at December 31, 2018 (December 31, 2017 - $19.2 million). Advantage Oil & Gas Ltd. - 51 December 31, 2018December 31, 2017Trade and other receivables28,350$ 28,678$ Deposits1,299 938 Derivative asset42,536 50,870 72,185$ 80,486$ 9. Financial risk management (continued) (b) Liquidity risk The Corporation is subject to liquidity risk attributed from trade and other accrued liabilities and bank indebtedness. Trade and other accrued liabilities are all 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 $400 million credit facility agreements. Although the credit facilities are a source of liquidity risk, the facilities also mitigate 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. To the extent that Advantage enters derivatives to manage market 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 market risk exposures. As such, liquidity risk is mitigated since any losses actually realized are offset by increased cash flows realized from the higher commodity price environment. The timing of cash outflows relating to financial liabilities as at December 31, 2018 and 2017 are as follows: 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 10). Under the terms of the agreements, the facilities are reviewed annually, with the next review scheduled in June 2019. 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. Advantage Oil & Gas Ltd. - 52 December 31, 2018 Less than one year One to three years TotalTrade and other accrued liabilities38,799$ -$ 38,799$ Derivative liability94822916Bank indebtedness- principal- 273,000 273,000 - interest (1)11,649 5,585 17,234 50,542$ 279,407$ 329,949$ Less than one year One to three years Total51,004$ -$ 51,004$ Derivative liability111 - 111 - principal- 210,001 210,001 - interest (1)9,404 4,483 13,887 60,519$ 214,484$ 275,003$ (1)Interest on bank indebtedness was calculated assuming conversion of the revolving credit facility to a one-year term facility at the next annual facility review.December 31, 2017Bank indebtednessTrade and other accrued liabilities 9. Financial risk management (continued) (c) Price risk Advantage’s derivative assets and liabilities are subject to price risk as their fair values are based on assumptions regarding forward market prices. The Corporation enters into non-financial derivatives to manage price risk exposure relative to actual commodity production and does not utilize derivative instruments for speculative purposes. Changes to price assumptions can have a significant effect on the fair value of the derivative assets and liabilities and thereby impact earnings. The estimated impact to net income for the year ended December 31, 2018 resulting from a 10% change to significant price assumptions is as follows: Advantage Oil & Gas Ltd. - 53 Price Assumption $ millions Forward AECO natural gas price2.5$ Forward basis differential between Henry Hub and AECO natural gas prices7.7$ Forward Dawn natural gas price2.2$ 9. Financial risk management (continued) (c) Price risk (continued) The Corporation’s derivative contracts are classified as Level 2 within the fair value hierarchy. As at December 31, 2018, the Corporation had the following derivative contracts in place: Description of Derivative Term Volume Price Natural gas – AECO Fixed price swap Fixed price swap Fixed price swap Fixed price swap Fixed price swap Fixed price swap Fixed price swap Fixed price swap October 2018 to March 2019 October 2018 to March 2019 October 2018 to March 2019 October 2018 to December 2019 November 2018 to March 2019 April 2019 to October 2019 April 2019 to October 2019 April 2019 to October 2019 18,956 mcf/d 18,956 mcf/d 9,478 mcf/d 25,000 mcf/d 9,478 mcf/d 61,608 mcf/d 4,739 mcf/d 18,956 mcf/d Cdn $3.00/mcf Cdn $3.00/mcf Cdn $3.00/mcf Cdn $2.58/mcf Cdn $2.64/mcf Cdn $1.77/mcf Cdn $1.28/mcf (1) Cdn $1.27/mcf (1) Natural gas – Dawn Fixed price swap Fixed price swap November 2018 to March 2019 November 2018 to October 2019 25,000 mcf/d US $3.13/mcf 20,000 mcf/d US $2.87/mcf Natural gas – AECO/Henry Hub Basis Differential Basis swap Basis swap Basis swap Basis swap Basis swap January 2020 to December 2020 January 2020 to December 2024 January 2021 to December 2024 January 2021 to December 2024 January 2021 to December 2024 5,000 mcf/d Henry Hub less US $1.20/mcf 15,000 mcf/d Henry Hub less US $1.20/mcf 5,000 mcf/d Henry Hub less US $1.135/mcf 2,500 mcf/d Henry Hub less US $1.185/mcf 17,500 mcf/d Henry Hub less US $1.20/mcf (1) Contract entered into subsequent to December 31, 2018. Advantage Oil & Gas Ltd. - 54 9. Financial risk management (continued) (c) Price risk (continued) As at December 31, 2018, the fair value of the derivatives outstanding resulted in an aggregate asset of $42.5 million (December 31, 2017 – $50.9 million) and an aggregate liability of $0.9 million (December 31, 2017 – $0.1 million). The fair value of the derivatives has been allocated to current and non-current assets and liabilities based on the expected timing of cash settlements. The table below summarizes realized and unrealized gains (losses) on derivatives recognized in net income. (d) Interest rate risk Interest rate risk is the risk that future cash flows will fluctuate as a result of changes in market interest rates. The 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, 2018, net income and comprehensive income would have changed by $1.8 million (December 31, 2017 - $1.2 million) based on the average debt balance outstanding during the year. Advantage Oil & Gas Ltd. - 55 Year ended Year ended December 31, 2018December 31, 2017Realized gains on derivatives28,269$ 27,847$ Unrealized gains (losses) on derivatives(9,139) 73,305 Gains on derivatives19,130$ 101,152$ 9. Financial risk management (continued) (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, 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, adjusting capital spending, or disposing of assets. The capital structure is reviewed by Management and the Board of Directors on an ongoing basis. Advantage’s capital structure as at December 31, 2018 and 2017 is as follows: Advantage Oil & Gas Ltd. - 56 Bank indebtedness (non-current) (note 10)270,918$ 208,978$ Working capital deficit1,912 13,808 Total debt (1)272,830$ 222,786$ Shares outstanding (note 13)185,942,141 185,963,186 Share closing market price ($/share)1.98$ 5.40$ Market capitalization368,165 1,004,201 Total capitalization640,995$ 1,226,987$ December 31, 2017(1) Total debt is a non-GAAP measure that includes bank indebtedness and working capital deficit. December 31, 2018 10. Bank indebtedness As at December 31, 2018, the Corporation had credit facilities with a borrowing base of $400 million. The Credit Facilities are comprised of a $20 million extendible revolving operating loan facility from one financial institution and a $380 million extendible revolving credit facility from a syndicate of financial institutions. In October 2018, the semi-annual redetermination of the Credit Facilities borrowing base was completed, with no changes to the borrowing base. The revolving period for the Credit Facilities will end in June 2019 unless extended at the option of the syndicate for a further 364 day period. If not extended, the credit facility will be converted at that time into a one-year term facility, with the principal payable at the end of such one-year term. The Credit Facilities are subject to re-determination of the borrowing base semi-annually in October and June of each year, with the next annual review scheduled to occur in June 2019. There can be no assurance that the Credit Facilities will be renewed at the current borrowing base level at that time. The borrowing base is determined based on, among other things, a thorough evaluation of Advantage's reserve estimates based upon the lenders commodity price assumptions. Revisions or changes in the reserve estimates and commodity prices can have either a positive or a negative impact on the borrowing base. In the event that the lenders reduce the borrowing base below the amount drawn at the time of redetermination, the Corporation has 60 days to eliminate any shortfall by repaying amounts in excess of the new re-determined borrowing base. Amounts borrowed under the Credit Facilities bear interest at rates ranging from LIBOR plus 1.5% to 3.5% per annum, and Canadian prime or US base rate plus 0.5% to 2.5% per annum, in each case, depending on the type of borrowing and the Corporation’s debt to Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) ratio. Undrawn amounts under the Credit Facilities bear a standby fee ranging from 0.3375% to 0.7875% per annum, dependent on the Corporation’s debt to EBITDA ratio. Repayments of principal are not required prior to maturity provided that the borrowings under the Credit Facilities do not exceed the authorized borrowing base and the Corporation is in compliance with all covenants, representations and warranties. The Credit Facilities prohibit the Corporation from entering into any fixed price derivative contract, excluding basis swaps, where the term of such contract exceeds five years. Further, the aggregate of such contracts cannot hedge greater than 75% of total estimated natural gas and liquids production over the first three years and 50% over the fourth and fifth years. In addition, the Credit Facilities allow us to enter into basis swap arrangements to any natural gas price point in North America for up to 100,000 MMbtu/day with a maximum term of seven years. Basis swap arrangements do not count against the limitations on hedged production. The Credit Facilities contain standard commercial covenants for credit facilities of this nature. The Corporation did not have any financial covenants at December 31, 2018 and December 31, 2017. All applicable non-financial covenants were met at December 31, 2018 and 2017. Breach of any covenant will result in an event of default in which case the Corporation has 30 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. The Credit Facilities are collateralized by a $1 billion floating charge demand debenture covering all assets. For the year ended December 31, 2018, the average effective interest rate on the outstanding amounts under the facilities was approximately 4.3% (December 31, 2017 – 4.5%). The Corporation had letters of credit of US$5 million outstanding at December 31, 2018 (December 31, 2017 – nil). Advantage Oil & Gas Ltd. - 57 December 31, 2018December 31, 2017Revolving credit facility273,000$ 210,001$ Discount on Bankers Acceptances and other fees(2,082) (1,023) Balance, end of year270,918$ 208,978$ 11. Decommissioning liability The Corporation’s decommissioning liability results from net ownership interests in natural gas and liquids 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 2019 and 2078. A risk-free rate of 2.15% (December 31, 2017 – 2.20%) and an inflation factor of 2.0% (December 31, 2017 – 2.0%) were used to calculate the fair value of the decommissioning liability at December 31, 2018. A reconciliation of the decommissioning liability is provided below: 12. Income taxes The provision for income taxes is as follows: 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: Advantage Oil & Gas Ltd. - 58 Year endedYear endedDecember 31, 2018December 31, 2017Balance, beginning of year46,913$ 40,992$ Accretion expense1,030 951 Property acquisitions- 751 Liabilities incurred1,381 2,175 Change in estimates(760) (2,665) Effect of change in risk-free rate and inflation rate factor3,246 5,899 Liabilities settled(1,782) (1,190) Balance, end of year50,028$ 46,913$ Year ended Year ended December 31, 2018December 31, 2017Current income tax expense-$ -$ Deferred income tax expense5,841 37,285 Income tax expense 5,841$ 37,285$ Year endedYear endedDecember 31, 2018December 31, 2017Income before taxes 16,960$ 132,324$ Combined federal and provincial income tax rates27.00%27.00%Expected income tax expense4,579 35,727 Increase (decrease) in income taxes resulting from:Non-deductible share based compensation2,002 2,261 Other(740) (703) 5,841$ 37,285$ Effective tax rate34.44%28.18% 12. 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: The estimated tax pools available at December 31, 2018 are as follows: The non-capital loss carry forward balances above expire no earlier than 2023. No deferred tax asset has been recognized for capital losses of $158 million (December 31, 2017 – $158 million). Recognition is dependent on the realization of future taxable capital gains. Advantage Oil & Gas Ltd. - 59 Deferred income tax liabilityProperty, plant and equipmentDerivative asset/liabilityOtherTotalBalance at December 31, 2016268,189$ (6,088)$ -$ 262,101$ Charged to income13,522 19,793 - 33,315 Balance at December 31, 2017281,711$ 13,705$ -$ 295,416$ Charged (credited) to income15,193 (2,468) 121 12,846 Balance at December 31, 2018296,904$ 11,237$ 121$ 308,262$ Deferred income tax assetDecommissioning liabilityNon-capital lossesOtherTotalBalance at December 31, 2016(11,073)$ (191,713)$ (24,100)$ (226,886)$ Charged (credited) to income(1,593) 5,268 295 3,970 Balance at December 31, 2017(12,666)$ (186,445)$ (23,805)$ (222,916)$ Charged (credited) to income(877) (6,623) 495 (7,005) Balance at December 31, 2018(13,543)$ (193,068)$ (23,310)$ (229,921)$ Net deferred income tax liabilityBalance at December 31, 201635,215$ Charged to income37,285 Balance at December 31, 201772,500$ Charged to income5,841 Balance at December 31, 201878,341$ Canadian development expenses $ 209,754 Canadian exploration expenses 65,994 Canadian oil and gas property expenses 13,588 Non-capital losses 715,067 Undepreciated capital cost 283,587 Capital losses 157,869 Scientific research and experimental development expenditures 32,506 Other 8,382 1,486,747$ 13. Share capital (a) Authorized The Corporation is authorized to issue an unlimited number of shares without nominal or par value. (b) Issued The Corporation’s common shares are publicly traded on the Toronto Stock Exchange. The Corporation voluntarily de-listed its common shares from the New York Stock Exchange effective September 21, 2018. During August 2018, in accordance with sunset clauses associated with past common share conversions, 256,387 common shares were cancelled and $2.0 million of proceeds were recognized as a reduction to deficit. On March 27, 2018, Advantage commenced an odd-lot share repurchase program for registered and beneficial shareholders of Advantage who owned 99 or fewer common shares. The program was voluntary and allowed odd-lot holders to sell all, but not less than all, of their common shares without incurring brokerage fees. The program expired on June 19, 2018 and 4,449 shares were repurchased under the program for a total of $18 thousand. Advantage Oil & Gas Ltd. - 60 Common SharesAmountBalance at December 31, 2016184,654,333 2,334,199$ 825,359 - - 5,374 Shares issued on exercise of stock options (note 15(a))483,494 - - 1,228 Balance at December 31, 2017 185,963,186 2,340,801$ 239,791 - - 1,906 Share cancellations(256,387) - Share repurchases(4,449) (18) Balance at December 31, 2018185,942,141 2,342,689$ Shares issued on Performance Award settlements (note 15(b))Shares issued on Performance Award settlements (note 15(b))Contributed surplus transferred on Performance Award settlements (note 15(b))Contributed surplus transferred on Performance Award settlements (note 15(b))Contributed surplus transferred on exercise of stock options (note 15(a)) 14. Net income per share The calculations of basic and diluted net income per share are derived from both net income and weighted average shares outstanding, calculated as follows: 15. Share based compensation (a) Stock Option Plan Under the Stock Option Plan, service providers are granted Stock Options 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 valuation model, using weighted average assumptions as follows: Volatility Expected forfeiture rate Dividend rate Risk-free rate 41% 0.98% 0% 1.05% 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, 2018: Advantage Oil & Gas Ltd. - 61 20182017Basic and diluted11,119$ 95,039$ Basic 186,039,947 185,641,050 Stock Options- 389,977 Performance Awards4,892,004 3,545,861 Diluted190,931,951 189,576,888 Net income per shareBasic0.06$ 0.51$ Diluted0.06$ 0.50$ Net incomeWeighted average shares outstandingYear endedDecember 31Stock OptionsWeighted-Average Exercise PriceBalance at December 31, 20163,109,915 5.75$ Exercised(1,085,681) 4.72 Forfeited(18,377) 6.82 Balance at December 31, 20172,005,857 6.30$ Forfeited(16,708) 6.82 Balance at December 31, 20181,989,149 6.29$ 15. Share based compensation (continued) (a) Stock Option Plan (continued) No Stock Options were exercised during the year ended December 31, 2018. (b) Performance Incentive Plan Under the Performance Incentive Plan, service providers can be granted two types of Incentive Awards: Restricted Awards and Performance Awards. As at December 31, 2018, no Restricted Awards have been granted. The following table is a continuity of Performance Awards: During April 2018, 136,631 Performance Awards matured and were settled with the issuance of 239,791 common shares, while 112,057 Performance Awards matured and were net settled for $0.5 million of cash consideration. Share based compensation recognized by plan for the years ended December 31, 2018 and 2017 is as follows: Advantage Oil & Gas Ltd. - 62 Number of Stock Options OutstandingWeighted Average Remaining Contractual Life - YearsWeighted Average Exercise PriceNumber of Stock Options ExercisableWeighted Average Exercise Price $5.87 - $6.81 1,110,009 0.295.87$ 1,110,009 5.87$ $6.82 879,140 1.266.82 879,140 6.82 $5.87 - $6.821,989,149 0.986.29$ 1,989,149 6.29$ Stock Options ExercisableStock Options OutstandingRange of Exercise PricePerformance AwardsBalance at December 31, 20161,327,663 Granted723,676 Settled(402,582) Forfeited(68,458) Balance at December 31, 20171,580,299 Granted1,695,135 Settled(248,688) Forfeited(87,495) Balance at December 31, 20182,939,251 20182017Stock Options57$ 355$ Performance Awards8,151 8,009 Total share based compensation8,208 8,364 Capitalized (note 8)(3,046) (3,245) Net share based compensation expense5,162$ 5,119$ Year ended December 31 16. Sales of natural gas and liquids from production Advantage’s revenue is comprised of natural gas and liquids sales to multiple customers. Revenue from the transfer of natural gas and liquids volumes to customers is recognized at a point of time, when Advantage’s performance obligations are fully satisfied upon transfer of these volumes to customers. For the years ended December 31, 2018 and 2017, revenue realized from natural gas and liquids sales was as follows: 17. Sales of natural gas purchased from third parties During the year ended December 31, 2018, the Corporation purchased natural gas volumes from third parties in order to satisfy physical sales commitments. No natural gas volumes were purchased during the year ended December 31, 2017. 18. General and administrative expense (“G&A”) 19. Finance expense Advantage Oil & Gas Ltd. - 63 20182017Natural gas sales188,528$ 207,623$ Liquids sales33,807 24,141 Sales of natural gas and liquids from production222,335$ 231,764$ Year ended December 3120182017Sales of natural gas purchased from third parties5,078$ -$ Natural gas purchased from third parties(3,967)$ -$ Year ended December 3120182017Salaries, benefits and consultants9,635$ 8,741$ Office rent1,072 1,069 Other2,316 1,432 Total G&A13,023 11,242 Capitalized (note 8)(4,150) (4,077) General and administrative expense8,873$ 7,165$ Year ended December 31 20182017Interest on bank indebtedness (note 10)10,922$ 6,931$ Accretion of decomissioning liability (note 11)1,030 951 Total finance expense11,952$ 7,882$ Year ended December 31 20. Related party transactions Key management compensation The compensation paid or payable to officers and directors is as follows: (1) Represents the grant date fair value of Performance Awards and Stock Options granted. As at December 31, 2018, there is a commitment of $3.4 million (December 31, 2017 - $2.9 million) related to change of control or termination of employment of officers. 21. Supplementary cash flow information Changes in non-cash working capital is comprised of: 22. Commitments At December 31, 2018, Advantage had lease commitments relating to office buildings of $6.4 million (December 31, 2017 - $1.8 million) and transportation commitments of $370.9 million (December 31, 2017 - $384.9 million). The estimated remaining annual minimum payments are as follows: Advantage Oil & Gas Ltd. - 64 20182017Salaries, director fees and short-term benefits3,283$ 2,495$ Share based compensation (1)4,600 4,300 7,883$ 6,795$ December 31 20182017Source (use) of cash:Trade and other receivables777$ (2,373)$ Prepaid expenses and deposits(576) 79 Trade and other accrued liabilities(12,205) 16,850 (12,004)$ 14,556$ Related to operating activities644$ (2,542)$ Related to financing activities- - Related to investing activities(12,648) 17,098 (12,004)$ 14,556$ Year ended December 31201820172018-$ 47,327 201950,250 51,316 202049,929 49,941 202148,885 45,997 202247,628 43,885 202341,107 36,821 2024 and thereafter139,472 111,418 Total commitments377,271$ 386,705$ December 31 ADVISORY This document contains certain forward-looking statements and forward-looking information (collectively, "forward- looking statements"), which are based on our current internal expectations, estimates, projections, assumptions and beliefs. These forward-looking 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 document include, but are not limited to, statements about our strategy, plans, objectives, priorities and focus; Corporation's focus on liquids-rich development; the Corporation's hedging activities; terms of the Corporation's derivative contracts, including the timing of settlement of such contracts; effect of fluctuations in commodity prices as compared to valuation assumptions on actual gains or losses realized on cash settlement of derivatives; expectation that carbon tax will be less in subsequent years and the Corporation will benefit from the new methodology going forward; variation of liquids transportation expense and reasons therefor; estimated tax pools; variation in Corporation's non-cash working capital and reasons therefor; future commitments and contractual obligations; terms of the Corporation's credit facilities, including timing of the next review of the credit facilities, the Corporation's expectations regarding extension of Advantage's credit facilities at each annual review; the Corporation’s belief that it is well positioned to successfully execute its multi-year development plan; the Corporation's strategy for managing its capital structure, including the use of equity financing arrangements, share repurchases, obtaining additional financing through bank indebtedness, refinancing current debt, issuing other financial or equity-based instruments, declaring a dividend or adjusting capital spending; the benefits to be derived by the Corporation over the next number of years from the expanded and newly constructed facilities; the Corporation's ability to satisfy all liabilities and commitments and meet future obligations as they become due; the Corporation's drilling and completion plans; the status of stakeholder communications, regulatory approvals and commencing construction, of the compressor/liquid handling hub and associated gathering system at Wembley; the benefits to be derived from the compressor and liquids handling facility at Valhalla; expected 2019 net capital expenditures; the estimated amount of planned investment in the first quarter of 2019 and the results therefrom; timing to review remainder of investment in 2019; ability to defer some capital projects in 2019; the statements under "critical accounting estimates" in this document; the benefits derived from accelerating certain well operations, market diversification and low cost structure; the capital expenditure acceleration is not anticipated to impact 2019 production guidance; the anticipated timing of when production will increase at east Glacier and Valhalla and the timing of when production from our Pipestone/Wembley assets is to be brought on-stream; Advantage’s 2019 anticipated revenue exposure to AECO daily natural gas prices; and other matters. In addition, statements relating to "reserves" are by their nature forward-looking statements, as they involve the implied assessment, based on certain estimates and assumptions that the reserves described can be profitably produced in the future. The recovery and reserve estimates of Advantage's reserves provided herein are estimates only and there is no guarantee that the estimated reserves will be recovered. Advantage’s actual decisions, activities, results, performance or achievement could differ materially from those expressed in, or implied by, such forward-looking statements and accordingly, no assurances can be given that any of the events anticipated by the forward-looking statements will transpire or occur or, if any of them do, what benefits that Advantage will derive from them. These forward-looking statements involve substantial known and unknown risks and uncertainties, many of which are beyond our control, including, but not limited to, risks related to changes in general economic, market and business conditions; continued volatility in market prices for oil and natural gas; the impact of significant declines in market prices for oil and natural gas; stock market volatility; changes to legislation and regulations and how they are interpreted and enforced; our ability to comply with current and future environmental or other laws; actions by governmental or regulatory authorities including increasing taxes, regulatory approvals, changes in investment or other regulations; changes in tax laws, Advantage Oil & Gas Ltd. - 65 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; failure to achieve production targets on timelines anticipated or at all; changes in commodity prices, currency exchange rates, capital expenditures, reserves or reserves estimates and debt service 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; lack of available capacity on pipelines; delays in obtaining stakeholder and regulatory approvals; the 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 document, in addition to other assumptions identified herein, Advantage has made assumptions regarding, but not limited to: current and future prices of oil and natural gas; that the current commodity price and foreign exchange environment will continue or improve; conditions in general economic and financial markets; effects of regulation by governmental agencies; receipt of required stakeholder and regulatory approvals; 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; availability of pipeline capacity; 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 document 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 document 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. Barrels of oil equivalent (boe) and thousand cubic feet of natural gas equivalent (mcfe) may be misleading, particularly if used in isolation. Boe and mcfe conversion ratios have been calculated using a conversion rate of six thousand cubic feet of natural gas equivalent to one barrel of oil. A boe and mcfe 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. This document contains a number of oil and gas metrics, including operating netback, F&D, reserve life index and reserve replacement which do not have standardized meanings or standard methods of calculation and therefore such measures may not be comparable to similar measures used by other companies and should not be used to make comparisons. Such Advantage Oil & Gas Ltd. - 66 metrics have been included herein to provide readers with additional measures to evaluate the Corporation's performance; however, such measures are not reliable indicators of the future performance of the Corporation and future performance may not compare to the performance in previous periods and therefore such metrics should not be unduly relied upon. Management uses these oil and gas metrics for its own performance measurements and to provide securityholders with measures to compare Advantage's operations over time. Readers are cautioned that the information provided by these metrics, or that can be derived from the metrics presented in this document, should not be relied upon for investment or other purposes. Operating netback is calculated by adding natural gas and liquids sales with realized gains/losses on derivatives and subtracting royalty expense, operating expense and transportation expense. Reserve replacement is calculated by dividing reserves net volume additions by the current annual production and expressed as a percentage. Reserve life index is calculated by dividing the total volume of reserves by the fourth quarter production rate and expressed in years. Reserves per share is calculated as the total volume of reserves divided by the number of common shares issued and outstanding at year end. The recovery and reserve estimates of reserves provided in this annual report are estimates only, and there is no guarantee that the estimated reserves will be recovered. Actual reserves may eventually prove to be greater than, or less than, the estimates provided herein. References in this annual report to short-term production rates are useful in confirming the presence of hydrocarbons, however such rates are not determinative of the rates at which such wells will commence production and decline thereafter and are not indicative of long-term performance, or of ultimate recovery. Additionally, some rates may also include recovered "load oil" fluids used in well completion stimulation. While encouraging, readers are cautioned not to place reliance on such rates in calculating the aggregate production of Advantage. A pressure-transient analysis or well-test interpretation has not been carried out in respect of all wells. Accordingly, the Corporation cautions that the test results should be considered preliminary. Non-GAAP Measures The Corporation discloses several financial and performance measures in the annual report that do not have any standardized meaning prescribed under GAAP. These financial and performance measures include “net capital expenditures”, “adjusted funds flow”, “operating netback”, “total debt”, “net sales of natural gas purchased from third parties” and “capital efficiency” which should not be considered as alternatives to, or more meaningful than “net income”, “comprehensive income”, “cash provided by operating activities”, “cash used in investing activities”, “bank indebtedness” or individual expenses presented within the consolidated statement of comprehensive income as determined in accordance with GAAP. Management believes that these measures provide an indication of the results generated by the Corporation’s principal business activities and provide useful supplemental information for analysis of the Corporation’s operating performance and liquidity. 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. Net Capital Expenditures Net capital expenditures include total capital expenditures related to property, plant and equipment and exploration and evaluation assets. Management considers this measure reflective of actual capital activity for the period as it excludes changes in working capital related to other periods. Please see the section “Cash Used in Investing Activities and Net Capital Expenditures” in the MD&A for a reconciliation to the nearest measure calculated in accordance with GAAP, cash used in investing activities. Adjusted Funds Flow The Corporation considers adjusted funds flow to be a useful measure of Advantage’s ability to generate cash from the production of natural gas and liquids, which may be used to settle outstanding debt and obligations, and to support future capital expenditures plans. Changes in non-cash working capital are excluded from adjusted funds flow as they may vary Advantage Oil & Gas Ltd. - 67 significantly between periods and are not considered to be indicative of the Corporation’s operating performance as they are a function of the timeliness of collecting receivables or paying payables. Expenditures on decommissioning liabilities are excluded from the calculation as the amount and timing of these expenditures are unrelated to current production, highly variable and discretionary. Please see the section “Cash Provided by Operating Activities and Adjusted Funds Flow” in the MD&A for a reconciliation to the nearest measure calculated in accordance with GAAP, cash provided by operating activities. Adjusted Funds Flow Per Share Adjusted funds flow per share is comprised of adjusted funds flow descried above, over the Corporation’s total outstanding common shares. Please see the section “Cash Provided by Operating Activities and Adjusted Funds Flow” in the MD&A for a reconciliation to the nearest measure calculated in accordance with GAAP, cash provided by operating activities. Total Debt Total debt is comprised of bank indebtedness and working capital deficit. Total debt provides Management and users with a measure of the Corporation’s indebtedness and expected settlement of net liabilities in the next year. Please see the section “Liquidity and Capital Resources” in the MD&A. Operating Netback Operating netback is comprised of sales revenue, realized gains on derivatives and net sales of natural gas purchased from third parties, net of expenses resulting from field operations, including royalty expense, operating expense and transportation expense. Operating netback provides Management and users with a measure to compare the profitability of field operations between companies, development areas and specific wells. Please see the section “Operating Netback” in the MD&A. Net Sales of Natural Gas Purchased from Third Parties Net sales of natural gas purchased from third parties represents the revenue or loss generated from the sale of natural gas volumes purchased from third parties, after deducting the cost to purchase the volumes. The purchase and sale transactions are non-routine and are considered by Management to be related for performance purposes. Capital Efficiency Three-year and single year capital efficiency is calculated by dividing total capital development costs for oil and gas activities including drilling, completion, facilities, infrastructure, office and capitalized general and administrative costs (excluding abandonment and reclamation costs, exploration and evaluation costs, and acquisition and disposition related costs and proceeds) by the average production additions of the applicable year to replace base production declines and deliver production growth targets, expressed in $/boe/d. Capital efficiency is considered by management to be a useful performance measure as a common metric used to evaluate the efficiency with which capital activity is allocated to achieve production additions. Additional Information Additional information relating to Advantage can be found on SEDAR at www.sedar.com and the Corporation’s website at www.advantageog.com. Such other information includes the annual information form, the management information circular, press releases, material change reports, material contracts and agreements, and other financial reports. The annual information form will be of particular interest for current and potential shareholders as it discusses a variety of subject matter including the nature of the business, description of our operations, general and recent business developments, risk factors, reserves data and other oil and gas information. March 19, 2019 Advantage Oil & Gas Ltd. - 68  Abbreviations Crude Oil and Natural Gas Liquids Natural Gas barrel barrels natural gas liquids bbl bbls NGLs BOE or boe means barrel of oil equivalent boe/d bbls/d barrels of oil equivalent per day barrels of oil per day Mcf MMcf Mcf/d MMcf/d Mcfe or mcfe mcfe/d MMcfe/d or mmcfe/d MMbtu MMbtu/d thousand cubic feet million cubic feet thousand cubic feet per day million cubic feet per day thousand cubic feet of natural gas equivalent, using the ratio of 6 Mcf of natural gas being equivalent to one bbl of oil thousand cubic feet of natural gas equivalent per day million cubic feet of natural gas equivalent per day million British Thermal Units million British Thermal Units per day Other AECO MM$ WTI Alberta Energy Company's natural gas storage facility located at Suffield, Alberta means millions of dollars means West Texas Intermediate, the reference price paid in U.S. dollars at Cushing, Oklahoma for the crude oil standard grade Advantage Oil & Gas Ltd. - 69 Directors Jill T. Angevine (1)(3) Stephen E. Balog (1)(2)(3) Grant B. Fagerheim (2)(3) Paul G. Haggis (1)(2)(3) Andy J. Mah Ronald A. McIntosh (2)(3) Legal Counsel Burnet, Duckworth and Palmer LLP Transfer Agent Computershare Trust Company of Canada Corporate Office (1) Member of Audit Committee (2) Member of Reserve Evaluation Committee (3) Member of Human Resources, Compensation & 300, 440 – 2nd Avenue SW Calgary, Alberta T2P 5E9 (403) 718-8000 Corporate Governance Committee Contact Us Toll free: 1-866-393-0393 Email: ir@advantageog.com Visit our website at www.advantageog.com Toronto Stock Exchange Trading Symbol AAV Officers Andy J. Mah, President and CEO Mike Belenkie, COO Craig Blackwood, Vice President, Finance and CFO Neil Bokenfohr, Senior Vice President David Sterna, Vice President, Marketing and Commercial 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 The Bank of Tokyo-Mitsubishi UFJ, Ltd., Canada Branch Alberta Treasury Branches Wells Fargo Bank N.A., /Canada Branch Independent Reserve Evaluators Sproule Associates Limited Advantage Oil & Gas Ltd. - 70 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 

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