Positioned for light oil growth
AR 10Early IdentificationCaptureCost Effective Exploitation ofHigh Impact Oil Resource Plays FINANCIAL AND OPERATING SUMMARY
3 MONTHS ENDED DECEMBER 31,
YEARS ENDED DECEMBER 31,
2010
2009
% CHANGE
2010
2009
% CHANGE
Financial highlights
Oil and NGL sales
Natural gas sales
Other revenue
Total oil, natural gas,
and NGL revenue
Funds from operations(1)
Per share basic and diluted ($)
Net loss excluding non-recurring
charges relating to the recapitalization(2)
Net earning (loss)
Per share basic and diluted ($)
Corporate & asset acquisitions
(cash and share consideration)(3)
Capital expenditures
15,014
3,322
208
9,999
2,934
-
18,544
12,933
7,907
0.15
(4,147)
(4,147)
(0.08)
66,239
26,465
5,320
0.32
(21)
(21)
-
-
50%
13%
nm
43%
49%
47,685
30,697
10,029
12,156
213
-
57,927
42,853
25,688
17,492
55%
(17%)
nm
35%
47%
(53%)
0.70
1.05
(33%)
nm
nm
nm
(1,307)
(2,112)
(38%)
(10,326)
(2,112)
(0.28)
(0.13)
389%
115%
nm
188,812
-
nm
5,154
414%
41,996
17,888
135%
Net debt at end of period(4)
46,240
46,902
3%
46,240
46,902
3%
Operating highlights
Production:
Oil and NGL (bbls per day)
Natural gas (mcf per day)
Total (boe per day) (6:1)
Average realized price (excluding hedges):
Oil and NGL ($per bbl)
Natural gas ($ per mcf)
Realized gain (loss) on commodity
contracts ($ per boe)
Netback (excluding hedges) ($ per boe):
2,308
10,182
4,005
70.70
3.55
1,614
6,887
2,762
67.35
4.63
43%
48%
45%
5%
(23%)
1,871
6,930
3,026
69.83
3.96
1,477
6,995
2,643
56.93
4.76
27%
(1%)
14%
23%
(17%)
1.92
0.54
256%
2.53
0.90
181%
Oil, natural gas and NGL sales
50.33
50.90
Royalties
Operating expenses
Transporation expenses
Operating netback
G&A expenses
Interest expense
Corporate netback
(6.43)
(5.77)
(14.87)
(15.60)
(1.72)
27.31
(5.96)
(0.80)
(1.84)
27.69
(4.32)
(2.37)
20.55
21.00
(1%)
11%
(5%)
(7%)
(1%)
38%
(66%)
(2%)
52.45
44.42
(7.35)
(5.23)
(15.25)
(13.52)
(2.20)
27.65
(5.60)
(0.90)
21.15
(2.03)
23.64
(4.03)
(2.11)
17.50
18%
41%
13%
8%
17%
39%
(57%)
21%
(1) Management uses funds from operations (before changes in non-cash working capital and non-recurring recapitalization costs)
to analyze operating performance and leverage. Funds from operations as presented does not have any standardized meaning
prescribed by Canadian GAAP and, therefore, may not be comparable with the calculation of similar measures for other entities.
(2) Excluding the non-recurring recapitalization costs, as well as the increase in stock-based compensation that resulted from the
recapitalization. Please see net income (loss) note.
(3) Please see capital expenditures note.
(4) The Corporation defines net debt as outstanding bank debt plus or minus cash-based working capital.
ABOUT SURGE
Surge Energy Inc. (“Surge” or “the Corporation”) is a light oil focused energy production company with four
core areas of operations throughout Alberta and South West Manitoba/North Dakota. The Company is focused
on building shareholder value by growing per share production, cash flow and reserves. Upon the closing of
Surge’s most recently announced acquisition, expected on May 12, 2011, the Corporation will have: a significant
undeveloped land base of more than 500,000 net acres, internally estimated DPIIP(1) of more than 460 million
barrels (gross) and more than 460 (350 net) oil drilling locations comprised of 85 percent light oil, with the
remainder of the inventory being medium gravity oil.
Surge’s business strategy is as follows:
• Target per share growth by the early identification, capture and cost effective exploitation of high impact oil
resource plays
• Position Surge in early stage oil resource plays that include the following key criteria:
> Significant oil in place per section and low recovery factor to date.
> Vertical well control for predicting horizontal multi-frac production performance.
> Significant undeveloped land.
> Available infrastructure.
> Operatorship and all-season access.
> Compelling economics.
• Apply the Corporation’s proven expertise and experience to build core areas which can deliver top quartile
corporate performance
Maintaining financial and operational flexibility is a key element in Surge’s business model. Surge’s 2011 capital
program is set at $98 million (excluding acquisitions and dispositions) with spending being allocated amongst the
Corporation’s four core operation areas. Surge will be flexible in its capital spending in order to be responsive to its
environment, costs and capital markets.
Surge is pleased with its many achievements during the transformational year of 2010 and is optimistic about
its future given its high quality asset base, large unbooked oil drilling inventory, financial position, solid netbacks
and technical and financial professional expertise. Surge’s common shares trade on the TSX Venture Exchange
under the symbol “SGY.” Surge looks forward to applying for listing of its common shares on the Toronto Stock
Exchange in the fourth quarter of 2011.
(1) Discovered Petroleum Initially In Place (DPIIP) is defined as quantity of hydrocarbons that are estimated to be in place within a known
accumulation, plus those estimated quantities in accumulations yet to be discovered. There is no certainty that it will be economically
viable or technically feasible to produce any portion of this DPIIP except for those identified as proved or probable reserves. There is no
certainty that it will be commercially viable to produce any portion of the resources.
CONTENTS
1 PRESIDENT’S LETTER 6 OPERATIONS REVIEW 16 MD&A 47 FINANCIAL STATEMENTS
50 NOTES TO THE FINANCIAL STATEMENTS 67 CORPORATE INFORMATION
EARLY IDENTIFICATION, CAPTURE, AND COST EFFECTIVE
5,000
4,500
4,000
3,500
3,000
2,500
2,000
1,500
BOE/D
2. MAY 5, 2010
Closed $50
million bought deal
financing
1
2
1. APRIL 13, 2010
Entered into a
reorganization
and investment
agreement
3 JUNE 25, 2010
Re-named the
company “Surge
Energy Inc.” and
changed stock ticker
symbol to “SGY”
4. JULY 9, 2010
Completed the Corinthian oil
resource acquisition and
announced the acquisition of
the remaining 25 percent
unit interest in Waskada
Unit No. 15 in South
West Manitoba
5
4
3
5. JULY 13, 2010
Bank line increased
from $50 to
$80 million
APRIL
MAY
JUNE
JULY
PRESIDENT’S LETTER
STRATEGY, EXECUTION, SUCCESS
We are delighted with Surge’s transformation during 2010 since the recapitalization of Zapata Energy Corporation
on April 13, 2010. Over this brief period, Surge completed two key transactions that positioned the Corporation
for growth in three exciting new light oil resource plays at Valhalla South (Doig), Windfall (Bluesky) and South
West Manitoba (Spearfish). Thanks to our talented team, we were able to commence drilling programs in these
key light oil resource plays before the end of 2010. At year end 2010, Surge had compiled an inventory of more
than 245 gross (220 net) oil drilling locations, increased internally estimated DPIIP to more than 300 million
barrels (gross), increased Proved plus Probable reserves by 114 percent and achieved a year end exit production
rate of more than 4,500 barrels of oil equivalent (boe) per day, a 125 percent increase from approximately 2,000
boe per day shortly after the recapitalization in April 2010.
During 2010, Surge built a strong platform for growth by recruiting 29 key employees and establishing four new
teams: corporate development, exploration and two area asset teams. Our financial stability was also significantly
improved by increasing our bank line from $50 million to $90 million during 2010 and maintaining a year end
debt of only $46 million, excluding the fair value of financial contracts. Surge’s profile was enhanced as a result
of the Corporation’s significant increase in analyst coverage (from zero to nine), trading liquidity and institutional
shareholder base, which grew from virtually none to an estimated 65 percent.
1
Surge Energy Inc. | AR 2010
EXPLOITATION OF HIGH IMPACT OIL RESOURCE PLAYS
6. OCTOBER 20, 2010
Closed $42 million bought
7
deal financing
6
7. NOVEMBER 1, 2010
Completed the Valhalla
South light oil resource
acquisition and increased
the bank line from $80 to
$90 million
8
8. DECEMBER 31, 2010
Exceeded 2010 exit
production guidance
of 4,500 boe/d
(>60% oil and NGLs)
and provided and
operational update on
three of its light oil
resource plays
AUGUST
SEPTEMBER
OCTOBER
NOVEMBER
DECEMBER
5. JULY 13, 2010
Bank line increased
from $50 to
$80 million
DURING 2010, SURGE POSITIONED ITSELF IN
THREE EXCITING NEW LIGHT OIL RESOURCE PLAYS
ACHIEVEMENTS, HIGHLIGHTS AND FORECAST
•
Increased production by 125 percent from approximately 2,000 boe per day shortly after the recapitalization
in April 2010 to a 2010 exit production rate of more than 4,500 boe per day with a forecast to exit 2011 at
7,500 boe per day, with oil and NGL weighting increasing from 60 percent to more than 70 percent.
• Realized an average production rate of 4,005 boe per day in the fourth quarter 2010, a 45 percent increase
as compared to 2009 production rate of 2,762 boe per day with a forecast to grow exit production by
67 percent to 7,500 boe per day in 2011.
• Realized an average production rate of 3,026 boe per day for the year ended December 31, 2010, a
14 percent increase as compared to the 2009 production rate of 2,643 boe per day, with a forecast to
grow production by 98 percent to an average of 6,000 boe per day in 2011.
• More than 80 percent of Surge’s revenue resulted from oil and natural gas liquids production, with less than
20 percent derived from natural gas production.
•
Increased Proved plus Probable reserves by 114 percent from 9.9 million boe at December 31 2009 to
21.2 million boe at December 31, 2010.
”
Surge Energy Inc. | AR 2010
2
“ •
MORE THAN 80 PERCENT OF SURGE’S REVENUE
RESULTED FROM OIL AND NATURAL GAS LIQUIDS PRODUCTION
Increased the Net Present Value discounted at 10 percent Before Tax (NPV10 BT) of Proved plus Probable
reserves by 90 percent from $217 million as at December 31, 2009 to $412 million(1) as at
December 31, 2010.
• Achieved Proved plus Probable Finding and Development (“F&D”) costs of $13.15 per boe, including a
$24.0 million change in Future Development Capital (“FDC”).
• Achieved a F&D recycle ratio for 2010 of 2.1 times.
• Attained a Proved plus Probable Reserve Life Index of 12.9 years based on the Corporation’s estimated 2010
exit production rate of approximately 4,500 boe per day.
• Achieved a Proved plus Probable reserves replacement ratio of 11.2 based on the Corporation’s estimated
2010 average production for the year of 3,026 boe per day.
• Achieved a 100 percent success rate drilling 10 gross (10 net) wells in the fourth quarter 2010; realized a
gross success rate of 91 percent drilling by 22 gross (21.5 net) wells in 2010.
• Executed preparation for 2011 drilling program targeting light oil, which is projected to increase operating
netbacks to approximately $47.00 by the fourth quarter of 2011 based on recent 2011 strip oil and gas prices
and increase light/medium oil weighting to greater than 70 percent.
• Reduced operating expenses per boe by five percent and transportation expenses per boe by seven percent
in the fourth quarter of 2010 as compared to the fourth quarter of 2009, with a forecast to reduce combined
operating and transportation costs by 21 percent to $13.00 per boe in the fourth quarter of 2011.
•
Increased Surge’s operating netback by 17 percent for the year ended December 31, 2010 as compared to
the year ended December 31, 2009 from $23.64 to $27.65 per boe. Surge’s fourth quarter 2011 netback is
forecast to be approximately $47.00 per boe based on recent 2011 strip oil and gas prices and as a result of
the Corporation’s increasing light oil weighting and decreasing costs in 2011.
•
Increased funds from operations by 49 percent to $8.0 million in the fourth quarter of 2010 from
$5.3 million in the fourth quarter of 2009. Increased funds from operations by 47 percent to $25.7 million
in 2010 from $17.5 million in 2009 with a forecast to grow funds from operations by 189 percent to
$75 million in 2011.
(1) The estimated values disclosed do not represent fair market value.
3
Surge Energy Inc. | AR 2010
SURGE’S MANAGEMENT TEAM HAS A SIMPLE
AND WELL DEFINED BUSINESS PLAN
”
BUSINESS STRATEGY
Surge’s management team has a simple and well defined business strategy to achieve per share growth in
production, cash flow and reserves. The business plan focuses on applying our proven expertise and experience
to build core areas which can deliver top quartile corporate performance via the early identification, capture and
cost-effective exploitation of high-impact oil resource plays. Our strategy includes the following principles:
• Significant oil in place and low recovery factor to date.
• Vertical well control for predicting horizontal multi-frac production performance.
• Significant undeveloped land.
• Available infrastructure.
• Operatorship and all-season access.
• Compelling economics.
This business strategy provides Surge with the flexibility to control our future and compete effectively for capital
and assets throughout Western Canada and the Northern US.
CORPORATE GOVERNANCE
Surge’s Board of Directors, working with the management team, strives to ensure that the Corporation’s governance
practices provide effective stewardship and efficient operations in the best interests of the shareholders. The Board,
which functions independently of management, meets frequently to consider a wide range of issues affecting
Surge, including strategic direction, reserves, financial performance, disclosure and compensation. The Board
reviews strategic plans proposed by management, business risks facing the Corporation and management’s
assessment of those risks.
OUTLOOK
Surge’s operational results in the first quarter 2011 have exceeded management’s expectations. The Corporation
continues to implement management’s business plan of targeting per share growth by positioning the Corporation
in high impact oil resource plays with significant oil in place and applying its proven expertise and experience to
build core areas. Surge continues to demonstrate this ability with the recent announcement of its expansion into
North Dakota, where the Corporation significantly strengthened its position in the Spearfish light oil resource
play by adding 205 gross (120 net) light oil horizontal drilling locations on 6,000 net acres of highly prospective
lands. Management estimates DPIIP to be approximately 125 million barrels (gross) within these lands.
Complementing Surge’s light oil resource plays at Valhalla South (Doig), Windfall (Bluesky) and South West
Manitoba/North Dakota (Spearfish) are the low cost, low decline, high rate of return, crude oil assets in South
East Alberta that have considerable secondary recovery potential. The infill drilling and secondary recovery
programs that have been implemented to date provide significant internally generated cash flow and enable
Surge to execute its capital program in each of its core areas.
Surge Energy Inc. | AR 2010
4
“SURGE IS COMMITTED TO DELIVERING TOP QUARTILE
CORPORATE PERFORMANCE AND CREATING VALUE FOR
SHAREHOLDERS BY GROWING RESERVES, CASH FLOW
AND PRODUCTION ON A PER SHARE BASIS
In 2011, Surge will continue to grow the Corporation organically by drilling in each of its core areas, continuing
the development of secondary recovery programs in South East Alberta and by evaluating plans for secondary
recovery pilot programs on its new light oil resource plays. Additionally, the Corporation will continue to make
accretive acquisitions that fit its business plan of positioning Surge in high impact, emerging crude oil resource
plays. Surge is committed to delivering top quartile corporate performance and creating value for shareholders by
growing reserves, cash flow and production on a per share basis. Surge looks forward to applying for listing of its
common shares on the Toronto Stock Exchange in the fourth quarter of 2011.
ACKNOWLEDGEMENTS
I would like to extend a sincere thanks to all Surge employees, management team and Board of Directors, who
continue to work hard to implement the Corporation’s business strategy and who have contributed to our success
over the past eight months. I would also like to extend my thanks to Surge’s shareholders for their support since
our inception. Surge’s success is your success, in 2010 and beyond.
Dan O’Neil
President & CEO
April 15, 2011
5
Surge Energy Inc. | AR 2010
OPERATIONS REVIEW
SURGE OPERATING AREAS
2010 Exit Production:
>4,500 boe/d (60% light/medium oil and NGLs)
2011 Exit Production Guidance
>7,500 boe/d (>70% light/medium oil and NGLs)
Net Undeveloped Land:
>400,000 acres
Current Oil Drilling Locations:
>350 gross (>265 net): 100% oil
1. VALHALLA SOUTH, WESTERN ALBERTA
• Horizontal multi-frac light oil (40 degree API) resource play property targeting the Doig Formation.
• Operated property with an average of 82 percent working interest, all-season access and a net land position
of approximately 8,600 acres.
• Up to 50 metres of gross pay in the Triassic Doig Formation.
• Located in North Western Alberta, approximately 40 kilometres west of Grande Prairie.
• Significant vertical well control, yielding lower risk inventory.
•
Internally estimated discovered petroleum initially in place (DPIIP) of approximately 115 million barrels
(mmbbls) gross.
• Average DPIIP per section of 16 mmbbls at a 0.1 millidarcies (mD) cutoff with an estimated current recovery
factor of less than three percent.
•
Internally estimated 25 gross (18.3 net) horizontal multi-frac development locations with only five gross
(3.75 net) horizontal multi-frac locations booked.
• 3-D seismic covering entire pool.
2. WINDFALL, WESTERN ALBERTA
• Horizontal multi-frac light oil (36 degree API) resource play property targeting the Bluesky Formation.
• Operated property with an average working interest of 100 percent, all-season access and a net land.
position of approximately 12,700 acres.
• Up to 16 metres of gross pay in the Bluesky light oil pool.
• Located in Western Alberta near Whitecourt.
• Vertical well control, yielding lower risk inventory.
•
Internally estimated DPIIP of approximately 55 mmbbls (gross).
• Average DPIIP per section of 4.4 mmbbls at a 0.1 mD cutoff with an estimated current recovery factor of
less than one percent.
•
Internally estimated 28 gross (28 net) horizontal multi-frac development locations with only seven gross
(seven net) horizontal multi-frac locations booked.
• The Corporation upgraded its battery facility and constructed additional flow lines during the first
quarter of 2011.
• 3-D seismic data covering entire pool.
Surge Energy Inc. | AR 2010
6
1
ALBERTA
2
3. SILVER LAKE/SOUNDING LAKE/
GOOSEBERRY/LEELA, SOUTH EAST ALBERTA
• Multi-zone medium oil property (22-25 degree API).
• Operated and owned property with an average working
interest of 90 percent on greater than 76,000 net acres
of undeveloped land, recently expanded infrastructure
and all-season access.
• Low decline rates of approximately 15 percent.
• Reliable, predictable, and stable oil production with significant
enhanced oil recovery potential.
•
Internally estimated DPIIP of approximately 26 mmbbls (gross).
• Potentially 2 to 5 mmbbls DPIIP per section at a 0.1 mD cutoff with
an estimated recovery factor of less than five percent.
•
Internally estimated 40 gross (40 net) development locations with 20 gross
(20 net) locations booked.
• Operates seven oil batteries and an oil blending facility.
SASKATCHEWAN
Edmonton
3
Calgary
Regina
MANITOBA
Winnipeg
4
5
4. WASKADA/PIERSON/GOODLANDS, SOUTH WEST MANITOBA
• Horizontal multi-frac light oil (34 degree API) targeting the Lower Spearfish/Amaranth
Formation.
• Operated property with 90 percent working interest, all-season access and a net land position of
approximately 4,500 acres.
• Up to 35 metres of gross pay in the Spearfish/Lower Amaranth Formation.
• Located in South West Manitoba.
• Significant vertical well control, yielding lower risk inventory.
•
Internally estimated DPIIP of approximately 76 mmbbls (gross) at Waskada.
• Average DPIIP per section of 15 mmbbls at a 0.1 mD cutoff with an estimated current recovery factor of less
than one percent at Waskada.
•
Internally estimated 124 gross (111 net) horizontal multi-frac development locations, primarily at Waskada
with only 12 gross (12 net) horizontal multi-frac locations booked.
7
Surge Energy Inc. | AR 2010
1
ALBERTA
2
Edmonton
3
Calgary
SASKATCHEWAN
Regina
MANITOBA
Winnipeg
4
5
5. NORTH DAKOTA
• Horizontal multi-frac light oil (36 degree API).
• Approximately 6,000 net undeveloped acres of highly prospective lands for Spearfish development.
• Located adjacent to the Canada/US border.
•
Internally estimated DPIIP of more than 125 mmbbls (gross) at a 0.1mD cutoff with an estimated current
recovery factor of less than one percent.
•
Internally estimated 205 gross (120 net) horizontal multi-frac development locations.
• Additional 100,000 net undeveloped acres that have potential for Spearfish, Basal Spearfish and
Madison development.
Surge Energy Inc. | AR 2010
8
350 GROSS (265 NET) UNBOOKED, HIGH RATE OF
RETURN OIL DRILLING LOCATIONS
“SURGE CURRENTLY HAS AN INVENTORY OF MORE THAN
DRILLING ACTIVITY
In 2010 Surge achieved a success rate of 86 percent drilling 22 (21.5 net) wells, resulting in a fourth quarter
2010 average production rate of 4,005 barrels of oil equivalent (boe) per day, an increase of 77 percent over
the second quarter 2010 average production rate of 2,258 boe per day. The new management team recapitalized
the Corporation during the second quarter of 2010. The 2010 capital program resulted in Proved plus Probable
reserve growth of 114 percent.
EXPLORATORY WELLS
DEVELOPMENT WELLS
TOTAL WELLS
SUCCESS RATE
GROSS
NET
GROSS
NET
GROSS
NET
NET
Valhalla South
Windfall
Waskada
SE Alberta & Other
Total
-
-
-
2
2
-
-
-
2
2
-
3
5
12
20
-
3
5
11.5
19.5
-
3
5
14
22
-
3
5
-
3
5
WI %
-
100%
100%
13.5
21.5
11.5
85.19%
19.5
91.00%
FUTURE DRILLING LOCATIONS
Surge currently has an inventory of more than 350 gross unbooked (265 net), high rate of return, oil drilling
locations and will have more than 460 gross (350 net) oil drilling locations in inventory post the closing of the
North Dakota acquisition expected for May 12, 2011. The table below outlines Surge’s future drilling locations
post the North Dakota acquisition expected for May 12, 2011:
PROPERTY
GROSS
NET
LOCATIONS
BOOKED
UNBOOKED
LOCATIONS
BOOKED
UNBOOKED
25
124
205
28
72
454
5
12
0
7
27
51
20
112
205
21
45
403
18.3
111
120
28
70
347.3
3.8
12
0
7
25.3
48.1
14.6
99
120
21
44.7
299.3
Valhalla South
South West Manitoba
North Dakota
Windfall
South East Alberta
Total
PRODUCTION
Surge’s production since the recapitalization during the second quarter of 2010 is outlined on the following table:
Oil and NGLs (bbls per day)
Natural gas (mcf per day)
Total (boe per day)
% Oil and NGLs
2010
1,871
6,930
3,026
62
2009
1,475
6,995
2,641
56
Q4 2010
2,308
10,182
4,005
58
Q3 2010
1,841
7,783
3,138
59
Q2 2010
1,621
3,823
2,258
72
9
Surge Energy Inc. | AR 2010
SURGE HAS GROWN PRODUCTION
IN EACH SUCCESSIVE QUARTER
”
Surge has grown production in each successive quarter since the recapitalization in April 2010. The fourth
quarter 2010 average production rate of 4,005 boe per day represents an increase of 77 percent over the second
quarter 2010 average production rate of 2,258 boe per day. Surge is forecasting a 2011 average production rate
of 6,000 boe/d (greater than 70 percent light/medium oil and NGLs) and an exit production rate of 7,500 boe/d
(greater than 70 percent light/medium oil and NGLs).
RESERVES
In accordance with National Instrument 51-101 – Standards of Disclosure for Oil and Gas Activities, Sproule
& Associates of Calgary, Alberta (“Sproule”) prepared a reserves report (the “Sproule Report”) that evaluated,
as at December 31, 2010, the oil, natural gas liquids (NGLs) and natural gas reserves attributable to Surge’s
properties. The Sproule Report is dated February 25, 2011.
During 2010, Surge added 12.4 thousand barrels of oil equivalent (mboe) of high quality oil and gas Proved plus
Probable reserves via total capital expenditures of approximately $231 million, which resulted in the following
at year end 2010:
• Proved plus Probable reserves growth to 21.2 million boe, a 114 percent increase over year end 2009.
• Proved plus Probable oil and NGLs reserves growth to 12.4 million boe, a 112 percent increase over
year end 2009.
• Proved plus Probable finding and development costs (F&D), including a $24 million change in Future
Development Capital (FDC) of $13.15 per boe.
• A recycle ratio of 2.1 times based on a netback of $27.65 per boe and F&D costs of $13.15, including the
$24.0 million change in FDC.
• Proved plus Probable Reserve Life Index of 12.9 years based on the Corporation’s estimated 2010 exit
production rate of approximately 4,500 boe per day.
• Proved plus Probable reserves replacement ratio of 11.2 based on the Corporation’s estimated 2010 average
production for the year of 3,026 boe per day.
• An estimated Net Asset Value (NAV) of $7.30 per basic share and $7.18 per fully diluted share at
December 31, 2010 based on the net present value (discounted 10 percent before tax) value of
Proved plus Probable reserves.
The tables below are a summary of the oil, NGL and natural gas reserves attributable to the Corporation’s
properties and the net present value of future net revenue attributable to such reserves as evaluated in the
Sproule Report based on forecast price and cost assumptions. The tables summarize the data contained in the
Sproule Report and, as a result, may contain slightly different numbers than such report due to rounding. Also
due to rounding, certain columns may not add exactly.
The net present value of future net revenue attributable to reserves is stated without provision for interest costs
and general and administrative costs, but after providing for estimated royalties, production costs, development
costs, other income, future capital expenditures and well abandonment costs for only those wells assigned
reserves by Sproule. It should not be assumed that the undiscounted or discounted net present value of future
net revenue attributable to reserves estimated by Sproule represent the fair market value of those reserves. Other
Surge Energy Inc. | AR 2010
10
assumptions and qualifications relating to costs, prices for future production and other matters are summarized
herein. The recovery and reserve estimates of oil, NGLs and natural gas reserves provided herein are estimates
only. Actual reserves may be greater than or less than the estimates provided herein.
SUMMARY OF OIL AND NATURAL GAS RESERVES – FORECAST PRICES AND COSTS
GROSS RESERVES
LIGHT AND
MEDIUM
CRUDE OIL
HEAVY
CRUDE OIL
NATURAL
GAS LIQUIDS
NATURAL
GAS
NET RESERVES
LIGHT AND
MEDIUM
CRUDE OIL
HEAVY
CRUDE OIL
NATURAL
GAS LIQUIDS
NATURAL
GAS
(MBBLS)
(MBBLS)
(MBBLS)
(MMCF)
(MBBLS)
(MBBLS)
(MBBLS)
(MMCF)
2,624.3
1,924.5
388.3 19,992.0 2,263.6
1,585.9
259.9 17,920.0
526.2
44.4
138.8
6,859.0
447.1
37.6
92.6
5,868.0
Proved
Developed
Producing
Developed
Non-Producing
Undeveloped
1,368.7
986.4
316.2
9,397.0
1,049.4
794.7
218.4
7,243.0
Total Proved
4,519.2
2,955.3
843.3 36,248.0 3,760.1
2,418.2
570.9 31,031.0
Probable
2,328.5
1,308.3
397.2 16,920.0 1,869.5
1,017.5
264.1 14,307.0
Total Proved
plus Probable
6,847.7
4,263.6
1,240.5 53,168.0 5,629.6
3,435.7
835.0 45,338.0
(1) "Total Company Interest Reserves" are the Corporation’s working interest plus its royalty interest share of remaining reserves before
the deduction of royalties.
(2) "Gross Reserves" are the Corporation's working interest (operating or non-operating) share of remaining reserves before deduction of
royalties and without including any royalty interests of the Corporation.
(3) "Net Reserves" are the Corporation's working interest (operating or non-operating) share of remaining reserves after deduction of
royalty obligations, plus its royalty interests in reserves.
NET PRESENT VALUE OF FUTURE NET REVENUE – FORECAST PRICES AND COSTS
($M)
Proved
BEFORE FUTURE INCOME TAX EXPENSES AND DISCOUNTED AT
0%
5%
10%
15%
20%
Developed Producing
297,142
235,164
197,284
171,364
152,433
Developed Non-Producing
Undeveloped
Total Proved
Probable
52,483
125,585
41,752
93,014
34,497
71,082
29,306
55,556
25,422
44,115
475,210
369,930
302,863
256,226
221,970
264,216
160,131
108,995
80,111
62,080
Total Proved plus Probable
739,426
530,061
411,858
336,337
284,050
(1) “Net Revenue” is net revenue after royalties.
(2) Including solution gas and other by-products.
(3) Including by-products, but excluding solution gas from oil wells.
11
Surge Energy Inc. | AR 2010
($M)
Proved
AFTER FUTURE INCOME TAX EXPENSES AND DISCOUNTED AT
0%
5%
10%
15%
20%
Developed Producing
270,383
213,850
179,674
156,398
139,432
Developed Non-Producing
Undeveloped
Total Proved
Probable
39,124
93,827
30,807
67,924
25,213
50,465
21,223
38,106
18,247
29,007
403,334
312,581
255,352
215,727
186,686
198,286
119,368
80,635
58,775
45,133
Total Proved plus Probable
601,620
431,949
335,987
274,502
231,819
Proved
Developed Producing
Developed Non-Producing
Undeveloped
Total Proved
Probable
Total Proved plus Probable
(1) “Net Revenue” is net revenue after royalties.
(2) Including solution gas and other by-products.
(3) Including by-products, but excluding solution gas from oil wells.
DISCOUNTED AT 10%/YEAR ($/BOE)
27.80
22.18
21.74
25.41
19.69
23.59
PRICING ASSUMPTIONS – FORECAST PRICES AND COSTS
Sproule employed the following pricing, exchange rate and inflation rate assumptions as of December 31, 2010 in
the Sproule Report in estimating reserves data using forecast prices and costs. The weighted average historical
prices received by the Corporation for 2010 are also reflected in the following table.
MEDIUM AND LIGHT CRUDE OIL
NATURAL
GAS
NGLS
WTI
CUSHING
OKLAHOMA
40˚ API
(US$/BBL)
79.43
88.40
89.14
88.77
88.88
90.22
91.57
92.94
94.34
EDMONTON
PAR PRICE
40˚ API ($/
BBL)
CROMER
MEDIUM
29.3˚ API
($/BBL)
AECO GAS
PRICE ($/
MMBTU)
PENTANES
PLUS FOB
FIELD GATE
($/BBL)
BUTANES
FOB FIELD
GATE ($/
BBL)
INFLATION
RATES (%/
YR)
EXCHANGE
RATE
($US/$CDN)
77.81
93.08
93.85
93.43
93.54
94.95
96.38
97.84
99.32
73.66
85.63
86.34
85.02
84.18
85.45
86.74
88.05
89.38
90.73
92.10
4.16
4.04
4.66
4.99
6.58
6.69
6.80
6.91
7.02
7.14
7.26
84.21
95.32
96.11
95.68
95.79
97.24
98.70
100.18
101.68
103.21
104.76
57.04
62.44
62.95
62.67
62.75
63.69
64.65
65.62
66.60
67.60
68.61
1.0
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
0.971
0.932
0.932
0.932
0.932
0.932
0.932
0.932
0.932
0.932
0.932
95.75
100.81
97.19
102.34
YEAR
2010 (Actual)
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
Surge Energy Inc. | AR 2010
12
RECONCILIATION OF CHANGES IN RESERVES
The following table sets forth a reconciliation of Surge’s gross reserves as at December 31, 2010, derived from
the Sproule Report using forecast prices and cost estimates, reconciled to the gross reserves of the Corporation
as at December 31, 2009. The additional reserves associated with royalty interest reserves, representing
2,438 Mboe and 3,756 Mboe on a Proved and Proved plus Probable basis, respectively, are not included in
the following tables.
LIGHT AND
MEDIUM CRUDE
OIL
(MBBLS)
HEAVY OIL
(MBBLS)
NATURAL GAS
LIQUIDS
NATURAL GAS
(MBBLS)
(MMCF)
BOE
(MBOE)
Proved
Balance at December 31, 2009
Extensions and
improved recovery
Technical revisions
Discoveries
Acquisitions
Dispositions
Economic factors
Production
1,271.0
1,201.5
2,564.6
615.0
347.0
269.5
15,967.0
6,843.8
7,109.0
3,270.9
176.2
48.8
-
2,243.0
-
-
-
-
-
-
(3.1)
-
705.0
339.4
-
-
306.3
15,635.0
5,155.1
(39.0)
(641.0)
(145.8)
-
-
-
(372.4)
(273.1)
(37.5)
(2,527.0)
(1,104.2)
Balance at December 31, 2010
4,519.3
2,955.3
843.2
36,248.0
14,359.2
LIGHT AND
MEDIUM CRUDE
OIL
(MBBLS)
HEAVY OIL
(MBBLS)
NATURAL GAS
LIQUIDS
NATURAL GAS
(MBBLS)
(MMCF)
BOE
(MBOE)
Probable
Balance at December 31, 2009
Extensions and
improved recovery
Technical revisions
Discoveries
Acquisitions
Dispositions
Economic factors
Production
481.4
1,023.9
997.4
397.2
164.2
138.0
8,502.0
4,011.0
3,060.1
2,227.6
(157.1)
(86.3)
(66.8)
(3,068.0)
(821.4)
-
980.3
-
-
-
-
-
-
-
-
-
169.4
(7.6)
-
-
-
-
7,599.0
2,416.2
(125.0)
(28.5)
-
-
-
-
Balance at December 31, 2010
2,328.5
1,308.3
397.2
16,919.0
6,854.0
13
Surge Energy Inc. | AR 2010
LIGHT AND MEDIUM
CRUDE OIL
(MBBLS)
HEAVY OIL
(MBBLS)
NATURAL GAS
LIQUIDS
NATURAL GAS
(MBBLS)
(MMCF)
BOE
(MBOE)
Proved plus Probable
Balance at December 31, 2009
Extensions and
improved recovery
Technical revisions
Discoveries
Acquisitions
Dispositions
Economic factors
Production
1,752.4
2,225.4
19.1
-
3,223.3
-
-
3,562.0
1,012.2
511.2
407.5
24,470.0
11,121.0
9,903.9
5,498.5
(37.5)
(69.8)
(2,363.0)
(482.0)
-
-
-
-
-
475.7
(46.6)
-
-
-
23,234.0
7,571.3
(766.0)
(174.2)
-
-
(372.4)
(273.1)
(37.5)
(2,527.0)
(1,104.2)
Balance at December 31, 2010
6,847.8
4,263.6
1,240.5
53,169.0
21,213.3
FINDING AND DEVELOPMENT (F&D) AND FINDING, DEVELOPMENT AND ACQUISITION (FD&A) COSTS
CAPITAL COSTS ($MM)
2010 capital expenditures (excl. non-cash items):
Change in FDC(4)
Proved
Proved plus Probable
Total capital (excl. non-cash items) including change in FDC ($MM)(4)
Proved
Proved plus Probable
FD&A and F&D costs without FDC ($/boe)
Proved
Proved plus Probable
FD&A and F&D costs including FDC ($/boe)(4)
Proved
Proved plus Probable
FD&A
$230.8
$47.0
$57.3
$277.8
$288.1
FD&A
$26.78
$18.59
$32.23
$23.21
F&D
$42.0
$34.8
$24.0
$76.8
$66.0
F&D
$9.61
$8.37
$17.59
$13.15
Surge’s netback for 2010 was $27.65 per boe. Using this netback the following recycle ratios were calculated:
RECYCLE RATIO INCLUDING FDC(4)
Proved
Proved plus Probable
FD&A
0.9
1.2
F&D
1.6
2.1
(4) Calculated using the Corporation’s undiscounted future development capital cost.
Surge Energy Inc. | AR 2010
14
Surge produced 1.1 million boe of oil and natural gas in 2010 (3,026 boe per day) and added 12.4 million boe of
Proved plus Probable reserves, resulting in a reserves replacement ratio of 11.2.
RESERVE REPLACEMENT
Proved
Proved plus Probable
SURGE 2010 NET ASSET VALUE PER FULLY DILUTED SHARE INFORMATION
Using reserve value at December 31, 2010 and forecast pricing and costs:
($MM Except Share Amounts)
PROVED PLUS PROBABLE RESERVE VALUE (NET PRESENT VALUE DISCOUNTED 10 PERCENT BEFORE TAX)
(incl. future capital)
Undeveloped land (435,413 acres @ $100/acre)(5)
Estimated net debt
Option proceeds
Total net assets (basic)
Total net assets (fully diluted)
Basic shares outstanding (MM)
Fully diluted shares outstanding (MM)
Estimated NAV per basic share
Estimated NAV per fully diluted share
(4) Calculated using the Corporation's undiscounted future development capital cost.
(5) Internal estimate equivalent to $100 per net corporate undeveloped acre.
7.8
11.2
$411.9
$43.5
($46.0)
$27.3
409.4
$436.7
56.1
60.8
$7.30
$7.18
15
Surge Energy Inc. | AR 2010
MD&A
FINANCIAL AND OPERATING SUMMARY ($000s except per share amounts)
3 MONTHS ENDED DECEMBER 31,
YEARS ENDED DECEMBER 31,
2010
2009
% CHANGE
2010
2009
% CHANGE
Financial highlights
Oil and NGL sales
Natural gas sales
Other revenue
15,014
9,999
3,322
2,934
208
-
50%
13%
nm
47,685
30,697
10,029
12,156
213
-
Total oil, natural gas, and NGL revenue
18,544
12,933
43%
57,927
42,853
Funds from operations(1)
7,907
5,320
49% 25,688
17,492
55%
(17%)
nm
35%
47%
Per share basic and diluted ($)
0.15
0.32
(53%)
0.70
1.05
(33%)
Net loss excluding non-recurring charges
relating to the recapitalization(2)
Net earning (loss)
Per share basic and diluted ($)
Corporate & asset acquisitions
(cash and share consideration)(3)
Capital expenditures
(4,147)
(4,147)
(0.08)
66,239
26,465
(21)
(21)
-
-
nm
nm
nm
(1,307)
(2,112)
(38%)
(10,326)
(2,112)
389%
(0.28)
(0.13)
115%
nm
188,812
-
nm
5,154
414%
41,996
17,888
135%
Net debt at end of period(4)
46,240
46,902
3% 46,240
46,902
3%
Operating highlights
Production:
Oil and NGL (bbls per day)
Natural gas (mcf per day)
Total (boe per day) (6:1)
Netback (excluding hedges) ($ per boe):
2,308
10,182
4,005
1,614
6,887
2,762
43%
48%
45%
1,871
6,930
3,026
1,477
6,995
2,643
Oil, natural gas and NGL sales
50.33
50.90
(1%)
52.45
44.42
Royalties
Operating expenses
Transportation expenses
Operating netback
G&A expenses
Interest expense
Corporate netback
Common shares (000s)
(6.43)
(5.77)
(14.87)
(15.60)
(1.72)
(1.84)
27.31
27.69
(5.96)
(0.80)
(4.32)
(2.37)
20.55
21.00
11%
(5%)
(7%)
(1%)
38%
(66%)
(2%)
(7.35)
(5.23)
(15.25)
(13.52)
(2.20)
(2.03)
27.65
23.64
(5.60)
(0.90)
21.15
(4.03)
(2.11)
17.50
Common shares outstanding, end of period
56,095
17,836
215% 56,095
17,836
Weighted average basic shares outstanding
53,065
16,667
218% 36,468
16,700
Stock option dilution (treasury method)
-
(69)
nm
-
-
27%
(1%)
14%
18%
41%
13%
8%
17%
39%
(57%)
21%
215%
118%
nm
Weighted average diluted shares outstanding
53,065
16,736
217% 36,468
16,700
118%
(1) Management uses funds from operations (before changes in non-cash working capital and non-recurring recapitalization costs) to analyze
operating performance and leverage. Funds from operations as presented does not have any standardized meaning prescribed by Canadian
GAAP and, therefore, may not be comparable with the calculation of similar measures for other entities.
(2) Excluding the non-recurring recapitalization costs, as well as the increase in stock-based compensation that resulted from the recapitalization.
Please see net income (loss) note.
(3) Please see capital expenditures note.
(4) The Corporation defines net debt as outstanding bank debt plus or minus cash-based working capital.
Surge Energy Inc. | AR 2010
16
OVERVIEW AND HIGHLIGHTS
Surge is pleased with the transformation achieved since recapitalizing Zapata Energy Corporation on April 13, 2010.
The Corporation is now well positioned in three exciting light oil resource plays and commenced drilling in these
key light oil resource plays late in 2010. Upon the closing of the recently announced North Dakota acquisitions
expected on May 12, 2011, Surge will have: a significant undeveloped land base of more than 500,000 net
acres, internally estimated DPIIP(1) of more than 460 million barrels and more than 460 gross (350 net)
oil drilling locations.
A timeline of some of the major events in 2010 is as follows:
• March 25, 2010: Announced the recapitalization of Zapata Energy Corporation.
• April 13, 2010: Entered into a reorganization and investment agreement, completed a $17 million
non-brokered private placement in conjunction with the recapitalization and named the new Board of
Directors and management team.
• May 5, 2010: Completed a bought deal financing for total proceeds of $50 million.
• June 25, 2010: Re-named the Corporation Surge Energy Inc. and changed the stock ticker symbol to SGY.
• July 12, 2010: Completed the acquisition of Corinthian Energy Corporation for 16.0 million common shares
and the assumption of approximately $15 million of net debt which added two high impact light oil resource
plays, 125 gross (100 net) light oil horizontal drilling locations, and 80,000 acres of net undeveloped land
and more than 160 million barrels of DPIIP.
• July 12, 2010: Acquired an additional 25 percent Unit Interest at Waskada in South West Manitoba.
• July 20, 2010: Increased bank line from $50 million to $80 million and completed the acquisition of
Crystal Lake Resources Ltd. for 0.3 million common shares.
• October 20, 2010: Completed a subscription receipt bought deal financing for gross proceeds of $42 million.
• November 1, 2010: Completed the acquisition of a low decline light oil resource play asset with all season
access at Valhalla South for $75 million, which added 24 gross (15.3 net) light oil horizontal drilling locations
and more than 100 million barrels of DPIIP and increased the bank line from $80 million to $90 million.
• Subsequent to the year ended December 31, 2010, Surge increased its bank line from $90 million to
$105 million and the Corporation forecasts that its bank line will increase to $120 million in May of 2011.
• Established a non-core dispositions package which has successfully resulted in approximately $6.5 million
of proceeds for Surge to date.
• Executed preparation for 2011 drilling program targeting light oil, which is projected to increase operating
netbacks to approximately $47.00(2) by the fourth quarter of 2011 and increase light/medium oil weighting to
greater than 70 percent.
• Surge had greater than 245 gross (more than 220 net) oil drilling locations in inventory at December 31,
2010, currently has more than 350 gross (more than 265 net) oil drilling locations and forecasts having
more than 460 gross (more than 350 net) oil drilling locations in inventory after the closing of the previously
announced acquisitions in North Dakota expected for May 12, 2011.
(1) Discovered Petroleum Initially In Place (DPIIP) is defined as quantity of hydrocarbons that are estimated to be in place within a known
accumulation, plus those estimated quantities in accumulations yet to be discovered. There is no certainty that it will be economically
viable or technically feasible to produce any portion of this DPIIP except for those identified as proved or probable reserves. There is
no certainty that it will be commercially viable to produce any portion of the resources.
(2) Based on April 18, 2011 forward strip: CDN $103.95 Edmonton Par (US $111.17 WTI) and CDN $4.00/mcf AECO using a CAD/USD
of $1.0346 for the fourth quarter.
17
Surge Energy Inc. | AR 2010
ACHIEVEMENTS AND FORECAST:
•
Increased production by 125 percent from approximately 2,000 boe per day shortly after the recapitalization
in April 2010 to a 2010 exit production rate of more than 4,500 boe per day with a forecast to exit 2011 at
7,500 boe per day, with oil and NGL weighting increasing from 60 percent to more than 70 percent.
• Realized an average production rate of 4,005 boe per day in the fourth quarter 2010, a 45 percent increase
as compared to 2009 production rate of 2,762 boe per day with a forecast to grow exit production by
67 percent to 7,500 boe/d in 2011.
• Realized an average production rate of 3,026 boe per day for the year ended December 31, 2010, a
14 percent increase as compared to the 2009 production rate of 2,643 boe per day; with a forecast to
grow production by 98 percent to an average of 6,000 boe/d in 2011.
• More than 80 percent of Surge’s revenue in 2010 resulted from oil and natural gas liquids production, with
less than 20 percent derived from natural gas production.
•
Increased Proved plus Probable reserves by 114 percent from 9.9 million boe at December 31 2009 to
21.2 million boe at December 31, 2010.
•
Increased the NPV10 BT of Proved plus Probable reserves by 90 percent from $217 million as at
December 31, 2009 to $412(3) million as at December 31, 2010.
• Achieved Proved plus Probable Finding and Development (“F&D”) costs of $13.15 per boe, including a
$24.0 million change in Future Development Capital (“FDC”).
• Achieved an F&D recycle ratio for 2010 of 2.1 times.
• Attained a Proved plus Probable Reserve Life Index of 12.9 years based on the Corporation’s estimated 2010
exit production rate of approximately 4,500 boe per day.
• Achieved a Proved plus Probable reserves replacement ratio of 11.2 based on the Corporation’s estimated
2010 average production for the year of 3,026 boe per day.
• Achieved a 100 percent success rate drilling 10 gross (10 net) wells in the fourth quarter 2010; realized a
gross success rate of 91 percent drilling by 22 gross (21.5 net) wells in 2010.
• Reduced operating expenses per boe by five percent and transportation expenses per boe by seven percent
in the fourth quarter of 2010 as compared to the fourth quarter of 2009, with a forecast to reduce combined
operating and transportation costs by 21 percent to $13.00 per boe in the fourth quarter of 2011.
•
Increased Surge’s operating netback by 17 percent for the year ended December 31, 2010 as compared to
the year ended December 31, 2009 from $23.64 per boe to $27.65 per boe. Surge’s fourth quarter 2011
netback is forecast to be approximately $47.00(2) per boe based on recent 2011 strip oil and gas prices and
as a result of the Corporation’s increasing light oil weighting and decreasing costs in 2011.
•
Increased funds from operations by 49 percent to $8.0 million in the fourth quarter of 2010 from
$5.3 million in the fourth quarter of 2009; Increased funds from operations by 47 percent to $25.7 million
in 2010 from $17.5 million in 2009 with a forecast to grow funds from operations by 189 percent to
$75(4) million in 2011.
(2) Based on April 18, 2011 forward strip: CDN $103.95 Edmonton Par (US $111.17 WTI) and CDN $4.00/mcf AECO using a CAD/USD
of $1.0346 for the fourth quarter.
(3) The estimated values disclosed do not represent fair market value.
(4) Based on April 18, 2011 forward strip: CDN $99.06 Edmonton Par (US$106.12 WTI) and CDN $3.90/mcf AECO using a CAD/USD
of 1.0307.
Surge Energy Inc. | AR 2010
18
NETBACK COMPARISON
Average production (boe per day)
Revenue
Royalties
Operating costs
Transportation costs
Operating netback
Q4 2010
4,005
$
50.33
$
(6.43)
(14.87)
(1.72)
$
27.31
$
Q3 2010
3,138
49.41
(6.07)
(14.98)
(1.86)
26.50
% CHANGE
28%
2%
6%
(1%)
(8%)
3%
The Corporation continued to achieve reductions in both operating costs and transportation expenses on a per
boe basis in the fourth quarter of 2010 as compared to the third quarter of 2010. Surge’s operating netback
increased by three percent from $26.50 in the third quarter of 2010 to $27.31 in the fourth quarter of 2010.
The management team continues to focus on finding efficiencies within existing operations and expects operating
netbacks to continue to grow through 2011. Surge exited 2010 with a low decline (approximately 15 percent)
oil-weighted production base of more than 4,500 boe per day and maintains a significant undeveloped land base
of more than 400,000 net acres. Surge maintained approximately $59 million of borrowing capacity at year-end
on the Corporation’s $105 million bank line, with $46 million of net debt at year-end (defined as outstanding
bank debt plus or minus cash-based working capital).
OUTLOOK
Surge has built a low decline, oil-weighted production base and positioned itself in several high impact, emerging
light oil resource plays. Upon the closing of the recently announced North Dakota acquisitions expected on
May 12, 2011, Surge will have: a significant undeveloped land base of more than 500,000 net acres, internally
estimated DPIIP of more than 460 million barrels (gross) and more than 460 gross (350 net) oil drilling
locations, comprised of 85 percent light oil, with the remainder of the inventory being medium gravity.
During 2010, since the recapitalization of Zapata on April 13, 2010 Surge has positioned itself in three high
impact light oil resource plays at Valhalla South (Doig), Windfall (Bluesky) and South West Manitoba (Spearfish),
adding more than 190 gross (175 net) light oil horizontal drilling locations, 80,000 acres of net undeveloped land
and more than 245 million barrels (gross) of DPIIP.
Surge has had an excellent start to 2011 and continues to implement its business plan of targeting per share
growth by positioning the Corporation in high impact oil resource plays with significant oil in place and applying
its proven expertise and experience to build core areas. Surge continues to demonstrate this ability with the
recent announcement of its expansion into North Dakota, where the Corporation significantly strengthened its
position in the Spearfish light oil resource play by adding 205 gross (120 net) light oil horizontal drilling locations
on 6,000 net acres of highly prospective lands. Management estimates DPIIP to be approximately 125 million
barrels (gross) within these lands.
Complementary to Surge’s high impact light oil resource plays at Valhalla South (Doig), Windfall (Bluesky) and
South West Manitoba/North Dakota (Spearfish) are the low cost, low decline, high rate of return oil resource
assets in South East Alberta that have considerable secondary recovery potential. The infill drilling and secondary
recovery programs that have been implemented to date provide significant internally generated cash flow and
enable Surge to execute its capital program in each of its core areas.
In 2011, Surge will continue to grow the Corporation organically through drilling, continued development of
secondary recovery programs in South East Alberta and by evaluating plans for secondary recovery pilot programs
on its new light oil resource plays. Additionally, the Corporation will continue to make accretive acquisitions that
fit its business plan of positioning Surge in high impact, emerging crude oil resource plays. Surge is committed
19
Surge Energy Inc. | AR 2010
to delivering top quartile corporate performance and creating value for shareholders by growing reserves, cash
flow and production on a per share basis. Surge looks forward to applying for listing of its common shares on
the Toronto Stock Exchange in the fourth quarter of 2011.
By the end of May 2011, Surge anticipates finalizing its syndicated bank facility and increasing its line of credit
to $120 million. Surge’s 2010 year end net debt was $46 million (defined as outstanding bank debt plus or
minus cash-based working capital) representing 0.6 times forecast 2011 funds flow based on April 18, 2011
forward strip pricing and Surge forecasts 2011 year end net debt of $91 million representing 0.8 times forecast
annualized fourth quarter 2011 funds flow based on April 18, 2011 forward strip pricing.
Surge forecasts a 2011 capital program of $120 million with guidance to achieve 2011 exit production of
7,500 boe per day (greater than 70 percent light/medium oil and NGLs), a 67 percent increase over 2010,
with 2011 annual production of 6,000 boe per day (greater than 65 percent light/medium oil and NGLs), a
98 percent increase over 2010. Based this 2011 production guidance, Surge is forecasting an increase in
funds from operations of approximately 189 percent as compared to 2010 to approximately $75 million in
2011 (based on April 18, 2011 forward strip pricing).
MANAGEMENT’S DISCUSSION AND ANALYSIS
This Management’s Discussion and Analysis (MD&A) of the consolidated financial position and results of operations
of Surge Energy Inc. (“Surge” or the “Corporation”), formerly Zapata Energy Corporation, which includes its
subsidiaries and partnership arrangements, is for the three months and years ended December 31, 2010 and 2009.
For a full understanding of the financial position and results of operations of the Corporation, the MD&A should be
read in conjunction with the documents filed on SEDAR, including historical financial statements, press releases and
the Annual Information Form (AIF). These documents are available at www.sedar.com.
FORWARD-LOOKING STATEMENTS
This MD&A contains forward-looking statements.
More particularly, this MD&A contains statements concerning anticipated: (i) production weighting for 2011,
(ii) exploration and development activities, (iii) changes to the Alberta royalty regime regulations in force,
(iv) effect on Surge of anticipated changes to the Alberta royalty regime, (v) capital expenditures for 2011,
(vi) sources of funding for future capital requirements, (vii) outcome and effect on Surge of outstanding legal
proceedings and claims, (viii) amounts received or paid to settle financial instruments currently entered into
upon maturity, and (ix) changes to accounting policies. The forward-looking statements are based on certain
key expectations and assumptions made by Surge, including expectations and assumptions concerning the
performance of existing wells and success obtained in drilling new wells, anticipated expenses, cash flow and
capital expenditures and the application of regulatory and royalty regimes.
Although Surge believes that the expectations and assumptions on which the forward-looking statements are
based are reasonable, undue reliance should not be placed on the forward-looking statements because Surge
can give no assurance that they will prove to be correct. Since forward-looking statements address future
events and conditions, by their very nature they involve inherent risks and uncertainties. Actual results could
differ materially from those currently anticipated due to a number of factors and risks. These include, but are
not limited to, risks associated with the oil and gas industry in general (e.g., operational risks in development,
exploration and production; delays or changes in plans with respect to exploration or development projects or
capital expenditures; the uncertainty of reserve estimates; the uncertainty of estimates and projections relating
to production, costs and expenses, and health, safety and environmental risks), commodity price and exchange
rate fluctuations and uncertainties resulting from potential delays or changes in plans with respect to exploration
or development projects or capital expenditures. Certain of these risks are set out in more detail in this MD&A
and in Surge’s AIF which has been filed on SEDAR and can be accessed at www.sedar.com.
Surge Energy Inc. | AR 2010
20
The forward-looking statements contained in this MD&A are made as of the date hereof and Surge undertakes no
obligation to update publicly or revise any forward-looking statements or information, whether as a result of new
information, future events or otherwise, unless so required by applicable securities laws.
All amounts are expressed in Canadian dollars unless otherwise noted. Oil, natural gas and natural gas liquids
reserves and volumes are converted to a common unit of measure, referred to as a barrel of oil equivalent (boe),
on the basis of 6,000 cubic feet of natural gas being equal to one barrel of oil. This conversion ratio is based
on an energy equivalency conversion method, primarily applicable at the burner tip and does not necessarily
represent a value equivalency at the wellhead. It should be noted that the use of boe might be misleading,
particularly if used in isolation.
The terms “funds from operations”, “funds from operations per share”, and “netback” used in this discussion
are not recognized measures under Canadian generally accepted accounting principles (GAAP). Management
believes that in addition to net income, funds from operations and netback are useful supplemental measures
as they provide an indication of the results generated by the Corporation’s principal business activities before the
consideration of how those activities are financed or how the results are taxed. Investors are cautioned, however,
that these measures should not be construed as alternatives to net income determined in accordance with GAAP,
as an indication of Surge’s performance.
Surge’s method of calculating funds from operations may differ from that of other companies, and, accordingly,
may not be comparable to measures used by other companies. Surge determines funds from operations as cash
flow from operating activities before changes in non-cash working capital and non-recurring recapitalization
costs as follows:
($000s)
2010
2009
2010
2009
3 MONTHS ENDED DECEMBER 31,
YEARS ENDED DECEMBER 31,
Cash flow from operating activities
(per GAAP)
Change in non-cash working capital
Non-recurring recapitalization costs
Funds from operations
594
7,313
-
7,907
5,732
(412)
-
5,320
17,137
3,142
5,409
25,688
16,341
1,151
-
17,492
Funds from operations per share is calculated using the weighted average basic and diluted shares used in
calculating earnings per share. Operating and corporate netbacks are also presented. Operating netbacks
represent Surge’s revenue, excluding realized and unrealized gains or losses on commodity contracts, less
royalties and operating and transportation expenses. Corporate netbacks represent Surge’s operating netback,
less general and administrative and interest expenses, in order to determine the amount of funds generated
by production. Operating and corporate netbacks have been presented on a per barrels of oil equivalent
(“boe”) basis.
21
Surge Energy Inc. | AR 2010
The term “net income (loss) before and after tax, excluding non-recurring charges relating to the recapitalization”
used in this discussion is not a recognized measure under Canadian generally accepted accounting principles
(GAAP). Management believes that in addition to net income, net income (loss) before and after tax,
excluding non-recurring charges relating to the recapitalization is a useful supplemental measure, as it
provides an indication of the results generated by the Corporation’s principal business activities before the
consideration of non-recurring recapitalization costs. Investors are cautioned, however, that these measures
should not be construed as alternatives to net income determined in accordance with GAAP, as an indication
of Surge’s performance.
Excluding the non-recurring recapitalization costs, as well as the increase in stock-based compensation that
resulted from the recapitalization, the Corporation’s approximate net loss would have been $4.1 million for
the three months ended December 31, 2010 and $1.3 million for the year ended December 31, 2010.
($000s)
2010
2009
2010
2009
Loss before taxes (per GAAP)
(3,899)
(506)
(11,147)
(3,716)
3 MONTHS ENDED DECEMBER 31,
YEARS ENDED DECEMBER 31,
Add back:
Recapitalization costs
Stock-based compensation expense relating
to the recapitalization
Net income (loss) before tax excluding non-
recurring charges relating to the recapitalization
Future income tax (reduction)
Net income (loss) excluding non-recurring
charges relating to the recapitalization
-
-
-
-
(3,899)
248
(506)
(485)
5,409
3,610
(2,128)
(821)
-
-
(3,716)
(1,604)
(4,147)
(21)
(1,307)
(2,112)
Surge’s management is responsible for the integrity of the information contained in this report and for the
consistency between the MD&A and financial statements. In the preparation of these statements, estimates are
necessary to make a determination of future values for certain assets and liabilities. Management believes these
estimates have been based on careful judgments and have been properly presented. The financial statements
have been prepared using policies and procedures established by management and fairly reflect Surge’s financial
position, results of operations and funds from operations.
Surge’s Board of Directors and Audit Committee have reviewed and approved the financial statements and MD&A.
This MD&A is dated April 27, 2011.
Surge Energy Inc. | AR 2010
22
OPERATIONS
DRILLING
Q1 2010
Q2 2010
Q3 2010
Q4 2010
Total
DRILLING
GROSS
1
6
5
10
22
NET
0.5
6
5
10
21.5
SUCCESS RATE
WORKING
(%) GROSS
INTEREST (%)
100%
83%
80%
100%
91%
50%
100%
100%
100%
98%
Surge achieved a 100 percent success rate in the fourth quarter of 2010, drilling 10 gross (10 net) wells,
resulting in 10 gross (10 net) oil wells. During 2010, Surge achieved an 91 percent success rate drilling
22 gross (21.5 net) wells.
PRODUCTION
Q4
2010
Q3
2010
Q2
2010
Q1
2010
Q4
2009
Q3
2009
Q2
2009
Q1
2009
Oil & NGL
(bbls per day)
Natural gas
(mcf per day)
Total
(boe per day)(6:1)
2,308
1,841
1,621
1,707
1,614
1,428
1,374
1,492
10,182
7,783
3,823
5,874
6,887
6,294
7,586
7,223
4,005
3,138
2,258
2,686
2,762
2,477
2,638
2,696
% Oil & NGL
58%
59%
72%
64%
58%
58%
52%
55%
Surge achieved production of 4,005 boe per day in the fourth quarter of 2010, a 45 percent increase from the
fourth quarter of 2009 production rate of 2,762 boe per day. Average production during 2010 was 3,026 boe per
day as compared to 2,643 boe per day during 2009. The increase in the quarterly and year to date production
volumes compared to the 2009 rates was primarily due to increased production from acquisitions and new drills
and partially offset by approximately 3,000 mcf a day of gas that was shut in over the course of 2010.
Surge realized a 58 percent oil and natural gas liquids production weighting in the fourth quarter of 2010.
The Corporation realized average oil and natural gas liquids production of 2,308 bbls per day for the fourth
quarter of 2010.
OIL, NATURAL GAS AND NGL, COMMODITY CONTRACTS AND OTHER REVENUES
A one percent decrease in average revenue per boe, combined with a 45 percent increase in production, resulted
in revenues of $18.5 million in the fourth quarter of 2010, up 43 percent from $12.9 million in the fourth quarter
of 2009. During 2010, an 18 percent increase in average revenue per boe, coupled with a 14 percent increase in
volume, resulted in revenues of $57.9 million, up 35 percent from $42.9 million during 2009.
Surge had certain oil and gas commodity contracts in place as of December 31, 2010. The Corporation
recognized an unrealized loss of $2.6 million and a realized gain of $0.7 million on its commodity contracts in
the fourth quarter of 2010. This compares to an unrealized loss of $1.1 million and a realized gain of $0.1 million
on its commodity contracts in the fourth quarter of 2009.
23
Surge Energy Inc. | AR 2010
Realized commodity contract gains resulted in an increase of $1.92 per boe to the average revenue, including
commodity contracts, for the fourth quarter of 2010. Realized commodity contract gains resulted in an increase
of $0.54 per boe to average revenue, including commodity contracts, for the fourth quarter of 2009.
The Corporation recognized an unrealized loss of $2.3 million and a realized gain of $2.8 million on its
commodity contracts during 2010. This compares to an unrealized loss of $1.2 million and a realized gain
of $0.9 million on its commodity contracts during 2009.
Please refer to the “Financial Instruments” section of this MD&A for further details on these oil and natural
gas commodity contracts, and interest rate swaps.
PRICES
In the fourth quarter of 2010, Surge realized average revenue of $50.33 per boe, before realized commodity
contract gains, a decrease of one percent from the $50.90 per boe recorded in the fourth quarter of 2009.
During 2010, Surge realized average revenue of $52.45 per boe, before realized commodity contract gains,
an increase of 18 percent from the $44.42 per boe recorded during 2009.
Surge realized an average of $70.70 per bbl of oil and natural gas liquids in the fourth quarter of 2010, an
increase of five percent per barrel from the $67.35 per bbl realized in the fourth quarter of 2009. This compares
to an average Edmonton Light Sweet price of $80.33 per bbl in the fourth quarter of 2010, which increased
five percent per barrel from the $76.56 per bbl in the fourth quarter of 2009. The increase in oil and natural
gas liquids prices is consistent with the increase in benchmark prices.
Surge realized an average of $69.83 per bbl of oil and natural gas liquids during 2010, an increase of 23 percent
per barrel from the $56.93 per bbl realized during 2009. This compares to an average Edmonton Light Sweet
price of $77.48 per bbl during 2010, which increased 17 percent per barrel from the $65.98 per bbl during
2009. The increase in oil and natural gas liquids prices is relatively consistent with the increase in benchmark
prices as well as an improvement in differentials due to increased light oil production.
The Corporation realized an average natural gas price of $3.55 per mcf in the fourth quarter of 2010, a
23 percent decrease from the $4.63 per mcf averaged in the fourth quarter of 2009. This compares to an
average Alberta Plant Gate reference price of $3.43 per mcf in the fourth quarter of 2010 and $4.26 per mcf
in the fourth quarter of 2009 reflecting a 19 percent decrease. The decrease in natural gas prices is relatively
consistent with the decrease in benchmark prices.
The Corporation realized an average natural gas price of $3.96 per mcf during 2010, a 17 percent decrease
from the $4.76 per mcf averaged during 2009. This compares to an average Alberta Plant Gate reference price
of $3.79 per mcf during 2010 and $3.74 per mcf during 2009 reflecting a one percent increase. The difference
in the average realized natural gas price is due to physical natural gas hedge gains included in the year ended
December 31, 2009 natural gas revenue, amounting to approximately $0.80 per mcf.
More than 80 percent of Surge’s revenue resulted from oil and natural gas liquids production, with less than
20 percent derived from natural gas production.
Realized commodity contract gains resulted in an increase of $2.53 per boe to the average revenue including
commodity contracts during 2010. Realized commodity contract gains resulted in an increase of $0.90 per boe
to average revenue including commodity contracts during 2009.
Surge Energy Inc. | AR 2010
24
REVENUE AND REALIZED PRICES
3 MONTHS ENDED DECEMBER 31,
YEARS ENDED DECEMBER 31,
2010
2009
% CHANGE
2010
2009
% CHANGE
Oil and NGL ($000s)
Natural gas ($000s)
Processing and other ($000s)
Total oil, natural gas and NGL revenue
($000s)
15,014
3,322
208
9,999
2,934
-
50%
13%
nm
47,685
30,697
10,029
12,156
213
-
18,544
12,933
43%
57,927
42,853
Oil and NGL ($ per bbl)
Natural gas ($ per mcf)
70.70
3.55
67.35
4.63
5%
69.83
56.93
(23%)
3.96
4.76
(17%)
55%
(17%)
nm
35%
23%
Total oil, natural gas and NGL revenue
($ per boe)
Unrealized gain loss) on commodity
contracts ($ per boe)
Realized gain(loss) on commodity
contracts ($ per boe)
Total oil, natural gas, and NGL revenue
after commodity contracts ($ per boe)
Reference Prices
50.33
50.90
(1%)
52.45
44.42
18%
(7.19)
(4.39)
64%
(2.13)
(1.27)
68%
1.92
0.54
256%
2.53
0.90
181%
45.06
47.05
(4%)
52.85
44.05
20%
Edmonton par - light oil ($ per bbl)
80.33
76.56
5%
77.48
65.98
Alberta reference price ($ per mcf)
3.43
4.26
(19%)
3.79
3.74
17%
1%
ROYALTIES
Surge realized royalty expense of $2.4 million or 13 percent of revenue in the fourth quarter of 2010,
compared to $1.5 million or 11 percent of revenue in the fourth quarter of 2009. During 2010, Surge
realized royalty expense of $8.1 million or 14 percent of revenue, compared to $5.0 million or 12 percent
of revenue during 2009.
The increase in royalties as a percentage of revenue during 2010 compared to the same periods in 2009
is primarily due to $0.5 million of prior period royalty adjustments recorded in the second quarter of 2010.
Excluding these prior period adjustments, royalties would have been approximately 13 percent of revenue.
On January 1, 2009 the Alberta government’s Alberta Royalty Framework (ARF) took effect. Under the ARF,
royalty rates on conventional and non-conventional oil and natural gas production in Alberta may increase to a
maximum of 50 percent. The sliding scale royalty calculations are based on a broader range of commodity prices
and production rates.
In response to the drop in commodity prices experienced during the second half of 2008, on November 19, 2008,
the Government of Alberta announced the introduction of a five year program of transitional royalty rates with the
intent of promoting new drilling. Under this new program, companies drilling new natural gas or conventional oil
wells (deeper than 1,000 metres and no deeper than 3,500 metres) will be given a one-time option, on a producing
zone per well basis, to adopt either the new transitional royalty rates or those outlined in the ARF. In order to
qualify for this program, wells must be drilled during the period starting on November 19, 2008 and ending on
December 31, 2013. Following this period all new wells drilled will automatically be subject to the ARF.
On March 3, 2009, an incentive program designed to encourage the execution of new drilling projects in Alberta
was announced in response to the global economic crisis and slowdown in drilling activity throughout the province
of Alberta. The incentive program provides for a drilling royalty credit for new conventional oil and natural gas
wells that initiate drilling on or after April 1, 2009 and that complete drilling by March 31, 2010. The incentive
program also provides a reduced royalty rate on new wells for the first year of production or up to an established
total production volume of 50,000 boe (boe cap is calculated at 10:1).
25
Surge Energy Inc. | AR 2010
In 2010, the Government of Alberta announced that this program will be permanently implemented. This
incentive program is expected to positively impact the Corporation.
In April 2010, the Government of Alberta announced an additional royalty incentive program relating to horizontal
oil well drilling projects. Horizontal oil wells drilled on or after May 1, 2010 qualify for the Horizontal Oil New
Well Royalty Rate program. This incentive program provides a reduced royalty rate on new horizontal oil wells for
the first 18 to 48 months of production, based on drilling depth, up to an established total production volume
of 50,000 to 100,000 boe (boe cap is calculated at 10:1).
During 2010, Surge recorded $2.6 million of drilling royalty credits as a reduction to capital costs.
As royalties under the ARF are sensitive to both commodity prices and production levels, the estimated ARF and
corporate royalty rates will fluctuate with commodity prices, well production rates, production decline of existing
wells, and performance and location of new wells drilled.
ROYALTIES
Total ($000s)
% of Revenue
$ per boe
3 MONTHS ENDED DECEMBER 31,
YEARS ENDED DECEMBER 31,
2010
2,371
13%
6.43
2009
% CHANGE
1,466
11%
5.77
62%
2%
11%
2010
8,122
14%
7.35
2009
% CHANGE
5,046
12%
5.23
61%
2%
41%
OPERATING EXPENSE
Operating expense per boe decreased five percent in the fourth quarter of 2010 to $14.87 per boe as compared
to $15.60 per boe in the same period of 2009. Total operating expenses in the fourth quarter of 2010 were
$5.5 million, up 38 percent from $4.0 million in the fourth quarter of 2009. During 2010, operating expense
per boe increased 13 percent during 2010 to $15.25 per boe as compared to $13.52 per boe in the same period
of 2009. Total operating expenses were $16.8 million, up 29 percent from $13.0 million during 2009.
The increase in operating expenses per boe in 2010 compared to the same periods in 2009 was mainly due
to increased workover and maintenance expenditures relating to optimization projects. This increase was also
attributable to increased government and regulatory costs, coupled with higher operating costs per boe on the
acquired Corinthian assets.
Operating expenses per boe fell from $14.98 per boe in the third quarter of 2010 to $14.87 per boe in the
fourth quarter of 2010, a less than one percent reduction. The management team continues to focus on finding
efficiencies within existing operations and expects combined operating and transportation expenses per boe to
continue decline into 2011.
OPERATING EXPENSES
Total ($000s)
$ per boe
3 MONTHS ENDED DECEMBER 31,
YEARS ENDED DECEMBER 31,
2010
5,481
14.87
2009
% CHANGE
2010
2009
% CHANGE
3,962
15.60
38%
(5%)
16,841
13,042
15.25
13.52
29%
13%
Surge Energy Inc. | AR 2010
26
TRANSPORTATION EXPENSES
Transportation expenses in the fourth quarter of 2010 were $0.6 million or $1.72 per boe as compared to
$0.5 million or $1.84 per boe recorded in the same period of 2009. The seven percent decrease in
transportation costs per boe in the fourth quarter of 2010 compared to the same period in 2009 was primarily
the result of a pipeline being constructed, connecting oil production from the Silver Battery. The pipeline tie
in was completed during August of 2010. During 2010, transportation expenses totalled $2.4 million, a
24 percent increase over 2009 expense of $2.0 million. The eight percent increase in transportation costs
per boe during 2010 compared to the same period in 2009 was primarily due to increased tariffs related to
a three year transportation agreement recorded in the first quarter of 2010.
The management team continues to focus on finding efficiencies within existing operations and expects combined
operating and transportation expenses per boe to continue decline.
TRANSPORTATION EXPENSES
Total ($000s)
% of Revenue
$ per boe
3 MONTHS ENDED DECEMBER 31,
YEARS ENDED DECEMBER 31,
2010
634
3%
1.72
2009
468
4%
1.84
% CHANGE
2010
2009
% CHANGE
35%
(1%)
(7%)
2,426
1,961
4%
2.20
5%
2.03
24%
(1%)
8%
GENERAL AND ADMINISTRATIVE EXPENSES (G&A)
Net G&A expenses for the fourth quarter of 2010 increased 38 percent to $5.96 per boe as compared to
$4.32 per boe in the fourth quarter of 2009. Total G&A expenses for the fourth quarter of 2010, net of
recoveries and capitalized amounts of $1.7 million, was $2.2 million, compared to $1.1 million in the fourth
quarter of 2009, after recoveries and capitalized amounts of $0.06 million.
Net G&A expenses during 2010 increased to $5.60 per boe as compared to $4.03 per boe for the same period
of 2009. Total G&A expenses during 2010, net of recoveries and capitalized amounts of $3.1 million, was
$6.2 million, compared to $3.9 million in the same period of 2009, after recoveries and capitalized amounts
of $0.3 million. The increase in net G&A expenses per boe in the fourth quarter and for the year is due primarily
to additional rent on newly acquired office space, increased consulting and legal expenditures and increased
staffing levels in 2010, in order to position the Corporation for future growth.
The increase in recoveries was a result of the management group capitalizing more administrative costs directly
attributable to capital activities, due to an increased focus on these types of activities.
The management team expects G&A expenses per boe to decline throughout 2011.
G&A EXPENSES
Total ($000s)
Recoveries and
capitalized amounts
Net G&A expenses
Net G&A expenses per boe
2010
3,878
(1,682)
2,196
5.96
3 MONTHS ENDED DECEMBER 31,
YEARS ENDED DECEMBER 31,
2009
% CHANGE
2010
2009
% CHANGE
1,155
236%
9,281
4,209
121%
(57)
2,851%
(3,096)
(323)
859%
1,098
4.32
100%
38%
6,185
5.60
3,886
4.03
59%
39%
27
Surge Energy Inc. | AR 2010
RECAPITALIZATION COSTS
On April 13, 2010, the Corporation was recapitalized by a new management group and Board of Directors. During
the course of the recapitalization, certain non-recurring recapitalization costs were incurred. These costs do not
reflect the ongoing cost of business incurred by Surge and are comprised primarily of legal fees, financial adviser
fees, severance and transaction due diligence costs.
RECAPITALIZATION COSTS
Recapitalization costs ($000s)
INTEREST EXPENSE
3 MONTHS ENDED DECEMBER 31,
YEARS ENDED DECEMBER 31,
2010
-
2009
% CHANGE
-
-
2010
5,409
2009
% CHANGE
-
nm
Surge incurred interest expense of $0.3 million or $0.80 per boe in the fourth quarter of 2010 as compared to
$0.6 million or $2.37 per boe in the fourth quarter of 2009, a decrease of 66 percent per boe. During 2010, the
Corporation incurred interest expense of $1.0 million or $0.90 per boe as compared to $2.0 million or $2.11 per
boe during 2009, a decrease of 57 percent. The decrease is due to the repayment of Surge’s outstanding debt
during the second quarter of 2010 and the reduced outstanding balance throughout the remainder of 2010.
INTEREST EXPENSE
Interest expense ($000s)
$ per boe
NETBACKS
3 MONTHS ENDED DECEMBER 31,
YEARS ENDED DECEMBER 31,
2010
295
0.80
2009
601
2.37
% CHANGE
(51%)
(66%)
2010
998
0.90
2009
% CHANGE
2,036
2.11
(51%)
(57%)
During 2010, the operating netback per boe (defined as revenue excluding realized and unrealized gains or losses
on commodity contracts per boe less royalties, operating and transportation expenses on a per boe basis) of the
Corporation was $27.65 per boe, a 17 percent increase over the $23.64 per boe recorded during 2009. The
increase in operating netback was largely due to an 18 percent increase in revenue per boe, partially offset by a
41 percent increase in royalty expenses per boe, a 13 percent increase in operating costs per boe and an eight
percent increase in transportation expenses per boe during 2010 as compared to the same period in 2009.
Surge’s operating netback per boe was $27.31 in the fourth quarter of 2010, a one percent decrease from
$27.69 recorded in the fourth quarter of 2009. The decrease in operating netback was largely due to an
11 percent increase in royalty expenses per boe partially offset by a five percent decrease in operating costs
per boe and a seven percent decrease in transportation expense per boe in the fourth quarter of 2010,
compared to the same period in 2009.
During 2010, the corporate netback per boe (defined as operating netback per boe less G&A and interest expense
per boe) of the Corporation was $21.15 per boe, a 21 percent increase over the $17.50 per boe recorded during
2009. The increase in corporate netback was impacted by the increase in G&A expense per boe in 2010 and
offset by a decrease in interest expense per boe, as compared to the same period in 2009.
Surge Energy Inc. | AR 2010
28
Surge’s corporate netback per boe was $20.55 in the fourth quarter of 2010, a two percent decrease as
compared to $21.00 in the fourth quarter of 2009. The decrease in corporate netback was impacted by the
increase in G&A expense per boe in 2010 and offset by a decrease in interest expense per boe, as compared to
the same period in 2009.
The management team continues to focus on finding efficiencies within existing operations and expects both
operating and corporate netbacks to continue to grow throughout 2011.
CORPORATE AVERAGE NETBACKS
($ PER BOE, EXCEPT PRODUCTION)
2010
2009
% CHANGE
2010
2009
% CHANGE
3 MONTHS ENDED DECEMBER 31,
YEARS ENDED DECEMBER 31,
Average production
(boe per day)
Revenue
Royalties
Operating costs
Transportation costs
Operating netback
G&A expense
Interest expense
Corporate netback
4,005
50.33
2,762
50.90
(6.43)
(5.77)
(14.87)
(15.60)
(1.72)
27.31
(5.96)
(0.80)
20.55
(1.84)
27.69
(4.32)
(2.37)
21.00
45%
(1%)
11%
(5%)
(7%)
(1%)
38%
(66%)
(2%)
3,026
52.45
2,643
44.42
(7.35)
(5.23)
(15.25)
(13.52)
(2.20)
27.65
(5.60)
(0.90)
21.15
(2.03)
23.64
(4.03)
(2.11)
17.50
14%
18%
41%
13%
8%
17%
39%
(57%)
21%
FUNDS FROM OPERATIONS AND CASH FLOW FROM OPERATIONS
For the fourth quarter of 2010 funds from operations increased by 49 percent to $7.9 million compared to
$5.3 million in the fourth quarter of 2009. On a per share basis, funds from operations decreased by 53 percent
to $0.15 per basic share in the fourth quarter 2010 from $0.32 per basic share in the same period of 2009
due to equity issuances in the past year. Funds from operations increased by three percent on a per boe basis
to $21.46 in the fourth quarter of 2010 from $20.94 in the fourth quarter of 2009.
During the past year, funds from operations increased by 47 percent to $25.7 million compared to $17.5 million
during 2009. On a per share basis, funds from operations decreased by 33 percent to $0.70 per basic share
during 2010 from $1.05 per basic share in the same period of 2009 due to equity issuances. Funds from
operations increased by 28 percent on a per boe basis to $23.26 during 2010 from $18.13 during 2009.
Cash flow from operations differs from funds from operations due to the inclusion of changes in non-cash
working capital, as well as non-recurring recapitalization costs. Cash flow from operations for the fourth quarter
of 2010 was $0.6 million as compared to $5.7 million in the fourth quarter of 2009. Included in cash flow
from operations is a decrease in non-cash working capital of $7.4 million for the fourth quarter of 2010 and
an increase of $0.4 million for the same period of 2009. Cash flow from operations during the past year was
$17.1 million as compared to $16.3 million during 2009. Included in cash flow from operations is a decrease
in non-cash working capital of $3.1 million during the past year, as well as a decrease due to recapitalization
costs of $5.4 million, and a decrease of $1.2 million for the same period of 2009.
29
Surge Energy Inc. | AR 2010
FUNDS FROM OPERATIONS
Funds from operations ($000s)
Per share - basic
Per share - diluted
Per boe
Cash flow from operations ($000s)
3 MONTHS ENDED DECEMBER 31,
YEARS ENDED DECEMBER 31,
2010
7,907
0.15
0.15
21.46
594
2009
% CHANGE
2010
2009
% CHANGE
5,320
49%
25,688
17,492
0.32
0.32
20.94
5,732
(53%)
(53%)
0.70
0.70
1.05
1.05
3%
23.26
18.13
(90%)
17,137
16,341
47%
(33%)
(33%)
28%
5%
STOCK-BASED COMPENSATION
Surge recorded stock-based compensation expense of $0.7 million in the fourth quarter of 2010 compared to
$0.2 million for the same period of 2009, calculated using the Black-Scholes option-pricing model. During
2010, Surge recorded stock-based compensation expense of $5.4 million compared to $0.4 million for the
same period of 2009.
During 2010, 2,636,000 options were issued at a weighted average exercise price of $6.38 per option and
295,000 options were forfeited at a weighted average price of $6.61 per option. In addition, as a result of
the recapitalization transaction, all options held on April 13, 2010 vested in full and the remaining stock-based
compensation on these options was recognized in the second quarter of 2010.
Included in stock-based compensation expense during 2010 is $3.6 million of stock based compensation
expense related to the fair value of flow-through share premiums and performance warrants issued on
April 13, 2010 as part of the recapitalization transaction. This amount was recorded in the second
quarter of 2010.
The following assumptions were used to calculate stock-based compensation during 2010: zero dividend yield;
expected volatility of 69 percent; risk free rate of two percent; and expected life of five years.
STOCK-BASED COMPENSATION EXPENSE
Stock-based compensation expense ($000s)
Per boe
3 MONTHS ENDED DECEMBER 31,
YEARS ENDED DECEMBER 31,
2010
680
1.85
2009 % CHANGE
211
0.83
222%
123%
2010
5,351
4.85
2009 % CHANGE
381
0.39
nm
nm
DEPLETION, DEPRECIATION AND ACCRETION (DD&A)
Depletion and depreciation are calculated based upon capital expenditures, production rates and reserves.
Surge uses the asset retirement obligation method to record the present value of estimated clean-up and
restoration costs for all of its facilities, including well sites and pipelines. The liability amount is increased each
reporting period due to the passage of time and the amount of accretion is charged to earnings in the period.
Excluded from the Corporation’s depletion and depreciation calculation are costs associated with salvage values,
unproven properties and seismic of $107.1 million. Future development costs for proved reserves of $63.8 million
have been included in the depletion calculation.
Surge Energy Inc. | AR 2010
30
Surge recorded $8.5 million or $22.94 per boe in DD&A expense in the fourth quarter of 2010, a 25 percent
increase as compared to $18.32 per boe in DD&A expense in the fourth quarter of 2009.
During 2010, $23.7 million or $21.44 per boe in DD&A expense were recorded, a nine percent increase as
compared to $19.72 per boe in DD&A expense during 2009.
The DD&A calculation is based on production volumes of 368,460 boe for the quarter and 1,104,490 boe for
the year ended December 31, 2010. This increase in the DD&A rate per boe is due to the corporate acquisitions
completed during the three months and year ended December 31, 2010.
DEPLETION, DEPRECIATION AND ACCRETION (DD&A) EXPENSE
(DD&A) ($000s)
Per boe
3 MONTHS ENDED DECEMBER 31,
YEARS ENDED DECEMBER 31,
2010
8,454
22.94
2009
% CHANGE
2010
2009
% CHANGE
4,654
18.32
82%
25%
23,681
19,022
21.44
19.72
24%
9%
INCOME AND OTHER TAXES
Surge recognized a combined net future tax liability of approximately $34.6 million as at December 31, 2010,
an increase of $16.9 million from the year-end 2009 future tax liability of $17.6 million. The future tax liability
increased by $0.7 million related to the $2.6 million of flow-through shares issued in 2009 and renounced in
2010. The future tax liability also increased by $17.5 million related to Corinthian acquisition and decreased by
$0.1 million due to the Crystal Lake acquisition. The future tax liability also decreased by the future tax reduction
of $0.8 million for the year ended December 31, 2010.
As at December 31, 2010, the Corporation had incurred the entire $2.6 million towards this flow-through share
obligation and has satisfied the terms of this flow-through share offering.
The provision for income taxes differs from the amount obtained by applying the combined federal and provincial
income tax rate for 2010, which was 28 percent and is calculated on earnings before income taxes. The
difference is mainly due to future tax rate differences.
TAX EXPENSES (REDUCTION)
Tax expenses (reduction) ($000s)
Per boe
NET INCOME (LOSS)
3 MONTHS ENDED DECEMBER 31,
YEARS ENDED DECEMBER 31,
2010
248
0.67
2009
% CHANGE
(485)
1.91
(151%)
(65%)
2010
(821)
(0.74)
2009
% CHANGE
(1,604)
(1.66)
(49%)
(55%)
The Corporation recorded net losses for the three months ended December 31, 2010 of $4.1 million or $0.08 per
basic share, a decrease of 100 percent from the $0.00 per basic share recorded for the comparable three months
of 2009. During 2010, the Corporation recorded net losses of $10.3 million or $0.28 per basic share, a decrease
of 115 percent from the $0.13 per basic share recorded during 2009. The non-recurring recapitalization costs,
combined with the increased stock-based compensation that resulted from the recapitalization and prior period
royalty adjustments recorded in the second quarter of 2010, were large contributors to the net loss.
31
Surge Energy Inc. | AR 2010
NET INCOME (LOSS)
Total ($000s)
Per share - basic
Per share - diluted
3 MONTHS ENDED DECEMBER 31,
YEARS ENDED DECEMBER 31,
2010
(4,147)
(0.08)
(0.08)
2009
(21)
-
-
% CHANGE
2010
2009
% CHANGE
nm
nm
nm
(10,326)
(2,112)
(0.28)
(0.28)
(0.13)
(0.13)
389%
115%
115%
NET INCOME (LOSS) EXCLUDING NON-RECURRING CHARGES RELATING
TO THE RECAPITALIZATION
($000S)
Net loss (per GAAP)
Add back:
Recapitalization costs
Stock-based compensation
expense relating to the recapitalization
Net income (loss) excluding non-recurring
charges relating to the recapitalization
CAPITAL EXPENDITURES
3 MONTHS ENDED DECEMBER 31,
YEARS ENDED DECEMBER 31,
2010
(4,147)
2009
(21)
2010
(10,326)
2009
(2,112)
-
-
-
-
5,409
3,610
-
-
(4,147)
(21)
(1,307)
(2,112)
Cash-based capital expenditures, net of any applicable Alberta drilling royalty credits, for the fourth quarter of
2010 were $92.7 million, an $87.6 million increase from the $5.2 million spent in the fourth quarter of 2009.
During 2010, Surge invested $31.5 million ($28.9 million net of $2.6 million in Alberta drilling royalty credits)
to drill 22 gross (21.5 net) wells, $5.9 million on seismic and land acquisitions, $4.9 million on facilities and
equipment, $76.8 million on property acquisitions ($75.3 million net of $1.4 million in disposition),
$113.5 million on corporate acquisitions and $2.4 million on other capital items.
Non-cash corporate and property acquisition costs consist primarily of future income taxes and asset
retirement obligations.
Surge Energy Inc. | AR 2010
32
147%
185%
69%
(15%)
nm
137%
100%
100%
100%
nm
nm
100%
100%
63%
100%
nm
nm
CAPITAL EXPENDITURE SUMMARY
3 MONTHS ENDED DECEMBER 31,
YEARS ENDED DECEMBER 31,
($000s)
Land and seimic
Drilling and intangibles
2010
1,441
22,204
Alberta drilling royalty credits
(1,388)
Facilities and equipment
Other
3,116
1,092
2009
585
3,202
(1,193)
2,558
1
26,465
5,154
% CHANGE
146%
593%
16%
22%
100%
414%
2010
5,877
2009
% CHANGE
2,382
31,495
11,042
(2,615)
(1,543)
4,882
2,357
5,812
20
41,996
17,713
Corporate acquisitions
Property acquisitions
Property dispositions
-
67,670
(1,431)
Total cash and share-based
acquisitions / dispositions
66,239
-
-
-
-
- %
113,469
100%
100%
76,774
(1,431)
nm
188,812
-
-
-
-
Total cash and
share-based capital
Non-cash corporate
acquisition costs
Non-cash property
acquisition costs
Non-cash ARO
Asset Additions
Capitalized SBC
including future taxes
Total non-cash-based capital
92,704
5,154
nm
230,808
17,713
-
1,228
109
794
2,131
-
-
-
-
-
- %
21,318
100%
1,228
100%
286
100%
100%
4,007
26,839
-
-
175
-
175
Total capital additions
94,835
5,154
nm
257,647
17,888
33
Surge Energy Inc. | AR 2010
QUARTERLY AND ANNUAL FINANCIAL INFORMATION
YEAR
END
2010
Q4
Q3
Q2
Q1
2010
2010
2010
2010
YEAR
END
2009
Q4
Q3
Q2
Q1
2009
2009
2009
2009
YEAR
END
2008
57,927
18,544
14,264
11,141
13,978
42,853
12,932
10,788
9,829
9,304
71,160
(2,349)
(2,648)
(1,110)
23
1,386
(1,222)
(1,116)
1,026
(22)
(1,110)
1,852
506
391
-
-
115
840
-
-
840
-
3,053
Oil, natural gas
& NGL sales
Unrealized gain
(loss) on financial
derivatives)
Provision for
bad debt
Net earnings (loss)
(10,326)
(4,147)
(832)
(7,515)
2,168
(2,112)
(21)
844
(1,294)
(1,641)
7,698
Net earnings (loss)
per share ($)
Basic
Diluted
(0.28)
(0.08)
(0.02)
(0.27)
0.12
(0.13)
(0.28)
(0.08)
(0.02)
(0.27)
0.11
(0.13)
Total assets
377,577
Total long-term
financial liabilities
30,000
-
-
-
-
-
-
- 132,360
-
41,650
-
-
-
-
0.05
(0.08)
(0.10)
0.05
(0.08)
(0.10)
0.45
0.45
-
-
-
-
- 135,410
-
39,650
Average daily sales
Oil & NGL (bbls/d)
1,871
2,308
1,841
1,621
1,707
1,477
1,614
1,428
1,374
1,492
1,365
Natural gas (mcf/d)
6,930
10,182
7,783
3,823
5,874
6,995
6,887
6,295
7,586
7,223
9,056
Barrels of oil
equivalent
(boe per day) (6:1)
Average sales price
Natural gas
($/mcf)
Oil & NGL
($/bbl)
Barrels of oil
equivalent ($/boe)
3,026
4,005
3,138
2,258
2,686
2,643
2,762
2,478
2,638
2,695
2,875
3.96
3.55
3.71
3.74
5.20
4.85
4.63
4.28
3.59
5.41
8.38
69.83
70.70
69.33
66.57
72.35
58.84
69.52
62.39
58.48
42.18
82.77
52.45
50.33
49.41
54.22
57.83
45.32
51.44
47.34
39.88
37.82
65.96
Surge Energy Inc. | AR 2010
34
SHARE CAPITAL AND OPTION ACTIVITY
Q4
2010
Q3
2010
Q2
2010
Q1
2010
Q4
2009
Q3
2009
Q2
2009
Q1
2009
53,065,155 30,874,642
27,589,374
18,576,487
16,669,721
16,666,811
16,668,503
16,695,117
-
-
-
457,033
-
69,353
-
-
53,065,155 30,874,642
27,589,374
19,033,520
16,669,721
16,736,164
16,668,503
16,695,117
Weighted
Common Shares
Stock option dilution
(treasury method)(1)
Weighted average
dilution shares
oustanding(1)
(1) In computing the net loss per diluted share, nil shares were added to the weighted average number of shares outstanding because
they were anti-dilutive.
On January 19, 2010, the Corporation issued 848,600 units at a price of $3.00 per unit, with each unit
consisting of one common share and one-half of a common share purchase warrant (with each whole warrant
exercisable into one common share at a price of $4.00 per share until December 23, 2010), for total gross
proceeds of $2,545,800. Certain former officers and directors purchased 20,000 units for total gross
proceeds of $60,000.
On January 29, 2010, the Corporation issued 78,333 units at a price of $3.00 per unit, with each unit
consisting of one common share and one-half of a common share purchase warrant (with each whole warrant
exercisable into one common share at a price of $4.00 per share until December 23, 2010), for total gross
proceeds of $235,000.
On April 13, 2010, pursuant to a private placement, the new management group, together with certain additional
subscribers identified by the new management group, subscribed for 1,394,317 common units of the Corporation
at a price of $4.40 per common unit, 1,787,500 common shares of the Corporation at a price of $4.40 per
common share and 681,819 flow-through units at a price of $4.40 per flow-through unit, for total proceeds to
the Corporation of approximately $17,000,000. Each common unit is comprised of one common share and one
common share performance warrant, entitling the holder to purchase one common share at a price of $5.17
for a period of five years. Each flow-through unit is comprised of one common share issued on a flow-through
basis pursuant to the Income Tax Act of Canada and one common share performance warrant, also entitling
the holder to purchase one common share at a price of $5.17 for a period of five years. The common and
flow-through shares issued as part of the common and flow-through units were ascribed a value of $3.30 per
share or $6,851,000 due to the escrow restrictions described below. For further details on the vesting conditions
and valuation of the common share performance warrants, please refer to note 8(d). The Corporation also
recorded $331,000 of stock-based compensation on the flow-through units.
All of the units issued were acquired by contractors, employees, officers or directors of the Corporation (“deemed
service providers”). For deemed service providers, units acquired through the private placement are held under
an escrow agreement in which one-third of the units are to be released equally every six months following the
date of issuance. No securities will be released from escrow after the date the deemed service provider ceases
to be a service provider, unless directed by a resolution of the Board of Directors. Upon the deemed service
provider ceasing to be a service provider, Surge will repurchase for cancellation or provide for a transfer to another
deemed service provider all of the securities of the deemed service provider then held in escrow at a price equal
to the lessor of $4.40 per unit and the market price of the common shares of Surge on the last day of trading
immediately prior to the deemed service provider ceasing to be a service provider.
35
Surge Energy Inc. | AR 2010
On May 5, 2010, the Corporation issued 6,945,000 common shares at a price of $7.20 per share for gross
proceeds of $50,004,000, pursuant to a short form prospectus.
On July 9, 2010, the Corporation issued 16,025,529 common shares at an ascribed price of $5.90 per share
in connection with the acquisition of Corinthian Energy Corp.
On July 19, 2010, the Corporation issued 288,639 common shares at an ascribed price of $5.90 per share
in connection with the acquisition Crystal Lake Resources Ltd.
On November 1, 2010, the Corporation issued 8,001,000 common shares at a price of $5.25 per share for gross
proceeds of $42.0 million.
During 2010, 672,199 warrants were exercised. As a result, the Corporation issued 672,199 common shares at
a price of $4.00 for gross proceeds of $2.7 million.
During 2010, two share purchase loans aggregating $360,000 due from two former officers of the Corporation
were repaid. The loans bore interest at a rate of 4.75 percent and were due on June 30, 2010. The entire amount
of the principal and interest outstanding has been repaid and the related common shares totaling 160,000 were
issued. The 160,000 shares attributable to the share purchase loans had been included in stock options.
On April 26, 2011 Surge had 56,096,547 common shares, 2,076,136 performance warrants and 3,081,666
options outstanding.
LIQUIDITY AND CAPITAL RESOURCES
On December 31, 2010, Surge had a net working capital deficit of $48.1 million including unrealized hedging
losses of $2.6 million, as well as bank debt of $30 million.
Surge anticipates that future capital requirements will be funded through a combination of internal cash flow,
divestitures, debt and/or equity financing. There is no assurance that debt and equity financing will be available
on terms acceptable to the Corporation to meet its capital requirements.
The Corporation has a $105.0 million extendible, revolving term credit facility with a Canadian bank bearing
interest at bank rates. The facility is available on a revolving basis until July 13, 2011. On July 13, 2011, at the
Corporation’s discretion, the facilities are available on a non-revolving basis for a one-year period, at the end of
which time the facility would be due and payable. Alternatively, the facilities may be extended for a further
364-day period at the request of the Corporation and subject to the approval of the bank. As the available
lending limits of the facilities are based on the bank’s interpretation of the Corporation’s reserves and future
commodity prices there can be no assurance that the amount of the available facilities will not decrease at the
next scheduled review. Interest rates vary depending on the ratio of net debt to cash flow. Under the terms of
the agreement, the Corporation is required to meet certain financial and engineering reporting requirements.
The Corporation defines net debt as outstanding bank plus or minus cash-based working capital:
NET DEBT
($000s)
Bank Debt
Cash
Accounts receivable
Prepaid expenses and deposits
Accounts payable
Total
$(30,000)
1,437
12,404
1,657
(31,738)
$(46,240)
Surge Energy Inc. | AR 2010
36
The facility is secured by a general assignment of book debts, debentures of $200.0 million with a floating charge
over all assets of the Corporation with a negative pledge and undertaking to provide fixed charges on the major
producing petroleum and natural gas properties at the request of the bank.
RELATED-PARTY AND OFF-BALANCE-SHEET TRANSACTIONS
Certain former officers and directors of the Corporation purchased 20,000 units for total gross proceeds of
$60,000 as part of the January 19, 2010 equity offering.
Certain officers and directors of the Corporation purchased 1,099,413 common units, 661,951 flow-through
units and 9,088 common shares as part of the April 13, 2010 private placement.
At December 31, 2009, two share purchase loans aggregating $360,000 were due from two former officers of
the Corporation and had been deducted from share capital. The loans bore interest at a rate of 4.75 percent and
were due on June 30, 2010. On April 13, 2010, the entire amount of the principal and interest outstanding has
been repaid and the related common shares totaling 160,000 have been issued.
Surge was not involved in any off-balance-sheet transactions during the three months or year ended
December 31, 2010 other than those mentioned under contracted obligations below.
CONTRACTUAL OBLIGATIONS AND CONTINGENCIES
The Corporation has entered into farm-in agreements in the normal course of its business. The Corporation
is also contractually obligated under its debt agreements as outlined under liquidity and capital resources.
Surge has future minimum payments relating to its operating leases and firm service transport agreements
totalling $9.5 million, as summarized below:
COMMITMENTS
($000s)
2011
2012
2013
2014
2015
2016+
Total
$ 1,599
2,245
1,611
1,109
960
2,019
$ 9,543
In 2009, the Corporation issued a total of 757,000 flow-through common shares at $3.40 per share for gross
proceeds of $2.6 million. The Corporation renounced these qualifying petroleum and natural gas expenditures on
December 31, 2009. As at December 31, 2010, the Corporation had incurred the entire $2.6 million towards this
flow-through share obligation and has satisfied the terms of this flow-through share offering.
In 2010, the Corporation issued a total of 681,819 flow-through common shares at $4.40 per share as part of a
flow-through unit for gross proceeds of $3.0 million. The Corporation renounced these qualifying petroleum and
natural gas expenditures effective December 31, 2010. As at December 31, 2010 Corporation had incurred
$0.8 million towards this flow-through share obligation and has until December 31, 2011 to incur the
$2.2 million of remaining expenditures.
37
Surge Energy Inc. | AR 2010
FINANCIAL INSTRUMENTS
Derivative contracts are recorded at fair value based on an estimate of the amounts that would have been received
or paid to settle these instruments prior to maturity given future market prices and other relevant factors. The
actual amounts received or paid to settle these instruments at maturity could differ significantly from
those estimated.
The following table outlines the realized and unrealized gains (losses) on oil and gas commodity contracts for the
year ended December 31, 2010:
FINANCIAL INSTRUMENTS
TERM
TYPE
(FLOATING
TO FIXED)
SWAP PRICE
(SURGE
RECEIVES)
(C$)
VOLUME
Jan 1 – Dec 31, 2010
Swap
2,000 GJs/d
$5.80
Apr 1 – Oct 31, 2010
Swap
1,000 GJs/d
$5.32
Nov 1, 2009 - Mar 31, 2010
Swap
500 GJs/d
$6.00
Jan 1 to Dec 31, 2011
Call
500 GJs/d
$6.55
Jan 1 to Dec 31, 2011
Put
500 GJs/d
$5.00
Mar 1, 2009 - Dec 31, 2010
Swap
750 GJs/d
$5.64
INDEX (SURGE PAYS)
(C$)
AECO Monthly
Average
AECO Monthly
Average
AECO Monthly
Average
AECO Monthly
Average
AECO Monthly
Average
AECO Monthly
Average
Jan 1 to Dec 31, 2010
Swap
100 bbls/d
$86.00
WTI - NYMEX
Jan 1 to Dec 31, 2010
Swap
100 bbls/d
$84.00
WTI - NYMEX
Jan 1 to Dec 31, 2010
Swap
100 bbls/d
$86.00
WTI - NYMEX
Jan 1 to Dec 31, 2010
Swap
200 bbls/d
$81.00
WTI - NYMEX
Feb 1 to Dec 31, 2010
Swap
100 bbls/d
$87.75
WTI - NYMEX
Feb 1 to Dec 31, 2010
Swap
100 bbls/d
$87.90
WTI - NYMEX
YEAR ENDED
DEC 31, 2010
UNREALIZED
GAINS
(LOSSES)
(C$000S)
-
-
-
(2)
454
-
-
-
-
-
-
-
Jan 1 to Dec 31, 2011
Swap
250 bbls/d
$80.00
WTI - NYMEX
(1,247)
Jan 1 to Dec 31, 2011
Call
250 bbls/d
$96.55
WTI - NYMEX
415
Jan 1 to Dec 31, 2011
Swap
250 bbls/d
$80.00
WTI - NYMEX
(1,247)
Jan 1 to Dec 31, 2011
Jan 1 to Dec 31, 2011
Call
Call
250 bbls/d
$91.00
WTI - NYMEX
125 bbls/d
$78.40
WTI - NYMEX
Jan 1 to Dec 31, 2011
Swap
250 bbls/d
$85.50
WTI - NYMEX
Jan 1 to Dec 31, 2011
Put
250 bbls/d
$78.40
WTI - NYMEX
661
(757)
(749)
123
YEAR ENDED
DEC 31,
2010
REALIZED
GAINS
(LOSSES)
(C$000S)
1,459
377
42
-
-
261
151
78
151
(63)
197
201
-
-
-
-
-
-
-
Total
(2,349)
2,854
Surge Energy Inc. | AR 2010
38
The following table outlines the unrealized and realized loss on an interest rate swap contract for the year ended
December 31, 2010:
TYPE
(FLOATING
TO FIXED)
TERM
AMOUNT (C$)
Feb 24 – Apr 15, 2010
Swap
35,000,000
COMPANY
FIXED
INTEREST
RATE (%)
4.42 to
4.44
COUNTER
PARTY
FLOATING
RATE INDEX
CAD-BA-
CDOR
YEAR ENDED
DEC 31, 2010
YEAR ENDED
DEC 31, 2010
UNREALIZED
GAINS
(LOSSES) (C$)
REALIZED
LOSSES (C$)
-
(60)
SUBSEQUENT EVENTS
Subsequent to December 31, 2010, the Corporation entered into seven financial oil contracts:
TERM
VOLUME
FLOOR PRICE (C$)
OTHER TERMS
Apr 1 to Dec 31, 2011
250 bbls/day
$80.00
Jul 1 to Dec 31, 2011
250 bbls/day
$90.00
Jan 1 to Dec 31, 2012
250 bbls/day
Jan 1 to Dec 31, 2012
250 bbls/day
$97.00
$80.00
Jan 1 to Dec 31, 2012
250 bbls/day
$90.00
Jan 1 to Dec 31, 2012
250 bbls/day
$80.00
Jan 1 to Dec 31, 2012
500 bbls/day
$90.00
Participation in 100% of the upside
above $84.35 CDN per barrel.
Participation in upside above $90.00
CDN per barrel at a rate of 74%.
N/A
Participation in upside above $80.00
CDN per barrel at a rate of 75%.
Participation in upside above $90.00
CDN per barrel at a rate of 63%.
Participation in 100% of the upside
above $89.95 CDN per barrel.
Participation in 68.5% of the upside
above $90.00 CDN per barrel.
NEW ACCOUNTING PRONOUNCEMENTS
INTERNATIONAL FINANCIAL REPORTING STANDARD
Effective January 1, 2011, Canadian public companies are required to adopt International Financial Reporting
Standards (“IFRS”) which will include comparatives for 2010. Surge’s financial statements up to and including
December 31, 2010 have been reported in accordance with Canadian GAAP as it existed on each reporting date.
Financial statements for the quarter ended March 31, 2011, including comparative amounts, will be prepared
on an IFRS basis.
A transition plan has been developed to convert the financial statements to IFRS. External advisors have been
retained and will continue to assist management with the project on an as needed basis. Training has been
provided to key employees and staff training programs will continue as needed. The Corporation continues to
assess the effect of the transition on information systems, internal controls over financial reporting and
disclosure controls and procedures.
Systems and controls are being updated as IFRS accounting processes are implemented. Significant system and
control changes are not anticipated. The project team continues to provide updates to senior management and the
Audit Committee. Calculations of the impact of changes in accounting policy have been prepared by management
and have not been approved by the Corporation’s Board of Directors or reviewed by the Corporation’s auditors.
The Corporation’s auditors have been involved throughout the process to ensure the Corporation’s policies are in
accordance with the new standards.
39
Surge Energy Inc. | AR 2010
There are significant accounting policy changes anticipated on adoption of IFRS which are described in more detail
below. Most adjustments required on transition to IFRS will be made retrospectively against opening retained
earnings as of the date of the first comparative balance sheet being January 1, 2010. In July 2009, the International
Accounting Standards Board (“IASB”) issued amendments to IFRS 1 “First time adoption of IFRS” allowing
additional exemptions for first-time adopters. Under these amendments, full cost oil and gas companies can elect
to use the recorded amount under a previous GAAP as the deemed cost for oil and gas assets on the transition date
to IFRS. Surge is planning to adopt this exemption. Management has analyzed the various other accounting policy
choices available under IFRS 1 and has determined the following to be most appropriate for Surge:
• Oil and gas properties formerly classified as Property, Plant and Equipment (“PP&E”) will be classified
under IFRS as either Development and Production assets (“D&P”) or Exploration and Evaluation assets
(“E&E”). Upon transition to IFRS, Surge will reclassify all E&E expenditures included in the PP&E balance
under Canadian GAAP, as a separate item under IFRS. These assets will be measured at cost and will not be
depleted but will be assessed for impairment when indicators suggest the possibility of impairment. Once
these E&E assets have reached technical feasibility and commercial viability, they will be transferred to D&P.
At the time of transfer, they will be subjected to an impairment test. Surge’s E&E assets will primarily consist
of undeveloped exploration lands and at January 1, 2010 are estimated at $0.3 million.
• Under IFRS, D&P assets are grouped into areas designated as cash generating units (“CGU”) for the purposes
of impairment testing and further broken down into components within the CGU for purposes of depletion
and depreciation. IFRS 1 provides for the allocation of the Canadian GAAP net book value of PP&E assets
excluding E&E assets, to IFRS CGUs and components on a pro rata basis using the reserve volumes or values
as at December 31, 2009. Surge has elected to allocate the D&P balance using reserve values and at
January 1, 2010, the value allocated to the PP&E assets is approximately $126.5 million.
• Under IFRS, divestitures of an oil and gas property will generally result in a gain or loss recognized in earnings.
Under Canadian GAAP, proceeds of divestitures are deducted from the full cost pool without recognition of
a gain or loss unless such a deduction resulted in a change to the depletion rate of 20 percent or greater.
• Under Canadian GAAP, impairment testing on oil and gas properties is performed at a cost centre level.
Under IFRS, impairment testing will be performed at the CGU level. This will result in a greater number of
impairment tests. At January 1, 2010, Surge did not have any impairment on its D&P assets under IFRS.
• Depletion and depreciation of D&P will be calculated at a component level. Depletion of resource properties
within D&P will be calculated using the unit-of-production method under IFRS with the option to base the
calculation on proved reserves or proved plus probable reserves. Surge will use proved plus probable reserves
to calculate the depletion of resource properties. Surge expects that depletion expense for the year ended
December 31, 2010 will be lower than currently reported under Canadian GAAP. Depreciation of office
equipment will continue to be calculated using a declining balance method.
•
IFRS 1 allows Surge to use the IFRS rules for business combinations on a prospective basis rather than
restating all business combinations prior to transition on January 1, 2010. Surge will elect to use this
exemption; therefore, Surge will not be recording any adjustments to retrospectively restate any of its
business combinations that have occurred prior to January 1, 2010. Under IFRS reporting, Surge will restate
two business combinations that occurred in each of the third and fourth quarters of 2010. Transaction costs
capitalized under Canadian GAAP to PP&E are expensed under IFRS.
• Under Canadian GAAP, Surge’s Asset Retirement Obligation is discounted over its life based on a credit
adjusted risk free rate which was 7.7 percent at December 31, 2009. Under IFRS, Surge is required to
revalue its liability for asset retirement costs at each balance sheet date using a risk-free discount rate. As
a result, the Corporation’s Asset Retirement Obligation will increase upon transition to IFRS as the liability
will be re-valued using a discount rate of 4.00 percent to reflect the Corporation’s estimated risk-free rate of
interest. The revalued Asset Retirement Obligation at the transition date is estimated at $13.0 million, with a
corresponding decrease in future tax of $2.0 million, the offsetting net increase in the liability of $5.0 million
charged to retained earnings.
Surge Energy Inc. | AR 2010
40
• Under IFRS, share-based payments are expensed based on a graded vesting schedule, which was also
permitted under GAAP. Surge has historically recorded stock-based compensation using the graded method,
which results in front loading of the expense. IFRS differs from GAAP in that the Corporation will also be
required to incorporate a forfeiture multiplier rather than account for forfeitures as they occur as currently
practiced under Canadian GAAP. The Corporation’s historical forfeiture rate is close to zero percent, and
therefore no opening balance sheet adjustment is anticipated.
• Under IFRS, risk-sharing agreements in which the Corporation cedes a portion of its working interest to a
third-party are generally considered to be disposals of property, plant and equipment, potentially resulting in
a gain or loss on disposition. Under the Corporation’s existing Canadian GAAP, no gain or loss is recorded on
these or other dispositions where the change in consolidated depletion is less than 20 percent. There is no
equivalent exemption in IFRS. As a result, it is expected that the Corporation will record gains or losses on
risk-sharing arrangements and other disposition transactions under IFRS. There is no impact on transition to
IFRS as result of this requirement. Subsequent to transition, the significance of these gains or losses will be
dependent on the details of specific transactions.
• Under Canadian GAAP, the future tax liability associated with the renouncement of tax deductions from the
issuance of flow through shares was recorded as a reduction in share capital at the time of renouncement.
Under IFRS, the difference between the future tax liability associated with the renouncement of the tax
deductions and the premium price received on the issuance of flow through shares over the market value of
the Corporation’s common shares at the time of issue is recorded as a future tax expense as the expenditures
are incurred. This future tax expense effectively represents the net loss on the distribution of the tax
deductions to investors. The transitional adjustment results in an increase of $2.5 million, before
the associated tax impact, to share capital with a resulting offset being charged to retained earnings.
In the first quarter of 2011, the Corporation plans to prepare its 2010 IFRS comparative quarterly financial
statements and will assess and continue to review the impact of the IFRS changes on disclosure controls and
internal controls, including identification of instances where controls may require amendments or additions in
order to address the accounting policy changes required under IFRS. No material changes in control procedures
are anticipated.
CRITICAL ACCOUNTING ESTIMATES
OIL AND NATURAL GAS RESERVES
Under National Instrument 51-101 (N.I. 51-101), “proved” reserves are those reserves that can be estimated
with a high degree of certainty to be recoverable, i.e., that it is likely that the actual remaining quantities
recovered will exceed the estimated proved reserves. In accordance with this definition, the level of certainty
targeted by the reporting corporation should result in at least a 90 percent probability that the quantities actually
recovered will equal or exceed the estimated reserves. In the case of “probable” reserves, which are obviously
less certain to be recovered than proved reserves, N.I. 51-101 states that it must be equally likely that the
actual remaining quantities recovered will be greater or less than the sum of the estimated proved plus probable
reserves. With respect to the consideration of certainty, in order to report reserves as proved plus probable, the
reporting corporation must believe that there is at least a 50 percent probability that the quantities actually
recovered will equal or exceed the sum of the estimated proved plus probable reserves. The implementation
of N.I. 51-101 has resulted in a more rigorous and uniform standard of reserve evaluation.
The oil and natural gas reserve estimates are made using all available geological and reservoir data as well as
historical production data. Estimates are reviewed and revised as appropriate. Revisions occur as a result of
changes in prices, costs, fiscal regimes, reservoir performance or a change in the Corporation’s plans. The
effect of changes in proved oil and natural gas reserves on the financial results and position of the Corporation
is described next under depletion expense and impairment of petroleum and natural gas properties.
41
Surge Energy Inc. | AR 2010
DEPLETION EXPENSE
The Corporation uses the full cost method of accounting for exploration and development activities. In accordance
with this method of accounting, all costs associated with exploration and development are capitalized whether
or not the activities funded were successful. The aggregate of net capitalized costs and estimated future
development costs, less estimated salvage values, is amortized using the unit-of-production method based on
estimated proved oil and natural gas reserves.
An increase or decrease in estimated proved oil and natural gas reserves would result in a corresponding
reduction or increase in depletion expense. A decrease or increase in estimated future development costs
would result in a corresponding reduction or increase in depletion expense.
WITHHELD COSTS
Certain costs related to unproved properties may be excluded from costs subject to depletion until proved reserves
have been determined or their value is impaired. These properties are reviewed quarterly and any impairment is
transferred to the costs being depleted, which would increase depletion expense for the given period.
IMPAIRMENT OF PETROLEUM AND NATURAL GAS ASSETS
The Corporation is required to review the carrying value of all petroleum and natural gas assets for potential
impairment. Impairment is indicated if the carrying value of the petroleum and natural gas assets is not
recoverable by the future undiscounted funds from operations. If impairment is indicated, the amount by which
the carrying value exceeds the estimated fair value of the property, plant and equipment is charged to earnings.
The assessment of impairment is dependent on estimates of reserves, production rates, prices, future costs and
other relevant assumptions.
ASSET RETIREMENT OBLIGATIONS
The Corporation is required to provide for future removal and site restoration costs. The Corporation must estimate
these costs in accordance with existing laws, contracts, or other policies. The fair value of the liability for the
Corporation’s asset retirement obligation is recorded in the period in which it is expected to be incurred, discounted
to its present value using the Corporation’s eight percent credit adjusted risk-free rate and two percent inflation rate.
The offset to the liability is recorded in the carrying amount of petroleum and natural gas properties. The liability
amount is increased each reporting period due to the passage of time and the amount of accretion is charged
to earnings in the period. Revisions to the estimated timing of funds from operations or to the original estimated
undiscounted cost could also result in an increase or decrease in the obligation. Actual costs incurred upon
settlement of the retirement obligation are charged against the obligation to the extent of the liability recorded.
STOCK-BASED COMPENSATION
The Corporation uses the fair value method for valuing the stock option grants. The fair value of each option grant
is estimated on the date of grant using the Black-Scholes option-pricing model. A zero dividend yield is used
as the Corporation does not issue dividends; the volatility is a calculation based on past trading history and the
risk-free rate is from the Bank of Canada. An increase in dividends would decrease the option exercise and an
increase in the volatility or the risk-free rate would increase the calculated expense.
LEGAL, ENVIRONMENTAL REMEDIATION AND OTHER CONTINENT MATTERS
The Corporation is required to determine whether a loss is probable based on judgment and interpretation of
laws and regulations and whether the loss can reasonably be estimated. When the loss is determined, it is
charged to earnings.
The Corporation’s management must continually monitor known and potential contingent matters and make
appropriate provisions by charges to earnings when warranted by circumstance.
Surge Energy Inc. | AR 2010
42
INCOME TAX ACCOUNTING
The determination of the Corporation’s income and other tax liabilities requires interpretation of complex laws
and regulations often involving multiple jurisdictions. All tax filings are subject to audit and potential
reassessment after the lapse of considerable time. Accordingly, the actual income tax liability may differ
significantly from that estimated and recorded by management. In addition, the Corporation calculates future
taxes based on rates substantively enacted at each reporting period and expected to apply when temporary
differences reverse. Any changes in the anticipated reversals may impact future tax rates and the increase or
decrease will be recorded through earnings.
FINANCIAL INSTRUMENTS
The Corporation recognizes the fair value for the unrealized portion of derivative contracts at each reporting date
on the financial statements. The fair value is based on an estimate of the amounts that would have been paid to
or received from counterparties to settle these instruments given future market prices and other relevant factors.
As the fair value is based on a number of subjective estimates such as future prices and volatility in commodity
markets, estimates could differ from actual results realized.
RISK FACTORS
Additional risk factors can be found under “Risk Factors” in the Corporation’s 2010 Annual Information Form,
which can be found on www.sedar.com. Many risks are discussed below and in the 2010 Annual Information
Form, but these risk factors should not be construed as exhaustive. There are numerous factors, both known and
unknown, that could cause actual results or events to differ materially from forecast results.
On October 25, 2007, the Alberta Government announced the New Royalty Framework (NRF) which took after
January 1, 2009. On March 3, 2009, the Alberta Government announced a drilling royalty credit and new well
incentive program that will be in effect from April 1, 2009 to March 31, 2010. On November 29, 2008, the
Alberta Government announced that in response to the global economic crisis and a slowdown in oil and natural
gas drilling in Alberta, companies drilling certain new wells after November 19, 2008 have a one-time option of
selecting a transitional rate or the NRF rate. All wells drilled between 2009 and 2013 that adopt the transitional
rate will required to shift to the NRF on January 1, 2014. All wells drilled prior to November 19, 2008 will move
to the NRF on January 1, 2009.
Oil and natural gas operations involve many risks that even a combination of experience, knowledge and careful
evaluation may not be able to overcome. The long-term commercial success of Surge depends on its ability to
find, acquire, develop, and commercially produce oil and natural gas reserves. Without the continual addition
of new reserves, any existing reserves Surge may have at any particular time and the production therefrom will
decline over time as such existing reserves are exploited. A future increase in Surge’s reserves will depend not
only on the Corporation’s ability to explore and develop any properties it may have from time to time, but also on
its ability to select and acquire suitable producing properties or prospects. No assurance can be given that further
commercial quantities of oil and natural gas will be discovered or acquired by Surge.
Surge’s principal risks include finding and developing economic hydrocarbon reserves efficiently and being able
to fund the capital program. The Corporation’s need for capital is both short-term and long-term in nature.
Short-term working capital will be required to finance accounts receivable, drilling deposits and other similar
short-term assets, while the acquisition and development of oil and natural gas properties requires large amounts
of long-term capital. Surge anticipates that future capital requirements will be funded through a combination of
internal funds from operations, debt and/or equity financing. There is no assurance that debt and equity financing
will be available on terms acceptable to the Corporation to meet its capital requirements. If any components of
the Corporation’s business plan are missing, the Corporation may not be able to execute the entire business plan.
43
Surge Energy Inc. | AR 2010
All phases of the oil and natural gas business present environmental risks and hazards and are subject to
environmental regulation pursuant to a variety of federal, provincial, and local laws and regulations. Environmental
legislation provides for, among other things, restrictions and prohibitions on spills, releases or emissions of
various substances produced in association with oil and natural gas operations. The legislation also requires
that wells and facility sites be operated, maintained, abandoned and reclaimed to the satisfaction of applicable
regulatory authorities. Compliance with such legislation can require significant expenditures and a breach
may result in the imposition of fines and penalties, some of which may be material. Environmental legislation
is evolving in a manner expected to result in stricter standards and enforcement, larger fines and liability
and potentially increased capital expenditures and operating costs. The discharge of oil, natural gas or other
pollutants into the air, soil, or water may give rise to liabilities to governments and third parties and may require
Surge’s operating entities to incur costs to remedy such discharge. Although Surge believes that it is in material
compliance with current applicable environmental regulations, no assurance can be given that environment laws
will not result in a curtailment of production or a material increase in the costs of production, development or
exploration activities or otherwise adversely affect Surge’s financial condition, results of operations or prospects.
Surge’s involvement in the exploration for and development of oil and natural gas properties may result in Surge
becoming subject to liability for pollution, blowouts, property damage, personal injury or other hazards. Although,
prior to drilling, Surge will obtain insurance in accordance with industry standards to address certain of these
risks, such insurance has limitations on liability that may not be sufficient to cover the full extent of such liability.
In addition, such risks may not, in all circumstances, be insurable or, in certain circumstances, Surge may elect
not to obtain insurance to deal with specific risks due to the high premiums associated with such insurance
or other reasons. The payment of such uninsured liabilities would reduce the funds available to Surge. The
occurrence of a significant event that was not fully insured against, or the insolvency of the insurer of such event,
could have a material adverse effect on Surge’s financial position, results of operations or prospects and will
reduce income otherwise used to fund operations.
The Corporation utilizes financial derivatives contracts to manage market risk. All such transactions are conducted
in accordance with the risk management policy that has been approved by the Board of Directors.
Surge Energy Inc. | AR 2010
44
MANAGEMENT’S LETTER
Management is responsible for the integrity and objectivity of the information contained in this annual report and
for the consistency between the financial statements and other financial and operating data contained elsewhere
in the report. In the preparation of these statements, estimates are sometimes necessary to make a determination
of future values for certain assets or liabilities. Management believes such estimates have been based on careful
judgments and have been properly reflected with all information available up to April 26, 2011. The financial
statements have been prepared using policies and procedures established by management in accordance with
Canadian generally accepted accounting principles and reflect fairly Breaker’s financial position, results of
operations and cash flow.
KPMG LLP, independent auditors appointed by the shareholders, have examined the consolidated financial
statements, and Sproule Associates Limited has reviewed the corporate reserves. Their examinations provide
independent views as to the amounts and disclosures in the financial statements.
The Audit Committee, consisting exclusively of independent directors, has reviewed in detail the financial
statements with management and the external auditors and has recommended their approval to the Board
of Directors.
The Board of Directors has approved the financial statements and information as presented in this annual report.
P. Daniel O’Neil
Maxwell A. W. Lof
President and Chief Executive Officer
Chief Financial Officer
April 26, 2011
45
Surge Energy Inc. | AR 2010
AUDITORS’ REPORT
To the Shareholders of Surge Energy Inc.
We have audited the accompanying consolidated financial statements of Surge Energy Inc., which comprise the
consolidated balance sheet as at December 31, 2010, the consolidated statements of operations, comprehensive
loss and retained earnings, and cash flows for the year then ended, and notes, comprising a summary of significant
accounting policies and other explanatory information.
Management’s Responsibility for the Consolidated Financial Statements
Management is responsible for the preparation and fair presentation of these consolidated financial statements in
accordance with Canadian generally accepted accounting principles, and for such internal control as management
determines is necessary to enable the preparation of consolidated financial statements that are free from material
misstatement, whether due to fraud or error.
Auditors’ Responsibility
Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We
conducted our audit in accordance with Canadian generally accepted auditing standards. Those standards require
that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about
whether the consolidated financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the
consolidated financial statements. The procedures selected depend on our judgment, including the assessment of
the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making
those risk assessments, we consider internal control relevant to the entity’s preparation and fair presentation of the
consolidated financial statements in order to design audit procedures that are appropriate in the circumstances,
but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also
includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates
made by management, as well as evaluating the overall presentation of the consolidated financial statements.
We believe that the audit evidence we have obtained in our audit is sufficient and appropriate to provide a basis for
our audit opinion.
Opinion
In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial
position of Surge Energy Inc. as at December 31, 2010, and the results of its consolidated operations and its
consolidated cash flows for the year then ended in accordance with Canadian generally accepted accounting principles.
Other Matter
The consolidated financial statements of Surge Energy Inc. as at and for the year ended December 31, 2009 were
audited by another auditor who expressed an unmodified opinion on those statements on March 8, 2010 except as
to note 13, which is as of March 25, 2010.
Chartered Accountants
Calgary, Canada
April 26, 2011
Surge Energy Inc. | AR 2010
46
FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
Stated in Thousand of Dollars
Assets
Current Assets:
Cash
Accounts receivable
Prepaid expenses and deposits
Current future income taxes (note 9)
Petroleum and natural gas properties (notes 4 and 5)
Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable and accrued liabilities
Fair value of financial contracts (note 12)
Bank debt (note 6)
Bank debt (note 6)
Future income taxes (note 9 )
Asset retirement obligations (note 7)
Shareholders’ equity:
Share capital (note 8)
Contributed surplus (note 8)
Performance warrants (note 8)
Retained earnings
Commitments (note 11)
Subsequent events (note 13)
AS AT DECEMBER 31,
2010
2009
$ 1,437
12,404
1,657
681
16,179
$ -
4,061
1,536
-
5,597
361,398
126,763
$ 377,577
$ 132,360
$ 31,738
$ 10,628
2,570
-
34,308
30,000
35,239
11,994
227,434
4,664
7,196
26,742
266,036
221
41,650
52,499
-
17,636
5,389
16,209
3,559
-
37,068
56,836
$ 377,577
$ 132,360
See accompanying notes to the consolidated financial statements.
Approved on behalf of the Board:
Keith MacDonald, Director
Peter Bannister, Director
47
Surge Energy Inc. | AR 2010
CONSOLIDATED STATEMENT OF OPERATIONS, COMPREHENSIVE LOSS AND RETAINED EARNINGS
Stated in Thousands of Dollars, except per share amounts
Revenues
Petroleum and natural gas
Royalties
Realized gain on financial contracts (note 12)
Unrealized loss on financial contracts (note 12)
Expenses:
Operating
Transportation
General and administrative
Stock-based compensation (note 8)
Interest expense
Bad debt provision
Depletion, depreciation and accretion
Loss before the undernoted
Recapitalization costs
Loss before income taxes
Future income tax reduction (note 9)
Net loss and comprehensive loss
Retained earnings, beginning of year
Common shares repurchased and cancelled
Retained earnings, end of year
Loss per share (note 8)
Basic
Diluted
See accompanying notes to the consolidated financial statements.
FOR THE YEARS ENDED DECEMBER 31,
2010
2009
$ 57,927
$ 42,853
(8,122)
2,794
(2,349)
50,250
(5,046)
867
(1,222)
37,452
16,841
13,042
2,426
6,185
5,351
998
506
23,681
55,988
(5,738)
5,409
(11,147)
(821)
(10,326)
37,068
-
1,961
3,886
381
2,036
840
19,022
41,168
(3,716)
-
(3,716)
(1,604)
(2,112)
39,219
(39)
$ 26,742
$ 37,068
$ (0.28)
$ (0.28)
$ (0.13)
$ (0.13)
Surge Energy Inc. | AR 2010
48
CONSOLIDATED STATEMENTS OF CASH FLOWS
Stated in Thousands of Dollars
Cash provided by (used in)
Operating
Loss including recapitalization costs of $5,409 for the
year ended December 31, 2010
Depletion, depreciation and accretion
Future income tax reduction
Bad debt provision
Stock-based compensation
Unrealized loss on financial contracts
Abandonment expenditures
Change in non-cash working capital (note 10)
Cash flow from operating activities
Financing
Bank debt
Issues of common shares and performance warrants,
net of issue costs
Repurchase of common shares under normal course issuer bid
Cash flow from financing activities
Investing
Petroleum and natural gas properties
Corporate acquistions (note 4)
Property acquisitions (note 4)
Proceeds on dispositions
Change in non-cash working capital (note 10)
Cash flow used in investing activities
Change in cash
Cash, beginning of year
Cash, end of year
Interest paid
See note 10 for additional cash flow information.
Cash is defined as cash and cash equivalents.
See accompanying notes to the consolidated financial statements.
FOR THE YEARS ENDED DECEMBER 31,
2010
2009
$ (10,326)
$ (2,112)
23,681
(821)
506
5,351
2,349
(461)
(3,142)
17,137
19,022
(1,604)
840
381
1,222
(257)
(1,151)
16,341
(27,460)
2,000
114,314
-
86,854
(41,996)
(1,009)
(76,774)
1,431
15,794
(102,554)
1,437
-
$ 1,437
3,511
(66)
5,445
(17,888)
-
-
-
(3,898)
(21,786)
-
-
$ -
$ 998
$ 2,036
49
Surge Energy Inc. | AR 2010
1. BASIS OF PRESENTATION
Surge Energy Inc. (“Surge” or the “Corporation”), formerly Zapata Energy Corporation, is incorporated under
the laws of the Province of Alberta. The Corporation is engaged in the exploration for and development and
production of oil and gas properties in western Canada.
2. SIGNIFICANT ACCOUNTING POLICIES
(A)
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Corporation, its wholly-owned subsidiaries
and partnerships. All inter-entity transactions and balances have been eliminated.
(B) MEASUREMENT UNCERTAINTY
The consolidated financial statements of the Corporation have been prepared by management in accordance with
Canadian generally accepted accounting principles. The preparation of these financial statements, in conformity
with generally accepted accounting principles, requires management to make estimates and assumptions that
affect the amounts reported in the statements and accompanying notes. As a result, actual amounts could
differ from estimated amounts. Specifically, the amounts recorded for depletion and depreciation of petroleum
and natural gas properties, the provision for and accretion of asset retirement obligations and the ceiling test
calculations are based on estimates of reserves, production rates, oil and natural gas prices, future development
costs, salvage values and other relevant assumptions.
Assumptions used in the determination of the fair value of stock options and warrants issued are based on
estimates of the future volatility of the Corporation’s stock price, expected lives of the options and warrants,
expected dividends and other relevant assumptions.
Future income taxes are based on estimates as to the timing of the reversal of temporary differences and tax rates
currently substantively enacted. The fair value of commodity contracts and the resultant unrealized gain (loss) on
commodity contracts is based upon expected future commodity prices, interest rates and volatility in those prices
and interest rates. These third-party prepared estimates are subject to change with fluctuations in commodity
prices and interest rates.
By their nature, these estimates are subject to measurement uncertainty, and the effect of changes in estimates
on the consolidated financial statements of future periods could be significant.
(C)
CASH AND CASH EQUIVALENTS
Cash and cash equivalents are comprised of cash and all investments that are highly liquid in nature and have
a maturity date of three months or less.
(D)
PETROLEUM AND NATURAL GAS PROPERTIES
The Corporation follows the full cost method of accounting whereby all costs related to the acquisition of,
exploration for and the development of petroleum and natural gas reserves are initially capitalized into a single
Canadian cost center. Costs capitalized include land acquisition costs, geological and geophysical expenditures,
lease rentals on undeveloped properties, costs of drilling productive and non productive wells, asset retirement
costs, together with overhead and interest directly related to exploration and development activities, and lease
and well equipment.
Proceeds from the disposal of properties are normally applied as a reduction of the cost of the remaining
petroleum and natural gas properties, except when such a disposition would alter the rate of depletion and
depreciation by more than 20%, in which case a gain or loss is recorded.
Surge Energy Inc. | AR 2010
50
Costs capitalized are depleted using the unit-of-production method based on estimated proved petroleum and
natural gas reserves before royalties as determined by independent engineers. For purposes of this calculation,
petroleum and gas reserves are converted to a common unit of measure on the basis of their relative energy
content, where six thousand cubic feet of gas equals one barrel of oil or liquids.
In determining its depletion base, the Corporation includes estimated future capital costs to be incurred in
developing proved reserves and excludes the cost of significant unproved properties until it is determined whether
proved reserves are attributable to the unproved properties or impairment has occurred. Unproved properties
are evaluated separately for impairment. When proved reserves are assigned to the property or the property is
considered impaired, the cost of the property or the amount of impairment is added to the depletion base.
Other assets are depreciated using the declining balance method at annual rates of 20% to 100%.
Petroleum and natural gas properties are evaluated in each reporting period to determine whether the carrying
amount in a cost centre is recoverable and does not exceed the fair value of the properties in the cost centre.
The carrying amounts are assessed to be recoverable when the sum of undiscounted cash flows expected
from proved reserves plus the cost of unproved properties net of impairment, exceeds the carrying amount of
petroleum and natural gas properties. If the carrying amount is considered not recoverable, the magnitude of
the impairment is measured by comparing the carrying amount of the petroleum and natural gas properties to
the estimated, discounted future cash flows of the Corporation’s proved plus probable reserves plus the cost of
unproved properties, net of impairment. The future cash flows are discounted at the Corporation’s risk-free interest
rate and are based on forecast prices and costs, as provided by an independent third party. Any recognized
impairment is recorded as additional depletion expense.
(E)
ASSET RETIREMENT OBLIGATIONS
The estimated fair value of asset retirement obligations is recorded in the period a well or related asset is drilled,
constructed or acquired. Fair value is estimated using the present value of the estimated future cash outflows
to abandon the asset at the Corporation’s credit-adjusted risk-free interest rate. The discounted obligations
are initially capitalized as part of the carrying amount of the related petroleum and natural gas properties, and
a corresponding liability is recognized. The increase in petroleum and natural gas properties is depleted and
depreciated on the same basis as the remainder of the petroleum and natural gas properties. The liability is
accreted against income until it is settled or the property is sold and is recorded as accretion expense. Revisions
to the estimated timing of cash flows or the cost estimates could also result in an increase or decrease to the
obligation. Actual restoration expenditures are charged to accumulated obligations as incurred to the extent of
the liability recorded.
(F)
INTEREST IN JOINT OPERATIONS
A portion of the Corporation’s exploration and production activities are conducted jointly with others and,
accordingly, these consolidated financial statements reflect only the Corporation’s proportionate interest in
such activities.
(G)
FUTURE INCOME TAXES
Income taxes are accounted for using the asset and liability method of income tax allocation. Under the asset
and liability method, future income tax assets and liabilities are recorded based on the difference between the
tax basis of an asset or liability and the carrying amount on the balance sheet. Future income tax assets are also
recognized for the benefits from tax losses and deductions that cannot be identified with particular assets or
liabilities. Future income tax assets and liabilities are determined based on the tax laws and substantively enacted
rates in effect. Actual rates in effect when the differences are expected to reverse may differ substantially as a
result of changes to tax legislation. A valuation allowance is recorded against any future income tax assets if it
is more likely than not that the asset will not be realized.
51
Surge Energy Inc. | AR 2010
(H) STOCK-BASED COMPENSATION AND WARRANT VALUATION
The Corporation uses the fair value method for valuing stock options and warrants. Under the fair value method,
compensation costs attributable to all stock options and warrants granted are measured at fair value at the date
of grant and expensed over the vesting period with a corresponding increase to contributed surplus or warrants.
The fair value of each option or warrant granted is estimated using the Black-Scholes option pricing model that
takes into account the grant date, the exercise price and expected life of the option or warrant, the price of the
underlying security, the expected volatility, the risk-free interest rate and dividends if any on the underlying
security. Upon the exercise of the stock options and warrants, consideration received together with the amount
previously recognized in contributed surplus or warrants is recorded as an increase to share capital and the
contributed surplus or warrants balance is reduced.
The Corporation has not incorporated an estimated forfeiture rate for stock options or warrants that will not vest,
rather, the Corporation accounts for actual forfeitures as they occur.
(I)
REVENUE RECOGNITION
Revenue from the sale of petroleum and natural gas is recorded on a gross basis when title passes to an external
party and collection is reasonably assured based on volumes delivered to customers at contractual delivery points
and rates. The costs associated with the delivery, including production costs, transportation and production based
royalty expenses are recognized in the same period in which the related revenue is earned and recorded.
(J)
PER SHARE INFORMATION
Per share amounts are calculated based on the weighted average number of common shares outstanding
during the year. The diluted weighted average number of shares is adjusted for the dilutive effect of options
and warrants. Under the treasury stock method, only “in the money” options and warrants are included in the
weighted average diluted number of shares. It is also assumed that any proceeds obtained upon the exercise
of options and warrants plus the unamortized portion of stock-based compensation would be used to purchase
common shares at the average price during the period. The weighted average number of shares is then reduced
by the number of shares acquired.
(K)
FLOW-THROUGH SHARES
The resource expenditure deductions for income tax purposes related to exploration and development activities
funded by flow-through share arrangements are renounced to subscribers. To recognize the foregone tax benefits
to the Corporation, share capital is reduced and a future tax liability is recorded equal to the estimated amount
of future income taxes payable when the income tax deduction is renounced.
(L)
FINANCIAL INSTRUMENTS
The financial instruments standard establishes the recognition and measurement criteria for financial assets,
financial liabilities and derivatives. All financial instruments are required to be measured at fair value on initial
recognition of the instrument. Measurement in subsequent periods depends on whether the financial instrument
has been classified as “held-for-trading”, “available-for-sale”, “held-to-maturity”, “loans and receivables”, or
“other financial liabilities” as defined by the standard.
The Corporation has designated its cash and cash equivalents as held for trading which are measured at fair
value with changes in those fair values recognized in net earnings. Accounts receivable are classified as loans
and receivables which are measured at amortized cost. Accounts payable and accrued liabilities and bank debt
are classified as other liabilities which are measured at amortized cost which is determined using the effective
interest rate method. The Corporation enters into forward swap, collar or put agreements to manage its exposure
to the risks associated with fluctuating oil and gas prices and interest rates.
Surge Energy Inc. | AR 2010
52
The Corporation has policies and procedures in place with respect to the required documentation and approvals
for the use of derivative financial instruments. All transactions of this nature entered into by the Corporation
are related to future oil and gas production or anticipated debt levels. Derivative financial instruments are used
by the Corporation to manage exposure to fluctuating commodity prices and interest rates and are not used for
speculative or trading purposes. The Corporation has elected not to designate these derivative instruments as
hedges for accounting purposes. As a result, all derivative financial instruments are recorded on a mark-to-market
basis or fair valued with the resulting gains or losses taken into income. The fair value of these derivative financial
instruments are based on an estimate of the amount that would have been recovered or paid to settle these
instruments prior to maturity given market prices and other relevant factors.
The Corporation has elected to account for its physical delivery commodity sales contracts and other non-financial
contracts held for the purpose of receipt or delivery of non-financial items in accordance with the expected
purchase, sale or usage requirements on an accrual basis. The Corporation measures and recognizes embedded
derivatives separately from the host contracts when the economic characteristics of the embedded derivative are
not closely related to those of the host contract, when it meets the definition of a derivative and when the entire
contract is not measured at fair value. Embedded derivatives are recorded at fair value. The Corporation nets
all transaction costs incurred, in relation to the acquisition of a financial asset or liability, against the related
financial asset or liability. Bank debt is presented net of deferred interest payments, with interest recognized
in earnings on an effective interest basis.
(M) COMPARATIVE FIGURES
Certain comparative figures have been reclassified to conform with current year’s presentation.
3.
FUTURE ACCOUNTING POLICIES
Adoption of International Financial Reporting Standards (“IFRS”)
On January 1, 2011 International Financial Reporting Standards (“IFRS”), as issued by the International
Accounting Standards Board, will become the generally accepted accounting principles in Canada. The transition
from Canadian GAAP to IFRS will result in significant differences affecting financial position and results of
operations. The Corporation will be reporting under IFRS for all periods beginning after January 1, 2011 and
will be required to restate comparative information for the year ended December 31, 2010, including the opening
balance sheet as at January 1, 2010.
4. ACQUISITIONS
(A)
CORINTHIAN ENERGY CORP.
Effective July 9, 2010, the Corporation acquired all of the issued and outstanding common shares of Corinthian
Energy Corp. (“Corinthian”), a privately held junior oil and gas exploration company, in exchange for 16,025,529
common shares of Surge with an assigned value of $94,477,000. The common shares have been ascribed
a fair value of $5.90 per common share issued, as determined based on the Corporation’s weighted average
trading price at the date of announcement being June 22, 2010. In addition, Surge incurred transaction costs
of $1,009,000. The operations of Corinthian have been included in the results of Surge commencing July 9,
2010. The transaction was accounted for by the purchase method. The allocation of the purchase price for the
acquisition has not been finalized. The following amounts are estimates based on information available at the time
of preparation of these financial statements. Accordingly, these amounts are subject to changes as cost estimates
and values are finalized. The preliminary allocation of the purchase price, based on management’s estimates of
fair values, is as follows:
53
Surge Energy Inc. | AR 2010
FAIR VALUE OF NET ASSETS ACQUIRED:
Petroleum and natural gas properties
Bank debt
Working capital
Asset retirement obligations
Future income tax liability
Net assets acquired
Consideration:
Common shares (16,025,529 common shares)
Transaction costs
Total consideration
(B)
CRYSTAL LAKE RESOURCES LTD.
$ 133,255
(15,810)
472
(4,959)
(17,472)
$ 95,486
$ 94,477
1,009
$ 95,486
Effective July 19, 2010, Surge acquired all of the issued and outstanding common shares of Crystal Lake
Resources Ltd. (“Crystal Lake”), a privately held junior oil and gas exploration company, in exchange for
288,639 common shares of Surge with an assigned value of $1,702,000. The common shares have been
ascribed a fair value of $5.90 per common share issued, as determined based on the Corporation’s weighted
average trading price at the date of announcement being June 22, 2010. The operations of Crystal Lake have
been included in the results of Surge commencing July 19, 2010. The transaction was accounted for by the
purchase method. The allocation of the purchase price for the acquisition has not been finalized. The following
amounts are estimates based on information available at the time of preparation of these financial statements.
Accordingly, these amounts are subject to changes as cost estimates and values are finalized. The preliminary
allocation of the purchase price, based on management’s estimates of fair values, is as follows:
FAIR VALUE OF NET ASSETS ACQUIRED:
Petroleum and natural gas properties
Working capital
Asset retirement obligations
Future income tax liability
Net assets acquired
Consideration:
Common shares (288,639 common shares)
Total consideration
$ 1,675
40
(90)
77
$ 1,702
$ 1,702
$ 1,702
(C)
VALHALLA PROPERTY ACQUISITION
Effective November 1, 2010, Surge acquired certain petroleum and natural gas properties in the Valhalla region
of Alberta, in exchange for cash of $74.5 million with associated asset retirement obligations of $1.1 million.
Surge Energy Inc. | AR 2010
54
5. PETROLEUM AND NATURAL GAS PROPERTIES
DECEMBER 31, 2010
Petroleum and natural gas properties
$ 487,055
$ 125,657
$ 361,398
Cost
Accumulated
Depletion
Net Book Value
December 31, 2009
Cost
Accumulated
Depletion
Net Book Value
Petroleum and natural gas properties
$ 229,352
$ 102,589
$ 126,763
During the year ended December 31, 2010, the Corporation capitalized $2.4 million (2009 - $0.02 million)
of overhead-related costs to petroleum and natural gas properties. In addition, $3.0 million in stock-based
compensation and the related tax impact of $1.0 million was capitalized during the year ended
December 31, 2010.
Costs associated with unproven properties, salvage values and seismic excluded from costs subject to depletion
as at December 31, 2010 totaled $107.1 million (2009 – $7.6 million). Future development costs for proved
reserves of $63.8 million (2009 – $16.8 million) have been included in the depletion calculation.
During 2010, the Corporation disposed of certain interests in petroleum and natural gas properties for cash
proceeds of $1.4 million, with associated asset retirement obligations of $0.1 million also eliminated.
The Corporation performed a ceiling test calculation at December 31, 2010 to assess the recoverable value
of the petroleum and natural gas assets. As at December 31, 2010 there was no impairment required. For
purposes of the ceiling test calculation, the Corporation used the January 1, 2011 commodity price forecast of
its independent reserve evaluators. The following table summarizes the benchmark prices used in the calculation:
MEDIUM AND LIGHT CRUDE OIL
NATURAL
GAS
NGL
WTI
CUSHING
OKLAHOMA
40˚ API
(US$/BBL)
88.40
89.14
88.77
88.88
90.22
91.57
92.94
94.34
95.75
97.19
EDMONTON
PAR PRICE
40˚ API ($/
BBL)
93.08
93.85
93.43
93.54
94.95
96.38
97.84
99.32
100.81
102.34
CROMER
MEDIUM
29.3˚ API
($/BBL)
85.63
86.34
85.02
84.18
85.45
86.74
88.05
89.38
90.73
92.10
YEAR
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
AECO GAS
PRICE ($/
MMBTU)
4.04
PENTANES
PLUS FOB
FIELD GATE
($/BBL)
95.32
BUTANES
FOB FIELD
GATE ($/
BBL)
62.44
INFLATION
RATES (%/
YR)
1.5
EXCHANGE
RATE ($US
/$CDN)
0.932
4.66
4.99
6.58
6.69
6.80
6.91
7.02
7.14
7.26
96.11
95.68
95.79
97.24
98.70
100.18
101.68
103.21
104.76
62.95
62.67
62.75
63.69
64.65
65.62
66.60
67.60
68.61
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
0.932
0.932
0.932
0.932
0.932
0.932
0.932
0.932
0.932
55
Surge Energy Inc. | AR 2010
6. BANK DEBT
The Corporation has a $105.0 million extendible, revolving term credit facility with a Canadian bank bearing
interest at bank rates. The facility is available on a revolving basis until July 13, 2011. On July 13, 2011, at the
Corporation’s discretion, the facility is available on a non-revolving basis for a one-year period, at the end of which
time the facility would be due and payable. Alternatively, the facilities may be extended for a further 364-day
period at the request of the Corporation and subject to the approval of the bank. As the available lending limits
of the facilities are based on the bank’s interpretation of the Corporation’s reserves and future commodity prices,
there can be no assurance that the amount of the available facilities will not decrease at the next scheduled
review. Interest rates vary depending on the ratio of net debt to cash flow. The facility had an effective interest
rate of prime plus 1.25 percent as at December 31, 2010 (2009 – prime plus 1.25 percent).
The facility is secured by a general assignment of book debts, debentures of $200.0 million with a floating charge
over all assets of the Corporation with a negative pledge and undertaking to provide fixed charges on the major
producing petroleum and natural gas properties at the request of the bank. Under the terms of the agreement,
the Corporation is required to meet certain financial and engineering reporting requirements.
Under the terms of the agreement, the Corporation must maintain an adjusted working capital ratio of not less
than 1.00:1.00 at all times. The working capital ratio is defined under the current credit facility as current assets,
including the undrawn portion of the facility, to current liabilities, excluding any current bank indebtedness. The
Corporation is compliant with this covenant at December 31, 2010.
7.
ASSET RETIREMENT OBLIGATIONS
The Corporation’s asset retirement obligations result from net ownership interests in petroleum and natural
gas assets including well sites, gathering systems and processing facilities. The Corporation estimates the
total undiscounted amount of cash flows required to settle its asset retirement obligations is approximately
$74.3 million (2009 – $19.7 million) which will be incurred between 2011 and 2059. The majority of
these costs will be incurred between 2011 and 2037. A credit-adjusted risk free rate of eight percent
(2009 – eight percent) and an inflation rate of two percent (2009 – two percent) was used to calculate
the fair value of the asset retirement obligations.
A reconciliation of the asset retirement obligations is provided below:
Balance, beginning of year
Liabilities related to acquisitions (note 4)
Liabilities related to dispositions (note 5)
Liabilities incurred
Accretion expense
Abandonment expenditures
Balance, end of year
YEARS ENDED DECEMBER 31,
2010
$ 5,389
6,162
(51)
342
613
(461)
2009
$ 5,243
-
-
(1)
404
(257)
$ 11,994
$ 5,389
Surge Energy Inc. | AR 2010
56
8. SHARE CAPITAL
(A) AUTHORIZED
Unlimited number of voting common shares.
Unlimited number of preferred shares, issuable in series.
(B)
ISSUED AND OUTSTANDING
Common Shares:
Balance, December 31, 2008
Issued pursuant to unit offering
Issued pursuant to flow-through offering
Share issue costs
Tax effect of share issue costs
NUMBER OF
SHARES
AMOUNT
16,697,811
$ 12,641
417,466
757,000
-
-
1,252
2,574
(315)
84
(27)
Shares purchased pursuant to a normal course issuer bid
(36,000)
Balance, December 31, 2009
Issued pursuant to unit offering
Issued pursuant to private placement
Issued pursuant to short form prospectus
Issued pursuant to Corinthian acquisition (note 4)
Issued pursuant to Crystal Lake acquisition (note 4)
Issued pursuant to short form prospectus
Share issue costs
Tax effect of share issue costs
Exercise of stock options
Exercise of warrants
Stock-based compensation of flow-through units
Tax effect of flow-through shares issued in 2009
17,836,277
$ 16,209
926,933
3,863,636
6,945,000
16,025,529
288,639
8,001,000
-
-
1,535,334
672,199
-
-
2,781
14,716
50,004
94,477
1,702
42,005
(5,029)
1,359
6,865
2,689
331
(675)
Balance, December 31, 2010
56,094,547
$ 227,434
On January 19, 2010, the Corporation issued 848,600 units at a price of $3.00 per unit, with each unit
consisting of one common share and one-half of a common share purchase warrant (with each whole warrant
exercisable into one common share at a price of $4.00 per share until December 23, 2010), for total gross
proceeds of $2,545,800. Certain former officers and directors purchased 20,000 units for total gross
proceeds of $60,000.
On January 29, 2010, the Corporation issued 78,333 units at a price of $3.00 per unit, with each unit
consisting of one common share and one-half of a common share purchase warrant (with each whole warrant
exercisable into one common share at a price of $4.00 per share until December 23, 2010), for total gross
proceeds of $235,000.
On April 13, 2010, pursuant to a private placement, the new management group, together with certain additional
subscribers identified by the new management group, subscribed for 1,394,317 common units of the Corporation
at a price of $4.40 per common unit, 1,787,500 common shares of the Corporation at a price of $4.40 per
common share and 681,819 flow-through units at a price of $4.40 per flow-through unit, for total proceeds to
57
Surge Energy Inc. | AR 2010
the Corporation of approximately $17,000,000. Each common unit is comprised of one common share and one
common share performance warrant, entitling the holder to purchase one common share at a price of $5.17
for a period of five years. Each flow-through unit is comprised of one common share issued on a flow-through
basis pursuant to the Income Tax Act of Canada and one common share performance warrant, also entitling
the holder to purchase one common share at a price of $5.17 for a period of five years. The common and flow-
through shares issued as part of the common and flow-through units were ascribed a value of $3.30 per share
or $6,851,000 due to the escrow restrictions described below. For further details on the vesting conditions
and valuation of the common share performance warrants, please refer to note 8(d). The Corporation also
recorded $331,000 of stock-based compensation on the flow-through units. Certain officers and directors of the
Corporation purchased 1,099,413 common units, 661,951 flow-through units and 9,088 common shares as part
of the private placement.
All of the units issued were acquired by contractors, employees, officers or directors of the Corporation (“deemed
service providers”). For deemed service providers, units acquired through the private placement are held under
an escrow agreement in which one-third of the units are to be released equally every six months following the
date of issuance. No securities will be released from escrow after the date the deemed service provider ceases
to be a service provider, unless directed by a resolution of the Board of Directors. Upon the deemed service
provider ceasing to be a service provider, Surge will repurchase for cancellation or provide for a transfer to another
deemed service provider all of the securities of the deemed service provider then held in escrow at a price equal
to the lessor of $4.40 per unit and the market price of the common shares of Surge on the last day of trading
immediately prior to the deemed service provider ceasing to be a service provider.
On May 5, 2010, the Corporation issued 6,945,000 common shares at a price of $7.20 per share for gross
proceeds of $50,004,000, pursuant to a short form prospectus.
On November 1, 2010, the Corporation issued 8,001,000 common shares at a price of $5.25 per share for gross
proceeds of $42.0 million. The proceeds were used to partially fund the Valhalla acquisition (note 4).
During the year ended December 31, 2010, two share purchase loans aggregating $360,000 due from two former
officers of the Corporation were repaid. The loans bore interest at a rate of 4.75 percent and were due on June
30, 2010. The entire amount of the principal and interest outstanding has been repaid and the related common
shares totaling 160,000 were issued. The 160,000 shares attributable to the share purchase loans had been
included in the stock options and are shown as part of the stock options exercised balance below.
(C)
STOCK OPTIONS
Under the Corporation’s stock option plan, it may grant options to its employees for up to 5,609,455 common
shares of the Corporation as at December 31, 2010. The exercise price of each option equals the market price of
the Corporation’s common shares at the date of grant. Options granted have a term of five years to maturity and
vest as to one-third on each of the first, second and third anniversaries from the date of grant.
Stock options oustanding,
beginning of year
Granted
Exercised
Forfeited
Stock options oustanding,
end of year
Exercisable at year-end
YEAR ENDED DECEMBER 31, 2010
YEAR ENDED DECEMBER 31, 2009
NUMBER OF OPTIONS
WEIGHTED AVERAGE
EXERCISE PRICE
NUMBER OF OPTIONS
WEIGHTED AVERAGE
EXERCISE PRICE
1,878,001
2,636,000
(1,535,334)
(295,000)
2,683,667
99,666
$ 3.74
$ 6.38
$ 3.17
$ 6.61
$ 6.24
$ 2.59
1,643,666
345,000
-
(110,665)
1,878,001
1,408,337
$ 3.87
$ 3.20
$ -
$ 4.04
$ 3.74
$ 4.07
Surge Energy Inc. | AR 2010
58
YEAR ENDED DECEMBER 31, 2010
OPTIONS OUTSTANDING
OPTIONS EXERCISABLE
OUTSTANDING
WEIGHTED AVERAGE
EXERCISE PRICE
WEIGHTED AVERAGE
CONTRACTUAL LIFE
(YEARS)
NUMBER
EXERCISABLE
WEIGHTED AVERAGE
EXERCISE PRICE
$ 1.75
$ 3.19
$ 5.77
$ 6.57
$ 6.24
2.95
3.91
4.60
4.56
4.53
46,666
51,000
-
2,000
99,666
$ 1.75
$ 3.19
$ -
$ 7.10
$ 2.59
RANGE OF EXERCISE
PRICES
$1.00 - $2.79
$2.80 - $4.59
$4.60 - $6.39
46,666
51,000
610,501
$6.40 - $8.19
1,975,500
$1.00 - $8.19
2,683,667
(D)
PERFORMANCE WARRANTS
As part of the private placement completed on April 13, 2010, 2,076,136 performance warrants were issued with
an exercise price of $5.17 as part of the common share and flow-through units. The performance warrants vest
and become exercisable as to one-third upon the 20 day weighted average trading price of the common shares
equaling or exceeding $5.69, an additional one-third upon the trading price equaling or exceeding $6.20 and a
final one-third upon the trading price equaling or exceeding $6.72. The performance warrants are released from
escrow one third on each of the six, twelve and eighteen month anniversaries from the date of grant.
The performance warrants expire on April 13, 2015. As at December 31, 2010, all 2,076,136 performance
warrants were outstanding, vested and two-thirds held in escrow.
A Black-Scholes derived fair value of $3.47 per warrant, or $7,196,000 was assigned to the performance
warrants. As the consideration received on the common and flow-through units of $4.40 per share, or
$9,135,000 was less than the total fair values ascribed to the common and flow-through shares ($6,851,000)
and the performance warrants ($7,196,000) of $14,047,000, an additional stock-based compensation cost of
$4,912,000 was recognized in the year.
(E)
STOCK PURCHASE WARRANTS
As part of equity financings completed in December 2009 and January 2010, the Corporation issued 672,199
warrants exercisable immediately at an exercise price of $4.00 and with an expiry date of December 23, 2010.
During the year ended December 31, 2010, all warrants were exercised.
(F)
STOCK-BASED COMPENSATION
A reconciliation of the stock-based compensation expense is provided below:
Stock-based compensation on options
Stock-based compensation on performance warrants (note 8(d))
Stock-based compensation on flow-through share premiums (note 8(b))
Capitalized stock-based compensation
Total stock-based compensation expense
YEARS ENDED DECEMBER 31,
2010
$ 3,106
4,912
331
(2,998)
$ 5,351
2009
$ 381
-
-
-
$ 381
The Corporation’s stock-based compensation expense for the year ended December 31, 2010 was $5.4 million
(2009 - $0.4 million). A Black-Scholes valuation model was applied to determine the fair value the options and
performance warrants.
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Surge Energy Inc. | AR 2010
The following assumptions were used to calculate stock-based compensation on options granted for the year
ended December 31, 2010: zero dividend yield (2009 – zero); expected volatility of 69 percent (2009 – 69
percent); risk free rate of 2 percent (2009 – 2 percent); and expected life of five years (2009 – 5 years). The
weighted average fair value of options granted in 2010 is $3.79 per option (2009 - $1.52).
The following assumptions were used to calculate stock-based compensation on performance warrants issued in
2010: zero dividend yield; expected volatility of 69 percent; risk free rate of three percent; and expected life of
five years. The weighted average fair value of performance warrants issued in 2010 is $3.47 per
performance warrant.
(G)
CONTRIBUTED SURPLUS
Balance, beginning of year
Stock-based compensation on options
Transfer on exercise of stock options
Balance, end of year
(H) PER SHARE AMOUNTS
The following table summarizes the shares used in calculating the loss per share:
YEARS ENDED DECEMBER 31,
2010
2009
$ 3,559
$ 3,178
3,106
(2,001)
381
-
$ 4,664
$ 3,559
YEARS ENDED DECEMBER 31,
2010
2009
Weighted average number of shares - basic and diluted
36,467,864
16,699,721
In computing diluted per share amount at December 31, 2010, 2,683,667 options (2009 – 1,878,001) and
2,076,136 performance warrants were excluded from the calculation as their effect was anti-dilutive.
9.
INCOME TAXES
Significant components of the Corporation’s future income tax liability are as follows:
Petroleum and natural gas properties
Asset retirement obligations
Fair value of financial contracts
Deferred partnership income
Non-capital losses
Other
YEARS ENDED DECEMBER 31,
2010
2009
$ 32,413
$ 15,680
(2,999)
(681)
11,822
(4,431)
(1,566)
(1,412)
-
3,535
-
(167)
$ 34,558
$ 17,636
The Corporation has recognized the benefit of $16.7 million of non-capital losses which are available to carry
forward to reduce future taxable income in future years. These losses expire between 2013 and 2029.
Surge Energy Inc. | AR 2010
60
Income tax recovery differs from that which would be expected from applying the combined effective Canadian
federal and provincial corporate tax rates of 28 percent (2009 - 29 percent) to the loss before income taxes
as follows:
Loss before income taxes
Combined federal and provincial statutory rate
Expected income tax recovery
Difference resulting from:
Changes in tax rates
Non-deductible stock-based compensation costs
Other
10. CASH FLOW INFORMATION
Accounts receviable
Prepaid expenses and deposits
Accounts payable and accrued liabilities
Working capital acquired on acquisitions (note 4)
Change in non-cash working capital
These changes relate to the following activities
Operating
Investing
YEARS ENDED DECEMBER 31,
2010
2009
$ (11,147)
$ (3,716)
28%
29%
$ (3,121)
$ (1,078)
116
1,498
686
$ (821)
(607)
110
(29)
$ (1,604)
YEARS ENDED DECEMBER 31,
2010
(8,849)
(121)
21,110
512
12,652
(3,142)
15,794
12,652
2009
539
(61)
(5,527)
-
(5,049)
(1,151)
(3,898)
(5,049)
$ 1,599
2,245
1,611
1,109
960
2,019
$ 9,543
11. COMMITMENTS
(A) FUTURE MINIMUM PAYMENTS RELATING TO OPERATING LEASE AND FIRM
TRANSPORT COMMITMENTS
2011
2012
2013
2014
2015
2016+
Total
61
Surge Energy Inc. | AR 2010
(B)
FLOW-THROUGH SHARES
In 2009, the Corporation issued a total of 757,000 flow-through common shares at $3.40 per share for gross
proceeds of $2.6 million. The Corporation renounced these qualifying petroleum and natural gas expenditures on
December 31, 2009. As at December 31, 2010, the Corporation had incurred the entire $2.6 million towards this
flow-through share obligation and has satisfied the terms of this flow-through share offering.
In 2010, the Corporation issued a total of 681,819 flow-through common shares at $4.40 per share as part of a
flow-through unit for gross proceeds of $3.0 million. The Corporation renounced these qualifying petroleum and
natural gas expenditures effective December 31, 2010. As at December 31, 2010 Corporation had incurred $0.8
million towards this flow-through share obligation and has until December 31, 2011 to incur the $2.2 million of
remaining expenditures.
12. FINANCIAL INSTRUMENTS OVERVIEW
The Corporation has exposure to the following risks from its use of financial instruments:
• Credit risk
• Liquidity risk
• Market risk
This note presents information about the Corporation’s exposure to each of the above risks, the Corporation’s
objectives, policies and processes for measuring and managing risk, and the Corporation’s management of capital.
Further quantitative disclosures are included throughout these financial statements. The Board of Directors
has overall responsibility for the establishment and oversight of the Corporation’s risk management framework.
The Board has implemented and monitors compliance with risk management policies. The Corporation’s risk
management policies are established to identify and analyze the risks faced by the Corporation, to set appropriate
risk limits and controls, and to monitor risks and adherence to market conditions and the Corporation’s activities.
(A)
CREDIT RISK
Credit risk is the risk of financial loss to the Corporation if a customer or counter party to a financial instrument
fails to meet its contractual obligations, and arises principally from the Corporation’s receivables from joint
venture partners and petroleum and natural gas marketers. As at December 31, 2010, the Corporation’s
receivables consisted of $8.2 million due from petroleum and natural gas marketers and $4.2 million due from
joint venture partners. These amounts are presented net of the allowance for doubtful accounts.
Receivables from petroleum and natural gas marketers are normally collected on the 25th day of the month
following production. The Corporation attempts to mitigate credit risk by establishing marketing relationships
with a variety of purchasers.
Joint venture receivables are typically collected within one to three months of the joint venture bill being
issued to the partner. The Corporation attempts to mitigate the risk from joint venture receivables by obtaining
partner approval of significant capital expenditures prior to the expenditure. However, the receivables are from
participants in the petroleum and natural gas sector, and collection of the outstanding balances is dependent
on industry factors such as commodity price fluctuations, escalating costs and the risk of unsuccessful drilling.
In addition, further risk exists with joint venture partners as disagreements occasionally arise that increase the
potential for non-collection. The Corporation does not typically obtain collateral from petroleum and natural gas
marketers or joint venture partners; however the Corporation does have the ability to withhold production from
joint venture partners in the event of non-payment.
Surge Energy Inc. | AR 2010
62
The carrying value of cash and accounts receivable represent the maximum credit exposure. The Corporation has
an allowance for doubtful accounts of $0.5 million (2009 - $4.0 million) at December 31, 2010. During
the year ended December 31, 2010, the Corporation allowed for $0.5 million of bad debts (2009 – $0.8 million)
and applied $4.0 million of its allowance for doubtful accounts against outstanding receivables.
As at December 31, 2010, the Corporation estimates its total accounts receivables, net of the allowance for
doubtful accounts, to be aged as follows:
YEAR ENDED
December 31, 2010
December 31, 2009
(B)
LIQUIDITY RISK
TOTAL RECEIVABLE
($000s)
$ 12,404
100%
CURRENT
$ 11,181
90%
PAST DUE
$ 1,223
10%
$ 4,061
$ 2,641
$ 1,420
100%
65%
35%
Liquidity risk is the risk that the Corporation will not be able to meet its financial obligations as they are due.
The Corporation actively manages its liquidity through cost control, debt and equity management policies. Such
strategies include continuously monitoring forecast and actual cash flows, financing activities and available credit
under existing banking arrangements. The nature of the oil and gas industry is very capital intensive. As a result,
the Corporation prepares annual capital expenditure budgets and utilizes authorizations for expenditures for
projects to manage capital expenditures. Management believes that future cash flows generated in the ordinary
course of business will be adequate to settle the Corporation’s liabilities as they come due.
Accounts payable are considered due to suppliers in one year or less while bank debt, which is subject to a
renewal after a 364-day revolving period, could be potentially due within the next year if the facility is not
renewed for a further 364-day period. Financial contracts are also due to be settled with the counter-parties in
one year at the estimated fair value on the balance sheet.
(C) MARKET RISK
Market risk is the risk that changes in market prices, such as foreign exchange rates, commodity prices, and
interest rates will affect the Corporation’s net income or the value of financial instruments. The objective
of market risk management is to manage and control market risk exposures within acceptable limits, while
maximizing returns. The Corporation utilizes financial derivative contracts to manage market risks. All such
transactions are conducted in accordance with the risk management policy that has been approved by the
Board of Directors.
(I)
FOREIGN CURRENCY EXCHANGE RISK
Foreign currency exchange rate risk is the risk that the fair value or future cash flows will fluctuate as a result of
changes in foreign exchange risks. Although substantially all of the Corporation’s petroleum and natural gas sales
are denominated in Canadian dollars, the underlying market prices in Canada for petroleum and natural gas are
impacted by changes in the exchange rate between the Canadian and United States dollar.
The Corporation had no forward exchange rate contracts in place as at or during the years ended
December 31, 2010 and 2009.
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Surge Energy Inc. | AR 2010
(II) COMMODITY PRICE RISK
Commodity price risk is the risk that the fair value or future cash flows will fluctuate as a result of changes in
commodity prices.
The nature of the Corporation’s operations results in exposure to fluctuations in commodity prices. Management
continuously monitors commodity prices and initiates instruments to manage exposure to these risks when it
deems appropriate. As a means of managing commodity price volatility, the Corporation enters into various
derivative financial instrument agreements and physical contracts.
The following table outlines the realized and unrealized losses on oil and gas commodity contracts for the year
ended December 31, 2010:
YEAR ENDED
DEC 31, 2010
YEAR ENDED
DEC 31, 2010
TERM
Jan 1 – Dec 31, 2010
TYPE
(FLOATING
TO FIXED)
Swap
Apr 1 – Oct 31, 2010
Swap
SWAP PRICE
(SURGE
RECEIVES)
(C$)
$5.80
$5.32
VOLUME
2,000
GJs/d
1,000
GJs/d
Nov 1, 2009 -
Mar 31, 2010
Swap
500 GJs/d
$6.00
Jan 1 to Dec 31, 2011
Call
500 GJs/d
$6.55
Jan 1 to Dec 31, 2011
Put
500 GJs/d
$5.00
Mar 1, 2009 -
Dec 31, 2010
Swap
750 GJs/d
$5.64
INDEX (SURGE PAYS)
(C$)
AECO Monthly
Average
AECO Monthly
Average
AECO Monthly
Average
AECO Monthly
Average
AECO Monthly
Average
AECO Monthly
Average
Jan 1 to Dec 31, 2010
Swap
100 bbls/d
$86.00
WTI - NYMEX
Jan 1 to Dec 31, 2010
Swap
100 bbls/d
$84.00
WTI - NYMEX
Jan 1 to Dec 31, 2010
Swap
100 bbls/d
$86.00
WTI - NYMEX
Jan 1 to Dec 31, 2010
Swap
200 bbls/d
$81.00
WTI - NYMEX
Feb 1 to Dec 31, 2010
Swap
100 bbls/d
$87.75
WTI - NYMEX
Feb 1 to Dec 31, 2010
Swap
100 bbls/d
$87.90
WTI - NYMEX
UNREALIZED
GAINS
(LOSSES)
(C$000S)
-
-
-
(2)
454
-
-
-
-
-
-
-
Jan 1 to Dec 31, 2011
Swap
250 bbls/d
$80.00
WTI - NYMEX
(1,247)
Jan 1 to Dec 31, 2011
Call
250 bbls/d
$96.55
WTI - NYMEX
415
Jan 1 to Dec 31, 2011
Swap
250 bbls/d
$80.00
WTI - NYMEX
(1,247)
Jan 1 to Dec 31, 2011
Jan 1 to Dec 31, 2011
Call
Call
250 bbls/d
$91.00
WTI - NYMEX
125 bbls/d
$78.40
WTI - NYMEX
Jan 1 to Dec 31, 2011
Swap
250 bbls/d
$85.50
WTI - NYMEX
Jan 1 to Dec 31, 2011
Put
250 bbls/d
$78.40
WTI - NYMEX
661
(757)
(749)
123
REALIZED
GAINS
(LOSSES)
(C$000S)
1,459
377
42
-
-
261
151
78
151
(63)
197
201
-
-
-
-
-
-
-
Total
(2,349)
2,854
Surge Energy Inc. | AR 2010
64
(III) INTEREST RATE RISK
Interest rate risk is the risk that future cash flows will fluctuate as a result of changes in market interest rates.
Over the course of the year ended December 31, 2010, the Corporation was exposed to interest rate fluctuations
on its bank debt, which bears a floating rate of interest. As at December 31, 2010, if interest rates had been
100 basis points lower with all other variables held constant, net earnings for year ended would have been
approximately $0.2 million (2009 - $0.4 million) higher, due to lower interest expense. An equal and opposite
impact would have occurred to net earnings had interest rates been 100 basis points higher.
The following table outlines the unrealized and realized loss on an interest rate swap contract for the year ended
December 31, 2010:
YEAR ENDED DEC
31, 2010
YEAR ENDED DEC
31, 2010
TERM
Feb 24 –
Apr 15, 2010
TYPE (FLOATING
TO FIXED)
AMOUNT (C$)
COMPANY FIXED
INTEREST RATE
(%)
COUNTER PARTY
FLOATING RATE
INDEX
UNREALIZED
GAINS (LOSSES)
(C$)
REALIZED LOSS
(C$)
Swap
35,000,000 4.42 to 4.44
CAD-BA-
CDOR
-
(60)
The following table summarizes the sensitivity of the fair value of the Corporation’s market risk management
positions to fluctuations in both crude oil and natural gas prices. Both such fluctuations were evaluated
independently, with all other variables held constant. In assessing the potential impact of these fluctuations, the
Corporation believes that the volatilities presented below are reasonable measures. Fluctuations in crude oil and
natural gas prices, which would impact the mark-to-market calculation of commodity contracts, could have had
the following impact on the net earnings:
Crude Oil - Change of +/- $1.00
Natural Gas - Change of +/- $0.50
(D)
CAPITAL MANAGEMENT
NET EARNINGS IMPACT FOR
YEAR ENDED DECEMBER 31, 2010
PRICE INCREASE
PRICE DECREASE
$ (212,156)
$ 212,156
$ (75,731)
$ 75,731
The Corporation’s policy is to maintain a strong capital base so as to maintain investor, creditor, and market
confidence and sustain the future development of the business. The Corporation manages its capital structure
and makes adjustments to it in light of changes in economic conditions and the risk characteristics of the
underlying petroleum and natural gas assets. The Corporation considers its capital structure to include
shareholder’s equity of $266.0 million (2009 - $56.8 million), bank debt of $ 30.0 million (2009 - $41.7
million) and a working capital deficiency excluding bank debt of $18.1 million (2009 – $5.3 million). In order
to maintain or adjust capital structure, the Corporation may from time to time issue shares and adjust its capital
spending to manage current and projected debt levels.
The Corporation monitors its capital based on the ratio of forecast net debt to forecast funds from operations.
Net debt is defined as outstanding bank debt plus or minus cash-based working capital. Funds from operations
is defined as cash flow from operating activities before changes in non-cash working capital. The Corporation’s
strategy is to maintain a one year forward looking forecast debt to forecast funds from operations ratio of less
than two to one. This ratio may increase at certain times as a result of acquisitions or other capital spending. In
order to facilitate the management of this ratio, the Corporation prepares annual capital expenditure budgets,
which are updated as necessary depending on varying factors including current and forecast prices, successful
capital deployment and general industry conditions. The annual and updated budgets are approved by the
Board of Directors.
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Surge Energy Inc. | AR 2010
(E)
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Corporation’s financial instruments as at December 31, 2010 and 2009 include cash, accounts receivable,
accounts payable and accrued liabilities, the fair value of financial contracts and bank debt. The fair value of
cash, accounts receivable and accounts payable and accrued liabilities approximate their carrying amounts due
to their short-terms to maturity.
The fair value of financial contracts is determined by discounting the difference between the contracted
commodity price/interest rate and published forward commodity price/interest rate curves as at the balance
sheet date, using the remaining contracted notional volumes.
Bank debt, when outstanding, bears interest at a floating market rate and accordingly the fair market value
approximates the carrying value.
The Corporation classifies its financial instruments recorded at fair value according to the following hierarchy
based on the amount of observable inputs used to value the instrument.
• Level 1 – Quoted prices are available in active markets for identical assets or liabilities as of the reporting
date. Active markets are those in which transactions occur in sufficient frequency and volume to provide
pricing information on an ongoing basis.
• Level 2 – Pricing inputs are other than quoted prices in active markets included in Level 1. Prices in Level
2 are either directly or indirectly observable as the reporting date. Level 2 valuations are based on inputs,
including quoted forward prices for commodities, time value and volatility factors, which can be substantially
observed or corroborated in the marketplace.
• Level 3 – Valuations in this level are those with inputs for the asset or liability that are not based on
observable market data.
The Corporation’s financial contracts are considered level 2, while cash is considered level 1.
13. SUBSEQUENT EVENTS
Subsequent to December 31, 2010, the Corporation entered into seven financial oil contracts:
TERM
VOLUME
FLOOR PRICE (C$)
OTHER TERMS.
Apr 1 to Dec 31, 2011
250 bbls/day
$80.00
Participation in 100 percent of the upside
above $84.35 CDN per barrel.
Jul 1 to Dec 31, 2011
250 bbls/day
$90.00
Participation in upside above
$90.00 CDN per barrel at a rate of
74 percent.
Jan 1 to Dec 31, 2012
250 bbls/day
$97.00
N/A
Jan 1 to Dec 31, 2012
250 bbls/day
$80.00
Participation in upside above
$80.00 CDN per barrel at a rate of
75 percent.
Jan 1 to Dec 31, 2012
250 bbls/day
$90.00
Participation in upside above
$90.00 CDN per barrel at a rate of
63 percent.
Jan 1 to Dec 31, 2012
250 bbls/day
$80.00
Participation in 100 percent of the upside
above $89.95 CDN per barrel.
Jan 1 to Dec 31, 2012
500 bbls/day
$90.00
Participation in 68.5 percent of the upside
above $90.00 CDN per barrel.
Surge Energy Inc. | AR 2010
66
CORPORATE INFO
DIRECTORS
Paul Colborne (Chairman)(4)
Peter Bannister(1)(2)
Dan O’Neil
Robert Leach(3)
James Pasieka(3)
Keith Macdonald(1)(2)(4)
Murray Smith(1)(3)
Colin Davies(2)(4)
(1) Member of the Audit Committee
(2) Member of the Reserves Committee
(3) Member of the Compensation Committee
(4) Member of the Environment, Health and Safety Committee
HEAD OFFICE
Address:
2100, 635 – 8th Avenue S.W.
Calgary, Alberta T2P 3M3
Phone: (403) 930-1010 Fax: (403) 930-1011
Email: invest@surgeenergy.ca
Website: www.surgeenergy.ca
ANNUAL GENERAL AND
SPECIAL MEETING
Shareholders are cordially invited to attend the
Annual General and Special Meeting of Surge Energy Inc.,
which will be held at 10:00 am Mountain Daylight Time
on Thursday, June 16, 2011 in the
Viking Room of the Calgary Petroleum Club
(319 - 5 Avenue SW, Calgary, Alberta).
MANAGEMENT
Dan O’Neil
President, Chief Executive Officer and Director
Max Lof
Chief Financial Officer
Dan Brown
Chief Operating Officer
Malcolm Adams
Vice President Corporate Development
Margaret Elekes
Vice President Land
Kevin Angus
Vice President Exploration
Tee Ong
Vice President Engineering
LEGAL COUNSEL
Heenan Blaikie LLP, Calgary, Alberta
BANKER
National Bank of Canada, Calgary, Alberta
REGISTRAR & TRANSFER AGENT
Olympia Trust Company, Calgary, Alberta
AUDITORS
KPMG LLP Chartered Accountants, Calgary, Alberta
INDEPENDENT ENGINEERS
Sproule Associates Limited, Calgary, Alberta
STOCK EXCHANGE LISTING
Toronto Stock Exchange (Venture) SGY
DESIGNED BY Bryan Mills Iradesso
67
Surge Energy Inc. | AR 2010
ABBREVIATIONS
bcf
bbl
billion cubic feet
barrel
bbls/d
barrels per day
boe
barrel of oil equivalent on the basis of 1 boe to 6 mcf of natural gas. Boe’s may be misleading,
particularly if used in isolation. A boe conversion ratio of 1 boe for 6 mcf is based on an energy
equivalency conversion method primarily applicable at the burner tip and does not necessarily
represent a value equivalency at the wellhead.
boe per day barrels of oil equivalent per day
cagr
compound annual growth rate
km
m
kilometre
thousand
mboe
thousand barrels of oil equivalent
mcf
thousand cubic feet
mcf per day
thousand cubic feet per day
mcfe
mm
thousand cubic feet equivalent
million
mmbtu
million British Thermal Units
mmcf
million cubic feet
Surge Energy Inc. | AR 2010
68
2100, 635 – 8th Avenue SW
Calgary, AB T2P 3M3
TSX-V: SGY
www.surgeenergy.ca