CALGARY, ALBERTA — (Marketwire) — 03/27/13 — CROCOTTA ENERGY INC. (TSX: CTA) is pleased to announce its financial and operating results for the year ended December 31, 2012, including consolidated financial statements, notes to the consolidated financial statements, and Management–s Discussion and Analysis. All dollar figures are Canadian dollars unless otherwise noted.
HIGHLIGHTS
PRESIDENT–S MESSAGE
Crocotta had a highly successful 2012 with respect to many aspects of the business. Great strides were made in building long term value by proving up material inventory in the Cardium at Edson, starting to build infrastructure for liquids recovery at Sunrise-Dawson in the Montney, and reducing operating costs to below $6 per boe.
The Cardium opened the year with one successful horizontal oil well producing at Edson and ended with 11 wells onstream and 35 additional net locations added to the drilling inventory.
Successful well tests in the Montney proved up a liquids-rich play at Sunrise-Dawson that will provide high growth and large returns for Crocotta in 2013 and beyond. Crocotta signed an agreement with a third party entity and will be constructing facilities in Q213 to extract a large portion of the natural gas liquids while materially reducing operating costs. This play, given liquids yield and high initial rates, will rival most liquids-rich plays in North America.
The last but certainly not the least play is the Bluesky at Edson. The 22 horizontal Bluesky wells drilled by Crocotta over the last two and half years provided a large portion of the growth from 2,200 boepd in 2010 to the 2012 exit rate of 8,500 boepd. While significantly delineated and de-risked, the Bluesky still has very material production upside with over 40 net locations in drilling inventory.
In 2013, Crocotta expects to further all three of its major plays which will contribute to our budgeted exit rate of 10,500 boepd. Crocotta also intends to drill two oil exploration plays and continues to pursue acquisitions in its core areas.
We look forward to updating our shareholders throughout the year as we execute our plan for 2013.
Rob Zakresky, President & Chief Executive Officer
MANAGEMENT–S DISCUSSION AND ANALYSIS (“MD&A”)
March 25, 2013
The MD&A should be read in conjunction with the audited consolidated financial statements and related notes for the years ended December 31, 2012 and 2011. The audited consolidated financial statements and financial data contained in the MD&A have been prepared in accordance with International Financial Reporting Standards (“IFRS”) in Canadian currency (except where noted as being in another currency).
DESCRIPTION OF BUSINESS
Crocotta Energy Inc. (“Crocotta” or the “Company”) is an oil and natural gas company, actively engaged in the acquisition, development, exploration, and production of oil and natural gas reserves in Western Canada. The Company trades on the Toronto Stock Exchange under the symbol “CTA”.
FREQUENTLY RECURRING TERMS
The Company uses the following frequently recurring industry terms in the MD&A: “bbls” refers to barrels, “mcf” refers to thousand cubic feet, and “boe” refers to barrel of oil equivalent. Disclosure provided herein in respect of a boe may be misleading, particularly if used in isolation. A boe conversion rate of six thousand cubic feet of natural gas to one barrel of oil equivalent has been used for the calculation of boe amounts in the MD&A. This boe conversion rate is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.
NON-GAAP MEASURES
This MD&A refers to certain financial measures that are not determined in accordance with IFRS (or “GAAP”). This MD&A contains the terms “funds from operations”, “funds from operations per share”, “net debt”, and “operating netback” which do not have any standardized meaning prescribed by GAAP and therefore may not be comparable to similar measures used by other companies. The Company uses these measures to help evaluate its performance.
Management uses funds from operations to analyze performance and considers it a key measure as it demonstrates the Company–s ability to generate the cash necessary to fund future capital investments and to repay debt. Funds from operations is a non-GAAP measure and has been defined by the Company as net loss plus non-cash items (depletion and depreciation, asset impairments, share based compensation, non-cash finance expenses, gains and losses on asset sales, deferred income taxes, and unrealized gains and losses on risk management contracts) and excludes the change in non-cash working capital related to operating activities and expenditures on decommissioning obligations. The Company also presents funds from operations per share whereby amounts per share are calculated using weighted average shares outstanding, consistent with the calculation of earnings per share. Funds from operations is reconciled from cash flow from operating activities under the heading “Funds from Operations”.
Management uses net debt as a measure to assess the Company–s financial position. Net debt includes current liabilities (including the revolving credit facility and excluding risk management contracts) less current assets.
Management considers operating netback an important measure as it demonstrates its profitability relative to current commodity prices. Operating netback, which is calculated as average unit sales price less royalties, production expenses, and transportation expenses, represents the cash margin for every barrel of oil equivalent sold. Operating netback per boe is reconciled to net loss per boe under the heading “Operating Netback”.
2012 HIGHLIGHTS
The Company has experienced significant growth in oil and natural gas sales and funds from operations over the past three years. Successful capital activity during the latter half of 2010 and throughout 2011 and 2012, mainly at Edson, AB, led to a significant increase in production which resulted in increased revenue and funds from operations. The Company had a net loss the past three years mainly due to asset impairments recorded on non-core properties in each year due to declines in commodity prices and limited capital activity in these non-core areas to increase reserves. Net debt increased significantly in 2012 due to significant capital expenditures of $104.0 million during the year. Net debt in 2011 and 2010 was lower as a result of several factors, including two equity financings in 2011 that raised gross proceeds of $61.0 million, non-core property dispositions during 2010 and 2011 that totaled $65.2 million, and funds flow from operations generated in 2010 and 2011 that totaled $44.8 million, which were offset by significant capital expenditures that totaled $123.4 million in 2010 and 2011.
Daily production for the three months ended December 31, 2012 increased 27% to 7,336 boe/d compared to 5,771 boe/d for the comparative period in 2011. For the year, daily production increased 83% to 6,911 boe/d in 2012 from 3,775 boe/d in 2011. The significant increase in production was due to successful drilling activity at Edson, AB which saw 18.0 gross (13.4 net) wells drilled during 2012 at a 100% success rate. During 2011, 14 gross (11.7 net) wells were drilled at Edson, AB at a 100% success rate. Compared to the previous quarter, daily production increased 6% in Q4 2012 from 6,945 boe/d in Q3 2012.
Crocotta–s production profile for 2012 was comprised of 68% natural gas and 32% oil and NGLs, consistent with the production profile for 2011.
Revenue totaled $24.9 million for the fourth quarter of 2012, up 22% from $20.4 million in the comparative period. For the year, revenue increased 46% to $80.5 million in 2012 from $55.0 million in 2011. The increase in revenue was due to significant increases in production, offset by declines in commodity prices.
The following table outlines the Company–s realized wellhead prices and industry benchmarks:
Differences between corporate and benchmark prices can be the result of quality differences (higher or lower API oil and higher or lower heat content natural gas), sour content, NGLs included in reporting, and various other factors. Crocotta–s differences are mainly the result of lower priced NGLs included in oil price reporting and higher heat content natural gas production that is priced higher than AECO reference prices. The Company–s corporate average oil and NGLs prices were 80.0% and 74.9% of Edmonton Par price for the three months and year ended December 31, 2012, consistent with 76.2% and 78.5% for the comparative periods in 2011. Corporate average natural gas prices were 110.6% and 112.6% of AECO prices for the three months and year ended December 31, 2012, consistent with the comparative period results of 106.1% and 106.8%.
Future prices received from the sale of the products may fluctuate as a result of market factors. Other than noted below, the Company did not hedge any of its oil, NGLs or natural gas production in 2012. During 2012, the Company had entered into the following commodity price contracts:
For the year ended December 31, 2012, the realized gain on the oil contract was $3.4 million and the realized loss on the gas contracts was $0.2 million. During the second quarter, the Company settled a portion of the original oil contract for the period from October 1, 2012 through December 31, 2012 for cash proceeds of $1.7 million, which was included in the realized gain. For the year ended December 31, 2012, the unrealized loss on the gas contracts was $1.6 million.
Subsequent to December 31, 2012, the Company entered into the following commodity price contracts:
The Company pays royalties to provincial governments (Crown), freeholders, which may be individuals or companies, and other oil and gas companies that own surface or mineral rights. Crown royalties are calculated on a sliding scale based on commodity prices and individual well production rates. Royalty rates can change due to commodity price fluctuations and changes in production volumes on a well-by-well basis, subject to a minimum and maximum rate restriction ascribed by the Crown. The provincial government has also enacted various royalty incentive programs that are available for wells that meet certain criteria, such as natural gas deep drilling, which can result in fluctuations in royalty rates.
For the three months ended December 31, 2012, oil, NGLs, and natural gas royalties increased 12% to $2.1 million from $1.9 million in the comparative period. For the year ended December 31, 2012, oil, NGLs, and natural gas royalties increased to $8.9 million from $6.1 million in 2011. These increases were the result of significant increases in oil, natural gas, and NGLs revenue stemming from increases in production.
The overall effective royalty rate was 8.3% for the three months ended December 31, 2012 compared to 9.1% for the three months ended December 31, 2011. For the year, the overall effective royalty rate was 11.1% in 2012 compared to 11.2% in 2011. The effective oil and NGLs royalty rate decreased as a result of royalty incentive rates received on the successful Edson, AB wells brought on production during the year. The effective natural gas royalty rate increased in 2012 compared to 2011 due mainly to a decrease in the monthly capital cost allowance deductions which effectively reduce gas Crown royalties.
Per unit production expenses for the three months ended December 31, 2012 were $6.41/boe, down from $7.05/boe for the comparative period ended December 31, 2011. For the year ended December 31, 2012, per unit production expenses decreased 26% to $5.83/boe from $7.85/boe for the year ended December 31, 2011. The Company has realized significant decreases in production expenses per boe due to operations at its core Edson, AB area. The Company is the operator and has ownership of the infrastructure at Edson, AB, enabling it to exercise control over operating costs. Control of operations and ownership of the infrastructure, combined with significant increases in production over the previous year, have allowed the Company to realize lower production expenses through economies of scale. The Company continues to focus on opportunities that will improve operational efficiencies and reduce per boe production expenses to enhance operating netbacks.
Transportation expenses are mainly third-party pipeline tariffs incurred to deliver production to the purchasers at main hubs. For the quarter ended December 31, 2012 compared to the quarter ended December 31, 2011, transportation expenses decreased 7% to $0.90/boe from $0.97/boe. For the year, transportation expenses increased to $0.98/boe in 2012 from $0.95/boe in 2011. The increase in oil and NGLs transportation expenses per boe was due to higher oil transportation expenses. In order to maximize the realized price on oil production, net of transportation expenses, the Company delivered an increased volume of oil to sales points with higher transportation expenses and higher net prices. The decrease in natural gas transportation expenses per boe is due to obtaining a lower contracted transportation fee in the fourth quarter of 2012 on the majority of the Company–s natural gas production. The lower contracted transportation fee is in effect until the fourth quarter of 2013.
During the fourth quarter of 2012, Crocotta generated an operating netback of $26.57/boe, consistent with an operating netback of $26.89/boe for the fourth quarter of 2011. For the year ended December 31, 2012, Crocotta generated an operating netback of $21.50/boe compared to $26.64/boe in the comparative period. The decrease was mainly due to declines in oil, natural gas, and NGLs commodity prices, offset by a decrease in royalties and operating costs in 2012 compared to 2011. Operating netbacks in Q4 2012 increased from operating netbacks of $17.27/boe in Q3 2012 due to an increase in oil, natural gas, and NGLs commodity prices.
The following is a reconciliation of operating netback per boe to net loss per boe for the periods noted:
The Company calculates depletion on property, plant, and equipment based on proved plus probable reserves. Plant turnarounds and major overhauls are depreciated over three or four years, depending on each facility. Depletion and depreciation for the three months ended December 31, 2012 was $13.49/boe compared to $14.87/boe in the comparative period. For the year, depletion and depreciation was $14.50/boe in 2012 compared to $15.04/boe in 2011. The decrease in depletion and depreciation per boe was due to a significant increase in reserves as a result of successful capital activity during 2012.
Exploration and evaluation assets and property, plant, and equipment are grouped into cash generating units (“CGU”) for purposes of impairment testing. Exploration and evaluation assets are assessed for impairment when they are transferred to property, plant, and equipment or if facts and circumstances suggest that the carrying amount exceeds the recoverable amount. For property, plant, and equipment, an impairment is recognized if the carrying value of a CGU exceeds the greater of its fair value less costs to sell or value in use.
For the year ended December 31, 2012, total exploration and evaluation asset impairments of $4.7 million were recognized. Asset impairments of $2.4 million were recognized relating to the determination of certain exploration and evaluation activities to be uneconomical (CGU – Miscellaneous AB). Additional exploration and evaluation impairments of $2.3 million were recognized in 2012 relating to the expiry of undeveloped land rights (CGUs – Lookout Butte AB, Miscellaneous AB, and Saskatchewan).
For the year ended December 31, 2011, total exploration and evaluation asset impairments of $13.7 million were recognized. Asset impairments of $12.5 million were recognized relating to the determination of certain exploration and evaluation activities to be uneconomical (CGUs – Miscellaneous AB and Saskatchewan). Of this $12.5 million impairment, $12.2 million related to unsuccessful exploration drilling activities in Southern Alberta during the year. Additional exploration and evaluation impairments of $1.2 million were recognized in 2011 relating to the expiry of undeveloped land rights (CGUs – Northeast BC and Miscellaneous AB).
For the year ended December 31, 2012, the Company recorded property, plant, and equipment impairments of $8.7 million relating to Smoky AB, Lookout Butte AB, Miscellaneous AB, and Saskatchewan CGUs mainly as a result of weakening natural gas prices and limited capital expenditures in these CGUs to maintain their reserve values.
For the year ended December 31, 2011, the Company recorded an impairment charge of $3.0 million relating to Smoky AB, Lookout Butte AB, Miscellaneous AB, and Saskatchewan CGUs mainly as a result of weakening natural gas prices at December 31, 2011. As well, the Company had limited capital expenditures in these CGUs to maintain their reserve values.
General and administrative expenses (“G&A”) increased to $3.87/boe for the fourth quarter of 2012 compared to $3.60/boe for the fourth quarter of 2011. The increase was mainly due to a decline in G&A recoveries in the fourth quarter of 2012 compared to the fourth quarter of 2011. For the year, net G&A expenses in 2012 were consistent with 2011. On a boe basis, G&A expenses of $2.17/boe in 2012 were down significantly from G&A expenses of $3.90/boe in 2011 as a result of a significant increase in production.
The Company grants stock options to officers, directors, employees and consultants and calculates the related share based compensation using the Black-Scholes-Merton option pricing model. The Company recognizes the expense over the individual vesting periods for the graded vesting awards and estimates a forfeiture rate at the date of grant and updates it throughout the vesting period. Share based compensation expense decreased to $1.01/boe and $1.39/boe, respectively, for the three months and year ended December 31, 2012 from $1.87/boe and $2.29/boe in the comparative periods, respectively. During 2012, the Company granted 0.7 million options (2011 – 4.2 million). The decrease in share based compensation per boe is a result of a significant increase in production.
Interest expense relates mainly to interest incurred on amounts drawn from the Company–s credit facility. The increase in interest expense is a result of higher amounts being drawn on the Company–s credit facility in 2012 compared to 2011. At December 31, 2012, $68.5 million (2011 – $5.2 million) had been drawn on the Company–s credit facility.
Investments included 875,000 warrants of Hyperion Exploration Corp. (“Hyperion”) at an exercise price of $2.00 per warrant. Each warrant was convertible into one common share of Hyperion and expired unexercised on November 7, 2011. The warrants were obtained as partial consideration for the sale of certain oil and natural gas assets to Hyperion in the fourth quarter of 2010. The investment was measured at fair value each reporting period using the Black-Scholes-Merton option pricing model. A realized loss was recognized in 2011 upon expiry of the warrants.
During 2011, the Company recognized a net loss on sale of assets of $2.6 million. A loss on sale of assets of $3.9 million was recognized during the fourth quarter relating to the disposition of certain non-core oil and natural gas assets located in the Miscellaneous AB CGU while additional losses of $1.5 million were recognized during the first half of 2011 on the disposition of certain non-producing assets in the Northeast BC CGU. These losses were offset by a gain on sale of assets of $2.8 million during the third quarter relating to dispositions of non-core oil and natural gas assets in Smoky AB and Miscellaneous AB CGUs.
DEFERRED INCOME TAX EXPENSE
Deferred income tax expense on the loss before taxes was $0.2 million in 2012 (2011 – $7.5 million income tax reduction). This was larger than expected by applying the statutory tax rate to the loss before taxes due mainly to flow-through shares and share based compensation and other non-deductible amounts.
Estimated tax pools at December 31, 2012 total approximately $299.6 million (2011 – $251.0 million).
FUNDS FROM OPERATIONS
Funds from operations for the three months and year ended December 31, 2012 were $14.5 million ($0.16 per diluted share) and $50.6 million ($0.56 per diluted share), respectively, compared to $12.1 million ($0.14 per diluted share) and $30.6 million ($0.38 per diluted share) for the three months and year ended December 31, 2011, respectively. The increase was mainly due to an increase in revenue in 2012 as a result of a significant increase in production.
The following is a reconciliation of cash flow from operating activities to funds from operations for the periods noted:
NET LOSS
The Company had a net loss of $2.1 million ($0.02 per diluted share) for the three months ended December 31, 2012 compared to a net loss of $7.1 million ($0.09 per diluted share) for the three months ended December 31, 2011. For the year, the Company had a net loss of $5.3 million ($0.06 per diluted share) in 2012 compared to a net loss of $5.6 million ($0.07 per diluted share) in 2011. The net loss in 2012 and 2011 arose mainly due to asset impairments recorded on non-core properties due to declines in commodity prices, limited capital activity in these non-core areas to maintain reserve values, and exploration and evaluation activities determined to be uneconomical.
For the three months ended December 31, 2012, the Company had net capital expenditures of $41.7 million compared to net capital expenditures of $32.3 million for the three months ended December 31, 2011. For the year ended December 31, 2012, the Company had net capital expenditures of $104.0 million compared to net capital expenditures of $80.2 million for the comparative period in 2011. The increase in exploration and development expenditures in 2012 was due mainly to an increase in capital activity in the Company–s core Edson, AB area. During 2012, Crocotta drilled a total of 21 (16.0 net) wells, which resulted in 12 (7.8 net) oil wells, 8 (7.2 net) liquids-rich natural gas wells, and 1 (1.0 net) exploratory well in a non-core area that was uneconomic. During 2011, Crocotta drilled a total of 20 (15.9 net) wells, which resulted in 4 (3.0 net) oil wells, 13 (10.9 net) liquids-rich natural gas wells, and 3 (2.0 net) exploratory wells in non-core areas that were uneconomic.
During 2011, the Company sold certain non-core oil and natural gas assets from the Smoky AB, Northeast BC, and Miscellaneous AB CGUs for cash proceeds of $14.6 million. The sale of these properties in 2011 allowed the Company to reduce net debt and focus capital spending on its two core areas, Edson Bluesky/Cardium and Dawson Montney.
LIQUIDITY AND CAPITAL RESOURCES
The Company had net debt of $80.1 million at December 31, 2012 compared to net debt of $27.7 million at December 31, 2011. The increase of $52.4 million was mainly due to $104.0 million used for the purchase and development of oil and natural gas properties and equipment and $0.7 million for decommissioning expenditures, offset by funds from operations of $50.6 million and share issuances of $1.7 million on the exercise of stock options and warrants during 2012.
At December 31, 2012, the Company had a $100.0 million revolving operating demand loan credit facility with a Canadian chartered bank. The revolving credit facility bears interest at prime plus a range of 0.50% to 2.50% and is secured by a $125 million fixed and floating charge debenture on the assets of the Company. At December 31, 2012, $68.5 million (December 31, 2011 – $5.2 million) had been drawn on the revolving credit facility. In addition, at December 31, 2012, the Company had outstanding letters of guarantee of approximately $1.5 million (December 31, 2011 – $1.0 million) which reduce the amount that can be borrowed under the credit facility. Subsequent to December 31, 2012, the Company signed an agreement to increase the revolving credit facility to $140.0 million. The next review of the revolving credit facility by the bank is scheduled on or before June 1, 2013.
In February 2011, the Company issued approximately 15.6 million common shares at a price of $2.30 per share for gross proceeds of approximately $36.0 million. In December 2011, the Company issued approximately 7.2 million common shares for gross proceeds of approximately $25.0 million. Under the December issuance, approximately 6.0 million common shares were issued at a price of $3.35 per share and approximately 1.2 million common shares were issued on a flow-through basis at a price of $4.00 per share. The proceeds were used to fund Crocotta–s Edson Bluesky/Cardium and Dawson Montney developments, other capital projects, and for general corporate purposes.
During 2011, the Company sold certain non-core oil and natural gas properties for cash proceeds of approximately $14.6 million. The proceeds of the dispositions were mainly used to reduce net debt and focus capital spending on its two core areas, Edson Bluesky/Cardium and Dawson Montney.
The ongoing global economic conditions have continued to impact the liquidity in financial and capital markets, restrict access to financing, and cause significant volatility in commodity prices. Despite the economic downturn and financial market volatility, the Company continued to have access to both debt and equity markets recently. The Company raised gross proceeds of approximately $61.0 million from the issuance of common shares during 2011, during the second quarter of 2012 the Company obtained an increase to its revolving credit facility from $80.0 million to $100.0 million, and subsequent to December 31, 2012, the Company obtained an increase to its revolving credit facility from $100.0 million to $140.0 million. The Company has also maintained a very successful drilling program which has resulted in significant increases in production and funds flow from operations in recent quarters in spite of downward trends and continued pressure on oil and natural gas commodity prices. Management anticipates that the Company will continue to have adequate liquidity to fund budgeted capital investments through a combination of cash flow, equity, and debt. Crocotta–s capital program is flexible and can be adjusted as needed based upon the current economic environment. The Company will continue to monitor the economic environment and the possible impact on its business and strategy and will make adjustments as necessary.
CONTRACTUAL OBLIGATIONS
The following is a summary of the Company–s contractual obligations and commitments at December 31, 2012:
Subsequent to December 31, 2012, the Company entered into farm-in agreements to drill and complete three Edson Cardium wells. Under the terms of the farm-in agreements, the Company is committed to spud one well prior to April 2013 and the remaining two wells prior to August 2013. The estimated total cost to drill and complete the wells is approximately $9.5 million.
OUTSTANDING SHARE DATA
The Company is authorized to issue an unlimited number of voting common shares, an unlimited number of non-voting common shares, Class A preferred shares, issuable in series, and Class B preferred shares, issuable in series. The voting common shares of the Company commenced trading on the TSX on October 17, 2007 under the symbol “CTA”. The following table summarizes the common shares outstanding and the number of shares exercisable into common shares from options, warrants, and other instruments:
A significant increase in production stemming from successful drilling activity during the previous two years resulted in substantial increases in revenue and funds from operations in Q4 2011 through Q4 2012 compared to prior quarters. The Company had a net loss in four of the five previous quarters mainly as a result of asset impairments recognized in each quarter on non-core properties.
2013 OUTLOOK
The information below represents Crocotta–s guidance for 2013, publicly released on January 31, 2013, based on management–s best estimates and the assumptions noted below.
Sensitivity Analysis
The outlook is based on estimates of key external market factors. Crocotta–s actual results will be affected by fluctuations in commodity prices as well as the U.S./Canadian dollar exchange rate. The following table provides a summary of estimates for 2013 of the sensitivity of Crocotta–s funds from operations to changes in commodity prices and the U.S./Canadian dollar exchange rate.
2012 OUTLOOK
The information below represents Crocotta–s guidance for 2012, publicly released on February 9, 2012, and a comparison to actual results for 2012:
During 2012, actual oil, NGLs, and natural gas commodity prices were significantly lower than the Company–s guidance. This resulted in actual revenue and funds from operations in 2012 being lower than guidance. Due to lower commodity prices during the middle half of 2012, the Company shifted gas-weighted capital projects to the fourth quarter. This shift resulted in a lower average daily production compared to guidance and also contributed to actual revenue and funds from operations being lower than guidance. Exit guidance of 8,500 boe/d was successfully achieved. Actual capital expenditures in 2012 exceeded budget as a result of property acquisitions, land acquisitions, and new farm-in opportunities as a result of the success of the Edson Cardium.
CRITICAL ACCOUNTING ESTIMATES
Management is required to make estimates, judgments, and assumptions in the application of IFRS that affect the reported amounts of assets and liabilities at the date of the financial statements and revenues and expenses for the period then ended. Certain of these estimates may change from period to period resulting in a material impact on the Company–s results from operations, financial position, and change in financial position. The following summarizes the Company–s significant critical accounting estimates.
Oil and natural gas reserves
The Company engages a qualified, independent oil and gas reserves evaluator to perform an estimation of the amount of the Company–s oil and natural gas reserves at least annually. Reserves form the basis for the calculation of depletion and assessment of impairment of oil and natural gas assets. Reserves are estimated using the definitions of reserves prescribed by National Instrument 51-101 and the Canadian Oil and Gas Evaluation Handbook.
Proved plus probable reserves are defined as the estimated quantities of crude oil, natural gas liquids including condensate, and natural gas that geological and engineering data demonstrate a 50 percent probability of being recovered at the reported level. Due to the inherent uncertainties and the necessarily limited nature of reservoir data, estimates of reserves are inherently imprecise, require the application of judgment, and are subject to change as additional information becomes available. The 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 changes in the Company–s plans.
Impairment testing
Exploration and evaluation assets
Exploration and evaluation assets are assessed for impairment (i) if sufficient data exists to determine technical feasibility and commercial viability, (ii) if facts and circumstances suggest that the carrying amount exceeds the recoverable amount, and (iii) upon transfer to property, plant, and equipment. For purposes of impairment testing, exploration and evaluation assets are allocated to CGUs. Impairment tests by their nature involve estimates and judgment, which for exploration and evaluation assets include estimates of proved and probable reserves found, the market value of undeveloped land, and future development plans. Crocotta allocated its exploration and evaluation assets to specific CGUs for the purpose of impairment testing.
Property, plant, and equipment
For the purpose of impairment testing, items of property, plant, and equipment, which includes oil and natural gas development and production assets, are grouped together into the smallest group of assets that generates cash inflows from continuing use that are largely independent of the cash inflows of other assets or groups of assets (CGU). The recoverable amount of an asset or a CGU is the greater of its value in use and its fair value less costs to sell. The Company uses fair value less costs to sell for its impairment tests which is determined as the net present value of the estimated future cash flows expected to arise from the continued use of the CGU, including any expansion prospects, and its eventual disposal, using assumptions that an independent market participant may take into account. These cash flows are discounted by an appropriate discount rate which would be applied by such a market participant to arrive at a net present value of the CGU. The significant estimates and judgments include proved plus probable reserves, the estimated value of those reserves, including future commodity prices, the discount rate used to present value the estimated future cash flows, and other assumptions that an independent market participant may take into account, including acquisition metrics of recent transactions for similar assets.
Decommissioning obligations
Decommissioning obligations are estimated based on existing laws, contracts, or other policies. Decommissioning obligations are measured at the present value of management–s best estimate of the expenditure required to settle the present obligation as at the reporting date. Subsequent to the initial measurement, the obligation is adjusted at the end of each reporting period to reflect the passage of time and changes in the estimated future cash flows underlying the obligation. The increase in the provision due to the passage of time is recognized as accretion whereas increases or decreases due to changes in the estimated future cash flows or changes in the discount rate are capitalized. Actual costs incurred upon settlement of the decommissioning obligations are charged against the provision to the extent the provision was established. By their nature, these estimates are subject to measurement uncertainty and the impact on the financial statements could be material.
Share based compensation
Measurement of compensation cost attributable to the Company–s share based compensation plan is subject to the estimation of fair value using the Black-Scholes-Merton option pricing model. The valuation is based on significant assumptions including the estimated forfeiture rate, the expected volatility (based on the weighted average historic volatility adjusted for changes expected due to publicly available information), the weighted average expected life of the instrument (based on historical experience and general information), the expected dividends, and the risk free interest rate (based on government bonds).
Deferred income taxes
The determination of the Company–s income taxes requires interpretation of complex laws and regulations. Tax interpretations, regulations, and legislation in the various jurisdictions in which the Company operates are subject to change. Deferred income tax assets are assessed by management at the end of the reporting period to determine the likelihood that they will be realized from future taxable earnings.
FUTURE CHANGES IN ACCOUNTING POLICIES
In May 2011, the IASB issued four new standards and two amendments. Five of these items related to consolidation, while the remaining one addresses fair value measurement. All of the new standards are effective for annual periods beginning on or after January 1, 2013. The adoption of these standards is not expected to have a significant impact on the amounts recorded in the Company–s consolidated financial statements.
IFRS 10, Consolidated Financial Statements replaces IAS 27, Consolidated Separate Financial Statements. It introduces a new principle-based definition of control, applicable to all investees to determine the scope of consolidation. The standard provides the framework for consolidated financial statements and their preparation based on the principle of control.
IFRS 11, Joint Arrangements replaces IAS 31, Interests in Joint Ventures. IFRS 11 divides joint arrangements into two types, each having its own accounting model. A “joint operation” continues to be accounted for using proportionate consolidation, whereas a “joint venture” must be accounted for using equity accounting. This differs from IAS 31, where there was the choice to use proportionate consolidation or equity accounting for joint ventures. A “joint operation” is defined as the joint operators having rights to the assets, and obligations for the liabilities, relating to the arrangement. In a “joint venture”, the joint venture partners have rights to the net assets of the arrangement, typically through their investment in a separate joint venture entity.
IFRS 12, Disclosure of Interests in Other Entities is a new standard, which combines all of the disclosure requirements for subsidiaries, associates and joint arrangements, as well as unconsolidated structured entities.
IFRS 13, Fair Value Measurement is a new standard meant to clarify the definition of fair value, provide guidance on measuring fair value and improve disclosure requirements related to fair value measurement.
IAS 27, Separate Financial Statements has been amended to focus solely on accounting and disclosure requirements when an entity presents separate financial statements, due to the issuance of the new IFRS 10 which is specific to consolidated financial statements.
IAS 28, Investments in Associates and Joint Ventures has been amended as a result of the issuance of IFRS 11 and the withdrawal of IAS 31. The amended standard sets out the requirements for the application of the equity method when accounting for interest in joint ventures, in addition to interests in associates.
In November 2009, the IASB published IFRS 9, Financial Instruments, which covers the classification and measurement of financial assets as part of its project to replace IAS 39, Financial Instruments: Recognition and Measurement. In October 2010, the requirements for classifying and measuring financial liabilities were added to IFRS 9. Under this guidance, entities have the option to recognize financial liabilities at fair value through earnings. If this option is elected, entities would be required to reverse the portion of the fair value change due to a company–s own credit risk out of earnings and recognize the change in other comprehensive income. IFRS 9 is effective for the Company on January 1, 2015. Early adoption is permitted and the standard is required to be applied retrospectively. The Company does not anticipate this standard to have a material impact on the consolidated financial statements.
RISK ASSESSMENT
The acquisition, exploration, and development of oil and natural gas properties involves many risks common to all participants in the oil and natural gas industry. Crocotta–s exploration and development activities are subject to various business risks such as unstable commodity prices, interest rate and foreign exchange fluctuations, the uncertainty of replacing production and reserves on an economic basis, government regulations, taxes, and safety and environmental concerns. While management realizes these risks cannot be eliminated, they are committed to monitoring and mitigating these risks.
Reserves and reserve replacement
The recovery and reserve estimates on Crocotta–s properties are estimates only and the actual reserves may be materially different from that estimated. The estimates of reserve values are based on a number of variables including price forecasts, projected production volumes and future production and capital costs. All of these factors may cause estimates to vary from actual results.
Crocotta–s future oil and natural gas reserves, production, and funds from operations to be derived therefrom are highly dependent on the Company successfully acquiring or discovering new reserves. Without the continual addition of new reserves, any existing reserves the Company may have at any particular time and the production therefrom will decline over time as such existing reserves are exploited. A future increase in Crocotta–s reserves will depend on its abilities to acquire suitable prospects or properties and discover new reserves.
To mitigate this risk, Crocotta has assembled a team of experienced technical professionals who have expertise operating and exploring in areas the Company has identified as being the most prospective for increasing reserves on an economic basis. To further mitigate reserve replacement risk, Crocotta has targeted a majority of its prospects in areas which have multi-zone potential, year-round access, and lower drilling costs and employs advanced geological and geophysical techniques to increase the likelihood of finding additional reserves.
Operational risks
Crocotta–s operations are subject to the risks normally incidental to the operation and development of oil and natural gas properties and the drilling of oil and natural gas wells. Continuing production from a property, and to some extent the marketing of production therefrom, are largely dependent upon the ability of the operator of the property.
Financial instruments
Market risk
Market risk is the risk that the fair value of future cash flows of a financial instrument will fluctuate because of changes in market prices. Market risk is comprised of foreign currency risk, interest rate risk, and other price risk, such as commodity price risk. The objective of market risk management is to manage and control market price exposures within acceptable limits, while maximizing returns. The Company may use financial derivatives or physical delivery sales contracts to manage market risks. All such transactions are conducted within risk management tolerances that are reviewed by the Board of Directors.
Foreign exchange risk
The prices received by the Company for the production of crude oil, natural gas, and NGLs are primarily determined in reference to US dollars, but are settled with the Company in Canadian dollars. The Company–s cash flow from commodity sales will therefore be impacted by fluctuations in foreign exchange rates. The Company currently does not have any foreign exchange contracts in place.
Interest rate risk
The Company is exposed to interest rate risk as it borrows funds at floating interest rates. In addition, the Company may at times issue shares on a flow-through basis. This results in the Company being exposed to interest rate risk to the Canada Revenue Agency for interest on unexpended funds on the Company–s flow-through share obligations. The Company currently does not use interest rate hedges or fixed interest rate contracts to manage the Company–s exposure to interest rate fluctuations.
Commodity price risk
Oil and natural gas prices are impacted by not only the relationship between the Canadian and US dollar but also by world economic events that dictate the levels of supply and demand. The Company–s oil, natural gas, and NGLs production is marketed and sold on the spot market to area aggregators based on daily spot prices that are adjusted for product quality and transportation costs. The Company–s cash flow from product sales will therefore be impacted by fluctuations in commodity prices. During 2012, the Company had entered into the following commodity price contracts:
For the year ended December 31, 2012, the realized gain on the oil contract was $3.4 million and the realized loss on the gas contracts was $0.2 million. During the second quarter, the Company settled a portion of the original oil contract for the period from October 1, 2012 through December 31, 2012 for cash proceeds of $1.7 million, which was included in the realized gain. For the year ended December 31, 2012, the unrealized loss on the gas contracts was $1.6 million.
Subsequent to December 31, 2012, the Company entered into the following commodity price contract:
Credit risk
Credit risk represents the financial loss that the Company would suffer if the Company–s counterparties to a financial instrument, in owing an amount to the Company, fail to meet or discharge their obligation to the Company. A substantial portion of the Company–s accounts receivable and deposits are with customers and joint venture partners in the oil and natural gas industry and are subject to normal industry credit risks. The Company generally grants unsecured credit but routinely assesses the financial strength of its customers and joint venture partners.
The Company sells the majority of its production to three petroleum and natural gas marketers and therefore is subject to concentration risk. Historically, the Company has not experienced any collection issues with its oil and natural gas marketers. Joint venture receivables are typically collected within one to three months of the joint venture invoice being issued to the partner. The Company attempts to mitigate the risk from joint venture receivables by obtaining partner approval for significant capital expenditures prior to the expenditure being incurred. The Company does not typically obtain collateral from petroleum and natural gas marketers or joint venture partners; however, in certain circumstances, the Company may cash call a partner in advance of expenditures being incurred.
The maximum exposure to credit risk is represented by the carrying amount on the statement of financial position. At December 31, 2012, $14.0 million or 87.3% of the Company–s outstanding accounts receivable were current while $2.0 million or 12.7% were outstanding over 90 days but not impaired. During the year ended December 31, 2012, the Company expensed $0.3 million in outstanding accounts receivable deemed to be uncollectable.
Liquidity risk
Liquidity risk is the risk that the Company will not be able to meet its financial obligations as they become due. The Company–s processes for managing liquidity risk include ensuring, to the extent possible, that it will have sufficient liquidity to meet its liabilities when they become due. The Company prepares annual, quarterly, and monthly capital expenditure budgets, which are monitored and updated as required, and requires authorizations for expenditures on projects to assist with the management of capital. In managing liquidity risk, the Company ensures that it has access to additional financing, including potential equity issuances and additional debt financing. The Company also mitigates liquidity risk by maintaining an insurance program to minimize exposure to insurable losses.
Safety and Environmental Risks
The oil and natural gas business is subject to extensive regulation pursuant to various municipal, provincial, national, and international conventions 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. Crocotta is committed to meeting and exceeding its environmental and safety responsibilities. Crocotta has implemented an environmental and safety policy that is designed, at a minimum, to comply with current governmental regulations set for the oil and natural gas industry. Changes to governmental regulations are monitored to ensure compliance. Environmental reviews are completed as part of the due diligence process when evaluating acquisitions. Environmental and safety updates are presented and discussed at each Board of Directors meeting. Crocotta maintains adequate insurance commensurate with industry standards to cover reasonable risks and potential liabilities associated with its activities as well as insurance coverage for officers and directors executing their corporate duties. To the knowledge of management, there are no legal proceedings to which Crocotta is a party or of which any of its property is the subject matter, nor are any such proceedings known to Crocotta to be contemplated.
DISCLOSURE CONTROLS AND PROCEDURES AND INTERNAL CONTROLS OVER FINANCIAL REPORTING
The Company–s President and Chief Executive Officer (“CEO”) and Vice President Finance and Chief Financial Officer (“CFO”) are responsible for establishing and maintaining disclosure controls and procedures and internal controls over financial reporting as defined in Multilateral Instrument 52-109 of the Canadian Securities Administrators.
Disclosure controls and procedures have been designed to ensure that information required to be disclosed by the Company is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure. The Company evaluated its disclosure controls and procedures for the year ended December 31, 2012. The Company–s CEO and CFO have concluded that, based on their evaluation, the Company–s disclosure controls and procedures are effective to provide reasonable assurance that all material or potentially material information related to the Company is made known to them and is disclosed in a timely manner if required.
Internal controls over financial reporting have been designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with IFRS. The Company–s internal controls over financial reporting include those policies and procedures that: pertain to the maintenance of records that in reasonable detail accurately and fairly reflect transactions and disposition of the assets; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures are being made only in accordance with authorizations of management and directors; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the annual financial statements or interim financial statements.
The Company evaluated the effectiveness of its internal controls over financial reporting as of December 31, 2012. In making this evaluation, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on their evaluation, the Company–s CEO and CFO have identified weaknesses over segregation of duties. Specifically, due to the limited number of finance and accounting personnel at the Company, it is not feasible to achieve complete segregation of duties with regards to certain complex and non-routine accounting transactions that may arise. This weakness is considered to be a common deficiency for many smaller listed companies in Canada. Notwithstanding the weaknesses identified with regards to segregation of duties, the Company concluded that all other of its internal controls over financial reporting were effective as of December 31, 2012. No material changes in the Company–s internal controls over financial reporting were identified during the most recent reporting period that have materially affected, or are likely to material affect, the Company–s internal controls over financial reporting.
Because of their inherent limitations, disclosure controls and procedures and internal controls over financial reporting may not prevent or detect misstatements, errors, or fraud. Control systems, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the control systems are met. As a result of the weaknesses identified in the Company–s internal controls over financial reporting, there is a greater likelihood that a material misstatement would not be prevented or detected. To mitigate the risk of such material misstatement in financial reporting, the CEO and CFO oversee all material and complex transactions of the Company and the financial statements are reviewed and approved by the Board of Directors each quarter. In addition, the Company will seek the advice of external parties, such as the Company–s external auditors, in regards to the appropriate accounting treatment for any complex and non-routine transactions that may arise.
FORWARD-LOOKING INFORMATION
This document contains forward-looking statements and forward-looking information within the meaning of applicable securities laws. The use of any of the words “expect”, “anticipate”, “continue”, “estimate”, “may”, “will”, “should”, “believe”, “intends”, “forecast”, “plans”, “guidance” and similar expressions are intended to identify forward-looking statements or information.
More particularly and without limitation, this MD&A contains forward looking statements and information relating to the Company–s risk management program, oil, NGLs, and natural gas production, capital programs, oil, NGLs, and natural gas commodity prices, and debt levels. The forward-looking statements and information are based on certain key expectations and assumptions made by the Company, including expectations and assumptions relating to prevailing commodity prices and exchange rates, applicable royalty rates and tax laws, future well production rates, the performance of existing wells, the success of drilling new wells, the availability of capital to undertake planned activities, and the availability and cost of labour and services.
Although the Company believes that the expectations reflected in such forward-looking statements and information are reasonable, it can give no assurance that such expectations will prove to be correct. Since forward-looking statements and information address future events and conditions, by their very nature they involve inherent risks and uncertainties. Actual results may differ materially from those currently anticipated due to a number of factors and risks. These include, but are not limited to, the risks associated with the oil and gas industry in general such as 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 estimates and projections relating to production rates, costs, and expenses, commodity price and exchange rate fluctuations, marketing and transportation, environmental risks, competition, the ability to access sufficient capital from internal and external sources and changes in tax, royalty, and environmental legislation. The forward-looking statements and information contained in this document are made as of the date hereof for the purpose of providing the readers with the Company–s expectations for the coming year. The forward-looking statements and information may not be appropriate for other purposes. The Company 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.
ADDITIONAL INFORMATION
Additional information related to the Company, including the Company–s Annual Information Form (AIF), may be found on the SEDAR website at .
MANAGEMENT–S RESPONSIBILITY FOR FINANCIAL STATEMENTS
The Management of Crocotta Energy Inc. is responsible for the preparation of the consolidated financial statements. The consolidated financial statements have been prepared in accordance with International Financial Reporting Standards and include certain estimates that reflect Management–s best estimates and judgments. Management has determined such amounts on a reasonable basis in order to ensure that the consolidated financial statements are presented fairly in all material respects.
Management is responsible for the integrity of the consolidated financial statements. Internal control systems are designed and maintained to provide reasonable assurance that assets are safeguarded from loss or unauthorized use and to produce reliable accounting records for financial reporting purposes.
KPMG LLP were appointed by the Company–s shareholders to express an audit opinion on the consolidated financial statements. Their examination included such tests and procedures, as they considered necessary, to provide a reasonable assurance that the consolidated financial statements are presented fairly in accordance with International Financial Reporting Standards.
The Board of Directors is responsible for ensuring that Management fulfills its responsibilities for financial reporting and internal control. The Board of Directors exercises this responsibility through the Audit Committee, with assistance from the Reserves Committee regarding the annual review of our oil and natural gas reserves. The Audit Committee meets regularly with Management and the Auditors to ensure that Management–s responsibilities are properly discharged, to review the consolidated financial statements and recommend that the consolidated financial statements be presented to the Board of Directors for approval. The Audit Committee also considers the independence of KPMG LLP and reviews their fees. The Auditors have access to the Audit Committee without the presence of Management.
Rob Zakresky
President, Chief Executive Officer and Director
Nolan Chicoine
Vice President, Finance and Chief Financial Officer
Calgary, Canada
March 25, 2013
INDEPENDENT AUDITORS– REPORT
To the Shareholders of Crocotta Energy Inc.
We have audited the accompanying consolidated financial statements of Crocotta Energy Inc., which comprise the consolidated statements of financial position as at December 31, 2012 and December 31, 2011, the consolidated statements of operations and comprehensive loss, shareholders– equity and cash flows for the years 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 International Financial Reporting Standards 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 audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the 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 audits 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 Crocotta Energy Inc. as at December 31, 2012 and December 31, 2011, and its consolidated financial performance and its consolidated cash flows for the years then ended in accordance with International Financial Reporting Standards.
signed “KPMG LLP”
Chartered Accountants
March 25, 2013
Calgary, Canada
The accompanying notes are an integral part of these consolidated financial statements.
Approved on behalf of the Board of Directors
Director, Rob Zakresky
Director, Larry Moeller
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
Crocotta Energy Inc.
Notes to the Consolidated Financial Statements Year Ended December 31, 2012
(Tabular amounts in 000s, unless otherwise stated)
1. REPORTING ENTITY
Crocotta Energy Inc. (“Crocotta” or the “Company”) is an oil and natural gas company, actively engaged in the acquisition, development, exploration, and production of oil and natural gas reserves in Western Canada. The Company conducts many of its activities jointly with others and these consolidated financial statements reflect only the Company–s proportionate interest in such activities. The Company currently has one wholly-owned subsidiary.
The Company–s place of business is located at 700, 639 – 5th Avenue SW, Calgary, Alberta, Canada, T2P 0M9.
2. BASIS OF PRESENTATION
(a) Statement of compliance
These consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”).
The consolidated financial statements were authorized for issuance by the Board of Directors on March 25, 2013.
(b) Basis of measurement
The consolidated financial statements have been prepared on the historical cost basis except for risk management contracts, which are measured at fair value. The methods used to measure fair value are discussed in note 4.
(c) Functional and presentation currency
These consolidated financial statements are presented in Canadian dollars, which is the Company–s functional currency.
(d) Use of estimates and judgments
The preparation of the consolidated financial statements in conformity with IFRS requires management to make estimates and use judgment regarding the reported amounts of assets and liabilities as at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the year. These judgments, estimates, and assumptions are based on current trends and all relevant information available to the Company at the time of preparation of the consolidated financial statements. As the effect of future events cannot be determined with certainty, the actual result