CALGARY, ALBERTA — (Marketwire) — 02/01/12 — Canadian Oil Sands Limited (TSX: COS) (OCTQX: COSWF)
All financial figures are unaudited and in Canadian dollars unless otherwise noted.
Highlights for the three and 12-month period ended December 31, 2011:
“I am pleased with the financial results we delivered in 2011, including a dividend increase in the second quarter. Our approach of providing unhedged exposure to crude oil delivered a 50 per cent increase in cash flow from operations over last year. We are in a very healthy financial position as we enter 2012, which supports our ability to fund both our capital program at Syncrude and our target of at least a $0.30 per Share quarterly dividend for 2012,” said Marcel Coutu, President and Chief Executive Officer. “Our strong balance sheet also positions us well in an uncertain economic environment, with the potential of a recession in Europe spreading to other regions. Despite that risk, oil prices currently remain around US$100 per barrel, providing robust support for our business.”
Highlights
Syncrude operations
Syncrude produced an average 252,000 barrels per day (total 23.2 million barrels) during the fourth quarter of 2011 compared with 316,000 barrels per day (total 29.0 million barrels) during the same 2010 period. Production was reduced in the 2011 fourth quarter largely by maintenance on a hydrogen unit. Production volumes in the fourth quarters of both years were also impacted by coker turnarounds, which were completed in late October of each year.
For the 2011 year, Syncrude production averaged about 288,000 barrels per day (total 105.3 million barrels) compared with about 293,000 barrels per day (107.0 million barrels) in 2010.
Said Coutu: “Syncrude production in 2011 was affected by the outage of our largest hydrogen unit which reduced our production by millions of barrels in the fourth quarter and, as a result, we missed our annual target; this exemplifies the value of the effort currently underway to target unplanned capacity losses. We do expect this to gradually result in increased capacity rates at Syncrude, and in 2012 we are looking forward to a seven per cent increase in volumes over 2011.”
2012 Outlook
The following highlights Canadian Oil Sands– updated key estimates and assumptions for 2012:
More information on the outlook is provided in the MD&A section of this report and the February 1, 2012 guidance document, which is available on our web site at under “Investor Information”.
The 2012 Outlook contains forward-looking information and users are cautioned that the actual amounts may vary from the estimates disclosed. Please refer to the “Forward-Looking Information Advisory” in the MD&A section of this report for the risks and assumptions underlying this forward-looking information.
MANAGEMENT–S DISCUSSION AND ANALYSIS
The following Management–s Discussion and Analysis (“MD&A”) was prepared as of February 1, 2012 and should be read in conjunction with the unaudited interim consolidated financial statements of Canadian Oil Sands Limited (the “Corporation”) for the three and twelve months ended December 31, 2011 and December 31, 2010, the audited consolidated financial statements and MD&A of the Corporation for the year ended December 31, 2010 and the Corporation–s Annual Information Form (“AIF”) dated March 10, 2011. Additional information on the Corporation, including its AIF, is available on SEDAR at or on the Corporation–s website at . References to Canadian Oil Sands or COS include the Corporation, its subsidiaries and partnerships and, as applicable, Canadian Oil Sands Trust (the “Trust”) prior to its dissolution. The financial results of Canadian Oil Sands have been prepared in accordance with Canadian Generally Accepted Accounting Principles (“GAAP”) and are reported in Canadian dollars, unless stated otherwise.
As a result of our conversion from an income trust to a corporate structure on December 31, 2010 pursuant to which all outstanding trust units of the Trust were exchanged on a one-for-one basis for common shares of the Corporation, the financial information of Canadian Oil Sands refers to common shares or shares (“Shares”), shareholders and dividends which were referred to as Units, Unitholders and distributions under the trust structure.
FORWARD-LOOKING INFORMATION ADVISORY: In the interest of providing the Corporation–s shareholders and potential investors with information regarding the Corporation, including management–s assessment of the Corporation–s future production and cost estimates, plans and operations, certain statements throughout this MD&A and the related press release contain “forward-looking information” under applicable securities law. Forward-looking statements are typically identified by words such as “anticipate”, “expect”, “believe”, “plan”, “intend” or similar words suggesting future outcomes. Forward-looking statements in this MD&A and the related press release include, but are not limited to, statements with respect to: the expectations regarding the 2012 annual Syncrude forecasted production range of 106 to 117 million barrels and the single-point Syncrude production estimate of 113 million barrels; the timing and impact on production of the turnaround of Coker 8-3 and maintenance on Coker 8-1; the expectation that capacity rates at Syncrude will gradually increase and that 2012 volumes at Syncrude will increase by seven per cent over 2011 volumes; future dividends and any increase or decrease from current payment amounts, and our intention to pay a quarterly dividend of at least $0.30 per Share for 2012; the establishment of future dividend levels with the intent of absorbing short-term market volatility over several quarters; the expectation that the new accounting standards relating to joint arrangements, employee benefits, consolidated financial statements, disclosures of interests in other entities, fair value measurements and stripping costs will not result in any significant accounting or disclosure changes; plans regarding crude oil hedges and currency hedges in the future; the level of natural gas consumption in 2012 and beyond; the expected sales, operating expenses, Crown royalties, capital expenditures, current and deferred taxes, and cash flow from operations for 2012;
the expectation that 2012 deferred taxes will flow through current taxes and cash flow from operations in 2013; the expected price for crude oil and natural gas in 2012; the expected foreign exchange rates in 2012; the expected realized selling price, which includes the anticipated differential to West Texas Intermediate (“WTI”) to be received in 2012 for the Corporation–s product; the expectations regarding net debt in 2012; the anticipated impact of increases or decreases in oil prices, production, operating expenses, foreign exchange rates and natural gas prices on the Corporation–s cash flow from operations; the expectation that regular maintenance capital costs will average approximately $10 per barrel over the next few years; the expected amount of total major project costs and anticipated target in-service dates for the Syncrude Emissions Reduction (“SER”) project, the Mildred Lake mine train replacements, the Aurora North mine train relocations and the composite tails plant at the Aurora North mine; the expectation that the SER project will significantly reduce total sulphur dioxide and other emissions; the expectation that the Corporation will finance the major projects primarily through cash flow from operations and the cost estimates for 2012 major project spending and post-2012 major project spending.
You are cautioned not to place undue reliance on forward-looking statements, as there can be no assurance that the plans, intentions or expectations upon which they are based will occur. By their nature, forward-looking statements involve numerous assumptions, known and unknown risks and uncertainties, both general and specific, that contribute to the possibility that the predictions, forecasts, projections and other forward-looking statements will not occur. Although the Corporation believes that the expectations represented by such forward-looking statements are reasonable and reflect the current views of the Corporation with respect to future events, there can be no assurance that such assumptions and expectations will prove to be correct.
The factors or assumptions on which the forward-looking information is based include, but are not limited to: the assumptions outlined in the Corporation–s guidance document as posted on the Corporation–s website at as of the date hereof and as subsequently amended or replaced from time to time, including without limitation, the assumptions as to production, operating expenses and oil prices; the successful and timely implementation of capital projects; the ability to obtain regulatory and Syncrude joint venture owner approval; our ability to either generate sufficient cash flow from operations to meet our current and future obligations or obtain external sources of debt and equity capital; the continuation of assumed tax, royalty and regulatory regimes and the accuracy of the estimates of our reserves volumes.
Some of the risks and other factors which could cause actual results or events to differ materially from current expectations expressed in the forward-looking statements contained in this MD&A and the related press release include, but are not limited to: the impacts of legislative or regulatory changes especially as such relate to royalties, taxation, the environment and tailings; the impact of technology on operations and processes and how new complex technology may not perform as expected; skilled labour shortages and the productivity achieved from labour in the Fort McMurray area; the supply and demand metrics for oil and natural gas; the impact that pipeline capacity and refinery demand have on prices for our products; the unanimous joint venture owner approval for major expansions and changes in product types; the variances of stock market activities generally; global economic conditions/volatility; normal risks associated with litigation, general economic, business and market conditions; the impact of Syncrude being unable to meet the conditions of its approval for its tailings management plan under Directive 074, and such other risks and uncertainties described in the Corporation–s AIF dated March 10, 2011 and in the reports and filings made with securities regulatory authorities from time to time by the Corporation which are available on the Corporation–s profile on SEDAR at and on the Corporation–s website at .
You are cautioned that the foregoing list of important factors is not exhaustive. Furthermore, the forward-looking statements contained in this MD&A are made as of the date of this MD&A, and unless required by law, the Corporation does not undertake any obligation to update publicly or to revise any of the included forward-looking statements, whether as a result of new information, future events or otherwise. The forward-looking statements contained in this MD&A are expressly qualified by this cautionary statement.
NON-GAAP FINANCIAL MEASURES: In this MD&A and the related press release, we refer to financial measures that do not have any standardized meaning as prescribed by Canadian generally accepted accounting principles (“GAAP”). These non-GAAP financial measures include cash flow from operations, cash flow from operations on a per Share basis, net debt, total capitalization and net debt to total capitalization. In addition, the Corporation refers to various per barrel figures, such as net realized selling prices, operating expenses and Crown royalties, which also are considered non-GAAP measures. We derive per barrel figures by dividing the relevant sales or cost figure by our sales volumes, which are net of purchased crude oil volumes in a period. Non-GAAP financial measures provide additional information that we believe is meaningful regarding the Corporation–s operational performance, its liquidity and its capacity to fund dividends, capital expenditures and other investing activities. Users are cautioned that non-GAAP financial measures presented by the Corporation may not be comparable with measures provided by other entities.
Since January, 2011, we report cash flow from operations in total and on a per Share basis. Previously, we reported cash from operating activities. Cash flow from operations is calculated as cash from operating activities, as reported on the Consolidated Statement of Cash Flows, before changes in non-cash working capital. Cash flow from operations per Share is calculated as cash flow from operations divided by the weighted-average number of Shares outstanding in the period. We believe cash flow from operations, which is not impacted by fluctuations in non-cash working capital balances, is more indicative of operational performance. The majority of our non-cash working capital is liquid and typically settles within 30 days.
Cash flow from operations is reconciled to cash from operating activities as follows:
TRANSITION TO INTERNATIONAL FINANCIAL REPORTING STANDARDS
Canadian GAAP has been revised to incorporate International Financial Reporting Standards (“IFRS”) and publicly traded companies like the Corporation are required to apply such standards for years beginning on or after January 1, 2011. Note 5 to the attached interim unaudited consolidated financial statements discloses the impact of the transition to IFRS on the Corporation–s reported financial position, income and cash flows, including the nature and effect of changes in accounting policies from those used in the Corporation–s Canadian GAAP audited consolidated financial statements for the year ended December 31, 2010.
Financial measures for the three and twelve months ended December 31, 2010 reported in this MD&A as comparative figures have been adjusted to reflect the transition to IFRS, as have the financial measures for all 2010 quarters reported in the summary of quarterly results on page 9. The accounting policies applied in these interim unaudited consolidated financial statements are based on IFRS issued, outstanding, and effective as of February 1, 2012. Any subsequent changes to IFRS that are given effect in the Corporation–s annual consolidated financial statements for the year ending December 31, 2011 could result in a restatement of these interim consolidated financial statements, including the adjustments recognized on transition to IFRS.
Under IFRS, the Corporation–s consolidated balance sheets are adjusted to reflect the following:
Under IFRS, beginning in 2010 net income is adjusted to reflect the following:
While the IFRS adjustments do not impact the Corporation–s total cash flow, beginning in 2010 cash flow from operations and cash used in investing activities have each been adjusted, by equal and offsetting amounts, to reflect the capitalization of both major turnaround costs and interest costs on certain qualifying assets during construction.
Revenues are now reported net of Crown royalties; previously Crown royalties were reported as an expense. Lastly, future income taxes are now referred to as deferred taxes.
REVIEW OF SYNCRUDE OPERATIONS
Synthetic crude oil (“SCO”) production from the Syncrude Joint Venture (“Syncrude”) during the fourth quarter of 2011 totalled 23.2 million barrels, or 252,000 barrels per day, compared with 29.0 million barrels, or 316,000 barrels per day, during the fourth quarter of 2010. Net to the Corporation, production totalled 8.5 million barrels in the fourth quarter of 2011 compared with 10.7 million barrels in the fourth quarter of 2010, based on Canadian Oil Sands– 36.74 per cent working interest in Syncrude. Lower production in the fourth quarter of 2011 reflected the unplanned shutdown of a hydrogen unit to perform required maintenance and a process upset in Coker 8-1. Production volumes in both the fourth quarters of 2011 and 2010 also reflected planned coker turnarounds, which were completed in late October of each year.
For the full year 2011, Syncrude production volumes fell 1.6 per cent to 105.3 million barrels, or about 288,000 barrels per day, from 107.0 million barrels, or about 293,000 barrels per day, in 2010. The production estimate in the original 2011 budget was for 110 million barrels. Production volumes in 2011 reflect the hydrogen unit and Coker 8-1 operational issues in the fourth quarter.
Canadian Oil Sands– operating expenses were $393 million, or $46.88 per barrel, in the fourth quarter of 2011, compared with $378 million, or $35.81 per barrel, in the fourth quarter of 2010. For the full year 2011, Canadian Oil Sands– operating expenses increased about eight per cent to $1,501 million, or $38.80 per barrel, from $1,387 million, or $35.42 per barrel, in 2010. The increase in year-over-year operating expenses was mainly due to increased maintenance and higher diesel costs in 2011. Per barrel operating expenses also reflect the Corporation–s lower sales volumes in the fourth quarter and full year 2011 relative to the comparative 2010 periods (see the “Operating Expenses” section of this MD&A for further discussion).
The productive capacity of Syncrude–s facilities is approximately 350,000 barrels per day on average, including an allowance for downtime, and is referred to as “barrels per calendar day”. All references to Syncrude–s production capacity in this report refer to barrels per calendar day, unless stated otherwise. Canadian Oil Sands– production volumes differ from its sales volumes due to changes in inventory, which are primarily in-transit pipeline volumes.
SUMMARY OF QUARTERLY RESULTS
During the last eight quarters, the following items have had a significant impact on the Corporation–s financial results:
Quarterly variances in net income and cash flow from operations are caused mainly by fluctuations in crude oil prices, production and sales volumes, operating expenses and natural gas prices. Net income is also impacted by unrealized foreign exchange gains and losses, depreciation and depletion, impairment charges and deferred tax amounts.
While the supply/demand balance for crude oil affects selling prices, the impact of this relationship is difficult to predict and quantify and has not displayed significant seasonality. Natural gas prices are typically higher in winter months as heating demand rises, but this seasonality is influenced by weather conditions and North American natural gas inventory levels. In addition, recent technological developments in North American natural gas production have significantly increased production levels and reduced natural gas prices. These conditions may persist for the next several years.
Syncrude production levels may not display seasonal patterns or trends. While maintenance and turnaround activities are typically scheduled to avoid the winter months, the exact timing of unit outages cannot be precisely scheduled, and unplanned outages may occur. The costs of major turnarounds are capitalized as property, plant and equipment and depreciated over the period until the next scheduled turnaround. The costs of all other turnarounds and maintenance activities are expensed in the period incurred, which can result in volatility in quarterly operating expenses. The effect on per barrel operating expenses of the expensed turnaround and maintenance work is amplified because it results in reduced sales volumes when this work is occurring.
REVIEW OF FINANCIAL RESULTS
Highlights
Net Income per Barrel
Cash flow from operations was $363 million, or $0.75 per Share, in the fourth quarter of 2011, about nine per cent lower than fourth quarter 2010 cash flow from operations of $398 million, or $0.82 per Share, reflecting lower sales net of crude oil purchases and transportation expense and higher operating expenses in the fourth quarter of 2011. On an annual basis, cash flow from operations increased 54 per cent to $1,897 million, or $3.91 per Share, in 2011 from $1,232 million, or $2.55 per Share, in 2010. The increase was due mainly to higher sales partially offset by higher operating expenses.
Sales net of crude oil purchases and transportation expense fell $28 million to $884 million in the fourth quarter of 2011 from $912 million in the fourth quarter of 2010. The decrease reflects lower sales volumes partially offset by a higher average realized SCO selling price. On an annual basis, sales net of crude oil purchases and transportation expense increased $754 million to $3,934 million in 2011 from $3,180 million in 2010, reflecting a higher average realized selling price partially offset by lower sales volumes (see the “Sales Net of Crude Oil Purchases and Transportation Expense” section of this MD&A for further discussion).
Crown royalties totalled $73 million, or $8.64 per barrel, in the fourth quarter of 2011, similar to the fourth quarter of 2010 when Crown royalties totalled $75 million, or $7.06 per barrel. On an annual basis, Crown royalties totalled $307 million, or $7.93 per barrel, in 2011, similar to 2010 when Crown royalties totalled $306 million, or $7.80 per barrel. Despite increases in realized SCO prices, bitumen prices were largely unchanged quarter-over-quarter and year-over-year. The impact of slightly lower bitumen production volumes and higher allowed costs in 2011 relative to 2010 was largely offset by additional royalties recognized in the fourth quarter of 2011 to reflect revisions to the estimated quality, transportation and handling deductions used to calculate bitumen values (see the “Crown Royalties” section of this MD&A for further discussion).
Operating expenses in the fourth quarter of 2011 were $393 million, or $46.88 per barrel, compared with $378 million, or $35.81 per barrel, in the fourth quarter of 2010. On an annual basis, operating expenses in 2011 increased about eight per cent to $1,501 million, or $38.80 per barrel, from $1,387 million, or $35.42 per barrel, in 2010. The increase in year-over-year operating expenses was primarily due to increased maintenance and higher diesel costs in 2011. Per barrel operating expenses also reflect the Corporation–s lower sales volumes in the fourth quarter and full year 2011 relative to the comparative 2010 periods (see the “Operating Expenses” section of this MD&A for further discussion).
Net income fell $343 million to $232 million, or $0.48 per Share, in the fourth quarter of 2011, from $575 million, or $1.19 per Share, in the fourth quarter of 2010. On an annual basis, net income fell $45 million to $1,144 million, or $2.36 per Share, in 2011, from $1,189 million, or $2.46 per Share, in 2010. In addition to the variances in sales and operating expenses described earlier, net income was impacted by variances in deferred taxes and foreign exchange gains and losses.
Canadian Oil Sands recorded deferred tax expenses of $70 million and $387 million in the fourth quarter and full year 2011, respectively, versus recoveries of $240 million and $289 million in the comparative 2010 periods. Prior to December 31, 2010, income was sheltered from current taxes by the payment of distributions to trust unitholders. As such, there were no significant drawdowns of tax pools or a resulting deferred tax expense in 2010. Upon conversion from an income trust to a corporate structure effective December 31, 2010, Canadian Oil Sands– earnings are sheltered from current taxes through the drawdown of tax pools. A deferred tax expense has been recognized in 2011 to reflect the cost of consuming these pools. The 2010 deferred tax recovery incorporates the $269 million re-measurement of the corporation–s deferred tax liability at a lower tax rate upon conversion to a corporation. While Canadian Oil Sands was structured as an income trust, deferred taxes were measured using the 39 per cent individual tax rate applicable to earnings not distributed to trust unitholders. Beginning December 31, 2010, deferred taxes are measured using the 25 per cent corporate tax rate (see the “Deferred Taxes” section of this MD&A for further discussion).
Canadian Oil Sands recorded a $24 million foreign exchange gain on the revaluation of its U.S. dollar-denominated long-term debt in the fourth quarter of 2011 as the Canadian dollar strengthened relative to the U.S. dollar. For the full year 2011, Canadian Oil Sands recorded a $25 million foreign exchange loss, reflecting a weaker Canadian dollar relative to the U.S. dollar at the end of 2011 compared with the end of 2010. By comparison, Canadian Oil Sands recorded foreign exchange gains of $39 million and $58 million in the fourth quarter and full year of 2010, respectively, reflecting a strengthening in the value of the Canadian dollar relative to the U.S. dollar.
Net debt, comprised of long-term debt less cash and cash equivalents, decreased to $0.4 billion at December 31, 2011 from $1.2 billion at December 31, 2010 as Canadian Oil Sands generated $1.9 billion in cash flow from operations in 2011 while capital expenditures and dividend payments were $0.6 billion and $0.5 billion, respectively.
Canadian Oil Sands increased its estimated asset retirement obligation during the fourth quarter of 2011 to $1,037 million at December 31, 2011 from $545 million at September 30, 2011 and $501 million at December 31, 2010. The increase was capitalized as property, plant and equipment and reflects the fourth quarter completion of a revised comprehensive mine development and closure plan (see the “Asset Retirement Obligation” section of this MD&A for further discussion).
Sales Net of Crude Oil Purchases and Transportation Expense
The $28 million, or three per cent, decrease in sales net of crude oil purchases and transportation expense in the fourth quarter of 2011 relative to the comparative 2010 period is the result of lower sales volumes in 2011 partially offset by a higher average realized selling price for our SCO. The higher realized SCO selling price reflects a higher West Texas Intermediate (“WTI”) crude oil price, which averaged U.S. $94 per barrel in the fourth quarter of 2011 compared with U.S. $85 per barrel in the comparative 2010 period, and a weaker Canadian dollar, which averaged $0.98 U.S./Cdn in the fourth quarter of 2011 compared with $0.99 U.S./Cdn in the comparative 2010 period. The Corporation–s SCO selling price is also affected by the premium or discount realized relative to Canadian dollar WTI (the “differential”). In the fourth quarter of 2011, the Corporation realized a weighted-average SCO premium of $8.51 per barrel versus a $2.63 per barrel discount in the fourth quarter of 2010. The Corporation–s fourth quarter sales volumes averaged 91,000 barrels per day in 2011 compared with 115,000 barrels per day in 2010, reflecting the operational issues with the hydrogen unit and Coker 8-1 in the fourth quarter of 2011.
On an annual basis, the $754 million, or 24 per cent, increase in sales net of crude oil purchases and transportation expense in 2011 relative to 2010 reflects a higher average realized SCO selling price in 2011 partially offset by lower sales volumes. Higher WTI crude oil prices, which averaged U.S. $95 per barrel in 2011 compared with U.S. $80 per barrel in 2010, were offset somewhat by a stronger Canadian dollar, which averaged $1.01 U.S./Cdn in 2011, up from $0.97 U.S./Cdn in 2010. In addition, the Corporation realized a weighted-average SCO premium of $7.32 per barrel in 2011 versus a $1.61 per barrel discount in 2010. Sales volumes averaged 106,000 barrels per day in 2011 compared with 107,000 barrels per day in 2010, reflecting the operational issues with the hydrogen unit and Coker 8-1 in the fourth quarter of 2011.
The differential between SCO and WTI can change quickly, reflecting changes in the short-term supply and demand dynamics in the market and pipeline availability for transporting crude oil. The increase in the 2011 differential was primarily the result of two factors. The first was the lower supply of SCO in the market because of operational upsets and maintenance at several oil sands plants during the year. The second was the dislocation of the WTI crude oil benchmark to other light oil benchmarks such as European Brent Crude (“Brent”) and Louisiana Light Sweet (“LLS”) crude due to an over-supply of crude oil to North American inland markets. In certain U.S. markets, SCO sometimes competes with crude oil priced higher than WTI, such as LLS, which can contribute to a positive differential to WTI.
The Corporation purchases crude oil from third parties to fulfill sales commitments with customers when there are shortfalls in Syncrude–s production and to facilitate certain transportation and tankage arrangements and operations. Sales include the sale of purchased crude oil while the cost of these purchases is included in crude oil purchases and transportation expense. Crude oil purchases were higher in the fourth quarter of 2011 relative to the comparative 2010 period, reflecting additional purchased volumes to support transportation arrangements and unanticipated production shortfalls, combined with higher crude oil prices in 2011. On an annual basis, crude oil purchases were lower in 2011 relative to 2010, reflecting lower purchased volumes partially offset by higher crude oil prices in 2011.
Crown Royalties
Crown royalties totalled $73 million, or $8.64 per barrel, in the fourth quarter of 2011, similar to the fourth quarter of 2010 when Crown royalties totalled $75 million, or $7.06 per barrel. On an annual basis, Crown royalties totalled $307 million, or $7.93 per barrel, in 2011, similar to 2010 when Crown royalties totalled $306 million, or $7.80 per barrel. Despite increases in realized SCO prices, bitumen prices were largely unchanged quarter-over-quarter and year-over-year. The impact of slightly lower bitumen production volumes and higher allowed costs in 2011 relative to 2010 was largely offset by additional royalties recognized in the fourth quarter of 2011 to reflect revisions to the estimated quality, transportation and handling deductions used to calculate bitumen values over the 2009 to 2011 period.
The Syncrude Royalty Amending Agreement requires that bitumen be valued by a formula that references the value of bitumen based on a Canadian heavy oil price adjusted for reasonable quality, transportation and handling deductions (including diluent costs) to reflect the quality and location differences between Syncrude–s bitumen and the reference price of bitumen. The Alberta government and the Syncrude owners are in discussions to determine the appropriate adjustments for quality, transportation and handling. For estimating and paying royalties, Syncrude used a bitumen value based on Syncrude and its owners– interpretation of the Syncrude Royalty Amending Agreement. In the fourth quarter of 2011, Syncrude revised its estimate of this bitumen value for the period from January 1, 2009 to December 31, 2011 and, as a result, approximately $20 million of additional Crown royalties were recognized.
In December 2010 the Alberta government provided a modified notice of a bitumen value for Syncrude (the “Syncrude BVM”) which is different than the bitumen value used by Syncrude for estimating and paying royalties. Canadian Oil Sands– share of the royalties recognized for the period from January 1, 2009 to December 31, 2011 are estimated to be approximately $40 million lower than the amount calculated using the Syncrude BVM. The Syncrude owners and the Alberta government continue to discuss the basis for reasonable quality, transportation, and handling adjustments but if such discussions do not result in an agreed upon solution, either party may seek judicial determination of the matter. Should these discussions or a judicial determination result in a deemed bitumen value different than that used by Syncrude for estimating and paying royalties, the cumulative impact on Canadian Oil Sands– share of royalties since January 1, 2009 will be recognized immediately and will impact both net income and cash flow from operations accordingly.
Operating Expenses
The following table breaks down operating expenses into their major components and shows operating expenses per barrel of bitumen and SCO. The information allocates costs to bitumen production and upgrading on the basis used to determine Crown royalties.
(1)Upgrading costs include the production and ongoing maintenance costs associated with processing and upgrading of bitumen to SCO.
(2)Reflects energy generated by the upgrader that is used in the bitumen production process and is valued by reference to natural gas prices. Natural gas prices averaged $3.19 per GJ and $3.48 per GJ for the three months and year ended December 31, 2011, respectively, and $3.45 per GJ and $3.87 per GJ for the three months and year ended December 31, 2010.
(3)Canadian Oil Sands– adjustments mainly pertain to actual reclamation costs and major turnaround costs, which Syncrude includes in operating expenses. Canadian Oil Sands capitalizes major turnaround costs and recognizes actual reclamation costs through its asset retirement obligation. Major turnaround costs are expensed through depreciation and reclamation costs are expensed through both depletion and accretion (within net finance expense).
In the fourth quarter of 2011, operating expenses were $393 million, averaging $46.88 per barrel, compared with $378 million, or $35.81 per barrel, in the fourth quarter of 2010. For the full year 2011, operating expenses increased about eight per cent to $1,501 million, or $38.80 per barrel, in 2011 from $1,387 million, or $35.42 per barrel, in 2010.
The increase in operating expenses for the full year 2011 relative to 2010 was primarily due to:
The increased diesel purchases are also reflected in the increased purchased energy consumption rate in 2011 relative to 2010.
Operating expenses on a per barrel basis are affected by the Corporation–s sales volumes, which were lower in the fourth quarter and full year 2011 relative to the comparative 2010 periods.
Non-Production Expenses
Non-production expenses were $27 million in the fourth quarter of 2011, similar to the fourth quarter of 2010 when non-production costs totalled $24 million. On an annual basis, non-production costs totalled $113 million in 2011 compared with $105 million in 2010.
Non-production expenses consist primarily of development expenditures relating to capital programs, which are expensed, such as pre-feasibility engineering, technical and support services, research and development, evaluation drilling and regulatory and stakeholder consultation expenditures. Non-production expenses can vary on a periodic basis depending on the number of projects underway and the development stage of the projects.
Net Finance Expense
Interest costs in 2011 were largely unchanged from 2010. However, interest expense was lower in 2011 because a higher portion of interest costs were capitalized in 2011 as cumulative capital expenditures on qualifying assets rose. As such, net finance expense decreased to $6 million and $46 million in the fourth quarter and full year 2011, respectively, from $16 million and $82 million in the comparative 2010 periods.
Depreciation and Depletion Expense
Depreciation and depletion expense totalled $96 million for the fourth quarter of 2011 and $381 million for the full year 2011 compared with $111 million and $429 million, respectively, for the comparative periods in 2010, reflecting changes made during 2011 to the estimated useful lives of certain assets.
Foreign Exchange (Gain) Loss
Foreign exchange gains/losses are primarily the result of revaluations of our U.S. dollar denominated long-term debt caused by fluctuations in U.S. and Canadian dollar exchange rates.
The foreign exchange gains on long-term debt in the fourth quarter of 2011 were the result of a strengthening in the value of the Canadian dollar relative to the U.S. dollar from $0.96 U.S./Cdn at September 30, 2011 to $0.98 U.S./Cdn at December 31, 2011. Conversely, the foreign exchange losses on long-term debt for the full year 2011 were the result of a weakening in the value of the Canadian dollar relative to the U.S. dollar from $1.01 U.S./Cdn at December 31, 2010. The foreign exchange gains in the fourth quarter and full year 2010 were the result of a strengthening in the value of the Canadian dollar relative to the U.S. dollar to $1.01 U.S./Cdn at December 31, 2010 from $0.97 U.S./Cdn at September 30, 2010 and $0.96 U.S./Cdn at December 31, 2009.
Deferred Taxes
Canadian Oil Sands recorded deferred tax expenses of $70 million and $387 million in the fourth quarter and full year 2011, respectively, versus recoveries of $240 million and $289 million in the comparative 2010 periods. Prior to December 31, 2010, income was sheltered from current taxes by the payment of distributions to trust unitholders. As such, there were no significant drawdowns of tax pools or a resulting deferred tax expense in 2010. Upon conversion from an income trust to a corporate structure effective December 31, 2010, Canadian Oil Sands– earnings are sheltered from current taxes through the drawdown of tax pools. A deferred tax expense has been recognized in 2011 to reflect the cost of consuming these pools.
The 2010 deferred tax recovery incorporates the $269 million re-measurement of the corporation–s deferred tax liability at a lower tax rate upon conversion to a corporation. While Canadian Oil Sands was structured as an income trust, deferred taxes were measured using the 39 per cent individual tax rate applicable to earnings not distributed to trust unitholders. Beginning December 31, 2010, deferred taxes are measured using the 25 per cent corporate tax rate.
Asset Retirement Obligation
Canadian Oil Sands– increased its estimated asset retirement obligation during the fourth quarter of 2011 to $1,037 million at December 31, 2011 from $545 million at September 30, 2011 and $501 million at December 31, 2010. The increase was capitalized as property, plant and equipment and reflects the fourth quarter completion of a comprehensive mine development and closure plan including:
The obligation also reflects $14 million and $49 million of reclamation spending during the three months and year ended December 31, 2011, respectively. A $29 million current portion of the asset retirement obligation is included in accounts payable and accrued liabilities, while the $1,008 million non-current portion is separately presented as an asset retirement obligation on the Consolidated Balance Sheet.
Pension and Other Post-Employment Benefit Plans
The Corporation–s share of the estimated unfunded portion of Syncrude Canada–s pension and other post-employment benefit plans increased to $465 million at December 31, 2011 from $397 million at September 30, 2011 and $327 million at December 31, 2010. The change reflects a decrease in the interest rate used to discount estimated future pension costs combined with lower than estimated returns on the pension plan assets. For the fourth quarter of 2011, a $56 million actuarial loss, net of $18 million in deferred taxes, has been recognized in other comprehensive income to reflect these estimate changes and a $128 million actuarial loss, net of $42 million in deferred taxes, has been recognized for the full year 2011. A liability for the $465 million unfunded balance is recognized on the December 31, 2011 Consolidated Balance Sheet.
CAPITAL EXPENDITURES
Capital expenditures totalled $643 million in 2011 compared with $582 million in 2010. In the fourth quarter of 2011, capital expenditures totalled $205 million compared with $189 million in the fourth quarter of 2010. Syncrude is investing in a number of major projects in 2011 through 2014 to support strong, stable production while achieving operational efficiencies and improving environmental performance. These projects include the following:
Capital expenditures also included:
The remaining capital expenditures related to regular maintenance of business and other investment activities, including relocation of tailings facilities and other infrastructure projects.
On an annual basis, capital expenditures were $284 million lower than the $927 million original budget due primarily to adjustments to the expected timing of spending on major projects. The expected completion dates for these major projects is not affected. More information on Canadian Oil Sands– major capital projects is provided in the “Outlook” section of this MD&A.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
Contractual obligations are summarized in Canadian Oil Sands– 2010 annual MD&A and include future cash payments that the Corporation is required to make under existing contractual arrangements entered into directly or as a 36.74 per cent owner in Syncrude. During 2011, Canadian Oil Sands entered into a new contractual obligation for approximately $700 million for the transportation of crude oil, and has assumed its share of new Syncrude capital commitments of approximately $300 million primarily related to the major projects discussed in the Outlook section of this MD&A. There have been no other significant new contractual obligations or commitments relative to the 2010 year-end disclosure.
DIVIDENDS
On February 1, 2012, the Corporation declared a quarterly dividend of $0.30 per Share for a total dividend of approximately $145 million. The dividend will be paid on February 29, 2012 to Shareholders of record on February 24, 2012.
Dividend payments continue to be set on a quarterly basis in the context of current and expected crude oil prices, economic conditions, Syncrude–s operating performance, and the Corporation–s capacity to finance operating and investing obligations. Dividend levels are established with the intent of absorbing short-term market volatility over several quarters. Dividend levels also recognize our intention to fund the current major projects primarily through cash flow from operations, and to maintain a strong balance sheet to reduce exposure to potential oil price declines, capital cost increases, or major operational upsets.
For 2012, Canadian Oil Sands is targeting a quarterly dividend of at least $0.30 per Share, based on current assumptions with support from our cash balances, as necessary.
LIQUIDITY AND CAPITAL RESOURCES
Net debt, comprised of long-term debt less cash and cash equivalents, decreased to $0.4 billion at December 31, 2011 from $1.2 billion at December 31, 2010, as Canadian Oil Sands generated $1.9 billion in cash flow from operations in 2011 while capital expenditures and dividend payments were $0.6 billion and $0.5 billion, respectively.
Shareholders– equity increased to $4.2 billion at December 31, 2011 from $3.7 billion at December 31, 2010, as net income exceeded dividends in 2011.
On June 1, 2011, Canadian Oil Sands entered into a four-year $1,500 million credit facility agreement expiring on June 1, 2015, which replaced the $800 million operating facility.
Debt covenants restrict Canadian Oil Sands– ability to sell all or substantially all of its assets or change the nature of its business, and limit total debt to total capitalization to 55 per cent. A significant increase in debt or decrease in Shareholders– equity would be required before covenants restrict the Corporation–s financial flexibility.
SHAREHOLDERS– CAPITAL AND TRADING ACTIVITY
The Corporation–s shares trade on the Toronto Stock Exchange under the symbol COS. The Corporation had a market capitalization of approximately $11 billion with 484.5 million shares outstanding and a closing price of $23.25 per Share on December 31, 2011. The following table reflects the trading activity for the fourth quarter of 2011.
Canadian Oil Sands Limited – Trading Activity
FINANCIAL RISK MANAGEMENT
The Corporation did not have any financial derivatives outstanding at December 31, 2011.
Crude Oil Price Risk
Canadian Oil Sands– revenues are impacted by changes in both the U.S. dollar-denominated crude oil prices and U.S./Cdn currency exchange rates. Over the last three years, daily WTI prices have experienced significant volatility, ranging from U.S. $114 per barrel to U.S. $34 per barrel. In addition, supply, demand, and other market factors can vary significantly between regions and, as a result, the spreads between crude oil benchmarks, such as WTI, Brent and LLS, can be volatile.
Canadian Oil Sands prefers to remain unhedged on crude oil prices; however, during periods of significant capital spending and financing requirements, management may hedge prices to reduce cash flow volatility. The Corporation did not have any crude oil price hedges in place during 2011 or 2010; instead, a strong balance sheet was used to mitigate the risk around crude oil price movements. As at February 1, 2012, and based on current expectations, the Corporation remains unhedged on its crude oil price exposure.
Foreign Currency Risk
Canadian Oil Sands– results are affected by fluctuations in the U.S./Cdn currency exchange rates, as sales generated are based on a WTI benchmark price in U.S. dollars while operating expenses and capital expenditures are denominated primarily in Canadian dollars. Our sales exposure is partially offset by U.S. dollar obligations, such as interest costs on U.S. dollar-denominated long-term debt (Senior Notes) and our share of Syncrude–s U.S. dollar vendor payments. In addition, when our U.S. dollar Senior Notes mature, we have exposure to U.S. dollar exchange rates on the principal repayment of the notes. This repayment of U.S. dollar debt acts as a partial economic hedge against the U.S. dollar-denominated sales receipts we collect from our customers.
In the past, the Corporation has hedged foreign currency exchange rates by entering into fixed rate currency contracts. The Corporation did not have any foreign currency hedges in place during 2011 or 2010, and does not currently intend to enter into any new currency hedge positions. The Corporation may, however, hedge foreign currency exchange rates in the future, depending on the business environment and growth opportunities.
Interest Rate Risk
Canadian Oil Sands– net income and cash flow from operations are impacted by U.S. and Canadian interest rate changes because our credit facilities and investments are exposed to floating interest rates. In addition, we are exposed to the refinancing of maturing long-term debt at prevailing interest rates. As at December 31, 2011, there were no amounts drawn on the credit facilities ($145 million – December 31, 2010, $nil – January 1, 2010) and the next long-term debt maturity is in August 2013. The Corporation did not have a significant exposure to interest rate risk based on the amount of floating rate debt or the short-term nature of investments outstanding during the three months or year ended December 31, 2011.
Liquidity Risk
Liquidity risk is the risk that Canadian Oil Sands will not be able to meet its financial obligations as they fall due. Canadian Oil Sands actively manages its liquidity risk through its cash, debt and equity strategies. The next long-term debt maturity is in August 2013, the $1.5 billion credit facility does not expire until June 2015, and Canadian Oil Sands held cash balances totalling $718 million at December 31, 2011, resulting in low liquidity risk.
Credit Risk
Canadian Oil Sands is exposed to credit risk primarily through customer accounts receivable balances, financial counterparties with whom the Corporation has invested its cash and cash equivalents, and with its insurance providers in the event of an outstanding claim. The maximum exposure to any one customer or financial counterparty is managed through a credit policy that limits exposure based on credit ratings.
Canadian Oil Sands carries credit insurance on some counterparties to help mitigate a portion of the impact should a loss occur and continues to transact primarily with investment grade customers. The vast majority of accounts receivable at December 31, 2011 was due from investment grade energy producers, financial institutions, and refinery-based customers.
At December 31, 2011, our cash and cash equivalents were invested in deposits and Bankers– Acceptances with high-quality senior banks as well as investment grade commercial paper. As of February 1, 2012, there are no financial assets that are past their maturity or impaired due to credit risk-related defaults.
CHANGES IN ACCOUNTING POLICIES
Apart from the changes described in the “Transition to International Financial Reporting Standards” section of this MD&A, there were no new accounting policies adopted, nor any changes to accounting policies, in 2011.
NEW ACCOUNTING STANDARDS
In May 2011, the International Accounting Standards Board (“IASB”) issued IFRS 11, Joint Arrangements, to replace International Accounting Standard (“IAS”) 31, Interests in Joint Ventures, IFRS 10, Consolidated Financial Statements, and IFRS 12, Disclosure of Interests in Other Entities, and IFRS 13, Fair Value Measurements, effective for years beginning on or after January 1, 2013 with earlier application permitted. IFRS 11 eliminates the accounting policy choice between proportionate consolidation and equity method accounting for joint ventures available under IAS 31 and, instead, mandates one of these two methodologies based on the economic substance of the joint arrangement. IFRS 10 establishes principles for the presentation and preparation of consolidated financial statements. IFRS 12 requires entities to disclose information about the nature of their interests in joint ventures and IFRS 13 defines, and establishes a framework for measuring, fair value.
In June 2011, the IASB issued an amendment to IAS 19, Employee Benefits, to address the accounting and disclosure of defined benefit pension plans effective for years beginning on or after January 1, 2013 with earlier application permitted.
In October 2011, the IASB issued International Financial Reporting Interpretations Committee (“IFRIC”) Interpretation 20, Stripping Costs in the Production Phase of a Surface Mine, which clarifies the accounting for costs associated with waste removal in surface mining effective for years beginning on or after January 1, 2013 with earlier application permitted.
Canadian Oil Sands has not applied any of these new standards as of December 31, 2011. We continue to assess their impact and, at this time, do not anticipate any of them to result in significant accounting or disclosure changes.
2012 OUTLOOK
In its February 1, 2012 Outlook, Canadian Oil Sands continues to estimate annual Syncrude production of 113 million barrels (309,000 barrels per day) with a range of 106 to 117 million barrels for 2012. Net to Canadian Oil Sands, this is equivalent to 41.5 million barrels (113,000 barrels per day). The production outlook incorporates a turnaround of Coker 8-3 in the second quarter of the year, as originally planned, and maintenance on Coker 8-1, beginning in early February. The 113 million barrel single-point estimate represents a 7.7 million barrel, or approximately seven per cent, increase over Syncrude–s actual 2011 production.
Sales, net of crude oil purchases and transportation expense, are estimated to be approximately $3.8 billion, reflecting our 41.5 million barrel production estimate and a $92 per barrel sales price. The sales price assumes an average U.S. $90 per barrel WTI crude oil price, a $0.98 U.S./Cdn foreign exchange rate, and no SCO premium/discount to Canadian dollar WTI.
We are estimating operating expenses of approximately $1.5 billion in 2012, comprised of approximately $1.3 billion in production costs and $0.2 billion in purchased energy costs. The purchased energy costs reflect a $3.50 per gigajoule (“GJ”) natural gas price assumption and a consumption rate of about one GJ per barrel of SCO produced. Based on our production assumption, this translates to operating expenses of $36.52 per barrel, a decrease from 2011 operating expenses of $38.80 per barrel.
Non-production expenses are estimated to rise by approximately $33 million over 2011 to $146 million due to a higher 2012 capital program. Also, mainly as a result of the higher capital program, 2012 Crown royalties are expected to be $54 million lower than 2011, totalling about $253 million.
Capital expenditures are estimated to total $1,460 million in 2012, comprised of $974 million of spending on major projects, $405 million in regular maintenance of the business and other projects, and $81 million in capitalized interest.
Current taxes are estimated to total $30 million in 2012. Based on the assumptions in our Outlook, Canadian Oil Sands expects to record deferred taxes of approximately 15 per cent to 20 per cent of (pre-tax) cash flow from operations in 2012, which are expected to flow through current taxes and cash flow from operations in 2013.
Based on these inputs, Canadian Oil Sands is estimating cash flow from operations of $1,825 million, or $3.77 per Share, in 2012. After deducting forecast 2012 capital expenditures, we estimate $365 million in remaining cash flow from operations for the year, or $0.75 per Share.
Net debt is expected to rise during 2012 as cash balances are used to fund a portion of capital expenditures and dividends. Our 2011 results have positioned Canadian Oil Sands to manage risk associated with a rising capital program and an uncertain outlook for the global economy, thereby providing some stability to our dividend level, which is set quarterly by our Board of Directors. For 2012, we are targeting a quarterly dividend of at least $0.30 per Share, based on current assumptions with support from our cash balances, as necessary.
Changes in certain factors and market conditions could potentially impact Canadian Oil Sands– Outlook. The following table provides a sensitivity analysis of the key factors affecting the Corporation–s performance.
Outlook Sensitivity Analysis (February 1, 2012)
The 2012 Outlook contains forward-looking information and users are cautioned that the actual amounts may vary from the estimates disclosed. Please refer to the “Forward-Looking Information Advisory” section of this MD&A for the risks and assumptions underlying this forward-looking information.
Major Projects
The following tables provide cost and schedule estimates for Syncrude–s major projects that have reached a sufficient stage of design definition. Cost estimates do not include estimates for the centrifuge plant at Mildred Lake, which will be provided when details on the scope have been refined. Regular maintenance capital costs post 2012 are provided on an annual basis with the budget for the following year, and are currently estimated to average approximately $10 per barrel over the next few years.
Major Projects (1) – Total Project Cost and Schedule Estimates (2)
Major Projects (1) – Annual Spending Profile (2)
Canadian Oil Sands plans to finance these major projects primarily through cash flow from operations.
The major projects tables contain forward-looking information and users of this information are cautioned that the actual yearly and total major project costs and the actual in-service dates for the major projects may vary from the plans disclosed. The major project cost estimates and major project target in-service dates are based on current spending plans. Please refer to the “Forward-Looking Information Advisory” section of this MD&A for the risks and assumptions underlying this forward-looking information. For a list of additional risk factors that could cause the actual amount of the major project costs and the major project target in-service dates to differ materially, please refer to the Corporation–s Annual Information Form dated March 10, 2011 which is available on the Corporation–s profile on SEDAR at and on the Corporation–s website at .
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(unaudited)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS– EQUITY
(unaudited)
CONSOLIDATED BALANCE SHEETS
(unaudited)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS AND YEAR ENDED DECEMBER 31, 2011
(Tabular amounts expressed in millions of Canadian dollars, except where otherwise noted)
Canadian Oil Sands Limited (the “Corporation”) indirectly owns a 36.74 per cent interest (“Working Interest”) in the Syncrude Joint Venture (“Syncrude”). Syncrude is involved in the mining and upgrading of bitumen from oil sands in Northern Alberta and is operated by Syncrude Canada Ltd. (“Syncrude Canada”).
The interim unaudited consolidated financial statements reflect the December 31, 2010 reorganization from an income trust into a corporate structure pursuant to which all outstanding trust units of Canadian Oil Sands Trust (the “Trust”) were exchanged on a one-for-one basis for common shares (“Shares”) of the Corporation (the “Corporate Conversion”). The financial information of the Corporation refers to common shares or Shares, Shareholders and dividends, which were formerly referred to as Units, Unitholders and distributions under the trust structure.
These interim unaudited consolidated financial statements are prepared and reported in Canadian dollars in accordance with Canadian generally accepted accounting principles (“Canadian GAAP”) as set out in the Handbook of the Canadian Institute of Chartered Accountants (“CICA Handbook”). Canadian GAAP has been revised to incorporate International Financial Reporting Standards (“IFRS”) and publicly accountable enterprises are required to apply such standards for years beginning on or after January 1, 2011. Accordingly, the Corporation is reporting on this basis in these interim unaudited consolidated financial statements. In these financial statements, the term “Canadian GAAP” refers to Canadian GAAP before the adoption of IFRS.
These financial statements have been prepared in accordance with International Accounting Standard (“IAS”) 34 Interim Financial Reporting and IFRS 1 First-time adoption of IFRS. Subject to certain transition exemptions and exceptions disclosed in Note 5, the Corporation has applied IFRS-compliant accounting policies to its transition date balance sheet at January 1, 2010 and throughout 2010 and 2011 as if these policies had always been in effect. Note 5 discloses the impact of the transition to IFRS on the Corporation–s reported equity, income and cash flows, including the nature and effect of changes in accounting policies from those used in the Corporation–s Canadian GAAP consolidated financial statements for the year ended December 31, 2010.
The accounting policies applied in these interim unaudited consolidated financial statements are based on IFRS issued, outstanding and effective as of February 1, 2012. As disclosed in Note 14, Canadian Oil Sands has not early-adopted any of the IFRS issued and outstanding but not yet effective. Any subsequent changes to IFRS that are given effect in the Corporation–s annual consolidated financial statements for the year ending December 31, 2011 could result in a restatement of these interim consolidated financial statements, including the adjustments recognized on transition to IFRS.
Certain disclosures that are normally required to be included in the notes to the annual audited consolidated financial statements have been condensed or omitted. These unaudited interim consolidated financial statements should be read in conjunction with the Corporation–s Canadian GAAP audited consolidated financial statements and notes thereto in the Corporation–s annual report for the year ended December 31, 2010.
Consolidation
The consolidated financial statements include the accounts of the Corporation and its subsidiaries and partnerships (collectively “Canadian Oil Sands”). The activities of Syncrude are conducted jointly with others and, accordingly, these financial statements reflect only Canadian Oil Sands– proportionate interest in such activities, which include the production, Crown royalties, operating expenses, and non-production expenses, as well as a proportionate interest in Syncrude–s property, plant and equipment, inventories, employee future benefits and other liabilities, asset retirement obligation, and associated accounts payable and receivable.
Cash and Cash Equivalents
Investments with maturities of less than 90 days at purchase are considered to be cash equivalents and are recorded at cost, which approximates fair value.
Property, Plant and Equipment
Property, plant and equipment (“PP&E”) are recorded at cost and include the costs of acquiring the Working Interest in, and costs that are directly related to the acquisition, development and construction of, oil sands projects, including the cost of initial overburden removal, major turnaround costs, certain interest costs, and reclamation costs associated with the asset retirement obligation. Repairs and maintenance, non-major turnaround costs and ongoing overburden removal on producing oil sands mines are expensed as operating expenses in the period incurred.
PP&E is depreciated on a straight-line basis over the estimated useful lives of the assets, with the exception of mine development and asset retirement costs, which are depleted on a unit-of-production basis over the estimated proved and probable reserves of the producing mines. The following estimated useful lives of the tangible assets are reviewed annually for any changes to those estimates:
Capitalized major turnaround costs are depreciated over the estimated period to the next turnaround.
Costs of assets under construction are capitalized as construction in progress. Construction in progress is not depreciated. On completion, the cost of construction in progress, including capitalized interest, is transferred to the appropriate category of PP&E and depreciated accordingly.
Exploration and Evaluation
Exploration and evaluation (“E&E”) assets include the costs of acquiring undeveloped oil sands leases (“oil sands lease acquisition costs”) and interests in natural gas licenses located in the Arctic Islands in northern Canada (the “Arctic natural gas assets”).
Impairment
The carrying amounts of PP&E and E&E assets are reviewed for possible impairment whenever changes in circumstances indicate that the carrying amounts may not be recoverable. For the purpose of measuring recoverable amounts, assets are grouped at the lowest levels for which there are separately identifiable cash inflows (“cash generating units” or “CGUs”). The recoverable amount is the higher of a CGU–s fair value less cost to sell (being the amount obtainable from the sale of a CGU in an arm–s length transaction, net of disposal costs) and its value in use (being the net present value of the CGU–s expected future cash flows). An impairment loss is recognized for the amount by which the carrying amount exceeds the recoverable amount.
E&E assets are also subject to impairment testing at the time they are transferred to PP&E.
PP&E consists entirely of Canadian Oil Sands– proportionate interest in Syncrude–s PP&E. PP&E is combined with the oil sands lease acquisition costs, within the E&E assets, to form one CGU for impairment testing purposes. The balance of the E&E assets, being the Arctic natur