Storm Exploration Inc. (TSX:SEO)
Highlights - Thousands
of $CDN except Three Three Nine Nine
volumetric and Months to Months to Months to Months to
per share amounts September September September September
(Unaudited) 30, 2008 30, 2007 30, 2008 30, 2007
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Financial
Gas sales 30,547(1) 15,140 86,335(1) 58,961(1)
NGL sales 3,612 1,288 9,240 3,629
Oil sales 5,835 3,007 16,886 9,599
Royalty Income 221 138 616 549
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Production Revenue 40,215 19,573 113,077 72,738
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Funds from operations(2) 24,290 9,372 67,058 38,710
Per share - basic ($) 0.54 0.21 1.50 0.90
Per share - diluted ($) 0.53 0.20 1.46 0.88
Net income 12,829 299 28,718 8,197
Per share - basic ($) 0.28 0.01 0.64 0.19
Per share - diluted ($) 0.28 0.01 0.63 0.19
Capital expenditures,
net of dispositions 27,057 19,953 59,612 76,796
Debt, including working
capital deficiency 83,904 80,943 83,904 80,943
Weighted average common
shares outstanding (000s)
Basic 44,692 43,423 44,638 43,086
Diluted 46,001 44,191 45,873 43,836
Common shares
outstanding (000s)
Basic 44,699 44,509 44,699 44,509
Fully Diluted 47,015 46,438 47,015 46,438
Operations
Oil Equivalent (6:1)
Barrels of oil
equivalent (000s) 654 517 1,803 1,557
Barrels of oil
equivalent per day 7,107 5,618 6,581 5,702
Average selling price
($CDN per BOE) 61.17(1) 37.60 62.37(1) 46.38(1)
Gas production
Thousand cubic feet (000s) 3,409 2,770 9,352 8,194
Thousand cubic feet per
day 37,050 30,104 34,131 30,014
Average selling price
($CDN per mcf) 8.96(1) 5.47 9.23(1) 7.20(1)
NGL Production
Barrels (000s) 37 18 95 57
Barrels per day 397 197 348 210
Average selling price
($CDN per barrel) 98.90 71.20 96.92 63.42
Oil Production
Barrels (000s) 49 37 149 134
Barrels per day 535 404 545 490
Average selling price
($CDN per barrel) 118.48 80.82 113.17 71.77
Wells drilled
Gross 9.0 8.0 20.0 19.0
Net 8.7 7.1 18.8 15.6
(1) Includes results of hedging activities
(2) Funds from operations is a non-GAAP measurement. See MD&A.
Boe Presentation - For the purpose of calculating unit revenues and costs,
natural gas is converted to a barrel of oil equivalent ("Boe") using six
thousand cubic feet ("Mcf") of natural gas equal to one barrel of oil unless
otherwise stated. Barrels of oil equivalent ("Boe") may be misleading,
particularly if used in isolation. A Boe conversion ratio of six Mcf to one
barrel ("bbl") is based on an energy equivalency conversion method primarily
applicable at the burner tip and does not represent a value equivalency at the
wellhead. All Boe measurements and conversions in this report are derived by
converting natural gas to oil in the ratio of six thousand cubic feet of gas to
one barrel of oil.
Third Quarter 2008 Highlights
- Production in the third quarter increased to 7,107 Boe per day, a 27% increase
from production of 5,618 Boe per day in the same period one year ago. This is a
per share increase of 23% using weighted average basic shares outstanding. Since
the end of the quarter, production has further increased to average
approximately 8,100 Boe per day in October and this leaves us on track to meet
our production guidance for 2008 which consists of averaging 8,200 Boe per day
in the fourth quarter.
- Drilled nine wells (8.7 net) with 89% success resulting in eight (7.7 net) gas
wells. Four of the successful wells (3.7 net) were horizontal development wells
in the Montney formation at Parkland. Three of those wells were completed and
tied in by the end of the quarter and produced a total of 2,200 net Boe per day
in the month of October.
- Funds from operations for the quarter totaled $24.3 million or $0.53 per
diluted share, an increase of 165% from funds from operations of $0.20 per
diluted share in the year earlier period. Growth in production and higher
commodity prices both contributed to the increase.
- Funds from operations per Boe or the cash flow netback was $37.14 per Boe, an
increase of 105% from the cash flow netback of $18.13 per Boe in the third
quarter of 2007. This significant increase resulted from higher commodity prices
as well as growth in production from our Montney discovery at Parkland, where a
higher price per Boe is received due to the produced natural gas having a higher
heat content and being liquids rich. Also contributing to the increase were
reductions in interest expense, operating costs and transportation costs per
Boe.
- Our continuing efforts to maintain or reduce our cost structure resulted in
third quarter operating costs averaging $6.50 per Boe and cash costs comprising
production, general and administrative and interest expenses averaging $8.58 per
Boe.
- Net income for the quarter was $12.9 million or $0.28 per diluted share, up
2,700% from net income of $0.01 per diluted share in the prior year period. The
increase is the result of growth in production, a higher corporate cash flow
netback and a dilution gain of $3.5 million related to a reduction in Storm's
ownership position in Storm Gas Resource Corp.
- Capital invested in field related activities totaled $27.1 million during the
quarter and, in addition to this, we increased our investment in Storm Ventures
International ('SVI') and Storm Gas Resource Corp ('SGR') at a cost of $6.2
million during the quarter. This resulted in the bank debt and working capital
deficiency ending the period at $83.9 million or 0.9 times annualized quarterly
funds from operations. At the end of the quarter, Storm had $26 million of
available capacity on our $110 million bank credit facility.
CORE AREA REVIEW
Parkland/Fort St. John Area, North East British Columbia
This area includes our Montney discovery and is the largest of Storm's core
areas, with net production averaging 4,425 Boe per day in the third quarter, an
increase of 101% from production of 2,200 Boe per day in the third quarter of
2007. Current production from this area is approximately 5,400 Boe per day.
During the third quarter of 2008, our activity included:
- Drilling five vertical Montney step-outs (5.0 net) resulting in four gas wells
(4.0 net) and one abandoned well (1.0 net). Two of the successful wells have
been completed and tied in and the remaining two successful wells are expected
to be completed and tied in early in the first half of 2009.
- Drilling and completing three horizontal Montney development wells (3.0 net).
Average first month production from each of these three horizontals was 4.0 Mmcf
per day of gross raw gas or 780 Boe per day of sales per well. By the end of
2008, Storm expects to have drilled a total of 13 horizontal Montney development
wells at Parkland since November 2007.
- Drilling the first horizontal Montney well (0.7 net) as part of a farm-in on a
seven section block just south-west of our Parkland property. We completed this
well with five fracs and the final test rate was 1.7 Mmcf per day of gross raw
gas. We are reviewing ways to improve upon this result with the 2nd horizontal
well. Storm has committed to paying 67% of the cost to drill and complete two
horizontal wells and has an option to drill a third with each horizontal well
earning a 33% working interest in two sections of land. Successful horizontal
wells will not be pipelined and producing until late in the first quarter of
2009.
To date in the fourth quarter, we have drilled another three Montney horizontal
development wells and one more successful vertical step-out. Two more Montney
horizontal development wells will be drilled before year-end.
As a result of the successful vertical step-outs we drilled in the third
quarter, we now estimate that gross original gas in place(1) has increased to
410 Bcf, which is at the upper end of the range (330 to 430 Bcf) which was
provided in our last quarterly update on August 14th. This was determined based
on an internal evaluation by Storm's technical staff using an areal extent of
10.25 sections (6,640 acres) with log analysis from 13 successful vertical gas
wells, which show average net pay of 39 metres (average gross pay of 86 metres)
and average porosity of 7.9%. Net pay has been determined using gas effect on
logs which is evidenced by cross-over on limestone scale neutron-density logs;
this is approximately equivalent to a 6% sandstone scale cut-off. Using a 3%
sandstone scale cut-off would result in gross original gas in place(1)
increasing to 770 Bcf with average net pay being 87 metres and with 6.4% average
porosity. Our confidence regarding the areal extent of the pool has increased
greatly as a result of the vertical step-outs we have drilled this year.
Geological mapping suggests that there is still potential to further expand the
size of our discovery and, as a result, we plan to drill one more vertical
step-out in the fourth quarter and one to two more in the first quarter next
year.
Development of our Montney discovery continues to progress as expected. During
October, we produced 20 Mmcf per day of gross raw gas from eight horizontal
Montney gas wells plus 3.2 Mmcf per day of gross raw gas from ten Montney
vertical wells. The ninth horizontal well has been drilled, completed and tested
nine Mmcf/d of gross raw gas, and will be pipeline connected and producing by
mid-November. Completion of the tenth horizontal well is underway and we expect
that it will be producing by the end of November. First year rates from each
horizontal well are expected to average approximately 2.2 Mmcf per day of raw
gas. Cost inflation and increasing the number of fracs (seven to eight fracs
instead of five) has increased the cost of drilling, completing and pipelining
each horizontal to $5.5 million. The presentation on our website
www.stormexploration.com is periodically updated (next update in mid-November)
and shows monthly average production for each of our producing vertical and
horizontal wells.
We are currently planning to drill four horizontal wells per section to develop
this pool which results in an undrilled inventory of 35 horizontal wells,
representing three years of activity. This inventory of horizontal locations
will further increase should our vertical well step-out program continue to be
successful in further expanding the pool size. Note that production results from
our vertical wells would suggest that reservoir quality and thickness does vary
across the pool, which is likely to result in the need for increased horizontal
well density in areas of thicker reservoir as well as in areas with lower
reservoir quality in order to ensure that the recovery of the resource in place
is maximized.
As a result of the success of our horizontal Montney development program, our
facility at Parkland is very close to being full, and we have started start
constructing a second facility with 12.5 Mmcf per day of initial capacity. The
total cost of this project is estimated to be $13.5 million, which includes $1.5
million to twin parts of our gathering system. When we first announced our
intention to add a second facility in mid-August, it was expected to be
operational by the end of November; however, due to a reduction in expected 2008
cash flow, this facility will now be operational in late January of 2009. This
results in approximately $7.5 million of the total cost being incurred in 2008
with the remainder incurred in early 2009. In the third quarter of 2009, an
additional $14 million will be invested on this facility to install a second
compressor which will increase the capacity of the second facility to 25 Mmcf
per day, electrify both compressors, and install a refridge plant which will
allow us to increase natural gas liquids recovery. This facility has been
designed to be expandable to 50 Mmcf per day of capacity.
Financial results from our Parkland property continue to exceed our
expectations. Operating costs at Parkland averaged $3.70 per Boe in the third
quarter and $4.10 per Boe year to date. The field netback during the third
quarter was $46.40 per Boe and is currently $34.00 per Boe, assuming a natural
gas price of $6.75 per GJ at AECO, an Edmonton Par oil price of $72.00 per
barrel, transportation costs of $1.60 per Boe and a royalty rate of 23%.
Peace River Arch, North West Alberta
Production from this area averaged 1,750 Boe per day in the third quarter, a
decline of 1% from the 1,760 Boe per day produced in the immediately prior
quarter. Declines are continuing to flatten as evidenced by current production
being approximately 1,700 Boe per day. Production in the third quarter of 2007
averaged 2,270 Boe per day.
During the quarter, we tied in one standing well (1.0 net) at our Culp property
which is currently producing 70 Boe per day. We have postponed drilling the four
wells (2.2 net) we had planned for this area in the second half of 2008 because
of the recent decline in natural gas prices. At higher commodity prices which
prevailed in the first half of 2008, the economic returns associated with these
prospects were reasonable under Alberta's New Royalty Framework ('NRF') which is
being implemented January 1, 2009. However, at current commodity prices the
economic return under the NRF is not great enough to put Storm's capital at
risk.
We are currently reviewing our producing wells in this area in order to ensure
that each well's production rate is optimized so that Storm's economic return is
maximized once the NRF is implemented January 1, 2009. This may lead to a modest
reduction in production from this area in January.
Cabin-Kotcho-Junior Area, North East British Columbia
Net production from this area averaged 885 Boe per day in the third quarter.
This represents a decline of 18% from average production of 1,075 Boe per day in
the year earlier period. Current production is approximately 850 Boe per day.
Historically, our drilling activity in this winter access area has mainly
targeted the Slave Point formation. In the future, our drilling activity will
also include prospects in the Bluesky/Debolt formations and horizontal wells in
the Jean Marie formation, all in the Junior area. This winter we do not plan to
be active in this area drilling wells targeting these conventional prospects,
given that our capital resources will be directed towards higher impact
opportunities including our Montney discovery at Parkland and the Horn River
Basin Devonian shale project.
Since the beginning of this year (including land acquired to date in the fourth
quarter), Storm has acquired a 40% interest in 34 sections of undeveloped land
(8,940 net acres) prospective for Devonian shale gas in the Horn River Basin,
which is just to the west of the Cabin area. This land position was acquired at
an average cost of $550 per acre. These lands were purchased in partnership with
Storm Gas Resource Corp. ('SGR') which owns the remaining 60% working interest.
Combined with Storm's 23% ownership position in SGR, our exposure to this
unconventional shale gas play is approximately 54%. Two to three vertical wells
(0.8 to 1.2 net) will be drilled and completed this winter to test the
productivity of the acquired lands. One of these wells will be drilled in
December but won't be completed until January. Approximately 21 sections (8.4
net) are located in close proximity to the planned vertical test wells, and we
estimate that there is 1.6 Tcf of gross original gas-in-place(1) (internal
estimate by Storm and SGR) on these lands which is based on average gross pay of
80 metres in the Muskwa and Otter Park shales. The Klua/Evie shale was not
included in this estimate because less information is available regarding the
productivity of this shale in the area. Although this winter's drilling program
will prove productivity of these lands, we don't expect to have an indication
regarding upside or potential economic returns until we have drilled several
horizontal wells and have long term production data from those wells, which is
likely at least two years away.
Surmont Oil Sands Lease, Alberta
As reported in our first quarter update on May 8th, McDaniel &Associates
Consultants Ltd updated its evaluation of the bitumen contingent resource
contained in the McMurray formation on Storm's 3,840 acres (6 sections) of oil
sands leases. The best case estimate of discovered bitumen resource (defined as
bitumen in place exploitable using a Steam-Assisted-Gravity Drainage or SAGD
process) is 312 million barrels with the best estimate of contingent bitumen
resources recoverable using a SAGD process, being 113 million barrels.
This winter (possibly in December), Storm will drill an additional three test
holes to further prove up and expand the estimated bitumen in place. One section
remains largely unevaluated and could materially increase our bitumen contingent
resources. Storm has no plans at present to initiate development of this
resource and no assurance can be provided that this resource will ever be
exploited with a conventional SAGD project.
(1) Original Gas in Place (OGIP) is the same as discovered Petroleum Initially
in Place which is defined in the COGEH handbook as the quantity of hydrocarbons
that are estimated to be in place within a known accumulation. OGIP is used here
as it is a more commonly used industry term when referring to gas accumulations.
Discovered Petroleum Initially in Place is divided into recoverable and
unrecoverable portions, with the estimated future recoverable portion classified
as reserves and contingent resources. There is no certainty that it will be
economically viable or technically feasible to produce any portion of this
Discovered Petroleum Initially in Place except for those portions identified as
proved or probable reserves.
STORM GAS RESOURCE CORP.
Storm Gas Resource Corp ('SGR') was formed in June 2007, to pursue
unconventional gas opportunities in the Horn River Basin and elsewhere. During
the third quarter, SGR completed a private equity issue and raised $38.2 million
(net of share issue costs) at a price of $6.50 per share. Storm invested $4.9
million to acquire 0.8 million shares as part of this offering. We have now
invested a total of $6.1 million in SGR and own 2.05 million shares representing
a 23% ownership position. SGR's focus in the short term will be to expand its
Devonian shale land position in the Horn River Basin, and to test the
productivity of acquired lands with vertical wells as well as horizontal wells.
This winter, two to three vertical wells (60% SGR working interest) are planned
in the Horn River Basin and, if flow testing results in commercial gas rates,
one to three horizontal test wells may be drilled next winter. SGR will also
look to identify other areas with unconventional gas potential where undeveloped
land can be acquired. This is a longer term investment and we don't expect to
have an indication regarding the upside potential for at least two to three
years.
STORM VENTURES INTERNATIONAL INC.
Storm owns 4.5 million shares of Storm Ventures International Inc. ('SVI'), a
Calgary based, private energy company focused on unconventional and
international exploration and exploitation opportunities. This includes an
additional 200,000 shares which Storm acquired as part of a rights offering
which closed in August 2008 and raised $31 million from existing shareholders at
$6.25 per share. Our share position has a value of $28 million or $0.60 per
fully diluted Storm share using the rights offering price of $6.25 per share.
SVI is active in the UK sector of the North Sea through its affiliate,
Silverstone Energy Limited, in which SVI has a 32% ownership position. The
initial entry into the North Sea came through a farm-in which provided access to
the Viking Fields area in the Southern Gas Basin of the North Sea where over
five Tcf of gas has been produced to date, and where multiple prospects greater
than 50 Bcf in size have been identified. More recently, Silverstone has
expanded its efforts and has been accumulating an acreage position with exposure
to oil prospects in the Central North Sea. Silverstone is currently producing 15
Mmcf per day from the recently tied in Victoria gas discovery (100% working
interest before payout, 50% after payout) and 1.5 to2 Mmcf per day from the
Tristan NW gas field (54% working interest), which was acquired as part of the
Granby Oil and Gas corporate acquisition earlier this year. Activity through to
the end of 2008 is expected to include:
- Drilling a well to test the 1.2 billion barrel, 11 degree API Broch prospect
in the Quad 9 fairway (Silverstone pays 10% and will maintain a 36% interest in
the prospect)
- Spudding the Northwest Vulcan well (12% interest) prior to the end of 2008
Activity by the end of 2009 is expected to include:
- A Field development plan for Vulcan East will be completed by the end of the
first quarter 2009
- The drilling of the Coriander exploration well (65%) and the Monkwell
appraisal well (20%) in the Central North Sea
With netbacks at current prices (71 pence per therm or US $11.00 per Mmbtu)
being in excess of Cdn $60 per Boe, much of this activity will be funded using
current cash balances cash flow, and, if required, a limited amount of debt from
a facility established with Royal Bank of Scotland.
In Tunisia, SVI has 2.5 million gross acres of land in five blocks, both onshore
and offshore. In the 1.2 million acre Remada Sud permit (71% working interest),
the recently drilled onshore TT2 Ordovician discovery tested 200 barrels of oil
per day from a 65 square kilometer structure with a 57 metre oil column and
estimated oil in place of 220 million barrels. The next step is to conduct an
extended production test, record 3-D seismic, and drill an additional one to two
appraisal wells over the next 12 months. This discovery provides significant
early stage encouragement as to the prospectivity of this very large undeveloped
land block. In the 60,000 acre Jenein Centre block (65% working interest) a well
will be drilled later in the first quarter of 2009 targeting light oil in the
Acacus formation. Offshore in the Gulf of Hammamet, SVI is planning to develop
the Cosmos Main discovery (100% working interest, estimated oil in place of 25
million barrels) with subsea wells and an FPSO. The decision to move ahead on
this project will be made by mid 2009 and is subject to finding a partner to
take on as much as a 40% working interest as well as obtaining approval of the
Tunisian authorities for the field development plan. First oil is expected in
late2010 with initial production possibly as high as 20,000 barrels of light oil
per day. Cosmos South, which is adjacent to this development, potentially holds
another 12 million barrels of oil in place and may be developed as a follow-up
project. This block also holds two more existing fallow discoveries at Yasmin
(estimated oil in place of 15 to 20 million barrels) and Tazerka (estimated oil
in place of 90 million barrels) which will be evaluated in the future as
resources allow. One offshore exploratory well is planned for mid-2009, testing
the Fushia prospect (50% working interest).
SVI is currently reviewing the possibility of a business combination with
Silverstone and also listing as a public company on the TSX to provide liquidity
to existing shareholders. Should such an event occur, it would be Storm's
intention to distribute the publicly traded shares to our shareholders. SVI has
made considerable progress in advancing its business plan over the last five
years, and has accumulated a focused asset base with significant upside
potential which could represent material incremental value for Storm's
shareholders.
OUTLOOK
When we released our second quarter results on August 14th, our planned level of
capital investment in 2008 was increased from $65 million to $105 million as a
result of the year to date average natural gas price at AECO being considerably
higher than our original budget assumption of $6.25 per GJ at AECO. The increase
would have been funded by higher levels of cash flow, assuming an average AECO
price of $7.75 per GJ in the second half of 2008. Since then, natural gas prices
have weakened (October averaged $6.40 per GJ at AECO) which has resulted in our
cash flow being lower than expected. With less cash flow available to invest in
our exploration and exploitation activities, we will reduce our capital invested
in 2008 to $95 million, which will still be funded primarily with cash flow plus
a limited amount of debt assuming natural gas prices at AECO average $6.50 per
GJ in the fourth quarter and $7.75 per GJ for the year. This does not include
the additional $6.2 million we invested in adding to our equity investments in
SVI or SGR. Our bank debt and working capital deficiency exiting 2008 is
forecast to be $95 million, which represents an increase of 12% or $10 million
over the past year, while production over the same period will have grown by 37%
from 5,992 Boe per day in the fourth quarter of 2007 to 8,200 Boe per day in the
fourth quarter of 2008. For the past four years, we have been consistent and
disciplined about using cash flow, plus limited amounts of debt, to fund our
exploitation and exploration activities, while debt and equity have been used to
fund acquisitions. This has resulted in strong production growth per share and
will continue to be a cornerstone of our business plan in the future.
Storm's revised 2008 capital program will now include:
- Drilling 27 wells (25.2 net) including 12 horizontal Montney development wells
(11.3 net) with 10 of those horizontals being completed this year and the
remaining three early in 2009.
- Investing $10 million on undeveloped land with 25,700 net acres of undeveloped
land having been acquired so far this year, primarily in north east British
Columbia at Parkland and in the Horn River Basin.
- Expanding our operated infrastructure with an investment of $12 million with
most of that being at our Parkland property. Construction of the second facility
at Parkland has commenced, and an estimated $7.5 million will be spent on this
project in 2008. The new facility will be completed in late January 2009,
resulting in the remaining $6 million of the project cost being incurred in the
first quarter of 2009.
- Minor non-core property and undeveloped land dispositions totalling $8 million.
Although we have reduced planned levels of activity, our production guidance
remains unchanged. Production in October averaged approximately 8,100 Boe per
day and we expect fourth quarter production to average 8,200 Boe per day which
represents production growth of 35% on both an absolute and per share basis from
the fourth quarter of 2007.
Our corporate average field netback has improved significantly so far in 2009
which is partly due to higher commodity prices and partly due to production
growth at our Parkland property. Gas produced from our Montney discovery at
Parkland receives a higher relative price per Boe, since we recover
approximately 25 barrels of natural gas liquids and condensate per Mmcf of sales
gas, plus the sales gas (after liquids are removed) has a higher heat content
resulting in a price per Mcf approximately 25% higher than the price in per GJ.
The field netback at Parkland in the third quarter averaged $46.40 per Boe which
was 17% higher than our corporate average field netback of $39.77 per Boe.
Production at Parkland represented 62% of our corporate production in the
quarter and has increased to approximately 67% of our current corporate
production.
Preliminary guidance for 2009 is as follows:
- Production exiting 2009 (fourth quarter average) at approximately 10,000 Boe
per day, which represents 24% growth from this year's exit rate.
- Capital investment totaling $100 to $110 million which will be directed
towards completing the second Parkland facility in late January ($6 million),
expanding the capacity and electrifying the new facility in the summer of 2009
($14 million), drilling 22 to 27 wells (90% working interest) including nine
Montney horizontal development wells (9.0 net), and completing 11 to 12 Montney
horizontal wells (11 to 11.7 net).
- Operating costs averaging $5.50 to $6.00 per Boe, cash G&A charges averaging
$1.00 per Boe and an average royalty rate of 23% to 24% (includes the impact of
Alberta's NRF).
Our 2009 capital program will be funded primarily with cash flow assuming a
natural gas price of $7.00 per GJ at AECO.
Using our expected results for this year and our guidance for 2009, we will have
used cash flow plus a limited amount of debt to:
- Grow production per share by approximately 18% this year and 28% next year.
- Significantly expand our infrastructure and competitive advantage in the
Parkland area.
- Acquire and, this winter, test the productivity of our large, undeveloped land
position in the Horn River Basin , containing material amounts of gas-in-place
in the Devonian shale.
Being disciplined and generating strong growth on a per share basis using cash
flow and a limited amount of debt is not a new direction for Storm. We have been
and will continue to review acquisition opportunities as a way of accelerating
our growth, however, we are unlikely to transact unless a high quality asset can
be acquired at a reasonable cost. The acquisition of a lower quality property
funded with debt and/or equity would lessen the impact of future growth
associated with our expanding Montney discovery at Parkland, our equity
ownership in SVI and the undeveloped land position we have accumulated in the
Horn River Basin. Although both the financial and commodity markets have been
going through a very turbulent period, this is an exciting time for Storm and we
appreciate the support and patience of our shareholders.
Respectfully,
Brian Lavergne,
President and Chief Executive Officer
November 13, 2008
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL AND OPERATING RESULTS FOR THE
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008
Set out below is management's discussion and analysis ("MD&A") of financial and
operating results for Storm Exploration Inc. ("Storm" or the "Company") for the
three and nine months ended September 30, 2008. It should be read in conjunction
with the audited financial statements for the year ended December 31, 2007 and
other operating and financial information included in this press release. This
management's discussion and analysis is dated November 13, 2008.
Introduction and Limitations:
Basis of Presentation - Financial data presented below have largely been derived
from the Company's unaudited financial statements for the three and nine months
ended September 30, 2008, prepared in accordance with Canadian Generally
Accepted Accounting Principles ("GAAP"). Specific accounting policies adopted by
the Company are set out in footnote 1 to the unaudited consolidated financial
statements for the three and nine months ended September 30, 2008 and in
footnote 2 to the Company's audited consolidated financial statements for the
year ended December 31, 2007 . The reporting and the measurement currency is the
Canadian dollar. Unless otherwise indicated, tabular financial amounts, other
than per share and per Boe amounts, are in thousands of dollars.
On January 1, 2008, Storm adopted, with prospective effect, certain new
accounting standards introduced as part of GAAP as follows:
- Capital Disclosures:
Section 1535 of the CICA Handbook, Capital Disclosures, requires companies to
disclose in their financial statements objectives, policies and processes for
managing capital, including compliance with any externally imposed capital
requirements.
- Financial Instrument Disclosure and Presentation:
Section 3862 of the CICA Handbook, Financial Instruments - Disclosures and
Section 3863, Financial Instruments - Disclosure and Presentation. The new
accounting standards require the Company to provide information about the
significance of financial instruments to the Company's financial position and
performance. In addition, information about the nature and extent of risks
associated with financial instruments, and how the Company manages such risks,
is to be provided.
Additional details about such accounting changes and their effect on the Company
are described in the footnotes to the unaudited consolidated financial
statements for the three and nine months ended September 30, 2008.
Forward-Looking Statements - Certain information set forth in this document,
including management's assessment of Storm's future plans and operations,
contains forward-looking statements. These statements are based on current
beliefs and expectations based on the information available at the time the
applicable assumptions were made. By their nature, forward-looking statements
are subject to numerous risks, uncertainties and assumptions, some of which are
beyond the Company's control, including the material risks described in Storm's
Annual Information Form and this MD&A under "Risk Assessment" and in
Management's Discussion and Analysis for the year ended December 31, 2007 also
under "Risk Assessment" and the material assumptions disclosed in the
"Production and Revenue" section hereof, under the headings "Production Profile
and Per Unit Prices", "Royalties", and "Transportation Costs"; under the
"Provision for Account Receivable" and "Depletion, Depreciation and Accretion"
sections hereof; under the "Investment and Finance" section hereof, under the
headings "Bank Debt, Liquidity and Capital Resources;" and " Asset Retirement
Obligation"; the effect of general economic conditions, industry conditions,
volatility of commodity prices, currency fluctuations, imprecision of reserve
estimates, environmental risks, competition from other industry participants,
the lack of availability of qualified personnel or management, stock market
volatility and ability to access sufficient capital from internal and external
sources. Readers are advised that the assumptions used in the preparation of
such information, although considered reasonable at the time of preparation, may
prove to be imprecise and, as such, undue reliance should not be placed on
forward-looking statements. Storm's actual results, performance or achievement,
could differ materially from those expressed in, or implied by, these
forward-looking statements. Storm disclaims any intention or obligation to
publicly update or revise any forward-looking statements, whether as a result of
new information, future events or otherwise, except as required under securities
law. References to forward looking information are also made in the press
release dated November 13, 2008 which this MD&A forms part of.
Boe Presentation - For the purpose of calculating unit revenues and costs,
natural gas is converted to a barrel of oil equivalent ("Boe") using six
thousand cubic feet ("Mcf") of natural gas equal to one barrel of oil unless
otherwise stated. Barrels of oil equivalent ("Boe") may be misleading,
particularly if used in isolation. A Boe conversion ratio of six Mcf to one
barrel ("Bbl") is based on an energy equivalency conversion method primarily
applicable at the burner tip and does not represent a value equivalency at the
wellhead. All Boe measurements and conversions in this report are derived by
converting natural gas to oil in the ratio of six thousand cubic feet of gas to
one barrel of oil.
Non-GAAP Measurements - Within management's discussion and analysis, references
are made to terms which are not recognized under GAAP in Canada. Specifically,
"funds from operations", "funds from operations per share", and "netbacks" do
not have any standardized meaning as prescribed by GAAP in Canada and are
regarded as non-GAAP measures. It is likely that these non-GAAP measurements may
not be comparable to the calculation of similar amounts for other entities. In
particular, funds from operations is not intended to represent, or be equivalent
to, cash flow from operating activities calculated in accordance with Canadian
GAAP which appears on the Company's Consolidated Statements of Cash Flows. Funds
from operations is used to benchmark operations against prior periods and peer
group companies. It is also used to determine leverage for the purposes of
determining interest costs under the Company's banking agreement.
A reconciliation of funds from operations to cash flows from operating
activities is as follows:
----------------------------------------------------------------------------
Three Three Nine Nine
Months to Months to Months to Months to
September September September September
30, 2008 30, 2007 30, 2008 30, 2007
----------------------------------------------------------------------------
Cash flow from operating
activities $ 24,131 $ 5,578 $ 65,901 $ 36,983
----------------------------------------------------------------------------
Add: Net changes in non-
cash working capital items 159 3,794 1,157 1,727
----------------------------------------------------------------------------
Funds from operations $ 24,290 $ 9,372 $ 67,058 $ 38,710
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Funds from operations per share is calculated using the weighted average number
of common shares outstanding consistent with the calculation of net income per
share. Netbacks equal total revenue adjusted for hedging gains or losses, plus
royalty income, less royalties, production and transportation costs, calculated
on a Boe basis for the reporting period. Total Boe is calculated by multiplying
the daily production by the number of days in the year or quarter as the case
may be.
PRODUCTION AND REVENUE
Average Daily Production
----------------------------------------------------------------------------
Three Three Nine Nine
Months to Months to Months to Months to
September September September September
30, 2008 30, 2007 30, 2008 30, 2007
----------------------------------------------------------------------------
Natural gas (Mcf/d) 37,050 30,104 34,131 30,014
----------------------------------------------------------------------------
Natural gas liquids (Bbls/d) 397 197 348 210
----------------------------------------------------------------------------
Crude oil (Bbls/d) 535 404 545 490
----------------------------------------------------------------------------
Total (Boe/d) 7,107 5,618 6,581 5,702
----------------------------------------------------------------------------
----------------------------------------------------------------------------
After a flat second quarter as a result of part of the Company's production
being shut in during June due to scheduled maintenance at the McMahon gas plant
operated by Spectra Energy in Fort St John, British Columbia, production in the
third quarter grew by 27%, when compared to the same quarter in 2007 and by 16%
when compared to the immediately preceding quarter. The quarterly year-over-year
production increase is largely attributable to rapidly growing Montney gas
production at the Company's core Parkland area.
Production per million shares outstanding in the third quarter of 2008 averaged
159 Boe per day, compared to 129 Boe per day for the third quarter of 2007, an
increase of 23%.
For the nine months ended September 30, 2008, production increased by 15% when
compared to the equivalent period in 2007, or an increase of 12% per million
shares outstanding for each period.
Production Profile and Per Unit Prices
----------------------------------------------------------------------------
Three Months to Three Months to
September 30, 2008 September 30, 2007
----------------------------------------------------------------------------
Average Average
Percentage Selling Price Percentage Selling Price
of Total Before of Total Before
Boe Transportation Boe Transportation
Production Costs Production Costs
----------------------------------------------------------------------------
Natural gas 87% $ 9.37(1) 89% $ 5.47(1)
----------------------------------------------------------------------------
Natural gas liquids 6% $ 98.90 4% $ 71.20
----------------------------------------------------------------------------
Crude oil 7% $ 118.48 7% $ 80.82
----------------------------------------------------------------------------
Per Boe $ 63.29(1) $ 37.60(1)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Average selling prices above do not include any hedging gains or losses.
----------------------------------------------------------------------------
Nine Months to Nine Months to
September 30, 2008 September 30, 2007
----------------------------------------------------------------------------
Average Average
Percentage Selling Price Percentage Selling Price
of Total Before of Total Before
Boe Transportation Boe Transportation
Production Costs Production Costs
----------------------------------------------------------------------------
Natural gas 87% $ 9.47(1) 87% $ 6.88(1)
----------------------------------------------------------------------------
Natural gas liquids 5% $ 96.92 4% $ 63.42
----------------------------------------------------------------------------
Crude oil 8% $ 113.17 9% $ 71.77
----------------------------------------------------------------------------
Per Boe $ 63.58(1) $ 44.74(1)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Average selling prices above do not include any hedging gains or losses.
Storm's production base is largely natural gas and associated liquids. Short and
medium term exploitation of the Company's existing asset base will not result in
crude oil increasing as a percentage of Boe production. Growth in gas production
to date in 2008 and for the remainder of the year is expected to come largely
from Parkland, in particular from the Company's Montney discovery.
The average AECO spot market reference prices for the third quarter of 2008 was
$7.45 per GJ; for the third quarter of 2007 was $4.91 per GJ; and for the nine
months to September 30, 2008 and 2007 was $8.19 and $6.21, respectively.
The corporate average realized price per GJ received by Storm for the third
quarter of 2008 was approximately 25% higher than the AECO reference price. This
pricing premium is in part attributable to high heat content natural gas
delivered from the Montney formation at Parkland, which receives a price
approximately 25% higher than the AECO reference price. The higher third quarter
net gas price is also due to natural gas hedges outstanding during the third
quarter of 2008 being priced at a monthly index price, which necessitates that
the equivalent amount of Storm's natural gas production be sold at monthly index
pricing, instead of AECO spot pricing. During the third quarter of 2008, the
monthly index price averaged $8.75 per GJ, which was considerably higher than
the AECO spot price. This price difference is normal when natural gas prices
decline rapidly; conversely spot prices will be higher than the monthly index
when natural gas prices are rapidly increasing. As these hedges have expired,
all of our natural gas is currently being sold at spot pricing. In addition to
superior heat content, Montney natural gas also has a natural gas liquids
content of approximately 25 barrels per Mmcf, which has in year-over-year
doubling of natural gas liquids production.
Production by Area - Boe per Day
----------------------------------------------------------------------------
Three Three Nine Nine
Months to Months to Months to Months to
September September September September
30, 2008 30, 2007 30, 2008 30, 2007
----------------------------------------------------------------------------
Peace River Arch - Parkland BC 4,422 2,196 3,758 1,995
----------------------------------------------------------------------------
Peace River Arch - Alberta 1,738 2,256 1,853 2,497
----------------------------------------------------------------------------
Cabin-Kotcho-Junior - BC 883 1,077 910 1,071
----------------------------------------------------------------------------
Other 64 89 60 139
----------------------------------------------------------------------------
Total 7,107 5,618 6,581 5,702
----------------------------------------------------------------------------
----------------------------------------------------------------------------
The above sets out the average production from each of Storm's core areas.
Within the Parkland area of the Peace River Arch, Montney gas production
averaged 2,939 Boe per day in the third quarter of 2008, an increase of 37% over
the second quarter, with Montney production representing 41% of total corporate
production for the quarter. Montney gas production in the third quarter of 2007
averaged 169 Boe per day. For the nine months to September 30, 2008, Montney
production averaged 2,250 Boe per day, compared to 105 Boe per day in 2007.
The Company's focus on the Parkland area has resulted in year-over-year
production from the area growing by 101%. Correspondingly, reduced investment in
Alberta is evidenced by a 23% reduction in year-over-year production.
Production Revenue
----------------------------------------------------------------------------
Three Three Nine Nine
Months to Months to Months to Months to
September September September September
30, 2008 30, 2007 30, 2008 30, 2007
----------------------------------------------------------------------------
Natural gas $ 31,932 $ 15,140 $ 88,522 $ 56,410
----------------------------------------------------------------------------
Natural gas liquids 3,612 1,288 9,240 3,629
----------------------------------------------------------------------------
Crude oil 5,835 3,007 16,886 9,599
----------------------------------------------------------------------------
Hedging (losses) gains (1,385) - (2,187) 2,551
----------------------------------------------------------------------------
Revenue from product sales 39,994 19,435 112,461 72,189
----------------------------------------------------------------------------
Royalty income 221 138 616 549
----------------------------------------------------------------------------
Total Production Revenue $ 40,215 $ 19,573 $ 113,077 $ 72,738
----------------------------------------------------------------------------
A reconciliation of revenue from product sales between the quarters ended
September 30, 2008 and 2007 is as follows:
----------------------------------------------------------------------------
Natural
Natural Gas Crude
Gas Liquids Oil Total
----------------------------------------------------------------------------
Revenue from product sales -
third quarter 2007 $ 15,140 $ 1,288 $ 3,007 $ 19,435
----------------------------------------------------------------------------
Contribution from increased
production quarter-over-quarter 5,991 1,823 1,428 9,242
----------------------------------------------------------------------------
Contribution from increased
product prices
quarter-over-quarter 10,801 501 1,400 12,702
----------------------------------------------------------------------------
Loss from hedging activities (1,385) - - (1,385)
----------------------------------------------------------------------------
Revenue from product sales -
third quarter 2008 $ 30,547 $ 3,612 $ 5,835 $ 39,994
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Hedging:
Hedging commitments outstanding during the three months to September 30,
2008 were as follows:
----------------------------------------------------------------------------
Product Volume Period Contract Price
----------------------------------------------------------------------------
12,000 GJ July 1, 2008 - Fixed Cdn $8.04 per GJ
Natural gas per day September 30, 2008 price
----------------------------------------------------------------------------
11,000 GJ July 1, 2008- Ceiling $8.70 per GJ -
Natural gas per day September 30, 2008 Collar Floor $7.50 per GJ
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Storm follows hedge accounting rules and recognized a loss of $1.4 million or
$2.12 per Boe, or $0.41 per Mcf, during the quarter ended September 30, 2008.
For the nine month period to September 30, 2008, the Company realized a loss of
$2.2 million, or $1.21 per Boe, or $0.23 per Mcf.
Storm followed hedge accounting rules with respect to hedges outstanding during
the quarter ended September 20, 2008, and for all prior hedges. However, any
future hedges entered into by Storm may not satisfy hedge accounting criteria;
correspondingly the Company may be obliged to follow mark-to-market rules.
ROYALTIES
----------------------------------------------------------------------------
Three Three Nine Nine
Months to Months to Months to Months to
September September September September
30, 2008 30, 2007 30, 2008 30, 2007
----------------------------------------------------------------------------
Charge for period $ 8,733 $ 4,013 $ 24,139 $ 15,003
----------------------------------------------------------------------------
Royalties as a
percentage of revenue
from product sales
before hedging
- Crown 19.8% 19.7% 19.8% 19.6%
- Other 1.3% 0.9% 1.2% 1.2%
----------------------------------------------------------------------------
Total 21.1% 20.6% 21.0% 20.8%
----------------------------------------------------------------------------
Per Boe $ 13.36 $ 7.76 $ 13.39 $ 9.64
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Royalty rates are based on provincial government reference rates and exclude
gains or losses from hedging. Higher per Boe royalty rates in 2008, when
compared to the prior year, are due to higher commodity prices.
The introduction of the New Royalty Framework by the Provincial Government of
Alberta announced in October 2007 which comes into effect on January 1, 2009,
will have the broad effect of increasing Alberta provincial royalties,
particularly on wells with high initial production rates. Such wells tend to be
wells with higher amounts of capital at risk, with a corresponding reduction in
returns accruing to oil and gas investment in the province. Approximately 25% of
Storm's production came from Alberta in the third quarter of 2008, compared to
40% in the third quarter of 2007. All other production comes from British
Columbia. For the remainder of 2008 and into the first quarter of 2009, Storm's
capital programs will continue to be focused on the exploitation of its largely
natural gas properties in the Peace River Arch area of north east British
Columbia, which, assuming operational success, will result in revenue from
Alberta continuing to fall as a percentage of total revenue. In addition to
lower investment, natural declines will further reduce Storm's Alberta based
production and revenue. The allocation of capital by the Company to projects
outside of Alberta is not exclusively in response to the changed Crown royalty
regime in Alberta as the Company's British Columbia projects, particularly
Montney natural gas, offer superior economic returns.
PRODUCTION COSTS
----------------------------------------------------------------------------
Three Three Nine Nine
Months to Months to Months to Months to
September September September September
30, 2008 30, 2007 30, 2008 30, 2007
----------------------------------------------------------------------------
Charge for period $ 4,253 $ 3,510 $ 12,679 $ 11,129
----------------------------------------------------------------------------
Percentage of revenue from
product sales before hedging 10% 18% 11% 16%
----------------------------------------------------------------------------
Per Boe $ 6.50 $ 6.79 $ 7.03 $ 7.15
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Total production costs for the quarter ended September 30, 2008 were largely
unchanged year-over-year, but fell as a percentage of revenue in response to
improved pricing. Per Boe, production costs for the quarter to September 30,
2008 fell by 4% when compared to the same period in 2007, in part due to the
concentration of Storm's asset base, cost reduction initiatives implemented in
the second half of 2007, and increased contribution from Parkland, which has
lower operating costs. Production costs per Boe for the nine month period to
September 30, 2008 were 2% lower compared to the same period in 2007.
Storm's cash costs, which comprise production, general and administrative costs
and interest, amounted to $8.58 for the quarter ended September 30, 2008,
compared to $9.48 for the quarter ended September 30, 2007. For the nine month
periods to September 30, cash costs for 2008 amounted to $9.78 and $9.88 for
2007. Lower interest costs, reflecting reduced borrowings, were primarily
responsible for the year-over-year decrease.
TRANSPORTATION COSTS
----------------------------------------------------------------------------
Three Three Nine Nine
Months to Months to Months to Months to
September September September September
30, 2008 30, 2007 30, 2008 30, 2007
----------------------------------------------------------------------------
Charge for period $ 1,221 $ 1,287 $ 3,887 $ 3,653
----------------------------------------------------------------------------
Percentage of revenue
from product sales
before hedging 3% 7% 3% 5%
----------------------------------------------------------------------------
Per Boe $ 1.87 $ 2.49 $ 2.16 $ 2.35
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Increased total charges for transportation reflect increasing production levels.
The reduction in transportation costs per Boe in both the third quarter and the
first nine months of 2008, is a result of increased production from the Parkland
area which has lower associated transportation costs per Boe.
FIELD NETBACKS
Details of field netbacks per commodity unit are as follows:
----------------------------------------------------------------------------
Three Months to September 30, 2008
----------------------------------------------------------------------------
Natural
Crude Gas Natural
Oil Liquids Gas Total
($ Bbl) ($ Bbl) ($ Mcf) ($ Boe)
----------------------------------------------------------------------------
Product sales $ 118.48 $ 98.90 $ 9.37 $ 63.29
----------------------------------------------------------------------------
Hedging loss - - (0.41) (2.12)
----------------------------------------------------------------------------
Royalty income 0.55 0.40 0.05 0.33
----------------------------------------------------------------------------
Royalties (19.48) (24.22) (2.02) (13.36)
----------------------------------------------------------------------------
Production costs(1) (8.63) - (1.12) (6.50)
----------------------------------------------------------------------------
Transportation (4.56) (1.33) (0.28) (1.87)
----------------------------------------------------------------------------
Field netback $ 86.36 $ 73.75 $ 5.59 $ 39.77
----------------------------------------------------------------------------
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Three Months to September 30, 2007
----------------------------------------------------------------------------
Natural
Crude Gas Natural
Oil Liquids Gas Total
($ Bbl) ($ Bbl) ($ Mcf) ($ Boe)
----------------------------------------------------------------------------
Product sales $ 80.82 $ 71.20 $ 5.47 $ 37.60
----------------------------------------------------------------------------
Hedging gain or loss - - -
----------------------------------------------------------------------------
Royalty income 0.73 0.74 0.04 0.27
----------------------------------------------------------------------------
Royalties (12.66) (20.54) (1.14) (7.76)
----------------------------------------------------------------------------
Production costs(1) (9.44) - (1.14) (6.79)
----------------------------------------------------------------------------
Transportation (3.56) (4.29) (0.39) (2.49)
----------------------------------------------------------------------------
Field netback $ 55.89 $ 47.11 $ 2.84 $ 20.83
----------------------------------------------------------------------------
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Nine Months to September 30, 2008
----------------------------------------------------------------------------
Natural
Crude Gas Natural
Oil Liquids Gas Total
($ Bbl) ($ Bbl) ($ Mcf) ($ Boe)
----------------------------------------------------------------------------
Product sales $ 113.17 $ 96.92 $ 9.47 $ 63.58
----------------------------------------------------------------------------
Hedging loss - - (0.23) (1.21)
----------------------------------------------------------------------------
Royalty income 1.03 0.43 0.04 0.34
----------------------------------------------------------------------------
Royalties (18.54) (22.39) (2.06) (13.39)
----------------------------------------------------------------------------
Production costs(1) (8.50) - (1.22) (7.03)
----------------------------------------------------------------------------
Transportation (5.23) (2.15) (0.31) (2.16)
----------------------------------------------------------------------------
Field netback $ 81.93 $ 72.81 $ 5.69 $ 40.13
----------------------------------------------------------------------------
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Nine Months to September 30, 2007
----------------------------------------------------------------------------
Natural
Crude Gas Natural
Oil Liquids Gas Total
($ Bbl) ($ Bbl) ($ Mcf) ($ Boe)
----------------------------------------------------------------------------
Product sales $ 71.77 $ 63.42 $ 6.88 $ 44.74
----------------------------------------------------------------------------
Hedging gain - - 0.31 1.64
----------------------------------------------------------------------------
Royalty income 0.52 0.68 0.05 0.35
----------------------------------------------------------------------------
Royalties (11.45) (17.53) (1.52) (9.64)
----------------------------------------------------------------------------
Production costs(1) (8.14) - (1.23) (7.15)
----------------------------------------------------------------------------
Transportation (2.44) (4.12) (0.38) (2.35)
----------------------------------------------------------------------------
Field netback $ 50.26 $ 42.45 $ 4.11 $ 27.59
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Production costs for natural gas liquids are included with natural gas
costs.
Field netback per Boe for the quarter ended September 30, 2008 increased by 91%
over the equivalent period of 2007. Storm benefited from increased prices for
each product category, supported by lower controllable costs, offset by a
hedging loss. For the nine months ended September 30, 2008, Storm's field
netback increased by 45% over the equivalent period in 2007. Excluding the
effects of hedging in both 2008 and 2007, the increase in netback per Boe for
the third quarter and first nine months of 2008 over the prior year periods
amounted to 101% and 59% respectively.
INTEREST
----------------------------------------------------------------------------
Three Three Nine Nine
Months to Months to Months to Months to
September September September September
30, 2008 30, 2007 30, 2008 30, 2007
----------------------------------------------------------------------------
Charge for period $ 825 $ 1,151 $ 2,830 $ 2,688
----------------------------------------------------------------------------
Per Boe $ 1.26 $ 2.23 $ 1.57 $ 1.73
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Interest is paid on Storm's revolving bank facility. Lower interest expense in
the third quarter of 2008 when compared to the prior year, is a result of lower
bank borrowings and lower debt service costs.
GENERAL AND ADMINISTRATIVE COSTS
Total costs:
----------------------------------------------------------------------------
Three Three Nine Nine
Months to Months to Months to Months to
September September September September
30, 2008 30, 2007 30, 2008 30, 2007
----------------------------------------------------------------------------
Gross general and
administrative costs $1,368 $1,293 $4,121 $3,800
----------------------------------------------------------------------------
Capital and operating
recoveries (835) (1,053) (1,997) (2,245)
----------------------------------------------------------------------------
Net general and
administrative costs $533 $240 $2,124 $1,555
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Costs per Boe:
----------------------------------------------------------------------------
Three Three Nine Nine
Months to Months to Months to Months to
September September September September
30, 2008 30, 2007 30, 2008 30, 2007
----------------------------------------------------------------------------
Gross general and
administrative costs $2.09 $2.50 $2.29 $2.44
----------------------------------------------------------------------------
Capital and operating
recoveries (1.27) (2.04) (1.11) (1.44)
----------------------------------------------------------------------------
Net general and
administrative costs $0.82 $0.46 $1.18 $1.00
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Increases in gross general and administrative costs for the quarter and nine
months ended September 30, 2008, when compared to the same periods in 2007, were
primarily due to an increased staff count, as well as higher year-over-year
compensation and accommodation costs.
Storm does not capitalize general and administrative costs.
PROVISION FOR ACCOUNT RECEIVABLE
In July 2008, SemCanada Energy Company ("SemCan"), a purchaser of part of
Storm's natural gas production in British Columbia, along with various
affiliated companies, filed for creditor protection under the Companies'
Creditors Arrangement Act. Storm is owed $718,000 and has set up a provision for
50% of the amount due. Sales contracts with SemCan were terminated immediately
and the Company has no continuing exposure under these contracts. It is not
presently determinable as to how much of the amount owing to Storm, if any, will
be recoverable.
The Company has taken necessary action to protect its position.
STOCK BASED COMPENSATION COSTS
----------------------------------------------------------------------------
Three Three Nine Nine
Months to Months to Months to Months to
September September September September
30, 2008 30, 2007 30, 2008 30, 2007
----------------------------------------------------------------------------
Charge for period $615 $314 $1,346 $992
----------------------------------------------------------------------------
Per Boe $0.94 $0.61 $0.75 $0.64
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Stock based compensation costs are non cash charges which reflect the value of
stock options and performance warrants awarded to directors and employees. The
value is recognized as an expense over the period from the grant date to the
date of vesting of the award. Storm's performance warrant plan was terminated
mid-2007, upon the exercise of the remaining warrants. The increase in the
charge in the third quarter of 2008, when compared to the third quarter of 2007,
is due to the issue of additional stock options late in 2007.
DEPLETION, DEPRECIATION AND ACCRETION
----------------------------------------------------------------------------
Three Three Nine Nine
Months to Months to Months to Months to
September September September September
30, 2008 30, 2007 30, 2008 30, 2007
----------------------------------------------------------------------------
Depreciation and
depletion charge for period $10,603 $8,619 $30,129 $25,116
----------------------------------------------------------------------------
Accretion charge for period 122 117 367 344
----------------------------------------------------------------------------
Total $10,725 $8,736 $30,496 $25,460
----------------------------------------------------------------------------
Total per Boe $16.40 $16.90 $16.91 $16.35
----------------------------------------------------------------------------
----------------------------------------------------------------------------
The increase in the total charge for depreciation, depletion and accretion for
the three and nine month periods to September 30, 2008, when compared to the
same periods in 2007, is a consequence of higher production volumes as the
depletion component of the charge is based on a cost per Boe.
Accretion is the increase for the reporting period in the present value of the
Company's asset retirement obligation, which is discounted using an interest
rate of 8%.
INVESTMENT GAINS
The Company is a shareholder in a private company, Storm Gas Resource Corp
("SGR"). In July 2008 SGR completed a private placement at a price greater than
the Storm's average investment cost. Storm's ownership percentage fell from 45%
to 23% after completion of the SGR private placement. Storm has included in net
income for the quarter and nine months ended September 30, 2008 a non-cash
dilution gain of $3.5 million.
INCOME AND OTHER TAXES
For the three months ended September 30, 2008, Storm recorded a future income
tax provision of $3.6 million compared to $0.02 million for the quarter ended
September 30, 2007. For the nine month periods ended September 30, 2008 and
2007, the future income tax provision amounted to $10.0 million and $4.1
million, respectively. The deferral of taxes to future periods largely results
from resource pool deductions exceeding the accounting charge for depletion,
depreciation and accretion. The statutory combined federal and provincial rate
applicable to pre tax income in 2008 is 30%, compared to 32% for 2007.
At September 30, 2008, Storm had tax pools carried forward estimated to be $187
million. In September 2007, the Company entered into a flow through share issue,
which provided for the renunciation of Canadian Exploration Expense of $15.1
million, and the incurrence of such expenditures by December 31, 2008. At
September 30, 2008, the Company considers that the necessary expenditures have
been incurred. Storm also has a capital loss in the amount of $10.0 million
available for application against future capital gains.
NET INCOME AND NET INCOME PER SHARE
Net income for the three months ended September 30, 2008 increased considerably
when compared to the quarter ended September 30, 2007, which was essentially
break even. Quarter-over-quarter, net income per diluted share showed a similar
increase. For the nine months ended September 30, 2008, net income increased by
250% when compared to the nine months ended September 30, 2007. Per diluted
share, net income increased by 232% in the first nine months of 2008 over the
same period in 2007.
----------------------------------------------------------------------------
Three Months Three Months Nine Months Nine Months
to to to to
September September September September
30, 2008 30, 2007 30, 2008 30, 2007
----------------------------------------------------------------------------
Per Per Per Per
diluted diluted diluted diluted
$'000 share-$ $'000 share-$ $'000 share-$ $'000 share-$
----------------------------------------------------------------------------
Net income 12,829 0.28 299 0.01 28,718 0.63 8,197 0.19
----------------------------------------------------------------------------
----------------------------------------------------------------------------
FUNDS FROM OPERATIONS
Non GAAP funds from operations for the quarter ended September 30, 2008
increased by 159% to $24.3 million, or $0.53 per diluted share, compared to $9.4
million, or $0.20 per diluted share for the equivalent quarter of 2007. For the
nine month period to September 30, 2008, funds from operations increased by 73%
to $67.1 million, or $1.46 per diluted share, compared to $38.7 million, or
$0.88 per diluted share for the equivalent period in 2007.
----------------------------------------------------------------------------
Three Months Three Months Nine Months Nine Months
to to to to
September September September September
30, 2008 30, 2007 30, 2008 30, 2007
----------------------------------------------------------------------------
Per Per Per Per
diluted diluted diluted diluted
$'000 share-$ $'000 share-$ $'000 share-$ $'000 share-$
----------------------------------------------------------------------------
Funds from
operations 24,290 0.53 9,372 0.20 67,058 1.46 38,710 0.88
----------------------------------------------------------------------------
----------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Non GAAP funds from operations is not a measure recognized by GAAP in Canada.
The most directly comparable measure under GAAP is cash flows from operating
activities. Cash flows from operating activities for each period is as follows:
----------------------------------------------------------------------------
Three Three Nine Nine
Months to Months to Months to Months to
September September September September
30, 2008 30, 2007 30, 2008 30, 2007
----------------------------------------------------------------------------
Cash flows from
operating activities $24,131 $5,578 $65,901 $36,983
----------------------------------------------------------------------------
----------------------------------------------------------------------------
INVESTMENT AND FINANCING
Working Capital
Receivables comprise production revenue receivables and accruals, and
receivables in respect of operating and capital costs. Prepaid costs and
deposits include unamortized insurance premiums and software licensing fees,
deposits and certain inventory items. Accounts payable include operating,
administrative and capital costs payable. Net payables in respect of cash calls
issued to partners regarding capital projects and estimates of amounts owing but
not yet invoiced to the Company have been included in accounts payable.
Storm had a working capital deficiency of $16.9 million at September 30, 2008
compared to $10.2 million at September 30, 2007 and $10.2 million at December
31, 2007. The working capital deficiency at each quarter end reflects the
Company's preference to act as operator and the seasonality of its field
operations. The Company's working capital deficiency is cyclical and is normally
highest at the end of the first quarter of each year and lowest at the end of
second quarter.
Property and Equipment
Capital costs incurred were as follows:
----------------------------------------------------------------------------
Three Three Nine Nine
Months to Months to Months to Months to
September September September September
30, 2008 30, 2007 30, 2008 30, 2007
----------------------------------------------------------------------------
Land and lease, net $1,416 $421 $4,213 $2,197
----------------------------------------------------------------------------
Seismic (1,122) 27 (1,199) 2,973
----------------------------------------------------------------------------
Drilling and completions 23,640 12,780 51,483 26,445
----------------------------------------------------------------------------
Facilities and equipment 6,523 6,568 10,661 16,425
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Field Expenditures 30,457 19,796 65,158 48,040
----------------------------------------------------------------------------
Property acquisitions - 157 507 28,756
----------------------------------------------------------------------------
Property dispositions (3,400) - (6,053) -
----------------------------------------------------------------------------
Total $27,057 $19,953 $59,612 $76,796
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Bank Debt, Liquidity and Capital Resources
Storm has a revolving borrowing base bank credit facility of $110 million. The
amount drawn on this facility at September 30, 2008 amounted to $67.0 million.
Net debt, including working capital deficiency, amounted to $83.9 million at
September 30, 2008, resulting in a ratio of net debt to annualized non GAAP
quarterly cash flow of 0.9 times.
In response to recent turmoil in capital and debt markets, management has met
with the Company's banking syndicate to review the Company's lending
arrangements, and has received assurances with respect to the capacity of each
member of the syndicate to continue to lend to the Company in accordance with
the current banking agreement. In addition, the Company's bankers have recently
completed a semi-annual review of the Company's borrowing base and have
confirmed that the facility will remain in place unchanged until the next
scheduled review date of May 31, 2009.
Storm funds its field capital programs through cash flow and bank borrowings.
Over a reasonable period of time, the cost of capital programs is limited to
available funds from operations which is dependent on commodity prices.
Acquisitions are funded by a combination of debt and, if required, equity. Field
capital programs tend to be concentrated in the winter months, with the result
that capital expenditures in the first and fourth quarters of the year may
exceed cash flow from operations, which is compensated by lower capital
expenditures in the second and third quarters. In quarters of high field
activity, Storm operates with a substantial working capital deficit, which is
paid down in quarters of lower field activity. The Company considers that its
estimate of cash flow, risked for potential changes in commodity prices, plus
its existing borrowing capacity, will be sufficient to fund field operations in
the winter of 2008 - 2009. In the event that cash flow and borrowing capacity
are not sufficient to fund activity, the Company will reduce its field capital
program.
Investments
Storm Ventures International Inc.
During the quarter ended September 30, 2008, the Company purchased an additional
200,000 common shares of Storm Ventures International Inc. ("SVI") for a total
price of $1,250,000 or $6.25 per share. At the quarter-end, Storm owned 4.5
million shares in SVI, comprising a 12% ownership position. The carrying amount
of the investment on the Company's balance sheet comprises the Company's
investment cost, plus a dilution gain recognized in a prior year and is
equivalent to $2.34 per share. This carrying amount should not be regarded as
representative of the value of Storm's investment in SVI.
Storm Gas Resource Corp.
SGR was incorporated to identify and participate in unconventional natural gas
opportunities; initially a shale gas resource in the Horn River Basin of north
east British Columbia Storm's initial ownership position was 45%, the remaining
shareholders being SVI, also at 45%, and SGR employees at 10%. Storm's initial
investment in SGR at $1.00 per share was satisfied by a cash contribution of
$833,000 and the transfer of properties at a value of $417,000. In July 2008,
Storm subscribed for 200,000 common shares in SGR at a price of $5.20 per share
and also participated in a private placement, subscribing for an additional
600,000 common shares at a price of $6.50. The private placement resulted in SGR
issuing 5,880,000 common shares at a price of $6.50 per share, for total
proceeds after commission and expenses, of $38,220,000. Storm owns 2,050,000
common shares of SGR, equivalent to an ownership position of 23%, at an average
cost per share of $3.02. Including the dilution gain, the carrying amount of the
investment is $4.14 per share. This amount should not be regarded as
representative of the value of Storm's investment in SGR. In addition, Storm has
a direct 40% working interest in the Horn River Basin prospect. This interest,
together with Storm's investment in SGR, provides the Company with 54% exposure
to the potential upside in the Horn River Basin.
Future Income Taxes
Estimated future income taxes at September 30, 2008 represents the excess of the
accounting amounts over the related tax bases of property and equipment and
share capital.
Details of the Company's tax pools are as follows:
----------------------------------------------------------------------------
As at Maximum Annual
September 30, 2008 deduction
----------------------------------------------------------------------------
Canadian oil and gas property expense $80,484 10%
----------------------------------------------------------------------------
Canadian development expense 75,157 30%
----------------------------------------------------------------------------
Canadian exploration expense - 100%
----------------------------------------------------------------------------
Undepreciated capital cost 29,833 20 - 100%
----------------------------------------------------------------------------
Other 1,611 20%
----------------------------------------------------------------------------
Total $187,085
-------------------------------------------------------------
-------------------------------------------------------------
Capital losses $9,666
-------------------------------------------------------------
-------------------------------------------------------------
Asset Retirement Obligation
Storm's asset retirement obligation represents the present value of estimated
future costs to be incurred to abandon and reclaim the Company's wells and
facilities. Changes in amount of the obligation between September 30, 2008 and
December 31, 2007 comprise the present value of additional obligations accruing
to the Company as a result of field activity and acquisitions during the
quarter, less costs paid in settlement of abandonment obligations, plus the
quarterly increase in the present value of the obligation. The discount rate
used to establish the present value is 8%. Future costs to abandon and reclaim
Storm's properties are based on an internal evaluation of each of the Company's
properties, supported by external data from industry sources.
Share Capital
Details of outstanding share capital and dilutive elements as at and for the
nine months ended September 20, 2008:
----------------------------------------------------------------------------
September 30, December 31,
2008 2007
----------------------------------------------------------------------------
Common shares outstanding - end of period 44,699 44,532
----------------------------------------------------------------------------
Stock options 2,316 2,166
----------------------------------------------------------------------------
Fully diluted common shares - end of period 47,015 46,698
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Weighted average common shares - basic 44,638 43,449
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Weighted average common shares - diluted 45,873 44,132
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Stock options outstanding are exercisable over five years on various dates
beginning September 2005 at prices ranging from $2.60 to $11.40.
CONTRACTUAL OBLIGATIONS
In the course of its business Storm enters into various contractual obligations,
including the following:
- purchase of services
- royalty agreements
- operating agreements
- processing agreements
- right of way agreements
- lease obligations for accommodation, office equipment and automotive equipment.
All such contractual obligations reflect market conditions at the time of
contract and do not involve related parties.
Obligations with a fixed term are as follows:
----------------------------------------------------------------------------
($000's) 2008 2009 2010 2011 2012
----------------------------------------------------------------------------
Lease of premises $ 759 $ 759 $ 772 $ 785 -
----------------------------------------------------------------------------
Equipment leases 27 56 - - -
----------------------------------------------------------------------------
Total $ 786 $ 815 $ 772 $ 785 -
----------------------------------------------------------------------------
----------------------------------------------------------------------------
QUARTERLY RESULTS
Summarized information by quarter for the two years ended September 30, 2008
appears below:
----------------------------------------------------------------------------
September 30, June 30, March 31, December 31,
Quarter Ended 2008 2008 2008 2007
----------------------------------------------------------------------------
Production revenue -
($000s) 40,215 38,888 33,974 25,553
----------------------------------------------------------------------------
Funds from operations
($000s) 24,290 23,250 19,518 13,233
Per share
- basic $ 0.54 $ 0.52 $ 0.44 $ 0.30
- diluted $ 0.53 $ 0.50 $ 0.43 $ 0.30
----------------------------------------------------------------------------
Net income - ($000s)
Per share 12,829 9,465 6,426 2,852
- basic $ 0.28 $ 0.21 $ 0.14 $ 0.06
- diluted $ 0.28 $ 0.20 $ 0.14 $ 0.06
----------------------------------------------------------------------------
Average daily
production - Boe 7,107 6,130 6,500 5,992
----------------------------------------------------------------------------
Average field netback
per Boe $ 39.77 $ 45.09 $ 35.87 $ 27.44
----------------------------------------------------------------------------
Capital expenditures
net - ($000s) 27,057 5,780 26,775 17,094
----------------------------------------------------------------------------
----------------------------------------------------------------------------
----------------------------------------------------------------------------
September 30, June 30, March 31, December 31,
Quarter Ended 2007 2007 2007 2006
----------------------------------------------------------------------------
Production revenue -
($000s) 19,573 25,156 28,009 23,590
----------------------------------------------------------------------------
Funds from operations
($000s) 9,372 12,921 16,417 12,748
Per share
- basic $ 0.21 $ 0.30 0.38 0.30
- diluted $ 0.20 $ 0.29 0.38 0.29
----------------------------------------------------------------------------
Net income - ($000s)
Per share 299 2,832 5,066 3,049
- basic $ 0.01 $ 0.06 $ 0.12 $ 0.07
- diluted $ 0.01 $ 0.06 $ 0.12 $ 0.07
----------------------------------------------------------------------------
Average daily
production - Boe 5,618 5,713 5,776 5,442
----------------------------------------------------------------------------
Average field netback
per Boe $ 20.83 $ 28.02 $ 33.91 $ 27.88
----------------------------------------------------------------------------
Capital expenditures
net - ($000s) 19,953 32,768 24,075 $ 13,635
----------------------------------------------------------------------------
----------------------------------------------------------------------------
CRITICAL ACCOUNTING ESTIMATES
Financial amounts included in the Company's Management's Discussion and Analysis
and in the unaudited consolidated financial statements for the three and nine
months ended September 30, 2008 are based on accounting policies, estimates and
judgment which reflect information available to management at the time of
preparation. Information with respect to the accounting policies selected by the
Company and the use of estimates is set out in the Company's annual report for
the year ended December 31, 2007 and the unaudited consolidated financial
statements for the three and nine months ended September 30, 2008.
RISK ASSESSMENT
There are a number of risks facing participants in the Canadian oil and gas
industry. Some of the risks are common to all businesses while others are
specific to the sector and others are specific to Storm. Information with
respect to such risks is set out in the Company's most recent Annual Information
Form and Management's Discussion and Analysis for the year ended December 31,
2007.
In addition to risks identified in Storm's most recent annual report and Annual
Information Form, a worldwide and unprecedented series of events in recent
months has resulted in the collapse of, or losses reported by, major
international financial institutions, along with severe curtailment of liquidity
in debt markets and the injection of public money to support both debt and
equity markets and financial institutions. Although the Canadian banking sector,
in comparison to its international peers, has shown resilience in the face of
these events, it has still incurred considerable losses and will be affected by
any continuing weakness in credit markets. In view of these circumstances, the
Company has reviewed its lending arrangements with its bankers and has received
assurances that existing credit arrangements will be maintained and that
criteria necessary to secure additional borrowing to support the Company's
growth has not been changed. However, additional circumstances may emerge that
could have the effect of reducing credit available to Storm, or being available
only at an unacceptable cost, thus reducing the Company's ability to finance
future growth. Further, access to equity markets is expected to be negatively
affected by recent events.
Nevertheless, Storm's long standing approach to financing operations through
internally generated cash flow should mitigate the effect of any reduction in
access to debt and equity markets. However, falling commodity prices will reduce
cash flows; correspondingly the rate of growth of the Company's business may
slow.
Recent events are likely to result in changed and increased regulation of debt
and equity markets, which may also have an undeterminable effect on Storm's
financial structure and cost of doing business.
REPORTING CONTROLS
The Company's Chief Executive Officer ("CEO") and Chief Financial Officer
("CFO") are responsible for developing and maintaining disclosure controls and
procedures and internal controls over financial reporting. Storm has codified
and distributed to staff its policies, controls and procedures with respect to
disclosure to third parties of information concerning the Company's operations
and results. In addition, disclosure controls and procedures are designed to
provide reasonable assurance that relevant information is collected and provided
to the CEO and CFO, who have concluded such controls and procedures are
effective to provide reasonable assurance that material information related to
Storm is made known to them by others within the Company. Internal controls over
financial reporting as designed by the CEO and CFO, either directly or under
their supervision, are intended to provide reasonable assurance regarding the
reliability of financial reporting, including financial reporting for external
purposes under GAAP. No changes to internal controls were made and no
circumstance suggesting a possible breach of disclosure controls were identified
in the three and nine months ended September 30, 2008.
Because of inherent limitations, disclosure controls and procedures and internal
controls over financial reporting cannot prevent or identify all
mismeasurements, errors and fraud.
ADDITIONAL INFORMATION
Additional information relating to the Company, including the Company's Annual
Information Form, can be viewed at www.sedar.com or on the Company's website at
www.stormexploration.com. Information can also be obtained by contacting the
Company at Storm Exploration Inc., 800, 205 - 5th Avenue, SW, Calgary, Alberta,
T2P 2V7.
Storm Exploration Inc.
Consolidated Balance Sheets
($000s)
UNAUDITED
September 30, December 31,
2008 2007
-------------- -------------
ASSETS
Current
Accounts receivable 15,292 11,949
Prepaid and other costs 3,195 1,945
-------------- -------------
18,487 13,894
Property and Equipment - Net (Note 2) 267,403 237,738
Investments (Note 9) 20,242 9,275
-------------- -------------
306,132 260,907
-------------- -------------
-------------- -------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current
Accounts payable and accrued liabilities 35,436 24,103
Unrealized mark-to-market hedging
provision (Note 10) - -
-------------- -------------
35,436 24,103
Bank Indebtedness (Note 4) 66,955 74,472
Asset Retirement Obligation (Note 5) 7,467 6,918
Future Income Taxes (Note 3) 20,544 10,519
-------------- -------------
130,402 116,012
-------------- -------------
Shareholders' Equity (Note 6)
Share capital 87,983 86,994
Contributed surplus 3,446 2,318
Retained earnings 84,301 55,583
Accumulated other comprehensive income (deficit) - -
-------------- -------------
175,730 144,895
-------------- -------------
306,132 260,907
-------------- -------------
-------------- -------------
Storm Exploration Inc.
Consolidated Statements of Income and Retained Earnings
($000s)
Unaudited
Three Three Nine Nine
Months to Months to Months to Months to
September September September September
30, 2008 30, 2007 30, 2008 30, 2007
----------- ----------- ----------- -----------
Revenue
Production revenue 40,215 19,573 113,077 72,738
Royalties (8,733) (4,013) (24,139) (15,003)
----------- ----------- ----------- -----------
31,482 15,560 88,938 57,735
----------- ----------- ----------- -----------
Expenses
Production 4,253 3,510 12,679 11,129
Transportation 1,221 1,287 3,887 3,653
Interest 825 1,151 2,830 2,688
General and administrative 533 240 2,124 1,555
Stock based compensation 615 314 1,346 992
Provision for account receivable 360 - 360 -
Depletion, depreciation and
accretion 10,725 8,736 30,496 25,460
----------- ----------- ----------- -----------
18,532 15,238 53,722 45,477
----------- ----------- ----------- -----------
Income before the following: 12,950 322 35,216 12,258
Investment gains (Note 9) 3,527 - 3,527 -
Future income taxes (Note 3) (3,648) (23) (10,025) (4,061)
----------- ----------- ----------- -----------
Net income for the period 12,829 299 28,718 8,197
Retained earnings, beginning
of period 71,472 52,432 55,583 44,534
----------- ----------- ----------- -----------
Retained earnings, end of
period 84,301 52,731 84,301 52,731
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Net Income per share (Note 7)
- basic 0.28 0.01 0.64 0.19
- diluted 0.28 0.01 0.63 0.19
Storm Exploration Inc.
Consolidated Statements of Comprehensive Income
($000s)
Unaudited
Three Three Nine Nine
Months to Months to Months to Months to
September September September September
30, 2008 30, 2007 30, 2008 30, 2007
----------- ----------- ----------- -----------
Net Income for the period 12,829 299 28,718 8,197
Reversal of unrealized
hedging loss 5,267 - - -
Related income tax benefit (1,580) - -
----------- ----------- ----------- -----------
Other Comprehensive income
(Note 10) 3,687 - - -
----------- ----------- ----------- -----------
----------------------------------------------------------------------------
Comprehensive income for
the period 16,516 299 28,718 8,197
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Storm Exploration Inc.
Consolidated Statements of Cash Flows
($000s)
Unaudited
Three Three Nine Nine
Months to Months to Months to Months to
September September September September
30, 2008 30, 2007 30, 2008 30, 2007
--------------------------------------------
Operating activities
Net income for the period 12,829 299 28,718 8,197
Less: Investment gains (Note 9) (3,527) - (3,527) -
Add non-cash items:
Depletion, depreciation and
accretion 10,725 8,736 30,496 25,460
Future income tax 3,648 23 10,025 4,061
Stock based compensation 615 314 1,346 992
--------------------------------------------
Funds from operations 24,290 9,372 67,058 38,710
Net change in non-cash working
capital items (Note 8) (159) (3,794) (1,157) (1,727)
--------------------------------------------
24,131 5,578 65,901 36,983
--------------------------------------------
Financing activities
Issue of common shares - net of
expenses 196 14,442 771 14,455
Increase (Decrease) in bank
indebtedness 541 (12,008) (7,517) 20,357
--------------------------------------------
737 2,434 (6,746) 34,812
--------------------------------------------
Investing activities
Increase in investments (6,190) - (7,440) -
Additions to property and
equipment (30,457) (19,953) (65,665) (76,796)
Disposals of property and
equipment 3,400 - 6,053 -
Net change in non-cash working
capital items (Note 8) 8,379 11,941 7,897 5,001
--------------------------------------------
(24,868) (8,012) (59,155) (71,795)
--------------------------------------------
Change in cash during the period - - - -
Cash, beginning of period - - - -
--------------------------------------------
Cash, end of period - - - -
--------------------------------------------
--------------------------------------------
Storm Exploration Inc.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008
(UNAUDITED)
1. SIGNIFICANT ACCOUNTING POLICIES
These interim unaudited consolidated financial statements of Storm Exploration
Inc. ("Storm" or "the Company") have been prepared by management in accordance
with accounting principles generally accepted in Canada, following, except as
described below, the same accounting policies and methods of computation as used
in the audited consolidated financial statements for the year ended December 31,
2007. The interim unaudited consolidated financial statement note disclosures do
not include all disclosures applicable for annual audited financial statements.
Accordingly, the interim unaudited consolidated financial statements should be
read in conjunction with the audited consolidated financial statements and the
notes thereto contained in the Company's annual report for the year ended
December 31, 2007.
CHANGES IN ACCOUNTING POLICIES
On January 1, 2008, the Company adopted additional accounting pronouncements
promulgated by the Canadian Institute of Chartered Accountants ("CICA"). The new
accounting policies are set out in CICA Handbook Section 1535 "Capital
Disclosures"; Section 3862 "Financial Instruments - Disclosures"; and Section
3863 "Financial Instruments - Presentation". As required by the new standards,
prior periods have not been restated.
Section 1535 - "Capital Disclosures" This new accounting pronouncement requires
companies to describe their objectives, policies and processes regarding
management of capital. Information about what constitutes capital is also
required; further, the existence of any obligations relating to capital
maintenance must be disclosed, along with the consequences of non-compliance.
Note 11 to these unaudited consolidated interim financial statements provides
the required disclosures.
Section 3862- "Financial Instruments - Disclosures" This pronouncement is an
expansion of existing standards relating to financial instruments and requires
the disclosure of information about financial instruments to which the Company
is a party. Information is provided about financial instruments and their actual
or potential effect on the financial position and results of the Company.
Further, information is provided about risks to which the Company is exposed
through recognized and unrecognized financial instruments and how these risks
are managed. See Note 10.
Section 3863 - "Financial Instruments - Presentation". This pronouncement also
enhances existing disclosure requirements and establishes presentation standards
for financial instruments and non-financial derivatives. See Note 10.
The adoption of these pronouncements has had no effect on the Company's net
income or funds from operations for the period.
2. PROPERTY AND EQUIPMENT
September 30, 2008 December 31, 2007
-----------------------------------------
Property and equipment 375,381 315,587
Accumulated depletion and
depreciation (107,978) (77,849)
-----------------------------------------
$267,403 $ 237,738
-----------------------------------------
-----------------------------------------
At September 30, 2008, the depletion calculation excluded unproved properties of
$19.7 million (December 31, 2007 - $21.0 million) and included future
development costs of $6.1 million (December 31, 2007 - $23.1 million).
3. FUTURE INCOME TAXES
The future income tax liability is made up of the excess of the accounting
amounts over the related tax bases of the Company's property and equipment,
share capital and other comprehensive income.
The Company has tax pools associated with property and equipment, for accounting
purposes, of approximately $187 million as well as capital losses of
approximately $10 million, all of which are not subject to expiry.
Under the terms of a flow-through share issue in September, 2007, the Company is
obligated to incur Canadian Exploration Expenditures in the amount of $15.1
million prior to December 31, 2008. As at September 30, 2008 the Company
estimates that it had incurred the full amount of qualifying expenditures. The
full amount has been renounced to the subscribers at December 31, 2007 and has
been deducted from the Company's tax pool balance.
The provision for future income taxes is different from the amount computed by
applying the combined statutory Canadian federal and provincial tax rates to
pre-tax income for the period.
The differences are as follows:
----------------------------------------------------------------------------
Three months Three months Nine months Nine months
to to to to
September September 30, September September
30, 2008 2007 30, 2008 30, 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Statutory combined
federal and provincial
income tax rate 30% 32% 30% 32%
----------------------------------------------------------------------------
Expected income taxes $ 5,060 $ 100 $ 11,764 $ 3,962
----------------------------------------------------------------------------
Add (deduct) the
income tax effect of:
----------------------------------------------------------------------------
Stock-based compensation 189 211 409 321
----------------------------------------------------------------------------
Investment gain (1,071) - (1,071) -
----------------------------------------------------------------------------
Rate adjustments (531) (288) (1,081) (222)
----------------------------------------------------------------------------
Other 1 - 4 -
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Future Income Tax $ 3,648 $ 23 $ 10,025 $ 4,061
----------------------------------------------------------------------------
----------------------------------------------------------------------------
The significant components of the future income tax liability are
as follows:
----------------------------------------------------------------------------
September 30, 2008 December 31, 2007
----------------------------------------------------------------------------
Property and equipment $ 23,076 $ 13,073
----------------------------------------------------------------------------
Asset retirement obligation (2,106) (2,006)
----------------------------------------------------------------------------
Share issue costs (426) (548)
----------------------------------------------------------------------------
Future income tax liability $ 20,544 $ 10,519
----------------------------------------------------------------------------
----------------------------------------------------------------------------
4. BANK INDEBTEDNESS
The Company has an extendible revolving bank facility in the amount of $110
million (December 31, 2007 - $94 million), based on the Company's producing
reserves. The revolving facility is available to the Company until May 31, 2009,
but may be extended at the Company's request until May 30, 2010, subject to the
bank's review of the Company's reserve lending base. If the revolving facility
is not renewed at the end of the current revolving phase, the facility moves
into a term phase whereby the loan is to be retired with one payment on the
366th day following the last day of the revolving phase, in an amount equal to
the outstanding principal. Interest is payable on the revolving facility at bank
prime rate or banker's acceptance rates plus a stamping fee. Security comprises
a floating charge demand debenture on the assets of the Company.
5. ASSET RETIREMENT OBLIGATION
The estimated future asset retirement obligation is based on the Company's net
ownership interest in wells and facilities, the estimated costs to abandon and
reclaim the wells and facilities and the estimated timing of the costs to be
incurred in future periods. The total estimated undiscounted amount required to
settle the Company's asset retirement obligations is approximately $13.7 million
(December 31, 2007 - $13.1 million), which will be paid over the next 20 years,
with the majority of costs incurred between 2018 and 2028. A credit adjusted
risk-free rate of eight percent was used to calculate the present value of the
asset retirement obligations, amounting to $7.5 million (December 31, 2007 -
$6.9 million).
The following table provides a reconciliation of the carrying amount of the
obligation associated with the retirement of oil and gas properties:
----------------------------------------------------------------------------
September 30, 2008 December 31, 2007
----------------------------------------------------------------------------
Asset retirement obligation,
beginning of period $ 6,918 $ 5,925
----------------------------------------------------------------------------
Liabilities incurred, net of
liabilities disposed 182 531
----------------------------------------------------------------------------
Accretion expense 367 462
----------------------------------------------------------------------------
Asset retirement obligation,
end of period $ 7,467 $ 6,918
----------------------------------------------------------------------------
----------------------------------------------------------------------------
6. SHARE CAPITAL
Authorized
An unlimited number of non-voting common shares
An unlimited number of voting common shares
An unlimited number of preferred shares
Included in the following common share balances are 1,275,000 non-voting common
shares.
Except for voting rights, non-voting and voting common shares are identical.
Issued
Number of Consideration
Shares
----------------------------------
Balance as at December 31, 2007 44,532 $ 86,994
Stock options exercised 167 989
----------------------------------
Balance as at September 30, 2008 44,699 $ 87,983
----------------------------------
----------------------------------
Stock Based Compensation Plans
(i) The Company has a stock option plan under which it may grant, at the
Company's discretion, options to purchase common shares to directors, officers
and employees. Under the stock option plan a total of 3,700,000 common shares
has been reserved for issuance. Details of the options outstanding at September
30, 2008 are as follows:
Outstanding Options Exercisable Options
----------------------------------------------
Weighted Weighted Weighted
Range of Number of Average Average Number of Average
Exercise Options Remaining Exercise Options Exercise
Price Outstanding Life (years) Price Outstanding Price
----------------------------------------------------------------------------
$2.60 to $3.61 266 1.4 $3.33 210 $3.27
$3.91 to $5.71 1,299 2.5 $5.46 635 $5.44
$6.03 to $8.57 743 3.9 $7.97 70 $6.79
$9.00 to $11.40 8 4.4 $11.40 - -
------------------------------------------------------------
2,316 2.9 $6.04 915 $5.05
------------------------------------------------------------
------------------------------------------------------------
7. PER SHARE AMOUNTS
----------------------------------------------------------------------------
Three months Three months Nine months Nine months
to to to to
September September 30, September September
30, 2008 2007 30, 2008 30, 2007
----------------------------------------------------------------------------
Basic
----------------------------------------------------------------------------
Net income per share $0.28 $0.01 $0.64 $0.19
----------------------------------------------------------------------------
Weighted average
number of shares
outstanding ('000) 44,692 43,423 44,638 43,086
----------------------------------------------------------------------------
Diluted
----------------------------------------------------------------------------
Net income per share $0.28 $0.01 $0.63 $0.19
----------------------------------------------------------------------------
Weighted average
number of shares
outstanding ('000) 46,001 44,191 45,873 43,836
----------------------------------------------------------------------------
The reconciling items between basic and diluted weighted average common shares
are stock options described in Note 6.
8. SUPPLEMENTAL CASH FLOW INFORMATION
Changes in non-cash working capital
Three Three Nine Nine
months to months to months to months to
September September September September
30, 2008 30, 2007 30, 2008 30, 2007
-----------------------------------------------
Accounts receivable $ (4,009) $ (3,514) $ (3,343) $ (1,633)
Prepaid costs and
deposits (213) (20) (1,249) 496
Accounts payable and
accrued liabilities 12,442 11,681 11,332 4,411
-----------------------------------------------
Change in non-cash
working capital $ 8,220 $ 8,147 $ 6,740 $ 3,274
-----------------------------------------------
-----------------------------------------------
Relating to:
Financing activities $ - $ - $ - $ -
Investing activities 8,379 11,941 7,897 5,001
Operating activities (159) (3,794) (1,157) (1,727)
-----------------------------------------------
$ 8,220 $ 8,147 $ 6,740 $ 3,274
-----------------------------------------------
-----------------------------------------------
Interest paid during the
period $ 825 $ 1,151 $ 2,830 $ 2,688
-----------------------------------------------
-----------------------------------------------
Income taxes paid
during the period $ - $ - $ - $ -
-----------------------------------------------
-----------------------------------------------
9. INVESTMENTS
September 30, December 31,
2008 2007
-----------------------------
Investment in Storm Gas Resources Corp. $ 9,717 $ -
Investment in Storm Ventures International Inc 10,525 9,275
-----------------------------
$ 20,242 $ 9,275
-----------------------------
-----------------------------
The Company holds shares in a private company, Storm Gas Resource Corp. ("SGR"),
which is accounted for using the equity method. The Company's initial
investment, comprising cash and lands transferred at fair value, totalled
$1,250,000 and represented a 45% interest. In July 2008 the Company participated
in a private placement of common shares in SGR in the amount of $4,940,000. The
terms of the private placement were such that the Company's ownership position
was reduced from 45% to 23%. As the shares issued under the private placement
were sold at a share price greater than the price of Storm's initial investment,
the Company recognized a dilution gain of $3,527,000.
The Company holds shares in another private company, Storm Ventures
International ("SVI"), which is accounted for using the cost method. In July,
2008 the Company participated in a private placement of common shares of SVI in
the amount of $1,250,000; as the Company's participation was not pro rata to its
existing interest, the Company's ownership position in SVI fell from 13% to 12%.
10. FINANCIAL INSTRUMENTS
The Company holds various financial instruments. These financial instruments
expose the Company to the following risks:
- credit risk
- market risk
- liquidity risk
Management has primary responsibility for monitoring and managing financial
instrument risks under direction from the Board of Directors, which has overall
responsibility for establishing the Company's risk management framework. In
certain circumstances, for example hedging of future production revenue, the
Board has established policies and has established risk limits and controls, and
monitors these risks in relation to market conditions. In other circumstances,
for example extending credit to purchasers of the Company's products, the Board
has delegated responsibility for credit assessment to management, but receives
frequent financial and operating reports.
The Company's financial instruments recognized on the unaudited consolidated
balance sheet consist of accounts receivable, bank indebtedness and accounts
payable and accrued liabilities. The fair value of these financial instruments
approximates their carrying amounts based on the short term to maturity.
Credit risk:
A substantial portion of the Company's accounts receivable are concentrated with
a limited number of purchasers of commodities and joint venture partners in the
oil and gas industry and are subject to normal industry credit risk. Management
considers this concentration of credit risk to be limited, as commodity
purchasers are major industry participants, and receivables from partners are
protected by effective industry standard legal remedies. In addition, the
Company's high working interest in its major operating properties mitigates the
risk of partner default. The Company requires cash calls from its partners on
major field projects in advance of commencement. Receivables related to the sale
of the Company's production are normally collected on the 25th day of the month
following delivery.
Market risk:
Market risks are as follows and are largely outside of the control of the Company:
- Commodity prices
- Interest rates
- Foreign exchange
The Company faces certain other financial risks as follows:
Liquidity risk:
Liquidity difficulties would emerge if the Company was unable to meet its
financial obligations as they fell due within normal credit terms. This may be
the consequence of diminished cash flows resulting from lower product prices,
production interruptions, or unexpected operating or capital cost increases.
Liquidity difficulties could also occur if the Company's bankers were unable to
continue to provide credit at a level and on terms compatible with the Company's
capital requirements. Generally the Company will, over a reasonable period of
time, limit its capital programs to cash flow from operations. In addition, the
Company endeavours to maintain its debt at a level somewhat less than the
maximum amount of its total bank facility to ensure financial flexibility to
deal with unforeseen or rapidly changing circumstances.
Commodity prices-
The Company is constantly exposed to the risk of declining prices for its
products with a corresponding reduction in cash flow. Reduced cash flow may
result in lower levels of capital being available for field activity, thus
compromising the Company's capacity to grow production while at the same time
replacing continuous declines from existing properties. In certain
circumstances, usually when debt levels are forecast to increase due to capital
expenditures exceeding cash flow, or where the Company has financed, in whole or
in part, an acquisition using bank debt, the Company may enter into oil and
natural gas hedging contracts in order to provide stability to future cash flow.
These contracts reduce the fluctuation in production revenue by fixing prices of
future deliveries of oil and natural gas.
For the three and nine month period ending September 30, 2008 the Company
realized hedging losses of $1.4 million and $2.2 million, respectively. (2007 -
Nil) This amount has been offset against production revenues.
As at September 30, 2008, Storm had no hedges in place. All unrealized hedge
losses and related income tax benefits previously charged to Other Comprehensive
Income have been reversed in the current quarter.
Interest rates -
Interest on the Company's revolving bank facility varies, and is most commonly
based on bankers' acceptance rates plus a stamping fee. The Company is thus
exposed to increased borrowing costs during periods of increasing interest
rates, with a corresponding reduction in both cash flows and project economics.
The Company had no interest rate swaps or similar contracts in place at
September 30, 2008 to reduce interest rate risk.
Foreign exchange -
Although the Company's product revenues are denominated in Canadian dollars, the
underlying market prices are affected by the exchange rate between the Canadian
and the United States dollar. As at September 30, 2008 the Company had no
contracts in place to reduce foreign exchange risk.
11. CAPITAL MANAGEMENT
Capital management is fundamental to the Company's objective of cost-effective
production growth, while simultaneously replacing continuous production
declines. The Company's capital comprises shareholders' equity, bank
indebtedness and working capital. Capital management involves the preparation of
an annual budget, which may only be implemented after approval by the Company's
Board of Directors. As the Company's business evolves during the fiscal year,
the budget may be amended; however, any changes are again subject to approval by
the Board of Directors. As part of the budget process, and as part of capital
management control procedures, the Company continuously during the fiscal year
uses a non-GAAP measurement of net debt to cash flow to measure and control debt
levels. This measurement is established as follows:
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September 30, December 31,
2008 2007
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Current assets $ 18,487 $ 13,894
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Accounts payable and accrued liabilities 35,436 24,103
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Working capital deficiency 16,949 10,209
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Bank indebtedness 66,955 74,472
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Net debt $ 83,904 $ 84,681
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Annualized cash flow for the period $ 97,160 $ 51,943
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Net debt to cash flow ratio 0.9 : 1 1.6 : 1
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Annualized cash flow is defined as the current quarter's funds from operations,
per the consolidated statements of cash flows, multiplied by four. The ratio of
net debt to cash flow is subject to quarterly variations and is usually highest
in the first and fourth quarter of each year, when capital expenditures normally
exceed cash flow, with a resulting increase in net debt.
The Company's bank indebtedness is based on the Company's producing reserves and
generally is not subject to restrictions which would potentially affect the
Company's operations. However, the ratio of net debt to cash flow is used to
determine the interest rate applied to the Company's bank indebtedness, with
interest rates changing at certain threshold levels of net debt to cash flow.
From time to time the Company may enter into hedging arrangements if capital
programs or acquisitions result in a high net debt to cash flow ratio. Such
arrangements provide for stability of cash flow during periods when the Company
applies cash flow to reduce its net debt.
The Company may issue share capital when debt levels are high and potentially
constrain operations, usually in circumstances when the Company has completed a
large acquisition.
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