Delphi Energy Corp. ("Delphi" or the "Company") (TSX:DEE) is pleased to announce
its financial and operational results for the quarter and year ended December
31, 2010.
2010 Highlights
- achieved record average production in 2010 with volumes of 8,086 barrels of
oil equivalent per day (boe/d), an increase of 19 percent compared to 2009;
- changed the production mix to approximately 24 percent crude oil and natural
gas liquids in the fourth quarter of 2010, up from 16 percent in the fourth
quarter of 2009, which contributed to higher operating and cash flow netbacks;
- generated funds from operations ("cash flow") of $61.3 million, an increase of
24 percent from the previous year;
- increased the cash flow netback by five percent to $20.75 per boe compared to
$19.81 per boe in 2009;
- Increased cash flow per share, excluding hedging gains, by 57 percent compared
to 2009;
- reduced operating costs by 18 percent to $7.46 per boe in 2010 from $9.08 per
boe in the previous year;
- realized $16.1 million in hedging gains on commodity contracts;
- increased total proved reserves by 26 percent to 22.7 million boe and
increased total proved plus probable reserves by 26 percent to 34.5 million boe;
- increased yearly average production per share by six percent and increased
year-end reserves per share by 13 percent;
- drilled 36 (23.3 net) wells with an overall success rate of 97 percent;
- achieved average finding, development, acquisitions and dispositions costs of
$18.10 per proved boe and $14.94 per proved plus probable boe;
- generated a recycle ratio of 1.6 times on an operating netback of $24.34 per boe;
- issued 11.0 million common shares for gross proceeds of $30.3 million;
- increased the Company's credit facilities from $125.0 million to $140.0
million throughout the year providing $31.9 million of available credit and a
twelve month trailing net debt to funds from operations ratio of 1.8:1 at
December 31, 2010;
- reduced net debt per boe at December 31, 2010 on a proved and proved plus
probable basis for the fourth year in a row to $4.76 and $3.13 per boe,
respectively; and
- increased the Company's total undeveloped land holdings by 42 percent to
244,475 net acres as compared to December 31, 2009, at an average acquisition
cost in 2010 of approximately $72.00 per acre.
Operational Highlights
Three Months Ended
December 31 Year Ended December 31
Production % %
2010 2009 Change 2010 2009 Change
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Natural gas (mcf/d) 38,918 34,626 12 38,816 34,673 12
Crude oil (bbl/d) 1,147 630 82 950 525 81
Natural gas liquids (bbl/d) 906 487 86 667 504 32
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Total (boe/d) 8,539 6,888 24 8,086 6,808 19
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Financial Highlights($ thousands except per unit amounts)
Three Months Ended
December 31 Year Ended December 31
% %
2010 2009 Change 2010 2009 Change
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Petroleum and natural gas
sales 30,475 26,297 16 117,199 98,164 19
Per boe 38.79 41.50 (7) 39.71 39.50 1
Funds from operations 17,987 14,218 27 61,252 49,241 24
Per boe 22.89 22.44 2 20.75 19.81 5
Per share - Basic 0.16 0.14 14 0.57 0.59 (3)
Per share - Diluted 0.16 0.14 14 0.57 0.59 (3)
Net earnings (loss) 204 1,386 (85) (844) (8,029) (89)
Per boe 0.25 2.19 (89) (0.29) (3.23) (91)
Per share - Basic - 0.02 (100) (0.01) (0.10) 90
Per share - Diluted - 0.02 (100) (0.01) (0.10) 90
Capital invested 18,314 8,442 117 105,791 33,946 212
Disposition of properties - (10,765) 100 (247) (20,718) (99)
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Net capital invested 18,314 (2,323) - 105,544 13,228 698
Acquisition of
properties (1) (369) 27,436 - 18 46,887 (100)
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Total capital invested 17,945 25,113 (29) 105,562 60,115 76
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December 31, December 31,
2010 2009 % Change
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Debt plus working capital 108,054 92,538
deficiency (2) 17
Total assets 412,329 361,698 14
Shares outstanding (000's)
Basic 112,825 101,166 12
Diluted 120,601 108,594 11
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(1) 2009 includes the costs of the acquisition of Fairmount Energy Inc.
(2) excludes risk management asset/liability and the related current future
income taxes.
MESSAGE TO SHAREHOLDERS
2010 was an exceptional year for Delphi with the reported results generating a
recurring theme of financial discipline and operational excellence in achieving
its targets. Having doubled reserves and increased production by 52 percent over
the past three years Delphi's rate of growth has been accelerating. The
Company's growth strategies are being executed successfully and our vision of
sustainable long term economic growth drives us on.
Production growth of 19 percent, cash flow growth of 24 percent and reserve
growth of 26 percent are only a part of the successes in 2010. Operating margins
are an integral part of the Company's measure of success. In a low commodity
price environment, these operating efficiencies are critical to maintaining
sufficient cash generating capability to execute an economic growth plan.
Delphi's cash generating capability on a per unit basis, excluding hedging
gains, increased 47 percent in 2010 as a result of a significant increase in its
crude oil and NGL production mix and material improvements in the Company's cost
structure.
Cash costs have been reduced 25 percent over the past 3 years adding over $3.00
of cash flow to each barrel of oil equivalent ("boe") produced and in 2010 the
Company produced 2.95 million boe. Those savings alone are enough to drill,
complete, equip and tie-in three 100 percent wells at Wapiti/Gold Creek.
Natural gas prices averaged $4.00 per mcf in 2010, essentially flat to 2009
levels of $3.96 per mcf. Natural gas future price curves appear to have settled
into a range-bound trading pattern for the next several years representative of
a perceived and persistent oversupply environment. Delphi is assuming 2011
natural gas prices will be flat to 2010 levels with improvements looking into
2012. Delphi has maintained an active and successful hedging program despite
lower price volatility, with the objective of protecting cash flow to execute a
minimum level of capital spending. The Company's hedging program successfully
contributed over $16.0 million to cash flow in 2010 or approximately $5.45 per
boe to the cash netback. With lower natural gas price volatility looking
forward, hedging becomes less about expectations for large hedging gains and
more about simple downside price protection.
The Company has hedged approximately 52 percent of its 2011 natural gas
production at $4.93 per mcf, potentially generating gains of $6.0 million or
increasing the cash netback by approximately $1.80 per boe. The successful
growth of Company's cash generating capabilities through commodity mix change
and cost structure improvements is by design, displacing less predictable
hedging gains as a material component of historically superior cash netbacks in
a low natural gas price environment.
The Company's recycle ratio continues to be a reliable measure of economic
growth defined by superior netbacks and top quartile finding and development
costs. Delphi's three year recycle ratio average is a robust 1.8 times.
Delphi achieved record reserve growth and top quartile finding and development
("F&D") costs as a result of a successful capital program in 2010, focused
within its three core areas but spread over two light oil projects and multiple
liquids-rich natural gas play-types. Economic results across multiple project
types have significantly grown the Company's future drilling inventory. The
inventory of liquids-rich natural gas projects with F&D costs ranging from $6.00
to $12.00 and light oil projects with F&D costs averaging $20.00 per boe offer
robust individual project economics and when blended deliver economic growth at
targeted corporate recycle ratios. Over the past three years total reserves have
doubled at an average F&D cost of $14.77 per boe.
The Company's fundamental principles within its growth strategies continue to
provide a competitive advantage:
- Synergistic play-types within our deep basin core areas mitigate exploration
and operational risks and drive down on-stream capital costs and maximize
reserve additions.
- Large contiguous land positions complete with ownership in strategic
infrastructure in each of our core areas provide repeatable and scalable project
inventory with capital and production cost structure advantages.
- The robust revenue generating quality of the Company's NGL production stream
and inventory of high liquids content growth opportunities is a natural hedge
against natural gas price weakness while maintaining significant exposure to a
recovery in natural gas prices.
- The Company maintains direct control over its core assets, operating over 93%
of its production and 97% of its capital programs.
- An active hedging program maintains a forward-looking 12 to 24 month hedge
position and provides protection for a defined level of capital spending.
- Financial stability and strength is maintained through prudent capital to cash
flow, debt to cash flow and debt to equity ratios.
Year in Review
Financial results in 2010 are highlighted again by strong growth in funds from
operations (cash flow) in a low natural gas price environment. The AECO natural
gas reference price averaged $4.00 per mcf in 2010 flat to $3.96 per mcf in
2009. The Company realized an average natural gas price of $5.45 per mcf in 2010
resulting in hedging gains of $16.1 million.
Cash flow increased 24 percent in 2010 to $61.3 million with hedging gains
contributing 26 percent of the 2010 cash flow compared to 48 percent in 2009.
Cash flow, excluding hedging gains, increased 75 percent as a result of a 19
percent increase in corporate production, a 58 percent increase in crude oil and
NGL production and an 18 percent decrease in operating costs per boe.
Corporate cash netbacks, including hedging, increased five percent to $20.75 per
boe compared to $19.81 per boe in 2009, while cash netbacks excluding hedging
gains increased 47 percent or $5.00 per boe. Delphi views a $20.00 per boe cash
netback target sustainable within the current natural gas price environment,
without expectation of any hedging gains given the growth in liquids production
and cost structure improvements.
Financial flexibility remained strong in 2010 with bank debt and working capital
totalling 77 percent of available bank facilities at December 31, 2010.
Unutilized credit available on the Company's $140.0 million banking facilities
at the end of 2010 remained flat to 2009 levels at approximately $31.9 million
while the debt to trailing cash flow ratio at December 31, 2010 improved to 1.8
times from 1.9 at December 31, 2009.
Operational results in 2010, for the third year in a row are highlighted by
record production volumes. Production during 2010 averaged 8,086 barrels of oil
equivalent per day (boe/d), representing a 19 percent increase over 2009.
Production during the fourth quarter of 2010 increased 24 percent to average a
record 8,539 boe/d as compared to the fourth quarter in 2009. The Company also
increased its crude oil and natural gas liquids production in the fourth quarter
of 2010 by 84 percent to 2,053 barrels per day from 1,117 barrels per day during
the fourth quarter of 2009. Crude oil and natural gas liquids production
represented 24 percent of corporate production in the fourth quarter of 2010
compared to 16 percent during the comparative quarter of 2009.
During 2010, Delphi completed a net field capital program of $105.8 million with
88 percent of the capital directed at drilling, completions and equipping of new
wells and production. The Company achieved 97 percent drilling success on a 36
(23.3 net) well program during 2010. The field capital program was expanded in
the second half of the year upon completing an equity issue of $30.3 million at
the end of the second quarter.
Delphi's total net land position, which is a measure of its future growth
prospect inventory, including developed, under-developed and undeveloped lands
has more than doubled over the past three years to 349,177 net acres (545
sections). Delphi's undeveloped land position grew 42 percent in 2010 to 244,475
net acres (382 sections). The Company has regulatory approval to drill up to
four natural gas wells per pool per section on its lands at its three core
properties of Bigstone, Hythe and Wapiti/Gold Creek.
Record reserve additions from the capital program replaced production in 2010 by
3.4 times, increasing the Company's reserve life index to 11.7 years. Proved
producing reserves increased in 2010 by 14 percent, with total proved reserves
and total proved plus probable reserves each increasing by 26 percent over 2009.
The Company has approximately 43 future development drilling locations booked in
its year-end 2010 GLJ Engineering Report, representing approximately 18 months
of drilling activity and requiring approximately $132 million of future capital.
These 43 future locations are expected to generate proved and probable reserves
of 11.3 million boe and 30 day initial production rates totaling 9,780 boe/d.
Delphi's total drilling inventory on its existing land base within its core
areas of Hythe, Bigstone and Wapiti/Gold Creek is now estimated to exceed 400
locations. Delphi's land position in the Duvernay Shale totaling 50,848 net
acres (79 sections) and 34,950 net acres (55 sections) in the Montney are also
expected to contribute significant future drilling inventory as these emerging
plays develop.
Finding, development and net acquisition cost ("FD&A") for 2010 on proved and
probable reserve additions, inclusive of future development capital ("FDC") was
$14.94 per boe. Operating netbacks were $24.34 per boe in 2010, generating a
recycle ratio of 1.6 times.
The Company is well positioned to deliver long term sustainable growth in an
environment of lower natural gas prices. Our production mix yields a high
quality revenue stream. The Company's low cost structure maximizes cash
generating margins to re-invest into the significant inventory of drilling
opportunities. Hythe, Wapiti/Gold Creek and Bigstone in North West Alberta
continue to deliver predictable economic production, reserves and cash flow
growth. We believe the low-cost reserve additions achieved over the past three
years are repeatable and scalable on our existing large undeveloped and
under-developed contiguous land bases within these core areas. Increased light
oil and natural gas liquids production is providing a natural hedge against low
natural gas prices.
Outlook
2011 will be an exciting year for Delphi as we continue focusing on numerous
liquids-rich natural gas development projects utilizing conventional vertical
well techniques as well as horizontal drilling and multistage fracing
techniques. The Company will also continue to direct capital to its light oil
plays in both the Cardium and Doe Creek.
The Company expects to spend an estimated $70 to $80 million in 2011, drilling
30 gross wells (23 net) with significant field capital directed towards
conventional vertical well opportunities in the "ultra" liquids-rich natural gas
(up to 120 barrels per million cubic feet) core area of Wapiti/Gold Creek where
up to 45 percent of the production are NGL's and F&D costs are under $8.00 per
boe. Wells will also be drilled at Bigstone and Hythe core areas pursuing both
light oil and liquids-rich natural gas. The first half 2011 capital program has
a forecast crude oil and NGL production mix of approximately 55 percent. Delphi
anticipates that at least 85 percent of the capital will be focused on light oil
and liquids-rich natural gas projects. The planned capital program is expected
to result in average 2011 production volumes of 8,800 to 9,200 boe/d with a
liquids weighting of approximately 27 percent.
We are forecasting continued low natural gas prices through 2011 due to the
ample supply of natural gas in storage and continued high drilling rig count
focused on the shale plays in the United States. Delphi is assuming 2011 AECO
natural gas prices to average between Cdn $3.75 and $4.00 per mcf for budgeting
purposes and has successfully mitigated downside commodity price risk with its
natural gas hedging program. For 2011, the Company has again hedged
approximately 52 percent of its natural gas production at an average floor price
of $4.93 per mcf which represents a 36 percent premium to the March 15, 2011
strip price of $3.63 per mcf.
Bank debt including working capital is estimated to be between $110.0 million
and $120.0 million at December 31, 2011.
We remain confident in our ability to maintain the momentum created over the
past three years and to continue to deliver sustainable long term economic
growth in this new paradigm of lower natural gas prices.
On behalf of the Board of Directors and all the employees of Delphi, we would
like to thank our shareholders for their continued support as we strive to
replicate the successes of 2010.
CONFERENCE CALL
A conference call to review 2010 results is scheduled for 10:00 a.m. Mountain
Time (12:00 noon Eastern Time) on Thursday, March 17, 2011. The conference call
number is 1-877-440-9795 or 416-340-2216. A brief presentation by David Reid,
President and CEO and Brian Kohlhammer, VP Finance & CFO will be followed by a
question and answer period.
If you are unable to participate in the conference call, a taped broadcast will
be available until March 24, 2011. To access the replay, dial 1-800-408-3053 or
905-694-9451. The passcode is 6811022. Delphi's annual and fourth quarter 2010
financial statements and management's discussion and analysis are available on
Delphi's website at www.delphienergy.ca and will be available on SEDAR at
www.sedar.com within 24 hours.
Delphi Energy is a Calgary-based company that explores, develops and produces
oil and natural gas in Western Canada. The Company is managed by a proven
technical team. Delphi trades on the Toronto Stock Exchange under the symbol
DEE.
Forward-Looking Statements. This management discussion and analysis contains
forward-looking statements and forward-looking information within the meaning of
applicable securities laws. The use of any of the words "expect", "anticipate",
"continue", "estimate", may", "will", "should", believe", "intends", "forecast",
"plans", "guidance" and similar expressions are intended to identify
forward-looking statements or information.
More particularly and without limitation, this management discussion and
analysis contains forward looking statements and information relating to the
Company's risk management program, petroleum and natural gas production, future
funds from operations, capital programs, commodity prices, costs and debt
levels. The forward-looking statements and information are based on certain key
expectations and assumptions made by Delphi, including expectations and
assumptions relating to prevailing commodity prices and exchange rates,
applicable royalty rates and tax laws, future well production rates, the
performance of existing wells, the success of drilling new wells, the capital
availability to undertake planned activities and the availability and cost of
labour and services.
Although the Company believes that the expectations reflected in such
forward-looking statements and information are reasonable, it can give no
assurance that such expectations will prove to be correct. Since forward-looking
statements and information address future events and conditions, by their very
nature they involve inherent risks and uncertainties. Actual results may differ
materially from those currently anticipated due to a number of factors and
risks. These include, but are not limited to, the risks associated with the oil
and gas industry in general such as operational risks in development,
exploration and production, delays or changes in plans with respect to
exploration or development projects or capital expenditures, the uncertainty of
estimates and projections relating to production rates, costs and expenses,
commodity price and exchange rate fluctuations, marketing and transportation,
environmental risks, competition, the ability to access sufficient capital from
internal and external sources and changes in tax, royalty and environmental
legislation. Additional information on these and other factors that could affect
the Company's operations or financial results are included in reports on file
with the applicable securities regulatory authorities and may be accessed
through the SEDAR website (www.sedar.com). The forward-looking statements and
information contained in this press release are made as of the date hereof for
the purpose of providing the readers with the Company's expectations for the
coming year. The forward-looking statements and information may not be
appropriate for other purposes. Delphi undertakes no obligation to update
publicly or revise any forward-looking statements or information, whether as a
result of new information, future events or otherwise, unless so required by
applicable securities laws.
Basis of Presentation. For the purpose of reporting production information,
reserves and calculating unit prices and costs, natural gas volumes have been
converted to a barrel of oil equivalent (boe) using six thousand cubic feet
equal to one barrel. A boe conversion ratio of 6:1 is based upon an energy
equivalency conversion method primarily applicable at the burner tip and does
not represent a value equivalency at the wellhead. This conversion conforms with
the Canadian Securities Administrators' National Instrument 51-101 when boes are
disclosed. Boes may be misleading, particularly if used in isolation.
Non-GAAP Measures. The MD&A contains the terms "funds from operations", "funds
from operations per share", "net debt", "cash operating costs" and "netbacks"
which are not recognized measures under Canadian generally accepted accounting
principles. The Company uses these measures to help evaluate its performance.
Management considers netbacks an important measure as it demonstrates its
profitability relative to current commodity prices. Management uses funds from
operations to analyze performance and considers it a key measure as it
demonstrates the Company's ability to generate the cash necessary to fund future
capital investments and to repay debt. Funds from operations is a non-GAAP
measure and has been defined by the Company as net earnings plus the addback of
non-cash items (depletion, depreciation and accretion, stock-based compensation,
future income taxes and unrealized gain/(loss) on risk management activities)
and excludes the change in non-cash working capital related to operating
activities and expenditures on asset retirement obligations and reclamation. The
Company also presents funds from operations per share whereby amounts per share
are calculated using weighted average shares outstanding consistent with the
calculation of earnings per share. Delphi's determination of funds from
operations may not be comparable to that reported by other companies nor should
it be viewed as an alternative to cash flow from operating activities, net
earnings or other measures of financial performance calculated in accordance
with Canadian GAAP. The Company has defined net debt as the sum of long term
debt plus working capital excluding the current portion of future income taxes
and risk management asset/liability. Net debt is used by management to monitor
remaining availability under its credit facilities. Cash operating costs have
been defined as the sum of operating expenses, transportation expenses, general
and administrative expenses and interest costs.
MANAGEMENT'S DISCUSSION AND ANALYSIS
(All tabular amounts are stated in thousands of dollars, except per unit amounts)
Management's discussion and analysis ("MD&A") has been prepared by management
and reviewed and approved by the Board of Directors of Delphi Energy Corp.
("Delphi" or "the Company"). The discussion and analysis is a review of the
financial condition and results of operations of the Company based upon
accounting principles generally accepted in Canada. Its focus is primarily a
comparison of the financial performance for the three and twelve months ended
December 31, 2010 and 2009 and should be read in conjunction with the audited
consolidated financial statements and accompanying notes for the years ended
December 31, 2010 and 2009. The discussion and analysis has been prepared as of
March 15, 2011.
For the purpose of reporting production information, reserves and calculating
unit prices and costs, natural gas volumes have been converted to a barrel of
oil equivalent ("boe") using six thousand cubic feet equal to one barrel. A boe
conversion ratio of 6:1 is based upon an energy equivalency conversion method
primarily applicable at the burner tip and does not represent a value
equivalency at the wellhead. This conversion conforms to the Canadian Securities
Administrators' National Instrument 51-101 when boes are disclosed. Boes may be
misleading, particularly if used in isolation.
The MD&A contains the terms "funds from operations", "funds from operations per
share", "net debt", "cash operating costs" and "netbacks" which are not
recognized measures under Canadian generally accepted accounting principles. The
Company uses these measures to help evaluate its performance. Management
considers netbacks an important measure as it demonstrates its profitability
relative to current commodity prices. Management uses funds from operations to
analyze performance and considers it a key measure as it demonstrates the
Company's ability to generate the cash necessary to fund future capital
investments and to repay debt. Funds from operations is a non-GAAP measure and
has been defined by the Company as net earnings plus the addback of non-cash
items (depletion, depreciation and accretion, stock-based compensation, future
income taxes and unrealized gain/(loss) on risk management activities) and
excludes the change in non-cash working capital related to operating activities
and expenditures on asset retirement obligations. The Company also presents
funds from operations per share whereby amounts per share are calculated using
weighted average shares outstanding consistent with the calculation of earnings
per share. Delphi's determination of funds from operations may not be comparable
to that reported by other companies nor should it be viewed as an alternative to
cash flow from operating activities, net earnings or other measures of financial
performance calculated in accordance with Canadian GAAP. The Company has defined
net debt as the sum of long term debt plus/minus working capital excluding the
current portion of future income taxes and risk management asset/liability. Net
debt is used by management to monitor remaining availability under its credit
facilities. Cash operating costs have been defined as the sum of operating
expenses, transportation expenses, general and administrative expenses and
interest costs.
DELPHI'S OPERATIONS
What is the nature of Delphi's business and where are its operations?
Delphi Energy Corp. is a publicly-traded company, listed on the Toronto Stock
Exchange, engaged in the acquisition, exploration for and development and
production of crude oil, natural gas and natural gas liquids from properties
located in Western Canada. Delphi's operations are principally concentrated in
the Deep Basin of North West Alberta which represents 90 percent of its
production in 2010. The Company has four primary core areas in the Deep Basin
located at Bigstone, Hythe, Wapiti/Gold Creek and Tower Creek.
2010 ACCOMPLISHMENTS
What were the highlights of Delphi's operations in 2010?
Canadian natural gas prices continued to be challenging in 2010, increasing only
one percent from 2009, which was the lowest average price in the last ten years.
Delphi focused its exploitation efforts in its core areas in the Deep Basin of
North West Alberta and in particular on its strategic acquisitions from 2009,
with vertical and horizontal drilling operations emphasizing light oil and
liquids-rich natural gas opportunities. Hence, despite a marginal increase in
natural gas prices, the Company's operations resulted in another successful year
towards growing long-term value for its shareholders.
In 2010, the Company achieved numerous accomplishments as follows:
- achieved record average production with daily volumes of 8,086 barrels of oil
equivalent per day ("boe/d"), an increase of 19 percent compared to 2009;
- changed the production mix to approximately 24 percent crude oil and natural
gas liquids in the fourth quarter of 2010, up from 16 percent in the fourth
quarter of 2009, which contributed to higher operating and cash flow netbacks;
- generated funds from operations ("cash flow") of $61.3 million, an increase of
24 percent from the previous year;
- increased the cash flow netback by five percent to $20.75 per boe compared to
$19.81 per boe in 2009;
- reduced operating costs by 18 percent to $7.46 per boe in 2010 from $9.08 per
boe in the previous year;
- realized $16.1 million in hedging gains on commodity contracts;
- increased total proved reserves by 26 percent to 22.7 million boe and
increased total proved plus probable reserves by 26 percent to 34.5 million boe;
- increased yearly average production per share by six percent and increased
year-end reserves per share by 13 percent;
- drilled 36 (23.3 net) wells with an overall success rate of 97 percent;
- achieved average finding, development, acquisitions and dispositions costs of
$18.10 per proved boe and $14.94 per proved plus probable boe;
- generated a recycle ratio of 1.6 times on an operating netback of $24.36 per boe;
- issued 11.0 million common shares for gross proceeds of $30.3 million;
- increased the Company's credit facilities from $125.0 million to $140.0
million throughout the year providing $31.9 million of available credit and a
twelve month trailing net debt to funds from operations ratio of 1.8:1 at
December 31, 2010;
- reduced net debt per boe at December 31, 2010 on a proved and proved plus
probable basis for the fourth year in a row to $4.76 and $3.13 per boe,
respectively; and
- increased the Company's total undeveloped land holdings by 42 percent to
244,475 net acres as compared to December 31, 2009, at an average acquisition
cost in 2010 of approximately $72.00 per acre.
Cash flow for 2010 was $61.3 million or $0.57 per basic share, compared to $49.2
million or $0.59 per basic share in 2009. The growth in cash flow in 2010 over
2009 was primarily a result of the continued reduction in operating costs,
change in production mix towards higher netback crude oil and natural gas
liquids production and the continued benefit of the Company's risk management
program.
Operating costs before processing income were $0.9 million lower than the
previous year despite average production growth of 19 percent in 2010 compared
to 2009. The fixed costs associated with owned natural gas plant infrastructure,
field compression facilities and pipelines continue to be allocated over more
production volumes resulting in lower marginal costs of new production. The
Company continues to focus production growth in its core areas where operating
costs in 2010 were less than $6.00 per boe on a weighted average basis. The
Company's operating costs were reduced by $1.62 to $7.46 per boe in 2010, 18
percent lower than the previous year.
Light crude oil prices traded at an average 18 times the price of natural gas in
2010 and the Company's natural gas liquids traded at an average of 12 times the
price of natural gas. Consequently, there existed a significant difference in
realized netbacks between crude oil and natural gas liquids versus natural gas
production. To maintain a cash netback of at least $20.00 per boe, the Company
increased its capital focus on light oil and liquids-rich natural gas
opportunities in 2010. As a result of this effort, Delphi was able to increase
its liquids production mix throughout the year resulting in a fourth quarter of
2010 liquids ratio of 24 percent of production versus 16 percent in the fourth
quarter of 2009. The increased liquids production contributed to achieving a
cash netback of $20.75 per boe in 2010.
For the year ended December 31, 2010, the Company recognized approximately $16.1
million in realized gains on financial and physical hedging contracts providing
significant stability to the Company's cash flow. The Company realized 98
percent of these gains on approximately 19.3 million cubic feet per day hedged
at an average floor price of $6.27 per mcf with the remaining $0.3 million due
to hedging gains on crude oil contracts in 2010.
On June 3, 2010, the Company closed an equity offering of 11.0 million common
shares at $2.75 per share for gross proceeds of approximately $30.3 million (net
proceeds of $28.3 million). The net proceeds were initially used to reduce the
Company's net debt and subsequently funded an expanded capital program in the
second half of 2010.
The combination of the above highlighted items resulted in Delphi's financial
position continuing to remain strong at the end of 2010, providing the financial
flexibility to execute its 2011 capital program. At December 31, 2010, the
Company had net debt of $108.1 million on total credit facilities of $140.0
million, providing excess financial capacity of approximately $31.9 million. On
a 12 month trailing funds from operations basis, Delphi's net debt to cash flow
ratio was 1.8:1 and on a net debt to annualized fourth quarter funds from
operations basis it was 1.5:1. Net debt includes bank debt plus working capital
deficiency excluding the risk management asset/liability and the related current
future income taxes.
FINANCIAL STRATEGIES
Are there financial strategies the Company employs to achieve results and
forecast expectations?
The Company maintains an active risk management program as an integral part of
its overall financial strategy to mitigate volatility in cash flow resulting
from fluctuating commodity prices. Delphi's program involves executing numerous
contracts over a period of time to take advantage of the volatility in the
natural gas and light crude oil market. The strategy takes advantage of the
swings in prices as a result of a) the changes in demand/supply fundamentals
and/or b) the movement of significant financial assets invested in the market as
a pure commodity play. The transactions are generally undertaken for contract
terms 12 to 24 months in advance with financially strong counterparties and are
predominantly executed on a physical basis with the Company's natural gas
marketer. Delphi's risk management program consists of fixed price contracts,
costless collars, participating swaps and puts and calls which provide downside
protection. Costless collars, participating swaps and puts also provide the
opportunity to share in the upside if market prices increase above the floor
price. If market prices are above fixed price contracts or the ceiling price of
costless collars and calls, the Company would continue to achieve its downside
protection while realizing losses on these hedging contracts. Delphi has a
strategy of hedging approximately 40 to 50 percent of its production as long as
demand/supply fundamentals indicate volatile markets in the future.
Delphi continues to direct efforts at maintaining or reducing its controllable
costs. Increasing production at its operating fields which are processed through
Company owned infrastructure reduces facility fixed costs on a per boe basis and
improves netbacks. Field operators are encouraged to undertake preventative
maintenance on field infrastructure and wellsite equipment to minimize
production downtime and prevent significant operating costs associated with
major repairs. The Company strives to achieve improvement in its costs of
production and at a minimum maintain current production costs while growing
production.
Maintaining or improving strong operating netbacks per boe through the risk
management program and the control of costs associated with production
operations and corporate overhead, allows the Company to pursue its planned
capital program with greater confidence that financial flexibility will be
maintained while incurring capital expenditures to grow production volumes. The
risk management program has been and will continue to be an integral part of
maximizing operating netbacks during periods of price volatility and excess
natural gas supply.
As a result of the significant difference in netbacks between crude oil and
natural gas, the Company's capital expenditures have been allocated more towards
light oil and liquids-rich natural gas opportunities. By altering the Company's
production mix, there is greater certainty of achieving the Company's cash flow
expectations due to the higher netback crude oil and natural gas liquids
production.
The annual net capital expenditure program in the field will continue to
approximate forecast cash flow. Additional capital may be approved as a result
of opportunistic acquisitions, incremental cash flow from greater than expected
production growth, higher than forecast cash netbacks or other sources of
financing.
Delphi continues to be focused on reducing its leverage and improving its
financial flexibility through net debt reduction or increasing cash flow growth
resulting in a lower net debt to funds from operations ratio. The Company
continues to be focused on achieving its internal target range for this ratio of
1.3 to 1.5 times. In a low price environment, the Company's objective would be
to reduce or at least not increase the net debt balance by undertaking a capital
program within cash flow.
2011 OUTLOOK AND FORWARD-LOOKING INFORMATION
This management discussion and analysis contains forward-looking statements and
forward-looking information within the meaning of applicable securities laws.
The use of any of the words "expect", "anticipate", "continue", "estimate",
may", "will", "should", believe", "intends", "forecast", "plans", "guidance" and
similar expressions are intended to identify forward-looking statements or
information.
More particularly and without limitation, this management discussion and
analysis contains forward-looking statements and information relating to the
Company's risk management program, petroleum and natural gas production, future
funds from operations, capital programs, commodity prices, costs and debt
levels. The forward-looking statements and information are based on certain key
expectations and assumptions made by Delphi, including expectations and
assumptions relating to prevailing commodity prices and exchange rates,
applicable royalty rates and tax laws, future well production rates, the
performance of existing wells, the success of drilling new wells, the capital
availability to undertake planned activities and the availability and cost of
labour and services.
Although the Company believes that the expectations reflected in such
forward-looking statements and information are reasonable, it can give no
assurance that such expectations will prove to be correct. Since forward-looking
statements and information address future events and conditions, by their very
nature they involve inherent risks and uncertainties. Actual results may differ
materially from those currently anticipated due to a number of factors and
risks. These include, but are not limited to, the risks associated with the oil
and gas industry in general such as operational risks in development,
exploration and production, delays or changes in plans with respect to
exploration or development projects or capital expenditures, the uncertainty of
estimates and projections relating to production rates, costs and expenses,
commodity price and exchange rate fluctuations, marketing and transportation,
environmental risks, competition, the ability to access sufficient capital from
internal and external sources and changes in tax, royalty and environmental
legislation. Additional information on these and other factors that could affect
the Company's operations or financial results are included in reports on file
with the applicable securities regulatory authorities and may be accessed
through the SEDAR website (www.sedar.com). The forward-looking statements and
information contained in this MD&A are made as of March 15 for the purpose of
providing the readers with the Company's expectations for the coming year. The
forward-looking statements and information may not be appropriate for other
purposes. Delphi undertakes no obligation to update publicly or revise any
forward-looking statements or information, whether as a result of new
information, future events or otherwise, unless so required by applicable
securities laws.
Delphi's operational and financial expectations for 2011 are based upon the
Company's projection of drilling plans, drilling success and production results
and the estimated related revenues and associated costs of royalties,
transportation expenses, operating costs, general and administrative expenses
and interest costs. Commodity prices used in the determination of forecast
revenues are based upon general economic conditions, commodity supply and demand
forecasts and publicly available price forecasts. The Company continually
monitors its forecast assumptions to ensure the stakeholders are informed of
material variances from previously communicated expectations.
OPERATIONS
How many wells does Delphi expect to drill in 2011?
Delphi expects to drill 30 gross wells (23 net) in 2011 focussed in its core
areas of Bigstone, Hythe and Wapiti/Gold Creek. In Bigstone and Hythe, drilling
will primarily be horizontal wells directed at light oil opportunities in the
Cardium formation and Doe Creek formation, respectively. At Wapiti/Gold Creek,
the drilling will primarily be directed at vertical multi-zone opportunities
with the liquids-rich Nikinassin formation being the primary target. The factors
that may hinder Delphi from achieving its drilling plans include the
availability of drilling rigs and equipment needed at the drill site, timely
receipt of well licenses and permits and approval by the landowners for surface
access to the location.
What are the Company's production expectations?
Delphi expects production from crude oil, natural gas and natural gas liquids to
average between 8,800 to 9,200 boe/d in 2011, up 11 percent from 2010. The
production mix is expected to be approximately 27 percent light oil and
liquids-rich natural gas in 2011, compared to 20 percent in 2010, as the capital
program focuses on light oil and liquids-rich natural gas drilling
opportunities. These production and sales mix expectations may not be achieved
if decline rates are greater than expected, the new wells do not perform as
expected, drilling plans are delayed for the reasons outlined above, completion
and tie-in of new wells is delayed due to weather or the unavailability of the
required service equipment in the field, mechanical failure of field equipment,
delays in accessing production facilities or additional waiting time for any
approvals.
REVENUES
What does the Company project for crude oil and natural gas prices in 2011?
Natural Gas
United States natural gas prices are commonly referenced to the New York
Mercantile Exchange Henry Hub in Louisiana (NYMEX) while Canadian natural gas
prices are typically referenced to the Canadian Alberta Energy Company
interconnect with the TransCanada Alberta system (AECO). Natural gas prices are
primarily influenced by North American, rather than global, supplies of natural
gas versus domestic demand for winter heating and summer cooling requirements.
However, with the growth in natural gas liquefaction and regasification
facilities around the world this North American supply and demand balance is
subject to disruption from time to time, primarily in periods of a shortfall in
supply. In addition, multi-stage fracturing technology has unlocked the
significant natural gas resource potential of numerous shale basins in North
America capable of initially producing at very high rates of natural gas.
For forecasting purposes, Delphi continues to expect a challenging natural gas
market for 2011 as a result of the high rig count in the United States directed
at horizontal drilling using multi-stage fracturing technology into the shale
gas plays. The Company has prepared its 2011 expectations based on an average
AECO price of $4.00 per million cubic feet.
Crude Oil
West Texas Intermediate at Cushing, Oklahoma (WTI) is the benchmark reference
for North American crude oil prices. Canadian crude oil prices are based upon
postings, primarily at Edmonton, Alberta and represent the WTI price adjusted
for quality and transportation differentials as well as the Canadian/United
States ("Cdn/US") dollar exchange rate. The fundamental supply/demand equation
for crude oil is more balanced on a daily basis than natural gas due to
consistent demand for crude oil of approximately 88 million barrels per day to
meet the global requirement for energy. The price of crude oil can also be
influenced significantly by geopolitical events in the major oil exporting
countries of the world and the strength or weakness of the global economies.
Delphi anticipates WTI to average U.S. $85.00 per barrel in 2011, based on a
balanced equation of supply and demand fundamentals supporting strengthening
world economies.
Canadian/United States Exchange Rate
Both crude oil and natural gas prices in Canada are premised on the U.S. dollar
price for each product adjusted for the Cdn/US dollar exchange rate and quality
and transportation differentials. The strength or weakness of the Canadian
dollar versus the U.S. dollar will largely reflect the global demand for raw
materials, particularly metals, minerals and crude oil. The global financial
markets tolerance for risk and its need for financial security in the form of
holding U.S dollars will also have an effect on the value of the Canadian dollar
against the U.S. dollar. Delphi believes the Canadian dollar will remain quite
strong relative to the U.S. dollar in 2011 as global economies recover from the
slowdown since 2008.
The Canadian dollar is expected, on average, to trade at parity with the U.S.
dollar in 2011. The exchange rate is influenced by many variables which will
continue to result in significant volatility.
Has Delphi undertaken any hedges for 2011 to mitigate the risk of volatility in
its product pricing?
In light of the low natural gas prices over the past two years and a future
outlook which has resulted in the forward price curve for natural gas to
decrease based on the view that there is more than an ample supply of natural
gas with the development of the shale gas plays, particularly in the United
States, Delphi has become more focused on protecting the downside of prices as
opposed to locking in gains to be made on unusually high prices. Currently,
Delphi has hedged approximately 52 percent of its before-royalty natural gas
production at a predominantly AECO based average floor price of $4.93 per mcf
for 2011. This compares to the forward strip commodity price for AECO of $3.52
per mcf for the remainder of 2011 as of February 25, 2010. Delphi continually
monitors the variables affecting the price of natural gas and crude oil in order
to ensure its capital program is in line with expected funds from operations.
The following natural gas hedges are in place to support the Company's cash
flow.
Jan-Mar Apr-Sep Oct-Dec Total
2011 2011 2011 2011
----------------------------------------------------------------------------
Production hedged (mmcf/d) 16.1 23.5 17.2 20.1
Percentage of natural gas production (1) 41% 60% 44% 52%
Price floor (Cdn $/mcf) $5.24 $4.77 $4.90 $4.93
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) based on 39 mmcf/d
The Company also has executed a call option at U.S. $90.00 on 600 bbls/d for
January 1, 2011 to December 31, 2012. The fair value of outstanding natural gas
contracts is estimated to be a gain of approximately $5.2 million with a loss of
approximately $6.8 million on outstanding crude oil contracts as of February 25,
2010.
ROYALTIES
What average royalty rate does Delphi expect to pay in 2011?
The Company pays royalties to provincial governments, individuals and companies
that own surface and/or mineral rights. These payments take the form of Crown,
freehold and overriding royalties. Crown royalty rates for crude oil and natural
gas are generally calculated on a sliding scale based on commodity prices and
production rates whereas freehold and overriding royalty rates are generally a
fixed percentage of revenue. Crown royalty rates can change due to price
fluctuations or changes in production volumes on a well by well basis subject to
minimum and maximum rates. For natural gas liquids, Crown royalty rates are a
fixed percentage of revenue with the rate varying according to the nature of the
product. Crown royalty credits are received from the Crown and represent the fee
earned by the owners of natural gas processing infrastructure to process the
Crown's royalty share of natural gas. Freehold royalties are paid on freehold
lands and overriding royalties are generally payable on lands where the Company
has earned an interest in the lands through a farm-in, whether the lands are
Crown or freehold. Royalties are not affected by gains or losses realized
through the Company's risk management program.
For 2011, Delphi expects its royalty rate, after the deduction for royalty
credits, will average between 15 to 17 percent of gross revenue, excluding
realized and unrealized gains or losses from its risk management program.
TRANSPORTATION EXPENSES AND OPERATING COSTS
Will Delphi be able to further reduce its costs of production in 2011?
Transportation expenses are costs incurred by the Company to transport its
production volumes from the wellhead to the point of sales. In British Columbia,
infrastructure is owned by Spectra Energy that enables natural gas producers to
avoid facility construction in exchange for regulated gathering, processing and
transmission fees. This all-in charge is included in transportation expenses.
Delphi expects its transportation expenses to be approximately $2.75 per boe in
2011. Transportation expenses are subject to the availability of pipeline
capacity on an interruptible basis in areas of significant production growth by
industry.
Operating costs have been trending downward over the past several years as
Delphi focuses its capital program and achieves growth in its core areas of
Bigstone, Hythe and Wapiti/Gold Creek, all areas with an operating cost
structure of less than $6.00 per boe. As production grows and fixed area costs
are allocated over increased production volumes, the marginal cost of the
incremental production is expected to be less than field average operating cost.
In 2011, Delphi will also realize the full year benefit of the 2010 disposition
of very high operating cost production in East Central Alberta.
The costs of production may be more than expected in periods of very high
industry activity causing considerable competition and rising prices for general
oilfield services and equipment. Further reductions in operating costs are
anticipated in 2011, down to an estimated $7.10 per boe.
GENERAL & ADMINISTRATIVE AND INTEREST COSTS
What are the Company's overhead costs for personnel and financing?
Delphi believes it is adequately staffed to grow the Company's production in
excess of 12,000 boe/d. In 2011, Delphi anticipates its general and
administrative costs, net of capitalized amounts, to be approximately $1.80 per
boe. A high level of industry activity may cause an increase in general and
administrative expenses due to higher than expected employee costs to retain
employees and to hire new employees and general cost inflation.
Interest costs will be dependent on market rates and credit spreads for the oil
and gas sector and will be a function of the general economic conditions in
Canada. If the economy is viewed as growing too fast, which may result in
inflation, interest rates may be increased to slow down the pace of growth in
the economy. Interest costs may also increase if cash flow from operations is
less than expected and bank debt is used to fund a larger portion of the capital
program than originally anticipated. Interest expense is expected to be $1.60
per boe in 2011.
CAPITAL PROGRAM AND NET DEBT LEVELS
What are the Company's forecast capital expenditures and net debt levels for 2011?
In 2011, Delphi anticipates a field capital program between $70.0 and $80.0
million resulting in net debt levels between $110.0 and $120.0 million by the
end of 2011. Growth in cash flow to approximately $65.0 million is expected to
result in a net debt to cash flow ratio of approximately 1.8:1 at the end of
2011.
As in prior years, net debt is expected to increase in the first quarter of 2011
as a result of a winter capital program greater than cash flow with net debt
being reduced in the second quarter as capital expenditures are expected to be
minimal due to spring breakup. The significant excess cash flow generated in the
second quarter will be applied against net debt. Capital expenditures for the
second half of the year will be planned according to the cash flow generated and
achieving net debt targets.
BUSINESS ENVIRONMENT
What external factors of the business environment did the Company have to
contend with in 2010?
The price the Company receives for its production volumes is a significant
determinant of the Company's cash flow. The table below outlines the changes in
the various benchmark commodity prices and economic parameters which affect the
prices received for the Company's production.
Benchmark Prices and Economic Parameters
Three Months Ended Three Months Ended
December 31 December 31
% %
2010 2009 Change 2010 2009 Change
----------------------------------------------------------------------------
Natural Gas
NYMEX (US $/mmbtu) 3.81 4.19 (9) 4.38 3.90 12
AECO (CDN $/mcf) 3.64 4.49 (19) 4.00 3.96 1
Crude Oil
West Texas Intermediate
(US $/bbl) 85.17 76.17 12 79.55 61.93 28
Edmonton Light (CDN $/bbl) 80.32 76.54 5 77.48 66.02 17
Foreign Exchange
Canadian to U.S. dollar 1.01 1.06 (4) 1.03 1.14 (10)
U.S. to Canadian dollar 0.99 0.95 4 0.97 0.88 10
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Natural Gas
In January, 2010, the AECO price for natural gas was range bound between Cdn.
$5.25 and $5.75 per mcf in anticipation of normal withdrawals of natural gas
from storage to meet winter heating demand. In late January, however, natural
gas prices began to decrease and continued to do so through the remainder of the
quarter as natural gas drilling activity was increasing and the primary
geographical areas for natural gas demand during the winter heating season began
experiencing above average temperatures. In addition, U.S. industrial demand
continued to be reduced due to the economic slowdown.
In the second quarter of 2010, natural gas prices followed the cyclical trend,
decreasing further as winter heating demand ended and natural gas production was
placed into storage to meet the upcoming winter's heating demand.
Throughout the summer months, natural gas prices continued declining as summer
cooling demand for natural gas was more than offset by domestic natural gas
production in the United States with excess production being placed into storage
to meet the coming winter's heating demand. Industrial demand was recovering but
not at a rate significant enough to alleviate the ample supply of natural gas
which continued to adversely affect the view of supply and demand fundamentals
putting additional downward pressure on natural gas prices in the short to
medium term.
In the fourth quarter of 2010, Cdn. natural gas prices rebounded from the lows
of approximately $3.15 per mcf to $4.20 per mcf in anticipation of winter
weather for the coming months. With more than adequate natural gas in storage to
meet heating demand requirements, Cdn. prices in the fourth quarter were $0.85
per mcf lower than the fourth quarter of 2009.
The overall drop in natural gas prices for the year had a significant effect on
the active drilling rig count in both Canada and the United States but this
reduced rig count has not had a significant effect on U.S. natural gas supply
and hence storage levels in the United States. Natural gas production failed to
decrease in a manner consistent with historical declines associated with reduced
drilling activity. Reduced overall drilling for natural gas was more than offset
by drilling horizontally into initially higher productivity non-conventional
formations, particularly shale gas.
AECO gas prices hit a low of $3.12 per mcf in October of 2010 but only recovered
to over $4.00 per mcf by the end of the year. AECO averaged $4.00 per mcf in
2010, one percent higher than the previous year.
Crude Oil
Through the first three quarters of 2010, the price for crude oil averaged
between U.S. $75.00 and U.S. $80.00 per barrel as the global demand for oil
continued to stabilize around the world. The U.S. based price for crude oil was
affected by several factors over that time period including the decline in the
value of the U.S. dollar compared to the currency of most of its major trading
partners and the global demand for oil due to concerns over the global economic
recovery in light of government deficits throughout parts of Europe.
In the fourth quarter of 2010, the price of crude oil averaged U.S. $85.17 per
barrel as the economies of the developing countries continued to grow at an even
stronger pace and the concerns over the European deficit crisis, while not
resolved, subsided as the issues were being addressed. WTI averaged U.S. $79.55
per barrel in 2010, an increase of 28 percent over the previous year.
Canadian/United States Exchange Rate
In 2010, the general trend for the value of the Canadian dollar against its U.S.
counterpart was that of a stronger Canadian dollar. As a producer of crude oil,
a stronger Canadian dollar has a negative effect on the price received for
production. The exchange rate volatility was affected by the financial markets
demand for the United States dollar as a safe haven in these uncertain economic
times. The Cdn/US exchange rate varied from a high of $1.08 early in 2010 to a
low of $0.99 later in the year. This negative effect to the price of oil for
Canadian producers was compounded by a widening basis differential between U.S.
and Canadian markets. In 2010, Canadian crude oil prices averaged $77.48 per
barrel compared to $66.02 per barrel in 2009, a 17 percent increase over the
previous year.
Industry Cost of Services
The increase in crude oil prices and unchanged average natural gas prices
throughout 2010 had a negative effect on industry cash flow available for
capital programs. Drilling contractors and oilfield service companies, however,
became very busy due to the high crude oil prices and the demand to drill
horizontal oil and natural gas wells using multi-stage fracturing technology.
Natural gas drilling focused on liquids-rich natural gas opportunities and high
deliverability natural gas wells in the Canadian shale gas plays, predominantly
the Montney formation. In the latter half of 2010, the high crude prices and
horizontal drilling activity resulted in pricing pressure on drilling equipment
capable of completing these types of operations. Completion services also
tightened up as more and more horizontal drilling was undertaken with the
intention of completing the wells using multi-stage fracturing technology.
2010 OPERATIONAL AND FINANCIAL RESULTS
DRILLING OPERATIONS
How active was Delphi in its drilling program in 2010 and where was the drilling
focused?
The Company had another successful year in 2010 drilling 36 gross (23.3 net)
wells with a success rate of 97 percent. The drilling was primarily focused on
the core properties of Bigstone, Hythe and Wapiti/Gold Creek in North West
Alberta. In light of decreasing natural gas prices experienced after the first
quarter of 2010, the Company focused its efforts on drilling light oil and
liquids-rich natural gas opportunities for the remainder of the year.
Three Months Ended Twelve Months Ended
December 31, 2010 December 31, 2010
Gross Net Gross Net
----------------------------------------------------------------------------
Natural gas wells 4.0 2.3 19.0 13.5
Oil wells 4.0 2.0 16.0 9.5
Dry holes - - 1.0 0.3
----------------------------------------------------------------------------
Total wells 8.0 4.3 36.0 23.3
Success rate (%) 100 100 97 99
----------------------------------------------------------------------------
----------------------------------------------------------------------------
CAPITAL INVESTED
How much did the Company spend in 2010 and where were the capital expenditures
incurred?
The Company continued to direct its capital program at its core areas in North
West Alberta to take advantage of the multi-zone nature of these assets, low
production operating costs and quick on-stream capability associated with owned
gathering and processing infrastructure. Total capital invested in the field was
$105.8 million, net of drilling credits of $5.9 million, with approximately 78
percent directed at drilling and completion operations and 11 percent incurred
on equipping and facility projects. Approximately $3.7 million of the capital
incurred in the fourth quarter related to the start of the 2011 winter drilling
program.
In prior years, Delphi generally acquired its undeveloped land as part of its
asset acquisition strategy. In 2010, the Company has been more active at Crown
land sales, acquiring undeveloped land in the Deep Basin of North West Alberta,
primarily focused in its core areas of Bigstone, Hythe and Wapiti/Gold Creek. In
2010, Delphi acquired 50,566 net acres in these areas. Delphi also added to its
growth potential with the acquisition of 50,848 net acres of Duvernay shale
rights at an attractive entry cost targeting light oil. Delphi's inventory of
undeveloped land has increased to approximately 244,475 net acres, up 42 percent
from December 31, 2009. In 2010, the Company incurred $7.3 million on land,
primarily at Crown land sales.
During the second quarter, the Company disposed of its non-core properties in
East Central Alberta for $0.3 million. The properties consisted of medium
quality oil and natural gas production with operating costs in excess of $30.00
per boe. With the disposition, the Company benefits from a reduction in total
operating costs per boe and the reduction of asset retirement obligations
associated with the properties of approximately $1.9 million.
Three Months Ended Twelve Months Ended
December 31 December 31
% %
2010 2009 Change 2010 2009 Change
----------------------------------------------------------------------------
Land 1,173 (155) - 7,316 828 784
Seismic 116 (11) - 462 369 25
Drilling and
completions 17,228 5,803 197 82,062 21,327 285
Equipping and
facilities (985) 1,198 - 11,281 6,789 66
Capitalized
expenses 1,468 1,579 (7) 4,480 4,202 7
Other (686) 28 - 190 431 (56)
----------------------------------------------------------------------------
Capital invested 18,314 8,442 117 105,791 33,946 212
Disposition of
properties - (10,765) 100 (247) (20,718) (99)
----------------------------------------------------------------------------
Net capital
invested 18,314 (2,323) - 105,544 13,228 698
Acquisition of
properties (369) 11,422 - 18 30,873 (100)
Acquisition of
Fairmount Energy Inc. - 16,014 (100) - 16,014 (100)
----------------------------------------------------------------------------
Total capital
invested 17,945 25,113 (29) 105,562 60,115 76
----------------------------------------------------------------------------
----------------------------------------------------------------------------
PRODUCTION
What factors contributed to the 19 percent growth in production volumes and the
success in growing oil and natural gas liquids volumes?
Production for the twelve months ended December 31, 2010 averaged 8,086 boe/d
representing an increase of 19 percent over the comparative period due to the
successful drilling and optimization programs at Bigstone, Hythe and Wapiti/Gold
Creek. With the weakness in natural gas pricing, Delphi's 2010 drilling program
targeted opportunities in its crude oil and liquids-rich natural gas inventory
to maximize netbacks. For the twelve months ended December 31, 2010, production
growth is highlighted by a 57 percent increase in crude oil and natural gas
liquids compared to 2009. A significant undeveloped land base, multi-zone
potential and the successful application of emerging technologies continue to
provide material growth opportunities in existing and new play concepts.
The Company's production portfolio for the year was weighted 80 percent to
natural gas, 12 percent to crude oil and eight percent to natural gas liquids.
Three Months Ended Twelve Months Ended
December 31 December 31
2010 2009 % Change 2010 2009 % Change
----------------------------------------------------------------------------
Natural gas
(mcf/d) 38,918 34,626 12 38,816 34,673 12
Crude oil (bbls/d) 1,147 630 82 950 525 81
Natural gas
liquids (bbls/d) 906 487 86 667 504 32
----------------------------------------------------------------------------
Total (boe/d) 8,539 6,888 24 8,086 6,808 19
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Crude oil production was 81 percent higher than the previous year. The increase
in oil production is due to the successful horizontal drilling targeting Cardium
light oil at Bigstone and the Doe Creek light oil at Hythe.
Natural gas liquids were 32 percent higher for the year primarily due to the
increased natural gas liquids production in the Wapiti/Gold Creek area where the
Company has been successfully drilling multi-zone vertical wells with the
Nikanassin formation as the primary target.
REALIZED SALES PRICES
What were the sales prices realized by the Company for each of its products?
For the three and twelve months ended December 31, 2010, Delphi's risk
management program realized a gain of $4.0 million and $16.1 million,
respectively. For the quarter, the realized gain was $1.13 per mcf with physical
contracts contributing a gain of $0.92 per mcf and financial contracts
contributing a gain of $0.21 per mcf. For the twelve months ended December 31,
2010, the average realized natural gas price was ten percent less than the
comparative period due to a decrease in hedge gains offset by higher heat
content and marketing arrangements on natural gas volumes.
Three Months Ended Twelve Months Ended
December 31 December 31
% %
2010 2009 Change 2010 2009 Change
----------------------------------------------------------------------------
AECO ($/mcf) 3.64 4.49 (19) 4.00 3.96 1
Heating content
and marketing
($/mcf) 0.23 0.25 (9) 0.33 0.26 27
Gain on physical
contracts ($/mcf) 0.92 1.32 (30) 0.90 1.57 (43)
Gain on financial
contracts ($/mcf) 0.21 0.09 130 0.22 0.28 (21)
----------------------------------------------------------------------------
Realized natural
gas price ($/mcf) 5.00 6.15 (19) 5.45 6.07 (10)
Edmonton Light
($/bbl) 80.32 76.54 5 77.48 66.02 17
Gain (loss) on
financial
contracts ($/bbl) (0.56) - - 0.82 - -
Quality
differential
($/bbl) (3.18) (2.41) 32 (1.67) (2.15) (22)
----------------------------------------------------------------------------
Realized oil price
($/bbl) 76.58 74.13 3 76.63 63.87 20
Realized natural
gas liquids price
($/bbl) 51.43 53.02 (3) 53.66 48.50 11
----------------------------------------------------------------------------
Total realized
sales price
($/boe) 38.79 41.50 (7) 39.71 39.50 1
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Delphi's oil production has changed from a mix of light and medium oil to
predominantly light oil therefore the Company's average price for crude oil,
since mid 2010, will generally fluctuate with the change in the benchmark crude
oil prices. With the disposition of the East Central Alberta properties in the
second quarter of 2010, increased production of light oil at Bigstone and Hythe
continues to high grade the Company's quality of crude oil resulting in pricing
more reflective of light oil. The Company's realized crude oil and natural gas
liquids prices were significantly higher than the comparative year as a result
of the increase in benchmark prices, the reduction in quality differential and
gains on risk management contracts.
How do the realized natural gas prices compare to the benchmark AECO pricing?
Excluding hedges, the Company continues to receive higher than the AECO spot
price on natural gas sales due to the high heating content of its natural gas
production and the sale of approximately 5,5 million British thermal units
(mmbtu) per day on the Alliance pipeline which is priced at the Chicago Monthly
Index.
The following table outlines the premium Delphi realized on its natural gas
price compared to the average quarterly AECO price due to the risk management
program, quality of production and gas marketing arrangements. In years of both
high and low commodity price environments, Delphi's realized sales price has
been a premium to AECO.
Dec. 31 Sep. 30 Jun. 30 Mar. 31 Dec. 31 Sept. 30 Jun. 30 Mar. 31
2010 2010 2010 2010 2009 2009 2009 2009
----------------------------------------------------------------------------
Natural Gas
Price
Delphi
realized
($/mcf) 5.00 5.28 5.30 6.26 6.15 5.77 5.81 6.55
AECO average
($/mcf) 3.64 3.54 3.89 4.96 4.49 2.94 3.47 4.95
Premium to
AECO 37% 49% 36% 26% 37% 96% 67% 32%
Hedging gain
($000's) 4,045 4,676 4,186 2,941 4,498 7,973 6,997 3,991
----------------------------------------------------------------------------
RISK MANAGEMENT ACTIVITIES
What is Delphi's risk management strategy and what contracts are in place to
mitigate the risk of volatility?
Delphi enters into both financial and physical commodity contracts as part of
its risk management program to manage commodity price fluctuations designed to
ensure sufficient cash is generated to fund its capital program particularly
when commodity prices are extremely volatile. For natural gas production, Delphi
has hedged approximately 52 percent of its before-royalty natural gas production
at a predominately AECO based average floor price of $4.93 per mcf for 2011.
With respect to financial contracts, which are derivative financial instruments,
management has elected not to use hedge accounting and consequently records the
fair value of its natural gas financial contracts on the balance sheet at each
reporting period with the change in the fair value being classified as
unrealized gains and losses in the statement of operations. Physical commodity
sale contracts based in U.S. dollars include an embedded derivative associated
with the foreign exchange rate. Due to this derivative, the changes in the fair
value of these contracts are included in the statement of earnings.
The Company has fixed the price applicable to future production through the
following contracts.
Contract
Type of Quantity Price
Time Period Commodity Contract Contracted ($/unit)
----------------------------------------------------------------------------
January 2010 - March 2011 Natural Gas Physical 1,500 GJ/d $5.74 fixed
January 2010 - March 2011 Natural Gas Financial 2,000 GJ/d $5.72 fixed
April 2010 - March 2011 Natural Gas Physical 3,000 GJ/d $6.12 fixed
April 2010 - March 2011 Natural Gas Physical 2,500 GJ/d $5.73 fixed
January 2011 - December 2011 Natural Gas Physical 2,500 GJ/d $3.79 fixed
January 2011 - December
2011(1) Natural Gas Financial 2,500 GJ/d $7.14 Call
January 2011 - December
2011(3) Natural Gas Financial 3,000 GJ/d $4.00 Put
January 2011 - December
2011(4) Natural Gas Physical 2,500 GJ/d $4.12 fixed
January 2011 - December U.S.
2012(2) Crude Oil Financial 600 bbls/d $90.00 Call
April 2011 - October 2011 Natural Gas Physical 2,000 GJ/d $5.66 fixed
April 2011 - October 2011 Natural Gas Physical 4,000 GJ/d $3.80 fixed
April 2011 - October 2011 Natural Gas Financial 2,000 GJ/d $3.82 fixed
April 2011 - October 2011 Natural Gas Financial 2,000 GJ/d $3.79 fixed
April 2011 - December 2011(2) Natural Gas Financial 6,810 GJ/d $5.69 fixed
January 2012 - December
2012(3) Natural Gas Financial 3,000 GJ/d $4.50 Call
January 2012 - December
2012(4) Natural Gas Physical 2,500 GJ/d $4.50 Call
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) The Company had a natural gas put contract at $4.75 per gigajoule on
2,500 gigajoules per day for the period April 1, 2010 through October
31, 2010. This put was paid for with the sale of a natural gas call on
2,500 gigajoules per day at a price of $7.14 per gigajoule for the
period January 1, 2011 through December 31, 2011.
(2) The Company has acquired a natural gas contract at $5.69 per gigajoule
on 6,810 gigajoules per day for the period April 1, 2011 through
December 31, 2011. This contract was paid for with the sale of a crude
oil call on 600 barrels per day at a price of U.S. $90.00 WTI per barrel
for the period January 1, 2011 through December 31, 2012.
(3) The Company has acquired a natural gas put contract at $4.00 per
gigajoule on 3,000 gigajoules per day for the period January 1, 2011
through December 31, 2011. This put was paid for with the sale of a
natural gas call on 3,000 gigajoules per day at a price of $4.50 per
gigajoule for the period January 1, 2012 through December 31, 2012.
(4) The Company has acquired a natural gas contract at $4.12 per gigajoule
on 2,500 gigajoules per day for the period January 1, 2011 through
December 31, 2011. This contract was paid for with the sale of a natural
gas call on 2,500 gigajoules per day at a price of $4.50 per gigajoule
for the period January 1, 2012 through December 31, 2012.
The Company recognized an unrealized loss on its financial contracts of $1.1
million in 2010. The fair values of these contracts are based on an
approximation of the amounts that would have been paid to or received from
counterparties to settle the contracts outstanding at the end of the period
having regard to forward prices and market values provided by independent
sources. Due to the inherent volatility in commodity prices, actual amounts
realized may differ from these estimates.
The Company accounts for its Canadian dollar physical sales contracts, which
were entered into and continue to be held for the purpose of delivery of
production, in accordance with its expected sale requirements as executory
contracts on an accrual basis rather than as non-financial derivatives.
REVENUE
How do revenues in 2010 compare to 2009 and what factors contributed to the change?
For the three and twelve months ended December 31, 2010, Delphi generated
revenue of $30.5 million and $117.2 million, respectively, representing an
increase of 16 percent and 19 percent over the comparative periods. The increase
in revenue is a result of an increase in production volumes. Contributing to the
increased price per boe is the increase in production of crude oil and natural
gas liquids.
The risk management program associated with natural gas and crude oil pricing
generated revenue of $16.1 million in 2010. For nine consecutive quarters,
Delphi has received a significant premium to AECO pricing primarily due to the
success of the risk management program.
What is the breakdown of revenues by product and the overall contribution to
revenue of the risk management program?
Delphi is predominantly a natural gas producer due to the nature and location of
its assets. Hence 52 percent of the Company's revenue for the year was from
natural gas sales at market prices, crude oil represented 22 percent and natural
gas liquids contributed 11 percent. The risk management program associated with
natural gas and crude oil pricing generated revenue of $16.1 million in 2010 or
14 percent of total revenues.
Three Months Ended Twelve Months Ended
December 31 December 31
2010 2009 % Change 2010 2009 % Change
----------------------------------------------------------------------------
Natural gas 13,848 15,093 (8) 61,352 53,363 15
Natural gas
physical contract
gains 3,303 4,218 (22) 12,705 19,913 (36)
Crude oil 8,140 4,239 92 26,287 12,238 115
Natural gas liquids 4,287 2,376 80 13,063 8,922 46
Sulphur 214 91 135 365 182 101
Realized gain on
risk management
contracts 683 280 144 3,427 3,546 (3)
----------------------------------------------------------------------------
Total 30,475 26,297 16 117,199 98,164 19
----------------------------------------------------------------------------
----------------------------------------------------------------------------
ROYALTIES
What were royalty costs in 2010?
In 2010, the Company paid Crown, freehold and gross overriding royalties. Crown
royalties of $15.8 million were partially offset by $5.9 million of royalty
credits for processing the Crown's share of natural gas with the net amount of
$9.9 million representing 69 percent of the total royalties paid in 2010
compared to 76 percent in 2009. The net Crown royalties increased in 2010
compared to 2009 primarily as a result of higher commodity prices in 2010 and
the Company's significant increase in crude oil and natural gas liquids
production.
Freehold royalties were $0.2 million in 2010 compared to $0.4 million in 2009.
Freehold royalties represent one percent of the total royalties paid versus four
percent in 2009 and are much lower than the previous year due to the disposition
of the properties in East Central Alberta in the second quarter of 2010.
Gross overriding royalties represented 30 percent of total royalties in 2010
compared to 20 percent in 2009. The increase in gross overriding royalties to
$4.4 million in 2010 compared to $1.8 million in 2009 is primarily a result of
the five percent gross overriding royalty granted on the Bigstone property late
in 2009 as well as various farm-in transactions undertaken by the Company.
Three Months Ended Twelve Months Ended
December 31 December 31
2010 2009 % Change 2010 2009 % Change
----------------------------------------------------------------------------
Crown royalties 3,416 3,316 3 15,843 14,134 12
Royalty credits (1,589) (1,863) (15) (5,963) (7,337) (19)
----------------------------------------------------------------------------
Crown royalties -
net 1,827 1,453 26 9,880 6,797 45
Freehold royalties (3) 91 - 167 361 (54)
Gross overriding
royalties 1,070 1,016 5 4,373 1,824 140
----------------------------------------------------------------------------
Total 2,894 2,560 13 14,420 8,982 61
Per boe 3.68 4.04 (9) 4.89 3.61 35
----------------------------------------------------------------------------
----------------------------------------------------------------------------
What were the average royalty rates paid on production in 2010?
The average royalty rates were not significantly different than the previous
year. Crown royalty rates were virtually unchanged as a result of a minimal
change in benchmark natural gas prices from year to year. Overriding royalties
increased primarily as a result of the overriding royalty granted late in 2009.
Three Months Ended Twelve Months Ended
December 31 December 31
2010 2009 % Change 2010 2009 % Change
----------------------------------------------------------------------------
Crown rate - net
of royalty credits 6.9% 6.7% 3 9.8% 9.1% 7
Gross overriding
rate 4.0% 4.7% (13) 4.3% 2.4% 77
Average rate 10.9% 11.7% (7) 14.3% 12.0% 19
----------------------------------------------------------------------------
----------------------------------------------------------------------------
The royalty rate calculations above exclude gains or losses on risk management
activities from revenue as the denominator.
OPERATING EXPENSES
How has the Company been able to reduce its operating expenses in 2010 as
compared to 2009?
Operating costs on a per boe basis for the twelve months ended December 31,
2010, decreased 18 percent over the comparative year. The decrease is attributed
to lower field operating costs as well as increased volumes from the cost
efficient core areas of Hythe, Wapiti/Gold Creek and Bigstone. The Company
accumulated new and additional infrastructure in its core areas during 2009
which will allow for lower per boe operating costs as production volumes
continue to increase. Additionally, the disposition of the East Central Alberta
properties in the second quarter of 2010 provided a decrease in absolute costs.
Operating costs in the fourth quarter of 2010 were $5.88 per boe which
represents a 13 percent decrease over the $6.76 per boe experienced in 2009. The
fourth quarter reduction can be attributed to increased operating efficiencies
as well as favorable prior period adjustments for natural gas plant
equalizations which decreased operating costs by $1.25 per boe in the fourth
quarter. Excluding the favorable prior period adjustments, Delphi's corporate
operating costs in the fourth quarter were $7.12 per boe.
The Company earns processing income on third party production volumes going
through facilities owned by Delphi. The processing income represents a reduction
of the Company's costs to operate these facilities and hence is deducted in
determining operating expenses. Processing income indicates the Company has
excess capacity at its facilities which it can access to handle growth in its
production volumes.
Three Months Ended Twelve Months Ended
December 31 December 31
2010 2009 % Change 2010 2009 % Change
----------------------------------------------------------------------------
Production costs 5,351 4,856 10 24,558 25,443 (3)
Processing income (735) (571) 29 (2,545) (2,892) (12)
----------------------------------------------------------------------------
Total 4,616 4,285 8 22,013 22,551 (2)
Per boe 5.88 6.76 (13) 7.46 9.08 (18)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
TRANSPORTATION EXPENSES
Three Months Ended Twelve Months Ended
December 31 December 31
2010 2009 % Change 2010 2009 % Change
----------------------------------------------------------------------------
Total 2,089 1,499 39 8,908 6,739 32
Per boe 2.66 2.37 12 3.02 2.71 11
----------------------------------------------------------------------------
----------------------------------------------------------------------------
What factors contributed to the increase in transportation costs in 2010?
On a per boe basis, transportation costs for the three and twelve months ended
December 31, 2010, increased by 12 percent and 11 percent, respectively, over
the comparative periods. The increase in transportation costs is attributed to
additional transportation capacity acquired in the latter half of 2009 which
will be utilized as production volumes grow in core areas and the increased cost
associated with trucking the Company's growth in crude oil volumes.
GENERAL AND ADMINISTRATIVE
Three Months Ended Twelve Months Ended
December 31 December 31
2009 % Change 2009 % Change
----------------------------------------------------------------------------
General and
administrative
costs 3,721 4,475 (17) 12,191 12,123 1
Overhead
recoveries (497) (261) 90 (1,940) (888) 118
Salary
allocations (1,636) (2,033) (20) (4,720) (5,447) (13)
----------------------------------------------------------------------------
Net 1,588 2,181 (27) 5,531 5,788 (4)
Per boe 2.02 3.44 (41) 1.87 2.33 (20)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
How do general and administrative costs in 2010 compare to 2009?
On a per boe basis, general and administrative (G&A) costs for the twelve months
ended December 31, 2010 decreased 20 percent over the comparative period in 2009
due to an increase in production volumes. Delphi is committed to delivering
strong growth and believes a strong team is paramount to achieve this goal.
STOCK-BASED COMPENSATION
What is stock-based compensation expense?
Stock-based compensation expense is the amortization over the vesting period of
the fair value of stock options granted to employees, directors and key
consultants of the Company. The fair value of all options granted is estimated
at the date of grant using the Black-Scholes option pricing model.
Three Months Ended Twelve Months Ended
December 31 December 31
2010 2009 % Change 2010 2009 % Change
----------------------------------------------------------------------------
Stock-based
compensation 325 301 8 1,457 1,467 (1)
Capitalized costs (130) (161) (19) (467) (852) (45)
----------------------------------------------------------------------------
Net 195 140 39 990 615 61
Per boe 0.25 0.22 13 0.34 0.25 34
----------------------------------------------------------------------------
----------------------------------------------------------------------------
The stock-based non-cash compensation expense for the three and twelve months
ended December 31, 2010, increased 13 percent and 34 percent, respectively, over
the comparative period. The increase in 2010 is attributed to additional stock
options granted to new employees. During the three and twelve months ended
December 31, 2010, Delphi capitalized $0.1 million and $0.5 million,
respectively, of stock-based compensation associated with exploration and
development activities.
INTEREST
How do the costs of borrowing compare against the prior year?
For the three and twelve months ended December 31, 2010, interest expense on a
per boe basis decreased 32 percent and 12 percent over the comparative periods.
The decrease in 2010 is attributed to the increase in production volumes.
Three Months Ended Twelve Months Ended
December 31 December 31
2010 2009 % Change 2010 2009 % Change
----------------------------------------------------------------------------
Total 1,301 1,555 (16) 5,075 4,863 4
Per boe 1.66 2.45 (32) 1.72 1.96 (12)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
During 2009, the Company converted $80.0 million of its outstanding long term
debt from prime-based loans to bankers' acceptances. At December 31, 2010, the
bankers' acceptances have terms ranging from 90 to 182 days and a weighted
average effective interest rate of 4.24 percent over the term.
What has the Company done to protect itself against an increase in interest rates?
The Company has entered into an interest rate swap transaction on borrowings
through bankers' acceptances in the amount of $40.0 million maturing on May 4,
2011. The bankers' acceptance rate on the transaction will increase in fixed
monthly increments of 4.55 basis points for an average fixed rate over two years
of 0.94 percent. The effective interest rate over the two year term on $40.0
million of bankers' acceptances will be 0.94 percent plus the applicable
stamping fee. The interest rate swap is fair valued at each reporting date and
presented in the risk management asset or liability.
DEPLETION, DEPRECIATION AND ACCRETION
Has the Company's depletion and depreciation rate and expense changed in 2010 as
compared to 2009?
Depletion and depreciation per boe for the three and twelve months ended
December 31, 2010 decreased four and 13 percent over the comparative periods.
With continued drilling success at Bigstone, Hythe and Wapiti/Gold Creek, Delphi
has been able to add proved reserves at a cost below the Company's current
depletion rate. The increase in total depletion and depreciation was a result of
increased production volumes as the average depletion rate for 2010 was lower
than the previous year.
Three Months Ended Twelve Months Ended
December 31 December 31
2010 2009 % Change 2010 2009 % Change
----------------------------------------------------------------------------
Depletion and
depreciation 15,648 13,271 18 59,732 57,906 3
Accretion expense 232 219 6 955 818 17
----------------------------------------------------------------------------
Total 15,880 13,490 18 60,687 58,724 3
----------------------------------------------------------------------------
Depletion and
depreciation per
boe 19.92 20.94 (5) 20.24 23.30 (13)
Accretion per boe 0.29 0.35 (15) 0.32 0.33 (2)
----------------------------------------------------------------------------
Total per boe 20.21 21.29 (5) 20.56 23.63 (13)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
What is accretion expense and how did this expense for 2010 compare to 2009?
The accretion of asset retirement obligations is an expense that relates to the
passing of time until the Company estimates it will retire its assets and
restore the asset locations to a condition which meets or exceeds environmental
standards. Due to the long term nature of certain assets of the Company, this
accretion expense is estimated to extend over a term of three to 20 years. The
Company uses a credit adjusted risk-free interest rate of eight to ten percent
for the purpose of calculating the fair value of its asset retirement
obligations and hence the accretion expense. The accretion expense for the three
and twelve months ended December 31, 2010 decreased 15 percent and two percent,
respectively, over the comparative periods.
INCOME TAXES
What was the affect on future income taxes as a result of the loss in the year?
The provision for future income taxes in the financial statements for the three
and twelve months ended December 31, 2010 was a recovery of $0.7 million. Delphi
does not anticipate it will be cash taxable before 2014.
Three Months Ended Twelve Months Ended
December 31 December 31
2010 2009 % Change 2010 2009 % Change
----------------------------------------------------------------------------
Current - - - - - -
Future (reduction) (640) (1,031) (38) (647) (4,171) (84)
----------------------------------------------------------------------------
Total (640) (1,031) (38) (647) (4,171) (84)
Per boe (0.81) (1.63) (50) (0.22) (1.68) (87)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
FUNDS FROM OPERATIONS
What are funds from operations and why is it a key performance measure?
Funds from operations is a non-GAAP measure that has been defined by the Company
as net earnings (loss) plus the add back of non-cash items (depletion,
depreciation and accretion, stock-based compensation, future income taxes and
unrealized gain (loss) on risk management activities) and excludes the change in
non-cash working capital related to operating activities and expenditures on
asset retirement obligations. Delphi uses funds from operations ("cash flow") to
analyze performance and considers it a key measure as it demonstrates the
Company's ability to generate the cash necessary to fund future capital
investments to grow the Company's value for the shareholders and to repay debt.
How do funds from operations in 2010 compare to 2009?
For the three and twelve months ended December 31, 2010, funds from operations
were $18.0 million ($0.16 per basic share) and $61.3 million ($0.57 per basic
share) compared to $14.2 million ($0.14 per basic share) and $49.2 million
($0.59 per basic share) in the comparative periods. The increase in funds from
operations is a result of an increase in production volumes and a reduction in
operating costs, interest expense and general and administrative expenses per
boe.
Three Months Ended Twelve Months Ended
December 31 December 31
2010 2009 % Change 2010 2009 % Change
----------------------------------------------------------------------------
Net earnings (loss) 204 1,386 (85) (844) (8,029) (89)
Non-cash items:
Depletion,
depreciation and
accretion 15,880 13,490 18 60,687 58,724 3
Unrealized loss on
risk management
activities 2,348 233 908 1,066 2,102 (49)
Stock-based
compensation
expense 195 140 39 990 615 61
Future income tax
reduction (640) (1,030) (38) (647) (4,171) (84)
----------------------------------------------------------------------------
Funds from
operations 17,987 14,218 27 61,252 49,241 24
----------------------------------------------------------------------------
----------------------------------------------------------------------------
How do funds from operations compare to cash flow from operating activities in
the financial statements?
Funds from operations reflect two primary differences from the GAAP term cash
flow from operating activities shown on the financial statements. These
differences are expenditures incurred for asset retirement obligations and
reclamation and changes in non-cash operating working capital. The following
table is a reconciliation of funds from operations to cash flow from operating
activities for the three and twelve months ended December 31, 2010 and 2009.
Three Months Ended Twelve Months Ended
December 31 December 31
2010 2009 % Change 2010 2009 % Change
----------------------------------------------------------------------------
Funds from
operations:
Non-GAAP 17,987 14,218 27 61,252 49,241 24
Settlement of
asset retirement
obligations (265) (167) 59 (265) (167) 59
Change in non-cash
working capital 819 (688) - (2,154) (4,142) (48)
----------------------------------------------------------------------------
Cash flow from
operating
activities: GAAP 18,541 13,363 39 58,833 44,932 31
----------------------------------------------------------------------------
----------------------------------------------------------------------------
NET EARNINGS
What factors contributed to the loss in 2010?
For the three and twelve months ended December 31, 2010, Delphi recorded net
earnings of $0.2 million ($nil per basic share) and a net earnings of $0.8
million ($0.01 per basic share), respectively. Net earnings were affected by
non-cash items such as depletion, depreciation and accretion, unrealized gains
on risk management activities, stock-based compensation and future income taxes.
These non-cash items represent the majority of the significant difference
between funds from operations and net earnings.
NETBACK ANALYSIS
How do Delphi's netbacks achieved in 2010 compare to the prior year?
For 2010, the Company's netbacks were higher than the previous year resulting
from a slightly higher realized sales price and significant operating cost, G&A
and interest cost reductions. The Company strives for an operating netback in
the $22.00 to $25.00 per boe range and a cash netback of $20.00 per boe in the
current commodity price environment. The operating netback and cash netback were
higher than the cost of finding and developing reserves resulting in a positive
recycle ratio.
Delphi's production is predominantly natural gas and therefore Delphi's
operating and cash netbacks are primarily driven by the price received for
natural gas. The Company is focused on increasing its light oil and natural gas
liquids percentage of total production volumes to further strengthen its cash
flow netback per boe.
Three Months Ended Twelve Months Ended
December 31 December 31
2010 2009 % Change 2010 2009 % Change
----------------------------------------------------------------------------
Barrels of oil
equivalent ($/boe)
Realized sales
price 38.79 41.50 (7) 39.71 39.50 1
Royalties 3.68 4.04 (9) 4.89 3.61 35
Operating expenses 5.88 6.76 (13) 7.46 9.08 (18)
Transportation 2.66 2.37 12 3.02 2.71 11
----------------------------------------------------------------------------
Operating netback 26.57 28.33 (6) 24.34 24.10 1
General and
administrative
expenses 2.02 3.44 (41) 1.87 2.33 (20)
Interest 1.66 2.45 (32) 1.72 1.96 (12)
----------------------------------------------------------------------------
Cash netback 22.89 22.44 2 20.75 19.81 5
Unrealized loss on
financial
contracts 2.99 0.37 708 0.36 0.85 (58)
Stock-based
compensation
expense 0.25 0.22 13 0.34 0.25 34
Depletion,
depreciation and
accretion 20.21 21.29 (5) 20.56 23.63 (13)
Future income
taxes reduction (0.81) (1.63) (50) (0.22) (1.68) (87)
----------------------------------------------------------------------------
Net earnings
(loss) 0.25 2.19 (89) (0.29) (3.23) (91)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
SELECTED INFORMATION
Over the past two years, how has Delphi performed and what significant factors
contributed to the results?
Over the last eight quarters production has grown from 6,762 boe/d to 8,539
boe/d. Production for the last eight quarters reflects the following events. In
the first six months of 2009, production growth was achieved with drilling
success at Bigstone and Hythe, Alberta, primarily focused on natural gas
opportunities. With crude oil and natural gas prices going in opposite
directions through 2009, the capital program in the second half of 2009 was
geared toward drilling for crude oil while acquiring strategic natural gas
properties and infrastructure. The Company completed four natural gas property
and infrastructure acquisitions in the Deep Basin of North West Alberta in the
latter half of 2009. Continued drilling success in 2010 focused on light oil and
liquids-rich natural gas opportunities has resulted in record fourth quarter and
annual production of 8,539 boe/day and 8,086 boe/day, respectively. The 2010
average production represents growth of 19 percent over 2009.
Over the past two years, the changes in revenue and cash flow from quarter to
quarter primarily reflect the increased production volumes achieved and the
volatility of commodity prices.
Natural gas prices over the past two years have generally reflected the cyclical
nature of demand. Higher prices have been realized in the winter months,
reflecting demand for heating with lower prices through the summer months as
production is placed in storage for the upcoming heating season demand. In 2009,
reduced heating and industrial demand due to the global economic crisis caused
natural gas prices to decrease further as a result of concerns over excess
supply relative to demand. The average spot price for AECO in 2009 was $3.96 per
mcf, the lowest average price in ten years. The average spot price for AECO in
2010 increased only one percent to $4.00 per mcf. Crude oil prices had recovered
to over U.S. $80.00 per barrel by the end of 2009 from a low earlier in the year
of U.S. $33.98 per barrel. In 2010, crude oil averaged U.S. $79.55, which was a
28 percent increase over the comparative period in 2009.
Net earnings of the Company are primarily driven by the difference between the
cash flow netback realized per boe of production versus the Company's depletion,
depreciation and amortization ("DD&A") rate of $20.56 per boe. The Company
continues to reduce its DD&A rate by finding and developing reserves at a cost
less than the average DD&A rate. Overall finding and development ("F&D") costs
were $12.06 per proved boe in 2009 and $18.10 per proved boe in 2010.
The following table sets forth certain information of the Company for the past
eight consecutive quarters outlining this performance.
Dec. Sep. Jun. Mar. Dec. Sept. Jun. Mar.
31 30 30 31 31 30 30 31
2010 2010 2010 2010 2009 2009 2009 2009
----------------------------------------------------------------------------
Production
Natural gas
(mcf/d) 38,918 39,439 38,540 38,349 34,626 33,628 35,641 34,813
Oil (bbls/d) 1,147 831 1,074 745 630 624 371 475
Natural gas
liquids
(bbls/d) 906 710 538 508 487 544 498 485
----------------------------------------------------------------------------
Barrels of
oil
equivalent
(boe/d) 8,539 8,114 8,035 7,645 6,888 6,773 6,809 6,762
Financial
($ thousands
except per
unit
amounts)
Petroleum
and natural
gas revenue 30,475 28,080 29,125 29,519 26,297 24,433 23,229 24,205
Funds from
operations
(cash flow) 17,987 15,120 12,988 15,157 14,218 12,635 12,371 10,017
Per share -
basic 0.16 0.13 0.12 0.15 0.14 0.16 0.16 0.13
Per share -
diluted 0.16 0.13 0.12 0.15 0.14 0.16 0.16 0.13
Net earnings
(loss) 204 (1,566) (2,742) 3,260 1,386 (3,278) (2,817) (3,320)
Per share -
basic - (0.01) (0.03) 0.03 0.02 (0.04) (0.04) (0.04)
Per share -
diluted - (0.01) (0.03) 0.03 0.02 (0.04) (0.04) (0.04)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
On an annual basis, how has Delphi performed?
The decrease in revenue and net earnings from 2008 to 2009 was primarily due to
the significant drop in natural gas prices. The increase in revenue and net
earnings from 2009 to 2010 was due to a combination of higher production
volumes, higher liquids prices and lower production costs offset by a lower
realized price for natural gas.
2010 2009 2008
----------------------------------------------------------------------------
Revenue 117,199 98,164 135,402
Net earnings/(loss) (844) (8,029) 5,094
Total assets 412,329 361,698 364,538
Bank debt plus working capital 108,054 92,538 109,237
----------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
Share Capital
What has been the market activity in the Company's common shares?
At December 31, 2010, the Company had 112.8 million common shares outstanding
(December 31, 2009 - 101.2 million). The common shares of Delphi trade on the
TSX under the symbol DEE. The following table summarizes outstanding share data
for the three and twelve months ended December 31, 2010.
Three Months Ended Twelve Months Ended
December 31, 2010 December 31, 2010
----------------------------------------------------------------------------
Weighted Average Common Shares
Basic 112,804 107,934
Diluted 115,238 107,934
Trading Statistics (1)
High 2.47 3.18
Low 2.02 1.70
Average daily volume 277,521 465,615
----------------------------------------------------------------------------
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(1) Trading statistics based on closing price
How many common shares and stock options are currently outstanding?
As at March 15, 2011, the Company had 113.3 million common shares outstanding
and 7.3 milllion stock options outstanding. The stock options have an average
exercise price of $1.63 per share.
Sources and Uses of Funds
Three Months Ended Twelve Months Ended
December 31, 2010 December 31, 2010
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Sources:
Funds from operations 17,987 61,252
Disposition of petroleum and natural
gas properties - 247
Acquisition of petroleum and natural
gas properties 369 -
Issue of common shares - 30,250
Exercise of stock options 102 775
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18,458 92,524
Uses:
Cash and cash equivalents 4,154 4,178
Capital expenditures 18,314 105,791
Acquisition of petroleum and natural
gas properties - 18
Share issue costs - 1,966
Expenditures on site restoration and
reclamation 265 265
Change in non-cash working capital 20,725 4,206
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43,458 116,424
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Increase in bank debt 25,000 23,900
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Bank Debt plus Working Capital Deficiency (Net Debt)
How much bank debt was outstanding on December 31, 2010?
At December 31, 2010, the Company had $80.0 million outstanding in the form of
bankers' acceptances, $25 million drawn under Canadian-based prime loans and a
working capital deficiency of $3.1 million for total net debt of $108.1 million
excluding the financial asset of $2.1 million relating to the unrealized gain on
financial commodity contracts and the associated future income tax liability.
What are the Company's credit facilities and when is the next scheduled review
of the borrowing base?
The Company has a revolving credit facility of $140.0 million with a syndicate
of Canadian chartered banks. The facility is a 364 day committed revolving
facility until May 31, 2011, the term-out date. The term-out date may be
extended for a further 364 day period upon approval by the banks. Following the
term-out date, the facilities would be available on a non-revolving basis for a
one year term. The credit facility bears interest based on a sliding scale
pricing grid tied to the Company's trailing debt to cash flow ratio: from a
minimum of the bank's prime rate plus 1.75 percent to a maximum of the bank's
prime rate plus 4.75 percent or from a minimum of bankers' acceptances rate plus
a stamping fee of 2.75 percent to a maximum of bankers' acceptances rate plus a
stamping fee of 4.75 percent.
Contractual Obligations
Does the Company have any contractual obligations as of December 31, 2010 that
will require funding in future years?
The Company is committed to future minimum payments for natural gas transmission
and processing and operating leases on compression equipment. The Company also
has a lease for office space in Calgary, Alberta.
The future minimum commitments over the next five years are as follows:
2011 2012 2013 2014 2015
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Gathering, processing and
transmission 4,280 3,870 3,072 2,958 2,958
Office and equipment lease 1,612 775 390 - -
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Total 5,892 4,645 3,462 2,958 2,958
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GUARANTEES AND OFF-BALANCE SHEET ARRANGEMENTS
Does Delphi have any outstanding guarantees on behalf of third parties or any
off-balance sheet arrangements which could lead to liabilities in the future?
Delphi has not entered into any guarantees or off-balance sheet arrangements.
Certain lease agreements entered into in the normal course of operations could
be considered off-balance sheet arrangements, however, all leases are operating
leases with lease payments charged to operating expenses or general and
administrative expenses on a monthly basis according to the lease.
CRITICAL ACCOUNTING ESTIMATES
In preparing the Company's financial statements, is Delphi required to make
estimates or assumptions about future events?
Delphi's financial statements have been prepared in accordance with Canadian
generally accepted accounting principles. Certain accounting policies require
management to make decisions with respect to the formulation of estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses. Delphi's management reviews its estimates frequently; however, the
emergence of new information and changed circumstances may result in actual
results or changes to estimate amounts that differ materially from current
estimates. Delphi attempts to mitigate this risk by employing individuals with
the appropriate skill set and knowledge to make reasonable estimates, developing
internal control systems and comparing past estimates to actual results.
The Company's financial and operating results include estimates of the following:
- Depletion, depreciation and accretion and the ceiling test are based on
estimates of crude oil and natural gas reserves;
- Revenues, operating expenses and royalties for which accruals have been
recorded for actual revenues and costs which have been earned or incurred but
have not yet been received;
- Capital expenditures on projects that are in progress;
- Fair value of derivative contracts;
- Asset retirement obligations including estimates of future costs and the
timing of the costs.
NEW ACCOUNTING STANDARDS
Were there any new accounting standards in 2010 which the Company has had to
adopt and comply with?
International Financial Reporting Standards (IFRS)
On January 1, 2011 International Financial Reporting Standards ("IFRS") will
become generally accepted accounting principles in Canada. The adoption date of
January 1, 2011 will require the restatement, for comparative purposes, of
amounts reported by the Company for the year ended December 31, 2010, including
the opening balance sheet as at January 1, 2010. The project to convert to IFRS
is being managed by an in-house team of accounting professionals who have
engaged in IFRS educational programs and continue to develop the Company's
transition to IFRS. The Company's auditors have been and will continue to be
involved throughout the process to ensure the Company's policies are in
accordance with these new standards.
In July 2009, an amendment to IFRS 1 - First Time Adoption of International
Reporting Standards was issued that applies to oil and gas assets. The amendment
allows an entity that used full cost accounting under its previous GAAP to
elect, at its time of adoption, to measure exploration and evaluation assets at
the amount determined under the entity's previous GAAP and to measure oil and
gas assets in the development and production phases by allocating the amount
determined under the entity's previous GAAP for those assets to the underlying
assets on a pro rata basis using reserve volumes or reserve values as of that
date. Delphi has elected to use this exemption. IFRS 1 also provides a number of
other optional exemptions and mandatory exceptions in certain areas to the
general requirement for full retrospective application which are:
Business Combinations - IFRS 1 would allow the Company to use the IFRS rules for
business combinations on a prospective basis rather than restating all business
combinations.
Share-based payments - IFRS 1 allows the Company an exemption on IFRS 2,
"Share-Based Payments" to equity instruments which vested before the Company's
transition date to IFRS.
Delphi has elected to use these exemptions.
The transition from Canadian GAAP to IFRS is significant and may materially
affect our reported financial position and results of operations. At this time,
the Company has identified key differences that will impact the financial
statements and the current status of those items:
- Exploration and Evaluation ("E&E") assets - On transition to IFRS Delphi will
re-classify all E&E assets that are currently included in the Property, Plant
and Equipment ("PP&E") balance on the consolidated balance sheet. This will
consist of the book value of undeveloped land that relates to exploration
properties. E&E assets will not be depleted and must be assessed for impairment
at the transition date and when indicators of impairment exist. Delphi has
currently determined its E&E asset balance to be approximately $0.3 million at
January 1, 2010 and that there is no transitional impairment of the E&E assets.
- Property, plant and equipment - This includes oil and gas assets in the
development and production phases. The Company will allocate the amount
recognized under current Canadian GAAP as at January 1, 2010 using reserve
values to a cash generating unit ("CGU").
- Impairment of PP&E assets - Under IFRS, impairment tests of PP&E must be
performed at the CGU level as opposed to the entire PP&E balance which is
required under current Canadian GAAP through the full cost ceiling test.
Impairment calculations are required to be performed using fair values of the
PP&E assets and Delphi anticipates using discounted proved plus probable reserve
values for impairment tests of PP&E. Delphi anticipates the PP&E assets of one
of its non-core CGU's will be impaired as at January 1, 2010 under IFRS,
resulting in a decrease to total PP&E of $3.9 million and an offsetting charge
to the opening retained earnings or deficit. This CGU was sold in the second
quarter of 2010.
- Depletion expense - On transition to IFRS Delphi has the option to base the
depletion calculation on either proved reserves or proved plus probable
reserves. Delphi will use proved plus probable reserves.
- Share-based payments - The Company has determined the major difference from
current Canadian GAAP that would impact the Company is estimating forfeiture
rates in advance as opposed to recognizing the impact when the forfeiture
occurs. Delphi does not anticipate the difference to be significant.
- Provisions - The major difference between the current Canadian standards and
IFRS appears to be the discount rate used to measure the asset retirement
obligation ("ARO"). Under the current Canadian standard a credit adjusted risk
free rate is used, whereby IFRS allow the use of a risk free rate when the
expected cash flows are risked. There was debate within the industry on the
discount rate and whether there should be a risk component to it. Based on
recent comments made by the standard setters and positions within the industry,
Delphi believes a risk free rate is more appropriate. As a result, Delphi has
measured its ARO liability on transition using a risk free rate of four percent
resulting in an increase to the liability of approximately $6.2 million with an
offsetting charge to the opening retained earnings or deficit.
- Share capital - On transition to IFRS Delphi will be required to account for
the issuance of flow-through shares differently. Under the current Canadian
standard the entire amount of the flow-through renouncement is removed from
share capital, whereas under IFRS the portion of the renouncement related to the
premium paid on the shares remains in share capital. This adjustment must be
applied retrospectively to all past flow-through transactions, resulting in an
increase to share capital of approximately $7.4 million with an offsetting
charge to the opening retained earnings or deficit.
In addition to the accounting policy differences, the Company's transition to
IFRS will impact the internal controls over financial reporting, the disclosure
controls and procedures and information technology ("IT") systems as follows:
Internal controls over financial reporting - Based on the Company's accounting
policies under IFRS Delphi has assessed whether additional controls or changes
in procedures are required. Delphi does not consider these changes to be
significant.
Disclosure controls and procedures - Throughout the transition process, Delphi
will be assessing stakeholder's information requirements and will ensure that
adequate and timely information is provided while ensuring the Company maintains
its due process regarding information that is disclosed.
IT Systems - Delphi has assessed the readiness of its accounting software and
has and continues to assess other system requirements that may be needed in
order to perform ongoing calculations and analysis under IFRS. These changes are
not considered to be significant.
Management continues to finalize its accounting policies and choices and is
continuing with its due process in regards to information that is disclosed. As
such, the Company is currently unable to quantify the full impact on the
financial statements of adopting IFRS, however, the Company has disclosed
certain expectations above based on information known to date. Due to
anticipated changes to IFRS and International Accounting Standards prior to
Delphi's adoption of IFRS, certain items may be subject to change based on new
facts and circumstances that arise after the date of this MD&A.
CORPORATE GOVERNANCE
Overview
The shareholders' interests are a critical factor in the operations and
management of Delphi. The Company is committed to maintaining the highest level
of investor confidence in the Company through the application of its corporate
policies and procedures. Delphi's Board of Directors consists of six independent
directors and two officers of the Company who meet regularly to discuss matters
of strategy and execution of the business plan. See Delphi's Management
Information Circular and Annual Information Form for a listing of committees
that oversee specific aspects of the Company's operating and financial strategy.
Disclosure Controls and Procedures and Internal Controls over Financial Reporting
Disclosure controls and procedures are designed to ensure that information
required to be disclosed by the Company is accumulated and communicated to the
issuer's management, including its President and Chief Executive Officer and
Vice President, Finance and Chief Financial Officer, as appropriate, to allow
timely decisions regarding required disclosure. The Company's President and
Chief Executive Officer and Vice President, Finance and Chief Financial Officer
have concluded that the Company's disclosure controls and procedures are
effective and provide a reasonable level of assurance that information required
to be disclosed by the Company is recorded, processed, summarized and reported
within the time periods specified.
The Company notes that while it believes the disclosure controls and procedures
and internal controls over financial reporting provide a reasonable level of
assurance that they are effective, it does not expect that the disclosure
controls and procedures and internal controls will prevent all errors and fraud.
A control system is designed to provide reasonable, not absolute, assurance that
the objectives of the control system are met. There were no changes made to the
disclosure controls and procedures or internal controls over financial reporting
during the fourth quarter.
ADDITIONAL INFORMATION
Where is additional information about Delphi available?
Additional information about Delphi is available on the Canadian Securities
Administrators' System for Electronic Distribution and Retrieval (SEDAR) at
www.sedar.com, at the Company's website at www.delphienergy.ca or by contacting
the Company at Delphi Energy Corp. Suite 300, 500 - 4th Avenue S.W., Calgary,
Alberta, T2P 2V6 or by e-mail at info@delphienergy.ca.
INDEPENDENT AUDITORS' REPORT
To the Shareholders of Delphi Energy Corp.
Report on the Consolidated Financial Statements
We have audited the accompanying consolidated financial statements of Delphi
Energy Corp. ("the Company"), which comprise the consolidated balance sheets as
at December 31, 2010 and 2009, the consolidated statements of operations,
comprehensive loss and retained earnings (deficit) and cash flows for the years
then ended, and notes, comprising a summary of significant accounting policies
and other explanatory information.
Management's Responsibility for the Consolidated Financial Statements
Management is responsible for the preparation and fair presentation of these
consolidated financial statements in accordance with Canadian generally accepted
accounting principles, and for such internal control as management determines is
necessary to enable the preparation of consolidated financial statements that
are free from material misstatement, whether due to fraud or error.
Auditors' Responsibility
Our responsibility is to express an opinion on these consolidated financial
statements based on our audits. We conducted our audits in accordance with
Canadian generally accepted auditing standards. Those standards require that we
comply with ethical requirements and plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the
amounts and disclosures in the consolidated financial statements. The procedures
selected depend on our judgment, including the assessment of the risks of
material misstatement of the consolidated financial statements, whether due to
fraud or error. In making those risk assessments, we consider internal control
relevant to the Company's preparation and fair presentation of the consolidated
financial statements in order to design audit procedures that are appropriate in
the circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Company's internal control. An audit also includes
evaluating the appropriateness of accounting policies used and the
reasonableness of accounting estimates made by management, as well as evaluating
the overall presentation of the consolidated financial statements.
We believe that the audit evidence we have obtained in our audits is sufficient
and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the consolidated financial statements present fairly, in all
material respects, the consolidated financial position of the Company as at
December 31, 2010 and 2009, and the results of its consolidated operations and
its consolidated cash flows for the years then ended in accordance with Canadian
generally accepted accounting principles.
(signed) KPMG LLP
Chartered Accountants
Calgary, Canada
March 15, 2011
DELPHI ENERGY CORP.
Consolidated Balance Sheets
As at December 31
(Stated in thousands of dollars) 2010 2009
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Assets
Current assets
Cash 4,039 -
Accounts receivable 17,897 15,630
Prepaid expenses and deposits 3,426 6,004
Risk management asset (Note 10) 2,080 -
Future income taxes (Note 9) - 112
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27,442 21,746
Property, plant and equipment (Note 5) 384,887 339,952
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Total assets 412,329 361,698
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Liabilities
Current liabilities
Outstanding cheques - 139
Accounts payable and accrued liabilities 28,416 32,933
Risk management liability (Note 10) - 381
Future income taxes (Note 9) 551 -
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28,967 33,453
Long term debt (Note 6) 105,000 81,100
Future income taxes (Note 9) 23,860 23,917
Asset retirement obligations (Note 7) 10,984 11,818
Risk management liability (Note 10) 3,527 -
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172,338 150,288
Shareholders' equity
Share capital (Note 8) 228,440 200,055
Contributed surplus (Note 8) 12,088 11,048
Retained earnings (deficit) (537) 307
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Total shareholders' equity 239,991 211,410
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Total liabilities and shareholders' equity 412,329 361,698
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Commitments (Note 11)
See accompanying notes to the consolidated financial statements.
Approved on behalf of the Board of Directors:
(signed) "Stephen Mulherin" (signed) "Lamont C. Tolley"
Stephen Mulherin Lamont C. Tolley
Director Director
DELPHI ENERGY CORP.
Consolidated Statements of Operations, Comprehensive Loss and Retained
Earnings (Deficit)
Years ended December 31
(Stated in thousands of dollars, except per share
amounts) 2010 2009
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Revenue
Petroleum and natural gas sales 113,772 94,618
Realized gain on risk management activities
(Note 10) 3,427 3,546
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117,199 98,164
Royalties (14,420) (8,982)
Unrealized loss on risk management activities
(Note 10) (1,066) (2,102)
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101,713 87,080
Expenses
Operating 22,013 22,551
Transportation 8,908 6,739
General and administrative 5,531 5,788
Stock-based compensation (Note 8) 990 615
Interest 5,075 4,863
Depletion, depreciation and accretion 60,687 58,724
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103,204 99,280
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Loss before income taxes (1,491) (12,200)
Taxes (Note 9)
Future income taxes (reduction) (647) (4,171)
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(647) (4,171)
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Net loss and comprehensive loss (844) (8,029)
Retained earnings, beginning of the year 307 8,336
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Retained earnings (deficit), end of the year (537) 307
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Loss per share (Note 8)
Basic and diluted (0.01) (0.10)
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See accompanying notes to the consolidated financial statements.
DELPHI ENERGY CORP.
Consolidated Statements of Cash Flows
Years ended December 31
(Stated in thousands of dollars) 2010 2009
----------------------------------------------------------------------------
Cash flow from (used in) operating activities
Net loss (844) (8,029)
Add non-cash items:
Depletion, depreciation and accretion 60,687 58,724
Stock-based compensation 990 615
Unrealized loss on risk management activities 1,066 2,102
Future income taxes (reduction) (647) (4,171)
Expenditures on asset retirement obligations (265) (167)
Change in non-cash working capital (Note 12) (2,154) (4,142)
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58,833 44,932
Cash flow from (used in) financing activities
Issue of common shares, net of issue costs 28,284 14,977
Issue of flow-through common shares - 6,360
Exercise of stock options 775 43
Repayment of acquired debt (Note 4) - (6,750)
Increase (decrease) in long term debt 23,900 (10,300)
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52,959 4,330
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Cash flow available for investing activities 111,792 49,262
Cash flow from (used in) investing activities
Capital expenditures (105,791) (33,946)
Disposition of petroleum and natural gas properties 247 20,718
Acquisition of petroleum and natural gas properties (18) (30,873)
Corporate acquisition costs (Note 4) - (869)
Change in non-cash working capital (Note 12) (2,052) (5,355)
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(107,614) (50,325)
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Increase (decrease) in cash and cash equivalents 4,178 (1,063)
Cash and cash equivalents, beginning of the year (139) 924
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Cash and cash equivalents, end of the year 4,039 (139)
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Cash and cash equivalents is comprised of:
Cash 4,039 -
Outstanding cheques - (139)
----------------------------------------------------------------------------
4,039 (139)
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Interest paid 5,003 5,099
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See accompanying notes to the consolidated financial statements.
DELPHI ENERGY CORP.
Notes to the Consolidated Financial Statements
As at and for the years ended December 31, 2010 and 2009
(All tabular amounts are stated in thousands of dollars, except per share amounts)
NOTE 1: DESCRIPTION OF BUSINESS
Delphi Energy Corp. ("the Company" or "Delphi") is incorporated under the
Business Corporations Act (Alberta) and is a publicly-traded company listed on
the Toronto Stock Exchange. Delphi is primarily engaged in the acquisition,
exploration for and development and production of crude oil, natural gas and
natural gas liquids from properties located in North West Alberta.
NOTE 2: SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements of Delphi have been prepared by management
in accordance with accounting principles generally accepted in Canada. The
preparation of financial statements in conformity with Canadian generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities,
shareholders' equity, revenue and expenses and disclosure of contingent assets
and liabilities at the date of the financial statements. Actual results may
differ from these estimates.
(a) Principles of consolidation
The consolidated financial statements include the accounts of the Company, its
wholly owned subsidiary and a partnership. All inter-entity transactions and
balances have been eliminated.
(b) Petroleum and natural gas operations
The Company follows the full cost method of accounting whereby all costs
associated with the exploration for and development of petroleum and natural gas
reserves are capitalized. Such costs include land acquisition costs, geological
and geophysical costs, lease rental costs on non-producing properties, costs of
both productive and unproductive drilling and the costs of production equipment.
Gains or losses are not recognized upon disposition of petroleum and natural gas
properties unless crediting the proceeds against accumulated costs would result
in a change in the depletion rate of 20 percent or more.
The accumulated costs, less the costs of acquisition of unproved properties, are
depleted using the unit-of-production method based upon total proved reserves
before royalties as determined by the Company's independent reserves engineers.
Natural gas reserves and production are converted into equivalent barrels of oil
at 6:1 based upon the estimated relative energy content.
The costs of acquiring and evaluating unproved properties are initially excluded
from the depletion calculation. These properties are assessed periodically to
ascertain whether impairment has occurred. When proved reserves are assigned or
the property is considered to be impaired, the cost of the property or the
amount of impairment is added to the costs subject to depletion.
The Company is required to perform a ceiling test at least annually to assess
the carrying amount of oil and gas assets. The costs are assessed to be
recoverable if the sum of the undiscounted cash flows expected from the
production of proved reserves using forecast prices and the lower of cost and
market of unproved properties exceed the carrying amount of the petroleum and
natural gas assets. If the carrying amount of the petroleum and natural gas
assets is assessed to not be recoverable, an impairment loss is recognized to
the extent that the carrying amount exceeds the sum of the discounted cash flows
expected from the production of proved and probable reserves and the lower of
cost and market of unproved properties. This approach incorporates risks and
uncertainties in the expected future cash flows, which are discounted using a
risk-free rate.
Depreciation of furniture and office equipment is provided using the declining
balance method based upon estimated useful lives of 20 percent to 50 percent.
(c) Joint operations
Certain of the Company's exploration, development and production activities are
conducted jointly with others and accordingly, the financial statements reflect
only the Company's proportionate interest in such activities.
(d) Goodwill
Goodwill, at the time of acquisition, represents the excess of the purchase
price of a business over the fair value of the net assets acquired. Goodwill is
assessed by the Company for impairment at least each year end. If the fair value
of the business is less than the book value, a second test is performed to
determine the amount of the impairment. The amount of the impairment is
determined by deducting the fair value of the business' assets and liabilities
from the fair value of the business to determine the implied fair value of
goodwill and comparing that amount to the book value of goodwill. Any excess of
the book value of goodwill over the implied fair value is the impairment amount
and is charged to earnings in the period of the impairment.
(e) Asset retirement obligations
The Company records the future cost associated with removal, site restoration
and asset retirement costs of property, plant and equipment. The fair value of
the liability for the Company's asset retirement obligation is recorded in the
period in which it is incurred, discounted to its present value using the
Company's credit adjusted risk-free interest rate and the corresponding amount
is recognized by increasing the carrying amount of property, plant and
equipment. The liability amount is increased each reporting period due to the
passage of time and the amount of accretion is charged to earnings in the
period. Actual costs incurred upon settlement of the retirement obligation are
charged against the obligation to the extent of the liability recorded. The
associated asset retirement cost included in property, plant and equipment is
amortized to earnings using the unit-of-production method over estimated proved
reserves consistent with the depletion and depreciation of the underlying asset.
(f) Stock-based compensation
The Company records a compensation cost for all stock options granted to
employees, directors or key consultants over the vesting period of the options
based on the fair value method. The compensation cost is a charge to earnings or
is capitalized as a cost of exploration and development activities with an
offsetting increase to contributed surplus on the balance sheet. Consideration
paid by employees, directors or key consultants upon exercise of the stock
options and the amount previously recognized in contributed surplus are recorded
as an increase to share capital. The Company has not incorporated an estimated
forfeiture rate for stock options that will not vest, rather, the Company
accounts for actual forfeitures as they occur.
(g) Future income taxes
The Company follows the asset and liability method of accounting for income
taxes. Under this method, estimated future income tax assets and liabilities are
determined based upon differences between the carrying amount as reported on the
balance sheet and the tax basis of assets and liabilities and measured using
substantively enacted tax rates and laws expected to be in effect when the
differences are expected to reverse. The effect on future tax assets and
liabilities of a change in tax rates is recognized in earnings in the period in
which the change occurs. A valuation allowance is recognized against any future
income tax assets if it is considered more likely than not that the asset will
not be realized.
(h) Flow-through shares
The resource expenditure deductions for income tax purposes related to
exploration and development activities funded by flow-through share arrangements
are renounced to investors in accordance with income tax legislation. To
recognize the foregone tax benefits to the Company, the future income tax
liability and share capital are adjusted by the estimated cost of the renounced
tax deduction on the date of renouncement.
(i) Per share amounts
Basic per share amounts are computed by dividing the net earnings by the
weighted average number of common shares outstanding for the year. Diluted per
share amounts reflect the potential dilution that would occur if securities or
other contracts to issue common shares were exercised or converted to common
shares. Diluted per share information is calculated using the treasury stock
method that assumes any proceeds received by the Company upon the exercise of
in-the-money stock options, plus the unamortized stock-based compensation cost,
would be used to buy back common shares at the average market price for the
period. Anti-dilutive options or instruments are not included in the
calculation.
(j) Financial instruments
i) Financial instruments - recognition and measurement
Financial instruments are classified into one of the following five categories:
held-for-trading, held-to-maturity, loans and receivables, available-for-sale
financial assets or other financial liabilities. All financial instruments,
including derivatives and non-financial derivatives are measured in the balance
sheet at fair value except for loans and receivables, held-to-maturity
investments and other financial liabilities which are measured at amortized cost
determined using the effective interest rate method. The accounting for
subsequent changes in fair value depends on initial classification, as follows:
changes in fair value of held-for-trading financial assets are recognized in net
earnings and changes in fair value of available-for-sale financial instruments
are recorded in other comprehensive income until the investment is derecognized
or impaired at which time the amounts are recorded in net earnings.
The Company classifies its cash as held-for-trading which is measured at fair
value. Risk management asset/liability is classified as held-for-trading and is
measured at fair value. Accounts receivable are classified as loans and
receivables and are measured at amortized cost. Accounts payable and long term
debt are classified as other financial liabilities and are measured at amortized
cost.
ii) Derivatives
All derivative instruments, including embedded derivatives, are recorded on the
balance sheet at fair value unless exempt from derivative accounting treatment
if the normal purchase and sale election is made at the time the Company entered
into the contract. All changes in the fair value of derivative instruments are
recorded in earnings unless cash flow hedge accounting is used, in which case
changes in fair value are recorded in other comprehensive income. The Company
has a risk management program whereby the commodity price associated with a
portion of its future production is fixed in order to mitigate cash flow
volatility resulting from fluctuating commodity prices. The Company sells
forward a portion of its future production by entering into a combination of
fixed price physical sale contracts with customers and fixed price financial
contracts with financial counterparties. The Company has elected not to use
hedge accounting on its fixed price contracts with financial counterparties
resulting in all changes in fair value being recorded in the statement of
earnings. The Company has elected to account for its physical commodity sales
contracts which were entered into and continue to be held for the purpose of
delivery of production in accordance with its expected sale requirements as
executory contracts on an accrual basis rather than as non-financial
derivatives. Physical commodity sale contracts based in United States dollars
include an embedded derivative associated with the foreign exchange rate. Due to
this embedded derivative, the changes in the fair value of these contracts are
included in the statement of earnings.
iii) Other comprehensive income
The Company includes a statement of comprehensive income, which is comprised of
net earnings and other comprehensive income which, for the Company, relates to
changes in gains or losses on derivatives designated as cash flow hedges. The
Company has combined this statement with the statement of earnings.
iv) Transaction costs
Transaction costs attributable to financial instruments classified as other than
held-for-trading are included in the recognized amount of the related financial
instrument and recognized over the term of the resulting financial instrument
using the effective interest rate method.
(k) Measurement uncertainty
The amounts recorded for depletion and depreciation of property, plant and
equipment are based upon estimates of proved petroleum and natural gas reserves,
production rates, commodity prices and future costs. The ceiling test is based
upon estimates of proved and, if applicable, probable reserves, production
rates, petroleum and natural gas prices, future costs and other assumptions. The
asset retirement obligations are based upon future costs, expected inflation
rates and other assumptions. The amounts for stock-based compensation are based
on estimates of risk-free interest rates, expected lives and volatility. The
fair value estimates for derivatives are based on expected future natural gas
prices and volatility in those prices. Future income taxes are based on
estimates as to timing of the reversal of temporary differences at tax rates
substantively enacted in those years. By their nature, these estimates are
subject to measurement uncertainty and the effect on the financial statements of
changes to estimates in future periods could be material.
(l) Cash and cash equivalents
The Company considers deposits in banks less outstanding cheques as cash and
cash equivalents.
(m) Revenue recognition
Petroleum and natural gas sales are recognized in earnings when the title and
risks pass from the Company to its customer.
NOTE 3: NEW ACCOUNTING STANDARDS
International Financial Reporting Standards
In February 2008, the Canadian Accounting Standards Board ("AcSB") confirmed
that Canadian publicly accountable entities will be required to report under
International Financial Reporting Standards ("IFRS"), which will replace
Canadian generally accepted accounting principles ("GAAP") for years beginning
on or after January 1, 2011. Thus, effective January 1, 2011, the Company will
be required to prepare its consolidated financial statements in accordance with
IFRS, with appropriate comparative figures for the year ended December 31, 2010.
NOTE 4: CORPORATE ACQUISITION
During the fourth quarter of 2009, the Company acquired all of the issued and
outstanding shares of Fairmount Energy Inc. ("Fairmount"), a publicly-traded
company involved in the exploration for, development and production of crude oil
and natural gas primarily in North West Alberta, for share consideration of
0.3571 of a share of the Company for each share of Fairmount. The aggregate
purchase price of $6.4 million was paid for by issuing 5,834,974 common shares
of the Company. The common shares issued by the Company were valued at $1.09 per
share, representing the weighted average closing price of the Company's shares
around the date of announcing the acquisition. The transaction was accounted for
using the purchase method. The consolidated accounts of the Company include the
results of Fairmount since October 8, 2009, the date the Company acquired
control of Fairmount.
The following table summarizes the estimated fair value of the assets acquired
and liabilities assumed at the date of acquisition.
Purchase Price:
----------------------------------------------------------------------------
Share consideration 6,360
Corporate acquisition costs 869
----------------------------------------------------------------------------
7,229
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Allocated:
Petroleum and natural gas properties 7,112
Future income tax asset 9,179
Working capital (2,035)
Bank debt (6,750)
Asset retirement obligation (277)
----------------------------------------------------------------------------
7,229
----------------------------------------------------------------------------
----------------------------------------------------------------------------
NOTE 5: PROPERTY, PLANT AND EQUIPMENT
Accumulated
depletion and
As at December 31, 2010 Cost depreciation Net book value
----------------------------------------------------------------------------
Petroleum and natural gas properties 532,308 270,294 262,014
Production equipment 164,741 42,359 122,382
Furniture, fixtures and office
equipment 1,326 835 491
----------------------------------------------------------------------------
698,375 313,488 384,887
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Accumulated
depletion and
As at December 31, 2009 Cost depreciation Net book value
----------------------------------------------------------------------------
Petroleum and natural gas properties 448,619 218,505 230,114
Production equipment 143,813 34,547 109,266
Furniture, fixtures and office
equipment 1,277 705 572
----------------------------------------------------------------------------
593,709 253,757 339,952
----------------------------------------------------------------------------
----------------------------------------------------------------------------
For the year ended December 31, 2010, the Company capitalized $4.5 million
(December 31, 2009 - $4.2 million) of general and administrative costs directly
related to exploration and development activities.
As at December 31, 2010, costs in the amount of $8.3 million (December 31, 2009
- $4.2 million) representing unproved properties were excluded from the
depletion calculation and estimated future development costs of $84.0 million
(December 31, 2009 - $51.3 million) have been included in costs subject to
depletion. All costs of unproved properties have been capitalized. Ultimate
recoverability of these costs will be dependent upon finding proved oil and
natural gas reserves.
The Company performed a ceiling test calculation at December 31, 2010 to assess
the recoverable value of property, plant and equipment, which indicated no write
down was required. The future commodity prices used in the ceiling test were
based on the December 31, 2010 commodity price forecasts of the Company's
independent reserve engineers adjusted for differentials specific to the
Company's reserves. The following table summarizes the future benchmark prices
the Company used in the ceiling test.
Natural Gas
Henry Hub AECO Spot Delphi Gas
(US$/mmbtu) (CDN$/mmbtu) (CDN$/mcf)
----------------------------------------------------------------------------
2011 4.50 4.16 3.98
2012 5.15 4.74 4.60
2013 5.75 5.31 5.19
2014 6.25 5.77 5.69
2015 6.75 6.22 6.20
2016 7.10 6.53 6.54
2017 7.32 6.76 6.79
2018 7.47 6.90 6.95
2019 7.62 7.06 7.12
2020 7.77 7.21 7.28
Thereafter (1) +2%/yr +2%/yr
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Crude Oil
West Texas Edmonton Bow River
Henry Hub Intermediate Light Hardisty Delphi Oil
(US$/mmbtu) (US$/bbl) (CDN$/bbl) (CDN$/bbl) (CDN$/bbl)
2011 88.00 86.22 75.87 83.34
2012 89.00 89.29 75.89 87.21
2013 90.00 90.92 75.10 88.98
2014 92.00 92.96 76.23 90.90
2015 95.17 96.19 78.88 94.04
2016 97.55 98.62 80.87 96.41
2017 100.26 101.39 83.14 99.15
2018 102.74 103.92 85.21 101.63
2019 105.45 106.68 87.48 104.38
2020 107.56 108.84 89.25 106.48
Thereafter (1) +2%/yr +2%/yr +2%/yr
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Percentage change of 2% represents the change in future prices each year
after 2020 to the end of the reserve life.
NOTE 6: LONG TERM DEBT
December 31, 2010 December 31, 2009
----------------------------------------------------------------------------
Prime-based loans 25,000 1,100
Bankers' acceptances 80,000 80,000
----------------------------------------------------------------------------
Total debt 105,000 81,100
----------------------------------------------------------------------------
----------------------------------------------------------------------------
The Company has a revolving facility for $140.0 million with a syndicate of
Canadian chartered banks. The facility is a 364 day committed revolving facility
until May 31, 2011, the term-out date. The term-out date may be extended for a
further 364 day period upon approval by the banks. Following the term-out date,
the facilities would be available on a non-revolving basis for a one year term.
The credit facility bears interest based on a sliding scale pricing grid tied to
the Company's trailing debt to cash flow ratio: from a minimum of the bank's
prime rate plus 1.75 percent to a maximum of the bank's prime rate plus 4.75
percent or from a minimum of bankers' acceptances rate plus a stamping fee of
2.75 percent to a maximum of bankers' acceptances rate plus a stamping fee of
4.75 percent.
The bankers' acceptances have terms ranging from 90 to 182 days and a weighted
average effective interest rate of 4.24 percent over the term.
The facility is secured by a $200.0 million demand floating charge debenture and
a general security agreement over all assets of the Company.
NOTE 7: ASSET RETIREMENT OBLIGATIONS
The Company's asset retirement obligations result from working interests in
petroleum and natural gas assets including well sites, gathering systems and
processing facilities. The Company estimates the total undiscounted amount of
cash flows required to settle its asset retirement obligations, over the next
three to 20 years, is approximately $22.7 million (December 31, 2009 - $25.1
million). A credit-adjusted risk-free rate of 8.0 to 10.0 percent and an
inflation rate of 2.5 percent were used to calculate the estimated fair value of
the asset retirement obligations.
A reconciliation of the asset retirement obligations is provided below.
As at December 31 2010 2009
----------------------------------------------------------------------------
Balance, beginning of the year 11,818 9,730
Liabilities incurred 385 132
Liabilities disposed (1,910) (487)
Liabilities acquired - 1,793
Liabilities settled (265) (167)
Accretion expense 956 817
----------------------------------------------------------------------------
Balance, end of the year 10,984 11,818
----------------------------------------------------------------------------
----------------------------------------------------------------------------
NOTE 8: SHARE CAPITAL
(a) Authorized
An unlimited number of common shares.
An unlimited number of preferred shares issuable in series.
(b) Common shares issued
2010 2009
----------------------------------------------------------------------------
Outstanding Outstanding
As at December 31 shares (000's) Amount shares (000's) Amount
----------------------------------------------------------------------------
Balance, beginning of
the year 101,166 200,055 79,067 174,995
Issue of common shares 11,000 30,250 13,200 16,500
Issue of common shares
- Fairmount (Note 4) - - 5,835 6,360
Issue of flow-through
common shares - - 3,000 6,360
Exercise of stock
options 659 775 64 43
Allocated from
contributed surplus - 418 - 23
Share issue costs - (1,966) - (1,523)
Future tax effect of
share issue costs - 523 - 405
Tax benefit renounced
to shareholders - (1,615) - (3,108)
----------------------------------------------------------------------------
Balance, end of the
year 112,825 228,440 101,166 200,055
----------------------------------------------------------------------------
----------------------------------------------------------------------------
On September 30, 2009, the Company issued 13.2 million common shares at a price
of $1.25 per share for gross proceeds of $16.5 million.
On November 16, 2009, the Company issued 3.0 million flow-through common shares
at a price of $2.12 per share for gross proceeds of $6.4 million.
On June 3, 2010, the Company issued 11.0 million common shares at a price of
$2.75 per share for gross proceeds of $30.3 million.
As at December 31, 2010, the Company has incurred the necessary qualifying
exploration expenditures to satisfy the terms of the flow-through common shares
issued in 2009. Although the Company believes it has incurred the necessary
qualifying expenditures, these amounts may be subject to audit and subsequent
interpretation by Canada Revenue Agency.
(c) Stock options
The Company has established a stock option plan under which it has granted
options to acquire common shares to certain officers, directors, employees and
key consultants. The plan provides for the granting of options up to ten percent
of the issued and outstanding common shares of the Company. Options issued under
the plan have a term of five years to expiry. Options granted prior to September
1, 2009 vested over a two-year period starting on the date of grant. Options
granted on September 1, 2009 or later vest over a two-year period with one-third
vesting six months after the date of grant and one-third on each of the first
and second anniversary of the grant date. The exercise price of each option
equals the five day weighted average of the market price of the Company's common
shares, immediately preceding the date of the grant. As at December 31, 2010
there were 7.8 million options to purchase shares outstanding.
The following table summarizes the changes in the number of options outstanding
and the weighted average share prices.
2010 2009
----------------------------------------------------------------------------
Weighted Weighted
Outstanding average Outstanding average
options exercise options exercise
As at December 31 (000's) price (000's) price
----------------------------------------------------------------------------
Balance, beginning of the year 7,428 1.40 4,731 1.75
Granted 1,074 2.64 3,017 0.83
Forfeited (67) 1.50 (256) 1.31
Exercised (659) 1.18 (64) 0.67
----------------------------------------------------------------------------
Balance, end of the year 7,776 1.59 7,428 1.40
----------------------------------------------------------------------------
Exercisable, end of the year 6,116 1.58 5,245 1.58
----------------------------------------------------------------------------
----------------------------------------------------------------------------
The following table summarizes information about the stock options
outstanding and exercisable at December 31, 2010.
Options outstanding Options exercisable
----------------------------------------------------------------------------
Weighted
Weighted average Weighted
Outstanding average remaining average
Range of options exercise term Exercisable exercise
exercise price (000's) price (years) (000's) price
----------------------------------------------------------------------------
$0.65 - $0.97 1,804 0.66 3.16 1,165 0.66
$0.98 - $1.54 525 1.21 3.35 280 1.25
$1.55 - $1.72 3,736 1.67 1.91 3,711 1.67
$1.73 - $2.15 560 1.88 2.44 440 1.82
$2.16 - $3.34 1,151 2.81 3.97 520 2.91
----------------------------------------------------------------------------
Total 7,776 1.59 2.64 6,116 1.58
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(d) Stock-based compensation
The Company accounts for its stock-based compensation using the fair value
method for all stock options. For the year ended December 31, 2010, Delphi
recorded non-cash compensation expense of $1.0 million (December 31, 2009 - $0.6
million). The Company capitalized $0.5 million (December 31, 2009 - $0.9
million) of stock-based compensation directly related to exploration and
development activities. The future income tax liability associated with the
capitalized stock-based compensation in the amount of $0.2 million (December 31,
2009 - $0.3 million) has also been capitalized for the year.
During the year ended December 31, 2010, the Company granted 1.1 million
options. The fair values of all options granted during the year are estimated at
the date of grant using the Black-Scholes option pricing model. The weighted
average fair value of options granted during the year was $1.51 per option
(December 31, 2009 - $0.43 per option). The assumptions used in the
Black-Scholes model to determine fair value were as follows.
Years ended December 31 2010 2009
----------------------------------------------------------------------------
Risk-free interest rate (%) 2.1
Expected life (years) 5.0
Expected volatility (%) 62.6
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(e) Contributed surplus
The following table outlines the changes in the contributed surplus balance.
As at December 31 2010 2009
----------------------------------------------------------------------------
Balance, beginning of the year 11,048 9,605
Stock-based compensation expensed 990 615
Stock-based compensation capitalized 468 851
Reclassification to common shares on exercise of stock
options (418) (23)
----------------------------------------------------------------------------
Balance, end of the year 12,088 11,048
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(f) Net loss per share
Net loss per share has been based on the following weighted average common
shares.
Years ended December 31 2010 2009
----------------------------------------------------------------------------
Basic 107,934 84,065
Diluted 107,934 84,065
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(g) Capital management
The Company considers share capital and net debt, being the sum of long term
debt and current liabilities less current assets, as the components of capital
to be managed.
The Company's objective in managing its capital is to ensure adequate and
appropriate sources of capital are available to execute a capital investment
program while maintaining a flexible overall capital structure. Maintaining a
flexible capital structure is important due to the inherent risks in oil and gas
operations and the volatility of commodity prices.
The Company manages its capital structure by keeping abreast of current and
forecast economic conditions and commodity prices, particularly natural gas
prices and the cost of oilfield services. Additionally, the Company establishes
internal processes to monitor and estimate planned capital expenditures,
forecast funds from operations and current and forecast debt levels.
The key measure used by the Company to evaluate its capital structure is the
ratio of net debt to funds from operations, defined as cash flow from operating
activities before expenditures on asset retirement obligations and change in
non-cash working capital from operating activities. This ratio represents the
time period required to repay the Company's net debt from funds generated from
operations on the assumption there are no further capital expenditures incurred
and funds from operations remain constant. The measure is often calculated on a
historic annual basis and on an annualized most recent quarter basis to provide
a more current view of the Company's capital structure.
At December 31, 2010 net debt, excluding risk management assets or liabilities
and the associated future income taxes, was $108.1 million and funds from
operations was $61.3 million resulting in a net debt to funds from operations
ratio of 1.8:1. The Company is focused on achieving its internal target range
for this ratio of approximately 1.5 times.
The Company maintains an active risk management program as an integral part of
its capital management strategy to mitigate the volatility in funds from
operations resulting from fluctuating commodity prices. The net debt to funds
from operations ratio is the key driver in determining whether to maintain or
alter the capital structure. To alter the capital structure of the Company,
consideration is given to the level of credit available under current banking
facilities, the proceeds on disposition of properties, the amount of the planned
capital expenditure program and the offering of new common share equity if
available on acceptable terms.
NOTE 9: TAXES
(a) Expected income tax rate
The provision for income taxes in the financial statements differs from the
result that would have been obtained by applying the combined federal and
provincial income tax rates to the Company's earnings before income taxes.
The difference relates to the following items:
Years ended December 31 2010 2009
----------------------------------------------------------------------------
Loss before income taxes (1,491) (12,200)
Statutory tax rate 28.01% 29.07%
Expected income tax expense (recovery) (418) (3,547)
Stock-based compensation 277 178
Reduction in future income tax rates (497) (771)
Other (9) (31)
----------------------------------------------------------------------------
Total income tax expense (recovery) (647) (4,171)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(b) Future income tax liability
The income tax effect of temporary differences that give rise to significant
portions of the future income tax assets and liabilities are presented below:
As at December 31 2010 2009
----------------------------------------------------------------------------
Future income tax assets:
Asset retirement obligations 2,812 2,955
Attributed Canadian Royalty Income 361 362
Non capital losses 4,097 4,093
Share issue costs 1,011 998
Risk management liability 934 112
Future income tax liabilities:
Risk management asset (551) -
Property, plant and equipment (33,075) (32,325)
----------------------------------------------------------------------------
Net future income tax liability (24,411) (23,805)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Non-capital losses of $16.4 million expire in the year 2028.
NOTE 10: FINANCIAL INSTRUMENTS
(a) Risk management overview
The Company is exposed to market risks related to the volatility of commodity
prices, foreign exchange rates and interest rates. Risk management is ultimately
established by the Board of Directors and is implemented and monitored by senior
management. The Company maintains an active risk management program as an
integral part of its overall financial strategy to mitigate volatility in funds
from operations resulting from fluctuating commodity prices. The strategy is
designed to take advantage of the upward swings in natural gas prices as a
result of the changes in demand/supply fundamentals and/or the movement of
significant financial assets invested in the natural gas market as a pure
commodity investment.
(b) Fair value of financial assets and liabilities
The Company's financial instruments recognized on the balance sheet include cash
and cash equivalents, accounts receivable, accounts payable and accrued
liabilities, long-term debt and the risk management asset or liability. The fair
value of financial assets and liabilities that are included on the balance
sheet, other than the risk management asset or liability, approximate their
carrying amounts due to long-term debt being at a floating interest rate and all
other financial assets and liabilities having a short term maturity.
The Company's financial derivative contracts are transacted in active markets.
The contracts are measured at fair values that are classified as Level 2 in
accordance with the following hierarchy.
Level 1 - Quoted prices are available in active markets for identical assets or
liabilities as of the reporting date. Active markets are those in which
transactions occur in sufficient frequency and volume to provide pricing
information on an ongoing basis.
Level 2 - Valuations are based on inputs, including quoted forward prices for
commodities, time value and volatility factors which can be substantially
observed or corroborated in the marketplace.
Level 3 - Valuations in this level are those with inputs for the asset or
liability that are not based on observable market data.
(c) Market risk
Market risk is comprised of foreign currency exchange rate risk, interest rate
risk and commodity price risk. The Company utilizes both financial derivatives
and physical delivery contracts to manage market risks.
Foreign currency exchange rate risk
Foreign currency exchange rate risk is the risk that future cash flows will
fluctuate as a result of changes in foreign exchange rates. Although
substantially all of the Company's petroleum and natural gas sales are
denominated in Canadian dollars, the underlying market prices in Canada for
petroleum and natural gas are affected by changes in the exchange rate between
the Canadian and United States dollar. The exchange rate could affect the values
of certain contracts, however, this indirect influence cannot be accurately
quantified. The Company had no foreign exchange rate swap or related financial
contracts in place as at December 31, 2010.
Interest rate risk
Interest rate risk is the risk that future cash flows will fluctuate as a result
of changes in market interest rates. The Company is exposed to interest rate
risk to the extent that bank debt is at a floating rate of interest.
Interest rate risk is partially mitigated through short-term fixed rate
borrowings using bankers' acceptances.
The Company has also entered into an interest rate swap transaction on
borrowings through bankers' acceptances in the amount of $40.0 million maturing
on May 4, 2011. The bankers' acceptance rate on the transaction has an average
fixed rate over two years of 0.94 percent. The effective interest rate over the
two year term on $40.0 million of bankers' acceptances will be 0.94 percent plus
the applicable stamping fee according to the pricing grid for bankers'
acceptances. The fair value of this contract at December 31, 2010 is a loss of
$21,000. If interest rates on prime-based loans had been 100 basis points lower
with all other variables held constant, net earnings for the year ended December
31, 2010 would have been higher by $0.1 million (December 31, 2009 - $0.2
million).
Commodity price risk
Commodity price risk is the risk that the future cash flows will fluctuate as a
result of changes in commodity prices. Commodity prices for petroleum and
natural gas are affected not only by the relationship between the Canadian and
United States dollar, as outlined above, but also world economic events that
dictate the levels of supply and demand. The Company has a commodity price risk
management program in place whereby the commodity price associated with a
portion of its future production is fixed. The Company sells forward a portion
of its future production by entering into a combination of fixed price physical
sale contracts with customers and financial commodity contracts. The Company's
policy is to enter into commodity contracts to a maximum of 40 - 50 percent of
current production volumes.
As at December 31, 2010, the Company had the following financial derivative
contracts which were recorded at fair value on the balance sheet as a current
asset of $2.1 million and long-term liability of $3.5 million (December 31, 2009
- current liability of $0.4 million) with changes in fair value included in
unrealized gain (loss) on risk management activities in the statement of
earnings. For the year ended December 31, 2010, the financial contracts resulted
in gains of $3.4 million (December 31, 2009 - $3.5 million) that have been
included in the statement of earnings as a realized gain on risk management
activities.
Type of Quantity Contract Price
Time Period Commodity Contract Contracted ($/unit)
----------------------------------------------------------------------------
January 2010 - Natural Gas Financial 2,000 GJ/d $5.72 fixed
March 2011
January 2011 - Natural Gas Financial 2,500 GJ/d $ 7.14 Call
December 2011(i)
January 2011 - Natural Gas Financial 3,000 GJ/d $ 4.00 Put
December 2011(iii)
January 2011 - Crude Oil Financial 600 bbls/d U.S. $90.00 Call
December 2012(ii)
April 2011 - Natural Gas Financial 6,810 GJ/d $5.69 fixed
December 2011(ii)
January 2012 - Natural Gas Financial 3,000 GJ/d $ 4.50 Call
December 2012(iii)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(i) The Company sold a natural gas call contract at $7.14 per gigajoule on
2,500 gigajoules per day for the period January 1, 2011 through
December 31, 2011. This call was sold to acquire a natural gas put on
2,500 gigajoules per day at a price of $4.75 per gigajoule for the
period April 1, 2010 through October 31, 2010.
(ii) The Company has acquired a natural gas contract at $5.69 per gigajoule
on 6,810 gigajoules per day for the period April 1, 2011 through
December 31, 2011. This contract was paid for with the sale of a crude
oil call on 600 barrels per day at a price of U.S. $90.00 WTI per
barrel for the period January 1, 2011 through December 31, 2012.
(iii) The Company has acquired a natural gas put contract at $4.00 per
gigajoule on 3,000 gigajoules per day for the period January 1, 2011
through December 31, 2011. This put was paid for with the sale of a
natural gas call on 3,000 gigajoules per day at a price of $4.50 per
gigajoule for the period January 1, 2012 through December 31, 2012.
The Company has Canadian dollar physical sales contracts. The Canadian dollar
physical sales contracts were entered into and continue to be held for the
purpose of delivery of non-financial items as executory contracts and have not
been recorded at fair value. As at December 31, 2010, the Company had the
following physical sales contracts.
Type of Quantity Contract Price
Time Period Commodity Contract Contracted ($/unit)
----------------------------------------------------------------------------
January 2010 - Natural Gas Physical 1,500 GJ/d $5.74 fixed
March 2011
April 2010 - Natural Gas Physical 3,000 GJ/d $6.12 fixed
March 2011
April 2010 - Natural Gas Physical 2,500 GJ/d $5.73 fixed
March 2011
January 2011 - Natural Gas Physical 2,500 GJ/d $3.79 fixed
December 2011
January 2011 - Natural Gas Physical 2,500 GJ/d $4.12 fixed
December 2011(iiii)
April 2011 - Natural Gas Physical 2,000 GJ/d $5.66 fixed
October 2011
January 2012 - Natural Gas Physical 2,500 GJ/d $ 4.50 Call
December 2012(iiii)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(iiii) The Company has acquired a natural gas contract at $4.12 per
gigajoule on 2,500 gigajoules per day for the period January 1, 2011
through December 31, 2011. This contract was paid for with the sale
of a natural gas call on 2,500 gigajoules per day at a price of $4.50
per gigajoule for the period January 1, 2012 through December 31,
2012.
For the year ended December 31, 2010, the Canadian dollar physical contracts
resulted in settlement gains of $12.7 million (December 31, 2009 - $19.2
million) that have been included in petroleum and natural gas sales.
As at December 31, 2010, if natural gas prices had been higher by $0.10 per mcf,
with all other variables held constant, the net change in the unrealized gain on
risk management activities in the statement of earnings for the year would have
been lower by approximately $0.4 million (December 31, 2009 - $0.4 million).
(d) Credit risk
Credit risk represents the financial loss to the Company if counterparties to a
financial instrument fail to meet their contractual obligations and arise
principally from the Company's receivables from joint interest partners. All of
the Company's accounts receivable are with customers and joint interest partners
in the oil and gas industry and are subject to normal industry credit risks.
With respect to counterparties to financial commodity contracts, the Company
partially mitigates associated credit risk by limiting transactions to
counterparties with investment grade credit ratings.
Receivables from petroleum and natural gas marketers are normally collected on
the 25th day of the month following production. The Company's policy to mitigate
credit risk associated with these balances is to establish marketing
relationships with large purchasers. The Company attempts to mitigate the risk
related to joint interest receivables by obtaining partner approval of
significant capital expenditures prior to expenditure. However, partners are
exposed to various industry and market risks that could result in
non-collection. The Company does not typically obtain collateral from natural
gas marketers or joint interest partners; however, the Company does have the
ability to request pre-payment of certain major capital expenditures and
withhold production from joint interest partners in the event of non-payment of
amounts owing.
The carrying amount of cash and accounts receivable represents the maximum
credit exposure. The Company does not consider an allowance for doubtful
accounts is required as at December 31, 2010, however, bad debt expense of $0.3
million was recorded during the year primarily related to the settlement of
disputed processing fees with a joint venture partner.
As at December 31, 2010 the Company's aged receivables are as follows.
December 31, 2010
----------------------------------------------------------------------------
Current (less than 30 days) 15,006
Past due (31-90 days) 1,598
Past due (more than 90 days) 1,293
----------------------------------------------------------------------------
Total 17,897
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(e) Liquidity risk
The Company requires sufficient cash to fund its operating costs and capital
program that are designed to maintain or increase production and develop
reserves, to acquire petroleum and natural gas assets and to satisfy debt
obligations. The majority of capital spent will be funded through cash flow from
operating activities. The Company enters into risk management contracts designed
to improve risk-adjusted returns and to ensure adequate cash flow to fund the
Company's capital program and maintain liquidity. The Company uses a combination
of both financial and physical commodity price contracts. Contracts are
initiated within the guidelines of the Company's risk management program and are
not entered into for speculative purposes. The Company also has a 364 day
revolving credit facility with a syndicate of Canadian chartered banks with a
one year term-out provision.
The following are the contractual maturities of financial liabilities as at
December 31, 2010.
less than 1 1 - 2 3 - 5
Financial liabilities Year Years Years Thereafter
----------------------------------------------------------------------------
Accounts payable and accrued
liabilities 28,416 - - -
Risk management liability - 3,527 - -
Long term debt - principal - 105,000 - -
----------------------------------------------------------------------------
Total 28,416 108,527 - -
----------------------------------------------------------------------------
----------------------------------------------------------------------------
NOTE 11: COMMITMENTS
The Company is committed to future minimum payments for natural gas transmission
and processing, operating leases on compression equipment and office space.
Payments required under these commitments for each of the next five years are:
2011 - $5.9 million; 2012 - $4.6 million; 2013 - $3.5 million; 2014 - $3.0
million; 2015 - $3.0 million.
NOTE 12: CHANGES IN NON-CASH WORKING CAPITAL ITEMS
Years ended December 31 2010 2009
----------------------------------------------------------------------------
Change in working capital item:
Accounts receivable (2,267) (550)
Prepaid expenses and deposits 2,578 (2,874)
Accounts payable and accrued liabilities (4,517) (6,073)
----------------------------------------------------------------------------
Total change in non-cash working capital (4,206) (9,497)
Relating to:
Operating activities (2,154) (4,142)
Investing activities (2,052) (5,355)
----------------------------------------------------------------------------
(4,206) (9,497)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
CORPORATE INFORMATION
DIRECTORS OFFICERS
David J. Reid David J. Reid
President and Chief Executive Officer President and Chief Executive
Delphi Energy Corp. Officer
Tony Angelidis
Tony Angelidis Senior Vice President Exploration
Senior Vice President Exploration
Delphi Energy Corp. Hugo H. Batteke
Vice President Operations
Harry S. Campbell, Q.C. (3)
Partner Michael K. Galvin
Burnet, Duckworth & Palmer LLP Vice President Land
Robert A. Lehodey, Q.C. (2) (3) Rod A. Hume
Partner Vice President Engineering
Osler, Hoskin & Harcourt LLP
Michael S. Kaluza
Stephen Mulherin (1) Chief Operating Officer
Partner
Polar Capital Corporation Brian P. Kohlhammer
Vice President Finance and Chief
Financial Officer
Andrew E. Osis (1)
Chief Executive Officer and Director CORPORATE OFFICE
Poynt Corporation
300, 500 - 4th Avenue S.W.
David Sandmeyer (2) Calgary, Alberta T2P 2V6
Director Telephone: (403) 265-6171
Freehold Royalty Trust Facsimile: (403) 265-6207
Email: info@delphienergy.ca
Lamont C. Tolley (1) (2) Website: www.delphienergy.ca
Independent Businessman
BANKERS
(1) Member of the Audit Committee
(2) Member of the Reserves Committee National Bank of Canada
(3) Member of the Corporate Governance The Bank of Nova Scotia
and Compensation Committee Alberta Treasury Branches
AUDITORS INDEPENDENT ENGINEERS
KPMG LLP GLJ Petroleum Consultants Ltd.
LEGAL COUNSEL STOCK EXCHANGE LISTING
Osler, Hoskin & Harcourt LLP Toronto Stock Exchange - DEE
TRANSFER AGENT
ABBREVIATIONS Olympia Trust Company
bbls barrels mmcf/d million cubic feet per day
bbls/d barrels per day NGL natural gas liquids
mbbls thousand barrels bcf billion cubic feet
mcf thousand cubic feet boe barrels of oil equivalent (6 mcf:1 bbl)
thousand cubic
mcf/d feet per day boe/d barrels of oil equivalent per day
mmcf million cubic feet mmboe million barrels of oil equivalent
Armadillo Resources Ltd (TSXV:ARO)
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Armadillo Resources Ltd (TSXV:ARO)
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