Duvernay Oil Corp.: Second Quarter Interim Report

2008-08-13 16:14:00

CALGARY, ALBERTA–(EMWNews – Aug. 13, 2008) – Duvernay Oil Corp. (TSX:DDV)

HIGHLIGHTS

– Record quarterly production of 25,584 boepd, a 6% increase over Q1 2008 and 22% over second quarter 2007.

– Record quarterly cash flow of $86.9 million, a 19% increase over first quarter 2008 and a 45% increase over the second quarter 2007.

– Net debt reduced to $437 million at the end of the second quarter, a 17% reduction since the beginning of the year.

– Quarterly operating costs of $5.30/boe, among the best in Industry.

– Five additional Montney horizontals drilled in NEBC and 19 additional Deep Basin gas wells drilled and completed in Alberta since post break-up operations commenced.

– Plant expansions with associated Development drilling programs are anticipated to add 100 mmcfpd of incremental production by April 2009.

PRODUCTION

Second quarter 2008 production of 25,584 boepd was a record and 6% above first quarter 2008 production of 24,102 boepd. This was the third consecutive quarter with sequential quarterly growth rates between 6 and 10%. Second quarter 2008 production was 22% higher then second quarter 2007.

Since post break-up operations commenced with 12 drilling rigs in June, Duvernay has drilled an additional 25 gas wells. The Company has approximately 30 mmcfpd of tested behind pipe volumes to bring on-stream between August and October.

The previously outlined major gas development and facility projects at Groundbirch BC and Sundance Alberta are expected to yield incremental gas volumes of 100 mmcfpd by next spring break-up in April 2009.

SUNSET – GROUNDBIRCH, NEBC

Duvernay has 5 rigs active in the Sunset – Groundbirch complex. The company has drilled an additional 5 horizontals since post break-up operations commenced and with the 3 rigs dedicated to Montney horizontal drilling expects approximately 35 additional horizontal wells by spring break-up 2009. One of the five new horizontals has been completed and tested at initial rates of 6.4 mmcfpd. Completion operations in the other three new wells are ongoing.

Duvernay has also been developing and improving completion and stimulation techniques in vertical Montney penetrations. Typical post-stimulation stabilized test rates of 1.5 – 2.0 mmcfpd are now being realized in these vertical wells. Two existing well-bores were recompleted in the Montney in July at these rates, the Company has an inventory of over 20 existing well bores where the Montney can either be completed or re-completed.

An additional delineation location has been drilled and cased as a multi-zone Triassic gas well at West Groundbirch. A further six wells at West Groundbirch are planned through the balance of 2008, as well as a major tie-in project.

The Groundbirch 4-15 facility expansion project has commenced. The First phase of expansion, which will add 20 to 25 mmcfpd of additional capacity, is on schedule for a late September – early October start-up. The second phase of the expansion, which will add approximately 50 mmcfpd, is planned for February 2009.

ALBERTA DEEP BASIN

Duvernay has seven rigs active in the Alberta Deep Basin complex, and has already drilled 19 new gas wells since post break-up operations commenced in June.

Deep Basin well results continue to improve through both an increase in total gas pay zones per well and improving stimulation techniques. The Obed 1-23 well tested at comingled gas rates of 316 e3m3/d (11.2 mmcfpd), the Sundance 12-8 well tested at comingled gas rates of 280 e3m3/d (10 mmcfpd), and the Oldman 11-13 well tested at final comingled gas rates of 140 e3m3/d (5.0 mmcfpd). Follow-ups to these high rate wells will be drilled during the next several months.

The project to twin the Sundance gas plant is underway with an October 2008 start-up currently anticipated. This project will add approximately 30 mmcfpd of incremental production from the greater Sundance-Obed-Pedley area.

FINANCIAL RESULTS AND OUTLOOK

Funds from operations increased to $86.9 million ($1.38 per diluted equity share) for the three months ending June 30 from $59.8 million ($1.05 per diluted equity share) for the comparable period in 2007. On a per share basis, funds from operations increased by 31% due to a combination of price and production increases. After tax earnings decreased by 66% for the second quarter of 2008 when compared to the same period in 2007 to $6.4 million from $18.6 million, as the Company was required to recognize unrealized natural gas hedging losses in the quarter. Before tax earnings from operations, excluding the effects of unrealized losses on hedging contracts, increased by 98% from $18.9 million to $37.4 million in the second quarter of 2008 compared to the second quarter of 2007. On a per share basis diluted before tax earnings from operations were $0.12 for the second quarter of 2008 compared to $0.41 for the second quarter of 2007. On a per share basis, diluted earnings decreased to $0.10 from $0.33, a 70% decrease.

As is typical of large resource development players, Duvernay engages in natural gas hedging activities to ensure sufficient base levels of cash flow to maintain the large ongoing EP programs. The Company plans to continue to hedge between 25 and 50% of current production when natural gas prices meet or exceed levels utilized in the Company’s five-year development outlook, Duvernay has 79 mmcfpd hedged for the balance of 2008 and 33 mmcfpd hedged in the first half of 2009. The 2008 price in this five-year development plan is $8.00/mcf, the hedged price on 49% of budgeted 2008 production is approximately $8.00/mcf. Unhedged budgeted volumes of 80.9 mmcfpd will receive the prices currently available. These hedged volumes will yield an average internal rate of return of approximately 45% for the Company’s NEBC and Alberta Deep Basin projects. Duvernay’s very low cost structure and its high deliverability gas wells allow these projects to remain profitable even at prices as low as $3.00/mcf.

A very strong year end 2007 reserve report has lead Duvernay’s banking syndicate to increase its line of credit to $575 million, up from $515 million.

Certain information set forth in this management’s discussion and analysis contains forward-looking statements. Forward-looking statements are subject to numerous risks and uncertainties, some of which are beyond Duvernay’s control, including the impact of general economic conditions, industry conditions, volatility of commodity prices, currency fluctuations, imprecision of reserve estimates, environmental risks, competition from other industry participants, the lack of availability of qualified personnel or management, stock market volatility and ability to access sufficient capital from internal and external sources. Readers are cautioned that the assumptions used in the preparation of such information, although considered reasonable at the time of preparation, may prove to be imprecise and, as such, undue reliance should not be placed on forward-looking statements. Duvernay’s actual results, performance or achievement could differ materially from those expressed in or implied by these forward-looking statements, and accordingly, no assurance can be given that any of the events anticipated by the forward-looking statements will transpire or occur, or if any of them do so, what benefits that Duvernay will derive therefrom. Duvernay disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise except as expressly required by applicable securities laws.

Funds from operations and operating netback are not recognized measures under GAAP. Management believes that in addition to net income, funds from operations and operating netback are useful supplemental measures as they demonstrate the Corporation’s ability to generate the cash necessary to repay debt or fund future growth through capital investment. Investors are cautioned, however, that these measures should not be construed as an alternative to net income determined in accordance with GAAP as an indication of Duvernay’s performance. Duvernay’s method of calculating these measures may differ from other companies and accordingly, they may not be comparable to measures used by other companies. Duvernay defines funds from operations as cash from operations before changes in non-cash operating working capital and abandonment costs incurred. The following table shows the reconciliation of funds from operations to operating cash flow as defined by GAAP:



Three months ended Six months ended
June 30 June 30
--------------------------------------------
(000s) 2008 2007 2008 2007
----------------------------------------------------------------------------
Operating Cash Flow,
per Cash flow Statement $ 90,729 $ 64,871 $ 168,739 $ 133,628
Changes in non-cash
working capital (3,843) (5,114) (8,701) (10,175)
----------------------------------------------------------------------------
Funds from operations,
as disclosed $ 86,886 $ 59,757 $ 160,038 $ 123,453
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Operating netback is calculated on a $/BOE basis and is defined as revenue
less royalties, transportation costs and operating expenses, as shown
below:

Three months ended Six months ended
June 30 June 30
--------------------------------------------
($/BOE) 2008 2007 2008 2007
----------------------------------------------------------------------------
Revenue, excluding unrealized
gains and losses on
financial instruments and
processing fee income $ 58.62 $ 48.93 $ 55.24 $ 50.44
Royalties (13.03) (7.31) (11.15) (8.22)
Transportation costs (1.32) (1.47) (1.32) (1.38)
Operating Expenses (5.30) (5.85) (5.38) (5.71)
----------------------------------------------------------------------------
Operating Netback $ 38.97 $ 34.30 $ 37.39 $ 35.13
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Per barrel of oil equivalent (“boe”) amounts have been calculated using a conversion rate of six thousand cubic feet of natural gas to one barrel of oil equivalent (6:1). Barrel of oil equivalents (boe) may be misleading, particularly if used in isolation. A boe conversion ratio of 6mcf:1bbl of oil 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 management’s discussion and analysis should be read in conjunction with Duvernay’s unaudited interim financial statements for the three months ended June 30, 2008 and audited financial statements and notes for the year ended December 31, 2007 and comparative information included therein.

This management’s discussion and analysis is dated August 12, 2008.

Additional information about Duvernay Oil Corp. may be found in documents filed on SEDAR at www.sedar.com and which are also available on Duvernay’s website www.duvernayoil.com.

Quarter ending June 30, 2008 compared to the Quarter ending June 30, 2007.

PRODUCTION

The Corporation’s production for the three months ended June 30, 2008 averaged 25,584 boe/d compared with 20,912 boe/d for the same period in 2007, an increase of 22%. Average production also increased 6% compared to the first quarter of 2008. The Corporation disposed of a small non-core property (500 boepd) during the quarter. Production for the first six months of 2008 averaged 24,843 per day, compared to 20,898 per day for the same period in 2007.



Three months ended June 30
---------------------------------
2008 2007 Change
----------------------------------------------------------------------------
Natural gas (mcf/d) 141,637 109,127 30%
Crude oil and liquids (bbls/d) 1,978 2,724 (27)%
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Oil equivalent - boe 2,328,151 1,902,961 22%
Oil equivalent - boe/d 25,584 20,912 22%
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Six months ended June 30
---------------------------------
2008 2007 Change
----------------------------------------------------------------------------
Natural gas (mcf/d) 135,997 110,450 23%
Crude oil and liquids (bbls/d) 2,176 2,489 (13)%
----------------------------------------------------------------------------
Oil equivalent - boe 4,521,390 3,782,493 20%
Oil equivalent - boe/d 24,843 20,898 19%
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Second First Fourth
Area (boe/d) Quarter Quarter Quarter
----------------------------------------------------------------------------
2008 2008 2007
----------------------------------------------------------------------------
Northeast B.C. 7,105 5,927 5,663
Deep Basin 18,111 17,484 15,882
Other Areas 368 691 475
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25,584 24,102 22,020
----------------------------------------------------------------------------
----------------------------------------------------------------------------

 

New production was sourced from the Deep Basin where 4 new wells were tied-in along with 5 new Montney Northeast B.C. wells also being tied in during the quarter. These production additions offset natural declines and added significant new gas volumes. Prior system constraints were alleviated with the commissioning of the new Oldman gas plant in March 2008. Deep Basin production for the quarter averaged 18,111 boe/d for an increase of 14% compared to the second quarter of 2007 Groundbirch/Sunset production increased to 7,105 boe/d, or 25%, from the same quarter in 2007.

REVENUE AND ROYALTIES

Revenue for the three months ended June 30, 2008 was $139.3 million representing a 48% increase from revenue of $94.4 million for the same period in 2007. Revenue includes all petroleum and natural gas sales, processing fee income and has been adjusted for the effects of commodity hedging (not including unrealized gains and losses). Realized oil and liquids prices for the second quarter of 2008 averaged $113.07 per barrel compared with $62.11 per barrel for the same period in 2007. When comparing Duvernay’s second quarter 2008 oil and liquids price to the second quarter 2007, realized prices increased 82%. World oil price benchmarks increased by $58.78 U.S. in the second quarter of 2008 when compared to the same time period in 2007, or 90%.

Duvernay’s realized corporate gas price for the second quarter of 2008 was lower than the AECO spot price ($8.26 – net of transportation and realized hedging gains/losses versus $9.67). AECO natural gas prices increased by 44% in the second quarter of 2008 compared to the second quarter of 2007. Duvernay’s realized natural gas price increased by 10% when comparing these quarters due to the effects of realized hedging losses. Transportation costs for the second quarter of 2008 were 2.2% of gross revenue or $1.32/boe, compared to 2.9% of gross revenue or $1.47/boe in the second quarter of 2007. Third party processing income of $3.0 million increased compared to the first quarter of 2008. Approximately 23 mmcf/d of third party natural gas continues to be processed through the 120 mmcf/d Cecilia 15-4 gas plant.



DUVERNAY PRICES

Three months ended June 30
---------------------------------
2008 2007 Change
----------------------------------------------------------------------------
Natural gas ($/mcf) $ 8.26 $ 7.54 10%
Crude oil and liquids ($/bbl) 113.07 62.11 82%
Oil equivalent ($/boe) $ 57.30 $ 47.46 21%
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BENCHMARK OIL & GAS PRICES

Three months ended June 30
---------------------------------
2008 2007 Change
----------------------------------------------------------------------------
Natural Gas
NYMEX Henry Hub U.S. ($/mcf) $ 11.47 $ 7.66 50%
AECO ($/mcf) $ 9.67 $ 7.09 36%
Oil
NYMEX U.S. ($/bbl) $ 123.80 $ 65.02 90%
Edmonton Par Cdn. ($/bbl) $ 127.13 $ 73.73 72%
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RECONCILIATION OF AECO INDEX TO DUVERNAY'S REALIZED NATURAL GAS PRICES

Three months ended June 30
----------------------------------------------------------------------------
($/mcf) 2008 2007
----------------------------------------------------------------------------
AECO Index Price $ 9.67 $ 7.09
Transportation (0.14) (0.14)
Heat/Quality Differential 0.56 0.32
Hedge (1.83) 0.27
----------------------------------------------------------------------------
Duvernay realized natural gas price $ 8.26 $ 7.54
----------------------------------------------------------------------------
----------------------------------------------------------------------------

CURRENCY - EXCHANGE RATES
Three months ended June 30
---------------------------------
2008 2007 Change
----------------------------------------------------------------------------
Cdn/U.S. $ $ 0.9903 $ 0.9104 9%
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Revenue is analyzed as follows:

Three months ended June 30
---------------------------------
Revenue 2008 2007 Change
----------------------------------------------------------------------------
Natural gas $ 114,855 $ 76,259 51%
Oil and liquids revenue 21,614 16,847 28%
----------------------------------------------------------------------------
Total Revenue from oil and gas sales 136,469 93,106 47%
Processing and Other Income 2,791 1,287 117%
----------------------------------------------------------------------------
Total revenue, before unrealized
commodity hedging gains/(losses) 139,260 94,393 48%
Unrealized commodity hedging
gains/(losses) (29,650) 4,405 (773)%
----------------------------------------------------------------------------
Total revenue, per financial statements $ 109,610 $ 98,798 11%
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Six months ended June 30
---------------------------------
Revenue 2008 2007 Change
----------------------------------------------------------------------------
Natural gas $ 207,973 $158,908 31%
Oil and liquids revenue 41,787 31,879 31%
----------------------------------------------------------------------------
Total Revenue from oil and gas sales 249,760 190,787 31%
Processing and Other Income 5,555 3,058 82%
----------------------------------------------------------------------------
Total revenue, before unrealized
commodity hedging gains/(losses) 255,315 193,845 32%
Unrealized commodity hedging
gains/(losses) (70,583) (2,904) 2331%
----------------------------------------------------------------------------
Total revenue, per financial
statements $ 184,732 $190,941 (3)%
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Duvernay's royalties are summarized as follows:

Three months ended June 30
---------------------------------
Royalties 2008 2007 Change
----------------------------------------------------------------------------
Natural gas $ 25,832 $ 10,109 156%
Oil and liquids 4,494 3,809 18%
----------------------------------------------------------------------------
Total royalties $ 30,326 $ 13,918 118%
----------------------------------------------------------------------------

Six months ended June 30
---------------------------------
Royalties 2008 2007 Change
----------------------------------------------------------------------------
Natural gas $ 41,862 $ 24,540 71%
Oil and liquids 8,546 6,545 31%
----------------------------------------------------------------------------
Total royalties $ 50,408 $ 31,085 62%
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For the three months ended June 30, 2008, the average effective royalty rate was 22%, compared to 14% for the same period in 2007. Duvernay continued to benefit from the royalty relief programs put into place by the Ministry of Energy and Mines for British Columbia in May 2003, allowing explorers to access reduced royalty rates for low-productivity natural gas wells, royalty credits for deep gas wells and royalty credits for wells drilled in the summer months. The increase in royalties in this period is due to the timing of recognition of royalty holidays in Alberta.

OPERATING EXPENSES

Operating expenses include all periodic lease and field level expenses and include no income recoveries for processing third party volumes. Operating expenses of $5.30/boe for the second quarter of 2008 decreased when compared to the second quarter 2007 operating expenses of $5.85/boe. This is due to Duvernay’s Oldman facility being commissioned late in the first quarter. Total operating expenses for the quarter were $12.3 million compared to $11.1 million in the second quarter of 2007. The Corporation’s second quarter operating expenses include third party processing, gathering and compression fees of $1.5 million or 12% of total operating costs.

GENERAL & ADMINISTRATIVE EXPENSES

General and administrative expenses (“G&A”) are summarized on the table below as follows:



Three months ended June 30
---------------------------------
2008 2007 Change
----------------------------------------------------------------------------
G&A expenses $ 4,435 $ 4,069 9%
Administrative and operating recovery (512) (476) 8%
Capital recovery (1,068) (1,204) (11)%
Capitalized G&A (830) (830) 0%
Stock based compensation 4,643 4,107 13%
Capitalized stock based compensation
(excluding income tax effect) (1,625) (1,781) (9)%
----------------------------------------------------------------------------
Total G&A $ 5,043 $ 3,885 30%
Oil equivalent ($/boe) $ 2.17 $ 2.04 6%
Oil equivalent cash costs ($/boe) $ 0.87 $ 0.82 6%
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Six months ended June 30
---------------------------------
2008 2007 Change
----------------------------------------------------------------------------
G&A expenses $ 8,833 $ 7,726 14%
Administrative and operating recovery (914) (868) 5%
Capital recovery (2,320) (2,559) (9)%
Capitalized G&A (1,780) (1,494) 19%
Stock based compensation 8,627 7,484 15%
Capitalized stock based compensation
(excluding income tax effect) (3,019) (3,246) (7)%
----------------------------------------------------------------------------
Total G&A $ 9,427 $ 7,043 34%
Oil equivalent ($/boe) $ 2.08 $ 1.86 12%
Oil equivalent cash costs ($/boe) $ 0.84 $ 0.74 14%
----------------------------------------------------------------------------

 

Net G&A expenses for the three months ending June 30, 2008 increased to $5.0 million from $3.9 million for the same period in 2007, primarily due to the decrease in capital recoveries as capital spending in the second quarter of 2008 was lower than in the same period in 2007. G&A for the second quarter of 2008 increased to $2.17/boe from $2.04/boe in 2007 as expenses were spread over a greater number of barrels of production. On a cash basis, general and administrative costs increased to $0.87/boe from $0.82/boe for the same period in 2007. This increase in cash G&A is due to administrative growth necessitated by increased regulatory requirements as well as operational growth. The percentage of expenses capitalized as attributable to exploration activities was 35%, consistent with the first quarter of 2007.

DEPLETION, DEPRECIATION AND ACCRETION

Depletion, depreciation and accretion expense (“DD&A”) increased to $46.4 million during the second quarter of 2008 from $38.5 million during the same period in 2007. On a dollars per boe basis, DD&A decreased to $19.86 from $20.12 in the second quarter of 2007. The percentage of the property, plant and equipment investment excluded from the Corporation’s costs subject to depletion (3% in 2008; 5% in 2007) decreased when comparing the second quarter of 2008 with 2007.

INCOME TAXES

The Corporation did not pay any cash income taxes in the second quarter of 2008. The Corporation does not expect to pay any cash income taxes in 2008 based on existing tax pools, planned capital expenditures and the most recent forecast of 2008 taxable income. Although current income tax horizons depend on product prices, production levels, and the nature, magnitude and timing of capital spending, the Corporation currently believes that no cash income tax will be payable for two to three years.

FUNDS FROM OPERATIONS AND EARNINGS

Funds from operations increased to $86.9 million ($1.38 per diluted equity share) for the three months ending June 30 from $59.8 million ($1.05 per diluted equity share) for the comparable period in 2007. On a per share basis, funds from operations increased by 31% due to increases in global commodity pricing as well as strong production growth. After tax earnings decreased by 66% for the second quarter of 2008 when compared to the same period in 2007 to $6.4 million from net earnings of $18.6 million. Significant increases in commodity prices over the last six months have led to unrealized losses on several hedging contracts, required to be recognized as per the recommendations of the financial instruments guidelines for recognition and measurement adopted in January of 2007. Financial Statement note 5 “Financial Instruments” provides further details. Before tax earnings from operations, excluding the effects of unrealized losses on hedging contracts, increased by 98% from $18.9 million to $37.4 million in the second quarter of 2008 compared to the second quarter of 2007. On a per share basis, earnings decreased to $0.10 from $0.33, a 70% decrease. This drop in earnings per share is attributable to the effects of “mark to market” accounting for commodity hedging contracts. There was a subsequent recovery of mark to market losses in the period from June 30, 2008 to July 31, 2008, with the unrealized loss on oil hedges shrinking to $1.7 million from $3.3 million and the gas hedges swinging from a loss of $67.6 million to a gain of $3.8 million.



Three months ended June 30
---------------------------------
2008 2007 Change
----------------------------------------------------------------------------
Funds from operations per equity share (1) $ 1.38 $ 1.05 31%
Earnings per equity share (1) $ 0.10 $ 0.33 (70)%
Operating netback per boe $ 38.97 $ 34.30 14%
----------------------------------------------------------------------------

Six months ended June 30
2008 2007 Change
----------------------------------------------------------------------------
Funds from operations per equity share (1) $ 2.64 $ 2.21 19%
Earnings per equity share (1) $ (0.06) $ 0.53 (111)%
Operating netback per boe $ 37.39 $ 35.13 6%
----------------------------------------------------------------------------
note: (1) diluted

 

LIQUIDITY AND CAPITAL RESOURCES

The Corporation invested $39.3 million in the second quarter of 2008 compared to $84.0 million in the second quarter of 2007, as set out in the following table.



Three Months Ended
---------------------------------------------
June 30 March 31 December 31
($ thousands) 2008 2008 2007
----------------------------------------------------------------------------
Land and seismic $ 8,922 $ 4,073 $ 1,891
Drilling and completions 46,173 105,657 114,180
Facilities 16,397 25,857 27,922
Property Acquisition/(Disposition) (33,088) - (2,138)
Other 855 1,006 1,232
----------------------------------------------------------------------------
Total $ 39,259 $ 136,593 $ 143,087
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The Corporation drilled 15 gross wells (12.7 net) of which 11 are Deep Basin and 4 are Sunset/Groundbirch. 4 gross wells were completed during the second quarter and 9 wells were tied in.

At June 30, 2008 the Corporation’s net debt was $437.0 million. Net debt for purposes of Canadian generally accepted accounting principles (GAAP) includes after tax unrealized hedging losses of $45.4 million. The Company has sold a non core asset (East Flank of the Peace River Arch) for total consideration of $38 million including cash of $33 million, which closed in the second quarter of 2008.

The Company has a syndicated bank facility with a group of Canadian banks. The facility has borrowing capacity of $550 million. In addition the Corporation has a $25 million operating line.

At June 30, 2008 the Corporation estimates that it has fully spent the 2007 flow-through offerings and has an $18.6 million remaining of the obligation for the March 2008 flow-through offering, which must be completed by December 31, 2009.

As at June 30, 2008, the Corporation had 62,746,729 shares outstanding and 4,562,863 stock options outstanding. As at August 12, 2008, the Corporation has 62,834,730 shares outstanding and 4,474,862 stock options outstanding. During the period from June 30, 2008 until August 12, 2008, 88,001 common shares were issued on the conversion of employee stock options, and 15,000 new stock options were issued.

COMMODITY PRICE RISK MANAGEMENT/DERIVATIVE CONTRACTS

The Corporation enters into commodity-based derivative financial instruments and physical commodity contracts such as forwards, futures, swaps, and costless collars to serve two primary business objectives. The first objective is to reduce the variability in cash flows from fluctuations in product prices to ensure a source of funding for the 2008 and 2009 capital program. The second objective is to fix the rate of return on capital invested in the gas prone resource projects. The Board of Directors has approved a policy permitting management to hedge up to a fixed percentage of budgeted corporate annual production. See below for a discussion of changes to the accounting for Financial Instruments effective January 1, 2007. Gains or losses resulting from changes in the fair value of derivative contracts are recognized in earnings and cash flows when those changes occur. None of the Corporations derivative commodity contracts qualify for hedge accounting.

Duvernay enters into most hedging transactions with the same party that the commodity is physically sold to, avoiding the need to provide credit in the event that the hedges are at prices below prevailing prices. The most significant risk with the commodity hedges is that the prevailing product prices are higher than those committed to in the hedging contract. The Corporation partially mitigates this risk by including collars in its hedging portfolio. A less significant risk relates to the Corporation’s ability to supply the production at future dates. This risk is managed by entering into the hedging contracts at multiple delivery points.

At June 30, 2008 Duvernay has calculated the market value of those contracts that were unsettled at June 30 and has estimated net loss from settling these instruments to be approximately $70.9 million. Financial Statement note 1 “Significant Accounting Policies” and note 5 “Financial Instruments” provide further details.

COMMITMENTS AND CONTRACTUAL OBLIGATIONS

Other than with respect to flow-through share obligations and long-term debt commitments, there have been no other significant changes in the Company’s commitments or contractual obligations from those disclosed in the December 31, 2007 Annual Management’s Discussion and Analysis.

CHANGES IN DISCLOSURE CONTROLS AND PROCEDURES/INTERNAL CONTROLS OVER FINANCIAL REPORTING

There have been no material changes in the Company’s disclosure controls and procedures, nor were there changes in the internal controls over financial reporting during the quarter ending June 30, 2008 from the previously reported period.

IMPACT OF NEW ENVIRONMENTAL REGULATIONS

Environmental legislation, including the Kyoto Accord, the federal government’s “EcoACTION” plan and Alberta’s Bill 3 – Climate Change and Emissions Management Amendment Act, is evolving in a manner expected to result in stricter standards and enforcement, larger fines and liability and potentially increased capital expenditures and operating costs.

Given the evolving nature of the debate related to climate change and the resulting requirements, it is not possible to determine the operational or financial impact of those requirements on Duvernay.

CHANGES IN ACCOUNTING POLICIES

FINANCIAL INSTRUMENTS/OTHER COMPREHENSIVEINCOME/HEDGES

Additional disclosure requirements for financial instruments have been approved by the CICA, and were adopted by the Company as of January 1, 2008. Refer to note 4 “Capital Management” and Note 5 “Financial Instruments” for further details.

CONVERSION PROJECT – INTERNATIONAL FINANCIAL REPORTING STANDARDS

In February, 2008, Canada’s Accounting Standards Board confirmed the changeover to International Financial Reporting Standards (‘IFRS’) from current Canadian GAAP for publicly accountable enterprises effective for fiscal years beginning on or after January 1, 2011. The eventual changeover to IFRS represents a change to new accounting standards. The transition from current Canadian GAAP to IFRS is a significant undertaking that may materially affect the Company’s reported financial position and results of operations. The Company is currently developing its transition plan and has commenced its assessment of the impact of IFRS on the entity, its processes and its financial reporting.

IMPACT OF CHANGES IN ALBERTA ROYALTY REGULATIONS

On October 25, 2007, the Government of Alberta announced changes to conventional oil and gas royalties. These changes are to be implemented effective January 1, 2009. Using currently available information, Duvernay has estimated that the impact on 2007 cash flow based on current gas prices would result in approximately a 7% cash flow reduction. The Alberta Deep Gas Royalty holiday will be eliminated, replaced under the new system by a royalty rate adjustment for “Deep Marginal Gas Wells”. Based on the average depth of a Duvernay Deep Basin gas well the impact on full cycle project economics is expected to be minimal.

On April 10, 2008 the October 25, 2007 announcement was changes by Alberta Energy due to “unintended consequences”. The new deep resources program for natural gas exploration and development wells is estimated to reduce the effective Alberta Royalty rates by between 3 and 4 percent based on historical activity levels and depths. This essentially offsets the negative cash flow impact estimated by the corporation that resulted from the October 25. 2007 New Royalty Framework announcement.

SALE TO SHELL CANADA LTD.

On July 11th, 2008 Shell Canada Limited presented an offer to purchase all of the common shares of Duvernay, including shares issuable upon exercise of any option. The offer is open for acceptance until August 22, 2008 unless withdrawn or extended.



SELECT QUARTERLY INFORMATION

2008
------------------------
Q2 Q1
------------------------
PRODUCTION
Crude oil and liquids (bbls) 179,988 216,172
Gas (mcf) 12,888,980 11,862,401
Oil equivalent (boe) 2,328,151 2,193,239
Crude oil and liquids (bbls/d) 25,584 2,376
Gas (mcf/d) 141,637 130,256
Oil equivalent (boe/d) 1,987 24,102
----------------------------------------------------------------------------
FINANCIAL
($ thousands, unless noted)
Gross revenue, net of royalties (2) 79,284 55,030
Cash flow from operations 90,728 78,010
Funds from operations 86,889 73,152
Per share basic 1.41 1.24
Net earnings 6,427 (10,261)
Per share basic 0.10 (0.17)
Per share diluted 0.10 (0.17)
Total assets 1,724,734 1,719,361
Bank debt 379,367 464,364
Cash and working capital (deficiency) (57,660) (117,344)
Basic outstanding Shares 62,747 59,672
----------------------------------------------------------------------------
PER UNIT
Gas, net of transportation ($/mcf) 8.26 7.70
Crude oil and liquids, net of 113.07 88.03
transportation ($/bbl)
Revenue, net of transportation ($/boe) 57.30 50.33
Operating netback ($/boe) 38.97 35.71
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2007 2006
--------------------------------------------------------------------
Q4 Q3 Q2 Q1 Q4 Q3
PRODUCTION
Crude oil
and liquids
(bbls) 184,732 205,034 247,865 202,719 196,225 170,051
Gas (mcf) 11,046,655 9,834,454 9,930,573 10,060,881 8,885,624 7,836,912
Oil
equivalent
(boe) 2,025,840 1,844,110 1,902,961 1,879,533 1,677,162 1,476,203
Crude oil
and liquids
(bbls/d) 2,008 2,229 2,724 2,252 2,133 1,848
Gas (mcf/d) 120,072 106,896 109,127 111,788 96,583 85,184
Oil equivalent
(boe/d) 22,020 20,045 20,912 20,884 18,230 16,046
----------------------------------------------------------------------------
FINANCIAL
($ thousands,
unless noted)
Gross
revenue,
net of
royalties (2) 86,536 63,531 84,880 74,976 72,472 60,355
Cash flow
from
operations 49,800 55,794 64,871 68,757 53,904 32,940
Funds from
operations 69,094 45,107 59,757 63,696 55,845 46,081
Per share basic 1.17 0.79 1.06 1.16 1.05 0.88
Net earnings 28,432 3,529 18,643 10,688 12,242 12,309
Per share basic 0.49 0.06 0.33 0.19 0.23 0.24
Per share
diluted 0.48 0.06 0.33 0.19 0.23 0.23
Total
assets 1,613,649 1,506,322 1,408,797 1,376,671 1,272,571 1,173,784
Bank debt 449,377 399,452 399,452 374,585 324,590 296,703
Cash and
working capital
(deficiency) (76,355) (88,556) (7,213) (72,948) (93,537) (87,959)
Basic outstanding
Shares 58,482 57,445 57,357 55,608 53,962 52,605
----------------------------------------------------------------------------
PER UNIT
Gas, net of
transportation
($/mcf) 6.79 6.23 7.54 8.05 7.25 6.62
Crude oil and
liquids, net
of
transportation
($/bbl) 81.56 71.76 62.11 62.00 56.17 73.07
Revenue, net of
transportation
($/boe) 44.46 41.27 47.46 50.68(1) 45.00 43.58
Operating netback
($/boe) 37.06 27.51 34.30 35.97(1) 34.92 32.42
----------------------------------------------------------------------------

Duvernay's quarterly growth in production volumes, gross revenue and per
share funds from operations is primarily attributed to an active and
successful exploration and development drilling program.

(1) restated to include realized hedging gains

(2) includes the effects of the unrealized gain/losses on financial
instruments

BALANCE SHEET

(Unaudited) (Thousands of dollars) June 30, 2008 December 31, 2007
----------------------------------------------------------------------------
ASSETS
Current assets:
Accounts receivable $ 61,199 $ 61,171
Prepaid expenses and deposits 5,849 1,148
Fair value of financial instruments
(note 5) - 728
Future income tax recovery 18,642
----------------------------------------------------------------------------
85,690 63,047
Investment 20,000 15,000
Property, plant and equipment (note 2) 1,619,044 1,535,602
----------------------------------------------------------------------------
$ 1,724,734 $ 1,613,649
----------------------------------------------------------------------------

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 79,341 $ 138,342
Fair value of financial instruments
(note 5) 64,009 1,060
----------------------------------------------------------------------------
143,350 139,402
Long-term debt (note 3) 379,367 449,377
Fair value of financial instruments (note 5) 7,648 -
Asset retirement obligations 16,822 15,424
Future income taxes 163,179 128,877

Shareholders' equity:
Share capital (note 4) 789,956 649,473
Contributed surplus (note 4) 21,168 24,018
Retained earnings 203,244 207,078
----------------------------------------------------------------------------
1,014,368 880,569
----------------------------------------------------------------------------
Subsequent Event (Note 6) $ 1,724,734 $ 1,613,649
----------------------------------------------------------------------------

See accompanying notes to interim financial statements

INTERIM STATEMENTS OF EARNINGS (LOSS),
COMPREHENSIVE INCOME (LOSS) AND RETAINED EARNINGS

Three months ended Six months ended
June 30 June 30
---------------------- ---------------------
(Unaudited) (Thousands of
dollars except per
share amounts) 2008 2007 2008 2007
----------------------------------------------------------------------------
Revenue:
Petroleum and natural gas sales $161,297 $ 90,370 $ 282,654 $ 182,215
Realized gain on financial
instruments (24,828) 2,736 (32,894) 8,572
Unrealized gain (loss) on
financial instruments
(note 5) (29,650) 4,405 (70,583) (2,904)
----------------------------------------------------------------------------
106,819 97,511 179,177 187,883
Royalties (30,326) (13,918) (50,408) (31,085)
Processing and other income 2,791 1,287 5,555 3,058
----------------------------------------------------------------------------
79,284 84,880 134,324 159,856
Expenses:
Operating 12,347 11,123 24,341 21,604
Transportation 3,066 2,798 5,961 5,218
General and administrative 2,025 1,559 3,819 2,805
Stock-based compensation 3,018 2,326 5,607 4,238
Interest 4,610 5,238 10,748 9,680
Depletion, depreciation and
accretion 46,421 38,543 92,997 77,457
----------------------------------------------------------------------------
71,487 61,587 143,473 121,002
----------------------------------------------------------------------------
Earnings (loss) before taxes 7,797 23,293 (9,149) 38,854
Future income tax (reduction) 1,370 4,650 (5,315) 9,523
----------------------------------------------------------------------------
Net earnings (loss) and
comprehensive income 6,427 18,643 (3,834) 29,331
Retained earnings, beginning of
period 196,817 156,473 207,078 145,785
----------------------------------------------------------------------------
Retained earnings, end of period $203,244 $ 175,116 $ 203,244 $ 175,116
----------------------------------------------------------------------------
Net earnings per share: (Note 4g)
Basic $ 0.10 0.33 $ (0.06) 0.53
Diluted 0.10 0.33 (0.06) 0.53
----------------------------------------------------------------------------

See accompanying notes to interim financial statements.

INTERIM STATEMENTS OF CASH FLOWS

Three months ended Six months ended
June 30 June 30
---------------------- ---------------------
(Unaudited)
(Thousands of dollars) 2008 2007 2008 2007
----------------------------------------------------------------------------
Cash provided by (used in):
Operations:
Net earnings (loss) $ 6,427 $ 18,643 $ (3,834) $ 29,331
Items not involving cash:
Depletion, depreciation, and
accretion 46,421 38,543 92,997 77,457
Stock-based compensation 3,018 2,326 5,607 4,238
Future income tax
(reduction) 1,370 4,650 (5,315) 9,523
Unrealized loss (gain) on
financial instruments 29,650 (4,405) 70,583 2,904
Change in non-cash operating
working capital 3,843 5,114 8,701 10,175
----------------------------------------------------------------------------
90,729 64,871 168,739 133,628
Financing:
Issue of common shares, net
of issue costs 112,629 60,680 148,811 102,752
Increase (decrease) in
long-term debt (85,000) 24,867 (70,010) 74,862
----------------------------------------------------------------------------
27,629 85,547 78,801 177,614
Investments:
Additions to property,
plant, and equipment (72,347) (83,681) (208,940) (220,415)
Property (acquisitions)/
dispositions 33,088 (293) 33,088 (1,024)
Change in non-cash working
capital (79,099) (66,444) (71,688) (89,803)
----------------------------------------------------------------------------
(118,358) (150,418) (247,540) (311,242)
Increase (Decrease) in cash - - - -
Cash, beginning of period - - - -
----------------------------------------------------------------------------
Cash, end of period $ - - $ - -
----------------------------------------------------------------------------
Cash tax $ - - $ - -
Cash interest $ 4,973 4,608 $ 9,486 9,967
----------------------------------------------------------------------------

See accompanying notes to interim financial statements.

 

Information as at June 30 and for the three and six months ended is unaudited

(Tabular Amounts in Thousands of Dollars)

1. SIGNIFICANT ACCOUNTING POLICIES:

The financial statements of the Corporation have been prepared by management in accordance with Canadian generally accepted accounting principles for Interim Financial Statements. These interim financial statements follow the same accounting policies and methods as the financial statements for the year ended December 31, 2007, except as noted below, and include all adjustments necessary to present fairly the results for the interim period. Certain information and footnote disclosure normally included in the annual financial statements has been omitted. These interim financial statements should be read in conjunction with the financial statements and notes for the year ended December 31, 2007.

2. PROPERTY, PLANT & EQUIPMENT:

The cost of unproven lands and seismic costs at June 30, 2008 of $54.8 million (December 31, 2007 – $111.6 million) has been excluded from the depletion calculation. Future development costs for the six months ended June 30, 2008 of $ 578.1 million (December 31, 2007 – $700.7 million) were included in the depletion calculation.

General and administrative expenditures of for the six months ended June 30, 2008 of $6.0 million (December 31, 2007 – $10.2 million) have been capitalized and included as costs of petroleum and natural gas properties. Included in this amount is the year to date non-cash related stock-based compensation of $4.2 million, which includes the associated future tax liability of $1.2 million.

3. LONG-TERM DEBT:

The Corporation has a syndicated financing arrangement with a group of Canadian Chartered banks for an extendible revolving loan in the amount of $550 million in addition to a $25 million operating line. The terms of this agreement are unchanged from the previous credit agreement. The facility has a renewal date of May 2009, if it is not renewed it becomes due and payable at that time. As at June 30, 2008, $379.4 million of this term loan was drawn.

4. CAPITAL:

(A) AUTHORIZED:

Unlimited number of common shares and Class A common shares

Unlimited number of first preferred shares and second preferred shares, each issuable in series.



(B) COMMON SHARES ISSUED:
Number of Shares Amount
----------------------------------------------------------------------------
Balance, December 31, 2007 58,481,774 $ 649,473
For cash on public share issue 2,000,000 91,000
For cash on private placement of
flow-through shares 720,000 30,420
For cash on exercise of stock options 1,544,955 33,283
Contributed surplus on exercise of stock
options 11,476
Share issue costs (5,892)
Tax effect on share issue costs 1,637
Tax effect on flow-through renunciation (21,441)
----------------------------------------------------------------------------
Balance, June 30, 2008 62,746,729 $ 789,956
----------------------------------------------------------------------------
----------------------------------------------------------------------------

 

(C) FLOW-THROUGH SHARES:

At June 30, 2008 the Corporation estimates that it has fully spent the two 2007 flow-through offerings and has a $18.6 million remaining of the obligation for the March 2008 flow-through offering, which must be completed by December 31, 2009.



(D) CONTRIBUTED SURPLUS:
----------------------------------------------------------------------------
Contributed surplus, December 31, 2007 $ 24,018
Stock-based compensation 8,627
Exercise of stock options (11,477)
----------------------------------------------------------------------------
Contributed surplus, June 30, 2008 $ 21,168
----------------------------------------------------------------------------
----------------------------------------------------------------------------

 

(E) STOCK OPTIONS:

The Corporation has a stock option plan. Under the employee stock option plan, the Corporation may grant options to its employees for up to 10% of outstanding common stock. The exercise price of each option equals the market price of the Corporation’s stock on the date of grant and an option’s maximum term is five years. Options are granted throughout the year and vest 1/3 on each of the first, second and third anniversaries from the date of grant.

Changes in the number of options, with their weighted average exercise price, are summarized below:



Weighted
Number of average
Options exercise price
----------------------------------------------------------------------------
Stock options outstanding, beginning of period 5,777,818 $ 30.21
Granted 330,000 48.83
Exercised (1,544,955) 21.54
----------------------------------------------------------------------------
Stock options outstanding, end of period 4,562,863 $ 34.25
----------------------------------------------------------------------------
----------------------------------------------------------------------------

 

(F) STOCK-BASED COMPENSATION:

The weighted average fair value of the stock options granted during the three month period ending June 30, 2008 was $22.28 (2007 – $9.66) per option and is estimated on the date of grant using the Black-Scholes option-pricing model with weighted average assumptions for grants as follows:



Three and Six Months Ended June 30
----------------------------------------------------------------------------
2008 2007
----------------------------------------------------------------------------
Risk-free interest rate (%) 4.0 - 4.5 4.5
Expected life (in years) 3.5 3.5
Expected volatility (%) 35 30
Expected forfeitures (%) 0 - 10 10
----------------------------------------------------------------------------
----------------------------------------------------------------------------

 

(G) PER SHARE AMOUNTS:

Per share amounts have been calculated on the weighted average number of shares outstanding. The weighted average shares outstanding for the quarter ended June 30, 2008 was 61,420,028 (six months – 59,754,821).

In computing diluted earnings per share for the quarter ended June 30, 2008, 1,435,840 shares were added to the weighted average number of common shares outstanding for the dilution from stock options. Due to the net loss realized in the 6 month period ending June 30, 2008, earnings per share and diluted earnings per share are equal. For the three months ended there were 180,000 options excluded (for the six months ended there were no options excluded, due to the net loss position) from the diluted earnings per share calculation on the basis that they were anti-dilutive.

(H) CAPITAL MANAGEMENT:

The Company’s policy is to maintain a strong capital base so as to maintain investor, creditor and market confidence and to sustain the future development of the business. The Company considers it capital structure to include shareholders’ equity, bank debt and working capital. In order to maintain or adjust the capital structure, the Company may from time to time issue shares and adjust its capital spending to manage current and projected debt levels. The annual and updated budgets are approved by the Board of Directors.

The key measures that the Company utilizes in evaluating its capital structure are total debt adjusted for unrealized gains and losses on financial instruments to cash flow from operations (before changes in non-cash working capital) and the current credit available from its creditors in relation to the Company’s budgeted capital program. Debt adjusted for unrealized gains and losses on fi

For more information, please contact

Duvernay Oil Corp.
Michael Rose
President and C.E.O.
(403) 571-3600

or

Duvernay Oil Corp.
Brian Robinson
Vice-President, Finance and C.F.O.
(403) 571-3609

or

Duvernay Oil Corp.
Scott Kirker
Manager – Corporate Affairs
(403) 571-3683

or

Duvernay Oil Corp.
1500 – 202 6th Avenue S.W.
Calgary AB T2P 2R9
(403) 571-3600
(403) 269-6510 (FAX)
Email: info@duvernayoil.com
Website: www.duvernayoil.com

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