2008-07-29 17:25:00
Masters Energy Inc. Reports Second Quarter 2008 Interim Results
CALGARY, ALBERTA–(EMWNews – July 29, 2008) – Masters Energy Inc. (“Masters” or the “Company”) (TSX:MSY) is pleased to report financial and operating results for the three and six month periods ended June 30, 2008. Several significant highlights were achieved during the periods:
– Funds generated by operations per fully diluted share increased 85 percent to $0.37 for the second quarter of 2008 and 84 percent to $0.69 for the first half of 2008 compared to the same periods in 2007.
– Increased bank line to $32 million from $28 million.
– Reduced 2008 net debt by $4.5 million in the quarter to $16.9 million. Debt to annualized second quarter cash from operations is 0.7 times.
Three Months Ended Six Months Ended
June 30, June 30,
HIGHLIGHTS 2008 2007 2008 2007
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(Unaudited)
Financial ($ thousands, except per share
amounts)
Gross revenue 10,225 6,889 19,675 12,997
Funds generated by operations (1) 5,828 3,129 10,625 5,834
Per share - basic 0.38 0.20 0.69 0.38
- diluted 0.37 0.20 0.68 0.37
Net earnings 2,014 553 2,890 459
Per share - basic 0.13 0.04 0.19 0.03
- diluted 0.13 0.04 0.19 0.03
Capital expenditures 1,018 3,615 5,677 7,249
Working capital deficiency 19 1,062 19 1,062
Long-term debt 16,929 20,741 16,929 20,741
Operations
Production
Crude oil (bbls/d) 674 768 732 751
NGL (bbls/d) 12 16 13 12
Natural gas (mcf/d) 4,244 4,758 4,733 4,489
Total production (boe/d at 6:1) 1,393 1,576 1,534 1,511
Average sales price
Crude oil ($/bbl) 101.36 49.08 87.67 48.45
NGL ($/bbl) 119.70 60.02 103.33 58.44
Natural gas ($/mcf) 9.48 7.27 8.55 7.27
(1) Funds generated by operations is calculated using cash flow from
operating activities as presented in the statement of cash flows before
non-cash working capital and settlement of asset retirement costs.
Presidents Message to the Shareholders
During the second quarter of 2008 Masters invested $1.0 million of capital with a relatively high allocation of funds to well recompletions. The low capital expenditure in the quarter is consistent with Masters’ strategy of conserving and redirecting capital to finance the Little Bow enhanced oil recovery (“EOR”) project with a combination of cash flow and available debt capacity. In the second quarter, we have increased our prospect inventory through purchases of undeveloped land at crown sales.
Strong commodity prices in the second quarter created an increase in cash flow and reduced net debt by $4.5 million from the end of the first quarter 2008. Production volumes were lower than anticipated for several reasons. At Little Bow there was an unusual amount of downtime due to wet weather and associated power interruptions. In addition, a well at Enchant which was placed on production in the fourth quarter of 2007, experienced higher than anticipated production decline. Offsetting this decline, 100 boe/d of natural gas production was brought onstream from the Panny area in July 2008. The Company is currently producing approximately 1,450 boe/d with approximately 250 boe/d being restricted due to lack of processing capacity at third party facilities. We anticipate 50 boe/d to be onstream in the third quarter and the remaining 200 boe/d to be onstream during the first quarter 2009.
For the remainder of 2008, Masters’ strategy is to proceed with implementing the EOR project at our Little Bow property. The project will involve an alkaline surfactant polymer (“ASP”) flood complementing our existing waterflood. The oil pool has produced for a total of 33 years and has been under waterflood for 25 of those years. Based on the results of core studies and reservoir simulation work by independent consultants, an incremental 15 to 20 percent of the original oil in place is expected to be recovered by implementing the ASP flood.
The ASP flood is designed to decrease interfacial tension and improve the vertical sweep efficiency, resulting in a higher ultimate oil recovery than would be achieved with the existing waterflood. Several industry participants in Western Canada have recently announced that they intend to implement an ASP flood in oil pools with similar reservoir characteristics.
Based on detailed engineering design and reservoir simulation studies, Masters’ estimated net cost to construct the ASP facility and install the field infrastructure is approximately $30 million. We anticipate that ASP injection will start in the summer of 2009, approximately one year from the project commencement date. We expect a production response within 3 to 4 months following the initiation of the chemical injection. Masters anticipates funding its share of the project with internal resources. Injection of the ASP will commence subsequent to completion of construction and the net chemical cost over the six year injection period is approximately $32 million.
Approximately 85 percent of the future funds generated by operations in the next 12 months will be allocated to the EOR project with the remaining 15 percent allocated to maintaining and building the Company’s prospect inventory by participating in Crown land sales and acquiring seismic.
Commodity prices have been extremely strong and are expected to remain robust. In particular, the price of medium gravity crude, which represents approximately 90 percent of Masters’ oil production, has risen significantly since the end of 2007. For the second quarter of 2008, the average crude price received by Masters was 34 percent higher than the price received in the fourth quarter of 2007 and 18 percent higher than first quarter 2008. As a result, cash flow per fully diluted share has increased significantly in 2008. The following table illustrates the recent price strength of oil and natural gas:
% %
Change Change
Q4 vs Q1 vs
Q4'07 Q1'08 Q1 Q2'08 Q2
------- ------- ------- -------- -------
Edmonton Par Light Crude($/bbl) 86.89 98.08 13% 126.41 29%
Bow River Medium Crude ($/bbl) 56.41 77.10 37% 104.05 35%
Masters average crude price ($/bbl) 55.49 75.99 37% 101.46 34%
Master average natural gas price
($/mcf) 6.39 7.80 22% 9.48 22%
In April 2008, the bank line was reviewed and consequently increased to $32 million from the bank line of $28 million which was established in 2007.
Director and Staff Announcements
Fred C. Coles, a founding Director of Masters, recently passed away. The Company will miss his guidance and enthusiasm. Masters would like to announce the new appointment of Charles (Chad) S. Weiss to the Board of Directors. Mr. Weiss, a co-founder and Managing Partner of JOG Capital Partners, has over 25 years of experience in the financial and oil and gas industries. From October 2002, until resigning in May 2006 to spend full time with JOG Capital, Mr. Weiss was a Managing Director and Head of the Energy Group for the Royal Bank of Canada (RBC). Before joining RBC, Mr. Weiss was Managing Director and Head of Energy and Power Group at Bank of America Securities. From early 1981, until joining Bank of America securities in 1998, Mr. Weiss was a senior investment banker with Smith Barney (now Citigroup), and for several years was the Managing Director in charge of the Energy and Power group. Mr. Weiss received a Bachelor of Arts degree from Vanderbilt University and a MBA from the University of Chicago Graduate School of Business.
Effective June 30, 2008, Peter Lundberg, Vice President Engineering, has resigned to pursue other business interests. We would like to thank Peter for his contribution and guidance in carrying out our plan of implementing the EOR project at Little Bow. Until a suitable replacement is employed, the duties and responsibilities for this position have been assumed by the President and CEO.
Outlook
Masters’ strategy for the remainder of 2008 and the first half of 2009 is to implement the EOR project at Little Bow and continue to build the Company’s prospect inventory. We estimate that $30 million will be required over the next year to build the infrastructure necessary to start chemical injection the summer of 2009. The source of capital will be a combination of cash flow and available debt capacity. Approximately 85 percent of cash flow will be allocated to the EOR project and the remainder of cash flow will be allocated to building the Company’s prospect inventory by purchasing land at future Crown sales.
We believe that the value of the Little Bow project has the potential to generate significant reserves and production for the Company and our shareholders. It is likely that the allocation of most of our capital budget to the Little Bow project will make it difficult to maintain and increase production over the next year. We believe the EOR project at Little Bow will begin to provide further growth in reserves and production for Masters shareholders during the next two years.
On behalf of the Board of Directors,
Geoff C. Merritt, President and Chief Executive Officer
July 29, 2008
MANAGEMENT’S DISCUSSION AND ANALYSIS
ADVISORIES
Management’s discussion and analysis (“MD&A”) of Masters Energy Inc. (“Masters” or the “Company”), provided as of July 29, 2008, should be read in conjunction with the unaudited financial statements presented for the three and six months ended June 30, 2008 and 2007 and the audited financial statements and related notes for the years ended December 31, 2007 and 2006.
Basis of Presentation – The financial data presented below has been prepared in accordance with Canadian generally accepted accounting principles (“GAAP”). The reporting and the measurement currency is the Canadian dollar.
Non-GAAP Measurements – The MD&A contains the terms ‘funds generated by operations’ and ‘funds generated by operations per share’, which should not be considered an alternative to, or more meaningful than net earnings or cash flow from operating activities as determined in accordance with GAAP as an indicator of the Company’s performance. Masters’ determination of funds generated by operations and funds generated by operations per share may not be comparable to that reported by other companies. Management uses funds generated by operations to analyze operating performance and leverage and considers funds generated by operations to be a key measure as it demonstrates the Company’s ability to generate cash necessary to fund future capital investments and to repay debt. Funds generated by operations is calculated using cash flow from operating activities as presented in the statement of cash flows before changes in non-cash working capital and settlement of asset retirement costs. Masters presents funds generated by operations per share, which is prohibited under GAAP. Per share amounts are calculated using weighted average shares outstanding consistent with the calculation of earnings per share. The following table reconciles funds generated by operations to cash flow from operating activities which is the most directly comparable measure calculated in accordance with GAAP:
Three Months Ended Six Months Ended
June 30, June 30,
($ thousands) 2008 2007 2008 2007
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Cash flow from operating activities $ 3,842 $ 2,990 $ 5,342 $ 3,352
Changes in non-cash working capital 1,955 121 5,252 2,402
Settlement of asset retirement costs 31 18 31 80
--------- -------- -------- --------
Funds generated by operations $ 5,828 $ 3,129 $10,625 $ 5,834
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Masters uses certain industry benchmarks such as operating netback to analyze financial and operating performance. Operating netback is the net result of resource revenues less royalties and operating expenses. This benchmark as presented does not have any standardized meaning prescribed by GAAP and therefore may not be comparable with the calculation of similar measures for other entities.
Working capital, which is defined as current assets less current liabilities, and net debt, which is defined as the sum of working capital and long-term bank debt, is used to assess efficiency and financial strength. There is no GAAP measure that is reasonably comparable to working capital and net debt.
Presentation of BOE – Masters bases calculations of barrels of oil equivalent (“boe”) on a conversion rate of six thousand cubic feet (“mcf”) of natural gas to one barrel (“bbl”) of crude oil. The boe unit may be misleading, particularly if used in isolation. A boe conversion ratio of six mcf equals one bbl is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.
Forward-Looking Information – This MD&A contains forward-looking or outlook information with regard to Masters within the meaning of applicable securities laws. Forward-looking statements may include estimates, plans, expectation, forecasts, guidance or other statements that are not statements of fact. Masters believes the expectations reflected in such forward-looking statements are reasonable. However, no assurance can be given that such expectations will prove to be correct. These statements are subject to certain risks and uncertainties and may be based on assumptions that could cause actual results to differ materially from those anticipated or implied in the forward-looking statements. These risks include but are not limited to: crude oil and natural gas price volatility, exchange rate and interest rate fluctuations, availability of services and supplies, market competition, uncertainties in the estimates of reserves, the timing of development expenditures, production levels and the timing of achieving such levels, Masters’ ability to replace and expand oil and natural gas reserves, the sources and adequacy of funding for capital investments, the Company’s future growth prospects and current and expected financial requirements, the cost of future reclamation and site restoration, the Masters’ ability to enter into or renew leases and to secure adequate product transportation, changes in environmental and other regulations and general economic conditions. These statements speak only as of the date of this MD&A and Masters does not undertake an obligation to update or revise its forward-looking statements as a result of new information, future events or otherwise, except as required by applicable security laws.
PRODUCTION
Three Months Ended Six Months Ended
June 30, June 30,
2008 2007 2008 2007
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Total Production
Crude oil (bbl) 61,301 69,882 133,136 135,968
Natural gas liquids ("NGL") (bbl) 1,066 1,413 2,433 2,151
Natural gas (mcf) 386,177 432,944 861,378 812,425
Total (boe) 126,730 143,452 279,132 273,523
Daily Production
Crude oil (bbl/d) 674 768 732 751
NGL (bbl/d) 12 16 13 12
Natural gas (mcf/d) 4,244 4,758 4,733 4,489
Total (boe/d) 1,393 1,576 1,534 1,511
Production volume for the second quarter ended June 30, 2008 averaged 1,393 boe/d, a decrease of 12 percent in comparison with the second quarter of 2007. Oil and NGL production for the second quarter of 2008 decreased 12 percent to 674 bbl/d from 768 bbl/d in the same period in 2007 as a result of limited seasonal access and facility repairs temporarily shutting in production. Natural gas production for the second quarter ended June 30, 2008 decreased 11 percent to 4.2 mmcf per day from 4.8 mmcf per day for the three months ended June 30, 2007. Natural gas production decreased during 2008 as a result of natural field declines.
Year to date production for the first six months of 2008 was 1,534 boe/d, an increase of two percent in comparison to the same period for 2007.
PRICES
Three Months Ended Six Months
June 30, June 30,
2008 2007 2008 2007
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Crude oil ($/bbl) 101.36 49.08 87.67 48.45
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NGL ($/bbl) 119.70 60.02 103.33 58.44
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Natural gas ($/mcf) 9.48 7.27 8.55 7.27
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West Texas Intermediate (“WTI”) is the benchmark for North American oil prices and is the crude type against which NYMEX futures contracts are priced. Canadian crude oil prices are based on refiners’ postings at hubs such as Edmonton and Hardisty, Alberta. The basis for Canadian postings is the WTI price at Cushing, Oklahoma minus a transportation differential, adjusted for the US/Canadian currency exchange rate and for relative quality and regional market conditions.
During the second quarter of 2008 North America saw significant strength in the price levels for WTI crude oil primarily due to concerns over global supply. As a result, the average price for a barrel of WTI crude during the period increased over $58.85(US) to $123.80(US) from the second quarter of 2007. The Canadian dollar strengthened relative to the US dollar during the course of the year. The average currency exchange rate for $1.00 Canadian increased from $0.882(US) in the first half of 2007 to $0.993(US) in the similar period of 2008. As a result, this lowered the effective price received for delivery of crude expressed in Canadian dollars. The narrowing quality price differential postings on medium type crudes compared to lighter sweet crudes experienced a positive effect during 2008. On a relative weighting comparison basis the Hardisty Bow River medium gravity crude price was approximately 81 percent (2007 – 71 percent) of the Edmonton Par posting prices for light sweet crude. The average price differential between Edmonton light sweet crude postings and Hardisty Bow River medium crude in the second quarter of 2008 of $22.36 per bbl was flat in comparison to 2007 at $22.02 per bbl.
The Company’s crude oil field price for the second quarter of 2008 increased 107 percent to $101.36 per bbl from the average price received in the second quarter of 2007 primarily due to the improvement in the market price for crude.
The Company’s crude oil field price for the first half of 2008 was $87.67 per bbl, an increase of 81 percent from the average price received in the first half 2007 primarily due to an increase in the average WTI posting and a decrease in the quality price differentials for medium gravity crudes relative to lighter sweet crude.
US natural gas prices are typically referenced off NYMEX at Henry Hub, Louisiana while Canadian prices are referenced at Nova Inventory Transfer (“NIT”) or the AECO Hub. Most of Masters’ natural gas is sold to the spot market according to the AECO reference price.
During 2007, record levels of US onshore drilling directed at natural gas prospects and the increase of Liquified Natural Gas (“LNG”) imports into North America, caused natural gas storage to reach historically high levels before the winter heating season.
Internationally, colder than normal conditions in Europe and Asia during the winter heating season, increased the demand for LNG. This resulted in the international spot prices for LNG increasing higher than North America prices. Deliveries of LNG to North America have seen a drop during the first half of 2008. However, this has been offset by a year over year increase in US domestic production of approximately 4 bcf/d, mainly the result of aggressive development of non-conventional natural gas reserves.
Weather is a key component for the demand of natural gas within North America. During the 2007 – 2008 winter, North America experienced colder than normal weather conditions causing the demand for natural gas to return to historic winter levels. Storage levels at the end of the second quarter 2008 were within the five-year averages.
During the first half of 2008, the price received for Masters’ natural gas production ranged from $7.33 per mcf in the month of January to $10.55 per mcf in June. The average natural gas price received during the second quarter of 2008 was $9.48 per mcf, an increase of 30 percent from the price received in the same period of 2007. During the second quarter of 2008 a loss of $0.3 million was realized from the fixed price financial commodity contract. The commodity contract decreased the average natural gas price received by $0.66 per mcf. During the similar period in 2007, the Company realized a gain of $0.1 million from a fixed price financial commodity contract which increased the average price received by $0.17 per mcf.
The average natural gas price received for the first half of 2008 was $8.55 per mcf, an increase of 18 percent from the average price received in the first six months of 2007. For the six months ended June 30, 2008 the realized loss of $0.3 million from the fixed price commodity contract decreased the average price received by $0.30 per mcf. During the similar period in 2007, the realized gain of $0.1 million received from the fixed price commodity contract increased the average price received by $0.09 per mcf.
Masters’ management complies with a Risk Management Policy approved by the board of directors. The objective of Masters’ risk management activities is to reduce exposure to decreases in commodity prices that would materially impact funds generated by operating activities and, ultimately, reduce capital spending which generates Masters’ growth. Any transactions entered would involve credit worthy purchasers and would be for less than one year.
For 2008 Masters has entered into a fixed price financial commodity contract as follows which was outstanding at June 30, 2008;
Daily Notional
Product Index Term Volume Price Received
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Apr. 1/08 - Oct.
Gas Fixed AECO-C 31/08 2,500 GJ $7.745 per GJ
REVENUES
Three Months Ended Six Months Ended
June 30, June 30,
($ thousands, except as indicated) 2008 2007 2008 2007
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Crude oil revenue 6,214 3,430 11,672 6,588
NGL revenue 128 85 252 126
Natural gas revenue 3,659 3,147 7,368 5,910
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Total petroleum and natural gas
revenue 10,001 6,662 19,292 12,624
Royalty revenue 224 227 383 373
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Total resource revenue 10,225 6,889 19,675 12,997
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Total petroleum and natural gas
revenue per boe ($) 78.91 46.44 69.11 46.15
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Total resource revenue per boe ($) 80.68 48.03 70.49 47.52
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Petroleum and natural gas revenues for the second quarter of 2008 increased 50 percent to $10.0 million from the similar period in 2007 as strong commodity prices offset lower production volumes. The petroleum and natural gas revenues for the first half of 2008 was $19.3 million, an increase of 53 percent over the same period in 2007 as a result of higher commodity prices.
Royalty and other income for the second quarter of 2008 remained constant in comparison to the second quarter of 2007 at $0.2 million. Similarly, the royalty and other revenue for the first half of 2008 remained unchanged at $0.4 million.
ROYALTIES
Three Months Ended Six Months Ended
June 30, June 30,
($ thousands, except as indicated) 2008 2007 2008 2007
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Crown 1,490 1,088 3,383 2,301
Freehold and gross overriding 207 129 442 271
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Net royalties 1,697 1,217 3,825 2,572
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Per boe ($) 13.39 8.49 13.70 9.40
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Average royalty rate - net (%)(1) 17.0 18.5 19.8 20.5
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(1) A percentage of total petroleum and natural gas revenue
For the three months ended June 30, 2008, royalties totaled $1.7 million for an average royalty rate relative to oil and gas revenues of 17.0 percent. The decrease in the net average royalty rate is a result of an annual Crown royalty reimbursement received during the second quarter of 2008. On a boe basis, royalties for the period were $13.39 per boe. For the similar period in 2007 the net royalty rate averaged 18.5 percent of oil and gas revenues or $8.49 per boe.
For the six months ended June 30, 2008, royalties totaled $3.8 million for an average rate of 19.8 percent or $13.70 per boe. For the comparable period in 2007 the royalty rate averaged 20.5 percent or $9.40 per boe.
On October 25, 2007, the Government of Alberta announced changes to the royalties payable on production from all Crown mineral rights owned by the province. If enacted as stated, on January 1, 2009, factors that will affect the calculation of Crown royalties to be paid will include the production rate per well, commodity prices and depth of producing wells. Based on Masters’ current production profile and commodity prices, future Crown royalties paid to the province of Alberta in 2009 and thereafter will increase and consequently reduce the cash flow available for future capital spending.
UNREALIZED LOSS ON COMMODITY CONTRACT
For 2008 Masters has entered into a fixed price financial contract as follows which was outstanding as of June 30, 2008;
Daily Notional
Product Index Term Volume Price Received
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Apr. 1/08 - Oct.
Gas Fixed AECO-C 31/08 2,500 GJ $7.745 per GJ
An unrealized loss of $1.1 million, for the second quarter of 2008, (unrealized gain $0.2 million – June 30, 2007) on the commodity contract represents the fair value of the contract at June 30, 2008 as the future average price is greater than the contracted price.
OPERATING EXPENSES
Three Months Ended Six Months Ended
June 30, June 30,
($ thousands except as indicated) 2008 2007 2008 2007
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Total operating expenses 1,845 1,580 3,576 2,944
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Per boe ($) 14.55 11.01 12.81 10.76
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Operating expenses for the three months ended June 30, 2008 was $1.8 million, an increase of 17 percent compared to $1.6 million during the same period in 2007. On a boe basis, the 2008 second quarter operating expenses increased 32 percent to an average cost of $14.55 per boe from $11.01 per boe in the same period in 2007 as a result of higher power and workover costs on productive wells. Operating expenses of $12.81 per boe in the first half of 2007 have increased 19 percent compared to the average boe operating expenses for the similar period in 2007.
Operating expenses per boe for the balance of 2008 are anticipated to remain consistent with the year to date results.
Netback Analysis
Three Months Ended Six Months Ended
June 30, June 30,
($ per boe) 2008 2007 2008 2007
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Oil and gas revenues 78.91 46.44 69.11 46.15
Royalty and other revenue 1.77 1.59 1.38 1.37
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80.68 48.03 70.49 47.52
Royalties, net of ARTC (13.39) (8.49) (13.70) (9.40)
Operating expenses (14.55) (11.01) (12.81) (10.76)
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Operating netback 52.74 28.53 43.98 27.36
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Operating income netback per boe for the second quarter and year to date
2008 were higher as a result of increased commodity prices since similar
periods in 2007.
GENERAL and ADMINISTRATIVE
Three Months Ended Six Months Ended
June 30, June 30,
($ thousands, except as indicated) 2008 2007 2008 2007
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Gross general and administrative 809 992 1,633 1,581
Operating recoveries (18) (16) (52) (32)
Capitalized expenses (159) (321) (423) (495)
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General and administrative expense,
before stock-based compensation 632 655 1,158 1,054
Stock-based compensation 73 89 147 191
Capitalized stock-based compensation (42) (49) (85) (103)
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Total general and administrative
expense 663 695 1,220 1,142
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General and administrative expense,
before stock-based compensation, per
boe ($) 4.99 4.56 4.15 3.85
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Total general and administrative
expense per boe ($) 5.23 4.85 4.37 4.18
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During the second quarter of 2008, net general and administrative costs before stock-based compensation decreased four percent over the similar period in 2007 primarily as a result of a performance-based compensation being awarded during the second quarter of 2007. General and administrative expense per boe has increased nine percent in the second quarter of 2008 versus the second quarter of 2007. The increase in the 2008 total general administrative costs compared to the first half of 2007 is due to staff terminations during the period.
Total general and administrative expenses for the remainder of 2008 are anticipated to be similar to 2007. Based on forecasted production and capital spending on drilling, 2008 average staff levels are anticipated to be lower than 2007.
INTEREST EXPENSE
Three Months Ended Six Months Ended
June 30, June 30,
($ thousands except as indicated) 2008 2007 2008 2007
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Total interest expense 223 308 491 593
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Per boe ($) 1.76 2.14 1.76 2.17
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Interest expense for the three months ended June 30, 2008 was $0.2 million, decreased 28 percent in comparison to the same period in 2007 as average debt levels are lower in 2008. On a boe basis, the 2008 second quarter interest expenses decreased 18 percent to an average cost of $1.76 per boe from $2.14 per boe in the same period in 2007. For the six months ended June 30, 2008, interest expense decreased 17 percent to $0.5 million in comparison to the similar period in 2007. Interest expense was lower during the 2008 period due to lower average debt levels.
DEPLETION, DEPRECIATION and ACCRETION
Three Months Ended Six Months Ended
June 30, June 30,
($ thousands except as indicated) 2008 2007 2008 2007
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Depletion 2,544 2,597 5,562 5,018
Depreciation 2 2 3 4
Accretion on asset retirement
obligations 29 30 59 61
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Total depletion, depreciation and
accretion expense 2,575 2,629 5,624 5,083
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Depletion, depreciation and
accretion expense per boe ($) 20.32 18.33 20.15 18.58
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For the second quarter of 2008, depletion, depreciation and accretion expense decreased two percent to $2.6 million from depletion, depreciation and accretion expense for the same period in 2007. On a boe basis depletion, depreciation and accretion for the second quarter of June 2008 increased eleven percent to $20.32 from $18.33 in the same period in 2007. The aggregate decrease is primarily due to a 12 percent decrease in production offset with a higher depletion rate per boe which has resulted from the cost of adding proved reserves since the second quarter of 2007.
For the six months ended June 30, 2008, depletion, depreciation and accretion expense increased 11 percent to $5.6 million from $5.1 million for the same period in 2007. For the first six months of 2008, depletion, depreciation and accretion expense per boe increased eight percent to $20.15.
At June 30, 2008, the ceiling test calculation indicated that the estimated undiscounted future cash flows from proven reserves exceeded the carrying values of producing petroleum and natural gas properties and therefore a ceiling test impairment does not exist.
INCOME TAXES
Three Months Ended Six Months Ended
June 30, June 30,
($ thousands, except as indicated) 2008 2007 2008 2007
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Future income tax expense 705 148 986 104
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Effective tax rate (%) 25.9 21.1 25.4 18.5
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The future income tax expense provision for the three months ended June 30, 2008 increased to $0.7 million from a future income tax expense of $0.1 million in the same period in 2007. The increase in 2008 future income tax expense was due to higher earnings before income taxes. For the six months ended June 30, 2008, the future tax provision was higher primarily due to the effect of higher earnings before taxes.
As of June 30, 2008, the Company had approximately $43.2 million in tax pools to shelter taxable income in future years.
NET EARNINGS and FUNDS GENERATED BY OPERATIONS
Net earnings was $2.0 million for the three months ended June 30, 2008 compared to net earnings of $0.6 million during the same period in 2007. Net earnings per basic and diluted share for the quarter was $0.13 compared to $0.04 per basic and diluted share during the same quarter in 2007.
For the six months ended June 30, 2008, net earnings increased 552 percent to $2.9 million compared to $0.5 million during the comparable period in 2007. Net earnings per basic and diluted share for the six month period was $0.19 compared to $0.03 during the same period in 2007.
Funds generated by operations increased 86 percent to $5.8 million for the three months ended June 30, 2008 compared to $3.1 million during the same period in 2007. For the first half of 2008, funds generated by operations increased 82 percent to $10.6 million compared to $5.8 million during the first six months of 2007.
The increase in both earnings and funds generated from operations is primarily the result of higher commodity prices.
CAPITAL EXPENDITURES
During the first half of 2008, the Company spent approximately $5.7 million in exploration and development capital expenditures compared to $6.6 million spent in the same period of 2007. The Company drilled seven wells (6.1 net), recompleted/re-entered eight wells (3.7 net), tied-in two wells and added 15,800 net undeveloped acres during the period. During the second quarter of 2007, the Company acquired minor interests in the Little Bow pool and disposed a minor interest in a non-core property in the North Peace River Arch area.
For the balance of the 2008 year, Masters’ strategy is to proceed with construction of an enhanced oil recovery (“EOR”) facility at Little Bow and continue to maintain and build the Company’s drilling prospect inventory. The forecasted capital spending budget for 2008 has been increased to $21.5 million from $15.5 million with approximately 70 percent of the total spending being allocated to the EOR project.
Three Months Ended Six Months Ended
June 30, June 30,
($ thousands) 2008 2007 2008 2007
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Land 229 536 540 1,180
Geological and geophysical 55 628 73 751
Drilling and completions 529 1,007 3,888 2,809
Equipping and facilities 205 827 1,176 1,892
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Total exploration and development
capital 1,018 2,998 5,677 6,632
Producing property acquisition - 882 - 882
Disposal of property - (265) - (265)
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Total capital expenditures 1,018 3,615 5,677 7,249
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Drilling/Recompletion Results
During the second quarter of 2008 the Company recompleted six (1.7) wells resulting in one (0.5) oil well and five (1.2 net) natural gas wells.
Three Months Six Months
Ended Ended Six Months Ended
June 30, 2008 June 30, 2008 June 30, 2007
(wells) Gross Net Gross Net Gross Net
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Oil 1 0.5 3 2.5 4 4.0
Natural Gas 5 1.2 8 3.6 2 1.0
Dry - - 5 4.7 5 3.9
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Total 6 1.7 16 10.8 11 8.9
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Success rate (%) 100 100 69 56 55 56
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LIQUIDITY and CAPITAL RESOURCES
The Company’s total capitalization at June 30, 2008 was $83.8 million (2007 – $77.3 million) with the market value of common shares representing 69 percent (2007 – 62 percent) of total capitalization. Net debt represented 20 percent (2007 – 28 percent) and asset retirement obligations and future income taxes accounted for 11 percent (2007 – 10 percent).
Total Capitalization
($ thousands except as indicated) June 30, December 31,
2008 % 2007 %
----------------------------------------------------------------------------
Common shares outstanding
(thousands) 15,422 15,356
Share price, March 31 ($ per share) 3.74 2.33
---------------------------------------
Total market capitalization 57,678 69 35,779 56
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Working capital deficiency 19 2,560
Bank debt 16,929 18,228
---------------------------------------
Net debt 16,948 20 20,788 32
---------------------------------------
Asset retirement obligation 4,044 5 3,957 6
Future income taxes 5,107 6 4,091 6
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Total capitalization 83,777 100 64,615 100
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---------------------------------------
Net debt to total capitalization 20% 32%
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---------------------------------------
At June 30, 2008 Masters had borrowed approximately $16.9 (December 31, 2007 – $18.2) million and had a working capital deficit of $nil (December 31, 2007 – $2.6 million) amounting to total net debt of $16.9 million (December 31, 2007 – $20.8 million). Net debt for the second quarter of 2008 represents approximately 0.7 times (2007 – 1.7 times) the annualized second quarter 2008 funds generated by operating activities of $23.3 million (2007 – $12.5 million).
Masters has a bank revolving term facility of $32 million to fund future activities. The facility is a borrowing base facility determined by Masters’ latest reserves assessment, results of operations, current and forecasted commodity prices and the prevailing economic market. The facility is reviewed annually with the next scheduled review as at April 30, 2009. At June 30, 2008 the Company had drawn $16.9 million of the revolving credit facility.
The seasonal and capital intensive nature of our activities can create a negative working capital position in quarters with high levels of exploration and development capital spending.
The industry has a pre-arranged monthly settlement day for payment of revenues from all buyers of crude and natural gas. This occurs on the 25th day following the month in which the production is sold. As a result Masters collects sales revenues in an organized manner. Management monitors purchaser credit positions to mitigate any potential credit losses. To the extent Masters has joint interest activities with industry partners we must collect, on a monthly basis, partners’ share of capital and operating expenses. These collections are subject to normal industry risk. Masters collects in advance for significant amounts related to partners’ share of capital expenditures in accordance with the industry operating procedures. At June 30, 2008, Masters had no material accounts receivable deemed uncollectible.
Accounts payable consists of invoices payable to trade suppliers relating to office and field operating activities and our capital spending program. Masters processes invoices within a normal payment period. In addition, the Company has recorded an unrealized loss of $1.0 million from a fixed price financial contract for the second quarter of 2008.
We continually manage Masters’ capital spending program by monitoring forecasted production, commodity prices and anticipated cash flow. Should circumstances arise that negatively affect funds generated by operations, Masters is capable of reducing the level of future capital spending.
The Company’s future investing activities, which consist primarily of capital expenditures on oil and gas activities, will be funded with working capital, funds generated by operations and bank debt.
SHARE CAPITAL
During the second quarter of 2008, 65,000 stock options were exercised for common shares for cash proceeds of $0.2 million. In addition, option holders elected a cashless settlement alternative whereby 175,000 stock options and 65,000 performance warrants were exercised in exchange for 65,792 common shares. The number of common shares issued under the cashless exercise alternative is determined by the difference between the market value of the options and warrants and the exercise price. No shares were issued during the first quarter of 2008.
On November 7, 2007, Masters announced the renewal of a normal course issuer bid which is in effect for one year. During the first quarter ended March 31, 2008, the Company purchased and cancelled 64,700 common shares, for total consideration of $167,000. No common shares were purchased and cancelled during the second quarter of 2008.
As at June 30, 2008, the issued and outstanding common shares of the Company were 15,421,971, options outstanding were 1,159,000 and performance warrants outstanding were 820,000.
OUTLOOK
Based on core analysis and reservoir simulation studies work done by independent consultants on the Little Bow field, incremental oil is anticipated to be recovered under an enhanced oil recovery process utilizing the injection of alkaline surfactant polymer (“ASP”) along with the existing waterflood. Detailed engineering design and the simulation studies have indicated that Masters’ estimated net cost to construct the ASP facility and install field infrastructure is approximately $30 million with approximately one half of the work carried out in 2008 and the balance in 2009. For the balance of the 2008 year, Masters will focus on the implementation of the ASP facility with a limited amount of resources allocated to maintaining and building the Company’s prospect inventory. As a result of the construction of the ASP facility proceeding ahead, the approved 2008 capital budget is $21.5 million, with approximately 70 percent of the 2008 capital spending being allocated to the facility construction with the remainder spent on conventional exploration and development opportunities.
CHANGES IN ACCOUNTING DISCLOSURES
The following disclosures to the financial statements are in effect as of January 1, 2008:
1. Financial instruments
CICA handbook section 3862 requires the Company to increase the disclosure on the nature, extent and risk arising from the financial instruments and how the Company manages those risks. Refer to note 10 of the financial statements for further discussion.
2. Capital disclosures
CICA handbook section 1535 requires the Company to disclose the Company’s objectives, policies and processes for managing the capital structure. Refer to note 5 (d) of the financial statements for further discussion.
FUTURE ACCOUNTING POLICY CHANGES
CICA handbook section 3064, Goodwill and Intangible Assets, will be in effect beginning January 1, 2009. This new section applies to goodwill subsequent to initial recognition and establishes standards for the recognition, measurement and disclosure of goodwill and intangible assets. The new disclosure requirement is not expected to have an impact on the Company’s financial statements.
INTERNATIONAL FINANCIAL REPORTING STANDANDS “IFRS”
In February 2008, the CICA Accounting Standards Board (“AcSB”) confirmed the changeover to IFRS from Canadian GAAP will be required for public entities effective for interim and annual financial statements relating to fiscal years beginning on or after January 1, 2011. The AcSB issued the “omnibus” exposure draft of IFRS with comments due July 31, 2008, wherein early adoption by Canadian entities is also permitted. The Canadian Securities Administrators (“CSA”) has also issued Concept Paper 52-402, which requested feedback on the early adoption of IFRS as well as the continued use of US GAAP by domestic issuers. The eventual changeover to IFRS represents changes due to new accounting standards. The transition from current Canadian GAAP to IFRS is a significant undertaking that may affect the Company’s reported financial position and results of operations.
The Company has not completed development of its IFRS changeover plan, which will include project structure and governance, resourcing and training, analysis of key GAAP differences and a phased plan to assess accounting policies under IFRS as well as potential IFRS 1 exemptions. The Company anticipates completing its project scoping, which will include a timetable for assessing the impact on data systems, internal controls over financial reporting, and business activities, such as financing and compensation arrangements, by the end of the third quarter 2009.
The International Accounting Standards Board (“IASB”) has stated that it plans to issue an exposure draft relating to certain amendments to IFRS 1 in order to make it more useful to Canadian entities adopting IFRSs for the first time. One such exemption relating to full cost oil and gas accounting is expected to result in a reduced administrative transition from the current Canadian AcG – 16 to IFRSs. It is anticipated that this exposure draft will not result in an amended IFRS 1 standard until late in 2009. The amendment will potentially permit the Company to apply IFRSs prospectively to their full cost pool, rather than the retrospective assessment of capitalized exploration and development costs, with the proviso that a ceiling test, under IFRS standards, be conducted at the transition date.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
During the most recent interim period, there have been no changes in Masters’ policies and procedures and other processes that comprise its internal controls over financial reporting, that have materially affected, or are reasonably likely to materially affect, Masters’ control over financial reporting. For further discussion of internal controls over financial reporting refer to Masters’ 2007 Annual Report.
SELECTED QUARTERLY INFORMATION (unaudited)
The unaudited financial data presented below has been prepared in accordance with Canadian generally accepted accounting principles. The reporting and measurement currency is the Canadian dollar.
2008 2007 2006
------ ------ ------
Operations Q2 Q1 Q4 Q3 Q2 Q1 Q4 Q3
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Production
Oil (bbl/d) 674 789 754 787 768 734 749 791
NGL (bbl/d) 12 15 13 13 16 8 10 10
Natural gas
(mcf/d) 4,244 5,222 4,711 4,698 4,758 4,216 4,417 2,897
Total (boe/d) 1,393 1,675 1,552 1,583 1,576 1,445 1,495 1,284
Pricing
Oil ($/bbl) 101.36 75.99 55.49 54.41 49.08 47.78 42.31 58.03
NGL ($/bbl) 119.70 90.56 84.34 63.02 60.02 55.43 71.65 62.71
Natural gas
($/mcf) 9.48 7.80 6.39 6.07 7.27 7.28 7.07 5.61
Total ($/boe) 78.91 60.96 47.04 45.57 46.44 45.83 42.57 48.92
Financial
----------
($ thousands,
except as
indicated)
Total revenue 10,225 9,450 6,966 6,823 6,889 6,108 5,960 5,971
Funds generated
by operations 5,828 4,797 3,384 3,309 3,129 2,705 2,200 3,144
Net earnings
(loss) 2,014 876 774 267 553 (94) 26 815
Per share - basic 0.13 0.06 0.05 0.02 0.04 (0.01) 0.00 0.05
Per share
- diluted 0.13 0.06 0.05 0.02 0.04 (0.01) 0.00 0.05
Capital spending
Exploration and
development 1,018 4,659 2,131 2,863 2,998 3,634 6,022 5,625
Acquisitions/
(dispositions) - - - - 617 - - (6,200)
Total assets 72,166 73,345 71,171 70,440 70,361 69,586 70,275 65,176
Working capital
deficiency 19 3,089 2,560 1,342 1,062 1,990 2,156 1,904
Long-term debt 16,929 18,288 18,228 20,300 20,741 19,550 17,824 14,467
Shareholders'
equity 42,523 40,283 39,501 38,805 38,552 37,910 39,921 39,861
Common Shares
--------------
Weighted average
common shares
outstanding
(thousands)
- basic 15,362 15,318 15,390 15,449 15,460 15,506 15,559 15,570
- diluted 15,725 15,543 15,450 15,586 15,745 15,717 15,974 16,093
Trading Activity
Volume (thousands)
- total 1,748 610 1,588 696 1,255 2,337 865 773
- daily 27 10 25 11 20 37 14 12
Price
($ per share)
- high 3.85 3.20 2.65 3.14 3.22 3.40 4.08 4.28
- low 2.90 2.20 2.01 2.08 2.72 2.41 3.00 3.25
- closing 3.74 3.08 2.33 2.18 3.08 2.89 3.40 3.35
Factors that caused variations over the quarters –
– Production growth, other than the acquisitions is a result of Masters’ exploration and development activities. Timing of production is subject to timing of drilling, facility construction, restricted field access due to poor weather conditions and routine maintenance on central gathering facilities.
– Growth in revenue and funds generated by operations is the combination of increased production and strong commodity prices. Oil prices for medium grade quality crude experienced a large drop in the latter portion of the fourth quarter 2004 due to wider than historical quality differentials. This impacted the prices received by Masters since that time as a majority of the crude production is of medium quality. During the first quarter of 2007 the price quality differentials for medium gravity crudes were returning to historical levels. In the first quarter of 2008, the demand for medium type crudes increased resulting in a decrease to the price quality differentials.
– The net earnings are impacted by depletion, depreciation, accretion and future income taxes. The Company estimates its reserves every quarter based on its acquisition and drilling activities. The annual reserves are determined by independent reservoir evaluators, the results of which can affect fourth quarter reserve additions. Enacted changes to the federal and provincial income tax rates for the oil and gas industry impact future income taxes.
– The development of future drilling prospects and seasonal field conditions influence capital spending. Funds generated by operations, bank debt, working capital and the issuance of common shares primarily funded capital spending.
Masters Energy Inc.
Balance Sheets
(unaudited)
----------------------------------------------------------------------------
($ thousands)
June 30, December 31,
2008 2007
------------- -------------
Assets
Current assets
Accounts receivable $ 3,043 $ 2,517
Prepaid expenses and deposits 500 317
------------- -------------
3,543 2,834
Property and equipment (note 2) 68,623 68,337
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$ 72,166 $ 71,171
------------- -------------
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Liabilities
Current liabilities
Accounts payable and accrued liabilities $ 3,562 $ 5,394
Long-term bank debt (note 3) 16,929 18,228
Asset retirement obligations (note 4) 4,044 3,957
Future income taxes (note 8) 5,107 4,091
------------- -------------
29,642 31,670
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For more information, please contact
Masters Energy Inc.
Geoff Merritt
President and CEO
(403) 290-1785
or
Masters Energy Inc.
Randall Boyd
Chief Financial Officer
(403) 290-1785
Website: www.mastersenergy.comMajor Newsire & Press Release Distribution with Basic Starting at only $19 and Complete OTCBB / Financial Distribution only $89
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