Petrolifera continued to make progress during the first half of 2007, overcoming disappointing successive operating and financial results in the second quarter of the year. Despite this temporary downturn, year over year progress was considerable, as evidenced by the highlights and the statistical table which precedes this letter. Revenue, cash flow and earnings growth was strong for the first half of the year, buoyed of course by an exceptional and record first quarter. However, a number of factors converged to make the second quarter of 2007 difficult and disappointing, thus breaking our string of successive quarterly growth which, in most categories, stretched back over most of the past two years.
Second quarter production and consequent sales declined rather sharply due to a number of factors. Prominent among the influencing issues was the late arrival of drilling rigs in Argentina, where all the company's crude oil and natural gas production occurs on the Puesto Morales Block in the Neuquén Basin. This delayed our systematic scheduling of both exploratory and infill wells, upon which we were relying to not only offset normal productivity declines but also to foster production growth. Additionally, we instituted some self-imposed curtailment of production at certain wells, especially those on the northern lobe, due to high gas/oil ratios and for sound reservoir management purposes until our planned waterflood became operative. Our results were also affected by unacceptable delays in completion of our field facilities, which in some cases needed to be reengineered and resulted in the company assuming full control of field operations from our contract operator. Water incursion in one of our best wells (1013) also affected overall production levels. Also, the timing of sales under Argentinean crude oil marketing procedures resulted in Petrolifera carrying increased short-run inventory, thus reducing reported sales, compared to production, by approximately 600 bbl/d during the second quarter 2007. It is likely the level of crude oil in inventory will be reduced to more normal levels during the balance of the year.
We signaled this downturn to capital markets in July 2007, once we became aware of the likelihood. Actual results ended up modestly lower than originally anticipated primarily due to the performance of the 1013 well and the aforementioned inventory adjustments. It should be noted that with the exception of two wells, most of the company's wells are still flowing oil wells and will only be placed on pump after natural flow ceases. In some cases, productive zones in dual producers remain shut-in until the second zone stops flowing before artificial lift can be employed. The decline experienced is not inexorable but in fact is reversible, with over 1,500 bbl/d of estimated productivity to be reinstated in existing wells during the balance of the year.
Despite the challenges, we remain optimistic for the full year. We have new discoveries at 1028, 1022, 1027 and 1056 at Puesto Morales. The 1028 well was completed at shallow depths in the Centenario Formation, after having flowed light gravity (46 degrees API) oil at rates up to 1,500 bbl/d on test. Centenario oil was recovered during drilling of the 1027 well, but was not tested after the Sierras Blancas Formation flowed over 2,400 bbl/d on test. A shallow twin well to the 1027 producer is scheduled to evaluate the Centenario during the balance of 2007 and Petrolifera also plans more drilling near the 1028 discovery.
Disappointing drilling results were obtained from the Sierras Blancas Formation during the drilling of the RN.PM.Ox-1001 well ("O-1001") on the southern half of the Puesto Morales Block. While the well tested over 1.8 mmcf/d of natural gas, it was accompanied by water at rates which would preclude commercial exploitation. The zone was plugged off and uphole testing of the Loma Montosa or Quintuco Formation for oil and natural gas will proceed later in the year. These results raise the risks associated with two other prospective Sierras Blancas structures identified by the late 2006 3D seismic program and, as noted below, this will impact on our outlook and guidance for the balance of 2007.
Perhaps the most important Argentinean development for the company since our last report was the drilling of wells on the Rinconada Block offsetting an old previously-suspended well which recovered oil in the 1970's when the lands were controlled by YPF. Our Rinconada 1001 well, which was drilled to just over 1,000 meters on a large stratigraphic/structural feature covering up to 90 square kilometers, flowed light gravity 34 degree API crude oil to surface on test at rates of approximately 690 bbl/d. This was followed up by successful drilling at the Rinconada 1003 well, which after a frac initially flowed at similar rates but is being placed on pump. Remedial work also resulted in recovery of oil from the old Rinconada 6 well.
A total of 22 new well locations have been licensed on the Rinconada Block and Petrolifera anticipates assigning one drilling rig (and possibly a second drilling rig) and one completion rig to this multi-well program for the balance of 2007. With continued success, this project could result in material reserve and production additions by year-end 2007 as the company could drill up to 19 wells before year end 2007.
To consolidate our land position on this play, Petrolifera was successful in securing the 253,000 acre Vaca Mahuida Concession at a competitive auction held by the government of the Province of Rio Negro. This block is contiguous with Rinconada, thereby providing protection for the continuation of the shallow Sierras Blancas crude oil play as well as affording new exploration opportunities. Petrolifera committed to reprocess 560 square kilometers of existing 3D seismic, secure an additional 1,150 square kilometers over the block and drill twelve exploratory wells during the ensuing three years, together with agreeing to pay a 23 percent royalty, higher than the Puesto Morales/Rinconada contract. Subsequently, a decision was made to farm out a portion of this commitment to a third party on a two for one basis, thereby leaving Petrolifera with a 75 percent interest while incurring 50 percent of the associated commitment. This is in keeping with the company's risk management strategy.
Subsequent to the reporting period, Petrolifera bid on the Angostura Block in Rio Negro Province. This block lies between our existing Puesto Morales and Rinconada acreage and is of more situational than strategic importance to the company. Results will not be known until sometime in August 2007. Also, Petrolifera was the sole bidder on another block ("Puesto Guevara"), situated southeast of and contiguous with Vaca Mahuida. As sole bidder, the company is awaiting confirmation if this will be awarded to it.
Petrolifera now owns or controls an interest or pending interest in approximately 900,000 acres along the eastern edge of Argentina's Neuquén Basin. The company is extremely well-positioned. To process this acreage and continue its planned drilling programs as now defined, during the balance of 2007 and into 2008 the company has now committed to four drilling rigs for much of this period and expects to imminently add a fifth rig under a short-term arrangement. Also, plans are being finalized to have access to up to four completion rigs for much of the balance of 2007. As mentioned, this should enable Petrolifera to drill 19 of the 22 new locations licensed on the Rinconada block, drill many of the 66 identified Sierras Blancas, Centenario and Loma Montosa locations on the Puesto Morales Block (including proposed injectors for the pending waterflood and natural gas wells to deliver non-associated gas alongside associated volumes through the company's new high pressure natural gas pipeline to Medanito). Having access to these rigs and completion rigs also means a major constraint which inhibited Second Quarter results will be substantially removed for the balance of the year. Three of the rigs and one of the completion rigs are presently operating under long-term contracts, so aggressive drilling plans will no longer be compromised by rig availability.
During the reporting period, Petrolifera advanced its high density airborne gravity/magnetics survey over Ucayali Block 107. A late start caused by bureaucratic delays in bringing an airplane into Peru placed the program in a less-preferred weather window, but over 90 percent of the planned activity has been completed. The company is also well-advanced in its planning to proceed with its proposed 800 kilometer, $20 million 2D seismic program on Block 107, which will proceed as soon as the formal approval of its Environmental Impact Assessment ("EIA") is secured. This is expected imminently. Once all the data is in hand and interpreted, drilling locations will be selected and drilling EIA's will be submitted. In the interim, discussions to secure a drilling rig or rigs for Block 107 and Maranon Block 106 are proceeding.
Work on Block 106 in the Maranon Basin is also proceeding, albeit at a somewhat slower pace than for Block 107 in the Ucayali Basin. Again, plans are being finalized for an exploratory 3D seismic program over lands in proximity to the Corrientes Field, which Block 106 surrounds. Also, 3D seismic is being planned for the Concordia prospect in the southeast corner of Block 106. An extensive 2D seismic program will supplement the 3D programs over near-term drillable prospects.
Subject to receipt of all regulatory approvals, drilling in Peru will initially be conducted initially on Block 107. Specific timing will be determined by rig availability.
Petrolifera now holds interests in one license ("Sierra Nevada") and one Technical Evaluation Agreement ("TEA") at Turpial in the Middle and Upper Magdalena Basin onshore Colombia. The award of a third block, the Sierra Nevada II TEA, which covers over 800,000 acres and surrounds much of the aforementioned license, has been approved by the state agency of Colombia ("ANH") and should be completed in the very near future. This will give Petrolifera an interest in over 1 million acres of prospective crude oil and natural gas rights in Colombia. At this stage the company is committed to modest work programs on the TEA's and plans a 13,000 foot exploratory well on the Sierra Nevada license in late 2008.
Summary results ------------------------------------------------------------------------- Three months ended June 30 Six months ended June 30 ------------------------------------------------------------------------- % % 2007 2006 Change 2007 2006 Change ------------------------------------------------------------------------- FINANCIAL ($000 except per share amounts) Total revenue 28,105 18,821 49 75,227 27,273 176 Cash flow from operations before working capital changes(1) 14,504 9,470 53 39,119 12,905 203 Per share, basic(1) 0.30 0.25 20 0.85 0.35 143 Per share, diluted(1) 0.28 0.19 47 0.77 0.27 185 Net earnings (loss) for the period 4,450 7,685 (42) 19,519 9,228 112 Per share, basic 0.09 0.21 (57) 0.43 0.25 72 Per share, diluted 0.09 0.16 (44) 0.38 0.19 100 Capital expenditures 19,842 2,310 759 27,356 4,631 491 Cash on hand 66,535 25,941 156 Working capital 69,690 28,913 141 Indebtedness - - Shareholders' equity 120,236 40,844 194 Total assets 139,054 52,760 164 OPERATING Daily sales volumes Crude oil - bbl/d 6,644 4,006 66 8,976 2,936 206 Natural gas - mcf/d 1,726 1,181 46 1,792 1,211 48 Barrels of oil equivalent - boe/d(2) 6,932 4,203 65 9,274 3,138 196 Average selling prices Oil - $/bbl 45.17 50.71 (11) 45.34 50.14 (10) Natural gas - $/mcf 1.42 1.33 7 1.48 1.25 18 Barrels of oil equivalent - $/boe(2) 43.65 48.71 (10) 44.16 47.40 (7) Common shares outstanding (000s) Weighted average Basic 47,816 37,399 28 45,835 36,721 25 Diluted 51,303 48,777 5 50,997 48,112 6 End of period Issued 50,084 37,855 32 Fully diluted 53,382 52,172 2 ------------------------------------------------------------------------- (1) Cash flow from operations before working capital changes and cash flow per share do not have standardized meanings prescribed by Canadian generally accepted accounting principles ("GAAP") and therefore may not be comparable to similar measures used by other companies. Cash flow from operations before working capital changes includes all cash flow from operating activities and is calculated before changes in non-cash working capital. The most comparable measure calculated in accordance with GAAP would be net earnings. Cash flow from operations before working capital changes is reconciled with net earnings on the Consolidated Statements of Cash Flows and in the accompanying Management's Discussion & Analysis. Management uses these non-GAAP measurements for its own performance measures and to provide its shareholders and investors with a measurement of the company's efficiency and its ability to fund a portion of its future growth expenditures. (2) All references to barrels of oil equivalent (boe) are calculated on the basis of 6 mcf : 1bbl. Boes may be misleading, particularly if used in isolation. This conversion is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead. >>
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