Bonterra Oil & Gas Ltd. Third Quarter 2009

Transcription

1 Bonterra Oil & Gas Ltd. Third Quarter HIGHLIGHTS Three months ended Sept. 30, Sept. 30, 2008 Nine Months Ended Sept. 30, Sept. 30, 2008 ($ 000 except $ per share/unit) FINANCIAL Revenue realized oil and gas sales 20,965 34,226 60,766 99,117 Funds flow (1) 10,753 21,158 28,909 60,568 Per share/unit basic Per share/unit diluted Payout ratio (2) 76% 77% 75% 70% Cash flow from operations 9,350 22,492 25,225 59,234 Per share/unit basic Per share/unit diluted Payout ratio (2) 87% 73% 85% 72% Cash dividends per share/unit (2) Net earnings 5,790 21,125 16,427 44,841 Per share/unit basic Per share/unit diluted Capital expenditures and acquisitions 17,660 6,038 22,616 15,002 Total assets 273, ,120 Working capital deficiency 14,455 47,499 Long-term bank debt 81,386 - Shareholders /Unitholders equity 74,025 57,623 OPERATIONS (3) Oil and NGLs barrels per day 3,084 2,998 3,126 3,053 average price ($ per barrel) Natural gas MCF per day 10,881 7,233 11,433 7,215 average price ($ per MCF) Total barrels of oil equivalent per day (BOE) (4) 4,898 4,204 5,032 4,256 (1) Funds flow is not a recognized measure under GAAP. For these purposes, the Company defines funds flow as funds provided by operations before changes in non-cash operating working capital items excluding gain on sale of property, restricted cash and asset retirement expenditures. (2) Cash payments per share/unit are based on payments made in respect of production months within the quarter. (3) Prior period volumes have been adjusted for prior period adjustments related to various 13 th month reviews and joint venture audits completed during the third quarter. Total 2008 volume adjustments are a negative 7,328 barrels of liquids and a negative 6,853 MCF of natural gas. (4) BOE is calculated using a conversion ratio of 6 MCF to 1 barrel of oil. The 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 and as such may be misleading if used in isolation.

2 - 2 - Bonterra Oil & Gas Ltd. REPORT TO SHAREHOLDERS Bonterra Oil & Gas Ltd. ( Bonterra or the Company ) is pleased to report its operating and financial results for the three months and nine months ended September 30,. Bonterra is committed to a long-term approach in both operating its business and creating additional value for its shareholders. As a result, the Company has continued its strong dividend policy while focusing on maintaining a sustainable pace of development and a conservative capital structure. Bonterra is always looking to develop new long-term growth opportunities and is currently developing the very promising extension of the Pembina Cardium pool using horizontal multi-stage frac technology. Operations Bonterra s operations are highly-focused with approximately 83 percent of corporate reserves and approximately 85 percent of production from the Pembina Cardium field, Canada s largest original-oil-inplace pool (17 percent recovered to date). The Company s capital development program of $35 million is focused on unlocking additional value from the Pembina field and includes a targeted drilling program of horizontal multi stage fractured wells and vertical wells and land and corporate acquisitions. Bonterra has developed a drilling inventory of over 14 years comprised of 400 primarily oil locations, including 80 to 100 horizontal locations in the Pembina field outside of the traditional producing area and numerous horizontal wells in the existing producing area (the number will be determined when there is a longer history from wells already drilled in this area by other oil companies). To date, Bonterra has drilled five gross (3.409 net) Pembina Cardium horizontal oil wells, all outside of the traditional producing area. The first well was placed on production in February of this year with cumulative production to the end of October of 39,000 BOE. The second well was placed on production in August of this year with cumulative production of 17,200 BOE, also to the end of October. The two wells are currently producing at a combined rate of approximately 235 BOE per day of clean oil. The third well came on production in mid-october and is currently producing approximately 40 BOE per day. This well was drilled further from the edge of the main Cardium pool (where the reservoir quality is poorer) as part of a farm-in to earn additional potential lands. Bonterra is currently monitoring the well s productivity to ensure there are no mechanical issues with the well and will be evaluating if remedial work may be required to improve the well s productivity. The fourth well was completed and tested at significant rates after recovery of all its load oil. This well is expected to produce at rates similar to the first two wells. The well is currently shut-in for a required pressure build-up and tie-in. The well should be on production by mid-november. The fifth well has been drilled and will be completed in November and placed on production by early December. Initial well information is encouraging. The drilling rig, after a brief weather delay, has commenced drilling the sixth well in early November. Bonterra has also expanded its land holding in the Pembina field with the acquisition of mineral rights at a cost of approximately $4.8 million. In addition, the acquisition of Cobalt Energy Ltd., effective July 1,, included interest in approximately 11 sections of land with Cardium horizontal potential in the Pembina area and an additional 40 BOE per day of production. The company s current land position totals approximately 150 gross sections in the Pembina area (93 net) of which the Company operates approximately 110 of these sections. The horizontal development program at Pembina has exceeded Company expectations and as such the Board of Directors and management have approved an acceleration of the program. The Company intends

3 - 3 - Bonterra Oil & Gas Ltd. to add a second rig to the project in mid-november. A total of at least 10 additional horizontal wells are planned to be drilled prior to spring break-up. Subsequent to quarter-end, Bonterra completed a disposition of non-core producing assets in the Shaunavon area of Saskatchewan to Eagle Rock Exploration for $24 million in cash and approximately 30.8 million common shares in Eagle Rock. The disposition consisted of approximately 200 BOE per day of medium gravity oil and 18.5 sections of land. Proceeds from the disposition will be used for the acceleration of the horizontal drill program in the Pembina area. Production Bonterra s production volumes have increased approximately 18 percent in the first nine months of from the same period last year to 5,032 BOE per day. As anticipated, production was slightly lower quarter over quarter due to longer than usual gas plant turnarounds which resulted in over 1,000 MCF per day shut in for a two week period in July. In addition, approximately 400 MCF per day was shut in at the beginning of August due to low natural gas prices. The Company will be reactivating these wells as natural gas prices continue to improve. Production guidance for the year has been lowered to approximately 5,100 BOE per day from 5,200 BOE per day to reflect the shut-in production mentioned above, deferring of capital expenditures to the second half of the year, the Shaunavon disposition and a net negative adjustment to resulting from underpayment of joint venture parties in 2008 after the Company completed several 13 th month adjustments and joint venture audits. However, this still represents an approximate 20 percent increase in average daily production rates over the previous year. Financial Financial results during the third quarter of continued to be negatively impacted by the low commodity price environment. Revenue and cash flow from operations in the first nine months of decreased 39 percent and 57 percent, respectively when compared to the same period in 2008 primarily due to a 42 percent decrease in crude oil prices and a 54 percent decrease in natural gas prices over the same time frame. However, quarter over quarter revenue and cash flow from operations began to show modest improvements due mainly to the healthier crude oil prices being received. Subsequent to quarter-end, prices continued to increase with WTI crude oil averaging approximately U.S. $76.00 per barrel and AECO natural gas averaging $4.68 per MCF in the month of October. The nine month increase in G&A to $2,835,000 from $2,577,000 in the 2008 nine month period is extremely perplexing. Despite reducing G&A costs by approximately $1,000,000, mainly from reductions in compensation paid to employees and consultants, the overall costs increased by $150,000. The $1,150,000 cost is almost entirely attributable to increases in fees for banks and the professional fees needed to deal with changes to financial and regulatory reporting requirements. These costs are out of control and contribute nothing towards Company operations. Individual companies have no control over these types of costs and something needs to be done on a united front to be able to intervene in the annual, very substantial increases that are taking place in these areas. Bonterra s netbacks have also shown improvements with a 12 percent increase to $23.96 per BOE in the third quarter of compared with $21.45 per BOE in the second quarter of. Netbacks have been positively impacted by the continued increase in crude oil prices and improving natural gas prices. In addition, Bonterra has decreased both field operating costs and general and administrative costs quarter over quarter which has contributed to the enhanced netback levels.

4 - 4 - Bonterra Oil & Gas Ltd. As a result, Bonterra was able to increase the dividend to shareholders to $0.16 per share beginning with the October 30, dividend payment (September production month) from $0.14 per share previously. Cash payments to shareholders during the second quarter of totaled $0.44 per share with a payout ratio of 76 percent of fund flow. The Board of directors and management will continue to monitor dividend levels, payout ratios and capital expenditures on a monthly basis and will adjust the payment if necessary. Outlook To ensure sustainability, the Company continues to develop new long-term, lower-risk opportunities with a particular focus on the acceleration of its Pembina Cardium horizontal play. The lower pricing environment may still provide opportunities for the Company in acquiring additional land and producing properties or additional corporate acquisitions for further growth of its asset base. As well, Bonterra will continue to seek out opportunities to strengthen its financial position through cost-reduction initiatives, project reviews and the implementation of further operational efficiencies across the company. Subject to commodity prices and regulatory policies such as the Alberta competition review, Bonterra is projecting 2010 capital expenditures of $40,000,000 to $50,000,000, production volumes of 5,700 BOE per day to 6,000 BOE per day and a debt to cash flow ratio of approximately 1.5 to 1. Bonterra remains well-positioned to continue paying a high dividend, maintaining the long-term sustainability of its business and providing superior value to its shareholders. George F. Fink Chief Executive Officer and Director Randy M. Jarock President and Chief Operating Officer

5 - 5 - Bonterra Oil & Gas Ltd. MANAGEMENT S DISCUSSION AND ANALYSIS The following report dated November 11, is a review of the operations and current financial position for Bonterra Oil & Gas Ltd. ( Bonterra or the Company ) and should be read in conjunction with the unaudited financial statements for the nine months ended September 30,, including the notes related thereto, and the audited financial statements for the fiscal year ended December 31, 2008, together with the notes related thereto. Non-GAAP Measures Throughout the MD&A we use the terms payout ratio and cash netback to analyze operating performance. Payout ratio is calculated by dividing cash distributions/dividends to unitholders/shareholders by cash flow from operating activities both of which are measures prescribed by GAAP which appear on our consolidated statements of cash flows. Cash netback is calculated by dividing various operation and deficit statement items as determined by GAAP by total production on a barrel of oil equivalent basis. The above terms do not have standardized meaning or definition as prescribed by GAAP and therefore may not be comparable with the calculation of similar measures by other entities. Forward-looking Information Certain statements contained in this MD&A include statements which contain words such as anticipate, could, should, expect, seek, may, intend, likely, will, believe and similar expressions, relating to matters that are not historical facts, and such statements of our beliefs, intentions and expectations about development, results and events which will or may occur in the future, constitute forward-looking information within the meaning of applicable Canadian securities legislation and are based on certain assumptions and analysis made by us derived from our experience and perceptions. Forward-looking information in this MD&A includes, but is not limited to: expected cash provided by continuing operations; cash dividends; future capital expenditures, including the amount and nature thereof; oil and natural gas prices and demand; expansion and other development trends of the oil and gas industry; business strategy and outlook; expansion and growth of our business and operations; and maintenance of existing customer, supplier and partner relationships; supply channels; accounting policies; credit risks; and other such matters. All such forward-looking information is based on certain assumptions and analyses made by us in light of our experience and perception of historical trends, current conditions and expected future developments, as well as other factors we believe are appropriate in the circumstances. The risks, uncertainties, and assumptions are difficult to predict and may affect operations, and may include, without limitation: foreign exchange fluctuations; equipment and labour shortages and inflationary costs; general economic conditions; industry conditions; changes in applicable environmental, taxation and other laws and regulations as well as how such laws and regulations are interpreted and enforced; the ability of oil and natural gas companies to raise capital; the effect of weather conditions on operations and facilities; the existence of operating risks; volatility of oil and natural gas prices; oil and gas product supply and demand; risks inherent in the ability to generate sufficient cash flow from operations to meet current and future obligations; increased competition; stock market volatility; opportunities available to or pursued by us; and other factors, many of which are beyond our control. Actual results, performance or achievements could differ materially from those expressed in, or implied by, this forward-looking information and, accordingly, no assurance can be given that any of the events anticipated by the forward-looking information will transpire or occur, or if any of them do, what benefits will be derived there from. Except as required by law, Bonterra disclaims any intention or obligation to update or revise any forward-looking information, whether as a result of new information, future events or otherwise. The forward-looking information contained herein is expressly qualified by this cautionary statement.

6 - 6 - Bonterra Oil & Gas Ltd. FINANCIAL AND OPERATIONAL DISCUSSION Quarterly Comparisons Financial ($ 000 except $ per share) Q3 Q2 Q1 Revenue realized oil and gas sales 20,965 20,501 19,300 Cash flow from operations 9,350 9,238 6,632 Per share basic Per share fully diluted Cash payments per share (1) Payout Ratio (1) 87% 77% 94% Net earnings 5,790 4,544 6,093 Per share basic Per share fully diluted Capital expenditures and acquisitions 17,660 2,255 2,696 Total assets 273, , ,732 Working capital deficiency 14,455 13,989 14,909 Long-term bank debt 81,386 71,573 89,383 Shareholders equity 74,025 72,332 56,377 Operations (2) Oil and NGLs (barrels per day) 3,084 3,029 3,268 Natural gas (MCF per day) 10,881 11,551 11,877 Total BOE per day (3) 4,898 4,954 5, Financial ($ 000 except $ per share/unit) Q4 Q3 Q2 Q1 Revenue realized oil and gas sales 22,613 34,226 34,398 30,493 Cash flow from operations 10,336 22,492 20,530 16,212 Per share/unit basic Per share/unit fully diluted Cash payments per share/unit (1) Payout Ratio (1) 105% 73% 69% 73% Net earnings 10,585 21,125 12,912 10,804 Per share/unit basic Per share/unit fully diluted Capital expenditures and acquisitions 30,405 6,038 2,543 6,421 Total assets 265, , , ,169 Working capital deficiency 23,878 47,499 57,148 57,810 Long-term bank debt 79, Shareholders /unitholders equity 56,777 57,623 46,612 48,136 Operations (3) Oil and NGLs (barrels per day) 3,055 2,998 3,009 3,153 Natural gas (MCF per day) 8,817 7,233 7,272 7,139 Total BOE per day (2) 4,525 4,204 4,221 4,343

7 - 7 - Bonterra Oil & Gas Ltd Financial ($ 000 except $ per unit) Q4 Q3 Q2 Q1 Revenue realized oil and gas sales 26,573 23,794 23,462 22,602 Cash flow from operations 13,369 11,886 13,413 12,765 Per unit basic Per unit fully diluted Cash distributions (1) Payout Ratio (1) 84% 94% 84% 87% Net earnings 8,372 8,945 5,371 7,662 Per unit basic Per unit fully diluted Capital expenditures and acquisitions 7,213 2,763 1,699 7,625 Total assets 143, , , ,926 Working capital deficiency 58,766 50,041 49,595 49,288 Long-term bank debt Unitholders equity 44,218 50,820 51,920 57,646 Operations Oil and NGLs (barrels per day) 3,098 3,054 3,074 3,227 Natural gas (MCF per day) 7,176 6,196 6,663 6,470 Total BOE per day (3) 4,295 4,086 4,184 4,305 (1) Cash payments per share/unit are based on payments made in respect of production months within the quarter. (2) and 2008 quarterly volumes have been adjusted for prior period adjustments related to various 13 th month reviews and joint venture audits that were completed during the third quarter of. (3) BOE is calculated using a conversion ratio of 6 MCF to 1 barrel of oil. The 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 and as such may be misleading if used in isolation. Production Sept. 30, Three months ended June 30, Sept. 30, 2008 Nine months ended Sept. 30, Sept. 30, 2008 Crude oil and NGLs (barrels per day) 3,084 3,029 2,998 3,126 3,053 Natural gas (MCF per day) 10,881 11,551 7,233 11,433 7,215 Average BOE per day 4,898 4,954 4,204 5,032 4,256 Barrels of oil equivalent (BOE) are calculated using a conversion ratio of 6 MCF to 1 barrel of oil. The 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 and as such may be misleading if used in isolation. Production volumes for the first nine months of were up 18.2 percent over the corresponding 2008 period. Added production related to the Silverwing Energy Inc. (Silverwing) acquisition, Bonterra s drilling program including the production from the Company s first two Pembina Cardium horizontal wells, new gas wells drilled and optimization of existing wells. These additions more than offset Bonterra s average corporate production decline. During the third quarter the Company completed several 13 th month adjustments and joint venture audits. The result of these audits was a net negative adjustment to 2008 volumes of 7,328 barrels of oil and natural gas liquids and 6,853 MCF of natural gas. These volumes and adjustments to quarters one and two of have been adjusted to each respective quarter.

8 - 8 - Bonterra Oil & Gas Ltd. Q3 production was down 56 BOE per day from Q2. The modest production declines per day during Q3 compared with Q2 and Q1 is mainly due to the lack of capital expenditures in the first two quarters of (Q3 - $17,660,000; Q2 - $2,255,000; Q1 - $2,701,000) and reductions in natural gas production resulting from shut-in gas wells due to extensive plant maintenance and shut-in wells due to low gas prices. The Company did not drill any wells in before June when it commenced with this year s drill program. Since June, Bonterra has drilled four horizontal wells (net 2.72) and five vertical wells (net 4.75). The Company s first horizontal well was drilled in 2008 and was completed in Q1. All of the drilled wells to date started producing during the latter part of Q3 or in Q4. In November, the Company engaged the serves of a second rig and will continue its horizontal drill program with both rigs for the balance of and until road bans are imposed in March Bonterra s first two wells have been producing for 9.5 months and 3.5 months, respectively and the Company is pleased with results to date. The acquisition of Cobalt Energy Ltd. (Cobalt) effective July 1, resulted in only a modest increase in production but provided the Company with additional ownership in potential horizontal drilling opportunities including the horizontal wells drilled during the third quarter. Subject to commodity prices and regulatory policies such as the Alberta competition review, Bonterra is projecting 2010 production volumes of 5,700 BOE per day to 6,000 BOE per day. Revenue ($) Sept. 30, Three months ended June 30, Sept. 30, 2008 Nine Months Ended Sept. 30, Sept. 30, 2008 Revenue oil and gas sales (000 s) 20,965 20,501 34,226 60,766 99,117 Average Realized Prices: Crude oil and NGLs (per barrel) Natural gas (per MCF) Revenue from petroleum and natural gas sales decreased $38,351,000 in the first nine months of from the corresponding period in 2008 primarily due to a 42 percent drop in crude oil prices and a 54 percent drop in natural gas prices. The drop in commodity prices was partially offset with the above mentioned production increases. Quarter over quarter the Company saw an increase in revenues of $464,000 due to improved crude oil prices offset partially by reduced gas prices and production volumes. Due to the above mentioned production adjustments, third quarter revenues were reduced by $578,000 relating to prior period items. Royalties ($ 000) Sept. 30, Three months ended June 30, Sept. 30, 2008 Nine Months Ended Sept. 30, Sept. 30, 2008 Crown royalties 1, ,523 3,286 11,399 Freehold royalties, gross overriding royalties and net carried interests ,134 1,785 2,921 Total royalty expense 1,945 1,261 4,657 5,071 14,320 % of total revenue

9 - 9 - Bonterra Oil & Gas Ltd. Royalties paid by the Company consist primarily of Crown royalties paid to the Provinces of Alberta, Saskatchewan and British Columbia. Most of the Company s wells are low productivity wells and therefore have low Crown royalty rates. The Company s average Crown royalty rate is approximately 5.4 percent ( percent) of gross revenue and approximately 2.9 percent ( percent) for other royalties. The increase in percent of other royalties is due to the new horizontal oil wells being drilled on freehold mineral right lands. The recently announced new Alberta Crown royalty rates vary by prices as well as productivity levels. With recent declines in commodity prices and the Silverwing acquisition (mostly BC production with lower Crown royalty rates) the Company has experienced a significant reduction in Crown royalties in the first nine months of. The third quarter royalties have increased $684,000 over second quarter due primarily to higher crude oil pricing and increased production resulting from the Company s new horizontal oil well which has a higher royalty rate. Production Costs ($ 000) Sept. 30, Three months ended June 30, Sept. 30, 2008 Nine Months Ended Sept. 30, Sept. 30, 2008 Production costs 6,585 7,355 6,148 20,978 18,554 $ per BOE (1) (1) Excludes impact of production adjustments Total production costs in the first nine months of have increased by $2,424,000 over the first nine months of The increase is due to increased production volumes (see Production). On a per BOE basis, production costs have declined in the first nine months of compared to the same period in 2008 mainly due to a general decline in service and material costs resulting from decreased industry demand and field optimization. During the third quarter, Bonterra recorded a reduction of $531,000 in production costs related to the above mentioned adjustments related to prior period operations. The Company s production comes primarily from low productivity wells. These wells generally result in higher production costs on a per unit-of-production basis as costs such as municipal taxes, surface leases, power and personnel costs are not variable with production volumes. The higher production costs for the Company are substantially offset by current low royalty rates of 8.3 percent, which is much lower than industry average for conventional production and results in high cash netbacks on a combined basis despite higher than industry average production costs. General and Administrative (G&A) Expense ($ 000) Sept. 30, Three months ended June 30, Sept. 30, 2008 Nine Months Ended Sept. 30, Sept. 30, 2008 G&A Expense 788 1, ,835 2,577 $ per BOE (1) (1) Excludes impact of production adjustments

10 Bonterra Oil & Gas Ltd. The increase in G&A expense in the first nine months of compared to the first nine months of 2008 was due to increased contract accounting personnel costs ($160,000) related to temporary staffing needs in place of full time personnel; professional service costs ($186,000) related to various legal and accounting services dealing with changes to annual filing requirements, IFRS and internal control reviews; computer services fees ($289,000) related to additional monthly geological software licensing fees, service costs related to new production accounting software, and the contracting of a new IT manager position; bad debt expense ($65,000) due to numerous accounts with small oil and gas organizations which have become delinquent; bank charges ($488,000) related to cancelling the old banking facility and setting up the new banking facility, offset partially by reduced employee compensation ($973,000). Quarter over quarter saw a decrease of $320,000 related primarily to an increase of $258,000 in administrative charges to capital projects. The balance of the decrease was attributable to reduced costs associated with continuous disclosure and general cost reductions. Interest Expense ($ 000) Sept. 30, Three months ended June 30, Sept. 30, 2008 Nine Months Ended Sept. 30, Sept. 30, 2008 Interest Expense ,556 1,994 Interest charges increased in the first nine months of as the average outstanding debt balance (including related party balances) increased by approximately $49 million over the first nine months of The acquisitions of Silverwing and Cobalt as well as the reorganization into a corporation resulted in approximately $47 million of additional debt. In addition the Company has incurred approximately $19 million in capital expenditures during this period. These increases were partially offset by net proceeds of $16,985,000 from a second quarter private equity issue. Offsetting the increased debt balance was an average reduction of one percent (4.5 percent in 2008 to 3.5 percent in ) in interest rates paid on the outstanding debt balance. Quarter over quarter saw a marginal decrease in interest charges due to reduced interest on the loan to related parties as well as timing of debt renewals. Effective April 29,, the Company entered into a new bank facility with new terms and conditions. The new facility consists of a $100,000,000 syndicated revolving credit facility and a $20,000,000 non-syndicated revolving credit facility. The interest rate on the new credit facility is calculated as follows: Consolidated Total Funded Debt (1) to Consolidated Cash flow Ratio Level I Level II Level III Level IV Level V Under 1.0:1 Over 1.0:1 to 1.5:1 Over 1.5:1 to 2.0:1 Over 2.0:1 to 2.5:1 Canadian Prime Rate Plus (2) Bankers Acceptances Rate Plus (2) (1) Consolidated total funded debt excludes related party amounts but includes working capital. (2) Numbers in table represent basis points. Over 2.5:1 Consolidated total funded debt to consolidated cash flow ratio shall be adjusted effective as of the first day of the next fiscal quarter following the end of each fiscal quarter, with each such adjustment to be effective until the next such adjustment.

11 Bonterra Oil & Gas Ltd. The above rate schedule combined with current bank prime and interest rates on the related party debt is expected to result in average borrowing costs of approximately three and a quarter percent for the balance of the fiscal year. Reorganization Costs Bonterra incurred $752,000 in G&A costs in 2008 related to the conversion to a corporation. These costs consisted primarily of legal, accounting and printing costs related to the negotiation, due diligence and preparation of the information circular. These were one-time costs that will not be incurred on a continuous basis. Stock-Based Compensation Stock-based compensation is a statistically calculated value representing the estimated expense of issuing employee stock options. The Company records a compensation expense over the vesting period based on the fair value of options granted to employees, directors and consultants. Based on currently outstanding options, the Company anticipates that an expense of approximately $210,000 will be recorded for the balance of, $425,000 in 2010 and $160,000 in Depletion, Depreciation, Accretion and Dry Hole Costs The Company follows the successful efforts method of accounting for petroleum and natural gas exploration and development costs. Under this method, the costs associated with dry holes are charged to operations. For intangible capital costs that result in the addition of reserves, the Company depletes its oil and natural gas intangible assets using the unit-of-production basis by field. For tangible assets such as well equipment, a life span of ten years is estimated and the related tangible costs are depreciated at one tenth of original cost per year. The use of a ten year life span instead of calculating depreciation over the life of reserves was determined to be more representative of actual costs of tangible property. Given the Company s long production life, wells generally require replacement of tangible assets more than once during their life time. Provision for depletion, depreciation and accretion was $14,714,000 and $10,611,000, respectively for the nine month periods ending September 30, and September 30, The increase in the depletion amount was due primarily to increased production volumes and an increase in the average cost of reserves resulting from the Silverwing and Cobalt acquisitions. Depletion, depreciation and accretion expense for Q3 compared to Q2 increased by $282,000 due to the additional capital cost associated with the Cobalt acquisition offset partially by reduced production volumes. Taxes On November 12, 2008, the Company converted from a trust to a corporation. Due to the conversion and the acquisition of Silverwing, the Company increased its usable tax pools to approximately $468,000,000. As a result of the reorganization, the Company has recorded a future income tax asset and a corresponding deferred tax credit. These amounts will be amortized into future tax expense as the associated tax pools are consumed. The current tax provision relates to a resource surcharge of $211,000 payable to the Province of Saskatchewan as well as a capital tax amount of $269,000 payable to the Province of Quebec. The resource

12 Bonterra Oil & Gas Ltd. surcharge is calculated as a flat percent of revenues generated from the sale of petroleum products produced in Saskatchewan. The resource surcharge rate is three percent in. The capital tax payable to the Province of Quebec is a one-time charge that resulted from the Company s conversion to a corporation. The Company and its subsidiaries have the following federal tax pools, which may be used to reduce taxable income in future years, limited to the applicable rates of utilization: ($ 000) Rate of Utilization (%) Amount Undepreciated capital costs ,638 Eligible capital expenditures 7 7,501 Share issue costs 20 4,064 Canadian oil and gas property expenditures 10 29,180 Canadian development expenditures 30 54,112 Canadian exploration expenditures ,390 SR&ED expenditures ,357 Income tax losses carried forward (1) , ,405 (1) Income tax losses carried forward expire in the following years; $1,069,000, $3,347,000, $7,532,000, $104,019,000, $117,436,000, $34,726,000, $10,034,000. The Company has used $28,346,000 of its 2026 provincial tax loss to shelter provincial income. In addition to the above tax pools, the Company has $22,284,000 of investment tax credits (ITC) that expire in the following years; $1,142,000, $4,667,000, $3,909,000, $3,155,000, $1,995,000, $2,257,000, $2,405,000, $2,009,000, $745,000. The current tax provision incorporates the claim of $5,386,000 ITC s against federal taxes payable. The amount and timing of reversals of temporary differences will also depend on the Company s future operating results, and acquisitions and dispositions of assets and liabilities. A significant change in any of the preceding assumptions could materially affect the Company s estimate of the future income tax asset. Net Earnings ($ 000) Sept. 30, Three months ended June 30, Sept. 30, 2008 Nine Months Ended Sept. 30, Sept. 30, 2008 Net Earnings 5,790 4,544 21,125 16,427 44,841 Net earnings decreased in the first nine months of by $28,414,000 from the corresponding 2008 period. Reduced revenues resulting from decreased commodity prices were the main reason for the reduction. This reduction was partially offset by production volume gains. The Company continues to return in excess of 25 percent of its gross realized revenues in net earnings. The Company s low capital costs per BOE of reserves combined with the Company s low production decline rates should allow for continued positive earnings. The three months ended September 30, saw an increase of $1,246,000 in net earnings from the three months ended June 30,. The increase was primarily due to reduced operating and administration costs.

13 Bonterra Oil & Gas Ltd. Comprehensive Income Other comprehensive income for consists of an unrealized gain on investment in a related party of $1,078,000 ( ($488,000)) due to an increase in the related company s fair value. Cash Flow from Operations ($ 000) Sept. 30, Three months ended June 30, Sept. 30, 2008 Nine Months Ended Sept. 30, Sept. 30, 2008 Cash flow from operations 9,350 9,238 22,492 25,225 59,234 Nine month cash flow from operations decreased 57 percent compared to first nine months of 2008 mainly due to decreased commodity prices received. Q3 cash flow increased by $112,000 from Q2 due primarily to reduced operating and administration costs offset by the reduction in operating accounts payable. Cash Netback The following table illustrates the Company s cash netback from operations for the nine month periods ended September 30: $ per Barrel of Oil Equivalent (BOE) 2008 Production volumes (BOE) 1,373,736 1,166,144 Gross production revenue $ $ Realized gain (loss) on risk management contracts - (7.13) Royalties (3.69) (12.25) Field operating costs (15.66) (15.87) Field netback General and administrative (2.06) (2.20) Interest and taxes (2.21) (2.03) Cash netback $ $ The following table illustrates the Company s cash netback from operations for the three month periods ended: $ per Barrel of Oil Equivalent (BOE) Sept. 30, June 30, Production volumes (BOE) 450, ,814 Gross production revenue $ $ Royalties (4.32) (2.76) Field operating costs (15.79) (16.12) Field netback General and administrative (1.75) (2.43) Interest and taxes (1.99) (2.17) Cash netback $ $ Related Party Transactions The Company owns 689,682 (December 31, ,682) common shares of Comaplex Minerals Corp. ( Comaplex ) which have a fair market value as of September 30, of $3,386,000 (December 31,

14 Bonterra Oil & Gas Ltd. $2,131,000). Comaplex is a publicly traded mineral company on the Toronto Stock Exchange. The Company s ownership in Comaplex represents approximately 1.2 percent of the issued and outstanding common shares of Comaplex. In addition, Comaplex owns 204,633 (December 31, ,633) common shares in the Company. The Company has common directors and management with Comaplex. Comaplex paid a management fee to the Company of $248,000 ( $248,000). Comaplex also shares office rental costs and reimburses the Company for costs related to employee benefits and office materials. Services provided by the Company include executive services (chief executive officer, president and vice president, finance duties), accounting services, oil and gas administration and office administration. All services performed are charged at estimated fair value. At September 30,, Comaplex owed the Company $75,000 (December 31, $56,000). As of September 30,, Comaplex has loaned the Company $12,000,000 (December 31, Nil). The loan is unsecured and until June 30, the Company paid interest at Canadian chartered bank prime plus one quarter of a percent and it has no set repayment terms. Effective July 1,, the interest rate was reduced to Canadian chartered bank prime less.25 percent. The reduction in rate was due to the lowering of the Company s bank interest rate with its banking syndicate resulting from an improved debt to cash flow ratio (see Interest Expense and Liquidity and Capital Resources sections) and since the benefits of this loan are shared with Comaplex, the interest rate was reduced accordingly. Interest paid on this loan during the first nine months of was $134,000. This results in being a substantial benefit to Bonterra and to Comaplex. The interest paid to Comaplex by Bonterra is substantially lower than bank interest and for Comaplex the interest earned is substantially higher than Comaplex would receive by investing in bank instruments such as BA s or GIC s. The Company also has a management agreement with Pine Cliff Energy Ltd. (Pine Cliff). Pine Cliff has common directors and management with the Company. Pine Cliff trades on the TSX Venture Exchange. Pine Cliff paid a management fee to the Company of $90,000 ( $178,000). Services provided by the Company include executive services (CEO, president and vice president, finance duties), accounting services, oil and gas administration and office administration. All services performed are charged at estimated fair value. The Company has no share ownership in Pine Cliff. As at September 30,, the Company had an account receivable from Pine Cliff of $1,000 (December 31, 2008 $1,000). As of September 30,, the Company s CEO and major shareholder has loaned the Company $10,000,000 (December 31, $6,000,000). The loan is unsecured, bears interest at Canadian chartered bank prime and has no set repayment terms. Effective July 1,, the interest rate was also decreased to Canadian chartered bank prime less.25 percent. Interest paid on this loan during the first nine months of was $152,000. This loan results in being a substantial benefit to Bonterra and to the CEO. The interest paid to the CEO by Bonterra is substantially lower than bank interest and for the CEO the interest earned is substantially higher than the CEO would receive by investing in bank instruments such as BA s or GIC s. Subsequent to quarter end, the Company s CEO made a further loan of $1,500,000 under the same terms and conditions. The Company s bank agreement requires that the loans to Comaplex and the Company s CEO can only be repaid should the Company have sufficient available borrowing limits under the Company s credit facility. Liquidity and Capital Resources During the first nine months of, the Company incurred capital costs of $22,616,000 ( $15,002,000). The Company drilled two (1.36 net) horizontal oil wells, five (4.75 net) vertical Cardium oil wells and commenced drilling of a third (0.68) horizontal oil well for total drilling costs of approximately

15 Bonterra Oil & Gas Ltd. $6,600,000 net of drilling credits of $1,741,000 million (see below). In addition Bonterra acquired and paid $4,746,000 for mineral rights in the Pembina area of Alberta. On July 2,, Bonterra completed its acquisition of Cobalt. The Company issued 201,438 common shares and assumed $2,856,000 of negative working capital and incurred approximately $170,000 in acquisition costs for a total calculated accounting cost of $7,105,000. This acquisition resulted in acquiring an additional 40 BOE per day of production as well as increasing the Company s working interest in approximately 11 sections of land with potential Cardium horizontal locations in the Pembina area of Alberta. During the first nine months of, Bonterra also participated in drilling a number of smaller interest natural gas wells for total costs of approximately $1,000,000 and spent approximately $1,300,000 on completion and tie in costs in respect to wells drilled in Q The balance of the capital expenditures related to various capital projects ranging from pipeline tie-ins to maximizing natural gas production to various battery upgrades to enhance overall production from existing wells. The government of Alberta has recently announced drilling incentives and royalty reductions in respect of wells drilled after April 1, and prior to March 31, The Company is planning to maximize the crown royalty credits available under the new drilling incentive program which will result in a substantial reduction of capital costs on a per well basis. The Company currently has plans to spend an estimated $22,000,000 (net of drilling incentives) in (approximately $10,000,000 in the fourth quarter) on development of its oil and gas properties. Land acquisitions and property or corporate acquisitions estimated to be $13,000,000 (including the Cobalt acquisition) will bring the total to approximately $35,000,000. With the recent finalizing of the Crown royalty credit program by the Alberta government, the Company plans on contracting a second drill rig in mid November for drilling additional horizontal Pembina Cardium oil wells. Subsequent to September 30,, the Company entered into a purchase and sale agreement to divest of a portion of its Shaunavon oil production to Eagle Rock Exploration Ltd. (Eagle Rock) (TSXV: ERX). The proceeds of disposition consist of $24,000,000 cash and 30,769,200 common shares in Eagle Rock (representing approximately 4.2 percent of the outstanding common shares of the company). The disposition closed on November 6,. These funds will be used to accelerate the development of the Company s horizontal Pembina Cardium oil play. Bonterra anticipates funding the capital program out of cash flow, the Company s line of credit, its recent equity issue and proceeds from the above mentioned sale. Effective April 29,, the Company entered into a new bank facility. The new facility consists of a $100,000,000 syndicated revolving credit facility and a $20,000,000 non-syndicated revolving credit facility. At September 30,, the Company s bank loan was $81,386,000 (December 31, $93,235,000). The terms of the new facility provides that the loan is revolving until April 28, 2011, is subject to annual review and has no fixed payment requirements. Subject to commodity prices and regulatory policies such as the Alberta competition review, Bonterra is projecting 2010 capital expenditures of $40,000,000 to $50,000,000. The following is a list of the material bank covenants: 1) The Company is required to not exceed $120,000,000 in consolidated debt (includes negative working capital but excludes debt to related parties). As of September 30, the Company had consolidated debt of $73,841,000.

16 Bonterra Oil & Gas Ltd. 2) Dividends paid in any quarter shall not exceed 80 percent of the average of the previous four quarters cash flow as defined under GAAP. During the quarter Bonterra paid $7,781,000 in dividends. This compares to $9,839,000 that was allowed under the bank covenant. During the third quarter the Company received a waiver of this requirement for the fourth quarter and instead is restricted to paying no more than the lesser of 80 percent of quarter four cash flow or $10,000,000. The Company is authorized to issue an unlimited number of common shares without nominal or par value. Issued Number Amount ($ 000) Common Shares Balance, January 1, 17,257,603 99,530 Issued pursuant to private placement 1,068,000 17,996 Issued on acquisition of Cobalt 201,438 3,207 Issue costs for private placement - (1,046) Future tax effect of share issue costs Balance, September 30, 18,527, ,954 During the second quarter, Bonterra issued 1,068,000 common shares at a price of $16.85 per share for net proceeds of $16,985,000. The funds from the equity placement were used to retire debt and for general working capital. On July 2,, the Company acquired all of the issued common shares of Cobalt for consideration of 201,438 common shares at a value of $15.92 per common share. The Company provides an option plan for its directors, officers, employees and consultants. Under the plan, the Company may grant options for up to 1,852,704 (December 31, ,725,760) common shares. The exercise price of each option granted equals the market price of the common shares on the date of grant and the option s maximum term is five years. A summary of the status of the Company s stock option plan as of September 30, and December 31, 2008, and changes during the nine month and twelve month periods ended on those dates is presented below: September 30, December 31, 2008 Weighted- Average Weighted- Average Options Exercise Price Options Exercise Price Outstanding at beginning of period 1,390,500 $ $ - Options granted 33, ,390, Outstanding at end of period 1,423,500 $ ,390,500 $ Options exercisable at end of period - $ - - $ - The following table summarizes information about options outstanding at September 30, : Options Outstanding Options Exercisable Range of Exercise Prices Number Outstanding At 9/30/09 Weighted-Average Remaining Contractual Life Weighted- Average Exercise Price Number Exercisable at 9/30/09 Weighted- Average Exercise Price $ , years $ $ ,390, years $ ,423, years $ $ -

17 Bonterra Oil & Gas Ltd. Disclosure Controls and Procedures Disclosure controls and procedures have been designed to ensure the information required to be disclosed by the Company is accumulated and communicated to the Company s Management, as appropriate, to allow timely decisions regarding required disclosures. The Company s Chief Executive Officer and Chief Financial Officer have concluded, based on their evaluation as of the end of the period covered by the interim filings that the Company s disclosure controls and procedures are effective to provide reasonable assurance that material information related to the issuer, is made known to them by others within the Company. It should be noted that while the Company s Chief Executive Officer and Chief Financial Officer believe that the Company s disclosure controls and procedures provide a reasonable level of assurance that they are effective, they do not expect that the disclosure controls and procedures or internal control over financial reporting will prevent all errors and fraud. A control system, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objective of the control system is met. Internal Control Update The Company has conducted a review of its ICFR, with the conclusion that as of September 30, the Company s system of ICFR as defined under NI is adequately designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. In addition, the Company has concluded that there exists sufficient mitigating controls that the below mentioned weaknesses have resulted in no material impact on the Company s financial reporting or ICFR. The control framework the Company used to design its ICFR was the model developed by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In its review, the Company identified certain material weaknesses in internal controls over financial reporting: 1. due to the limited number of staff at the Company, it is not feasible to achieve the complete segregation of incompatible duties; and 2. due to the limited number of staff, the Company relies upon third parties as participants in the Company s internal controls over financial reporting. The Company believes these weaknesses are adequately mitigated by: the active involvement of senior management and the board of directors in the affairs of the Company; open lines of communication within the Company; the present levels of activities and transactions within the Company being readily transparent; the thorough review of the Company s financial statements by management, the board of directors; and the establishment of a whistle-blower policy. However, these mitigating factors will not necessarily prevent a material misstatement occurring as a result of the aforesaid weaknesses in the Company s internal controls over financial reporting. Based on the above identified weaknesses, the Company has concluded that the Company s ICFR are ineffective. A system of internal controls over financial reporting, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the internal controls over financial reporting are met. The Company has no plans for remediating the above weaknesses. Financial Reporting Update In January, the CICA issued EIC-173, Credit Risk and the Fair Value of Financial Assets and Financial Liabilities. The EIC provides guidance on how to take into account credit risk of an entity and counterparty when determining the fair value of financial assets and financial liabilities, including derivative instruments. This standard is effective for the Company s fiscal periods ending on or after January 20, with