ITHACA ENERGY INC. MANAGEMENT S DISCUSSION AND ANALYSIS FOR THE YEAR ENDED DECEMBER 31, 2010

Transcription

1 ITHACA ENERGY INC. MANAGEMENT S DISCUSSION AND ANALYSIS FOR THE YEAR ENDED DECEMBER 31, 2010 The following is management s discussion and analysis ( MD&A ) of the operating and financial results of Ithaca Energy Inc. (the Corporation or Ithaca or the Company ) for the year ended December 31, The information is provided as of April 21, The 2010 results have been compared to the results of This discussion and analysis should be read in conjunction with the Corporation s consolidated financial statements as at December 31, 2010 and 2009 together with the accompanying notes, MD&A and Annual Information Form ( AIF ) for the 2010 fiscal year. These documents and additional information about Ithaca are available on SEDAR at Certain statements contained in this MD&A, including estimates of reserves, estimates of future cash flows and estimates of future production as well as other statements about future events or anticipated results, are forward-looking statements. The forward-looking statements contained herein are based on assumptions and are subject to known and unknown risks, uncertainties and other factors. Should the underlying assumptions prove incorrect or should one or more of these risks, uncertainties or factors materialize, actual results may vary significantly from those expected. See Forward-Looking Information, below. All financial data contained herein is presented in accordance with Canadian generally accepted accounting principles ( GAAP ) and is expressed in United States dollars ( $ ), unless otherwise stated. BUSINESS OF THE CORPORATION Ithaca is an oil and gas exploration, development and production company active in the United Kingdom s Continental Shelf ( UKCS ). The goal of Ithaca, in the near term, is to maximize production and achieve early production from the development of existing discoveries on properties held by Ithaca, to originate and participate in exploration and appraisal on properties held by Ithaca when capital permits, and to consider other opportunities for growth as they are identified from time to time by Ithaca. The Corporation s common shares are listed for trading on the TSX Venture Exchange and the Alternative Investment Market of the London Stock Exchange under the symbol IAE. 1

2 NON-GAAP MEASURES Operating costs per boe referred to in this MD&A are not prescribed by GAAP. This non-gaap financial measure does not have any standardized meaning and therefore is unlikely to be comparable to similar measures presented by other companies. Ithaca includes operating costs per barrel data because investors may use this information to analyze operating performance. The additional information should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. See Results of Operations section for details. Cash flow from operations referred to in this MD&A is not prescribed by GAAP. The Corporation uses this measure to help evaluate its performance. As an indicator of the Corporation s performance, cash flow from operations should not be considered as an alternative to, or more meaningful than, cash flows from operating activities as determined in accordance with GAAP. The Corporation s determination of cash flow from operations does not have any standardized meaning and therefore may not be comparable to similar measures presented by other companies. The Corporation considers cash flow from operations to be a key measure as it demonstrates the Corporation s ability to generate the cash necessary to fund operations and support activities related to its major assets. Cash flows from operations are determined by adding back changes in non-cash operating working capital to cash provided by operating activities. BOE PRESENTATION The calculation of barrels of oil equivalent ( boe ) is based on a conversion rate of six thousand cubic feet of natural gas ( mcf ) to one barrel of crude oil ( bbl ). The term boe may be misleading, particularly if used in isolation. A boe conversion ratio of 6 mcf: 1 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. 2

3 2010 HIGHLIGHTS Ithaca achieved the following highlights during 2010: Financial Earnings before income tax $38.0 million (2009 $7.9 million) Net Earnings $54.0 million after recognition of a future tax asset (2009 $7.9 million) Record Cashflow from Operations of $94.6 million (2009 $53.9 million) Cash $201.9 million, inclusive of $6.3 million restricted cash (2009 $35.5 million) Netback $57 / boe (2009 $37 / boe) Closed new equity raise, generating over $150 million Signed and completed $140 million senior debt facility (the Credit Facility ) no debt drawn at December 31, 2010 Tax losses attributable to upstream oil and gas activities of $215.7 million (2009 $233.0 million) Rising Earnings before income tax in 2010 compared to the prior year were driven by rising production from Beatrice and Jacky, a higher realized average oil price of $80.37 / bbl ($68.65 / bbl in 2009) and a reduction in operating and depletion, depreciation, and amortization ( DD&A ) costs. The strong cash flow from operations combined with the equity raise proceeds increased the Company s overall cash balance to $201.9 million at December 31, The combination of the above factors has placed the Company in a strong financial position, with current projects fully funded through to first production. 3

4 Operational Beatrice & Jacky Combined production from Beatrice and Jacky averaged 9,336 barrels of oil per day ( bopd ) gross (4,485 bopd net to Ithaca) over the year as measured at the Nigg storage facility. Production from Beatrice Alpha was reinstated in March 2010 after repairs and modifications to the vessel protection systems were completed. As a result of the well intervention program that occurred from Q to Q the production from the Beatrice Bravo facility was increased. In May coiled tubing work commenced on the Beatrice Alpha platform to undertake preparatory clean up work on a number of production wells. A Hydraulic Workover Unit ( HWU ) was mobilized to the platform in early July The HWU is undertaking the replacement of electric submersible pumps in four production wells. In Q3 2010, the first of the Beatrice Alpha well workover program was completed (the A04 well) increasing production on the well by 100%. In September 2010 production from Jacky was halted temporarily to allow a chemical squeeze operation which has successfully protected the reservoir from potential scale damage and maintained productivity. In Q4 2010, activities commenced to workover the second well of the five well campaign (Beatrice Alpha well A23). Stable production was reinstated by the end of 2010 and increased production by approximately 115% In December the Corporation announced that in Q it planned to drill a second production well on the Jacky field to access additional reserves. Daily production from this well is expected to initially exceed 5,000 bopd (2,375 bopd net to Ithaca) when the well is expected to come on stream in Q Stella In February 2010 the Galaxy II rig commenced drilling at the Stella appraisal well location in block 30/6a. In April 2010 Ithaca announced that the Stella field appraisal well (30/6a-8) had proved the presence of significant additional volumes of hydrocarbon and excellent quality reservoir. A successful drill stem test was performed providing critical information allowing development planning to commence. The total measured hydrocarbon column height was shown to be in excess of 820 feet and the well confirmed connected hydrocarbons more than 500 feet lower than in any previous wells. As planned, a sidetrack well (30/6a-8Z) was subsequently drilled and confirmed a 4

5 fully hydrocarbon-saturated reservoir interval in the Andrew sandstone. Successful sampling and pressure tests also provided essential fluid composition information to appropriately size and plan the development of the Stella field. All objectives were fully met by the drilling program. Following a successful drill stem test of the Stella appraisal well and subsequent interim reserves audit, the Company announced a significant increase in reserves. Total Proved ( 1P ) reserves increased by 30.6% from million barrels of oil equivalent ( mmboe ) to mmboe and total Proved plus Probable ( 2P ) reserves increased by 12.8% from mmboe to mmboe. In September 2010 the earn in agreement signed on October 27, 2009 between Ithaca and Challenger Minerals (North Sea) Limited ( CMI ) was completed. Under the terms of the earn in CMI paid 27% of gross Stella appraisal well costs in exchange for an 18% equity interest in the Stella and Harrier discoveries, thereby carrying a part of Ithaca s share of drilling costs. In addition, due to the successful appraisal of Stella, CMI will carry Ithaca on a further Stella or Harrier development well for up to 2 million ($3.2 million) or 9%, whichever is the lesser. The revised Ithaca interests in the Stella and Harrier discoveries are now 50.33%. Athena On September 21, 2010, Field Development Plan approval was received from the UK Department for Energy and Climate Change ( DECC ) for the Athena oil field. Key contracts on the Athena development were awarded through 2010, including the charter of the Floating Production, Storage and Offloading ( FPSO ) vessel BW Carmen (now renamed BW Athena ) from BW Offshore; the provision of drilling management services and the supply of the Sedco 704 semi-submersible drilling rig from Applied Drilling Technology International ( ADTI ) (a subsidiary of Transocean Ltd.); and the installation of subsea equipment and the FPSO mooring system from Bibby Offshore Limited. UKCS 26 th Seaward Production License Round In November 2010, the Corporation was successful in the UKCS 26 th Seaward Production License Round, expanding the Company s portfolio in the Greater Stella Area. Ithaca was offered, as operator, one new license from the 26th Round, namely Block 29/10d (the block ). The block lies in the Greater Stella Area and is neighbour to Block 29/10b (Hurricane discovery) and Block 30/6a (Stella and Harrier discoveries). Ithaca has identified a large structure encompassed by the block which is known as the Helios discovery. 5

6 Corporate In May 2010, the Company announced the appointment of Ron Brenneman, formerly Chief Executive Officer of Petro-Canada, as non-executive director of the Company. In July 2010, the Corporation signed and completed the Credit Facility for up to $140 million with the Bank of Scotland Plc as Lead Arranger. The loan term is up to five years and in accordance with normal industry borrowing base facilities. In July the Company completed a bought deal equity issue, with a syndicate of underwriters led by CIBC World Markets, of 47.6 million common shares in Ithaca at a price of C$1.70 per common share for aggregate gross proceeds of C$81 million (the Bought Deal Offering ). At the same time completion took place of a private placement of 45.1 million common shares in Ithaca to purchasers in the United Kingdom at a price of 1.07 per common share (approximately equivalent to C$1.70 per common share) for aggregate proceeds of approximately C$77 million (the Private Placement ). Together, the equity issues generated gross proceeds of C$158 million (approximately $153 million). In August 2010 an agreement was entered into to acquire certain UK North Sea gas interests from GDF SUEZ E&P UK Ltd for a cash consideration of million (approximately $16.9 million) (the GdF Acquisition ). The GdF Acquisition included operated interests in the producing Anglia Field, the Garnet and Opal discoveries, and a non operated interest in the producing Topaz Field. The Corporation completed the transaction on December 17, 2010 for an adjusted cash consideration of 6.7 million (approx $10.5 million) with an effective date of January 1, The adjustment results from free cash flow generated by strong production throughout 2010 since the effective date. The Company believes the GdF Acquisition has the potential to create significant additional value through the further exploitation and optimization of the acquired interests. In September 2010 the Company entered into an agreement with Gemini Oil & Gas Fund II, L.P. ( Gemini ) in relation to the Company s interest in the Athena field (the Agreement"). The Agreement provided that the Company would not make any payment to Gemini in relation to proceeds received by the Company as part of the previously announced Athena asset sale of interests in 2008 and 2009 involving transactions which relate to certain assets sold by the Company to Dyas UK Limited. In exchange for and in consideration of Gemini s waiver of any right to proceeds from the disposal of equity interest in the Athena discovery and in substitution for any previously awarded or agreed warrants, Ithaca granted to Gemini warrants to acquire up to 2,500,000 Common Shares in Ithaca. The warrants were available for 6

7 exercise at a price of C$2.25 per share on or before March 21, The total fair value attributed the warrants issued in the quarter was $0.3 million. In addition to these terms, the Agreement terminated all rights that Gemini has in respect of the Company s interests. HIGHLIGHTS SUBSEQUENT TO YEAR END: In January 2011, preparation works commenced to re-certify existing equipment and install new equipment on the FPSO BW Athena at dockside in Dubai. All work is anticipated to be completed in Q allowing the vessel to return to UK waters and arrive on location at Athena at end Q In February 2011, Lawrie Payne, Non-Executive Chairman of the Board, notified the Company of his intention to retire from service of the Company and resigned from the Board of Directors effective February 22, Jack C. Lee succeeded Lawrie Payne as Non-Executive Chairman effective as of the same date. In February 2011 the Company successfully completed the drilling of a water injection well for the Athena field development. The well was drilled down flank from three successful appraisal wells and was the first well of a 180 day campaign of drilling and completion activities. In March 2011 the Sedco 704 semi submersible drilling unit commenced the drilling of the final production well for the development of the Athena field. The well is being drilled from the Athena drill centre and is the final well to be drilled. As at the date hereof, the well is progressing on schedule. The well has been directionally drilled to the north west of the field and has entered the top reservoir (Top Scapa A sands). These operations precede subsea equipment installation and hook-up of the BW Athena FPSO later in the year. In March 2011 the Energy Enhancer jack-up drilling unit commenced drilling on a second production well on the Jacky field. The well is being drilled to access additional reserves and increase production as part of a field management strategy. The drilling unit was positioned over the Jacky platform to drill from an existing spare well bay to facilitate early tie in to the existing production stream. In March 2011 mechanical issues were experienced on the Energy Enhancer jack-up drilling unit that is currently drilling the J03 well on the Jacky field. This caused an increase in the time that production was suspended from the J01 well to complete the top hole section of the J03 well. Following successful repair to the drilling mud handling system onboard the rig and completion of the top hole section, production from the J01 well was reinstated by the end of March. 7

8 In March 2011 Gemini exercised all warrants granted to acquire 2,500,000 common shares of the Company at C$2.25 per share. In April 2011 the Corporation entered into an agreement to acquire a 28.46% non-operated interest in the Cook oil field and a 7.41% non-operated interest in the Maclure oil field from Hess Limited ( Hess ) for a consideration of $74.5 million and the transfer from Ithaca to Hess of a 10% interest in each of exploration Blocks 42/25b, 43/16a and 43/21c in the Southern North Sea (the Cook & Maclure Acquisition ). The acquisition of Maclure is subject to preemption within 30 days of notification to other parties in the Maclure field. The Company has commissioned Sproule International Ltd ( Sproule ) to provide a Reserves Audit Opinion on Cook and Maclure. The opinion from Sproule is anticipated in mid May, 2011 and, on receipt, the Company expects to make a further, more detailed announcement including information on reserves and other potential upsides associated with the Cook & Maclure Acquisition together with details, if any, of pre-emption by any Maclure parties. The transaction is expected to complete in Q with an effective date of January 1, In April 2011 the Company signed an earn in agreement with CMI to drill an appraisal well on the Hurricane discovery. Under the terms of the agreement CMI has agreed to pay a share of the initial well costs in return for an option, exercisable within 90 days of abandonment or suspension of the initial appraisal and any sidetrack well, to acquire an interest in Block 29/10b. CMI will pay 40% of gross Hurricane appraisal well costs in exchange for a 31% equity interest in Block 29/10b, thereby carrying a part of Ithaca s share of all costs of drilling an initial appraisal well. In addition, upon successful appraisal, CMI will pay 40% of gross costs of a drill stem well test of any sidetrack. All additional costs, including those for planned sidetrack drilling, shall be apportioned such that CMI shall pay its 31% pro rata share. The transaction is subject to agreed turnkey terms with ADTI for the provision of a suitable drilling unit and well management services. Upon agreement of turnkey terms and provision of a suitable rig, Ithaca anticipates that the appraisal well will be commenced in Q In April 2011 both downhole electrical submersible pumps ( ESP ) in the Jacky production well, J01, failed. Technical experts confirmed that both ESP units developed electrical faults under routine operations, and must be replaced. The well is now free flowing and gross production from the J01 well following this event has reduced to approximately 700 barrels of oil per day ( bopd )(approximately 335 bopd net to Ithaca); prior to this, under ESP support gross production was approximately 2,800 bopd (1,330 bopd net to Ithaca) as measured at the Nigg storage facility. The Company intends to continue to free flow the J01 production well until the J03 well has reached the target reservoir formation, the Beatrice A Sand, and has been completed. 8

9 This operation is anticipated to last until mid May. The Northern Enhancer rig (currently located over the Jacky platform) will then be utilised to undertake a workover operation to replace the failed ESPs in the J01 production well; this is expected to take a further 15 days. Production from the J03 well is planned to be optimised throughout the J01 work over operation period. 9

10 RESULTS OF OPERATIONS Oil and gas sales revenue has increased 31% to $132.4 million. This was due to an increase in total net production, an increase in average realized prices, and the addition of gas sales from the Anglia and Topaz fields from December 17, Oil production has increased 11% from 4,042 bopd in 2009 to 4,485 bopd for 2010 predominantly due to a full year of production on Jacky compared to less than 9 months of production in 2009 (Jacky achieved first oil in April 2009) and optimization of production on Beatrice. The Corporation has also benefited from an increase in average realized oil prices of over 17% from $68.65/bbl in 2009 to $80.37/bbl, due to an increase in the spot Brent oil price in the year. The acquisition of the producing gas assets from GDF SUEZ E&P UK Ltd that completed in December 2010 also contributed to increased revenue in Operating costs have decreased 18% in 2010 to $37.9 million. On a per barrel of oil equivalent basis, operating costs moved from $31 / boe in 2009 to $23 / boe in This rate has reduced steadily through the reinstatement of Beatrice Bravo production, the start-up of Jacky production in April 2009, and the continuing focus on optimisation of production through the workover program on the shared operating costs centre of Beatrice and Jacky. General and administrative ( G&A ) costs have decreased 49% in 2010 to $3.4 million. Tight cost control combined with increased capitalization of costs associated with higher levels of project work has delivered the reduction in costs charged to the income statement. DD&A expense for the year has decreased 6% in 2010 to $50 million. Although production has increased year on year, a reduction in expense has been achieved as a result of a decrease in the depletion rate per barrel of oil and gas properties from $35 / boe to $30 / boe due to the increases in proved reserves reported in The Corporation recorded a $5.1 million loss on derivatives for the year ended December 31, 2010 (2009: $8.1 million gain). $3.1 million of the loss resulted from a currency instrument put in place to remove the currency fluctuation risk between closing of the $150 million equity raise and receipt of the funds. This objective was achieved however GAAP necessitated that the proceeds were recorded as $153.2 million and $3.1 million was recorded as a one-off derivatives loss. A loss of $2.0 million was also generated from the foreign currency instrument taken out in the year which ensured Sterling required to fund operating costs was available at a rate of no worse than USD1.60 / In the year ended December 31, 2010, a charge of $1.2 million ( $0.6 million) was recorded for stock based compensation. The increase in stock based compensation charged relates to an increase in staff numbers combined with the issue of 10,100,000 options during

11 The reduction in financing, interest and bank charges in the year ended December 31, 2010 is due to the repayment of all outstanding debt in From Q charges have included amortization of fees in relation to the Credit Facility. At the year end the Corporation recognized a derivative financial instrument liability of $4.4 million in respect of the marking to market of a gas sales contract acquired as part of the GDF Acquisition. This has no impact on Earnings for the year. A future tax asset of $16 million has been recognized in the year, arising from a combination of accumulated tax losses and accelerated capital allowances. While the company was loss making, it was not prudent to recognize a future tax asset as it was more likely than not that the asset would not be realized. However as a result of the last two years of earnings history and with earnings forecast to continue, it is appropriate to recognize the asset in All of the above contributed to Earnings before income tax of $38.0 million and Net Earnings of $54.0 million for the year ended December 31, This was achieved through the building of production levels, strong commodity prices and successful reductions in operating and depletion costs per boe in the year. This compared to Net Earnings of $7.9 million in 2009, a period with lower commodity prices, higher unit operating costs and higher depletion rates due to lower proved reserves. 11

12 SUMMARY OF QUARTERLY RESULTS The following table provides a summary of quarterly results of the Corporation for its eight most recently completed quarters: REVENUE 31/12/ /09/ /06/ /03/ /12/2009* 30/09/2009* 30/06/2009* 31/03/2009* (Restated) $'000 $'000 $'000 $'000 $'000 $'000 $'000 $'000 Oil & Gas Sales 33,721 35,434 33,094 30,102 33,850 36,375 28,280 2,776 Other income , , , Interest income ,316 36,015 34,133 30,769 39,676 37,395 29,903 3, COSTS AND EXPENSES General and administrative 689 1, (447) 2,500 1,918 2,644 Operating 9,460 10,241 9,460 8,689 13,665 8,712 11,724 12,211 DD&A 12,350 13,287 13,104 11,248 12,894 20,379 17,585 2,468 (Gain) / Loss on foreign exchange (990) (1,766) 362 1,576 2,319 2,051 (891) (227) Revaluation of Nigg Heel of Tank (184) (363) (4) (Gain) / Loss on Financial Instruments 439 1, ,158 (5,361) 4,325 (5,602) (1,441) Stock based compensation (640) 1,151 (600) Interest and bank charges (0) ,590 25,565 23,617 25,418 22,107 38,540 26,123 16,104 EARNINGS / (LOSSES) BEFORE TAX 11,726 10,450 10,516 5,351 17,569 (1,145) 3,780 (12,267) INCOME TAXES - current (80) INCOME TAXES - future 16, (81) NET EARNINGS 27,720 10,450 10,516 5,351 17,488 (1,145) 3,780 (12,267) NET EARNINGS / (LOSS) PER SHARE Deficit, beginning of period Surplus / (Deficit) end of period (4,114) (14,564) (23,886) (29,236) (46,724) (45,580) (49,360) (37,093) ,606 (4,114) (14,564) (23,886) (29,236) (46,724) (45,580) (49,360) * Certain comparative figures have been reclassified to conform with the current year s financial statement presentation 12

13 Significant factors and trends that have impacted the Corporation's results during the above periods include: The Jacky field commenced its first oil production along with the restart of production from the Beatrice Bravo facility in April The optimization of production on Beatrice Bravo and Alpha through the workover campaigns. Fluctuations in underlying commodity prices. Commodity prices have generally risen through the periods in which the Corporation had production. The Corporation has utilized forward sales contracts and foreign exchange contracts to take advantage of higher commodity prices while reducing the exposure to price volatility. These contracts can cause volatility in net income as a result of unrealized gains and losses due to movements in the oil price and US Dollar: British Pounds Sterling exchange rate. FOURTH QUARTER Oil and gas sales revenue decreased less than 1% to $33.7 million from Q The decrease was due to a 19% decrease in total net oil production to 3,966 bopd, predominantly due to the natural decline of production on Jacky, offset by a 21% increase in average realized oil prices to $90.25 / bbl and the addition of gas production from the producing gas assets acquired from GDF SUEZ E&P UK Ltd that completed on December 17, No significant transactions or adjustments occurred in Q outwith the normal course of business. SELECTED ANNUAL INFORMATION The consolidated financial statements of the Corporation and the financial data contained in the MD&A are prepared in accordance with GAAP. The consolidated financial statements include the accounts of Ithaca and its wholly-owned subsidiary Ithaca Energy (UK) Limited ( Ithaca UK ). All inter-company transactions and balances have been eliminated on consolidation. A significant portion of the Corporation s North Sea oil and gas activities are carried out jointly with others. The consolidated financial statements reflect only the Corporation s proportionate interest in such activities. The following table sets forth selected consolidated financial information of the Corporation for its three most recently completed fiscal years. 13

14 Year ended December 31, ($ 000) Total revenues 135, ,812 3,282 Net Earnings 54,037 7,938 (30,447) Total assets 561, , ,670 Total long-term liabilities 28,118 10,674 72,745 Net gain / (loss) per share ($) (0.23) Net gain / (loss) per share diluted basis ($) (0.23) LIQUIDITY AND CAPITAL RESOURCES As at December 31, 2010, Ithaca had working capital of $224.9 million including a free cash balance of $195.6 million. Available cash has been, and is currently, invested in money market deposit accounts with the Bank of Scotland. Management has received confirmation from the financial institution that these funds are available on demand. The restricted cash of $6.3 million comprises $5.9 million currently held by the Bank of Scotland as decommissioning security provided as part of the acquisition of gas interests from GDF SUEZ E&P UK Ltd and $0.4 million held by the Bank of Scotland as cash security for a bank guarantee that Ithaca UK provided to the Crown Estate when it was granted Field Development Plan approval for the Jacky Field. During the year ended December 31, 2010 there was a cash inflow from operating, investing and financing activities of $165.7 million (2009 inflow of $2.9 million). The net inflow was due to: positive cash flows from operating activities of $93.8 million; positive cash flows from financing activities of $143.3 million, predominantly due to the Bought Deal Offering and Private Placement that completed in the year; offset by a decrease in cashflows from investing activities, being $63.8 million investment in fixed assets, $4.5 million realized foreign exchange loss on derivatives and movements in capex related working capital. The fixed asset investment in the year predominantly related to the Beatrice workovers, the appraisal well drilling on Stella, and capital expenditure on the Athena development. The combination of the proceeds from the Bought Deal Offering and Private Placement, together with debt made available from the Credit Facility and a portion of anticipated cash flows from current operations, means that all of the Corporation s current projects are anticipated to be fully funded through to first production. 14

15 COMMITMENTS The Corporation has the following financial commitments of which the largest component relates to the Engineering (Athena and Stella projects): Year ended Subsequent to 2014 US$ US$ US$ US$ US$ Office lease Exploration license fees 1,275 1,635 1, Engineering 20, Total 21,989 1,882 2, OUTSTANDING SHARE INFORMATION As at December 31, 2010, Ithaca had 255,789,464 common shares outstanding along with 20,146,003 options to employees and directors to acquire common shares. The total number of options outstanding is inclusive of 10,100,000 options granted to employees and directors through the year in accordance with the Company s stock option plan. The options were approved by the Board of Directors at a range of prices from C$1.54 to C$2.25 which were the closing prices on the TSX Venture Exchange on the dates of grant. Each of the options granted may be exercised for a period of four years from the grant date. One third of the options will vest at the end of each of the first, second and third years from the effective date of grant. In addition, Ithaca granted Gemini 2,500,000 warrants to purchase common shares of the Corporation in These warrants were exercised after the year end on March 3, As at April 21, 2011, Ithaca had 258,535,295 common shares outstanding along with 19,798,505 options to employees and directors to acquire common shares. CRITICAL ACCOUNTING ESTIMATES Ithaca's significant accounting policies are disclosed in note 2 to the December 31, 2010 consolidated financial statements. Certain accounting policies require that management make appropriate decisions with respect to the formulation of estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. These accounting policies are discussed below and are included to aid the reader in assessing the critical accounting policies and practices of the Corporation and the likelihood of materially different results being reported. Ithaca's management reviews these estimates regularly. The emergence of new information and changed circumstances may result in actual results or changes to estimated amounts that differ materially from current estimates. 15

16 The following assessment of significant accounting policies and associated estimates is not meant to be exhaustive. The Company might realize different results from the application of new accounting standards promulgated, from time to time, by various rulemaking bodies. Capitalized costs relating to the exploration and development of oil and gas reserves, along with estimated future capital expenditures required in order to develop proved reserves, are depreciated on a unit-of-production basis using estimated proved reserves as adjusted for production. The carrying value of property, plant and equipment is reviewed annually for impairment. The carrying value is assessed to be recoverable if the sum of the undiscounted cash flows expected from the production of proved reserves exceeds the carrying value of the property, plant and equipment. If the carrying value of the property plant and equipment is not assessed to be recoverable, an impairment loss is recognized to the extent that the carrying value exceeds the sum of the cash flows, discounted using a risk-free rate, expected from the production of proved and probable reserves. The cost recovery ceiling test and calculation of impairment are based on estimates of reserves, production rates, oil and gas prices, future costs and other relevant assumptions. By their nature, these estimates are subject to measurement uncertainty and the impact on the financial statements could be material. Liability recognition for asset retirement obligations ( ARO ) associated with oil and gas wells are determined using estimated costs discounted based on the estimated life of the asset. Over time, the liability is accreted up to the actual expected cash outlay to perform the abandonment and reclamation. Financial assets or liabilities are only recognized when the entity becomes a party to the contractual provisions of the financial instrument. Financial assets and financial liabilities are, with certain exceptions, initially measured at fair value. Derivative financial instruments are required to be recorded on the balance sheet at fair value. Any changes in fair value are immediately recorded as a net gain or loss in the statement of net income. In order to recognize stock based compensation expense, the Corporation estimates the fair value of stock options granted using assumptions related to interest rates, expected life of the option, volatility of the underlying security and expected dividend yields. These assumptions may vary over time. The determination of the Corporation s income and other tax liabilities / assets requires interpretation of complex laws and regulations. Tax filings are subject to audit and potential reassessment after the lapse of considerable time. Accordingly, the actual income tax liability may differ significantly from that estimated and recorded on the financial statements. 16

17 The accrual method of accounting will require management to incorporate certain estimates of revenues, production costs and other costs as at a specific reporting date. In addition, the Company must estimate capital expenditures on capital projects that are in progress or recently completed where actual costs have not been received as of the reporting date. OFF-BALANCE SHEET ARRANGEMENTS The Corporation has certain lease agreements which were entered into in the normal course of operations, all of which are disclosed under the heading Commitments, above. All leases have been treated as operating leases whereby the lease payments are included in operating expenses or general and administrative expenses depending on the nature of the lease. No asset or liability value has been assigned to these leases on the balance sheet as at December 31, RELATED PARTY TRANSACTIONS A director of the Corporation is a partner of Burstall Winger LLP who acts as counsel for the Corporation. The amount of fees paid to Burstall Winger LLP in 2010 was $0.6 million ( $0.2 million). All related party transactions are in the normal course of business and have been measured at the exchange values, being the consideration established and agreed to by the parties and on normal commercial terms comparable to those charged by third parties. RISKS AND UNCERTAINTIES The business of exploring for, developing and producing oil and natural gas reserves is inherently risky. There is substantial risk that the manpower and capital employed will not result in the finding of new reserves in economic quantities. There is a risk that the sale of reserves may be delayed due to processing constraints, lack of pipeline capacity or lack of markets. The Corporation is dependent upon the production rates and oil price to fund the current development program. In order to mitigate the Corporation s risk to fluctuations in oil price, the Corporation has taken out a number of commodity derivatives. As at December 31, 2010, the Corporation had one forward swap outstanding for 80,600 bbls to hedge a proportion of December 2010 production, priced in January In March 2011, a put option to sell 804,500 bbls of the Corporation s 2011 forecast production at $105 / bbl was entered into. In April 2011 a further put option to sell an additional 300,000 bbls of the Corporation s forecast 2011 production at $115 / bbl was entered into. The Corporation is exposed to financial risks including financial market volatility, fluctuation in interest rates and various foreign exchange rates. Given the increasing 17

18 development expenditure and operating costs in currencies other than the United States dollar, the Board of the Corporation has a hedging policy to mitigate foreign exchange rate risk on committed expenditure. On October 12, 2009, the Corporation entered into a contract with the Bank of Scotland to hedge its British Pounds Sterling 2010 forecast operating costs, including general and administrative expenses. The hedge amounts to $4 million per month (total $48 million) at a $/ rate of no worse than $1.60/ 1.00 and allows the Corporation to benefit from spot movements down to $1.4975: A realized loss of $1.3 million has been recognized on the contract for the year ended December 31, The contract expired on December 31, On July 7, 2010, in order to protect against the strengthening of the US Dollar and secure the gross proceeds from the equity raise of $150 million the Corporation entered into a foreign exchange forward contract to swap the Canadian dollars and GBP proceeds of the Bought Deal Offering and the Private Placement in exchange for US Dollars when the proceeds where estimated to be received at contracted rates of USD$ / CAD$ and USD /. During the hedged period the US Dollar weakened hence the forex hedges prevented an exchange gain being realized and forex losses of $3.1 million were recorded. In 2011 in order to protect against movements in USD/ exchange rates, the Corporation holds GBP denominated cash on deposit in order to match the forecast 2011 GBP denominated expenditure. A further risk relates to the Corporation s ability to meet the conditions precedent for a full drawdown on the Credit Facility. Ability to drawdown the Credit Facility is based on the Corporation meeting certain tests including coverage ratio tests, liquidity tests and development funding tests which are determined by a detailed economic model of the Corporation. There can be no assurance that the Corporation will satisfy such tests in order to have access to the full amount of the Credit Facility, however at present the Corporation believes that there are no circumstances present that would lead to failure to meet those tests. In addition, the Facility contains covenants that require the Corporation to meet certain financial tests and that restrict, among other things, the ability of Ithaca to incur additional debt or dispose of assets. To the extent the cash flow from operations is not adequate to fund Ithaca's cash requirements, external financing may be required. Lack of timely access to such additional financing, or which may not be on favorable terms, could limit the future growth of the business of Ithaca. To the extent that external sources of capital, including public and private markets, become limited or unavailable, Ithaca's ability to make the necessary capital investments to maintain or expand its current business and to make necessary principal payments under the Credit Facility may be impaired. At present the Corporation believes that there are no circumstances present that would lead to failure to meet those certain financial tests. A failure to access adequate capital to continue its expenditure program may require that the Corporation meet any liquidity shortfalls through the selected divestment of its portfolio or delays to existing development programs. As is standard to a Credit facility, 18

19 the Corporation's and Ithaca UK assets have been pledged as Credit Facility collateral and are subject to foreclosure in the event the Corporation or Ithaca UK defaults. At present the Corporation believes that there are no circumstances present that would lead to selected divestment, delays to existing programs or a default relating to the Credit Facility. The Corporation is and may in the future be exposed to third-party credit risk through its contractual arrangements with its current and future joint venture partners, marketers of its petroleum production and other parties. The Corporation extends unsecured credit to these parties, and therefore, the collection of any receivables may be affected by changes in the economic environment or other conditions. Management believes the risk is mitigated by the financial position of the parties. The Corporation has entered in to a five year marketing agreement with BP Oil International Limited to sell all of its North Sea oil production. All gas production, acquired through the purchase of the Anglia and Topaz fields from GDF SUEZ E&P UK Ltd, is sold through three contracts on a monthly basis to RWE NPower PLC and Hess Energy Gas Power (UK) Ltd. The Corporation has not experienced any material credit loss in the collection of accounts receivable to date. The Corporation s properties will be generally held in the form of licenses, concessions, permits and regulatory consents ( Authorizations ). The Corporation s activities are dependent upon the grant and maintenance of appropriate Authorizations, which may not be granted; may be made subject to limitations which, if not met, will result in the termination or withdrawal of the Authorization; or may be otherwise withdrawn. Also, in the majority of its licenses, the Corporation is often a joint interest-holder with another third party over which it has no control. An Authorization may be revoked by the relevant regulatory authority if the other interest-holder is no longer deemed to be financially credible. There can be no assurance that any of the obligations required to maintain each Authorization will be met. Although the Corporation believes that the Authorizations will be renewed following expiry or granted (as the case may be), there can be no assurance that such Authorizations will be renewed or granted or as to the terms of such renewals or grants. The termination or expiration of the Corporation s Authorizations may have a material adverse effect on the Corporation s results of operations and business. In addition, the areas covered by the Authorizations are or may be subject to agreements with the proprietors of the land. If such agreements are terminated, found void or otherwise challenged, the Corporation may suffer significant damage through the loss of opportunity to identify and extract oil or gas. The Corporation is also subject to the risks associated with owning oil and natural gas properties, including environmental risks associated with air, land and water. The Corporation takes out market insurance to mitigate many of these operational, construction and environmental risks. In all areas of the Corporation s business there is competition with entities that may have greater technical and financial resources. There are numerous uncertainties in estimating the Corporation s reserve base due to the complexities in estimating the magnitude and timing of future production, revenue, expenses and capital. All of the Corporation's operations are conducted offshore in the 19

20 UKCS; as such Ithaca is exposed to operational risk associated with weather delays that can result in a material delay in project execution. Third parties operate some of the assets in which the Corporation has interests. As a result, the Corporation may have limited ability to exercise influence over the operations of these assets and their associated costs. The success and timing of these activities may be outside the Corporation's control. It should be noted that the Corporation is not required to certify the design and evaluation of the Corporation's disclosure controls and procedures and internal control over financial reporting and it has not completed such an evaluation. Furthermore, given the size of the Corporation there are inherent limitations on the certifying officers to design and implement on a cost effective basis disclosure controls and procedures and internal control over financial reporting that may result in additional risks to the quality, reliability, transparency, and timeliness of annual filings. For additional detail regarding the Corporation s risks and uncertainties, refer to the Corporation s most recent Annual Information Form filed on SEDAR at CONTROL ENVIRONMENT As of December 31, 2010, there were no changes in our internal control over financial reporting that occurred during 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on their inherent limitations, disclosure controls and procedures and internal controls over financial reporting may not prevent or detect misstatements and even those options determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. CHANGES IN ACCOUNTING POLICIES The consolidated financial statements for the year ended December 31, 2010 have been prepared following the same accounting policies and methods of computation as the consolidated financial statements as at December 31, IMPACT OF FUTURE ACCOUNTING CHANGES In February 2008, the CICA Accounting Standards Board ( AcSB ) confirmed the changeover from GAAP to IFRS will be required for publicly accountable enterprises, for interim and annual financial statements effective, for fiscal years beginning on or after January 1, 2011, with corporations required to report comparatives in accordance with IFRS for the year preceding implementation of the change. 20

21 IFRS adoption is currently scheduled for the Corporation's fiscal year commencing January 1, Ithaca s financial statements up to and including the December 31, 2010 financial statements continue to be reported in accordance with GAAP as it exists on each reporting date. Financial statements for the quarter ended March 31, 2011, including comparative amounts, will be prepared on an IFRS basis. In July 2009, the International Accounting Standards Board ( IASB ) issued amendments to IFRS 1 First time adoption of IFRS allowing additional exemptions for first-time adopters. These amendments allow an entity that used full cost accounting under its previous GAAP to elect to measure oil and gas assets, including exploration and evaluation assets and development and production assets, being allocated pro rata using reserves volumes or reserve values as of the date of the adoption, providing that all assets are tested for impairment on adoption. Ithaca is currently planning to adopt this exemption. The Corporation has completed the diagnostic assessment phase by performing comparisons of the differences between GAAP and IFRS. The Corporation currently follows full cost accounting as prescribed in the Accounting Guideline ( AcG ) 16, Oil and Gas Accounting-Full Cost. Conversion to IFRS may have a significant impact on how the company accounts for costs pertaining to oil and gas activities and the Corporation has determined that the most significant impact of IFRS conversion is to property, plant and equipment (PP&E). The Corporation has completed the initial procedures required to convert its opening balance sheet at 1 January The resulting proposed adjustments are discussed below but are subject to final review and audit. Although the conversion may have a significant impact on accounting for PP&E going forward, at the opening balance sheet date, the Deemed Cost exemption has been taken, with the existing cost pool being allocated across oil and gas assets on a pro rata basis using reserve values as of that date. The assets have subsequently been assessed for impairment at the date of transition and no impairment adjustment is required, hence the total value of PP&E remains unchanged. The ARO liability at 1 January 2010 has been recalculated as required under IAS 37 and an increase in the liability of approximately $0.8m is proposed as a result of discount rate changes. Contingent consideration amounts on transactions prior to 1 January 2010 are in the process of being valued in accordance with IAS 39. On transition to IFRS, this is likely to result in a liability of between $5m and $10m being recognized. Other opening balance sheet adjustments are still being finalized but are not expected to be significant. 21

22 The Corporation is also in the process of finalizing its accounting policy choices under IFRS. The Corporation s transition plan remains on schedule and all changes to comply with IFRS required from January 1, 2011 will have been incorporated as required. FINANCIAL INSTRUMENTS AND OTHER INSTRUMENTS All financial instruments are initially measured in the balance sheet at fair value. Subsequent measurement of the financial instruments is based on their classification. The Corporation has classified each financial instrument into one of these five categories: held-for-trading, held-to-maturity investments, loans and receivables, available-for-sale financial assets or other financial liabilities. Loans and receivables, held-to-maturity investments and other financial liabilities are measured at amortized cost using the effective interest rate method. For all financial assets and financial liabilities that are not classified as held-for-trading, the transaction costs that are directly attributable to the acquisition or issue of a financial asset or financial liability are adjusted to the fair value initially recognized for that financial instrument. These costs are expensed using the effective interest rate method and are recorded within interest expense. Held-for-trading financial assets are measured at fair value and changes in fair value are recognized in net income. Available-for-sale financial instruments are measured at fair value with changes in fair value recorded in other comprehensive income until the instrument is derecognized or impaired. All derivative instruments are recorded in the balance sheet at fair value unless they qualify for the expected purchase, sale and usage exemption. All changes in their fair value are recorded in income unless cash flow hedge accounting is used, in which case changes in fair value are recorded in other comprehensive income. The Corporation has classified its cash and cash equivalents, restricted cash, commodity hedge and long term liability as held-for-trading, which are measured at fair value with changes being recognized in net income. Accounts receivable are classified as loans and receivables; operating bank loans, accounts payable and accrued liabilities are classified as other liabilities, all of which are measured at amortized cost. The classification of all financial instruments is the same at inception and at December 31, FORWARD-LOOKING INFORMATION This MD&A and any documents incorporated by reference herein contain certain forward-looking statements and forward-looking information which are based on the Corporation's internal expectations, estimates, projections, assumptions and beliefs as at the date of such statements or information, including, among other things, assumptions with respect to production, future capital expenditures and cash flow. The reader is cautioned that assumptions used in the preparation of such information may prove to be 22