Form 10-K for OILSANDS QUEST INC
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27-Jun-2008
Annual Report
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introduction
The following discussion and analysis presents management's perspective of our business, financial condition and overall performance. This information is intended to provide investors with an understanding of our past performance, current financial condition and outlook for the future. Our discussion and analysis relates to the following topics:
? Overview of Business
? Overview of 2008 Results and Outlook
? Liquidity and Capital Resources
? Changes in Financial Condition and Results of Operations
? Share Capital
? Critical Accounting Policies
? Contractual Cash Obligations
Overview of Business
We are a U.S. public company based in Calgary, Alberta engaging in a variety of projects in the oil and gas sector and in particular the oil sands and oil shale sectors in Western Canada. We are aggressively exploring Canada's largest contiguous oil sands land holding, which is located in northeast Alberta, northwest Saskatchewan and Oilsands Quest is leading the development of an oil sands industry in the Province of Saskatchewan.
Oilsands Quest, together with its subsidiaries, is in the exploration and development stage and does not currently have any income from operating activities. For a more detailed discussion of our business see Part 1, Item 1, "Description of Business".
Overview of 2008 Results and Outlook
During the year ended April 30, 2008, the Company's activities included an exploration drilling program of 175 delineation test wells on its permit lands in Saskatchewan and Alberta, advancement of its pre-commercialization evaluation studies on and reservoir test program on its Axe Lake Discovery, a comprehensive 2-D and 3-D seismic program in Saskatchewan and on adjacent Alberta permits, and an extensive environmental program consisting of monitoring and baseline assessment studies.
During the year ended April 30, 2008, we raised $144.4 million, net of issuance costs, through private placement share issuances, a marketed public offering and proceeds of warrant and option exercises to fund these activities and future programs.
Operations Summary:
Exploration Program
On March 26, 2008, we concluded the 2007/2008 exploration program in the field for which drilling began on September 14, 2007. The program demonstrated continued success on the Company's contiguous oil sands exploration lands in Saskatchewan and Alberta. Overall, a total of 175 test wells were drilled with 150 in Saskatchewan and 25 in the Company's first exploration program conducted on its adjacent land holdings in Alberta. We also conducted a comprehensive 2-D and 3-D seismic program on our permit lands in Saskatchewan and Alberta
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totaling 1,847 kilometres (1,149 miles). In addition, we continued to conduct a comprehensive $4 million CDN environmental program on the permit lands, consisting of monitoring and baseline studies which formed the basis of the plans approved by the Federal and Saskatchewan Provincial governments. For a more detailed discussion on the Company's exploration program and results see
Part I, Item 1, "Description of Business - Activities To Date" and Part I,
Item 2, "Properties and Statement of Oil and Gas Information". Axe Lake Discovery
In January 2007, following our initial drilling season, we designated the discovery area, plus certain additional prospective lands associated with it, as the Axe Lake Discovery. The designated Axe Lake Discovery area is a notional area identified by us and located in an area of approximately 72 sections (72 square miles) located in Townships 94 and 95, Ranges 24 and 25 West of the 3rd Meridian. As a result of the winter 2007/2008 program, the drilled portion of the Axe Lake Discovery area now covers approximately 65 sections (65 square miles) of Permits PS00208 and PS00210 (100% Oilsands Quest) located in the north half of Township 94 and the south half of Township 95, Ranges 24 and 25 West of the 3rd Meridian.
Axe Lake Discovery - Reservoir Development Activities In January 2008, following extensive, ongoing laboratory testing, reservoir simulation studies and the determination of the initial definition of a reservoir field test program to evaluate reservoir response to varying temperatures and pressures of steam and steam with solvents, we announced a program of reservoir testing at up to three sites within the Axe Lake Discovery for 2008.
Site preparation and construction of facilities for Oilsands Quest's reservoir test program at Axe Lake commenced in January 2008 and were halted through April and May for spring break-up. Activity recommenced in June 2008 and is ongoing at present. The large steam generator Final Acceptance Test was successfully concluded and the steam generator is being transported to site. Other major equipment will also arrive on site during facilities installation which commences first week of July. Steam and hot water injection into the reservoir on Test Site 1 is planned for late summer 2008.
Phase One of the Axe Lake Discovery reservoir test program will consider up to three test sites (with varying overburden and pay thicknesses) with one vertical injection well and five vertical observation wells per test site. The purpose of Phase One of the Axe Lake test program is to measure resource specific heat and fluid movement under specific operating conditions on a field scale to complement our ongoing simulation and laboratory analysis studies. Phase One has received regulatory approval. Current plans call for placement of horizontal wells in late summer 2008, with injection to begin following initial results from the Phase One program at Test Site 1 subject to the requisite approvals. Phase Two of the test program will consider expanding the three test sites with horizontal wells and/or injecting mobilization agents other than steam. The purpose of Phase Two is to evaluate and analyze information gathered from Phase One regarding mobilization with steam and/or hot water and to measure field-scale response using horizontal wells. Phase Three of the Axe Lake Discovery test program is currently in the scoping phase; options being considered range from a continued reservoir test program to a technology feasibility pilot to a full commercial demonstration project.
By June 2008 six 1,000-barrel heated liquid storage tanks were received at Test Site 1, and two 1,000-barrel heated liquid storage tanks were delivered to both Test Sites 2 and 3. The preliminary engineering contracts for the surface facilities for Test Site 2 were awarded and design work has commenced. The large steam generator Final Acceptance Test was successfully concluded and the steam generator is being transported to site. Other major equipment will also arrive on site during facilities installation which commences first week of July and most of this equipment will be installed in all-season building structures. Construction of these facilities is expected to be completed approximately eight weeks after the arrival of the major equipment.
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By the end of July 2008, we expect to resume drilling of the wells required for injection and monitoring at the three reservoir test sites, including the remaining two of the six wells at Test Site 1 and wells at Test Site 2 and 3 as appropriate.
Abandonment and Reclamation Costs
We are responsible for compliance with terms and conditions of environmental and regulatory approvals and all laws and regulations regarding the abandonment of a project and reclamation of its lands at the end of its economic life, which abandonment and reclamation costs may be substantial. A breach of such legislation and/or regulations may result in the issuance of remedial orders, the suspension of approvals, or the imposition of fines and penalties, including an order for cessation of operations at the site until satisfactory remedies are made. We have not yet recognized any retirement, abandonment or reclamation obligation in our financial statements. All delineation wells are abandoned and reclaimed immediately and these costs are included with our exploration costs incurred. As at April 30, 2008, we estimate the total undiscounted amount required to settle the asset retirement obligations in respect of the Company's wells and facilities is approximately $3 million. This estimate includes the costs to reclaim the air strip, camp site, access roads and four reservoir test wells. However, since we have yet to determine the commercial viability of the Axe Lake Discovery we cannot with certainty determine a reasonable timeframe in which those costs will be incurred. This estimate could change as the reclamation requirements will be a function of regulatory regulations in place at the time.
Outlook
Over the next twelve months we will initiate the activities necessary to establish a commercial development plan for the Axe Lake Discovery, including aggressively progressing the reservoir test programs in order to evaluate an optimum in-situ oil sands recovery process. We expect to select one or more recovery technology options, conduct one or more technology feasibility tests and commence development of a commercial project. The following is an overview of key activities continuing and planned in the next twelve months:
? continue exploration and delineation activities to further define the location, extent and quality of the Discovered Resources at Axe Lake and Raven Ridge (for a complete description of our independent resource estimates, see Part I, Item 2 "Properties and Statement of Oil and Gas Information");
? continue to evaluate drilling data and perform advanced laboratory studies of bitumen characterization and recovery methods;
? continue to undertake computer reservoir modeling and simulation studies to aid in the selection of the optimal recovery technologies at Axe Lake and Raven Ridge;
? continue to engineer and procure surface and down-hole equipment for reservoir field tests;
? conduct injection tests with steam and other mobilization agents in vertical and horizontal wells to confirm laboratory and simulation studies;
? continue to conduct environmental programs to establish base-line data and facilitate regulatory approvals;
? continue to conduct advanced economic feasibility and risk assessment studies for full commercial project development;
? continue to accelerate scoping and engineering designs for our initial commercial development at the Axe Lake Discovery, including initiating engineering plans for the first 30,000 barrel per day commercial project at the Axe Lake Discovery;
? initiate joint venture partnership and capital market negotiations for the development of the Axe Lake Discovery; and
? evaluate market alternatives for bitumen sales from one or more commercial projects at Axe Lake.
Oilsands Quest and its engineering consultants have embarked upon preliminary engineering of an initial 30,000 barrels per day commercial project planned for the development of a portion of Axe Lake in the specific area where the first series of reservoir tests is being conducted. Management also continues to conduct advanced economic
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feasibility and risk assessment studies for full commercial project development, including assessment of an aggressive approach to a first prospective project, which could result in completion during 2012 or 2013. Oilsands Quest has also commissioned a study of infrastructure and markets by Purvin & Gertz Inc. to assist in its planning process. Development of a commercial project remains subject to regulatory and other contingencies such as successful reservoir tests, board sanctioning and financing.
In addition, we will continue to conduct an extensive exploration program activity to further define the location, extent and quality of the potential oil sands resource at the Wallace Creek and Eagles Nest Prospects. We also intend to conduct an exploratory drilling program on the Pasquia Hills Oil Shale Prospect in 2008/2009 and research potential methods for kerogen recovery from oil shales.
Our planned activities over the next twelve months as outlined above will require expenditures of approximately $200 - $250 million. If we accelerate commercial development at Axe Lake or any of our other prospects, our cash requirements over the next two years will increase significantly from the amount noted above. Additional funding may also be required if our current planned activities are changed in scope or if actual costs differ from estimates of current plans. We believe the Company will have access to sufficient funding and sources of capital for its planned activities to April 30, 2009. Because we constantly and actively monitor our expenditure budgets, if sufficient funding is not available we can adjust our expenditure plans based on available cash. We plan to fund future operations by way of financing, including a public offering or private placement of equity or debt securities. Our development strategy also includes considering partners on a joint venture basis on our specific projects to fund the development of such projects in a timely and responsible manner. However, there is no assurance that debt or equity financing or joint venture partner arrangements will be available to us on acceptable terms, if at all, to meet these requirements. The Company has no revenues, and its operating results, profitability and the future rate of growth depend solely on management's ability to successfully implement the business plans and on the ability to raise further funding.
Liquidity and Capital Resources
The following discussion of liquidity and capital resources should be read in conjunction with the consolidated financial statements included in Part II, Item 8, "Financial Statements and Supplementary Data".
On May 3, 2007, the Company issued 13,900,000 shares of common stock at a price of $2.75 per share for gross proceeds of $38,225,000 pursuant to a private placement. In connection with the private placement, the Company paid an aggregate of $2,197,938 in fees to the agents pursuant to an agency agreement. On May 3, 2007, the Company issued 2,164,166 shares of common stock on a flow-through basis at a price of $3.44 ($3.85 CDN) per share for gross proceeds of $7,444,731 ($8,332,039 CDN) in a private placement pursuant to an amended underwriting agreement originally entered into on March 6, 2007. These shares have been issued on a flow through basis whereby the proceeds must be used for exploration in Canada and the tax benefits from that exploration will flow through to the subscribers. In connection with this private placement, the Company received an additional payment of $3,499,419 ($3,873,857 CDN) from the underwriters pursuant to their obligations under the underwriting agreement, as amended. The Company paid an aggregate of $551,305 ($610,295 CDN) in fees to the underwriters.
On September 21, 2007, the Company issued 750,000 shares of common stock as part of the consideration provided for the purchase of a royalty which encumbered the Saskatchewan permit lands and the interests of one of the joint venture partners to the Triple 7 Joint Venture Agreement, which encumbered the Eagles Nest Prospect.
On December 5, 2007, the Company issued 11,000,000 units at a price of $5.00 per unit for gross proceeds of $55,000,000 pursuant to a marketed public offering. Each unit was comprised of one share of common stock and one-half of a share of common stock purchase warrant with each whole warrant entitling the holder to purchase one share of common stock of the Company for $6.75 per share until December 5, 2009.
On December 5, 2007, as part of the marketed public offering, the Company issued 2,600,000 shares of common stock of a flow-through basis at a price of $6.11 ($6.17 CDN) per share for gross proceeds of $15,886,000 ($16,042,000 CDN).
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On December 20, 2007, an over-allotment option granted to the underwriters as part of the agreement under the marketed public offering was exercised. As a result the Company issued an additional 1,650,000 units at a price of $5.00 per unit for gross proceeds of $8,250,000. Each unit is comprised of one share of common stock and one-half of a share of common stock purchase warrant with each whole warrant entitling the holder to purchase one share of common stock of the Company for $6.75 per share until December 5, 2009.
Under the terms of the flow-through shares issued on March 6, 2007, March 9, 2007, May 3, 2007 and December 5, 2007, the Company renounced the tax benefits of the related expenditures to the subscribers effective December 31, 2007. As at April 30, 2008 all amounts have been expended on exploration in Canada. The March 6, 2007, March 9, 2007, May 3, 2007 and December 5, 2007 flow-through shares were issued at a premium to the then market price in recognition of the tax benefits accruing to subscribers. In accordance with US GAAP the premium was originally recorded as a current liability and then it was drawn down as a reduction of deferred tax expense as the exploration expenditures were incurred. Subsequent to April 30, 2008, the Company issued 12,976,761 shares of common stock at a price of $4.20 per share for gross proceeds of $54,502,396 pursuant to a private placement. The Company paid an aggregate of $1,225,120 in fees to the underwriters.
On June 17, 2008, we acquired the rights of the remaining external joint venture partners to the Triple 7 Joint Venture Agreement, which encumbered the Eagles Nest Prospect, for aggregate consideration of $1,632,000 CDN and 640,000 shares of the Company's common stock valued at $2,860,800 based on the May 29, 2008, closing market price of the shares. The Company's obligations under the Triple 7 Joint Venture Agreement have therefore been eliminated.
At June 16, 2008, the Company has approximately $90 million in cash on hand. Changes in Financial Condition and Results of Operations During the year ended April 30, 2008, the primary focus of the Company was the delineation of the Axe Lake Discovery, exploring the Saskatchewan and Alberta permit lands, raising exploration funds, completing the acquisition of an outstanding $0.07 per barrel royalty obligation on the Saskatchewan permit lands, completing the acquisition of all the rights of one of the three external joint venture partners to the Triple 7 Joint Venture Agreement (which encumbered the Eagles Nest Prospect) the acquisition of five oil sands exploration licenses in Saskatchewan, the acquisition of two oil sands exploration permits in Alberta, and the continuation of pre-commercialization studies on our Axe Lake Discovery.
During the year ended April 30, 2007, the primary focus of the Company was exploring the Saskatchewan permit lands, raising exploration funds, completing the acquisition of the non-controlling (minority) interest (35.92%) in OQI Sask, the acquisition of a 2.5% gross overriding royalty on the Saskatchewan permit lands, the acquisition of four oil sands exploration permits in Alberta and the initiation of pre-commercialization studies on our Axe Lake Discovery. During the year ended April 30, 2006, the primary focus of the Company was on completing the purchase of the Saskatchewan permits, obtaining funds for exploration programs, assessing and acquiring other possible investment opportunities within the Athabasca Oil Sands region which resulted in the purchase of the Eagles Nest Oil Sands Lease and conducting the first exploration program on our Saskatchewan permit lands. Net Loss
Year ended April 30, 2008 as compared to year ended April 30, 2007. The Company experienced a net loss of $98,870,931 or $0.44 per share for the year ended April 30, 2008 as compared to a net loss of $68,794,741 or $0.40
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per share for the year ended April 30, 2007. The Company expects to continue to incur operating losses and will continue to be dependent on additional equity or debt sales and/or property joint ventures to fund its activities in the future. Year ended April 30, 2007 as compared to year ended April 30, 2006. The Company experienced a net loss of $68,794,741 or $0.40 per share for the year ended April 30, 2007 as compared to a net loss of $52,640,903 or $0.64 per share for the year ended April 30, 2006.
Exploration costs
Year ended April 30, 2008 as compared to year ended April 30, 2007. Exploration costs for the year ended April 30, 2008 were $96,419,694 (2007 - $26,877,906). Exploration costs in the current year relate to drilling, seismic and environmental work done on our Saskatchewan and Alberta permits. Approximately $27 million was spent on seismic programs and the balance of costs relates to exploration and related environmental monitoring activity of which approximately 75% was spent in Saskatchewan and 25% was spent in Alberta. In addition OQI recovered $242,748 on a uranium property interest that had been previously written off, which was credited to Exploration costs. Exploration costs for the year ended April 30, 2007 are detailed in the next section. Increased activity on the Axe Lake Discovery is the main reason for the increase from 2007 to 2008. Year ended April 30, 2007 as compared to year ended April 30, 2006. Exploration costs for the year ended April 30, 2007 were $26,877,906 (2006 - $8,291,018). $26,947,900 was expended on the Axe Lake Discovery and other Saskatchewan oil sand permits and $349,390 was expended on other project areas. In addition, OQI sold its interest in several technology joint ventures to one of the remaining partners for consideration of $419,384 which was credited to Exploration costs. OQI's rights and obligations under the agreements were assigned to and assumed by the purchasing partner and OQI was released from any further obligations and liabilities under the agreements. Exploration costs for the year ended April 30, 2006 included $645,798 in costs associated with the Pasquia Hills Oil Shale Prospect and $6,232,122 in costs incurred on the Saskatchewan oil sands permit lands including the Axe Lake Discovery. In addition, OQI incurred costs related to the Sylvan Lake and Barrhead oil and gas prospects of $452,577 and $202,418 respectively, $234,433 was expended in conjunction with the Company's interests in a technology joint ventures and $176,732 in costs were associated with the Eagles Nest Prospect. Also included in exploration was $233,333 related to property acquired which was subsequently written off. General and administrative
Cash consideration
Year ended April 30, 2008 as compared to year ended April 30, 2007. General and administrative expenses settled with cash increased from $10,782,651 in 2007 to $11,170,499 in 2008. The increase in total costs year over year is not significant. Increases in certain costs (salaries and professional fees) were offset by reductions in other areas (2007 included one time reorganization costs).
Year ended April 30, 2007 as compared to Year ended April 30, 2006. General and administrative expenses settled with cash increased from $4,138,482 in 2006 to $10,782,651 in 2007. The increase occurred as consulting fees, corporate salaries and professional fees were higher. Consulting expenses increased by $3,281,653 as almost all consulting fees incurred in 2006 were settled with the issuance of shares whereas all fees incurred in 2007 were settled with cash. Corporate salaries increased $2,468,660 because subsequent to the August 14, 2006 reorganization, operations increased significantly and permanent employees were hired to run the Company, prior to the reorganization the Company was primarily run by consultants. Professional fees increased by $929,756 in 2007 as a direct result of the additional costs associated with the August 14, 2006 reorganization.
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Stock-based consideration
Year ended April 30, 2008 as compared to year ended April 30, 2007. Stock-based consideration expense for the year ended April 30, 2008 of $16,187,715 (2007 - $39,755,592) consists of stock-based compensation related to the issuance of options to directors, officers, employees and consultants and to bonus shares issued to employees. The fair value of the stock options was estimated using the Black-Scholes valuation model consistent with the provisions of SFAS No. 123R. The Black-Scholes valuation model requires the input of highly subjective assumptions, including the option's expected life and the expected price volatility determined using the historical volatility of the Company's common stock. OQI has unrecognized stock-based compensation costs of $12,607,254 related to unvested options which will be recognized in future periods as the options vest. The large decrease in Stock-based consideration in 2008 is due to the vesting terms of the stock options that were granted in 2007. Approximately 3.9 million stock options that were granted in 2007 vested in that same year compared to only 1.4 million stock options that were granted in 2008. Stock based compensation is a non-cash expense.
Year ended April 30, 2007 as compared to year ended April 30, 2006. Stock-based consideration expense for the year ended April 30, 2007 of $39,755,592 (2006 - $44,319,817) consists of stock-based compensation related to the issuance of options to directors, officers, employees and consultants. The fair value of the stock options was estimated using the Black-Scholes valuation model consistent with the provisions of SFAS No. 123R. The Black-Scholes valuation model requires the input of highly subjective assumptions, including the option's expected life and the expected price volatility determined using the historical volatility of the Company's common stock. Stock-based compensation is a non-cash expense. In 2006 stock-based consideration was comprised of $34,047,988 in non-cash financing expenses, $8,957,324 in consulting and advertising services provided and $1,314,505 in stock-based compensation. The non-cash financing costs in 2006 were as a result of OQI's contractual commitment in fiscal 2006 to file a re-sale registration statement with respect to a private placement done in December, 2005. OQI issued 2,889,371 shares of common stock as a penalty for delays and recorded a non-cash financing expense of $17,312,623. In addition, OQI recorded non-cash financing costs of $16,735,365 related to warrants issued in conjunction with the private placement completed in December 2005 and the convertible debentures issued during the year. The fair value of the warrants was calculated using the Black-Scholes pricing model. Depreciation
Year ended April 30, 2008 as compared to year ended April 30, 2007. Depreciation expense of $1,072,565 (2007 - $367,827) relates to camp facilities, equipment and corporate assets acquired during fiscal 2007 and 2008.
Year ended April 30, 2007 as compared to year ended April 30, 2006. Depreciation expense of $367,827 (2006 - nil) relates to camp facilities, equipment and corporate assets acquired during fiscal 2007. Interest income
Year ended April 30, 2008 as compared to year ended April 30, 2007. Interest income of $2,468,694 (2007 - $1,530,720) was recognized in fiscal 2008 because the Company had pre-funded its 2008 winter exploration resulting in cash on hand which was invested in short-term deposits.
Year ended April 30, 2007 as compared to year ended April 30, 2006. Interest income of $1,530,720 (2006 - $273,304) was recognized in fiscal 2007 because the Company had pre-funded its exploration programs resulting in cash on hand which was invested in short-term deposits.
Gain on extinguishments of certain liabilities Year ended April 30, 2008 as compared to year ended April 30, 2007. No such transactions occurred in fiscal 2008 or 2007. |
