<DOCUMENT>
<TYPE>EX-99
<SEQUENCE>130
<FILENAME>ex99-127form40_f.txt
<DESCRIPTION>EXHIBIT 99.127
<TEXT>
EXHIBIT 99.127
--------------
[ADVANTAGE LOGO]
[Q1 LOGO]
2004 FIRST QUARTER
MANAGEMENTS DISCUSSION &
ANALYSIS
The following MD&A provides a detailed explanation of the financial and
operating results of Advantage Energy Income Fund ("Advantage" or "the Fund")
for the quarter ended March 31, 2004 and should be read in conjunction with the
financial statements contained within this interim report and the audited
financial statements and MD&A for the year ended December 31, 2003.
All per barrel of oil equivalent ("boe") numbers are stated at a 6:1 conversion
rate for natural gas to oil.
CASH DISTRIBUTIONS
Cash distributions per Unit for the three months ended March 31, 2004 were $0.69
per Unit, or $26.3 million, an increase of 8% over the $0.64 per Unit paid in
the first quarter of 2003. The first quarter 2004 distributions were comprised
of $0.23 per month for each of January, February and March. The amount
distributed for the quarter represents 88% of total cash available for
distribution. Cash available for distribution is defined as cash flow from
operations less interest on convertible debentures. The remaining cash withheld
of $3.6 million was used to partially finance the Fund's ongoing capital
expenditure program. Since its inception on May 23, 2001 the Fund has
distributed $178.7 million or $6.58 per Unit.
Cash distributions to Unitholders were paid as follows:
<TABLE>
<CAPTION>
Period ended Record date Payment date Distribution Distribution per
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Jan. 31,2004 Jan. 30,2004 Feb. 17, 2004 $ 8,734 $ 0.23
Feb. 29,2004 Feb. 27,2004 March 15, 2004 $ 8,755 0.23
Mar. 31,2004 Mar. 31,2004 Apr. 15, 2004 $ 8,778 0.23
----------------------------------------------------------------------------------
$ 26,267 $ 0.69
----------------------------------------------------------------------------------
</TABLE>
PRODUCTION
During the three months ended March 31, 2004 Advantage's natural gas production
increased by 39% to 75.6 mmcf/d compared to 54.5 mmcf/d for the quarter ended
March 31, 2003 and by 10.3 mmcf/d or 16% over the fourth quarter of 2003. The
increase in natural gas production is primarily due to the acquisition of
MarkWest Resources on December 2, 2003. MarkWest added approximately 20 mmcf/d
of new natural gas production to Advantage. Additional natural gas production
related to the Fund's active first quarter drilling program are expected to come
on-stream late in the second quarter.
Crude oil and natural gas liquids production averaged 2,841 bbls/d in the first
quarter of 2004 compared to 2,946 bbls/d for the quarter ending March 31, 2003.
The 4% decline in production from the first quarter of 2003 is due to a minor
property disposition of approximately 240 bbls/d and natural declines partially
offset by the acquisition of MarkWest Resources on December 2, 2003.
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EXHIBIT 99.127
E
PRICES
During the three months ended March 31, 2004 Advantage's natural gas price
averaged $6.28 per mcf ($6.28 per mcf including hedging) compared to $7.65 per
mcf ($6.18 per mcf including hedging) in the first quarter of 2003. Advantage
did not have natural gas hedges in place during the first quarter of 2004. For
the three months ended March 31, 2004 AECO daily prices averaged $6.36 per mcf
compared to $7.95 per mcf in the same period in 2003.
Natural gas prices have remained relatively strong during the first quarter of
2004. Continued strength of natural gas has been attributed to (i) the strength
of crude oil prices which has eliminated the economic advantage of fuel
switching away from natural gas, (ii) the potential for a hotter than normal
summer and reduced coal inventories which may increase demand for gas-fired
power generation and (iii) the US economy is showing signs of sustained growth
which will add to non-weather demand for natural gas. Advantage continues to
believe the pricing fundamentals for natural gas remain strong.
Crude oil and NGLs prices averaged $40.93 per barrel ($40.93 per barrel
including hedging) in the first quarter of 2004 compared to $45.74 per barrel
($44.34 per barrel including hedging) in the three months ended March 31, 2003.
Advantage had no crude oil hedges in place in the first quarter of 2004. First
quarter 2004 prices for WTI crude oil averaged US$35.15 per barrel, 4% higher
than the US$33.80 per barrel realized during the first quarter of 2003.
Partially offsetting the increase in WTI prices was a stronger Canadian dollar
which averaged $US/$Cdn $0.76 in the first quarter of 2004 compared to $0.66 in
the first quarter of 2003.
Crude oil prices continued to be strong during the first quarter of 2004.
Factors that affect the continued strength of crude oil include (i) continued
conflict in the middle east, (ii) low global inventory levels and (iii) strong
world oil demand. All of these factors are expected to keep crude oil prices
high for the remainder of the year.
HEDGING
Advantage had no hedging contracts related to first quarter 2004 production. The
Fund currently has the following hedge contracts in place:
Volume Effective Period Average Price
----------------------------------------------------------------------
Natural gas - AECO
50,350 mcf/d April 1, 2004 - December 31, 2004 $ 6.12/mcf
10,450 mcf/d January 1, 2005 - March 31, 2005 $ 6.30/mcf
At March 31, 2004 the mark to market valuation of Advantage's outstanding hedges
was a loss of $11.1 million. This amount has been included in the income
statement as an unrealized hedging loss with a corresponding hedging liability
recorded on the balance sheet. Advantage will continue to maintain a hedging
program in order to add stability to the level of cash distributions to
Unitholders.
ROYALTIES
During the first quarter of 2004 Advantage's royalties amounted to $10.6 million
(19.6% of pre-hedged revenue) compared to $8.2 million (16.5% of pre-hedged
revenue) in the first quarter of 2003. Total royalties in 2004 are higher as a
result of higher revenues. The increase in the royalty rate in 2004 is the
result of the acquisition of MarkWest Resources properties in December 2003
which attract higher royalty rates than other Advantage properties. Advantage
expects royalty rates to approximate 20% for the balance of 2004.
OPERATING COSTS
Operating costs for the three months ended March 31, 2004 amounted to $8.3
million or $5.92 per boe compared to $5.5 million or $5.09 per boe in the first
quarter of 2003. Operating costs steadily increased throughout 2003 due to
higher power costs and higher field costs associated with the shortage of
supplies, services and materials that have occurred as a result of very high
levels of industry activity. Advantage's increased operating costs over 2003 are
in line with overall industry trends.
GENERAL AND ADMINISTRATIVE AND MANAGEMENT FEES
General and administrative (G&A) expense in the first quarter of 2004 amounted
to $0.8 million or $0.60 per boe compared to $0.8 million or $0.76 per boe in
the first quarter of 2003. Total G&A expense in the first quarter was unchanged
from the prior year while G&A per boe declined by 21% as a result of increased
production.
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EXHIBIT 99.127
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Management fees for the three months ended March 31, 2004 amounted to $0.5
million or $0.37 per boe compared to $0.4 million or $0.39 per boe in the first
quarter of 2003. Management fees are calculated based on 1.5% of operating cash
flow which is defined as revenue less royalties and operating costs.
The Manager of the Fund is entitled to earn a performance incentive fee which is
calculated at the end of each year based on the total return of the Fund. At
March 31, 2004 no amount was paid to the Manager, nor is the Manager entitled to
receive any payment related to the Fund's performance for the first three months
of 2004 as the actual amount is calculated and paid on an annual basis only. If
the performance fee was paid at March 31, 2004, based on the performance of the
Trust in the first quarter, the total fee payable would be $5.6 million. The
Trust has accrued one quarter of this amount or $1.4 million for the first
quarter of 2004. There is no certainty that the fee accrued in the financial
statements will be paid at year end. Any performance incentive fee paid to the
Manager at year end is expected to be settled in Advantage Trust Units.
INTEREST
Interest expense for the three months ended March 31, 2004 amounted to $1.3
million ($0.91 per boe) compared to $1.6 million ($1.47 per boe) for the first
quarter of 2003. Lower interest expense in the first quarter of 2004 is the
result of lower average bank debt balances in 2004 combined with lower interest
rates.
TAXES
Current taxes are comprised primarily of capital tax, which amounted to $0.3
million for the three months ended March 31, 2004 compared to $0.4 million for
the same period of 2003. Capital taxes are determined based on debt and equity
levels at the end of the year. As a result of new legislation in 2003, capital
taxes are to be gradually eliminated over the next five years.
For the three months ended March 31, 2004 a future income tax recovery of $7.8
million was included in income compared to a $3.1 million recovery for the
comparable period in 2003. On March 31, 2004, Bill 27 Alberta Corporate Tax
Amendment Act, 2004, which reduces the corporate provincial tax rate by 1%, was
tabled and received first reading in the Alberta Legislative Assembly. As a
result Bill 27 is substantively enacted and a non-recurring benefit of $2.2
million was recorded in the first quarter of 2004. There was no similar tax rate
adjustment to income tax expense in the first quarter of 2003.
CASH FLOW NETBACK
<TABLE>
<CAPTION>
Three months ended Three months ended
Breakdown of cash flow per boe March 31, 2004 March 31, 2003
($000) (per boe) ($000) (per boe)
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Crude oil & natural gas sales $ 53,836 $ 38.29 $ 49,638 $ 45.84
Hedging gains (losses) - - (7,559) (6.98)
Government & other royalties (10,552) (7.51) (8,196) (7.57)
Operating costs (8,320) (5.92) (5,514) (5.09)
----------------------------------------------------------------------------------
Operating netback 34,964 24.86 28,369 26.20
General and administrative (846) (0.60) (825) (0.76)
Management fees (525) (0.37) (425) (0.39)
Interest & taxes (1,593) (1.13) (1,978) (1.83)
----------------------------------------------------------------------------------
Cash flow from operations $ 32,000 $ 22.76 $ 25,141 $ 23.22
Interest on convertible debentures (2,100) (1.49) (1,332) (1.23)
----------------------------------------------------------------------------------
Cash available for distribution $ 29,900 $ 21.27 $ 23,809 $ 21.99
----------------------------------------------------------------------------------
</TABLE>
DEPLETION, DEPRECIATION AND ACCRETION OF ASSET RETIREMENT OBLIGATION
The depletion, depreciation and accretion (D,D&A) rate for the first quarter of
2004 was $14.24 per boe compared to $10.63 per boe for the first quarter of
2003. The D,D&A rate per boe increased in the first quarter of 2004 compared to
the first quarter of 2003 due the acquisition of MarkWest Resources and
revisions to the Fund's total proven reserves pursuant to National Instrument
51-101. Included in D,D&A is $0.2 million of accretion of the asset retirement
obligation. Costs subject to depletion include $7.1 million relating to the
capitalized portion of the asset retirement obligation in the first quarter of
2004. The retroactive application of the new accounting policy for asset
retirement obligations requires restatement of prior periods, which
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EXHIBIT 99.127
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resulted in the first quarter 2003 D,D&A rate to increase to $10.63 per boe
compared to the previously reported rate of $10.59 per boe and D,D&A expense to
increase by $0.2 million.
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EXHIBIT 99.127
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FINANCIAL REPORTING UPDATE
Hedging Relationships
Effective in the Fund's first quarter of 2004, the new CICA Accounting Guideline
13 "Hedging Relationships" requires that hedging relationships be identified,
designated, documented and measured in order for the Fund to apply hedge
accounting. Although the Fund believes that all of the hedges Advantage enters
into are effective economic hedges, Advantage has elected to not use hedge
accounting. The Fund will be using the fair value method to account for all of
its hedge transactions. This method requires Advantage to mark to market at the
balance sheet date the fair value of all outstanding hedges. At March 31, 2004
the mark to market valuation of Advantage's outstanding hedges was a loss of
$11.1 million. This amount has been included in the income statement as an
unrealized hedging loss with a corresponding hedging liability recorded on the
balance sheet.
Asset Retirement Obligations
In March 2003 the CICA issued handbook section 3110 "Asset Retirement
Obligations" which requires liability recognition for retirement obligations
associated with the Fund's property and equipment. The obligations are initially
measured at fair value, which is the discounted future value of the liability.
The fair value is capitalized as part of the cost of the related assets and
depleted to earnings over the assets useful life. The liability accretes until
the retirement obligations are settled. Advantage adopted the new standard in
the first quarter of 2004. The impact to the Trust of the implementation of this
policy is disclosed in note 1 (b) of the March 31, 2004 financial statements.
Full Cost Accounting
Effective January 1, 2004 the Trust adopted CICA accounting guideline 16 "Oil
and Gas Accounting - Full Cost". This accounting guideline replaced CICA
accounting guideline 5, "Full cost accounting in the oil and gas industry".
Accounting guideline 16 modifies how the ceiling test calculation is performed.
The recoverability of a cost centre is tested by comparing the carrying value of
the cost centre to the sum of the undiscounted cash flows expected from the cost
centre. If the carrying value is not recoverable the cost centre is written down
to its fair value. Adopting accounting guideline 16 had no effect on the Trust's
financial results.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The Trust has contractual obligations in the normal course of operations
including purchase of assets and services, operating agreements, transportation
commitments and sales contracts. These obligations are of a recurring and
consistent nature and impact cash flow in an ongoing manner. The following is a
summary of the Fund's contractual obligations and commitments:
<TABLE>
<CAPTION>
Payments due by
period
($millions) Total 2004 2005-2006 2007-2008 2009 & thereafter
--------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Building lease $ 3.5 $ 0.8 $ 1.6 $ 1.1 -
Capital lease $ 2.7 $ 0.4 $ 0.9 $ 1.4 -
Pipeline/transportation $ 4.3 $ 0.6 $ 2.1 $ 1.2 $ 0.4
--------------------------------------------------------------------------------------------------
Total contractual obligations $ 10.5 $ 1.8 $ 4.6 $ 3.7 $ 0.4
--------------------------------------------------------------------------------------------------
</TABLE>
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EXHIBIT 99.127
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LIQUIDITY AND CAPITAL RESOURCES
Advantage's capital expenditures on development activities for the quarter
ending March 31, 2004 were $29.4 million net of $0.8 million of minor property
dispositions. Expenditures were focused on drilling, completions, pipelines and
compression at Medicine Hat, Bantry, Nevis and Shouldice. A total of 44 (39.6
net) wells were drilled during the first quarter of 2004. Production from this
drilling program is anticipated to come on-stream late in the second quarter of
2004.
Sources and Uses of Funds ($ thousands)
Three months ended
------------------
Sources of funds
Cash flow from operations $ 32,000
Units issued, net of costs 116
Increase in bank debt 33,187
Property dispositions 791
------------------
$ 66,094
------------------
Uses of funds
Capital expenditures $ 30,202
Distributions paid to Unitholders 25,934
Interest paid to debenture holders 1,644
Increase in working capital 8,174
Other 140
------------------
$ 66,094
------------------
Total bank debt outstanding at March 31, 2004 was $136.2 million. Advantage has
an agreement with a syndicate of three Canadian chartered banks that provides
for a $180 million facility consisting of $170 million extendible revolving loan
facility and a $10 million operating loan facility both of which mature on May
29, 2004. The credit facilities are secured by a $250 million floating charge
demand debenture, a general security agreement and a subordination agreement for
the Trust covering all assets and cash flows. At March 31, 2004 Advantage also
had a working capital deficit of $20.2 million.
Forward Looking Information
The information in this report contains certain forward-looking statements that
involve substantial known and unknown risks and uncertainties, certain of which
are beyond Advantage's control, including: the impact of general economic
conditions, industry conditions, changes in laws and regulations including the
adoption of new environmental laws and regulations and changes in how they are
interpreted and enforced, increased competition, fluctuations in commodity
prices and foreign exchange and interest rates, stock market volatility and
obtaining required approvals of regulatory authorities. Advantage's actual
results, performance or achievement could differ materially from those expressed
in, or implied by, such forward-looking statements and, accordingly, no
assurances can be given that any of the events anticipated by the
forward-looking statements will transpire or occur or, if any of them do, what
benefits that Advantage will derive from them.
Non-GAAP Measures
Cash flow from operations and per Unit and cash available for distribution and
per Unit are not recognized measures under the Canadian generally accepted
accounting principles (GAAP). Management believes that cash flow and cash
available for distribution are useful supplemental measures to analyse operating
performance and provide an indication of the results generated by the Trust's
principal business activities prior to the consideration of how those activities
are financed or how the results are taxed. Investors should be cautioned,
however, that these measures should not be construed as an alternative to net
income determined in accordance with GAAP as an indication of Advantage's
performance. Advantage's method of calculating these measures may differ from
other companies, and accordingly, they may not be comparable to measures used by
other companies.
May 12, 2004
6
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