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(g) Asset Retirement Obligations
The Fund is a taxable entity under the
Income Tax Act (Canada) and is taxable only on Canadian income that is
not distributed or distributable to the Fund's unitholders. In the Trust
structure, payments made between the Canadian operating entities and the
Fund, ultimately transfers both income and future income tax liability
to the unitholders. The future income tax liability associated with Canadian
assets recorded on the balance sheet is recovered over time through these
payments. As the Canadian operating entities transfer all of their Canadian
taxable income to the Fund, no provision for current Canadian income tax
has been made by any Canadian operating entity.
The following table summarizes the income statement effects of other financial contracts:
During the year ended December 31, 2005, the Fund realized cash costs of $27,256,000 (net gains and losses) from financial contracts that qualified as hedges compared to cash costs of $18,167,000 during 2004. 4. ASSET RETIREMENT OBLIGATIONS Total future asset retirement obligations were estimated by management based on the Fund's net ownership interest in wells and facilities, estimated costs to abandon and reclaim the wells and facilities and the estimated timing of the costs to be incurred in future periods. The Fund has estimated the net present value of its total asset retirement obligations to be $110,606,000 at December 31, 2005 compared to $105,978,000 at December 31, 2004 based on a total liability of $422,045,000 and $383,942,000 respectively. These payments are expected to be made over the next 66 years with the majority of costs incurred between 2026 and 2035. To calculate the present value of the asset retirement obligations for 2005 the Fund used a weighted credit-adjusted rate of approximately 6.3% (2004 - 6.5%) and an inflation rate of 2.0% for both years. Settlements during the year approximated our estimates and as a result, no gains or losses were recognized. Following is a reconciliation of the asset retirement obligations:
5. PROPERTY, PLANT AND EQUIPMENT
Capitalized development G&A of $11,571,000 (2004 - $8,451,000) is included in PP&E and the depletion and depreciation calculation includes future capital costs of $464,423,000 (2004 - $279,700,000) included in our reserve reports. Excluded from PP&E for the depletion and depreciation calculation is $61,795,000 (2004 - $28,574,000) related to the Joslyn development project that has not commenced commercial production. An impairment test calculation was performed on a country by country basis on the PP&E values at December 31, 2005 in which the estimated undiscounted future net cash flows associated with the proved reserves exceeded the carrying amount of the Fund's PP&E. The following table outlines benchmark prices and the exchange rate used in the impairment tests for both Canadian and U.S. cost centres at December 31, 2005:
6. PROPERTY ACQUISITIONS Assets of Sleeping Giant LLC ("Sleeping Giant") On October 4, 2005 the Fund acquired all ownership interests and retired the debt of Sleeping Giant, a private U.S. company holding additional working interests in certain properties of Lyco Energy Corporation for total cash consideration of $111,914,000 which was financed through existing credit facilities. The fair value of this consideration was allocated to cash and positive working capital assumed of $5,754,000 and PP&E of $106,160,000. This acquisition has been accounted for as an asset acquisition. The operating results of Sleeping Giant subsequent to October 4, 2005 are included in the Fund's consolidated financial statements. Assets of ChevronTexaco Corporation ("ChevronTexaco") On June 30, 2004 the Fund acquired certain oil and natural gas properties from ChevronTexaco. Total consideration was $467,199,000 financed concurrently by subscription receipts issued on June 15, 2004 and available lines of credit. Results from operations have been included in Enerplus' financial results from June 30, 2004 forward. 7. CORPORATE ACQUISITIONS The allocation to the fair value of the assets acquired and liabilities assumed plus the future income tax cost are summarized as follows:
Goodwill is comprised of the following:
Lyco Energy Corporation ("Lyco") On August 30, 2005 the Fund acquired all the outstanding common shares and retired the debt including all outstanding mandatorily redeemable preferred shares of Lyco, a private U.S. company operating in the states of Montana and North Dakota. Total consideration was approximately $501,946,000, and the Fund assumed a net working capital deficiency of $4,433,000. Goodwill of $179,019,000 was recorded based on the excess of the consideration paid over the value assigned to the identifiable assets and liabilities including the future income tax liability. The acquisition, which was financed through an equity offering and available credit facilities, has been accounted for using the purchase method of accounting for business combinations. Results from the operations of Lyco subsequent to August 30, 2005 are included in the Fund's consolidated financial statements. TriLoch Resources Inc. ("TriLoch") On July 1, 2005 the Fund acquired all the outstanding common shares of TriLoch, a public Alberta corporation operating in southern Alberta, in exchange for 1,632,516 trust units of the Fund with a recorded value of $69,088,000. The trust unit value was based on the weighted average price of the Fund's trust units on the Toronto Stock Exchange during the five day trading period surrounding the announcement of the TriLoch transaction. Total consideration was $77,387,000 consisting of units, deal costs and the retirement of TriLoch's bank indebtedness. The Fund also assumed a working capital deficiency of $399,000. Goodwill of $18,450,000 has been recorded as a result of the excess of the consideration paid over the value allocated to the identifiable assets and liabilities including the future income tax liability. This acquisition has been accounted for using the purchase method of accounting for business combinations. Results from the operations of TriLoch subsequent to July 1, 2005 are included in the Fund's consolidated financial statements. Ice Energy Limited ("Ice Energy") On January 7, 2004 the Fund acquired all of the outstanding common shares of Ice Energy for total consideration of $121,171,000. The excess of the consideration paid over the fair value of the identifiable assets and liabilities resulted in the recording of $29,082,000 of goodwill. Available lines of credit financed the acquisition, which has been accounted for using the purchase method of accounting for business combinations. Results from operations of Ice Energy subsequent to January 7, 2004 are included in the Fund's consolidated financial statements. 8. LONG-TERM DEBT
(a) Unsecured Bank Credit Facilities In November 2004 the Fund negotiated an $850,000,000 unsecured covenant based three year term facility. Enerplus has the ability to extend the facility each year or repay the entire balance at the end of the three year term. During 2005, the facility was extended until November 2008. At December 31, 2005, Enerplus had available credit of $521,368,000 under this facility. The facility is extendible each year with a bullet payment required at the end of the three year term. Various borrowing options are available under the facility including prime rate based advances and banker's acceptance loans. This facility carries floating interest rates that are expected to range between 60.0 and 115.0 basis points over Bankers Acceptance rates, depending on Enerplus' ratio of senior debt to earnings before interest, taxes and non-cash items. The effective interest rate on the facilities for the year ended December 31, 2005 was 3.4% (2004 - 3.1%). (b) Senior Unsecured Notes On October 1, 2003 Enerplus issued US$54,000,000 senior unsecured notes that mature October 1, 2015. The notes have a coupon rate of 5.46% priced at par with interest paid semi-annually on April 1 and October 1 of each year. Principal payments are required in five equal installments beginning October 1, 2011 and ending October 1, 2015. Costs incurred in connection with issuing the notes in the amount of $475,000 are classified as deferred charges on the balance sheet and are being amortized as a part of depletion, depreciation, amortization and accretion ("DDA&A") over the term of the notes. At December 31, 2005, the amount remaining to be amortized associated with these costs was $386,000 (2004 - $425,000). The notes are subject to fluctuations in foreign exchange rates. On June 19, 2002 Enerplus issued US$175,000,000 senior unsecured notes that mature June 19, 2014. The notes have a coupon rate of 6.62% priced at par, with interest paid semi-annually on June 19 and December 19 of each year. Principal payments are required in five equal installments beginning June 19, 2010 and ending June 19, 2014. Costs incurred in connection with issuing the notes in the amount of $1,892,000 are classified as deferred charges on the balance sheet and are being amortized to DDA&A over the term of the notes. At December 31, 2005, the amount remaining to be amortized was $1,335,000 (2004 - $1,492,000). Concurrent with the issuance of the notes on June 19, 2002, the Fund entered into a cross currency swap with a syndicate of financial institutions. Under the terms of the swap, the amount of the notes was fixed for purposes of interest and principal repayments at a notional amount of CDN$268,328,000. Interest payments are made on a floating rate basis, set at the rate for three-month Canadian banker's acceptances, plus 1.18%. The bank credit facilities and the senior notes (the "Combined Facilities") are the legal obligation of EnerMark Inc. and are guaranteed by its subsidiaries. Payments with respect to the Combined Facilities have priority over payments to the Fund and over claims of and future distributions to the unitholders. However, unitholders have no direct liability beyond their equity investment should cash flow be insufficient to repay the Combined Facilities. 9. Foreign Exchange
The US$54,000,000 senior unsecured notes that are exposed to foreign currency fluctuations are translated into Canadian dollars at the exchange rate in effect at the balance sheet date. Foreign exchange gains and losses are included in the determination of net income for the year. 10. FUND CAPITAL (a) Unitholders' Capital Trust Units Authorized: Unlimited number of trust units
On August 9, 2005 the Fund completed a Canadian equity offering of 10,637,500 subscription receipts at a price of $46.25 per subscription receipt for gross proceeds of $491,984,000 ($466,885,000 net of issuance costs). The subscription receipts were exchanged for an equal number of trust units on August 30, 2005 upon the closing of the Lyco transaction. The holders of the subscription receipts received the August 2005 cash distribution of $0.37 per trust unit and this amount has been included in cash distributions to unitholders. On July 1, 2005 the Fund issued 1,632,516 trust units pursuant to the acquisition of TriLoch valued at $42.32 per trust unit, being the weighted average trading price of the Fund's trust units on the Toronto Stock Exchange during the five day trading period surrounding the announcement of the TriLoch transaction, for a recorded value of $69,088,000 ($69,062,000 net of issuance costs). On June 15, 2004 Enerplus completed an equity offering of 8,800,000 subscription receipts at a price of $34.30 per subscription receipt for gross proceeds of $301,840,000 ($286,248,000 net of issuance costs). The subscription receipts were exchanged for trust units on June 30, 2004 upon closing of the ChevronTexaco asset acquisition. The holders of the subscription receipts received the June 2004 cash distribution of $0.35 per trust unit and this amount has been included in cash distributions to unitholders. Pursuant to the monthly Distribution Reinvestment and Unit Purchase Plan ("DRIP"), Canadian unitholders are entitled to reinvest cash distributions in additional trust units of the Fund. Trust units are issued at 95% of the weighted average market price on the Toronto Stock Exchange for the 20 trading days preceding a distribution payment date without service charges or brokerage fees. Eligible unitholders are also entitled to make optional cash payments to acquire additional trust units, however the 5% discount does not apply. Trust units are redeemable by unitholders at approximately 85% of the current market price. Redemptions are limited to $500,000 during any rolling two calendar months. Redemption requests in excess of $500,000 can be paid using investments of the Fund or a non-interest bearing instrument. (b) Trust Unit Rights Incentive Plan As at December 31, 2005 a total of 2,621,000 rights issued pursuant to the Trust Unit Rights Incentive Plan ("Rights Plan") at an average exercise price of $42.80 were outstanding. This represents 2.2% of the total trust units outstanding of which 643,000 rights with an average exercise price of $32.46 were exercisable. Under the Rights Plan, distributions per trust unit to Enerplus unitholders in a calendar quarter which represent a return of more than 2.5% of the net PP&E of Enerplus at the end of such calendar quarter, may result in a reduction in the exercise price of the rights. Results for the year ended December 31, 2005 reduced the exercise price of the outstanding rights by $1.64 per trust unit of which a $0.41 reduction is effective January 2006 and a $0.48 reduction is effective April 2006. Plan members have the choice to exercise rights using the original exercise price or a reduced strike price, should a reduction take place. In certain circumstances, it may be more advantageous to use the original exercise price as it could effectively lower the plan member's tax rate on the transaction. The Fund uses a binomial lattice option-pricing model to calculate the estimated fair value of rights granted under the plan. The following assumptions were used to arrive at the estimate of fair value:
The fair value of the rights granted under the plan ranged between 7% and 10% of the underlying market price of a trust unit on the grant date. During the year the Fund expensed $3,040,000 of unit based compensation expense using the fair value method. The remaining future fair value of the rights of $6,380,000 at December 31, 2005 will be recognized in earnings over the remaining vesting period of the rights. Activity for the rights issued pursuant to the Rights Plan is as follows:
The following table summarizes information with respect to outstanding Unit Rights as at December 31, 2005. Unit rights vest between one and three years and expire between four and six years.
Non-cash compensation costs of $3,040,000 ($0.03 per unit) related to the rights issued since January 1, 2003 have been charged to G&A expense during 2005 compared to $4,668,000 ($0.05 per unit) during 2004. The following table outlines the estimated compensation cost associated with the rights issued during 2002 and the pro forma effects on net income and net income per unit, had the Canadian Institute of Chartered Accountants Handbook ("CICA") section 3870 been applied retroactive to 2002.
(b) Basic and Diluted per Trust Unit Calculations Net income per trust unit has been determined based on the following:
In calculating the weighted average number of diluted units outstanding for the year ended December 31, 2005, we excluded 132,511 rights (2004 - 40,929), because their exercise price was greater than the annual average unit market price in those periods. During the last two years, outstanding rights were the only potential dilutive instrument. 11. INCOME TAXES (a) Enerplus Resources Fund The Fund is an inter-vivos trust for income tax purposes. As such, the Fund's income that is not allocated to the Fund's unitholders is taxable. The Fund intends to allocate all income to unitholders. For 2005, the Fund had taxable income of $451,000,000 (2004 - $381,000,000) or $4.05 per trust unit (2004 - $3.77 per trust unit). Taxable income of the Fund is comprised of dividend, royalty, interest and partnership income, less deductions for Canadian oil and gas property expense ("COGPE") and trust unit issue costs. The amounts of COGPE and issue costs remaining in the Fund at December 31, 2005 are $466,700,000 and $40,109,000 respectively (2004 - $506,985,000 and $32,297,000). (b) Corporate Subsidiaries The future income tax liability on the balance sheet arises as a result of the following temporary differences:
The provision for income taxes varies from the amounts that would be computed by applying the combined Canadian federal and provincial income tax rates for the following reasons:
12. financial instruments The Fund's financial instruments presented on the balance sheet consist of cash, accounts receivable, deferred financial assets, other current assets, a portion of deferred charges, current liabilities and long-term debt. The carrying value of cash, accounts receivable, current liabilities and the outstanding bank credit facility balances approximate their fair value. Other current assets are comprised of prepaid expenses and marketable securities. The marketable securities are carried on the balance sheet at the lower of cost and fair value. The fair value of the marketable securities at December 31, 2005 exceeded the cost of these securities by $10,898,000. T he Fund carried US$54,000,000 of fixed rate debt. In addition, it carried US$175,000,000 of fixed rate debt that was converted to CDN$268,328,000 floating rate debt through a cross-currency swap with a syndicate of financial institutions. At December 31, 2005 the fair value of the senior unsecured notes was $64,110,000 (for the US$54,000,000 notes) and $212,025,000 (for the US$175,000,000 notes), see Note 8 . The balance related to derivative instruments that did not qualify for hedge accounting treatment upon adoption of AcG-13 in 2004, was fully amortized at December 31, 2005. At December 31, 2004, this balance was $3,144,000 and was included in deferred charges. The estimated fair values have been determined based on available market information and appropriate valuation methods. The actual amounts realized may differ from these estimates. (a) Credit Risk Most of the Fund's accounts receivable relate to oil and natural gas sales and are exposed to typical industry credit risks. The Fund manages this credit risk by entering into sales contracts with only highly rated entities and reviewing its exposure to individual entities on a regular basis. The Fund is also exposed to certain losses in the event of non-performance by counterparties to derivative financial instruments. This credit risk is managed by the Fund by selecting financially sound counterparties. (b) Interest Rate Risk The Fund is exposed to movements in interest rates. Long-term debt is comprised of both variable rate bank facilities and fixed rate senior notes. The Fund monitors the interest rate forward market and through the use of interest rate swaps along with the fixed-rate notes has fixed the interest rate on approximately 21% of its debt. See part (d) below. (c) Currency Risk The Fund is exposed to fluctuations in foreign currency as a result of its U.S. operations and the issuance of senior unsecured notes denominated in U.S. dollars. Through the use of a financial swap, the exposure on our US$175,000,000 senior unsecured notes has been converted to Canadian dollar debt. As well, the Fund has indirect exposure to fluctuations in foreign currency as crude oil sales and a portion of natural gas sales are based on U.S. dollar indices. We have not entered into any foreign currency derivatives with respect to oil and natural gas sales. (d ) Derivative Financial Instruments The Fund uses certain derivative financial instruments to manage its commodity price, foreign currency and interest rate exposures. The fair values of these instruments are based on an approximation of the amounts that would have been paid to or received from counterparties to settle the instruments outstanding as at December 31, 2005 with reference to forward prices and market valuations provided by third party sources. The fair values of derivative financial instruments are as follows: Interest Rate and Cross Currency Swaps The Fund has entered into interest rate swaps on $75,000,000 of notional debt at rates varying from 3.74% to 4.12% before banking fees that are expected to range between 0.60% and 1.15%. These interest rate swaps mature between June 2006 and January 2007. The fair value of the $75,000,000 interest rate swaps as at December 31, 2005 represents an unrealized cost of $206,000. These swaps have been designated as hedges for accounting purposes. The fair value of the cross currency swap related to the US$175,000,000 senior unsecured notes as at December 31, 2005 represents an unrealized cost of $62,439,000 where as the fair value of the underlying debt instrument as at December 31, 2005 represents an unrealized gain of $56,303,000. The cross currency swap has been designated as a hedge for accounting purposes. Crude Oil Instruments Enerplus has entered into the following financial option contracts to reduce the impact of a downward movement in crude oil prices. Effective December 31, 2005, the Fund elected to stop designating commodity contracts as qualified hedges. The fair value of the financial crude oil contracts that are no longer designated as hedges for accounting purposes results in a liability of $13,321,000 (see Note 3) . The following table summarizes the Fund's crude oil risk management positions at February 15, 2006 :
Natural Gas Instruments Enerplus has physical and financial contracts in place on its natural gas production as described below. Effective December 31, 2005, the Fund elected to stop designating commodity contracts as qualified hedges. The fair value of the financial natural gas contracts that are no longer designated as hedges for accounting purposes results in a liability of $36,553,000 (see Note 3) . The following table summarizes the Fund's natural gas risk management positions at February 15, 2006:
The Fund has an electricity swap contract that fixed the price of electricity on 5MWh of Alberta Power Pool electricity consumption at $49.99/MWh from January 1, 2006 to December 31, 2006. This has been designated as a cash flow hedge and the fair value of this instrument as at December 31, 2005 is an unrealized gain of $1,019,000. Proceeds or costs realized from the electricity hedge are recognized as operating costs. 13. commitments and contingencies (a) Pipeline Transportation Enerplus has contracted to transport natural gas with various pipelines totaling 35.3 MMcf/day until 2008; of this amount 5 MMcf/day extends until 2015. Enerplus also has a contract to transport a minimum of 2,480 bbls/day of crude oil from the field to suitable marketing sales points until 2010. (b) Oil Sands Lease #24 During 2002 the Fund acquired a 16% working interest in the Oil Sands Lease #24 (Joslyn Creek Lease). The acquisition included the assumption of contingent project debt that is comprised of principal of $3,360,000 plus accrued interest to December 31, 2005 of $1,281,000. Interest is accrued at the Bank of Canada prime business rate and is not compounded. The debt is contingent on production hurdles with respect to development on the lease. As it is still too early in the development of this project to determine if these hurdles will be satisfied, the contingent debt has not been accrued in the consolidated financial statements. (c) Office Lease Enerplus has office lease commitments for both its Canadian and U.S. operations that expire between November 2009 and January 2011. Annual costs of these lease commitments, which include rent and operating fees, amount to approximately $5,700,000. (d) Guarantee (i) Corporate indemnities have been provided by the Fund to all directors and certain officers of its subsidiaries and affiliates for various items including, but not limited to, all costs to settle suits or actions due to their association with the Fund and its subsidiaries and/or affiliates, subject to certain restrictions. The Fund has purchased directors' and officers' liability insurance to mitigate the cost of any potential future suits or actions. Each indemnity, subject to certain exceptions, applies for so long as the indemnified person is a director or officer of one of the Fund's subsidiaries and/or affiliates. The maximum amount of any potential future payment cannot be reasonably estimated. (ii) The Fund may provide indemnifications in the normal course of business that are often standard contractual terms to counterparties in certain transactions such as purchase and sale agreements. The terms of these indemnifications will vary based upon the contract, the nature of which prevents the Fund from making a reasonable estimate of the maximum potential amounts that may be required to be paid. Management believes the resolution of these matters would not have a material adverse impact on the Fund's liquidity, consolidated financial position or results of operations. Enerplus has the following minimum annual commitments including long-term debt:
In addition, the Fund is involved in claims and litigation arising in the normal course of business. The resolution of these claims is uncertain and there can be no assurance they will be resolved in favour of the Fund, however management believes the resolution of these matters would not have a material adverse impact on the Fund's liquidity, consolidated financial position or results of operations. 14. Geographical information Due to the acquisitions of Lyco and Sleeping Giant, the Fund now operates in Canada and the United States.
15. differences between Canadian and Unites States generally accepted accounting principles The Fund's consolidated financial statements have been prepared in accordance with Canadian GAAP. These principles, as they pertain to the Fund's consolidated statements differ from United States GAAP ("U.S. GAAP") as follows: The application of U.S. GAAP would have the following effects on net income as reported:
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