Canadian Oil Sands Trust (the “Trust”) is an open-ended investment trust formed under the laws of the Province of Alberta in October 1995 pursuant to a trust indenture (“Trust Indenture”) which has since been amended and restated. Computershare Trust Company of Canada is appointed as Trustee under the Trust Indenture. The beneficiaries of the Trust are the holders (“Unitholders”) of the units (“Units”) in the Trust.
During 2006 and 2005, the Trust indirectly owned a 35.49% interest (“Working Interest”) in the Syncrude Joint Venture (“Syncrude”) which is involved in the mining and upgrading of bitumen from oil sands in Northern Alberta and operated by Syncrude Canada Ltd. (“Syncrude Canada”). On January 2, 2007, a subsidiary of the Trust acquired an additional 1.25% interest in Syncrude (Note 22), raising the Working Interest to 36.74%.
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in Canada (“GAAP”) and include the accounts of the Trust and its subsidiaries (collectively, “Canadian Oil Sands”). The activities of Syncrude are conducted jointly with others and, accordingly, these financial statements reflect only the proportionate interest in such activities, which include the production, operating costs, non-production costs, Crown royalty expenses, property, plant and equipment capital expenditures, inventories, employee future benefits and other liabilities, asset retirement obligation, and associated amounts payable. Substantially all operations of Canadian Oil Sands are carried out through the joint venture.
Investments with maturities of less than three months at purchase are considered to be cash equivalents and are recorded at cost, which approximates market value.
Property, plant and equipment (“PP&E”) include oil sands assets and varying interests in natural gas licenses located in the Arctic Islands in Northern Canada (“the Arctic assets”). The oil sands assets are recorded at cost and include the costs of acquiring the Working Interest and subsequent additions to PP&E, which include those costs that are directly related to the exploration, development and construction of oil sands projects. Also included in the oil sands assets is the estimated fair value of Canadian Oil Sands’ asset retirement obligation (Note 9). Overburden removal, repairs and maintenance, and turnaround costs are expensed in the period incurred. Proceeds from the sale of oil sands assets are deducted from the capital base without recognition of a gain or loss, unless crediting the proceeds against accumulated costs would result in a material change in the rate of depreciation and depletion.
Oil sands assets are depreciated and depleted on the unit-of-production method based on estimated proved plus probable reserves. For purposes of the depreciation and depletion provision, capital costs include future capital costs expected to be necessary in the mining, extraction and upgrading process to recover the estimated proved plus probable reserves.
An asset impairment test is applied to the oil sands assets to ensure that the capitalized costs, less the cost of unproved properties, do not exceed management’s estimate of future undiscounted revenues from proved reserves, less operating expenses, asset retirement costs, Crown royalties, and general and administrative expenses. If it is determined that the net recoverable amount is less than the net carrying amount, a write-down to the fair value is taken and charged to earnings in the period. The Trust performs this test at least annually, or whenever there is an indication that asset impairment has occurred.
The Arctic assets are recorded at cost and include the costs of acquiring the varying interests in natural gas licenses located in the Arctic Islands in Northern Canada. The Arctic assets are not amortized as they are not yet developed. A test for impairment of the Arctic assets is performed at least annually, or sooner if events or changes in circumstances indicate that its carrying amount may not be recoverable. If it is determined that the net recoverable amount is less than the net carrying amount, a write-down to the fair value is taken and charged to earnings in the period.
Goodwill is recorded at cost and represents the excess of the purchase price over the accounting fair value of the identifiable assets and liabilities acquired. Goodwill is tested annually for impairment, or when events or changes in circumstances indicate that its carrying amount may not be recoverable. If it is determined that the net recoverable amount is less than the net carrying amount, a write-down to the fair value is taken and charged to earnings in the period.
Product inventories are valued at the lower of the average cost of production for the period and their net realizable value. Materials and supplies inventories are valued at the lower of average cost and replacement cost.
The estimated fair value of the Trust’s 35.49% share of Syncrude’s retirement obligations pertaining to PP&E is recognized on the Trust’s Consolidated Balance Sheet. Syncrude’s reclamation obligations relate to the site restoration of each mine site, of which the discounted full amount of the liability is recorded upon initial land disturbance, or when a reasonable estimate of the amount and timing of the reclamation expenditures can be determined. The fair value is determined by estimating the timing and amounts of the future reclamation expenditures, and discounting the expenditures using a credit- adjusted risk free rate applicable to the Trust. The asset retirement cost is equal to the estimated fair value of the asset retirement obligation, and is capitalized as part of the Trust’s PP&E. These capital assets are depreciated using the unit-of-production method. The obligation is accreted based on the Trust’s applied discount rate. The depreciation expense and accretion expense are reflected in the Trust’s depreciation, depletion and accretion (“DD&A”) expense in consolidated net income.
Actual reclamation costs are charged against the accumulated obligation when incurred.
Canadian Oil Sands may enter into derivative financial instrument contracts such as foreign currency exchange rate, crude oil and natural gas price contracts to hedge fluctuations in exchange rates, and the prices of crude oil and natural gas. Canadian Oil Sands may also enter into interest rate swap agreements to manage its interest rate risk.
Pursuant to Canadian Oil Sands’ risk management policies, relationships between hedging instruments and hedged items and the strategy for undertaking the hedge transaction are documented. Canadian Oil Sands records the derivative contract as a hedge for accounting purposes when, at the time of initiating the contract, it is identified as a hedge of a specific transaction and, at both the inception of the contract and on an ongoing basis, Canadian Oil Sands assesses the derivative instrument as effective in offsetting cash flows of the hedged item. Canadian Oil Sands uses a statistical methodology called correlation analysis to test effectiveness of its crude oil and foreign exchange financial instruments on a quarterly basis. For its interest rate swaps which qualify as hedges, an effectiveness test is not required each quarter as long as the critical terms of the swap contract continue to match the underlying debt instrument. Canadian Oil Sands reviews the critical terms of the swap contract against the terms of the debt each quarter.
If a derivative contract cannot be designated as a hedge under Canadian GAAP or the hedge is no longer effective, then mark-to-market accounting is used, whereby the fair value of the contract is recorded on the balance sheet as an asset or liability. Subsequent changes in the fair value of the asset or liability are recognized in other income, which is included in net interest expense on the income statement, when those changes occur.
Gains and losses on hedge contracts which qualify for hedge accounting are recognized in net income and cash flows when the related revenues, costs, interest expense and cash flows are recognized. Crude oil and foreign currency hedging gains and losses are included in revenues as incurred. As natural gas is used in the production of Syncrude™ Sweet Blend (“SSB”), any natural gas hedging gains and losses are included in operating expenses. For interest rate swaps that qualify for hedge accounting, any gains or losses on the swaps are included in net interest expense as incurred.
Revenues from the sale of SSB and other products are recorded when title passes from Canadian Oil Sands to a third party. Revenues are recorded inclusive of hedging gains and losses, if any, from foreign currency exchange rate and crude oil hedge contracts.
Canadian Oil Sands accrues its obligations as a joint venture owner in respect of Syncrude Canada’s employee benefit plans and the related costs, net of plan assets. The cost of employee pension and other retirement benefits is actuarially determined using the projected benefit method based on length of service and reflects Canadian Oil Sands’ best estimate of the expected performance of the plan investment, salary escalation factors, retirement ages of employees and future health care costs. The expected return on plan assets is based on the fair value of those assets. Past service costs from plan amendments are amortized on a straight-line basis over the estimated average remaining service life of active employees (“EARSL”) at the date of amendment. The excess of any net actuarial gain or loss exceeding 10% of the greater of the benefit obligation and fair value of the plan assets is amortized over the EARSL (Note 6(a)).
Canadian Oil Sands follows the liability method of accounting for income taxes. Under this method, future income taxes of operating corporations are calculated as the difference between the accounting and income tax basis of an asset or liability, referred to as temporary differences, tax effected using substantively enacted income tax rates expected to be in effect when such temporary differences reverse. Future income tax balances recorded on the Consolidated Balance Sheet are adjusted to reflect changes in temporary differences and income tax rates with the adjustments being recognized in net income in the period that the changes occur.
Canadian Oil Sands recognizes stock-based compensation expense in its Consolidated Statement of Income and Unitholders’ Equity for all Trust unit options (“options”) granted during the year, with a corresponding increase to contributed surplus in Unitholders’ Equity. Canadian Oil Sands determines compensation expense based on the estimated fair values of the options at the time of grant, the cost of which is recognized in net income over the vesting periods of the options.
Canadian Oil Sands also recognizes stock-based compensation expense related to its performance units (“PUPs”), which are awards granted to officers, other select employees and consultants of the Trust and its affiliates under the Trust’s performance unit incentive plan. Canadian Oil Sands determines compensation expense based on the estimated fair values of the PUPs, the cost of which is recognized in net income over the vesting periods of the PUPs.
As an owner in the Syncrude Joint Venture, Canadian Oil Sands also records its share of costs for Syncrude Canada’s stock-based compensation programs. Syncrude Canada’s programs include incentive phantom share units (“phantom units”) and incentive restricted share units (“restricted units”), both of which require settlement by cash payments. Compensation expense for the phantom units and restricted units is recognized over the shorter of the normal vesting period and the period to eligible retirement if vesting is accelerated on retirement. Canadian Oil Sands’ share of the change in the fair value of the vested phantom units, which is based on market related values of various Syncrude owners’ shares/units at period ends, is recognized in operating expense in the year the change occurs.
Canadian Oil Sands receives a portion of its revenues, incurs various expenses, and has U.S. dollar denominated debt, which result in monetary assets and liabilities denominated in U.S. dollars. These U.S. denominated balances are translated to Canadian dollars at exchange rates in effect at the end of the period, with the resulting gain or loss being recorded in the income statement. Translation gains and losses on U.S. denominated long-term debt are recorded as unrealized and excluded from cash from operating activities. All other translation gains and losses, which relate to the translation of U.S. denominated cash, accounts receivable and accounts payable and accrued liabilities, are classified as realized since they are settled in less than one year.
Canadian Oil Sands applies the treasury stock method to determine the dilutive impact, if any, of options assuming they were exercised in a reporting period. The treasury stock method assumes that all proceeds received by the Trust when options are exercised would be used to purchase Units at the average market price during the period.
The preparation of the consolidated financial statements under Canadian GAAP requires management personnel to make estimates and assumptions for many financial statement items based on their best estimate and judgment. Significant judgments and estimates relate to depreciation, depletion, the impairment test and asset retirement obligation costs as they are based on reserve engineering studies, environmental studies and future price and cost estimates, which by their nature, are subjective and contain measurement uncertainty. The values of pension and other benefit plan accrued obligations and plan assets and the amount of pension cost charged to net income depend on certain actuarial and economic assumptions, which by their nature are subject to measurement uncertainty. The calculation of future income tax is based on assumptions, which are subject to uncertainty as to the timing and at which tax rates temporary differences are expected to reverse. Uncertainties related to various income tax positions exist because the timing of resolution and the impact on tax pool balances are not currently determinable. Accordingly, actual results may differ from all of these estimated amounts as future events occur.
In the third quarter of 2006, through a take-over bid process, Canadian Oil Sands acquired approximately 78% of the common shares of Canada Southern Petroleum Ltd. (“Canada Southern”) for US$13.10 per share, for total consideration of approximately Cdn$174 million ($151 million net of $23 million cash acquired), including acquisition-related costs of approximately $1 million. On October 25, 2006, Canadian Oil Sands completed its acquisition of the remaining 22% of the outstanding common shares for additional consideration of approximately Cdn$49 million ($48 million net of $1 million cash acquired), including acquisition-related costs of approximately $1 million. Concurrent with the final purchase of shares, Canada Southern was amalgamated with another two subsidiaries of Canadian Oil Sands to form Canadian Arctic Gas Ltd. (“Canadian Arctic”).
The acquisition was accounted for as a business purchase between arms length parties, in accordance with GAAP. The total purchase price was allocated based on fair values to the assets and liabilities as follows:
| Property, plant and equipment | $ | 165 |
| Cash | 24 | |
| Goodwill1 | 52 | |
| Assets held for sale2 | 34 | |
| Future income taxes | (52) | |
| $ | 223 | |
| Consideration | ||
|---|---|---|
| Cash | $ | 221 |
| Costs associated with acquisition | 2 | |
| $ | 223 | |
| 1 Goodwill is entirely due to the temporary differences created between the tax basis of the Arctic assets compared to the fair value of such assets. Goodwill is not subject to amortization, but is tested annually for impairment, or more frequently if events or circumstances arise that could result in impairment. | ||
| 2 Assets held for sale include $35 million of oil and gas properties and equipment, working capital of $3 million, less asset retirement obligations of $3 million and estimated costs to sell the properties of $1 million. | ||
As at December 31, 2006, Canadian Oil Sands disposed of a portion of Canadian Arctic’s conventional oil and gas exploration and development properties (the “conventional assets”) for proceeds of approximately $28 million. No gain or loss was recorded on the sale of the conventional assets as the carrying values approximated the consideration received. These properties did not generate material revenue or pre-tax earnings in the period which Canadian Oil Sands owned them prior to disposal.
Canadian Oil Sands continues to hold the Arctic assets and the remaining conventional assets, which are currently being marketed for sale. The remaining conventional assets and related working capital and liabilities have been recorded at fair values, less the estimated costs to sell the assets, and classified as “Held for sale” in the Trust’s Consolidated Balance Sheet at December 31, 2006. The results of operations of the conventional assets of Canadian Arctic are considered discontinued operations on the Trust’s Consolidated Statement of Income and Unitholders’ Equity as there will be no continuing involvement by Canadian Oil Sands in the operations of the conventional assets once they have been sold. The discontinued operations include Canadian Oil Sands’ share of Canadian Arctic’s loss from the conventional assets from the date of the initial take-up of shares in the third quarter to the end of the year.
| 2006 | 2005 | |||
| Materials and supplies | $ | 64 | $ | 61 |
| Product and linefill | 20 | 26 | ||
| $ | 84 | $ | 87 | |
| December 31, 2006 | Cost | Accumulated Depreciation and Depletion |
Net Book Value | |||
|---|---|---|---|---|---|---|
| Oil sands assets | $ | 6,633 | $ | 1,059 | $ | 5,574 |
| Arctic assets | 165 | – | 165 | |||
| $ | 6,798 | $ | 1,059 | $ | 5,739 | |
| December 31, 2005 | ||||||
| Oil sands assets | $ | 6,316 | $ | 814 | $ | 5,502 |
The net book value of the Arctic assets acquired in 2006 is not being amortized as the related properties have not yet been developed.
Total DD&A expense is comprised of the following amounts for the year ended December 31:
| 2006 | 2005 | |||
| Depreciation and depletion expense | $ | 246 | $ | 169 |
| Accretion expense | 9 | 29 | ||
| $ | 255 | $ | 198 | |
| 2006 | 2005 | |||
| Employee future benefits (a) | $ | 108 | $ | 99 |
| Other | 3 | 4 | ||
| 111 | 103 | |||
| Less current portion of employee future benefits | (11) | (10) | ||
| $ | 100 | $ | 93 | |
Syncrude Canada has a defined benefit and two defined contribution plans providing pension benefits, and other retirement and post-employment benefit plans covering most of its employees. Other post-employment benefits include certain health care and life insurance benefits for retirees, their beneficiaries and covered dependants.
Syncrude measures its accrued benefit obligation and the fair value of plan assets for accounting purposes as at December 31 of each year. The most recent actuarial valuation of the pension plans for funding purposes was as of December 31, 2003, and the next required valuation will be as of December 31, 2006, and is expected to be completed by the second quarter of 2007.
Canadian Oil Sands’ share of Syncrude Canada’s defined benefit plan accrued liability, based on its 35.49% ownership at December 31 for each of 2006 and 2005, is comprised of its share of Syncrude Canada’s accrued benefit obligation, partially offset by its share of Syncrude Canada’s defined benefit plan assets
as follows:
| Pension Benefit Plan |
Other Post- Employment Benefits |
Total | ||||||||||
| 2006 | 2005 | 2006 | 2005 | 2006 | 2005 | |||||||
| Accrued benefit obligation: | ||||||||||||
| Balance - Beginning of year | $ | 498 | $ | 412 | $ | 37 | $ | 38 | $ | 535 | $ | 450 |
| Current service cost | 21 | 17 | 1 | 2 | 22 | 19 | ||||||
| Interest cost | 25 | 24 | 2 | 2 | 27 | 26 | ||||||
| Transferred in | 5 | 4 | – | – | 5 | 4 | ||||||
| Benefits paid | (16) | (14) | (1) | (1) | (17) | (15) | ||||||
| Actuarial loss (gain) | – | 55 | – | (4) | – | 51 | ||||||
| Balance - End of year | $ | 533 | $ | 498 | $ | 39 | $ | 37 | $ | 572 | $ | 535 |
| Fair value of plan assets: | ||||||||||||
| Actuarial fair value - | ||||||||||||
| Beginning of year | $ | 287 | $ | 247 | $ | – | $ | – | $ | 287 | $ | 247 |
| Actual return on plan assets | 41 | 28 | – | – | 41 | 28 | ||||||
| Employer contributions | 22 | 21 | – | – | 22 | 21 | ||||||
| Contributions - transfers | 5 | 4 | – | – | 5 | 4 | ||||||
| Benefits paid | (16) | (13) | – | – | (16) | (13) | ||||||
| Actuarial fair value - | ||||||||||||
| End of year | 339 | 287 | – | – | 339 | 287 | ||||||
| Funded status - Plan deficit | (194) | (211) | (39) | (37) | (233) | (248) | ||||||
| Unamortized net actuarial loss1 | 120 | 144 | 6 | 7 | 126 | 151 | ||||||
| Unamortized past service costs1 | 1 | 1 | (2) | (3) | (1) | (2) | ||||||
| Accrued benefit liability | $ | (73) | $ | (66) | $ | (35) | $ | (33) | $ | (108) | $ | (99) |
| 1 Amortized over the expected average remaining service lives of employees covered by the plan, generally 12 years. | ||||||||||||
The asset allocation for Syncrude Canada’s plan assets as of December 31 was as follows:
| Percentage of plan assets | ||
| 2006 | 2005 | |
| Equity securities | 70 | 70 |
| Debt securities | 30 | 30 |
| 100 | 100 | |
Elements of defined benefit costs recognized in the year:
| Pension Benefit Plan |
Other Post- Employment Benefits |
Total | ||||||||||
| 2006 | 2005 | 2006 | 2005 | 2006 | 2005 | |||||||
| Current service cost | $ | 21 | $ | 17 | $ | 1 | $ | 2 | $ | 22 | $ | 19 |
| Interest cost | 25 | 24 | 2 | 2 | 27 | 26 | ||||||
| Actual return on plan assets | (41) | (28) | – | – | (41) | (28) | ||||||
| Actuarial loss (gain) | – | 55 | – | (4) | – | 51 | ||||||
| Elements of employee future benefits costs before adjustments to recognize the long-term nature of employee future benefit costs | $ | 5 | $ | 68 | $ | 3 | $ | – | $ | 8 | $ | 68 |
| Adjustments to recognize the long-term nature of employee future benefit costs: | ||||||||||||
| Difference between expected return and actual return on plan assets | 16 | 6 | – | – | 16 | 6 | ||||||
| Difference between actuarial loss (gain) recognized for year and actual actuarial loss (gain) on accrued benefit obligation for year | 8 | (50) | – | 2 | 8 | (48) | ||||||
| Difference between amortization of past service costs for year and actual plan amendments for year | – | – | – | 2 | – | 2 | ||||||
| 24 | (44) | – | 4 | 24 | (40) | |||||||
| Defined benefit costs recognized in net income | $ | 29 | $ | 24 | $ | 3 | $ | 4 | $ | 32 | $ | 28 |
The significant assumptions adopted in measuring Syncrude Canada’s accrued benefit obligations are as follows:
| Pension Benefit Plan | Other Post-Employment Benefits |
|||
| 2006 | 2005 | 2006 | 2005 | |
| Accrued benefit obligation as of December 31: | ||||
| Discount rate | 5.0% | 5.0% | 5.0% | 5.0% |
| Rate of compensation increase | 4.0% | 4.0% | 4.0% | 4.0% |
| Benefit costs for years ended December 31: | ||||
| Discount rate | 5.0% | 5.75% | 5.0% | 5.75% |
| Expected long-term rate of return on plan assets | 8.5% | 8.5% | N/A | N/A |
| Rate of compensation increase | 4.0% | 4.0% | 4.0% | 4.0% |
For measurement purposes, a 9% annual rate of increase in the cost of supplemental health care benefits was assumed for 2006 (2005 – 9.5%), decreasing by 0.5% each year thereafter to a 5% ultimate rate. In addition, annual rate increases of 3% in Alberta health care premiums and 4% in dental rates were used in 2006 and 2005.
Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans under other post-employment benefits. A 1% increase (decrease) in assumed health care cost trend rates would have increased (decreased) the Trust’s accrued benefit obligation by $3 million, but would not have had a material impact on the Trust’s current service and interest cost.
Canadian Oil Sands’ share of the total expense, based on its 35.49% working interest during 2006 and 2005 for Syncrude Canada’s defined contribution pension plans was approximately $2 million in each year.
Canadian Oil Sands’ share of Syncrude’s total cash payments for employee future benefits for 2006, consisting of cash contributed by Syncrude Canada to its funded pension plans, cash to fund pension payments in excess of registered plan limits, cash payments directly to beneficiaries for its unfunded other benefit plans, and cash contributed to its defined contribution plans, was $26 million (2005 - $25 million), based on its 35.49% ownership in 2006 and 2005.
| Credit facility | ||
| Extendible revolving term facility (a) | $ | 40 |
| Line of credit (b) | 35 | |
| Operating credit facility (c) | 800 | |
| $ | 875 | |
Each of the credit facilities of Canadian Oil Sands Limited (“COSL”) is unsecured and contains typical covenants relating to the restriction on Canadian Oil Sands’ ability to sell all or substantially all of its assets or to change the nature of its business. In addition, Canadian Oil Sands has agreed to maintain its total debt-to-total book capitalization at an amount less than 0.60 to 1.0, or 0.65 to 1.0 in certain circumstances involving acquisitions.
The $40 million extendible revolving term facility is a 364-day facility with a one year term out, expiring April 25, 2007. This facility may be extended on an annual basis with the agreement of the bank. Amounts borrowed through this facility bear interest at a floating rate based on bankers’ acceptances plus a credit spread, while any unused amounts are subject to standby fees.
The $35 million line of credit is a one year revolving letter of credit facility. Letters of credit drawn on the facility mature April 30th each year and are automatically renewed, unless cancelled by Canadian Oil Sands or the financial institution providing the facility within 60 days prior to expiry. Letters of credit on this facility bear interest at a credit spread.
Letters of credit of approximately $49 million have been written against the extendible revolving term facility and line of credit as disclosed in Note 19.
The $800 million operating credit facility is a five year facility, expiring April 27, 2011. Amounts borrowed through this facility bear interest at a floating rate based on bankers’ acceptances plus a credit spread, while any unused amounts are subject to standby fees.
As at December 31, 2006, no amounts were drawn on the operating credit facilities (2005 - $92 million).
| 2006 | 2005 | |||
| 3.95% medium term notes due January 15, 2007 (a) | $ | 175 | $ | 175 |
| Floating rate medium term notes due January 15, 2007 (a) | 20 | 20 | ||
| 7.625% Senior Notes due May 15, 2007 (b) | 81 | 82 | ||
| 5.75% medium term notes due April 9, 2008 (c) | 150 | 150 | ||
| 5.55% medium term notes due June 29, 2009 (d) | 200 | 200 | ||
| 4.8% Senior Notes due August 10, 2009 (e) | 291 | 291 | ||
| 5.8% Senior Notes due August 15, 2013 (f) | 350 | 350 | ||
| 7.9% Senior Notes due September 1, 2021 (g) | 291 | 291 | ||
| 8.2% Senior Notes due April 1, 2027 (h) | 86 | 86 | ||
| Credit facilities drawn, excluding letters of credit (Note 6) | – | 92 | ||
| $ | 1,644 | $ | 1,737 | |
All of Canadian Oil Sands’ medium term notes and Senior Notes are unsecured, rank pari passu with other senior unsecured debt of COSL, and contain certain covenants which place limitations on the sale of assets and the granting of liens or other security interests. The medium term notes are guaranteed by the Trust.
On January 15, 2004 COSL issued $20 million of floating rate unsecured medium term notes as well as $175 million of 3.95% unsecured medium term notes. The fixed interest rate debt was swapped into floating rates pursuant to interest rate swap agreements (Note 16(b)(ii)). Interest on the 3.95% notes was payable semi-annually on January 15 and July 15. Interest on the floating rate notes was payable quarterly on January 15, April 15, July 15, and October 15. Both the floating rate and 3.95% medium term notes matured and were repaid on January 15, 2007.
On May 20, 1997 COSL issued US$70 million of 7.625% Senior Notes, maturing May 15, 2007. Interest rate swap agreements (Note 16(b)(i)) were entered into to swap the interest rate to a 5.95% fixed rate U.S. dollar payment. Interest is payable on the notes semi-annually on May 15 and November 15.
On April 8, 2003 COSL issued $150 million of 5.75% unsecured medium term notes, maturing April 9, 2008. Interest is payable on the notes semi-annually on April 9 and October 9.
On June 29, 2004 COSL issued $200 million of 5.55% unsecured medium term notes, maturing June 29, 2009. Interest is payable on the notes semi-annually on June 29 and December 29.
On August 9, 2004 COSL issued US$250 million of 4.8% Senior Notes, maturing August 10, 2009. Interest is payable on the notes semi-annually on February 10 and August 10.
On August 6, 2003 COSL issued US$300 million of 5.8% Senior Notes, maturing August 15, 2013. Interest is payable on the notes semi-annually on February 15 and August 15.
On August 24, 2001 COSL issued US$250 million of 7.9% Senior Notes, maturing September 1, 2021. Interest is payable on the notes semi-annually on March 1 and September 1. COSL has agreed to maintain its senior debt to book capitalization at an amount less than 0.55 to 1.0.
On April 4, 1997 COSL issued US$75 million of 8.2% Senior Notes, maturing April 1, 2027, and retired US$1.05 million during 2000. Interest is payable on the notes semi-annually on April 1 and October 1.
i) Future payments payable under long-term debt are as follows:
| 2007 | $ | 276 |
| 2008 | 150 | |
| 2009 | 491 | |
| After five years | 727 | |
| $ | 1,644 | |
Canadian Oil Sands intends to refinance on a long-term basis the 3.95% medium term notes, the floating rate medium term notes, and the 7.625% Senior Notes, which are maturing in 2007. The Trust has $824 million of unutilized operating credit facilities at December 31, 2006 to draw on to refinance these obligations, and $800 million of these facilities do not expire until April 27, 2011. In accordance with EIC-122, debt maturing in 2007 has not been reclassified to current liabilities.
| 2006 | 2005 | |||
| Asset retirement obligation - Beginning of year | $ | 148 | $ | 44 |
| Liabilities settled | (2) | (2) | ||
| Accretion expense | 9 | 29 | ||
| Revisions to estimated cash flows | 18 | 77 | ||
| Asset retirement obligation - End of year | $ | 173 | $ | 148 |
Canadian Oil Sands and each of the other owners of Syncrude are liable for their share of ongoing environmental obligations for the ultimate reclamation of the Syncrude Joint Venture on abandonment. The Trust estimates reclamation expenditures will be made over approximately the next 60 years, and has applied an average credit-adjusted risk free discount rate of approximately 6% in deriving the asset retirement obligation.
Syncrude’s upgrader facilities have indeterminate useful lives. Therefore, the fair values of the related asset retirement obligations cannot be reasonably determined. Also, the timing and amount of the reclamation expenditures, if any, related to Syncrude’s sulphur blocks are not determinable at the present time. The asset retirement obligations pertaining to the upgrader facilities and the sulphur blocks will be recognized in the year in which the settlement amounts and dates can be reasonably estimated.
The total undiscounted estimated cash flows required to settle the Trust’s share of the Syncrude obligation rose to $595 million in 2006 (2005 - $525 million), primarily the result of revised estimates for reclamation material handling contract costs and adjustments for industry-wide cost escalations. Discounting these incremental cash flows resulted in an $18 million increase in the asset retirement obligation at December 31, 2006.
The reclamation expenditures will be funded from the Trust’s cash from operating activities and from the Trust’s mining reclamation trust. The Trust paid $2 million in each of 2006 and 2005 for its share of Syncrude’s reclamation expenditures. The Trust deposits $0.1322 per barrel of production attributable to its 35.49% working interest to a mining reclamation trust established for the purpose of funding the operating subsidiaries’ share of environmental and reclamation obligations. As at December 31, 2006, including interest earned on the account, the balance of the mining reclamation trust was $30 million.
In addition, the Trust has posted letters of credit with the Province of Alberta in the amount of $49 million (2005 - $42 million) to secure its pro rata share of the ultimate reclamation obligations of the Syncrude Joint Venture participants.
Canadian Oil Sands is exposed to fluctuations in the U.S.-Canadian currency exchange rate. In 1996, Canadian Oil Sands entered into currency hedging contracts to fix the exchange rate in future years. During 1999, Canadian Oil Sands unwound various positions and exchanged the resulting gain for adjustments to other existing currency contracts. During 2006, Canadian Oil Sands received payments totalling $3 million (2005 – $6 million) related to the unrecognized gain. In 2006, the Trust recognized $2 million in revenues (2005 – nil) related to the deferred gains. The remaining cumulative deferral of $35 million included in currency hedging gains will be recognized as revenue over the period 2007 to 2016, which is when the hedging contracts would have expired had they not been unwound (Note 16(a)).
Payments received by the Trust in the form of royalty payments, interest, dividends, distributions or other income from its subsidiaries are taxable income to the Trust. Under current tax legislation, the Trust is entitled to deduct its cost of acquiring trust royalties, its administrative costs and taxable distributions to Unitholders from its taxable income.
The Trust’s most significant operating subsidiary is COSL, which is subject to tax in the same manner as any other corporation. However, as royalty and interest payments made by COSL to the Trust and COSL’s affiliates are deductible in computing its taxable income, COSL is not expecting to pay significant cash taxes under existing income tax legislation.
The tax provision recorded on the consolidated financial statements differs from the amount computed by applying the combined Canadian federal and provincial income tax statutory rate to income before tax as follows:
| 2006 | 2005 | |||
| Income before taxes | $ | 851 | $ | 839 |
| Statutory rates | ||||
| Federal | 33.00% | 36.00% | ||
| Federal abatement | -10.00% | -10.00% | ||
| Federal surtax | 1.12% | 1.12% | ||
| Alberta provincial rate | 10.38% | 11.50% | ||
| 34.50% | 38.62% | |||
| Expected taxes at statutory rate | $ | 294 | $ | 324 |
| Add (Deduct) the tax effect of: | ||||
| Net income of the Trust - tax sheltered | (260) | (297) | ||
| Resource allowance | (39) | (27) | ||
| Non-deductible Crown charges | 44 | 4 | ||
| Capital tax | – | 8 | ||
| Tax rate changes | (36) | 1 | ||
| Assessments and adjustments | 14 | 2 | ||
| Other | – | (7) | ||
| Provision for taxes | $ | 17 | $ | 8 |
Canadian Oil Sands' income taxes are calculated according to government tax laws and regulations, which results in different values for certain assets and liabilities for income tax purposes than for financial statement purposes. The amount shown on the Consolidated Balance Sheet as future income taxes represents the net differences between tax values and book carrying values on the operating subsidiaries’ Balance Sheets at substantively enacted tax rates expected to apply when the differences reverse.
As at December 31, future income taxes are comprised of the following:
| 2006 | 2005 | |||
| Capital and other assets in excess of tax value | $ | (826) | $ | (720) |
| Net liabilities in excess of tax value | 517 | 481 | ||
| Balance at December 31 | $ | (309) | $ | (239) |
As at December 31, 2006, the following are the estimated balances available for deduction against future taxable income:
| 2006 | ||
| Canadian Oil Sands Trust: | $ | 90 |
| Canadian Development Expense1 | $ | 7 |
| Equity Issue Costs | ||
| Canadian Oil Sands Limited and other operating subsidiaries: | ||
| Undepreciated Capital Costs (“UCC”)2 | ||
| Federal UCC | $ | 2,204 |
| Provincial UCC | $ | 1,991 |
| Scientific Research and Exploration Development | $ | 7 |
| Debt Issue Costs | $ | 5 |
| 1 Deductible at a declining balance rate of 30% annually. | ||
| 2 Majority deductible at a declining balance rate of 25% annually as well as an accelerated rate based on the "income from a mine". Approximately $71 million is not available for use, primarily related to Syncrude's Emissions Reduction project. | ||
| 2006 | 2005 | |||
| Accumulated earnings | $ | 3,410 | $ | 2,576 |
| Accumulated unitholder distributions | (1,718) | (1,206) | ||
| Retained earnings | 1,692 | 1,370 | ||
| Unitholders’ capital (a) | 2,260 | 2,010 | ||
| Contributed surplus | 4 | 3 | ||
| $ | 3,956 | $ | 3,383 | |
The Units represent a beneficial interest in the Trust, share equally in all distributions from the Trust and carry equal voting rights. No conversion or pre-emptive rights, and limited retraction rights are attached to the Units. Units are redeemable at the option of the Unitholder at a price that is the lesser of 90% of the average closing price of the Units on the principal trading market for the previous 10 trading days and the closing market price on the date of tender for redemption, subject to restrictions on the amount to be redeemed each quarter.
In 2006, 8.3 million Units were issued (2005 – 5.3 million) for proceeds of approximately $250 million (2005 - $99 million), primarily related to the Premium Distribution, Distribution Reinvestment and Optional Unit Purchase Plan (“DRIP”) with respect to the distributions paid on February 28, 2006, May 31, 2006, August 31, 2006 and November 30, 2006. Units issued prior to May 2006 have been adjusted to reflect the 5:1 Unit split, which occurred on May 3, 2006.
The following table summarizes the Units that have been issued:
| Date | Net Proceeds per Unit |
Number of Units |
Net Proceeds |
|||
|---|---|---|---|---|---|---|
| Balance, January 1, 2005 | 457.2 | $ | 1,911 | |||
| February 28, 2005 | $ | 15.20 | 1.2 | 18 | ||
| May 31, 2005 | $ | 14.93 | 1.3 | 19 | ||
| August 31, 2005 | $ | 21.54 | 1.0 | 21 | ||
| November 30, 2005 | $ | 21.38 | 1.9 | 41 | ||
| Balance, December 31, 2005 | 462.6 | $ | 2,010 | |||
| February 28, 2006 | $ | 28.14 | 1.5 | 42 | ||
| May 31, 2006 | $ | 31.75 | 2.2 | 68 | ||
| August 31, 2006 | $ | 34.44 | 2.0 | 69 | ||
| November 30, 2006 | $ | 27.67 | 2.5 | 70 | ||
| Option exercises during the year | $ | 8.60 | 0.1 | 1 | ||
| Balance, December 31, 2006 | 470.9 | $ | 2,260 | |||
The Trust has a Unitholder Rights Plan (the “Rights Plan”) designed to provide the Trust and its Unitholders with sufficient time to explore and develop alternatives for maximizing Unitholder value if a takeover bid is made for the Trust. One right has been issued and attached to each issued and outstanding Unit. Rights issued under the Rights Plan become exercisable when a person, and any related parties, has acquired or begins a takeover bid to acquire 20% or more of the Units without complying with certain provisions in the Rights Plan. Should such an acquisition or announcement occur, each right entitles the holder, other than the acquiring person, to purchase Units at a 50% discount to the market price.
In January 2002, the Trust received regulatory approval in Canada for the DRIP. Eligible Unitholders were able to participate in the DRIP for the quarterly distributions payable subject to enrollment and certain other conditions. The DRIP allowed eligible Unitholders to direct their distributions to the purchase of additional Units at 95% of the Average Market Price, as defined in the DRIP. The DRIP also provided an alternative whereby eligible Unitholders could, under the premium distribution component, have had their distributions invested in new Units and exchanged through the Plan broker for a premium distribution equal to up to 102% of the amount that the other Unitholders would otherwise have received on the distribution date. Under the terms of the DRIP, Unitholders had the option to purchase additional Units for cash at 100% of the Average Market Price if they had participated in either of the premium distribution or distribution reinvestment components of the DRIP.
The DRIP has been suspended as of January 31, 2007 as the Trust no longer requires this source of funding; however, it may reinstate the DRIP to fund future investing activities, if required.
The following table summarizes the Units used in calculating net income per Unit:
| (millions) | 2006 | 2005 |
|---|---|---|
| Weighted-average Trust Units outstanding - Basic | 466 | 459 |
| Effect of options | 2 | – |
| Weighted-average Trust Units outstanding - Diluted | 468 | 459 |
Canadian Oil Sands’ stock-based compensation includes stock option and performance unit plan grants for COSL employees pursuant to a long term incentive program. In addition, Syncrude Canada has stock-based compensation plans for which Canadian Oil Sands records its 35.49% working interest.
Canadian Oil Sands maintains two stock-based compensation plans as described below.
As at December 31, 2006, Canadian Oil Sands has 2,479,625 options issued under a unit option and distribution equivalent plan (the “2002 Plan”) and 214,450 options issued under a unit incentive option plan (the “2005 Plan”). The initial exercise price of options granted under the 2002 Plan was based on the weighted-average price of the Units for the five days prior to the issuance of the options and the preceding day for options granted under the 2005 Plan. Subject to customary exceptions relating to retirement, death or termination, each option has a term of seven years and vests in equal amounts over a three-year period. For options granted under the 2005 Plan, the exercise price is reduced to the extent distributions exceed a threshold set by the Board of Directors at the time of the grant.
As at December 31, 2006 the following options were issued and outstanding:
| Date | Number of Options |
Weighted- Average Exercise Price |
||
|---|---|---|---|---|
| Outstanding at January 1, 2005 | 2.1 | $ | 8.14 | |
| Granted in 2005 | 0.5 | $ | 15.00 | |
| Outstanding at December 31, 2005 | 2.6 | $ | 9.44 | |
| Granted in 2006 | 0.2 | $ | 29.70 | |
| Exercised in 2006 | (0.1) | $ | (7.13) | |
| Outstanding at December 31, 2006 | 2.7 | $ | 11.01 | |
| Exercisable at December 31, 2005 | 1.6 | $ | 7.93 | |
| Exercisable at December 31, 2006 | 2.0 | $ | 8.67 | |
| Number of Options Outstanding |
Number of Options |
Weighted- Average Exercise Price |
||||
| Exercise Price | 2.5 | 3.7 | $ | 9.45 | ||
|---|---|---|---|---|---|---|
| $6.95 - $14.69 (2002 Plan) | 0.2 | 6.1 | $ | 29.04 | ||
| $24.19 - $35.78 (2005 Plan) | 2.7 | 3.9 | $ | 11.01 | ||
The fair value of each option is estimated on the grant date using an option-pricing model. The weighted-average fair values of the options granted during the various periods and the weighted-average assumptions used in their determination are as noted below:
| 2006 | 2005 | |||
| Risk-free interest rate (%) | 3.75 | 3.54 | ||
| Expected life (years) | 4.5 | 5 | ||
| Expected volatility (%) | 26 | 22 | ||
| Expected distribution per Unit ($) | 0.80 | 0.40 | ||
| Fair value per stock option ($) | 5.44 | 2.12 | ||
The weighted-average fair value of all options granted during the year was approximately $1 million (2005 - $1 million).
Canadian Oil Sands adopted a performance unit incentive plan (“the Incentive Plan”) and granted awards of performance units (“PUPs”) pursuant to this plan during 2006. The PUPs are earned on the third anniversary of the date of grant, at which time the holder is entitled to receive an amount either in the form of units or in cash equal to the aggregate current market value of the number of units subject to the PUPs. No units are to be issued from treasury and instead will be purchased in the secondary market. The number of units granted under the PUPs is dependent on the total unitholder return generated by the Trust at the end of the three years compared to a peer group, with the actual unit equivalents earned ranging from zero to double the target award.
The weighted-average fair value of all PUPs granted during the year was approximately $1 million.
Canadian Oil Sands recorded approximately $2 million in 2006 (2005 - $1 million) in Administration expense related to its stock-based compensation plans.
Syncrude Canada maintains two stock-based compensation plans as described below.
Syncrude Canada implemented an incentive restricted unit program in 2006,
which awards restricted share units (“restricted units”) to certain employees. The restricted units vest three years after the date of issuance and require settlement by cash payments. Employees who retire prior to the vesting period may be eligible to receive pro rated restricted units based upon the ratio of service provided during the vesting period relative to the full vesting period. The number of restricted units issued at the vesting date is dependent on the weighted-average price of the shares of certain of the Syncrude owners at that time and the total shareholder return of the owners’ shares as compared to a relative peer group. At December 31, 2006 a total of 50,417 restricted units were outstanding, however none of these units were exercisable at year-end.
Syncrude Canada implemented a stock-based compensation plan during 2002 which awarded phantom units to certain employees. The phantom units have value if the composite value of the weighted-average stock price of 70% of Canadian Oil Sands Trust’s Units and 30% of various other joint venture owners’ public shares at the time of exercise by Syncrude Canada employees exceeds the issue price of the awards. The phantom units issued up to 2005 had a term of seven years and vest based on a graded vesting schedule: after the first year of issuance, 50% of the phantom units are exercisable, 25% the following year and the last 25% after year three. Subject to customary exceptions relating to early retirement, death or termination, each phantom unit issued under this plan in 2006 has a term of seven years and vests in equal amounts over a three-year period. When the awards are exercised, they are settled in cash. At December 31, 2006 a total of one million phantom units were outstanding (2005 - 1.3 million), and a total of 0.4 million (2005 - 0.3 million) phantom units were exercisable.
In 2006, Canadian Oil Sands recorded approximately $27 million in operating expenses related to its 35.49% share of Syncrude Canada’s stock-based compensation expense related to the above Syncrude plans (2005 - $36 million).
| 2006 | 2005 | |||
| Interest expense on long-term debt | $ | 102 | $ | 107 |
| Interest income and other | (4) | (3) | ||
| Interest expense, net | $ | 98 | $ | 104 |
The Consolidated Statements of Unitholder Distributions is provided to assist Unitholders in reconciling cash from operating activities to Unitholder distributions.
Pursuant to Section 5.1 of the Trust Indenture, the Trust is required to distribute all the income received or receivable by the Trust in a quarter less expenses and any other amounts required by law or under the terms of the Trust Indenture. The Trust primarily receives income by way of a royalty and interest on intercompany loans from its operating subsidiary, COSL. The royalty is designed to capture the cash generated by COSL, after the deduction of all costs and expenses including operating and administrative costs, income taxes, capital expenditures, debt interest and principal repayments, working capital and reserves for future obligations deemed appropriate. The amount of royalty income that the Trust receives in any period has a considerable amount of flexibility through the use of discretionary reserves and debt borrowings or repayments (either intercompany or third party). Quarterly distributions are determined by the Board of Directors after considering the current and expected economic and operating conditions, ensuring financing capacity for Syncrude’s expansion projects and/or Canadian Oil Sands acquisitions, and with the objective of maintaining an investment grade credit rating.
In 2005, distributions were paid to Unitholders on the last business day of the second month following the quarter and were recorded as payable at each quarter end even though they were not declared. Commencing in the fourth quarter of 2005, distributions are recorded in the quarter declared and paid. The change in recording Unitholder distributions had no impact on the ultimate distributions declared and paid to the Unitholders or to the timing of such payments nor did it impact Canadian Oil Sands’ net income or cash from operating activities.
| For the years ended December 31 | 2006 | 2005 | ||
|---|---|---|---|---|
| Cash from operating activities | $ | 1,142 | $ | 949 |
| Add (Deduct): | ||||
| Capital expenditures | (300) | (800) | ||
| Acquisition of Canadian Arctic Gas Ltd. | (199) | – | ||
| Disposition of properties | 28 | – | ||
| Non-acquisition financing, net1 | (107) | 102 | ||
| Change in non-cash working capital2 | (47) | (63) | ||
| Reclamation trust funding | (5) | (4) | ||
| Unitholder distributions | $ | 512 | $ | 184 |
| Unitholder distributions per Trust Unit | $ | 1.10 | $ | 0.40 |
| 1 Primarily represents net financing to fund the Trust's share of investing activities and is a discretionary item. | ||||
| 2 From financing and investing activities. | ||||
The fair values of financial instruments that are included in the Consolidated Balance Sheet, with the exception of the Senior Notes and medium term notes, approximate their recorded amount due to the short-term nature of those instruments. The fair values of the Senior Notes and medium term notes, based on third party market value indications, are as follows:
| 2006 | 2005 | |||||||
| Carrying Amount |
Estimated Fair Value |
Carrying Amount |
Estimated Fair Value |
|||||
| 3.95% medium term notes due January 15, 2007 | $ | 175 | $ | 175 | $ | 175 | $ | 175 |
| Floating rate medium term notes due January 15, 2007 | 20 | 20 | 20 | 20 | ||||
| 7.625% Senior Notes due May 15, 2007 (US$70 million) | 81 | 82 | 82 | 84 | ||||
| 5.75% medium term notes due April 9, 2008 | 150 | 152 | 150 | 155 | ||||
| 5.55% medium term notes due June 29, 2009 | 200 | 205 | 200 | 208 | ||||
| 4.8% Senior Notes due August 10, 2009 (US$250 million) | 291 | 286 | 291 | 291 | ||||
| 5.8% Senior Notes due August 15, 2013 (US$300 million) | 350 | 349 | 350 | 354 | ||||
| 7.9% Senior Notes due September 1, 2021 (US$250 million) | 291 | 340 | 291 | 345 | ||||
| 8.2% Senior Notes due April 1, 2027 (US$73.95 million) | 86 | 101 | 86 | 106 | ||||
| $ | 1,644 | $ | 1,710 | $ | 1,645 | $ | 1,738 | |
Canadian Oil Sands has entered into currency exchange contracts and interest rate swap agreements to minimize the impact of fluctuations in currency exchange and interest rates. Unrecognized gains (losses) on these risk management activities and the fair values of the derivative financial instruments as at December 31 were as follows:
| 2006 | 2005 | |||||||
| Unrecognized Gains (Losses) |
Estimated Fair Value |
Unrecognized Gains (Losses) |
Estimated Fair Value |
|||||
| Currency exchange contracts (a) | $ | 6 | $ | 6 | $ | 26 | $ | 25 |
| 7.625% Interest rate swap contracts (b(i)) | N/A1 | 1 | N/A1 | 2 | ||||
| 3.95% Interest rate swap contracts (b(ii)) | (1) | (1) | (1) | (1) | ||||
| Total gains | $ | 5 | $ | 6 | $ | 25 | $ | 26 |
| 1 Effective January 1, 2004, pursuant to AcG-13, the 7.625% interest rate swap does not qualify for hedge accounting, and therefore, the fair value of the swap is recognized on the Consolidated Balance Sheet. | ||||||||
As at December 31, 2006, Canadian Oil Sands had entered into foreign exchange contracts to sell approximately US$20 million at a rate of US$0.692 during 2007. As at December 31, 2006, the unrecognized gain on forward foreign currency exchange contracts was $6 million (2005 – $26 million). In 1996, Canadian Oil Sands entered into currency exchange contracts, fixing the exchange rate on US$1.5 billion at approximately US$0.694 per Canadian dollar with quarterly cash settlements until June 2016. During 1999, Canadian Oil Sands exchanged gains on closing certain forward currency contracts for adjustments to the terms of existing currency contracts. These transactions eliminated currency exchange commitments beyond June 30, 2006, and swapped the underlying value for currency exchange contracts, which reduced the exchange rate to US$0.658 from US$0.694 on the remaining US$466 million of currency commitments.
In 2006, Canadian Oil Sands settled US$60 million of currency exchange contracts at a net gain of $23 million, and in 2005 it settled US$100 million in currency exchange contracts at a net gain of $29 million. Gains of $20 million and $24 million in 2006 and 2005, respectively, have been recognized in the income statement as an adjustment to revenues. The remaining portion of these realized gains of $3 million and $5 million for 2006 and 2005, respectively, relate to the unwound positions and were deferred. From July 1, 2006 to December 31, 2006 Canadian Oil Sands recognized revenues of $2 million related to these deferred gains. The remaining deferred gains of $35 million at December 31, 2006 will be recognized in revenues over 2007 to 2016. The deferred balance is reflected in the Consolidated Balance Sheet under “Deferred currency hedging gains” and is more fully described in Note 10.
Canadian Oil Sands has entered into interest rate swap agreements which effectively convert the fixed rate U.S. dollar payments on the 7.625% Senior Notes to a 5.95% fixed rate U.S. dollar payment for the remaining term of the notes. The effective Canadian dollar interest rates were 5.8% and 6.2% in 2006 and 2005, respectively. Settlements on these contracts have been recorded as other income, rather than as a reduction of interest expense, as these swaps do not qualify as a hedge for accounting purposes.
Canadian Oil Sands has entered into interest rate swap agreements which effectively convert the fixed rate Canadian dollar payments on the 3.95% medium term notes to a floating rate Canadian dollar payment for the remaining term of the notes. The effective interest rates were 4.0% and 2.8% in 2006 and 2005, respectively. These swap contracts qualify as hedges for accounting purposes, and as such, the settlements have been recorded in interest expense in the financial statements.
Crude oil sales revenue credit risk is managed by limiting the exposure to customers with a credit rating below investment grade to a maximum of 25% of Canadian Oil Sands’ consolidated accounts receivable. The maximum exposure to any one customer is also limited based on the credit rating of that customer. Risk is further mitigated as sales revenue receivables typically are due and settled in the month following the sale. The use of financial instruments involves a degree of credit risk which Canadian Oil Sands manages through its credit policies and by selecting counterparties of high credit quality.
Under Alberta’s generic Oil Sands Royalty, the Crown royalty is calculated as the greater of 1% of gross revenue after transportation costs or 25% of gross plant gate revenue before hedging, less Syncrude operating, non-production and capital costs. In May 2006, there was a shift in the royalty rate from the minimum 1% of gross revenues to 25% of net revenues. As at December 31, 2006, there are no carry forward deductions for royalty purposes.
Canadian Oil Sands is obligated to make future cash payments under existing contractual agreements that it has entered into either directly or as an owner in Syncrude. The following commitments that relate to Syncrude reflect Canadian Oil Sands’ 36.74% working interest in the joint venture (Note 22).
Effective November 1, 2006, Syncrude Canada entered into a comprehensive Management Services Agreement with Imperial Oil Resources (“Imperial”) to provide operational, technical and business management services to Syncrude Canada. The agreement has an initial term of ten years, with five year renewal provisions. Either Syncrude Canada or Imperial has the option to cancel the agreement on 24 months notice for any reason. Canadian Oil Sands’ 36.74% share of the annual fixed fee payable to Imperial for the first 10 years under the agreement is $17 million. After the first three years through to year 10, variable performance fees will also apply based on the achievement of certain performance targets. Such variable fees may be comparable to the fixed fee component if Syncrude Canada realizes a corresponding benefit through higher production and/or lower per barrel operating costs.
Syncrude has entered into multi-year purchase commitments for natural gas deliveries at floating market–related prices. There are two long-term natural gas supply contracts that expire on October 31, 2008 and October 31, 2010, respectively. The remaining contracts expire at varying dates during 2007, unless they are renewed. Canadian Oil Sands’ 36.74% share of this commitment is for 38 million GJs.
The latest actuarial valuation completed in 2004 for Syncrude Canada’s defined benefit pension plan requires payments to fund the pension plan solvency deficiency. Canadian Oil Sands’ 36.74% share of these funding requirements is $103 million over the next 12 years. Canadian Oil Sands’ share of funding requirements related to Syncrude Canada’s registered pension plan will be updated when Syncrude Canada’s December 31, 2006 actuarial valuation is completed in the second quarter of 2007.
The total estimated project cost of Syncrude’s Stage 3 expansion as at February 22, 2007 is approximately $8.55 billion, or approximately $3.1 billion net to Canadian Oil Sands based on its 36.74% working interest. While the project is essentially complete, remaining expenditures of approximately $33 million, net to Canadian Oil Sands, remain to be incurred over the next two years. Canadian Oil Sands is also committed to remaining costs of approximately $232 million related to its 36.74% share of Syncrude’s Emissions Reduction project, expected to be incurred over the next four years, as well as $29 million related to miscellaneous other capital commitments over the next two years.
Syncrude introduced an employee retention incentive program for permanent Fort McMurray based employees that began on April 1, 2006 and ends on March 31, 2009. Syncrude’s estimated commitment related to the program for 2007 to 2009 is $166 million, or $61 million net to Canadian Oil Sands.
Syncrude has various vendor commitments owing in 2007 to 2009 for non-capital items of which the more significant purchases total $193 million, or $71 million net to Canadian Oil Sands.
Syncrude has entered into an agreement with Marsulex Inc. to utilize flue gas from Coker 8-3 of Stage 3 to manufacture fertilizer. Under the agreement, which began in 2005 and has a minimum term of 15 years, Syncrude is committed to provide the waste stream from the Flue Gas Desulphurization Unit and pay an annual disposal fee. Syncrude receives a portion of the proceeds from the fertilizer sales as a cost recovery. Canadian Oil Sands’ share of this commitment, before any recovery, is approximately $3 million per year.
For the period prior to 2000, the tax filings for COSL’s predecessors, Canadian Oil Sands Investments Inc. (“COSII”) and Athabasca Oil Sands Investments Inc. (“AOSII”), have been reassessed and closed. AOSII’s 2000 and 2001 and COSII’s 2000, 2001 and 2002 Tax Returns have been reassessed by the Canada Revenue Agency (“CRA”) and Notices of Objection have been filed pertaining to the Syncrude Remission Order and other items. AOSII’s 2002 tax return is currently under review and is expected to be reassessed on a similar basis. The resolution of this dispute regarding the Syncrude Remission Order is not expected to result in significant additional cash taxes being paid, however an unfavorable resolution would reduce the amount of tax pools available for carry forward. Timing of resolution of this issue and the impact on tax pool balances was not determinable at December 31, 2006.
Canadian Oil Sands has a long-term agreement with Alberta Oil Sands Pipeline Limited (“AOSPL”) to transport production from the Syncrude plant gate to Edmonton, Alberta. The agreement provides for reimbursement on a cost of service basis, including operating expenses, cash taxes paid, and a return on the depreciated rate base. The agreement commits Canadian Oil Sands to pay its proportionate share of the cost of service whether or not it ships any volumes on the pipeline. The cost of service in 2006, based on Canadian Oil Sands’ 35.49% working interest, was $21 million (2005 - $19 million). The projected cost of service for 2007 is $21 million, based on Canadian Oil Sands’ 36.74% working interest, and is expected to remain around $20 million through 2035.
Canadian Oil Sands has additional pipeline commitments related to transporting production from Edmonton, Alberta on various pipelines in Canada and the United States. These agreements commit Canadian Oil Sands to pay approximately $13 million over 2007 and 2008.
Syncrude has a long-term agreement with TransCanada Pipelines Ventures L.P. to transport gas volumes to Syncrude, which expires in 2023. The agreement provides for a minimum delivery obligation of which Canadian Oil Sands’ share is $1 million per year.
Various suits and claims arising in the ordinary course of business are pending against Syncrude Canada, the operator of the Syncrude project for the participants. While the ultimate effect of such actions cannot be ascertained at this time, in the opinion of the Trust’s management and in consultation with its legal counsel, the liabilities which could reasonably be expected to arise from such actions would not be significant in relation to the operations of Syncrude. Syncrude Canada as well as Canadian Oil Sands and the other Syncrude Joint Venture owners also have claims pending against various parties, the outcomes of which are not yet determinable.
Canadian Oil Sands has posted performance standby letters of credit with the Province of Alberta which are renewed annually. The letters of credit guarantee to the Province of Alberta the reclamation obligations of Canadian Oil Sands’ interest in future reclamation of the Syncrude mine sites. The Province of Alberta can draw on the letters of credit if Syncrude fails to perform its reclamation duties on its mine sites. The maximum potential amount of payments Canadian Oil Sands may be liable for pursuant to these letters of credit is $49 million. Canadian Oil Sands accrues an asset retirement obligation on its Consolidated Balance Sheet for its share of Syncrude’s reclamation costs, which was $173 million at December 31, 2006.
Comparative figures reflect the reclassification of crude oil purchases from revenues to conform to the current year’s presentation. Trust Unit information has been adjusted to reflect the 5:1 Unit split, which occurred on May 3, 2006.
On January 2, 2007, the Trust closed an acquisition with Talisman Energy Inc. to purchase an additional 1.25% indirect interest in the Syncrude Joint Venture for approximately $475 million. The transaction price was comprised of $237.5 million in cash and 8,189,655 Units issued from treasury with an approximate value at the time of entering the acquisition agreement of $29 per Unit. As at February 22, 2007 the Trust owns 36.74% in the Syncrude Joint Venture.
| Consolidated Statements of Cash Flows |  Print This Section |
Statistical Summary |
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