2011-04-20 sea dragon annual report
TRANSCRIPT
2010 ANNUAL REPORT
wORkiNg AREA . . . . . . . . . 1
FiNANCiAL AND OPERATiNg HigHLigHTS . . . . . . . . . 2
mESSAgE TO SHAREHOLDERS . . . . . . . . . 4
REviEw OF OPERATiONS . . . . . . . . . 7
mANAgEmENT’S DiSCUSSiON & ANALYSiS . . . . . . . . . 15
REPORT OF mANAgEmENT . . . . . . . . . 38
AUDiTOR’S REPORT . . . . . . . . . 39
CONSOLiDATED FiNANCiAL STATEmENTS . . . . . . . . . 40
NOTES TO THE CONSOLiDATED FiNANCiAL STATEmENTS . . . . . . . . . 43
CORPORATE iNFORmATiON . . . . . . . . . 56
HigHLigHTS: • IncreasedProvedplusProbablereserves
by382percentto8.2millionboefrom1.7
millionboein2009;
• Increasednetassetvalueby280percentto
$91.3millionfrom$24.0millionin2009;
• Replaced2010production10timeswith
Provedreservesand19timeswithProved
andProbablereserves;
• Achievedaverageproductionof1,001bopd
ascomparedto67bopdin2009;
• Increased2010operatingnetbackto$9.1
millionfrom$0.1millionin2009;
• Attainedtopquartilefindingand
developmentcost(“F&D”)of$3.79bblper
boeonaProvedplusProbablebasiswith
anetbackrecycleratioof6.6;
• Attainedanattractivefinding,developmentand
acquisition(“FD&A”)costsof$10.11perboeona
ProvedplusProbablebasiswithanetbackrecycle
ratioof2.5;
• Exitedtheyearwithcashandcashequivalentsof
$14.8millionandworkingcapitalof$15.7million
andnodebt;
• Closedtheacquisitionofafiftypercent(50%)
workinginterestintheKomOmboConcessionfor
approximately$44.5millioninlateApril2010;
• Closedyear-endwithsufficientcashtofundthe
2011CapitalProgramof$12.4million.
1
HIG
HLIG
HTS
SEA DRAgON ENERgY (SDX-TSX.V)
isprimarilyfocusedonNorth
AfricaandSub-SaharanAfrica.
Currentlyouractivitiesare
concentratedinEgypt,where
wehaveinterestsintwolarge
concessionswithshortand
long-termpotential.
Ourstrategycallsforgaining
entryintoothercountries
thatoffersignificantpotential
andopportunitiesthatwould
enhancetheCompany’sgrowth
withinareasonabletimeframe.
Nw gEmSA
AFRiCA
kOm OmBO
0
Mediterranean Sea
Red Sea
Gulf of Suez
NW GEMSA
KOM OMBO
EGYPT
Nile River
MatruhAlexandria Nile Delta
Sinai Dessert
Eastern Dessert
Western Dessert
Catara Depression
SallumPort Said
Cairo
Luxor
Aswan
Minya
Asyut
Suez
100 200 300 400 500 KM
NW Gemsa
Geyad
Al Amir
Aswan
Nile River
Kom Ombo
2 SeaDragonEnergyInc. |2010AnnualReport
FINANCIAL AND OPERATING HIGHLIGHTS
ThefollowingtableprovidesasummaryofSeaDragon’sfinancialandoperatingresultsforthethreeandtwelvemonth periods ended December 31, 2010 and 2009. Consolidated financial statements with Management’sDiscussionandAnalysis(“MD&A”)areavailableontheCompany’swebsiteatwww.seadragonenergy.comandonSEDARatwww.sedar.com.
THREE mONTHS ENDED DECEmBER 31
TwELvE mONTHS ENDED DECEmBER 31
$000’s except per unit amounts2010 2009
(restated) (8)2010 2009
(restated) (8)
Financial
Oil sales 7,535 365 27,400 365
Royalties (3,683) (186) (14,871) (186)
Operating costs (1,267) (37) (3,423) (37)
netback (1) 2,585 143 9,106 143
net loss (1,294) (1,717) (6,152) (14,080)
cash and cash equivalents 14,751 1,999 14,751 1,999
cash and cash equivalents plus working capital 15,670 3,267 15,670 3,267
Total assets 83,687 21,240 83,687 21,240Debt – – – –
Shareholders’ equity 78,412 20,226 78,412 20,226
capital expenditures 5,545 14,709 56,633 24,503
Weighted average outstanding shares 375,867 181,019 326,252 153,717
OpeRaTiOnal
Oil Sales (bbl/d) 995 67 1,001 67
Brent Oil price (US$/bbl) 87.34 75.54 80.33 75.54
Realized oil price (US$/bbl) 82.34 73.20 75.02 73.20
Royalties (US$/bbl) 40.23 37.02 40.70 37.02
Operating costs (US$/bbl) 13.85 7.43 9.37 7.43
netback (US$/bbl) 28.26 28.75 24.95 28.75
DRilling
gross wells (number of wells) – – 11 –
Success rate (%) – – 91 –
net wells (number of wells) – – 4.3 –
Success rate (%) – – 88 –
cOMpanY gROSS ReSeRVeS (2)
proved
Oil and liquids (mbbl) 3,804 999 3,804 999
natural gas (mmcf) 2,575 – 2,575 –
Total oil equivalent (mboe) (7) 4,233 999 4,233 999
proved plus probable
Oil and liquids (mbbl) 7,553 1,674 7,553 1,674
natural gas (mmcf) 3,828 – 3,828 –
Total oil equivalent (mboe) 8,191 1,674 8,191 1,674
proved plus probable plus possible
Oil and liquids (mbbl) 9,960 1,674 9,960 1,674
natural gas (mmcf) 3,828 – 3,828 –
Total oil equivalent (mboe) 10,598 1,674 10,598 1,674
3
neT pReSenT Value OF FuTuRe caSh FlOWS aFTeR TaX ($000’s) (3)
proved
5% discount rate 51,360 16,962 51,360 16,962
10% discount rate 41,822 15,055 41,822 15,055
15% discount rate 34,866 13,479 34,866 13,479
proved plus probable
5% discount rate 98,058 24,261 98,058 24,261
10% discount rate 75,650 20,774 75,650 20,774
15% discount rate 60,299 18,066 60,299 18,066
proved plus probable plus possible
5% discount rate 144,468 24,261 144,468 24,261
10% discount rate 105,270 20,774 105,270 20,774
15% discount rate 80,139 18,066 80,139 18,066
ReSeRVe liFe inDeX (years) (4)
proved 11.7 n/m 11.7 n/m
proved plus probable 22.6 n/m 22.6 n/m
FinDing anD DeVelOpMenT cOSTS (“F&D”) ($/boe) (5)
proved 4.57 n/m 4.57 n/m
proved plus probable 3.79 n/m 3.79 n/m
RecYcle RaTiO (6)
proved 5.5 n/m 5.5 n/m
proved plus probable 6.6 n/m 6.6 n/m
FinDing, DeVelOpMenT anD acquiSiTiOn cOSTS (“FD&a”) ($/boe)
proved 16.76 n/m 16.76 n/m
proved plus probable 10.11 n/m 10.11 n/m
RecYcle RaTiO (6)
proved 1.5 n/m 1.5 n/m
proved plus probable 2.5 n/m 2.5 n/m
pRODucTiOn ReplaceMenT (%)
proved 986 n/m 986 n/m
proved plus probable 1,885 n/m 1,885 n/m
ReSeRVeS peR ThOuSanD ShaReS OuTSTanDing
proved 11 5 11 5
proved plus probable 22 8 22 8
HIG
HLIG
HTS
(1) Netback is a non-GAAP measure that represents sales net of all operating expenses and government royalties. Management believes that netback is a useful supplemental measure to analyze operating performance and provide an indication of the results generated by the Company’s principal business activities prior to the consideration of other income and expenses. Management considers netbacks an important measure as it demonstrates the Company’s profitability relative to current commodity prices. Netback may not be comparable to similar measures used by other companies.(2) Company gross reserves are gross working interest reserves before the deduction of royalties as determined by the Company’s independent reserves evaluators. (3) As determined by the Company’s independent reserves evaluators. Estimated values of future net revenue disclosed do not represent fair market values.(4) Calculated by dividing the Company’s gross reserves by the 2010 fourth quarter production rate (5) The aggregate of the exploration and development costs incurred in the most recent financial year and the change during that year in estimated future development costs generally will not reflect total finding and development costs related to reserve additions for that year.(6) Recycle ratio is calculated by dividing netback by finding and development costs or netback by finding, development and acquisition costs. (7) Disclosure provided herein in respect of BOEs may be misleading, particularly if used in isolation. A BOE conversion ratio of 6 Mcf:1 Bbl is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.(8) Effective July 1, 2010, the Company changed its reporting and functional currency from Canadian dollars (CDN$) to United States dollars (US$), as significant portions of the Company’s revenues, expenses and cash flows are denominated in US$. The change in reporting currency is to better reflect the Company’s business activities and to improve investors’ ability to compare the Company’s financial results with other publicly traded businesses in the international oil and gas industry. Prior to July 1, 2010, the Company reported its annual and quarterly consolidated balance sheets and the related consolidated statements of operations and cash flows in CDN$.n/m – not meaningful, acquired NW Gemsa at the end of 2009
4 SeaDragonEnergyInc. | 2010AnnualReport
Sea Dragon began 2010 with a focused strategy of populating the Company with the right management, additional producing assets and exploration prospects to enhance shareholder value. The transformational strategy has begun to show results:
• Significant increase in production with a 2010 average rate of 1,001 bopd compared to 67 bopd in 2009;
• Impressive drilling results in both of the Company’s concessions with an 88% success rate;
• Increased Proved plus Probable reserves by 382 percent to 8.2 million boe from 1.7 million boe in the prior year;
• Top quartile finding and development costs of only $3.79 per barrel of Proved and Probable reserves;
• Achieved FD&A costs of $10.11 per boe with a recycle ratio of 2.5;
• Increased net asset value by 280 percent to US$91.3 million from US$24.0 million in 2009.
Inlate2009,SeaDragonEnergyreshapeditsstrategytofocusonbuildingasolidreserveandproductionbaseinEgypt.Thestrategyculminatedwiththesuccessfulacquisitionofa10percent(10%)workinginterestintheonshoreGulfofSuezNorthWestGemsaConcession(“NWGemsa”),anda50percent(50%)workinginterestinthelargeKomOmboConcessioninSouthEgypt.Inadditiontothepropertyacquisition,theCompanyrecruitedthekeyexecutivesfromCenturionEnergy(CenturionsoldtoDanaGasin2006for$1.2billion)includingTonyAntonasPresidentandCOO(formerCOOofCenturion)andMikeZayat(formerVPExplorationofCenturion)withtheintentionofreplicatingthesuccessofCenturionandultimatelyincreasingshareholdervalue.
SeaDragonisdeterminedtobuildaportfolioofopportunitiestosustaingrowthandcreateshareholdervalue.TheCompanyhasdevelopedanaggressiveapproachtoexpanditsactivities,andpursueandcaptureopportunitieswithinEgyptaswellasoutsideofEgypt.In2010,theCompanyhaslaidthefoundationforanexciting2011andintendsongrowingtheCompanyintoapreeminentintermediateoilandgascompanywithoperationsinseveralcountries.In2011,theCompanybelievesshareholderswillbegintoseeanincreaseinproduction,cashflowandshareholdervalueastheCompanybeginstoexploitthelargereserveandresourcebaseitcapturedinjustoverayearsincethetransformationstrategybegan.
CEO’S MESSAGE TO SHAREHOLDERS
ELEVEN DEVELOPMENT WELLS WERE DRILLED IN TWO CONCESSIONS WITH AN IMPRESSIVE 88% OVERALL SUCCESS RATE.
5
MESSAG
ETO
SHA
REHO
LDERS
YEAR IN REVIEW:North west gemsa:IntheNWGemsathetwomainlightoilKareemFormations(ShagarandRahmi)weredelineatedandappraised,heavieroilfromtheshallowerreservoirwasputonlongtermtest,andapotentiallynewgasandcondensatereservoirwasdiscoveredinthedeeperLowerRudeisFormation.TheAlAmirSEfieldwasextendedtothesouthwithadiscoveryoflightoilintheKareemFormationintheAlOlaX-1well.ThepresenceofhydrocarbonsintheLowerRudeisFormationinbothAlAmirSE#6andAlOlaX-1bodeswellfordiscoveringadditionalreservesinthedeeperprolificNubiaFormation.During2011,theAlAmirSEfieldwillundergopressuremaintenancethroughwaterinjection,preservationofassociatedgasandstrippingofhydrocarbonliquids.TheCompany’s$5.0millioncapitalexpenditureprogramincludes,butisnotlimitedto,expandingtheproductionfacilities,buildinga20kmeightinchgasline,thedrillingofuptofourwaterinjectionwellsanduptotwodevelopmentwellsandthebuildingofgascompressionfacilities.
INCREASED PROVED PLUS PROBABLE RESERVES BY 382%
6 SeaDragonEnergyInc. | 2010AnnualReport
MESSAGE TO SHAREHOLDERS
kom Ombo:InKomOmbo,developmentoftheestablishedreservoirscontinuedintheAlBarakafield,additionalshallowanddeeperoilpayzoneswerediscoveredandplacedonproduction.Asaresultofthe2010drillingcampaignandinterpreta-tionofthenewlyacquiredseismic,severalnewprospectsandleadsweremappedandaddedtotheCompany’sprospectinventory.During2011,theCompany’s$7.4millioncapitalexpenditureprogramincludes,butisnotlimitedto,thedrillingoffiveadditionaldevelopmentwells,severalworkoversandfracs,anduptotwoexplorationwellsoutsideofthedevelopmentlease.
SaidArrata,ChairmanandChiefExecutiveOfficer
7
REVIEWOF
OPERATiONS
OPERATIONS REPORT
8 SeaDragonEnergyInc. | 2010AnnualReport
WATER FLOOD AND GAS CONSERVATION WILL BECOME THE FOCUS OF THE 2011 PROGRAM - RESULTING IN PRODUCTION GROWTH.
In August 2009, the Company entered into a share purchase agreement withPremierOilOverseasBVtoacquireallof the issuedandoutstandingsharesofPremierEgypt (NWGemsa)BV, theholderofa ten (10%)percentparticipatinginterestintheNWGemsaConcessionlocatedinEgypt’sEasternDesertonshoretheGulfofSuez.Thesharepurchase transactionwascompletedonDecember21,2009witha July1,2009effectivedate. Thepurchasepriceof the shareswasUS$12.5millionandwassubjecttoadjustmentsforworkingcapitalfromtheeffectivedatetothedateofclosing.OnJanuary12,2010,followingtheclosing,PremierEgyptchangeditsnametoSeaDragonEnergy(NWGemsa)B.V.
TheNWGemsaConcessionisa250squarekilometreonshoreconcessionlocatedapproximately300kilometres southeastofCairo in theEasternDeserton thesouthwesternpartoftheGulfofSuez.Thetermsoftheconcessionareasfollows:
Nw gEmSA
Basin GulfofSuez
YearAcquired 2009
Status Development/Exploration
ConcessionOperator VegasOilandGasLtd.
SeaDragonParticipatingInterest(%) 10%
Area(km2) 250
Area(acres) 61,776
ExpiryDateofCurrentExplorationPhase July2010(1)
DevelopmentLeaseTerms 20year+3x5yearextensions
Production sharing
Contractor’sShareofCostOil 30%
Contractor’sShareofProfitOil 16.1%
Contractor’sShareofExcessCostOil nil
Depreciation of Costs
Operating(asIncurred) 100%
Capital(Annual) 20%(1) The Company and its partners successfully drilled an exploration well south of the Al Amir SE oil field resulting in a field development lease extension being agreed in principle with Ganope. The Company and partners are awaiting Ministry of Petroleum’s ratification.
43
2
5
16
Al Ola X-1
Al Amir SE Field
NW Gemsa Concession
Al Amir -1X
Development Lease
Development Lease
Heavy OilOil Location
Location
7
1
2Geyad Field
NORTH wEST gEmSA
OPERATIO
NS
REVIEW
9
OPERATIO
NS
REVIEW
In Geyad, one well was side-tracked,completedandtiedinforproduction.
TheAlAmir1-Xoriginaldiscoverywellwasre-enteredandplacedonextendedproduction test,achiev-ing an initial daily productionrateof300bopdof18°APIoil.Plans are to hydraulically frac-ture the interval in 2011. Drillingresults indicate this same poolmay extend south to theAlAmirSE-6 and Al Amir SE-7 wells.Gas and condensate was alsodiscoveredintheunderlyingLowerRudeisformation,inAlAmirSE-6andAlOla-1Xwells.
North West Gemsa development leasesThree fields have been dis-covered in the NW GemsaConcession, Al Amir SE, AlAmir and Geyad. Develop-ment leaseswere issued foreachofthefields.
The Al Amir SE field islocated in the southeasternportion of the NW GemsaConcessionandliesapproxi-matelysixkilometreswestof theoilproducingGazwarinafield.ProductionfromtheAlAmirSEfieldcommencedinFebruary2009.TheGeyadfieldislocatedapproximatelytenkilometresnorthwestoftheAlAmirSEfield.
ThefieldsareoperatedbyPetroAmirCompany,aJointOperatingCompanybetween the partners and Ganoub El Wadi (Ganope a subsidiary of theEgyptianGovernmentPetroleumCorporation).
IntheAlAmirSEandGeyadfieldsthetwomainpayzonesareintheKareemsandscontaininglightoil(40-42°API).IntheAlAmirfieldtheheavieroilpay(17ºAPI)belongstotheyoungerSouthGharibFormation.
In 2010 development, appraisal and step out drillingresultedin3additionalwellsinAlAmirSE.TheAlOla-1Xsuccessfully extended Al Amir SE field Kareem reservesbeyond the current lease boundaries. Application wasmadetothegovernmentforextendingthedevelopmentlease,bothsouthandwestoftheexistingboundaries.
Technicalstudiesindicatethatsignificantpotentialexiststowater flood theAlAmir SEandGeyad fields.Up tosix injectors and one producer are planned for 2011whichwillenhancerecoveryandboostproductionrates.Potential exists to increase gross production to 15,000bbls/dandpushrecoveryfactorsto45%. BASEMENT
LOWER RUDEIS POTENTIALKAREEM PAY ZONES
SOUTH GHARIBPAY ZONE
Al Amir Field
NUBIA POTENTIAL
N:\Data Rooms\Projects\Egypt\NW Gemsa\Maps\NW Gemsa over 4X well.vsd
NW Gemsa Exploration TheNWGemsaconcessionoriginalexplo-ration phase expired in January 2011.Primaryexplorationwasmainlyfocusedonthecentralandsouthernpartoftheconces-sionresultedinthediscoveryoftheAlAmir,AlAmirSEandGeyadfields.
RecentLowerRudeisdiscoveryisindicativethat additional potential may exist in thedeeperprolificNubiareservoir.Horstblockandtiltedfaultprospectshavebeenidenti-fiedthatwillbecomethefocusoffutureex-plorationactivities.
OPERATIONS REPORT
TheCompanyholdsa50%workinginterestandisco-operatorintheKomOmboBlock2Concession.Thislargeundeveloped,11,466km²concessionissituatedintheKomOmboBasin,Egyptnewoilprovince,located1,000kmsouthofCairo.TheKomOmboConcessionhasexcellentproductionsharingtermsasnotedbelow.
kOm OmBO
Basin KomOmbo
YearAcquired 2010
Status Development/Exploration
ConcessionOperator DGE/SeaDragon
SeaDragonParticipatingInterest(%) 50%
Area (km2) 11,446
Area(acres) 2,828,368
ExpiryDateofCurrentExplorationPhase July2012
DevelopmentLeaseTerms 20year+3x5yearextensions
Production sharing
Contractor’sShareofCostOil 40%
Contractor’sShareofProfitOil 21%
Contractor’sShareofExcessCostOil 21%
Depreciation of Costs
Operating(asIncurred) 100%
Capital(Annual) 25%
TheKomOmboBasinispartoftheNEAfricariftsystemthatincludesknownAfricanprolificbasinssuchasMugladBasinofSudanandUganda,LakeAlbertBasinsandothers.
Extensive2Dand3Dseismichavebeenacquired,productionhas been established, discoveries made, and several highimpactpotentialprospectshavebeenidentified.
Al Baraka field TheAlBarakafieldwasdiscoveredin2007,adevelopmentleaseissued with production established from the two Cretaceousshallowpayzones,theAbuBallasandSixHillsF.In2010whenSeaDragonentered theconcession, thefieldwasproducingfromthreewells,andimmediatelyembarkedwiththeoperatoronanaggressiveappraisalandfielddevelopmentcampaignofninewellsthatestablishedthemultiplepaycharacteristicsofthefield.TwoadditionalpayzoneswerediscoveredincludingtheSixHillsEandthedeeperBasalKomOmbosands.TheBasalKomOmboconsistsoftworeservoirintervals;KomOmboAwhichdirectlyoverliesthebasement,andKomOmboCsandsseparatedbytheoilsourcebeds.TheAbuBallasandSixHillspayzonesareencounteredatshallowdepth,3,000-4,000feetwith theBasalKomOmbopayzoneatanaveragedepthof8,000feet.
10 SeaDragonEnergyInc. | 2010AnnualReport
kOm OmBO CONCESSiON
THE 2010 DRILLING CAMPAIGN RESULTED IN THE DISCOVERY OF ADDITIONAL SHALLOW RESERVOIRS IN AL BARAkA FIELD AND ESTABLISHED THE PROSPECTIVITY AND TREND FOR THE DEEPER BASAL kOM OMBO SANDS.
Kom OmboBasin
MugladBasin
Lake AlbertBasin
CONGOUGANDA
KENYA
ETHIOPIA
SUDAN
EGYPTSAUDI
ARABIA
Nile River
NW Basin
Nile R
iver
South Al Baraka
IsisAl Baraka
Field
Kilometers
5 10 15 200
Amun
Kom Ombo BasinUndiscovered Prospects and Leads West
Al Baraka
Memphis
FieldProspectLeadP&A
Development Lease
Nile River
Nile River
Althoughmostofthewellshavemorethanonepayzone,theyarecompletedinasinglezone,thereforeprovidingopportuni-ties to increaseproductionand recovery throughcominglingproductionandtwinningwellsinthefuture.Aswell,applicationofnewdrillingandcompletion techniquessuchashorizontaldrilling and fracture stimulation could result in increasedproductionand recovery rates.ThebasalKomOmbosandstrend is aerially extensiveand is themain focusof the2011appraisal and development program. Additional Abu Ballasupsideexists in thefield inuntested faultblocks,andon theeasternflankintherecentlydiscoveredSixHillsDreservoir.
Theoilis37°API,waxywithverylowGORopeninguppotentialfortheapplicationofwaterfloodtoenhanceoilrecoveryfromsomereservoirs.TheoiliscurrentlytruckedtotheAssuitrefinerylocated300kmnorth.
kom Ombo Concession Exploration The 2010 drilling campaign resulted in the discovery ofadditionalshallowreservoirsinAlBarakafieldandestablishedtheprospectivityand trend for thedeeperBasalKomOmbosands.Allreservoirsarechargedfromacommonsourcerock.TheMemphis#1well,drilled40kmnorthofAlBarakafieldwaspluggedandabandoned inearly2011.Newlyacquired2D seismic data indicate the NW Basin could have similarcharacteristicsandprospectivityasthemainbasin.
A 477 km 2D seismic program acquired in mid 2010was integratedwith thecurrentdatabaseandmappingto firm prospects and leads. For 2011 geochemical,stratigraphicandbasinmodellingandseismicreprocess-ingareplannedtorefinethegeologicalandgeophysicalinterpretationoftheblockandhi-gradetheprospects.
TheKomOmbobasinislightlyexplored.SeaDragonandpartners have identified and assembled an impressiveportfolio of eight (8) prospects and leads, targeting theAbuBallas,SixHillsandthebasalKomOmbosandsinstructuralandstratigraphictraps.
The 2011 plans include the drilling of twoexploratory wells, to test and extend theshallowanddeepprospectiveplaysoutsidethe development lease. The shallow AbuBallas – SixHills play include traps in fourway and three way fault closures on trendwith Al Baraka field and in closures alongthe Rift shoulder. The Basal Kom Ombosand play consists of a series of structuraland stratigraphic traps.TheKomOmboAis confined to structures within the deeper
partoftheacreage,whiletheKomOmboCdrapesoverpartofthestructure.TheKomOmboAandC sandsarealso trappedas theypinchout to thewestagainstthebasement.
OPERATIO
NS
REVIEW
11
OPERATIO
NS
REVIEW
AB-3
AB-1AB-6AB-7
AB-2
AB-5
AB-9
AB-15AB-10 K-1
K-2
ABSE-1
Meters
1,000 1,500 2,0005000
Oil WellProposed WellRepsol Drilled Well
AB-4
AB-13
AB-14
Abandoned Well
AB-12
AB-11
-2000
1500
1000
500
SIX HILLS
SABAYA
BASEMENT
KOM OMBOPINCHOUT PROSPECT
MAGHRABI
ABU BALLASSIX HILLS
KOM OMBO SANDSSTRUCTURAL PROSPECTS
SHALLOW STRUCTURAL PROSPECTS
RIFTSHOULDERPROSPECTS
2000
3000
4000
5000
6000
7000
8000
FT
Basement
SW
Abu BallasPay Zone
Six Hills FPay Zone
Kom Ombo A Pay Zone
Abu Ballas Shale
Kom Ombo Shale
Six Hills EPay ZoneSabaya
Six Hills DPay Zone
NE
RESERVES SUMMARY
12 SeaDragonEnergyInc. | 2010AnnualReport
Reserves / Resources ReserveandresourceestimateshavebeencalculatedincompliancewiththeStandardsofDisclosureforOilandGasActivities(“NI51-101”).
OfthenetpresentvalueoftheCompany’sreserves,100percentwereevaluatedbyindependentthirdpartyengineers,Gaffney,Cline&AssociatesLtd(“GCA”)andRyderScottCompanyCanada(“RyderScott”)intheirreportsdatedMarch11,2011andFebruary25,2011,respectively.
UnriskedUndiscoveredResourceswithintheKomOmboblockweredeterminedprobabilisticallybyRyderScottintheirreportdatedApril8,2011.TheindependentassessmentwascarriedoutinaccordancewithNI51-101StandardsofDisclosureforOilandGasactivities.TheeffectivedateofthereportisDecember31,2010.Usingtheavailablewelldata,seismicdataandinformationobtainedfromtheAlBarakafield,RyderScottdeterminedanoilinplacevolumesof156-642mmbblsfortheeightprospectsandleadsidentifiedontheblock.
RESERvES / RESOURCES SUmmARY
382%to 8.2 million boe from 1.7 million boe in 2009
increased Proved plus Probable reserves by
324%
Year-over-year increase in proved reserves
13
COmPANY gROSS RESERvE RECONCiLiATiON (mboe) PROvEDPROvED PLUS
PROBABLE
December31,2009Reserves 999 1,674
InfillDrilling&Extensions 1,380 3,622
ImprovedRecovery 2,093 3,205
TechnicalRevisions – (187)
Acquisitions 146 287
EconomicFactors (20) (45)
Production (365) (365)
December31,2010Reserves 4,233 8,191
Yearoveryearincreaseinreserves 324% 389%
Productionreplacement 986% 1885%
COmPANY gROSS RESERvES OiL LiqUiDS NATURAL gAS TOTAL
RESERvES CATEgORY (mbbls) (mbbls) (mmcf) (mboe)
Proved(1)
ProvedProducing 1,311 – – 1,311
Undeveloped(2) 2,282 211 2,575 2,922
TotalProved 3,593 211 2,575 4,233
Probable(3) 3,646 103 1,253 3,958
TotalProvedPlusProbable 7,239 314 3,828 8,191
Possible(4) 2,407 – – 2,407
TotalProvedPlusProbablePlusPossible 9,646 314 3,828 10,598
Reserve Definitions:(1) Proved reserves are those that can be estimated with a high degree of certainty to be recoverable. It is likely that the actual remaining quantities recovered
will exceed the estimated Proved reserves.(2) Proved Undeveloped reserves have been recognized in cases where plans are in place to bring the reserves on production within a short, well defined time
frame. Proved Undeveloped reserves often involve infill drilling into existing pools.(3) Probable reserves are those additional reserves that are less certain to be recovered than proved reserves. It is equally likely that the actual remaining
quantities recovered will be greater or less than the sum of estimated proved plus probable.(4) Possible reserves are those additional reserves that are less certain to be recovered than probable reserves. It is unlikely that the actual remaining
quantities recovered will exceed the sum of the estimated proved plus probable plus possible reserves.
NET PRESENT vALUE AFTER iNCOmE TAx ($000’s) DiSCOUNT FACTOR
RESERvES CATEgORY 0% 5% 10% 15%
Proved:
ProvedProducing 29,491 26,008 23,247 21,018
ProvedUndeveloped 35,436 25,352 18,575 13,848
TotalProved 64,927 51,360 41,822 34,866
Probable 67,510 46,698 33,828 25,433
TotalProvedPlusProbable 132,437 98,058 75,650 60,299
Possible 77,080 46,410 29,620 19,840
TotalProvedPlusProbablePlusPossible 209,517 144,468 105,270 80,139
RESERVESSU
MM
ARY
RESERVES SUMMARY
14 SeaDragonEnergyInc. | 2010AnnualReport
FiNDiNg AND DEvELOPmENT COSTS (“F&D”)PROvED PROvED PLUS
PROBABLE
Capitalexpenditures,excludingacquisitioncosts($000’s) 12,132 12,132
Changeinfuturedevelopmentcosts($000’s) 3,653 12,893
Totalcosts($000’s) 15,785 25,025
Netadditions(mboe)excludingacquisitions 3,453 6,595
FindingandDevelopmentcosts($/bbl) 4.57 3.79
Recycle Ratio
2010Netback($/bbl) 24.95 24.95
FindingandDevelopmentcosts($/bbl) 4.57 3.79
RecycleRatio 5.5 6.6
FiNDiNg, DEvELOPmENT, AND ACqUiSiTiON COSTS (“FD&A”)PROvED PROvED PLUS
PROBABLE
Capitalexpenditures,includingacquisitioncosts($000’s) 56,633 56,633
Changeinfuturedevelopmentcosts($000’s) 3,653 12,893
Totalcosts($000’s) 60,286 69,526
Netadditions(mboe) 3,599 6,882
Finding,DevelopmentandAcquisitioncosts($/bbl) 16.76 10.11
Recycle Ratio
2010Netback($/bbl) 24.95 24.95
FD&Acostsincludingfuturedevelopmentcapital 16.76 10.11
RecycleRatio 1.5 2.5
NET ASSET vALUE 2010 2009
Netpresentvalueofoilandgasreservesafterincometax($000’s),discountedat10% 75,650 20,774
Workingcapital,endofyear 15,670 3,267
NetAssetValue 91,320 24,041
kOm OmBO BLOCk-2 AS AT 2010-12-31
UNRiSkED UNDiSCOvERED RESOURCES (1) (mmstb) LOw (P90) (2) BEST (P50) (3) HigH (P10) (4)
Prospects&Leads 156 339 642Resource Definitions:(1) Estimates are Gross (100%). Sea Dragon holds a 50% working interest at Kom Ombo.(2) This is considered to be conservative estimate of the Undiscovered Resources volumes. It is likely that the actual volumes of Undiscovered Resources will
exceed the Low estimate. If probabilistic methods are used, there should be a 90% chance that the volumes of Undiscovered Resources will equal or exceed the low estimate.
(3) This is considered to be the best estimate of the volumes of Undiscovered Resources. It is equally likely that the actual volumes of Undiscovered Resources will be greater or less than the best estimate. If probabilistic methods are used, there should be a 50% probability that the volumes of Undiscovered Resources will equal or exceed the best estimate.
(4) This is considered to be an optimistic estimate of the volumes of Undiscovered Resources. It is unlikely that the actual volumes of Undiscovered Resources will exceed the high estimate. If probabilistic methods are used, there should be a 10% probability that the volumes of Undiscovered Resources will equal or exceed the high estimate.
UndiscoveredResourceshavebothanassociatedchanceofdiscoveryandachanceofdevelopment.ThereisnocertaintythatanyportionoftheUndiscoveredResourceswillbediscovered.Ifdiscovered,thereisnocertaintythatitwillbecommerciallyviabletoproduceanyportionoftheresources.
ThedisclosuresrequiredinaccordancewithNationalInstrument51-101oftheCanadianSecuritiesAdministratorsisavailableintheCompany’sAnnualInformationFormfiledontheSEDARwebsiteatwww.sedar.com.
15
mANAgEmENT’SDiSCUSSiON & ANALYSiS
16 SeaDragonEnergyInc. | 2010AnnualReport |MANAGEMENT’SDISCUSSION&ANALYSIS(PREPAREDINUS$)
MANAGEMENT’S DISCUSSION & ANALYSIS FOR THE THREE AND TWELVE MONTHS ENDED DECEMBER 31, 2010
BASiS OF PRESENTATiONThefollowingmanagement’sdiscussionandanalysis(the“MD&A”)datedMarch29,2011isareviewofresultsofoperationsandtheliquidityandcapitalresourcesofSeaDragonEnergyInc.(the”Company”or“SeaDragon”)forthethreeandtwelvemonthsendedDecember31,2010.ThisMD&AshouldbereadinconjunctionwiththeaccompanyingauditedfinancialstatementsfortheyearsendedDecember31,2010and2009.Thecon-solidatedfinancialstatementsoftheCompanyarepreparedinaccordancewithCanadiangenerallyacceptedaccountingprinciples(“GAAP”).ThereportingandthefunctionalcurrencyoftheCompanyistheUnitedStatesdollar(US$).
Certaininformationcontainedhereinisforward-lookingandbaseduponassumptionsandanticipatedresultsthataresubjecttorisks,uncertaintiesandotherfactors.Shouldoneormoreoftheseuncertaintiesmaterializeorshouldtheunderlyingassumptionsproveincorrect,actualresultsmayvarymateriallyfromthoseexpected.See“ForwardLookingStatements”,below.
CHANgE iN REPORTiNg CURRENCY AND ACCUmULATED OTHER COmPREHENSivE iNCOmEEffective July 1, 2010, the Company changed its reporting and functional currency from Canadian dollars(CDN$)toUnitedStatesdollars(US$),assignificantportionsoftheCompany’srevenues,expensesandcashflowsaredenominated inUS$.Thechange in reportingcurrency is tobetter reflect theCompany’sbusinessactivitiesandtoimproveinvestors’abilitytocomparetheCompany’sfinancialresultswithotherpubliclytradedbusinessesintheinternationaloilandgasindustry.PriortoJuly1,2010,theCompanyreporteditsannualandquarterlyconsolidatedbalancesheetsand the relatedconsolidatedstatementsofoperationsandcashflowsinCDN$. Inmaking this change in reporting currency, theCompany followed the recommendationsof theEmergingIssuesCommittee(EIC)oftheCanadianInstituteofCharteredAccountants(CICA),setoutinEIC-130,TranslationMethodwhentheReportingCurrencyDiffersfromtheMeasurementCurrencyorthereisaChangeintheReportingCurrency.InaccordancewithEIC-130,thefinancialstatementsforallyearsandperiodspresentedhavebeen translated into thenewreportingcurrencyusing thecurrent ratemethod.Under thismethod, thestatementsofoperationsandcashflowstatementitemsforeachyearandperiodhavebeentranslatedintothereportingcurrencyusing theaverageexchange ratesprevailingduringeach reportingperiod.Allassetsandliabilities havebeen translatedusing theexchange rateprevailingat the consolidatedbalance sheetsdates.Shareholders’equitytransactionshavebeentranslatedusingtheratesofexchangeineffectasofthedatesofthevariouscapitaltransactions,whileshareholders’equitybalancesfromthetranslationareincludedasaseparatecomponentofothercomprehensiveincome.Allresultingexchangedifferencesarisingfromthetranslationareincludedasaseparatecomponentofothercomprehensiveincome.All comparative financial information has been restated to reflect the Company’s results as if they had been historically reported in US$ and the effect on the consolidated financial statements resulted in an accumulated and other comprehensive income adjustment of $8.3 million as at July 1, 2010.
AllfinancialreferencesinthisMD&AareinthousandsofUnitedStatesDollarsunlessotherwisenoted.
AdditionalinformationrelatedtotheCompanycanbefoundonSEDARatwww.sedar.com.
FORwARD-LOOkiNg STATEmENTSCertain statements included or incorporated by reference in this MD&A constitute forward-looking statements or forward-looking information under applicable securities legislation. Such forward-looking statements or information are for the purpose of providing information about Management’s current expectations and plans relating to the future. Readers are cautioned that reliance on such information may not be appropriate for other purposes, such as making investment decisions. Forward-looking statements or information typically contain statements with words such as “anticipate”, “believe”, “expect”, “plan”, “intend”, “estimate”, “propose”, “project” or similar words suggesting future outcomes or statements regarding an outlook. Forward-looking statements or information in this MD&A include, but are not limited to, statements or information with respect to: business strategy and objectives; development plans; exploration plans; acquisition and disposition plans and the timing thereof; reserve quantities and the discounted present value of future net cash flows from such reserves; future production levels; capital expenditures; net revenue; operating and other costs; royalty rates and taxes.
MD
&A
17MANAGEMENT’SDISCUSSION&ANALYSIS(PREPAREDINUS$)
Forward-looking statements or information are based on a number of factors and assumptions that have been used to develop such statements and information but may prove to be incorrect. Although the Company believes that the expectations reflected in such forward-looking statements or information are reasonable, undue reliance should not be placed on forward-looking statements because the Company can give no assurance that such expectations will prove to be correct. In addition to other factors and assumptions that may be identified in this MD&A, assumptions have been made regarding, among other things: the impact of increasing competition; the general stability of the economic and political environment in which the Company operates; the timely receipt of any required regulatory approvals; the ability of the Company to obtain qualified staff, equipment and services in a timely and cost-efficient manner; the ability of the operator of the projects which the Company has an interest in to operate the field in a safe, efficient and effective manner; the ability of the Company to obtain financing on acceptable terms; field production rates and decline rates; the ability to replace and expand oil and natural gas reserves through acquisition, development or exploration; the timing and costs of pipeline, storage and facility construction and expansion and the ability of the Company to secure adequate product transportation; future oil and natural gas prices; currency, exchange and interest rates; the regulatory framework regarding royalties, taxes and environmental matters in the countries in which the Company operates; and the ability of the Company to successfully market its oil and natural gas products. Readers are cautioned that the foregoing list is not exhaustive of all factors and assumptions that may have been used.
Forward-looking statements or information are based on current expectations, estimates and projections that involve a number of risks and uncertainties that could cause actual results to differ materially from those anticipated by the Company and described in the forward-looking statements or information. The risks and uncertainties that may cause actual results to differ materially from the forward-looking statements or information include, among other things: the ability of Management to execute its business plan; general economic and business conditions; the risk of war or instability affecting countries or states in which the Company operates; the risks of the oil and natural gas industry, such as operational risks in exploring for, developing and producing crude oil and natural gas; market demand; the possibility that government policies or laws may change or governmental approvals may be delayed or withheld; risks and uncertainties involving geology of oil and natural gas deposits; the uncertainty of reserves estimates and reserves life; the ability of the Company to add production and reserves through acquisition, development and exploration activities; the Company’s ability to enter into or renew production sharing concession; potential delays or changes in plans with respect to exploration or development projects or capital expenditures; the uncertainty of estimates and projections relating to production (including decline rates), costs and expenses; fluctuations in oil and natural gas prices, foreign currency, exchange, and interest rates; risks inherent in the Company’s marketing operations, including credit risk; uncertainty in amounts and timing of oil revenue payments; health, safety and environmental risks; risks associated with existing and potential future law suits and regulatory actions against the Company; uncertainties as to the availability and cost of financing; and financial risks affecting the value of the Company’s investments. Readers are cautioned that the foregoing list is not exhaustive of all possible risks and uncertainties.
NON-GAAP MEASURESTheMD&Acontains the terms“funds fromoperations”,and“netbacks”whicharenotrecognizedmeasuresunderCanadianGAAP.TheCompanyusesthesemeasurestohelpevaluateitsperformance.
FUNDS FROm OPERATiONSFundsfromoperationsisanon-GAAPmeasurethatrepresentsfundsgeneratedfromoperatingactivitiesbeforechanges innon-cashworkingcapital.Funds fromoperationsshouldnotbeconsideredanalternative to,ormoremeaningfulthan,cashflowfromoperatingactivities.ManagementusesfundsfromoperationstoanalyzeperformanceandconsidersitanindicationoftheCompany’sabilitytogeneratethecashnecessarytofundfuturecapitalinvestmentsandtorepaydebt.SeaDragon’sdeterminationoffundsfromoperationsmaynotbecomparabletothatreportedbyothercompaniesnorshoulditbeviewedasanalternativetocashflowfromoperatingactivities,netearningsorothermeasuresoffinancialperformancecalculated inaccordancewithCanadianGAAP.
18 SeaDragonEnergyInc. | 2010AnnualReport |MANAGEMENT’SDISCUSSION&ANALYSIS(PREPAREDINUS$)
MANAGEMENT’S DISCUSSION & ANALYSIS FOR THE THREE AND TWELVE MONTHS ENDED DECEMBER 31, 2010
RECONCiLiATiON OF CASH FLOw FROm OPERATiONS AND FUNDS FLOw FROm OPERATiONSTHREE mONTHS ENDED
DECEmBER 31TwELvE mONTHS ENDED
DECEmBER 31
$000’s2010 2009
(restated)2010 2009
(restated)
Cashfrom/(usedin)operatingactivities 526 20 (4,484) (2,450)
Less:changesinnon-cashworkingcapital 399 1,621 (6,092) 2,130
Fundsfrom/(usedin)operations 127 (1,601) 1,608 (4,580)
NETBACkNetbackisanon-GAAPmeasurethatrepresentssalesnetofalloperatingexpensesandgovernmentroyalties.ManagementbelievesthatnetbackisausefulsupplementalmeasuretoanalyzeoperatingperformanceandprovideanindicationoftheresultsgeneratedbytheCompany’sprincipalbusinessactivitiespriortothecon-siderationofotherincomeandexpenses.Managementconsidersnetbacksanimportantmeasureasitdem-onstrates theCompany’sprofitability relative tocurrentcommodityprices.Netbackmaynotbecomparabletosimilarmeasuresusedbyothercompanies.Seenetbackreconciliationscheduleundertheoutlooksectionbelow.
SEA DRAGON’S BUSINESS, STRATEGY AND OUTLOOkSEA DRAgON’S BUSiNESSSeaDragonisengagedinexploring,developingandoperatingoilandgasproperties,focusingprimarilyonNorthAfrica,WestAfricaandtheMiddle-East.CurrentlytheCompany’sactivitiesareconcentratedinEgypt,wheretheCompanyhasinterestsintwoconcessionswithshortandlong-termpotential.TheCompany’sstrategycallsforgainingentryintoothercountriesthatoffersignificantpotentialandopportunitiesthatwouldenhancethe Company’s growth within a reasonable timeframe. The Company intends to create shareholder valuethroughsignificantandrapidgrowthinproductionvolumes,cashflowandearnings.
Asaresultof largedemonstrations inEgyptbeginning inJanuary2011, thecountry’sPresidentresignedonFebruary11,2011andturnedoverallpowertoatransitionalgovernmenttointroducethenecessarypoliticalreformstowardsdemocracyandciviliangovernmentwithtransparentelections.Inaddition,theprimeministerofEgyptwhowaspreviouslyappointedbythePresidentresignedonMarch3,2011.ThedemonstrationshadaminimaleffectontheoperationsoftheCompanywiththeexceptionofminordelaysinmaterialsandpermitting.
SeaDragonbelievesEgypthasalonghistoryofcreatinganenvironmenttoattractandretainforeigninvestmentanddoesnotanticipateanyadversechangestotheconcessionagreementsgoverningbothNWGemsaandKomOmboandwillcontinuetoattempttoexpanditsassetbaseinEgyptandabroad.
STRATEgYIncrease shareholder value through growth in production, reserves and cash flow in the Company’s twoexistingconcessions.Afast-trackeddevelopmentprogramisinplace.Inaddition,theCompany’stwocurrentconcessionsofferworld-class,long-termexplorationopportunitieswithsignificantoil-in-placeresourcepotential.SeaDragonisalsocontinuingtosearchfor,identifyandevaluatenewandeconomicallyattractiveinvestments.
Acquire interestswithsignificantupsidepotential indiscovered,butundevelopedoilandnaturalgasassets.The Company’s growth strategy is based on working with established companies and identifying andnegotiating theacquisitionofassetswithhighgrowthpotential.Todate,SeaDragonhasacquired interestsin twodevelopmentconcessions inEgypt: theNWGemsaConcession(“NWGemsa”)andtheKomOmboConcession(“KomOmbo”).Eachconcessionofferscurrentproduction,developmentdrilling,andlonger-termexplorationopportunitiescreatingupsideforsignificantreservesgrowth.
MD
&A
19MANAGEMENT’SDISCUSSION&ANALYSIS(PREPAREDINUS$)
OUTLOOkTheCompany’sexpectedcapitalexpenditureprogramfor2011isapproximately$12.4million.
TheCompany’scapitalexpenditureprogramforKomOmboincludes,butisnotlimitedtothedrillingoftwoexplorationwells,fivedevelopmentwells,severalworkoversandafracturingprogram.
With respect toNWGemsa,during2011, theAlAmir SEfieldwill undergopressuremaintenance throughwaterinjectionandpreservationofassociatedgasandstrippingofhydrocarbonliquids.TheCompany’scapitalexpenditureprogramincludes,butisnotlimitedto,expandingtheproductionfacilities,buildinga20kmsixinchgasline,thedrillingofuptofourwaterinjectionwellsanduptotwodevelopmentwellsandthebuildingofgascompressionfacilities.
OPERATIONAL AND FINANCIAL HIGHLIGHTS:InaccordancewithCanadianindustrypractice,productionvolumesandrevenuesarereportedonaCompanyinterestbasis,beforedeductionofroyalties.
PRiOR qUARTER (1)
THREE mONTHS ENDED DECEmBER 31
TwELvE mONTHS ENDED DECEmBER 31
$000’s except per unit amounts2010 2009
(restated)2010 2009
(restated)
Operational
Oilsales 7,886 7,535 365 27,400 365
Royalties (4,212) (3,683) (186) (14,871) (186)
Operating (828) (1,267) (37) (3,423) (37)
Netback 2,846 2,585 143 9,106 143
Oilsales (bbl/d) 1,190 995 67 1,001 67
Brentoilprice(US$/bbl) 76.92 87.34 75.54 80.33 75.54
Realizedoilprice(US$/bbl) 72.01 82.34 73.20 75.02 73.20
Royalties(US$/bbl) 38.47 40.23 37.02 40.70 37.02
Operatingcosts(US$/bbl) 7.56 13.85 7.43 9.37 7.43
Netback(US$/bbl) 25.98 28.26 28.75 24.95 28.75
Capitalexpenditures 3,982 5,545 14,709 56,633 38,603(1) Three months ended September 30, 2010
PRODUCTiONProductionforthethreeandtwelvemonthsendedDecember31,2010averaged995bbl/dand1,001bbl/dcomparedto67bbl/dinthecomparativeperiodsand1,190bbl/dinthethreemonthsendedSeptember30,2010(the“PriorQuarter”).Theincreaseinproductionin2010ascomparedto2009isduetotheCompany’sacquisitionofNWGemsainDecember2009,thecompany’sacquisitionofKomOmboinlateApril2010,andthedrillingof11wells,8weredrilledinKomOmbo(4net)and3weredrilledinNWGemsa(0.3net)duringthetwelvemonthsendedDecember31,2010.AtthetimeofacquisitionofNWGemsa,theconcessionwasproducing2,200bbl/dgross(220bbl/dnet),whereasduringthethreemonthsendedDecember31,2010(the“Quarter”),productionaveragedapproximately7,220bbl/dgross(722bbl/dnet)andisexpectedtoexit2011inexcessof10,000bbl/dgross(1,000bbl/dnet).
20 SeaDragonEnergyInc. | 2010AnnualReport |MANAGEMENT’SDISCUSSION&ANALYSIS(PREPAREDINUS$)
MANAGEMENT’S DISCUSSION & ANALYSIS FOR THE THREE AND TWELVE MONTHS ENDED DECEMBER 31, 2010
PRiCiNgTheCompany isexposed to the volatility in commoditypricemarkets forallof itsproductionvolumesandchangesinforeignexchangeratebetweentheCanadianandUSdollarforcertaingeneralandadministrativeexpenses.Theabove tableoutlines thechanges in thevariousbenchmarkcommoditypricesandeconomicparameterswhichaffectthepricesreceivedfortheCompany’sproduction.
For the threeand twelvemonthsendedDecember31,2010 theCompanyreceived$82.34perbarreland$75.02perbarrel compared to theBrentOil price (“Brent”)of$87.34perbarreland$80.33perbarrel.TheCompanyreceivesa$3-5/bbldiscounttoBrentduetothequalityoftheoilproducedandacontracteddiscountedpriceleviedbytherefineries.
Oilpricesended2010higherthanwheretheystartedwithincreasedvolatilitysubsequenttoyearend.BrentrangedfromalowUS$88.92perbarreltoahighofUS$94.59perbarrelduringthethreemonthsendedDecember31,2010andfromalowofUS$69.55perbarreltoahighofUS$94.59perbarrelduringthetwelvemonthsendedDecember31,2010.Duetostrongeconomicgrowthinbothdevelopedandmoreimportantlyemergingmarkets,oildemandhasincreasedprovidingpricesupportforoilprices.RecentturmoilintheMiddleEasthasincreasedBrentpricestooverUS$110perbarrelasatthedateofthisMD&A.SeaDragonexpectspricestoremainvolatilethrough2011.Atthistime,SeaDragondoesnothedgeanyofitsproduction.
CRUDE OiL SALESPRiOR
qUARTERTHREE mONTHS ENDED
DECEmBER 31TwELvE mONTHS ENDED
DECEmBER 31
$000’s except per unit amounts2010 2009
(restated)2010 2009
(restated)
Oilsales 7,886 7,535 365 27,400 365
Perbbl 72.01 82.34 73.20 75.02 73.20
Crudeoil sales for the twelvemonthsendedDecember31,2010 increaseddue to theCompany’saverageproductionincreasingfrom67bbls/din2009to1,001bbls/din2010.
CrudeoilsalesforthethreemonthsendedDecember31,2010was$7.5millioncomparedto$7.9millioninthepriorthreemonthperiodendingSeptember30,2010.ForthethreemonthsendedDecember31,2010theincreaseinrevenueisattributabletoa13percentincreaseinrealizedsalespriceoffsetbya20percentdecreaseinsalesvolumes.
(0000’s)
ThreemonthsendedSeptember30,2010oilsales 7,886
Pricevariance 945
Productionvariance (1,296)
ThreemonthsendedDecember31,2010oilsales 7,535
R O Y A L T i E S THREE mONTHS ENDED
DECEmBER 31TwELvE mONTHS ENDED
DECEmBER 31
PRiOR qUARTER
2010 2009 (restated)
2010 2009 (restated)
Royalties 4,212 3,683 186 14,871 186
Perbbl 38.47 40.23 37.02 40.70 37.02
Royaltiesasapercentofrevenue(%) 54 49 51 54 51
MD
&A
21MANAGEMENT’SDISCUSSION&ANALYSIS(PREPAREDINUS$)
Royalties fluctuate in Egypt due to changes in the cost oil, whereby the Concession agreements allow forrecoveryofoperatingcostsandcapitalcosts throughareduction ingovernment takeashighlightedbelow:
CONCESSiONSEA DRAgON’S
wi (1)
COST OiL TO
CONTRACTOR (2)CAPiTAL COST RECOvERED (2)
OPERATiNg COST
RECOvERED (2)
ExCESS OiL TO
CONTRACTOR (3)
PROFiT OiL TO
CONTRACTOR (4)
NWGemsa 10% 30% 5years Immediate Nil 16.1%
KomOmbo 50% 40% 4years Immediate 21% 21%(1) WI denotes the Company’s Working interest
(2) Cost oil is the amount of oil revenue that is attributable to Sea Dragon and their joint venture partners (the “Contractor”) subject to the limitation of the cost recovery pool. Oil revenue, up to a specified percentage is available for recovery by the Contractor for costs incurred in exploring and developing the concession. Operating costs and capital costs are added to a cost recovery pool (the “Cost Pool”). Capital costs for exploration and development expenditures are amortized into the Cost Pool over a specified number of years with operating costs being added to the Cost Pool as incurred.
(3) If the available costs in the Cost Pool are less than the cost oil attributable to the Contractor, the shortfall, referred to as excess cost oil (“Excess Oil”), reverts 100% to the State in NW Gemsa and 21 percent to the Contractor in Kom Ombo.
(4) Profit oil is the amount of oil revenue that is attributable to Contractor
OPERATiNg COSTS
THREE mONTHS ENDED DECEmBER 31
TwELvE mONTHS ENDED DECEmBER 31
$000’s except per unit amountsPRiOR
qUARTER2010 2009
(restated)2010 2009
(restated)
Operatingcosts 828 1,267 37 3,423 37
Perbbl 7.56 13.85 7.43 9.37 7.43Operatingcostsforthethreeandtwelvemonthsendedwere$1.3million($13.85perbbl)and$3.4million($9.37perbbl)respectively.TheincreaseinoperatingcostsfromtheprioryearisduetotheacquisitionofKomOmbo.TheproducingfieldwithinKomOmbo,AlBaraka,hashigheroperatingcoststhantheproducingfiledwithinNWGemsaprimarilyduetohigherfixedcostsspreadoveralowerproductionbase.TheAlBarakafieldhasalargepercentageoffixedcostsandasproductionincreasesfromthefieldthecostperbarrelisexpectedtodecrease.Notwithstanding,theCompanycontinuestoworkwiththeoperatorofKomOmbotodecreasethecostofoperationsandmaximizeefficiencies.
CURRENT TAxES
THREE mONTHS ENDED DECEmBER 31
TwELvE mONTHS ENDED DECEmBER 31
$000’s except per unit amountsPRiOR
qUARTER2010 2009
(restated)2010 2009
(restated)
Currenttaxes 928 896 29 3,175 29
Taxesasapercentofrevenue(%) 12 12 8 12 8PursuanttothetermsofNWGemsaandKomOmboconcessionagreements,thecorporatetaxliabilityofthejointventurepartnersispaidbytheEgyptianGeneralPetroleumCorporation(the“EGPC”)forNWGemsaandbyGanoubElWadiPetroleumHoldingCompany(“Ganope”)forKomOmbo,outoftheprofitoilattributabletotheEGPCandGanope,andnotbytheCompany.ForaccountingpurposesthecorporatetaxespaidbytheEGPCandGanopearetreatedasabenefitearnedbytheCompany;theamountisincludedinnetoilrevenuesanddeductedasanincometaxexpense.
22 SeaDragonEnergyInc. | 2010AnnualReport |MANAGEMENT’SDISCUSSION&ANALYSIS(PREPAREDINUS$)
MANAGEMENT’S DISCUSSION & ANALYSIS FOR THE THREE AND TWELVE MONTHS ENDED DECEMBER 31, 2010
CAPiTAL ExPENDiTURES THREE mONTHS ENDED
DECEmBER 31TwELvE mONTHS ENDED
DECEmBER 31
$000’s PRiOR qUARTER2010 2009
(restated)2010 2009
(restated)
Propertyandequipmentexpen-ditures 3,982 5,545 14,709 12,132 9,743
Propertyandequipmentacquisition – – – 44,501 14,760
During the twelvemonths endedDecember31,2010, theCompany closed theacquisitionof KomOmboforapproximately$44.5million,drilled3wells (0.3net) inNWGemsaand8wells (4net) inKomOmbo.Inaddition, theCompanycompleteda475kmseismicprogramoveraportionofKomOmbo.Thecapitalprogramresultedintheadditionof6.9millionboeofprovedplusprobablereserves.DuringthethreemonthsendedDecember31,2009theCompanycompletedtheacquisitionofNWGemsa.
Thefollowingtableis thecumulativecostsforpropertyandequipmentonallof theCompany’soilandgasproperties:
DECEmBER 31 2010
DECEmBER 31 2009
(restated)
Oilandgasproperties,atcost 99,175 44,344
Accumulateddepletion (6,710) (102)
Accumulatedimpairmentofoilandgasproperties (29,996) (29,996)
62,469 14,246
Furnitureandequipment,atcost 369 134
Accumulateddepreciation (96) (24)
273 110
62,742 14,356
Kom Ombo Concession
OnApril29,2010,theCompanyclosedtheacquisitionofafiftypercent(50%)workinginterestintheKomOmboconcessionlocatedapproximately1,000kmsouthofCairoontheWestBankoftheNileRiverforatotalpurchasepriceofapproximately$44.5million.TheKomOmboconcessionisalargeexplorationblock(ap-proximately11,500Sq.Km)whichcontainstheAl-BarakaDevelopmentLeaseandseveralprospectsandleadswithpotentiallysignificantundiscoveredresources.
NW Gemsa Concession
OnDecember21,2009SeaDragonacquiredallofthecommonsharesofPremierOilEgypt(NWGemsa)B.V.(“POE”)forcashconsiderationof$14.8million.POE’smainassetwasa10percentworkinginterestintheNorthWestGemsaoilandgasconcessionintheArabRepublicofEgypt.TheresultsofPOE’soperationshavebeenincludedintheconsolidatedfinancialstatementssincethatdate.Revenues,expensesandcapitalexpen-dituresarisingbetweentheeffectiveJuly1,2009dateandtheclosingDecember21,2009datehavebeenrecognizedasadjustmentstothepurchase.SeaDragonprimarilyfundedtheacquisitionwiththeproceedsoftheprivateplacementthatclosedonNovember6,2009.
EWA Concession
During 2009 Sea Dragon assessed its exploration efforts on the East Wadi Araba Concession (the “EWAConcession”)inEgypt.Althoughhydrocarbonswerefoundtheyweredeterminedtobeuneconomic.ManagementdecidedthatgiventhelackofevidenceofoilmigrationintheareaandthefactithadfulfilleditsobligationundertheEWAconcessionagreement,theCompanydecidedthatnofurtherexplorationontheblockwouldbeundertaken.Consequently,in2009theCompanywroteoffapproximately$8.9millionofthecostsexceptforunuseddrillingmaterials.NoadditionalcapitalexpenditureswereincurredduringthetwelvemonthsendedDecember31,2010ontheEWAproperty.
MD
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23MANAGEMENT’SDISCUSSION&ANALYSIS(PREPAREDINUS$)
gENERAL AND ADmiNiSTRATivE COSTSTHREE mONTHS ENDED
DECEmBER 31TwELvE mONTHS ENDED
DECEmBER 31
$000’sPRiOR
qUARTER2010 2009
(restated)2010 2009
(restated)
Wagesandemployeecosts 496 642 183 2,083 779
Consultants 296 312 556 1,304 1,450
Travel 24 69 57 664 311
Officeexpense 107 573 200 828 702
Foreignoffices 178 32 – 479 –
Finance/banking 3 (58) 336 (335) 485
Total 1,106 1,570 1,332 5,023 3,726
Generalandadministrative(“G&A”)costsforthethreeandtwelvemonthsendedDecember31,2010were$1.6 million and $5.0 million, respectively, compared to $1.3 million and $3.8 million in the comparativeperiodsintheprioryear.Overall,G&Acostsincreasedduetoadditionalemployees,increasedtravel,andtheopeningofaCairoandParisoffice.Thecostincreasesarecommensuratewithincreasedactivityandthehiringofadditionalpersonnel.DuringthetwelvemonthsendedDecember31,2010,theCompanyrecordedanon-recurringreductioninG&Aforapproximately$0.4relatingtoareceivablewhichpreviouslywaswrittenoffandcollectedinfullduringtheyear.
STOCk BASED COmPENSATiONStock-basedcompensationexpenseistheamortizationoverthevestingperiodofthefairvalueofstockoptionsgrantedtoemployees,directorsandkeyconsultantsoftheCompany.Thefairvalueofalloptionsgrantedisestimatedusing theBlack-Scholesoptionpricingmodel.Thenon-cashcompensationexpense for the threemonthsandtwelvemonthsendedDecember31,2010,was$0.5millionand$1.3millionrespectively,comparedto$0.1millionand$0.4millioninthecomparativeperiodsintheprioryear.
DuringtheyeartheCompanygranted2.8millionoptionsthatvestoverthreeyearstoemployeesandofficersataweightedaveragepriceof$0.32CDN.Inaddition,theCompanygranted1.3millionoptionsthatvestimmediatelytodirectorsataweightedaveragepriceof$0.27CDN.
THREE mONTHS ENDED DECEmBER 31
TwELvE mONTHS ENDED DECEmBER 31
2010 2009 (restated)
2010 2009 (restated)
Riskfreerate (%) 2.19 2.42 2.23 2.58
Expectedlife(years) 5 5 5 5
Expectedvolatility(%) 117 147 125 155
Dividendpershare(%) – – – –
Weightedaveragefairvalue(CDN$) 0.22 0.45 0.26 0.26
24 SeaDragonEnergyInc. | 2010AnnualReport |MANAGEMENT’SDISCUSSION&ANALYSIS(PREPAREDINUS$)
MANAGEMENT’S DISCUSSION & ANALYSIS FOR THE THREE AND TWELVE MONTHS ENDED DECEMBER 31, 2010
DEPLETiON & DEPRECiATiON (“D&D”)THREE mONTHS ENDED
DECEmBER 31TwELvE mONTHS ENDED
DECEmBER 31
$000’s, except per unit amountPRiOR
qUARTER 20102009
(restated)2010 2009
(restated)
Depletion&depreciation 2,603 1,087 109 6,642 123
Perbbl 23.77 11.88 17.68 18.18 19.95
For the threeand twelvemonthsendedDecember31,2010,depletionanddepreciation (“D&D”)was$1.1millionand$6.6millionrespectively.TheincreaseinD&DonanabsolutebasisisduetoincreasedproductioninNWGemsaandthepurchaseofKomOmbo.ThesignificantdecreaseinD&Dfrompriorquarterisduetothesignificantprovenreserveadditionsin2010.Inthecomparativeperiods,theCompanyhadonly10daysofproduction.
NET LOSSForthethreeandtwelvemonthsendedDecember31,2010,theCompanyrecordedanetlossof$1.3millionand$6.2million respectively, compared toanet lossof$1.7millionand$14.1million in thecomparativeperiodsintheprioryear.
LIQUIDITY AND CAPITAL RESOURCESSHARE CAPiTALTheCompany’sauthorizedsharecapitalconsistsofanunlimitednumberofcommonsharesandanunlimitednumberofpreferredshares,issuableinoneormoreseries.ThecommonsharesofSeaDragontradeontheTSXVentureExchangeunderthesymbolSDX.
THREE mONTHS ENDED DECEmBER 31
TwELvE mONTHS ENDED DECEmBER 31
TRADiNg STATiSTiCSPRiOR
qUARTER 2010 2009 2010 2009
Low(CDN) $0.23 $ 0.23 $0.24 $ 0.23 $0.07
High(CDN) $0.32 $ 0.34 $0.56 $ 0.66 $0.56
Averagedailyvolume 1,208,179 1,179,394 1,038,076 1,207,256 595,359The following tablesummarizes theoutstandingcommonshares,warrantsandoptionsasatDecember31,2009,December31,2010andMarch25,2011.
OUTSTANDiNg AS ATmARCH 29
2011DECEmBER 31
2010DECEmBER 31
2009
Commonshares 376,459,358 376,459,358 206,131,405
Warrants 30,000,000 30,000,000 37,659,671
Options 13,250,000 13,250,000 9,816,666
AsatDecember31,2010theCompanyhad30.0millionwarrantswithanexercisepriceof$0.50CDNperwarrant.ThewarrantsexpireonNovember6,2012.
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25MANAGEMENT’SDISCUSSION&ANALYSIS(PREPAREDINUS$)
ThefollowingtablesummarizestheoutstandingoptionsasatDecember31,2010:
OUTSTANDiNg OPTiONS vESTED OPTiONS
ExERCiSE PRiCE RANgENUmBER OF
OPTiONSREmAiNiNg
CONTRACTUAL LiFENUmBER OF
OPTiONSREmAiNiNg
CONTRACTUAL LiFE
$0.00to$0.19 3,000,000 3.6years 999,998 3.6years
$0.20to$0.39 4,000,000 4.6years 1,250,000 4.7years
$0.40to$0.59 1,750,000 2.0years 650,002 1.9years
$0.60to$0.79 4,500,000 2.6years 3,266,664 2.6years
13,250,000 3.4years 6,166,664 3.1years
CAPiTAL RESOURCESAsatDecember31,2010theCompanyhadworkingcapitalofapproximately$15.7millionincludingcashonhandof$14.8million.TheCompanyexpectstofundits2011capitalprogramfromfundsfromoperationsandcashonhand.Theuseofnewfinancing,eitherdebtorequity,mayalsobeutilizedtofinanceotheropportunitiestoexpandtheCompany’sassetbase.
AsatDecember31,2010,theCompanyhad$6.1millioninaccountsreceivableoutstandingcomparedto$2.3millionasatDecember31,2009.Approximately$5.6millionisduefromtwoseparateentitiesbothofwhicharegovernmentcontrolledagenciesinEgyptforoilsalesandisexpectedtobereceivedinthenormalcourseofoperations.
Asevidencedbelow,SeaDragoncontinuedtohaveaccesstoequitymarketsinlate2009andearly2010inspiteofthedifficulteconomicconditionsandfinancialmarketvolatility:
• OnApril13,2010theCompanyconverted22.7millionspecialwarrantsthatwereissuedonJanuary25,2010.Eachspecialwarrantentitledtheholderthereoftoreceiveonecommonshareontheexerciseofthespecialwarrantfornoadditionalconsideration,subjecttoanadjustmentwherebyiftheCompanywasnotqualifiedtoissuethecommonsharesundertheoriginalofferingbyApril1,2010,eachwarrantwouldbe exercisable for1.05 common shares (the “Additional Shares”) for noadditional consideration. TheCompanyqualifiedtoissuethecommonsharesonApril13,2010andasaresultonApril13,2010,23.9millioncommonshareswereissuedupontheexerciseofthespecialwarrants.TheCompanyrecognizedanexpenseof$0.5millionfortheestimatedfairvalueoftheAdditionalSharesontheexerciseofthespecialwarrants.ThenetproceedstotheCompanywere$11.0million.
• OnApril19,2010,SeaDragoncompletedanissuanceof142.5millioncommonsharesonaboughtdealbasispursuanttoashortformprospectusfornetproceedstotheCompanyof$53.5million.
26 SeaDragonEnergyInc. | 2010AnnualReport |MANAGEMENT’SDISCUSSION&ANALYSIS(PREPAREDINUS$)
MANAGEMENT’S DISCUSSION & ANALYSIS FOR THE THREE AND TWELVE MONTHS ENDED DECEMBER 31, 2010
ThefollowingtableoutlinestheCompany’ssourcesandusesofcashforthethreeandtwelvemonthsendedDecember31,2010and2009.
THREE mONTHS ENDED DECEmBER 31
TwELvE mONTHS ENDED DECEmBER 31
$000’sPRiOR
qUARTER2010 2009
(restated)2010 2009
(restated)
Sources:
Fundsfromoperations 766 127 – 1,608 –
Proceedsfromissuanceofshares 49 87 13,885 64,638 13,931
Depositandrestrictedcash – – – 2,168 –
Restrictedcash – 310 4,388 310 9,336
Demandloan – – 283 – –
Convertibledebenture – – – 287 –
Effectofforeignexchangeoncashandcashequivalents 550 176 – – –
Changesinnon-cashworkingcapital – 399 1,621 – 2,130
Changesinnon-cashinvestingworkingcapital 1,174 747 – 6,501 –
2,539 1,846 20,177 75,512 25,397
Uses:
Fundsusedinoperations – – (1,601) – (4,580)
Capitalacquisitions – – – (44,501) (14,760)
Capitalexpenditures (3,982) (5,544) (14,709) (12,132) (9,743)
Depositandrestrictedcash – – (1,987) – (1,987)
Demandloan – – – – –
Effectofforeignexchangeoncashandcashequivalents – – (449) (35) (203)
Changesinnon-cashinvestingworkingcapital – – (1,268) – (5,789)
Changesinnon-cashworkingcapital (1,037) – – (6,092) –
(5,019) (5,544) (20,014) (62,760) (37,062)
Increase/(decrease)incash (2,480) (3,698) 163 12,752 (11,665)
Cashandcashequivalentsatbeginningofperiod 20,929 18,449 1,836 1,999 13,664
Cashandcashequivalentsatendofperiod 18,449 14,751 1,999 14,751 1,999
FiNANCiAL iNSTRUmENTSTheCompanyisexposedtofinancialrisksduetothenatureofitsbusinessandthefinancialassetsandliabilitiesthatitholds.Thefollowingdiscussionreviewsmaterialfinancialrisks,quantifiestheassociatedexposures,andexplainshowtheserisks,andtheCompany’scapital,aremanaged.
Market Risk
Changes incommoditypricesand foreigncurrencyexchange ratescanhavean impacton theCompany’searningsandvalueoffinancialassetsandliabilities.
Commodity Price Risk – Commoditypriceriskistheriskthatthefairvalueorfuturecashflowswillfluctuateasaresultofchangesincommodityprices.TheCompanyisexposedtocommoditypriceriskduetothenatureofitsbusiness.Oilpricesareimpactedbyglobalsupplyanddemand,aswellaspoliticalandotherfactors.
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TheCompanyreceivesworldoilpricesfor itsoilproductionwhichissubject topricefluctuations.Thepricereceivedforcrudeoilcanbeveryvolatileandcanundergosignificantchangesinrelativelyshorttimeperiods.DuringtheyearendedDecember31,2010theCompanyreceivedanaveragepriceof$75.02perbblcomparedtoanaverageBrentoilpriceof$80.33.Duringtheyear,thepriceofoilfluctuatedfromahighof$94.59perbbltoalowof$69.55perbbl.AsatDecember31,2010theCompanydidnothaveanyderivativecommoditypricecontractsinplace.
Foreign Currency Exchange Rate Risk - Foreignexchangerateriskistheriskthatthefairvalueoffuturecashflowswillfluctuateasaresultofchangesinforeignexchangerates.AstheeffectsofforeignexchangefluctuationsareembeddedintheCompany’sresults,thetotaleffectofforeignexchangefluctuationsarenotseparatelyidentifiable.ThereportingcurrencyoftheCompanyisUnitedStatesdollars(US$).SubstantiallyalloftheCompany’soperationsareinforeignjurisdictionsandasaresult, theCompanyisexposedtoforeigncurrencyexchangerateriskonsomeofitsactivitiesprimarilyonexchangefluctuationsbetweentheCanadiandollar (CDN$)and theUS$.Themajorityofcapitalexpendituresare incurred inUS$andoil revenuesarereceivedinUS$thereforetheCompany’sexposuretoforeignexchangeisreduced.
ThetablebelowshowstheCompany’sexposuretoforeigncurrenciesforitsfinancialinstruments:
AS AT DECEmBER 31, 2010 US$ EgP EUR CAD
TOTAL PER FS (1) US$ Equivalent
Cashandcashequivalents 14,751 9,955 6 22 4,768
Accountsreceivable 6,082 6,040 – 4 38
Accountspayableandaccruedliabilities (5,275) (4,881) – (24) (370)
Balancesheetexposure 15,558 11,114 6 2 4,436(1) denotes Financial Statements
US$ EgP EUR CAD
AS AT DECEmBER 31, 2009 TOTAL PER FS (1) US$ Equivalent
Cashandcashequivalents 1,999 840 5 – 1,154
Accountsreceivable 2,266 2,217 – – 49
Accountspayableandaccruedliabilities (1,014) (20) – – (994)
Balancesheetexposure 3,251 3,037 5 – 209(1) denotes Financial StatementsAthreepercentstrengtheningoftheUS$wouldresultinachangeinearningsasfollows:
AS AT DECEmBER 31, 2010 EgP EUR CAD
US$ Equivalent
Decreaseinearnings – – 133
Credit Risk
CreditriskistheriskofafinanciallosstotheCompanyifacounterpartytoafinancialinstrumentfailstomeetitscontractualobligationandarisesprincipallyfromjointventurepartnersandoilmarketers.TheCompanyisexposedtocreditriskinrespecttoitscashandcashequivalentsandaccountsreceivable.
CashandcashequivalentsareheldinoperatingaccountswithmajorinternationalbanksinCanada,EgyptandtheUnitedKingdom,andthereforetheCompanyconsiderstheseassetstohavenegligiblecreditrisk.
ThecarryingamountofcashandcashequivalentsandaccountsreceivablerepresentstheCompany’smaximumcreditexposure.
28 SeaDragonEnergyInc. | 2010AnnualReport |MANAGEMENT’SDISCUSSION&ANALYSIS(PREPAREDINUS$)
MANAGEMENT’S DISCUSSION & ANALYSIS FOR THE THREE AND TWELVE MONTHS ENDED DECEMBER 31, 2010
AtDecember31,2010theCompanyhadaccountsreceivableof$6.0millionofwhich92percentwasduefromtwoseparateentities,bothofwhicharegovernmentcontrolledagenciesinEgypt.AtDecember31,2009theCompanyhadaccountsreceivableof$2.3millionofwhich98percentwasduefromoneentity,whichisagovernmentcontrolledagencyinEgypt.TheCompanyexpectstocollecttheoutstandingreceivablesinthenormalcourseofoperations.
Accountsreceivableareanalyzedinthetablebelow.Therearenoindicationsasofthereportingdatethatthedebtorswillnotmeettheirpaymentobligations.
ACCOUNTS RECEivABLE AT DECEmBER 31, 2010
Totalaccountsreceivable 6,082
Aging:
0-60days 3,398
61-90days 633
Over90days 2,050
Liquidity Risk
LiquidityriskistheriskthattheCompanywillnotbeabletomeetitsfinancialobligationsastheybecomedue.TheCompany’sapproachtomanagingliquidityriskistoensure,totheextentpossible,thatitwillhavesufficientcashresourcestomeetitsliabilitieswhentheybecomedue.TheCompanymanagesitsriskofnotmeetingitsfinancialobligationsthroughmanagementofitscapitalstructure,annualbudgetingofitsrevenues,expendituresandcashflows.Onamonthlybasis,internalreportingofactualresultsiscomparedtothebudgetinordertomodifybudgetassumptions,ifnecessary,toensureliquidityismaintained.
TheCompanybelievesthatthecurrentworkingcapitalbalanceandcashflowfromoperationswillbeadequatetosupporttheCompany’sfinancialliabilitiesandcommitments.
AsofDecember31,2010,theCompany’sfinancialliabilitiesareduewithinoneyear.
Capital Management
TheCompanydefinesandcomputesitscapitalasfollows:
DECEmBER 31 2010
DECEmBER 31 2009
(restated)
ShareholderEquity 78,412 20,226
Workingcapital(1) (15,670) (3,267)
Totalcapital 62,742 16,959 (1) Working capital is defined as current assets less current liabilities.
TheCompany’sobjectivewhenmanagingitscapitalistoensureithassufficientcapitaltomaintainitsongoingoperations,pursuetheacquisitionofinterestsinproducingorneartoproductionoilandgaspropertiesandtomaintainaflexiblecapitalstructurewhichoptimizesthecostofcapitalatanacceptablerisk.TheCompanymanagesitscapitalstructureandmakesadjustmentstoit,basedonthefundsavailabletotheCompany,inordertosupporttheexplorationanddevelopmentofitsinterestsinitsexistingpropertiesandtopursueotheropportunities.
WorkingcapitalasatDecember31,2010of$15.7millionhasincreasedfromtheDecember31,2009balanceof$3.3millionprimarilyasaresultoftheCompanyraising$11.0millionand$53.5millionnetofrelatedcostsintwoprivateplacementsduringtheyearendedDecember31,2010(Note8).TheCompanyisnotsubjecttoexternallyimposedcapitalrequirements.
Financial Instruments
TheCompany’sfinancialinstrumentsasatDecember31,2010and2009werecomprisedofcashandcashequivalents,accountsreceivableandaccountspayableandaccruedliabilities.Thefairvalueoffinancialassetsandfinancialliabilitiesthatareincludedonthebalancesheetapproximatetheircarryingamountsduetotheirshorttermnature.
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29MANAGEMENT’SDISCUSSION&ANALYSIS(PREPAREDINUS$)
Level1–Quotedpricesareavailable inactivemarkets for identicalassetsor liabilitiesasof the reportingdate.Activemarketsarethoseinwhichtransactionsoccurinsufficientfrequencyandvolumetoprovidepricinginformationonanongoingbasis.
Level2–Pricing inputsareother thanquotedprices inactivemarkets included inLevel1.Pricesareeitherdirectlyor indirectlyobservableasof the reportingdate. Level2 valuationsarebasedon inputs, includingquotedforwardpricesforcommodities,timevalueandvolatilityfactorswhichcanbesubstantiallyobservedorcorroboratedinthemarketplace.
Level3–Valuationsinthislevelarethosewithinputsfortheassetorliabilitythatarenotbasedonobservablemarketdata.
TheCompanydoesnothaveanyfinancialderivativecontractsasatDecember31,2010.
Summary of Quarterly Results
FiSCAL YEAR 2010 2009
q4 q3 q2 q1 q4 q3 q2 q1
Financial $000’s (restated) (restated)
Cash,beginningofperiod 18,449 20,929 5,201 1,999 1,836 1,822 4,669 13,664
Cash,endofperiod 14,751 18,449 20,929 5,201 1,999 1,836 1,822 4,669
Workingcapital/(deficiency) 15,670 20,514 23,132 16,385 3,267 2,225 1,582 (7,447)
Fundsfrom/(usedin)operations 127 766 668 47 (1,601) (1,428) (917) (671)
pershare 0.00 0.00 0.00 0.00 (0.01) (0.01) (0.01) (0.00)
Netloss (1,294) (1,742) (1,352) (1,764) (1,717) (2,017) (977) (9,367)
pershare (0.00) (0.00) (0.00) (0.01) (0.01) (0.01) (0.01) (0.06)
Capitalexpenditures (5,545) (3,982) (140) (46,965) (14,709) (14,709) (531) (8,654)
Totalassets 83,687 83,210 83,011 35,089 21,240 8,023 9,152 21,347
Shareholders’Equity 78,412 79,108 83,049 31,513 20,226 7,644 8,806 8,956
Commonsharesoutstanding (000’s) 376,459 375,959 375,704 208,430 206,131 144,509 144,509 144,509
Warrantsoutstanding 30,000 30,000 30,255 32,185 37,660 9,088 9,282 9,282
Operational
Oilsales (bbl/d) 995 1,190 1,032 786 67 – – –
Brentoilprice($/bbl) 87.34 76.92 79.41 77.37 75.54 – – –
Realizedoilprice($/bbl) 82.34 72.01 75.83 68.68 73.20 – – –
Royalties($/bbl) 40.23 38.47 40.85 44.38 37.02 – – –
Operatingcosts ($/bbl) 13.85 7.56 10.37 5.02 7.43 – – –
Netback($/bbl) 28.26 25.98 24.62 19.28 28.75 – – –
Theincreaseinrevenueanddecreaseinnetlossfrom2008to2009isprimarilyduetotheacquisitionofNWGemsainDecember2009andadecreaseinwrite-offrelatingtotheEWAconcession.Theincreaseinrevenueanddecreaseinnetlossfrom2009to2010isprimarilyduetotheacquisitionofKomOmboinApril2010andinclusionoftheoperationsofNWGemsaforallof2010.
30 SeaDragonEnergyInc. | 2010AnnualReport |MANAGEMENT’SDISCUSSION&ANALYSIS(PREPAREDINUS$)
MANAGEMENT’S DISCUSSION & ANALYSIS FOR THE THREE AND TWELVE MONTHS ENDED DECEMBER 31, 2010
Thedecreaseintotalassetsfrom2008to2009isduetothewritedownoftheEWAproperty.Inaddition,during2009theCompanyusedproceedsofaprivateplacementtoacquiretheNWGemsaproperty.Theincreaseintotalassetsfrom2009to2010isaresultoftheCompanyraising$64.5millionthroughtwoshareissuancesandthesubsequentpurchaseoftheKomOmbopropertyinApril2010.
2010 2009 2008
Revenue 12,547 337 239
Netloss (6,152) (14,079) (17,934)
Netlosspershare (0.02) (0.09) (0.19)
Totalassets 83,687 21,240 24,346
Contractual obligations, commitments and contingenciesCONTRACTUAL OBLigATiON AND COmmiTmENTSPursuanttoconcessionagreementsinEgypt,theCompanyisrequiredtoperformcertainminimumexplorationactivities that include the drilling of explorationwells. These obligations have not been provided for in thefinancialstatements.
TheCompanyhasofficeleasecommitmentsinCalgary,ParisandCairo.
Thefollowingaretheanticipatedpaymentsunderthecontracts:
FiSCAL YEAR CONCESSiON
AgREEmENTS OFFiCE LEASES($000s)
TOTAL
2011 1,000 420 1,420
2012 – 397 397
2013 – 357 357
2014 – 357 357
2015 – 357 357
CONTiNgENCiESOnApril16,2010,astatementofclaim(the“Claim”)wasfiledintheprovinceofAlbertaagainsttheCompanyinwhichtheplaintiffsallege,amongotherthings,thattheactionsoftheCompanycontributedtotheplaintiffsnotbeingrecognizedfora25%interestintheEWAConcessionAgreement.Theplaintiffsseekinjunctionsanddamagesof$32.0millionascompensation.OnFebruary3,2011,theAlbertaCourtofQueen’sBenchgrantedanapplicationbytheCompanytostaytheCourtproceedingsinrespectofthisClaim,onthegroundsthattheClaimissubjecttoanarbitrationagreementandanarbitrationtribunalhaspreviouslybeenappointedtoadjudicatethesamesubjectmatterastheClaim.ThearbitrationhasitselfbeenstayedsinceApril2009,duetothefailurebytheplaintiffstopayadepositrequiredbythearbitrationtribunalforthearbitrators’feesandexpenses.
TheCompanybelievesthisClaimtobewithoutmeritandwillvigorouslydefenditselfagainsttheclaim.Asanassessmentofthelikelihoodoflossisindeterminableatthistime,noprovisionhasbeenmadeinthefinancialstatementsforthisclaim.Anysuchlosswillberecognizedintheperioditbecomeslikelytooccur.
CHANgES iN ACCOUNTiNg POLiCiES AND RECENT ACCOUNTiNg PRONOUNCEmENTS iNTERNATiONAL FiNANCiAL REPORTiNg STANDARDSOnJanuary1,2011InternationalFinancialReportingStandards (“IFRS”)willbecomethegenerallyacceptedaccounting principles in Canada. The adoption date of January 1, 2011 will require the restatement, forcomparativepurposes,ofamountsreportedbySeaDragonfortheyearendedDecember31,2010,includingtheopeningbalancesheetasatJanuary1,2010.TheprojecttoconverttoIFRSisbeingmanagedbyanin-houseteamofaccountingprofessionalswhohaveengagedinIFRSeducationalprogramsandcontinuetodeveloptheCompany’sadoptiontoIFRS.TheCompany’sauditorshavebeenandwillcontinuetobeinvolvedthroughouttheprocesstoensuretheCompany’spoliciesareinaccordancewiththesenewstandards.
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InJuly2009anamendmenttoIFRS1FirstTimeAdoptionofInternationalReportingStandardswasissuedthatappliestooilandgasassets.TheamendmentallowsanentitythatusedfullcostaccountingunderitspreviousGAAPtoelect,atitstimeofadoption,tomeasureexplorationandevaluationassetsattheamountdeterminedundertheentity’spreviousGAAPandtomeasureoilandgasassetsinthedevelopmentandproductionphasesbyallocatingtheamountdeterminedundertheentity’spreviousGAAPforthoseassetstotheunderlyingassetsproratausingreservevolumesorreservevaluesasofthatdate.IFRS1alsoprovidesanumberofotheroptionalexemptionsandmandatoryexceptionsincertainareastothegeneralrequirementforfullretrospectiveapplication.ManagementisanalyzingthevariousaccountingpolicychoicesavailableandwillimplementthosedeterminedtobethemostappropriatefortheCompanywhichotherthanthefullcostaccountingexemptionnotedaboveare:
BusinessCombinations–IFRS1wouldallowSeaDragontousetheIFRSrulesforbusinesscombinationsonaprospectivebasisratherthanre-statingallbusinesscombinations.
Share-basedpayments–IFRS1allowsSeaDragonanexemptiononIFRS2,“Share-BasedPayments”toequityinstrumentswhichvestedbeforeSeaDragon’transitiondatetoIFRS.
Cumulativetranslationdifferences–IFRS1allowsSeaDragontoresettheforeigncurrencytranslationreservetozeroatthetransitiondate.
SeaDragonanticipatesusingtheseexemptions.
The transition fromCanadianGAAP to IFRS issignificantandmaymateriallyaffect theCompany’s reportedfinancialpositionandresultsofoperations.Atthistime,SeaDragonhasidentifiedkeydifferencesthatwillimpactthefinancialstatementsandthecurrentstatusofthoseitems:
• ExplorationandEvaluation(“E&E”)expenditures–OntransitiontoIFRSSeaDragonwillre-classifyallE&EexpendituresthatarecurrentlyincludedinthePP&Ebalanceontheconsolidatedbalancesheet.Thiswillconsistofthebookvalueofundevelopedlandthatrelatestoexplorationproperties.E&Eassetswillnotbedepletedandmustbeassessedforimpairmentwhenindicatorsofimpairmentexist.
• Property,plantandequipment–TheCompanycurrentlycapitalizescostsofdevelopmentandproductionassetsthatmeetthedefinitionofanassetunderCanadianGAAPanddepletesthesecostsbycostcentre,whichisacountry,basedontotalprovedreserves.Under IFRS, theCompanyisanticipatingcalculatingthedepletionrateatthefieldlevel.OntransitiontoIFRSSeaDragonhastheoptiontobasethedepletioncalculation using either proved reserves or proved plus probable reserves. Sea Dragon is anticipatingcalculatingdepletionusingprovedplusprobablereserves.TheCompanycontinuestoassesstheimpactofthechanges.
• ImpairmentofPP&Eassets–UnderIFRS,impairmenttestsofPP&EmustbeperformedonspecificportionsofPP&E(“cashgeneratingunit”)asopposedtotheentirePP&EbalancewhichiscurrentlyrequiredundercurrentCanadianGAAPthroughthefullcostceilingtest.Impairmentcalculationswillbeperformedatthecashgeneratingunitlevelusingeithertotalprovedorprovedplusprobablereserves.SeaDragoniscurrentlydeterminingitscashgeneratingunitsforthepurposeofimpairmenttestingandanticipatesusingprovedplusprobablereservevaluesforimpairmenttests.
• Share based payments – The Company has determined the major differences from current CanadianGAAPthatwouldimpacttheCompanysuchastreatinggradedvestingawardsasmultipleseparateawardswithdifferentlivesandestimatingforfeitureratesinadvanceasopposedtorecognizingtheimpactwhenthe forfeiture occurs. The Company is currently performing the revised share-based payment expensecalculationsunderIFRS.
• DuetotherecentwithdrawaloftheexposuredraftonIAS12IncomeTaxesinNovember2009andtheissuanceoftheexposuredraftonIAS37Provisions,ContingentLiabilitiesandContingentAssetsinJanuary2010,ManagementisstilldeterminingtheimpactoftheserevisedstandardsonitsIFRStransition.
ThislistofareasimpactedbyIFRSshouldnotberegardedasacomprehensivelistofchangesthatwillresultfromthetransitiontoIFRS.TheCompanycontinuestomonitorthedevelopmentofstandards.
32 SeaDragonEnergyInc. | 2010AnnualReport |MANAGEMENT’SDISCUSSION&ANALYSIS(PREPAREDINUS$)
MANAGEMENT’S DISCUSSION & ANALYSIS FOR THE THREE AND TWELVE MONTHS ENDED DECEMBER 31, 2010
Inadditiontotheaccountingpolicydifferences,SeaDragon’stransitiontoIFRSwillimpacttheinternalcontrolsoverfinancialreporting,thedisclosurecontrolsandproceduresandinformationtechnology(“IT”)systemsasfollows:
Internalcontrolsoverfinancialreporting–BaseontheCompany’saccountingpoliciesunderIFRSSeaDragonhas assessed whether additional controls or changes in procedures are required. The Company does notconsiderthesechangestobesignificant.
ITSystems–SeaDragonhasassessedthereadinessofitsaccountingsoftwareandhasandcontinuestoassessothersystemrequirementsthatmaybeneededinordertoperformongoingcalculationsandanalysisunderIFRS.Thesechangesarenotconsideredtobesignificant.
Managementiscontinuingtofinalizeitsaccountingpoliciesandchoicesandiscontinuingwithitsdueprocessinregardstoinformationthatisdisclosed.Assuch,theCompanyiscurrentlyunabletoquantifythefullimpactonthefinancialstatementsofadoptingIFRShowever,theCompanyhasdisclosedcertainexpectationsabovebasedoninformationknowntodate.DuetoanticipatedchangestoIFRSandInternationalAccountingStandardspriortoSeaDragon’sadoptionof IFRS,certain itemsmaybesubject tochangebasedonnewfactsandcircum-stancesthatariseafterthedateofthisMD&A.
NEw ACCOUNTiNg PRONOUNCEmENTSAmendments to IFRS 7 – Financial Instruments: Disclosures – The amendments emphasize the interactionbetweenquantitativeandqualitativedisclosuresaboutthenatureandextentofrisksassociatedwithfinancialinstrumentsand is effective forannualperiodsbeginningonorafter July1,2011.SeaDragon is currentlyassessingtheimpactoftheseamendments.
IFRS9–FinancialInstruments–ThisisthefirststandardissuedaspartofawiderprojecttoreplaceIAS39–Financial Instruments: Recognition and Measurement. IFRS 9 simplifies the mixed measurement model andestablishestwoprimarymeasurementcategoriesforfinancialassets:amortizedcostandfairvalue.Thebasisofclassificationdependsontheentity’sbusinessmodelandcontractualcashflowcharacteristicsofthefinancialasset.TheguidanceinIAS39onimpairmentoffinancialassetsandhedgeaccountingcontinuestoapply.IFRS9alsoincludestherequirementsrelatedtotheclassificationandmeasurementoffinancialliabilities,andde-recognitionoffinancialassetsandliabilities.Guidanceonhowtomeasure thefairvalueandaccountingforderivativesembeddedinacontractthatcontainsahostthatisnotafinancialasset,remainthesameasIAS39.ThisstandardiseffectiveJanuary1,2013.
USE OF ESTimATESThepreparationofconsolidatedfinancialstatementsinconformitywithgenerallyacceptedaccountingprinciplesrequiresmanagementtomakeestimatesandassumptionsbasedoninformationavailableatthetime.Theseestimatesandassumptionsaffect the reportedamountsofassets,particularly the recoverabilityofaccountsreceivableandacquisitioncostsofpropertyandequipment.Estimatesandassumptionsalsoaffecttherecordingof liabilities and contingent liabilities at the date of the consolidated financial statements and the reportedamountsofrevenuesandexpensesduringthereportingperiod.Duetovariousfactorsaffectingfuturecostsandoperations,actualresultscoulddifferfrommanagement’sbestestimates.
PROPERTY AND EqUiPmENTInaccordancewithCICAAccountingGuideline16,theCompanyaccountsforexplorationanddevelopmentactivitiesunderthefull-costmethod.Allcostsassociatedwithoilandgaspropertyacquisition,explorationanddevelopmentarecapitalizedonacountry-by-countrycostcentrebasispendingdeterminationofthefeasibilityoftheproject.Costsincurredincludelicenseacquisitioncosts,materialsanddrillingcostsforbothproductiveand non-productive wells, geological and geophysical consulting fees and expenses related to explorationactivities.Ifanoilandgaspropertydevelopmentprojectissuccessful,therelatedexpenditureswillbedepletedandamortizedovertheestimatedlifeofthereservesonaunitofproductionbasis.Wherealicenseordeedofassignmentisrelinquished,aprojectisabandoned,orisconsideredtobeofnofurthercommercialvaluetotheCompany,therelatedcostswillbechargedtoearningsduringtheperiod.
MD
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33MANAGEMENT’SDISCUSSION&ANALYSIS(PREPAREDINUS$)
DEPRECiATiON, DEPLETiON AND imPAiRmENTCapitalizedcostswithineachcountrywillbedepletedanddepreciatedontheunit-of-productionmethodbaseduponestimatedprovedreserves,beforeroyalties,asdeterminedbyanindependentengineer.Forpurposesofthecalculation,oilandgasreservesandproductionwillbeconvertedtoequivalentvolumesofpetroleumbaseduponrelativeenergycontent.Depletionanddepreciation iscalculatedusing thecapitalizedcosts, includingestimatedassetretirementcosts,plustheestimatedfuturecoststobeincurredindevelopingprovedreserves,netofestimatedsalvagevalue.Costsofacquiringunprovedpropertiesareinitiallyexcludedfromthefullcostpoolandareassessedyearlytoascertainwhetherimpairmenthasoccurred.
Furnitureandfixturesaredepreciatedatdecliningbalanceratesof20to30percent.
TheCompanyappliesa“ceilingtest”annuallyandatinterimperiodswheneventsorcircumstancesmaycauseimpairmentsincetheendofthepreviousfiscalyeartoensurethatcapitalizedcostsdonotexceedtotalestimatedfuturenetrevenuesfromtheproductionofprovedreserveslesssiterestorationcostsandincometaxesdirectlyrelatedtofutureproduction.Anyreductioninvalueasaresultoftheceilingtestwillbechargedtooperationsasanimpairmentofoilandgasproperties.
Costcentresintheexplorationstageareassessedateachreportingdatetodeterminewhetheritislikelythatthenetcosts,inaggregate,mayberecoveredinthefuture.Costsconsideredunlikelytoberecoveredarechargedtoearningsduringtheperiod.
iNCOmE TAxESThedeterminationoftheCompany’sincomeandothertaxassetsorliabilitiesrequiresinterpretationofcomplexlawsandregulationsofteninvolvingmultiplejurisdictions.Alltaxfilingsaresubjecttoauditandpotentialreas-sessmentafterthelapseofconsiderabletime.Accordingly,theactualincometaxassetorliabilitymaydiffersignificantlyfromthatestimatedandrecorded.
BUSiNESS RiSk ASSESSmENTThereareanumberofinherentbusinessrisksassociatedwithoilandgasoperationsanddevelopment.Manyoftheserisksarebeyondthecontrolofmanagement.ThefollowingoutlinessomeoftheprincipalrisksandtheirpotentialimpacttotheCompany.
Political Risk
SeaDragonoperatesinEgyptwhichhasdifferentpolitical,economicandsocialsystemsthaninNorthAmericaandwhichsubject theCompanytoanumberofrisksnotwithin thecontrolof theCompany.Explorationordevelopmentactivitiesinsuchcountriesmayrequireprotractednegotiationswithhostgovernments,nationaloilcompaniesandthirdpartiesandarefrequentlysubjecttoeconomicandpoliticalconsiderationssuchastaxation,nationalization,expropriation,inflation,currencyfluctuations,increasedregulationandapprovalrequirements,corruption and the risk of actions by terrorist or insurgent groups, changes in laws andpolicies governingoperationsof foreign-basedcompanies,economicand legal sanctionsandotheruncertaintiesarising fromforeigngovernments,anyofwhichcouldadverselyaffecttheeconomicsofexplorationordevelopmentprojects.
Financial Resources
TheCompany’scashflowfromoperationsmaynotbesufficienttofunditsongoingactivitiesandimplementitsbusinessplans.FromtimetotimetheCompanymayenterintotransactionstoacquireassetsorthesharesofothercompanies.Dependingonthefutureexplorationanddevelopmentplans,theCompanymayrequireadditionalfinancing,whichmaynotbeavailableor, ifavailable,maynotbeavailableon favorable terms.Failure toobtain suchfinancingona timelybasis couldcause theCompany to forfeit its interest incertainproperties, miss certain acquisition opportunities and reduce or terminate operations. If the revenues fromtheCompany’sreservesdecreaseasaresultofloweroilpricesorotherwise,itwillimpactitsabilitytoexpendthenecessarycapitaltoreplaceitsreservesortomaintainitsproduction.Ifcashflowfromoperationsarenotsufficienttosatisfycapitalexpenditurerequirements,therecanbenoassurancethatadditionaldebt,equity,orassetdispositionswillbeavailabletomeettheserequirementsoravailableonacceptableterms.Inaddition,cashflowisinfluencedbyfactorswhichtheCompanycannotcontrol,suchascommodityprices,exchangerates,interestratesandchangestoexistinggovernmentregulationsandtaxandroyaltypolicies.
34 SeaDragonEnergyInc. | 2010AnnualReport |MANAGEMENT’SDISCUSSION&ANALYSIS(PREPAREDINUS$)
MANAGEMENT’S DISCUSSION & ANALYSIS FOR THE THREE AND TWELVE MONTHS ENDED DECEMBER 31, 2010
Exploration, Development and Production
The long-term success of Sea Dragon will depend on its ability to find, acquire, develop and commerciallyproduceoilandnaturalgasreserves.TheserisksaremitigatedbySeaDragonthroughtheuseofskilledstaff,focusingexplorationeffortsinareasinwhichtheCompanyhasexistingknowledgeandexpertiseoraccesstosuch expertise, using up-to-date technology to enhancemethods, and controlling costs tomaximize returns.Despitetheseefforts,oilandnaturalgasexplorationinvolvesahighdegreeofrisk,whichevenacombinationofexperience,knowledgeandcarefulevaluationmaynotbeabletoovercome.ThereisnoassurancethatSeaDragonwillbeabletolocatesatisfactorypropertiesforacquisitionorparticipationorthattheCompany’sexpen-dituresonfutureexplorationwillresultinnewdiscoveriesofoilornaturalgasincommercialquantities.Itisdifficulttoaccuratelyprojectthecostsofimplementinganexploratorydrillingprogramduetotheinherentuncertaintiesofdrillinginunknownformations,thecostsassociatedwithencounteringvariousdrillingconditionssuchasover-pressuredzones,toolslostintheholeandchangesindrillingplansandlocationsasaresultofpriorexploratorywellsoradditionalseismicdataandinterpretationsthereof.
Futureoilandgasexplorationmayinvolveunprofitableefforts,notonlyfromdrywells,butfromwellsthatareproductivebutdonotproducesufficientnetrevenuestoreturnaprofitafterdrilling,operatingandothercosts.Completionofawelldoesnotassureaprofitontheinvestmentorrecoveryofdrilling,completion,infrastructureandoperatingcosts.Inaddition,drillinghazardsand/orenvironmentaldamagecouldgreatlyincreasethecostsofoperationsandvariousfieldoperatingconditionsmayadverselyaffecttheproductionfromsuccessfulwells.Theseconditionsincludedelaysinobtaininggovernmentalapprovalsorconsents,shut-inofwellsresultingfromextremeweatherconditionsornaturaldisasters,insufficienttransportationcapacityorothergeologicalandmechanicalconditions.Aswell,approvedactivitiesmaybesubjecttolimitedaccesswindowsordeadlineswhichmaycausedelaysoradditionalcosts.Whilediligentwellsupervisionandeffectivemaintenanceoperationscancontributetomaximizingproductionratesovertime,productiondelaysanddeclinesfromnormalfieldoperatingconditionscannotbeeliminatedandcanbeexpectedtoadverselyaffectrevenueandcashflowlevelstovaryingdegrees.
The nature of oil and gas operations exposes SeaDragon to risks normally incident to the operation anddevelopmentofoilandnaturalgasproperties, includingencounteringunexpected formationsorpressures,blow-outs,andfires,allofwhichcouldresultinpersonalinjuries,lossoflifeanddamagetothepropertyoftheCompanyandothers.TheCompanyhasbothsafetyandenvironmentalpoliciesinplacetoprotectitsoperatorsandemployees,aswellastomeettheregulatoryrequirementsinthoseareaswhereitoperates.Inaddition,theCompanyhasliabilityinsurancepoliciesinplace,insuchamountsasitconsidersadequate.TheCompanywillnotbefullyinsuredagainstalloftheserisks,norareallsuchrisksinsurable.
Oil and Natural Gas Prices
ThepriceofoilandnaturalgaswillfluctuatebasedonfactorsbeyondtheCompany’scontrol.Thesefactorsincludedemandforoilandnaturalgas,marketfluctuations,thestabilityofregionalstate-ownedmonopoliestocontrolgasprices, theproximityandcapacityofoilandnaturalgaspipelinesandprocessingequipmentandgovernment regulations, including regulations relating to environmental protection, royalties, allowableproduction,pricing,importingandexportingofoilandnaturalgas.FluctuationsinpricewillhaveapositiveornegativeeffectontherevenuetobereceivedbytheCompany.
Reserve Estimates
Therearenumerousuncertainties inherent inestimatingquantitiesofoil,naturalgasandnaturalgasliquids,reservesandcashflows tobederived there from, includingmany factorsbeyond theCompany’scontrol. Ingeneral,estimatesofeconomicallyrecoverableoilandnaturalgasreservesandthefuturenetcashflowstherefromarebaseduponanumberof variable factorsandassumptions, suchashistoricalproduction from theproperties,productionrates,ultimatereserverecovery,timingandamountofcapitalexpenditures,marketabilityofoilandnaturalgas, royalty rates, theassumedeffectsof regulationbygovernmentalagenciesand futureoperatingcosts,allofwhichmayvaryfromactualresults.Allsuchestimatesaretosomedegreespeculative,andclassificationsofreservesareonlyattemptstodefinethedegreeofspeculationinvolved.Forthosereasons,estimatesoftheeconomicallyrecoverableoilandnaturalgasreservesattributabletoanyparticulargroupofproperties,classificationofsuchreservesbasedonriskofrecoveryandestimatesoffuturenetrevenuesexpectedtherefrompreparedbydifferentengineers,orbythesameengineersatdifferenttimes,mayvary.TheCompany’sactualproduction,revenuesanddevelopmentandoperatingexpenditureswithrespecttoitsreserveswillvaryfromestimatesthereofandsuchvariationscouldbematerial.
MD
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35MANAGEMENT’SDISCUSSION&ANALYSIS(PREPAREDINUS$)
Estimatesofprovedreservesthatmaybedevelopedandproducedinthefutureareoftenbaseduponvolumetriccalculations and upon analogy to similar types of reserves rather than actual production history. Estimatesbasedonthesemethodsaregenerallylessreliablethanthosebasedonactualproductionhistory.Subsequentevaluationofthesamereservesbaseduponproductionhistoryandproductionpracticeswillresultinvariationsintheestimatedreservesandsuchvariationscouldbematerial.
TheCompany’sactual futurenet cashflowsasestimatedby independent reserveengineerswill beaffectedbymanyfactorswhichinclude,butarenotlimitedto:actualproductionlevels;supplyanddemandforoilandnaturalgas;curtailmentsorincreasesinconsumptionbyoilandnaturalgaspurchasers;changesingovernmentalregulation;taxationchanges;thevalueoftheCanadiandollarandUS$;andtheimpactofinflationoncosts.
Actualproductionandcashflowsderivedtherefromwillvaryfromtheestimatescontainedintheapplicableengineeringreports.ThereservereportsarebasedinpartontheassumedsuccessofactivitiestheCompanyintendstoundertakeinfutureyears.Thereservesandestimatedcashflowstobederivedtherefromcontainedintheengineeringreportswillbereducedtotheextentthatsuchactivitiesdonotachievethelevelofsuccessassumedinthecalculations.
Reliance on Operators and Key Employees
TotheextenttheCompanyisnottheoperatorofitsoilandnaturalgasproperties,theCompanywillbedependentonsuchoperators for the timingofactivitiesrelated tosuchpropertiesandwill largely isunable todirectorcontroltheactivitiesoftheoperators.Inaddition,thesuccessoftheCompanywillbelargelydependentupontheperformanceofitsmanagementandkeyemployees.TheCompanyhasnokey-maninsurancepolicies,andthereforethereisariskthatthedeathordepartureofanymemberofmanagementoranykeyemployeecouldhaveamaterialadverseeffectontheCompany.
Government Regulations
The Company may be subject to various laws, regulations, regulatory actions and court decisions that canhave negative effects on theCompany.Changes in the regulatory environment imposed upon SeaDragoncouldadverselyaffect theabilityof theCompany toattain its corporateobjectives. The current exploration,developmentandproductionactivitiesoftheCompanyrequirecertainpermitsandlicensesfromgovernmen-talagenciesandsuchoperationsare,andwillbe,governedby lawsand regulationsgoverningexploration,developmentandproduction,laborlaws,wastedisposal,landuse,safety,andothermatters.TherecanbenoassurancethatalllicensesandpermitsthattheCompanymayrequiretocarryoutexplorationanddevelopmentofitsprojectswillbeobtainableonreasonabletermsoronatimelybasis,orthatsuchlawsandregulationwouldnothaveanadverseeffectonanyprojectthattheCompanymayundertake.
Environmental Factors
All phases of the Company’s operations are subject to environmental regulation in Egypt. Environmentallegislation is evolving in amannerwhich requires stricter standards and enforcement, increased fines, andpenaltiesfornon-compliance,morestringentenvironmentalassessmentsofproposedprojectsandaheighteneddegreeofresponsibilityforcompaniesandtheirofficers,directorsandemployees.
Insurance
TheCompany’sinvolvementintheexplorationforanddevelopmentofoilandnaturalgaspropertiesmayresultintheCompanyoritssubsidiaries,asthecasemaybe,becomingsubjecttoliabilityforpollution,blow-outs,propertydamage,personalinjuryorotherhazards.Priortodrilling,theCompanyortheoperatorwillobtaininsuranceinaccordancewithindustrystandardstoaddresscertainoftheserisks.However,suchinsurancehaslimitationsonliabilitythatmaynotbesufficienttocoverthefullextentofsuchliabilities.Inaddition,suchrisksmaynotinallcircumstancesbeinsurableor,incertaincircumstances,theCompanyoritssubsidiaries,asthecasemaybe,mayelectnottoobtaininsurancetodealwithspecificrisksduetothehighpremiumsassociatedwithsuchinsuranceorotherreasons.TheoccurrenceofasignificanteventthattheCompanymaynotbefullyinsuredagainst,ortheinsolvencyoftheinsurerofsuchevent,couldhaveamaterialadverseeffectontheCompany’sfinancialposition.
36 SeaDragonEnergyInc. | 2010AnnualReport |MANAGEMENT’SDISCUSSION&ANALYSIS(PREPAREDINUS$)
MANAGEMENT’S DISCUSSION & ANALYSIS FOR THE THREE AND TWELVE MONTHS ENDED DECEMBER 31, 2010
Regulatory Matters
TheCompany’soperationswillbesubjecttoavarietyoffederalandprovincialorstatelawsandregulations,includingincometaxlawsandlawsandregulationsrelatingtotheprotectionoftheenvironment.TheCompany’soperationsmayrequirelicensesfromvariousgovernmentalauthoritiesandtherecanbenoassurancethattheCompanywillbeabletoobtainallnecessarylicensesandpermitsthatmayberequiredtocarryoutplannedexplorationanddevelopmentprojects.
Operating Hazards and Risks
Exploration for natural resources involvesmany risks,which even a combination of experience, knowledgeand careful evaluation may not be able to overcome. Operations in which the Company has a direct orindirectinterestwillbesubjecttoallthehazardsandrisksnormallyincidentaltoexploration,developmentandproductionofresources,anyofwhichcouldresult inworkstoppages,damages topersonsorpropertyandpossibleenvironmentaldamage.
AlthoughtheCompanyhasobtainedliabilityinsuranceinanamountitconsidersadequate,thenatureoftheserisksissuchthatliabilitiesmightexceedpolicylimits,theliabilitiesandhazardsmightnotbeinsurable,ortheCompanymightnotelecttoinsureitselfagainstsuchliabilitiesduetohighpremiumcostsorotherreasons,inwhichevent theCompanycould incursignificantcosts thatcouldhaveamaterialadverseeffectuponitsfinancialcondition.
Repatriation of earnings
CurrentlytherearenorestrictionsontherepatriationfromEgyptofearningstoforeignentities.However,therecanbenoassurancethoserestrictionsonrepatriationofearningsfromEgyptwillnotbeimposedinthefuture.
Disruptions in Production
Otherfactorsaffectingtheproductionandsaleofoilandgasthatcouldresultindecreasesinprofitabilityinclude:(i)expirationorterminationofpermitsorlicenses,orsalespriceredeterminationsorsuspensionofdeliveries;(ii)futurelitigation;(iii)thetimingandamountofinsurancerecoveries;(iv)workstoppagesorotherlabordifficulties;(v)changesinthemarketandgeneraleconomicconditions,equipmentreplacementorrepair,fires,civilunrestorotherunexpectedgeologicalconditionsthatcanhaveasignificantimpactonoperatingresults.
Foreign Investments
All of theCompany’s oil investments are located outside ofCanada. These investments are subject to therisksassociatedwithforeigninvestmentincludingtaxincreases,royaltyincreases,re-negotiationofcontracts,currencyexchangefluctuationsandpoliticaluncertainty.SeaDragonwillbepaidinUSdollarsonitsoilandgassales.
AsoperationsareprimarilycarriedoutinUSdollars,themainexposuretocurrencyexchangefluctuationsistheconversiontoequivalentCanadianfundsforreportingpurposes.
Competition
TheCompanyoperatesinthehighlycompetitiveareasofoilandgasexploration,developmentandacquisitionwithasubstantialnumberofothercompanies, includingU.S.-basedand foreigncompaniesdoingbusinessinEgypt.TheCompanyfacesintensecompetitionfromindependent,technology-drivencompaniesaswellasfrombothmajorandotherindependentoilandgascompaniesinseekingoilandgasexplorationlicencesandproductionlicencesinEgypt;andacquiringdesirableproducingpropertiesornewleasesforfutureexploration.
TheCompanybelievesithassignificantin-countryrelationshipswithinthebusinesscommunityandgovernmentauthoritiesneededtoobtaincooperationtoexecuteprojects.
DiSCLOSURE CONTROLS AND PROCEDURESAstheCompanyisclassifiedasaVentureIssuerunderapplicableCanadiansecuritieslegislation,itisrequiredtofilebasicChiefExecutiveOfficerandChiefFinancialOfficerCertificates,which ithasdone for theyearendedDecember31,2010.TheCompanymakesnoassessmentrelatingtoestablishmentandmaintenanceofdisclosurecontrolsandproceduresandinternalcontrolsoverfinancialreportingasdefinedunderMultilateralInstrument52-109asatDecember31,2010.
37
FiNANCiALSTATEmENTS
38 SeaDragonEnergyInc. |2010AnnualReport
ManagementisresponsiblefortheConsolidatedFinancialStatements.
ManagementhaspreparedtheConsolidatedFinancialStatementsinaccordancewithaccountingprinciplesgenerallyacceptedinCanada.Ifalternativeaccountingmethodsexist,managementhaschosenthoseitdeemsmostappropriateinthecircumstances.Financialstatementsarenotprecisesincetheyincludecertainamountsbasedonestimatesandjudgments.ManagementhasensuredthattheConsolidatedFinancialStatementsarepresentedfairlyinallmaterialrespects.
TheBoardofDirectorsisresponsibleforreviewingandapprovingtheConsolidatedFinancialStatementsandManagement’sDiscussionandAnalysisand,primarilythroughitsAuditCommittee,ensuresthatmanagementfulfilsitsresponsibilitiesforfinancialreporting.
TheAuditCommitteeisappointedbytheBoardofDirectorsandiscomposedofindependentdirectors.ItreviewstheConsolidatedFinancialStatementsandtheexternalauditors’report.TheAuditCommitteealsoconsiders,forreviewbytheBoardofDirectorsandapprovalbytheshareholders,theengagementorreappointmentoftheexternalauditors.
PricewaterhouseCoopersLLP,theexternalauditors,haveauditedtheConsolidatedFinancialStatementsinaccordancewithauditingstandardsgenerallyacceptedinCanadaonbehalfoftheshareholders.
SaidArrata OlivierSerraChiefExecutiveOfficer ChiefFinancialOfficer
REPORT OF MANAGEMENT
39
FINA
NC
IAL
STATEMEN
TS
Independent Auditor’s Report To the Shareholders of Sea Dragon Energy Inc.:
WehaveauditedtheaccompanyingconsolidatedfinancialstatementsofSeaDragonEnergyInc.,whichcomprisethebalancesheetasatDecember31,2010andtheconsolidatedstatementsofoperationsanddeficit,comprehensivelossandcumulativeothercomprehensivelossandcashflowsfortheyearthenended,andtherelatednotesincludingasummaryofsignificantaccountingpolicies.
Management’s responsibility for the Consolidated Financial Statements
ManagementisresponsibleforthepreparationandfairpresentationoftheseconsolidatedfinancialstatementsinaccordancewithCanadiangenerallyacceptedaccountingprinciples,andforsuchinternalcontrolasmanagementdeterminesisnecessarytoenablethepreparationofconsolidatedfinancialstatementsthatarefreefrommaterialmisstatement,whetherduetofraudorerror.
Auditor’s responsibility
Ourresponsibilityistoexpressanopinionontheseconsolidatedfinancialstatementsbasedonouraudit.WeconductedourauditinaccordancewithCanadiangenerallyacceptedauditingstandards.Thosestandardsrequirethatwecomplywithethicalrequirementsandplanandperformtheaudittoobtainreasonableassuranceaboutwhethertheconsolidatedfinancialstatementsarefreefrommaterialmisstatement.
Anauditinvolvesperformingprocedurestoobtainauditevidenceabouttheamountsanddisclosuresintheconsolidatedfinancialstatements.Theproceduresselecteddependontheauditor’sjudgment,includingtheassessmentoftherisksofmaterialmisstatementoftheconsolidatedfinancialstatements,whetherduetofraudorerror.Inmakingthoseriskassessments,theauditorconsidersinternalcontrolrelevanttotheentity’spreparationandfairpresentationoftheconsolidatedfinancialstatementsinordertodesignauditproceduresthatareappropriateinthecircumstances,butnotforthepurposeofexpressinganopinionontheeffectivenessoftheentity’sinternalcontrol.Anauditalsoincludesevaluatingtheappropriatenessofaccountingpoliciesusedandthereasonablenessofaccountingestimatesmadebymanagement,aswellasevaluatingtheoverallpresentationoftheconsolidatedfinancialstatements.
Webelievethattheauditevidencewehaveobtainedinourauditsissufficientandappropriatetoprovideabasisforourauditopinion.
Opinion
Inouropinion,theconsolidatedfinancialstatementspresentfairly,inallmaterialrespects,thefinancialpositionofSeaDragonEnergyInc.asatDecember31,2010andtheresultsoftheiroperationsandtheircashflowsfortheyearthenendedinaccordancewithCanadiangenerallyacceptedaccountingprinciples.
Other matters
TheconsolidatedfinancialstatementsofSeaDragonEnergyInc.fortheyearendedDecember31,2009,wereauditedbyanotherauditorwhoexpressedanunmodifiedopiniononthosestatementsonApril29,2010.
Aspartofourauditofthe2010consolidatedfinancialstatements,wealsoauditedtheadjustmentsdescribedinNote4thatwereappliedtoretrospectivelychangethereportingcurrencyofthe2009consolidatedfinancialstatements.Inouropinion,suchadjustmentsareappropriateandhavebeenproperlyapplied.Wewerenotengagedtoaudit,review,orapplyanyprocedurestothe2009consolidatedfinancialstatementsofthecompanyotherthanwithrespecttotheadjustmentsand,accordingly,wedonotexpressanopinionoranyotherformofassuranceonthe2009consolidatedfinancialstatementstakenasawhole.
CharteredAccountantsCalgary,Alberta
March29,2011
AUDITOR’S REPORT
(THOUSANDSOFUNITEDSTATESDOLLARS)
40 SeaDragonEnergyInc. |2010AnnualReport
DECEmBER 31 2010
DECEmBER 31 2009
(restated Note 4)
Assets
Current
Cashandcashequivalents 14,751 1,999
Accountsreceivable(Note 5) 6,082 2,266
Prepaidexpenses 112 16
20,945 4,281
Restrictedcash (Note 15) – 310
Acquisitiondeposit(Note 6) – 2,006
Investment (Note 7) – 287
Propertyandequipment(Note 8) 62,742 14,356
83,687 21,240
Liabilities and Shareholders’ Equity
Liabilities
Current
Accountspayableandaccruedliabilities 5,275 1,014
Shareholders’ Equity
Commonshares (Note 9) 120,036 53,804
Warrants(Note 9) 4,122 5,392
Contributedsurplus (Note 9) 2,239 386
Accumulatedothercomprehensiveloss(Note 4) (8,296) (5,819)
Deficit (39,689) (33,537)
78,412 20,226
83,687 21,240
Basisofpresentation(Note 2)
Significantaccountingpolicies(Note 3)
Commitments (Note 11)
Contingency (Note 12)
See accompanying notes to the consolidated financial statements.
CONSOLIDATED BALANCE SHEETS
41
YEAR ENDED DECEmBER 31
2010
YEAR ENDED DECEmBER 31
2009
(restated Note 4)
Netlossfortheyear (6,152) (14,080)
Othercomprehensive(loss)/income
Foreignexchangeadjustment(loss)/gainonchangeinreportingcurrrency(Note 4) (2,477) 1,551
Comprehensivelossfortheyear (8,629) (12,529)
Cumulativeothercomprehensiveloss,beginningoftheyear (5,819) (7,370)
Othercomprehensive(loss)/income (2,477) 1,551
Cumulativeothercomprehensiveloss,endofyear (8,296) (5,819)
See accompanying notes to the consolidated financial statements.
YEAR ENDED DECEmBER 31
2010
YEAR ENDED DECEmBER 31
2009
(restated Note 4)
Revenue
Oilsales,netofroyalties 12,529 180
Interestincomeandother 18 157
12, 547 337
Expenses
Operating 3,423 37
Generalandadministrative 5,023 3,827
Foreignexchange(gain)/loss (1,343) 1,097
Stock-basedcompensation 1,317 371
Additionalshares (Note 9) 462 –
Impairmentofoilandgasproperties(Note 8) – 8,933
Depletionanddepreciation (Note 8) 6,642 123
15,524 14,388
Loss before income taxes (2,977) (14,051)
Incometaxes-current (Note 10) (3,175) (29)
Net loss for the year (6,152) (14,080)
Deficit, beginning of year (33,537) (19,457)
Deficit, end of year (39,689) (33,537)
Basicanddilutedlosspershare (0.02) (0.09)
Weightedaveragecommonsharesoutstanding(000’s) 326,252 153,717
(THOUSANDSOFUNITEDSTATESDOLLARS,EXCEPTPERSHAREDATA)
(THOUSANDSOFUNITEDSTATESDOLLARS)
CONSOLIDATED STATEMENTS OF OPERATIONS AND DEFICIT
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS AND ACCUMULATED OTHER COMPREHENSIVE LOSS
FINA
NC
IAL
STATEMEN
TS
(THOUSANDSOFUNITEDSTATESDOLLARS)
YEAR ENDED DECEmBER 31
2010
YEAR ENDED DECEmBER 31
2009
(restated Note 4)
Cash provided by (used in)
Operating activities
Netlossfortheyear (6,152) (14,080)
Noncashitems
Stock-basedcompensation 1,317 371
Depletionanddepreciation 6,642 123
Impairmentofoilandgasproperties – 8,933
Unrealizedexchange(gain)/loss (661) 73
Additionalshares 462 –
1,608 (4,580)
Netchangeinnon-cashworkingcapital (6,092) 2,130
(4,484) (2,450)
Financing activities
Proceedsfromissuanceofshares,netofcosts 64,638 13,931
64,638 13,931
Investing activities
Propertyandequipmentexpenditures (12,132) (9,743)
Propertyandequipmentacquisitions (44,501) (14,760)
Restrictedcash 310 9,336
Acquisitiondeposit 2,168 (1,987)
Investment–convertibledebenture 287 –
Changeinnon-cashworkingcapital 6,501 (5,789)
(47,367) (22,943)
Change in cash and cash equivalents 12,787 (11,462)
Effect of foreign exchange on cash and cash equivalents (35) (203)
Cash and cash equivalents, beginning of year 1,999 13,664
Cash and cash equivalents, end of year 14,751 1,999
Supplemental cash flow information
Interestpaid – 108
See accompanying notes to the consolidated financial statements.
42 SeaDragonEnergyInc. |2010AnnualReport
CONSOLIDATED STATEMENTS OF CASH FLOWS
NO
TES
43NOTESTOTHECONSOLIDATEDFINANCIALSTATEMENTS(EXPRESSEDINTHOUSANDSOFUNITEDSTATESDOLLARS)
NOTE 1 – DESCRIPTION OF BUSINESS
SeaDragonEnergyInc.anditswhollyownedsubsidiarieshereafterreferredtoasthe“Company”or“SeaDragon”is headquartered inCalgary,Alberta. The consolidated financial statementsof theCompanyasat and for thetwelvemonthsendedDecember31,2010and2009comprisetheCompanyanditswhollyownedsubsidiaries.TheCompanyisengagedintheexplorationforanddevelopmentandproductionofoilandnaturalgas.TheCompanyconductsmanyofitsactivitiesjointlywithothers;thesefinancialstatementsreflectonlytheCompany’sproportionateinterestinsuchactivities.TheCompany’sprinciplepropertiesarelocatedintheArabRepublicofEgypt.
TheCompanyislistedontheTorontoVentureStockExchange(TSX-V)andtradesunderthesymbolSDX.
NOTE 2 – BASIS OF PRESENTATION
TheauditedconsolidatedfinancialstatementsofSeaDragonhavebeenpreparedbymanagementinaccordancewithCanadiangenerallyacceptedaccountingprinciples.ThepreparationoffinancialstatementsinaccordancewithCanadiangenerallyacceptedaccountingprinciplesrequiresmanagementtomakeestimatesandassumptionsthataffectthereportedamountsofassetsandliabilitiesanddisclosureofcontingentassetsandliabilitiesatthedateofthefinancialstatementsandthereportedamountsofrevenueandexpensesduringthereportingperiod.Actualresultsmaydifferfromtheseestimates.Unlessotherwiseindicated,allfinancialamountsarereportedinthousandsofUnitedStatesdollars.
NOTE 3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a)Petroleumandnaturalgasproperties:
(i) Capitalizedcosts:
TheCompanyfollowsthefullcostmethodofaccountingforitspetroleumandnaturalgasproperties.Underthismethod,allcostsrelatedtotheexplorationfor,anddevelopmentof,oilandnaturalgasreservesarecapitalizedincostcentresonacountry-by-countrybasis.Costsincludeleaseacquisitioncosts,geologicalandgeophysicalexpenses,overheaddirectlyrelatedtoexplorationanddevelopmentactivities,andcostsofdrillingbothproductiveandnon-productivewells.Proceeds from thesaleofpropertiesareappliedagainstcapitalizedcosts,withoutanygainorlossbeingrealized,unlesssuchsalewouldsignificantlyaltertherateofdepletionanddepreciationby20percentormore.
(ii) Depletionanddepreciation:
Depletionofoilandnaturalgaspropertiesanddepreciationofproductionequipmentisprovidedbyusingtheunit-of-productionmethodbaseduponestimatedprovenoilandnaturalgasreserves,beforeroyalties,onacostcentrebasis.Thecostsofsignificantunevaluatedpropertiesandmajordevelopmentprojectsareexcludedfromcostssubjecttodepletion.Fordepletionanddepreciationpurposes,relativevolumes,beforeroyalties,ofoilandnaturalgasproductionandreservesareconvertedattheenergyequivalentconversionrateofsixthousandcubicfeetofnaturalgastoonebarrelofcrudeoil.
(iii)Assetretirementobligation(“ARO”):
Thefairvalueofthestatutory,contractualorlegalliabilityassociatedwiththeretirementandreclamationoftangiblelong-livedassetsisrecognizedwhenincurred.Theassetretirementcost,equaltotheestimatedfairvalueoftheARO,iscapitalizedaspartofthecostoftherelatedlong-livedasset.Assetretirementcostsforthecrudeoilassetsareamortizedusingtheunit-of-productionmethod.
(EXPRESSEDINTHOUSANDSOFUNITEDSTATESDOLLARS,EXCEPTPERSHAREAMOUNTSOROTHERWISENOTED)
FINA
NC
IAL
STATEMEN
TSNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2010 AND 2009
44 SeaDragonEnergyInc. |NOTESTOTHECONSOLIDATEDFINANCIALSTATEMENTS(EXPRESSEDINTHOUSANDSOFUNITEDSTATESDOLLARS)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2010 AND 2009
TheAROliabilitiesarecarriedontheConsolidatedBalanceSheetsattheirdiscountedpresentvalueandareaccretedovertimeforthechangeinpresentvalue,withtheaccretionchargeincludedindepreciation,depletionandaccretion.
Actualexpendituresincurredarechargedagainsttheaccumulatedobligation.
SeaDragondoesnothaveanyAROasthereisnolegalobligationfortheCompanyinEgypt.
(iv) Impairmenttests:
Infollowingthefullcostmethod,animpairmentlossisrecognizedwhenthecarryingamountofthepetroleumandnaturalgaspropertiesofacostcentreisnotrecoverableandexceedsitsfairvalue.Thecarryingamountsareassessedtobeunrecoverablewhenthesumoftheundiscountedcashflowsexpectedfromtheproductionofprovedreserves,thelowerofcostandmarketvalueofunprovedpropertiesandthecostofmajordevelopmentprojectsarelessthanthecarryingamountofthecostcentre.Indeterminingtheamountofimpairment,thecarryingamountofoilandgaspropertiescapitalizedinacostcentreiscomparedtothefairvalueoftheassociatedprovedandprobablereservesandthelowerofcostandmarketvalueofanyunprovedpropertieswhicharesubjecttoaseparatetestforimpairment.Indeterminingthefairvalueoftheprovedandprobablereserves,theCompanyusescashflowsbaseduponoilandgaspricesasquotedinthefuturesmarketwhereobtainable,adjustedforqualitydifferences,transportationandotherrelevantfactors.Thesecashflowsarethendiscountedusingarisk-freeinterestrate.Ifthecarryingvalueoftheoilandgaspropertiesisinexcessofitsfairvalue(the“ceilingtest”),theexcessischargedagainstearningsasadditionaldepletionanddepreciation.
(iv)Jointactivities:
TheCompanyconductssubstantiallyallofitsoilandgasexplorationandproductionactivitiesonajointbasis.ThesefinancialstatementsreflectonlytheCompany’sproportionateinterestinsuchactivities.
(b) Officefurnitureandequipment:
Depreciationofofficefurnitureandequipmentisbasedonestimatesofusefullivesandiscalculatedusingthedecliningbalancemethodatratesrangingfrom20percentto30percentperannum.
(c) Foreigncurrencytranslation:
TheCompanytranslatesforeigncurrencydenominatedmonetaryassetsandliabilitiesattheexchangerateineffectatthebalancesheetdateandnon-monetaryassetsandliabilitiesaretranslatedathistoricalexchangerates.Revenuesandexpensesaretranslatedattransactiondateexchangerates.Exchangegainsorlossesareincludedinthedeterminationofnetincomeasforeignexchangeloss/(gain).
(d) Revenuerecognition:
Revenuesassociatedwiththesaleofcrudeoilarerecordedwhentitlepassestothecustomer.RevenuesfromcrudeproductionfrompropertiesfromwhichtheCompanyhasaninterestwithotherproducersisrecognizedonthebasisoftheCompany’snetworkinginterest.
(e) Inventory:
Inventoriesofpetroleumproducts,comprisingofcrudeoilandcondensate,arevaluedatthelowerofcostandnetrealizablevalues.Costisdeterminedbaseduponactualoperating,transportationanddepletioncosts.
(f) Incometaxes:
TheCompanyusestheliabilitymethodtoaccountforincometaxes.Underthismethod,futureincometaxesarebasedonthedifferencebetweenassetsandliabilitiesreportedforfinancialaccountingpurposesfromthosereportedforincometax.Futureincometaxassetsandliabilitiesaremeasuredusingthesubstantivelyenactedtaxratesexpectedtoapply to taxable incomein theyears inwhichthetemporarydifferencesareexpectedtoberecoveredorsettled.TheCompany’scontractualarrangementsinforeignjurisdictionsstipulatethatincometaxesarepaidbytherespectivegovernmentoutofitsentitlementshareofproductionsharingoil.Suchamountsareincludedinincometaxexpenseatthestatutoryrateineffectatthetimeofproduction.
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45NOTESTOTHECONSOLIDATEDFINANCIALSTATEMENTS(EXPRESSEDINTHOUSANDSOFUNITEDSTATESDOLLARS)
(g) Persharedata:
Basicpershareamountsarecomputedbydividingnetlossfromoperationsbytheweightedaveragenumberof common shares outstanding for the year. Diluted per share amounts reflect the potential dilution thatcouldoccurifsecuritiesorothercontractstoissuecommonshareswereexercisedorconvertedtocommonshares.Thetreasurystockmethodisusedtodeterminethedilutiveeffectofstockoptionsandotherdilutiveinstruments.Underthetreasurystockmethod,onlyoptionsforwhichtheexercisepriceislessthanthemarketvalueimpactthedilutioncalculations.
(h) Cashandcashequivalents:
Cashandcashequivalentsarecomprisedofcash,termdepositsandotherhighlyliquidinvestmentswithanoriginalmaturityofthreemonthsorlessatthetimeofpurchase.
(j) Stock-basedcompensation:
TheCompanyuses the fairvaluemethod forvaluingstockoptionsgrantedasstock-basedcompensation.Under the fair valuemethod,a compensation cost ismeasuredat fair value for stockoptionsgrantedatthegrantdateandexpensedoverthevestingperiodwithacorrespondingincreasetocontributedsurplus.Upontheexerciseofthestockoptions,considerationpaidtogetherwiththeamountpreviouslyrecognizedascontributedsurplus,isrecordedasanincreasetosharecapital.
(j) Financialinstruments:
Allfinancialinstrumentsarerecordedinitiallyatestimatedfairvalueonthebalancesheetexceptforcertainrelatedpartytransactionsandclassifiedintooneoffivecategories:heldfortrading,heldtomaturity,availableforsale,loansandreceivablesandotherliabilities.Cashandcashequivalents,andinvestmentsareclassifiedasheld for tradingandmeasuredatestimated fair value.Accounts receivableareclassifiedas loansandreceivablesandmeasuredatamortizedcost.Accountspayableisclassifiedasotherliabilitiesandmeasuredatamortizedcost.
TheCompanymayenterintoderivativecontracts(commodityprice,interestrateorforeigncurrency)inordertomanagerisk.Derivativecontractsaremarked-to-marketateachreportingperiodwiththechangeinestimatedfairvaluerecordedasgainorlossinearnings.TheCompanydoesnotutilizederivativecontractsforspeculativepurposes,hasnotdesignatedanyderivativecontractsashedges,andhasnotrecordedanyassetsorliabilitiesasaresultofembeddedderivatives.
Theestimatedfairvalueofcashandcashequivalents,accountsreceivableandaccountspayableapproximatetheircarryingamountsduetotheirshorttermstomaturity.
NOTE 4 – CHANGES IN ACCOUNTING POLICIES
New Accounting Standards Adopted
OnJanuary1,2010,theCompanyadoptedthefollowingCanadianInstituteofCharteredAccountants(“CICA”)Handbooksections:
“Business Combinations”, Section 1582, which replaces the previous business combinations standard.The standard requires assets and liabilities acquired in a business combination, contingent consideration andcertainacquiredcontingenciestobemeasuredattheirfairvaluesasofthedateofacquisition.Inaddition,acquisi-tion-relatedandrestructuringcostsaretoberecognizedseparatelyfromthebusinesscombinationandincludedinthestatementofearnings.TheadoptionofthisstandardhashadnomaterialimpactontheaccountingtreatmentofbusinesscombinationsenteredintoafterJanuary1,2010.
46 SeaDragonEnergyInc. |NOTESTOTHECONSOLIDATEDFINANCIALSTATEMENTS(EXPRESSEDINTHOUSANDSOFUNITEDSTATESDOLLARS)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2010 AND 2009
“Non-ControllingInterests”,Section1602andConsolidatedFinancialStatements,Section1601wereissuedinDecember2008.Section1601establishes standards for thepreparationof consolidatedfinancial statements.Section 1602 provides guidance on accounting for a non-controlling interest in a subsidiary in consolidatedfinancialstatementssubsequenttoabusinesscombination.ThesestandardsareeffectiveonorafterthebeginningofthefirstannualreportingperiodbeginningonorafterJanuary2011withearlierapplicationpermitted.ThesestandardscurrentlydonotimpacttheCompanyasithasfullcontrollinginterestofallofitssubsidiaries.
Change in reporting currency and accumulated other comprehensive income
EffectiveJuly1,2010,theCompanychangeditsreportingandfunctionalcurrencyfromCanadiandollars(CDN$)toUnitedStatesdollars (US$),assignificantportionsof theCompany’srevenues,expensesandcashflowsaredenominatedinUS$.ThechangeinreportingcurrencyistobetterreflecttheCompany’sbusinessactivitiesandtoimproveinvestors’abilitytocomparetheCompany’sfinancialresultswithotherpubliclytradedbusinessesintheinternationaloilandgasindustry.PriortoJuly1,2010,theCompanyreporteditsannualandquarterlyconsolidatedbalancesheetsandtherelatedconsolidatedstatementsofoperationsandcashflows inCDN$. Inmaking thischange in reportingcurrency, theCompany followed the recommendationsof theEmerging IssuesCommittee(EIC)of theCanadianInstituteofCharteredAccountants(CICA),setout inEIC-130,TranslationMethodwhentheReportingCurrencyDiffersfromtheMeasurementCurrencyorthereisaChangeintheReportingCurrency.InaccordancewithEIC-130, thefinancial statements forall yearsandperiodspresentedhavebeen translatedintothenewreportingcurrencyusingthecurrentratemethod.Underthismethod,thestatementsofoperationsandcashflowstatementitemsforeachyearandperiodhavebeentranslatedintothereportingcurrencyusingtheaverageexchangeratesprevailingduringeachreportingperiod.Allassetsandliabilitieshavebeentranslatedusing theexchange rateprevailingat theconsolidatedbalancesheetsdates.Shareholders’equity transactionshavebeentranslatedusingtheratesofexchangeineffectasofthedatesofthevariouscapitaltransactions,whileshareholders’equitybalancesfromthetranslationareincludedasaseparatecomponentofothercomprehensiveincome.Allresultingexchangedifferencesarisingfromthetranslationareincludedasaseparatecomponentofothercomprehensive income.Allcomparativefinancial informationhasbeenrestatedtoreflect theCompany’sresultsas if theyhadbeenhistorically reported inUS$and theeffecton theconsolidatedfinancial statementsresultedinanaccumulatedandothercomprehensiveincomeadjustmentof$8.3millionasatJuly1,2010.
NOTE 5 – FINANCIAL RISK MANAGEMENT
TheCompanyisexposedtofinancialrisksduetothenatureofitsbusinessandthefinancialassetsandliabilitiesthatitholds.Thefollowingdiscussionreviewsmaterialfinancialrisks,quantifiestheassociatedexposures,andexplainshowtheserisks,andtheCompany’scapital,aremanaged.
a. Market Risk
ChangesinforeigncurrencyexchangeratescanhaveanimpactontheCompany’searningsandvalueoffinancialassetsandliabilities.
Foreign Currency Exchange Rate Risk - Foreignexchangerateriskistheriskthatthefairvalueoffuturecashflowswillfluctuateasaresultofchangesinforeignexchangerates.AstheeffectsofforeignexchangefluctuationsareembeddedintheCompany’sresults,thetotaleffectofforeignexchangefluctuationsarenotseparatelyidentifiable.ThereportingcurrencyoftheCompanyisUnitedStatesdollars(US$).SubstantiallyalloftheCompany’soperationsareinforeignjurisdictionsandasaresult,theCompanyisexposedtoforeigncurrencyexchangerateriskonsomeofitsactivitiesprimarilyonexchangefluctuationsbetweentheCanadiandollar(CDN$)andtheUS$.ThemajorityofcapitalexpendituresareincurredinUS$andoilrevenuesarereceivedinUS$thereforetheCompany’sexposuretoforeignexchangeisreduced.
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47NOTESTOTHECONSOLIDATEDFINANCIALSTATEMENTS(EXPRESSEDINTHOUSANDSOFUNITEDSTATESDOLLARS)
ThetablebelowshowstheCompany’sexposuretoforeigncurrenciesforitsfinancialinstruments:
AS AT DECEmBER 31, 2010 US$ EgP EUR CAD
TOTAL PER FS (1) US$ Equivalent
Cashandcashequivalents 14,751 9,955 6 22 4,768
Accountsreceivable 6,082 6,040 – 4 38
Accountspayableandaccruedliabilities (5,275) (4,881) – (24) (370)
Balancesheetexposure 15,558 11,114 6 2 4,436(1) denotes Financial Statements
US$ EgP EUR CAD
AS AT DECEmBER 31, 2009 (restated - note 4)
TOTAL PER FS (1) US$ Equivalent
Cashandcashequivalents 1,999 840 5 – 1,154
Accountsreceivable 2,266 2,217 – – 49
Accountspayableandaccruedliabilities (1,014) (20) – – (994)
Balancesheetexposure 3,251 3,037 5 – 209(1) denotes Financial StatementsAthreepercentstrengtheningoftheUS$wouldresultinachangeinearningsasfollows:
AS AT DECEmBER 31, 2010 EgP EUR CAD
US$ Equivalent
Decreaseinearnings – – 133
b. Credit Risk
CreditriskistheriskofafinanciallosstotheCompanyifacounterpartytoafinancialinstrumentfailstomeetitscontractualobligationandarisesprincipallyfromjointventurepartnersandoilmarketers.TheCompanyisexposedtocreditriskinrespecttoitscashandcashequivalentsandaccountsreceivable.
CashandcashequivalentsareheldinoperatingaccountswithmajorinternationalbanksinCanada,EgyptandtheUnitedKingdom,andthereforetheCompanyconsiderstheseassetstohavenegligiblecreditrisk.
The carrying amount of cash and cash equivalents and accounts receivable represents the Company’smaximumcreditexposure.
AtDecember31,2010theCompanyhadaccountsreceivableof$6.0millionofwhich92percentwasduefromtwoseparateentities,bothofwhicharegovernmentcontrolledagenciesinEgypt.AtDecember31,2009theCompanyhadaccountsreceivableof$2.3millionofwhich98percentwasduefromoneentity,whichisagovernmentcontrolledagencyinEgypt.TheCompanyexpectstocollecttheoutstandingreceivablesinthenormalcourseofoperations.
Accountsreceivableareanalyzedinthetablebelow.Therearenoindicationsasofthereportingdatethatthedebtorswillnotmeettheirpaymentobligations.
48 SeaDragonEnergyInc. |NOTESTOTHECONSOLIDATEDFINANCIALSTATEMENTS(EXPRESSEDINTHOUSANDSOFUNITEDSTATESDOLLARS)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2010 AND 2009
ACCOUNTS RECEivABLE AT DECEmBER 31, 2010
Totalaccountsreceivable 6,082
Aging:
0-60days 3,398
61-90days 633
Over90days 2,050
c. Liquidity Risk
LiquidityriskistheriskthattheCompanywillnotbeabletomeetitsfinancialobligationsastheybecomedue.TheCompany’sapproachtomanagingliquidityriskistoensure,totheextentpossible,thatitwillhavesufficientcashresourcestomeetitsliabilitieswhentheybecomedue.TheCompanymanagesitsriskofnotmeetingitsfinancialobligationsthroughmanagementofitscapitalstructure,annualbudgetingofitsrevenues,expendituresandcashflows.Onamonthlybasis,internalreportingofactualresultsiscomparedtothebudgetinordertomodifybudgetassumptions,ifnecessary,toensureliquidityismaintained.
TheCompanybelievesthatthecurrentworkingcapitalbalanceandcashflowfromoperationswillbeadequatetosupporttheCompany’sfinancialliabilitiesandcommitments.
AsofDecember31,2010,theCompany’sfinancialliabilitiesareduewithinoneyear.
d. Capital Management
TheCompanydefinesandcomputesitscapitalasfollows:
DECEmBER 31, 2010 DECEmBER 31, 2009 (restated - note 4)
ShareholderEquity 78,412 20,226
Workingcapital(1) (15,670) (3,267)
Totalcapital 62,742 16,959 (1) Working capital is defined as current assets less current liabilities.
TheCompany’sobjectivewhenmanagingitscapitalistoensureithassufficientcapitaltomaintainitsongoingoperations,pursuetheacquisitionofinterestsinproducingorneartoproductionoilandgaspropertiesandtomaintainaflexiblecapitalstructurewhichoptimizesthecostofcapitalatanacceptablerisk.TheCompanymanagesitscapitalstructureandmakesadjustmentstoit,basedonthefundsavailabletotheCompany,inordertosupporttheexplorationanddevelopmentofitsinterestsinitsexistingpropertiesandtopursueotheropportunities.
Working capital as at December 31, 2010 of $15.7 million has increased from the December 31, 2009balanceof$3.3millionprimarilyasaresultoftheCompanyraising$11.0millionand$53.5millionnetofrelatedcostsintwoprivateplacementsduringtheyearendedDecember31,2010(Note8).TheCompanyisnotsubjecttoexternallyimposedcapitalrequirements.
e. Financial Instruments
TheCompany’sfinancialinstrumentsasatDecember31,2010and2009werecomprisedofcashandcashequivalents,accountsreceivableandaccountspayableandaccruedliabilities.Thefairvalueoffinancialassetsandfinancialliabilitiesthatareincludedonthebalancesheetapproximatetheircarryingamountsduetotheirshorttermnature.
Level1–Quotedpricesareavailableinactivemarketsforidenticalassetsorliabilitiesasofthereportingdate.Activemarketsarethoseinwhichtransactionsoccurinsufficientfrequencyandvolumetoprovidepricinginformationonanongoingbasis.
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49NOTESTOTHECONSOLIDATEDFINANCIALSTATEMENTS(EXPRESSEDINTHOUSANDSOFUNITEDSTATESDOLLARS)
Level2–PricinginputsareotherthanquotedpricesinactivemarketsincludedinLevel1.Pricesareeitherdirectlyor indirectlyobservableasofthereportingdate.Level2valuationsarebasedoninputs, includingquotedforwardpricesforcommodities,timevalueandvolatilityfactorswhichcanbesubstantiallyobservedorcorroboratedinthemarketplace.
Level3–Valuationsinthislevelarethosewithinputsfortheassetorliabilitythatarenotbasedonobservablemarketdata.
TheCompanydoesnothaveanyfinancialderivativecontractsasatDecember31,2010.
NOTE 6– ACQUISITIONS
Kom Ombo
OnDecember31,2009,theCorporation,throughitswholly-ownedsubsidiary,SeaDragonEnergy(KomOmbo)Ltd., entered into a farmout agreement (“Agreement”) with Dana Gas Egypt (“DGE”) for the acquisition of afifty (50%)percentparticipating interest in theKomOmboConcession (“KomOmbo”) inEgypt foraggregateconsiderationof$44.5million.TheeffectivedateoftheKomOmboAcquisitionwasJuly1,2009.OnDecember30,2009theCompanytransferred$2.0milliontoitslawyertobeheldintrustasadepositfortheAgreement.
OnApril29,2010,substantiallyallconsiderationfortheacquisitionofKomOmbowaspaidtoDGE.
Thefollowingtablepresentsthepreliminaryallocationofthepurchasepricetotheacquiredassetsandliabilitiesassumed,basedonestimatesoffairvalue:
Consideration:
Cash 44,501
Allocatedto:
PropertyandEquipment 44,501
Theabove amounts are estimates,whichweremadebymanagement at the timeof the preparationof thesefinancialstatementsbasedoninformationavailable.Amendmentsmaybemadetotheseamountsasvaluessubjecttoestimatearefinalized.
North West Gemsa
OnDecember21,2009SeaDragonacquiredallofthecommonsharesofPremierOilEgypt(NWGemsa)B.V.(“POE”)forcashconsiderationof$14.8million.POE’smainassetwasa10percentworkinginterestintheNorthWestGemsaoilandgasconcessionintheArabRepublicofEgypt.TheresultsofPOE’soperationshavebeenincluded in theconsolidatedfinancial statements since thatdate.Revenues,expensesandcapitalexpendituresarisingbetweentheeffectiveJuly1,2009dateandtheclosingDecember21,2009datehavebeenrecognizedasadjustments to thepurchase. SeaDragonprimarily funded theacquisitionwith theproceedsof theprivateplacementthatclosedonNovember6,2009.
TheacquisitionhasbeenaccountedforusingthepurchasemethodwithSeaDragonastheacquirer.Thefollowingtablepresentstheallocationofthepurchasepricetotheacquiredassetsandliabilitiesassumed,basedonestimatesoffairvalue:
Accountsreceivable 1,908
Propertyandequipment 13,149
Accountspayableandaccruedliabilities (297)
14,760
50 SeaDragonEnergyInc. |NOTESTOTHECONSOLIDATEDFINANCIALSTATEMENTS(EXPRESSEDINTHOUSANDSOFUNITEDSTATESDOLLARS)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2010 AND 2009
NOTE 7 – INVESTMENT
On December 12, 2008, the Company purchased a $0.3 million convertible debenture issued by a privateCanadiancorporationwithajointventureinterestinanoilandgasconcessioninTheRepublicoftheCongo.OnJanuary22,2010,theCompanyreceivedfullpaymentoftheprincipalandinterestearnedtoJanuary22,2010.
NOTE 8 – PROPERTY & EQUIPMENT
DECEmBER 31 2010
DECEmBER 31 2009
(restated - note 4)
Oilandgasproperties,atcost 99,175 44,344
Accumulateddepletion (6,710) (102)
Accumulatedimpairmentofoilandgasproperties (29,996) (29,996)
62,469 14,246
Furnitureandequipment,atcost 369 134
Accumulateddepreciation (96) (24)
273 110
62,742 14,356
DuringyearendedDecember31,2010,theCompanycapitalized$0.7millionofgeneralandadministrativecostsrelatedtodevelopmentandproductionactivitiesinEgypt(2009-$0.6million).
AtDecember31,2010,expendituresassociatedwiththeCompany’sunprovenpropertiestotaling$20.1million(December31,2009–Nil)havebeenexcludedfromdepletion.Estimatedfuturedevelopmentcostsof$6.6million(December31,2009-$3.0million)havebeenincludedincostssubjecttodepletion.
In2009theCompanywroteoffapproximately$8.9millionofcostsrelatedtoEWAConcession.NoadditionalcapitalexpenditureswereincurredduringthetwelvemonthsendedDecember31,2010ontheEWAproperty.
The Company performed a ceiling test calculation at December 31, 2010 to assess the recoverable value ofpropertyandequipment,whichindicatednowritedownwasrequired.Thefuturecommoditypricesusedintheceiling testwerebasedon theDecember31,2010commodityprice forecastsof theCompany’s independentreserveengineersadjustedfordifferentialsspecifictotheCompany’sreserves.ThefollowingtablesummarizesthefuturebenchmarkpricestheCompanyusedintheceilingtest.
BRENT REFERENCE PRiCE iNFLATiON RATES LPg PRiCE gAS PRiCE
YEAR (US$/Bbl) % Year (US$/Bbl) (US$/Mcf)
2011 90.15 2.0 54.15 1.00
2012 88.98 2.0 54.14 1.00
2013 88.49 2.0 54.15 1.00
2014 90.20 3.0 55.39 1.00
2015 92.04 2.0 56.52 1.00
Thereafter +2.0%/Year +2.0%/Year +2.0%/Year 1.00
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51NOTESTOTHECONSOLIDATEDFINANCIALSTATEMENTS(EXPRESSEDINTHOUSANDSOFUNITEDSTATESDOLLARS)
NOTE 9 – SHARE CAPITAL
a. Authorized
TheCompany is authorized to issueunlimited common shareswith no-par valueandunlimitedpreferredshareswithno-parvalue.
b. Common shares
2010 2009
DECEmBER 31NUmBER OF SHARES
(000`s) AmOUNTNUmBER OF SHARES
(000`s)AmOUNT
(restated - note 4)
Balance, beginning of year 206,131 53,804 144,509 44,269
Warrantsexercised 3,461 908 – 430
Optionsexercised 500 88 – –
Conversionofspecialwarrants,netofshareissuancecosts 23,867 11,005 – –
Privateplacement,netofissuancecosts 142,500 53,497 60,000 8,923
Transferfromexerciseofwarrants – 657 1,622 183
Transferfromexerciseofoptions – 77 – –
Balance, end of year 376,459 120,036 206,131 53,804
DuringtheyearendedDecember31,2010theCompanyissued3.5millioncommonsharesupontheexerciseofwarrantsatanaveragepriceof$0.35CDNpercommonsharefortotalproceedsonexerciseof$0.9million.
DuringtheyearendedDecember31,2010theCompanyissued0.5millioncommonsharesupontheexerciseofstockoptionsatanaveragepriceof$0.18CDNpercommonsharefortotalproceedsonexerciseof$88.
OnApril13,2010theCompanyconverted22.7millionspecialwarrants thatwereissuedonJanuary25,2010.Eachspecialwarrantentitledtheholderthereoftoreceiveonecommonshareontheexerciseofthespecialwarrantfornoadditionalconsideration,subjecttoanadjustmentwherebyif theCompanywasnotqualifiedto issuethecommonsharesunder theoriginalofferingbyApril1,2010,eachwarrantwouldbeexercisablefor1.05commonshares(the“AdditionalShares”)fornoadditionalconsideration.TheCompanyqualified to issue the common sharesonApril 13,2010andasa result onApril 13,2010,23.8millioncommonshareswereissuedupontheexerciseofthespecialwarrants.TheCompanyrecognizedanexpenseof$0.5millionfortheestimatedfairvalueoftheAdditionalSharesontheexerciseofthespecialwarrants.ThenetproceedstotheCompanywere$11.0million.
OnApril19,2010theCompanycompletedanissuanceof142.5millioncommonsharesonaboughtdealbasispursuanttoashortformprospectusatapriceof$0.40CDNpercommonsharefornetproceedstotheCompanyof$53.5million.ProceedsofthisofferingwereusedtopaythebalanceoftheconsiderationduefortheacquisitionofafiftypercentparticipatinginterestintheKomOmboConcession(Note5).
ThroughouttheyearendedDecember31,2009theCompanyissued1.6millionsharesupontheexerciseof 1.6 million warrants at an average price of $0.29 CDN per share for total proceeds on exercise of$0.2million.
52 SeaDragonEnergyInc. |NOTESTOTHECONSOLIDATEDFINANCIALSTATEMENTS(EXPRESSEDINTHOUSANDSOFUNITEDSTATESDOLLARS)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2010 AND 2009
OnNovember6,2009theCompanycompletedaprivateplacementandissued60millionUnitsfor$0.25CDNperunit.Eachunitconsistedofonecommonshareandonehalfwarrant.OnefullwarrantisconvertibleintoonecommonshareofSeaDragonEnergyInc.atapriceof$0.50CDNpershareuntiltheexpirydateofNovember6,2012.Proceedsoftheplacementwere$13.3million,netofcosts.Thefairvalueofthewarrantswasestimatedtobe$4.4millionor$0.15CDNperfullwarrantbasedontherelativefairvalueofacommonshareandafullwarrantusingtheBlackScholespricingmodelwiththefollowingassumptions:averageriskfreerate–2%,expectedlife–3years,expectedvolatilityrate-159%andexpecteddividendyieldof0.00%.DirectorsandOfficersoftheCompanypurchased1.5millionunitsofthisoffering.
c. Stock option plan
2010 2009
STOCk OPTiONS
NUmBER OF OPTiONS
(000’s)
wEigHTED AvERAgE ExERCiSE PRiCE
(CDN)
NUmBER OF OPTiONS
(000’s)
wEigHTED AvERAgE ExERCiSE PRiCE
(CDN)
Outstanding,beginningofyear 9,817 $0.42 4,700 $0.60
Granted 4,000 $0.31 5,250 $0.29
Exercised (500) $0.18 – –
Forfeited (67) $0.60 (133) $0.60
Outstanding,endofyear 13,250 $0.40 9,817 $0.42
Exercisable,endofyear 6,167 $0.43 1,500 $0.43
ThefollowingsummarizesdetailsabouttheCompany’sstockoptionsasatDecember31,2010:
OUTSTANDiNg OPTiONS vESTED OPTiONS
ExERCiSE PRiCE RANgENUmBER OF
OPTiONS
REmAiNiNg CONTRACTUAL
LiFENUmBER OF
OPTiONSREmAiNiNg
CONTRACTUAL LiFE
$0.00to$0.19 3,000,000 3.6years 999,998 3.6years
$0.20to$0.39 4,000,000 4.6years 1,250,000 4.7years
$0.40to$0.59 1,750,000 2.0years 650,002 1.9years
$0.60to$0.79 4,500,000 2.6years 3,266,664 2.6years
13,250,000 3.4years 6,166,664 3.1years
DuringtheyeartheCompanygranted2.7millionoptionsthatvestoverthreeyearstoemployeesandofficersataweightedaveragepriceof$0.32CDN.Inaddition,theCompanygranted1.3millionoptionsthatvestimmediatelytodirectorsataweightedaveragepriceof$0.27CDN.
TheweightedaverageassumptionsandresultantfairvaluesforstockoptionsgrantedduringtheyearsendedDecember31,2010and2009wereasfollows:
2010 2009
RiskFreeRate(%) 2.23 2.58
ExpectedLife (years) 5 5
ExpectedVolatility(%) 125 155
DividendperShare(%) – –
WeightedAverageFairValue(CDN$) 0.26 0.26
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53NOTESTOTHECONSOLIDATEDFINANCIALSTATEMENTS(EXPRESSEDINTHOUSANDSOFUNITEDSTATESDOLLARS)
d. Warrants ThefollowingsharepurchasewarrantswereoutstandingasatDecember31,2010:
2010 2009
NUmBER OF wARRANTS
(000s)ExERCiSE PRiCE
(CDN)
NUmBER OF wARRANTS
(000s)ExERCiSE PRiCE
(CDN)
Outstanding,beginningofyear 37,659 $0.49 9,281 $0.41
Issued – $0.34 30,000 $0.50
Exercised (3,461) (1,622) $0.29
Expired (4,198) $0.53 – –
Outstandingandexercisable,endofyear 30,000 $0.50 37,659 $0.49
DECEmBER 31 20102009
(restated - note 4)
Balance,beginningofyear 5,392 1,217
Fairvalueofwarrantsissued – 4,357
Transfertocommonsharesonexerciseofwarrants (657) (182)
Transfertocontributedsurplusonexpirationofwarrants (613) –
Balance,endofyear 4,122 5,392
OnMarch2,2010 theCompany informedholdersof certainoutstandingwarrants thatearly terminationprovisionswerebeingexercisedbytheCompanyandthewarrantswouldexpirewithin30daysofsuchnotice.OnApril1,2010,1.0millionunexercisedwarrantsexpired.
e. Contributed surplus
DECEmBER 312010 2009
(restated - note 4)
Balance,beginningofyear 386 15
Stock-basedcompensationexpense 1,317 371
Transferonexpirationofwarrants 613 –
Transferonexerciseofoptions (77) –
Balance,endofyear 2,239 386
NOTE 10 – FUTURE INCOME TAXES
ThefollowingincometaxassetsatDecember31,2010and2009arecomprisedofthetaxeffectoftemporarydifferencesasfollows:
2010 2009 (restated - note 4)
Differencesrelatedto:
Propertyandequipment 6,084 3,068
Non-capitallosses 4,830 5,422
Shareissueexpenses 1,359 692
Unrealizedforeignexchangelosses – 55
12,273 9,237
Valuationallowanceforfutureincometaxassets (12,273) (9,237)
Futureincometaxasset – –
54 SeaDragonEnergyInc. |NOTESTOTHECONSOLIDATEDFINANCIALSTATEMENTS(EXPRESSEDINTHOUSANDSOFUNITEDSTATESDOLLARS)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2010 AND 2009
TheCompanyhasnon-capitallossesof$19.3millionthatexpirebetween2026and2030.
Pursuant tothetermsofNWGemsaandKomOmboconcessionagreements, thecorporatetax liabilityof thejointventurepartnersispaidbytheEgyptianGeneralPetroleumCorporation(the“EGPC”)forNWGemsaandbyGanoubElWadiPetroleumHoldingCompany(“Ganope”)forKomOmbo,outoftheprofitoilattributabletotheEGPCandGanope,andnotbytheCompany.ForaccountingpurposesthecorporatetaxespaidbytheEGPCandGanopearetreatedasabenefitearnedbytheCompany;theamountisincludedinnetoilrevenuesanddeductedasanincometaxexpense.
IncometaxesvaryfromtheamountthatwouldbecomputedbyapplyingtheCanadianstatutoryincometaxrateof28.0%(2009–29.5%)toincomebeforetaxesasfollows:
2010 2009 (restated - note 4)
Lossbeforeincometaxes (2,977) (16,056)
Canadianstatutoryincometaxrate 28.0% 29.5%
Expectedincometaxes(recovery) (834) (4,737)
Adjustments:
Stockbasedcompensation 369 118
Changeinvaluationallowance,netofforeignexchange 2,017 4,061
Foreigntaxratedifferential 983 703
Expensesincurredwithnorecognizedtaxbenefit 1,492 –
Changeinincometaxratesandcertaintaxbalances (668) –
Other (184) (116)
Currentincometaxes 3,175 29
NOTE 11 – COMMITMENTS
Pursuant toconcessionagreements inEgypt, theCompany is required toperformcertainminimumexplorationactivitiesthatincludethedrillingofexplorationwells.Theseobligationshavenotbeenprovidedforinthefinancialstatements.
TheCompanyhasofficeleasecommitmentsinCalgary,ParisandCairo.Thefollowingaretheanticipatedpaymentsunderthecontracts:
FiSCAL YEAR CONCESSiON AgREEmENTS OFFiCE LEASES TOTAL
2011 1,000 420 1,420
2012 – 397 397
2013 – 357 357
2014 – 357 357
2015 – 357 357
SeaDragonmayberequiredtoprovideaLetterofGuarantee(“Letter”)notexceeding$4.5millionfortheKomOmboconcessionthatwillsecureitsshareoftheconcessionworkcommitment.TheLetterhasnotyetbeenissuedandhasnotbeenprovidedforinthefinancialstatements.
NO
TES
55NOTESTOTHECONSOLIDATEDFINANCIALSTATEMENTS(EXPRESSEDINTHOUSANDSOFUNITEDSTATESDOLLARS)
NOTE 12 – CONTINGENCY
OnApril16,2010,astatementofclaim(the“Claim”)wasfiledintheprovinceofAlbertaagainsttheCompanyinwhich theplaintiffsallege,amongother things, that theactionsof theCompanycontributed to theplaintiffsnotbeingrecognizedfora25%interest in theEWAConcessionAgreement.Theplaintiffsseekinjunctionsanddamagesof$32.0millionascompensation.OnFebruary3,2011,theAlbertaCourtofQueen’sBenchgrantedanapplicationbytheCompanytostaytheCourtproceedingsinrespectofthisClaim,onthegroundsthattheClaimissubjecttoanarbitrationagreementandanarbitrationtribunalhaspreviouslybeenappointedtoadjudicatethesamesubjectmatterastheClaim.ThearbitrationhasitselfbeenstayedsinceApril2009,duetothefailurebytheplaintiffstopayadepositrequiredbythearbitrationtribunalforthearbitrators’feesandexpenses.
TheCompanybelieves thisClaimtobewithoutmeritandwillvigorouslydefend itselfagainst theclaim.Asanassessmentof the likelihoodof loss is indeterminableat this time,noprovisionhasbeenmadein thefinancialstatementsforthisclaim.Anysuchlosswillberecognizedintheperioditbecomeslikelytooccur.
NOTE 13 – GEOGRAPHIC SEGMENTATION
TheCompanyhasacorporateofficeinCanadaandoperationsinEgypt.Setoutbelowissegmentedinformationonageographicbasis.
TwELvE mONTHS ENDED DECEmBER 31, 2010 TwELvE mONTHS ENDED DECEmBER 31, 2009
CANADA EgYPT TOTAL CANADA (restated)
EgYPT (restated)
TOTAL (restated)
Oilsales,netofroyalties – 12,529 12,529 – 180 180
Interestandotherincome 18 – 18 157 – 157
NetIncome/(Loss) (5,961) (191) (6,152) (4,707) (9,372) (14,080)
CapitalExpenditures (134) (56,499) (56,633) (183) (24,320) (24,503)
TotalAssets,endofyear 21,003 62,684 83,687 6,890 14,350 21,240
Sales toEGPCandGanopefor the twelvemonthsendedDecember31,2010account for70percentand30percentrespectively,oftotaloilsales,netofroyalties.ForthetwelvemonthsendedDecember31,2009,oilsaleswere100%toEGPC.
NOTE 14 – COMPARATIVE AMOUNTS
Certaincomparative informationhasbeen restated toconform to thepresentationof theDecember31,2010information.
NOTE 15 – RESTRICTED CASH
Restrictedcashconsistsofcashondepositthatsecurealetterofcredit,andaminimumcashbalancethatsecurescorporatecreditcards.
HEADER 1
56 Sea Dragon Energy Inc. | 2010 Annual Report
EXECUTIVE OFFICERS
Said Arrata P.Eng.
Chairman and Chief Executive Officer
Tony Anton P.Eng.
President and Chief Operating Officer
Olivier Serra
Chief Financial Officer
Mike Zayat
Senior Vice-President, Exploration
Ahmed Farid Moaaz
Country Manager and Director
STOCK EXCHANGE LISTING
TSX Venture Exchange
Symbol: SDX
REGISTRAR AND TRANSFER AGENT
Equity Financial Trust Company
200 University Avenue,
Suite 400
Toronto, ON
M5H 4H1 Canada
Telephone: +(416) 361-0152
Fax: +(416) 361-0470
INDEPENDENT ENGINEERS
Ryder Scott
Calgary, Alberta, Canada
Gaffney, Cline & Associates
Hampshire, United Kingdom
AUDITORS
PriceWaterhouseCoopers LLP
Calgary, Alberta, Canada
INVESTOR RELATIONS
Brisco Capital Partners Corp.
Suite 400, 505 - 8th Ave S.W.
Calgary, Alberta, T2P 1G2
Telephone: (403) 262-9888
Fax: (403) 263-1339
SEA DRAGON’S OFFICE LOCATIONS
CANADA
255 - 5th Avenue S.W.
Suite 2320
Calgary, Alberta
Canada T2P 3G6
Telephone: +(403) 457-5035
FAX: +(403) 457-5420
EGYPT
Apt #1,
Building #12, Al Nahda St.,
El-Maadi, Kornish El Nile
Cairo, Egypt
Telephone: +(20) 2 2358 2172
Fax: +(20) 2 2750 8534
FRANCE
17 square Edouard VII
75009 Paris, France
Tel: +331 5343 9442
Fax: +331 5343 9393EMAIL: [email protected]
www.seadragonenergy.com
CORPORATE INFORMATION
CO
RPORATE
INFO
RMATIO
N
aBBReViaTiOnS
bbls.........................................................barrels
bbls/d......................................... barrelsperday
mbbls........................................ thousandbarrels
mcf....................................... thousandcubicfeet
mcf/d........................ thousandcubicfeetperday
mmcf........................................millioncubicfeet
mmcf/d.........................millioncubicfeetperday
NGL....................................... naturalgasliquids
bcf.............................................billioncubicfeet
boe..............barrelsofoilequivalent(6mcf:1bbl)
boe/d..................barrelsofoilequivalentperday
mmboe................millionbarrelsofoilequivalent
Boes may be misleading, particularly if used in isolation. A boe conversion ration of 6:1 is based upon an energy equivalence conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.
www.seadragonenergy.com