Petrolifera Petroleum Limited reports 2007 year end results and schedules conference call March 17, 2008, 9:00 A.M. MT



    CALGARY, March 14 /CNW/ - Petrolifera Petroleum Limited (PDP - TSX) had a
productive year in 2007. It was in many ways more complicated than prior
years, but resulted in your company entering 2008 with more land, more
reserves, higher production and sales and the prospect ahead of it of exciting
drilling activity in Colombia and Peru. As previously announced, all results
for 2006 mentioned herein have been restated. Certain statements contained in
this press release contain forward looking information. See "Forward Looking
Information".
    These year end results will be subject to a Conference Call event. To
participate in the live conference call please dial either (416) 644-3414 or
(800) 733-7560. A replay of the event will be available from March 17, 2008 at
11:00 a.m. MT until March 24, 2008 at 11:59 p.m. MT. To listen to the replay
please dial either (416) 640-1917 or (877) 289-8525 and enter the passcode
21264784 followed by the pound sign.

    Highlights were as follows:

    
    -   Total revenue increased 27 percent to $134 million, compared to
        $106 million in 2006. Revenue growth was constrained by the strength
        in the Canadian dollar relative to the US dollar and the Argentinean
        peso. Petrolifera reports its financial results in Canadian dollars.
    -   Cash flow from operations before working capital changes ("cash
        flow")(1) increased 37 percent to $68 million after deduction of
        current income taxes of $21 million, compared to cash flow of
        $50 million in 2006, after a current tax provision of $26 million
        last year.
    -   Cash flow per share(1) increased 13 percent to $1.43 per share in
        2007 compared to $1.27 per share in 2006; on a weighted average
        basis, there were 48 million common shares outstanding in 2007,
        compared to 39 million shares in 2006. At December 31, 2007 there
        were 50.1 million common shares outstanding ($51.6 million fully
        diluted). All per share results reported herein are per basic common
        share outstanding, calculated on a weighted average basis unless
        otherwise noted.
    -   Earnings were $29 million ($0.61 per share) compared to net income in
        2006 of $37 million ($0.95 per share).
    -   Proved ("1P") recoverable crude oil, natural gas liquids and natural
        gas reserves(3), expressed on an equivalent basis, increased
        38 percent during 2007 to 17.8 million boe; proved and probable
        ("2P") reserves(3) rose five percent to 25.6 million boe and proved,
        probable and possible ("3P") reserves(3) reached 39 million boe, with
        possible reserves(3) accounting for 13.5 million boe. Readers are
        cautioned that a barrel of oil equivalent (boe) is derived by
        converting natural gas to oil in the ratio of six thousand cubic feet
        of gas to one barrel of oil and that this may be misleading,
        particularly if used in isolation. A boe conversion is based on an
        energy equivalency conversion method primarily applicable at the
        burner tip and does not represent a value equivalency at the
        wellhead.
    -   GLJ estimated future pre-tax net revenue from 3P reserves, using
        their January 1, 2008 price forecast effective December 31, 2007, to
        be $1 billion with a 10 percent present value of $656 million.
    -   Petrolifera's three year average finding and development costs,
        calculated in accordance with the requirements of National Instrument
        51-101 ("NI 51-101"), were $5.37 for 1P reserves and $5.76 for
        2P reserves.
    -   Thirty-three new crude oil wells, two natural gas wells, three water
        injector wells, two dry holes, four non-productive or suspended wells
        and three wells were being completed at year end all in Argentina.
    -   New water treatment, water handling and water injection facilities
        and a high pressure natural gas pipeline were built during 2007. The
        company's Puesto Morales Norte waterflood was activated in early
        2008.
    -   Daily average sales in 2007 increased 34 percent to 8,279 boe/d,
        compared to 6,171 boe/d in 2006. Crude oil sales increased 33 percent
        to 7,919 bbl/d in 2007 compared to 5,973 bbl/d in 2006. Production
        growth was front ended during the year as facilities for water
        handling, treatment and our waterflood at Puesto Morales Norte had to
        be redesigned and then installed during the year.
    -   Six new concessions, three in Argentina and three in Colombia, were
        secured during 2007, increasing the company's acreage inventory to
        approximately 7 million acres in three countries.

    The following table summarizes these highlights and provides other
information with comparisons to results in 2006.

    HIGHLIGHTS
                                                    2007      2006  % Change

    FINANCIAL ($000 except per share amounts)

    Total revenue                                134,223   105,583        27%
    Cash flow from operations before working
     capital changes(1)                           68,445    49,784        37%
    Per share, basic(1)                             1.43      1.27        13%
    Per share, diluted(1)                           1.33      1.00        33%
    Net earnings                                  29,301    37,312      (21)%
    Per share, basic                                0.61      0.95      (36)%
    Per share, diluted                              0.57      0.75      (24)%
    Capital expenditures                         111,025    36,400       205%
    Cash on hand                                  13,052    51,008      (74)%
    Working capital                              (31,019)   40,456     (177)%
    Indebtedness                                  29,612         -       n/a
    Shareholders' equity                         120,303    78,074        54%
    Total assets                                 204,227   118,517        72%

    OPERATING

    Daily sales volumes
    Crude oil - bbl/d                              7,919     5,973        33%
    Natural gas - mcf/d                            2,157     1,192        81%
    Barrels of oil equivalent - boe/d(2)           8,279     6,171        34%
    Reserves (mboe)(3)
    Proved (1P)                                   17,782    12,898        38%
    Proved plus probable (2P)                     25,566    24,334         5%
    Proved plus probable plus possible (3P)       39,037         -       n/a
    Prices
    Oil - $/bbl                                    45.51     47.71       (5)%
    Natural gas - $/mcf                             1.55      1.36        14%
    Barrels of oil equivalent - $/boe              43.94     46.43       (5)%
    Common shares outstanding (000s)
    Weighted average - Basic                      47,990    37,132        29%
    Weighted average - Diluted                    51,435    49,956         3%
    End of period - Issued                        50,127    43,613        15%
    End of period - Fully diluted                 51,574    52,704       (2)%

    (1) Cash flow from operations before working capital changes ("cash
        flow"), cash flow per share and cash flow per boe do not have
        standardized meanings prescribed by GAAP and therefore may not be
        comparable to similar measures used by other companies. Cash flow
        includes all cash flow from operating activities and is calculated
        before changes in non-cash working capital. The most comparable
        measure calculated in accordance with GAAP would be net earnings.
        Cash flow is reconciled with net earnings on the Consolidated
        Statement of Cash Flows and within our MD&A. Cash flow per share is
        calculated by dividing cash flow by the weighted average shares
        outstanding; cash flow per boe is calculated by dividing cash flow by
        the quantum of crude oil and natural gas (expressed in boe) sold in
        the period. Management uses these non-GAAP measurements for its own
        performance measures and to provide its shareholders and investors
        with a measurement of the company's efficiency and its ability to
        fund a portion of its future growth expenditures.
    (2) All references to barrels of oil equivalent ("boe") have been
        calculated using a conversion rate of six thousand cubic feet of
        natural gas to one barrel of crude oil (6:1). The conversion is based
        on an energy equivalency conversion method primarily applicable to
        the burner tip and does not represent a value equivalency at the
        wellhead. Boes may be misleading, particularly if used in isolation.
    (3) The reserve estimates for 2007 and 2006 were prepared by an
        independent professional petroleum engineering firm in accordance
        with National Instrument 51-101 (NI 51-101). Under NI 51-101, Proved
        reserves are those reserves 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. 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 the estimated proved plus probable reserves.
        Possible reserves are those additional reserves that are less certain
        to be recovered than probable reserves. It is unlikely that the
        quantities actually recovered will exceed the sum of proved plus
        probable plus possible reserves.
    

    2007 IN REVIEW

    Petrolifera experienced considerable progress and growth during 2007. The
company has a meaningful reserves, production and sales base in Argentina.
During the year, the company expanded into Colombia and secured three new
concessions, thereby increasing to three the number of South American
countries in which Petrolifera is active. Our extensive land base provides
attractive diversification, risk distribution and exposure to significant
resource potential.
    In addition to a very successful drilling program during the year in
Argentina, field facilities and a high pressure natural gas pipeline were
constructed and activated at our Puesto Morales Norte operation in the Neuquén
Basin, Argentina. This program was comprised of $97.5 million of capital
spending and included the drilling of 47 wells at Puesto Morales and
Rinconada.
    Rig availability limited Petrolifera's activity during the early part of
2007. We also experienced delays arising from the assumption of direct
operatorship and the need to redesign the various facilities required by the
company to properly manage its production operations. Also, equipment
shortages and delays in the fabrication of facilities during the year as a
result of energy shortages in Argentina, during their winter months, affected
overall intrayear production and sales levels. By year end, however, these
facilities had been constructed and activated and improved production
stability and growth is anticipated as a consequence as the impact of our
newly activated waterflood becomes evident.
    During 2007, Petrolifera was successful in securing six new concessions,
three in Argentina at Vaca Mahuida and Puesto Guevara in the Province of Rio
Negro, Argentina and one at Gobernador Ayala II in La Pampa Province,
Argentina; and three in the Middle and Upper Magdalena Basins (Sierra Nevada I
and II and Turpial) in Colombia. This expanded land base exposes Petrolifera
to additional potential and exploration programs will be activated on these
blocks during 2008.
    Revenue for the year was healthy at $133 million. This was achieved
despite the adverse impact of Argentina's export tax on pricing of crude oil
in their domestic market, where Petrolifera's light gravity Medanito crude oil
production is sold. This tax was further increased in late 2007. The increase
in the tax, which had the effect of placing a cap on crude oil prices in
Argentina, had a marked adverse impact on investor's attitudes towards the
Argentinean oil industry, as the effect of the tax took away the prospect of
improving prices as world oil prices rise. It profoundly affected our share
price, well in excess of the calculated adverse financial effect, although
some recovery has since occurred due to our strong reserve growth and
successful completion and activation of our new field facilities.
    During 2007, the average price received of $45.51 per barrel of crude oil
was five percent below the 2006 price of $47.71 per barrel. By comparison, WTI
averaged US$72.31 per barrel during 2007 and late in the year surpassed
US$100 per barrel while averaging over US$90.00 per barrel in the fourth
quarter 2007.
    Petrolifera's natural gas sales price improved 14 percent in 2007 to
$1.55 per mcf from $1.36 per mcf in 2006. As with crude oil, this price in
Argentina is well below comparable levels in most regional and global markets,
well below comparative energy value and undoubtedly a contributing factor to
low reinvestment levels and consequent shortages in local markets.
    On an equivalent basis, Petrolifera's selling price in 2007 was
$43.94 per boe, also five percent lower than last year given the significant
production weighting to crude oil. More realistic pricing policies will be
needed in Argentina to stimulate new investment, especially as the country is
approaching the prospective need to import energy to meet its domestic
requirements and as other countries in South America enable producers to
secure world prices. In the interim, we will continue a responsible
reinvestment program to protect our discoveries, reserve base and revenue
stream in Argentina and would expand our activity if improved returns were
discernible. Despite these challenges, we have been successful in our programs
since 2005.
    As a result of inflationary pressures and occasional production
curtailments during the construction and startup phases of our new facilities
at Puesto Morales, operating costs rose to $6.05 per boe during 2007, still
low by worldwide industry standards. Last year when most of our wells were
flowing crude oil wells, our operating costs were only $4.49 per boe. We
anticipate that as our wells are all tied in, on site treatment occurs and
sales are all transported to market through our own pipelines for both crude
oil and natural gas, as opposed to trucking significant volumes of crude oil,
our operating costs can remain competitive. There is considerable inflationary
pressure in Argentina at present which will have to be taken into account in
our future planning and budgeting.
    Despite the adverse impact of Argentinean price controls, our corporate
netback per boe in 2007 was $32.58, representing a significant 74 percent of
selling prices. Netbacks do not have a standardized meaning prescribed by
Canadian GAAP. It is a calculation used by management as a measurement of
efficiency. Boe netbacks are calculated by deducting royalties and operating
costs from revenue (including interest income earned) by the number of boe
sold in a reporting period. The most comparable measures calculated in
accordance with GAAP would be net earnings. Netbacks are reconciled with net
earnings in our MD&A.
    During 2007, Petrolifera's Argentina finding and development costs,
calculated in accordance with the requirements of NI 51-101, were $9.59 per
boe for 1P reserves and $20.61 per boe for 2P reserves. This results in a one-
year recycle ratio (calculated by dividing the corporate netback per boe by
the respective finding and development cost per boe) of 3.4 times for 1P and
1.6 times for 2P reserves. Readers should note that the aggregate of the
exploration and development costs incurred in the most recent financial year
and the change during that year of the estimated future development costs
generally will not reflect total finding and development costs related to
reserve additions for that year. Using three year average finding costs for
the period from 2005 to and including 2007, calculated by dividing the sum of
annual finding costs calculated in accordance with NI 51-101 for each year, by
the number of years so calculated, results in a more reliable indicator of
finding and development costs, especially for a project like the discovery and
development of Puesto Morales Norte field.
    Petrolifera's finding and development costs calculated in this manner
were $5.37 for 1P reserves and $5.76 for 2P reserves. When compared to our
2007 netback, our calculated recycle ratio is 6.1 times for 1P reserves and
5.7 times for 2P reserves. These are considered to be very favorable ratios.
    Cash flow amounted to $68 million ($1.43 per share) in 2007, compared to
only $50 million ($1.27 per share) in 2006. This was achieved after provision
for $21 million of current taxes during 2007 and $26 million last year.
    Capital spending totaled $111 million, mostly in Argentina, where
$98 million was invested in wells, seismic and facilities. The balance of
approximately $13 million was spent in Peru and in Colombia. We completed an
extensive airborne gravity and magnetic survey of our Ucayali Block 107 during
2007 and also initiated our 2D seismic program on that block. Environmental
Impact Assessment ("EIA") and other work continued on Block 106 in the Maranon
Basin onshore Peru. We established an office in Colombia and secured three new
100 percent owned onshore concessions in that country.
    Earnings were a healthy $29.3 million ($0.61 per share), although lower
than in 2006 when earnings were $37.3 million ($0.95 per share). Higher
non-cash charges, including a fair value charge against the value of our asset
backed commercial paper ("ABCP") investments and charges for stock based
compensation due to increased share price volatility, were factors in reducing
year over year earnings.
    During 2007, our investments in ABCP, in which we had invested
successfully since 2006, became illiquid due to the problems which arose in
credit markets in Canada and the United States and then worldwide during 2007.
Petrolifera had purchased this form of investment with surplus cash, with an
emphasis on security of principal. We had restricted such investments to
highly rated commercial paper and until mid 2007 had not experienced any
problem with this type of investment, rolling over proceeds on maturity into
new similarly rated instruments. Furthermore, it was felt that investing our
surplus funds in Canada was a prudent decision due to the historical stability
of Canadian capital markets.
    Unfortunately, liquidity evaporated in mid-2007 and we have been unable
to recover our funds and related interest owing since August of last year. Due
to this, we provided for an impairment of these investments in the third and
fourth quarter of 2007 and reclassified these short term investments to long
term, thereby reducing working capital. We and other holders of ABCP are
awaiting receipt of a proposal from the Pan-Canadian Committee, formed to
resolve the loss of liquidity in the Canadian ABCP money market. As noted in
earlier releases, the investments which are now frozen were made through the
auspices of the money market desk of the Canadian commercial bank with which
we had dealt in Canada since our inception and were rated R-1 High by Dominion
Bond Rating Service, the rating agency. We continue to seek solutions to this
dilemma with a view to recovering all or substantially all of our invested
funds, plus interest if at all possible and we are examining all available
alternatives in this regard. Unfortunately, there can be no assurance that
such efforts will result in a full or satisfactory recovery of our funds.
    Fortuitously, prior to the credit crisis we had made arrangements for a
new reserve-backed credit facility with an international bank. This was
established at US$100 million with an initial agreed availability of
US$60 million, which amount is currently under review following the tabling of
our 2007 reserve report. At this writing and based on the expansion of our
1P reserve base, we anticipate the available facility will be expanded,
despite the adverse impact of new Argentinean taxation which was taken into
account in the new report and adversely affects economic values. We also
established a non-recourse credit facility for up to an additional $18 million
with a Canadian chartered bank, with such amount solely secured by our
illiquid ABCP holdings.
    As our 2007 capital expenditures exceeded our cash flow, we were not
self-sufficient during the year. Accordingly, because we could not access our
cash balances which were invested in ABCP, we incurred bank debt for the first
time in the company's history during the year. We continued to have
significant unused credit available at year end and our current debt to 2007
cash flow ratio of 0.4 times, calculated by dividing outstanding debt by 2007
cash flow, is very conservative.
    During the year, 6.5 million common shares were issued from treasury upon
the exercise of outstanding warrants and options under our Stock Option Plan.
Proceeds totaled $18 million and were added to working capital.
    As previously reported, Petrolifera's proved reserves ("1P") of crude
oil, natural gas liquids and natural gas increased 38 percent during 2007 to
reach 17.8 million boe at December 31, 2007. Proved and probable reserves
("2P") improved modestly to 25.6 million boe after record production of
approximately three million boe during the year. In 2007, we also had
3P reserves estimated for the first time since 2005, when it was undertaken by
a different evaluator. A total of 13.5 million boe of possible reserves were
identified, bringing our 3P reserves to a total of 39 million boe. When
combined with our production of 2006 and 2007, Petrolifera's Puesto Morales
Norte field and surrounding areas appears to be an accumulation with
recoverable 3P reserves of approximately 45 million boe, a significant
accomplishment in any basin, but particularly so in the Neuquén Basin, as it
is considered mature by industry standards. These reserve volumes were
estimated by GLJ Petroleum Consultants ("GLJ"), independent engineering
consultants of Calgary, Alberta.

    Fourth Quarter 2007

    Petrolifera's fourth quarter 2007 results were weaker than the third
quarter and than the similar period last year. Crude oil sales were
6,565 bbl/d and natural gas sales were 2.9 mmcf/d, or 7,042 boe/d on an
equivalent basis. This is considerably below 2006 levels when flush production
was being realized from new prolific wells at Puesto Morales. Also, sales were
lower than reported third quarter 2007 results, when equivalent sales were
7,557 boe/d. This trend has now been reversed with the completion of
construction of new facilities at Puesto Morales, contributions from new wells
and improved stability in field operations.
    Revenue in the reporting period was $27 million compared to $31 million
in the previous quarter and $45 million in 2006, reflecting lower crude oil
prices in Argentina due to the effect of higher export taxes and the strength
of the Canadian dollar, which appreciated almost 20 percent against the
US dollar during 2007.
    The average price received for crude oil sales in the fourth quarter of
2007 was $44.36 per barrel and boe prices were $42.07 per boe, the lowest for
the year.
    Cash flow was a modest $10.7 million (0.21 per share) due to higher
provisions for cash taxes compared to the prior quarter in 2007 and below 2006
due to lower volumes and higher costs. In 2006, fourth quarter cash flow was a
record $18.5 million ($0.42 per share).
    Earnings in the fourth quarter 2007 were $4.9 million ($0.10 per share),
essentially the same as the third quarter earnings but considerably less than
in 2006 when fourth quarter net income was $12.4 million ($0.29 per share).
    Capital spending in the fourth quarter 2007 was substantial at
$57.6 million as the company operated four rigs in Argentina for much of the
period and also completed its field facility construction program.
    Current production in Argentina has recently surpassed 9,700 boe/d and
improved financial and operating results are anticipated throughout 2008.

    Outlook

    Petrolifera plans an active and exciting capital program in 2008. It is
anticipated this program will be dominated by our anticipated drilling in Peru
on Ucayali Block 107, after we complete our 2D seismic program and interpret
the data. Early returns are encouraging although a full interpretation will be
required. Timing will depend upon rig availability, government EIA approval,
scheduling and normal industry factors which can affect operations in a jungle
environment. An active 2D seismic program is also planned over selected
portions of Maranon Block 106 with a view to drilling in 2009, again subject
to the usual conditions and qualifiers related to regulatory approval and rig
availability and the timely completion of the planned seismic program. Our
Peru budget for 2008 is estimated at approximately $56 million.
    In Argentina, we have allocated $76 million for new drilling and seismic
at Puesto Morales, Rinconada, Vaca Mahuida, Puesto Guevara and Gobernador
Ayala II. With our Puesto Morales facilities now completed, our focus again
turns to exploration with a view to finding new pools for future development.
    Recently, we completed the excellent PMNa-1081 well, located in proximity
to our recently completed and successful Loma Montosa Zone 9 crude oil wells
in the northwest portion of the Puesto Morales Norte Field. The 1081 well
encountered a previously untapped Sierras Blancas accumulation which, on test
at original reservoir pressure, flowed light gravity crude oil at rates in
excess of 1,000 bbl/d. At least two follow up locations have initially been
identified for drilling.
    Based on log analysis and drilling results, up to eight zones in four
formations, including the Loma Montosa, in our first exploratory well on the
Puesto Morales Este concession have been or are to be evaluated for
hydrocarbons by an ongoing testing program. Test results of the Sierras
Blancas zone in the well were equivocal as minor amounts of crude oil and
uphole natural gas with water were recovered. However, we remain optimistic of
the concessions potential based on the results obtained to date, including
indications of a common oil/water contact with the Puesto Morales Norte Field.
    In Colombia, Petrolifera has already identified three drillable prospects
on our Sierra Nevada I license and exploration activity is anticipated for our
Sierra Nevada TEA and the Turpial Block. At least one well will be drilled
during 2008 to meet contractual obligations on Sierra Nevada I, although
programs may be expanded to include the drilling of up to three wells before
year end 2008, alone or with partners.
    Petrolifera remains strong, is focused and is committed to the principal
of enhancing shareholder value through its activities in South America.
Readers and shareholders are referred to the company's website at
www.petrolifera.ca for occasional updates on activity and to access regularly
updated investor presentations.

    Petrolifera Petroleum Limited is a public Canadian crude oil and natural
gas exploration and production company engaged in drilling production and
sales activity in Argentina, Colombia and Peru in South America. The company's
current reserve, production and sales derive from its Puesto Morales/Rinconada
Concession in the Neuquén Basin, Argentina. Two large licenses comprising
5.2 million acres onshore Peru are also held 100 percent by the company.
Petrolfiera recently entered Colombia and holds one license and two technical
evaluation agreements in the Lower and Middle Magdalena Basin. Active
drilling, facility construction and exploration programs are planned in all
three jurisdictions during 2008 with an announced capital budget approximating
$140 million.

    FORWARD LOOKING INFORMATION

    This press release contains forward-looking information, including but
not limited to estimated reserves and future net revenues, future exploration
and development plans and the anticipated timing associated therewith,
anticipated capital expenditures and sources of funding in respect thereof,
anticipated production growth from planned capital programs, current
production and the recently activated waterflood, anticipated productivity of
certain recently drilled wells and follow-up potential to the PME x-1001
exploratory well which is presently being tested and potential recovery of
investments in ABCP. This information is based on current expectations that
involve a number of risks and uncertainties, which could cause actual results
to differ materially from those anticipated. These risks include, but are not
limited to risks associated with the oil and gas industry (e.g. operational
risks in development, exploration and production delays or changes in plans
with respect to exploration or development projects or capital expenditures;
the uncertainty of reserve estimates; the uncertainty of estimates and
projections in relation to production, costs and expenses and health, safety
and environmental risks), the risk of commodity price and foreign exchange
rate fluctuations, the uncertainty associated with negotiating with foreign
governments and risk associated with international activity. Additional risks
and uncertainties are described in the company's Annual Information Form which
is filed on SEDAR at www.sedar.com.
    The reserves and future net revenue in this press release represent
estimates only. The reserves and future net revenue from the company's
properties have been independently evaluated by GLJ with effective date of
December 31, 2007. This evaluation includes a number of assumptions relating
to factors such as initial production rates, production decline rates,
ultimate recovery of reserves, timing and amount of capital expenditures,
marketability of production, future prices of crude oil and natural gas,
operating costs, well abandonment and salvage values, royalties and other
government levies that may be imposed during the producing life of the
reserves. These assumptions were based on price forecasts in use at December
31, 2007 and many of these assumptions are subject to change and are beyond
the control of the company. Actual production, sales and cash flows derived
therefrom will vary from the evaluation and such variations could be material.
The present value of estimated future net cash flows referred to herein should
not be construed as the current market value of estimated crude oil and
natural gas reserves attributable to the company's properties. Reference is
made to the Company's Annual Information Form for a detailed description of
the assumptions utilized in the reserves report prepared by GLJ.
    Forecast capital expenditures are based on Petrolifera's current budgets
and development plans which are subject to change based on commodity prices,
market conditions, drilling success and potential timing delays. Petrolifera's
capital budget has been prepared based upon anticipated costs for equipment
and services which are subject to fluctuation based upon market conditions,
availability and potential charges or delays in capital expenditures.
Additionally, forecast capital expenditures do not include capital required to
pursue future acquisitions. Anticipated production growth has been estimated
based on the proposed drilling program with a success rate based upon
historical drilling success and an evaluation of the particular wells to be
drilled and has been risked, current production and anticipated decline rates
and the projected impact of the company's waterflood program.
    Recovery of the company's investment in ABCP is dependent on the value of
the underlying assets held by the applicable trusts (which is unknown to the
company) and the restoration of liquidity in this market. There can be no
assurance as to the timing or extent of recovery of this investment.
    Due to the risks, uncertainties and assumptions inherent in
forward-looking information, prospective investors in the company's securities
should not place undue reliance on this forward-looking information. Readers
should review the risk-factors set forth in the company's Annual Information
Form, available at www.sedar.com, for a detailed description of the risks and
uncertainties facing the company. Forward looking information contained in
this press release is made as of the date hereof and are subject to change.
The company assumes no obligation to revise or update forward looking
information to reflect new circumstances, except as required by law.
    A barrel of oil equivalent (boe), derived by converting gas to oil in the
ratio of six thousand cubic feet of gas to oil, may be misleading,
particularly if used in isolation. A boe conversion is based on an energy
equivalency conversion method primarily applicable at the burner tip and does
not represent a value equivalency at the wellhead.

    MANAGEMENT'S DISCUSSION AND ANALYSIS

    The following is dated as of March 14, 2008 and should be read in
conjunction with the consolidated financial statements of Petrolifera
Petroleum Limited ("Petrolifera" or the "company") for the years ended
December 31, 2007 and 2006 as contained in this annual report.
    The consolidated financial statements have been prepared in accordance
with Canadian generally accepted accounting principles ("GAAP") and are
presented in Canadian dollars. This MD&A provides management's view of the
financial condition of the company and the results of its operations for the
reporting periods. Information in this report contains forward-looking
information based on current expectations, estimates and projections of future
production, future commodity prices, capital expenditures and available
sources of financing. See "Forward Looking Information". It should be noted
forward-looking information involves a number of risks and uncertainties and
actual results may vary materially from those anticipated by the company.
These risks and uncertainties include, but are not limited to, political and
economic conditions in the countries in which the company operates, changes in
market conditions, law or governing policy, operating conditions and costs,
operating performance, demand for crude oil and natural gas, foreign currency
exchange rate fluctuations, currency controls, commercial negotiations and
technical and economic factors. Reference should be made to Petrolifera's
Annual Information Form for our year-ended December 31, 2007 for a detailed
description of the risks and uncertainties facing Petrolifera. Throughout the
MD&A, per barrel of oil equivalent ("boe") amounts have been calculated using
a conversion rate of six thousand cubic feet of natural gas to one barrel of
crude oil (6:1). The conversion is based on an energy equivalency conversion
method primarily applicable to the burner tip and does not represent a value
equivalency at the wellhead. Boes may be misleading, particularly if used in
isolation.

    SELECTED FINANCIAL INFORMATION

    
    -------------------------------------------------------------------------
    As at and for the Year Ended
     December 31(1,2)                  2007       2006       2005       2004
    -------------------------------------------------------------------------
    ($000, except per share
     amounts)
    -------------------------------------------------------------------------
    Total revenue                  $134,223   $105,583   $  2,864   $    123
    -------------------------------------------------------------------------
    Net earnings (loss)              29,301     37,312       (415)       (26)
    -------------------------------------------------------------------------
    Per share, basic                   0.61       0.95      (0.02)         -
    -------------------------------------------------------------------------
    Per share, diluted                 0.57       0.75      (0.02)         -
    -------------------------------------------------------------------------
    Total assets                    204,227    118,517     31,581      3,884
    -------------------------------------------------------------------------
    Long-term liabilities            10,259      2,347        467      3,172
    -------------------------------------------------------------------------

    (1) No cash dividends have been declared by the company since
        incorporation.
    (2) Bank debt of $29,612 is classified as a current liability as such
        facilities are repayable on demand.
    

    Since incorporation, Petrolifera's management has concentrated on
building a financially strong company. To this end, the company completed
three equity financings, two by way of private placement and one by way of
initial public offering, pursuant to a prospectus dated October 17, 2005. The
company's common shares trade on the Toronto Stock Exchange under the symbol
PDP.
    Petrolifera conducts its business in Argentina, Colombia and Peru, in
South America. Growth to date has been organic, derived from successful
exploration and development drilling programs. This has resulted in an
expanded crude oil, natural gas liquids ("NGL") and natural gas reserves base
with attendant growth in production.
    During 2007, Petrolifera completed a $111.0 million capital program. In
Argentina, this included the drilling of 47 wells, and the design,
construction and activation of the company's infrastructure and production
facilities and three new exploratory concessions were acquired. In Peru, work
included the completion of an aeromagnetic study, approval of Block 107's
seismic EIA and Block 107 seismic acquisition. In Colombia, we established an
office and secured three new exploration blocks.
    Petrolifera faces the normal challenges, risks and opportunities of any
small independent oil company. We strive to establish a competitive advantage
by applying modern exploration techniques, being opportunistic, employing a
consistent strategy and hiring national staff with in country expertise in our
branch offices in Buenos Aires, Lima and Bogota. We also access professional
advisors as required. Where possible it is our goal to operate our concessions
with a large working interest acquired on a ground floor basis. In this
manner, the company has greater control over its operations and its future
business activities.

    FINANCIAL AND OPERATING REVIEW
    PRODUCTION, PRICING AND REVENUE

    
    -------------------------------------------------------------------------
    Year Ended December 31                        2007       2006          %
    -------------------------------------------------------------------------
    Daily sales volumes
    -------------------------------------------------------------------------
    Oil - bbl/d                                  7,919      5,973         33
    -------------------------------------------------------------------------
    Natural gas - mcf/d                          2,157      1,192         81
    -------------------------------------------------------------------------
    Total - boe/d                                8,279      6,171         34
    -------------------------------------------------------------------------
    Product pricing ($)
    -------------------------------------------------------------------------
    Oil - per bbl                                45.51       47.71        (5)
    -------------------------------------------------------------------------
    Natural gas - per mcf                         1.55        1.36        14
    -------------------------------------------------------------------------
    Revenue per boe                              43.94       46.43        (5)
    -------------------------------------------------------------------------
    Petroleum and natural gas sales ($000)     132,779     104,595        27
    -------------------------------------------------------------------------
    Interest and other income ($000)             1,444         988        46
    -------------------------------------------------------------------------
    Total ($000)                               134,223     105,583        27
    -------------------------------------------------------------------------
    

    Petroleum and natural gas revenues for 2007 were $132.8 million (2006 -
$104.6 million) from crude oil sales of 7,919 bbl/d (2006 - 5,973 bbl/day) and
natural gas sales of 2.2 mmcf/d (2006 - 1.2 mmcf/d). The increases in revenue
primarily resulted from higher crude oil production volumes. These were
derived from the successful development of the Puesto Morales crude oil and
natural gas field in the Neuquén basin onshore Argentina, offset by a lower
average realized price for crude oil.
    Crude oil production increased 33 percent in 2007. New discoveries and
development drilling resulted in production rising to an average of
7,919 bbl/d. The company's boe sales volumes continue to be heavily weighted
to crude oil, which represented 96 percent of the company's volumes in 2007
compared to 97 percent in 2006.
    Crude oil prices decreased five percent to average $45.51 per barrel
throughout the year compared to $47.71 in 2006. Argentinean crude oil prices
reflect world prices for the respective quality of oil, adjusted for the
impact of an Argentinean export tax on domestic sales prices. All of
Petrolifera's production is sold in domestic markets. In November of 2007, the
Argentine government announced an increase in the export tax that has the
effect of limiting the price of crude oil to a maximum of US$42.00 per barrel,
which impacted fourth quarter 2007 prices.
    Natural gas prices increased 14 percent to average $1.55 per mcf in 2007
compared to $1.36 per mcf in 2006, reflecting some relaxation of regulated
Argentinean natural gas prices, which are still substantially below prices
prevailing in North American markets. Natural gas prices have been improving
and are expected to continue improving in the future due to market conditions
and new policy initiatives of the Argentine government aimed at gradual market
deregulation. Late in 2007, the Company began selling natural gas under a new
natural gas sales contract and now receives approximately US$2.10 per mcf, a
substantial increase from the average of $1.55 per mcf received in 2007.
    Interest and other income of $1.4 million was earned in 2007 compared to
$1.0 million for 2006, This primarily relates to interest earned on short-term
cash deposits and interest on the Company's investments. The company had an
investment of $37.7 million face value in non-bank asset backed commercial
paper ("ABCP") on which no interest income has been accrued since August 2007,
due to the lack of liquidity for these investments. There are also fair value
concerns for these investments and they were reclassified as a long term
investment during the year. See long-term investments for additional details
including estimates of valuation.

    ROYALTIES

    Royalties represent charges against production or revenue by governments
and landowners. Included in royalties are revenue taxes levied by provincial
jurisdictions. Royalties in 2007 were $17.5 million ($5.79 per boe), or
13 percent of crude oil and natural gas revenue compared to $14.8 million
($6.57 per boe), or 14 percent of crude oil and natural gas revenue in 2006.

    OPERATING EXPENSES AND NETBACKS
    Company Netbacks(1)

    
    -------------------------------------------------------------------------
    Year ended December 31                 2007                  2006
    -------------------------------------------------------------------------
                                      Total    Per boe      Total    Per boe
    -------------------------------------------------------------------------
    ($000, except per unit amounts)
    -------------------------------------------------------------------------
    Average daily sales (boe/d)           8,279                 6,171
    -------------------------------------------------------------------------
    Petroleum and natural
     gas sales                     $132,779   $  43.94   $104,595   $  46.43
    -------------------------------------------------------------------------
    Interest and other income         1,444       0.48        988       0.44
    -------------------------------------------------------------------------
    Royalties                       (17,500)     (5.79)   (14,796)     (6.57)
    -------------------------------------------------------------------------
    Net revenue                     116,723      38.63     90,787      40.30
    -------------------------------------------------------------------------
    Operating costs                 (18,267)     (6.05)   (10,111)     (4.49)
    -------------------------------------------------------------------------
    Corporate netback              $ 98,456   $  32.58   $ 80,676   $  35.81
    -------------------------------------------------------------------------

    (1) Calculated by dividing related revenue and costs by total boe sold,
        resulting in an overall company netback. Netbacks do not have a
        standardized meaning prescribed by GAAP and therefore may not be
        comparable to similar measures used by other companies. Nevertheless,
        Petrolifera's management uses netbacks as a performance measurement
        of operating efficiency and the prevailing royalty regime. A high
        ratio of netback to selling price is a positive indicator.
    

    Petrolifera's netbacks decreased nine percent over those recorded in the
2006 reporting period. This primarily reflects a lower average sales price
received for crude oil and an increase in operating expenses for the year.
Petrolifera's calculated netback at $32.58 per boe is a healthy 74 percent of
selling price (2006 - 77 percent).

    OPERATING EXPENSES

    Operating costs in 2007 increased 81 percent in total and 35 percent per
boe from 2006. The overall increase reflects the higher volumes produced. Unit
costs rose due to the significant increase in the number of wells that are on
pump or require servicing on a more frequent basis, inflationary pressures,
and start up costs related to the new field facilities. We anticipate these
pressures can be mitigated in 2008 by a reduced dependency on trucking
compared to the prior years as most of our Argentinean production is now being
treated onsite and being transported through a company owned pipeline.
Petrolifera anticipates unit operating costs will be more stable after the
permanent field facilities and pipelines are optimally utilized. This is
expected to occur during 2008 and 2009.

    General and Administrative Expenses

    General and administrative ("G&A") expenses were $6.4 million in 2007
(2006 - $3.7 million), comprised of costs incurred in Canada, Argentina, Peru
and Colombia. These costs primarily consist of management and administrative
salaries, legal and advisory fees, insurance, the cost of independent reserve
reports, travel and other administrative expenses. The increase from 2006 is
attributable to increased staffing levels to handle the expanded nature of the
company's operations and activity levels and increased public company costs.
G&A of $2.4 million was capitalized in 2007 (2006 - $0.7 million) mainly
related to costs associated with exploration activities in Argentina, Peru and
Colombia. Non-cash stock-based compensation costs of $6.8 million were
recorded in the year (2006 - $3.6 million) for the calculated value of the
stock options issued and vesting during the year. Stock-based compensation
increased significantly from the prior year due to an increase in options
outstanding and a volatile stock price. This volatility contributes to a
higher calculated value per option issued, which value is expensed over the
life of the option. Stock-based compensation is a non-cash charge against
earnings.

    FINANCE CHARGES

    Included in the finance charges of $0.4 million for the year are interest
paid and accrued on the outstanding debt and the pro-rata portion of the
deferred financing charges that are being allocated over the life of the
facility. The company did not have any debt outstanding in 2006.

    FOREIGN EXCHANGE

    The impact of fluctuations in the Argentinean peso and the US dollar
relative to the Canadian dollar arising from settling foreign-denominated
transactions and from translating foreign denominated financial statements and
operating results of Petrolifera's integrated foreign operations resulted in a
foreign exchange loss of $2.3 million in 2007 (2006 - $0.4 million loss). The
company's main exposure to foreign currency risk relates to the pricing of
crude oil sales, costs and capital expenditures and debt, which are largely
denominated in US dollars and Argentinean pesos.

    FAIR VALUE IMPAIRMENT - ABCP

    In recognition of the loss of liquidity in the company's ABCP investment,
a charge for a non-cash fair value impairment of $6.2 million was provided for
in the financial statements. This represents 16% of the face value of the
investment at the time of the loss of liquidity in the Canadian commercial
paper market. The basis for this charge is explained under long term
investments. It is not known when or whether these amounts can or will be
recovered.

    DEPLETION, DEPRECIATION AND ACCRETION ("DD&A")

    DD&A is calculated using the unit-of-production method based on total
estimated proved reserves. DD&A in 2007 was $16.9 million (2006 -
$9.6 million) or $5.59 per boe (2006 - $4.27 per boe). This includes a charge
of $0.1 million (2006 - $0.03 million) to accrete the company's estimated
asset retirement obligation. These charges will continue to be necessary in
future to accrete the currently booked discounted liability of $5.6 million to
the estimated total undiscounted liability of $11.3 million over the estimated
remaining economic life of the company's crude oil and natural gas properties.
Additionally, future development costs of $18.6 million for proved undeveloped
reserves in Argentina have been included in the depletion calculation. Capital
costs of $15.3 million related to unevaluated properties in Argentina, and
other assets in the pre-production stage related to Peru and Colombia have
been excluded from depletable costs. No proved reserves have yet been assigned
to these projects.

    CEILING TEST

    Oil and gas companies are required to compare the recoverable value of
their oil and gas assets to their recorded carrying value at the end of each
reporting period. Excess carrying values over fair value are to be written off
against earnings. No write-down was required in 2007 or in 2006 as a
significant surplus exceeding $300 million was calculated pursuant to this
test.

    TAXES

    The current income tax provision of $21.1 million for 2007 (2006 -
$26.4 million), primarily relates to income taxes in Argentina. Additionally,
a future tax expense of $6.9 million for 2007 (2006 - recovery of $1.2
million) was recorded to recognize the changes in tax pool balances during the
year. The increase in the effective tax rate to 49 percent in 2007 from 40
percent in 2006 is primarily caused by the impairment on the ABCP. Taxes other
than income taxes of $2.1 million (2006 - $0.7 million) mainly represent taxes
charged at a rate of 0.6 percent on all banking transactions in Argentina.

    NET EARNINGS AND SHARES OUTSTANDING

    
    -------------------------------------------------------------------------
                                            Year ended            Year ended
                                     December 31, 2007     December 31, 2006
    -------------------------------------------------------------------------
                                      Total    Per boe      Total    Per boe
    -------------------------------------------------------------------------
    ($000, except per unit amounts)
    -------------------------------------------------------------------------
    Netback                        $ 98,456   $  32.58   $ 80,676   $  35.81
    -------------------------------------------------------------------------
    General & administrative         (6,369)     (2.11)    (3,744)     (1.66)
    -------------------------------------------------------------------------
    Stock-based compensation         (6,833)     (2.26)    (3,628)     (1.61)
    -------------------------------------------------------------------------
    Finance charges                    (421)     (0.14)       (88)     (0.04)
    -------------------------------------------------------------------------
    Foreign exchange (loss) gain     (2,331)     (0.77)      (439)     (0.19)
    -------------------------------------------------------------------------
    Fair value impairment - ABCP     (6,169)     (2.04)         -          -
    -------------------------------------------------------------------------
    Taxes other than income taxes    (2,138)     (0.71)      (655)     (0.29)
    -------------------------------------------------------------------------
    Depletion, depreciation and
     accretion                      (16,890)     (5.59)    (9,614)     (4.27)
    -------------------------------------------------------------------------
    Income tax recovery (provision) (28,004)     (9.27)   (25,196)    (11.19)
    -------------------------------------------------------------------------
    Net earnings (loss) for
     the period                    $ 29,301   $   9.69   $ 37,312   $  16.56
    -------------------------------------------------------------------------
    

    In 2007 the company reported earnings of $29.3 million (2006 -
$37.3 million), which equates to $0.61 (2006 - $0.95) per basic and
$0.57 (2006 - earnings of $0.75) per weighted average diluted share
outstanding.
    For 2007, the weighted average number of common shares outstanding was
48.0 million (2006 - 39.1 million). In 2007, 3.4 million additional shares
(2006 - 10.8 million) were included in the diluted earnings per share
calculations related to the potentially dilutive effect of options and
warrants.

    As at March 14, 2008, the company had the following securities issued and
outstanding:

    
    -  50,193,010 common shares;
    -  160,000 warrants; and
    -  3,162,367 stock options
    

    Details of the exercise rights and terms of the warrants and options are
noted in the Consolidated Financial Statements, included in this Annual
Report.

    LIQUIDITY AND CAPITAL RE

SOURCES Cash flow from operations before working capital changes ("cash flow"), cash flow per share and cash flow per boe do not have standardized meanings prescribed by GAAP and therefore may not be comparable to similar measures used by other companies. Cash flow includes all cash flow from operating activities and is calculated before changes in non-cash working capital. The most comparable measure calculated in accordance with GAAP would be net earnings. Cash flow is reconciled with net earnings on the Consolidated Statement of Cash Flows and below. Cash flow per share is calculated by dividing cash flow by the weighted average shares outstanding; cash flow per boe is calculated by dividing cash flow by the quantum of crude oil and natural gas (expressed in boe) sold in the period. Management uses these non-GAAP measurements for its own performance measures and to provide its shareholders and investors with a measurement of the company's efficiency and its ability to fund a portion of its future growth expenditures. Reconciliation of net earnings to cash flow: ------------------------------------------------------------------------- Year ended December 31 2007 2006 ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- Net earnings for the period $ 29,301 $ 37,312 ------------------------------------------------------------------------- Add (deduct) ------------------------------------------------------------------------- Stock-based compensation 6,833 3,628 ------------------------------------------------------------------------- Depletion, depreciation, and accretion 16,890 9,614 ------------------------------------------------------------------------- Future income tax provision (recovery) 6,921 (1,209) ------------------------------------------------------------------------- Foreign exchange loss 2,331 439 ------------------------------------------------------------------------- Fair value impairment - ABCP 6,169 - ------------------------------------------------------------------------- Cash flow $ 68,445 $ 49,784 ------------------------------------------------------------------------- Cash flow in 2006 was $68.4 million (2006 - $49.8 million) which equates to $1.43 per basic share and $1.33 per diluted share compared to 2006 - $1.27 per basic share and $1.00 per weighted average diluted share. Cash flow increased by 37 percent overall due to higher crude oil production, offset by lower prices and higher costs. Cash flow per share increased 13 percent year over year and reflects the above factors and issuance of additional common shares in 2007 for the exercise of outstanding warrants and stock options. CREDIT FACILITIES During 2007 the company entered into two separate credit facilities. In September the Company finalized a US$100 million reserve-based revolving credit facility, with initial available draws established at US$60 million. The facility was for three years, bears interest at LIBOR plus a margin, is secured by a pledge of the shares of Petrolifera's subsidiaries and has a provision for a borrowing base adjustment every six months. In December 2007 the company established an $18 million line of credit with a Canadian Chartered bank to partially restore the liquidity that has been frozen by the current credit crisis for ABCP. This facility pays interest a floating rate and is solely secured by the ABCP notes. As of December 31, 2007, the reserve based facility had US$20.0 million outstanding and the line of credit facility had $9.9 million outstanding. Capital Spending ------------------------------------------------------------------------- Year ended December 31 2007 2006 ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- Argentina $ 97,465 $ 34,333 ------------------------------------------------------------------------- Peru 12,931 1,799 ------------------------------------------------------------------------- Colombia 594 - ------------------------------------------------------------------------- Corporate 35 268 ------------------------------------------------------------------------- Total capital expenditures $111,025 $ 36,400 ------------------------------------------------------------------------- Capital spending in 2007 totaled $111.0 million, an increase of 205% over the $36.4 million spent in 2006. In Argentina, the company spent $97.5 million on the drilling of 47 wells, design, completion and activation of the crude oil water treatment facilities, and handling facilities associated with a waterflood project and the construction of a high-pressure natural gas pipeline. The Company spent $12.9 million in Peru for the completion of the Block 107 high-resolution airborne gravity-magnetic survey, the Block 107 seismic environmental impact assessment ("EIA"), the commencement of the Block 107 seismic program and further advancing the Block 106 EIA in preparation of a seismic program anticipated in 2008. In Colombia, the company spent $0.6 million to secure new concessions, open an office and the reprocessing of seismic and on preliminary geological studies in anticipation of drilling during 2008. At year end Petrolifera had a working capital deficit of $31.8 million, largely a result of reclassifying short term ABCP investments to long term and due to the incurrence of $29.6 million of borrowings from available credit facilities. The company has cash, cash flow and sufficient unused portions of its available credit facilities to fund its planned 2008 capital budget. It is the company's opinion that it has the financial wherewithal to repay its indebtedness pursuant to its terms under current industry conditions. As a public company, Petrolifera can, if it so chooses and if prevailing market conditions are favorable, raise new capital from the sale of equity or alternatives thereto from its treasury. The company's 2008 approved capital program of $140 million includes expenditures to satisfy work commitments related to the Argentine, Peruvian and Colombian properties. The company has sufficient cash balances and cash flow is being generated in Argentina to fund these capital expenditures and funds are being moved among Canada, Barbados, Argentina, Peru and Colombia as required. LONG-TERM INVESTMENTS Due to the early success of the Argentinean drilling program since December 2006, after the company completed its initial public offering, significant cash balances were retained in Petrolifera's bank accounts. These funds were largely kept in Canada for capital preservation and security. In mid-2006 the company commenced a program to invest its surplus funds in high quality, highly rated, liquid commercial paper with a primary emphasis on security of capital. Investments were made in R-1 High rated ABCP, as rated by Dominion Bond Rating Service, sold to us by the money market facilities of a Canadian chartered bank with whom we held bank accounts. These investments were made in more than one issuing entity, were made for various time periods and were acquired to earn a reasonable return in relation to prevailing market conditions. On maturity proceeds including earned interest were generally reinvested on a regular basis. In August 2007 the ABCP market experienced severe liquidity problems. This has caused the conduits that issued the notes to default on the redemption of the notes. As a result, holders could not receive their cash plus interest at maturity. On September 6, 2007 a panel of banks, asset providers, and major investors formed the Pan-Canadian Investors Committee for Third-Party Structured Asset-Backed Commercial Paper ("Pan-Canadian Committee") to oversee a proposed restructuring process. The proposed restructuring called for the ABCP to be converted into longer term floating rate notes which more closely match the maturities of the underlying assets. On December 23, 2007, the Pan-Canadian Committee announced the framework of the restructuring of the conduits in which the company is invested. Under this framework, groups of assets from the trusts that are either wholly or partially represented by synthetic assets ("synthetic pool") will be pooled together and exchanged for two sets of notes, a senior note and a subordinated note. The ratio of the breakdown between senior and subordinated notes for any individual trust will be determined by the relative contribution of value of the assets contributed to the synthetic pool by the trust to the total value of the pool of synthetic assets. Also under the proposed restructuring, certain pools of the assets that do not qualify for the synthetic pool will remain in the trust and new notes will be distributed to the existing noteholders with a term similar to the maturities of the underlying assets ("non-qualifying pool"). Therefore, should the Pan-Canadian committee proposal be adopted it is anticipated that the company would receive three types of notes, synthetic pool senior notes, synthetic pool subordinated notes, and non-qualifying pool notes. Quoted market values of the ABCP are not available due to the market disruption that is currently paralyzing the ABCP market. Management has therefore estimated the fair value of the owned ABCP based on a probabilistic recovery of principal and interest taking into account all relevant available information. Under this valuation method, several different outcomes of the recovery of the principal and interest are estimated considering the information available as at December 31, 2007. A weighted average recovery is then calculated. This weighted average recovery is used to determine the discounted cash flows that are expected from these investments. The recovery factors used for the synthetic pool notes were as follows: from 50 percent to 100 percent with a weighted average recovery of 98 percent for the principal portion of senior notes and from 0 percent to 50 percent with a weighted average recovery of 45 percent for the principal portion of the subordinated notes; from 0 percent to 100 percent with a weighted average recovery of 93 percent for the interest applicable to senior notes and from 0 percent to 50 percent with a weighted average recovery of 45 percent for the interest applicable to the subordinated notes. The recovery factors used for the non-qualifying pool notes ranged from 0 percent to 100 percent with a weighted average recovery of 70 percent for principal portion and from 0 percent to 100 with a weighted average recovery of 50 percent for interest applicable to the notes. The term for the synthetic pool notes was between two and nine years and for the non-qualifying pool notes the term was nine years. The fair value of the investment in ABCP is estimated to be $31.4 million which implies an impairment of $6.2 million or approximately 16 percent. As at December 31, 2007, included in long-term investments were ABCP with a face value of $37.7 million. These investments are classified as Held for Trading and are carried at fair value which is assessed each reporting date. Previously these were classified as current assets and were part of working capital. Petrolifera has taken a non-cash impairment charge of $6.2 million against the carrying value of the notes classified as long term investments. The theoretical fair value of the company's ABCP could range from $26.0 million to $34.4 million using the same valuation methodology with alternative reasonably possible assumptions. The company anticipates that it presently has sufficient cash resources and available credit to satisfy obligations as they come due. Assuming the ABCP problems are restructured in 2008 and normal liquidation for cash occurs, the company would be able to substantially reduce its indebtedness incurred from lack of access to these amounts. The outcome of the restructuring process, actual timing and amount ultimately recoverable from these notes may differ materially from this estimate which would impact the company's earnings. LEGAL PROCEEDINGS Petrolifera is a party to an arbitration proceeding initiated by the former contract operator of the Puesto Morales/Rinconada block. The former operator is seeking financial compensation including damages for wrongful dismissal. Petrolifera is of the opinion that the claim is without merit and has filed a counterclaim against the former operator. Potential damages, if any, against the company are not quantifiable at this time, but in any event are not anticipated to be material to the company. RELATED PARTY TRANSACTIONS AND SIGNIFICANT TRANSACTIONS Under the terms of a Management Services Agreement with Connacher Oil and Gas Limited ("Connacher"), which has been extended on a month-to-month basis since its original term, which expired in May, 2007, Connacher provides some management and general and administrative services to assist in the administration of the company. The fee for this service is $15,000 per month. From time to time Connacher also pays bills on behalf of Petrolifera, for which it is reimbursed at cost. Connacher is also guarantor for Petrolifera in Peru and operator of record on behalf of Petrolifera in Colombia for which Connacher is indemnified by Petrolifera. Petrolifera paid Connacher $0.2 million in 2007 under the management agreement which is anticipated to be replaced on substantially the same terms by a new agreement effective January 1, 2008. SIGNIFICANT ACCOUNTING POLICIES AND APPLICATION OF CRITICAL ACCOUNTING ESTIMATES The significant accounting policies used by the company are described below. Certain accounting policies require that management make appropriate decisions with respect to the formulation of estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Changes in these judgments and estimates may have a material impact on the company's financial results and condition. The following discusses such accounting policies and is included in the MD&A to aid the reader in assessing the significant accounting policies and practices of the company and the likelihood of materially different results being reported. Management reviews its estimates regularly. The emergence of new information and changed circumstances may result in changes to estimates which could be material and the company might realize different results from the application of new accounting standards promulgated, from time to time, by various rule-making bodies. The following assessment of significant accounting polices is not meant to be exhaustive. Oil and Gas Reserves Under Canadian Securities Regulators' "National Instrument 51-101-Standards of Disclosure for Oil and Gas Activities" ("NI 51-101") proved reserves are those reserves that can be estimated with a high degree of certainty to be recoverable. In accordance with this definition, the level of certainty should result in a 90 percent probability that the quantities actually recovered will equal or exceed the estimated proved reserves. In the case of probable reserves, which are less certain to be recovered than proved reserves, NI 51-101 states that it is equally likely that the actual remaining quantities recovered will be greater than or less than the sum of the estimated proved plus probable reserves. Possible reserves are those reserves less certain to be recovered than probable reserves. There is at least a 10 percent probability that the quantities actually recovered will be equal to or exceed the sum of proved plus probable plus possible reserves. The company's crude oil and natural gas reserve estimates are made by independent reservoir engineers using all available geological and reservoir data as well as historical production data. Estimates are reviewed and revised as appropriate. Revisions occur as a result of changes in prices, costs, fiscal regimes, reservoir performance or a change in the company's plans. The reserve estimates are also used in determining the company's borrowing base for its credit facilities and may impact the same upon revision or changes to the reserve estimates. The effect of changes in proved oil and gas reserves on the financial results and position of the company is described under the heading "Full Cost Accounting for Oil and Gas Activities". Full Cost Accounting for Oil and Gas Activities The company uses the full cost method of accounting for exploration and development activities. In accordance with this method of accounting, all costs associated with exploration and development are capitalized whether successful or not. The aggregate of net capitalized costs and estimated future development costs is amortized using the unit-of-production method based on estimated proved oil and gas reserves. Major Development Projects and Unproved Properties Certain costs related to major development projects and unproved properties are excluded from net capitalized costs subject to depletion until proved reserves have been determined, the project becomes commercial, or their value is impaired. These costs are reviewed quarterly and any impairment is transferred to the costs being depleted or, if the properties are located in a cost centre where there is no reserve base, the impairment is charged directly to income. Full Cost Accounting Ceiling Test The company is required to review the carrying value of all property, plant and equipment, including the carrying value of oil and gas assets, for potential impairment. Impairment is indicated if the carrying value of the long-lived asset or oil and gas cost centre is not recoverable by the future undiscounted cash flows. If impairment is indicated, the amount by which the carrying value exceeds the estimated fair value of the long-lived asset is charged to earnings. The ceiling test is based on estimates of reserves, production rate, petroleum and natural gas prices, future costs and other relevant assumptions. By their nature these estimates are subject to measurement uncertainty and the impact on the consolidated financial statements could be material. Asset Retirement Obligations The company is required to provide for future removal and site restoration costs by estimating these costs in accordance with existing laws, contracts or other policies. These estimated costs are charged to earnings and the appropriate liability account over the expected service life of the asset. When the future removal and site restoration costs cannot be reasonably determined, a contingent liability may exist. Contingent liabilities are charged to earnings only when management is able to determine the amount and the likelihood of the future obligation. The company estimates future retirement costs based on current estimates adjusted for inflation and credit risk. These estimates are subject to measurement uncertainty. Income Taxes The company follows the liability method of accounting for income taxes. Under this method tax assets are recognized when it is more than likely realization will occur. Tax liabilities are recognized for temporary differences between recorded book values and underlying tax values. Rates used to determine income tax asset and liability amounts are enacted rates expected to be used in future periods when the timing differences change. The period in which a timing difference reverses are impacted by future income and capital expenditures. Rates are also affected by legislation changes. Stock-Based Compensation The company uses the fair value method to account for stock options. The determination of the amounts for stock-based compensation is based on assumptions of stock volatility, interest rates and the term of the option. These assumptions by their nature are subject to measurement uncertainty. Legal, Environment Remediation and Other Contingent Matters In respect of these matters, the company is required to determine whether a loss is probable based on judgment and interpretation of laws and regulations and determine if such a loss can be estimated. When any such loss is determined, it is charged to earnings. Management continually monitors known and potential contingent matters and makes appropriate provisions by charges to earnings when warranted by circumstance. Foreign Currency Translation Business conducted in Colombia and Peru is considered to be an "integrated foreign operation" for accounting purposes and, therefore, its financial statements are translated into Canadian dollars using the temporal method. Under the temporal method, the company translates foreign denominated monetary assets and liabilities at the exchange rate prevailing at year end; non-monetary assets, liabilities and related depletion and depreciation are translated at historic rates; revenues and expenses are translated at the average rate of exchange for the period; and any resulting foreign exchange gains or losses are included in operations. During 2006, the company determined its Argentinean activities comprise a self-sustaining operation. Prior to this determination, the Argentinean operations were considered to be integrated with the Canadian operations and were translated using the temporal method described above. As a self-sustaining foreign operation, the Argentinean financial statements are translated into Canadian dollars using the current rate method, whereby assets and liabilities are translated at the rate of exchange in effect at the balance sheet date; revenues and expenses are translated at the average monthly rates of exchange during the period and gains or losses on translation are included as a foreign currency translation adjustment in the consolidated statement of comprehensive income and accumulated other comprehensive income (loss). IMPACT OF NEW AND PROPOSED ACCOUNTING PRONOUNCEMENTS Effective January 1, 2007 the company adopted CICA Handbook sections 1530, 3251, 3855, 3861 and 3865 relating to Comprehensive Income, Equity, Financial Instruments - Recognition and Measurement, Financial Instruments - Disclosure and Presentation, and Hedges, respectively. Under the new standards, additional financial statement disclosure, namely Consolidated Statements of Comprehensive Income, has been introduced. This statement identifies certain gains and losses, which in the company's case at this time, include only foreign currency translation adjustments arising from translation of the company's Argentinean business unit, that are recorded outside the income statement. Additionally, a separate component of equity, Accumulated Other Comprehensive Income, has been introduced to disclose other comprehensive income balances on a cumulative basis. Finally, all financial instruments, including derivatives, are recorded in the company's consolidated balance sheet and measured at their fair values. Under section 3855, the company is required to classify its financial instruments into one of five categories. The company has classified all of its financial instruments, with the exception of the revolving bank debt facility, as Held for Trading, which requires measurement on the balance sheet at fair value with any changes in fair value recorded in earnings. This classification has been chosen due to the nature of the company's financial instruments. Transaction costs related to financial instruments classified as held for trading are recorded in earnings in accordance with the new standards. The revolving bank debt facility has been classified as "other financial liabilities". The adoption of section 3865, "Hedges", has had no effect on the company's consolidated financial statements as the company has no hedging transactions in place at this time. Effective January 1, 2007, the company adopted the revised recommendations of CICA Handbook section 1506, Accounting Changes. The new recommendations permit voluntary changes in accounting policy only if they result in financial statements which provide more relevant and reliable financial information. Accounting policy changes must be applied retrospectively unless it is impractical to determine the period or cumulative impact of the change in policy. Additionally, when an entity has not applied a new primary source of GAAP that has been issued but is not yet effective, the entity must disclose that fact along with information relevant to assessing the possible impact that the application of the new primary source of GAAP will have on the entity's financial statements in the period of initial application. As of January 1, 2008, the company will be required to adopt two new CICA Handbook requirements, section 3862, "Financial Instruments - Disclosures" and section 3863, "Financial Instruments - Presentation" which will replace current section 3861. The new standards require disclosure of the significance of financial instruments to an entity's financial statements, the risks associated with the financial instruments and how those risks are managed. The new presentation standard essentially carries forward the current presentation requirements. The company is assessing the impact of these new standards. As of January 1, 2008, the company will be required to adopt CICA Handbook section 1535, "Capital Disclosures" which requires entities to disclose their objectives, policies and processes for managing capital and, in addition, whether the entity has complied with any externally imposed capital requirements. The company is assessing the impact of this new standard. As of January 1, 2008, Petrolifera is required to adopt the CICA Handbook Section 3031, "Inventories," which will replace the existing inventories standard. The new standard requires inventory to be valued on a first-in, first-out or weighted average basis, which is consistent with Petrolifera's current treatment. The adoption of this standard should not have a material impact on Petrolifera's Consolidated Financial Statements. In February 2008, the CICA issued Section 3064, Goodwill and Intangible Assets, replacing Section 3062, Goodwill and Other Intangible Assets and Section 3450, Research and Development Costs. Various changes have been made to other sections of the CICA Handbook for consistency purposes. The new Section will be applicable to financial statements relating to fiscal years beginning on or after October 1, 2008. Accordingly, the company will adopt the new standards for its fiscal year beginning January 1, 2009. It establishes standards for the recognition, measurement, presentation and disclosure of goodwill subsequent to its initial recognition and of intangible assets by profit-oriented enterprises. Standards concerning goodwill are unchanged from the standards included in the previous Section 3062. The company is currently evaluating the impact of the adoption of this new Section. Over the next three years the CICA will adopt its new strategic plan for the direction of accounting standards in Canada, which was ratified in January 2006. As part of the plan, Canadian GAAP for public companies will converge with International Financial Reporting Standards ("IFRS") over the next three years. The company continues to monitor and assess the impact of the convergence of Canadian GAAP with IFRS. Commitments, Contingencies, Guarantees, Contractual Obligations and Off Balance Sheet Arrangements In 2005 Petrolifera acquired two significant oil and gas exploration licenses in Peru. The licenses have a total US$41.8 million financial commitment to complete negotiated work programs on the two licenses over seven years. The company has the right to withdraw from the licenses at the end of each period associated with the term of the licenses. The first license term for Block 106 ended in 2007 and the company has met its commitment and is currently in the second license term with a commitment to invest a minimum of US$1.6 million in this term. These expenditures are budgeted to be fully discharged in 2008. In Block 107, the company is in the first term of the license and expects to complete all the required work commitments for the term during 2008. The company has issued letters of credit in the total amount of US$2.3 million to secure the capital expenditure requirements associated with the two exploration licenses in Peru. In 2007 the Company was granted three concessions in Colombia with a total work commitment of US$5.7 million over a two year period. These work commitments are budgeted to be completed during 2008. The company has issued letters of credit in the total amount of US$0.6 million in support of these work commitments. In Argentina the company has total work commitments of US$54.0 million over the next three years related to the Vaca Mahuida, Puesto Guevara and Gobernador Ayala II blocks. Additionally, the company has various guarantees and indemnifications in place in the ordinary course of business, none of which are expected to have a significant impact on the company's financial statements or operations. The company's annual commitments under service contracts for drilling, leases for office premises, various operating costs, software license agreements and other equipment are as follows: ------------------------------------------------------------------------- Contractual Subsequent Obligations 2008 2009-2011 2012-2013 to 2013 Total ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- Asset retirement obligations - - - 11,265 11,265 Service contracts and other 14,454 11,601 - - 26,055 ------------------------------------------------------------------------- Total 14,454 11,601 - 11,265 37,320 ------------------------------------------------------------------------- The company has no off balance sheet financing arrangements. DISCLOSURE CONTROLS AND PROCEDURES Disclosure controls and procedures have been designed to ensure that information required to be disclosed by the company is accumulated, recorded, processed and reported to the company's management as appropriate to allow timely decisions regarding disclosure. The company's Executive Chairman and Chief Financial Officer have concluded, based on their evaluation as of the end of the period covered by this MD&A, that the company's disclosure controls and procedures as of the end of such period are effective to provide reasonable assurance that material information related to the company, including its consolidated subsidiaries, is communicated to them as appropriate to allow timely decisions regarding required disclosure. INTERNAL CONTROL OVER FINANCIAL REPORTING Management of the company is responsible for designing adequate internal controls over the company's financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with Canadian GAAP. Management assessed the design of the company's internal controls over financial reporting as of December 31, 2007 and based on that assessment, determined that the company's internal controls over financial reporting were adequately designed. It should be noted that while the company's Executive Chairman and Chief Financial Officer believe that the company's disclosure controls and procedures provide a reasonable level of assurance that they are effective, and that the internal controls over financial reporting are adequately designed, they do not expect that the financial disclosure controls and procedures or internal control over financial reporting will prevent all errors and fraud. In reaching a reasonable level of assurance, management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. A control system, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. BUSINESS RISKS Petrolifera is exposed to certain risks and uncertainties inherent in the crude oil and natural gas business. Furthermore, being a smaller independent company, it is exposed to financing and other risks which may impair its ability to realize on its assets or to capitalize on opportunities which might become available to it. Additionally, Petrolifera operates in various foreign jurisdictions and is exposed to other risks including currency fluctuations, political risk, price controls and varying forms of fiscal regimes or changes thereto which may impair Petrolifera's ability to conduct profitable operations. The risks arising in the crude oil and natural gas industry include price fluctuations for both crude oil and natural gas over which the company has limited control; risks arising from exploration and development activities; production risks associated with the depletion of reservoirs and the ability to market production. Additional risks include environmental and safety concerns. The success of the company's capital programs as embodied in its productivity and reserve base could also impact its prospective liquidity and pace of future activities. Control of finding, development, operating and overhead costs per boe is an important criterion in determining company growth, success and access to new capital sources. To date, the company has utilized equity financing and reserve based revolving debt facilities and investment backed lines of credit and has had a bias towards conservatively financing its operations under normal industry conditions to offset the inherent risks of domestic and international oil and gas exploration, development and production activities. From time to time, the company may have to access capital markets for new equity to supplement internally generated cash flow and bank borrowings to finance its growth plans. Periodically, these markets may not be receptive to offerings of new equity from treasury, whether by way of private placement or public offerings. This may be further complicated by the smaller market capitalization and limited market liquidity for shares of smaller companies, restricting access to some institutional investors. Periodic fluctuations in energy prices may also affect lending policies of the company's bankers, for new borrowings. This in turn could limit growth prospects over the short run or may even require the company to dedicate cash flow, dispose of properties or raise new equity to reduce bank borrowings under circumstances of declining energy prices or disappointing drilling results. While hedging activities may have opportunity costs when realized prices exceed hedged pricing, such transactions are not meant to be speculative and are considered within the broader framework of financial stability and flexibility. Management continuously reviews the need to utilize such financing techniques. The company attempts to mitigate its business and operational risk exposures by maintaining comprehensive insurance coverage on its assets and operations, by employing or contracting competent technicians and professionals, by instituting and maintaining operational health, safety and environmental standards and procedures and by maintaining a prudent approach to exploration and development activities. The company also addresses and regularly reports on the impact of risks to its shareholders, writing down the carrying values of assets that may not be recoverable. OUTLOOK Petrolifera plans an active and exciting capital program in 2008. It is anticipated this program will be dominated by our anticipated drilling in Peru on Ucayali Block 107, after we complete our 2D seismic program and interpret the data. Early returns are encouraging although a full interpretation will be required. Timing will depend upon rig availability, government EIA approval, scheduling and normal industry factors which can affect operations in a jungle environment. An active 2D seismic program is also planned over selected portions of Maranon Block 106 with a view to drilling in 2009, again subject to the usual conditions and qualifiers related to regulatory approval and rig availability and the timely completion of the planned seismic program. Our Peru budget for 2008 is estimated at approximately $56 million. In Argentina, we have allocated $76 million for new drilling and seismic at Puesto Morales, Rinconada, Vaca Mahuida, Puesto Guevara and Gobernador Ayala II. With our Puesto Morales facilities now completed, our focus again turns to exploration with a view to finding new pools for future development. In Colombia, Petrolifera has already identified three drillable prospects on our Sierra Nevada I license and exploration activity is anticipated for our Sierra Nevada TEA and the Turpial Block. At least one well will be drilled during 2008 to meet contractual obligations on Sierra Nevada I, although programs may be expanded to include the drilling of up to three wells before year end 2008, alone or with partners. FOURTH QUARTER 2007 Petrolifera's fourth quarter 2007 results were weaker than the third quarter and than the similar period last year. Crude oil sales were 6,565 bbl/d and natural gas sales were 2.9 mmcf/d, or 7,042 boe/d on an equivalent basis. This is considerably below 2006 levels when flush production was being realized from new prolific wells at Puesto Morales. Also, sales were lower than reported third quarter 2007 results, when equivalent sales were 7,557 boe/d. This trend has now been reversed with the completion of construction of new facilities at Puesto Morales, contributions from new wells and improved stability in field operations. Revenue in the reporting period was $27 million compared to $31 million in the previous quarter and $45 million in 2006, reflecting lower crude oil prices in Argentina due to the effect of higher export taxes and the strength of the Canadian dollar, which appreciated almost 20 percent against the US dollar during 2007. The average price received for crude oil sales in the fourth quarter of 2007 was $44.36 per barrel and boe prices were $42.07 per boe, the lowest for the year. Cash flow was a modest $10.7 million ($0.21 per share) due to higher provisions for cash taxes compared to the prior quarter in 2007 and below 2006 due to lower volumes and higher costs. In 2006, fourth quarter cash flow was a record $18.5 million ($0.42 per share). Earnings in the fourth quarter 2007 were $4.9 million ($0.10 per share), essentially the same as the third quarter earnings but considerably less than in 2006 when fourth quarter net income was $12.4 million ($0.29 per share). Capital spending in the fourth quarter 2007 was substantial at $57.6 million as the company operated four rigs in Argentina for much of the period and also completed its field facility construction program. QUARTERLY RESULTS ------------------------------------------------------------------------- 2006 ------------------------------------------------------------------------- Three months ended -------------------------------------- Mar 31 June 30 Sept 30 Dec 31 ------------------------------------------------------------------------- Financial results ($000 except per share amounts) - unaudited ------------------------------------------------------------------------- Total revenue 8,452 18,821 33,157 45,153 ------------------------------------------------------------------------- Cash flow from operations before working capital changes(1) 3,435 9,470 18,384 18,495 ------------------------------------------------------------------------- Basic, per share(1) 0.10 0.25 0.46 0.42 ------------------------------------------------------------------------- Diluted, per share(1) 0.07 0.19 0.38 0.35 ------------------------------------------------------------------------- Earnings for the period 1,543 7,685 15,683 12,401 ------------------------------------------------------------------------- Basic, per share 0.04 0.21 0.39 0.28 ------------------------------------------------------------------------- Diluted, per share 0.03 0.16 0.32 0.24 ------------------------------------------------------------------------- Capital expenditures 2,321 2,310 9,738 22,031 ------------------------------------------------------------------------- Cash on hand 21,999 25,941 36,206 51,008 ------------------------------------------------------------------------- Working capital surplus (deficit) 21,959 28,913 41,361 40,456 ------------------------------------------------------------------------- Indebtedness - - - - ------------------------------------------------------------------------- Shareholders' equity 32,991 40,844 61,440 78,074 ------------------------------------------------------------------------- Total assets 38,989 52,760 81,226 118,517 ------------------------------------------------------------------------- Operating results ------------------------------------------------------------------------- Production/sales volumes ------------------------------------------------------------------------- Crude oil - bbl/d 1,855 4,006 7,202 10,716 ------------------------------------------------------------------------- Natural gas - mcf/d 1,243 1,181 1,259 1,101 ------------------------------------------------------------------------- Equivalent - boe/d(2) 2,062 4,203 7,412 10,900 ------------------------------------------------------------------------- Pricing ------------------------------------------------------------------------- Crude oil - $/bbl 48.90 50.71 49.49 45.20 ------------------------------------------------------------------------- Natural gas - $/mcf 1.17 1.33 1.44 1.50 ------------------------------------------------------------------------- Selected highlights - $/boe(2) ------------------------------------------------------------------------- Weighted average selling price per boe 44.70 48.71 48.33 44.59 ------------------------------------------------------------------------- Interest and other income 0.84 0.50 0.30 0.44 ------------------------------------------------------------------------- Royalties 5.74 7.20 6.73 6.37 ------------------------------------------------------------------------- Operating costs 4.52 4.42 5.21 4.02 ------------------------------------------------------------------------- Netback(3) 35.28 37.59 36.69 34.64 ------------------------------------------------------------------------- Common share information (000) ------------------------------------------------------------------------- Shares outstanding at end of period 37,100 37,855 42,817 43,612 ------------------------------------------------------------------------- Fully diluted 52,172 52,172 52,671 52,704 ------------------------------------------------------------------------- Weighted average shares outstanding for the period ------------------------------------------------------------------------- Basic 36,036 37,399 40,442 43,418 ------------------------------------------------------------------------- Diluted 47,500 48,777 48,594 51,002 ------------------------------------------------------------------------- Volume traded during quarter (000) 26,745 8,697 16,732 18,086 ------------------------------------------------------------------------- Common share price ($) ------------------------------------------------------------------------- High 13.75 12.60 21.95 25.24 ------------------------------------------------------------------------- Low 6.55 8.15 10.92 14.71 ------------------------------------------------------------------------- Close (end of period) 12.25 11.00 20.90 17.65 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 2007 ------------------------------------------------------------------------- Three months ended -------------------------------------- Mar 31 June 30 Sept 30 Dec 31 ------------------------------------------------------------------------- Financial results ($000 except per share amounts) - unaudited ------------------------------------------------------------------------- Total revenue 47,122 28,105 31,730 27,266 ------------------------------------------------------------------------- Cash flow from operations before working capital changes(1) 24,615 14,504 18,619 10,707 ------------------------------------------------------------------------- Basic, per share(1) 0.56 0.30 0.37 0.21 ------------------------------------------------------------------------- Diluted, per share(1) 0.49 0.28 0.36 0.21 ------------------------------------------------------------------------- Earnings for the period 15,069 4,450 4,919 4,863 ------------------------------------------------------------------------- Basic, per share 0.34 0.09 0.10 0.10 ------------------------------------------------------------------------- Diluted, per share 0.30 0.09 0.10 0.09 ------------------------------------------------------------------------- Capital expenditures 7,514 19,842 26,061 57,608 ------------------------------------------------------------------------- Cash on hand 59,155 66,535 11,368 13,052 ------------------------------------------------------------------------- Working capital surplus (deficit) 58,811 69,690 22,742 (31,779) ------------------------------------------------------------------------- Indebtedness - - - 29,612 ------------------------------------------------------------------------- Shareholders' equity 98,124 120,236 121,727 120,303 ------------------------------------------------------------------------- Total assets 137,840 139,054 144,016 204,227 ------------------------------------------------------------------------- Operating results ------------------------------------------------------------------------- Production/sales volumes ------------------------------------------------------------------------- Crude oil - bbl/d 11,333 6,644 7,195 6,565 ------------------------------------------------------------------------- Natural gas - mcf/d 1,858 1,726 2,169 2,860 ------------------------------------------------------------------------- Equivalent - boe/d(2) 11,643 6,932 7,557 7,042 ------------------------------------------------------------------------- Pricing ------------------------------------------------------------------------- Crude oil - $/bbl 45.43 45.17 46.99 44.36 ------------------------------------------------------------------------- Natural gas - $/mcf 1.53 1.42 1.41 1.76 ------------------------------------------------------------------------- Selected highlights - $/boe(2) ------------------------------------------------------------------------- Weighted average selling price per boe 44.47 43.65 45.15 42.07 ------------------------------------------------------------------------- Interest and other income 0.50 0.90 0.49 0.01 ------------------------------------------------------------------------- Royalties 5.59 6.19 5.77 5.76 ------------------------------------------------------------------------- Operating costs 4.40 5.56 6.96 8.20 ------------------------------------------------------------------------- Netback(3) 34.98 32.80 32.91 28.12 ------------------------------------------------------------------------- Common share information (000) ------------------------------------------------------------------------- Shares outstanding at end of period 44,029 50,084 50,119 50,127 ------------------------------------------------------------------------- Fully diluted 53,380 53,382 51,803 51,670 ------------------------------------------------------------------------- Weighted average shares outstanding for the period ------------------------------------------------------------------------- Basic 43,800 47,816 50,107 50,123 ------------------------------------------------------------------------- Diluted 50,635 51,303 51,800 51,689 ------------------------------------------------------------------------- Volume traded during quarter (000) 7,202 6,211 10,921 12,223 ------------------------------------------------------------------------- Common share price ($) ------------------------------------------------------------------------- High 20.20 19.29 22.35 17.10 ------------------------------------------------------------------------- Low 16.05 16.60 13.18 9.14 ------------------------------------------------------------------------- Close (end of period) 19.14 17.04 15.20 9.87 ------------------------------------------------------------------------- (1) Cash flow from operations before working capital changes ("cash flow") and cash flow per share do not have standardized meanings prescribed by Canadian generally accepted accounting principles ("GAAP") and therefore may not be comparable to similar measures used by other companies. Cash flow from operations before working capital changes includes all cash flow from operating activities and is calculated before changes in non-cash working capital. The most comparable measure calculated in accordance with GAAP would be net earnings. Cash flow from operations before working capital changes is reconciled with net earnings on the Consolidated Statement of Cash Flows and in the accompanying Management's Discussion & Analysis. Management uses these non-GAAP measurements for its own performance measures and to provide its shareholders and investors with a measurement of the company's efficiency and its ability to fund a portion of its future growth expenditures. (2) All references to barrels of oil equivalence (boe) are calculated on the basis of 6 mcf : 1 bbl. Boe may be misleading particularly if used in isolation. This conversion is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalent at the wellhead. (3) Netback is a non-GAAP measure used by management as a measure of operating efficiency and profitability. It is calculated as petroleum and natural gas revenue and other income less royalties and operating costs. CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATED BALANCE SHEETS Petrolifera Petroleum Limited December 31 ------------------------------------------------------------------------- 2007 2006 ------------------------------------------------------------------------- $000 ------------------------------------------------------------------------- ASSETS ------------------------------------------------------------------------- Current ------------------------------------------------------------------------- Cash and cash equivalents $13,052 $51,008 ------------------------------------------------------------------------- Accounts receivable 27,512 26,868 ------------------------------------------------------------------------- Prepaid expenses 468 302 ------------------------------------------------------------------------- Inventories (Note 4) 854 374 ------------------------------------------------------------------------- 41,886 78,552 ------------------------------------------------------------------------- Long-term investments (Note 5) 33,378 - ------------------------------------------------------------------------- Deferred financing costs (Note 8) 2,089 - ------------------------------------------------------------------------- Future income taxes (Note 6) - 2,150 ------------------------------------------------------------------------- Property and equipment (Note 7) 126,874 37,815 ------------------------------------------------------------------------- $204,227 $118,517 ------------------------------------------------------------------------- ------------------------------------------------------------------------- LIABILITIES ------------------------------------------------------------------------- Current ------------------------------------------------------------------------- Accounts payable and accrued liabilities $37,963 $14,066 ------------------------------------------------------------------------- Income taxes payable 6,090 23,998 ------------------------------------------------------------------------- Bank debt (Note 8) 29,612 - ------------------------------------------------------------------------- Due to a related company (Note 9) - 32 ------------------------------------------------------------------------- 73,665 38,096 ------------------------------------------------------------------------- Asset retirement obligations (Note 10) 5,639 2,347 ------------------------------------------------------------------------- Future income taxes (Note 6) 4,620 - ------------------------------------------------------------------------- 83,924 40,443 ------------------------------------------------------------------------- ------------------------------------------------------------------------- SHAREHOLDERS' EQUITY ------------------------------------------------------------------------- Share capital, warrants and contributed surplus (Note 11) 64,544 39,275 ------------------------------------------------------------------------- Accumulated other comprehensive income (loss) (10,674) 1,667 ------------------------------------------------------------------------- Retained earnings 66,433 37,132 ------------------------------------------------------------------------- 120,303 78,074 ------------------------------------------------------------------------- $204,227 $118,517 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Commitments, contingencies and guarantees (Note 14) Approved by the board Signed, Signed, "C.J. Smith" "D.D. Barkwell" Director Director CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS (DEFICIT) Petrolifera Petroleum Limited Years Ended December 31 ------------------------------------------------------------------------- 2007 2006 ------------------------------------------------------------------------- $000 (except per share amounts) ------------------------------------------------------------------------- Revenue ------------------------------------------------------------------------- Petroleum and natural gas sales $132,779 $104,595 ------------------------------------------------------------------------- Interest and other income 1,444 988 ------------------------------------------------------------------------- 134,223 105,583 ------------------------------------------------------------------------- Royalties (17,500) (14,796) ------------------------------------------------------------------------- 116,723 90,787 ------------------------------------------------------------------------- Expenses ------------------------------------------------------------------------- Operating 18,267 10,111 ------------------------------------------------------------------------- General and administrative 6,369 3,744 ------------------------------------------------------------------------- Stock-based compensation 6,833 3,628 ------------------------------------------------------------------------- Finance charges 421 88 ------------------------------------------------------------------------- Fair value impairment - ABCP (Note 5) 6,169 - ------------------------------------------------------------------------- Foreign exchange loss 2,331 439 ------------------------------------------------------------------------- Taxes other than income taxes 2,138 655 ------------------------------------------------------------------------- Depletion, depreciation and accretion 16,890 9,614 ------------------------------------------------------------------------- 59,418 28,279 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Earnings before income taxes 57,305 62,508 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Current income tax provision (Note 6) 21,083 26,405 ------------------------------------------------------------------------- Future income tax provision (recovery) (Note 6) 6,921 (1,209) ------------------------------------------------------------------------- 28,004 25,196 ------------------------------------------------------------------------- ------------------------------------------------------------------------- NET EARNINGS 29,301 37,312 ------------------------------------------------------------------------- ------------------------------------------------------------------------- RETAINED EARNINGS (DEFICIT), BEGINNING OF YEAR 37,132 (180) ------------------------------------------------------------------------- ------------------------------------------------------------------------- RETAINED EARNINGS, END OF YEAR $66,433 $37,132 ------------------------------------------------------------------------- ------------------------------------------------------------------------- ------------------------------------------------------------------------- NET EARNINGS PER SHARE (Note 13) ------------------------------------------------------------------------- Basic $0.61 $0.95 ------------------------------------------------------------------------- Diluted $0.57 $0.75 ------------------------------------------------------------------------- CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME Petrolifera Petroleum Limited Year Ended December 31 ------------------------------------------------------------------------- 2007 ------------------------------------------------------------------------- $000 ------------------------------------------------------------------------- Net Earnings $29,301 ------------------------------------------------------------------------- Foreign currency translation adjustment (12,341) ------------------------------------------------------------------------- Comprehensive income $16,960 ------------------------------------------------------------------------- CONSOLIDATED STATEMENT OF ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Petrolifera Petroleum Limited Year Ended December 31 ------------------------------------------------------------------------- 2007 ------------------------------------------------------------------------- $000 ------------------------------------------------------------------------- Accumulated other comprehensive income, beginning of year $1,667 ------------------------------------------------------------------------- Foreign currency translation adjustment (12,341) ------------------------------------------------------------------------- Accumulated other comprehensive income (loss), end of year $(10,674) ------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS Petrolifera Petroleum Limited Years Ended December 31 ------------------------------------------------------------------------- 2007 2006 ------------------------------------------------------------------------- $000 ------------------------------------------------------------------------- Cash provided by (used in) the following activities: ------------------------------------------------------------------------- ------------------------------------------------------------------------- Operating ------------------------------------------------------------------------- Net earnings $29,301 $37,312 ------------------------------------------------------------------------- Items not involving cash: ------------------------------------------------------------------------- Depletion, depreciation and accretion 16,890 9,614 ------------------------------------------------------------------------- Stock-based compensation 6,833 3,628 ------------------------------------------------------------------------- Fair value impairment - ABCP (Note 5) 6,169 - ------------------------------------------------------------------------- Foreign exchange loss 2,331 439 ------------------------------------------------------------------------- Future income tax provision (recovery) 6,921 (1,209) ------------------------------------------------------------------------- Cash flow from operations before working capital changes 68,445 49,784 ------------------------------------------------------------------------- Changes in non-cash working capital (Note 13) (19,604) 3,899 ------------------------------------------------------------------------- 48,841 53,683 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Financing ------------------------------------------------------------------------- Issue of common shares, net of share issue costs 18,435 8,407 ------------------------------------------------------------------------- Proceeds from bank debt 29,612 - ------------------------------------------------------------------------- Deferred financing costs (2,089) - ------------------------------------------------------------------------- 45,958 8,407 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Investing ------------------------------------------------------------------------- Development of oil and gas properties (111,025) (36,400) ------------------------------------------------------------------------- Long-term investments (Note 5) (39,633) - ------------------------------------------------------------------------- Changes in non-cash working capital (Note 13) 24,271 4,796 ------------------------------------------------------------------------- (126,387) (31,604) ------------------------------------------------------------------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (31,588) 30,486 ------------------------------------------------------------------------- ------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 51,008 19,744 ------------------------------------------------------------------------- Impact of foreign exchange on foreign currency denominated cash balances (6,368) 778 ------------------------------------------------------------------------- ------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS, END OF YEAR $13,052 $51,008 ------------------------------------------------------------------------- ------------------------------------------------------------------------- ------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS IS COMPOSED OF: ------------------------------------------------------------------------- Cash in banks $13,052 $18,345 ------------------------------------------------------------------------- Term deposits - 32,663 ------------------------------------------------------------------------- $13,052 $51,008 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Supplementary information - Note 13 ------------------------------------------------------------------------- NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Petrolifera Petroleum Limited December 31 1. INCORPORATION Petrolifera Petroleum Limited ("Petrolifera" or the "company") was incorporated on November 9, 2004. Through subsidiaries and foreign branches, it is engaged in petroleum and natural gas exploration, development and production activities in Argentina, Colombia and Peru. 2. FINANCIAL STATEMENT PRESENTATION The financial statements include the accounts of the company and its subsidiaries and are presented in Canadian dollars and in accordance with Canadian generally accepted accounting principles. 3. SIGNIFICANT ACCOUNTING POLICIES Cash and cash equivalents Cash and cash equivalents includes short-term deposits with initial maturities of three months or less when purchased. Inventory Crude oil inventory is measured at the lower of cost (on a weighted average cost basis) and net realizable value. Income taxes The company follows the liability method of accounting for income taxes. Under this method, income tax liabilities and assets are recognized for the estimated tax consequences attributed to differences between the amounts reported in the financial statements and their respective tax bases, using substantively enacted income tax rates. The effect of a change in income tax rates on future income tax liabilities and assets is recognized in income in the period that the change occurs. Future tax assets are assessed by management at each balance sheet date and recognized when realization is more likely than not. Petroleum and natural gas operations The company follows the full cost method of accounting whereby all costs relating to the exploration for and development of crude oil and natural gas reserves are capitalized on a country by country cost centre basis. Capitalized costs of petroleum and natural gas properties and related equipment within a cost centre are depleted and depreciated using the unit-of-production method based on estimated proved crude oil and natural gas reserves, as determined by independent consulting engineers. For the purpose of this calculation, production and reserves of natural gas are converted to equivalent units of crude oil based on relative energy content (6:1). The company applies a "ceiling test" to the net book value of petroleum and natural gas properties for each cost centre to ensure that such carrying value does not exceed the estimated fair value of the properties. The carrying value is assessed to be recoverable when the sum of the undiscounted cash flows expected from the production of proved reserves and the cost, less impairment, of unproved properties exceeds the carrying value. If the carrying value is assessed to not be recoverable, the calculation compares the carrying value to the sum of the discounted cash flows expected from the production of proved and probable reserves and the cost, less impairment, of unproved properties. Should the carrying value exceed this sum, an impairment loss is recognized. The cash flows are estimated using projected future product prices and costs and are discounted using the credit adjusted risk-free interest rate. Costs of acquiring and evaluating unproved properties and major development projects are excluded from costs subject to depletion and depreciation until it is determined whether or not proved reserves are attributable to the properties, the project becomes commercial, or impairment occurs. These costs are reviewed quarterly and any impairment is transferred to the costs being depleted or, if the properties are located in a cost centre where there is no reserve base, the impairment is charged directly to earnings. Gains or losses on sales of properties are recognized only when crediting the proceeds to cost would result in a change of 20 percent or more in the depletion and depreciation rate. Asset retirement obligations The company provides for the costs of retirement obligations associated with long-lived assets, including the abandonment of oil and natural gas wells, related facilities, compressors and gas plants, removal of equipment from leased acreage and returning such land to its original condition. The estimated fair value of each asset retirement obligation is recorded in the period a well or related asset is drilled, constructed or acquired. Fair value is estimated using the present value of the estimated future cash outflows to abandon the asset using the company's credit adjusted risk-free interest rate and expected inflation rate. The obligation is reviewed regularly by management based upon current regulations, costs, technologies and industry standards. The discounted obligation is initially capitalized as part of the carrying amount of the related oil and natural gas properties and a corresponding liability is recognized. The liability is accreted against income until it is settled or the property is sold and is included as a component of depletion and depreciation expense. The increase in oil and natural gas properties is depleted and depreciated on the same basis as the remainder of the oil and natural gas properties. Actual restoration expenditures are charged to the accumulated obligation as incurred. Foreign operations The company is exposed to foreign currency fluctuations, political risks, price controls and varying forms of fiscal regimes or changes thereto which may impair its ability to conduct profitable operations as it operates internationally and holds foreign denominated cash and other assets. Revenue recognition Petroleum and natural gas sales are recognized as revenue at the time the respective commodities are delivered to purchasers at the point of sale. Stock-based compensation The company uses the fair value method for valuing stock option grants. Compensation costs attributed to share options granted are measured at fair value at the grant date and expensed over the vesting period with a corresponding increase to contributed surplus. Upon exercise of the stock options, consideration paid by the option holder together with the amount previously recognized in contributed surplus is recorded as an increase to share capital. Financial instruments Financial instruments include cash and cash equivalents, accounts receivable, long-term investments, accounts payable, bank debt and amount due to a related company. All carrying values of financial instruments approximate fair values due to their short-term maturities other than long-term investments which are carried at estimated fair value. Credit risk The majority of the accounts receivable is in respect of sales of petroleum and natural gas. The company generally extends unsecured credit to customers and therefore, the collection of accounts receivable may be affected by changes in economic or other conditions. Management believes the risk is mitigated by the size and reputation of the companies to which credit has been extended. The company is exposed to credit risk on its short term and long term investments including asset-backed commercial paper ("ABCP") (Note 5). Interest rate risk Drawings under the Company's bank credit facilities are at floating interest rates and expose the company to interest rate risk. Deferred financing costs Deferred financing costs include amounts incurred in relation to the company's revolving credit facility and are recognized against earnings over the life of the associated credit facility. Commodity risk The company is exposed to fluctuations in commodity prices and has no contracts in place to mitigate these exposures. Measurement uncertainty The timely preparation of the financial statements in conformity with Canadian generally accepted accounting principles requires that management make estimates and assumptions and use judgment regarding the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Such estimates primarily relate to unsettled transactions and events as of the date of the consolidated financial statements. Accordingly, actual results may differ from estimated amounts as future confirming events occur. Amounts recorded for depreciation, depletion and accretion, amounts used for ceiling test and impairment calculations and amounts used in the determination of the future tax asset or liability are based, in part, on estimates of natural gas and crude oil reserves and future costs required to develop those reserves. By their nature, these estimates of reserves, including the estimates of future prices and costs and the related future cash flows are subject to measurement uncertainty. Per share amounts Basic per share amounts are calculated using the weighted average number of common shares outstanding for the period. The company follows the treasury stock method to calculate diluted per share amounts. The treasury stock method assumes that any proceeds from the exercise of in- the-money stock purchase warrants and other dilutive instruments, in addition to stock-based compensation not yet recognized, would be used to purchase common shares at the average market price during the period. Foreign currency translation Business conducted in Colombia and Peru is considered to be an "integrated foreign operation" for accounting purposes and, therefore, the foreign operations financial statements are translated into Canadian dollars using the temporal method. Under the temporal method, the company translates foreign denominated monetary assets and liabilities at the exchange rate prevailing at year end; non-monetary assets, liabilities and related depletion and depreciation are translated at historic rates; revenues and expenses are translated at the average rate of exchange for the period; and any resulting foreign exchange gains or losses are included in earnings. Due to the significant increase in cash flow generated in Argentina in the second quarter of 2006, the company determined its Argentinean activities comprise a self-sustaining operation. This necessitated a change in the way the Argentinean operations were translated into Canadian dollars for reporting purposes. As a self-sustaining foreign operation, the Argentinean financial statements are translated into Canadian dollars using the current rate method, whereby assets and liabilities are translated at the rate of exchange in effect at the balance sheet date; revenues and expenses are translated at the average monthly rates of exchange during the period; and gains or losses on translation are included as a foreign currency translation adjustment in the consolidated statement of comprehensive income and accumulated other comprehensive income. Impact of New and Proposed Accounting Pronouncements Effective January 1, 2007 the company adopted CICA Handbook sections 1530, 3251, 3855, 3861 and 3865 relating to Comprehensive Income, Equity, Financial Instruments - Recognition and Measurement, Financial Instruments - Disclosure and Presentation, and Hedges, respectively. Under the new standards, additional financial statement disclosure, namely Consolidated Statements of Comprehensive Income, has been introduced. This statement identifies certain gains and losses, which in the company's case at this time, include only foreign currency translation adjustments arising from translation of the company's Argentinean business unit, that are recorded outside the statement of operations. Additionally, a separate component of equity, Accumulated Other Comprehensive Income, has been introduced to disclose other comprehensive income balances on a cumulative basis. Finally, all financial instruments, including derivatives, are recorded in the company's consolidated balance sheet and measured at their fair values. Under section 3855, the company is required to classify its financial instruments into one of five categories. The company has classified all of its financial instruments, with the exception of the revolving bank debt facility, as Held for Trading, which requires measurement on the balance sheet at fair value with any changes in fair value recorded in income. This classification has been chosen due to the nature of the company's financial instruments. Transaction costs related to financial instruments classified as held for trading are recorded in income in accordance with the new standards. The revolving bank debt facility has been classified as "other financial liabilities". The adoption of section 3865, "Hedges", has had no effect on the company's consolidated financial statements as the company has no hedging transactions in place at this time. Effective January 1, 2007, the company adopted the revised recommendations of CICA Handbook section 1506, Accounting Changes. The new recommendations permit voluntary changes in accounting policy only if they result in financial statements which provide more relevant and reliable financial information. Accounting policy changes must be applied retrospectively unless it is impractical to determine the period or cumulative impact of the change in policy. Additionally, when an entity has not applied a new primary source of GAAP that has been issued but is not yet effective, the entity must disclose that fact along with information relevant to assessing the possible impact that the application of the new primary source of GAAP will have on the entity's financial statements in the period of initial application. As of January 1, 2008, the company will be required to adopt two new CICA Handbook requirements, section 3862, "Financial Instruments - Disclosures" and section 3863, "Financial Instruments - Presentation" which will replace current section 3861. The new standards require disclosure of the significance of financial instruments to an entity's financial statements, the risks associated with the financial instruments and how those risks are managed. The new presentation standard essentially carries forward the current presentation requirements. The company is assessing the impact of these new standards. As of January 1, 2008, the company will be required to adopt CICA Handbook section 1535, "Capital Disclosures" which requires entities to disclose their objectives, policies and processes for managing capital and, in addition, whether the entity has complied with any externally imposed capital requirements. The company is assessing the impact of this new standard. As of January 1, 2008, Petrolifera is required to adopt the CICA Handbook Section 3031, "Inventories," which will replace the existing inventories standard. The new standard requires inventory to be valued on a first-in, first-out or weighted average basis, which is consistent with Petrolifera's current treatment. The adoption of this standard should not have a material impact on Petrolifera's Consolidated Financial Statements. In February 2008, the CICA issued section 3064, Goodwill and Intangible Assets, replacing section 3062, Goodwill and Other Intangible Assets and section 3450, Research and Development Costs. Various changes have been made to other sections of the CICA Handbook for consistency purposes. The new section will be applicable to financial statements relating to fiscal years beginning on or after October 1, 2008. Accordingly, the company will adopt the new standard for its fiscal year beginning January 1, 2009. It establishes standards for the recognition, measurement, presentation and disclosure of goodwill subsequent to its initial recognition and of intangible assets by profit-oriented enterprises. Standards concerning goodwill are unchanged from the standards included in the previous section 3062. The company is currently evaluating the impact of the adoption of this new section. Over the next three years the CICA will adopt its new strategic plan for the direction of accounting standards in Canada, which was ratified in January 2006. As part of the plan, Canadian GAAP for public companies will converge with International Financial Reporting Standards ("IFRS") over the next three years. The company continues to monitor and assess the impact of the convergence of Canadian GAAP with IFRS. 4. INVENTORIES The company maintains inventory as a consequence of the sales process for its products, whereby crude oil which has been produced is not delivered to customers for periods of up to several days, during which time it must be stored. ------------------------------------------------------------------------- Years ended December 31 2007 2006 ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- Crude oil $854 $374 ------------------------------------------------------------------------- At December 31, 2007 and 2006 inventory is composed of crude oil and natural gas liquids held in storage at the company's facilities and in transportation pipelines. Crude oil and natural gas liquids are carried at the lower of cost or market. 5. LONG-TERM INVESTMENTS In August 2007 the ABCP market experienced severe liquidity problems. This has caused the conduits that issued the notes to default on the redemption of the notes. As a result, holders could not receive their cash plus interest at maturity. On September 6, 2007 a panel of banks, asset providers, and major investors formed the Pan-Canadian Investors Committee for Third-Party Structured Asset-Backed Commercial Paper ("Pan-Canadian Committee") to oversee a proposed restructuring process. The proposed restructuring called for the ABCP to be converted into longer term floating rate notes which more closely match the maturities of the underlying assets. On December 23, 2007, the Pan-Canadian Committee announced the framework of the restructuring of the conduits in which the company is invested. Under this framework, groups of assets from the conduits that are either wholly or partially represented by synthetic assets ("synthetic pool") will be pooled together and exchanged for two sets of notes, a senior note and a subordinated note. The ratio of the breakdown between senior and subordinated notes for any individual trust will be determined by the relative contribution of value of the assets contributed to the synthetic pool by the trust to the total value of the pool of synthetic assets. Also, under the proposed restructuring certain pools of the assets that do not qualify for the synthetic pool will remain in the trust and new notes will be distributed to the existing noteholders with a term similar to the maturities of the underlying assets ("non-qualifying pool"). Therefore, should the Pan-Canadian Committee proposal be adopted it is anticipated that the company would receive three types of notes: synthetic pool senior notes, synthetic pool subordinated notes, and non- qualifying pool notes. Quoted market values of the ABCP are not available due to the market disruption that is currently paralyzing the ABCP market. Management has therefore estimated the fair value of the owned ABCP based on a probabilistic recovery of principal and interest taking into account all available information. Under this valuation method, several different outcomes of the recovery of the principal and interest are estimated considering the information available as at December 31, 2007. A weighted average recovery is then calculated. This weighted average recovery is used to determine the discounted cash flows that are expected from these investments. The recovery factors used for the synthetic pool notes were as follows: from 50 percent to 100 percent with a weighted average recovery of 98 percent for the principal portion of senior notes and from 0 percent to 50 percent with a weighted average recovery of 45 percent for the principal portion of the subordinated notes; from 0 percent to 100 percent with a weighted average recovery of 93 percent for the interest applicable to senior notes and from 0 percent to 50 percent with a weighted average recovery of 45 percent for the interest applicable to the subordinated notes. The recovery factors used for the non-qualifying pool notes ranged from 0 percent to 100 percent with a weighted average recovery of 70 percent for principal portion and from 0 percent to 100 with a weighted average recovery of 50 percent for interest applicable to the notes. The term for the synthetic pool notes was between two and nine years and for the non-qualifying pool notes the term was nine years. The fair value of the investment in ABCP is estimated to be $31.4 million which implies an impairment of $6.2 million or approximately 16 percent of the carrying value of the ABCP. As at December 31, 2007, included in long-term investments were ABCP with a face value of $37.7 million. These investments are classified as Held for Trading and are carried at fair value which is assessed each reporting date. Previously these were classified as current assets and were part of working capital. Petrolifera has taken a non-cash impairment charge of $6.2 million against the carrying value of the notes classified as long term investments. The theoretical fair value of the company's ABCP could range from $26.0 million to $34.4 million using the same valuation methodology with alternative reasonably possible assumptions. The Company anticipates that it presently has sufficient cash resources and available credit to satisfy obligations as they come due. Assuming the ABCP problems are restructured in 2008 and normal liquidation for cash occurs, the company would be able to substantially reduce its indebtedness incurred from lack of access to these amounts. The outcome of the restructuring process, actual timing and amount ultimately recoverable from these notes may differ materially from this estimate which would impact the company's earnings in future periods. 6. INCOME TAXES The following table reconciles income taxes calculated at the Canadian statutory rate with recorded income taxes: ------------------------------------------------------------------------- Years ended December 31 2007 2006 ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- Earnings before income taxes $57,305 $62,508 ------------------------------------------------------------------------- Statutory income tax rate 32.12% 32.2% ------------------------------------------------------------------------- Expected income tax $18,406 $20,128 ------------------------------------------------------------------------- Non deductible expenditures and foreign taxes 5,073 1,686 ------------------------------------------------------------------------- Stock compensation 2,195 1,167 ------------------------------------------------------------------------- Rate adjustment and other 2,330 2,215 ------------------------------------------------------------------------- Tax expense $28,004 $25,196 ------------------------------------------------------------------------- Future tax assets and liabilities relate to the following temporary timing differences: ------------------------------------------------------------------------- Years ended December 31 2007 2006 ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- Property and equipment $(611) $(717) ------------------------------------------------------------------------- Non-capital loss carryforwards 182 645 ------------------------------------------------------------------------- Share issue costs 6 524 ------------------------------------------------------------------------- Future foreign tax credit (4,115) 1,127 ------------------------------------------------------------------------- Asset retirement obligation 12 644 ------------------------------------------------------------------------- Valuation allowance (102) (73) ------------------------------------------------------------------------- Other 8 - ------------------------------------------------------------------------- Future tax asset (liability) $(4,620) $2,150 ------------------------------------------------------------------------- 7. PROPERTY AND EQUIPMENT ------------------------------------------------------------------------- Accumulated Depletion and Deprec- Net Book Cost iation Value ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- As at December 31, 2007 Petroleum and natural gas properties and equipment $150,152 $24,096 $126,056 Furniture, equipment and leaseholds 1,094 276 818 ------------------------------------------------------------------------- $151,246 $24,372 $126,874 ------------------------------------------------------------------------- As at December 31, 2006 Petroleum and natural gas properties and equipment $47,803 $10,445 $37,358 Furniture, equipment and leaseholds 523 66 457 ------------------------------------------------------------------------- $48,326 $10,511 $37,815 ------------------------------------------------------------------------- Included in property and equipment are estimated future asset retirement costs of $5.4 million (2006 - $2.3 million). In 2007, the company capitalized $2.4 million (2006 - $0.7 million) of general and administrative expenses related to exploration and development activities. Depletion, depreciation and accretion expense includes a charge of $0.1 million (2006 - $0.03 million) to accrete the company's estimated asset retirement obligations (Note 10). Capital costs of $15.3 million (2006 - $6.4 million) incurred for unevaluated properties in Argentina and for major development projects and other assets in a pre-production stage located in Peru and Colombia have been excluded from the depletion, depreciation and accretion calculation. No proved reserves have been assigned to these projects. These costs have been separately evaluated by management for impairment. No impairment has been recorded at December 31, 2007 or 2006. Based on the ceiling test as at December 31, 2007, which excludes the above costs incurred for unevaluated properties, no impairment has been recorded at December 31, 2007 or 2006. Petrolifera's petroleum and natural gas reserves were evaluated by independent reservoir engineers as at December 31, 2007 in a report dated March 3, 2008. The evaluation was conducted in accordance with Canadian Securities Administrators' National Instrument 51-101, using the following price assumptions: ------------------------------------------------------------------------- Crude Oil Price Natural Gas Price ($CDN/bbl) ($CDN/mcf) ------------------------------------------------------------------------- 2008 42.00 2.44 2009 42.84 2.49 2010 43.70 2.54 2011 44.57 2.59 2012 45.46 2.64 ------------------------------------------------------------------------- + approximately 2% + approximately 2% thereafter thereafter ------------------------------------------------------------------------- 8. CREDIT FACILITIES During 2007 the company entered into two separate credit facilities. In September the Company finalized a US$100 million reserve-based revolving credit facility, with initial available draws established at US$60 million. The initial facility was for three years, bears interest at LIBOR plus a margin, is secured by a pledge of the shares of Petrolifera's subsidiaries and has a provision for a borrowing base adjustment every six months, with the next adjustment being calculated as at December 31, 2007. Drawings under this facility are made for a term of less than one year and are therefore classified as a current liability. Deferred financing costs of $2.1 million related to this facility are being amortized over the term of the facility. In December 2007 the company established an $18 million line of credit with a Canadian chartered bank. This facility bears interest at a floating rate and is solely secured by the ABCP notes. As of December 31, 2007, the reserve based facility had US$20.0 million outstanding and the line of credit facility had $9.9 million outstanding. 9. RELATED PARTY TRANSACTIONS Under the terms of a Management Services Agreement with Connacher Oil and Gas Limited ("Connacher"), for a term of twelve months effective January 1, 2008, Connacher provides some management and general and administrative services to assist in the administration of the company. The fee for this service is $15,000 per month. From time to time Connacher also pays bills on behalf of Petrolifera, for which it is reimbursed at cost. Connacher is also guarantor for Petrolifera in Peru and operator of record on behalf of Petrolifera in Colombia for which Connacher is indemnified by Petrolifera. Petrolifera paid Connacher $0.2 million in 2007 for the previous management services agreement, which was replaced by the new agreement effective January 1, 2008. In 2007 the company paid professional legal fees in the amount of $0.2 million (2006 - $0.6 million) to a law firm in which an officer of the company is a related party. Transactions with the related party occurred within the normal course of business and have been measured at the exchange amount on normal business terms. The exchange amount is the amount of consideration established and agreed to with the related parties. 10. ASSET RETIREMENT OBLIGATIONS At December 31, 2007 the estimated total undiscounted amount required to settle the asset retirement obligations was $11.3 million (2006 - $6.3 million). These obligations are expected to be settled over the useful lives of the underlying assets, which currently extend into the future for up to 20 years. This amount has been discounted using a credit-adjusted risk-free interest rate of six percent and an annual inflation rate of two percent. Changes to asset retirement obligations were as follows: ------------------------------------------------------------------------- Years ended December 31 2007 2006 ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- Asset retirement obligations, beginning of year $2,347 $467 Liabilities incurred 2,678 1,853 Changes in estimates 490 - Accretion expense 124 27 ------------------------------------------------------------------------- Asset retirement obligations, end of year $5,639 $2,347 ------------------------------------------------------------------------- 11. SHARE CAPITAL, WARRANTS AND CONTRIBUTED SURPLUS Authorized: The authorized share capital is comprised of an unlimited number of common shares. Issued: ------------------------------------------------------------------------- Number Amount of Shares ($000) ------------------------------------------------------------------------- Share capital and warrants: ------------------------------------------------------------------------- Balance share capital and warrants, December 31, 2005 34,403,895 $27,089 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Issued upon exercise of warrants in 2006 (a) 8,677,275 7,908 ------------------------------------------------------------------------- Issued upon exercise of options in 2006 (b) 531,333 515 ------------------------------------------------------------------------- Assigned value of options exercised 139 ------------------------------------------------------------------------- Assigned value of broker compensation warrants exercised 27 ------------------------------------------------------------------------- Share issue costs (16) ------------------------------------------------------------------------- Balance, share capital and warrants, December 31, 2006 43,612,503 $35,662 ------------------------------------------------------------------------- Issued upon exercise of warrants in 2007 (a) 6,031,507 17,822 ------------------------------------------------------------------------- Issued upon exercise of options in 2007 (b) 482,500 614 ------------------------------------------------------------------------- Assigned value of options exercised 258 ------------------------------------------------------------------------- Balance, share capital and warrants, December 31, 2007 50,126,510 $54,356 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Contributed surplus: ------------------------------------------------------------------------- Balance, contributed surplus, December 31, 2005 $151 ------------------------------------------------------------------------- Assigned value of broker compensation warrants exercised (27) ------------------------------------------------------------------------- Assigned fair value of options exercised (139) ------------------------------------------------------------------------- Assigned fair value of stock options vesting 3,628 ------------------------------------------------------------------------- Balance, contributed surplus, December 31, 2006 $3,613 ------------------------------------------------------------------------- Assigned fair value of options exercised (258) ------------------------------------------------------------------------- Assigned fair value of stock options vesting 6,833 ------------------------------------------------------------------------- Balance, contributed surplus, December 31, 2007 $10,188 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Total share capital, warrants and contributed surplus ------------------------------------------------------------------------- December 31, 2007 $64,544 ------------------------------------------------------------------------- December 31, 2006 $39,275 ------------------------------------------------------------------------- (a) Common Share Purchase Warrants Transactions in Common Share Purchase Warrants occurred during 2006 and 2007 as follows: ------------------------------------------------------------------------- Closing balance, December 31, 2005 14,351,947 ------------------------------------------------------------------------- Issued upon exercise of Broker Compensation Warrants in 2006 520,000 ------------------------------------------------------------------------- Exercised in 2006 (8,677,275) ------------------------------------------------------------------------- Closing balance, December 31, 2006 6,194,672 ------------------------------------------------------------------------- Exercised in 2007 (6,031,507) ------------------------------------------------------------------------- Expired in 2007 (3,165) ------------------------------------------------------------------------- Closing balance, December 31, 2007 160,000 ------------------------------------------------------------------------- In 2007 the following warrants were exercised: - 5,926,507 Common Share Purchase Warrants at $3.00 per share from the Initial Public Offering in 2005 resulting in the issuance of 5,926,507 common shares; and - 105,000 Common Share Purchase Warrants at $0.40 per share, resulting in the issuance of 105,000 common shares. As at December 31, 2007, the following Common Share Purchase Warrants were outstanding: (i) 160,000 Common Share Purchase Warrants exercisable to acquire 160,000 common shares at $0.40 per share until October 17, 2008. (b) Stock Options The company had stock options outstanding to acquire common shares, as follows: ------------------------------------------------------------------------- As at December 31 2007 2006 ------------------------------------------------------------------------- Weighted Weighted Average Average Number Exercise Number Exercise of Shares Price of Shares Price ------------------------------------------------------------------------- Outstanding, beginning of year 2,896,667 4.86 2,437,000 $1.04 ------------------------------------------------------------------------- Granted 824,700 18.34 991,000 12.17 ------------------------------------------------------------------------- Exercised (482,500) (1.27) (531,333) 0.97 ------------------------------------------------------------------------- Cancelled (10,000) (13.23) - - ------------------------------------------------------------------------- Outstanding, end of year 3,228,867 8.71 2,896,667 $4.86 ------------------------------------------------------------------------- Exercisable, end of year 1,911,499 6.32 1,057,666 $3.84 ------------------------------------------------------------------------- All options have been granted for a period of five years. Options granted under the plan are generally fully exercisable after three years and expire five years after the date granted. The table below summarizes unexercised stock options. ------------------------------------------------------------------------- Weighted Average Number Remaining Contractual Range of Exercise Prices Outstanding Life at December 31, 2007 ------------------------------------------------------------------------- $0.50 - $2.00 1,433,167 1.9 $8.55 - $20.95 1,795,700 3.7 ------------------------------------------------------------------------- Total 3,228,867 2.9 ------------------------------------------------------------------------- Vested at December 31, 2007 1,911,499 3.0 ------------------------------------------------------------------------- In 2007 a compensatory non-cash expense of $6.8 million (2006 - $3.6 million) was recorded, reflecting the fair value of stock options amortized over the vesting period. The fair value of each option granted in 2007 is estimated on the date of grant using the Black-Scholes option-pricing model with assumptions for grants as follows: ------------------------------------------------------------------------- Risk free interest Expected Expected rate life Volatility ------------------------------------------------------------------------- 2007 4.14% - 4.73% 4 years 70.3% - 75.9% 2006 4.1% 3 years 43% - 66% ------------------------------------------------------------------------- The weighted average fair value at the date of grant of all options granted in 2007 was $10.38 per option (2006 - $4.88 per option). 12. SEGMENTED INFORMATION The Company has corporate offices in Canada and Barbados (combined to comprise the corporate segment), petroleum and natural gas operations in Argentina and exploration activities in Peru and Colombia. Financial information pertaining to these operating segments is presented below. ------------------------------------------------------------------------- Corporate Argentina Peru Colombia Total ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- 2007 ------------------------------------------------------------------------- Revenue, gross $750 $133,473 $- $- $134,223 ------------------------------------------------------------------------- Net earnings (loss) (18,411) 47,791 (43) (36) 29,301 ------------------------------------------------------------------------- Property and equipment 302 110,605 15,373 594 126,874 ------------------------------------------------------------------------- Capital expenditures 35 97,465 12,931 594 111,025 ------------------------------------------------------------------------- Total assets 46,258 139,192 18,170 607 204,227 ------------------------------------------------------------------------- 2006 ------------------------------------------------------------------------- Revenue, gross $826 $104,757 $- $ $105,583 ------------------------------------------------------------------------- Net earnings (loss) (6,262) 43,734 (160) 37,312 ------------------------------------------------------------------------- Property and equipment 268 35,027 2,520 37,815 ------------------------------------------------------------------------- Capital expenditures 268 34,333 1,799 36,400 ------------------------------------------------------------------------- Total assets 29,118 86,486 2,913 118,517 ------------------------------------------------------------------------- Crude oil sales totaling $132 million were made to two large international oil companies during 2007 (2006 - $104 million). 13. SUPPLEMENTARY INFORMATION (a) Per share amounts The following table summarizes the common shares used in the per share calculations. ------------------------------------------------------------------------- For the years ended December 31 2007 2006 ------------------------------------------------------------------------- Weighted average common shares outstanding 47,990,246 39,132,413 Dilutive effect of all stock options and all stock purchase warrants 3,444,904 10,823,848 ------------------------------------------------------------------------- Weighted average common shares outstanding - diluted 51,435,150 49,956,261 ------------------------------------------------------------------------- (b) Net change in non-cash working capital ------------------------------------------------------------------------- For the years ended December 31 2007 2006 ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- Accounts receivable $(644) $(24,808) ------------------------------------------------------------------------- Prepaid expenses (166) (166) ------------------------------------------------------------------------- Accounts payable 23,897 10,234 ------------------------------------------------------------------------- Crude oil inventory (480) (374) ------------------------------------------------------------------------- Income taxes payable (17,908) 23,998 ------------------------------------------------------------------------- Due to a related company (32) (189) ------------------------------------------------------------------------- $4,667 $8,695 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Operating $(19,604) $3,899 ------------------------------------------------------------------------- Investing 24,271 4,796 ------------------------------------------------------------------------- $4,667 $8,965 ------------------------------------------------------------------------- (c) Supplementary cash flow information ------------------------------------------------------------------------- For the years ended December 31 2007 2006 ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- Interest paid $25 $- Income taxes paid 31,400 552 ------------------------------------------------------------------------- 14. WORK COMMITMENTS In 2005 Petrolifera acquired two significant oil and gas exploration licenses in Peru. The licenses have a total US$41.8 million financial commitment to complete negotiated work programs on the two licenses over seven years. The company has the right to withdraw from the licenses at the end of each period associated with the term of the licenses. The first license term for Block 106 ended in 2007 and the company has met its commitment and is currently in the second license term with a commitment to invest a minimum of US$1.6 million in this next term. The company has issued letters of credit in the total amount of US$2.3 million to secure the capital expenditure requirements associated with the two exploration licenses in Peru. In 2007 the Company was granted three concessions in Colombia with a total work commitment of US$5.7 million over a two year period. The company has issued letters of credit in the total amount of US$0.6 million in support of these work commitments. In Argentina the company has total work commitments of US$54.0 million over the next three years related to the Vaca Mahuida, Puesto Guevara and Gobernador Ayala II blocks. Additionally, the company has various guarantees and indemnifications in place in the ordinary course of business, none of which are expected to have a significant impact on the company's financial statements or operations. 15. CONTRACTUAL COMMITMENTS The company's annual commitments under service contracts for drilling, leases for office premises, various operating costs, software license agreements and other equipment are as follows: ------------------------------------------------------------------------- Contractual Subsequent Obligations 2008 2009-2011 2012-2013 to 2013 Total ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- Service contracts and other 14,454 11,601 - - 26,055 ------------------------------------------------------------------------- Total 14,454 11,601 - 11,265 26,055 ------------------------------------------------------------------------- Petrolifera is a party to an arbitration proceeding initiated by the former contract operator of the Puesto Morales/Rinconada block. The former operator is seeking financial compensation including damages for wrongful dismissal. Petrolifera is of the opinion that the claim is without merit and has filed a counterclaim against the former operator. Potential damages, if any against the company are not quantifiable at this time, but in any event are not anticipated to be material to the company.

For further information:

For further information: Richard A Gusella, Executive Chairman,
Petrolifera Petroleum Limited, Phone: (403) 538-6201, Fax: (403) 538-6225,
inquiries@petrolifera.ca, www.petrolifera.ca

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PETROLIFERA PETROLEUM LIMITED

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