Keyera Facilities Income Fund - Q2 Second Quarter Report



    CALGARY, Aug. 8 /CNW/ -

    
    2007 SECOND QUARTER HIGHLIGHTS

    -   Keyera delivered strong second quarter financial results, with net
        earnings before tax and non-controlling interest of $21.6 million, up
        44% compared to the second quarter of 2006. However, Keyera recorded
        a net loss of $59.8 million for the quarter due to an $80.2 million
        non-cash future income tax expense resulting from the enactment of
        the Canadian government's tax on publicly traded income trusts
        starting in 2011.

    -   Distributable cash flow(1) was $31.2 million ($0.51 per unit), 31%
        higher than the same period last year. Distributions to unitholders
        totaled $22.5 million in the second quarter, or $0.369 per unit.

    -   All business segments delivered strong second quarter results.
        Contribution from Gathering and Processing was $15.4 million, up 14%
        from the same period last year. Contribution from NGL Infrastructure
        was $11.2 million, 26% higher than the second quarter of 2006. The
        Marketing business posted a record contribution of $18.1 million, up
        83% from the second quarter of last year.

    -   Keyera announced a project to extract ethane from the raw gas
        processed at its Rimbey gas plant. Subject to regulatory approval and
        other conditions, the project is expected to be completed in 2008 at
        an estimated cost of $26 million. The project will allow Keyera to
        extract up to 5,000 barrels of ethane, the majority of which are
        incremental to Alberta supply, for delivery to a major petrochemical
        producer in Alberta.

    -   Keyera continued to pursue its goal of being the best positioned
        midstream service provider in the key Edmonton/Fort Saskatchewan
        energy hub. It has initiated a project to expand the truck rack at
        its Fort Saskatchewan facility, to increase Keyera's operating
        flexibility and provide enhanced product loading services. In
        addition, opportunities to increase connections to other pipelines,
        enhance terminals and expand storage are being investigated.

    -   Two scheduled maintenance turnarounds were completed in the second
        quarter at Keyera's Rimbey and Brazeau North gas processing plants.
    

    (1) See "Non-GAAP Financial Measures"


    Message to Unitholders

    Building on our track record, Keyera once again generated strong
financial and operating results in the second quarter of 2007, and it is my
pleasure to have the opportunity to share with you a few highlights from this
successful quarter.
    Second quarter earnings before tax and non-controlling interest were
$21.6 million, another record quarter for Keyera and 44% higher than the same
period in 2006. Second quarter distributable cash flow was $31.2 million, or
$0.51 per unit.
    All three of our business lines contributed to these strong results.
Contribution from our Gathering and Processing segment was $15.4 million, 14%
higher than the same period last year, primarily due to very strong results
from the Foothills Region. Our NGL Infrastructure also had another strong
quarter, posting contribution of $11.2 million, a 26% increase from the same
period last year. As well, Keyera used its strategic assets to take advantage
of opportunities in the condensate, propane and butane markets during the
second quarter of 2007. This, along with strong results from our crude oil
midstream business, allowed our Marketing segment to deliver contribution of
$18.1 million, 83% higher than the results in the second quarter of 2006.
These impressive results were achieved in spite of scheduled maintenance
turnarounds at our Rimbey and Brazeau North gas plants.
    Throughout the second quarter, we continued to pursue projects that build
on our long-term business strategy. One of the most exciting projects we have
on the go is the ethane extraction project at our Rimbey gas plant, which will
involve plant modifications and the construction of a 32-kilometre pipeline.
When completed, the project is expected to extract about 5,000 barrels per day
of ethane, the majority of which will be incremental to existing supply. We
took the opportunity to complete the plant tie-ins and some additional plant
modifications required for the project while the Rimbey gas plant was off-line
for its scheduled maintenance turnaround. By completing this initial work
during the turnaround, we should be able to avoid having to shut the plant
down again to complete the balance of the work for the project. Preparations
are well underway for regulatory approvals and we are optimistic that if the
approvals can be received on a timely basis, we will be able to complete the
project in the third quarter of 2008.
    Another project we are excited about is the expansion of the truck
loading rack at our Fort Saskatchewan facility. This $5.5 million project is
designed to enhance our product loading services and provide us with increased
operational flexibility. Assuming construction proceeds as planned, we expect
the expansion to be operational by the end of 2007.
    Building on our existing assets, we also completed a number of smaller
initiatives in the second quarter, including purchasing a pipeline near our
Brazeau River gas plant, increasing our working interest in the Easyford
battery, and purchasing a propane terminal in Montana. We believe they are
strategic investments tied to existing assets and supporting our business
strategy. We are also pleased with the progress that we have made with respect
to the tie-in of a fourth pipeline between Edmonton and Fort Saskatchewan that
we previously announced.
    As noted above, another major accomplishment during the second quarter
was the completion of two scheduled plant turnarounds. These scheduled
turnarounds are part of our comprehensive maintenance program designed to keep
our long-life facilities in good working order and to maintain their ability
to operate reliably for many years. While bad weather hampered the turnaround
at the Rimbey gas plant, our largest facility, we were able to successfully
complete the most extensive turnaround ever undertaken by Keyera. I'd like to
thank our employees for their hard work in making this happen.
    A factor that had implications for our financial statements for the
second quarter was the enactment of the Budget Implementation Act, 2007, the
legislation implementing the federal government's proposals to tax publicly
traded income trusts in Canada. As a result of the enactment of this
legislation, we have recorded a non-cash future income tax expense of
approximately $80 million for the quarter ending June 30, 2007. There is no
immediate impact on Keyera's cashflows or operations as a result of this
recorded expense. We continue to evaluate our options to best position Keyera
for the implementation of the tax (which is not expected to apply to Keyera
until 2011 so long as we comply with the normal growth guidelines) and we are
taking steps to preserve Keyera's tax pools, including continuing to work
toward the implementation of the internal reorganization approved by
Unitholders at our last annual meeting in June.
    The results that we have achieved this quarter are consistent with
Keyera's track record of delivering stable financial performance. We believe
these results, combined with the increase in our distributions to 12.5 cents
per unit announced in May of this year, demonstrate the success of our
long-term strategy. Looking forward, we are committed to continuing to pursue
our long-term strategy by exploring business development opportunities and
examining new prospects for enhancing our existing core assets and services.
    On behalf of the Fund's directors and management team, I thank you for
your continued support and look forward to continuing success in 2007.

    Jim V. Bertram
    President and CEO
    Keyera Facilities Income Fund


    Contribution From Operating Segments

    Keyera operates one of the largest natural gas midstream businesses in
Canada with three major operating segments: Gathering and Processing, NGL
Infrastructure and Marketing. The Gathering and Processing segment includes
natural gas gathering systems and processing plants strategically located in
the natural gas production areas on the western side of the Western Canadian
Sedimentary Basin. The NGL Infrastructure segment includes NGL and crude oil
pipelines, terminals, processing and storage facilities in Edmonton and Fort
Saskatchewan, Alberta, one of North America's major energy hubs. The Marketing
segment includes activities such as the marketing of propane, butane and
condensate to customers in Canada and the United States, and crude oil
midstream activities.
    Keyera's Gathering and Processing and NGL Infrastructure segments provide
most of the total contribution. Keyera benefits from the geographical
diversity of its natural gas processing plants, NGL infrastructure facilities
and associated assets. The revenues generated from these facilities are
fee-for-service based, with minimal direct exposure to commodity prices. The
remainder of Keyera's contribution is derived from its Marketing segment.
Because of Keyera's integrated approach to its business, its infrastructure
provides a significant competitive advantage in NGL marketing. Keyera also
benefits from diversified sources of NGL supply and a diversified customer
base across North America.
    The following table shows the contribution from each of Keyera's
operating segments and includes inter-segment transactions that are eliminated
in the Fund's consolidated financial statements. Because this is not a
standard measure under Canadian generally accepted accounting principles
("GAAP"), it may not be comparable with the calculation of similar measures
for other entities. Contribution does not include the elimination of
inter-segment transactions as required by GAAP and refers to operating
revenues less operating expenses. Management believes contribution provides an
accurate portrayal of profitability by operating segment. The most comparable
GAAP measure is Segmented Information, which is found in financial statement
note 16.



    
    -------------------------------------------------------------------------
                                   Three months ended        Year to date
    Contribution by Operating           June 30,                June 30,
    Segment ($ thousands)           2007        2006        2007        2006
    -------------------------------------------------------------------------
    Gathering & Processing(1)
    Revenue before inter-segment
     eliminations(4)              45,074      41,655      87,782      80,647
    Operating expenses before
     inter-segment
     eliminations(4)             (29,713)    (28,189)    (50,939)    (48,703)
    -------------------------------------------------------------------------
    Gathering & Processing
     contribution                 15,361      13,466      36,843      31,944
    -------------------------------------------------------------------------

    NGL Infrastructure(1)
    Revenue                       17,865      14,292      35,434      30,760
    Unrealized gain/(loss)          (207)          -         (95)          -
    Revenue before inter-segment
     eliminations(4)              17,658      14,292      35,339      30,760
    Operating expenses before
     inter-segment
     eliminations(4)              (6,476)     (5,389)    (11,856)    (11,017)
    -------------------------------------------------------------------------
    NGL Infrastructure
     contribution                 11,182       8,903      23,483      19,743
    -------------------------------------------------------------------------

    Marketing(2)
    Revenue                      291,519     278,877     604,318     596,189
    Unrealized gain/(loss)           807         364      (4,650)       (107)
    Revenue before inter-segment
     eliminations(4)             292,326     279,241     599,668     569,082
    Operating expenses before
     inter-segment
     eliminations(4)            (273,489)   (268,657)   (571,545)   (573,994)
    General & administration        (731)       (699)     (1,544)     (1,285)
    -------------------------------------------------------------------------
    Marketing contribution        18,106       9,885      26,579      20,803
    -------------------------------------------------------------------------
    Total contribution            44,649      32,254      86,905      72,490
    -------------------------------------------------------------------------
    Other expenses(3)            (23,004)    (17,172)    (43,400)    (38,487)
    -------------------------------------------------------------------------
    Earnings before tax and
     non-controlling interest     21,645      15,082      43,505      34,003
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    Notes:
    (1)  Gathering and Processing and NGL Infrastructure contribution
         includes revenues for processing, transportation and storage
         services provided to Keyera's Marketing business.
    (2)  The Marketing contribution is net of expenses for processing,
         transportation and storage services provided by Keyera's facilities
         and general and administrative costs directly attributable to the
         Marketing segment.
    (3)  Other expenses include corporate general and administrative,
         interest, depreciation and amortization, accretion and impairment
         expense. Corporate general and administrative costs exclude the
         direct Marketing general and administrative costs.
    (4)  Revenue and operating expenses before inter-segment eliminations as
         shown above are both non-GAAP measures and do not consider the
         elimination of inter-segment sales and expenses. Inter-segment
         transactions are eliminated upon consolidation of Keyera's financial
         results to arrive at external revenue and external operating
         expenses, both GAAP measures, as reported in note 16, Segmented
         Information.
    

    Management's Discussion and Analysis

    The following management's discussion and analysis ("MD&A") was prepared
as of August 8, 2007 and is a review of the results of operations and the
liquidity and capital resources of Keyera Facilities Income Fund (the "Fund or
Keyera"). It should be read in conjunction with the accompanying unaudited
consolidated financial statements of the Fund for the quarter ended June 30,
2007 and the notes thereto as well as the consolidated financial statements of
the Fund for the year ended December 31, 2006 and its related management's
discussion and analysis. Additional information related to the Fund, including
the Fund's Annual Information Form, is filed on SEDAR at www.sedar.com.

    NON-GAAP FINANCIAL MEASURES

    This discussion and analysis refers to certain financial measures that
are not determined in accordance with Canadian Generally Accepted Accounting
Principles ("GAAP"). These measures do not have standardized meanings and may
not be comparable to similar measures presented by other trusts or
corporations. Measures such as operating margin (operating revenues minus
operating expenses), EBITDA (earnings before interest, taxes, depreciation and
amortization) and distributable cash flow (cash flow from operating activities
adjusted for changes in non-cash working capital, maintenance capital
expenditures and the distributable cash flow attributable to any
non-controlling interest) are not standard measures under GAAP and therefore
may not be comparable with the calculation of similar measures for other
entities. Management believes that these supplemental measures facilitate the
understanding of the Fund's results of operations and financial position.
Investors are cautioned, however, that these measures should not be construed
as an alternative to net earnings determined in accordance with GAAP as an
indication of the Fund's performance.

    FORWARD LOOKING STATEMENTS

    Certain statements contained in this MD&A and accompanying documents
contain forward-looking statements. These statements relate to future events
or the Fund's future performance. Such statements are predictions only and
actual events or results may differ materially. The use of words such as
"anticipate", "continue", "estimate", "expect", "may", "will", "project",
"should", "plan," "intend", "believe", and similar expressions, including the
negatives thereof, is intended to identify forward looking statements. All
statements other than statements of historical fact contained in this document
are forward looking statements, including, without limitation, statements
regarding: the future financial position of Keyera; business strategy and
plans of management; anticipated growth and proposed activities; budgets,
including future capital, operating or other expenditures and projected costs;
estimated utilization rates; objectives of or involving Keyera; impact of
commodity prices; treatment of Keyera under governmental regulatory regimes;
the existence, operation and strategy of the risk management program,
including the approximate and maximum amount of forward sales and hedging to
be employed; and expectations regarding Keyera's ability to raise capital and
to add to its assets through acquisitions or internal growth opportunities.
    The forward looking statements reflect management's current beliefs and
assumptions with respect to such things as the outlook for general economic
trends, industry trends, commodity prices, capital markets, and the
governmental, regulatory and legal environment. In some instances, this MD&A
and accompanying documents may also contain forward-looking statements
attributed to third party sources. Management believes that its assumptions
and analysis are reasonable and that the expectations reflected in the forward
looking statements contained herein are also reasonable. However, Keyera
cannot assure readers that these expectations will prove to be correct.
    All forward looking statements involve known and unknown risks,
uncertainties and other factors that may cause actual results, events, levels
of activity and achievements to differ materially from those anticipated in
the forward looking statements. Such factors include but are not limited to:
general economic, market and business conditions; operational matters,
including potential hazards inherent in our operations; risks arising from
co-ownership of facilities; activities of other facility owners; competitive
action by other companies; activities of producers and other customers and
overall industry activity levels; changes in gas composition; fluctuations in
commodity prices and supply/demand trends; processing and marketing margins;
effects of weather conditions; fluctuations in interest rates and foreign
currency exchange rates; changes in operating and capital costs, including
fluctuations in input costs; actions by governmental authorities; decisions or
approvals of administrative tribunals; changes in environmental and other
regulations; reliance on key personnel; competition for, among other things,
capital, acquisition opportunities and skilled personnel; changes in tax laws
relating to income trusts, including the effects that such changes may have on
Unitholders, and in particular any differential effects relating to
Unitholder's country of residence; and other factors, many of which are beyond
the control of Keyera, some of which are discussed in this MD&A and in
Keyera's Annual Information Form dated February 27, 2007 (the "Annual
Information Form") filed on SEDAR.
    In addition, the discussion of the proposed reorganization (the
"Reorganization") contained in this MD&A contains forward-looking information.
Unitholders and prospective investors are cautioned not to place undue
reliance on such forward-looking information as such information is based on
certain assumptions and a number of known and unknown risks and uncertainties,
of both a general and specific nature, that could result in the Reorganization
not being completed or not being completed in the manner described in Keyera's
Information Circular. These assumptions and factors include, but are not
limited to: the Alberta Court of Queen's Bench granting a final order
approving the plan of arrangement pursuant to which Keyera intends to
implement the Reorganization; the board of directors exercising its discretion
to proceed with the Reorganization; no change in taxation or other laws which
would have a material adverse significance in respect of the Reorganization; a
favourable advance ruling being obtained from the Canada Revenue Agency; all
third party approvals and consents being obtained on terms which are
acceptable to Keyera; no laws or policies being enacted or promulgated, or no
order or decree being issued or made, which would cease trade, enjoin,
prohibit or impose material limitations on the Reorganization or the
transactions contemplated thereby; no material tax being payable by any
participant in the Reorganization; and the counterparties to certain material
contracts to which Keyera is a party agreeing to the assignment or amendment
of such agreements in order to reflect the new organizational structure and to
substantially preserve, in modified form, the existing governance structure of
the Fund going forward. Keyera cautions that the foregoing list of factors and
assumptions is not exhaustive.
    Readers are cautioned that they should not unduly rely on the forward
looking statements in this MD&A and accompanying documents. Further, readers
are cautioned that the forward looking statements in this MD&A speak only as
of the date of this MD&A and Keyera does not undertake any obligation to
publicly update or to revise any of the forward looking statements, whether as
a result of new information, future events or otherwise, except as may be
required by applicable laws.
    All forward looking statements contained in this MD&A and accompanying
documents are expressly qualified by this cautionary statement. Further
information about the factors affecting forward looking statements and
management's assumptions and analysis thereof, is available in filings made by
Keyera with Canadian provincial securities commissions available on SEDAR at
www.sedar.com.

    BUSINESS ENVIRONMENT

    Producers in Canada drilled over 1,700 wells in the second quarter, down
42% from the same quarter in 2006. The decline is believed to be in response
to lower commodity pricing and higher finding and development costs. In
addition, wet weather during the quarter, resulting in extended road bans and
a longer spring breakup period, also contributed to the decline in wells
drilled.
    The regions where Keyera operates also experienced significant declines
in drilling activity during the second quarter. Compared to the same period
last year, the number of wells drilled in the foothills front region decreased
70%, while drilling in the central Alberta region was 64% lower. British
Columbia also experienced a 41% decrease in wells drilled compared to the
second quarter of 2006.
    To date, the decline in drilling activity in Western Canada has not had a
material impact on the raw gas volumes delivered to Keyera's facilities for
processing. Throughput volumes at most Keyera plants increased compared to the
first quarter of 2007, with the exception of the Rimbey and Brazeau North gas
plants, where scheduled maintenance turnarounds were completed in the second
quarter. These increases are the result of producer drilling undertaken in
previous years. However, lower activity levels may affect the volume of raw
gas delivered to Keyera's gathering and processing facilities in the future.
    Keyera's management believes that, over the long term, natural gas
supply-demand fundamentals will be strong and that the Western Canadian
Sedimentary Basin will continue to be a key supply basin for many years to
come. Keyera's facilities are well positioned in the western regions of the
basin, which is relatively under-developed and has deeper gas prone zones that
often contain larger reserves. Keyera's facilities are able to process both
sweet and sour gas and extract NGLs from the raw gas stream, making them well
suited to process gas from this region.

    Climate change regulations

    On March 8, 2007 the Alberta government introduced amendments to the
Climate Change and Emissions Management Act (Bill 3) and the accompanying
Specified Gas Emitters Regulation (the "Regulation"). The Regulation applies
to all facilities in Alberta that produce over 100,000 tonnes of carbon
dioxide equivalent annually and is designed to reduce the emissions intensity
of greenhouse gases at applicable facilities. The Regulation was implemented
as expected on July 1, 2007.
    Following the Alberta announcement, the federal government released the
Regulatory Framework for Air Emissions on April 26, 2007 which sets out new
greenhouse gases and air pollutant emission reduction targets for various
industrial sectors, including the oil and gas industry.
    There has been no significant change in management's interpretation of
the effect of these programs on Keyera from the analysis presented in the MD&A
for the first quarter of 2007.

    New tax on flow-through entities

    On October 31, 2006, the Government of Canada announced a new tax on the
distributions of publicly-traded Canadian income trusts and limited
partnerships. On June 22, 2007, Bill C-52 received Royal Assent and became law
thereby implementing this new tax. Assuming Keyera only experiences "normal
growth", the Fund, as an existing income trust, will be subject to the new tax
as of January 2011. Details of the new tax can be found in the Government's
website at http://www.fin.gc.ca/news06/06-061e.html.
    Under the legislation, effective January 1, 2011 a tax of 31.5% will be
payable by Keyera on the portion of its distributions that is ordinary taxable
income. For a Canadian resident taxpayer, this portion of Keyera's
distributions will be treated as dividend income for tax purposes. The
legislation also provides there will be no change in taxation of Keyera's
distributions that are considered to be a return of capital or dividend
income.
    As at January 1, 2007, Keyera had approximately $385 million of
unutilized tax pools and deductions, consisting mostly of class 41
undepreciated capital costs, available for deduction by the Fund's
subsidiaries. Keyera is proposing to undertake a reorganization of its
internal legal structure as described under "Fund Reorganization" in this
MD&A. Assuming the reorganization is implemented substantially in the manner
approved by unitholders, Keyera plans to reduce the use of its available tax
deductions in the years 2007 through 2010, thereby increasing deductions
available for the years after 2010.

    RESULTS OF OPERATIONS

    Keyera's midstream activities are conducted through three business
segments. The Gathering and Processing segment provides natural gas gathering
and processing services to producers. The NGL Infrastructure segment provides
NGL processing, transportation and storage services to producers, marketers
(including Keyera) and others. The services in both these segments are
provided on a fee-for-service basis. The Marketing segment is focused on the
marketing of by-products recovered from the processing of raw gas, primarily
NGLs, and crude oil midstream activities. A more complete description of
Keyera's businesses by segment can be found in the Fund's Annual Information
Form, which is available at www.sedar.com.
    Keyera posted record results in the second quarter, with operating margin
of $45.4 million, exceeding the same quarter of 2006 by $12.4 million. These
results were achieved despite maintenance turnarounds at the Rimbey gas plant,
Keyera's largest facility, and at the Brazeau North gas plant. If these
facilities had not been offline for a portion of the second quarter, and
assuming May's throughput levels, Keyera estimates that its operating margin
would have been approximately $55 million.
    Strong performance was achieved from all segments in the second quarter
of 2007, resulting in $21.6 million of earnings before tax and non-controlling
interest compared to $15.1 million in the second quarter of 2006. In the
second quarter of 2007, higher operating margins in the Gathering and
Processing and Marketing segments along with stable operating margins in the
NGL Infrastructure segment were partially offset by higher general and
administrative costs and interest expense, when compared to the same period
last year.
    The growth in operating margin for the Gathering and Processing segment
was achieved despite the completion of a turnaround at the Rimbey gas plant,
Keyera's largest processing facility. Most of Keyera gas plants experienced
higher throughput than in the same period last year. In the Marketing segment,
colder than usual weather in a U.S. regional propane market early in the
second quarter of 2007 and opportunities to earn strong condensate margins
resulted in above-normal operating margin for this quarter. The increase in
general and administrative costs was primarily related to higher long-term
incentive plan costs. The increase in interest expense was related to higher
average debt balances during the second quarter of 2007 when compared to the
same period last year, as well as a $0.7 million unrealized loss on an
interest rate derivative contract recorded in the second quarter of 2007.
    However, the strong operating performance in the second quarter of 2007
was overshadowed by an $81.5 million income tax expense that included a
non-cash future income tax expense of $80.2 million. The future income tax
expense was related to the recently enacted tax on publicly-traded Canadian
income trusts and limited partnerships. This non-cash income tax expense
resulted in a net loss of $59.9 million compared to net earnings of $26.0
million in the second quarter of 2006. Earnings in the second quarter of 2006
were favourably affected by an $11.5 million non-cash recovery of future
income tax expense due to a reduction in corporate tax rates.
    Year to date, a net loss of $40.9 million has been incurred compared to
net earnings of $41.4 million for the same period last year. The unfavourable
variance is primarily related to the $80.2 million non-cash future income tax
expense incurred in the second quarter of 2007. This expense more than offset
the growth in operating margin resulting from higher throughput in the
Gathering and Processing segment and stronger unit margins in the Marketing
segment.

    Gathering and Processing

    Gathering and Processing revenue for the second quarter of 2007 was
$44.3 million, an increase of $3.5 million, or 9%, compared to the second
quarter of 2006. The increase was due primarily to higher throughput at most
plants other than the Rimbey gas plant, which was down for 17 days to complete
its scheduled turnaround.
    Gathering and Processing operating expenses for the second quarter of
2007 were $29.7 million, an increase of $1.5 million, or 5%, compared to the
second quarter of 2006. The increase was primarily due to greater than
anticipated repair costs at several plants. The Rimbey gas plant turnaround
costs of approximately $9.5 million did not significantly affect the year over
year variance, as the second quarter of 2006 included turnaround and
refurbishment costs for the Strachan and Caribou gas plants.
    Average gross processing throughput in the second quarter of 2007 was
817 million cubic feet per day, down 3% from the first quarter of 2007 and up
2% from the second quarter last year. Year to date, average gross processing
throughput was 828 million cubic feet per day, up 1% from last year. The
growth in throughput was attributable to the tie-in of new wells that were
drilled in previous periods and the capture of new volumes through the
recently constructed Caribou North Gas Gathering System and the Brazeau North
Gas Gathering System, partially offset by downtime associated with the
turnarounds at the Rimbey and Brazeau North gas plants in the second quarter.
    Year to date, gathering and processing revenue was $86.2 million, an
increase of $7.4 million or 9% compared to last year. The increase was due
primarily to higher throughput at most gas plants other than Rimbey.
    Year to date, Gathering and Processing operating expenses were
$50.9 million, an increase of $2.2 million or 5% compared to last year. In
2007 operating costs were higher due to the turnarounds completed at the
Rimbey and Brazeau North gas plants and unscheduled repairs at the Caribou,
Rimbey and Bigoray gas plants. The increase was mostly offset by lower costs
at the Strachan and Caribou gas plants relative to 2006, when extensive
turnaround and refurbishment costs were incurred.

    Gathering and Processing - West Central Region

    The West Central Region experienced a very active quarter from both a
growth capital and a maintenance perspective. Second quarter raw gas
throughput was down 10% from the first quarter of 2007 and 15% lower than the
same period in 2006.
    The decrease in volumes in the second quarter was the result of two
facilities in the region being offline for their scheduled maintenance
shutdowns and a decline in shallow gas and coalbed methane drilling in the
Rimbey area. The plant turnarounds had a substantial impact on the second
quarter contribution from the West Central Region; however, the reduction in
shallow gas volumes had only a moderate impact on Keyera's revenues as these
volumes attract relatively lower fees due to their reduced processing
requirements.
    During the quarter, the Rimbey and Brazeau North gas plants were taken
offline to complete their scheduled four-year maintenance turnarounds. During
that time, extensive work was undertaken to complete routine inspections,
regular maintenance and required repair work. The size and scope of the
maintenance work at the Rimbey plant, Keyera's largest natural gas processing
facility, was significant. Costs for the Rimbey turnaround are recoverable
over a four-year period, with only a portion being recoverable in 2007. Costs
for the Brazeau North turnaround are fully recoverable in 2007.
    In the Drayton Valley region, where Keyera's Bigoray, Brazeau North and
West Pembina plants are located, the delivery of raw gas at increased and more
sustained rates led to increased throughput at Keyera's facilities during the
quarter. With most facilities in the area approaching their sour gas handling
capacity, Keyera is currently investigating opportunities to expand the sour
gas handling capabilities of the Bigoray gas plant.
    In July, Keyera announced the initiation of a project to extract ethane
from the raw gas processed at the Rimbey gas plant. The project will involve
plant modifications and the construction of a 32-kilometre pipeline to deliver
the product to existing ethane gathering infrastructure in the province.
Subject to regulatory approval and other conditions, project completion is
anticipated in 2008 and is expected to cost $26 million. When operational,
Keyera will extract up to 5,000 barrels per day of ethane, most of which will
be incremental to existing Alberta supply. Modifications were completed while
the Rimbey plant was offline during its scheduled maintenance shutdown to
allow the project to be completed with minimal disruption to normal plant
operations.
    During the second quarter, a number of smaller growth capital projects
were also completed. A new condensate truck loading facility became
operational at the Rimbey plant, providing additional truck loading capacity
and increased flexibility in the marketing of condensate. An asset swap
completed during the quarter resulted in Keyera increasing its ownership
interest in the Easyford oil battery located in the Pembina region and
disposing of its interest in a gathering system connected to a third party
facility.
    Maintenance shutdowns are scheduled for the Medicine River and Bigoray
gas plants in the third quarter. The costs for the Bigoray turnaround are
largely recoverable in 2007. While the costs for the Medicine River turnaround
are not recoverable through the existing fee structure, the impact on the West
Central Region cashflow is expected to be minimal. These turnarounds will
complete the scheduled turnarounds for 2007 in the West Central Region.

    Gathering and Processing - Foothills Region

    The Foothills Region experienced a record quarter, benefiting from
incremental volumes at several facilities. Second quarter raw gas throughput
was up 7% from the first quarter of this year and was 26% higher than the
second quarter of 2006, when significant scheduled maintenance shutdowns were
completed at the Strachan and Caribou gas plants.
    Active drilling by a number of producers is currently underway along the
Garrington pipeline, east of the Strachan gas plant. Assuming producers are
successful, this activity is expected to result in the delivery of incremental
raw gas volumes to the Strachan plant in the second half of 2007. Construction
also continued on a new gathering pipeline connecting to Keyera's Strachan
North pipeline. The pipeline is expected to begin delivering raw gas from this
new capture area to the Strachan plant during the third quarter of 2007,
provided that construction is completed as planned.
    Producer activity in the areas around the Brazeau River gas plant
resulted in a number of new wells being licensed. Raw gas delivered to the
Brazeau River plant increased during the second quarter as sour Nisku gas from
the Pembina region was delivered to the plant at increased and more sustained
rates. A project has been initiated to construct a new gas gathering pipeline
and associated plant facilities to capture a sweet gas development that is
evolving southwest of the plant. Construction is expected to be completed by
year-end. A 38-kilometre, 8 inch sales gas pipeline running northeast of the
plant was acquired in July, for use as a low-pressure sweet gas gathering
pipeline.
    At the Caribou gas plant, producers continued to be active along the
Caribou North pipeline. During the quarter, a new producer-owned compressor
was installed along the pipeline, resulting in the delivery of incremental
production to the Caribou plant. In July Keyera agreed to purchase an
18- ilometre gas gathering pipeline, roads and production assets in the North
Trutch/Bougie area near the north end of the Caribou North pipeline. The
acquisition will provide Keyera with new infrastructure in a geologically
prospective area and additional flexibility for future operations.
    At the Nordegg River gas plant, work is underway to install new inlet
separation facilities to accommodate incremental sweet gas volumes from
drilling activity southwest of the plant. If work continues as planned,
construction is expected to be completed in August.
    The Brazeau River gas plant will undergo its scheduled maintenance
turnaround during the third quarter. The costs associated with the maintenance
work will be fully recoverable in the quarter. This will complete the
scheduled turnarounds for 2007 in the Foothills Region.

    NGL Infrastructure

    NGL Infrastructure revenue for the second quarter of 2007 was
$9.5 million, an increase of $1.0 million compared to the second quarter of
2006. This increase is primarily due to the ongoing demand for storage
services at Fort Saskatchewan.
    NGL Infrastructure operating expenses for the second quarter of 2007 were
$6.5 million, an increase of $1.1 million compared to the second quarter of
2006. The increase was primarily due to the replacement of a charcoal bed
filter at the Edmonton terminal and the scheduled workover of a storage cavern
at Fort Saskatchewan.
    Year to date, NGL Infrastructure revenue was $19.2 million, an increase
of $1.0 million compared to last year. The higher revenue in 2007 is the
result of ongoing demand for storage services and higher volumes of propane
moving through the Edmonton rail rack in response to cold weather in the U.S.
during the first quarter of 2007, partially offset by a favourable
non-recurring adjustment of $1.0 million in 2006.
    Year to date, NGL Infrastructure operating expenses were $11.9 million,
an increase of $0.9 million compared to last year. Higher operating costs
related to increased staffing levels to handle the higher volume at the rail
rack in the first quarter of 2007, the replacement of a charcoal bed filter at
the Edmonton terminal and the scheduled workover of a storage cavern.
    Fractionation, pipeline and rail and truck loading services operated at
typical levels in the second quarter. Demand for storage services continues to
be strong and Keyera entered into additional short-term storage agreements in
the second quarter.
    Keyera's Fort Saskatchewan fractionation facility was off line for five
days in April to complete its annual turnaround. Unlike Keyera's natural gas
processing plants, which have a four year schedule, this fractionation
facility is taken off line annually to clean process vessels and equipment and
undertake routine maintenance. During this outage, the storage facilities,
truck rack and pipeline system remained operational. In addition, a
maintenance workover of a storage cavern was undertaken during the second
quarter. A workover is performed on each of the ten storage caverns every
eight years, resulting in at least one cavern workover being completed each
year.
    As part of its strategy of creating additional value from existing
assets, Keyera has initiated a project to expand its truck loading rack at the
Fort Saskatchewan facility. The project will cost approximately $5.5 million
and is expected to be operational by year-end if construction continues to
proceed as planned. With the capability to load propane, butane and
condensate, the new truck rack will increase Keyera's operational flexibility
and will provide enhanced product loading services for customers serving the
domestic NGL market.
    Work continued in the second quarter on the necessary connections for the
new leased pipeline between Keyera's Fort Saskatchewan facility and its
Edmonton terminal, which Keyera announced in May. The project has been
modified to increase the pipeline's capacity and, as a result, Keyera's share
of the project costs has increased to about $7 million. Assuming construction
is completed as planned, the pipeline is expected to be operational in the
first quarter of 2008.
    In the second quarter, Keyera converted Rimbey Pipe Line Co. Ltd. to a
limited partnership, Rimbey Pipeline Limited Partnership ("RPLP"), and
acquired the ownership interests of the former minority shareholders of Rimbey
Pipe Line Co. Ltd. As a result of these transactions, Keyera owns 100% of
RPLP.

    Marketing

    Marketing revenue for the second quarter of 2007 was $292.3 million, an
increase of $13.1 million compared to the second quarter of 2006. The increase
was primarily due to growth in the crude oil midstream business, higher
condensate sales volumes and higher product sales prices. Marketing revenues
from NGL products were down slightly from the second quarter of 2006 due to
lower volumes partially offset by higher average prices. Also included in
revenues for the quarter was a $0.8 million unrealized gain on financial
instruments, which is discussed later in this section.
    The Marketing segment posted record results in the second quarter of
2007, delivering operating margin of $27.8 million, an increase of
$10.6 million compared to the second quarter of 2006. All products, and in
particular condensate, contributed to the strong results. As well, the crude
oil midstream business was a strong contributor, as activity levels continued
to grow and differentials remained strong. The Marketing business benefits
from the utilization of Keyera's extensive NGL asset infrastructure, and the
second quarter results reflected Keyera's ability to use these assets to
capture business opportunities.
    Year to date, Marketing revenue was $599.7 million, an increase of
$3.6 million. The increase was primarily related to higher crude oil midstream
revenues, higher condensate volumes, and higher average product prices
partially offset by lower sales volumes of other NGL products and an
unrealized loss on financial instruments, which is discussed later in this
section.
    The table below outlines the composition of the revenues generated from
Keyera's Marketing business.


    
                                               Three Months      Six Months
    Composition of Marketing Revenue          Ended June 30,   Ended June 30,
    (in thousands of dollars)                       2007           2007
    -------------------------------------------------------------------------
    Physical sales                                   290,562         602,319
    Financial instruments - realized                     957           1,999
    Financial instruments - unrealized                   807          (4,650)
    -------------------------------------------------------------------------
    Marketing revenue                                292,326         599,668
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    

    NGL sales volumes for the second quarter of 2007 averaged 43,400 barrels
per day compared to 47,000 barrels per day in the second quarter of 2006. Year
to date, NGL sales volumes averaged 51,500 barrels per day compared to
54,500 barrels per day last year. The decreases were due to lower sales of
butane and propane, partially offset by higher condensate sales compared to
the second quarter of 2006.
    Marketing operating expense for the second quarter of 2007 was
$264.6 million, an increase of $2.5 million compared to the second quarter of
2006. The increase was primarily due to the growth in the crude oil midstream
business and higher average unit costs of NGL products.
    Year to date, Marketing operating expense was $553.9 million, a decrease
of $5.7 million. Lower average product costs and lower sales volumes partially
offset by higher crude oil midstream costs accounted for the majority of the
variance.
    The Marketing business is exposed to commodity price fluctuations arising
between the time contracted volumes are purchased and the time they are sold,
as well as fluctuations in the margins between purchase prices and sales
prices and other risks that affect price and supply - demand trends. Keyera
manages its supply and sales portfolio by monitoring its inventory position
and its purchase and sale commitments, as well as by actively participating in
various hub markets. In addition, Keyera manages some of its price risk by
using financial contracts, such as energy-related forward sales, price swaps,
physical exchanges and options and by offsetting some of its physical and
financial contracts in terms of volumes, timing of performance and delivery
obligation.
    NGL product inventories of $46.9 million were $3.3 million higher than in
the second quarter of 2006. Although the value of inventory had not changed
significantly, volumes in storage have increased compared to the same period
last year. NGL inventory levels typically increase throughout the second and
third quarters due to the seasonality of product demand.
    Propane demand was strong during the early part of the second quarter due
to cold weather in a regional U.S. market. By the end of the second quarter,
propane demand had returned to more normal levels for this time of year. The
strong demand early in the second quarter of 2007 enabled Keyera to achieve
higher than expected propane margins. Propane demand in the third quarter is
expected to remain at the lower levels typical of the summer season.
    In June 2007, Keyera acquired a propane terminal in Superior, Montana at
a cost of $0.5 million. This acquisition complements the three propane
terminals in the U.S. that were acquired last year and provides further
vertical integration to the propane marketing business. The terminal has the
ability to accept propane rail car deliveries and a truck rack for loading
product for delivery to end use customers.
    Butane markets continued to perform well during the second quarter of
2007. Sales were somewhat lower than the second quarter last year but margins
remained strong.
    Condensate market conditions were variable during the second quarter.
Keyera was able to use its asset infrastructure to exploit periods of
short-term price volatility and deliver strong condensate margins in the
quarter.
    Keyera's crude oil midstream business continued to grow in the second
quarter of 2007. Second quarter results increased relative to the first
quarter of 2007 and the same period last year. Despite road bans during the
spring break up period that resulted in lower volumes being delivered to
Keyera field oil terminals compared to the first quarter, the crude oil
business operated in line with expectations.
    In the second quarter of 2007, the $0.8 million unrealized gain on
financial contracts was primarily related to the change in the value of crude
oil price swap contracts. On a year to date basis, an unrealized loss of
$4.7 million had been recorded related to the change in fair value of the
crude oil price swap contracts and fixed price contracts. At June 30, 2007,
the fair market value of these contracts represented a liability of
$2.4 million, which represents an estimate of the amount that the Fund would
receive (pay) if these instruments had been closed out at the end of the
period. The estimated fair value of all derivatives held for trading is based
on quoted market prices and, if not available, on estimates from third party
brokers or dealers.
    Of the $4.7 million year to date unrealized loss, the unrealized loss
related to changes in crude oil financial contracts amounted to approximately
$2.3 million. These contracts are used to protect inventory from fluctuations
in the price of NGL products. To the extent these contracts are effective
(i.e., the change in the market price of crude oil is correlated to the change
in the prices of the underlying physical NGL products), gains and losses on
these financial contracts will be offset by gains or losses in the proceeds
that will be realized upon the sale of the products.
    On January 1, 2007, new accounting standards related to the measurement,
recognition and disclosure of financial instruments came into effect. In
accordance with the new accounting standards, a fixed price physical contract
is considered a derivative financial instrument that must be recognized on the
balance sheet. As Keyera routinely utilizes fixed price physical contracts to
sell forward a portion of its physical inventory, the adoption of this
standard resulted in a $2.3 million unrealized loss in the first quarter of
2007 related to the maturity of fixed price physical contracts on hand at
January 1, 2007. As the fixed price contracts were priced higher than market,
the new accounting standards required an asset of $2.3 million to be recorded
with a corresponding increase in opening accumulated earnings. As these
contracts matured and the actual proceeds on the fixed price sales were
recorded in revenue, the previously recorded asset of $2.3 million was reduced
to nil with a corresponding charge (unrealized loss) to earnings in the first
quarter of 2007.
    The adoption of the new accounting standards is expected to result in
increased volatility in operating margins due to unrealized gains and losses.
    For a further discussion of the risks and trends that could affect the
marketing performance and the steps that Keyera takes to mitigate these risks,
readers are referred to the descriptions in this MD&A and to Keyera's Annual
Information Form, which is available on SEDAR.

    Non-operating expenses and other earnings

    General and administrative expenses for the second quarter of 2007 were
$7.2 million, up $3.4 million from the second quarter of 2006. Long-term
incentive plan costs accounted for $2.8 million of the increase, reflecting
the growth in unit price during the second quarter of 2007 and the effect of
the distribution increase implemented in May 2007.
    Year to date, general and administrative costs were $12.5 million, up
$1.2 million compared to last year due primarily to the higher long-term
incentive plan costs. Excluding the effect of the long-term incentive plan,
general and administrative expenses were in line with those incurred in 2006.
    Interest expense, net of interest revenue, was $5.5 million for the
second quarter of 2007, $1.6 million greater than the second quarter of 2006,
and $10.1 million year to date, $2.1 million greater than last year. The
increase was due to the inclusion of a $0.7 million unrealized loss on
financial instruments related to an interest rate financial contract used to
lock in interest rates on a portion of the new long-term debt issue. The
remainder was due to higher short-term borrowings used to fund capital
projects, partially offset by a reduction in interest paid on lower
convertible debenture balances.
    Depreciation and amortization expenses were $10.4 million for the second
quarter of 2007, $0.7 million greater than the second quarter of 2006, and
$21.0 million year to date, $2.0 million greater than last year. The increase
was due to growth in the asset base resulting from the completion of several
major growth capital projects during the past year.
    Income tax expense for the second quarter of 2007 was $81.5 million,
$92.6 million greater than the $11.1 million recovery in the second quarter of
2006. The tax expense for the second quarter of 2007 included a non-cash
future income tax expense of $80.2 million resulting from the new tax imposed
on publicly traded income trusts and limited partnerships in Canada. The
future tax expense is an estimate of the tax that will ultimately be payable
by the Fund due to differences between the accounting and tax basis of assets
and liabilities of the operating partnership. As a result of the new tax
legislation, distributions will no longer be deductible by the Fund beginning
in 2011. Accordingly, any taxable income of the operating partnership
allocated to the Fund will be subject to this tax.
    The remainder of the $92.6 million variance was related to the effect of
recording of a non-cash future income tax recovery in the second quarter of
2006 that reflected a reduction in future statutory income tax rates and the
deductibility of the long-term incentive plan costs.
    Current income tax expense for the second quarter of 2007 was
$1.2 million, $0.8 million higher than last year, largely as a result of
stronger earnings posted by the Rimbey Pipeline business.
    Year to date, income tax expense was $84.1 million, $92.0 million higher
than the same period last year primarily due to the $80.2 million future
income tax expense relating to the new tax legislation. In 2006, future income
tax expense was unusually low due to the impact of the reduction in future
statutory income tax rates and the recognition of the deductibility of the
long-term incentive plan costs in the second quarter. Current income tax
expense on a year to date basis was $2.4 million, $0.1 million higher than
last year.

    Critical Accounting Estimates

    The Fund's consolidated financial statements have been prepared in
accordance with GAAP. Certain accounting policies require that management make
appropriate decisions with respect to the formulation of estimates and
assumptions that affect the recorded amounts of certain assets, liabilities,
revenues and expenses. Management reviews its assumptions and estimates
regularly, but new information and changes in circumstances may result in
actual results or revised estimates that differ materially from current
estimates. A description of the accounting estimates and the methodologies and
assumptions underlying the estimates are described in MD&A presented with the
December 31, 2006 consolidated financial statements of the Fund. There have
been no changes to the methodologies and assumptions. The most significant
estimates are those indicated below:

    Estimation of Gathering and Processing and NGL Infrastructure revenues:

    At June 30, 2007, operating revenues and accounts receivable for the
Gathering and Processing and NGL Infrastructure segments contained an estimate
of $18.4 million primarily for June 2007 operations.

    Estimation of Gathering and Processing and NGL Infrastructure operating
    expenses:

    At June 30, 2007, operating expenses and accounts payable contained an
estimate of $15.4 million primarily for June 2007 operations.

    Estimation of Gathering and Processing and NGL Infrastructure
    equalization adjustments:

    Much of the revenue from the Gathering and Processing and NGL
Infrastructure assets is generated on a cost-of-service basis. Under this
method, the operating component of the fee is a pro rata share of the
operating costs for the facility, calculated based upon total throughput.
Users of each facility are charged a fee per unit based upon estimated costs
and throughput, with an adjustment to actual throughput completed after the
end of the year. Each quarter, throughput volumes and operating costs are
reviewed to determine whether the estimated unit fee charged during the
quarter properly reflects the actual volumes and costs, and the allocation of
revenues and operating costs to other plant owners is also reviewed.
Appropriate adjustments to revenue and operating expenses are recognized in
the quarter and allocations to other owners are recorded.
    For the Gathering and Processing and NGL Infrastructure segments,
operating revenues and accounts receivable contained an equalization
adjustment of $5.8 million at June 30, 2007. Operating expenses and accounts
payable contained an estimate of $6.2 million.

    Estimation of Marketing revenues:

    At June 30, 2007, the Marketing sales and accounts receivable contained
an estimate for June 2007 revenues of $35.4 million.

    Estimation of Marketing product purchases:

    Marketing cost of goods sold, inventory and accounts payable contained an
estimate of NGL product purchases of $65.1 million at June 30, 2007.

    Estimation of Asset Retirement Obligation:

    In the second quarter of 2007, there were no material changes to the
assumptions used in the estimate prepared for December 31, 2006. Additional
information related to decommissioning, abandonment and reclamation costs is
provided in Keyera's Annual Information Form, which is available on SEDAR.

    LIQUIDITY AND CAPITAL RE

SOURCES Liquidity and working capital Cash provided by operating activities during the second quarter of 2007 was $24.8 million. Cash provided by operating activities before changes in non-cash operating working capital was $31.5 million. From this cash flow, the Fund paid $22.2 million of distributions to unitholders, used $10.8 million for capital expenditures and acquisitions and required $6.7 million to fund changes in non-cash working capital. The resulting net cash outflow of $8.2 million for the quarter was funded with $1.6 million of cash on hand and $6.6 million of short term borrowings. Year to date, cash provided by operating activities was $82.4 million. Cash provided by operating activities before changes in non-cash operating working capital was $68.7 million. From this cash flow, the Fund paid $43.9 million of distributions to unitholders, used $14.8 million for capital expenditures and acquisitions and required $3.0 million to fund changes in non-cash working capital related to investing activities. The Fund also repaid $32.9 million of debt. The Fund received $4.2 million from the disposition of electrical generating equipment and $1.6 million of proceeds from the issuance of trust units under the distribution reinvestment plan ("DRIP"). The resulting net cash outflow of $20.1 million for the quarter was funded with $6.5 million of borrowings and $13.6 million of funds generated from changes in non-cash working capital related to operating activities. A deficiency of $32.0 million in working capital existed at June 30, 2007 compared to a deficit of $41.1 million at December 31, 2006. The deficit in working capital results from the use of short-term debt to finance growth capital expenditures in 2005 and 2006. Capital additions and Three months ended Year to date acquisitions June 30, June 30, (in millions of dollars) 2007 2006 2007 2006 ------------------------------------------------------------------------- Growth capital expenditures 5.8 26.0 7.5 50.4 Maintenance capital expenditures 0.2 0.4 0.6 2.2 ------------------------------------------------------------------------- Total capital expenditures 6.0 26.4 8.1 52.6 ------------------------------------------------------------------------- Acquisition of non-controlling interest 5.2 - 6.7 - ------------------------------------------------------------------------- Total capital additions and acquisitions 11.2 26.4 14.8 52.6 ------------------------------------------------------------------------- In the second quarter of 2007, additions to property, plant and equipment including acquisitions amounted to $11.2 million, consisting of $0.2 million of maintenance capital, $5.8 million of growth capital and $5.2 million of acquisitions. In addition to maintenance capital expenditures, Keyera incurred maintenance and repair expenses of $14.2 million that were included in operating costs. The growth capital expenditures included $2.0 million for the purchase of a pipeline to be used as a gathering line to extend the capture area of the Brazeau River gas plant, $1.4 million related to modifications at the Rimbey gas plant to enable the tie-in of equipment required for the ethane extraction project, $1.1 million for upgrades and expansion of equipment at the Rimbey gas plant and $5.2 million related to the acquisition of an additional ownership interest in RPLP, bringing Keyera's ownership to 100%. Year to date, total capital additions and acquisitions amounted to $14.8 million consisting of $0.6 million of maintenance capital, $7.5 million of growth capital and $6.7 million of acquisitions. In addition to maintenance capital expenditures, Keyera incurred maintenance and repair expenses of $16.5 million that were included in operating costs. The growth capital expenditures included those in the second quarter of 2007 described above and several small projects undertaken in the first quarter of 2007. Growth capital expenditures for 2007 are expected to be between $40 and $60 million, assuming timely receipt of regulatory approvals and construction schedules proceeding as currently planned. In May 2007, Keyera announced the commencement of a pipeline project that will enable Keyera to deliver condensate and butane at increased rates into and out of the Edmonton terminal and Fort Saskatchewan storage facilities. The incremental deliverability is expected to add value to Keyera's existing storage services and may support the development of new storage caverns in the future. Keyera will lease a 6-inch 30-kilometre pipeline and spend approximately $7 million (net) to connect the leased pipeline to its Edmonton and Fort Saskatchewan facilities. Keyera has also initiated a project to extract ethane from the raw gas processed at the Rimbey gas plant. The project will involve plant modifications, some of which have already been completed, and the construction of a 32-kilometre pipeline. Subject to regulatory approval and other conditions, the project is expected to be completed in 2008 at an estimated cost of $26 million. As well, Keyera announced the expansion of the truck loading rack at Fort Saskatchewan. This project is designed to enhance product loading services and provide increased operational flexibility. Assuming construction proceeds as planned, the expansion is expected to be operational by the end of 2007 at an estimated cost of $5.5 million. For a discussion of the risks that could affect the liquidity and working capital of the Fund and the steps Keyera takes to mitigate these risks, as well as information relating to Keyera's commitments and contractual obligations, readers are referred to Keyera's 2006 MD&A and to Keyera's AIF which is available on SEDAR. Debt covenants In order for Keyera to manage seasonal fluctuations in cash flow and working capital, fund growth capital expenditures and stabilize distributions, if required, Keyera has established credit facilities consisting of a $150 million revolving term facility that matures on April 21, 2010 and $25 million of revolving demand facilities. As at June 30, 2007, $75 million was drawn under these credit facilities. Management expects that, upon maturity of these facilities, adequate replacement facilities will be established. These credit facilities are subject to two major financial covenants: Debt to EBITDA and Debt to Capitalization. The calculation for each ratio is based on specific definitions, is not in accordance with GAAP and cannot be readily replicated by referring to the Fund's financial statements. The definitions in this agreement provide for the deduction of net working capital in the calculation of debt. Following are the ratios as calculated in accordance with the covenants as at June 30, 2007: ------------------------------------------------------------------------- Covenant Position as at June 30, 2007 ------------------------------------------------------------------------- Debt to EBITDA not to exceed 3.50 1.85 ------------------------------------------------------------------------- Debt to Capitalization not to exceed 0.55 0.26 ------------------------------------------------------------------------- Keyera has $215 million of unsecured senior notes. Of that amount, $20 million matures in August 2008 and bears interest at 5.42%, $90 million matures in October 2009 and bears interest at 5.23%, $52.5 million matures in August 2010 and bears interest at 5.79%, and $52.5 million matures in August 2013 and bears interest at 6.16%. These notes are subject to three major financial covenants: Debt to EBITDA, EBITDA to Interest Charges and Priority Debt to Total Assets. The calculations for each of these ratios are based on specified definitions. Following are the ratios as calculated in accordance with the covenants as at June 30, 2007: ------------------------------------------------------------------------- Covenant Position as at June 30, 2007 ------------------------------------------------------------------------- Debt to EBITDA not to exceed 3.50 2.26 ------------------------------------------------------------------------- EBITDA to Interest Charges not less than 3.00 9.26 ------------------------------------------------------------------------- Priority Debt to Total Assets not to exceed 15% 0% ------------------------------------------------------------------------- Failure to adhere to the covenants described above may impair Keyera's ability to pay distributions. On July 19, 2007, the Fund initiated a private placement of long-term senior unsecured notes in the principal amount of $120 million. Once the conditions to the private placement have been satisfied, the notes will be issued in two tranches: $60 million due in 2017 bearing interest at 5.89% and $60 million due in 2022 bearing interest at 6.14%. The proceeds will be used to repay short-term debt and will be a source of long term funding for Keyera's ongoing growth capital program, working capital requirements and general corporate purposes. Risk factors For a discussion of the risks and trends that could affect the financial performance of the Fund and the steps that Keyera takes to mitigate these risks, readers are referred to the descriptions in this MD&A and to Keyera's Annual Information Form, which is available on SEDAR. Unitholder Distributions Keyera pays distributions to unitholders from its distributable cash flow. The Fund declared $22.5 million of distributions to unitholders in the second quarter of 2007 and $44.3 million year to date. The Fund's distributable cash flow of $31.2 million in the second quarter of 2007 and $67.7 million year to date was sufficient to fund all the distributions made to unitholders. In determining the level of distributions to unitholders, the Board of Directors takes into consideration current and expected future levels of cash flow, growth capital expenditures, debt repayments, working capital requirements and other factors. The following table presents the calculation of "distributable cash flow" for the Fund. Keyera management believes that distributable cash flow is an appropriate measure of the Fund's cash flow available for distribution to Unitholders. Because distributable cash flow is a non GAAP measure, it may not be comparable to similar measures reported by other business entities. Therefore, when assessing Keyera's performance relative to other entities, "cash flow from operating activities" as presented in the Fund's Consolidated Statements of Cash Flows may be a more comparable measure. Distributable Cash Flow Three months ended Six months ended (in thousands of dollars) June 30, June 30, 2007 2006(1) 2007 2006(1) ------------------------------------------------------------------------- Cash flow from operating activities 24,786 3,574 82,377 80,975 Add (deduct): Changes in non cash working capital 6,729 20,808 (13,647) (28,854) Maintenance capital (293) (357) (644) (2,160) Non-controlling interest distributable cash flow (53) (200) (369) (588) ------------------------------------------------------------------------- Distributable cash flow 31,169 23,825 67,717 49,373 ------------------------------------------------------------------------- Distributions to unitholders 22,538 21,631 44,311 43,184 (1) The calculation of distributable cash flow for the comparative period has been amended to consider the non-cash effect of unrealized foreign exchange gains and losses. For the three and six months ended June 30, 2006, $502 and $55 of unrealized foreign exchange gains have been included in the change in non-cash working capital. The business of the Fund is subject to operational and commercial risks that could adversely affect future operating results, earnings, cash flow and distributions to unitholders. These risks include declines in throughput, operational problems and hazards, cost overruns, increased competition, regulatory intervention, environmental considerations, uncertainty of abandonment costs and dependence upon key personnel. These risks are identified and discussed in greater detail in the most recent Annual Information Form available on www.sedar.com as well as in the "Business Environment", "Results of Operations - Marketing" and "Liquidity and Capital Resources" sections of this MD&A. Standard and Poor's has assigned the Fund an SR-3 stability rating, indicating the expectation of a high level of stability in distributions. Units and Convertible Debentures During the second quarter of 2007, $0.5 million of convertible debentures (before adjustment for deferred financing costs) were converted into 39,996 trust units and 45,509 trust units were issued under the DRIP in consideration of $0.8 million, bringing the total units outstanding at June 30, 2007 to 61,104,864. Convertible debentures outstanding at June 30, 2007 were $22.2 million. FUND REORGANIZATION Keyera proposed a reorganization of its legal structure that was presented in the Management's Discussion and Analysis for the quarter ended March 31, 2007 and is described in detail in Keyera's Notice of Meeting and Proxy Statement and Information Circular, which was filed on SEDAR (www.sedar.com) on May 8, 2007. The intent of the reorganization is to streamline the existing legal structure and simplify accounting, legal, reporting and income tax compliance, thereby reducing the general and administrative costs associated with these activities. The proposed reorganization will result in the elimination of most taxable Canadian corporations from Keyera's structure. As a result it is anticipated that cash taxes within the structure, which were $4.3 million in 2006, will be substantially reduced until 2011. Assuming the reorganization is implemented as planned, Keyera plans to reduce the use of its available tax deductions in years 2007 through to 2010, thereby increasing deductions available for the years after 2010. Unitholders approved the reorganization at the Annual and Special Meeting of Unitholders on June 6, 2007. As Keyera has yet to receive an advanced ruling from the Canada Revenue Agency, the implementation date of the reorganization will be later than previously anticipated. Due to the delay in implementation, the taxability estimate of distributions has been revised. Distributions to Canadian residents are expected to be approximately 50% to 70% return of capital in 2007, with distributions becoming largely or fully taxable in 2008 for Canadian non- exempt unitholders. Accounting Matters and Controls Critical accounting policies Our unaudited Interim Consolidated Financial Statements have been prepared in accordance with Canadian GAAP. The changes in accounting policies are described in Note 3 to our unaudited Interim Consolidated Financial Statements and Note 2 of our 2006 Annual Report. Changes in accounting policies On January 1, 2007, we adopted the following CICA handbook sections: - Section 1530, Comprehensive Income; - Section 3251, Equity; - Section 3855, Financial Instruments - Recognition and Measurement; - Section 3861, Financial Instruments - Presentation and Disclosure; and - Section 3865, Hedges The new accounting standards address the classification, recognition and measurement and presentation and disclosure of financial instruments in the financial statements and require the inclusion of comprehensive income. As well, the new standards expand the definition of derivatives to include both financial and non-financial contracts. Upon adoption of these new accounting standards, financial assets and liabilities are initially recognized at fair value and are subsequently accounted for based on their classification. Gains and losses on financial instruments measured at fair value are recognized in net earnings in the period in which they arise. As of January 1, 2007, Keyera recorded $3.3 million as an asset held for trading and $0.1 million as a liability held for trading to recognize the fair value of the existing natural gas and electricity contracts previously designated as hedging items, as well as the fair value of all fixed price physical contracts not previously recognized. A corresponding adjustment was made to opening accumulated earnings. Subsequent changes in the fair value of the positions were recorded in net earnings. The changes in accounting policies were applied prospectively, where applicable. Comparative figures have not been restated. For further details, see Note 3 to the interim consolidated financial statements. Future changes in accounting policies In 2006, the CICA issued three new accounting standards: Section 1535, Capital Disclosures; Section 3862, Financial Instruments - Disclosures; and Section 3863, Financial Instruments - Presentation. These new standards will be effective for the Fund on January 1, 2008. Section 1535 establishes new disclosures of capital including disclosing information regarding capital objectives, policies and processes for managing capital. Section 3862 and 3863 replace Section 3861, revising and enhancing disclosure requirements. In June 2007, the CICA issued a new accounting standard, Section 3031, Inventories. This new standard replaces Section 3030 modifying the guidance concerning the scope, measurement and allocation of costs for inventory. This standard will be effective for the Fund on January 1, 2008. Internal control over financial reporting No changes were made in our internal control over financial reporting during the interim period ended June 30, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. SUMMARY OF QUARTERLY RESULTS The following table presents selected financial information for Keyera: Three months ended (in thousands of dollars) ------------------------------------------------------------------------- Sep 30, Dec 31, Mar 31, Jun 30, 2005 2005 2006 2006 ------------------------------------------------------------------------- Operating revenues: - Marketing 243,114 317,863 316,841 279,241 - Gathering and Processing 35,927 37,278 38,053 40,772 - NGL Infrastructure 8,506 10,349 9,606 8,549 Net earnings(1) 16,200 15,491 15,384 25,969 Net earnings per unit ($/unit) Basic 0.27 0.26 0.26 0.43 Diluted 0.25 0.23 0.22 0.39 Trust units outstanding (thousands) Weighted average (basic) 59,475 59,926 60,291 60,560 Weighted average (diluted) 63,194 63,246 63,321 62,768 Distributions to unitholders 20,223 21,062 21,553 21,631 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Sep 30, Dec 31, Mar 31, Jun 30, 2005 2005 2006 2006 ------------------------------------------------------------------------- Operating revenues: - Marketing 279,492 286,325 307,342 292,326 - Gathering and Processing 44,290 43,621 41,949 44,277 - NGL Infrastructure 10,878 10,855 9,692 9,525 Net earnings(1) 11,797 14,928 19,012 (59,870) Net earnings per unit ($/unit) Basic 0.19 0.25 0.31 (0.98) Diluted 0.16 0.24 0.31 (0.95) Trust units outstanding (thousands) Weighted average (basic) 60,692 60,865 60,972 61,061 Weighted average (diluted) 62,817 62,869 62,918 62,967 Distributions to unitholders 21,679 21,742 21,763 22,538 ------------------------------------------------------------------------- (1) Since the adoption of the new accounting standards effective January 1, 2007, Keyera has had no transactions that required the use of other comprehensive income and therefore comprehensive income equals net earnings. For a discussion of the factors affecting variations over the quarters, refer to "Results of Operations" in this MD&A. Investor Information Distributions to Unitholders Distributions paid to Unitholders were $0.363 per unit in the second quarter. Keyera increased its distribution by 5% to 12.5 cents per unit per month, beginning with its May distribution, payable to unitholders on June 15, 2007. The Fund is focused on stable long-term distributions that grow over time. The Board of Directors considers increasing the level of cash distributions when it is confident that such an increase can be sustained. Taxability of Distributions Keyera currently anticipates that, for Canadian residents, approximately 50% to 70% of the Fund's 2007 distributions will be deemed a tax-deferred return of capital, with distributions becoming largely or fully taxable for Canadian non-exempt unitholders in 2008. This outlook is affected by Keyera's organizational structure and the implementation of the proposed internal reorganization, which was approved by Unitholders in June. This outlook is subject to change, depending on the levels of profitability and capital expenditures in each of Keyera's operating entities. Both Canadian and non- resident unitholders should seek independent tax advice in respect of the consequences to them of acquiring, holding and disposing of units. Factors that could affect the performance of the Fund and the taxability of the distributions are discussed in the Fund's Annual Information Form. Supplementary Information A breakdown of Keyera's operational and financial results, including volumetric and contribution information by major business unit, is available on our website at www.keyera.com under Investor Information, Financial Information. SECOND Quarter 2007 Results Conference Call and Webcast Keyera will be conducting a conference call and webcast for investors, analysts, brokers and media representatives to discuss the second quarter 2007 results at 8:00 am MDT (10:00 am EDT) on August 9, 2007. Callers may participate by either dialing 866-250-4877 or 416-915-5651. A recording of the call will be available for replay until midnight, August 16, 2007 by dialing 877-289-8525 or 416-640-1917 and entering pass code 21241891 followed by the pound key. Internet users can listen to the call live on Keyera's website at www.keyera.com under Investor Information, Webcasts. Shortly after the call, an audio archive will be posted on the website for 90 days. Questions We welcome questions from interested parties. Calls should be directed to Keyera's Investor Relations Department at 403-205-7670, toll free at 888-699-4853 or via email at ir@keyera.com. Information on Keyera can also be found on our website at www.keyera.com. Keyera Facilities Income Fund Interim Consolidated Statements of Financial Position (Thousands of Canadian dollars) (unaudited) June 30, December 31, 2007 2006 As at: $ $ ------------------------------------------------------------------------- ASSETS Current assets Accounts receivable 175,224 160,112 Inventory 46,940 53,939 Asset held for sale (note 6) - 4,200 Other current assets 7,882 4,327 ------------------------------------------------------------------------- 230,046 222,578 Property, plant and equipment 917,981 924,947 Intangible assets 7,545 10,553 Goodwill 71,234 64,934 Future income tax assets (note 8) 751 - ------------------------------------------------------------------------- 1,227,557 1,223,012 ------------------------------------------------------------------------- ------------------------------------------------------------------------- LIABILITIES AND UNITHOLDERS' EQUITY Current liabilities Bank indebtedness 6,622 96 Accounts payable and accrued liabilities 172,743 148,318 Distributions payable (note 11) 7,638 7,251 Credit facilities (note 4) 75,000 107,984 ------------------------------------------------------------------------- 262,003 263,649 Long-term debt (note 4) 214,190 215,000 Convertible debentures (note 5) 22,166 23,542 Asset retirement obligation (note 7) 36,441 34,533 Future income tax liabilities (note 8) 154,106 65,424 ------------------------------------------------------------------------- 426,903 602,148 ------------------------------------------------------------------------- Non-controlling interest - 2,744 Unitholders' equity Unitholders' capital (note 9) 679,541 677,025 Accumulated earnings 121,409 159,083 Accumulated distributions to unitholders (note 11) (262,299) (217,988) ------------------------------------------------------------------------- 538,651 618,120 ------------------------------------------------------------------------- 1,227,557 1,223,012 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Commitments and contingencies (note 14) The accompanying notes to the interim consolidated financial statements are an integral part of these statements. Keyera Facilities Income Fund Interim Consolidated Statements of Net (Loss) Earnings, Comprehensive (Loss) Income and Accumulated Earnings (Thousands of Canadian dollars, except unit information) (unaudited) Three months ended Six months ended June 30, June 30, 2007 2006 2007 2006 $ $ $ $ ------------------------------------------------------------------------- Operating revenues Marketing 292,326 279,241 599,668 596,082 Gathering and Processing 44,277 40,772 86,226 78,825 NGL Infrastructure 9,525 8,549 19,217 18,155 ------------------------------------------------------------------------- 346,128 328,562 705,111 693,062 Operating expenses Marketing 264,559 262,031 553,867 559,567 Gathering and Processing 29,713 28,189 50,939 48,703 NGL Infrastructure 6,476 5,389 11,856 11,017 ------------------------------------------------------------------------- 300,748 295,609 616,662 619,287 ------------------------------------------------------------------------- 45,380 32,953 88,449 73,775 General and administrative 7,181 3,769 12,528 11,377 Interest expense on long-term indebtedness 4,254 3,456 7,755 6,969 Other interest expense 1,267 482 2,394 1,072 Depreciation and amortization 10,421 9,681 21,009 19,015 Accretion expense (note 7) 612 483 1,258 966 Impairment expense - - - 373 ------------------------------------------------------------------------- 23,735 17,871 44,944 39,772 ------------------------------------------------------------------------- Earnings before tax and non-controlling interest 21,645 15,082 43,505 34,003 Income tax expense (recovery) (note 8) 81,475 (11,076) 84,057 (7,896) ------------------------------------------------------------------------- (Loss) earnings before non-controlling interest (59,830) 26,158 (40,552) 41,899 Non-controlling interest 40 189 306 546 ------------------------------------------------------------------------- Net (loss) earnings (59,870) 25,969 (40,858) 41,353 Other comprehensive income - - - - ------------------------------------------------------------------------- Comprehensive (loss) income (note 3) (59,870) 25,969 (40,858) 41,353 Accumulated earnings, beginning of period 181,279 106,389 159,083 91,005 Change in accounting policy (note 3) - - 3,184 - ------------------------------------------------------------------------- Accumulated earnings, end of period 121,409 132,358 121,409 132,358 ------------------------------------------------------------------------- Weighted average number of units (thousands) (note 10) - basic 61,061 60,560 61,017 60,426 - diluted 62,967 62,768 62,943 62,744 Net (loss) earnings per unit (note 10) - basic (0.98) 0.43 (0.67) 0.68 - diluted (0.95) 0.39 (0.64) 0.64 ------------------------------------------------------------------------- The accompanying notes to the interim consolidated financial statements are an integral part of these statements. Keyera Facilities Income Fund Interim Consolidated Statements of Cash Flows (Thousands of Canadian dollars) (unaudited) Three months ended Six months ended June 30, June 30, 2007 2006 2007 2006 Net inflow (outflow) of cash: $ $ $ $ ------------------------------------------------------------------------- Operating activities Net (loss) earnings (59,870) 25,969 (40,858) 41,353 Items not affecting cash: Depreciation and amortization 10,421 9,681 21,009 19,015 Accretion expense 612 483 1,258 966 Impairment expense - - - 373 Unrealized loss on derivatives held for trading 140 (364) 5,485 106 Future income tax expense (note 8) 80,235 (11,545) 81,631 (10,183) Non-controlling interest 40 189 306 546 Asset retirement obligation expenditures (note 7) (63) (31) (101) (55) Changes in non-cash working capital (note 15) (6,729) (20,808) 13,647 28,854 ------------------------------------------------------------------------- 24,786 3,574 82,377 80,975 ------------------------------------------------------------------------- Investing activities Capital expenditures (6,002) (26,364) (8,104) (52,637) Acquisition of non-controlling interest (note 17) (5,203) - (6,716) - Additions to intangibles - (1,115) - (1,115) Proceeds on sale of assets (note 6) - - 4,200 - Changes in non-cash working capital (note 15) 367 (7,610) (2,987) (270) ------------------------------------------------------------------------- (10,838) (35,089) (13,607) (54,022) ------------------------------------------------------------------------- Financing activities (Repayment) issuance of debt under credit facilities (835) 46,380 (32,984) 6,380 Issuance of trust units (note 9) 812 943 1,612 2,303 Distributions paid to unitholders (note 11) (22,161) (21,613) (43,924) (43,123) Distributions or dividends paid to others - (239) - (239) ------------------------------------------------------------------------- (22,184) 25,471 (75,296) (34,679) ------------------------------------------------------------------------- Net cash outflow (8,236) (6,044) (6,526) (7,726) ------------------------------------------------------------------------- Cash and cash equivalents (bank indebtedness), beginning of period 1,614 3,952 (96) 5,634 ------------------------------------------------------------------------- (Bank indebtedness) cash and cash equivalents, end of period (6,622) (2,092) (6,622) (2,092) ------------------------------------------------------------------------- ------------------------------------------------------------------------- The accompanying notes to the interim consolidated financial statements are an integral part of these statements. See note 15 for cash interest and taxes paid Keyera Facilities Income Fund Notes to Interim Consolidated Financial Statements As at and for the three and six months ended June 30, 2007 (All amounts expressed in thousands of Canadian dollars, except as otherwise noted) (unaudited) 1. Structure of the Fund Keyera Facilities Income Fund (the "Fund") is an unincorporated open- ended trust established under the laws of the Province of Alberta pursuant to the Fund Declaration of Trust dated April 3, 2003. The Fund indirectly owns a 100% interest in Keyera Energy Partnership ("the "Partnership"). The Partnership is involved in the business of natural gas gathering and processing, as well as natural gas liquids ("NGLs") and crude oil processing, transportation, storage and marketing in Canada and the U.S. Its wholly-owned subsidiaries include Keyera Energy Facilities Ltd. ("KEFL"), Keyera Energy Ltd. ("KEL"), Keyera Energy Inc. ("KEI"), Keyera RPL Holdings Ltd. ("KRPL") and Rimbey Pipeline Limited Partnership ("Rimbey LP"). The Fund is administered by and the Partnership is managed by Keyera Energy Management Ltd. ("KEML" or the "Managing Partner"). The Managing Partner has a 33.83% interest in the Partnership. The Fund makes monthly cash distributions to unitholders of record on the last business day of each month. The amount of the distributions per trust unit is equal to the pro rata share of the distribution received indirectly from the Partnership and, in the event of the termination of the Fund, participating pro rata in the net assets remaining after satisfaction of all liabilities. 2. Basis of presentation These unaudited interim consolidated financial statements have been prepared by management in accordance with Canadian generally accepted accounting principles ("GAAP"). The accounting policies applied are consistent with those disclosed in the Fund's consolidated financial statements as at and for the year ended December 31, 2006 as included in the Fund's 2006 Annual Report to unitholders except for the changes made in adopting new accounting standards. These unaudited interim consolidated financial statements as at and for the three and six months ended June 30, 2007 do not include all disclosures required for the preparation of annual consolidated financial statements and should be read in conjunction with the Fund's consolidated financial statements as at and for the year ended December 31, 2006. Interim periods may not be representative of the results expected for the full year of operation due to seasonality. Certain of the comparative figures in prior periods have been reclassified to conform to the presentation in the current period. 3. Change in accounting policies Effective January 1, 2007, the Fund adopted the following accounting standards issued by the Canadian Institute of Chartered Accountants ("CICA"): - Section 1530, Comprehensive Income; - Section 3855, Financial Instruments - Recognition and Measurement; - Section 3861, Financial Instruments - Disclosure and Presentation; and - Section 3865, Hedges The Fund has adopted these standards prospectively and comparative consolidated financial statements have not been restated. Transition amounts have been recorded in opening accumulated earnings. Financial instruments and hedges All financial instruments must initially be recognized at fair value on the balance sheet. The Fund has classified each financial instrument into the following categories: - Financial assets and financial liabilities held for trading - Loans or receivables - Held to maturity - Financial assets available for sale - Other financial liabilities Subsequent measurement of the financial instruments is based on their classification. Financial assets and financial liabilities held for trading are measured at fair value and changes in those fair values are recognized in net earnings. Financial assets available for sale are measured at fair value, with changes in those fair values recognized in other comprehensive income. Financial assets held to maturity, loans or receivables and other financial liabilities are measured at amortized cost using the effective interest rate method of amortization. Upon adoption, the Fund has classified all financial assets as loans or receivables, with the exception of cash and cash equivalents and derivative instruments. Derivative instruments and cash and cash equivalents have been classified as held for trading. The Fund has classified all financial liabilities as other financial liabilities, with the exception of derivative instruments. Derivative instruments have been classified as held for trading. Gains and losses related to derivative contracts are recognized in revenue in the period in which they arise. The estimated fair value of assets and liabilities held for trading is determined by reference to quoted market prices and, if not available, to estimates from third-party brokers or dealers. For long-term financial liabilities, the transaction costs that are directly attributable to the issue of a financial liability are added to the fair value initially recognized for that financial instrument. These costs are amortized to earnings using the effective interest rate method. For all financial assets and short-term financial liabilities, transaction costs are charged to earnings as incurred. As of January 1, 2007, unamortized deferred financing fees of $985 relating to the Fund's long-term debt and $502 relating to convertible debentures have been reclassified for presentation purposes from intangible assets to long-term debt and convertible debentures. These fees are now amortized to earnings using the effective interest rate method. The Fund assesses at each balance sheet date whether a financial asset carried at cost is impaired. If there is objective evidence that an impairment loss exists, the amount of the loss is measured as the difference between the carrying amount of the asset and its fair value. The carrying amount of the asset is reduced and the amount of the loss is recognized in earnings. Effective January 1, 2007 the Fund has opted to discontinue the use of hedge accounting. All derivative instruments that previously qualified for hedge accounting have been recognized at fair value and unrealized gains and losses have been recorded in earnings. Adopting these standards on January 1, 2007 resulted in the recognition of an asset held for trading in the amount of $3,314, a liability held for trading in the amount of $130 and a $3,184 increase to opening accumulated earnings. Assets held for trading are included in accounts receivable and liabilities held for trading are included in accounts payable and accrued liabilities. Comprehensive income Comprehensive income consists of net (loss) earnings and other comprehensive income ("OCI"). OCI comprises the changes in the fair value of the effective portion of derivatives used as hedging items in a cash flow hedge, changes in the fair value of any available for sale financial instruments and foreign currency translation adjustments of self-sustaining foreign operations. Accumulated other comprehensive income ("AOCI") is a new equity category comprised of the cumulative amounts of OCI. No amounts have been recorded in OCI or AOCI as a result of adopting this accounting standard. Future accounting changes In 2006, the CICA issued three new accounting standards: Section 1535, Capital Disclosures; Section 3862, Financial Instruments - Disclosures; and Section 3863, Financial Instruments - Presentation. These new standards will be effective for the Fund on January 1, 2008. Section 1535 establishes new disclosures of capital including disclosing information regarding capital objectives, policies and processes for managing capital. Sections 3862 and 3863 replace Section 3861, revising and enhancing disclosure requirements. In June 2007, the CICA issued the new accounting standard, Section 3031 - Inventories. This new standard replaces Section 3030 modifying the guidance concerning the scope, measurement and allocation of costs of inventory. This standard will be effective for the Fund on January 1, 2008. The Fund is currently evaluating the impact of adopting these new standards on the consolidated financial statements. 4. Credit facilities and long-term debt June 30, December 31, 2007 2006 As at $ $ --------------------------------------------------------------------- Bank credit facilities(a) 75,000 100,984 Revolving demand loan (note 18) - 7,000 --------------------------------------------------------------------- Total credit facilities 75,000 107,984 --------------------------------------------------------------------- --------------------------------------------------------------------- Long-term debt(b & c) 215,000 215,000 Deferred financing costs(1) (810) - --------------------------------------------------------------------- Total long-term debt 214,190 215,000 --------------------------------------------------------------------- --------------------------------------------------------------------- (1) Deferred financing costs have been reclassified to long-term debt upon adoption of the new accounting standards (see note 3). Previously, these costs were included in intangible assets. (a) The Partnership has a $150,000 unsecured revolving credit facility with certain Canadian financial institutions led by the Royal Bank of Canada. The facility has a three-year revolving term and matures on April 21, 2010, unless extended. In addition, the Royal Bank of Canada has provided a $15,000 revolving demand facility and the Toronto Dominion Bank has provided a $10,000 revolving demand facility. The revolving credit facilities bear interest based on the lenders' rates for Canadian prime commercial loans, U.S. Base rate loans, Libor loans, or Bankers' Acceptances rates. The weighted average interest rates for the three and six months ended June 30, 2007 were 5.70% and 5.56% (5.30% and 4.97% for the three and six months ended June 30, 2006). As at June 30, 2007, the balance outstanding on the bank credit facilities was $75,000 ($100,984 as at December 31, 2006). (b) In 2003, $125,000 of unsecured senior notes were issued by the Partnership and KEFL in three parts: $20,000 due in 2008 bearing interest at 5.42%, $52,500 due in 2010 bearing interest at 5.79% and $52,500 due in 2013 bearing interest at 6.16%. Interest is payable monthly. Financing costs of $1,215 have been deferred and are amortized using the effective interest rate method over the remaining terms of the related debt. The effective interest rates for the three and six months ended June 30, 2007 were 5.63%, 5.95% and 6.29% for the notes due in 2008, 2010 and 2013 respectively (5.42%, 5.79% and 6.16% for the three and six months ended June 30, 2006). (c) In 2004, $90,000 of unsecured senior notes were issued by KEFL and guaranteed by the Partnership. The notes bear interest at 5.23% and mature on October 1, 2009. Interest is payable semi- annually. Financing costs of $568 have been deferred and are amortized using the effective interest rate method over the remaining term of the debt. The effective interest rate for the three and six months ended June 30, 2007 was 5.37% (5.23% for the three and six months ended June 30, 2006). 5. Convertible debentures In 2004, the Fund issued convertible unsecured subordinated debentures in the principal amount of $100,000. The convertible debentures bear interest at 6.75% per annum, payable semi-annually in arrears on June 30 and December 31 each year. Interest expense of $409 and $809 has been accrued for the three and six months ended June 30, 2007 ($441 and $938 for the three and six months ended June 30, 2006). These debentures will mature on June 30, 2011 and are convertible into trust units of the Fund at the option of the holders at any time prior to maturity at a conversion price of $12.00 per unit. At June 30, 2007, $77,403 debentures had been converted to trust units ($76,458 at December 31, 2006). Financing costs consisting of an underwriters' commission of $4,000 and issuance costs of $332 have been deferred, and when there are no conversions, are being amortized over the term of the debt using the effective interest rate method. Upon conversion of the debentures, the financing cost related to the principal amount of debt converted is adjusted and is recognized as a charge to unitholders' equity. As a result of conversions to date at June 30, 2007, $2,823 has been reclassified to unitholders' equity ($2,782 at December 31, 2006). As at June 30, 2007, $431 of deferred financing costs remain. The effective interest rate for the three and six months ended June 30, 2007 was 7.36% (6.75% for the three and six months ended June 30, 2006). 6. Asset held for sale Asset held for sale consisted of an interest in an electrical generator. In 2006, the equipment was written down to its estimated net realizable value recognizing a $373 charge to impairment expense. On January 23, 2007, the Fund sold its interest in the electrical generator for proceeds of $4,200. 7. Asset retirement obligation The following table presents the reconciliation between the beginning and ending aggregate carrying amount of the obligation associated with the retirement of the Fund's facilities. $ --------------------------------------------------------------------- Balance, January 1, 2006 27,776 Liabilities acquired 151 Liabilities settled (160) Revisions in estimated cash flows 4,509 Accretion expense 2,257 --------------------------------------------------------------------- Balance, December 31, 2006 34,533 Liabilities settled (101) Revisions in estimated cash flows 751 Accretion expense 1,258 --------------------------------------------------------------------- Balance, June 30, 2007 36,441 --------------------------------------------------------------------- --------------------------------------------------------------------- 8. Income taxes On June 22, 2007, Bill C-52 Budget Implementation Act, 2007 was enacted by the Canadian federal government. This legislation proposes to tax publicly traded trusts in Canada. The new tax is not expected to apply to the Fund until 2011 as the government has provided a transition period for publicly traded trusts that existed prior to November 1, 2006. As a result of the new tax legislation, the Fund recorded an additional $80.2 million future income tax expense and increased its future income tax liability in the second quarter of 2007. This adjustment represents taxable temporary differences of the Partnership that were previously not recorded for future income tax purposes. These temporary differences have been recorded at a tax effected rate of 31.5% which is the rate that will be applicable in 2011 under the current legislation. The following is a reconciliation of income taxes, calculated at the combined federal and provincial income tax rate, to the income tax provision included in the consolidated statements of net (loss) earnings. Three months ended Six months ended June 30, June 30, 2007 2006 2007 2006 $ $ $ $ --------------------------------------------------------------------- Earnings before tax and non-controlling interest 21,645 15,082 43,505 34,003 Income from the Fund distributable to unitholders (13,654) (8,143) (26,277) (18,201) --------------------------------------------------------------------- Income before taxes - operating subsidiaries 7,991 6,939 17,228 15,802 --------------------------------------------------------------------- Income tax at statutory rate of 32.12% (2006 - 34.49%) 2,567 2,293 5,534 5,450 Impact of recording temporary differences of the Partnership 82,182 - 82,182 - Non deductible items excluded from income for tax purposes 157 (425) 727 45 Rate adjustments and changes in estimates (3,022) (10,124) (3,371) (10,205) Benefit of long-term incentive plan previously not recorded - (2,202) - (2,202) Benefit of non-capital losses previously not recorded (220) (606) (786) (822) Resource allowance - 161 - 152 Adjustments to tax pool balances (180) (35) (476) (196) Other (9) (1) 247 (118) Large corporation tax - (137) - - --------------------------------------------------------------------- 81,475 (11,076) 84,057 (7,896) --------------------------------------------------------------------- Classified as: Current 1,240 469 2,426 2,287 Future 80,235 (11,545) 81,631 (10,183) Income tax expense 81,475 (11,076) 84,057 (7,896) --------------------------------------------------------------------- --------------------------------------------------------------------- For income tax purposes, the subsidiaries of the Fund have non- capital losses carried forward of approximately $3,307 at June 30, 2007 ($11,987 at December 31, 2006) which are available to offset income of specific entities of the consolidated group in future periods. The benefit of these losses has been recorded at June 30, 2007. During the second quarter of 2007, the Fund recorded a $5,780 future income tax liability with a corresponding increase to Goodwill. This adjustment relates to a prior period acquisition that did not reflect a future income tax impact for a temporary difference. A further $520 future tax liability and increase to Goodwill was recorded relating to the acquisition of the minority interest in Rimbey Pipeline LP (see note 17). The future income tax (liabilities) assets relate to the (taxable) deductible temporary differences in the carrying values and tax bases as follows: June 30, December 31, 2007 2006 As at $ $ --------------------------------------------------------------------- Property, plant and equipment (163,317) (71,611) Asset retirement obligation 10,869 4,308 Long-term incentive plan 3,993 1,513 Non-capital losses 23 3,475 Intangible assets (1,654) (616) Other (4,020) (2,493) --------------------------------------------------------------------- Future income tax liabilities (154,106) (65,424) --------------------------------------------------------------------- --------------------------------------------------------------------- Property, plant and equipment (282) - Asset retirement obligation 64 - Non-capital losses 969 - --------------------------------------------------------------------- Future income tax assets 751 - --------------------------------------------------------------------- --------------------------------------------------------------------- 9. Unitholders' capital The Declaration of Trust provides that an unlimited number of trust units may be authorized and issued. Each trust unit is transferable, and represents an equal undivided beneficial interest in any distribution from the Fund and in the net assets of the Fund in the event of termination or winding-up of the Fund. All trust units are of the same class with equal rights and privileges. The Declaration of Trust also provides for the issuance of an unlimited number of special trust units that will be used solely for providing voting rights to persons holding securities that are directly or indirectly exchangeable for units and that, by their terms, have voting rights in the Fund. The trust units are redeemable at the holder's option at an amount equal to the lesser of: (i) 90% of the weighted average price per unit during the period of the last 10 trading days during which the trust units were traded on the Toronto Stock Exchange; and (ii) an amount equal to (a) the closing market price of the units; (b) an amount equal to the average of the highest and lowest prices of units if there was trading on the date on which the units were tendered for redemption; or (c) the average of the last bid and ask prices if there was no trading on the date on which the units were tendered for redemption. Redemptions are subject to a maximum of $50 cash redemptions in any particular month. Redemptions in excess of this amount will be paid by way of a distribution in specie of assets of the Fund that may include Commercial Trust Series 1 notes. The Fund has a Distribution Reinvestment and Optional Unit Purchase Plan ("DRIP") that permits unitholders to reinvest cash distributions for additional units. This plan allows eligible participants an opportunity to reinvest distributions into trust units at a 3% discount to a weighted average market price, so long as units are issued from treasury under the DRIP. The Fund has the right to notify participants that units will be acquired in the market, in which case units will be purchased at the weighted average market price. Eligible unitholders can also make optional unit purchases under the optional unit purchase component of the plan at the weighted average market price. Trust units issued and Number of unitholders' capital Units $ --------------------------------------------------------------------- Balance, January 1, 2006 60,125,193 665,914 Units issued on conversion of convertible debentures 597,563 6,859 Units issued pursuant to DRIP 207,997 4,252 --------------------------------------------------------------------- Balance, December 31, 2006 60,930,753 677,025 Units issued on conversion of convertible debentures 78,742 904 Units issued pursuant to DRIP 95,369 1,612 --------------------------------------------------------------------- Balance, June 30, 2007 61,104,864 679,541 --------------------------------------------------------------------- --------------------------------------------------------------------- 10. Net (loss) earnings per unit Basic per unit calculations for the three and six months ended June 30, 2007 and 2006 were based on the weighted average number of units outstanding for the related period. Convertible debentures were in the money for the three and six months ended June 30, 2007 and 2006 and contributed to the increase in diluted weighted average number of units for these periods. Beginning in the second quarter of 2006, incentive awards have been excluded from the calculation of diluted weighted average number of units as units are delivered by acquiring them on the market, rather than issuing them from treasury. Three months ended Six months ended June 30, June 30, 2007 2006 2007 2006 --------------------------------------------------------------------- Weighted average number of units - basic 61,061 60,560 61,017 60,426 Additional units if debentures converted 1,906 2,208 1,926 2,318 --------------------------------------------------------------------- Weighted average number of units - diluted 62,967 62,768 62,943 62,744 --------------------------------------------------------------------- --------------------------------------------------------------------- 11. Accumulated distributions to unitholders $ --------------------------------------------------------------------- Balance, January 1, 2006 131,383 Unitholders' distributions declared and paid 79,354 Unitholders' distributions declared 7,251 --------------------------------------------------------------------- Balance, December 31, 2006 217,988 Unitholders' distributions declared and paid 36,673 Unitholders' distributions declared 7,638 --------------------------------------------------------------------- Balance, June 30, 2007 262,299 --------------------------------------------------------------------- --------------------------------------------------------------------- Pursuant to the Fund Declaration of Trust dated April 3, 2003 and its subsequent amendments, the Fund makes monthly distributions to holders on record on the last day of each month. Payments are made on or about the 15th day of the following month. Distributions are paid from "Cash Flow of the Trust", a term that is defined in the Fund Declaration of Trust dated April 3, 2003. The Board of Directors of the Fund may, on or before each Distribution Record Date, declare payable all or any part of the Cash Flow of the Trust for the Distribution Period. The amount and level of distributions to be made for each Distribution Period is determined at the discretion of the Board of Directors of the Fund. In determining its distribution policy, the Board of Directors of the Fund considers several factors, including the Fund's current and future cash flow, capital requirements, debt repayments and other factors. 12. Compensation plans The Long Term Incentive Plan (the "LTIP" or the "Plan") compensates officers, directors, key employees and consultants by delivering units of the Fund or paying cash in lieu of units. Participants in the LTIP are granted rights ("unit awards") to receive units of the Fund on specified dates in the future. The Plan permits the directors of KEML to authorize the grant of unit awards from time to time. Units are acquired in the marketplace under the plan. The Plan consists of two types of unit awards, which are described below. Unit awards and the delivery of units under the Plan are accounted for in accordance with the intrinsic value method of accounting for stock-based compensation. The aggregate compensation cost recorded for the Plan was $3,111 and $4,247 for the three and six months ended June 30, 2007 ($293 and $2,792 for the three and six months ended June 30, 2006). (a) Performance Unit Awards The Performance Unit Awards will vest 100% on the third anniversary of the effective date of each award, July 1, 2004, July 1, 2005 and July 1, 2006. The number of units to be delivered will be determined by the financial performance of the Fund over the three-year period and is calculated by multiplying the number of unit awards by an adjustment ratio and a payout multiplier. The adjustment ratio adjusts the number of units to be delivered to reflect the per unit cash distributions paid by the Fund to its unitholders during the term that the unit award is outstanding. The payout multiplier is based upon the actual three-year average annual cash distributions per unit of the Fund. The table below describes the relationship between the three-year average annual cash distribution per unit and the payout multiplier. ------------------------------------------------------------------------- Three-year annual cash distributions per unit ------------------------------------------------------------------------- July 1, 2004 July 1, 2005 July 1, 2006 Payout Grant Grant Grant Multiplier ------------------------------------------------------------------------- Less than 1.15 Less than 1.32 Less than 1.42 Nil First range 1.15 - 1.22 1.32 - 1.39 1.42 - 1.51 50%-99% Second range 1.23 - 1.38 1.40 - 1.55 1.52 - 1.71 100%-199% Third range 1.39 and greater 1.56 and greater 1.72 and greater 200% ------------------------------------------------------------------------- As of June 30, 2007, 494,092 Performance Unit Awards (529,867 at December 31, 2006) were outstanding: 148,237 effective July 1, 2004, 184,830 effective July 1, 2005 and 161,025 effective July 1, 2006. The compensation cost recorded for these units for the three and six months ended June 30, 2007 were $2,705 and $3,659, using the applicable closing market price of a unit of the Fund ($328 and $2,263 for the three and six months ended June 30, 2006). (b) Time Vested Unit Awards ("Restricted Unit Awards") Restricted Unit Awards will vest automatically, over a three-year period from the effective date of the award on July 1, 2004, July 1, 2005 and July 1, 2006, regardless of the performance of the Fund. The number of units to be delivered will be modified by an adjustment ratio which reflects the per unit distributions paid by the Fund to its unitholders during the term that the unit award is outstanding. As of June 30, 2007, 93,959 Restricted Unit Awards (98,735 at December 31, 2006) were outstanding: 21,548 effective July 1, 2004, 29,086 effective July 1, 2005 and 43,325 effective July 1, 2006. The compensation cost recorded for these units for the three and six months ended June 30, 2007 was $406 and $588, using the applicable closing market price of a unit of the Fund (($35) and $529 for the three and six months ended June 30, 2006). 13. Financial instruments Financial instruments include cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, distributions payable, credit facilities, long-term debt, convertible debentures and derivatives held for trading (derivative financial instruments such as foreign exchange contracts, interest rate contracts, oil price contracts, natural gas price contracts, power price contracts and physical fixed price contracts). Derivatives held for trading Subsidiaries of the Fund enter into contracts to purchase and sell natural gas, NGLs and crude oil. These contracts are exposed to commodity price risk between the time contracted volumes are purchased and sold and currency exchange risk for those sales denominated in U.S. dollars. These risks are actively managed by using forward currency contracts and swaps, energy related forwards, swaps and options and by balancing physical and financial contracts in terms of volumes, timing of performance and delivery obligations. Management monitors the exposure to the above risks and regularly reviews its financial instrument activities and all outstanding positions. A significant amount of electricity is consumed by the operating entities at their facilities. Due to the fixed fee nature of some service contracts in place with customers, these entities are unable to flow the cost of electricity to customers in all situations. In order to mitigate this exposure to fluctuations in the price of electricity, price swap agreements may be used. Natural gas, NGL and crude oil contracts that require physical delivery at fixed prices and do not meet the Fund's expected purchase, sale or usage requirements are accounted for as derivative financial instruments. The Fund issues fixed-rate long-term debt to finance its growth strategy. Due to the volatility of the debt market, the Fund is exposed to interest rate fluctuations on new debt issues between the time when the debt is offered and when it is priced. In order to mitigate against this exposure, the Fund may enter into interest rate financial contracts. Derivative instruments held for trading are recorded on the consolidated statement of financial position at fair value. Changes in the fair value of these financial instruments are recognized in earnings in the period in which they arise. As at June 30, 2007, $1,773 of assets held for trading were included in accounts receivable and $4,150 of liabilities held for trading were included in accounts payable and accrued liabilities. Unrealized gains (losses), representing the change in fair value of derivative contracts are recorded in revenue of the Marketing and NGL Infrastructure segments. The unrealized gains (losses) relating to derivative contracts were as follows: Three months ended Six months ended June 30, June 30, Unrealized gain (loss) 2007 2006 2007 2006 --------------------------------------------------------------------- Marketing 807 364 (4,650) (106) NGL Infrastructure (207) - (95) - --------------------------------------------------------------------- --------------------------------------------------------------------- A further unrealized loss of $740 was recorded in interest expense for the three and six months ended June 30, 2007 relating to the change in fair value of an interest rate financial contract ($nil for the three and six months ended June 30, 2006). The fair value of the derivatives are listed below and represent an estimate of the amount that the Fund would receive (pay) if these instruments were closed out at the end of the period. Weighted Carrying Fair Average Notional As at June 30, 2007 Amount $ Value $ Price Volume --------------------------------------------------------------------- Natural gas: Price swaps (maturing by March 31, 2008) (294) (294) $7.85/GJ 275,000 GJs Electricity: Price swaps (maturing by December 31, 2008) 1,100 1,100 $55/MWh 33,000 MWhs NGLs: Price swaps (maturing by March 31, 2008) (2,331) (2,331) $69.33/Bbl 362,181 Bbls Currency: Forward contracts (maturing by July 20, 2007) 23 23 $1.0661/USD US $8,750 Physical contracts: Fixed price forward contracts (maturing by December 31, 2007) (63) (63) $54.51/Bbl 119,396 Bbls Embedded derivative contracts (maturing by July 31, 2007) (72) (72) $65.39/Bbl 18,585 Bbls Interest Rate: Interest rate financial contracts (maturing by September 4, 2007) (740) (740) N/A $50,000 --------------------------------------------------------------------- --------------------------------------------------------------------- As at December 31, 2006 Natural gas: Price swaps (maturing by March 31, 2007) - (130) $7.78/GJ 90,000 GJs Electricity: Price swaps (maturing by December 31, 2008) - 1,031 $55/MWh 43,860 MWhs NGLs: Price swaps (maturing by March 30, 2007) 211 211 $72.25/Bbl 450,000 Bbls Currency: Forward contracts (maturing by January 26, 2007) (287) (287) $1.1477/USD US $16,350 Physical contracts: Fixed price forward contracts - - - - Embedded derivative contracts - - - - Interest Rate: Interest rate financial contracts - - - - --------------------------------------------------------------------- --------------------------------------------------------------------- The estimated fair value of all derivatives held for trading is based on quoted market prices and, if not available, on estimates from third-party brokers or dealers. Fair value The carrying values of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities and distributions payable approximate their fair values because the instruments are near maturity or have no fixed repayment terms. The fair value of the credit facilities approximates fair value due to their floating rates of interest. Credit risk The majority of accounts receivable are due from entities in the oil and gas industry and are subject to normal industry credit risks. Concentration of credit risk is mitigated by having a broad domestic and international customer base. The Fund evaluates and monitors the financial strength of its customers in accordance with its credit policy. At June 30, 2007, the accounts receivable from the two largest customers amounted to less than 1% of accounts receivable (December 31, 2006 - less than 1%). Revenue from the two largest customers amounted to 19% and 15% of operating revenue for the three and six months ended June 30, 2007 (11% for the three and six months ended June 30, 2006). With respect to counterparties for derivative financial instruments, the credit risk is managed through dealing with recognized futures exchanges or investment grade financial institutions and by maintaining credit policies, which significantly minimize overall counter party credit risk. Foreign currency rate risk The Gathering and Processing and NGL Infrastructure segments, where all sales and virtually all purchases are denominated in Canadian dollars, are not subject to foreign currency rate risk. In the Marketing business, approximately US$31,795 and US$113,753 of sales were priced in U.S. dollars for the three and six months ended June 30, 2007 (US$74,624 and US$164,862 for the three and six months ended June 30, 2006). Currency exchange risk is actively managed by using forward currency contracts and swaps. Management monitors the exposure to currency exchange risk and regularly reviews its financial instrument activities and all outstanding positions. The Fund realized and recorded $536 and $712 of foreign currency loss in Marketing operating expenses for the three and six months ended June 30, 2007 ($676 and $537 for the three and six months ended June 30, 2006). A further $1,131 and $1,285 of unrealized foreign currency gains were recorded in Marketing operating expenses for the three and six months ended June 30, 2007 ($502 and $55 of unrealized foreign currency gains for the three and six months ended June 30, 2006). Interest rate risk The majority of the Fund's interest rate risk is attributed to its fixed and floating rate debt, which is used to finance operations. The Fund's remaining financial instruments are not significantly exposed to interest rate risk. The floating rate debt creates exposure to interest rate cash flow risk, whereas the fixed rate debt creates exposure to interest rate price risk. At June 30, 2007, fixed rate borrowings comprised 74% of total debt outstanding (December 31, 2006 - 67%). The fair value of the senior fixed rate debt at June 30, 2007 was $214,300 (December 31, 2006 - $224,457). The fair value of the Fund's unsecured convertible debentures at June 30, 2007 was $34,178 (December 31, 2006 - $31,782). In the second quarter of 2007, the Fund entered into an interest rate financial contract as an economic hedge against fluctuations in long- term interest rates relating to the new long-term senior unsecured notes as described in note 18. At June 30, 2007, the fair value of this interest rate financial contract was $740, which represents the amount that the Fund would pay if this financial instrument were to be closed out at the end of the period. This value was obtained from independent third party estimates. 14. Commitments and contingencies The Fund, through its operating entities, is involved in various contractual agreements with a major oil and gas producer. The agreements range from one to eleven years and comprise the processing of the producer's natural gas and the purchase of NGL production in the areas specified in the agreements. The purchase prices are based on current period market prices. There are operating lease commitments relating to railway tank cars, vehicles, computer hardware, office space, terminal space and natural gas transportation. The estimated annual minimum operating lease rental payments from these commitments are as follows: $ --------------------------------------------------------------------- 2007 4,160 2008 6,475 2009 5,012 2010 3,466 2011 2,790 Thereafter 4,262 --------------------------------------------------------------------- 26,165 --------------------------------------------------------------------- --------------------------------------------------------------------- There are legal actions for which the ultimate results cannot be ascertained at this time. Management does not expect the outcome of any of these proceedings to have a material effect on the financial position or results of operations. 15. Supplemental cash flow information Changes in non-cash working capital Three months ended Six months ended June 30, June 30, 2007 2006 2007 2006 $ $ $ $ --------------------------------------------------------------------- Cash provided by (used in): Accounts receivable (6,694) (15,151) (17,208) 28,551 Inventory 13,154 (19,185) 6,999 8,054 Other current assets (4,533) (5,475) (3,555) (4,913) Accounts payable and accrued liabilities (8,289) 11,393 24,424 (3,108) --------------------------------------------------------------------- Changes in non-cash working capital (6,362) (28,418) 10,660 28,584 --------------------------------------------------------------------- Relating to: Operating activities (6,729) (20,808) 13,647 28,854 Investing activities 367 (7,610) (2,987) (270) --------------------------------------------------------------------- Other cash flow information: Interest paid 3,513 3,412 8,740 8,215 Taxes paid 1,035 1,088 1,992 2,521 16. Segmented information The Fund has three reportable segments: Marketing, Gathering and Processing and NGL Infrastructure. The Marketing business consists of marketing NGLs, sulphur and crude oil. Gathering and Processing includes natural gas gathering and processing. NGL Infrastructure includes NGL and crude oil processing, transportation and storage. The accounting policies of the segments are the same as that described in the summary of significant accounting policies. Inter- segment sales and expenses are recorded at current market prices. Gathering and NGL Proces- Infrast- Three months ended Marketing sing ructure Corporate Total June 30, 2007 $ $ $ $ $ ------------------------------------------------------------------------- Revenue 292,326 45,074 17,658 - 355,058 Inter-segment revenue - (797) (8,133) - (8,930) ------------------------------------------------------------------------- External revenue 292,326 44,277 9,525 - 346,128 Operating expenses (273,489) (29,713) (6,476) - (309,678) Inter-segment expenses 8,930 - - - 8,930 ------------------------------------------------------------------------- External operating expenses (264,559) (29,713) (6,476) - (300,748) ------------------------------------------------------------------------- 27,767 14,564 3,049 - 45,380 General and administrative, interest and other - - - (12,702) (12,702) Depreciation and amortization (702) (7,285) (2,171) (263) (10,421) Accretion expense (2) (529) (81) - (612) Impairment expense - - - - - ------------------------------------------------------------------------- Earnings (loss) before tax and non-controlling interest 27,063 6,750 797 (12,965) 21,645 ------------------------------------------------------------------------- Income tax (expense) recovery 60 - (1,364) (80,171) (81,475) ------------------------------------------------------------------------- (Loss) earnings before non-controlling interest 27,123 6,750 (567) (93,136) (59,830) ------------------------------------------------------------------------- ------------------------------------------------------------------------- Identifiable assets 167,112 811,139 238,101 11,205 1,227,557 ------------------------------------------------------------------------- Capital expenditures 536 4,905 2,548 166 8,155 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Gathering and NGL Proces- Infrast- Three months ended Marketing sing ructure Corporate Total June 30, 2006 $ $ $ $ $ ------------------------------------------------------------------------- Revenue 279,241 41,655 14,292 - 335,188 Inter-segment revenue - (883) (5,743) - (6,626) ------------------------------------------------------------------------- External revenue 279,241 40,772 8,549 - 328,562 Operating expenses (268,657) (28,189) (5,389) - (302,235) Inter-segment expenses 6,626 - - - 6,626 ------------------------------------------------------------------------- External operating expenses (262,031) (28,189) (5,389) - (295,609) ------------------------------------------------------------------------- 17,210 12,583 3,160 - 32,953 General and administrative, interest and other - - - (7,707) (7,707) Depreciation and amortization (578) (6,954) (1,876) (273) (9,681) Accretion expense - (412) (71) - (483) Impairment expense - - - - - ------------------------------------------------------------------------- Earnings (loss) before tax and non- controlling interest 16,632 5,217 1,213 (7,980) 15,082 ------------------------------------------------------------------------- Income tax recovery - - 3,649 7,427 11,076 ------------------------------------------------------------------------- Earnings (loss) before non-controlling interest 16,632 5,217 4,862 (553) 26,158 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Identifiable assets 160,006 817,510 224,950 15,096 1,217,562 ------------------------------------------------------------------------- Capital expenditures 12,032 9,861 3,680 791 26,364 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Gathering and NGL Proces- Infrast- Six months ended Marketing sing ructure Corporate Total June 30, 2007 $ $ $ $ $ ------------------------------------------------------------------------- Revenue 599,668 87,782 35,339 - 722,789 Inter-segment revenue - (1,556) (16,122) - (17,678) ------------------------------------------------------------------------- External revenue 599,668 86,226 19,217 - 705,111 Operating expenses (571,545) (50,939) (11,856) - (634,340) Inter-segment expenses 17,678 - - - 17,678 ------------------------------------------------------------------------- External operating expenses (553,867) (50,939) (11,856) - (616,662) ------------------------------------------------------------------------- 45,801 35,287 7,361 - 88,449 General and administrative, interest and other - - - (22,677) (22,677) Depreciation and amortization (1,773) (14,505) (4,266) (465) (21,009) Accretion expense (5) (1,086) (167) - (1,258) Impairment expense - - - - - ------------------------------------------------------------------------- Earnings (loss) before tax and non-controlling interest 44,023 19,696 2,928 (23,142) 43,505 ------------------------------------------------------------------------- Income tax (expense) recovery 893 - (4,068) (80,882) (84,057) ------------------------------------------------------------------------- Earnings (loss) before non-controlling interest 44,916 19,696 (1,140) (104,024) (40,552) ------------------------------------------------------------------------- ------------------------------------------------------------------------- Identifiable assets 167,112 811,139 238,101 11,205 1,227,557 ------------------------------------------------------------------------- Capital expenditures 538 6,364 4,389 479 11,770 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Gathering and NGL Proces- Infrast- Six months ended Marketing sing ructure Corporate Total June 30, 2006 $ $ $ $ $ ------------------------------------------------------------------------- Revenue 596,082 80,647 30,760 - 707,489 Inter-segment revenue - (1,822) (12,605) - (14,427) ------------------------------------------------------------------------- External revenue 596,082 78,825 18,155 - 693,062 Operating expenses (573,994) (48,703) (11,017) - (633,714) Inter-segment expenses 14,427 - - - 14,427 ------------------------------------------------------------------------- External operating expenses (559,567) (48,703) (11,017) - (619,287) ------------------------------------------------------------------------- 36,515 30,122 7,138 - 73,775 General and administrative, interest and other - - - (19,418) (19,418) Depreciation and amortization (1,153) (13,566) (3,731) (565) (19,015) Accretion expense - (825) (141) - (966) Impairment expense - (373) - - (373) ------------------------------------------------------------------------- Earnings (loss) before tax and non-controlling interest 35,362 15,358 3,266 (19,983) 34,003 ------------------------------------------------------------------------- Income tax recovery - - 1,386 6,510 7,896 ------------------------------------------------------------------------- Earnings (loss) before non-controlling interest 35,362 15,358 4,652 (13,473) 41,899 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Identifiable assets 160,006 817,510 224,950 15,096 1,217,562 ------------------------------------------------------------------------- Capital expenditures 12,032 34,799 5,015 791 52,637 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Three months ended Six months ended June 30, June 30, 2007 2006 2007 2006 $ $ $ $ --------------------------------------------------------------------- Marketing revenue derived from export sales to the U.S. 9,172 14,701 32,993 40,871 Property, plant and equipment located in the U.S. 12,212 12,030 12,212 12,030 --------------------------------------------------------------------- 17. Non-controlling interest In the first quarter of 2007, the Fund purchased an additional ownership interest in Rimbey Pipe Line Co. Ltd. for a purchase price of $1,513. In the second quarter of 2007, Rimbey Pipe Line Co. Ltd. was converted to a limited partnership (Rimbey Pipeline LP) and the Fund acquired the remaining interest in Rimbey Pipeline LP for a purchase price of $5,203 bringing the Fund's ownership in Rimbey Pipeline LP to 100%. The difference between the fair value of the transactions and the carrying value of Rimbey Pipeline LP's net assets resulted in a difference of $3,665, which was applied to property, plant and equipment. A future tax liability and corresponding increase to Goodwill was recorded in the amount of $520. As a result, the non-controlling interest has been removed from the Consolidated Statement of Financial Position. 18. Subsequent events On July 19, 2007, the Fund initiated a private placement arrangement to issue long-term senior unsecured notes in the principal amount of $120,000. The notes will be issued in two tranches: $60,000 due in 2017 bearing interest at 5.89% and $60,000 due in 2022 bearing interest at 6.14%. On July 12, 2007, the $7,000 unsecured revolving demand loan facility relating to a subsidiary of the Partnership was terminated. Corporate Information Board of Directors Officers E. Peter Lougheed(1)(3) Jim V. Bertram Counsel President and Chief Executive Officer Bennett Jones LLP Calgary, Alberta David G. Smith Executive Vice President, Jim V. Bertram(4) Chief Financial Officer and President and CEO Corporate Secretary Keyera Energy Management Ltd. Calgary, Alberta Marzio Isotti Vice President, West Central Region Robert B. Catell Chairman and CEO Steven B. Kroeker KeySpan Corporation Vice President, Corporate Development New York, New York Bradley W. Lock Michael B.C. Davies(2) Vice President, Engineering & Principal Operational Services Davies & Co. Banff, Alberta David A. Sentes Vice President, Comptroller Nancy M. Laird(3)(4) Corporate Director Calgary, Alberta Stock Exchange Listing The Toronto Stock Exchange H. Neil Nichols(2)(3) Trading Symbols KEY.UN; KEY.DB Management Consultant Mississauga, Ontario Unit Trading Summary Q2 2007 --------------------------------------- William R. Stedman(3)(4) TSX:KEY.UN - Cdn $ Chairman and CEO --------------------------------------- ENTx Capital Corporation High $20.18 Calgary, Alberta Low $16.61 Close March 30, 2007 $17.46 Wesley R. Twiss(2) Volume 8,545,683 Corporate Director Average Daily Volume 135,646 Calgary, Alberta Auditors (1) Chairman of the Board Deloitte & Touche LLP (2) Member of the Audit Chartered Accountants Committee Calgary, Canada (3) Member of the Compensation and Governance Committee Investor Relations (4) Member of the Health, Contact: Safety and Environment John Cobb or Avery Reiter Committee Toll Free: 1-888-699-4853 Direct: 403-205-7670 Email: ir@keyera.com Head Office Keyera Facilities Income Fund Suite 600, Sun Life Plaza West Tower 144 - 4th Avenue S.W. Calgary, Alberta T2P 3N4 Main phone: 403-205-8300 Website: www.keyera.com %SEDAR: 00019203E

For further information:

For further information: Keyera's Investor Relations Department at (403)
205-7670, toll free at (888) 699-4853 or via email at ir@keyera.com;
Information on Keyera can also be found on our website at www.keyera.com


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