Arsenal is highly leveraged to the rising oil prices and narrowing heavy oil differentials that occurred during the first quarter of 2008. Arsenal’s cash flow is up sharply from Q4, when prior period adjustments and one time provisions reduced cash from operations to zero. Realized prices have continued to rise in the second quarter. Production volumes are also rising in the second quarter, as exploration successes from the last two quarters come on line. Management anticipates reporting another large increase in cash flow in Q2.
HIGHLIGHTS
• Average production of 1725 boe/d vs. 1685 boe/d in Q4
• Operating netbacks of $32.82/boe vs. $21.73/boe in Q4
• Quarterly cash flow from operations of $3.8 million vs. nil in Q4
• Quarter end total debt + working capital deficiency of $18.7 million vs. $20.7 million at Dec 31,
2007.
PROFIT/LOSS
Arsenal showed a loss of $488,026 for the first quarter. Arsenal decided to write off the remaining $495,650 of value on the books for its Egyptian concession. Excluding that write off, Arsenal would have shown a small profit.
OPERATIONS IN REVIEW
Arsenal’s exploration strategy of focusing on internally generated grassroots plays is beginning to show results. The company has established three key exploration areas at, Evi Alberta, East Central Alberta, and Stanley North Dakota. In the first quarter, Arsenal participated in the drilling of 8 gross (5.5 net) wells resulting in 7 gross (4.5 net) oil wells and one (1 net) dry hole. Arsenal expects to drill 9 (8.5 net) wells in the second quarter, all in East Central Alberta.
EVI
By the end of Q1 all of Arsenal’s production was tied in to the battery acquired in Q4. Operating cost savings should be evident in Arsenal’s second quarter results. Two (0.75 net) new successful wells were drilled and placed on production at 600 (250 net) bbls/d. Arsenal’s total production for the area is now approximately 400bbls/d of light sweet crude. Two (0.75 net) locations have been selected for drilling in the third quarter and Arsenal has an additional 4 locations in inventory.
EAST CENTRAL ALBERTA
At Galahad, Arsenal drilled two (2 net) oil wells in Q1. Those two wells and a Glauconitic gas well drilled in Q4 were tied in to a company owned facility at the end of March. Net Galahad production has risen from approximately 150 boe/d in February, 2008 to about 400 boe/d currently. In addition, Arsenal shot and interpreted a new 3D seismic program on offsetting lands. The program has identified a large structure that will be tested in Q2.
Arsenal participated in two (0.8 net) wells at Alderson in Q1. One well encountered a thick glauconitic oil zone that tested gas at 750 mcf/d and oil at 50 bbls/d. The operator is examining tie in options. The second well is marginal and will likely be abandoned.
The Q4 discovery well at Consort (100% WI) continues to produce at over 100 bbls/d. Arsenal plans to drill three offset wells in early June, and depending on results a battery may be constructed. Arsenal has additional leads on this trend.
The company has developed plays on three other East Central Alberta properties. Arsenal has three drill ready locations at Wildmere, two at Provost, and two at Princess. These wells will likely be drilled late in the second quarter or in the third quarter.
STANLEY
Arsenal has 1896 net acres of Bakken deep rights held by production. Bakken drilling continues all around Arsenal’s land base. Production results from properties surrounding Arsenal’s property released to date vary from 100bbls/d to 2000bbls/d. The company has budgeted three gross (0.5 net) Bakken wells for 2008. The first well (23.4% WI) is scheduled to spud November of 2008.
EGYPT
Arsenal continues its review of strategic alternatives for Egypt. Industry interest in the concession has been low to date, and therefore, management has made the decision to write off the remaining value.
COMMODITY PRICING
In Q4 of 2007 Arsenal’s blended mix of production received an average sale price of $53.92/boe. Rising oil prices and narrowing heavy oil differentials resulted in an increase to $72.04/boe in the first quarter. Mid April pricing for Arsenal’s mix is in the range of $95/boe.
OPERATING EXPENSES
Operating costs averaged $22.65/boe during the first quarter. Arsenal’s production mix is dominated by heavy oil and low rate light oil. These properties have higher operating costs than average for the basin.
Over the medium term, production from new wells and disposition of small noncore properties should
slowly average down operating expenses.
CASH FLOW
Cash flow from operations for the first quarter was $3.8 million or $0.05/share. The large increase from Q4 2007 is due to higher realized prices, higher volumes, a better quality production mix, and a decrease in one time charges and prior period adjustments.
DEBT
In the second quarter of 2007 Arsenal made a strategic decision to move towards a more conservative financial model. Arsenal will target a ratio of total debt plus working capital deficiency to cash flow of one to one. The ratio for Q1 was 1.23:1.
OUTLOOK
Arsenal’s leverage to higher oil prices and lower heavy oil differentials should translate into much improved operating netbacks and cash flow in the second quarter. Production volumes for the second quarter should be approximately 2000 boe/d and that cash flow for the second quarter should be in excess of $8 million.
Over the next six months Arsenal has a very exciting exploration and development program. The capital budget has been increased to $22 million for 2008 with $17 million remaining to be spent. Arsenal has plans to drill 16 gross (13.5 net) wells by yearend. This would include high impact wells at Evi, Galahad, Consort and the Bakken in North Dakota.