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Vermilion Energy Inc. Announces Year End 2011 Operating and Financial Results

March 5, 2012

CALGARY, March 5, 2012 /CNW/ - Vermilion Energy Inc. ("Vermilion" or the "Company") (TSX - VET) is pleased to report interim operating and unaudited financial results for the year ended December 31, 2011.

HIGHLIGHTS

  • Achieved 10% growth in full year average production to 35,202 boe/d in 2011 as compared to 32,132 boe/d in 2010.  Fourth quarter of 2011 production averaged 36,654 boe/d, an increase of 4% and 6% as compared to 35,302 boe/d in the fourth quarter of 2010 and 34,676 boe/d in the third quarter of 2011, respectively.  The growth in fourth quarter of 2011 production was attributable to the strong performance of the Company's Cardium light oil program in Canada.

  • Generated a significant 33% increase in fund flows from operations to $474.3 million ($5.22 per share) for the full year 2011, as compared to $357.5 million ($4.05 per share) in 2010.  Fund flows from operations for fourth quarter of 2011 of $136.9 million ($1.46 per share) were higher as compared to $98.2 million ($1.11 per share) in the fourth quarter of 2010 and $116.4 million ($1.29 per share) in the third quarter of 2011, respectively.  The growth in fund flows from operations in 2011 was attributable to Vermilion's strong growth in average production volumes during 2011, in addition to the Company's significant exposure (46%) to Dated Brent crude, which averaged a $16.15 premium to West Texas Intermediate during 2011, and the Company's high netback natural gas production in the Netherlands (16%) which received an average price of $9.59 per mcf in 2011.  With the addition of Vermilion's Cardium related production, which is priced against West Texas Intermediate, the Company's consolidated production volumes for 2011 were approximately 80% weighted to crude oil pricing.

  • Significantly grew production in the Company's Cardium light oil play in Western Canada and continued with the long-term development of the assets.  Vermilion increased Cardium related production by more than 260% from an average of approximately 1,000 boe/d in 2010 to more than 3,800 boe/d in 2011 and exited 2011 with Cardium related production in excess of 6,000 boe/d.  Vermilion participated in the drilling of 48.9 net Cardium wells in 2011 and completed the development and commissioning of a 15,000 bbls/d oil battery to accommodate full field development of the play.

  • Subsequent to year end 2011, Vermilion acquired certain working interests in six producing fields located in the Paris and Aquitaine basins in France.  The assets are expected to average approximately 2,200 boe/d of production in 2012, weighted 86% to high quality Dated Brent based crude, and add an estimated 6.7(1) million boe of proved plus probable reserves (96% crude oil).  Taking into consideration an effective date of January 1, 2011 and customary closing adjustments, Vermilion paid approximately $107 million cash at closing of the acquisition reflecting a cash cost of approximately $48,600 per flowing boe and $16.00 per boe of proved plus probable reserves as evaluated by GLJ and effective December 31, 2011.

  • Received all key regulatory approvals required to begin construction of the Corrib onshore pipeline.  Subsequent to year end 2011, all open periods for appeal of the regulatory approvals expired with no open appeals remaining outstanding.  The tunneling site has been handed over to the tunnel contractor who will prepare and install the tunnel boring machine and is scheduled to commence tunneling in the fourth quarter of 2012 with first gas currently anticipated in late 2014.

  • Invested approximately $61.0 million in 2011 to acquire 154 net sections of undeveloped lands in Canada with exposure to potential emerging shale oil and liquids-rich gas resource opportunities.  Subsequent to year end 2011, an additional 43 net sections have been added to these opportunities for a total exposure of 197 sections.

  • Added 16.8 million barrels of oil equivalent of proved plus probable reserves in 2011 through drilling and development, replacing 130% of 2011 production and increasing total reserves by 2.7%.  Vermilion's proved plus probable reserve life index at the end of 2011 was approximately 10.9 years based on fourth quarter of 2011 production volumes.

  • Generated a positive total return to investors of 3.1% for the year ending December 31, 2011.  Over the past five years, Vermilion has generated a compound annualized rate of return of 10.1% as compared to a peer group average of 6.4%.
1 Estimated proved plus probable reserves attributable to the assets as evaluated by GLJ Petroleum Consultants Ltd. ("GLJ") in a report dated October 14, 2011 with an effective date of December 31, 2011.

Conference Call and Audio Webcast Details

Vermilion will discuss these results in a conference call to be held on Monday, March 5, 2012 at 9:00 AM MST (11:00 AM EST).  To participate, you may call toll free 1-877-407-9205 (North America) or 1-201-689-8054 (International).  The conference call will also be available on replay by calling 1-877-660-6853 (North America) or 1-201-612-7415 (International) using account number 286 and conference ID number 384826.  The replay will be available until midnight eastern time on March 12, 2012.

You may also listen to the audio webcast by clicking http://www.investorcalendar.com/IC/CEPage.asp?ID=166857 or visit Vermilion's website at http://www.vermilionenergy.com/ir/eventspresentations.cfm.

DISCLAIMER

Certain statements included or incorporated by reference in this document may constitute forward looking statements under applicable securities legislation.  Forward looking statements or information typically contain statements with words such as "anticipate", "believe", "expect", "plan", "intend", "estimate", "propose", or similar words suggesting future outcomes or statements regarding an outlook.  Forward looking statements or information in this document may include, but are not limited to:

  • capital expenditures;
  • business strategies and objectives;
  • reserve quantities and the discounted present value of future net cash flows from such reserves;
  • revenue;
  • future production levels and rates of average annual production growth;
  • exploration plans;
  • development plans;
  • acquisition and disposition plans and the timing thereof;
  • operating and other expenses;
  • royalty rates;
  • the timing of regulatory proceedings and approvals;
  • the timing of first commercial gas from the Corrib field; and
  • estimate of Vermilion's share of the expected gas rates from the Corrib field.

Such forward looking statements or information are based on a number of assumptions all or any of which may prove to be incorrect.  In addition to any other assumptions identified in this document, assumptions have been made regarding, among other things:

  • the ability of Vermilion to obtain equipment, services and supplies in a timely manner to carry out its activities in Canada and internationally;
  • the ability of Vermilion to market oil and natural gas successfully to current and new customers;
  • the timing and costs of pipeline and storage facility construction and expansion and the ability to secure adequate product transportation;
  • the timely receipt of required regulatory approvals;
  • the ability of Vermilion to obtain financing on acceptable terms;
  • foreign currency exchange rates and interest rates;
  • future oil and natural gas prices; and
  • Management's expectations relating to the timing and results of development activities.

Although Vermilion believes that the expectations reflected in such forward looking statements or information are reasonable, undue reliance should not be placed on forward looking statements because Vermilion can give no assurance that such expectations will prove to be correct.  Forward looking statements or information are based on current expectations, estimates and projections that involve a number of risks and uncertainties which could cause actual results to differ materially from those anticipated by Vermilion and described in the forward looking statements or information.  These risks and uncertainties include but are not limited to:

  • the ability of management to execute its business plan;
  • the risks of the oil and gas industry, both domestically and internationally, such as operational risks in exploring for, developing and producing crude oil and natural gas and market demand;
  • risks and uncertainties involving geology of oil and natural gas deposits;
  • risks inherent in Vermilion's marketing operations, including credit risk;
  • the uncertainty of reserves estimates and reserves life;
  • the uncertainty of estimates and projections relating to production, costs and expenses;
  • potential delays or changes in plans with respect to exploration or development projects or capital expenditures;
  • Vermilion's ability to enter into or renew leases;
  • fluctuations in oil and natural gas prices, foreign currency exchange rates and interest rates;
  • health, safety and environmental risks;
  • uncertainties as to the availability and cost of financing;
  • the ability of Vermilion to add production and reserves through development and exploration activities;
  • general economic and business conditions;
  • the possibility that government policies or laws may change or governmental approvals may be delayed or withheld;
  • uncertainty in amounts and timing of royalty payments;
  • risks associated with existing and potential future law suits and regulatory actions against Vermilion; and
  • other risks and uncertainties described elsewhere in this document or in Vermilion's other filings with Canadian securities regulatory authorities.

The forward looking statements or information contained in this document are made as of the date hereof and Vermilion undertakes no obligation to update publicly or revise any forward looking statements or information, whether as a result of new information, future events or otherwise, unless required by applicable securities laws.

Natural gas volumes have been converted on the basis of six thousand cubic feet of natural gas to one barrel of oil equivalent.  Barrels of oil equivalent (boe) may be misleading, particularly if used in isolation.  A boe conversion ratio of six thousand cubic feet to one barrel of oil is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.

HIGHLIGHTS

($M except as indicated below) Three Months Ended     Year Ended
  Dec 31, Sept 30, Dec 31,     Dec 31, Dec 31,
Financial 2011  2011  2010      2011  2010 
Petroleum and natural gas sales 275,172  248,361  216,426      1,031,570  727,805 
Fund flows from operations 1 136,883  116,369  98,162      474,336  357,529 
  Fund flows from operations ($/adjusted basic share) 1.46  1.29  1.11      5.22  4.05 
  Fund flows from operations ($/adjusted diluted share) 1.44  1.27  1.09      5.14  3.99 
Net earnings (loss) (30,243) 64,442  (21,809)     142,821  44,395 
  Net earnings (loss) per share, basic ($/basic share) (0.32) 0.71  (0.25)     1.57  0.53 
Capital expenditures 152,251  134,781  105,435      490,780  432,182 
Acquisitions 12,777      50,878  448 
Asset retirement obligations settled 7,559  4,269  5,110      23,071  6,861 
Cash dividends ($/share) 0.57  0.57  0.57      2.28  2.28 
Dividends declared 53,871  51,612  50,664      207,846  189,744 
  Less: Issuance of shares pursuant to the dividend reinvestment plan (16,802) (15,219) (13,467)     (59,081) (40,824)
  Net dividends 1 37,069  36,393  37,197      148,765  148,920 
  % of fund flows from operations, gross 39% 44% 52%     44% 53%
  % of fund flows from operations, net 27% 31% 38%     31% 42%
Total net dividends, capital expenditures and asset retirement obligations settled1 196,879  175,443  147,742      662,616  587,151 
  % of fund flows from operations 144% 151% 151%     140% 164%
  % of fund flows from operations (excluding the Corrib project) 134% 132% 136%     125% 142%
Net debt 1           428,961  303,295 
Return on shareholders' equity (%)           12% 5%
Operations
Production              
  Crude oil (bbls/d) 22,096  20,464  21,573      20,979  18,479 
  NGLs (bbls/d) 1,312  1,369  1,412      1,355  1,462 
  Natural gas (mcf/d) 79,478  77,056  73,899      77,207  73,144 
  Boe/d (6:1) 36,654  34,676  35,302      35,202  32,132 
Average selling price              
  Crude oil and NGLs ($/bbl) 105.49  100.71  83.88      104.58  79.54 
  Natural gas ($/mcf) 6.57  6.50  5.74      6.35  5.58 
Netbacks (6:1) ($/boe) 1              
  Operating netback 54.86  49.85  44.21      51.53  40.94 
  Fund flows netback 40.60  36.46  30.23      36.93  30.48 
  Operating expenses 12.01  13.57  12.20      12.64  12.33 
Average reference prices              
  WTI (US $/bbl) 94.06  89.76  85.17      95.12  79.53 
  Dated Brent (US $/bbl) 109.31  113.46  86.48      111.27  79.47 
  AECO ($/mcf) 3.17  3.66  3.62      3.62  4.00 
Average foreign exchange rates              
  CDN $/US $ 1.02  0.98  1.01      0.99  1.03 
  CDN $/Euro 1.3 1.38  1.38      1.38  1.37 
Share information
Shares outstanding ('000s)              
  Basic shares outstanding           96,430  88,998 
  Diluted shares outstanding 1           98,778  91,144 
Weighted average shares outstanding ('000s)              
  Adjusted basic shares outstanding 1 93,616  90,492  88,832      90,878  88,213 
  Adjusted diluted shares outstanding 1 95,082  91,710  90,273      92,272  89,555 
Share trading ($/share)              
  High 50.90  51.01  47.59      52.45  47.59 
  Low 38.62  40.30  37.77      38.62  31.25 
  Close 45.37  44.04  46.22      45.37  46.22 
1 The above table includes non-GAAP measures which may not be comparable to other companies.  Please see "Non-GAAP Measures" section of Management's Discussion and Analysis in this news release.

2011 IN REVIEW AND 2012 OUTLOOK

2011 highlighted the strength of Vermilion's international operations and the advantages of its global commodity exposure.  While many of Vermilion's Canadian peers struggled with difficult operating conditions during the second quarter of 2011, Vermilion's operations and production growth continued largely unabated due to the strength of its international operations in Australia, France and the Netherlands.  Robust year over year production growth in Australia (11%) and the Netherlands (17%) combined with steady growth in Cardium related production volumes in Canada during the second half of the year resulted in strong 10% year over year growth in Vermilion's consolidated production volumes in 2011.

The advantages of Vermilion's global commodity exposure has never been more apparent than in 2011, a year where Dated Brent crude averaged US$111.27 per bbl, a US$16.15 per bbl premium to West Texas Intermediate which averaged US$95.12 per bbl in 2011.  This afforded Vermilion a significant advantage with approximately 46% of 2011 production volumes comprised of Dated Brent crude and a further 16% comprised of Netherlands natural gas which averaged $9.59 per mcf during 2011 as a result of being priced off a basket of primarily Dated Brent crude linked heating and fuel oil products.  Vermilion's strong leverage to global commodity markets, through its diversified international operations, places Vermilion in a strong competitive position relative to its peers who are faced with significant exposure to weakening North American natural gas prices and a recent widening of the discount for Canadian based crude products relative to West Texas Intermediate, which remains at a significant discount to Dated Brent.  Vermilion's global commodity leverage enabled fund flows from operations to grow by nearly 33% in 2011, notably outpacing the Company's strong year over year production growth of 10%.

Vermilion continues to be recognized for excellence in its business practices.  In 2011, Vermilion was recognized for the second consecutive year as one of the top 25 Best Workplaces in Canada as compiled by the Great Place to Work® Institute and was similarly recognized for the second consecutive year as one of the top 15 Best Workplaces in France.  Vermilion was also recognized as one of Canada's top oil and gas companies in terms of corporate governance in the Globe and Mail's annual Board Games survey.

Operational Year in Review

Development capital spending was $490.8 million in 2011 compared to $432.2 million in 2010.  These investments included approximately $61.0 million for land acquisition in Canada, directed towards the purchase of 154 net sections of undeveloped land with exposure to potential emerging shale oil and liquids-rich gas resource opportunities.  A further $62.0 million was directed towards the Corrib gas project in Ireland.

Canada

Vermilion's development activities focused primarily on the initiation of full scale development of the Cardium light oil play.  In August of 2011, the Company commissioned a 15,000 bbl/d oil processing facility to handle anticipated volumes arising from ongoing development of the play.  Completion of the facility allowed Vermilion to accelerate development activities during the second half of the year enabling the Company to significantly grow production volumes and exit with more than 6,000 boe/d of Cardium related production.  Vermilion's well performance to date has remained relatively consistent and continues to outpace that of most peers in the West Pembina region of the Cardium play supporting management's belief that drilling activity in this region will provide for reasonably consistent and highly repeatable results over the life of the program.  While development of this play is still in the early stages, Vermilion has made significant strides in reducing average per well costs from more than $4.7 million at the start of 2011 to between $3.5 and $3.7 million per well toward the end of the year.  Transportation costs also continue to decrease as Vermilion ties in and processes greater volumes through the Company's newly constructed oil processing facility.  Vermilion's Cardium reserves also reinforced the continued success of the program with average per well reserves increasing from 146 mboe per well to 163 mboe per well.  At the end of 2011, Vermilion had drilled approximately 68 net wells, 57 of which were on production at year end.  With an inventory of approximately 300 additional economic prospects currently identified in the West Pembina region, Vermilion has a drilling inventory that is expected to last at least five to six years at an expected drilling rate of 40 to 50 wells per year beginning in 2013.  A further 120 prospects have been identified, however they are viewed as having marginal economics in the current environment but could be drilled in future years if technological improvements, costs or commodity prices change sufficiently to improve the economics of these prospects.

Australia

Vermilion continued to benefit from strong volumes from three wells brought on production in the fall of 2010.  The new wells were all lateral extensions to existing wellbores and were brought on at a combined restricted rate of 2,000 to 3,000 boe/d to minimize water coning and to maximize ultimate recovery from the reservoir.  Vermilion has identified additional infill drilling opportunities at Wandoo that should enable the Company to maintain production levels between 6,000 and 8,000 boe/d for the foreseeable future, dependent on the timing of future drilling programs.  Wandoo continues to be a strong cash flow generator for the Company attracting pricing at a slight premium to Dated Brent crude with no transportation costs as a result of production being inventoried and sold directly at the platform.

France

Vermilion maintained a steady workover and completion program during 2011.  Subsequent to year end, Vermilion announced that it had acquired certain working interests in six producing fields located in the Paris and Aquitaine basins in France. The assets are expected to average approximately 2,200 boe per day of production in 2012, weighted 86% to high quality Dated Brent based crude, and add an estimated 6.71 million boe of proved plus probable reserves (96% crude oil).  Taking into consideration an effective date of January 1, 2011 and customary closing adjustments, Vermilion paid approximately $107 million cash at closing of the acquisition reflecting a cash cost of approximately $48,600 per flowing boe and $16.00 per boe of proved plus probable reserves as evaluated by GLJ and effective December 31, 2011.  The acquired assets consist of interests in the Itteville (79%), Vert Le Grand (90%), Vert Le Petit (100%), La Croix Blanche (100%) and Dommartin-Lettrée (56%) fields in the Paris Basin and the Vic Bilh (73%) field in the Aquitaine Basin.  Vermilion previously held the remaining non-operated working interests in each of the Itteville, Vert Le Grand and Vic Bilh fields and now holds a 100% operated working interest in each of the acquired fields with the exception of the Dommartin-Lettrée field in the Paris Basin, in which the Company now holds a 56% non-operated interest.  The acquisition was a natural addition to Vermilion's existing France asset base and is well aligned with the Company's strategic objective to maintain and consolidate its core operating areas and own and operate 100% of its assets. The acquired assets further strengthen Vermilion's position as the leading oil producer in France, and with a significant weighting toward high quality oil, are expected to provide robust netbacks in the current commodity price environment.

Netherlands

Vermilion drilled four gas wells in the second half of 2011 and continued permitting related work efforts in preparation for the 2012 drilling campaign.  In addition, Vermilion finalized unitization negotiations relating to production from the Rotliegend zone of the Vinkega-1 discovery well enabling the Company to tie-in additional production volumes in mid-December of 2011.  Production volumes from the De Hoeve-1 well are currently expected to be brought on production by mid-year 2012 while production volumes from the 2011 drilling campaign are expected to be tied in late 2012 or early 2013.

Ireland

The Corrib partners received all key approvals enabling construction of the tunnelling site for the on-shore pipeline to begin in late summer 2011.  On January 22, 2012, the period for appeals of the regulatory permits expired with no appeals remaining outstanding effectively bringing the regulatory approval phase of the project to a close.  The Corrib partners currently expect construction of the onshore pipeline to take approximately two years and first gas to occur in late 2014 following commissioning of the field, the pipelines and all related facilities.

Outlook

Vermilion remains positioned to deliver strong operational and financial performance over the next several years as the Company anticipates growing production to 50,000 boe/d in 2015 through the continued development of its significant portfolio of organic growth opportunities.  Near term development will continue to focus on high netback oil and European gas opportunities, including light oil production growth from the Cardium play in Western Canada and continued development of high-netback natural gas prospects in the Netherlands.  In addition, with the regulatory process now complete, Vermilion and its partners are positioned to complete construction of the on-shore pipeline, the final remaining phase of development for the Company's Corrib natural gas project in Ireland.  With five wells currently drilled, tested and ready for production and construction of related pipelines and facilities largely complete, the Corrib project is anticipated to deliver approximately 55 mmcf per day (9,000 boe/d) of net production to Vermilion when it comes on stream in late 2014 providing strong production and cash flow growth for the Company in 2015.  Beyond 2015, growth is anticipated to come from the development of new and emerging resource plays in Canada and Western Europe.  Beginning in late 2010, the Company launched its New Growth Initiative forming two teams of senior technical professionals focused on the identification and capture of positions in Canada and Europe providing exposure to new and emerging unconventional shale oil and natural gas development opportunities with potential to deliver meaningful production and reserves growth over the next five to ten years and beyond.  Relatively stable production in Australia, France and Ireland is expected to deliver free cash flow to enable the funding of these new growth opportunities.

Vermilion currently expects average production volumes for 2012 of between 37,000 boe/d and 38,000 boe/d representing approximately six to eight percent growth over 2011, while fund flows from operations growth is anticipated to significantly outpace production growth in the near term as the Company focuses on high netback oil and European gas drilling opportunities and continues to benefit from premium pricing available as a result of the Company's exposure to global commodity markets.

Dated Brent crude, which represents approximately 46% of Vermilion's production, continues to trade at a significant premium to West Texas Intermediate with the recent forward strip indicating a spot premium of more than US$15.00 per bbl and an average premium in excess of US$11.00 per bbl for calendar 2012.   Pricing for Vermilion's 2012 natural gas production in the Netherland's, representing approximately 16% of consolidated production, remains strong and is currently anticipated to meet or exceed 2011 pricing levels of $9.59 per mcf.  Combined with Vermilion's Cardium related production volumes, the Company's anticipated 2012 consolidated production volumes are expected to be approximately 83% levered to crude oil pricing, predominantly Dated Brent.

Vermilion's Canadian development program will focus on the ongoing development of the Cardium light oil resource play.  The Company's 2012 capital program currently contemplates the drilling of approximately 20 net new Cardium wells and completion of an additional 11 net drilled wells.  The transition to water-based frac fluids during 2011 has significantly reduced overall well costs and Vermilion is currently targeting drilling, completion, equipping and tie-in related costs to average between $3.5 million and $3.7 million per well in 2012.  The Company is currently evaluating the potential for additional Cardium related capital expenditures in 2012 of between $50 million and $75 million.  The additional capital would target incremental drilling of between 10 and 20 additional wells in 2012, however given the majority of this incremental activity would take place late in the year, it is not expected to materially impact anticipated 2012 production volumes.

In France, Vermilion will continue with its annual workover and recompletion programs in addition to work activities related to its newly acquired assets in both the Paris and Aquitaine basins.  Vermilion is in the preliminary stages of evaluating these new properties and believes it has identified numerous areas where it can reduce the current cost structure of these assets and increase production over time through optimized production operations, water flood management and exploitation of infill development opportunities.

In the Netherlands, Vermilion expects to begin producing from the 2009 De Hoeve-1 well by mid-year 2012 and is planning to drill two new development opportunities towards the latter half of the year.  The Company will also begin preparation and permitting work for the 2013 drilling campaign.  Vermilion plans to maintain a rolling inventory of projects such that each year will involve a combination of new wells and the tie-in of prior successes.

In Australia, Vermilion is currently planning to drill three wells in the fall of 2012 keeping with its planned objective to maintain average production levels at between 6,000 boe/d and 8,000 boe/d by drilling two to three wells every other year.

The Board of Directors of Vermilion wishes to advise stakeholders that Bob Mac Dougall, Executive Vice President and Chief Operating Officer is leaving the organization.  An international search for Mr. Mac Dougall's replacement has been initiated and the Board is pleased to announce that Bob will remain with the Company until August 31, 2012 to ensure business continuity and an orderly transition.  The Board and management at Vermilion would like to thank Bob for his hard work and strong contributions to Vermilion's success over the last eight years during which time Bob was instrumental in assembling Vermilion's top rated international operations team.

Vermilion continues to target production growth of approximately 35% to 50,000 boe/d in 2015 which, when combined with anticipated fund flows from operations growth, should ensure a sustainable dividend for investors and the potential for dividend growth once Vermilion's Corrib gas project comes on-stream in late 2014.  The Company's conservative fiscal management and limited use of equity to finance its growth objectives should ensure that future growth is realized on a per share basis for investors.  The management and directors of Vermilion continue to control approximately 8% of the outstanding shares and remain committed to delivering superior rewards to all stakeholders.

1 Estimated proved plus probable reserves attributable to the assets as evaluated by GLJ Petroleum Consultants Ltd. ("GLJ") in a report dated October 14, 2011 with an effective date of December 31, 2011.

FOR ADDITIONAL INFORMATION ABOUT VERMILION, INCLUDING FURTHER INFORMATION REGARDING VERMILION'S RESERVES, PLEASE REVIEW THE COMPANY'S DECEMBER 31, 2011 ANNUAL INFORMATION FORM THAT WILL BE FILED ON SEDAR AT WWW.SEDAR.COM ON OR BEFORE MARCH 31, 2012.

RESERVES SUMMARY

GLJ Petroleum Consultants Ltd. ("GLJ"), independent petroleum engineering consultants in Calgary (qualified reserve evaluators), has prepared the 2011 year-end reserves evaluation report for Vermilion dated February 3, 2012, with an effective date of December 31, 2011, in accordance with National Instrument 51-1011 and the Canadian Oil and Gas Evaluation Handbook (COGEH).

Vermilion added total proved plus probable reserves of 16.8 mmboe, approximately 1.3 times production in 2011.  Adjusting for production of 12.8 mmboe, Vermilion's proved reserves (P90) remained relatively flat at 96.5 mmboe at December 31, 2011.  Total proved plus probable reserves (P50) increased by approximately 2.7% to 146.2 mmboe.  Based on fourth quarter production rates, Vermilion's effective reserve life index at January 1, 2012 is approximately 7.2 years for proved reserves and 10.9 years for P50 reserves.  Vermilion booked 100.7 additional net Cardium wells in addition to an upward revision to reserves for previously booked Cardium wells to bring average bookings across Vermilion's 207.7 net booked Cardium wells to approximately 162.9 mboe per well.  Continued strong well performance to date resulted in increased reserve bookings per well in the Cardium resource play while continuing to remain relatively conservative given the lack of long term production history.  Vermilion believes that the potential remains for further positive revisions in the booked recoverable resource potential of the Cardium play as additional production history is observed.

Estimates of reserves have been made assuming that development of each property, in respect of which estimates have been made, will occur without regard to the availability of funding required for that development.

The summary reserves table and reserves reconciliation table are included below.  The reserves shown are Vermilion's working interest share before deducting royalties.

Company Working Interest Reserves Summary Table as at December 31, 2011

 
Future Net Revenue
(Escalated Prices - Before Tax)
    Crude Oil
(mmbbls)
    Natural Gas
(bcf)
    NGLs
(mmbbls)
    Oil Equivalent
6:1 2
(mmboe)
    Undiscounted
($mm)
    10%
($mm)
Total Proved   52.80     241.77     3.41     96.50     4,088     2,526
Total Proved Plus Probable   83.44     346.02     5.13     146.23     6,548     3,563

1 Under the NI 51-101 guidelines, proved reserves are defined as those reserves that have a 90% probability of being exceeded at the reported level. Proved reserves, by definition, are conservative. Nine times out of ten actual reserves will be greater than the proved estimate. Proved plus probable reserves are defined as those reserves that have a 50% probability of being exceeded at the reported level. They are the best estimate, or the most realistic case. It is equally likely that the actual reserves will be higher or lower than the estimate.
2 Natural gas volumes have been converted on the basis of six thousand cubic feet of natural gas to one barrel of oil equivalent.  Barrels of oil equivalent (boe) may be misleading, particularly if used in isolation.  A boe conversion ratio of six thousand cubic feet to one barrel of oil is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.

The future net revenue values shown above are based on GLJ's escalating price and cost scenario and are presented for comparative purposes only and are not necessarily representative of fair market value.

Company Working Interest Reserves Reconciliation Summary as at December 31, 2011

           
    Total     Total Proved
Oil Equivalent (mboe) Gas at 6:1   Proved     Plus Probable
Opening balance   96,421     142,329
  Drilling additions and improved recovery   8,728     16,127
  Disposition   (130)     (212)
  Technical revisions   4,920     1,799
  Economic factors   (592)     (963)
  Production   (12,848)     (12,848)
Closing balance   96,499     146,232

The following table summarizes the net future capital investment associated with Vermilion's reserve estimates at December 31, 2011 and 2010:

Net Future Capital Investment as at December 31, 2011

                   
($M)         Total Proved       Total Proved
Plus Probable
Canada         335,511        675,287
France         98,820        198,738
Netherlands         11,532        24,372
Australia         24,602        32,602
Ireland         239,901        241,472
Total         710,366        1,172,471

Net Future Capital Investment as at December 31, 2010

                   
($M)         Total Proved       Total Proved
Plus Probable
Canada         301,722        551,660 
France         79,436        195,575 
Netherlands         10,996        23,836 
Australia         28,994        38,494 
Ireland         260,950        260,962 
Total         682,098        1,070,527 

FOR A COMPLETE COPY OF VERMILION'S 2011 FINANCIAL STATEMENTS AND RELATED MANAGEMENT'S DISCUSSION AND ANALYSIS, PLEASE REFER TO SEDAR AT WWW.SEDAR.COM OR VERMILION'S WEBSITE AT WWW.VERMILIONENERGY.COM.  THESE DOCUMENTS WILL BE MADE AVAILABLE ON OR BEFORE MARCH 31, 2012.

MANAGEMENT'S DISCUSSION AND ANALYSIS 

The following is Management's Discussion and Analysis ("MD&A"), dated March 1, 2012, of Vermilion Energy Inc.'s ("Vermilion" or the "Company") operating and financial results as at and for the three months and year ended December 31, 2011 compared with the corresponding periods in the prior year.  This discussion should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2010 and 2009, together with accompanying notes.  Additional information relating to Vermilion, including its Annual Information Form, is available on SEDAR at www.sedar.com or on Vermilion's website at www.vermilionenergy.com.

The audited consolidated financial statements for the year ended December 31, 2011 and comparative information have been prepared in Canadian dollars, except where another currency has been indicated, and in accordance with International Financial Reporting Standards ("IFRS") as issued by the International Accounting Standards Board.

CORPORATE CONVERSION

On September 1, 2010, Vermilion Energy Trust (the "Trust") completed the conversion from an income trust to a corporation pursuant to an arrangement under the Business Corporations Act (Alberta).  As a result of the conversion, units of the Trust were converted to common shares of Vermilion on a one-for-one basis and holders of exchangeable shares in Vermilion Resources Ltd. received 1.89344 common shares for each exchangeable share held.  There were no exchangeable shares outstanding following the conversion.

Vermilion retained the same board of directors and management team which continues to be led by Lorenzo Donadeo as President and Chief Executive Officer.  There were no changes in Vermilion's underlying operations associated with the conversion.  The consolidated financial statements and related financial information have been prepared on a continuity of interest basis, which recognizes Vermilion as the successor entity and accordingly all comparative information presented for the pre-conversion period is that of the Trust.  For the convenience of the reader, when discussing prior periods this MD&A refers to shares, shareholders and dividends although for the pre-conversion period such items were units, unitholders and distributions, respectively.

NON-GAAP MEASURES

This report includes non-GAAP measures as further described herein.  These measures do not have standardized meanings prescribed by GAAP and therefore may not be comparable with the calculations of similar measures for other entities.

"Fund flows from operations" represents cash flows from operating activities before changes in non-cash operating working capital and asset retirement obligations settled.  Management considers fund flows from operations and per share calculations of fund flows from operations (see discussion relating to per share calculations below) to be key measures as they demonstrate Vermilion's ability to generate the cash necessary to pay dividends, repay debt, fund asset retirement obligations and make capital investments.  Management believes that by excluding the temporary impact of changes in non-cash operating working capital, fund flows from operations provides a useful measure of Vermilion's ability to generate cash that is not subject to short-term movements in non-cash operating working capital.  The most directly comparable GAAP measure is cash flows from operating activities.

Cash flows from operating activities as presented in Vermilion's consolidated statements of cash flows is reconciled to fund flows from operations below:

      Three Months Ended   % change     Year Ended   % change
      Dec 31,   Sept 30,   Dec 31,   Q4/11 vs.   Q4/11 vs.     Dec 31,   Dec 31,   2011 vs.
($M)   2011   2011    2010   Q3/11   Q4/10     2011    2010    2010 
Cash flows from operating activities   158,639    99,906    127,191              447,092    421,282     
Changes in non-cash operating working capital   (29,315)   12,194    (34,139)             4,173    (70,614)    
Asset retirement obligations settled   7,559    4,269    5,110              23,071    6,861     
Fund flows from operations   136,883    116,369    98,162    18%   39%     474,336    357,529    33%

"Net debt" is the sum of long-term debt and working capital as presented in Vermilion's consolidated balance sheets.  Net debt is used by management to analyze the financial position and leverage of Vermilion.  The most directly comparable GAAP measure is long term debt.

Long term debt as presented in Vermilion's consolidated balance sheets is reconciled to net debt below:

    As At
    Dec 31,     Dec 31,
($M)   2011      2010 
Long-term debt   373,436      302,558 
Current liabilities1   491,184      340,934 
Current assets   (435,659)     (340,197)
Net debt   428,96     303,295 
1 As at December 31, 2011, current liabilities includes the amount due pursuant to acquisition relating to the Corrib project.

"Cash dividends per share" represents cash dividends declared per share by Vermilion during the relevant periods.

"Net dividends" is calculated as dividends declared for a given period less proceeds received by Vermilion pursuant to the dividend reinvestment plan.  Dividends both before and after the dividend reinvestment plan are reviewed by management and assessed as a percentage of fund flows from operations to analyze how much of the cash that is generated by Vermilion is being used to fund dividends.  Dividends declared is the most directly comparable GAAP measure to net dividends.  Dividends declared as presented in Vermilion's consolidated statement of changes in shareholders' equity is reconciled to net dividends as follows:

      Three Months Ended     Year Ended
      Dec 31,   Sept 30,   Dec 31,     Dec 31,   Dec 31,
($M)   2011   2011   2010      2011    2010 
Dividends declared   53,871    51,612    50,664      207,846    189,744 
Issuance of shares pursuant to the dividend reinvestment plan   (16,802)   (15,219)   (13,467)     (59,081)   (40,824)
Net dividends   37,069    36,393    37,197      148,765    148,920 

"Total net dividends, capital expenditures and asset retirement obligations settled" is calculated as net dividends as determined above plus the following amounts for the relevant periods from Vermilion's consolidated statements of cash flows:  "Drilling and development", "Exploration and evaluation", "Withdrawals from reclamation fund" and "Asset retirement obligations settled".

Total net dividends, capital expenditures and asset retirement obligations settled (excluding the Corrib project) is the above amount excluding capital expenditures and asset retirement obligations settled relating to Vermilion's share of the 18.5% non-operated interest in the offshore Corrib gas field in Ireland.

These measures are reviewed by management and assessed as a percentage of fund flows from operations to analyze the amount of cash that is generated by Vermilion that is available to repay debt and fund potential acquisitions.  This measure is the sum of the following GAAP measures:

    Three Months Ended     Year Ended
    Dec 31, Sept 30, Dec 31,     Dec 31, Dec 31,
($M) 2011 2011 2010     2011  2010 
Dividends declared 53,871  51,612  50,664      207,846  189,744 
Issuance of shares pursuant to the dividend reinvestment plan (16,802) (15,219) (13,467)     (59,081) (40,824)
Drilling and development 129,478  89,332  103,592      411,227  414,152 
Exploration and evaluation 22,773  45,449  1,843      79,553  18,030 
Withdrawals from reclamation fund     (812)
Asset retirement obligations settled 7,559  4,269  5,110      23,071  6,861 
Total net dividends, capital expenditures and asset retirement obligations settled 196,879  175,443  147,742      662,616  587,151 

           
    Three Months Ended     Year Ended
    Dec 31, Sept 30, Dec 31,     Dec 31, Dec 31,
($M) 2011 2011 2010     2011  2010 
Total net dividends, capital expenditures and asset retirement obligations settled 196,879  175,443  147,742      662,616  587,151 
Less: Capital expenditures and asset retirement obligations settled related to the Corrib project (13,869) (21,686) (14,613)     (68,260) (78,498)
Total net dividends, capital expenditures and asset retirement obligations settled (excluding the Corrib project) 183,010  153,757  133,129      594,356  508,653 

"Netbacks" are per unit of production measures used in operational and capital allocation decisions.

"Diluted shares outstanding" is the sum of shares outstanding at the period end plus outstanding awards under Vermilion's equity based compensation plan, based on current performance factor and forfeiture estimates.

"Adjusted basic weighted average shares outstanding" is different from the most directly comparable GAAP figure in that in the comparative period they included amounts relating to outstanding exchangeable shares at the period end exchange ratio.  As the exchangeable shares were convertible into shares of Vermilion, management believes that their inclusion in the comparative period calculation of basic rather than only in diluted per share statistics provides more meaningful information.

"Diluted adjusted weighted average shares outstanding" is the sum of diluted weighted average shares outstanding as presented on the consolidated statements of net earnings and comprehensive income plus the weighted average amount of exchangeable shares and equity based compensation awards outstanding for the period, if those instruments were considered to be anti-dilutive in the calculation of diluted net earnings per share.

These GAAP measures are reconciled to the relevant non-GAAP measures below:

            As At
            Dec 31, Dec 31,
('000s of shares)           201 2010 
Shares outstanding           96,430  88,998 
Potential shares issuable pursuant to equity based compensation plans           2,34 2,146 
Diluted shares outstanding           98,778  91,144 
               
         
  Three Months Ended     Year Ended
  Dec 31, Sept 30, Dec 31,     Dec 31, Dec 31,
('000s of shares) 2011  2011  2010      201 2010 
Basic weighted average shares outstanding 93,616 90,492  88,832      90,878  83,155 
Shares issuable pursuant to exchangeable shares     5,058 
Adjusted basic weighted average shares outstanding 93,616 90,492  88,832      90,87 88,213 
               
         
  Three Months Ended     Year Ended
  Dec 31, Sept 30, Dec 31,     Dec 31, Dec 31,
('000s of shares) 2011  2011  2010      201 2010 
Diluted weighted average shares outstanding 93,616  91,710  88,832      92,272  83,155 
Shares issuable pursuant to exchangeable shares, if anti-dilutive     - 5,058 
Shares issuable on equity based compensation plans, if anti-dilutive 1,466  1,441      1,342 
Adjusted diluted weighted average shares outstanding 95,082  91,710  90,273      92,272  89,555 

2011 REVIEW AND 2012 GUIDANCE

The following table summarizes Vermilion's 2011 actual results as compared to guidance and Vermilion's 2012 guidance:

          Date     Capital Expenditures
($MM)
    Average Production
(boe/d)
2011 Guidance       November 5, 2010     460      35,000 to 36,000
2011 Actual       December 31, 2011     491      35,202
2012 Guidance       December 21, 2011     375      37,000 to 38,000

Capital expenditures in 2011 were $491 million, an increase of approximately $31 million relative to Vermilion's original guidance of $460 million provided on November 5, 2010.  The increase in capital expenditures was the result of incremental outlays related to the purchase of land in Canada and an acceleration of Cardium related development activities, partially offset by lower than anticipated expenditures in each of Vermilion's operating regions outside of Canada.  Vermilion achieved production volumes in-line with the Company's original guidance of 35,000 boe/d to 36,000 boe/d.

OPERATIONAL ACTIVITIES  

Canada

In Canada, Vermilion participated in the drilling of 88 (51.3 net) wells during 2011, resulting in eight (2.4 net) gas wells and 80 (48.9 net) Cardium oil wells.  These wells included 42 (37.5 net) operated Cardium oil wells and 38 (11.4 net) non-operated  Cardium oil wells.  At year end, 49 (43.5 net) operated  Cardium wells were on production and 41 (13.6 net) non-operated  wells were on production.  While drilling activity is expected to remain steady through the first half of 2012, some completions and tie-ins will be deferred until the summer months when spring break-up is complete.

France

In France, Vermilion drilled the Cazaux 91-D well in 2011, an exploratory well designed to appraise an undeveloped fault block.  Vermilion also completed an active workover and recompletion program including 20 workovers across the Paris and Aquitaine basins and two optimizations in the Aquitaine basin.

Netherlands

In the Netherlands, Vermilion drilled four (2.3 net) new exploration wells including the Nieuwehorne-1, Langezwaag-1, Wommels-1 and De Kom-1.  Vermilion continues to test and evaluate the results of this drilling campaign and currently anticipates bringing on related production volumes in late 2012 or early 2013.  The Company also completed related facilities construction and unitization negotiations for the 2009 Vinkega-1 discovery well bringing on production from the Vlieland zone in May of 2011 and subsequently from the Rotliegend zone in mid-December of 2011.  The final phases of permitting and facilities construction were also underway for the fourth and final well of the 2009 drilling campaign, De Hoeve-1, and the Company currently anticipates bringing the well on production by mid-2012.  The balance of 2011 activity involved facility maintenance, permitting and site construction related activities for the 2012 and 2013 drilling campaigns.  Vermilion plans to commence a two (1.3 net) well development program in late 2012.

Australia

Vermilion completed three workovers in the second quarter of 2011 resulting in modest incremental volumes upon their completion.  While the economics of the workover program were strong, the incremental volumes were not as expected resulting in the deferral of future workover programs until further reservoir studies are completed.

PRODUCTION

    Three Months Ended   % change     Year Ended   % change
    Dec 31, Sept 30, Dec 31,   Q4/11 vs. Q4/11 vs.     Dec 31, Dec 31,   2011 vs.
    2011  2011  2010    Q3/11 Q4/10     2011  2010    2010 
Canada                        
  Crude oil & NGLs (bbls/d) 7,837  5,831  4,859    34% 61%     5,998  4,205    43%
  Natural gas (mmcf/d) 43.96  42.94  42.33    2% 4%     43.38  43.91    (1%)
  Total (boe/d) 15,163  12,987  11,913    17% 27%     13,227  11,524    15%
  % of consolidated 41% 38% 34%           38% 36%    
France                        
  Crude oil & NGLs (bbls/d) 7,819  7,946  8,539    (2%) (8%)     8,110  8,347    (3%)
  Natural gas (mmcf/d) 0.94  0.97  1.10    (3%) (15%)     0.95  0.92    3%
  Total (boe/d) 7,976  8,108  8,723    (2%) (9%)     8,269  8,501    (3%)
  % of consolidated 22% 23% 25%           23% 26%    
Netherlands                        
  NGLs (bbls/d) 66  64  26    3% 154%     58  35    66%
  Natural gas (mmcf/d) 34.58  33.15  30.47    4% 13%     32.88  28.31    16%
  Total (boe/d) 5,829  5,589  5,105    4% 14%     5,538  4,753    17%
  % of consolidated 16% 16% 14%           16% 15%    
Australia                        
  Crude oil (bbls/d) 7,686  7,992  9,561    (4%) (20%)     8,168  7,354    11%
  % of consolidated 21% 23% 27%           23% 23%    
Consolidated                        
  Crude oil & NGLs (bbls/d) 23,408  21,833  22,985    7% 2%     22,334  19,941    12%
  % of consolidated 64% 63% 65%           63% 62%    
  Natural gas (mmcf/d) 79.48  77.06  73.90    3% 8%     77.21  73.14    6%
  % of consolidated 36% 37% 35%           37% 38%    
  Total (boe/d) 36,654  34,676  35,302    6% 4%     35,202  32,132    10%

                                 
(boe/d)   Q4 2011   Q3 2011   Q2 2011   Q1 2011   Q4 2010   Q3 2010   Q2 2010   Q1 2010
Canada   15,163    12,987    12,426    12,304    11,913    11,233    11,434    11,514 
France   7,976    8,108    8,419    8,582    8,723    8,741    8,472    8,057 
Netherlands   5,829    5,589    5,682    5,039    5,105    5,099    5,269    3,519 
Australia   7,686    7,992    8,692    8,309    9,561    6,225    6,522    7,094 
Total   36,654    34,676    35,219    34,234    35,302    31,298    31,697    30,184 

Average total production in Canada of 13,227 boe/d during 2011 represented an increase of 15% compared to 11,524 boe/d in 2010, as growth in Cardium related production volumes more than offset natural declines associated with Vermilion's Canadian conventional natural gas production.  Fourth quarter of 2011 production of 15,163 boe/d was 17% higher than production levels in the third quarter of 2011 and more than 27% higher than in the fourth quarter of 2010, illustrating the significant growth in Vermilion's Cardium related production volumes in the second half of 2011.  Vermilion also achieved noticeable growth in oil and NGL production of 34% and 61%, as compared to the third quarter of 2011 and fourth quarter of 2010, respectively.

Production in France averaged 8,269 boe/d in 2011, a 3% decline from 2010 production volumes of 8,501 boe/d.  This modest decline was illustrative of the effectiveness of Vermilion's annual workover and recompletion activities at offsetting natural declines in production.

Average production volumes in the Netherlands increased by 785 boe/d in 2011 to 5,538 boe/d, a gain of more than 17%, largely attributable to the tie-in of production volumes from the Vlieland formation of the Vinkega-1 discovery well in May of 2011.  These production volumes were later replaced by production from the Rotliegend formation, also from the Vinkega-1 discovery well, following completion of unitization negotiations in mid-December of 2011.  Looking forward, Netherlands production is expected to see continued production increases from new drilling, although the timing of such increases is less predictable due to the variability in the length of time it takes to complete the production permitting process for individual prospects.

Australia production averaged 8,168 boe/d in 2011, compared to 7,354 boe/d in 2010 due largely to the strong performance of three wells drilled and brought on production in November 2010.  Vermilion also added modest but incremental volumes through its 2011 workover program.  Vermilion expects to sustain annual average production at between 6,000 boe/d and 8,000 boe/d over the next few years with a two to three well drilling campaign every other year.  The next planned drilling campaign is scheduled for the fall of 2012. 

FINANCIAL REVIEW

During the three months ended December 31, 2011, Vermilion generated fund flows from operations of $136.9 million compared to $116.4 million for the three months ended September 30, 2011 and $98.2 for the three months ended December 31, 2010.  The increase in fund flows from operations for the fourth quarter of 2011 versus both the three months ended September 30, 2011 and December 31, 2010 were the result of overall higher commodity prices and generally increased average production volumes in Canada and the Netherlands.

During the year ended December 31, 2011, Vermilion generated fund flows from operations of $474.3 million compared to $357.5 million in 2010.  The year over year increase in fund flows from operations of $116.8 million resulted primarily from overall higher commodity prices, including highly favourable variances in the price of Dated Brent crude, and generally increased average production volumes, including an increase in Dated Brent priced oil production in Australia and gas production in the Netherlands, the pricing of which is highly correlated to Dated Brent.   

Vermilion's net debt was $429.0 million at December 31, 2011 (December 31, 2010 - $303.3 million) representing approximately 90% of fund flows from operations.  The increase in net debt was the result of the change in the classification of the amount due pursuant to acquisition, which relates to Vermilion's acquisition of an 18.5% non-operated interest in the Corrib gas field in 2009, and the increase in Iong-term debt.  On December 31, 2011, the amount due pursuant to acquisition ($127.1 million) was reclassified to current liabilities as the amount is payable at the end of 2012.  Long-term debt increased to $373.4 million at December 31, 2011 (December 31, 2010 - $302.6 million).  The increase in long-term debt was used to fund Vermilion's capital expenditures, including continued development of the Cardium resource play in Canada and the acquisition of additional undeveloped Cardium acreage.  The impact of this increase in capital expenditures on net debt was partially offset by Vermilion's November 2011 equity issuance for net proceeds of $252.0 million.

For the year ended December 31, 2011, total net dividends, capital expenditures and asset retirement obligations settled (excluding the Corrib project) as a percentage of fund flows from operations were 125% (December 31, 2010 - 142%).  The year over year changes in this ratio relate primarily to improved fund flows from operations partially offset by increases to capital expenditures and asset retirement obligations settled.

COMMODITY PRICES

  Three Months Ended   % change     Year Ended   % change
    Dec 31, Sept 30, Dec 31,   Q4/11 vs. Q4/11 vs.     Dec 31, Dec 31,   2011 vs.
  2011 2011  2010   Q3/11 Q4/10     2011  2010    2010 
Average reference prices                        
WTI (US $/bbl) 94.06  89.76  85.17    5% 10%     95.12  79.53    20%
Edmonton sweet index (US $/bbl) 95.49  93.97  79.47    2% 20%     96.44  75.54    28%
Dated Brent (US $/bbl) 109.31  113.46  86.48    (4%) 26%     111.27  79.47    40%
AECO ($/mcf) 3.17  3.66  3.62    (13%) (12%)     3.62  4.00    (10%)
Netherlands oil-linked gas price ($/mcf) 10.57  9.78  8.39    8% 26%     9.69  7.50    29%
Netherlands oil-linked gas price (€/mcf) 7.67  7.07  6.10    8% 26%     7.04  5.48    28%
Average realized prices ($/boe)                        
Canada 59.03  51.81  45.26    14% 30%     53.82  44.04    22%
France 112.71  108.40  85.10    4% 32%     107.38  80.26    34%
Netherlands 62.95  58.11  48.26    8% 30%     57.51  42.53    35%
Australia 108.00  102.98  86.23    5% 25%     111.16  81.86    36%
Consolidated 81.60  77.85  66.64    5% 22%     80.29  62.06    29%
Production mix (% of production)                        
% priced with reference to WTI 21% 17% 14%           17% 13%    
% priced with reference to AECO 20% 21% 20%           21% 23%    
% priced with reference to Dated Brent 59% 62% 66%           62% 64%    

Reference prices

During the year ended December 31, 2011, the average WTI reference price increased by 20%, the average Edmonton sweet index increased by 28% and the average reference price of Dated Brent increased by 40%.  The overall increase in crude oil reference prices was attributable to increased demand, supply constraints, improving economic conditions in North America, as well as supply disruptions due to geopolitical events in the Middle East and North Africa.  For Canadian crude sales the most directly comparable reference price is the Edmonton sweet index reference price which during 2011, traded at a slight premium to WTI.

Throughout 2011, Dated Brent maintained a significant premium over WTI, whereas in previous years, Dated Brent traded at a slight discount to WTI.  Fourth quarter 2011 developments, including the announcement by Enbridge Inc. to reverse the flow direction of the Seaway pipeline, which previously transported crude oil from Houston to Cushing, helped to reduce the Brent-WTI premium from US $23.70 per bbl in the third quarter of 2011 to US $15.25 per bbl in the fourth quarter of 2011.  Vermilion continues to benefit from the premium Dated Brent commands over WTI, with 62% of total consolidated production in 2011 (2010 - 64%) priced with reference to Dated Brent.

In 2011, the AECO reference price for natural gas remained depressed, on a heat equivalency basis, relative to the pricing of crude oil due to an abundance of supply of natural gas in North America.  This trend continued in the fourth quarter with the AECO average reference price declining 13% from the third to the fourth quarter as warm weather in North America reduced the consumption of natural gas and increased inventory levels.

The price of natural gas in the Netherlands is based on pricing established by GasTerra, a statutory entity which purchases all natural gas produced by Vermilion in the Netherlands.  The price is derived using a formula that takes into account the market price of heating and fuel products; as such, it is highly correlated with Dated Brent pricing. The Netherlands oil-linked gas price is formulaically derived to approximate the price of gas in the Netherlands and accordingly, is calculated using a trailing average of Dated Brent and the National Balancing Point reference price for natural gas in the United Kingdom.

Realized pricing

The realized price of Vermilion's production of crude oil in Canada is highly correlated to WTI but is subject to market conditions in Alberta, which can lead to a significant price differential, as reflected by the Edmonton sweet index price above.  The realized price of Vermilion's production of NGLs in Canada is based on a market based differential to WTI and pricing at the Edmonton, Alberta and Conway, Kansas trading hubs for NGLs.  The realized price of Vermilion's production of natural gas in Canada is based on the AECO spot price in Alberta.

The realized price of Vermilion's production of crude oil in France and Australia is based on Dated Brent.

The increase in the Netherlands realized gas price in 2011 relative to 2010 is associated with the strengthening of Dated Brent prices in the latter part of 2010 and early 2011.  The year over year increase in Dated Brent led to an increase in the Netherlands realized gas price as the pricing increased from $9.78 (€ 7.07) per mcf for the third quarter of 2011 to $10.57 (€ 7.67) per mcf for the fourth quarter of 2011.

Average realized prices in each country will differ from their corresponding average reference prices due to a number of factors, including the timing of the sale of production and differences in the grade of production and point of settlement.  Additionally, in Canada, average realized prices are impacted by the production mix of crude oil, NGLs and natural gas.  The increase in average realized prices in Canada quarter over quarter were due in large part to the increased price of WTI, as noted above, and an increase in relative crude oil and NGLs production from 36% of the total production in Canada in the year ended December 31, 2010 to 45% of the total production in Canada in the year ended December 31, 2011.

On a consolidated basis, for the year ended December 31, 2011, crude oil and NGL production represented approximately 63% of total production (year ended December 31, 2010 - 62%).  Production priced with reference to crude oil (WTI and Dated Brent) represented approximately 79% of total production in the year ended December 31, 2011 (year ended December 31, 2010, 77%).  This increase in relative crude oil and NGL production, along with the increase in the reference prices of WTI and Dated Brent, resulted in an increase to the consolidated average realized price from $62.06 per boe in the year ended December 31, 2010 to $80.29 per boe in the year ended December 31, 2011.

CAPITAL EXPENDITURES AND ACQUISITION OF PROPERTIES

  Three Months Ended     Year Ended
By category Dec 31, Sept 30, Dec 31,     Dec 31, Dec 31,
($M) 2011 2011 2010     2011  2010 
Land 18,073  35,041  911      68,319  97,215 
Seismic 3,731  2,090  3,651      9,694  6,600 
Drilling and completion 74,287  62,412  47,099      227,666  167,771 
Production equipment and facilities 47,283  28,049  41,534      151,488  114,369 
Recompletions 3,377  3,399  4,590      17,767  14,798 
Other 5,500  3,790  7,650      15,846  31,429 
Total capital expenditures 152,251  134,781  105,435      490,780  432,182 
Property acquisitions 12,777      50,878  448 
Total capital expenditures and acquisitions 165,028  134,781  105,435      541,658  432,630 
 
             
  Three Months Ended     Year Ended
By classification Dec 31, Sept 30, Dec 31,     Dec 31, Dec 31,
($M) 2011 2011 2010     2011  2010 
Drilling and development 129,478  89,332  103,592      411,227  414,152 
Exploration and evaluation 22,77 45,449  1,843      79,553  18,030 
Total capital expenditures 152,251  134,781  105,435      490,780  432,182 
Property acquisitions 12,777      50,878  448 
Total capital expenditures and acquisitions 165,02 134,781  105,435      541,658  432,630 
 
               
  Three Months Ended     Year Ended
By country Dec 31, Sept 30, Dec 31,     Dec 31, Dec 31,
($M) 2011 2011 2010     2011  2010 
Canada 110,147  92,993  52,967      364,453  242,900 
France 12,663  8,806  20,793      57,534  48,758 
Netherlands 17,172  8,707  4,513      37,015  11,017 
Australia 11,205  2,549  12,549      20,653  51,457 
Ireland 13,841  21,726  14,613      62,003  78,498 

Capital expenditures for the three months ended December 31, 2011 were higher than for the three months ended September 30, 2011 and the three months ended December 31, 2010.  The increase in expenditures from the third to the fourth quarter of 2011 was primarily the result of increased drilling and completion activity in Canada associated with Vermilion's development of the Cardium light oil resource play, offset partially by fewer land acquisitions in the fourth quarter of 2011.  Acquisitions in the fourth quarter of 2011 pertained to the unitization of the Rotleigend zone of the Vinkega-1 well in the Netherlands resulting from the purchase of production licenses relating to this zone.

Year over year increases in capital expenditures were primarily the result of the development of the Cardium light oil resource play during the year in addition to work over activity in France, a drilling program in the Netherlands, and preliminary spending for a drilling campaign in Australia for 2012.

PETROLEUM AND NATURAL GAS SALES

  Three Months Ended   % change     Year Ended   % change
By product Dec 31, Sept 30, Dec 31,   Q4/11 vs. Q4/11 vs.     Dec 31, Dec 31,   2011 vs.
($M except per boe and per mcf) 2011 2011 2010   Q3/11 Q4/10     2011  2010    2010
Crude oil & NGLs 227,166  202,303  177,374    12% 28%     852,514  578,926    47%
Per boe 105.49  100.71  83.88    5% 26%     104.58  79.54    31%
Natural gas 48,006  46,058  39,052    4% 23%     179,056  148,879    20%
Per mcf 6.57  6.50  5.74    1% 14%     6.35  5.58    14%
Petroleum and natural gas sales 275,172  248,361  216,426    11% 27%     1,031,570  727,805    42%
Per boe 81.60  77.85  66.64    5% 22%     80.29  62.06    29%
 
                       
  Three Months Ended   % change     Year Ended   % change
By country Dec 31, Sept 30, Dec 31,   Q4/11 vs. Q4/11 vs.     Dec 31, Dec 31,   2011 vs.
($M except per boe) 2011 2011 2010   Q3/11 Q4/10     2011  2010    2010
Canada 82,342  61,903  49,608    33% 66%     259,854  185,241    40%
Per boe 59.03  51.81  45.26    14% 30%     53.82  44.04    22%
France 82,707  80,845  68,297    2% 21%     324,090  249,031    30%
Per boe 112.71  108.40  85.10    4% 32%     107.38  80.26    34%
Netherlands 33,753  29,883  22,667    13% 49%     116,227  73,789    58%
Per boe 62.95  58.11  48.26    8% 30%     57.51  42.53    35%
Australia 76,370  75,730  75,854    1% 1%     331,399  219,744    51%
Per boe 108.00  102.98  86.23    5% 25%     111.16  81.86    36%

Vermilion's consolidated petroleum and natural gas sales for the three months ended December 31, 2011 increased relative to the three months ended September 30, 2011 by $26.8 million.  This increase was primarily a result of overall higher pricing for crude oil and Netherlands' gas in the fourth quarter of 2011 as compared to the third quarter of 2011 and increased production in Canada and the Netherlands.  Higher crude oil and Netherlands' gas prices resulted in a favorable price variance of $15.8 million while significantly increased volumes in Canada and slight increases in the Netherlands resulted in a favorable volume variance of $16.3 and $1.2 million, respectively.  These favorable variances were offset partially by lower AECO natural gas prices, which resulted in $2.3 million lower natural gas sales in Canada and by lower production in France and Australia, which decreased sales by $1.3 million and $2.9 million, respectively.

Vermilion's consolidated petroleum and natural gas sales for the three months and year ended December 31, 2011 were higher than the comparable periods in 2010.  Petroleum and natural gas sales increased from 2010 to 2011 by $303.8 million, resulting in $1.03 billion in overall petroleum and natural gas sales.  Favorable crude oil and Netherlands gas prices resulted in a $238.1 million increase in sales year over year; however, this increase was partially offset by lower AECO natural gas prices, which resulted in an $11.2 million decrease in Canadian natural gas sales.  Significantly increased production in Canada from Vermilion's Cardium light oil resource play resulted in a $47.1 million increase in sales while increased production in the Netherlands and Australia resulted in a $12.4 million and $24.3 million increase, respectively.  These production increases were partially offset by slightly lower production in France, which resulted in unfavorable volume variance of $6.9 million.

Please refer to the Production and Commodity Prices sections of the MD&A for further discussion of these variances.

CRUDE OIL INVENTORY

Vermilion carries an inventory of crude oil in France and Australia, which reflects a timing difference between production and sales.  Crude oil inventories increased in the fourth quarter of 2011 versus the third quarter of 2011 due to an increase in Australia's inventory of approximately 50,162 bbls, partially offset by a decrease in France's inventory of approximately 22,682 bbls.

The following table summarizes Vermilion's ending inventory positions for the most recent four quarters:

Ending inventory balance     Q4 2011     Q3 2011     Q2 2011     Q1 2011
France (bbls)     186,955      209,637      215,132      167,438 
France ($M)     6,518      7,152      8,525      5,439 
Australia (bbls)     221,898      171,736      62,397      226,183 
Australia ($M)     7,36     6,058      2,250      7,932 
Total (bbls)     408,853      381,373      277,529      393,621 
Total ($M)     13,88     13,210      10,775      13,371 
Represents the cost of the produced crude oil including operating costs, depletion and certain royalties.

DERIVATIVE INSTRUMENTS

The nature of Vermilion's operations results in exposure to fluctuations in commodity prices, interest rates and foreign currency exchange rates.  Vermilion monitors and, when appropriate, uses derivative financial instruments to manage its exposure to these fluctuations.  All transactions of this nature entered into by Vermilion are related to an underlying financial position or to future petroleum and natural gas production. Vermilion does not use derivative financial instruments for speculative purposes.  Vermilion has elected not to designate any of its price risk management activities as accounting hedges and thus accounts for changes in fair value in net earnings at each reporting period.  During the normal course of business, Vermilion may enter into fixed price arrangements to sell a portion of its production or purchase commodities for operational use.  Vermilion does not apply fair value accounting on these contracts as they were entered into and continue to be held for the sale of production or operational use in accordance with the Company's expected requirements.  Vermilion does not obtain collateral or other security to support its financial derivatives as management reviews the creditworthiness of its counterparties prior to entering into derivative contracts.

The following table summarizes Vermilion's outstanding financial derivative positions as at December 31, 2011:

                         
Risk Management       Funded Cost       bbls/d       US $/bbl
Collar - WTI                        
January 2012 to June 2012       US $1.00/bbl       500        78.00 -   97.25
January 2012 to June 2012       US $1.00/bbl       500        78.00 - 101.80
January 2012 to June 2012       US $1.00/bbl       500        82.00 - 116.20
January 2012 to June 2012       US $1.00/bbl       500        82.00 - 116.25
January 2012 to June 2012       US $1.00/bbl       350        82.00 - 121.75
January 2012 to June 2012       US $1.00/bbl       250        82.00 - 124.05
January 2012 to June 2012       US $1.00/bbl       250        82.00 - 123.00
January 2012 to December 2012       US $1.00/bbl       250        82.00 - 119.45
July 2012 to December 2012       US $1.00/bbl       500        78.00 - 104.15
July 2012 to December 2012       US $1.00/bbl       500        82.00 -   99.35
July 2012 to December 2012       US $1.00/bbl       500        82.00 - 115.10
Collar - DATED BRENT                        
January 2012 to June 2012       US $1.00/bbl       750        82.00 - 105.60
January 2012 to June 2012       US $1.00/bbl       750        82.00 - 104.80
January 2012 to June 2012       US $1.00/bbl       750        82.00 - 106.10
January 2012 to June 2012       US $1.00/bbl       500        95.00 - 120.65
January 2012 to June 2012       US $1.00/bbl       350        95.00 - 123.05
January 2012 to December 2012       US $1.00/bbl       1,000        82.00 - 113.40
January 2012 to December 2012       US $1.00/bbl       500        82.00 - 115.50
January 2012 to December 2012       US $1.00/bbl       500        82.00 - 130.75
July 2012 to December 2012       US $1.00/bbl       1,000        82.00 - 126.55
July 2012 to December 2012       US $1.00/bbl       1,000        82.00 - 126.05
Put - DATED BRENT                        
January 2012 to December 2012       US $4.46/bbl       600        83.00 
January 2012 to December 2012       US $4.90/bbl       600        83.00 
January 2012 to December 2012       US $4.49/bbl       600        83.00 
January 2012 to December 2012       US $4.39/bbl       600        83.00 
January 2012 to December 2012       US $3.65/bbl       500        83.00 

The impact of Vermilion's derivative based risk management activities decreased the fund flows netback for the three months and year ended December 31, 2011 by $1.81 per boe and $2.20 per boe, respectively.  This compares to an increase of $0.72 per boe and $0.61 per boe for the same periods in 2010.  The higher cost of risk management activities in the three and twelve months ended December 31, 2011 was associated with stronger crude oil prices that exceeded the ceiling on certain collars entered into for 2011.  An up to date listing of Vermilion's outstanding derivative instruments is available on Vermilion's website at http://www.vermilionenergy.com/ir/hedging.cfm

ROYALTIES

  Three Months Ended   % change     Year Ended   % change
By product Dec 31, Sept 30, Dec 31,   Q4/11 vs. Q4/11 vs.     Dec 31, Dec 31,   2011 vs.
($M except per boe and per mcf) 2011 2011 2010   Q3/11 Q4/10     2011  2010    2010
Crude oil & NGLs 14,233  12,675  10,989    12% 30%     50,945  39,556    29%
Per boe 6.61  6.31  5.20    5% 27%     6.25  5.43    15%
Natural gas 772  808  98    (4%) 688%     3,290  4,416    (25%)
Per mcf 0.11  0.11  0.01    1,000%     0.12  0.17    (29%)
Royalties 15,005  13,483  11,087    11% 35%     54,235  43,972    23%
Per boe 4.45  4.23  3.41    5% 30%     4.22  3.75    13%
% of petroleum and natural gas sales 5.5% 5.4% 5.1%           5.3% 6.0%    
 
                       
  Three Months Ended   % change     Year Ended   % change
By country Dec 31, Sept 30, Dec 31,   Q4/11 vs. Q4/11 vs.     Dec 31, Dec 31,   2011 vs.
($M except per boe) 2011 2011 2010   Q3/11 Q4/10     2011  2010    2010
Canada 10,176  8,351  6,819    22% 49%     34,980  27,982    25%
Per boe 7.29  6.99  6.22    4% 17%     7.25  6.65    9%
% of petroleum and natural gas sales 12.4% 13.5% 13.7%           13.5% 15.1%    
France 4,829  5,132  4,268    (6%) 13%     19,255  15,990    20%
Per boe 6.58  6.88  5.32    (4%) 24%     6.38  5.15    24%
% of petroleum and natural gas sales 5.8% 6.3% 6.2%           5.9% 6.4%    

As a result of Vermilion's adoption of IFRS, Australian PRRT is no longer classified as a royalty and instead is accounted for as an income tax.  Accordingly, royalty figures presented for both the current and prior periods in this MD&A and the accompanying financial statements exclude PRRT.  Vermilion's previously published MD&A for the three and twelve months ended December 31, 2010 included PRRT of $18.2 million and $39.5 million, respectively, within royalties for those periods.  The prior period figures presented here have been restated to reflect the reclassification of these amounts to income taxes.

Consolidated royalties per boe for the three and twelve months ended December 31, 2011 were $4.45 and $4.22, respectively, (three and twelve months ended December 31, 2010, $3.41 and $3.75, respectively).  As a percent of sales, royalties for the three and twelve months ended December 31, 2011 were 5.5% and 5.3%, respectively (three and twelve months ended December 31, 2010, 5.1% and 6.0%, respectively).  Royalties for the third quarter of 2011 were $4.23 per boe and represented 5.4% of consolidated petroleum and natural gas sales.

In Canada, royalties as a percentage of sales for the three and twelve months ended December 31, 2011 were 12.4% and 13.5%, respectively (three and twelve months ended December 31, 2010, 13.7% and 15.1%, respectively).  Canadian royalties as a percentage of sales for the third quarter of 2011 were 13.5%.  Crude oil and NGL royalties as a percentage of sales decreased for the current year to 16.0% from 21.0% for the prior year due to a change in the royalty framework implemented in 2010 whereby royalties are levied on horizontal crude oil wells at a flat 5% rate for the first 50,000 bbls to 100,000 bbls of production depending on well depth.  As Vermilion has continued to drill more Cardium wells which benefit from this royalty incentive, the Company's crude oil and NGL royalty expense as a percentage of sales has declined.  Canadian natural gas royalties as a percentage of sales decreased to 5.3% for the year ended December 31, 2011 as compared to 6.0% for the prior year as a result of lower pricing year over year.

In France, the primary portion of the royalties levied is based on units of production and therefore is not subject to changes in commodity prices.  Accordingly, as crude oil prices were higher during 2011 as compared to 2010, royalties as a percentage of sales decreased to 5.9% for 2011 from 6.4% in the prior year.

Production in the Netherlands and Australia is not subject to royalties.

OPERATING EXPENSE

  Three Months Ended   % change     Year Ended   % change
By product Dec 31, Sept 30, Dec 31,   Q4/11 vs. Q4/11 vs.     Dec 31, Dec 31,   2011 vs.
($M except per boe and per mcf) 2011 2011 2010   Q3/11 Q4/10     2011  2010    2010
Crude oil & NGLs 29,249  32,190  25,479    (9%) 15%     119,448  98,278    22%
Per boe 13.58  16.03  12.05    (15%) 13%     14.65  13.50    9%
Natural gas 11,264  11,098  14,135    1% (20%)     42,936  46,317    (7%)
Per mcf 1.54  1.57  2.08    (2%) (26%)     1.52  1.73    (12%)
Operating 40,513  43,288  39,614    (6%) 2%     162,384  144,595    12%
Per boe 12.01  13.57  12.20    (11%) (2%)     12.64  12.33    3%
 
                       
  Three Months Ended   % change     Year Ended   % change
By country Dec 31, Sept 30, Dec 31,   Q4/11 vs. Q4/11 vs.     Dec 31, Dec 31,   2011 vs.
($M except per boe) 2011 2011 2010   Q3/11 Q4/10     2011  2010    2010
Canada 11,970  13,473  11,464    (11%) 4%     51,473  40,848    26%
Per boe 8.58  11.28  10.46    (24%) (18%)     10.66  9.71    10%
France 11,381  14,281  11,161    (20%) 2%     46,922  43,498    8%
Per boe 15.51  19.15  13.91    (19%) 12%     15.55  14.02    11%
Netherlands 5,141  3,991  6,008    29% (14%)     17,487  18,217    (4%)
Per boe 9.59  7.76  12.79    24% (25%)     8.65  10.50    (18%)
Australia 12,021  11,543  10,981    4% 9%     46,502  42,032    11%
Per boe 17.00  15.70  12.48    8% 36%     15.60  15.66    -

Consolidated operating expense was $40.5 million or $12.01 per boe and $162.4 million or $12.64 per boe, respectively, for the three and twelve months ended December 31, 2011 (three and twelve months ended December 31, 2010, $39.6 million or $12.20 per boe and $144.6 million or $12.33 per boe, respectively).  Consolidated operating expense for the third quarter of 2011 was $43.3 million or $13.57 per boe.

In Canada, fourth quarter operating expense of $12.0 million was lower than the $13.5 million for the third quarter of 2011 due to lower costs related to road and lease maintenance as well as less major project work.  Operating expense for the fourth quarter of 2011 is consistent with the expense for the same quarter of the prior year.  Increased volumes resulted in lower Canadian operating expense per boe in the fourth quarter of 2011 as compared to both the third quarter of 2011 and the fourth quarter of the prior year.  Canadian operating expense increased to $51.5 million for the year ended December 31, 2011 from $40.8 million in the prior year as a result of additional expenses associated with Vermilion's Cardium program.   On a per boe basis, the impact of this increase in full year operating expense was partially offset by the associated increase in volumes.

In France, fourth quarter operating expense of $11.4 million was lower than the third quarter of 2011 expense of $14.3 million due to the timing of downhole intervention work.  Operating expense for the fourth quarter of 2011 is consistent with the expense for the same quarter of the prior year.  Lower volumes year over year resulted in an increase in France operating expense per boe for the fourth quarter of 2011 as compared to 2010.  Fourth quarter 2011 operating expense per boe was lower than the previous quarter due to the lower levels of downhole expenditure on slightly lower volumes quarter over quarter.  France operating expense increased to $46.9 million for the year ended December 31, 2011 from $43.5 million in 2010 as a result of higher salary and major project costs.   The impact of this increase in full year operating expense coupled with slightly lower volumes resulted in a year over year increase in the operating expense per boe.

In the Netherlands, fourth quarter operating expense of $5.1 million was higher than the third quarter of 2011 expense of $4.0 million due to a scheduled maintenance program at the Garijp Treatment Centre.  Operating expense for the fourth quarter of 2011 of $5.1 million was lower than the $6.0 million for the same quarter of the prior year due to higher treatment centre maintenance costs in the comparative period.  The increased spending in the fourth quarter of 2011 as compared to the third quarter of 2011 resulted in increased operating expense per boe despite a slight increase in production in the fourth quarter.  Year over year, fourth quarter 2011 operating expense was $3.20 per boe lower as compared to the fourth quarter of 2010 due in equal parts to reduced spending and increased volumes.  Netherlands operating expense decreased slightly to $17.5 million for the year ended December 31, 2011 from $18.2 million in 2010.

In Australia, fourth quarter operating expense increased slightly to $12.0 million from the previous quarter's expense of $11.5 million and expense of $11.0 million for the same quarter of prior year due to a higher proportion of days where diesel, rather than produced gas, was used to operate the offshore platform.  Lower volumes year over year coupled with this increased diesel use resulted in an increase in operating expense per boe for the fourth quarter of 2011 as compared to the same period in 2010.  Fourth quarter 2011 operating expense per boe was slightly higher than the previous quarter due to the additional diesel expense as well as a minor decrease in production volume.  Australia operating expense increased to $46.5 million for the year ended December 31, 2011 from $42.0 million in 2010 as a result of the additional use of diesel and higher salary costs.

The impact of this increase in full year operating expense was offset by higher volumes resulting in a $0.06 per boe decrease in operating expense per boe year over year.

TRANSPORTATION EXPENSE

  Three Months Ended   % change     Year Ended   % change
By country Dec 31, Sept 30, Dec 31,   Q4/11 vs. Q4/11 vs.     Dec 31, Dec 31,   2011 vs.
($M except per boe) 2011 2011 2010   Q3/11 Q4/10     2011  2010    2010 
Canada 1,972  1,641  1,582    20% 25%     6,599  6,251    6%
Per boe 1.41  1.37  1.44    3% (2%)     1.37  1.49    (8%)
France 2,955  2,567  2,477    15% 19%     10,118  10,637    (5%)
Per boe 4.03  3.44  3.09    17% 30%     3.35  3.43    (2%)
Ireland 2,101  2,253  2,242    (7%) (6%)     8,822  9,810    (10%)
Transportation 7,028  6,461  6,301    9% 12%     25,539  26,698    (4%)
Per boe 2.08  2.03  1.94    2% 7%     1.99  2.28    (13%)

Transportation expense is a function of the point of legal transfer of the product and is dependent upon where the product is sold, product split, location of properties and industry transportation rates that are driven by supply and demand of available transport capacity.

For the majority of Canadian crude oil and natural gas production, legal title transfers upon delivery to major pipelines.  In France, the majority of Vermilion's transportation expense relates to production from the Aquitaine Basin, which is transported by pipeline to the Ambès terminal in Bordeaux and then shipped by tanker to refineries in North Western Europe, where the production is sold when the tanker is unloaded.  In Australia, crude oil is sold at the Wandoo B Platform and in the Netherlands, gas is sold at the plant gate, resulting in no transportation expense relating to Vermilion's production in these countries.

Transportation expense also includes the amount due under a ship or pay agreement related to the Corrib project.  However, as there is a ceiling on the total payments due in relation to the associated pipeline, these expenses essentially represent a prepayment for future pipeline transportation services.

Overall, transportation expense for 2011 was lower than the previous year as a result of generally lower Ambès terminal costs in France.  On a per boe basis, transportation expense for 2011 was lower than the previous year due to production increases in Canada that did not result in significantly higher transportation costs.

Transportation expense was higher during the three months ended December 31, 2011 when compared to the same period in 2010.  This increase was primarily the result of pipeline inspection and training costs that were incurred for the Ambès terminal during the fourth quarter of this year.

GENERAL AND ADMINISTRATION EXPENSE

  Three Months Ended   % change     Year Ended   % change
  Dec 31, Sept 30, Dec 31,   Q4/11 vs. Q4/11 vs.     Dec 31, Dec 31,   2011 vs.
($M except per boe) 2011 2011 2010   Q3/11 Q4/10     2011  2010    2010 
General and administration 9,753  11,375  12,675    (14%) (23%)     44,583  42,842    4%
Per boe 2.89  3.57  3.90    (19%) (26%)     3.47  3.65    (5%)

General and administration expense for the fourth quarter of 2011 were lower than in the same period in the 2010.  This variance was primarily the result of one-time costs incurred in the fourth quarter of 2010, including head office relocation costs and legal and advisory costs associated with the trust conversion and the restructuring of Vermilion's international holding companies, that were not incurred in the current year.

Overall, general and administration expenses in 2011 were higher than 2010 as a result of higher employee costs as Vermilion increased its staffing levels in Canada in support of its Cardium program and to identify future opportunities to generate long-term growth.  On a per boe basis, general and administration expense was lower as production growth exceeded the increase in expenditures.

EQUITY BASED COMPENSATION EXPENSE

  Three Months Ended   % change     Year Ended   % change
  Dec 31, Sept 30, Dec 31,   Q4/11 vs. Q4/11 vs.     Dec 31, Dec 31,   2011 vs.
($M except per boe) 2011 2011 2010   Q3/11 Q4/10     2011  2010    2010 
Equity based compensation 16,150  7,609  10,614    112% 52%     38,667  34,576    12%
Per boe 4.79  2.39  3.27    100% 46%     3.01  2.95    2%

Equity based compensation expense relates to non-cash compensation expense attributable to long-term incentives granted to directors, officers and employees under the Vermilion Incentive Plan. The expense is recognized over the vesting period of the award based on the grant date fair value of awards, adjusted for the ultimate number of awards that actually vest as determined by the Company's achievement of a number of performance conditions.

The increase in equity based compensation expense from the third to the fourth quarter of 2011 and the increase from the fourth quarter of 2010 to the fourth quarter of 2011 was primarily attributable to performance condition adjustments based on new information available in the fourth quarter of 2011.  Overall, equity based compensation expense was higher in 2011 compared to 2010 as a result of the aforementioned increase in staffing levels in Canada in support of its Cardium program and to identify future opportunities to generate long-term growth.

INTEREST EXPENSE

  Three Months Ended   % change     Year Ended   % change
  Dec 31, Sept 30, Dec 31,   Q4/11 vs. Q4/11 vs.     Dec 31, Dec 31,   2011 vs.
($M except per boe) 2011 2011 2010   Q3/11 Q4/10     2011  2010    2010 
Interest expense 6,365  6,659  3,482    (4%) 83%     24,967  13,370    87%
Per boe 1.89  2.09  1.07    (10%) 77%     1.94  1.14    70%

While year end borrowings under the revolving credit facility have decreased, they have on average been higher during 2011 than in 2010 as a result of increased capital expenditures.  This higher average debt level during 2011 and the issuance of the senior unsecured notes in the first quarter of 2011 coupled with the higher interest rate associated with these notes resulted in higher interest expense in 2011 compared to 2010.

DEPLETION AND DEPRECIATION, ACCRETION AND IMPAIRMENT EXPENSES

  Three Months Ended   % change     Year Ended   % change
  Dec 31, Sept 30, Dec 31,   Q4/11 vs. Q4/11 vs.     Dec 31, Dec 31,   2011 vs.
($M except per boe) 2011 2011 2010   Q3/11 Q4/10     2011  2010    2010 
Depletion and depreciation 64,895  60,516  60,462    7% 7%     236,708  183,620    29%
Per boe 19.24  18.97  18.62    1% 3%     18.42  15.66    18%
Accretion 5,793  5,378  4,597    8% 26%     21,889  17,903    22%
Per boe 1.72  1.69  1.42    2% 21%     1.70  1.53    11%
Impairments 64,400  19,840    100% 225%     64,400  19,840    225%
Per boe 19.10  6.11    100% 213%     5.01  1.69    196%

Depletion and depreciation expense on a per boe basis has remained relatively consistent throughout 2011 and overall are higher than expenses on a per boe basis recognized in 2010.  This increase is primarily the result of higher finding, development and acquisition costs incurred by Vermilion, which resulted from increased liquids development in Canada.

Accretion expense on a per boe basis has similarly remained relatively consistent throughout 2011 and overall are higher than expenses recognized in 2010.  Accretion expense has generally increased year over year as a result of increases in the underlying asset retirement obligations due to new wells drilled during 2011 and previously recorded adjustments to the present value of the obligations.

The impairment loss in the fourth quarter of 2011 relates to impairment charges recorded on certain of Vermilion's Canadian natural gas producing properties.  These impairment charges were the result of significant declines in the forward pricing assumptions for natural gas in Canada.  Impairment charges in 2010 relate to goodwill acquired in a previous business combination, which was identified as impaired in the fourth quarter of 2010.

TAXES

  Three Months Ended   % change     Year Ended   % change
By product Dec 31, Sept 30, Dec 31,   Q4/11 vs. Q4/11 vs.     Dec 31, Dec 31,   2011 vs.
($M except per boe) 2011 2011 2010   Q3/11 Q4/10     2011  2010    2010 
Current taxes before PRRT 33,446  24,599  29,349    36% 14%     120,019  72,701    65%
Per boe 9.92  7.71  9.04    29% 10%     9.34  6.20    51%
PRRT 21,541  18,281  18,192    18% 18%     99,075  39,537    151%
Per boe 6.39  5.73  5.60    12% 14%     7.71  3.37    129%
Current taxes 54,987  42,880  47,541    28% 16%     219,094  112,238    95%
Per boe 16.31  13.44  14.64    21% 11%     17.05  9.57    78%
 
                       
  Three Months Ended   % change     Year Ended   % change
By country Dec 31, Sept 30, Dec 31,   Q4/11 vs. Q4/11 vs.     Dec 31, Dec 31,   2011 vs.
($M except per boe) 2011 2011 2010   Q3/11 Q4/10     2011  2010    2010 
Canada (783) 467  623    (268%) (226%)     508  1,343    (62%)
Per boe (0.56) 0.39  0.57    (244%) (198%)     0.11  0.32    (66%)
France 17,738  13,696  28,768    30% (38%)     65,964  50,075    32%
Per boe 24.17  18.36  35.85    32% (33%)     21.86  16.14    35%
Netherlands 6,431  2,571  (8,910)   150% 172%     18,149  (3,425)   630%
Per boe 11.99  5.00  (18.97)   140% 163%     8.98  (1.97)   556%
Australia 31,601  26,146  27,060    21% 17%     134,473  64,245    109%
Per boe 44.69  35.56  30.76    26% 45%     45.10  23.93    88%

Vermilion pays current taxes in France, the Netherlands and Australia.  Corporate income taxes in France and the Netherlands apply to taxable income after eligible deductions at a rate of approximately 34% and 46%, respectively.

In Australia, current taxes include both corporate income taxes and PRRT.  Corporate income taxes are applied at a rate of approximately 30% on taxable income after eligible deductions, which include PRRT.  PRRT is a profit based tax applied at a rate of 40% on revenues less eligible expenditures, which includes operating expenses and capital expenditures.

Current taxes before PRRT increased in 2011 relative to 2010 both in dollar terms and on a per boe basis.  This increase is attributable to higher year over year taxable income associated with overall stronger commodity prices and generally higher production.

PRRT increased in 2011 relative to 2010 both in dollar terms and on a per boe basis due to higher crude oil prices and reduced capital expenditures.  On a percentage of operating income basis, PRRT was 37% of operating income for 2011, higher than the 2010 percentage of 22% due to lower capital expenditures in 2011 as compared to 2010.  Capital expenditures are deductible in determining PRRT when incurred, and the reduction of capital spending in Australia in 2011 versus 2010 resulted in an increase in PRRT in 2011.

As a function of the impact of Vermilion's Canadian tax pools, the Company does not presently pay current taxes in Canada.  The Canadian segment includes holding companies that pay current taxes in foreign jurisdictions.

As at December 31, 2011, Vermilion had the following tax pools:

($M)     Oil & Gas
Assets
        Tax Losses4     Other     Total
Canada     736,578    1     369,662     18,472      1,124,712 
France     137,467    2     64,914          202,381 
Netherlands     36,058    3     -         36,058 
Australia     201,746    1     -         201,746 
Ireland     616,246    4     137,784          754,030 
Total     1,728,095          572,360      18,472      2,318,927 
1 Deduction calculated using various declining balance rates
2 Deduction calculated using a combination of straight-line over the assets life and unit of production method
3 Deduction calculated using a unit of production method
4 Development expenditures and tax losses are deductible at 100% against taxable income

 

FOREIGN EXCHANGE

  Three Months Ended     Year Ended
  Dec 31, Sept 30, Dec 31,     Dec 31, Dec 31,
($M except per boe) 2011 2011 2010     2011  2010 
Unrealized foreign exchange loss 24,974  1,260  15,293      11,022  40,582 
Per boe 7.41  0.39  4.71      0.86  3.46 
Realized foreign exchange (gain) loss (1,252) 670  (76)     (1,024) (5,623)
Per boe (0.37) 0.21  (0.02)     (0.08) (0.48)
Foreign exchange loss 23,722  1,930  15,217      9,998  34,959 
Per boe 7.04  0.60  4.69      0.78  2.98 

Foreign exchange losses are comprised of both unrealized losses and realized gains and losses.  Unrealized foreign exchange losses are the result of translating monetary assets and liabilities held in non-functional currencies to the respective functional currencies of Vermilion and its subsidiaries.  Realized gains and losses are the result of foreign exchange fluctuations on transactions conducted in non-functional currencies.

As a result of Vermilion's international operations, Vermilion conducts business in currencies other than the Canadian dollar and has monetary assets and liabilities (including cash, receivables, payables, derivative assets and liabilities, and intercompany loans) denominated in such currencies.  Vermilion's exposure to foreign currencies include the U.S. Dollar, the Euro and the Australian Dollar.

In 2011 and 2010, unrealized foreign exchange loss of $11.0 million and $40.6 million, respectively, resulted from the impact of the appreciation of the Canadian dollar against the Euro on Euro denominated loans made by Vermilion to its subsidiaries.  The impact of the Canadian dollar appreciation against the Euro was more significant in 2010 due to the 11.2% appreciation from December 31, 2009 to December 31, 2010 as compared to the 0.9% appreciation from December 31, 2010 to December 31, 2011.

Changes quarter over quarter and year over year in realized foreign exchange gains and losses are the result of changes in the volumes of transactions and daily fluctuations in foreign currencies.

NET EARNINGS (LOSS)

For the three months and year ended December 31, 2011, Vermilion had a net loss of $30.2 million or $0.32 per share and net earnings of $142.8 million or $1.57 per share, respectively (three months and year ended December 31, 2010, net loss of $21.8 million or $0.25 per share and net earnings of $44.4 million or $0.53 per share, respectively).

The net loss in the fourth quarter of 2011 was the result of impairment charges of $64.4 million recorded on Vermilion's Canadian natural gas producing properties.   These impairment charges resulted from significant declines in the price forecasts for natural gas in Canada.  In the event that commodity prices recover, the carrying value of these assets, net of applicable depletion, will be recovered resulting in a gain to net earnings in the period the impairment reversal occurs.

The significant increase year over year in net earnings, is the primarily result of overall higher production and generally favourable commodity prices offset partially by higher current taxes and the impairment charge discussed above.

Summary of Results

    Year Ended     Three Months Ended
    Dec 31, Dec 31,     Dec 31, Sept 30, June 30, March 31, Dec 31, Sept 30, June 30, March 31,
($M except per share) 2011 2010      2011  2011  2011  2011  2010  2010  2010  2010 
Petroleum and natural gas sales 1,031,570  727,805      275,172  248,361  278,297  229,740  216,426  172,253  169,545  169,581 
Net earnings (loss) 142,821  44,395      (30,243) 64,442  81,429  27,193  (21,809) 24,576  49,811  (8,183)
Net earnings (loss) per share                        
  Basic 1.57  0.53      (0.32) 0.71  0.90  0.30  (0.25) 0.29  0.62  (0.10)
  Diluted 1.55  0.53      (0.32) 0.70  0.89  0.30  (0.25) 0.29  0.44  (0.10)

LIQUIDITY AND CAPITAL RESOURCES

Vermilion's net debt as at December 31, 2011 was $429.0 million compared to $303.3 million as at December 31, 2010.

Long term debt was comprised of the following balances as at December 31, 2011 and December 31, 2010:

      As At
      Dec 31,       Dec 31,
($M)     2011        2010 
Revolving credit facility     152,086        302,558 
Senior unsecured notes     221,350       
Total long-term debt     373,436        302,558 

Revolving Credit Facility

At December 31, 2011, Vermilion had in place a bank revolving credit facility totalling $800 million.  The facility, which matures in May 2014, is fully revolving up to the date of maturity.  The facility is extendable from time to time, but not more than once per year, for a period not longer than three years, at the option of the lenders and upon notice from Vermilion.  If no extension is granted by the lenders, the amounts owing pursuant to the facility are repayable on the maturity date.  This facility bears interest at a rate applicable to demand loans plus applicable margins.  For the year ended December 31, 2011, the interest rate on the revolving credit facility was between 3.2% and 3.8% (2010 - between 2.9 and 3.5%).

The amount available to Vermilion under this facility is reduced by outstanding letters of credit associated with Vermilion's operations totaling $3.7 million as at December 31, 2011.

The facility is secured by various fixed and floating charges against the subsidiaries of Vermilion.  Under the terms of the facility, Vermilion must maintain a ratio of total bank borrowings less certain debts related to Corrib (defined as consolidated total debt), to consolidated net earnings before interest, income taxes, depreciation, accretion and other certain non-cash items of not greater than 4.0.  In addition, Vermilion must maintain a ratio of consolidated total senior debt (consolidated total debt excluding unsecured and subordinated debt) to consolidated earnings before interest, income taxes, depreciation, accretion and other certain non-cash items of not greater than 3.0.

As at December 31, 2011, Vermilion is in compliance with its financial covenants.

Senior Unsecured Notes

On February 10, 2011, Vermilion issued $225.0 million of senior unsecured notes at par.  The notes bear interest at a rate of 6.5% per annum and will mature on February 10, 2016.  As direct senior unsecured obligations of Vermilion, the notes rank pari passu with all other present and future unsecured and unsubordinated indebtedness of the Company.

Vermilion may, at its option, prior to February 10, 2014, redeem up to 35% of the notes with net proceeds of equity offerings by the Company at a redemption price equal to 106.5% of the principal amount of the notes to be redeemed, plus accrued and unpaid interest, if any, to the applicable redemption date.  Subsequently, Vermilion may, on or after February 10, 2014, redeem all or part of the notes at fixed redemption prices, plus, in each case, accrued and unpaid interest, if any, to the applicable redemption date.  The notes were initially recognized at fair value net of transaction costs and are subsequently measured at amortized cost using an effective interest rate of 7.1%.

CONTRACTUAL OBLIGATIONS AND COMMITMENTS

As at December 31, 2011, Vermilion had the following contractual obligations and commitments:

($M)   Less than 1 year     1 - 3 years     3 - 5 years     After 5 years     Total
Long-term debt (excluding interest)       152,086      221,350          373,436 
Amount due pursuant to acquisition   137,295                  137,295 
Operating lease obligations   8,575      17,297      14,921      41,681      82,474 
Ship or pay agreement related to the Corrib project   7,588      11,954      9,273      43,292      72,107 
Purchase obligations   19,309      2,207      2,111      670      24,297 
Drilling and service agreements   10,913                  10,913 
Total contractual obligations   183,680      183,544      247,655      85,643      700,522 

EQUITY ISSUANCE

On November 28, 2011 Vermilion completed an equity issuance of 5,370,000 common shares at $49.00 per common share for gross proceeds of approximately $263.1 million including the partial exercise of the underwriters' overallotment option (the "Offering").

The intended use of net proceeds of the Offering of approximately $252.0 million was to reduce a certain amount of outstanding indebtedness under the revolving credit facility and to partially fund Vermilion's future development capital program and for use in prospective acquisitions.

For the year ending December 31, 2011, Vermilion used the net proceeds as follows:

($M)   Intended use of
net proceeds
    Use of net
proceeds
    Remaining net
proceeds
Reduction of outstanding indebtedness under the revolving credit facility   59,000      61,000      (2,000)
Partially fund the Company's development capital program and prospective acquisitions   192,204      107,000      85,204 
General purposes   800          800 
    252,004      168,000      84,004 

RECLAMATION FUND

After an extensive review, Vermilion concluded that the reclamation fund assets would be more effectively employed supporting Vermilion's operations.  On July 2010, the reclamation fund assets were liquidated and the proceeds were initially used to reduce outstanding bank indebtedness and will ultimately help support Vermilion's capital programs.  Vermilion will fund future reclamation costs out of current resources as they become due, consistent with standard industry practice.

ASSET RETIREMENT OBLIGATIONS

As at December 31, 2011, Vermilion's asset retirement obligations were $310.5 million compared to $267.4 million as at December 31, 2010.

The increase in asset retirement obligations is largely attributable to changes in the discount rates applied to the obligations, accretion and additions from the recognition of obligations relating to the wells drilled during 2011.  These increases were partially offset by obligations settled during the year, changes in estimates for existing obligations and the impact of foreign exchange rates on foreign currency denominated obligations.

DIVIDENDS

  Three Months
Ended
    Year Ended
  Dec 31,     Dec 31, Dec 31,
($M) 2011      2011  2010 
Cash flows from operating activities 158,639      447,092  421,282 
Net earnings (loss) (30,243)     142,821  44,395 
Dividends declared 53,871      207,846  189,744 
Excess of cash flows from operating activities over dividends declared 104,768      239,246  231,538 
(Shortfall) excess of net earnings (loss) over dividends declared (84,114)     (65,025) (145,349)

Vermilion maintained monthly dividends at $0.19 per share and declared dividends totalling $207.8 million for 2011.

Excess cash flows from operating activities over dividends declared are used to fund capital expenditures, asset retirement obligations and debt repayments.

Vermilion's policy with respect to dividends is to be conservative and retain a low ratio of dividends to fund flows from operations.  During low price commodity cycles, Vermilion will initially maintain dividends and allow the ratio to rise.  Should commodity price cycles remain low for an extended period of time, Vermilion will evaluate the necessity to change the level of dividends, taking into consideration capital development requirements, debt levels and acquisition opportunities.

Following Vermilion's conversion to a trust in January 2003, distributions remained at $0.17 per unit per month until an increase to $0.19 per unit per month in December 2007.  Effective September 1, 2010, Vermilion converted to a corporation and has been paying dividends of $0.19 per share per month.

Over the next three years, the Corrib, Cardium and other exploration and development activities will require a significant capital investment by Vermilion.  As such, Vermilion's fund flows from operations may not be sufficient during this period to fund future cash dividends, capital expenditures and asset retirement obligations.  Vermilion will evaluate its ability to finance any shortfalls with debt, an issuance of equity or by reducing some or all categories of expenditures to ensure that total expenditures do not exceed available funds.

SHAREHOLDERS' EQUITY

During the year ended December 31, 2011, Vermilion issued 7,431,893 common shares pursuant to the November equity offering, the dividend reinvestment plan and Vermilion's equity based compensation programs.  Shareholders' capital increased by $342.4 million as a result of the issuance of those shares.

As at December 31, 2011, there were 96,430,135 shares outstanding.  As at March 1, 2012, there were 96,713,280 shares outstanding.

Since inception, Vermilion has declared $1.3 billion in dividends to shareholders as compared to shareholders' capital of $1.4 billion as at December 31, 2011.

CORRIB PROJECT

Vermilion holds an 18.5% non-operating interest in the offshore Corrib gas field located off the northwest coast of Ireland.  Production from Corrib is expected to increase Vermilion's volumes by approximately 54 mmcf (9,000 boe/d) once the field reaches peak production.  Vermilion acquired its 18.5% working interest in the project on July 30, 2009.  The project comprises seven offshore wells, both offshore and onshore pipeline segments as well as a significant natural gas processing facility.  At the time of the acquisition most of the key components of the project, with the exception of the onshore pipeline, were either complete or in the latter stages of development.  Vermilion's interest was acquired for cash consideration of $136.8 million with subsequent capital expenditures to December 31, 2011 of $243.8 million, primarily related to completion of the natural gas processing facility, sub-surface well work, and permitting and preparations for construction of the onshore pipeline.  Furthermore, pursuant to the terms of the acquisition agreement, Vermilion will make an additional payment to the vendor of US$135 million at the end of 2012.  In 2011, approvals and permissions were granted for the onshore gas pipeline and construction has commenced with tunnelling expected to begin in the fourth quarter of 2012.  Vermilion expects to continue significant capital investment on this project over the next two years and currently expects to achieve initial gas production from this field in late 2014.

RISK MANAGEMENT

Vermilion is exposed to various market and operational risks.

For a detailed discussion of these risks, please see Vermilion's 2011 Annual Report which will be made available on SEDAR at www.sedar.com or on the Company's website at www.vermilionenergy.com on or before March 31, 2012.

CRITICAL ACCOUNTING ESTIMATES

Vermilion's financial and operating results contain estimates made by management in the following areas:

i.      Capital expenditures are based on estimates of projects in various stages of completion;
ii.      Revenues, royalties, operating expenses, and current taxes include accruals based on estimates of management;
iii.      Fair value of derivative instruments are based on estimates that are subject to the fluctuation of commodity prices and foreign exchange rates;
iv.      Depletion, depreciation and accretion are based on estimates of oil and gas reserves that Vermilion expects to recover in the future;
v.      Asset retirement obligations are based on estimates of future costs and the timing of expenditures;
vi.      The future recoverable value of capital assets and exploration and evaluation assets are based on estimates that Vermilion expects to realize; and
vii.      Equity based compensation expense is determined using accepted fair value approaches which rely on historical data and certain estimates made by management.

OFF BALANCE SHEET ARRANGEMENTS

Vermilion has certain lease agreements that are entered into in the normal course of operations.  All leases are operating leases and accordingly no asset or liability value has been assigned in the balance sheet as of December 31, 2011.

Vermilion uses a variety of derivatives including puts and calls to manage the risks associated with fluctuating commodity prices.  Vermilion does not obtain collateral or other security to support its financial derivatives as Vermilion reviews the creditworthiness of the counterparty prior to entering into a derivative contract.

Vermilion has not entered into any guarantee or off balance sheet arrangements that would adversely impact Vermilion's financial position or results of operations.

INTERNAL CONTROL OVER FINANCIAL REPORTING

There was no change in Vermilion's internal control over financial reporting that occurred during the period covered by this MD&A that has materially affected, or is reasonably likely to materially affect, its internal control over financial reporting.

SENSITIVITIES

Crude oil and natural gas prices may change significantly because of factors Vermilion cannot control.  The following table provides a summary of estimated sensitivities to price fluctuations for pro-forma production levels and expenses.

      Change in Cash Available for
Dividends ($/share)
      Change in Cash Available for
Dividends ($MM)
Change in crude oil by US $1.00/bbl     0.06        6.0 
Change in AECO prices by $0.10/mcf     0.02        1.6 
Change in interest rate by one basis point     0.03        2.8 
Change in CDN $/US $ foreign exchange rate by $0.01     0.06        5.3 
Change in CDN $/Euro foreign exchange rate by $0.01           0.2 

INTERNATIONAL FINANCIAL REPORTING STANDARDS ("IFRS") TRANSITION

Adoption of IFRS

Vermilion has prepared its December 31, 2011 consolidated financial statements in accordance with IFRS as issued by the International Accounting Standards Board.  Previously, Vermilion prepared its financial statements in accordance with Canadian Generally Accepted Accounting Principles as issued by the Canadian Accounting Standards Board ("Previous GAAP").  The adoption of IFRS has not had a material impact on Vermilion's operations, strategic decisions, cash flow or capital expenditures.

Vermilion's IFRS accounting policies and reconciliations between Vermilion's 2010 Previous GAAP results and the restated 2010 IFRS results are provided in the notes to the consolidated financial statements, which will be filed on SEDAR at www.sedar.com and on Vermilion's website at www.vermilionenergy.com on or before March 31, 2012.

The following provides summary reconciliations of Vermilion's 2010 Previous GAAP and IFRS results:

EFFECT OF TRANSITION ON NET EARNINGS AND COMPREHENSIVE INCOME

  Three Months Ended     Year Ended
  Dec 31, 2010     Dec 31, 2010
Net earnings and comprehensive income - Previous GAAP 15,817      111,263 
Increase in equity based compensation expense 2,618      (6,406)
Increase in loss on derivative instruments (2,139)     (3,013)
Increase in unrealized foreign exchange loss (29,011)     (61,091)
Decrease in accretion expense (2)     250 
Decrease in depletion and depreciation 16,494      69,783 
Decrease in deferred income tax recovery (5,746)     (23,663)
Goodwill impairment (19,840)     (19,840)
Reversal of non-controlling interest - exchangeable shares     8,241 
Remeasurement loss on liability associated with exchangeable shares     (31,129)
Net earnings (loss) (21,809)     44,395 
Currency translation adjustments (14,697)     (31,577)
Comprehensive income (loss) (36,506)     12,818 

SUMMARY OF CHANGES IN ROYALTY AND CURRENT TAX EXPENSES

  Three Months Ended Year Ended
($M) Dec 31, 2010 Dec 31, 2010
Royalty expense - Previous GAAP 29,279  83,509 
Reclassification of Australia PRRT from royalties to current taxes (18,192) (39,537)
Royalties - IFRS 11,087  43,972 
     
  Three Months Ended Year Ended
($M) Dec 31, 2010 Dec 31, 2010
Current tax expense - Previous GAAP 29,349  72,701 
Reclassification of Australia PRRT from royalties to current taxes 18,192  39,537 
Current tax expense - IFRS 47,541  112,238 
     
SUMMARY OF CHANGES IN FINANCIAL METRICS    
     
  Three Months Ended Year Ended
($M) Dec 31, 2010 Dec 31, 2010
Fund flows from operations - Previous GAAP 100,177  363,487 
Reclassification of contingent consideration to operating activities from investing activities (2,015) (5,958)
Fund flows from operations - IFRS 98,162  357,529 
     
($M) As At Dec 31, 2010
Net debt - Previous GAAP   300,393 
Reclassify current portion of deferred taxes to non-current   2,902 
Net debt - IFRS   303,295 

ABBREVIATIONS

bbl(s)     barrel(s)
mbbls      thousand barrels
bbls/d      barrels per day
mcf      thousand cubic feet
mmcf      million cubic feet
bcf      billion cubic feet
mcf/d      thousand cubic feet per day
mmcf/d      million cubic feet per day
boe      barrels of oil equivalent of natural gas and crude oil on the basis of one boe for six mcf of natural gas
mboe      thousand barrels of oil equivalent
mmboe      million barrels of oil equivalent
boe/d      barrels of oil equivalent per day
CBM      coalbed methane
NGLs      natural gas liquids
GJ/d      gigajoules per day
WTI      West Texas Intermediate, the reference price paid in U.S. dollars at Cushing, Oklahoma for crude oil of standard grade
AECO      the daily average Alberta natural gas price as traded on the Natural Gas Exchange
$M      thousand dollars
$MM      million dollars
PRRT      Petroleum Resource Rent Tax, a profit based tax levied on petroleum projects in Australia
GAAP      Canadian Generally Accepted Accounting Principles, or alternatively IFRS

NETBACKS (6:1)

  Three Months Ended Dec 31, 2011   Year Ended Dec 31, 2011     Three Months
Ended
Dec 31, 2010
  Year Ended
Dec 31, 2010
  Oil & NGLs Natural Gas Total   Oil & NGLs Natural Gas Total     Total   Total
  $/bbl $/mcf $/boe   $/bbl $/mcf $/boe     $/boe   $/boe
Canada                        
Price 95.24  3.38  59.03    91.00  3.83  53.82      45.26    44.04 
Realized hedging (loss) gain (0.27) (0.03) (0.24)   (0.57) (0.02) (0.32)     1.44    1.36 
Royalties (13.08) (0.19) (7.29)   (14.52) (0.20) (7.25)     (6.22)   (6.65)
Transportation (1.75) (0.18) (1.41)   (1.68) (0.18) (1.37)     (1.44)   (1.49)
Operating (8.60) (1.43) (8.58)   (12.43) (1.53) (10.66)     (10.46)   (9.71)
Operating netback 71.54  1.55  41.51    61.80  1.90  34.22      28.58    27.55 
France                        
Price 113.39  13.15  112.71    108.08  11.98  107.38      85.10    80.26 
Realized hedging (loss) gain (3.57) (3.50)   (4.07) (3.99)     0.94    0.48 
Royalties (6.68) (0.27) (6.58)   (6.47) (0.27) (6.38)     (5.32)   (5.15)
Transportation (4.11) (4.03)   (3.42) (3.35)     (3.09)   (3.43)
Operating (15.33) (4.07) (15.51)   (15.45) (3.41) (15.55)     (13.91)   (14.02)
Operating netback 83.70  8.81  83.09    78.67  8.30  78.11      63.72    58.14 
Netherlands                        
Price 92.59  10.43  62.95    94.33  9.52  57.51      48.26    42.53 
Operating (1.62) (9.59)   (1.46) (8.65)     (12.79)   (10.50)
Operating netback 92.59  8.81  53.36    94.33  8.06  48.86      35.47    32.03 
Australia                        
Price 108.00  108.00    111.16  111.16      86.23    81.86 
Realized hedging loss (4.55) (4.55)   (4.94) (4.94)      
Operating (17.00) (17.00)   (15.60) (15.60)     (12.48)   (15.66)
PRRT 1 (30.46) (30.46)   (33.23) (33.23)     (20.68)   (14.73)
Operating netback 55.99  55.99    57.39  57.39      53.07    51.47 
Total Company                        
Price 105.49  6.57  81.60    104.58  6.35  80.29      66.64    62.06 
Realized hedging (loss) gain (2.78) (0.02) (1.81)   (3.44) (0.01) (2.20)     0.72    0.61 
Royalties (6.61) (0.11) (4.45)   (6.25) (0.12) (4.22)     (3.41)   (3.75)
Transportation (1.96) (0.38) (2.08)   (1.69) (0.42) (1.99)     (1.94)   (2.28)
Operating (13.58) (1.54) (12.01)   (14.65) (1.52) (12.64)     (12.20)   (12.33)
PRRT 1 (10.00) (6.39)   (12.15) (7.71)     (5.60)   (3.37)
Operating netback 70.56  4.52  54.86    66.40  4.28  51.53      44.21    40.94 
General and administration     (2.89)       (3.47)     (3.90)   (3.65)
Interest expense     (1.89)       (1.94)     (1.07)   (1.14)
Realized foreign exchange gain     0.37        0.08      0.02    0.48 
Other income     0.07        0.07      0.01    0.05 
Current income taxes     (9.92)       (9.34)     (9.04)   (6.20)
Fund flows netback     40.60        36.93      30.23    30.48 
Accretion     (1.72)       (1.70)     (1.42)   (1.53)
Depletion and depreciation     (19.24)       (18.42)     (18.62)   (15.66)
Impairments     (19.10)       (5.01)     (6.11)   (1.69)
Deferred income taxes 5.42        3.60      3.03    2.70 
Unrealized other expense (income) 0.17        (0.16)     (0.02)   (0.26)
Unrealized foreign exchange loss     (7.41)       (0.86)     (4.71)   (3.46)
Remeasurement of liability associated with exchangeable shares             (2.65)
Unrealized loss on derivative instruments (2.90)       (0.24)     (5.83)   (1.20)
Equity based compensation     (4.79)       (3.01)     (3.27)   (2.95)
Earnings (loss) netback     (8.97)       11.13      (6.72)   3.78 

The above table includes non-GAAP measures which may not be comparable to other companies.  Please see "Non-GAAP Measures" for further discussion.

1  Vermilion considers Australian PRRT to be an operating item and accordingly has included PRRT in the calculation of operating netbacks.  Current income taxes presented above excludes PRRT.

CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF CANADIAN DOLLARS, UNAUDITED)

    December 31,     December 31,     January 1,
    2011      2010      2010
ASSETS                
Current                
Cash and cash equivalents   234,507      160,755      114,961 
Accounts receivable   176,820      147,329      117,051 
Crude oil inventory   13,885      10,707      5,235 
Derivative instruments   186      10,249      8,217 
Prepaid expenses   10,26     11,157      11,422 
    435,659      340,197      256,886 
Derivative instruments       942      7,896 
Deferred taxes   175,545      147,949      124,707 
Exploration and evaluation assets   92,301      17,157     
Goodwill           19,840 
Reclamation fund           69,003 
Capital assets   2,031,682      1,819,552      1,614,909 
    2,735,187      2,325,797      2,093,241 
LIABILITIES                
Current                
Accounts payable and accrued liabilities   297,756      252,319      195,909 
Dividends or distributions payable   18,322      16,910      15,109 
Derivative instruments   11,568      12,143      6,544 
Income taxes payable   36,407      59,562      4,090 
Amount due pursuant to acquisition   127,131         
    491,184      340,934      221,652 
Derivative instruments   767      8,157      4,563 
Long-term debt   373,436      302,558      159,723 
Amount due pursuant to acquisition       114,349      111,402 
Asset retirement obligations   310,531      267,389      224,005 
Equity based compensation liability           30,307 
Deferred taxes   227,668      246,508      255,598 
    1,403,586      1,279,895      1,007,250 
Liability associated with exchangeable shares           217,992 
                 
SHAREHOLDERS' OR UNITHOLDERS' EQUITY                
Shareholders' capital   1,368,145      1,025,770     
Unitholders' capital           711,667 
Contributed surplus   56,468      40,726     
Accumulated other comprehensive loss   (33,387)     (31,577)    
Retained earnings (deficit)   (59,625)     10,983      156,332 
    1,331,601      1,045,902      867,999 
    2,735,187      2,325,797      2,093,241 

CONSOLIDATED STATEMENTS OF NET EARNINGS (LOSS) AND COMPREHENSIVE INCOME (LOSS)
(THOUSANDS OF CANADIAN DOLLARS, EXCEPT SHARE OR UNIT AND PER SHARE OR UNIT AMOUNTS, UNAUDITED)

    Three Months Ended   Year Ended
    Dec 31,   Dec 31,   Dec 31,   Dec 31,
    2011    2010    2011    2010 
REVENUE                
Petroleum and natural gas sales   275,172    216,426    1,031,570    727,805 
Royalties   (15,005)   (11,087)   (54,235)   (43,972)
Petroleum and natural gas revenue   260,167    205,339    977,335    683,833 
                 
EXPENSES                
Operating   40,513    39,614    162,384    144,595 
Transportation   7,028    6,301    25,539    26,698 
Equity based compensation   16,150    10,614    38,667    34,576 
Loss on derivative instruments   15,880    16,599    31,340    6,919 
Interest expense   6,365    3,482    24,967    13,370 
General and administration   9,753    12,675    44,583    42,842 
Foreign exchange loss   23,722    15,217    9,998    34,959 
Other (income) expense   (787)   38    1,155    2,469 
Accretion   5,793    4,597    21,889    17,903 
Depletion and depreciation   64,895    60,462    236,708    183,620 
Impairments   64,40   19,840    64,400    19,840 
    253,712    189,439    661,630    527,791 
EARNINGS BEFORE INCOME TAXES AND OTHER ITEM   6,45   15,900    315,705    156,042 
                 
INCOME TAXES                
Deferred   (18,289)   (9,832)   (46,210)   (31,720)
Current   54,987    47,541    219,094    112,238 
    36,698    37,709    172,884    80,518 
OTHER ITEM                
Remeasurement loss on liability associated with exchangeable shares         31,129 
NET EARNINGS (LOSS)   (30,243)   (21,809)   142,821    44,395 
                 
OTHER COMPREHENSIVE LOSS                
Currency translation adjustments   (18,984)   (14,697)   (1,810)   (31,577)
COMPREHENSIVE INCOME (LOSS)   (49,227)   (36,506)   141,011    12,818 
                 
NET EARNINGS (LOSS) PER SHARE OR UNIT                
Basic       (0.32)   (0.25)   1.57    0.53 
Diluted   (0.32)   (0.25)   1.55    0.53 
                 
WEIGHTED AVERAGE SHARES OR UNITS OUTSTANDING ('000s)                
Basic   93,616    88,832    90,878    83,155 
Diluted   93,61   88,832    92,272    83,155 

CONSOLIDATED STATEMENTS OF CASH FLOWS
(THOUSANDS OF CANADIAN DOLLARS, UNAUDITED)

    Three Months Ended   Year Ended
    Dec 31, Dec 31,   Dec 31,   Dec 31,
    2011  2010    2011    2010 
OPERATING                
Net earnings (loss)   (30,243)   (21,809)   142,821    44,395 
Adjustments:                
   Accretion   5,793    4,597    21,889    17,903 
   Depletion and depreciation   64,895    60,462    236,708    183,620 
   Impairments   64,400    19,840    64,400    19,840 
   Unrealized loss on derivative instruments   9,765    18,936    3,040    14,115 
   Equity based compensation   16,150    10,614    38,667    34,576 
   Unrealized foreign exchange loss   24,974    15,293    11,022    40,582 
   Remeasurement loss on liability associated with exchangeable shares         31,129 
   Unrealized other (income) expense   (562)   61    1,999    3,089 
   Deferred taxes   (18,289)   (9,832)   (46,210)   (31,720)
    136,883    98,162    474,336    357,529 
Asset retirement obligations settled   (7,559)   (5,110)   (23,071)   (6,861)
Changes in non-cash operating working capital   29,31   34,139    (4,173)   70,614 
Cash flows from operating activities   158,639    127,191    447,092    421,282 
                 
INVESTING                
Drilling and development   (129,478)   (103,592)   (411,227)   (414,152)
Exploration and evaluation   (22,773)   (1,843)   (79,553)   (18,030)
Property acquisitions   (12,777)     (50,878)   (448)
Sale of short-term investments     (3)     64,126 
Withdrawals from reclamation fund         812 
Changes in non-cash investing working capital   (15,989)   (14,770)   (6,068)   7,866 
Cash flows used in investing activities   (181,017)   (120,208)   (547,726)   (359,826)
                 
FINANCING                
(Decrease) increase in long-term debt   (36,001)   52,701    (150,001)   142,700 
Issuance of senior unsecured notes       220,561   
Issuance of shares or trust units pursuant                
   to the dividend or distribution reinvestment plans   16,802    13,467    59,081    40,824 
Cash dividends or distributions   (52,777)   (50,598)   (206,434)   (187,943)
Issuance of shares   252,00     252,004   
Cash flows from (used in) financing activities   180,02   15,570    175,211    (4,419)
Foreign exchange loss on cash held in foreign currencies   (6,194)   (4,399)   (825)   (11,243)
                 
Net change in cash and cash equivalents   151,456    18,154    73,752    45,794 
Cash and cash equivalents, beginning of period   83,05   142,601    160,755    114,961 
Cash and cash equivalents, end of period   234,50   160,755    234,507    160,755 
                 
Supplementary information for operating activities - cash payments                
   Interest paid   2,349    2,908    18,907    13,585 
   Income taxes paid   73,301    24,067    242,249    56,766 

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' (UNITHOLDERS') EQUITY
(THOUSANDS OF CANADIAN DOLLARS, UNAUDITED)

    Shareholders'
or Unitholders'
Capital
  Contributed
Surplus
  Accumulated
Other
Comprehensive
Loss
  Retained
Earnings
  Total
Shareholders'
or Unitholders'
Equity
Balances as at January 1, 2010   711,667        156,332    867,999 
Currency translation adjustments       (31,577)     (31,577)
Vesting of equity based awards   23,149          23,149 
Modification of equity based compensation from liability to equity     7,159        7,159 
Issuance of shares or units pursuant to the dividend or distribution reinvestment plan   40,824          40,824 
Equity based compensation expense     33,567        33,567 
Shares or units issued on conversion of exchangeable shares   249,121          249,121 
Units issued for bonus plan   1,009          1,009 
Net earnings         44,395    44,395 
Dividends or distributions declared         (189,744)   (189,744)
Balances as at December 31, 2010   1,025,770    40,726    (31,577)   10,983    1,045,902 
                     
    Shareholders'
Capital
  Contributed
Surplus
  Accumulated
Other
Comprehensive
Loss
  Retained
Earnings
(Deficit)
  Total
Shareholders'
Equity
Balances as at January 1, 2011   1,025,770    40,726    (31,577)   10,983    1,045,902 
Currency translation adjustments       (1,810)     (1,810)
Vesting of equity based awards   22,139    (22,139)      
Issuance of shares, net of deferred taxes   254,786          254,786 
Issuance of shares pursuant to the dividend reinvestment plan   59,081          59,081 
Equity based compensation expense     37,881        37,881 
Shares issued for bonus plan   786          786 
Net earnings         142,821    142,821 
Dividends declared         (207,846)   (207,846)
Share-settled dividends on vested equity based awards   5,583        (5,583)  
Balances as at December 31, 2011   1,368,145    56,468    (33,387)   (59,625)   1,331,601 

DESCRIPTION OF EQUITY RESERVES

Shareholders' (Unitholders') capital
Represents the recognized amount for common shares or trust units when issued, net of equity issuance costs and deferred taxes. Prior to September 1, 2010, the equity instruments issued and outstanding were trust units.

Contributed surplus
Represents the recognized value of employee awards which are settled in shares. Once vested, the value of the awards is transferred to shareholders' capital.

Accumulated other comprehensive loss
Represents the cumulative income and expenses which are not recorded immediately in net earnings and are accumulated until an event triggers recognition in net earnings. Any such event would result in a change to both accumulated other comprehensive loss and retained earnings (deficit).  The current balance consists of currency translation adjustments resulting from translating financial statements of subsidiaries with a foreign functional currency to Canadian dollars at period end rates.

Retained earnings (deficit)
Represents the consolidated earnings less distributed earnings of Vermilion Energy Inc.

 

 

 

 

Vermilion Energy Inc.
3500, 520 3rd Avenue SW
Calgary, Alberta T2P 0R3
Phone: 1-403-269-4884
Fax: 1-403-476-8100
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