2007-03-09 06:03:53 -

We pay royalties to the owners of the mineral rights with whom we hold leases, including provincial governments. Overriding royalties are also paid to other parties according to contracts. In Alberta, where we produce the majority of our natural gas, a Crown royalty is invoiced on the Crown's share of production based on a monthly established Alberta Reference Price. The Alberta Reference Price is a monthly weighted average price of gas consumed in Alberta and natural gas exported from Alberta reduced for transportation and marketing allowances. For 2006, the Alberta

Reference Price averaged $6.22/Gj or about $6.56/mcf. There is a maximum rate of 30 percent for new gas and 35 percent on old gas. The vast majority of our gas production is from new natural gas. In the 2006 gas price environment, we were subject to the maximum rates. Natural gas cost allowance, low productivity and other incentive schemes serve to reduce our effective royalty rate.

The majority of our oil production is in Alberta and Saskatchewan. Royalty rates in both Alberta and Saskatchewan vary depending on the rate of production, oil prices and applicable incentives. For the year ended December 31, 2006, royalties totalled $258.3 million as compared to $175.7 million during the same period a year earlier. As a percentage of sales, royalties averaged 18.3 percent during 2006 as compared to 22 percent in the same period in 2005.

For 2006, royalties averaged $9.51/boe or approximately 18.3 percent of Canetic's total petroleum and natural gas sales price (before hedging) of $51.83/boe. This compares to $11.90/boe or 22.0 percent of average sales price reported for the same period in 2005 (2004 - $8.50/boe). The reduced effective royalty rate results from the acquisition of properties that carry a lower royalty burden.

For the three months ended December 31, 2006, royalties totalled $63.6 million as compared to $52.3 million during the same period a year earlier due to higher production volumes. During the fourth quarter, royalties as a percentage of sales averaged approximately 18.3 percent as compared to 16.9 percent in the third quarter.

OPERATING COSTS Operating Costs ($000s) 2006 2005 2004 ------------------------------------------------------------------------- Operating costs before unit-based compensation 249,623 125,448 98,001 Unit-based compensation: Cash expense 412 124 251 Accrued compensation 2,107 4,074 1,102 ------------------------------------------------------------------------- Total operating costs and unit-based compensation 252,142 129,646 99,354 ------------------------------------------------------------------------- ------------------------------------------------------------------------- $/boe before unit-based compensation $ 9.19 $ 8.49 $ 8.01 $/boe after unit-based compensation $ 9.28 $ 8.78 $ 8.12 ------------------------------------------------------------------------- -------------------------------------------------------------------------

Producing petroleum and natural gas involves many field activities including lifting the oil and natural gas to surface, as well as treating, processing, gathering and storing the commodities. Other costs involved in the production function include those incurred to operate and maintain the wells along with the leases and well equipment.

Assets most suitable for the trust environment are generally more mature with more predictable production profiles. Operating costs associated with these types of assets will generally be higher on a unit-of-production basis reflecting the amount of manpower, repairs and maintenance required to keep the wells on production and the recovery techniques utilized to extract the reserves.

Our operating costs net of processing fees and unit-based compensation, increased to $249.6 million compared to $125.4 million during the same period a year earlier (2004 - $98.0 million). On a unit-of-production basis, operating costs averaged $9.19/boe compared to $8.49/boe for the prior year (2004 - $8.01/boe). A general theme throughout the industry in 2005 and 2006 has been higher field service costs including higher energy and fuel costs, labour, trucking and other related mechanical services. These increases, combined with the operating cost structures inherited from acquisitions made, caused operating costs year-over-year to increase on a unit-of-production basis. In addition, certain assets within our portfolio, primarily in east central Alberta, are significantly more costly to operate. Although these assets increase our operating costs in total and on a per unit basis, they provide positive cash flow during a high commodity price cycle.

Production Expense Variance Analysis ($000s) % Change ------------------------------------------------------------------------- Reported operating costs - 2005 125,448 ------------------------------------------------------------------------- Increase due to production volumes 105,260 85 Increase due to increased costs 18,915 15 ------------------------------------------------------------------------- Total increase 124,175 100 ------------------------------------------------------------------------- Reported operating costs - 2006 249,623 ------------------------------------------------------------------------- -------------------------------------------------------------------------

During the fourth quarter, operating costs before unit-based compensation totalled $71.4 million or $9.67 per boe as compared to $32.9 million or $9.05 per boe in 2005. Our estimate of $8.50 - $9.50/boe operating costs for the fourth quarter was impacted by a plant turnaround at Acheson in October and cold weather and associated repairs and maintenance in November required to restore production. The increase also reflects cost pressures due to industry activity.

Canetic was also active in 2006 in completing operational activities associated with the EUB's guidelines for the suspension of existing wells, resulting in incremental costs incurred throughout the year.

Although operating costs year-over-year increased on a unit-of-production basis, we are committed to managing operational efficiencies and maximizing field netbacks in all areas where we do business. As we continue to experience higher field costs throughout our asset base, considerable effort and focus is being given to operational efficiencies which will control operating costs on a unit-of-production basis. To date, Canetic has been successful in maintaining control of our operational costs in a high priced operating environment and will continue to focus on doing so in 2007.

PETROLEUM AND NATURAL GAS TRANSPORTATION Transportation ($000s) 2006 2005 2004 ------------------------------------------------------------------------- Transportation expense 18,968 9,897 8,807 $/boe $ 0.70 $ 0.67 $ 0.72 ------------------------------------------------------------------------- -------------------------------------------------------------------------

Transportation costs are defined by the point of legal custody transfer of the commodity and are dependent upon the type of product being sold, location of the producing asset, availability of pipeline capacity and sales point of the product.

For crude oil, Canetic sells all of its production at the lease. The purchaser picks up the production at the lease and pays Canetic a price for the applicable crude type based upon a price posted at the appropriate market hub, less the transportation costs between that market hub and the lease. For natural gas, Canetic transports its natural gas from the plant gate to certain established market hubs such as AECO C in Alberta, at which point title transfers to the purchaser. In both cases, transportation costs associated with getting natural gas and clean marketable oil to the point of title transfer are shown separately as a transportation expense.

NETBACKS

Operating netbacks represent the profit margin associated with the production and sale of petroleum and natural gas. For 2006, our netbacks were influenced by our product mix, commodity prices, financial derivative losses, royalty rates, the appreciation in the Canadian dollar and higher operating costs.

------------------------------------------------------------------------- Cash Netbacks Per Unit Natural Of Production Oil Gas NGL's Total ------------------------------------------------------------------------- Conven- tional Heavy ($/bbl) ($/bbl) ($/mcf) ($/bbl) ($/boe) ------------------------------------------------------------------------- Sales Price 63.39 43.57 7.01 47.84 51.83 Less: Royalties 10.58 6.54 1.42 11.77 9.51 Operating costs 10.80 12.97 1.44 - 9.19 Transportation 0.24 0.23 0.22 0.25 0.70 ------------------------------------------------------------------------- Cash Netbacks Per Unit Of Production 41.77 23.83 3.93 35.82 32.43 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Components of our netbacks are as follows: Netbacks ($/boe) 2006 2005 2004 ------------------------------------------------------------------------- Petroleum and natural gas revenue 51.83 54.19 42.63 Less: Royalties 9.51 11.90 8.50 Operating costs 9.19 8.49 8.01 Transportation 0.70 0.67 0.72 ------------------------------------------------------------------------- Cash net operating income 32.43 33.13 25.40 General and administrative 1.46 1.46 1.39 Interest on long term debt 1.98 0.93 0.98 Interest on convertible debentures 0.32 0.30 0.37 Realized loss on financial derivatives 0.31 5.43 3.21 Capital tax 0.64 0.54 0.21 ------------------------------------------------------------------------- Cash netback from operations 27.72 24.47 19.24 Non-cash unit-based compensation 0.62 1.90 0.74 Depletion, depreciation and amortization 23.76 15.82 14.68 Accretion 0.42 0.31 0.25 Unrealized (gain) loss on financial derivatives (3.51) 1.40 0.91 Future income taxes (recovery) (1.78) 0.58 0.10 ------------------------------------------------------------------------- Net earnings 8.21 4.46 2.56 ------------------------------------------------------------------------- ------------------------------------------------------------------------- GENERAL AND ADMINISTRATIVE EXPENSES General and Administrative Expenses ($000s) 2006 2005 2004 ------------------------------------------------------------------------- G&A expenses 60,631 31,885 21,356 Overhead recoveries (20,925) (10,299) (4,343) ------------------------------------------------------------------------- Cash G&A expenses before unit-based compensation 39,706 21,586 17,013 Unit-based compensation: Cash expense 2,336 695 1,421 Accrued compensation 11,941 23,091 6,242 ------------------------------------------------------------------------- Total G&A and unit-based compensation 53,983 45,372 24,676 ------------------------------------------------------------------------- ------------------------------------------------------------------------- $/boe before unit-based compensation $ 1.46 $ 1.46 $ 1.39 $/boe after unit-based compensation $ 1.99 $ 3.07 $ 2.02 ------------------------------------------------------------------------- -------------------------------------------------------------------------

General and administrative expenses net of overhead recoveries and unit-based compensation totalled $39.7 million in 2006, as compared to $21.6 million in 2005 (2004 - $17.0 million). On a unit-of-production basis, general and administrative expenses averaged $1.46/boe as compared to $1.46/boe for the same period in 2005 (2004 - $1.39/boe).

During 2006, we increased our head office staff in order to properly manage our business. The level of activity in the trust sector increased the cost of hiring qualified candidates and retaining existing employees and consultants. In 2006, approximately 66 percent of our total general and administrative expenses were labour related, including salary, benefits and consulting fees.

For the three months ended December 31, 2006, general and administrative expenses increased slightly to $1.62 per boe (net of unit-based compensation), reflecting costs associated with hiring additional permanent staff, leasing additional office space and integrating the assets acquired during the third quarter.

Unit-based Compensation

On December 19, 2005, the unitholders of Canetic approved a unit award incentive plan. The plan authorizes the Board of Directors to grant rights to acquire up to five percent of the trust units outstanding to directors, officers, employees and consultants of the Trust and its affiliates. These rights consist of Restricted Trust Units ("RTU's") and Performance Trust Units ("PTU's"). The number of PTU's granted is dependent on the performance of the Trust relative to a peer comparison group of petroleum and natural gas trusts and other companies or other criteria the Board of Directors may determine. A holder of an RTU or PTU may elect, subject to consent of the Trust, to receive cash upon vesting in lieu of the number of units to be issued. The plan provides for adjustments to the number of units issued based on the cumulative distributions of the Trust during the period that the RTU or PTU is outstanding.

The compensation issued upon vesting of the PTU's is dependant upon the performance of the Trust compared to its peers. The performance multiplier is based on our percentile rank of total unitholder return compared to a select group of peers approved by the Board of Directors. Total return is calculated as the sum of the change in market price plus distributions in the period divided by the opening market price. The performance multiplier ranges from zero, where our total return is less than the 35th percentile, to two, if our performance exceeds the 75th percentile.

For the year ended December 31, 2006, the Trust recorded a compensation expense of $16.8 million (2005 - $28.0 million) and capitalized unit-based compensation of $3.4 million (2005 - $11.0 million). Upon vesting, the obligation may be settled in units or cash, therefore, the amounts due in the next year of $7.3 million (2005 - $40.8 million) has been classified as a current liability. The compensation liability is remeasured each period at the current market price. The December 31, 2006 compensation liability was based on the period-end closing price of $16.44 and the number of RTU's and PTU's outstanding at that time and the number of PTU's expected to vest using a PTU multiplier of 0.6.

As of December 31, 2006, there were 915,916 RTU's and 1,386,377 PTU's outstanding.

INTEREST EXPENSE ON LONG-TERM DEBT Interest Expense ($000s) 2006 2005 2004 ------------------------------------------------------------------------- Interest expense 53,809 13,752 12,054 Bank loans, December 31 1,289,678 309,146 283,845 Debt to funds flow 1.7 0.9 1.2 ------------------------------------------------------------------------- -------------------------------------------------------------------------

Interest expense, representing interest on bank debt increased to $53.8 million or $1.98 per boe from $13.8 million or $0.93 per boe a year earlier (2004 - $12.1 million or $0.98/boe). In addition to slightly higher interest rates due to increases in the Bank of Canada lending rate in 2006, average debt levels have increased as a result of the corporate and property acquisitions made during the year. At December 31, 2006, $1.29 billion was drawn under our facility. Although interest rates continue to be favourable and are not expected to increase substantially in the short-term, interest expense in future periods will reflect our higher debt levels. Average interest rates incurred by Canetic during 2006 averaged approximately 5.1 percent.

INTEREST EXPENSE ON CONVERTIBLE DEBENTURES

Interest expense on convertible debentures totalled $8.6 million for the year ended December 31, 2006 as compared to $4.4 million for the same period in 2005. During the year, debentures totaling $230.0 million were issued in conjunction with the Samson acquisition. At December 31, 2006, debentures totaling $263.2 million remain outstanding.

For the three months ended December 31, 2006, interest expense increased to $19.6 million reflecting the increased debt levels incurred to finance the Samson acquisition.

INTEREST RATE RISK MANAGEMENT

Canetic has assumed through the StarPoint arrangement, fixed interest rate swaps between January 6, 2006 and September 30, 2007 covering $40.0 million of principal, with interest rates varying between 3.58 percent and 3.65 percent, plus a stamping fee. The fair value of the fixed interest swaps at December 31, 2006 was a gain of approximately $0.3 million.

DEPLETION, DEPRECIATION AND AMORTIZATION

The current year provision for depletion, depreciation and amortization totalled $645.2 million as compared to $233.7 million in 2005 (2004 - $179.6 million). On a unit-of-production basis, depletion, depreciation and amortization costs averaged $23.76 per boe as compared to $15.82 per boe in 2005 (2004 - $14.68/boe). The increase in the 2006 depletion rate results from the assets acquired in 2006.

UNREALIZED LOSS ON FINANCIAL DERIVATIVES

Accounting standards require that we determine the fair value of our financial contracts and record a liability or asset at the end of each accounting period. Any changes in the fair value of the financial contracts are included in net earnings for the period. At December 31, 2006, we recorded a current financial derivative liability of $1.1 million and a long-term financial derivative asset of $6.2 million. The estimated fair value is based on a mark-to-market calculation as at December 31, 2006 to settle the financial contracts. The actual gain or loss realized upon settlement could vary significantly due to fluctuations in commodity prices. At December 31, 2006, Canetic recorded an unrealized financial derivative gain of $95.4 million (2005-loss of $20.6 million) which represents the change in the mark-to-market calculations from December 31, 2005.

Gain (Loss) On Financial Derivatives ($000s) 2006 2005 ------------------------------------------------------------------------- Realized cash loss on financial derivatives (8,465) (80,157) Unrealized gain (loss) on financial derivatives 95,371 (20,635) ------------------------------------------------------------------------- Gain (loss) on financial derivatives 86,906 (100,792) ------------------------------------------------------------------------- ------------------------------------------------------------------------- ASSET RETIREMENT OBLIGATIONS

The total future asset retirement obligation was estimated by management based on the Trust's net ownership interest in all wells and facilities, estimated costs to reclaim and abandon the facilities and the estimated timing of the costs to be incurred in future periods. The costs are expected to be incurred over an average of 15 years. The estimated cash flow has been calculated using a credit adjusted risk free discount rate of 8 percent and an inflation rate of 2 percent.

As of December 31, 2006, the amount to be recorded as the fair value of the liability was estimated to be $191.9 million (December 31, 2005 - $68.2 million). During this year, Canetic incurred $16.9 million (2005 - $6.3 million) of actual abandonment and reclamation costs and recorded accretion of $11.4 million (2005 - $4.6 million).

INCOME TAXES Future Income Taxes

Future income taxes arise from differences between the accounting and tax bases of assets and liabilities of certain operating subsidiaries of the Trust. The future taxes recorded on the balance sheet are expected to be recovered over time through interest and/or royalty payments to the Trust from its operating subsidiaries. The Trust is a taxable entity under Canadian tax law and is subject to cash taxes only to the extent that income is not distributed or distributable to its unitholders. As the Trust is required to distribute all of its taxable income to unitholders, the Trust is not expected to be subject to current or future income taxes.

For the period ended December 31, 2006, a future tax recovery of $48.3 million was included in income compared to a future tax expense of $8.6 million in 2005. The change year-over-year was mainly due to a significant increase in temporary differences arising from the acquisition of StarPoint Energy Trust, increased depletion on recognition of purchase price increments. Also, reductions to future corporate tax rates were enacted during the year by Federal, Alberta and Saskatchewan governments resulting in a future tax recovery of $32 million. These were offset by a future tax expense of $33.6 million related to unrealized hedging gains.

On October 31, 2006, the Federal Government announced a proposal to introduce a new tax on publicly traded income trusts beginning in 2011. On December 21, 2006, draft legislation to implement these proposals was released for comment. If the legislation becomes enacted as currently proposed, the Trust will effectively become subject to tax on earnings in excess of available tax pools, in a similar manner as a corporation. It is anticipated that future taxes would be then be adjusted to include temporary differences between accounting and tax bases of assets and liabilities at the Trust level.

Current Income Taxes

In general, both current and future income taxes are transferred to the unitholder level through various interest and/or royalty payments. There are some corporate entities in the underlying structure which hold minority interests in some of the Trust's operating partnerships which subject them to a small amount of current income tax. The Trust has provided $2 million in this respect for the current year and $4 million in respect of prior periods.

Capital Taxes

Federal Large Corporations Tax was eliminated effective January 1, 2006 and thus no amount is provided for federal capital taxes in respect of 2006.

The Trust has recorded $12 million of capital tax for the year, of this amount, $11 million relates to the Saskatchewan Resource Surcharge and is higher compared to the previous year due to an increase in oil and gas revenue earned in the Province of Saskatchewan, a result of the significant number of Saskatchewan properties added through the StarPoint acquisition.

Estimated Income Tax Pools ($000s) December 31, 2006 ------------------------------------------------------------------------- Undepreciated capital costs 505,232 Canadian oil and gas property expenses 611,509 Canadian exploration expenses 2,966 Canadian development expenses 285,662 Non-capital losses 276,270 Financing charges 48 ------------------------------------------------------------------------- Total estimated income tax pools 1,681,687 ------------------------------------------------------------------------- ------------------------------------------------------------------------- CAPITAL EXPENDITURES

Petroleum and natural gas reserves are a non-renewable resource. As they are produced, our objective is to replace those reserves through a combination of property acquisitions and internal drilling opportunities. In 2005 and 2006, we have continued to increase our focus on upgrading the quality of our asset base through acquisition, exploiting our reserve base, drilling new wells and optimizing existing production.

Capital Expenditures ($000s) 2006 2005 2004 ------------------------------------------------------------------------- Land 14,868 13,361 3,792 Geological and geophysical 2,783 3,139 1,067 Drilling and completion 215,593 100,182 56,493 Production equipment and facilities 118,044 55,539 30,418 ------------------------------------------------------------------------- Net development expenditures 351,288 172,221 91,770 Major acquisitions StarPoint 2,511,746 - - Samson 924,635 - - Producing properties 23,869 - 477,168 Minor property acquisitions 32,416 13,554 10,447 Minor property dispositions (17,167) (4,610) (9,280) ------------------------------------------------------------------------- Net capital expenditures 3,826,787 181,165 570,105 Office 8,134 4,667 3,609 Asset retirement obligation - change in estimate 56,537 11,319 13,043 Asset retirement obligation - Samson 18,228 - - Capitalized non-cash compensation 3,365 11,016 - Other non-cash 11,000 - - ------------------------------------------------------------------------- Total capital expenditures 3,924,051 208,167 586,757 ------------------------------------------------------------------------- -------------------------------------------------------------------------

During 2006, expenditures for exploration and development activities totalled $351.3 million as compared to $172.2 million in 2005 (2004 - $91.8 million). A total of 378 gross (174.4 net) wells were drilled during the year, including 115 gross (48.8 net) wells in the fourth quarter, compared to 82 gross (52.4 net) wells during the fourth quarter 2005 resulting in 161 gross (81.9 net) oil wells and 205 gross (85.4 net) natural gas wells. The increase reflects the larger opportunity associated with our assets as a result of the acquisitions made in 2006. Of the total wells drilled in 2006, 102 gross (90.6 net) were operated by Canetic resulting in 64 gross (58.0 net) oil wells and 32 gross (26.9 net) natural gas wells.

The Trust also completed two major acquisitions in 2006 totalling $3.5 billion. The StarPoint transaction was completed by way of a Plan of Arrangement whereby unitholders of Acclaim received 0.8333 units of Canetic for each unit held and unitholders of StarPoint received one Canetic unit for each unit held. Costs associated with the transaction were financed through our bank facility. The merger was strategic in that it provided unitholders with a high quality asset base; a reserve base in excess of 230 million boe on a proved plus probable basis; a reserve life index in excess of 9 years; a diversified production base weighted 60 percent towards primarily light oil and a high quality low risk development drilling program.

On August 31, 2006, we closed the Samson acquisition which included properties in British Columbia and central Alberta. We acquired approximately 13,500 boe/d of production, 40.1 million boe of proved plus probable reserves and 230,000 net acres of undeveloped land. The acquisition was financed by the issuance of 20.8 million trust units for net proceeds of $437 million, as well as $230.0 million principal ($220.8 million net) of 6.5% convertible, extendible, unsecured, subordinated debentures. The balance of the transaction was financed with bank debt. In addition, we also acquired approximately $87 million of working capital including $77 million of cash which was financed with long-term debt.

Sources Of Funding Net Capital Expenditures Acquisitions Net -------------------------------- Development StarPoint Samson Other Total ------------------------------------------------------------------------- ($million) Net Capital Expenditures $ 351.3 $ 2,511.7 $ 924.6 $ 39.2 $ 3,826.8 ------------------------------------------------------------------------- Percentage funded by: Cashflow 47% - - - 5% DRIP 14% - - - 1% Issuance of equity - 99% 47% - 77% Issuance of debentures - - 24% - 6% Bank debt 39% 1% 29% 100% 11% ------------------------------------------------------------------------- 100% 100% 100% 100% 100% ------------------------------------------------------------------------- ------------------------------------------------------------------------- GOODWILL

The Trust recognizes goodwill on corporate acquisitions when the total purchase price exceeds the fair value of the net identifiable assets and liabilities of the acquired entity. Goodwill is tested annually at year-end for impairment or as events occur that could result in impairment. Impairment is recognized and charged to income in the period in which the impairment occurs when the fair value of the Trust is less than the book value of the Trust. A write down of goodwill was not required at December 31, 2006 or 2005.

The goodwill balance of $943.8 million arose primarily as a result of the StarPoint acquisition in 2006. The balance was determined based on the excess of total consideration plus the future income tax liability less the fair value of the assets acquired for accounting purposes.

LIQUIDITY AND CAPITAL RESOURCES

As an oil and gas trust we have a declining asset base and therefore rely on acquisitions and ongoing development activities to mitigate production and reserve declines. Future production volumes and reserves are highly dependent on our success in exploiting our asset base and acquiring addition reserves.

The increase in capital expenditures in 2006 reflects both the costs associated with maintaining the larger producing asset base we now have, as well as the execution of growth programs that continue to be developed as we increase our operational knowledge of the properties acquired over the past three years.

We finance our operations and capital activities primarily with funds generated from operating activities, but also through the issuance of trust units, debentures and borrowings from our credit facility. The amount of equity we raise through the issuance of trust units depends on many factors including projected cash needs, availability of funding through other sources, our unit price and the state of the capital markets. We believe our sources of cash, including bank debt, will be sufficient to fund our operations and anticipated capital expenditure program in 2007 as well as make monthly distribution payments. Our ability to fund will also depend on performance and is subject to commodity prices and other economic conditions which are beyond our control.

In August 2006, in connection with the Samson acquisition, Canetic completed a $690 million bought deal equity and debenture issue. The net proceeds of $657.8 million in addition to bank borrowings under our credit facility were utilized to fund the acquisition. In addition, Canetic purchased working capital at May 31, 2006, of $89.1 million by drawing upon its bank facility. Working capital included approximately $77 million of cash. Under the terms of the agreement Canetic will be kept whole in the event of uncollectability or valuation of working capital.

Canetic's capital structure at December 31, 2006 is reconciled as follows: 2006 2005 ($000s except per unit amounts) Amount % $/unit Amount % $/unit ------------------------------------------------------------------------- Debt Bank debt 1,289,678 25 5.71 309,146 27 3.38 Working capital deficiency 29,794 1 0.13 74,466 6 0.81 ------------------------------------------------------------------------- Net debt 1,319,472 26 5.84 383,612 33 4.19 Convertible debentures 258,959 5 1.15 16,289 1 0.18 Unitholders' equity 3,506,915 69 15.53 764,583 66 8.35 ------------------------------------------------------------------------- Total capitalization 5,085,346 100 22.52 1,164,484 100 12.72 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Bank Debt

Canetic has an unsecured covenant based credit facility with a syndicate of financial institutions in the amount of $1.6 billion including a $50.0 million operating facility. The facility carries floating interest rates which range between 65.0 and 115.0 basis points over Banker's Acceptance rates. This facility was increased in the third quarter from $1.1 billion upon closing of the Samson acquisition. The loan has a maturity date of May 31, 2009 and is reviewed annually and may be extended at the option of the lender for an additional 1 year period. The loan has therefore been classified as long-term on the balance sheet.

At December 31, 2006, $1.29 billion was drawn under the facility. Working capital liquidity is maintained by drawing from and repaying the unutilized credit facility as needed. At December 31, 2006, Canetic had a working capital deficiency of $29.8 million including a financial derivative liability of $1.1 million. The increase in bank debt year over year includes $293.5 million drawn on the facility related to the acquisition of Samson which closed on August 31, 2006. As part of this acquisition, Canetic acquired $89.1 million of working capital including $77 million of cash at May 31, 2006.

Our net debt at December 31, 2006 and 2005 is reconciled as follows: December 31, 2006 December 31, 2005 ------------------------------------------------------------------------- Star- ($000s) Acclaim Point(1) Total ------------------------------------------------------------------------- Bank debt 1,289,678 309,146 434,123 743,269 Working capital deficiency 29,794 45,630 101,477 147,107 ------------------------------------------------------------------------- Net debt 1,319,472 354,776 535,600 890,376 ------------------------------------------------------------------------- ------------------------------------------------------------------------- (1) As at closing, January 5, 2006 Convertible Debentures

As at December 31, 2006, we had convertible debentures outstanding of $260.7 million. The debentures consist of the StarPoint 9.4% convertible, unsecured, subordinated debentures; StarPoint 6.5% convertible, extendible, unsecured, subordinated debentures; Acclaim 8% convertible, extendible, unsecured, subordinated debentures; Acclaim 11% convertible, extendible, unsecured, subordinated debentures and Canetic 6.5% convertible, extendible, unsecured, subordinated debentures. The StarPoint debentures are described further below.

The debentures are convertible into Canetic trust units at the following conversion prices:

- StarPoint 9.4% Debentures (CNE.DB.A) - $16.02. Each $1,000 principal amount of 9.4% Debentures is convertible into approximately 62.42 Canetic trust units; - StarPoint 6.5% Debentures (CNE.DB.B) - $18.96. Each $1,000 principal amount of StarPoint 6.5% Debentures is convertible into approximately 52.74 Canetic trust units; - Acclaim 8% Debentures (CNE.DB.C) - $15.56. Each $1,000 principal amount of 8% Debentures is convertible into approximately 64.27 Canetic trust units; - Acclaim 11% Debentures (CNE.DB.D) - $11.24. Each $1,000 principal amount of 11% Debentures is convertible into approximately 88.97 Canetic trust units; and - Canetic 6.5% Debentures (CNE.DB.E) - $26.55. Each $1,000 principal amount of Canetic 6.5% Debentures is convertible into approximately 37.66 Canetic trust units.

The following table is a summary of the dollar value of issuances and conversions of the convertible debentures:

------------------------------------------------------------------------- ($000s) 9.4% 6.5% 8% ------------------------------------------------------------------------- (CNE.DB.A) (CNE.DB.B) (CNE.DB.C) Balance, December 31, 2004 $ - $ - $ 72,901 Converted to units - (59,330) ------------------------------------------------------------------------- Balance, December 31, 2005 - - 13,571 Acquisition of StarPoint 9,255 43,944 - Samson acquisition - - - Converted to units (3,633) (26,123) (5,525) ------------------------------------------------------------------------- Balance, December 31, 2006 $ 5,622 $ 17,821 $ 8,046 ------------------------------------------------------------------------- ------------------------------------------------------------------------- ($000s) 11% 6.5% ------------------------------------------------------------------------- (CNE.DB.D) (CNE.DB.E) Total Balance, December 31, 2004 $ 6,562 $ - $ 79,463 Converted to units (3,844) (63,174) ------------------------------------------------------------------------- Balance, December 31, 2005 2,718 - 16,289 Acquisition of StarPoint - - 53,199 Samson acquisition - 227,470 227,470 Converted to units (1,021) - (36,302) ------------------------------------------------------------------------- Balance, December 31, 2006 $ 1,697 $ 227,470 $ 260,656 ------------------------------------------------------------------------- ------------------------------------------------------------------------- (000s) 9.4% 6.5% 8% ------------------------------------------------------------------------- Units Issuable Upon Conversion (CNE.DB.A) (CNE.DB.B) (CNE.DB.C) Balance, December 31, 2004 - - 5,401 Converted to units - - (4,395) ------------------------------------------------------------------------- Balance, December 31, 2005 - - 1,006 Adjustment to conversion ratio - - (135) Acquisition of StarPoint 576 2,313 - Samson acquisition - - - Converted to units (225) (1,373) (354) ------------------------------------------------------------------------- Balance, December 31, 2006 351 940 517 ------------------------------------------------------------------------- ------------------------------------------------------------------------- (000s) 11% 6.5% ------------------------------------------------------------------------- Units Issuable Upon Conversion (CNE.DB.D) (CNE.DB.E) Total Balance, December 31, 2004 672 - 6,073 Converted to units (394) - (4,789) ------------------------------------------------------------------------- Balance, December 31, 2005 278 - 1,284 Adjustment to conversion ratio (36) - (171) Acquisition of StarPoint - - 2,889 Samson acquisition - 8,663 8,663 Converted to units (90) - (2,042) ------------------------------------------------------------------------- Balance, December 31, 2006 152 8,663 10,623 -------------------------------------------------------------------------

On August 24, 2006, Canetic issued $230.0 million principal amount of 6.5% convertible, extendible, unsecured, subordinated debentures to partially fund the Samson acquisition. The conversion feature was valued at $2.5 million which has been allocated to equity. The debentures have a face value of $1,000 per debenture, a coupon of 6.5%, a maturity date of December 31, 2011 and are convertible at any time, at the option of the holder, into the trust units of Canetic at a conversion price of $26.55 per trust unit. The Trust may redeem the debentures in whole or in part at a redemption price of $1,050 per debenture after December 31, 2009 and at a redemption price of $1,025 per debenture after December 31, 2010 and before the maturity date.

On June 15, 2004, Acclaim issued $75.0 million principal amount of 8% convertible, extendible, unsecured, subordinated debentures. The debentures have a face value of $1,000 per debenture, a coupon of 8.0%, a maturity date of August 31, 2009 and are convertible at any time, at the option of the holder, into trust units of Canetic at a price of $15.56 per trust unit. The Trust may redeem the debentures in whole or in part at a redemption price of $1,050 per debenture after August 31, 2007 and at a redemption price of $1,025 per debenture after August 31, 2008 and before the maturity date.

In December 2002, Acclaim issued $45.0 million principal amount of 11% convertible, extendible, unsecured, subordinated debentures. The debentures have a face value of $1,000 per debenture, a coupon of 11%, a maturity date of December 31, 2007 and are convertible at any time, at the option of the holder, into trust units of Canetic at a price of $11.24 per trust unit. The Trust may redeem the debentures in whole or in part at a redemption price of $1,025 per debenture before the maturity date.

Convertible Debentures Assumed on Acquisition of StarPoint

StarPoint issued $60.0 million of 6.5% convertible, extendible, unsecured, subordinated debentures (the "StarPoint 6.5% Debentures") on May 26, 2005. The StarPoint 6.5% Debentures mature on July 31, 2010 and are convertible at any time, at the option of the holder, into the trust units of Canetic at a conversion price of $18.96 per trust unit. The StarPoint 6.5% Debentures are not redeemable at the option of the Trust on or before July 31, 2008. After July 31, 2008, and prior to the maturity date, the StarPoint 6.5% Debentures may be redeemed in whole or in part, at a price of $1,050 per debenture after July 31, 2008 and after July 31, 2009 at a price of $1,025 per debenture.

In connection with the StarPoint/APF Energy Trust Combination, and pursuant to a debenture agreement dated June 27, 2005, the 9.4% Debentures were assumed by StarPoint. The 9.4% unsecured, subordinated, convertible debentures are convertible at the holder's option into fully paid and non-assessable trust units of Canetic at any time prior to July 31, 2008 at a conversion price of $16.02 per trust unit. The 9.4% Debentures are redeemable at $1,050 per 9.4% Debenture, in whole or in part, after July 31, 2006 and redeemable at $1,025 per debenture after July 31, 2007 and before maturity.

Trust Unit Capital

As at December 31, 2006, we had issued capital of 225.8 million units and as at March 7, 2007, we had issued capital of 226.6 million units. If all the outstanding convertible debentures were converted into units, a total of 236.4 million units would have been outstanding as at December 31, 2006 and 237.2 million units as at March 7, 2007.

The merger of Acclaim and StarPoint on January 5, 2006, occurred pursuant to a Plan of Arrangement in which Canadian unitholders could elect to exchange their units on a tax-deferred basis. Each Acclaim unitholder received 0.8333 of a Canetic trust unit for each unit held and each StarPoint unitholder received 1.0000 Canetic trust unit for each unit they held. A total of 106.2 million units were issued pursuant to the arrangement. Also pursuant to the Arrangement, all exchangeable shares were exchanged for trust units.

a) Trust Units 2006 2005 ------------------------------------------------------------------------- Units Units (000s) Amount (000s) Amount ------------------------------------------------------------------------- Balance, beginning of year 91,583 $ 1,087,459 86,313 $ 1,003,294 Issued for cash: Acquisition of Samson, net of costs 20,769 437,001 - - Pursuant to equity offering, net of costs - - - (350) Employee Unit Savings Plan 274 6,184 89 1,646 Distribution reinvestment plan 2,470 44,825 456 8,492 Issued pursuant to Arrangement 106,242 2,562,563 - - Properties contributed to TriStar - (5,000) - - Conversion of debentures 2,042 36,302 3,990 63,174 Conversion of debentures - equity portion - 4,636 - - Conversion of exchangeable shares 358 3,804 357 4,033 Unit award incentive plan 2,058 46,696 378 7,170 ------------------------------------------------------------------------- Balance, end of year 225,796 $ 4,224,470 91,583 $ 1,087,459 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Units Amount (000s) ($000s) (Restated b) Exchangeable Shares - Note 1) ------------------------------------------------------------------------- Balance, December 31, 2004 673 7,837 Shares exchanged (357) (4,033) Adjustment to exchange ratio for distributions 42 - ------------------------------------------------------------------------- Balance, December 31, 2005 358 3,804 Shares exchanged (358) (3,804) ------------------------------------------------------------------------- Balance, December 31, 2006 - - ------------------------------------------------------------------------- ------------------------------------------------------------------------- Funds Flow from Operations

Funds flow from operations as presented is not intended to represent operating cash flow or operating profits for the period nor should it be viewed as an alternative to cash flow from operating activities, net earnings or other measures of financial performance calculated in accordance with GAAP.

Funds flow from operations is reconciled as follows: Funds Flow ($000s) 2006 2005 2004 ------------------------------------------------------------------------- Net Earnings 223,101 65,848 31,263 ------------------------------------------------------------------------- Adjustments for: Unit-based compensation expense 14,049 27,166 7,344 Depletion, depreciation and amortization 645,203 233,693 179,557 Accretion 11,410 4,560 3,045 Unrealized gain on financial derivatives (95,371) 20,635 11,093 Future income taxes (48,246) 8,573 1,171 ------------------------------------------------------------------------- Funds flow from operations 750,146 360,475 233,473 ------------------------------------------------------------------------- Unitholder's equity 3,506,915 764,583 780,980 -------------------------------------------------------------------------

For the year ended December 31, 2006, funds flow from operations totalled $750.1 million or $3.57 per diluted unit, representing a 108 percent increase from the $360.5 million, or $3.98 per diluted unit during the same period in 2005 (2004 - $233.5 million or $3.09 per diluted unit). The increase is due to higher production levels associated with the StarPoint and Samson acquisitions. Our 2006 funds flow included a realized loss on financial derivative contracts of $8.5 million ($0.04 per diluted unit) as compared to a loss of $80.2 million ($0.88 per diluted unit) in 2005.

Funds flow for the fourth quarter was $170.1 million or $0.75 per diluted unit as compared to $106.5 million or $1.15 per diluted unit during the same quarter in 2005 (2004 - $73.8 million or $0.84 per diluted unit). The increase is attributable to an increase in production due to the StarPoint and Samson acquisitions.

We believe that funds generated from our operations, together with borrowings under our credit facility and proceeds from property dispositions, will be sufficient to finance our operations and planned capital expenditure program. During 2006, funds flow in excess of distributions funded 47 percent of our capital expenditure program. Our dividend reinvestment program plus additional bank borrowings funded the remaining 53 percent or $186.2 million. We anticipate that our annual capital expenditures over the next few years will be similar to our capital expenditures in fiscal 2006. We establish our capital expenditure program based on an annual budget review process, including budgeted cash flow from operations, and we closely monitor changes throughout the year.

Cash Distributions

Canetic declared cash distributions of $583.5 million ($2.76/unit), representing 78 percent of 2006 funds flow from operations compared to cash distributions of $208.5 million ($2.34/unit), representing 58 percent of funds flow from operations in 2005. The remaining 22 percent of funds flow in 2006 was utilized to fund 47 percent of Canetic's 2006 capital program.

Effective with the merger with StarPoint, Canetic set its monthly distribution at $0.23 per unit per month beginning with distributions payable on February 15, 2006. This represented an 18 percent increase to former Acclaim unitholders and a five percent increase to former StarPoint unitholders.

($000s, except where indicated) 2006 2005 2004 ------------------------------------------------------------------------- Funds flow from operations 750,146 360,475 233,473 Total distributions 583,528 208,477 176,741 Distributions per unit ($) 2.76 2.34 2.34 Payout ratio (%) 78% 58% 74% ------------------------------------------------------------------------- -------------------------------------------------------------------------

In aggregate our distributions and net capital expenditure program totalled approximately $4.4 billion or approximately 586% of our 2006 cash flow of $750.1 million. We fund our distributions and capital expenditure programs with cash flow, but also supplement growth and fund acquisitions with long-term debt and equity.

We distribute a portion of the funds flow from operations to our Trust unitholders on a monthly basis with a portion withheld to initially repay bank debt and ultimately fund capital expenditures. Although the level of funds retained for capital expenditures and/or debt repayment typically varies, we monitor our distribution policy with respect to forecasted funds flows from operations, debt levels, spending plans and taxability.

Our 2006 distributions are summarized as follows: Value of Units Number Total Distri- Issued of DRIP ($000, except Distri- butions under Units Unit where indicated) butions Paid DRIP Issued Price ------------------------------------------------------------------------- Distributions declared: December 2006 51,933 47,793 4,140 284,172 $ 14.57 November 2006 51,848 46,743 5,104 330,490 $ 15.44 October 2006 51,739 45,419 6,321 424,474 $ 14.90 September 2006 51,642 45,289 6,353 374,054 $ 16.98 August 2006 51,577 47,029 4,548 225,495 $ 20.18 July 2006 46,699 41,236 5,463 252,973 $ 21.61 June 2006 46,583 42,538 4,045 189,023 $ 21.40 May 2006 46,516 42,570 3,946 184,238 $ 21.48 April 2006 46,439 43,175 3,264 145,356 $ 22.46 March 2006 46,272 43,230 3,042 130,570 $ 23.29 February 2006 46,208 43,629 2,579 119,674 $ 21.55 January 2006 46,072 46,000 72 3,175 $ 22.70 -------------------------------------------------------------- Total 583,528 534,651 48,877 2,663,694 -------------------------------------------------------------- --------------------------------------------------------------

In light of the weaker short-term outlook for commodity prices, Canetic announced on January 15, 2007 that it would reduce the monthly distribution in order to increase the level of cash flow available to fund drilling and development opportunities, bring Canetic's payout ratio in line with the Trust's long-term target of 60 to 70 percent of funds flow from operations, and prudently manage the level of Canetic's long-term debt. The regular monthly distribution was fixed at $0.19 per trust unit, commencing with the January 31, 2007 distribution paid on February 15, 2007.

For the year ended December 31, 2006, we declared distributions of $583.5 million ($2.76 per unit) which represented 78 percent of funds flow from operations as compared to cash distributions of $208.5 million ($2.34 per unit) representing a 58 percent payout ratio in 2005.

For the three months ended December 31, 2006, our payout ratio increased to 91 percent as we generated $170.1 million of funds flow from operations and distributed $155.5 million.

CONTRACTUAL OBLIGATIONS

In addition to financial derivative commitments, the Trust has the following contractual obligations as at December 31, 2006:

------------------------------------------------------------------------- ($000s) Total 2007 2008 2009 2010 2011 Thereafter ------------------------------------------------------------------------- Credit facility 1,289,678 - - - - - 1,289,678 Convertible debentures 260,656 1,697 5,622 8,046 17,821 227,740 - Office lease 24,659 6,415 6,295 6,295 3,231 2,423 - Pipeline contract 6,116 636 802 814 877 823 2,164 ------------------------------------------------------------------------- Total 1,581,109 8,748 12,719 15,155 21,929 230,986 1,291,842 ------------------------------------------------------------------------- ------------------------------------------------------------------------- TAXATION OF CASH DISTRIBUTIONS

The following sets out a general discussion of the Canadian and U.S. tax consequences of holding Canetic units as capital property. The summary is not exhaustive in nature and is not intended to provide legal or tax advice. Unitholders or potential unitholders should consult their own legal or tax advisors as to their particular tax consequences.

CANADIAN TAXPAYERS

The Trust qualifies as a mutual fund trust under the Income Tax Act (Canada) and, accordingly, trust units are qualified investments for RRSP's, RRIF's, RESP's and DPSP's. Each year, the Trust is required to file an income tax return and any taxable income of the Trust is allocated to unitholders.

Unitholders are required to include in computing income their pro-rata share of any taxable income earned by the Trust in that year. An investor's adjusted cost base ("ACB") in a trust unit equals the purchase price of the unit less any non-taxable cash distributions received from the date of acquisition. To the extent the unitholders' ACB is reduced below zero, such amount will be deemed to be a capital gain to the unitholder and the unitholders' ACB will be brought to nil.

Canetic paid $2.76 per trust unit in cash distributions to unitholders during the period February 2006 to January 2007. For Canadian tax purposes, 100 percent of these distributions are taxable as other income. During the same period in 2005, the Trust paid $1.95 per trust unit in cash distributions, of which 31.28 percent was a tax-deferred return of capital and 68.72 percent taxable.

The taxability of our distributions increased during 2006, a direct result of increased cash flows due to strong commodity prices and limited tax pools associated with the acquired assets.

U.S. TAXPAYERS

Prior to 2005, U.S. unitholders who received cash distributions were subject to a 15 percent withholding tax, applied only on the taxable portion of the distribution as computed under Canadian tax law. Legislative changes which took effect on January 1, 2005, imposed an additional 15 percent withholding tax on the non-taxable portion of the distribution. U.S. taxpayers should be eligible for a foreign tax credit with respect to 100 percent of Canadian withholding taxes paid.

The taxable portion of the cash distributions is determined by the Trust in relation to its current and accumulated earnings and profit using U.S. tax principles. The taxable portion so determined, is considered to be a dividend for U.S. tax purposes. For most taxpayers, these dividends should be considered "Qualifying Dividends" and eligible for a reduced rate of tax.

The non-taxable portion of the cash distributions is a return of the cost (or other basis). The cost (or other basis) is reduced by this amount for computing any gain or loss from disposition. However, if the full amount of the cost (or other basis) has been recovered, any further non-taxable distributions should be reported as a gain.

Canetic paid US$2.23 per trust unit to US residents during the calendar year 2006. The portion considered to be a qualified dividend will be announced immediately upon completion of the Trust's calculation of current earnings and accumulated deficit for the year.

RISK MANAGEMENT

Investors who purchase our units are participating in the net funds flow from a portfolio of western Canadian crude oil and natural gas producing properties. As such, the funds flow paid to investors and the value of the units are subject to numerous risks inherent in the industry.

Our expected funds flow from operations depends largely on the volume of petroleum and natural gas production and the price received for such production, along with the associated operating costs and taxability of distributions. The price we receive for our oil depends on a number of factors, including West Texas Intermediate oil prices, Canadian/U.S. currency exchange rates, quality differentials and Edmonton par oil prices. The price we receive for our natural gas production is primarily dependent on current Alberta market prices. Canetic has an ongoing commodity price risk management policy that provides for downside protection on a portion of its future production while allowing access to the upside price movements.

Acquisition of oil and natural gas assets depends on our assessment of value at the time of acquisition. Incorrect assessments of value can adversely affect distributions to unitholders and the value of the units. We employ experienced staff on the business development team and perform stringent levels of due diligence on our analysis of acquisition targets, including a detailed examination of reserve reports; re-engineering of reserves for a large portion of the properties to ensure the results are consistent; site examinations of facilities for environmental liabilities; detailed examination of balance sheet accounts; review of contracts; review of prior year tax returns and modeling of the acquisition to ensure accretive results to the unitholders. The Board of Directors appr