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PART 1

 

Item 1 - Financial Sta tem ents

 

Gran Tierra Energy Inc.

Condensed Consolidated Statements of Operations and Retained Earnings (Unaudited)

(Thousands of U.S. Dollars, Except Share and Per Share Amounts)

 

		Three Months Ended March 31,
		2012				2011
REVENUE AND OTHER INCOME
Oil and natural gas sales		$	155,248			$	122,296
Interest income			703				223
			155,951				122,519
EXPENSES
Operating			24,487				16,396
Depletion, depreciation, accretion and impairment (Note 5)			60,367				63,357
General and administrative			15,899				13,638
Equity tax (Note 8)			-				8,050
Financial instruments gain (Notes 3 and 6)			-				(230	)
Gain on acquisition (Note 3)			-				(24,300	)
Foreign exchange loss			24,375				5,199
			125,128				82,110
INCOME BEFORE INCOME TAXES			30,823				40,409
Income tax expense (Note 8)			(31,136	)			(26,696	)
NET (LOSS) INCOME AND COMPREHENSIVE (LOSS) INCOME			(313	)			13,713
RETAINED EARNINGS, BEGINNING OF PERIOD			185,014				58,097
RETAINED EARNINGS, END OF PERIOD		$	184,701			$	71,810
NET (LOSS) INCOME PER SHARE — BASIC		$	(0.00	)		$	0.05
NET (LOSS) INCOME PER SHARE — DILUTED		$	(0.00	)		$	0.05
WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC (Note 6)			278,734,280				260,930,753
WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED (Note 6)			278,734,280				267,819,800

(See notes to the condensed consolidated financial statements)

 

 

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Gran Tierra Energy Inc.

Condensed Consolidated Balance Sheets (Unaudited)

(Thousands of U.S. Dollars, Except Share and Per Share Amounts)

 

		March 31,				December 31,
		2012				2011
ASSETS
Current Assets
Cash and cash equivalents		$	230,076			$	351,685
Restricted cash			2,880				1,655
Accounts receivable			145,606				69,362
Inventory (Note 5)			14,339				7,116
Taxes receivable			19,501				21,485
Prepaids			4,215				3,597
Deferred tax assets (Note 8)			3,229				3,029
Total Current Assets			419,846				457,929
Oil and Gas Properties (using the full cost method of accounting)
Proved			627,620				618,982
Unproved			433,530				417,868
Total Oil and Gas Properties			1,061,150				1,036,850
Other capital assets			8,441				7,992
Total Property, Plant and Equipment (Note 5)			1,069,591				1,044,842
Other Long-Term Assets
Restricted cash			43,039				13,227
Deferred tax assets (Note 8)			6,462				4,747
Other long-term assets			4,994				3,454
Goodwill			102,581				102,581
Total Other Long-Term Assets			157,076				124,009
Total Assets		$	1,646,513			$	1,626,780
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Accounts payable		$	37,775			$	82,189
Accrued liabilities			90,238				66,832
Taxes payable			120,328				95,482
Asset retirement obligation (Note 7)			-				326
Total Current Liabilities			248,341				244,829
Long-Term Liabilities
Deferred tax liability (Note 8)			198,505				186,799
Equity tax payable (Note 8)			7,029				6,484
Asset retirement obligation (Note 7)			12,124				12,343
Other long-term liabilities			2,187				2,007
Total Long-Term Liabilities			219,845				207,633
Commitments and Contingencies (Note 9)
Shareholders’ Equity
Common shares (Note 6) (264,256,159 and 262,304,249 common shares and 14,717,917 and 16,323,819 exchangeable shares, par value $0.001 per share, issued and outstanding as at March 31, 2012 and December 31, 2011, respectively)			7,983				7,510
Additional paid in capital			983,919				980,014
Warrants (Note 6)			1,724				1,780
Retained earnings			184,701				185,014
Total Shareholders’ Equity			1,178,327				1,174,318
Total Liabilities and Shareholders’ Equity		$	1,646,513			$	1,626,780

(See notes to the condensed consolidated financial statements)

 

 

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Gran Tierra Energy Inc.

Condensed Consolidated Statements of Cash Flows (Unaudited)

(Thousands of U.S. Dollars)

	Three Months Ended March 31,
	2012				2011
Operating Activities
Net (loss) income		$	(313	)		$	13,713
Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities:
Depletion, depreciation, accretion and impairment			60,367				63,357
Deferred taxes (Note 8)			(5,250	)			(187	)
Stock-based compensation (Note 6)			3,192				3,453
Gain on financial instruments (Note 3)			-				(62	)
Unrealized foreign exchange loss			21,351				4,458
Settlement of asset retirement obligation (Note 7)			(404	)			(4	)
Equity tax			-				6,132
Gain on acquisition (Note 3)			-				(24,300	)
Net change in assets and liabilities from operating activities
Accounts receivable			(72,865	)			(83,036	)
Inventory			(4,500	)			736
Prepaids			(618	)			(831	)
Accounts payable and accrued and other liabilities			(34,035	)			(22,756	)
Taxes receivable and payable			19,595				8,101
Net cash used in operating activities			(13,480	)			(31,226	)
Investing Activities
Increase in restricted cash			(31,037	)			(5,600	)
Additions to property, plant and equipment			(77,983	)			(77,516	)
Proceeds from disposition of oil and gas property (Note 5)			-				3,253
Cash acquired on acquisition (Note 3)			-				7,747
Proceeds on sale of asset-backed commercial paper (Note 3)			-				22,679
Net cash used in investing activities			(109,020	)			(49,437	)
Financing Activities
Settlement of bank debt (Notes 3 and 11)			-				(22,853	)
Proceeds from issuance of common shares			891				1,989
Net cash provided by (used in) financing activities			891				(20,864	)
Net decrease in cash and cash equivalents			(121,609	)			(101,527	)
Cash and cash equivalents, beginning of period			351,685				355,428
Cash and cash equivalents, end of period		$	230,076			$	253,901
Cash		$	148,035			$	243,399
Term deposits			82,041				10,502
Cash and cash equivalents, end of period		$	230,076			$	253,901
Supplemental cash flow disclosures:
Cash paid for interest		$	-			$	668
Cash paid for income taxes		$	13,733			$	9,693
Non-cash investing activities:
Non-cash working capital related to property, plant and equipment, end of period		$	53,090			$	42,698

(See notes to the condensed consolidated financial statements)

 

 

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Gran Tierra Energy Inc.

Condensed Consolidated Statements of Shareholders’ Equity (Unaudited)

(Thousands of U.S. Dollars)

 

	Three Months Ended				Year Ended
	March 31, 2012				December 31, 2011
Share Capital
Balance, beginning of period		$	7,510			$	4,797
Issue of common shares			473				2,713
Balance, end of period			7,983				7,510
Additional Paid in Capital
Balance, beginning of period			980,014				821,781
Issue of common shares			105				142,109
Exercise of warrants (Note 6)			56				411
Exercise of stock options (Note 6)			313				1,990
Stock-based compensation (Note 6)			3,431				13,723
Balance, end of period			983,919				980,014
Warrants
Balance, beginning of period			1,780				2,191
Exercise of warrants (Note 6)			(56	)			(411	)
Balance, end of period			1,724				1,780
Retained Earnings
Balance, beginning of period			185,014				58,097
Net (loss) income			(313	)			126,917
Balance, end of period			184,701				185,014
Total Shareholders’ Equity		$	1,178,327			$	1,174,318

(See notes to the condensed consolidated financial statements)

 

 

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Gran Tierra Energy Inc.

Notes to the Condensed Consolidated Financial Statements (Unaudited)

 

1. Description of Business

 

Gran Tierra Energy Inc., a Nevada corporation (the “Company” or “Gran Tierra”), is a publicly traded oil and gas company engaged in the acquisition, exploration, development and production of oil and natural gas properties. The Company’s principal business activities are in Colombia, Argentina, Peru and Brazil.

 

2. Significant Accounting Policies

 

These interim unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”). The information furnished herein reflects all normal recurring adjustments that are, in the opinion of management, necessary for the fair presentation of results for the interim periods.

The note disclosure requirements of annual consolidated financial statements provide additional disclosures to that required for interim unaudited condensed consolidated financial statements. Accordingly, these interim unaudited condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements as at and for the year ended December 31, 2011 included in the Company’s 2011 Annual Report on Form 10-K, filed with the Securities and Exchange Commission (“SEC”) on February 27, 2012.

The Company’s significant accounting policies are described in Note 2 of the consolidated financial statements which are included in the Company’s 2011 Annual Report on Form 10-K and are the same policies followed in these interim unaudited condensed consolidated financial statements, except as disclosed below. The Company has evaluated all subsequent events through to the date these interim unaudited condensed consolidated financial statements were issued.

Revenue recognition

Revenue from the production of oil and natural gas is recognized when title passes to the customer and when collection of the revenue is reasonably assured. On February 1, 2012, the sales point for the Company’s Colombian oil sales in the Putumayo basin changed. Gran Tierra’s customer now takes title at the Port of Tumaco on the Pacific coast of Colombia rather than at the entry into the Ecopetrol-operated Trans-Andean oil pipeline (“the OTA pipeline”) at the Orito station in the Putumayo basin.

Adopted accounting pronouncements

 

Goodwill

In September 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-08, "Intangibles – Goodwill and Other (Topic 350)." The update is intended to simplify how entities test goodwill for impairment. The update permits entities to assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount and whether it is necessary to perform the two-step goodwill impairment test. This ASU was effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. The implementation of this update did not materially impact the Company’s consolidated financial position, results of operations or cash flows.

Recently issued accounting pronouncements

Disclosure about Offsetting Assets and Liabilities

In December 2011, the FASB issued ASU 2011-11, "Balance Sheet – Disclosure about Offsetting Assets and Liabilities (Topic 210)." The update requires an entity to disclose information about offsetting assets and liabilities and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. This ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after January 1, 2013. The implementation of this update is not expected to materially impact the Company’s disclosure.

3. Business Combination

 

On March 18, 2011 (the “Acquisition Date”), Gran Tierra completed its acquisition of all the issued and outstanding common shares and warrants of Petrolifera Petroleum Limited (“Petrolifera”), a Canadian corporation, pursuant to the terms and conditions of an arrangement agreement dated January 17, 2011 (the “Arrangement”). Petrolifera is a Calgary based oil, natural gas and natural gas liquids exploration, development and production company active in Argentina, Colombia and Peru. The transaction contemplated by the Arrangement was effected through a court approved plan of arrangement in Canada. The Arrangement was approved at a special meeting of Petrolifera shareholders on March 17, 2011 and by the Court of Queen's Bench of Alberta on March 18, 2011.

Under the Arrangement, Petrolifera shareholders received, for each Petrolifera share held, 0.1241 of a share of Gran Tierra common stock, and Petrolifera warrant holders received, for each Petrolifera warrant held, 0.1241 of a Replacement Warrant to purchase a share of Gran Tierra common stock at an exercise price of $9.67 Canadian (“CDN”) dollars per share. The Replacement Warrants expired unexercised on August 28, 2011.

Gran Tierra acquired all the issued and outstanding Petrolifera shares and warrants through the issuance of 18,075,247 Gran Tierra common shares, par value $0.001, and 4,125,036 Replacement Warrants. Upon completion of the transaction on the Acquisition Date, Petrolifera became an indirect wholly-owned subsidiary of Gran Tierra. On a diluted basis, upon the closing of the Arrangement, Petrolifera and Gran Tierra security holders owned approximately 6.6% and 93.4% of the Company, respectively, immediately following the transaction. The total consideration for the transaction was approximately $143 million.

The fair value of Gran Tierra’s common shares was determined as the closing price of the common shares of Gran Tierra as at the Acquisition Date.

 

 

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The fair value of the Replacement Warrants was estimated on the Acquisition Date using the Black-Scholes option pricing model with the following assumptions:

 

Exercise price (CDN dollars per warrant)		$	9.67
Risk-free interest rate			1.3	%
Expected life		0.45 Years
Volatility			44	%
Expected annual dividend per share		Nil
Estimated fair value per warrant (CDN dollars)		$	0.32

The acquisition is accounted for using the acquisition method, with Gran Tierra being the acquirer, whereby Petrolifera’s assets acquired and liabilities assumed are recognized at their fair values as at the Acquisition Date and the results of Petrolifera have been consolidated with those of Gran Tierra from that date.

The following table shows the allocation of the consideration transferred based on the fair values of the assets and liabilities acquired:

(Thousands of U.S. Dollars)
Consideration Transferred:
Common shares issued net of share issue costs		$	141,690
Replacement warrants			1,354
		$	143,044
Allocation of Consideration Transferred:
Oil and gas properties
Proved		$	58,457
Unproved			161,278
Other long-term assets			4,417
Net working capital (including cash acquired of $7.7 million and accounts receivable of $6.4 million)			(17,223	)
Asset retirement obligation			(4,901	)
Bank debt			(22,853	)
Other long-term liabilities			(14,432	)
Gain on acquisition			(21,699	)
		$	143,044

As shown above, the fair value of identifiable assets acquired and liabilities assumed exceeded the fair value of the consideration transferred. Consequently, Gran Tierra reassessed the recognition and measurement of identifiable assets acquired and liabilities assumed and concluded that all acquired assets and assumed liabilities were recognized and that the valuation procedures and resulting measures were appropriate. As a result, Gran Tierra initially recognized a gain of $24.3 million, which was reported as “Gain on acquisition”, in the consolidated statement of operations for the three months ended March 31, 2011. Subsequent to the initial allocation of the consideration in the first quarter of 2011, further assessments of Petrolifera’s tax position resulted in a reduction of the gain on acquisition to $21.7 million. The gain reflects the impact on Petrolifera’s pre-acquisition market value of a lack of liquidity and capital resources required to maintain current production and reserves and further develop and explore their inventory of prospects.

As part of the assets acquired and included in the net working capital in the allocation of the consideration transferred, the Company assigned $22.5 million in fair value to investments in notes that Petrolifera received in exchange for asset-backed commercial paper (“ABCP”) with a face value of $31.3 million. On March 28, 2011, these notes were sold to an unrelated party for proceeds of $22.7 million after the associated line of credit was settled resulting in a financial instruments gain for the three months ended March 31, 2011 of $0.2 million.

The associated ABCP line of credit that Gran Tierra assumed was with a Canadian Chartered Bank, to a maximum of CDN$23.2 million with an initial expiry in April 2012. Gran Tierra settled this line of credit immediately after the completion of the acquisition of Petrolifera for the face value of CDN$22.5 million in borrowings plus accrued interest.

Also upon the acquisition of Petrolifera, Gran Tierra assumed a second line of credit agreement (“Second ABCP line of credit”) with the same Canadian chartered bank to a maximum of CDN$5.0 million, which was fully drawn as at the Acquisition Date. This Second ABCP line of credit, which expired on April 8, 2011, was secured by ineligible master asset vehicles Classes 1 & 2 (“MAV IA 1 & 2”) notes with a face value of $6.6 million. Gran Tierra retained the option to settle the Second ABCP line of credit of CDN$5.0 million through delivery to the lender of the MAV IA 1 & 2 notes. Subsequent to the acquisition, Gran Tierra elected to record this second line of credit at fair value and planned at that time to settle the debt through delivery of the MAV IA 1 & 2 notes. Accordingly, a value of $nil was recorded for the debt upon its acquisition. Gran Tierra settled such borrowings by delivery of the MAV IA 1 & 2 notes on April 8, 2011.

Gran Tierra also assumed a reserve-backed credit facility upon the Petrolifera acquisition with an outstanding balance of $31.3 million. The amount outstanding under this credit facility was included as part of net working capital in the allocation of consideration transferred. The credit facility bore interest at LIBOR plus 8.25% and was partially secured by the pledge of the shares of Petrolifera’s subsidiaries. The outstanding balance was repaid when the Argentine restriction preventing its repayment expired on August 5, 2011.

 

 

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Pro forma results for the three months ended March 31, 2011 are shown below, as if the acquisition had occurred on January 1, 2010. Pro forma results are not indicative of actual results or future performance.

		Three Months Ended March 31,
(Thousands of U.S. Dollars except per share amounts)		2011
Revenue and other income		$	131,714
Net loss		$	(21,711	)
Net loss per share - basic		$	(0.08	)
Net loss per share - diluted		$	(0.08	)

The supplemental pro forma earnings of Gran Tierra for the three months ended March 31, 2011 were adjusted to exclude $4.4 million of acquisition costs recorded in g eneral and administrative (“G&A”) expenses and the $24.3 million gain on acquisition because they are not expected to have a continuing impact on Gran Tierra’s results of operations. Petrolifera’s oil and natural gas sales and results of operations between the Acquisition Date and March 31, 2011 were not significant and therefore are not separately disclosed.

4. Segment and Geographic Reporting

 

The Company is primarily engaged in the exploration and production of oil and natural gas. The Company’s reportable segments are Colombia, Argentina and Peru based on a geographic organization. The Company’s operations in Brazil are not a reportable segment because the level of activity in Brazil was not significant at March 31, 2012 or December 31, 2011. The All Other category represents the Company’s corporate activities and operations in Brazil.

The accounting policies of the reportable segments are the same as those described in Note 2. The Company evaluates segment performance based on income or loss before income taxes. The segmented results include the operations of Petrolifera subsequent to March 18, 2011, the date of acquisition of Petrolifera (Note 3).

The following tables present information on the Company’s reportable segments and other activities:

(Thousands of U.S. Dollars except per unit of production amounts)		Three Months Ended March 31, 2012
		Colombia				Argentina				Peru				All Other				Total
Oil and natural gas sales		$	138,633			$	15,369			$	-			$	1,246			$	155,248
Interest income			204				47				15				437				703
Depletion, depreciation, accretion and impairment			32,286				5,925				115				22,041				60,367
Depletion, depreciation, accretion and impairment - per unit of production			25.80				22.80				-				1,741.47				39.62
Income (loss) before income taxes			60,120				(477	)			(727	)			(28,093	)			30,823
Segment capital expenditures		$	20,349			$	14,105			$	16,655			$	36,482			$	87,591
		Three Months Ended March 31, 2011
(Thousands of U.S. Dollars except per unit of production amounts)		Colombia				Argentina				Peru				All Other				Total
Oil and natural gas sales		$	117,304			$	4,992			$	-			$	-			$	122,296
Interest income			87				-				-				136				223
Depletion, depreciation, accretion and impairment			30,036				1,147				31,933				241				63,357
Depletion, depreciation, accretion and impairment - per unit of production			24.77				11.90				-				-				48.39
Income (loss) before income taxes			57,886				(430	)			(32,625	)			15,578				40,409
Segment capital expenditures (1)		$	42,264			$	11,622			$	14,287			$	930			$	69,103

 

(1) Net of proceeds from the farm out of a 50% interest in the Santa Victoria Block in Argentina in March 2011 (see Note 5).

 

The Company’s revenues are derived principally from uncollateralized sales to customers in the oil and natural gas industry. The concentration of credit risk in a single industry affects the Company’s overall exposure to credit risk because customers may be similarly affected by changes in economic and other conditions.

 

 

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In the three months ended March 31, 2012 and 2011, the Company had one significant customer for its Colombian oil, Ecopetrol S.A. (“Ecopetrol”). Sales to Ecopetrol accounted for 85% and 96% of the Company’s revenues for the three months ended March 31, 2012 and 2011, respectively. In the three months ended March 31, 2012, the Company had two significant customers in Argentina, Shell C.A.P.S.A. (“Shell”) and Refineria del Norte S.A. (“Refiner”). Sales to Shell and Refiner accounted for 4% and 3%, respectively, of the Company’s oil and natural gas sales for the three months ended March 31, 2012. In the three months ended March 31, 2011, Refiner was the Company’s only significant customer in Argentina.

 

(Thousands of U.S. Dollars)		As at March 31, 2012
		Colombia				Argentina				Peru				All Other				Total
Property, plant and equipment		$	801,810				137,414				50,845				79,522			$	1,069,591
Goodwill			102,581				-				-				-				102,581
Other assets			269,744				38,103				8,602				157,892				474,341
Total Assets		$	1,174,135			$	175,517			$	59,447			$	237,414			$	1,646,513
		As at December 31, 2011
(Thousands of U.S. Dollars)		Colombia				Argentina				Peru				All Other				Total
Property, plant and equipment		$	816,396				129,072				34,305				65,069			$	1,044,842
Goodwill			102,581				-				-				-				102,581
Other assets			269,843				34,672				9,597				165,245				479,357
Total Assets		$	1,188,820			$	163,744			$	43,902			$	230,314			$	1,626,780

 

5. Property, Plant and Equipment and Inventory

 

Property, Plant and Equipment

		As at March 31, 2012												As at December 31, 2011
(Thousands of U.S. Dollars)		Cost				Accumulated depletion, depreciation and impairment				Net book value				Cost				Accumulated depletion, depreciation and impairment				Net book value
Oil and natural gas properties
Proved		$	1,252,252				(624,632	)			627,620			$	1,181,503			$	(562,521	)		$	618,982
Unproved			433,530				-				433,530				417,868				-				417,868
			1,685,782				(624,632	)			1,061,150				1,599,371				(562,521	)			1,036,850
Furniture and fixtures and leasehold improvements			7,226				(4,457	)			2,769				6,973				(4,002	)			2,971
Computer equipment			9,370				(4,422	)			4,948				8,443				(4,174	)			4,269
Automobiles			1,295				(571	)			724				1,295				(543	)			752
Total Property, Plant and Equipment		$	1,703,673			$	(634,082	)		$	1,069,591			$	1,616,082			$	(571,240	)		$	1,044,842

 

Depletion and depreciation expense on property, plant and equipment for the three months ended March 31, 2012 was $42.6 million (three months ended March 31, 2011 - $32.1 million). A portion of d epletion and depreciation expense was capitalized as inventory during the period.

In September 2011, the Company announced two farmout agreements with Statoil do Brasil Ltda. ("Statoil") in a joint venture with PetróleoBrasileiro S.A., in Brazil’s deepwater offshore Camamu-Almada Basin, pursuant to which, the Company would receive an assignment of a non-operated 10% working interest in Block BM-CAL-7 and a non-operated 15% working interest in Block BM-CAL-10. Both blocks are located in the Camamu Basin, offshore Bahia, Brazil.

On February 17, 2012, in accordance with the terms of the farmout agreement for BM-CAL-10, the Company gave notice to Statoil that it would not enter into and assume its share of the work obligations of the second exploration period of the block. As a result, the farmout agreement has terminated and the Company will not receive any interest in the block. Pursuant to the farmout agreement, the Company was obligated to make payment for a certain percentage of the costs relating to Block BM-CAL-10, which relate primarily to a well that was drilled during the term of the farmout agreement. The notice of withdrawal was a trigger for payment of amounts that would otherwise have been due if the farmout agreement had closed and the Company had acquired a participating interest. In the three months ended March 31, 2012, the Company recorded a ceiling test impairment loss in the Company’s Brazil cost center of $20.2 million. This impairment charge resulted from the recognition of $23.8 million of capital expenditures in relation to the Block BM-CAL-10 farmout agreement in the first quarter of 2012.

 

 

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During the first quarter of 2012, the Company received regulatory approval from Agência Nacional de Petróleo, Gás Natural e Biocombustíveis ("ANP") for the Block BM-CAL-7 farmout agreement. Purchase consideration of $0.7 million was paid and the assignment became effective on April 3, 2012 . The block is an unproved property.

In the three months ended March 31, 2011, the Company recorded ceiling test impairment loss in the Company’s Peru cost center of $31.9 million. This impairment charge related to seismic and drilling costs from a dry well.

In March 2011, the Company recorded proceeds of $3.3 million from the farmout of a 50% interest in the Santa Victoria Block in Argentina to Apache Corporation.

The amounts capitalized in each of the Company's cost centers during the three months ended March 31, 2012 and 2011 were as follows:

		Three Months Ended March 31, 2012
(Thousands of U.S. Dollars)		Colombia				Argentina				Peru				Brazil				Total
Capitalized G&A, including stock-based compensation		$	1,852			$	1,080			$	927			$	1,068			$	4,927
Capitalized stock-based compensation		$	114			$	66			$	-			$	59			$	239
		Three Months Ended March 31, 2011
(Thousands of U.S. Dollars)		Colombia				Argentina				Peru				Brazil				Total
Capitalized G&A, including stock-based compensation		$	1,815			$	410			$	294			$	-			$	2,519
Capitalized stock-based compensation		$	76			$	47			$	-			$	-			$	123

Unproved oil and natural gas properties consist of exploration lands held in Colombia, Argentina, Peru and Brazil. As at March 31, 2012, the Company had $274.3 million (December 31, 2011 - $274.8 million) of unproved assets in Colombia, $52.9 million (December 31, 2011 - $57.0 million) of unproved assets in Argentina, $50.2 million (December 31, 2011 - $33.7 million) of unproved assets in Peru and $56.1 million (December 31, 2011 - $52.4 million) of unproved assets in Brazil for a total of $433.5 million (December 31, 2011 - $417.9 million). These properties are being held for their exploration value and are not being depleted pending determination of the existence of proved reserves. Gran Tierra will continue to assess the unproved properties over the next several years as proved reserves are established and as exploration dictates whether or not future areas will be developed.

Inventories

As at March 31, 2012, oil and supplies inventories were $12.1 million and $2.2 million, respectively (December 31, 2011 - $4.7 million and $2.4 million, respectively).

 

6. Share Capital

 

The Company’s authorized share capital consists of 595,000,002 shares of capital stock, of which 570 million are designated as common stock, par value $0.001 per share, 25 million are designated as preferred stock, par value $0.001 per share, and two shares are designated as special voting stock, par value $0.001 per share. As at March 31, 2012, outstanding share capital consists of 264,256,159 common voting shares of the Company, 8,494,107 exchangeable shares of Gran Tierra Exchange Co., automatically exchangeable on November 14, 2013, and 6,223,810 exchangeable shares of Goldstrike Exchange Co., automatically exchangeable on November 10, 2012. The exchangeable shares of Gran Tierra Exchange Co., were issued upon acquisition of Solana Resources Limited (“ Solana”). The exchangeable shares of Gran Tierra Goldstrike Inc. were issued upon the business combination between Gran Tierra Energy Inc., an Alberta corporation, and Goldstrike, Inc., which is now the Company. Each exchangeable share is exchangeable into one common voting share of the Company. The holders of common stock are entitled to one vote for each share on all matters submitted to a stockholder vote and are entitled to share in all dividends that the Company’s board of directors, in its discretion, declares from legally available funds. The holders of common stock have no pre-emptive rights, no conversion rights, and there are no redemption provisions applicable to the common stock. Holders of exchangeable shares have substantially the same rights as holders of common voting shares.

 

Warrants

 

At March 31, 2012, the Company had 6,098,224 warrants outstanding to purchase 3,049,112 common shares for $1.05 per share, expiring between June 20, 2012 and June 30, 2012. For the three months ended March 31, 2012, 100,003 common shares were issued upon the exercise of 200,006 warrants (three months ended March 31, 2011, 210,000 common shares were issued upon the exercise of 420,000 warrants).

The Company issued 4,125, 036 Replacement Warrants in connection with its acquisition of Petrolifera during March 2011 (Note 3). The Replacement Warrants expired unexercised during August 2011.The fair value of the Replacement Warrants as of March 31, 2011 was determined using the Black-Scholes option pricing model with the following assumptions:

 

Exercise price (CDN dollars per warrant)		$	9.67
Risk-free interest rate			1.3	%
Expected life		0.45 Years
Volatility			44	%
Expected annual dividend per share		Nil
Estimated fair value per warrant (CDN dollars)		$	0.32

During the three months ended March 31, 2011, a financial instruments gain resulting from the change in fair value of the Replacement Warrants of $32,075 was recorded.

 

 

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Stock Options

 
 

For the three months ended March 31, 2012, the stock-based compensation expense was $3.4 million (three months ended March 31, 2011 - $3.6 million) of which $2.9 million (three months ended March 31, 2011 - $3.2 million) was recorded in G&A expenses, $0.3 million was recorded in operating expense (three months ended March 31, 2011 – $0.3 million) and $0.2 million of stock-based compensation was capitalized as part of exploration and development costs (three months ended March 31, 2011 – $0.1 million).

At March 31, 2012, there was $18.3 million (December 31, 2011 - $11.7 million) of unrecognized compensation cost related to unvested stock options which is expected to be recognized over the next three years.

The following table provides information about stock option activity for the three months ended March 31, 2012:

 

		Number of Outstanding Options				Weighted Average Exercise Price $/Option
Balance, December 31, 2011			12,864,002			$	4.90
Granted in 2012			3,213,150				5.81
Exercised in 2012			(246,005	)			(3.20	)
Forfeited in 2012			(136,646	)			(7.05	)
Balance, March 31, 2012			15,694,501			$	5.10

 

The weighted average grant date fair value for options granted in the three months ended March 31, 2012 was $3.37 (three months ended March 31, 2011 - $5.20). The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option pricing model based on assumptions noted in the following table.

 

		Three Months Ended March 31,
		2012
Dividend yield (per share)		$	nil
Volatility			75	%
Risk-free interest rate			0.4	%
Expected term		4-6 years

 

Weighted average shares outstanding

 

		Three Months Ended March 31,
		2012				2011
Weighted average number of common and exchangeable shares outstanding			278,734,280				260,930,753
Shares issuable pursuant to warrants			-				3,203,257
Shares issuable pursuant to stock options			-				5,894,518
Shares to be purchased from proceeds of stock options			-				(2,208,728	)
Weighted average number of diluted common and exchangeable shares outstanding			278,734,280				267,819,800

 

Net (loss) income per share

 

For the three month period ended March 31, 2012, 15,694,501 options and 6,098,224 warrants to purchase 3,049,112 common shares were excluded from the diluted income per share calculation as the instruments were anti-dilutive. For the three months ended March 31, 2011, 4,125,036 Replacement Warrants were excluded from the diluted income per share calculation as the instruments were anti-dilutive.

 

7. Asset Retirement Obligation

 

As at March 31, 2012, the Company’s asset retirement obligation was comprised of a Colombian obligation in the amount of $5.6 million (December 31, 2011 - $5.5 million), an Argentine obligation in the amount of $6.0 million (December 31, 2011 - $6.7 million) and a Brazilian obligation in the amount of $0.5 million (December 31, 2011 - $0.5 million). As at March 31, 2012, the undiscounted asset retirement obligation was $29.2 million (December 31, 2011 - $29.9 million). Revisions to estimated liabilities relate primarily to changes in estimates of asset retirement costs and include, but are not limited to, revisions of estimated inflation rates, changes in property lives and the expected timing of settling the asset retirement obligation. Changes in the carrying amounts of the asset retirement obligation associated with the Company’s oil and natural gas properties were as follows:

 

 

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		Three Months Ended				Year Ended
(Thousands of U.S. Dollars)		March 31, 2012				December 31, 2011
Balance, beginning of period		$	12,669			$	4,807
Settlements			(404	)			(345	)
Disposal			-				(172	)
Liability incurred			193				867
Liability assumed in a business combination (Note 3)			-				4,901
Foreign exchange			35				17
Accretion			247				673
Revisions in estimated liability			(616	)			1,921
Balance, end of period		$	12,124			$	12,669
Asset retirement obligation - current		$	-			$	326
Asset retirement obligation – long-term			12,124				12,343
Balance, end of period		$	12,124			$	12,669

 

  8. Taxes

 

The income tax expense reported differs from the amount computed by applying the U.S. statutory rate to income before income taxes for the following reasons:

	Three Months Ended March 31,
(Thousands of U.S. Dollars)	2012			2011
Income before income taxes	$	30,823			$	40,409
		35	%			35	%
Income tax expense expected		10,788				14,143
Foreign currency translation adjustments		8,718				1,981
Impact of foreign taxes		(631	)			(1,598	)
Stock-based compensation		1,003				1,143
Increase in valuation allowance		10,145				15,288
Branch and other foreign loss pick-up in the United States and Canada		(622	)			(1,619	)
Non-deductible third party royalty in Colombia		1,943				1,820
Non-taxable gain on acquisition		-				(8,527	)
Other permanent differences		(208	)			4,065
Total income tax expense	$	31,136			$	26,696
Current income tax		36,384				26,677
Deferred tax recovery		(5,248	)			19
Total income tax expense	$	31,136			$	26,696
	As at
(Thousands of U.S. Dollars)	March 31, 2012			December 31, 2011
Deferred Tax Assets
Tax benefit of loss carryforwards	$	73,645			$	63,910
Tax basis in excess of book basis		15,732				17,065
Foreign tax credits and other accruals		27,224				27,164
Capital losses		2,494				2,433
Deferred tax assets before valuation allowance		119,095				110,572
Valuation allowance		(109,404	)			(102,796	)
	$	9,691			$	7,776
Deferred tax assets - current	$	3,229			$	3,029
Deferred tax assets - long-term		6,462				4,747
		9,691				7,776
Deferred Tax Liabilities
Long-term - book value in excess of tax basis		(198,505	)			(186,799	)
Net Deferred Tax Liabilities	$	(188,814	)		$	(179,023	)

 

 

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As at March 31, 2012, the Company had operating loss carryforwards of $388.5 million (December 31, 2011 - $361.6 million) and capital losses of $13.9 million (December 31, 2011 – $13.7 million). Of these losses, $368.4 million (December 31, 2011 - $339.8 million) were losses generated by the foreign subsidiaries of the Company. In certain jurisdictions, the net operating loss carryforwards expire between 2012 and 2031 and the capital losses expire between 2012 and 2016, while certain other jurisdictions allow net operating losses to be carried forward indefinitely. Of the total net operating loss carryforwards, $4.0 million will begin to expire by 2013.

 

As at March 31, 2012, the total amount of Gran Tierra’s unrecognized tax benefits was approximately $20.5 million (December 31, 2011 - $20.5 million), a portion of which, if recognized, would affect the Company’s effective tax rate. To the extent interest and penalties may be assessed by taxing authorities on any underpayment of income tax, such amounts have been accrued and are classified as a component of income taxes in the c onsolidated statement of operations. As at March 31, 2012, the amount of interest and penalties on unrecognized tax benefits included in current income tax liabilities in the interim unaudited consolidated balance sheet was approximately $1.6 million (December 31, 2011 - $1.6 million). The Company had no material interest or penalties included in the interim unaudited consolidated statement of operations for the three months ended March 31, 2012 and 2011.

 

Changes in the Company's unrecognized tax benefit are as follows:

		Three Months Ended March 31,
		2012				2011
(Thousands of U.S. Dollars)
Unrecognized tax benefit at January 1		$	20,500			$	4,175
Changes for positions relating to prior year			-				70
Additions to tax position related to the current year			-				12,364
Unrecognized tax benefit at March 31		$	20,500			$	16,609

The Company and its subsidiaries file income tax returns in the U.S. federal and state jurisdictions and certain other foreign jurisdictions. The Company is subject to income tax examinations for the calendar tax years ended 2005 through 2011 in most jurisdictions. The Company does not anticipate any material changes to the unrecognized tax benefits disclosed above within the next twelve months.

Equity tax for the three months ended March 31, 2011 of $8.1 million represented a Colombian tax of 6% on a legislated measure which is based on the Company’s Colombian segment’s balance sheet equity at January 1, 2011. The equity tax is assessed every four years. The tax is payable in eight semi-annual installments over four years, but was expensed in the first quarter of 2011 at the commencement of the four-year period. The equity tax liability at March 31, 2012 and December 31, 2011 also partially related to an equity tax liability assumed upon the acquisition of Petrolifera.

 

9. Commitments and Contingencies

 

Purchase Obligations, Firm Agreements and Leases

 

The following is a schedule by year of purchase obligations, future minimum payments for firm agreements and leases that have initial or remaining non-cancellable lease terms in excess of one year as of March 31, 2012:

		As at March 31, 2012
		Payments Due in Period
		Total				Less than 1 Year				1 to 3 years				3 to 5 years				More than 5 years
(Thousands of U.S. Dollars)
Oil transportation services		$	36,922			$	13,072			$	7,100			$	7,100			$	9,650
Drilling and geological and geophysical			58,336				47,086				11,250				-				-
Completions			24,821				19,201				5,620				-				-
Facility construction			41,389				24,557				16,832				-				-
Operating leases			7,661				3,085				3,142				1,434				-
Software and telecommunication			4,790				3,811				979				-				-
Consulting			1,989				1,989				-				-				-
Total		$	175,908				112,801				44,923				8,534				9,650

 

 

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Indemnities

 

Corporate indemnities have been provided by the Company to directors and officers for various items including, but not limited to, all costs to settle suits or actions due to their association with the Company and its subsidiaries and/or affiliates, subject to certain restrictions. The Company has purchased directors’ and officers’ liability insurance to mitigate the cost of any potential future suits or actions. The maximum amount of any potential future payment cannot be reasonably estimated.

 

The Company may provide indemnifications in the normal course of business that are often standard contractual terms to counterparties in certain transactions such as purchase and sale agreements. The terms of these indemnifications will vary based upon the contract, the nature of which prevents the Company from making a reasonable estimate of the maximum potential amounts that may be required to be paid.

Letters of credit

At March 31, 2012, the Company had provided promissory notes totalling $24.5 million (December 31, 2011 - $20.7 million) as security for letters of credit relating to work commitment guarantees contained in exploration contracts.

Contingencies

 

Ecopetrol and Gran Tierra Energy Colombia Ltd. (“Gran Tierra Colombia”), the contracting parties of the Guayuyaco Association Contract, are engaged in a dispute regarding the interpretation of the procedure for allocation of oil produced and sold during the long-term test of the Guayuyaco -1 and Guayuyaco -2 wells. There is a material difference in the interpretation of the procedure established in Clause 3.5 of Attachment-B of the Guayuyaco Association Contract. Ecopetrol interprets the contract to provide that the extended test production up to a value equal to 30% of the direct exploration costs of the wells is for Ecopetrol’s account only and serves as reimbursement of its 30% back-in to the Guayuyaco discovery. Gran Tierra Colombia’s contention is that this amount is merely the recovery of 30% of the direct exploration costs of the wells and not exclusively for the benefit of Ecopetrol. There has been no agreement between the parties, and Ecopetrol has filed a lawsuit in the Contravention Administrative Court in the District of Cauca regarding this matter. Gran Tierra Colombia filed a response on April 29, 2008 in which it refuted all of Ecopetrol’s claims and requested a change of venue to the courts in Bogota. At this time no amount has been accrued in the financial statements as the Company does not consider it probable that a loss will be incurred. Ecopetrol is claiming damages of approximately $5.8 million.

Gran Tierra is subject to a third party 10% net profits interest on 50% of the Company’s production from the Costayaco field that arises from the original acquisition in 2006 of 50% of Gran Tierra’s interest in the Chaza Block Contract. There is currently a disagreement between Gran Tierra and the third party as to the calculation of the net profits interest. Gran Tierra and the third party agreed to resolve this issue through an arbitration which was heard in Texas, in accordance with the rules of the American Arbitration Association, in the fourth quarter of 2011. The Company now expects to receive the arbitrator’s decision in the second quarter of 2012. At this time no amount has been accrued in the financial statements as the Company does not consider it probable that a loss will be incurred. The disputed amount at March 31, 2012 is $10.9 million (December 31, 2011 - $9.6 million).

Gran Tierra’s production from the Costayaco field is subject to an additional royalty that applies when cumulative gross production from a commercial field is greater than five million barrels. This additional royalty is calculated on the difference between a trigger price defined by the Agencia Nacional de Hidrocarburos (National Hydrocarbons Agency) (“ANH”) and the sales price. The ANH has requested that the additional compensation be paid with respect to production from wells relating to the Moqueta discovery and has initiated a non-compliance procedure under the Chaza Contract. The Moqueta discovery is not located in the Costayaco Exploitation Area. Further, Gran Tierra views the Costayaco field and the Moqueta discovery as two clearly separate and independent hydrocarbon accumulations. Therefore, it is Gran Tierra’s view that it is clear that, pursuant to the Chaza Contract, the additional compensation payments are only to be paid with respect to production from the Moqueta wells when the accumulated oil production from any new Exploitation Area created with respect to the Moqueta discovery exceeds five million barrels. As at March 31, 2012, total cumulative production from the Moqueta field was 0.4 MMbbl. The estimated compensation which would be payable on cumulative production to date if the ANH’s interpretation is successful is $7.4 million. At this time no amount has been accrued in the financial statements as Gran Tierra does not consider it probable that a loss will be incurred.

Gran Tierra has several lawsuits and claims pending for which the Company currently cannot determine the ultimate result. Gran Tierra records costs as they are incurred or become probable and determinable. Gran Tierra believes the resolution of these matters would not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

10. Financial Instruments, Fair Value Measurements and Credit Risk

 

At March 31, 2012, the Company’s financial instruments recognized in the balance sheet consist of cash and cash equivalents, restricted cash, accounts receivable and accounts payable and accrued liabilities. The fair value of long-term restricted cash approximates its carrying value because interest rates are variable and reflective of market rates. The fair values of other financial instruments approximate their carrying amounts due to the short-term maturity of these instruments.

 

 

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GAAP establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. This hierarchy consists of three broad levels. Level 1 inputs consist of quoted prices (unadjusted) in active markets for identical assets and liabilities and have the highest priority. Level 2 and 3 inputs are based on significant other observable inputs and significant unobservable inputs, respectively, and have lower priorities. The Company uses appropriate valuation techniques based on the available inputs to measure the fair values of assets and liabilities. At March 31, 2012, the Company did not have any financial assets or liabilities measured at fair value on the balance sheet and held no derivative instruments. The Company does not use derivative financial instruments for speculative purposes. The fair value of financial instruments at March 31, 2012 as disclosed above was determined using Level 3 inputs.

At March 31, 2011, the Replacement Warrants (Note 3) met the definition of a derivative. Because the exercise price of the Replacement Warrants was denominated in Canadian dollars, which is different from Gran Tierra’s functional currency, the Replacement Warrants were not considered indexed to Gran Tierra’s common shares and the Replacement Warrants could not be classified within equity. Therefore the Replacement Warrants were classified as a current liability on Gran Tierra’s condensed consolidated balance sheet. Furthermore, these derivative instruments did not qualify as fair value hedges or cash flow hedges, and accordingly, changes in their fair value were recognized as income or expense in the consolidated statement of operations and retained earnings with a corresponding adjustment to the fair value of derivative instruments recognized on the balance sheet. The fair value of the Replacement Warrants at March 31, 2011 was determined using Level 3 inputs (Note 6).

Credit risk arises from the potential that the Company may incur a loss if a counterparty to a financial instrument fails to meet its obligation in accordance with agreed terms. The Company’s financial instruments that are exposed to concentrations of credit risk consist primarily of cash and accounts receivables. The carrying value of cash and accounts receivable reflects management’s assessment of credit risk .

At March 31, 2012, cash and cash equivalents and restricted cash included balances in savings and checking accounts, as well as term deposits and certificates of deposit, placed primarily with governments and financial institutions with strong investment grade ratings, or the equivalent in the Company’s operating areas. Any foreign currency transactions are conducted on a spot basis, with major financial institutions in the Company’s operating areas.

 

Most of the Company’s accounts receivable relate to uncollateralized sales to customers in the oil and natural gas industry and are exposed to typical industry credit risks. The concentration of revenues in a single industry affects the Company’s overall exposure to credit risk because customers may be similarly affected by changes in economic and other conditions. The Company manages this credit risk by entering into sales contracts with only credit worthy entities and reviewing its exposure to individual entities on a regular basis. For the three months ended March 31, 2012, the Company had one significant customer for its Colombian oil, Ecopetrol, and in Argentina the Company had two significant customers, Shell and Refiner .

Additionally, foreign exchange gains and losses mainly result from fluctuation of the U.S. dollar to the Colombian peso due to Gran Tierra’s current and deferred tax liabilities, monetary liabilities, which are mainly denominated in the local currency of the Colombian foreign operations. As a result, foreign exchange gains and losses must be calculated on conversion to the U.S. dollar functional currency. A strengthening in the Colombian peso against the U.S. dollar results in foreign exchange losses, estimated at $104,000 for each one peso decrease in the exchange rate of the Colombian peso to one U.S. dollar .

 

11. Bank Debt and Credit Facilities

 

Effective July 30, 2010, a subsidiary of Gran Tierra, Solana, established a credit facility with BNP Paribas for a three-year term which may be extended or amended by agreement between the parties. This reserve-based facility has a maximum borrowing base up to $100 million and is supported by the present value of the petroleum reserves of two of the Company’s subsidiaries with operating branches in Colombia – Gran Tierra Colombia and Solana Petroleum Exploration (Colombia) Ltd. The initial committed borrowing base is $20 million. Amounts drawn down under the facility bear interest at the U.S. dollar LIBOR rate plus 3.5%. In addition, a stand-by fee of 1.5% per annum is charged on the unutilized balance of the committed borrowing base and is included in G&A expenses. Under the terms of the facility, the Company is required to maintain and was in compliance with certain financial and operating covenants. As at March 31, 2012 and December 31, 2011, the Company had not drawn down any amounts under this facility. In February 2012, BNP Paribas announced the sale of its North American reserve-based lending business to Wells Fargo Bank National Association. Solana’s credit facility is expected to be part of that sale. Closing documents are being processed, and the sale is expected to be finalized in the second quarter of 2012.

12. Related Party Transactions

 

On January 12, 2011, the Company entered into an agreement to sublease office space to a company of which Gran Tierra’s President and Chief Executive Officer serves as an independent director. The term of the sublease runs from February 1, 2011 to January 30, 2013 and the sublease payment is $4,400 per month plus approximately $5,600 of operating and other expense.

On August 3, 2010, Gran Tierra entered into a contract related to the Peru drilling program with a company for which one of Gran Tierra’s directors is a shareholder and director. For the three months ended March 31, 2012, $nil million was incurred and capitalized under this contract (three months ended March 31, 2011 - $2.0 million) and at March 31, 2012, $nil was included in accounts payable related to this contract (December 31, 2011 - $nil).

On February 1, 2009, the Company entered into a sublease for office space with a company, of which one of Gran Tierra’s directors is a shareholder and director. The term of the sublease ran from February 1, 2009 to August 31, 2011 and the sublease payment was $8,000 per month plus approximately $4,700 for operating and other expenses.

Item 2. Management’s Discussion and Analysis of Fina ncial Condition and Results of Operations

 

This report, and in particular this Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Please see the cautionary language at the very beginning of this Quarterly Report on Form 10-Q regarding the identification of and risks relating to forward-looking statements, as well as Part II, Item 1A “Risk Factors” in this Quarterly Report on Form 10-Q.

 

The following discussion of our financial condition and results of operations should be read in conjunction with the Financial Statements as set out in Part I – Item 1 of this Quarterly Report on Form 10-Q as well as the financial statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K, filed with the U.S. Securities and Exchange Commission (“SEC”) on February 27, 2012.

Overview

 

We are an independent international energy company incorporated in the United States and engaged in oil and natural gas acquisition, exploration, development and production. Our operations are carried out in South America in Colombia, Argentina, Peru, and Brazil, and we are headquartered in Calgary, Alberta, Canada. Our reportable segments are Colombia, Argentina and Peru. Brazil is not a reportable segment because the level of activity in Brazil is not significant at this time. For the three months ended March 31, 2012, 89% (three months ended March 31, 2011 - 96%) of our revenue and other income was generated in Colombia.

 

 

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Highlights

 

		Three Months Ended March 31,
		2012				2011				% Change
Production (BOEPD) (1)			16,742				14,546				15
Prices Realized - per BOE		$	101.90			$	93.41				9
Revenue and Other Income ($000s)		$	155,951			$	122,519				27
Net (Loss) Income ($000s)		$	(313	)		$	13,713				(102	)
Net (Loss) Income Per Share - Basic		$	(0.00	)		$	0.05				(100	)
Net (Loss) Income Per Share - Diluted		$	(0.00	)		$	0.05				(100	)
Funds Flow From Operations ($000s) (2)		$	78,943			$	66,560				19
Capital Expenditures ($000s)		$	87,591			$	69,103				27

		As at
		March 31, 2012				December 31, 2011				% Change
Cash & Cash Equivalents ($000s)		$	230,076			$	351,685				(35	)
Working Capital (including cash & cash equivalents) ($000s)		$	171,505			$	213,100				(20	)
Property, Plant & Equipment ($000s)		$	1,069,591			$	1,044,842				2

(1) Production represents production volumes NAR adjusted for inventory changes. NGL volumes are converted to BOE on a one-to-one basis with oil. Gas volumes are converted to BOE at the rate of 6 Mcf of gas per bbl of oil, based upon the approximate relative energy content of gas and oil, which rate is not necessarily indicative of the relationship of oil and gas prices.

 

(2) Funds flow from operations is a non-GAAP measure which does not have any standardized meaning prescribed under generally accepted accounting principles in the United States of America (“GAAP”). Management uses this financial measure to analyze operating performance and the income generated by our principal business activities prior to the consideration of how non-cash items affect that income, and believes that this financial measure is also useful supplemental information for investors to analyze operating performance and our financial results. Investors should be cautioned that this measure should not be construed as an alternative to net income or other measures of financial performance as determined in accordance with GAAP. Our method of calculating this measure may differ from other companies and, accordingly, it may not be comparable to similar measures used by other companies. Funds flow from operations, as presented, is net (loss) income adjusted for depletion, depreciation, accretion and impairment (“DD&A”) expenses, deferred taxes, stock-based compensation, gain on financial instruments, unrealized foreign exchange loss, settlement of asset retirement obligation, equity tax and gain on acquisition. A reconciliation from funds flow from operations to net (loss) income is as follows:

 

 

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		Three Months Ended March 31,
Funds Flow From Operations - Non-GAAP Measure ($000s)		2012				2011
Net (loss) income		$	(313	)		$	13,713
Adjustments to reconcile net (loss) income to funds flow from operations
DD&A expenses			60,367				63,357
Deferred taxes			(5,250	)			(187	)
Stock-based compensation			3,192				3,453
Gain on financial instruments			-				(62	)
Unrealized foreign exchange loss			21,351				4,458
Settlement of asset retirement obligation			(404	)			(4	)
Equity tax			-				6,132
Gain on acquisition			-				(24,300	)
Funds flows from operations		$	78,943			$	66,560

Operational Highlights

 

·

In the first quarter of 2012, oil and natural gas production, NAR and adjusted for inventory changes, averaged 16,742 BOEPD, an increase of 15% over the first quarter of 2011. The increase was due to increased production from the Moqueta and Jilguero fields in Colombia and the Neuquen Basin in Argentina, partially offset by the impact of pipeline disruptions and an increase in pipeline inventory as a result of the change in the sales point in Colombia.

 

·

In Colombia, the Ramiriqui-1 oil exploration well reached total depth at 19,519 feet measured depth (“MD”) in basement. Along with our operating partner Compania Espanola de Petroleos, S.A.U. (“CEPSA”), we completed initial testing on the well with natural flow rates, without pumps, of up to 2,525 BOPD gross over 32.5 hours with a 28/64 inch choke and a 0.12% watercut with 26°API gravity oil from the Mirador formation. The Ramiriqui-1 well flowed at a restricted rate due to gas flaring limitations. We are awaiting approval from the Agencia Nacional de Hidrocarburos (National Hydrocarbons Agency) (“ANH”) of the transfer of our 45% working interest in this Block.

 

·

In Colombia, we completed the Moqueta 3D seismic program with interpretation ongoing to assist in full field development planning.

·

In Argentina, we completed drilling and testing the Proa -2 appraisal well, the second well in the Proa oil field. The well went on production in the second quarter of 2012 at a constrained rate of approximately 2,000 BOPD gross to further analyze reservoir performance while additional transportation capacity is evaluated.

 

·

In Brazil, the 3-GTE-03D-BA appraisal well reached a total depth of 2,273 meters MD during the first quarter of 2012 and oil bearing reservoir intervals were encountered. Additionally, a second appraisal well, 3-GTE-4DPA-BA, encountered the Agua Grande formation at 2,065 meters MD and the Sergi formation at 2,182 meters MD.

·

In September 2011, we announced two farmout agreements with Statoil do Brasil Ltda. ("Statoil") in a joint venture with PetróleoBrasileiro S.A. ("Petrobras"), in Brazil’s deepwater offshore Camamu-Almada Basin, pursuant to which, we would receive an assignment of a non-operated 10% working interest in Block BM-CAL-7 and a non-operated 15% working interest in Block BM-CAL-10. On February 17, 2012, in accordance with the terms of the farmout agreement, we gave notice to Statoil that we would not enter into and assume our share of the work obligations of the second exploration period of Block BM-CAL-10. As a result, the farmout agreement has terminated and we will not receive any interest in the block. We paid $23.8 million in the second quarter of 2012 related to our obligation on this farmout agreement.

 

·

During the first quarter of 2012, we received regulatory approval from the ANP in Brazil for the Block BM-CAL-7 farmout agreement and the assignment became effective on April 3, 2012 .

 

·

On January 20, 2012, we entered into a purchase and sale agreement to acquire the remaining 30% participating interest in Blocks 129, 142, 155 and 224 in the Recôncavo Basin in Brazil from our partner. The completion of the purchase is subject to ANP approval.

 

  Financial Highlights

 

●

Revenue and other income increased by 27% to $156.0 million in the first quarter of 2012 compared with $122.5 million in the first quarter of 2011 due to increased production and higher oil prices. Average oil and NGL prices realized per bbl in the first quarter of 2012 were $105.36, an increase of 12% compared with $94.31 in the first quarter of 2011.

 

●

We incurred a net loss of $0.3 million in the first quarter of 2012, representing basic and diluted net loss per share of $nil. This compares with net income of $13.7 million, or $0.05 per share basic and diluted in the first quarter of 2011. In the first quarter of 2012, i ncreased oil and natural gas sales, reduced impairment charges and no Colombian equity tax expense were more than offset by a $24.4 million foreign exchange loss, the absence of the comparative period gain on acquisition, increased operating, depletion, depreciation and accretion and general and administrative ("G&A") expenses and increased income taxes. Net income in the comparable quarter in 2011 included a gain on the acquisition of Petrolifera Petroleum Limited (“Petrolifera”) of $24.3 million and Colombian equity tax of $8.1 million. The Colombian equity tax is assessed every four years.

 

●

Funds flow from operations increased by 19% to $78.9 million in the first quarter of 2012 from $66.6 million in the first quarter of 2011. The increase was primarily due to increased oil and natural gas sales and no Colombian equity tax expense , partially offset by increased operating and G&A expenses.

 

●

Cash and cash equivalents was $230.1 million at March 31, 2012 compared with $351.7 million at December 31, 2011. The change in cash and cash equivalents during the first quarter of 2012 was primarily the result of funds flow from operations of $78.9 million and proceeds from issuance of common shares of $0.9 million being more than offset by an increase in net assets from operating activities of $92.4 million, $78.0 million of capital expenditures and a $31.0 million increase in restricted cash during the first quarter of 2012.

 

 

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●

Working capital (including cash and cash equivalents) was $171.5 million at March 31, 2012, a $41.6 million decrease from December 31, 2011.The decrease is a result of a $121.6 million decrease in cash and cash equivalents and a $24.8 million increase in taxes payable due to increased taxable income in Colombia, partially offset by a $76.2 million increase in accounts receivable due to increased sales and the timing of collection of receivables, a $7.2 million increase in inventory due to the new transportation agreement in Colombia and a $21.0 million decrease in accounts payable and accrued liabilities. The decrease in accounts payable and accrued liabilities was primarily the result of a $19.0 million reduction in royalties payable due to the timing of royalty payments and a $13.7 million reduction in VAT payable, partially offset by a $12.0 million increase in capital expenditure related liabilities. Capital expenditure related accounts payable included $23.8 million related to the Block BM-CAL-10 at March 31, 2012.

 

●

Property, plant and equipment at March 31, 2012 was $1.1 billion, an increase of $24.7 million from December 31, 2011, as a result of $87.6 million of capital expenditures, partially offset by $62.9 million of depletion, depreciation and impairment expenses.

 

Business combination

On March 18, 2011, we completed the acquisition of all the issued and outstanding common shares and warrants of Petrolifera pursuant to the terms and conditions of an arrangement agreement dated January 17, 2011. Petrolifera is a Calgary-based oil, natural gas and NGL exploration, development and production company active in Argentina, Colombia and Peru. For further details reference should be made to Note 3 of the consolidated financial statements.

 

The acquisition was accounted for using the acquisition method, with Gran Tierra being the acquirer, whereby Petrolifera’s assets acquired and liabilities assumed were recorded at their fair values as at the acquisition date and the results of Petrolifera were consolidated with those of Gran Tierra from that date.

 

As indicated in the allocation of the consideration transferred, the fair value of identifiable assets acquired and liabilities assumed exceeded the fair value of the consideration transferred. Consequently, we reassessed the recognition and measurement of identifiable assets acquired and liabilities assumed and concluded that all acquired assets and assumed liabilities were recognized and that the valuation procedures and resulting measures were appropriate. As a result, we recognized a gain on acquisition of $24.3 million in the consolidated statement of operations for the three months ended March 31, 2011. Subsequent to the initial allocation of the consideration in the first quarter of 2011, further assessments of Petrolifera’s tax position resulted in a reduction of the gain on acquisition to $21.7 million. The gain reflects the impact on Petrolifera’s pre-acquisition market value resulting from their lack of liquidity and capital resources required to maintain current production and reserves and further develop and explore their inventory of prospects.

 

Business Environment Outlook

 

Our revenues have been significantly affected by the continuing fluctuations in oil prices. Oil prices are volatile and unpredictable and are influenced by concerns about financial markets and the impact of the worldwide economy on oil demand growth. However, based on projected production, prices, costs and our current liquidity position, we believe that our current operations and 2012 capital expenditure program can be maintained from cash flow from existing operations and cash on hand, barring unforeseen events or a downturn in oil and gas prices. Should our operating cash flow decline, we would examine measures such as reducing our capital expenditure program, possible periodic draws from our revolving credit facility, issuance of debt, disposition of assets, or issuance of equity. The continuing uncertainty regarding the Middle East and continued economic instability in the United States and Europe is having an impact on world markets, and we are unable to determine the impact, if any, these events may have on oil prices and demand.

 

Our future growth and acquisitions may depend on our ability to raise additional funds through equity and debt markets. Should we be required to raise debt or equity financing to fund capital expenditures or other acquisition and development opportunities, such funding may be affected by the market value of our common stock. If the price of our common stock declines, our ability to utilize our stock to raise capital may be negatively affected. Also, raising funds by issuing stock or other equity securities would further dilute our existing shareholders, and this dilution would be exacerbated by a decline in our stock price. Any securities we issue may have rights, preferences and privileges that are senior to our existing equity securities. Borrowing money may also involve further pledging of some or all of our assets and will expose us to interest rate risk. Depending on the currency used to borrow money, we may also be exposed to further foreign exchange risk. Our ability to borrow money and the interest rate we pay for any money we borrow will be affected by market conditions, and we cannot predict what price we may pay for any borrowed money.

 

 

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Consolidated Results of Operations

		Three Months Ended March 31,
		2012				2011				% Change
(Thousands of U.S. Dollars)
Oil and natural gas sales		$	155,248			$	122,296				27
Interest income			703				223				215
			155,951				122,519				27
Operating expenses			24,487				16,396				49
DD&A expenses			60,367				63,357				(5	)
G&A expenses			15,899				13,638				17
Equity tax			-				8,050				-
Financial instruments gain			-				(230	)			-
Gain on acquisition			-				(24,300	)			-
Foreign exchange loss			24,375				5,199				369
			125,128				82,110				52
Income before income taxes			30,823				40,409				(24	)
Income tax expense			(31,136	)			(26,696	)			17
Net (loss) income		$	(313	)		$	13,713				(102	)
Production
Oil and NGL's, bbl			1,461,404				1,293,453				13
Natural gas, Mcf			372,947				94,317				295
Total production, BOE (1)			1,523,562				1,309,173				16
Average Prices
Oil and NGL's, per bbl		$	105.36			$	94.31				12
Natural gas, per Mcf		$	3.42			$	3.35				2
Consolidated Results of Operations (per BOE)
Oil and natural gas sales		$	101.90			$	93.41				9
Interest income			0.46				0.17				171
			102.36				93.58				9
Operating expenses			16.07				12.52				28
DD&A expenses			39.62				48.39				(18	)
G&A expenses			10.44				10.42				-
Equity tax			-				6.15				-
Financial instruments gain			-				(0.18	)			-
Gain on acquisition			-				(18.56	)			-
Foreign exchange loss			16.00				3.97				303
			82.13				62.71				31
Income before income taxes			20.23				30.87				(34	)
Income tax expense			(20.44	)			(20.39	)			-
Net (loss) income		$	(0.21	)		$	10.48				(102	)

 

(1) Production represents production volumes NAR adjusted for inventory changes. NGL volumes are converted to BOE on a one-to-one basis with oil. Gas volumes are converted to BOE at the rate of 6 Mcf of gas per bbl of oil, based upon the approximate relative energy content of gas and oil, which rate is not necessarily indicative of the relationship of oil and gas prices.

 

Net loss was $0.3 million, or $nil per share basic and diluted, for the first quarter of 2012 compared with net income of $13.7 million, or $0.05 per share basic and diluted, for the comparable quarter in 2011. In the first quarter of 2012, i ncreased oil and natural gas sales due to increased production and higher realized oil prices , reduced impairment charges and no Colombian equity tax expense were more than offset by a $24.4 million foreign exchange loss, the absence of the comparative period gain on acquisition, increased operating, depletion, depreciation and accretion and G&A expenses and increased income taxes. The Colombian equity tax is assessed every four years. Net income in the comparable quarter in 2011 included a gain on the acquisition of Petrolifera of $24.3 million.

Oil and NGL production , NAR and adjusted for inventory changes, for the first quarter of 2012 increased to 1.5 MMbbl compared with 1.3 MMbbl for the comparable quarter in 2011 primarily due to increased production from the Moqueta and Jilguero fields in Colombia and the addition of the Neuquen Basin in Argentina, from the acquisition of Petrolifera in March 2011. Production during the first quarter of 2012 reflects approximately 26 days of oil delivery restrictions due to three separate disruptions in the Ecopetrol-operated Trans-Andean oil pipeline (“the OTA pipeline”) in Colombia. We continued production at a reduced rate while the OTA pipeline was down, selling a portion of our oil through trucking and storing excess oil, resulting in a reduction in oil production, NAR and adjusted for inventory changes, of approximately 800 BOPD for the first quarter of 2012.

Also, as a result of entering into new oil sales and transportation agreements with Ecopetrol as of February 1, 2012, which changed the sales point of oil from Orito station to Tumaco Port, our reported oil inventory increased representing ownership of oil in the OTA pipeline and associated Ecopetrol owned facilities. This change in sales point and the increase in pipeline inventory had a corresponding one-time reduction in oil production, NAR and adjusted for inventory changes, of approximately 1,040 BOPD for the first quarter of 2012.

Production during the first quarter of 2011 was adversely affected by a maintenance program at the Tumaco Port offloading terminal between December 28, 2010 and February 7, 2011 which reduced sales through the OTA pipeline.

 

 

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Average realized oil prices in the first quarter of 2012 increased by 12% to $105.36 per bbl from $94.31 per bbl in 2011 reflecting higher oil prices. The average West Texas Intermediate (“WTI”) oil price for the first quarter of 2012 was $102.89 per bbl compared with $93.95 per bbl in the comparable quarter in 2011. Average Brent oil price for the first quarter of 2012 was $118.56 per bbl.

Increased production and higher oil prices resulted in a 27% increase in revenue and other income to $156.0 million   for the first quarter of 2012 compared with $122.5 million in the comparable quarter in 2011.

Operating expenses for the first quarter of 2012 amounted to $24.5 million, or $16.07 per BOE, compared with $16.4 million, or $12.52 per BOE, in the comparable quarter in 2011. The increase in operating expenses was due to an increase of $3.7 million in Colombia, $3.8 million in Argentina and $0.6 million in Brazil.

DD&A expenses for the first quarter of 2012 decreased to $60.4 million compared with $63.4 million for the comparable quarter in 2011. DD&A expenses for the first quarter of 2012 included a $20.2 million ceiling test impairment in our Brazil cost center. The impairment loss related to seismic and drilling costs on Block BM-CAL-10. The farmout agreement for that block terminated during the first quarter of 2012 when we provided notice that we would not enter into the second exploration period. DD&A expenses for the comparable quarter in 2011 included a $31.9 million ceiling test impairment in our Peru cost center relating to seismic and drilling costs from a dry well.

The remaining increase in DD&A expenses was due to higher production levels and increased future development costs included in the depletable base, partially offset by an increase in reserves. On a BOE basis, DD&A expenses in 2012 were $39.62 compared with $48.39 for 2011, representing an 18% decrease. Excluding the effects of impairment charges, DD&A expenses were $26.36 per BOE in the first quarter of 2012, compared with $24.02 per BOE in the comparable period in 2011.

G&A expenses of $15.9 million for the first quarter of 2012 increased by 17% from $13.6 million in the comparable quarter in 2011 primarily due to a full quarter of Petrolifera G&A expenses and increased employee related costs reflecting the expanded operations in all business segments, partially offset by the absence of $1.2 million of expenses associated with the acquisition of Petrolifera recorded in the first quarter of 2011. G&A expenses per BOE were comparable with the first quarter in 2011 at $10.44 per BOE.

 

Equity tax in the three months ended March 31, 2011 represents a Colombian tax of 6% on a legislated measure which is based on our Colombian segment’s balance sheet equity at January 1, 2011. The equity tax is assessed every four years.

Gain on acquisition of $24.3 million in the three months ended March 31, 2011 related to the Petrolifera acquisition. This gain reflects the impact on Petrolifera’s pre-acquisition market value of its lack of liquidity and capital resources required to maintain production and reserves and further develop and explore its inventory of prospects.

Foreign exchange loss of $24.4 million for the first quarter of 2012, of which $21.4 million was an unrealized non-cash foreign exchange loss, primarily represents a foreign exchange loss resulting from the translation of current and deferred tax liabilities in Colombia. In the first quarter of 2011, the foreign exchange loss was $5.2 million, of which $4.5 million was an unrealized non-cash foreign exchange loss. Under GAAP, deferred taxes are considered a monetary liability and require translation from local currency to U.S. dollar functional currency at each balance sheet date. This translation results in the recognition of unrealized exchange losses or gains. The Colombian Peso strengthened by 8% and 2% against the U.S. dollar in the three months ended March 31, 2012 and 2011, respectively.

Income tax expense for the first quarter of 2012 was $31.1 million compared with $26.7 million recorded in the comparable quarter in 2011. The increase was primarily due to higher income. For the three months ended March 31, 2012, the effective tax rate was 101% compared with 66% in the comparable quarter in 2011. The change was primarily due to a non-taxable gain on acquisition being recorded in 2011 and an increase in the non-deductible unrealized foreign currency translation loss in 2012. The variance from the 35% U.S. statutory rate for the first quarter of 2012 results from non-deductible foreign currency translation losses and an increase in valuation allowances taken on losses incurred in the U.S., Canada, Argentina, Peru and Brazil. The variance from the 35% U.S. statutory rate for the first quarter of 2011 was primarily attributable to non-deductible foreign currency translation losses as described above and an increase in valuation allowances taken on losses incurred in the U.S., Canada, Argentina, Peru and Brazil, offset partially by the inclusion of the non-taxable gain on acquisition.

2012 Work Program and Capital Expenditure Program

 

Our capital expenditures during the first quarter of 2012 were $87.6 million (including changes in non-cash working capital) compared with $69.1 million in the comparable quarter in 2011. In 2012, capital expenditures included drilling and acquisition expenditures of $60.7 million, geological and geophysical (“G&G”) expenditures of $22.2 million, facilities expenditures of $2.3 million and other expenditures of $2.4 million.

Our capital program for 2012 has been revised to $444 million from $367 million. This includes $196 million for Colombia, an increase of $ 14 million due primarily to additional facilities costs on the Garibay and Chaza Blocks and testing of the successful Ramiriqui-1 oil exploration well; $122 million for Brazil, an increase of $ 54 million due primarily to the acquisition of the remaining 30% working interest in four onshore blocks and associated proportional increase in work program; $47 million for Argentina, a $7 million decrease primarily due to the deferral of drilling in the Santa Victoria block into the first quarter of 2013; and $78 million for Peru, a $16 million increase primarily due to the acquisition costs of an over-riding royalty interest in Block 107; and $1 million associated with corporate activities. Of this, $294 million is for drilling and acquisitions, $58 million is for facilities and pipelines and $92 million is for G&G expenditures. Of the $294 million allocated to drilling and acquisitions, approximately $140 million is for exploration, $43 million is for acquisitions and the balance is for delineation and development drilling.

Our 2012 work program is intended to create both growth and value through strategic acquisitions of working interests, by leveraging existing assets to increase reserves and production levels and through the construction of pipelines and facilities in the areas with proved reserves. We are financing our capital program through cash flows from operations and cash on hand, while retaining financial flexibility with a strong cash position and no debt, so that we can be positioned to undertake further development opportunities and pursue acquisitions. However, as a result of the nature of the oil and natural gas exploration, development and exploitation industry, budgets are regularly reviewed with respect to both the success of expenditures and other opportunities that become available. Accordingly, while we currently intend that funds will be expended as set forth in our 2012 work program, there may be circumstances where, for sound business reasons, actual expenditures may in fact differ.

 

Excluding potential exploration success, average production in 2012 is expected to range between 20,000 and 21,000 BOEPD NAR.

 

 

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Segmented Results – Colombia

 

		Three Months Ended March 31,
		2012				2011				% Change
(Thousands of U.S. Dollars)
Oil and natural gas sales		$	138,633			$	117,304				18
Interest income			204				87				134
			138,837				117,391				18
Operating expenses			16,474				12,785				29
DD&A expenses			32,286				30,036				7
G&A expenses			6,599				3,313				99
Equity tax			-				8,050				-
Foreign exchange loss			23,358				5,321				339
			78,717				59,505				32
Segment income before income taxes		$	60,120			$	57,886				4
Production
Oil and NGL's, bbl			1,249,581				1,203,615				4
Natural gas, Mcf			9,474				55,257				(83	)
Total production, BOE (1)			1,251,160				1,212,825				3
Average Prices
Oil and NGL's, per bbl		$	110.92			$	97.27				14
Natural gas, per Mcf		$	3.39			$	4.04				(16	)
Segmented Results of Operations (per BOE)
Oil and natural gas sales		$	110.80			$	96.72				15
Interest income			0.16				0.07				129
			110.96				96.79				15
Operating expenses			13.17				10.54				25
DD&A expenses			25.80				24.77				4
G&A expenses			5.27				2.73				93
Equity tax			-				6.64				-
Foreign exchange loss			18.67				4.39				(325	)
			62.91				49.07				28
Segment income before income taxes		$	48.05			$	47.72				1

 

(1)

Production represents production volumes NAR adjusted for inventory changes. NGL volumes are converted to BOE on a one-to-one basis with oil. Gas volumes are converted to BOE at the rate of 6 Mcf of gas per bbl of oil, based upon the approximate relative energy content of gas and oil, which rate is not necessarily indicative of the relationship of oil and gas prices.

 

For the first quarter of 2012, income before income taxes from Colombia amounted to $60.1 million compared with $57.9 million recorded for the comparable quarter in 2011. The increase is mainly due to higher oil sales due to increased production and higher prices and no Colombian equity tax expense, partially offset by increases in operating, DD&A and G&A expenses and foreign exchange losses.

For the first quarter of 2012, production of oil and NGLs , NAR and adjusted for inventory changes, was 1.3 MMbbl, slightly higher than the comparable quarter in 2011 of 1.2 MMbbl. Increased production from new producing wells was offset by the impact of OTA pipeline disruptions and increased inventory due to a change in the sales point. Increases in production resulted from the development of the Moqueta field with six producing wells and production in the Garibay Block from the Jilguero -1 and -2 wells.

 

 

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Production during the first quarter of 2012 was affected by approximately 26 days of oil delivery restrictions due to three separate OTA pipeline disruptions. We continued production at a reduced rate while the OTA pipeline was down, selling a portion of our oil through trucking and storing excess oil, resulting in a reduction in oil production, NAR and adjusted for inventory changes, of approximately 800 BOPD for the first quarter of 2012.

Also, as a result of entering into new oil sales and transportation agreements with Ecopetrol as of February 1, 2012, which changed the sales point of produced oil from Orito station to Tumaco Port, our reported oil inventory increased by approximately 121 Mbbl representing ownership of oil in the OTA pipeline and associated Ecopetrol owned facilities. This change in sales point and the increase in pipeline inventory had a corresponding one-time reduction in oil production, NAR and adjusted for inventory changes, of approximately 1,040 BOPD for the first quarter of 2012.

 

Production during the first quarter of 2011 was adversely affected by a maintenance program at the Tumaco Port offloading terminal between December 28, 2010 and February 7, 2011 which reduced sales through the OTA pipeline.

 

As a result of achieving gross field production of five MMbbl in our Costayaco field in the fourth quarter of 2009, we are subject to an additional government royalty payable. This royalty is calculated on 30% of field production revenue over an inflation adjusted trigger point. That trigger point for Costayaco oil was $32.61 in the first quarter of 2012. Production revenue for this calculation is based on production volumes net of other government royalty volumes. Average government royalties at Costayaco with gross production of 17,000 bbl of oil per day and $100 WTI price per bbl are approximately 27.6%, including the additional government royalty of approximately 20.2%. The ANH sliding scale royalty at 17,000 bbl of oil per day is approximately 9.2% and this royalty is deductible prior to calculating the additional government royalty.

Revenue and other income increased by 18% to $138.8 million in the first quarter of 2012 compared with $117.4 million in the comparable quarter in 2011. Oil and natural gas sales were positively affected by higher net realized oil prices in the first quarter of 2012 and increased production. The average net realized price for oil in the first quarter of 2012 was $110.92 per bbl, an increase of 14% from the comparable quarter in 2011.

O perating expenses for the first quarter of 2012 increased to $16.5 million, or $13.17 per BOE, from $12.8 million, or $10.54 per BOE in the comparable quarter in 2011. Operating expenses per BOE were higher in the first quarter of 2012 due to OTA pipeline oil transportation costs now recorded as operating costs and increased production at Moqueta and Jilguero with higher per BOE operating costs. Under the new sales agreements with Ecopetrol, effective February 1, 2012, our oil sales point moved from Orito to the Port of Tumaco. OTA transportation costs were previously factored into the price we received for oil, but are now invoiced separately and included in operating costs. This is expected to result in an increase in OTA oil transportation costs of $3.49 per bbl. The effect of increased transportation costs was partially offset by a decrease in trucking costs as compared to the same period in 2011. Workover costs were $0.25 per BOE higher than the comparable quarter in 2011 due to increased activity in the Costayaco field .

 

For the first quarter of 2012, DD&A expenses increased to $32.3 million from $30.0 million in the comparable quarter in 2011 due to higher production levels. DD&A expenses were $25.80 per BOE which was consistent with $24.77 per BOE in the comparable quarter in 2011. Increased costs in our depletable pools were offset by increased reserves.

G&A   expenses for the first quarter of 2012 increased to $6.6 million ($5.27 per BOE) from $3.3 million ($2.73 per BOE) in the comparable quarter in 2011. The increase was mainly due to increased salaries and stock-based compensation resulting from an increased headcount and increased consulting fees related to expanded operations and a full quarter of Petrolifera’s G&A expenses.

Equity tax of $8.1 million in the three months ended March 31, 2011 represents a Colombian tax of 6% on a legislated measure which is based on our Colombian segment’s balance sheet equity at January 1, 2011. Equity tax is assessed every four years.

 

The results for the first quarter of 2012 included a foreign exchange loss of $23.4 million, of which $21.4 million was an unrealized non-cash foreign exchange loss on the translation of Colombian peso denominated current and deferred taxes to the U.S. dollar functional currency. For the comparable quarter in 2011, the foreign exchange loss was $5.3 million, of which $4.4 million was unrealized. The Colombian Peso strengthened by 8% and 2% against the U.S. dollar in the first quarter of 2012 and 2011, respectively, resulting in the unrealized foreign exchange loss. A strengthening in the Colombian peso against the U.S. dollar results in foreign exchange losses, estimated at $104,000 for each one peso decrease in the exchange rate of the Colombian peso to one U.S. dollar.

Capital Program - Colombia

 

Capital expenditures in our Colombian segment during the first quarter of 2012 were $20.3 million, a decrease of 52% from the comparable quarter in 2011. The following table provides a breakdown of capital expenditures during the first quarter of 2012 and 2011:

		Three Months Ended March 31,
(Millions of U.S. Dollars)		2012				2011
Drilling and completion		$	10.5			$	30.4
Facilities and equipment			1.8				5.1
G&G			7.1				0.9
Other			0.9				5.9
		$	20.3			$	42.3

The significant elements of our first quarter 2012 Capital Program in Colombia were as follows:

·

Costayaco Field, Chaza Block (100% working interest and operator)

The Costayaco-15 water injector well was spud on January 25, 2012 and reached a total depth of 10,069 feet. This well is intended to assist in maintaining reservoir pressure .

 

 

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·

Moqueta Field, Chaza Block (100% working interest and operator)

We initiated pre-drilling activities on the Moqueta-7 development well. This well is expected to be drilled from the Moqueta-4 surface location in order to further investigate the down dip limits of the oil columns encountered in the Villeta U, Villeta T and Caballos formation reservoirs. We plan to target the oil water contact with the Moqueta-7 development well, which will either be used as an oil producer or water injector for pressure support depending on the well results.

 

We completed 3D seismic acquisition over the Moqueta structure and interpretation is ongoing. Combining the results of the Moqueta-7 well with the seismic interpretation will aid in the full field development plan.

 

·

Verdeyaco Field, Guayuyaco Block (70% working interest and operator)

We completed the acquisition of 3D seismic.

·

Azar Block (40% working interest and operator)

We commenced civil construction for the La Vega Este-1 oil exploration well.

Outlook - Colombia

The 2012 capital program in Colombia is $196 million with $107 million allocated to drilling, $37 million to facilities and pipelines and $52 million for G&G expenditures.

Our planned work program for the remainder of 2012 in Colombia includes the following:

Exploration Activities

·

Together with our partner, we are evaluating options for testing additional reservoir intervals, potentially drilling an appraisal well and implementing an early production program on the Ramiriqui-1 exploration well on the Llanos -22 Block. We are awaiting approval from the ANH of the transfer of our 45% working interest in this Block.

·

On the Azar Block, a drilling rig was mobilized to the La Vega Este-1 wellsite. The La Vega Este-1 well is expected to spud in the second quarter of 2012.

·

We expect to drill the Bordon-1 oil exploration well on the Garibay Block and the Verdeyaco-1 oil exploration well on the Guayuyaco Block in the second half of 2012.

Development and Delineation Activities

In the Costayaco field, we plan to drill three additional development wells: the Costayaco -7ST water injector well; and two production wells, Costayaco -16 and -17. In the Moqueta field, we plan to drill two development wells: Moqueta -7; and Moqueta -8, a further water injector well. We also plan to drill the Brillante -3 natural gas delineation well in the Sierra Nevada Block.

Facilities and Equipment

 

Facilities work will include continued electrification of the Moqueta fields, water injection facilities and a production battery at the Jilguero oil discovery.

G&G

 

G&G work will consist of 3D and 2D seismic planned for the Llanos 22, Chaza, Garibay, Piedemonte Norte, Piedemonte Sur, Putumayo -1 and Putumayo -10 Blocks to mature leads and prospects for drilling in 2013 and beyond.

 

 

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Segmented Results – Argentina

 

		Three Months Ended March 31,
		2012				2011				% Change
(Thousands of U.S. Dollars)
Oil and natural gas sales		$	15,369			$	4,992				208
Interest income			47				-				-
			15,416				4,992				209
Operating expenses			7,346				3,547				107
DD&A expenses			5,925				1,147				417
G&A expenses			2,251				918				145
Foreign exchange loss (gain)			371				(190	)			295
			15,893				5,422				193
Segment loss before income taxes		$	(477	)		$	(430	)			11
Production
Oil and NGL's, bbl			199,300				89,838				122
Natural gas, Mcf			363,473				39,060				831
Total production, BOE (1)			259,879				96,348				170
Average Prices
Oil and NGL's, per bbl		$	70.87			$	54.54				30
Natural gas, per Mcf		$	3.42			$	2.37				44
Segmented Results of Operations (per BOE)
Oil and natural gas sales		$	59.14			$	51.81				14
Interest income			0.18				-				-
			59.32				51.81				14
Operating expenses			28.27				36.81				(23	)
DD&A expenses			22.80				11.90				92
G&A expenses			8.66				9.53				(9	)
Foreign exchange loss (gain)			1.43				(1.97	)			173
			61.16				56.27				9
Segment loss before income taxes		$	(1.84	)		$	(4.46	)			(59	)

 

(1)

Production represents production volumes NAR adjusted for inventory changes. NGL volumes are converted to BOE on a one-to-one basis with oil. Gas volumes are converted to BOE at the rate of 6 Mcf of gas per bbl of oil, based upon the approximate relative energy content of gas and oil, which rate is not necessarily indicative of the relationship of oil and gas prices.

 

For the first quarter of 2012, loss before income taxes in Argentina amounted to $0.5 million compared with $0.4 million in the comparable quarter in 2011. In the first quarter of 2012, increased oil and natural gas sales were more than offset by increased operating, DD&A and G&A expenses and a foreign exchange loss. Results of the Argentina segment were significantly affected by the inclusion of Petrolifera’s results. The acquisition of Petrolifera on March 18, 2011, added seven blocks in the Neuquen Basin, including production from four blocks, to the Argentina segment. The impact of Petrolifera on the financial and operational results of the Argentina segment is discussed below.

 

Oil and NGL production,   NAR and adjusted for inventory changes, increased 122% to 0.2 MMbbl for the first quarter of 2012 compared with 0.1 MMbbl for the comparable period in 2011. The increase was due a full quarter of Petrolifera production of 0.1 MMbbl, NAR and adjusted for inventory changes, in the first quarter of 2012 compared with 13 days of post-acquisition Petrolifera production in the comparable quarter.

 

Natural gas sales NAR relate solely to Petrolifera’s properties. Natural gas sales amounted to 0.4 Bcf in the first quarter of 2012.

 

Overall, total production of oil and gas from the Argentina segment increased by 170% to 0.3 MMBOE in the first quarter of 2012.

 

Revenue and other income increased by 209% to $15.4 million in the first quarter of 2012 compared with $5.0 million in the comparable quarter in 2011. The increase was primarily due to higher production due to the inclusion of Petrolifera’s oil and gas production and increased prices. Average oil prices increased by 30% in the first quarter of 2012 compared with the comparable quarter in 2011.

Due to the Argentine regulatory regime, the average oil price we received for production from our blocks during the first quarter of 2012 was $70.87 per bbl. Currently most oil and gas producers in Argentina are operating without sales contracts for periods longer than several months. We are continuing deliveries to refineries and are negotiating a price for those deliveries on a regular and short-term basis. We have recently been able to negotiate higher oil prices with refineries as a result of the Argentine government’s decision to allow an increase in domestic petroleum product prices.

 

Operating expenses in the first quarter of 2012 amounted to $7.3 million compared with $3.5 million in the comparable quarter in 2011. Petrolifera’s operating expenses were $4.8 million in the first quarter of 2012 compared with $0.6 million in the comparable quarter in 2011. Operating expenses were $28.27 per BOE in the first quarter of 2012 compared with $36.81 per BOE in the comparable quarter in 2011. Workover costs decreased by $2.61 per BOE as a result of more workovers being performed in the comparable quarter in 2011, particularly in the Palmar Largo Block. Other operating costs decreased as a result of a higher percentage of production being from blocks with lower per BOE transportation and operating costs, such as the Puesto Morales Block.

 

 

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DD&A   expenses in the first quarter of 2012 were $5.9 million compared with $1.1 million in the comparable quarter in 2011. Petrolifera’s DD&A expense was $3.6 million in the first quarter of 2012. DD&A expenses per BOE in the first quarter of 2012 were $22.80, significantly higher than DD&A expenses in the comparable quarter of $11.90 due to a reduction of reserves at December 31, 2011.

G&A   expenses in the first quarter of 2012 were $2.3 million ($8.66 per BOE) compared with $0.9 million ($9.53 per BOE) in the comparable quarter in 2011. The increase was primarily due to the inclusion of Petrolifera’s G&A and increased headcount and consulting fees as a result of expanded operations.

 

Capital Program - Argentina

 

Capital expenditures in our Argentine segment during the first quarter of 2012 were $14.1 million, including drilling expenditures of $11.5 million, G&G expenses of $1.4 million, facilities expenses of $0.6 million and other expenditures of $0.6 million. In the comparative quarter in 2011, c apital expenditures in our Argentine segment were $11.6 million mainly relating to Valle Morado drilling for $13.5 million, El Chivil facilities for $0.7 million and Santa Victoria expenditures of $0.2 million offset by farmout proceeds of $3.3 million.

 

The significant elements of our first quarter 2012 Capital Program in Argentina were as follows:

·

Surubi Block (85% working interest and operator)

We completed drilling and tested the Proa -2 appraisal well, the second well in the Proa oil field. The successful well encountered approximately 31 meters of net pay in two Palmar Largo intervals. Production tests were performed on the two intervals independently, resulting in combined natural flow rates of 6,300 BOPD gross. The well went on production in the second quarter of 2012 at a constrained rate of approximately 2,000 BOPD gross to further analyze reservoir performance while additional transportation capacity is evaluated.

·

Puesto Morales Block (100% working interest and operator)

The PMN-1121 development well spud during December 2011 and is now on production. It reached a total depth of 1,700 meters and encountered oil in the Sierras Blancas and Loma Montosa formations. Flow rate tested at 128 BOPD. We also completed workovers on this Block.

·

Rinconada Sur Block (100% working interest and operator)

The R.-1036 development well spud in December 2011 and is now on production. It reached a total depth of 1,200 meters and encountered oil in the Sierras Blancas formation. Flow rate tested at 145 BOPD. The R.x-1059 exploration well spud in January 2012 and reached a total depth of 1,148 meters. The well is currently shut-in for further evaluation.

·

Rinconada Norte Block (35% non-operated working interest)

The RN x-1000 and RN x-1001 exploration wells were shut in after reaching total depths of 1,050 meters and 1,250 meters, respectively.

Outlook – Argentina

 

The 2012 capital program in Argentina is $47 million with $33 million allocated to drilling, $7 million to facilities and pipelines, and $7 million to G&G expenditures.

 

Our planned work program for the remainder of 2012 in Argentina includes drilling an oil exploration well on each of the Rinconada Sur Block and the Puesto Guevara Block, six gross development wells on the Puesto Morales Block and conducting nine workovers on existing wells in Argentina. The intention of the drilling program is to improve recovery of oil in place and grow production. We also plan to drill and are also evaluating the potential to drill a gas exploration well in the Santa Victoria Block in early 2013.

 

Segmented Results – Peru

 

		Three Months Ended March 31,
		2012				2011				% Change
(Thousands of U.S. Dollars)
Interest income		$	15			$	-				-
Operating expenses		$	81			$	64				26
DD&A expenses			115				31,933				-
G&A expenses			616				565				9
Foreign exchange (gain) loss			(70	)			63				(212	)
			742				32,625				(98	)
Segment loss before income taxes		$	(727	)		$	(32,625	)			(98	)

DD&A expenses in the first quarter of 2011 included a $31.9 million ceiling test impairment in our Peru cost center relating to seismic and drilling costs related to a dry hole.

 

 

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Capital Program – Peru

 

Capital expenditures in our Peruvian segment during the first quarter of 2012 were $16.7 million, including G&G and acquisition expenses of $14.5 million and other expenditures of $2.2 million. I n the comparative quarter, c apital expenditures in our Peruvian segment were $14.3 million mainly related to the drilling of Kanatari -1 on Block 128.

 

The significant elements of our first quarter 2012 Capital Program in Peru were as follows:

·

Block 95 (60% working interest and operator)

On January 17, 2012, PeruPetro S.A. signed the assignment documents for Block 95, officially transferring 60% of the block to us. A drilling site location has been identified for the first exploration well on Block 95 and civil construction of a platform and dock facility started in the first quarter of 2012. The block continues to be in Force Majeure.

 

·

Blocks 107 and 133 (100% working interest and operator)

We acquired an over-riding royalty interest in Block 107 that was held by a third party. Permitting for drilling on Block 107 is advancing, with drilling expected to begin in 2013. G&G studies are ongoing on the adjacent Block 133 where we expect to acquire airborne gravity magnetics data this year.

·

Blocks 123 and 129 (20% non-operated working interest)

 

The acquisition of an infill 2D seismic program began in the first quarter of 2012.

 

  Outlook - Peru

 

The 2012 capital program in Peru is $78 million with $47 million allocated to drilling, $1 million to facilities and pipelines and $30 million for G&G expenditures.

Our planned work program for the remainder of 2012 in Peru includes drilling one gross exploration well on Block 95, pre drilling activities on Block 107 and an infill 2D seismic program for Blocks 123 and 129.

Results - Corporate Activities and Operations in Brazil

 

		Three Months Ended March 31,
		2012				2011				% Change
(Thousands of U.S. Dollars)
Oil and natural gas sales		$	1,246			$	-				-
Interest income			437				136				222
			1,683				136				-
Operating expenses			585				-				-
DD&A expenses			22,041				241				-
G&A expenses			6,434				8,842				(27	)
Financial instruments gain			-				(230	)			-
Gain on acquisition			-				(24,300	)			-
Foreign exchange loss			717				5				-
			29,776				(15,442	)			(293	)
Segment (loss) income before income taxes		$	(28,093	)		$	15,578				(280	)

 

Corporate activities include costs associated with our headquarters in Calgary, Alberta, Canada, and expenses related to technical reviews, business development and compliance and reporting under securities regulations.

 

Oil and natural gas sales and o perating expenses in the first quarter of 2012 represented sales and operating expense from Block 155 in the onshore Recôncavo Basin of Brazil. We began earning revenue from this block on June 15, 2011, the date regulatory approval was received for the purchase of our 70% participating interest in that block.

DD&A expenses in the first quarter of 2012 of $22.0 million included a ceiling test impairment loss of $20.2 million in our Brazil cost center. The impairment loss related to seismic and drilling costs on Block BM-CAL-10. The farmout agreement for that block terminated during the first quarter of 2012 when we provided notice that we would not enter into the second exploration period. DD&A expense also included $1.6 million of depletion and depreciation in Brazil primarily related to Block 155 which began production mid-2011.

 

 

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G&A   expenses in the first quarter of 2012 were $6.4 million compared with $8.8 million in the comparable quarter in 2011. In 2011, G&A expenses included $1.2 million related to the acquisition of Petrolifera. In 2012, increases in salary, stock-based compensation expense and consulting charges due to expanded operations, were offset by an increase in the amount of costs recovered from business segments or capitalized in Brazil.

 

Gain on acquisition in the three months ended 2011 related to the acquisition of Petrolifera. The gain reflected the impact on Petrolifera’s pre-acquisition market value of their lack of liquidity and capital resources required to maintain production and reserves and further develop and explore their inventory of prospects.

 

The foreign exchange loss resulted from the translation of foreign currency denominated transactions to U.S. dollars.

 

Capital Program – Corporate and Brazil

 

Capital expenditures in Corporate and Brazil during the first quarter of 2012 were $36.5 million, including $23.8 million paid in relation to Block BM-CAL-10, $11.3 million of drilling expenditures and $1.4 million of other expenditures. I n the comparative quarter in 2011, c apital expenditures were $0.9 million.

 

The significant elements of our first quarter 2012 Capital Program in Brazil were as follows:

·

Blocks 129, 142, 155 and 224 (70% working interest and operator)

The 3-GTE-03D-BA and 3-GTE-4DPA-BA appraisal wells on Block 155 spud on December 1, 2011 and January 8, 2012. Additionally, we purchased long-lead inventory items for these wells. Pre-drilling activities for the 1-GTE-6-BA exploration well on Block 142 also commenced in the first quarter of 2012.

 

·

BM-CAL-7 Block, Camamu Basin   (10% non-operated working interest)

During the first quarter of 2012, we received regulatory approval from the ANP for the Block BM-CAL-7 farmout agreement. Purchase consideration of $0.7 million was paid and the assignment became effective on April 3, 2012 .

 

·

BM-CAL-10 Block, Camamu Basin

We recognized $23.8 million of capital expenditures in relation to the Block BM-CAL-10 farmout agreement upon our decision to withdraw from this agreement.

Outlook – Brazil

 

The 2012 capital program in Brazil is $122 million with $107 million allocated to drilling and acquisition costs, $12 million to facilities and pipelines and $3 million to G&G expenditures.

Our planned work program for the remainder of 2012 in Brazil includes:

 

·

The 3-GTE-03D-BA and 3-GTE-4DPA-BA appraisal wells on Block 155 are expected to be tested and on production in mid-2012. Additionally, we are preparing the necessary ANP documents for the declaration of commerciality and the development plan for the field.

·

Also on Block 155, we expect to commence drilling the 1-GTE-5-BA oil exploration well in the second half of 2012.

·

On Block 142, drilling of the first horizontal sidetrack well, planned to be drilled from the 1-GTE-01-BA pilot hole, is expected to commence in mid-2012, subject to rig availability. This will be the first of three horizontal sidetrack wells that we expect to drill to test the productivity of the light oil sandstone reservoir targets in the Recôncavo Basin. Completion of the 1-GTE-01-BA well is pending the results of the horizontal leg drilling.

·

Additionally, we expect to drill the 1-GTE-6-BA oil exploration well from the 1-GTE-02-BA well bore on Block 129. We anticipate the horizontal sidetrack operations will start in the fourth quarter of 2012, with completion pending the results of the horizontal leg.   Completion of the 1-GTE-02-BA well is pending the results of the horizontal leg drilling.

·

Planned facilities work includes additional tankage, pipelines and gas facilities on Block 155.

·

On January 20, 2012, we entered into a purchase and sale agreement to acquire the remaining 30% participating interest in Blocks 129, 142, 155 and 224 from our partner. The completion of the purchase is subject to ANP approval.

 

Liquidity and Capital Resources

 

At March 31, 2012, we had cash and cash equivalents of $230.1 million compared with $351.7 million at December 31, 2011.

We believe that our cash position and cash generated from operations will provide us with sufficient liquidity to meet our strategic objectives and planned capital program for the current year, at current oil and production levels. In accordance with our investment policy, cash balances are held in our primary cash management bank, HSBC Bank plc., in interest earning current accounts or are invested in U.S. or Canadian government-backed federal, provincial or state securities with the highest credit ratings and short-term liquidity. We believe that our current financial position provides us the flexibility to respond to both internal growth opportunities and those available through acquisitions.

 

At March 31, 2012, 79% of our cash and cash equivalents was held by our foreign subsidiaries. This balance is not available to fund domestic operations unless funds are repatriated. We do not intend to repatriate funds, but if we did we would have to accrue and pay taxes.

 

 

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Effective July 30, 2010, we established a credit facility with BNP Paribas for a three-year term which may be extended or amended by agreement between the parties. This reserve based facility has a maximum borrowing base of up to $100 million and is supported by the present value of our Colombian petroleum reserves of two of our subsidiaries with operating branches in Colombia – Gran Tierra Energy Colombia Ltd. and Solana Petroleum Exploration (Colombia) Ltd. The initial committed borrowing base is $20 million. Amounts drawn down under the facility bear interest at the U.S. dollar LIBOR rate plus 3.5%. In addition, a stand-by fee of 1.5% per annum is charged on the unutilized balance of the committed borrowing base and is included in G&A expenses. Under the terms of the facility, we are required to maintain and were in compliance with certain financial and operating covenants. At March 31, 2012 and December 31, 2011, we had not drawn down any amounts under this facility. In February 2012, BNP Paribas announced the sale of its North American reserve based lending business to Wells Fargo Bank NA. This credit facility is expected to be part of that sale. Closing documents are being processed, and the sale is expected to be finalized in the second quarter of 2012.

 

As part of the acquisition of Petrolifera, we assumed a reserve backed credit facility with outstanding balance as at the acquisition date of $31.3 million. The outstanding balance was repaid when the Argentine restriction preventing its repayment expired on August 5, 2011. The credit facility bore interest at LIBOR plus 8.25% and was partially secured by the pledge of the shares of Petrolifera's subsidiaries.

Cash Flows

 

During the first quarter of 2012, our cash and cash equivalents decreased by $121.6 million as a result of cash used in operating activities of $13.5 million, cash used in investing activities of $109.0 million, partially offset by cash provided by financing activities of $0.9 million.

 

Cash used in operating activities in the first quarter of 2012 was positively affected by increased production and oil prices; however, these positive contributions were offset by increased operating and G&A expenses and a $92.4 million increase in assets and liabilities from operating activities. The main changes in assets and liabilities from operating activities were as follows: accounts receivable increased by $76.2 million due to due to increased sales and the timing of collection of receivables; inventory increased by $7.2 million due to the new transportation agreement in Colombia; accounts payable and accrued liabilities decreased by $21.0 million; partially offset by an increase in taxes payable of $24.8 million due to increased taxable income in Colombia. The decrease in accounts payable and accrued liabilities was due to a $19.0 million reduction in royalties payable due to royalty payments and a $13.7 million reduction in VAT payable, partially offset by a $12.0 million increase in capital expenditure related liabilities. Capital expenditure related accrued liabilities included $23.8 million related to the Block BM-CAL-10 at March 31, 2012.

Cash outflows from investing activities in the first quarter of 2012 included capital expenditures of $78.0 million and an increase in restricted cash of $31.0 million.

 

Cash provided by financing activities in the first quarter of 2012 related to proceeds from issuance of common shares.

 

Off-Balance Sheet Arrangements

 

As at March 31, 2012, we had no off-balance sheet arrangements.

 

Contractual Obligations

 

The following is a schedule by year of purchase obligations, future minimum payments for firm agreements and leases that have initial or remaining non-cancellable lease terms in excess of one year as of March 31, 2012:

		As at March 31, 2012
		Payments Due in Period
		Total				Less than 1 Year				1 to 3 years				3 to 5 years				More than 5 years
(Thousands of U.S. Dollars)
Oil transportation services		$	36,922			$	13,072			$	7,100			$	7,100			$	9,650
Drilling and geological and geophysical			58,336				47,086				11,250				-				-
Completions			24,821				19,201				5,620				-				-
Facility construction			41,389				24,557				16,832				-				-
Operating leases			7,661				3,085				3,142				1,434				-
Software and telecommunication			4,790				3,811				979				-				-
Consulting			1,989				1,989				-				-				-
Total		$	175,908				112,801				44,923				8,534				9,650

 

Contractual commitments increased from $146.2 million at December 31, 2011 mainly as a result of increased drilling cost commitments for Block 95 in Peru and the Recôncavo Basin Blocks in Brazil and increased facilities cost commitments for the Puesto Morales Block in Argentina.

At March 31, 2012, we had also provided promissory notes totalling $24.5 million as security for letters of credit relating to work commitment guarantees contained in exploration contracts.

 

Related Party Transactions

 

On January 12, 2011, we entered into an agreement to sublease office space to a company of which our President and Chief Executive Officer serves as an independent director. The term of the sublease runs from February 1, 2011 to January 30, 2013 and the sublease payment is $4,400 per month plus approximately $5,600 of operating and other expense.

 

 

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On August 3, 2010, we entered into a contract related to the Peru drilling program with a company for which one of our directors is a shareholder and director. For the three months ended March 31, 2012, $nil million was incurred and capitalized under this contract (three months ended March 31, 2011 - $2.0 million) and at March 31, 2012, $nil was included in accounts payable related to this contract (December 31, 2011 - $nil).

On February 1, 2009, we entered into a sublease for office space with a company, of which one of our directors is a shareholder and director. The term of the sublease ran from February 1, 2009 to August 31, 2011 and the sublease payment was $8,000 per month plus approximately $4,700 for operating and other expenses.

Critical Accounting Policies and Estimates

 

Our critical accounting policies and estimates are disclosed in Item 7 of our 2011 Annual Report on Form 10-K, filed with the SEC on February 27, 2012, and have not changed materially since the filing of that document.

 

Item 3 - Quantitative and Qualitative Disclosures About Market risk

 

Our principal market risk relates to oil prices. Most of our revenues are from oil sales at prices which are defined by contract relative to WTI or Brent and adjusted for transportation and quality each month. In Argentina, a further discount factor which is related to a tax on oil exports establishes a common pricing mechanism for all oil produced in the country, regardless of its destination.

 

Foreign currency risk is a factor for our company but is ameliorated to a large degree by the nature of expenditures and revenues in the countries where we operate. We have not engaged in any formal hedging activity with regard to foreign currency risk. Our reporting currency is U.S. dollars and essentially 100% of our revenues are related to the U.S. dollar price of WTI or Brent oil.

 

In Colombia, we receive 100% of our revenues in U.S. dollars and the majority of our capital expenditures are in U.S. dollars. In Argentina and Brazil, prices for oil are in U.S. dollars, but revenues are received in local currency translated according to current exchange rates. The majority of our capital expenditures within Argentina and Brazil are based on U.S. dollar prices, but are paid in local currency translated according to current exchange rates. The majority of our capital expenditures in Peru are in U.S. dollars. The majority of office expenditures and income and value added taxes in all locations are in local currency. While we operate in South America exclusively, the majority of our acquisition expenditures have been valued and paid in U.S. dollars.

 

Additionally, unrealized foreign exchange gains and losses result from the fluctuation of the U.S. dollar to the Colombian peso due to our current and deferred tax liabilities, monetary liabilities, which are mainly denominated in the local currency of the Colombian foreign operations. As a result, a foreign exchange gain or loss must be calculated on conversion to the U.S. dollar functional currency. A strengthening in the Colombian peso against the U.S. dollar results in foreign exchange losses, estimated at $104,000 for each one peso decrease in the exchange rate of the Colombian peso to one U.S. dollar.

 

We consider our exposure to interest rate risk to be immaterial. Our interest rate exposures primarily relate to our investment portfolio. Our investment objectives are focused on preservation of principal and liquidity. By policy, we manage our exposure to market risks by limiting investments to high quality bank issues at overnight rates, or government securities of the United States or Canadian federal governments such as Guaranteed Investment Certificates or Treasury Bills. A 10% change in interest rates would not have a material effect on the value of our investment portfolio. We do not hold any of these investments for trading purposes. We do not hold equity investments, and we have no debt.

Item 4. - Controls and Procedures

 

(a) Evaluation of Disclosure Controls and Procedures

 

Disclosure Controls and Procedures

 

We have established disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, or Exchange Act). Our management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report, as required by Rule l3a-15(e) of the Exchange Act. Based on their evaluation, our principal executive and principal financial officers have concluded that Gran Tierra's disclosure controls and procedures were effective as of March 31, 2012 to provide reasonable assurance that the information required to be disclosed by Gran Tierra in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting during the quarter ended March 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II

 

Item 1. Legal Proc eedin gs

 

Gran Tierra is subject to a third party 10% net profits interest on 50% of Gran Tierra’s production from the Chaza Block that arises from the original acquisition in 2006 of 50% of Gran Tierra’s interest in the Chaza Block Contract. There is currently a disagreement between Gran Tierra and the third party as to the calculation of the net profits interest. Gran Tierra and the third party have agreed to resolve this issue through arbitration. An arbitration hearing was heard in Texas, in accordance with the rules of the American Arbitration Association, in the fourth quarter of 2011. We now expect to receive the arbitrator’s decision in the second quarter of 2012. At this time no amount has been accrued in the financial statements as Gran Tierra does not consider it probable that a loss will be incurred. The disputed amount at March 31, 2012 is $10.9 million. If Gran Tierra is unsuccessful in arbitration this would also increase future net profit interests payable to this third party.

 

 

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Gran Tierra’s production from the Costayaco field is subject to an additional royalty that applies when cumulative gross production from a commercial field is greater than five million barrels. This additional royalty is calculated on the difference between a trigger price defined by the Agencia Nacional de Hidrocarburos (National Hydrocarbons Agency) (“ANH”) and the sales price. The ANH has requested that the additional compensation be paid with respect to production from wells relating to the Moqueta discovery and has initiated a noncompliance procedure under the Chaza Contract. The Moqueta discovery is not located in the Costayaco Exploitation Area. Further, Gran Tierra views the Costayaco field and the Moqueta discovery as two clearly separate and independent hydrocarbon accumulations. Therefore, it is Gran Tierra’s view that it is clear that, pursuant to the Chaza Contract, the additional compensation payments are only to be paid with respect to production from the Moqueta wells when the accumulated oil production from any new Exploitation Area created with respect to the Moqueta discovery exceeds five million barrels. As at March 31, 2012, total cumulative production from the Moqueta field was 0.4 MMbbl. The estimated compensation which would be payable on cumulative production to date if the ANH’s interpretation is successful is $7.4 million. At this time no amount has been accrued in the financial statements as Gran Tierra does not consider it probable that a loss will be incurred.

We have several other lawsuits and claims pending for which we currently cannot determine the ultimate result. We record costs as they are incurred or become determinable. We believe the resolution of these matters would not have a material adverse effect on our consolidated financial position or results of operations.

 

Item 1A. Risk F acto rs

 

The risks relating to our business and industry, as set forth in our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the Securities and Exchange Commission on February 27, 2012, are set forth below and are unchanged substantively at March 31, 2012, other than those designated by an asterisk “*”.

 

Risks Related to Our Business

 

Our Lack of Diversification Will Increase the Risk of an Investment in Our Common Stock.

 

Our business focuses on the oil and gas industry in a limited number of properties in Colombia, Argentina, Peru, and Brazil. Most of our production is in one basin in Colombia and two basins in Argentina. As a result, we lack diversification, in terms of both the nature and geographic scope of our business. Accordingly, factors affecting our industry or the regions in which we operate, including the geographic remoteness of our operations and weather conditions, will likely impact us more acutely than if our business was more diversified.

 

*We May Encounter Difficulties Storing and Transporting Our Production, Which Could Cause a Decrease in Our Production or an Increase in Our Expenses.

 

To sell the oil and natural gas that we are able to produce, we have to make arrangements for storage and distribution to the market. We rely on local infrastructure and the availability of transportation for storage and shipment of our products, but infrastructure development and storage and transportation facilities may be insufficient for our needs at commercially acceptable terms in the localities in which we operate. This could be particularly problematic to the extent that our operations are conducted in remote areas that are difficult to access, such as areas that are distant from shipping and/or pipeline facilities. In certain areas, we may be required to rely on only one gathering system, trucking company or pipeline, and, if so, our ability to market our production would be subject to their reliability and operations. These factors may affect our ability to explore and develop properties and to store and transport our oil and gas production, and may increase our expenses. Furthermore, future instability in one or more of the countries in which we operate, weather conditions or natural disasters, actions by companies doing business in those countries, labor disputes or actions taken by the international community may impair the distribution of oil and/or natural gas and in turn diminish our financial condition or ability to maintain our operations.

 

The majority of our oil in Colombia is delivered by a single pipeline to Ecopetrol and sales of oil could be disrupted by damage to this pipeline or displaced by Ecopetrol’s use of the pipeline itself. Starting in February 2012, we are operating under a new transportation contract with Ecopetrol which changes the point at which Ecopetrol takes delivery of our oil. Previously, Ecopetrol took delivery of our oil at the beginning of the export pipeline. Under the new transportation contract, Ecopetrol takes delivery at the end of the export pipeline. This creates a risk of loss of oil due to sabotage by guerrillas or theft from the pipeline which may result in reduced revenues and increased clean-up or third party costs. We have attempted to mitigate the risk of increased costs with insurance and are investigating potential ways to mitigate the reduced revenue risk. Ecopetrol maintains responsibility for clean-up of any spilled oil and for pipeline repair.

 

Problems with these pipelines can cause interruptions to our producing activities if they are for a long enough duration that our storage facilities become full. For example, we experienced disruptions in transportation on this pipeline in March and April of 2008, June, July and August of 2009, June, August, and September 2010, February 2011 and February and March 2012 as a result of sabotage by guerrillas. In addition, there is competition for space in these pipelines, and additional discoveries in our area of operations by other companies could decrease the pipeline capacity available to us. Trucking is an alternative to transportation by pipeline; however, it is generally more expensive and carries higher safety risks for us, our employees and the public.

 

As some of our oil production in Argentina is trucked to a local refinery, sales of oil in the Noroeste basin can be delayed by adverse weather and road conditions, particularly during the months November through February when the area is subject to periods of heavy rain and flooding. While storage facilities are designed to accommodate ordinary disruptions without curtailing production, delayed sales will delay revenues and may adversely impact our working capital position in Argentina. Furthermore, a prolonged disruption in oil deliveries could exceed storage capacities and shut-in production, which could have a negative impact on future production capability.

 

*Guerrilla Activity in Colombia Could Disrupt or Delay Our Operations and We Are Concerned About Safeguarding Our Operations and Personnel in Colombia.

 

Over the years, our profile in Colombia has increased which creates a greater risk for us and our employees to be targeted by guerrilla or other criminal groups. Despite significant recent security gains, Colombia remains a country where safety is a significant concern. For over 40 years, the government has been engaged in a civil war with two main Marxist guerrilla groups: the Revolutionary Armed Forces of Colombia (FARC) and the National Liberation Army (ELN). Both of these groups have been designated as terrorist organizations by the United States and the European Union. In recent years, however, the government has successfully dissolved the AUC militia, a paramilitary group that originally sprouted up to combat the FARC and ELN. The dissolved AUC militia members have reorganized in the form of criminal gangs.

 

We operate principally in the Putumayo basin in Colombia, and have properties in other basins, including the Catatumbo, Cauca, Llanos, Middle Magdalena and Lower Magdalena basins. The Putumayo and Catatumbo regions have been prone to guerrilla activity. In 1989, our predecessor company’s facilities in one field were attacked by guerrillas and operations were briefly disrupted. Again in October 2010, two of our sites in the Putumayo/Cauca were attacked by FARC guerrillas causing some disruption to operations. Pipelines have also been targets, including the Ecopetrol-operated OTA pipeline which transports oil from the Putumayo region. In March and April of 2008, in June, July, August and October of 2009, in June, August, and September 2010, in February 2011 and in February and March 2012, sections of the Trans Andean pipeline were sabotaged by guerrillas, which temporarily reduced our deliveries to Ecopetrol during the affected periods.

 

Continuing attempts by the Colombian government to reduce or prevent guerrilla activity may not be successful and guerrilla activity may disrupt our operations in the future. There can also be no assurance that we can maintain the safety of our field and Bogota head office personnel or operations in Colombia or that this violence will not affect our operations in the future and cause significant loss.

 

 

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Our Business May Suffer If We Do Not Attract and Retain Talented Personnel.

 

Our success will depend in large measure on the abilities, expertise, judgment, discretion, integrity and good faith of our executive team and other personnel in conducting our business. The loss of any of these individuals or our inability to attract suitably qualified individuals to replace any of them could materially adversely impact our business. We are experiencing difficulties in finding and retaining suitably qualified staff in certain jurisdictions, particularly in Brazil, Argentina, Peru and Calgary, where experienced personnel in our industry are in high demand and competition for their talents is intense.

 

Our success depends on the ability of our management and employees to interpret market and geological data successfully and to interpret and respond to economic, market and other business conditions to locate and adopt appropriate investment opportunities, monitor such investments and ultimately, if required, successfully divest such investments. Further, our key personnel may not continue their association or employment with us and we may not be able to find replacement personnel with comparable skills. If we are unable to attract and retain key personnel, our business may be adversely affected.

 

*Our Oil Sales Will Depend on a Relatively Small Group of Customers, Which Could Adversely Affect Our Financial Results.

 

Oil sales in Colombia are mainly to Ecopetrol. While oil prices in Colombia are related to international market prices, lack of competition and reliance on a limited number of customers for sales of oil may diminish prices and depress our financial results.

 

The entire Argentine domestic refining market is small and export opportunities are limited by available infrastructure. As a result, our oil and gas sales in Argentina will depend on a relatively small group of customers, and currently, on two significant customers. The lack of competition in this market could result in unfavorable sales terms which, in turn, could adversely affect our financial results. Currently all operators in Argentina are operating without long-term sales contracts. We cannot provide any certainty as to when the situation will be resolved or what the final outcome will be.

 

In Brazil, there are a number of potential customers for our oil, and we are working to establish relationships with as many as possible to ensure a stable market for our oil. Currently essentially all of our production in Brazil is sold to Petrobras. Petrobras’ refinery in the area of our operations has had some technical difficulties which have restricted its ability to receive deliveries. Our second option in the area is at full capacity. This could mean that we cannot produce to full capacity in the area because of restrictions in being able to deliver our oil.

 

*Our Business is Subject to Local Legal, Political and Economic Factors Which are Beyond Our Control, Which Could Impair Our Ability to Expand Our Operations or Operate Profitably.

 

We operate our business in Colombia, Argentina, Peru, and Brazil, and may eventually expand to other countries in the world. Exploration and production operations in foreign countries are subject to legal, political and economic uncertainties, including terrorism, military repression, social unrest, strikes by local or national labor groups, interference with private contract rights (such as privatization), extreme fluctuations in currency exchange rates, high rates of inflation, exchange controls, changes in tax rates, changes in laws or policies affecting environmental issues (including land use and water use), workplace safety, foreign investment, foreign trade, investment or taxation, as well as restrictions imposed on the oil and natural gas industry, such as restrictions on production, price controls and export controls. For example, starting on November 21, 2008, we were forced to reduce production in Colombia on a gradual basis, culminating on December 11, 2008 when we suspended all production from the Santana, Guayuyaco and Chaza blocks in the Putumayo Basin. This temporary suspension of production operations was the result of a declaration of a state of emergency and force majeure by Ecopetrol due to a general strike in the region. In January 2009, the situation was resolved and we were able to resume production and sales shipments. Starting in 2010, there was an increased presence of illegitimate unionization activities in the Putumayo Basin by the Sindicato de Trabajadores Petroleros del Putumayo , which disrupted our operations from time to time and may do so in the future. During 2012 and 2011, Argentina has experienced increased union activity and this may create disruptions in our Argentine operations in the future. We have also experienced related issues with landowners blocking access to our fields for short periods of time in Argentina. South America has a history of political and economic instability. This instability could result in new governments or the adoption of new policies, laws or regulations that might assume a substantially more hostile attitude toward foreign investment, including the imposition of additional taxes. In an extreme case, such a change could result in termination of contract rights and expropriation of foreign-owned assets. Any changes in oil and gas or investment regulations and policies or a shift in political attitudes in Argentina, Colombia, Peru or Brazil or other countries in which we intend to operate are beyond our control and may significantly hamper our ability to expand our operations or operate our business at a profit.

 

For instance, changes in laws in the jurisdiction in which we operate or expand into with the effect of favoring local enterprises, and changes in political views regarding the exploitation of natural resources and economic pressures, may make it more difficult for us to negotiate agreements on favorable terms, obtain required licenses, comply with regulations or effectively adapt to adverse economic changes, such as increased taxes, higher costs, inflationary pressure and currency fluctuations. In certain jurisdictions the commitment of local business people, government officials and agencies and the judicial system to abide by legal requirements and negotiated agreements may be more uncertain, creating particular concerns with respect to licenses and agreements for business. These licenses and agreements may be susceptible to revision or cancellation and legal redress may be uncertain or delayed. Property right transfers, joint ventures, licenses, license applications or other legal arrangements pursuant to which we operate may be adversely affected by the actions of government authorities and the effectiveness of and enforcement of our rights under such arrangements in these jurisdictions may be impaired.

 

*We Have an Aggressive Business Plan, and if we do not Have the Resources to Execute on our Business Plan, We May Be Required to Curtail Our Operations.

 

Our capital program for 2012 calls for approximately $444 million to fund our exploration and development, which we intend to fund through existing cash and cash flows from operations, with possible periodic draws from our revolving credit facility. Funding this program relies in part on oil prices remaining high and other factors to generate sufficient cash flow. If we are not able to generate the sales which, together with our current cash resources, are sufficient to fund our capital program, we will not be able to efficiently execute our business plan which would cause us to decrease our exploration and development, which could harm our business outlook, investor confidence and our share price.

 

Strategic and Business Relationships upon Which We May Rely are Subject to Change, Which May Diminish Our Ability to Conduct Our Operations.

 

Our ability to successfully bid on and acquire additional properties, to discover reserves, to participate in drilling opportunities and to identify and enter into commercial arrangements will depend on developing and maintaining effective working relationships with industry participants and on our ability to select and evaluate suitable partners and to consummate transactions in a highly competitive environment. These relationships are subject to change and may impair our ability to grow.

 

 

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To develop our business, we endeavor to use the business relationships of our management and board of directors to enter into strategic and business relationships, which may take the form of joint ventures with other private parties or with local government bodies, or contractual arrangements with other oil and gas companies, including those that supply equipment and other resources that we will use in our business. We also have an active business development program to develop those relationships and foster new relationships. We may not be able to establish these business relationships, or if established, we may choose the wrong partner or we may not be able to maintain them. In addition, the dynamics of our relationships with strategic partners may require us to incur expenses or undertake activities we would not otherwise be inclined to take to fulfill our obligations to these partners or maintain our relationships. If we fail to make the cash calls required by our joint venture partners in the joint ventures we do not operate, we may be required to forfeit our interests in these joint ventures. If our strategic relationships are not established or maintained, our business prospects may be limited, which could diminish our ability to conduct our operations.

 

In addition, in cases where we are the operator, our partners may not be able to fulfill their obligations, which would require us to either take on their obligations in addition to our own, or possibly forfeit our rights to the area involved in the joint venture. In addition, despite our partner’s failure to fulfill its obligations, if we elect to terminate such relationship, we may be involved in litigation with such partners or may be required to pay amounts in settlement to avoid litigation despite such partner’s failure to perform. Alternatively, our partners may be able to fulfill their obligations, but will not agree with our proposals as operator of the property. In this case there could be disagreements between joint venture partners that could be costly in terms of dollars, time, deterioration of the partner relationship, and/or our reputation as a reputable operator. These joint venture partners may not comply with their responsibilities or may engage in conduct that could result in liability to us.

 

In cases where we are not the operator of the joint venture, the success of the projects held under these joint ventures is substantially dependent on our joint venture partners. The operator is responsible for day-to-day operations, safety, environmental compliance and relationships with government and vendors.

 

We have various work obligations on our blocks that must be fulfilled or we could face penalties, or lose our rights to those blocks if we do not fulfill our work obligations. Failure to fulfill obligations in one block can also have implications on the ability to operate other blocks in the country ranging from delays in government process and procedure to loss of rights in other blocks or in the country as a whole. Failure to meet obligations in one particular country may also have an impact on our ability to operate in others.

 

Disputes or Uncertainties May Arise in Relation to our Royalty Obligations

 

Our production is subject to royalty obligations which may be prescribed by government regulation or by contract. These royalty obligations may be subject to changes in interpretation as business circumstances change.

 

In accordance with our Hydrocarbon Exploration and Exploitation Agreement with ANH for the Chaza Block in Colombia our oil production from each Exploitation Area on the Block is subject to the payment of additional compensation to the ANH over and above the basic sliding scale royalty that applies when cumulative gross production from an Exploitation Area exceeds five million barrels. Production from the Costayaco Exploitation Area on the Chaza Block became subject to this additional compensation in the fourth quarter of 2009 after cumulative production from the Costayaco field exceeded five million barrels.

 

The ANH has requested that the additional compensation be paid with respect to production from the recently drilled wells relating to the Moqueta discovery and has initiated a noncompliance procedure under the Chaza Contract. The Moqueta discovery is not located in the Costayaco Exploitation Area. Further, we view the Costayaco field and the Moqueta discovery as two clearly separate and independent hydrocarbon accumulations. Therefore, it is our view that it is clear that, pursuant to the Chaza Contract, the additional compensation payments are only to be paid with respect to production from the Moqueta wells when the accumulated oil production from any new Exploitation Area created with respect to the Moqueta discovery exceeds five million barrels. We have responded to the ANH in accordance with the provisions of the Chaza contract and are discussing the situation with them. However, no assurance can be made that our interpretation will prevail and, depending on the ultimate size of the cumulative production from the Moqueta field in the future, such amounts may be material if such additional compensation must be paid. As at March 31, 2012, total cumulative production from the Moqueta field was 0.4 MMbbl. The estimated compensation which would be payable on cumulative production to date if the ANH’s interpretation is successful is $7.4 million. At this time no amount has been accrued in the financial statements as Gran Tierra does not consider it probable that a loss will be incurred.

 

In Brazil, a new regulatory regime was introduced; however, the royalty distribution between producing states has not been approved.

 

*Negative Political and Regulatory Developments in Argentina May Negatively Affect our Operations.

 

The oil and natural gas industry in Argentina is subject to extensive regulation including land tenure, exploration, development, production, refining, transportation, and marketing, imposed by legislation enacted by various levels of government and, with respect to pricing and taxation of oil and natural gas, by agreements among the federal and provincial governments, all of which are subject to change and could have a material impact on our business in Argentina. The Federal Government of Argentina has implemented controls for domestic fuel prices and has placed a tax on oil and natural gas exports.

 

In October 2010, ENARGAS issued Regulation I-1410 aiming at securing the supply of natural gas to residential consumers and small industry given the decline in gas production and the expected growing demand for gas. The regulation includes all the procedures created by the authorities since 2004 (restrictions of exports, deviation of gas sales, to residential consumption) and gives ENARGAS power to control gas marketing in order to assure the supply of gas to residential consumers and small industry.

 

Any future regulations that limit the amount of oil and gas that we could sell or any regulations that limit price increases in Argentina and elsewhere could severely limit the amount of our revenue and affect our results of operations.

 

Currently most oil and gas producers in Argentina are operating without sales contracts. In 2008, a new withholding tax regime for exports was introduced without specific guidance as to its application. The domestic price was regulated in a similar way, so that both exported and domestically sold products were priced the same. Producers and refiners of oil in Argentina were unable to determine an agreed sales price for oil deliveries to refineries. In our case, the refineries’ price offered to oil producers reflects their price received, less taxes and operating costs and their usual mark up. Along with most other oil producers in Argentina, we are continuing negotiating sales on a spot price basis with one refiner, Refineria del Norte S.A, and the price is negotiated on a month by month basis. As a result of our acquisition of Petrolifera, we are now also selling our oil through short-term contracts to Shell Compania Argentina de Petroleo S.A. and YPF S.A. (“YPF”) and natural gas to Rafael G. Albenesi S.A. The Provincial governments have also been hurt by these changes as their effective royalty take has been reduced and capital investment in oilfields has declined, and so they are lobbying to change the situation. We are working with other oil and gas producers in the area, as well as Refineria del Norte S.A., to lobby the federal government for change. The government introduced the Petro Plus and Gas Plus programs in 2009, which grant higher prices to producers that sell production from new reserves. This is a positive step forward that will hopefully lead to further opening of price regulation in Argentina.

 

 

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Recently, the government of Argentina has been active in the oil and gas business. On April 16, 2012, the government announced their intention to acquire a 51% interest in YPF from Repsol S.A. (Respol S.A. holds 56.7% of YPF), and retain 51% control for the Federal Government and distribute 49% of the shares to Argentine provinces. Prior to this announcement, various provincial governments announced contract cancellations effecting YPF, Petrobras Argentina S.A., and Azabache Energy Inc., among others. The reason cited for the contract cancellations was lack of activity in the areas in question. We have experienced recent success in Argentina and have active programs in all areas, which we believe helps mitigate our risk. However, despite the fact that our operating entity in Argentina is a locally incorporated company the employees of which are all Argentine, we are viewed as a foreign company and could therefore face increased risk.

*Foreign Currency Exchange Rate Fluctuations May Affect Our Financial Results.

 

We expect to sell our oil and natural gas production under agreements that will be denominated in United States dollars and foreign currencies. Many of the operational and other expenses we incur will be paid in the local currency of the country where we perform our operations. Our production in Argentina is primarily invoiced in United States dollars, but payment is made in Argentine pesos, at the then current exchange rate. As a result, we are exposed to translation risk when local currency financial statements are translated to United States dollars, our functional currency. Since September 1, 2005, exchange rates between the Colombian peso and U.S. dollar have varied between 1,648 pesos to one U.S. dollar to 2,632 pesos to one U.S. dollar, a fluctuation of approximately 60%. Since we began operating in Argentina (September 1, 2005), the rate of exchange between the Argentine peso and U.S. dollar has varied between 3.05 pesos to one U.S. dollar to 4.35 pesos to the U.S. dollar, a fluctuation of approximately 43%. Production in Brazil is invoiced and paid in Brazilian Reals. Since September 1, 2005, the exchange rate of the Brazilian Real has varied between 1.56 Real to one U.S. dollar to 2.45 Real to the U.S. dollar, a variance of 57%. A foreign exchange loss of $24.4 million, of which $21.4 million was an unrealized non-cash foreign exchange loss resulting from the translation of current and deferred tax liabilities, was recorded in the three months ended March 31, 2012. Current and deferred tax liabilities in Colombia are denominated in Colombian pesos and the strengthening of 8% in the Colombian Peso against the U.S. dollar in the three months ended March 31, 2012 resulted in the foreign exchange loss.

 

Exchange Controls and New Taxes Could Materially Affect our Ability to Fund Our Operations and Realize Profits from Our Foreign Operations.

 

Foreign operations may require funding if their cash requirements exceed operating cash flow. To the extent that funding is required, there may be exchange controls limiting such funding or adverse tax consequences associated with such funding. In addition, taxes and exchange controls may affect the dividends that we receive from foreign subsidiaries.

 

Exchange controls may prevent us from transferring funds abroad. For example, the Argentine government has imposed a number of monetary and currency exchange control measures that include restrictions on the free disposition of funds deposited with banks and tight restrictions on transferring funds abroad, with certain exceptions for transfers related to foreign trade and other authorized transactions approved by the Argentine Central Bank. The Central Bank may require prior authorization and may or may not grant such authorization for our Argentine subsidiaries to make dividend payments to us and there may be a tax imposed with respect to the expatriation of the proceeds from our foreign subsidiaries. The Brazilian government has similar regulations in place regarding foreign exchange controls.

 

Competition in Obtaining Rights to Explore and Develop Oil and Gas Reserves and to Market Our Production May Impair Our Business.

 

The oil and gas industry is highly competitive. Other oil and gas companies will compete with us by bidding for exploration and production licenses and other properties and services we will need to operate our business in the countries in which we expect to operate. Additionally, other companies engaged in our line of business may compete with us from time to time in obtaining capital from investors. Competitors include larger companies, which, in particular, may have access to greater resources than us, may be more successful in the recruitment and retention of qualified employees and may conduct their own refining and petroleum marketing operations, which may give them a competitive advantage. In addition, actual or potential competitors may be strengthened through the acquisition of additional assets and interests. In the event that we do not succeed in negotiating additional property acquisitions, our future prospects will likely be substantially limited, and our financial condition and results of operations may deteriorate.

 

Maintaining Good Community Relationships and Being a Good Corporate Citizen may be Costly and Difficult to Manage.

 

Our operations have a significant effect on the areas in which we operate. To enjoy the confidence of local populations and the local governments, we must invest in the communities where were operate. In many cases, these communities are impoverished and lack many resources taken for granted in North America. The opportunities for investment are large, many and varied; however, we must be careful to invest carefully in projects that will truly benefit these areas. Improper management of these investments and relationships could lead to a delay in operations, loss of license or major impact to our reputation in these communities, which could adversely affect our business.

 

Our Operations Involve Substantial Costs and are Subject to Certain Risks Because the Oil and Gas Industries in the Countries in Which We Operate are Less Developed.

 

The oil and gas industry in South America is not as efficient or developed as the oil and gas industry in North America. As a result, our exploration and development activities may take longer to complete and may be more expensive than similar operations in North America. The availability of technical expertise, specific equipment and supplies may be more limited than in North America. We expect that such factors will subject our international operations to economic and operating risks that may not be experienced in North American operations.

 

Further, we operate in remote areas and may rely on helicopter or other transport methods. Some of these transport methods may result in increased levels of risk and could lead to operational delays, serious injury or loss of life and could have a significant impact on our reputation.

 

Negative Political Developments in Peru May Negatively Affect our Proposed Operations.

 

Peru held a national election in June 2011 after which a new political regime was elected, led by the left-populist candidate, Ollante Humala, who was elected the President. Mr. Humala has noted that the past decade prioritized the strengthening of democracy with economic growth, while the new government will enhance social inclusion to benefit the neediest. This newly elected political regime may adopt new policies, laws and regulations that are more hostile toward foreign investment which may result in the imposition of additional taxes, the adoption of regulations that limit price increases, termination of contract rights, or the expropriation of foreign-owned assets. While we do not have any reserves or any producing wells in Peru at this point, we do hold significant land holdings in Peru and such actions by the newly elected political regime could limit the amount of our future revenue in that country and affect our results of operations.

 

 

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The United States Government May Impose Economic or Trade Sanctions on Colombia That Could Result In A Significant Loss To Us.

 

Colombia is among several nations whose eligibility to receive foreign aid from the United States is dependent on its progress in stemming the production and transit of illegal drugs, which is subject to an annual review by the President of the United States. Although Colombia is currently eligible for such aid, Colombia may not remain eligible in the future. A finding by the President that Colombia has failed demonstrably to meet its obligations under international counternarcotics agreements may result in any of the following:

 

●	all bilateral aid, except anti-narcotics and humanitarian aid, would be suspended;

 

●	the Export-Import Bank of the United States and the Overseas Private Investment Corporation would not approve financing for new projects in Colombia;

 

●	United States representatives at multilateral lending institutions would be required to vote against all loan requests from Colombia, although such votes would not constitute vetoes; and

 

●	the President of the United States and Congress would retain the right to apply future trade sanctions.

 

Each of these consequences could result in adverse economic consequences in Colombia and could further heighten the political and economic risks associated with our operations there. Any changes in the holders of significant government offices could have adverse consequences on our relationship with ANH and Ecopetrol and the Colombian government’s ability to control guerrilla activities and could exacerbate the factors relating to our foreign operations. Any sanctions imposed on Colombia by the United States government could threaten our ability to obtain necessary financing to develop the Colombian properties or cause Colombia to retaliate against us, including by nationalizing our Colombian assets.

 

Accordingly, the imposition of the foregoing economic and trade sanctions on Colombia would likely result in a substantial loss and a decrease in the price of our common stock. The United States may impose sanctions on Colombia in the future, and we cannot predict the effect in Colombia that these sanctions might cause.

 

We May Be Unable to Obtain Additional Capital That We Will Require to Implement Our Business Plan, Which Could Restrict Our Ability to Grow.

 

We expect that our existing cash resources will be sufficient to fund our currently planned activities. We may require additional capital to expand our exploration and development programs to additional properties. We may be unable to obtain additional capital required.

 

When we require additional capital, we plan to pursue sources of capital through various financing transactions or arrangements, including joint venturing of projects, debt financing, equity financing or other means. We may not be successful in locating suitable financing transactions in the time period required or at all, and we may not obtain the capital we require by other means. If we do succeed in raising additional capital, future financings may be dilutive to our shareholders, as we could issue additional shares of common stock or other equity to investors. In addition, debt and other mezzanine financing may involve a pledge of assets and may be senior to interests of equity holders. We may incur substantial costs in pursuing future capital financing, including investment banking fees, legal fees, accounting fees, securities law compliance fees, printing and distribution expenses and other costs. We may also be required to recognize non-cash expenses in connection with certain securities we may issue, such as convertibles and warrants, which will adversely impact our financial results.

 

Our ability to obtain needed financing may be impaired by factors such as the capital markets (both generally and in the oil and gas industry in particular), the location of our oil and natural gas properties in South America, prices of oil and natural gas on the commodities markets (which will impact the amount of asset-based financing available to us), and/or the loss of key management. Further, if oil and/or natural gas prices on the commodities markets decrease, then our revenues will likely decrease, and such decreased revenues may increase our requirements for capital. Some of the contractual arrangements governing our exploration activity may require us to commit to certain capital expenditures, and we may lose our contract rights if we do not have the required capital to fulfill these commitments. If the amount of capital we are able to raise from financing activities, together with our cash flow from operations, is not sufficient to satisfy our capital needs (even to the extent that we reduce our activities), we may be required to curtail our operations.

 

We May Not Be Able To Effectively Manage Our Growth, Which May Harm Our Profitability.

 

Our strategy envisions continually expanding our business, both organically and through acquisition of other properties and companies. If we fail to effectively manage our growth or integrate successfully our acquisitions, our financial results could be adversely affected. Growth may place a strain on our management systems and resources. Integration efforts place a significant burden on our management and internal resources. The diversion of management attention and any difficulties encountered in the integration process could harm our business, financial condition and results of operations. In addition, we must continue to refine and expand our business development capabilities, our systems and processes and our access to financing sources. As we grow, we must continue to hire, train, supervise and manage new or acquired employees. We may not be able to:

 

●	expand our systems effectively or efficiently or in a timely manner;

 

●	allocate our human resources optimally;

 

●	identify and hire qualified employees or retain valued employees; or

 

●	incorporate effectively the components of any business that we may acquire in our effort to achieve growth.

 

If we are unable to manage our growth and our operations our financial results could be adversely affected by inefficiencies, which could diminish our profitability.

*Guerrilla Activity in Peru Could Disrupt or Delay Our Operations and We Are Concerned About Safeguarding Our Operations and Personnel in Peru.

 

The Shining Path Guerilla group has been active in Peru since the early 1980’s and, at one point, was active throughout the country. Recently, the group’s activity has been confined to small areas of Peru and operations have been hampered by the capture of many high profile leaders and membership has fallen dramatically. During April 2012, 30 people working on the Camisea natural gas project in central Peru were kidnapped. Most of the workers were released after a short period of time, and the remainder were freed within a few days. The kidnapping was attributed to the Shining Path Guerilla group. Camisea is a very large, high profile project in an area where the group continues to be active. Our operations in Peru are in a different region, with no known activity by the group. Nevertheless, we are concerned about the security of our operations in Peru and mitigate our risks through good relationships with local communities and stakeholders as well as strong security procedures.

 

 

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Risks Related to Our Industry

 

Unless We are Able to Replace Our Reserves, and Develop and Manage Oil and Gas Reserves and Production on an Economically Viable Basis, Our Reserves, Production and Cash Flows May Decline as a Result.

 

Our future success depends on our ability to find, develop and acquire additional oil and gas reserves that are economically recoverable. Without successful exploration, development or acquisition activities, our reserves and production will decline. We may not be able to find, develop or acquire additional reserves at acceptable costs.

 

To the extent that we succeed in discovering oil and/or natural gas, reserves may not be capable of production levels we project or in sufficient quantities to be commercially viable. On a long-term basis, our viability depends on our ability to find or acquire, develop and commercially produce additional oil and gas reserves. Without the addition of reserves through exploration, acquisition or development activities, our reserves and production will decline over time as reserves are produced. Our future reserves will depend not only on our ability to develop and effectively manage then-existing properties, but also on our ability to identify and acquire additional suitable producing properties or prospects, to find markets for the oil and natural gas we develop and to effectively distribute our production into our markets. Future oil and gas exploration may involve unprofitable efforts, not only from dry wells, but from wells that are productive but do not produce sufficient net revenues to return a profit after drilling, operating and other costs. Completion of a well does not assure a profit on the investment or recovery of drilling, completion and operating costs. In addition, drilling hazards or environmental damage could greatly increase the cost of operations, and various field operating conditions may adversely affect the production from successful wells. These conditions include delays in obtaining governmental approvals or consents, shut-downs of connected wells resulting from extreme weather conditions, problems in storage and distribution and adverse geological and technical conditions. While we will endeavor to effectively manage these conditions, we may not be able to do so optimally, and we will not be able to eliminate them completely in any case. Therefore, these conditions could diminish our revenue and cash flow levels and result in the impairment of our oil and natural gas interests.

 

We are Required to Obtain Licenses and Permits to Conduct Our Business and Failure to Obtain These Licenses Could Cause Significant Delays and Expenses That Could Materially Impact Our Business.

 

We are subject to licensing and permitting requirements relating to exploring and drilling for and development of oil and natural gas, including seismic permits. We may not be able to obtain, sustain or renew such licenses and permits on a timely basis or at all. Regulations and policies relating to these licenses and permits may change, be implemented in a way that we do not currently anticipate or take significantly greater time to obtain. These licenses and permits are subject to numerous requirements, including compliance with the environmental regulations of the local governments. As we are not the operator of all the joint ventures we are currently involved in, we may rely on the operator to obtain all necessary permits and licenses. If we fail to comply with these requirements, we could be prevented from drilling for oil and natural gas, and we could be subject to civil or criminal liability or fines. Revocation or suspension of our environmental and operating permits could have a material adverse effect on our business, financial condition and results of operations.

 

Our Exploration for Oil and Natural Gas Is Risky and May Not Be Commercially Successful, Impairing Our Ability to Generate Revenues from Our Operations.

 

Oil and natural gas exploration involves a high degree of risk. These risks are more acute in the early stages of exploration. Our exploration expenditures may not result in new discoveries of oil or natural gas in commercially viable quantities. It is difficult to project the costs of implementing an exploratory drilling program due to the inherent uncertainties of drilling in unknown formations, the costs associated with encountering various drilling conditions, such as over pressured zones and tools lost in the hole, and changes in drilling plans and locations as a result of prior exploratory wells or additional seismic data and interpretations thereof. If exploration costs exceed our estimates, or if our exploration efforts do not produce results which meet our expectations, our exploration efforts may not be commercially successful, which could adversely impact our ability to generate revenues from our operations.

 

Estimates of Oil and Natural Gas Reserves that We Make May Be Inaccurate and Our Actual Revenues May Be Lower and Our Operating Expenses may be Higher than Our Financial Projections.

 

We make estimates of oil and natural gas reserves, upon which we will base our financial projections. We make these reserve estimates using various assumptions, including assumptions as to oil and natural gas prices, drilling and operating expenses, capital expenditures, taxes and availability of funds. Some of these assumptions are inherently subjective, and the accuracy of our reserve estimates relies in part on the ability of our management team, engineers and other advisors to make accurate assumptions. Economic factors beyond our control, such as interest rates and exchange rates, will also impact the value of our reserves. The process of estimating oil and gas reserves is complex, and will require us to use significant decisions and assumptions in the evaluation of available geological, geophysical, engineering and economic data for each property. As a result, our reserve estimates will be inherently imprecise. Actual future production, oil and natural gas prices, revenues, taxes, development expenditures, operating expenses and quantities of recoverable oil and gas reserves may vary substantially from those we estimate. If actual production results vary substantially from our reserve estimates, this could materially reduce our revenues and result in the impairment of our oil and natural gas interests.

 

Exploration, development, production, marketing (including distribution costs) and regulatory compliance costs (including taxes) will substantially impact the net revenues we derive from the oil and gas that we produce. These costs are subject to fluctuations and variation in different locales in which we operate, and we may not be able to predict or control these costs. If these costs exceed our expectations, this may adversely affect our results of operations. In addition, we may not be able to earn net revenue at our predicted levels, which may impact our ability to satisfy our obligations.

 

*If Oil and Natural Gas Prices Decrease, We May be Required to Take Write-Downs of the Carrying Value of Our Oil and Natural Gas Properties.

 

We follow the full cost method of accounting for our oil and gas properties. A separate cost center is maintained for expenditures applicable to each country in which we conduct exploration and/or production activities. Under this method, the net book value of properties on a country-by-country basis, less related deferred income taxes, may not exceed a calculated “ceiling”. The ceiling is the estimated after tax future net revenues from proved oil and gas properties, discounted at 10% per year. In calculating discounted future net revenues, oil and natural gas prices are determined using the average price during the 12 months period prior to the ending date of the period covered by the balance sheet, calculated as an unweighted arithmetic average of the first-day-of-the month price for each month within such period for that oil and natural gas. That average price is then held constant, except for changes which are fixed and determinable by existing contracts. The net book value is compared with the ceiling on a quarterly basis. The excess, if any, of the net book value above the ceiling is required to be written off as an expense. Under full cost accounting rules, any write-off recorded may not be reversed even if higher oil and natural gas prices increase the ceiling applicable to future periods. Future price decreases could result in reductions in the carrying value of such assets and an equivalent charge to earnings. In countries where we do not have proved reserves, dry wells drilled in a period would directly result in ceiling test impairment for that period.

 

 

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In 2011, we recorded a ceiling test impairment loss of $42.0 million in our Peru cost center related to seismic and drilling costs on two blocks which were relinquished and a ceiling test impairment loss of $25.7 million in our Argentina cost center related to an increase in estimated future operating and capital costs to produce our remaining Argentine proved reserves and a decrease in reserve volumes. In the three months ended March 31, 2012, we recorded a ceiling test impairment loss of $20.2 million in our Brazil cost center related to seismic and drilling costs on Block BM-CAL-10. The farmout agreement for that block terminated during the first quarter of 2012 when we provided notice that we would not enter into the second exploration period.

 

Drilling New Wells and Producing Oil and Natural Gas from Existing Facilities Could Result in New Liabilities, Which Could Endanger Our Interests in Our Properties and Assets.

 

There are risks associated with the drilling of oil and natural gas wells, including encountering unexpected formations or pressures, premature declines of reservoirs, blow-outs, craterings, sour gas releases, fires and spills. Earthquakes or weather related phenomena such as heavy rain, landslides, storms and hurricanes can also cause problems in drilling new wells. There are also risks in producing oil and natural gas from existing facilities. For example, the Valle Morado GTE.St.VMor-2001 re-entry operations started in the third quarter of 2010, with integrity testing and remediation operations required for the sidetrack operations. Due to operational difficulties, the initial side-track attempt was not successful. The operation was placed on standby pending the arrival of additional side-track equipment and operations recommenced in the fourth quarter of 2010. In February 2011, these operations were suspended and the wellbore has been abandoned due to a number of operational challenges encountered. We continue to review alternatives associated with the field development. Also for example, on February 7, 2009 we experienced an incident at our Juanambu-1 well, involving a fire in a generator, resulting in total damage to equipment estimated at $500,000, and production in the amount of approximately $125,000 being deferred due to shutting down production facilities while dealing with the incident. The occurrence of any of these events could significantly reduce our revenues or cause substantial losses, impairing our future operating results. We may become subject to liability for pollution, blow-outs or other hazards. Incidents such as these can lead to serious injury, property damage and even loss of life. We generally obtain insurance with respect to these hazards, but such insurance has limitations on liability that may not be sufficient to cover the full extent of such liabilities. The payment of such liabilities could reduce the funds available to us or could, in an extreme case, result in a total loss of our properties and assets. Moreover, we may not be able to maintain adequate insurance in the future at rates that are considered reasonable. Oil and natural gas production operations are also subject to all the risks typically associated with such operations, including premature decline of reservoirs and the invasion of water into producing formations.

 

Our Inability to Obtain Necessary Facilities and/or Equipment Could Hamper Our Operations.

 

Oil and natural gas exploration and development activities are dependent on the availability of drilling and related equipment, transportation, power and technical support in the particular areas where these activities will be conducted, and our access to these facilities may be limited. To the extent that we conduct our activities in remote areas, needed facilities or equipment may not be proximate to our operations, which will increase our expenses. Demand for such limited equipment and other facilities or access restrictions may affect the availability of such equipment to us and may delay exploration and development activities. The quality and reliability of necessary facilities or equipment may also be unpredictable and we may be required to make efforts to standardize our facilities, which may entail unanticipated costs and delays. Shortages and/or the unavailability of necessary equipment or other facilities will impair our activities, either by delaying our activities, increasing our costs or otherwise.

 

Decommissioning Costs Are Unknown and May be Substantial; Unplanned Costs Could Divert Resources from Other Projects.

 

We are responsible for costs associated with abandoning and reclaiming some of the wells, facilities and pipelines which we use for production of oil and gas reserves. Abandonment and reclamation of these facilities and the costs associated therewith is often referred to as “decommissioning.” We have determined that we require a reserve account for these potential costs in respect of our current properties and facilities at this time, and have booked such reserve on our financial statements. If decommissioning is required before economic depletion of our properties or if our estimates of the costs of decommissioning exceed the value of the reserves remaining at any particular time to cover such decommissioning costs, we may have to draw on funds from other sources to satisfy such costs. The use of other funds to satisfy decommissioning costs could impair our ability to focus capital investment in other areas of our business.

 

*Prices and Markets for Oil and Natural Gas Are Unpredictable and Tend to Fluctuate Significantly, Which Could Reduce Our Profitability, Growth and Value.

 

Oil and natural gas are commodities whose prices are determined based on world demand, supply and other factors, all of which are beyond our control. World prices for oil and natural gas have fluctuated widely in recent years. The average price for WTI per barrel was $66 in 2006, $72 in 2007, $100 in 2008, $62 in 2009, $79 in 2010, $95 in 2011 and $103 for the three months ending March 31, 2012 demonstrating the inherent volatility in the market. Given the current economic environment and unstable conditions in the Middle East, Libya, the United States and Europe, the oil price environment is increasingly unpredictable and unstable. We expect that prices will fluctuate in the future. Price fluctuations will have a significant impact upon our revenue, the return from our oil and gas reserves and on our financial condition generally. Price fluctuations for oil and natural gas commodities may also impact the investment market for companies engaged in the oil and gas industry. Furthermore, prices which we receive for our oil sales, while based on international oil prices, are established by contract with purchasers with prescribed deductions for transportation and quality differentials. These differentials can change over time and have a detrimental impact on realized prices. Future decreases in the prices of oil and natural gas may have a material adverse effect on our financial condition, the future results of our operations and quantities of reserves recoverable on an economic basis.

 

In addition, oil and natural gas prices in Argentina are effectively regulated and during 2009, 2010, 2011 and 2012 were substantially lower than those received in North America. Oil prices in Colombia are related to international market prices, but adjustments that are defined by contract with Ecopetrol, the purchaser of most of the oil that we produce in Colombia, may cause realized prices to be lower or higher than those received in North America. Oil prices in Brazil are defined by contract with the refinery and may be lower or higher than those received in North America.

 

Penalties We May Incur Could Impair Our Business.

 

Our exploration, development, production and marketing operations are regulated extensively under foreign, federal, state and local laws and regulations. Under these laws and regulations, we could be held liable for personal injuries, property damage, site clean-up and restoration obligations or costs and other damages and liabilities. We may also be required to take corrective actions, such as installing additional safety or environmental equipment, which could require us to make significant capital expenditures. Failure to comply with these laws and regulations may also result in the suspension or termination of our operations and subject us to administrative, civil and criminal penalties, including the assessment of natural resource damages. We could be required to indemnify our employees in connection with any expenses or liabilities that they may incur individually in connection with regulatory action against them. As a result of these laws and regulations, our future business prospects could deteriorate and our profitability could be impaired by costs of compliance, remedy or indemnification of our employees, reducing our profitability.

 

 

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Policies, Procedures and Systems to Safeguard Employee Health, Safety and Security May Not be Adequate.

 

Oil and natural gas exploration and production is dangerous. Detailed and specialized policies, procedures and systems are required to safeguard employee health, safety and security. We have undertaken to implement best practices for employee health, safety and security; however, if these policies, procedures and systems are not adequate, or employees do not receive adequate training, the consequences can be severe including serious injury or loss of life, which could impair our operations and cause us to incur significant legal liability.

 

Environmental Risks May Adversely Affect Our Business.

 

All phases of the oil and natural gas business present environmental risks and hazards and are subject to environmental regulation pursuant to a variety of international conventions and federal, provincial and municipal laws and regulations. Environmental legislation provides for, among other things, restrictions and prohibitions on spills, releases or emissions of various substances produced in association with oil and gas operations. The legislation also requires that wells and facility sites be operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities. Compliance with such legislation can require significant expenditures and a breach may result in the imposition of fines and penalties, some of which may be material. Environmental legislation is evolving in a manner we expect may result in stricter standards and enforcement, larger fines and liability and potentially increased capital expenditures and operating costs. The discharge of oil, natural gas or other pollutants into the air, soil or water may give rise to liabilities to foreign governments and third parties and may require us to incur costs to remedy such discharge. The application of environmental laws to our business may cause us to curtail our production or increase the costs of our production, development or exploration activities.

 

Our Insurance May Be Inadequate to Cover Liabilities We May Incur.

 

Our involvement in the exploration for and development of oil and natural gas properties may result in our becoming subject to liability for pollution, blowouts, property damage, personal injury or other hazards. Although we have insurance in accordance with industry standards to address such risks, such insurance has limitations on liability that may not be sufficient to cover the full extent of such liabilities. In addition, such risks may not in all circumstances be insurable or, in certain circumstances, we may choose not to obtain insurance to protect against specific risks due to the high premiums associated with such insurance or for other reasons. The payment of such uninsured liabilities would reduce the funds available to us. If we suffer a significant event or occurrence that is not fully insured, or if the insurer of such event is not solvent, we could be required to divert funds from capital investment or other uses towards covering our liability for such events.

 

Challenges to Our Properties May Impact Our Financial Condition.

 

Title to oil and natural gas interests is often not capable of conclusive determination without incurring substantial expense. While we intend to make appropriate inquiries into the title of properties and other development rights we acquire, title defects may exist. In addition, we may be unable to obtain adequate insurance for title defects, on a commercially reasonable basis or at all. If title defects do exist, it is possible that we may lose all or a portion of our right, title and interest in and to the properties to which the title defects relate.

 

Furthermore, applicable governments may revoke or unfavorably alter the conditions of exploration and development authorizations that we procure, or third parties may challenge any exploration and development authorizations we procure. Such rights or additional rights we apply for may not be granted or renewed on terms satisfactory to us.

 

If our property rights are reduced, whether by governmental action or third party challenges, our ability to conduct our exploration, development and production may be impaired.

 

We Will Rely on Technology to Conduct Our Business and Our Technology Could Become Ineffective Or Obsolete.

 

We rely on technology, including geographic and seismic analysis techniques and economic models, to develop our reserve estimates and to guide our exploration and development and production activities. We will be required to continually enhance and update our technology to maintain its efficacy and to avoid obsolescence. The costs of doing so may be substantial, and may be higher than the costs that we anticipate for technology maintenance and development. If we are unable to maintain the efficacy of our technology, our ability to manage our business and to compete may be impaired. Further, even if we are able to maintain technical effectiveness, our technology may not be the most efficient means of reaching our objectives, in which case we may incur higher operating costs than we would were our technology more efficient.

 

Risks Related to Our Common Stock

 

The Market Price of Our Common Stock May Be Highly Volatile and Subject to Wide Fluctuations.

 

The market price of our common stock may be highly volatile and could be subject to wide fluctuations in response to a number of factors that are beyond our control, including but not limited to:

●	dilution caused by our issuance of additional shares of common stock and other forms of equity securities, which we expect to make in connection with acquisitions of other companies or assets;

●	announcements of new acquisitions, reserve discoveries or other business initiatives by our competitors;

●	fluctuations in revenue from our oil and natural gas business;

 

●	changes in the market and/or WTI or Brent price for oil and natural gas commodities and/or in the capital markets generally;

 

●	changes in the demand for oil and natural gas, including changes resulting from the introduction or expansion of alternative fuels;

 

●	changes in the social, political and/or legal climate in the regions in which we will operate;

 

 

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●	changes in the valuation of similarly situated companies, both in our industry and in other industries;

 

●	changes in analysts’ estimates affecting us, our competitors and/or our industry;

 

●	changes in the accounting methods used in or otherwise affecting our industry;

 

●	announcements of technological innovations or new products available to the oil and natural gas industry;

 

●	announcements by relevant governments pertaining to incentives for alternative energy development programs;

 

●	fluctuations in interest rates, exchange rates and the availability of capital in the capital markets;

 

●	significant sales of our common stock, including sales by future investors in future offerings we expect to make to raise additional capital.

 

In addition, the market price of our common stock could be subject to wide fluctuations in response to various factors, which could include the following, among others:

 

●	quarterly variations in our revenues and operating expenses; and

 

●	additions and departures of key personnel.

 

These and other factors are largely beyond our control, and the impact of these risks, singularly or in the aggregate, may result in material adverse changes to the market price of our common stock and/or our results of operations and financial condition.

 

We Do Not Expect to Pay Dividends In the Foreseeable Future.

 

We do not intend to declare dividends for the foreseeable future, as we anticipate that we will reinvest any future earnings in the development and growth of our business. Therefore, investors will not receive any funds unless they sell their common stock, and shareholders may be unable to sell their shares on favorable terms or at all. Investors cannot be assured of a positive return on investment or that they will not lose the entire amount of their investment in our common stock.

Item 2. Unregistered Sales of Equi ty Securities and Use of Proceeds

 

On four separate dates beginning on January 1, 2012 and ending on March 31, 2012, we sold an aggregate of 100,003 shares of our common stock for an aggregate purchase price of $105,003. These shares were issued to five holders of warrants to purchase shares of our common stock upon exercise of the warrants.   The shares were issued to these holders in reliance on Section 4(2) under the Securities Act, in that they were issued to the original purchasers of the warrants, who had represented to us in the private placement of the warrants that they were accredited investors as defined in Regulation D under the Securities Act. On February 8, 2012 we issued 1,587,302 shares of our common stock to one holder of exchangeable shares, which were issued by a subsidiary of Gran Tierra in a share exchange on November 10, 2005. The shares were issued to this holder in reliance on Regulation S promulgated by the SEC as the investor was not a resident of the United States.

 

Item 5. Other In for mation

 

On May 2, 2012, the Board of Directors promoted James Rozon from Acting Chief Financial Officer to Chief Financial Officer. Mr. Rozon had been serving as acting Chief Financial Officer since December 9, 2011, as a result of Martin Eden, Gran Tierra’s then Chief Financial Officer, having been placed on medical leave while he recovered from emergency surgery. In connection with Mr. Rozon’s promotion to Chief Financial Officer, Gran Tierra terminated its search for a replacement Chief Financial Officer. On May 2, 2012, the Board of Directors appointed Mr. Eden as Vice President, Finance Special Projects.

 

In connection with Mr. Rozon’s promotion, his base salary was increased to CDN$300,000 (US $293,887 at an exchange rate of CAD$1.0208 as at December 31, 2011). Mr. Rozon’s target bonus continues to be 70% of base salary and, as a result, was commensurately increased in dollar terms. In addition, the Board of Directors approved change in control benefits for Mr. Rozon such that Mr. Rozon is entitled to severance payments in the event of an involuntary termination of employment by Gran Tierra other than for “cause” (as defined in his employment agreement), or a termination of employment by Mr. Rozon for “good reason” (as defined in his employment agreement, including a change in control of Gran Tierra) in an amount equal to 1.5 times his previous 12 months base salary and annual bonus.

 

Item 6. Exhibits

 

See Index to Exhibits at the end of this Report, which is incorporated by reference here. The Exhibits listed in the accompanying Index to Exhibits are filed as part of this report.

 

SI GN ATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

GRAN TIERRA ENERGY INC.

 

Date: May 7, 2012	/s/ Dana Coffield
	By: Dana Coffield
	Chief Executive Officer and President
	(Principal Executive Officer)

 

Date: May 7, 2012	/s/ James Rozon
	By: James Rozon Chief Financial Officer
	(Principal Financial and Accounting Officer)

 

 

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EX HI BIT INDEX

Exhibit

No.		Description		Reference
2.1		Arrangement Agreement, dated as of July 28, 2008, by and among Gran Tierra Energy Inc., Solana Resources Limited and Gran Tierra Exchangeco Inc.		Incorporated by reference to Exhibit 2.1 to the Current Report on Form 8-K (SEC File No. 001-34018), filed with the SEC on August 1, 2008.
2.2		Amendment No. 2 to Arrangement Agreement, which supersedes Amendment No. 1 thereto and includes the Plan of Arrangement, including appendices		Incorporated by reference to Exhibit 2.2 to the Registration Statement on Form S-3 (SEC File No. 333-153376), filed with the SEC on October 10, 2008.
2.3		Arrangement Agreement, dated January 17, 2011, by and between Gran Tierra Energy Inc. and Petrolifera Petroleum Limited. #		Incorporated by reference to Exhibit 2.1 to the Current Report on Form 8-K, filed with the SEC on January 21, 2011 (SEC File No. 001-34018).
3.1		Amended and Restated Articles of Incorporation.		Incorporated by reference to Exhibit 3.1 to the Quarterly Report on Form 10-Q/A (SEC File No. 001-34018), filed with the SEC on January 6, 2010.
3.2		Amended and Restated Bylaws of Gran Tierra Energy Inc.		Incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K filed with the SEC on September 22, 2008 (SEC File No. 000-52594).
4.1		Reference is made to Exhibits 3.1 to 3.2.
4.2		Form of Warrant issued to institutional and retail investors in connection with the private offering in June 2006.		Incorporated by reference to Exhibit 4.2 to the Current Report on Form 8-K filed with the SEC on June 21, 2006 (SEC File No. 333-111656).
4.3		Details of the Goldstrike Special Voting Share.		Incorporated by reference to Exhibit 10.14 to the Annual Report on Form 10-KSB/A for the period ended December 31, 2005 and filed with the SEC on April 21, 2006 (SEC File No. 333-111656).
4.4		Goldstrike Exchangeable Share Provisions.		Incorporated by reference to Exhibit 10.15 to the Annual Report on Form 10-KSB/A for the period ended December 31, 2005 and filed with the SEC on April 21, 2006 (SEC File No. 333-111656).
4.5		Provisions Attaching to the GTE–Solana Exchangeable Shares.		Incorporated by reference to Annex E to the Proxy Statement on Schedule 14A filed with the SEC on October 14, 2008 (SEC File No. 001-34018).
4.6		Supplemental Warrant Indenture, dated as of March 18, 2011, among Gran Tierra Energy Inc., Petrolifera Petroleum Limited, and Computershare Trust Company of Canada.		Incorporated by reference to Exhibit 4.6 to the Quarterly Report on Form 10-Q filed with the SEC on May 10, 2011 (SEC File No. 001-34018).
10.1		Amendment No. 4 dated June 13, 2011 to the Colombian Participation Agreement dated June 22, 2006, between Gran Tierra Colombia Ltd and Crosby Capital, LLC		Filed herewith.
10.2		Amendment No. 5 dated February 10, 2011 to the Colombian Participation Agreement dated June 22, 2006, between Gran Tierra Colombia Ltd and Crosby Capital, LLC		Filed herewith.
10.3		Amendment dated January 30, 2012 to contract, dated July 27, 2011, between Gran Tierra Colombia Ltd and Ecopetrol S.A., for the Purchase and Sale of Crude Oil from the Chaza, Santana and Guayuyaco Blocks.		Incorporated by reference to Exhibit 10.58 to the Annual Report on Form 10-K filed with the SEC on February 27, 2012 (SEC File No. 001-34018).
10.4		Amendment dated January 30, 2012 to contract, dated July 27, 2011, between Solana Petroleum Exploration Colombia Ltd. and Ecopetrol S.A., for the Purchase and Sale of Crude Oil from the Chaza, Santana and Guayuyaco Blocks.		Incorporated by reference to Exhibit 10.59 to the Annual Report on Form 10-K filed with the SEC on February 27, 2012 (SEC File No. 001-34018).
10.5		Agreement between Gran Tierra Colombia Ltd and Ecopetrol S.A., dated January 30, 2012 with respect to the transportation of crude oil from the Chaza Block		Filed herewith.
10.6		Agreement between Solana Petroleum Exploration Colombia Ltd. and Ecopetrol S.A., dated January 30, 2012 with respect to the transportation of crude oil from the Chaza Block		Filed herewith.
10.7		Cash Compensation Arrangements with Executive Officers		Filed herewith.
10.8		Fourth Amendment to Credit Agreement, dated as of February 14, 2012, among Solana Resources Limited, Gran Tierra Energy Inc., BNP Paribas and Other Lenders		Filed herewith.
10.9		Amendment No. 6 dated March 1, 2012 to the Colombian Participation Agreement dated June 22, 2006, between Gran Tierra Colombia Ltd and Crosby Capital, LLC		Filed herewith.

 

 

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10.10		Amendment to Employment Agreement dated May 2, 2012 between Gran Tierra Energy Inc. and Martin Eden		Filed herewith.
10.11		Amendment to Employment Agreement dated May 2, 2012 between Gran Tierra Energy Inc. and David Hardy		Filed herewith.
10.12		Executive Employment Agreement dated May 2, 2012 between Gran Tierra Energy Inc. and James Rozon		Filed herewith.
31.1		Certification of Principal Executive Officer		Filed herewith.
31.2		Certification of Principal Financial Officer		Filed herewith.
32.1		Section 1350 Certifications.		Filed herewith.

 

101.INS* XBRL Instance Document

101.SCH* XBRL Taxonomy Extension Schema Document

101.CAL* XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF XBRL Taxonomy Extension Definition Linkbase Document

101.LAB* XBRL Taxonomy Extension Label Linkbase Document

101.PRE* XBRL Taxonomy Extension Presentation Linkbase Document

 

#  Schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K. Gran Tierra undertakes to furnish supplemental copies of any of the omitted schedules upon request by the SEC.

 

* XBRL information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934, and is not subject to liability under those sections, is not part of any registration statement or prospectus to which it relates and is not incorporated or deemed to be incorporated by reference into any registration statement, prospectus or other document.

 

 

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