1998 MESSAGE TO UNITHOLDERS | 1998 FINANCIAL AND OPERATING STATS • MESSAGE TO UNITHOLDERS At the time of this writing, the oil and gas industry is in the midst of the most protracted bear market ever experienced in the modern era of the oil business. The price of benchmark West Texas Intermediate (“WTI”) crude oil is in its sixteenth straight month of weakness and averaged only $14.40 US per barrel (“Bbl”) in 1998, its lowest level since 1977. The average 1998 price was 31 percent lower than the 1997 price of $20.82 US per Bbl; through the first two months of 1999, the price averaged only $12.18 US per Bbl. Clearly, the very low price of crude oil is having a dramatic impact on both the conventional oil and gas royalty trust sector as well as the broad oil and gas equities market. In the context of the highly challenging environment for the oil and gas industry, ARC Energy Trust (the “Trust”) has pursued strategies and initiatives that we believe reaffirm our leadership position in the sector. As a result, the Trust continues to be a top performer on a total return basis. Since inception in mid 1996, the Trust has outperformed the conventional royalty trust index by 13 percent. It is noteworthy that the Trust has also significantly outperformed the TSE Oil and Gas Producers Index on a total return basis by 23 percent. The Trust’s distributions were maintained at $0.10 per unit per month through the year and were the most stable among all of the royalty trusts. The leadership role which the Trust has developed is consistent with our vision to become the premier conventional oil and gas royalty trust in Canada. Our continued superior results in a weak market confirm that the Trust is delivering on its commitment to be a top performer in the sector. ACQUISITION AND DISPOSITION ACTIVITY Management of the Trust’s assets involves both the acquisition and disposition of oil and gas properties to capitalize on opportunities which develop in the market. During 1998, the oil and gas asset market underwent a dramatic transition from a seller’s market in the first half of the year to a buyer’s market by the end of the year. We were not prepared to pay the prices required to acquire quality assets in the first half of 1998 and instead chose to divest of $14.5 million of assets of which a significant component was non-producing natural gas reserves. With the shift to a buyer’s market later in the year, a number of attractive acquisition opportunities developed. However, capital market support for the oil and gas industry essentially disappeared in the second half of 1998 which meant that acquisitions had to be debt financed. Again, we were not prepared to debt finance a major acquisition in the prevailing commodity price environment which would have increased our leverage and financial risk to our unitholders. Accordingly, the Trust re-deployed the net proceeds (net of funds applied to distribution stabilization) from the first half dispositions, coupled with a minor debt component, into $14.8 million of mainly oil acquisitions later in the year. These acquisitions were primarily within existing Trust properties, including our main core area of Pembina. As a result of the Trust’s acquisition and disposition activity in 1998, 1.1 million barrels of oil equivalent (“Mmboe”) reserves were acquired at a net effective cost of $0.29 per barrel of oil equivalent (“Boe”). Similarly, the Trust added approximately 309 Boe per day of production at a net effective cost of $1,027 per Boe per day. RESERVE REPLACEMENT A successful going concern strategy requires that a trust maintains or grows its reserves and production on a costeffective basis. In combination with the acquisition and disposition activity described above, the Trust’s drilling and development activities and revisions to its existing assets replaced 101 percent of production in 1998 at a net total cost of $2.81 per Boe. We are very pleased with this performance, especially given the difficult market environment which prevailed during 1998. FINANCIAL AND OPERATING PERFORMANCE Production during 1998 was 10,225 Boe per day which was eight percent greater than 1997 production of 9,425 Boe per day. During 1998, oil production increased 21 percent to 4,439 Bbl per day, natural gas production decreased two percent to 37.7 million cubic feet (“Mmcf”) per day and natural gas liquids production increased five percent to 2,018 Bbl per day. The decline in natural gas production was the result of the first half disposition of a large gas property. As a result of weak crude oil and natural gas liquids prices, revenue before royalties for the year decreased nine percent to $67.1 million. Cash flow during the year declined 20 percent to $30.0 million. The average commodity prices for the year were $18.99 per Bbl for oil, $1.93 per thousand cubic feet (“Mcf”) for gas and $13.17 per Bbl for natural gas liquids. On an oil equivalent basis, the average price was $17.99 per Boe, which was 16 percent lower than 1997. Despite the significant decline in commodity prices, the Trust’s operating netback remained relatively strong at $10.38 per Boe. Operating costs for 1998 were $5.04 per Boe; general and administrative costs net of recoveries and reimbursements were $0.79 per Boe and management fees were $0.32 per Boe, resulting in overall costs of $6.15 per Boe net of the residual one percent royalty reimbursement; this compares to $6.24 per Boe for 1997. The Trust incurred a net loss of $14.1 million for the year which included the impact of a writedown in the book value of the Trust’s assets by $14.7 million (six percent). Earnings prior to the writedown fell to $0.6 million in 1998 from $9.2 million in 1997 which is entirely attributable to the decline in oil prices. The low oil price in 1998 (especially the fourth quarter average price for WTI of $12.83 US per Bbl) and continuing low oil prices in 1999 were the main factors in the writedown of the carrying value of the Trust’s assets. COMMODITY PRICE OUTLOOK As we begin 1999, oil prices remain very weak and the market sentiment has become extremely negative; there is considerable discussion about a new low price era that could last several years. We strongly disagree with this view. Our analysis indicates that the world oil market is experiencing a cyclical downturn and we do not see any secular or structural changes to world oil supply or demand fundamentals that would support an environment in which low oil prices prevail long term. The oil market is currently burdened by excess inventories which were created by overproduction relative to demand due to an economic downturn in Asia and several consecutive warmer than normal winters in the northern hemisphere. We believe economic forces are already in motion that will correct this situation. Oil supply outside of OPEC is expected to decline modestly in 1999 and this trend will gain depth and momentum the longer oil prices remain depressed. Oil demand will continue to increase as stability and growth returns to the Asian economies and demand in the rest of the world continues to grow. Assuming OPEC stands still at current output levels, we see balance returning to the oil market within the next 12 months. This process could be greatly accelerated by further output reductions on the part of OPEC which is a distinct possibility given the mounting financial stress affecting virtually all OPEC members. It is noteworthy that since 1985, the WTI oil price has only been below $16.00 US per Bbl 20 percent of the time (32 months) during four down cycles, having an average duration of approximately eight months each. During the current price cycle, the price has been below $16.00 US per Bbl for 13 consecutive months, the longest period yet. WTI has averaged less than $14.00 US per Bbl only eight percent (11 months) of the time since 1985 during three down cycles, having an average duration of approximately four months each. During the current cycle, the price has been below $14.00 US per Bbl for six months including the last four straight months (including February 1999). We do not view prices at this level to be sustainable for much longer. As crude oil stocks and refinery inventories return to more normal levels, we expect prices to also return to a more normal level of $16.00 US to $20.00 US per Bbl for WTI. With regard to natural gas, despite another warm winter across North America and the resultant excess storage inventories, we believe the outlook is very positive. Prospects for long-term demand growth are attractive based on the environmental qualities and competitive position of natural gas versus alternative fuels. Supply is tight across North America and should become substantially tighter later this year because of the constraints on drilling imposed by reduced industry cash flow from continued low oil prices and the absence of financial market support. Given high decline rates and full utilization of existing productive capacity, the upstream sector will have to maintain a very high level of drilling to supply future demand growth. An attractive pricing environment will be necessary to draw the capital needed to finance this activity. Downside risk in prices is mitigated by the fact that, unlike oil, there is no dominant low-cost supplier of natural gas in North America. The outlook for Canadian natural gas is particularly bright because pipeline capacity expansions are likely to lead supply growth for the next three to five years. Surplus pipeline capacity ensures producers have an outlet for their production and creates strong support for Canadian natural gas prices. Given these positive fundamentals, we are of the view that a plantgate pricing range of $2.00 to $2.50 per Mcf is sustainable on a long-term basis for Canadian producers. John P. Dielwart President and Chief Executive Officer • How do our 1998 numbers measure up?  Click here to find out. View another year: 2007 | 2006 | 2005 | 2004 | 2003 | 2002 | 2001 | 2000 | 1999 | 1998 | 1997 | 1996