Guidance Notes on Claiming Allowable Expenditures

Preamble

The Allowable Expenditure provisions of exploration licences are necessitated by the work expenditure criterion by which winning bids for exploration lands are selected. These bids represent the total amount of money that the bidder proposes to spend doing exploratory work on the (licence) lands during Period 1 of the term of the exploration licence. The Schedule of Allowable Expenditures attached to each exploration licence describes how the cost of exploratory work of different categories may be claimed and approved. Until 2002, this has generally been through application of set rates applicable to different types of activity.

During 2002, a Task Force comprising the Northern Oil and Gas Directorate (NOGD) and Canadian Association of Petroleum Producers (CAPP) members with specific experience and interest in petroleum exploration North of 60 examined ways to improve the administration of allowable expenditures. The consensus of the Task Force was that expenditures should be claimed on the basis of actual cost (the 'at cost' approach) rather than use of predetermined rates. These Guidance Notes were developed to aid both companies and NOGD to apply the new approach.

Three points should be noted:

• Firstly, the Guidance Notes address a specific and limited provision of the licence, that is, the draw-down of the deposit against the work proposal bid (and of any rental in Period 2 of the exploration licence). The approach is not intended to cover the entire range of explorer's costs but rather a high percentage that can act as a close proxy for the full cost. Certain support or ancillary costs will be treated under a miscellaneous category represented by 10% of the major cost items.

  Generally, only costs that apply directly to exploratory work on the specific lands held under licence, and incurred during the term of the licence will be considered. A specific exception to this general rule relates to seismic purchase and reprocessing after the announcement of the winning bid on an exploration licence, described in section G.

• Secondly, the adequacy of the Guidance Notes will be gauged by their utility in administering future licences issued with the 'at cost' provision and may be revised accordingly. As of December 15, 2010, certain revisions have been included in this document and will apply to the administration of allowable expenditures.

• Thirdly, an external audit requirement for the major cost category related to drilling will assure the administrator as to the accuracy of these submissions and is expected to streamline the administration of the allowable expenditure provision.

Section A. General

These Guidance Notes describe the classes and scope of expenditures which may be viewed as allowable under the terms of exploration licences (ELs) issued pursuant to Parts II and III of the Canada Petroleum Resources Act (CPRA) in areas under the jurisdiction of the Minister of Indian and Northern Affairs, and are intended to assist an interest holder or Representative of the interest owner of ELs to claim refunds from the Northern Oil and Gas Directorate of the Department of Indian and Northern Affairs.

The bid selection criterion in general use for ELs issued in the North is the Work Proposal Bid. This is the total amount of money that the bidder proposes to spend doing exploratory work on the EL within Period 1 of the term of the EL. Schedule III to each EL, the Schedule of Allowable Expenditures, determines the basis for refund of the Work Deposits for Work Proposal Bids related to Period 1 of ELs, and for annual rentals as may apply. Allowable expenditures will be calculated on an 'at cost' (i.e. actual cost) basis for exploration licences issued during 2002 and later, subject to certain limitations outlined in these Guidance Notes.

These Guidance Notes are intended to assist the applicant to identify costs that will be eligible for 'at cost' treatment. Costs attributed to administrative personnel, program management, office overhead and data interpretation will not be considered allowable expenditures. However, the applicant can claim an additional 10% of direct allowable expenditures in recognition of miscellaneous costs, including (but not limited) to overhead, incurred in support of exploration work programs.

Eligible costs are submitted net of GST, sales and other taxes. Land use and access fees, surface lease rentals, the cost of preparing applications for regulatory and access approval and for the regulatory process itself are not eligible 'at cost' items, but are recognized indirectly in the 10% miscellaneous cost allowance. Also not eligible are indirect expenses such as depreciation and reserves, interest or other costs of borrowed funds, return on investment, overhead, or any expense that can be deemed unreasonable or that the applicant has not incurred in carrying out exploration work on the exploration licence lands.

With the exception of research costs described under Section I, eligible costs will be related to work authorized by the National Energy Board (NEB) under Section 5(1)(b) of the Canada Oil and Gas Operations Act (COGOA). Where the work is regulated by the National Energy Board reporting requirements required by the NEB pursuant to the appropriate regulations must be fulfilled before a refund will be processed.

Section B. Mobilization and Demobilization

The applicant may claim the costs of mobilization and/or demobilization of equipment and supplies that are distinct cost elements of an operation and are charged directly to the operation. The costs must be reasonable in the circumstance and must be adequately documented (such as by a third party invoice or a joint venture billing statement).

Contract termination charges incurred by the applicant for contracts that were entered into in good faith by the applicant in order to mobilize and retain equipment in the north may be included as a demobilization expense.

When equipment (e.g. seismic party or drilling rig) is mobilized to a region or area to conduct more than one operation then there will be a reasonable allocation of mobilization and/or demobilization costs among the operations utilizing the equipment. In such cases the allowable cost will be the lesser of:

1. the actual mobilization/demobilization cost charged against the operation and documented by a third party invoice or a joint venture billing statement;

   or

2. a reasonable allocation of cost using the following formula or a similar calculation method;

Allocated Mob/Demob Cost:

= ((full cost of mob/demob) × (operational days for operation subject to the allowable expenditure claim)) ÷ (total operational days between mob and demob)

For a drilling operation: 'operational days' commence on the spud date and conclude at the rig release date of the well. For a seismic operation: 'operational days' commence when data recording or shot hole drilling (if applicable) commences and concludes when data recording concludes.

Section C. Standby Costs Between Seasons

Generally, standby charges will be an integral cost component of a drilling or seismic operation and will be evidenced by a joint venture billing statement or an approved AFE with a supporting third party invoice. However, the applicant may incur between-season standby charges that may not be directly charged to an operation. The applicant may include additional standby costs in the claim for allowable expenditures if the following conditions are met.

1. An associated operation has in fact been carried out. Stand-alone standby charges are not an allowable expenditure.
2. The costs have been incurred by the applicant and are supported by documentation such as a third party invoice.
3. The costs are deemed reasonable in the circumstance.
4. There is a fair allocation of the standby costs to all operations that utilized the equipment (e.g. drilling rig or seismic party) prior to and following the standby period.

Section D. Staging Areas

Costs incurred by the applicant to construct and maintain a multi-season, regional staging area/base camp or staging area/base camp charges billed to the applicant by a third party are not an allowable expenditure. These costs are considered to be within the category of support costs offset by the 10% miscellaneous allowance.

The costs of a establishing a single season or single purpose staging site will be considered as an allowable expenditure for the associated operation or operations and will receive full 'at cost' treatment.

Section E. Drilling Operations

The usual starting point for accumulation of eligible costs is the commencement of access road and drilling site construction or the commencement of movement of the drilling rig, consumables and equipment from a staging area to the drilling location, whichever occurs first. eligible cost accumulation will usually terminate when the drilling rig and equipment have been re-stacked at a staging area or at conclusion of the applicant's contractual obligations for the drilling rig, whichever occurs last.

Under the conditions described in sections B and C, the applicant may also include costs of mobilization and/or demobilization and 'between seasons' standby charges in the allowable expenditure claim.

The applicant can claim costs for drilling site preparation, such as offshore island and berm construction or access road construction that were incurred in the operating season(s) prior to the season when the well is spudded. However, these costs are not submitted, nor claimable, until the well operation is complete.

The applicant can also claim an additional 10% of the allowable expenditures to offset miscellaneous costs such as internal general and administrative expenses, community consultation visits, project supervision and management, data interpretation and analysis, report preparation, regional staging area and base camp charges, regional office operations and follow-up site clean-up and reclamation carried out after the end of Period 1 (or end of Period 2 for an operation conducted during the rental period). No documentation is required to support a claim for miscellaneous costs.

The applicant shall submit an itemized cost breakdown, using the following format as a model where applicable. However, the applicant may choose an alternative format that presents drilling operation costs at a comparable level of detail as the prescribed format. If the applicant submits a copy of an approved AFE to support the expenditure claim, it must be adjusted to reflect actual incurred costs and must conform to all the cost eligibility limitations set out in this document. For example; any land use fees and surface rentals appearing on the AFE should be excluded from the claim application.

Section F. Geophysical (Seismic) Operations

The usual starting point for accumulation of eligible costs is the commencement of access road, airstrip, seismic line or camp site construction or the commencement of movement of the seismic and/or clearing equipment from a staging area, whichever occurs first. eligible cost accumulation will usually terminate when the seismic party has been re-stacked at a staging area or at the conclusion of the applicant's contractual obligations for the seismic party, whichever occurs last.

Under the conditions described in sections B and C, the applicant may also include costs of mobilization and/or demobilization and 'between seasons' standby charges in the allowable expenditure claim.

The applicant can claim costs for facility construction (e.g. airstrips, staging areas, access roads, docking facilities) that were incurred in the operating season(s) prior to the season when the seismic operation commenced. However, these costs are not submitted, nor claimable, until the operation is complete.

Seismic over lands within the exploration licence boundaries and for a distance of 3 kilometers outside the boundaries is eligible. For certain operations, primarily in the offshore, an extension beyond 3 kms may be permitted to ensure that full-fold imagery of the subsurface within the licence boundaries can be acquired. Of requested by the applicant, this may be approved on a program by program basis following consultation with the National Energy Board.

In addition, individual lines extending beyond the 3-kilometer limit, acquired for the purpose of establishing well tie-ins or tie-ins to existing proximate seismic surveys, may be accepted upon the approval of the Rights Administrator.

The applicant can also claim an additional 10% of the allowable expenditures to offset miscellaneous costs, such as internal general and administrative costs, community consultation visits, project supervision and management, data interpretation and analysis, report preparation, regional staging area and base camp charges, regional office operations and follow-up site clean-up and reclamation carried out after the end of Period 1 (or end of Period 2 for an operation conducted during the rental period). No documentation is required to support a claim for miscellaneous costs.

The applicant shall submit an itemized cost breakdown, using the following format as a model where applicable. However, the applicant may choose an alternative format that presents seismic operation costs at a comparable level of detail as the prescribed format. If the applicant submits a copy of an approved AFE to support the expenditure claim, it must be adjusted to reflect actual incurred costs and must conform to all the cost eligibility limitations set out in this document. For example; any land use fees and surface rentals appearing on the AFE should be excluded from the claim application.

Section G. Seismic Purchase and Reprocessing

Seismic purchase and reprocessing costs incurred by the company after the announcement of the winning bid on an exploration licence but prior to the effective date of the licence may be approved, in addition to any such costs incurred during the term of the licence.

The applicant may claim the actual cost of seismic purchased from an arms-length vendor. Seismic over lands within the exploration licence boundaries and for a distance of 3 kilometers outside the boundaries is eligible. Variation to the 3 km rule may be considered in accordance with the provisions stated in Section F above. In addition, individual lines extending beyond the 3-kilometer limit, acquired for the purpose of establishing well tie-ins or tie-ins to existing proximate seismic surveys, may be accepted upon the approval of the Rights Administrator.

The claim should include:

1. a copy of the purchase invoice;
2. a copy of the licencing agreement, providing evidence that rights to the data have passed from the original owner to the applicant; and
3. a map indicating the locations of the purchased seismic lines and the boundaries of the exploration licence.

The applicant may also claim the direct cost of reprocessing the purchased seismic if performed by an arm's length party. Reprocessing of the purchased seismic under a non-arm's length arrangement or reprocessing carried out by the applicant's own personnel and computing equipment will be governed by the applicable rules set out in Section A. - General.

In order to claim the costs of a reprocessing project, the applicant is required to obtain NEB authorization prior to commencement of the project and to comply with the reporting requirements as per s. 38(6) of the Canada Oil and Gas Geophysical Operations Regulations.

The applicant can also claim the additional 10% miscellaneous allowance, calculated on the full cost of the purchase and reprocessing.

Section H. Regional and Other Work Programs

The cost of all or a portion of a regional geophysical (e.g. aero-magnetic survey, gravity survey) or geological field program that relates directly to the exploration licence lands may be considered as eligible work program. The applicant should consult with the Rights Administrator prior to commencing work if the intention is to claim any work program that will be conducted on or over lands beyond the boundaries of the exploration licence. Off-licence work may eligible if the applicant can demonstrate that the work will directly contribute to the evaluation of the licence lands.

Studies and surveys that are authorized as geophysical or geological programs or drilling programs, or as field environmental studies directly relevant to proposed programs will generally be considered eligible. Socio-economic studies, engineering feasibility studies, in-house studies and purchased studies are not considered as comprising exploratory work on the licence and will not be considered. However, the Rights Administrator may approve certain programs that will directly or indirectly contribute to evaluation of the licence lands through the application or testing of new technology or techniques.

Section I. Costs for Research on the Bio-Physical Environment

Requirements and costs to undertake substential work to characterize the bio-physical environment related to primary exploration activities are becoming increasingly significant and not easily accommodated within the 'Miscellaneous Cost' category. Cost-effective ways of collecting such information which minimise effects on the environment can be achieved through collaboration with non-industry entities and using shared research platforms.

These costs may be considered allowable expenditures if supported by a statement of the nature of the research undertaken, and how and where results will be published or otherwise made available to the public.

Such research may be regional in nature and may be apportioned between extant licences represented by the applicant on the basis of area or as otherwise agreed with the Administrator.

The amount claimed under this category is limited to the greater of 5% of the original work expenditure bid or $100,000.