2001 Performance

2001 FINANCIAL AND OPERATING STATS

Message to Unitholders

Total cash distributions increased 81 per cent to $234 million. On a per unit basis, cash distributions increased 15 per cent to $2.31, the highest in our history. Cumulative distributions to December 31, 2001 totalled $9.08, which represents 91 per cent of our initial public offering price of $10.00 per unit.

Behind these superior returns were activities to position ARC for further strong performance. Through the Startech acquisition in January and a Trust unit offering in November, we increased the units outstanding by about 50 per cent to 111.7 million. Funds from the November equity offering were used to reduce debt and to establish a source of capital for future development expenditures. The benefits of the Startech acquisition are evident in the Trust’s significant operational growth. Overall production increased 58 per cent during the year and total oil equivalent reserves were up 37 per cent. There is more to come. We believe the assets acquired will provide significant additional reserve additions in 2002 and beyond.

Opportunities in the New Industry Environment
The past year saw many changes within the oil and gas industry. The beginning of the year saw high commodity prices and aggressive spending on mergers and acquisitions by the energy sector followed by a transition to lower commodity prices and a reduction in capital expenditures. As a result, a number of interesting events and trends have emerged that will affect the industry going forward.

We have witnessed dramatic consolidation in the industry, with a significant reduction in the number of active companies, particularly the so-called “intermediates” and “seniors” which are loosely categorized as those companies producing 25,000 to 100,000 barrels of oil equivalent per day. The companies sold in 2001 have been acquired by many organizations, a number of them US-based companies with global assets.

The consolidation of so many Canadian operating companies has produced a new wave of asset sales as companies are evaluating recently acquired assets and are rationalizing their property portfolios. We believe this will lead to significant new acquisition opportunities for ARC. With such opportunities in sight, there is growing investor interest in the royalty trust sector. We see another factor behind this trend of increasing favour of royalty trusts – the benefits to investors from the trust structure. ARC’s 28 per cent total return on investment for 2001 is superior to many alternative investment vehicles. In fact, based on the Trust’s formula for success – superior financial and operating expertise; acquiring high quality assets; applying technical expertise to maximize production and cash flow – the result has been superior rates of return since inception in 1996.

At this point in time, the level and stability of returns provided by ARC is proving to be attractive to existing and new unitholders alike. Looking forward, however, the test is not what we have done, but what we will do. We want to share with you our plans for continuing this superior performance.

Turn Strategic Analysis into Action
Commodity price volatility is an enduring industry condition. At inception, ARC resolved to provide superior long-term returns to investors and ARC management also identified the need to stabilize distributions and enhance the ability to capture opportunities throughout all phases of the business cycle. It was for this reason that we have always withheld a portion of our cash flow for reinvestment in our business. In 2000, we revised our distribution policy to withhold up to 20 per cent of cash flow for reinvestment. This allows us to maintain more stable distributions during all phases of the commodity price cycle, facilitate opportunistic and accretive acquisitions and maintain a strong balance sheet.

Commodity price volatility will continue and it appears that cycles will be shorter with higher peaks and lower valleys. Managing effectively in this environment requires an in-depth understanding of both commodity and financial markets and a proven analytical and decision making capability.

Build a Team of Excellent People
Put simply, we apply ARC’s expertise to transform quality assets into value for our unitholders. We have developed a highly effective team of geologists, geophysicists, engineers, landmen, accountants and business experts to identify and evaluate opportunities and optimize every property we operate. We believe good people make good decisions, so we set out to hire and retain the best people in our business. Our ability to tap into the advice and expertise at ARC Financial Corporation lends depth and insight to our financial decision-making. Since 1994, ARC Financial Group, which encompasses ARC Resources Management Ltd., the manager of the Trust, and ARC Financial Corporation, has been cited as one of Canada’s 50 Best Managed Private Companies based on an annual comprehensive survey led by Arthur Andersen LLP and sponsored by CIBC World Markets, Queen’s School of Business and the National Post.

Acquisitions Must Meet the Test
To maximize unitholder value, we look for high quality producing properties with upside reserve potential. Ideal characteristics include high netbacks, extensive production histories to reduce technical risk and low decline rates which translates into more stable distributions. To further reduce risk, we have assembled a diverse portfolio of assets to ensure that no one property accounts for a significant portion of reserves or value.

The key criteria for ongoing success is low finding, development and acquisition costs for high netback properties which translates into a high recycle ratio. Since inception, our FD&A costs have been among the lowest in the industry and our recycle ratio among the highest. Our 2001 FD&A costs of $9.75 were high relative to our execeptionally low inception to date costs of $6.32/boe. Our acquisition criteria have not changed, the increased FD&A costs reflect the relatively higher commodity price environment which is expected to prevail in the future. The costs in 2001 also reflect a higher component of capital expenditures directed to converting reserves from undeveloped to producing. Given the variability which can exist in annual FD&A costs, three-year rolling average costs are considered more representative of our ongoing cost structure. At $6.94/boe, our three-year average FD&A costs remain among the lowest in the industry while our recycle ratio remains among the highest.

The Startech acquisition in 2001 has been our most significant transaction to date. This acquisition provided ARC with complementary oil and gas assets, as well as a significant entry into several new core areas. More importantly, this transaction was completed early in the cycle of corporate acquisitions before the market became expensive later in the year. Rather than participate in the overheated acquisition market during the balance of 2001, ARC focused on the acquisition and consolidation of smaller interests in existing assets, integrating the Startech assets and identifying development opportunities on existing lands to maximize long-term value.

Looking forward, we believe the opportunity for new acquisitions has never been brighter. The consolidation of our industry during 2000 and 2001 was, in many cases, driven by the desire to expand natural gas asset portfolios. Today, many of these companies are left with a material component of assets that are not core to their longerterm strategy and some are dealing with weak balance sheets in the lower end of the commodity price cycle. This should result in major near-term property dispositions, particularly of oil assets. While we strive for a relatively balanced commodity exposure, we have a technical bias to crude oil assets, as the reserves tend to demonstrate a longer reserve life and long-term reserve upside. Therefore, we expect significant opportunities to develop to acquire attractive assets in this new wave of rationalization activity.

Optimize Assets to Maximize Economic Returns
It is not enough to acquire the best possible asset for the best possible price; that is just the beginning. Once a property has been integrated into our portfolio, our team focuses on optimizing its value on a continual basis. While the tools we use are unique to each property or process, our methodology is always the same. We identify the challenge or opportunity, we assemble a team of experts to determine the most economic solution and then we implement that solution as cost effectively and efficiently as possible.

Part of our optimization strategy involves vigilant cost control. In evaluating acquisition opportunities, we assess operating costs. We look for synergistic opportunities as our large operating base creates economies of scale to enhance cost control and improve netbacks. Typically, as a property matures and its remaining reserve life declines, operating costs on a per unit of production basis escalate. Our minor property disposition program works to identify properties with high costs and limited upside and targets these for disposition. In fact, every asset in our portfolio is reviewed annually to determine its continuing fit in our asset portfolio. As properties decline in value, they become candidates for disposition.

Our management team works to reduce commodity price risk by maintaining a portfolio of sales contracts with diverse counterparties and different terms of varying duration. Depending on the relative strength or weakness of commodity prices, we seek to protect prices on up to 50 per cent of our production. Our objective is to manage risk and ensure a more stable, predictable stream of revenue.

Evaluate all Decisions based on Delivering Unitholder Value
Our objective is as clear today as it was on July 11, 1996 when ARC was established: we are resolved to be the top performing, highest return conventional oil and gas royalty trust in Canada. To achieve that goal, we recognize the need for deliberate and disciplined decision-making at all levels of the organization. We attempt to make every decision add value over the long term, from hiring new staff to evaluating acquisition opportunities.

We recognize the true measure of our success is long-term, consistent, superior returns to unitholders. As a result of our corporate-wide focus on this commitment, ARC has delivered superior performance in every year since our inception. We have recorded six consecutive years of strong results consistently outperforming our peers in the royalty trust sector, the TSE’s Oil and Gas Producers Index and the TSE 300 Index. Throughout every phase of the commodity price cycle, ARC has thrived, providing unitholders with returns averaging 15 per cent per year for those unitholders receiving cash distrubutions and returns exceeding 20 per cent per year for investors enrolled in the Distribution Reinvestment Plan.

As one of Canada’s top performing royalty trusts, our resolve to deliver value to unitholders is as strong today as it was at our inception. Our industry has changed considerably over the past six years, but our goal has not. It has been proven in our results over the past six years and how ARC applies its expertise – in the success of our distribution policy, the quality of our acquisitions and in our ability to consistently transform potential into value. We remain absolutely committed to continuing our superior performance.

John P. Dielwart
President and Chief Executive Officer

• How do our 2001 numbers measure up?  Click here to find out.