2002 Performance

2002 FINANCIAL AND OPERATING STATS

Message to Unitholders

The past year was characterized by extreme volatility in oil and gas commodity prices, a seller's market for oil and gas assets and a business environment that led to an increase in the size and number of royalty and income trusts.

Despite the challenge of volatile commodity prices, ARC Energy Trust maintained stable distributions throughout the year. We remained absolutely true to our long-standing policies and processes that are designed to create long-term value for our unitholders. Stability and predictability of distributions remain key objectives for the Trust. During 2002, we again demonstrated our commitment to leadership in our sector by becoming the first conventional oil and gas royalty trust to eliminate its external management contract and all associated fees.

An important issue facing our industry in 2002 was Canada ratifying the Kyoto Protocol that commits our industry and country to significant reductions in greenhouse gas emissions. As the current Chairman of the Canadian Association of Petroleum Producers ("CAPP"), I was extensively involved in all discussions between our industry and various government bodies regarding this issue. While we believe the Kyoto Protocol is severely flawed for the country as a whole, we do not expect its implementation will have a material impact on our business due to the nature of the Trust's assets.

Looking forward to 2003 and beyond, I believe that our historic approach to managing the Trust's business through all cycles of the market will continue to deliver superior returns to our unitholders.

Commodity Price Environment
Oil prices began 2002 at US$21.00/bbl and fell below US$18.00/bbl in mid-January. Prices recovered to almost US$33.00/bbl in December and closed the year at US$31.20/bbl. The average price in 2002 for West Texas Intermediate crude oil was US$26.10/bbl, the second highest average since 1990. Canadian natural gas spot prices opened the year at $3.18/mcf, increased to over $5.00/mcf in April and declined to $1.28/mcf in July. Prices rallied to $6.33/mcf in December and closed the year at $5.70/mcf. The average price for the year was $4.08/mcf which was 35 per cent lower than 2001. Commodity price cycles are a fact of life in our industry but seldom have we been exposed to such extreme price fluctuations in such a compressed time period. The price volatility was significantly influenced by concerns about near-term supplies of crude oil and near to long-term supplies of natural gas.

The fourth quarter rally in oil prices resulted from a combination of supply disruptions associated with civil unrest in Venezuela and concern over a possible attack on Iraq by the United States. While we expect both of these issues to be resolved in 2003, it will take time to rebuild depleted inventories and consequently, we expect higher prices than the analyst average forecast of US$24.00/bbl.

The current strength of natural gas prices is directly associated with below normal inventory levels and concern about the North American natural gas industry's ability to replace production on an on-going basis. High natural gas prices have occurred despite the dampening of demand caused by the prolonged poor performance of the United States' economy. Improved performance by the U.S. economy should increase demand causing further strain in an already tight natural gas market. Therefore, while consensus forecasts call for an average Canadian gas price of $5.00/mcf in 2003, we believe there is a strong probability of higher actual prices than most analysts predict.

Stable Distributions in 2002
Managing our business in a volatile price environment is challenging, particularly when providing stable, predictable distributions is an objective of the Trust. The Trust reviews distributions on a quarterly basis and may adjust distributions to reflect current commodity prices. Through our price risk management program (hedging) and the flexibility built into our distribution policy, the Trust maintained cash distributions at $0.13 per unit for revenue earned each month during 2002. This was achieved while withholding two per cent of our cash flow to fund future abandonment liabilities and 16 per cent to partially fund our capital program. In 2002, approximately 55 per cent of the Trust's oil and natural gas liquids production was hedged at an average price of US$24.15/bbl; 40 per cent of our natural gas production was hedged at an average price of $4.11/mcf.

By the end of January 2003, ARC had hedged approximately 50 per cent of its total 2003 oil production at an average price of US$26.98/bbl. The highest quarterly hedge price is US$27.77/bbl in the first quarter and the lowest quarterly hedge price is US$26.20 in the fourth quarter, based on current commodity prices. On the gas side, our strategy is to maintain maximum exposure to market prices during the winter months when we could experience price spikes due to low inventory levels and lock in attractive prices during the spring, summer and fall when we typically see price weakness. For the first quarter, ARC has a $4.22/mcf fixed price contract on four per cent of its gas production and has not limited the upside on the remainder.

For the second through the fourth quarters of 2003, ARC has hedged approximately 38 per cent of natural gas production at an average price of $5.44/mcf.

Cumulative distributions through to the end of 2002 (including the December 2002 distribution paid in January 2003) totaled $10.64 per unit, which represents 106 per cent of our July 1996 initial public offering price of $10.00 per unit. The total return to unitholders for 2002 was 11.7 per cent and total returns since inception have averaged 13.4 per cent per year. Other trusts may have delivered higher total returns than ARC during 2002, but few have performed better over the long-term. We believe long-term, consistent and superior returns are the true measure of success in the trust sector and in this regard we have few equals. Throughout every phase of commodity price cycles, the Trust has delivered among the most stable and consistent distributions in the sector.

Acquisition Market for Oil and Gas Assets
Despite weak commodity prices early in 2002, it was a seller's market for oil and gas assets throughout the year. Not only were prices higher than the Trust was prepared to pay, many of the assets available and acquired by others were, in our view, of relatively low quality and/or had a short reserve life index (RLI). ARC's strategy did not waiver from that which has resulted in superior returns since inception for our unitholders; we opportunistically acquire high quality properties that complement our existing asset base or will add a new core area to support future growth. We completed $119 million of high netback acquisitions net of dispositions at an average cost of $9.18/boe for established reserves with an average RLI of 10 years. The majority of the assets acquired were in existing core areas such as Ante Creek and Medicine River. ARC's total corporate RLI at December 31, 2002 increased slightly to 11.8 years.

ARC's 2002 acquisitions compared favorably to the royalty trust sector where transactions totaling approximately $3.0 billion at an average reported cost of $9.76/boe for established reserves and an average RLI of 7.9 years were completed. While ARC maintained its RLI, many of our sector peers completed acquisitions that resulted in reductions to their RLIs. Complementing our acquisition program was an $88.3 million capital expenditure program that focused on the development of our existing asset base. In total, we replaced 145 per cent of our production at an average cost of $9.27/boe for established reserves. We expect this to once again place the Trust in the top quartile for finding, development and acquisition costs in both the royalty trust sector and the overall oil and gas industry.

Looking forward to 2003, the strong commodity price environment experienced during the first quarter should result in a continued seller's market for assets. With strong cash flow, there may be fewer dispositions by companies needing to improve the strength of their balance sheet. The continued growth of the royalty trust sector and the declining average RLI will result in strong competition for assets as the sector tries to maintain itself. We will continue with our strategy to seek high quality assets outside of the broad competitive acquisition market, including non-traditional assets, to complement our existing asset base.

Business Environment
In 2002, the income and royalty trust sectors outperformed the broader equity market for the third consecutive year. A record $9.7 billion was raised in the equity market in 89 transactions including $5.3 billion from 36 initial public offerings ("IPO"); over $1.0 billion of the total equity raised was in the form of convertible debentures. The royalty trust sector had one small, new IPO as well as 20 follow-on offerings totaling in excess of $1.5 billion. Additionally, one exploration and production ("E&P") company converted to a royalty trust structure and two other E&P companies converted to royalty trusts subsequent to year-end. The total market capitalization of the income fund sector increased 112 per cent in 2002 from $21.4 billion to $45.4 billion. The total market capitalization in the royalty trust sector increased 89 per cent in 2002 from $7.6 billion to $14.4 billion. The outlook for 2003 is a continuation in the growth of both the income and royalty trust sectors.

The end result of all this activity is increased competition for a finite amount of available investment capital. To maintain an edge in this competitive environment, the Trust must maintain its strong franchise in the market through continued superior performance and expand its universe of prospective investors through initiatives such as the elimination of the management contract. To this end, the Trust is taking a lead role in an initiative to lobby the Alberta government to legislate comparable liability protection for unitholders of trusts as that accorded to shareholders of corporations. If we are successful, one of the last remaining obstacles for significant pension fund participation in the sector would be removed. Without this obstacle, we believe the Trust is well-positioned to attract additional institutional capital, given our size, quality of assets, record of performance and the absence of any external management fees.

During 2002, the Trust issued 10 million trust units at a price of $12.05 per unit for total gross proceeds of $121 million. In February 2003, the Trust issued 12.5 million trust units at a price of $11.50 per unit for total gross proceeds of $144.0 million. A new development during the year was two cross border equity issues by two large cap trusts which raised total gross proceeds of CDN$287 million from U.S. investors. In addition, another large cap trust secured a listing on the New York Stock Exchange ("NYSE"). The Trust continues to review the merits of a U.S. listing but has not yet concluded that the benefits outweigh the costs involved. Our focus continues to be on expanding our investor base in Canada but we may in the future pursue a NYSE listing.

Elimination of the Management Contract
The Trust has always been committed to being a leader in our sector in all aspects of our business. When we were formed in 1996, external management contracts were the "norm". Managers of the trusts received certain base fees calculated as a per cent of cash flow as well as transaction related fees for acquisitions and dispositions. In our case, these fees were always among the lowest in the sector. However, as the Trust grew in size, these fees became significant and the external management structure became less suited to an organization of our size.

On August 28, 2002, the Trust's unitholders voted in favour of eliminating the external management contract and all related future fees. The contract was purchased for $55 million plus expenses related to the purchase, paid primarily in the form of trust units and exchangeable shares to 73 shareholders of the management company. The transaction was accretive to the Trust and met all of the Trust's acquisition criteria. In completing this transaction, the Trust became the first conventional oil and gas trust to eliminate its management contract and all related fees. Following our leadership in this matter, five other royalty trusts have since eliminated their management contracts, most of which were done under comparable terms and conditions to our transaction.

Elimination of the management contract improves our competitive position in the acquisition market and should provide greater opportunities going forward for adding value. The Trust's officers and directors now own approximately two per cent of the outstanding securities. A significant component of these securities are subject to escrow and forfeiture provisions for up to five years. Your management team remains absolutely committed to continuing to deliver top quartile returns and superior performance.

The benefits of the internalization transaction include the potential reduction in the Trust's cost of capital through the expansion of our investor base. Institutions and pension funds that would not typically invest in an oil and gas royalty trust with external management fees may now invest in the Trust. Corporate governance is improved through transparency in reporting of management compensation and increasing the number of non-management directors from four to six. Overall costs are reduced through the elimination of management fees and acquisition and disposition fees, without impacting the general and administrative expenses of the Trust. Most importantly, the management contract and related fees created concerns about the possible misalignment of management and unitholder interests – this is no longer an issue.

Kyoto Protocol
On December 10, 2002, Canada ratified the Kyoto Protocol committing this country to major reductions in greenhouse gas emissions over the next 10 years. ARC supports the position taken by CAPP that strongly opposed ratification of the accord and instead proposed reductions in emission intensity, thereby allowing our industry and the Canadian economy to continue to grow. First as Vice-Chairman and later as Chairman of CAPP in 2002, I was personally present in meetings with the Prime Minister and senior Cabinet Ministers to discuss the Kyoto Protocol and its impact on the Canadian economy in general and our industry in particular. I believe that ratification occurred purely for political reasons without a firm understanding of how Canada can achieve the targets to which we are now obligated.

Post-ratification, the government came to understand that the investment community was genuinely concerned about the uncertainty created by ratification of the accord and the lack of firm details with regard to the cost of the accord for our industry. CAPP strongly encouraged the government to clarify our industry's obligations under the accord based on data presented to us in closed meetings. On December 18, 2002, the government confirmed that they would set the emission intensity targets for the oil and gas sector at a level not more than 15 per cent below projected "business as usual" levels for 2010. The government also committed that our industry's cost of carbon credits to meet these reduction targets would not exceed $15 per tonne.

The targeted reductions focus on the so-called large industrial emitters such as oil sands operations, major sour gas plants and oil and gas transmission facilities. ARC's production is predominantly light sweet oil and sweet natural gas, which, on a relative basis, have the lowest emission levels per unit of production. As a result, our exposure to increased costs under the government's identified targets is much less than the industry as a whole.

Our opposition to the Kyoto Protocol should not be misconstrued as being dismissive about greenhouse gas emissions. Rather it is recognition of the fact that, although well intentioned, the Kyoto accord and Canada's ratification thereof is severely flawed. We believe a better solution exists for our country that takes into consideration the uniqueness of our situation. Our company and our industry will continue to invest in emission reduction initiatives that will benefit future generations of Canadians and we will work constructively with government agencies in all areas of environmental stewardship. As evidence of our commitment in this regard, ARC was recently awarded Gold Champion Level Reporter status (the highest level achievable) from Canada's Voluntary Climate Change Registry.

John P. Dielwart
President and Chief Executive Officer

• How do our 2002 numbers measure up?  Click here to find out.