Qwest Investment Management Oil and Gas Flow-Through Fund

Transcription

1 Siddharth Rajeev, B.Tech, MBA, CFA Analyst Daniel Iwata, BA Associate March 21, 2014 Qwest Investment Management Oil and Gas Flow-Through Fund Sector/Industry: Oil and Gas Investment Highlights Issuer CEE Portfolio Min/Max Qwest 2014 Oil & Gas Exploration and Development Flow-Through Limited Partnership $0.25 million min / $20 million max CDE Portfolio Min/Max $0.25 million min / $20 million max Minimum Investment Securities Offered Price Management Fee Maturity $5,000 (500 units) Class A, B and F of CDE and CEE units $10 per unit 2% of NAV plus performance bonus Expected liquidity event in 1-2 years Sales & commissions Class A - 6.5% Class B- 3.5% Dealer / Wholesaler fee Auditor Offering S ummary 1% EMD fee + 1% wholesaler fee PwC Based on an Offering Memorandum ( OM ) dated January 31, FRC Rating IRR (base-case) N/A Rating 3 Risk 4 Risks Qwest Investment Management is currently offering investors the opportunity to invest in oil and gas companies flow-through shares through their Qwest 2014 Oil & Gas Exploration and Development Flow-Through Limited Partnership ( LP ). Qwest is an investment management company headquartered in Vancouver, BC. They have been managing flow-through funds for the last 10 years. Flow-through shares allow companies to pass along exploration or development expenses to investors, which they can use as tax deductions. Due to the tax benefits offered by flow-through shares, the capital at risk is lower for investors. Management intends to roll the LP units into a mutual fund in 1-2 years to provide liquidity for investors. Management has an equal focus on oil and gas investments at this time. The management fee is 2% of the Net Asset Value ( NAV ) of the LP. There is also a performance bonus that may be paid to management on the day prior to the LP units being rolled over into a mutual fund. Investments are typically made in smaller capitalization oil and gas companies, which are more susceptible to market risk factors. Investments into companies with exploration/development projects are typically exposed to higher risks than companies with producing/mature projects. Volatility in oil and gas prices may negatively impact the portfolio s investments. As with most funds, the portfolio manager is crucial to operations, which exposes investors to key personnel risk. A portion of the portfolio may be invested in private companies. Private companies tend to have lower liquidity. A weakness in the junior resource capital markets will result in lower flow-through financing opportunities. Changes in tax regulations, and the treatment of flow-through shares, may negatively impact investors. *see back of report for rating definitions

2 Page 2 Background Qwest Investment Management is an investment management firm that specializes in oil and gas investments. They currently manage two mutual funds, and have formed, on average, two flow-through Limited Partnerships every year since Flow-through investments allow companies to transfer their exploration and development expenses to those invested in flow-through shares. Investors can use these expenses as tax deductions, while still holding the shares. The LP units are intended to be rolled into one of the funds that Qwest manages, called Qwest Energy Canadian Resource Mutual fund ( CRC ), in 1 to 2 years after inception. The benefit of the roll over is that a mutual fund structure provides liquidity to investors by allowing them to redeem their units. Qwest was founded in late One of its founders, Maurice Levesque, is the current President and Chairman of Qwest. Qwest currently has four different divisions: Qwest Investment Management Corp (QIM), Qwest Investment Fund Management Ltd., (QIFM), Qwest Capital Partners (QCP), and Heritage Bancorp. The following gives a brief description of each. Qwest Investment Management Corp. QIM is the parent company and specializes in identifying emerging trend opportunities, managing merchant banking transactions, and structuring investment products. This company s senior management consists of Maurice Levesque (President), Chris Harrison (CFO), Don Short (Sr. VP and Portfolio Manager), and a sales team. Qwest Investment Fund Management Ltd. Provides investment fund management and portfolio management services to the funds under management. The portfolio management team consists of two portfolio managers (Cam Hui and Don Short), and an associate portfolio manager (Greg McLean). QIFM is also an exempt market dealer. Qwest Capital Partners Ltd. Provides investment banking and advisory services to mid-market companies. It is managed by Maurice Levesque and David Mears. Heritage Bancorp Ltd. Heritage is a wholly owned subsidiary of QIM, and provides accounting and administrative services to Qwest and related entities. As mentioned earlier, Qwest s primary business is managing flow-through oil and gas LPs, which are rolled over into the CRC. This fund, and the flow-through LPs, are managed by Don Short. Don Short joined Qwest as a portfolio manager in June In addition to those funds, Cam Hui manages the Qwest Global Tactical Balanced Class

3 Page 3 ( GTB ), and provides the macro outlook for the firm. GTB focuses on gaining exposure to a diversified portfolio of equity and income investments. The fund looks to invest in equity ETFs (Exchange Traded Funds) in the U.S. and Canada, fixed income ETFs, or fixed income investments issued by governments or corporations. The portfolio composition of the Tactical Balanced fund is shown below. Flow-through investments Flow-through investments allow resource companies to raise capital for exploration and development, and pass on the expenses incurred to investors for tax use purposes. Qwest offers investors the opportunity to invest in a portfolio comprised of either Canadian Exploration Expenses (CEE) or Canadian Development Expenses (CDE) flow-through shares. Flow-through shares are typically priced at a premium to a company s common shares due to the tax advantage. Premiums range approximately 10% - 30% for CEE, and 0% - 15% for CDE. Management notes that institutional investors usually have priority on securing flow-through shares, making this type of investment difficult to access by retail investors. How a flow-through investment works is shown below. Source: Qwest

4 Page 4 CEE flow-through shares are primarily issued by small and/or early-stage companies that are engaged in exploration. The exploration business is risky, but shares of such companies have potential for high returns due to their inherent risks. A company that issues CEE flow-through shares this year has until December 31, 2015 to incur CEE expenses. Investors, however, will be eligible for tax deductions, in most cases, by the end of this year. CDE flow-through shares are primarily issued by larger junior to medium size companies that are looking to develop resources that have already been identified. These investments are less risky, but also do not have the higher upside of CEE investments. CDE investments also provide a 100% deduction, however the deduction is calculated on an annual 30% p.a. declining balance (discussed more later). Companies that issue CDE flowthrough shares, have until December 31, 2014 to incur their CDE expenses. The following table outlines the key differences between CEE and CDE investments. CEE CDE Used for Exploration Development Risk Is generally riskier, but offers Lower risk, but lower upside higher upside potential potential Size of Company Early stage to large juniors Larger juniors to mid size Price premium relative to common share price Higher premium because 100% of the deduction can be used in the year the expense is transferred Lower premium because deduction is spread over time Tax deduction 100% in the year expenses are transferred 100% tax deduction based on an annual 30% declining balance basis An example of the tax benefits from CEE and CDE flow-through shares are shown below. CEE investments provide a 100% deduction in the year expenses are transferred. For example, on a $100 tax deduction an investor with a 45% marginal tax rate can reduce his/her income by the full $100, and save $45 in taxes. CDE is done on an annual declining balance, which allows the first 30% of the total deduction to be taken when the expense is transferred. The remaining balance can further be used each year (up to 30% of the declining balance). For example, in year one, 30% of the $100 is used leaving a $70 deductible balance the next year. This method allows deductions every year until the full $100 is used up. Both CEE and CDE tax deductions can be carried forward indefinitely. Examples of CEE and CDE tax credits are shown below.

5 Page 5 CEE Example CEE CDE Example CDE Capital at risk Due to the tax advantages of the flow-through shares, the amount of capital at risk for an investor is decreased. Given a $10,000 investment, the following table shows the amount at risk and breakeven point, with the tax benefit offered by the flow-through shares. Keep in mind that the table below assumes no sales fee and operating fees. Once an investor uses his/her $10,000 deduction, the cost base for the investment is $0. Therefore, 100% of the funds the investors eventually recoups are subject to capital gains tax. For BC, investors will need a before tax amount of $7,030 (investment at risk of $5,420 / 1 marginal tax rate * 50%) in order to recoup the at risk portion of their original investment.

6 Page 6 Source: Qwest Overall, we believe flow-through shares offer attractive options for those looking to gain exposure to smaller resource companies, and take advantage of the tax benefits offered by these investments. Management Team Qwest has their head office located in Vancouver, BC. The company also maintains a Calgary, Alberta office that Don Short and Greg Mclean operate out of. Don Short is responsible for actively managing the investments in the flow-through funds and the CRC. Biographies of the principals of Qwest, and the portfolio management team, as provided by management, are shown below. Maurice Levesque Maurice Levesque is a founder and the Chairman, Managing Director, and President of QIM., a financial services company, and its core activity is the marketing of its mutual funds, flow-through funds and its other products and services. Maurice Levesque is the Chairman, CEO and Chief Compliance Officer of QIFM, a 100% wholly owned subsidiary of QIM. Additionally, Maurice Levesque is Chairman and Director of Heritage Bancorp Ltd., a wholly owned subsidiary of QIM, which provides accounting and administration services to the Qwest group of companies and other entities. Maurice Levesque has 30 years of experience in the Canadian financial industry and is a founder and/or a director of several private and publicly traded companies, which operate in a variety of industries. Maurice Levesque graduated from The Northern Alberta Institute of Technology with a diploma in Administration Management, is a member of the Institute of Corporate Directors and a member of the Board of Directors for the Private Capital Markets Association.

7 Page 7 Cam Hui, CFA Cam Hui is a Portfolio Manager and a Director of QIFM, a 100% wholly owned subsidiary of QIM. Cam Hui began his investment career in 1985 with Wood Gundy Inc. (now CIBC World Markets), where he eventually became a quantitative equity analyst and was part of a Brendan Wood top-ranked small cap research team. He joined the Battery march organization in 1990, where he was a portfolio manager with mandates for Canadian, U.S., international and emerging market equities for large public clients, such as the Ontario Teachers' Pension Plan and the California State Teachers' Retirement System plan. During his tenure at Battery march, his global resource fund was named the top-rank fund in its class. Cam Hui also has extensive portfolio management experience gained from equity longshort portfolios at Graham Capital Management LLC, a Connecticut-based hedge fund with US$5 billion in assets. Prior to joining QIFM, he was part of an Institutional Investor-ranked research technical analysis team at Merrill Lynch, Pierce, Fenner & Smith in New York City. Cam Hui has been involved in all phases of the investment spectrum and brings to QIFM a diverse background in investment management and quantitative research, along with his considerable global economic insights. Over the course of his career, Cam Hui has lectured extensively and presented numerous papers to quantitative discussion groups. He has consulted with various hedge funds on topics such as quantitative stock selection strategies, portfolio risk control and trading cost optimization. He also publishes a widely followed investment blog, "Humble Student of the Markets" in addition to QIFM's weekly "Trend Watch" and monthly "Qwest for Returns" publications. Cam Hui obtained his Bachelor of Science degree (Honours) in Computer Science in 1980 at the University of British Columbia and his CFA Charter designation in Don Short, CFA Don Short is a Senior Vice President and Portfolio Manager of QIM and QIFM. Don Short, based in Calgary, Alberta, has been involved as an investment manager and equity analyst in the energy sector since the early 1990 s. From 2006 to mid-2010, Don Short was the President and Portfolio Manager of Origin Capital Management Ltd., a Calgary based investment management company he founded which specialized in the energy sector. Prior to establishing Origin, Don Short was an oil and gas equity analyst at Raymond James Ltd. from 2003 to late There he was responsible for Canadian energy and royalty trust research. From 2001 to 2003, he was a founder and principal of Core Partners Inc., a business advisory services firm. Prior to this, from 1995 to 2001, Don Short was an institutional equity salesman and investment analyst with First Energy Capital Corp., providing Canadian energy industry research focused on institutional sales coverage. From 1991 to 1994, Don Short was an energy market 45 analyst for Northridge Canada Inc. where he researched NYMEX natural gas price behaviour and also developed and managed one of the early offerings in Canada of an oil and gas flow-through limited partnership. Don Short holds both a B.Comm and B.Sc. (computer science and math), with distinction, from the University of Calgary and is a licensed Portfolio Manager and Investment Counsellor. Don Short is also a Chartered Financial Analyst charterholder.

8 Page 8 Greg McLean, M.B.A. Based in Calgary, Alberta, Greg McLean is the Associate Portfolio Manager of QIFM. Greg McLean spent five years as the Executive Vice-President - Investments with Cavendish Investing Ltd., where his duties encompassed profitable portfolio management, investing in successful venture capital and private equity opportunities, tax efficiency, and working with investee companies on strategic alternatives. In his roles, he invested in companies ranging from publicly-listed biotechnology companies to private resource companies, and constructed the liquidity strategy for numerous public and private investments. He also worked as an investment banker for nine years at bank-owned and independent investment dealers. Prior to his finance career, Greg Mclean served for six years as a policy advisor for Canadian Cabinet Ministers. Formally educated at the University of Alberta, where he received a Bachelor of Commerce degree, Greg McLean also attended the Richard Ivey School of Business at the University of Western Ontario, where he attained his Masters of Business Administration. Greg McLean has continued his education by taking courses in pursuit of his Chartered Business Valuator designation, and through the Canadian Securities Institute, for his previous role as an unregistered Investment Director. Greg McLean presently serves on the board of directors of a private oil and gas service company. Chris Harrison, CGA Chris Harrison is the Chief Financial Officer for QIM, QIFM and Heritage Bancorp Ltd. where he is responsible for overseeing the financial and tax reporting for all entities in the Qwest group. Chris Harrison has over 16 years of experience working in the investment management industry. From 1997 to 2007, Chris Harrison was employed by Genus Capital Management Inc., a Vancouver-based investment counsel and portfolio management firm. Chris Harrison left Genus in the position of Senior Manager of Administration, in which capacity he was responsible for operations, compliance, regulatory reporting and internal and external financial reporting for the Genus group of funds. From 2007 to 2010 Chris Harrison was Vice-President, Finance & Compliance for QIM and QIFM. Since 2010 Chris Harrison has been the Chief Financial Officer for all of the entities in the Qwest group. Chris Harrison, a Certified General Accountant, is a graduate of the University of Victoria (B.A. Economics) and the British Columbia Institute of Technology (Diploma of Technology in Financial Management). Chris Harrison is a member of the Certified General Accountants Association of British Columbia and the Certified General Accountants Association of Canada. Strategy Management typically invests in approximately stocks per fund. They look at the following key parameters in their due diligence: (i) experienced and reputable management with a defined track record in the energy or alternative energy industries;

9 Page 9 (ii) (iii) (iv) have a knowledgeable board of directors; have exploration programs or exploration and development programs in place; and have securities that are suitably priced and offer capital appreciation potential; etc. Management has a preference for projects located in Western Canada. They tend not to invest in companies with offshore projects, or projects outside the US and Canada. Management intends to follow the following guidelines to manage the risk profile of the portfolio: Public to private company mix a minimum of 90% of the portfolio will be invested in shares of public companies. Size at least 50% of the portfolio will be invested in companies with a market capitalization of at least $10 million. Non flow-through investments - up to 10% of the gross proceeds raised in the offering may be invested in non flow-through shares. Cross-over investments if CDE opportunities are limited, management may purchase up to 50% of the funds available for CDE to acquire CEE flow-through shares. Diversification the portfolio will invest no more than 20% of the gross proceeds in a single issuer Alternative flow-through investments may invest up to 10% of the gross proceeds in alternative flow-through investments Will not acquire more than 20% of the outstanding shares of an issuer. Qwest undertakes very limited short selling, and does not anticipate that it will be a material component of any of its current investment products. Commodity price outlook: We have a positive long-term outlook on both oil and gas. The consensus oil and gas price forecasts through 2022 are shown on the following page.

10 Page 10 Oil (WTI Cushing Oklahoma) Source: GLJ and Sproule Based on consensus forecasts, WTI prices are expected to range between US$90/bbl and US103/bbl, between 2014, and The henry hub spot price (see chart below) is expected to range between US$4.3/mmbtu and US$5.6/mmbtu, between 2014, and Natural Gas (Henry Hub - US$/mmbtu) Source: GLJ and Sproule The following excerpts from the OM gives us an indication of management s outlook on the oil and gas sector.

11 Page 11 Macro-economic view We continue to believe central bankers policies will spur economic growth and therefore by extension, support most commodity prices. Oil price and producers We believe the fundamentals of supply and demand, and growing global economic growth, will keep the price of crude oil between $85 and $110 per barrel in This will reinforce society s need to look for alternative sources of energy supply, mainly natural gas. There continues to be value-based opportunities in senior oil weighted producers, junior international exploration companies, and junior oil producer companies. Natural gas price and producer We believe the price of NYMEX natural gas bottomed in Our bullish forecast is based on changing fundamentals of plateauing US supply and structural increases in U.S. demand from electricity generation, industrial use and the emergence of LNG export as a source of natural gas demand. Looking to late 2014, investor sentiment will continue to improve as we get closer to seeing increased LNG export capacity coming on stream, which will be a catalyst for further upward price pressure for natural gas. We would caution not all natural gas producers share prices will perform well; therefore, stock selection will be a key to positive performance in a portfolio. Portfolio weighting In 2014, we will likely balance our focus between oil-weighted and natural gas producers. That said, with our more bullish outlook for the price of natural gas, the equity price performance for well-managed natural gas producers may outperform the oil-weighted producers. Track record and process The tables on the next pages show a breakdown of the return of each of Qwest s flowthrough LPs from inception to being rolled over into a mutual fund. Keep in mind that Don Short has been the principal manager of the flow-through funds only since The returns were calculated by management as of January 31, 2014, for the current funds, and on the date of rollover for the funds that were rolled over. The return calculations also include tax deduction benefits based on the highest marginal tax bracket in Ontario (49.53%). We have reviewed the audited financial statements by PwC for all the funds (except the first two funds Qwest Energy IV FTLP, and Qwest Energy RSP FTLP, as they did not have audited financials prepared), and feel that the NAV and return calculations presented are accurate. As shown, there is a high variance between the returns of each LP. The total returns ranged from % to %. Key dates of the funds rolled over are shown below.

12 Page 12 Qwest Energy Fund Preliminary Prospectus Rollover 2011 II Aug 2011 May Dec 2010 May II Sep 2010 Apr Feb 2010 Feb II Sep 2009 Jun Feb 2009 Jan II Aug 2008 Apr Dec 2007 Apr II Sep 2007 Sep Dec 2006 Mar II Aug 2006 June Feb 2006 June III Sep 2005 Jun II Apr 2005 Jun Jan 2005 Jan Aug 2004 Mar 2005 The table below shows the rate of returns generated by all the funds. As mentioned earlier, flow-through shares are typically issued at a premium to the common share price. After investors receive their tax benefit, these shares trade at common share price.

13 Page 13 Source: Qwest Of the 18 flow-through LPs that were rolled over, eight generated net positive returns for investors, and 10 generated net negative returns. Four of the eight funds that had positive overall returns were rolled over at a NAV below the issue price; indicating the importance of tax benefits in the overall returns of such investments. A comparison of Qwest and other flow-through LP funds is shown below. The LPs are shown by year of inception. In the table below, Qwest Energy represents the first LP formed by Qwest in a year, while Qwest Energy II represents the second LP formed in the year. The returns shown below were calculated by the respective companies and include tax benefits (generally calculated at Ontario s highest marginal rate). We have chosen the below funds because we feel the calculation of their performance is similar to Qwest (NAV change + tax benefits).

14 Page 14 LP Date Qwest Energy Qwest Energy II Pathway Oil & Gas Sprott FTLP Front Street LP I Front Street LP II Mapleleaf FT % % 16.70% % % % % % % % % -1.51% % 46.20% 15.00% -8.10% % % 39.78% 57.85% % 90.50% % 49.54% 22.74% 30.00% % % % % 14.49% 11.90% % % 70.40% % 86.90% Source: FRC and various sources Management has provided the following comparisons of other flow-through funds NAVs initiated in 2012 and The NAVs are as of January 31, 2014, and based on a $25 unit value at the time of inception Offerings 2012 Offerings Source: Qwest Based on the above tables, we can see that Qwest funds outperformed their peers in some years, and underperformed in other years. No particular fund, included in the above tables, has consistently outperformed its peers. Once the LP units are rolled over into the CRC, management focuses on providing liquidity. The overall strategy for the CRC is to: 1) Provide liquidity for redemptions.

15 Page 15 2) Provide liquidity once flow-through funds are rolled into the mutual fund (historically, 50%-80% usually redeem in the weeks following rollover). 3) Position remaining funds in larger cap junior resource companies with good growth prospects. The following chart shows the performance of the CRC fund. Given the mandate of the fund, we feel that the portfolio is not designed for return maximization, but rather, the primary mandate is to provide liquidity. Also, keep in mind that shares rolled into the fund are of micro and small cap companies ($20 million to $40 million), and therefore, are less liquid relative to shares of mid/large cap companies. The adjusted NAV (including distributions) of CRC from May 2006 is shown below. Source: Globefunds DB The chart below shows the performance of the TSX Venture, BMO junior oil, and BMO junior gas indices. TSX-V (5 Year) / BMO Junior Oil (since inception) / BMO Junior Gas (Since inception) Indexed to BMO Junior Oil Share price Source: Capital IQ

16 Page 16 As shown in the charts above, CRC traded fairly in line with the TSXV index. Both BMO junior indices outperformed the CRC, but they are not really comparable to CRC as they both contain companies with higher market capitalization than are typical for flow-through funds. Since CRC s primary objective is to provide liquidity, we do not believe any of the above three indices are adequate comparables to CRC. The annualized returns to investors over various periods, as provided by management, are shown below. We have confirmed these returns with the audited financial statements. CRC Series A returns (annualized) Series A 1 MO -1.17% 3 MO -3.30% 6 MO 4.57% 9 MO 2.74% 1 Year % 2 Year % 3 Year % 4 Year % 5 Year -9.67% 6 Year % 7 Year % From Inception % Source: Qwest The table below shows the net assets, management expense ratio (MER = operating expenses + management expenses divided by net assets), and the amount of redemptions per year. The high amount of redemptions each year highlights the liquidity benefits provided by the mutual fund Net Assets (000's) $ 13,620 $ 31,322 $ 29,136 $ 35,894 $ 39,693 $ 17,422 $ 13,356 Redemptions (000's) $ 27,150 $ 17,665 $ 34,108 $ 22,007 $ 32,819 $ 24,490 $ 17,189 MER 3.48% 3.70% 3.57% 4.15% 3.91% 4.09% 4.74% We feel that the MER is in the mid-range for mutual funds that have flow-through funds rolled into them. Annual MERs that we have reviewed for other funds ranged from 2.75% to 7%. Global Tactical Balanced Mutual Fund GTB was founded in 2010, and is primarily managed by Cam Hui. As per this fund s audited financials, as of June 30, 2013, the fund had $7.88 million in net assets. The flowthrough units will be rolled into CRC, but following rollover, investors may switch their investment into GTB with no capital gains tax being triggered. The following shows the change in NAV since GTB s inception.

17 Page 17 Source: Globefunds DB The returns over various time periods for GTB are shown below. Annualized Performance GTB GTB Series A Series F 1 MO -0.81% -0.71% 3 MO 0.54% 0.71% 6 MO 2.60% 3.05% 9 MO -1.68% -0.97% 1 Year 0.78% 1.79% 2 Year 2.82% 3.95% 3 Year -3.43% -2.36% From Inception -4.48% -2.32% The MER for GTB has declined since fund inception, and for the 6 months ended June 2013, was 4.94% for class A, and 3.79% for class F. We feel that the MER for GTB is higher than comparable sized funds, which start in the 2.5% - 3% range. For larger mutual funds ($100+ million in assets), the MER is typically in the 1% - 2% range.

18 Page 18 Offering Structure Investors will invest in the Qwest 2014 Oil & Gas Exploration and Development Flow- Through Limited Partnership. The LP has various units for sale including different classes (A, B and F) of CDE and CEE units. All the classes are identical except for the sales and commission fees, and performance bonus paid. Units purchased in either CDE or CEE will be actively managed in separate portfolios. The NAV per unit of each portfolio will also be calculated separately. Management Fees The annual management fee is 2% of NAV. There is also a performance bonus paid to management on the day prior to the LP being rolled over into the fund. The calculation of the performance bonus is described below. Class A and F units (CDE and CEE): The performance bonus is equal to 20% of any funds in excess of available funds. Available funds (see table below) is defined as gross proceeds raised in this offering, net of agents sales commissions, offering expenses, and operating reserves. B class units: The performance bonus is equal to 20% of any funds in excess of 110% of the original NAV.

19 Page 19 Sales and commissions Class A: 6.5% to sales agents+ 1% dealer fee + 1% for wholesalers. These units are targeted towards Exempt Market Dealers and Mutual Fund Dealers. Class B: 3.5% to sales agents + 1% dealer fee + 1% for wholesalers. These units are targeted towards IIROC dealers. Class F: No fees paid. These units are targeted towards fee based advisors. Redemption Investors are restricted from reselling or redeeming their units. Note that the fund plans to rollover the LP units into the CRC in 1-2 years. Offering Breakdown The table below shows the breakdown of proceeds given the minimum and maximum offering for each unit type. Please see notes contained in the OM For the minimum offering, the LP will take $100,000 as operating reserves ($50,000 per portfolio). For funds above the minimum raise, each portfolio will take an additional 2% of gross proceeds for operating reserves. The operating reserves are to fund operating costs and management fees of each portfolio. The following shows an example of the flow of funds of a $100 investment. The sales and commission fees, and operating reserves, will come out of the gross proceeds of the offering, leaving the LP with $88.00 available to purchase flow-through shares. Management estimates they intend to keep aside 2.5% of the gross proceeds as operating reserves and pay approximately 1% in offering costs. The following discussion relates to CEE flow-through shares. CDE shares would have the same tax deduction, but over an extended period of time.

20 Page 20 Flow of funds - Class A CEE Investment $ Sales fee (8.5% of gross proceeds) $8.50 Operating reserve (2.5% of gross proceeds) + Offering Costs (1% of gross proceeds - management est.) $3.50 Available funds for investment in flow through funds $88.00 The investment will provide a tax benefit to investors of $49.53 ($100 * 49.53% assuming Ontario s highest tax bracket). We have assumed investors will receive 100% of the operating reserves and sales and commission fees for tax deduction. This leaves the amount of capital at risk at $ The fund s investments should be sold for at least $67.08 for investors to break even, after accounting for capital gains tax see table below. Flow of funds - Class A CEE (A) Investment $ Sales fee (8.5% of gross proceeds) $8.50 Operating reserve (2.5% of gross proceeds) + Offering Costs (1% of gross proceeds - management est.) $3.50 Available funds for investment in flow through funds $88.00 Notes (B) Tax savings (Ontario %) $ Investment at risk $ (A) - (B) (C) Required proceeds to break even $ = $50.47 / 1- (49.53% * 50%) (D) Flow-through shares purchased from available funds $ Value of common shares (assuming flow-through shares are priced at a 15% premium) $ = $89 * (1-15%) (E) Difference between value of the common shares and break $ 7.72 even (D) - (C) Benefit to investors (percentage over breakeven) 11.50% (E) / (C) We have assumed that flow-through shares are purchased at a 15% premium above the common share price (the typical premium range is 10% - 30% for CEE). Based on a 15% premium, the value of $88 worth of flow-through shares is $74.80 common shares. This implies that investors would effectively be purchasing $74.80 worth of common shares for $67.08 after accounting for the tax benefit. The difference between the breakeven point ($67.08) and the common share price ($74.80) is $7.72, or 11.50% over break even. Over a two year hold period, we assume annual management fees and operating costs to equal 3% of the gross proceeds from this offering. This is in line with the costs associated with Qwest s previous LPs. We estimate the fund will have to liquidate $3.50 ($6.00 total over two years less $2.50 operating reserves taken up front keep in mind that these figures are based on a $100 investment as mentioned above) of shares to meet the operating expenses in the second year. After accounting for the capital gain tax incurred from

21 Page 21 liquidating the shares, we estimate the value of the portfolio could decline to $70.43 (from $74.80), indicating an upside of 4.99% from the break-even point. In other words, an investor s total return will be 4.99% if there is no change in the value of investments purchased by the fund. The following table shows how a change in share prices of the investments in the portfolio, by the end of the hold period, will impact investors returns. Note that the returns shown are total returns (not annualized) and include management s performance bonus. Change in Portfolio Value -50% -25% -10% 0% 10% 25% 50% Value of Portfolio $ $ $ $ $ $ $ Break Even $ $ $ $ $ $ $ Investors' Return % % -6.15% 4.99% 16.15% 32.88% 55.44% Rating We feel that the flow-through funds offered by Qwest are an attractive investment for those in higher tax brackets looking for alternative tax planning strategies. As discussed earlier, the tax benefit significantly reduces the capital at risk, which will provide for some downside protection to the investment. We have a positive outlook on the oil and gas industry. However, keep in mind that the underlying assets are shares issued by companies that are highly speculative, as highlighted by the volatile historical returns. We assign an overall rating of 3, and a risk rating of 4. FRC Rating IRR (base-case) N/A Rating 3 Risk 4

22 Page 22 Fundamental Research Corp. Rating Scale: Rating 1: Excellent Return to Risk Ratio Rating 2: Very Good Return to Risk Ratio Rating 3: Good Return to Risk Ratio Rating 4: Average Return to Risk Ratio Rating 5: Weak Return to Risk Ratio Rating 6: Very Weak Return to Risk Ratio Rating 7: Poor Return to Risk Ratio A + indicates the rating is in the top third of the category, A - indicates the lower third and no + or - indicates the middle third of the category. Fundamental Research Corp. Risk Rating Scale: 1 (Low Risk) 2 (Below Average Risk) 3 (Average Risk) 4 (Speculative) 5 (Highly Speculative) FRC Distribution of Ratings Rating - 1 0% Risk - 1 0% Rating % Risk - 2 2% Rating % Risk % Rating - 4 8% Risk % Rating - 5 6% Risk - 5 8% Rating - 6 2% Suspended 16% Rating - 7 0% Suspended 12% Disclaimers and Disclosure The opinions expressed in this report are the true opinions of the analyst about this company and industry. 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