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Financial Instruments, Fair Value Measurement, Credit Risk and Foreign Exchange Risk

12 Months Ended

Dec. 31, 2021

Financial Instruments, Fair Value Measurement, Credit Risk and Foreign Exchange Risk

Financial Instruments

Financial instruments are initially recorded at fair value, defined as the price that would be received to sell an asset or paid to market participants to settle liability at the measurement date. For financial instruments carried at fair value, GAAP establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. This hierarchy consists of three broad levels:

•Level 1 - Inputs representing quoted market prices in active markets for identical assets and liabilities

•Level 2 - Inputs other than quoted prices included within Level 1 that are observable for the assets and liabilities, either directly or indirectly

•Level 3 - Unobservable inputs for assets and liabilities

At December 31, 2021, the Company’s financial instruments recognized on the balance sheet consist of cash and cash equivalents, restricted cash and cash equivalents, accounts receivable, other long-term assets, derivatives, accounts payable and accrued liabilities, current portion of long-term debt, long-term debt, current and long-term equity compensation reward liability and other long-term liabilities. The Company uses appropriate valuation techniques based on the available information to measure the fair values of assets and liabilities.

Fair Value Measurement

The following table presents the Company’s fair value measurements of its financial instruments as of December 31, 2021 and 2020:


	As at December 31,
	2021		2020
(Thousands of U.S. Dollars)
Level 1
Assets
Investment	$	—	$	48,323
PEF(1)	7,578		—
	$	7,578	$	48,323

Liabilities
DSUs liability - long-term(3)	$	4,346	$	1,480
6.25% Senior Notes	273,672		205,500
7.75% Senior Notes	271,500		206,865
	$	549,518	$	413,845
Level 2
Assets
Derivative asset(2)	$	219	$	—
Restricted cash and cash equivalents - long-term(1)	4,903		3,409
	$	5,122	$	3,409
Liabilities
Derivative liability	$	2,976	$	12,050
Revolving credit facility	66,987		188,704
PSUs liability - current	2,710		805
PSUs liability - long-term(3)	9,372		2,475
	$	82,045	$	204,034

Level 3
Liabilities
Asset retirement obligation	$	54,525	$	48,214

(1)The long-term portion of restricted cash and PEF are included in the other long-term assets on the Company’s balance sheet

(2) Included in the other current assets on the Company’s balance sheet

(3) Long-term DSUs and PSUs liabilities are included in the long-term equity compensation award liability on the Company’s balance sheet

The fair values of cash and cash equivalents, current restricted cash and cash equivalents, accounts receivable and accounts payable and accrued liabilities approximate their carrying amounts due to the short-term maturity of these instruments.

The fair value of long-term restricted cash and cash equivalents approximate its carrying value because interest rates are variable and reflective of market rates.

Prepaid Equity Forward (PEF)

To reduce the Company’s exposure to changes in the trading price of the Company’s common shares on outstanding PSUs, the Company entered into PEF. At the end of the term, the counterparty will pay the Company an amount equivalent to the notional amount of the shares using the price of the Company’s common shares at the valuation date. The Company has the discretion to increase or decrease the notional amount of the prepaid equity forwards or terminate the agreement early. As at December 31, 2021, the Company’s PEF had a notional amount of 10.0 million shares and a fair value of $7.6 million. During the year ended December 31, 2021, the Company recorded a gain of $0.9 million on the PEF in general and administrative expenses (December 31, 2020 and 2019- nil). The fair value of PEF asset was estimated using Company’s share price quoted in active markets at the end of each reporting period.

DSUs liability

The fair value of DSUs liability was estimated using Company’s share price quoted in active markets at the end of each reporting period.

PSUs liability

The fair value of the PSUs liability was estimated using the inputs, such as Company’s share price and PSU performance factor.

Derivative asset and derivative liability

The fair value of derivatives is estimated based on various factors, including quoted market prices in active markets and quotes from third parties. The Company also performs an internal valuation to ensure the reasonableness of third party quotes. In consideration of counterparty credit risk, the Company assessed the possibility of whether the counterparty to the derivative would default by failing to make any contractually required payments. Additionally, the Company considers that it is of substantial credit quality and has the financial resources and willingness to meet its potential repayment obligations associated with the derivative transactions.

The following table presents gains or losses on derivatives and other instruments recognized in the accompanying consolidated statements of operations:


	Year Ended December 31,
(Thousands of U.S. Dollars)	2021		2020		2019
Commodity price derivative loss (gain)	$	48,723	$	(220)	$	3,642
Foreign currency derivative loss	115		3,155		27
Derivative instruments loss	$	48,838	$	2,935	$	3,669

Unrealized investment loss (gain)	$	2,032	$	46,883	$	(49,884)
Loss on sale of investment	1,355		—		—
Financial instruments (gain) loss	(18)		1,164		—
Other financial instruments loss (gain)	$	3,369	$	48,047	$	(49,884)

These gains or losses are presented as financial instruments gains or losses in the consolidated statements of operations and cash flows.

During the year ended December 31, 2021, the Company sold 100% (246.1 million common shares) of its interest in PetroTal Corp. (“PetroTal”) for cash proceeds net of transaction costs of $43.1 million, resulting in a loss on sale of $1.4 million. As at December 31, 2021, Gran Tierra no longer holds an investment in the common shares of PetroTal.

Revolving credit facility and Senior Notes

Financial instruments not recorded at fair value at December 31, 2021, include the Senior Notes and the Revolving Credit Facility (Note 8).

The fair value of the Revolving Credit Facility approximates its carrying value. The fair value of the Revolving Credit Facility is estimated based on the amount the Company would have to pay a third party to assume the debt, including the credit spread for the difference between the issue rate and the period-end market rate. The credit spread is the Company’s default or repayment risk. The credit spread (premium or discount) is determined by comparing the debt to new issuances (secured or unsecured) and secondary trades of similar size and credit statistics for public and private debt.

At December 31, 2021, the carrying amounts of the 6.25% Senior Notes and 7.75% Senior Notes were $294.0 million and $292.0 million, respectively, which represents the aggregate principal amounts less unamortized debt issuance costs, and the fair values were $273.7 million and $271.5 million.

Asset retirement obligation

The Company’s non-recurring fair value measurements include asset retirement obligations. The fair value of an asset retirement obligation is measured by reference to the expected future cash outflows required to satisfy the retirement obligation discounted at the Company’s credit-adjusted risk-free interest rate. The significant level 3 inputs used to calculate such liabilities include estimates of costs to be incurred, the Company’s credit-adjusted risk-free interest rate, inflation rates, and estimated dates of abandonment. Accretion expense is recognized over time as the discounted liabilities are accreted to their expected settlement value, while the asset retirement cost is amortized over the estimated productive life of the related assets.

Commodity Price Risk

The Company may at time utilize commodity price derivatives to manage the variability in cash flows associated with the forecasted sale of its oil production, reduce commodity price risk and provide a base level of cash flow in order to assure it can execute at least a portion of its capital spending. As at December 31, 2021, the Company had 3,000 bopd outstanding commodity price derivative positions and entered into additional 6,000 bopd commodity derivatives subsequent to year-end for a total hedging program presented as follows:


Period and Type of Instrument	Volume, bopd	Reference	Sold Swap ($/bbl, Weighted Average)	Sold Put ($/bbl, Weighted Average)	Purchased Put ($/bbl, Weighted Average)	Sold Call ($/bbl, Weighted Average)	Premium ($/bbl, Weighted Average)
Three-way Collars: January 1, to June 30, 2022	5,000	ICE Brent	—	63.56	73.56	91.28	—
Swaps: January 1, to June 30, 2022	3,000	ICE Brent	80.41	—	—	—	—
Deferred Puts: January 1, to June 30, 2022	1,000	ICE Brent	—	—	70.00	—	4.00

Foreign Exchange Risk

The Company is exposed to foreign exchange risk in relation to its Colombian operations predominantly in operating costs, general and administrative costs and transportation costs. To mitigate exposure to fluctuations in foreign exchange, the Company may enter into foreign currency exchange derivatives. As at December 31, 2021 the Company had no outstanding foreign currency exchange derivative positions.

Unrealized foreign exchange gains and losses primarily result from fluctuation of the U.S. dollar to the Colombian peso and Canadian dollar due to Gran Tierra’s current and deferred tax assets and taxes receivable, which are monetary assets and liabilities mainly denominated in the local currencies. As a result, foreign exchange gains and losses must be calculated on conversion to the U.S. dollar functional currency. A strengthening in one Colombian peso against the U.S. dollar results in foreign exchange gain of approximately $17,000 on deferred tax asset balance and a foreign exchange gain of approximately $13,000 on taxes receivable. This effect was calculated based on the Company’s December 31, 2021, deferred tax assets and taxes receivable.

For the years ended December 31, 2021, 2020 and 2019 respectively, 100% of the Company's oil sales were generated in Colombia. In Colombia, the Company receives 100% of its revenues in U.S. dollars and the majority of its capital expenditures are in U.S. dollars or are based on U.S. dollar prices.

Credit Risk

Credit risk arises from the potential that the Company may incur a loss if counterparty to a financial instrument fails to meet its obligation in accordance with agreed terms. The Company’s financial instruments that are exposed to concentrations of credit risk consist primarily of cash and cash equivalents, restricted cash and accounts receivable. The carrying value of cash and cash equivalents, restricted cash and accounts receivable reflects management’s assessment of credit risk.

At December 31, 2021, cash and cash equivalents and restricted cash included balances in bank accounts, term deposits and certificates of deposit, placed with financial institutions with investment grade credit ratings.

Most of the Company’s accounts receivable relate to sales to customers in the oil and natural gas industry and are exposed to typical industry credit risks. The concentration of revenues in a single industry affects the Company’s overall exposure to credit

risk because customers may be similarly affected by changes in economic and other conditions. The Company manages this credit risk by entering into sales contracts with only credit worthy entities and reviewing its exposure to individual entities on a regular basis and obtaining letters of credits from customers which amounted to $18.3 million as of December 31, 2021. For the years ended December 31, 2021, 2020 and 2019, respectively, the Company had three customers which accounted for over 10% of sales.

To reduce the concentration of exposure to any individual counterparty, the Company utilizes a group of investment-grade rated financial institutions for its derivative transactions. The Company monitors counterparty creditworthiness on an ongoing basis; however, it cannot predict sudden changes in counterparties’ creditworthiness. In addition, even if such changes are not sudden, the Company may be limited in its ability to mitigate an increase in counterparty credit risk. Should one of these counterparties not perform, the Company may not realize the benefit of some of its derivative instruments.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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