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Press release from Marketwire

Fairborne Energy Ltd.- Second Quarter Interim Report and News Release

Friday, August 06, 2010

Fairborne Energy Ltd.- Second Quarter Interim Report and News Release00:05 EDT Friday, August 06, 2010 CALGARY, ALBERTA--(Marketwire - Aug. 6, 2010) - Fairborne Energy Ltd. (TSX:FEL) 2010 SECOND QUARTER HIGHLIGHTS ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months Six months ended June 30, ended June 30, 2010 2009 2010 2009 ----------------------------------------- Financial ($thousands, except per share amounts) Petroleum and natural gas revenue 59,633 58,430 123,015 126,975 Funds generated from operations(1) 27,448 35,742 67,003 68,712 Per share - basic $0.27 $0.41 $0.65 $0.79 Per share - diluted $0.27 $0.41 $0.65 $0.79 Cash flow from operations (including changes in working capital) 19,692 27,653 63,214 62,435 Per share - basic $0.19 $0.32 $0.62 $0.72 Per share - diluted $0.19 $0.32 $0.62 $0.72 Net loss (7,121) (17,333) (3,312) (22,024) Per share - basic $(0.07) $(0.20) $(0.03) $(0.25) Per share - diluted $(0.07) $(0.20) $(0.03) $(0.25) Exploration and development expenditures 18,413 15,925 83,959 68,570 Acquisitions, net of dispositions 1,469 (605) 2,933 (605) Working capital deficit (surplus) 6,352 (7,227) 6,352 (7,227) Bank indebtedness 123,081 232,184 123,081 232,184 Convertible debentures 97,476 95,525 97,476 95,525 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Operations (Units as noted) Average production Natural gas (Mcf per day) 66,812 66,744 63,862 67,130 Crude oil (bbls per day) 3,110 3,552 3,055 3,575 Natural gas liquids (bbls per day) 1,149 632 919 602 Sulphur (tonnes per day)(2)(4) 92 64 73 78 ---------------------------------------------------------------------------- Total (BOE per day) 15,486 15,372 14,690 15,444 ---------------------------------------------------------------------------- Average sales price (3) Natural gas ($ per Mcf) 4.91 5.30 5.31 5.85 Crude oil ($ per bbl) 75.79 64.65 77.48 60.81 Natural gas liquids ($ per bbl) 36.24 26.86 40.78 27.04 Sulphur ($ per tonne)(4) 60.26 128.16 29.64 161.72 ---------------------------------------------------------------------------- Netback per BOE ($ per BOE) Petroleum and natural gas sales(3) 39.63 39.75 42.14 41.55 Sulphur block revenue 2.52 4.26 3.95 4.05 Royalties (6.16) (2.19) (5.35) (3.98) Operating expenses (9.78) (10.44) (9.33) (11.45) Transportation (1.10) (0.96) (1.07) (1.05) ---------------------------------------------------------------------------- Operating netback 25.11 30.42 30.34 29.12 ---------------------------------------------------------------------------- Wells drilled (gross) 1 3 17 19 Undeveloped land (net acres) 232,466 222,213 232,466 222,213 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 1) Funds generated from operations is calculated using cash flow from operations as presented in the consolidated statement of cash flows before non-cash working capital and asset retirement expenditures. 2) A BOE conversion ratio has been calculated using a conversion rate of one tonne of sulphur to one barrel. 3) Excludes the change in fair value of derivatives. 4) Excludes the sale of inventory at the West Pembina sulphur block. COMMITMENT TO CORE AREAS RESULTS IN SECOND QUARTER PRODUCTION GROWTHFairborne continues to focus on generating solid economic returns while expanding its position on four core projects: natural gas at Marlboro (Wilrich); liquids rich natural gas at Harlech (multizone); liquids rich natural gas at Westerose (Glauconite) and light oil at Sinclair and Brazeau. Capital expenditures during the second quarter and a significant property acquisition announced at the beginning of the third quarter were concentrated on these projects:- Acquired 12,871 acres (100% working interest) in the Harlech area at crown land sales, complimenting our existing acreage;- Acquired additional 3D seismic data over the Wilrich trend in Marlboro;- Completed the tie-in of new wells and purchased additional 3D seismic on the high netback light oil property at Sinclair;- Entered into a property acquisition which will significantly expand Fairborne's land position on the core asset at Marlboro/Pine Creek, including 71.8 net sections of Wilrich rights. The acquisition is scheduled to close late in the third quarter of 2010;- Upon completion of the property acquisition, Fairborne expects exit production for 2010 to be between 17,000 and 17,500 BOE per day, more than 30% higher than exit production of 13,000 BOE per day at the end of 2009.The impact of Fairborne's exploitation, development and operational focus was reflected in second quarter results with production up 12% over the first quarter to an average of 15,486 BOE per day. Second quarter financial and operating highlights included:- Average production of 15,486 BOE per day (66.8 MMcf per day of natural gas and 4,259 bbls per day of light oil and NGL's), up 12% from the first quarter 2010 (13,886 BOE per day);- On a per share basis, second quarter production averaged 151 BOE per day per million outstanding common shares, an increase of 12% from the first quarter 2010 which averaged 135 BOE per day per million outstanding common shares;- Operating netback of $25.11 per BOE was impacted by the sharp drop in natural gas prices during the second quarter as evidenced by the 28% decrease in the average AECO Monthly index compared to the first quarter of 2010;- Funds generated from operations of $27.4 million ($0.27 per share) reflected lower natural gas prices, crown royalty adjustments and higher operating costs due to scheduled turnarounds and workovers;- Fairborne's hedging strategy has continued to add significant value with second quarter realized natural gas prices 26% above the AECO Daily index prices;- 33% of natural gas production is hedged for the balance of 2010 at an average price of $6.63 per Mcf.PRODUCTION AND OPERATING RESULTSFairborne's production remained consistent throughout the second quarter averaging 15,486 BOE per day, which was 12% higher than first quarter average production, reflecting the success of the Company's active first quarter drilling program. Fairborne's second quarter drilling program was limited to one (0.9 net) successful natural gas well drilled on the Company's Marlboro property.Natural gas prices fell during the second quarter, with the average AECO Monthly index prices 28% lower compared to the first three months of 2010. Fairborne's second quarter financial results reflected the decline in natural gas prices with an operating netback of $25.11 per BOE (Q1 2010 - $36.26 per BOE). Also impacting the second quarter netback was $3.3 million ($2.34 per BOE) of 2009 crown royalty expense adjustments and operating costs of $9.78 per BOE, which included scheduled workovers and turnarounds. Capital expenditures of $18.4 million included drilling one (0.9 net) natural gas well in Marlboro and $7.4 million on land and seismic purchases on core resource and development properties.EXPANDING AND DEVELOPING CORE ASSETSDuring the remainder of 2010, Fairborne will continue to focus on the advancement of emerging plays and development of core projects within the Company's asset base which provide the greatest return in light of current market conditions.- Marlboro/Pine Creek: The acquisition of additional land and facilities in the Marlboro/Pine Creek area is scheduled to close late in the third quarter of 2010. The acquisition will strengthen Fairborne's position in the area with an increased Wilrich land position (141 net sections post acquisition), facilities interests and an expanded inventory of drilling prospects. Fairborne has recently drilled and completed its seventh Wilrich well with the eighth well drilled and awaiting completion. The inline production test rate on the seventh well was 4.7 MMcf per day. The Company plans to drill eight (6.3 net) wells in the second half of 2010; however, with the expanded opportunities arising from the property acquisition, additional capital spending may be allocated to this key area.- Harlech: Fairborne will continue to develop the liquid rich natural gas at Harlech by testing multizones in vertical wells. Fairborne's land position in Harlech was expanded in the second quarter with 12,871 net acres acquired at crown land sales. The Company currently plans to drill an additional three (2.3 net) wells at Harlech in 2010.- Westerose: Following up on the success of the two (2.0 net) horizontal Glauconite wells drilled at Westerose in the first quarter, the Company plans to drill up to two (2.0 net) additional horizontal wells in the second half of 2010. On production for four months, the liquid rich production from these two wells combined is currently 2.8 MMcf per day with 65 bbls of liquids per MMcf of natural gas. Fairborne currently controls 19.0 net sections of land on this prolific gas trend.- Sinclair: Fairborne will continue its development of this high netback oil property with four (3.6 net) wells planned to be drilled in the last six months of 2010 and a second waterflood project currently being developed.- Brazeau: In the Belly River Unit 6, Fairborne drilled a horizontal well (0.9 net) in the oil charged Basal Belly River sands during the first quarter of 2010 and, after four months, the well is producing at a rate of 100 barrels per day of 42 Degree API oil. Fairborne is planning to drill up to three (2.7 net) additional wells during the remainder of 2010.OUTLOOKWe are pleased with the progress we have made to expand and develop our core asset base as reflected in the production growth achieved and sustained through the second quarter of 2010. Our disciplined commitment to maintain a strong balance sheet gave us the financial flexibility to take advantage of a strategic property acquisition at the beginning of the third quarter. Production and reserve growth through drilling in our four core project areas while maintaining financial flexibility will continue to be a key goal moving forward. Despite another drop in natural gas prices during the second quarter, cash flow from operations in the second half of 2010 will benefit from increased production levels as well as our risk management program with 33% of natural gas production for the balance of 2010 hedged at an average price of $6.63 per Mcf.Steven R. VanSicklePresident & CEOAugust 4, 2010MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following Management Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") was prepared at, and is dated, August 4, 2010. This document is provided by the management of Fairborne Energy Ltd. ("Fairborne" or the "Company") to review second quarter 2010 activities and results as compared to the same period in the previous year, and should be read in conjunction with the unaudited interim consolidated financial statements including selected notes for the three and six months ended June 30, 2010 and the audited consolidated financial statements including notes for the years ended December 31, 2009 and 2008. The MD&A should also be read in conjunction with the Company's MD&A for the year ended December 31, 2009, as disclosure which is unchanged from the December 31, 2009 MD&A has not been duplicated herein. Additional information relating to Fairborne, including Fairborne's annual information form, is available on SEDAR at www.sedar.com.Nature of Business: Fairborne is a growth-oriented exploration and production company. The Company maintains its head office in Calgary and is engaged in the business of exploring for, developing, acquiring and producing crude oil and natural gas in Western Canada. Fairborne follows a strategy of balancing risk and reward by focusing on opportunities by geographic area and prospect type. Within the selected areas, the Company develops a portfolio of exploration and development prospects in conjunction with an active acquisition strategy.Forward Looking Statements: This document contains forward-looking statements. Management's assessment of future plans and operations, drilling plans, expected closing of acquisition, funding thereof, timing and the anticipated impact thereof, timing of expected completion of certain projects, timing of phases of IFRS conversion project, anticipated elections under IFRS and the effects and impacts thereof and anticipation that there will not be any impairments under IFRS at January 1, 2010, planned capital expenditures, the nature of the expenditures and the timing thereof and method of funding of capital expenditures, anticipated 2010 production and exit rates, realized prices, royalties and operating costs may constitute forward-looking statements under applicable securities laws and necessarily involve risks including, without limitation, risks associated with oil and gas exploration, development, exploitation, production, marketing and transportation, loss of markets, volatility of commodity prices, currency fluctuations, imprecision of reserve estimates, environmental risks, competition from other producers, inability to retain drilling rigs and other services, incorrect assessment of the value of acquisitions, failure to realize the anticipated benefits of acquisitions, the inability to fully realize the benefits of the acquisitions, delays resulting from or inability to obtain required regulatory approvals and ability to access sufficient capital from internal and external sources. As a consequence, the Company's actual results may differ materially from those expressed in, or implied by, the forward looking statements.Forward looking statements or information are based on a number of factors and assumptions which have been used to develop such statements and information but which may prove to be incorrect. Although Fairborne believes that the expectations reflected in such forward-looking statements or information are reasonable, undue reliance should not be placed on forward looking statements because the Company can give no assurance that such expectations will prove to be correct. In addition to other factors and assumptions which may be identified in this document and other documents filed by the Company, assumptions have been made regarding, among other things: the impact of increasing competition; the general stability of the economic and political environment in which Fairborne operates; the ability of the Company to obtain qualified staff, equipment and services in a timely and cost efficient manner; drilling results; the ability of the operator of the projects which the Company has an interest in to operate the field in a safe, efficient and effective manner; Fairborne's ability to obtain financing on acceptable terms; field production rates and decline rates; the ability to replace and expand oil and natural gas reserves through acquisition, development or exploration; the timing and costs of pipeline, storage and facility construction and expansion; the ability of the Company to secure adequate product transportation; future oil and natural gas prices; currency, exchange and interest rates; the regulatory framework regarding royalties, taxes and environmental matters in the jurisdictions in which the Company operates; and Fairborne's ability to successfully market its oil and natural gas products. Included herein is an estimate of Fairborne's year end debt based on assumptions as to cash flow, capital spending in 2010 and the other assumptions utilized in arriving at the 2010 capital budget. To the extent such estimates constitutes a financial outlook, it was approved by management of Fairborne on August 5, 2010 and such financial outlook is included herein to provide readers with an understanding of estimated capital expenditures and the effect thereof on debt levels and readers are cautioned that the information may not be appropriate for other purposes. Readers are cautioned that the foregoing list of factors is not exhaustive. Additional information on these and other factors that could affect the Company's operations and financial results are included in reports on file with Canadian securities regulatory authorities and may be accessed through the SEDAR website (www.sedar.com) or at the Company's website (www.fairborne-energy.com).Furthermore, the forward looking statements contained in this document are made as at the date of this document and the Company does not undertake any obligation to update publicly or to revise any of the included forward looking statements, whether as a result of new information, future events or otherwise, except as may be required by applicable securities laws.Non GAAP Terms: This document contains the terms "funds generated from operations", "funds generated from operations per share", "cash flow from operations per share", "net debt" and "netbacks" which are non-GAAP terms. The Company uses these measures to help evaluate its performance. The Company uses net debt (bank indebtedness plus negative working capital or less positive working capital) as an alternative measure of outstanding debt. The Company considers corporate netbacks a key measure as it demonstrates its profitability relative to current commodity prices. Netbacks which have no GAAP equivalent, are calculated on a BOE basis by deducting royalties, operating costs, and transportation from petroleum and natural gas sales and sulphur block sales. The Company considers funds generated from operations a key measure as it demonstrates Fairborne's ability to generate funds necessary to repay debt and to fund future growth through capital investment. Funds generated from operations should not be considered as an alternative to, or more meaningful than, cash flow from operating activities as determined in accordance with Canadian GAAP as an indicator of Fairborne's performance. Fairborne's determination of funds generated from operations may not be comparable to that reported by other companies. The reconciliation between cash flow from operations and funds generated from operations can be found in the statement of cash flows in the consolidated financial statements with funds generated from operations calculated before non-cash working capital and asset retirement expenditures. Fairborne also presents funds generated from operations per share and cash flow from operations per share whereby per share amounts are calculated using weighted average shares outstanding consistent with the calculation of income (loss) per share.BOE Conversions: Barrel of oil equivalent ("BOE") amounts may be misleading, particularly if used in isolation. A BOE conversion ratio has been calculated using a conversion rate of one tonne of sulphur to one barrel and six thousand cubic feet of natural gas to one barrel. This conversion ratio of six thousand cubic feet of natural gas to one barrel is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.PROPERTY ACQUISITION AND REVISED 2010 OUTLOOKSubsequent to the end of the second quarter, Fairborne announced a property acquisition around the Company's core Marlboro area. The acquisition includes undeveloped land, facilities interests and properties which are currently producing approximately 980 BOE per day. The cost of the acquisition is $71.5 million, subject to closing adjustments, which is anticipated to be funded entirely from bank credit facilities. The acquisition is scheduled to close, subject to satisfaction of customary conditions, late in the third quarter of 2010.Other than the effect of the acquisition on bank indebtedness, which was not previously contemplated in the Company's 2010 capital budget, Fairborne's outlook for 2010 remains the same. The exploration and development program for 2010 remains at $150 million, which the Company expects to be funded from cash flows for the year. Key operating assumptions have been revised, assuming completion of the acquisition, as follows: average production between 15,400 and 15,600 BOE per day with exit production between 17,000 and 17,500 BOE per day; average realized prices of CDN$76.80 per bbl for crude oil and $5.25 per Mcf for natural gas, including in-place hedging contracts; 12% average royalties and operating costs between $9.75 and $10.25 per BOE. SECOND QUARTER 2010 FINANCIAL RESULTS Production ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended June 30, Six months ended June 30, 2010 2009 change 2010 2009 change ------------------------------------------------------- Natural gas (Mcf per day) 66,812 66,744 - 63,862 67,130 (5%) Crude oil (bbls per day) 3,110 3,552 (12%) 3,055 3,575 (15%) Natural gas liquids (bbls per day) 1,149 632 82% 919 602 53% Sulphur (tonnes per day) (1),(2) 92 64 44% 73 78 (6%) ---------------------------------------------------------------------------- Total (BOE per day) 15,486 15,372 1% 14,690 15,444 (5%) ---------------------------------------------------------------------------- Natural gas % of production 72% 72% - 72% 72% - ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 1) A BOE conversion ratio has been calculated using a conversion rate of one tonne of sulphur to one barrel. 2) Excludes the sale of inventory at the West Pembina sulphur block. The impact of Fairborne's successful first quarter drilling program was reflected in second quarter average production of 15,486 BOE per day, up 12% from the first quarter of 2010 (13,886 BOE per day) and consistent with the prior year (15,372 BOE per day). First quarter exit production of 15,500 BOE per day held steady through the second quarter despite workovers and turnarounds completed during the second quarter and a limited drilling program associated with spring break up. On a year to date basis, 2010 average production of 14,690 BOE per day was 5% lower than the first six months of 2009 (15,444 BOE per day) reflecting Fairborne's decision to restrict drilling operations in the latter part of 2009 as a result of low natural gas prices.Natural gas production increased 10% from 60.9 MMcf per day in the first quarter to 66.8 MMcf per day in the second quarter of 2010, with additional production from wells drilled during the first quarter on the Company's Marlboro, Westerose and Harlech properties.Crude oil and NGL production of 4,259 bbls per day for the second quarter of 2010 was 16% higher than the preceding first quarter of 2010 (3,686 BOE per day) with new oil production from Sinclair and additional NGL production from new wells drilled at Marlboro and Westerose. Commodity Prices & Risk Management Activities ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended June 30, Six months ended June 30, 2010 2009 change 2010 2009 change ------------------------------------------------------- Average Prices (1) Natural gas ($ per Mcf) 4.91 5.30 (7%) 5.31 5.85 (9%) Crude oil ($ per bbl) 75.79 64.65 17% 77.48 60.81 27% Natural gas liquids ($ per bbl) 36.24 26.86 35% 40.87 27.04 51% Sulphur ($ per tonne)(2) 60.26 128.16 (53%) 29.64 161.72 (82%) ---------------------------------------------------------------------------- BOE ($ per BOE) 39.45 39.59 - 41.89 41.36 1% ---------------------------------------------------------------------------- Benchmark Prices AECO Daily Index (Cdn$ per Mcf) 3.89 3.45 13% 4.42 4.18 6% AECO Monthly Index (Cdn$ per Mcf) 3.86 3.66 5% 4.61 4.65 (1%) Edmonton par (Cdn$ per bbl) 75.14 66.16 14% 77.72 57.19 36% Nymex Calendar Average (US$ per bbl) 78.03 59.62 31% 78.37 51.35 53% ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 1) Excludes the change in the fair value of derivatives. 2) Excludes revenue from the sale of inventory at the West Pembina sulphur block. Risk Management - Physical Sales ContractsFairborne's risk management strategy is based on the following objectives:- protect shareholder return on investment;- reduce risk exposure in budgeted annual funds flow projections; and- help ensure transaction economics on acquisitions.Natural GasDuring the second quarter of 2010, Fairborne's realized natural gas prices were 7% lower than the average price received during the same period in the prior year. The decrease from the previous year was due to lower average spot prices received in 2010; however, Fairborne's second quarter realized prices were 26% higher than the AECO Daily benchmark reference price due to corporate hedging activities and the higher heat content of Fairborne's production. An average of 21,014 Mcf per day was sold under fixed price physical sales contracts during the second quarter of 2010 representing 31% of the Company's natural gas production. Risk management activities during the second quarter of 2010 increased the Company's natural gas revenue by $4.8 million which had an effect of increasing Fairborne's realized natural gas price by $0.79 per Mcf to $4.91 per Mcf.The following table summarizes the outstanding fixed price physical sales contracts for natural gas, including contracts outstanding at June 30, 2010 as well as contracts entered into after June 30, 2010: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Q3 2010 Q4 2010 2011 ------------------------------- AECO Swaps Volume (Mcf per day) 24,551 24,551 8,927 Average price ($ per Mcf) $6.63 $6.63 $5.60 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Conversion factor: 1 Mcf = 1.12 GJ Crude OilDuring the second quarter of 2010, Fairborne had an average of 1,500 bbls per day of crude oil under fixed price physical sales contracts representing 48% of crude oil production. Risk management activities, including option costs for puts purchased during the second quarter of 2010 had no significant impact on the Company's crude oil revenue. The Company's realized crude oil price of $75.79 per bbl for the second quarter of 2010 represented an increase of 17% from the same period in 2009, reflecting the overall increase in average market prices.The following table summarizes the outstanding fixed price physical sales and derivative contracts on crude oil, including contracts outstanding at June 30, 2010 as well as contracts entered into after June 30, 2010: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Q3 2010 Q4 2010 2011 ------------------------------- Collars Volume (bbls per day) 1,500 1,500 500 Average floor price (CDN$ per bbl) $60.00 $60.00 $70.00 Average ceiling price (CDN$ per bbl) $103.72 $103.72 $101.25 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- At June 30, 2010, Fairborne had three crude oil collars that were accounted for as derivative contracts and the combined mark-to-market value of these contracts was recorded as an asset of $96,000 at June 30, 2010.SulphurSulphur prices began to recover during the second quarter of 2010 and have remained consistent into the third quarter. As a result, Fairborne received revenue for its sulphur production during the second quarter with an average realized price of $60.26 per tonne. Petroleum and Natural Gas Revenue ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended June 30, Six months ended June 30, ($thousands 2010 2009 change 2010 2009 change except as noted) ------------------------------------------------------- Petroleum and natural gas sales: Natural gas 29,847 32,197 (7%) 61,342 71,034 (14%) Crude oil 21,449 20,897 3% 42,846 39,350 9% Natural gas liquids 3,789 1,545 145% 6,794 2,948 130% Sulphur 504 747 (33%) 390 2,292 (83%) ---------------------------------------------------------------------------- Total 55,589 55,386 - 111,372 115,624 (4%) ---------------------------------------------------------------------------- Per BOE $39.45 $39.59 - $41.89 $41.36 1% ---------------------------------------------------------------------------- Other revenue items: Sulphur block 3,552 5,964 (40%) 10,511 11,317 (7%) Change in fair value of derivatives 233 (3,140) 107% 455 (497) 192% Other income 259 220 18% 677 531 27% ---------------------------------------------------------------------------- Total 4,044 3,044 33% 11,643 11,351 3% ---------------------------------------------------------------------------- Total petroleum and natural gas revenue 59,633 58,430 2% 123,015 126,975 (3%) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Per BOE $42.32 $41.77 1% $46.27 $45.42 2% ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Fairborne reported petroleum and natural gas sales of $55.6 million for the second quarter of 2010, consistent with the preceding first quarter of 2010 ($55.8 million) as well as the second quarter of 2009 ($55.4 million). When compared to the preceding first quarter of 2010, increased production largely offset the impact of weakened gas prices resulting in consistent petroleum and natural gas sales. On a year to date basis, sales of petroleum and natural gas for the first six months of 2010 of $111.4 million were 4% lower than the same period in 2009 ($115.6 million) primarily due to lower average production.Other revenue items in the second quarter of 2010 included $3.6 million (2009 - $6.0 million) of revenue on the sale of inventory from the West Pembina sulphur block and $0.2 million (2009 - loss of $3.1 million) on the change in fair value of derivative contracts. As at June 30, 2010 Fairborne's contract for the sale of inventory at the West Pembina sulphur block has been satisfied with no further sales to be recognized in 2010. On a year to date basis, other revenue items for the first six months of 2010 were consistent with the same period in 2009. Royalties ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended June 30, Six months ended June 30, ($thousands 2010 2009 change 2010 2009 change except as noted) ------------------------------------------------------- Crown 6,762 874 674% 10,398 7,231 44% Freehold and overriding 1,924 2,184 (12%) 3,822 3,900 (2%) ---------------------------------------------------------------------------- Total 8,686 3,058 184% 14,220 11,131 28% ---------------------------------------------------------------------------- Crown (% of P&NG sales) 12.2% 1.6% 663% 9.3% 6.2% 50% Freehold and overriding (% of P&NG sales) 3.5% 3.9% (10%) 3.4% 3.4% - ---------------------------------------------------------------------------- Total (% of P&NG sales) 15.6% 5.5% 184% 12.8% 9.6% 33% ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Per BOE $6.16 $2.19 181% $5.35 $3.98 34% ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Crown royalties of $6.8 million during the second quarter of 2010 included $3.3 million of prior year crown royalty adjustments charged in June 2010 as a result of the Crown's recalculation of allowable deductions and credits under the new royalty regime effective January 2009. Excluding the prior year adjustment, Fairborne's effective royalty rate was 9.7% in the second quarter compared to 9.9% reported in the first quarter of 2010. Comparatively, crown royalties for the second quarter of 2009 were unusually low due to a 2008 credit adjustment received during the second quarter of 2009. Freehold and overriding royalty rates for 2010 remain consistent with the prior year. Operating Costs ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended June 30, Six months ended June 30, ($thousands 2010 2009 change 2010 2009 change except as noted) ------------------------------------------------------- Operating costs Natural gas 10,069 10,494 (4%) 18,242 22,966 (21%) Oil and NGLs 3,715 4,116 (10%) 6,567 9,048 (27%) ---------------------------------------------------------------------------- Total 13,784 14,610 (6%) 24,809 32,014 (23%) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Per BOE $9.78 $10.44 (6%) $9.33 $11.45 (19%) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Fairborne recorded operating costs of $13.8 million ($9.78 per BOE) during the second quarter of 2010, an increase of 11% when compared to the preceding first quarter of 2010 ($8.82 per BOE), as a result of scheduled overhauls, annual regulatory fees, and various workovers performed during the second quarter. Compared to 2009, operating costs have decreased both quarterly and year to date as a result of cost reduction initiatives implemented in 2009 on the Company's Wild River and Sinclair properties. Transportation Expenses ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended June 30, Six months ended June 30, 2010 2009 change 2010 2009 change ------------------------------------------------------- Transportation ($thousands) 1,553 1,345 15% 2,844 2,939 (3%) Per BOE $1.10 $0.96 15% $1.07 $1.05 2% ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Transportation costs of $1.6 million ($1.10 per BOE) for the second quarter of 2010 increased marginally from the first quarter of 2010 ($1.03 per BOE) and compared to the prior year primarily due to increased costs associated with the usage of natural gas pipelines. Operating Netbacks ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended June 30, Six months ended June 30, ($ per BOE) 2010 2009 change 2010 2009 change ------------------------------------------------------- Petroleum and natural gas sales(1) 39.45 39.59 - 41.89 41.36 1% Sulphur block revenue 2.52 4.26 (41%) 3.95 4.05 (2%) Other income (1) 0.18 0.16 13% 0.25 0.19 32% Royalties (6.16) (2.19) 181% (5.35) (3.98) 34% Operating costs (9.78) (10.44) (6%) (9.33) (11.45) (19%) Transportation (1.10) (0.96) 15% (1.07) (1.05) 2% ---------------------------------------------------------------------------- Operating netback 25.11 30.42 (17%) 30.34 29.12 4% ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 1) Excludes the change in fair value of derivatives Fairborne's operating netback of $25.11 per BOE in the second quarter of 2010 reflects lower natural gas prices, lower sulphur block revenues and higher royalties and operating expenses compared to the first quarter ($36.26 per BOE). Compared to 2009, lower sulphur block revenues and higher royalty costs offset operating cost reductions resulting in lower netbacks in 2010. General and Administrative ("G&A") Expenses ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended June 30, Six months ended June 30, ($thousands 2010 2009 change 2010 2009 change except as noted) ------------------------------------------------------- G&A expenses, net of recoveries 4,703 3,166 49% 7,041 5,317 32% Compensation costs 1,094 13,019 (92%) 3,369 15,689 (79%) ---------------------------------------------------------------------------- Total G&A expenses 5,797 16,185 (64%) 10,410 21,006 (50%) ---------------------------------------------------------------------------- G&A expenses, net of recoveries, per BOE $3.34 $2.26 48% $2.64 $1.90 39% Compensation costs, per BOE $0.78 $9.31 (92%) $1.27 $5.61 (77%) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Fairborne recorded $4.7 million of G&A expenses, net of recoveries, in the second quarter of 2010, representing $3.34 per BOE. Compared to the preceding first quarter of 2010, G&A expenses, net of recoveries, increased from $1.87 per BOE as a result of additional employee cash compensation costs recorded in the second quarter combined with reduced recoveries associated with a considerably smaller capital expenditure program compared to the first quarter of 2010. Fairborne does not capitalize G&A expenses, other than recoveries permitted under joint operating agreements. G&A for the first six months of 2010 included higher employee cash compensation costs while 2009 was reduced by an accrual adjustment for the 2008 employee bonus program.Non-cash compensation expense of $1.1 million recorded in the second quarter of 2010 was 52% lower than the $2.3 million recorded in the first quarter of 2010 as a result of the vesting of stock options in the first quarter. Compensation costs of $13.0 million in the comparative second quarter of 2009 included $12.6 million of accelerated compensation expense for the remaining life of 6.6 million stock options that were voluntarily surrendered by employees, officers and directors on June 1, 2009. Interest ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended June 30, Six months ended June 30, ($thousands 2010 2009 change 2010 2009 change except as noted) ------------------------------------------------------- Interest expense 3,226 3,649 (12%) 6,219 7,208 (14%) Accretion of convertible debentures 483 501 (4%) 966 1,003 (4%) ---------------------------------------------------------------------------- Total interest 3,709 4,150 (11%) 7,185 8,211 (12%) Per BOE $2.63 $2.97 (11%) $2.70 $2.94 (8%) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Fairborne recorded $3.2 million in interest expense in the second quarter of 2010, up from $3.0 million recorded during the preceding first quarter of 2010. The increase in interest expense was consistent with the increase in bank indebtedness in the second quarter. Compared to the prior year, interest expense has decreased in 2010 consistent with lower debt levels maintained during the first half of 2010. Net debt has decreased substantially in 2010; however, lower interest costs have been partially offset by higher borrowing margins and stamping fees initiated by the Company's lenders. Also included in interest expense is the accretion of convertible debentures. The costs associated with the debenture offering along with the amount allocated to the conversion feature are included in interest expense over the term of the debentures. Depletion, Depreciation and Accretion (DD&A) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended June 30, Six months ended June 30, 2010 2009 change 2010 2009 change ------------------------------------------------------- Depletion, depreciation and accretion ($thousands) 35,048 37,736 (7%) 66,197 75,277 (12%) Per BOE $24.87 $26.98 (8%) $24.90 $26.93 (8%) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Fairborne recorded $35.0 million in depletion and depreciation of capital assets and accretion of asset retirement obligations during the second quarter of 2010. On a BOE basis, the 2010 second quarter DD&A rate of $24.87 per BOE was consistent with the preceding first quarter of 2010 ($24.92 per BOE) and 8% lower than the comparative DD&A rate for the prior year ($26.98 per BOE) as a result of reserve additions associated with the Company's first quarter capital expenditure program. Taxes ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended June 30, Six months ended June 30, 2010 2009 change 2010 2009 change ------------------------------------------------------- Future tax expense (reduction) ($thousands) (1,823) (1,321) (38%) 662 (1,579) 142% Per BOE $(1.29) $(0.95) (36%) $0.25 $(0.56) 145% ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Fairborne recorded a future tax recovery of $1.8 million in the second quarter of 2010 compared to a future tax expense of $2.5 million recorded during the first quarter of 2010, both of which reflect a provision for future tax at tax rates expected to apply when the related temporary differences reverse. The decline in tax expense is consistent with the decline in net earnings before taxes. Net Loss and Funds Generated from Operations ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended June 30, Six months ended June 30, ($thousands 2010 2009 change 2010 2009 change except as noted) ------------------------------------------------------- Funds generated from operations 27,448 35,742 (23%) 67,003 68,712 (2%) Per share - basic $0.27 $0.41 (34%) $0.65 $0.79 (18%) Per share - diluted $0.27 $0.41 (34%) $0.65 $0.79 (18%) Cash flow from operations (including changes in working capital) 19,692 27,653 (29%) 63,214 62,435 1% Per share - basic $0.19 $0.32 (41%) $0.62 $0.72 (14%) Per share - diluted $0.19 $0.32 (41%) $0.62 $0.72 (14%) Net loss (7,121) (17,333) 59% (3,312) (22,024) 85% Per share - basic $(0.07) $(0.20) 65% $(0.03) $(0.25) 88% Per share - diluted $(0.07) $(0.20) 65% $(0.03) $(0.25) 88% ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- The following table provides a reconciliation between cash flow from operations and funds generated from operations. ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months Six months ended June 30, ended June 30, ($thousands) 2010 2009 2010 2009 --------------------------------------- Cash flow from operations 19,692 27,653 63,214 62,435 Change in non-cash working capital 7,661 7,504 3,383 5,193 Asset retirement expenditures 95 585 406 1,084 ---------------------------------------------------------------------------- Funds generated from operations 27,448 35,742 67,003 68,712 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- BOE ANALYSIS ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months ended June 30, 2010 2009 ----------------------------------------------------- ($thousands) ($ per BOE) ($thousands) ($ per BOE) ----------------------------------------------------- Petroleum and natural gas revenue (1) 59,633 42.32 58,430 41.77 Royalties (8,686) (6.16) (3,058) (2.19) Operating expenses (13,784) (9.78) (14,610) (10.44) Transportation (1,553) (1.10) (1,345) (0.96) Change in fair value of derivatives (233) (0.17) 3,140 2.24 General & administrative(2) (4,703) (3.34) (3,166) (2.26) Interest expense (3) (3,226) (2.29) (3,649) (2.61) ---------------------------------------------------------------------------- Funds generated from operations 27,448 19.48 35,742 25.55 Change in fair value of derivatives 233 0.17 (3,140) (2.24) Compensation expense - non-cash (1,094) (0.78) (13,019) (9.31) Accretion of convertible debentures (483) (0.34) (501) (0.36) Depletion, depreciation and accretion (35,048) (24.87) (37,736) (26.98) Future tax reduction 1,823 1.29 1,321 0.95 ---------------------------------------------------------------------------- Net loss (7,121) (5.05) (17,333) (12.39) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 1) Including the change in fair value of derivatives (non-cash) and revenue from the sale of inventory at the West Pembina sulphur block. 2) Net of compensation expense (non-cash). 3) Net of accretion on convertible debentures (non-cash). ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Six months ended June 30, 2010 2009 ----------------------------------------------------- ($thousands) ($ per BOE) ($thousands) ($ per BOE) ----------------------------------------------------- Petroleum and natural gas revenue (1) 123,015 46.27 126,975 45.42 Royalties (14,220) (5.35) (11,131) (3.98) Operating expenses (24,809) (9.33) (32,014) (11.45) Transportation (2,844) (1.07) (2,939) (1.05) Change in fair value of derivatives (455) (0.18) 497 0.17 General & administrative(2) (7,041) (2.64) (5,317) (1.90) Compensation expense(3) (424) (0.16) (151) (0.05) Interest expense (4) (6,219) (2.34) (7,208) (2.58) ---------------------------------------------------------------------------- Funds generated from operations 67,003 25.20 68,712 24.58 Change in fair value of derivatives 455 0.18 (497) (0.17) Compensation expense - non-cash (2,945) (1.11) (15,538) (5.56) Accretion of convertible debentures (966) (0.36) (1,003) (0.36) Depletion, depreciation and accretion (66,197) (24.90) (75,277) (26.93) Future tax reduction (expense) (662) (0.25) 1,579 0.56 ---------------------------------------------------------------------------- Net loss (3,312) (1.25) (22,024) (7.88) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 1) Including the change in fair value of derivatives (non-cash) and revenue from the sale of inventory at the West Pembina sulphur block. 2) Net of compensation expense. 3) Cash component of compensation expense which resulted from the cash settlement of Restricted Units and Performance Units. 4) Net of accretion on convertible debentures (non-cash). Fairborne reported funds generated from operations of $27.4 million for the second quarter of 2010 (Q2 2009 - $35.7 million) and $67.0 million for the six months ended June 30, 2010 (YTD 2009 - $68.7 million). On a year to date basis the decrease in funds generated from operations reflects the decrease in revenue due to lower natural gas prices, a decrease in sulphur block revenue as well as an increase in royalties and general and administrative expenses in the first half of 2010.The net loss of $7.1 million for the second quarter of 2010 (Q2 2009 - net loss of $17.3 million) and the net loss of $3.3 million for the six months ended June 30, 2010 (YTD 2009 - net loss of $22.0 million) reflects the decrease in cash flows. The net loss in 2009 also includes the $12.6 million charge to compensation expense for stock options that were surrendered in June 2009. LIQUIDITY AND CAPITAL RESOURCES Capital Expenditures ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months Six months ended June 30, ended June 30, ($thousands) 2010 2009 2010 2009 --------------------------------------- Exploration and development Land and lease acquisitions 6,235 1,272 14,064 5,082 Geological and geophysical 1,183 - 4,504 84 Drilling and completions 7,809 5,841 51,691 45,211 Well equipment and facilities 3,054 8,792 13,563 18,084 Corporate assets 132 20 137 109 ---------------------------------------------------------------------------- 18,413 15,925 83,959 68,570 Property acquisitions 1,469 - 2,933 - Property dispositions - (605) - (605) ---------------------------------------------------------------------------- Total 19,882 15,320 86,892 67,965 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- During the second quarter of 2010, Fairborne's exploration and development expenditures were $18.4 million with capital expenditures financed entirely by funds generated from operations. Land and lease acquisitions of $6.2 million during the second quarter of 2010 were primarily focused in the Company's Harlech area where $5.9 million was utilized to acquire additional acreage at Alberta provincial land sales. Fairborne also purchased $1.2 million of seismic data during the second quarter of 2010, with the majority of the seismic purchased in the Marlboro and Sinclair areas. Property acquisitions of $1.5 million during the quarter were focused on increasing working interests in core properties.Fairborne spent $7.8 million on drilling and completion activities in the second quarter of 2010 which included one (0.9 net) well drilled on the Company's Marlboro property as well as initial costs associated with an earlier than expected start to the third and fourth quarter capital program as Fairborne commenced drilling and completion activities on the Marlboro and Brazeau areas. These projects will be completed in the third and fourth quarters. Tangible capital expenditures of $3.0 million during the three months ended June 30, 2010 included various tie-ins in the Sinclair, Marlboro and Westerose areas.Working Capital and Bank IndebtednessAt June 30, 2010, Fairborne had drawn $123.1 million against its credit facilities and had a working capital deficit of $6.4 million for a net debt position (excluding convertible debentures) of $129.5 million (December 31, 2009 - $110.1 million). With continued volatility in commodity and capital markets, Fairborne has limited its 2010 capital expenditure program to a level which it anticipates to be financed entirely from funds generated from operations on an annualized basis.Fairborne's credit facilities at June 30, 2010 included a $270 million extendible revolving term credit facility and a $15 million demand operating credit facility for a total available facility of $285 million. The extendible revolving term facility is available on a revolving basis until May 27, 2011 and, if not renewed at this date, repayment of the amounts drawn will be required on May 27, 2012. The facilities continue to be subject to semi-annual reviews.Shareholders' EquityThe Company is authorized to issue an unlimited number of common shares and an unlimited number of preferred shares, issuable in series.During the second quarter of 2010, 9,472 common shares were issued on the exercise of stock options. In addition 4.1 million warrants expired with no warrants exercised in 2010.As a result of the 2009 flow-through financing, Fairborne has a commitment to spend $20.0 million on qualifying Canadian exploration expenditures prior to December 31, 2010. As at June 30, 2010, $10.9 million of qualifying exploration expenditures have been incurred.The following table provides a summary of outstanding common shares, warrants, convertible debentures, shares under incentive plans and stock options, at the dates indicated: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- July 31, June 30, December 31, (thousands) 2010 2010 2009 ---------------------------------- Common shares 102,489 102,489 102,462 Warrants (1) - - 4,406 Convertible debentures (2) $100,000 $100,000 $100,000 Incentive plans Restricted Units - - 30 Performance Units - - 92 Stock options 6,786 6,757 5,235 Weighted average common shares Basic n/a 102,474 90,609 Diluted n/a 102,474 90,609 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 1) Each warrant entitled the holder to acquire 0.39 of a common share at an exercise price of $8.13 per common share. All remaining warrants expired on June 1, 2010. 2) The convertible debentures are convertible into common shares at a conversion price of $13.50 per share. BUSINESS ENVIRONMENT AND RISKThe business risks the Company is exposed to are those inherent in the oil and gas industry as well as those governed by the individual nature of Fairborne's operations. Geological and engineering risks, the uncertainty of discovering commercial quantities of new reserves, commodity prices, interest rate and foreign exchange risks, competition and government regulations - all of these govern the businesses and influence the controls and management at the Company. Fairborne manages these risks by:- attracting and retaining a team of highly qualified and motivated professionals who have a vested interest in the success of the Company;- operating properties in order to maximize opportunities;- employing risk management instruments to minimize exposure to volatility of commodity prices, interest rate and foreign exchange rates;- maintaining a strong financial position; and- maintaining strict environmental, safety and health practices.CHANGE IN ACCOUNTING POLICIES AND RECENT ACCOUNTING PRONOUNCEMENTSInternational Financial Reporting Standards ("IFRS")Effective January 1, 2011, Canadian public companies are required to adopt International Financial Reporting Standards ("IFRS"). In the time leading up to the conversion date, some existing Canadian standards will change to converge with IFRS. Fairborne's financial statements up to and including the December 31, 2010 financial statements will continue to be reported in accordance with Canadian generally accepted accounting principles ("GAAP") as it exists on each reporting date. Financial statements for the quarter ended March 31, 2011, including comparative amounts, will be prepared on an IFRS basis.In order to transition to IFRS, management has formed an executive steering committee which oversees the project team. A transition plan is in place to convert the financial statements to IFRS. Training has been provided to key employees and the Company continues to assess the effect of the transition on information systems, internal controls over financial reporting and disclosure controls and procedures. Systems and controls are being updated as IFRS accounting processes are implemented. Significant system and control changes are not anticipated. Analysis and quantification of differences between IFRS and Fairborne's current accounting policies is continuing. Some accounting policies may change on adoption of IFRS even though Fairborne's current accounting policies are acceptable under IFRS. Changes in accounting policy may materially impact the financial statements.The Company is in the process of preparing a balance sheet as at January 1, 2010 on an IFRS basis as well as financial statements for the three months ended March 31, 2010 on an IFRS basis. Calculations of the impact of the changes in accounting policy are being finalized and Fairborne anticipates that quantitative information about the impact of the change from Canadian GAAP to IFRS will be included in the Management Discussion and Analysis for the three and nine months ended September 30, 2010.There are several significant accounting policy changes anticipated on adoption of IFRS. Changes in IFRS prior to adoption may result in other accounting policy changes which could significantly impact the financial statements. Numerous accounting policy changes will be made under IFRS, with the most significant changes expected to include accounting for petroleum and natural gas assets and equipment ("P&NG assets"), accounting for business combinations and accounting for future taxes.Petroleum and Natural Gas AssetsIFRS standards require that a company choose to report their P&NG assets either at the amount which would have been recorded had the company always followed current IFRS standards or at fair value on the date of adoption of IFRS. Alternatively, IFRS standards allow for a conversion exemption whereby companies can choose to record opening petroleum and natural gas properties at a deemed cost equal to historic cost as calculated under Canadian GAAP. Fairborne currently intends to elect to record P&NG assets at historic cost as calculated under Canadian GAAP on January 1, 2010.Under Canadian GAAP, all petroleum and natural gas assets are accounted for under the full cost accounting guideline. Under IFRS, P&NG assets will be divided into exploration and evaluation properties ("E&E assets") and petroleum and natural gas properties and equipment ("development assets"). E&E assets will initially be capitalized and accumulated pending determination of technical feasibility and economic viability. E&E assets will not be depreciated and will be carried at cost less any accumulated impairment losses. Development assets will be measured at cost less accumulated depletion and depreciation and any accumulated impairment losses. E&E assets will initially be recorded at January 1, 2010 based on the Canadian GAAP historic cost of those assets. IFRS permits the remaining deemed cost of P&NG assets at January 1, 2010 to be allocated to development assets on a pro rata basis using either reserve values or reserve volumes. Fairborne currently intends to allocate the deemed cost to development assets pro rata based on reserve values. Due to the nature of Fairborne's assets, management currently anticipates that substantially all assets at January 1, 2010 will be development assets.Both E&E assets and development assets will be assessed to determine whether impairment losses exist under IFRS as at January 1, 2010. These impairment tests will differ from the current Canadian GAAP full cost ceiling test in several significant ways. Assets (including goodwill) will be allocated to Cash Generating Units ("CGU"s) and a separate impairment test will be completed for each CGU identified. Fairborne has identified five CGUs, Northern Alberta, Southern Alberta, Deep Basin, West Pembina and Manitoba/Saskatchewan. Under current Canadian GAAP the ceiling test is a two step test. The carrying value of assets is first compared to the undiscounted future cash flows. If the carrying value of the assets exceeds the undiscounted future cash flows, then the second step of the test is required whereby the assets are written down to the value of the discounted future cash flows. Under IFRS, the impairment test compares the carrying value of the assets to the greater of the fair value of the assets and the value-in-use of the assets, which is a discounted cash flow measure. As a result, impairments may be recorded more frequently under IFRS. Future impairment tests may be required when management determines that indicators of impairment exist. Should impairment losses be recorded in accordance with IFRS, certain of those losses can reverse in the future if facts and circumstances change. Fairborne is in the process of completing an IFRS impairment test for each CGU as at January 1, 2010 and does not currently anticipate that any impairment will be recorded at January 1, 2010.Depreciation under Canadian GAAP is calculated using a unit-of-production method based on total proved reserves for all accumulated costs (excluding unproved properties). Under IFRS, the net carrying value of development assets will still be depleted using a unit of production method; however, significant components with different useful lives, will be accounted for as separate items and depreciated separately. Fairborne is in the process of finalizing the components which will be used for the purpose of depreciating development assets. In addition, IFRS allows depreciation to be calculated using either proved reserves or proved plus probable reserves. Fairborne currently intends to depreciate assets using proved plus probable reserves. Depreciation is expected to be lower on an IFRS basis than that recorded under Canadian GAAP. Under the full cost accounting guideline, gains or losses are not recognized upon the disposition of P&NG assets unless the disposition results in a significant change in the depletion rate. Under IFRS, gains and losses are recognized in net income on the disposal of an item of P&NG assets. The amount of the gain or loss is determined by comparing the proceeds from disposal with the carrying amount of the item. This will include transactions such as sales of assets, farm-outs, asset swaps and other non-monetary transactions which typically did not result in gains or losses being recorded under Canadian GAAP. Fairborne is currently reviewing non-monetary transactions which occurred in the three months ended March 31, 2010 to determine the impact of recording gains or losses on these transactions. The Company currently does not anticipate that the gains or losses recorded on non-monetary transactions for the three months ended March 31, 2010 will be material, however material non-monetary transactions may occur during the remainder of the year.Under Canadian GAAP, Fairborne did not capitalize general and administrative expenses to P&NG assets other than recoveries permitted under joint operating agreements. IFRS offers more guidance on amounts which should be capitalized. There is no impact of this change on P&NG assets recorded at January 1, 2010 due to the conversion exemption which Fairborne intends to elect. Fairborne is calculating the amounts which will be capitalized under IFRS for the three months ended March 31, 2010 and expects that the amount of general and administrative costs capitalized will be higher than those which were recorded under Canadian GAAP. This will result in an increase in profit and an increase in P&NG assets for the three months ended March 31, 2010.Business CombinationsAccounting for business combinations also differs under IFRS. Fairborne intends to elect not to restate business combinations recorded prior to January 1, 2010 in accordance with IFRS standards. As a result, in respect of acquisitions prior to January 1, 2010, goodwill continues to represent the amount recognized under Canadian GAAP. However, goodwill recognized in business combinations after January 1, 2010 recorded under IFRS will represent the excess of the cost of the acquisition over the net fair value of the identifiable assets, liabilities and contingent liabilities of the acquired entity. When the excess is negative, it will be recognized immediately in profit and loss. In addition, transaction costs which are included in the cost of the acquisition under Canadian GAAP will be expensed under IFRS. The Company has the option to early adopt the IFRS standard for business combinations. The Company will assess this option if the Company enters into a business combination in 2010. As of June 30, 2010, Fairborne has not entered into any business combinations.Deferred Income TaxesDeferred income taxes are calculated under IFRS using a liability approach which is conceptually similar to Canadian GAAP however there are differences in the manner in which deferred income taxes are calculated. On adoption of IFRS, Fairborne anticipates that adjustments will be required to the deferred income tax liability recorded, and is in the process of determining the quantitative impact of these adjustments. Each other adjustment recorded on adoption of IFRS is being assessed to determine if there is a related income tax impact. In addition to these changes, Fairborne anticipates changes related to the tax effects of share issue costs and flow through shares. Under Canadian GAAP, when shares are issued the related costs are recorded on an after tax basis as an offset to the proceeds of the share issue. As the tax effect of the share issue costs reverses, the change in deferred income tax is recorded through profit and loss. Under IFRS, subsequent changes in tax rates related to these tax amounts are recorded to share capital, where the original tax benefit was recognized. Fairborne is in the process of quantifying the impact of this adjustment as at January 1, 2010 and for the three months ended March 31, 2010. The Company is also assessing the accounting policy for flow-through shares under IFRS.Other ItemsThere are other accounting policy changes with potentially material impacts, including accounting for asset retirement obligations (ARO), convertible debentures, warrants, exchangeable shares and stock based compensation. The ARO calculation differs under IFRS in some respects. On initial adoption of IFRS, the ARO liability will be recorded at its revised amount and the difference from the amount recorded under Canadian GAAP will be recorded as an adjustment to retained earnings at January 1, 2010. Fairborne currently anticipates using a risk-free discount rate in calculating ARO which will result in an increase to the ARO liability at January 1, 2010. The calculation is currently being finalized.Under IFRS, accounting for equity items such as Trust Units, warrants, convertible debentures and exchangeable shares held within a Trust structure can be materially different than under Canadian GAAP. Given that Fairborne was a Trust from June 2005 until December 2007, certain of these items may result in a material adjustment to the Company's statements under IFRS. Fairborne is in the process of assessing and quantifying the impact of these differences on the Company's IFRS statements.Retention awards are cash settled stock based payments which are recorded as a liability under both Canadian GAAP and IFRS. Under Canadian GAAP, the retention awards are measured at their intrinsic value while under IFRS they are measured at fair value. Fairborne is currently calculating the impact of this change. CONTROLS AND PROCEDURESDisclosure Controls and ProceduresFairborne's Chief Executive Officer and Chief Financial Officer have designed or caused to be designed under their supervision, disclosure controls and procedures to provide reasonable assurance that (i) material information relating to the Company is made known to Fairborne's Chief Executive Officer and Chief Financial Officer by others, particularly during the period in which the annual and interim filings are being prepared; and (ii) information required to be disclosed by the Company in its annual filings or other reports filed or submitted by it under securities legislation is recorded, processed, summarized and reported within the time period specified in securities legislation.Internal Controls over Financial ReportingFairborne's Chief Executive Officer and Chief Financial Officer have designed or caused to be designed under their supervision, internal controls over financial reporting to provide reasonable assurance regarding the reliability of the Company's financial reporting and the preparation of financial statements for external purposes in accordance with Canadian GAAP.No material changes in Fairborne's internal controls over financial reporting were identified during the three months ended June 30, 2010, that have materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting.It should be noted that a control system, including Fairborne's disclosure and internal controls and procedures, no matter how well conceived, can provide only reasonable, but not absolute, assurance that the objectives of the control system will be met and it should not be expected that the disclosure and internal controls and procedures will prevent all errors or fraud. QUARTERLY FINANCIAL INFORMATION The following is a summary of select financial information for the quarterly periods indicated: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 2010 2009 Q2 Q1 Q4 Q3 ---------------------------------------- Financial ($thousands, except per share amounts) Petroleum and natural gas revenue 59,633 63,382 58,338 55,244 Funds generated from operations 27,448 39,555 37,863 37,236 Per share - basic $ 0.27 $ 0.39 $ 0.37 $ 0.43 Per share - diluted $ 0.27 $ 0.38 $ 0.37 $ 0.43 Cash flow from operations (including changes in working capital) 19,692 43,522 38,750 40,048 Per share - basic $ 0.19 $ 0.42 $ 0.38 $ 0.46 Per share - diluted $ 0.19 $ 0.42 $ 0.38 $ 0.46 Net income (loss) (7,121) 3,809 (3,124) (497) Per share - basic $ (0.07)$ 0.04 $ (0.02) $ (0.01) Per share - diluted $ (0.07)$ 0.04 $ (0.02) $ (0.01) Total assets 951,477 976,138 940,443 961,920 Working capital deficit (surplus) 6,352 34,611 6,370 (1,539) Bank indebtedness 123,081 102,536 103,738 204,046 Convertible debentures 97,476 96,993 96,510 96,027 ---------------------------------------------------------------------------- Operations Average production Natural gas (Mcf per day) 66,812 60,878 59,132 56,797 Crude oil (bbls per day) 3,110 3,000 3,037 3,292 Natural gas liquids (bbls per day) 1,149 686 617 563 Sulphur (tonnes per day) (1) 92 54 33 100 ---------------------------------------------------------------------------- Total (BOE per day) 15,486 13,886 13,542 13,421 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 1) Excludes the sale of inventory at the West Pembina sulphur block. ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 2009 2008 Q2 Q1 Q4 Q3 ---------------------------------------- Financial ($thousands, except per share amounts) Petroleum and natural gas revenue 58,430 68,545 85,165 97,489 Funds generated from operations 35,742 32,970 40,309 55,307 Per share - basic $ 0.41 $ 0.38 $ 0.46 $ 0.64 Per share - diluted $ 0.41 $ 0.38 $ 0.46 $ 0.63 Cash flow from operations (including changes in working capital) 27,653 34,782 37,693 65,598 Per share - basic $ 0.32 $ 0.40 $ 0.43 $ 0.76 Per share - diluted $ 0.32 $ 0.40 $ 0.43 $ 0.76 Net income (loss) (17,333) (4,691) 11,657 19,182 Per share - basic $ (0.20) ($0.05)$ 0.14 $ 0.22 Per share - diluted $ (0.20) ($0.05)$ 0.14 $ 0.22 Total assets 1,001,840 1,023,526 1,013,177 999,065 Working capital deficit (surplus) (7,227) 31,641 27,917 64,814 Bank indebtedness 232,184 209,925 196,282 161,302 Convertible debentures 95,525 95,024 94,522 94,020 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Operations Average production Natural gas (Mcf per day) 66,744 67,520 69,460 62,601 Crude oil (bbls per day) 3,552 3,599 4,086 3,312 Natural gas liquids (bbls per day) 632 572 657 580 Sulphur (tonnes per day) (1) 64 93 138 129 ---------------------------------------------------------------------------- Total (BOE per day) 15,372 15,517 16,458 14,454 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 1) Excludes the sale of inventory at the West Pembina sulphur block. Interim Consolidated Financial Statements INTERIM CONSOLIDATED BALANCE SHEETS (Unaudited) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- June 30, December 31, ($thousands) 2010 2009 ---------------------- Assets Current assets Cash and cash equivalents $ 256 $ 147 Accounts receivable 26,784 35,155 Derivative asset (Note 7) 96 - Prepaid expenses and deposits 5,890 8,079 ---------------------------------------------------------------------------- 33,026 43,381 Petroleum and natural gas properties and equipment (Note 1) 902,281 880,892 Goodwill 16,170 16,170 ---------------------------------------------------------------------------- $ 951,477 $ 940,443 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Liabilities Current liabilities Accounts payable and accrued liabilities $ 39,378 $ 44,602 Derivative liability (Note 7) - 359 Current portion of compensation plans - 505 Deferred revenue - 4,285 ---------------------------------------------------------------------------- 39,378 49,751 Bank indebtedness (Note 2) 123,081 103,738 Convertible debentures (Note 3) 97,476 96,510 Asset retirement obligation (Note 4) 11,488 11,200 Future income taxes 95,629 89,919 Shareholders' equity Common shares (Note 5) 531,919 536,789 Warrants (Note 5) - 2,721 Equity component of convertible debentures (Note 3) 5,581 5,581 Contributed surplus (Note 5) 30,830 24,827 Retained earnings 16,095 19,407 ---------------------------------------------------------------------------- 584,425 589,325 ---------------------------------------------------------------------------- $ 951,477 $ 940,443 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- See accompanying notes to the interim consolidated financial statements. INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS (Unaudited) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months Six months ended June 30, ended June 30, ($thousands except per share amounts) 2010 2009 2010 2009 --------------------------------------------- Revenue Petroleum and natural gas $ 59,633 $ 58,430 $ 123,015 $ 126,975 Royalties (8,686) (3,058) (14,220) (11,131) ---------------------------------------------------------------------------- 50,947 55,372 108,795 115,844 Expenses Operating 13,784 14,610 24,809 32,014 Transportation 1,553 1,345 2,844 2,939 General and administrative 5,797 16,185 10,410 21,006 Interest 3,709 4,150 7,185 8,211 Depletion, depreciation and accretion 35,048 37,736 66,197 75,277 ---------------------------------------------------------------------------- 59,891 74,026 111,445 139,447 ---------------------------------------------------------------------------- Loss before taxes (8,944) (18,654) (2,650) (23,603) Future taxes (reduction) (1,823) (1,321) 662 (1,579) ---------------------------------------------------------------------------- Net loss and comprehensive loss (7,121) (17,333) (3,312) (22,024) Retained earnings, beginning of period 23,216 40,361 19,407 45,052 ---------------------------------------------------------------------------- Retained earnings, end of period $ 16,095 $ 23,028 $ 16,095 $ 23,028 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Net loss per share (Note 5) Basic $ (0.07) $ (0.20) $ (0.03) $ (0.25) Diluted $ (0.07) $ (0.20) $ (0.03) $ (0.25) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- See accompanying notes to the interim consolidated financial statements INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months Six months ended June 30, ended June 30, ($thousands) 2010 2009 2010 2009 ---------------------------------------------- Cash provided by (used in): Operating activities Net loss $ (7,121) $ (17,333) $ (3,312) $ (22,024) Items not involving cash: Depletion, depreciation and accretion 35,048 37,736 66,197 75,277 Compensation expense 1,094 13,019 2,945 15,538 Future taxes (reduction) (1,823) (1,321) 662 (1,579) Accretion of convertible debentures 483 501 966 1,003 Change in fair value of derivatives (233) 3,140 (455) 497 Asset retirement expenditures (95) (585) (406) (1,084) ---------------------------------------------------------------------------- 27,353 35,157 66,597 67,628 Change in non-cash working capital (7,661) (7,504) (3,383) (5,193) ---------------------------------------------------------------------------- 19,692 27,653 63,214 62,435 ---------------------------------------------------------------------------- Financing activities Bank indebtedness 20,545 22,259 19,343 35,902 Issuance of common shares 10 - 10 - ---------------------------------------------------------------------------- 20,555 22,259 19,353 35,902 ---------------------------------------------------------------------------- Investing activities Expenditures on petroleum and natural gas properties (18,413) (15,925) (83,959) (68,570) Acquisition of petroleum and natural gas properties (1,469) - (2,933) - Disposition of petroleum and natural gas properties - 605 - 605 Change in non-cash working capital (20,303) (34,563) 4,434 (30,345) ---------------------------------------------------------------------------- (40,185) (49,883) (82,458) (98,310) ---------------------------------------------------------------------------- Change in cash and cash equivalents 62 29 109 27 Cash and cash equivalents, beginning of period 194 124 147 126 ---------------------------------------------------------------------------- Cash and cash equivalents, end of period $ 256 $ 153 $ 256 $ 153 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Interest paid $ 4,971 $ 6,400 $ 5,787 $ 8,837 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- See accompanying notes to the interim consolidated financial statements SELECTED NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTSFor the six months ended June 30, 2010 (unaudited)(tabular amounts are stated in thousands and thousands of dollars except per share amounts)The interim consolidated financial statements of Fairborne Energy Ltd. (the "Company" or "Fairborne") have been prepared by management in accordance with accounting principles generally accepted in Canada. The interim consolidated financial statements have been prepared following the same accounting policies and methods of computation as the consolidated financial statements for the year ended December 31, 2009. The disclosure which follows is incremental to the disclosure included with the annual financial statements. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2009. 1. PETROLEUM AND NATURAL GAS PROPERTIES AND EQUIPMENT ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- June 30, December 31, 2010 2009 ---------------------------- Petroleum and natural gas properties and equipment $ 1,522,248 $ 1,435,282 Accumulated depletion and depreciation (621,807) (556,289) Corporate assets 4,444 4,307 Accumulated depreciation (2,604) (2,408) ---------------------------------------------------------------------------- $ 902,281 $ 880,892 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- As at June 30, 2010, future development costs of $205.5 million (December 31, 2009 - $193.8 million) were included in the depletion calculation and costs of acquiring unproved properties in the amount of $58.1 million (December 31, 2009 - $48.2 million) were excluded from the depletion calculation. Subsequent to the end of the second quarter, Fairborne signed a purchase and sale agreement to acquire undeveloped land and producing assets for a total purchase price of $71.5 million, subject to closing adjustments. The property acquisition is scheduled to close in September 2010.2. BANK INDEBTEDNESSAt June 30, 2010 the Company had a $270 million extendible revolving term credit facility and a $15 million demand operating credit facility available from a syndicate of Canadian chartered banks, subject to the banks' semi-annual valuation of Fairborne's petroleum and natural gas properties. The extendible revolving term facility is available on a revolving basis until May 27, 2011 (364 day facility) at which time it may be extended, at the lenders option. If the revolving period is not extended, the undrawn portion of the facility will be cancelled and the amount outstanding will convert to a 365 day non-revolving term facility. The amounts outstanding under the non-revolving term facility are required to be repaid at the end of the term facility being May 27, 2012. Interest payable on amounts drawn under the facilities is at the prevailing bankers' acceptance rates plus stamping fees, lenders' prime rate or LIBOR rates plus applicable margins, depending on the form of borrowing by the Company. The margins and stamping fees vary from 0.56% to 4.00% depending on financial statement ratios and the form of borrowing. The credit facilities are secured by a general security agreement and a first ranking floating charge on the assets of the Company. At June 30, 2010 letters of credit totaling $0.5 million were outstanding. 3. CONVERTIBLE DEBENTURESThe following table sets forth a reconciliation of the convertible debentures for the six months ended June 30, 2010: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Number of Debt Equity debentures component component ------------------------------------------ Balance, beginning of period 100,000 $ 96,510 $ 5,581 Accretion - 966 - ---------------------------------------------------------------------------- Balance, end of period 100,000 $ 97,476 $ 5,581 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 4. ASSET RETIREMENT OBLIGATIONThe following table sets forth a reconciliation of the asset retirement obligation for the six months ended June 30, 2010: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Balance, beginning of period $ 11,200 Liabilities incurred 211 Liabilities settled (406) Accretion expense 483 ---------------------------------------------------------------------------- Balance, end of period $ 11,488 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 5. SHAREHOLDERS' EQUITY The Company is authorized to issue an unlimited number of common shares and an unlimited number of preferred shares, issuable in series.a) Common Shares The following table sets forth a reconciliation of the common shares issued and outstanding for the six months ended June 30, 2010: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Number of shares Amount ---------------------------- Balance, beginning of period 102,462 $ 536,789 Issued on vesting of Restricted Units and Performance Units 15 140 Issued on exercise of stock options 12 38 Tax effect of flow-through shares issued in 2009 - (5,048) ---------------------------------------------------------------------------- Balance, end of period 102,489 $ 531,919 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- As a result of the 2009 flow-through financing, Fairborne has a commitment to spend $20.0 million on qualifying Canadian exploration expenditures. As at June 30, 2010, $10.9 million of qualifying exploration expenditures have been incurred.b) WarrantsOn June 1, 2010 all remaining warrants expired unexercised. c) Per share amountsThe following table summarizes the weighted average common shares used in calculating net loss per share: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Three months Six months ended June 30, ended June 30, ($thousands) 2010 2009 2010 2009 ---------------------------------------- Numerator Net loss - basic and diluted $ (7,121) $(17,333) $ (3,312) $(22,024) ---------------------------------------------------------------------------- Denominator Weighted average shares - basic and diluted 102,483 87,033 102,474 86,988 ---------------------------------------------------------------------------- Basic net loss per share $ (0.07) $ (0.20) $ (0.03) $ (0.25) Diluted net loss per share $ (0.07) $ (0.20) $ (0.03) $ (0.25) ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Excluded from the diluted number of shares for the three and six months ended June 30, 2010 is the effect of convertible debentures (7.4 million shares) and 6.8 million stock options as they are anti-dilutive to the net loss for the period. Excluded from the diluted number of shares for the three and six months ended June 30, 2009 is the effect of convertible debentures (7.4 million shares), warrants (1.7 million shares) and 2.0 million stock options.d) Equity and liability based compensation plansi) Incentive PlanThe following table sets forth a reconciliation of the restricted and performance incentive plan activity for the six months ended June 30, 2010: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Number of Number of Restricted Performance Units Units Total ------------------------------------------ Balance, beginning of period 30 92 122 Exercised (30) (92) (122) ---------------------------------------------------------------------------- Balance, end of period - - - ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- In March 2010, all remaining restricted and performance units vested and were settled with either cash or common shares. As such, no liability remains at June 30, 2010.ii) Stock Option PlanThe following table sets forth a reconciliation of the stock option plan activity for the six months ended June 30, 2010: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Weighted Number average of exercise awards price ---------------------------- Balance, beginning of period 5,235 $ 4.25 Granted 1,763 4.15 Exercised (26) 2.97 Forfeited (215) 4.55 ---------------------------------------------------------------------------- Balance, end of period 6,757 $ 4.22 ---------------------------------------------------------------------------- Exercisable, end of period 1,675 $ 4.39 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- The weighted average fair value of options granted during the six months ended June 30, 2010 was $1.63 per option using the Black-Scholes option pricing model with the following assumptions: risk free interest rate of two percent, expected volatility of 65 percent, average expected life of three years and dividend rate of nil. An estimated forfeiture rate of two percent has been applied to the compensation costs recognized. The following table summarizes stock options outstanding at June 30, 2010: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Options Remaining Exercise Price outstanding term (years) ---------------------------- $ 2.00 - $ 4.99 6,568 4.3 $ 5.00 - $ 7.99 55 3.9 $ 8.00 - $ 10.99 58 3.3 $ 11.00 - $ 13.99 76 3.1 ---------------------------------------------------------------------------- 6,757 4.3 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- iii) Retention Award PlanThe following table sets forth a reconciliation of the retention award plan activity for the six months ended June 30, 2010: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Weighted Number average of exercise awards price ---------------------------- Balance, beginning of period 1,390 $ 5.74 Forfeited (185) 5.75 ---------------------------------------------------------------------------- Balance, end of period 1,205 $ 5.74 ---------------------------------------------------------------------------- Exercisable, end of period 803 $ 5.74 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- e) Contributed SurplusThe following table sets forth a reconciliation of the contributed surplus for the six months ended June 30, 2010: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Balance, beginning of period $ 24,827 Equity based compensation 3,310 Warrants expired 2,721 Stock options exercised (28) ---------------------------------------------------------------------------- Balance, end of period $ 30,830 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 6. FINANCIAL INSTRUMENTS As at June 30, 2010, the Company's accounts receivable is aged as follows: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Current (less than 90 days) $ 21,893 Past due (more than 90 days) 4,891 ---------------------------------------------------------------------------- Total $ 26,784 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Fair value of financial instruments:The carrying value of Fairborne's financial instruments, other than bank indebtedness and convertible debentures, approximate their fair value due to their short maturity. The fair value of the bank indebtedness approximates its carrying value as it bears interest at a floating rate. The fair value of the convertible debentures at June 30, 2010 was $101.8 million (December 31, 2009 - $100.3 million).7. COMMODITY CONTRACTSFairborne has a risk management program whereby the Company sells forward a portion of its future production through fixed price sales contracts with customers.a) Commodity Contracts Recorded at Fair Value:At June 30, 2010 certain contracts have been recorded on the balance sheet at their estimated fair value as a $0.1 million asset (December 31, 2009 - $0.4 million liability). The change in the fair value has been recorded in petroleum and natural gas sales for the six months ended June 30, 2010. Oil: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Volume Price Settlement (bbls per day) (CDN$ per bbl) Index ---------------------------------------------- Collars Jul 1, 2010 - Dec 31, 2010 500 55.00 - 108.00 WTI Jul 1, 2010 - Dec 31, 2010 500 70.00 - 100.15 WTI Jan 1, 2011 - Dec 31, 2011 500 70.00 - 101.25 WTI ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- b) Commodity Contracts not Recorded at Fair Value:The following crude oil and natural gas fixed price physical sales contracts outstanding at June 30, 2010 have been entered into for the purpose of physical delivery of a non-financial item; therefore, the physical delivery contracts are not fair valued. Settlements on these contracts are included in petroleum and natural gas revenue as they occur. Oil: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Volume Price Settlement (bbls per day) (CDN$ per bbl) Index ---------------------------------------------- Collars Jul 1, 2010 - Dec 31, 2010 500 55.00 - 103.00 WTI ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Natural Gas: ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Volume Price Settlement (GJs per day) (CDN$ per GJ) Index ------------------------------------------------ AECO Swaps Jul 1, 2010 - Dec 31, 2010 5,000 5.86 AECO C Monthly Jul 1, 2010 - Dec 31, 2010 2,500 5.67 AECO C Monthly Jul 1, 2010 - Dec 31, 2010 1,500 5.90 AECO C Monthly Jul 1, 2010 - Dec 31, 2010 1,500 5.86 AECO C Monthly Jul 1, 2010 - Dec 31, 2010 1,500 5.88 AECO C Monthly Jul 1, 2010 - Dec 31, 2010 1,500 6.00 AECO C Monthly Jul 1, 2010 - Dec 31, 2010 4,000 6.00 AECO C Monthly Jul 1, 2010 - Dec 31, 2010 2,000 6.13 AECO C Monthly Jul 1, 2010 - Dec 31, 2010 2,000 6.15 AECO C Monthly Jul 1, 2010 - Dec 31, 2010 2,000 6.16 AECO C Monthly Jul 1, 2010 - Dec 31, 2010 4,000 5.72 AECO C Monthly Jan 1, 2011 - Dec 31, 2011 5,000 5.00 AECO C Monthly Jan 1, 2011 - Dec 31, 2011 5,000 5.00 AECO C Monthly ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- FOR FURTHER INFORMATION PLEASE CONTACT: Fairborne Energy Ltd. Steven R. VanSickle President and Chief Executive Officer (403) 290-7759 (403) 290-7724(FAX) svansickle@fairborne-energy.com or Fairborne Energy Ltd. Aaron G. Grandberg Chief Financial Officer (403) 290-3217 (403) 290-7724(FAX) agrandberg@fairborne-energy.com www.fairborne-energy.com