ZARGON ENERGY TRUST
TSX : ZAR.UN

ZARGON ENERGY TRUST
Zargon Oil & Gas Ltd.
TSX : ZAR

Zargon Oil & Gas Ltd.

November 11, 2009 17:01 ET

Zargon Energy Trust Announces 2009 Third Quarter Results

CALGARY, ALBERTA--(Marketwire - Nov. 11, 2009) - Zargon Energy Trust (TSX:ZAR.UN) (TSX:ZOG.B)



FINANCIAL & OPERATING HIGHLIGHTS

Three Months Ended Nine Months Ended
September 30, September 30,
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Percent Percent
(unaudited) 2009 2008 Change 2009 2008 Change
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Financial
Income and Investments
($ millions)
Petroleum and natural gas
revenue 40.96 66.35 (38) 108.77 188.25 (42)
Funds flow from operating
activities 22.84 29.75 (23) 61.61 86.51 (29)
Cash flows from operating
activities 23.30 33.58 (31) 60.97 85.29 (29)
Cash distributions 12.22 9.87 24 33.51 29.13 15
Net earnings 4.47 40.05 (89) 2.28 40.09 (94)
Net capital expenditures 29.32 17.47 68 91.72 103.36 (11)
Per Unit, Diluted
Funds flow from operating
activities ($/unit) 0.90 1.42 (37) 2.67 4.21 (37)
Cash flows from operating
activities ($/unit) 0.92 1.60 (43) 2.64 4.15 (36)
Net earnings ($/unit) 0.20 2.20 (91) 0.11 2.24 (95)
Cash Distributions ($/trust
unit) 0.54 0.54 - 1.62 1.62 -
Balance Sheet at Period End
($ millions)
Property and equipment, net 431.72 385.37 12
Bank debt 77.05 74.95 3
Unitholders' equity 258.05 203.00 27
Total Units Outstanding at
Period End (millions) 25.93 21.05 23

Operating

Average Daily Production
Oil and liquids (bbl/d) 5,382 4,367 23 4,911 4,263 15
Natural gas (mmcf/d) 28.23 29.84 (5) 28.20 29.61 (5)
Equivalent (boe/d) 10,088 9,340 8 9,610 9,198 4
Equivalent per million trust
units (boe/d) 398 445 (11) 413 446 (7)
Average Selling Price (before
the impact of financial risk
management contracts)
Oil and liquids ($/bbl) 64.72 109.34 (41) 56.51 102.15 (45)
Natural gas ($/mcf) 3.43 8.17 (58) 4.29 8.50 (50)
Wells Drilled, Net 10.3 7.7 34 20.7 22.0 (6)
Undeveloped Land at Period End
(thousand net acres) 594 464 28
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Notes:

Throughout this report, the calculation of barrels of oil equivalent ("boe")
is based on the conversion ratio that six thousand cubic feet of natural gas
is equivalent to one barrel of oil. For a further discussion about this
term, refer to the Management's Discussion and Analysis section in this
report.

For net capital expenditures, amounts include capital expenditures acquired
for cash, equity issuances, acquisition costs and net debt assumed on
corporate acquisitions.

Funds flow from operating activities is a non-GAAP term that represents net
earnings/losses and asset retirement expenditures except for non-cash items.
For a further discussion about this term, refer to the Management's
Discussion and Analysis section in this report.

Total units outstanding include trust units plus exchangeable shares
outstanding at period end. The exchangeable shares are converted at the
exchange ratio at the end of the period.

Average daily production per million trust units is calculated using the
weighted average number of units outstanding during the period plus the
weighted average number of exchangeable shares outstanding for the period
converted at the average exchange ratio for the period.


FINANCIAL & OPERATING HIGHLIGHTS

Zargon Energy Trust is pleased to report its financial results for the third quarter of 2009. Highlights from the three and nine months ended September 30, 2009, are noted below:

- Funds flow from operating activities was $22.84 million ($0.90 per diluted trust unit) in the 2009 third quarter compared to $20.92 million ($0.91 per diluted trust unit) in the 2009 second quarter and $29.75 million ($1.42 per diluted trust unit) in the 2008 third quarter.

- Third quarter 2009 production averaged 10,088 barrels of oil equivalent per day, six percent above the preceding quarter and eight percent above the corresponding quarter of 2008. Higher third quarter production volumes were primarily due to a full quarter of additional volumes provided by the acquisition of Masters Energy Inc. ("Masters") and flush production volumes from this summer's Williston Basin horizontal drilling program. For the 2009 third quarter, Zargon's production averaged 398 barrels of oil equivalent per day per million trust units outstanding compared to 413 barrels of oil equivalent per day per million trust units outstanding for the prior quarter and 445 barrels of oil equivalent per day per million trust units outstanding in the corresponding quarter of 2008.

- The Trust declared three monthly cash distributions of $0.18 per trust unit in the 2009 third quarter for a total of $12.22 million. These cash distributions were equivalent to a payout ratio of 60 percent of the Trust's third quarter funds flow from operating activities on a diluted trust unit basis and, after considering the effect of the exchangeable shares not receiving distributions, the distributions amounted to 53 percent of funds flow from operating activities.

- Reflecting a now expanded 2009 field related capital program of $48 million, the Trust's third quarter exploration and development capital expenditures (excluding corporate and property acquisitions and dispositions) increased 49 percent from the prior quarter to $12.75 million primarily as a result of increased drilling, completions and equipping of wells. For the first nine months of 2009, Zargon spent $34.09 million on field related capital expenditures and drilled a total of 20.7 net wells.

- On September 23, 2009, Zargon closed the acquisition of Churchill Energy Inc. ("Churchill") for a total consideration of approximately 0.555 million Zargon trust units, $0.11 million in cash and the assumption of approximately $6.85 million of net debt (including adjustments and transactions costs) for a total transaction value of approximately $16.31 million.

- Debt net of working capital (excluding unrealized risk management assets/liabilities and future income taxes) increased 12 percent from the prior quarter to $87.14 million at September 30, 2009, which represents approximately 48 percent of the Trust's available credit facilities at September 30, 2009. The Trust's balance sheet remains strong with a debt net of working capital to annualized funds flow from operating activities ratio of 1.06 times.

Production (1)

Oil and liquids production averaged 5,382 barrels per day in the 2009 third quarter, a 13 percent increase from the preceding quarter and a 23 percent increase from the corresponding 2008 quarter. The increase in production volumes was primarily due to a full quarter's contribution from the Masters corporate acquisition that was closed on April 29, 2009, as well as the completion and tie-in of five horizontal oil exploitation wells drilled over the summer primarily in the Williston Basin. In particular, the drilling results from our horizontal drilling program exploiting Frobisher ridges at Steelman, Saskatchewan have been particularly strong (with initial flush rates of more than 100 barrels of oil per day per well) and should provide further oil production gains during the balance of 2009.

Natural gas production volumes in the 2009 third quarter averaged 28.23 million cubic feet per day, a one percent decrease from the previous quarter and a five percent decrease from the corresponding period of 2008. The 2009 third quarter natural gas production decreased primarily due to natural declines and the shut-in of selected high cost natural gas properties during a period of exceptionally low natural gas prices. For the remainder of the year, we anticipate that the Trust's natural gas production volumes will remain relatively flat as natural declines are offset by production volumes from the Churchill acquisition and from recent tie-ins at the Kakut property in the Peace River Arch region of our West Central Alberta core area.

Over the last two years, Zargon has made a concerted effort to increase its oil volumes through a series of oil-weighted corporate acquisitions and related oil exploitation projects. Specifically, in the two year period since the 2007 third quarter, Zargon has successfully grown its oil volumes by 50 percent and has increased its oil production weighting from 42 percent to 53 percent.

Capital Expenditures (1)

Zargon's third quarter field capital program totalled $12.75 million, a 22 percent decrease from the 2008 third quarter field capital expenditures and a 49 percent increase from the prior quarter. During the quarter, Zargon drilled 12 gross wells (10.3 net) that resulted in 6.0 net oil wells and 4.3 net gas wells for a 100 percent success ratio. This oil exploitation focused drilling program included one Taber horizontal well in the Alberta Plains and three Steelman horizontal wells along with one horizontal well at Elswick in the Williston Basin. Also, during the quarter, Zargon drilled three Jarrow natural gas wells in the Alberta Plains, one step-out natural gas well at Kakut in the Peace River Arch area and one Pembina natural gas exploration well in West Central Alberta.

For the remainder of 2009, Zargon is planning on drilling three oil exploitation horizontal wells with two additional Frobisher ridge targets at Steelman in the Williston Basin and one Sunburst target at Taber in the Alberta Plains. Natural gas drilling will be limited to one Alberta Plains Jarrow natural gas development well.

Throughout 2009, Zargon has successfully redirected its business to emphasize the exploitation of oil-in-place or gas-in-place resources as enabled by periodic accretive acquisitions and focused reservoir management. Specifically, we have made good progress with our oil exploitation initiatives in the Williston Basin and Taber, Alberta properties along with last year's corporate acquisitions of Rival Energy Ltd. and Newpact Energy Corp. and this year's corporate acquisitions of Masters and Churchill. Furthermore, we continue to advance our detailed technical review of our Little Bow Alkaline Surfactant Polymer ("ASP") tertiary oil recovery initiative and look forward to making our final decision regarding project implementation for this Southern Alberta opportunity by the end of the first quarter of 2010.

In the third quarter of 2009, the purchase of 21 thousand net acres of Crown lands at an average price of $39 per acre and the addition of approximately 60 thousand net acres from the Churchill acquisition, allowed Zargon to increase its quarter end undeveloped land inventory to 594 thousand net acres, up 61 thousand net acres from the balance reported at the end of the 2009 second quarter. For the remainder of the year, Zargon will continue to be an active participant at Alberta Crown land sales during this period of low Crown land sale costs.

Zargon continues to take advantage of the industry's current lower property and corporate acquisition costs with the announcement and closing of the Masters and Churchill acquisitions. During this period of opportunity, Zargon will continue to use its strong balance sheet and solid cash flows augmented by substantial hedge gains to pursue additional property and corporate acquisitions.

Guidance (1)

In the August 12, 2009 press release announcing the 2009 second quarter results, Zargon provided updated production guidance of 9,800 barrels of oil equivalent per day for the remainder of 2009 (not including volumes from the pending acquisition of Churchill). This previous guidance had been premised on a 2009 capital budget of $37 million. Due to the combination of improved field and service costs, strong oil production netbacks and promising oil exploitation drilling results, Zargon elected to expand its Williston Basin and Taber horizontal drilling programs in addition to proceeding with an enhanced facility upgrade and modification program, thereby taking the 2009 field capital budget to $48 million. Supported by flush production volumes coming from our Steelman Frobisher ridge initiative, Zargon's third quarter production exceeded guidance by three percent and averaged 10,088 barrels of oil equivalent per day. With the addition of the late September Churchill acquisition, production volumes for the fourth quarter of this year are now anticipated to average (with approximately 400 barrels of oil equivalent per day of flush production) in excess of 10,400 barrels of oil equivalent per day.

For 2010, Zargon is providing preliminary guidance of 10,400 barrels of oil equivalent per day, which is based on a 2010 field capital program of $58 million that includes the drilling of 44 net wells. This field capital budget continues to emphasize oil exploitation projects in the Williston Basin and the Alberta Plains (South) as well as natural gas directed exploitation drilling in the West Central Alberta and Alberta Plains (North), which will be designed to take advantage of the improved economics provided by the Alberta Crown drilling incentives. On a preliminary basis, the field capital program will be allocated $26 million to the Williston Basin, $11 million to the West Central Alberta and $21 million to the Alberta Plains core areas. Finally, this budget and related guidance level does not include the potential ASP tertiary recovery project initiation expenditures, that may be authorized at the end of the 2010 first quarter, nor does it include any allowance for additional corporate or property acquisitions.

Zargon continues to be well positioned with a strong balance sheet, positive production growth momentum and an inventory of promising opportunities that has recently been augmented by corporate acquisitions. We are pleased that our historical conservative hedging, debt and distribution policies have enabled our organization to maintain the current monthly $0.18 per unit distribution for 48 consecutive months. To date, during this commodity price downturn, we have been able to maintain distributions primarily due to our substantial positive hedges and the strength of the forward commodity price strip, which indicates improved pre-hedge cash flows in 2010. Going forward we will continue to carefully balance our projected cash flows with the competing uses for our cash resources, while remaining committed to a 50 percent cash flow distributing model before the trust sunset date. Post December 2010, we remain committed to a partial distribution model that will evolve into a corporate structure that targets a stable dividend representing approximately 35 percent of cash flow in addition to providing our equity holders a modest level of per unit growth.

(1) Please see comments on "Forward-Looking Statements" in the Management's Discussion and Analysis section in this report.

MANAGEMENT'S DISCUSSION AND ANALYSIS

Management's discussion and analysis ("MD&A") is a review of Zargon Energy Trust's 2009 third quarter financial results and should be read in conjunction with the unaudited interim consolidated financial statements for the three and nine months ended September 30, 2009 and the audited consolidated financial statements and related notes for the year ended December 31, 2008. The consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles ("GAAP"). All amounts are in Canadian dollars unless otherwise noted. All references to "Zargon" or the "Trust" refer to Zargon Energy Trust and all references to the "Company" refer to Zargon Oil & Gas Ltd.

In the MD&A, reserves and production are commonly stated in barrels of oil equivalent ("boe") on the basis that six thousand cubic feet of natural gas is equivalent to one barrel of oil. Boes may be misleading, particularly if used in isolation. A boe conversion ratio of six thousand cubic feet of natural gas to one barrel of oil is based on an energy equivalent conversion method primarily applicable to the burner tip and does not represent a value equivalent at the wellhead.

The following are descriptions of non-GAAP measures used in this MD&A:

- The MD&A contains the term "funds flow from operating activities" ("funds flow"), which should not be considered an alternative to, or more meaningful than, "cash flows from operating activities" as determined in accordance with Canadian GAAP as an indicator of the Trust's financial performance. This term does not have any standardized meaning as prescribed by GAAP and, therefore, the Trust's determination of funds flow from operating activities may not be comparable to that reported by other trusts. The reconciliation between cash flows from operating activities and funds flow from operating activities can be found in the table below and in the consolidated statements of cash flows in the consolidated financial statements. The Trust evaluates its performance based on net earnings and funds flow from operating activities. The Trust considers funds flow from operating activities to be a key measure as it demonstrates the Trust's ability to generate the cash necessary to pay distributions, repay debt and to fund future capital investment. It is also used by research analysts to value and compare oil and gas trusts, and it is frequently included in published research when providing investment recommendations. Funds flow from operating activities per unit is calculated using the diluted weighted average number of units for the period.



Funds Flow from Operating Activities Reconciliation

Three Months Ended Nine Months Ended
September 30, September 30,
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($ millions) 2009 2008 2009 2008
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Cash flows from operating activities 23.30 33.58 60.97 85.29
Changes in non-cash operating
working capital (0.46) (3.83) 0.64 1.22
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Funds flow from operating activities 22.84 29.75 61.61 86.51
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- The Trust also uses the term "debt net of working capital" or "net debt". Debt net of working capital, as presented, does not have any standardized meaning prescribed by Canadian GAAP and may not be comparable with the calculation of similar measures for other entities. Debt net of working capital, as used by the Trust, is calculated as bank debt and any working capital deficit excluding unrealized risk management assets/liabilities and future income taxes.

- Operating netbacks per boe equal total petroleum and natural gas revenue per boe adjusted for realized risk management gains and/or losses per boe, royalties per boe and production costs per boe. Operating netbacks are a useful measure to compare the Trust's operations with those of its peers.

- Funds flow netbacks per boe are calculated as operating netbacks less general and administrative expenses per boe, interest and financing charges per boe, asset retirement expenditures per boe and current income taxes per boe. Funds flow netbacks are a useful measure to compare the Trust's operations with those of its peers.

References to "production volumes" or "production" in this document refer to sales volumes.

Forward-Looking Statements - This document offers our assessment of Zargon's future plans and operations as at November 11, 2009, and contains forward-looking statements including:

- our expectations for production referred to under the heading "Financial & Operating Highlights";

- our expectations for capital expenditures referred to under the heading "Financial & Operating Highlights";

- our expectations for royalties referred to under the heading "Financial Analysis";

- our expectations for production costs referred to under the heading "Financial Analysis";

- our expectations for interest expenses referred to under the heading "Financial Analysis";

- our expectations for current taxes referred to under the headings "Financial Analysis";

- our distribution policy referred to under the headings "Financial & Operating Highlights" and "Liquidity and Capital Resources";

- our expected sources of funds for distributions and capital expenditures referred to under the headings "Liquidity and Capital Resources" and "Financial & Operating Highlights";

- our expectations for future commodity pricing and operating results referred to under the headings "Financial & Operating Highlights" and "Outlook"; and

- our expectations for designing and implementing International Financial Reporting Standards referred to under the heading "Changes in Accounting Policies".

Such statements are generally identified by the use of words such as "anticipate", "continue", "estimate", "expect", "forecast", "may", "will", "project", "should", "plan", "intend", "believe" and similar expressions (including the negatives thereof). By their nature, forward-looking statements are subject to numerous risks and uncertainties, some of which are beyond our control, including such as those relating to results of operations and financial condition, general economic conditions, industry conditions, changes in regulatory and taxation regimes, volatility of commodity prices, escalation of operating and capital costs, currency fluctuations, the availability of services, imprecision of reserve estimates, geological, technical, drilling and processing problems, environmental risks, weather, the lack of availability of qualified personnel or management, stock market volatility, the ability to access sufficient capital from internal and external sources and competition from other industry participants for, among other things, capital, services, acquisitions of reserves, undeveloped lands and skilled personnel. Risks are described in more detail in our Annual Information Form, which is available on our website and at www.sedar.com. Forward-looking statements are provided to allow investors to have a greater understanding of our business.

You are cautioned that the assumptions, including among other things, future oil and natural gas prices; future capital expenditure levels; future production levels; future exchange rates; the cost of developing and expanding our assets; our ability to obtain equipment in a timely manner to carry out development activities; our ability to market our oil and natural gas successfully to current and new customers; the impact of increasing competition, our ability to obtain financing on acceptable terms; and our ability to add production and reserves through our development and acquisition activities used in the preparation of such information, although considered reasonable at the time of preparation, may prove to be imprecise and, as such, undue reliance should not be placed on forward-looking statements. Our actual results, performance, or achievement could differ materially from those expressed in, or implied by, these forward-looking statements. We can give no assurance that any of the events anticipated will transpire or occur, or if any of them do, what benefits we will derive from them. The forward-looking information contained in this document is expressly qualified by this cautionary statement. Our policy for updating forward-looking statements is that Zargon disclaims, except as required by law, any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

This MD&A has been prepared as of November 11, 2009.

SUMMARY OF SIGNIFICANT EVENTS IN THE THIRD QUARTER

- During the third quarter of 2009, the Trust realized funds flow from operating activities of $22.84 million ($0.90 per diluted trust unit) and declared total distributions of $12.22 million ($0.54 per trust unit) to unitholders. For Canadian income tax purposes, the distributions are currently estimated to be 100 percent taxable income to unitholders.

- Average field prices received (before the impact of financial risk management contracts) for oil and liquids and for natural gas increased eight percent to $64.72 per barrel and decreased nine percent to $3.43 per thousand cubic feet, respectively, compared to the second quarter of 2009.

- Third quarter production volumes were 10,088 barrels of oil equivalent per day, a six percent increase from the second quarter 2009 production levels.

- During the third quarter of 2009, the Trust drilled 12 gross wells (10.3 net) with a 100 percent success rate. Total field exploration and development capital expenditures (excluding property acquisitions and dispositions) were $12.75 million for the quarter compared to $8.56 million for the prior quarter.

- The Trust continues to maintain a strong balance sheet with a combined debt net of working capital (excluding unrealized risk management assets/liabilities and future income taxes) of $87.14 million, which represents approximately 48 percent of the Trust's available credit facilities at September 30, 2009.

- On September 23, 2009, Zargon closed the Arrangement Agreement to acquire all the issued and outstanding common shares of Churchill Energy Inc. ("Churchill") for a total consideration of approximately 0.555 million Zargon trust units, $0.11 million in cash and the assumption of approximately $6.85 million of net debt (including adjustments and transactions costs) for a total transaction value of approximately $16.31 million. This acquisition brought oil exploitation opportunities at Grand Forks and Brazeau, Alberta along with significant tax pools.

- On July 27, 2009, the Trust amended and renewed its syndicated committed credit facilities of $180 million. These facilities are available for general corporate purposes and the acquisition of oil and natural gas properties.

FINANCIAL ANALYSIS

Third quarter 2009 revenue of $40.96 million was 14 percent above the $35.84 million in the second quarter of 2009 and 38 percent below the $66.35 million in the third quarter of 2008. An eight percent increase in oil and liquids prices received and a six percent increase in production volumes were the primary reasons for the increased revenues when compared to the prior quarter amounts. Third quarter 2009 realized oil and liquids field prices averaged $64.72 per barrel before the impact of financial risk management contracts and were eight percent higher than the preceding quarter's $59.95 per barrel and were 41 percent lower than the $109.34 per barrel recorded in the 2008 third quarter. Zargon's crude oil field price differential from the Edmonton par price increased to $6.78 per barrel in the third quarter of 2009 compared to $5.95 per barrel in the second quarter of 2009. Natural gas field prices received averaged $3.43 per thousand cubic feet before the impact of financial risk management contracts in the third quarter of 2009 ($2.83 per thousand cubic feet before the impact of physical and financial risk management contracts), a nine percent decrease from the preceding quarter levels and 58 percent below the 2008 third quarter prices. Zargon's realized field prices differ from the benchmark AECO average daily price due to a combination of fixed price physical contracts (see note 11 to the interim unaudited consolidated financial statements) and from the impact of Zargon receiving AECO monthly index pricing for a portion of its natural gas production.



Pricing

Three Months Ended Nine Months Ended
September 30, September 30,
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Percent Percent
Average for the period 2009 2008 Change 2009 2008 Change
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Natural Gas:
NYMEX average daily spot
price ($US/mmbtu) 3.16 9.00 (65) 3.81 9.68 (61)
AECO average daily spot
price ($Cdn/mmbtu) 2.94 7.73 (62) 3.78 8.64 (56)
Zargon realized field price
before the impact of
financial risk
management contracts
($Cdn/mcf) 3.43 8.17 (58) 4.29 8.50 (50)
Zargon realized field price
before the impact of
physical and financial
risk management contracts
($Cdn/mcf) 2.83 7.80 (64) 3.62 8.53 (58)
Zargon realized field price
after the impact of
physical and financial
risk management contracts
($Cdn/mcf) 3.91 7.77 (50) 4.80 8.33 (42)
Zargon realized natural
gas field price
differential/(premium) (1) (0.49) (0.44) (0.51) 0.14
Zargon realized natural
gas field price
differential/(premium)
before the impact of
physical and financial risk
management contracts 0.11 (0.07) 0.16 0.11
Crude Oil:
WTI ($US/bbl) 68.30 117.98 (42) 57.00 113.27 (50)
Edmonton par price
($Cdn/bbl) 71.50 121.85 (41) 62.31 115.14 (46)
Zargon realized field
price before the impact
of financial risk
management contracts
($Cdn/bbl) 64.72 109.34 (41) 56.51 102.15 (45)
Zargon realized field price
after the impact of
financial risk management
contracts ($Cdn/bbl) 76.00 92.07 (17) 69.92 86.29 (19)
Zargon realized oil field
price differential (2) 6.78 12.51 5.80 12.99
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(1) Calculated as Zargon's realized field price before the impact of
financial risk management contracts ($Cdn/mcf) as compared to AECO
average daily spot price ($Cdn/mmbtu). Note: premiums may occur as a
result of the realization of fixed price physical contracts and the
impact of Zargon receiving AECO monthly index pricing for a portion of
its natural gas production.

(2) Calculated as Zargon's realized field price before the impact of
financial risk management contracts ($Cdn/bbl) as compared to Edmonton
par price ($Cdn/bbl).


Natural gas production volumes decreased by one percent in the third quarter of 2009 to 28.23 million cubic feet per day from 28.44 million cubic feet per day in the second quarter of 2009 and were five percent lower than the 2008 third quarter. When compared to the prior quarter, the 2009 third quarter decrease in natural gas production volumes were primarily a result of reduced production from the shut-in of high cost natural gas properties, facility and processing plant maintenance related outages and natural production declines, which did not offset production volume additions from the April 29, 2009 acquisition of Masters and the September 23, 2009 acquisition of Churchill. Oil and liquids production during the third quarter of 2009 was 5,382 barrels per day, which is 13 percent above the 2009 second quarter rate of 4,780 barrels per day and 23 percent above the third quarter of 2008 level. The year-over-year increase in oil and liquids production volumes was primarily due to an active oil exploitation drilling program and the post acquisition contribution of production volume additions coming from the Masters properties. On a barrel of oil equivalent basis, Zargon produced 10,088 barrels of oil equivalent per day in the third quarter of 2009, which represents a six percent increase from the 9,520 barrels of oil equivalent per day in the second quarter of 2009 and an eight percent increase when compared to the third quarter of 2008.



Production by Core Area

Three Months
Ended
September 30, 2009 2008
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Oil and Natural Oil and Natural
Liquids Gas Equivalents Liquids Gas Equivalents
(bbl/d) (mmcf/d) (boe/d) (bbl/d) (mmcf/d) (boe/d)
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Alberta Plains 2,115 16.42 4,853 1,313 19.44 4,554
West Central
Alberta 424 11.37 2,319 328 9.93 1,983
Williston
Basin 2,843 0.44 2,916 2,726 0.47 2,803
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5,382 28.23 10,088 4,367 29.84 9,340
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Nine Months
Ended
September 30, 2009 2008
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Oil and Natural Oil and Natural
Liquids Gas Equivalents Liquids Gas Equivalents
(bbl/d) (mmcf/d) (boe/d) (bbl/d) (mmcf/d) (boe/d)
----------------------------------------------------------------------------
Alberta Plains 1,759 16.89 4,573 1,240 19.68 4,521
West Central
Alberta 390 10.82 2,194 278 9.44 1,851
Williston
Basin 2,762 0.49 2,843 2,745 0.49 2,826
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4,911 28.20 9,610 4,263 29.61 9,198
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Zargon's commodity price risk management policy, which is approved by the Board of Directors, allows the use of forward sales, costless collars and other instruments up to a 24 month term and approximately 30 percent of the combined oil and natural gas working interest production in order to partially offset the effects of commodity price fluctuations. Zargon's management considers financial risk management contracts to be effective on an economic basis, but has decided not to designate these contracts as hedges for accounting purposes and, accordingly, for these contracts, an unrealized gain or loss is recorded based on the fair value (mark-to-market) of the contracts at the period end.

Specifically, in the 2009 third quarter, relatively higher oil and natural gas prices brought about a smaller net realized financial risk management gain totalling $6.83 million, consisting of a $1.24 million gain on natural gas contracts and a $5.59 million gain on oil contracts (foreign exchange contracts are considered in conjunction with the oil contracts), that compares to a $7.45 million realized net gain in the second quarter of 2009 and a $8.02 million realized net loss in the third quarter of 2008.

The 2009 third quarter unrealized risk management loss resulted from oil contract (including related foreign exchange contract) losses of $2.49 million, and unrealized risk management natural gas contract losses of $1.11 million resulting in a total loss of $3.60 million for the quarter, which compares to a net $13.65 million loss for the 2009 second quarter and a net $46.58 million gain in the third quarter of 2008. These non-cash unrealized risk management gains or losses are generated by the change over the reporting period in the mark-to-market valuation of Zargon's risk management contracts. Recent volatility in commodity prices has resulted in significant fluctuations in the mark-to-market amount of unrealized risk management assets and liabilities. The period-over-period changes in these valuations directly impact net earnings/losses. Zargon's commodity risk management positions are fully described in note 11 to the unaudited consolidated interim financial statements.

Royalties, inclusive of the Saskatchewan Resource Surcharge, totalled $7.57 million for the third quarter of 2009, an increase of 26 percent from the $5.99 million preceding quarter expense and a decrease of 44 percent from $13.46 million in the third quarter of 2008. The variations in royalty rates generally track changes in production volumes and prices. As a percentage of petroleum and natural gas revenue, royalty rates in 2008 tended to move in a relatively narrow range from 20 to 21 percent and were 20.3 percent in the third quarter of 2008. Commencing in 2009, the oil and natural gas royalty structure changed for Alberta production volumes (as disclosed in our 2008 Annual Financial Report). Reflecting the 2009 relatively lower commodity prices and the modified royalty structure, on a consolidated basis, the third quarter of 2009 royalties resulted in a rate of 18.5 percent (19.2 percent excluding revenue that does not attract royalty expenses) which compared to 16.7 percent (17.4 percent excluding revenue that does not attract royalty expenses) in the second quarter of 2009. For the remainder of 2009 and for calendar 2010 Zargon expects that its royalty rate will range from 18 to 20 percent, but will ultimately depend on the actual price received for our production.

On a unit of production basis, production costs of $13.18 per barrel of oil equivalent in the third quarter of 2009 compares with $13.08 per barrel of oil equivalent in the preceding quarter and $12.10 per barrel of oil equivalent in the third quarter of 2008. The increase in the 2009 third quarter costs (on a unit of production basis) primarily relates to seasonal repairs and annual maintenance programs and the relatively higher operating cost properties acquired in recent corporate acquisitions. Despite the impact of these higher cost oil-weighted properties, Zargon anticipates that its production costs can be maintained in the $13.00 to $13.50 range for the remainder of the 2009 year. For 2010, Zargon anticipates a moderation in the upward cost pressures, and anticipates maintaining operating costs in the $13.50 to $14.00 per barrel of oil equivalent range.



Operating Netbacks

Three Months Ended September 30, 2009 2008
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Oil and Natural Oil and Natural
Liquids Gas Liquids Gas
($/bbl) ($/mcf) ($/bbl) ($/mcf)
----------------------------------------------------------------------------
Production revenue 64.72 3.43 109.34 8.17
Realized risk management gain/(loss) 11.29 0.48 (17.27) (0.39)
Royalties (13.54) (0.33) (22.82) (1.56)
Production costs (13.65) (2.11) (16.02) (1.44)
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Operating netbacks 48.82 1.47 53.23 4.78
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----------------------------------------------------------------------------


Nine Months Ended September 30, 2009 2008
----------------------------------------------------------------------------
Oil and Natural Oil and Natural
Liquids Gas Liquids Gas
($/bbl) ($/mcf) ($/bbl) ($/mcf)
----------------------------------------------------------------------------
Production revenue 56.51 4.29 102.15 8.50
Realized risk management gain/(loss) 13.41 0.51 (15.86) (0.16)
Royalties (11.41) (0.50) (21.00) (1.69)
Production costs (14.28) (2.04) (14.54) (1.48)
----------------------------------------------------------------------------
Operating netbacks 44.23 2.26 50.75 5.17
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Measured on a unit of production basis, third quarter 2009 general and administrative expenses (net of recoveries) of $2.96 million were $3.19 per barrel of oil equivalent which compared to $4.29 in the prior quarter and $3.06 in the third quarter of 2008. The year-over-year increase in general and administrative expenses on a per unit of production basis is primarily due to additional office lease costs and the costs related to the expansion of Zargon's technical staff and consultants, as Zargon repositions itself for its expanded exploitation and acquisition initiatives. The second quarter 2009 costs included $0.53 per barrel of oil equivalent of one-time employment related charges.

Unit-based compensation in the third quarter of 2009 was $0.39 million, a 23 percent increase from the third quarter of 2008 and a 40 percent increase from the prior quarter. The increase is a result of unit rights granted late in the prior quarter pursuant to the Trust's new unit rights incentive plan as approved at Zargon's Annual and Special meeting of Unitholders held on April 22, 2009.

Zargon's borrowings are through its syndicated bank credit facilities. Interest and financing charges on these facilities in the 2009 third quarter were $0.80 million, $0.31 million higher than the previous quarter amount of $0.49 million and a decrease of $0.45 million from $1.25 million in the third quarter of 2008. This year-over-year decrease is primarily due to a slight decrease in average bank debt levels and lower average borrowing costs. In particular, bank debt levels were decreased in June 2009, when the Trust closed an offering of 2.365 million trust units on a bought deal basis at $15.00 per unit for total gross proceeds of $35.48 million ($33.44 million net of equity issuance expenses). Zargon's current available syndicated committed credit facilities and borrowing base are $180 million, with approximately 57 percent unutilized at September 30, 2009.

On July 27, 2009, Zargon amended and renewed its syndicated committed credit facilities of $180 million. The next renewal date is June 29, 2010. These facilities continue to be available for general corporate purposes and the potential acquisition of oil and natural gas properties. For the remainder of 2009 through to the 2010 renewal, it is anticipated that Zargon's borrowing costs will be higher as general debt pricing, standby fees and extension fees have risen considerably in the current economic environment. Interest rates fluctuate under the syndicated facilities with Canadian prime, US prime, and US base rates plus an applicable margin between 125 basis points and 275 basis points (2008 - zero and 32.5 basis points, respectively), as well as with Canadian banker's acceptance and LIBOR rates plus an applicable margin between 275 basis points and 425 basis points (2008 - 97.5 and 157.5 basis points, respectively).

Current income taxes for the 2009 third quarter were $0.68 million, and related primarily to the United States operations. When compared to prior periods, current income taxes increased $0.25 million from the 2009 second quarter and decreased $0.01 million relative to the third quarter of 2008. The decreased 2009 taxable income is primarily due to reduced oil prices. Total corporate tax pools and future tax benefits as at September 30, 2009, are approximately $295 million, which represents an increase of 57 percent from the comparable $188 million of tax pools available to Zargon at December 31, 2008, primarily a result of the tax pools acquired as part of the recent Masters and Churchill corporate acquisitions.



Trust Netbacks

Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------------------------------------------------
($/boe) 2009 2008 2009 2008
----------------------------------------------------------------------------
Petroleum and natural gas revenue 44.13 77.22 41.46 74.69
Realized risk management gain/(loss) 7.35 (9.34) 8.35 (7.87)
Royalties (8.15) (15.66) (7.30) (15.16)
Production costs (13.18) (12.10) (13.27) (11.50)
----------------------------------------------------------------------------
Operating netbacks 30.15 40.12 29.24 40.16
General and administrative (3.19) (3.06) (3.83) (2.96)
Interest and financing charges (0.86) (1.46) (0.73) (1.56)
Asset retirement expenditures (0.75) (0.17) (0.60) (0.27)
Current income taxes (0.74) (0.81) (0.60) (1.05)
----------------------------------------------------------------------------
Funds flow netbacks 24.61 34.62 23.48 34.32
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Reflecting higher production volumes and the impact of recent corporate acquisitions, depletion and depreciation expense for the third quarter of 2009 increased seven percent to $16.82 million compared to the $15.68 million prior quarter expense and increased 10 percent from the $15.30 million 2008 third quarter expense. On a per barrel of oil equivalent basis, the depletion and depreciation rates were $18.12, $18.09 and $17.80 for the third and second quarters of 2009 and the third quarter of 2008, respectively. The 2008 calendar year depletion and depreciation rate was $17.61 per barrel of oil equivalent.

The provision for accretion of asset retirement obligations for the first nine months of 2009 was $1.99 million, a 24 percent increase compared to the first nine months of 2008. The year-over-year increase is due to changes in the estimated future liability for asset retirement obligations as a result of wells added through Zargon's drilling program inclusive of wells acquired/disposed of in the current year and wells acquired with the recent corporate acquisitions.

The recovery of future taxes for the third quarter of 2009 was $3.13 million compared to a recovery of $6.11 million in the prior quarter and an expense of $14.27 million in the third quarter of 2008. The 2009 third quarter recovery is primarily related to the quarter's unrealized risk management losses.

On October 31, 2006, the Federal Government announced tax proposals pertaining to taxation of distributions paid by trusts and the personal tax treatment of trust distributions. Currently, the Trust does not pay tax on distributions as tax is paid by the unitholders. On June 12, 2007, the Federal Government enacted these tax proposals, which would have resulted in taxation of distributions at the Trust level at a rate of 31.5 percent effective January 1, 2011. Subsequent 2007 fourth quarter legislation lowered this tax rate to 29.5 percent in 2011 and 28.0 percent beyond 2011. Prior to June 2007, the Trust estimated the future income tax on certain temporary differences between amounts recorded on its balance sheet for book and tax purposes to have a nil effective tax rate. On February 26, 2008, the Federal Government, in its Federal Budget, announced further changes to the specified investment flow through ("SIFT") tax rules. The provincial component of the SIFT tax will be based on the provincial rates where the SIFT has a permanent establishment rather than using a 13.0 percent flat rate. During the 2009 first quarter this tax rate change had been substantively enacted, and the future income tax impact has been recorded in the financial statements. Under the legislation, the Trust now estimates the effective tax rate on the post 2010 reversal of these temporary differences to be approximately 26.5 percent for 2011 and 25.0 percent thereafter. Until 2011, Zargon's future tax obligations are reduced as distributions are made from the Trust and, consequently, it is anticipated that Zargon's effective tax rate will continue to be low until that time.

On December 15, 2006, the Canadian Federal Department of Finance stated its intention to allow conversions of SIFT income trusts to a corporation without any adverse tax consequences to investors. On July 14, 2008, the Department of Finance released the draft legislative proposals to allow the conversion of these SIFT trusts into corporations. Zargon is currently reviewing and assessing this recent legislation and is considering its potential impact on the organization while Zargon's management develops its strategic plan beyond December 2010, which is the effective date of the new SIFT tax rules.

According to the January 19, 2005 CICA pronouncement, EIC-151 "Exchangeable Securities Issued by Subsidiaries of Income Trusts", Zargon Energy Trust must reflect the exchangeable securities issued by its subsidiary (Zargon Oil & Gas Ltd.) as a non-controlling interest. Prior to 2005, these exchangeable shares were reflected as a component of unitholders' equity. Accordingly, the Trust has reflected a non-controlling interest of $27.63 million on the Trust's consolidated balance sheet as at September 30, 2009. Consolidated net earnings have been reduced for net earnings attributable to the non-controlling interest of $0.57 million in the third quarter of 2009. In accordance with EIC-151 and given the circumstances in Zargon's case, each exchangeable share redemption is accounted for as a step-purchase, which, in the third quarter of 2009, resulted in an increase in property and equipment of $0.01 million, an increase in unitholders' equity and non-controlling interest of $0.58 million and a nominal increase in future income tax liability. Funds flow was not impacted by this change. The cumulative impact to date of the application of EIC-151 has been to increase property and equipment by $55.24 million, unitholders' equity and non-controlling interest by $66.22 million, increase future income tax liability by $18.21 million and allocate net earnings of $29.19 million to exchangeable shareholders.

Funds flow from operating activities in the 2009 third quarter of $22.84 million was $1.92 million, or nine percent higher than the preceding quarter and $6.91 million or 23 percent lower than the prior year third quarter. The increase in funds flow from the preceding quarter was primarily due to increased revenues (net of related royalties) as a result of higher oil prices and higher oil production volumes. Compared to the prior year third quarter, an eight percent increase in production volumes were more than offset by the 43 percent decline in commodity prices and rising production costs and general and administrative expenses. Funds flow on a per diluted trust unit basis was $0.90 for the third quarter of 2009, a one percent decrease from the prior quarter and a 37 percent decrease from the 2008 third quarter.

Net earnings were $4.47 million for the 2009 third quarter compared to $2.55 million of net losses in the preceding quarter and $40.05 million of net earnings in the third quarter of 2008. The net earnings track the funds flow from operating activities for the respective periods modified by asset retirement expenditures and non-cash charges, which include depletion and depreciation, unrealized risk management gains/losses, future income taxes/recoveries and non-controlling interest.



Capital Expenditures

Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------------------------------------------------
($ millions) 2009 2008 2009 2008
----------------------------------------------------------------------------
Undeveloped land 1.47 1.67 4.00 6.05
Geological and geophysical (seismic) 0.63 0.43 2.22 2.93
Drilling and completion of wells 6.08 10.09 16.07 19.59
Well equipment and facilities 4.57 4.14 11.80 8.61
----------------------------------------------------------------------------
Exploration and development 12.75 16.33 34.09 37.18
----------------------------------------------------------------------------
Property acquisitions (1) 0.11 1.14 0.81 6.35
Property dispositions (0.11) - (0.11) (0.17)
----------------------------------------------------------------------------
Net property acquisitions (1) - 1.14 0.70 6.18
----------------------------------------------------------------------------
Corporate acquisitions assigned to
property and equipment (2) 16.31 - 56.34 59.85
----------------------------------------------------------------------------
Total net capital expenditures
excluding administrative
assets (1) (2) 29.06 17.47 91.13 103.21
Administrative assets 0.26 - 0.59 0.15
----------------------------------------------------------------------------
Total net capital expenditures (1) (2) 29.32 17.47 91.72 103.36
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Amounts include capital expenditures acquired for cash and equity
issuances.
(2) Amounts include capital expenditures acquired for cash, equity
issuances, acquisition costs and net debt assumed on corporate
acquisitions.


CORPORATE ACQUISITIONS

On September 23, 2009, Zargon closed the Arrangement Agreement to acquire all the issued and outstanding common shares of Churchill Energy Inc. for a total consideration of approximately 0.555 million Zargon trust units, $0.11 million in cash and the assumption of approximately $6.85 million of net debt (including adjustments and transactions costs) for a total transaction value of approximately $16.31 million. This acquisition brought oil exploitation opportunities at Grand Forks and Brazeau, Alberta along with significant tax pools.

The results of operations of Churchill have been included in the consolidated financial statements since September 23, 2009. In relation to the third quarter 2009 results, the Churchill acquisition has contributed approximately 27 barrels of oil equivalent per day of production volumes to Zargon's total quarterly production volumes of 10,088 barrels of oil equivalent per day.

On April 29, 2009, Zargon closed the Arrangement Agreement to acquire all the issued and outstanding common shares of Masters Energy Inc. for a total consideration of approximately 1.475 million Zargon trust units, $5.70 million in cash and the assumption of approximately $13.29 million of net debt (including adjustments and transactions costs) for a total transaction value of approximately $40.03 million. This acquisition brought approximately 1,230 barrels of oil equivalent per day of production along with a significant Alkaline Surfactant Polymer (ASP) tertiary oil recovery opportunity at the Little Bow oil property in Southern Alberta. The results of operations of Masters have been included in the consolidated financial statements since April 29, 2009.

LIQUIDITY AND CAPITAL RESOURCES

Total net capital expenditures (including net property acquisitions and consideration and net debt assumed for corporate acquisitions) of $91.72 million in the first nine months of 2009 were 11 percent lower than the first nine months of 2008 which included the Rival Energy Ltd. and Newpact Energy Corp. acquisitions. Field expenditures of $34.09 million for the 2009 first nine months reflected a reduced exploration and development field program when compared to $37.18 million for the 2008 first nine months, representing an eight percent decrease. Drilling and completion expenses of $16.07 million were 18 percent lower than the prior year's first nine months amount of $19.59 million. During the first nine months of 2009, 20.7 net wells were drilled compared to 22.0 net wells in the first nine months of 2008. Field capital expenditures (excluding net property acquisitions) for the first nine months of 2009 were allocated to Alberta Plains - $13.25 million, West Central Alberta - $7.48 million and Williston Basin - $13.36 million. Field capital expenditures for the nine months ended September 30, 2009 are net of $1.44 million and $0.31 million in Alberta drilling credits in the respective Alberta Plains and West Central Alberta core areas. Alberta drilling credits are designed to encourage the execution of new drilling projects in Alberta and were announced in response to the slow down in drilling throughout the province of Alberta. The drilling credit is based on $200 per metre credit on total metres drilled with a cap based on production levels and Alberta Crown royalties paid.

On June 5, 2009, the Trust closed an offering of 2.365 million trust units on a bought deal basis at $15.00 per unit for total gross proceeds of $35.48 million ($33.44 million net of equity issuance costs). The net proceeds of the offering were used to reduce outstanding borrowings under existing credit facilities, and in turn will also be used to partially fund the 2009 capital expenditure program and for general corporate purposes.

Funds flow from operating activities in the 2009 first nine months of $61.61 million and proceeds from the issuance of trust units of $65.11 million (due to the acquisition of Masters and Churchill, the equity issuance and unit right exercises) funded the capital program including corporate and property acquisitions, the decrease in bank debt, the changes in working capital and the cash distributions to the unitholders.

At September 30, 2009, the Trust continues to maintain a strong balance sheet with a combined debt net of working capital (excluding unrealized risk management assets and liabilities and future income taxes) of $87.14 million, compared to $77.47 million at the end of the 2009 second quarter, which represents approximately 48 percent of the Trust's available credit facilities at September 30, 2009.

The volatility of oil and natural gas prices, the changes relating to Alberta royalties and Canadian income trust tax rules and recent global economic concerns have partially restricted the oil and natural gas industry's ability to attract new capital from debt and equity markets. Zargon's historically conservative strategy of maintaining a relatively low cash distribution to funds flow ratio and conservative debt levels should enable Zargon to maintain modified capital and distribution programs during periods of limited access to debt and equity capital.



Cash Distributions Analysis

Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------------------------------------------------
($ millions) 2009 2008 2009 2008
----------------------------------------------------------------------------
Cash flows from operating activities 23.30 33.58 60.97 85.29
Net earnings 4.47 40.05 2.28 40.09
Actual cash distributions paid or
payable relating to the period (12.22) (9.87) (33.51) (29.13)
----------------------------------------------------------------------------
Excess of cash flows from operating
activities over cash distributions
paid 11.08 23.71 27.46 56.16
Excess (shortfall) of net earnings
over cash distributions paid (7.75) 30.18 (31.23) 10.96
----------------------------------------------------------------------------
----------------------------------------------------------------------------


During the first nine months of 2009, Zargon has maintained a base monthly distribution of $0.18 per trust unit. Management monitors the Trust's distribution policy with respect to forecasted net cash flows, debt levels and capital expenditures. Zargon's cash distributions are discretionary to the extent that these distributions do not cause a breach of the financial covenants under Zargon's credit facilities and to the extent the Trust (non-consolidated) is not taxable. As a crude oil and natural gas Trust, Zargon's reserve base is depleted with production and Zargon, therefore, relies on ongoing exploration, development and acquisition activities to replace reserves and to offset production declines. The success of these exploration, development and acquisition capital programs, along with commodity price fluctuations and the Trust's ability to manage costs, are the main factors influencing the sustainability of the Trust's distributions.

For the three and nine months ended September 30, 2009, cash flows from operating activities (after changes in non-cash working capital) of $23.30 million and $60.97 million, respectively, exceeded cash distributions of $12.22 million and $33.51 million, respectively. For the three months and nine months ended September 30, 2008, cash flows from operating activities (after changes in non-cash working capital) of $33.58 million and $85.29 million, respectively, exceeded cash distributions of $9.87 million and $29.13 million, respectively.

For the three and nine months ended September 30, 2009, cash distributions of $12.22 and $33.51 million, exceeded net earnings of $4.47 and $2.28 million, respectively. For the three and nine months ended September 30, 2008, net earnings of $40.05 million and $40.09 million, respectively, exceeded cash distributions of $9.87 million and $29.13 million, respectively. Net earnings include significant non-cash charges, which were $19.06 million for the 2009 third quarter and $60.88 million for the nine months ended September 30, 2009, that do not impact cash flow. Net earnings also include fluctuations in future income taxes due to changes in tax rates and tax rules. In the instances where distributions exceed net earnings, a portion of the cash distribution paid to unitholders may represent an economic return of the unitholders' capital.

For the 2009 third quarter, cash distributions and net capital expenditures totalled $41.54 million ($25.23 million excluding the $16.31 million attributed to the Churchill corporate acquisition), which was $18.24 million higher than the cash flows from operating activities (after changes in non-cash working capital) of $23.30 million. For the nine months ended September 30, 2009, cash flows from operating activities (after changes in non-cash working capital) were exceeded by cash distributions and net capital expenditures (including the cash and non-cash portion of corporate acquisitions) by $64.26 million ($7.92 million excluding the $56.34 million attributed to the Masters and Churchill corporate acquisitions). For the three and nine months ended September 30, 2008, cash distributions and net capital expenditures were exceeded by and exceeded cash flows from operating activities (after changes in non-cash working capital) by $6.25 million and $47.20 million, respectively. Zargon relies on access to debt and capital markets to the extent cash distributions and net capital expenditures exceed cash flows from operating activities (after changes in non-cash working capital). Over the long term, Zargon expects to fund cash distributions and capital expenditures with its cash flows from operating activities; however, it will continue to fund acquisitions and growth through additional debt and equity issuances. In the crude oil and natural gas industry, because of the nature of reserve reporting, the natural production declines and the risks involved in capital investment, it is not possible to distinguish between capital spent on maintaining productive capacity and capital spent on growth opportunities. Therefore, maintenance capital is not disclosed separately from development capital spending.

At November 11, 2009, Zargon Energy Trust had 22.991 million trust units and 1.848 million exchangeable shares outstanding. Assuming full conversion of exchangeable shares at the effective November 11, 2009 exchange ratio of 1.60561, there would be 25.958 million trust units outstanding. Pursuant to the trust unit rights incentive plans, there are currently an additional 1.746 million trust unit incentive rights issued and outstanding.



Capital Sources and Uses

Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------------------------------------------------
($ millions) 2009 2008 2009 2008
----------------------------------------------------------------------------
Funds flow from operating activities 22.84 29.75 61.61 86.51
Change in bank debt 6.62 (10.50) (0.53) 18.08
Issuance of trust units 9.36 1.25 65.11 24.88
Cash distributions to unitholders (12.22) (9.87) (33.51) (29.13)
Changes in working capital and other 2.72 6.84 (0.96) 3.02
----------------------------------------------------------------------------
Total capital sources 29.32 17.47 91.72 103.36
----------------------------------------------------------------------------
----------------------------------------------------------------------------


CHANGES IN ACCOUNTING POLICIES

As disclosed in the December 31, 2008 annual audited consolidated financial statements, on January 1, 2009, the Trust adopted the following Canadian Institute of Chartered Accountants ("CICA") Handbook Sections:

Section 3064 "Goodwill and Intangible Assets", replacing Section 3062 "Goodwill and Other Intangible Assets". Under this new guidance, fewer items meet the criteria for capitalization. Section 3064 establishes standards for the recognition, measurement, presentation and disclosure of goodwill and intangible assets subsequent to its initial recognition. Requirements concerning goodwill are unchanged from the requirements included in the previous Section 3062, as the new Section was only amended for intangible assets. The adoption of the abstract did not significantly impact the Trust's consolidated financial statements.

Effective January 1, 2009, the Trust retrospectively adopted the recommendations of Emerging Issues Committee abstract 173 "Credit Risk and the Fair Value of Financial Assets and Financial Liabilities", which was issued in January 2009, without restatement of prior periods. The abstract requires that an entity's own credit risk and the credit risk of the counterparty are taken into account in determining the fair value of financial assets and liabilities, including derivative instruments, for presentation and disclosure purposes. The adoption of the abstract did not significantly impact the Trust's consolidated financial statements.

In addition, the Trust has assessed new and revised accounting pronouncements that have been issued that are not yet effective and determined the following may have a significant impact on the Trust:

In December 2008, the CICA issued Section 1582 "Business Combinations", which will replace CICA Section 1581 of the same name. Under this guidance, the purchase price used in a business combination is based on the fair value of shares exchanged at the market price at the date of the exchange. Currently the purchase price used is based on the market price of the shares for a reasonable period before and after the date the acquisition is agreed upon and announced. This new guidance generally requires all acquisition costs to be expensed, which currently are capitalized as part of the purchase price. Contingent liabilities are to be recognized at fair value at the acquisition date and remeasured at fair value through earnings each period until settled. Currently, only contingent liabilities that are resolved and payable are included in the cost to acquire the business. In addition, negative goodwill is required to be recognized immediately in earnings, unlike the current requirement to eliminate it by deducting it from the non-current assets in the purchase price allocation. Section 1582 will be effective for the Trust on January 1, 2011, with prospective application. The Trust is currently evaluating the impact of the adoption of the new Section on its consolidated financial statements.

In December 2008, the CICA issued Sections 1601 "Consolidated Financial Statements", and 1602 "Non-controlling Interests", which replaces existing guidance under Section 1600 "Consolidated Financial Statements". Section 1601 establishes standards for the preparation of consolidated financial statements. Section 1602 provides guidance on accounting for a non-controlling interest in a subsidiary in consolidated financial statements subsequent to a business combination. These standards will be effective for the Trust on January 1, 2011. The Trust is currently evaluating the impact of the adoption of these new Sections on its consolidated financial statements.

In January 2006, the CICA Accounting Standards Board ("AcSB") adopted a strategic plan for the direction of accounting standards in Canada. As part of that plan, the AcSB confirmed in February 2008 that International Financial Reporting Standards ("IFRS") will replace Canadian GAAP in 2011 for profit-oriented Canadian publicly accountable enterprises. As Zargon will be required to report its results in accordance with IFRS starting in 2011, the Trust is assessing the potential impacts of this changeover and is developing and implementing its plan accordingly. While IFRS uses a conceptual framework similar to Canadian GAAP, there are significant differences in accounting policies that must be addressed. Zargon management, with the assistance of an independent consulting firm, has performed a diagnostic analysis that identifies key differences between Canadian GAAP and IFRS. Zargon has determined that the most significant changes will relate to our accounting for the exploration and evaluation of oil and gas resources, as well as accounting for property, plant and equipment and asset impairment testing. The quantitative impact of these new standards on our financial statements is not reasonably determinable or estimable at this time. Zargon's internal steering committee is currently focused on IFRS accounting policy decisions, designing IT systems to incorporate IFRS reporting and internal training. We expect the design and implementation phase to continue into 2010.

The International Accounting Standards Board ("IASB") has issued amendments to IFRS 1, which addresses first time adoption of IFRS. The IASB will allow additional optional exemptions, one of which relates to full cost oil and gas accounting, resulting in a reduced administrative transition from the current Canadian full cost accounting for oil and gas activities to IFRS. The election is available at the time of adoption only. The exemption would permit the Trust to measure exploration and evaluation assets under IFRS at the carrying amount determined under Canadian GAAP at the date of transition to IFRS. In addition, the carrying amount under Canadian GAAP of production or development assets could be allocated on a pro rata basis to the underlying assets using either reserve volumes or reserve values at the date of transition. The assets to which this exemption is applied would be required to be tested for impairment at the date of transition under IFRS standards. This exemption will relieve the Trust from retrospective application of IFRS for its oil and gas assets. The Trust currently anticipates utilizing this exemption.

MANAGEMENT AND FINANCIAL REPORTING SYSTEMS

Zargon is required to comply with National Instrument 52-109 "Certification of Disclosure in Issuers' Annual and Interim Filings", otherwise referred to as Canadian SOX ("C-Sox"). The 2009 certificate requires that the Trust disclose in the interim MD&A any changes in the Trust's internal controls over financial reporting that occurred during the period that have materially affected, or are reasonably likely to materially affect the Trust's internal control over financial reporting. The Trust confirms that no such changes were made to the internal controls over financial reporting during the first nine months of 2009.

Because of their inherent limitations, internal controls over financial reporting may not prevent or detect misstatements, errors or fraud. Control systems, no matter how well conceived or operated, can provide only reasonable, not absolute assurance that the objectives of the control systems are met.

OUTLOOK

With a strong balance sheet, 594 thousand net acres of undeveloped land, a promising internally generated project inventory and its ability to execute accretive asset and/or corporate acquisitions, Zargon continues to be well positioned to meet its value-creating objectives in 2009 and beyond. Furthermore, there is evidence that some of the upward pressures on the industry's input costs have been alleviated, allowing for improved capital program efficiencies for field activities and for property and corporate acquisitions.

Although the recent world-wide economic crisis, depressed commodity prices and changes to the Canadian income trust tax rules after 2010 have negatively impacted our industry, we are optimistic about Zargon's long term value-seeking strategy. Consistent with its history, Zargon will continue to adhere to a conservative and focused strategy of exploiting its existing asset base while executing accretive acquisitions which will be funded by debt or equity issuances.



SUMMARY OF QUARTERLY RESULTS
2009
----------------------------------------------------------------------------
Q1 Q2 Q3
----------------------------------------------------------------------------
Petroleum and natural gas revenue
($ millions) 31.98 35.84 40.96
Net earnings/(losses) ($ millions) 0.37 (2.55) 4.47
Net earnings/(losses) per diluted
unit ($) 0.02 (0.13) 0.20
Funds flow from operating activities
($ millions) 17.85 20.92 22.84
Funds flow from operating activities
per diluted unit ($) 0.84 0.91 0.90
Cash flows from operating activities
($ millions) 15.73 21.94 23.30
Cash flows from operating activities
per diluted unit ($) 0.74 0.95 0.92
Cash distributions ($ millions) 10.03 11.26 12.22
Cash distributions declared per trust
unit ($) 0.54 0.54 0.54
Net capital expenditures ($ millions)
(1) (2) 13.44 48.96 29.32
Total assets ($ millions) 440.76 466.60 473.47
Bank debt ($ millions) 85.78 70.43 77.05
Average daily production (boe) 9,213 9,520 10,088
Average realized commodity
field price before the impact
of financial risk management
contracts ($/boe) 38.57 41.37 44.13
Funds flow netback ($/boe) 21.53 24.14 24.61
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Second quarter 2009 expenditures include corporate acquisition amounts
as follows; cash consideration of $5.70 million, transaction costs of
$0.36 million, net debt assumed of $12.93 million and the equity
issuance of trust units valued at $21.04 million.

(2) Third quarter 2009 expenditures include corporate acquisition amounts
as follows; cash consideration of $0.11 million, transaction costs of
$0.27 million, net debt assumed of $6.58 million and the equity issuance
of trust units valued at $9.36 million.


2008
----------------------------------------------------------------------------
Q1 Q2 Q3 Q4
----------------------------------------------------------------------------
Petroleum and natural gas revenue
($ millions) 52.24 69.66 66.35 41.25
Net earnings/(losses) ($ millions) 4.56 (4.51) 40.05 28.19
Net earnings/(losses) per diluted
unit ($) 0.26 (0.25) 2.20 1.53
Funds flow from operating activities
($ millions) 24.75 32.02 29.75 20.40
Funds flow from operating activities
per diluted unit ($) 1.23 1.55 1.42 0.97
Cash flows from operating activities
($ millions) 15.27 36.44 33.58 24.84
Cash flows from operating activities
per diluted unit ($) 0.76 1.76 1.60 1.18
Cash distributions ($ millions) 9.55 9.71 9.87 9.96
Cash distributions declared per
trust unit ($) 0.54 0.54 0.54 0.54
Net capital expenditures
($ millions) (1) (2) (3) 59.61 26.28 17.47 16.37
Total assets ($ millions) 396.90 418.88 426.63 447.60
Bank debt ($ millions) 92.18 85.45 74.95 77.58
Average daily production (boe) 9,015 9,239 9,340 9,410
Average realized commodity field
price before the impact
of financial risk management
contracts ($/boe) 63.68 82.85 77.22 47.65
Funds flow netback ($/boe) 30.17 38.08 34.62 23.56
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) First quarter 2008 expenditures include corporate acquisition amounts as
follows; cash consideration of $16.40 million, transaction costs of
$0.29 million, net debt assumed of $17.77 million and the equity
issuance of trust units valued at $13.37 million.

(2) Second quarter 2008 net capital expenditures include corporate
acquisition amounts as follows; transaction costs of $0.15 million, net
debt assumed of $2.49 million and the equity issuance of trust units
valued at $9.39 million.

(3) Third quarter 2008 net capital expenditures include property acquisition
amounts as follows; the equity issuance of trust units valued at $1.14
million.


2007
----------------------------------------------------------------------------
Q1 Q2 Q3 Q4
----------------------------------------------------------------------------
Petroleum and natural gas revenue
($ millions) 38.53 39.21 36.64 41.13
Net earnings ($ millions) 5.22 11.63 5.50 2.20
Net earnings per diluted unit ($) 0.31 0.68 0.32 0.13
Funds flow from operating
activities ($ millions) 21.80 20.56 17.38 20.10
Funds flow from operating
activities per diluted unit ($) 1.12 1.05 0.88 1.02
Cash flows from operating
activities ($ millions) 18.35 19.09 24.64 14.23
Cash flows from operating
activities per diluted unit ($) 0.94 0.97 1.25 0.72
Cash distributions ($ millions) 9.12 9.17 9.19 9.21
Cash distributions declared per
trust unit ($) 0.54 0.54 0.54 0.54
Net capital expenditures
($ millions) 20.93 10.97 16.43 18.35
Total assets ($ millions) 324.31 324.96 327.54 343.11
Bank debt ($ millions) 37.68 46.74 44.10 56.87
Average daily production (boe) 8,483 8,465 8,501 8,790
Average realized commodity field
price before the impact
of financial risk management
contracts ($/boe) 50.47 50.91 46.84 50.86
Funds flow netback ($/boe) 28.55 26.69 22.22 24.86
----------------------------------------------------------------------------
----------------------------------------------------------------------------


ADDITIONAL INFORMATION

Additional information regarding the Trust and its business operations, including the Trust's Annual Information Form for December 31, 2008, is available on the Trust's SEDAR profile at www.sedar.com.

"Signed" C.H. Hansen

President and Chief Executive Officer

Calgary, Alberta

November 11, 2009



CONSOLIDATED BALANCE SHEETS

(unaudited)
----------------------------------------------------------------------------
September 30, December 31,
($ thousands) 2009 2008
----------------------------------------------------------------------------
ASSETS (note 5)
Current
Accounts receivable 22,719 20,725
Prepaid expenses and deposits 2,352 1,162
Unrealized risk management asset (note 11) 11,241 29,641
Future income taxes 369 -
----------------------------------------------------------------------------
36,681 51,528
Long term deposit 1,710 1,612
Unrealized risk management asset (note 11) 385 4,745
Goodwill 2,969 2,969
Property and equipment, net (notes 3 and 4) 431,720 386,746
----------------------------------------------------------------------------
473,465 447,600
----------------------------------------------------------------------------
----------------------------------------------------------------------------
LIABILITIES
Current
Accounts payable and accrued liabilities 31,022 28,687
Cash distributions payable (note 15) 4,138 3,326
Unrealized risk management liability (note 11) 1,247 724
Future income taxes 3,325 8,553
----------------------------------------------------------------------------
39,732 41,290
Long term debt (note 5) 77,050 77,581
Unrealized risk management liability (note 11) 420 281
Asset retirement obligations (note 6) 35,432 28,592
Future income taxes 35,150 49,704
----------------------------------------------------------------------------
187,784 197,448
----------------------------------------------------------------------------
NON-CONTROLLING INTEREST
Exchangeable shares (note 8) 27,633 27,610
----------------------------------------------------------------------------
UNITHOLDERS' EQUITY
Unitholders' capital (note 7) 186,960 120,650
Contributed surplus (note 7) 5,043 4,617
Accumulated earnings 259,385 257,104
Accumulated cash distributions (193,340) (159,829)
----------------------------------------------------------------------------
258,048 222,542
----------------------------------------------------------------------------
473,465 447,600
----------------------------------------------------------------------------
----------------------------------------------------------------------------
See accompanying notes.


CONSOLIDATED STATEMENTS OF EARNINGS AND
COMPREHENSIVE INCOME AND ACCUMULATED EARNINGS

Three Months Ended Nine Months Ended
(unaudited) September 30, September 30,
----------------------------------------------------------------------------
($ thousands, except per unit
amounts) 2009 2008 2009 2008
----------------------------------------------------------------------------
REVENUE
Petroleum and natural gas revenue 40,955 66,352 108,773 188,247
Unrealized risk management
gain/(loss) (note 11) (3,597) 46,584 (23,422) 10,092
Realized risk management gain/(loss)
(note 11) 6,826 (8,021) 21,904 (19,835)
Royalties (7,568) (13,459) (19,148) (38,210)
----------------------------------------------------------------------------
36,616 91,456 88,107 140,294
----------------------------------------------------------------------------
EXPENSES
Production 12,234 10,398 34,812 28,992
General and administrative 2,964 2,627 10,054 7,469
Unit-based compensation (note 7) 394 320 819 837
Interest and financing charges 801 1,253 1,912 3,942
Unrealized foreign exchange
(gain)/loss 82 (31) 131 (42)
Accretion of asset retirement
obligations (note 6) 730 558 1,992 1,607
Depletion and depreciation 16,818 15,297 47,211 44,212
----------------------------------------------------------------------------
34,023 30,422 96,931 87,017
----------------------------------------------------------------------------
EARNINGS/(LOSSES) BEFORE INCOME
TAXES 2,593 61,034 (8,824) 53,277
----------------------------------------------------------------------------
INCOME TAXES
Current 684 695 1,583 2,646
Future tax expense/(recovery) (3,132) 14,267 (12,969) 4,510
----------------------------------------------------------------------------
(2,448) 14,962 (11,386) 7,156
----------------------------------------------------------------------------
EARNINGS FOR THE PERIOD BEFORE
NON-CONTROLLING INTEREST 5,041 46,072 2,562 46,121
Non-controlling interest -
exchangeable shares (note 8) (574) (6,022) (281) (6,027)
----------------------------------------------------------------------------
NET EARNINGS AND COMPREHENSIVE
INCOME FOR THE PERIOD 4,467 40,050 2,281 40,094

ACCUMULATED EARNINGS, BEGINNING OF
PERIOD 254,918 188,863 257,104 188,819
----------------------------------------------------------------------------
ACCUMULATED EARNINGS, END OF PERIOD 259,385 228,913 259,385 228,913
----------------------------------------------------------------------------
----------------------------------------------------------------------------
NET EARNINGS PER UNIT (note 9)
Basic 0.20 2.20 0.11 2.24
Diluted 0.20 2.20 0.11 2.24
----------------------------------------------------------------------------
----------------------------------------------------------------------------
See accompanying notes.


CONSOLIDATED STATEMENTS OF CASH FLOWS

Three Months Ended Nine Months Ended
(unaudited) September 30, September 30,
----------------------------------------------------------------------------
($ thousands) 2009 2008 2009 2008
----------------------------------------------------------------------------
OPERATING ACTIVITIES
Net earnings for the period 4,467 40,050 2,281 40,094
Add (deduct) non-cash items:
Non-controlling interest -
exchangeable shares 574 6,022 281 6,027
Unrealized risk management
gain/(loss) 3,597 (46,584) 23,422 (10,092)
Depletion and depreciation 16,818 15,297 47,211 44,212
Accretion of asset retirement
obligations 730 558 1,992 1,607
Unit-based compensation 394 320 819 837
Unrealized foreign exchange
(gain)/loss 82 (31) 131 (42)
Future income tax
expense/(recovery) (3,132) 14,267 (12,969) 4,510
Asset retirement expenditures (692) (154) (1,563) (643)
----------------------------------------------------------------------------
22,838 29,745 61,605 86,510
Changes in non-cash operating
working capital (note 12) 462 3,832 (638) (1,221)
----------------------------------------------------------------------------
23,300 33,577 60,967 85,289
----------------------------------------------------------------------------
FINANCING ACTIVITIES
Advances/(repayment) of bank debt 6,619 (10,498) (531) 1,168
Cash distributions to unitholders (12,215) (9,868) (33,511) (29,126)
Exercise of unit rights - 97 1,269 974
Issuance of unitholders capital, net
of issue costs - - 33,444 -
Changes in non-cash financing
working capital (note 12) 100 48 812 240
----------------------------------------------------------------------------
(5,496) (20,221) 1,483 (26,744)
----------------------------------------------------------------------------
INVESTING ACTIVITIES
Additions to property and equipment (13,107) (16,313) (35,486) (42,523)
Proceeds on disposal of property and
equipment 101 - 107 170
Corporate acquisitions (cash
portion) (378) - (19,260) (16,835)
Long term deposit 172 - (98) (157)
Changes in non-cash investing
working capital (note 12) (4,592) 2,957 (7,713) 800
----------------------------------------------------------------------------
(17,804) (13,356) (62,450) (58,545)
----------------------------------------------------------------------------
NET CHANGE IN CASH DURING THE PERIOD
AND CASH, END OF PERIOD - - - -
----------------------------------------------------------------------------
----------------------------------------------------------------------------
See accompanying notes.


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the three and nine months ended September 30, 2009 and 2008(unaudited).

1. BASIS OF PRESENTATION

The interim unaudited consolidated financial statements of Zargon Energy Trust (the "Trust" or "Zargon") have been prepared by management in accordance with Canadian generally accepted accounting principles. The interim unaudited consolidated financial statements have been prepared following the same accounting policies and methods in computation as the consolidated financial statements for the fiscal year ended December 31, 2008, except as noted below. The disclosures provided below are incremental to those included with the annual audited consolidated financial statements. These interim unaudited consolidated financial statements do not include all disclosures required in the annual consolidated financial statements and should be read in conjunction with the consolidated financial statements and notes thereto in the Zargon Energy Trust annual financial report for the year ended December 31, 2008.

The Trust's principal business activity is the exploration for and development and production of petroleum and natural gas in Canada and the United States ("US").

2. CHANGES IN ACCOUNTING POLICIES

As disclosed in the December 31, 2008 annual audited consolidated financial statements, on January 1, 2009, the Trust adopted the following Canadian Institute of Chartered Accountants ("CICA") Handbook Sections:

Section 3064 "Goodwill and Intangible Assets", replacing Section 3062 "Goodwill and Other Intangible Assets". Under this new guidance, fewer items meet the criteria for capitalization. Section 3064 establishes standards for the recognition, measurement, presentation and disclosure of goodwill and intangible assets subsequent to its initial recognition. Requirements concerning goodwill are unchanged from the requirements included in the previous Section 3062, as the new Section was only amended for intangible assets. The adoption of the abstract did not significantly impact the Trust's consolidated financial statements.

Effective January 1, 2009, the Trust retrospectively adopted the recommendations of Emerging Issues Committee abstract 173 "Credit Risk and the Fair Value of Financial Assets and Financial Liabilities", which was issued in January 2009, without restatement of prior periods. The abstract requires that an entity's own credit risk and the credit risk of the counterparty are taken into account in determining the fair value of financial assets and liabilities, including derivative instruments, for presentation and disclosure purposes. The adoption of the abstract did not significantly impact the Trust's consolidated financial statements.

In addition, the Trust has assessed new and revised accounting pronouncements that have been issued that are not yet effective and determined the following may have a significant impact on the Trust:

In December 2008, the CICA issued Section 1582 "Business Combinations", which will replace CICA Section 1581 of the same name. Under this guidance, the purchase price used in a business combination is based on the fair value of shares exchanged at the market price at the date of the exchange. Currently the purchase price used is based on the market price of the shares for a reasonable period before and after the date the acquisition is agreed upon and announced. This new guidance generally requires all acquisition costs to be expensed, which currently are capitalized as part of the purchase price. Contingent liabilities are to be recognized at fair value at the acquisition date and remeasured at fair value through earnings each period until settled. Currently, only contingent liabilities that are resolved and payable are included in the cost to acquire the business. In addition, negative goodwill is required to be recognized immediately in earnings, unlike the current requirement to eliminate it by deducting it from the non-current assets in the purchase price allocation. Section 1582 will be effective for the Trust on January 1, 2011, with prospective application. The Trust is currently evaluating the impact of the adoption of the new Section on its consolidated financial statements.

In December 2008, the CICA issued Sections 1601 "Consolidated Financial Statements", and 1602 "Non-controlling Interests", which replaces existing guidance under Section 1600 "Consolidated Financial Statements". Section 1601 establishes standards for the preparation of consolidated financial statements. Section 1602 provides guidance on accounting for a non-controlling interest in a subsidiary in consolidated financial statements subsequent to a business combination. These standards will be effective for the Trust on January 1, 2011. The Trust is currently evaluating the impact of the adoption of these new Sections on its consolidated financial statements.

In January 2006, the CICA Accounting Standards Board ("AcSB") adopted a strategic plan for the direction of accounting standards in Canada. As part of that plan, the AcSB confirmed in February 2008 that International Financial Reporting Standards ("IFRS") will replace Canadian GAAP in 2011 for profit-oriented Canadian publicly accountable enterprises. As Zargon will be required to report its results in accordance with IFRS starting in 2011, the Trust is assessing the potential impacts of this changeover and is developing and implementing its plan accordingly. While IFRS uses a conceptual framework similar to Canadian GAAP, there are significant differences in accounting policies that must be addressed. Zargon management, with the assistance of an independent consulting firm, has performed a diagnostic analysis that identifies key differences between Canadian GAAP and IFRS. Zargon has determined that the most significant changes will relate to our accounting for the exploration and evaluation of oil and gas resources, as well as accounting for property, plant and equipment and asset impairment testing. The quantitative impact of these new standards on our financial statements is not reasonably determinable or estimable at this time. Zargon's internal steering committee is currently focused on IFRS accounting policy decisions, designing IT systems to incorporate IFRS reporting and internal training. We expect the design and implementation phase to continue into 2010.

The International Accounting Standards Board ("IASB") has issued amendments to IFRS 1, which addresses first time adoption of IFRS. The IASB will allow additional optional exemptions, one of which relates to full cost oil and gas accounting, resulting in a reduced administrative transition from the current Canadian full cost accounting for oil and gas activities to IFRS. The election is available at the time of adoption only. The exemption would permit the Trust to measure exploration and evaluation assets under IFRS at the carrying amount determined under Canadian GAAP at the date of transition to IFRS. In addition, the carrying amount under Canadian GAAP of production or development assets could be allocated on a pro rata basis to the underlying assets using either reserve volumes or reserve values at the date of transition. The assets to which this exemption is applied would be required to be tested for impairment at the date of transition under IFRS standards. This exemption will relieve the Trust from retrospective application of IFRS for its oil and gas assets. The Trust currently anticipates utilizing this exemption.

3. ACQUISITIONS

Churchill Energy Inc.

On September 23, 2009, a subsidiary of the Trust acquired all of the outstanding shares of Churchill Energy Inc. ("Churchill"), a public oil and gas company, for consideration of $9.74 million. Consideration consisted of $0.11 million cash, the issuance of 554,669 Zargon trust units valued at $16.87 per unit and acquisition costs of $0.27 million.

The results of operations for Churchill have been included in the consolidated financial statements since September 23, 2009.

The acquisition was accounted for by the purchase method and the preliminary purchase price allocation is as follows:



Net Assets Acquired

($ thousands)
----------------------------------------------------------------------------
Property and equipment 12,606
Working capital deficiency (6,576)
Future income tax asset 6,108
Asset retirement obligations (2,403)
----------------------------------------------------------------------------
Total net assets acquired 9,735
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Consideration

($ thousands)
----------------------------------------------------------------------------
Cash 108
Trust units issued 9,357
Acquisition costs 270
----------------------------------------------------------------------------
Total purchase price 9,735
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Masters Energy Inc.

On April 29, 2009, a subsidiary of the Trust acquired all of the outstanding shares of Masters Energy Inc. ("Masters"), a public oil and gas company, for consideration of $27.10 million. Consideration consisted of $5.70 million cash, the issuance of 1,475,468 Zargon trust units valued at $14.26 per unit and acquisition costs of $0.36 million. Zargon assumed Masters' long term debt, which was repaid on the closing date of the acquisition.

The results of operations for Masters have been included in the consolidated financial statements since April 29, 2009.

The acquisition was accounted for by the purchase method and the preliminary purchase price allocation is as follows:



Net Assets Acquired

($ thousands)
----------------------------------------------------------------------------
Property and equipment 43,698
Working capital deficiency (105)
Long term debt (12,825)
Future income tax asset 69
Asset retirement obligations (3,740)
----------------------------------------------------------------------------
Total net assets acquired 27,097
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Consideration

($ thousands)
----------------------------------------------------------------------------
Cash 5,700
Trust units issued 21,040
Acquisition costs 357
----------------------------------------------------------------------------
Total purchase price 27,097
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Newpact Energy Corp.

On May 16, 2008, a subsidiary of the Trust acquired all of the outstanding shares of Newpact Energy Corp. ("Newpact"), a private oil and gas company, for consideration of $9.54 million. Consideration consisted of the issuance of 425,940 Zargon trust units valued at $22.04 per unit and acquisition costs of $0.15 million.

The results of operations for Newpact have been included in the consolidated financial statements since May 16, 2008.

The acquisition was accounted for by the purchase method and the purchase price allocation is as follows:



Net Assets Acquired

($ thousands)
----------------------------------------------------------------------------
Property and equipment 13,925
Working capital deficiency (2,491)
Future income tax liability (922)
Asset retirement obligations (976)
----------------------------------------------------------------------------
Total net assets acquired 9,536
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Consideration

($ thousands)
----------------------------------------------------------------------------
Trust units issued 9,388
Acquisition costs 148
----------------------------------------------------------------------------
Total purchase price 9,536
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Rival Energy Ltd.

On January 23, 2008, a subsidiary of the Trust acquired all of the outstanding shares of Rival Energy Ltd. ("Rival"), a public oil and gas company, for consideration of $30.06 million. Consideration consisted of $16.40 million cash, the issuance of 573,300 Zargon trust units valued at $23.32 per unit and acquisition costs of $0.29 million.

The results of operations for Rival have been included in the consolidated financial statements since January 23, 2008.

The acquisition was accounted for by the purchase method and the purchase price allocation is as follows:



Net Assets Acquired

($ thousands)
----------------------------------------------------------------------------
Property and equipment 54,065
Goodwill 2,969
Working capital deficiency (854)
Long term debt (16,914)
Future income tax liability (5,443)
Asset retirement obligations (3,767)
----------------------------------------------------------------------------
Total net assets acquired 30,056
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Consideration

($ thousands)
----------------------------------------------------------------------------
Cash 16,400
Trust units issued 13,369
Acquisition costs 287
----------------------------------------------------------------------------
Total purchase price 30,056
----------------------------------------------------------------------------
----------------------------------------------------------------------------


4. PROPERTY AND EQUIPMENT

September 30, 2009
----------------------------------------------------------------------------
Accumulated
Depletion and Net Book
($ thousands) Cost Depreciation Value
----------------------------------------------------------------------------
Petroleum, natural gas
properties and other equipment
(1) 763,509 331,789 431,720
----------------------------------------------------------------------------
----------------------------------------------------------------------------


December 31, 2008
----------------------------------------------------------------------------
Accumulated
Depletion and Net Book
($ thousands) Cost Depreciation Value
----------------------------------------------------------------------------
Petroleum, natural gas
properties and other equipment
(1) 671,324 284,578 386,746
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) As a result of shareholders redeeming exchangeable shares, property and
equipment has cumulatively increased $55.24 million, $0.09 million
relating to the first nine months of 2009, $3.39 million relating to
2008 and $51.76 million relating to prior years. The effect of these
increases has resulted in additional depletion and depreciation expense
of approximately $25.97 million, $3.66 million relating to the first
nine months of 2009, $5.59 million relating to 2008, and $16.72 million
relating to prior years.


5. LONG TERM DEBT

On July 27, 2009, Zargon amended and renewed its syndicated committed credit facilities, the result of which was the maintaining of the available facilities and borrowing base of $180 million. These facilities consist of a $170 million tranche available to the Canadian borrower and a US $8 million tranche available to the US borrower. A $300 million demand debenture on the assets of the subsidiaries of the Trust has been provided as security for these facilities. The facilities are fully revolving for a 336 day period with the provision for an annual extension at the option of the lenders and upon notice from Zargon's management. The next renewal date is June 29, 2010. Should the facilities not be renewed, they convert to one year non-revolving term facilities at the end of the revolving 336 day period. Repayment would not be required until the end of the non-revolving term, and, as such, these facilities have been classified as long term debt.

Interest rates fluctuate under the syndicated facilities with Canadian prime, US prime and US base rates plus an applicable margin between 125 basis points and 275 basis points (2008 - zero and 32.5 basis points, respectively), as well as with Canadian banker's acceptance and LIBOR rates plus an applicable margin between 275 basis points and 425 basis points (2008 - 97.5 and 157.5 basis points, respectively). At September 30, 2009, $77.05 million (December 31, 2008 - $77.58 million) had been drawn on the syndicated committed credit facilities with any unused amounts subject to standby fees. In the normal course of operations Zargon enters into various letters of credit. At September 30, 2009, the approximate value of outstanding letters of credit totalled $0.61 million (December 31, 2008 - $0.52 million).



6. ASSET RETIREMENT OBLIGATIONS

The following table reconciles Zargon's asset retirement obligations:

Nine Months Ended September 30,
----------------------------------------------------------------------------
($ thousands) 2009 2008
----------------------------------------------------------------------------
Balance, beginning of period 28,592 21,184
Net liabilities incurred/acquired 6,551 5,684
Liabilities settled (1,563) (643)
Accretion expense 1,992 1,607
Foreign exchange (140) 60
----------------------------------------------------------------------------
Balance, end of period 35,432 27,892
----------------------------------------------------------------------------
----------------------------------------------------------------------------


7. UNITHOLDERS' EQUITY

The Trust is authorized to issue an unlimited number of voting trust units.

Trust Units

Nine Months Ended
September 30, 2009
----------------------------------------------------------------------------
Number Amount
(thousands) of units ($)
----------------------------------------------------------------------------
Balance, beginning of period 18,479 120,650
Unit rights exercised for cash 96 1,269
Unit-based compensation recognized on
exercise of unit rights - 387
Issued on corporate acquisitions 2,030 30,397
Equity issuance 2,365 35,475
Issue costs, net of future tax effect of $487 - (1,544)
Issued on conversion of exchangeable shares 21 326
----------------------------------------------------------------------------
Balance, end of period 22,991 186,960
----------------------------------------------------------------------------
----------------------------------------------------------------------------


The proforma total units outstanding at September 30, 2009, including trust units outstanding and trust units issuable upon conversion of exchangeable shares, after giving effect to the exchange ratio at the end of the period (see note 8) is 25.929 million units.

On June 5, 2009, the Trust closed an offering of 2.365 million trust units on a bought deal basis at $15.00 per unit for total gross proceeds of $35.48 million ($33.44 million net of issue costs).



The following table summarizes information about the Trust's contributed
surplus account:

Contributed Surplus

($ thousands) Nine Months September 30, 2009
----------------------------------------------------------------------------
Balance, beginning of period 4,617
Unit-based compensation expense (1) 813
Unit-based compensation recognized on
exercise of unit rights (387)
----------------------------------------------------------------------------
Balance, end of period 5,043
----------------------------------------------------------------------------
----------------------------------------------------------------------------
1) During the fourth quarter of 2008, the Trust issued 10,000 unit
appreciation rights ("UARS"). The intrinsic value at September 30, 2009
has decreased by $0.01 million since December 31, 2008 ($0.04 million).
These UARS are awards entitling the recipients to receive cash in an
amount equivalent to any excess of the market value of a stated number of
units over a stated price. UARS are included in unit-based compensation
expense; however rewards settled in cash are liabilities and therefore
are not included in contributed surplus.


Trust Unit Rights Incentive Plans and Unit-Based Compensation

The Trust has a unit rights incentive plan (the "Old Plan") that allows the Trust to issue rights to acquire trust units to directors, officers, employees and other service providers. On April 22, 2009, a new unit rights incentive plan (the "New Plan") was approved. The Trust is authorized to issue up to an aggregate of 2.13 million unit rights; however, the number of trust units reserved for issuance upon exercise of the rights shall not at any time exceed 10 percent of the aggregate number of the total outstanding units, including units issuable upon exchange of exchangeable shares of Zargon and other fully paid securities of Zargon entities exchangeable into units, which are the economic equivalent of units including full voting rights. At the time of grant, unit right exercise prices approximate the market price for the trust units. At the time of exercise, the rights holder has the option of exercising at the original grant price or the exercise price as calculated under the Old Plan or the New Plan (the "modified price"). Under the Old Plan, the modified price was based on the increment of the amount the monthly distribution exceeded a monthly return of 0.833 percent of the Trust's recorded net book value of oil and natural gas properties (as defined in the Old Plan). Under the New Plan, if the monthly distribution exceeds the monthly return of 0.833 percent of the Trust's recorded net book value of oil and natural gas properties (as defined in the New Plan), the entire amount (not the increment) of the distribution is deducted from the original grant price. Rights granted under either Plan generally vest over a three-year period and expire approximately five years from the grant date. Zargon uses a fair value methodology to value the unit rights grants.

The weighted average assumptions made for unit rights granted for the nine months ended September 30, 2009 include a volatility factor of expected market price of 34.5 percent, a risk-free interest rate of 1.7 percent and an expected life of the unit rights of four years. The weighted average assumptions made for unit rights granted for the three months ended September 30, 2009 include a volatility factor of expected market price of 34.5 percent, a risk-free interest rate of 2.4 percent and an expected life of the unit rights of four years. The fair value of the unit rights granted in the quarter was calculated at $4.82 per unit right. Unit-based compensation expense for the three and nine months ended September 30, 2009 of $0.37 million (2008 - $0.32 million) and $0.81 million (2008 - $0.84 million), respectively.

Compensation expense associated with unit rights granted under either Plan is recognized in earnings over the vesting period of the Plan with a corresponding increase in contributed surplus. The exercise of trust unit rights is recorded as an increase in trust units with a corresponding reduction in contributed surplus. Forfeiture of rights are recorded as a reduction in expenses in the period in which they occur.



The following table summarizes information about the Trust's unit rights
under the Old Plan:

Nine Months Ended September 30, 2009
----------------------------------------------------------------------------
Weighted Average
Number of Exercise Price
Unit Rights Initial and Modified
(thousands) ($/unit right)
----------------------------------------------------------------------------
Outstanding at beginning of period 1,654 25.57 / 23.63
Unit rights granted - -
Unit rights exercised (96) 13.20
Unit rights forfeited (226) 26.61
---------------------------------------------------
Outstanding at end of period 1,332 25.96 / 23.69
---------------------------------------------------
---------------------------------------------------
Unit rights exercisable at period end 968 26.85 / 24.16
----------------------------------------------------------------------------
----------------------------------------------------------------------------


The following table summarizes information about the Trust's unit rights
under the New Plan:

Nine Months Ended September 30, 2009
----------------------------------------------------------------------------
Weighted Average
Number of Exercise Price
Unit Rights Initial and Modified
(thousands) ($/unit right)
----------------------------------------------------------------------------
Outstanding at beginning of period - -
Unit rights granted 403 15.63 / 14.88
Unit rights exercised - -
Unit rights forfeited (3) 15.56
---------------------------------------------------
Outstanding at end of period 400 15.63 / 14.88
---------------------------------------------------
---------------------------------------------------
Unit rights exercisable at period end - -
----------------------------------------------------------------------------
----------------------------------------------------------------------------


8. NON-CONTROLLING INTEREST - EXCHANGEABLE SHARES

Zargon Oil & Gas Ltd. is authorized to issue an unlimited number of exchangeable shares. The exchangeable shares are convertible into trust units at the option of the shareholder, based on the exchange ratio, which is adjusted monthly to reflect the distribution paid on the trust units. Cash distributions are not paid on the exchangeable shares. During the nine months ended September 30, 2009, a total of 0.01 million (2008 - 0.17 million) exchangeable shares were converted into 0.02 million (2008 - 0.23 million) trust units based on the exchange ratio at the time of conversion. At September 30, 2009, the exchange ratio was 1.58991 trust units per exchangeable share.



Non-Controlling Interest - Exchangeable Shares

Nine Months Ended September 30, 2009
----------------------------------------------------------------------------
(thousands, except exchange ratio) Number of Shares Amount ($)
----------------------------------------------------------------------------
Balance, beginning of period 1,862 27,610
Exchanged for trust units at book
value and including earnings
attributed during the period (14) (258)
Earnings attributable to
non-controlling interest - 281
----------------------------------------------------------------------------
Balance, end of period 1,848 27,633
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Exchange ratio, end of period 1.58991
Trust units issuable upon conversion
of exchangeable shares, end of
period 2,938
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Per EIC-151 "Exchangeable Securities Issued by Subsidiaries of Income Trusts", if certain conditions are met, the exchangeable shares issued by a subsidiary must be reflected as non-controlling interest on the consolidated balance sheets and, in turn, net earnings must be reduced by the amount of net earnings attributed to the non-controlling interest.

The non-controlling interest on the consolidated balance sheets consists of the book value of exchangeable shares at the time of the Plan of Arrangement, plus net earnings attributable to the exchangeable shareholders, less exchangeable shares (and related cumulative earnings) redeemed. The net earnings attributable to the non-controlling interest on the consolidated statements of earnings and comprehensive income represents the cumulative share of net earnings attributable to the non-controlling interest based on the trust units issuable for exchangeable shares in proportion to total trust units issued and issuable each period end.



The effect of EIC-151 on Zargon's unitholders' capital and exchangeable
shares is as follows:

Zargon Zargon Oil
Energy & Gas Ltd.
Trust Exchangeable
($ thousands) Units Shares Total
----------------------------------------------------------------------------
Balance at January 1, 2009 120,650 27,610 148,260
Issued on redemption of
exchangeable shares at book
value 35 (35) -
Effect of EIC-151 291 58 349
Unit-based compensation
recognized on exercise of unit
rights 387 - 387
Issued on corporate
acquisitions 30,397 - 30,397
Unit rights exercised for cash 1,269 - 1,269
Equity issuance (net of share
issue costs) 33,931 - 33,931
----------------------------------------------------------------------------
Balance at September 30, 2009 186,960 27,633 214,593
----------------------------------------------------------------------------
----------------------------------------------------------------------------


9. WEIGHTED AVERAGE NUMBER OF TOTAL UNITS

Basic per unit amounts are calculated using the weighted average number of trust units outstanding during the period. Diluted per unit amounts are calculated using the treasury stock method to determine the dilutive effect of unit-based compensation. Diluted per unit amounts also include exchangeable shares using the "if-converted" method. Due to the fact that at the time of exercise, the rights holder has the option of exercising at the original grant price or a modified price as calculated under the Plans, the prices used in the treasury stock calculation are the lower prices calculated under the Plans.



Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------------------------------------------------
(thousands of units) 2009 2008 2009 2008
----------------------------------------------------------------------------
Basic 22,478 18,219 20,444 17,884
Diluted 25,325 20,980 23,102 20,568
----------------------------------------------------------------------------
----------------------------------------------------------------------------


10. CAPITAL DISCLOSURES

The Trust's capital structure is comprised of unitholders' equity plus long term debt. The Trust's objectives when managing its capital structure are to:

i) maintain financial flexibility so as to preserve Zargon's access to capital markets and its ability to meet its financial obligations; and

ii) finance internally generated growth as well as acquisitions.

The Trust monitors its capital structure and short term financing requirements using the non-GAAP financial metric of debt net of working capital ("net debt") to funds flow from operating activities. Net debt, as used by the Trust, is calculated as bank debt and any working capital deficit excluding the current portion of unrealized risk management assets and liabilities and future income taxes. Funds flow from operating activities represents net earnings/losses and asset retirement expenditures except for non-cash items. The metric is used to steward the Trust's overall debt position as a measure of the Trust's overall financial strength and is calculated as follows:



September 30, December 31,
($ thousands, except ratio) 2009 2008
----------------------------------------------------------------------------
Net debt 87,139 87,707
Annualized funds flow from operating
activities (1) 82,366 106,909
Net debt to funds flow from operating
activities ratio 1.06 0.82
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Annualized funds flow from operating activities based on nine months for
2009.


Zargon's net debt to funds flow from operating activities ratio was 1.06, an increase from 0.82 at December 31, 2008, primarily due to weak commodity prices negatively affecting funds flow from operating activities. Bank debt levels increased in the current quarter when the Trust acquired Churchill on September 23, 2009. On June 5, 2009, the Trust closed an offering of 2.365 million trust units on a bought deal basis of $15.00 per unit for total gross proceeds of $35.48 million ($33.44 million net of issue costs). On July 27, 2009, Zargon amended and renewed its syndicated committed credit facilities of $180 million. The next renewal date is June 29, 2010. These facilities continue to be available for general corporate purposes and the potential acquisition of oil and natural gas properties.

To manage its capital structure, the Trust may adjust capital spending, adjust distributions paid to unitholders, issue new units, issue new debt or repay existing debt.

The Trust's capital management objectives, evaluation measures, definitions and targets have remained unchanged over the periods presented. Zargon is subject to certain financial covenants in its credit facility agreements and is in compliance with all financial covenants.

11. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT CONTRACTS

All financial instruments are required to be measured at fair value on initial recognition of the instrument, except for certain related party transactions. Measurement in subsequent periods depends on whether the financial instrument has been classified as "held-for-trading", "available-for-sale", "held-to-maturity", "loans and receivables", or "other financial liabilities" as defined by CICA Section 3855.

Financial assets and financial liabilities classified as "held-for-trading" are measured at fair value with changes in fair value recognized in earnings. Financial assets classified as "available-for-sale" are measured at fair value, with changes in fair value recognized in other comprehensive income ("OCI") until the asset is removed from the consolidated balance sheets. Financial assets classified as "held-to-maturity", "loans and receivables" and "other financial liabilities" are measured at amortized cost using the effective interest method of amortization.

Fair Value of Financial Assets and Liabilities

Zargon's financial assets and liabilities are comprised of accounts receivable, deposits, accounts payable, cash distributions payable, unrealized risk management assets and liabilities and long term debt. Fair values of financial assets and liabilities, summarized information related to risk management positions and discussion of risks associated with financial assets and liabilities are presented as follows:

A) Fair Value of Financial Assets and Liabilities

Accounts receivable are designated as "loans and receivables". Accounts payable and accrued liabilities, cash distributions payable and long term debt are designated as "other liabilities". The fair values of these accounts approximate their carrying amounts.

Risk management assets and liabilities are derivative financial instruments classified as "held-for-trading". These accounts are recorded at their estimated fair value using quoted market prices.

B) Risk Management Assets and Liabilities

The Trust is a party to certain financial instruments that have fixed the price of a portion of its oil and natural gas production and foreign exchange conversion rates. The Trust enters into these contracts for risk management purposes only, in order to protect a portion of its future cash flow from the volatility of oil and natural gas commodity prices and foreign exchange rates. For financial risk management contracts, the Trust considers these contracts to be effective on an economic basis but has decided not to designate these contracts as hedges for accounting purposes and, accordingly, any unrealized gains or losses are recorded in earnings based on the fair value (mark-to-market) of the contracts at each reporting period. The unrealized loss for the first nine months of 2009 was $23.42 million and the unrealized gain for the first nine months of 2008 was $10.09 million.

As at September 30, 2009, the Trust had the following outstanding commodity and foreign currency risk management contracts:



Commodity Financial Risk Management Contracts:

Fair Market
Value
Weighted Gain/(Loss)
Rate Average Price Range of Terms ($ thousands)
----------------------------------------------------------------------------
Oil swaps 1,000 bbl/d $100.14 US/bbl Oct. 1/09 - Dec. 31/09 2,867
300 bbl/d $132.98 US/bbl Oct. 1/09 - Jun. 30/10 5,312
200 bbl/d $75.25 US/bbl Oct. 1/09 - Dec. 31/10 151
400 bbl/d $77.40 US/bbl Oct. 1/09 - Jun. 30/11 724
1,000 bbl/d $70.56 US/bbl Jan. 1/10 - Dec. 31/10 (1,491)
Natural gas
swaps 2,000 gj/d $9.60/gj Oct. 1/09 - Oct. 31/09 417
----------------------------------------------------------------------------
Total Fair Market Value, Commodity Price Financial Contracts 7,980
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Oil swaps are settled against the NYMEX WTI pricing index, whereas natural
gas swaps are settled against the AECO pricing index.

Foreign Exchange Financial Risk Management Contracts:

Average Foreign
Monthly US Exchange Fair Market
Dollar Volume Rate Value Gain
($ thousands) ($Cdn/$US) Range of Terms ($ thousands)
----------------------------------------------------------------------------
Foreign exchange
forwards $1,652 1.1760 Oct. 1/09 - Dec. 31/09 523
$1,321 1.2550 Oct. 1/09 - Dec. 31/09 731
$1,203 1.1715 Jan. 1/10 - Jun. 30/10 725
----------------------------------------------------------------------------
Total Fair Market Value, Foreign Exchange Financial Contracts 1,979
----------------------------------------------------------------------------
----------------------------------------------------------------------------


The contracts are settled based on the average daily noon close rate for US
dollars converted to Canadian dollars as published by the Bank of Canada.

Physical Risk Management Contracts:

Weighted Fair Market
Average Value Gain
Rate Price Range of Terms ($ thousands)
----------------------------------------------------------------------------
Natural gas fixed
price 3,000 gj/d $8.47/gj Oct. 1/09 - Oct. 31/09 520
----------------------------------------------------------------------------
Total Fair Market Value, Physical Contracts 520
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Contracts settled by way of physical delivery are recognized as part of the normal revenue stream. These instruments have no book values recorded in the consolidated financial statements.

Commodity Price Sensitivities

The following table summarizes the sensitivity of the fair value of the Trust's risk management positions to fluctuations in commodity prices, with all other variables held constant. When assessing the potential impact of these commodity price changes, the Trust believes 10 percent volatility is a reasonable long term measure.

Fluctuations of 10 percent in commodity prices could have resulted in unrealized gains/(losses) on risk management contracts impacting net earnings as follows:



Three and Nine Months Ended
September 30,
----------------------------------------------------------------------------
($ thousands) 2009 2008
----------------------------------------------------------------------------
Natural gas price 18 878
Crude oil price 7,016 7,421
----------------------------------------------------------------------------
----------------------------------------------------------------------------


C) Risks Associated with Financial Assets and Liabilities

The Trust is exposed to financial risks arising from its financial assets and liabilities. The financial risks include market risk (commodity prices, interest rates and foreign exchange rates), credit risk and liquidity risk.

- Market Risk

Market risk is the risk that the fair value or future cash flows of financial assets or liabilities will fluctuate due to movements in market prices and is comprised of the following:

- Commodity Price Risk

As a means of mitigating exposure to commodity price risk volatility, the Trust has entered into various derivative agreements. The use of derivative instruments is governed under formal policies and is subject to limits established by the Board of Directors. The Trust's policy is to not use derivative financial instruments for speculative purposes.

Natural Gas - To partially mitigate the natural gas commodity price risk, the Trust enters into swaps, which fix the Canadian dollar AECO prices.

Crude Oil - The Trust has partially mitigated its exposure to the WTI NYMEX price with fixed price swaps.

- Interest Rate Risk

Borrowings under bank credit facilities are market rate based (variable interest rates); thus, carrying values approximate fair values.

At the September 30, 2009 debt pricing levels, the increase or decrease in net earnings for the nine month period for each one percent change in interest rates would amount to $0.63 million (2008 - $0.64 million).

- Foreign Exchange Risk

As Zargon operates in North America, fluctuations in the exchange rate between the US/Canadian dollar can have a significant effect on the Trust's reported results. A $0.01 change in the US to Canadian dollar exchange rate would have resulted in a $0.45 million (2008 - $0.87 million) increase or decrease in net earnings for the nine month period at September 30, 2009. In order to mitigate the Trust's exposure to foreign exchange fluctuations, the Trust enters into foreign exchange derivative agreements.

- Credit Risk

Credit risk is the risk that the counterparty to a financial asset will default, resulting in the Trust incurring a financial loss. This credit exposure is mitigated with credit practices that limit transactions according to counterparties' credit quality. A substantial portion of the Trust's accounts receivable are with customers in the oil and gas industry and are subject to normal industry credit risks.

The maximum credit risk exposure associated with accounts receivable, accrued revenues and risk management assets is the total carrying value. The Trust monitors these balances monthly to limit the risk associated with collection. Of Zargon's accounts receivable at September 30, 2009, approximately 36 percent (December 31, 2008 - 37 percent) was owing from two companies and Zargon anticipates full collection.

- Liquidity Risk

Liquidity risk is the risk the Trust will encounter difficulties in meeting its financial liability obligations. The Trust manages its liquidity risk through cash and debt management. See note 10 for a more detailed discussion.

As at September 30, 2009, Zargon had available unused committed bank credit facilities of approximately $102.34 million compared to $101.90 at December 31, 2008. The Trust believes it has sufficient funding through the use of these facilities to meet foreseeable borrowing requirements.



The timing of cash outflows relating to financial liabilities are outlined
in the table below:

($ thousands) 1 year 2-3 years Total
----------------------------------------------------------------------------
Accounts payable and accrued
liabilities 31,022 - 31,022
Cash distributions payable 4,138 - 4,138
Risk management liabilities (1) 1,247 420 1,667
Long term debt - 77,050 77,050
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) See the section titled "Commodity Price Sensitivities" in this note for
a better understanding of the volatility around these amounts.


12. CHANGES IN NON-CASH WORKING CAPITAL

Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------------------------------------------------
($ thousands) 2009 2008 2009 2008
----------------------------------------------------------------------------
Changes in non-cash working capital
items:
Accounts receivable (1,124) 5,419 (1,994) (5,600)
Prepaid expenses and deposits (839) 226 (1,190) 480
Accounts payable and accrued
liabilities 4,914 915 2,335 7,664
Cash distributions payable 100 48 812 240
Working capital acquired from
corporate acquisitions (6,576) - (6,681) (3,345)
Foreign exchange and other (505) 229 (821) 380
----------------------------------------------------------------------------
(4,030) 6,837 (7,539) (181)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Changes relating to operating
activities 462 3,832 (638) (1,221)
Changes relating to financing
activities 100 48 812 240
Changes relating to investing
activities (4,592) 2,957 (7,713) 800
----------------------------------------------------------------------------
(4,030) 6,837 (7,539) (181)
----------------------------------------------------------------------------
----------------------------------------------------------------------------


13. SUPPLEMENTAL CASH FLOW INFORMATION

Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------------------------------------------------
($ thousands) 2009 2008 2009 2008
----------------------------------------------------------------------------
Cash interest paid 1,170 1,266 2,501 3,042
Cash taxes paid 72 1,841 9 3,646
----------------------------------------------------------------------------
----------------------------------------------------------------------------


14. SEGMENTED INFORMATION

Zargon's entire operating activities are related to exploration, development
and production of oil and natural gas in the geographic segments of Canada
and the US.

Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------------------------------------------------
($ thousands) 2009 2008 2009 2008
----------------------------------------------------------------------------
Petroleum and Natural Gas Revenue
Canada 36,867 58,290 98,077 164,980
United States 4,088 8,062 10,696 23,267
----------------------------------------------------------------------------
Total 40,955 66,352 108,773 188,247
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Net Capital Expenditures (1)
Canada 28,886 17,225 91,208 102,610
United States 431 240 509 747
----------------------------------------------------------------------------
Total 29,317 17,465 91,717 103,357
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) For net capital expenditures, amounts include capital expenditures
acquired for cash, equity issuances, acquisition costs and net debt
assumed on corporate acquisitions.


September 30, December 31,
($ thousands) 2009 2008
----------------------------------------------------------------------------
Property and Equipment, net
Canada 399,707 353,174
United States 32,013 33,572
----------------------------------------------------------------------------
Total 431,720 386,746
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Goodwill
Canada 2,969 2,969
United States - -
----------------------------------------------------------------------------
Total 2,969 2,969
----------------------------------------------------------------------------
----------------------------------------------------------------------------


15. CASH DISTRIBUTIONS

During the nine month period, the Trust declared distributions to the
unitholders in the aggregate amount of $33.51 million (2008 - $29.13
million) in accordance with the following schedule:

2009 Distributions Record Date Distribution Date Per Trust Unit
----------------------------------------------------------------------------
January January 31, 2009 February 16, 2009 $0.18
February February 28, 2009 March 16, 2009 $0.18
March March 31, 2009 April 15, 2009 $0.18
April April 30, 2009 May 15, 2009 $0.18
May May 31, 2009 June 15, 2009 $0.18
June June 30, 2009 July 15, 2009 $0.18
July July 31, 2009 August 17, 2009 $0.18
August August 31, 2009 September 15, 2009 $0.18
September September 30, 2009 October 15, 2009 $0.18
----------------------------------------------------------------------------
----------------------------------------------------------------------------
For Canadian income tax purposes, the distributions are currently estimated
to be 100 percent taxable income to unitholders.


CORPORATE INFORMATION

BOARD OF DIRECTORS STOCK EXCHANGE LISTING
Craig H. Hansen Toronto Stock Exchange
Calgary, Alberta
Zargon Energy Trust
K. James Harrison (3) (4) Trust Units
Chairman of the Board Trading Symbol: ZAR.UN
Oakville, Ontario
Zargon Oil & Gas Ltd.
Kyle D. Kitagawa (1) (2) Exchangeable Shares
Calgary, Alberta Trading Symbol: ZOG.B

Geoffrey C. Merritt (2) TRANSFER AGENT
Calgary, Alberta Valiant Trust Company
310, 606 - 4th Street S.W.
Margaret A. McKenzie (1) (3) Calgary, Alberta T2P 1T1
Calgary, Alberta
BANKERS
Jim Peplinski (2) (4) The Toronto Dominion Bank
Calgary, Alberta 910, 333 - 7th Avenue S.W.
Calgary, Alberta T2P 2Z1
J. Graham Weir (1) (2)
Calgary, Alberta Canadian Imperial Bank of Commerce
9th Floor, Bankers Hall East
Grant A. Zawalsky (3) (4) 855 - 2nd Street S.W.
Calgary, Alberta Calgary, Alberta T2P 2P2

OFFICERS The Bank of Nova Scotia
Craig H. Hansen 2000, 700 - 2nd Street S.W.
President and Chief Executive Officer Calgary, Alberta T2P 2N7

Brent C. Heagy LEGAL COUNSEL
Executive Vice President and Burnet, Duckworth & Palmer LLP
Chief Financial Officer 1400, 350 - 7th Avenue S.W.
Calgary, Alberta T2P 3N9
Henry J. Baird
Vice President, Reservoir Engineering CONSULTING ENGINEERS
McDaniel & Associates Consultants
Jason B. Dranchuk Ltd.
Vice President, Finance and Controller 2220, 255 - 5th Avenue S.W.
Calgary, Alberta T2P 3G6
Tracy L. Howard
Corporate Secretary AUDITORS
Ernst & Young LLP
Brian G. Kergan 1000, 440 - 2nd Avenue S.W.
Vice President, Corporate Development Calgary, Alberta T2P 5E9
and Alberta Plains South
HEAD OFFICE
Mark I. Lake 700, 333 - 5th Avenue S.W.
Vice President, Geosciences and West Calgary, Alberta T2P 3B6
Central Alberta Telephone: 403-264-9992
Fax: 403-265-3026
Kevin C.Y. Lee Email: zargon@zargon.ca
Vice President, Alberta Plains North
WEBSITE
Daniel A. Roulston www.zargon.ca
Vice President, Engineering and
Williston Basin

Lorne D. Schwetz
Vice President, Land

Al D. Thorsen
Vice President, Operations


(1) Audit Committee
(2) Reserves Committee
(3) Governance and Nominating Committee
(4) Compensation Committee

Contact Information

  • Zargon Energy Trust
    C.H. Hansen
    President and Chief Executive Officer
    (403) 264-9992
    or
    B.C. Heagy
    Executive Vice President and Chief Financial Officer
    (403) 264-9992
    Email: zargon@zargon.ca
    Website: www.zargon.ca