Birchcliff Energy Ltd.
TSX : BIR

Birchcliff Energy Ltd.

March 22, 2007 00:10 ET

Birchcliff Energy Ltd. Announces 2006 Financial Results and 2007 Operations Update

CALGARY, ALBERTA--(CCNMatthews - March 22, 2007) -

THIS PRESS RELEASE IS NOT FOR DISTRIBUTION TO UNITED STATES NEWSWIRE SERVICES OR FOR DISSEMINATION IN THE UNITED STATES.

Birchcliff Energy Ltd. ("Birchcliff") (TSX:BIR) is pleased to announce its audited financial statements for the year ended December 31, 2006 and the related Management's Discussion and Analysis. This information is substantially the same as the unaudited results previously released on February 26, 2007.

2006 Highlights

- Birchcliff increased its 2006 average daily production to 5,368 boe/d, a 13% increase over its 2005 average daily production for the seven months in which it had substantial production.

- Cash flow for 2006 was $46.7 million, a 29% increase over 2005.

- Total year-end debt (including working capital) was $87.8 million. Birchcliff's $120 million credit facilities were drawn to $81.3 million

- Birchcliff added 9,527 mboe of Proved and Probable Reserves during 2006 resulting in Proved and Probable Reserves at the end of 2006 of 28,344 mboe. These reserve additions are 46% of Birchcliff's Proved and
Probable Reserves at the start of 2006.

- Finding and development costs for 2006 on a proved and probable basis were $10.57/boe excluding future development costs and $20.39/boe including future development costs.

- Birchcliff added Proved and Probable Reserves equal to 4.86 boe for each boe produced during 2006.

- Of the 39 net wells drilled in 2006, 40% were exploratory with new discoveries in the Kiskatinaw, Montney, Doig, Halfway, Bluesky and Gething zones.

- Birchcliff's reserve life index on a proved and probable basis increased to 12.7 years from 10.7 years.

- Fourth quarter 2006 production averaged 5,861 boe per day, a 17% increase over the fourth quarter of 2005.

- Based on finding and development costs, Birchcliff has a proved plus probable operating netback recycle ratio of 2.8, excluding future capital and 1.4, including future capital.

- Birchcliff increased its net undeveloped land at December 31, 2006 to 171,829 net acres, a 52% increase over year end 2005. All of Birchcliff's land is in the Peace River Arch Arch area of Alberta and includes large contiguous blocks.

Fourth Quarter 2006 Highlights

- Fourth quarter cash flow increased to $11.7 million, a 9% increase over the third quarter.

- Fourth quarter cash flow per share (basic) increased to $0.19 per share, as compared to $0.18 for the third quarter.

- Fourth quarter average production increased to 5,861 boe per day, a 5% increase over the third quarter and a 17% increase over the fourth quarter of 2005.

- Fourth quarter natural gas sales price was $7.33 per mcf as compared to $12.23 for the fourth quarter of 2005.

Operations Update

- To date in 2007, Birchcliff has drilled 9 gross (7.1 net) wells in the Peace River Arch, all but one of which have been cased. Of these wells 4(3.6 net) were exploration wells.

- Spring break-up has now shut down Birchcliff's operated drilling.

Production Guidance

- Estimated production for the first quarter of 2007 is approximately 5,900 to 6,000 boe per day.

- At present 9 gross (7.5 net) wells remain to be tied-in and brought on production.

- Birchcliff expects to exit 2007 at approximately 7,000 boe per day, of which 84% is expected to be natural gas and 16% is expected to be light oil and liquids.

Land

- Birchcliff's undeveloped land base has increased since year end 2006 to 224,197 gross (184,084 net) undeveloped acres all in the Peace River Arch area of Alberta.

Management's Discussion & Analysis

Management's Discussion and Analysis ("MD&A"), dated March 21, 2007, is management's assessment of the historical financial position and operating results of Birchcliff Energy Ltd. (the "Corporation" or "Birchcliff") and should be read in conjunction with the audited financial statements and notes thereto for the years ended December 31, 2006 and 2005. The financial statements have been prepared in accordance with Generally Accepted Accounting Principles ("GAAP") in Canada. Readers should be advised that the Corporation did not have any petroleum or natural gas production until May 2005 and did not have significant petroleum or natural gas production until June 2005.

Additional information relating to the Corporation, the Annual Information Form and Birchcliff's Statement of Reserves Data and Other Oil and Gas Information are available on SEDAR at www.sedar.com. Birchcliff is listed for trading on the Toronto Stock Exchange under the symbol "BIR".

All dollar amounts are stated in Canadian dollars unless otherwise stated.

FORWARD LOOKING STATEMENTS

This disclosure includes forward-looking statements and assumptions respecting the Corporation's strategies, future operations, expected financial results, financing sources, commodity prices, costs of production and quantum of petroleum and natural gas reserves and discusses certain issues, risks and uncertainties that can be expected to impact on any of such matters.

By their nature, forward-looking statements are subject to numerous risks and uncertainties that can significantly affect future results. Actual future results may differ materially from those assumed or described in such forward-looking statements as a result of the impact of issues, risks and uncertainties whether described herein or not, which the Corporation may not be able to control. The reader is therefore cautioned not to place undue reliance on such forward-looking statements.

The Corporation disclaims any intention or obligation to update or revise these forward-looking statements as a result of new information, future events or otherwise, except to the extent required by law.

NON-GAAP MEASURES

This MD&A and the Corporation's Annual Report for 2006 make references to terms commonly used in the petroleum and natural gas industry, such as cash flow or cash generated from operations, cash flow per share, operating netback and cash flow netback.

Cash flow, as discussed in this MD&A and in the Corporation's Annual Report for 2006, appears as a separate line on the Corporation's Statements of Cash Flows above "changes in non-cash working capital" and is reconciled to net earnings or loss. In the Corporation's disclosure, netback and/or operating netback denotes petroleum and natural gas revenue less royalties (net of ARTC), less operating expenses and less transportation and marketing expenses. Cash flow netback as used herein denotes net earnings plus future income tax expense (less any recovery), depletion, depreciation and accretion expense and non-cash stock-based compensation expense.

These terms are not defined by Generally Accepted Accounting Principles and consequently, they are referred to as non-GAAP measures. The reader should be cautioned that these amounts may not be directly comparable to measures for other companies where similar terminology is used.

BOE CONVERSIONS

Barrel of oil equivalent ("BOE") amounts may be misleading, particularly if used in isolation. A BOE conversion ratio has been calculated using a conversion rate of six thousand cubic feet of natural gas to one barrel and is based on an energy equivalent conversion method primarily applicable at the burner tip and does not necessarily represent an economic value equivalency at the wellhead. This conversion basis conforms to National Instrument 51-101 Standards for Oil and Gas Activities of the Canadian Securities Administrators.

DISCLOSURE CONTROLS AND PROCEDURES

The Chief Executive Officer and the Chief Financial Officer have evaluated the effectiveness of the Corporation's disclosure controls and procedures as at December 31, 2006 and have concluded that such disclosure controls and procedures were effective as at that date to provide reasonable assurance that material information relating to Birchcliff is made known to them by others within the Corporation possessing such information.



SELECTED ANNUAL INFORMATION

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Year or Period Ended December 31 2006 2005(1) 2004(2)
($000's except production and share info)
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Petroleum and natural gas revenue 93,769 67,790 -
Total revenues, net of royalties 77,629 53,067 66
Cash flow (use) from (in) operations 46,687 36,182 (638)
Basic per share $ 0.79 $ 0.89 n/a (4)
Diluted per share $ 0.77 $ 0.84 n/a (4)
Net income (loss) (1,113) 3,189 (719)
Basic per share $ (0.02) $ 0.08 n/a (4)
Diluted per share $ (0.02) $ 0.07 n/a (4)
Capital expenditures, net 102,154 306,628 439
Total assets 362,255 311,364 42,983
Working capital (deficiency) surplus (6,479) (23,730) 41,343
Revolving credit facility 81,304 36,614 -
Total debt 87,783 60,344 -
Shareholders' equity 246,399 223,894 41,694
Average daily production (BOE at 6:1) 5,368 2,793(3) -
Common shares outstanding - end of
period
Basic 64,139,413 58,147,747 1
Diluted 72,168,746 65,091,912 1,665,001
Weighted average common shares
outstanding
Basic 58,806,783 40,631,465 1
Diluted 61,011,246 42,948,811 1
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(1) The year ended December 31, 2005 had only seven months of significant
production, revenue and royalties commencing on June 1, 2005.
(2) For the period from incorporation on July 6, 2004 to December 31, 2004.
(3) This is a twelve month average. The average for the seven months during
which Birchcliff had significant production is 4,751 BOE per day.
(4) Comparative per share information is not provided because the comparison
is not meaningful due to there being only one common share outstanding
during and at the end of the period.


OVERALL PERFORMANCE

Birchcliff is a natural gas producer with 82% of its 2006 average production being natural gas. Accordingly revenues, cash flow and net income are affected by the price of natural gas to a large degree. In the seven months of 2005 during which the Corporation had significant production (from June 1 to December 31) the AECO-C daily spot price averaged $9.96/mmbtu. The 2006 average was $6.54/mmbtu which was $3.42/mmbtu lower or just over a 34% decline. This represented a loss in cash flow to Birchcliff during 2006 of approximately $27 million or $0.44 per diluted weighted average common share. Birchcliff's diluted cash flow per common share for 2006 was $0.77 based on realized prices. This loss in cash flow due to the significant price decline in 2006 represents 57% of the Corporation's current diluted cash flow per share. Birchcliff was unhedged for 2006.

As a result of the significant deterioration in natural gas prices Birchcliff reduced its capital expenditure program during 2006 from its original budget and issued equity late in 2006 in order to maintain its financial flexibility and keep its total debt to a manageable level. The Corporation is unable to predict with certainty whether natural gas prices will increase or decrease during 2007, however it has positioned itself to take advantage of rising natural gas prices should that occur during 2007.

Birchcliff's proved-plus-probable reserve additions in 2006 were 9,527 MBOE which represents a finding, development and acquisitions ("FD&A") cost, including future capital of $20.56. The operating netback for the year was $29.14 per BOE which results in a reserve recycle ratio of 1.4. Although 82% of Birchcliff's production in 2006 was natural gas and the natural gas price environment was weaker than 2005, the Corporation was still able to sell its production for a price in excess of its costs of replacing that production. The two-year average FD&A cost for 2005 and 2006, including future capital, was $17.94 per BOE which results in an operating netback recycle ratio of 1.6 based on a two-year weighted average operating netback of $33.33 per BOE. Overall, management is pleased with the two-year finding and acquisition costs which are "all-in", including future capital, and believes Birchcliff is well positioned for any future commodity price increases that may materialize.

Throughout 2006 the Corporation remained focused on its strategy of generating internal projects on and around Birchcliff's significant undeveloped land base. Total capital expenditures for the year ended December 31, 2006 were $102.2 million, with $56.3 million (55%) spent on drilling and completions; $28.2 million (28%) spent on equipment and facilities; $12.1 million (12%) spent on land acquisitions; $3.3 million (3%) spent on seismic and other exploration; and $1.1 million (1%) on minor acquisitions.

Birchcliff reached record production levels in December 2006, recording production of 6,528 BOE per day for the month. Average daily production volumes increased by 13% to 5,368 BOE per day in 2006 from 4,751 BOE/d
for the seven month period in 2005 during which the Corporation had significant production (from June 1 onward).

Total debt grew by 45% or $27.5 million, increasing to $87.8 million at December 31, 2006 compared to $60.3 million at December 31, 2005. This increase was due to capital spending of $102.2 million during the year, which exceeded Birchcliff's cash flow of $46.7 million and net proceeds of an equity issue of $28.4 million in 2006. The Corporation's credit facilities limit is $120 million excluding the working capital deficit. As at December 31, 2006, Birchcliff had drawn $81.3 million on the credit facilities.

The Corporation is always reviewing potential property acquisitions, joint venture opportunities and corporate mergers and acquisitions with the intention of completing such a transaction if acceptable terms can be negotiated. As a result, Birchcliff is continuously involved in negotiations with other parties in respect of property and corporate merger and acquisition opportunities. Management is confident that in the current environment, the Corporation is capable of raising sufficient equity and/or debt financing to fund one or more of these transactions should it be necessary.

MAJOR TRANSACTIONS AFFECTING FINANCIAL RESULTS

Birchcliff's financial results have been and will continue to be significantly affected by a number of transactions that were closed during the years ended December 31, 2006 and 2005. These transactions are summarized below:

- On January 18, 2005 the Corporation raised $60 million of gross proceeds from the issuance of equity and completed its merger with Scout Capital Corp. ("Scout") to become a public corporation.

- On May 31, 2005 the Corporation raised $136 million of gross proceeds from the issuance of equity and completed its merger with Veracel Inc ("Veracel").

- Immediately following the Veracel merger, on May 31, 2005 the Corporation completed the acquisition of significant properties in the Peace River Arch of Alberta for a purchase price of approximately $243 million (the "Acquisition).

- The Corporation's credit facility was amended and syndicated during the second quarter of 2006 into a syndicated extendible revolving term credit facility with an authorized limit of $105 million and an extendible revolving working capital facility with an authorized limit of $15 million. The mid-year review was completed in October 2006 and the credit facilities amounts remained unchanged at a combined $120 million. The $120 million of credit facilities are provided by a syndicate of two Canadian chartered banks.

- On November 22, 2006 Birchcliff issued 3,200,000 common shares at $4.40 per share and 2,740,000 flow-through common shares at $5.85 per share. The Corporation is thus committed to spend $16,029,000 on Canadian Exploration Expenditures ("CEE") by December 31, 2007. Birchcliff raised total net proceeds of $28.4 million in relation to this offering.

- In January 2007, Birchcliff issued stock options in respect of 1,647,000 common shares to employees and management at fair market value at the time of grant, with an exercise price of $3.87 per common share.

LIQUIDITY AND BANK DEBT

Working Capital

The equity issue completed on November 22, 2006 allowed Birchcliff to reduce its working capital deficit to just under $6.5 million at December 31, 2006, as compared to a working capital deficit of $23.7 million at December 31, 2005.

At December 31, 2006 the largest component of Birchcliff's current assets (71%) was the cash to be received from its marketers in respect of December 2006 production which was subsequently received in January 2007. In contrast, the current liabilities consist of trade payables (47%); accrued capital and operating costs (29%); and royalties and other minor amounts. Management expects the working capital deficit to continue into the foreseeable future as Birchcliff continues its capital program in the Peace River Arch area.

Bank Debt

The Corporation's bank debt or revolving credit facilities which have an aggregate limit of $120 million were drawn to $81.3 million at December 31, 2006 as compared to $36.6 million at December 31, 2005. The increase is mainly attributable to the capital expenditure program being greater than the Corporation's cash flow and the majority of the difference being funded through Birchcliff's available credit facilities. At December 31, 2006 the interest rate applicable to the working capital facility was 6%, and slightly less for the syndicated facility because banker's acceptances, which have a lower effective rate of interest, are used in the syndicated facility.

Overall, the Corporation did not have any liquidity issues with respect to the operations of its petroleum and natural gas business in the Reporting Period nor does it anticipate a liquidity issue in the foreseeable future. However, there is a risk that should natural gas prices decrease significantly from the budgeted $7.50/GJ at AECO-C, the Corporation would be required to either reduce its capital expenditure program or raise additional equity to ensure it stays within its credit facilities. There is also a risk that should the price decline be perceived by its lender(s) as long-term then there could be a decrease in the credit facility available to the Corporation which would result in a further reduction in capital spending. Any reduction in capital spending will reduce the production of the Corporation and its ability to meet its production targets.

The Corporation intends to finance its oil and natural gas business primarily through cash generated from operations, proceeds from bank debt, and equity financings to the extent required. Management expects to be able to continue to raise additional equity and debt financing sufficient to meet both its short-term and long-term growth requirements in the current environment. Birchcliff is now at such a size that it anticipates it will not require additional equity except to fund significant acquisitions or to increase its capital spending.

CASH FLOW FROM OPERATIONS

Birchcliff's cash flow from operations was $46.7 million for the year ended December 31, 2006 as compared to $36.2 million for the year ended December 31, 2005. In the seven months following the Acquisition in 2005, sales volumes averaged 4,751 BOE per day. The average sales volume for the year ended December 31, 2006 was 5,368 BOE per day, an increase of 13%.

The two key factors currently influencing the Corporation's cash flow from operations are the level of daily production and commodity prices. Birchcliff continues to focus on incremental production additions through acquisitions, recompletions and workovers, while also pursuing its drilling program. Birchcliff's 2006 production was 82% weighted to natural gas and as a result the Corporation has been affected by natural gas commodity price volatility during the year. Birchcliff's natural gas is all sold at a price based on the AECO-C daily spot price. Birchcliff has not hedged any of its production and although it does monitor the natural gas market, its strategy is to continue unhedged and to sell its production into the spot market. Management remains bullish about future natural gas prices and believes Birchcliff is poised to take advantage of a rising natural gas price environment.

SENSITIVITY ANALYSIS

The following table sets forth management's estimates of the sensitivity of cash flow expected to be generated by the Corporation in 2007 based on the budget approved by Birchcliff's Board of Directors. The budget contains numerous assumptions and anticipates a capital expenditure program of approximately $77.2 million. The budget does not include capital for any significant acquisitions but Birchcliff continues to pursue such opportunities and management believes the Corporation will be able to fund such acquisitions outside of the budget.



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Variance
In annual
2007 Variance Cash Flow
Factor Budget In Factor CDN$
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WTI oil price US $ 58.00 /bbl US $1.00 /bbl 360,000
Natural gas spot price (AECO) CDN $ 7.50 /GJ CDN $ 0.10 /GJ 946,000
CDN $/US$ $ 1.1640 CDN $ 0.0100 179,000
Prime rate 6.00% 1.00% 930,000

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OUTSTANDING SHARE DATA

The common shares of Birchcliff began trading on the TSX Exchange on July 21, 2005 under the symbol "BIR" and were at the same time de-listed from the TSX Venture Exchange where they were trading under the same symbol prior to such time. The following table summarizes the common shares issued, on a quarterly basis, from December 31, 2004 to December 31, 2006 which are the only class of shares outstanding:



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Common Shares
----------------------------------------------------------------------------
Balance at December 31, 2004 1
Exercise of Options and Warrants -
Private Placements 5,225,900
Issue of Common Shares for Subscription Receipts 13,966,000
Issue of Common Shares for Common Shares of Scout 1,056,436
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Balance at March 31, 2005 20,248,337
Exercise of Options and Warrants -
Issue of Common Shares for Veracel Subscription Receipts
and/or Class B Common Shares 34,000,000
Issue of Common Shares for Common Shares of Veracel 117,010
Issue of Flow-Through Common Shares 2,000,000
----------------------------------------------------------------------------
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Balance at June 30, 2005 56,365,347
Issue of Common Shares and Exercise of Options and Warrants -
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Balance at September 30, 2005 56,365,347
Issue of Common Shares upon Exercise of Warrants 300,000
Issue of Flow-Through Common Shares 1,482,400
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Balance at December 31, 2005 58,147,747
Issue of Common Shares upon Exercise of Options 20,000
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Balance at March 31, 2006 58,167,747
Issue of Common Shares upon Exercise of Options -
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Balance at June 30, 2006 58,167,747
Issue of Common Shares upon Exercise of Options 6,666
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Balance at September 30, 2006 58,174,413
Issue of Common Shares 3,200,000
Issue of Flow-Through Common Shares 2,740,000
Issue of Common Shares upon Exercise of Options 25,000
----------------------------------------------------------------------------
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Balance at December 31, 2006 64,139,413
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RESULTS OF OPERATIONS

Petroleum and Natural Gas Revenue

Petroleum and natural gas revenues totaled $93.8 million for the year ended December 31, 2006 as compared to $67.8 million for the year ended December 31, 2005. Only seven months of significant revenue was received in 2005 due to the completion of the Acquisition on May 31, 2005. The following table details Birchcliff's petroleum and natural gas revenue, production and sales prices by category for the years ended December 31, 2006 and 2005:




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Year ended December 31, 2006
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Total Average
Revenue Daily % Average
($000's) Production ($/unit)
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Natural gas (mcf) 67,005 26,375 82 6.96
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Light oil (bbls) 18,952 763 14 68.07
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Natural gas liquids (bbls) 5,389 210 4 68.58
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Total petroleum and natural gas sales
(BOE) 91,346 5,368 100 46.62
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Royalty revenue 2,423 1.24
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Total petroleum and natural gas revenue 93,769 47.86
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Year ended December 31, 2005 (1)
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Total Average
Revenue Daily Average
($000's) Production % ($/unit)
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Natural gas (mcf) 52,192 22,793 80 10.67
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Light oil (bbls) 11,697 767 16 71.29
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Natural gas liquids (bbls) 2,735 185 4 68.25
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Total petroleum and natural gas sales
(BOE) 66,624 4,751 100 65.36
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Royalty revenue 1,166 1.14
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Total petroleum and natural gas revenue 67,790 66.50
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(1) The year ended December 31, 2005 only includes seven months of
significant production, revenue and cash flow. These averages are for
the seven month period ending December 31, 2005.


Revenue during 2006 was significantly affected by the price of natural gas. Birchcliff had 97% more total natural gas production during 2006 than 2005, as it produced 26,375 mcf per day for 365 days as compared to 22,793 mcf per day for 214 days. With 97% more natural gas production, natural gas revenues only increased by $14.8 million or 28% due to the 35% decline in natural gas prices received by Birchcliff.

Commodity Prices

Birchcliff sells virtually all of its natural gas production at the AECO daily spot price. Due to the high heat content of its natural gas, Birchcliff receives premium pricing. Birchcliff received an average of $6.96/mcf for its natural gas sales in the year ended December 31, 2006 as compared to an average price of $10.67/mcf in the seven month period ended December 31, 2005 which is a 35% decline in price. The AECO daily spot price averaged $6.54/mmbtu in the year ended December 31, 2006 as compared to $9.96/mmbtu in seven month period ended December 31, 2005 which is a 34% decline. The differential from the well head to AECO daily spot was $0.42/mcf in the year ended December 31, 2006 as compared to $0.71/mcf in the seven months ended December 31, 2005.
The price the Corporation receives for its production depends on a number of factors, including AECO Canadian dollar spot market prices for natural gas, U.S. dollar oil prices, the U.S./Canadian dollar exchange rate, and transportation and product quality differentials. Birchcliff regularly considers managing the risk associated with fluctuating spot market prices for natural gas and U.S. dollar oil prices and the U.S./Canadian dollar exchange rate. Birchcliff currently has no fixed commodity price contracts or other hedge type contracts and no current plans to enter into such contracts.

Royalties and ARTC

Oil and natural gas royalties, net of ARTC totaled $16.2 million ($8.25 per BOE) during the year ended December 31, 2006 as compared to $15.4 million ($15.13 per BOE) in 2005. The overall effective royalty rate in the year ended December 31, 2006 was 18% as compared to 23% in the year ended December 31, 2005. The most significant factor in the decrease of the royalties on a per unit basis was the drop in natural gas prices. The 5% drop in royalty rate was due to greater Gas Cost Allowance ("GCA") credits received in 2006 as a result of capital spent on facilities in 2005 and due to the lower price of natural gas.

The proportion of Crown royalties to total royalties in the Reporting Periods is approximately 98% of total royalties paid. This is expected to remain relatively consistent as most of Birchcliff's new drilling is on Crown land.

Birchcliff maximized its ARTC claim for the year ended December 31, 2006. Effective January 1, 2007 the ARTC program was discontinued which will result in the Corporation no longer receiving the $500,000 annual tax credit.

Operating Costs

Operating costs were $17.3 million ($8.83 per BOE) for the year ended December 31, 2006 and $8.6 million ($8.47 per BOE) for the year ended December 31, 2005. Operating costs on a unit of volume basis were within 4% of the prior year even though service costs dramatically increased during 2006 and the Corporation experienced extended periods of downtime at a third-party facility during the year. The following table compares operating costs for the years ended December 31, 2006 and 2005:



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Operating Costs Year ended Year ended
($000's) December 31, 2006 December 31, 2005(1)
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Total ($000's) $/BOE Total ($000's) $/BOE
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Field operating costs 16,059 8.20 8,233 8.08
Expensed workovers 1,247 0.63 401 0.39
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Total operating costs 17,306 8.83 8,634 8.47
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(1) The year ended December 31, 2005 only includes seven months of
significant production, revenue and cash flow due to the Acquisition
being completed on May 31, 2005.


Operating costs are mitigated by the impact of third party revenues Birchcliff receives for processing, treating and transporting other companies' production, water disposal fees, road use fees and other minor recoveries. One of Birchcliff's strategic objectives is to maximize the use of its underutilized facilities in order to bring unit production costs down.

Birchcliff continues to implement strategies aimed at lowering its operating costs on a per BOE basis, but these decreases are being offset by rising processing fees at third party plants and general increases in costs of necessary services.

Transportation and Marketing Expenses

Transportation and marketing expenses were $3.2 million ($1.63 per BOE) for the year ended December 31, 2006 compared to $1.6 million ($1.55 per BOE) for the year ended December 31, 2005. These costs consist primarily of transportation costs. Although the aggregate amount of these costs will increase with increased production volumes, Birchcliff does not expect these costs to increase significantly on a per BOE basis.

General and Administrative Expense

Net general and administrative costs for the year ended December 31, 2006 were $5.9 million ($3.02 per BOE) and $5.3 million ($5.19 per BOE) for the year ended December 31, 2005. The components of G&A are as follows:



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General and Administrative
Expense
Year Ended Year ended
($000's) December 31, 2006 December 31, 2005(1)
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Salaries, benefits and
consultants 5,228 60% 4,793 69%
Other 3,479 40% 2,139 31%
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G & A expense, gross 8,707 100% 6,932 100%
Overhead recoveries (1,882) (22%) (749) (11%)
Capitalized overhead (905) (10%) (892) (13%)
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G & A expense, net 5,920 68% 5,291 76%
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G & A expense, net per BOE $ 3.02 $ 5.19(1)
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(1) This includes G&A costs prior to completion of the Acquisition when
Birchcliff did not have any production. For the period June 1 to
December 31, 2005 G&A was $4.01 per BOE.


The Corporation expects that as it increases production its G&A cost per BOE will be reduced because it is currently staffed for further growth. However, the market for qualified staff continues to be competitive and therefore staffing costs are likely to continue to rise which will somewhat mitigate the G&A per BOE reduction.

Interest Expense

Interest expense for 2006 was $4.2 million ($2.17 per BOE) compared to $1.2 million ($1.14 per BOE) in 2005. The increase in aggregate interest expense and interest expense per BOE result directly from the Corporation increasing its debt level throughout much of 2006 to fund the capital program which significantly exceeded Birchcliff's cash flow.

Depletion, Depreciation and Accretion Expense ("DD&A")

Depletion, depreciation and accretion ("DD&A") expenses in 2006 were $44.7 million ($22.84 per BOE) compared to $20.2 million ($19.81 per BOE) in 2005. The DD&A on a per BOE basis is 15% higher in 2006 than in 2005 mainly due to the increased cost of services which are resulting in higher finding costs which are ultimately are reflected in DD&A. The components of DD&A are as follows:



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Year Ended Year Ended
DD&A Expense December 31, 2006 December 31, 2005(1)
($000's) Total ($000's) $/BOE Total ($000's) $/BOE
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Depletion & depreciation 43,921 22.42 19,951 19.57
Accretion for Asset
Retirement Obligations 813 0.42 241 0.24
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Total DD&A 44,734 22.84 20,192 19.81
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(1) The year ended December 31, 2005 only includes seven months of
significant production, revenue and cash flow due to the Acquisition
being completed on May 31, 2005.


Depletion and depreciation expense is a function of the proved reserve additions and the cost of petroleum and natural gas properties in the full cost pool attributable to those proved reserves. At December 31, 2006, Birchcliff has excluded from its full cost pool $48.3 million (2005 - $64.4 million) of costs for undeveloped land acquired by Birchcliff and for unproved properties acquired from the Acquisition relating to opportunities in the probable reserve category and the potential drilling, recompletion and workover opportunities which have not yet been assigned any reserves. The Corporation intends that over time it will, for depletion calculation purposes, continue to reduce the cost amount excluded from the full cost pool in respect of unproved properties as those unproved properties are drilled, developed, or have their value impaired by new information or circumstances.

Petroleum and Natural Gas Properties Impairment Test

The Corporation follows the full cost method of accounting which requires periodic review of capitalized costs to ensure that they do not exceed the recoverable value of the petroleum and natural gas properties and that they do not exceed the fair value of the assets.

Birchcliff performed an impairment (ceiling) test review at December 31, 2006 on its petroleum and natural gas assets. Based on this review, Birchcliff determined there was no impairment of its petroleum and natural gas assets.

Taxes

During the year ended 2006, the May 2, 2006 federal budget was passed and the Large Corporation Tax ("LCT") was repealed effective January 1, 2006. Consequently, the Corporation has recorded $60,000 of current tax expense for 2006 relating to its tax year ended May 31, 2006 as compared to $212,000 of current tax expense for 2005.

Future income taxes arise from differences between the accounting and tax bases of the Corporation's assets and liabilities. The Corporation utilized a significant portion of its 2005 future tax asset due to flow-through shares issued in 2005 and will utilize more of it in the first quarter of 2007 due to its November 2006 flow-through share issue. At December 31, 2006 Birchcliff has the following estimated income tax pools:



TAX POOL $ millions

Canadian Exploration Expenditures 43.9
Canadian Development Expenditures 17.0
Canadian Oil & Gas Property Expenditures 183.0
Undepreciated Capital Cost 70.7
Non-Capital Losses 4.6
Scientific Research & Experimental Development 15.6
Investment Tax Credits 2.4
Share Issue Costs 7.3


The above tax pools have been reduced for $23.5 million of flow-through shares issued in 2005 but have not yet been reduced by $16 million for the November 22, 2006 flow-through share issue.

Birchcliff recorded a future income tax expense of $590,000 ($0.30 per BOE) for 2006 as compared to $5.9 million ($5.74 per BOE) in 2005. The Corporation will record future income tax expense in future years because it expects to utilize the tax basis of its assets at a rate greater than the book rate of depletion and depreciation in order to remain non-taxable.

Stock-Based Compensation

Birchcliff accounts for its stock-based compensation programs, including performance warrants and stock options, using the fair value method. Under this method, the Corporation records compensation expense related to the stock-based compensation programs in the income statement over the vesting period.

The Corporation recorded $2.7 million ($1.37 per BOE) of stock-based compensation expense relating to stock options in 2006 compared to $6.9 million ($6.82 per BOE) during 2005 which included $1.1 million ($1.10 per BOE) of expense relating to stock options and $5.8 million ($5.72 per BOE) of expense relating to performance warrants. The performance warrants vested in late 2005, therefore there is no stock-based compensation expense related to performance warrants in 2006.

During the year ended December 31, 2006, Birchcliff issued 51,666 shares due to exercise of vested stock options in respect of 51,666 common shares, and stock options in respect of 248,168 common shares were forfeited. Furthermore, vested stock options in respect of 54,998 common shares were cancelled. The cancellation of vested stock options resulted in a cash-paid stock-based compensation expense of $214,000 in 2006. The cash-paid expense is included in total stock-based compensation expense.

CAPITAL EXPENDITURES AND CAPITAL RESOURCES

Capital expenditures amounted to $102.2 million in 2006 compared to $306.6 million in 2005.

The following table sets forth a summary of the capital expenditures incurred for the Reporting Periods and the Comparable Prior Periods:



Capital Expenditures

----------------------------------------------------------------------------
Year Ended December 31 ($000's) 2006 2005
----------------------------------------------------------------------------
Land 12,098 7,609
Exploration - drilling and completions(1) 30,875 22,812
Exploration - seismic 2,670 4,885
Exploration - other 597 587
Development - drilling and completions 25,470 4,424
Development - other 135 491
Well equipment and facilities 28,238 12,070
Capitalized general and administrative expenses 905 893
----------------------------------------------------------------------------
Total F&D costs 100,988 53,771
Acquisitions 1,106 249,895
----------------------------------------------------------------------------
Total FD&A costs 102,094 303,666
Corporate acquisitions - non oil and natural
gas related - 2,155
Administrative assets 60 807
----------------------------------------------------------------------------
Total Capital Expenditures 102,154 306,628
----------------------------------------------------------------------------
(1) The exploration categorization is based on internal criteria, mainly
utilizing information from the well license and does not necessarily
coincide with the Canadian Exploration Expenditure tax classification.


The following table sets forth a summary of the Corporation's capital
resources for the Reporting Periods and the Comparable Prior Periods:

Capital Resources

----------------------------------------------------------------------------
Year Ended December 31 ($000's) 2006 2005
----------------------------------------------------------------------------
Cash generated by (used in) operations 46,687 36,182
Changes in working capital from operations 1,448 (283)
Asset retirement expenditures (570) -
Loans payable - (708)
Equity issues, net of issue costs 28,598 168,759
Increase in revolving credit facility 44,690 36,614
Changes in working capital from investing (18,698) 24,097
----------------------------------------------------------------------------
Total Capital Resources 102,155 264,661
----------------------------------------------------------------------------


SELECTED QUARTERLY INFORMATION
----------------------------------------------------------------------------
Quarter Ended
($000's, except share December September June March
and per share amounts) 31, 2006 30, 2006 30, 2006 31, 2006
----------------------------------------------------------------------------

Petroleum and natural gas
production (BOE per day) 5,861 5,571 4,760 5,271
Petroleum and natural gas
commodity price ($ per BOE) 46.86 43.11 45.42 51.24
Natural gas commodity price
at wellhead ($ per mcf) 7.33 5.91 6.48 8.09
Total petroleum and natural
gas revenue 25,750 22,546 20,515 24,958
Total royalties, net of ARTC (4,407) (4,073) (2,820) (4,871)
Total interest and other
revenue 28 - - 3
Total revenues, net 21,371 18,473 17,695 20,090

Net income (loss) (2,313) (1,342) 961 1,581
Per share basic (0.04) (0.02) 0.02 0.03
Per share diluted (0.04) (0.02) 0.02 0.03

Cash generated by operations 11,657 10,666 11,068 13,296
Per share basic 0.19 0.18 0.19 0.23
Per share diluted 0.19 0.18 0.18 0.22

Book value of total assets 362,255 359,073 345,092 329,632
Revolving credit facility (81,304) (100,127) (85,299) (66,601)
Total indebtedness (87,783) (115,100) (100,321) (86,708)
Shareholder's equity 246,399 219,066 219,719 218,124

Common shares outstanding -
end of period
Basic 64,139,413 58,174,413 58,167,747 58,167,747
Diluted 72,168,746 66,383,746 66,277,414 66,292,746

Weighted average common
shares outstanding
Basic 60,701,424 58,173,508 58,167,747 58,163,525
Diluted 61,347,463 60,681,252 61,499,413 61,827,830
----------------------------------------------------------------------------

----------------------------------------------------------------------------
Quarter Ended
($000's, except share December September June March
and per share amounts) 31, 2005 30, 2005 30, 2005 31, 2005
----------------------------------------------------------------------------

Petroleum and natural gas
production (BOE per day) 5,009 4,626 1,460(1) -
Petroleum and natural gas
commodity price ($ per BOE) 72.65 62.20 50.16 -
Natural gas commodity price
at wellhead ($ per mcf) 12.23 9.91 7.69
Total petroleum and natural
gas revenue 34,175 26,843 6,772 -
Total royalties (8,269) (5,711) (1,441) -
Total interest and other
revenue 1 2 365 329
Total revenues 25,907 21,134 5,696 329

Net income (loss) 126 4,336 (601) (672)
Per share basic - 0.08 (0.02) (0.04)
Per share diluted - 0.07 (0.02) (0.04)

Cash generated by (used in)
operations 18,112 15,303 3,109 (342)
Per share basic 0.32 0.27 0.10 (0.02)
Per share diluted 0.30 0.26 0.09 (0.02)

Book value of total assets 311,364 276,961 266,655 57,658
Revolving credit facility (36,614) (47,945) (55,155) -
Total (indebtedness) /
working capital (60,344) (53,748) (54,244) 29,232
Shareholder's equity 223,894 204,198 199,193 56,923

Common shares outstanding -
end of period
Basic 58,147,747 56,365,347 56,365,347 20,248,337
Diluted 65,091,912 63,259,512 63,143,512 25,963,002

Weighted average common
shares outstanding
Basic 56,614,330 56,365,347 32,507,978 16,423,651
Diluted 59,964,046 58,842,965 34,012,050 17,862,366
----------------------------------------------------------------------------
(1) Average for the quarter is based on production for June 2005 only,
which is the period during which Birchcliff recorded petroleum and
natural gas production and associated revenues and expenses following
its acquisition of significant oil and natural gas properties.


Discussion of Quarterly Results

Birchcliff has generally grown its average daily production quarter over quarter with the exception of the quarter ended June 30, 2006 during which production was reduced as a result of plant turnarounds and the effect of spring break-up on drilling, completion and pipelining operations.

Since December 31, 2005 the Corporation has issued equity for net proceeds of $28.6 million (including exercises of options) and increased its total debt by $27.4 million, as a result of an additional $56 million of incremental spending above its cash flow during the year because of continued capital spending in an environment of significantly decreased natural gas prices and significantly increased service costs. Notwithstanding a 17% increase in average quarterly production, cash flows have decreased $6.4 million (35%) from $18.1 million in Q4 2005 with a natural gas price of $12.23/mcf at the wellhead to $11.7 million in Q4 2006 with a natural gas price of $7.33 at the wellhead.

The high cost of services experienced over the past year coupled with decreasing natural gas prices results in the high cost for the production additions that Birchcliff achieved in 2006. In order to add value on a sustainable basis through development of Birchcliff's Doig/Montney resource play, either natural gas prices need to increase or the cost of services must decrease. Should the cost of services remain high and natural gas prices remain low, the Corporation will need to defer development of this resource play and focus on higher deliverability and less capital intensive opportunities in its asset base.

Fourth Quarter 2006

Fourth quarter results were somewhat negatively affected by the continued curtailment of a portion of Birchcliff's production due to third party gas plant capacity issues. Nevertheless, Birchcliff surpassed its target exit rate of 6,500 BOE per day with production of 6,528 BOE per day recorded in the month of December 2006.

The total indebtedness of the Corporation was reduced by the issuance of 5,940,000 common shares on November 22, 2006 for net proceeds of $28.4 million.

During the fourth quarter the Corporation's capital expenditure program was significantly reduced as compared to the prior quarters of 2006.

SUMMARY 2007 OUTLOOK

Birchcliff has undertaken an in depth review of its strategy and the environment in which it operates, particularly given the Minister of Finance's October 31, 2006 announcement regarding taxation of royalty trusts, and has reorganized itself to pursue a longer-term strategy of growth in terms of both reserves and production. Birchcliff will also endeavor to achieve reductions to operating costs and will continue to vigilantly monitor its capital expenditures. To this end, the Corporation has added a VP Operations; realigned its technical team members geographically within the Peace River Arch; and dedicated personnel and resources to reviewing strategic acquisitions inside and outside of the Peace River Arch.

The Corporation is aware of how lower natural gas prices and higher service costs are affecting the economics of its capital spending program and is closely monitoring the situation. The Corporation's 2007 operating budget is based on a projected average AECO spot natural gas price of $7.50 per GJ ($7.88 per mmbtu) and an average WTI price of US$ 58.00. Based on its operating budget, the Corporation has set a 2007 capital budget of $77.2 million which it expects to fund from cash flow and existing credit facilities.

CONTRACTUAL COMMITMENTS

Flow-Through Share Commitments

In the fourth quarter of 2006, the Corporation committed to renounce approximately $16 million of exploration expenditures pursuant to a flow-through common share issue completed on November 22, 2006. Birchcliff has until December 31, 2007 to incur these exploration expenditures. The Corporation will be subject to Part XII.6 tax based on the prescribed rate and the balance of exploration expenditures not yet incurred at the end of each month subsequent to January 31, 2007. To December 31, 2006 the costs incurred with respect to the $16 million flow-through share obligation totaled just under $2 million.

Office Premises

The Corporation is committed under an operating lease for its current office premises which expires on September 30, 2008. It is also committed to March 29, 2011 under an operating lease for some other premises which it does not use and has sublet to an arm's length party on a basis that recovers all of its rental costs. The Corporation is committed to the following aggregate minimum lease payments (not reduced by rents receivable):



---------
$
---------

2007 877,000
2008 787,000
2009 202,000
2010 202,000
2011 51,000
Thereafter -


Drilling Rig Commitments

The Corporation has fulfilled without penalty, its commitments in respect of the use of drilling rigs for a specified term and presently the Corporation does not have any long term commitments to use drilling rigs.

CRITICAL ACCOUNTING ESTIMATES

Management is required to make judgments, assumptions and estimates in the application of Generally Acceptable Accounting Principles ("GAAP") that may have a significant impact on the financial results of the Corporation. The following summarizes the accounting estimates that are critical to determining Birchcliff's financial results.

Estimates of P&NG Reserves, Depletion and Depreciation and Ceiling Test

The Corporation, at least annually, engages a qualified independent reserves evaluator to provide an estimate of the Corporation's year-end reserve volumes and associated future net revenues. These estimates are herein referred to as the "Reserve Estimates". To facilitate this process, the Corporation provides relevant production, financial and technical data to the reserves evaluator. The Corporation considers the Reserve Estimates to be critical estimates for the reasons discussed below. For further details on the methodology and assumptions relating to the Reserve Estimates, please see the Statement of Reserves Data and Other Oil and Gas Information filed by the Corporation on SEDAR at www.sedar.com in accordance with National Instrument 51-101.

The Reserves Estimates relating to the volume of reserves are utilized in the calculation of depletion and depreciation expense in the financial statements. The reserves volume together with the production volumes for the relevant period is utilized in calculating a depletion rate for the Corporation. This depletion rate is used together with other accounting information to determine the depletion and depreciation for that period.

The Reserve Estimates relating to future net revenues of reserves are utilized in a ceiling test calculation to determine if the costs capitalized under the full cost method of accounting have been impaired and thus should be written down. This potential impairment is based on a determination of whether the carrying value of petroleum and natural gas properties exceeds the estimated undiscounted future net cash flows from the proved reserves attributable to such properties.

Should the Reserve Estimates relating to the volume of reserves be materially incorrect, it could have a material impact on the Corporation's recorded amount of depletion and depreciation expense. Should the Reserves Estimates relating to the future net revenues of reserves be materially incorrect it may have a material impact on the determination of whether or not the Corporation is required to write down its petroleum and natural gas assets as a result of the ceiling test. The Reserve Estimates will from time to time change based on changes in the many factors underlying the Reserve Estimates, which include but are not limited to: production performance, commodity prices, amount and timing of projected capital expenditures, revised technical interpretations based on activity and new information and the impact of additional activities not contemplated in the preparation of the Reserve Estimates.

The Reserve Estimates are also relied upon by the Corporation's major lending syndicate in determining the production loan amount available to the Corporation under its credit facilities. The lending syndicate relies on all components of the Reserve Estimates and the underlying assumptions, except for the price forecast. The lending syndicate in most instances utilizes its own price forecast. The availability of these credit facilities are important to the Corporation because it relies on this source of capital to fund its capital budget in excess of its internally generated funds. Should the Reserves Estimates change materially and negatively, it may have a material adverse affect on the amount of capital available to the Corporation under the credit facilities, which may impair the Corporation's ability to pursue its business plans.

Asset Retirement Obligations

Birchcliff records a liability for the fair value of legal obligations associated with the retirement of long-lived assets in the period in which they are incurred, normally when the asset is purchased or developed. In the oil and gas industry this retirement obligation is normally associated with abandonment and reclamation costs relating to wells and facilities. On recognition of the asset retirement obligation there is a corresponding increase in the carrying amount of the related asset (an increase to petroleum and natural gas properties and equipment) which is recorded as the asset retirement cost. The total future asset retirement obligation is an estimate at a point in time based on the Corporation's net ownership interest in all wells (producing, shut-in, suspended and others) and facilities, the estimated cost to abandon and reclaim these wells and facilities, and the estimated timing of the costs to be incurred in future periods. The total undiscounted amount of the estimated cash flows required to settle the asset retirement obligation is the Corporation's best estimate at any given point in time that is subject to measurement uncertainty and any change may potentially impact the liability materially.

Birchcliff attempts to mitigate this risk by reviewing all of its wells and facilities included in the calculation and by utilizing the expertise of its reserve evaluation consultants in order to provide the best estimates possible at the time.

Current Income Taxes

The Corporation is required to file a corporate income tax return annually and is required to pay any income tax liability in a timely manner. As a result of this requirement, Birchcliff must estimate at the end of each reporting period its potential current income tax liability for the particular fiscal year in question. In order to determine its income tax liability for the fiscal year, the Corporation must estimate revenue, royalties (net of ARTC), other income, operating expenses, general and administrative expenses, interest expense, capital expenditures and other relevant items. The Corporation makes these estimates using its budget approved by the Board of Directors and adjusts it for any actual history up to the time the estimate is made. The critical estimates in this process are production rates, commodity prices, capital expenditures and the tax category of these capital expenditures for the entire fiscal period. The risk of materially misstating the amount of current taxes payable is highest in respect of the first quarter and reduces for each quarter thereafter as more actual data is used and the estimated amounts apply to a shorter period.

To the extent that the estimate of current taxes payable varies materially from the actual amount of taxes payable, the Corporation may be required to pay an unexpected material amount of taxes which may adversely affect the Corporation's financial condition. The most critical part of this estimate is the estimate of the amount and tax category of capital expenditures that will be incurred during the relevant year as those expenditures form the basis of any new tax pools that Birchcliff can use as deductions in respect of that year. To the extent that a material amount of capital allocated to exploration drilling which is 100% deductible in the fiscal year, is ultimately allocated to development drilling which is only 30% deductible in the fiscal year, the Corporation's current taxes payable can change materially. There is a risk that wells that are drilled in an effort to encounter a new oil or natural gas accumulation can encounter an already discovered accumulation, thus changing the tax category from exploration expenditure to development expenditure. This risk is significant because many wells drilled by the Corporation are drilled in proximity to other wells and the tax category of the expenditures is not finally determined until drilling is completed. To mitigate this risk, the Corporation allocates its entire budget to tax categories based on discussions with its operations group and reviews the continuing validity of these categorizations at each reporting period.

The determination of the Corporation's income and other tax liabilities requires interpretation of complex laws and regulations. All tax filings are subject to audit and potential reassessment after the lapse of considerable time. Accordingly, the actual income tax liability may differ from that estimated and recorded by Management.

RISK FACTORS & RISK MANAGEMENT

Commodity Price Risk

Since Birchcliff was 82% weighted to natural gas during the year ended December 31, 2006 one major risk factor affecting the Corporation's liquidity is a further decline in commodity prices for natural gas. Birchcliff has not hedged any of its production and although it does monitor the hedge market, its strategy is to continue unhedged and to sell its production into the spot market. Management remains bullish about future natural gas prices and believes Birchcliff is well positioned to take advantage of a rising natural gas price environment. If there is a significant deterioration in the natural gas price it receives, Birchcliff will be required to reduce its planned capital program or access alternate sources of capital.

Production Risk

Birchcliff believes it has a stable production base from a large number of wells (including 2 wells which each produce more than 500 BOE per day), and that an adverse event affecting production at any single well would not cause a liquidity issue. Nonetheless, Birchcliff remains subject to the risk that production rates of its most significant wells may decrease in an unpredictable and uncontrollable manner, which could result in a material decrease in the Corporation's overall production and associated cash flows.

Reserve Replacement Risk

Oil and natural gas reserves naturally deplete as they are produced over time. The success of the Corporation's business is highly dependent on its ability to acquire and/or discover new reserves in a cost efficient manner. Substantially all of the Corporation's cash flow is derived from the sale of the petroleum and natural gas reserves it accumulates and develops. In order to remain financially viable, the Corporation must be able to replace reserves over time at a lesser cost on a per unit basis than its cash flow on a per unit basis. The reserves and costs used in this determination are estimated each year based on numerous assumptions and these estimates and costs may vary materially from the actual reserves produced or from the costs required to produce those reserves. In order to mitigate this risk, the Corporation employs a competent and experienced team of petroleum and natural gas professionals and closely monitors the capital expenditures made for the purposes of increasing its petroleum and natural gas reserves.

Health, Safety & Environmental ("HS&E") Risk

Health, safety and environment risks influence the workforce, operating costs and the establishment of regulatory standards. Birchcliff provides staff with the training and resources need to complete work safely and effectively; incorporates hazard assessment and risk management as an integral part of everyday operations; monitors performance to ensure its operations comply with legal obligations and internal standards; and identifies and manages environmental liabilities associated with its existing asset base. The Corporation has a site inspections program and a corrosion risk management program designed to ensure compliance with environmental laws and regulations. Birchcliff carries insurance to cover a portion of property losses, liability to others and business interruption resulting from unusual events.

Regulatory Risk

Government royalties, income tax laws, environmental laws and regulatory requirements can have a significant financial and operational impact on the Corporation. As an oil and natural gas producer, Birchcliff is subject to a broad range of regulatory requirements. Birchcliff does its best to remain knowledgeable regarding changes to the regulatory regime under which it operates.

Access to Capital Markets

Since Birchcliff spends the majority of cash flow on operations and capital spending, the Corporation must finance most major acquisition activity with equity and debt. As such, Birchcliff is dependent to a certain extent on continued access to equity and debt capital markets. The Corporation is listed on the Toronto Stock Exchange and maintains an active investor relations program. Continued access to capital is dependent on Birchcliff's ability to continue to perform at a level that meets market expectations.

Counterparty Risk

Birchcliff assumes customer credit risk associated with oil and gas sales and joint venture participants. To mitigate this risk, the Corporation performs regular reviews of receivables to minimize default or non-payment and takes the majority of its production in kind. The Corporation also puts in place security arrangements with respect to amounts owed to it by others when reviews indicate it is appropriate to do so.

2006 Financial Statements

Financial Statements of

BIRCHCLIFF ENERGY LTD.

December 31, 2006



Deloitte & Touche LLP
3000 Scotia Centre
700 Second Street S.W.
Calgary AB T2P 0S7 Canada

Tel: (403) 267-1700
Fax: (403) 264-2871
www.deloitte.com


Auditors' Report

To the Shareholders of Birchcliff Energy Ltd.:

We have audited the balance sheets of Birchcliff Energy Ltd. as at December 31, 2006 and 2005 and the statements of net income (loss) and retained earnings and cash flows for the years then ended. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.

In our opinion, these financial statements present fairly, in all material respects, the financial position of the Corporation as at December 31, 2006 and 2005 and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles.

(signed) "Deloitte & Touche LLP"

Chartered Accountants

Calgary, Alberta

March 9, 2007



BIRCHCLIFF ENERGY LTD.
Balance Sheets
As at December 31, ($000's)
----------------------------------------------------------------------------
2006 2005
-----------------------------
ASSETS
CURRENT
Cash and cash equivalents 65 64
Accounts receivable 13,498 16,385
Prepaid and other 3,240 1,426
-----------------------------
16,803 17,875

Future income tax benefit (Note 6) 6,689 14,735

Petroleum and natural gas properties and
equipment (Note 5) 338,763 278,754
-----------------------------
362,255 311,364
-----------------------------
-----------------------------
LIABILITIES
CURRENT
Accounts payable and accrued liabilities 23,282 41,605
-----------------------------
23,282 41,605
-----------------------------

Revolving credit facility (Note 7) 81,304 36,614
Asset retirement obligations (Note 8) 11,270 9,251

SHAREHOLDERS' EQUITY
Share capital (Note 9) 236,158 214,951

Contributed surplus (Note 10) 8,990 6,579
1,251 2,364
Retained earnings
-----------------------------
246,399 223,894
-----------------------------
362,255 311,364
-----------------------------
-----------------------------
Commitments (Note 12)

See accompanying notes to the financial statements.

APPROVED BY THE BOARD

"Larry A Shaw"
Larry A. Shaw, Director

"A. Jeffery Tonken"
A. Jeffery Tonken, Director


BIRCHCLIFF ENERGY LTD.
Statements of Net Income (Loss) and Retained Earnings
For the Year Ended December 31, ($000's)
----------------------------------------------------------------------------
2006 2005
-----------------------------
REVENUE
Petroleum and natural gas 93,769 67,790
Royalties, net of ARTC (16,171) (15,421)
Interest and other 31 698
-----------------------------
77,629 53,067
-----------------------------
EXPENSES
Production 17,306 8,634
Transportation and marketing 3,194 1,583
General and administrative 5,920 5,291
Stock-based compensation (Note 10) 2,691 6,948
Depletion, depreciation and accretion
(Note 5 and 8) 44,734 20,192
Interest 4,247 1,165
-----------------------------
78,092 43,813
-----------------------------
INCOME (LOSS) BEFORE TAXES (463) 9,254

TAXES
Capital taxes 60 212
Future income taxes (Note 6) 590 5,853
-----------------------------
650 6,065
-----------------------------
NET INCOME (LOSS) (1,113) 3,189

RETAINED EARNINGS (DEFICIT), BEGINNING OF
YEAR 2,364 (789)

PLAN OF ARRANGEMENT COSTS (Note 3) - (36)
-----------------------------

RETAINED EARNINGS, END OF YEAR 1,251 2,364
-----------------------------
-----------------------------

Net income (loss) per common share (Note 11)
basic ($0.02) $ 0.08
diluted ($0.02) $ 0.07

Weighted average common shares
basic 58,806,783 40,631,465
diluted 58,806,783 42,948,811

See accompanying notes to the financial statements.


BIRCHCLIFF ENERGY LTD.
Statements of Cash Flows
For the Year Ended December 31, ($000's)
----------------------------------------------------------------------------
2006 2005
-----------------------------
CASH FLOWS RELATED TO THE FOLLOWING
ACTIVITIES:

OPERATING

Net income (loss) (1,113) 3,189
Adjustments for items not affecting cash:
Depletion, depreciation and accretion 44,734 20,192
Stock-based compensation 2,476 6,948
Future income taxes 590 5,853
-----------------------------
-----------------------------

46,687 36,182
Changes in non-cash working capital (Note 13) 1,448 (283)
Asset retirement expenditures incurred (570) -
-----------------------------
47,565 35,899
-----------------------------
FINANCING
Increase in revolving credit facility
(Note 7) 44,690 36,614
Decrease in loans payable - (708)
Issuance of share capital, net of issue costs 28,598 168,759
-----------------------------
73,288 204,665
-----------------------------
INVESTING
Scout arrangement costs (Note 3) - (36)
Purchase of petroleum and natural gas
properties and equipment (Note 4) - (242,812)
Purchase of minor petroleum and natural gas
properties and equipment (1,106) (9,202)
Development of petroleum and natural gas
properties and equipment (101,048) (54,578)
Changes in non-cash investing working capital
(Note 13) (18,698) 24,097
-----------------------------
(120,852) (282,531)
-----------------------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 1 (41,967)

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 64 42,031
-----------------------------
-----------------------------

CASH AND CASH EQUIVALENTS, END OF YEAR 65 64
-----------------------------
-----------------------------

Cash interest paid 4,247 1,165
Cash taxes paid 60 272

See accompanying notes to the financial statements


1. BASIS OF PRESENTATION

Birchcliff Energy Ltd. ("Birchcliff" or the "Corporation") was a private company, incorporated under the Business Corporations Act (Alberta) on July 6, 2004 as 1116463 Alberta Ltd. The name was changed from 1116463 Alberta Ltd. to Birchcliff Energy Ltd. on September 10, 2004. The Corporation is engaged in the exploration for and the development, production and acquisition of, petroleum and natural gas reserves in Western Canada.

On January 18, 2005, the Corporation completed a merger arrangement ("Scout Arrangement") involving the Corporation and Scout Capital Corp. ("Scout"), a publicly traded corporation. The newly amalgamated entity, Birchcliff Energy Ltd., became a publicly traded corporation on the TSX Venture Exchange on January 20, 2005. This transaction was accounted for using reverse takeover accounting principles.

On May 31, 2005, the Corporation completed a merger arrangement ("Veracel Arrangement") involving the Corporation and Veracel Inc. ("Veracel"), a privately held corporation that sought to reorganize and enter the oil and gas business. Concurrent with the Veracel Arrangement, Birchcliff completed the purchase of certain properties in the South West Peace River Arch area of Alberta (the "Acquisition"). On July 21, 2005, Birchcliff commenced trading on the Toronto Stock Exchange and was de-listed from the TSX Venture Exchange.

2. SIGNIFICANT ACCOUNTING POLICIES

The financial statements have been prepared by management in accordance with Canadian generally accepted accounting principles ("GAAP"), within an acceptable level of materiality, utilizing the framework of the accounting policies below. The financial statements are expressed in Canadian dollars.

(a) Basis of accounting

The Corporation's financial statements include the accounts of Birchcliff. There are no subsidiary companies.

(b) Revenue recognition

Revenue associated with sales of petroleum and natural gas are recorded when the commodities are delivered and title passes to the purchaser. Revenue associated with sales of petroleum and natural gas are recorded gross of transportation and marketing charges.

(c) Joint venture activities

A portion of the Corporation's exploration and production activities are conducted jointly with others and, accordingly, the accounts reflect only the Corporation's proportionate interest in such activities.

(d) Measurement uncertainty

The preparation of timely financial statements necessitates the use of estimates when transactions affecting the current accounting period cannot be finalized until future periods. These estimates will affect assets, liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as revenues and expenses during the reporting periods. Such estimates are based on informed judgments made by management. Actual results could differ materially from those estimated.

Amounts recorded for depletion, depreciation, asset retirement and amounts used for ceiling test calculations are based on estimates of oil and natural gas reserves which include estimates of future commodity prices, future costs and other relevant assumptions. The Corporation's reserves are estimated and evaluated, at a minimum, annually by an independent engineering firm. By their nature, these estimates of reserves and the related cash flows are subject to measurement uncertainty and the impact of changes in such estimates on the financial statements of future periods could be material.

(e) Cash and cash equivalents

Cash and cash equivalents includes cash and highly liquid short-term investments having a maturity date of not more than ninety days at the time of purchase.

(f) Property, plant and equipment

Capitalized costs

The Corporation follows the full cost method of accounting whereby all costs relating to the exploration, acquisition and development of petroleum and natural gas reserves are capitalized. Such costs include land acquisition costs, geological and geophysical expenses, production equipment, carrying charges of non-producing properties, costs of drilling both productive and non-productive wells and corporate charges directly related to acquisition, exploration and development activities. Proceeds from the sale of properties are applied against capitalized costs, with no gain or loss recognized, unless such a sale would alter the rate of depletion and depreciation by 20% or more.

Depletion and depreciation

Depletion and depreciation of petroleum and natural gas properties and equipment, together with the estimated future costs to be incurred in developing proved reserves, are depleted or depreciated using the unit-of-production method based on the proved reserves before royalties as estimated by independent engineers. Oil and natural gas reserves and production are converted into equivalent units based upon estimated relative energy content of six thousand cubic feet of natural gas to one barrel of oil. The costs of undeveloped properties are excluded from the costs subject to depletion and depreciation until it is determined whether proved reserves are attributable to the properties or impairment occurs.

Impairment

Oil and natural gas properties are evaluated each reporting period through an impairment test to determine the recoverability of capitalized costs. The carrying amount is assessed as recoverable when the sum of the undiscounted cash flows expected from proved reserves plus the cost of unproved interests, net of impairments, exceeds the carrying amount. When the carrying amount is assessed not to be recoverable, an impairment loss is recognized to the extent that the carrying amount exceeds the sum of the discounted cash flows from proved and probable reserves plus the cost of unproved interests, net of impairments. The cash flows are estimated using expected future prices and costs and are discounted using a credit adjusted risk-free interest rate.

Administrative assets

The Corporation records depreciation on its office furniture and equipment, which includes computer equipment, on a straight-line basis using an expected useful life of four years.

(g) Asset retirement obligations

The Corporation recognizes the estimated liability associated with future site reclamation costs in the financial statements when a well or related asset is drilled, constructed or acquired. Costs are estimated by management in consultation with the Corporation's engineers based on current costs and technology in accordance with current legislation and industry practices. The obligation is initially measured at fair value, and subsequently adjusted for the accretion of discount and any changes to the underlying cash flows. The asset retirement cost is capitalized to oil and natural gas properties and equipment and amortized into earnings in depletion expense on a basis consistent with depletion and depreciation. Actual site restoration and abandonment expenditures are applied directly against the asset retirement obligation. The Corporation reviews the obligation regularly such that revisions to the estimated timing of cash flows, discount rates and estimated costs will result in an increase or decrease to the asset retirement obligation.

(h) Future income taxes

The Corporation accounts for its income taxes using the liability method. Under this method, future income tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities using the tax rates anticipated to apply in relevant future periods. The effect of a change in income tax rates on future income tax liabilities and assets is recognized in the period that the change occurs.

(i) Stock-based compensation

The Corporation accounts for its stock-based compensation plans using the fair value method to value stock options and performance warrants granted to officers, directors, employees and consultants. Under this method, compensation cost attributed to stock options and performance warrants granted to officers, directors, employees and consultants is measured at fair value at the grant date and expensed over the vesting period with a corresponding increase to contributed surplus. Upon the exercise of stock options or performance warrants, consideration paid together with the amount previously recognized in contributed surplus is recorded as an increase to share capital. The Corporation does not incorporate an estimated forfeiture rate for stock options or performance warrants that will not vest, but instead accounts for forfeitures as a change in estimate in the period in which they occur. In the event that vested stock options or performance warrants expire without being exercised, previously recognized compensation costs associated with such stock options and performance warrants are not reversed.

(j) Flow-through shares

The resource expenditure deductions for income tax purposes related to exploratory and development activities funded by flow-through share arrangements are renounced to investors in accordance with tax legislation. The Corporation records the carrying value of the expenditures in property, plant and equipment as incurred and records the future income taxes associated with the renunciation of expenditures with a corresponding reduction to share capital.

(k) Financial instruments

The Corporation has determined that the fair value of the financial instruments consisting of cash and cash equivalents, accounts receivable and accounts payable and accrued liabilities is not materially different from the carrying value of such instruments reported on the balance sheet due to their short-term nature. In respect of the revolving credit facility, the carrying value is not materially different than its fair values as the credit facility bears interest based on the prevailing interest rate.

(l) Per share information

Per share information is computed using the weighted average number of common shares outstanding during the period. Diluted per share information is calculated using the treasury stock method, which assumes that any proceeds from the exercise of "in-the-money" stock options or performance warrants plus the unamortized stock based compensation expense amounts would be used to purchase common shares at the average market price during the period. No adjustment to diluted earnings per share is made if the result of these calculations is anti-dilutive.

3. SCOUT ARRANGEMENT

Pursuant to an arrangement agreement dated November 8, 2004, as amended on December 1, 2004, the Corporation implemented a Plan of Arrangement with Scout that was completed on January 18, 2005. The Corporation accounted for this transaction as a reverse takeover of Scout by Birchcliff. Costs incurred to December 31, 2005 of $36,000 relating to the transaction were charged directly to the deficit in 2005.



----------------------------------------------------------------------------
----------------------------------------------------------------------------
Net assets acquired: $ 000's
----------------------------------------------------------------------------
Cash and short-term investments 3,411
Marketable securities, accounts receivable and other 18
Current liabilities, including Scout transaction costs (260)
----------------------------------------------------------------------------
3,169
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Consideration: $ 000's
----------------------------------------------------------------------------
Common shares of the Corporation (1,056,436) 3,169
----------------------------------------------------------------------------
----------------------------------------------------------------------------


4. VERACEL ARRANGEMENT AND ACQUISITIONS OF PETROLEUM AND NATURAL GAS PROPERTIES AND EQUIPMENT

Veracel Arrangement and South West Peace River Arch Acquisition

On March 29, 2005, the Corporation signed a purchase and sale agreement relating to the purchase of certain properties in the South West Peace River Arch area of Alberta (the "Acquisition"), effective January 1, 2005, for $255 million before closing adjustments and related costs. The Acquisition closed on May 31, 2005, immediately after the completion of the Veracel Arrangement. Birchcliff recorded operating results from June 1, 2005 forward for the Acquisition in these financial statements.

Pursuant to an arrangement agreement, the Corporation implemented a Plan of Arrangement with Veracel which was completed on May 31, 2005. Veracel was in the process of re-organizing itself. All comparative figures are those of the Corporation.



The following table details the purchase price allocation for the Veracel
Arrangement and the Acquisition:

----------------------------------------------------------------------------
----------------------------------------------------------------------------
Net assets acquired: $ 000's
----------------------------------------------------------------------------
Petroleum and natural gas properties and equipment 233,921
Asset retirement costs (8,357)
Future tax benefit 17,248
----------------------------------------------------------------------------
242,812
----------------------------------------------------------------------------
----------------------------------------------------------------------------

----------------------------------------------------------------------------
----------------------------------------------------------------------------
Consideration: $ 000's
----------------------------------------------------------------------------
Purchase price, net of adjustments, paid in cash 238,564
Costs related to the Veracel Arrangement 2,119
Costs related to the Acquisition 2,129
----------------------------------------------------------------------------
242,812
----------------------------------------------------------------------------
----------------------------------------------------------------------------


5. PETROLEUM AND NATURAL GAS PROPERTIES AND EQUIPMENT

----------------------------------------
2006
----------------------------------------
Accumulated
Depletion and
Cost Depreciation Net Book Value
$ $ $
------------------------------------------------------------------------
Petroleum and natural gas assets 401,626 (63,468) 338,158
Office furniture and equipment 1,027 (422) 605
----------------------------------------
402,653 (63,890) 338,763
----------------------------------------
----------------------------------------

----------------------------------------
2005
----------------------------------------
Accumulated
Depletion and
Cost Depreciation Net Book Value
$ $ $
----------------------------------------
Petroleum and natural gas assets 297,756 (19,804) 277,952
Office furniture and equipment 967 (165) 802
----------------------------------------
298,723 (19,969) 278,754
----------------------------------------
----------------------------------------


As of December 31, 2006, the cost of petroleum and natural gas properties includes $48.3 million (2005 - $64.4 million) relating to unproved properties which have been excluded from costs subject to depletion and depreciation. Most of these costs relate to unproved properties acquired in the Acquisition (Note 4).

Birchcliff has capitalized general and administrative costs of $905,000 in the year ended December 31, 2006 (2005 - $893,000) relating to exploration and development activities.

The Corporation performed an impairment (ceiling) test review at December 31, 2006 to ensure the carrying value of its petroleum and natural gas properties and equipment is recoverable and does not exceed fair value. The petroleum and natural gas future prices are based on December 31, 2006 commodity price forecasts of the Corporation's independent reserve evaluators. The following table summarizes the benchmark prices used in the ceiling test calculation:



--------------------------------------------------------------------------
WTI Oil Foreign Exchange Edmonton Light Crude Oil AECO Gas
Year ($US/bbl) Rate ($Cdn/bbl) ($Cdn/mcf)
--------------------------------------------------------------------------

2007 65.00 0.880 72.85 7.40
2008 69.35 0.880 77.75 8.00
2009 70.75 0.880 79.35 7.90
2010 69.00 0.880 77.30 8.00
2011 67.10 0.880 75.15 8.25
2012 66.25 0.880 74.15 8.40
2013 67.55 0.880 75.60 8.50
2014 68.90 0.880 77.15 8.75
2015 70.30 0.880 78.70 8.90
2016 71.70 0.880 80.25 9.10
2017 73.15 0.880 81.85 9.25
2018 74.60 0.880 83.50 9.45
2019 76.10 0.880 85.15 9.65
2020 77.60 0.880 86.85 9.85
2021 79.15 0.880 88.60 10.05
2022 80.75 0.880 90.40 10.25
2023 82.35 0.880 92.20 10.45
2024 84.00 0.880 94.05 10.65
2025 85.70 0.880 95.90 10.85
2026 87.40 0.880 97.85 11.05
2026+ 2% 0.880 2% 2%
--------------------------------------------------------------------------
--------------------------------------------------------------------------


Based on these assumptions, management's assessment is that there is no impairment of petroleum and natural gas properties and equipment as at December 31, 2006.

6. FUTURE INCOME TAX BENEFIT

The provision for income taxes differs from the result that would be obtained by applying the combined current year Canadian federal and provincial income tax rates of 34.5% (2005 - 37.62%) to the income (loss) before taxes. The difference results from the following items:



2006 2005
($000's) ($000's)
-----------------------

Net income (loss) before taxes (463) 9,254
-----------------------

Computed expected income tax expense (recovery) (160) 3,481
Increase (decrease) in taxes resulting from:
Non-deductible Crown payments 1,669 3,135
Resource allowance (1,558) (2,642)
Non-deductible stock-based compensation 854 2,614
Non-deductible expenses 16 12
Valuation allowance - (204)
Change in rate and other (231) (543)

-----------------------
Future income tax expense 590 5,853
-----------------------
-----------------------


The components of the future income tax assets and liabilities at December
31 are as follows:

---------------------------
2006 2005
($000's) ($000's)
---------------------------
Future income tax liabilities:
Property, plant and equipment (7,399) (2,693)
Future income tax assets:
Asset retirement obligation 3,320 3,145
Share issue costs 2,241 2,687
ACRI 550 460
NCL's, SR&ED's & ITC's (1) 7,977 11,136
---------------------------
6,689 14,735
Valuation allowance - -
---------------------------
Net future income tax asset 6,689 14,735
---------------------------
---------------------------

(1) "NCL" equals Non Capital Losses; "SR&ED" equals "Scientific
Research & Experimental Development"; "ITC" equals "Investment Tax
Credits"


At December 31, 2006, the Corporation has estimated non-capital losses for income tax purposes of approximately $4,600,000 (2005 - $18,956,000), expiring in 2017 available to shelter future taxable income.

7. REVOLVING CREDIT FACILITY

The Corporation has available to it an extendible revolving term credit facility with an authorized limit of $105 million and an extendible revolving working capital facility with an authorized limit of $15 million. The $120 million of credit facilities are provided by a syndicate of two Canadian chartered banks (the "Syndicate"). As at December 31, 2006, Birchcliff had drawn $81.3 million on the credit facilities. At December 31, 2006 the rate applicable to the working capital facility was 6%.

The credit facilities allow for prime rate loans, US base rate loans, bankers' acceptances, letters of credit and LIBOR loans. The credit facilities bear interest at varying rates depending on the instrument utilized and the debt to EBITDA ratio, where EBITDA equals net earnings after income taxes, plus interest expense, income taxes and non-cash items deducted in determining net earnings. The revolving term facility has a conversion date of May 24, 2007 and a maturity date which is two years after the conversion date. Birchcliff may request an extension of the conversion date with such an extension not exceeding 364 days, in order to maintain the revolving term facility. If the Syndicate does not grant an extension of the conversion date, then upon the expiry of the conversion date, the revolving term facility will convert to a term loan whereby all principal and interest will be required to be repaid at the maturity date.

The revolving working capital facility has a conversion date of May 24, 2007 and a maturity date which is two years after the conversion date. Birchcliff may request an extension of the conversion date with such an extension not exceeding 364 days, in order to maintain the revolving working capital facility. If the Syndicate does not grant an extension of the conversion date, then upon 4 months after the expiry of the conversion date, the revolving working capital facility will convert to a term loan whereby all principal and interest will be required to be repaid at the maturity date.

The credit facilities are subject to the Syndicate's redetermination of the borrowing base twice a year as of October 31 and the conversion date. Upon any change in or redetermination of the borrowing base limit which results in a borrowing base shortfall, Birchcliff must eliminate the borrowing base shortfall amount. The facility is secured by a fixed and floating charge debenture, an instrument of pledge, and a general security agreement encompassing all of the Corporation's assets.

8. ASSET RETIREMENT OBLIGATIONS

The Corporation's asset retirement obligations result from net ownership interests in petroleum and natural gas properties including well sites, gathering systems and processing facilities. Birchcliff estimates the total undiscounted amount of cash flows required to settle its asset retirement obligation as at December 31, 2006 to be approximately $32,362,000 (2005 - $25,562,000) which will be incurred between 2007 and 2056. A credit-adjusted risk-free interest rate of 8% and an inflation rate of 2% were used to calculate the fair value of the asset retirement obligation.

A reconciliation of the asset retirement obligations is provided below:



----------------------------------------------------------------------------
----------------------------------------------------------------------------
2006 2005
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Balance, January 1, 2005 9,251 -
Obligations incurred 1,387 9,010
Changes in estimate 389 -
Accretion expense 813 241
Actual expenditures incurred (570) -
----------------------------------------------------------------------------
Balance December 31, 2006 11,270 9,251
----------------------------------------------------------------------------
----------------------------------------------------------------------------


9. SHARE CAPITAL

(a) Authorized:

Unlimited number of voting common shares

Unlimited number of non-voting first preferred shares

The preferred shares may be issued in one or more series and the directors are authorized to fix the number of shares in each series and to determine the designation, rights, privileges, restrictions and conditions attached to the shares of each series.

A series of 25,129,885 Series 1 Preferred Shares were designated by the Directors of the Corporation on May 30, 2005 for issuance pursuant to the Veracel Arrangement. On May 31, 2005, 17,287,432 Series 1 Preferred Shares were issued under the Veracel Arrangement in exchange for 9,988,008 common shares of Veracel and 7,299,424 Class A Preferred Shares of Veracel. All of the Series 1 Preferred Shares that were issued have been redeemed for cash.



(b) Issued:
---------------------------
Number of Amount
Common Shares $
---------------------------
Incorporation on July 6, 2004 1 3
---------------------------
Balance, December 31, 2004 1 3

Issued (Note (c) (i)) 383,800 575,700
Issued, net of costs (Note (c) (ii through iv)) 19,864,536 57,462,253
Issued (Note (d) (i)) 117,010 468,040
Issued, net of costs (Note (d) (ii)) 34,000,000 129,422,500
Issued, net of costs (Note (e)) 2,000,000 9,473,920
Issued upon exercise of warrants (Note (f)) 300,000 1,332,000
Issued, net of costs (Note (g)) 1,482,400 12,876,768
Tax effect of share issue costs (Note (h)) - 3,340,160
--------------------------
Balance, December 31, 2005 58,147,747 214,951,344

Issued upon exercise of stock options 51,666 245,614
Share issue costs (Note (i)) - (19,321)
Tax effect of share issue costs (Note (i)) - 6,500
Tax effect of flow-through shares (Note (e) and (g)) - (7,997,000)
Issued, net of costs (Note (j)) 5,940,000 28,437,352
Tax effect of share issue costs (Note (k)) - 533,500

--------------------------
Balance, December 31, 2006 64,139,413 236,157,989
--------------------------
--------------------------


(c) On January 18, 2005, as a result of the exchange of shares pursuant to the successful completion of the Scout Arrangement, the following shares were issued:

(i) 383,800 common shares of Birchcliff were issued to employees and consultants (not management), for which gross proceeds of $575,700 were collected on January 18, 2005, as a result of subscription agreements entered into in November 2004. These shares are held by a trustee and are subject to an option granted to Birchcliff to repurchase the shares if the holder ceases to be employed by Birchcliff (or any successor thereto) prior to January 1, 2008 at a purchase price per share equal to the lesser of $1.50 and the weighted average trading price of Birchcliff shares on a recognized stock exchange during the five trading days immediately prior to the date of which such holder ceases to be employed by Birchcliff or any successor thereto;

(ii) 13,966,000 subscription receipts issued by Birchcliff, as a private corporation, were exchanged for 13,966,000 common shares of Birchcliff for net proceeds of $39,766,677;

(iii) 4,842,100 common shares of Birchcliff were issued to management, directors and associates at a price of $3.00 per common share for net proceeds of $14,526,300;

(iv) 1,056,436 common shares of Birchcliff were issued to shareholders of Scout for net consideration of $3,169,276.


(d) On May 31, 2005, as a result of the successful completion of the Veracel Arrangement, the following shares were issued:

(i) 117,010 common shares of Birchcliff, at a price of $4.00 per common shares, were issued to Veracel shareholders who elected to receive shares rather than cash;

(ii) 34,000,000 common shares of Birchcliff were issued in exchange for 34,000,000 subscription receipts and/or Veracel class B common shares, previously issued by Veracel for net proceeds of $129,422,500;

(iii) 17,287,432 of Series 1 Preferred Shares of Birchcliff were issued in exchange for 9,988,008 common shares of Veracel and 7,299,424 Class A Preferred Shares of Veracel. All of the Series 1 Preferred Shares that were issued were redeemed for cash.

(e) On June 2, 2005, Birchcliff issued 2,000,000 flow-through shares at $5.00 per common share in exchange for flow-through share commitments made by Veracel prior to completion of the Veracel Arrangement, for net proceeds of $9,473,920. As at December 31, 2005 the commitment to spend and renounce $10,000,000 of qualified 100% deductible tax pools with respect to these flow-through shares was fulfilled.

(f) On December 2, 2005, 300,000 common shares were issued in exchange for 300,000 performance warrants with an exercise price of $3.00 per common share for gross proceeds of $900,000; in addition, $432,000 of compensation costs previously recorded to contributed surplus for these performance warrants was removed from contributed surplus and added to share capital.

(g) On December 20, 2005, Birchcliff issued 1,482,400 flow-through shares at a price of $9.12 per share for net proceeds of $12,876,768. As at December 31, 2005 Birchcliff renounced $13,519,488 of qualified 100% deductible tax pools with respect to these flow-through shares. As at December 31, 2006 the commitment to spend and renounce $13,519,488 of qualified 100% deductible tax pools with respect to these flow-through shares was fulfilled.

(h) Birchcliff recognized a future tax benefit of $3,340,160 in respect of total share issue costs of $9,823,320 incurred to December 31, 2005.

(i) Birchcliff recognized a future tax benefit of $6,500 in respect of share issue costs of $19,321 recorded in 2006 relating to the issuance of flow- through shares on December 20, 2005.

(j) On November 22, 2006, Birchcliff issued 2,740,000 flow-through shares at a price of $5.85 per share and 3,200,000 common shares at a price of $4.40 per share for total net proceeds of $28,437,352. As at December 31, 2006 Birchcliff renounced $16,029,000 of qualified 100% deductible tax pools with respect to the flow-through shares.

(k) Birchcliff recognized a future tax benefit of $533,500 in respect of share issue costs of $1,671,649 incurred with respect to the issuance of 5,940,000 shares on November 22, 2006.

10. STOCK-BASED COMPENSATION

The Corporation has established a stock-based compensation plan whereby officers, employees, directors and consultants may be granted options or performance warrants to purchase one common share for each option or performance warrant granted, at a fixed price not less than the fair market value of the stock at the time of grant, subject to certain conditions being met. Stock options granted under this plan vest over a three year period at the rate of one-third on each anniversary date of the stock option grant. All stock options granted are for a five year term.

In order to calculate the compensation expense, the fair value of the stock options or performance warrants is estimated using the Black-Scholes option-pricing model that takes into account, as of the grant date: exercise price, expected life, current price, expected volatility, expected dividends, and risk-free interest rates.

Stock Options

For the year ended December 31, 2006, the Corporation recorded $2.5 million (2005 - $1.1 million) of non-cash stock-based compensation expense and a corresponding increase to contributed surplus related to the issuance of stock options.

The Corporation also recorded stock-based compensation expense of $214,000 (2005 - $NIL) related to cash paid to cancel vested stock options during the year.

Using the fair value method, the weighted average fair value of stock options granted during the year ended December 31, 2006 was $2.88 per option.

At December 31, 2006 the Corporation had authorized for issuance options in respect of 6,413,941 common shares (2005 - 5,814,775). At December 31, 2006, there remained available for issuance options in respect of 2,134,273 common shares (2005 - 2,620,275).

Subsequent to year end in early 2007, options in respect of 1,647,000 common shares were granted to employees and management at fair market value at the time of grant.

A summary of the changes during the year ended December 31, 2006 and 2005 and the Corporation's outstanding stock options as at December 31, 2006 is presented below:



----------------------------------------------------------------------------
----------------------------------------------------------------------------
Weighted
----------------------------------------------------------------------------
Average Exercise
Price
Number $
----------------------------------------------------------------------------

Outstanding, December 31, 2004 1,665,000 3.00

Granted 1,529,500 4.40
Exercised - -
Cancelled - -
-----------------------------
Outstanding, December 31, 2005 3,194,500 3.67

Granted 1,440,000 6.88
Exercised (51,666) (3.49)
Forfeited (248,168) (5.40)
Cancelled (54,998) (3.13)
-----------------------------
Outstanding, December 31, 2006 4,279,668 4.66
----------------------------
----------------------------


---------------------------------------------------------------------------
Number Number
Outstanding at Exercisable at
December 31, Date of Exercise December 31,
Date of Grant 2006 Expiry Price $ 2006
---------------------------------------------------------------------------

December 3,
2004 (1) 1,583,334 January 21, 2010 3.00 473,334 (1)(2)

Apr 20 to Apr 20 to 3.50 to
Jun 22, 2005 961,834 Jun 22, 2010 4.09 252,834 (3)

Jul 4 to Jul 4 to 4.06 to
Sep 7, 2005 98,500 Sept 7, 2010 5.45 21,166 (4)

Oct 6 to Oct 6 to 5.85 to
Nov 28, 2005 250,000 Nov 28, 2010 6.46 16,667 (5)

Jan 11 to Jan 11 to 6.50 to
Mar 6, 2006 1,163,500 Mar 6, 2011 7.60 - (6)

Apr 11 to Apr 11 to 6.86 to
Apr 25, 2006 23,000 Apr 25, 2011 7.10 -

Aug 14 to Aug 14 to 4.00 to
Sep 26, 2006 184,500 Sep 26, 2011 5.70 -

Oct 23, 2006 15,000 Oct 23, 2011 4.12 -

---------------------------------------------------------------------------
4,279,668 764,001
---------------------------------------------------------------------------
---------------------------------------------------------------------------

(1) All options granted under the stock-based compensation plan vest
as to one-third on each anniversary date of their grant except for the
initial options granted. These options vest one-third on January 1 in
each of the years 2006, 2007 and 2008.
(2) 20,000 options were exercised, 48,332 options were cancelled, and
13,334 options were forfeited in 2006.
(3) 31,666 options were exercised, 6,666 options were cancelled, and
63,334 options were forfeited in 2006.
(4) 17,500 options were forfeited in 2006.
(5) 100,000 options were forfeited in 2006.
(6) 54,000 options were forfeited in 2006.


Performance Warrants

At December 31, 2006, there were 3,749,665 performance warrants outstanding (2005 - 3,749,665) with an exercise price of $3.00. Each performance warrant entitles the holder to purchase one common share at the exercise price.

The performance conditions were fulfilled in the fourth quarter of 2005, resulting in all of the performance warrants vesting and becoming fully exercisable. As a result, the full amount of the compensation expense related to the performance warrants was recorded by the Corporation in the fourth quarter of 2005. In December 2005, 300,000 performance warrants were exercised and the compensation expense ($432,000) relating to these exercised warrants was removed from contributed surplus and credited to share capital in accordance with the Corporation's accounting policy.

Consequently, for the year ended December 31, 2006, the Corporation recorded $NIL (2005 - $5.8 million) compensation expense in the statement of net income (loss) relating to stock based compensation for the performance warrants.

A summary of the changes during the year ended December 31, 2006 and the Corporation's outstanding performance warrants as at December 31, 2006 is presented below:



-------------------------------
Weighted
Average Exercise
Price
Number $
-------------------------------
Outstanding, December 31, 2004 - -
Issued 4,049,665 3.00
Exercised (300,000) 3.00
-------------------------------
Outstanding, December 31, 2005 3,749,665 3.00
Issued - -
Exercised - -
-------------------------------
Outstanding, December 31, 2006 3,749,665 3.00
-------------------------------
-------------------------------


Number Number
Outstanding at Exercisable at
December 31, Exercise December 31,
Date of Grant 2006 Date of Expiry Price 2006
---------------------------------------------------------------------------
January 14, 2005 3,749,665 January 31, 2010 $ 3.00 3,749,665
---------------------------------------------------------------------------
---------------------------------------------------------------------------

The fair value of each option and performance warrant was determined on the
date of the grant using the Black-Scholes option-pricing model. The
weighted average assumptions used in calculating the fair values are set
forth below:

-------------------
2006 2005
-------------------

Risk-free interest rate 4.0% 3.6%

Expected maturity (years) 5.0 5.0

Expected volatility 41.5% 47.3%

Dividend yield 0% 0%


Contributed Surplus Continuity
$ 000's $ 000's
Balance, December 31, 2004 63
Stock-based compensation expense - stock options 1,116
Stock-based compensation expense - performance
warrants (1) 5,832
-------
Stock-based compensation expense - total 2005 6,948
Exercise of performance warrants (432)
---------------------
Balance, December 31, 2005 6,579
Stock-based compensation expense - stock options 2,707

Stock-based compensation expense - forfeiture of stock
options (153)

Stock-based compensation expense - cancellation of
stock options 137
-------
Stock-based compensation expense - total 2006 2,691

Exercise of stock options (66)

Cancellation of stock options (214)
----------------
Balance, December 31, 2006 8,990
----------------
----------------

(1) All of the performance warrants vested during the fourth quarter of
2005 and as such 100% of the stock- based compensation value to be expensed
was charged against income in the fourth quarter of 2005.


11. PER SHARE INFORMATION

2006 2005
Basic Net income (loss) per share ($0.02) $0.08
Weighted average shares outstanding 58,806,783 40,631,465
Diluted Net income (loss) per share ($0.02) $0.07
Weighted average shares outstanding 58,806,783 42,948,811


The weighted average diluted shares outstanding at December 31, 2006 includes the 58,806,783 (2005 - 40,631,465) weighted average number of shares outstanding, plus the following: NIL (2005 - 1,438,508) shares related to the dilutive effect of the performance and retention warrants and NIL (2005 - 878,838) shares related to the dilutive effect of stock options. Because the Corporation reported a loss for the year ended December 31, 2006 the basic and diluted weighted average shares outstanding are 58,806,783.

12. COMMITMENTS

Flow-Through Shares

In the fourth quarter of 2006, the Corporation committed to renounce $16,029,000 of exploration expenditures pursuant to a flow-through common share issue completed on November 22, 2006. Birchcliff has until December 31, 2007 to incur these exploration expenditures. The Corporation will be subject to Part II.6 tax based on the prescribed rate and the balance of exploration expenditures not yet incurred at the end of each month subsequent to January 31, 2007. To December 31, 2006, the costs incurred with respect to the $16,029,000 flow-through share obligation are approximately $1.9 million.

Office Premises

Subsequent to December 31, 2006, the Corporation is committed under an operating lease for its current office premises which expires September 30, 2008. It is also committed to March 29, 2011 under an operating lease for some other premises which it does not use and has sublet to an arm's length party on a basis that recovers all of its rental costs. The Corporation is committed to the following aggregate minimum lease payments (not reduced by rents receivable by the Corporation) which are shown below:



-------
$
-------

2007 877,000
2008 787,000
2009 202,000
2010 202,000
2011 51,000


13. SUPPLEMENTARY CASH FLOW INFORMATION

The following table details the components of non-cash working capital:

2006 2005
$000's $000's
-----------------------------
Provided by (used in)
Accounts receivable 2,887 (15,785)
Prepaid and other (1,813) (1,426)
Accounts payable and accrued liabilities (18,324) 41,025
-----------------------------
(17,250) 23,814
-----------------------------
-----------------------------

Operating 1,448 (283)
Investing (18,698) 24,097
-----------------------------
(17,250) 23,814
-----------------------------
-----------------------------


Advisory

Finding and Development Costs: With respect to disclosure of finding and development costs disclosed above:

(a) In calculating the amounts of finding and development costs, the change during the year in estimated future development costs is based on the change from the estimated future development costs contained in the reserves evaluation prepared by AJM effective December 31, 2005.

(b) National Instrument 51-101 requires the inclusion of the following warning statement:

The aggregate of the exploration and development costs incurred in the most recent financial year and any change during that year in estimated future development costs generally will not reflect total finding and development costs related to reserves additions for that year.

BOE Conversions: The term barrels of oil equivalent ("boe") may be misleading, particularly if used in isolation. Per barrel of oil equivalent ("boe") amounts have been calculated using a conversion rate of six thousand cubic feet of natural gas to one barrel of oil equivalent ("6:1"). A boe conversion ratio of 6:1 is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.

Forward Looking Statements: This document may contain forward-looking statements regarding the business and operations of Birchcliff Energy Ltd. All statements other than statements of historical fact contained here are forward-looking statements under applicable securities law, and there can be no assurance that the plan, intentions or expectations upon which these forward looking statements are based will occur.

In addition, all such forward-looking information necessarily involve risks associated with oil and gas exploration, production, marketing and transportation such as loss of market, volatility of prices, currency fluctuations, imprecision of reserve estimates, environmental risks, competition from other producers and ability to access sufficient capital from internal and external sources. As a consequence, actual results may differ materially from those anticipated in the forward-looking statements.

Birchcliff is a publicly traded company that trades on the TSX Exchange under the symbol "BIR".

The TSX Exchange has not reviewed and does not accept responsibility for the adequacy or accuracy of this release.

Contact Information

  • Birchcliff Energy Ltd.
    Jeff Tonken
    President and Chief Executive Officer
    (403) 261-6401
    or
    Birchcliff Energy Ltd.
    Bruno Geremia
    Vice President and Chief Financial Officer
    (403) 261-6401
    or
    Birchcliff Energy Ltd.
    Jim Surbey
    Vice President, Corporate Development
    (403) 261-6401
    (403) 261-6424 (FAX)