Birchcliff Energy Ltd.
TSX : BIR

Birchcliff Energy Ltd.

March 20, 2008 04:23 ET

Birchcliff Energy Ltd. Announces 2007 Financial Results and 2008 Operations Update

CALGARY, ALBERTA--(Marketwire - March 20, 2008) -

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 2007 financial results as well as a 2008 operations update.

2007 Highlights

- Acquired a high quality light oil resource play by completion of the $263.3 million acquisition of the Worsley light oil property on September 27, 2007, concurrently with a $115 million equity financing and a $100 million non-revolving acquisition debt facility.

- Significant expansion of our Montney/Doig natural gas resource play, by drilling, completing and bringing on production 2 horizontal natural gas wells in the fourth quarter of 2007, as well as identifying up to 120 potential Montney/Doig horizontal drilling locations on its proven 30 net sections of land on the trend.

- Drilled and cased 15.6 net exploratory wells in our high impact exploration program.

- Doubled proved & probable reserves to 56.6 million boe at December 31, 2007 from 28.3 million boe at December 31, 2006, an increase of 100%.

- More than doubled its proven reserves to 34.3 million boe at December 31, 2007 from 14.1 million boe at December 31, 2006, an increase of 143%.

- 2007 Finding and Development costs, including future development costs, on a proved and probable basis were $12.03/boe. This resulted in an operating netback recycle ratio of 2.5 times. The recycle ratio is calculated on a netback which is based on a 2007 annual average AECO price of CDN$6.45/mmbtu. Substantial upside exists with a rise in natural gas prices.

- At December 31, 2007 Birchcliff's reserve life index on a proved and probable basis increased to 15.5 years from 12.7 years based upon an average production rate of approximately 10,000 boe/day.

2008 Highlights

- Increased its Montney/Doig natural gas horizontal well drilling inventory to 140 potential drilling locations on 35 net sections of land from 120 potential drilling locations on 30 net sections of land.

- Birchcliff has added additional undeveloped lands to maintain an inventory of approximately 20 net sections of undeveloped land in the Pouce Coupe area where Birchcliff believes there is a high likelihood of the extension of the Montney/Doig play.

- Drilled and cased 14 gross, (13.8 net) wells with 100% success including 4 Montney/Doig horizontal natural gas wells.

- Winter drilling has extended the north end of the Worsley light oil pool.

- On March 14, 2008 Birchcliff completed a $130 million equity financing and retired its $100 million non-revolving acquisition facility.

2008 First Quarter Operations Update

Production:

Current production is approximately 9,800 BOE/day. Currently, there are 15 gross (13.4 net) wells that are completed and awaiting tie-in. Four of these wells represent significant potential incremental production. Three wells are new horizontal Montney/Doig natural gas wells. The fourth well is a Triassic natural gas discovery, on trend with a prior Triassic natural gas discovery, previously announced in December 2007, which is currently producing approximately 4 mmcf/day (666 BOE/day). As noted below and subject to an early spring break-up Birchcliff expects to bring most of these newly drilled wells on production as soon as reasonably possible.

Drilling:

Birchcliff had up to 4 drilling rigs operating during the first quarter of 2008. To date 14 gross, (13.8 net) wells have been drilled, and all have been cased yielding 100% success. Three rigs are still active drilling the last 3 wells before break up, with these last 3 wells our activity would total 17 gross (16.3 net) wells for the first quarter 2008.

Two vertical new pool exploration wells were successful in expanding our Montney/Doig natural gas resource play at Pouce Coupe. Both wells have been drilled, cased and completed and have delineated our play onto lands that were previously not considered proven.

In its 2008 drilling program, Birchcliff drilled and cased 3 Montney/Doig horizontal natural gas wells while the fourth Montney/Doig horizontal gas well is currently drilling. The first of these wells was recently brought on production and the other two are currently being completed. All of the producing Montney/Doig horizontal natural gas wells, continue to meet our forecast production expectations.

At Worsley Birchcliff had one rig drilling vertical infill and delineation wells. Seven light oil wells have been drilled, cased and are at various stages of completion and tie in. We also initiated our horizontal well program for this oil pool. Two light horizontal wells were recently drilled and cased. Due to timing of break up we will not get these horizontal wells completed and on production until after breakup, but we are encouraged with the results we have to date.

Continued efforts on our high impact exploration program resulted in a new Triassic natural gas discovery that was recently completed. This exploration well will be brought on production shortly after break up.

Project Updates:

Montney/Doig Gas Resource Play

With the 2 recent first quarter 2008 exploration successes, Birchcliff has now drilled 24 (21.4 net) vertical wells on the Montney/Doig gas resource play that has proved a producing fairway where Birchcliff has now accumulated 35 net sections of land. In addition, Birchcliff has approximately 20 net sections of undeveloped land in the Pouce Coupe area where Birchcliff believes there is a high likelihood of the extension of the Montney/Doig play on these lands.

Industry has shown that the Montney/Doig gas resource play is an excellent candidate to drill horizontal wells and perform multi stage fracture stimulations. Industry has demonstrated that 4 wells/section is an effective exploitation program for this high original gas in place play. To date Birchcliff has drilled 6 horizontal wells in this play. The first 2, drilled in late 2007, have now been on production for a few months. Of the four wells drilled in 2008 the first well was recently brought on production. The other three wells are at various stages of drilling, completion, testing and tie in. We expect all 6 wells will be on production by May, 2008.

Birchcliff expects to drill 4-6 Montney/Doig horizontal natural gas wells in the second half of 2008 bringing the aggregate total to 8-10 Montney/Doig horizontal natural gas wells for 2008. Further, Birchcliff is executing the operational planning to significantly increase (beyond 6) the number of horizontal wells it could drill in the second half of 2008. The drilling of these wells will be dependent on drilling results, commodity prices, and industry conditions.

Worsley Light Oil Resource Play

Birchcliff initiated its drilling program on its recently acquired Worsley (38degrees API) light oil pool in the first quarter of 2008. Birchcliff has drilled and cased 7 vertical and 2 horizontal light oil wells to date. Drilling activity will resume as soon as possible after breakup. Four of the vertical wells were delineation wells to extend the Worsley Charlie Lake pool to the north on 100% owned lands. The program also included 3 infill wells. Initial results of the vertical program are very encouraging, but due to timing issues these wells will not be on production until after breakup. The two horizontal wells have been drilled and cased but have not been completed, the drilling results are positive and we anticipate 70-100 boe/day from each of these horizontal wells.

Birchcliff is actively planning and has commenced the operational activities to significantly expand and optimize the water flood program at the Worsley property. Recent production profiles increase our confidence in the ultimate water flood potential of the pool. Based on recent commodity prices and recent drilling success, Birchcliff expects a very active drilling program at Worsley in the second half of 2008.

High Impact Exploration Program

In the third quarter of 2007, Birchcliff announced a significant Triassic natural gas discovery. This 100% working interest well continues to produce at a rate of approximately 4.0 mmcf/day (666 boe/day). As a follow up to this well an exploration well was drilled on trend in the first quarter of 2008. This well was successful in finding a new pool, it has been cased and completed. The well will be tied-in and brought on production after break up.

Another success of 2007 was a Doig oil discovery. In the first quarter of 2008 Birchcliff shot a 100% 3-D seismic program over this discovery to assist in the development of the pool. The geophysical data was recently received and a full development plan is currently being prepared.

Birchcliff has 4 full technical teams that continue to evaluate land acquisitions, build new play concepts, and high-grade drilling opportunities. Birchcliff has built a diverse portfolio of drilling opportunities that currently exceeds 387 (328 net) potential locations.



2007 Statistics, MD&A and Financial Statements
FINANCIAL AND OPERATIONAL HIGHLIGHTS


Three Three Twelve Twelve
months months months months
ended ended ended ended
December 31, December 31, December 31, December 31,
2007 2006 2007 2006
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OPERATING
Daily Average
Production
Light Oil - barrels 2,887 760 1,289 763
Natural Gas -
thousands of cubic
feet 36,689 29,362 31,330 26,375
NGLs - barrels 258 207 201 210
Total - barrels of
oil equivalent (6:1) 9,260 5,861 6,711 5,368
Average Sales Price
($ Canadian)
Light Oil - per barrel 80.94 60.99 76.39 68.07
Natural Gas - per
thousand cubic feet 6.71 7.33 6.82 6.96
NGLs - per barrel 84.41 63.26 74.24 70.45
Total - per barrel of
oil equivalent (6:1) 54.18 46.86 48.71 46.62
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Undeveloped Land
Gross (acres) 317,070 210,916 317,070 210,916
Net (acres) 266,966 171,834 266,966 171,834
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NETBACK AND COST
($ per barrel of oil
equivalent at 6:1)
Petroleum & natural
gas revenue 54.46 47.76 49.27 47.86
Royalties, net of ARTC (9.16) (8.17) (7.89) (8.25)
Operating expense (8.47) (9.94) (8.86) (8.83)
Transportation and
marketing expense (2.79) (1.58) (2.04) (1.63)
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Netback 34.04 28.07 30.48 29.15
General & administrative
expense (3.05) (3.77) (3.07) (3.02)
Stock-based
compensation expense (0.01) - (0.02) (0.11)
Realized risk management
contracts (2.19) - (0.76) -
Realized foreign exchange (0.02) - (0.01) -
Interest expense (5.45) (2.47) (3.55) (2.17)
Other income 0.01 0.05 - 0.02
Taxes - (0.11) (0.11) (0.03)
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Cash Flow Netback 23.33 21.77 22.96 23.84
Depletion and
depreciation (23.94) (26.23) (26.46) (22.42)
Accretion (0.49) (0.42) (0.51) (0.42)
Stock-based
compensation expense (1.01) (1.08) (0.88) (1.26)
Unrealized risk
management contracts (6.57) - (2.76) -
Unrealized foreign
exchange (0.03) - (0.01) -
Future income tax
recovery (expense) 1.13 1.68 1.85 (0.30)
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Net Earnings(Loss) (7.58) (4.28) (5.81) (0.56)
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FINANCIAL

Petroleum & Natural Gas
Revenue ($000) 46,398 25,750 120,696 93,769
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Cash Flow from
Operations ($000) 19,881 11,657 56,245 46,687
Per share -
basic ($) 0.21 0.19 0.78 0.79
Per share -
diluted ($) 0.21 0.19 0.77 0.77
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Net Earnings (Loss)
($000) (6,457) (2,313) (14,244) (1,113)
Per share -
basic ($) (0.07) (0.04) (0.20) (0.02)
Per share -
diluted ($) (0.07) (0.04) (0.20) (0.02)
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Common Shares
Outstanding
End of Period -
Basic 94,554,269 64,139,413 94,554,269 64,139,413
End of Period -
Diluted 103,639,748 72,168,746 103,639,748 72,168,746
Weighted Average for
Period - Basic 94,486,372 60,701,424 72,156,544 58,806,783
Weighted Average for
Period - Diluted 96,548,884 61,347,463 73,285,368 61,011,246
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Capital Expenditures
($000) 30,306 12,577 350,173 102,154
Working Capital
(Deficiency) ($000) (18,232)(1) (6,479) (18,232)(1) (6,479)
Non-Revolving Credit
Facility ($000) 98,830 - 98,830 -
Revolving Credit
Facilities ($000) 155,854 81,304 155,854 81,304
Total Debt ($000) 272,916 87,783 272,916 87,783
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(1) This amount excludes the accrued liability for oil price risk management
contracts of $6.8 million and future income tax asset thereon of $2.0
million.


MANAGEMENT'S DISCUSSION AND ANALYSIS

Management's Discussion and Analysis ("MD&A"), dated March 19, 2008, 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, 2007 and 2006. The financial statements have been prepared in accordance with Canadian Generally Accepted Accounting Principles ("GAAP").

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 ("TSX") 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 2007 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, netback and cash flow netback.

Cash flow, as discussed in this MD&A and in the Corporation's Annual Report for 2007, appears as a separate line on the Corporation's Statement 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, unrealized losses from risk management contracts and foreign exchange (less unrealized gains) 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 CONVERSION

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, 2007 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 2007 2006 2005(1)
($000's except production and
share information)
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Petroleum and natural gas revenue 120,696 93,769 67,790
Total revenues, net of royalties 101,373 77,629 53,067
Cash flow from operations 56,245 46,687 36,182
Basic per share $ 0.78 $ 0.79 $ 0.89
Diluted per share $ 0.77 $ 0.77 $ 0.84
Net income (loss) (14,244) (1,113) 3,189
Basic per share ($0.20) ($0.02) $ 0.08
Diluted per share ($0.20) ($0.02) $ 0.07
Capital expenditures, net 350,173 102,154 306,628
Total assets 662,252 362,255 311,364
Working capital (deficiency)
surplus(3) (18,232) (6,479) (23,730)
Non-Revolving credit facility 98,830 - -
Revolving credit facility 155,854 81,304 36,614
Total debt 272,916 87,783 60,344
Shareholders' equity 340,756 246,399 223,894
Average daily production
(BOE at 6:1) 6,711 5,368 2,793(2)
Common shares outstanding -
end of period
Basic 94,554,269 64,139,413 58,147,747
Diluted 103,639,748 72,168,746 65,091,912
Weighted average common shares
outstanding
Basic 72,156,544 58,806,783 40,631,465
Diluted 73,285,368 61,011,246 42,948,811
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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) This is a twelve month average. The average for the seven months during
which Birchcliff had significant production is 4,751 BOE per day.
(3) The working capital calculation does not include amounts relating to
risk management contracts including the future income taxes thereon.


OVERALL PERFORMANCE

During 2007, the Corporation achieved a number of successes that affect its financial results for the year.

Worsley Acquisition

The Corporation was able to identify an attractive light oil producing asset within its Peace River Arch area at Worsley, Alberta and negotiated and completed the acquisition of the Worsley Property on September 27, 2007. This initiative increased the Corporation's crude oil production significantly and the corresponding cash flows as crude oil prices remained quite high during the balance of 2007. A significant amount of debt was used to complete the acquisition and therefore the Company entered into some oil price risk management contracts prior to the closing. Therefore and as a result, the cash flows were mitigated somewhat by those oil price risk management contracts. This acquisition also reduced the degree of the Corporation's dependence on natural gas prices and added both reserves and potential to expand the Corporation's crude oil reserves in this area at a time when crude oil prices were high. Birchcliff has the ability now to direct its capital to either oil projects, gas projects or either combination thereof. For details of this acquisition, see the discussion under the heading "Major Transactions Affecting Financial Results".

Natural Gas Weighting & Commodity Prices

Birchcliff is primarily a natural gas producer with 78% of its 2007 average production being natural gas. Through the first three quarters of the year, prior to the Worsley Acquisition, Birchcliff was weighted 84% to natural gas production. Accordingly, the Corporation's revenues, cash flows and net income were significantly affected by the price of natural gas during 2007. At present the Corporation's production consists of approximately 64% natural gas and 36% crude oil and natural gas liquids. Birchcliff's natural gas production was unhedged for 2007 and remains unhedged at the present time.

Continued low natural gas prices below Birchcliff's expectations resulted in reduced cash flows, and as a result Birchcliff operated under a constrained capital budget during 2007. Nonetheless Birchcliff was able to increase both its production and reserves during 2007 and it drilled and completed its first two horizontal wells on the Montney/Doig natural gas resource play at Pouce Coupe and Pouce Coupe South which will have a positive effect on future production rates and cash flows in the future. In light of recent increased natural gas prices, Birchcliff's cash flow should increase during 2008 should this increased price continue throughout the year. However, natural gas prices depend on a number of complex factors such as the world Liquefied Natural Gas ("LNG") markets, demand for the commodity, transportation and thus cannot be easily predicted.

Crude oil prices have been very high recently and if they remain high through 2008, the cash flows generated by the Worsley oil properties beyond the capital re-invested at Worsley will allow continued investment in the Corporation's natural gas resource play that will position Birchcliff to take advantage of any increase in natural gas prices during 2008 and beyond.

Capital Expenditures

The most significant effect on capital spending during 2007 was the $263.3 million Worsley property acquisition that accounted for approximately 75% of the total capital spent in 2007. Remaining capital expenditures for the year ended December 31, 2007 were $86.9 million, with 15% ($53.6 million) spent on drilling and completions; 5% ($15.9 million) spent on equipment and facilities; 1% ($4.8 million) spent on land acquisitions; 1% ($4.5 million) spent on seismic and other exploration and approximately 1% ($300,000) spent on administrative assets. Other minor acquisitions accounted for the remaining 2% ($7.8 million) of capital spent.

Reserve Additions

Birchcliff significantly increased its proved plus probable reserves during 2007 despite the decrease in forecast natural gas prices used during the first two years in Birchcliff's 2007 Reserve Report as compared to the forecast natural gas prices used in the 2006 Reserve Report. This was primarily as a result of the allocation of reserves to horizontal well locations on the Montney/Doig natural gas resource play at Pouce Coupe and Pouce Coupe South, the acquisition of the Worsley porperty and the expanded geologic mapping and technical review of the Worsley oil pool.

Debt

Total indebtedness at December 31, 2007 was $272.9 million as compared to $87.8 million at December 31, 2006. The $185.1 million increase was due to $154.4 million relating to the Worsley Acquisition, $7.8 million relating to minor acquisitions, and an additional $22.9 million of capital spending in excess of cash flow. The Worsley Acquisition added significantly to Birchcliff's indebtedness and interest expense during 2007 and it further strengthened the Corporation's position in the Peace River Arch and provided additional drilling and production opportunities without adding significant overhead expense. Birchcliff continues to seek this type of targeted acquisition on an ongoing basis as part of its normal business strategy.

Mergers & Acquisitions

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 acquisitions, joint venture opportunities and corporate merger acquisition opportunities.

MAJOR TRANSACTIONS AFFECTING FINANCIAL RESULTS

Birchcliff's financial results have been and will continue to be significantly affected by a number of transactions that occurred during 2007 and 2006. These transactions are summarized below:

- 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 was 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.

- On September 27, 2007 the Corporation closed the Worsley Acquisition for total cash consideration of $263.3 million, after interim closing adjustments and related costs. Approximately 3,400 BOE/d of production was acquired, 75% of which is light oil and natural gas liquids production. Essentially all of the production is operated, the related infrastructure is owned, and the lands are large contiguous blocks at mainly 100% working interest. The Worsley Acquisition was effective July 1, 2007, for purposes of adjusting the purchase price. Production, revenues and expenses will be recorded by Birchcliff from September 27, 2007 forward. The Corporation expects the final adjustment to the purchase price to be completed early in the second quarter of 2008. The adjustments to purchase price included on the interim statement of adjustments are estimates based on information and knowledge at the time of the closing. The final purchase price adjustments may vary materially from the interim purchase price adjustments.

- In order to finance the Worsley Acquisition, Birchcliff issued 30,263,170 common shares at $3.80 per common share for gross proceeds of approximately $115 million. In addition, the Corporation's $120 million syndicated revolving credit facilities were increased to $200 million and a new syndicated $100 million non-revolving credit facility was added in conjunction with the Worsley Acquisition. The terms of the syndicated revolving credit facilities remained the same. The syndicated non-revolving credit facility was drawn in full on September 27, 2007 and matures one year thereafter.

- On March 14, 2008, Birchcliff completed a bought deal equity financing whereby it issued 1,522,843 flow-through common shares at a price of $9.85 per flow-through share and 14,375,000 common shares at a price of $8.00 per common share for total gross proceeds of $130 million and estimated net proceeds of $123 million. Proceeds of the offering will be used to repay the $100 million syndicated non-revolving credit facility used for the Worsley Acquisition, to finance the 2008 drilling program and for general corporate purposes.

LIQUIDITY AND BANK DEBT

Working Capital

The Corporation's working capital deficit (current assets less current liabilities) of $121.8 million at December 31, 2007 includes $98.8 million of short-term debt relating to the $100 million non-revolving facility drawn to complete the Worsley Acquisition, an accrued liability of $6.8 million relating to the mark-to-market unrealized loss on oil price risk management contracts, and an accrued asset of $2 million relating to future income taxes on the unrealized loss relating to the risk management contracts. Excluding the non-revolving facility, the unrealized loss from oil price risk management contracts, and the future income taxes thereon, the working capital deficit at December 31, 2007 was $18.2 million.

Throughout this MD&A the Corporation has excluded from its working capital deficit the accrued liability for the mark-to-market unrealized loss on oil price risk management contracts and the associated future income tax asset because the benefit the Corporation receives from higher oil prices in the future will offset substantially all of this liability. This liability is categorically different than the other current liabilities in that it does not represent indebtedness but rather an opportunity cost when oil prices go beyond the ceiling price in the oil price risk management contracts. In order to estimate this liability, future oil prices were estimated beyond the ceiling of our costless collars, yet there is no offsetting asset recorded for the future value that the same estimated future oil price will provide Birchcliff in increased cash flows. Therefore Birchcliff believes excluding this amount from the working capital deficit calculation is appropriate.

At December 31, 2007 the largest component of Birchcliff's current assets (64%) is the cash to be received from its marketers in respect of December 2007 production which was subsequently received in January 2008. In contrast, the current liabilities (excluding the non-revolving credit facility and oil price risk management contracts) consist of trade payables (47%); accrued capital and operating costs (35%); and royalties and other minor amounts. Management expects this working capital deficiency to continue into the foreseeable future as result of its continuing 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 $200 million were drawn to $155.9 million at December 31, 2007 as compared to $81.3 million for the year ended December 31, 2006 when the aggregate limit was $120 million. The significant increase is due to the Worsley Acquisition during the third quarter of 2007 and the capital expenditure program being greater than the Corporate cash flow during 2007. The Corporation's revolving credit facilities consist of a $20 million working capital facility and a $180 million syndicated facility.

The Corporation's non-revolving credit facility which has an aggregate limit of $100 million was drawn in full to $98.8 million at December 31, 2007, the $1.2 million difference being the discounted interest amount for bankers' acceptances. The non-revolving facility was not in existence prior to the third quarter of 2007 as it was created and used to complete the Worsley Acquisition. The non-revolving credit facility matures in one year from the draw down date of September 27, 2007. The Corporation recently completed a $130 million equity issue, the proceeds of which are being used in part to retire in full the non-revolving facility. Once the non-revolving facility is repaid, it cannot be redrawn and will no longer be available to the Corporation.

At December 31, 2007 the interest rate applicable to the working capital facility was 6.0% plus a 0.65% margin which is based on the Corporation's current debt level as compared to its cash flow before interest and taxes. The effective interest rate for the syndicated revolving facility is slightly less due to banker's acceptances being utilized, which have a lower effective rate of interest.

Overall, the Corporation did not have any liquidity issues with respect to the operations of its petroleum and natural gas business in the Reporting Periods nor does it anticipate a liquidity issue in the foreseeable future.

The Corporation intends to finance its oil and natural gas business primarily through cash generated from operations, proceeds from bank debt, proceeds from long-term debt arrangements 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 a significant acquisition or to significantly increase its capital spending.

CASH FLOW FROM OPERATIONS

Cash generated by the Corporation for 2007 was $56.2 million as compared to $46.7 million in 2006. The $9.5 million increase was due to increased natural gas production as a result of drilling success, increased oil production resulting from the Worsley Acquisition and much higher oil prices than in the prior year. However, this was mitigated by higher interest costs than in the prior year due to the Worsley Acquisition and capital spending beyond cash flow, and the realized loss on oil price risk management contracts. Future cash flow will be dependent mainly on production levels and commodity prices.

SENSITIVITY ANALYSIS

The following table sets forth management's estimates of the sensitivity of cash flow expected to be generated by the Corporation in 2008 based on internal estimates. The estimates contain numerous assumptions and anticipate a capital expenditure program of approximately $105 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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Factor Variance
In annual
Variance Cash Flow
In Factor CDN$
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WTI oil price US $1.00/bbl $ 700,000
Natural gas spot price (AECO) CDN $0.10/mcf $ 1,400,000
CDN $/US $ CDN $0.01 $ 850,000
Canadian Prime rate 1% $ 1,900,000

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OUTSTANDING SHARE DATA

The common shares of Birchcliff began trading on the TSX on July 21, 2005 under the symbol "BIR". The following table summarizes the common shares issued from December 31, 2005 to December 31, 2007 which are the only class of shares outstanding:



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Common Shares
----------------------------------------------------------------------------
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Balance at December 31, 2005 58,147,747
Issue of Common Shares upon Exercise of Options 20,000
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Balance at March 31, 2006 and June 30, 2006 58,167,747
Issue of Common Shares upon Exercise of Options 6,666
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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
----------------------------------------------------------------------------
Balance at December 31, 2006 64,139,413
Issue of Common Shares upon Exercise of Options 50,000
----------------------------------------------------------------------------
Balance at March 31, 2007 and June 30, 2007 64,189,413
Issue of Common Shares upon Exercise of Options 20,000
Issue of Common Shares(1) 30,263,170
----------------------------------------------------------------------------
Balance at September 30, 2007 94,472,583
Issue of Common Shares upon Exercise of Options 81,686
----------------------------------------------------------------------------
Balance at December 31, 2007 94,554,269
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Common shares issued in conjunction with the Worsley Acquisition.


In January, February and early March 2008 an additional 1,332,978 common shares were issued as a result of the exercise by a former officer of 809,933 performance warrants and 523,045 options for gross proceeds of approximately $4.4 million. On March 14, 2008, 15,897,843 common shares were issued for gross proceeds of $130 million as a result of the equity financing described under the heading Major Transactions. As a result, at the date of this MD&A there are 111,785,090 common shares outstanding which is an 18% increase from 2007 year end.

RESULTS OF OPERATIONS

Petroleum and Natural Gas Revenue

Petroleum and natural gas revenues totaled $120.7 million for 2007 compared to $93.8 million for 2006. The increase was due to increased natural gas production as a result of drilling success, increased oil production resulting from the Worsley Acquisition and much higher oil prices than in the prior year. The following table details Birchcliff's petroleum and natural gas revenue, production and sales prices by category for the years ended December 31, 2007 and 2006:



----------------------------------------------------------------------------
----------------------------------------------------------------------------
Year ended Year ended
December 31, 2007 December 31, 2006
----------------------------------------------------------------------------
Total Average Total Average
Revenue Daily Average Revenue Daily Average
($000's) Production % ($/unit) ($000's) Production % ($/unit)
----------------------------------------------------------------------------
Natural
Gas
(mcf) 77,957 31,330 78 6.82 67,005 26,375 82 6.96
Light oil
(bbls) 35,933 1,289 19 76.39 18,952 763 14 68.07
Natural
gas
liquids
(bbls) 5,438 201 3 74.24 5,389 210 4 68.58
----------------------------------------------------------------------------

Total
petroleum
and
natural
gas sales
(BOE) 119,328 6,711 100 48.71 91,346 5,368 100 46.62
Royalty
revenue 1,368 0.56 2,423 1.24
----------------------------------------------------------------------------
Total
petroleum
and
natural
gas
revenue 120,696 49.27 93,769 47.86
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Commodity Prices

Birchcliff sells virtually all of its natural gas production at the AECO daily spot price. Birchcliff receives premium pricing for its natural gas due to the high heat content of its natural gas. The following table details the average sales price and differential received by Birchcliff:



COMMODITY PRICES
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Year ended Year ended
December 31, 2007 December 31, 2006
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Average Sales Price ($/mcf) 6.82 6.96
Average of the AECO Daily Spot
Prices ($/mmbtu) (1) 6.45 6.54
----------------------------------------------------------------------------
Positive Differential 0.37 0.42
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) $1.00/mmbtu equals $1.00/mcf based on a standard heat value mcf.


The price the Corporation receives for its commodity production depends on a number of factors, including AECO Canadian dollar spot market prices for natural gas, Canadian dollar Edmonton par oil prices, U.S. dollar oil prices, the U.S./Canadian dollar exchange rate, and transportation and product quality differentials. Birchcliff regularly considers managing the risks 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 for its natural gas production, but entered into the following oil price risk management contracts during 2007 for its light oil production for the terms noted below:



RISK MANAGEMENT CONTRACTS
----------------------------------------------------------------------------
----------------------------------------------------------------------------
WTI Price
Term Type Quantity (USD)(3)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
November 1, 2007 - December 31, 2007(1) Put 2,500 $65.00
November 1, 2007 - December 31, 2007(1) Call 2,500 $81.00
January 1 - March 31, 2008(2) Put 1,000 $67.50
January 1 - March 31, 2008(2) Call 1,000 $81.40
January 1 - December 31, 2008 Costless 1,000 $67.50 -
collar $79.10
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Each contract was entered into separately on different dates but the two
contracts essentially form a costless collar.
(2) Each contract was entered into separately on different dates but the two
contracts essentially form a costless collar.
(3) Each contract is settled on the average of the daily NYMEX WTI US$
price.


The Corporation entered into the above contracts during the month of September 2007 and did not enter into any new contracts during the fourth quarter of 2007. The Corporation actively monitors the market to determine whether any additional contracts are warranted.

Gain or Loss on Oil Price Risk Management Contracts

Due to the significant time and costs required to document the effectiveness of risk management contracts as hedges, Birchcliff does not account for its risk management contracts as hedges in its financial statements. The contracts are instead recorded at their fair values (mark to market) at each period end date, and realized and unrealized gains or losses on risk management contracts are shown as a separate category in the statement of income.

As a result of changes in the fair value of its oil price risk management contracts during the period, the Corporation recorded a realized oil price risk management loss of $1.9 million and an unrealized oil price risk management loss of $6.8 million in 2007. Until the third quarter of 2007, Birchcliff had no commodity price risk management contracts in place so the 2006 comparatives are $NIL.

Royalties and ARTC

Royalties are paid to various government entities and other land and mineral rights owners. The following table illustrates the Corporation's royalty expense as well as the impact of ARTC and prior year adjustments:



----------------------------------------------------------------------------
----------------------------------------------------------------------------


Year ended Year ended
December 31, 2007 December 31, 2006
----------------------------------------------------------------------------
----------------------------------------------------------------------------

$000's
Oil & natural gas royalties 19,332 16,823
ARTC (1) - (652)
----------------------------------------------------------------------------
Oil & natural gas royalties,
net of ARTC 19,332 16,171
----------------------------------------------------------------------------
----------------------------------------------------------------------------

$/BOE
Oil & natural gas royalties 7.89 8.58
ARTC (1) - (0.33)
----------------------------------------------------------------------------
Oil & natural gas royalties,
net of ARTC 7.89 8.25
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Overall effective royalty rate 16% 18%
----------------------------------------------------------------------------
----------------------------------------------------------------------------

----------------------------------------------------------------------------
----------------------------------------------------------------------------
Effect of Prior Year Gas Cost Allowance
("GCA") Adjustments(3)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Oil & natural gas royalties,
net of ARTC 7.89 8.25
Impact of 2005 adjustments(2) ($/BOE) (0.01) 1.19
Impact of 2006 adjustments(2) ($/BOE) 1.91 (1.91)
Impact of 2007 adjustments ($/BOE) Not yet determined
----------------------------------------------------------------------------
Oil & natural gas royalties,
net of ARTC adjusted for
prior year GCA credits 9.79 7.53
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Overall effective royalty rate
without prior year adjustments 20% 16%
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) The Alberta Royalty Tax Credit program was discontinued effective
December 31, 2006.
(2) The adjustments include custom processing adjustment, operating cost
adjustment and capital cost adjustment.
(3) The GCA credits are estimated by the Government in the current year and
adjusted for actual by the 2nd quarter of the following year.


The Corporation's estimated GCA credits for 2005 and 2006 were much lower than actual due to the significant level of capital investment during both those years on its natural gas facilities as compared to the prior year Government estimate. Due to the significant complexity of the GCA adjustments which are calculated by well and by facility the Corporation does not attempt to estimate the actual but relies on the Government estimate as such. The Government estimate is based on the prior year claim. As the above table illustrates, the estimate can be significantly different than the actual mainly due to the level of capital investment. If the level of capital investment escalates from year to year it is expected the GCA estimate will be low and if the capital investment is similar to the prior year then the GCA estimate will be reasonable.

The proportion of Crown royalties to total royalties for 2007 was generally consistent with the 2006 at approximately 95% and 94% of total royalties paid respectively. This is expected to remain consistent as most of Birchcliff's new drilling is on Crown land.

Proposed Changes to Alberta's Royalty Regime

Proposed changes to Alberta's royalty regime were announced on October 25, 2007 which will take effect on January 1, 2009. All of the Corporation's assets are in Alberta and will be subject to this new royalty framework. The Corporation is currently reviewing the proposal and evaluating, in detail, the impact the changes will have on Birchcliff's operating results, cash flows and reserves valuation. While the extent of the impact has not yet been fully quantified, it is apparent that beginning in 2009, the reserves valuation and cash flow will be adversely affected by the proposed changes. The degree to which cash flow will be adversely affected depends mainly on the commodity price level. The higher the prices the higher Birchcliff's effective royalty rate will be. This will result in Birchcliff having less cash flow to reinvest in its properties than it otherwise would have had under the existing royalty regime.

Any estimate of the effect of the new regime based on current or past production may be misleading because wells decline, and new wells are brought on that can change the production mix and thus the effective royalty rates. Birchcliff expects that its current high volume wells will decline and be replaced by different wells which may or may not be subject to the same royalty treatment depending on depth, productive capacity and commodity prices. As an example, the Corporation currently has very few horizontal wells producing from its Montney/Doig resource play, whereas in 2009 a significant portion of its production may come from this play type. The Corporation has not re-run its reserve evaluation to incorporate the proposed changes to the new royalty regime as it is waiting for clearer guidance from the Government of Alberta. Once the Government of Alberta clarifies the new royalty regime, the Corporation will be able to accurately determine the impact on the Corporation's petroleum and natural gas reserves.

Operating Costs

Operating costs were $21.7 million ($8.86 per BOE) for the year ended December 31, 2007 as compared to $17.3 million ($8.83 per BOE) for the year ended December 31, 2006. On a per unit basis, operating costs have remained fairly consistent. This is primarily a result of fewer expensed workovers and fairly flat recoveries in absolute dollar terms. The following table compares components of operating costs for the years ended December 31, 2007 and 2006:



----------------------------------------------------------------------------
----------------------------------------------------------------------------

Operating Costs Year ended Year ended
($000's) December 31, 2007 December 31, 2006
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Total ($000's) $/BOE Total ($000's) $/BOE
----------------------------------------------------------------------------
Field operating costs 22,917 9.35 17,750 9.06
Recoveries (1,820) (0.74) (1,691) (0.86)
----------------------------------------------------------------------------
Field operating costs,
net of recoveries 21,097 8.61 16,059 8.20
Expensed workovers and
other(1) 618 0.25 1,247 0.63
----------------------------------------------------------------------------
Total operating costs 21,715 8.86 17,306 8.83
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Expensed workovers and other includes $100,000 in the third quarter of
2007 relating to a reclamation event. The Corporation believes the costs
of this loss will be covered by insurance, so only the deductible has
been accrued.


Operating costs are somewhat mitigated by the impact of third party revenues Birchcliff receives for processing, treating and transporting other producers' production, water disposal 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 just under $5.0 million ($2.04 per BOE) for the year ended December 31, 2007 as compared to $3.2 million ($1.63 per BOE) in 2006. These costs consist primarily of transportation costs. The aggregate and per unit costs increased significantly in the fourth quarter of 2007 due to the Worsley Acquisition as the light oil produced at Worsley is transported by truck a significant distance to a sales terminal.

General and Administrative Expense

Net general and administrative costs in the year ended December 31, 2007 were $7.5 million ($3.07 per BOE) as compared to $5.9 million ($3.02 per BOE) in 2006. The G&A per BOE has been consistent from year to year.

The components of G&A are as follows:



----------------------------------------------------------------------------
----------------------------------------------------------------------------

General and Administrative Year Ended Year Ended
Expense ($000's) December 31, 2007 December 31, 2006
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Salaries, benefits and consultants 7,403 65% 5,228 60%
Other 4,057 35% 3,479 40%
----------------------------------------------------------------------------
G & A expense, gross 11,460 100% 8,707 100%
Overhead recoveries (2,652) (23%) (1,882) (22%)
Capitalized overhead (1,280) (11%) (905) (10%)
----------------------------------------------------------------------------
G & A expense, net 7,528 66% 5,920 68%
----------------------------------------------------------------------------
----------------------------------------------------------------------------
G & A expense, net per BOE $3.07 $3.02
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Interest Expense

Interest expense for 2007 was $8.7 million ($3.55 per BOE) compared to $4.2 million ($2.17 per BOE) in 2006. The increase in aggregate interest expense and interest expense per BOE result directly from the Corporation maintaining a higher debt level and being subject to higher interest rates during the year. The higher debt level was a result of the Corporation's capital expenditure program being greater than cash flow. In addition, the Corporation's debt increased substantially on September 27, 2007 with the closing of the Worsley Acquisition.

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

Depletion, depreciation and accretion ("DD&A") expenses for the year ended December 31, 2007 was $66.1 million ($26.97 per BOE) as compared to $44.7 million ($22.84 per BOE) in 2006. The DD&A on a per BOE basis is 18% higher mainly due to the high finding costs in 2006 and due to the fact many of the proved reserves added during 2007 came in the fourth quarter of 2007, which had a reduced impact on the entire year. The components of DD&A are as follows:



----------------------------------------------------------------------------
----------------------------------------------------------------------------

Year Ended Year Ended
December 31, 2007 December 31, 2006
DD&A Expense
($000's) Total ($000's) $/BOE Total ($000's) $/BOE
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Depletion & depreciation 64,826 26.46 43,921 22.42
Accretion for Asset
Retirement Obligations 1,253 0.51 813 0.42
----------------------------------------------------------------------------
Total DD&A 66,079 26.97 44,734 22.84
----------------------------------------------------------------------------
----------------------------------------------------------------------------


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, 2007, Birchcliff has excluded from its full cost pool $31.8 million (December 31, 2006 - $48.3 million) of costs for undeveloped land acquired by Birchcliff and for unproved properties acquired 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 and developed, or have their value confirmed or 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 calculation review at December 31, 2007 on its petroleum and natural gas assets. Based on this calculation review, Birchcliff determined there was no impairment of its petroleum and natural gas assets.

Taxes

Birchcliff recorded a future income tax recovery of $4.5 million ($1.85 per BOE) for the year ended December 31, 2007 as compared to an expense of $590,000 ($0.30 per BOE) for 2006.

Birchcliff incurred $269,000 ($0.11 per BOE) of Part XII.6 taxes in 2007 relating mainly to the issue of $16,029,000 of flow-through shares in November 2006. Birchcliff fulfilled its obligation with respect to the flow-through share issue in the third quarter of 2007.

The Large Corporation Tax ("LCT") was repealed effective January 1, 2006. Consequently, the Corporation has recorded $NIL current tax expense for 2007 with respect to LCT for its tax year ended May 31, 2007 as compared to $60,000 of current tax expense for 2006 relating to LCT for its tax year ended May 31, 2006.

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



---------------------------------------------------------
TAX POOLS 2007
---------------------------------------------------------
$ millions
---------------------------------------------------------

---------------------------------------------------------
Canadian Exploration Expenditures 42
---------------------------------------------------------
Canadian Development Expenditures 53
---------------------------------------------------------
Canadian Oil & Gas Property Expenditures 372
---------------------------------------------------------
Undepreciated Capital Cost 137
---------------------------------------------------------
Non-Capital Losses -
---------------------------------------------------------
Scientific Research & Experimental Development 15
---------------------------------------------------------
Investment Tax Credits 3
---------------------------------------------------------
Share Issue Costs 10
---------------------------------------------------------


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 a $2.2 million expense ($0.90 per BOE) for stock-based compensation relating to stock options in 2007, as compared to $2.7 million ($1.37 per BOE) in 2006. In 2007 approximately 1.2 million of out-of-the-money stock options were forfeited. These forfeitures, as well as approximately 638,000 options forfeited due to employee resignations, resulted in a stock-based compensation recovery of $1.1 million ($0.45 per BOE). The majority of this impact (approximately $897,000) occurred in the second quarter of 2007.

During the year ended December 31, 2007, the Corporation issued 151,686 common shares due to the exercise of vested stock options, and stock options in respect of 1.6 million common shares were forfeited. In addition, the cancellation of vested stock options resulted in a cash-paid stock-based compensation expense of $54,000. The cash-paid expense is included in total stock-based compensation expense.

CAPITAL EXPENDITURES AND CAPITAL RESOURCES

Capital expenditures amounted to $350.2 million in 2007 as compared to $102.2 million during 2006. The increase in expenditures was mainly the result of the Worsley Acquisition for approximately $263.3 million after interim closing adjustments and related costs. Excluding the Worsley Acquisition, capital expenditures totaled $86.9 million in 2007.

The following table sets forth a summary of the Corporation's capital expenditures incurred for the reporting period and the comparable prior period:



Capital Expenditures

---------------------------------------------------------------
Year Ended December 31 ($000's) 2007 2006
---------------------------------------------------------------
Land 4,799 12,098
Seismic 2,387 2,670
Other 2,121 732
Drilling and completions 52,274 56,345
Well equipment and facilities 15,889 28,238
Capitalized general and administrative expenses 1,280 905
---------------------------------------------------------------
Total F&D costs 78,750 100,988
Acquisitions 271,120 1,106
---------------------------------------------------------------
Total FD&A costs 349,870 102,094

Administrative assets 303 60
---------------------------------------------------------------
Total Capital Expenditures 350,173 102,154
---------------------------------------------------------------


The following table sets forth a summary of the Corporation's capital resources for the reporting period and the comparable prior period:



Capital Resources

------------------------------------------------------------
Year Ended December 31 ($000's) 2007 2006
------------------------------------------------------------
Cash generated by (used in) operations 56,245 46,687
Changes in working capital from operations (1,359) 1,448
Asset retirement expenditures (588) (570)
Equity issues, net of issue costs 109,380 28,598
Increase in non-revolving credit facility 98,830 -
Increase in revolving credit facilities 74,550 44,690
Changes in working capital from investing 13,116 (18,698)
------------------------------------------------------------
Total Capital Resources 350,174 102,155
------------------------------------------------------------




SELECTED QUARTERLY INFORMATION

----------------------------------------------------------------------------
----------------------------------------------------------------------------
Quarters Ended
($000's, except share December 31, September 30, June 30, March 31,
and per share amounts) 2007 2007 2007 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Petroleum and natural
gas production (BOE
per day) 9,260 6,014 5,712 5,829
Petroleum and natural
gas commodity price
($ per BOE) 54.18 40.10 48.20 49.43
Natural gas commodity
price at wellhead
($ per mcf) 6.71 5.48 7.39 7.78
Total petroleum and
natural gas revenue 46,398 22,467 25,462 26,369
Total royalties (7,804) (4,007) (3,233) (4,288)
Total interest and other
revenue 8 - - 1
Total revenues, net 38,602 18,460 22,229 22,082
Capital expenditures 30,306 288,321 13,727 17,819

Net income (loss) (6,457) (5,707) (707) (1,373)
Per share basic (0.07) (0.09) (0.01) (0.02)
Per share diluted (0.07) (0.09) (0.01) (0.02)

Cash generated by
operations 19,881 9,327 13,641 13,396
Per share basic 0.21 0.14 0.21 0.21
Per share diluted 0.21 0.14 0.21 0.21

Book value of total
assets 662,252 644,876 359,423 360,164
Non-revolving credit
facility 98,830 97,431 - -
Revolving credit
facilities 155,854 153,360 88,833 85,431
Total indebtedness 272,916 262,557 92,218 92,099
Shareholders' equity 340,756 342,451 240,250 241,065

Common shares
outstanding - end of
period
Basic 94,554,269 94,472,583 64,189,413 64,189,413
Diluted 103,639,748 103,046,582 72,709,078 73,709,246
Weighted average common
shares outstanding
Basic 94,486,372 65,521,290 64,189,413 64,168,302
Diluted 96,548,884 66,152,795 65,394,368 64,174,235
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) ARTC is not applicable to periods after December 31, 2006.


----------------------------------------------------------------------------
Quarters Ended
($000's, except share December 31, September 30, June 30, March 31,
and per share amounts) 2006 2006 2006 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(1) (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
Capital expenditures 12,577 25,273 24,627 39,677

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
Non-revolving credit
facility - - - -
Revolving credit
facilities (81,304) (100,127) (85,299) (66,601)
Total indebtedness (87,783) (115,100) (100,321) (86,708)
Shareholders' 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
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(2) ARTC is not applicable to periods after December 31, 2006.


DISCUSSION OF QUARTERLY RESULTS

The Corporation's greatest growth came in the fourth quarter of 2007 after completion of the Worsley Acquisition on September 27, 2007. Production, revenues and expenses relating to the properties acquired via the Worsley Acquisition were recorded from September 27, 2007. Average daily production increased by 3,246 BOE per day or 54% over the third quarter of 2007. Commodity prices were much higher in the fourth quarter of 2007 as compared to the third quarter. The combination of more production and higher commodity prices generated significantly more cash flow for the Corporation in the fourth quarter. Cash flow for the fourth quarter was 113% greater than the third quarter on only a 54% increase in production.

Birchcliff's debt, equity and total assets increased substantially from the second quarter of 2007 to the third quarter of 2007 again as a result of the Worsley Acquisition. The transaction was completed on September 27, 2007 and therefore impacted the September 30, 2007 ending balance sheet accounts, but had minimal impact on the income statement accounts such as revenue and expenses.

SUMMARY 2008 OUTLOOK

Birchcliff has a market capitalization in excess of $1 billion and an enterprise value in excess of $1.15 billion. As such Birchcliff is financially positioned to capitalize on its two large resource plays and to be very competitive with the other large producers in the Peace River Arch.

The Corporation will balance its capital spending between its two resource plays and its continued exploration and development of other play types in the Peace River Arch. Birchcliff will continue to aggressively acquire lands in order to expand its potential opportunities in the Peace River Arch.

With the new horizontal well completion technology we are now using, we expect to be able to continue to expand Birchcliff's natural gas reserves in the Montney/ Doig play.

CONTRACTUAL COMMITMENTS

Flow-Through Share Commitments

In February 2008, Birchcliff announced a bought deal equity financing which includes $15 million of flow-through shares which commits the Corporation to renounce $15 million of exploration expenditures for the 2008 taxation year. Birchcliff has a little more than 21 months or until December 31, 2009 to incur these expenditures and 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, 2009. At December 31, 2007 the Corporation had fulfilled all previous flow-through share commitments.

Office Premises Commitments

The Corporation is committed under a new operating lease beginning December 1, 2007 which expires on November 30, 2017. Birchcliff will not use all of the space and has sublet the excess space to an arms' length party on a basis that recovers approximately 50% of the rental costs for the first five years. The Corporation is committed to the following aggregate minimum lease payments (not reduced by rents receivable by the Corporation):



Aggregate Minimum Lease Payments

-------------------
-------------------
Year $000s

-------------------
-------------------
2008 3,020
2009 3,020
2010 3,020
2011 3,020
2012 3,029
Thereafter 15,424
-------------------
-------------------


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 78% weighted to natural gas during the year ended December 31, 2007 and approximately 66% weighted to natural gas in the fourth quarter of 2007, 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 natural gas production and although it does monitor the hedge market, its strategy is to continue unhedged and to sell its natural gas 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.

Foreign Currency Exchange Risk

The Corporation is exposed to foreign currency fluctuations because Canadian revenues are strongly linked to United States dollar denominated benchmark prices.

Production Risk

Birchcliff believes it has a stable production base from a large number of producing wells 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.

Regulatory Uncertainty

All of Birchcliff's properties are currently located within the province of Alberta. There is a risk that although the Corporation believes it is making an economic investment at the time all of the upfront capital is invested in facilities or drilling, completing and equipping an oil or natural gas well, the Government may at any point in the economic life of that project, expropriate without compensation a portion of the expected profit under a new royalty/tax regulation or regime with no grandfathering provisions. Without grandfathering provisions this may cause that particular project to become uneconomic once the new royalties or taxes take effect. This type of possible future government action is unpredictable and cannot be forecast by the Corporation.

Management's Report

To the Shareholders of Birchcliff Energy Ltd.

The financial statements of Birchcliff Energy Ltd. were prepared by management within the acceptable limits of materiality and are in accordance with accounting principles generally accepted in Canada. Management is responsible for ensuring that the financial and operating information presented in this annual report is consistent with that shown in the financial statements.

The financial statements have been prepared by management in accordance with the accounting policies as described in the notes to the financial statements. Timely release of financial information sometimes necessitates the use of estimates when transactions affecting the current accounting period cannot be finalized until future periods. When necessary, such estimates are based on informed judgments made by management.

Management has designed and maintains an appropriate system of internal controls to provide reasonable assurance that all assets are safeguarded and financial records properly maintained to facilitate the preparation of financial statements for reporting purposes.

Deloitte & Touche LLP, an independent firm of Chartered Accountants appointed by shareholders, have conducted an examination of the corporate and accounting records in order to express their opinion on the financial statements.

The Audit Committee, consisting of non-management directors, have met with representatives of Deloitte & Touche LLP and management in order to determine if management has fulfilled its responsibilities in the preparation of the financial statements. The Board of Directors has approved the financial statements on the recommendation of the Audit Committee.



A. Jeffery Tonken, Bruno P.Geremia
President and Vice President and
Chief Executive Officer Chief Financial Officer

March 13, 2008




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

Tel: (403) 267-1700
Fax: (403) 264-2871


Auditors' Report

To the Shareholders of Birchcliff Energy Ltd.:

We have audited the balance sheets of Birchcliff Energy Ltd. as at December 31, 2007 and 2006 and the statements of net loss, comprehensive loss and retained earnings (deficit) 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, 2007 and 2006 and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles.



Calgary, Alberta (signed) Deloitte & Touche LLP
March 13, 2008 Chartered Accountants






BIRCHCLIFF ENERGY LTD.

Balance Sheet

As at December 31, ($000's)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
2007 2006
-----------------
ASSETS
CURRENT
Cash and cash equivalents 66 65
Accounts receivable 20,036 13,498
Prepaid and other 2,879 3,240
Future income tax benefit (Note 9) 2,004 -
-----------------
24,985 16,803

Future income tax benefit (Note 9) 6,287 6,689

Petroleum and natural gas properties and
equipment (Note 5) 630,980 338,763
-----------------
662,252 362,255
-----------------
-----------------

LIABILITIES
CURRENT
Accounts payable and accrued liabilities 41,213 23,282
Non-revolving credit facility (Note 6) 98,830 -
Risk management contacts (Note 8) 6,793 -
-----------------
146,836 23,282

Revolving credit facilities (Note 7) 155,854 81,304
Asset retirement obligations (Note 10) 18,806 11,270

SHAREHOLDERS' EQUITY
Share capital (Note 11) 342,819 236,158

Contributed surplus (Note 12) 10,930 8,990

Retained earnings (deficit) (12,993) 1,251
-----------------
340,756 246,399
-----------------
662,252 362,255





APPROVED BY THE BOARD
Larry A. Shaw A. Jeffery Tonken
Director Director





BIRCHCLIFF ENERGY LTD.
Statements of Net Loss, Comprehensive Loss and Retained Earnings (Deficit)
For the Year Ended December 31, ($000's)
----------------------------------------------------------------------------
2007 2006
--------------------

REVENUE
Petroleum and natural gas 120,696 93,769
Royalties, net of ARTC (19,332) (16,171)
Interest and other 9 31
--------------------
101,373 77,629
Loss on risk management contracts (Note 8)
Realized (1,865) -
Unrealized (6,769) -
--------------------
92,739 77,629

EXPENSES
Production 21,715 17,306
Transportation and marketing 4,988 3,194
General and administrative 7,528 5,920
Stock-based compensation (Note 12) 2,207 2,691
Depletion, depreciation and accretion
(Note 5 and 10) 66,079 44,734
Unrealized foreign exchange loss (Note 8) 24 -
Realized foreign exchange loss (Note 8) 19 -
Interest 8,690 4,247
--------------------
111,250 78,092

--------------------
LOSS BEFORE TAXES (18,511) (463)


TAXES
Capital and other taxes 269 60
Future income taxes (recovery) (Note 9) (4,536) 590
--------------------
(4,267) 650

--------------------
NET LOSS AND COMPREHENSIVE LOSS (14,244) (1,113)

RETAINED EARNINGS, BEGINNING OF YEAR 1,251 2,364

--------------------

RETAINED EARNINGS (DEFICIT), END OF YEAR (12,993) 1,251
--------------------
--------------------


Net loss per common share (Note 13)

basic and diluted ($0.20) ($0.02)

Weighted average common shares

basic and diluted 72,156,544 58,806,783

See accompanying notes to the financial statements.





BIRCHCLIFF ENERGY LTD.
Statements of Cash Flows
For the Year Ended December 31, ($000's)
----------------------------------------------------------------------------
2007 2006
--------------------
CASH FLOWS RELATED TO THE FOLLOWING ACTIVITIES:

OPERATING

Net loss (14,244) (1,113)
Adjustments for items not affecting cash:
Depletion, depreciation and accretion 66,079 44,734
Stock-based compensation 2,153 2,476
Loss on risk management contracts 6,769 -
Loss on foreign exchange 24 -
Future income taxes (recovery) (4,536) 590
--------------------
56,245 46,687


Changes in non-cash working capital (Note 15) (1,359) 1,448
Asset retirement expenditures incurred (588) (570)
--------------------
54,298 47,565

FINANCING
Increase in non-revolving credit facility (Note 6) 98,830 -
Increase in revolving credit facility (Note 7) 74,550 44,690
Issuance of share capital, net of issue costs
(Note 11) 109,380 28,598
--------------------
282,760 73,288

INVESTING
Purchase of petroleum and natural gas properties
and equipment (Note 4) (263,320) -
Purchase of minor petroleum and natural gas
properties and equipment (7,800) (1,106)
Development of petroleum and natural gas properties
and equipment (79,053) (101,048)
Changes in non-cash investing working capital
(Note 15) 13,116 (18,698)
--------------------
(337,057) (120,852)
--------------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 1 1

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 65 64

--------------------
CASH AND CASH EQUIVALENTS, END OF YEAR 66 65
--------------------
--------------------


Cash interest paid 8,690 4,247
Cash taxes paid 6 60

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. Birchcliff trades on the Toronto Stock Exchange under the symbol "BIR".

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 nonproducing 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) Derivative financial instruments

Derivative instruments that do not qualify as hedges, or are not designated as hedges, are recorded using the mark-to-market method of accounting whereby
instruments are recorded in the Balance Sheet as either an asset or liability with changes in fair value recognized in net earnings.

Derivative financial instruments are used by the Corporation to manage economic exposure to market risks relating to commodity prices. Birchcliff's policy is not to utilize derivative financial instruments for speculative purposes.

(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.

(m) Foreign currency translations

Monetary assets and liabilities of the Corporation that are denominated in foreign currencies are translated into its functional currency at the rates of exchange in effect at the period end date. Any gains or losses are recorded in the Statements of Net Loss.

3. CHANGES IN ACCOUNTING POLICY/RECENT ACCOUNTING PRONOUNCEMENTS

Effective January 1, 2007, Birchcliff adopted CICA Section 1506 Accounting Changes which provides expanded disclosures for changes in accounting policies, accounting estimates and corrections of errors. Under the new standard, accounting changes are applied retrospectively unless otherwise permitted or where impracticable to determine. Also, voluntary changes in accounting policy are made only when required by a primary source of GAAP or if the change results in more relevant and reliable information. Application of this standard did not have a material impact on Birchcliff's Financial Statements. Birchcliff also adopted the Canadian Institute of Chartered Accountants (CICA) Section 1530 Comprehensive Income, Section 3251 Equity, and Section 3855 Financial Instruments - Recognition and Measurement which were issued in January 2005.

Under these new standards, comprehensive income was introduced which provides for certain gains and losses to be temporarily recorded outside of net earnings. In additional, all financial instruments, including derivatives, are included in the Corporation's Balance Sheet and measured, in most cases, at fair values. Because Birchcliff did not have financial derivatives until the current year, this standard did not have a material impact to the Corporation's Financial Statements.

The Corporation has made the following classifications:

a) Cash and cash equivalents are classified as financial assets held for trading and are measured at fair value. Gains and losses from revaluation are recognized in net income.

b) Accounts receivable are classified as loans and receivables and are initially measured at fair value. Subsequent revaluations are recorded at amortized cost using the effective interest rate method.

c) Revolving credit facilities, accounts payable and accrued liabilities are classified as other liabilities and are initially measured at fair value. Subsequent revaluations are recorded at amortized cost using the effective interest rate method.

The Corporation has adopted these sections retroactively without restatement and has therefore not restated prior periods. Further, because the Corporation did not have any financial instruments that were impacted at the time of adoption, the adoption of these sections had no material impact on the Corporation's net earnings, cash flows or retained earnings at January 1, 2007.

The Corporation has assessed new and revised accounting pronouncements that have been issued but are not yet effective and determined that the following may have a significant impact on the Corporation:

- As of January 1, 2008, Birchcliff will be required to adopt two new CICA Handbook standards, Section 3862 Financial Instruments - Disclosures and Section 3863 Financial Instruments - Presentation which will replace Section 3861 Financial Instruments - Disclosure & Presentation. The new disclosure standard increases the emphasis on the risks associated with both recognized and unrecognized financial instruments and how those risks are managed. The new presentation standard carries forward the former presentation requirements. The new financial instruments presentation and disclosure requirements were issued in December 2006.

- In January 2006, the CICA Accounting Standards Board (AcSB) adopted a strategic plan for the direction of accounting standards in Canada. As part of that plan, accounting standards in Canada for public companies are expected to converge with International Financial Reporting Standards (IFRS) by the end of 2011. Birchcliff continues to monitor and assess the impact of convergence of Canadian GAAP and IFRS.

Birchcliff has assessed the following new accounting pronouncements that have been issued but are not yet effective and determined that they will not have a material impact on its financial statements:

- As of January 1, 2008, Birchcliff will be required to adopt CICA Handbook Section 1535 Capital Disclosures which will require companies to disclose their objectives, policies and processes for managing capital. In addition, disclosures are to include whether companies have complied with externally imposed capital requirements.

- In February 2008, the CICA issued Section 3064 Goodwill and Other Intangible Assets, replacing Section 3062 Goodwill and Other Intangible Assets and Section 3450 Research and Development Costs. Various other changes have been made to other sections of the CICA Handbook for consistency. The new Section will be applicable to financial statements relating to fiscal years beginning on or after October 1, 2008. Accordingly, the Corporation will adopt the new standard for its fiscal year beginning January 1, 2009. The new Section establishes standards for the recognition, measurement, presentation and disclosure of goodwill subsequent to its initial recognition and of intangible assets by profitoriented enterprises. Standards concerning goodwill are unchanged from the standards included in the previous Section 3062.

4. ACQUISITIONS

On September 27, 2007, Birchcliff acquired certain oil and natural gas assets in the Worsley area ("Worsley Acquisition"), effective July 1, 2007, for $270 million before closing adjustments and related costs.

The following table details the purchase price allocation for the Worsley Acquisition:



-------------------------------------------------------------------
-------------------------------------------------------------------
Net assets acquired: $000's
-------------------------------------------------------------------
-------------------------------------------------------------------
Petroleum and natural gas properties and equipment 269,239
Asset retirement costs (5,919)
-------------------------------------------------------------------
Total net assets acquired 263,320
-------------------------------------------------------------------
-------------------------------------------------------------------
Consideration: $000's
-------------------------------------------------------------------
-------------------------------------------------------------------
Purchase price, net of adjustments, paid in cash 260,808
Costs related to the Worsley Acquisition 2,512
-------------------------------------------------------------------
Total consideration paid 263,320
-------------------------------------------------------------------
-------------------------------------------------------------------


In relation to the Worsley Acquisition, the Corporation has made its best estimate as to the net assets acquired and the consideration given. The final purchase price adjustment has not yet been determined by the Corporation and the vendor, and all costs have not yet been finalized. Therefore, the above amount may be subject to adjustment.

These financial statements incorporate the operations of the Worsley Acquisition from September 27, 2007 forward.

5. PETROLEUM AND NATURAL GAS PROPERTIES AND EQUIPMENT



-------------------------------------
2007
-------------------------------------
Accumulated
Depletion and
Cost Depreciation Net Book Value
$000's $000's $000's
-------------------------------------

Petroleum and natural gas assets 758,365 (128,011) 630,354
Office furniture and equipment 1,331 (705) 626
-------------------------------------
759,696 (128,716) 630,980
-------------------------------------
-------------------------------------

-------------------------------------
2006
-------------------------------------
Accumulated
Depletion and
Cost Depreciation Net Book Value
$000's $000's $000's
-------------------------------------

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
-------------------------------------
-------------------------------------


As of December 31, 2007, the cost of petroleum and natural gas properties includes $31.8 million (2006 - $48.3 million) relating to unproved properties which have been excluded from costs subject to depletion and depreciation.

Birchcliff has capitalized general and administrative costs of $1,280,000 in the year ended December 31, 2007 (2006 - $905,000) relating to exploration and development activities.

The Corporation performed an impairment (ceiling) test review at December 31, 2007 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, 2007 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)
--------------------------------------------------------------------------

2008 $85.00 0.980 $85.65 $6.90
2009 $81.60 0.950 $84.75 $7.75
2010 $81.15 0.920 $87.05 $8.10
2011 $79.60 0.900 $87.25 $8.50
2012 $77.95 0.900 $85.40 $8.65
2013 $77.30 0.900 $84.60 $9.10
2014 $78.85 0.900 $86.30 $9.30
2015 $80.40 0.900 $88.05 $9.50
2016 $82.00 0.900 $89.80 $9.65
2017 $83.65 0.900 $91.60 $9.85
2018 $85.35 0.900 $93.45 $10.05
2019 $87.05 0.900 $95.30 $10.25
2020 $88.80 0.900 $97.20 $10.45
2021 $90.55 0.900 $99.15 $10.65
2022 $92.35 0.900 $101.10 $10.90
2023 $94.20 0.900 $103.15 $11.10
2024 $96.10 0.900 $105.20 $11.35
2025 $98.00 0.900 $107.30 $11.55
2026 $100.00 0.900 $109.45 $11.80
2027 $102.00 0.900 $111.65 $12.00
2027+ 2.0% 0.900 2.0% 2.0%
--------------------------------------------------------------------------
--------------------------------------------------------------------------


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, 2007.

6. NON-REVOLVING CREDIT FACILITY

Birchcliff entered into an Acquisition Credit Agreement with a syndicate of banks on September 4, 2007. The agreement allowed for Birchcliff to make a one time draw of up to $100 million on a non-revolving credit facility for the purpose of closing the Worsley Acquisition. The credit facility matures one year from the date of drawdown and has no other terms for extension. The interest applicable to prime loan advances under the agreement is prime plus 2.5% for the first six months and prime plus 3% for the final six months. The interest applicable to advances using bankers' acceptances would be the prevailing bankers' acceptance rate at the time plus a 3.5% stamping fee. On September 27, 2007 the Corporation gave notice to draw the entire amount of the credit facility in bankers' acceptances. The drawn amount at December 31, 2007 is $98.8 million with the $1.2 million difference being the discounted value from the $100 million credit facility limit based on the market interest rate at that time for bankers' acceptances. The facility is subordinate to the revolving term credit facilities and is secured by a fixed and floating debenture, an instrument of pledge, and a general security agreement encompassing all of the Corporation's assets. The average interest rate applicable to the non-revolving credit facilities in 2007 was approximately 8.5%.

7. REVOLVING CREDIT FACILITIES



2007 2006
$000s $000s
-----------------------------------------------------------------
-----------------------------------------------------------------
Syndicated credit facility 146,238 75,571
Working capital facility 9,616 5,733
-----------------------------------------------------------------
Revolving credit facilities 155,854 81,304
-----------------------------------------------------------------
-----------------------------------------------------------------


The Corporation has available to it an extendible revolving term credit facility with an authorized limit of $180 million and an extendible revolving working capital facility with an authorized limit of $20 million. The $180 million syndicated credit facility is provided by a syndicate of three banks (the "Syndicate"). The $20 million working capital facility is provided by the lead bank in the current bank syndicate. As at December 31, 2007, Birchcliff had drawn $155.9 million on the credit facilities. As at December 31, 2007, the prime rate that may be applicable to the working capital facility was 6.0%. The credit facilities allow for prime rate loans, US base rate loans, bankers' acceptances, letters of credit and LIBOR loans. The interest rates applicable to the drawn loans are based on a pricing grid and will increase as a result of the increased ratio of outstanding indebtedness to earnings before interest, taxes, depreciation and amortization.

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.

Syndicated Credit Facilities

The syndicated credit facility has a conversion date of May 23, 2008 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.

Working Capital Facility

The working capital facility has a conversion date of May 23, 2008 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.

8. FINANCIAL INSTRUMENTS & RISK MANAGEMENT CONTRACTS

Birchcliff is exposed to a number of financial risks that are part of its normal course of business. The Corporation has implemented a risk management program that includes derivative financial instruments as disclosed in this note. The objective of the risk management program is to mitigate the Corporation's exposure to commodity price fluctuations. The Board of Directors periodically reviews the results of all risk management activities and all outstanding positions.

Commodity Price Risk

Oil and natural gas prices have fluctuated widely during recent years and are determined by economic and, in the case of oil prices, political factors. Supply and demand factors, including weather and generaal economic conditions as well as conditions in other oil and natural gas producing regions impact prices. Any movement in oil and natural gas prices could have an effect on Birchcliff's financial condition. The Corporation may manage the risk associated with changes in commodity prices by entering into oil or natural gas price derivative contracts. To the extent that Birchcliff engages in risk management activities related to commodity prices, it will be subject to credit risks associated with counterparties with which it contracts.

Foreign Currency Exchange Risk

The Corporation is exposed to foreign currency fluctuations because Canadian revenues are strongly linked to United States dollar denominated benchmark prices.

Credit Risk

A substantial portion of the Corporation's accounts receivable are with customers and joint-venture participants in the oil and natural gas industry and are subject to normal industry credit risks.

Interest Rate Risk

Birchcliff is exposed to interest rate cash flow risk on floating interest rate bank debt due to fluctuations in market interest rates. The remainder of the Corporation's financial assets and liabilities are not exposed to interest rate risk.

Financial Instruments

Financial instruments of the Corporation carried on the balance sheet consist mainly of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, non-revolving credit facility, other long-term liabilities, commodity contracts and revolving credit facilities.

At December 31, 2007 there were no significant differences between the carrying value of these financial instruments and their estimated fair value.

Derivative Contracts

Following is a summary of all derivative contracts in place as at December 31, 2007 in order to mitigate the risks discussed above. Each contract is settled on the average of the daily NYMEX WTI US$ price:

Financial WTI Crude Oil Contracts



---------------------------------------------------------------------------
---------------------------------------------------------------------------


Term


Volume Put Call
Contract (bbls/d) ($US/bbl) ($US/bbl)
---------------------------------------------------------------------------
---------------------------------------------------------------------------
January 1 - March 31, 2008 Costless collar 1,000 67.50 81.40
January 1 - December 31, 2008 Costless collar 1,000 67.50 79.10
---------------------------------------------------------------------------
---------------------------------------------------------------------------


None of the commodity contracts have been designated as effective accounting hedges for accounting purposes. All commodity contracts have been accounted for as assets and liabilities in the balance sheet based on their fair values. The following table reconciles the movement in the fair value of the financial commodity contracts:



------------------------------------------------------------------------
------------------------------------------------------------------------
December 31, 2007 December 31, 2006(1)
$000s $000s
------------------------------------------------------------------------
------------------------------------------------------------------------

Fair value, beginning of year - -
Fair value, end of year 6,769 -
------------------------------------------------------------------------
Change in fair value of
contracts in the year 6,769 -
Realized losses in the year 1,865 -
------------------------------------------------------------------------
Loss on risk management
contracts 8,634 -
------------------------------------------------------------------------
------------------------------------------------------------------------
(1) Birchcliff did not have any risk management contracts
in place until September 2007.


At December 31, 2007, the fair value of the contracts was a loss of approximately $6.8 million. The Corporation recorded an unrealized loss on risk management contracts of approximately $6.8 million and a realized loss of approximately $1.9 million in the statement of net loss. This amount includes the realized and unrealized gains and losses on risk management contracts. There were no comparable amounts in the prior year because Birchcliff did not have any risk management contracts in place until September 2007.

9. 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 32.12% (2006 - 34.5%) to the loss before taxes. The difference results from the following items:



-----------------------
2007 2006
($000's) ($000's)
-----------------------

Net income (loss) before taxes (18,511) (463)
-----------------------

Computed expected income tax expense (recovery) (5,946) (160)
Increase (decrease) in taxes resulting from:
Non-deductible Crown payments 433 1,669
Resource allowance - (1,558)
Non-deductible stock-based compensation 692 854
Non-deductible expenses 19 16
Change in rate and other 266 (231)

-----------------------
Future income tax expense (recovery) (4,536) 590
-----------------------
-----------------------


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



-----------------------
2007 2006
($000's) ($000's)
-----------------------
Future income tax liabilities:
Property, plant and equipment (6,756) (7,399)
Future income tax assets:
Asset retirement obligation 4,896 3,320
Share issue costs 2,806 2,241
ACRI - 550
NCL's, SR&ED's & ITC's (1) 5,341 7,977
-----------------------
Net long term asset 6,287 6,689

Future income tax assets (short term):
Risk management contracts 2,004 -
-----------------------
Net short term asset 2,004 -
-----------------------
Net future income tax asset 8,291 6,689
-----------------------
-----------------------
(1) "NCL" = Non Capital Losses; "SR&ED" = "Scientific Research &
Experimental Development"; "ITC" = "Investment Tax Credits"


At December 31, 2007, the Corporation has estimated non-capital losses for income tax purposes of approximately $NIL (2006 - $4,600,000) available to shelter future taxable income.

10. 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, 2007 to be approximately $60,981,000 (2006 - $32,362,000) which will be incurred between 2008 and 2057. 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:



------------------------------------------------------------
------------------------------------------------------------

2007 2006
------------------------------------------------------------
------------------------------------------------------------
Balance, January 1 11,270 9,251
Obligations incurred 1,368 1,387
Obligations acquired (Note 4) 5,919 -
Changes in estimate (415) 389
Accretion expense 1,252 813
Actual expenditures incurred (588) (570)
------------------------------------------------------------
Balance December 31 18,806 11,270
------------------------------------------------------------
------------------------------------------------------------


11. 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.

(b) Issued:



----------------------------------------------------------------------------
Number of
Common Shares Amount
$
----------------------------------------------------------------------------

Balance, December 31, 2005 58,147,747 214,951,344
Issued upon exercise of stocks 51,666 245,614
Tax effect of flow-through shares (Note (c)
and (d)) - (7,997,000)
Share issue costs (Note (e)) - (19,321)
Tax effect of share issue costs (Note (e)) - 6,500
Issued, net of costs (Note (f)) 5,940,000 28,437,352
Tax effect of share issue costs (Note (g)) - 533,500

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

Issued upon exercise of stock options 151,686 681,017
Tax effect of flow-through shares (Note (f)) - (4,770,000)
Issued, net of costs (Note (h)) 30,263,170 108,913,115
Tax effect of share issue costs (Note (i)) - 1,836,500

---------------------------------------------------------------------------
Balance, December 31, 2007 94,554,269 342,818,621

---------------------------------------------------------------------------
---------------------------------------------------------------------------


(c) 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.

(d) 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.

(e) 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.

(f) 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, 2007 the commitment to spend and renounce $16,029,000 of qualified 100% deductible tax pools with respect to the flow-through shares was fulfilled.

(g) 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.

(h) On September 27, 2007, Birchcliff issued 30,263,170 common shares at a price of $3.80 per share for total net proceeds of $108,913,115.

(i) Birchcliff recognized a future tax benefit of $1,836,500 in respect of share issue costs of $6,086,931 incurred with respect to the issuance of 30,263,170 common shares on September 27, 2007.

12. 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, 2007, the Corporation recorded just over $2.2 million (2006 - $2.5 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 $54,000 (2006 - $214,000) 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, 2007 was $2.32 (2006 - $2.88) per option.

At December 31, 2007 the Corporation's amended and restated stock option plan permitted the grant of options in respect of 9,455,426 common shares (2006 - 6,413,941). At December 31, 2007, there remained available for issuance options in respect of 4,119,612 common shares (2006 - 2,134,273).

Subsequent to year end in early 2008, options in respect of 1,667,000 common shares were granted to employees and management at fair market value at the time of grant, with an average exercise price of $7.43.

A summary of the changes during the year ended December 31, 2007 and 2006 and the Corporation's outstanding stock options as at December 31, 2007 is presented below:



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


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

Granted 2,845,000 4.32
Exercised (151,686) (3.08)
Forfeited (1,581,169) (6.46)
Cancelled (55,999) (3.44)
------------------------------------
Outstanding, December 31, 2007 5,335,814 4.00
------------------------------------
------------------------------------


----------------------------------------------------------------------------
Weighted
Number Average Weighted Number Weighted
Outstanding Remaining Average Exercisable Average
at December Contractual Exercise at December Exercise
Date of Grant 31, 2007 Life Price $ 31, 2007 Price ($)
----------------------------------------------------------------------------

Dec 3, 2004
(1) 1,368,334 2.1 3.00 870,001 (1)(2) 3.00
Apr 20 to Jun
22, 2005 876,834 2.4 3.79 582,334 (3) 3.79

Jul 4 to Sep 9,
2005 72,500 2.5 4.33 46,333 (4) 4.31
Oct 6 to Nov
28, 2005 95,000 2.9 6.24 50,000 (5) 6.22
Jan 11 to Mar
6, 2006 86,666 3.0 6.90 31,666 (6) 7.14
Apr 11 to Apr
25, 2006 5,000 3.3 6.86 1,667 (7) 6.86
Aug 14 to Sep
26, 2006 82,000 3.6 5.37 27,333 (8) 5.37
Oct 23, 2006 14,980 3.8 4.12 4,980 (9) 4.12
Jan 23 to Mar
31, 2007 1,797,500 4.1 3.89 - (10) -
May 1 to May
14, 2007 100,000 4.4 4.90 - (11) -
Jul 16 to Sep
27, 2007 227,000 4.7 4.34 - (12) -
Oct 9 to Dec 14,
2007 610,000 4.9 5.59 - (13) -

----------------------------------------------------------------------------
5,335,814 1,614,314 3.55
----------------------------------------------------------------------------
----------------------------------------------------------------------------


(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) 135,000 options were exercised, 30,000 options were cancelled, and
50,000 options were forfeited in 2007.
(3) 16,666 options were exercised, 19,999 options were cancelled, and
48,335 options were forfeited in 2007.
(4) No options were exercised, 6,000 options were cancelled, and 20,000
options were forfeited in 2007.
(5) No options were exercised, no options were cancelled, and 155,000
options were forfeited in 2007.
(6) No options were exercised, no options were cancelled, and 1,076,834
options were forfeited in 2007.
(7) No options were exercised, no options were cancelled, and 18,000
options were forfeited in 2007.
(8) No options were exercised, no options were cancelled, and 102,500
options were forfeited in 2007.
(9) 20 options were exercised, no options were cancelled, and no options
were forfeited in 2007.
(10) No options were cancelled, and 110,500 options were forfeited in 2007.
(11) No options were cancelled, and no options were forfeited in 2007.
(12) No options were cancelled, and no options were forfeited in 2007.
(13) No options were cancelled, and no options were forfeited in 2007.


Performance Warrants

At December 31, 2007, there were 3,749,665 performance warrants outstanding (2006 - 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.

Because the performance conditions were fulfilled in 2005, resulting in the performance warrants vesting and the full related expense being recorded in that year, for the year ended December 31, 2007, the Corporation recorded $NIL (2006 - $NIL) compensation expense in the statement of net loss relating to stock based compensation for the performance warrants.

A summary of the changes during the year ended December 31, 2007 and the Corporation's outstanding performance warrants as at December 31, 2007 is presented below:



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

------------------------------------------
Outstanding, December 31, 2005 3,749,665 3.00
Issued - -
Exercised - -
------------------------------------------
Outstanding, December 31, 2006 3,749,665 3.00
Issued - -
Exercised - -
------------------------------------------
Outstanding, December 31, 2007 3,749,665 3.00
------------------------------------------
------------------------------------------



---------------------------------------------------------------------------
Number
Number Exercisable at
Outstanding at Exercise December 31,
Date of Grant December 31, 2007 Date of Expiry Price 2007
---------------------------------------------------------------------------
January 14, 2005 3,749,665 January 31, 2010 $ 3.00 3,749,665
---------------------------------------------------------------------------
---------------------------------------------------------------------------


Subsequent to year end, in early 2008, performance warrants in respect of 809,933 common shares were exercised by a former officer. After this exercise, 2,939,732 performance warrants remain outstanding.

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:



-------------------------
2007 2006
-------------------------

Risk-free interest rate 4.1% 4.0%
Expected maturity (years) 5.0 5.0
Expected volatility 58.6% 41.5%
Dividend yield 0.0% 0.0%


Contributed Surplus Continuity
$000's $000's
--------------------------------------------------------------------------
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
Stock-based compensation expense - stock options 3,340
Stock-based compensation expense - forfeiture
of stock options (1,112)
Stock-based compensation expense - cancellation
of stock options (21)
-------
Stock-based compensation expense - total 2007 2,207
Exercise of stock options (213)
Cancellation of stock options (54)
--------------------------------------------------------------------------
Balance, December 31, 2007 10,930
--------------------------------------------------------------------------
--------------------------------------------------------------------------


13. PER SHARE INFORMATION



2007 2006
---------------------------------------------------------------------------
Basic Net loss per share ($0.20) ($0.02)
Weighted average shares outstanding 72,156,544 58,806,783
---------------------------------------------------------------------------
Diluted Net loss per share ($0.20) ($0.02)
Weighted average shares outstanding 72,156,544 58,806,783
---------------------------------------------------------------------------


The weighted average diluted shares outstanding at December 31, 2007 includes the 72,156,544 (2006 - 58,806,783) weighted average number of shares outstanding, plus the following: NIL (2006 - NIL) shares related to the dilutive effect of the performance and retention warrants and NIL (2006 - NIL) shares related to the dilutive effect of stock options. Because the Corporation reported a loss for the year ended December 31, 2007 the basic and diluted weighted average shares outstanding are 72,156,544 (2006 - 58,806,783).

14. COMMITMENTS

Office Premises

The Corporation is committed under a new operating lease beginning December 1, 2007 which expires on November 30, 2017. Birchcliff will not use all of the space and has sublet the excess space to an arms' length party on a basis that recovers approximately 50% of the rental costs for the first five years. The Corporation is committed to the following aggregate minimum lease payments (not reduced by rents receivable by the Corporation):


-------------------------------------

2008 3,020
2009 3,020
2010 3,020
2011 3,020
2012 3,029
Thereafter 15,424
-------------------------------------


It is also committed to March 29, 2011 under an operating lease for another premises that it does not use and has sublet to an arm's length party on a basis that recovers all of its rental costs.

Reclamation Costs

During September 2007, a reclamation event occurred at one of Birchcliff's nonoperated facilities. Birchcliff believes the bulk of the costs will be covered under its insurance policies. The total net cost to Birchcliff is currently estimated to be $357,000. There is a risk that the estimated reclamation costs may be materially understated due to the nature of this type of salt water spill. The Corporation has provided its best estimate at this point in time. Birchcliff has recorded only its $100,000 insurance deductible in the current period operating costs. Should the costs of this reclamation event not be covered under Birchcliff's insurance policies then the full amount of the costs will be charged to operating expenses in future periods. The insurers are currently in the process of reviewing the matter to determine whether the costs will be covered under the Corporation's existing insurance policies.

Flow-Through Shares

In the fourth quarter of 2006, the Corporation committed to renounce $16,029,000 of exploration expenses pursuant to a flow-through share issue completed on November 22, 2006. Birchcliff had until December 31, 2007 to incur these exploration expenditures. The Corporation was subject to Part XII.6 tax based on the prescribed rate and the balance of Canadian Exploration Expenditures not yet incurred at the end of each month subsequent to January 31, 2007. At December 31, 2007 the commitment to spend and renounce $16,029,000 was fulfilled.

15. SUPPLEMENTARY CASH FLOW INFORMATION

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



2007 2006
$000's $000's
---------------------
Provided by (used in)
Accounts receivable (6,535) 2,887
Prepaid and other 361 (1,813)
Accounts payable and accrued liabilities 17,931 (18,324)
----------------------------------------------------------------------------
11,757 (17,250)
---------------------
---------------------
Operating (1,359) 1,448
Investing 13,116 (18,698)
---------------------
11,757 (17,250)
---------------------
---------------------


16. SUBSEQUENT EVENT

Equity Offering

On February 21, 2008 the Corporation entered into an underwriting agreement for a bought deal equity financing agreement with a syndicate of underwriters, pursuant to which the underwriters agreed to purchase for resale to the public 12,500,000 common shares (the "Common Shares") at a price of $8.00 per Common Share and 1,522,843 common shares to be issued on a flow-through basis (the "Flow-Through Common Shares") at a price of $9.85 per Flow Through Common Share for aggregate gross proceeds of $115,000,000 (the "Offering"). In addition, the Underwriters were granted an overallotment option (which may be exercised up to 30 days after closing of the Offering) to purchase up to 1,875,000 additional common shares at a price of $8.00 per Common Share for further gross proceeds of $15,000,000. This overallotment option was fully exercised, raising the gross proceeds from the Offering to $130,000,000. The Offering is subject to certain conditions including required regulatory approvals. The closing of the Offering is expected to occur on March 14, 2008.

Finding and Development Cost Data

Birchcliff's finding and development costs are as follows:



Finding and Development Cost Data

Birchcliff's finding and development costs are as follows:

------------------------------------------------------------------------
Three
FD&A Costs Excluding Future Year
Development Capital 2007 2006 2005 Average
------------------------------------------------------------------------
F&D - Exploration and
Development - Proved $6.92 $34.46 $9.03 $11.52
------------------------------------------------------------------------
F&D - Exploration and
Development - Proved and
Probable $5.07 $10.57 $5.50 $6.70
------------------------------------------------------------------------
Acquisitions - Proved $24.12 $62.51 $30.28 $26.76
------------------------------------------------------------------------
Acquisitions - Proved and
Probable $17.83 $47.28 $20.80 $19.17
------------------------------------------------------------------------
FD&A - Total - Proved $15.46 $35.05 $21.37 $19.01
------------------------------------------------------------------------
FD&A - Total - Proved and
Probable $11.38 $10.72 $13.93 $12.17
------------------------------------------------------------------------

------------------------------------------------------------------------
FD&A Costs Including Future
Development Capital (1)
------------------------------------------------------------------------
F&D - Exploration and
Development - Proved $17.04 $47.44 $14.63 $20.73
------------------------------------------------------------------------
F&D - Exploration and
Development - Proved and
Probable $12.03 $20.39 $10.57 $13.91
------------------------------------------------------------------------
Acquisitions - Proved $26.44 $62.51 $31.25 $28.51
------------------------------------------------------------------------
Acquisitions - Proved and
Probable $20.96 $47.28 $21.86 $21.38
------------------------------------------------------------------------
FD&A - Total - Proved $21.71 $48.11 $24.29 $24.57
------------------------------------------------------------------------
FD&A - Total - Proved and
Probable $16.45 $20.56 $16.79 $17.20
------------------------------------------------------------------------
(1) Includes the increase of $ 155.8 million in future development
capital from the 2006 amount of $156.1 million.


Advisory

Finding and Development Costs:

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

(a) The amounts of 2007 finding and development and/or acquisition costs contained in the table set forth above are calculated by dividing the total of the particular costs noted in each line incurred during 2007 by the amounts of additions to proved reserves and proved and probable reserves durinng 2007 that resulted from the expenditure of such costs during 2007 which are based upon the AJM Evaluation and Birchcliff's internal estimates of the proven and probable reserves attributable to the Worsley property acquisition.

(b) In calculating the amounts of finding and development and/ or acquisition costs, the change during the year in estimated future development costs is based upon the evaluation of Birchcliff's reserves prepared by AGM Petroleum Consultants effective December 31, 2006 and the AJM Evaluation effective December 31, 2007;

(c) In calculating the amounts of finding and development and/ or acquisition costs with respect to the Worsley property at the time of its acquisition is based on Birchcliff's internal estimate of future development costs for the Worsley property at September 27, 2007; and

(d) 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 forwardlooking 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 CEO
    (403) 261-6401
    (403) 261-6424 (FAX)
    or
    Birchcliff Energy Ltd.
    Bruno Geremia
    Vice President and CFO
    (403) 261-6401
    (403) 261-6424 (FAX)
    or
    Birchcliff Energy Ltd.
    Jim Surbey
    Vice President, Corporate Development
    (403) 261-6401
    (403) 261-6424 (FAX)