Birchcliff Energy Ltd.
TSX : BIR

Birchcliff Energy Ltd.

March 19, 2009 00:05 ET

Birchcliff Energy Ltd. Announces 2008 Financial Results and 2009 Operating Update

CALGARY, ALBERTA--(Marketwire - March 19, 2009) -

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 2008 financial results as well as a 2009 operations update.



Financial Highlights


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Three months Three months Twelve months Twelve months
FINANCIAL AND ended ended ended ended
OPERATIONAL HIGHLIGHTS December 31 December 31 December 31 December 31

2008 2007 2008 2007
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OPERATING
Daily Average Production
Light Oil - barrels 3,244 2,887 2,989 1,289
Natural Gas - thousands
of cubic feet 47,687 36,689 40,746 31,330
NGLs - barrels 332 258 368 201
Total - barrels of oil
equivalent (6:1) 11,524 9,260 10,148 6,711
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Average Sales Price
($ Canadian)
Light Oil - per barrel 59.10 80.94 96.68 76.39
Natural Gas - per
thousand cubic feet 7.14 6.71 8.63 6.82
NGLs - per barrel 59.27 84.41 93.97 74.24
Total - barrels of oil
equivalent (6:1) 47.88 54.18 66.53 48.71
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Undeveloped Land
Gross (acres) 396,451 317,070 396,451 317,070
Net (acres) 348,249 266,966 348,249 266,966
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NETBACK AND COST
($ per barrel of oil
equivalent at 6:1)
Petroleum & natural
gas revenue 48.13 54.46 66.90 49.27
Royalties (8.38) (9.16) (11.16) (7.89)
Operating expense (10.66) (8.47) (10.41) (8.86)
Transportation and
marketing expense (2.43) (2.79) (2.68) (2.04)
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Netback 26.66 34.04 42.65 30.48
General & administrative
expense, net (2.49) (3.05) (1.75) (3.07)
Stock-based compensation
expense - (0.01) (0.01) (0.02)
Realized gain (loss) on
risk management contracts 1.03 (2.19) (2.65) (0.76)
Realized gain (loss) on
foreign exchange 0.12 (0.02) (0.06) (0.01)
Interest expense (2.17) (5.45) (2.78) (3.55)
Other Income - 0.01 - -
Taxes - - - (0.11)
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Cash Flow Netback 23.15 23.33 35.40 22.96
Depletion and depreciation
expense (22.17) (23.94) (23.75) (26.46)
Accretion expense (0.38) (0.49) (0.39) (0.51)
Stock-based compensation
expense (0.93) (1.01) (1.34) (0.88)
Unrealized gain (loss) on
risk management contracts 1.92 (6.57) 1.82 (2.76)
Unrealized gain (loss) on
foreign exchange (0.12) (0.03) 0.01 (0.01)
Future income tax recovery
(expense) (1.87) 1.13 (3.69) 1.85
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Net Earnings (Loss) (0.40) (7.58) 8.06 (5.81)
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FINANCIAL
Petroleum & Natural Gas
Revenue ($000) 51,034 46,398 248,441 120,696
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Cash Flow ($000) 24,627 19,881 131,453 56,245
Per share - basic ($) 0.22 0.21 1.21 0.78
Per share - diluted ($) 0.22 0.21 1.16 0.77
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Net Earnings (Loss) ($000) (355) (6,457) 29,898 (14,244)
Per share - basic ($) - (0.07) 0.27 (0.20)
Per share - diluted ($) - (0.07) 0.26 (0.20)
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Common Shares Outstanding
End of Period - Basic 112,395,970 94,554,269 112,395,970 94,554,269
End of Period
- Diluted 121,659,923 103,639,748 121,659,923 103,639,748
Weighted Average for
Period - Basic 112,399,570 94,486,372 108,986,165 72,156,544
Weighted Average for
Period - Diluted 112,801,866 96,548,884 113,092,125 73,285,368
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Capital Expenditures
($000) 58,916 30,306 237,079 350,173
Working Capital
(Deficiency) ($000) (1) (38,276) (18,232) (38,276) (18,232)
Non-Revolving Credit
Facility ($000) - 98,830 - 98,830
Revolving Credit
Facilities ($000) 211,586 155,854 211,586 155,854
Total Debt ($000) 249,862 272,916 249,862 272,916
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(1) This amount excludes both accrued liability for the unrealized gain
(loss) on oil price risk management contracts and the related future
income tax assets.


2008 Highlights

- Substantially increased proved and probable reserves to 98.5 million boe at December 31, 2008 from 56.6 million boe at December 31, 2007, an increase of 74%.

- Substantially increased its proved reserves to 55.7 million boe at December 31, 2008 from 34.3 million boe at December 31, 2007, an increase of 62%.

- Substantially increased its proved plus probable reserves per share at year end 2008 by 46% over December 31, 2007.

- Increased its proved reserves per share at year end 2008 by 36% over December 31, 2007.

- At December 31, 2008, the net present value of the future net revenue from its proved and probable reserves discounted at 10% before tax is $1.64 billion, a 59% increase from December 31, 2007. In each case calculated using the pre tax present value of proved and probable reserves discounted at 10% based on the then current forecast of commodity prices by AJM.

- Estimated net asset value at December 31, 2008 amounted to $11.78 per diluted share, an increase of 54% over December 31, 2007, in each case determined using the net present value of all reserves calculated as above and deducting total debt and assuming exercise of all options and warrants and without including any value for Birchcliff's substantial high working interest, undeveloped land base.

- Birchcliff's reserve life index on a proved and probable basis increased to 21.3 years which is an increase from the 2007 reserve life index of 15.5 years.

- 2008 average production was 10,148 boe per day, a 51% increase over 2007 average production of 6,711 boe per day.

- 2008 Finding, Development and Acquisition costs on a proved and probable basis were $5.17/boe excluding future development costs and $14.06/boe including future development costs.

- 2008 Finding and Development costs excluding acquisitions on a proved and probable basis were $4.99/boe excluding future development costs and $13.98/boe including future development costs.

- Based on 2008 Finding and Development costs, Birchcliff had a proved plus probable operating netback recycle ratio in 2008 of 8.5, excluding future capital and 3.1, including future capital as estimated by AJM Petroleum Consultants.

- Birchcliff increased by 199% its Montney/Doig proved and probable reserves to 57.7 million boe at December 31, 2008 from approximately 19.3 million boe at December 31, 2007.

- Birchcliff increased by 16% its Worsley Light Oil pool proved and probable reserves to 24.6 million boe at December 31, 2008 from 21.2 million boe at December 31, 2007.

- From the effective date of its acquisition of the Worsley Light Oil pool at July 1, 2007 Birchcliff has increased the proved and probable reserves to 24.6 million boe from 15.1 million boe, a 63% increase.

Report to Shareholders

On behalf of the directors, management and staff of Birchcliff, I am very pleased to report our 2008 results and take the opportunity to provide you with our current outlook for 2009 and beyond. Birchcliff had a very successful year, increasing production, cash flow, earnings, reserves, recycle ratios and significantly extending its reserve life index, its undeveloped land base, and its portfolio of potential future drilling locations for both our Montney/Doig horizontal natural gas resource play and our Worsley light oil resource play. At the same time we reduced our finding and development costs and our G&A per boe. Virtually all of this was accomplished with the drill bit. We see the opportunity to continue to significantly grow our company in the years to come as we execute on the development of our two resource plays, the Montney/Doig natural gas resource play and the Worsley light oil resource play. With our success in 2008, Birchcliff has established the asset foundation from which we can have sustainable growth for many years. We believe that we have proven our two resource plays to a point where the risk is now measured in terms of execution, and is primarily driven by commodity price and associated economics. We have an inventory of at least 607 net potential Montney/Doig horizontal natural gas drilling locations. Further, our Worlsey light oil resource play continues to expand with our waterflood slowing production declines and adding reserves each year. These assets will allow Birchcliff to grow with the drill bit, stay focused on its map sheet and pay attention to its core business.

As a measure of last year's success, I note in a year where our business environment was challenging, Birchcliff increased its proved and probable reserves by 74% and added those reserves for approximately $5.17 per BOE without future capital, and $14.06 per boe including future capital. Birchcliff also increased its fourth quarter average production by 24% over the same quarter in 2007 while increasing its reserve life index to 21.3 years as a result of the large proved and probable reserves additions.

I would like to address our current level of indebtedness. Our year end bank debt of $211.6 million and our working capital deficiency of $38.3 million was higher than we had originally budgeted. Our cash flow was severely eroded in the last four months of 2008, as commodity prices continued to decline beyond our expectations. As commodity prices fell we were faced with the decision of executing our land strategy and purchasing critical undeveloped lands which we had posted in crown land sales. As part of our exploration strategy we had posted these lands months before the scheduled drilling in adjacent tracts so that we would have drilling results shortly before these land sales. As this drilling was successful, Birchcliff was well aware of the huge future potential value of these undeveloped lands. Accordingly, we chose to aggressively bid on and we successfully purchased these undeveloped lands notwithstanding the deterioration of commodity prices and our cash flow and the resulting increase in debt. These lands were well worth the additional capital as they are very prospective, they offset our successful Montney/Doig drilling and they comprise large contiguous blocks predominantly purchased without partners. Essentially we did not want to let our future drilling opportunities disappear because of a short term weakness in commodity prices. Our results speak for themselves and we expect that our shareholders are pleased with our decisions to complete our 2008 land acquisition strategy.

We remain in compliance with all covenants under our credit facilities and the working capital deficiency does not reduce what can be drawn under the credit facilities. We have moved to address the level of our debt by requesting that our bank syndicate expand our credit facilities from the current $240 million to a level which will give Birchcliff more financial flexibility. We believe that under normal circumstances the very large reserves that were added last year as confirmed by our Reserve Report prepared by AJM Petroleum Consultants would result in significantly increased credit facilities. Based on discussions with members of the banking syndicate we are optimistic that our credit facilities will be increased to an acceptable level.

In light of the current economic environment, we intend to limit capital spending in 2009 to cash flow because commodity prices are extremely low, the financial markets are in crisis and we believe the preservation of capital and maintenance of our balance sheet is more important than production growth in 2009. Notwithstanding all of the above our production remains very strong and at current spending levels we could achieve 20% annual average production per share growth in 2009 as compared to 2008. We have recently rejected offers of equity financing as a means to reduce debt. We believe that our solid production base, which has a 21 year reserve life index based on our current production rate, the high quality of our asset base, our extensive Montney/Doig natural gas development drilling opportunities and our light oil resource play give us the confidence that Birchcliff can support a 20% level of indebtedness to asset value. When commodity prices return to higher levels we will increase our spending to capitalize on the tremendous opportunities that our resource plays present.

Montney/Doig Natural Gas Resource Play

We believe that our 2008 drilling program continued the establishment of a long life, repeatable, low risk, large reserve, natural gas resource play in the Montney/Doig producing zones in our Pouce Coupe and Pouce Coupe South Areas. We successfully drilled, fracture stimulated, completed and tied in 15 (12.9 net) horizontal Montney/Doig natural gas wells in 2008. We believe that we have an inventory of at least 607 potential undrilled Montney/Doig natural gas horizontal well locations, of which 105 horizontal well locations have been attributed reserves in our independent reserve report. Our reserve report recognizes 314 BCF of proved plus probable reserves and we believe that there is significant potential to increase the reserves attributed to these properties in the future. Birchcliff's lands include further potential from shale gas within the Montney/Doig pay package which is yet to be quantified.

As part of the future growth of our Montney/Doig natural gas resource play Birchcliff plans to construct and operate a 100% owned sour gas plant in Pouce Coupe. A critical component of a sour gas plant is an acid gas injection well. In 2008 Birchcliff drilled, cased, completed and successfully tested a drill for purpose acid gas disposal well. Birchcliff has filed all required regulatory applications for its sour gas plant, which is initially expected to process approximately 30 mmcf per day. Birchcliff expects to receive approval of its application to construct the gas plant in the next several months. In light of current industry conditions, Birchcliff has made the decision to rebid certain parts of the sour gas plant as Birchcliff believes that falling steel prices, availability of constructions crews, the reduction of costs associated with these crews and the availability of engineering time to construct certain parts of the plant all should lead to a reduction in Birchcliff's costs. Accordingly, when Birchcliff is in receipt of its license to build the plant and its new estimated costs, it will then determine a course of action that will allow Birchcliff to construct the plant in a timely but financially prudent manner.

We continue to focus on the development and expansion of this very large Montney/Doig natural gas resource play, adding both land and potential drill locations whenever the opportunity to do so arises. The majority of our drilling opportunities are held at 100 percent working interest.

Worsley Light Oil Resource Play

As you may recall, the $264 million acquisition of the Worsley light oil property was completed on September 27, 2007. The acquisition added approximately 15 million BOE of proved and probable reserves, 3,400 BOE/day of production and significant exploitation, development and exploration drilling opportunities. As of the end of 2008, I am pleased to advise you that we have 24.6 million BOE of proved and probable reserves at the Worsley property. We have drilled, discovered and added production on the North and South ends of the pool on our 100 percent owned lands and expanded a water flood program which ultimately we believe will lead to significant incremental reserves being recovered from this light oil pool. I am pleased to advise you that since the acquisition we have received approximately $76 million in operating cash flow and re-invested approximately $63.6 million in the property. In time, Birchcliff believes that it could spend in the order of $200-$300 million developing this light oil pool.

Shareholder Support

Another essential ingredient to our success is Mr. Seymour Schulich. Recently Mr. Schulich increased his share position to 25 million common shares which is approximately 22% of the outstanding shares of Birchcliff. Mr. Schulich is a very well known, savvy investor who has enjoyed significant success with other energy companies. His sage advice and support have had a significant positive effect on our internal decision making and ultimately our share price. To Mr. Schulich's credit he was very aggressively buying Birchcliff's stock in recent months as the financial markets collapsed. I would like to take this opportunity to thank Mr. Schulich for his unconditional support.

2009 Outlook

On February 12, 2009 Birchcliff announced a 2009 capital expenditure program of $80 million, the majority of which is focused on the continued development of its Montney/Doig natural gas resource play. We continue to manage our capital very, very carefully, spending money on those items which require immediate attention, such as land expires or those items which create significant long term strategic value to Birchcliff. We intend to adjust this capital spending profile to match our estimated 2009 cash flow. The directors of Birchcliff will meet in June to consider the third and fourth quarter capital spending programs.

Q1 2009 Drilling Results

Birchcliff's exploration program for the first half of 2009 included drilling 3 Montney/Doig New Pool Wildcat vertical wells. To date, 2 (1.4 net) wells have been drilled and results from both wells suggest new pools were discovered. The third (0.7 net) vertical exploration well is currently drilling.

Birchcliff's Montney/Doig horizontal well program continues to achieve cost reductions and both production and reserves continue to increase. In the first half of 2009, Birchcliff plans to drill 2 (1.4 net) Montney/Doig horizontal wells. The first horizontal well (0.7 net) has been drilled, cased and completed and is expected to come on production shortly after April 1, 2009. The second (0.7 net) Montney/Doig horizontal well is currently drilling. This well will be completed and brought on production after spring break-up.

The vertical exploration wells were drilled on lands that Birchcliff had previously categorized as trend land. Trend land is land Birchcliff believes has a high likelihood of extending the Montney/Doig natural gas resource play based on technical information including geologic and geophysical data. These exploration successes will result in significant new reserves, increased potential natural gas horizontal well locations and further expansion of our Montney/Doig natural gas resource play.

Commodity Prices

Commodity prices have continued to deteriorate. The result of this is that Birchcliff has restricted its capital spending to drilling lands which will expire and other capital items that will result in strategic long term value to Birchcliff. We believe that we can afford to wait for better commodity prices for both oil and natural gas and in the meantime improve all parts of our cost structure, advance our technological knowledge, review all opportunities within our play areas and plan for an aggressive capital spending program on both our resource plays and our exploration program when commodity prices return to higher levels.

Current Production

Birchcliff's January and February production averaged approximately 12,500 BOE per day. Production remains strong especially in light of the fact that no production from our first quarter drilling will be added until after April 1, 2009. Taking into account the production impact of planned facility turn-arounds later in the year, we confirm our previously announced annual average production guidance of 12,000 boe per day.

Royalty Incentives

Recent changes to the royalty structure announced on March 3, 2009 are extremely advantageous to Birchcliff. Both the one year drilling royalty credit of $200 per metre drilled after April 1, 2009, as well as the one year incentive royalty rate of 5% on initial production from new wells brought on production after April 1, 2009, improve the economics of all our opportunities, but especially our Montney/Doig horizontal natural gas wells. The Montney/Doig horizontal natural gas wells have high initial production rates with high initial declines, so that a very low royalty rate on the initial production significantly improves the economics of these wells. The incentive royalty rate applies to the first 0.5 BCF of production from each eligible well.

Summary

2008 was a very, very successful year for Birchcliff. We are focused on building an inventory of high working interest, repeatable, sustainable, long term growth opportunities in the Peace River Arch area of Alberta. We have a tremendous number of development drilling opportunities and we are determined to wait for better commodity prices before we increase our spending beyond cash flow. In light of the resource plays that we are pursuing, we expect to continue to add significant long life reserves and corresponding net asset value in the future. Due to the nature of these plays we expect production growth to continue to lag reserves growth.

It is important to recognize both our office staff who developed and planned each of the individual initiatives that have brought us this success and our field staff who have safely and efficiently performed the field operations that turned good ideas into actual physical results. I gratefully acknowledge that without the hard work and tireless dedication of our staff, Birchcliff could not have achieved the success we now enjoy. Thank you to the Directors for their continued dedication and input. Thank you to our management team who worked very long hours, at the expense of their families, for the benefit of our employees and shareholders.

We all thank Mr. Seymour Schulich for his support and advice which has played an integral role in our success.

A. Jeffery Tonken, President and Chief Executive Officer

Management's Discussion and Analysis

Management's Discussion and Analysis ("MD&A"), dated March 18, 2009, 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, 2008 and 2007. 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 will be filed 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.

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.



SELECTED ANNUAL INFORMATION

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Year or Period Ended December 31 2008 2007 2006
($000's except production and
share information)
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Petroleum and natural gas revenue 248,441 120,696 93,769
Total revenues, net of royalties 206,992 101,373 77,629
Cash flow from operations 131,453 56,245 46,687
Basic per share $ 1.21 $ 0.78 $ 0.79
Diluted per share $ 1.16 $ 0.77 $ 0.77
Net income (loss) 29,898 (14,244) (1,113)
Basic per share $ 0.27 ($0.20) ($0.02)
Diluted per share $ 0.26 ($0.20) ($0.02)
Capital expenditures, net 237,079 350,173 102,154
Total assets 814,823 662,252 362,255
Working capital (deficiency)
surplus(1) (38,276) (18,232) (6,479)
Non-Revolving credit facility - 98,830 -
Revolving credit facility 211,586 155,854 81,304
Total debt 249,862 272,916 87,783
Shareholders' equity 507,371 340,756 246,399
Average daily production
(BOE at 6:1) 10,148 6,711 5,368
Common shares outstanding - end
of period
Basic 112,395,970 94,554,269 64,139,413
Diluted 121,659,923 103,639,748 72,168,746
Weighted average common shares
outstanding
Basic 108,986,165 72,156,544 58,806,783
Diluted 113,092,125 73,285,368 61,011,246
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(1) This amount excludes both the accrued liability for the unrealized
gains (losses) on oil price risk management contracts and the related
future income tax asset.


2008 OVERALL PERFORMANCE

During 2008, the Corporation achieved a number of successes that affected its financial results for the year.

Production

Production in 2008 averaged 10,148 BOE per day. This is a 51% increase from the 6,711 BOE per day the Corporation averaged during 2007. Included in the 51% increase is the production from the acquisition of the Worsley property in September 2007 (the "Worsley Acquisition"), which is included for the full year in 2008 and only for one quarter of the year in 2007. The Corporation averaged 11,524 BOE per day of production in Q4 2008 as compared to 9,260 BOE per day in Q4 2007, an increase of 24%, each of which quarters include production from the Worsley property for the entire quarter. Accordingly, this 24% increase results mainly from the Corporation's drilling and operational success on its two resource plays. Birchcliff currently has 17 Montney/Doig horizontal wells on production compared to two horizontal wells in 2007.

At present the Corporation's production consists of approximately 70% natural gas and 30% crude oil and natural gas liquids.

Cash Flows and Earnings

Cash flow was $131.5 million or $1.21 per share for 2008, as compared to $56.2 million or $0.78 per share for 2007. Birchcliff had earnings of $29.9 million or $0.27 per share for 2008 as compared to a loss of $14.2 million or $0.20 loss per share for 2007. The increases in cash flow and earnings resulted from higher average commodity prices, significantly increased natural gas production (30%) and a full year of production from the Worsley property in 2008.

Capital Expenditures and Total Debt

Birchcliff spent $237.1 million of capital in 2008 as compared to $131.5 million in cash flow generated from operations in 2008. The difference of $105.6 million was financed through the Corporation's existing credit facilities and the issuances of equity in 2008.

Capital expenditures for the year ended December 31, 2008 were $237.1 million, with 53% ($125.7 million) spent on drilling and completions; 25% ($58.5 million) spent on equipment and facilities; 11% ($25.6 million) spent on land acquisitions; 4% (9.1 million) spent on workovers and other; 2% ($4.5 million) spent on seismic and other exploration and approximately 1% ($3.3 million) spent on administrative assets and capitalized G&A. Acquisitions of minor properties accounted for the remaining 4% ($10.4 million) of capital spent. A significant amount of the acquisition capital was spent on undeveloped land.

During 2008, the Corporation continued to spend a significant amount of capital on natural gas infrastructure to expand its Montney/Doig resource play. Birchcliff also spent significant capital on infrastructure and injection well drilling and conversions for the waterflood project at Worsley. In the future, the Corporation expects to benefit from this infrastructure spending as it should be able to reduce its costs of well tie-ins.

The execution of the 2008 capital spending program in combination with a significant decline in commodity prices and cash flow during the last four months of 2008 resulted in total debt of $249.9 million at December 31, 2008, including the working capital deficit. Despite declining commodity prices, Birchcliff continued forward with its 2008 planned capital spending in order to expand and enhance the value of the Corporation's resource plays. We expect total debt to slightly increase during the first quarter of 2009 and thereafter be reduced during the second quarter of 2009 to about the same level or lower at December 31, 2008 as capital expenditures are drastically reduced and operations are suspended during spring break-up.

The Corporation's working capital deficit does not reduce the amount available under the Corporation's credit facilities which have a combined limit of $240 million. Birchcliff was compliant with all its covenants under its credit facilities throughout 2008 and continues to be compliant with such covenants at the date hereof. Birchcliff has requested an increase to its credit facilities from its syndicate of banks.

Worsley Acquisition

Management is extremely pleased with the Worsley Acquisition, which closed on September 27, 2007. Both the original oil in place and the estimated recoverable reserves for the pool continue to grow. As at December 31, 2008, reserves attributed to the Worsley property were estimated by AJM Petroleum Consultants ("AJM") to be 17.5 million boe proved, and 24.6 million boe proved plus probable. Comparable reserves estimated by AJM at December 31, 2007 were 15.0 million boe proved and 21.2 million boe proved plus probable.

The following table shows Birchcliff's net cash outlay in respect of the Worsley Acquisition after taking into account the netback generated by the Worsley property and the capital invested in that property, to the end of 2008 and reserves volumes and future net revenues estimated by AJM Petroleum Consultants at December 31, 2008 for the Worsley property.



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Final purchase price, net of adjustments
and costs at Sept 27, 2007 ($M) 264.0
Operating netback from Sept 27, 2007 to Dec 31, 2008 ($M) (76.0)
Capital expenditures from Sept 27, 2007 to Dec 31, 2008 ($M) 63.6
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Total Net Cash Outlay for the Worsley Property ($M) 251.6
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Total Proved Reserves (million boe) (1) 17.5
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Net Cash Outlay per BOE of Proved Reserves ($/BOE) $14.38
Total Proved plus Probable Reserves (million boe) (1) 24.6
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Net Cash Outlay per BOE of Proved plus Probable Reserves ($/BOE) $10.23

Future Net Revenues Discounted at 10% (Before Tax)
- Total Proved ($M) (1) (2) 458.6
Future Net Revenues Discounted at 10% (Before Tax)
- Total Proved plus Probable ($M) (1) (2) 600.5
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(1) The estimates of reserves and future net revenue for individual
properties may not reflect the same confidence level as estimates of
reserves and future net revenues for all properties, due to the
effects of aggregation. AJM Petroleum Consultants estimated
Birchcliff's total reserves at December 31, 2008 to be 55.7 million
boe total proved reserves and 98.5 million boe total proved plus
probable reserves.
(2) National Instrument 51-101 requires the following warning - The
estimates of discounted future net revenue disclosed in this table
do not represent fair market values.


The future net revenues for the Worsley property of $600.5 million compares favorably to Birchcliff's net cash outlay for the Worsley property of $251.6 million. The net cash outlay per BOE of total proved plus probable reserves is estimated at $10.23 per BOE, which is significantly lower than the realized average netback from the Worsley property (calculated by subtracting royalties, operating and transportation costs from petroleum and natural gas revenues) of $31.23 per BOE during the fourth quarter of 2008, when the WTI price averaged US$58.73 per barrel.

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 may at any time be 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 2008 and 2007. These transactions are summarized below:

- On September 27, 2007 the Corporation closed the Worsley Acquisition for total cash consideration of $264.0 million, after closing adjustments and related costs. Approximately 3,400 BOE per day of production was acquired, 75% of which was 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 have been recorded by Birchcliff from September 27, 2007 forward. The purchase price has been finalized by the Corporation and the vendor.

- 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 in conjunction with the closing of the Worsley Acquisition.

- 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 net proceeds of approximately $123 million. Proceeds of the offering were used to retire the $100 million syndicated non-revolving credit facility used for the Worsley Acquisition and to reduce the amount outstanding under the Corporation's revolving credit facility.

- During the second quarter of 2008, the Corporation's $200 million syndicated credit facilities were increased to $240 million and extended until May 22, 2009. The Corporation's Bank Syndicate performed a midyear review of Birchcliff's reserves during October 2008 and no adjustments were made to the $240 million of credit facilities.

LIQUIDITY AND BANK DEBT

Working Capital

The Corporation's working capital deficit decreased to $38.3 million at December 31, 2008, as compared to $117.1 million at December 31, 2007 primarily due to the repayment of the $100 million non-revolving credit facility in the first quarter of 2008. The non-revolving credit facility was drawn on September 27, 2007 to complete the Worsley Acquisition. Excluding the $100 million non-revolving credit facility, the Corporation's working capital deficit was $18.2 million at December 31, 2007 as compared to the $38.3 million working capital deficit as at December 31, 2008. The increase of 110% was due to the significantly larger capital spending program in 2008. The unrealized losses from the oil price risk management contracts and the future income taxes thereon have been excluded from the working capital deficit for this comparison.

At December 31, 2008 the largest component of Birchcliff's current assets (46%) is the cash to be received from its marketers in respect of December 2008 production which was subsequently received in January 2009. In contrast, the current liabilities consist of trade payables (61%); accrued capital and operating costs (26%); and royalties and other minor amounts.

Birchcliff expects to continue to have a working capital deficit into the foreseeable future as a result of its continuing capital program in the Peace River Arch area. However, as capital expenditures are decreased in light of the current economic environment, the amount of working capital deficit will decrease correspondingly. Birchcliff manages its working capital deficiency using its cash flow and advances under its revolving credit facilities.

Bank Debt

The Corporation's bank debt or revolving credit facilities which have an aggregate limit of $240 million were drawn to $211.6 million at December 31, 2008 as compared to $155.9 million for the year ended December 31, 2007 when the aggregate limit was $200 million. The increase of $55.7 million was due to significantly higher exploration and development capital spending in 2008 and an unexpected significant drop in commodity prices during the latter part of 2008. The Corporation's revolving credit facilities at December 31, 2008 consist of a $20 million working capital facility and a $220 million syndicated facility. As at December 31, 2008, the effective interest rate applicable to the working capital facility was 4.7% (2007 - 6.0%). The effective interest rate applicable to the bankers' acceptances in the syndicated credit facility was 3.9% for year ended December 31, 2008 (2007 - 4.6%).

Total debt at December 31, 2008 was $249.9 million as compared to $272.9 million at December 31, 2007. The $23.0 million net decrease in total debt resulted from the total capital spent during 2008 of $237.1 million and reclamation expenditures incurred of $1.1 million totaling less than the combination of $129.8 million in proceeds from issuance of equity and cash flow of $131.5 million.

The Corporation did not have any liquidity issues with respect to the operation of its petroleum and natural gas business during 2008 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 beyond its cash flow.

CASH FLOW FROM OPERATIONS

Cash generated by the Corporation for 2008 was $131.5 million as compared to $56.2 million in 2007. The 134% increase was due to increased natural gas production as a result of drilling success, increased oil production resulting from the Worsley Acquisition and higher average commodity prices than in the prior year. Future cash flow will be dependent mainly on production levels and future 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 2009 based on internal estimates. These estimates are based on numerous assumptions as to costs, drilling success and production results from future operations and a 2009 capital expenditure program of approximately $80 million. The budget does not include capital for any significant acquisitions or for the construction of the proposed sour gas plant at Pouce Coupe.



----------------------------------------------------------------------------
Variance
In Annual
Variance Cash Flow
Factor In Factor CDN$ Millions
----------------------------------------------------------------------------
----------------------------------------------------------------------------

WTI oil price US $1.00/bbl $1.0
Natural gas spot price (AECO) CDN $0.10/mcf $1.6
CDN $/US$ CDN $0.01 $2.0
Canadian Prime rate 1% $2.4
----------------------------------------------------------------------------
----------------------------------------------------------------------------


OUTSTANDING SHARE DATA

The common shares of Birchcliff are the only class of shares outstanding. Birchcliff's common shares began trading on the TSX Exchange on July 21, 2005 under the symbol "BIR" and were at the same time de-listed from the TSX Venture Exchange where they were trading under the same symbol prior to such time. The following table summarizes the common shares issued from December 31, 2006 to December 31, 2008 which are the only class of shares outstanding:



----------------------------------------------------------------------------
Common Shares
----------------------------------------------------------------------------
----------------------------------------------------------------------------
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
Issue of Common Shares upon Exercise of Options and Warrants 1,410,977
Issue of Common Shares 14,375,000
Issue of Flow-Through Shares 1,522,843
----------------------------------------------------------------------------
Balance at March 31, 2008 111,863,089
Issue of Common Shares upon Exercise of Options 512,881
----------------------------------------------------------------------------
Balance at June 30, 2008 112,375,970
Issue of Common Shares upon Exercise of Options 20,000
----------------------------------------------------------------------------
Balance at September 30, 2008 112,395,970
Issue of Common Shares upon Exercise of Options -
----------------------------------------------------------------------------
Balance at December 31, 2008 112,395,970
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Common shares issued in conjunction with the Worsley Acquisition.


RESULTS OF OPERATIONS

Petroleum and Natural Gas Revenue

Petroleum and natural gas revenues totaled $248.4 million for 2008 compared to $120.7 million for 2007. The increases were primarily due to additional production volumes associated with the Worsley Acquisition, as well as significantly higher average commodity prices in 2008. The following table details Birchcliff's petroleum and natural gas revenue, production and sales prices by category for the years ended December 31, 2008 and 2007:



----------------------------------------------------------------------------
Year ended December 31, 2008
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Total Average
Revenue Daily Average
($000's) Production % ($/unit)
----------------------------------------------------------------------------
Natural gas (mcf) 128,673 40,746 67 8.63
Light oil (bbls) 105,747 2,989 29 96.68
Natural gas liquids (bbls) 12,661 368 4 93.97
----------------------------------------------------------------------------

Total petroleum and natural
gas sales 247,081 10,148 100 66.53
Royalty revenue 1,360 0.37
----------------------------------------------------------------------------
Total petroleum and natural
gas revenue 248,441 66.90
----------------------------------------------------------------------------
----------------------------------------------------------------------------


----------------------------------------------------------------------------
Year ended December 31, 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Total Average
Revenue Daily Average
($000's) Production % ($/unit)
----------------------------------------------------------------------------
Natural gas (mcf) 77,957 31,330 78 6.82
Light oil (bbls) 35,933 1,289 19 76.39
Natural gas liquids (bbls) 5,438 201 3 74.24
----------------------------------------------------------------------------

Total petroleum and natural
gas sales 119,328 6,711 100 48.71
Royalty revenue 1,368 0.56
----------------------------------------------------------------------------
Total petroleum and natural
gas revenue 120,696 49.27
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Commodity Prices

Birchcliff sells virtually all of its natural gas production for prices based on the AECO daily spot price. Birchcliff receives premium pricing for its natural gas due to its high heat content. Birchcliff sells all of its crude oil on a spot basis. The following table details the average sales price and differential received by Birchcliff during 2008:



----------------------------------------------------------------------------
Year ended Year ended
December 31, 2008 December 31, 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Average Natural Gas Sales Price ($/mcf) 8.63 6.82
Average of the AECO Daily Spot Prices
($/mmbtu) (1) 8.16 6.45
----------------------------------------------------------------------------
Positive Differential 0.47 0.37
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) $1.00/mmbtu = $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

----------------------------------------------------------------------------
Term Type Quantity WTI Price (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 collar 1,000 $ 67.50 - $79.10
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Each contract was entered into separately on different dates but the
two contracts essentially form a costless collar.
(2) Each contract was entered into separately on different dates but the
two contracts essentially form a costless collar.
(3) Each contract is settled on the average of the daily NYMEX WTI US$
price.


The Corporation entered into the above contracts during the month of September 2007 and has not entered into any new commodity price risk management contracts since then. At December 31, 2008, all of the oil price risk management contracts were settled.

The Corporation actively monitors the market to determine whether any additional commodity price risk management contracts are warranted. The Corporation has no current intention to enter into further commodity price risk management contracts.

Due to the significant time and costs required to document the effectiveness of commodity price risk management contracts as hedges, Birchcliff does not account for its risk management contracts as hedges in its financial statements. The commodity price risk management 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 ended December 31, 2008, the Corporation recorded a realized oil price risk management loss of $9.9 million (2007 - $1.9 million realized loss) and an unrealized oil price risk management gain of $6.8 million in 2008 (2007 - $6.8 million unrealized loss).

Royalties

Royalties are paid to various government entities and other land and mineral rights owners. The following table illustrates the Corporation's royalty expense.



----------------------------------------------------------------------------
Year ended Year ended
December 31, 2008 December 31, 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Oil & natural gas royalties ($000's) 41,451 19,332
Oil & natural gas royalties ($/BOE) 11.16 7.89
Royalties as a % of Sales 17% 16%
----------------------------------------------------------------------------


Oil and natural gas royalties totaled $41.5 million ($11.16 per BOE) for the year ended December 31, 2008 as compared to $19.3 million ($7.89 per BOE) for the year ended December 31, 2007. The overall effective royalty rate increased to 17% in 2008 as compared to 16% in 2007 due mainly to higher realized prices during that time period.

Proposed Changes to Alberta's Royalty Regime

On April 10, 2008, the Alberta Government announced revisions to its royalty program, calling it the New Royalty Framework ("NRF") and its effective date of January 1, 2009. The NRF included increased royalty rates on conventional and non-conventional oil and natural gas production in Alberta, sliding scale royalty calculations based on a broader range of commodity prices and the elimination of royalty incentive and royalty holiday programs with the exception of specific programs relating to deep oil and natural gas drilling programs, innovative technology and enhanced recovery programs.

During November 2008, the Alberta Government announced a further royalty program or Transitional Royalty Rates ("TRR"). Wells eligible for the TRR are those wells that have a spud date on or after November 19, 2008 and the operator must elect the transition well royalty rates within the specified time period for election, which at this time has not yet been formally released by the Alberta Government. The base of the producing interval in the well event must be deeper than 1,000 meters and no deeper than 3,500 meters. The TRR well royalty formulas only apply to production obtained starting January 1, 2009 and ending December 31, 2013.

As royalties under the NRF are sensitive to both commodity prices and production levels, the estimated Alberta and corporate royalty rates under the NRF will fluctuate with commodity prices, well production rates, production decline of existing wells, and performance and location of new wells drilled. 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.

The future impact of the NRF and the TRR has been reflected in the evaluation of Birchcliff's reserves at December 31, 2008 prepared by AJM, an independent qualified reserves evaluator, contained in AJM's report dated February 10, 2009 (the"AJM Evaluation").

Birchcliff has obtained from AJM a re-run of the AJM Evaluation at December 31, 2008 using the old royalty framework which applied prior to the NRF which also used AJM's December 31, 2008 price forecast (the "Old Royalty Case"). For 2009 the AJM Evaluation used a price forecast of CAD $7.00/mmbtu for natural gas at AECO and a USD $55.00/bbl for a WTI oil price and a USD $1 equal to CAD $0.82. Under the AJM Evaluation the total royalty burden for 2009 on total proved reserves was 26.8% of AJM's estimate of revenues for 2009. Under the Old Royalty Case the total royalty burden for 2009 on total proved reserves was 24.3% of AJM's estimate of revenues for 2009. The royalty rate increase between these two cases, which is 2.5% for 2009, represents an increase of $6.9 million of estimated royalty expense for 2009 as a result of the NRF/TRR.

Birchcliff has obtained from AJM two additional re-runs of the AJM Evaluation at December 31, 2008 both of which used a constant price forecast of CAD $4.50/mmbtu for natural gas at AECO and a USD $40.00/bbl for a WTI oil price and a USD $1 equal to CAD $0.80. One of these cases was run using the old royalty framework which applied prior to the NRF (the "Constant Price Old Royalty Case") and the other case was run using the NRF/TRR (the "Constant Price New Royalty Case"). Under the Constant Price New Royalty Case the total royalty burden for 2009 on total proved reserves was 20.4% of AJM's estimate of revenues for 2009. Under the Constant Price Old Royalty Case the total royalty burden for 2009 on total proved reserves was 23.6% of AJM's estimate of revenues for 2009. The royalty rate decrease between these two cases, which is 3.2% for 2009, represents a decrease of $5.7 million of estimated royalty expense for 2009 as a result of the NRF/TRR.

The above comparisons also demonstrate that Birchcliff's estimated royalty burden in future years under the NRF/TRR is quite sensitive to commodity prices.

New Royalty and Drilling Incentives

On March 3, 2009 the Government of Alberta announced two new short-term royalty incentives to stimulate new and continued economic activity in Alberta. The most important aspects of these initiatives are as follows:

a) New conventional oil and natural gas wells spud after April 1, 2009 and rig released on or before March 31, 2010 will be entitled to a royalty credit of $200 per metre drilled, up to a maximum of 50% (in Birchcliff's case) of the aggregate royalties payable by Birchcliff in 2009 during that period.

b) An incentive royalty rate of five-per-cent for the first year of production from each new oil or gas well brought on production after April 1, 2009 and before March 31, 2010 up to a maximum for such well of 50,000 barrels of oil or 500 million cubic feet of natural gas.

The province has indicated that it will monitor the impact of the incentive program, and at the end of the year, assess whether it is necessary or appropriate for it to be continued.

These incentives will provide material royalty relief with respect to Birchcliff's drilling activities. As a result, during the one year term of the drilling royalty credit and the term of the incentive royalty rate, Birchcliff intends to focus its capital spending program in large part on its Montney/Doig horizontal wells.

At approximately 4,000 metres of measured depth, each Montney/Doig horizontal well may obtain a drilling royalty credit of up to $800,000. This is significant and amounts to approximately 16% of the total costs of approximately $5 million on average to drill, complete, equip and tie-in a horizontal well.

With respect to the royalty incentive rate, a typical horizontal well would attract a first year royalty rate of approximately 28%, assuming a $4.50/mmbtu AECO natural gas price, production of 800 million cubic feet of natural gas during the first year and application of the NRF and TRR described above. The incentive rate royalty of 5% on the first 500 million cubic feet of production will result in royalty savings of up to 23% or 115 million cubic feet of natural gas for such well.

The AJM Evaluation as at December 31, 2008 does not take into account either of these two new royalty incentives announced on March 3, 2009.

Operating Costs

Operating costs were $38.7 million ($10.41 per BOE) for the year ended December 31, 2008 as compared to $21.7 million ($8.86 per BOE) for the year ended December 31, 2007. The following table compares components of operating costs for the years ended December 31, 2008 and 2007:



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

Year ended December Year ended December
Operating Costs 31, 2008 31, 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Total Total
($000's) $/BOE ($000's) $/BOE
----------------------------------------------------------------------------
Field operating costs 39,100 10.53 22,917 9.35
Recoveries (2,213) (0.60) (1,820) (0.74)
----------------------------------------------------------------------------
Field operating costs, net of
recoveries 36,887 9.93 21,097 8.61
Expensed workovers and other 1,780 0.48 618 0.25
----------------------------------------------------------------------------
Total operating costs 38,667 10.41 21,715 8.86
----------------------------------------------------------------------------
----------------------------------------------------------------------------


The $1.55 per BOE increase in 2008 as compared to 2007 was comprised of $0.23 per BOE relating to expensed workovers, $0.14 per BOE resulting from lower third party recoveries, and $1.18 per BOE due to generally higher costs of supplies and services.

Recoveries continue to decrease on a per BOE basis in 2008 because Birchcliff's production volumes have increased significantly as a result of its drilling success on the Montney/Doig resource play and the full year benefit during 2008 of the Worsley Acquisition in September 2007, without a corresponding increase in third party recoveries which have remained relatively constant on a total dollar basis.

Birchcliff continues to implement strategies aimed at lowering its operating costs on a per BOE basis, but these decreases were being offset by rising processing fees at third party plants and general increases in costs of necessary services during 2008.

Transportation and Marketing Expenses

Transportation and marketing expenses were $9.9 million ($2.68 per BOE) for the year ended December 31, 2008 as compared to $5.0 million ($2.04 per BOE) in 2007. These costs consist primarily of transportation costs. The aggregate and per unit costs for 2008 are higher than in 2007 because the light oil produced at Worsley is transported by truck a significant distance to a sales terminal. The Worsley Acquisition was not closed until September 27, 2007 so these additional costs did not significantly impact the transportation and marketing expenses for the entire 2007 period.

General and Administrative Expense

Net general and administrative costs in the year ended December 31, 2008 were $6.5 million ($1.75 per BOE) as compared to $7.5 million ($3.07 per BOE) in 2007.



The components of G&A are as follows:

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

Year Ended December Year Ended December
General and Administrative Expense 31, 2008 31, 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------
($000's) Change% ($000's) Change%
----------------------------------------------------------------------------
Salaries, benefits and consultants 10,389 64% 7,403 65%
Other 5,874 36% 4,057 35%
----------------------------------------------------------------------------
G & A expense, gross 16,263 100% 11,460 100%
Overhead recoveries (7,892) (49%) (2,652) (23%)
Capitalized overhead (1,858) (11%) (1,280) (11%)
----------------------------------------------------------------------------
G & A expense, net 6,513 40% 7,528 66%
----------------------------------------------------------------------------
----------------------------------------------------------------------------
G & A expense, net per BOE $1.75 $3.07
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Net G&A expense per BOE has decreased for the year ended December 31, 2008 as compared to 2007 due to additional volumes added as a result of its drilling success on the Montney/Doig resource play and the full year benefit during 2008 of the Worsley acquisition and significant increases in overhead and capital recoveries which are directly attributable to the increased capital spent in 2008.

The low net G&A expense for the year ended December 31, 2008 is directly attributable to the Corporation's large capital program in 2008 and resulting capital overhead recoveries. The capital overhead recoveries are charged to each AFE as per industry standard. Accordingly, some of the recovery is a true third party recovery, from partners who participate in Birchcliff's capital projects, but the majority of the amount is a recovery from Birchcliff's own capital spent and this results in capitalizing a portion of Birchcliff's G&A costs.

The capitalization of costs in the "overhead recoveries" category reflects an industry standard charge per AFE to capitalize engineering, land, accounting and operations time spent on capital projects, whereas the "capitalized overhead" category reflects a portion of costs in relation to only Birchcliff's exploration and geology department.

Interest Expense

Interest expense in the year ended December 31, 2008 was $10.3 million ($2.78 per BOE) compared to $8.7 million ($3.55 per BOE) in 2007. The increase in aggregate interest expense was a result of the Corporation maintaining a higher debt level due to the Worsley Acquisition and related non-revolving credit facility of $98.8 million that was outstanding for most of the first quarter of 2008. The decrease in interest expense per BOE was mainly due to higher production volumes in 2008 as compared to 2007. The Corporation's average bank debt was approximately $209.8 million in 2008 as compared to $152.1 million in 2007, in each case calculated as the simple average of the month end amounts.

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

Depletion, depreciation and accretion ("DD&A") expense for the year ended December 31, 2008 was $89.7 million ($24.14 per BOE) as compared to $66.1 million ($26.97 per BOE) in 2007. The DD&A expense on a per BOE basis is 10% lower mainly due to the reduced costs of adding proved reserves during 2008 than in 2007.



The components of DD&A are as follows:

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

Year Ended December Year Ended December
31, 2008 31, 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Total Total
DD&A Expense ($000's) $/BOE ($000's) $/BOE
----------------------------------------------------------------------------
Depletion & depreciation 88,201 23.75 64,826 26.46
Accretion for Asset Retirement
Obligations 1,466 0.39 1,253 0.51
----------------------------------------------------------------------------
Total DD&A 89,667 24.14 66,079 26.97
----------------------------------------------------------------------------
----------------------------------------------------------------------------


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, 2008, Birchcliff has excluded from its full cost pool $49.7 million (2007 - $31.8 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.

Petroleum and Natural Gas Properties Impairment Test

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

Birchcliff performed an impairment (ceiling test) review at December 31, 2008 on its petroleum and natural gas assets. Based on this calculation, Birchcliff determined there was no impairment of its petroleum and natural gas assets.

Taxes

Birchcliff recorded a future income tax expense of $13.7 million ($3.69 per BOE) for the year ended December 31, 2008 as compared to a recovery of $4.5 million ($1.85 per BOE) for 2007. The increase is due to net income recorded during 2008 as compared to a net loss in 2007, mainly as a result of higher commodity prices and lower finding and development costs in 2008 as compared to 2007.

Birchcliff recovered $7,000 of Part XII.6 taxes in 2008 relating mainly to the issue of $16,029,000 of flow-through shares in November 2006. Birchcliff fulfilled its obligation with respect to that flow-through share issue in the third quarter of 2007.

Future income taxes arise from differences between the accounting and tax bases of the Corporation's assets and liabilities. At December 31, 2008 Birchcliff has the following estimated income tax pools:



----------------------------------------------------------------------------
TAX POOLS 2008
$ millions
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Canadian Exploration Expenditures 71
Canadian Development Expenditures 102
Canadian Oil & Gas Property Expenditures 353
Undepreciated Capital Cost 156
Non-Capital Losses 19
Scientific Research & Experimental Development & Investment Tax
Credits 19
Share Issue Costs 12
----------------------------------------------------------------------------
----------------------------------------------------------------------------


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 $5.0 million expense ($1.35 per BOE) for stock-based compensation relating to stock options in 2008, as compared to $2.2 million ($0.90 per BOE) in 2007.

During the period ended December 31, 2008, the Corporation granted options to purchase 2,330,000 common shares (2007 - 2,845,000) at a weighted average exercise price of $8.23 (2007 - $4.32) per common share. Of these options, at December 31, 2008, there remained outstanding options to purchase 2,284,000 common shares (2007 - 2,734,500).

During the year ended December 31, 2008, the Corporation issued 1,133,925 common shares (2007 - 151,686) due to the exercise of vested warrants and stock options, and stock options in respect of 202,668 common shares (2007 - 1,581,169) were forfeited or expired. In addition, the cancellation of 5,000 (2007 - 55,999) vested stock options resulted in a cash-paid stock-based compensation expense of $20,000 for the year ended December 31, 2008 as compared to $54,000 in 2007. The cash-paid expense is included in total stock-based compensation expense. The Corporation is no longer making cash payments for the cancellation of vested stock options.

CAPITAL EXPENDITURES AND CAPITAL RESOURCES

Capital expenditures, excluding acquisitions, amounted to $225.3 million in 2008 as compared to $79.0 million during 2007. The increase in expenditures was the result of significant growth in drilling and operational activity in 2008. Acquisitions costs incurred in 2008 were minimal compared to $271.1 million spent in 2007 to acquire the Worsley properties and other minor acquisitions.

The following table sets forth a summary of the Corporation's capital expenditures incurred for the years ended December 31, 2008 and 2007:



Capital Expenditures

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

Year Ended December 31 ($000's) 2008 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Land 25,616 4,799
Seismic 4,503 2,387
Workovers and other 9,096 2,121
Drilling and completions 125,719 52,274
Well equipment and facilities 58,467 15,889
Capitalized general and administrative expenses 1,858 1,280
----------------------------------------------------------------------------
Total Finding and Development Costs (F&D) 225,259 78,750
Acquisitions, net 10,369 271,120
----------------------------------------------------------------------------
Total Finding, Development and Acquisition
Costs (FD&A) 235,628 349,870
----------------------------------------------------------------------------
Administrative assets 1,451 303
----------------------------------------------------------------------------
Total Capital Expenditures 237,079 350,173
----------------------------------------------------------------------------
----------------------------------------------------------------------------



The following table sets forth a summary of the Corporation's capital
resources for the years ended December 31, 2008 and 2007:


Capital Resources

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

Year Ended December 31 ($000's) 2008 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Cash generated by operations 131,453 56,245
Changes in working capital from operations 2,068 (1,359)
Asset retirement expenditures (1,082) (588)
Equity issues, net of issue costs 129,764 109,380
Increase (decrease) in non-revolving credit facility (98,830) 98,830
Increase in revolving credit facilities 55,732 74,550
Changes in working capital from investing 17,973 13,116
----------------------------------------------------------------------------
Total Capital Resources 237,078 350,174
----------------------------------------------------------------------------
----------------------------------------------------------------------------



SELECTED QUARTERLY INFORMATION

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

Quarters Ended
($000's, except
share and per December 31, September 30, June 30, March 31,
share amounts) 2008 2008 2008 2008
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Petroleum and
natural gas
production (BOE
per day) 11,524 10,000 9,583 9,470
Petroleum and
natural gas
commodity price
($ per BOE) 47.88 73.44 83.58 64.83
Natural gas
commodity
price at
wellhead ($
per mcf) 7.14 8.47 10.93 8.35
Petroleum
commodity
price at
wellhead ($
per bbl) 59.10 115.95 121.39 94.72

Total petroleum
and natural gas
revenue 51,034 67,942 73,273 56,192
Total royalties (8,888) (12,502) (11,361) (8,700)
Total interest
and other revenue - - - 2
Total revenues, net 42,146 55,440 61,912 47,494
Total capital
expenditures 58,916 89,158 37,487 51,518

Net income (loss) (355) 16,649 9,776 3,828
Per share basic - $ 0.15 $ 0.09 $ 0.04
Per share diluted - $ 0.14 $ 0.08 $ 0.04

Cash generated
by operations 24,627 37,886 41,676 27,264
Per share basic $ 0.22 $ 0.34 $ 0.37 $ 0.28
Per share diluted $ 0.22 $ 0.33 $ 0.36 $ 0.27

Book value of
total assets 814,823 774,794 719,292 699,567
Non-revolving
credit facility - - - -
Revolving credit
facilities 211,586 180,995 148,922 133,035
Total debt 249,862 214,642 163,378 169,614
Shareholders' equity 507,371 506,742 488,579 475,453

Common shares
outstanding -
end of period
Basic 112,395,970 112,395,970 112,375,970 111,863,089
Diluted 121,659,923 121,451,823 121,270,357 121,175,691

Weighted average
common shares
outstanding
Basic 112,395,970 112,386,829 112,234,676 98,852,346
Diluted 112,801,866 116,859,500 117,074,630 102,589,422
----------------------------------------------------------------------------
----------------------------------------------------------------------------



----------------------------------------------------------------------------
Quarters Ended
($000's, except
share and per December 31, September 30, June 30, March 31,
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
Petroleum
commodity
price at
wellhead ($
per bbl) 80.94 76.95 69.92 63.86

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
Total 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 debt 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
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Discussion of Quarterly Results

Birchcliff increased its average quarterly production to 11,524 BOE per day in the fourth quarter 2008, which is a 24% increase from 9,260 BOE per day in the fourth quarter 2007 and a 15% increase from 10,000 BOE per day in the third quarter 2008. The increases are the direct result of the success of the Corporation's 2008 capital spending program on its resource plays and the resulting increased production.

Cash generated by the Corporation for the fourth quarter 2008 was $24.6 million as compared to $37.9 million in for the third quarter 2008. This 35% decrease was mainly due to lower average commodity prices in fourth quarter of 2008 than in 2007. Overall, cash flow increased by 24% in fourth quarter of 2008 compared to fourth quarter of 2007, due to higher average quarterly production.

SUMMARY 2009 OUTLOOK

Given the current economic downturn and reduced commodity prices, Birchcliff intends to carefully monitor its cash flow and capital spending to ensure that capital spent in 2009 does not exceed its cash flow. Birchcliff will re-evaluate its 2009 second half capital spending late in the second quarter of 2009.

Birchcliff has a very strong asset base with its two main resource plays, 1) the Montney/Doig natural gas resource play and 2) the Worsley light oil resource play. These properties provide the Corporation with a long term and operationally reliable cash flow base, the level of which is primarily dependent on commodity prices. The extensive portfolio of development opportunities on these properties will not expire in the near term and provide low risk long life future production additions that are readily available with the investment of additional capital. In the near term Birchcliff can adjust its capital investments to match its cash flow as commodity prices fluctuate and it is therefore capable of weathering the current economic environment.

In effect, short term commodity prices will dictate the rate at which we invest in our resource plays and the rate at which we can grow our production but short term commodity prices do not affect the quality or the long term value of our asset base.

CONTRACTUAL COMMITMENTS

Flow-Through Share Commitments

In the first quarter of 2008, the Corporation committed to renounce $15 million of exploration expenses pursuant to a flow-through share issue completed on March 14, 2008. Birchcliff has until December 31, 2009 to incur these exploration expenditures. As at December 31, 2008 the Corporation had fulfilled its obligation with respect to the flow-through shares and consequently will not be subject to part XII.6 tax.

Office Premises Commitments

The Corporation is committed under a premises lease which commenced December 1, 2007 and which expires on November 30, 2017. Birchcliff does not presently use all of the leased premises and has sublet the excess space to an arms' length party on a basis that recovers approximately 40% of the rental costs for the first five years. The Corporation is committed to the following aggregate minimum lease payments (not reduced by sublease rents receivable by the Corporation):



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

2009 3,214
2010 3,214
2011 3,214
2012 3,223
2013 3,331
Thereafter 13,045
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DISCLOSURE CONTROLS AND PROCEDURES

Disclosure controls and procedures have been designed to ensure that information required to be disclosed by the Corporation is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure. The Chief Executive Officer ("CEO") and the Chief Financial Officer ("CFO") have evaluated the effectiveness of the Corporation's disclosure controls and procedures as at December 31, 2008 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. It should be noted that while the Corporation's CEO and CFO believe that the Corporation's disclosure controls and procedures are effective to provide a reasonable level of assurance, they do not expect that the disclosure controls and procedures will prevent all errors and fraud. A control system, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are achieved.

INTERNAL CONTROL OVER FINANCIAL REPORTING

Internal control over financial reporting is a process designed to provide reasonable assurance that all assets are safeguarded, transactions are appropriately authorized and to facilitate the preparation of relevant, reliable and timely information. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. The Corporation's Chief Executive Officer and Chief Financial Officer (the "Certifying Officers") have evaluated, or caused to be evaluated under their supervision, the effectiveness of the Corporation's internal control over financial reporting as required by National Instrument 52-109, Certification of Disclosure in Issuers' Annual and Interim Filings. The Certifying Officers concluded that the Corporation's internal control over financial reporting was effective at December 31, 2008, based on that evaluation.

CHANGE IN ACCOUNTING POLICIES

On January 1, 2008 the Corporation prospectively adopted the following Canadian Institute of Chartered Accountant ("CICA") Handbook Sections:

Section 1535 Capital Disclosures establishes standards for disclosing information about an entity's capital and how it is managed. It describes the disclosure requirements of the entity's objectives, policies and processes for managing capital; the quantitative data relating to what the entity regards as capital; whether the entity has complied with regulatory capital requirements and, if it has not complied, the consequences of such non-compliance. The only effect of adopting this standard is to add disclosures on the Corporation's capital and how it is managed. There are no regulatory requirements on how the Corporation must manage its capital.

Section 3862 Financial Instruments - Disclosures, describes the required disclosure for the assessment of the significance of financial instruments for an entity's financial position and performance and of the nature and extent of risks arising from financial instruments to which the entity is exposed and how the entity manages those risks.

Section 3863 Financial Instruments - Presentation, establishes standards for presentation of financial instruments and non-financial derivatives. These sections replaced Section 3861 Financial Instruments - Disclosure and Presentation. The additional disclosures required under these standards are included in notes to the financial statements.

The CICA also amended Section 1400 General Standard of Financial Statement Presentations, to include requirements to assess and disclose the Corporation's ability to continue as a going concern. The adoption of this standard did not have an impact on the Corporation's financial statements.

Future Accounting Policy Changes

Effective January 1, 2009, the Corporation will be required to adopt CICA Handbook Section 3064 Goodwill and Intangible Assets, which defines the criteria for the recognition of intangible assets. The adoption of this standard is not expected to have a significant impact on the Corporation's financial statements.

INTERNATIONAL FINANCIAL REPORTING STANDARDS

In February 2008, the CICA Accounting Standards Board ("ACSB") confirmed the changeover to International Financial Reporting Standards ("IFRS") from GAAP, will be required for publicly accountable enterprises' interim and annual financial statements effective for fiscal years beginning on or after January 1, 2011. The transition from current GAAP to IFRS is a significant undertaking that may materially affect the Corporation's reported financial position and operations. The Corporation has appointed internal staff to lead the IFRS conversion project. The Corporation has retained an external advisor to assist in the initial scoping and has prepared a diagnostic analysis that identifies the differences between Birchcliff's current accounting policies and IFRS. At this time, Birchcliff is evaluating the impact of these differences and assessing the need for amendments to existing accounting policies in order to comply with IFRS. Birchcliff expects to be IFRS compliant by January 1, 2011.

Birchcliff has not yet prepared a complete IFRS changeover plan (the "IFRS Plan"), but has completed a high-level scoping study to consider the potential impact of the implementation of IFRS on the Corporation's financial reporting. IFRS will not only impact the presentation and disclosure of items in the financial statements of Birchcliff but also the determination of future net income and the measurement of balance sheet items. The next stage for Birchcliff will be to develop a detailed IFRS Plan. This IFRS Plan will include modeling the impact of individual IFRS standards and related interpretations on the financial statements of Birchcliff. As part of the Corporation's IFRS Plan, it will be required to prepare a transition balance sheet as at December 31, 2009 (to be representative of the opening January 1, 2010 balance sheet) in accordance with IFRS. This opening balance sheet will form the opening position of the Corporation's comparative financial statements when it reports under IFRS. Based on the high-level scoping study, the following IFRS standards are expected to have the most significant impact on Birchcliff.

- IFRS 1 - First-time adoption of IFRS

- IFRS 2 - Share Based Payments

- IFRS 6 - Exploration and evaluation of mineral resources

- IAS 12 - Income Taxes (as pertains to Flow Through Shares)

- IAS 16 - Property, plant and equipment

- ED 9 - Joint arrangements (replacing IAS 31 - Interests in joint ventures)

- IAS 36 - Impairment of Assets

- IAS 37 - Provisions, contingent liabilities and contingent assets (Flow Through Shares)

Once the detailed IFRS Plan is complete, Birchcliff will begin to design and build its IFRS framework, which includes decisions on available accounting policy choices, formulate policy positions and execution and roll-out of communications strategy. Once the design and build phase is complete Birchcliff will move to the implement and review phase which includes, preparation of IFRS opening balance sheet, compilation of comparative data, preparation of quarterly financial statements and disclosures, preparation of annual financial statements and disclosures, monitoring evolving IFRS, conducting post implementation review and communicating ongoing requirements.

FORWARD LOOKING STATEMENTS

This MD&A contains certain forward-looking statements and forward-looking information (hereinafter collectively referred to as "forward-looking statements") within the meaning of applicable Canadian securities laws. These statements relate to future events or our future performance and are based upon the Corporation's current internal expectations, estimates, projections, assumptions and beliefs. All statements other than statements of historical fact are forward-looking statements. In some cases, words such as "plan", "expect", "project", "intend", "believe", "anticipate", "estimate", "may", "will", "potential", "proposed" and other similar words, or statements that certain events or conditions "may" or "will" occur, are intended to identify forward-looking statements.

Undue reliance should not be placed on these forward-looking statements, as there can be no assurance that the plans, intentions or expectations upon which they are based will occur. By their nature, forward-looking statements involve numerous assumptions and known and unknown risks and uncertainties, that the predictions, forecasts, projections and other forward-looking statements will not occur. Although the Corporation believes that the expectations reflected in the forward-looking statements are reasonable, there can be no assurance that such expectations will prove to be correct. The Corporation cannot guarantee future results, levels of activity, performance or achievements. Consequently, there is no representation by the Corporation that actual results achieved will be the same in whole or in part as those set out in the forward-looking statements. Such forward-looking statements in this MD&A speak only as of the date of this.

In particular, this MD&A contains forward-looking statements pertaining to the following: drilling inventory, drilling plans and timing of drilling, re-completion and tie-in of wells; plans for facilities construction and completion of the timing and method of funding thereof; productive capacity of wells, anticipated or expected production rates and anticipated dates of commencement of production; drilling, completion and facilities costs; results of projects of the Corporation; ability to lower costs borne by the Corporation; production growth expectations; timing of development of undeveloped reserves; the tax horizon of the Corporation; the future performance and characteristics of the Corporation's oil and natural gas properties; oil and natural gas production levels; the quantity of oil and natural gas reserves; planned capital expenditure programs; supply and demand for oil and natural gas; commodity prices; currency exchange rates; interest rates; the impact of Canadian federal and provincial governmental regulation on the Corporation; weighting of production between different commodities; expected levels of royalty rates and incentives; operating costs, general administrative costs, costs of services and other costs and expenses; expectations regarding the Corporation's ability to raise capital and to add to reserves through acquisitions, exploration and development; and treatment under tax laws. These forward-looking statements are based upon various assumptions including; that future prices for crude oil and natural gas, future currency exchange rates and interest rates and future availability of debt and equity financing will be at levels and costs that allow the Corporation to manage, operate and finance its business and develop its properties and meet its future obligations; that the regulatory framework in respect of royalties, taxes and environmental matters applicable to the Corporation will not become so onerous as to preclude the Corporation from viably managing, operating and financing it business and the development of its properties; and that the Corporation will continue to be able to identify, attract and employ qualified staff and obtain the outside expertise and specialized and other equipment it requires to manage, operate and finance its business and develop its properties.

This MD&A also contains forward-looking statements pertaining to recoverable reserves volumes and associated future net revenues and numbers of future wells that may be drilled. These forward looking statements are based upon various assumptions as to future prices for crude oil and natural gas, currency exchange rates, inflation rates, future well production rates, well drainage areas, success rates of future well drilling and future costs and availability of labour and services. With respect to estimates of reserves volumes and associated future net revenues and numbers of future wells to be drilled a key assumption is the validity of the commodity prices, currency exchange rates, future capital and operating costs and well production rates forecast by the Corporation's independent reserves evaluator. With respect to the number of future wells to be drilled another key assumption is the validity of the geological and other technical interpretations that have been performed by Birchcliff's technical staff and which indicate that commercially economic reserves can be recovered from Birchcliff's lands as a result of drilling such future wells.

All such forward-looking statements necessarily involve risks associated with oil and gas exploration, production and marketing which may cause actual results may differ materially from those anticipated in the forward-looking statements. Some of those risks include; general economic conditions in Canada, the United States and globally; uncertainties with estimating oil and natural gas reserves; industry conditions, including fluctuations in the price of oil and natural gas; changes in governmental regulation of the oil and gas industry, including environmental regulation; fluctuations in foreign exchange rates or interest rates; geological, technical, drilling and processing problems and other difficulties in producing reserves; unanticipated operating events which can damage facilities or reduce production or cause production to be shut in or delayed; failure to obtain regulatory approvals in a timely manner; adverse conditions in the debt and equity markets; competition from others for scarce resources; and other factors disclosed under "Risk Factors and Risk Management" in this MD&A.

Readers are cautioned that the foregoing list of factors is not exhaustive. The forward-looking statements contained in this MD&A are expressly qualified by this cautionary statement. The Corporation is not under any duty to update any of the forward-looking statements after the date of this MD&A to conform such statements to actual results or to changes in the Corporation's plans or expectations, except as otherwise required by applicable securities laws.

NON-GAAP MEASURES

This MD&A and the Corporation's Annual Report for 2008 make references to terms commonly used in the petroleum and natural gas industry, such as cash flow or cash flow netback, cash flow per share, operating netback and netback.

Cash flow, as discussed in this MD&A and in the Corporation's Annual Report for 2008, 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 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.

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 in conjunction 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 lending syndicate in determining the amounts 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 is 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 financial 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 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 the end of 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 67% weighted to natural gas during the year ended December 31, 2008, 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 in 2009 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 its 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.

The majority of Birchcliff's production passes through owned or third party infrastructure prior to it being ready for transfer at designated commodity sales points. There is a risk that should this infrastructure fail and cause a significant portion of Birchcliff's production to be shut-in and unable to be sold, this could have a material adverse effect on Birchcliff's available cash flow. The Corporation mitigates this risk by purchasing business interruption insurance policies for its significant owned infrastructure and contingent business interruption insurance policies for its significant third party infrastructure.

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.

Birchcliff is subject to the risk that the unexpected failure of its equipment used in drilling, completing or producing wells or in transporting production could result in releases of fluids substances that pollute or contaminate lands at or near its facilities which could result in significant liability to the Corporation for costs of clean up, remediation and reclamation of contaminated lands. Birchcliff's policy with regards to the environment is to conduct all operations with due regard for the potential impact on the environment. This policy is implemented by hiring skilled personnel and reminding staff involved with operations of their responsibilities in this regard and by retaining expert environment advice and assistance to deal with environmental releases and remediation and reclamation work where such expertise is needed.

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.

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.

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.

Access to Credit Markets

Due to the nature of the Corporation's business it is necessary from time to time for the Corporation to access other sources of capital beyond its internally generated cash flow in order to fund the development and acquisition of its long term asset base. As part of this strategy the Corporation obtains some of this necessary capital by incurring debt and therefore the Corporation is dependent to a certain extent on continued availability of the credit markets.

The continued availability of the credit markets for Birchcliff is primarily dependent on the state of the economies and the health of the banking industry in Canada and United States. There is risk that should these economies and banking industry see unexpected and/or prolonged deterioration, then Birchcliff's access to credit markets may contract or disappear all together. The Corporation tries to mitigate this risk by dealing with reputable lenders and tries to structure its lending agreements to give it the most flexibility possible should these situations arise. However, the situations that may give rise to credit markets tightening or disappearing are ultimately uncontrollable by Birchcliff.

Climate Change Risks

North American climate change policy is evolving at both regional and national levels and recent political and economic events may significantly affect the scope and timing of new climate change measures that are ultimately put in place. Although it is not the case today, the Corporation expects that some of its significant facilities may ultimately be subject to future regional, provincial and/or federal climate change regulations to manage greenhouse gas ("GHG") emissions.

The Specified Gas Emitters Regulation, which came into effect In Alberta, in 2007, requires large industrial facility emitters of GHG to reduce GHG emissions intensities by 12 per cent. Each of Birchcliff's facilities is below the 100,000 tonnes per year threshold that this regulation applies to.

Last year the Government of Alberta released it its climate change strategy which sets a target to reduce GHG emissions in Alberta by 50% by 2050. Implementing carbon capture and storage technology across industrial sectors is a large component of the strategy, along with energy-efficiency measures, clean energy technologies, and expanding the use of renewable sources of energy. Details of specific requirements and proposed regulations are not yet available and therefore the impact on the Corporation's business remains uncertain at this time.

The Canadian government has expressed interest in pursuing the development of a North American cap and trade system for GHG emissions. In April 2007, the Government of Canada released the Regulatory Framework for Air Emissions ("Framework"). The Framework outlines short, medium and long-term objectives for managing both GHG emissions and air pollutants in Canada. It is uncertain how the Framework will fit within a North American cap and trade system and what the specific requirements for industrial emitters such as Birchcliff will be. Proposed regulations have not yet been released and therefore it is uncertain whether the impacts from such future regulations will be material to the Corporation.

In addition there are a number of regional initiatives being pursued by various provinces and US states such as the Western Climate Initiative which involves seven western US states and Alberta and three other Canadian provinces which are focused on the implementation of a cap and trade program. The Corporation anticipates a number of its facilities may be affected by these initiatives, however, the level of impact is uncertain as key details remain unknown.



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, 2008 and 2007 and the statements of net income (loss), comprehensive income (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, 2008 and 2007 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 10, 2009 Chartered Accountants



BIRCHCLIFF ENERGY LTD.

Balance Sheets
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As at December 31, ($000's) 2008 2007
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ASSETS

CURRENT
Cash and cash equivalents 65 66
Accounts receivable 29,836 20,036
Prepaid and other 3,031 2,879
Future income tax benefit (Note 10) - 2,004
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32,932 24,985

Future income tax benefit (Note 10) - 6,287
Petroleum and natural gas properties
and equipment (Note 5) 781,891 630,980
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814,823 662,252
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LIABILITIES

CURRENT
Accounts payable and accrued liabilities 71,208 41,213
Non-revolving credit facility (Note 6) - 98,830
Risk management contacts (Note 9) - 6,793
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71,208 146,836

Revolving credit facilities (Note 7) 211,586 155,854
Asset retirement obligations (Note 11) 21,223 18,806
Future income tax liability (Note 10) 3,435 -
Commitments (Note 15)

SHAREHOLDERS' EQUITY

Share capital (Note 12) 477,482 342,819
Contributed surplus (Note 13) 12,984 10,930
Retained earnings (deficit) 16,905 (12,993)
----------------------------------------------------------------------------
507,371 340,756
----------------------------------------------------------------------------
814,823 662,252
----------------------------------------------------------------------------
----------------------------------------------------------------------------
See accompanying notes to the financial statements.


APPROVED BY THE BOARD

Larry A. Shaw, Director

A. Jeffery Tonken, Director



BIRCHCLIFF ENERGY LTD.

Statements of Net Income (Loss), Comprehensive Income (Loss) and Retained
Earnings (Deficit)
----------------------------------------------------------------------------

For the Year Ended December 31, ($000's) 2008 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------

REVENUE

Petroleum and natural gas 248,441 120,696
Royalties (41,451) (19,332)
Interest and other 2 9
----------------------------------------------------------------------------
206,992 101,373
Gain (loss) on risk management contracts (Note 9)
Realized (9,859) (1,865)
Unrealized 6,769 (6,769)
----------------------------------------------------------------------------
203,902 92,739

EXPENSES

Production 38,667 21,715
Transportation and marketing 9,941 4,988
General and administrative 6,513 7,528
Stock-based compensation (Note 13) 5,004 2,207
Depletion, depreciation and accretion
(Notes 5 and 11) 89,667 66,079
Realized foreign exchange loss (gain) (Note 9) 226 19
Unrealized foreign exchange loss (gain) (Note 9) (24) 24
Interest 10,320 8,690
----------------------------------------------------------------------------
160,314 111,250
----------------------------------------------------------------------------

INCOME (LOSS) BEFORE TAXES 43,588 (18,511)

TAXES

Other taxes (recovery) (7) 269
Future income taxes (recovery) (Note 10) 13,697 (4,536)
----------------------------------------------------------------------------
13,690 (4,267)
----------------------------------------------------------------------------

NET INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS) 29,898 (14,244)

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

RETAINED EARNINGS (DEFICIT), END OF YEAR 16,905 (12,993)
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Net income (loss) per common share (Note 14)

Basic $0.27 ($0.20)
Diluted $0.26 ($0.20)

Weighted average common shares (Note 14)

Basic 108,986,165 72,156,544
Diluted 113,092,125 72,156,544

See accompanying notes to the financial statements



BIRCHCLIFF ENERGY LTD.

Statement of Cash Flows
----------------------------------------------------------------------------

For the Year Ended December 31, ($000's) 2008 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------

OPERATING

Net income (loss) 29,898 (14,244)
Adjustments for items not affecting cash:
Depletion, depreciation and accretion 89,667 66,079
Stock-based compensation 4,984 2,153
Unrealized risk management contracts (gain) loss (6,769) 6,769
Unrealized foreign exchange (gain) loss (24) 24
Future income taxes (recovery) 13,697 (4,536)
----------------------------------------------------------------------------
131,453 56,245
Changes in non-cash working capital (Note 16) 2,068 (1,359)
Asset retirement expenditures incurred (Note 11) (1,082) (588)
----------------------------------------------------------------------------
132,439 54,298

FINANCING

Increase (decrease) in non-revolving credit
facility (Note 6) (98,830) 98,830
Increase in revolving credit facility (Note 7) 55,732 74,550
Issuance of share capital, net of issue costs
(Note 12) 129,764 109,380
----------------------------------------------------------------------------
86,666 282,760
INVESTING

Purchase of petroleum and natural gas properties
and equipment (Note 4) - (263,320)
Purchase of minor petroleum and natural gas
properties and equipment (10,369) (7,800)
Development of petroleum and natural gas properties
and equipment (226,710) (79,053)
Changes in non-cash investing working capital
(Note 16) 17,973 13,116
----------------------------------------------------------------------------
(219,106) (337,057)
----------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS (1) 1

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

Cash interest paid 10,320 8,690
Cash taxes paid 254 6

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. The provision for income taxes is based on judgments in applying income tax law and estimates on the timing, likelihood and reversal of temporary differences between the accounting and tax bases of assets and liabilities. By their nature, these estimates are subject to measurement uncertainty and the impact of changes in such estimates on the financial statements of future periods could be material.

(e) Cash and cash equivalents

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

(f) Property, plant and equipment

Capitalized costs

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

Depletion and depreciation

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

Impairment

Petroleum 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 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 including facilities. 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 substantively enacted tax rates anticipated to apply in relevant future periods. The effect of a change in income tax rates on future income tax liabilities and assets is recognized in the period that the change occurs.

(i) Stock-based compensation

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

(j) Flow-through shares

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

(k) Financial instruments

All financial instruments are initially recognized at fair value on the balance sheet. 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.

(l) 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.

(m) 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.

(n) 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 Income (Loss).

3. CHANGES IN ACCOUNTING POLICY/RECENT ACCOUNTING PRONOUNCEMENTS

On January 1, 2008 the Corporation adopted the following Canadian Institute of Chartered Accountant ("CICA") Handbook Sections:

Section 1535 Capital Disclosures establishes standards for disclosing information about an entity's capital and how it is managed. It describes the disclosure requirements of the entity's objectives, policies and processes for managing capital; the quantitative data relating to what the entity regards as capital; whether the entity has complied with capital requirements and, if it has not complied, the consequences of such non-compliance. The only effect of adopting this standard is disclosures on the Corporation's capital and how it is managed, as included in Note 8.

Section 3862 Financial Instruments - Disclosures describes the required disclosure for the assessment of the significance of financial instruments for an entity's financial position and performance and of the nature and extent of risks arising from financial instruments to which the entity is exposed and how the entity manages those risks. Section 3863 Financial Instruments - Presentation, establishes standards for presentation of financial instruments and non-financial derivatives. These sections replaced Section 3861 Financial Instruments - Disclosure and Presentation. The additional disclosures required under these standards are included in Note 9.

The CICA also amended Section 1400 General Standard of Financial Statement Presentations, to include requirements to assess and disclose the Corporation's ability to continue as a going concern. The adoptions of this new section did not have an impact on the corporation's financial statements.

Future Accounting Policy Changes

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 profit-oriented enterprises. Standards concerning goodwill are unchanged from the standards included in the previous Section 3062. The adoption of this section is not expected to have a significant impact on the Corporation's financial statements.

Recent Accounting Pronouncements

In February 2008, the CICA Accounting Standards Board ("ACSB") confirmed the changeover to International Financial Reporting Standards ("IFRS") from GAAP will be required for publicly accountable enterprises' interim and annual financial statements effective for fiscal years beginning on or after January 1, 2011. The transition from current GAAP to IFRS is a significant undertaking that may materially affect the Corporation's reported financial position and operations. The Corporation has appointed internal staff to lead the IFRS conversion project. At this time, Birchcliff is evaluating the impact of these differences and assessing the need for amendments to existing accounting policies in order to comply with IFRS. Birchcliff expects to be IFRS compliant by January 1, 2011.

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 final purchase price allocation for the Worsley Acquisition:



----------------------------------------------------------------------------
Net assets acquired: $000's
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Petroleum and natural gas properties and equipment 269,880
Asset retirement costs (5,919)
----------------------------------------------------------------------------
Total net assets acquired 263,961
----------------------------------------------------------------------------
----------------------------------------------------------------------------


----------------------------------------------------------------------------
Consideration:
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Purchase price, net of adjustments, paid in cash 261,448
Costs related to the Worsley Acquisition 2,513
----------------------------------------------------------------------------
Total consideration paid 263,961
----------------------------------------------------------------------------
----------------------------------------------------------------------------


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

5. PETROLEUM AND NATURAL GAS PROPERTIES AND EQUIPMENT

----------------------------------------------------------------------------
2008
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Accumulated
Depletion and
($000's) Cost Depreciation Net Book Value
----------------------------------------------------------------------------

Petroleum and natural gas assets 996,028 (215,719) 780,309
Office furniture and equipment 2,780 (1,198) 1,582
----------------------------------------------------------------------------
998,808 (216,917) 781,891
----------------------------------------------------------------------------
----------------------------------------------------------------------------

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


As of December 31, 2008, the cost of petroleum and natural gas properties includes $49.7 million (2007 - $31.8 million) relating to unproved properties which have been excluded from costs subject to depletion and depreciation.

Birchcliff has capitalized general and administrative costs of $1.9 million in the year ended December 31, 2008 (2007 - $1.3 million) directly relating to exploration and development activities.

The Corporation performed an impairment (ceiling test) review at December 31, 2008 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, 2008 commodity price forecasts of the Corporation's independent reserve evaluators. The following table summarizes the actual 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)
----------------------------------------------------------------------------
2009 55.00 0.82 65.40 7.00
----------------------------------------------------------------------------
2010 76.50 0.86 87.20 8.05
----------------------------------------------------------------------------
2011 88.45 0.90 96.50 8.20
----------------------------------------------------------------------------
2012 100.80 0.95 104.30 9.00
----------------------------------------------------------------------------
2013 108.25 0.95 112.05 9.75
----------------------------------------------------------------------------
2014 110.40 0.95 114.25 9.95
----------------------------------------------------------------------------
2015 112.60 0.95 116.55 10.15
----------------------------------------------------------------------------
2016 114.85 0.95 118.90 10.35
----------------------------------------------------------------------------
2017 117.15 0.95 121.25 10.55
----------------------------------------------------------------------------
2018 119.50 0.95 123.70 10.75
----------------------------------------------------------------------------
2019 121.90 0.95 126.15 10.95
----------------------------------------------------------------------------
2020 124.35 0.95 128.70 11.20
----------------------------------------------------------------------------
2021 126.80 0.95 131.25 11.40
----------------------------------------------------------------------------
2022 129.35 0.95 133.90 11.65
----------------------------------------------------------------------------
2023 131.95 0.95 136.55 11.90
----------------------------------------------------------------------------
2024 134.60 0.95 139.30 12.10
----------------------------------------------------------------------------
2025 137.30 0.95 142.10 12.35
----------------------------------------------------------------------------
2026 140.00 0.95 144.90 12.60
----------------------------------------------------------------------------
2027 142.80 0.95 147.80 12.85
----------------------------------------------------------------------------
2028 145.70 0.95 150.80 13.10
----------------------------------------------------------------------------
thereafter 2.0% 0.95 2.0% 2.0%
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Actual prices used in the impairment test were adjusted for crude oil and natural gas differentials, transportation and marketing costs specific to the Corporation's operations. Management's assessment is that there is no impairment of petroleum and natural gas properties and equipment as at December 31, 2008.

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 was to mature one year from the date of drawdown and had no other terms for extension. The interest applicable to prime loan advances under the agreement was 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 was $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 was subordinate to the revolving term credit facilities and was secured by a fixed and floating debenture, an instrument of pledge, and a general security agreement encompassing all of the Corporation's assets. On March 14, 2008 the facility was repaid in full and cancelled, following the completion of the equity financing described in Note 12 (g).



7. REVOLVING CREDIT FACILITIES
----------------------------------------------------------------------------
$000s 2008 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Syndicated credit facility 197,410 146,238
Working capital facility 14,176 9,616
----------------------------------------------------------------------------
Revolving Credit Facilities 211,586 155,854
----------------------------------------------------------------------------
----------------------------------------------------------------------------


The Corporation has available to it an extendible revolving term credit facility with an authorized limit of $220 million and an extendible revolving working capital facility with an authorized limit of $20 million. The $220 million syndicated credit facility is provided by a syndicate of four banks (the "Syndicate"). The $20 million working capital facility is provided by the lead bank in the current bank syndicate. As at December 31, 2008, the effective rate applicable to the working capital facility was 4.7% (2007 - 6.0%). The overall effective interest rate applicable to the bankers' acceptances in the revolving credit facility was 3.9% for the year ended December 31, 2008 (2007 - 4.6%). As at December 31, 2008, Birchcliff had drawn $211.6 million on its credit facilities. Also included as a reduction of the available working capital facility are letters of credit issued to various service providers in the amount of $1.8 million (2007 - $1.0 million) at December 31, 2008.

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 22, 2009 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 22, 2009 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. CAPITAL MANAGEMENT

The Corporation's general policy is to maintain a sufficient capital base in order to manage its business in the most effective manner with the goal of increasing the value of its assets and thus its underlying share value. The Corporation's objectives when managing capital are to maintain financial flexibility in order to preserve its ability to meet financial obligations, including potential obligations arising from additional acquisitions; to maintain a capital structure that allows Birchcliff to favour the financing of its growth strategy using internally-generated cash flow and its debt capacity; and to optimize the use of its capital to provide an appropriate investment return to its shareholders.

Birchcliff strives to properly exploit its current asset base and to acquire top quality assets. To that end, the Corporation is not averse to maintaining a high ratio of debt to total capital if management determines the assets it is acquiring or the projects it is drilling are of high quality.



The capital structure of the Corporation is as follows:

----------------------------------------------------------------------------
(000's) 2008 2007 Change%
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Total shareholders' equity 507,371 340,756 49%
----------------------------------------------------------------------------
Total shareholders' equity as a %
of total capital 67% 56%

Working capital deficit (1) 38,276 18,232
Non-revolving credit facility - 98,830
Revolving credit facilities 211,586 155,854
----------------------------------------------------------------------------
Total debt 249,862 272,916 (8%)
Total debt as a % of total capital 33% 44%

----------------------------------------------------------------------------
Total Capital 757,233 613,672 23%
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Working capital deficit is defined as current assets (excluding the
current portion of future income tax benefit) less current liabilities
(excluding the risk management contracts).


Shareholders' equity is defined as share capital plus contributed surplus plus retained earnings, less any deficit. During the year ended December 31, 2008, total equity increased due to the exercise of options and warrants for common shares (Note 12 (f)), due to issuance of common and flow-through shares (Note 12 (g)), and due to recording stock-based compensation expense (Note 13).

Total debt decreased during the year ended December 31, 2008 by $23.1 million. Repayment and cancellation of the $100 million non-revolving credit facility described in Note 6 after the equity issuance described in Note 12 (g) was offset by capital spending in excess of cash flow.

9. FINANCIAL INSTRUMENTS & RISK MANAGEMENT CONTRACTS

Birchcliff is exposed to credit risk, liquidity risk and market risk as part of its normal course of business. This Note presents information about the Corporation's exposure to each of these risks, as well as Birchcliff's objectives, policies and processes for measuring and managing risk. Further quantitative disclosures are included throughout these financial statements.

The Board of Directors has overall responsibility for the establishment and oversight of the Corporation's financial risk management framework and periodically reviews the results of all risk management activities and all outstanding positions. Management identifies and analyzes the risks faced by the Corporation and may utilize financial instruments to mitigate these risks.

Credit risk

A substantial portion of the Corporation's accounts receivable are with customers in the oil industry and are subject to normal industry credit risks. The carrying amount of accounts receivable reflects management's assessment of the credit risk associated with these customers. Of the Corporation's significant individual accounts receivable at December 31, 2008, approximately 21% was due from one marketer (December 31, 2007 - 46%, two marketers). Of the Corporation's revenue for the year ended December 31, 2008, approximately 57% was received from three marketers (December 31, 2007 - 74%, four marketers). Typically, Birchcliff's maximum credit exposure to customers is revenue from two months of commodity sales.

The following table illustrates the Corporation's receivables:



----------------------------------------------------------------------------
($000's) 2008 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Marketers 15,265 16,018
Joint venture partners 14,500 3,737
Other 71 281
----------------------------------------------------------------------------
Total Receivables 29,836 20,036
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Receivables from marketers are normally collected on the 25th day of the month following production. Birchcliff's policy to mitigate credit risk associated with these balances is to establish marketing relationships with credit worthy purchasers, to obtain guarantees from their ultimate parent companies and to obtain letters of credit as appropriate. The Corporation historically has not experienced any material collection issues with its marketers.

Cash and cash equivalents consist of bank balances and short term deposits maturing in less than 90 days. Historically the Corporation has not carried short term investments. Should this change in the future, counterparties will be selected based on credit ratings and management will monitor all investments to ensure a stable return, and complex investment vehicles with higher risk will be avoided.

The carrying amounts of accounts receivable and cash and cash equivalents represent the maximum credit exposure. As at December 31, 2008, the Corporation has a $99,000 allowance for doubtful accounts (2007 - NIL).

Birchcliff's accounts receivables are aged as follows:



----------------------------------------------------------------------------
($000's) 2008 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Current (less than 30 days) 20,175 17,120
30 to 60 days 3,723 1,283
61 to 90 days 4,771 1,146
Over 90 days 1,167 487
----------------------------------------------------------------------------
Total Receivables 29,836 20,036
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Liquidity Risk

Liquidity risk is the risk that the Corporation will not be able to meet its financial obligations as they become due. Birchcliff's approach to managing liquidity is to ensure, as much as possible, that it will have sufficient liquidity to meet its short term and long term financial liabilities when due, under both normal and unusual conditions without incurring unacceptable losses or risking harm to the Corporation's reputation.

The following table lists the contractual maturities of financial liabilities as at December 31, 2008:



----------------------------------------------------------------------------
less than 1 1 - 2 2 - 5
Financial Liability ($000's) Year Years Years Thereafter
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Accounts payable and accrued
liabilities 71,208 - - -
Revolving Credit Facilities(1) - - 211,586 -
----------------------------------------------------------------------------
TOTAL 71,208 - 211,586 -
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) The revolving credit facilities bear interest at a floating rate and
include a $14.2 million working capital facility and a $197.4 million
syndicated credit facility.


Birchcliff prepares annual capital expenditure budgets, which are regularly monitored and updated as considered necessary. Petroleum and natural gas production is monitored weekly and is used to provide monthly current cash flow estimates. To facilitate the capital expenditure program, the Corporation has a revolving reserves-based credit facility, as outlined in Note 7, which is reviewed at least annually by the lender. Birchcliff also attempts to match its payment cycle with collection of petroleum and natural gas revenues.

Market Risk

Market risk is the risk that changes in market prices, such as exchange rates, commodity prices and interest rates, will affect the Corporation's net earnings or the value of financial instruments. The objective of market risk management is to manage and control exposures within acceptable limits, while maximizing returns. These risks are consistent with prior years.

Foreign Currency Risk

Foreign currency risk is the risk that the fair value of future cash flows will fluctuate as a result of changes in foreign currency exchange rates. Birchcliff was exposed to foreign currency fluctuations with respect to its WTI oil option contracts which are denominated in United States dollars. If the US dollar had depreciated 10% against the Canadian dollar with all other variables held constant, Birchcliff's net income and other comprehensive income for year ended December 31, 2008 would have been unchanged (2007 - $679,000) with respect to the US dollar denominated WTI oil price risk management contracts. All risk management contracts were settled as at December 31, 2008.

Commodity Price Risk

Commodity price risk is the risk that the fair value of future cash flows will fluctuate as a result of changes in commodity prices. Significant changes in commodity prices can materially impact the Corporation's borrowing base under its credit facility. Lower commodity prices can also reduce the Corporation's ability to raise capital. Commodity prices for crude oil are impacted by world economic events that dictate the levels of supply and demand. From time to time the Corporation may attempt to mitigate commodity price risk through the use of financial derivatives.

For the year ended December 31, 2008, the realized and unrealized gain (loss) ("total gain (loss)") related to the oil price risk management contracts, recognized in net income, was $3.1 million loss (2007 - $8.6 million loss).

Included in the year ended December 31, 2008 is a net cash outlay of $9.9 million (2007 - $1.9 million) relating to the actual monthly settlements incurred in the period. An unrealized gain of $6.8 million for the period ended December 31, 2008 (2007 - $6.8 million unrealized loss) is also included within the total loss, identified as "unrealized risk management contracts (gain) loss" on the statements of cash flows. The unrealized gain (loss) represents the change in the fair value of the contracts related to expected future settlements.

The fair value of these risk management liabilities at December 31, 2008 was NIL (2007 - $6.8 million). As of December 31, 2008 if WTI crude oil prices had been $1.00 USD higher or lower, with all other variables held constant, the change in the fair value of the risk management contracts would have resulted in net income and other comprehensive income that was $428,000 higher or lower (2007 - $463,000).

Interest Rate Risk

Interest rate risk is the risk that future cash flows will fluctuate as a result of changes in market interest rates. The Corporation is exposed to interest rate cash flow risk on floating interest rate bank debt due to fluctuations in market interest rates. The remainder of Birchcliff's financial assets and liabilities are not exposed to interest rate risk.

As at December 31, 2008 if the interest rate had changed 1% with all other variables held constant, Birchcliff's net income and other comprehensive income would have changed by $1.8 million (2007 - $1.4 million). A sensitivity of 1% is considered reasonable given the current level of the bank prime rate and market expectations for future movements. The Corporation considers this risk to be limited and thus does not hedge its interest rate risk.

The Corporation had no interest rate swaps or financial contracts for the period ended December 31, 2008.

Fair Value of Financial Instruments

Birchcliff's financial instruments are classified as cash and cash equivalents, accounts receivable and other current assets, accounts payable and accrued liabilities, risk management contracts, and revolving credit facilities on the balance sheet.

The carrying value and fair value of these financial instruments at December 31, 2008 is disclosed below by financial instrument category, as well as any related loss and interest expense for the period:



----------------------------------------------------------------------------
Interest
Carrying Fair Expense
Financial Instrument(1)($000's) Value Value Loss(2) (3)
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Assets Held for Trading
Cash and cash equivalents 65 65 - -

Loans and Receivables
Accounts receivable and other
current assets 29,836 29,836 - -

Liabilities Held for Trading
Risk management contracts - - 3,091 -

Other Liabilities
Accounts payable and accrued
liabilities 71,208 71,208 - -
Revolving credit facilities 211,586 211,586 - 10,320

----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) The revolving credit facilities bear interest at a floating rate and
accordingly the fair market value approximates the carrying value before
the carrying value is reduced for the remaining deferred financing
costs. All of the oil price risk management contracts were settled at
December 31, 2008.
(2) Included in the "gain (loss) on risk management contracts" on the
statements of net income (loss) and comprehensive income (loss) and
retained earnings (deficit) are an unrealized gain of $6.8 million and
a realized loss of $9.9 million for the period ended December 31, 2008.
(3) Included in interest expense on the statements of net income (loss) and
comprehensive income (loss) and retained earnings (deficit).


10. FUTURE INCOME TAX

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 29.5% (2007 - 32.12%) to the loss before taxes. The difference results from the following items:



----------------------------------------------------------------------------
($000's) 2008 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Net income (loss) before taxes 43,588 (18,511)
----------------------------------------------------------------------------

Computed expected income tax expense (recovery) 12,858 (5,946)
Increase (decrease) in taxes resulting from:
Non-deductible Crown payments - 433
Non-deductible stock-based compensation 1,639 692
Non-deductible expenses 72 19
Change in rate and other (872) 266
----------------------------------------------------------------------------

Future income tax expense (recovery) 13,697 (4,536)
----------------------------------------------------------------------------
----------------------------------------------------------------------------


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


----------------------------------------------------------------------------
($000's) 2008 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Future income tax liabilities:
Property, plant and equipment (21,338) (6,756)
Future income tax assets:
Asset retirement obligation 5,393 4,896
Share issue costs 3,189 2,806
NCL's, SR&ED's & ITC's(1) 9,321 5,341
----------------------------------------------------------------------------
Net long term asset (liability) (3,435) 6,287

Future income tax assets (short term):
Risk management contracts - 2,004
----------------------------------------------------------------------------
Net short term asset (liability) - 2,004
----------------------------------------------------------------------------
Net future income tax asset (liability) (3,435) 8,291
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) "NCL" = Non Capital Losses; "SR&ED" = "Scientific Research &
Experimental Development"; "ITC" = "Investment Tax Credits"


11. 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, 2008 to be approximately $68 million (2007 - $61 million) which will be incurred between 2009 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:



----------------------------------------------------------------------------
($000's) 2008 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Balance, January 1 18,806 11,270
Obligations incurred 1,778 1,368
Obligations acquired 89 5,919
Changes in estimate 166 (415)
Accretion expense 1,466 1,252
Actual expenditures incurred (1,082) (588)
----------------------------------------------------------------------------
Balance, December 31 21,223 18,806
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----------------------------------------------------------------------------


12. SHARE CAPITAL

Authorized:

Unlimited number of voting common shares

Unlimited number of non-voting 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:



(b) Issued:

----------------------------------------------------------------------------
Number of
Common Shares Amount $
----------------------------------------------------------------------------
----------------------------------------------------------------------------
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 (c)) - (4,770,000)
Issued, net of costs (Note (d)) 30,263,170 108,913,115
Tax effect of share issue costs (Note (e)) - 1,836,500
----------------------------------------------------------------------------
Balance, December 31, 2007 94,554,269 342,818,621

Issued upon exercise of stock options 1,133,925 6,009,537
Issued upon exercise of warrants (Note (f)) 809,933 3,596,103
Issued, net of costs (Note (g)) 15,897,843 123,088,169
Tax effect of share issue costs (Note (h)) - 1,970,000
----------------------------------------------------------------------------
Balance, December 31, 2008 112,395,970 477,482,430
----------------------------------------------------------------------------
----------------------------------------------------------------------------


(c) 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.

(d) 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.

(e) 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.

(f) In January 2008, 809,933 common shares were issued to a former officer in exchange for 809,933 performance warrants with an exercise price of $3.00 for gross proceeds to the Corporation of $2,429,799. In addition, $1,166,304 of non-cash costs attributable to these warrants, which was previously recorded to contributed surplus, was reclassified from contributed surplus to share capital.

(g) On March 14, 2008, Birchcliff issued 1,522,843 flow-through shares at a price of $9.85 per share and 14,375,000 common shares at a price of $8.00 per share for total net proceeds of $123,088,169. As at December 31, 2008, the commitment to spend and renounce $15 million of qualified 100% deductible tax pools with respect to the flow-through shares was fulfilled.

(h) Birchcliff recognized a future income tax benefit of $1,970,000 in respect of share issue costs of $6,911,832 incurred with respect to the issuance of 15,897,843 shares on March 14, 2008.

13. STOCK-BASED COMPENSATION

The Corporation has established a stock-based compensation plan whereby officers, employees, directors and consultants may be granted options to purchase common shares 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, 2008, the Corporation recorded $5.0 million (2007 - $2.2 million) of non-cash stock-based compensation expense and a corresponding increase to contributed surplus related to the issuance of stock options. During the year ended December 31, 2008, the Corporation also recorded cash stock-based compensation expense of $20,000 (2007 - $54,000) 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, 2008 was $3.98 (2007 - $2.32) per option.

At December 31, 2008 the Corporation's Amended and Restated Stock Option Plan permitted the grant of options in respect of 11,239,597 common shares (2007 - 9,455,426). At December 31, 2008, there remained available for issuance options in respect of 4,915,376 common shares (2007 - 4,119,612).

Subsequent to year end in early 2009, 3,193,100 options in respect of common shares were granted to employees and management at fair market value at the time of grant, with an average exercise price of $5.03.

A summary of the changes during the year ended December 31, 2008 and 2007 and the Corporation's outstanding stock options as at December 31, 2008 is presented below:



----------------------------------------------------------------------------
Weighted
Average
Exercise
Number Price ($)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
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
Granted 2,330,000 8.23
Exercised (1,133,925) (3.74)
Forfeited (202,668) (4.75)
Cancelled (5,000) (3.75)
----------------------------------------------------------------------------
Outstanding, December 31, 2008 6,324,221 5.58
----------------------------------------------------------------------------
----------------------------------------------------------------------------


The fair value of each option 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:



----------------------------------------------------------------------------
2008 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Risk-free interest rate 3.1% 4.1%
Expected maturity (years) 5.0 5.0
Expected volatility 52.0% 58.6%
Dividend yield 0% 0%
----------------------------------------------------------------------------
----------------------------------------------------------------------------


A summary of the stock options outstanding and exercisable under the plan at
December 31, 2008 and 2007 are presented below:

----------------------------------------------------------------------------
Awards Outstanding By Range - 2008
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Exercise Price Awards Outstanding Awards Exercisable
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Weighted Weighted
Average Weighted Average Weighted
Remaining Average Remaining Average
Contractual Exercise Contractual Exercise
Low High Quantity Life Price Quantity Life Price
----------------------------------------------------------------------------
$3.00 $ 6.00 3,861,354 2.53 $ 3.93 2,154,394 1.83 $3.61
----------------------------------------------------------------------------
$6.01 $ 9.00 2,016,967 3.95 $ 7.26 162,129 3.11 $6.55
----------------------------------------------------------------------------
$9.01 $12.00 158,100 4.59 $10.68 - - -
----------------------------------------------------------------------------
$12.01 $14.25 287,800 4.50 $13.24 - - -
----------------------------------------------------------------------------
6,324,221 3.13 $ 5.58 2,316,523 1.92 $3.82
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Awards Outstanding By Range - 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Exercise Price Awards Outstanding Awards Exercisable
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Weighted Weighted
Average Weighted Average Weighted
Remaining Average Remaining Average
Contractual Exercise Contractual Exercise
Low High Quantity Life Price Quantity Life Price
----------------------------------------------------------------------------
$3.00 $ 6.00 4,889,148 3.25 $3.78 1,540,968 2.25 $3.40
----------------------------------------------------------------------------
$6.01 $ 7.60 446,666 4.19 $6.46 113,328 2.94 $6.54
----------------------------------------------------------------------------
5,335,814 3.32 $4.00 1,654,296 2.30 $3.62
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Performance Warrants

In January 2005, as part of the Corporation's initial restructuring to become a public entity, the Corporation issued performance warrants with an exercise price of $3.00 to members of its management team as a long term incentive. Each performance warrant entitles the holder to purchase one common share at the exercise price. At December 31, 2008 there were 2,939,732 performance warrants outstanding and exercisable (2007 - 3,749,665).

In order to calculate the compensation expense, the fair value of the performance warrants was 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. Because the performance conditions were fulfilled in 2005, resulting in the performance warrants vesting and the full related expense being recorded in that net income (loss) year, for the year ended December 31, 2008, the Corporation recorded no compensation expense in the statement of net income (loss) relating to stock based compensation for the performance warrants in 2007 and 2008.

A summary of the changes during the year ended December 31, 2008 and the Corporation's outstanding performance warrants as at December 31, 2008 is presented below:



----------------------------------------------------------------------------
Weighted
Average
Exercise
Number Price ($)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Outstanding, December 31, 2006 3,749,665 3.00
Issued - -
Exercised - -
----------------------------------------------------------------------------
Outstanding, December 31, 2007 3,749,665 3.00
Issued - -
Exercised (809,933) (3.00)
----------------------------------------------------------------------------
Outstanding, December 31, 2008 2,939,732 3.00
----------------------------------------------------------------------------
----------------------------------------------------------------------------

----------------------------------------------------------------------------
Date of Grant Number Outstanding Date of Expiry Exercise Number
----------------------------------------------------------------------------
----------------------------------------------------------------------------

January 14, 2005 2,939,732 January 31, 2010 $ 3.00 2,939,732
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Contributed Surplus Continuity

----------------------------------------------------------------------------
$000's $000's
----------------------------------------------------------------------------
----------------------------------------------------------------------------
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
Stock-based compensation expense
- stock options 5,144
Stock-based compensation expense
- forfeiture of stock options (154)
Stock-based compensation expense
- cancellation of stock options 14
-----------
Stock-based compensation expense - total 2008 5,004
Exercise of stock options (2,930)
Cancellation of stock options (20)
----------------------------------------------------------------------------
Balance, December 31, 2008 12,984
----------------------------------------------------------------------------
----------------------------------------------------------------------------


14. PER SHARE INFORMATION

----------------------------------------------------------------------------
2008 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Basic Net income (loss) per share $0.27 ($0.20)
Weighted average shares outstanding 108,986,165 72,156,544
----------------------------------------------------------------------------
Diluted Net income (loss) per share $0.26 ($0.20)
Weighted average shares outstanding 113,092,125 72,156,544
----------------------------------------------------------------------------
----------------------------------------------------------------------------


The weighted average diluted shares outstanding for 2008 includes 108,986,165 (2007 - 72,156,544) weighted average number of shares outstanding, plus the following: 2,031,061 (2007 - NIL) shares related to the dilutive effect of the performance and retention warrants and 2,074,899 (2007 - 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 the same for that period.


15. 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 40% 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):



----------------------------------------------------------------------------
Year $000s
----------------------------------------------------------------------------
----------------------------------------------------------------------------
2009 3,214
2010 3,214
2011 3,214
2012 3,223
2013 3,331
Thereafter 13,045
----------------------------------------------------------------------------
----------------------------------------------------------------------------


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

Flow-Through Shares

In the first quarter of 2008, the Corporation committed to renounce $15 million of exploration expenses pursuant to a flow-through share issue completed on March 14, 2008. Birchcliff has until December 31, 2009 to incur these exploration expenditures. As at December 31, 2008 the Corporation had fulfilled its obligation with respect to the flow-through shares and consequently will not be subject to part XII.6.



16. SUPPLEMENTARY CASH FLOW INFORMATION

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

----------------------------------------------------------------------------
$000's 2008 2007
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Provided by (used in)
Accounts receivable (9,800) (6,535)
Prepaid and other (152) 361
Accounts payable and accrued liabilities 29,993 17,931
----------------------------------------------------------------------------
20,041 11,757
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Operating 2,068 (1,359)
Investing 17,973 13,116
----------------------------------------------------------------------------
20,041 11,757
----------------------------------------------------------------------------
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Forward Looking Statements: This document contains forward-looking statements regarding the business and operations of Birchcliff Energy Ltd. Please see the information and warnings regarding such forward looking statements set forth above in Management's Discussion and Analysis.

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)