Fairborne Energy Ltd.
TSX : FEL

Fairborne Energy Ltd.

March 04, 2008 00:05 ET

Fairborne Energy Ltd. ("Fairborne") Announces 2007 Financial and Operating Results and Reserve Summary

CALGARY, ALBERTA--(Marketwire - March 4, 2008) - Fairborne Energy Ltd. (TSX:FEL):



FINANCIAL AND OPERATING SUMMARY


2007(1) 2006(1) change
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FINANCIAL ($thousands, except per share amounts)
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Petroleum and natural gas sales 213,791 204,129 5%
Funds generated from operations (2) 108,107 112,897 (4%)
Per share - basic $ 1.84 $ 2.39 (23%)
Per share - diluted $ 1.78 $ 2.05 (13%)
Net income 15,034 44,079 (66%)
Per share - basic $ 0.26 $ 0.93 (72%)
Per share - diluted $ 0.25 $ 0.90 (72%)
Exploration and development expenditures 71,959 69,643 3%
Acquisitions, net of dispositions 237,461 22,378 -
Working capital surplus (deficit) (7,467) 7,158 -
Bank indebtedness 86,866 101,156 (14%)
Convertible debentures 92,455 90,302 2%
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OPERATIONS (Units as noted)
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Average production
Natural gas (Mcf per day) 52,899 45,660 16%
Crude oil (bbls per day) 2,480 2,577 (4%)
Natural gas liquids (bbls per day) 490 375 31%
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Total (BOE per day) 11,786 10,562 12%
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Proved and probable reserves (gross)
Natural gas (Bcf) 220.5 165.4 33%
Crude oil (Mbbl) 7,443 7,971 (7%)
Natural gas liquids (Mbbl) 6,525 2,533 158%
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BOE (MBOE) 50,711 38,078 33%
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Netback per BOE ($ per BOE)
Petroleum and natural gas sales (3) 49.95 52.95 (6%)
Royalties (7.93) (8.61) (8%)
Operating expenses (8.96) (9.38) (4%)
Transportation (0.83) (1.38) (40%)
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Operating netback 32.23 33.58 (4%)
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Wells drilled (gross) 62 62 -
Undeveloped land (net acres) 229,933 174,511 32%
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(1) Amounts shown prior to the effective date of the Reorganization are in
respect of the Trust and per share numbers are per unit.
(2) Funds generated from operations is calculated using cash flow from
operations as presented in the consolidated statement of cash flows
before non-cash working capital and asset retirement expenditures.
(3) Excludes unrealized gains and losses on derivatives.


2007 HIGHLIGHTS

- Successful conversion from an oil and gas income trust to an exploration and production corporation in December 2007.

- $100 million equity investment at $7.45 per share by Denham Capital Equity Partners completed concurrent with corporate reorganization.

- Acquisition of Fairquest Energy Limited which added 2,800 BOE per day of production and 11.3 MMBOE of proved plus probable reserves.

- Proved plus probable reserves increased 33% to 50.7 MMBOE at year end 2007

- Total reserve additions in 2007 replaced 394% of production with proved plus probable additions of 16.9 MMBOE.

- Finding and development costs for proved plus probable reserves were $14.94 per BOE, including change in future capital ($14.19 excluding change in future capital).

- Finding, development and acquisition costs for proved plus probable reserves were $18.27 excluding change in future capital ($21.33 per BOE including change in future capital), representing a recycle ratio of 1.76 times based on Fairborne's 2007 average operating netback of $32.23 per BOE.

- 2007 average production increased 12% to 11,786 BOE per day.

- Fourth quarter production averaged 13,005 BOE per day, an increase of 22% from fourth quarter 2006.

- Fairborne drilled 62 (39.1 net) wells resulting in 20 (9.7 net) natural gas wells, 40 (28.0 net) CBM wells and one (1.0 net) crude oil well for an overall success rate of 98%.

- Funds generated from operations was $108.1 million, $1.84 per share with an average operating netback of $32.23 per BOE.

- 2007 operating costs averaged $8.96 per BOE, 4% lower than 2006

SUMMARY OF RESERVES

The Company's independent engineering evaluation, effective December 31, 2007, was prepared by the independent engineering firms of GLJ Petroleum Consultants ("GLJ") and Sproule Associates Ltd. ("Sproule") in accordance with the definitions set out under National Instrument 51-101 Standards of Disclosure for Oil and Gas Activities ("NI 51-101").



SUMMARY OF OIL AND GAS RESERVES
- GROSS (1) AND NET (2) RESERVES (FORECAST PRICES)

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Light/Medium Heavy Natural
Crude Oil Oil Gas Liquids
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Gross Net Gross Net Gross Net
(Mbbl) (Mbbl) (Mbbl) (Mbbl) (Mbbl) (Mbbl)
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Proved reserves
Developed producing 3,574 3,093 16 14 1,850 1,260
Developed non-producing 273 242 - - 338 233
Undeveloped 962 826 376 327 1,529 1,095
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Total Proved 4,809 4,161 393 341 3,718 2,588
Probable 1,982 1,714 260 221 2,808 1,898
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Total Proved plus Probable 6,791 5,875 652 563 6,525 4,486
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Natural Coal Bed 2007
Gas Methane BOE
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Gross Net Gross Net Gross Net
(Bcf) (Bcf) (Bcf) (Bcf) (MBOE) (MBOE)
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Proved reserves
Developed producing 65.3 50.3 18.3 16.0 19,381 15,414
Developed non-producing 7.9 6.2 0.5 0.4 2,013 1,574
Undeveloped 27.0 21.6 16.4 14.1 10,097 8,193
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Total Proved 100.0 78.0 35.3 30.5 31,491 25,182
Probable 73.3 58.2 11.7 10.3 19,219 15,248
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Total Proved plus Probable 173.5 136.3 47.0 40.8 50,711 40,430
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NOTE: May not add due to rounding.
(1) "Gross" reserves means Fairborne's working interest (operating and non-
operating) share before deduction of royalties payable to others and
without including any royalty interest of Fairborne.
(2) "Net" reserves means Fairborne's working interest (operating and non-
operating) share after deduction of royalty obligations plus Fairborne's
royalty interests in reserves.



RECONCILIATION OF GROSS RESERVES (FORECAST PRICES) (1)

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Total Total Proved
Proved Probable plus Probable
Factors (MBOE) (MBOE) (MBOE)
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December 31, 2006 24,475 13,603 38,078
Extensions and improved recovery 3,879 2,055 5,934
Technical revisions 34 (2,394) (2,360)
Discoveries 714 724 1,438
Acquisitions 6,898 5,555 12,453
Dispositions (253) (337) (590)
Economic factors 46 15 61
Production (4,302) - (4,302)
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December 31, 2007 31,491 19,219 50,711
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NOTE: May not add due to rounding
(1) "Gross" reserves means Fairborne's working interest (operating and non-
operating) share before deduction of royalties payable to others and
without including any royalty interest of Fairborne.


NET PRESENT VALUE OF RESERVES, BEFORE INCOME TAXES (5)

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December 31, 2007 Discounted at:
(1),(2),(3),(4)
($thousands) Undiscounted 5% 10% 15% 20%
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Proved reserves
Developed producing 614,504 497,788 423,664 371,900 333,424
Developed non-producing 64,471 49,011 39,152 32,430 27,601
Undeveloped 224,959 153,369 109,472 80,365 59,984
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Total Proved 903,933 700,167 572,289 484,695 421,009
Probable 591,340 350,156 236,455 171,894 130,945
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Total Proved plus
Probable 1,495,273 1,050,324 808,744 656,589 551,954
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NOTE: May not add due to rounding

(1) Utilizing GLJ January 1, 2008 price forecast
(2) As required by NI 51-101, undiscounted well abandonment costs of $19.0
million for total proved reserves and $25.5 million for total proved
plus probable reserves are included in the Net Present Value
determination
(3) Prior to provision of income taxes, interest, debt service charges and
general and administrative expenses. It should not be assumed that the
undiscounted and discounted future net revenues estimated represent
the fair market value of the reserves.
(4) Net present values reflected in the above table have been determined
under the existing Alberta royalty regime, as the New Royalty Framework
as announced by the Government of Alberta has not yet been enacted.
(5) Net present value after income taxes for total proved reserves is
$534.3 million and for total proved plus probable reserves is $709.2
million based on a discount factor of 10%.


CAPITAL EFFICIENCY HIGHLIGHTS - 2007

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Total
Proved
plus
Proved Probable
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Capital costs ($thousands)
Exploration and development (1) 71,959 71,959
Acquisitions, net of dispositions 237,461 237,461
Change in future development costs (1)
Exploration and development 13,925 3,790
Acquisitions, net of dispositions 23,073 48,067
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Reserve additions (MBOE)
Exploration and development 4,674 5,072
Acquisitions, net of dispositions 6,644 11,863
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Finding & development costs, including change in future
capital (1), (2) ($ per BOE) 18.38 14.94
Finding & development costs, excluding change in future
capital (1), (5) ($ per BOE) 15.40 14.19
Finding, development and acquisition costs, including
change in future capital (1), (4), (5) ($ per BOE) 30.61 21.33
Finding development and acquisitions costs, excluding
change in future capital (1), (4), (5) ($ per BOE) 27.34 18.27
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Operating netback (6),(7) ($ per BOE) 32.23 32.23
Finding development and acquisitions costs, excluding
change in future capital (1), (5) ($ per BOE) 27.34 18.27
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Recycle ratio 1.18 1.76
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Reserve additions, including acquisitions and
revisions (MBOE) 11,318 16,934
Total 2007 production (MBOE) 4,302 4,302
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Production replacement ratio 2.6 3.9
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Gross reserves (3) (MBOE) 31,491 50,711
Fourth quarter 2007 production (BOE per day) 13,005 13,005
Annual 2007 production (BOE per day) 11,786 11,786
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Reserve Life Index, using annualized Q4 production (years) 6.6 10.7
Reserve Life Index, using 2007 production (years) 7.3 11.8
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(1) The aggregate of the exploration and development costs incurred in the
most recent financial year and the change during that year in estimated
future development costs generally will not reflect total finding and
development costs related to reserve additions for that year.
(2) Calculated in accordance with NI 51-101 as exploration and development
costs incurred in the year along with the change in estimated future
development costs divided by the applicable reserve additions. In 2006,
F&D costs as calculated in accordance with NI 51-101 were $28.18 per
BOE for proved reserves and $17.45 per BOE for proved plus probable
reserves. F&D costs on a three year average were $23.77 per BOE for
proved reserves and $22.60 per BOE for proved plus probable reserves
(3) Gross reserves means Fairborne's working interest (operating and non-
operating) share before deduction of royalties payable to others and
without including any royalty interest.
(4) Fairborne also calculates finding, development and acquisition ("FD&A")
costs which incorporate both the costs and associated reserve additions
related to acquisitions net of any dispositions during the year. Since
acquisitions can have a significant impact on Fairborne's annual
reserve replacement costs, the Company believes that FD&A costs provide
a more meaningful portrayal of Fairborne's cost structure.
(5) F&D costs, excluding future capital for proved reserves were $27.11 per
BOE in 2006 (proved plus probable - $14.24 per BOE) and $20.16 per BOE
on a three year average (proved plus probable - $18.22 per BOE). FD&A
costs, including future capital for proved reserves were $29.53 per BOE
in 2006 (proved plus probable - $18.73 per BOE) and $29.77 per BOE on a
three year average (proved plus probable - $24.14 per BOE). FD&A costs,
excluding future capital for proved reserves were $28.68 per BOE in
2006 (proved plus probable - $16.00 per BOE) and $25.96 per BOE on a
three year average (proved plus probable - $19.58 per BOE).
(6) Operating netback is calculated by subtracting royalties and operating
costs, including transportation, from revenue.
(7) Excludes unrealized gains and losses on derivatives.


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") was prepared at, and is dated, March 3, 2008. This MD&A is provided by the management of Fairborne Energy Ltd. ("Fairborne" or the "Company") to review 2007 activities and results as compared to the previous year, and should be read in conjunction with the audited consolidated financial statements including notes for the years ended December 31, 2007 and 2006. Additional information relating to Fairborne, including Fairborne's annual information form, is available on SEDAR at www.sedar.com.

NATURE OF BUSINESS: Fairborne Energy Ltd. was incorporated as a private company and commenced active operations in June, 2002. In 2003, Fairborne Energy Ltd. became a publicly traded company. Effective June 1, 2005, Fairborne Energy Ltd. was reorganized resulting in two new entities, Fairquest Energy Limited ("Fairquest"), a publicly traded exploration-focused company, and Fairborne Energy Trust, an open-ended unincorporated investment trust. Effective December 19, 2007, Fairborne Energy Trust was reorganized and converted to Fairborne Energy Ltd., a growth-oriented exploration and production company (the"Reorganization"). If the context requires, reference herein to "Fairborne" also includes a reference to Fairborne Energy Trust prior to the Reorganization.

The Company maintains its head office in Calgary and is engaged in the business of exploring for, developing, acquiring and producing crude oil and natural gas in Western Canada. Fairborne follows a strategy of balancing risk and reward by focusing on opportunities by geographic area and prospect type. Within these selected areas, the Company develops a portfolio of exploration and development prospects in conjunction with an active acquisition strategy.

FORWARD LOOKING STATEMENTS: This MD&A contains forward-looking statements. Management's assessment of future plans and operations, expected production levels, expected royalty rates, transportation costs and operating costs, capital expenditures, and methods of financing capital expenditures may constitute forward-looking statements under applicable securities laws and necessarily involve risks including, without limitation, risks associated with oil and gas exploration, development, exploitation, production, marketing and transportation, loss of markets, volatility of commodity prices, currency fluctuations, imprecision of reserve estimates, environmental risks, competition from other producers, inability to retain drilling rigs and other services, incorrect assessment of the value of acquisitions, failure to realize the anticipated benefits of acquisitions, delays resulting from or inability to obtain required regulatory approvals and ability to access sufficient capital from internal and external sources. As a consequence, the Company's actual results may differ materially from those expressed in, or implied by, the forward-looking statements. Readers are cautioned that the foregoing list of factors is not exhausted. Additional information on these and other factors that could effect the Company's operations and financial results are included in reports on file with Canadian securities regulatory authorities and may be accessed through the SEDAR website (www.sedar.com) or at the Company's website (www.fairborne-energy.com). Furthermore, the forward-looking statements contained in this MD&A are made as at the date of this MD&A and the Company does not undertake any obligation to update publicly or to revise any of the included forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required by applicable securities laws.

NON-GAAP TERMS: This document contains the terms "funds generated from operations", "funds generated from operations per share", "cash flow from operations per share" and "netbacks" which are non-GAAP terms. The Company uses these measures to help evaluate its performance. The Company considers corporate netbacks a key measure as it demonstrates its profitability relative to current commodity prices. The Company considers funds generated from operations a key measure as it demonstrates Fairborne's ability to generate funds necessary to repay debt and to fund future growth through capital investment. Funds generated from operations should not be considered as an alternative to, or more meaningful than, cash flow from operating activities as determined in accordance with Canadian GAAP as an indicator of Fairborne's performance. Fairborne's determination of funds generated from operations may not be comparable to that reported by other companies. The reconciliation between cash flow from operations and funds generated from operations can be found in the statement of cash flows in the consolidated financial statements with funds generated from operations calculated before non-cash working capital and asset retirement expenditures. Fairborne also presents funds generated from operations per share and cash flow from operations per share whereby per share amounts are calculated using weighted average shares outstanding consistent with the calculation of income per share.

BOE CONVERSIONS: Barrel of oil equivalent ("BOE") amounts may be misleading, particularly if used in isolation. A BOE conversion ratio has been calculated using a conversion rate of 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 represent a value equivalency at the wellhead.

RESTRUCTURING AND EQUITY FINANCING

On December 19, 2007, Fairborne Energy Trust (the "Trust") converted into Fairborne Energy Ltd. ("Fairborne" or the "Company"), a growth-oriented, exploration and production company (the "Reorganization"). As a result of the Reorganization, unitholders of the Trust received an equal number of common shares of the Company, which now holds the assets and liabilities previously held, directly or indirectly, by the Trust. Exchangeable shares were exchanged for common shares of the Company based on the exchange ratio on December 18, 2007. The Trust's outstanding convertible debentures bearing a coupon rate of 6.5% and a conversion price of $13.50 were assumed by the Company and are convertible into common shares of the Company with no other changes to the terms.

Concurrent with the closing of the Reorganization, Denham Commodity Partners Fund IV LP ("Denham"), a U.S.-based private equity fund, subscribed for, on a private placement basis, 13.4 million common shares of the Company at a subscription price of $7.45 per share for proceeds of $100 million. The Reorganization and Denham's $100 million investment has significantly improved Fairborne's financial flexibility and has positioned the Company as a natural gas focused exploration and production company.

COMPARATIVE INFORMATION

The Reorganization of Fairborne from a trust to a growth-oriented exploration and production company has been accounted for on a continuity of interest basis and, accordingly, the consolidated financial statements for 2007 and 2006 reflect the financial position, results of operations and cash flows as if the Company had always carried on the business formerly carried on by the Trust. The December 31, 2007 consolidated financial statements reflect the results of operations and cash flows of the Trust and its subsidiaries prior to the Reorganization.

CORPORATE ACQUISITION - FAIRQUEST ENERGY LIMITED ("FAIRQUEST")

On June 4, 2007, the Trust completed the acquisition of Fairquest. As consideration for the acquisition, the Trust issued an aggregate of 15.8 million trust units to Fairquest shareholders and assumed $51.7 million of net debt. In addition, the Trust also issued 4.6 million warrants to acquire an additional 1.8 million trust units in exchange for outstanding Fairquest warrants. Results of operations from Fairquest properties have been included in Fairborne's results beginning June 4, 2007.

The immediate impact of the combination resulted in increased production and cash flow from operations for Fairborne, thereby providing the opportunity to execute a more extensive capital investment program on a broader range of prospects. The combination also provided Fairborne with the unique opportunity to increase its interest in core areas of exploration and development including Columbia/Harlech and West Pembina. Moving forward, the combined resources of Fairborne and Fairquest are significant in terms of development drilling opportunities, undeveloped land, prospects and property enhancement projects.



SELECT ANNUAL INFORMATION

($thousands, except per share amounts) 2007 (1) 2006 (1) 2005
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Petroleum and natural gas sales 213,791 204,129 226,648
Funds generated from operations 108,107 112,897 125,243
Per share - basic $1.84 $2.39 $2.65
Per share - diluted $1.78 $2.05 $2.39
Cash flow from operations (including changes
in working capital) 115,637 107,774 108,880
Per share - basic $1.96 $2.28 $2.31
Per share - diluted $1.90 $1.97 $2.23
Net income 15,034 44,079 43,553
Per share - basic $0.26 $0.93 $0.92
Per share - diluted $0.25 $0.90 $0.89
Total assets 749,715 539,579 499,920
Working capital surplus (deficit) (7,467) 7,158 1,373
Long term financial liabilities
Bank indebtedness 86,866 101,156 136,302
Convertible debentures 92,455 90,302 -
Non-controlling interest - 27,132 27,598
Asset retirement obligation 9,084 10,994 11,386
Future income taxes 45,039 41,592 51,465
Cash distributions per unit $1.07 $1.56 $1.36
Shareholders' equity / unitholders' equity 457,188 200,715 204,359
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(1) Amounts shown prior to the effective date of the Reorganization are in
respect of the Trust and per share numbers are per unit.



The year 2005 was a year of transition for Fairborne. In June 2005, the Trust was established as part of a Plan of Arrangement whereby two new entities were formed, Fairquest, a publicly traded exploration-focused company, and the Trust. As a trust, Fairborne's operations were focused on development projects to generate stable results and consistent distributions for its unitholders. A capital program of $126.3 million included drilling a total of 72 (43.9 net) wells resulting in 32 (26.8 net) coal bed methane wells, 29 (11.1 net) natural gas wells and 11 (6.0 net) oil wells. The Trust recorded $125.2 million in funds generated from operations ($2.65 per unit) and made monthly distributions to unitholders of $0.11 per unit from June through November, with an increase to $0.13 per unit starting with the December 15, 2005 distribution.

In 2006, in its first full year as a trust, the Trust met its objective to maintain stable production, funds generated from operations and distributions to unitholders by focusing on the development of its core properties and using an active commodity price risk management program. In a year marked by volatility in natural gas prices, the Trust recorded $112.9 million in funds generated from operations ($2.39 per unit), of which 65% was distributed to unitholders ($1.56 per unit) through consistent monthly distributions of $0.13 per unit. The balance of funds generated from operations was used, in part, to fund capital expenditures of $92.0 million, which included a property acquisition of $22.4 million. The Trust's capital program was focused on the development of core properties with 62 wells drilled (32.3 net) resulting in 24 (9.7 net) natural gas wells, 30 (17.9 net) coal bed methane ("CBM") wells and five (3.2 net) oil wells. Financing for the remainder of the 2006 capital program was obtained through a combination of bank debt and proceeds from a $100 million convertible debenture financing completed in October 2006.

The year 2007 was a year of repositioning and restructuring for Fairborne. In response to the federal government's announcement to tax trusts beginning in 2011, Fairborne began evaluating alternatives that would add more value for its stakeholders. Effective June 4, 2007 Fairborne acquired Fairquest and added approximately 2,800 BOE per day of production, 11.3 million proved plus probable reserves and over 68,000 net acres of undeveloped land. The Fairquest acquisition provided the Trust with the unique opportunity to increase its interest and participation in exploitation and exploration prospects in its existing areas of focus. In December 2007, Fairborne successfully completed its plan to convert into a growth-oriented, exploration and production company. Concurrent with the closing of the Reorganization, Fairborne completed a private placement equity financing by issuing approximately 13.4 million common shares for aggregate proceeds of $100 million. The restructuring coupled with the equity financing of $100 million significantly improved Fairborne's financial flexibility and positioned the Company as a natural gas focused exploration and production company. Proceeds from the private placement were used to reduce outstanding indebtedness, leaving Fairborne with $86.9 million of bank debt on December 31, 2007 drawn against its current borrowing base of $220 million.

Fairborne recorded $108.1 million in funds generated from operations ($1.84 per share) in 2007, and paid total distributions of $1.07 per unit prior to the Reorganization. As a result of ongoing weak commodity prices for natural gas, Fairborne decreased its monthly distributions from $0.13 per unit to $0.09 per unit, commencing with the March distribution that was paid in April 2007. The last distribution occurred on December 17, 2007 to unitholders of record on November 30, 2007. The balance of funds generated from operations was used primarily to fund capital expenditures of $72.0 million. During 2007, and prior to the Reorganization, Fairborne's capital program was focused on maintaining stable production through the development of its core properties. This program resulted in 62 wells drilled (39.1 net) resulting in 20 (9.7 net) natural gas wells, 40 (28.0 net) CBM wells and one (1.0 net) oil well.



QUARTERLY FINANCIAL INFORMATION

The following is a summary of select financial information for the quarterly
periods indicated:

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2007
Q4 (1) Q3 (1) Q2 (1) Q1 (1)
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FINANCIAL ($thousands, except per
share amounts)

Petroleum and natural gas sales 59,976 54,648 49,501 49,666
Funds generated from operations 29,363 27,164 25,547 26,033
Per share - basic $0.43 $0.41 $0.45 $0.55
Per share - diluted $0.51 $0.38 $0.41 $0.48
Cash flow from operations
(including changes in working
capital) 36,004 24,159 27,724 27,750
Per share - basic $0.53 $0.37 $0.47 $0.59
Per share - diluted $0.61 $0.34 $0.43 $0.52
Net Income (loss) (1,136) 2,271 6,739 7,160
Per share - basic ($0.03) $0.03 $0.11 $0.15
Per share - diluted ($0.03) $0.03 $0.10 $0.15
Total assets 749,715 732,276 753,661 561,906
Working capital surplus (deficit) (7,467) (27,051) 11,594 7,093
Bank indebtedness 86,866 159,834 179,120 119,645
Convertible debentures 92,455 91,933 91,389 90,819
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OPERATIONS

Average production
Natural gas (Mcf per day) 59,194 58,435 48,689 45,060
Crude oil (bbls per day) 2,616 2,600 2,303 2,396
Natural gas liquids (bbls per day) 524 582 449 402
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Total (BOE per day) 13,005 12,921 10,867 10,308
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(1) Amounts shown prior to the effective date of the Reorganization are in
respect of the Trust and per share numbers are per unit.


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2006
Q4 Q3 Q2 Q1
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FINANCIAL ($thousands, except per
unit amounts)

Petroleum and natural gas sales 49,581 48,845 50,914 54,789
Funds generated from operations 26,108 27,825 30,340 28,624
Per unit - basic $0.54 $0.58 $0.65 $0.62
Per unit - diluted $0.43 $0.51 $0.57 $0.54
Cash flow from operations
(including changes in working
capital) 10,189 29,969 38,037 29,579
Per unit - basic $0.21 $0.63 $0.80 $0.64
Per unit - diluted $0.15 $0.55 $0.71 $0.56
Net Income 8,900 10,439 13,881 10,859
Per unit - basic $0.18 $0.22 $0.30 $0.23
Per unit - diluted $0.17 $0.22 $0.28 $0.23
Total assets 539,579 514,681 499,826 522,482
Working capital surplus (deficit) 7,158 (2,395) (3,199) 35
Bank indebtedness 101,156 177,595 147,202 153,933
Convertible debentures 90,302 - - -
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OPERATIONS

Average production
Natural gas (Mcf per day) 46,752 45,966 43,441 46,472
Crude oil (bbls per day) 2,522 2,604 2,607 2,575
Natural gas liquids (bbls per day) 308 376 432 384
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Total (BOE per day) 10,623 10,640 10,280 10,705
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Throughout 2006 and the first two quarters of 2007, Fairborne's production remained stable, with fluctuations from quarter to quarter primarily due to interruptions on sales pipelines and gas facility turnarounds. Production levels increased during the third and fourth quarters of 2007 as a result of the Fairquest acquisition in June 2007 and a successful drilling program throughout 2007.

Fairborne's revenue and funds generated from operations over the past two years have reflected its stable production base with revenue variances from quarter to quarter largely influenced by changes in natural gas prices. During the second quarter of 2006, natural gas prices started to decline which resulted in corresponding decreases in Fairborne's revenues and funds generated from operations. Fairborne's active risk management program helped to stabilize revenues and funds generated from operations throughout 2007. In addition, increased revenues during the third and fourth quarters of 2007 reflected the increase in production levels from the Fairquest acquisition.

The most significant impact to Fairborne's net income over the past two years can be attributed to the acquisition of Fairquest in June 2007. Net income during 2006 declined in response to the overall decline of natural gas prices which began in the second quarter of 2006 and continued through the first half of 2007. During the third quarter of 2007, net income decreased significantly as a result of the Fairquest acquisition which increased the Company's depletable asset base resulting in an increase to the DD&A rates. Net income during the fourth quarter of 2007 decreased from the previous quarter primarily due to the one time corporate reorganization costs of $9.3 million that were incurred as a result of the Reorganization in December 2007. Overall, changes in net income continued to reflect a general increase in DD&A rates due to an increase in Fairborne's depletable asset base as a result of the Fairquest acquisition and accounting for exchangeable shares, whereby the conversion of exchangeable shares resulted in an increase of $19.6 million to depletable assets (2006 - $15.9 million), with no corresponding increase in reserves.

FOURTH QUARTER 2007 RESULTS

Fairborne's average production of 13,005 BOE per day during the fourth quarter of 2007 was 22% higher than average production for the fourth quarter of the previous year (Q4 2006 - 10,623 BOE per day) and was marginally higher than average production during the immediately preceding quarter (Q3 2007 - 12,921 BOE per day). Revenues of $60.0 million for the fourth quarter were 10% higher than the preceding quarter (Q3 2007 - $54.6 million) primarily due to continually increasing oil prices and more favorable natural gas prices as compared to the third quarter of 2007. Fairborne reported a net loss of $1.1 million in the fourth quarter of 2007. The most significant impact on the fourth quarter was the one time costs of $9.3 million associated with the Reorganization in December 2007, all of which were incurred during the fourth quarter.

Fairborne recorded funds generated from operations of $29.4 million ($0.43 per share) during the fourth quarter. Distributions were maintained at $0.09 per unit in October and November, with total distributions for the fourth quarter of $11.8 million. As a result of the Reorganization, the final distribution to unitholders was paid out on December 17, 2007 to unitholders of record on November 30, 2007.

Capital expenditures in the fourth quarter totaled $13.0 million which included $9.1 million for drilling and completions and $3.1 million for well equipment and facilities. Fairborne drilled 11 (4.5 net) wells during the fourth quarter and farmed out two (0.2 net) wells to an industry partner, resulting in eight (2.8 net) CBM wells, two (0.8 net) natural gas wells and one (1.0 net) oil well. The fourth quarter capital program was financed through a combination of debt and funds generated from operations after distributions to unitholders.



PRODUCTION
----------------------------------------------------------------------------
2007 2006 change
----------------------------------------------------------------------------
Natural gas (Mcf per day) 52,899 45,660 16%
Crude oil (bbls per day) 2,480 2,577 (4%)
Natural gas liquids (bbls per day) 490 375 31%
----------------------------------------------------------------------------
Total (BOE per day) 11,786 10,562 12%
Natural gas % of production 75% 72% -
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Fairborne reported average production of 11,786 BOE per day in 2007 which reflected an increase during the second half of the year with completion of the Fairquest acquisition in June 2007. Production from Fairquest properties at the time of the acquisition was approximately 2,800 BOE per day, the vast majority of which was from natural gas and associated liquids.

Natural gas production of 52.9 MMcf per day for 2007 reflected the addition of approximately 14.0 MMcf per day from Fairquest properties during the second half of the year. Several outages and interruptions which negatively impacted production in the second and third quarters of 2007 were offset by the Company's successful development drilling programs in Columbia/Harlech, Clive CBM and Westerose with new production substantially offsetting natural declines.

Crude oil and NGL production of 2,970 bbls per day for 2007 was slightly higher than the 2006 average of 2,952 bbls per day, with natural declines offset by additional volumes added through property acquisitions in the Brazeau area and through the Fairquest acquisition.



COMMODITY PRICES & RISK MANAGEMENT ACTIVITIES
----------------------------------------------------------------------------
2007 2006 change
----------------------------------------------------------------------------
Average Prices
Natural gas ($ per Mcf) (1) 7.16 7.88 (9%)
Crude oil ($ per bbl) (1) 73.57 68.22 8%
Natural gas liquids ($ per bbl) 47.64 49.11 (3%)
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BOE ($ per BOE) (1) 49.60 52.45 (5%)
----------------------------------------------------------------------------
Benchmark Prices
AECO Daily Index (Cdn$ per Mcf) 6.44 6.51 (1%)
AECO Monthly Index (Cdn$ per Mcf) 6.61 6.99 (5%)
WTI - Edmonton par (Cdn$ per bbl) 77.02 73.29 5%
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Excludes unrealized gains and losses on derivatives


Risk Management - Physical Sales Contracts

Fairborne's risk management strategy is based on the following objectives:

- protect shareholder return on investment;

- reduce risk exposure in budgeted annual funds flow projections; and

- help ensure transaction economics on acquisitions.

Natural Gas

In 2007, Fairborne continued to realize above-average natural gas prices due to the higher heat content of the Company's production combined with an active risk management program. An average of 21,515 Mcf per day was sold under fixed price physical sales contracts during 2007 representing 41% of the Company's natural gas production. Risk management activities during 2007 increased the Company's natural gas revenue by $12.9 million which had an effect of increasing Fairborne's realized natural gas price by $0.67 per Mcf to $7.16 per Mcf, an 11% premium to the daily AECO index.

The following table summarizes the outstanding fixed price physical sales contracts for natural gas, including contracts outstanding at December 31, 2007 as well as contracts entered into after December 31, 2007:



----------------------------------------------------------------------------
Q1 Q2 Q3 Q4 Q1
2008 2008 2008 2008 2009
----------------------------------------------------------------------------
Collars
Volume (Mcf per day) 5,455 - - - -
Average floor ($ per Mcf) 8.80 - - - -
Average ceiling ($ per Mcf) 11.17 - - - -
Swaps
Volume (Mcf per day) 15,580 15,830 11,035 9,828 4,545
Average price ($ per Mcf) 8.50 8.22 8.05 8.17 8.82
----------------------------------------------------------------------------
Total volume (Mcf per day) 21,035 15,830 11,035 9,828 4,545
Average floor price ($ per Mcf) 8.58 8.22 8.05 8.17 8.82
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Conversion factor: 1 Mcf = 1.10 GJ


Fairborne has also locked in the AECO basis on 5,000 mmbtu per day at NYMEX less US$0.845 per mmbtu for the second quarter of 2008 and NYMEX less US$0.865 per mmbtu for the third quarter of 2008. These basis swap contracts are accounted for as derivative contracts. The mark-to-market value of these contracts has been recorded as an asset of $12,000 at December 31, 2007.

Crude oil

During 2007, Fairborne had an average of 849 bbls per day of crude oil under fixed price physical sales contracts representing 34% of crude oil production. Risk management activities, including option costs for puts purchased during the year, reduced the Company's crude oil revenue by $1.3 million for the year ($1.39 per bbl). The Company's realized crude oil price of $73.57 per bbl for 2007 represented an increase of 8% from 2006 which reflects the overall increase in average market prices which more than offset the impact of the stronger Canadian dollar throughout most of 2007.

The following table summarizes the outstanding fixed price physical sales contracts on crude oil, including contracts outstanding at December 31, 2007 as well as contracts entered into after December 31, 2007:



----------------------------------------------------------------------------
Q1 Q2 Q3 Q4
2008 2008 2008 2008
----------------------------------------------------------------------------
Collars
Volume (bbl per day) 500 500 1,000 1,000
Average floor ($US per bbl) 70.00 70.00 75.00 75.00
Average ceiling ($US per bbl) 75.60 75.60 87.25 87.25
Swaps
Volume (bbls per day) 500 500 - -
Average price ($US per bbl) 70.70 70.55 - -
----------------------------------------------------------------------------
Total volume (bbls per day) 1,000 1,000 1,000 1,000
Average floor price ($US per bbl) 70.35 70.28 75.00 75.00
----------------------------------------------------------------------------
----------------------------------------------------------------------------


PETROLEUM AND NATURAL GAS REVENUE
----------------------------------------------------------------------------
($thousands except as noted) 2007 2006 change
----------------------------------------------------------------------------
Natural gas 138,269 131,319 5%
Crude oil 66,587 64,168 4%
Natural gas liquids 8,516 6,719 27%
Unrealized loss on derivatives (1,087) - -
Other income 1,506 1,923 (22%)
----------------------------------------------------------------------------
Total 213,791 204,129 5%
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Per BOE $ 49.70 $ 52.95 (6%)
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Fairborne reported revenue of $213.8 million in 2007, representing a 5%
increase compared to 2006. Weaker natural gas prices throughout 2007 were
more than offset by an increase in production from the acquisition of the
Fairquest properties in June 2007.


ROYALTIES
----------------------------------------------------------------------------
($thousands except as noted) 2007 2006 change
----------------------------------------------------------------------------
Crown 25,523 23,790 7%
Freehold and overriding 8,578 9,395 (9%)
----------------------------------------------------------------------------
Total 34,101 33,185 3%
----------------------------------------------------------------------------
Crown (% of revenue) 12.0% 11.7% 3%
Freehold and overriding (% of revenue) 4.0% 4.6% (13%)
----------------------------------------------------------------------------
Total (% of revenue) 16.0% 16.3% (2%)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Per BOE $ 7.93 $ 8.61 (8%)
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Fairborne recorded $34.1 million in royalties in 2007 (2006 - $33.2 million), representing a royalty rate of 16.0% (2006 - 16.3%). Consistent with 2006, Fairborne's realized natural gas price continued to be higher than the reference price utilized in calculating crown royalties due to Fairborne's risk management program. Other factors that contributed to the reduced effective royalty rate for 2007 were increased deductions for allowable operating costs and gas cost allowance as well as deep gas well royalty holidays received on Fairborne's Columbia/Harlech property. In 2008, Fairborne expects royalties to average between 16% and 18% based on new allowable costs deductions and market reference prices.



OPERATING COSTS
----------------------------------------------------------------------------
($thousands except as noted) 2007 2006 change
----------------------------------------------------------------------------
Operating costs
Natural gas 28,630 25,022 14%
Oil and NGLs 9,895 11,160 (11%)
----------------------------------------------------------------------------
Total 38,525 36,182 6%
----------------------------------------------------------------------------
Per BOE $ 8.96 $ 9.38 (4%)
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Fairborne recorded operating costs of $38.5 million in 2007 ($8.96 per BOE) compared to $36.2 million ($9.38 per BOE) in 2006. The decrease in per unit operating costs in 2007 is primarily due to facility equalization credits related to 2005 and 2006, the most significant of which was for a major third party facility in Fairborne's West Pembina area.

Based on current production levels and current service industry costs, Fairborne expects operating costs to average approximately $9.00 per BOE in 2008.



TRANSPORTATION EXPENSES
----------------------------------------------------------------------------
2007 2006 change
----------------------------------------------------------------------------
Transportation costs ($thousands) 3,585 5,313 (33%)
Per BOE $ 0.83 $ 1.38 (40%)
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Fairborne's transportation costs of $3.6 million ($0.83 per BOE) for 2007 include clean oil trucking, trucking of natural gas liquids, certain third party fuel charges and transportation and fuel costs associated with the usage of natural gas pipelines. Transportation costs in 2007 decreased compared to 2006 primarily due to reduced third party fuel usage at Fairborne's Columbia/Harlech property for a portion of the year as well as an accounting adjustment ($0.7 million) recorded in 2007 for transportation costs relating to the periods June 2005 to June 2007.

In 2008, Fairborne expects per BOE transportation costs to average between $1.00 and $1.25.



OPERATING NETBACKS
----------------------------------------------------------------------------
2007

Natural Gas CBM Crude oil
($ per Mcf) ($ per Mcf) ($ per bbl)
----------------------------------------------------------------------------
Petroleum and
natural gas sales (1) 7.31 6.42 73.57
Other income 0.09 - 0.06
Royalty expense (1.19) (0.70) (12.59)
Operating costs (1.66) (0.56) (9.41)
Transportation expense (0.21) - (0.24)
----------------------------------------------------------------------------
Operating netback 4.34 5.16 51.39
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Excludes unrealized loss on derivatives

----------------------------------------------------------------------------
2006

BOE BOE
NGLs Production Production
($ per bbl) ($ per BOE) ($ per BOE) change
----------------------------------------------------------------------------
Petroleum and
natural gas
sales (1) 47.64 49.60 52.45 (5%)
Other income - 0.35 0.50 (30%)
Royalty expense (7.50) (7.93) (8.61) (8%)
Operating costs (7.69) (8.96) (9.38) (4%)
Transportation
expense - (0.83) (1.38) (40%)
----------------------------------------------------------------------------
32.45 32.23 33.58 (4%)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Excludes unrealized loss on derivatives


Fairborne's operating netback of $32.23 for 2007 decreased 4% compared to 2006 reflecting weaker natural gas prices throughout 2007. The impact of reduced commodity prices was partially offset by lower royalties, transportation costs and operating costs in 2007. The operating netback remained strong as a direct result of Fairborne's risk management program and reduced royalty expenses in 2007.



GENERAL AND ADMINISTRATIVE ("G&A") EXPENSES
----------------------------------------------------------------------------
($thousands except as noted) 2007 2006 change
----------------------------------------------------------------------------
G&A expenses, net of recoveries 12,294 7,279 69%
Compensation costs 6,545 5,007 31%
----------------------------------------------------------------------------
Total G&A expenses 18,839 12,286 53%
----------------------------------------------------------------------------
G&A expenses, per BOE $ 2.86 $ 1.89 51%
Compensation costs, per BOE $ 1.52 $ 1.30 17%
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Fairborne recorded $12.3 million (2006 - $7.3 million) of G&A expenses, net of recoveries in 2007, representing $2.86 per BOE (2006 - $1.89 per BOE). Compared to the prior year, G&A costs per BOE have increased by 69% due to reduced overhead recoveries and increased employee compensation costs when compared to the prior year. Throughout all of 2006 and for the first five months of 2007, Fairquest was charged a technical services fee by Fairborne, on a cost recovery basis, in respect of the management, development, exploitation, operations and marketing activities on the basis of relative production and capital expenditures. The Technical Services Agreement was terminated in June 2007, concurrent with the acquisition of Fairquest. In 2007, recoveries of $1.7 million reduced G&A expenses under this agreement compared to a $2.6 million reduction of G&A expenses in the prior year. In addition, G&A for 2007 includes cash bonuses paid to employees in April 2007 as part of 2006 compensation reviews as well as accrued amounts related to employee performance bonuses for 2007.

Compensation expense of $6.5 million in 2007 (2006 - $5.0 million) was 31% higher than the amount expensed during the prior year primarily due to additional Restricted Units and Performance Units issued to employees during 2007 as part of the Company's annual compensation reviews. Compensation expense includes amortization of the fair value of units to be issued pursuant to the Trust Incentive Plan up to the date of the Reorganization as well as amortization of remaining incentive rights.

Concurrent with the Reorganization, Fairborne instituted a cash settled retention award program which is designed to compensate and retain officers, directors, employees and other service providers through cash payments available annually over a three year term. Retention Awards vest annually over a three-year period and expire three years from the date of grant. Upon vesting, the holder is entitled to exercise the awards for cash equal to the amount by which the fair value of a Fairborne common share on the date of exercise exceeds the fair value of a Fairborne common share on the date of grant. Compensation expense associated with this compensation plan is recognized in income over the vesting period of the plan based on the intrinsic value of the plan at each reporting period. Included in compensation expense at December 31, 2007 is $129,000 representing the intrinsic value of vested retention awards.



INTEREST AND FINANCING COSTS
----------------------------------------------------------------------------
($thousands except as noted) 2007 2006 change
----------------------------------------------------------------------------
Interest expense 15,348 9,070 69%
Accretion of convertible debentures 2,153 362 -
----------------------------------------------------------------------------
Total interest and financing costs 17,501 9,432 86%
Per BOE $ 4.07 $ 2.45 66%
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Fairborne recorded $15.3 million in interest expense in 2007, up from $9.1 million in 2006. The increase in interest expense reflects higher interest rates as well as an increase in Fairborne's debt levels throughout most of 2007. Fairborne's debt levels increased by $100 million with the issuance of convertible debentures in October 2006 and with the assumption of $51.7 million of net debt on the acquisition of Fairquest in June 2007. The reduction in debt as a result of the $100 million equity financing did not occur until the end of 2007 resulting in debt of $179.3 million at December 31, 2007 (December 31, 2006 - $191.5 million). Also included in interest and financing costs is the amortization of financing charges associated with the issuance of the convertible debentures. The financing charges recorded in 2007 were significantly higher than the prior year because 2006 only reflected two months of amortization compared to a full year of amortization recorded in 2007. These costs will continue to be expensed over the term of the debentures.

CORPORATE REORGANIZATION COSTS

Upon closing of the Reorganization in December 2007, all Restricted Units and Performance Units vested, with the exception of those held by the Board of Directors, the Chief Executive Officer, the Chief Operating Officer, and the Chief Financial Officer. As a result, the remaining unamortized stock based compensation costs of $6.4 million were included in corporate reorganization costs on the income statement. The Restricted Units and Performance Units that did not vest in December 2007 will follow the predetermined vesting schedule in accordance with the original Incentive Plan; however, holders of the remaining incentive rights will receive Fairborne common shares rather than trust units upon vesting of such incentive rights. Future charges to compensation expense will reflect the amortization of the fair value of the remaining incentive rights.

The Company also incurred $2.9 million of restructuring costs which, together with unit-based compensation expense, have been included in corporate reorganization costs on the consolidated statement of operations.



DEPLETION, DEPRECIATION AND ACCRETION (DD&A)
----------------------------------------------------------------------------
2007 2006 change
----------------------------------------------------------------------------
Depletion, depreciation and accretion
($thousands) 97,050 74,185 31%
Per BOE $ 22.56 $ 19.24 17%
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Fairborne recorded $97.1 million in depletion and depreciation of capital assets and accretion of asset retirement obligations during 2007. On a BOE basis, the DD&A rate of $22.56 per BOE in 2007 was 17% higher than the prior year's rate of $19.24 per BOE. The increase in DD&A rates in 2007 is due to an increase in Fairborne's depletable asset base resulting from several factors: the acquisition of Fairquest assets at their estimated fair market value, and accounting for exchangeable shares, whereby the conversion of exchangeable shares resulted in an increase of $19.6 million to depletable assets (2006 - $15.9 million), with no corresponding increase in reserves.



TAXES
----------------------------------------------------------------------------
($thousands except as noted) 2007 2006 change
----------------------------------------------------------------------------
Future tax reduction (21,433) (15,272) 40%
Capital - 203 -
----------------------------------------------------------------------------
Total taxes (21,433) (15,069) 42%
Per BOE $ (4.98) $ (3.91) 27%
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Fairborne recorded a future tax recovery of $21.4 million in 2007 compared to $15.3 million in 2006. The future tax recovery in both years resulted from interest deductions associated with Fairborne's previous trust structure as well as reductions in rates for both federal and provincial taxes which were enacted during 2006 and 2007. The 40% increase in the future tax recovery in 2007 is consistent with increased interest deductions associated with additional Trust notes issued in late 2006 concurrent with the closing of the convertible debenture financing as well as in June 2007 concurrent with the Fairquest acquisition.

Consistent with completion of the Reorganization, Fairborne is now operating under a corporate structure and, as such, the interest deductions and resulting future tax recoveries will not continue in 2008. Fairborne does not anticipate paying cash income taxes in its operating entities in 2008 as these entities have sufficient tax pools to offset taxable income.

NON-CONTROLLING INTEREST

As a result of the 2005 trust conversion, a subsidiary of the Trust issued 7.0 million exchangeable shares. The exchangeable shares were listed on the Toronto Stock Exchange (trading symbol: FXL), traded separately from the trust units and represented a non-controlling interest to the Trust. The exchangeable shares were recorded as a non-controlling interest of the Trust and were allocated a pro rata share of net income as required by Canadian accounting standards. Concurrent with the Reorganization in December 2007, all remaining exchangeable shares outstanding were exchanged for common shares of Fairborne.

During 2007 and prior to December 19, 1.5 million exchangeable shares (2006 - 1.0 million) were exchanged for 1.9 million trust units (2006 - 1.1 million). As a result of the Reorganization, the remaining 3.1 million exchangeable shares were exchanged for 4.2 million common shares of Fairborne using the exchange ratio in effect on December 18, 2007. The exchange ratio for the retraction of exchangeable shares into trust units was 1:1.35931 at December 18, 2007.



NET INCOME AND FUNDS GENERATED FROM OPERATIONS
----------------------------------------------------------------------------
($thousands except as noted) 2007 (1) 2006(1) change
----------------------------------------------------------------------------
Funds generated from operations 108,107 112,897 (4%)
Per share - basic $ 1.84 $ 2.39 (23%)
Per share - diluted $ 1.78 $ 2.05 (13%)
Cash flow from operations
(including changes in working capital) 115,637 107,774 7%
Per share - basic $ 1.96 $ 2.28 (14%)
Per share - diluted $ 1.90 $ 1.97 (4%)
Net Income 15,034 44,079 (66%)
Per share - basic $ 0.26 $ 0.93 (72%)
Per share - diluted $ 0.25 $ 0.90 (72%)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Amounts shown prior to the effective date of the Reorganization are in
respect of the Trust and per share numbers are per unit.

The following table provides a reconciliation between cash flow from
operations and funds generated from operations.
----------------------------------------------------------------------------
($thousands except as noted) 2007 2006
----------------------------------------------------------------------------
Cash flow from operating activities 115,637 107,774
Change in non-cash working capital (12,313) 3,450
Asset retirement expenditures 4,783 1,673
----------------------------------------------------------------------------
Funds generated from operations 108,107 112,897
----------------------------------------------------------------------------
----------------------------------------------------------------------------


UNIT ANALYSIS

----------------------------------------------------------------------------
2007 2006
($ thousands) ($ per BOE) ($ thousands) ($ per BOE)
----------------------------------------------------------------------------
Petroleum and natural
gas revenue 213,791 49.70 204,129 52.95
Royalties (34,101) (7.93) (33,185) (8.61)
Operating expenses (38,525) (8.96) (36,182) (9.38)
Transportation costs (3,585) (0.83) (5,313) (1.38)
Unrealized loss on
derivatives 1,087 0.25 - -
General & administrative (1) (12,294) (2.86) (7,279) (1.89)
Corporate reorganization
costs (2) (2,918) (0.68) - -
Interest expense (3) (15,348) (3.57) (9,070) (2.35)
Capital taxes - - (203) (0.05)
----------------------------------------------------------------------------
Funds generated from
operations 108,107 25.12 112,897 29.29
Unrealized loss on
derivatives (1,087) (0.25) - -
Compensation expense (6,545) (1.52) (5,007) (1.30)
Compensation expense
- corporate reorganization (6,403) (1.49) - -
Accretion of convertible
debentures (2,153) (0.50) (362) (0.10)
Depletion, depreciation
and accretion (97,050) (22.56) (74,185) (19.24)
Future tax reduction 21,433 4.98 15,272 3.96
Non-controlling interest (1,268) (0.29) (4,536) (1.18)
----------------------------------------------------------------------------
Net income 15,034 3.49 44,079 11.43
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) net of compensation expense (non-cash)
(2) net of compensation expense resulting from the Reorganization (non-cash)
(3) net of accretion on convertible debentures (non-cash)


LIQUIDITY AND CAPITAL RESOURCES

CAPITAL EXPENDITURES

----------------------------------------------------------------------------
($thousands) 2007 2006
----------------------------------------------------------------------------
Exploration and development
Land and lease acquisitions 2,945 2,763
Geological and geophysical 1,391 1,723
Drilling, completions and workovers 41,726 40,594
Well equipment and facilities 25,897 23,989
Corporate assets - 574
----------------------------------------------------------------------------
71,959 69,643
Property acquisitions, net of dispositions 16,035 22,378
Corporate acquisitions 221,426 -
Conversion of exchangeable shares 19,594 15,879
----------------------------------------------------------------------------
Total 329,014 107,900
----------------------------------------------------------------------------
----------------------------------------------------------------------------


During 2007, Fairborne's exploration and development expenditures totaled $72.0 million with an additional $16.0 million spent to increase the Company's interest in the core areas of Brazeau, Columbia/Harlech and Clive. Capital expenditures, including net acquisitions, were financed through a combination of debt, including convertible debentures and bank debt, and funds generated from operations after distributions to unitholders. The Fairquest corporate acquisition, which was completed during the second quarter of 2007, was financed through the issue of 15.8 million trust units and the assumption of $51.7 million of Fairquest's net debt.

Fairborne spent $41.7 million on drilling and completion activities in 2007 with a total of 62 wells (39.1 net) drilled resulting in 20 (9.7 net) natural gas wells, 40 (28.0 net) coal bed methane wells and one (1.0 net) oil well. The majority of 2007 drilling activities were focused on the Trust's Columbia/Harlech and Clive properties, with 11 wells drilled in Columbia/Harlech and 34 CBM wells drilled on Fairborne's Clive property. The remainder of the wells were drilled in various locations across Alberta with six CBM wells drilled on Fairborne's Woodriver property, four wells drilled in the Basset Lake area and three wells drilled in the Deep Basin Pine Creek area. Capital expenditures also included $25.9 million spent on tangible equipment and facilities which included the installation of additional compression at Wild River, Clive and Columbia/Harlech as well as construction of a major pipeline at West Pembina. Exploration expenditures included $2.9 million on land and lease acquisitions and $1.4 million on geophysical programs including a 3D seismic program at the Company's Marlboro/Pine Creek property.

The conversion of exchangeable shares to trust units during the year and in conjunction with the Reorganization in December 2007 was recorded as a $19.6 million (2006 - $15.9 million) acquisition of petroleum and natural gas assets for the year. The addition to petroleum and natural gas assets was based on the market value of Trust units issued on conversion and the carrying value of the non-controlling interest.

WORKING CAPITAL AND BANK INDEBTEDNESS

Fairborne had $86.9 million (2006 - $101.2 million) of bank indebtedness outstanding at December 31, 2007 with a working capital deficit of $7.5 million (2006 - working capital surplus of $7.2 million). The reduction in bank indebtedness from 2006 to the end of 2007 reflects an increase in debt levels associated with 2007 capital expenditures and property acquisitions offset by the $100 million proceeds of the private placement completed in December 2007.

Fairborne's credit facilities at December 31, 2007 included a $205 million extendible revolving term credit facility and a $15 million demand operating credit facility for a total available facility of $220 million. The extendible revolving term facility is available on a revolving basis until May 30, 2008 (364 day facility) at which time it may be extended, at the lenders option. If the revolving period is not extended, the undrawn portion of the facility would be cancelled and the amount outstanding would convert to a 365 day non-revolving term facility. The amounts outstanding under the non-revolving term facility are required to be repaid at the end of the term facility being May 30, 2009. Interest payable on amounts drawn under the facilities is at the prevailing bankers' acceptance rates plus stamping fees, lenders' prime rate or LIBOR rates plus applicable margins, depending on the form of borrowing by the Company. The margins and stamping fees vary from 0% to 1.5% depending on financial statement ratios and the form of borrowing. The credit facilities are secured by a general security agreement and a first ranking floating charge on the assets of the Company. The facility is subject to a semi-annual valuation of Fairborne's petroleum and natural gas assets.

CONVERTIBLE DEBENTURES

On October 31, 2006, Fairborne issued 100,000 Convertible Unsecured Subordinated Debentures (the "Debentures") through a public issue for gross proceeds of $100 million. The Debentures bear interest at a rate of 6.5% per annum, which is payable semi-annually in arrears on December 31 and June 30 of each year and commenced on June 30, 2007. Net proceeds from the issue of the Debentures were initially used to reduce the outstanding indebtedness of Fairborne. As part of the Reorganization, Fairborne assumed all of the covenants and obligations of the Trust under the Debenture Indenture in respect of outstanding Debentures. Following the successful completion of the Reorganization, holders of the Debentures are now entitled to receive Fairborne common shares on conversion of the Debentures rather than units, with no other changes to the terms.

SHAREHOLDERS' EQUITY

The Company is authorized to issue an unlimited number of common shares and an unlimited number of preferred shares, issuable in series.

In 2007, prior to the Reorganization, 1.9 million trust units were issued in exchange for 1.5 million exchangeable shares. As a result of the Reorganization, the remaining 3.1 million exchangeable shares were exchanged for 4.2 million Fairborne common shares. Also as part of the Reorganization in December 2007, 0.9 million trust units were issued to employees and officers of Fairborne on the accelerated vesting of certain remaining Restricted Units and Performance Units. Pursuant to the Reorganization, the Company issued, in aggregate, 70.9 million common shares.

The following table provides a summary of outstanding shares, trust units, exchangeable shares and shares under Incentive Plans at the dates indicated:



----------------------------------------------------------------------------
February 29 December 31 December 31
(thousands) 2008 2007 2006
----------------------------------------------------------------------------
Common shares 84,282 84,282 -
Trust units - - 47,677
Exchangeable shares - - 4,622
Warrants (1) 4,627 4,627 -
Convertible debentures (2) $ 100,000 $ 100,000 $ 100,000
Incentive plans
Restricted Units (3) 176 176 496
Performance Units (4) 356 356 629
Weighted average shares
Basic n/a 58,856 47,244
Diluted n/a 60,729 53,741
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Each warrant entitles the holder to acquire 0.39 of a common share at
an exercise price of $8.13 per common share, exercisable until June 1,
2010.
(2) The convertible debentures are convertible into common shares at a
conversion price of $13.50 per share.
(3) The number of common shares to be issued pursuant to the
Restricted Units will be increased for accumulated distributions up to
the date of the Reorganization.
(4) The number of common shares to be issued pursuant to the
Performance Units will be determined using a multiplier of
0.92 which includes accumulated distributions.


CASH FLOW AND DISTRIBUTIONS

----------------------------------------------------------------------------
($thousands except as noted) 2007 2006
----------------------------------------------------------------------------
Cash flow from operating activities 115,637 107,774
Net Income 15,034 44,079
Cash distributions declared 61,037 73,793
----------------------------------------------------------------------------
Excess of cash flow from operating
activities over cash distributions 54,600 33,981
----------------------------------------------------------------------------
Shortfall of net income over cash distributions (46,003) (29,714)
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Consistent with 2006, for tax purposes, all 2007 distributions are taxable as a return on capital with no return of capital.

During 2007, cash distributions exceeded net income by $46.0 million (2006 - $29.7 million) however net income for the year included $93.1 million of non-cash items (2006 - $68.8 million) that do not impact cash flow from operating activities. Non-cash charges such as DD&A are not representative of the costs of maintaining the Company's productive capacity as they are based on the historical costs of capital assets and not the fair market value of replacing those assets within the context of the current commodity price environment.

Upon the completion of the Reorganization in December 2007, Fairborne became a growth oriented exploration and production company. Fairborne ceased making monthly distributions following the closing of the Reorganization. The final cash distribution was payable on December 17, 2007 to unitholders of record on November 30, 2007. Fairborne does not currently anticipate paying distributions or dividends to its shareholders.

CONTRACTUAL OBLIGATIONS & COMMITMENTS

Fairborne has certain lease commitments for its office premises through to June 2011. As at December 31, 2007, the payments due under these leases is approximately $0.9 million per year (2006 - $0.9 million per year).

Fairborne entered into a three year contractual agreement with a third party drilling company for the use of one of their drilling rigs. The contract has a remaining annual commitment of $4.3 million for each of the years ending December 31, 2008 and 2009.

OFF-BALANCE-SHEET ARRANGEMENTS

Fairborne has no off-balance-sheet arrangements.

BUSINESS ENVIRONMENT AND RISK

The business risks the Company is exposed to are those inherent in the oil and gas industry as well as those governed by the individual nature of Fairborne's operations. Geological and engineering risks, the uncertainty of discovering commercial quantities of new reserves, commodity prices, interest rate and foreign exchange risks, competition and government regulations - all of these govern the businesses and influence the controls and management at the Company. Fairborne manages these risks by:

- attracting and retaining a team of highly qualified and motivated professionals who have a vested interest in the success of the Company;

- operating properties in order to maximize opportunities;

- employing risk management instruments to minimize exposure to volatility of commodity prices, interest rate and foreign exchange rates;

- maintaining a strong financial position; and

- maintaining strict environmental, safety and health practices.

Fairborne continues to evaluate the Alberta government's royalty changes and its impact on both the Company's current reserve base and its future opportunities. Based on publicly available information in respect of the New Royalty Framework and sensitivities conducted by Fairborne's independent reserve evaluators, utilizing the December 31, 2007 reserves of the Company and the external engineer's price forecast at that date, Fairborne estimates the royalty changes, if enacted in their current form, to have the following impact: a 3% to 6% reduction to the net present value of future net reserves from proved plus probable reserves (at a 10% discount rate) and a negligible change to proved plus probable reserves for both gross and net reserves.

The government has stated its intention to consult with industry and review the New Royalty Framework for unintended consequences. Fairborne will continue to monitor government announcements and proposal revisions as they become available.

CRITICAL ACCOUNTING ESTIMATES

DEPLETION AND DEPRECIATION EXPENSE

Fairborne uses the full cost method of accounting for exploration and development activities whereby all costs associated with these activities are capitalized, whether successful or not. The aggregate of capitalized costs, including future development costs, net of certain costs related to unproved properties is subject to amortization as depletion and depreciation expense. Depletion and depreciation expense is calculated on a unit-of-production method based on estimated proved reserves.

The costs of acquiring and evaluating unproved properties are initially excluded from depletion calculations. These properties are assessed periodically to ascertain whether impairment has occurred. When proved reserves are assigned or the property is considered to be impaired, the cost of the property or the amount of impairment is added to the costs subject to depletion.

FULL COST ACCOUNTING CEILING TEST

The carrying value of petroleum and natural gas properties and equipment is reviewed at least annually for impairment. Any impairment would be included as additional depletion and depreciation in the period in which it occurred. The carrying value is based on estimates of proved reserves, production rates, commodity prices, future capital costs, royalty rates and other assumptions. By their nature, these estimates are subject to measurement uncertainty and the effect on the financial statements of changes in such estimates in future periods could be significant.

ASSET RETIREMENT OBLIGATION ("ARO")

Fairborne estimates the fair value of ARO in the period in which it is incurred and records an ARO liability with a corresponding increase in the carrying amount of the related asset. The capitalized amount is depleted on the unit-of-production method based on estimated proved reserves. The liability amount is increased each reporting period due to the passage of time based on an estimated risk-free interest rate, and the amount of accretion is expensed to income in the period.

INCOME TAXES

Fairborne follows the liability method of accounting for income taxes. The determination of the Company's income and other tax liabilities requires interpretation of laws and regulations, which are revised periodically. All tax filings are subject to audit and could be reassessed after a considerable period of time. Future tax assets and liabilities are booked at substantively enacted future income tax rates which include changes over a period of time. The rate used by Fairborne is based on estimated future net revenues, estimated future depletion rates and other assumptions. Accordingly, the actual income tax liability may differ significantly from the amounts estimated and can impact the current and future income tax expense recorded in future periods.

CHANGE IN ACCOUNTING POLICIES

FINANCIAL INSTRUMENTS - RECOGNITION AND MEASUREMENT

On January 1, 2007, the Company adopted the new Canadian accounting standard for financial instruments - recognition and measurement, financial instruments - presentation and disclosures, hedging, comprehensive income and equity. As prescribed by the new standards, prior periods have not been restated.

The financial instruments standard establishes the recognition and measurement criteria for financial assets, financial liabilities and derivatives. Under the new standard, the Company must recognize all financial instruments and non-financial derivatives, including embedded derivatives, on the balance sheet initially at fair value. Measurement in subsequent periods depends on whether the financial instrument has been classified as "held-for-trading", "available-for-sale", "other accounts receivable or payable" or "held-to-maturity" as defined by the standard.

Fairborne manages its exposure to commodity price fluctuations by using physical delivery contracts with fixed prices, collars, puts or participating swaps. Under the new accounting standards, the majority of these contracts have been designated as "normal sale" contracts; therefore, these commodity contracts are not recorded on the balance sheet at fair value. Amounts received on the settlement of the "normal sale" commodity contracts are included in petroleum and natural gas revenue as the contracts settle. Certain of these contracts do not qualify as "normal sale" contracts and, as such, are accounted for as derivative contracts and recorded on the balance sheet at fair value. Changes in the fair value of derivative contracts are recorded in earnings for the corresponding period.

The effect of initially adopting the new financial instruments accounting standard resulted in recognition of a derivative asset of $0.6 million with a corresponding amount recorded as an adjustment to opening retained earnings ($0.4 million net of future income taxes). This adjustment represented the fair market value of the derivative contracts outstanding at January 1, 2007. At December 31, 2007, the estimated fair value of outstanding derivatives was an asset of $12,000, with an unrealized loss of $0.6 million being charged to earnings for the year ended December 31, 2007.

Management did not identify any material embedded derivatives which required separate recognition and measurement under the new accounting standards.

The new accounting standard on hedges had no impact on the Company's financial statements as Fairborne does not apply hedge accounting.

The new accounting standards require a new statement of comprehensive income (loss); however, there are no amounts that Fairborne would include in other comprehensive income except net income.

FINANCIAL INSTRUMENTS - DISCLOSURES

Effective January 1, 2008, Fairborne will be required to provide expanded disclosures in the Company's financial statements with respect to financial instruments. Fairborne will be required to expand its disclosure with respect to the nature and extent of risk arising from the financial instruments and how Fairborne manages those risks.

CAPITAL DISCLOSURES

Effective January 1, 2008, Fairborne will be required to disclose details about the Company's capital and how it is managed. The new standard requires qualitative information about Fairborne's objectives, policies and processes for managing capital and quantitative data about what the Company regards as capital. It also requires disclosure of compliance with any capital requirements that may exist and consequences of any non-compliance.

Fairborne's management is currently assessing the impact that these new requirements will have on the Company's disclosure.

CONTROLS AND PROCEDURES

MANAGEMENT'S EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

Disclosure controls and procedures have been designed to ensure that information required to be disclosed by the Company is accumulated and communicated to Fairborne's management as appropriate to allow timely decisions regarding required disclosure. Fairborne's Chief Executive Officer and Chief Financial Officer have concluded, based on their evaluation as of the end of the period covered by the annual filings, that the Company's disclosure controls and procedures as of the end of such period are effective to provide reasonable assurance that material information related to the Company, including its consolidated subsidiaries, is made known to them by others within those entities, particularly during the period in which the annual filings are being prepared.

INTERNAL CONTROLS OVER FINANCIAL REPORTING

Fairborne's Chief Executive Officer and Chief Financial Officer have designed or caused to be designed under their supervision, internal controls over financial reporting related to the Company, including its consolidated subsidiaries, to provide reasonable assurance regarding the reliability of the Company's financial reporting and the preparation of financial statements for external purposes in accordance with Canadian GAAP.

Fairborne's Chief Executive Officer and Chief Financial Officer are required to cause the Company to disclose herein any change in the Company's internal controls over financial reporting that occurred during the Company's most recent interim period that has materially affected, or is reasonably likely to materially affect, the Company's internal controls over financial reporting. During 2006 and 2007, Fairborne engaged external consultants to assist in documenting and assessing the Company's internal controls over financial reporting. No material changes in the Company's internal controls over financial reporting were identified during the year ended December 31, 2007, that have materially affected, or are reasonably likely to materially affect, the Company's internal controls of financial reporting.

It should be noted that a control system, including the Company's disclosure and internal controls and procedures, no matter how well conceived, can provide only reasonable, but not absolute, assurance that the objectives of the control system will be met and it should not be expected that the disclosure and internal controls and procedures will prevent all errors or fraud.

Financial Reports

MANAGEMENT'S REPORT

TO THE SHAREHOLDERS OF FAIRBORNE ENERGY LTD.

The accompanying consolidated financial statements of Fairborne Energy Ltd. and all the information in this Annual Report are the responsibility of management and have been approved by the Board of Directors.

The consolidated financial statements have been prepared by management in accordance with Canadian generally accepted accounting principles. When alternative accounting methods exist, management has chosen those it deems most appropriate in the circumstances. Financial statements are not precise since they include certain amounts based on estimates and judgments. Management has determined such amounts on a reasonable basis in order to ensure that the consolidated financial statements are presented fairly, in all material respects. The financial information contained elsewhere in this report has been reviewed to ensure consistency with the consolidated financial statements.

Management has established systems of internal controls, which are designed to provide reasonable assurance that assets are safeguarded from loss or unauthorized use and to produce reliable accounting records for the preparation of financial information.

The Board of Directors is responsible for ensuring that management fulfills its responsibilities for financial reporting and internal controls. It exercises its responsibilities primarily through the Audit Committee, which is comprised of independent, non-management directors. The Audit Committee has reviewed the consolidated financial statements with management and the auditors and has reported to the Board of Directors which have approved the consolidated financial statements.

The consolidated financial statements have been audited by KPMG LLP, the external auditors, in accordance with auditing standards generally accepted in Canada on behalf of the shareholders.

STEVEN R. VANSICKLE

President and Chief Executive Officer

AARON G. GRANDBERG

Chief Financial Officer


Calgary, Canada

March 3, 2008



AUDITORS' REPORT


TO THE SHAREHOLDERS OF FAIRBORNE ENERGY LTD.

We have audited the consolidated balance sheets of Fairborne Energy Ltd. as at December 31, 2007 and 2006 and the consolidated statements of operations and retained earnings (deficit) and cash flows for the years then ended. These financial statements are the responsibility of the Company'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 consolidated financial statements present fairly, in all material respects, the financial position of the Company as at December 31, 2007 and 2006 and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles.

KPMG LLP

Chartered Accountants

Calgary, Canada

March 3, 2008




Consolidated Financial Statements

CONSOLIDATED BALANCE SHEETS

As at December 31,

----------------------------------------------------------------------------
($thousands) 2007 2006
----------------------------------------------------------------------------

Assets
Current assets
Cash and cash equivalents $ 116 $ 764
Accounts receivable 45,485 70,804
Prepaid expenses and deposits 6,015 3,278
----------------------------------------------------------------------------
51,616 74,846
Petroleum and natural gas properties and equipment
(Note 5) 681,929 448,563
Goodwill 16,170 16,170
----------------------------------------------------------------------------
$ 749,715 $ 539,579
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Liabilities
Current liabilities
Accounts payable and accrued liabilities $ 59,083 $ 61,490
Distributions payable - 6,198
----------------------------------------------------------------------------
59,083 67,688
Bank indebtedness (Note 6) 86,866 101,156
Convertible debentures (Note 7) 92,455 90,302
Non-controlling interest (Note 8) - 27,132
Asset retirement obligation (Note 9) 9,084 10,994
Future income taxes (Note 10) 45,039 41,592

Shareholders' Equity
Common shares (Note 11) 445,105 -
Trust units (Note 11) - 216,575
Warrants (Note 11) 2,857 -
Equity component of convertible debentures (Note 7) 5,581 5,581
Contributed surplus (Note 11) 3,294 4,694
Retained earnings (deficit) (Note 3) 351 (26,135)
----------------------------------------------------------------------------
457,188 200,715
----------------------------------------------------------------------------

Commitments (Note 14)
$ 749,715 $ 539,579
----------------------------------------------------------------------------
----------------------------------------------------------------------------
See accompanying notes to the consolidated financial statements.



Approved on behalf of the Board:

ROBERT B. HODGINS

Director

RICHARD A. WALLS

Director



CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS (DEFICIT)

For the years ended December 31,

----------------------------------------------------------------------------
($thousands except per share amounts) 2007 2006
----------------------------------------------------------------------------

Revenue
Petroleum and natural gas $ 213,791 $204,129
Royalties (34,101) (33,185)
----------------------------------------------------------------------------
179,690 170,944

Expenses
Operating 38,525 36,182
Transportation 3,585 5,313
General and administrative 18,839 12,286
Interest 17,501 9,432
Corporate reorganization costs (Note 3) 9,321 -
Depletion, depreciation and accretion 97,050 74,185
----------------------------------------------------------------------------
184,821 137,398
----------------------------------------------------------------------------
Income (loss) before taxes (5,131) 33,546
Taxes (Note 10)
Future tax reduction (21,433) (15,272)
Capital - 203
----------------------------------------------------------------------------
(21,433) (15,069)
----------------------------------------------------------------------------
Net Income before non-controlling interest 16,302 48,615
Non-controlling interest (Note 8) 1,268 4,536
----------------------------------------------------------------------------
Net income 15,034 44,079
Retained earnings (deficit), beginning of year (26,135) 3,579
Retained earnings adjustment, financial instruments
(Note 2) 406 -
Reclassification of deficit pursuant to Reorganization
(Note 3) 72,083 -
Distributions declared (61,037) (73,793)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Retained earnings (deficit), end of year $ 351 $(26,135)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Net income per share (Note 11)
Basic $ 0.26 $ 0.93
Diluted $ 0.25 $ 0.90
----------------------------------------------------------------------------
----------------------------------------------------------------------------
See accompanying notes to the consolidated financial statements.



CONSOLIDATED STATEMENTS OF CASH FLOWS

For the years ended December 31,


----------------------------------------------------------------------------
($thousands) 2007 2006
----------------------------------------------------------------------------

Cash provided by (used in):
Operating activities
Net income $ 15,034 $ 44,079
Items not involving cash:
Depletion, depreciation and accretion 97,050 74,185
Non-controlling interest 1,268 4,536
Compensation expense 6,545 5,007
Future tax reduction (21,433) (15,272)
Accretion of convertible debentures 2,153 362
Corporate reorganization costs (Note 3) 6,403 -
Unrealized loss on derivatives 1,087 -
Asset retirement expenditures (4,783) (1,673)
----------------------------------------------------------------------------
103,324 111,224
Change in non-cash working capital 12,313 (3,450)
----------------------------------------------------------------------------
115,637 107,774

Financing activities
Issuance of common shares, net of costs 100,111 -
Distributions to unitholders (67,235) (73,627)
Bank indebtedness (14,290) (35,146)
Convertible debentures, net of costs - 95,521
Change in non-cash working capital (Note 4) (32,372) -
----------------------------------------------------------------------------
(13,786) (13,252)
----------------------------------------------------------------------------
Investing activities
Expenditures on petroleum and natural gas properties (71,959) (69,643)
Acquisition of petroleum and natural gas properties (16,035) (22,378)
Corporate acquisition costs (Note 4) (2,500) -
Change in non-cash working capital (12,005) (1,954)
----------------------------------------------------------------------------
(102,499) (93,975)
----------------------------------------------------------------------------
Change in cash and cash equivalents (648) 547
Cash and cash equivalents, beginning of year 764 217
----------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 116 $ 764
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Interest paid $ 16,233 $ 7,829
Capital taxes paid $ - $ 921
----------------------------------------------------------------------------
----------------------------------------------------------------------------
See accompanying notes to the consolidated financial statements.


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the Years Ended December 31, 2007 and 2006

(tabular amounts are stated in thousands and thousands of dollars except per share amounts)

NATURE OF OPERATIONS

Fairborne Energy Ltd. (the "Company" or "Fairborne") is engaged in the exploration for, and the development and production of natural gas, natural gas liquids and crude oil in Western Canada. The Company resulted from a reorganization effective December 19, 2007 as part of a Plan of Arrangement involving, among others, Fairborne Energy Trust (the "Trust"), Fairborne and the securityholders of the Trust ("Reorganization").

Pursuant to the Reorganization, the Trust was restructured from an open-end unincorporated trust to Fairborne Energy Ltd., a publicly traded exploration and development corporation. Unitholders of the Trust received an equal number of common shares of Fairborne which holds the assets and liabilities previously held, directly or indirectly, by the Trust. Exchangeable shares of the Trust were exchanged for common shares of the Company at the current exchange ratio in effect on December 18, 2007.

The reorganization to a corporation has been accounted for on a continuity of interest basis and accordingly, the consolidated financial statements for 2007 and 2006 reflect the financial position, results of operations and cash flows as if the Company had always carried on the business formerly carried on by the Trust.

1. SIGNIFICANT ACCOUNTING POLICIES

a) BASIS OF PRESENTATION

The consolidated financial statements of the Company have been prepared by management in accordance with generally accepted accounting principles in Canada and they include the accounts of the Company and its wholly owned subsidiaries. All inter-company transactions have been eliminated.

b) PETROLEUM AND NATURAL GAS OPERATIONS

The Company follows the full cost method of accounting for petroleum and natural gas properties and facilities whereby all costs associated with the exploration for and development of petroleum and natural gas reserves are capitalized. Such costs include land acquisition costs, geological and geophysical costs, lease rental costs on non-producing properties, costs of both productive and unproductive drilling and production equipment. Gains or losses are not recognized upon disposition of petroleum and natural gas properties unless crediting the proceeds against accumulated costs would result in a change in the depletion rate of 20% or more.

The accumulated costs, less the costs of unproved properties, are depleted and depreciated using the unit-of-production method based on total proved reserves before royalties as determined by independent evaluators. Natural gas reserves and production are converted into equivalent barrels of oil based upon the estimated relative energy content.

The costs of acquiring and evaluating unproved properties are initially excluded from depletion calculations. These properties are assessed periodically to ascertain whether impairment has occurred. When proved reserves are assigned or the property is considered to be impaired, the cost of the property or the amount of impairment is added to the costs subject to depletion.

The Company places a limit on the carrying value of petroleum and natural gas properties and equipment, which may be depleted against revenues of future periods (the "ceiling test"). The carrying value is assessed to be recoverable when the sum of the undiscounted cash flows expected from the production of proved reserves, the lower of cost and market of unproved properties and the cost of major development projects exceeds the carrying value. When the carrying value is not assessed to be recoverable, an impairment loss is recognized to the extent that the carrying value of assets exceeds the sum of the discounted cash flows expected from the production of proved and probable reserves, the lower of cost and market of unproved properties and the cost of major development projects. The cash flows are estimated using expected future product prices and costs and are discounted using a risk-free interest rate.

Repairs and maintenance are expensed as operating costs as incurred.

c) ASSET RETIREMENT OBLIGATION ("ARO")

The Company recognizes the fair value of ARO in the period in which it is incurred when a reasonable estimate of the fair value can be made. The fair value of the estimated ARO is recorded as a liability, with a corresponding increase in the carrying amount of the related asset. The capitalized amount is depleted on the unit-of-production method based on proved reserves. The liability amount is increased each reporting period due to the passage of time and the amount of accretion is expensed to income in the period. Actual costs incurred upon the settlement of the ARO are charged against the ARO.

d) JOINT ARRANGEMENTS

Substantially all of the Company's oil and gas exploration and development activities are conducted jointly with others and, accordingly, the financial statements reflect only the Company's proportionate interest in such activities.

e) GOODWILL

The Company records goodwill relating to acquisitions when the total purchase price exceeds the fair value of the net identifiable assets and liabilities acquired. Goodwill is assessed for impairment annually at year-end or if events occur that could result in an impairment. Impairment is recognized if the estimated fair value of the Company is less than the book value of the Company. If the fair value of the Company is less than the book value, impairment is measured by allocating the fair value to the identifiable assets and liabilities as if the Company had been acquired for a purchase price equal to its fair value. The excess of the fair value of the Company over the amounts assigned to the assets and liabilities is the fair value of the goodwill. Any excess of the book value of goodwill over this implied fair value of goodwill is the impairment amount. Impairment is charged to income in the period in which it occurs.

f) FINANCIAL INSTRUMENTS

Financial instruments may be utilized by the Company to manage its exposure to commodity price fluctuations and foreign currency exposures. The Company's practice is not to utilize financial instruments for trading or speculative purposes.

Fairborne recognizes all financial instruments, including embedded derivatives, on the balance sheet initially at fair value. Measurement in subsequent periods depends on whether the financial instrument has been classified as "held-for-trading", "available-for-sale", "other accounts receivable or payable" or "held-to-maturity".

Cash and cash equivalents and certain non-financial derivative contracts, as discussed below, are classified as held for trading. All of Fairborne's other financial instruments have been designated as other accounts receivable or payable. Fairborne has not elected to designate any financial instruments as held for trading.

Fairborne manages its exposure to commodity price fluctuations by using physical delivery contracts with fixed prices, collars, puts or participating swaps. The majority of these contracts have been designated as "normal sale" contracts; therefore, these commodity contracts are not recorded on the balance sheet at fair value. Amounts received on the settlement of the commodity contracts are included in petroleum and natural gas revenue as the contracts settle. Certain of these contracts do not qualify as "normal sale" contracts and, as such, are accounted for as derivative contracts and recorded on the balance sheet at fair value. Changes in the fair value of derivative contracts are included in oil and natural gas revenue for the corresponding period.

Transaction costs associated with Fairborne's financial instruments are shown net of the related financial instrument and accreted using the effective interest rate method.

g) EQUITY BASED COMPENSATION

Prior to the Reorganization, the Trust had a Trust Incentive Plan which included granting of restricted trust units ("Restricted Units") and performance trust units ("Performance Units") to directors, officers, employees and consultants and other service providers to the Trust and its subsidiaries. The Plan was modified as part of the Reorganization as described in Note 11(e).

Compensation expense associated with the equity based compensation plan is recognized in income over the vesting period of the plan with a corresponding increase in contributed surplus. Compensation expense is based on the fair value of the equity based compensation at the date of the grant. The amount of non-cash compensation expense recognized in contributed surplus is recorded as an increase in shareholders' equity when equity based compensation plans are exercised.

In 2007, the Company instituted a retention award plan which is described in Note 11(f). The intrinsic value of vested cash settled compensation awards is calculated at each reporting period and recorded as a liability. Compensation expense associated with the liability based compensation plan is recognized in income over the vesting period of the plan based on the intrinsic value of the plan at each reporting period. Cash payments on exercise of liability based compensation plans are recorded as a reduction in the liability at the exercise date.

h) INCOME TAXES

Fairborne uses the liability method of accounting for future income taxes. Under the liability method, future income tax assets and liabilities are determined based on "temporary differences" (differences between the accounting basis and the tax basis of the assets and liabilities), and are measured using the substantively enacted tax rates and laws expected to apply when these differences reverse. A valuation allowance is recorded against any future income tax assets if it is more likely than not that the asset will not be realized. Tax benefits associated with tax uncertainties, if any, are recognized to the extent it is probable that they will be sustained.

Prior to the Reorganization in December 2007, the Trust was a taxable trust under the Canadian Income Tax Act. In June 2007, legislation was enacted which will result in distributions from flow-through entities, like the Trust, being taxed at a rate of approximately 30%. As such, the Trust was required to recognize future income tax assets and liabilities in 2007 pertaining to temporary differences at the trust level. The Trust did not have any significant future income tax assets or liabilities at the trust level, therefore, the SIFT tax did not result in a significant future tax expense or recovery being recognized in the 2007 consolidated financial statements.

i) CORPORATE ASSETS

Corporate assets are stated at cost. Depreciation is provided on a declining balance basis at a rate of 20%.

j) CASH AND CASH EQUIVALENTS

The Company considers cash and short term deposits with original maturities of three months or less as cash and cash equivalents.

k) MEASUREMENT UNCERTAINTY

The preparation of financial statements in conformity with Canadian generally accepted accounting principles requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and revenue and expenses for the period then ended. Actual results could differ from those estimates.

The amount recorded for depletion is based on the estimates of reserve volumes and ARO is based on estimated costs and timing of expenditures. The ceiling test calculation is based on estimates of proved and probable reserves, production rates, petroleum and natural gas prices, future costs and relevant assumptions. By their nature, these estimates are subject to measurement uncertainty and may impact the consolidated financial statements of future periods.

l) PER SHARE INFORMATION

Basic per share amounts, and prior to the Reorganization, per unit amounts, are calculated using the weighted average number of shares/units outstanding during the year. Diluted per share/unit amounts are calculated using the treasury stock method which is based on shares/units that would be issued under the Company's incentive plans. The dilutive effect of convertible debentures is calculated using the if-converted method which is based on the number of shares/units issuable on conversion of outstanding convertible debentures. In addition, in calculating diluted net income per share/unit, net income is increased by the interest on the convertible debentures and accretion of the convertible debenture discount.

m) REVENUE RECOGNITION

Revenue from the sale of oil and natural gas is recognized when the product is delivered and collection is reasonably assured. Revenue from processing and other miscellaneous sources is recognized upon completion of the relevant service.

n) COMPARATIVE NUMBERS

Certain of the comparative numbers have been restated to conform to the current year presentation.

2. CHANGES IN ACCOUNTING POLICIES AND PRACTICES

On January 1, 2007, Fairborne adopted the new Canadian accounting standards pertaining to financial instruments - recognition and measurement, financial instruments - presentation and disclosures, hedging and comprehensive income as described in Note 1(f). As prescribed by the new standards, prior periods have not been restated.

The effect of initially adopting the new financial instruments accounting standard resulted in recognition of a derivative asset of $0.6 million ($0.4 million net of tax) with a corresponding amount recorded as an adjustment to opening retained earnings. This adjustment represented the fair market value of the derivative contracts outstanding at January 1, 2007. At December 31, 2007, the estimated fair value of outstanding derivatives was an asset of $12,000 resulting in an unrealized loss of $0.6 million being included in oil and natural gas revenue for the year ended December 31, 2007.

Management did not identify any material embedded derivatives which required separate recognition and measurement under the new accounting standards.

The new accounting standard on hedges had no impact on the Company's financial statements as Fairborne does not apply hedge accounting.

The new accounting standards require a statement of other comprehensive income; however, there are no amounts that Fairborne would include in other comprehensive income except net income.

FINANCIAL INSTRUMENTS - DISCLOSURES

Effective January 1, 2008, Fairborne will be required to provide expanded disclosures in the Company's financial statements with respect to financial instruments. Fairborne will be required to expand its disclosures with respect to the nature and extent of risk arising from the financial instruments and how Fairborne manages those risks.

CAPITAL DISCLOSURES

Effective January 1, 2008, Fairborne will be required to disclose details about the Company's capital and how it is managed. The new standard requires qualitative information about Fairborne's objectives, policies and processes for managing capital and quantitative data about what the Company regards as capital. It also requires disclosure of compliance with any capital requirements that may exist and consequences of any non-compliance.

3. RESTRUCTURING AND EQUITY FINANCING

Pursuant to a Plan of Arrangement effective December 19, 2007, the Trust was reorganized into Fairborne Energy Ltd., an exploration and production company. As a result of the Reorganization, unitholders of the Trust received common shares of the Company, which now holds the assets and liabilities previously held, directly or indirectly, by the Trust. The Trust's outstanding convertible debentures bearing a coupon rate of 6.5% and a conversion price of $13.50 were assumed by the Company and became convertible into common shares of the Company with no other change in the terms.

As part of the Reorganization, the 3.1 million outstanding exchangeable shares were exchanged for 4.2 million common shares based on the exchange ratio of 1:1.35931 on December 18, 2007 (Note 8). In addition, 0.9 million trust units were issued on the accelerated vesting of certain rights under the Trust Incentive Plan. In aggregate, a total of 70.9 million common shares were issued by the Company, in exchange for all outstanding trust units and all outstanding exchangeable shares on the closing date of the Reorganization.

Pursuant to the Reorganization, the Board of Directors, the Chief Executive Officer, the Chief Operating Officer, and the Chief Financial Officer all waived their rights to accelerated vesting of an aggregate of 175,711 Restricted Units and 356,275 Performance Units outstanding under the Trust Incentive Plan. These units continue to follow the predetermined vesting schedule in accordance with the original Trust Incentive Plan; however, holders of the remaining incentive rights will receive Fairborne common shares rather than trust units upon vesting of such incentive rights (Note 11(e)).

All remaining Restricted Units and Performance Units outstanding under the Trust Incentive Plan vested as part of the Reorganization. As a result, the remaining unamortized stock based compensation costs of $6.4 million were charged to earnings. The Company also incurred $2.9 million of restructuring costs, which together with unit-based compensation expense, has been included in the corporate reorganization costs on the consolidated statement of operations. Also pursuant to the Reorganization, stated capital was reduced by the deficit balance of $72.1 million.

Concurrent with the closing of the Reorganization, a U.S.-based private equity fund subscribed for, on a private placement basis, 13.4 million common shares of the Company at a subscription price of $7.45 per share for aggregate proceeds of $100 million.

4. ACQUISITIONS

On June 4, 2007, the Trust acquired all of the outstanding shares of Fairquest Energy Ltd. ("Fairquest") pursuant to a plan of arrangement under the Business Corporations Act (Alberta) and an Arrangement Agreement dated March 11, 2007. Fairquest was a publicly traded oil and gas company with properties located in western Canada. As consideration for the transaction, Fairquest shareholders received 0.39 of a trust unit for each Fairquest common share held. The Trust issued 15.8 million units to acquire Fairquest at a deemed value of $145 million, based on the trading price of trust units on or about the date the acquisition was announced. The Trust also issued 4.6 million warrants to acquire an additional 1.8 million trust units in exchange for outstanding Fairquest warrants. The acquisition has been accounted for using the purchase method. The results of operations for Fairquest have been included in Fairborne's financial statements beginning June 4, 2007. Details of the acquisition are as follows:



----------------------------------------------------------------------------
Cost of Acquisition:
Trust units $ 144,801
Transaction costs 2,500
Warrants 2,879
----------------------------------------------------------------------------
$ 150,180
----------------------------------------------------------------------------
Allocated:
Current assets $ 9,373
Petroleum and natural gas properties and equipment 221,426
Current liabilities (61,096)
Asset retirement obligations (1,471)
Future income taxes (18,052)
----------------------------------------------------------------------------
$ 150,180
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Included in current assets acquired was $1.1 million receivable from the Trust and included in current liabilities was $50.1 million payable to the Trust. The total amount payable to the Trust included a $32.7 million advance received from the Trust to repay amounts outstanding under Fairquest's credit facilities which were due prior to the date of acquisition (May 30, 2007).



5. PETROLEUM AND NATURAL GAS PROPERTIES AND EQUIPMENT

----------------------------------------------------------------------------
2007 2006
----------------------------------------------------------------------------
Petroleum and natural gas properties
and equipment $ 974,780 $ 645,350
Accumulated depletion and depreciation (294,701) (199,111)
Corporate assets 3,672 3,672
Accumulated depreciation (1,822) (1,348)
----------------------------------------------------------------------------
$ 681,929 $ 448,563
----------------------------------------------------------------------------
----------------------------------------------------------------------------


As at December 31, 2007, future development costs of $126.0 million (2006 - $90.0 million) were included in the depletion calculation and costs of acquiring unproved properties in the amount of $50.0 million (2006 - $20.7 million) were excluded from the depletion calculation. Included in Fairborne's petroleum and natural gas properties and equipment balance is $5.4 million (2006 - $5.9 million) relating to asset retirement obligation, net of accumulated depletion.

Fairborne performed a ceiling test calculation at December 31, 2007 and December 31, 2006 to assess the recoverable value of petroleum and natural gas properties and equipment. The oil and gas future prices for the December 31, 2007 ceiling test are based on the January 1, 2008 commodity price forecast of our independent reserve evaluators. The following table summarizes the benchmark prices used in the ceiling test calculation. Based on these assumptions, the undiscounted value of future net revenues from Fairborne's proved reserves exceeded the carrying value of petroleum and natural gas properties and equipment at December 31, 2007.



Edmonton
WTI Foreign Light
Oil Exchange Crude Oil AECO Gas
Year ($U.S./bbl) Rate ($Cdn/bbl) ($Cdn/mmbtu)
----------------------------------------------------------------------------

2008 92.00 1.00 91.10 6.75
2009 86.28 1.00 85.39 7.55
2010 80.74 1.00 79.87 7.60
2011 77.27 1.00 76.42 7.60
2012 75.76 1.00 74.92 7.60
2013 74.27 1.00 73.46 7.60
2014 72.81 1.00 72.01 7.80
2015 71.39 1.00 70.60 7.97
2016 70.00 1.00 69.23 8.14
2017 70.00 1.00 69.25 8.31
2018 70.00 1.00 69.25 8.48
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Escalate thereafter 2.0% per year


6. BANK INDEBTEDNESS

At December 31, 2007 the Company had a $205 million extendible revolving term credit facility and a $15 million demand operating credit facility available from a syndicate of Canadian chartered banks, subject to the banks' semi-annual valuation of Fairborne's petroleum and natural gas properties. The extendible revolving term facility is available on a revolving basis until May 30, 2008 (364 day facility) at which time it may be extended, at the lenders option. If the revolving period is not extended, the undrawn portion of the facility would be cancelled and the amount outstanding would convert to a 365 day non-revolving term facility. The amounts outstanding under the non-revolving term facility are required to be repaid at the end of the term facility being May 30, 2009. Interest payable on amounts drawn under the facilities is at the prevailing bankers' acceptance rates plus stamping fees, lenders' prime rate or LIBOR rates plus applicable margins, depending on the form of borrowing by the Company. The margins and stamping fees vary from 0% to 1.5% depending on financial statement ratios and the form of borrowing. The credit facilities are secured by a general security agreement and a first ranking floating charge on the assets of the Company. At December 31, 2007, letters of credit totaling $0.6 million were outstanding.

7. CONVERTIBLE DEBENTURES

The following tables set forth a reconciliation of the convertible debentures for the years ended December 31, 2007 and 2006:



----------------------------------------------------------------------------
Number of Debt Equity
2007 Debentures Component Component
----------------------------------------------------------------------------

Balance, beginning of year 100,000 $ 90,302 $ 5,581
Accretion - 2,153 -
----------------------------------------------------------------------------
Balance, end of year 100,000 $ 92,455 $ 5,581
----------------------------------------------------------------------------
----------------------------------------------------------------------------


----------------------------------------------------------------------------
Number of Debt Equity
2006 Debentures component component
----------------------------------------------------------------------------

Issued on October 31, 2006 100,000 $ 94,419 $ 5,581
Debt issue costs - (4,479) -
Accretion - 362 -
----------------------------------------------------------------------------
Balance, end of year 100,000 $ 90,302 $ 5,581
----------------------------------------------------------------------------
----------------------------------------------------------------------------


On October 31, 2006, the Trust issued 100,000 Convertible Unsecured Subordinated Debentures for gross proceeds of $100 million. Pursuant to the Reorganization, Fairborne assumed the liability for the convertible debentures and the debentures became convertible into common shares of Fairborne at the same conversion price in effect prior to the Reorganization. The debentures bear interest at a rate of 6.5% per annum, which is payable semi-annually in arrears on December 31 and June 30 of each year commencing June 30, 2007. The debentures have a face value of $1,000 per debenture and mature on December 31, 2011. The debentures can be converted into common shares of Fairborne at any time at the option of the holders at a conversion price of $13.50 per share. After December 31, 2009 and prior to December 31, 2010, the Company will have the right to redeem all or a portion of the debentures at a price of $1,050 plus accrued and unpaid interest. After December 31, 2010 and prior to the maturity date, the debentures will be redeemable in whole or in part at the option of the Company at a redemption price of $1,025 plus accrued and unpaid interest.

As the debentures are convertible into common shares, they are considered to represent both debt and equity to the Company under generally accepted accounting principles. The debt component of the debentures of $94.4 million is recorded at the fair value of the obligation without the conversion feature. This fair value was calculated based on the present value of all future payments of principal and interest using a discount rate applicable to similar debt instruments absent the conversion feature. The balance of the proceeds, $5.6 million, represents the fair value of the conversion feature and is recorded as the equity component of the debentures. Issue costs of $4.5 million have been offset against the debt component and are being amortized using the effective interest rate method. The debt component will accrete up to the principal balance at maturity and the accretion is included in interest expense.

8. NON-CONTROLLING INTEREST

As a result of the 2005 conversion to a trust, 7.0 million exchangeable shares were issued by a subsidiary of the Trust. The exchangeable shares were listed on the Toronto Stock Exchange as a security separate from the trust units and represented a non-controlling interest in the financial statements of the Trust. Holders of exchangeable shares did not receive cash distributions however, the rate at which exchangeable shares were convertible into trust units increased in relation to distributions paid on trust units. Pursuant to the Reorganization, the 3.1 million outstanding exchangeable shares were exchanged for 4.2 million common shares of the Company based on the exchange ratio of 1:1.35931 on December 18, 2007.

The following table sets forth a reconciliation of the non-controlling interest for the years ended December 31, 2007 and 2006:



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

Number of Number of
Exchangeable Exchangeable
Shares Amount Shares Amount
----------------------------------------------------------------------------

Balance, beginning of year 4,622 $ 27,132 5,612 $ 27,598
Non-controlling interest
net income - 1,268 - 4,536
Converted to trust units (1,498) (8,936) (990) (5,002)
Converted pursuant to
Reorganization (Note 3) (3,124) (19,464) - -
----------------------------------------------------------------------------
Balance, end of year - $ - 4,622 $ 27,132
----------------------------------------------------------------------------
----------------------------------------------------------------------------


9. ASSET RETIREMENT OBLIGATION

The Company's asset retirement obligation results from ownership interests in petroleum and natural gas assets including well site, gathering systems and processing facilities. The Company estimated the total undiscounted amount required to settle its asset retirement obligation to be approximately $49.0 million (2006 - $47.6 million). The majority of the costs are scheduled to be incurred between 2014 and 2020. A credit-adjusted risk-free interest rate of 8.5 percent and an inflation rate of 1.5 percent was used to calculate the fair value of the asset retirement obligation.

A reconciliation of the asset retirement obligation is provided below:



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

Balance, beginning of year $ 10,994 $ 11,386
Fairquest acquisition (Note 4) 1,471 -
Liabilities incurred 416 299
Liabilities settled (4,783) (1,673)
Accretion expense 986 982
----------------------------------------------------------------------------
Balance, end of year $ 9,084 $ 10,994
----------------------------------------------------------------------------
----------------------------------------------------------------------------


10. FUTURE INCOME TAXES

The provision for income taxes in the financial statements differs from the result which would have been obtained in applying the combined federal and provincial tax rate to the Company's earnings before income taxes. The difference results from the following items:



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

Income (loss) before taxes $ (5,131) $ 33,546
Combined federal and provincial tax rate 32.42% 34.86%
----------------------------------------------------------------------------
Computed "expected" income tax expense (1,663) 11,694
Increase (decrease) in income taxes resulting from:
Net income attributable to the Trust (20,146) (25,332)
Non-deductible unit based compensation 4,240 1,745
Effect of change in tax rate (3,460) (2,939)
Non-deductible crown charges - 4,119
Resource allowance - (4,550)
Other (404) (9)
----------------------------------------------------------------------------
Future tax reduction (21,433) (15,272)
Capital taxes - 203
----------------------------------------------------------------------------
Total taxes $ (21,433) $ (15,069)
----------------------------------------------------------------------------
----------------------------------------------------------------------------

The components of the future income tax liability at December 31, 2007 and
2006 are as follows:

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

Future income tax liabilities:
Petroleum and natural gas properties and equipment $ 82,053 $ 82,496
Future income tax assets:
Asset retirement obligation (2,287) (3,207)
Share issue costs (1,680) (646)
Income tax losses (expire 2008 to 2027) (33,047) (37,051)
----------------------------------------------------------------------------
(37,014) (40,904)
----------------------------------------------------------------------------
Net future income tax liability $ 45,039 $ 41,592
----------------------------------------------------------------------------
----------------------------------------------------------------------------


11. SHAREHOLDERS' EQUITY AND UNITHOLDERS' CAPITAL

The Company is authorized to issue an unlimited number of common shares and an unlimited number of preferred shares, issuable in series.



a) COMMON SHARES OF FAIRBORNE ENERGY LTD.

----------------------------------------------------------------------------
2007

Number
of Shares Amount
----------------------------------------------------------------------------

Balance, beginning of year - $ -
Issued on corporate reorganization (Note 3) 66,612 320,684
Issued on conversion of exchangeable shares (Note 8) 4,247 24,421
Issued for cash 13,423 100,000
----------------------------------------------------------------------------
Balance, end of year 84,282 $ 445,105
----------------------------------------------------------------------------
----------------------------------------------------------------------------


b) TRUST UNITS OF FAIRBORNE ENERGY TRUST

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

Number Amount Number Amount
----------------------------------------------------------------------------

Balance, beginning of year 47,677 $ 216,575 46,400 $ 199,022
Fairquest acquisition (Note 4) 15,833 144,801 - -
Issued on exercise of warrants 14 133 - -
Issued on conversion of
exchangeable shares 1,851 16,910 1,075 15,482
Issued on vesting of Restricted
Units 293 2,827 202 2,071
----------------------------------------------------------------------------
Balance, prior to Reorganization 65,668 381,246 47,677 216,575
Issued on vesting of Restricted
and Performance Units 944 11,521 - -
Reduction in capital for
reclassification of deficit - (72,083) - -
Exchanged for Fairborne common
shares (Note 3) (66,612) (320,684) - -
----------------------------------------------------------------------------
Balance, end of year - $ - 47,677 $ 216,575
----------------------------------------------------------------------------
----------------------------------------------------------------------------


During the period January 1 to December 18, 2007, 1.5 million exchangeable shares were exchanged for 1.9 million trust units. The market value of trust units issued on conversion was $16.9 million resulting in a reduction in non-controlling interest of $8.9 million, an increase in capital assets of $12.0 million and a future tax liability of $4.1 million. Pursuant to the Reorganization the 3.1 million outstanding exchangeable shares were exchanged for 4.2 million common shares based on the exchange ratio of 1:1.35931 on December 18, 2007. The market value of common shares issued on conversion was $24.4 million resulting in a reduction in non-controlling interest of $19.5 million, an increase in capital assets of $7.5 million and a future tax liability of $2.6 million.

In 2006, 1.0 million exchangeable shares were converted into 1.1 million trust units. The market value of trust units issued on conversion was $15.5 million, resulting in a reduction in non-controlling interest of $5.0 million, an increase in capital assets of $15.9 million and a future tax liability of $5.4 million.

Pursuant to the trust conversion in 2005, a deficit balance of $6.8 million was reclassified against share capital.



c) WARRANTS

----------------------------------------------------------------------------
Number Amount
----------------------------------------------------------------------------

Balance, beginning of year - $ -
Issued on acquisition of Fairquest (Note 4) 4,662 2,879
Exercised for Trust units (35) (22)
----------------------------------------------------------------------------
Balance, end of year 4,627 $ 2,857
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Following the Reorganization, each warrant entitles the holder to acquire 0.39 of a common share of the Company at an exercise price of $8.13 per common share and is exercisable at any time prior to June 1, 2010. Prior to the Reorganization the warrants were convertible into trust units at the same exchange ratio and exercise price. The fair value of the warrants of $1.58 per warrant was calculated using the Black Scholes model with the following weighted average assumptions: risk free rate of 4 percent, expected volatility of 40 percent and an expected life of 3 years.

d) PER UNIT AMOUNTS

The following table summarizes the weighted average common shares and, prior to 2007, trust units used in calculating net income per share:



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

Numerator
Net income - basic $ 15,034 $ 44,079
Non-controlling interest - 4,536
----------------------------------------------------------------------------
Numerator for diluted net income per share $ 15,034 $ 48,615
----------------------------------------------------------------------------
Denominator
Weighted average shares - basic 58,856 47,244
Exchangeable shares - 5,296
Restricted Units 811 584
Performance Units 1,062 617
----------------------------------------------------------------------------
Denominator for diluted net income per share 60,729 53,741
----------------------------------------------------------------------------
Basic net income per share $ 0.26 $ 0.93
Diluted net income per share $ 0.25 $ 0.90
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Excluded from the diluted number of shares for the year ended December 31, 2007 is the effect of convertible debentures (7.4 million shares) and exchangeable shares (4.1 million shares) which are anti-dilutive to net income. Excluded from the diluted number of units for the year ended December 31, 2006 is the effect of convertible debentures (1.2 million units) which are anti-dilutive.

e) INCENTIVE PLAN

The following tables set forth a reconciliation of the equity based incentive plan activity for the years ended December 31, 2007 and 2006:



----------------------------------------------------------------------------
2007

Number of Number of
Restricted Performance
Units Units Total
----------------------------------------------------------------------------

Balance, beginning of period 496 629 1,125
Issued 319 307 626
Exercised (237) (10) (247)
Forfeited (32) (38) (70)
Vested on Reorganization (370) (532) (902)
----------------------------------------------------------------------------
Balance, end of period 176 356 532
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Exercisable, end of period - - -
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Equivalent common shares,
end of period (1) 215 328 543
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) including additional common shares to be issued for accumulated
distributions earned prior to the Reorganization and adjusted for the
performance factor set in connection with the Reorganization.


----------------------------------------------------------------------------
2006

Number of Number of
Restricted Performance
Units Units Total
----------------------------------------------------------------------------

Balance, beginning of period 562 323 885
Issued 144 326 470
Exercised (183) - (183)
Forfeited (27) (20) (47)
----------------------------------------------------------------------------
Balance, end of period 496 629 1,125
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Exercisable, end of period - - -
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Equivalent trust units,
end of period (1) 554 721 1,275
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) including additional Trust units to be issued for accumulated
distributions earned under the Trust Incentive Plans.


Prior to the Reorganization the Trust had a Trust Incentive Plan (the "Plan") which included granting of restricted trust units ("Restricted Units") and performance trust units ("Performance Units") to directors, officers, employees and consultants and other service providers to the Trust and its subsidiaries.

Under the Plan, Restricted Units vested annually over a three-year period and, upon vesting, entitled the holder to receive the number of trust units designated by the Restricted Unit plus the value of accumulated distributions on the vested Restricted Units. Performance Units vested on the third anniversary of the date of grant and actual payouts were to be determined based on the performance of the Trust compared to its peers. Performance factors could range from zero to 2.0 times the initial Performance Unit grant. Performance Units also received additional trust units equal to the value of accumulated distributions paid to unitholders during the vesting period. Prior to the Reorganization, the stock-based compensation expense was based on a performance factor of one, prior to the effect of accumulated distributions. Payouts under the Trust Incentive Plan could be in cash, trust units or some combination thereof at the discretion of the Board of Directors.

As part of the Reorganization, all outstanding Restricted Units and Performance Units were eligible for accelerated vesting pursuant to the terms of the Trust Incentive Plan. However, the Board of Directors, the Chief Executive Officer, the Chief Operating Officer, and the Chief Financial Officer all waived their rights to accelerated vesting leaving an aggregate of 175,711 Restricted Units and 356,275 Performance Units outstanding under the Trust Incentive Plan. All remaining Restricted Units and Performance Units under the Trust Incentive Plan vested as part of the Reorganization. The performance factor for both vested and unvested Performance Units was determined in connection with the Reorganization to be 0.92 including accumulated distributions. Compensation expense of $6.4 million related to Performance Units and Restricted Units, which received accelerated vesting, was included in corporate restructuring costs in the 2007 consolidated statement of operations.

Restricted Units and Performance Units which remain outstanding will continue to follow the predetermined vesting schedule in accordance with the original Trust Incentive Plan; however, holders of the remaining incentive rights will receive Fairborne common shares rather than trust units upon vesting of such incentive rights. The performance factor on the remaining Performance Units has been fixed at 0.92, including accumulated distributions.

f) RETENTION AWARD PLAN

In conjunction with the Reorganization, Fairborne established a Retention Award Plan which includes granting of Retention Awards to directors, officers, employees, consultants and other service providers to the Company and its subsidiaries. The total number of Retention Awards which may be outstanding and not yet exercised shall not exceed 10% of the aggregate number of issued and outstanding common shares of the Company.

Retention Awards vest annually over a three-year period and expire three years from the date of grant. Upon vesting, the holder is entitled to exercise the Retention Awards for cash equal to the amount by which the exercise price (the fair value of a Fairborne common share on the date of exercise) exceeds the grant price (the fair value of a Fairborne common share on the date of grant).

On December 19, 2007, the Company issued 7.4 million Retention Awards at a grant date price of $5.75, none of which were exercisable on December 31, 2007. Included in accounts payable at December 31, 2007, is $129,000 pertaining to these awards.

g) CONTRIBUTED SURPLUS

The following table sets forth a reconciliation of the contributed surplus for the years ended December 31, 2007 and 2006:



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

Balance, beginning of year $ 4,694 $ 1,758
Trust unit based compensation 6,644 5,134
Restricted Units exercised (2,827) (2,071)
Trust incentive plan grants forfeited (99) (127)
----------------------------------------------------------------------------
Balance, prior to Reorganization 8,412 4,694
Trust unit based compensation on accelerated vesting 6,403 -
Restricted and Performance Units vested (Note 3) (11,521) -
----------------------------------------------------------------------------
Balance, end of year $ 3,294 $ 4,694
----------------------------------------------------------------------------
----------------------------------------------------------------------------


12. FINANCIAL INSTRUMENTS

a) CREDIT RISK:

Virtually all of Fairborne's accounts receivable are from counterparties in the oil and gas industry and are subject to normal industry credit risks.

b) FAIR VALUE OF FINANCIAL INSTRUMENTS:

The carrying value of Fairborne's financial instruments, other than bank indebtedness and the convertible debentures, approximate their fair value due to their short maturity. The fair value of the bank indebtedness approximates its carrying value as it bears interest at a floating rate. The fair value of the convertible debentures at December 31, 2007 was $98.0 million.

13. COMMODITY CONTRACTS

The Company has a risk management program whereby the Company sells forward a portion of its future production through fixed price physical sales contracts with customers.

a) COMMODITY CONTRACTS RECORDED AT FAIR VALUE:

At December 31, 2007 the following natural gas contracts have been recorded at their estimated fair value as a $12,000 asset. The corresponding amount has been recorded in petroleum and natural gas revenue as an unrealized gain on financial instruments for the year ended December 31, 2007.



----------------------------------------------------------------------------
Volume Price
Remaining Term (mmbtu/day) (US$ per mmbtu) Settlement Index
----------------------------------------------------------------------------
Swaps
Apr 1, 2008 - Jun 30, 2008 5,000 NYMEX-$0.845 US NYMEX LD
Jul 1, 2008 - Sep 30, 2008 5,000 NYMEX-$0.865 US NYMEX LD
----------------------------------------------------------------------------
----------------------------------------------------------------------------


b) COMMODITY CONTRACTS NOT RECORDED AT FAIR VALUE:

The following crude oil and natural gas fixed price physical sales contracts outstanding at December 31, 2007 have been entered into for the purpose of physical delivery of a non-financial item; therefore, the physical delivery contracts are not fair valued. Settlements on these contracts are included in petroleum and natural gas revenue as they settle.



OIL:
----------------------------------------------------------------------------
Volume Price
Remaining Term (bbls per day) (US$ per bbl) Settlement Index
----------------------------------------------------------------------------

Swaps
Jan 1, 2008 - Mar 31, 2008 500 70.70 WTI
Apr 1, 2008 - Jun 30, 2008 500 70.55 WTI
Collars
Jan 1, 2008 - Jun 30, 2008 500 70.00 - 75.60 WTI
Jul 1, 2008 - Dec 31, 2008 500 70.00 - 74.00 WTI
----------------------------------------------------------------------------
----------------------------------------------------------------------------

NATURAL GAS:

----------------------------------------------------------------------------
Volume Price
Remaining Term (GJ per day) (CDN$ per GJ) Settlement Index
----------------------------------------------------------------------------

AECO Collars
Jan 1, 2008 - Mar 31, 2008 3,000 8.00 - 10.00 AECO C Daily
Jan 1, 2008 - Mar 31, 2008 1,000 8.00 - 10.00 AECO C Daily
Jan 1, 2008 - Mar 31, 2008 2,000 8.00 - 10.45 AECO C Daily
AECO Swaps
Jan 1, 2008 - Mar 31, 2008 1,500 8.25 AECO C Monthly
Jan 1, 2008 - Mar 31, 2008 2,500 8.71 AECO C Monthly
Jan 1, 2008 - Mar 31, 2008 1,500 9.00 AECO C Monthly
Jan 1, 2008 - Mar 31, 2008 1,500 9.27 AECO C Monthly
Jan 1, 2008 - Mar 31, 2008 5,000 7.00 AECO C Monthly
Jan 1, 2008 - Dec 31, 2008 1,000 7.53 AECO C Monthly
Jan 1, 2008 - Dec 31, 2008 1,500 6.52 AECO C Monthly
Jan 1, 2008 - Dec 31, 2008 2,638 7.015 AECO C Monthly
----------------------------------------------------------------------------
----------------------------------------------------------------------------


14. COMMITMENTS

The Company has certain lease commitments for its office premises through to June 2011. As at December 31, 2007 the payments due under these commitments are approximately $0.9 million per annum.

Fairborne entered into a three year contractual agreement with a third party drilling company for the use of one of their drilling rigs. The contract has a remaining annual commitment of $4.3 million for each of the years ending December 31, 2008 and 2009.

ADVISORIES

FORWARD LOOKING STATEMENTS: This document contains forward-looking statements. Management's assessment of future plans and operations, expected production levels, expected royalty rates, transportation costs and operating costs, capital expenditures, the nature of capital expenditures, methods of financing capital expenditures and the timing of increases in production may constitute forward-looking statements under applicable securities laws and necessarily involve risks including, without limitation, risks associated with oil and gas exploration, development, exploitation, production, marketing and transportation, loss of markets, volatility of commodity prices, currency fluctuations, imprecision of reserve estimates, environmental risks, competition from other producers, inability to retain drilling rigs and other services, incorrect assessment of the value of acquisitions, failure to realize the anticipated benefits of acquisitions, delays resulting from or inability to obtain required regulatory approvals and ability to access sufficient capital from internal and external sources. As a consequence, the Company's actual results may differ materially from those expressed in, or implied by, the forward-looking statements. Readers are cautioned that the foregoing list of factors is not exhausted. Additional information on these and other factors that could effect the Company's operations and financial results are included in reports on file with Canadian securities regulatory authorities and may be accessed through the SEDAR website (www.sedar.com) or at the Company's website (www.fairborne-energy.com). Furthermore, the forward looking statements contained in this MD&A are made as at the date of this MD&A and the Company does not undertake any obligation to update publicly or to revise any of the included forward looking statements, whether as a result of new information, future events or otherwise, except as may be required by applicable securities laws.

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

Contact Information

  • Fairborne Energy Ltd.
    Steven R. VanSickle
    President & CEO
    (403) 290-7750
    (403) 290-7724 (FAX)
    or
    Fairborne Energy Ltd.
    Aaron G. Grandberg
    CFO
    (403) 290-7750
    (403) 290-7724 (FAX)
    or
    Fairborne Energy Ltd.
    3400, 450 - 1st Street S.W.
    Calgary, Alberta T2P 5H1
    Email: info@fairborne-energy.com
    Website: www.fairborne-energy.com