Fairborne Energy Ltd.
TSX : FEL

Fairborne Energy Ltd.

August 08, 2008 00:05 ET

Fairborne Energy Ltd. Reports Record Quarterly Production and Cash Flow

CALGARY, ALBERTA--(Marketwire - Aug. 8, 2008) - Fairborne Energy Ltd. (TSX:FEL):



HIGHLIGHTS

Three months ended Six months ended
June 30, June 30,
2008 2007 (1) 2008 2007 (1)
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FINANCIAL ($thousands, except per
share amounts)
Petroleum and natural gas sales 85,670 49,501 156,288 99,167
Funds generated from operations (2) 51,458 25,547 93,559 51,580
Per share - basic $ 0.60 $ 0.48 $ 1.10 $ 1.03
Per share - diluted $ 0.60 $ 0.44 $ 1.10 $ 0.92
Cash flow from operations
(including changes in working
capital) 41,650 27,724 84,507 55,474
Per share - basic $ 0.49 $ 0.52 $ 1.00 $ 1.11
Per share - diluted $ 0.48 $ 0.47 $ 0.99 $ 0.99
Net income 3,717 6,739 13,862 13,899
Per share - basic $ 0.04 $ 0.13 $ 0.16 $ 0.28
Per share - diluted $ 0.04 $ 0.11 $ 0.16 $ 0.26
Exploration and development
expenditures 31,704 6,095 89,625 33,963
Acquisitions, net of dispositions 134,482 226,328 135,671 226,328
Working capital surplus (deficit) (7,363) 11,594 (7,363) 11,594
Bank indebtedness 180,977 179,120 180,977 179,120
Convertible debentures 93,499 91,389 93,499 91,389
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OPERATIONS (Units as noted)
Average production
Natural gas (Mcf per day) 59,529 48,689 58,171 46,885
Crude oil (bbls per day) 2,506 2,303 2,459 2,349
Natural gas liquids (bbls per day) 610 449 604 426
Sulphur (tonnes per day) (3) 106 - 158 -
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Total (BOE per day) 13,143 10,867 12,916 10,589
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Average sales price
Natural gas ($ per Mcf) (4) 9.90 7.43 9.14 7.93
Crude oil ($ per bbl) (4) 109.82 69.90 99.12 67.00
Natural gas liquids ($ per bbl) 65.94 50.37 62.38 44.52
Sulphur ($ per tonne) 351.32 - 260.90 -
Netback per BOE ($ per BOE)
Petroleum and natural gas sales (4) 72.40 50.33 66.85 52.04
Royalties (13.37) (8.82) (12.04) (9.14)
Operating costs (9.70) (8.01) (8.95) (8.92)
Transportation (0.94) (0.47) (0.92) (0.77)
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Operating netback 48.39 33.03 44.94 33.21
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Wells drilled (gross) 5 1 30 28
Undeveloped land (net acres) 262,267 233,467 262,267 233,467
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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) A BOE conversion ratio has been calculated using a conversion rate of
one tonne of sulphur to one barrel.
(4) Excludes unrealized gains and losses on derivatives.


HIGHLIGHTS

- Record production of 13,143 BOE per day, a 21% increase over the second quarter of 2007.

- Record funds generated from operations of $51.5 million ($0.60 per share), more than double the second quarter of 2007.

- Record operating netback of $48.39 per BOE.

- Acquisition of Grand Banks Energy Corporation ("Grand Banks"), resulting in a new core area in Sinclair, Manitoba.

- Devonian discovery at Peppers 13-10 tested at 4.0 MMcf per day.

- Expansion of the 2008 capital program to $208 million.

- Successful expansion of the Company's landbase at Harlech to 142 gross (110 net) sections, a 32% increase from the first quarter.

- First horizontal Nordegg well successfully drilled at Harlech.

- Completed flow through equity financing for gross proceeds of $28.4 million.

- Executed final agreement with Mosaic Fertilizer, LLC for the disposition of the West Pembina Sulphur Block (approximately 210,000 tonnes).

PRODUCTION OUTLOOK

Second quarter production averaged 13,143 BOE per day, consisting of 59.5 MMcf per day of natural gas, 3,116 bbls per day of oil and natural gas liquids and 106 BOE per day of sulphur. Production volumes were negatively impacted by outages associated with two weeks of planned turnaround activity at the Nevis gas plant and a further three weeks of unplanned outages at Nevis required by the plant operator to restart the facility. Additional production from the Grand Banks' properties will not be fully reflected until the third quarter as the acquisition closed late in the second quarter 2008.

Based on the Company's expanded capital program and eight rigs currently drilling, the Company expects to deliver significant production growth through the balance of the drilling season. Drilling activities for the remainder of 2008 are expected to focus mainly in the core areas of Sinclair, Manitoba as well as Harlech and Marlboro in the Alberta Deep Basin.

OPERATIONS UPDATE

On June 12, 2008, Fairborne completed the acquisition of Grand Banks through a takeover bid which was financed entirely from existing credit facilities. In addition to established production of approximately 1,500 BOE per day, 35,000 acres of undeveloped land and 4.9 MMBOE of proven plus probable reserves (December 31, 2007), a key benefit of the acquisition was the establishment of a new core area in southwest Manitoba at Sinclair. Development of the assets acquired from Grand Banks has already begun, with an active 2008 drilling program and incremental capital expenditure program planned in the new area of Sinclair, Manitoba.

Fairborne continued to benefit from strong demand and increased prices for sulphur during the second quarter. Sulphur sales in the second quarter averaged 106 tonnes of sulphur per day (106 BOE per day) with realized prices as high as $415 per tonne. In addition to ongoing production, the Company is pleased to announce it has finalized the sale of the sulphur block in West Pembina where Fairborne owns approximately 210,000 tonnes of sulphur. Crushing operations have commenced with deliveries under the sales contract beginning late in the third quarter.

Completion of a flow-through equity financing in May 2008 resulted in the issue of 2.3 million common shares for gross proceeds of $28.4 million. Net debt of $188.3 million on June 30, 2008 reflected the proceeds of the equity financing offset by financing for the Grand Banks acquisition.

Strong commodity prices including sulphur sales contributed to record quarterly funds generated from operations of $51.5 million ($0.60 per share). Operating costs averaged $9.70 per BOE for the second quarter, including turnaround costs at Nevis. The Company has natural gas hedges for the remainder of 2008, with approximately 27% of forecast natural gas production volumes hedged with an average minimum price of $8.86 per Mcf.

Fairborne drilled five wells (3.8 net) during the second quarter with a 100% success rate resulting in three natural gas wells (2.1 net), one CBM well (0.7 net) and one oil well (1.0 net).

COLUMBIA/HARLECH

Drilling at Harlech has commenced following spring breakup with four drilling rigs currently active in the area.

To date, Fairborne has successfully completed the Jurassic Nordegg gas zones in three (2.2 net) vertical wells, and encountered the zone in five (4.3 net) other wells. These results confirm the presence of the Nordegg sand over Fairborne's extensive land position at Harlech. Based on these results, Fairborne added significant additional lands on its Nordegg play in Harlech through successful crown acquisitions during the second quarter. The Company's current land position now includes 142 gross (110 net) sections, an increase of 32% from the first quarter.

The first horizontal well in the Nordegg has been successfully drilled and completion operations are now underway. The 8-7 well was drilled to a vertical depth of 3,363m (3,496m measured depth) and cased. The horizontal section of the well was then successfully drilled with the wellbore path staying within the target 5m upper porous interval for 770m of the total horizontal length of 883m giving a total measured depth of 4,379m. This zone contained log measured average porosities of 11% with some intervals reaching 20% porosity. Planned completion operations include up to eight intervals to be fracture stimulated using multistage horizontal fracturing technology.

The Company has also drilled the third follow up well to our 2006 Belly River oil discovery at Harlech. The 5-2 well encountered a 14m thick Belly River channel with six meters of oil pay with greater than 11% porosity. This well confirms the 3D seismic model and indicates eight more development locations in offsetting spacing units. The oil from this pool is 43º API, realizing very high netbacks. There are currently three producing wells in this area and a total of three new development wells (2.3 net) are planned in 2008.

DEEP BASIN

Fairborne's Deep Basin strategy is to pursue lower risk Cretaceous gas zones at Marlboro, Pine Creek and Lambert and to drill exploration wells targeting deep sour gas in the Nisku and Leduc.

The Company drilled a total of six (3.0 net) successful new gas wells in 2008. Application of mutlizone completion and production commingling has yielded strong results. Five of these wells are currently on production, one well is awaiting tie-in and the Company plans to drill up to 10 (6.4 net) wells over the balance of 2008.

The Company's 13-10 Peppers well (43.8% working interest) was successfully drilled during the quarter and encountered a full section of porous Leduc reef which was water bearing. However, a secondary zone in the Devonian was completed and has yielded strong results flowing at 4.0 MMcf per day during the flow test with increasing flowing pressure throughout the test. The flow test was conducted with a beginning pressure of 14,900 KPA and an ending pressure of 18,800 KPA. An H2S content of 40% restricted the length of the test and, as such, further testing will be required to more accurately determine the production capacity of the well.

CLIVE

Fairborne's coal bed methane project at Clive continues to deliver stable production. The drilling program for the second half of 2008 is currently underway with plans to drill 40 gross (28.0 net) wells by the end of the year.

OUTLOOK

Commodity prices have strengthened since the fourth quarter of 2007, resulting in much stronger cash flows than originally budgeted in the fall of 2007. As a result, the Company was again able to expand its 2008 capital program by an additional $38 million to $208 million, with the majority of the incremental $38 million being spent on the Sinclair property in southwest Manitoba.

In addition to our drilling based strategy, we continue to look at acquisitions in our core operating areas as well as opportunities in new areas that would provide for accretive production and reserve growth. As always, we continue to add undeveloped land to utilize our strong technical staff for organic growth opportunities.

STEVEN R. VANSICKLE

President and CEO

August 7, 2008

ADVISORIES

The following Management Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") was prepared at, and is dated, August 7, 2008. This MD&A is provided by the management of Fairborne Energy Ltd. ("Fairborne" or the "Company") to review second quarter 2008 activities and results as compared to the previous year, and should be read in conjunction with the unaudited interim consolidated financial statements including selected notes for the six months ended June 30, 2008 and the audited consolidated financial statements including notes for the year 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 is a growth-oriented exploration and production company resulting from the reorganization of Fairborne Energy Trust (the "Trust") on December 19, 2007 (the "Reorganization"). If the context requires, reference herein to "Fairborne" also includes a reference to the 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 document contains forward-looking statements. Management's assessment of future plans and operations, use of proceeds from flow-through financing, timing of sulphur sales, capital expenditures, methods of financing capital expenditures, expected commodity prices and expectations that the Company and its subsidiaries will not pay cash taxes in 2008 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, risks that the sale of the Company's sulphur inventory does not occur or changing the timing thereof, the inability to fully realize the benefits of the acquisition of Grand Banks Energy Corporation, 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. Forward-looking statements or information are based on a number of factors and assumptions which have been used to develop such statements and information but which may prove to be incorrect. Although Fairborne believes that the expectations reflected in such forward-looking statements or information are reasonable, undue reliance should not be placed on forward-looking statements because the Company can give no assurance that such expectations will prove to be correct.
In addition to other factors and assumptions which may be identified in this document and other documents filed by the Company, assumptions have been made regarding, among other things: the impact of increasing competition; the general stability of the economic and political environment in which Fairborne operates; the ability of the Company to obtain qualified staff, equipment and services in a timely and cost efficient manner; drilling results; the ability of the operator of the projects which the Company has an interest in to operate the field in a safe, efficient and effective manner; Fairborne's ability to obtain financing on acceptable terms; field production rates and decline rates; the ability to replace and expand oil and natural gas reserves through acquisition, development or exploration; the timing and costs of pipeline, storage and facility construction and expansion; the ability of the Company to secure adequate product transportation; future oil and natural gas prices; currency, exchange and interest rates; the regulatory framework regarding royalties, taxes and environmental matters in the jurisdictions in which the Company operates; and Fairborne's ability to successfully market its oil and natural gas products. Readers are cautioned that the foregoing list of factors is not exhaustive. Additional information on these and other factors that could affect 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 document are made as at the date of this document 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 one tonne of sulphur to one barrel and six thousand cubic feet of natural gas to one barrel. This conversion ratio of six thousand cubic feet of natural gas to one barrel is based on an energy equivalent conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.

ACQUISITION OF GRAND BANKS ENERGY CORPORATION ("GRAND BANKS")

On June 12, 2008, Fairborne Energy Ltd. ("Fairborne" or the "Company") acquired all of the issued and outstanding common shares of Grand Banks by way of a takeover bid. As consideration for the acquisition, Fairborne paid Grand Banks shareholders $2.90 per share for a total of $102.1 million and assumed $10.7 million of net debt. With operations focused in southeast Saskatchewan, southwest Manitoba and west central Alberta, the acquisition provides Fairborne with the opportunity to establish a new core operated area in a favourable royalty environment, providing premium netbacks. Production from Grand Banks' properties at the time of the acquisition was approximately 1,500 BOE per day (50% oil and 50% gas). Results of operations from Grand Banks have been included in Fairborne's results beginning June 13, 2008.

EQUITY FINANCING

On May 28, 2008, Fairborne completed a private placement financing of 2.3 million common shares, issued on a flow through basis ("Flow-Through Common Shares") at a price of $12.35 per Flow-Through Common Share for gross proceeds of $28.4 million. Proceeds of the offering were initially applied against bank debt and will be used to fund Fairborne's exploration program. As a result of the financing, the Company has a commitment to spend $28.4 million on qualifying Canadian exploration expenditures. The expenditures will be renounced to investors on or before December 31, 2008. As at June 30, 2008, $2.3 million of qualifying exploration expenditures have been incurred.

COMPARATIVE INFORMATION - RESTRUCTURING

On December 19, 2007, Fairborne Energy Trust (the "Trust") converted into Fairborne, a growth-oriented, exploration and production company (the "Reorganization"). The Reorganization of Fairborne from a trust to a company has been accounted for on a continuity of interest basis and, accordingly, the interim consolidated financial statements for 2008 and 2007 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. Specifically, the comparative three and six months ended June 30, 2007 reflect the results of operations and cash flows of the Trust and its subsidiaries prior to the Reorganization (December 19, 2007).



SECOND QUARTER 2008 FINANCIAL RESULTS

PRODUCTION

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Three months ended Six months ended
June 30, June 30,
2008 2007 change 2008 2007 change
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Natural gas (Mcf per
day) 59,529 48,689 22% 58,171 46,885 24%
Crude oil (bbls per day) 2,506 2,303 9% 2,459 2,349 5%
Natural gas liquids
(bbls per day) 610 449 36% 604 426 42%
Sulphur (tonnes per day)
(1) 106 - - 158 - -
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Total (BOE per day) 13,143 10,867 21% 12,916 10,589 22%
Natural gas % of
production 75% 75% - 75% 74% -
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(1) A BOE conversion ratio has been calculated using a conversion rate of
one tonne of sulphur to one barrel.


Fairborne reported average production of 13,143 BOE per day for the second quarter of 2008, 4% higher than the first quarter of 2008 (12,689 BOE per day), and 21% higher than the comparative second quarter of 2007 (10,867 BOE per day). Compared to the second quarter of 2007, the increase in production was primarily due to the acquisition of Fairquest in June 2007 which added approximately 2,900 BOE per day at the time of the transaction but was not fully reflected in Fairborne's production until July 2007. Partially offsetting the increased production during the second quarter of 2008 was the impact of outages associated with two weeks of planned turnaround activity at the Nevis gas plant and a further three weeks of unplanned outages at Nevis required by the plant operator to restart the facility.

Natural gas production of 59.5 MMcf per day during the second quarter of 2008 was 5% higher than the first quarter of 2008 (56.8 MMcf per day) reflecting fewer of the production outages that existed during the first quarter of 2008 that resulted from extreme weather conditions. As well, the acquisition of Grand Banks, effective June 13, 2008, increased natural gas production for the quarter by approximately 1%. The full impact of production from Grand Banks' properties will be reflected beginning in the third quarter of 2008.

Crude oil and NGL production of 3,116 bbls per day for the second quarter of 2008 was 4% higher than production during the first quarter of 2008 (3,010 bbls per day) primarily due to the addition of production from properties acquired from Grand Banks on June 13, 2008.

In the first quarter of 2008 Fairborne began recording sulphur production as a separate revenue stream. Fairborne has benefited from a material increase in sulphur prices over the past nine months. Prior to this dramatic increase in sulphur prices, Fairborne accounted for sulphur as an operating cost with no associated production volumes. This treatment reflected the financial impact of sulphur disposal as a cost to Fairborne. However, with prices as high as $415 per tonne during 2008, sulphur has become a significant revenue stream for Fairborne. Sulphur sales during the second quarter of 2008 averaged 106 tonnes per day, lower than the 210 tonnes per day recorded during the first quarter, which included volumes produced in November and December 2007.



COMMODITY PRICES & RISK MANAGEMENT ACTIVITIES

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Three months ended Six months ended
June 30, June 30,
2008 2007 change 2008 2007 change
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Average Prices
Natural gas ($ per Mcf)
(1) 9.90 7.43 33% 9.14 7.93 15%
Crude oil ($ per bbl) (1) 109.82 69.90 57% 99.12 67.00 48%
Natural gas liquids
($ per bbl) 65.94 50.37 31% 62.38 44.52 40%
Sulphur ($ per tonne) 351.32 - - 260.90 - -
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BOE ($ per BOE) 71.65 50.17 43% 66.15 51.78 28%
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Benchmark Prices
AECO Daily Index (Cdn$
per Mcf) 10.20 7.07 44% 9.09 7.24 26%
AECO Monthly Index
(Cdn$ per Mcf) 9.35 7.37 27% 8.24 7.41 11%
WTI - Edmonton par
(Cdn$ per bbl) 126.25 72.62 74% 112.69 70.19 61%
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(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

Natural gas prices continued to increase during the second quarter of 2008, with average AECO daily prices increasing 28% when compared to the first quarter of 2008 ($7.98 per Mcf) and 44% from the second quarter of 2007. Strengthened natural gas prices can be attributed to dramatic decreases in liquefied natural gas ('LNG") deliveries into North America, as well as lower U.S. storage levels.

During the second quarter of 2008, Fairborne had an average of 20,557 Mcf per day sold under fixed price physical sales contracts representing 35% of the Company's natural gas production. Risk management activities for the second quarter of 2008 decreased Fairborne's realized natural gas revenue by $3.9 million which had an effect of decreasing the Company's natural gas price by $0.72 per Mcf to $9.90 per Mcf. On a year to date basis, risk management activities have reduced the Company's realized natural gas revenue by $3.4 million, resulting in a $0.32 per Mcf decrease in Fairborne's natural gas price to $9.14 per Mcf.

The following table summarizes the outstanding fixed price physical sales and derivative contracts for natural gas, including contracts outstanding at June 30, 2008 as well as contracts entered into after June 30, 2008:



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Q3/08 Q4/08 Q1/09
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Collars
Volume (Mcf per day) 3,612 3,311 3,161
Average floor ($ per Mcf) 8.86 9.56 9.97
Average ceiling ($ per Mcf) 10.63 15.84 18.82
Puts/Participating Swaps
Volume (Mcf per day) 7,473 903 -
Average floor ($ per Mcf) 10.29 10.32 -
Swaps
Volume (Mcf per day) 12,768 10,360 4,516
Average price ($ per Mcf) 8.22 8.26 8.88
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Total volume (Mcf per day) 23,853 14,574 7,677
Average floor price ($ per Mcf) 8.97 8.69 9.33
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Conversion factor: 1 Mcf = 1.107 GJ


Included in the above table is a participating swap for 3,000 GJ per day of natural gas at $9.32 per GJ until October 31, 2008 as well as an additional contract whereby Fairborne has locked in 5,275 GJ per day of natural gas with a floor price of $9.28 per GJ for the third quarter of 2008. These contracts have been accounted for as derivative contracts. The mark-to-market value of both of these contracts has been recorded as a liability of $391,000 at June 30, 2008.

Crude oil

Crude oil prices continued to rally during the second quarter of 2008, increasing by 29% compared to average market prices in the first quarter of 2008 ($98.13 per bbl). During the second quarter of 2008, Fairborne had an average of 1,000 bbls per day of crude oil under fixed price physical sales contracts and derivative contracts representing 40% of crude oil production. Risk management activities, including option costs for puts purchased during the year reduced Fairborne's realized crude oil revenue by $4.7 million or $20.61 per bbl for the quarter and $7.0 million or $15.64 per bbl on a year to date basis. Compared to the second quarter of 2007, the Company's realized crude oil price of $109.82 per bbl for the second quarter of 2008 represented an increase of 57% from $69.90 per bbl, reflecting the overall increase in average market prices for oil throughout the first half of 2008.

The following table summarizes the outstanding fixed price physical sales and derivative contracts on crude oil, including contracts outstanding at June 30, 2008 as well as contracts entered into after June 30, 2008:



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Q3/08 Q4/08 2009
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Collars
Volume (bbls per day) 1,000 1,000 500
Average floor ($ per bbl) 75.00 75.00 90.00
Average ceiling ($ per bbl) 87.25 87.25 204.75
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Total volume (bbls per day) 1,000 1,000 500
Average floor price ($ per bbl) 75.00 75.00 90.00
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The crude oil collar arrangement on 500 bbls per day for the full year 2009 has been accounted for as a derivative contract. The mark-to-market value of this contract has been recorded as a liability of $443,000 at June 30, 2008.

Sulphur

Fairborne continues to benefit from a material change in the market for sulphur. The Company's average realized sulphur price for the second quarter of 2008 was $351.32 per tonne which represents an increase of 63% from the first quarter of 2008. In July 2008, Fairborne also executed the final contract for the sale of its share of sulphur inventory at the storage block in West Pembina. Deliveries under the contract are expected to commence in the third quarter of 2008.



PETROLEUM AND NATURAL GAS REVENUE

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Three months ended Six months ended
($thousands except June 30, June 30,
as noted) 2008 2007 change 2008 2007 change
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Natural gas 53,608 32,907 63% 96,784 67,327 44%
Crude oil 25,044 14,647 71% 44,363 28,489 56%
Natural gas liquids 3,660 2,058 78% 6,853 3,430 100%
Sulphur 3,380 - - 7,494 - -
Unrealized loss on
derivatives (924) (266) 247% (846) (579) 46%
Other income 902 155 482% 1,640 500 228%
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Total 85,670 49,501 73% 156,288 99,167 58%
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Per BOE $ 71.63 $ 50.06 43% $ 66.49 $ 51.74 29%
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Fairborne's reported revenue of $85.7 million for the second quarter of 2008 was 21% higher than the preceding first quarter ($70.6 million) and 73% higher than the $49.5 million recorded in the second quarter of 2007. When compared to the prior year, both second quarter and year to date revenue is higher in 2008 due to the impact of increased production, higher realized commodity prices and the addition of sulphur revenues. Compared to the preceding first quarter, the increase in second quarter 2008 revenue was also attributed to higher production and stronger commodity prices.



ROYALTIES

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Three months ended Six months ended
($thousands except June 30, June 30,
as noted) 2008 2007 change 2008 2007 change
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Crown 12,059 6,396 89% 22,961 13,068 76%
Freehold and overriding 3,930 2,326 69% 5,337 4,448 20%
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Total 15,989 8,722 83% 28,298 17,516 62%
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Crown (% of revenue) 14.1% 12.9% 9% 14.7% 13.2% 11%
Freehold and overriding
(% of revenue) 4.6% 4.7% (2%) 3.4% 4.5% (24%)
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Total (% of revenue) 18.7% 17.6% 6% 18.1% 17.7% 2%
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Per BOE $ 13.37 $ 8.82 52% $ 12.04 $ 9.14 32%
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Fairborne recorded $16.0 million of royalties for the second quarter of 2008, representing a rate of 18.7%, up from 17.4% in the preceding first quarter. During the second quarter of 2008, Fairborne's risk management program reduced oil and natural gas revenues resulting in realized prices below the reference prices utilized in calculating royalties. This resulted in a higher effective royalty rate for the second quarter and year to date royalties in 2008 when compared to 2007.



OPERATING COSTS

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Three months ended Six months ended
($thousands except June 30, June 30,
as noted) 2008 2007 change 2008 2007 change
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Operating costs
Natural gas 8,707 6,131 42% 15,719 12,867 22%
Oil and NGLs 2,899 1,785 62% 5,318 4,236 26%
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Total 11,606 7,916 47% 21,037 17,103 23%
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Per BOE $ 9.70 $ 8.01 21% $ 8.95 $ 8.92 -
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Operating costs of $11.6 million ($9.70 per BOE) were recorded for the second quarter of 2008, up from $8.16 per BOE in the first quarter and $8.01 per BOE in the second quarter of 2007. Operating costs for both the second quarter of 2007 and the first quarter of 2008 were unusually low due to prior period credits relating to third party equalizations and adjustments at third party operated gas plants. On a normalized basis, second quarter 2008 operating costs are marginally higher than the first quarter 2008 and the second quarter of 2007 due to turnarounds and annual overhauls completed during the second quarter. On a year to date basis, operating costs of $8.95 per BOE remain consistent with 2007 operating costs of $8.92 per BOE.



TRANSPORTATION EXPENSES

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Three months ended Six months ended
June 30, June 30,
2008 2007 change 2008 2007 change
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Transportation costs
($thousands) 1,126 465 142% 2,163 1,469 47%
Per BOE $ 0.94 $ 0.47 100% $ 0.92 $ 0.77 19%
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Transportation costs of $1.1 million ($0.94 per BOE) for the second quarter of 2008 are consistent with the first quarter 2008 ($0.90 per BOE). Transportation expenses 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. Fairborne's sulphur sales contracts are currently paid net of transportation; therefore no transportation expense is recorded on the Company's sulphur sales. Lower transportation costs in 2007 resulted from an accounting adjustment of $0.7 million which related to prior periods.



OPERATING NETBACKS

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Three months ended Six months ended
June 30, June 30,
($ per BOE) 2008 2007 change 2008 2007 change
----------------------------------------------------------------------------
Petroleum and natural
gas revenue (1) 71.65 50.17 43% 66.15 51.78 28%
Other income 0.75 0.16 369% 0.70 0.26 169%
Royalties (13.37) (8.82) 52% (12.04) (9.14) 32%
Operating costs (9.70) (8.01) 21% (8.95) (8.92) -
Transportation (0.94) (0.47) 100% (0.92) (0.77) 19%
----------------------------------------------------------------------------
Operating netback 48.39 33.03 47% 44.94 33.21 35%
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Excludes unrealized gains and losses on derivatives.


Fairborne's operating netback of $48.39 per BOE increased 17% from the preceding first quarter of 2008 ($41.37 per BOE) and increased 47% compared to the second quarter of 2007. Both increases reflect stronger commodity prices as well as the addition of sulphur revenue in 2008.



GENERAL AND ADMINISTRATIVE ("G&A") EXPENSES

----------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30,
($thousands except as noted) 2008 2007 change 2008 2007 change
----------------------------------------------------------------------------
G&A expenses, net of
recoveries 3,353 3,384 (1%) 6,206 5,119 21%
Compensation costs 17,251 1,869 823% 19,257 3,658 426%
----------------------------------------------------------------------------
Total G&A expenses 20,604 5,253 292% 25,463 8,777 190%
----------------------------------------------------------------------------
----------------------------------------------------------------------------
G&A expenses, per BOE $ 2.80 $ 3.42 (18%) $ 2.64 $ 2.67 (1%)
Compensation costs,
per BOE $ 14.42 $ 1.89 663% $ 8.19 $ 1.91 329%
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Fairborne recorded $3.4 million of G&A expenses, net of recoveries, in the second quarter of 2008 (Q2 2007 - $3.4 million), representing $2.80 per BOE (Q2 2007 - $3.42 per BOE). G&A expenses, net of recoveries, recorded during the second quarter of 2008 were 18% higher than the preceding first quarter of 2008 primarily due to an accrual for the 2008 employee bonus program to be paid in early 2009. G&A expenses, net of recoveries, for the second quarter of 2008 were consistent with the comparable period in 2007. Recoveries from Fairquest during the second quarter of 2007 reduced G&A expenses by $1.0 million (Q2 2008 - nil). However, this reduction in G&A expenses in the second quarter of 2007 was more than offset by employee cash bonuses paid out in April 2007. As a result, G&A expenses, net of recoveries, for the second quarter of 2008 is comparable to the same period in the prior year.

Compensation expense of $17.3 million in the second quarter of 2008 was significantly higher than the $1.9 million recorded during the second quarter of 2007. Compensation expense recorded during the second quarter of 2008 primarily resulted from the new liability based retention award program instituted by the Company following the Reorganization in December 2007. Compensation expense associated with this new compensation plan is based on increases in the intrinsic value of the plan, being the difference between Fairborne's share price at the end of the period and the exercise price of the award. The intrinsic value of the plan is calculated at each reporting date and recognized in income using an accelerated accrual method which results in the majority of the intrinsic value of the plan being recorded in the first year. In July 2008, most of the retention awards were capped at a ceiling price of $12.85 concurrent with the issue of options under the Company's new stock option plan. No additional retention awards will be issued. Included in compensation expense for the second quarter is $16.8 million representing the intrinsic value of the plan using the prescribed accelerated accrual method. Also included in compensation expense for the second quarter of 2008 is the amortization of remaining Restricted Units and Performance Units for senior officers and directors who waived their accelerated vesting rights at the time of the Reorganization. Compensation expense recorded during 2007 only included the amortization of Restricted Units and Performance Units.



INTEREST AND FINANCING COSTS

----------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30,
($thousands except as noted) 2008 2007 change 2008 2007 change
----------------------------------------------------------------------------
Interest expense 3,062 3,733 (18%) 5,871 6,959 (16%)
Accretion of convertible
debentures 522 570 (8%) 1,044 1,087 (4%)
----------------------------------------------------------------------------
Total interest and
financing costs 3,584 4,303 (17%) 6,915 8,046 (14%)
Per BOE $ 3.00 $ 4.35 (31%) $ 2.94 $ 4.20 (30%)
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Fairborne recorded $3.1 million in interest during the second quarter of 2008, up from $2.8 million in the first quarter of 2008 and down from $3.7 million in the second quarter of 2007. The decrease in interest expense reflected lower average debt levels throughout the second quarter of 2008 compared to the second quarter of 2007. Debt levels in 2008 increased near the end of the second quarter following the acquisition of Grand Banks, and were partially offset by the $28.4 million equity financing in May 2008. Included in interest and financing costs is the accretion of convertible debentures. The costs associated with the debenture offering along with the amount allocated to the conversion feature are included in interest and financing costs over the term of the debentures.



DEPLETION, DEPRECIATION AND ACCRETION (DD&A)

----------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30,
2008 2007 change 2008 2007 change
----------------------------------------------------------------------------
Depletion, depreciation
and accretion
($thousands) 27,984 22,825 23% 52,940 42,195 25%
Per BOE $ 23.40 $ 23.08 1% $ 22.52 $ 22.01 2%
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Fairborne recorded $28.0 million in depletion and depreciation of capital assets and accretion of asset retirement obligations during the second quarter of 2008. On a BOE basis, the 2008 second quarter DD&A rate of $23.40 per BOE was marginally higher than the second quarter 2007 ($23.08 per BOE) and 8% higher than the DD&A rate for the prior quarter of $21.61 per BOE. The increase in the DD&A rate in the second quarter of 2008 is primarily attributable to an increase in Fairborne's depletable base resulting from the acquisition of Grand Banks assets at their estimated fair market value.



TAXES

----------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30,
2008 2007 change 2008 2007 change
----------------------------------------------------------------------------
Future tax expense
(reduction) ($thousands) 1,060 (7,026) n/a 5,610 (10,805) n/a
Per BOE $ 0.89 $ (7.10) n/a $ 2.39 $ (5.64) n/a
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Fairborne recorded future tax expense of $1.1 million in the second quarter of 2008 compared to a future tax recovery of $7.0 million recorded during the second quarter of 2007. Prior to the Reorganization, the future tax recoveries resulted from additional interest deductions associated with Fairborne's previous trust structure. 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 are no longer applicable and the Company is now recording future tax expense. Fairborne does not anticipate paying significant amounts of cash income taxes in its operating entities in 2008 as these entities have sufficient tax pools to offset taxable income.



NET INCOME AND FUNDS GENERATED FROM OPERATIONS

----------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30,
($thousands except as noted) 2008 2007 change 2008 2007 change
(1) (1)
----------------------------------------------------------------------------
Funds generated from
operations 51,458 25,547 101% 93,559 51,580 81%
Per share - basic $ 0.60 $ 0.48 25% $ 1.10 $ 1.03 7%
Per share - diluted $ 0.60 $ 0.44 36% $ 1.10 $ 0.92 20%
Cash flow from operations
(including changes in
working capital) 41,650 27,724 50% 84,507 55,474 52%
Per share - basic $ 0.49 $ 0.52 (6%) $ 1.00 $ 1.11 (10%)
Per share - diluted $ 0.48 $ 0.47 2% $ 0.99 $ 0.99 -
Net Income 3,717 6,739 (45%) 13,862 13,899 -
Per share - basic $ 0.04 $ 0.13 (69%) $ 0.16 $ 0.28 (43%)
Per share - diluted $ 0.04 $ 0.11 (64%) $ 0.16 $ 0.26 (38%)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(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.

----------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30,
($thousands) 2008 2007 2008 2007
----------------------------------------------------------------------------
Cash flow from operating activities 41,650 27,724 84,507 55,474
Change in non-cash working capital 9,749 (2,185) 8,755 (4,092)
Asset retirement expenditures 59 8 297 198
----------------------------------------------------------------------------
Funds generated from operations 51,458 25,547 93,559 51,580
----------------------------------------------------------------------------
----------------------------------------------------------------------------


UNIT ANALYSIS

----------------------------------------------------------------------------
Three months ended June 30,
2008 2007
($thousands) ($ per BOE) ($thousands) ($ per BOE)
----------------------------------------------------------------------------
Petroleum and
natural gas
revenue (1) 85,670 71.63 49,501 50.06
Royalties (15,989) (13.37) (8,722) (8.82)
Operating costs (11,606) (9.70) (7,916) (8.01)
Transportation (1,126) (0.94) (465) (0.47)
Unrealized
gain/loss on
derivatives 924 0.77 266 0.27
General &
administrative(2) (3,353) (2.80) (3,384) (3.42)
Interest expense(3) (3,062) (2.56) (3,733) (3.78)
----------------------------------------------------------------------------
Funds generated
from operations 51,458 43.03 25,547 25.83
Unrealized
gain/loss on
derivatives (924) (0.77) (266) (0.27)
Compensation
expense (17,251) (14.42) (1,869) (1.89)
Accretion of
convertible
debentures (522) (0.44) (570) (0.57)
Depletion,
depreciation
and accretion (27,984) (23.40) (22,825) (23.08)
Future taxes
(reduction) (1,060) (0.89) 7,026 7.10
Non-controlling
interest - - (304) (0.31)
----------------------------------------------------------------------------
Net income 3,717 3.11 6,739 6.81
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) including unrealized gain/loss on derivatives (non-cash)
(2) net of compensation expense (non-cash)
(3) net of accretion on convertible debentures (non-cash)


----------------------------------------------------------------------------
Six months ended June 30,
2008 2007
($thousands) ($ per BOE) ($thousands) ($ per BOE)
----------------------------------------------------------------------------
Petroleum and
natural gas
revenue (1) 156,288 66.49 99,167 51.74
Royalties (28,298) (12.04) (17,516) (9.14)
Operating
costs (21,037) (8.95) (17,103) (8.92)
Transportation (2,163) (0.92) (1,469) (0.77)
Unrealized
gain/loss on
derivatives 846 0.36 579 0.30
General &
administrative(2) (6,206) (2.64) (5,119) (2.67)
Interest expense(3) (5,871) (2.50) (6,959) (3.63)
----------------------------------------------------------------------------
Funds generated
from operations 93,559 39.80 51,580 26.91
Unrealized
gain/loss on
derivatives (846) (0.36) (579) (0.30)
Compensation
expense (19,257) (8.19) (3,658) (1.91)
Accretion of
convertible
debentures (1,044) (0.44) (1,087) (0.57)
Depletion,
depreciation and
accretion (52,940) (22.52) (42,195) (22.01)
Future taxes
(reduction) (5,610) (2.39) 10,805 5.64
Non-controlling
interest - - (967) (0.51)
----------------------------------------------------------------------------
Net income 13,862 5.90 13,899 7.25
----------------------------------------------------------------------------
----------------------------------------------------------------------------

(1) including unrealized gain/loss on derivatives (non-cash)
(2) net of compensation expense (non-cash)
(3) net of accretion on convertible debentures (non-cash)


Fairborne reported a new record for funds generated from operations of $51.5 million ($43.03 per BOE) for the second quarter of 2008, up 22% from the preceding first quarter of 2008 ($42.1 million) and more than double the second quarter of 2007 ($25.5 million). The increase in cash flow was the direct result of increased production levels, continued strong commodity prices and high operating netbacks. Net income of $3.7 million ($3.11 per BOE) for the second quarter of 2008 was 45% lower than net income for the second quarter of 2007. The increase in funds generated from operations during the second quarter of 2008 was more than offset by increased compensation expense and DD&A as well as the future tax expense associated with the change in the structure of the Company following the Reorganization. These factors resulted in an overall decrease in net income for the quarter compared to the same period last year.



LIQUIDITY AND CAPITAL RESOURCES

CAPITAL EXPENDITURES


Three months ended Six months ended
June 30, June 30,
($thousands) 2008 2007 2008 2007
----------------------------------------------------------------------------
Exploration and development
Land and lease acquisitions 1,298 632 1,614 1,055
Geological and geophysical - 28 - 28
Drilling, completions and workovers 21,254 668 66,513 16,502
Well equipment and facilities 8,982 4,767 21,328 16,378
Corporate assets 170 - 170 -
----------------------------------------------------------------------------
31,704 6,095 89,625 33,963
Property acquisitions, net of
dispositions 621 6,324 1,810 6,324
Corporate acquisitions 133,861 220,004 133,861 220,004
Conversion of exchangeable shares - 8,802 - 13,570
----------------------------------------------------------------------------
Total 166,186 241,225 225,296 273,861
----------------------------------------------------------------------------
----------------------------------------------------------------------------


During the second quarter of 2008, Fairborne's exploration and development expenditures totaled $31.7 million with capital expenditures financed from funds generated from operations. The Company also completed a small property acquisition and the corporate acquisition of Grand Banks during the second quarter of 2008. The Grand Banks corporate takeover was financed primarily through Fairborne's bank credit facilities. Tangible capital expenditures during the three months ended June 30, 2008 included the completion of the de-bottlenecking project at the Harlech gas facility as well as the purchase of a compressor for the Columbia/Harlech area. Fairborne was also active in provincial land sales resulting in $1.3 million spent during the quarter to acquire new lands in core areas including Columbia/Harlech.

Fairborne spent $21.3 million on drilling and completion activities in the second quarter of 2008 with a total of five wells (3.8 net) drilled resulting in one oil well (1.0 net), three natural gas wells (2.1 net) and one coal bed methane ("CBM") well (0.7 net) with a 100% success rate. The oil well which was drilled on the Sinclair, Manitoba property was started by Grand Banks and completed by Fairborne in June 2008. The remaining second quarter drilling activities were focused on Fairborne's Columbia/Harlech, Clive and Deep Basin properties, with one well (1.0 net) drilled in Columbia/Harlech, one well (0.7 net) drilled on the Company's Clive property and two wells (1.1 net) drilled in the Deep Basin area. Drilling operations on new wells in Sinclair, Harlech and the Deep Basin also began in the second quarter but will not be completed until the third quarter of 2008.

WORKING CAPITAL AND BANK INDEBTEDNESS

In June 2008, in conjunction with the Grand Banks acquisition, Fairborne's credit facilities were increased to $255 million, including a $240 million extendible revolving term credit facility and a $15 million demand operating credit facility on the same terms and conditions of the existing facility. At June 30, 2008, Fairborne had drawn $181.0 million against its credit facilities and had a working capital deficit of $7.4 million (December 31, 2007 - working capital deficit of $7.5 million) for a net debt position of $188.3 million. The increase in net debt during the second quarter from $112.9 million at the end of March 2008 was primarily attributable to the purchase of Grand Banks in June 2008 and was partially offset by funds received from the $28.4 million flow through equity financing completed in May 2008.

Fairborne actively manages its capital structure. The Company's objective when managing capital is to maintain a flexible capital structure which will allow it to execute its capital investment program, including investing in oil and gas activities which may or may not be successful. As a result, Fairborne continually strives to balance the proportion of debt and equity in its capital structure to take into account the level of risk being incurred in its capital expenditures.

In order to maintain or adjust the capital structure, Fairborne considers various factors including: its forecasted debt to forecasted funds from operations ratio while attempting to finance an acceptable investment program including incremental investment and acquisition opportunities; the current level of bank credit available from the banking syndicate; the level of bank credit that may be obtainable from the banking syndicate as a result of reserve growth; the availability of other sources of debt with different characteristics than the existing bank debt; the sale of assets; limiting the size of the investment program; and new common equity if available on favorable terms.

CONVERTIBLE DEBENTURES

Fairborne had 100,000 Convertible Unsecured Subordinated Debentures outstanding at June 30, 2008 with a principal amount 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. The Debentures mature on December 31, 2011 and 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.

SHAREHOLDERS' EQUITY

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

During the six months ended June 30, 2008, 264,262 shares were issued on the vesting of Performance and Restricted Units and 82,472 shares were issued on the exercise of outstanding warrants. On May 28, 2008, 2.3 million shares were issued as a result of the equity financing.

On May 29, 2008, at the Company's Annual and Special Meeting, shareholders voted in favour of a stock option plan. In July 2008, 6.6 million stock options were issued to Fairborne employees, officers and directors at an average exercise price of $12.85. In conjunction with the issuance of the stock options, most of the retention awards granted to Fairborne employees, officers and directors in December 2007 have been capped at a ceiling price of $12.85 and no additional retention awards will be granted.

The following table provides a summary of outstanding common shares, warrants, convertible debentures, shares under Incentive Plans and stock options at the dates indicated:



----------------------------------------------------------------------------
July 31, June 30, December 31,
(thousands) 2008 2008 2007
----------------------------------------------------------------------------
Common shares 86,931 86,929 84,282
Warrants (1) 4,411 4,416 4,627
Convertible debentures (2) $100,000 $100,000 $100,000
Incentive plans
Restricted Units (3) 78 78 176
Performance Units (4) 204 204 356
Stock options 6,632 - -
Weighted average common shares
Basic n/a 84,764 58,856
Diluted n/a 85,211 60,729
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(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 Restricted Units entitle the holders to acquire an aggregate of
91,429 common shares of the Company, subject to vesting in accordance
with the restricted unit and performance unit incentive plan (the
"Incentive Plan").
(4) The Performance Units entitle the holders to acquire an aggregate of
187,565 common shares of the Company, subject to vesting in accordance
with the Incentive Plan.


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. Fairborne will continue to monitor government announcements and proposal revisions as they become available.

CHANGE IN ACCOUNTING POLICIES AND RECENT ACCOUNTING PRONOUNCEMENTS

FINANCIAL INSTRUMENTS - DISCLOSURES

On January 1, 2008, Fairborne adopted the new Canadian Institute of Chartered Accountants ("CICA") Handbook Section 3862 Financial Instruments - Disclosures which applies to both recognized and unrecognized financial instruments. These disclosures, which include the nature and extent of risks arising from financial instruments, are included in Note 8 of the interim consolidated financial statements.

CAPITAL DISCLOSURES

On January 1, 2008, Fairborne adopted the new recommendations of the CICA, Handbook section 1535, for disclosure of the Company's objectives, policies and processes for managing capital as discussed in Note 7(g) of the interim consolidated financial statements.

INTERNATIONAL FINANCIAL REPORTING STANDARDS ("IFRS")

The Canadian Accounting Standards Board has confirmed that the use of IFRS will be required for public companies beginning January 1, 2011. Fairborne understands that the Canadian Securities Administrators are in the process of examining changes to securities rules as a result of this initiative. Fairborne is in the process of assessing the impact of adopting IFRS in order to formulate an implementation plan for the transition.

CONTROLS AND PROCEDURES

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 control 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 control over financial reporting. No material changes in Fairborne's internal control over financial reporting were identified during the three months ended June 30, 2008, that has materially affected, or are reasonably likely to materially affect, the Company's internal control of financial reporting.

It should be noted that a control system, including Fairborne'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.



QUARTERLY FINANCIAL INFORMATION

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

----------------------------------------------------------------------------
2008 2008 2007(1) 2007(1)
Q2 Q1 Q4 Q3
----------------------------------------------------------------------------

FINANCIAL ($thousands, except per share amounts)

Petroleum and natural gas sales 85,670 70,618 59,976 54,648
Funds generated from operations 51,458 42,101 29,363 27,164
Per share - basic $0.60 $0.50 $0.43 $0.41
Per share - diluted $0.60 $0.50 $0.43 $0.38
Cash flow from operations
(including changes in working capital) 41,650 42,857 36,004 24,159
Per share - basic $0.49 $0.51 $0.53 $0.37
Per share - diluted $0.48 $0.51 $0.53 $0.34
Net Income (loss) 3,717 10,145 (1,136) 2,271
Per share - basic $0.04 $0.12 ($0.03) $0.03
Per share - diluted $0.04 $0.12 ($0.03) $0.03
Total assets 946,025 792,918 749,715 732,276
Working capital deficit (7,363) (27,255) (7,467) (27,051)
Bank indebtedness 180,977 85,634 86,866 159,834
Convertible debentures 93,499 92,977 92,455 91,933
----------------------------------------------------------------------------

OPERATIONS

Average production
Natural gas (Mcf per day) 59,529 56,813 59,194 58,435
Crude oil (bbls per day) 2,506 2,413 2,616 2,600
Natural gas liquids (bbls per day) 610 597 524 582
Sulphur (tonnes per day) 106 210 - -
----------------------------------------------------------------------------
Total (BOE per day) 13,143 12,689 13,005 12,921
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Amounts shown prior to the effective date of the Reorganization are in
respect of the Trust and per share numbers are per unit.

----------------------------------------------------------------------------
2007 2007 2006 2006
Q2 Q1 Q4 Q3
----------------------------------------------------------------------------

FINANCIAL ($thousands, except per unit amounts)

Petroleum and natural gas sales 49,501 49,666 49,581 48,845
Funds generated from operations 25,547 26,033 26,108 27,825
Per unit - basic $0.48 $0.55 $0.54 $0.58
Per unit - diluted $0.44 $0.48 $0.43 $0.51
Cash flow from operations (including
changes in working capital) 27,724 27,750 10,189 29,969
Per unit - basic $0.52 $0.59 $0.21 $0.63
Per unit - diluted $0.47 $0.52 $0.15 $0.55
Net Income 6,739 7,160 8,900 10,439
Per unit - basic $0.13 $0.15 $0.18 $0.22
Per unit - diluted $0.11 $0.15 $0.17 $0.22
Total assets 753,661 561,906 539,579 514,681
Working capital surplus (deficit) 11,594 7,093 7,158 (2,395)
Bank indebtedness 179,120 119,645 101,156 177,595
Convertible debentures 91,389 90,819 90,302 -
----------------------------------------------------------------------------

OPERATIONS

Average production
Natural gas (Mcf per day) 48,689 45,060 46,752 45,966
Crude oil (bbls per day) 2,303 2,396 2,522 2,604
Natural gas liquids (bbls per day) 449 402 308 376
----------------------------------------------------------------------------
Total (BOE per day) 10,867 10,308 10,623 10,640
----------------------------------------------------------------------------
----------------------------------------------------------------------------


INTERIM CONSOLIDATED BALANCE SHEETS
(Unaudited)

----------------------------------------------------------------------------
June 30, December 31,
($thousands) 2008 2007
----------------------------------------------------------------------------

Assets

Current assets
Cash and cash equivalents $ 850 $ 116
Accounts receivable 68,039 45,485
Prepaid expenses and deposits 5,998 6,015
----------------------------------------------------------------------------
74,887 51,616
Petroleum and natural gas properties and equipment
(Note 3) 854,968 681,929
Goodwill 16,170 16,170
----------------------------------------------------------------------------
$946,025 $749,715
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Liabilities

Current liabilities
Accounts payable and accrued liabilities $ 72,318 $ 58,954
Current portion of compensation plan (Note 7) 9,932 129
----------------------------------------------------------------------------
82,250 59,083
Bank indebtedness (Note 4) 180,977 86,866
Convertible debentures (Note 5) 93,499 92,455
Compensation plan (Note 7) 8,365 -
Asset retirement obligation (Note 6) 10,812 9,084
Future income taxes 70,017 45,039

Shareholders' Equity

Common shares (Note 7) 475,928 445,105
Warrants (Note 7) 2,727 2,857
Equity component of convertible debentures (Note 5) 5,581 5,581
Contributed surplus (Note 7) 1,656 3,294
Retained earnings 14,213 351
----------------------------------------------------------------------------
500,105 457,188
----------------------------------------------------------------------------

Commitment (Note 7(a))

Subsequent event (Note 7(e))
$946,025 $749,715
----------------------------------------------------------------------------
----------------------------------------------------------------------------
See accompanying notes to the interim consolidated financial statements


INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS
(DEFICIT)
(Unaudited)

----------------------------------------------------------------------------
For the three months For the six months
ended June 30, ended June 30,
($thousands except per share amounts) 2008 2007 2008 2007
----------------------------------------------------------------------------

Revenue
Petroleum and natural gas $ 85,670 $ 49,501 $156,288 $ 99,167
Royalties (15,989) (8,722) (28,298) (17,516)
----------------------------------------------------------------------------
69,681 40,779 127,990 81,651

Expenses
Operating 11,606 7,916 21,037 17,103
Transportation 1,126 465 2,163 1,469
General and administrative 20,604 5,253 25,463 8,777
Interest 3,584 4,303 6,915 8,046
Depletion, depreciation and
accretion 27,984 22,825 52,940 42,195
----------------------------------------------------------------------------
64,904 40,762 108,518 77,590
----------------------------------------------------------------------------

Income before taxes and
non-controlling interest 4,777 17 19,472 4,061
Future taxes (reduction) 1,060 (7,026) 5,610 (10,805)
----------------------------------------------------------------------------

Net income before non-controlling
interest 3,717 7,043 13,862 14,866
Non-controlling interest - 304 - 967
----------------------------------------------------------------------------

Net income and comprehensive income 3,717 6,739 13,862 13,899
Retained earnings (deficit),
beginning of period 10,496 (35,356) 351 (26,135)
Retained earnings adjustment,
financial instruments - - - 404
Distributions declared - (14,723) - (31,508)
----------------------------------------------------------------------------
Retained earnings (deficit), end of
period $ 14,213 $(43,340) $ 14,213 $(43,340)
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Net income per share (Note 7)

Basic $ 0.04 $ 0.13 $ 0.16 $ 0.28

Diluted $ 0.04 $ 0.11 $ 0.16 $ 0.26
----------------------------------------------------------------------------
----------------------------------------------------------------------------
See accompanying notes to the interim consolidated financial statements


INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

----------------------------------------------------------------------------
For the three months For the six months
ended June 30, ended June 30,
($thousands) 2008 2007 2008 2007
----------------------------------------------------------------------------
Cash provided by (used in):

Operating activities
Net income $ 3,717 $ 6,739 $ 13,862 $ 13,899
Items not involving cash:
Depletion, depreciation and
accretion 27,984 22,825 52,940 42,195
Non-controlling interest - 304 - 967
Compensation expense 17,251 1,869 19,257 3,658
Future taxes (reduction) 1,060 (7,026) 5,610 (10,805)
Accretion of convertible
debentures 522 570 1,044 1,087
Unrealized loss on derivatives 924 266 846 579
Asset retirement expenditures (59) (8) (297) (198)
----------------------------------------------------------------------------
51,399 25,539 93,262 51,382
Change in non-cash working capital (9,749) 2,185 (8,755) 4,092
----------------------------------------------------------------------------
41,650 27,724 84,507 55,474
----------------------------------------------------------------------------
Financing activities
Bank indebtedness 83,758 59,475 82,526 77,964
Issuance of common shares, net of
costs 27,597 111 27,597 111
Distributions to unitholders - (13,188) - (31,804)
Change in non-cash working capital - (32,732) - (32,732)
----------------------------------------------------------------------------
111,355 13,666 110,123 13,539
----------------------------------------------------------------------------
Investing activities
Expenditures on petroleum and
natural gas properties (31,704) (6,095) (89,625) (33,963)
Acquisition of petroleum and
natural gas properties (621) (6,324) (1,810) (6,324)
Corporate acquisitions
(Note 2) (102,054) (2,500) (102,054) (2,500)
Change in non-cash working capital (17,978) (27,015) (407) (26,759)
----------------------------------------------------------------------------
(152,357) (41,934) (193,896) (69,546)
----------------------------------------------------------------------------
Change in cash and cash
equivalents 648 (544) 734 (533)
Cash and cash equivalents,
beginning of period 202 775 116 764
----------------------------------------------------------------------------
Cash and cash equivalents, end of
period $ 850 $ 231 $ 850 $ 231
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Interest paid $ 4,796 $ 6,459 $ 5,584 $ 7,722
----------------------------------------------------------------------------
----------------------------------------------------------------------------
See accompanying notes to the interim consolidated financial statements


SELECTED NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS
For the six months ended June 30, 2008 (unaudited)
(tabular amounts are stated in thousands and thousands of dollars except per
share amounts)


The interim consolidated financial statements of Fairborne Energy Ltd. (the "Company" or "Fairborne") have been prepared by management in accordance with accounting principles generally accepted in Canada. The interim consolidated financial statements have been prepared following the same accounting policies and methods of computation as the consolidated financial statements for the year ended December 31, 2007, except as noted below. The disclosure which follows is incremental to the disclosure included with the annual financial statements. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2007.

1. CHANGES IN ACCOUNTING POLICIES AND PRACTICES

FINANCIAL INSTRUMENTS - DISCLOSURES

On January 1, 2008, Fairborne adopted the new Canadian accounting standards with respect to disclosures of financial instruments which applies to both recognized and unrecognized financial instruments. These disclosures, which include the nature and extent of risk arising from the financial instruments and how Fairborne manages those risks, are included in Note 8.

CAPITAL DISCLOSURES

On January 1, 2008, Fairborne adopted the new Canadian accounting standards with respect to disclosures regarding the Company's objectives, policies and processes for managing capital. These disclosures are included in Note 7(g).

2. ACQUISITIONS

On June 12, 2008, Fairborne acquired all of the outstanding shares of Grand Banks Energy Corporation ("Grand Banks") pursuant to a takeover bid. Grand Banks was a publicly traded junior exploration and production company with operations focused in southeast Saskatchewan, southwest Manitoba and west central Alberta. As consideration for the transaction, Grand Banks shareholders received $2.90 for each Grand Banks common share held. The acquisition has been accounted for using the purchase method. The results of operations for Grand Banks have been included in the Company's financial statements beginning June 13, 2008. Preliminary details of the acquisition are as follows and are subject to change:



----------------------------------------------------------------------------
Cost of Acquisition:
Cash $ 101,704
Transaction costs 350
----------------------------------------------------------------------------
$ 102,054
----------------------------------------------------------------------------
Allocated:
Current assets $ 6,712
Petroleum and natural gas properties and equipment 133,861
Current liabilities (5,855)
Bank indebtedness (11,585)
Asset retirement obligation (1,342)
Future income taxes (19,737)
----------------------------------------------------------------------------
$ 102,054
----------------------------------------------------------------------------
----------------------------------------------------------------------------


3. PETROLEUM AND NATURAL GAS PROPERTIES AND EQUIPMENT

----------------------------------------------------------------------------
June 30, December 31,
2008 2007
----------------------------------------------------------------------------
Petroleum and natural gas properties and
equipment $ 1,200,184 $ 974,780
Accumulated depletion and depreciation (347,171) (294,701)
Corporate assets 3,815 3,672
Accumulated depreciation (1,860) (1,822)
----------------------------------------------------------------------------
$ 854,968 $ 681,929
----------------------------------------------------------------------------
----------------------------------------------------------------------------


As at June 30, 2008, future development costs of $122.2 million (December 31, 2007 - $126.0 million) were included in the depletion calculation and costs of acquiring unproved properties in the amount of $53.2 million (December 31, 2007 - $50.0 million) were excluded from the depletion calculation.

4. BANK INDEBTEDNESS

At June 30, 2008, the Company had a $240 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 the Company's petroleum and natural gas properties. The extendible revolving term facility is available on a revolving basis until May 30, 2009 (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 will be cancelled and the amount outstanding will 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, 2010. 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 June 30, 2008, letters of credit totaling $0.6 million were outstanding.



5. CONVERTIBLE DEBENTURES

The following table sets forth a reconciliation of the convertible
debentures for the six months ended June 30, 2008:

----------------------------------------------------------------------------
Number of Debt Equity
Debentures component component
----------------------------------------------------------------------------
Balance, beginning of period 100,000 $ 92,455 $ 5,581
Accretion - 1,044 -
----------------------------------------------------------------------------
Balance, end of period 100,000 $ 93,499 $ 5,581
----------------------------------------------------------------------------
----------------------------------------------------------------------------


6. ASSET RETIREMENT OBLIGATION

The following table sets forth a reconciliation of the asset retirement
obligation for the six months ended June 30, 2008:

----------------------------------------------------------------------------
Balance, beginning of period $ 9,084
Grand Banks acquisition 1,342
Liabilities incurred 277
Liabilities settled (297)
Accretion expense 406
----------------------------------------------------------------------------
Balance, end of period $ 10,812
----------------------------------------------------------------------------
----------------------------------------------------------------------------


7. SHAREHOLDERS' EQUITY

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

The following table sets forth a reconciliation of the common shares issued
and outstanding for the six months ended June 30, 2008:

----------------------------------------------------------------------------
Number
of Shares Amount
----------------------------------------------------------------------------
Balance, beginning of period 84,282 $ 445,105
Flow through shares issued for cash 2,300 28,405
Issued on vesting of Restricted Units and
Performance Units 264 2,727
Issued on exercise of warrants 83 800
Share issue costs - (1,478)
Future tax benefit of issue costs - 369
----------------------------------------------------------------------------
Balance, end of period 86,929 $ 475,928
----------------------------------------------------------------------------
----------------------------------------------------------------------------


As a result of the flow-through financing, Fairborne has a commitment to spend $28.4 million on qualifying Canadian exploration expenditures. The expenditures will be renounced to investors on or before December 31, 2008. As at June 30, 2008, $2.3 million of qualifying exploration expenditures have been incurred.



b) WARRANTS

The following table sets forth a reconciliation of the warrants issued and
outstanding for the six months ended June 30, 2008:

----------------------------------------------------------------------------
Number
of Warrants Amount
----------------------------------------------------------------------------
Balance, beginning of period 4,627 $ 2,857
Exercised for common shares (211) (130)
----------------------------------------------------------------------------
Balance, end of period 4,416 $ 2,727
----------------------------------------------------------------------------
----------------------------------------------------------------------------

c) PER SHARE AMOUNTS

The following table summarizes the weighted average common shares and, prior
to December 19, 2007, trust units used in calculating net income per share:

----------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30,
2008 2007 2008 2007
----------------------------------------------------------------------------
Numerator
Net income - basic $ 3,717 $ 6,739 $ 13,862 $ 13,899
Non-controlling interest - 304 - 967
----------------------------------------------------------------------------
Numerator for diluted net income
per share $ 3,717 $ 7,043 $ 13,862 $ 14,866
----------------------------------------------------------------------------
Denominator
Weighted average shares - basic 85,234 52,622 84,764 50,178
Exchangeable Shares - 4,000 - 4,293
Restricted Units 142 877 138 863
Performance Units 291 1,007 309 979
----------------------------------------------------------------------------
Denominator for diluted net income
per share 85,667 58,506 85,211 56,313
----------------------------------------------------------------------------
Basic net income per share $ 0.04 $ 0.13 $ 0.16 $ 0.28
Diluted net income per share $ 0.04 $ 0.11 $ 0.16 $ 0.26
----------------------------------------------------------------------------


Excluded from the diluted number of shares for the six months ended June 30, 2008 and June 30, 2007 is the effect of convertible debentures (7.4 million shares) which are anti-dilutive to net income.



d) INCENTIVE PLAN

The following table sets forth a reconciliation of the equity based
incentive plan activity for the six months ended June 30, 2008.

----------------------------------------------------------------------------
Number of Number of
Restricted Performance
Units Units Total
----------------------------------------------------------------------------
Balance, beginning of period 176 356 532
Exercised (98) (152) (250)
----------------------------------------------------------------------------
Balance, end of period 78 204 282
----------------------------------------------------------------------------
Exercisable, end of period - - -
----------------------------------------------------------------------------
Equivalent common shares, end of period (1) 91 188 279
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) including additional common shares to be issued for accumulated
distributions earned prior to the reorganization of Fairborne Energy
Trust on December 19, 2007 (the "Reorganization") and adjusted for the
performance factor set in connection with the Reorganization.

e) RETENTION AWARD PLAN

The following table sets forth a reconciliation of the retention award plan
activity for the six months ended June 30, 2008:

----------------------------------------------------------------------------
Number Weighted
of average
Awards exercise
price
----------------------------------------------------------------------------
Balance, beginning of period 7,420 $ 5.75
Granted 975 6.88
Forfeited (365) 5.78
----------------------------------------------------------------------------
Balance, end of period 8,030 $ 5.89
----------------------------------------------------------------------------
----------------------------------------------------------------------------


In July 2008, 6.6 million stock options were issued at an average exercise price of $12.85. Options vest over a three year period and expire five years from the date of grant. In conjunction with the issuance of the stock options, most of the retention awards granted in December 2007 have been capped at a ceiling price of $12.85 and no additional retention awards will be granted.



f) CONTRIBUTED SURPLUS

The following table sets forth a reconciliation of the contributed surplus
for the six months ended June 30, 2008:

----------------------------------------------------------------------------
Balance, beginning of period $ 3,294
Equity based compensation 1,089
Restricted and Performance Units exercised (2,727)
----------------------------------------------------------------------------
Balance, end of period $ 1,656
----------------------------------------------------------------------------
----------------------------------------------------------------------------


g) MANAGEMENT OF CAPITAL STRUCTURE

Fairborne actively manages its capital structure which includes shareholders' equity, bank debt, convertible debentures, compensation plan liabilities and working capital. In order to maintain or adjust the capital structure, Fairborne considers the following: incremental investment and acquisition opportunities; the current level of bank credit available from the banking syndicate; the level of bank credit that may be obtainable from the banking syndicate as a result of reserve growth; the availability of other sources of debt with different characteristics than the existing bank debt; the sale of assets; limiting the size of the investment program; and new share issuances if available on favorable terms. The Company's objective is to maintain a flexible structure that will allow it to execute its investment program, including exploration and development of its oil and gas properties and acquisition and disposition transactions which all carry varying amounts of risk. Fairborne continually strives to balance the proportion of debt and equity in its capital structure to take into account the level of risk being incurred in its investment program. Fairborne may from time to time issue shares and adjust its capital spending to manage current and projected debt levels.

The Company monitors capital based on the ratio of net debt to annualized cash flow. This ratio is calculated as net debt, defined as outstanding bank debt plus or minus working capital, divided by annualized cash flow from operations before changes in non-cash working capital and asset retirement expenditures. Fairborne's current strategy is to maintain a ratio of no more than 1 to 1. This ratio may increase at certain times as a result of acquisitions as it did on June 30, 2008 (1.01 to 1) with the acquisition of Grand Banks on June 12, 2008. In order to facilitate the management of this ratio, the Company prepares annual budgets, which are updated as necessary depending on varying factors including current and forecast prices, successful capital deployment and general industry conditions. The annual and updated budgets are approved by the Board of Directors.

8. FINANCIAL INSTRUMENTS

The Company has exposure to the following risks from its use of financial instruments:

- Credit risk

- Liquidity risk

- Market risk

a) CREDIT RISK:

Credit risk is the risk of a financial loss to the Company if a customer or counterparty to a financial instrument fails to meet its contractual obligation and arises principally from joint venture partners and natural gas marketers. Virtually all of Fairborne's accounts receivable are from counterparties in the oil and gas industry and are subject to normal industry credit risks. As at June 30, 2008, the Company's accounts receivable consisted of $27.8 million from joint venture partners, $38.6 million from petroleum and natural gas marketers and $1.6 million of other trade receivables.

The carrying amount of accounts receivable and cash and cash equivalents represents the maximum credit exposure. Fairborne does not have an allowance for doubtful accounts as at June 30, 2008 and did not provide for any doubtful accounts nor was it required to write-off any receivables during the six months ended June 30, 2008. The amounts outstanding for more than 90 days are predominantly due from large well established joint venture partners.



As at June 30, 2008, the Company's accounts receivable is aged as follows:

----------------------------------------------------------------------------
Aging
----------------------------------------------------------------------------
Current (less than 90 days) $ 60,146
Past due (more than 90 days) 7,893
----------------------------------------------------------------------------
Total $ 68,039
----------------------------------------------------------------------------
----------------------------------------------------------------------------


b) LIQUIDITY RISK:

Liquidity risk relates to the risk that a company will not be able to meet its financial obligations as they become due. Fairborne's financial liabilities on the balance sheet consist of accounts payable, bank debt, incentive plan liabilities and convertible debentures. The Company expects to satisfy obligations under accounts payable in less than one year. Fairborne has a revolving reserve based credit facility and demand loan facility as outlined in Note 4. The credit facility is available on a revolving basis which converts to a 365 day facility if not extended by the lenders and the convertible debentures mature on December 31, 2011. Fairborne anticipates it will have adequate liquidity to fund its financial liabilities as they come due. The Company has no defaults or breaches on its bank debt or any of its financial liabilities.

c) MARKET RISK:

Market risk is the risk that fluctuations in currency rates, interest rates and commodity prices will affect a Company's income or the value of its financial assets and liabilities.

Foreign currency exchange rate risk

Foreign currency exchange rate risk is the risk that the fair value or future cash flows will fluctuate as a result of changes in foreign exchange rates. The underlying market prices in Canada for petroleum and natural gas are impacted by changes in the exchange rate between the Canadian and United States dollar. In general, while the underlying foreign exchange rate affects oil and natural gas prices, Fairborne does not sell a significant amount of oil or natural gas denominated in U.S. dollars. Settlement of fixed price physical sales contracts denominated in U.S. dollars would have been directly impacted by changes in the foreign exchange rate. If the foreign exchange rate had changed by $0.10 during the second quarter of 2008, after tax net earnings would have changed by $0.3 million as a result of the impact on the settlement of these contracts. Currency risk has no significant impact on the value of financial assets and liabilities on the balance sheet at June 30, 2008 as the majority of the Company's financial instruments are denominated in Canadian dollars.

Commodity price risk

Commodity price risk is the risk that the fair value or future cash flows will fluctuate as a result of changes in commodity prices. Commodity prices for petroleum and natural gas are impacted by not only the relationship between the Canadian dollar and United States dollar, as outlined above, but also world economic events that dictate the levels of supply and demand. Fairborne has attempted to mitigate commodity price risk through the use of various financial derivatives and physical delivery sales contracts as outlined in Note 9. These contracts resulted in a settlement loss of $0.8 million for the six months ended June 30, 2008 which have been included in petroleum and natural gas sales. In addition, fixed price physical delivery contracts for oil and natural gas that settled during the quarter ended June 30, 2008 reduced realized revenue by $3.9 million for the natural gas contracts and reduced realized revenue by $4.7 million for the oil contracts. As at June 30, 2008, a one dollar change to the price per barrel of oil would have an impact to net earnings of approximately $0.4 million for the second quarter of 2008 and a $0.25 change to the price per thousand cubic feet of natural gas would have an impact to second quarter net earnings of approximately $2.0 million.

Interest rate risk

Interest rate risk is the risk that future cash flows will fluctuate as a result of changes in market interest rates. The Company is exposed to interest rate risk on its bank debt which has a floating interest rate. The convertible debentures do not bear interest rate risk as they are at a fixed rate. An increase in interest rates of 1% would reduce net income for the six months ended June 30, 2008 by approximately $1.4 million based on the average amount of bank debt outstanding during the quarter. An opposite impact would have occurred to net income had interest rates decreased 1%. The Company had no interest rate hedges or swaps outstanding at June 30, 2008.

d) FAIR VALUE OF FINANCIAL INSTRUMENTS:

The carrying value of Fairborne's financial instruments, other than bank indebtedness and 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 June 30, 2008 was $111.2 million.

9. COMMODITY CONTRACTS

Fairborne 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 June 30, 2008, the following natural gas and crude oil contracts have been recorded at their estimated fair value as an $834,000 liability. The corresponding amount has been recorded in petroleum and natural gas sales as an unrealized loss on derivatives for the six months ended June 30, 2008.



Natural Gas:

----------------------------------------------------------------------------
Volume Price Settlement
Remaining Term (GJ per day) (CDN$ per GJ) Index
----------------------------------------------------------------------------
Swaps
Jul 1, 2008
- Sep 30, 2008 5,000 9.28 AECO C Monthly
Jul 1, 2008
- Oct 31, 2008 3,000 9.32 + 50% participating AECO C Monthly
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Oil:
----------------------------------------------------------------------------
Volume Price
Remaining Term (bbls per day) (US$ per bbl) Settlement Index
----------------------------------------------------------------------------
Collar
Jan 1, 2009 - Dec 31, 2009 500 90.00 - 204.75 WTI
----------------------------------------------------------------------------
----------------------------------------------------------------------------


b) COMMODITY CONTRACTS NOT RECORDED AT FAIR VALUE:

The following crude oil and natural gas fixed price physical sales contracts outstanding at June 30, 2008 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
----------------------------------------------------------------------------
Collars
Jul 1, 2008 - Dec 31, 2008 500 70.00 - 74.00 WTI
Jul 1, 2008 - Dec 31, 2008 500 80.00 - 100.50 WTI
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Natural Gas:

----------------------------------------------------------------------------
Volume Price
Remaining Term (GJ per day) (CDN$ per GJ) Settlement Index
----------------------------------------------------------------------------
AECO Collars
Jul 1, 2008 - Oct 31, 2008 2,000 8.00 - 10.05 AECO C Daily
Jul 1, 2008 - Oct 31, 2008 2,000 8.00 - 9.15 AECO C Daily
Nov 1, 2008 - Mar 31, 2008 3,500 9.00 - 17.00 AECO C Monthly
----------------------------------------------------------------------------
----------------------------------------------------------------------------

AECO Swaps
Jul 1, 2008 - Oct 31, 2008 2,000 8.05 AECO C Monthly
Jul 1, 2008 - Oct 31, 2008 2,000 8.04 AECO C Monthly
Jul 1, 2008 - Oct 31, 2008 2,000 7.39 AECO C Monthly
Jul 1, 2008 - Dec 31, 2008 1,000 7.53 AECO C Monthly
Jul 1, 2008 - Dec 31, 2008 1,500 6.52 AECO C Monthly
Jul 1, 2008 - Dec 31, 2008 2,638 7.015 AECO C Monthly
Nov 1, 2008 - Mar 31, 2009 5,000 8.02 AECO C Monthly
----------------------------------------------------------------------------
----------------------------------------------------------------------------


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