Fairquest Energy Limited
TSX : FQE

Fairquest Energy Limited

November 07, 2005 22:39 ET

Fairquest Reports Results for its First Four Months of Operations

CALGARY, ALBERTA--(CCNMatthews - Nov. 7, 2005) - Fairquest Energy Limited (TSX:FQE):



HIGHLIGHTS
------------------------------------------------------------------------
Three months Four months
ended ended
September 30, September 30,
2005 2005
------------------------------------------------------------------------

Financial ($ thousands,except per share amounts)
Petroleum and natural gas revenue 5,599 7,059
Funds generated from operations 2,993 3,732
Per share - basic $ 0.12 $ 0.15
Per share - diluted $ 0.10 $ 0.13
Net income 467 586
Per share - basic $ 0.02 $ 0.02
Per share - diluted $ 0.02 $ 0.02
Exploration and development expenditures 20,280 21,032
Acquisitions,net of dispositions 40,955 40,955
Total assets 81,848 81,848
------------------------------------------------------------------------
------------------------------------------------------------------------

Operations (units as noted)
Production
Natural gas (Mcf per day) 5,664 5,627
Natural gas liquids (bbls per day) 112 113
Total (BOE per day) 1,056 1,051
Average sales price
Natural gas ($ per Mcf) 9.41 8.93
Natural gas liquids ($ per bbl) 67.28 67.21
Netback per BOE ($ per BOE)
Petroleum and natural gas sales 57.62 55.07
Royalties (12.74) (12.14)
Transportation (1.41) (1.38)
Operating expenses (7.78) (7.84)
------------------------------------------------------------------------
Operating netback 35.69 33.71
Wells drilled (gross) 13 13
------------------------------------------------------------------------
------------------------------------------------------------------------


MESSAGE TO SHAREHOLDERS

Fairquest Energy Limited ("Fairquest" or the "Company") is pleased to present the results of its operations for the three month and four month periods ended September 30, 2005. Fairquest commenced commercial operations on June 1, 2005 pursuant to a Plan of Arrangement under which Fairborne Energy Ltd. ("Fairborne") reorganized its affairs and created Fairborne Energy Trust, that acquired approximately 90% of Fairborne's oil and gas properties, and Fairquest which acquired the balance of Fairborne's oil and gas properties and certain undeveloped lands. As a result of the Plan of Arrangement, Fairquest initially acquired 68,000 net acres of prospective undeveloped lands and entered into farm-in agreements whereby Fairquest received an option to farm-in on 83,000 net acres of Fairborne lands, retained by Fairborne Energy Trust. This land inventory, with extensive drill ready prospects, provides Fairquest with an extensive portfolio of exploration and development opportunities.

Fairquest commenced an active drilling program during the third quarter drilling 13 (5.0 net) wells in the quarter with a 100% success rate resulting in 9 (3.7 net) natural gas wells and 4 (1.3 net) oil wells. Fairquest's current activity is concentrated in West Central Alberta at West Pembina/Columbia Harlech and the Deep Basin, which combined represents 87 percent of the capital program. Fairquest's capital program during the quarter totaled $20.3 million and the budget is approximately $30 million for capital expenditures in the fourth quarter of 2005 to tie in production from the third quarter drilling program, drill an additional 10 (4.5 net) wells and acquire land as well as to conduct a 3-D seismic program in three areas. New production from wells presently drilled and completed is expected to add between 400 and 500 BOE per day of production by year end. Capital expenditures for 2006 are estimated at $75 million to $80 million.

To permit the Company to accelerate the development of its extensive land base Fairquest entered into an agreement, in September, 2005, with a syndicate of underwriters to issue, on a "bought deal" private placement basis, 1,000,000 common shares at a price of $10.00 per share and 1,000,000 flow-through common shares at a price of $13.00 per flow-through common share, resulting in gross proceeds of $23 million. Flow-through expenditures on Canadian exploration expenses will be renounced to subscribers effective on or before December 31, 2005. This issue closed on October 12, 2005.

OPERATIONS:

Fairquest's production for the three months ended September 30, 2005 averaged 1,056 BOE per day consisting of 5.7 MMcf per day of natural gas and 112 barrels per day of natural gas liquids. High gas and oil prices resulted in funds generated from operations for the three months of $3 million ($0.12 per share). Fairquest's completion and tie-in operations have been hampered and delayed by serious wet weather conditions during the months of June, August and again in September. Weather conditions have improved measurably thus far in the fourth quarter with fewer delays in drilling, completion, and facilities construction and it is expected that production levels will be approximately 1,500 BOE per day by the end of 2005.

Fairquest's original capital budget for the seven month period of 2005 had been established at $35 million but has been increased to $50 million with an additional $30 million planned for the first quarter of 2006. This program should result in the drilling of approximately 30 wells in the next six months.

Since June 1, 2005 Fairquest has been active in four main areas:

West Pembina/Columbia Harlech:

West Pembina/Columbia Harlech accounts for 60 percent of the Company's current production and Fairquest either owns or has farm-in rights on 125 sections (80,000 gross acres) in this area. This is the Company's most active area of operations and since June, ten (3.9 net) wells have been drilled for prospective gas and oil targets ranging in depth from 1650 meters to 4000 meters. All wells have been cased and eight have been completed to date resulting in five gas wells and three oil wells. The Company currently is drilling a 4000 meter Nisku test and plans to drill 20 (9.0 net) wells in this area from now until April 2006. The majority of these wells will be drilled to a depth of approximately 2000 meters to evaluate prospective sandstone reservoirs in the Belly River Formation.

Deep Basin - Wild River/Marsh

Although the Deep Basin area currently accounts for only 24 percent of the Company's production, Fairquest either owns or has farm-in rights on 140 sections (89,600 gross acres) in the Wild River, Marsh, Pedley, Lambert and Marlboro areas of the Deep Basin. Presently the Company is drilling four wells (two operated and two non-operated) in the Marsh area to test multiple Cretaceous gas targets ranging in depth from 2500 meters to 4000 meters. At Wild River the Company produces sour gas from a Nisku gas pool and plans to drill two new exploration wells to test additional Nisku reef targets identified on 3-D seismic. Both of these wells will spud in the next two months.

Central Alberta - Westerose/Pigeon Lake

Fairquest has drilled and completed four (1.4 net) wells in this area in the third quarter resulting in three (1 net) natural gas well and one suspended gas well. Production from these wells will be tied into facilities in the next 60 to 90 days. Fairquest plans to drill two (1.1 net) tests in this area for sour gas in the upper Devonian (2,200 meters) in the fourth quarter of 2005 and first quarter of 2006.

Peace River Arch

Fairquest produces gas at Rycroft and Woking and these two areas account for 16 percent of the Company's current production. One (0.34 net) well was drilled in the third quarter and it currently is being equipped and tied-in as an oil producer. In addition a suspended gas well will be connected to the Company's Rycroft gas plant in the next 30 days. In 2006 the Company currently plans to drill five wells in this area.



"signed"

Richard A. Walls
President and CEO,
November 7, 2005


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

The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") was prepared at, and is dated, November 7, 2005. This MD&A is provided by the management of Fairquest Energy Ltd. ("Fairquest" or the "Company") to review third quarter 2005 activities. This MD&A should be read in conjunction with the unaudited interim financial statements including notes for the period from commencement of operations on June 1 to September 30, 2005. Additional information relating to Fairquest, is available on SEDAR at www.sedar.com.

NATURE OF BUSINESS: Fairquest was incorporated on March 7, 2005 and commenced commercial operations on June 1, 2005 under a Plan of Arrangement involving Fairborne Energy Ltd., Fairborne Energy Trust ("Fairborne"), Fairquest and securityholders of Fairborne Energy Ltd. ("Plan of Arrangement"). Pursuant to the Plan of Arrangement, Fairquest acquired certain petroleum and natural gas properties of Fairborne Energy Ltd.

Fairquest 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. Fairquest follows a strategy of balancing risk and reward by focusing on opportunities by geographic area and prospect type. Within these select areas, Fairquest develops a portfolio of exploration and development prospects in conjunction with an active acquisition strategy.

FORWARD LOOKING STATEMENTS: This MD&A contains forward-looking statements. Forward-looking statements are based on current expectations that involve a number of risks and uncertainties which could cause events or results to differ materially from those reflected in the MD&A. Forward-looking statements are based on the estimates and opinions of Fairquest's management at the time the statements were made. Fairquest assumes no obligation to update forward-looking statements should circumstances or management's estimates change except as required by applicable law.

NON-GAAP TERMS: This document contains the terms "funds generated from operations" 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 Fairquest'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 Fairquest's performance. Fairquest's determination of funds generated from operations may not be comparable to that reported by other companies. The reconciliation between net income and funds generated from operations can be found in the statement of cash flows in the financial statements. Fairquest also presents funds generated from operations per share whereby per share amounts are calculated using weighted average shares outstanding consistent with the calculation of income per share.

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

PLAN OF ARRANGEMENT

Fairquest Energy Limited (the "Company" or "Fairquest") was incorporated on March 7, 2005 and commenced commercial operations on June 1, 2005 upon completion of a Plan of Arrangement involving Fairborne Energy Ltd., Fairborne Energy Trust ("Fairborne"), Fairquest and securityholders of Fairborne Energy Ltd. ("Plan of Arrangement"). Pursuant to the Plan of Arrangement, Fairquest acquired certain petroleum and natural gas properties of Fairborne Energy Ltd. The assets and liabilities transferred to Fairquest were accounted for on a continuity of interest basis and recorded at their carrying value.

RELATIONSHIP WITH FAIRBORNE ENERGY TRUST

As a result of the Plan of Arrangement, Fairquest and Fairborne have joint interests in certain properties and undeveloped land. In addition, the companies have entered into farm-in agreements whereby Fairquest received an option to farm-in on 83,000 net acres of Fairborne exploratory lands.

In conjunction with the Plan of Arrangement, Fairborne and Fairquest entered into a Technical Services Agreement which provides for the shared services required to manage Fairquest's activities and sets forth the allocation of general and administrative expenses between the entities. Under the Technical Services Agreement, Fairquest is charged a technical services fee by Fairborne, on a cost recovery basis, in respect of the management, development, exploitation, operations and marketing activities on the basis of relative production and capital expenditures. In addition, under the Technical Services Agreement, Fairborne markets Fairquest's natural gas and natural gas liquids. For the period June 1 to September 30, 2005 the technical services fee was $434,000. The Technical Services Agreement has no set termination date and will continue until terminated by either party with six months prior written notice to the other party or on some other date as may be mutually agreed. As contemplated in the Plan of Arrangement, the Company has issued Performance Shares to the employees of Fairborne as service providers to Fairquest.



QUARTERLY FINANCIAL INFORMATION

The following is a summary of selected financial information for the
quarterly periods indicated:
Q2
Q3 2005
2005 (June 1 to 30)
------------------------------------------------------------------------

Financial ($ thousands,except per share amounts)
Petroleum and natural gas sales, before royalties 5,599 1,460
Funds generated from operations 2,993 739
Per share - basic $ 0.12 $ 0.03
Per share - diluted $ 0.10 $ 0.03
Net Income 467 119
Per share - basic $ 0.02 $ -
Per share - diluted $ 0.02 $ -
Total assets 81,848 71,041
------------------------------------------------------------------------
------------------------------------------------------------------------

Operations
Average production
Natural gas (Mcf per day) 5,664 5,514
Natural gas liquids (bbls per day) 112 115
------------------------------------------------------------------------
Total (BOE per day) 1,056 1,034
------------------------------------------------------------------------
------------------------------------------------------------------------


THIRD QUARTER 2005 RESULTS

Production and Prices

Fairquest recorded average natural gas production of 5,664 Mcf per day and 112 bbls per day of associated natural gas liquids during the third quarter. All of the Company's production was from properties acquired from Fairborne Energy Ltd. pursuant to the Plan of Arrangement. Fairquest plans to tie-in additional production in the fourth quarter of 2005 as a result of its successful third quarter drilling program. Exit production for 2005 is currently expected to approximate 1,500 BOE per day.



------------------------------------------------------------------------
Three months Four months
ended ended
September 30, September 30,
2005 2005
------------------------------------------------------------------------
Prices
Natural gas ($ per Mcf) 9.41 8.93
Natural gas liquids ($ per bbl) 67.28 67.21
------------------------------------------------------------------------
Total ($ per BOE) 57.62 55.07
------------------------------------------------------------------------
------------------------------------------------------------------------


Fairquest benefited from continued strength in commodity prices during the third quarter, realizing a natural gas price of $9.41 per Mcf and an average price of $67.28 per bbl for associated natural gas liquids. Fairquest does not currently utilize any hedging or fixed sales contracts on its production.



Petroleum and Natural Gas Revenue

Fairquest recorded total revenue of $5.7 million in the third quarter
and $7.2 million year to date.

------------------------------------------------------------------------
Three months Four months
ended ended
September 30, September 30,
($ thousands) 2005 2005
------------------------------------------------------------------------
Revenues
Natural gas 4,905 6,134
Natural gas liquids 694 925
Other income 145 150
------------------------------------------------------------------------
Total 5,744 7,209
------------------------------------------------------------------------
------------------------------------------------------------------------


Royalties

Fairquest recorded royalty expense of $1.2 million for the three months ended September 30, 2005 for an effective royalty rate of 22.1%. The Company expects royalties to range between 22% and 24% for the remainder of 2005.

Transportation costs

The majority of Fairquest's transportation costs are transportation and fuel costs associated with usage of the TransCanada natural gas pipeline. Fairquest has a contract directly with its marketing company for transportation costs. Consistent with the third quarter cost of $1.41 per BOE, the Company expects transportation costs to be between $1.20 and $1.50 per BOE for the remainder of 2005.

Operating Expenses

Fairquest recorded operating costs of $756,000 or $7.78 per BOE for the three months ended September 30, 2005. All of Fairquest's properties are currently operated by Fairborne. The Company expects BOE operating costs of approximately $8.00 for the remainder of 2005.



Operating Netbacks
------------------------------------------------------------------------
Three months Four months
ended ended
September 30, September 30,
($ per BOE) 2005 2005
------------------------------------------------------------------------
Revenue 57.62 55.07
Royalties (12.74) (12.14)
Transportation costs (1.41) (1.38)
Operating costs (7.78) (7.84)
------------------------------------------------------------------------
Operating netback 35.69 33.71
------------------------------------------------------------------------
------------------------------------------------------------------------


Strong commodity prices resulted in an increased operating netback of $35.69 per BOE for the third quarter of 2005 compared to the second quarter netback of $27.49 per BOE.

General and Administrative ("G&A") Expenses

Fairquest recorded $802,000 ($5.46 per BOE) for G&A expenses during the third quarter ended September 30, 2005. The per unit G & A costs will decrease in the future as additional production is placed on-stream. G&A expenses for the third quarter included $395,000 payable to Fairborne under the Technical Services Arrangement and $217,000 of non-cash compensation expense for stock options and performance shares issued by Fairquest.

Depletion, Depreciation and Accretion

Depletion and depreciation expense for the third quarter was $1.8 million, including accretion, or $18.22 per BOE. Fairquest's depletion rate reflects the carrying value of properties transferred from Fairborne pursuant to the Plan of Arrangement as well as additions during the third quarter.

At September 30, 2005 the Company estimates its total undiscounted future liability for asset retirement obligations to be approximately $2.4 million, the present value of which is $797,000. Accretion of asset retirement obligations in the third quarter of 2005 was $17,000 ($0.17 per BOE).

Taxes

Fairquest recorded a future tax expense of $0.5 million in the third quarter of 2005 for an effective tax rate equal to 52% primarily as a result of non-deductible crown charges and compensation expenses. Fairquest recorded a tax asset on the transfer of properties from Fairborne under the Plan of Arrangement. The tax asset resulted from future tax deductions based on fair market values which are in excess of the carrying values used to record the acquisition in Fairquest's accounting records. Based on available tax pools, expected capital expenditures and forecast net income for 2005, the Company does not anticipate paying cash taxes other than capital taxes in 2005 and 2006.



Funds Generated from Operations and Net Income
------------------------------------------------------------------------
Three months Four months
ended ended
September 30, September 30,
($ thousands) 2005 2005
------------------------------------------------------------------------
Funds generated from operations 2,993 3,732
Per share - basic $ 0.12 $ 0.15
Per share - diluted $ 0.10 $ 0.13
Net Income 467 586
Per share - basic $ 0.02 $ 0.02
Per share - diluted $ 0.02 $ 0.02
------------------------------------------------------------------------
------------------------------------------------------------------------

Unit Analysis

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

Three months ended
September 30, 2005
($thousands) ($ per BOE)
------------------------------------------------------------------------
Production revenue 5,599 57.62
Less:
Royalties 1,238 12.74
Transportation costs 137 1.41
Operating expenses 756 7.78
General & administrative (1) 585 6.02
Interest (income) (145) (1.49)
Capital taxes 35 0.36
------------------------------------------------------------------------
Funds generated from operations 2,993 30.80
Compensation expense 217 2.23
Depletion,depreciation and accretion 1,770 18.22
Future income taxes 539 5.55
------------------------------------------------------------------------
Net Income 467 4.80
------------------------------------------------------------------------
------------------------------------------------------------------------
(1) net of compensation expense (non-cash)

------------------------------------------------------------------------
Four months ended
September 30, 2005
($thousands) ($ per BOE)
------------------------------------------------------------------------
Production revenue 7,059 55.07
Less:
Royalties 1,556 12.14
Transportation costs 177 1.38
Operating expenses 1,005 7.84
General & administrative (1) 699 5.46
Interest (income) (150) (1.17)
Capital taxes 40 0.31
------------------------------------------------------------------------
Funds generated from operations 3,732 29.11
Compensation expense 255 1.99
Depletion,depreciation and accretion 2,250 17.55
Future income taxes 641 5.01
------------------------------------------------------------------------
Net Income 586 4.56
------------------------------------------------------------------------
------------------------------------------------------------------------
(1) net of compensation expense (non-cash)


LIQUIDITY AND CAPITAL RESOURCES

Cash and Short-term Investments

At September 30, 2005, Fairquest had $7.1 million in cash and term deposits with maturities of less than three months. In addition Fairquest had $8.0 million invested in bearer deposit notes that are also readily convertible to cash. The majority of these cash balances are attributable to funds remaining from the private placement of $26.6 million completed in June 2005 with the balance of the private placement used for capital spending during the third quarter. The Company plans to utilize its cash balances, together with funds generated from operations to fund capital expenditures over the remainder of 2005.

Capital Expenditures

Fairquest's exploration and development expenditures for the four months ended September 30, 2005 totalled $21.0 million, the majority of which was focused on drilling activities.



------------------------------------------------------------------------
Three months Four months
ended ended
September 30, September 30,
($ thousands) 2005 2005
------------------------------------------------------------------------
Exploration and development
Land and lease acquisitions 393 417
Geological and geophysical 58 58
Drilling,completions and workovers 18,832 19,423
Well equipment and facilities 997 1,134
------------------------------------------------------------------------
20,280 21,032
Property acquisitions - 40,955
------------------------------------------------------------------------
Total 20,280 61,987
------------------------------------------------------------------------
------------------------------------------------------------------------


Fairquest undertook an active drilling program during the third quarter drilling 13.0 (5.0 net) wells with a 100% success rate resulting in 9 (3.7) natural gas wells and 4 (1.3) oil wells. Fairquest's most active area of operations has been at Columbia/Harlech and the Deep Basin, both located in West Central Alberta, which represented 85 percent of the capital program. Both of these areas will continue to command capital through the next year of operations. Fairquest has budgeted to spend approximately $30 million for capital expenditures in the fourth quarter of 2005 to tie in production from the third quarter drilling program and drill an additional 10 (4.5 net) wells. This capital program will be financed through a combination of funds generated from operations, proceeds from the recent equity issue and available bank indebtedness. New production from wells drilled is expected to add between 400 and 500 BOE per day of production by year end.

The acquisition of properties from Fairborne on June 1, 2005 was treated as a continuity of interests with the petroleum and natural gas assets recorded as at their carrying value of $41.7 million.

Bank Indebtedness

At September 30, 2005 the Company has available $16 million of demand operating credit facilities from a syndicate of Canadian chartered banks subject to the bank's valuation of the Company's petroleum and natural gas properties. The facilities are secured by a first ranking floating charge on all real property of the Company and a general security agreement.

Share Capital

The Company is authorized to issue an unlimited number of common shares, an unlimited number of first preferred shares, issuable in series and 1,000,000 performance shares.

On June 1, 2005, prior to completion of the Plan of Arrangement, Fairquest completed an initial private placement of 4,740,000 units at a price of $2.11 per unit and 1,000,000 Performance Shares at a price of $0.01 per share for total gross proceeds of $10 million. Each unit included one common share and one warrant to acquire a common share at a price of $3.17 per share exerciseable until May 31, 2010. All of the common shares, warrants and Performance shares issued under the initial private placement are subject to 3 year vesting periods and/or contractual hold periods and contain provisions which require holders to remain as Fairquest service providers.

On June 1, 2005, pursuant to the Plan of Arrangement, 17,308,830 common shares were issued to the former shareholders of Fairborne Energy Ltd. On June 28, 2005, pursuant to a private placement, the Company issued 4,000,000 common shares at a price of $6.65 per share for gross proceeds of $26.6 million.

On October 12, 2005, pursuant to a private placement, Fairquest issued 1,000,000 common shares at a price of $10.00 per share and 1,000,000 flow-through common shares at a price of $13.00 per flow-through common share, resulting in gross proceeds of $23 million. Proceeds of the private placement are planned for exploration and development expenses on Fairquest's oil and natural gas properties. Flow-through expenditures on Canadian exploration expenses will be renounced to subscribers of the flow-through common shares effective on or before December 31, 2005.

The following table provides a summary of outstanding common shares and other equity instruments as at the dates indicated:



------------------------------------------------------------------------
November 4, September 30,
2005 2005
------------------------------------------------------------------------
Common shares 28,048,831 26,048,831
Warrants 4,740,000 4,740,000
Performance shares 1,000,000 1,000,000
Stock options 1,188,400 1,188,400
Weighted average common shares
Basic n/a 24,950
Diluted n/a 28,661
------------------------------------------------------------------------
------------------------------------------------------------------------


Commitments

Pursuant to the Technical Services Agreement entered into between Fairquest and Fairborne in conjunction with the Plan of Arrangement, Fairquest is committed to shared services to mange its activities on a cost recovery basis with Fairborne. Fairquest has also committed to drill 25 wells on Fairborne lands over the two year term of the farm-in agreement with Fairborne.

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 Fairquest'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. Fairquest 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 identify and capitalize on opportunities;

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

- maintaining a strong financial position; and

- maintaining strict environmental, safety and health practices.

CRITICAL ACCOUNTING ESTIMATES

Depletion and depreciation expense

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

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

Full cost accounting ceiling test

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

Asset Retirement Obligation ("ARO")

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

Income Taxes

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



INTERIM FINANCIAL STATEMENTS


INTERIM BALANCE SHEET (Unaudited)
------------------------------------------------------------------------
($ thousands) September 30, 2005
------------------------------------------------------------------------
Assets
Current assets
Cash and cash equivalents $ 7,142
Short term investments 8,000
Accounts receivable 4,422
------------------------------------------------------------------------
19,564
Capital assets (Note 3) 60,534
Future income taxes (Note 6) 1,750
------------------------------------------------------------------------
$ 81,848
------------------------------------------------------------------------

Liabilities

Current liabilities
Accounts payable and accrued liabilities $ 11,706
Asset retirement obligation (Note 5) 797

Shareholders' Equity

Capital stock and warrants (Note 7) 68,504
Contributed surplus (Note 7) 255
Retained earnings 586
------------------------------------------------------------------------
69,345
------------------------------------------------------------------------
$ 81,848
------------------------------------------------------------------------
------------------------------------------------------------------------

See accompanying notes to the interim financial statements


INTERIM STATEMENT OF OPERATIONS AND RETAINED EARNINGS (Unaudited)
------------------------------------------------------------------------
Three months Four months
ended ended
September 30, September 30,
($ thousands) 2005 2005
------------------------------------------------------------------------
Revenue
Petroleum and natural gas $ 5,599 $ 7,059
Royalties (1,238) (1,556)
Transportation (137) (177)
Interest 145 150
------------------------------------------------------------------------
4,369 5,476
Expenses
Operating 756 1,005
General and administrative 802 954
Depletion, depreciation and accretion 1,770 2,250
------------------------------------------------------------------------
3,328 4,209

Income before taxes 1,041 1,267
Taxes (Note 6)
Future 539 641
Capital 35 40
------------------------------------------------------------------------
574 681
------------------------------------------------------------------------
Net income 467 586
Retained earnings, beginning of period 119 -
------------------------------------------------------------------------
Retained earnings, end of period $ 586 $ 586
------------------------------------------------------------------------
------------------------------------------------------------------------
Net income per share (Note 7)
Basic $ 0.02 $ 0.02
Diluted $ 0.02 $ 0.02
------------------------------------------------------------------------

See accompanying notes to the interim financial statements.


INTERIM STATEMENT OF CASH FLOWS (Unaudited)
------------------------------------------------------------------------
Three months Four months
ended ended
September 30, September 30,
($ thousands) 2005 2005
------------------------------------------------------------------------
Cash provided by (used in):
Operating activities
Net income $ 467 $ 586
Items not involving cash
Depletion, depreciation and accretion 1,770 2,250
Compensation expense 217 255
Future income taxes 539 641
------------------------------------------------------------------------
2,993 3,732
Change in non-cash working capital 331 (341)
------------------------------------------------------------------------
3,324 3,391
------------------------------------------------------------------------
Financing activities
Issuance of common shares, warrants
and performance shares, net of costs - 35,158
Repayment of bank debt - (10,000)
------------------------------------------------------------------------
- 25,158
------------------------------------------------------------------------
Investing activities
Capital expenditures (20,280) (21,032)
Short term investments (8,000) (8,000)
Change in non-cash working capital 6,809 7,625
------------------------------------------------------------------------
(21,471) (21,407)
------------------------------------------------------------------------
Change in cash and cash equivalents (18,147) 7,142
Cash and cash equivalents,
beginning of period 25,289 -
------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 7,142 $ 7,142
------------------------------------------------------------------------
------------------------------------------------------------------------

See accompanying notes to the interim financial statements


NOTES TO THE INTERIM FINANCIAL STATEMENTS

For the period from commencement of operations on June 1 to September 30, 2005 (unaudited)

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

NATURE OF OPERATIONS:

Fairquest Energy Limited (the "Company" or "Fairquest") was incorporated on March 7, 2005 and commenced commercial operations on June 1, 2005 upon completion of a Plan of Arrangement involving Fairborne Energy Ltd., Fairborne Energy Trust ("Fairborne"), Fairquest and security holders of Fairborne Energy Ltd. ("Plan of Arrangement"). Pursuant to the Plan of Arrangement, Fairquest acquired certain petroleum and natural gas properties of Fairborne. The assets and liabilities transferred to Fairquest were accounted for on a continuity of interest basis and recorded at their carrying value.

RELATIONSHIP WITH FAIRBORNE ENERGY TRUST

As a result of the Plan of Arrangement, Fairquest and Fairborne have joint interests in certain properties and undeveloped land. In addition, the companies have entered into farm-in agreements whereby Fairquest received an option to farm-in on 83,000 net acres of Fairborne exploratory lands.

In conjunction with the Plan of Arrangement, Fairborne and Fairquest entered into a Technical Services Agreement which provides for the shared services required to manage Fairquest's activities and govern the allocation of general and administrative expenses between the entities. Under the Technical Services Agreement, Fairquest is charged a technical services fee by Fairborne, on a cost recovery basis, in respect of the management, development, exploitation, operations and marketing activities on the basis of relative production and capital expenditures. In addition, under the Technical Services Agreement, Fairborne markets Fairquest's natural gas, crude oil and natural gas liquids. For the period June 1 to September 30, 2005 the technical services fee was $434,000. The Technical Services Agreement has no set termination date and will continue until terminated by either party with six months written notice to the other party or on some other date as may be mutually agreed. As contemplated in the Plan of Arrangement, the Company has issued Performance Shares to the employees of Fairborne as service providers to Fairquest.

As at September 30, 2005, accounts payable included $2.6 million due to Fairborne, which includes joint venture amounts including capital expenditures.

1. SIGNIFICANT ACCOUNTING POLICIES

a) Basis of presentation

The financial statements of the Company have been prepared by management in accordance with Canadian generally accepted accounting principles.

b) Petroleum and natural gas operations

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

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

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

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

c) Asset retirement obligations ("ARO")

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

d) Interest in joint ventures

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

e) Stock-Based Compensation

The Company has a stock based compensation plan, which is described in Note 7. Compensation expense associated with the stock based compensation plan is recognized in income over the vesting period of the plan with a corresponding increase in contributed surplus. Compensation expense is based on the fair value of the stock based compensation at the date of the grant using a Black-Scholes option pricing model.

Any consideration received upon exercise of the stock based compensation together with the amount of non-cash compensation expense recognized in contributed surplus is recorded as an increase in capital stock.

f) Income Taxes

The Company uses the liability method of accounting for future income taxes. Under the liability method, future income tax assets and liabilities are determined based on "temporary differences" (differences between the accounting basis and the tax basis of the assets and liabilities), and are measured using the currently enacted, or substantively enacted tax rates and laws expected to apply when these differences reverse. A valuation allowance is recorded against any future income tax assets if it is more likely than not that the asset will not be realized.

g) Cash and cash equivalents

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

h) Measurement uncertainty

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

The amounts recorded for depletion and depreciation and the provision for asset retirement obligations are based on estimates. The ceiling test calculation is based on estimates of proved and probable reserves, production rates, petroleum and natural gas prices, future costs and relevant assumptions. By their nature, these estimates are subject to measurement uncertainty and may impact the consolidated financial statements of future periods.

i) Per Share Information

Basic per share amounts are calculated using the weighted average number of shares outstanding during the year. Diluted per share amounts are calculated based on the treasury-stock method, which assumes that any proceeds obtained on the exercise of in the money options and warrants would be used to purchase common shares at the average market price during the period. The weighted average number of shares outstanding is then adjusted by the net change.

j) Revenue Recognition

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

2. TRANSFER OF ASSETS AND COMMENCEMENT OF COMMERCIAL OPERATIONS

Under the Plan of Arrangement, Fairborne transferred to Fairquest certain producing petroleum and natural gas properties, undeveloped lands and a portion of its bank debt. The assets and liabilities transferred to Fairquest were accounted for on a continuity of interest basis and recorded at their carrying value as follows:



------------------------------------------------------------------------
Net assets received:
Petroleum and natural gas properties and equipment $ 41,712
Future income taxes 1,890
Bank debt assumed (10,000)
Asset retirement obligations (757)
Deficit 3,766
------------------------------------------------------------------------
Common shares issued (17,308,830 shares) 36,611
Reduction of stated capital (3,766)
------------------------------------------------------------------------
Common shares $ 32,845
------------------------------------------------------------------------
------------------------------------------------------------------------

Pursuant to the Plan of Arrangement, the deficit was eliminated by an
equal reduction to the stated share capital of common shares.

3. CAPITAL ASSETS

------------------------------------------------------------------------
September 30, 2005
------------------------------------------------------------------------
Petroleum and natural gas properties and equipment $ 62,762
Accumulated depletion and depreciation (2,228)
------------------------------------------------------------------------
$ 60,534
------------------------------------------------------------------------
------------------------------------------------------------------------


As at September 30, 2005, costs of acquiring unproved properties in the amount of $9.2 million were excluded from the depletion calculation. In addition, costs of $9.6 million were excluded related to wells that were not yet completed or evaluated at September 30, 2005. Included in the Company's petroleum and natural gas properties and equipment balance is $0.8 million relating to asset retirement obligation, net of accumulated depletion.

4. BANK INDEBTEDNESS

At September 30, 2005 the Company has available $16 million of demand operating credit facilities from a syndicate of Canadian chartered banks based on the bank's valuation of the Company's petroleum and natural gas properties. The facilities bear interest at the bank's prime rate, banker's acceptance rates, or Libor rates plus margins ranging from 0.0% to 1.4% depending on financial statement ratios and the nature of the advance. The facilities are secured by a first ranking floating charge on all real property of the Company and a general security agreement.

5. ASSET RETIREMENT OBLIGATIONS

The Company's asset retirement obligations result from net ownership interests in petroleum and natural gas assets including well site, gathering systems and processing facilities. The Company estimated the total undiscounted amount required to settle its asset retirement obligations to be approximately $2.4 million which is scheduled to be incurred between 2018 and 2020. The majority of the costs are scheduled to be incurred in 2018. A credit-adjusted risk-free interest rate of 8.5 percent and an inflation rate of 1.5 percent was used to calculate the fair value of the asset retirement obligations.



A reconciliation of the asset retirement obligations is provided below:

------------------------------------------------------------------------
Four Months
ended
September 30,
2005
------------------------------------------------------------------------
Transfer of assets through Plan of Arrangement (Note 2) $ 757
Liabilities incurred 18
Accretion expense 22
------------------------------------------------------------------------
Balance,September 30,2005 $ 797
------------------------------------------------------------------------
------------------------------------------------------------------------


6. FUTURE INCOME TAXES

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



------------------------------------------------------------------------
Four Months
ended
September 30,
2005
------------------------------------------------------------------------
Earnings before taxes $ 1,267
Combined federal and provincial tax rate 37.6%
------------------------------------------------------------------------
Computed "expected"income tax expense 476
Increase (decrease) in income taxes resulting from:
Non-deductible crown charges 350
Non-deductible stock based compensation 96
Resource allowance (289)
Other 8
------------------------------------------------------------------------
Future income taxes 641
Capital taxes 40
------------------------------------------------------------------------
Total taxes $ 681
------------------------------------------------------------------------
------------------------------------------------------------------------

The components of the future income tax asset at September 30,2005 are
as follows:

------------------------------------------------------------------------
Petroleum and natural gas properties and equipment $ 996
Asset retirement obligations 253
Share issue costs 501
------------------------------------------------------------------------
Future income tax asset $ 1,750
------------------------------------------------------------------------
------------------------------------------------------------------------


7. CAPITAL STOCK

a) Authorized

(i) Unlimited number of common shares; and
(II) An unlimited number of first preferred shares, issuable in
series; and
(III) 1,000,000 Performance Shares.

b) Issued and Outstanding

------------------------------------------------------------------------
Number
of Shares Amount
------------------------------------------------------------------------
Common Shares
Issued on incorporation 1 $ -
Issued pursuant to private placement 4,740,000 8,928
Issued pursuant to Plan of Arrangement (Note 2) 17,308,830 32,845
Issued for cash 4,000,000 26,600
Share issue costs - (1,453)
Future tax benefit of issue costs - 501
------------------------------------------------------------------------
Balance,September 30,2005 26,048,831 $ 67,421
------------------------------------------------------------------------
------------------------------------------------------------------------

Warrants
Issued pursuant to private placement 4,740,000 $ 1,073
------------------------------------------------------------------------
Balance,September 30,2005 4,740,000 $ 1,073
------------------------------------------------------------------------
------------------------------------------------------------------------

Performance Shares
Issued pursuant to private placement 1,000,000 $ 10
------------------------------------------------------------------------
Balance,September 30,2005 1,000,000 $ 10
------------------------------------------------------------------------
------------------------------------------------------------------------


On June 1, 2005, prior to completion of the Plan of Arrangement, Fairquest completed a private placement of 4,740,000 units at a price of $2.11 per unit and 1,000,000 Performance Shares at a price of $0.01 per share for total gross proceeds of $10 million. Each unit included one common share and one warrant to acquire a common share at a price of $3.17 per share. The common shares are subject to a contractual hold period and will be released as to one-third of the aggregate number held on each of June 1, 2006, 2007 and 2008. Any holder that ceases to be a Fairquest service provider will not be entitled to any further releases.

The warrants are exercisable as to one-third on each of June 1, 2006, 2007 and 2008 and expire May 31, 2010. The weighted average fair value of warrants was determined using the Black-Scholes valuation model with the following weighted average assumptions: risk free rate of 4 percent, expected volatility of 30 percent and an expected life of 3 years. In the event that a subscriber voluntarily ceases to be a Fairquest service provider or is terminated with cause, such person shall lose all unvested warrants.

The Performance Shares were issued for cash and recorded at $0.01 per share. The Performance Shares are convertible into the percentage of a common share equal to the weighted average trading price of the common shares for the five trading days prior to such conversion (the "Fairquest Price"), less $2.11, if positive, divided by the Fairquest Price. The Performance Shares become convertible into common shares as to one third on each of June 1, 2006, 2007 and 2008 and will be automatically converted if not previously converted on June 1, 2010. If the holder ceases to be a Fairquest service provider before the Performance Shares become convertible, Fairquest may, subject to applicable law, redeem each Performance Share at a redemption price of $0.01 per share. If the Fairquest Price less $2.11 is not positive on the conversion date, Fairquest will, subject to applicable law, redeem each outstanding Performance Shares at a redemption price of $0.01 per share. The weighted average fair value of the Performance Shares was determined using the Black-Scholes valuation model with the resulting value recorded as compensation cost over the vesting term of the shares (Note 7(e)).

On June 1, 2005, pursuant to the Plan of Arrangement, 17,308,830 common shares were issued to the former shareholders of Fairborne Energy Ltd.

On June 28, 2005, the Company issued 4,000,000, pursuant to a private placement, common shares at a price of $6.65 per share for gross proceeds of $26.6 million.



c) Per Share Amounts

The following table summarizes the weighted average common shares used
in calculating net income per share:

------------------------------------------------------------------------
Three months Four months
ended ended
September 30, September 30,
2005 2005
------------------------------------------------------------------------
Basic 26,049,000 24,950,000
Diluted 29,760,000 28,661,000
------------------------------------------------------------------------
------------------------------------------------------------------------


The reconciling item between the basic and diluted average common shares are outstanding stock options, Performance shares and warrants. Excluded from weighted average common shares are 1,188,400 stock options which are not dilutive under treasury method calculations.

d) Stock Options

There are 1,188,400 stock options outstanding at September 30, 2005 with an average exercise price of $7.29 per share. Options vest evenly over a three year period and expire five years from the date of grant. The outstanding options expire between June 13 and August 29, 2010.



e) Contributed Surplus

------------------------------------------------------------------------
Four Months
ended
September 30,
2005
------------------------------------------------------------------------
Balance,beginning of period $ -
Stock based compensation expense
Stock options 204
Performance shares 51
------------------------------------------------------------------------
Balance,September 30,2005 $ 255
------------------------------------------------------------------------
------------------------------------------------------------------------


The weighted average fair value of stock options granted during the period from June 1 to September 30, 2005 was $1.86 per option and the weighted average fair value of Performance shares granted during the same period was $0.48 per share using the Black-Scholes option pricing model with the following weighted average assumptions: risk free rate of 4 percent, expected volatility of 30 percent and an expected life of 3 years.

8. FINANCIAL INSTRUMENTS

a) Credit Risk:

A significant portion of the Company's accounts receivable is from an oil and gas marketing agent and is subject to normal industry credit risks.

b) Fair value of financial instruments:

The carrying value of the Company's financial instruments approximate their fair value due to their short maturity.

9. SUBSEQUENT EVENTS

On October 12, 2005, pursuant to a private placement, Fairborne issued 1,000,000 common shares at a price of $10.00 per share and 1,000,000 flow-through common shares at a price of $13.00 per flow-through common share, resulting in gross proceeds of $23 million. Proceeds of the private placement are planned for exploration and development expenses on Fairquest's oil and natural gas properties. Flow-through expenditures on Canadian exploration expenses will be renounced to subscribers of the flow-through common shares effective on or before December 31, 2005.

INFORMATION FOR SHAREHOLDERS

READER ADVISORY: Certain information set forth in this document, including managements' assessment of the future plans and operations of Fairquest Energy Limited ('Fairquest'), contains forward looking statements. By their nature, forward-looking statements are subject to numerous risks and uncertainties, some of which are beyond these parties' control, including the impact of general economic conditions, industry conditions, volatility of commodity prices, currency fluctuations, imprecision of reserve estimates, environmental risks, competition from other industry participants, the lack of availability of qualified personnel or management, stock market volatility and ability to access sufficient capital from internal and external sources. Readers are cautioned that the assumptions used in the preparation of such information, although considered reasonable at the time of preparation, may prove to be imprecise and, as such, undue reliance should not be placed on forward looking statements. The actual results, performance or achievement of Fairquest could differ materially from those expressed in, or implied by, these forward-looking statements and, accordingly, no assurance can be given that any of the events anticipated by the forward looking statements will transpire or occur, or if any of them do so, what benefits that Fairquest will derive therefrom. Fairquest disclaims any intention or obligation to update or revise any forward-looking statements,whether as a result of new information, future events or otherwise, unless required by applicable law. BOE disclosure may be misleading, particularly if used in isolation. A BOE conversion ratio of 6 Mcf to 1 Bbl is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead. Fairquest Energy Limited is a growth oriented, junior gas exploration, development and production company operating exclusively in western Canada. Fairquest's common shares are publicly traded on the Toronto Stock Exchange under the trading symbol "FQE".



INFORMATION FOR SHAREHOLDERS


FAIRQUEST ENERGY LIMITED

3400,450 - First Street S.W.
Calgary,Alberta T2P 5H1
Telephone (403) 290-7750
Fax (403) 290-3216
Email: info@fairquestenergy.com
Website: www.fairquestenergy.com

DIRECTORS

Richard A. Walls
Robert A. Maitland
Donald J. Nelson
Gary F. Aitken
Brian A. Felesky
David M. Fitzpatrick

OFFICERS

Richard A. Walls
Robert A. Maitland

STOCK EXCHANGE LISTING

The Toronto Stock Exchange
Trading Symbol: FQE


Contact Information