Grand Petroleum Inc.
TSX VENTURE : GPP

Grand Petroleum Inc.

August 22, 2005 19:00 ET

Grand Petroleum Inc. Announces Continued Strong Growth with Second Quarter Results

CALGARY, ALBERTA--(CCNMatthews - Aug. 22, 2005) - Grand Petroleum Inc. (TSX VENTURE:GPP) ("Grand" or the "Corporation") is pleased to announce results for the second quarter of 2005. The quarterly report to shareholders is posted on the Corporation's web site www.grandpetroleum.com and will be filed on www.sedar.com.

Highlights

- Cash flow increased 126% to $2,360,021 in the second quarter of 2005 from $1,045,818 in the second quarter of 2004 and was 50% higher on a fully diluted per share basis at $0.12 versus $0.08.

- Production averaged 1,302 boe/day, up 60% from 813 boe/day in the second quarter of 2004 and 19% higher than the 1,092 boe/day produced in the first quarter of 2005.

- Grand exited the second quarter with production in excess of 1,800 boe/day. Current production is estimated to be more than 2,000 boe/day.

- The Company drilled seven (5.2 net) wells in the quarter at a 100% success rate.

- Grand closed an $8.1 million acquisition of approximately 250 bbls/day at Hazelwood in Southeastern Saskatchewan which directly offsets our large exploration land base.

- Grand raised $16.9 million in two equity issues, maintaining our strong balance sheet and pre-funding an extremely active third quarter drilling program.



FINANCIAL AND OPERATING HIGHLIGHTS

Three months ended Six months ended
June 30 June 30 % June 30 June 30 %
2005 2004 change 2005 2004 change
------------------------------------------------------------------------
Financial
Petroleum and
natural gas
sales $ 5,531,579 $3,067,504 80 $10,025,867 $5,000,635 100
Cash flow
from
operations 2,360,021 1,045,818 126 4,258,038 1,639,182 160
Per share
- basic 0.12 0.08 50 0.22 0.12 85
Per share
- diluted 0.12 0.08 44 0.22 0.12 87
Net earnings (172,167) 36,010 (578) (336,396) (53,138) (358)
Per share
- basic (0.00) 0.00 - (0.01) (0.00) -
Per share
- diluted (0.00) 0.00 - (0.01) (0.00) -
Capital
expenditures,
net 14,665,760 4,263,933 244 23,962,980 9,872,808 143
Net working
capital
(deficiency)(6,461,939)(3,748,323) 72 (6,461,939)(3,748,323) 72
Total assets 54,279,023 17,549,329 208 54,279,023 17,549,329 208
Shareholders'
equity $35,755,351 $7,905,334 349 $35,755,351 $7,905,334 349
------------------------------------------------------------------------

Common shares outstanding
Weighted
average (#)
Basic 19,729,018 13,452,523 47 19,144,020 13,452,523 42
Fully
diluted 20,430,706 14,587,523 40 19,855,357 14,587,523 36
End of
period (#)
Basic 23,693,523 13,452,523 76 23,693,523 13,452,523 76
Fully
diluted 25,548,523 14,587,523 75 25,548,523 14,587,523 75

Operations
Average daily
production
Crude oil
and NGLs
(bbls/day) 824 679 21 831 556 49
Natural gas
(mcf/day) 2,866 804 256 2,196 726 202
------------------------------------------------------------------------
Total
(boe/day) 1,302 813 60 1,197 677 77
------------------------------------------------------------------------
Netback ($/boe)
Average
selling
price 46.70 41.46 13 46.28 40.57 14
Royalties (6.12) (3.94) 55 (5.62) (4.48) 25
Production
expense (16.43) (17.54) (6) (16.46) (17.09) (4)
Transportation
expense (0.94) (1.33) (29) (0.98) (1.25) (22)
------------------------------------------------------------------------
Realized
netback 23.21 18.65 24 23.22 17.75 31
------------------------------------------------------------------------
Drilling
Gross (net)
wells
drilled (#)
Crude oil 6 (4.5) 2 (1.3) 246 8 (6.25) 3 (2.3) 172
Gas 1 (0.7) 0 (0.0) - 4 (3.3) 1 (1.0) 230
Abandoned 0 (0.0) 1 (1.0) - 2 (1.5) 1 (1.0) 50
------------------------------------------------------------------------
Total 7 (5.2) 3 (2.3) 160 14 (11.05) 5 (4.3) 157
------------------------------------------------------------------------
------------------------------------------------------------------------


Second Quarter Drilling

Grand continued to achieve success with the drill bit in the second quarter, drilling seven (5.2 net) wells at a 100% success rate. Five (4.0 net) wells were drilled in our East Central Alberta core area, including three that are currently on production and two wells expected to be on production before the end of the third quarter.

Grand also successfully drilled a high impact well at Sylvan Lake (69.25% BPO, 49.25% APO) which is scheduled to begin production in September at an initial rate of 4 (2.8 net) mmcf/day.

At Grand's new core area at Hazelwood in Southeast Saskatchewan, the first well (0.5 net to Grand) was cased as a potential oil well late in the second quarter and is scheduled to be completed in the third quarter.

Third Quarter Drilling Update

Grand launched a very active drilling program early in the third quarter. At St. Anne, west of Edmonton, the Company drilled and cased two (2 net) wells. The first has been completed and is awaiting an extended test which will take place over the next two to three months. The second well, which has been completed for Belly River gas, has been tested at more than1 mmcf/day. Grand is evaluating tie-in options for this well, which is expected to be on production in the fourth quarter.

At Atim, east of St. Anne, Grand drilled two (1.2 net) wells. Grand elected not to participate in the casing of the first well. The second well (Grand 60%) has been cased as a potential gas well and is currently being completed. Grand and its partner are planning to drill one (0.6 net) more well at Atim in the third quarter. The Company currently has an inventory of six (3.6 net) locations on offsetting lands to drill over the next year.

At Pine Creek, northwest of Edmonton, Grand (50% before payout, 30% after payout) drilled and cased a 2,886 metre well in July. We are encouraged by our evaluation of the open-hole logs and intend to complete and test the well beginning late September. One well (Grand 50% before payout, 30% after payout) is currently drilling and an additional well (Grand 50%) is licensed and is planned to be drilled before the end of the third quarter. The Cardium test drilled in the first quarter (Grand 75% BPO, 50% APO) commenced production in late July.

At Sylvan Lake, Grand plans to spud a 100% working interest exploration well in September and has one (0.6 net) additional location to drill in the area. After much delay a partner-operated, potentially high-impact Nisku recompletion (Grand 50%) began production in late July but has experienced numerous operational difficulties. Current productive capacity is estimated to be at least 200 boe/day net to Grand.

Production

Production averaged 1,302 boe/day in the second quarter; however, Grand exited the quarter with production in excess of 1,800 boe/day. We estimate from field receipts that current production is more than 2,000 boe/day, almost double first quarter average production of 1,092 boe/day. The Company expects to tie-in additional production before year end which should allow Grand to exit 2005 with production of over 2,500 boe/day.

Hazelwood Acquisition

On June 29, Grand closed the acquisition of the strategically important Hazelwood field in Southeast Saskatchewan for approximately $8.1 million. Grand now owns a 50% interest in 14 wells and the associated facility operated by our Southeast Saskatchewan exploration partner. We drilled our first successful exploration well in June and to date in the third quarter have drilled and cased two (1.0 net) exploration wells and one (0.5 net) horizontal development well. One well is on production and three others are being completed. Grand has a sizable inventory of locations to pursue in Saskatchewan and is on track to drill a total of 16 to 18 (8 to 9 net) wells in the area in 2005.

Capital Expenditures

Capital expenditures totaled $14.7 million in the second quarter including the $8.1 million purchase at Hazelwood. Following the two equity issues, net debt was $6.5 million or approximately 0.7 times annualized second quarter cash flow. Grand has total available bank lines of $22.7 million, which, when combined with our growing cash flow, should support our 2005 capital expenditures. We are encouraged by recent drilling successes, especially in Pine Creek. Accordingly, the Board of Directors has approved an increase in total 2005 budgeted capital expenditures up to $45 million. On this basis, Grand still anticipates having a year-end debt to cash flow ratio of approximately 0.5.

Financing

On May 4, Grand closed an issue of 1.82 million flow-through shares at a price of $3.30 per share for gross proceeds of $6 million. On June 30, Grand closed an additional financing of 1.75 million common shares at $2.90 per share and 1.571 million flow-through shares at $3.70 per flow-through share for additional gross proceeds of $10.9 million. As a result, Grand exited the second quarter with $6.5 million in net debt, which is 0.7 times annualized second quarter cash flow and approximately 0.25 times annualized projected third quarter cash flow.

Grand entered the third quarter with approximately 1,800 boe/day and we are striving to put our new discoveries on production as rapidly as possible. We estimate current production to be more than 2,000 boe/day and expect to tie in an additional 500 boe/day of productive capacity prior to the end of the year. This would position us to exceed our annual average forecast rate of 1,750 boe/day. We are forecasting annual fully diluted cash flow per share in excess of $0.75 based upon a July 1 price forecast from our independent engineers, Gilbert Laustsen Jung Associates.

Our team is justifiably proud of our performance to date in 2005 and we look forward to reporting continued growth for the remainder of the year.

MANAGEMENT'S DISCUSSION AND ANALYSIS

The following discussion is management's opinion about Grand's operating and financial results for the three and six months ended June 30, 2005 and 2004 and previous periods, and the outlook for Grand based on information available as at August 19, 2005.

The following discussion and analysis should be read in conjunction with the audited financial statements and notes for the year ended December 31, 2004, and the period ended December 31, 2003. Per barrel of oil equivalent amounts have been calculated using a conversion rate of six thousand cubic feet of natural gas to one barrel of oil (6:1).

Management's discussion and analysis contains the term "funds from operations", and "operating netback" which do not have a standardized meaning prescribed by Canadian generally accepted accounting principles and therefore may not be comparable with the calculation of similar measures by other companies. Management believes that in addition to net income, funds from operations and operating netback are useful supplemental measures as they demonstrate the Corporation's ability to generate the cash necessary to repay debt or fund future growth. Funds from operations is calculated by adding non-cash items (stock-based compensation expense and depletion, depreciation and accretion) to earnings for the period, and excludes the change in non-cash working capital related to operating activities. Operating netback is a benchmark used in the oil and gas industry to measure revenues received after deducting royalties and operating expenses.

This discussion contains forward-looking statements. Forward-looking statements address future events and conditions, and are based on current expectations. Because of the nature of forward-looking statements, they involve inherent risks and uncertainties, and therefore actual results could differ materially from those currently anticipated.

QUARTERLY FINANCIAL INFORMATION

The following is a summary of selected financial information for the Company for the periods indicated:



Three months ended
Jun 30 Mar 31 Dec 31 Sept 30
2005 2005 2004 2004
------------------------------------------------------------------------

Petroleum and
natural gas sales,
net of royalties $ 5,531,579 $ 4,494,288 $ 4,648,270 $ 4,086,709
Funds from operations 2,360,021 1,898,017 2,150,574 1,659,758
Per share - Basic 0.12 0.10 0.15 0.12
- Diluted 0.12 0.10 0.14 0.12
Earnings (loss) (172,167) (164,229) 2,716,318 357,052
Per share - Basic (0.00) (0.01) 0.19 0.02
- Diluted $ (0.00)$ (0.01)$ 0.19 $ 0.02
------------------------------------------------------------------------
Earnings (loss),
before income
tax recovery (79,282) (316,758) (206,170) 357,052
Per share - Basic (0.00) (0.02) (0.01) 0.02
- Diluted $ (0.00)$ (0.02)$ (0.01)$ 0.02
------------------------------------------------------------------------
------------------------------------------------------------------------


Three months ended
Jun 30 Mar 31 Dec 31 Sept 30
2004 2004 2003 2003
------------------------------------------------------------------------

Petroleum and
natural gas sales,
net of royalties $ 3,067,504 $ 1,933,131 $ 195,072 $ 65,095
Funds from operations 1,045,818 593,363 (9,442) (11,335)
Per share - Basic 0.08 0.04 (0.01) (0.01)
- Diluted 0.08 0.04 (0.01) (0.01)
Earnings (loss) 36,010 (89,148) (64,260) (21,371)
Per share - Basic 0.00 (0.01) (0.01) (0.03)
- Diluted $ 0.00 $ (0.01)$ (0.01)$ (0.03)
------------------------------------------------------------------------
Earnings (loss),
before income
tax recovery 36,010 (89,148) (64,260) (21,371)
Per share - Basic 0.00 (0.01) (0.01) (0.03)
- Diluted $ 0.00 $ (0.01)$ (0.01)$ (0.03)
------------------------------------------------------------------------
------------------------------------------------------------------------


DETAILED FINANCIAL ANALYSIS



Production

Three months ended June 30 Six months ended June 30
% %
2005 2004 Change 2005 2004 Change
------------------------------------------------------------------------

Oil (bbls/day) 812 670 21 819 548 49
Gas (mcf/day) 2,866 804 256 2,196 726 202
NGLs (bbls/day) 12 9 33 12 8 50
------------------------------------------------------------------------
Total
(boe/day) 1,302 813 60 1,197 677 77
------------------------------------------------------------------------
------------------------------------------------------------------------


Grand's production increased from an average of 813 boe/day for the three months ended June 2004 to 1,302 boe/day for the three months ended June 30, 2005. The increase in second quarter-over- second quarter production is due to increased production from the successful drilling and tie-in activities throughout 2004 and the first quarter of 2005. Production is expected to increase further in the third quarter of 2005 as additional successful wells from the 2005 drilling program come on production. As well, the acquisition of the Saskatchewan properties will add an additional 250 boe/day beginning July 1, 2005.



Petroleum and Natural Gas Sales

Three months ended June 30 Six months ended June 30
% %
2005 2004 Change 2005 2004 Change
------------------------------------------------------------------------

Revenue
Oil $ 3,521,854 $ 2,525,117 39 $ 7,013,051 $ 4,049,653 73
Gas 1,962,409 516,083 280 2,915,263 896,031 225
NGLs 47,316 26,304 80 97,553 54,951 78
------------------------------------------------------------------------
Total $ 5,531,579 $ 3,067,504 80 $10,025,867 $ 5,000,635 100
------------------------------------------------------------------------
------------------------------------------------------------------------

Average sales price
Oil ($/bbl) $ 47.66 $ 41.42 15 $ 47.31 $ 40.63 16
Gas ($/mcf) $ 7.52 $ 7.05 7 $ 7.33 $ 6.79 8
NGLs ($/bbl) $ 43.33 $ 31.88 36 $ 44.91 $ 35.07 28
------------------------------------------------------------------------
Total
($/boe) $ 46.70 $ 41.46 13 $ 46.28 $ 40.57 14
------------------------------------------------------------------------
------------------------------------------------------------------------


Revenue from petroleum and natural gas sales, before transportation costs, totaled $5,531,579 for the second quarter of 2005, compared with $3,067,504 for the second quarter of 2004. Prices increased by approximately 18%, while production increased by 60% quarter-over-quarter.

In the three months ended June 30, 2005, crude oil prices averaged $47.66 per barrel ("bbl"), natural gas prices averaged $7.52 per thousand cubic feet ("mcf") and natural gas liquids prices averaged $43.33/bbl. This compares to $41.42/bbl, $7.05/mcf and $31.88/bbl respectively, for the three months ended June 30, 2004. The Company sells all its oil and natural gas on the spot market, therefore, both the historical prices received and future prices expected fluctuate with the prevailing market prices of crude oil and natural gas. The Company did not hedge or enter into any fixed price arrangements in the period ended June 30, 2005. For the period of July 1 to December 31, 2005 Grand has entered into a costless collar contract with a floor price of $50.00 USD WTI per barrel and a cap price of $66.55 USD WTI per barrel for 200 boe/day.



Royalties

Three months ended June 30 Six months ended June 30
% %
2005 2004 Change 2005 2004 Change
------------------------------------------------------------------------

Royalties
Crown $ 216,672 $ 107,654 101 $ 348,944 $ 117,967 196
Freehold 305,960 131,505 133 588,818 334,283 76
GORR 202,366 52,282 287 280,098 99,849 181
------------------------------------------------------------------------
Total $ 724,998 $ 291,441 149 $ 1,217,860 $ 552,099 121
------------------------------------------------------------------------
------------------------------------------------------------------------

Average percent of total sales
Crown 3.9% 3.5% 12 3.5% 2.4% 48
Freehold 5.5% 4.3% 29 5.9% 6.7% (12)
GORR 3.7% 1.7% 115 2.8% 2.0% 40
------------------------------------------------------------------------
Total 13.1% 9.5% 38 12.1% 11.0% 10
------------------------------------------------------------------------
------------------------------------------------------------------------


Royalties for the three months ended June 30, 2005 totaled $724,998 net of Alberta Royalty Tax Credit, compared to $291,441 for the comparable period in 2004. The higher royalties reflect year-over-year production and price increases. as well as higher royalties on new wells on production in 2005.

Royalties as a percentage of sales increased to 13.1% for the three months ended June 30, 2005 from 9.5% for the three months ended June 30, 2004. Crown royalties increased due to new wells drilled or acquired on Crown lands; and freehold and GORR royalties as a percentage of sales increased due to farm in agreements on some of the new wells drilled in West Central Alberta.



Production Expenses

Three months ended June 30 Six months ended June 30
% %
2005 2004 Change 2005 2004 Change
------------------------------------------------------------------------

Production
expenses $ 2,004,381 $ 1,401,152 43 $ 3,684,601 $ 2,189,350 68
Transportation
expenses 111,222 51,579 116 213,166 153,523 39
Overhead
recoveries
- operating (51,750) (54,000) (4) (102,500) (76,750) 34
Water
disposal
income (5,296) (3,234) 64 (14,518) (5,935) 145
------------------------------------------------------------------------
Total $ 2,058,557 $ 1,395,497 48 $ 3,780,749 $ 2,260,188 67
------------------------------------------------------------------------
------------------------------------------------------------------------


Production expenses for the three months ended June 30, 2005 were
$2,058,557 compared to $1,395,497 for the comparable period in 2004.
The increase of 48% was due mainly to the 60% increase in production.


Operating Netbacks

Barrels of Three months ended June 30 Six months ended June 30
oil equivalent % %
($/boe) 2005 2004 Change 2005 2004 Change
------------------------------------------------------------------------

Sales price $ 46.70 $ 41.46 13 $ 46.28 $ 40.57 14
Royalties (6.12) (3.94) 55 (5.62) (4.48) 25
Production
expense (16.43) (17.54) (6) (16.46) (17.09) (4)
Transportation
expense (0.94) (1.33) (29) (0.98) (1.25) (22)
------------------------------------------------------------------------
Operating
netback $ 23.21 $ 18.65 24 $ 23.22 $ 17.75 31
------------------------------------------------------------------------
------------------------------------------------------------------------


Grand's average operating netback for the three months ended June 30, 2005 was $23.21/boe, compared to $18.65/boe for the three months ended June 30, 2004. The higher netback was primarily due to higher commodity prices. Operating costs per boe decreased to $16.43 in the second quarter of 2005 from $17.54 in the comparable period in 2004. Royalties per boe increased due to additional production on crown and farm-in lands in West Central Alberta, some of which came on production in the first half of 2005.



General and Administrative Expense

Three months ended June 30 Six months ended June 30
% %
2005 2004 Change 2005 2004 Change
------------------------------------------------------------------------

General and
administrative
expense $ 560,216 $ 491,069 14 $ 1,230,058 $ 829,414 48
Overhead
recoveries
- capital (142,588) (82,345) 73 (311,698) (122,821) 154
Interest
income 0 (384) (100) 0 (14,128) (100)
Capitalized
general and
administrative
expense (83,556) (115,495) (28) (210,934) (219,484) (4)

------------------------------------------------------------------------
Total $ 334,072 $ 292,845 14 $ 707,426 $ 472,981 50
------------------------------------------------------------------------
------------------------------------------------------------------------
Total
- net
($/boe) $ 2.82 $ 3.96 (29)$ 3.27 $ 3.84 (15)
------------------------------------------------------------------------
------------------------------------------------------------------------


Net general and administrative expense ("G&A") for the three month period June 30, 2005 totaled $334,072, compared to $292,845 for the three month period ended June 30, 2004, however decreased to $2.82 from $3.96 per boe year-over-year. Costs increased by only 14%, while production increased by 60%. Future G&A costs should remain fairly constant, reducing per boe as production increases.

Depletion, Depreciation and Accretion

For the three months ended June 30, 2005, depletion, depreciation and accretion totaled $2,299,912, or $19.41 per boe, compared with $941,628 or $12.73/boe for the three month period ended June 30, 2004. Total costs subject to depletion and depreciation in the second quarter of 2005 include approximately $3.3 million relating to future development costs estimated to complete oil and gas wells for which proved reserves have been assigned. Undeveloped land with a value of approximately $2.5 million has been excluded from the costs subject to depletion. Undeveloped land is included in the depletion calculation once it is considered to be developed. Accretion of the asset retirement obligation was $73,062 and depletion and depreciation totaled $2,226,850. The increase in the depletion and depreciation per boe is mainly due to the large amount of capital expenditures in 2004 and 2005 for seismic and drilling in West Central Alberta, some of which do not have reserves assigned yet.

Income Taxes

At December 31, 2004, Grand recorded a future tax asset of $3,180,535 on the balance sheet and corresponding future tax recovery of $2,922,488 on the income statement, with the difference of $258,047 recorded to share capital as the tax effect of the share issue costs. Grand's future tax asset was created at December 31, 2004 using tax pools acquired from the amalgamation with RightsMarket Inc. During the six month period ended June 30, 2005, Grand recorded current income taxes of $nil. On September 30, 2004 Grand completed a flow-through share issue and at March 31, 2005, renounced $5.24 million of Canadian Exploration Expense and $1.0 million of Canadian Development Expense to shareholders. The effect of the renunciation was to reduce the future tax asset on the balance sheet to $1,488,628. At February 28, 2005 the spending for the commitment had been completed. Grand does not expect to pay any cash income taxes in 2005.

Net Earnings and Cash Flow

For the three month period ended June 30, 2005 Grand recorded a net loss of ($172,167) or ($0.00) per share, compared with a net income of $36,010 or $0.00 per share for the three months ended June 30, 2004. Cash flow from operations increased to $2,360,021 or $0.12 per fully diluted share for the three months ended June 30, 2005 from $1,045,818 or $0.08 per share for the three months ended June 30, 2004. The increase in cash flow is due to higher production and commodity prices.



Capital Expenditures


East West
2005 Capital Central Central
Expenditures Saskatchewan Alberta Alberta Total
------------------------------------------------------------------------
Land 8,450,579 86,903 1,115,919 9,653,401
Geological and
geophysical 518,264 242,122 1,018,563 1,778,949
Drilling 273,615 1,594,365 6,318,642 8,186,622
Recompletions and
workovers 66,206 624,111 315,417 1,005,734
Well equipment/tie-ins - 1,227,355 1,893,219 3,120,574
Administrative capital - - - 217,700
------------------------------------------------------------------------
Total 9,308,664 3,774,856 10,661,760 23,962,980
------------------------------------------------------------------------
------------------------------------------------------------------------


For the six months ended June 30, 2005, the Company's capital expenditures totaled $23,962,980, including an $8.1 million property acquisition for a 50% working interest in an oil property in the Hazelwood area of Southeast Saskatchewan. Grand plans to drill a total of 18 gross (9 net) wells in the general Hazelwood area in 2005.

During the three months ended June 30, 2005, the Company drilled seven (5.2 net) wells with a 100% success rate, resulting in one (0.7 net) gas well and six (4.5 net) oil wells. Five (4.0 net) of these wells were in Grand's East Central Alberta area, one (0.7 net) gas well was in West Central Alberta and one (0.5 net) oil well was in Southeast Saskatchewan.

Liquidity and Capital Resources

For the six months ended June 30, 2005, Grand's capital expenditures of $24 million (including the $8.1 million acquisition) were funded by funds from operations, its bank line and proceeds from two share issues which were completed in the second quarter of 2005. The first share issue, which closed in May, 2005 raised $6,006,000 by issuing 1,820,000 flow-through shares at $3.30 per share. The second share issue, which closed at the end of June, 2005 raised $10,887,700 by issuing 3,321,000 shares; 1,571,000 flow-through shares at $3.70 and 1,750,000 common shares at $2.90. Of the total qualifying expenditures of the May issue of $6,006,000, $4.2 million remained to be expended at June 30, 2005, and all of the June issue of $5,812,700 remained to be expended. Grand has access to a $15.2 million revolving loan facility and a $7.5 million acquisition and development loan In addition, Grand has contractual obligations for office rent totaling $362,171 (2005 - $94,589; 2006 - $199,536; 2007 - $68,226).

Commodity prices and production volumes have the largest impact on Grand's ability to generate adequate cash flow to meet its obligations. A prolonged decrease in commodity prices would negatively affect funds from operations and would also likely result in a reduction in the size of bank loan available.

At this time the Company expects to spend up to $45 million on capital expenditures in 2005. The Company may adjust its capital expenditure program depending on the outlook for commodity prices. The Company believes that the financings completed in May and June, internally-generated cash flow and incremental bank debt will be sufficient to finance current operations and planned capital spending in 2005.

Share Capital

Grand is authorized to issue an unlimited number of common shares as well as first preferred shares and second preferred shares, all without nominal or par value. To date, no preferred shares have been issued. The Company's share capital at June 30, 2005 is outlined below:



Share Capital

Shares Amount
------------------------------------------------------------------------
Outstanding shares at December 31, 2004 18,552,523 18,438,151
Tax effect of flow-through shares issued
September 2004 (2,116,608)
Share issue May, 2005 - flow-through shares 1,820,000 6,006,000
Share issue June, 2005 - flow-through shares 1,571,000 5,812,700
Share issue June, 2005 - common shares 1,750,000 5,075,000
Share issue costs (net of tax effect
of $365,056) - (669,975)
------------------------------------------------------------------------
Balance, June 30, 2005 23,693,523 $32,545,268
------------------------------------------------------------------------
------------------------------------------------------------------------


During the second quarter of 2005, the Company issued 10,000 stock options to employees and directors. The options vest over two years and are exercisable into common shares at a price of $2.70. Total outstanding stock options at June 30, 2005 were 1,855,000.

As of the date of this MD&A there has been no significant change in the number of outstanding shares and stock options.

Subsequent Event

On July 1, 2005 Grand entered into a costless collar contract for the period of July 1, 2005 to December 31, 2005 for 200 boe/day. The floor price is $50.00 USD WTI per barrel, and the cap price is $66.55 USD WTIper barrel, with the average price for the month used to determine if the price has fallen below or risen above the hedge parameters.

Business Conditions and Risk

The business of exploration, development and acquisition of oil and gas reserves involves a number of uncertainties and as a result Grand is exposed to certain business risks inherent in the oil and gas industry which affect results. These business risks can generally be grouped into two major areas: operations, including environmental, and financial.

Operationally the Company faces risks associated with finding, developing and producing oil and gas reserves. The Company attempts to control operating risks by maintaining a disciplined approach to implementation of the exploration and development program. Exploration risks are managed by hiring experienced technical staff and by concentrating the exploration activity on specific core regions where the Company has experience and expertise. The Company also attempts to operate associated projects where its level of ownership is sufficient. Operational control allows the Company to manage costs, timing and sales of production.

Estimates of economically recoverable reserves and the future net cash flow they will generate are based on a number of factors and assumptions, such as commodity prices, projected production and future operating costs. All of these estimates may vary from actual results. The Company has its reserves evaluated annually by an independent engineering firm and reviews their findings with the Reserves Committee and the Board of Directors.

Environmental risks are also associated with field operations. The Company has health and safety programs and procedures, and an environmental standards policy. These policies and procedures are designed to protect and maintain the environment with respect to all Company operations. The Company performs an annual third party audit of the safety and environmental policies designed to ensure compliance. Grand also carries environmental liability, property, drilling and general liability insurance.

The Company is exposed to financial risks in the form of commodity prices, interest rates, the Canadian to US dollar exchange rate and inflation. Grand manages commodity price risks by focusing its capital program on are expected to generate attractive rates of return even at substantially lower commodity prices than the industry is currently receiving.



BALANCE SHEETS

------------------------------------------------------------------------
As at June 30, December 31,
2005 2004
($) ($)
------------------------------------------------------------------------
(unaudited)

Assets
Current assets
Cash - 1,845,018
Accounts receivable 7,296,304 3,482,274
Prepaids and deposits 719,909 251,019
------------------------------------------------------------------------
8,016,213 5,578,311

Future income tax asset (note 7) 1,488,628 3,180,535

Property, plant and equipment (note 2) 44,774,182 24,719,570
------------------------------------------------------------------------
54,279,023 33,478,416
------------------------------------------------------------------------

Liabilities and Shareholders' Equity
Current liabilities
Accounts payable and accrued liabilities 11,737,228 8,193,976
Bank debt (note 4) 2,740,924 -
------------------------------------------------------------------------
14,478,152 8,193,976
Asset retirement obligation (note 3) 4,045,520 3,580,474
Shareholders' equity
Share capital (note 5) 32,545,268 18,438,151
Contributed surplus (note 6) 560,692 280,029
Retained earnings (deficit) 2,649,391 2,985,786
------------------------------------------------------------------------
35,755,351 21,703,966
------------------------------------------------------------------------
Commitment (note 10)
------------------------------------------------------------------------
Subsequent event (note 11)
------------------------------------------------------------------------
54,279,023 33,478,416
------------------------------------------------------------------------
------------------------------------------------------------------------

See accompanying notes to the financial statements.

On behalf of the Board of Directors,

J.C. (JIM) SMITH ANDREW L. HOGG
Director Director



STATEMENT OF OPERATIONS AND RETAINED EARNINGS (DEFICIT)

------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30, June 30, June 30,
2005 2004 2005 2004
(unaudited) ($) ($) ($) ($)
------------------------------------------------------------------------
Revenue
Petroleum and natural
gas sales 5,531,579 3,067,504 10,025,867 5,000,635
Royalties expense,
net of Alberta
Royalty Tax Credit (724,998) (291,441) (1,217,860) (552,099)
Interest Income 53 - 1,388 -
------------------------------------------------------------------------
4,806,634 2,776,063 8,809,395 4,448,536
------------------------------------------------------------------------
Expenses
Production 1,947,335 1,343,918 3,567,583 2,106,665
Transportation 111,222 51,579 213,166 153,523
General and
administrative 334,072 292,845 707,426 472,981
Interest 46,649 41,903 55,847 76,186
Stock-based
compensation 146,726 68,180 280,663 77,630
Depletion and
depreciation 2,226,850 875,657 4,237,271 1,505,839
Accretion 73,062 65,971 143,479 108,850
------------------------------------------------------------------------
4,885,916 2,740,053 9,205,435 4,501,674
------------------------------------------------------------------------
Net income (loss)
for the period
before taxes (79,282) 36,010 (396,040) (53,138)

Future income tax
recovery (expense)
(note 7) (92,885) - 59,644 -
------------------------------------------------------------------------
------------------------------------------------------------------------

Net income (loss)
for the period (172,167) 36,010 (336,396) (53,138)

Retained earnings
(deficit), beginning
of period 2,821,558 (123,594) 2,985,787 (34,446)

------------------------------------------------------------------------
Retained earnings
(deficit), end of
period 2,649,391 (87,584) 2,649,391 (87,584)
------------------------------------------------------------------------
Earnings (loss)
per share
Basic and diluted (0.00) 0.00 (0.00) (0.00)
------------------------------------------------------------------------
------------------------------------------------------------------------

See accompanying notes to the financial statements.


STATEMENT OF CASH FLOWS
------------------------------------------------------------------------
Three months ended Six months ended
June 30, June 30, June 30, June 30,
2005 2004 2005 2004
(unaudited) ($) ($) ($) ($)
------------------------------------------------------------------------

Cash provided by (used in):
Operations
Net income (loss) for
the period (172,167) 36,010 (336,396) (53,138)
Add items not
affecting cash:
Future income tax
expense (recovery) 92,885 - (59,644) -
Stock-based
compensation 146,726 68,180 280,663 77,630
Depletion and
depreciation 2,226,850 875,657 4,237,271 1,505,839
Accretion 73,062 65,971 143,479 108,850
Abandonment
expenditures (7,335) - (7,335) -
------------------------------------------------------------------------
Funds from
operations 2,360,021 1,045,818 4,258,038 1,639,181
Change in non-cash
working capital (1,841,194) 280,628 (2,198,761) (47,104)
------------------------------------------------------------------------
518,827 1,326,446 2,059,277 1,592,077
------------------------------------------------------------------------
Investing
Expenditures on
property, plant
and equipment (6,527,149) (4,047,863) (15,821,087) (6,205,169)
Acquisitions of
property, plant
and equipment
(note 2) (8,138,611) (216,070) (8,141,893) (3,667,639)
Change in non-cash
working capital (773,360) 800,508 1,459,093 1,881,046
------------------------------------------------------------------------
(15,439,120) (3,463,425) (22,503,887) (7,991,762)
------------------------------------------------------------------------
Financing
Issue of capital
stock for cash 16,893,700 - 16,893,700 -
Share issue costs
(note 7(b)) (1,036,032) (2,332) (1,035,032) (6,452)
Bank indebtedness (937,375) 1,482,677 2,740,924 1,482,677
------------------------------------------------------------------------
14,920,293 1,480,345 18,599,592 1,476,225
------------------------------------------------------------------------
Increase (decrease)
in cash - (656,634) (1,845,018) (4,923,460)
Cash, beginning of
period - 656,634 1,845,018 4,923,460
------------------------------------------------------------------------
Cash, end of period - - - -
------------------------------------------------------------------------
------------------------------------------------------------------------

See accompanying notes to the financial statements.



NOTES TO FINANCIAL STATEMENTS

Three and six months ended June 30, 2005 and three and six months ended June 30, 2004

1. BASIS OF PRESENTATION

The interim financial statements of Grand Petroleum Inc. (the "Company") have been prepared by management in accordance with Canadian generally accepted accounting principles. The preparation of interim financial statements in conformity with Canadian generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the interim financial statements and accompanying notes. Actual results could differ from those estimates. The interim financial statements have, in management's opinion, been properly prepared using careful judgments within reasonable limits of materiality.

These interim financial statements should be read in conjunction with the most recent annual financial statements for the year ended December 31, 2004. The significant accounting policies follow those of the most recently reported annual financial statements.



2. PROPERTY, PLANT AND EQUIPMENT

Accumulated
depletion
and Net book
June 30, 2005 Cost depreciation value
------------------------------------------------------------------------
Petroleum and natural
gas properties $ 37,250,090 $ (6,541,900) $ 30,708,190
Production equipment 12,883,804 (1,394,800) 11,489,004
Asset retirement costs 3,651,900 (1,158,391) 2,493,509
Furniture, fixtures and
office equipment 113,526 (30,047) 83,479
------------------------------------------------------------------------
Balance June 30, 2005 $ 53,899,320 $ (9,125,138) $ 44,774,182
------------------------------------------------------------------------
------------------------------------------------------------------------

Accumulated
depletion
and Net book
December 31, 2004 Cost depreciation value
------------------------------------------------------------------------
Petroleum and natural
gas properties $ 20,468,673 $ (3,431,900) $ 17,036,773
Production equipment 5,616,157 (598,500) 5,017,657
Asset retirement costs 3,322,999 (840,391) 2,482,608
Furniture, fixtures and
office equipment 199,609 (17,077) $ 182,532
------------------------------------------------------------------------
Balance June 30, 2005 $ 29,607,438 $ (4,887,868) $ 24,719,570
------------------------------------------------------------------------
------------------------------------------------------------------------


In calculating the Company's depletion and depreciation, approximately $2.5 million (December 31, 2004 - $1.3 million) of unproven properties were excluded from the depletion calculation. Future development costs required to complete wells for which proved reserves have been assigned of approximately $3.3 million (December 31, 2004 - $2.8 million) were added to the Company's net book value for the purposes of the depletion calculation.

On June 29, 2005 Grand closed a property acquisition for a total of $8.1 million after adjustments. As a result of the acquisition, $96,853 was added to asset retirement costs, with the offset to the asset retirement obligation. No future tax asset or liability was incurred as a result of the acquisition.

The Company made the following pricing assumptions based on future prices from Gilbert, Laustsen Jung Associates as at July 1, 2005 for the purposes of conducting a ceiling test on its petroleum and natural gas properties at June 30, 2005:



Edmonton Cromer
Light Medium Foreign
WTI Oil Crude Oil Crude Oil AECO Gas Exchange
($US/bbl) ($Cdn/bbl) ($Cdn/bbl) ($Cdn/Mmbtu) ($US/Cdn)
------------------------------------------------------------------------
2005 53.25 65.00 55.00 7.40 0.820
2006 54.00 64.75 56.25 7.75 0.820
2007 50.00 60.25 52.50 7.35 0.820
2008 45.25 54.50 47.25 7.10 0.820
2009 41.50 50.00 43.75 6.80 0.820
2010- 2.0% 2.0% 2.0% 2.0%
2015 esclated esclated esclated esclated 0.820
------------------------------------------------------------------------
------------------------------------------------------------------------


3. ASSET RETIREMENT OBLIGATION (ARO)

The Company's asset retirement obligation result from working interests in petroleum and natural gas assets including well sites, gathering systems and processing facilities. The Company estimates the total undiscounted amount of cash flows required to settle its asset retirement obligation, over the next twenty three years, is approximately $8.6 million. The amount has been discounted using a credit adjusted risk free interest rate of 8% and an inflation rate of 1.5%. A reconciliation of the ARO is provided below:



Three months ended Six months ended
June 30, June 30, June 30, June 30,
2005 2004 2005 2004
------------------------------------------------------------------------

Beginning of period 3,824,364 3,583,808 3,580,474 1,635,805
Liabilities incurred
during the period 76,660 33,944 250,133 1,939,068
Liabilities acquired
during the period 96,853 - 96,853 -
Liabilities settled
during the period (7,335) (28,440) (7,335) (28,440)
Revisions in estimate of
timing of cash flows (18,085) - (18,085) -
Accretion expense 73,063 65,971 143,480 108,850
------------------------------------------------------------------------
End of period 4,045,520 3,655,283 4,045,520 3,655,283
------------------------------------------------------------------------
------------------------------------------------------------------------

Revisions are a result of extended reserve life.


4. BANK LOAN

The Company has a financing commitment with a Canadian chartered bank for a revolving demand credit facility in the amount of $15,200,000. The facility bears interest at bank prime rate plus 0.50% payable monthly and is secured by a $50,000,000 demand debenture and a general security agreement. The Company also has available a $7,500,000 non-revolving acquisition development demand loan. This facility bears interest at bank prime rate plus 0.75% with a drawdown rate of 0.25% on the amount drawn for acquisitions and 0.375% on development expenditures.

The facilities are subject to a semi-annual review. The next review is to be undertaken before October 31, 2005. This review includes a borrowing base re-determination, including any completed acquisitions, and a full assessment of the Company's financial position and operations.


5. SHARE CAPITAL

a) Authorized

Unlimited number of common shares without par value

Unlimited number of first preferred shares, of which none have been issued

Unlimited number of second preferred shares, of which none have been issued



b) Issued and Outstanding
Shares Amount
(#) ($)
------------------------------------------------------------------------

Common shares
Balance, December 31, 2004 18,552,523 18,438,151
Common shares issued 1,750,000 5,075,000
Flow-through shares issued 3,391,000 11,818,700
Tax effect of flow-through shares
issued September 2004 - (2,116,608)
Share issue costs
(net of tax effect of $365,056) - (669,975)
------------------------------------------------------------------------
Balance, June 30, 2005 23,693,523 32,545,268
------------------------------------------------------------------------
------------------------------------------------------------------------


c) Stock Options

The Company has adopted a stock option plan (the "Plan") for directors, senior officers, employees and key consultants of the Company. Options granted pursuant to the Plan will not exceed a term of five years, and are granted at an option price and on other terms that the directors determine are necessary to achieve the goal of the Plan and in accordance with regulatory policies. Options vest one-third immediately, one-third one year later, and one-third one year after that. As at June 30, 2005, there were 1,855,000 stock options outstanding with an exercise price between $1.00 and $2.90.



The following table sets forth a reconciliation of the Plan activity to
June 30, 2005:

Weighted
average
Options exercise
outstanding price
(#) ($)
------------------------------------------------------------------------

Balance, December 31, 2004 1,755,000 1.61
Granted 100,000 2.82
Cancelled - -
Exercised - -
------------------------------------------------------------------------
Balance, June 30, 2005 1,855,000 1.67
------------------------------------------------------------------------


Weighted
average
Options contractual
Exercise price outstanding life (years)
------------------------------------------------------------------------

$1.00 - $1.50 860,000 3.5
$1.51 - $2.25 285,000 3.6
$2.26 - $2.90 620,000 4.4
$2.33 - $2.90 90,000 4.7
------------------------------------------------------------------------
$1.00 - $2.90 1,855,000 3.9
------------------------------------------------------------------------
------------------------------------------------------------------------


d) Flow-through Shares

Pursuant to the May and June 2005 flow-through share offerings, the Company renounced $11,818,700 of qualifying expenditures effective December 31, 2005. Of the total qualifying expenditures of the May issue of $6,006,000, $4.2 million remained to be expended at June 30, 2005, and all of the June issue of $5,812,700 remained to be expended.

e) Per Share Amounts

Per share amounts have been calculated based on the weighted average number of shares outstanding. The basic weighted average shares outstanding at June 30, 2005 was 19,144,020. The diluted weighted average shares outstanding at June 30, 2005 was 19,855,357, calculated using the treasury stock method.

f) Stock-based Compensation

The Company has calculated its stock-based compensation expense using the Black-Scholes option pricing model to estimate the fair value of stock options issued at the date of the grant. The weighted average fair market value per option granted in the six months ended June 30, 2005 and 2004 and the assumptions used in their determination are as follows:



Six months ended June 30 2005 2004
------------------------------------------------------------------------

Weighted average fair value per option $ 1.11 $ 0.48
Risk free interest rate (%) 5 5
Volatility (%) 42 30
Expected life (years) 5 5
------------------------------------------------------------------------
------------------------------------------------------------------------

The Company has recorded an expense for stock options during the six
months ended June 2005 of $280,663 (six months ended June 30, 2004, an
expense of $68,180).

6. CONTRIBUTED SURPLUS

June 30, December 31,
2005 2004
------------------------------------------------------------------------

Balance, beginning of period $ 280,029 $ -
Stock-based compensation expense 280,663 280,029
Transfer to share capital on exercise
of options - -
------------------------------------------------------------------------
Balance, end of period $ 560,692 $ 280,029
------------------------------------------------------------------------
------------------------------------------------------------------------


7. INCOME TAXES

a) Future income tax recovery

The provision for income tax reflects an effective tax rate which
differs from Federal, and Provincial statutory tax rates. The main
difference is as follows:


2005 2004
------------------------------------------------------------------------

Earnings before tax $ (396,040) $ 97,744
Enacted tax rate 37.62% 38.62%
------------------------------------------------------------------------
Computed income taxes at the enacted rate (148,990) 37,749

Increase (decrease) in taxes resulting from:
Non-deductible crown payments 106,008 201,333
Resource allowance (247,753) (362,742)
Income tax rate reduction 200,594 (16,193)
Change in valuation allowance - (2,892,671)
Stock-based compensation 105,585 108,147
Other (75,088) 1,889
------------------------------------------------------------------------
Provision (recovery) for income taxes $ (59,644) $ (2,922,488)
------------------------------------------------------------------------
------------------------------------------------------------------------


b) The components of the net future income tax asset are as follows:


2005 2004
------------------------------------------------------------------------

Future income tax assets:
Non-capital losses $2,577,039 $3,863,306
Asset retirement obligation 1,358,486 1,202,246
Share issue costs 579,870 295,346
------------------------------------------------------------------------
4,515,394 5,360,898
------------------------------------------------------------------------
Future income tax liabilities:
Property, plant and equipment (3,026,766) (2,180,363)
------------------------------------------------------------------------

Net future tax asset $1,488,628 $3,180,535
------------------------------------------------------------------------
------------------------------------------------------------------------


8. FINANCIAL INSTRUMENTS

The Company's financial instruments recognized in the balance sheet consist of accounts receivable, accounts payable and accrued liabilities and bank debt.

The carrying value of accounts receivable, accounts payable and accrued liabilities approximate their fair market value.



9. SUPPLEMENTAL CASH FLOW INFORMATION

Three months ended Six months ended
June 30, June 30, June 30, June 30,
2005 2004 2005 2004
------------------------------------------------------------------------

Accounts receivable (3,452,449) (621,772) (3,814,030) (1,133,566)
Prepaid expenses (333,466) (99,094) (468,890) (121,168)
Accounts payable and
accrued liability 2,718,081 200,986 625,066 (673,416)
Change in non-cash
working capital from
investing (773,360) 800,508 1,459,093 1,881,046
------------------------------------------------------------------------
Change in non-cash
working capital from
operations (1,841,194) 280,628 (2,198,761) (47,104)
------------------------------------------------------------------------
------------------------------------------------------------------------

The following cash payments have been included in the determination
of earnings:
2005 2004 2005 2004
------------------------------------------------------------------------
Interest paid 46,649 41,903 55,847 76,186
Taxes paid - - - -
------------------------------------------------------------------------
------------------------------------------------------------------------


10. COMMITMENT

The Company is committed to payments under an operating lease for office space through April 30, 2007 totaling $363,035 (2005 - $95,273; 2006 - $199,536; 2007 - $68,226).

11. SUBSEQUENT EVENT

On July 1, 2005, Grand entered into a costless collar contract for the period of July 1, 2005 to December 31, 2005 for 200 boe/day. The floor price is $50.00 USD WTI per barrel, and the cap price is $66.55 USD WTI per barrel.

Certain information set forth in this press release contains forward-looking statements. 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, reliance should not be placed on forward-looking statements. Grand's actual results, performance or achievement 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 Grand will derive therefrom. Grand disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

The TSX Venture Exchange has neither approved nor disapproved the contents of this press release.

Contact Information

  • Grand Petroleum Inc.
    Andrew Hogg
    President and CEO
    (403) 231-8403
    or
    Grand Petroleum Inc.
    Brenda Galonski
    Vice President Finance and CFO
    (403) 231-8402
    Website: www.grandpetroleum.com