ZARGON ENERGY TRUST
TSX : ZAR.UN

ZARGON ENERGY TRUST
Zargon Oil & Gas Ltd.
TSX : ZAR

Zargon Oil & Gas Ltd.

August 13, 2008 17:01 ET

Zargon Energy Trust Announces 2008 Second Quarter Results

CALGARY, ALBERTA--(Marketwire - Aug. 13, 2008) - Zargon Energy Trust (TSX:ZAR.UN) and Zargon Oil & Gas Ltd. (TSX:ZOG.B):

FINANCIAL & OPERATING HIGHLIGHTS

Zargon Energy Trust is pleased to report strong financial results for the second quarter of 2008. Funds flow from operations were a record $32.02 million ($1.55 per diluted trust unit) in the 2008 second quarter compared with $24.75 million ($1.23 per diluted trust unit) in the 2008 first quarter and $20.56 million ($1.05 per diluted trust unit) in the 2007 second quarter.

Highlights from the three and six months ended June 30, 2008 are noted below:

- Second quarter 2008 production averaged 9,239 barrels of oil equivalent per day, two percent above the preceding quarter and a nine percent increase over the corresponding 2007 quarter. Second quarter production volume increases were primarily due to the first half 2008 corporate acquisitions of Rival Energy Ltd. ("Rival") and Newpact Energy Corp. ("Newpact"), which closed on January 23, 2008 and May 16, 2008, respectively. For the second quarter of 2008, Zargon's production averaged 447 barrels of oil equivalent per day per million trust units outstanding compared to 446 and 432 barrels of oil equivalent per day per million trust units outstanding for the prior quarter and the corresponding quarter of 2007, respectively.

- Petroleum and natural gas revenue and funds flow from operations in the 2008 second quarter increased 33 percent and 29 percent, respectively, from the prior quarter. Increased realized oil prices of 31 percent and increased realized natural gas prices of 29 percent from the prior quarter were partially offset by realized risk management losses. The net loss for the quarter of $4.51 million was a result of a non-cash charge for unrealized risk management losses of $29.63 million due to the significant increase in market prices for both crude oil and natural gas which resulted in a mark-to-market loss on outstanding commodity risk management positions.

- The Trust declared three monthly cash distributions of $0.18 per trust unit in the second quarter of 2008 for a total of $9.71 million. These cash distributions were equivalent to a payout ratio of 35 percent of the Trust's second quarter funds flow on a diluted trust unit basis and, after considering the effect of the exchangeable shares not receiving distributions, the distributions amounted to 30 percent of funds flow from operations.

- The Trust's second quarter exploration and development capital expenditures (excluding acquisitions and dispositions) increased 21 percent from the prior quarter to $11.43 million primarily as a result of increased completion, equipping and facilities expenditures. In the second quarter, Zargon also completed $2.60 million of net property acquisitions primarily relating to additional interests in the Bellshill Lake and Killam oil exploitation properties in the Alberta Plains core area.

- The acquisition of Newpact was completed on May 16, 2008. The total consideration was 425,940 Zargon trust units for all the issued and outstanding Newpact common shares along with the assumption of $2.49 million of net debt for a total transaction value of approximately $12.03 million (including acquisition costs).

- Debt net of working capital (excluding unrealized risk management assets and liabilities) decreased to $88.51 million at June 30, 2008, as a result strong funds flows from operations during the quarter partially offset by assumed net debt related to the acquisition of Newpact. The Trust's balance sheet remains strong with a debt net of working capital to annualized funds flow ratio of 0.8 times.

- On July 28, 2008, the Trust amended and renewed its syndicated committed credit facilities, the result of which was an increase in the borrowing base and available facilities to $180 million from the previous amount of $150 million. These facilities are available for general corporate purposes and the acquisition of oil and natural gas properties.



Three Months Ended Six Months Ended
June 30, June 30,
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Percent Percent
(unaudited) 2008 2007 Change 2008 2007 Change
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FINANCIAL
Income and Investments
($ millions)
Petroleum and natural
gas revenue 69.66 39.21 78 121.90 77.75 57
Funds flow from
operations 32.02 20.56 56 56.77 42.36 34
Cash flows from
operating activities 36.44 19.09 91 51.71 37.44 38
Cash distributions 9.71 9.17 6 19.26 18.29 5
Net earnings/(losses) (4.51) 11.63 (139) 0.04 16.86 (100)
Net capital expenditures 26.28 10.97 140 85.89 31.89 169
Per Unit, Diluted
Funds flow from
operations ($/unit) 1.55 1.05 48 2.78 2.17 28
Cash flows from operating
activities ($/unit) 1.76 0.97 81 2.53 1.92 32
Net earnings/(losses)
($/unit) (0.25) 0.68 (137) - 1.00 (100)
Cash Distributions
($/trust unit) 0.54 0.54 - 1.08 1.08 -
Balance Sheet at Period
End ($ millions)
Property and
equipment, net 380.18 299.59 27
Bank debt 85.45 46.74 83
Unitholders' equity 166.86 169.53 (2)
Total Units Outstanding
at Period End (millions) 20.94 19.64 7

OPERATING
Average Daily Production
Oil and liquids (bbl/d) 4,249 3,707 15 4,210 3,725 13
Natural gas (mmcf/d) 29.94 28.55 5 29.50 28.50 4
Equivalent (boe/d) 9,239 8,465 9 9,127 8,474 8
Equivalent per million
trust units (boe/d) 447 432 3 446 434 3
Average Selling Price
(before the impact of
financial risk
management contracts)
Oil and liquids ($/bbl) 111.58 62.37 79 98.38 59.71 65
Natural gas ($/mcf) 9.73 7.00 39 8.66 7.27 19
Wells Drilled, Net 5.1 2.6 96 14.3 17.0 (16)
Undeveloped Land at
Period End (thousand
net acres) 462 385 20
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Notes:

Throughout this report, the calculation of barrels of oil equivalent ("boe")
is based on the conversion ratio that six thousand cubic feet of natural
gas is equivalent to one barrel of oil. For a further discussion about this
term, refer to the Management's Discussion and Analysis section in this
report.

For net capital expenditures, amounts include capital expenditures acquired
for cash, equity issuances, acquisition costs and net debt assumed on
corporate acquisitions.

Funds flow from operations is a non-GAAP term that represents net
earnings/losses and asset retirement expenditures except for non-cash items.
For a further discussion about this term, refer to the Management's
Discussion and Analysis section in this report.

Total units outstanding include trust units plus exchangeable shares
outstanding at period end. The exchangeable shares are converted at the
exchange ratio at the end of the period.

Average daily production per million trust units is calculated using the
weighted average number of units outstanding during the period plus the
weighted average number of exchangeable shares outstanding for the period
converted at the average exchange ratio for the period.


PRODUCTION (1)

Natural gas production volumes in the second quarter of 2008 averaged 29.94 million cubic feet per day, a three percent increase from the previous quarter and a five percent increase from the corresponding period of 2007. The second quarter natural gas production gains were primarily from the Rival and Newpact corporate acquisitions that were partially offset by production curtailments relating to third party facility maintenance and by higher than anticipated initial natural declines from last year's Alberta Plains and West Central Alberta core area drilling programs. For the remainder of the year, we anticipate natural gas production volumes to remain relatively flat as production additions from the drilling and tie-in of new wells are offset by naturally occurring declines.

Also reflecting the Rival and Newpact corporate acquisitions, the 2008 second quarter oil and liquids production was 4,249 barrels per day, a two percent increase from the preceding quarter and a 15 percent increase from the corresponding 2007 quarter. For the remainder of this year, we anticipate modest production increases as our exploitation drilling programs at the Alberta Plains Bellshill Lake and Taber properties plus the Williston Basin horizontal drilling programs at Steelman and Elswick provide additional production volumes that should more than offset natural production declines.

CAPITAL EXPENDITURES (1)

During the second quarter of 2008, Zargon drilled six gross wells (5.1 net) that resulted in 2.6 net natural gas wells, 1.0 net oil well, a 0.5 net water injection well and 1.0 net dry and abandoned well for an 80 percent success ratio. Natural gas wells drilled in the second quarter include 2.0 net wells at Jarrow and Bellshill in the Alberta Plains core area and a 0.6 net well in the Peace River Arch in the West Central Alberta core area. In the Williston Basin, 1.0 net horizontal oil well was drilled at Steelman and a 0.5 net water injection well was drilled at Midale, Saskatchewan.

In the second quarter of 2008, Zargon purchased 39 thousand net acres of freehold and Crown lands at an average price of $73 per acre. These purchases were augmented by the addition of 21 thousand net acres of Newpact undeveloped land and allowed Zargon to increase its quarter end undeveloped land inventory to 462 thousand net acres, up 48 thousand net acres from the balance reported at the end of the prior quarter. For the remainder of the year, Zargon will continue to be an active participant at land sales during this period of lower Alberta Crown land sale costs in the Alberta Plains core area.

For the first six months of 2008, our $20.85 million field capital program ($11.43 million in the second quarter) was relatively modest and resulted in the drilling of only 14.3 net wells. In the second half of the year, we are projecting a more active $29 million field capital program with 26 net wells that will be skewed towards oil exploitation drilling, and will take the year's total field capital expenditures to $50 million and 40 net wells. Specifically, in the Williston Basin we are planning five horizontal wells at Elswick and Steelman, Saskatchewan and three vertical wells at Pinto and Frys, Saskatchewan. Exploitation success at Steelman could lead to numerous additional exploitation locations in 2009.

In the West Central Alberta core area, we plan on drilling three wells at St. Anne, Highvale and Morinville. West Central Alberta production additions at Rycroft and Pembina will come from the tie-in of three natural gas wells. Field activities in the Alberta Plains core area will include Jarrow and Bellshill Lake natural gas well tie-ins and continued high-volume lift and related modifications at Taber and Bellshill Lake, Alberta. By year end, we expect to drill seven Jarrow exploration targets and seven Bellshill Lake oil exploitation locations pursuant to the recent EUB approval of our Bellshill Lake spacing unit applications.

In the first half of 2008, Zargon took advantage of improved market values for corporate acquisitions with the closing of the Rival and Newpact acquisitions for a total of $59.85 million. Zargon also concluded three smaller property acquisitions totalling $5.21 million. Assuming no substantive additional acquisitions this year, we forecast that our total 2008 capital program will entail $50 million of field capital and $66 million of property and corporate acquisitions. To date, we are pleased with both our acquisition and field capital programs and we anticipate improved 2008 capital efficiencies from those delivered in 2007.

GUIDANCE (1)

In the May 14, 2008 press release announcing the first quarter results, Zargon provided updated production guidance of 9,400 barrels of oil equivalent per day for the second quarter of 2008, but actual production was two percent lower than this guidance at 9,239 barrels of oil equivalent per day. Also at that time, the second half 2008 production guidance was set at a range of 9,600 to 9,900 barrels of oil equivalent per day with the variance being largely dependent on the timing and availability of further property acquisitions. Assuming no additional acquisitions, we are now anticipating third quarter 2008 production volumes will average 9,300 barrels of oil equivalent per day. The previous 9,600 barrels of oil equivalent third quarter guidance level had been based on the now achieved combined Rival/Newpact production contribution of approximately 1,250 barrels of oil equivalent per day. Production shortfalls have instead been mostly related to higher than anticipated production declines from the 2007 Alberta Plains and West Central Alberta core area natural gas discoveries. In light of these results, we have elected to rebalance our 2008 field capital programs to emphasize our oil exploitation opportunities in all three core areas. Furthermore, our Alberta Plains and West Central Alberta natural gas exploration programs have been high-graded to improve capital efficiencies and deliver more reliable production profiles.

Looking forward to the fourth quarter of 2008, we expect that incremental oil volumes from our expanded Williston Basin and Alberta Plains oil exploitation drilling programs will increase our production to 9,500 barrels of oil equivalent per day. This guidance does not contemplate any further property or corporate acquisitions. With our very strong balance sheet providing more than $80 million of unutilized credit facilities, Zargon is well positioned to pursue additional property and corporate acquisitions should value-added opportunities become available.

Finally, powered by strong commodity prices, Zargon has been generating very significant funds flows that are readily funding our capital programs and the $0.18 per unit monthly distribution. Specifically, second quarter distributions of $9.71 million represented only 30 percent (35 percent after allowance for the exchangeable shares) of the quarters $32.02 million of funds flow. During the quarter, our surplus funds flow was allocated to debt reduction and permitted a $5.84 million decrease in our net debt to the quarter end $88.51 million balance.

Although our recent cash distributions have dropped below our target distribution range, we are not proposing an increase to our distributions at this time due to the current volatile and uncertain commodity price trends. We will, however, monitor the situation closely while we use excess funds to reduce debt, and plan on revisiting this distribution decision later this fall.

(1) Please see comments on "Forward-Looking Statements" in the Management's Discussion and Analysis section in this report.

MANAGEMENT'S DISCUSSION AND ANALYSIS

Management's discussion and analysis ("MD&A") should be read in conjunction with the unaudited interim consolidated financial statements for the three and six months ended June 30, 2008 and the annual audited consolidated financial statements and MD&A for the year ended December 31, 2007. All amounts are in Canadian dollars unless otherwise noted. All references to "Zargon" or the "Trust" refer to Zargon Energy Trust.

In the MD&A, reserves and production are commonly stated in barrels of oil equivalent ("boe") on the basis that six thousand cubic feet of natural gas is equivalent to one barrel of oil. Boes may be misleading, particularly if used in isolation. A boe conversion ratio of six thousand cubic feet of natural gas to one barrel of oil is based on an energy equivalent conversion method primarily applicable to the burner tip and does not represent a value equivalent at the wellhead.

The following are descriptions of non-GAAP measures used in this MD&A:

- The MD&A contains the term "funds flow from operations" ("funds flow"), which should not be considered an alternative to, or more meaningful than, "cash flows from operating activities" as determined in accordance with Canadian GAAP as an indicator of the Trust's financial performance. This term does not have any standardized meaning as prescribed by GAAP and, therefore, the Trust's determination of funds flow from operations may not be comparable to that reported by other trusts. The reconciliation between cash flows from operating activities and funds flow from operations can be found in the table below and in the unaudited interim consolidated statements of cash flows in the unaudited interim consolidated financial statements. The Trust evaluates its performance based on net earnings/losses and funds flow from operations. The Trust considers funds flow from operations to be a key measure as it demonstrates the Trust's ability to generate the cash necessary to pay distributions, repay debt and to fund future capital investment. It is also used by research analysts to value and compare oil and gas trusts, and it is frequently included in published research when providing investment recommendations. Funds flow from operations per unit is calculated using the diluted weighted average number of units for the period.



Funds Flow from Operations Reconciliation

Three Months Ended Six Months Ended
June 30, June 30,
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($ millions) 2008 2007 2008 2007
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Cash flows from operating activities 36.44 19.09 51.71 37.44

Changes in non-cash working capital (4.42) 1.47 5.06 4.92
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Funds flow from operations 32.02 20.56 56.77 42.36
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- The Trust also uses the term "debt net of working capital" or "net debt". Debt net of working capital as presented does not have any standardized meaning prescribed by Canadian GAAP and may not be comparable with the calculation of similar measures for other entities. Debt net of working capital as used by the Trust is calculated as bank debt and any working capital deficit excluding unrealized risk management assets and liabilities.

- Operating netbacks per boe equal total petroleum and natural gas revenue per boe adjusted for realized risk management gains and/or losses per boe, royalties per boe and production costs per boe. Operating netbacks are a useful measure to compare the Trust's operations with those of its peers.

- Funds flow netbacks per boe are calculated as operating netbacks less general and administrative expenses per boe, interest and financing charges per boe, asset retirement expenditures per boe and current income taxes per boe. Funds flow netbacks are a useful measure to compare the Trust's operations with those of its peers.

References to "production volumes" or "production" in this MD&A refer to sales volumes.

Forward-Looking Statements - This document offers our assessment of Zargon's future plans and operations as at August 12, 2008, and contains forward-looking statements including:

- our expectations for production referred to under the headings "Financial & Operating Highlights - Production" and "Financial & Operating Highlights - Guidance";

- our expectations for capital spending, drilling activity and finding and development costs referred under the heading "Financial & Operating Highlights - Capital Expenditures";

- our expectations for royalty rates referred to under the heading "Financial Analysis";

- our expectations for production costs referred to under the heading "Financial Analysis";

- our expected sources of funds for distributions and capital expenditures referred to under the heading "Liquidity and Capital Resources";

- our expectations of the impact of higher prices on our net asset value referred to under the heading "Business Risks - Alberta Royalty and Tax Regime"; and

- our distribution policy referred to under the heading "Financial & Operating Highlights - Guidance".

Such statements are generally identified by the use of words such as "anticipate", "continue", "estimate", "expect", "forecast", "may", "will", "project", "should", "plan", "intend", "believe", and similar expressions (including the negatives thereof). By their nature, forward-looking statements are subject to numerous risks and uncertainties, some of which are beyond our control, including such as those relating to results of operations and financial condition, general economic conditions, industry conditions, changes in regulatory and taxation regimes, volatility of commodity prices, escalation of operating and capital costs, currency fluctuations, the availability of services, imprecision of reserve estimates, geological, technical, drilling and processing problems, environmental risks, weather, the lack of availability of qualified personnel or management, stock market volatility, the ability to access sufficient capital from internal and external sources and competition from other industry participants for, among other things, capital, services, acquisitions of reserves, undeveloped lands and skilled personnel. Risks are described in more detail in our Annual Information Form, which is available on our website. Forward-looking statements are provided to allow investors to have a greater understanding of our business.

You are cautioned that the assumptions, including among other things, future oil and natural gas prices; future capital expenditure levels; future production levels; future exchange rates; the cost of developing and expanding our assets; our ability to obtain equipment in a timely manner to carry out development activities; our ability to market our oil and natural gas successfully to current and new customers; the impact of increasing competition; our ability to obtain financing on acceptable terms; and our ability to add production and reserves through our development and acquisition activities 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. Our actual results, performance, or achievement could differ materially from those expressed in, or implied by, these forward-looking statements. We can give no assurance that any of the events anticipated will transpire or occur, or if any of them do, what benefits we will derive from them. The forward-looking information contained in this document is expressly qualified by this cautionary statement. Our policy for updating forward-looking statements is that Zargon disclaims, except as required by law, any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

This MD&A has been prepared as of August 12, 2008.

SUMMARY OF SIGNIFICANT EVENTS IN THE SECOND QUARTER

- During the second quarter of 2008, the Trust realized funds flow from operations of $32.02 million and declared total distributions of $9.71 million ($0.54 per trust unit) to unitholders. For Canadian income tax purposes, the distributions are currently estimated to be 100 percent taxable income to unitholders.

- Average field prices received (before the impact of financial risk management contracts) for oil and liquids and for natural gas increased 31 percent to $111.58 per barrel and 29 percent to $9.73 per thousand cubic feet, respectively, compared to the first quarter of 2008.

- Second quarter production volumes were 9,239 barrels of oil equivalent per day, a two percent increase from the first quarter of 2008 production levels.

- During the second quarter of 2008, the Trust drilled six gross wells (5.1 net) with an 80 percent success rate. Total field exploration and development capital expenditures were $11.43 million for the quarter compared to $9.42 million for the prior quarter.

- The Trust continues to maintain a strong balance sheet with a combined debt net of working capital (excluding unrealized risk management assets and liabilities) of $88.51 million, which represents slightly more than nine months of the 2008 year-to-date annualized funds flow.

- On May 16, 2008, Zargon completed the corporate acquisition of Newpact Energy Corp. ("Newpact") for total consideration of 425,940 Zargon trust units for all the issued and outstanding Newpact common shares. Net debt of approximately $2.49 million was assumed as part of this acquisition.

- Subsequent to June 30, 2008, Zargon amended and renewed its syndicated credit facilities, which resulted in an increase in the available facilities and the borrowing base by $30 million to $180 million. These expanded facilities continue to be available for general corporate purposes and the acquisition of oil and natural gas properties. In conjunction with this amendment and renewal, Zargon has added another major Canadian based financial institution to its existing banking syndicate.

FINANCIAL ANALYSIS

Second quarter 2008 revenue of $69.66 million was 33 percent above the $52.24 million in the first quarter of 2008 and 78 percent above the $39.21 million in the second quarter of 2007. A 29 percent increase in natural gas prices received and a 31 percent increase in oil and liquids prices received were the primary reasons for the increased revenues when compared to the prior quarter amounts. Average daily production volumes also showed gains with a two percent increase over the prior quarter rate. Second quarter 2008 realized oil and liquids field prices averaged $111.58 per barrel before the impact of financial risk management contracts and were 31 percent higher than the preceding quarter's $84.93 per barrel and were 79 percent higher than the $62.37 per barrel recorded in the 2007 second quarter. Zargon's crude oil field price differential from the Edmonton par price increased to $14.49 per barrel in the second quarter of 2008 compared to $12.57 per barrel in the first quarter of 2008. Natural gas field prices received averaged $9.73 per thousand cubic feet before the impact of financial risk management contracts in the second quarter of 2008, 39 percent above the 2007 second quarter prices received and a 29 percent increase from the preceding quarter levels. Zargon's realized field prices differ from the benchmark AECO average daily price due to a combination of fixed price physical contracts (See note 14 to the interim unaudited consolidated financial statements) and from the impact of Zargon receiving AECO monthly index pricing for a portion of its natural gas production.



Pricing
Three Months Ended Six Months Ended
June 30, June 30,
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Percent Percent
Average for the period 2008 2007 Change 2008 2007 Change
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Natural Gas:
NYMEX average daily
spot price ($US/mmbtu) 11.38 7.53 51 10.02 7.37 36
AECO average daily
spot price ($Cdn/mmbtu) 10.22 7.07 45 9.10 7.24 26
Zargon realized field
price before the impact
of financial risk
management contracts
($Cdn/mcf) 9.73 7.00 39 8.66 7.27 19
Zargon realized field
price before the impact
of physical and
financial risk
management contracts
($Cdn/mcf) 10.04 6.90 46 8.90 7.07 26
Zargon realized field
price after the impact
of physical and
financial risk
management contracts
($Cdn/mcf) 9.32 7.24 29 8.62 7.60 13
Crude Oil:
WTI ($US/bbl) 123.98 65.04 91 110.92 61.60 80
Edmonton par price
($Cdn/bbl) 126.07 71.93 75 111.79 69.51 61
Zargon realized field
price before the impact
of financial
risk management
contracts ($Cdn/bbl) 111.58 62.37 79 98.38 59.71 65
Zargon realized field
price after the impact
of financial risk
management contracts
($Cdn/bbl) 91.37 63.84 43 83.26 62.29 34
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Natural gas production volumes increased by three percent in the second quarter of 2008 to 29.94 million cubic feet per day from 29.06 million cubic feet per day in the first quarter of 2008 and were five percent higher than the 2007 second quarter. When compared to the prior quarter, the 2008 second quarter increase in natural gas production volumes were primarily as a result of the addition of volumes related to the acquisition of Newpact. Oil and liquids production during the second quarter of 2008 was 4,249 barrels per day, which is two percent above the 2008 first quarter rate of 4,171 barrels per day and 15 percent above the second quarter of 2007 level. The year-over-year increase in oil and liquids production was primarily due to production volume additions related to the Rival Energy Ltd. ("Rival") corporate acquisition. On a barrel of oil equivalent basis, Zargon produced 9,239 barrels of oil equivalent per day in the second quarter of 2008, which represents a two percent increase from the 9,015 barrels of oil equivalent per day in the first quarter of 2008 and a nine percent increase when compared to the second quarter of 2007.



Production by Core Area

Three Months Ended
June 30, 2008 2007
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Oil and Natural Equiva- Oil and Natural Equiva-
Liquids Gas lents Liquids Gas lents
(bbl/d) (mmcf/d) (boe/d) (bbl/d) (mmcf/d) (boe/d)
----------------------------------------------------------------------------
Alberta Plains 1,271 20.27 4,650 511 19.17 3,706
West Central Alberta 265 9.08 1,778 177 9.09 1,692
Williston Basin 2,713 0.59 2,811 3,019 0.29 3,067
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4,249 29.94 9,239 3,707 28.55 8,465
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Six Months Ended
June 30, 2008 2007
----------------------------------------------------------------------------
Oil and Natural Equiva- Oil and Natural Equiva-
Liquids Gas lents Liquids Gas lents
(bbl/d) (mmcf/d) (boe/d) (bbl/d) (mmcf/d) (boe/d)
----------------------------------------------------------------------------
Alberta Plains 1,202 19.81 4,504 523 19.92 3,843
West Central Alberta 253 9.19 1,785 167 8.32 1,553
Williston Basin 2,755 0.50 2,838 3,035 0.26 3,078
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4,210 29.50 9,127 3,725 28.50 8,474
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Zargon's commodity price risk management policy, which is approved by the Board of Directors, allows the use of forward sales and costless collars for a targeted range of 20 to 30 percent of oil and natural gas working interest production in order to partially offset the effects of large commodity price fluctuations. Zargon's management considers financial risk management contracts to be effective on an economic basis but has decided not to designate these contracts as hedges for accounting purposes and, accordingly, for these contracts, an unrealized gain or loss is recorded based on the fair value (mark-to-market) of the contracts at the period end.

Specifically, in the 2008 second quarter, relatively higher oil and natural gas prices resulted in a net realized financial risk management loss totalling $8.95 million (consisting of a $1.13 million loss on natural gas contracts and a $7.82 million loss on oil contracts) that compares to a $2.87 million realized net loss in the first quarter of 2008 and a $1.12 million realized net gain in the second quarter of 2007.

The 2008 second quarter unrealized risk management loss resulted from oil contract losses ($26.11 million) and by unrealized risk management natural gas contract losses ($3.52 million) resulting in a total loss of $29.63 million for the quarter, which compares to a net $6.86 million loss for the 2008 first quarter and a net $1.22 million gain in the second quarter of 2007. These non-cash unrealized risk management gains or losses are generated by the change over the reporting period in the mark-to-market valuation of Zargon's financial risk management contracts. Recent volatility in commodity prices has resulted in significant fluctuations in the mark-to-market amount of unrealized risk management assets and liabilities. The period-over-period changes in these valuations directly impact net earnings/losses. As at June 30, 2008, the total current and long term portion of unrealized risk management liabilities on financial risk management contracts were $47.49 million. The comparable July 31, 2008 net unrealized risk management liabilities are estimated at $23.87 million which would positively impact July net earnings by approximately $23.62 million. Zargon's commodity risk management positions are fully described in note 14 to the unaudited consolidated interim financial statements.

Royalties, inclusive of the Saskatchewan Resource Surcharge, totalled $14.04 million for the second quarter of 2008, an increase of 31 percent from the $10.71 million preceding quarter expense and an increase of 65 percent from the $8.53 million in the second quarter of 2007. The variations generally track changes in production, prices and volumes. As a percentage of gross revenue, royalty rates moved in a relatively narrow range from 21.8 percent in the second quarter of 2007 to 20.5 percent in the first quarter of 2008 and 20.2 percent in the second quarter of 2008. For the remainder of the 2008 year, assuming current commodity prices and rates of production, Zargon expects that its royalty rate will remain in the 20 to 22 percent range. Commencing in 2009, the oil and natural gas royalty structure will change for Alberta production volumes. Further discussion regarding this issue is provided later in this report.

On a unit of production basis, production costs of $11.22 per barrel of oil equivalent in the second quarter of 2008 compares with $11.17 per barrel of oil equivalent in the preceding quarter and $9.97 per barrel of oil equivalent in the second quarter of 2007. The increase in the 2008 second quarter costs relate to the relatively higher operating cost properties acquired in the Rival and Newpact corporate acquisitions and the industry-wide trend of increased unit operating costs. For the remainder of 2008, assuming current industry trends and cost inflation, Zargon anticipates that production costs can be maintained in the $11.00 to $11.75 range.



Operating Netbacks

Three Months Ended June 30, 2008 2007
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Oil and Natural Oil and Natural
Liquids Gas Liquids Gas
($/bbl) ($/mcf) ($/bbl) ($/mcf)
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Production revenue 111.58 9.73 62.37 7.00
Realized risk management gain/(loss) (20.22) (0.41) 1.48 0.24
Royalties (22.71) (1.93) (14.00) (1.47)
Production costs (13.93) (1.48) (13.36) (1.22)
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Operating netbacks 54.72 5.91 36.49 4.55
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Six Months Ended June 30, 2008 2007
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Oil and Natural Oil and Natural
Liquids Gas Liquids Gas
($/bbl) ($/mcf) ($/bbl) ($/mcf)
----------------------------------------------------------------------------
Production revenue 98.38 8.66 59.71 7.27
Realized risk management gain/(loss) (15.12) (0.04) 2.58 0.33
Royalties (20.05) (1.75) (13.11) (1.56)
Production costs (13.76) (1.50) (13.25) (1.29)
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Operating netbacks 49.45 5.37 35.93 4.75
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Measured on a unit of production basis (net of recoveries), general and administrative expenses were $2.92 per barrel of oil equivalent in the first half of 2008 compared to $2.26 in the first half of 2007 and $2.63 for the twelve month period of 2007. The year-over-year increase in general and administrative expenses on a per unit of production basis are primarily due to additional office lease costs and the costs related to the expansion of Zargon's technical staff and consultants. Additionally, commencing January 1, 2008, Zargon records on a monthly basis anticipated staff bonuses, which had only been recorded in the second half of prior years.

Expensing of unit-based compensation in the first half of 2008 was $0.52 million, a 29 percent decrease from the corresponding 2007 first half expense. The decrease is a result of increased cancellations of unit rights and a general decline in the valuation of new quarterly grants.

Zargon's borrowings are through its syndicated bank credit facilities. Interest and financing charges on these facilities in the 2008 second quarter were $1.36 million, two percent higher than the previous quarter amount of $1.33 million and an increase of $0.63 million from $0.73 million in the second quarter of 2007. This year-over-year increase is primarily due to an increase in average bank debt levels. On July 28, 2008, Zargon amended and renewed its syndicated committed credit facilities, which resulted in an increase in the available facilities and borrowing base to $180 million from the previous amount of $150 million. The next renewal date is July 28, 2009. In conjunction with this amendment and renewal, Zargon has added another major Canadian based financial institution to its existing banking syndicate. These expanded facilities continue to be available for general corporate purposes and the potential acquisition of oil and natural gas properties.

Current income taxes for the 2008 second quarter were $0.99 million, primarily relating to the United States operations, where increased taxable income resulted in higher United States income taxes. When compared to prior periods, current income taxes increased $0.29 million over the 2007 second quarter and increased $0.03 million relative to the first quarter of 2008. The increased 2008 taxable income is due to increased revenue attributed to increased oil commodity prices and a reduced capital program for this geographic region, resulting in reduced tax pool claims and, therefore, resulting in higher United States taxes. Provided that oil prices remain high, a similar or slightly higher level of United States current income taxes is predicted for the remaining quarters of 2008. Tax pools, as at June 30, 2008, are approximately $172 million, which represents an increase of 16 percent from the comparable $148 million of tax pools available to Zargon at December 31, 2007, primarily a result of the tax pools acquired as part of the recent Rival and Newpact acquisitions.



Trust Netbacks

Three Months Ended Six Months Ended
June 30, June 30,
----------------------------------------------------------------------------
($/boe) 2008 2007 2008 2007
----------------------------------------------------------------------------
Petroleum and natural gas revenue 82.85 50.91 73.38 50.69
Realized risk management gain/(loss) (10.64) 1.45 (7.11) 2.25
Royalties (16.70) (11.08) (14.90) (10.99)
Production costs (11.22) (9.97) (11.19) (10.15)
----------------------------------------------------------------------------
Operating netbacks 44.29 31.31 40.18 31.80
General and administrative (3.10) (2.45) (2.92) (2.26)
Interest and financing charges (1.61) (0.95) (1.62) (0.85)
Asset retirement expenditures (0.32) (0.31) (0.29) (0.30)
Capital and current income taxes (1.18) (0.91) (1.18) (0.77)
----------------------------------------------------------------------------
Funds flow netbacks 38.08 26.69 34.17 27.62
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Depletion and depreciation expense for the second quarter of 2008 increased three percent to $14.69 million compared to $14.23 million in the prior quarter and increased 25 percent when compared to the second quarter of 2007 expense of $11.76 million. On a per barrel of oil equivalent basis, the depletion and depreciation rates were $17.47, $17.34 and $15.27 for the second and first quarters of 2008 and the second quarter of 2007, respectively. The primary reasons for the year-over-year expense increase are due to the impact of last year's increased finding, development and acquisition costs, the financial impact of the conversion of exchangeable shares pursuant to the application of EIC-151 "Exchangeable Securities Issued by Subsidiaries of Income Trusts", increased production volumes and the capital asset additions resulting from the recent Rival and Newpact corporate acquisitions.

The provision for accretion of asset retirement obligations for the first half of 2008 was $1.05 million, a 61 percent increase compared to the first half of 2007. The year-over-year increase is due to changes in the estimated future liability for asset retirement obligations as a result of wells added through Zargon's drilling program inclusive of wells acquired/disposed of in the year, changes resulting from revisions to the timing and the amounts of the original estimates of undiscounted cash flows and wells acquired with the recent Rival and Newpact corporate acquisitions.

The recovery of future taxes for the second quarter of 2008 was $7.77 million when compared to a recovery of $1.98 million in the prior quarter and a recovery of $3.35 million in the second quarter of 2007. The 2008 second quarter increase in the future tax recovery, when compared to the 2008 first quarter recovery, is primarily related to a decrease in net earnings as a result of the significant increase in unrealized risk management losses in the quarter.

On October 31, 2006, the Federal Government announced tax proposals pertaining to taxation of distributions paid by trusts and the personal tax treatment of trust distributions. Currently, the Trust does not pay tax on distributions as tax is paid by the unitholders. On June 12, 2007, the Federal Government enacted these tax proposals, which would have resulted in taxation of distributions at the Trust level at a rate of 31.5 percent effective January 1, 2011. Subsequent 2007 fourth quarter legislation has lowered this tax rate to 29.5 percent in 2011 and 28.0 percent beyond 2011 to assimilate recent corporate tax rate changes. Prior to June 2007, the Trust estimated the future income tax on certain temporary differences between amounts recorded on its balance sheet for book and tax purposes to have a nil effective tax rate. Under the legislation, the Trust now estimates the effective tax rate on the post 2010 reversal of these temporary differences to be approximately 28.0 percent. Until 2011, Zargon's future tax obligations are reduced as distributions are made from the Trust and, consequently, it is anticipated that Zargon's effective tax rate will continue to be low until that time.

On December 15, 2006, the Canadian Federal Department of Finance stated its intention to allow conversions of specified investment flow through ("SIFT") income trusts to a corporation without any adverse tax consequences to investors. On July 14, 2008, the Department of Finance released the draft legislative proposals to allow the conversion of these SIFT trusts into corporations. Zargon is currently reviewing and assessing this recent legislation, and is considering its potential impact on the organization while Zargon's management develops its strategic plan beyond 2010, which is the effective date of the new SIFT tax rules.

According to the January 19, 2005 CICA pronouncement, EIC-151 "Exchangeable Securities Issued by Subsidiaries of Income Trusts", Zargon Energy Trust must reflect the exchangeable securities issued by its subsidiary, Zargon Oil & Gas Ltd., as a non-controlling interest. Prior to 2005, these exchangeable shares were reflected as a component of unitholders' equity. Accordingly, the Trust has reflected a non-controlling interest of $20.56 million on the Trust's consolidated balance sheet as at June 30, 2008. Consolidated net losses have been reduced for net losses attributable to the non-controlling interest of $0.70 million in the second quarter of 2008. In accordance with EIC-151 and given the circumstances in Zargon's case, each exchangeable share redemption is accounted for as a step-purchase, which, in the second quarter of 2008, resulted in an increase in property and equipment of $0.04 million, a decrease in unitholders' equity and non-controlling interest of $0.67 million and an increase in future income tax liability of $0.01 million. Funds flow was not impacted by these changes. The cumulative impact to date of the application of EIC-151 has been to increase property and equipment by $52.16 million, unitholders' equity and non-controlling interest by $53.62 million, future income tax liability by $17.35 million and an allocation of net earnings/losses to exchangeable shareholders' of $18.81 million.

Funds flow from operations in the 2008 second quarter of $32.02 million was $7.27 million, or 29 percent higher than the preceding quarter and $11.45 million or 56 percent higher than the prior year second quarter. The increase in funds flow from the preceding quarter was primarily due to increased revenues (net of related royalties and realized risk management contract losses) as a result of higher average field commodity prices and increased production volumes. Compared to the prior year second quarter, a 63 percent increase in commodity prices and a nine percent increase in production volumes were partially offset by rising production costs and the 2008 second quarter realized risk management contract losses. Funds flow on a per diluted trust unit basis was $1.55 for the second quarter of 2008, a 26 percent increase from the prior quarter and a 48 percent increase from the 2007 second quarter.

Net losses of $4.51 million for the 2008 second quarter were 199 percent below the $4.56 million of net earnings in the preceding quarter and 139 percent below the $11.63 million of net earnings in the second quarter of 2007. The net earnings/losses track the funds flow from operations for the respective periods modified by asset retirement expenditures and non-cash charges, which include depletion and depreciation, unrealized risk management gains/losses, future income taxes/recoveries and non-controlling interest. The primary reason for the second quarter 2008 net loss is due to $29.63 million of non-cash unrealized risk management losses in the quarter.



Capital Expenditures

Three Months Ended Six Months Ended
June 30, June 30,
----------------------------------------------------------------------------
($ millions) 2008 2007 2008 2007
----------------------------------------------------------------------------
Undeveloped land 2.18 1.99 4.38 3.34
Geological and geophysical (seismic) 1.20 0.69 2.50 2.45
Drilling and completion of wells 5.29 2.37 9.50 14.13
Well equipment and facilities 2.76 3.24 4.47 9.17
----------------------------------------------------------------------------
Exploration and development 11.43 8.29 20.85 29.09
----------------------------------------------------------------------------
Property acquisitions 2.75 2.41 5.21 2.50
Property dispositions (0.15) - (0.17) -
----------------------------------------------------------------------------
Net property acquisitions 2.60 2.41 5.04 2.50
----------------------------------------------------------------------------
Corporate acquisitions (1) (2) 12.22 - 59.85 -
----------------------------------------------------------------------------
Total capital expenditures excluding
administrative assets (1) (2) 26.25 10.70 85.74 31.59
----------------------------------------------------------------------------
Administrative assets 0.03 0.27 0.15 0.30
----------------------------------------------------------------------------
Total net capital expenditures (1) (2) 26.28 10.97 85.89 31.89
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) For the three months ended June 30, 2008, amounts include transaction
costs of $0.15 million, net debt assumed of $2.69 million and the
equity issuance of trust units valued at $9.39 million.
(2) For the six months ended June 30, 2008, amounts include cash
consideration of $16.40 million, transaction costs of $0.44 million,
net debt assumed of $20.26 million and the equity issuance of trust
units valued at $22.76 million.


CORPORATE ACQUISITIONS

On May 16, 2008, a subsidiary of the Trust acquired all of the issued and outstanding common shares of Newpact Energy Corp. ("Newpact"), a private oil and gas company, for consideration of $9.54 million. Consideration consisted of the issuance of 425,940 Zargon trust units valued at $22.04 per unit and transaction costs of $0.15 million. Net debt of approximately $2.49 million was assumed as part of this acquisition.

Newpact's operating results have been included in the consolidated financial statements since May 16, 2008. In relation to the second quarter 2008 results, the Newpact acquisition has contributed approximately 157 barrels of oil equivalent per day of production volumes to Zargon's total quarterly production volumes of 9,239 barrels of oil equivalent per day.

On January 23, 2008, a subsidiary of the Trust acquired all of the issued and outstanding common shares of Rival Energy Ltd. ("Rival"), a public oil and gas company, for consideration of $30.06 million. Consideration consisted of $16.40 million cash, the issuance of 573,300 Zargon trust units valued at $23.32 per unit and transaction costs of $0.29 million. Net debt of approximately $17.77 million was assumed as part of this acquisition.

LIQUIDITY AND CAPITAL RESOURCES

Total net capital expenditures (including net property acquisitions, consideration and net debt assumed for corporate acquisitions) of $85.89 million in the first half of 2008 were 169 percent higher than the first half of 2007, reflecting the $59.85 million attributed to the corporate acquisitions of Rival and Newpact. Conversely, 2008 first half field expenditures of $20.85 million reflected a muted exploration and development field program when compared to $29.09 million for the comparable 2007 period, representing a 28 percent decrease. Specifically, the year-to-date drilling and completion expenses of $9.50 million were 33 percent lower than the prior year's first half amount of $14.13 million. During the second quarter of 2008, 5.1 net wells were drilled compared to 9.2 net wells in the first quarter of 2008 and 2.6 net wells in the second quarter of 2007. Field capital expenditures for the first half of 2008 were allocated to Alberta Plains - $9.67 million, West Central Alberta - $6.89 million and Williston Basin - $4.29 million.

Funds flow from operations in the 2008 first half of $56.77 million, proceeds from the issuance of trust units of $23.63 million and the increase in bank debt of $28.58 million funded the capital program including corporate and property acquisitions, the changes in working capital and the cash distributions to the unitholders.

At June 30, 2008, the Trust continues to maintain a strong balance sheet with a combined debt net of working capital (excluding unrealized risk management assets and liabilities) of $88.51 million, compared to $94.35 million at the end of the 2008 first quarter, and represents slightly more than nine months of the 2008 year-to-date annualized funds flow. The $5.84 million quarter-over-quarter decline in the debt net of working capital resulted from strong funds flow from operations in the 2008 second quarter and occurred despite the assumption of additional net debt in the Newpact corporate acquisition. Unutilized credit facilities of $53.61 million were available at June 30, 2008.

The volatility of oil and natural gas prices and the uncertainty relating to Alberta royalties and Canadian income trust tax rules has partially restricted the oil and gas industry's ability to attract new capital from debt and equity markets. Zargon's historically conservative strategy of maintaining a relatively low cash distribution to funds flow ratio and conservative debt levels should enable Zargon to maintain its capital and distribution programs during periods of limited access to debt and equity capital.



Cash Distributions Analysis

Three Months Ended Six Months Ended
June 30, June 30,
----------------------------------------------------------------------------
($ millions) 2008 2007 2008 2007
----------------------------------------------------------------------------
Cash flows from operating activities 36.44 19.09 51.71 37.44
Net earnings/(losses) (4.51) 11.63 0.04 16.86
Actual cash distributions paid or
payable relating to the period (9.71) (9.17) (19.26) (18.29)
----------------------------------------------------------------------------
Excess of cash flows from operating
activities over cash distributions
paid 26.73 9.92 32.45 19.15
Excess/(shortfall) of net
earnings/(losses) over cash
distributions paid (14.22) 2.46 (19.22) (1.43)
----------------------------------------------------------------------------
----------------------------------------------------------------------------


During the first half of 2008, Zargon has maintained a base monthly distribution of $0.18 per trust unit. Management monitors the Trust's distribution policy with respect to forecasted net cash flows, debt levels and capital expenditures. Zargon's cash distributions are discretionary to the extent that these distributions do not cause a breach of the financial covenants under Zargon's credit facilities and to the extent the Trust (non-consolidated) is not taxable. As a crude oil and natural gas Trust, Zargon's reserve base is depleted with production and Zargon, therefore, relies on ongoing exploration, development and acquisition activities to replace reserves and to offset production declines. The success of these exploration, development and acquisition capital programs, along with commodity price fluctuations are the main factors influencing the sustainability of the Trust's distributions.

For the three and six months ended June 30, 2008, cash flows from operating activities (after changes in non-cash working capital) of $36.44 million and $51.71 million, respectively, exceeded cash distributions of $9.71 million and $19.26 million, respectively. This was consistent with the three months and six months ended June 30, 2007, in which cash flows from operating activities (after changes in non-cash working capital) of $19.09 million and $37.44 million, respectively, exceeded cash distributions of $9.17 million and $18.29 million, respectively.

For the three and six months ended June 30, 2008, cash distributions of $9.71 and $19.26 million, exceeded net losses of $4.51 million and net earnings of $0.04 million, respectively. For the three months ended June 30, 2007, net earnings of $11.63 million exceeded cash distributions of $9.17 million. For the six months ended June 30, 2007, net earnings of $16.86 million were exceeded by cash distributions of $18.29 million. Net earnings/losses include significant non-cash charges, which were $36.79 million for the 2008 second quarter and $57.21 for the six months ended June 30, 2008, that do not impact cash flow. Net earnings/losses also include fluctuations in future income taxes due to changes in tax rates and tax rules. In addition, other non-cash charges such as depletion and depreciation are not a good proxy for the cost of maintaining Zargon's productive capacity given the natural declines associated with crude oil and natural gas assets. In these instances, where distributions exceed net earnings/losses, a portion of the cash distribution paid to unitholders may represent an economic return of the unitholders' capital.

For the 2008 second quarter, cash distributions and net capital expenditures totalled $35.99 million ($23.77 million excluding the $12.22 million attributed to the Newpact corporate acquisition and a minor Rival corporate purchase price adjustment), which was $0.45 million lower than the cash flows from operating activities (after changes in non-cash working capital) of $36.44 million. For the six months ended June 30, 2008, cash flows from operating activities (after changes in non-cash working capital) were exceeded by cash distributions and net capital expenditures (including the cash and non-cash portion of corporate acquisitions) by $53.44 million. For the three and six months ended June 30, 2007, cash distributions and net capital expenditures exceeded cash flows from operating activities (after changes in non-cash working capital) by $1.05 million and $12.74 million, respectively. Zargon relies on access to debt and capital markets to the extent cash distributions and net capital expenditures exceed cash flows from operating activities (after changes in non-cash working capital). Over the long term, Zargon expects to fund cash distributions and capital expenditures with its cash flows from operating activities; however, it will continue to fund acquisitions and growth through additional debt and equity issuances. In the crude oil and natural gas industry, because of the nature of reserve reporting, the natural reservoir declines and the risks involved in capital investment, it is not possible to distinguish between capital spent on maintaining productive capacity and capital spent on growth opportunities. Therefore, maintenance capital is not disclosed separately from development capital spending.

At August 12, 2008, Zargon Energy Trust had 18.205 million trust units and 2.046 million exchangeable shares outstanding. Assuming full conversion of exchangeable shares at the effective August 12, 2008 exchange ratio of 1.36679, there would be 21.001 million trust units outstanding. Pursuant to the trust unit rights incentive plan there are currently an additional 1.613 million trust unit incentive rights issued and outstanding.



Capital Sources and Uses

Three Months Ended Six Months Ended
June 30, June 30,
----------------------------------------------------------------------------
($ millions) 2008 2007 2008 2007
----------------------------------------------------------------------------
Funds flow from operations 32.02 20.56 56.77 42.36
Changes in working capital and other 0.63 (10.41) (3.83) (10.76)
Change in bank debt (6.74) 9.06 28.58 16.70
Cash distributions to unitholders (9.71) (9.17) (19.26) (18.29)
Issuance of trust units 10.08 0.93 23.63 1.88
----------------------------------------------------------------------------
Total capital sources 26.28 10.97 85.89 31.89
----------------------------------------------------------------------------
----------------------------------------------------------------------------


CHANGE IN ACCOUNTING POLICIES

As disclosed in the December 31, 2007 annual audited consolidated financial statements, on January 1, 2008, the Trust adopted the following Canadian Institute of Chartered Accountants ("CICA") Handbook Sections:

"Financial Instruments - Presentation", Section 3863 and "Financial Instruments - Disclosures", Section 3862. The new disclosure standards increase Zargon's disclosure regarding the nature and extent of the risks associated with financial instruments and how those risks are managed (See note 14 of the interim unaudited consolidated financial statements). The new presentation standard carries forward the former presentation requirements.

"Capital Disclosures", Section 1535. The new standard requires Zargon to disclose its objectives, policies and processes for managing its capital structure (See note 10 of the interim unaudited consolidated financial statements).

In addition, the Trust has assessed new and revised accounting pronouncements that have been issued that are not yet effective and determined that the following may have a significant impact on the Trust:

As of January 1, 2009, Zargon will be required to adopt the CICA Handbook Section 3064, "Goodwill and Intangible Assets", which will replace the existing Goodwill and Intangible Assets standard. The new standard revises the requirement for recognition, measurement, presentation and disclosure of intangible assets. The adoption of this standard is not expected to have a material impact on Zargon's consolidated financial statements.

In January 2006, the CICA Accounting Standards Board ("AcSB") adopted a strategic plan for the direction of accounting standards in Canada. As part of that plan, the AcSB confirmed in February 2008 that International Financial Reporting Standards ("IFRS") will replace Canadian GAAP in 2011 for profit-oriented Canadian publicly accountable enterprises. As Zargon will be required to report its results in accordance with IFRS starting in 2011, the Trust is assessing the potential impacts of this changeover and developing its plan accordingly. Zargon has enlisted an independent consulting firm to assist with the assessment and planning of this project.

MANAGEMENT AND FINANCIAL REPORTING SYSTEMS

Zargon is required to comply with Multilateral Instrument 52-109 "Certification of Disclosure in Issuers' Annual and Interim Filings", otherwise referred to as Canadian SOX ("C-Sox"). The 2008 certificate requires that the Trust disclose in the interim MD&A any changes in the Trust's internal controls over financial reporting that occurred during the period that has materially affected, or is reasonably likely to materially affect the Trust's internal control over financial reporting. The Trust confirms that no such changes were made to the internal controls over financial reporting during the second quarter of 2008.

Because of their inherent limitations, disclosure controls and procedures and internal controls over financial reporting may not prevent or detect misstatements, errors or fraud. Control systems, no matter how well conceived or operated, can provide only reasonable, not absolute assurance that the objectives of the control systems are met.

BUSINESS RISKS

ENVIRONMENTAL REGULATION AND RISK

All phases of the oil and natural gas business present environmental risks and hazards and are subject to environmental regulation pursuant to a variety of federal, provincial and local laws and regulations. In 2002, the Government of Canada ratified the Kyoto Protocol (the "Protocol"), which calls for Canada to reduce its greenhouse gas emissions to specified levels. There has been much public debate with respect to Canada's ability to meet these targets and the Government's strategy or alternative strategies with respect to climate change and the control of greenhouse gases.

Recently the Federal Government released its Action Plan to Reduce Greenhouse Gases and Air Pollution (the "Action Plan"), also known as "ecoACTION", which includes the Regulatory Framework for Air Emissions and the Alberta Government has also introduced legislation regarding greenhouse gas emissions.

On March 8, 2007, the Alberta Government introduced legislation to reduce greenhouse gas emission intensity. Bill 3 states that facilities emitting more than 100,000 tonnes of greenhouse gases per year must reduce their emissions intensity by 12 percent over the average emissions levels of 2003, 2004 and 2005; if they are not able to do so, these facilities will be required to pay $15 per tonne for every tonne above the 12 percent target, beginning on July 1, 2007. At this time, the Trust has determined that there is currently no impact of this legislation on Zargon's existing facilities ownership.

Although Zargon is not a large emitter of greenhouse gases, the Trust continues to monitor developments in this area. Although environmental legislation is evolving in a manner which could result in stricter standards and enforcement, larger fines and liability, and potentially increased capital expenditures and operating costs, at this time it is not possible to predict the impact of these requirements on the Trust and its operations and financial condition.

ALBERTA ROYALTY AND TAX REGIME

On February 16, 2007, the Alberta Government announced that a review of the Province's royalty and tax regime (including income tax and freehold mineral rights tax) pertaining to oil and gas resources, including oil sands, conventional oil and gas and coalbed methane, would be conducted by a panel of experts, with the assistance of individual Albertans and key stakeholders. On September 18, 2007, the Royalty Review Panel delivered its final report and recommendations to the Government of Alberta. The report titled "Our Fair Share" recommended significant increases to royalties levied on natural gas, conventional oil and oil sands produced in Alberta. On October 25, 2007, the Alberta Government released details of its planned implementation of the final Royalty Review Panel report, titled "The New Royalty Framework" ("NRF"). Zargon has reviewed the modifications proposed by the Government of Alberta to its royalty program, which is scheduled to take effect on January 1, 2009.

While more detailed analysis is ongoing, the following observations have been noted:

- Currently, approximately 32 percent of Zargon's production is from properties located outside Alberta and is therefore, not affected by the NRF.

- Royalties determined under the NRF will be determined based on commodity prices, well productivity and depth of wells. A significant portion of Zargon's wells are lower productivity wells that, on a relative basis, are less impacted by the NRF than higher productivity wells.

- Zargon has recalculated its January 1, 2007, and January 1, 2008, reserves using Zargon's independent engineering firm of McDaniel & Associates Consultants Ltd., using the respective escalated price forecasts (present value before tax at 10 percent) under both the existing and NRF proposed royalty rates. The impact of the proposed change in royalty rates on the net present value of Zargon's proved and probable reserves, was less than one percent of Zargon's net asset value but we would expect a greater impact if commodity prices continue to increase as they have over recent months.

- The NRF will have a more significant negative impact on the economics of Zargon's ongoing natural gas exploration programs, which target moderate rate natural gas wells in our West Central Alberta and Alberta Plains core areas.

OUTLOOK

With a strong balance sheet, 462 thousand net acres of undeveloped land and a promising internally generated project inventory, Zargon continues to be well positioned to meet its value creating objectives in 2008. Consistent with its history, Zargon will adhere to a focused strategy of exploring and exploiting its existing asset base while executing value-added corporate and property acquisitions, which if available, will be funded by bank debt or equity issuances.



SUMMARY OF QUARTERLY RESULTS

2008 Q1 Q2
----------------------------------------------------------------------------
Petroleum and natural gas revenue ($ millions) 52.24 69.66
Net earnings/(losses) ($ millions) 4.56 (4.51)
Net earnings/(losses) per diluted unit ($) 0.26 (0.25)
Funds flow from operations ($ millions) 24.75 32.02
Funds flow from operations per diluted unit ($) 1.23 1.55
Cash flows from operating activities ($ millions) 15.27 36.44
Cash flows from operating activities per diluted
unit ($) 0.76 1.76
Cash distributions ($ millions) 9.55 9.71
Cash distributions declared per trust unit ($) 0.54 0.54
Net capital expenditures ($ millions) (1) (2) 59.61 26.28
Total assets ($ millions) 396.90 418.88
Bank debt ($ millions) 92.18 85.45
Average daily production (boe) 9,015 9,239
Average realized commodity field price before
the impact of financial risk management
contracts ($/boe) 63.68 82.85
Funds flow netback ($/boe) 30.17 38.08
----------------------------------------------------------------------------
----------------------------------------------------------------------------

(1) First quarter 2008 expenditures include corporate acquisition amounts
as follows; cash consideration of $16.40 million, transaction costs of
$0.29 million, net debt assumed of $17.57 million and the equity
issuance of trust units valued at $13.37 million.
(2) Second quarter 2008 net capital expenditures include corporate
acquisition amounts as follows: transaction costs of $0.15 million, net
debt assumed of $2.69 million and the equity issuance of trust units
valued at $9.39 million.



2007 Q1 Q2 Q3 Q4
----------------------------------------------------------------------------
Petroleum and natural gas revenue
($ millions) 38.53 39.21 36.64 41.13
Net earnings ($ millions) 5.22 11.63 5.50 2.20
Net earnings per diluted unit ($) 0.31 0.68 0.32 0.13
Funds flow from operations
($ millions) (1) 21.80 20.56 17.38 20.10
Funds flow from operations per
diluted unit ($) (1) 1.12 1.05 0.88 1.02
Cash flows from operating activities
($ millions) 18.35 19.09 24.64 14.23
Cash flows from operating activities
per diluted unit ($) 0.94 0.97 1.25 0.72
Cash distributions ($ millions) 9.12 9.17 9.19 9.21
Cash distributions declared per trust
unit ($) 0.54 0.54 0.54 0.54
Net capital expenditures ($ millions) 20.93 10.97 16.43 18.35
Total assets ($ millions) 324.31 324.96 327.54 340.19
Bank debt ($ millions) 37.68 46.74 44.10 56.87
Average daily production (boe) 8,483 8,465 8,501 8,790
Average realized commodity field
price before the impact of financial
risk management contracts ($/boe) 50.47 50.91 46.84 50.86
Funds flow netback ($/boe) (1) 28.55 26.69 22.22 24.86
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Throughout this report, funds flow from operations, funds flow from
operations per diluted unit and funds flow netbacks are now calculated
inclusive of asset retirement expenditures. All prior period
calculations have been restated to reflect this change.



2006 Q1 Q2 Q3 Q4
----------------------------------------------------------------------------
Petroleum and natural gas revenue
($ millions) 40.94 38.66 37.93 36.50
Net earnings ($ millions) 11.92 13.22 12.31 7.05
Net earnings per diluted unit ($) 0.72 0.79 0.73 0.43
Funds flow from operations
($ millions) (1) 22.12 22.06 19.87 18.84
Funds flow from operations per
diluted unit ($) (1) 1.15 1.14 1.02 0.97
Cash flows from operating activities
($ millions) 17.45 23.34 24.67 18.28
Cash flows from operating activities
per diluted unit ($) 0.91 1.21 1.27 0.94
Cash distributions ($ millions) 8.89 8.96 9.00 9.05
Cash distributions declared per trust
unit ($) 0.54 0.54 0.54 0.54
Net capital expenditures ($ millions) 15.19 8.78 18.99 20.41
Total assets ($ millions) 282.35 283.86 294.14 310.57
Bank debt ($ millions) 26.64 18.14 20.71 30.04
Average daily production (boe) 8,812 8,322 8,194 8,366
Average realized commodity field
price before the impact of financial
risk management contracts ($/boe) 51.63 51.06 50.32 47.42
Funds flow netback ($/boe) (1) 27.89 29.13 26.36 24.47
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Throughout this report, funds flow from operations, funds flow from
operations per diluted unit and funds flow netbacks are now calculated
inclusive of asset retirement expenditures. All prior period
calculations have been restated to reflect this change.


ADDITIONAL INFORMATION

Additional information regarding the Trust and its business operations,
including the Trust's Annual Information Form for December 31, 2007, is
available on the Trust's SEDAR profile at www.sedar.com.

"Signed" C.H. Hansen
President and Chief Executive Officer

Calgary, Alberta
August 12, 2008


CONSOLIDATED BALANCE SHEETS

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

ASSETS (note 7)
Current
Accounts receivable (note 14) 32,687 21,668
Prepaid expenses and deposits 1,436 1,690
Unrealized risk management asset (note 14) - 1,432
----------------------------------------------------------------------------
34,123 24,790
Long term deposit 1,612 1,455
Goodwill (notes 4 and 5) 2,969 -
Property and equipment, net (notes 4 and 6) 380,180 313,949
----------------------------------------------------------------------------
418,884 340,194
----------------------------------------------------------------------------
----------------------------------------------------------------------------
LIABILITIES
Current
Accounts payable and accrued liabilities 33,921 27,172
Cash distributions payable (note 15) 3,266 3,074
Unrealized risk management liability (note 14) 38,380 11,127
----------------------------------------------------------------------------
75,567 41,373
Long term debt (note 7) 85,448 56,868
Unrealized risk management liability (note 14) 9,111 1,303
Asset retirement obligations (note 8) 27,224 21,184
Future income taxes 34,117 37,258
----------------------------------------------------------------------------
231,467 157,986
----------------------------------------------------------------------------

NON-CONTROLLING INTEREST
Exchangeable shares (note 3) 20,557 20,730
----------------------------------------------------------------------------

UNITHOLDERS' EQUITY
Unitholders' capital (note 9) 113,940 89,688
Contributed surplus (note 9) 4,058 3,714
Accumulated earnings 188,863 188,819
Accumulated cash distributions (140,001) (120,743)
----------------------------------------------------------------------------
166,860 161,478
----------------------------------------------------------------------------
418,884 340,194
----------------------------------------------------------------------------
----------------------------------------------------------------------------

See accompanying notes.



CONSOLIDATED STATEMENTS OF EARNINGS/(LOSSES) AND COMPREHENSIVE INCOME AND
ACCUMULATED EARNINGS

Three Months Ended Six Months Ended
(unaudited) June 30, June 30,
----------------------------------------------------------------------------
($ thousands, except per
unit amounts) 2008 2007 2008 2007
----------------------------------------------------------------------------

REVENUE
Petroleum and natural gas revenue 69,656 39,213 121,895 77,745
Unrealized risk management
gain/(loss) (note 14) (29,632) 1,215 (36,492) (4,620)
Realized risk management
gain/(loss) (note 14) (8,947) 1,120 (11,814) 3,446
Royalties (14,040) (8,534) (24,751) (16,860)
----------------------------------------------------------------------------
17,037 33,014 48,838 59,711
----------------------------------------------------------------------------

EXPENSES
Production 9,433 7,683 18,594 15,561
General and administrative 2,609 1,889 4,842 3,466
Unit-based compensation (note 9) 262 367 517 726
Interest and financing charges 1,356 726 2,689 1,299
Unrealized foreign exchange
(gain)/loss 139 (517) (11) (578)
Accretion of asset retirement
obligations (note 8) 542 328 1,049 652
Depletion and depreciation 14,686 11,761 28,915 23,305
----------------------------------------------------------------------------
29,027 22,237 56,595 44,431
----------------------------------------------------------------------------

EARNINGS/(LOSSES) BEFORE
INCOME TAXES (11,990) 10,777 (7,757) 15,280
----------------------------------------------------------------------------

INCOME TAXES
Current 990 699 1,951 1,178
Future (recovery) (7,773) (3,350) (9,757) (5,354)
----------------------------------------------------------------------------
(6,783) (2,651) (7,806) (4,176)
----------------------------------------------------------------------------

EARNINGS/(LOSSES) FOR THE PERIOD
BEFORE NON CONTROLLING INTEREST (5,207) 13,428 49 19,456
Non-controlling interest -
exchangeable shares (note 3) 695 (1,794) (5) (2,601)
----------------------------------------------------------------------------

NET EARNINGS/(LOSSES) AND
COMPREHENSIVE INCOME FOR THE PERIOD (4,512) 11,634 44 16,855
ACCUMULATED EARNINGS, BEGINNING OF
PERIOD 193,375 169,488 188,819 164,267
----------------------------------------------------------------------------

ACCUMULATED EARNINGS, END OF PERIOD 188,863 181,122 188,863 181,122
----------------------------------------------------------------------------
----------------------------------------------------------------------------
NET EARNINGS/(LOSSES) PER UNIT
(note 11)
Basic (0.25) 0.69 - 1.00
Diluted (0.25) 0.68 - 1.00
----------------------------------------------------------------------------
----------------------------------------------------------------------------

See accompanying notes.



CONSOLIDATED STATEMENTS OF CASH FLOWS

Three Months Ended Six Months Ended
(unaudited) June 30, June 30,
----------------------------------------------------------------------------
($ thousands) 2008 2007 2008 2007
----------------------------------------------------------------------------

OPERATING ACTIVITIES
Net earnings/(losses) for the period (4,512) 11,634 44 16,855
Add (deduct) non-cash items:
Non-controlling interest -
exchangeable shares (695) 1,794 5 2,601
Unrealized risk management
(gain)/loss 29,632 (1,215) 36,492 4,620
Depletion and depreciation 14,686 11,761 28,915 23,305
Accretion of asset retirement
obligations 542 328 1,049 652
Unit-based compensation 262 367 517 726
Unrealized foreign exchange
(gain)/loss 139 (517) (11) (578)
Future income taxes (recovery) (7,773) (3,350) (9,757) (5,354)
Asset retirement expenditures
(note 8) (266) (240) (489) (469)
----------------------------------------------------------------------------
32,015 20,562 56,765 42,358
Changes in non-cash working capital 4,423 (1,470) (5,053) (4,916)
----------------------------------------------------------------------------
36,438 19,092 51,712 37,442
----------------------------------------------------------------------------

FINANCING ACTIVITIES
Advances (repayment) of bank debt (6,736) 9,059 11,666 16,702
Cash distributions to unitholders
(note 15) (9,713) (9,173) (19,258) (18,294)
Exercise of unit rights 693 925 877 1,876
Changes in non-cash financing
working capital 83 12 192 39
----------------------------------------------------------------------------
(15,673) 823 (6,523) 323
----------------------------------------------------------------------------

INVESTING ACTIVITIES
Additions to property and equipment (14,215) (10,965) (26,210) (31,890)
Proceeds on disposal of property
and equipment 150 - 170 -
Corporate acquisitions
(cash portion) (note 4) (148) - (16,835) -
Long term deposit (76) - (157) -
Changes in non-cash investing
working capital (6,476) (8,950) (2,157) (5,875)
----------------------------------------------------------------------------
(20,765) (19,915) (45,189) (37,765)
----------------------------------------------------------------------------

NET CHANGE IN CASH DURING THE PERIOD
AND CASH, END OF PERIOD - - - -
----------------------------------------------------------------------------
----------------------------------------------------------------------------

See accompanying notes.


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the three and six months ended June 30, 2008 and 2007 (unaudited).

1. BASIS OF PRESENTATION

The interim unaudited consolidated financial statements of Zargon Energy Trust (the "Trust" or "Zargon") have been prepared by management in accordance with Canadian generally accepted accounting principles. The interim unaudited consolidated financial statements have been prepared following the same accounting policies and methods in computation as the consolidated financial statements for the fiscal year ended December 31, 2007, except as noted below. The disclosures provided below are incremental to those included with the annual audited consolidated financial statements. These interim unaudited consolidated financial statements do not include all disclosures required in the annual consolidated financial statements and should be read in conjunction with the consolidated financial statements and notes thereto in the Zargon Energy Trust annual report for the year ended December 31, 2007.

The Trust's principal business activity is the exploration for and development and production of petroleum and natural gas in Canada and the United States ("US").

2. CHANGES IN ACCOUNTING POLICIES

Zargon recorded goodwill for the first time in 2008. See note 5 for a description of the accounting policy adopted.

As disclosed in the December 31, 2007 annual audited consolidated financial statements, on January 1, 2008, the Trust adopted the following Canadian Institute of Chartered Accountants ("CICA") Handbook Sections:

"Financial Instruments - Presentation", Section 3863 and "Financial Instruments - Disclosures", Section 3862. The new disclosure standards increase Zargon's disclosure regarding the nature and extent of the risks associated with financial instruments and how those risks are managed (See note 14). The new presentation standard carries forward the former presentation requirements.

"Capital Disclosures", Section 1535. The new standard requires Zargon to disclose its objectives, policies and processes for managing its capital structure (See note 10).

In addition, the Trust has assessed new and revised accounting pronouncements that have been issued that are not yet effective and determined that the following may have a significant impact on the Trust:

As of January 1, 2009, Zargon will be required to adopt the CICA Handbook Section 3064, "Goodwill and Intangible Assets", which will replace the existing Goodwill and Intangible Assets standard. The new standard revises the requirement for recognition, measurement, presentation and disclosure of intangible assets. The adoption of this standard should not have a material impact on Zargon's consolidated financial statements.

In January 2006, the CICA Accounting Standards Board ("AcSB") adopted a strategic plan for the direction of accounting standards in Canada. As part of that plan, the AcSB confirmed in February 2008 that international Financial Reporting Standards ("IFRS") will replace Canadian GAAP in 2011 for profit-oriented Canadian publicly accountable enterprises. As Zargon will be required to report its results in accordance with IFRS starting in 2011, the Trust is assessing the potential impacts of this changeover and developing its plan accordingly.

3. NON-CONTROLLING INTEREST - EXCHANGEABLE SHARES

Zargon Oil & Gas Ltd. is authorized to issue an unlimited number of exchangeable shares. The exchangeable shares are convertible into trust units at the option of the shareholder, based on the exchange ratio, which is adjusted monthly to reflect the distributions paid on the trust units. Cash distributions are not paid on the exchangeable shares. During the six months ended June 30, 2008, a total of 15.15 thousand exchangeable shares were converted into 19.95 thousand trust units based on the exchange ratio at the time of conversion. At June 30, 2008, the exchange ratio was 1.35736 trust units per exchangeable share.



Non-Controlling Interest - Exchangeable Shares

Six Months Ended June 30, 2008
----------------------------------------------------------------------------
(thousands, except exchange ratio) Number of Shares Amount ($)
----------------------------------------------------------------------------
Balance, beginning of period 2,071 20,730
Earnings attributable to non-controlling
interest - 5
Exchanged for trust units at book value and
including earnings attributed during the
period (15) (178)
----------------------------------------------------------------------------
Balance, end of period 2,056 20,557
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Exchange ratio, end of period 1.35736
Trust units issuable upon conversion of
exchangeable shares, end of period 2,791
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Per EIC-151 "Exchangeable Securities Issued by Subsidiaries of Income Trusts", if certain conditions are met, the exchangeable shares issued by a subsidiary must be reflected as non-controlling interest on the consolidated balance sheets and, in turn, net earnings/losses must be reduced by the amount of net earnings/losses attributed to the non-controlling interest.

The non-controlling interest on the consolidated balance sheets consists of the book value of exchangeable shares at the time of the Plan of Arrangement, plus net earnings/losses attributable to the exchangeable shareholders, less exchangeable shares (and related cumulative earnings/losses) redeemed. The net earnings/losses attributable to the non-controlling interest on the consolidated statements of earnings/losses represents the cumulative share of net earnings/losses attributable to the non-controlling interest based on the trust units issuable for exchangeable shares in proportion to total trust units issued and issuable each period end.



The effect of EIC-151 on Zargon's unitholders' capital and exchangeable
shares is as follows:

Zargon Zargon Oil
Energy & Gas Ltd.
Trust Exchangeable
($ thousands) Units Shares Total
----------------------------------------------------------------------------
Balance at January 1, 2008 89,688 20,730 110,418
Issued on redemption of exchangeable shares
at book value 37 (37) -
Effect of EIC-151 408 (136) 272
Unit-based compensation recognized on
exercise of unit rights 173 - 173
Issued on corporate acquisitions 22,757 - 22,757
Unit rights exercised for cash 877 - 877
----------------------------------------------------------------------------
Balance at June 30, 2008 113,940 20,557 134,497
----------------------------------------------------------------------------
----------------------------------------------------------------------------


4. ACQUISITIONS

Rival Energy Ltd.

On January 23, 2008, a subsidiary of the Trust acquired all of the outstanding shares of Rival Energy Ltd. ("Rival"), a public oil and gas company, for consideration of $30.06 million. Consideration consisted of $16.40 million cash, the issuance of 573,300 Zargon trust units valued at $23.32 per unit and acquisition costs of $0.29 million.

The results of operations for Rival have been included in the consolidated financial statements since January 23, 2008.

In the second quarter of 2008 the Rival purchase price allocation was modified for some tax adjustments. The acquisition was accounted for by the purchase method and the preliminary purchase price allocation is as follows:



Net Assets Acquired

($ thousands)
----------------------------------------------------------------------------
Property and equipment 54,065
Goodwill 2,969
Working capital deficiency (854)
Long term debt (16,914)
Future income tax liability (5,443)
Asset retirement obligations (3,767)
----------------------------------------------------------------------------
Total net assets acquired 30,056
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Consideration

($ thousands)
----------------------------------------------------------------------------
Cash 16,400
Trust units issued 13,369
Acquisition costs 287
----------------------------------------------------------------------------
Total purchase price 30,056
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Newpact Energy Corp.

On May 16, 2008, a subsidiary of the Trust acquired all of the outstanding shares of Newpact Energy Corp. ("Newpact"), a private oil and gas company, for consideration of $9.54 million. Consideration consisted of the issuance of 425,940 Zargon trust units valued at $22.04 per unit and acquisition costs of $0.15 million.

The results of operations for Newpact have been included in the consolidated financial statements since May 16, 2008.

The acquisition was accounted for by the purchase method and the preliminary purchase price allocation is as follows:



Net Assets Acquired

($ thousands)
----------------------------------------------------------------------------
Property and equipment 13,925
Working capital deficiency (2,491)
Future income tax liability (922)
Asset retirement obligations (976)
----------------------------------------------------------------------------
Total net assets acquired 9,536
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Consideration

($ thousands)
----------------------------------------------------------------------------
Trust units issued 9,388
Acquisition costs 148
----------------------------------------------------------------------------
Total purchase price 9,536
----------------------------------------------------------------------------
----------------------------------------------------------------------------


5. GOODWILL

The goodwill is entirely due to the timing differences created between the tax basis of the assets acquired on corporate acquisitions compared to the fair value of these assets acquired. To assess impairment, the fair value of the reporting entity ("consolidated Trust") is determined and compared to the book value of the consolidated Trust. If the fair value of the consolidated Trust is less than the book value, then a second test is performed to determine the amount of the impairment. The amount of the impairment is determined by deducting the fair value of the consolidated Trust's assets and liabilities from the fair value of the consolidated Trust to determine the implied fair value of goodwill and comparing that amount to the book value of the consolidated Trust's goodwill. Any excess of the book value of goodwill over the implied fair value of goodwill is the impairment amount. The goodwill balance is assessed for impairment annually at year end or as events occur that could result in an impairment.



6. PROPERTY AND EQUIPMENT

June 30, 2008
----------------------------------------------------------------------------
Accumulated
Depletion and Net Book
($ thousands) Cost Depreciation Value
----------------------------------------------------------------------------
Petroleum, natural gas properties
and other equipment (1) 634,102 253,922 380,180
----------------------------------------------------------------------------
----------------------------------------------------------------------------


December 31, 2007
----------------------------------------------------------------------------
Accumulated
Depletion and Net Book
($ thousands) Cost Depreciation Value
----------------------------------------------------------------------------
Petroleum, natural gas properties
and other equipment (1) 538,957 225,008 313,949
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) As a result of shareholders redeeming exchangeable shares, property and
equipment has cumulatively increased $52.16 million, $0.40 million
relating to the first six months of 2008, $8.82 million relating to
2007 and $42.94 million relating to prior years. The effect of these
increases has resulted in additional depletion and depreciation expense
of approximately $19.49 million, $2.77 million relating to the first
six months of 2008, $6.16 million relating to 2007 and $10.56 million
relating to prior years.


7. LONG TERM DEBT

On January 31, 2008, Zargon amended its syndicated committed credit facilities, the result of which was an increase in the available facilities and borrowing base to $150 million. These facilities consisted of a $130 million tranche available to the Canadian borrower and a US $18 million tranche available to the US borrower.

On July 28, 2008, Zargon amended and renewed its syndicated committed credit facilities, the result of which is an increase in the available facilities and borrowing base to $180 million from the previous amount of $150 million. These facilities consist of a $170 million tranche available to the Canadian borrower and a US $8 million tranche available to the US borrower. A $300 million demand debenture on the assets of the subsidiaries of the Trust has been provided as security for these facilities. The facilities are fully revolving for a 364 day period with the provision for an annual extension at the option of the lenders and upon notice from Zargon's management. The next renewal date is July 28, 2009. Should the facilities not be renewed, they convert to one year non-revolving term facilities at the end of the revolving 364 day period. Repayment would not be required until the end of the non-revolving term, and, as such, these facilities have been classified as long term debt. In the normal course of operations Zargon enters into various letters of credit. At June 30, 2008, the approximate value of outstanding letters of credit totalled $10.94 million.

Additionally, with the acquisition of Newpact, Zargon assumed a $4.20 million revolving demand credit facility with a Canadian chartered bank. Borrowings under this facility bear interest at the bank's prime lending rate plus 0.5 percent per annum. Security is provided by a general security agreement, a general assignment of book debts and a floating charge demand debenture in the amount of $5 million covering the oil and gas properties of Newpact. The facility will revolve until December 31, 2008, at which time the bank may either convert it to a term facility or extend the revolving facility for up to an additional 364 days. At June 30, 2008 nothing had been drawn on this facility and Zargon plans on terminating this credit facility in the third quarter of 2008.



8. ASSET RETIREMENT OBLIGATIONS

The following table reconciles Zargon's asset retirement obligations:

Six Months Ended June 30,
----------------------------------------------------------------------------
($ thousands) 2008 2007
----------------------------------------------------------------------------
Balance, beginning of period 21,184 17,307
Net liabilities incurred/acquired 5,455 435
Liabilities settled (489) (469)
Accretion expense 1,049 652
Foreign exchange 25 (89)
----------------------------------------------------------------------------
Balance, end of period 27,224 17,836
----------------------------------------------------------------------------
----------------------------------------------------------------------------


9. UNITHOLDERS' EQUITY

The Trust is authorized to issue an unlimited number of voting trust units.

Trust Units

Six Months Ended June 30, 2008
----------------------------------------------------------------------------
Number of Amount
(thousands) Units ($)
----------------------------------------------------------------------------
Balance, beginning of period 17,076 89,688
Unit rights exercised for cash 50 877
Unit-based compensation recognized on exercise of
unit rights - 173
Issued on corporate acquisitions 999 22,757
Issued on conversion of exchangeable shares 20 445
----------------------------------------------------------------------------
Balance, end of period 18,145 113,940
----------------------------------------------------------------------------
----------------------------------------------------------------------------


The proforma total units outstanding at June 30, 2008, including trust units outstanding and trust units issuable upon conversion of exchangeable shares, after giving effect to the exchange ratio at the end of the period (See note 3), is 20.936 million units.



The following table summarizes information about the Trust's contributed
surplus account:

Contributed Surplus

($ thousands) Six Months Ended June 30, 2008
----------------------------------------------------------------------------
Balance, beginning of period 3,714
Unit-based compensation expense 517
Unit-based compensation recognized on exercise of unit rights (173)
----------------------------------------------------------------------------
Balance, end of period 4,058
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Trust Unit Rights Incentive Plan and Unit-Based Compensation

The Trust has a unit rights incentive plan (the "Plan") that allows the Trust to issue rights to acquire trust units to directors, officers, employees and other service providers. The Trust is authorized to issue up to 2.36 million unit rights; however, the number of trust units reserved for issuance upon exercise of the rights shall not at any time exceed 10 percent of the aggregate number of the total outstanding units, including units issuable upon exchange of exchangeable shares of Zargon and other fully paid securities of Zargon entities exchangeable into units, which are the economic equivalent of units including full voting rights. At the time of grant, unit right exercise prices approximate the market price for the trust units. At the time of exercise, the rights holder has the option of exercising at the original grant price or the exercise price as calculated under the Plan (the "modified price"). The modified price is calculated by deducting from the grant price the amount by which monthly distributions, on a per unit basis, made by the Trust after the grant date exceed a monthly return of 0.833 percent of the Trust's recorded net book value of oil and natural gas properties. Rights granted under the Plan generally vest over a three-year period and expire approximately five years from the grant date. Zargon uses a fair value methodology to value the unit rights grants.

The weighted average assumptions made for unit rights granted for the six months ended June 30, 2008 include a volatility factor of expected market price of 26.4 percent, a risk-free interest rate of 3.2 percent, a dividend yield of 9.0 percent and an expected life of the unit rights of four years. The weighted average assumptions made for unit rights granted for the three months ended June 30, 2008 include a volatility factor of expected market price of 26.9 percent, a risk-free interest rate of 3.0 percent, a dividend yield of 8.3 percent and an expected life of the unit rights of four years. These unit rights, together with the continued vesting of unit rights granted in prior years resulted in unit-based compensation expense for the three and six months ended June 30, 2008 of $0.26 million (2007 - $0.37 million) and $0.52 million (2007 - $0.73 million), respectively.

Compensation expense associated with rights granted under the Plan is recognized in earnings/losses over the vesting period of the Plan with a corresponding increase in contributed surplus. The exercise of trust unit rights is recorded as an increase in trust units with a corresponding reduction in contributed surplus. Forfeiture of rights are recorded as a reduction in expense in the period in which they occur.



The following table summarizes information about the Trust's unit rights:


Six Months Ended June 30, 2008
----------------------------------------------------------------------------
Weighted
Average
Exercise
Price
Number of Initial and
Unit Rights Modified
(thousands) ($/unit right)
----------------------------------------------------------------------------
Outstanding at beginning of period 1,488 26.41/24.60
Unit rights granted 266 24.09
Unit rights exercised (50) 17.74
Unit rights cancelled (89) 28.01
-------------------------------------------------------------
Outstanding at end of period 1,615 26.13/24.29
-------------------------------------------------------------
Unit rights exercisable at period end 924 26.46/23.82
----------------------------------------------------------------------------
----------------------------------------------------------------------------


10. CAPITAL DISCLOSURES

The Trust's capital structure is comprised of unitholders' equity plus long term debt. The Trust's objectives when managing its capital structure are to:

i) maintain financial flexibility so as to preserve Zargon's access to capital markets and its ability to meet its financial obligations; and

ii) finance internally generated growth as well as acquisitions.

The Trust monitors its capital structure and short term financing requirements using the non-GAAP financial metric of debt net of working capital ("net debt") to funds flow from operations. Net debt, as used by the Trust, is calculated as bank debt and any working capital deficit excluding the current portion of unrealized risk management assets and liabilities. Funds flow from operations represents net earnings/losses and asset retirement expenditures except for non-cash items. The metric is used to steward the Trust's overall debt position as a measure of the Trust's overall financial strength and is calculated as follows:



June 30, December 31,
($ thousands, except ratio) 2008 2007
----------------------------------------------------------------------------
Net debt 88,512 63,756
Annualized funds flow from operations 113,530 79,838
----------------------------------------------------------------------------
Net debt to funds flow from operations ratio 0.8 0.8
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Zargon's net debt to funds flow from operations ratio was even with the 0.8 at December 31, 2007, primarily due to the strong funds flow from operations being offset by cash consideration and net debt assumed related to the acquisitions of Rival and Newpact.

To manage its capital structure, the Trust may adjust capital spending, adjust distributions paid to unitholders, issue new units, issue new debt or repay existing debt.

The Trust's capital management objectives, evaluation measures, definitions and targets have remained unchanged over the periods presented. Zargon is subject to certain financial covenants in its credit facility agreements and is in compliance with all financial covenants.

11. WEIGHTED AVERAGE NUMBER OF TOTAL UNITS

Basic per unit amounts are calculated using the weighted average number of trust units outstanding during the period. Diluted per unit amounts are calculated using the treasury stock method to determine the dilutive effect of unit-based compensation. Diluted per unit amounts also include exchangeable shares using the "if-converted" method. Due to the fact that at the time of exercise, the rights holder has the option of exercising at the original grant price or a modified price as calculated under the Plan, the prices used in the treasury stock calculation are the lower prices calculated under the Plan.



Three Months Ended Six Months Ended
June 30, June 30,
----------------------------------------------------------------------------
(thousand units) 2008 2007 2008 2007
----------------------------------------------------------------------------
Basic 17,906 16,971 17,714 16,920
Diluted 20,706 19,610 20,422 19,505
----------------------------------------------------------------------------
----------------------------------------------------------------------------


For the purpose of calculating the diluted net loss per unit for the three months ended June 30, 2008, incremental Trust units from assumed redemption of Trust unit rights and exchangeable shares are not included due to the anti-dilutive effect. The dilutive units not included were 2.80 million for the three months ended June 30, 2008 therefore the basic amount of 17.91 million units was used in the calculation of the dilutive net loss per unit.

12. SEGMENTED INFORMATION

Zargon's entire operating activities are related to exploration, development and production of oil and natural gas in the geographic segments of Canada and the US.



Three Months Ended Six Months Ended
June 30, June 30,
----------------------------------------------------------------------------
($ thousands) 2008 2007 2008 2007
----------------------------------------------------------------------------
Petroleum and Natural Gas Revenue
Canada 61,176 33,733 106,690 67,187
United States 8,480 5,480 15,205 10,558
----------------------------------------------------------------------------
Total 69,656 39,213 121,895 77,745
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Net Capital Expenditures (1)
Canada 26,185 10,975 85,385 31,756
United States 101 (10) 507 134
----------------------------------------------------------------------------
Total 26,286 10,965 85,892 31,890
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) For net capital expenditures, amounts include capital expenditures
acquired for cash, equity issuances, acquisition costs and net debt
assumed on corporate acquisitions.


June 30, December 31,
($ thousands) 2008 2007
----------------------------------------------------------------------------
Property and Equipment, net
Canada 345,785 278,444
United States 34,395 35,505
----------------------------------------------------------------------------
Total 380,180 313,949
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Goodwill
Canada 2,969 -
United States - -
----------------------------------------------------------------------------
Total 2,969 -
----------------------------------------------------------------------------
----------------------------------------------------------------------------



13. SUPPLEMENTAL CASH FLOW INFORMATION

Three Months Ended Six Months Ended
June 30, June 30,
----------------------------------------------------------------------------
($ thousands) 2008 2007 2008 2007
----------------------------------------------------------------------------
Cash interest paid 1,093 824 1,776 1,404
Cash taxes paid 1,746 699 1,805 1,462
----------------------------------------------------------------------------
----------------------------------------------------------------------------


14. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT CONTRACTS

Zargon's financial assets and liabilities are comprised of accounts receivable, deposits, accounts payable, cash distributions payable, unrealized risk management assets and liabilities and long term debt. Fair values of financial assets and liabilities, summarized information related to risk management positions and discussion of risks associated with financial assets and liabilities are presented as follows:

A) Fair Value of Financial Assets and Liabilities

The fair values of accounts receivable, deposits, accounts payable, cash distributions payable and long term debt approximate their carrying amount.

Risk management assets and liabilities are recorded at their estimated fair value based on the mark-to-market method of accounting, using quoted market prices.

B) Risk Management Assets and Liabilities

The Trust is a party to certain financial instruments that have fixed the price of a portion of its oil and natural gas production. The Trust enters into these contracts for risk management purposes only, in order to protect a portion of its future cash flow from the volatility of oil and natural gas commodity prices. The Trust has outstanding financial contracts as follows:



Financial Contracts at June 30, 2008:

Fair Market
Weighted Value Loss
Rate Average Price Range of Terms ($ thousands)
----------------------------------------------------------------------------
Oil swaps 1,200 bbl/d $70.24 US/bbl Jul. 1/08-Dec. 31/08 (15,926)
500 bbl/d $87.58 US/bbl Jul. 1/08-Jun. 30/09 (9,961)
500 bbl/d $72.74 US/bbl Jan. 1/09-Mar. 31/09 (3,153)
300 bbl/d $107.40 US/bbl Jan. 1/09-Sep. 30/09 (2,800)
500 bbl/d $114.97 US/bbl Apr. 1/09-Dec. 31/09 (3,555)
500 bbl/d $85.30 US/bbl Jul. 1/09-Dec. 31/09 (5,129)
300 bbl/d $132.98 US/bbl Oct. 1/09-Jun. 30/10 (483)
Natural gas
swaps 8,000 gj/d $7.31/gj Jul. 1/08-Oct. 31/08 (4,636)
4,000 gj/d $9.71/gj Nov. 1/08-Mar. 31/09 (1,540)
1,000 gj/d $8.92/gj Apr. 1/09-Oct. 31/09 (308)
----------------------------------------------------------------------------
Total Fair Market Value, Financial Contracts (47,491)
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Oil swaps are settled against the NYMEX pricing index, whereas natural gas swaps are settled against the AECO pricing index.

For financial risk management contracts, the Trust considers these contracts to be effective on an economic basis but has decided not to designate these contracts as hedges for accounting purposes and, accordingly, any unrealized gains or losses are recorded based on the fair value (mark-to-market) of the contracts at the period end. The unrealized loss for the first six months of 2008 was $36.49 million and the unrealized loss for the first six months of 2007 was $4.62 million. The realized loss for the first six months of 2008 was $11.81 million and the realized gain for the first six months of 2007 was $3.45 million.

Contracts settled by way of physical delivery are recognized as part of the normal revenue stream. These instruments have no book values recorded in the interim consolidated financial statements. The Trust has outstanding physical contracts as follows:



Physical Contracts at June 30, 2008:

Fair Market
Weighted Value Loss
Rate Average Price Range of Terms ($ thousands)
----------------------------------------------------------------------------
Natural gas
fixed price 2,000 gj/d $7.88/gj Jul. 1/08-Oct. 31/08 (1,020)
5,000 gj/d $8.99/gj Nov. 1/08-Mar. 31/09 (2,468)
3,000 gj/d $8.47/gj Apr. 1/09-Oct. 31/09 (1,215)
----------------------------------------------------------------------------
Total Fair Market Value, Physical Contracts (4,703)
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Commodity Price Sensitivities

The following table summarizes the sensitivity of the fair value of the Trust's risk management positions to fluctuations in commodity prices, with all other variables held constant. When assessing the potential impact of these commodity price changes, the Trust believes 10 percent volatility is a reasonable measure.

Fluctuations in commodity prices could have resulted in unrealized gains/(losses) on risk management contracts impacting net earnings/losses as follows:



Three and Six Months Ended June 30, 2008
----------------------------------------------------------------------------
($ thousands) 10% Increase 10% Decrease
----------------------------------------------------------------------------
Natural gas price (2,145) 2,145
Crude oil price (12,057) 12,057
----------------------------------------------------------------------------
----------------------------------------------------------------------------


C) Risks Associated with Financial Assets and Liabilities

The Trust is exposed to financial risks arising from its financial assets and liabilities. The financial risks include market risk (commodity prices, interest rates and foreign exchange rates) credit risk and liquidity risk.

-- Market Risk

Market risk, the risk that the fair value or future cash flows of financial assets or liabilities will fluctuate due to movements in market prices, is comprised of the following:

- Commodity Price Risk

As a means of mitigating exposure to commodity price risk volatility, the Trust has entered into various derivative agreements. The use of derivative instruments is governed under formal policies and is subject to limits established by the Board of Directors. The Trust's policy is to not use derivative financial instruments for speculative purposes.

Natural Gas - To partially mitigate the natural gas commodity price risk, the Trust enters into swaps, which fix the Canadian dollar AECO prices.

Crude Oil - The Trust has partially mitigated its exposure to the WTI NYMEX price with fixed price swaps.

- Interest Rate Risk

Borrowings under bank credit facilities are market rate based (variable interest rates); thus, carrying values approximate fair values.

At June 30, 2008, the increase or decrease in net earnings/losses for each one percent change in interest rates amounts to $0.45 million for the six months ended June 30, 2008.

- Foreign Exchange Risk

As Zargon operates in North America, fluctuations in the exchange rate between the US/Canadian dollar can have a significant effect on the Trust's reported results. A $0.01 change in the US to Canadian dollar exchange rate would have resulted in a $0.58 million increase or decrease in net earnings/losses for the six months ended June 30, 2008.

-- Credit Risk

Credit risk is the risk that the counterparty to a financial asset will default, resulting in the Trust incurring a financial loss. This credit exposure is mitigated with credit practices that limit transactions according to counterparties' credit quality. A substantial portion of the Trust's accounts receivable are with customers in the oil and gas industry and are subject to normal industry credit risks.

The maximum credit risk exposure associated with accounts receivable and accrued revenues and risk management assets is the total carrying value. The Trust monitors these balances monthly to limit the risk associated with collection. Of Zargon's significant individual accounts receivable at June 30, 2008, approximately 50 percent was owing from two companies and Zargon anticipates full collection.

-- Liquidity Risk

Liquidity risk is the risk the Trust will encounter difficulties in meeting its financial liability obligations. The Trust manages its liquidity risk through cash and debt management. See note 10 for a more detailed discussion.

As at June 30, 2008, Zargon had available unused committed bank credit facilities in the amount of $53.61 million. The Trust believes it has sufficient funding through the use of these facilities to meet foreseeable borrowing requirements.



The timing of cash outflows relating to financial liabilities are outlined
in the table below:

($ thousands) 1 year 2-3 years Total
----------------------------------------------------------------------------
Accounts payable and accrued liabilities 33,921 - 33,921
Cash distributions payable 3,266 - 3,266
Risk management liabilities (1) 38,380 9,111 47,491
Long term debt (2) - 85,448 85,448
----------------------------------------------------------------------------
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(1) See the section titled "Commodity Price Sensitivities" in this note for
a better understanding of the volatility around these amounts.
(2) See note 7 for the details on the fully revolving credit facilities.


15. CASH DISTRIBUTIONS

During the six month period, the Trust declared cash distributions to the unitholders in the aggregate amount of $19.26 million (2007 - $18.29 million) in accordance with the following schedule:



2008 Distributions Record Date Distribution Date Per Trust Unit
----------------------------------------------------------------------------
January January 31, 2008 February 15, 2008 $0.18
February February 29, 2008 March 17, 2008 $0.18
March March 31, 2008 April 15, 2008 $0.18
April April 30, 2008 May 15, 2008 $0.18
May May 31, 2008 June 16, 2008 $0.18
June June 30, 2008 July 15, 2008 $0.18
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Zargon's cash distributions are discretionary to the extent that these distributions do not cause a breach of the financial covenants under Zargon's credit facilities and to the extent the Trust (non-consolidated) is not taxable. For Canadian income tax purposes, the distributions are currently estimated to be 100 percent taxable income to unitholders.

16. COMPARATIVE FIGURES

Certain comparative figures have been reclassified to conform with the current year's financial statement presentation.



CORPORATE INFORMATION

BOARD OF DIRECTORS STOCK EXCHANGE LISTING

Craig H. Hansen Toronto Stock Exchange
Calgary, Alberta
Zargon Energy Trust
K. James Harrison (4) Trust Units
Chairman of the Board Trading Symbol: ZAR.UN
Oakville, Ontario
Zargon Oil & Gas Ltd.
Kyle D. Kitagawa (1) (2) Exchangeable Shares
Calgary, Alberta Trading Symbol: ZOG.B

John O. McCutcheon (3) TRANSFER AGENT
Vancouver, British Columbia
Valiant Trust Company
Margaret A. McKenzie (1) (3) 310, 606 - 4th Street S.W.
Calgary, Alberta Calgary, Alberta T2P 1T1

Jim Peplinski (2) (4) HEAD OFFICE
Calgary, Alberta 700, 333 - 5th Avenue S.W.
Calgary, Alberta T2P 3B6
J. Graham Weir (1) (2) Telephone: (403) 264-9992
Calgary, Alberta Fax: (403) 265-3026
Email: zargon@zargon.ca
Grant A. Zawalsky (3) (4)
Calgary, Alberta WEBSITE

(1) Audit Committee www.zargon.ca
(2) Reserves Committee
(3) Governance and Nominating Committee
(4) Compensation Committee

OFFICERS

Craig H. Hansen
President and Chief Executive Officer

Brent C. Heagy
Executive Vice President and Chief Financial Officer

Daniel A. Roulston
Executive Vice President, Operations

Henry J. Baird
Vice President, Exploitation

Jason B. Dranchuk
Controller and Treasurer

Tracy L. Howard
Corporate Secretary

Brian G. Kergan
Vice President, Corporate Development and Reserves

Mark I. Lake
Vice President, Exploration

Lorne D. Schwetz
Vice President, Land


Contact Information

  • Zargon Energy Trust
    C.H. Hansen
    President and Chief Executive Officer
    (403) 264-9992
    or
    B.C. Heagy
    Executive Vice President and Chief Financial Officer
    (403) 264-9992
    Email: zargon@zargon.ca
    Website: www.zargon.ca