ZARGON ENERGY TRUST
TSX : ZAR.UN

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

Zargon Oil & Gas Ltd.

August 11, 2005 17:01 ET

Zargon Energy Trust Announces an Increase in Distributions and Second Quarter 2005 Results

CALGARY, ALBERTA--(CCNMatthews - Aug. 11, 2005) -

FINANCIAL & OPERATING HIGHLIGHTS

Zargon Energy Trust (TSX:ZAR.UN) is pleased to report continued record financial results in the second quarter of 2005. Crude oil prices reached new high levels, natural gas prices were strong and the production base remained relatively stable. For the six months ended June 30, 2005, revenues increased 19 percent and cash flow from operations increased 13 percent from the same prior year period. On these strong results, the Trust is announcing that, commencing with the August 2005 distribution payable on September 15, 2005, the Trust's monthly cash distribution rate will be increased by $0.02 to $0.16 per trust unit.

Highlights from the three and six months ended June 30, 2005 are noted below:

- The combination of historically high commodity prices and relatively stable production volumes resulted in record revenues and cash flows for the Trust. Revenues for the 2005 second quarter of $35.87 million were 16 percent above the second quarter 2004 levels and five percent above first quarter 2005. Cash flow from operations of $19.01 million was 15 percent higher than the 2004 second quarter and nine percent higher than the preceding quarter.

- Oil and liquids production volumes of 3,582 barrels per day in the second quarter 2005 held at the first quarter level and were 10 percent higher than the prior year's second quarter. The 2005 second quarter natural gas production volumes of 27.94 million cubic feet per day were four percent lower than the previous quarter as new production additions were offset by a sudden decline at a single prolific well (see discussion below). On an equivalent basis, second quarter 2005 production averaged 8,238 barrels of equivalent per day, up one percent from the prior year quarter and down two percent from the preceding quarter. First half production volumes averaged 8,341 barrels of equivalent per day, an increase of four percent from the first half of 2004. Production on a per million trust unit outstanding basis averaged 439 barrels of equivalent per day for the second quarter and 445 barrels of equivalent per day for the first half and is little changed from the comparable prior year period rates of 446 barrels of equivalent per day and 440 barrels of equivalent per day, respectively.

- The Trust paid six monthly cash distributions of $0.14 per trust unit in the 2005 first half for a total of $13.34 million. These distributions were equivalent to a payout ratio of 43 percent of the Trust's record first half cash flow of $1.94 per diluted trust unit, or reflecting the effect of the exchangeable shares that do not receive cash distributions, a 37 percent payout of the Trust's total cash flow. With the forward price curves showing continued commodity price strength, the Trust is raising its monthly cash distribution to $0.16 per trust unit for the August 2005 distribution payable on September 15, 2005. As a sustainable trust, Zargon will continue to fulfill its commitment to maintain a stable production base through internal exploration, exploitation and development while distributing over the long-term an average of 50 percent of the cash flow attributed to the outstanding unitholders.

- First half capital expenditures included $20.31 million for the exploration and development program of 21.9 net wells and $1.34 million of net property acquisitions. The Trust's balance sheet remains very strong with net debt of $21.10 million (excluding unrealized risk management liability) at June 30, 2005, which equates to 29 percent of annualized cash flow. During the first half of 2005, the Trust financed 100 percent of its distribution and capital expenditure program from cash flows from operations.



Three Months Ended June 30, Six Months Ended June 30,
Percent Percent
(unaudited) 2005 2004 Change 2005 2004 Change
------------------------------------------------------------------------

FINANCIAL

Income and
Investments
($ million)
Petroleum and
natural gas
revenue 35.87 30.96 16 69.99 58.66 19
Cash flow from
operations 19.01 16.53 15 36.50 32.26 13
Cash
distributions 6.73 - - 13.34 - -
Net earnings 6.48 5.54 17 11.62 11.08 5
Net capital
expenditures 10.96 7.61 44 21.65 17.38 25

Per Trust Unit,
Diluted
Cash flow from
operations
($/unit) 1.01 0.88 15 1.94 1.72 13
Net earnings
($/unit) 0.41 0.29 41 0.73 0.59 24

Cash
Distributions
($/trust unit) 0.42 - - 0.84 - -

Balance Sheet
at Period End
($ million)
Property and
equipment, net 235.61 172.88 36
Bank indebtedness 15.52 - -
Unitholders'
equity 138.88 125.19 11

Total Units
Outstanding at
Period End
(million) 18.77 18.28 3

OPERATING

Average Daily
Production
Oil and liquids
(bbl/d) 3,582 3,266 10 3,589 3,310 8
Natural gas
(mmcf/d) 27.94 29.30 (5) 28.52 28.25 1
Equivalent
(boe/d) 8,238 8,150 1 8,341 8,019 4
Equivalent per
million total
units (boe/d) 439 446 (2) 445 440 1

Average Selling
Price (before
hedges)
Oil and liquids
($/bbl) 54.13 44.32 22 52.47 42.11 25
Natural gas
($/mcf) 7.17 6.67 7 6.96 6.47 8

Wells Drilled, Net 10.2 8.4 21 21.9 18.3 20

Undeveloped Land
at Period End
(thousand net acres) 368 405 (9)

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

Notes: The calculation of barrels of equivalent is based on the
conversion ratio that six thousand cubic feet of natural gas is
equivalent to one barrel of oil (boe).

Average daily production per million total 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 exchange ratio at the end of the period.

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.


PRODUCTION

Natural gas production volumes averaged 29.10 million cubic feet per day in the first quarter 2005 but dropped to 27.94 million cubic feet per day in the second quarter when a step-function production decline of almost two million cubic feet per day was experienced due to water influx at Zargon's previously most prolific well located at Progress in the Peace River Arch region of the West Central Alberta core area. Consequently, second quarter natural gas production volumes were down five percent from the same prior year period and four percent from the preceding quarter although the first half of 2005 volumes still remained one percent higher than the volumes reported in the first half of 2004. During the quarter, Zargon was successful in partially offsetting the Progress well's production decline and the natural occurring production declines from other properties with production additions coming from exploration and development programs at Zargon's principal gas property located at Jarrow in the Alberta Plains and from West Central Alberta exploration initiatives at Highvale, Pembina and selected properties in the Peace River Arch.

Oil and liquids production of 3,582 barrels per day in the 2005 second quarter increased 10 percent over the 2004 second quarter and was essentially unchanged from the preceding quarter. The year-over-year gains came from a 2004 Williston Basin acquisition and ongoing Williston Basin exploitation initiatives.

CAPITAL EXPENDITURES (a)

Following a prolonged spring break-up period, Zargon commenced an active Alberta drilling program in May with the result that by the end of the 2005 first half, Zargon had completed a 25 gross well (21.9 net) program that delivered 14.7 net natural gas wells, 5.3 net oil wells, 0.9 net service wells and 1.0 net dry hole for a 95 percent success ratio. During the half, natural gas drilling focused on the Alberta Plains where 12.3 net wells were drilled, primarily at the Jarrow property. The 4.4 net wells drilled in the West Central Alberta core area were also natural gas exploration focused and were approximately equally divided between the Pembina and Peace River Arch properties. During the half, 5.2 net oil exploitation wells were drilled in the Williston Basin core area with wells at Pinto, Steelman and Weyburn, Saskatchewan plus Haas, North Dakota.

The recent high level of field activity will continue throughout the remainder of the year in order to reach the 2005 budgeted program of 46 net wells, allocated 22, 10 and 14 net wells to the Alberta Plains, West Central Alberta and Williston Basin core areas respectively. Consistent with past programs, the Alberta Plains drilling program will focus on natural gas exploration and development at the Jarrow natural gas property. West Central Alberta activities will include additional Pembina natural gas locations, augmented by Highvale and Peace River Arch natural gas exploration. An expanded Williston Basin program will include seven horizontals at Steelman, Pinto, Ralph and Elswick in Southeast Saskatchewan and at Haas and Truro in North Dakota.

As a sustainable trust, Zargon has continued to post land and bid at Crown sales, but on an increasingly selective basis during this current period of high Crown land costs. In the six months ended June 30, 2005, Zargon spent $1.73 million on undeveloped land, slightly less than in the prior year period. Land expiries in the first half of 2005 were partially offset by land purchases, leaving a net reduction of eight thousand net acres. Zargon's undeveloped land inventory at June 30, 2005 totalled 368 thousand net acres.

Because of the property market's current high valuation levels, Zargon's acquisitions in the first half of 2005 were limited in size with an aggregate cost of $1.34 million, and were mostly related to Williston Basin properties in Southeast Saskatchewan.

GUIDANCE (a)

In the May 12, 2005 press release announcing the 2005 first quarter results, second quarter 2005 production guidance for the Trust was revised to 8,250 barrels of equivalent per day based on estimates of 28.50 million cubic feet per day of natural gas and 3,500 barrels per day of oil and liquids. Actual second quarter results of 8,238 barrels of equivalent per day, made up of 27.94 million cubic feet per day of natural gas and 3,582 barrels per day of oil and liquids, essentially met this target, although the actual production split had a slightly higher oil production component. In the same May 12, 2005 press release, 2005 second half production was guided to exceed 8,500 barrels of equivalent per day (29.25 million cubic feet per day of natural gas and 3,625 barrels per day of oil and liquids). The Trust was on track to exceed these levels until impacted by this spring's single well Progress area production problems. Now, third quarter 2005 rates are anticipated to roughly match second quarter levels, and growth in production volumes will be delayed until the fourth quarter when an active Williston Basin exploitation drilling program will have been completed. Based on the Trust's 2005 exploration and development $40 million capital program, fourth quarter 2005 production volumes of 8,500 barrels of equivalent, comprised of 3,750 barrels of oil and liquids and 28.50 million cubic feet per day of natural gas, are forecasted. Further oil production gains are anticipated during the first half of calendar 2006.

The aforementioned production guidance volumes do not include an allowance for opportunistic property or corporate acquisitions that would be funded by bank debt or possibly equity issues. Zargon's acquisition initiatives will continue to be focused on acquiring underdeveloped oil properties (particularly in the Williston Basin) or undeveloped natural gas prospective lands that provide Zargon exploration and development opportunities to sustain production and reserves on a per unit basis, while distributing over the long-term an average of 50 percent of the Trust's cash flows attributed to the outstanding unitholders.

(a) Please see comments on "Forward-Looking Statements" on the last page of 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, 2005 and the audited consolidated financial statements and MD&A for the year ended December 31, 2004. All amounts are in Canadian dollars unless otherwise noted. All references to "Zargon" or the "Trust" refer to Zargon Energy Trust and all references to the "Company" refer to Zargon Oil & Gas Ltd.

In the MD&A, reserves and production are commonly stated in barrels of equivalent (boe) on the basis that six thousand cubic feet of natural gas is equivalent to one barrel of oil (boe). 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.

Non-GAAP Measurements: The MD&A contains the term "cash flow from operations"("cash flow") which should not be considered an alternative to, or more meaningful than, "cash flow 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 cash flow from operations may not be comparable to that reported by other trusts. The reconciliation between net earnings and cash flow from operations can be found in the consolidated statements of cash flows in the consolidated financial statements. The Trust evaluates its performance based on net earnings and cash flow from operations. The Trust considers cash 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. Cash flow from operations per unit is calculated using the diluted weighted average number of units for the period.

This MD&A has been prepared as of August 10, 2005.

PLAN OF ARRANGEMENT

On July 15, 2004, approval was given by the shareholders to a resolution in favour of a Plan of Arrangement (the "Arrangement") reorganizing Zargon Oil & Gas Ltd. (the "Company") into Zargon Energy Trust (the "Trust" or "Zargon"). The Arrangement received court approval and also became effective on July 15, 2004. The Arrangement resulted in shareholders of the Company receiving either one trust unit or one exchangeable share for each common share held. The unitholders of the Trust are entitled to receive cash distributions paid by the Trust. Holders of exchangeable shares are not eligible to receive distributions but rather on each payment of a distribution, the number of trust units into which each exchangeable share is exchangeable is increased on a cumulative basis in respect of the distribution. The exchangeable shares are traded on the Toronto Stock Exchange and can be converted, at the option of the holder, into trust units at any time. On July 15, 2014, all the remaining outstanding exchangeable shares will be redeemed into trust units unless the Board of Directors of the Company elect to extend the redemption period. In certain circumstances, the Company has the right to require redemption of the exchangeable shares prior to July 15, 2014. Upon completion of the Arrangement, 14.87 million trust units and 3.66 million exchangeable shares were issued. The Trust is an unincorporated open-end investment trust governed by the laws of the Province of Alberta. It is the intent of the Trust to distribute over the long-term an average of 50 percent of the cash flow from operations attributable to outstanding unitholders.

The reorganization of the Company into a Trust has been accounted for using the continuity of interest method. Accordingly, the consolidated financial statements for the three and six months ended June 30, 2005 reflect the financial position, results of operations and cash flows as if the Trust had always carried on the business of the Company. The comparative figures referred to in the consolidated financial statements and this MD&A include the previous consolidated results of the Company.

SUMMARY OF SIGNIFICANT EVENTS IN THE SECOND QUARTER

- As a result of continued high commodity prices, the Trust realized record cash flow from operations of $19.01 million in the second quarter of 2005 and declared monthly distributions of $0.14 per trust unit with a total of $6.73 million ($0.42 per trust unit) paid or declared distributable to unitholders, resulting in a payout ratio of 35 percent of cash flow or 42 percent on a per diluted trust unit basis. For Canadian income tax purposes, the distributions are currently estimated to be 100 percent taxable income to unitholders.

- Average field prices for the second quarter received (before risk management losses) for oil and liquids increased to $54.13 per barrel and for natural gas increased to $7.17 per thousand cubic feet, a seven percent and six percent increase, respectively, from the first quarter of 2005. Production of 8,238 barrels of oil equivalent was down two percent from the previous quarter.

- During the second quarter of 2005, the Trust drilled 12 gross wells (10.2 net) with a 100 percent success rate. Total capital expenditures were $10.96 million for the quarter.

- The Trust continues to maintain its balance sheet strength with a combined debt and working capital deficiency of $21.10 million (excluding unrealized risk management liability), which represents under four months of the first half 2005 annualized cash flow.

FINANCIAL ANALYSIS

During the second quarter of 2005, commodity prices increased to record high levels and more than offset a decrease in production volumes of two percent from the previous quarter, resulting in record revenue of $35.87 million, a five percent gain compared to the first quarter of 2005. Oil and liquids prices received averaged $54.13 per barrel before risk management losses in second quarter 2005 compared to $44.32 in the 2004 second quarter and $50.79 in the preceding quarter, gains of 22 percent and seven percent respectively. West Texas Intermediate (WTI) crude oil prices were significantly higher in the second quarter due to continued world demand growth and concern over limited world spare production capacity. Reflecting industry trends, Zargon's crude oil field price differential from the Edmonton par price, increased to $11.63 per barrel in the second quarter of 2005 compared to $6.29 per barrel in the second quarter of 2004. Natural gas prices also averaged a very strong $7.17 per thousand cubic feet before risk management losses in the second quarter and showed increases of seven percent and six percent, respectively, over the 2004 second quarter and the preceding quarter levels. Natural gas prices have reached historical high levels due to supply/demand concerns and the relative valuation of natural gas and crude oil prices.



Pricing

Three Months Ended June 30, Six Months Ended June 30,
--------------------------------------------------------
Average For Percent Percent
The Period 2005 2004 Change 2005 2004 Change
------------------------------------------------------------------------

Natural Gas:
NYMEX price
($US/mmbtu) 6.83 5.96 15 6.61 5.83 13
AECO price
($Cdn/mcf) 7.37 7.00 5 7.13 6.71 6
Realized price
($Cdn/mcf)
(note 1) 7.17 6.67 7 6.96 6.47 8

Crude Oil:
WTI ($US/bbl) 53.19 38.31 39 51.52 36.73 40
Edmonton par
price ($Cdn/bbl) 65.76 50.61 30 63.61 48.11 32
Realized price
($Cdn/bbl)
(note 1) 54.13 44.32 22 52.47 42.11 25
------------------------------------------------------------------------
------------------------------------------------------------------------

Note 1: Amounts are before risk management losses.


Natural gas production volumes of 27.94 million cubic feet per day in the 2005 second quarter decreased four percent over the preceding quarter and five percent from 2004 second quarter levels due to production losses at a significant well in the West Central Alberta core area. Oil and liquids production volumes in the second quarter of 2005 of 3,582 barrels per day were essentially unchanged from the previous quarter's production of 3,596 barrels per day. On a year-over-year basis, oil and liquids volumes increased 10 percent when compared to the second quarter of 2004 amount of 3,266 barrels per day, primarily due to the July 2004 acquisition of Southeast Saskatchewan properties and new exploitation drilling in the Williston Basin core area.



Production by Core Area

2005 2004
Three Months -----------------------------------------------------------
Ended Oil and Natural Oil and Natural
June 30, Liquids Gas Equivalents Liquids Gas Equivalents
------------------------------------------------------------------------
(bbl/d) (mmcf/d) (boe/d) (bbl/d) (mmcf/d) (boe/d)

Alberta
Plains 597 19.53 3,852 606 18.81 3,742
West
Central
Alberta 209 8.13 1,563 226 10.26 1,937
Williston
Basin 2,776 0.28 2,823 2,434 0.23 2,471
-----------------------------------------------------------
3,582 27.94 8,238 3,266 29.30 8,150
------------------------------------------------------------------------
------------------------------------------------------------------------

2005 2004
Six Months -----------------------------------------------------------
Ended Oil and Natural Oil and Natural
June 30, Liquids Gas Equivalents Liquids Gas Equivalents
------------------------------------------------------------------------
(bbl/d) (mmcf/d) (boe/d) (bbl/d) (mmcf/d) (boe/d)

Alberta
Plains 569 19.55 3,827 612 18.47 3,691
West
Central
Alberta 203 8.70 1,652 227 9.53 1,815
Williston
Basin 2,817 0.27 2,862 2,471 0.25 2,513
-----------------------------------------------------------
3,589 28.52 8,341 3,310 28.25 8,019
------------------------------------------------------------------------
------------------------------------------------------------------------


Zargon's commodity price risk management policy uses forward sales, options, puts and costless collars for, on average, 20 to 35 percent of working interest production in order to partially offset the effects of large price fluctuations. Because our risk management strategy is protective in nature and is designed to guard the Trust against extreme effects on cash flow from sudden falls in prices and revenues, upward price trends tend to produce overall losses. Risk management contracts in place as at December 31, 2004 were designated as hedges for accounting purposes and the Trust continues to monitor these contracts in determining the continuation of hedge effectiveness. For these contracts, realized gains and losses are recorded in the statement of earnings as the contracts settle and no unrealized gain or loss is recognized. For risk management contracts entered into after December 31, 2004, 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. Accordingly, for outstanding contracts not designated as hedges as at June 30, 2005, an unrealized gain or loss is recorded on the fair value (mark-to-market) of the contracts at that time. Thus, the 2005 second quarter's continued high oil and natural gas prices brought about a realized risk management loss of $1.23 million compared to a $1.31 million loss in the second quarter of 2004 and $0.79 million in the preceding quarter. The unrealized risk management loss for the second quarter of 2005 was $1.10 million compared to $2.26 million in the preceding quarter. The primary driver for these losses was the record high oil prices recorded in the current quarter. Zargon's commodity risk management positions are fully described in note 9 to the unaudited consolidated interim financial statements.

Royalties, inclusive of Alberta Royalty Tax Credit and Saskatchewan Resource Surcharge, totalled $7.91 million for the second quarter of 2005, a decrease of two percent from the preceding quarter and an increase of 15 percent from $6.89 million in the 2004 second quarter. As a percentage of gross revenue, royalty rates have moved in a narrow range from 22.2 percent in the second quarter of 2004 to 23.5 percent in the first quarter of 2005 and 22.1 percent in the second quarter of 2005. The higher rate in the first quarter of 2005 was a result of adjustments related to prior periods.

On a unit of production basis, production costs have shown a modest decrease to $7.67 per barrel of equivalent in second quarter 2005 compared with $7.74 in the preceding quarter and $8.09 in the fourth quarter 2004. During this current period of significantly increased industry-wide cost pressures, Zargon is continuing its efforts to contain increases in per unit operating costs.



Operating Netbacks

2005 2004
----------------------------------------
Oil and Natural Oil and Natural
Three Months Ended June 30, Liquids Gas Liquids Gas
------------------------------------------------------------------------
($/bbl) ($/mcf) ($/bbl) ($/mcf)

Production revenue 54.13 7.17 44.32 6.67
Realized risk management loss (2.84) (0.12) (2.77) (0.18)
Royalties (12.00) (1.57) (9.15) (1.56)
Production costs (9.84) (1.00) (9.77) (0.80)
----------------------------------------

Operating netbacks 29.45 4.48 22.63 4.13
------------------------------------------------------------------------
------------------------------------------------------------------------


2005 2004
----------------------------------------
Oil and Natural Oil and Natural
Six Months Ended June 30, Liquids Gas Liquids Gas
------------------------------------------------------------------------
($/bbl) ($/mcf) ($/bbl) ($/mcf)

Production revenue 52.47 6.96 42.11 6.47
Realized risk management loss (2.84) (0.04) (2.34) (0.03)
Royalties (11.83) (1.60) (8.72) (1.47)
Production costs (10.09) (0.98) (9.53) (0.76)
----------------------------------------

Operating netbacks 27.71 4.34 21.52 4.21
------------------------------------------------------------------------
------------------------------------------------------------------------


Measured on a unit of production basis (net of recoveries), general and administrative expenses were $1.69 per barrel of equivalent in the first half of 2005 compared to $1.34 per barrel of equivalent in the first half of 2004 and $1.45 for the 2004 year. The increase in costs on a per unit of production basis are primarily due to increased staff costs, increased outside advisory costs related to operating as a trust and securities regulatory compliance costs.

Expensing of unit-based compensation in the first half of 2005 was $0.47 million, a 53 percent increase compared to the first half of 2004. The unit-based compensation expense, arising from unit rights granted upon and subsequent to the July 15, 2004 Plan of Arrangement, were originally calculated using the intrinsic value method up until December 31, 2004. In response to an emphasis by securities regulators that fair value methodologies be used, new measurement techniques were adopted for 2005 utilizing a fair value option-pricing model for such unit rights grants. Zargon has assessed the impact on 2004 unit-based compensation expense, and there is no significant impact. Prior to the effective date of the Arrangement, expensing of stock-based compensation benefits in the consolidated statement of earnings was calculated using the Black-Scholes option-pricing model.

Interest expense in the first half of 2005 was $0.38 million, $0.25 million higher compared to the first half of 2004. The primary reason for the increase on a year-over-year basis is the increase in average bank indebtedness due to the acquisition of Southeastern Saskatchewan properties and reorganization costs related to the trust conversion incurred in the third quarter of 2004.

Capital and current income taxes were $0.96 million in the first half of 2005 compared to $0.27 million in the first half of 2004. On a year-to-date basis, United States current income taxes are $0.50 million and Canadian capital taxes are $0.46 million. The primary reason for this increase is due to current income taxes being incurred related to the United States operations as a result of the increasing profitability of those operations due to high commodity prices.



Trust Netbacks

Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------------------
($/boe) 2005 2004 2005 2004
------------------------------------------------------------------------

Petroleum and natural
gas revenue 47.85 41.75 46.35 40.20
Realized risk
management loss (1.65) (1.77) (1.34) (1.09)
Royalties (10.55) (9.29) (10.57) (8.78)
Production costs (7.67) (6.79) (7.70) (6.61)
--------------------------------------------

Operating netbacks 27.98 23.90 26.74 23.72

General and administrative (1.66) (1.34) (1.69) (1.34)
Interest (0.27) (0.07) (0.25) (0.09)
Capital and current
income taxes (0.69) (0.21) (0.63) (0.19)
--------------------------------------------

Cash flow netbacks 25.36 22.28 24.17 22.10

Depletion and depreciation (12.05) (8.66) (11.79) (8.66)
Unrealized risk
management loss (1.46) - (2.22) -
Accretion of asset
retirement obligations (0.40) (0.36) (0.39) (0.36)
Unit/stock-based
compensation (0.20) (0.29) (0.31) (0.21)
Unrealized foreign
exchange (0.13) (0.09) (0.10) (0.02)
Future income taxes (0.93) (5.41) (0.25) (5.26)
--------------------------------------------

Earnings before
non-controlling
interest 10.19 7.47 9.11 7.59
------------------------------------------------------------------------
------------------------------------------------------------------------


The second quarter 2005 depletion and depreciation unit expense of $12.05 per barrel of equivalent is a five percent increase over the previous quarter expense of $11.53 per barrel of oil equivalent and a 39 percent increase from the second quarter 2004 expense of $8.66 per barrel of oil equivalent. The primary reason for this increase is due to the increase in the property and equipment balance from the conversion of exchangeable shares due to the application of EIC-151.

The provision for accretion of asset retirement obligations for the first half of 2005 was $0.59 million, a 13 percent increase compared to the first half of 2004. The year-over-year change is due to changes in the estimated future liability for asset retirement obligations as a result of wells added through the drilling program and the 2004 acquisition of Southeast Saskatchewan properties in the Williston Basin core area.

The provision for future taxes was $0.70 million for the second quarter of 2005 compared to a recovery of future taxes of $0.32 million in the prior quarter and an expense of $4.01 million in the second quarter of 2004. The year-over-year reduction is due to the trust conversion since Zargon's future tax obligations are reduced as distributions are made from the Trust. Also impacting the first and second quarter of 2005 was the future tax impact of unrealized risk management losses of $0.88 million and $0.43 million respectively. Excluding the future tax impact of unrealized risk management losses, for the 2005 second quarter, future taxes were 11 percent of before tax earnings, which compares respectively with the 2005 first quarter and 2004 second quarter rates of six percent and 41 percent.

On January 19, 2005 the CICA issued EIC-151 "Exchangeable Securities Issued by Subsidiaries of Income Trusts" that states that exchangeable securities issued by a subsidiary of an Income Trust should be reflected as either a non-controlling interest or debt on the consolidated balance sheet unless they meet certain criteria. The exchangeable shares issued by Zargon Oil & Gas Ltd., a corporate subsidiary of the Trust, are publicly traded and have an expiry term, which could be extended at the option of the Board of Directors. Therefore, these securities are considered, by EIC-151, to be transferable to third parties and to have an indefinite life. EIC-151 states that if these criteria are met, the exchangeable shares should be reflected as a non-controlling interest. Previously, the exchangeable shares were reflected as a component of unitholders' equity. In accordance with the transitional provisions of EIC-151, the Trust adopted this standard as at December 31, 2004 and has retroactively restated prior periods dating back to the Plan of Arrangement dated July 15, 2004. As a result of this change in accounting policy, the Trust has reflected a non-controlling interest of $9.20 million on the Trust's consolidated balance sheet as at June 30, 2005. Consolidated net earnings have been reduced for net earnings attributable to the non-controlling interest of $2.13 million in the first half of 2005. In accordance with EIC-151 and given the circumstances in Zargon's case, each redemption is accounted for as a step-purchase, which to date in 2005 has resulted in an increase in property and equipment of $21.66 million, an increase in unitholders' equity by $18.49 million, and an increase in future income tax liability of $5.63 million. Cash flow was not impacted by this change. The cumulative impact to date of the application of EIC-151 has been to increase property and equipment by $32.94 million, accumulated depletion and depreciation by $2.40 million, unitholders' equity and non-controlling interest by $28.31 million, future income tax liability by $8.63 million and an allocation of net earnings to exchangeable shareholders' of $4.00 million.

Cash flow from operations in second quarter 2005 of $19.01 million was $1.53 million or nine percent higher than the preceding quarter and $2.49 million or 15 percent higher than the 2004 second quarter. The 2005 first half cash flow of $36.50 million was 13 percent higher than the prior year's comparative period primarily as a result of a nine percent increase in the cash flow netback to $24.17 per barrel of oil equivalent and a four percent increase in production volumes to 8,341 barrels of oil equivalent. Cash flow per diluted unit showed similar gains with the 2005 second quarter cash flow of $1.01 per diluted unit increasing nine percent over the first quarter levels and the 2005 first half cash flow of $1.94 per diluted unit improving 13 percent over the 2004 comparable period.

Net earnings of $6.48 million for the second quarter of 2005 increased 26 percent from the preceding quarter and 17 percent from the second quarter of 2004. The net earnings track the cash flow from operations for the respective periods modified by non-cash charges which in the 2005 period include increased depletion and depreciation, unrealized risk management losses and non-controlling interest.



Capital Expenditures

Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------------------
($ million) 2005 2004 2005 2004
------------------------------------------------------------------------

Undeveloped land 0.87 0.77 1.73 1.85
Geological and geophysical
(seismic) 0.64 0.94 1.47 2.36
Drilling and completion
of wells 6.88 4.67 13.15 9.73
Well equipment
and facilities 1.85 1.14 3.96 2.92
--------------------------------------------

Exploration and development 10.24 7.52 20.31 16.86
--------------------------------------------

Property acquisitions 0.72 0.36 1.34 0.79
Property dispositions - (0.27) - (0.27)
--------------------------------------------

Net property acquisitions 0.72 0.09 1.34 0.52
--------------------------------------------

Total capital
expenditures (net) 10.96 7.61 21.65 17.38
------------------------------------------------------------------------
------------------------------------------------------------------------


LIQUIDITY AND CAPITAL RESOURCES

Capital expenditures of $21.65 million in the first half of 2005 were 25 percent higher than in the first half of 2004, reflecting an active field program of 25 gross (21.9 net) wells compared to 23 gross (18.3 net) wells in the first half of 2004. Capital expenditures for the first half of 2005 were allocated to Alberta Plains $8.45 million, West Central Alberta $6.57 million and Williston Basin $6.63 million. Drilling and completion expenditures increased 35 percent from the previous year to $13.15 million and well equipping correspondingly increased 36 percent during the same period while undeveloped land purchases fell six percent as Zargon continues a more selective land acquisition program as Crown sales continue to be competitive. A modest amount of acquisitions of various properties to complement Zargon's existing asset base resulted in an increase of $0.55 million in property acquisition costs compared to the first half of 2004. Cash flow from operations in the first half of $36.50 million and proceeds from the exercise of trust unit rights of $1.01 million funded the capital program, payment of distributions and a reduction of the working capital deficiency (including bank indebtedness). As at June 30, 2005, the Trust continues to maintain a strong balance sheet with a working capital deficiency balance (including bank indebtedness and excluding the unrealized risk management liability) of $21.10 million, which is less than four months of the first half annualized cash flow.

At August 10, 2005, Zargon Energy Trust has 16.145 million trust units and 2.474 million exchangeable shares outstanding. Assuming full conversion of exchangeable shares at the effective exchange ratio of 1.06759, there would be 18.786 million trust units outstanding. Pursuant to the trust unit rights incentive plan there are currently an additional 0.671 million trust unit incentive rights issued and outstanding.



Capital Sources

Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------------------
($ million) 2005 2004 2005 2004
------------------------------------------------------------------------

Cash flow from operations 19.01 16.53 36.50 32.26
Changes in working capital
and other 1.19 (5.58) (3.81) (9.23)
Change in bank indebtedness (2.70) (3.68) 1.29 (6.98)
Cash distributions (6.73) - (13.34) -
Issuance of trust
units/shares related
to exercise of trust
unit rights/stock
options 0.19 0.34 1.01 1.33
--------------------------------------------

Total capital sources 10.96 7.61 21.65 17.38
------------------------------------------------------------------------
------------------------------------------------------------------------


OUTLOOK

As a result of the continuing strength of commodity prices and the demonstrated ability of the Trust to meet its objectives as a sustainable trust, distributions have been increased to $0.16 per unit per month beginning with the August distribution payable on September 15, 2005. Zargon is well positioned with a very strong balance sheet, 368 thousand net acres of undeveloped land and a promising project inventory. Zargon intends to continue its disciplined approach with a strategy of focusing on exploration and exploitation of its existing asset base while executing value-added property acquisitions if and when they become available.



SUMMARY OF QUARTERLY RESULTS
2005
----------------
Q1 Q2
---------------------------------------------------------------------
Petroleum and natural gas revenue ($ million) 34.12 35.87
Net earnings ($ million) 5.14 6.48
Net earnings per diluted unit ($) 0.32 0.41
Cash flow ($ million) 17.48 19.01
Cash flow per diluted unit ($) 0.93 1.01
Cash distributions ($ million) 6.60 6.73
Cash distributions paid or declared per unit ($) 0.42 0.42
Net capital expenditures ($ million) 10.69 10.96
Total assets ($ million) 245.20 253.75
Bank debt ($ million) 18.23 15.52
Daily production (boe) 8,446 8,238
Average realized commodity price
before risk management losses ($/boe) 44.90 47.85
Cash flow netback ($/boe) 23.01 25.36
---------------------------------------------------------------------
---------------------------------------------------------------------


2004
-------------------------------
Q1 Q2 Q3 Q4
------------------------------------------------------------------------
Petroleum and natural gas
revenue ($ million) 27.70 30.96 32.41 32.90
Net earnings ($ million) (note 1) 5.54 5.54 4.22 5.33
Net earnings per diluted unit ($)
(note 1) 0.30 0.29 0.28 0.34
Cash flow ($ million) 15.73 16.53 16.13 15.36
Cash flow per diluted unit ($) 0.84 0.88 0.87 0.82
Cash distributions ($ million) - - 4.27 6.43
Cash distributions paid
or declared per unit ($) - - 0.28 0.42
Net capital expenditures ($ million) 9.77 7.61 23.64 15.25
Total assets ($ million) (note 1) 186.18 189.80 215.23 226.96
Bank debt ($ million) 3.67 - 9.77 14.23
Daily production (boe) 7,889 8,150 8,405 8,440
Average realized commodity
price before risk management
losses ($/boe) 38.59 41.75 41.91 42.36
Cash flow netback ($/boe) 21.91 22.28 20.86 19.78
------------------------------------------------------------------------
------------------------------------------------------------------------


2003
-------------------------------
Q1 Q2 Q3 Q4
------------------------------------------------------------------------
Petroleum and natural gas
revenue ($ million) 29.19 24.20 23.76 24.51
Net earnings ($ million) (note 1) 6.65 9.17 4.44 4.10
Net earnings per diluted unit ($)
(note 1) 0.36 0.50 0.24 0.22
Cash flow ($ million) 15.23 13.53 12.34 13.24
Cash flow per diluted unit ($) 0.84 0.74 0.67 0.72
Net capital expenditures ($ million) 6.86 8.10 12.11 12.84
Total assets ($ million) (note 1) 165.12 165.98 172.81 181.05
Bank debt ($ million) 20.78 11.47 8.92 6.98
Daily production (boe) 7,060 7,222 7,470 8,020
Average realized commodity
price before risk management
losses ($/boe) 45.94 36.82 34.57 33.22
Cash flow netback ($/boe) 23.96 20.58 17.96 17.95
------------------------------------------------------------------------
------------------------------------------------------------------------

Note 1: Certain comparative period numbers reflect retroactive
restatements due to changes in accounting policies.


ADDITIONAL INFORMATION

Additional information regarding the Trust and its business operations,
including the Trust's Renewal Annual Information Form for December 31,
2004, is available on the Trust's SEDAR profile at www.sedar.com.

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


Calgary, Alberta
August 10, 2005


ZARGON ENERGY TRUST
CONSOLIDATED BALANCE SHEETS

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

ASSETS

Current
Accounts receivable 15,942 14,275
Prepaid expenses and deposits 2,197 2,953
---------------------------
18,139 17,228

Property and equipment, net (note 3) 235,608 209,736
---------------------------

253,747 226,964
---------------------------
---------------------------
LIABILITIES

Current
Bank indebtedness 15,522 14,230
Accounts payable and accrued liabilities 21,464 24,153
Cash distributions payable 2,258 2,210
Unrealized risk management
liability (note 9) 3,351 -
---------------------------
42,595 40,593

Asset retirement obligations (note 4) 15,133 14,390

Future income taxes 47,938 41,830
---------------------------

105,666 96,813
---------------------------
NON-CONTROLLING INTEREST

Exchangeable shares (note 2) 9,199 9,529
---------------------------

UNITHOLDERS' EQUITY

Unitholders' capital/share capital (note 5) 65,585 45,755
Contributed surplus (note 5) 1,314 1,170
Accumulated earnings 96,021 84,399
Accumulated cash distributions (note 10) (24,038) (10,702)
---------------------------

138,882 120,622
---------------------------

253,747 226,964
---------------------------
---------------------------

See accompanying notes.


ZARGON ENERGY TRUST
CONSOLIDATED STATEMENTS OF EARNINGS AND ACCUMULATED EARNINGS

(unaudited) Three Months Ended Six Months Ended
($ thousand, except June 30, June 30,
per unit amounts) 2005 2004 2005 2004
------------------------------------------------------------------------

Revenue
Petroleum and natural
gas revenue 35,868 30,959 69,992 58,663
Unrealized risk management
loss (note 9) (1,095) - (3,351) -
Realized risk management
loss (note 9) (1,234) (1,310) (2,019) (1,583)
Royalties (net of Alberta
Royalty Tax Credit) (7,911) (6,886) (15,946) (12,809)
-----------------------------------------
25,628 22,763 48,676 44,271
-----------------------------------------
Expenses
Production 5,749 5,036 11,633 9,651
General and administrative 1,246 996 2,554 1,958
Unit/stock-based
compensation (note 5) 147 218 473 309
Interest 200 49 384 134
Unrealized foreign
exchange loss 97 65 151 24
Accretion of asset
retirement obligations
(note 4) 298 266 592 525
Depletion and depreciation 9,037 6,422 17,801 12,639
-----------------------------------------
16,774 13,052 33,588 25,240
-----------------------------------------

Earnings before income taxes 8,854 9,711 15,088 19,031
-----------------------------------------

Income taxes
Future 696 4,013 377 7,680
Current 515 156 959 270
-----------------------------------------
1,211 4,169 1,336 7,950
-----------------------------------------

Earnings for the period
before non-controlling
interest 7,643 5,542 13,752 11,081
Non-controlling interest
- exchangeable shares
(note 2) (1,161) - (2,130) -
-----------------------------------------

Net earnings for the period 6,482 5,542 11,622 11,081
-----------------------------------------

Accumulated earnings,
beginning of period
As previously reported 89,539 75,544 84,399 70,125
Retroactive application
of change in accounting
policy - asset retirement
obligations - - - (120)
-----------------------------------------
As restated 89,539 75,544 84,399 70,005
-----------------------------------------

Accumulated earnings,
end of period 96,021 81,086 96,021 81,086
-----------------------------------------
-----------------------------------------

Net earnings per unit/per
common share (note 6)
Basic 0.41 0.30 0.74 0.61
Diluted 0.41 0.29 0.73 0.59
-----------------------------------------
-----------------------------------------

See accompanying notes.



ZARGON ENERGY TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS


Three Months Ended Six Months Ended
(unaudited) June 30, June 30,
($ thousand) 2005 2004 2005 2004
------------------------------------------------------------------------

Operating activities
Net earnings for the period 6,482 5,542 11,622 11,081
Add non-cash items:
Non-controlling interest
- exchangeable shares 1,161 - 2,130 -
Unrealized risk management
loss 1,095 - 3,351 -
Depletion and depreciation 9,037 6,422 17,801 12,639
Accretion of asset
retirement obligations 298 266 592 525
Unit/stock-based
compensation 147 218 473 309
Unrealized foreign
exchange loss 97 65 151 24
Future income taxes 696 4,013 377 7,680
-----------------------------------------
19,013 16,526 36,497 32,258

Asset retirement
expenditures (159) (14) (221) (56)
Changes in non-cash
working capital 1,325 (2,898) (231) (3,210)
-----------------------------------------
20,179 13,614 36,045 28,992
-----------------------------------------

Financing activities
Advances (repayment)
of bank indebtedness (2,703) (3,675) 1,292 (6,978)
Cash distributions
to unitholders (6,732) - (13,336) -
Exercise of unit
rights/stock options 195 336 1,008 1,330
Changes in non-cash
working capital 34 - 111 -
-----------------------------------------
(9,206) (3,339) (10,925) (5,648)
-----------------------------------------

Investing activities
Additions to property
and equipment (10,965) (7,883) (21,650) (17,651)
Proceeds on disposal
of property and equipment - 275 - 275
Changes in non-cash
working capital (8) (1,462) (3,470) (4,763)
-----------------------------------------
(10,973) (9,070) (25,120) (22,139)
-----------------------------------------

Change in cash, and cash
end of period - 1,205 - 1,205
-----------------------------------------
-----------------------------------------

See accompanying notes.


ZARGON ENERGY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the three and six months ended June 30, 2005 and 2004 (unaudited)

1. NATURE OF THE ORGANIZATION AND BASIS OF PRESENTATION

Organization

On July 15, 2004, Zargon Oil & Gas Ltd. (the "Company") was reorganized into Zargon Energy Trust (the "Trust" or "Zargon") as part of a Plan of Arrangement (the "Arrangement"). Shareholders of the Company received one trust unit or one exchangeable share for each common share held. All outstanding common share options were settled for cash prior to the completion of the reorganization. The unitholders of the Trust are entitled to receive cash distributions paid by the Trust. Holders of exchangeable shares are not eligible to receive cash distributions paid, but rather, on each payment of a distribution, the number of trust units into which each exchangeable share is exchangeable is increased on a cumulative basis in respect of the distribution. The Trust is an unincorporated open-ended investment trust established under the laws of the Province of Alberta and was created pursuant to a trust indenture ("Trust Indenture").

The Trust's principal business activity is the exploration for and development and production of petroleum and natural gas.

Basis of Presentation

The interim unaudited consolidated financial statements of 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, 2004. The interim unaudited consolidated financial statements 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, 2004.

While the Trust commenced operations on July 15, 2004, these unaudited interim consolidated financial statements follow the continuity of interest basis of accounting as if the Trust had always existed. This basis is intended to provide unitholders with meaningful and comparative financial information.

2. NON-CONTROLLING INTEREST - EXCHANGEABLE SHARES

Zargon Oil & Gas Ltd. is authorized to issue a maximum of 3.66 million 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 distribution paid on the trust units. Cash distributions are not paid on the exchangeable shares. During the six months ended June 30, 2005, a total of 702,000 exchangeable shares were converted into 732,000 trust units based on the exchange ratio at the time of conversion. At June 30, 2005, the exchange ratio was 1.06165 trust units per exchangeable share.



Non-Controlling Interest
- Exchangeable Shares June 30, 2005
--------------------------
Number of
(thousand, except exchange ratio) Shares Amount ($)
--------------------------
Non-controlling interest exchangeable
shares issued
Balance, beginning of year 3,186 9,529
Earnings attributable to non-controlling
interest - 2,130
Exchanged for trust units at book value
and including earnings attributed since
beginning of year (702) (2,460)
--------------------------
Balance, end of period 2,484 9,199
--------------------------
--------------------------

Exchange ratio, end of period 1.06165
Trust units issuable upon conversion of
exchangeable shares, end of period 2,637
--------------------------
--------------------------


For the year ended December 31, 2004 the Trust retroactively applied EIC-151 "Exchangeable Securities Issued by Subsidiaries of Income Trusts". Per EIC-151, if certain conditions are met, the exchangeable shares issued by a subsidiary must be reflected as non-controlling interest on the consolidated balance sheet and in turn, net earnings must be reduced by the amount of net earnings attributed to the non-controlling interest.

The non-controlling interest on the consolidated balance sheet consists of the book value of exchangeable shares at the time of the Plan of Arrangement, plus net earnings attributable to the exchangeable shareholders, less exchangeable shares (and related cumulative earnings) redeemed. The net earnings attributable to the non-controlling interest on the consolidated statement of earnings represents the cumulative share of net earnings 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.

Immediately prior to the July 15, 2004 Plan of Arrangement, the Company had $45.14 million in share capital. Upon conversion to the Trust structure these amounts were allocated $36.22 million to trust units and $8.92 million to exchangeable shares, based on the terms of the Arrangement.

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



Zargon Oil Zargon Zargon Oil
& Gas Ltd. Energy & Gas Ltd.
Common Trust Exchangeable
($ thousand) Shares Units Shares Total
-----------------------------------------------
Immediately prior to
July 15, 2004 Plan of
Arrangement 45,136
Plan of Arrangement
July 15, 2004 (45,136) 36,219 8,917
-----------------------------------------------
- 36,219 8,917 45,136
Issued on redemption of
exchangeable shares at
book value - 1,155 (1,155) -
Effect of EIC-151 - 8,381 1,767 10,148
-----------------------------------------------
Balance at December 31, 2004 - 45,755 9,529 55,284

Issued on redemption of
exchangeable shares at
book value - 1,710 (1,710) -
Effect of EIC-151 - 16,783 1,380 18,163
Unit-based compensation
recognized - 329 - 329
Unit rights exercised for
cash - 1,008 - 1,008
-----------------------------------------------
Balance at June 30, 2005 - 65,585 9,199 74,784
-----------------------------------------------
-----------------------------------------------


3. PROPERTY AND EQUIPMENT

($ thousand) June 30, 2005
-----------------------------------
Accumulated
Depletion
and Net Book
Cost Depreciation Value
-----------------------------------
Petroleum, natural gas
properties and other equipment 318,845 113,780 205,065
Adjustment due to conversion
of exchangeable shares 32,943 2,400 30,543
-----------------------------------
351,788 116,180 235,608
-----------------------------------
-----------------------------------


($ thousand) June 30, 2004
-----------------------------------
Accumulated
Depletion
and Net Book
Cost Depreciation Value
-----------------------------------
Petroleum, natural gas
properties and other equipment 256,500 83,620 172,880
-----------------------------------
-----------------------------------


As a result of shareholders redeeming exchangeable shares, property and equipment increased $21.66 million in the first six months of 2005 and $11.28 million in 2004. The effect of these increases has resulted in additional depletion and depreciation expense recorded in the 2005 six months of approximately $2.40 million.



4. ASSET RETIREMENT OBLIGATIONS

The following table reconciles Zargon's asset retirement obligation:

June 30,
-----------------------
($ thousand) 2005 2004
-----------------------

Balance, beginning of year 14,390 12,194
Liabilities incurred 359 255
Liabilities settled (221) (56)
Accretion expense 592 525
Foreign exchange 13 (69)
-----------------------
Balance, end of period 15,133 12,849
-----------------------
-----------------------


5. UNITHOLDERS' EQUITY

Pursuant to the Plan of Arrangement on July 15, 2004, 14.87 million units of the Trust and 3.66 million exchangeable shares (see note 2) of the Company were issued in exchange for all of the outstanding shares of the Company on a one-for-one basis.

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



Trust Units June 30, 2005
-----------------------
Number Amount
(thousand) of Units ($)
-----------------------
Units issued
Balance, beginning of year 15,341 45,755
Unit rights exercised for cash 57 1,008
Unit-based compensation recognized - 329
Issued on conversion of
exchangeable shares 732 18,493
-----------------------
Balance, end of period 16,130 65,585
-----------------------
-----------------------



The proforma total units outstanding at period end, including trust units outstanding, and trust units issuable upon conversion of exchangeable shares and after giving effect to the exchange ratio at the end of the period (see note 2) is 18.77 million units.

A summary of the Company's share capital account for the first six months of 2004 is as follows:



Common Shares of Zargon Oil & Gas Ltd. June 30, 2004
-----------------------
Number Amount
(no par value) (thousand) of Shares ($)
-----------------------
Shares issued
Balance, beginning of year 17,992 42,200
Stock options exercised for cash 289 1,330
Stock-based compensation recognized - 38
-----------------------
Balance, end of period 18,281 43,568
-----------------------
-----------------------


Contributed Surplus

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

Contributed Surplus

June 30,
-----------------------
($ thousand) 2005 2004
-----------------------

Balance, beginning of year 1,170 264
Unit/stock-based compensation
expense 473 309
Unit/stock-based compensation
recognized on exercise of unit
rights/stock options (329) (38)
-----------------------
Balance, end of period 1,314 535
-----------------------
-----------------------


Compensation Plans

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 service providers. The Trust is authorized to issue up to 1.82 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 issued and outstanding trust units of the Trust. 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 per the Arrangement. Rights granted under the plan generally vest over a three-year period and expire approximately five years from the grant date.

The Plan allows for the exercise price of rights to be reduced in future periods by an amount that distributions exceed a stated return on assets. The unit-based compensation expense arising from unit rights granted upon and subsequent to, the July 15, 2004 Plan of Arrangement, were originally calculated using the intrinsic value method. In response to an emphasis by securities regulators that fair value methodologies be used, new measurement techniques have recently been developed utilizing a fair value option-pricing model for such unit rights grants. Zargon has reassessed the previous unit rights grants under this fair value model and there is no significant impact on 2004 unit-based compensation expense. Zargon will continue to use fair value methodologies, where possible, for future unit rights grants.

The assumptions made for unit rights granted for 2005 include a volatility factor of expected market price of 24 percent, a weighted average risk-free interest rate of 3.39 percent, a dividend yield of 7.64 percent and a weighted average expected life of the unit rights of four years.

Compensation expense associated with rights granted under the Plan is recognized in earnings over the vesting period of the Plan with a corresponding increase or decrease 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, 2005
-----------------------
Number Weighted
of Unit Average
Rights Exercise
(thousand) Price ($)
-----------------------
Outstanding at beginning of year 579 17.79
Unit rights granted 163 22.00
Unit rights exercised (57) 17.58
Unit rights cancelled (15) 17.70
-----------
Outstanding at end of period 670 18.82
-----------
-----------
Unit rights exercisable at period end 144 17.82
-----------
-----------


Stock Option Plan and Stock-based Compensation

Prior to the Plan of Arrangement, the Company calculated the value of stock-based compensation for its predecessor stock-option plan using a Black-Scholes option-pricing model to estimate the fair value of stock options at the date of grant. This stock-option plan ceased to exist at the July 15, 2004 Plan of Arrangement.



A summary of the Company's predecessor stock option plan prior to the
Plan of Arrangement is as follows:

Six Months Ended
June 30, 2004
-----------------------
Number Weighted
of Average
Shares Exercise
(thousand) Price ($)
-----------------------
Outstanding at beginning of year 1,297 7.05
Granted 430 16.00
Exercised (289) 4.60
Cancelled (9) 9.61
----------
Outstanding at end of period 1,429 10.22
----------
----------

Options exercisable at period end 696 6.94
----------
----------


6. WEIGHTED AVERAGE NUMBER OF TOTAL UNITS/SHARES

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. Comparative amounts reflect the basic and diluted calculation of the common shares of Zargon Oil & Gas Ltd.



Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------------------------------------------
(thousand) 2005 2004 2005 2004
------------------------------------------------------------------------
(units) (shares) (units) (shares)

Basic 15,930 18,257 15,776 18,208

Diluted 18,840 18,851 18,803 18,797
------------------------------------------------------------------------
------------------------------------------------------------------------


7. 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,
------------------------------------------------------------------------
($ thousand) 2005 2004 2005 2004
------------------------------------------------------------------------
Petroleum and Natural Gas
Revenue
Canada 31,173 27,379 60,630 51,748
United States 4,695 3,580 9,362 6,915
------------------------------------------------------------------------
Total 35,868 30,959 69,992 58,663
------------------------------------------------------------------------
------------------------------------------------------------------------

Net Capital Expenditures
Canada 9,999 5,976 20,642 15,434
United States 966 1,632 1,008 1,942
------------------------------------------------------------------------
Total 10,965 7,608 21,650 17,376
------------------------------------------------------------------------
------------------------------------------------------------------------

Total Assets
Canada 224,373 164,209
United States 29,374 25,594
--------------------
Total 253,747 189,803
--------------------
--------------------



8. SUPPLEMENTAL CASH FLOW INFORMATION

Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------------------------------------------
($ thousand) 2005 2004 2005 2004
------------------------------------------------------------------------
Cash interest paid 173 34 391 108

Cash taxes paid 420 49 864 188
------------------------------------------------------------------------
------------------------------------------------------------------------


9. FINANCIAL INSTRUMENTS

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 contracts at June 30, 2005 as follows:



Volume Rate Price Range of Terms
------------------------------------------------------------------------
Financial
Contracts
Designated
as Hedges
Jul. 1/05-
Oil swaps 73,600 bbl 400 bbl/d $44.05 US/bbl Dec. 31/05

Oil collars 36,800 bbl 200 bbl/d $37.00 US/bbl Put Jul. 1/05-
$44.40 US/bbl Call Dec. 31/05

36,200 bbl 200 bbl/d $36.00 US/bbl Put Jan. 1/06-
$48.40 US/bbl Call Jun. 30/06

Natural Jul. 1/05-
gas swaps 492,000 gj 4,000 gj/d $6.49/gj Oct. 31/05

Natural
gas
collars 246,000 gj 2,000 gj/d $6.00/gj Put Jul. 1/05-
$8.01/gj Call Oct. 31/05

453,000 gj 3,000 gj/d $5.90/gj Put Nov. 1/05-
$10.00/gj Call Mar. 31/06

Natural Jul. 1/05-
gas put 246,000 gj 2,000 gj/d $5.10/gj Oct. 31/05
------------------------------------------------------------------------
Financial
Contracts Not
Designated as
Hedges

Jul. 1/05-
Oil swaps 55,200 bbl 300 bbl/d $45.70 US/bbl Dec. 31/05

Jan. 1/06-
36,200 bbl 200 bbl/d $48.50 US/bbl Jun. 30/06

Jan. 1/06-
109,500 bbl 300 bbl/d $51.83 US/bbl Dec. 31/06

Jul. 1/06-
36,800 bbl 200 bbl/d $51.12 US/bbl Dec. 31/06

Oil collars 36,200 bbl 200 bbl/d $40.00 US/bbl Put Jan. 1/06-
$49.05 US/bbl Call Jun. 30/06

Natural Jul.1/05-
gas swaps 246,000 gj 2,000 gj/d $6.52/gj Oct. 31/05
Apr. 1/06-
214,000 gj 1,000 gj/d $7.05/gj Oct. 31/06

Natural
gas
collars 302,000 gj 2,000 gj/d $6.50/gj Put Nov. 1/05-
$8.80/gj Call Mar. 31/06


302,000 gj 2,000 gj/d $7.00/gj Put Nov. 1/05-
$9.35/gj Call Mar. 31/06
------------------------------------------------------------------------
Physical
Contracts

Natural
gas Apr. 1/06-
swaps 642,000 gj 3,000 gj/d $7.13/gj Oct. 31/06

Natural
gas
collars 151,000 gj 1,000 gj/d $8.47/gj Put Nov. 1/05-
$9.50/gj Call Mar. 31/06

Natural Jul. 1/05-
gas put 246,000 gj 2,000 gj/d $6.05/gj Oct. 31/05
------------------------------------------------------------------------
------------------------------------------------------------------------



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

Financial risk management contracts in place as at December 31, 2004 were designated as hedges for accounting purposes and the Trust continues to monitor these contracts in determining the continuation of hedge effectiveness. For these contracts, realized gains and losses are recorded in the statement of earnings as the contracts settle and no unrealized gain or loss is recognized. The realized losses for the first six months of 2005 were $2.02 million (2004 - $1.58 million). At June 30, 2005, an additional $2.63 million would have been required to settle the above designated hedge contracts. 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.

For financial risk management contracts entered into after December 31, 2004, the Trust does consider these contracts to be effective on an economic basis but has decided not to designate these contracts as hedges for accounting purposes and accordingly, for outstanding contracts not designated as hedges, an unrealized gain or loss is recorded based on the fair value (mark-to-market) of the contracts at that time. The unrealized losses for the first six months of 2005 were $3.35 million (2004 - nil). These instruments have been recorded as a liability in the interim consolidated balance sheet.

10. ACCUMULATED CASH DISTRIBUTIONS

During the six month period, the Trust paid or declared distributions to the unitholders in the aggregate amount of $13.34 million in accordance with the following schedule:



Month Record Date Distribution Date Per Trust Unit
------------------------------------------------------------------------
January 2005 January 31, 2005 February 15, 2005 $0.14
February 2005 February 28, 2005 March 15, 2005 $0.14
March 2005 March 31, 2005 April 15, 2005 $0.14
April 2005 April 30, 2005 May 16, 2005 $0.14
May 2005 May 31, 2005 June 15, 2005 $0.14
June 2005 June 30, 2005 July 15, 2005 $0.14
------------------------------------------------------------------------
------------------------------------------------------------------------


For Canadian income tax purposes, the distributions are currently
estimated to be 100 percent taxable income to unitholders.


CORPORATE INFORMATION

------------------------------------------------------------------------
Board of Directors Officers Stock Exchange Listing


Craig H. Hansen John O. McCutcheon Toronto Stock Exchange
Calgary, Alberta Chairman Trading Symbols:
ZAR.UN - Trust Units
K. James Harrison Craig H. Hansen ZOG.B - Exchangeable Shares
Oakville, Ontario President and
Chief Executive Transfer Agent
H. Earl Joudrie Officer
Toronto, Ontario Valiant Trust Company
Brent C. Heagy 310, 606 - 4th Street S.W.
Kyle D. Kitagawa Vice President, Calgary, Alberta T2P 1T1
Calgary, Alberta Finance and Chief
Financial Officer Head Office
John O. McCutcheon
Vancouver, British Mark I. Lake 700, 333 - 5th Avenue S.W.
Columbia Vice President, Calgary, Alberta T2P 3B6
Exploration Phone:(403) 264-9992
Jim D. Peplinski Fax: (403) 265-3026
Calgary, Alberta Daniel A. Roulston Email: zargon@zargon.ca
Executive Vice
J. Graham Weir President, Operations Website
Calgary, Alberta
Sheila A. Wares www.zargon.ca
William J. Whelan Vice President,
Calgary, Alberta Accounting

Grant A. Zawalsky Kenneth W. Young
Calgary, Alberta Vice President, Land


Forward-Looking Statements - This document contains statements that are forward-looking, such as those relating to results of operations and financial condition, capital spending, financing sources, commodity prices, costs of production and the magnitude of oil and natural gas reserves. By their nature, forward-looking statements are subject to numerous risks and uncertainties that could significantly affect anticipated results in the future and, accordingly actual results may differ materially from those predicted. The forward-looking statements contained in this quarterly report are as of August 10, 2005 and are subject to change after this date. Readers are cautioned that the assumptions used in the preparation of such information, although considered reasonable at the time of preparation, may prove to be imprecise and, as such, undue reliance should not be placed on forward-looking statements. Zargon disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Telephone: 403-264-9992
E-mail: zargon@zargon.ca
Website: www.zargon.ca

Contact Information

  • Zargon Energy Trust
    C.H. Hansen
    President and Chief Executive Officer
    or
    B.C. Heagy
    Vice President, Finance and Chief Financial Officer