Kereco Energy Ltd. Announces 2007 Results



    CALGARY, March 14 /CNW/ - Kereco Energy Ltd. ("Kereco") or the
("Company") is pleased to announce results for the Company's fourth quarter
and year end ended December 31, 2007.

    
    FINANCIAL AND OPERATING HIGHLIGHTS
    -------------------------------------------------------------------------
    FINANCIAL                Three months ended                   Year ended
                                    December 31                  December 31

    ($000s, unless                            %                            %
    otherwise indicated) 2007      2006  Change       2007      2006  Change
    -------------------------------------------------------------------------
    Petroleum and
     natural gas
     sales             48,325    39,753      22    184,579   131,674      40
    Funds flow
     from
     operations        21,560    20,592       5     89,178    72,226      23
      Per share
       - basic ($)       0.37      0.40      (8)      1.55      1.87     (17)
      Per share
       - diluted ($)     0.37      0.39      (5)      1.55      1.81     (14)
    Net earnings
     (loss)(1)         (4,383)     (234) (1,773)  (126,413)   20,005    (732)
      Per share
       - basic ($)      (0.08)    (0.01)   (700)     (2.20)     0.52    (523)
      Per share
       - diluted ($)    (0.08)    (0.01)   (700)     (2.20)     0.50    (540)
    Capital
     expenditures
      Exploration
       and
       development     29,205    22,930      27    118,540   102,095      16
      Net
       acquisitions
       (dispositions) (71,327)  291,783    (124)   (40,935)  299,258    (114)
    -------------------------------------------------------------------------
      Total           (42,122)  314,713    (113)    77,605   401,353     (81)
    -------------------------------------------------------------------------
    Bank debt          80,193   188,673     (57)    80,193   188,673     (57)
    Working capital
     deficiency(2)     21,962     7,228     204     21,962     7,228     204
    -------------------------------------------------------------------------
    Total net
     debt(3)          102,155   195,901     (48)   102,155   195,901     (48)
    -------------------------------------------------------------------------
    Shareholders'
     equity           387,651   481,248     (19)   387,651   481,248     (19)
    Common shares
     outstanding
     (000s)
      Basic            57,840    55,336       5     57,840    55,336       5
      Diluted          65,606    62,808       4     65,606    62,808       4
    Weighted average
     common shares
     outstanding
     (000s)
      Basic            57,802    51,189      13     57,469    38,611      49
      Diluted(4)       57,802    52,504      10     57,469    39,984      44
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    OPERATING
     HIGHLIGHTS(5)
    -------------------------------------------------------------------------
    Average daily
     production
      Natural gas
       (mcf/day)       27,151    22,406      21     27,054    16,896      60
      Crude oil
       and NGLs
       (bbls/day)       4,118     4,376      (6)     4,311     3,408      27
      Barrels of
       oil
       equivalent
       (boe/day)        8,643     8,111       7      8,820     6,224      42
    Average selling
     prices(6)
      Natural gas
       ($/mcf)           6.30      7.08     (11)      6.95      7.14      (3)
      Crude oil
       and NGLs
       ($/bbl)          82.72     59.47      39      70.87     67.23       5
      Barrels of
       oil
       equivalent
       ($/boe)          59.20     51.64      15      55.96     56.19       0
    Wells drilled
     (No.)
      Gross               6.0       8.0     (25)      39.0      30.0      30
      Net                 5.4       4.7      15       32.7      19.9      64
      Success (%)         100        75      33         87        83       5
    Undeveloped
     land (000s of
     acres)
      Gross               202       336     (40)       202       336     (40)
      Net                 168       225     (25)       168       225     (25)
    Average working
     interest (%)          83        67      24         83        67      24
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    (1) Includes goodwill impairment write-down of $120.0 million in 2007.
    (2) Excluding financial derivative contracts and includes advance payment
        for property disposition.
    (3) Net debt - excludes debt associated with the $70 million principal
        amount of convertible debentures issued June 25, 2007.
    (4) Excludes anti-dilutive incremental options and warrants of 379,826
        and 808,142 for the fourth quarter and the year to date respectively.
    (5) References in this report to boe refer to barrel of oil equivalent
        whereby natural gas volumes have been converted at a rate of
        six thousand cubic feet of natural gas to one barrel of oil. See
        "Management's Discussion and Analysis" on page five.
    (6) Average selling prices are net of transportation costs and excluding
        financial derivatives.
    

    MESSAGE TO SHAREHOLDERS

    Kereco is pleased to provide our results for the fourth quarter and year
ended December 31, 2007 as well as a preview of the newly repositioned Kereco
for the future. A summary of the key achievements for the 2007 year are as
follows:

    
    -   Production
        2007 average daily production was 8,820 boe/day (27.1 mmcf/day of
        natural gas and 4,311 boe/day of oil and liquids), a 42% increase
        over 2006.

    -   Capital
        The company spent $118.5 million for the full year on exploration and
        development, excluding the $77.5 million of asset dispositions and
        $36.6 million of asset acquisitions that closed prior to year end
        providing an overall net capital program of $77.6 million.

    -   Wells Drilled
        For the full year, Kereco drilled a total of 39 wells with an 87%
        success rate including 22 oil wells, 12 gas wells and 5 abandonments.

    -   Funds Flow
        Funds flow from operations for the year was $89.2 million ($1.55 per
        basic share), an increase of 23% over 2006 funds flow however a 14%
        decrease over 2006 cash flow per fully diluted share.
    

    Corporate Repositioning and Outlook

    Although we had many operational successes in 2007, the main undertaking
for the year was our corporate repositioning which has resulted in Kereco
being a significantly different company today than the one I described to you
12 months ago.
    In July of 2007, we embarked upon a repositioning of Kereco in order to
lay the foundation for the company's future. The objective was to eliminate
the indebtedness of the company by generating sufficient cash to capitalize on
what we expect to be an opportunity rich 2008 and 2009. That process resulted
in the sale of $240 million in assets and concluded with the closing of the
last sale on January 14, 2008. The assets that we disposed of were shorter
life, more economically challenged natural gas assets as well as assets that
we did not see as strategically relevant to move forward with.
    The last step in the repositioning, as previously communicated, is our
anticipated offer to repurchase the currently outstanding Convertible
Debentures (the "Debentures"). The board of directors has received an
independent valuation of the Debentures from Clark Valuation Services Ltd.
("Clark") as required by MI 61-101. In the opinion of Clark, the fair market
value of the Debentures at February 29, 2008 was within a range of $887 to
$958 per $1,000 of Debentures. The board of directors has resolved to make a
formal offer to acquire all of the outstanding Debentures at a price of $950
per $1,000 Debenture. Kereco anticipates that the offer will be mailed to
Debenture holders by mid April and will close prior to the June 30, 2008
interest payment being due. The offer will be subject to a minimum tender of
90% of the outstanding Debentures and other customary conditions.
    The net result of the reorganization is a go forward company that is
positioned primarily in light sweet, long reserve life oil assets at Sturgeon
Lake together with a small group of operated assets in the Peace River Arch,
both in Alberta. Financially, the balance sheet is exceptionally strong as the
company has no debt, a positive cash position and approximately 4,000 boe/day
of production (70% light oil and NGL's, 30% natural gas). Funds flow from
these assets alone is currently in excess of $4 million per month and is
projected to be approximately $52 - $58 million in total for 2008 on the
current assets (based on an oil price of WTI US$86/bbl, CDN$7.00/GJ AECO
natural gas and a 1:1 Canada/US exchange rate). The "starter kit" has 13.3
mmboe of proved reserves 18.2 mmboe of proved plus probable reserves with a
reserve life index of 12.5 years and undeveloped land of 50,000 net acres. As
well, the company has an inventory of opportunities on which the company is of
the opinion that, together with its retained Sturgeon Lake asset, is expected
to achieve 15% annual growth in value over the next one, three and five year
time periods.
    A summary of the retained assets for the go-forward company follows.
These reserves were evaluated effective December 31, 2007 by GLJ Petroleum
Consultants Ltd. ("GLJ") in accordance with National Instrument 51-101
Standards of Disclosure of Oil and Gas Activities ("NI 51-101").

    
    Summary of Oil and Gas Reserves (Gross - Forecast Price Case)
     - Post Disposition(1)(2)(3)

                                                                    2007 Boe
                             Natural gas   Crude oil        NGLs  equivalent
                                   (mmcf)     (mmbls)     (mbbls)      (mboe)
    -------------------------------------------------------------------------
    Proved producing              15,646       6,898         652      10,158
    Proved non-producing           1,257         731          58         998
    -------------------------------------------------------------------------
    Total proved developed        16,903       7,629         710      11,156
    Proved undeveloped             2,980       1,577         136       2,210
    -------------------------------------------------------------------------
    Total proved                  19,883       9,206         847      13,366
    Probable additional            6,924       3,438         288       4,880
    -------------------------------------------------------------------------
    Total proved plus probable    26,807      12,643       1,135      18,246
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------


    Net Present Value of Reserves - Post Disposition(2)(3)(4)

    ($000s)     Undiscounted  Discounted  Discounted  Discounted  Discounted
                                   at 8%      at 10%      at 12%      at 15%
    -------------------------------------------------------------------------
    Total Proved     513,507     329,191     303,073     281,019     253,649
    Probable         196,187      77,713      65,133      55,258      43,942
    -------------------------------------------------------------------------
    Total Proved
     Plus Probable   709,694     406,903     368,205     336,277     297,592
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    (1) Since inception, the company's reserves have been evaluated by the
        independent engineering firm of GLJ Petroleum Consultants ("GLJ").
    (2) After the disposition of assets which closed on January 14, 2008, but
        as evaluated effective December 31, 2007
    (3) For the complete NI 51-101 disclosures, both for the reserves as at
        December 31, 2007 (before the January 14, 2008 disposition) and also
        for additional information regarding the reserves after the
        January 14, 2008 disposition, please refer to the company's Annual
        Information Form which will be filed on SEDAR on or before March 30,
        2008.
    (4) The Government of Alberta released its New Royalty Framework ("NRF")
        on October 25, 2007. The NRF is anticipated to become effective
        January 1, 2009, and will result in a reduction in Kereco's present
        value of reserves, relative to that determined on a pre-NRF basis
        using GLJ's January 1, 2008 forecasted prices and a 10 percent
        discount rate, of between 9 and 13 percent.
    

    We have altered our strategy from a production growth strategy to a
strategy of growth in value of reserves and net present value. Using this
strategy, we are confident that we can achieve our targeted 15% annual growth
in value over one, three and five year time periods with the assets we
currently have under management in addition to assets we anticipate adding to
our company.
    The primary retained asset is located at Sturgeon Lake where we have had
considerable success in adding meaningful value after purchasing it in April
of 2005. Since that time, Kereco has added 5.6 mmboe of new reserves at a cost
of $17.71/boe achieving a superior average recycle ratio of 2.1 times. This
efficient addition of high quality light oil reserves has resulted in a
realized increase in this property's NPV of approximately $200 million for an
annualized return of 32%.
    Going forward Kereco intends to leverage this success at Sturgeon with a
four part value creation strategy targeting approximately 15% annualized
return over the next five years.
    The first component of the business plan is to continue to optimize and
efficiently grow the value of Sturgeon Lake oil property. This includes
continued low risk infill development drilling of the asset's numerous
sizeable oil in place reservoirs, modest small "E" exploration, and product
optimization through a number of business initiatives utilizing the extensive
owned and controlled infrastructure. We have a minimum of four years worth of
development opportunities based on our current technical and business
assessments.
    The second component is the continued maturation of the Sturgeon Lake
property's enhanced light oil recovery projects. We have recently commenced
the Triassic A pool (Montney) waterflood project and are optimistic regarding
implementation of the tertiary flood on the sizeable Leduc oil pool. The past
two years have seen significant progress on this project, including continued
development on achieving a source of CO(2) that could lead to implementation
of the project between 2011 and 2013. In subsequent years, enhanced oil
recovery ("EOR") schemes on the smaller, but not insignificant, Sturgeon Lake
oil pools will be established utilizing the infrastructure developed for these
two initial projects.
    The third component consists of utilizing the now available capital
resources established through the aforementioned asset disposition process to
strategically and opportunistically aggregate hydrocarbon in place projects
where technology can be utilized to manage up recovery factors. It is our
belief that this will primarily consist of property acquisitions, although
wide area farm-ins or corporate acquisitions will be considered if the
involved asset meets our intended strategy and return thresholds.
    And finally, in order to optimize the returns generated, Kereco intends
to focus on achieving operational excellence and maintaining disciplined
capital spending combined with prudent capital structure management and
enhancement as it relates to both internally generated activity and the
acquisition of new opportunities.
    As for the capital investment environment, we believe that we are upon an
exceptional time period for our company. We have extremely strong commodity
prices, somewhat softer costs for services, stressed balance sheets of many
operating entities (both on the exploration and production side as well as the
service sector of our business) and cautious equity markets - all of which
provide Kereco with the opportunity to utilize its cash position and excess
funds flow to grow the value of our business. We are excited about the new
start to Kereco with a before tax (discounted at 10 percent) net present value
of the proved and probable reserves only of $6.38/basic share.
    For the year 2008, we are targeting growth in the value to our company by
15% through investment in capital and operating initiatives on our assets and
the aggregation of additional assets into our portfolio.  At this time we
anticipate spending between $35 - $40 million on our existing asset base out
of our contemplated $52 - $58 million of funds flow from our current
production operations and will look to deploy capital towards obtaining
additional assets that are able to achieve our return requirements for
investment.
    We would like to thank all of our past and current employees, officers,
directors, shareholders and stakeholders for their patience and understanding
as we worked through the process of repositioning ourselves for the future, a
future in which we believe that we can demonstrate significant growth in value
in the years to come.
    Thank you again for your continued interest in Kereco.

    On behalf of the Board of Directors,

    Grant B. Fagerheim
    President and Chief Executive Officer
    March 14, 2008



    MANAGEMENT'S DISCUSSION AND ANALYSIS

    The following management's discussion and analysis ("MD&A") should be
read in conjunction with the audited consolidated financial statements and
MD&A for the years ended December 31, 2007 and 2006 contained in the 2007
consolidated financial statements of Kereco and is based on information to
March 13, 2008. The reader should be aware that historical results are not
necessarily indicative of future performance. Additional information relating
to Kereco Energy Ltd. ("Kereco") or the ("Company") can be found at
www.sedar.com.
    Funds flow from operations, which is determined before changes in
non-cash working capital, is used by us as a key measure of performance. Funds
flow from operations does not have a standardized meaning prescribed by
Canadian Generally Accepted Accounting Principles ("GAAP") and therefore may
not be comparable with the calculation of similar measures for other
companies. Funds flow from operations as presented is not intended to
represent operating profits for the period nor should it be viewed as an
alternative to cash provided by operating activities, net earnings or other
measures of financial performance calculated in accordance with GAAP. Funds
flow from operations per share is calculated using the same share bases which
are used in the determination of earnings per share.
    Net debt, which is determined as bank debt and working capital (comprised
of accounts receivable, prepaid expenses and accounts payable and accrued
liabilities) is used by us as a key indicator of the financial position of the
Company. Net debt does not have a standardized meaning prescribed by Canadian
Generally Accepted Accounting Principles ("GAAP") and therefore may not be
comparable with the calculation of similar measures for other companies.
    The financial data contained herein has been prepared in accordance with
GAAP, and unless otherwise indicated, all comments in this report are in
thousands of Canadian dollars. In conformity with Canadian Securities
Administrators National Instrument 51-101, natural gas volumes have been
converted to equivalent barrels of oil ("boe") using a conversion ratio of six
thousand cubic feet ("mcf") to one boe. This ratio is based on an energy
equivalency conversion method primarily applicable at the burner tip and does
not represent a value equivalency at the wellhead. Readers are cautioned that
boes may be misleading, particularly if used in isolation.

    FORWARD LOOKING STATEMENTS

    Certain information set forth in this disclosure, including management's
assessment of the future plans and operations of Kereco, contains
forward-looking statements. By their nature, forward-looking statements are
subject to numerous risks and uncertainties, some of which are beyond our
control, including the impact of general economic conditions, industry
conditions, changes in laws and regulations including the adoption of new
environmental laws and regulations and changes in how they are interpreted and
enforced, volatility of commodity prices, currency fluctuations, interest rate
volatility, imprecision of reserve estimates, environmental risks, competition
from other industry participants, the lack of availability of qualified
personnel or management, stock market volatility and ability to access
sufficient capital from internal and external sources, market valuations with
respect to announced transactions and the final valuations thereof and
obtaining required approvals of regulatory authorities. Readers are cautioned
that the assumptions used in the preparation of such information, although
considered reasonable at the time of preparation, may prove to be imprecise
and, as such, undue reliance should not be placed on forward looking
statements. The actual results, performance or achievement of Kereco could
differ materially from those expressed in, or implied by, these
forward-looking statements and, accordingly, no assurance can be given that
any of the events anticipated by the forward looking statements will transpire
or occur, or if any of them do so, what benefits that Kereco will derive
therefrom. Except as required by law, Kereco disclaims any intention or
obligation to update or revise any forward-looking statements, whether as a
result of new information, future events or otherwise.

    BASIS OF PRESENTATION

    Kereco is a Calgary-based intermediate light oil and natural gas
exploration, development and production company whose key business activities
for 2007 were focused in central and north western Alberta and north eastern
British Columbia. Kereco began operations as an oil and gas exploration and
production company on January 18, 2005 with the conveyance of oil and gas
properties from Ketch Resources Ltd. ("Ketch"). Our strategy is to create
value primarily through the generation and drilling of exploration and
development prospects as well as through the exploitation and production of
existing reserves, otherwise referred to as organic growth. In addition, we
seek strategic acquisitions which add to our production, reserves and growth
potential. We target areas and prospects that we believe can result in
meaningful reserve and production additions on a per share basis. Subsequent
to year end, after a disposition of assets that closed January 14, 2008, the
company's assets are now solely focused in north western Alberta.

    RESULTS OF OPERATIONS

    Production in 2007 averaged 8,820 boe/day (27,054 mcf/day of natural gas
and 4,311 bbls/day of crude oil and NGLs) up 42 percent from the 6,224 boe/day
(16,896 mcf/day of natural gas and 3,408 bbls/day of crude oil and NGLs)
averaged in 2006.
    Capital expenditures in 2007, including net property acquisitions and
dispositions of $40.9 million, were $77.6 million. During the year ended
December 31, 2007, our net $77.6 million capital program, resulted in the
drilling of 39 wells, 12 of which were cased as natural gas wells and 22 were
cased as oil wells (87 percent success). Of the 34 successful wells drilled in
2007, 8 were completed as oil wells in our Sturgeon Lake area, 12 were
completed as oil wells and 8 as gas wells in our Central Alberta area and 2
were completed as oil wells and 4 as gas wells in our British Columbia area.

    
    Selected Quarterly Information

                                                2007
    -------------------------------------------------------------------------
    ($000s, except per share
     amounts)                         Q4          Q3          Q2          Q1
    -------------------------------------------------------------------------
    Revenues (net of royalties)   37,987      33,485      38,051      34,150

    -------------------------------------------------------------------------
    Funds flow from operations    21,560      23,345      22,299      21,974
      Per share - basic ($)         0.37        0.40        0.39        0.39
      Per share - diluted ($)       0.37        0.40        0.38        0.38
    -------------------------------------------------------------------------
    Net earnings (loss)           (4,383)   (122,643)      2,547      (1,934)
      Per share - basic ($)        (0.08)      (2.12)       0.04       (0.03)
      Per share - diluted ($)      (0.08)      (2.12)       0.04       (0.03)
    -------------------------------------------------------------------------
    Total assets                 639,799     697,275     806,637     784,570
    -------------------------------------------------------------------------
    Bank debt                     80,193     150,713     151,892     179,576
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------


                                                2006
    -------------------------------------------------------------------------
    ($000s, except per share
     amounts)                         Q4          Q3          Q2          Q1
    -------------------------------------------------------------------------
    Revenues (net of royalties)   31,461      24,152      22,984      24,048

    -------------------------------------------------------------------------
    Funds flow from operations    20,592      17,422      16,690      17,522
      Per share - basic ($)         0.40        0.49        0.49        0.52
      Per share - diluted ($)       0.39        0.48        0.48        0.50
    -------------------------------------------------------------------------
    Net earnings (loss)             (234)      7,006       7,765       5,468
      Per share - basic ($)        (0.01)       0.20        0.23        0.16
      Per share - diluted ($)      (0.01)       0.19        0.22        0.16
    -------------------------------------------------------------------------
    Total assets                 767,411     391,933     364,342     347,063
    -------------------------------------------------------------------------
    Bank debt                    188,673      84,695      74,284      79,565
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    Significant events and variances that have occurred over the last eight
quarters are as follows:

    (1) On October 19, 2006, Kereco acquired Chamaelo Exploration Ltd.
        ("Chamaelo"), resulting in subsequent increases in revenues and funds
        flow. The acquisition did also result in a significant increase in
        depletion, depreciation and amortization which has negatively
        impacted net earnings since that point.
    (2) During the third quarter of 2007, Kereco's production at Sturgeon
        Lake was down for over one month as a result of a scheduled
        turnaround, resulting in a negative impact on revenues that quarter.
        In addition, the entire balance of goodwill was written off in the
        third quarter of 2007, resulting in a large net loss.
    (3) In the fourth quarter of 2007, Kereco completed 3 separate
        dispositions of assets for total net proceeds of $71.3 million. These
        proceeds reduced both bank debt and total assets in the quarter.

    Selected Annual Information
                                                 Year ended December 31
    -------------------------------------------------------------------------
    ($000s, except per share amounts)           2007        2006        2005
    -------------------------------------------------------------------------
    Revenues (net of royalties)              143,673     102,645      69,427
    -------------------------------------------------------------------------
    Funds flow from operations                89,178      72,226      50,357
      Per share - basic ($)                     1.55        1.87        1.78
      Per share -  diluted ($)                  1.55        1.81        1.72
    -------------------------------------------------------------------------
    Net earnings (loss)                     (126,413)     20,005      16,488
      Per share - basic ($)                    (2.20)       0.52        0.58
      Per share -  diluted ($)                 (2.20)       0.50        0.56
    -------------------------------------------------------------------------
    Total assets                             639,799     767,411     328,267
    -------------------------------------------------------------------------
    Bank debt                                 80,193     188,673      71,737
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    FUNDS FLOW FROM OPERATIONS

    Funds flow from operations increased 23 percent in 2007 to $89.2 million,
or $1.55 per share on a diluted basis from $72.2 million, or $1.81 per share
on a diluted basis for 2006, largely as a result of increased production
volumes. Funds flow from operations is calculated as follows:

                                                      Year ended December 31
    -------------------------------------------------------------------------
    ($000s)                                                 2007        2006
    -------------------------------------------------------------------------
    Cash provided by operating activities                110,895      67,977
    Change in non-cash working capital                   (21,717)      4,249
    -------------------------------------------------------------------------
    Funds flow from operations                            89,178      72,226
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    NET OPERATING INCOME

                                                      Year ended December 31
    -------------------------------------------------------------------------
    ($000s, except per share amounts)                       2007        2006
    -------------------------------------------------------------------------
    Petroleum and natural gas sales                      189,013     131,674
    Transportation                                        (4,434)     (4,012)
    Realized financial derivative gains (losses)           4,800       1,854
    -------------------------------------------------------------------------
    Total net sales                                      189,379     129,516
    Royalty expenses                                     (40,906)    (29,029)
    Operating expenses                                   (36,107)    (21,193)
    -------------------------------------------------------------------------
    Net operating income                                 112,366      79,294
    -------------------------------------------------------------------------
      Per share - basic ($)                                 1.96        2.05
                - diluted ($)                               1.96        1.98
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------



    OPERATING NETBACKS

                                                      Year ended December 31
    -------------------------------------------------------------------------
                                                            2007        2006
    -------------------------------------------------------------------------
    Boe netback ($/boe)
      Sales price                                          57.33       57.96
      Transportation                                       (1.37)      (1.77)
      Realized gains on financial derivatives               1.49        0.82
    -------------------------------------------------------------------------
      Sales price, net of transportation and realized
       gains on financial derivatives                      57.45       57.01
      Royalty expenses - ($/boe)                          (12.71)     (12.78)
                       - (%)                                22.7        22.7
      Operating expenses                                  (11.22)      (9.33)
    -------------------------------------------------------------------------
      Netback                                              33.52       34.90
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    Natural gas netback ($/mcf)
      Sales price                                           7.17        7.37
      Transportation                                       (0.22)      (0.23)
      Realized gains on financial derivatives               0.46        0.31
    -------------------------------------------------------------------------
      Sales price, net of transportation and realized
       gains on financial derivatives                       7.41        7.45
      Royalty expenses - ($/mcf)                           (1.47)      (1.57)
                       - (%)                                21.1        22.0
      Operating expenses                                   (1.86)      (1.55)
    -------------------------------------------------------------------------
      Netback                                               4.08        4.33
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    Crude oil and NGL netback ($/bbl)
      Sales price                                          72.31       69.31
      Transportation                                       (1.44)      (2.07)
      Realized gains (losses) on financial derivatives      0.15       (0.05)
    -------------------------------------------------------------------------
      Sales price, net of transportation realized gains
       (losses) on financial derivatives                   71.02       67.19
      Royalty expenses - ($/bbl)                          (16.77)     (15.54)
                       - (%)                                23.7        23.1
      Operating expenses                                  (11.26)      (9.35)
    -------------------------------------------------------------------------
      Netback                                              42.99       42.30
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    


    PETROLEUM AND NATURAL GAS SALES

    Production in 2007 averaged 8,820 boe/day and net realized prices of
$55.96/boe resulted in revenues of $184.6 million, a 42 percent increase in
production and no change in realized prices compared to the year ended 2006
which had production of 6,224 boe/day and realized prices of $56.19/boe.
Production increases for the year ended 2007 over 2006 are largely
attributable to the recognition of a full year of production from the Chamaelo
acquisition which closed on October 19, 2006. Average price realizations in
2007, net of transportation costs, were $55.96/boe ($6.95/mcf for natural gas,
$70.87/bbl for crude oil & NGLs and realized financial derivative gains of
$1.49/boe). Financial derivative contracts in place (see note 13 to the
consolidated financial statements for further details) resulted in realized
gains of $4.8 million ($1.49/boe) for 2007. Comparatively, average price
realizations for the year ended 2006, net of transportation costs, were
$56.19/boe ($7.14/mcf for natural gas, $67.23/bbl for crude oil & NGLs and a
financial derivative gains of $0.82/boe). The relatively unchanged net
realized prices tracked changes in the underlying commodity prices over these
periods. Gas prices averaged, for AECO daily index ($Cdn/mcf) $6.44/mcf in
2007, relatively unchanged from $6.53/mcf in 2006, and the average monthly
index AECO natural gas price was $6.60/mcf for 2007, only five percent lower
than $6.98/boe in 2006. WTI crude oil strengthened significantly to average
U.S.$72.37/bbl in 2007, nine percent higher than U.S. $66.25/bbl averaged in
2006, however, the increased value of the Canadian dollar and widening
differentials between Edmonton light sweet and WTI over these two respective
periods mitigated some of the gains seen in WTI. On a boe basis, the decreases
in realized gas commodity prices for 2007 were partially offset by the
financial derivative contracts we entered into which resulted in gains of
$4.8 million or $1.49/boe.
    All of our production is sold within Canada, and revenues are received in
Canadian dollars. The commodities we produce and sell are sensitive to both
worldwide (crude oil) and North American (natural gas) price fluctuations and
the Canada/U.S. exchange rate. An increase in the value of the Canadian dollar
negatively impacts our price realizations. There was an increase in the value
of the Canadian dollar versus the U.S. dollar in 2007 compared to 2006 and
other historical levels, which negatively impacted our price realizations. The
average Canada/U.S. exchange rate was 1.08 for 2007 and was an average of 1.13
for 2006.

    Realized Financial Derivatives

    On an ongoing basis we enter into several financial and physical
commodity contracts to assist in minimizing exposure to commodity prices.
Decreasing natural gas prices throughout 2007 resulted in gains from our
natural gas financial derivative contracts of $4.6 million and crude oil
contracts resulted in gains of $0.2 million compared to a gain of $1.9 million
gain, all of it related to natural gas derivative contracts, in 2006. In the
third and fourth quarters of 2007, we realized net gains of $2.3 million on
pre-existing natural gas contracts, some of which extended into 2008, by
collapsing them early.

    
    Transportation Costs

                                                      Year ended December 31
    -------------------------------------------------------------------------
    ($000s, except as indicated)                            2007        2006
    -------------------------------------------------------------------------
    Transportation costs                                   4,434       4,012
      - $/boe                                               1.38        1.77
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    Increases in transportation costs in 2007 are related to the increase in
sales volumes compared to 2006. Transportation costs have remained relatively
level throughout the year and are expected to remain fairly static in the
$1.30 /boe to $1.50/boe range throughout 2008. The decrease in the per boe
cost in 2007 is also the result of recording transportation expenses
associated with prior period product sales being recorded in 2006.

    ROYALTIES

                                                      Year ended December 31
    -------------------------------------------------------------------------
    ($000s, except as indicated)                            2007        2006
    -------------------------------------------------------------------------
    Royalties                                             40,906      29,029
      - $/boe                                              12.71       12.78
      - rate %                                              22.7        22.7
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    

    Our royalty burdens are predominantly Crown, along with some overriding,
freehold and net profits interest royalties ("other royalties"). For the year
ended 2007, average royalty rates remained flat at 22.7 percent (Crown
royalties of 18.8 percent and other royalties of 3.9 percent) compared to
22.7 percent (Crown royalties of 20.6 percent and other royalties of
2.1 percent) for the year ended 2006. ARTC of $0.5 million has been recognized
in 2006 and no ARTC was recognized in 2007 as the ARTC incentive program was
suspended. The percentage of crown royalties in 2007 decreased slightly
compared to 2006 and other royalties increased slightly in 2007 compared to
2006 as result of the higher mix of freehold properties and lower crown
royalty rates associated with the Chamaelo properties which are incorporated
into the entire 2007 year's results. Kereco's overall corporate royalty rate
is expected to be in the 22 to 24 percent range for 2008.

    CASH COSTS

    Cash costs (operating, general and administrative and interest) increased
to $16.97/boe in 2007 from $12.60/boe in 2006 due to higher interest expense
and higher operating costs. Cash costs are expected to be in the $14.50/boe to
$15.50/boe range for 2008.
    There was an increase in costs on a per boe basis in all three categories
driven largely by the effects of lower than expected production volumes and
higher than expected costs resulting from the Chamaelo properties acquired and
higher interest costs with the incremental debt assumed.

    
    Operating Costs

                                                      Year ended December 31
    -------------------------------------------------------------------------
    ($000s, except as indicated)                            2007        2006
    -------------------------------------------------------------------------
    Operating costs                                       36,107      21,193
      - $/boe                                              11.22        9.33
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    

    Operating costs increased on a per boe basis in 2007 compared to 2006 as
increases in costs outpaced production increases. Year to date 2007 costs were
$11.22/boe ($1.86/mcf for natural gas and $11.26/bbl for crude oil and NGLs)
compared to 2006 costs of $9.33/boe ($1.55/mcf for natural gas and $9.35/bbl
for crude oil and NGLs). Operating costs are largely influenced by power costs
for our Sturgeon Lake facility, repair and maintenance at Sturgeon Lake and
the ability to attract third party volumes for processing through our Sturgeon
Lake Plant. The increase in costs over these respective periods is largely
attributable to the lower production volumes than expected for the year to
date, the realization of higher than expected costs on the Chamaelo assets and
higher maintenance costs associated with our Sturgeon Lake property. We also
continue to have approximately 70 percent of the electrical power load
required for Sturgeon Lake fixed at a rate of $65.50 per KWh for most of 2008.
Operating costs are expected to be in the $11.00/boe to $12.00/boe range for
2008.

    
    General and Administrative Expenses

                                                      Year ended December 31
    -------------------------------------------------------------------------
    ($000s, except as indicated)                            2007        2006
    -------------------------------------------------------------------------
    Gross                                                 10,229       4,664
    Capitalized overhead                                  (1,769)       (611)
    Recoveries                                            (2,021)     (1,973)
    -------------------------------------------------------------------------
    Net                                                    6,439       2,080
    -------------------------------------------------------------------------
      - $/boe                                               2.00        0.92
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    

    General and administrative costs increased 209 percent on a boe basis to
$2.00/boe for the year ended 2007 from $0.92/boe for the year ended 2006. The
majority of the increase is related to $1.8 million in staff severance costs
related to the company's corporate repositioning process as well as an
increase in total costs as a result of increased staff levels and support
costs in 2007 as additions and expenditures were made to transition the
company from a junior to intermediate producer subsequent to the acquisition
of Chamaelo. Increases on a boe basis were influenced by both the higher
overall expenses realized in the year in addition to the relative lower
production base realized in the year offset slightly by the higher overhead
recoveries related to increased drilling activity. Total general and
administrative expenses are expected to increase in 2008 averaging $3.00/boe
for the year. After the reductions in staff which occurred with the corporate
repositioning, we believe that we are currently adequately staffed to execute
our currently planned 2008 activities.

    
    Interest Expense

                                                      Year ended December 31
    -------------------------------------------------------------------------
    ($000s, except as indicated)                            2007        2006
    -------------------------------------------------------------------------
    Bank debt and other interest expense                  10,375       5,329
    Convertible debenture - amortization non cash          1,644           -
    Convertible debenture - 4.75% cash interest            1,709           -
    -------------------------------------------------------------------------
    Interest expense                                      13,728       5,329
      - $/boe                                               4.26        2.35
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    

    Interest expense increased to $13.7 million in 2007 compared to
$5.3 million in 2006. This increase was a result of the increase in the
company's size and asset base as a result of the Chamaelo acquisition and
increased capital activity over the past year, and the corresponding increase
in the size of, and utilization of, our credit facilities. In addition, the
issuance of $70 million of 4.75% coupon rate convertible debentures in June of
2007 resulted in additional interest expense. The average draw on our bank
line during 2007 was $165.2 million (at an average interest rate of 6.01
percent) compared to a draw on the bank line in 2006 of $97.3 million (at an
average interest rate of 5.48 percent). This increase in bank debt interest
expense is a result of the significant increase in the company's size and
asset base as a result of the acquisitions and increased activity over the two
respective periods. The average interest rate increased as a result of
increases in prime lending rates, which directly impact our floating rate
obligations, over the two respective periods. Interest expense is expected to
decrease significantly in 2008 to a negligible level in 2008 as a result of
the repayment of our bank line in full subsequent to year end with the closing
of the last disposition related to the corporate repositioning process. The
capital expenditure program planned for 2008 is expected to be fully funded
from funds flow from operations.
    The issuance of convertible debentures on June 25, 2007 resulted in the
recognition of cash interest expense of $1.7 million and non cash interest
accretion expense of $1.6 million for the year to date. The cash interest
expense is calculated at a rate of 4.75 percent on $70 million over a five
year and six day term beginning on June 25, 2007 and ending on June 30, 2012.
See note 8, "Convertible Debentures" to the consolidated financial statements
for more details.

    NET EARNINGS (LOSS)

    The net loss for 2007 was $126.4 million ($2.20 per diluted share)
compared to net earnings of $20.0 million ($0.50 per share on a diluted basis)
in 2006. The loss in 2007 was predominantly attributable to the goodwill
impairment recognized in the year.

    Goodwill Impairment

    In the third quarter of 2007, the Company assessed its balance of
goodwill and determined that based on the then prevailing market conditions
there was a full impairment of previously recorded goodwill of $119.3 million
and therefore it was written down with a corresponding non-cash charge to the
income statement in 2007. Market conditions resulted in a significantly
reduced market valuation of Kereco at the end of the third quarter of 2007
compared to the prevailing valuations when Kereco acquired Chariot and
Chamaelo and upon which the resultant goodwill was recognized. This decrease
in the market valuation of Kereco resulted in the writedown of the goodwill.
Subsequent to the third quarter 2007 writedown, an additional $0.7 million of
goodwill was recognized and immediately written off related to the
finalization of the Chamaelo purchase equation.
    These amounts eliminated the entire balance of goodwill from the balance
sheet and therefore, there will be no further charges to income with respect
to the impairment of goodwill.

    
    Depletion, Depreciation and Accretion ("DD&A")

                                                      Year ended December 31
    -------------------------------------------------------------------------
    ($000s, except as indicated)                            2007        2006
    -------------------------------------------------------------------------
    Depletion and depreciation                            84,057      42,294
    Accretion                                              1,253         661
    -------------------------------------------------------------------------
    Total DD&A                                            85,310      42,955
    -------------------------------------------------------------------------
      - $/boe                                              26.50       18.91
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    

    Depletion, depreciation and accretion ("DD&A") amounted to $85.3 million,
or $26.50/boe in 2007 compared to $42.9 million or $18.91/boe for 2006. The
DD&A rate throughout 2007 was largely influenced by the carrying value of the
property, plant and equipment acquired with Chamaelo on October 19, 2006, the
fair value of property, plant and equipment acquired with Chariot on April 19,
2005 and the capital expenditures added to the depletable asset pool since
inception, relative to the proven reserves added. The DD&A rate increased in
2007 due to the capital expenditures added to the depletable pool throughout
the year. These cumulative additions to the depletable pools relative to year
end reserves result in the increased DD&A rate per boe. The property
dispositions in the fourth quarter resulted in a relatively proportionate
adjustment to the depletable carrying value base and the related reserves
resulting in no gain or loss recognized related to the property dispositions.
The DD&A rate for 2008 will be approximately $32.00 per boe, post January 14,
2008 property disposition and prior to incorporating any 2008 activities.

    
    Stock-Based Compensation Expense

                                                      Year ended December 31
    -------------------------------------------------------------------------
    ($000s, except as indicated)                            2007        2006
    -------------------------------------------------------------------------
    Stock based compensation expense                       3,880       4,011
    -------------------------------------------------------------------------
      - $/boe                                               1.21        1.77
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    

    Stock-based compensation expense decreased 3 percent to $3.9 million in
2007 from $4.0 million in 2006. This decrease reflects mainly the effect of
compensation expense having been mostly recognized on one tranche of Kereco
share purchase warrants by the end of 2006. In the first quarter of 2007,
2.4 million options of non-insiders of the company were cancelled and
1.5 million new options were granted and an additional 2.2 million options
were granted in June of 2007. Stock-based compensation expense continues to be
recognized on the cancelled options over their original life as well as
additional expense for the incremental fair value of the replacement options
granted. See note 11 to the consolidated financial statements for more
details. Stock-based Compensation Expense will change in 2008 as Management
and the Board of Director's intend on amending the structure of Kereco's long
term incentive plans.
    
    Unrealized (Gains) Losses on Financial Derivatives

                                                      Year ended December 31
    -------------------------------------------------------------------------
    ($000s)                                                 2007        2006
    -------------------------------------------------------------------------
    Unrealized (gain) loss                                14,547      (5,198)
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    

    Unrealized losses on financial derivative contracts at year end 2007
amounted to $14.5 million compared to an unrealized gain of $5.2 million at
year end 2006. All of our derivative contracts are based upon the commodity
benchmarks of (WTI) for oil and (AECO) natural gas and the Alberta power
market for electricity. These losses realized for the year to date are a
result of the significant rise in crude oil commodity prices at the end of
2007. These financial instruments include our financial and physical commodity
contracts as well as our fixed price electrical power purchase contract. All
of our physical and financial commodity contracts and our electrical power
purchase contract are included as financial instruments in accordance with the
new accounting standards for Financial Instruments. See note 3, "Changes in
Accounting Policies" to the consolidated financial statements for more
details. Accounting standards require that the change in the fair value ("mark
to market") of these positions at each quarter end be included in earnings for
the period. See note 13 in the notes to the consolidated financial statements
for additional details.

    
    Taxes

                                                      Year ended December 31
    -------------------------------------------------------------------------
    ($000s, except as indicated)                            2007        2006
    -------------------------------------------------------------------------
    Future income tax expense (recovery)                  (9,893)     10,336
    Current income tax expense (recovery)                    349        (224)
    -------------------------------------------------------------------------
    Total taxes                                           (9,544)     10,112
    -------------------------------------------------------------------------
    Effective tax rate (%)                                     7          34
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    

    Total tax recovery for 2007 was $ 9.5 million, $9.8 million of future
income recoveries and $0.3 million of current income taxes (December 31, 2006:
$10.1 million, $10.3 million of future income taxes and a recovery of
$0.2 million of current income taxes). This results in an effective tax rate
of seven percent for the year compared to a rate of 34 percent for 2006. This
decrease in the effective tax rate is mainly a result of the goodwill
impairment writedown realized in 2007. Substantively enacted federal income
tax rate reductions were also recognized in the fourth quarter of 2007.
    Current taxes of $0.4 million were recognized in the year. This resulted
from the disallowance by the Canada Revenue Agency (CRA) of the majority of a
Scientific Research and Experimental Development claim "SR&ED" made by Chariot
Energy Ltd. in 2004 prior to Kereco's acquisition of Chariot in April 2005 and
from an Alberta Revenue audit of prior year's provincial tax returns of a
predecessor corporation which was acquired by Chamaelo. These will not result
in any further current tax expense to Kereco. The current tax recovery of
$0.2 million in 2006 resulted from a large corporations tax recovery
associated with the filing of the 2005 tax return.

    Income Tax Pools

    At the end of 2007, we had $ 488.2 million of tax pools and losses
available for deduction against future taxable income. The CEE pools remaining
of $29.8 million are comprised of $45.5 million in expenditures, net of
$15.7 million in flow-through eligible expenditures incurred to December 31,
2007. Of the $19.4 million flow-through share offering on February 16, 2007,
approximately $15.7 million has been spent to date. The remaining $4.4 million
will be spent throughout 2008 under the Canada Revenue Agency's defined
"lookback" rules. The tax pools available at year end are as follows:

    
    As at December 31 ($000s)                                           2007
    -------------------------------------------------------------------------
    Canadian oil and gas property expense ("COGPE")                    219.4
    Canadian development expense ("CDE")                               105.2
    Canadian exploration expense ("CEE")                                29.8
    Undepreciated capital costs ("UCC")                                101.9
    Non-capital losses carried forward                                  31.9
    -------------------------------------------------------------------------
    Total pools and losses                                             488.2
    Share issue costs                                                   12.2
    -------------------------------------------------------------------------
    Total pools, losses and share issue costs                          500.4
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    

    As a result of the filing of the change of control tax return for
Chamaelo during the month of April 2007 and the 2006 year end tax returns in
June, there were some movements between our various tax pools. The numbers in
the table above reflect the net effect of those movements. The Company does
not expect any current income taxes payable in 2008. Subsequent to year end
the company closed the last disposition related to its corporate repositioning
process. This resulted in reductions to our tax pools as follows: COGPE
(132.8 million), UCC (25.5 million) and CEE (8.5 million).

    
    LIQUIDITY AND CAPITAL RE

SOURCES Capital Resources Year ended December 31 ------------------------------------------------------------------------- 2007 2006 ------------------------------------------------------------------------- Funds flow from operations 89,178 72,226 Change in non-cash working capital 13,792 (10,768) Increase (decrease) in bank debt (108,480) 19,209 Chamaelo acquisition transaction costs - (2,780) Issuance of convertible debentures - net 67,475 - Proceeds from the exercise of options or warrants 820 443 Deferred financing charge (2,130) - Proceeds from share issuances 18,304 20,626 ------------------------------------------------------------------------- Total capital resources 78,959 98,956 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Bank Debt At December 31, 2007 we had in place a syndicated committed credit facility, in the amount of $177 million, with two major Canadian Chartered Banks and the Canadian branch of a major international bank. Interest on this facility is charged at monthly rates and borrowings can be made in Canadian or U.S. dollars. Borrowings can also be made by way of prime rate advances or Banker's Acceptances which attract interest at increments to prime based on our debt/cash flow ratio, calculated utilizing the two most recent fiscal quarters. We have provided a $500 million demand fixed and floating charge debenture as collateral for the facility. As at December 31, 2007, $80.2 million (December 31, 2006 - $188.7 million) had been drawn under the bank facility. The average interest rate on borrowings outstanding for the year was 6.1 percent, totaling $12.1 million in cash interest expense (December 31, 2006 - 5.48 percent and $5.3 million in interest expense). In January 2008 the entire amount of the outstanding bank debt balance was repaid in full (resulting from the disposition referenced below) which resulted in the classification of the outstanding amount on the balance sheet as a current liability at year end 2007. At December 31, 2006, $27 million of the balance under the credit facility was potentially repayable within 12 months and was therefore presented as current on the balance sheet and $162 million was presented as long term. Subsequent to December 31, 2007, the credit facility was reduced from $177 million to $100 million. This reduction was the result of the corporate repositioning related property disposition subsequent to year end on January 14, 2008 (See Note 15). The annual review of our credit facility is currently being conducted by the syndicate of lenders and is expected to be complete by the first week of April 2008. We do not anticipate any changes to the facility as a result of this review. Working Capital We ended the year with a working capital deficiency of $22.0 million which is comprised of accounts payable and accrued liabilities of $48.2 million, the advance payment for the property disposition of $17.0 million and accounts receivable and prepaid expenses of $43.3 million. Accounts receivable mainly consist of monthly revenue which is predominantly collected on the 25th day of the month following the month of production as well as joint venture receivables from partners with whom we conduct joint operations. Accounts payable and accrued liabilities consist of payments owing for capital, operating and general and administrative activities. Capital intensive periods will tend to create situations of a working capital deficiency. We constantly monitors its working capital position in conjunction with its undrawn bank credit lines. We anticipate that the expected funds flow for the year will be more than adequate to fund the upcoming year's expected capital program and operating commitments without requiring utilization of the undrawn credit facility. We will continue to monitor all aspects and make changes to our plans if required. Convertible Debentures On June 25, 2007, we issued $70 million of convertible unsecured subordinated debentures which mature on June 30, 2012 and bear interest at 4.75% (the "Debentures"). Interest on the Debentures is payable semi-annually in arrears on June 30 and December 31 each year, that commenced on December 31, 2007. Each debenture can be converted into common shares of the Corporation at the option of the holder at any time prior to the close of business on June 29, 2012 at a conversion price of $10.00 per common share. The Debentures are not redeemable by us prior to June 30, 2010. On or after June 30, 2010 and prior to June 30, 2012, the Debentures may be redeemed at an option, in whole or in part at a redemption price equal to 100% of the principal amount of the Debentures to be redeemed plus accrued and unpaid interest to, but excluding, the redemption date provided that the Current Market Price (as defined in the Short Form Prospectus filed in conjunction with the offering) is at least 125% of the Conversion Price. The board of directors has received an independent valuation of the Debentures from Clark Valuation Services Ltd. ("Clark") as required by MI 61-101. In the opinion of Clark, the fair market value of the Debentures at February 29, 2008 was within a range of $887 to $958 per $1,000 of Debentures. The board of directors has resolved to make a formal offer to acquire all of the outstanding Debentures at a price of $950 per $1,000 Debenture. Kereco anticipates that the offer will be mailed to Debenture holders in mid April and will close prior to the June 30, 2008 interest payment being due. The offer will be subject to a minimum tender of 90% of the outstanding Debentures and other customary conditions. Share Capital Year ended December 31 ------------------------------------------------------------------------- 2007 2006 ------------------------------------------------------------------------- Weighted average shares outstanding Basic 57,469,293 38,610,662 Options and warrants(1) - 1,373,198 ------------------------------------------------------------------------- Diluted 57,469,293 39,983,860 ------------------------------------------------------------------------- Common shares outstanding ------------------------------------------------------------------------- Basic 57,839,731 55,336,432 Options and warrants 7,766,452 7,471,492 ------------------------------------------------------------------------- Diluted 65,606,183 62,807,924 ------------------------------------------------------------------------- ------------------------------------------------------------------------- (1) Anti-dilutive incremental options and warrants in the amount of 808,142 for the year to date are excluded from the weighted average diluted shares outstanding. As at March 13, 2008, we had 58,672,235 shares outstanding, reflecting the issuance of 928,804 warrants and 96,300 common shares repurchased under the normal course issuer bid since December 31, 2007. For the year to date 2,503,299 common shares were issued pursuant to the exercise of 253,299 warrants and the issuance of 2,250,000 flow through common shares during 2007. CAPITAL EXPENDITURES Capital expenditures in 2007, including net property dispositions of $40.9 million, were $77.6 million. Year ended December 31 ------------------------------------------------------------------------- ($000s) 2007 2006 ------------------------------------------------------------------------- Land 4,006 2,621 Geological and geophysical 3,724 9,595 Drilling and completions 66,007 61,743 Facilities and equipment 40,495 26,735 Office and corporate costs 2,538 764 Capitalized general and administrative costs 1,770 637 ------------------------------------------------------------------------- Total exploration and development 118,540 102,095 ------------------------------------------------------------------------- Chamaelo acquisition - 302,397 Property acquisitions 36,604 7,475 Property dispositions (77,539) (10,614) ------------------------------------------------------------------------- Total capital expenditures 77,605 401,353 ------------------------------------------------------------------------- ------------------------------------------------------------------------- We drilled 39 (32.7 net) wells in 2008 which resulted in 12 cased gas wells (9.1 net) and 22 oil wells (20 net) comprised of two (two net) oil wells and four (3.2 net) gas wells in Northeast British Columbia, 12 (10 net) oil wells and eight (5.9 net) gas wells in Central Alberta and eight (8 net) oil wells in the Sturgeon Lake area. We also completed eight major recompletions and workovers at Sturgeon Lake in 2008. This amounted to $66.0 million in drilling and completion expenditures for the year to date. Related equipping costs and facility costs amounted to $40.5 million, including $3.7 million related to the Sturgeon plant turnaround and $3.3 million to upgrade to our Willesden Green gas compression facility. $4.0 million was also spent on land. $3.7 million was spent on seismic for the year, mainly in the north eastern British Columbia exploration area. We acquired a producing property in the Ferrier Alberta area for $36.6 million in the second quarter of 2007 which added approximately 700 boe/day of production. Two non-strategic properties were also sold during the second quarter of 2007, resulting in $6.2 million in proceeds. Related to the corporate repositioning, three property dispositions were closed later in the fourth quarter of 2007 for proceeds of $71.3 million. Subsequent to year end a final property disposition related to our corporate restructuring process was disposed of for net proceeds of $166.8 million. CONTRACTUAL OBLIGATIONS On February 16, 2007, we issued 2,250,000 flow-through common shares for proceeds of $19.4 million before issue costs of $1.0 million which will require us to incur $19.4 million of flow-through share eligible CEE, as defined in the Canadian Income Tax Act, by December 31, 2008. As of December 31, 2007 approximately $15.7 million in qualifying CEE expenditures related to this flow-through share commitment have been incurred. We have also executed separate contracts with two large drilling contractors for the exclusive use of two specific drilling rigs. One contract is a three year contract which commenced in December of 2006 and requires us to utilize the rig for a minimum of 225 days per year. If not utilized we are is obligated to pay a minimum $5,800 rate per day . A second drilling contract (which was for two years, commenced June 1, 2007 and required Kereco to utilize the rig for a minimum of 225 days per year for two years with a minimum rate per day of $4,785) was terminated on March 11, 2008 and replaced with a new service rig contract. The new contract will commence on June 1, 2008 and requires us to utilize the rig for a total of 7,200 hours at a rate of $645 per hour. There is no timeframe by which this rig capacity needs to be utilized by. If we are unable to utilize the rig, a liability of $200 of per unutilizable hour will result. Therefore the minimum payments under the service rig contract will be $1,440,000. During 2007, the Company signed a nine year office lease which commences on February 15, 2008. Average annual payments under the lease will be $1.5 million. Kereco has also fixed the price on approximately seventy percent of its electricity requirements for a period which commenced on February 1, 2006 and which ends on December 31, 2008. Following are the future minimum payments required under these drilling, office and electrical contracts; net of any prepayments: Drilling Office Electricity ($000s) contracts lease contract ------------------------------------------------------------------------- 2008 $ 1,305 $ 1,314 $ 2,008 2009 $ 1,196 $ 1,434 $ - 2010-2016 $ - $ 9,962 $ - Indeterminate $ 1,440 $ - $ - ------------------------------------------------------------------------- Total $ 3,941 $ 12,710 $ 2,008 ------------------------------------------------------------------------- The Company has other commitments and guarantees in the normal course of business which are not material, and are therefore not disclosed here. RISK MANAGEMENT We have entered into financial and physical derivative contracts as outlined in notes 13 and 15 to the unaudited interim consolidated financial statements. These positions were undertaken in order to secure pricing on a portion of our future production and to protect against reductions in future commodity prices. We have not designated any of these financial derivative contracts as hedges and they have therefore been recorded on the balance sheet as assets or liabilities with changes in their fair value recorded in net earnings for the applicable periods. As an alternative presentation, were Kereco to have locked in the volumes currently hedged at the December 31, 2007 strip pricing for both crude oil and natural gas, over the term of those hedges, Kereco would actually realize a net $7.1 million cash loss over the term of the contracts in place. The financial and physical derivative contracts entered up to and including March 13, 2008 and as listed in notes 13 and 15 to the Consolidated Financial Statements result in the following downside price protection and ceiling prices on future production: 2008 2009 ------------------------------------------------------- Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 ------------------------------------------------------------------------- Natural Gas Volume (GJ/day) - 2,000 2,000 674 - - - - Floor price (AECO CDN $/GJ) - 7.63 7.63 7.63 - - - - Ceiling price (AECO CDN $/GJ) - 8.23 8.23 8.23 - - - - ------------------------------------------------------------------------- Crude Oil Volume (bbls/day) 1,500 1,500 1,500 1,500 500 500 500 500 Floor price (WTI US$/bbl) 61.50 61.50 61.50 61.50 77.50 77.50 77.50 77.50 Ceiling Price (WTI US$/bbl) 78.88 78.88 78.88 78.88 103.95 103.95 103.95 103.95 ------------------------------------------------------------------------- ------------------------------------------------------------------------- DISCLOSURE CONTROLS AND PROCEDURES AND INTERNAL CONTROLS OVER FINANCIAL REPORTING In accordance with the requirements of Multilateral Instrument 52-109 of the Canadian Securities Administrators, the President and Chief Executive Officer and Vice President Finance and Chief Financial Officer performed an evaluation of Kereco's disclosure controls and procedures and have concluded that such controls and procedures are effective at December 31, 2007. Management with the participation of the Company's President and Chief Executive Officer and Vice-President Finance and Chief Financial Officer, has evaluated the design of the Company's internal controls over financial reporting. Based on that evaluation, the Company's President and Chief Executive Officer and Vice-President Finance and Chief Financial Officer have concluded that as of December 31, 2007, the Company's internal controls over financial reporting are designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial reporting for the year ended December 31, 2007 that have materially affected, or are reasonably likely to affect, the Company's internal control over financial reporting. 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. CRITICAL ESTIMATES Management is required to make judgments and use estimates in the application of generally accepted accounting principles that have a significant impact on the financial results of Kereco. The following discussion outlines the accounting policies and practices that will be critical to determining Kereco's financial results. Full Cost Accounting Kereco follows the Canadian Institute of Chartered Accountants' guideline on full cost accounting in the oil and gas industry to account for oil and gas properties. Under this method, all costs associated with the acquisition of, exploration for and development of natural gas and crude oil reserves are capitalized and costs associated with production are expensed. The capitalized costs are depreciated, depleted and amortized using the unit-of-production method based on estimated proved reserves. Reserve estimates can have a significant impact on earnings, as they are a key component in the calculation of depreciation, depletion and accretion ("DD&A"). A downward revision in a reserve estimate could result in a higher DD&A charge to earnings. In addition, if net capitalized costs are determined to be in excess of the calculated ceiling, which is based largely on reserve estimates, the excess must be written off as an expense and charged against earnings. In the event of a property disposition, proceeds are normally deducted from the full cost pool without recognition of a gain or loss unless there is a change in the DD&A rate of 20 percent or greater. Asset Retirement Obligations Kereco records a liability for the fair value of legal obligation associated with the retirement of long-lived tangible assets in the period in which they are incurred, normally when the asset is purchased or developed. On recognition of the liability there is a corresponding increase in the carrying amount of the related asset and the asset retirement obligation. The total amount of the asset retirement obligation is an estimate based on the Company's net ownership interest in all wells and facilities, the estimated costs to abandon and reclaim the wells and facilities and the estimated timing of the costs to be incurred in future periods. The total amount of the estimated cash flows required to settle the asset retirement obligation, the timing of those cash flows and the discount rate used to calculate the present value of those cash flows are estimates subject to measurement uncertainty. Any change in these estimates would impact the asset retirement liability. Reserves Determination The proved crude oil, natural gas and natural gas liquid reserves used in determining our depletion rates, the magnitude of the borrowing base available to us from our lender and the ceiling test are based upon management's best estimates, and are subject to uncertainty. Through the use of geological, geophysical and engineering data, the reservoirs and deposits of natural gas, crude oil and natural gas liquids are examined to determine quantities available for future production, given existing operating and economic conditions and technology. The evaluation of recoverable reserves is an ongoing process impacted by current production, continuing development activities and changing economic conditions as reflected in crude oil and natural gas prices and costs. Consequently, the reserves are estimates which are subject to variability. To assist with the reserve evaluation process, we employ the services of independent oil and gas reservoir engineers. Income Taxes The determination of Kereco's income and other tax liabilities requires interpretation of complex laws and regulations often involving multiple jurisdictions. All tax filings are subject to audit and potential reassessment after lapse of considerable time. Accordingly, the actual income tax liability may differ significantly from the liability estimated or recorded. Other Estimates The accrual method of accounting requires management to incorporate certain estimates including estimates of revenues, royalties and production costs as at a specific reporting date but for which actual revenues and costs have not yet been received; and estimates on capital projects which are in progress or recently completed where actual costs have not been received at a specific reporting date. Ceiling Test Under the full cost accounting method, a ceiling test is performed at least annually to ensure that the net capitalized costs in each country do not exceed the undiscounted future net revenues from proved plus probable reserves, plus the cost of unproved properties. Any excess capitalized costs will be written off as an expense and charged to earnings; however, future depletion and depreciation expense would be reduced. Goodwill Goodwill is recorded when the purchase price of an acquired business exceeds the fair value of the net identifiable assets and liabilities of the acquired business. The goodwill balance is assessed for impairment by comparing the book value to the fair value of the reporting entity. If the fair value of the entity is less than the book value, impairment is deemed to have occurred. The extent of the impairment is measured by allocating the fair value of the entity to the identifiable assets and liabilities based on their fair values. Any remainder of this allocation is the implied value of goodwill, and if this excess is less than the actual goodwill recorded, impairment exists and that difference is written off as an expense and charged to earnings. RISK AND UNCERTAINTY Kereco is involved in the exploration, development, production and acquisition of petroleum and natural gas in the Western Canada Sedimentary Basin. These activities involve a number of risks and uncertainties inherent in the industry. Inherent in exploration and development are the risks, among others, of drilling dry holes, encountering production or drilling difficulties or experiencing high decline rates in producing wells. To minimize these risks, we use experienced staff to evaluate and operate wells and utilize appropriate technology in our operations. In addition, we use prudent safety programs and risk management, including insurance coverage against potential losses. We are exposed to commodity price and market risk for our principal products of petroleum and natural gas. Commodity prices are influenced by a wide variety of factors most of which are beyond our control. At times when we believe we are at risk for a significant reduction in the market price of the commodities we produce, or require a certain commodity price to fund our capital expenditure program, we may enter into contracts that provide downside price protection. We are subject to credit risk associated with the purchase of the commodities produced. In order to mitigate the risk of non-payment, we will minimize the total sales value with each particular purchaser. Kereco's expected cash flow and funds flow from operations depends largely on the volume of our petroleum and natural gas production and the price received for such production, along with the associated production costs. The price we receive for oil depends on a number of factors, including WTI oil prices, Canadian/US currency exchange rates, quality differentials and Edmonton par oil prices. The price we receive for natural gas production will primarily be dependent on current Alberta market prices. Our access to markets may be restricted at times by pipeline or processing capacity. We minimize these risks by controlling as much of our processing and transportation activities as possible. The petroleum and natural gas industry is subject to extensive controls, regulatory policies and income and resource taxes imposed by various levels of government. These regulations, controls and taxation policies are amended from time to time. Kereco has no control over the level of government intervention or taxation in the petroleum and natural gas industry. However, we will operate in such a manner to ensure that we are in compliance with all applicable regulations and are able to respond to changes as they occur. The petroleum and natural gas industry is subject to both environmental regulations and an increased environmental awareness. We have reviewed our environmental risks and are in compliance with the appropriate environmental legislation and have determined that there is no current material impact on our operations. Kereco is subject to financial market risk. In order to achieve substantial rates of growth, we need to keep reinvesting in drilling for or acquiring petroleum and natural gas properties. One source of funding for our expenditure program is through the issuance of equity. If we are not able to access the equity markets due to unfavorable market conditions for an extended period of time, this may adversely impact our growth rate. In addition, Kereco utilizes bank financing and cash flow from operations to fulfill capital requirements. Kereco minimizes the financial market risk by maintaining a conservative financing structure. We are exposed to interest rate risk due to the floating nature of interest rates on our bank loan. Kereco has retained an independent engineering consulting firm that assists Kereco in evaluating recoverable amounts of oil and gas reserves. Values of recoverable reserves are based on a number of variable factors and assumptions such as commodity prices, projected production, future production costs and government regulation. Such estimates may vary from actual results. Oil and gas exploration and production can involve environmental risks such as pollution of the environment and destruction of natural habitat, as well as safety risks such as personal injury. We conduct our operations with high standards in order to protect the environment and the general public; we maintain insurance coverage for comprehensive and general liability as well as limited pollution liability. The amount and terms of this insurance are reviewed on an on going basis and adjusted as necessary to reflect current corporate requirements, as well as industry standards and government regulations. 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. Compliance with such legislation can require significant expenditures and a breach may result in the imposition of fines and penalties, some of which may be material. Environmental legislation is evolving in a manner expected to result in stricter standards and enforcement, larger fines and liability and potentially increased capital expenditures and operating costs. 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. Implementation of strategies for reducing greenhouse gases whether to meet the limits required by the Protocol or as otherwise determined could have a material impact on the nature of oil and natural gas operations, including those of the Company. On March 8, 2007, the Alberta Government introduced Bill 3, the Climate Change and Emissions Management Amendment Act, which intends to reduce greenhouse gas emission intensity from large industries. Bill 3 states that facilities emitting more than 100,000 tones of greenhouse gases a year must reduce their emissions intensity by 12% starting July 1, 2007; if such reduction is not initially possible the companies owning the large emitting facilities will be required to pay $15 per tonne for every tonne above the 12% target. These payments will be deposited into an Alberta-based technology fund that will be used to develop infrastructure to reduce emissions or to support research into innovative climate change solutions. As an alternate option, large emitters can invest in projects outside of their operations that reduce or offset emissions on their behalf, provided that these projects are based in Alberta. Prior to investing, the offset reductions, offered by a prospective operation, must be verified by a third party to ensure that the emission reductions are real. The Federal Government released on April 26, 2007, its Action Plan to Reduce Greenhouse Gases and Air Pollution (the "Action Plan"), also known as ecoACTION and which includes the Regulatory Framework for Air Emissions. This Action Plan covers not only large industry, but regulates the fuel efficiency of vehicles and the strengthening of energy standards for a number of energy-using products. Regarding large industry and industry related projects the Government's Action Plan intends to achieve the following: (i) an absolute reduction of 150 megatonnes in greenhouse gas emissions by 2020 by imposing mandatory targets; and (ii) air pollution from industry is to be cut in half by 2015 by setting certain targets. New facilities using cleaner fuels and technologies will have a grace period of three years. In order to facilitate the companies' compliance of the Action Plan's requirements, while at the same time allowing them to be cost-effective, innovative and adopt cleaner technologies, certain options are provided. These are: (i) in-house reductions; (ii) contributions to technology funds; (iii) trading of emissions with below-target emission companies; (iv) offsets; and (v) access to Kyoto's Clean Development Mechanism. On March 10, 2008, the Government of Canada released "Turning the Corner - Taking Action to Fight Climate Change" (the "Updated Action Plan") which provides some additional guidance with respect to the Government of Canada's plan to reduce greenhouse gas emissions by 20% by 2020 and by 60% to 70% by 2050. The Updated Action Plan is primarily directed towards industrial emissions from certain specified industries including the oil sands, oil and gas and refining industries. The Updated Action Plan is intended to force industry to reduce greenhouse gas emissions and to create a carbon emissions trading market, including an offset system, to provided incentive to reduce greenhouse gas emission and establish a market price for carbon. The Updated Action Plan provides for: (i) mandatory reductions of 18% from the 2006 baseline starting in 2010 and by an additional 2% in subsequent years for existing facilities; (ii) new facilities built between 2004 and 2011 will have mandatory emissions standards based upon clean fuel standards (natural gas) with a 2% reduction below the third years intensity levels; and (iii) oil sands plants built in 2012 and later which use heavier hydrocarbons and upgraders and in situ production will have mandatory standards in 2018 based carbon capture and storage or other green technologies intensity. For the upstream oil and gas industry the Updated Action Plan also provides for a company threshold of 10,000 boe/day and facility threshold of 3,000 tonnes of CO(2). Given the evolving nature of the debate related to climate change and the control of greenhouse gases and resulting requirements, it is not possible to predict the impact of those requirements on the Company and its operations and financial condition. Review of Alberta Royalty and Tax Regime On September 18, 2007 the Alberta Royalty Review Panel ("ARRP"), a panel commissioned by the Government of Alberta to review the province's royalty regime, issued their recommendations. Those recommendations were the subject of a very lively public debate involving not only our industry, but all Albertans that ensued following its release. The debate was answered with the Government of Alberta releasing their proposed New Royalty Framework ("NRF") on October 25, 2007. The NRF is anticipated to become effective January 1, 2009, and will result in a reduction in Kereco's present value of reserves (post the January 14, 2008 asset disposition), relative to that determined on a pre-NRF basis using GLJ's January 1, 2008 forecasted prices and a 10 percent discount rate, of between 9 and 13 percent. NEW ACCOUNTING STANDARDS IN 2007 AND 2008 Financial Instruments Effective January 1, 2007, the Company adopted the Canadian Institute of Chartered Accountants ("CICA") Handbook section 3855, "Financial Instruments - Recognition and Measurement", section 3865, "Hedges", section 1530, "Comprehensive Income", and section 3861, "Financial Instruments - Disclosure and Presentation" and section 3251 ("Equity"). The Company has adopted these standards retroactively without restatement and comparative consolidated financial statements have not been restated. The adoption of these new financial instruments standards resulted in changes in accounting for financial instruments as well as the recognition of transitional adjustments that have been recorded into adjusted retained earnings as described below. In accordance with these new standards, all Financial Instruments including both financial and non financial derivatives and certain embedded derivatives qualify as assets or liabilities and need to be recorded on the balance sheet. Financial Instruments are categorized into one of five categories which determines their initial measurement value and subsequent recognition of gains and losses. Section 3251 introduces new standards for the presentation of Equity with "Accumulated other income" as a result of the application of section 1530. Kereco has designated its short term and long term debt as well as cash balances as Held for Trading. Held for Trading instruments are measured at fair value at each balance sheet date with gains and losses recognized in net earnings in the current period. The transaction costs or deferred financing costs related to Held for Trading financial assets and liabilities are expensed as incurred. The adoption of this CICA Handbook section and designation of Held for Trading was done retroactively without restatement, and resulted in a reduction to retained earnings of $154,000 a reduction to the future income tax liability of $81,000 and the reduction of the previous deferred financing charges current asset account to nil. All derivatives are classified as Held for Trading and are therefore carried at their fair value in the balance sheet caption "Financial Derivative Contracts". Gains or losses in the fair values between periods are recognized in net earnings through the account "Unrealized Gain or Loss on Financial Derivative Contracts". The adoption of this section resulted in the recognition of two sole derivatives. One is the three year contract to acquire electricity at a fixed rate and the other is the physical commodity collar sole contract for first quarter 2007 production. These resulted in the following retroactive adjustments without restatement: an increase in retained earnings by $707,000 and increase in the future tax liability of $372,000 and an increase in the Financial Derivative Contract asset of $1,079,000. Accounting Changes In July 2006, the CICA issued a revised section 1506, "Accounting Changes". The new recommendations permit voluntary changes in accounting policy only if they result in financial statements which provide more reliable and relevant information. Accounting policy changes are applied retrospectively unless it is impractical to determine the period or cumulative impact of the change. Corrections of prior period errors are applied retrospectively and changes in accounting estimates are applied prospectively by including these changes in earnings. The guidance is effective for all changes in accounting policies, changes in accounting estimates and corrections of prior periods errors initiated in periods that began on or after January 1, 2007. ACCOUNTING PRONOUNCEMENTS Capital Disclosures As of January 1, 2008 the Company will be required to adopt CICA Handbook section 1535, "Capital Disclosures", which requires entities to disclose their objectives, policies and processes for managing capital, and in addition, whether the entity has complied with any externally imposed capital requirements. The Company is assessing the impact of this new standard on its consolidated financial statements and anticipates that the main impact will be in terms of additional disclosures required. Inventories As of January 1, 2008 the Company will be required to adopt CICA Handbook section 3031, "Inventories" This new standard is not expected to have a significant impact on the Company's financial statements other than the additional disclosure required. Goodwill and Intangible Assets and Research and Development Costs In February 2008, the Canadian Institute of Chartered Accountants ("CICA") issued Section 3064, Goodwill and intangible assets, replacing Section 3062, Goodwill and other intangible assets and Section 3450, Research and development costs. Various changes have been made to other sections of the CICA Handbook for consistency purposes. The new Section will be applicable to financial statements relating to fiscal years beginning on or after October 1, 2008. Accordingly, the Company will adopt the new standards for its fiscal year beginning January 1, 2009. It establishes standards for the recognition, measurement, presentation and disclosure of goodwill subsequent to its initial recognition and of intangible assets by profit-oriented enterprises. Standards concerning goodwill are unchanged from the standards included in the previous Section 3062. The Company is currently evaluating the impact of the adoption of this new Section, and does not expect that the adoption of this new Section will have a material impact on its consolidated financial statements. Financial Instruments - Disclosures and Presentation As of January 1, 2008 the company will be required to adopt CICA Handbook section 3862 - "Financial Instruments - Disclosures" which enhances the disclosure around a financial instrument's fair value and the qualitative and quantitative exposure risks around financial instruments. As of January 1, 2008 the company will also be required to adopt CICA Handbook section 3863 - "Financial Instruments - Presentation" which addresses the required disclosures and presentation required for financial instruments. The Company is assessing the impact of this new standard on its consolidated financial statements and anticipates that the main impact will be in terms of additional disclosures required. CORPORATE REPOSITIONING AND OUTLOOK Although we had many operational successes in 2007, the main undertaking for the year was our corporate repositioning which has resulted in Kereco being a significantly different company today than the one I described to you 12 months ago. In July of 2007, we embarked upon a repositioning of Kereco to in order to lay the foundation for the company's future. The objective was to eliminate the indebtedness of the company by generating sufficient cash to capitalize on what we expect to be an opportunity rich 2008 and 2009. That process resulted in the sale of $240 million in assets and concluded with the closing of the last sale on January 14, 2008. The assets that we disposed of were shorter life, more economically challenged natural gas assets as well as assets that we did not see as strategically relevant to move forward with. The last step in the repositioning, as previously communicated, is our anticipated offer to repurchase the currently outstanding Convertible Debentures (the "Debentures"). The board of directors has received an independent valuation of the Debentures from Clark Valuation Services Ltd. ("Clark") as required by MI 61-101. In the opinion of Clark, the fair market value of the Debentures at February 29, 2008 was within a range of $887 to $958 per $1,000 of Debentures. The board of directors has resolved to make a formal offer to acquire all of the outstanding Debentures at a price of $950 per $1,000 Debenture. Kereco anticipates that the offer will be mailed to Debenture holders by mid April and will close prior to the June 30, 2008 interest payment being due. The offer will be subject to a minimum tender of 90% of the outstanding Debentures and other customary conditions. The net result of the reorganization is a go forward company that is positioned primarily in light sweet, long reserve life oil assets at Sturgeon Lake together with a small group of operated assets in the Peace River Arch, both in Alberta. Financially, the balance sheet is exceptionally strong as the company has no debt, a positive cash position and approximately 4,000 boe/day of production (70% light oil and NGL's, 30% natural gas). Funds flow from these assets alone is currently in excess of $4 million per month and is projected to be approximately $52 - $58 million in total for 2008 on the current assets (based on an oil price of WTI US$86/bbl, CDN$7.00/GJ AECO natural gas and a 1:1 Canada/US exchange rate. The "starter kit" has 13.3 mmboe of proved reserves 18.2 mmboe of proved plus probable reserves with a reserve life index of 12.5 years and undeveloped land of 50,000 net acres. As well, the company has an inventory of opportunities on which the company is of the opinion that, together with its retained Sturgeon Lake asset, is expected to achieve 15% annual growth in value over the next one, three and five year time periods. We have altered our strategy from a production growth strategy to a strategy of growth in value of reserves and net present value. Using this strategy, we are confident that we can achieve our targeted 15% annual growth in value over one, three and five year time periods with the assets we currently have under management in addition to assets we anticipate adding to our company. The primary retained asset is located at Sturgeon Lake where we have had considerable success in adding meaningful value after purchasing it in April of 2005. Since that time, Kereco has added 5.6 mmboe of new reserves at a cost of $17.71/boe achieving a superior average recycle ratio of 2.1 times. This efficient addition of high quality light oil reserves has resulted in a realized increase in this property's NPV of approximately $200 million for an annualized return of 32%. Going forward Kereco intends to leverage this success at Sturgeon with a four part value creation strategy targeting approximately 15% annualized return over the next five years. The first component of the business plan is to continue to optimize and efficiently grow the value of Sturgeon Lake oil property. This includes continued low risk infill development drilling of the asset's numerous sizeable oil in place reservoirs, modest small "E" exploration, and product optimization through a number of business initiatives utilizing the extensive owned and controlled infrastructure. We have a minimum of four years worth of development opportunities based on our current technical and business assessments. The second component is the continued maturation of the Sturgeon Lake property's enhanced light oil recovery projects. We have recently commenced the Triassic A pool (Montney) waterflood project and are optimistic regarding implementation of the tertiary flood on the sizeable Leduc oil pool. The past two years have seen significant progress on this project, including continued development on achieving a source of CO(2) that could lead to implementation of the project between 2011 and 2013. In subsequent years, enhanced oil recovery ("EOR") schemes on the smaller, but not insignificant, Sturgeon Lake oil pools will be established utilizing the infrastructure developed for these two initial projects. The third component consists of utilizing the now available capital resources established through the aforementioned asset disposition process to strategically and opportunistically aggregate hydrocarbon in place projects where technology can be utilized to manage up recovery factors. It is our belief that this will primarily consist of property acquisitions, although wide area farm-ins or corporate acquisitions will be considered if the involved asset meets our intended strategy and return thresholds. And finally, in order to optimize the returns generated, Kereco intends to focus on achieving operational excellence and maintaining disciplined capital spending combined with prudent capital structure management and enhancement as it relates to both internally generated activity and the acquisition of new opportunities. As for the capital investment environment, we believe that we are upon an exceptional time period for our company. We have extremely strong commodity prices, somewhat softer costs for services, stressed balance sheets of many operating entities (both on the exploration and production side as well as the service sector of our business) and cautious equity markets - all of which provide Kereco with the opportunity to utilize its cash position and excess funds flow to grow the value of our business. We are excited about the new start to Kereco with a before tax (discounted at 10 percent) net present value of the proved and probable reserves only of $6.38/basic share. For the year 2008, we are targeting growth in the value to our company by 15% through investment in capital and operating initiatives on our assets and the aggregation of additional assets into our portfolio. At this time we anticipate spending between $35 - $40 million on our existing asset base out of our contemplated $52 - $58 million of funds flow from our current production operations and will look to deploy capital towards obtaining additional assets that are able to achieve our return requirements for investment. We would like to thank all of our past and current employees, officers, directors, shareholders and stakeholders for their patience and understanding as we worked through the process of repositioning ourselves for the future, a future in which we believe that we can demonstrate significant growth in value in the years to come. Thank you again for your continued interest in Kereco. On behalf of the Board of Directors, Grant B. Fagerheim President and Chief Executive Officer March 14, 2008 KERECO ENERGY LTD. CONSOLIDATED BALANCE SHEETS As at December 31 ($000s) 2007 2006 ------------------------------------------------------------------------- ASSETS Current Accounts receivable $ 39,173 $ 41,268 Prepaid expenses 4,092 3,459 Future income taxes (Note 9) 2,486 - Financial derivative contracts (Note 13) - 4,990 ------------------------------------------------------------------------- 45,751 49,717 Property, plant and equipment, net (Note 4) 591,918 600,964 Deferred charge (Note 15) 2,130 - Goodwill (Note 6) - 116,730 ------------------------------------------------------------------------- Total assets $ 639,799 $ 767,411 ------------------------------------------------------------------------- ------------------------------------------------------------------------- LIABILITIES Current Accounts payable and accrued liabilities $ 48,227 $ 51,955 Bank debt (Note 7) 80,193 27,000 Advance payment for property disposition (Note 15) 17,000 Financial derivative contracts (Note 13) 8,477 - ------------------------------------------------------------------------- 153,897 78,955 ------------------------------------------------------------------------- Bank debt (Note 7) - 161,673 Asset retirement obligation (Note 10) 13,827 16,038 Convertible debentures (Note 8) 53,600 - Future income taxes (Note 9) 30,824 29,497 ------------------------------------------------------------------------- 98,251 207,208 ------------------------------------------------------------------------- Total liabilities 252,148 286,163 ------------------------------------------------------------------------- Commitments and guarantees (Note 14) Contingencies (Note 17) SHAREHOLDERS' EQUITY Share capital (Note 11) 451,110 438,216 Contributed surplus (Note 11) 10,204 6,539 Convertible debentures (Note 8) 15,704 - Retained earnings (deficit) (89,367) 36,493 ------------------------------------------------------------------------- Total shareholders' equity 387,651 481,248 ------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 639,799 $ 767,411 ------------------------------------------------------------------------- ------------------------------------------------------------------------- The accompanying notes form an integral part of these consolidated financial statements. Approved by the Board of Directors: "Signed" Grant B. Fagerheim "Signed" Gerry A. Romanzin Director Director KERECO ENERGY LTD. CONSOLIDATED STATEMENTS OF EARNINGS (LOSS), COMPREHENSIVE INCOME (LOSS) AND RETAINED EARNINGS (DEFICIT) Three months ended Year ended ($000s, except per December 31 December 31 share amounts) 2007(1) 2006(1) 2007 2006 ------------------------------------------------------------------------- REVENUES Petroleum and natural gas sales $ 48,325 $ 39,753 $ 184,579 $ 131,674 Royalties, net of ARTC 10,338 8,292 40,906 29,029 ------------------------------------------------------------------------- 37,987 31,461 143,673 102,645 ------------------------------------------------------------------------- EXPENSES Operating 9,878 7,184 36,107 21,193 Transportation 1,254 1,221 4,434 4,012 General and administrative 2,972 703 6,439 2,080 Interest and bank charges (Note 7 & 8) 4,000 2,401 13,728 5,329 Loss (gain) on financial derivatives (Note 13) 8,267 (2,634) 9,746 (7,052) Goodwill impairment (Note 6) 708 - 119,986 - Depletion, depreciation and accretion (Note 4 & 10) 21,929 19,096 85,310 42,955 Stock-based compensation (Note 11) 437 1,414 3,880 4,011 ------------------------------------------------------------------------- 49,445 29,385 279,630 72,528 ------------------------------------------------------------------------- EARNINGS (LOSS) BEFORE INCOME TAXES (11,458) 2,076 (135,957) 30,117 ------------------------------------------------------------------------- INCOME TAXES (Note 9) Current income tax expense (recovery) 191 - 349 (224) Future income tax expense (recovery) (7,266) 2,310 (9,893) 10,336 ------------------------------------------------------------------------- (7,075) 2,310 (9,544) 10,112 ------------------------------------------------------------------------- NET EARNINGS (LOSS) (4,383) (234) (126,413) 20,005 OTHER COMPREHENSIVE INCOME - - - - ------------------------------------------------------------------------- COMPREHENSIVE INCOME (LOSS) (4,383) (234) (126,413) 20,005 Retained earnings, beginning of year (84,984) 36,727 36,493 16,488 Transitional adjustment upon adoption of new accounting policy (Note 3) - - 553 - ------------------------------------------------------------------------- Retained earnings (deficit), end of year $ (89,367) $ 36,493 $ (89,367) $ 36,493 ------------------------------------------------------------------------- ------------------------------------------------------------------------- EARNINGS (LOSS) PER SHARE (Note 11) Basic $ (0.08) $ (0.01) $ (2.20) $ 0.52 Diluted $ (0.08) $ (0.01) $ (2.20) $ 0.50 ------------------------------------------------------------------------- ------------------------------------------------------------------------- (1) unaudited The accompanying notes form an integral part of these consolidated financial statements. KERECO ENERGY LTD. CONSOLIDATED STATEMENTS OF CASH FLOWS Three months ended Year ended December 31 December 31 (000s) 2007(1) 2006(1) 2007 2006 ------------------------------------------------------------------------- OPERATING ACTIVITIES Net earnings (loss) $ (4,383) $ (234) $(126,413) $ 20,005 Add items not requiring cash: Depletion, depreciation and accretion 21,929 19,096 85,310 42,955 Goodwill impairment (Note 6) 708 - 119,986 - Future income tax expense (recovery) (7,266) 2,310 (9,893) 10,336 Unrealized loss (gain) on financial derivatives 9,310 (2,014) 14,547 (5,198) Employee common share benefit plan expense (Note 11) 29 20 117 117 Non-cash interest expense on convertible debentures (Note 8) 796 - 1,644 - Stock-based compensation (Note 11) 437 1,414 3,880 4,011 ------------------------------------------------------------------------- 21,560 20,592 89,178 72,226 Change in non- cash working capital (Note 12) 14,907 (11,410) 21,717 (4,249) ------------------------------------------------------------------------- Cash provided by operating activities 36,467 9,182 110,895 67,977 ------------------------------------------------------------------------- FINANCING ACTIVITIES Issuance of common shares and warrants, net of share issue costs 195 (139) 19,124 21,069 Issuance of convertible debentures - net of issue costs (Note 8) 0 - 67,475 - Bank debt (70,520) 6,251 (108,480) 19,209 Change in non- cash working capital (Note 12) 620 (1,232) 1,498 (1,357) ------------------------------------------------------------------------- Cash provided by financing activities (69,705) 4,880 (20,383) 38,921 ------------------------------------------------------------------------- CASH AVAILABLE FOR INVESTING ACTIVITIES (33,238) 14,062 90,512 106,898 ------------------------------------------------------------------------- INVESTING ACTIVITIES Petroleum and natural gas expenditures (29,205) (22,930) (118,540) (102,095) Property acquisitions 0 - (36,604) (7,475) Property dispositions net of transaction costs (Note 4 & 15) 70,457 10,614 76,669 10,614 Business combination (Note 5) - (2,780) (484) (2,780) Deferred charges (Note 15) (2,130) - (2,130) - Change in non- cash working capital (Note 12) (5,884) 1,034 (9,423) (5,162) ------------------------------------------------------------------------- Cash used in investing activities 33,238 (14,062) (90,512) (106,898) ------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS, BEGINNING AND END OF YEAR $ - $ - $ - $ - ------------------------------------------------------------------------- ------------------------------------------------------------------------- (1) unaudited The accompanying notes form an integral part of these consolidated financial statements. Notes to the Consolidated Financial Statements Years ended December 31, 2007 and 2006 (Unless otherwise stated, tabular amounts presented in these notes are in thousands of Canadian dollars.) 1. BASIS OF PRESENTATION Kereco Energy Ltd. (the "Company" or "Kereco") has been active in oil and gas exploration and production as of January 18, 2005 following a Plan of Arrangement between Ketch Resources Ltd. and Bear Creek Energy Ltd. The Arrangement was approved at meetings of security holders, and received court approval, on January 17, 2005 and was implemented on January 18, 2005. Under the Arrangement and the terms of the Kereco Conveyance Agreement dated January 18, 2005 Kereco was reorganized as a public oil and gas exploration and development company receiving interests in various producing oil and gas properties and facilities as well as interests in several undeveloped properties. The consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles ("GAAP"). These principles require management to use estimates and assumptions that affect the reported amounts of assets and liabilities as at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods presented. Actual results may differ from these estimates and assumptions and the difference may be material. 2. SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation The consolidated financial statements include those of the Company and its subsidiaries. Joint Venture Operations The majority of the Company's petroleum and natural gas exploration activities are conducted jointly with others. These financial statements reflect only the Company's proportionate interest in such activities. Measurement Uncertainty Amounts recorded for depletion, depreciation and accretion, goodwill, asset retirement costs and obligations, future income taxes and amounts used for impairment calculations ("ceiling test") are based on estimates of oil and natural gas reserves and future costs required to develop those reserves. By their nature, these estimates and related future cash flows are subject to measurement uncertainty, and the impact of changes in those estimates on the financial statements of future periods could be material. Property, Plant and Equipment (i) Petroleum and Natural Gas Properties The Company follows the full-cost method of accounting for petroleum and natural gas operations, whereby all costs related to the exploration and development of petroleum and natural gas reserves are capitalized on a country-by-country basis. Such costs include land acquisition costs, costs of drilling both productive and non- productive wells, well equipment, gathering line and plant costs, geological and geophysical expenses and overhead expenses directly related to exploration and development activities. Gains or losses on sales of properties are recognized only when crediting the proceeds against the recorded costs would result in a change of 20 percent or more in the depletion and depreciation rate. Capitalized costs plus estimated future capital costs are depleted using the unit-of-production method based on estimated proven reserves of petroleum and natural gas before royalties as determined by independent petroleum engineers. Costs relating to unproved properties are excluded from costs subject to depletion and depreciation until it is determined whether or not proved reserves exist or if impairment occurs. Proved natural gas reserves and production are converted to equivalent volumes of crude oil based on the basis of six thousand cubic feet of natural gas to one barrel of crude oil equivalent. Depreciation of gas plants and related facilities is calculated on a straight-line basis over periods ranging from 10 to 40 years. The net book value of the Company's petroleum and natural gas properties and equipment is subject to a ceiling test. Impairment is recognized if the carrying amount of the property, plant and equipment exceeds the sum of the undiscounted cash flows expected to result from the Company's proved reserves. If the carrying value is not fully recoverable, the amount of impairment is measured by comparing the carrying amount of property, plant and equipment to an amount equal to the estimated net present value of future cash flows from proved plus probable reserves. This calculation incorporates risks and uncertainties in the expected future cash flows that are discounted using a risk-free rate. Any excess carrying value above the net present value of the future cash flows would be recorded as a permanent impairment and expensed immediately. (ii) Asset Retirement Obligations The Company recognizes the estimated liability associated with an asset retirement obligation ("ARO") in the financial statements at the time the liability is incurred. The estimated fair value of the ARO is recorded as a long-term liability, with a corresponding increase in the capitalized amount of the related asset. The capitalized amount is depleted on a unit-of-production method over the life of the proved reserves. The liability amount is increased each reporting period due to the passage of time, and therefore as the reserves are produced, the amount of accretion is charged to earnings in the period. The ARO can also periodically increase or decrease due to changes in the estimates of timing of cash flows or changes in the original estimated undiscounted cost. Actual costs incurred upon settlement of the ARO are charged against the ARO to the extent of the liability recorded. (iii) Office Furniture, Equipment and Leaseholds Office furniture, equipment and leaseholds are recorded at the lower of cost less accumulated amortization or fair value. Office furniture and equipment is depreciated on a declining-balance method at annual rates of 10 to 33 percent. Leasehold improvements are depreciated over the remaining lease term. Income Taxes The Company follows the liability method of accounting for income taxes. Under this method, the Company records future income taxes based on the differences between the book value and the income tax value of its assets and liabilities, as temporary differences, using substantively enacted income tax rates that are expected to apply in the year in which the temporary differences are estimated to reverse. Income tax assets are also recognized for the benefits from tax losses and deductions with no accounting basis provided those benefits are more likely than not to be realized. Future income tax assets and liabilities are determined based on the tax laws and rates that are anticipated to apply in the period of estimated realization. Stock-Based Compensation Plan The Company follows the fair-value method of accounting for stock options granted and initial private placement share purchase warrants issued to employees, officers and directors. Fair value is determined at the grant date using the Black-Scholes option-pricing model and recognized over the vesting periods of the options granted and the share purchase warrants issued as stock-based compensation expense with a corresponding credit to contributed surplus. The contributed surplus balance is reduced as the options are exercised with the amount initially recorded being credited to share capital. Revenue Recognition Revenues from the sale of crude oil, natural gas and natural gas liquids are recorded when title transfers to an external party, the seller's price to the buyer is fixed or determinable and there is reasonable assurance regarding collectibility of the consideration. Per Share Information Basic earnings per share is calculated using the weighted average number of shares outstanding during the period. Diluted earnings per share is calculated using the treasury stock method to determine the dilutive effect of stock options and warrants. The treasury stock method assumes that proceeds from the exercise of "in-the-money" stock options and warrants, net of "in-the-money" unamortized stock based compensation expense, as well as "in-the money" convertible debentures "if converted" are used to re-purchase common shares at the average market price over the period. Goodwill Goodwill is the residual amount that results when the purchase price of an acquired business exceeds the fair value of the net identifiable assets and liabilities of the acquired business. Goodwill is stated at cost less impairment and is not amortized. The goodwill balance is assessed for impairment each year-end or more frequently if events or changes in circumstances indicate that the asset may be impaired. The test for impairment is conducted by comparing the book value to the fair value of the reporting entity. If the fair value of the Company is less than the book value, impairment is deemed to have occurred. The extent of the impairment is measured by allocating the fair value of the Company to the identifiable assets and liabilities at their fair values. Any remainder of this allocation is the implied value of goodwill. Any excess of the book value of goodwill over this implied value is the impairment amount. Impairment is charged to income in the period in which it is determined to occur. Flow-Through Shares The resource expenditure deductions for income tax purposes related to exploratory activities funded by flow-through share arrangements are renounced to investors in accordance with applicable tax legislation. The future income liability associated with the flow- through shares is recognized by the Company when the tax credits are renounced. Share capital is reduced and the future income tax liability is increased by the tax related to the renounced tax deductions. Financial Instruments All financial instruments are initially recognized at fair value on the balance sheet. The Company has classified each financial instrument into one of the following categories: held-for-trading (assets and liabilities), loans and receivables, financial assets available-for-sale, financial assets held-to-maturity, and other financial liabilities. Subsequent measurement of financial instruments is based on their classification. Financial assets and liabilities "held-for-trading" are subsequently measured at fair value with charges in those fair values recognized in net earnings. Financial assets "available-for-sale" are subsequently measured at fair value with changes in fair value recognized in other comprehensive income, net of tax. Financial assets "held-to-maturity: "loans and receivables", and "other financial liabilities" are subsequently measured at amortized cost using the effective interest method. Cash and cash equivalents and short term investments as well as short and long term debt are classified as "held-for-trading". Accounts receivable and advances are classified as "loans and receivable". Accounts payable and accrued liabilities are designated as "other financial liabilities". Transaction costs and premiums or discounts directly attributable to the issuance of long-term debt classified as "held for trading" are expensed as incurred. Transaction costs associated with financial instruments designated as "other financial liabilities" are added to the fair value of the debt upon initial recognition and expensed to earnings using the effective interest rate method. 3. CHANGE IN ACCOUNTING POLICY A) Financial Instruments Effective January 1, 2007, the Company adopted the Canadian Institute of Chartered Accountants ("CICA") section 3855, "Financial Instruments - Recognition and Measurement," section 3865, "Hedges", section 1530, "Comprehensive Income" and section 3861, "Financial Instruments - Disclosure and Presentation" and section 3251 ("Equity"). The Company has adopted these standards retroactively without restatement and comparative consolidated financial statements have not been restated. The adoption of these new financial instruments standards resulted in changes in accounting for financial instruments as well as the recognition of transitional adjustments that have been recorded into adjusted retained earnings as described below. In accordance with these new standards, all financial instruments including both financial and non financial derivatives and certain embedded derivatives qualify as assets or liabilities and need to be recorded on the balance sheet. Financial Instruments are categorized into one of five categories which determines their initial measurement value and subsequent recognition of gains and losses. Section 3251 introduces new standards for the presentation of Equity with "Accumulated other comprehensive income" as a result of the application of section 1530. Upon adoption of these standards, Kereco has classified all financial instruments into one of the following five categories: 1) Loans and Receivables 2) Assets Held to Maturity 3) Assets Available for Sale 4) Held for Trading and 5) Other Liabilities. Kereco has designated its short term and long term debt as well as cash balances as Held for Trading. These are measured at fair value at each balance sheet date with gains and losses recognized in net earnings in the current period. The transaction costs or deferred financing costs related to Held for Trading financial assets and liabilities are expensed as incurred. The adoption of this section and designation of Held for Trading was done retroactively without restatement, and resulted in a reduction to retained earnings of $154,000 a reduction to the future income tax liability of $81,000 and the reduction of the previous deferred finance charges current asset account to nil. Kereco has designated its accounts receivable as Loans and Receivables which are accounted for at amortized cost with gains or losses recognized in net earnings in the current period. The Company's accounts payable and accrued liabilities have been designated as Other Liabilities which are also recorded at amortized cost. The convertible debentures issued by the company have been designated as Other Liabilities and therefore, the transaction costs associated with the issuance of the debentures are netted against the carrying value of the debentures and are accreted over the life of the debentures using the effective interest rate method. Kereco has not designated any financial instruments as Held to Maturity which include non-derivative financial assets with fixed or determinable payments and a fixed maturity which the Company intends to hold until maturity. These financial instruments are recognized at amortized cost. Kereco also has not designated any financial instruments as Available for Sale. Available for Sale assets are non derivative financial assets which are not designated into any of the other four categories. Available for Sale assets are carried at fair value with gains or losses recognized in other comprehensive income until realized when the cumulative gain or loss is transferred to earnings or loss. Because the Company has no items related to comprehensive loss under section 1530, comprehensive loss for the year is equivalent to net loss. Derivatives All derivatives are classified as held for trading and are therefore carried at their fair value in the balance sheet caption "Financial Derivative Contracts". Changes in the fair values between periods are recognized in net earnings through the account "Unrealized Gain or Loss on Financial Derivative Contracts". The adoption of this section resulted in the recognition of two derivatives. One was a three year contract to acquire electricity at a fixed rate and the other was a physical commodity collar sale contract. These resulted in the following retroactive adjustments without restatement: an increase in retained earnings of $707,000, an increase in the future tax liability of $372,000 and an increase in the Financial Derivative Contract asset of $1,079,000. Embedded Derivatives Embedded derivatives are components within a host contract that have features that are similar to a derivative. Under the new standards, the embedded derivatives are to be accounted for separately from the host contract as a derivative when their economic characteristics and risks are not clearly and closely related to those of the host contract, the terms of the embedded derivative are the same as those of a stand alone derivative and the combined contract is not held for trading or designated at fair value. Embedded derivatives are designated as Held for Trading and are measured at fair value with subsequent gains or losses recognized in earnings. Kereco does not have any embedded derivatives. Comprehensive Income Comprehensive income is comprised of the Company's net earnings and other comprehensive income. Other comprehensive income is comprised of unrealized gains and losses on available for sale securities, net of taxes, and financial contracts designated as hedges among other elements. Kereco does not have any assets designated as available for sale and no contracts designated as hedges and therefore has no other comprehensive income. The fair value of all financial instruments and derivatives are determined from the independent banks or corporations with which Kereco has entered into these contracts. These fair values are calculated using forward market pricing forecasts at the applicable ending balance sheet dates. B) Accounting Changes In July 2006, the CICA issued a revised section 1506, "Accounting Changes". The new recommendations permit voluntary changes in accounting policy only if they result in financial statements which provide more reliable and relevant information. Accounting policy changes are applied retrospectively unless it is impractical to determine the period or cumulative impact of the change. Corrections of prior period errors are applied retrospectively and changes in accounting estimates are applied prospectively by including these changes in earnings in the period of change. The guidance is effective for all changes in accounting policies, changes in accounting estimates and corrections of prior periods errors initiated in periods that began on or after January 1, 2007. ACCOUNTING PRONOUNCEMENTS A) Capital Disclosures As of January 1, 2008 the Company will be required to adopt CICA Handbook section 1535, "Capital Disclosures", which requires entities to disclose their objectives, policies and processes for managing capital, and in addition, whether the entity has complied with any externally imposed capital requirements. The Company is assessing the impact of this new standard on its consolidated financial statements and anticipates that the main impact will be in terms of additional disclosures required. B) Inventories As of January 1, 2008 the Company will be required to adopt CICA Handbook section 3031, "Inventories". This new standard is not expected to have a significant impact on the Company's financial statements. C) Goodwill and Intangible Assets and Research and Development Costs In February 2008, the Canadian Institute of Chartered Accountants ("CICA") issued Section 3064, "Goodwill and Intangible Assets", replacing Section 3062, "Goodwill and Other Intangible Assets" and Section 3450, Research and Development costs. Various changes have been made to other sections of the CICA Handbook for consistency purposes. The new Section will be applicable to financial statements relating to fiscal years beginning on or after October 1, 2008. Accordingly, the Company will adopt the new standards for its fiscal year beginning January 1, 2009. It establishes standards for the recognition, measurement, presentation and disclosure of goodwill subsequent to its initial recognition and of intangible assets by profit-oriented enterprises. Standards concerning goodwill are unchanged from the standards included in the previous Section 3062. The Company is currently evaluating the impact of the adoption of this new Section on its consolidated financial statements. The Company does not expect that the adoption of this new Section will have a material impact on its consolidated financial statements. D) Financial Instruments - Disclosures and Presentation As of January 1, 2008 the company will be required to adopt CICA Handbook section 3862 - "Financial Instruments - Disclosures" which enhances the disclosure around a financial instrument's fair value and the qualitative and quantitative exposure risks around financial instruments. As of January 1, 2008 the company will also be required to adopt CICA Handbook section 3863 - "Financial Instruments - Presentation" which addresses the required disclosures and presentation required for financial instruments. The Company is assessing the impact of this new standard on its consolidated financial statements and anticipates that the main impact will be in terms of additional disclosures required. 4. PROPERTY, PLANT AND EQUIPMENT As at December 31 2007 --------------------------------------------------------------------- Accumulated Depletion, and Net Book Cost Depreciation Value Petroleum and natural gas properties $734,411 $145,094 $589,317 Office equipment & corporate 3,282 681 2,601 --------------------------------------------------------------------- Total $737,693 $145,775 $591,918 --------------------------------------------------------------------- --------------------------------------------------------------------- As at December 31 2006 --------------------------------------------------------------------- Accumulated Depletion, and Net Book Cost Depreciation Value Petroleum and natural gas properties $661,581 $61,521 $600,060 Office equipment & corporate 1,102 198 904 --------------------------------------------------------------------- Total $662,683 $61,719 $600,964 --------------------------------------------------------------------- --------------------------------------------------------------------- The Company capitalized $1.8 million of indirect general and administrative overhead in 2007 (2006 - $0.8 million). $20.9 million of undeveloped land was excluded from the year end depletion calculation in 2007 (2006 - $51.4 million). The Company closed property acquisitions and dispositions with other oil and gas companies totaling a net $36.6 million and $77.5 million ($76.7 million including transaction costs), respectively in 2007 (2006 - $7.5 million and $10.6 million respectively). The Company had no impairment under the December 31, 2007 year end ceiling test using the following reference prices from the December 31, 2007 GLJ Petroleum Consultants reserve report: 2008 2009 2010 2011 2012 2013 ------------------------------------------------------------ WTI (Oil) ($US/bbl) 92.00 88.00 84.00 82.00 82.00 82.00 AECO (Gas) ($Can/mcf) 6.75 7.55 7.60 7.60 7.60 7.60 2014 2015 2016 2017 2018 2019+ --------------------------------------------------------------------- WTI (Oil) ($US/bbl) 82.00 82.00 82.02 83.66 85.33 85.33 + 2.0%/yr AECO (Gas) ($Can/mcf) 7.80 7.97 8.14 8.31 8.48 8.48 + 2.0%/yr 5. BUSINESS COMBINATION Chamaelo Exploration Ltd. On October 19, 2006, Kereco acquired all of the common shares of Chamaelo Exploration Ltd., a publicly traded Company listed on the Toronto Stock Exchange. The acquisition was financed through the issuance of 20,080,034 Kereco common shares to the former shareholders of Chamaelo Exploration Ltd which exchanged each Chamaelo common share into 0.51 of a Kereco common share. The 20,080,034 common shares issued were valued at $11.49 per share based on the five day average trading price on the announcement date of the transaction on August 17, 2006. Subsequent to December 31, 2006, adjustments have been made to the purchase equation as it had originally been estimated. Adjustments identified as part of the filing of the Chamaelo change of control tax return resulted in an increase in future tax liability of $2,063,000 and a corresponding increase in goodwill. Additional transaction costs in the amount of $484,000 related to the acquisition of Chamaelo were also recorded in 2007 which resulted in an adjustment to the purchase equation with an increase in transaction costs and a corresponding increase in goodwill. Final adjustments to working capital balances in accounts receivable and accounts payable and accrued liabilities in the amount of $708,000 were made with a corresponding increase in goodwill. The acquisition has been accounted for using the purchase method and the final purchase price has been allocated to the fair value of the assets acquired and liabilities assumed as follows: ($000s) Cost of Acquisition Adjusted --------------------------------------------------------------------- Issuance of common shares $ 230,720 Transaction costs 3,265 --------------------------------------------------------------------- $ 233,985 --------------------------------------------------------------------- --------------------------------------------------------------------- Allocation of Purchase Price --------------------------------------------------------------------- Property, plant and equipment $ 302,397 Goodwill 54,607 Accounts receivable 10,430 Prepaid expenses 705 Asset retirement obligation (6,235) Future income tax liability (8,037) Accounts payable and accrued liabilities (22,155) Bank debt (97,727) --------------------------------------------------------------------- $ 233,985 --------------------------------------------------------------------- --------------------------------------------------------------------- 6. GOODWILL The Company assessed its balance of goodwill and determined in 2007 that based on the then currently prevailing market conditions there was a full impairment of recorded goodwill of $120.0 million and it was therefore written down with a corresponding charge to the income statement. Market conditions resulted in a significantly reduced market valuation of Kereco at the end of the third quarter of 2007 compared to the prevailing valuations that existed when Kereco acquired each of Chariot Energy Inc. and Chamaelo and upon which the resultant goodwill was recognized. This decrease in the market valuation of Kereco resulted in the writedown of the goodwill. 7. BANK DEBT At December 31, 2007 the Company had in place a syndicated committed credit facility, in the amount of $177 million, with two major Canadian Chartered Banks and the Canadian branch of a major international bank. Interest on this facility is charged at monthly rates and borrowings can be made in Canadian or U.S. dollars. Borrowings can also be made by way of prime rate advances or Banker's Acceptances which attract interest at increments to prime based on the Company's debt/cash flow ratio, calculated utilizing the two most recent fiscal quarters. The Company has provided a $500 million demand fixed and floating charge debenture as collateral for the facility. As at December 31, 2007, $ 80.2 million (December 31, 2006, $188.7 million) had been drawn under the bank facility. The average interest rate on borrowings outstanding for the year was 6.1 percent, totaling $12.1 million in cash interest expense (December 31, 2006 - 5.48 percent and $5.3 million in interest expense). In January 2008 the entire amount of the outstanding bank debt balance was repaid in full (resulting from the disposition referred to below), which resulted in the classification of the outstanding amount on the balance sheet as a current liability at year end. At December 31, 2006, $27 million of the balance under the credit facility was potentially repayable within 12 months and was therefore presented as current on the balance sheet and $162 million was presented as long term. Subsequent to December 31, 2007, the credit facility was reduced from $177 million to $100 million. This reduction was the result of the effect of the property disposition subsequent to year end on January 14, 2008 (See Note 15). The annual review of our credit facility currently being conducted by the syndicate of lenders and is expected to be complete by the first week of April 2008. The Company does not anticipate any changes to the facility as a result of this review. 8. CONVERTIBLE DEBENTURES On June 25, 2007, the Company issued $70 million of convertible unsecured subordinated debentures which mature on June 30, 2012 and bear interest at 4.75% (the "Debentures"). The interest is payable semi-annually in arrears on June 30 and December 31 each year. The first interest payment was made on December 31, 2007. Each debenture can be converted into common shares of the Corporation at the option of the holder at any time prior to the close of business on June 29, 2012 at a conversion price of $10.00 per common share. The Debentures are not redeemable by the Corporation prior to June 30, 2010. On or after June 30, 2010 and prior to June 30, 2012, the Debentures may be redeemed at the option of the Corporation, in whole or in part at a redemption price equal to 100% of the principal amount of the Debentures to be redeemed plus accrued and unpaid interest to, but excluding, the redemption date provided that the Current Market Price (as defined in the Short Form Prospectus filed in conjunction with the offering) is at least 125% of the Conversion Price. The Debentures are classified as debt and equity with the equity portion representing the fair value of the conversion feature of the Debentures. As the Debentures are converted, a portion of the debt and equity amounts are transferred to share capital. The debt balance accretes over the life of the Debentures using the effective interest rate method to the amount owing on maturity and the increases in the debt balance are reflected as non-cash interest expense in the consolidated statement of cash flows. The debentures are designated as Other Liabilities and the transaction costs associated with the issuance of the debentures are netted against the carrying value of the debentures and are accreted over the life of the debentures using the effective interest rate method. Following is a reconciliation of the debt and equity components of the convertible debentures: Convertible debentures - debt Issued on June 25, 2007 $ 70,000 Transaction fees and costs (2,525) Portion allocated to equity - inclusive of transaction costs (15,519) Accretion (non cash interest expense) 1,644 --------------------------------------------------------------------- Debt balance as at December 31, 2007 $ 53,600 --------------------------------------------------------------------- Convertible debentures - equity Issued on June 25, 2007 $ 15,519 Tax effect of transaction fees and costs 185 Conversion of debentures - --------------------------------------------------------------------- Equity balance as at December 31, 2007 $ 15,704 --------------------------------------------------------------------- Subsequent to year end, the board of directors has resolved to make a formal offer to acquire all of the outstanding Debentures at a price of $950 per $1,000 Debenture. Kereco anticipates that the offer will be mailed to Debenture holders in mid April and will close prior to the June 30, 2008 interest payment being due. The offer will be subject to a minimum tender of 90% of the outstanding Debentures and other customary conditions. 9. INCOME TAXES The total tax recovery for 2007 was $ 9.5 million, $9.9 million of future income recoveries and $0.3 million of current income taxes (December 31, 2006: expense of $10.1 million, $10.3 million of future income taxes and a recovery of $0.2 million of current income taxes). This results in an effective tax rate of seven percent for the year compared to a rate of 34 percent for 2006. This decrease in the effective tax rate is mainly a result of the goodwill impairment writedown realized in the year. Substantively enacted federal income tax rate reductions were also recognized in the fourth quarter. The provision for income taxes in the Consolidated Statement of Earnings (Loss) differs from that which would be expected by applying the applicable statutory tax rates. Differences for the respective periods are as follows: 2007 2006 --------------------------------------------------------------------- Earning (Loss) before income taxes $(135,957) $ 30,117 Statutory income tax rate (%) 32.12 34.50 --------------------------------------------------------------------- Expected income taxes (recovery) (43,669) 10,390 Effect on income taxes of: Non-deductible crown charges - 3,211 Resource allowance - (2,822) Statutory rate change (3,773) (910) Stock-based compensation 1,246 1,384 Goodwill impairment 38,540 - Interest expense - non deductible 528 - Alberta Royalty Tax credit - 60 Change due to adjustment of opening tax pools (2,809) (1,018) Other 44 41 --------------------------------------------------------------------- Provision for (recovery of) future income taxes (9,893) 10,336 Current income tax 349 (224) --------------------------------------------------------------------- Provision for (recovery of) income taxes $ (9,544) $ 10,112 --------------------------------------------------------------------- --------------------------------------------------------------------- The future income tax liability is comprised of the following: 2007 2006 --------------------------------------------------------------------- Property, plant and equipment $ (29,821) $ (41,871) Asset retirement obligation 3,456 4,650 Non capital losses 9,084 4,439 ACRI 2,109 1,280 Financial derivative contracts 2,581 (1,602) Convertible debenture - cost (606) - Deferred partnership income (18,519) - Share issue costs 3,378 3,607 --------------------------------------------------------------------- Net future income tax liability $ (28,338) $ (29,497) --------------------------------------------------------------------- Less current portion - future income tax asset (2,486) - --------------------------------------------------------------------- Future income tax liability $ (30,824) $ (29,497) --------------------------------------------------------------------- --------------------------------------------------------------------- At December 31, 2007, the Company had tax pools and non-capital losses of approximately $488.2 million, comprised of $29.8 million in Canadian Exploration Expense (CEE) ($45.5 million less $15.7 million of estimated qualifying flow-through share eligible expenditures), $105.2 million in Canadian Development Expenditures (CDE), $219.4 million in Canadian Oil and Gas Property Expenditures (COGPE), $101.9 million Capital Cost Allowance (CCA) pools as well as accumulated non-capital losses for income tax purposes of approximately $31.9 million (2006 - $14.5 million) that can be used to offset otherwise taxable income in future periods. The remaining non-capital losses, after deductions taken to date, amount to $31.9 million and expire as follows: --------------------------------------------------------------------- Year of expiry ($millions) --------------------------------------------------------------------- 2010 $ 9.2 2016 22.7 --------------------------------------------------------------------- $ 31.9 --------------------------------------------------------------------- --------------------------------------------------------------------- In addition to the above losses and tax pools, the Company also has accumulated capital losses of approximately $ 21.5 million (2006 - $21.5 million). On February 16, 2007, the Company issued 2,250,000 flow-through common shares for proceeds of $19.4 million before issue costs of $1.0 million which will require the Company to incur $19.4 million of flow-through share eligible Canadian Exploration Expenditures, as defined in the Canadian Income Tax Act, by December 31, 2008. As of December 31, 2007 approximately $15.7 million in qualifying CEE expenditures related to this flow-through share commitment have been incurred. On June 9, 2006 the Company issued 1,500,000 flow-through common shares for gross proceeds of $22.0 million before issue costs of $1.2 million. As of September 30, 2007 the entire $22.0 million of qualifying expenditures had been spent and renounced and the related tax impact has been recorded as a reduction to share capital. 10. ASSET RETIREMENT OBLIGATION The Company has recorded an asset retirement obligation associated with the present value of the estimated future costs to abandon its petroleum and natural gas properties. To determine this obligation, the Company used an inflation rate of two percent and a credit- adjusted risk-free interest rate of seven percent to discount the future estimated cash flows of $50.9 million, which will be paid over a period ranging from two to forty-five years with the majority of costs being incurred between 12 and 16 years. The December 31, 2007 asset retirement obligation is comprised of the following: 2007 2006 --------------------------------------------------------------------- Balance at January 1, $ 16,038 $ 8,292 New liabilities added 2,787 735 New liabilities added from Chamaelo acquisition - 6,235 Changes in estimates (66) 393 Disposition of liabilities (6,185) (278) Accretion of asset retirement obligation 1,253 661 --------------------------------------------------------------------- Balance at December 31, $ 13,827 $ 16,038 --------------------------------------------------------------------- --------------------------------------------------------------------- 11. SHARE CAPITAL i) Issued and Outstanding Common Shares --------------------------------------------------------------------- Common Common Non-Voting Total Amount ($) --------------------------------------------------------------------- Balance at December 31, 2005 31,207,886 2,507,692 33,715,578 191,432 --------------------------------------------------------------------- Issued in conjunction with the acquisition of Chamaelo 20,080,034 - 20,080,034 230,720 Issued pursuant to exercise of options and warrants 40,820 - 40,820 443 Fair value of options exercised - - - 137 Amortization of common shares held for employee benefit plan - - - 117 Tax effect of flow- through shares - - - (5,668) Conversion of common non-voting shares to common 2,507,692 (2,507,692) - - Issued pursuant to flow-through share offering 1,500,000 - 1,500,000 21,975 Share issue costs - - - (1,350) Tax effect of share issue costs - - - 410 --------------------------------------------------------------------- Balance at December 31, 2006 55,336,432 - 55,336,432 438,216 --------------------------------------------------------------------- Exercise of warrants 253,299 - 253,299 820 Adjustment to share capital for warrants exercised - - - 217 Issued pursuant to flow through share offering 2,250,000 - 2,250,000 19,351 Tax effect of flow- through shares - - - (6,883) Amortization of common shares held for employee benefit plan - - - 117 Share issue costs - - - (1,047) Tax effect of share issue costs - - - 319 --------------------------------------------------------------------- Balance at December 31, 2007 57,839,731 - 57,839,731 451,110 --------------------------------------------------------------------- --------------------------------------------------------------------- ii) Normal Course Issuer Bid Subsequent to December 31, 2007 the Company announced its intention to initiate a normal course issuer bid ("NCIB") to repurchase up to 5,339,424 of its issued and outstanding common shares (representing approximately 10 percent of the 58,184,217 outstanding common shares as of January 15, 2008, net of 4,789,977 common shares held by insiders as held in escrow) through the facilities of the Toronto Stock Exchange ("TSX"). The bid commenced on January 18, 2008 and will terminate on January 17, 2009 or such earlier time as the bid is completed or terminated of the option of Kereco. iii) Flow-through Common Shares On February 16, 2007, the Company issued 2,250,000 flow-through common shares for proceeds of $19.4 million before issue costs of $1.0 million. The future tax impact and related reduction to share capital will be recorded when the expenditures are renounced. On June 9, 2006 the Company issued 1,500,000 flow-through common shares for proceeds of $22.0 million before issue costs of $1.2 million. As of December 31, 2007 the entire $22.0 million had been spent and renounced and the related tax impact of $6.9 million has been recorded as a reduction to share capital. iv) Share Purchase Warrants In conjunction with the private placement of non-voting shares to employees, officers and directors on January 18, 2005, each of the 2,507,692 common shares issued carried with them 0.83 share purchase warrants to purchase in the future one common share at a price of $3.12 per share. On issuance, the share purchase warrants were attributed a fair market value totaling $1.8 million that will be recognized as stock-based compensation expense over the vesting period of the warrants. The fair value of $0.96 for each warrant was determined as of the date they were issued using the Black-Scholes method with the following assumptions: risk free interest rate - 3.25 percent, expected life - 4 years and volatility - 33 percent and dividend yield - nil. No estimate has been made for forfeitures as they will be addressed when they occur. At December 31, 2007 there were a total of 1,611,987 of these warrants outstanding, 748,806 warrants are exercisable until January 18, 2008, after which the remaining 863,181 warrants become exercisable until their expiry date of January 18, 2009. In conjunction with the Chamaelo acquisition, 3,740,710 warrants held by previous officers, directors and employees of Chamaelo were converted at an exchange rate of 0.51 into 1,907,762 (1,847,665 are outstanding at December 31, 2007) warrants exercisable into Kereco common shares. The weighted average post conversion exercise price of these warrants is $10.28 per warrant. Number of Exercise Contractual Warrants Warrants Price Life Exercisable Expiry Date (000s) ($/share) (years) (000s) --------------------------------------------------------------------- January 18, 2008 749 3.12 0.1 749 January 18, 2009 863 3.12 1.1 - May 26, 2009 279 4.12 1.4 279 June 21, 2010 1,569 11.37 2.5 1,569 --------------------------------------------------------------------- 3,460 6.94 1.5 2,597 --------------------------------------------------------------------- --------------------------------------------------------------------- v) Stock-Based Compensation The Company has a stock-based compensation plan under which options to purchase common shares of the Company have been granted to employees, officers and directors. Under the plan, all options awarded have a maximum term of five years, and vest over a three year period at a rate of one-third per year. The plan currently has 5,783,973 shares reserved for issuance upon the exercise of options, of which 4,306,800 were granted as at December 31, 2007. Weighted Weighted Average Average Number Of Exercise Contractual Options Prices Life (000s) ($/share) (years) --------------------------------------------------------------------- Balance at December 31, 2006 3,650 10.34 3.7 Granted 3,960 5.71 4.4 Exercised - - - Expired or cancelled (3,303) 9.35 3.2 --------------------------------------------------------------------- Balance December 31, 2007 4,307 6.85 3.9 --------------------------------------------------------------------- --------------------------------------------------------------------- During 2007, the Company implemented a Stock Appreciation Rights ("SAR") plan under which rights were granted to officers of Kereco. Under the plan, all rights granted have a maximum term of five years, vest over a three year period at a rate of one-third per year and provide for settlement in cash. In late March, 439,875 SAR's were granted at a price of $5.79 and in June 853,875 SAR's were granted at a price of $5.73. As at December 31, 2007, there are a total of 1,293,750 SAR's outstanding at an average price of $5.75. Compensation expense for options granted and share purchase warrants issued by the Company is based on the estimated fair values at the time of their grants and is recognized as expense over the vesting periods of the options and share purchase warrants. Compensation expense for SARs is calculated based upon the intrinsic value and is recognized as expense over the vesting periods of the SARS. The Company recognized $3.9 million non-cash stock-based compensation expense in 2007 (2006 - $4.0 million of expense) with an equal amount recorded in contributed surplus. No expense was recognized in non- cash stock based compensation expense from the SARs and $217,000 was transferred out of contributed surplus to share capital for employee warrants which were exercised in 2007. The fair value of each option and share purchase warrant has been determined as at each stock option grant date using a Black-Scholes model. For the options currently outstanding, the average terms used are: risk free interest rate - 4.28 percent, expected life - 4 years, and volatility - 35 percent. The weighted average fair value of the options outstanding is $2.31 per option. No estimate has been made for expected forfeitures as they are addressed when they occur. Additional details on the Company's stock options outstanding at December 31, 2007 are as follows: Weighted Weighted Average Average Range of Number of Exercise Contractual Options Exercise Prices Options Price Life Exercisable ($/share) (000s) ($/share) (years) (000s) --------------------------------------------------------------------- 3.84 - 5.73 2,636 5.52 4.4 0 5.90 - 7.24 525 6.56 4.3 13 8.93 - 9.80 641 9.37 2.6 364 10.50 - 11.20 505 10.84 2.4 307 --------------------------------------------------------------------- 3.84 - 11.20 4,307 6.85 3.9 684 --------------------------------------------------------------------- --------------------------------------------------------------------- vi) Employee Benefit Plan During 2005, the Company created an employee benefit plan under which Kereco common shares have and will from time to time be purchased on behalf of certain employees. These shares will be given to certain employees, on the basis of one third per year, over a period not exceeding three years. To date 23,950 common shares have been purchased for the plan at an average price of $14.67 per common share. Of the 23,950 common shares, 14,402 have been issued to certain employees by December 31, 2007 and 9,548 are being held in trust. The purchase of the shares is recorded as a reduction to shareholder's equity at the purchased value of the common shares of $0.4 million and will be amortized to general and administrative expense evenly over the three year vesting period. At December 31, 2007, $117,000 has been expensed and recorded to share capital (December 31, 2006: $117,000). vii) Per Share Amounts The calculation of basic and diluted net earnings per share is based on the weighted average number of common shares outstanding as shown in the table below: Year ended Year ended December 31, December 31, 2007 2006 --------------------------------------------------------------------- Net earnings (loss) $(126,413) $ 20,005 Net earnings (loss) per share Basic $ (2.20) $ 0.52 Diluted $ (2.20) $ 0.50 Weighted average shares outstanding Basic 57,469,293 38,610,662 Options and warrants(1) - 1,373,198 --------------------------------------------------------------------- Diluted 57,469,293 39,983,860 Common shares outstanding --------------------------------------------------------------------- Basic 57,839,731 55,336,432 Options and warrants 7,766,452 7,471,492 --------------------------------------------------------------------- Diluted 65,606,183 62,807,924 --------------------------------------------------------------------- --------------------------------------------------------------------- (1) Anti-dilutive incremental options and warrants in the amount of 808,142 for the year are excluded from the weighted average diluted shares outstanding. 12. SUPPLEMENTAL CASH FLOW INFORMATION i) Changes in Non-Cash Working Capital Year ended Year ended December 31, December 31, 2007 2006 --------------------------------------------------------------------- Decrease (increase) in non-cash working capital: Accounts receivable $ 1,655 $ (9,666) Prepaid expenses (867) (1,655) Accounts payable and accrued liabilities (3,996) 553 Advance payment for property disposition 17,000 - --------------------------------------------------------------------- Change in non-cash working capital 13,792 $ (10,768) --------------------------------------------------------------------- Relating to: Operating activities $ 21,717 $ (4,249) Financing activities 1,498 (1,357) Investing activities (9,423) (5,162) --------------------------------------------------------------------- Change in non-cash working capital $ 13,792 $ (10,768) --------------------------------------------------------------------- --------------------------------------------------------------------- ii) Other Cash Flow Information Year ended Year ended December 31, December 31, 2007 2006 --------------------------------------------------------------------- Cash taxes paid $ 349 $ - Cash interest paid $ 12,084 $ 5,329 --------------------------------------------------------------------- --------------------------------------------------------------------- 13. RISK MANAGEMENT AND FINANCIAL INSTRUMENTS The Company has not designated any of these financial contracts as hedges and has therefore recorded the unrealized gains and losses on these contracts in the balance sheet as assets or liabilities with changes in their fair value recorded in net earnings for the period. At December 31, 2007 the Company recognized a financial derivative contract liability of $ 8.5 million (December 31, 2006 - asset of $5.0 million). The following financial derivative and physical sales contracts were outstanding on December 31, 2007: Oil and Natural Gas Price Risk Management Period Volume Type Pricing terms(1) --------------------------------------------------------------------- Crude Oil Jan 1, 2008 - $61.50 - $78.88 Dec 31, 2008 1,500 bbls/day Financial Collar (WTI US$/BBL) Jan 1, 2009 - $75.00 - $101.40 Dec 31, 2009 250 bbls/day Financial Collar (WTI US$/BBL) --------------------------------------------------------------------- (1) Collar price indicates minimum floor and maximum ceiling. Power Consumption price risk management Period Volume Type Pricing terms --------------------------------------------------------------------- Electricity Jan 1, 2008 - Dec 31, 2008 3.5 MW Fixed Price $65.50/MWh --------------------------------------------------------------------- Kereco is exposed to commodity price fluctuations of crude oil and natural gas and manages a portion of this risk by entering into forward contracts. The Company is exposed to credit risk due to the potential non-performance by counter parties to these contracts. Kereco mitigates this risk by dealing with only well established marketing companies or major chartered banks. The Company deals with customers in the oil and gas industry and is subject to normal industry credit risks. The Company is exposed to interest rate risk due to the floating nature of the interest rates on its bank loan. The estimated fair values of financial instruments approximate their carrying values due to their short term nature. 14. COMMITMENTS AND GUARANTEES On February 16, 2007, we issued 2,250,000 flow-through common shares for proceeds of $19.4 million before issue costs of $1.0 million which will require us to incur $19.4 million of flow-through share eligible CEE, as defined in the Canadian Income Tax Act, by December 31, 2008. As of December 31, 2007 approximately $15.7 million in qualifying CEE expenditures related to this flow- through share commitment have been incurred. We have also executed separate contracts with two large drilling contractors for the exclusive use of two specific drilling rigs. One contract is a three year contract which commenced in December of 2006 and requires us to utilize the rig for a minimum of 225 days per year. If not utilized we are is obligated to pay a minimum $5,800 rate per day. A second drilling contract (which was for two years, commenced June 1, 2007 and required Kereco to utilize the rig for a minimum of 225 days per year for two years with a minimum rate per day of $4,785) was terminated on March 11, 2008 and replaced with a new service rig contract. The new contract will commence on June 1, 2008 and requires us to utilize the rig for a total of 7,200 hours at a rate of $645 per hour. There is no timeframe by which this rig capacity needs to be utilized by. If we are unable to utilize the rig, a liability of $200 of per unutilizable hour will result. Therefore the minimum payments under the service rig contract will be $1,440,000. During 2007, the Company signed a nine year office lease which commences on February 15, 2008. Average annual payments under the lease will be $1.5 million. Kereco has also fixed the price on approximately seventy percent of its electricity requirements for a period which commenced on February 1, 2006 and which ends on December 31, 2008. Following are the future minimum payments required under these drilling, office and electrical contracts; net of any prepayments: Drilling Electricity ($000s) contracts Office lease contract --------------------------------------------------------------------- 2008 $ 1,305 $ 1,314 $ 2,008 2009 $ 1,196 $ 1,434 $ - 2010-2016 $ - $ 9,962 $ - Indeterminate $ 1,440 $ - $ - --------------------------------------------------------------------- Total $ 3,941 $ 12,710 $ 2,008 --------------------------------------------------------------------- The Company has other commitments and guarantees in the normal course of business which are not material, and are therefore not disclosed here. 15. SUBSEQUENT EVENTS i) Risk Management Subsequent to December 31, 2007, the Company entered into additional financial derivative contracts to mitigate its exposure to future fluctuations in natural gas and crude oil commodity prices as follows: Period Volume Type Pricing terms(1) --------------------------------------------------------------------- Crude Oil Jan 1, 2009 - $80.00 - $106.50 Dec 31, 2009 250 bbls/day Financial Collar (WTI US$/BBL) Natural Gas Apr 1, 2008 - $7.25 - $8.45 Oct 31, 2008 1,000 GJ/day Financial Collar (AECO CDN$/GJ) Apr 1, 2008 - $8.01 Oct 31, 2008 1,000 GJ/day Fixed Price (AECO CDN$/GJ) --------------------------------------------------------------------- (1) Collar price indicates minimum floor and maximum ceiling. ii) Repositioning Process On January 14, 2008, the Company announced it had completed the last sale of assets related to the corporate repositioning process it had embarked upon on July 18, 2007 for proceeds of $166.8 million including adjustments. That process resulted in the Company disposing of the majority of its natural gas prone properties and the full repayment of the Company's bank debt. On January 14, 2008, the Company also announced its intention to undertake a normal course issuer bid (see Note 11) and also its intention to make an offer to repurchase the convertible debentures at 95% of their par value. The company received an advance payment of $17.0 million in December 2007 related to one of these property dispositions. There are deferred charges in the amount of $2.1 million at year end which will be charged to transaction costs in the first quarter of 2008 relating to the repositioning process. Severance expenses related to the repositioning process in the amount of $1.8 million have been charged to earnings in 2007. 16. RELATED PARTY TRANSACTIONS During 2007 and 2006, Kereco conducted business with a company controlled by a director of Kereco. These transactions for drilling services were made under normal business terms and conditions at the same rates as with non-related parties. Capital additions to property plant and equipment in the amount of $857,000 were conducted in 2007 and $250,000 in 2006. None of these amounts were owing at each respective period end. 17. CONTINGENCIES The Company has been served with three statements of claim totaling $3.6 million. The Company has not provided for these claims in the financial statements as it is believed the Company will be successful in defending all of them. In the unlikely circumstance that the Company is not successful in defending these claims, there is in place adequate insurance coverage to mitigate any losses which may result. Subsequent to December 31, 2007, the Company reached a favorable settlement in the amount of $40,000 with respect to one of the above claims noted above. The remaining two statements of claim total $2.6 million. CORPORATE INFORMATION Kereco Energy Ltd. is a Canadian energy company engaged in the exploration, development and production of natural gas and crude oil. The Company's common shares are listed on the Toronto Stock Exchange under the trading symbol "KCO". OFFICERS BANKERS Grant B. Fagerheim Bank of Montreal President and Chief Executive Calgary, Alberta Officer Canadian Imperial Bank of Commerce Nathan R. MacBey Calgary, Alberta Vice President, Negotiations Société Générale (Canada Branch) David M. Mombourquette Calgary, Alberta Vice-President, Business Development ENGINEERING CONSULTANTS Stephen C. Nikiforuk GLJ Petroleum Consultants Ltd. Vice President, Finance and Chief Calgary, Alberta Financial Officer LEGAL COUNSEL Kirby J. Wanner Chief Operating Officer Burnet Duckworth & Palmer LLP Calgary, Alberta DIRECTORS REGISTRAR AND TRANSFER AGENT Daryl E. Birnie Computershare Trust Company of J. Paul Charron Canada Calgary, Alberta Grant B. Fagerheim WARRANT AGENT Daryl H. Gilbert Valiant Trust Company Barry M. Heck Calgary, Alberta Brian M. Krausert STOCK EXCHANGE LISTING Peter J. Kurceba Toronto Stock Exchange Trading Symbol "KCO" Gerry A. Romanzin HEAD OFFICE Grant A. Zawalsky 1100, 530 - 8th Avenue SW AUDITORS Calgary, Alberta T2P 3S8 Deloitte & Touche LLP Telephone: (403) 290-3400 Chartered Accountants Facsimile: (403) 290-3447 Calgary, Alberta Email: info@kereco.com Website: www.kereco.com ABBREVIATIONS AECO Alberta Energy Company interconnect with the Nova System ARTC Alberta Royalty Tax Credit Bbls barrels bbls/day barrels per day Bcf billion cubic feet Boe barrels of oil equivalent (6mcf = 1bbl) boe/day barrels of oil equivalent per day GJ gigajoule MWh Mega watt hour GJ/day gigajoule per day kWh Kilo watt hour Mbbls thousand barrels Mboe thousand barrels of oil equivalent mboe/day thousand barrels of oil equivalent per day Mcf thousand cubic feet mcf/day thousand cubic feet per day mmbbls million barrels mmboe million barrels of oil equivalent mmbtu million British thermal units mmcf million cubic feet mmcf/day million cubic feet per day NGLs natural gas liquids NI Canadian Securities Administrator's National Instrument WI Working Interest WTI West Texas Intermediate %SEDAR: 00021661E

For further information:

For further information: Grant B. Fagerheim, President and Chief
Executive Officer, Telephone (403) 290-3401

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KERECO ENERGY LTD.

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