Heavy Oil Gems. Large Resource. Low Risk. High Potential.

Transcription

1 BLACKPEARL RESOURCES INC Annual report Heavy Oil Gems Large Resource. Low Risk. High Potential.

2 Contents: Highlights President s Letter A Conversation with Management Operations Review Reserves Management s Discussion and Analysis Financial Statements Notes to the Consolidated Financial Statements Assemble the assets, define the program and execute the growth plan. Our objective is to build a company focused on heavy oil. We believe we have the properties in our existing inventory to build a company capable of producing 50,000 barrels of oil per day. This inventory includes conventional heavy oil properties as well as properties which will require a thermal process such as SAGD to recover the oil. We are starting with a base of about 6,000 boe per day today. It will likely take 7 to 10 years to reach our objective, but the most important ingredient to achieving this objective, in addition to highly talented staff, is to have great resource. It is getting more and more difficult to capture attractive heavy oil opportunities in western Canada. We think our three core areas provide an excellent foundation to grow the Company. When evaluating opportunities we look for properties where we can have a high working interest and can be the operator, there is a significant amount of oil in place and there is an existing proven method to recover the oil. All of our core areas meet these criteria.

3 2009 Highlights FINANCIAL FINANCIAL Twelve months ended Twelve months ended ($000s, except per share data) December 31, 2009 December 31, 2008 Total revenue 89, ,536 Funds from operations 29,004 72,120 Per common share Basic and diluted ($) Net earnings (Loss) (47,315) (78,862) Per common share Basic and diluted ($) (0.19) (0.42) Capital expenditures (1) 27, ,367 Total assets 468, ,143 Long-term debt Working capital 57,995 6,451 Shareholders equity 426, ,635 Weighted average shares outstanding (basic and diluted) 243,185, ,241,716 Common shares outstanding at period end 261,960, ,241,716 OPERATIONAL Daily Production Oil (bbls/d) 4,324 6,182 Natural gas net production (mcf/d) 5,582 8,942 Total production boe/d 5,254 7,692 Sales Prices Oil average selling price per bbl ($) Gas average selling price per mcf ($) Operating Costs Operating costs ($000s) 29,461 49,907 Operating costs per boe ($) (1) Excludes non-cash acquisitions cost Annual report 1

4 President s Letter JOHN FESTIVAL, PRESIDENT AND CEO Despite its turbulence on many fronts economic recession, commodity prices, credit and capital markets and investor scepticism 2009 was also a year that confirmed BlackPearl s strategic direction. As the theme line of this annual report suggests, we have a suite of heavy oil/oil sands gems and will be taking full advantage of the ongoing oil price recovery as we build to our 50,000 barrels per day target over the next several years. It s a good time to be in oil, period. We have accomplished much in the past year. When the new management group joined BlackPearl in January 2009, we began to develop a multi-year strategy to unlock the Company s tremendous heavy oil potential. At the time, BlackPearl owned a diverse collection of oil and natural gas properties. Following a thorough review of these properties, we decided to focus on three core heavy oil/oil sands assets. Our goal was to choose those assets that had a significant amount of oil in place, which could be recovered using a proven commercial recovery process and which we operated. Once we had chosen our core properties Mooney, Onion Lake and Blackrod the strategy for development evolved into a four-step process. Laying a Foundation In the first quarter of 2009, the oil price was below US$40 per barrel and our first concern was reducing our operating costs in order to survive. Second, we needed to add technical and operating people with heavy oil and oil sands experience. And third, we had to raise sufficient funds in order to test and validate our core projects. We achieved all of these objectives during Building BlackPearl to 2 50,000 boe/d boe/day BLACKPEARL RESOURCES INC. 5,000 We are starting with a base of about 5,000 boe/day. The first step in building BlackPearl was to reduce its cost structure. We achieved, on a boe basis, a 14% reduction in operating costs and a 32% reduction in administrative costs.

5 Validating the Potential of Each Core Property It was important at the outset to verify key information for each of our core properties, that would allow us to proceed with confidence through to development. At Mooney, we continued working with our polymer pilot, achieving significant oil recovery rates and proving the effectiveness of the polymer process. We are now finalizing our lab and field-testing that will likely see us add alkali and surfactant to enhance the recovery process. At Onion Lake, we completed a detailed geological mapping of the Dina and Cummings reservoirs and identified more than 200 potential primary locations. We completed our first 28-well development drilling program and these initial results will help us extrapolate the property s ultimate potential. At Blackrod, we drilled 10 delineation wells, which validated the areal extent of the resource and provided valuable rock and fluid properties that verified our assumptions. We are now planning to construct facilities and drill our SAGD pilot well pair in Q and commence steam injection in early 2011 the final step before designing a commercial project. 1,700 boe/day Our first growth iniative occured in late 2009 with the drilling of 28 wells at Onion Lake, which added over 1,700 barrels of oil per day to our production base. There are over 200 additional primary drilling locations at Onion Lake which could add over 7,500 boe/day. Formulating a Development Plan For each of our core properties we have chosen an enhanced oil recovery technology that has proven successful in similar heavy oil reservoirs in Canada. For Blackrod, the choice of SAGD technology was obvious. Although several different thermal configurations would be effective at Onion Lake, we selected a SAGD technique that operated successfully at Tangleflags, Saskatchewan for 17 years. This choice will allow us to drill primary heavy oil wells at Onion Lake for the next several years until we decide to convert the wells to steam injection and proceed with a SAGD recovery project. At Mooney, we are making a final decision regarding the combination of alkali, surfactant and polymer to use in our flood. We anticipate completing plant modifications and commencing injection at Mooney in late 2010 or first quarter of ,500 boe/day Implementation of the first stage of an ASP flood at Mooney could add 3,500 boe/day. 4,500 boe/day The next stage of the ASP flood at Mooney could add an incremental 4,500 boe/day Annual report 3

6 Implementation The implementation phase is all about execution delivering projects on-time and on-budget. Our previous hands-on experience with numerous heavy oil projects in Canada gives us confidence that we will deliver on this goal. In 2010, we will continue primary development of Onion Lake, commence Phase 1 of the commercial polymer flood at Mooney and construct a SAGD pilot at Blackrod. Further stages of development for our three core projects will continue in the years ahead. In conclusion, we have laid a solid foundation for BlackPearl. We have nearly completed the design phase for our core projects and will complete the validation of all key variables in Beyond that, we will be busy with implementation on our road to 50,000 barrels of oil per day. Shareholders can take comfort in the fact that the management team has been intimately involved in these types of activities for the past fifteen years and we are excited for the opportunity to tackle this new assignment. Two-thousand-nine was a transition year for employees, directors and shareholders. Sincere thanks to our employees for their dedication and hard work, to directors for their guidance and of course our shareholders for their patience as we charted a new direction. On behalf of the Board of Directors, JOHN FESTIVAL President and Chief Executive Officer February 24, 2010 The Future 10,000 boe/day The first phase of our SAGD development at Blackrod will add 10,000 boe/day to our production. 30,000 boe/day Future phases of expansion at Blackrod could add 20,000 to 30,000 boe/day, and the SAGD development at Onion Lake could add 10,000 boe/day. 4 BLACKPEARL RESOURCES INC.

7 Q/A: A conversation with management Q Q In 2009, the price difference between light and heavy oil narrowed to near-record levels which benefits BlackPearl s heavy oil wellhead price. Do you expect this situation to continue? What should an investor look for in a resource company? Yes. Three fundamental changes have occurred within North America, which should continue to contribute to a narrower price differential between light and heavy oil. North American refiners have expanded their ability to process heavy oil, which increases demand for our product. We have also seen pipeline expansions to the U.S. Gulf Coast, which is the major heavy oil processing hub in North America. Third, Gulf Coast refiners have experienced decreased heavy oil shipments from both Mexico and Venezuala which has increased the demand for Canadian heavy oil. The most important aspect of any resource company is quality of assets. Based on our collective experience in oil sands and heavy oil, we recognize the world-class potential of the three core assets in this company. Q Q These are the same assets that were in BlackPearl before you joined. What has changed? The San Miguel property in Texas does not appear to be part of your future plans. What has changed? What we brought to BlackPearl as a management team is execution. Execution entails a number of skills, which includes identifying quality assets, picking the appropriate technology for development, managing the major risks and finally, developing the assets in a cost efficient and timely manner. Our team has worked together for many years and our skills are specific to heavy oil and oil sands. When we joined BlackPearl, there were few technical people in the Company with that specific type of experience. After a thorough technical and economic review of all the BlackPearl properties, we concluded that the San Miguel property was not one of our top three or four projects. Although San Miguel has tremendous oil potential, it needs a higher sustained oil price in order to be developed Annual report 5

8 Q/A: Q Q Q Q Why do you emphasize low operating costs and no debt? Will you consider company and property acquisitions to enhance your growth? Why sell all non-core assets? Isn t it better to retain the production and cash flow? Do you have too many outstanding shares for a junior oil company? In a word, survival. By achieving and maintaining a low cost structure we ensure our survival in times of low oil prices. That is also the reason we will take on little or no debt. We have learned that being a low cost producer with a conservative balance sheet will allow us to: 1) maintain control of our company under most circumstances, 2) take advantage of opportunities in down markets and 3) sleep very well at night. As both managers and investors, we have a significant portion of our net worth invested in BlackPearl shares and we do not want to jeopardize the potential that we see in the company. We will only entertain acquisitions if they are accretive to BlackPearl both on an asset quality and financial basis. BlackPearl has many years of planned activity with our current properties and we don t need acquisitions to grow the company. Selling our non-core properties allows us to achieve two very important objectives. Our most precious resource, our people, are focused solely on our core properties. In addition, by redirecting the cash from the sale of properties to drilling new wells at Onion Lake, we are able to accelerate our production growth. Compared to most junior oil companies, we have a lot of outstanding shares. However, if you compare BlackPearl to other oil sands companies our share count is reasonable. 6 BLACKPEARL RESOURCES INC.

9 Q Q Q Q In your presentation you talk about needing at least one billion dollars of capital over the next 10 years. How will you source the funds? The goal of 50,000 barrels of oil per day is a lofty one. When will you know if that goal is achievable? What price of oil is required for BlackPearl s three core projects to be economic? Lukas Lundin was a significant shareholder of Pearl. Does he still own BlackPearl shares and why did he step down from the Board? At this stage we have not established our capital structure beyond the next couple of years; however, it is expected that our capital requirements will come from a number of sources. Firstly, cash flow from operations at current prices and production, we would generate roughly $50 million per year in cash flow. Another source of capital is the sale of our non-core properties, which should generate between fifty and one hundred and fifty million dollars. This would then be supplemented by equity infusions and potentially some form of term debt instrument. By the end of 2011 we will have tested all of our core projects and we will be able to project the ultimate potential of each one. The price of oil needs to be US$50 to US$60 per barrel W.T.I. for our projects to generate an acceptable return on our invested capital. Lukas Lundin has not sold any of his shares since the new management team joined the company. In fact, he participated in the April 2009 equity financing to maintain his pro rata share of the company. He resigned from the Board of Directors because he felt his presence was no longer directly needed. Mr. Lundin is active in a number of other companies within the Lundin Group. We are pleased that Mr. Lundin continues to offer his wealth of experience even though he is no longer a member of the Board of Directors Annual report 7

10 ALBERTA SASKATCHEWAN BLACKROD MOONEY ONION LAKE OIL SANDS 8 BLACKPEARL RESOURCES INC.

11 Operations Review 2009 Production (boe/d) by Area Land (net acres) by Area 1,423 58,000 2, ,000 50, ,000 46, Proved + Probable Reserves (mmbbls) by Area (as at December 31, 2009) 2009 Net Operating Revenues ($mm) by Area Onion Lake Mooney Salt Lake/Ear Lake Southern Alberta Gas Other OVERVIEW Our activities are concentrated in the traditional heavy oil In 2009, our capital expenditures were $28 million. areas of Alberta and Saskatchewan in western Canada. During 2009, we established development plans for Onion Lake is located near Lloydminster on the Alberta/ each of these areas and our capital spending in 2010 Saskatchewan border, Mooney is just outside the Peace will triple compared to 2009 as we start to implement River Oil Sands region and our Blackrod property is these plans. located in the Athabasca Oil Sands Annual report 9

12 Onion Lake, Alberta AT A GLANCE Working interest 87.5% Land 12,623 net acres 2P Reserves 10.1 mmbbls API 11 oil 2009 production 2,297 boe/day Depth metres Formations Dina, Cummings 2009 Milestones Drilled 28 conventional heavy oil wells Completed successful two-well CSS steam pilot Developed a conceptual SAGD development plan 2010 Plans Drill 50 conventional heavy oil wells Upgrade fuel gas system and water disposal facilities Continue developing SAGD thermal plans Total capital program of $30 million BARREL ECONOMICS* $60.00 Wellhead Price $17.00 Royalties $1.50 Transportation $12.00 Operating Costs $29.50 Netback * Per barrel economics are estimates based on a WTI oil price of US$75 per barrel and a light to heavy differential of US$11 per barrel. Onion Lake is a heavy oil property located in Saskatchewan on the Onion Lake First Nation reserve. BlackPearl has an 87.5% working interest in the majority of the producing wells, with the First Nation holding the remaining 12.5% interest. The Company s technical team undertook a thorough review of the property in 2009 and identified in excess of 200 conventional development drilling locations. Of these, 28 were drilled in late 2009 and an additional 50 are planned for In addition to conventional drilling, a portion of the lands at Onion Lake are amenable to thermal development. This was confirmed in 2009 when the Company undertook a successful two-well thermal pilot on the property. The reservoir underlying BlackPearl s lands is 15 to 23 metres thick, which makes it suitable for SAGD development. The thermal development area contains approximately 100 million barrels of oil-in-place. As SAGD development would typically be expected to recover 50-70% of the oil, thermal development at Onion Lake has the potential to add significant long-life reserves for the Company, translating into 5,000-10,000 barrels of oil per day of production for 15 to 20 years. As the Company continues to develop the property with conventional drilling, it will prepare a SAGD commercial development plan. Management anticipates three or four years of conventional heavy oil development drilling before launching thermal development. Onion Lake provides near-term production growth as well as a longer term SAGD opportunity. 10 BLACKPEARL RESOURCES INC.

13 Onion Lake Onion Lake Map Twelve development wells were drilled on the northern block in Additional wells are planned for Onion Lake North Onion Lake North 1 mile T57 2 miles Onion Lake North Block T56 GR ø SP CUMMINGS RES Onion Lake Central Block PALEO T56 T55 BlackPearl land Producing wells Producing wells - drilled in 2009 Future drilling locations R26W3 Onion Lake South Block BlackPearl land CNRL land Oil pools T54 R1W4 R27W3 GR ø SP RES CUMMINGS The Dina sand in the Onion Lake central block is metres thick, which makes it suitable for SAGD development. Onion Lake Central PALEO Onion Lake Central 1 mile T56 Onion Lake South One well was drilled on the southern block in 2009 to retain the leases. Technical evaluation of the southern block lands is ongoing. GR ø SP RES Onion Lake South BlackPearl land Producing wells Producing wells - drilled in 2009 Future drilling locations T55 GR ø SP RES T55 DINA CUMMINGS PALEO T54 DINA PALEO R27W3 BlackPearl land Producing wells Producing wells - drilled in 2009 Future drilling locations Future SAGD thermal development area 1 mile R1W4 R28W3 R Annual report 11

14 Blackrod, Alberta AT A GLANCE Working interest % Land 30,080 net acres 2P Reserves none assigned API 9 oil 2009 production none Depth 300 metres Formation Grand Rapids 2009 Milestones Increased working interest to 80% on the main development lands Drilled 10 stratigraphic wells to confirm areal extent of the reservoir Filed regulatory application to undertake a single-well SAGD pilot Completed construction of a steam generator for the pilot and began construction of a 31-kilometre all-weather road 2010 Plans Complete regulatory review of pilot project Drill two water source wells and two observation wells Drill SAGD well pair Initiate construction of surface facilities Total capital program of $20-23 million * These are estimated economics based on modeling using a WTI price of US$75 per barrel and gas costs of $7 per mcf. BARREL ECONOMICS* $55.00 Wellhead Price $11.00 Royalties $10.00 Operating Costs $10.00 Gas Costs $7.00 Capital $17.00 Profit Blackrod is a SAGD property located in the Athabasca oil sands. The geological formation of interest is the Lower Grand Rapids at a depth of approximately 300 metres. The Company has an 80% working interest in the main development lands and operates the project. In 2009, BlackPearl participated in drilling 10 stratigraphic wells on the property to confirm the areal extent and quality of the reservoir and filed an application with regulatory authorities to undertake a single-well SAGD pilot. If approval is granted in 2010, it is expected that steaming could commence during the first quarter of In conjunction with filing the pilot application, BlackPearl completed the construction of a 50 mmbtu steam generator that will be used for the pilot. The Company has also completed about 75% of a 31-kilometre all-weather road into the proposed facility site. The remainder of the road will be completed in the spring. This winter BlackPearl is planning to drill water source and water disposal wells in addition to two observation wells. Oil and water handling facilities and the SAGD well pair will be deferred until we receive all regulatory approvals. Blackrod has approximately one billion barrels of oil-in-place on its Blackrod property, which has potential to produce 30,000-40,000 barrels per day as a commercial project. Blackrod is a potential 25 year, 30,000 40,000 bopd opportunity. 12 BLACKPEARL RESOURCES INC.

15 Blackrod Contours R18 12 T Blackrod We have internally mapped over a billion barrels of oil in place on the Blackrod Lease. The next step in the development of the resource is to construct a SAGD pilot to confirm operating data to design a commercial project. BlackPearl land 2009 evaluation wells Phase 1 development Lower Grand Rapids Net Oil Pay (<17m pay cut off) T R18 36 T76 Proposed SAGD pilot well pair Phase 1 SAGD well pairs Phase 1 development Observation wells 25 Water disposal well Proposed Pilot Site The Blackrod resource has the potential to support a 40,000 bopd development. Phase 1 of commercial development will be 10,000 bopd Annual report 13

16 Mooney, Alberta AT A GLANCE Working interest 98% Land 46,490 net acres 2P Reserves 8.7 mmbbls API 16 oil 2009 production 1,423 boe/day Depth 900 metres Formation Bluesky 2009 Highlights Achieved an oil recovery rate of 15% for the polymer pilot project Plans Finalize optimal mix of alkali, surfactant and polymer in preparation for commercial injection. Apply to Department of Energy for reduced government royalties under its enhanced oil recovery program. Initiate phase one of the commercial ASP flood including converting existing wells to injectors and constructing water and chemical handling facilities. Total capital program of $25-30 million. * Per barrel economics are estimates for primary recovery based on a WTI oil price of US$75 per barrel and a light to heavy differential of US$11 per barrel. BARREL ECONOMICS* $60.00 Wellhead Price $16.00 Royalties $2.50 Transportation $18.00 Operating Costs $23.50 Netback Mooney is a conventional heavy oil property located in north-central Alberta. BlackPearl currently has an average working interest of approximately 98% in 79 sections in the Mooney field. The Mooney field produces mainly from the Bluesky sand formation, at a depth of approximately 900 metres. During 2009, oil and gas production averaged 1,423 boe per day net to BlackPearl. BlackPearl has been operating the Mooney property for about five years. The field was initially developed using primary production; however, the Company believes the performance of the Mooney field will be enhanced through Alkali Surfactant Polymer (ASP) flooding. ASP flooding involves adding a polymer chemical to the water to thicken it and additional alkali and surfactant chemicals to mobilize additional reservoir oil. This water and chemical mix is then injected re-pressurizing the reservoir and sweeping additional oil to the producing wells. Primary production is expected to recover 3-5% of the oil-in-place. An ASP flood is expected to boost recovery to 20-30% of the 14 BLACKPEARL RESOURCES INC. oil-in-place. Mooney has an estimated 150 million barrels of oil-in-place so any increased recovery represents a significant amount of additional oil. To date, a three well polymer pilot, operating for about 14 months, has recovered approximately 15% of the oil in place. As a result of the success of the polymer pilot, in late 2009, the Company filed a development application with the ERCB to commence a commercial ASP flood at Mooney. If approved, the first phase of the flood will likely commence in late 2010 or early in This will initially involve the conversion of producing wells to injectors and installing water and polymer handling facilities. It is expected that it will take 8 to 16 months after initial injection before there will be a production response from the ASP flood. Future phases of the ASP flood will require drilling additional horizontal wells and expansion of the surface facilities. The Alberta government has programs in place that encourage enhanced oil recovery developments by reducing royalties on fields with tertiary recovery programs. BlackPearl plans to submit an application for royalty relief in early 2010.

17 6 miles Phase 1 T72 Phase 2 Pilot Site BlackPearl land Delineation wells Phase 1 existing horizontal wells Phase 2 future horizontal wells Bluesky oil pool R8W5 T71 Mooney Phase 1 of the ASP flood will require converting up to half of the existing wells to injectors, and constructing injection and water handling facilities. Expansion of the ASP flood (Phase 2) will require drilling up to an additional 50 horizontal wells and upgrading the surface facilities. ASP Flood An ASP flood uses three chemicals to recover more oil from the reservoir. Alkali and surfactant acts like a detergent to help wash more oil from the rock. Polymer is added to thicken the water which enhances the ability to push or sweep the oil to the well bore. Fluid is injected at the Injection wells Injected fluid moves through the Bluesky oil reservoir Mobilized oil is produced at the Production wells 2009 Annual report 15

18 Oil and Gas Reserves The following tables summarize certain information contained in the independent reserves report prepared by Sproule Associates Limited ( Sproule ) as of December 31, The report was prepared in accordance with definitions, standards and procedures contained in the Canadian Oil and Gas Evaluation Handbook ( COGHE ) and National Instrument , Standards of Disclosure for Oil and Gas Activities ( NI ). This was the first year Sproule was engaged to prepare a reserves evaluation for the Company. In the prior year the Company requested another independent engineer to evaluate possible ( 3P ) reserves on the Company s properties. The 2008 reserves report included possible reserves for the Company s SAGD project at Blackrod. In 2009, the Company elected not to undertake an evaluation of its possible reserves. Given the significant capital expenditures required and the uncertainty of the timing of those expenditures, the Company felt it was appropriate to defer further review of possible reserves until we have results from our proposed pilot project and a commitment from the Company s Board of Directors to proceed with commercial development of the Blackrod lease. On a net present value basis (10% discount, before tax), approximately 58% of the value of reserves were attributable to the Onion Lake area and 24% was attributable to the Mooney area. No reserves were assigned to the Blackrod project. The complete list of schedules required under National Instrument Standards of Disclosure for Oil and Gas Activities are included in Pearl s Annual Information Form filed on SEDAR at or available on BlackPearl s website at Summary of Oil and Gas Reserves Forecasted Prices and Costs Oil & NGL Natural Gas Reserves Reserves BOE (1) BOE (1) (Company interest, before royalties) (Mbbls) (MMcf) (Mboe) (Mboe) Proved developed producing 2,733 4,484 3,480 5,405 Proved developed non-producing 1, ,080 1,594 Proved undeveloped 6, ,013 3,475 Total proved 10,754 4,913 11,573 10,474 Probable 11,795 1,659 12,071 15,856 Total proved plus probable 22,549 6,572 23,645 26,330 (1) BOE s may be misleading, particularly if used in isolation. In accordance with NI , a BOE conversion ratio of 6 Mcf: 1barrel is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead. Net Present Value of Reserves Forecasted Prices and Costs Net Present Value of Before Tax Future Net Revenue Discounted at ($000s) 0% 5% 10% 15% 20% Proved Developed producing 117, , ,361 94,023 88,655 Developed non-producing 38,930 32,594 28,022 24,613 21,997 Undeveloped 194, , ,799 99,424 84,324 Total proved 350, , , , ,976 Probable 403, , , , ,923 Total proved plus probable 753, , , , , BLACKPEARL RESOURCES INC.

19 Net Present Value of After Tax Future Net Revenue Discounted at ($000s) 0% 5% 10% 15% 20% Proved Developed producing 117, , ,361 94,023 88,655 Developed non-producing 38,930 32,594 28,022 24,613 21,997 Undeveloped 194, , ,799 99,424 84,324 Total proved 350, , , , ,976 Probable 302, , , ,120 87,725 Total proved plus probable 653, , , , ,701 Notes: Columns may not add due to rounding The pricing assumptions used in the Sproule evaluation are summarized below. Pricing Assumptions Forecast Prices and Costs Edmonton Hardisty WTI Cushing Par Price Lloydblend Alberta 40 API 40 API 20.5 API AECO-C Spot Inflation rate Exchange rate Year (US$/bbl) (CDN$/bbl) (CDN$/bbl) (CDN$/MMBtu) (%/yr) (US$/Cdn$) Escalation rate of 2.0% thereafter Notes: 1) The pricing assumptions were provided by Sproule Associates Limited 2) None of the Company s future production is subject to a fixed or contractually committed price Annual report 17

20 Reconciliation of Company Gross Reserves by Principal Product Type Forecasted Prices and Costs Associated and Light and Medium Oil Heavy Oil Non-Associated Gas Natural Gas Liquids Gross Gross Gross Gross Proved Proved Proved Proved Gross Gross Plus Gross Gross Plus Gross Gross Plus Gross Gross Plus Proved Probable Probable Proved Probable Probable Proved Probable Probable Proved Probable Probable Factors (Mbbl) (Mbbl) (Mbbl) (Mbbl) (Mbbl) (Mbbl) (MMcf) (MMcf) (MMcf) (Mbbl) (Mbbl) (Mbbl) 31-Dec ,543 13,935 22,478 10,286 10,786 21, Extensions Improved Recovery Technical Revisions ,401-2, ,168-8,872-12, Discoveries Acquisitions Dispositions Economic Factors Production , ,542-2, , Dec ,621 11,744 22,365 4,914 1,659 6, Production History The following table indicates the Company s average daily production from its significant fields in 2009 and 2008: Oil(bbl/d) (1) Gas(mcf/d) boe/d Oil(bbl/d) (1) Gas(mcf/d) boe/d Onion Lake 2, ,297 2, ,278 Mooney 1,178 1,469 1,423 1,671 2,605 2,105 Ear Lake Salt Lake LongCoulee/Little Bow 9 2, , Other ,535 1,675 1,815 4,324 5,582 5,254 6,182 8,942 7,672 (1) Includes natural gas liquids 18 BLACKPEARL RESOURCES INC.

21 Management s Discussion and Analysis The following is Management s Discussion and Analysis (MD&A) of the operating and financial results of BlackPearl Resources Inc. for the year ended December 31, These results are being compared with the year ended December 31, The MD&A should be read in conjunction with the Company s audited consolidated financial statements for the twelve months ended December 31, 2009, together with the accompanying notes. References to we, our, us, the Company or BlackPearl means BlackPearl Resources Inc. and its subsidiaries. All dollar amounts are referenced in thousands of Canadian dollars, except where otherwise noted. The consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles (GAAP). Throughout this MD&A the calculation of barrels of oil equivalent (boe) is based on a conversion rate of six thousand cubic feet (mcf) of natural gas for one barrel of oil. Boe may be misleading, particularly if used in isolation. A boe conversion ratio of 6 mcf:1 bbl is based on an energy equivalence conversion method primarily applicable at the burner tip and does not represent a value equivalence at the wellhead. This report includes terms commonly used in the oil and gas industry, such as cash flow and funds from operations which represent cash flow from operating activities expressed before changes in non-cash working capital, and cash flow per share. These terms are used by the Company to analyze operating performance, leverage and liquidity and to provide shareholders and investors with additional information to measure the Company s performance and efficiency and its ability to fund a portion of its future activities. These terms do not have standardized meanings prescribed by GAAP and therefore may not be comparable with the calculations of similar measures for other entities. Consequently, these are referred to as non-gaap measures. Additional information relating to the Company, including its Annual Information Form, is available on SEDAR at This MD&A contains forward-looking information and statements. At the end of this MD&A is an advisory on forwardlooking information and statements. The effective date of this MD&A is February 25, OVERVIEW BlackPearl is a Canadian-based oil and gas company whose common shares are traded on the TSX Exchange under the symbol PXX and on the First North (OMX Nordic Exchange) under the symbol PXXS. BlackPearl s main focus is heavy oil projects in Western Canada and the USA. The Company also holds interests in a number of natural gas properties. BlackPearl s current core properties include: Onion Lake, Saskatchewan heavy oil; Mooney, Alberta heavy oil; and Blackrod, Alberta heavy oil Annual report 19

22 These core properties provide the Company with a combination of short-term cash flow generation, medium-term reserves and production growth, enhanced oil recovery (EOR) development and longer-term reserves and production growth using thermal processes. As part of BlackPearl s overall business plan, management intends to sell the majority of the Company s non-core assets. In early 2010, the Company has accepted offers to sell assets producing approximately 350 boe/day of primarily natural gas assets in Southern Alberta and plans to market for sale a 350 boe/day heavy oil field in Saskatchewan. Additional non-core asset sales are planned over the next two or three years SIGNIFICANT EVENTS The deterioration in the financial markets, which began in 2008 as a result of a credit crisis and global recession, continued throughout The worldwide financial crisis has directly impacted the demand for crude oil and natural gas and resulted in dramatically lower commodity prices compared to BlackPearl has not been immune from these circumstances and this has resulted in significantly lower revenues. The Company has been successful in lowering operating costs and administrative expenses to reduce the effects of lower revenues. On January 1, 2009, the Company amalgamated CODA Holdings (acquired in 2008) with Pearl E&P Canada Ltd. On January 8, 2009, the Company acquired all of the issued and outstanding shares of BlackCore Resources Inc. in exchange for 17,600,000 common shares of the Company, as well as 5,000,160 Class A and 5,000,160 Class B share purchase warrants. Each Class A and Class B warrant allows the holder to acquire one BlackPearl share for a price of $0.60 when the BlackPearl share price reaches a volume-weighted average price for 30 consecutive days of $1.50 and $2.00, respectively. In addition, 2,500,000 common shares of the Company were issued to extinguish the potential contingency payments related to the purchase of lands in the Blackrod area. In conjunction with the acquisition, the Company hired a new management team which was formerly with BlackRock Ventures Inc. Members of the new BlackPearl management team were also the principal shareholders of BlackCore. On January 28, 2009, the Company closed an agreement with Serrano Energy Ltd. (Serrano) to exchange the Company s equity interest in Serrano for an additional 15% interest in the Blackrod area lands (increasing the Company s working interest to 80% in the main project area) and a carried work commitment of $5 million. The Company has become the operator of the Blackrod project. Due, in part, to lower commodity prices, the Company reduced its capital program during 2009 to total expenditures of $27.9 million. In 2008 capital expenditures were $107.4 million. On April 20, 2009, the Company issued 52,334,000 special warrants of BlackPearl at a price of $0.88 per special warrant, for aggregate net proceeds of approximately $43.7 million. Each special warrant was converted into one common share of the Company on May 6, On May 8, 2009, Pearl Exploration and Production Ltd. changed its name to BlackPearl Resources Inc. 20 BLACKPEARL RESOURCES INC.

23 ANNUAL FINANCIAL INFORMATION As at and for the Period Ended 12 months 12 months 15 months $000s, except where noted December 31, 2009 December 31, 2008 December 31, 2007 Total revenues 89, , ,524 Loss from continuing operations and net loss (47,315) (78,862) (227,206) Per share basic (0.19) (0.42) (1.73) Per share diluted (0.19) (0.42) (1.73) Cash flow from operations (1) 29,004 72,120 21,646 Per share basic Per share diluted Capital expenditures 27, , ,246 Total assets 468, , ,865 Common shares outstanding 261, , ,242 (1) Cash flow from operations before working capital changes and cash flow per share do not have standardized meanings prescribed by Canadian generally accepted accounting principles (GAAP) and therefore may not be comparable to similar measures used by other companies. Cash flow from operations before working capital changes includes all cash flow from operating activities and is calculated before changes in noncash working capital. Cash flow from operations before working capital changes is reconciled with net loss on the Consolidated Statements of Cash Flows. Management uses these non-gaap measurements for its own performance measures and to provide its shareholders and investors with a measurement of the Company s efficiency and its ability to fund a portion of its growth expenditures. SELECTED QUARTERLY INFORMATION 31-Dec 30-Sep 30-Jun 31-Mar 31-Dec 30-Sep 30-Jun 31-Mar $000s, except where noted Production (boe/d) 5,306 5,091 5,170 5,510 6,198 5,776 8,246 10,503 Revenue ($/boe) Oil & gas revenue 27,674 24,065 22,143 15,755 20,687 45,180 59,839 57,830 Production costs 7,251 6,172 5,873 10,165 10,299 9,272 11,453 18,883 Net earnings (loss) (1) (3,897) (12,013) (10,889) (20,516) (83,686) 1,926 6,688 (3,790) Per share, basic and diluted ($) (0.01) (0.05) (0.05) (0.10) (0.44) (0.02) Cash flow from operations 14,677 8,221 7,910 (1,804) 3,623 21,021 28,023 19,452 Per share, basic and diluted ($) (0.01) Total assets 468, , , , , , , ,237 Weighted average shares outstanding (000s) 261, , , , , , , ,242 (1) The higher losses in 2009, compared to 2008, are a result of lower commodity prices and higher depletion costs. The loss in the fourth quarter of 2008 was the result of a write-down of the carrying value of the Company s US properties of $57.4 million Annual report 21

24 RESULTS OF OPERATIONS $000s, except where noted Net loss (47,315) (78,862) Per share, basic and diluted ($) (0.19) (0.42) For the year ended December 31, 2009, the Company incurred a net loss of $47.3 million or $0.19 per share compared to a net loss of $78.9 million or $0.42 in The net loss for the current year is principally a result of lower commodity prices and high depletion costs. The 2008 loss is mainly a result of high depletion costs as well, but also includes a $57.4 million write-down of the Company s U.S. oil and gas assets. Commodity Prices Crude oil prices, on average, were weaker in 2009, with the West Texas Intermediate (WTI) reference price averaging US$61.80 per barrel compared with US$99.65 per barrel in Lower 2009 commodity prices were due to decreased demand as a result of the global recession and financial crisis. The WTI forward strip price for 2010 is approximately US$81 although oil prices are expected to remain volatile due to the effects of the economic slowdown on supply and demand. The majority of BlackPearl s production revenues are derived from the sale of heavy oil, which receives a lower price than light oil due to increased processing requirements for a heavy barrel. The difference between the reference price of light oil and the reference price of heavy oil is commonly referred to as the light/heavy differential. The light/heavy differential averaged 17% in 2009 and 22% in The recent light/heavy differential is considerably narrower than the five-year average of approximately 26%, a trend that has been attributed to increased heavy oil refining capacity in the U.S., increased demand for Canadian heavy oil due to reduced supply of heavy oil from Mexico and Venezuela, as well as improved pipeline access for Canadian heavy crude to the Gulf Coast, a heavy oil refining hub. Oil prices in Canada are also impacted by the Canada/U.S. dollar exchange rate since the WTI reference price of oil is in U.S. dollars. During 2009, the Canadian dollar weakened against the U.S. dollar, averaging compared with in The weakening of the Canadian dollar partially offsets the reduced WTI benchmark pricing experienced during In 2009, natural gas prices decreased 54% compared to 2008, reflecting lower demand. The AECO-C gas price averaged $3.75 per GJ in 2009 compared to $8.13 per GJ in As with oil prices, natural gas prices decreased as a result of lower demand caused by slowing economies and warm weather which resulted in higher than normal gas storage levels WTI oil (US$/bbl) Western Canadian Select heavy oil (Cdn$/bbl) Light/heavy differential 17% 22% Foreign exchange rate (Cdn$/US$) AECO natural gas (Cdn$/GJ) BLACKPEARL RESOURCES INC.

25 Oil and Gas Production, Pricing and Revenue Daily production/sales volumes (1) Oil (bbls/d) 4,324 6,182 Natural gas (mcf/d) 5,582 8,942 Combined (boe/d) 5,254 7,672 Product pricing Oil ($/bbl) Natural gas ($/mcf) Combined ($/boe) Revenue ($000s) Oil and gas revenue gross 89, ,536 Royalties (21,262) (45,192) Oil and gas revenue net 68, ,344 (1) Gas production converted at 6:1 Oil and gas revenues decreased 51% in 2009 to $89.6 million compared with $183.5 million in The decrease is attributable to: a 30% decrease in oil production; a 25% decrease in the average oil price; a 38% decrease in natural gas production; and a 49% decrease in the average gas price. On a boe basis, 81% of the Company s oil and gas production was heavy oil. The percentage of revenues derived from heavy oil will likely increase in the future as all of the Company s ongoing development activities will be in heavy oil areas. The Onion Lake area accounted for 44% of total production in 2009 and will contribute a higher proportion in 2010 as it will account for most of BlackPearl s near-term drilling activity Oil (bbls/d) (1) Gas (mcf/d) boe/d Oil (bbls/d) (1) Gas (mcf/d) boe/d Onion Lake 2, ,297 2, ,278 Mooney 1,178 1,469 1,423 1,671 2,605 2,105 Ear Lake Salt Lake Long Coulee/Little Bow 9 2, , Other ,535 1,675 1,815 4,324 5,582 5,254 6,182 8,942 7,672 (1) Includes NGL s 2009 Annual report 23

26 Overall, average production decreased 32% to 5,254 boe/d for the year ended December 31, 2009 compared with 7,672 boe/d in the same period The decrease in 2009 production is attributable to the sale of certain oil and gas properties in May At the time of sale these properties were producing approximately 3,200 boe/d. The decrease in production was also impacted by natural declines and reduced drilling activity in As a result of a fourth quarter drilling program at Onion Lake, the Company exited 2009 with production in excess of 6,000 boe/d. The Company did not enter into any hedging arrangements in 2009, and, at the present time, does not anticipate hedging any of its production in Royalties $000s, except where noted Royalties 21,262 45,192 As a percentage of revenue 24% 25% Royalties decreased 53% from $45.2 million in 2008 to $21.3 million in 2009, mainly reflecting lower revenues and production during 2009, as well as lower commodity prices. The Company s largest area, Onion Lake, is on the Onion Lake First Nation reserve, and royalties are paid to the First Nation based on Saskatchewan Crown equivalent rates. The New Royalty Framework (NRF) in Alberta took effect January 1, The NRF generally increased royalty rates in Alberta, with some sensitivity to well production rates and commodity prices, and also eliminated most royalty incentive and holiday programs. Subsequent to the introduction of the NRF, the Alberta government has introduced various amendments to the royalty structure in response to the economic downturn and the resulting decrease in oilfield activity. These amendments included a 5% royalty for one year for production from new wells drilled after March 31, Approximately 35% of BlackPearl s total production is from Alberta-based properties. The significant areas affected by the new royalty schemes are Mooney and Little Bow/Long Coulee. Mooney has higher volume wells, which was negatively affected by the NRF royalty changes; Little Bow/Long Coulee have low productivity wells and pay lower royalties than under the old royalty structure. The Alberta government is currently undertaking a review of the energy sector to determine if, among other things, the royalty structure in Alberta is competitive with other jurisdictions. Results of this review are expected in the first quarter of Production Costs $000s, except where noted Production costs 29,461 49,907 Per boe ($) BLACKPEARL RESOURCES INC.

27 The 41% decrease in overall production costs in 2009 versus 2008 is the result of lower production levels. Production costs on a per boe basis averaged $15.36 in 2009, a decrease from $17.77 in The lower rates are due to improved operating efficiencies resulting in lower labour costs, fuel and chemical usage and improved sandhandling processes. Management expects production expenses will remain on the order of $15 per boe in New heavy oil wells tend to have higher initial expenses due to increased sand production but these fixed costs can be reduced on a per boe basis by higher production. Transportation Costs $000s, except where noted Transportation costs 3,466 3,664 Per boe ($) Transportation costs are incurred to move marketable crude oil and natural gas to their selling points. Average transportation costs in 2009 were $1.81 per boe which is an increase from the $1.30 realized in Changes in transportation costs are generally related to moving crude oil to different sales points to capture better marketing opportunities. Operating Netback Revenues Royalties Transportation costs Production costs Netback per boe The 2009 netback of $18.48 per boe is considerably lower than the $30.18 reported in 2008, but is consistent with the lower oil and gas prices during the year. General and Administrative Expenses (G&A) $000s, except where noted Gross G&A expense (before provision for bad debts) 9,681 16,075 Operator recoveries (1,446) (2,891) 8,235 13,184 Provision for bad debts (1,322) 1,816 Net G&A expense 6,913 15,000 Per boe ($) The decrease in general and administrative costs is a result of staff reductions implemented early in 2009 as well as other cost reduction initiatives adopted by the Company that resulted in savings in areas such as outside consulting fees, travel costs and office expenses Annual report 25

28 In 2008, BlackPearl recorded a provision for bad debts of $1.8 million. This included taking a $0.6 million provision for receivables due from SemCanada Crude Company and SemCanada Energy Company, which filed for creditor protection in Canada and the United States. In 2009, as a result of collecting some of the receivables we had taken provision for in prior years, as well as exercising our right of offset to net some of our liabilities against receivables, we were able to reduce the provision for bad debts previously set up, resulting in a recovery of $1.3 million in Net general and administrative costs are expected to be in the area of $8 million in As production volumes are expected to increase in 2010, general and administrative costs on a boe basis should decline. Depletion, Depreciation and Accretion (DD&A) $000s, except where noted Depletion, depreciation and accretion 81,100 85,385 Per boe ($) DD&A expense was $81.1 million or $42.29 per boe for 2009 in comparison to $85.3 million or $30.41 per boe for Although production decreased in 2009, the Company still recognized a higher depletion rate as a result of a significant reduction in proved reserves as detailed in the Company s 2008 reserve report. Proved reserves increased in the 2009 report and, as a result, the Company expects a slightly lower depletion rate in A write-down in the amount of $2.9 million of the US assets has been included in 2009 depletion, depreciation and accretion in the Company s December 31, 2009 financial statements. Stock-Based Compensation $000s, except where noted Stock-based compensation 1,461 3,116 Per boe ($) The Company uses the fair value method of accounting for stock options granted to directors, officers, employees and consultants whereby the fair value of all stock options granted is recorded as a charge to operations. The fair value of common share options granted is estimated on the date of grant using the Black-Scholes options pricing model. In 2009, the Company issued 6.3 million options at prices ranging from $0.63 to $2.21 per share. In addition, 0.3 million options were exercised and 3.7 million were forfeited. The reduction in expenses for 2009 is a result of a large number of options being forfeited by former employees during the period. Any previous expense recorded that related to the unvested forfeited options was reversed in the current period. 26 BLACKPEARL RESOURCES INC.

29 Interest Expense $000s, except where noted Interest income (321) (1,511) Interest expense Net interest expense (income) (44) (683) Per boe ($) (0.02) (0.24) Interest expense consists mainly of standby fees on the Company s undrawn credit facility. Any interest earned on excess cash held by the Company is netted against interest expense. The decrease in 2009 is a result of less favourable interest rates on excess cash during the year. Income Taxes $000s, except where noted Current income and other taxes (2,351) (517) Future income tax (recovery) (5,634) 4,066 (7,985) 3,549 BlackPearl pays Saskatchewan resource surcharge based on its production revenues in the province. The recovery of current income tax in 2009 is the result of amendments filed on previously paid amounts for Saskatchewan resource surcharge. The Company does not have any current income tax payable and does not expect to pay current income taxes in The Company has the following estimated tax pools as at December 31, 2009: $000s, except where noted Rate % Canadian exploration expenses 100 $ 9,581 $ 9,353 Canadian development expenses , ,840 Canadian oil and gas property expenses 10 15,128 12,701 Undepreciated capital costs , ,532 Non-capital losses (various expiry dates) ,173 64,107 Share issuance costs 5 years 10,419 12,435 $ 420,964 $ 410,968 The provision for future income taxes in 2009 is a recovery of $5.6 million compared to an expense of $4.1 million in The significant write-down in 2008, together with the net loss in 2009, triggered the recovery. LIQUIDITY AND CAPITAL RESOURCES BlackPearl began 2009 with a working capital position of $6.5 million and an undrawn credit facility of $47 million. However, in the first quarter, due to low commodity prices, the Company did not generate any positive cash flow from operations. Management is committed to a philosophy of funding capital budgets from available cash flow from operations, working capital, non-core asset sales, equity financings and minimizing the use of debt. As a result, early in the year BlackPearl reduced capital expenditures to a minimum and conserved its working capital. Due to the economic slowdown and uncertainty in the financial and credit markets, access to additional capital was limited Annual report 27

30 In the spring, oil prices began to improve and financial markets began to stabilize. The Company s cash flow was improving but was insufficient to fund a meaningful capital program. With the equity markets opening up management completed an offering of 52.3 million common shares at $0.88 per share, which raised net proceeds of $43.7 million. This financing provided the financial flexibility to plan a capital expenditure program for the next 12 to 18 months that was not completely tied to the generation of operating cash flow. With the successful equity placement, the Company opted to reduce its credit facility to $25 million to reduce standby fees and other charges. The amount available under the credit facility is based on the value of oil and gas reserves. The next annual review of the Company s credit facility is scheduled to be completed by May 31, At December 31, 2009, BlackPearl had a working capital position of $58 million and an undrawn credit facility. The only financial covenant in the Company s credit facility is to maintain a working capital ratio of 1:1 at the end of each fiscal quarter. Working capital ratio is defined as current assets plus unutilized credit under the credit facility compared to current liabilities. The Company had a working capital ratio of 6.1:1 at December 31, 2009 and was in compliance with these covenants throughout Cash flow from operations was $29.0 million in 2009, compared to $72.1 million in The decrease is a direct result of lower commodity pricing and lower production levels in CAPITAL EXPENDITURES BlackPearl s capital program is focused on heavy oil opportunities. During 2009, BlackPearl s capital program totalled $27.9 million, a significant decrease from the $107.4 million spent in $000s Land 3,692 4,559 Seismic 168 3,083 Drilling and completion 18,849 57,107 Equipment 5,169 35,804 Other 561 Total exploration and development 27, ,114 Property acquisitions 6,253 Total capital expenditures 27, ,367 Property dispositions (250) (79,097) Net capital expenditures 27,628 28, BLACKPEARL RESOURCES INC.

31 SEGMENTED INFORMATION The Company presently has one reportable business segment, that being oil and gas exploration, development and production. The Company s operations are located in the following geographic locations: 2009 $000s Canada U.S. Consolidated Total revenues, net of royalties $ 67,922 $ 453 $ 68,375 Net loss (42,876) (4,439) (47,315) Segment assets 461,529 6, ,309 Capital additions $ 25,837 $ 2,041 $ 27, $000s Canada u.s. Consolidated Total revenues, net of royalties $ 136,440 $ 1,904 $ 138,344 Net income (20,921) (57,941) (78,862) Segment assets 459,659 12, ,143 Capital additions $ 86,765 $ 20,602 $ 107,367 CONTRACTUAL OBLIGATIONS AND CONTINGENCIES The Company has a number of financial obligations in the ordinary course of business. The following table summarizes the outstanding contractual obligations and commitments of the Company as at December 31, 2009: $000s Thereafter Long-term debt Operating leases (1) 1,098 1,166 1,234 1,234 1,626 2,946 Drilling rig commitment (2) , ,714 2,101 2,445 1,553 1,626 2,946 (1) Relates to a lease for office premises, including estimated operating costs (net of sublease recoveries). The Company s office lease was executed jointly with another party. Under the terms of the lease, BlackPearl and the other party are joint and severally liable for the obligations pursuant to the lease. Accordingly, if the other party or any of the subtenants of a portion of the space are unable to fulfill their lease obligation, BlackPearl would be required to pay an additional $19.3 million (including an estimate for operating costs) over the next seven years. (2) Relates to a commitment to utilize a drilling rig from a specific company for a minimum number of days per year. These obligations are expected to be funded from operating cash flow. The Company also has ongoing obligations related to the abandonment and reclamation of well sites and facilities which have reached the end of their economic lives. Remediation programs are undertaken regularly in accordance with applicable legislative requirements. FINANCIAL INSTRUMENTS AND OTHER INSTRUMENTS At December 31, 2009, BlackPearl s financial assets and liabilities primarily consisted of cash, accounts receivable, taxes receivable and accounts payable and accrued liabilities. The Company is exposed to commodity price risk, foreign exchange risk, credit risk, interest rate and liquidity risks associated with these financial assets and liabilities Annual report 29

32 A description of these risks as they relate to BlackPearl is provided below. The Company has not entered into any derivative financial instruments or any other hedging activities to reduce these risks. Commodity Price Risk Commodity price risk is the risk that future cash flows will fluctuate as a result of changes in the price of oil and natural gas. Commodity prices are impacted by world economic events that affect supply and demand, which are generally beyond the Company s control. Changes in crude oil and natural gas prices may significantly affect the Company s results of operations, costs generated from operating activities, capital spending and the Company s ability to meet its obligations. The majority of the Company s production is sold under short-term contracts; consequently, BlackPearl is at risk to near-term price movements. A $1.00 change in oil prices at the wellhead would have altered net earnings for 2009 by approximately $1.2 million. The Company manages this risk by constantly monitoring commodity prices and factoring them into operational decisions, such as contracting or expanding its capital expenditures program. Throughout 2009, the Company did not use derivative financial instruments to manage its exposure to this risk. Foreign Currency Exchange Risk The Company is exposed to risks arising from fluctuations in foreign currency exchange rates and the volatility of those rates. This exposure primarily relates to: (i) prices received for its crude oil and natural gas are primarily determined in reference to U.S. dollars; (ii) certain expenditure commitments, deposits, accounts receivable, and accounts payable which are denominated in U.S. dollars, and (iii) its operations in the United States. The Company manages this risk by monitoring foreign exchange rates and evaluating their effects on using Canadian or U.S. vendors as well as timing of transactions. As at December 31, 2009, the Company has not entered into any fixed rate contracts. As at December 31, 2009, the Company held US$2,302,000 in cash and short-term deposits and other net working capital items of US$2,159,000. As at December 31, 2009, if US$ exchange rates had been $0.10 lower with all other variables held constant, after-tax earnings for the period would have been approximately $543,000 higher, due to a decreased foreign exchange loss. An equal but opposite impact would have occurred to net earnings had exchange rates been $0.10 higher. The Company does not hedge its foreign currency risk. Credit Risk Credit risk is the risk that a third party fails to meet its contractual obligations that could result in the Company incurring a loss. The Company s accounts receivable are primarily with oil and gas marketers and joint-venture partners. Receivables from oil and gas marketers are generally collected on the 25th day of the month following production. The Company attempts to mitigate this risk by assessing the financial strength of its counterpart and entering into relationships with larger purchasers with established credit history. During 2009, the Company did not experience any collection issues with its marketers. At December 31, 2009, more than 81% of total accounts receivables were for revenue accruals. Receivables from joint-venture partners arise when the Company conducts joint operations on behalf of its partners and invoices them for their share of costs. To mitigate the risk of non-payment from joint-venture partners the Company can 30 BLACKPEARL RESOURCES INC.

33 require partners to pay certain costs in advance or can withhold production from partners in the event of non-payment. As at December 31, 2009, accounts receivable included an allowance for doubtful accounts of $826,000 from jointinterest partners. These amounts primarily relate to joint-venture receivables inherited from other companies that were acquired by BlackPearl over the last three years. The Company typically does not obtain collateral or security from its joint-venture partners or oil and gas marketers. The carrying amounts of accounts receivable represent the maximum credit exposure. The Company is not the operator of certain oil and gas properties in which it has an ownership interest. The Company is dependent on such operators for the timing of activities related to these properties and will largely be unable to direct or control the activities of the operators. In addition, the Company s activities may be impacted by the ability, expertise, judgement and financial capability of the operators. As at December 31, 2009, one of the operators of a U.S. property in which the Company has an interest had filed for creditor protection in U.S. bankruptcy court and had failed to pay certain suppliers, resulting in various liens on the property. Subsequent to December 31, 2009 the operator sold its interest in the property and the liens are in the process of being removed. As at December 31, 2009, the Company held $56.4 million in cash at various financial institutions throughout Canada and the U.S., as well as $1.3 million in investments. At December 31, 2009, two Canadian financial institutions held approximately 95% of the Company s cash and short-term deposits. Cash balances in excess of the Company s day-today requirements are invested in short-term deposits of less than 30 days. Interest Rate Risk Interest rate risk refers to the risk that a financial instrument or cash flows associated with the instrument will fluctuate due to changes in market interest rates. The Company is exposed to interest rate risk in relation to interest expense on its revolving credit facility due to the floating interest rate charged on advances. At this time, the Company is not drawn on this facility and, as a result, the Company considers this risk to be limited. In addition, the Company is exposed to interest rate risk on its excess cash balances and certain investments. Liquidity Risk Liquidity risk is the risk the Company is unable to meet its financial obligations as they come due. The Company uses operating cash flows, bank credit facilities and equity offerings to fund its capital requirements. The Company manages this risk by maintaining a conservative balance sheet with minimal use of long-term debt. As at December 31, 2009, the Company had an undrawn $25 million credit facility, and a positive working capital position of $58.0 million. The Company believes it has sufficient funding from these sources to meet its foreseeable obligations. The maturity dates for the Company s financial liabilities are as follows: <6 Months 6 months 1 Year 1-2 Years Accounts payable and accrued liabilities $ 16,318 OFF-BALANCE SHEET ARRANGEMENTS The Company has no off-balance sheet arrangements Annual report 31

34 OUTSTANDING SHARE DATA As at February 25, 2010, the Company had 262,024,051 common shares outstanding, 10,000,320 vested warrants outstanding and 13,390,999 stock options outstanding under its stock-based compensation. RELATED PARTY TRANSACTIONS Namdo Management Services Ltd. (Namdo) provided executive and support services to the Company. During 2009, the Company paid Namdo $45,000 (2008 $180,000). Namdo is a private corporation owned by a former director of the Company. PROPOSED TRANSACTIONS The Company has accepted offers to sell certain oil and gas properties, producing approximately 350 boe/day, for about $10 million. The offers are subject to completion of the purchaser s due diligence and execution of a formal binding purchase and sale agreement. CRITICAL ACCOUNTING ESTIMATES The preparation of financial statements requires management to make estimates and assumptions that affect reported assets and liabilities, disclosure of contingencies and revenues and expenses. Management is also required to adopt accounting policies that require the use of significant estimates. Actual results could differ materially from those estimates. A comprehensive discussion of the Company s significant accounting policies adopted by BlackPearl can be found in notes 2 and 3 to the Consolidated Financial Statements. Management believes the most critical accounting policies, including judgements in their application, which may have an impact on the Company s financial results, relate to the accounting for property, plant and equipment, and asset retirement obligations (ARO). The rate at which the Company s assets are depreciated or otherwise written off and the asset retirement liability provided for, with the associated accretion expensed to the income statement, are subject to a number of judgements about future events, many of which are beyond management s control. Reserves recognition is central to much of the accounting for an oil and gas company, as described below. The following areas contain estimates made by management: (i) Oil and natural gas reserves Estimating oil and gas reserves is a subjective process. It requires significant judgements using geological, engineering and economic data. Some of the important assumptions made in preparing an estimate of oil and gas reserves include expected reservoir performance, future rates of production, oil and gas price forecasts, future operating and development costs, timing of expenditures and future fiscal regimes. These estimates can change substantially as additional data from ongoing development activities and production performance becomes available and as economic conditions change. The Company s oil and gas reserves are evaluated by Sproule Associates Limited, an independent reserve evaluator. Reserves estimates can have a significant impact on net earnings, as they are a key component in the calculation of depletion. The reserve estimates are also used in determining the Company s borrowing base for its credit facilities. 32 BLACKPEARL RESOURCES INC.

35 (ii) Depreciation, depletion and accretion expense BlackPearl uses the full cost method of accounting for exploration and development activities whereby all costs associated with these activities are capitalized whether successful or not. The aggregate of capitalized costs, net of certain costs related to unproved properties, and estimated future development costs is amortized using the unit-of-production method based on estimated proved reserves. Changes in estimated proved reserves or future development costs have a direct impact on depreciation and depletion expense. Certain costs related to unproved properties and major development projects may be excluded from costs subject to depletion until proved reserves have been determined or their value is impaired. These properties are reviewed quarterly to determine if proved reserves should be assigned, at which point they would be included in the depletion calculation. In the case of impairment, any write-down would be charged to depreciation and depletion expense. (iii) Ceiling test The Company is required to review the carrying value of all property, plant, and equipment for potential impairment. Impairment is indicated if the carrying value of the long-lived asset or oil and gas cost centre is not recoverable by the future undiscounted cash flows. If impairment is indicated, the amount by which the carrying value exceeds the estimated fair value of the long-lived asset is charged to earnings. The ceiling test is based on estimates of reserves prepared by qualified independent evaluators, production rate, crude oil and natural gas prices, future costs and other relevant assumptions. By their nature, reserve estimates are subject to measurement uncertainty and the impact of ceiling test calculations on the consolidated financial statements of changes to reserve estimates could be material. At December 31, 2009, the carrying value of the Company s Canadian oil and gas properties (less the amount for unproved properties) exceeded the undiscounted cash flows from proved properties only; therefore, assessing impairment using discounted cash flows from both proved and probable reserves was required. In performing this test, proved plus probable reserves were discounted at a risk-free rate of 4%. This calculation resulted in the discounted cash flows exceeding the carrying value of the oil and gas properties by approximately $235.5 million, and therefore no impairment was recorded. As at December 31, 2009 the Company recorded a $2.9 million write-down of its U.S. oil and gas assets as this represents their salvage value. (iv) Asset retirement obligation The asset retirement obligation is estimated based on existing laws, contracts or other policies. The fair value of the obligation is based on estimated future costs for abandonment and reclamation, discounted at a credit-adjusted risk-free rate. The costs are included in property, plant and equipment and amortized over their useful life. The liability is adjusted each reporting period to reflect the passage of time, with the accretion charged to earnings and for revisions to the estimated future cash flows. The estimates or assumptions required to calculate asset retirement obligation includes, among other items, abandonment and reclamation amounts, inflation rates, credit-adjusted discount rates and timing of retirement of assets. By their nature, these estimates are subject to measurement uncertainty and the impact on the financial statements could be material Annual report 33

36 The following significant assumptions were assumed for the purpose of estimating asset retirement obligation: Undiscounted abandonment costs ($000s) $ 38,290 $ 34,600 Credit-adjusted risk-free rate 6.5% 6.5% Inflation rate 2% 2% Average years to reclamation (v) Income taxes The Company follows the liability method of accounting for income taxes. Under this method the Company records future income tax assets and liabilities based on temporary differences between the carrying value and tax basis of the Company s assets and liabilities. Future income tax provisions require estimating the timing of these temporary differences and estimating whether tax assets will be realized before expiry. The determination of the Company 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 the lapse of considerable time. Accordingly, the actual income tax liability may differ significantly from that estimated and recorded. In addition, the Company is required to estimate whether it will be able to utilize all of its existing tax pools before their expiry. (vi) Stock-based compensation The Company uses the fair value method to account for stock options. The determination of the amounts for stock-based compensation is based on estimates of stock volatility, risk-free interest rates and the expected lives of the option. By their nature, these estimates are subject to measurement uncertainty. (vii) Other estimates The Company is required to make certain estimates for revenues, royalties, operating costs and capital expenditures as at a specific reporting date if actual amounts for these items have not been received. RISKS AND UNCERTAINTIES The Company is exposed to a number of risks and uncertainties inherent in exploring for, developing and producing crude oil and natural gas. These risks and uncertainties include, but are not limited to, the following: risk of fluctuating oil and natural gas prices; operational risk of finding and producing reserves economically; uncertainties associated with estimating the quantity of reserves; risk associated with securing the needed capital to carry out the Company s operations; changes in global economic conditions, particularly in Canada and the U.S.; risk of changes in government policies, especially related to royalty legislation, income tax laws, incentive programs, operating practices and environmental protection, social instability or other political, economic or diplomatic developments in its operations, risk of changes to interest rates; environmental and safety risks related to its oil and gas properties; competition for, among other things, capital, undeveloped land, skilled labour and equipment; risk of fluctuating foreign currency exchange rates; 34 BLACKPEARL RESOURCES INC.

37 credit or counterparty risk with respect to non-performance by counterparties to financial instruments; risk of changes to interest rates; marketing reserves at acceptable prices; uncertainty associated with obtaining drilling licenses and other regulatory consents and approvals; and production risks associated with sour hydrocarbons. Further information regarding these risks may be found under the heading Risk Factors in the Annual Information Form. Many of the previously mentioned risks are beyond the Company s control and it is impossible to ensure that any exploration drilling program or piloting program will ultimately result in commercial operations. The Company does not currently utilize derivative instruments to hedge its commodity price, foreign currency exchange or interest rate risks. BlackPearl strives to minimize and manage these risks in a number of ways, including: Employing qualified professional and technical staff; Maintaining a healthy balance sheet that minimizes the use of debt; Carrying insurance to provide a reasonable amount of protection from risk of loss; Communicating openly with members of the public regarding its activities; Concentrating in areas with long-life reserves to reduce the risk associated with commodity price cycles; Monitoring price trends and establishing relationships with creditworthy counterparties; Utilizing the latest technology for finding and developing reserves; Constructing high-quality, environmentally sensitive and safe production facilities; and Maximizing operational control of drilling and producing operations. Environmental Risks 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. In addition, in December 2009, Canada was a signatory to the United Nations Framework Convention on Climate Change (Copenhagen Accord) which committed Canada to quantified economy-wide emissions targets for 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, the Copenhagen Accord or as otherwise determined, could have a material impact on the nature of oil and natural gas operations, including those of the Company. 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 either the nature of those requirements or the impact on the Company and its operations and financial condition Annual report 35

38 NEW ACCOUNTING STANDARDS ADOPTED January 1, 2009, the Company adopted the new CICA Handbook Sections 3064 Goodwill and Intangible Assets ; 1582 Business Combinations ; 1601 Consolidated Financial Statements, 1602 Non-controlling Interests and amendments to Section 3862 Financial Instruments Disclosures. The adoption of these standards has had no material impact on the Company s net income or cash flows. Additional information on the implementation of these new standards can be found in Note 3 to the Company s Annual Audited Consolidated Financial Statements. RECENT ACCOUNTING PRONOUNCEMENTS International Financial Reporting Standards In January 2006, the CICA Accounting Standards Board (AcSB) adopted a strategic plan for the direction of accounting standards in Canada. As part of that plan, the Accounting Standards Board confirmed in February, 2008 that International Financial Reporting Standards (IFRS) will replace Canadian GAAP for interim and annual reporting purposes. The required changeover date is for fiscal years beginning on or after January 1, The Company has commenced the process to transition from current Canadian GAAP to IFRS. There are three phases in the process: diagnostic, detailed assessment and design and implementation. The Company has completed a high level review of the major differences between current Canadian GAAP and IFRS and has commenced the detailed assessment and design phase of the project. The Company s internal staff has been appointed the task of performing the actual conversion, while the Company s external auditors have been engaged to act as advisors. A comprehensive analysis of the impact of the IFRS differences, identified in the initial diagnostic assessment, is currently being performed and documented. The Company has identified property, plant and equipment, asset retirement obligations, income taxes and impairment testing as areas that may be significantly affected by the changeover to IFRS. Establishing new IFRS accounting policies has begun and is expected to be completed by the end of the first quarter of The Company also expects to have an opening balance sheet (January 1, 2010) that is in accordance with IFRS by the end of the first half of One of the major steps for many oil and gas companies moving to IFRS is transitioning away from the full cost accounting method for property, plant and equipment costs. The full cost method is not supported by IFRS. The International Accounting Standards Board has approved a transition amendment to IFRS 1 First Time Adoption of IFRS that will allow Canadian oil and gas companies that use the full cost method of accounting for exploration and development activities to use their independent reserve report to allocate their property, plant and equipment full cost pool to individual cash generating units, which is required under IFRS. BlackPearl has elected to utilize this exemption. During the implementation phase, the Company will execute the required changes to business processes, financial systems, accounting policies, disclosure controls and internal controls over financial reporting. At this time, the impact on financial statements cannot be reasonably determined. 36 BLACKPEARL RESOURCES INC.

39 CONTROL CERTIFICATION Disclosure Controls and Procedures Disclosure controls and procedures have been designed to ensure that information required to be disclosed by the Company is accumulated and communicated to management to allow for timely decisions regarding required disclosures. The Company carried out an evaluation and effectiveness of the Company s disclosure controls and procedures as at December 31, The evaluation was carried out under the supervision and with the participation of the Chief Executive Officer and the Chief Financial Officer. The Company s Chief Executive Officer and Chief Financial Officer, together with management, have concluded, based on their evaluation of the effectiveness of the Company s disclosure controls and procedures as at year-end, that the Company s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company is (i) recorded, processed, summarized and reported within the time periods specified in Canadian securities law and (ii) accumulated and communicated to the Company s management, including its Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. It should be noted that while the Company s Chief Executive Officer and Chief Financial Officer believe that the Company s disclosure controls and procedures provide a reasonable level of assurance that they are effective, they do not expect that the disclosure controls and procedures will necessarily prevent all errors and fraud. A control system, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Internal Controls over Financial Reporting The Company s Chief Executive Officer and Chief Financial Officer have designed, or caused to be designed under their supervision, internal control over financial reporting to provide reasonable assurance regarding the reliability of the Company s financial reporting and the preparation of financial statements for external purposes in accordance with Canadian GAAP. Such officers have evaluated, or caused to be evaluated under their supervision, the effectiveness of the Company s internal control over financial reporting at the financial year-end of the Company and concluded that the Company s internal control over financial reporting is effective, at the financial year-end of the Company, for the foregoing purpose. The Company is required to disclose herein any change in the Company s internal control over financial reporting during the period that has materially affected, or is reasonably likely to materially affect, the Company s internal control over financial reporting. No material changes in the Company s internal control over financial reporting were identified during such period that has materially affected, or are reasonably likely to materially affect, the Company s internal control over financial reporting. It should be noted that a control system, including the Company s disclosure and internal controls and procedures, no matter how well conceived, can provide only reasonable, but not absolute, assurance that the objectives of the control system will be met and it should not be expected that the disclosure and internal controls and procedures will prevent all errors or fraud Annual report 37

40 FOURTH QUARTER 2009 ACTIVITIES Crude oil prices increased by 12% in the fourth quarter 2009 from the third quarter, with WTI oil averaging US$76.19 per barrel. Heavy oil prices also increased from the third quarter. The Bow River Heavy oil price differential averaged US$10.93 per barrel in the fourth quarter compared to US$9.30 per barrel in the third quarter. The increase in commodity prices is attributable to a slight increase in demand as markets slowly start to recover from the recent worldwide economic downturn, which originally caused a lower demand for commodities. This also resulted in an increase in BlackPearl s average wellhead price from $51.94 in Q3 to $56.69 in Q4. BlackPearl sold an average of 5,306 boe per day during the fourth quarter, an increase of 4% over the third quarter level. The increased sales volumes are attributable to continued development at Onion Lake. Production revenues were $27.7 million in the fourth quarter of 2009 compared to $24.1 million in the third quarter, due to the increase in wellhead prices. Operating costs increased slightly from the third quarter, averaging $14.85 per barrel from $ The slight increase is a result of 25 new wells coming online at Onion Lake during Q4. Operating costs were incurred on those wells without a full month of production. Cash flow from operations and net loss in the fourth quarter were $14.7 million and $3.9 million, respectively, compared to $8.2 million and $12.0 million, respectively in the third quarter. The increased cash flow in the fourth quarter of 2009 was due to the increase in heavy oil prices. The net loss in the fourth quarter of 2009 was due to the high depletion rate that was present throughout Capital expenditures in the fourth quarter of 2009 were $17.6 million, 181% higher than in the third quarter. The increase is a result of the drilling of 28 wells at Onion Lake during Q4. OUTLOOK In 2010, BlackPearl is planning an $85-$90 million capital expenditure program. The major components of this program will include: Onion Lake area $30 million: activities to include drilling 50 primary development wells and upgrading infrastructure; Blackrod area $17-$20 million: activities to include constructing a single-well SAGD pilot, with associated infrastructure; and Mooney area $25-$30 million: activities to include constructing the first phase of a commercial polymer flood. The funding for this program is expected to come from existing working capital ($58 million at December 31, 2009), cash flow from operations of $40-$50 million (see below) and possible non-core asset sales ($10-$30 million). Although the Company has a $25 million un-drawn credit facility, management does not expect to utilize this facility to fund the 2010 capital program. If commodity prices drop and cash flow is not as high as anticipated the Company could reduce its capital program, initially by reducing the number of wells drilled at Onion Lake. 38 BLACKPEARL RESOURCES INC.

41 Production in the first quarter of 2010 is expected to be between 6,000 and 6,500 boe/d. The planned capital spending at Blackrod and Mooney will not immediately add to this production base; however, drilling at Onion Lake is expected to result in a 2010 exit rate of 7,500-8,000 boe/d, net of natural declines from base production. These production volumes could be impacted by non-core asset sales. Management expects to sell the Southern Alberta gas properties during the first quarter of 2010 which are producing approximately 350 boe/d and has started to market a heavy oil field that is currently producing approximately 350 boe/d. Based on an average production rate of 6,400 boe/d, management expects to generate cash flow from operations of $45-$50 million, assuming WTI oil prices of US$72, a light/heavy differential of US$10 and a US/CDN dollar exchange rate of Sensitivities The significant factors that would affect forecast cash flows include commodity prices, heavy oil differentials, exchange rates and production volumes. The following table summarizes the approximate effect changes in these factors could have on the Company s 2010 performance: ($000s, except production data) Cash Flow Net Earnings Price change US$5 per barrel decrease in the price of WTI oil 7,480 7,480 US$2 per barrel increase in the light/heavy differential 2,992 2,992 Exchange rate $0.05 change in US/CDN rate 4,488 4,488 Production rate 500 barrel per day change 4,753 2,227 BlackPearl has no specific plans to access additional capital in 2010; however, this will be reviewed internally on a regular basis. In summary, 2010 will be more active than Management believes the Company has a strong suite of assets and that stabilized prices, as well as a strong balance sheet, will help further develop BlackPearl s core properties Annual report 39

42 FORWARD-LOOKING STATEMENTS This report contains certain forward-looking statements and forward-looking information within the meaning of applicable Canadian securities legislation (collectively referred to as forward-looking statements ). All statements other than statements of historical fact may be forward-looking statements. Forward-looking statements are often, but not always, identified by the use of words such as anticipate, believe, plan, continuous, estimate, expect, may, will, project, should, predict, targeting, seek, intend, could, potential or similar words. These statements involve known and unknown risks, uncertainties and other factors that may cause actual results or events to differ materially from those anticipated in such forward-looking statements. The Company believes the expectations reflected in those forward-looking statements are reasonable but no assurance can be given that these expectations will prove to be correct and such forward-looking statements should not be unduly relied upon. In particular, this report contains forward-looking statements pertaining to the following: business plans and strategies; capital expenditure programs; methods and ability to finance capital expenditure programs; future oil and gas prices and their impact on BlackPearl; the quantity of reserves; anticipated production levels; future costs including operating and administrative costs and royalty rates; future cash flows and its uses; future earnings; future asset dispositions; and tax pools. Actual results could differ materially from the results anticipated in these forward-looking statements as a result of several risk factors. These factors include, but are not limited to, volatility of oil and natural gas prices, ability to replace reserves, uncertainties associated with estimating oil and gas reserves, substantial capital requirements and the Company s ability to access additional capital, risks and uncertainties inherent in exploration and development activities, government regulation and changes in legislation, environmental matters, aboriginal claims, dependence on key personnel, availability of drilling equipment and skilled personnel, expiration of licenses and leases, competition, conflicts of interest, issuance of debt or equity, title to properties, variations in exchange rates and hedging and uncertainty in global financial markets. Further information regarding these risk factors may be found under the heading Risk Factors in the Annual Information Form. 40 BLACKPEARL RESOURCES INC.

43 With respect to forward-looking statements contained in this report, management has made assumptions regarding future production levels; future oil and gas prices; future operating costs; timing and amount of capital expenditures; the ability to obtain financing on acceptable terms; availability of skilled labour and drilling and related equipment; general economic and financial market conditions; continuation of existing tax and regulatory regimes; and the ability to market oil and natural gas successfully to current and new customers. A description of some of the assumptions used for 2010 are located in the Outlook section of this MD&A. Although management considers these assumptions to be reasonable based on information currently available to it, they may prove to be incorrect. Statements relating to reserves are forward-looking statements, as they involve the implied assessment, based on certain estimates and assumptions that the reserves described exist in the quantities predicted or estimated and can profitably be produced in the future. Undue reliance should not be placed on forward-looking statements, which are inherently uncertain, are based on estimates and assumptions, and are subject to known and unknown risks and uncertainties (both general and specific) that contribute to the possibility that the future events or circumstances contemplated by the forward-looking statements will not occur. There can be no assurance that the plans, intentions or expectations upon which forward-looking statements are based will in fact be realized. Actual results will differ, and the difference may be material and adverse to the Company and its shareholders. Readers are also cautioned that the foregoing list of factors and risks is not exhaustive. Consequently, there is no representation by the Company that actual results achieved will be the same in whole or in part as those set out in the forward-looking information. Furthermore, the forward-looking statements contained in this report are made as of the date hereof, and the Company does not undertake any obligation, except as required by applicable securities legislation, to update publicly or to revise any of the included forward-looking statements, whether as a result of new information, future events or otherwise. The forward-looking statements contained herein are expressly qualified by this cautionary statement Annual report 41

44 Management s Report The accompanying Consolidated Financial Statements of BlackPearl Resources Inc. and related financial information presented in this annual report are the responsibility of Management and have been approved by the Board of Directors. The Consolidated Financial Statements have been prepared in accordance with Canadian generally accepted accounting principles. The Consolidated Financial Statements and related financial information reflect amounts which must, of necessity, be based upon informed estimates and judgments of Management with appropriate consideration to materiality. All financial information contained in the annual report is consistent, where appropriate, with that contained in the Consolidated Financial Statements. The Company has developed and maintains systems of internal controls, policies and procedures in order to provide reasonable assurance as to the reliability of the financial records and the safeguard of assets. PricewaterhouseCoopers, LLP, independent external auditors appointed by the shareholders of the Company, review BlackPearl Resources Inc. s systems of internal controls and conduct their work to the extent they deem appropriate. They have examined the Consolidated Financial Statements and they have expressed an opinion on the statements. Their report is included in the Consolidated Financial Statements. The Board of Directors has established an Audit Committee. The Audit Committee reviews with Management and the external auditors any significant financial reporting issues, the financial statements, and any other matters of relevance to the parties. The Audit Committee meets quarterly to review and approve the interim financial statements prior to their release, as well as annually to review the Company s annual financial statements and Management s discussion and analysis, and to recommend their approval to the Board of Directors. The external auditors have unrestricted access to the Company, the Audit Committee and the Board of Directors. John L. Festival President and Chief Executive Officer Donald W. Cook Chief Financial Officer February 24, BLACKPEARL RESOURCES INC.

45 Auditors Report February 25, 2010 To the Shareholders of BlackPearl Resources Inc. We have audited the consolidated balance sheets of BlackPearl Resources Inc. as at December 31, 2009 and 2008 and the consolidated statements of operations, comprehensive loss and deficit, and cash flows for the periods then ended. These consolidated financial statements are the responsibility of the company s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the company as at December 31, 2009 and 2008 and the results of its operations and its cash flows for the periods then ended in accordance with Canadian generally accepted accounting principles. Chartered Accountants Calgary, Alberta 2009 Annual report 43

46 Consolidated Balance Sheets As at December 31 (audited) (Cdn$ in thousands) Assets Current assets Cash $ 56,352 $ 24,059 Accounts receivable 11,977 9,536 Income and other taxes receivable 4,817 5,607 Prepaid expenses and deposits 1,167 1,658 74,313 40,860 Investments (note 6) 1,284 9,619 Petroleum and natural gas properties (note 7) 392, ,664 $ 468,309 $ 472,143 Liabilities Current liabilities Accounts payable and accrued liabilities $ 16,318 $ 34,408 Future income tax (note 12) 4,036 Asset retirement obligation (note 9) 25,435 20,064 41,753 58,508 Shareholders equity Share capital (note 11) 779, ,122 Contributed surplus (note 11) 15,444 11,895 Deficit (368,697) (321,382) 426, ,635 $ 468,309 $ 472,143 Commitments and contingencies (note 13) See accompanying notes to consolidated financial statements Signed on behalf of the Board: Keith C. Hill Chairman and Director brian D. Edgar Director 44 BLACKPEARL RESOURCES INC.

47 (Audited) Year ended December 31 (Cdn$ in thousands, except for per share amounts) Revenue Oil and gas sales $ 89,637 $ 183,536 Royalties (21,262) (45,192) Expenses 68, ,344 Production 29,461 49,907 Transportation 3,466 3,664 General and administrative 6,913 15,000 Depletion, depreciation and accretion 81,100 85,385 Write-down of petroleum and natural gas properties 57,427 Stock-based compensation (note 11) 1,461 3,116 Interest (income) (44) (683) Foreign currency exchange loss (gain) 762 (466) Dilution gain on investment (2,268) Write-down of investments 556 2, , ,657 Loss before income taxes (55,300) (75,313) Income taxes (note 12) Consolidated Statement of Operations, Comprehensive Loss and Deficit Current income tax (recovery) (2,351) (517) Future income tax (recovery) (5,634) 4,066 (7,985) 3,549 Comprehensive loss for the year (47,315) (78,862) Deficit, beginning of year (321,382) (242,520) Deficit, end of year $ (368,697) $ (321,382) Basic and diluted loss per share $ (0.19) $ (0.42) Weighted average number of common shares used in computing loss per share: basic 243,185, ,241,716 diluted (1) 243,185, ,241,716 See accompanying notes to consolidated financial statements (1) Any impact of unexercised stock options or warrants are not included in the calculation of net loss per share or weighted average number of shares outstanding as they would be anti-dilutive Annual report 45

48 Consolidated Statements of Cash Flow (Audited) Year ended December 31 (Cdn$ in thousands) Operating activities Net loss for the year $ (47,315) $ (78,862) Items not involving cash: Depletion,depreciation and accretion 81,100 85,385 Stock-based compensation 1,461 3,116 Future income tax (recovery) (5,634) 4,066 Foreign exchange loss (gain) 762 (466) Gain on investments (2,268) Provision for bad debts (reduction) (1,322) 1,815 Write-down of investments 556 2,575 Write-down of petroleum and natural gas properties 57,427 Abandonment costs (604) (668) 29,004 72,120 Changes in non-cash working capital balances related to operations (29,593) (2,613) (589) 69,507 Financing activities Proceeds on issue of common shares, net of costs 43,838 Advances of bank loan 25,000 Repayments of bank loan (25,000) 43,838 Investing activities Additions to petroleum and natural gas properties (27,878) (107,367) Proceeds from sale of petroleum and natural gas properties ,097 Proceeds from sale of investment 4 Cash received on acquisition of BlackCore Resources Inc. 5,589 Changes in non-cash working capital from investing 11,079 (21,977) (10,956) (50,247) Net increase in cash 32,293 19,260 Cash, beginning of year 24,059 4,799 Cash, end of year $ 56,352 $ 24,059 Supplementary Information Cash interest paid $ 87 $ 828 Cash taxes paid $ 1,004 $ 1,010 See accompanying notes to consolidated financial statements 46 BLACKPEARL RESOURCES INC.

49 Notes to the Consolidated Financial Statements (audited) (tabular amounts in thousands of Cdn$, except as noted) 1. NATURE OF OPERATIONS On May 8, 2009, Pearl Exploration and Production Ltd. formally changed its name to BlackPearl Resources Inc. BlackPearl Resources Inc. (collectively with its subsidiaries, the Company or BlackPearl ) is listed and traded on the TSX Exchange under the trading symbol PXX and on the First North (OMX Nordic Exchange) under the symbol PXXS. The Company is engaged in the business of oil and gas exploration, development and production in North America. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in Canada ( Canadian GAAP ). The significant accounting policies used in these consolidated financial statements are as follows: (a) Consolidation These consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. (b) Cash and Cash Equivalents Cash and cash equivalents include short-term highly liquid interest-bearing investments with maturities of three months or less from the date of acquisition. Cash and cash equivalents are designated as held-for-trading and are carried at fair value. (c) Measurement Uncertainty The preparation of consolidated financial statements in conformity with Canadian GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and the disclosure of contingencies. These estimates are subject to measurement uncertainty. Actual results could differ from and affect the results reported in these consolidated financial statements. Significant estimates used in the preparation of the consolidated financial statements include asset retirement obligations, future income taxes, stock-based compensation, the estimate of oil and gas reserves and the related depletion, depreciation and accretion, asset impairment, the estimate of capital and operating costs incurred, as well as revenue earned, but not invoiced as of December 31, (d) Foreign Currency Translation The Company s reporting and functional currency is Canadian dollars. The Company s U.S. operations are considered integrated. Accordingly, the Company uses the temporal method of accounting for the foreign currency transactions of its U.S. subsidiaries. Under the temporal method, monetary assets and liabilities are translated at the exchange rates in effect at the balance sheet date. Non-monetary assets and liabilities are translated at the historical exchange rates. Revenues and expenses are translated at the average rate for the period, except for charges related to non-monetary assets which are translated at the historical rate for the assets to which the charge relates, and material items where a specific date can be identified for the transaction which is translated at the rate on that specific date. Exchange gains or losses are included in the determination of net income Annual report 47

50 (e) Joint Interests A substantial portion of the Company s activities are conducted jointly with others through joint ventures. These consolidated financial statements reflect only the Company s proportionate interest in such activities. (f) Petroleum and Natural Gas Properties The Company follows the full cost method of accounting for its petroleum and natural gas properties whereby all costs relating to the exploration for and development of oil and gas reserves are capitalized in country-by-country cost centres and charged against income as set out below. Capitalized costs include lease acquisition costs, geological and geophysical expenditures, costs of drilling exploration and development wells, gathering and production facilities and other development expenditures. Gains and losses are not recognized upon disposition of petroleum and natural gas properties unless such a disposition would alter the rate of depletion by 20 percent or more. Depreciation, Depletion and Amortization Capitalized costs, along with estimated future costs to develop proved reserves, are depleted on a unit-of-production basis using estimated proved oil and gas reserves before royalties, as determined by independent engineers. Natural gas reserves and production are converted to equivalent barrels of oil based upon the relevant energy content (6:1). Costs of acquiring and evaluating unproved properties are excluded from costs subject to depletion until it is determined whether proved reserves are attributable to the properties or impairment occurs. Unproved properties are evaluated for impairment on at least an annual basis. If an unproved property is considered to be impaired, the amount of the impairment is added to costs subject to depletion. Office furniture and equipment is depreciated on the declining balance basis at rates ranging from 10 to 30 percent per year. Ceiling Test The net amount at which petroleum and natural gas properties are carried is subject to a cost recovery test (the ceiling test ). The ceiling test is an impairment test whereby the carrying amount of petroleum and natural gas properties, excluding the cost of unproved properties, is compared to the undiscounted cash flows from proved reserves using future forecast prices, adjusted for the Company s contract prices and quality differentials. If the carrying value exceeds the undiscounted cash flows, an impairment loss would be recorded against income. The impairment is measured as the amount by which the carrying amount of petroleum and natural gas properties exceeds the discounted cash flows from proved and probable reserves. The Company s risk-free interest rate is used to arrive at the net present value of future cash flows. (g) Revenue Recognition Revenue from the sale of petroleum and natural gas is recorded when title passes to an external party. 48 BLACKPEARL RESOURCES INC.

51 (h) Investments Long-term investments include interest-bearing investments with maturities longer than one year. Long-term investments whereby the Company has significant influence are accounted for using the equity method. All other longterm investments are designated as held-for-trading and available-for-sale and are carried at fair value (see note 15(a) for classification). (i) Stock-Based Compensation Stock options granted are accounted for using the fair value method. Fair values are determined, at the grant date, using the Black-Scholes option-pricing model. The compensation expense associated with these options is charged to earnings over the vesting period with a corresponding increase in contributed surplus. When stock options are exercised, the consideration paid to the Company, along with amounts previously credited to contributed surplus, is credited to common shares. Forfeitures are accounted for as they occur and result in a reduction in compensation expense. (j) Asset Retirement Obligation The fair values of the estimated asset retirement obligation is recorded as a liability when incurred and the associated cost is capitalized as part of the cost of the related asset. Over time, the liability is accreted for the change in its present value and the initial capitalized costs are depleted on a unit-of-production basis over the life of the reserves. The associated accretion is charged to earnings in the period. Actual expenditures incurred are charged against the accumulated obligation. Revisions to the estimated timing of cash flows or the original estimated undiscounted cost would also result in an increase or decrease to the obligation and related asset. (k) Earnings per Share Basic earnings per share is calculated using the weighted average number of common shares outstanding during the year. Diluted earnings per share is calculated based upon the treasury stock method which assumes that any proceeds from the exercise of in-the-money stock options or warrants would be used to purchase the Company s common shares at the average market price during the year (or period if applicable). Diluted earnings per share do not include any antidilutive conversions, nor is diluted earnings per share presented where the total effect would be anti-dilutive. (l) 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 tax legislation. A future tax liability is recognized upon the filing of the renunciation with the tax authorities and share capital is reduced by the estimated costs of the renounced tax deductions. (m) Income Taxes The Company follows the liability method of accounting for income taxes. Under this method, future income tax liabilities and assets are recognized for the estimated tax consequences attributable to differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases. Future tax liabilities and assets are measured using enacted or substantially enacted tax rates. The effect on future tax liabilities and assets of a change in tax rates is recognized in income in the period that the change occurs Annual report 49

52 (n) Financial Instruments A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument to another entity. Financial assets and financial liabilities are recognized on the consolidated balance sheet at the time the Company becomes a party to the contractual provisions. Upon initial recognition, financial instruments are measured at fair value. Measurement in subsequent periods is dependent on the classification of the financial instrument. These instruments will be classified into one of the following five categories: held-for-trading, held-tomaturity, loans and receivables, available-for-sale or other financial liabilities. Held-for-trading instruments are financial assets and liabilities typically acquired with the intention of generating revenues in the short-term. However, an entity is allowed to designate any financial instrument as held-for-trading on initial recognition even if it would otherwise not satisfy the definition. As at December 31, 2009, the Company does not hold any financial instruments that do not satisfy the definition. Financial assets and financial liabilities required to be classified or designated held-for-trading are measured at fair value, with gains and losses recorded in net earnings for the period in which the change occurs. Held-to-maturity investments are non-derivative financial assets, with fixed or determinable payments and fixed maturity that an entity has the intention and ability to hold to maturity. These financial assets are measured at amortized cost using the effective interest method. As at December 31, 2009, the Company does not have any financial assets classified as held-to-maturity. Available-for-sale financial assets are non-derivative assets that are designated as available-for-sale or that are not classified as loans and receivables, held-to-maturity investments or held-for-trading. Available-for-sale financial assets are carried at fair value with unrealized gains and losses included in other comprehensive income (OCI) until such gains or losses are realized or an other than temporary impairment is determined to have occurred. Available-forsale assets are measured at fair value, except for assets that do not have a readily determinable fair value which are recorded at cost. Financial assets classified as loans and receivables are measured at amortized cost using the effective-interest method. Other financial liabilities are measured at amortized cost using the effective interest method and include all liabilities other than derivatives or liabilities that have been identified as held-for-trading. The Company will assess at each reporting period whether there is any objective evidence that a financial asset, other than those classified as held-for-trading, is impaired. 50 BLACKPEARL RESOURCES INC.

53 3. CHANGES IN ACCOUNTING POLICIES During 2009 the Company adopted the following CICA Handbook Sections: Section 3064 Goodwill and Intangible Assets, which replaces Section 3062 Goodwill and other Intangible Assets. The new standard revises the requirement for recognition, measurement, presentation and disclosure of intangible assets. It was adopted on January 1, 2009 and has had no effect on the consolidated financial statements as of December 31, Section 1582 Business Combinations, which replaces Section 1581 Business Combinations. The new standard establishes principles and requirements of the acquisition method for business combinations and related disclosures. It was adopted on January 1, 2009 and has had no effect on the consolidated financial statements as of December 31, Section 1601 Consolidated Financial Statements and Section 1602 Non-controlling Interests, both of which replace Section 1600 Consolidated Financial Statements. Section 1601 establishes standards for the preparation of consolidated financial statements. Section 1602 provides guidance on accounting for a non-controlling interest in a subsidiary in consolidated financial statements subsequent to a business combination. Both sections were adopted on January 1, 2009 and have had no effect on the consolidated financial statements as of December 31, Section 3862 Financial Instruments Disclosures was amended to include additional disclosure requirements about fair value measurement for financial instruments and liquidity risk disclosures. These amendments require a three-level hierarchy that reflects the significance of the inputs used in making the fair value measurement. Fair values of assets and liabilities in Level 1 are determined by reference to quoted prices in active markets for identical assets and liabilities. Assets and liabilities in Level 2 include valuations using inputs other than quoted prices for which all significant outputs are observable, either directly or indirectly. Level 3 valuations are based on inputs that are unobservable and significant to the overall fair value measurement. The amendments to this standard were adopted on December 31, 2009 and result in increased note disclosures for financial instruments. 4. RECENT ACCOUNTING PRONOUNCEMENTS The CICA Accounting Standards Board ( AcSB ) has confirmed that the use of International Financial Reporting Standards ( IFRS ) will be required for interim and annual reporting purposes for fiscal years beginning on or after January 1, 2011 for publicly accountable profit-oriented enterprises. Companies will be required to provide comparative IFRS information for The Company is assessing the potential impacts of this changeover and has developed a plan for the conversion, but the Company has not at this time made any determination on the impact on its financial statements. 5. ACQUISITIONS On January 8, 2009, the Company acquired all of the issued and outstanding shares of BlackCore Resources Inc., a private oil and gas company, in exchange for 17,600,000 common shares of the Company, as well as 5,000,160 Class A and 5,000,160 Class B share purchase warrants. Each Class A and B warrant allow the holder to acquire one BlackPearl share for a price of $0.60 when the BlackPearl share price reaches a volume weighted average price for 30 consecutive days of $1.50 and $2.00, respectively. These price thresholds were met during The warrant price was calculated by using the weighted average share price for the five days before and after the date the agreement was entered into Annual report 51

54 The consideration, including transaction costs, for the BlackCore acquisition totaled $12.9 million. The allocation of the purchase price is as follows: Net assets acquired Petroleum and natural gas properties $ 12,691 Working capital 5,468 Asset retirement obligation (3,023) Future income tax (2,274) Total net assets acquired $ 12,862 Consideration paid Common shares $ 10,560 Warrants 2,200 Acquisition costs 102 Total purchase price $ 12, INVESTMENTS December 31, 2009 December 31, 2008 Investment in Serrano Energy Ltd. ( Serrano ) $ $ 7,768 MAV Notes (formerly Asset-backed commercial paper) 1,284 1,288 Investment in Tyner Resources Ltd. ( Tyner ) 563 $ 1,284 $ 9,619 (a) On January 28, 2009, the Company closed an agreement with Serrano Energy Ltd. ( Serrano ) to exchange the Company s equity interest in Serrano for an additional 15% working interest in the Blackrod area lands and a carried work commitment of $5 million. The Company was also appointed the operator of the Blackrod project. (b) The Company acquired an interest in third party asset-backed commercial paper ( ABCP ) with a face value of $5 million on October 19, 2007 as part of a corporate acquisition. As a result of liquidity issues in the ABCP market, these investments did not settle on maturity. On January 21, 2009, a restructuring plan was implemented which resulted in the Company receiving longer-term replacement notes for its investment in short-term ABCP. The Company received the following replacement notes: Notes Maturity Date (1) Interest Rate (2) Face Amount MAV II Class A-1 July 15, 2056 BA 0.5% $ 1,534 MAV II Class A-2 July 15, 2056 BA 0.5% 2,804 MAV II Class B July 15, 2056 BA 0.5% 509 MAV II Class C July 15, 2056 BA +20% 150 $ 4,997 1) Maturity date reflects legal maturity date. The latest maturity date of the underlying assets is December 31, ) BA represents Bankers Acceptance interest rates with a maturity of 90 days. 52 BLACKPEARL RESOURCES INC.

55 The replacement notes have been classified as held-for-trading which will require them to be measured at fair value at each period end with changes in fair value included in the consolidated statement of operations in the period in which they arise. Although a small number of transactions have been made public, the Company does not consider them to be of sufficient volume or value to constitute an active market. Accordingly, the Company has not used these trades to determine the fair value of the notes. Until an active market is established, however, the fair value will be determined using a probability weighted discounted cash flow considering the best available public information regarding market conditions and other factors that a market participant would consider for such investments. As at December 31, 2009, the Company has estimated the fair value of the notes at $1,284,000 (December 31, 2008 $1,288,000). This includes a principle prepayment of $4,000 which was received in No gain or loss was recorded on the exchange of ABCP for the replacement notes. (c) On December 30, 2008, the Company sold all of its interests in certain lands, wells, pipelines and other associated equipment located in the Palo Duro Basin area of Texas. In exchange, BlackPearl received 18,756,414 common shares of Tyner Resources Ltd. at a price of $0.03 per share. The Company has written down the value of its investment in Tyner to NIL in accordance with equity investment accounting, based on BlackPearl s ownership interest in Tyner, and the losses incurred since the acquisition was made on December 30, PETROLEUM AND NATURAL GAS PROPERTIES December 31, 2009 Accumulated depreciation net book Cost and depletion value Petroleum and natural gas properties $ 650,744 $ 259,903 $ 390,841 Office equipment 2,916 1,045 1,871 $ 653,660 $ 260,948 $ 392,712 December 31, 2008 Accumulated depreciation net book Cost and depletion value Petroleum and natural gas properties $ 600,297 $ 180,581 $ 419,716 Office equipment 2, ,948 $ 603,036 $ 181,372 $ 421,664 The depletion and ceiling test calculations have excluded the cost of unproved properties of $33.6 million (December 31, 2008 $31.1 million) and included future development costs of $63.6 million (December 31, 2008 $34.7 million). The Company performed the ceiling test calculations at December 31, 2009 to assess whether the carrying value of the petroleum and natural gas properties were recoverable. A write-down in the amount of $2.9 million (December 31, 2008 $57.4 million) of the US assets has been included in depletion, depreciation and accretion in the Company s December 31, 2009 financial statements. The following represent the prices that were used in the December 31, 2009 ceiling test: 2009 Annual report 53

56 Average Price Forecast (1) Hardisty WTI Cushing lloydblend Alberta 40 API 20.5 API AECO-C Spot exchange rate Year (US$/bbl) (CDN$/bbl) (CDN$/MMBtu) (US$/Cdn$) Escalation rate of 2.0% thereafter (2) (1) The benchmark prices listed above are adjusted for quality differentials, heat content, distance to market and other factors in performing the ceiling test. (2) Percentage change represents the change in each year after 2020 to the end of the reserve life. 8. CREDIT FACILITY The Company has a credit facility with a Canadian financial institution which is comprised of a $25 million revolving 364-day extendible term facility. The Company may borrow, repay and re-borrow advances with the aggregated outstanding not to exceed the total credit facility. The facility bears interest at the institution s prime rate or at banker s acceptance or LIBOR loan rates, plus applicable margins, which varies depending on the Company s working capital ratio. At December 31, 2009, a prime rate based drawdown would be at the institution s prime rate plus 0.75%. The Company also incurs a standby fee for undrawn amounts. The facility is secured by a fixed and floating charge on the assets of the Company and is secured by a general securities agreement. At December 31, 2009, there were no advances outstanding under this facility. The facility is subject to annual reviews. The next scheduled review is to be completed by May 31, ASSET RETIREMENT OBLIGATION The Company s asset retirement obligation results from ownership interest in oil and gas assets, including well sites, gathering systems, batteries and processing facilities. The total undiscounted amount of the estimated cash flows required to settle the asset retirement obligation is approximately $38.3 million which will be incurred over the next 28 years with the majority of costs incurred between 2010 and The fair value of the asset retirement obligation was calculated using a credit adjusted risk-free rate of 6.5 percent and an inflation factor of 2 percent. Settlement of the obligation is expected to be funded from general corporate funds at the time of retirement. As at December 31, 2009, no funds have been set aside to settle this obligation. 54 BLACKPEARL RESOURCES INC.

57 Changes to the asset retirement obligation were as follows: Asset retirement obligation at beginning of year $ 20,064 $ 16,586 Liabilities acquired through acquisitions, net of dispositions 2,939 (6,464) Liabilities incurred during the year 1, Adjustment for change in reserve life, abandonment costs, inflation and discount rates 8,545 Actual remediation costs (604) (668) Accretion 1,520 1,169 Asset retirement obligation at end of year $ 25,435 $ 20, RELATED PARTY TRANSACTIONS During the year ended December 31, 2009, the Company entered into the following transactions with related parties in the normal course of business, which are recorded at the exchange amount established and agreed to by the related parties: The Company paid $45,000 (2008 $180,000) to Namdo Management Services Ltd. ( Namdo ) for executive and support services pursuant to a services agreement. Namdo is a private corporation owned by Lukas H. Lundin, a former director of the Company. 11. SHARE CAPITAL (a) Authorized: The Company is authorized to issue an unlimited number of common shares. (b) Common Shares Issued: number of Shares Attributed Value Balance as at December 31, 2008 and December 31, ,241,716 $ 723,122 Shares issued for BlackCore acquisition (note 5) 17,600,000 10,560 Shares issued for property acquisitions 2,500,000 1,500 Shares issued for cash (i) 52,334,000 46,046 Shares issued upon exercise of stock options 285, Share issuance costs, net of tax (1,745) Balance as at December 31, ,960,717 $ 779,809 (i) On April 20, 2009, the Company issued 52,334,000 special warrants of BlackPearl at a price of $0.88 per special warrant for aggregate gross proceeds of $46 million. On May 6, 2009 each special warrant was converted into one common share of the Company Annual report 55

58 (c) Warrants Outstanding: The following summarizes warrants outstanding as at December 31, 2009 and December 31, 2008: Number of warrants Weighted average exercise price per share Outstanding at December 31, ,091,800 $ 0.98 Expired (4,091,800) 0.98 Outstanding at December 31, Class A warrants issued on BlackCore Acquisition (note 5) (i) 5,000, Class B warrants issued on BlackCore Acquisition (note 5) (i) 5,000, Outstanding at December 31, ,000,320 $ 0.60 (i) Each outstanding warrant allows the holder to acquire, on or before January 13, 2013, one BlackPearl share for a price of $0.60 when the Company s share price reaches a volume weighted average price for 30 consecutive days of $1.50 (Class A warrants) and $2.00 (Class B warrants). As of December, 2009, the Class A and B warrants have vested and can be used to purchase common shares at the option of the holder. (d) Stock Options Outstanding The Company has a stock option plan (the Plan ) available to directors, officers, employees and certain consultants of the Company and its subsidiaries. Under the Plan, the number of common shares to be reserved and authorized for issuance pursuant to options granted under the Plan cannot exceed ten percent of the total number of issued and outstanding shares in the Company. The term and the vesting period of any options granted are determined at the discretion of the board of directors. The maximum term for options granted is ten years. The exercise price of the option cannot be less than the five-day volume weighted average trading price of the common shares immediately preceding the day the option is granted. The following summarizes stock options outstanding as at December 31, 2009 and December 31, 2008: Weighted average number of options exercise price ($) Outstanding at December 31, ,726, Granted 6,484, Forfeited (1,620,751) 4.12 Expired (1,451,670) 4.21 Outstanding at December 31, ,138, Granted 6,325, Exercised (285,001) 0.75 Forfeited (3,724,602) 3.32 Outstanding at December 31, ,454, BLACKPEARL RESOURCES INC.

59 Options outstanding and exercisable as at December 31, 2009 are summarized below: options Outstanding options Exercisable Weighted- Weighted- Average Weighted- Average Weighted- Range of number of Exercise Average Number Exercise Average Exercise Price ($) Options Price ($) Life (Years) of Options Price ($) Life (Years) ,388, ,602, ,029, , , , , , ,454, ,300, (e) Stock-Based Compensation Stock-based compensation of $1,461,000, net of recoveries of $1,290,000, has been recorded in the Consolidated Statements of Operations and Deficit for the year ended December 31, 2009 (2008 expense of $3,116,000). The fair value of common share options granted is estimated on the date of grant using the Black-Scholes option pricing model. The weighted average fair value of options granted during 2009 and the assumptions used in their determination are noted below: December 31, 2009 December 31, 2008 Weighted average fair value of stock options granted (per option) $ 0.85 $ 0.73 Expected life of stock options (years) Volatility (weighted average) 88% 117% Risk-free rate of return (weighted average) 1.43% 1.69% Expected dividend yield 0% 0% (f) Contributed Surplus Continuity The following table summarizes changes in contributed surplus during the year: December 31, 2009 December 31, 2008 Balance, beginning of the year $ 11,895 $ 8,778 Stock-based compensation 2,751 3,749 Recovery of expense on forfeited stock options (1,290) (632) Warrants issued on BlackCore acquisition 2,200 Transferred to share capital on exercise of stock options (112) Balance, end of year $ 15,444 $ 11, Annual report 57

60 12. income taxes (a) Future Income Tax Expense: The provision for income taxes reflects an effective income tax rate which differs from Federal and Provincial statutory tax rates. The main differences are as follows: December 31, 2009 December 31, 2008 Income (loss) before income taxes (55,300) (75,315) Corporate income tax rate 30.46% 30.88% Computed income tax recovery (16,843) (23,257) Increase (decrease) resulting from: Change in valuation allowance 9,002 27,992 Non-deductible stock-based compensation expense Foreign exchange (785) (144) Change in enacted tax rates 1,768 (2,136) Capital tax and Saskatchewan Resource Surcharge (2,352) 1,642 Other 780 (1,510) Income tax expense (recovery) $ (7,985) $ 3,549 (b) The components of the future income tax liability are as follows: December 31, 2009 December 31, 2008 Future Income Tax Assets: Non-capital losses 32,759 11,370 Share issue costs 2,785 2,729 Asset retirement obligation 6,829 5,863 Other 1, Valuation allowance (38,034) (29,032) 5,491 (8,672) Future Income Tax Liabilities: Property, plant and equipment (5,491) 4,636 Net future tax asset (liability) $ 0 $ (4,036) The Company has $116.1 million of non-capital losses with various expiry dates between 2009 to commitments and contingencies (a) The Company has a seven-year operating lease for office space as at December 31, 2009, the payments (net of sublease proceeds) due under this lease agreement (including an estimate for operating costs) are as follows: Subsequent to 2014 Office rent $ 1,098 $ 1,166 $ 1,234 $ 1,234 $ 1,626 $ 2, BLACKPEARL RESOURCES INC.

61 The Company s office lease was executed jointly with another party. Under the terms of the lease, BlackPearl and the other party are joint and severally liable for the obligations pursuant to the lease. Accordingly, if the other party or any of the subtenants of a portion of the space are unable to fulfill their lease obligation, BlackPearl would be required to pay an additional $19.3 million (including an estimate for operating costs) over the next seven years. (b) The Company has contracted drilling rig services over the next four years. In the event that the Company does not utilize the minimum contracted days, the Company would be obligated to pay the rig operator a variable rate based on days not utilized under the contracts. As at December 31, 2009, the payments that would be due under the agreement (assuming no drilling days used) are as follows: Subsequent to 2014 Drilling Contract $ 616 $ 935 $ 1,211 $ 319 Nil (c) In connection with a November 2007 property acquisition, the Company may be required to pay a performance payment of US $9.8 million in cash prior to November 6, 2010, if either: (i) production from the assets reaches 5,000 barrels of oil per day; or (ii) proven reserves from the assets is greater than 50 million barrels of oil. As at December 31, 2009, there was no production from and no reserves attributable to these assets. 14. S E V E R A N C E B E N E F I T S During the first quarter of 2009, the Company incurred a number of staff terminations. As a result, the Company has included severance benefits in the aggregate amount of $431,000 in general and administrative costs in the Company s financial statements. All severance benefits were paid in the first quarter F I N A N C I A L I N S T R U M E N T S A N D R I S K M A N A G E M E N T The Company is exposed to financial and market risk in a range of financial instruments including cash, accounts receivable, certain investments and accounts payable. The Company manages its risk through its policies and processes, but the Company generally has not used derivative financial instruments to manage these risks. (a) Fair Value of Financial Instruments The following tables set out the Company s classification, carrying amount and fair values of its financial assets and liabilities as at December 31, 2009 and December 31, 2008: December 31, 2009 December 31, 2008 Carrying Fair Carrying Fair Classification Amount Value Amount Value Cash and cash equivalents Held-for-trading (i) $ 56,352 $ 56,352 $ 24,059 $ 24,059 Accounts receivable loans and receivables (i) 11,977 11,977 9,536 9,536 Investment in MAV Notes Held-for-trading (ii) 1,284 1,284 1,288 1,288 Other investments Available-for-sale (iii) 7,768 7,768 Accounts payable and accrued liabilities other financial liabilities (iv) (16,318) (16,318) (34,408) (34,408) 2009 Annual report 59

62 The fair values of financial assets and financial liabilities are calculated on the basis of information available at the balance sheet date using the following methods: (i) The fair value of cash and cash equivalents and accounts receivable approximates their carrying amounts due to the short-term nature of the instruments. (ii) Effective December 31, 2009, the Company adopted the amendments to Section 3862 Financial Instruments Disclosures. These amendments require the Company to present information about financial instruments measured at fair value in accordance with a three level hierarchy. The hierarchy groups financial assets and liabilities into three levels based on the significance of inputs used in measuring the fair value of the financial assets and liabilities. The fair value hierarchy has the following levels: a. Level 1: quoted prices (unadjusted) in active markets for identical assets or liabilities; b. Level 2: inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (ie. as prices) or indirectly (ie. derived from prices); and c. Level 3: inputs for the asset or liability that are not based on observable market data (unobservable inputs). The level within which the financial asset or liability is classified is determined based on the lowest level of significant input to the fair value measurement. At December 31, 2009, the only instrument held by the Company that is subject to valuation through the hierarchy is the Company s investment in MAV notes. The fair value of the investment is determined by a cash flow model considering the best available public information regarding market conditions and other factors that a market participant would consider for such investments. The change in value from December 31, 2008 is the result of a principle prepayment on the investment and not a change in fair value. (iii) Investment in shares of a private company are valued at fair market value based on some comparable transactions involving the issuance of additional shares of the private company. (iv) The fair value of accounts payable and accrued liabilities approximates their carrying amounts due to the shortterm nature of the instruments. (b) Commodity Price Risk Commodity price risk is the risk that future cash flows will fluctuate as a result of changes in the price of oil and natural gas. Commodity prices are impacted by world economic events that affect supply and demand, which are generally beyond the Company s control. Changes in crude oil and natural gas prices may significantly affect the Company s results of operations, costs generated from operating activities, capital spending and the Company s ability to meet its obligations. The majority of the Company s production is sold under short-term contracts, consequently BlackPearl is at risk to near term price movements. A $1.00 change in oil prices at the wellhead would have the effect of changing net earnings for 2009 by approximately $1.2 million. The Company manages this risk by constantly monitoring commodity prices and factoring them into operational decisions, such as contracting or expanding its capital expenditures program. As at December 31, 2009 and throughout 2009, the Company did not use derivative financial instruments to manage its exposure to this risk. 60 BLACKPEARL RESOURCES INC.

63 (c) Foreign Currency Exchange Risk The Company is exposed to risks arising from fluctuations in foreign currency exchange rates and the volatility of those rates. This exposure primarily relates to: (i) prices received for its crude oil and natural gas are primarily determined in reference to US dollars; (ii) certain expenditure commitments, deposits, accounts receivable, and accounts payable which are denominated in US dollars; and (iii) its operations in the United States. The Company manages this risk by monitoring foreign exchange rates and evaluating their effects on using Canadian or US vendors as well as timing of transactions. As at December 31, 2009, the Company has not entered into any fixed rate contracts. As at December 31, 2009, the Company held US$2,302,000 in cash and short-term deposits and other net working capital items of US$2,159,000. As at December 31, 2009, if US$ exchange rates had been $0.10 lower with all other variables held constant, after tax earnings for the period would have been approximately $543,000 higher, due to a decreased foreign exchange loss. An equal opposite impact would have occurred to net earnings had exchange rates been $0.10 higher. The Company does not hedge its foreign currency risk. (d) Credit Risk Credit risk is the risk that a third party fails to meet its contractual obligations that could result in the Company incurring a loss. The Company s accounts receivable are primarily with oil and gas marketers and joint venture partners. Receivables from oil and gas marketers are generally collected on the 25th day of the month following production. The Company attempts to mitigate this risk by assessing the financial strength of its counterpart and entering into relationships with larger purchasers with established credit history. During 2009, the Company has not experienced any collection issues with its marketers. At December 31, 2009, over 81% of total accounts receivables are for revenue accruals. Receivables from joint venture partners arise when the Company conducts joint operations on behalf of its partners and invoices them for their share of costs. To mitigate the risk of non-payment from joint venture partners the Company can require partners to pay certain costs in advance as well as the Company has the ability to withhold production from partners in the event of non-payment. As at December 31, 2009, accounts receivable includes an allowance for doubtful accounts of $826,000 from joint interest partners. These amounts primarily relate to joint venture receivables inherited from other companies that were acquired by BlackPearl over the last three years. The Company typically does not obtain collateral or security from its joint venture partners or oil and gas marketers. The carrying amounts of accounts receivable represent the maximum credit exposure. The Company is not the operator of certain oil and gas properties in which it has an ownership interest. The Company is dependent on such operators for the timing of activities related to such properties and will largely be unable to direct or control the activities of the operators. In addition, the Corporation s activities may be impacted by the ability, expertise, judgment and financial capability of the operators. As at December 31, 2009, one of the operators of a US property in which the Company has an interest in has filed for creditor protection in US bankruptcy court and has failed to pay certain suppliers, resulting in various liens on the property. Subsequent to December 31, 2009, the operator sold its interest in the property and the liens are in the process of being removed Annual report 61

64 As at December 31, 2009, the Company held $56.4 million in cash at various major banks throughout Canada and the USA, as well as $1.3 million in investments. At December 31, 2009, two Canadian financial institutions held approximately 99% of our cash and short-term deposits. Cash balances in excess of the Company s day to day requirements are invested in short-term deposits of less than 30 days. (e) Interest Rate Risk Interest rate risk refers to the risk that a financial instrument or cash flows associated with the instrument will fluctuate due to changes in market interest rates. The Company is exposed to interest rate risk in relation to interest expense on its revolving credit facility due to the floating interest rate charged on advances. At this time, the Company is not drawn on this facility and, as a result, the Company considers this risk to be limited. In addition, the Company is exposed to interest rate risk on its excess cash balances and certain investments. (f) Liquidity Risk Liquidity risk is the risk the Company is unable to meet its financial obligations as they come due. The Company uses operating cash flows, credit facilities and equity offerings to fund its capital requirements. The Company manages this risk by maintaining a conservative balance sheet with minimal use of long-term debt. As at December 31, 2009, the Company had an undrawn $25 million credit facility, and a positive working capital position of $58.0 million. The Company believes it has sufficient funding from these sources to meet its foreseeable obligations. The maturity dates for the Company s financial liabilities are as follows: <6 Months 6 months 1 Year 1-2 Years Accounts payable and accrued liabilities $ 16,318 (g) Capital Management The Company defines capital as working capital, total debt and equity. The current capital management strategy is designed to minimize the use of long-term debt and maintain positive working capital. This strategy should provide the financial flexibility to fund the Company s capital program and profitable growth opportunities. The unutilized $25 million credit facility capacity provides additional liquidity to the Company. This structure can be adjusted as a result of changes in economic conditions or risks associated with its oil and gas assets. During 2008, the Company elected to eliminate its existing bank debt from the sale of certain non-strategic assets. In order to maintain or adjust its capital structure, the Company may from time to time issue additional common shares. As a result of the economic global downturn access to capital markets may be limited. In addition, the Company s credit facilities are based on its petroleum and natural gas reserves whose values are impacted by, among other things, global commodity prices. The Company will adjust it s capital spending if access to external capital sources is unavailable. In order to manage the balance in the Company s capital structure, some of the financial tests that BlackPearl considers are debt-to-equity ratios, debt-to-cash flow from operating activities and interest coverage tests. To facilitate the management and control of these ratios, the Company prepares annual operating and capital budgets. These budgets are generally updated quarterly, or more frequently if circumstances change. In order to improve its financial flexibility, the Company raised approximately $43 million of additional equity during the second quarter of These funds will be used to expand exploration and development programs over the next months. 62 BLACKPEARL RESOURCES INC.

65 Financial covenants associated with the Company s credit facility are reviewed regularly and controls are in place to maintain compliance with these covenants. The only financial covenant in the Company s credit facility is to maintain a working capital ratio of 1:1 at the end of each fiscal quarter. Working capital ratio is defined as current assets plus unutilized credit under the bank credit facility compared to current liabilities. The Company had a working capital ratio of 6.1:1 at December 31, 2009 and was in compliance with these covenants throughout SEGMENTED INFORMATION The Company presently has one reportable business segment, that being oil and gas exploration, development and production. The Company s operations are carried on in the following geographic locations: Year Ended December 31, 2009 Canada USA Consolidated Total revenues, net of royalties $ 67,922 $ 453 $ 68,375 Expenses 118,744 3, ,357 Foreign currency loss (gain) (281) 1, Write-down of investments Net loss before income taxes (50,541) (4,759) (55,300) Income tax recovery (7,665) (320) (7,985) Net loss $ (42,876) $ (4,439) $ (47,315) Segment assets 461,529 6, ,309 Segment petroleum and natural gas properties 390,713 1, ,712 Capital additions $ 25,837 $ 2,041 $ 27,878 Year Ended December 31, 2008 Canada usa Consolidated Total revenues, net of royalties $ 136,440 $ 1,904 $ 138,344 Expenses 150,611 5, ,389 Foreign currency loss (gain) 8 (474) (466) Write-downs 2,575 57,427 60,002 Dilution gain on investment (2,268) (2,268) Net loss before income taxes (14,486) (60,827) (75,313) Income taxes (recovery) 6,435 (2,886) 3,549 Net loss $ (20,921) $ (57,941) $ (78,862) Segment assets 459,659 12, ,143 Segment petroleum and natural gas properties 418,444 3, ,664 Capital additions $ 86,765 $ 20,602 $ 107, COMPARATIVE FIGURES Certain comparative figures have been reclassified to conform to the presentation adopted in Annual report 63

66 Corporate Information DIRECTORS AND OFFICERS Brian D. Edgar Director (1)(2)(3)(4) Vancouver, British Columbia Keith C. Hill Chairman and Director (4) Vancouver, British Columbia Victor Luhowy Director (1)(2)(3)(4) Calgary, Alberta John Craig Director (1)(2)(3) Toronto, Ontario AUDITORS PricewaterhouseCoopers LLP Calgary, Alberta TAX ADVISORS KPMG LLP Calgary, Alberta BANKERS ATB Financial Calgary, Alberta LEGAL COUNSEL Bennet Jones LLP Calgary, Alberta (1) Audit Committee (2) Compensation Committee (3) Corporate Governance Committee (4) Reserves Committee John L. Festival Director President and CEO Calgary, Alberta Donald W. Cook Chief Financial Officer Christopher W. Hogue Vice President, Operations Edward Sobel Vice President, Exploration Diane Phillips Corporate Secretary CERTIFIED ADVISOR ON FIRST NORTH E. Öhman J:or Fondkommission AB CORPORATE OFFICE 700, 444 7th Avenue S.W. Calgary, Alberta T2P 0X8 Telephone: Fax: Website: TRANSFER AGENT Computershare Trust Company of Canada Calgary, Alberta and Toronto, Ontario STOCK EXCHANGE LISTINGS TSX Exchange PXX First North, Sweden PXXS annual general meeting The Annual General Meeting will be held at 3:00 p.m. MDT on Wednesday, May 12, 2010 in the Viking Room of the Calgary Petroleum Club at 319 5th Avenue S.W., Calgary, Alberta.

67 700, 444 7th Avenue S.W. Calgary, Alberta T2P 0X8 Telephone: Facsimile: Website: