CVR Energy Annual Report 2010

FY2010 Annual Report · CVR Energy

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2 0 1 0 A N N U A L R E P O R T

MOMENTUM

AN INTERNATIONAL ENERGY PRODUCER ON THE RISE

Calvalley Petroleum Inc. (“the Company”) has established a strong record of reserves
growth from its initial Exploration and Production Project, at Block 9 in the Masila Basin of the
Republic of Yemen. The Project is based on a Production Sharing Agreement (“PSA”) which
was signed with the Government of Yemen. Since initiating commercial production in 2006,
the Company has had consistently positive cash ﬂows without the requirement for any debt
ﬁnancing which has provided a growth momentum that continues to carry Calvalley forward as
a corporation.

Calvalley’s ongoing Block 9 exploration success has led to the successive development of the
Hiswah, Al Roidhat, Auqban and, most recently, Ras Nowmah Fields. During 2010, the Company
completed appraisal activities at Ras Nowmah which led to the acquisition of 340 kilometers of
2D seismic data. Interpretation of that data has produced two additional prospects for the Company’s
rich exploration asset inventory. The development of these ﬁelds has enabled the Company to
continue investing in future growth activities.

Since 2006, Calvalley has exported its production via truck transport through the Safer Petroleum
export transit facility at Block 18, to the Red Sea port of Ras Isa. However, completion of the
Company’s new Bock 51 Truck Ofﬂoading Facility (“TOF”) will allow Calvalley to access the higher
value export market afforded by the Masila Export Pipeline System (“MEPS”) to the Arabian
Gulf port of Ash Shihr at Mukalla, Yemen. The near-term commissioning of the TOF will further
enable the Company to pursue mid and long-term growth and to enhance shareholder value.

Yemen

Ethiopia

Chairman and Chief Executive Ofﬁcer’s Letter

Selected Highlights

04
06
08
17
18 Management’s Discussion and Analysis

Exploration and Operations Review

Operations Statistical Review

Independent Auditor’s Report

40 Management’s Report
41
42
45
IBC Corporate Information

Consolidated Financial Statements

Notes to the Consolidated Financial Statements

Note: All currency references are in United States dollars unless otherwise indicated.

During 2010, Calvalley successfully
achieved a number of key accomplishments
which are setting the stage for signiﬁcant
growth potential:

1) Construction completion of the TOF at
Block 51, which will be commissioned in
the second quarter of 2011, will allow the
Company to produce and sell a blend of all
Block 9 crude oil production at the high value

Masila Blend price.

2010 HAS BEEN A MILESTONE YEAR
IN BUILDING A PLATFORM FOR GROWTH

2) The Ras Nowmah-2 appraisal well
conﬁrmed the quality and highly productive
nature of the ﬁeld by producing 30˚ API
crude oil at a stabilized rate of 3,000 bbls/day
with only a 9.5% pressure drawdown and
no formation water present.

3) Due to both the discovery success
at Ras Nowmah and to the successful
implementation of the pressure maintenance
program at the Hiswah Field, the Company’s
reserves grew at impressive rates. Proved plus
Probable (“2P”) reserves increased to
31.8 mmbbls at December 31, 2010 compared
to 26.5 mmbbls at December 31, 2009
representing a 20% increase.

2010 Annual Report

CALVALLEY IS POSITIONED

Since initiating commercial
production in 2006, Calvalley
has established a strong
foundation for growth with
effective long-range planning which
prioritized exploration success,
focused on signiﬁcant reserves
additions and established key scalable
infrastructure. This enabled the
Company to maintain limited but
stable production which has funded all
capital activities without the need for
debt ﬁnancing.

CATALYSTS

Exploration Success

Key Infrastructure –
Truck Ofﬂoading Facility

Production Growth

Calvalley Petroleum Inc.

FOR GROWTH

As Calvalley begins operation of
the TOF, it is initiating an active
program of development and
appraisal drilling that will
unlock the full production and
reserves potential of Block 9 in
the Masila Basin. And, with the
Company having established an
improved export outlet via the
Masila Export Pipeline System,
the TOF will enable the Company
to market its blend of crude oil
production at an improved price,
equivalent to the traditional
26˚ API Masila Blend.

Combined with the recent
exploration success at
Ras Nowmah, the acquisition
and analysis of 340 kilometers of
2D seismic data has yielded two
additional exploration prospects
for a total of six. Additionally,
the 31.8 mmbbls of 2P reserves, as
veriﬁed in Calvalley’s Reserves
Report as at December 31, 2010,
has conﬁrmed the Company’s
position for continued production
growth which will translate into
increased shareholder value.

2010 Annual Report

SELECTED HIGHLIGHTS

Years ended December 31,

Sales revenues, net of royalties ($000s)

Funds ﬂow from operations ($000s)

Cash ﬂow from operating activities ($000s)

Net income ($000s)

Shares outstanding (millions) at December 31

Weighted average shares outstanding (millions)

Per common share (basic)

Funds ﬂow ($/share)

Cash ﬂow ($/share)

Net income ($/share)

Production (bbls/share)

Proved + probable reserves (bbls/share)

Cash and GICs ($000s)

Total assets at year-end ($000s)

Long-term debt

Oil production (bopd)

Exploration and development spending ($000s)

Year-end proved + probable reserves (mbbls)

Reserve replacement ratio (proved + probable)

Wells drilled (number)

Realized oil price ($/bbl)

Dated Brent oil price ($/bbl)

2010

39,494

21,915

21,592

10,941

97.7

97.9

0.22

0.11

0.008

0.32

73,020

190,710

–

2,256

21,077

31,824

740%

85.44

86.48

2009

31,354

13,600

13,971

2,951

98.2

98.9

0.14

0.03

0.008

0.27

70,426

172,991

–

2,160

11,803

26,540

343%

57.08

61.67

Note: All currency references are in United States dollars unless otherwise indicated.

change

26.0

61.1

54.5

370.8

(0.5)

(1.0)

57.1

366.7

–

18.5

3.7

10.2

–

4.4

78.6

19.9

215.7

233.3

49.7

40.2

Calvalley Petroleum Inc.

Reserves (mmboe)

2006
24.527
17.734
8.933

2007
23.385
16.468
8.065

2008
35.418
24.623
11.476

2009
39.499
26.54
11.907

2010
47.304
31.824
15.573

Proved

Probable

Possible

Over the past ﬁve years, Calvalley
has demonstrated a strong and
consistent record of reserves growth.
During 2010, the Company realized
for
year-over-year growth of 31%
for proved
reserves, 20%
proved
plus probable reserves, and 21% for
proved plus probable plus possible
reserves. Over the past ﬁve years,
1P reserves have increased by 174%,
2P reserves have increased by 179%,
and 3P
increased
reserves have
by 194%.

Finding and Development Costs
Three-year average ($/boe)

5.70
Proved

2.55
Proved plus
Probable

2.16
Proved plus Probable
plus Possible

The Company has efﬁciently realized
its strong reserves growth. Attractive
and
three-year
development costs of $5.70/bbl for
1P reserves, $2.55/bbl for 2P reserves,
and $2.16/bbl for 3P reserves.

average

ﬁnding

Working Capital ($ mm)

Reserves Replacement Ratio
Three Year Average (%)

2006
72,352

2007
75,059

2008
75,775

2009
70,705

2010
69,683

The Company has consistently
funded the majority of exploration
and development activities through
operating cash ﬂows. As a result,
Calvalley has maintained strong
working capital ranging between
$69.7 million and $75.8 million over
the past ﬁve years.

2008
408%

2009
730%

2010
1093%

through

While continuing to fund its capital
the
development program
production and sale of crude oil from
Block 9, the Company has maintained
strong
reserve
three-year average
replacement ratios of 408% for proved
reserves, 730% for proved plus probable
reserves, and 1,093% for proved plus
probable plus possible reserves.

$0 Debt

Calvalley continues to
execute its growth strategies
while incurring no debt.

2010 Annual Report

CHAIRMAN AND CHIEF EXECUTIVE OFFICER’S LETTER

I am pleased to report to you the Company’s ﬁnancial and operating

results for the 2010 ﬁscal year. Our strong team of experienced

personnel in both Yemen and in Calgary has contributed to

continued efficient reserve growth along with the establishment

of key

infrastructure projects and ongoing enhancement of

exploration potential. These important developments clear the

way for signiﬁcant near-term production growth which will lead to

enhanced shareholder value.

The Company continued its strong record of consistent reserve growth
during 2010. Proved plus probable reserves rose to 31.8 mmbbls at
December 31, 2010, representing a 20% increase over the 26.5 mmbbls
reported at December 31, 2009. An equally important component of our
achievements in exploring for and successfully appraising and developing
new discoveries is the efﬁciency with which we have realized success.
Finding & Development
to
(“F&D”) costs
$3.22/bbl for proved (“1P”) reserves, $0.64/bbl for proved plus probable
(“2P”) reserves, and $0.80/bbl for proved plus probable and possible
(“3P”) reserves. In addition to cost containment in the short-term, we have
demonstrated industry-leading exploration cost efﬁciency over the longer
term. On a three-year average basis, our F&D costs were $5.70/bbl for
1P reserves, $2.55/bbl for 2P reserves, and $2.16/bbl for 3P reserves.

for 2010 amounted

Our exploration success resulted in part from the successful appraisal well
at Ras Nowmah-2 which ﬂowed at a stabilized rate of 3,000 bbls/day of
30˚ API crude oil with no formation water and with only a 9.5% pressure
drawdown during production tests. We have also made signiﬁcant progress in
implementing our pressure maintenance program at the Hiswah Field.

Calvalley Petroleum Inc.

During the ﬁrst quarter of 2011, the Company also
completed drilling of the Qarn Qaymah-3 (“QQ-3”)
appraisal well which is currently undergoing a pressure
build-up in preparation for full ﬁeld assessment.

The Company has also focused signiﬁcant energy
and resources to relieve transportation and marketing
bottlenecks by constructing a new TOF at Block 51.
As Calvalley nears completion of the TOF, the
Company begins an active program of development
and appraisal drilling that will unlock the full potentiality
of Block 9 in the Masila Basin. And with the Company
having established an improved export outlet, via the
Masila Export Pipeline System, the TOF will enable
the Company to market its blend of better than
26˚ API crude at a price equivalent
the
traditional Masila Blend.

in Ethiopia,
With regard to Calvalley’s project
the Metema and
surface geological work at
Gimbi Blocks was completed and fully evaluated.
Based on the surface geological work, Calvalley
undertook the acquisition of aeromagnetic survey
data over a region covering an area of approximately
26,000 square kilometers. The Company is currently
interpreting and mapping the coverage area based on
the results of this aeromagnetic survey.

Looking to the future, your management will
continue to focus on its strategy of continued
exploration success along with a marked increase
in production from the Block 9 project in Yemen.

I would like to thank the Calvalley team and the
Board of Directors for their outstanding efforts and
achievements during 2010 and their continuing
efforts to maximize shareholder value.

Sincerely,

Edmund Shimoon
Chairman and Chief Executive Ofﬁcer
March 31, 2011

2010 Annual Report

EXPLORATION AND OPERATIONS REVIEW

Yemen

Strategies

Execution and Outlook

(cid:85)(cid:202) (cid:10)(cid:156)(cid:152)(cid:204)(cid:136)(cid:152)(cid:213)(cid:105)(cid:202)(cid:204)(cid:156)(cid:202)(cid:105)(cid:221)(cid:171)(cid:62)(cid:152)(cid:96)(cid:202)(cid:204)(cid:133)(cid:105)(cid:202)(cid:136)(cid:152)(cid:118)(cid:192)(cid:62)(cid:195)(cid:204)(cid:192)(cid:213)(cid:86)(cid:204)(cid:213)(cid:192)(cid:105)(cid:202)
and production capacity to markedly
increase production of all crude
reserves on Block 9

(cid:85)(cid:202) (cid:44)(cid:105)(cid:62)(cid:143)(cid:136)(cid:226)(cid:105)(cid:202)(cid:171)(cid:192)(cid:156)(cid:96)(cid:213)(cid:86)(cid:204)(cid:136)(cid:156)(cid:152)(cid:202)(cid:125)(cid:192)(cid:156)(cid:220)(cid:204)(cid:133)

(cid:85)(cid:202) (cid:42)(cid:213)(cid:192)(cid:195)(cid:213)(cid:105)(cid:202)(cid:105)(cid:221)(cid:171)(cid:143)(cid:156)(cid:192)(cid:62)(cid:204)(cid:136)(cid:156)(cid:152)(cid:202)(cid:62)(cid:86)(cid:204)(cid:136)(cid:219)(cid:136)(cid:204)(cid:136)(cid:105)(cid:195)(cid:202)(cid:156)(cid:152)(cid:202)

Block 9 to increase the Company’s
reserve base

(cid:85)(cid:202) (cid:19)(cid:213)(cid:152)(cid:96)(cid:202)(cid:9)(cid:143)(cid:156)(cid:86)(cid:142)(cid:202)(cid:153)(cid:202)(cid:156)(cid:171)(cid:105)(cid:192)(cid:62)(cid:204)(cid:136)(cid:152)(cid:125)(cid:93)(cid:202)(cid:105)(cid:221)(cid:171)(cid:143)(cid:156)(cid:192)(cid:62)(cid:204)(cid:136)(cid:156)(cid:152)(cid:202)
and development activities through
internally-generated cash ﬂows

(cid:85)(cid:202) (cid:10)(cid:156)(cid:147)(cid:147)(cid:136)(cid:195)(cid:195)(cid:136)(cid:156)(cid:152)(cid:202)(cid:204)(cid:133)(cid:105)(cid:202)(cid:47)(cid:192)(cid:213)(cid:86)(cid:142)(cid:202)(cid:34)(cid:118)(cid:121)(cid:156)(cid:62)(cid:96)(cid:136)(cid:152)(cid:125)(cid:202)
Facility at Block 51 and expand
production and deliveries of oil
reserves from the Hiswah, Al-Roidhat,
and Ras Nowmah Fields

(cid:85)(cid:202) (cid:10)(cid:156)(cid:152)(cid:204)(cid:136)(cid:152)(cid:213)(cid:105)(cid:202)(cid:171)(cid:192)(cid:105)(cid:195)(cid:195)(cid:213)(cid:192)(cid:105)(cid:202)(cid:147)(cid:62)(cid:136)(cid:152)(cid:204)(cid:105)(cid:152)(cid:62)(cid:152)(cid:86)(cid:105)(cid:202)
program at the Hiswah Field

(cid:85)(cid:202) (cid:42)(cid:213)(cid:192)(cid:195)(cid:213)(cid:105)(cid:202)(cid:105)(cid:221)(cid:171)(cid:143)(cid:156)(cid:192)(cid:62)(cid:204)(cid:156)(cid:192)(cid:222)(cid:202)(cid:171)(cid:192)(cid:156)(cid:125)(cid:192)(cid:62)(cid:147)(cid:202)(cid:62)(cid:204)(cid:202)

Block 9

Ethiopia

Strategies

(cid:85)(cid:202)

(cid:22)(cid:152)(cid:204)(cid:105)(cid:192)(cid:171)(cid:192)(cid:105)(cid:204)(cid:202)(cid:62)(cid:152)(cid:96)(cid:202)(cid:147)(cid:62)(cid:171)(cid:202)(cid:204)(cid:133)(cid:105)(cid:202)(cid:86)(cid:156)(cid:219)(cid:105)(cid:192)(cid:62)(cid:125)(cid:105)(cid:202)
area based on the results of the
aeromagnetic survey completed
during 2010

(cid:85)(cid:202) (cid:42)(cid:213)(cid:192)(cid:195)(cid:213)(cid:105)(cid:202)(cid:118)(cid:213)(cid:192)(cid:204)(cid:133)(cid:105)(cid:192)(cid:202)(cid:105)(cid:221)(cid:171)(cid:143)(cid:156)(cid:192)(cid:62)(cid:204)(cid:136)(cid:156)(cid:152)(cid:202)(cid:62)(cid:86)(cid:204)(cid:136)(cid:219)(cid:136)(cid:204)(cid:136)(cid:105)(cid:195)(cid:202)
as warranted by the Company’s
geological and geophysical team

Execution and Outlook

(cid:85)(cid:202) (cid:12)(cid:105)(cid:171)(cid:105)(cid:152)(cid:96)(cid:136)(cid:152)(cid:125)(cid:202)(cid:156)(cid:152)(cid:202)(cid:204)(cid:133)(cid:105)(cid:202)(cid:192)(cid:105)(cid:195)(cid:213)(cid:143)(cid:204)(cid:195)(cid:202)(cid:156)(cid:118)(cid:202)(cid:204)(cid:133)(cid:105)(cid:202)

aeromagnetic survey, the Company
may pursue additional acquisition of
technical data with the objective of
identifying leads and prospects

Calvalley Petroleum Inc.

Turkey

Azerbaijan

Armenia

Turkmenistan

Syria

Iraq

Iran

Jordan

Kuwait

Libya

Egypt

United Arab
Emirates

Saudi Arabia

Oman

Chad

Sudan

Red
Sea

YEMEN

BLOCK 9

Sana’a

Central African Republic

METEMA

GIMBI

Adis Ababa

ETHIOPIA

Somalia

Congo

Uganda

Kenya

Indian Ocean

Demographic Republic of Congo

Ruanda

Burundi

United Republic of
Tanzania

Angola

Zambia

Zimbabwe

Mozambique

2010 Annual Report

EXPLORATION AND OPERATIONS REVIEW

Yemen Block 9

Stratigraphic Column for Block 9

SAYUN - MASILA BASIN

E
N
E
G
O
E
L
A
P

S
U
O
E
C
A
T
E
R
C

Umm Er
Radhuma
Fm

Wadi

ZONE OF INTEREST
FIELD DISCOVERY

Mukalla Fm

HARSHIYAT SAND
RAS NOOR

500m

1,000m

1,500m

Harshiyat Fm

QISHN CLASTICS SAND
AL ROIDHAT, HISWAH,
RAS NOWMAH

2,000m

Aptian
Unconformity

SAAR DOLOMITE
AL HEDBA, RAS NOWMAH

2,500m

Qishn Carbs

Valanginian Unconformity

SAAR/NAIFA LIMESTONE
HISWAH

S
S
A
R
U
J

3,000m

3,500m

Precambrian
4,000m

Saar Fm

Naifa Fm

Madbi Fm
Shuqra Fm

Kohlan Fm

Basement

SHUQRA LIMESTONE
AUQBAN
GRANITE WASH/KOHLAN SAND
QARN QAYMAH, AUQBAN

FRACTURED BASEMENT
QARN QAYMAH

Block 9 occupies the western part of the Sayun-Masila Basin. The
Sayun-Masila Basin is an important extensional basin initiated in the
middle Jurassic. Prior to the rifting event, the Arabian craton was exposed
and sandstones of the Kohlan Formation were deposited in a dominantly
ﬂuvial environment. Subsidence in the early to middle Jurassic resulted in
a regional marine transgression, during which time the Kohlan sandstones
were re-worked and carbonate deposition of the Shuqra Formation was
initiated. The basal Kohlan sandstones and overlying Shuqra carbonates
both contain reservoir quality rock and are sealed by tight carbonates and
shales. Both reservoirs are oil-charged at Auqban and the Kohlan is one of
the primary reservoirs at Qarn Qaymah.

Onset of rifting began in Oxfordian-Kimmeridgian time. The Jurassic
rifting event was responsible for the creation of restricted marine
embayments where the Madbi Formation source-rock shale was
deposited. Continued extensional rift tectonics and basin subsidence
resulted in the dramatic thickening of sediments within the rift
basins. Both grabens and half-grabens are developed within the
faults are often viewed as
Sayun-Masila Basin. Basin-margin
growth-faults and
lap
pre-existing basement horst blocks.

the basinal sediments appear

to on

The rifting phase was followed in the Cretaceous by structural sagging.
Development of the sag basin was the result of both continued subsidence
and differential compaction. These processes resulted in the draping of
sediments over pre-existing basement horst blocks. The structural draping
results in positive structural closures that are the primary targets for oil
exploration in Block 9.

Composite Seismic Line 06CV-45 to CY9-91-W9

AUQBAN-2

AUQBAN-1

QUARN QAYMAH -1

QUARN QAYMAH -2

Qishn

Saar

Naifa
Madbi
Shuqra

Basement

M
0
0
5

2500 M

Calvalley Petroleum Inc.

Block 9

Gas cap

Oil pool

The Sayun-Masila Basin has attractive
source-reservoir-seal combinations. Oil that
has been generated from the Madbi source
rock is responsible for charging all reservoirs
in Block 9.

Oil migrating out of the source-rock basins
can charge prospective reservoirs both
laterally and vertically via faults.

AUQBAN

HISWAH

QARN QAYMAH

RAS NOWMAH

AL ROIDHAT

Concessions

Saudi Arabia

Yemen

2 OMV

9 CALVALLEY

10 TOTAL

32 DNO

51 CDN NEXEN

53 DOVE ENERGY

71 SINOPEC

S2 OMV

2010 Annual Report

EXPLORATION AND OPERATIONS REVIEW

Yemen Block 9 Al Roidhat

Development of Al Roidhat continued during
2010. Calvalley worked over the four wells which
had previously been completed and tested and
three additional wells. Extended
completed
production
to better
tests were conducted
understand the sustainable production capability
of the wells and the ﬁeld. Currently six wells are
fully equipped and ready to commence production
as soon as the TOF is completed at Block 51.
Production from these wells will be accumulated
at the ﬁeld storage tanks from which oil will be
transported by tanker truck to the CPF for blending
with lighter oil produced by other ﬁelds. The wells
are ready to produce.

Yemen Block 9 Hiswah

During 2010, Calvalley successfully completed
the drilling of ﬁve horizontal producers at
Hiswah. The ﬁrst three wells were placed on
production at an initial ﬂow rate of approximately
250-400 bbls/day with no water. The remaining
two wells are currently shut-in awaiting delivery
of downhole pumps (ESPs). The wells produced
at rates better than modelled production
rates as a result of our improved reservoir
modeling and completion techniques. The
successful development of these wells resulted
in an upward revision of recoverable reserves
in both Proved and Proved plus Probable
categories from the ﬁeld by the independent
reserve engineers.

The Company is also continuing its pressure maintenance and production optimization program for the Hiswah Field. The pressure
maintenance program at Hiswah involves the reinjection of produced gas to reduce ﬂaring and increase oil recoveries.

During 2010, Calvalley commenced Hiswah water injection at 6,500 bbls/day with a single horizontal well, H-26, which has been
performing better than expected. The Company also commissioned a second water injector (H-25) which is also performing
better than expected. The Company will continue to monitor long-term performance of water injection as a means of pressure
maintenance to optimize the ongoing development of the ﬁeld and to extend the life of plateau production. Up to ﬁve more
water injectors are included in the 2011 drilling program. The Company plans to drill two of these wells in the ﬁrst half of 2011.
Management expects a total water injection volume greater than 25,000 bbls/day by the end of 2011.

With the recent installation of gas compression facilities, the Company is currently injecting more than 2 mmcf/day of produced
gas into the Hiswah Field. An additional injection well is currently being tied-in in an attempt to increase gas injection up to the
compression facility’s capacity of approximately 5 mmcf/day. The pressure maintenance scheme is expected to reduce the natural
ﬁeld production decline and to improve the recovery percentage.

Calvalley Petroleum Inc.

EXPLORATION AND OPERATIONS REVIEW

Yemen Block 9 Qarn Qaymah

Drilling of the Qarn Qaymah-3 appraisal well
was completed on March 8, 2011 to a total
depth of 4,460 meters, including an openhole
section of approximately 1,000 meters in the
Fractured Granitic Basement (“FGB”). The
wellbore image logs and electrical logs indicate
that the openhole section encountered a
number of fractured sections in the FGB. On
March 9, 2011, Calvalley began testing of
QQ-3. The well
is currently undergoing
pressure build up. Due to the complicated
nature of the FGB reservoirs, the testing
program is usually a lengthy process and is
expected to be completed in the second quarter of 2011. Calvalley has retained the services of two reputable reservoir consulting
ﬁrms in Calgary to analyze the wellbore image logs and electrical logs in order to better deﬁne and model the reservoir.

Yemen Block 9 Ras Nowmah

57 meters

The Company successfully drilled the
Ras Nowmah-2 appraisal well in record
time with a total gross hydrocarbon
column
including
41 meters in the Qishn and 16 meters in
the Saar Formations. The initial test results
have signiﬁcant implications for the future
exploration and development of Block 9.
The ﬁrst implication is lighter oil – contrary
to previous belief that Qishn structures
in Block 9 contain only heavy oil, the
Ras Nowmah discovery has proven
that the Block 9 Qishn structures are
similar to those in the Masila block. The
success of Ras Nowmah has added a
new and exciting exploration dimension to Calvalley’s already rich portfolio of prospect inventory. As a result, both of the near-
term and long-term exploration programs are expected to expand signiﬁcantly. Ras Nowmah is situated along a prospective
fairway where Calvalley has already identiﬁed several other Qishn structures based on new seismic interpretation. The success of
Ras Nowmah-2 has reduced the geological risk of exploration drilling on these structures.

Calvalley has recently commenced drilling of the Ras Nowmah East-1 (“RNE-1”) exploration well. The well is targeting
both Qishn and Saar Formations similar to those of the Ras Nowmah wells. The well is expected to reach total depth by
mid-April 2011, at which time the drilling rig will be mobilized to the Ras Nowmah Field to drill two successive
development wells (RN-4 and RN-5).

2010 Annual Report

EXPLORATION AND OPERATIONS REVIEW

Oil Transportation and Marketing

A critical component of Calvalley’s future success is the
ability to market different qualities of crude without

delivery restrictions which limit production to reservoirs
containing light, sweet crude. During 2010, Calvalley
management focused on negotiating transportation

agreements which would allow the Company to commence

production from all existing and future discoveries on Block 9.

Calvalley
Block 9

Block 14

Block 18

Block 4

Gas pipeline
Oil pipeline
Calvalley key block

These efforts were rewarded in February 2010 with the execution of

agreements which will enable Calvalley to activate shut-in

Al Roidhat wells and transport blended crude of 26˚ API or higher
from Block 9 through the Masila System. Immediate production
growth is expected to be realized upon completion of the TOF

which is pictured above.

Calvalley Petroleum Inc.

EXPLORATION AND OPERATIONS REVIEW

Exploration Upside: Yemen

Calvalley has successfully completed a 340 kilometer
2D seismic program over the Plateau area which covers the
Ras Nowmah discovery and nearby structures such as Sueda,
East Ras Nowmah, North Ras Nowmah, South Ras Nowmah,
Al Hedba, Al Gadaﬁr and Malik. The ﬁnal processing of the
2D seismic
indicates that good quality data have been
than
acquired. The ﬁnal
expected prospectivity over the coverage area. To date, two
additional prospects have been identiﬁed for a total of six in the
Qishn Formation.

interpretation suggests better

Ethiopia: Exploration

Ethiopia represents an opportunity for Calvalley to diversify its
operations outside Yemen.

Surface geological work at the Metema and Gimbi Blocks in
Ethiopia has been completed and fully evaluated. Based on the
surface geological work, Calvalley has completed the acquisition
of aeromagnetic survey data over a region covering an area
of approximately 26,000 square kilometers. The Company is
currently interpreting and mapping the coverage area based on
the results of this aeromagnetic survey.

2010 Annual Report

EXPLORATION AND OPERATIONS REVIEW

Yemen – Pools, Prospects and Leads

AL HORG
Q, Sc

AL AKABA
Q, Sc

MASVAN
Q

EL ALDWI
Q. Sc, S/N K, B

NORTH QARN QAYMAH

RUBEYA NW

WADI EL AFAR
Q. Sc, S/N, K, B

Sq, K, B

QARN QAYMAH

RUBEYA
K,B

K, B

WADI EL BAN – EL GARB
Q. Sc, S/N, K, B

MAHBUD
LM

GOREID
Sc, LM, K, B

AUQBAN

N. DAYSAH
Q. Sc

SOUTH QARN QAYMAH
K, B

N. HISWAH
S/N

HISWAH
S/N

MALIK PLATEAU
Q. B

MALIK

EL GADAFIR
Q. Sc

SAGHIRA
S/N

TAHIA
Q, Sc

EL GADAFIR
Q, Sc

RAS NOWMAH NORTH
Q, Sd

SUEDA
Q, Sd

RAS NOWMAH

RAS NOWMAH EAST
Q, Sd

RAS NOWMAH SOUTH
Q, Sd

AL ROIDHAT

AL KHOWEIT
Q. Sc, K, B

DAHBIL
Q, Sc, K, B

AL HEDBA
PLATEAU

AL HEDBA

SOLEYL
Q. Sc, LM, K, B

BAFARAG
Q. Sd

AL FURAG
Q, Sd

Gas pool

Oil pool

Sd Saar dolomite

S/N Saar/Naifa carbonates

Prospect/lead

LM Lower Madbi build ups

H Harshiyat

and debris fan

Q Qishn clastics

GW Granite Wash

Sc Saar clastics

Kohlan

Basement

RASNAFOOD
H, Q

SHAMEH/SHARKIA/DARIN
H, Q

RAS NOOR

Calvalley Petroleum Inc.

OPERATIONS STATISTICAL REVIEW

Drilling Activity

The Company drilled one exploration well, two appraisal wells and ﬁve development wells during 2010. As a result
of the production testing activity at Ras Nowmah and ﬁeld optimization work at the Hiswah Field, the Company’s
proved and probable reserves increased to 31.8 million bbls at December 31, 2010, representing a 20% increase
(23% including reserves produced in 2010) over the 26.5 million bbls at December 31, 2009.

Production

Oil and NGL

2010

2009

(Block 9 gross boe/day)

4,334 4,512

4,606

4,597 4,404

4,184

4,164 4,532

Oil and NGL

(Calvalley working interest boe/day)

2,167 2,256

2,303

2,299 2,202

2,092

2,082 2,266

Production rates during 2010 were generally stable. While four development wells were drilled at Hiswah, the
production increase has been offset by the fact that as of year-end, twelve producing wells remained shut-in due
to delays in delivery of production equipment.

Reserves and NPV

Proved
Developed producing
Developed non-producing
Undeveloped
Total Proved

Probable
Total Proved + Probable

Possible

Total Proved + Probable + Possible

* Based on McDaniel forecast prices (Jan 2011 Forecast)

Reserves

NPV
(10% After Tax)

NPV
(8% After Tax)

Gross (WI)
(MMbbls)

Net (after royalty & tax)
(MMbbls)

($ million)

3.8
4.7
10.9
15.7

16.3
31.8

15.8

47.6

2.3
2.6
4.9
7.5

6.9
14.4

6.0

20.3

75.7
89.1
125.3
214.4

180.2
394.7

165.0

559.7

78.5
92.3
135.5
227.8

199.6
427.3

188.2

615.5

2010 Annual Report

ManageMent’s Discussion anD analysis

References to “Calvalley” or the “Company” refer to Calvalley Petroleum Inc. and its share of consolidated subsidiaries and joint
ventures unless the context indicates otherwise. All currency references are to United States dollars unless otherwise specifically
indicated. References to “C$” are to Canadian dollars.

The purpose of this Management’s Discussion and Analysis (MD&A) is to provide readers the ability to view Calvalley in
much the same way as Company management. The following combination of historical and prospective information and
financial and business analyses, together with the consolidated financial statements, are intended to impart useful knowledge
to investors and other readers. This MD&A should be read in conjunction with the Company’s unaudited consolidated financial
statements and related notes for the year ended December 31, 2010. Additional information relating to the Company,
including the Company’s Annual Information Form, is available on SEDAR at www.sedar.com or on the Company’s website at
www.calvalleypetroleum.com.

References in text or tables throughout this document to “2010”, “2009”, and “2008” refer to the years ended
December 31, 2010, 2009 and 2008, respectively. References in text or tables labelled “Q4”, “Q3”, “Q2” and “Q1” refer to the
periods ended December 31, September 30, June 30 and March 31, respectively, of the year indicated.

This MD&A contains information current to March 22, 2010.

non-gaaP MeasuRes

Funds Flow From operations

Funds flow from operations is a measure not recognized under Canadian generally accepted accounting principles (GAAP) that
represents funds generated from operating activities before changes in non-cash working capital. Funds flow from operations
should not be considered an alternative to, or more meaningful than, cash flow from operating activities. Management believes
that funds flow from operations is a useful supplemental measure to analyze the Company’s ability to generate cash flow to fund
capital investment and working capital requirements. Funds flow from operations may not be comparable to similar measures
used by other companies.

eBitDa and operating income

Earnings before interest, taxes, depreciation and amortization (EBITDA) and operating income are non-GAAP measures. The
Company calculates EBITDA as revenue net of royalties, operating expenses, taxes, and general and administrative expenses. The
Company calculates operating income by deducting depletion, depreciation and amortization expense from EBITDA. Management
believes that EBITDA and operating income are useful supplemental measures to analyze operating performance and to provide
an indication of the results generated by the Company’s principal business activities prior to the consideration of other income and
expenses. EBITDA and operating income may not be comparable to similar measures used by other companies.

netback

Netback is a non-GAAP measure that represents oil and natural gas revenue net of royalties, operating expenses and current
taxes. Management believes that netback is a useful supplemental measure to analyze operating performance and provides an
indication of the results generated by the Company’s principal business activities prior to the consideration of other income and
expenses. Netback may not be comparable to similar measures used by other companies.

Finding and Development costs

Finding and development costs refers to all current year capital expenditures excluding property acquisitions, property dispositions
and corporate office expenditures and including changes in future development capital on a proved and proved plus probable
basis (as applicable). “Finding and development costs per barrel of oil equivalent” (“F&D $/boe”) is calculated by dividing finding
and development costs by the current year’s reserve extensions, discoveries and revisions on a proved or proved plus probable
reserve basis (as applicable).

Calvalley Petroleum Inc.

selecteD QuaRteRly inFoRMation

2010

($000s unless otherwise noted)

Full year

Full Year

2009

Avg. production volume –
Calvalley share (bopd)

Average sales volume (bopd)

Average realized price ($/bbl)

Oil sales
Oil sales, net (1)

Cash flow from operating activities
Funds flow from operations (1)

Funds flow from operations
per share ($/share) (1)

Basic and diluted

Net income (loss)

per share ($/share)

Basic and diluted

Working Capital

Total assets

Long-term debt

2,256

2,186

80.03

2,167

2,804

85.44

63,867

22,042

39,494

13,681

21,592

11,863

21,915

7,976

2,256

2,839

76.10

19,877

12,328

1,150

6,744

2,303

973

84.70

7,499

4,564

3,457

1,926

2,299

2,115

75.91

2,160

2,440

57.08

2,202

2,081

73.83

2,092

2,020

67.74

14,449

50,839

14,136

12,591

8,921

5,122

5,269

31,354

13,971

13,600

8,742

9,271

4,652

7,766

3,587

4,453

2,082

3,695

51.30

17,252

10,686

3,325

4,644

2,266

1,967

38.75

6,860

4,160

(962)

(149)

0.22

10,941

0.08

4,987

0.07

2,744

0.02

485

0.05

2,725

0.14

2,951

0.05

2,109

0.04

2,122

0.05

765

0.00

(2,045)

0.11

0.05

0.03

0.01

0.03

0.02

0.01

(0.02)

69,683

73,293

72,650

72,182

70,705

71,278

72,059

72,599

190,710

176,970

172,390

172,378

172,991

165,178

164,193

165,683

–

(1) Revenue net of royalties and government share of profit oil
(2) See “Non-GAAP Measures”. See “Operating Activities” in “Consolidated Cash Flow” section for reconciliation between Funds flow from operations

and Cash provided by (used in) operations.

oVeRall PeRFoRMance
Net income for the year ended December 31, 2010 was $10.9 million versus $3.0 million for 2009. Working capital at
December 31, 2010 decreased to 69.7 million from $70.7 million at December 31, 2009. Funds flow from operations for the year
ended December 31, 2010 improved to $21.9 million from $13.6 million for the year ended December 31, 2009.

During the year ended December 31, 2010, the Company’s ability to generate positive funds flow from operations enabled it to
finance its capital program and to buy back 718,662 shares at a cost of $2.2 million representing an average cost of C$3.13/share.
The Company continues to generate cash flow from its operations at Block 9 in the Republic of Yemen.

2010 Annual Report

Business enViRonMent
Calvalley produces high quality crude oil sold at world prices. As such, the Company’s financial results are significantly influenced
by fluctuations in commodity prices. The following table shows selected market benchmark prices as well as the Company’s
realized selling price of oil for the five most recent quarters:

Dated Brent average oil price ($/bbl)

Calvalley realized price ($/bbl)

Premium/(discount) to Dated Brent

2010 Q4

2010 Q3

2010 Q2

2010 Q1

2009 Q4

86.48

85.44

76.86

76.10

(1.04)

(0.76)

78.24

84.70

6.46

76.37

75.91

(0.45)

74.53

73.83

(0.70)

The price of Dated Brent oil averaged $86.48/bbl in Q4 2010, an increase of 16% from the Q4 2009 price of $74.53/bbl. The price
of Dated Brent oil reached a record high of $144.23/bbl. However, financial market instability and a worldwide recession resulted
in a steep decline in the price of Dated Brent oil from August to December 2008. During 2009 and into 2010, the price of oil
recovered some of this decline. The price of Dated Brent oil at December 31, 2010 was $92.55/bbl.

outlooK
As Calvalley nears completion of the Truck Offloading Facilities (“TOF”) at Block 51, the Company is entering an active phase
of the development and appraisal drilling program to unlock the production and reserves potential of Block 9. As well, with the
Company having established an improved export outlet, via the Masila Export Pipeline System (“MEPS”), the TOF will enable the
Company to market its blend of better than 26˚ API crude at a price equivalent to the traditional Masila Blend.

At the field level, Calvalley has positioned itself to gradually increase its production of blended crude to 10,000 bopd
(5,000 bopd net). In that regard, the Company continues to add new development wells at its Hiswah and Ras Nowmah fields
in preparation for the production increase. As well, the shut-in Al Roidhat wells are set to begin production which will be trucked
for storage at the CPF until the TOF is commissioned. During Q4 2010, Calvalley successfully drilled a development well at the
Al Roidhat field encountering 22 meters (72 feet) of net oil pay with average porosity of 23.5%. The well is now completed and
is currently being production tested.

Drilling of the Qarn Qaymah-3 (“QQ-3”) appraisal well was completed on March 8, 2011 to a total depth of 4,460 meters including
an openhole section of approximately 1,000 meters in the Fractured Granitic Basement (“FGB”). The wellbore image logs and
electrical logs indicate that the openhole section encountered a number of fractured sections in the FGB. On March 9, 2011,
Calvalley began testing of QQ-3. The well is currently undergoing pressure build up. Calvalley has retained services of two reputable
reservoir consulting firms in Calgary to analyze the well bore image logs and electrical logs in order to better define the reservoir.

Calvalley has recently commenced drilling of the Ras Nowmah East-1 (“RNE-1”) exploration well. The well is targeting both Qishn
and Saar Formation similar to those of the Ras Nowmah wells. The well is expected to reach total depth by mid-April 2011, at
which time the drilling rig will be mobilized to the Ras Nowmah Field to drill two successive development wells (RN-4 and RN-5).

Calvalley Petroleum Inc.

We have successfully completed a 2D seismic program of 340 km over the Plateau area which covers the Ras Nowmah discovery
and nearby prospects such as Sueda, Ras Nowmah East, Al Hedba, Al Gadafir, and the Malik Plateau. The recent mapping and
interpretation of the seismic program data indicates a better than expected prospectivity of the coverage area. Two new prospects
over the Plateau have also been identified.

With regard to Block 9 infrastructure developments, Calvalley has recently commenced technical work associated with an
inter-field pipeline connecting the Al Roidhat and Ras Nowmah fields to the Hiswah CPF.

During 2010, Calvalley commenced Hiswah water injection at 6,500 barrels a day with a single horizontal well, H-26, which has
been performing better than expected. The Company also commissioned a second water injector (H-25) and is monitoring the well
performance. Up to five more water injectors are included in the 2011 drilling program. Two of these wells will be drilled in the first
half of 2011. We expect a total water injection volume greater than 25,000 bbl/d by the end of 2011.

As well, with the recent installation of gas compression facilities, we are currently injecting more than 2 MMcf/d of produced
gas into the Hiswah Field. An additional injection well is currently being tied-in in an attempt to increase gas injection up to the
compression facility’s capacity of approximately 5MMcf/d. The pressure maintenance scheme is expected to reduce the natural
field production decline and to improve the recovery percentage.

Surface geological work at the Metema and Gimbi Blocks in Ethiopia has been completed and fully evaluated. Based on the
surface geological work, Calvalley has completed the acquisition of aeromagnetic survey data over a region covering an area of
approximately 26,000 square km. The company is currently interpreting and mapping the coverage area based on the results of
this aeromagnetic survey.

eXPloRation anD DeVeloPMent PRogRaM

Block 9 – Republic of yemen

Joint Operating Agreement (JOA)

Substantially all of Calvalley’s operations and assets are related to its 50% working interest in the Block 9 Production Sharing
Agreement (PSA) with the Government of Yemen. Calvalley is the operator of the Block 9 Joint Venture (JV) pursuant to the
JOA among Calvalley, HoodOil Ltd. (“HoodOil”), Reliance Industries Limited (“Reliance”) and a subsidiary of the Yemen Oil
and Gas General Corporation (“Yemen Co.”), an entity owned by the Government of Yemen. Yemen Co.’s interest under the
JOA consists of a 15% overriding royalty on the JV’s allocation of profit oil under the PSA.

Production Sharing Agreement

Oil and natural gas production from Block 9 is allocated between the JV and agencies of the Government of Yemen pursuant to the
terms of the PSA. The Government of Yemen receives a 10% royalty in kind from all Block 9 production, after which the remaining
oil production is shared between the JV and the Government of Yemen. The JV is first allocated up to 45% of gross production to
recover capital and operating costs incurred in order to operate Block 9. To the extent that recoverable costs exceed 45% of the

2010 Annual Report

fair value of gross production, any excess costs are carried forward for recovery against future production. After deducting cost
oil, the remaining profit oil is allocated between the Government of Yemen and the JV as follows:

• 39.23% of total profit oil to the JV (before deducting 35% income tax on JV’s share of profit oil and after deducting

15% override to Yemen Co.); and

• 60.77% to the Government of Yemen (including Yemen Co.’s override and before including income tax on JV’s share of

profit oil).

Provided that total recoverable costs do not exceed 45% of gross production, the JV may recover operating costs during the
year in which they are incurred and may deduct 50% of capital costs incurred during the year of expenditure and 50% during the
following year.

As at December 31, 2010, the Company’s share of capital costs to be carried forward for recovery against future production
was approximately $51.4 million. Until these costs have been recovered, together with future operating and capital costs that
become eligible for recovery during that time period, the Company’s net oil production will equal 31.33% of gross oil production
(22.5% from cost oil and 8.83% from profit oil). Following full recovery of past operating costs, the Company’s net oil production
will range between 17.65% and 31.33% of gross oil production, which will vary depending upon prevailing crude oil selling prices
and the capital and operating costs incurred by the JV. The Company’s share of profit oil is subject to 35% income tax to the
Government of Yemen which is paid by the Government of Yemen out of its share of profit oil.

ethiopia

Production Sharing Contract

In 2008, Calvalley entered into its first Production Sharing Contract with the Ethiopian Government for the exploration, development
and production of petroleum substances in the Gimbi and Metema blocks under a single contract covering a total area of over
46,470 km2 (11.5 million acres).

Calvalley has a 100% operated working interest in both blocks for an exploration period of eight years, consisting of an initial period
of four years followed by two subsequent option periods consisting of two years each. The option period will be activated at the
discretion of Calvalley. Furthermore, subject to hydrocarbon discovery during the total eight year period, the PSC provides for an
additional 25 year development period with a 10-year optional extension. The PSC gives Calvalley the rights to explore, develop,
and produce hydrocarbons including oil, condensate, natural gas, and associated liquids.

Total initial work obligations under the PSC, to be incurred during the initial 4-year exploration program amount to approximately
$8.5 million and consist of the acquisition and processing of 400 km of 2D seismic and the drilling of one exploration well. As at
December 31, 2010, the Company has incurred $1.2 million in exploration expenditures in fulfillment of these obligations.

Key PeRFoRMance inDicatoRs
Calvalley uses key financial indicators to help assess its business performance and manage its operations. These financial
indicators measure business growth (revenue and capital expenditures), cash generation (EBITDA and funds flow from
operations) and profitability (operating income and net income). These key financial indicators are discussed in more detail in the
following sections.

Production and sales information

Block 9 oil production (bopd)

Company working interest share (bopd)

Calvalley Petroleum Inc.

Year
Total

4,512

2,256

4,334

2,167

2010

4,512

2,256

4,606

2,303

4,597

2,299

2009

Year
Total

4,320

2,160

4,404

2,202

Production

Substantially all of Calvalley’s crude oil production in 2010 and 2009 came from the Hiswah oil field, which produces high-quality,
lighter crude oil that is sold at prices comparable to the Dated Brent crude oil reference price. All of the Company’s crude oil
production was trucked more than 250 kilometers to the Safer Exploration and Production Operations Co. processing facility on
Block 18, where the crude oil was processed and shipped via pipeline to the Ras Isa marine terminal facility for export. During
the year ended December 2010, the Company’s working interest oil production averaged 2,256 barrels of oil per day (bopd)
(2009 – 2,160 bopd).

Production rates during the year ended December 2010 improved in comparison to rates during the year ended December 2009.

During the fourth quarter of 2010, the Company conducted a detailed review of its Hiswah field development plan and material
requirements. Delays in receiving delivery of certain materials had resulted in the shutting in of 12 producing wells and 2 new
development wells. As a result of the review, the Company has selected a new supplier with superior downhole production
equipment that will result in long-term optimization of production rates. The Company ordered 23 electric submersible pumps,
4 of which have been delivered to Block 9. This will allow the Company to bring all shut-in wells into production in 2011.

During 2010 the Company finalized transportation agreements which will provide for the Company’s use of export facilities at
Block 51 and Block 14. Once shipments to Block 51 commence, the Company will begin production from the Al Roidhat and
Ras Nowmah fields.

Finding and Development costs (F&D costs)

The following table summarizes finding and development costs for 2010, 2009, and 2008.

Reserve Additions (000 boe)

Proved

Probable

F&D Costs – Proved ($000)

Change in future development costs
Capital expenditures (1)

Total F&D costs – proved

F&D Costs – Proved Plus Probable ($000)

Change in future development costs
Capital expenditures (1)

Total F&D costs – proved

Finding and Development Costs Per Barrel ($/boe)

Proved (F&D costs/reserve additions)

Proved plus probable (F&D costs/reserve additions)

Three Years

2010

2009

2008

9,947

17,795

4,492

6,111

1,219

2,704

4,236

8,980

(794)

(3,963)

57,455

56,661

18,406

14,443

11,110

13,456

24,566

(7,941)

25,593

17,652

(12,148)

(14,467)

25,850

(23,531)

57,455

45,307

18,406

3,939

13,456

39,306

25,593

2,062

5.70

2.55

3.22

0.64

20.15

14.53

4.17

0.23

(1) Capital expenditures exclude capitalized general and administrative expenditures (2010 – $2.0 million; 2009 – $1.2 million; 2008 – $2.4 million) as well as

expenditures associated with the Company’s activities in Ethiopia (2010 – $0.6 million; 2009 – $0.3 million; 2008 – $0.3 million).

(2) The aggregate of the exploration and development costs incurred in the most recent financial year and the change during that year in estimated future

development costs generally will not reflect total finding and development costs related to reserves additions for that year.

(3) BOEs may be misleading, particularly if used in isolation. A BOE conversion ratio of 6 Mcf: 1bbl is based on an energy equivalency conversion method
primarily applicable at the burner tip and does not represent a value equivalency. Note however, that the Company reserves are comprised of in excess
of 98% oil.

2010 Annual Report

selected operating information

The following table sets forth key indicators for the periods indicated:

2010

2009

($000)

Oil sales

Royalties (including government
share of profit oil)

Operating expenses

Current taxes
Netback (2)

Management fees
Facility usage fee (1)

Taxes
EBITDA (2)

Depletion, depreciation and amortization
Operating income (loss) (2)

Net income (loss)

Capital expenditures
Funds flow from operations (2)

Year
Total

63,867

22,042

19,877

7,499

14,449

Year
Total (1)

50,839

(24,373)

(10,157)

(3,940)

25,397

466

–

(8,361)

(3,588)

(1,362)

8,731

146

–

(7,549)

(3,487)

(1,229)

7,612

125

–

(2,935)

(1,194)

(463)

2,907

–

3,940

25,454

1,362

9,212

1,229

7,876

463

2,295

(5,528)

(19,485)

(1,888)

(10,313)

(886)

(3,143)

6,147

17,898

101

–

886

389

(1,025)

(4,413)

3,143

6,071

15,992

14,136

(5,394)

(2,321)

(880)

5,541

107

–

(1,095)

880

5,433

(9,437)

(2,690)

(3,235)

(1,178)

(2,334)

(9,850)

(2,433)

16,017

10,941

21,077

21,915

6,522

4,987

10,302

7,976

4,641

2,744

4,734

6,744

1,150

1,117

485

2,842

1,926

3,457

3,737

2,725

3,199

5,269

5,122

6,142

2,951

11,803

13,600

13,971

3,000

2,109

4,813

4,652

9,271

General and administrative expenses

(4,349)

(1,027)

(1,090)

(1,169)

(1,063)

Cash flow (deficiency) from operating activities 21,592

11,863

(1) For the purpose of calculating netback, operating expenses for the year total of 2009 were adjusted to exclude the portion of the facility usage fee (FUF)
which relates to deliveries of crude oil prior to January 1, 2009 in the amount of $1,025. See discussion on operating expenses for further details.

(2) See “Non-GAAP Measures”.

Netbacks are calculated on barrels sold as sales revenue less government royalties, taxes and operating expenses and are
recognized when the underlying oil is sold. Government royalties and taxes taken in kind are attributed value at the price received
by Calvalley for its production as follows:

netbacks

($/bbl)

Oil sales

Royalties (including government
share of profit oil)

Operating expenses

Current taxes
Netback (2)

2010

2009

Year
Total

80.03

(30.59)

(12.73)

(4.94)

31.77

85.44

76.10

84.70

75.91

(32.43)

(13.91)

(5.28)

33.82

(28.96)

(13.35)

(4.70)

29.09

(33.25)

(13.49)

(5.23)

32.73

(29.09)

(9.92)

(4.69)

32.21

Year
Total (1)

57.08

(21.92)

(11.58)

(3.53)

20.05

73.83

(28.28)

(12.12)

(4.56)

28.87

(1) For the purpose of calculating netback, operating expenses for the first quarter and year total of 2009 were adjusted to exclude the portion of the FUF

which relates to deliveries of crude oil prior to January 1, 2009 in the amount of $5.79/bbl. See “Operating Expenses”.

(2) See “Non-GAAP Measures”.

Calvalley Petroleum Inc.

Netbacks for the quarter ended December 2010 were $33.82/bbl compared to $28.87/bbl for the quarter ended December 2009.
Netbacks for the year ended December 31, 2010 were $31.77/bbl in comparison to $20.05/bbl for the comparable period in 2009.
Fluctuations in netbacks are primarily attributable to changes in the prevailing price of crude oil. Netbacks are also impacted by
fluctuations in operating costs as discussed below.

Revenue

During the fourth quarter of 2010, Calvalley recorded oil revenue of $22.0 million as compared to $14.1 million for the three
months ended December 31, 2009. The significant increase in revenue is attributable to a 34.8% increase in sales volume and
a 15.7% increase in selling price. The Company recognized revenue on the sale of 258,004 barrels during the quarter ended
December 31, 2010 compared with 191,456 barrels during the three-month period ended December 31, 2009. The average
selling price realized during three months ended December 31, 2010 was $85.44/bbl in comparison to $73.83/bbl during the fourth
quarter of 2009. The increase in sales volume is attributable to the timing of lifts and is not directly correlated with production,
which was 398,717 bbls in 2010 versus 405,160 bbls in 2009.

For the year ended December 31, 2010 oil revenues totalled $63.9 million compared to $50.8 million for the year ended
December 31, 2009. The directional variance for the twelve-month period is attributable to the same factors as for the three-month
period. The decrease in sales volume from 890,636 barrels during the year ended December 31, 2009 to 798,066 barrels during
the year ended December 31, 2010 accounted for a 10.4% decline in revenue. The decrease was offset by a 40.2% increase in
the average selling price which improved from $57.08/bbl in 2009 to $80.03/bbl in 2010.

other Revenue

Other revenue amounted to $0.3 million for the quarter ended December 31, 2010 (2009 – $0.2 million) and $0.9 million for the
year ended December 31, 2010 (2009 – $1.2 million). Interest revenue resulted from maintaining significant cash reserves and
guaranteed investment certificates (GICs) throughout the period. Interest income has declined from 2009 due to reduced interest
rates throughout the year. Interest rates on interest-bearing deposits declined throughout 2008 and 2009, and have remained
depressed during 2010 as central banks attempt to stimulate their economies by reducing borrowing rates.

operating expenses

Operating expenses during the fourth quarter of 2010 were $3.6 million ($13.91/bbl) as compared to $2.3 million (12.12/bbl) in
the year ended December 31, 2009. Operating expenses for the year ended December 31, 2010 were $10.2 million ($12.73/bbl)
compared to $11.3 million ($11.58/bbl) for the year ended December 31, 2009.

Total operating expenses were higher in the quarter ended December 31, 2010 than during the comparable period during 2009 as
a result a $0.3 million charge ($1.01/bbl) taken by the Company in respect of processing fees associated with the sulphur content
of certain oil deliveries. Total operating expenses were higher for the year ended December 31, 2010 in comparison to the year
ended December 31, 2009 as a result a $0.6 million charge ($0.75/bbl) taken by the Company in respect the processing fee issue
noted above. In addition, the Company conducted certain non-recurring maintenance projects.

During the first quarter of 2009, the Government of Yemen charged Calvalley $1.1 million for facilities usage. All producers
of crude oil in Yemen are subject to the FUF. The charge was applied retroactively from the commencement of production at
Block 9. The portion of the charge related to deliveries that occurred prior to January 1, 2009 amounted to $1.0 million and has
been excluded from operating expenses for the purpose of this MD&A to maintain comparability of operating expenses. The
balance of the charge in the amount of $81,000 ($0.40/bbl) related to oil that was delivered to the government facility during the
first quarter of 2009. The FUF is recoverable from the Company’s share of cost oil in accordance with the terms of the PSA.

Operating expenses include $5.47 (2009 – $5.06) per gross barrel for trucking costs, third-party processing costs, and tariffs for
use of pipeline and marine terminal facilities. The increase in costs relates to the sulphur processing fees discussed above.

2010 Annual Report

general and administrative expenses (g&a)

G&A, net of $0.7 million that was capitalized into resource development costs, totalled $1.0 million for the quarter ended
December 31, 2010 as compared to $1.1 million for the quarter ended December 31, 2009. For the year ended
December 31, 2010 G&A costs were $4.3 million compared to $4.4 million during the year ended December 31, 2009. G&A costs
directly associated with Block 9 operations become recoverable costs and will be recovered from revenue associated with cost
oil under the terms of the PSA.

eBitDa

During 2010, the Company generated EBITDA of $25.5 million compared with $16.0 million during 2009. For the fourth quarter
EBITDA was $9.2 million compared to $5.4 million for the corresponding period in 2009. The fluctuation in EBITDA is primarily
attributable to changes in the prevailing price of crude oil. The FUF referred to above in the discussion on operating expenses
was a significant contributor to the decrease in EBITDA recognized for the twelve and three months ended December 31, 2009.
EBITDA is also impacted by the timing of lifts by the purchaser of the Company’s crude oil.

Depletion, Depreciation and amortization (DD&a) expenses

DD&A ($000)

DD&A ($/bbl)

Year
Total

9,437

11.82

2,690

10.43

2010

3,235

12.39

1,178

13.31

2,334

12.26

2009

Year
Total

9,850

11.06

2,433

12.71

Calvalley recorded DD&A expenses of $2.7 million for the quarter ended December 31, 2010 as compared to $2.4 million for the
fourth quarter of 2009. For the year ended December 31, 2010, DD&A expenses of $9.4 million were recorded in comparison
to $9.9 million for the year ended December 31, 2009. The changes in the 2010 versus 2009 annual DD&A rates per barrel are
primarily related to adjustments as reflected in the Company’s December 31, 2010 reserve report. The DD&A provision is also
impacted by the build up of inventory at each period end.

operating income

During the fourth quarter of 2010, the Company generated operating income of $6.5 million compared with $3.0 million during the
three months ended December 31, 2009. During the year ended December 31, 2010 the Company generated operating income
of $16.0 million in comparison with $6.1 million for the corresponding period during 2009. Operating income was impacted by the
same factors as those affecting netbacks and EBITDA.

income taxes

Current income tax expense amounted to $1.4 million (2009 – $0.9 million) for the fourth quarter of 2010 and 3.9 million
(2009 – $3.1 million) for the year ended December 31, 2010. The charge represents income taxes incurred and paid under the laws
of Yemen pursuant to the PSA. The income tax is calculated as 35% of the Company’s profit oil revenue in Yemen, and is paid by
the Government of Yemen out of its share of profit oil.

Calvalley Petroleum Inc.

consoliDateD casH FloW

operating activities

($000)

Funds flow from operations

Change in non-cash working capital

Year
Total

21,915

(323)

7,976

3,887

Cash provided by (used in) operations

21,592

11,863

2010

6,744

(5,594)

1,150

1,926

1,531

3,457

2009

Year
Total

5,269

13,600

(147)

371

5,122

13,971

4,652

3,369

8,021

As at December 31, 2010, the Company held cash and cash equivalents of $19.5 million compared with $20.0 million at the
end of 2009. Additionally, the Company held GICs with an initial term greater than 90 days in the amount of $53.4 million
(December 31, 2009 – $50.4 million). The Company invests its cash reserves in GICs issued by an Alberta credit union in which
deposits are guaranteed by the Province of Alberta.

Funds flow from operations of $8.0 million during the fourth quarter of 2010 was sufficient to fund the majority of additions to
property, plant and equipment in the amount of $10.3 million. During the fourth quarter of 2009, funds flow from operations of
$4.7 million. Funds flow from operations was 21.9 million during the year ended December 31, 2010 compared to 13.6 million for
the year ended December 31, 2009.

investing activities

($000)

Year
Total

Additions to property, plant and equipment

(21,077)

(10,302)

2010

(4,734)

(2,538)

2009

Year
Total

(2,842)

(3,199)

(11,803)

(4,811)

Change in non-cash working capital

Net investment in GICs

3,843

(3,064)

6,731

(69)

(281)

6,960

(168)

4,327

1,286

(8,509)

(7,637)

Cash provided by (used in) investing activities

(20,298)

(3,739)

(2,945)

(1,625)

(11,989)

(12,480)

5,608

(6,359)

(5,562)

During 2010, the Company made capital expenditures of $21.1 million compared with $11.8 million during 2009. The Company
invested in the construction of additional facilities for water and gas injection, and the blending of crude oil. The Company also
continues to invest resources to construct the truck offloading facility at Block 51 in anticipation of delivering oil to this location in
accordance with the terms of the agreements described in detail in the Outlook section of this MD&A. Expenditures were incurred
to prepare and complete the Al Roidhat wells for production, to drill development wells in the Hiswah area, and to drill exploration
and appraisal wells in the Ras Nomah and Salmin areas. Finally, the Company conducted a seismic acquisition program during
the fourth quarter of 2010. The Company’s funding of expenditures on behalf of its partners exceeded payments received from
the Company’s partners in the amount of $1.7 million during 2010. Capital expenditures related to the shortfall amounted to $2.7
million. The Company also invested in GICs during the year ended December 31, 2010.

Financing activities

($000)

Issuance of common shares

Common share repurchase

Year
Total

393

(2,189)

(1,796)

183

(720)

(537)

2010

(626)

(585)

2009

114

(843)

(729)

Year
Total

776

(3,342)

(2,566)

(521)

(502)

–

2010 Annual Report

During 2010 the Company repurchased 718,662 Class A Common Voting Shares on the open market pursuant to its normal
course issuer bids at a cost of $2.2 million representing an average cost of $3.04/share (C$3.13/share). Proceeds from the issuance
of Class A Common Voting Shares during the year were related solely to the exercise of stock options and totalled $0.4 million.

consoliDateD Financial Position

Assets ($000)
As at period-end

Cash and cash equivalents

GICs

Accounts receivable

Due from joint venture partners

Oil inventory

Prepaid expenses

Property and equipment

Total assets

2010

2009

19,573

53,447

4,611

11,937

53,279

3,910

10,825

12,052

120

371

1,804

608

14,316

57,606

5,825

2,947

549

12,437

58,892

3,007

6,607

428

201

20,043

50,383

2,821

9,112

225

341

17,997

44,024

2,707

12,143

266

373

101,763

190,710

93,380

91,114

90,806

90,066

87,668

176,970

172,390

172,378

172,991

165,178

As at December 31, 2010, the Company’s total assets were $190.8 million, an increase of $17.7 million from December 31, 2009.
Cash and cash equivalents amounted to $19.6 million compared with $20.0 million at the beginning of the year. The decrease was
offset by an increase of $3.1 million in GICs.

Accounts receivable increased by $1.8 million to $4.6 million as at December 31, 2010. The amount due from JV partners increased
from $9.1 million at the beginning of the year to $10.8 million as at December 31, 2010.

Oil inventory decreased from $0.2 million at December 31, 2009 to $0.1 million at December 31, 2010. Oil inventory results
from the timing of lifts and relates to oil production in storage at the end of a period, valued at the average cost of production. At
December 31, 2010, the Company’s oil inventory net of royalties and taxes amounted to 2,562 bbls compared to 5,805 bbls at
December 31, 2009.

Property and equipment increased to $101.8 million as at December, 2010. The movement in property and equipment resulted
from capital expenditures of $21.1 million, which was offset by DD&A expense of $9.4 million less $0.1 million in net adjustments
to depletion related to oil in inventory.

Liabilities and Shareholders’ Equity ($000)
As at period-end

Accounts payable and accrued liabilities

19,264

10,297

8,626

9,390

12,220

6,232

Share capital

116,140

116,079

116,227

116,143

116,387

116,622

2010

2009

Accounts payable and accrued liabilities increased to $19.3 million as at December 31, 2010, from $12.2 million as at
December 31, 2009. The primary reason for this decrease is the increased capital spending related to heightened exploration and
development activity during the last two months of 2010 and the timing of payments made to suppliers and contractors.

Share capital decreased to $116.1 million as at December 31, 2010 from $116.4 million as at the end of 2009 as a result of
the repurchase of common shares through the Company’s normal course issuer bids. The decrease was partially offset by the
issuance of Class “A” Common Voting Shares from the exercise of stock options during the period.

Calvalley Petroleum Inc.

liQuiDity anD caPital ResouRces
Calvalley’s principal source of liquidity has been funds flow from operations. Calvalley manages its liquidity risk by regularly
monitoring its cash flows from operating activities and holding adequate amounts of cash and cash equivalents. The Company
does not invest its funds in speculative securities. The 2010 budget is expected to be funded from cash flow from operations and
existing cash resources. Should the prevailing Dated Brent Crude price decline to lower than budgeted, Calvalley has sufficient
flexibility in its capital budget to adjust capital expenditures to enable the capital program to be funded through internally generated
cash flow. Fluctuations in commodity prices, product demand, foreign exchange rates and interest rates, as well as various other
risks relating to factors beyond the control of Calvalley may impact capital resources.

Calvalley has no outstanding bank debt or other interest-bearing indebtedness as at December 31, 2010. The Company has not
arranged any undrawn operating lines of credit with any financial institution as the Company intends to fund its near-term capital
expenditure programs from available cash on hand, funds flow from operations and, if required, from the issuance of additional
share capital.

As at December 31, 2010, the Company’s total assets were $190.7 million, an increase of $17.7 million from December 31, 2009.
Cash and cash equivalents amounted to $19.6 million compared with $20.0 million at the beginning of the year. Cash equivalents
are invested with high-quality financial institutions with terms to maturity of less than three months. Additionally, the Company
held GICs with an initial term greater than 90 days. Total cash and cash equivalents plus GICs increased from $70.4 million at
December 31, 2009 to $73.0 million at December 31, 2010.

Interest rates on interest-bearing deposits have remained depressed over the past year as central banks attempt to stimulate their
economies by reducing borrowing rates. Most of Calvalley’s funds are deposited at a credit union where deposits are guaranteed
by the Government of Alberta.

As at December 31, 2010 the Company’s working capital decreased to $69.7 million as compared to $70.7 million as at
December 31, 2009.

At December 31, 2010 the Company had Canadian tax pools of approximately $34.2 million, of which $16.8 million were
non-capital losses, $7.1 million were Canadian resource tax pools, $10.3 million were undepreciated capital cost allowance and
$Nil were deferred financing costs. No provision has been made to record these pools as an asset because the Company is not
likely to take advantage of them due to the insignificance of its Canadian operations and assets.

The Company has no long-term contractual obligations in Canada other than an operating lease for office space of
approximately $0.2 million in each of 2011, 2012, and 2013. Its long-term commitments regarding its Yemen property include its
50% proportionate share of government allowances and bonuses payable under the terms of the PSA of $450,000 per year, plus its
50% proportionate share of certain other bonus payments of $2 million, $3 million and $4 million when and if sustainable
production exceeds 25,000, 75,000 and 100,000 bopd day, respectively.

During 2008, Calvalley entered into its first Production Sharing Contract (PSC) with the government of the Federal Democratic
Republic of Ethiopia. Pursuant to the PSC, the Company has entered into certain commitments to spend approximately
$8.5 million during the first four years of its work program.

Calvalley had no off-balance-sheet arrangements as at December 31, 2010 or December 31, 2009.

2010 Annual Report

econoMic sensitiVities
The following table shows the estimated after-tax effect that changes to crude oil prices, gross crude oil production, operating
costs and interest rates would have had on Calvalley’s net income for the year ended December 31, 2010, had these changes
occurred on January 1, 2010. These calculations are based on business conditions, production and sales volumes existing for the
current period. The 1,000 bopd increase assumes the increase is to gross field production and Calvalley’s entitlement is calculated
according to the provisions of the PSA and JOA.

Average realized price

Crude oil production

Increase in operating expenses

Interest rate

Change (+)

$10.00/bbl

1,000 bopd

$1.00/bbl

Net Income
Impact
($ millions)

Net Income
Impact
($ per basic share)

4.5

3.6

(0.8)

0.7

0.05

0.04

(0.01)

0.01

The impact of the above changes may be compounded or offset by changes to other business conditions. In addition, the table does
not reflect any inter-relationships between the above factors. Changes in the foreign exchange rates have not been considered in
this analysis as they do not have a significant impact on Calvalley’s operations.

RelateD-PaRty tRansactions
On June 10, 2009 the Company advanced $113,000 to a member of the Board of Directors. The advance was provided to provide
funds for the exercise of options and was included in accounts receivable, was non-interest-bearing, repayable within 90 days, and
secured by shares of the Company. The advance was repaid in full during August 2009.

RisK FactoRs
Calvalley is exposed to a number of risks inherent in exploring for, developing and producing oil and natural gas. This section
describes the risks and other matters that would be most likely to influence an investor’s decision to purchase securities
of Calvalley.

Calvalley manages a number of risks in its business in order to achieve an acceptable level of risk without hindering the ability to
maximize returns. Management has adopted procedures to identify and manage significant operational and financial risks.

commodity Risk

Calvalley’s principal business is the production and sale of crude oil. Revenues, earnings and cash flows from the sale of
crude oil are sensitive to change in market prices, over which the Company has little or no control. The Company has the ability to
address its price-related exposures through the limited use of options, future and forward contracts, but generally does not enter
into such arrangements.

currency Fluctuations

Calvalley undertakes transactions in currencies other than the United States dollar. The Company’s primary foreign exchange
risk is to changes in the value of the Canadian dollar relative to the United States dollar. Fluctuations in exchange rates between
the United States dollar and other currencies will give rise to foreign currency exposure, either favourable or unfavourable,
which may have material effects on the Company’s operations and financial condition. The Company has the ability to address
its currency-related exposures through the use of foreign exchange contracts. It generally does not enter into such hedging
arrangements but maintains a portion of its currency in Canadian dollars to meet its Canadian dollar requirements.

Calvalley Petroleum Inc.

interest Rates

The Company has no interest-bearing debt. The Company invests surplus cash balances in short-term investments with recognized
Canadian financial institutions. Fluctuations in interest rates, either favourable or unfavourable, may have material effects on the
Company’s interest income on short-term cash investments.

credit Risk and concentration of sales Risk

In January 2007, the Company entered into a long-term crude oil marketing agreement under which the Company sells all of its
crude oil production to a single purchaser for a period of 18 months. The purchaser is a subsidiary of Reliance Industries Limited,
India’s largest business enterprise, which is a party to the JOA for Yemen Block 9. The purchaser’s obligations under the crude oil
marketing agreement are guaranteed by Reliance, which has been assigned credit ratings of Baa2 Stable Outlook by Moody’s and
BBB Stable Outlook by S&P (above Sovereign Rating). The contract was formally extended in April 2009 and remains in effect.

Credit risk also relates to the risk that joint venture partners may not fulfill their contractual obligations for financial contributions
towards exploration, development, appraisal and production operations.

During the initial agreement negotiations and ratification, these risks are considered and incorporated into the terms of the
applicable contracts. Furthermore, cash calls can be made in advance of incurring costs to help ensure costs are recovered.
However, it is possible that the interest of Calvalley and its JV partners are not aligned, resulting in project delays, additional costs
or disagreements, which could adversely affect business results.

insurable Risk

Calvalley employs risk management practices to reduce and mitigate operational risks and other hazard risks and exposures,
although it is impossible to completely protect its operations from all such risks. The Company places types and an amount of
insurance that it considers consistent with industry practice to the extent coverage is available and cost effective. Such coverage
includes third-party liability insurance and property and business interruption insurance.

The Company may become liable for damages arising from unforeseen events which it cannot insure against or chooses to
self-insure. Costs incurred to repair such uninsured damage or to pay associated liabilities may have a material effect on the
financial condition of the Company.

legal contingencies

The Company has been named in a claim filed in the Commercial Court of Yemen by a Saudi Arabian company. The claimant
alleges that, pursuant to an agency agreement entered into in 1996, it is entitled to a percentage of the net profit attributable to
the Company. Over the past several years this issue has been before the Commercial Court of Yemen, the Yemeni Court of Appeal
and the Supreme Court of Yemen on a number of procedural issues and has now been sent back to the Supreme Court of Yemen
for reassessment. Interim judgments have been issued and both parties appealed an initial ruling which limited the plaintiff’s
entitlement to an interest on the net profit from profit oil production prior to February, 2008. Calvalley has cross-appealed on a
number of matters of substance and procedure.

The Company’s legal advisors in Sana’a and Calgary are pursuing the appeal jointly. The outcome of the action in the Supreme
Court of Yemen is undeterminable at this time and the Company is exploring both judicial, and extra judicial, resolution. No
amounts have been accrued in the consolidated financial statements for the periods ended December 31, 2010 as the ultimate
resolution is uncertain. The Company will record any amounts due, if any, once the outcome of the contingency is likely and
reasonably estimated.

2010 Annual Report

Company and its JV Partners have now agreed to enter into a binding expert determination in London, England to interpret the
terms of the JOA and to obtain a ruling on whether the fees in question are billable. While management is not able to determine
the likelihood of a positive or negative outcome, the maximum liability to the Company related to fees charged from 2004 to 2007
is $1.0 million. Conversely, should the fees be deemed billable, the Company would recover fees which have not previously been
recorded in the accounts in the amount of $926,997.

In the normal course of operations, the Company may be subject to litigation and claims. In the opinion of management, other than
as disclosed above, no such litigation or claim, individually or in aggregate, would result in a liability that would have a significant
adverse effect on the financial position or results of operations of the Company.

concentration of Producing assets

Substantially all of Calvalley’s production is generated from highly productive individual wells in Yemen. The production and sale
of crude oil in Yemen involves the use of central production facilities, oil pipelines, and export terminals, either operated by the
Company or by third parties. As significant production is generated from each of these assets, any single event causing an
interruption to any one of these operations could result in the loss of production and reserves as a result.

exploration, Development and Production Risks

Acquiring, developing and exploring for oil and natural gas involves many risks which include but are not limited to encountering
unexpected formations or pressures, premature declines of reservoirs, blow-outs, well bore collapse, equipment failures and other
accidents, craterings and sour gas releases, uncontrollable flows of oil, natural gas or well fluids, and environmental risks.

In many oil and natural gas producing countries, oil and natural gas properties, together with related production and transportation
infrastructure, can be situated in remote areas. In addition to the operational risks described above, oil and natural gas properties in
some of these countries may be vulnerable to premeditated acts of violence which have the potential to cause significant damage
to oil and natural gas operations and injury or death to personnel. The Company relies on the Government of Yemen’s support in
providing appropriate security for crude oil operations in Block 9.

Calvalley may not be fully insured against all of these risks. Losses resulting from the occurrence of these risks could have a
material impact on the Company’s financial results.

Reserve additions

Calvalley’s future crude oil reserves and production, and therefore its operating cash flows and results of operations, are highly
dependent upon the Company’s success in exploiting its current reserve base and acquiring or discovering additional reserves.
Without reserve additions through exploration, development or acquisitions, the Company’s reserves and production will decline
over time as reserves are produced. The business of exploring for, developing or acquiring reserves is capital-intensive. To the
extent cash flows from operations are insufficient and external sources of capital become limited or unavailable, Calvalley’s ability
to make the necessary capital investments to maintain and expand its oil production and reserves will be impaired.

environment, Health, safety and Regulatory approvals

Environmental, health and safety laws and regulations are continually evolving. Compliance with such laws and regulations can
require significant expenditures which may materially affect the Company’s financial condition or results of operations.

Expansion of existing operations and the development of new operating sites generally require approval of regulatory authorities.
If such approvals are delayed or not achieved, the Company’s ability to meet project schedule or cost objectives or to operate at
expanded or existing levels could be materially impacted.

Workplace health and safety risks for workers arise from the inherent nature of the Company’s operations and the jurisdictions
within which it operates.

Calvalley Petroleum Inc.

Political Risks

Beyond the risk inherent in the oil and gas industry, the Company is subject to additional risks resulting from the current unrest in
the Middle East. These risks can involve matters arising out of the evolving laws and policies, the imposition of special taxes or
similar charges, oil export or pipeline restrictions, foreign currency controls, the unenforceability of contractual rights, restrictions
on the use of expatriates in the operations and other matters.

There can be no assurance that agreements entered into with various parties are enforceable or binding in accordance with the
Company’s understanding of their terms or that if breached, the Company would be able obtain favourable remedies. The Company
bears the risk that political change could occur and that such change could have a further impact on the Company’s operations.

competition

There is strong competition relating to all aspects of the oil and natural gas industry. Calvalley actively competes for skilled industry
personnel who are in high demand, particularly at its Canadian headquarters, with a substantial number of other oil and natural gas
companies, many of which have significantly greater financial and other resources.

changes in legislation

There can be no assurance that laws and regulations relating to the oil and natural gas industry will not be changed in a manner
which would adversely affect the operations of the Company. Under the PSA, the Company is not obligated to comply with
regulatory changes that are inconsistent with the provisions of the PSA. Further, the PSA stipulates that the interests, rights and
obligations of the Government of Yemen and the Company shall be solely governed by the provisions of the PSA unless altered or
amended by mutual agreement. In particular, the PSA requires that the Government of Yemen pay profit taxes on the Company’s
behalf, out of the Government of Yemen’s share of profit oil.

MeasuReMent unceRtainty
The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial
statements and revenue and expenses during the reporting period. Actual results, including petroleum and natural gas sales,
royalties and operating expenses, can differ from these estimates.

In particular, amounts recorded for depreciation and depletion and amounts used for ceiling test calculations are based on
estimates of petroleum and natural gas reserves and future costs required to develop those reserves. The Company’s reserve
estimates are evaluated annually by an independent engineering firm. By their nature, these estimates of reserves and the related
future cash flows are subject to measurement uncertainty and the impact on the consolidated financial statements of future
periods could be material.

Computations of provisions and estimates for income taxes involve management making judgments with respect to interpretation
of tax regulations and related legislation which is continually changing. In addition, there are tax matters that have not yet been
confirmed by taxation authorities. While management believes the provision for income taxes is adequate, these amounts are
subject to measurement uncertainty. Adjustments required, if any, to these provisions will be reflected in the period when it is
determined that adjustments are warranted.

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which were fully
tradable with no vesting restrictions. This option valuation model requires the input of highly subjective assumptions including the
expected stock price volatility. Because the Company’s stock options and warrants have characteristics significantly different from
those of traded options and because changes in the subjective input assumptions can materially affect the calculated fair value,
such value is subject to measurement uncertainty.

2010 Annual Report

Amounts recorded as due from joint venture partners are based on the Company’s interpretation of underlying agreements and
may be subject to joint approval. The Company has recorded balances due based on costs incurred and its interpretation of
allowable expenditures. Any adjustments required as a result of joint venture audits are recorded in the period of settlement with
joint venture partners.

aDDitional inFoRMation
As at December 31, 2010, the Company had 97,714,280 common shares outstanding. Additionally, there were 4,801,668 options
outstanding which were issued pursuant to the Company’s stock option plan. As at March 22, 2011, the Company had 97,554,679
common shares outstanding. Additionally, there were 4,764,341 options outstanding which were issued pursuant to the Company’s
stock option plan.

DisclosuRe contRols anD PRoceDuRes
Disclosure Controls and Procedures (“DC&P”) are designed to provide reasonable assurance that information required to be
disclosed is recorded, processed, summarized and reported within the time periods specified in applicable securities legislation, and
include controls and procedures designed to ensure that information required to be disclosed is accumulated and communicated
to management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

As at December 31, 2010, an evaluation of the design of the Company’s DC&P was carried out under the supervision of,
and with the participation of management including its certifying officers. Based on that evaluation, the Company’s certifying
officers concluded that the design of the Company’s DC&P was effective as at December 31, 2010 and would provide reasonable
assurance that material information relating to the Company and its consolidated subsidiaries would be made known to them
by others within those entities during the period in which the annual filings were prepared, and that information required to be
disclosed by the Company would be recorded, processed, summarized and reported within the time periods specified under
applicable securities legislation.

inteRnal contRols oVeR Financial RePoRting
Internal Controls over Financial Reporting (“ICFR”) are designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements in accordance with Canadian GAAP. ICFR can only provide
reasonable assurance and may not prevent or detect misstatements. Projections of an evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate due to changes in conditions, or that the degree of compliance
with the policies and procedures may deteriorate. As at December 31, 2010, an evaluation of the design of the Company’s
ICFR was carried out under the supervision of, and with the participation of management including its certifying officers. Based
on that evaluation, the Company’s certifying officers concluded that the design of the Company’s ICFR was effective as at
December 31, 2010 and would provide reasonable assurance that material weaknesses in ICFR would be made known to them,
and reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external
purposes in accordance with GAAP.

Calvalley Petroleum Inc.

eFFect oF FutuRe cHanges in accounting Policies

international Financial Reporting standards (iFRs)

In February 2008, the CICA’s Accounting Standards Board confirmed that all Canadian publicly accountable enterprises will be
required to adopt IFRS for interim and annual reporting purposes for fiscal years beginning on or after January 1, 2011. Calvalley
is continually assessing the impact of the convergence of Canadian GAAP with IFRS on the Company’s results of operations,
financial position and disclosures. Under the direction and oversight of the Board of Directors and Audit Committee, the Company
has assembled a project team to manage the transition and to ensure successful implementation within the required timeframe.

The Company recognizes that the changeover to IFRS has complex implications on a combination of accounting, financial reporting,
and information technology and business systems. Consequently, senior management has engaged external consultants to conduct
a business impact study, to assist in the development a project plan, and to provide assistance in considering various accounting
policy decisions which will be required throughout the transition period. Company personnel involved with the transition project
have also received appropriate training and education.

The overall IFRS transition project consists of five phases: (i) Scope; (ii) Plan; (iii) Design and Build; (iv) Implement; (v) Review.

The Scope phase, which consisted of identifying the significant differences between Canadian GAAP and IFRS, has been
completed. The Company concluded that the following key issues will have the most significant impact on Calvalley’s results of
operations, financial position and disclosures:

IFRS 1 – First-time adoption of International Financial Reporting Standards;

IFRS 6 – Exploration and Evaluation of Mineral Resources;

International Accounting Standard (IAS) 16 – Property, Plant and Equipment; and

IAS 36 – Impairment of Assets.

The Company has also completed the Plan phase. During this phase, the Company gathered information and financial data to
assess the potential impacts of the differences identified during the Scope phase. Management established the resources that are
required to complete the transition to IFRS, assembled an IFRS transition project team, and established internal milestones and
timelines. The Company is currently adhering to the timelines established in its transition project plan.

The Company continues to progress through the Design and Build phase of the transition project. The IFRS project team’s
development of recommendations for IFRS policy decisions is ongoing, based on appropriately documented consideration of the
following factors:

• Impact on financial and key performance indicators;

• Impact on information technology and systems;

• Impact on the internal control and disclosure control frameworks;

• Transition and maintenance costs;

• Impact on communications with key stakeholders; and

• Other general business impacts.

2010 Annual Report

Accounting Policies

The IFRS project team conducted a preliminary detailed analysis of all IFRSs identified during the Scope phase and has identified
the impact of the available policy alternatives to the Company’s financial reports. A draft IFRS transition date consolidated balance
sheet has been reviewed and approved by management and by the Audit Committee. Management has reviewed the available
policy alternatives and has presented recommendations to the Audit Committee.

IFRS 1 provides the framework for the first-time adoption of IFRS and specifies that, in general, an entity shall apply the principles
under IFRS retrospectively. Adjustments that arise on retrospective conversion to IFRS from other GAAP are recognized directly
in retained earnings. However, certain optional exemptions and mandatory exceptions to retrospective application are provided
for under IFRS 1.

Anticipated impacts to the Company of applying certain IFRS 1 exemptions and other relevant accounting differences between
Canadian GAAP and IFRS on the consolidated financial statements of the Company are as follows:

Financial Statement Item Implications of IFRS

Expected Impact on Calvalley

Property, plant and
equipment (PP&E)

The Company plans to use the IFRS 1
deemed cost exemption for the opening
IFRS carrying value of oil and gas assets,
and management has assessed that all oil
and gas assets in Yemen and Canada are
technically feasible and commercially viable
as at January 1, 2010. As a result, exploration
costs incurred in Ethiopia will be reclassified
from PP&E to intangible E&E assets, and
Yemen PP&E costs will be classified as D&P
PP&E in the opening IFRS balance sheet.

The Company conducted IAS 36 impairment
tests on its PP&E as at January 1, 2010.
None of the Company’s assets were found
to be impaired at the date of transition. Going
forward under IFRS, the one-step impairment
test approach could trigger more frequent
impairment losses, and the reversal of
impairments could result in greater volatility
in net income and carrying values of assets.

The existing Canadian GAAP oil and gas
full cost pool must be segregated into
exploration and evaluation (E&E) assets and
development and producing (D&P) PP&E.
Per IFRS 6, assets are to be reclassified from
E&E assets to D&P PP&E once technical
feasibility and commercial viability have been
achieved. Using the IFRS 1 deemed cost
exemption the carrying value of the assets
in the full cost pool under Canadian GAAP
is deemed to be the opening carrying value
under IFRS, subject to an impairment test.

Canadian GAAP requires a two-step approach
to impairment testing. Asset carrying
values are first compared to undiscounted
cash flows to determine whether impairment
exists. If an impairment is indicated,
the magnitude of the impairment is
measured by comparing the carrying
value to the fair value of discounted cash
flows. IAS 36 uses a one-step approach
for testing and measuring impairment.
Asset carrying values are compared to the
higher of fair value less costs to sell and
value in use (which uses discounted future
cash flows). IFRS also requires reversal of
impairment losses when circumstances for
previous impairment have changed, however
Canadian GAAP prohibits reversal.

Calvalley Petroleum Inc.

Financial Statement Item Implications of IFRS

Expected Impact on Calvalley

Contributed surplus –
stock-based compensation

Where the Company recorded stock-based
compensation expense on a straight-line
basis and forfeitures as they occurred
under Canadian GAAP, IFRS 2 Share-based
Payment requires expense recognition
over the individual vesting periods of
graded vesting awards and an estimation
of forfeiture rates. Using the IFRS 1 share-
based payment transactions exemption,
IFRS 2 is retrospectively applied only to stock
options issued after November 7, 2002, that
had not vested as at January 1, 2010.

Accumulated other
comprehensive income
– cumulative translation
differences

Applying the IFRS 1 cumulative translation
differences exemption resets previously
recognized translation differences relating to
investments in foreign operations to zero.

IAS 21 The Effects of Changes in Foreign
Exchange Rates requires the Company to
formally assess the functional currency of
each entity in the consolidated group. Some
variances in functional currency criteria exist
between IFRS and Canadian GAAP.

The Company plans to apply the
IFRS 1 share-based payment transactions
exemption. The opening IFRS balance
sheet will reflect an increase to contributed
surplus and a corresponding decrease to
retained earnings for additional stock-based
compensation expense. Going forward under
IFRS, stock-based compensation expense
will be concentrated in the earlier years of an
issue of graded vesting options.

The Company plans to elect the
IFRS 1 cumulative translation differences
exemption. Accumulated other
comprehensive income as at January 1,
2010 will consequently be decreased with a
corresponding increase to retained earnings.

Consistent with its assessment
under Canadian GAAP, the Company
determined that the US dollar is the
functional currency of each entity within
the consolidated group. Accounting for the
Company’s foreign currency transactions and
balances under IFRS will remain consistent
with Canadian GAAP.

While management and the Audit Committee have made preliminary decisions and approvals regarding some of the Company’s
IFRS accounting policies, the areas impacted by IFRS discussed above should not be regarded as a comprehensive list of changes
that will result from the transition to IFRS. The Company’s selected IFRS policies have not been finalized and remain subject to
review by the Company’s external auditors. As the Company proceeds with the Implementation and Review stages, management
may find it necessary to refine its policy choices in order to accommodate developments to industry best practices and to provide
more useful information in the financial statements. Further, the International Accounting Standards Board has ongoing projects
that could affect IFRS prior to conversion in 2011 as well as the Company’s financial statements in future years.

DC&P and ICFR

Implementation of the necessary changes to entity level, information technology, financial reporting, disclosure, and business
process controls will be executed as policy choices are finalized. Where significant changes are identified, these changes will be
mapped and tested to ensure that no material deficiencies exist as a result of the Company’s conversion to IFRS.

2010 Annual Report

Business Activities

In conjunction with policy development, the Company continues to assess whether the transition to IFRS will have an impact on
business activities. Management does not anticipate that IFRS will significantly affect the Company’s contractual agreements,
as the Company has no debt covenants, and the Yemen PSA and Ethiopian PSC stipulate particular accounting and reporting
requirements. Management has not identified any instances where IFRS would have major implications on existing contractual
arrangements or on other business activities.

Information Technology and Data Systems

In respect of information technology systems implications, management has communicated with software suppliers to confirm
that systems in place are sufficient to enable the IFRS transition. Management is in the process of developing a strategy for
implementing IFRS-compliant financial reporting processes during 2010 using the existing accounting software suite and financial
reporting infrastructure. Plans are also under development in preparation for the Q1 2011 transition to IFRS, which will require the
loading of IFRS financial information into the current accounting and reporting systems.

noRMal couRse issueR BiDs
On April 21, 2009, the Company made the necessary filings, and received the necessary approvals, to make a normal course issuer
bid through the facilities of the Toronto Stock Exchange (TSX) commencing April 23, 2009 and ending April 22, 2010. A copy of the
notice filed with the Toronto Stock Exchange can be obtained by any shareholder of the Company, without charge, by contacting
the Company.

A total of 4,948,029 Class A Common Shares (the “Common Shares”) were authorized to be acquired under the bid, representing
5% of the 98,960,580 Common Shares outstanding as of April 15, 2009. Calvalley was to acquire Common Shares under the bid
at the market price at the time of purchase, and all Common Shares acquired were to be cancelled. Unless Calvalley utilized a
Block Purchase Exemption as permitted by the TSX, purchases were subject to a daily purchase restriction equal to 25% of the
average daily trading volume of the Common Shares over the preceding six calendar months, or a maximum of 28,824 Common
Shares per trading day.

In the opinion of Calvalley’s Board of Directors, Calvalley’s Common Shares were, from time to time, undervalued by the market,
and the cost of acquiring the shares is an expense prudently incurred by Calvalley to increase shareholder value.

A total of 1,657,688 shares were acquired under the bid at an average cost of C$1.93/share.

On September 14, 2010, the Company made the necessary filings, and received the necessary approvals, to make a normal course
issuer bid through the facilities of the Toronto Stock Exchange (TSX) commencing September 16, 2010 and ending September 15,
2011. A copy of the notice filed with the Toronto Stock Exchange can be obtained by any shareholder of the Company, without
charge, by contacting the Company.

A total of 7,841,792 Class A Common Shares (the “Common Shares”) were authorized to be acquired under the bid, representing
10% of the public float of Common Shares of the Company. Calvalley may acquire Common Shares under the bid at the
market price at the time of purchase, and all Common Shares acquired are to be cancelled. Unless Calvalley utilizes a Block
Purchase Exemption as permitted by the TSX, purchases are subject to a daily purchase restriction equal to 25% of the average
daily trading volume of the Common Shares over the preceding six calendar months, or a maximum of 32,134 Common Shares
per trading day.

In the opinion of Calvalley’s Board of Directors, Calvalley’s Common Shares are, from time to time, undervalued by the market, and
the cost of acquiring the shares is an expense prudently incurred by Calvalley to increase shareholder value.

As of March 22, 2011, a total of 563,804 shares have been acquired under the bid at an average cost of C$4.17/share.

Calvalley Petroleum Inc.

coMPaRaBility WitH PRioR PeRioDs
Revenue may fluctuate from period to period due to the timing of shipments of oil from the Ras Isa Oil Terminal. Revenue is
recognized only when oil is loaded onto a tanker. Oil in storage at period-end is recorded as inventory at the average cost of
production and depletion and in situations where the take-or-pay provisions of the crude marketing agreement take effect, any
receivable related to those provisions is recorded in the accounts as deferred revenue. At December 31, 2010, the Company had
no take-or-pay revenue and oil inventory was $0.1 million.

In April 2009, the Government of Yemen charged Calvalley $1.1 million for facilities usage. All producers of crude oil in Yemen are
subject to the Facility Usage Fee (FUF). The charge was applied retroactively from the commencement of production at Block 9
and was accrued in the first quarter 2009 financial statements. The portion of the charge related to deliveries that occurred prior to
January 1, 2009 amounted to $1.0 million. The balance of the charge in the amount of $81,000 ($0.40/bbl) related to oil that was
delivered to the government facility during Q1 2009. The Company will continue to incur the $0.40/bbl FUF in future periods. The
FUF is recoverable from the Company’s share of cost oil in accordance with the terms of the Production Sharing Agreement.

FoRWaRD-looKing stateMents
This MD&A contains certain forward-looking statements. Some of the statements contained herein including, without
limitation, financial and business prospects and financial outlooks of the Company may be forward-looking statements
which reflect management’s expectations regarding future plans and intentions, growth, results of operations, performance
and business prospects and opportunities. Words such as “may”, “will”, “should”, “could”, “anticipate”, “believe”,
“expect”, “intend”, “plan”, “potential”, “continue”, and similar expressions have been used to identify these forward-looking
statements. These statements reflect management’s current beliefs and are based on information currently available to
management. Forward-looking statements involve significant risk and uncertainties. A number of factors could cause actual results
to differ materially from the results discussed in the forward-looking statements including, but not limited to, changes in general
economic, political and market conditions and other risk factors. Although the forward-looking statements contained herein are
based upon what management believes to be reasonable assumptions, management cannot assure that actual results will be
consistent with these forward-looking statements. Investors should not place undue reliance on forward-looking statements.
These forward-looking statements are made as of the date hereof.

Forward-looking statements and other information contained herein concerning the oil and natural gas industry and Calvalley’s
general expectations concerning this industry are based on estimates prepared by management using data from publicly available
industry sources as well as from reserve reports, market research and industry analysis and on assumptions based on data
and knowledge of this industry which Calvalley believes to be reasonable. However, this data is inherently imprecise, although
generally indicative of relative market positions, market shares and performance characteristics. While Calvalley is not aware of
any misstatements regarding any industry data presented herein, the industry involves risks and uncertainties and is subject to
change based on various factors. See “Risk Factors.”

Calvalley does not undertake any obligation to update publicly or revise any forward-looking statements contained in this or in any
other document filed with Canadian securities regulatory authorities, whether as a result of new information, future events or
otherwise, except as required by applicable securities laws.

2010 Annual Report

ManageMent’s RePoRt

The consolidated financial statements of Calvalley Petroleum Inc. were prepared by management within acceptable limits of
materiality and are in accordance with Canadian generally accepted accounting principles. Management is responsible for ensuring
that the financial and operating information presented in the Company’s 2010 annual report is consistent with that shown in the
consolidated financial statements.

The consolidated financial statements have been prepared by management in accordance with the accounting principles as
described in the notes to the consolidated financial statements. Timely release of financial information sometimes necessitates
the use of estimates when transactions affecting the current accounting period cannot be finalized until future periods. When
necessary, such estimates are based on informed judgments made by management.

Management has designed and maintains an appropriate system of internal controls to provide reasonable assurance that all
assets are safeguarded and financial records properly maintained to facilitate the preparation of consolidated financial statements
for reporting purposes.

Deloitte & Touche LLP, an independent firm of Chartered Accountants appointed by the shareholders, have conducted an
examination of the corporate and accounting records in order to express their opinion on the consolidated financial statements.
The Audit Committee, consisting of three independent directors, has met with representatives of Deloitte & Touche LLP and
management in order to determine if management has fulfilled its responsibilities in the preparation of the consolidated financial
statements. The Board of Directors has approved the consolidated financial statements.

Edmund Shimoon
Chairman and CEO

March 22, 2011

Zacharie J. Magnan
Acting Chief Financial Officer

Calvalley Petroleum Inc.

inDePenDent auDitoR’s RePoRt

to the shareholders of calvalley Petroleum inc.:

We have audited the accompanying consolidated financial statements of Calvalley Petroleum Inc., which comprise the consolidated
balance sheets as at December 31, 2010, and 2009, and the consolidated statements of operations and retained earnings and cash
flows for the years then ended, and a summary of significant accounting policies and other explanatory information.

Management’s Responsibility for the consolidated Financial statements

Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance
with Canadian generally accepted accounting principles, and for such internal control as management determines is necessary
to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to
fraud or error.

auditor’s Responsibility

Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our
audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical
requirements and plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements
are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial
statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material
misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the
auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements
in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion
on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies
used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the
consolidated financial statements.

We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our
audit opinion.

opinion

In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of Calvalley
Petroleum Inc. as at December 31, 2010 and 2009, and its results from operations and its cash flows for the years then ended in
accordance with Canadian generally accepted accounting principles.

Calgary, Alberta

March 22, 2011

Deloitte & Touche LLP

Chartered Accountants

2010 Annual Report

2010

19,573

53,447

4,611

120

10,825

371

88,947

101,763

190,710

19,264

116,140

8,462

3,963

42,881

171,446

190,710

2009

20,043

50,383

2,821

225

9,112

341

82,925

90,066

172,991

12,220

116,387

7,146

3,963

33,275

160,771

172,991

consoliDateD Balance sHeets
(Expressed in thousands of United States Dollars)

As at December 31

ASSETS

Current

Cash and cash equivalents (note 4)

Guaranteed investment certificates (note 5)

Accounts receivable

Oil inventory (note 6)

Due from joint venture partners (note 7)

Prepaid expenses

Property, Plant and Equipment (note 8)

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current

Accounts payable and accrued liabilities

Commitments (note 17)

Contingencies (note 18)

Shareholders’ Equity

Share capital (note 9)

Contributed surplus (note 10)

Accumulated other comprehensive income (note 2)

Retained earnings

See accompanying notes

On behalf of the Board:

Edmund Shimoon

Gary Robertson

Calvalley Petroleum Inc.

consoliDateD stateMents oF oPeRations
anD RetaineD eaRnings
(Expressed in thousands of United States Dollars)

For the years ended December 31

REVENUE

Oil sales

Royalties

Management fees

Interest and other

EXPENSES

Operating

General and administrative, net of recoveries

Stock-based compensation

Depletion, depreciation and amortization

Income Before Other Items

Foreign exchange gain (loss)

Income Before Income Tax

Income tax (note 12)

Net Income and Comprehensive Income

Retained earnings, beginning of year

Common share repurchases (note 9)

Retained Earnings, End of Year

Earnings Per Share (note 15)

Basic

Diluted

See accompanying notes

2010

63,867

(24,373)

39,494

466

400

40,360

10,157

4,349

1,530

9,437

25,473

14,887

(6)

14,881

3,940

10,941

33,275

(1,335)

42,881

$ 0.11

2009

50,839

(19,485)

31,354

389

798

32,541

11,338

4,413

928

9,850

26,529

6,012

6,094

3,143

2,951

30,480

(156)

33,275

$ 0.03

2010 Annual Report

consoliDateD stateMents oF casH FloWs
(Expressed in thousands of United States Dollars)

For the years ended December 31

OPERATING ACTIVITIES

Net income for the year

Add (deduct) items not affecting cash:

Stock-based compensation

Depletion, depreciation and amortization

Unrealized foreign exchange gain (loss)

Change in non-cash working capital (note 13)

INVESTING ACTIVITIES

Additions to property, plant and equipment

Investment in guaranteed investment certificates

Redemption of guaranteed investment certificates

Change in non-cash working capital (note 13)

FINANCING ACTIVITIES

Issuance of common shares (note 9)

Common share repurchases (note 9)

Foreign exchange gain on cash and cash equivalents held in foreign currencies

Decrease in cash and cash equivalents

Cash and cash equivalents, beginning of year (note 4)

Cash and Cash Equivalents, End of Year

See accompanying notes – non-cash transactions (note 7)

2010

10,941

1,530

9,437

21,915

(323)

21,592

(21,077)

(224,090)

221,026

3,843

(20,298)

393

(2,189)

(1,796)

(470)

20,043

19,573

2009

2,951

928

9,850

(129)

13,600

371

13,971

(11,803)

(148,576)

140,939

6,960

(12,480)

776

(3,342)

(2,566)

129

(946)

20,989

20,043

Calvalley Petroleum Inc.

notes to tHe consoliDateD Financial stateMents
(Financial figures expressed in thousands of United States Dollars)
December 31, 2010 and 2009

1. Description of Business

Calvalley Petroleum Inc. (the “Company” or “Calvalley”) was incorporated on July 1, 1996 under the Canada Business
Corporations Act and is engaged in the exploration, development and production of crude oil and natural gas. The Company’s
activities are carried out in Yemen, Ethiopia, and Canada.

2. summary of significant accounting Policies

These consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting
principles (GAAP). In these consolidated financial statements, all dollar amounts are expressed in United States dollars, unless
otherwise indicated. All references to US$ or $ are to United States dollars and references to C$ are to Canadian dollars.

consolidation

The consolidated financial statements include the financial statements of the Company and its wholly owned subsidiaries.
Inter-company accounts and balances are eliminated on consolidation.

accumulated other comprehensive income

Effective December 31, 2005, management changed the reporting currency of the Company from Canadian dollars (C$) to
United States dollars ($), as this currency is more appropriate for the Company’s investors and other users of the financial
statements. The Company followed the recommendations of the Emerging Issues Committee (EIC) of the Canadian Institute
of Chartered Accountants (CICA), set out in EIC-130, “Translation Method when the Reporting Currency Differs from the
Measurement Currency or there is a Change in the Reporting Currency.” Financial statements for all periods were translated
from Canadian dollars to US dollars using the current rate method. Using this method, all consolidated assets and liabilities were
translated using the exchange rate at the balance sheet dates, while shareholders’ equity was translated using the historical
rates of exchange in effect on the dates of the corresponding transactions. The consolidated statements of operations and deficit
and consolidated statements of cash flows were translated using the prevailing average exchange rates for the periods. The
resulting exchange difference due to this translation of $3,963 was included in shareholders’ equity as accumulated other
comprehensive income.

Joint interests

Substantially all of the Company’s exploration and development activities are conducted jointly with other parties. These
financial statements reflect only the Company’s proportionate interest in such activities.

Foreign currency

The activities of the Canadian parent have been translated into United States dollars using the temporal method. Under this
method, monetary assets and liabilities are translated at exchange rates in effect at the balance sheet date. Non-monetary
assets and liabilities are translated at rates in effect on the dates the assets were acquired or liabilities were incurred. Revenue
and expenses are translated at the rates of exchange prevailing at the date of the transaction. Foreign exchange gains and
losses are included in net income in the period in which they arise.

Foreign-currency-denominated transactions are recorded at the rates of exchange prevailing at the date of the transaction.

2010 Annual Report

notes to the consolidated Financial statements
(Financial figures expressed in thousands of United States Dollars) December 31, 2010 and 2009

Measurement uncertainty

The preparation of consolidated financial statements requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and revenue and expenses during the reporting period. Actual results, including petroleum and natural
gas sales, royalties and operating expenses, can differ from these estimates.

In particular, amounts recorded for depreciation and depletion and amounts used for ceiling test calculations are based on
estimates of petroleum and natural gas reserves and future costs required to develop those reserves. The Company’s reserve
estimates are evaluated annually by an independent engineering firm. By their nature, these estimates of reserves and the
related future cash flows are subject to measurement uncertainty and the impact on the consolidated financial statements of
future periods could be material.

Computations of provisions and estimates for income taxes involve management making judgments with respect to
interpretation of tax regulations and related legislation which is continually changing. In addition, there are tax matters that
have not yet been confirmed by taxation authorities. While management believes the provision for income taxes is adequate,
these amounts are subject to measurement uncertainty. Adjustments required, if any, to these provisions will be reflected in
the period when it is determined that adjustments are warranted.

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which were fully
tradable with no vesting restrictions. This option valuation model requires the input of highly subjective assumptions including
the expected stock price volatility. Because the Company’s stock options and warrants have characteristics significantly
different from those of traded options and because changes in the subjective input assumptions can materially affect the
calculated fair value, such value is subject to measurement uncertainty.

Amounts recorded as due from joint venture partners are based on the Company’s interpretation of underlying agreements
and may be subject to joint approval. The Company has recorded balances due from its joint venture partners based on costs
incurred and its interpretation of allowable expenditures. Any adjustments required as a result of joint venture audits are
recorded in the period of settlement with joint venture partners.

Revenue Recognition

Revenues associated with the sale of the Company’s crude oil are recognized when the title passes from the Company to
its customer.

Pursuant to the crude oil sales agreement, the Block 9 joint venture is entitled to invoice the buyer in any month that the
crude oil available for sale but not purchased by the buyer exceeds 200,000 barrels (commonly referred to as a “take or
pay” feature). The price used in such a take or pay invoice is the price that would apply had a crude oil transfer occurred in
that particular month and is based on the average of the Dated Brent benchmark price for the applicable month. Due to the
revenue recognition accounting policy stated above, take or pay invoice amounts are not recorded as sales revenue. Rather,
such amounts are reported as deferred revenue in the current liabilities section of the balance sheet. These amounts are
recognized as revenue in the period in which the underlying crude oil is sold.

In Yemen, the government receives crude oil production as payment of the Company‘s profit taxes on the profit oil share of
production. The Company recognizes this amount as revenue with a corresponding income tax expense when the oil is sold.

Management fees are based on amounts expended and are recognized in the period when the underlying expenditure
is incurred.

cash and cash equivalents

Cash and cash equivalents include short-term deposits with maturity terms of three months or less at the date of investment.

Calvalley Petroleum Inc.

notes to the consolidated Financial statements
(Financial figures expressed in thousands of United States Dollars) December 31, 2010 and 2009

Financial instruments

All financial instruments are initially recognized at fair value on the consolidated balance sheet. The Company has classified
each financial instrument into one of the following categories: held-for-trading (assets and liabilities), loans and receivables,
financial assets available-for-sale, financial assets held-to-maturity, and other financial liabilities. Subsequent measurement of
financial instruments is based on their classification.

Financial assets and liabilities held-for-trading are subsequently measured at fair value with changes in those fair values
recognized in net earnings. Financial assets available-for-sale are subsequently measured at fair value with changes in fair
value recognized in other comprehensive income, net of tax.

Financial assets held-to-maturity, loans and receivables, and other financial liabilities are subsequently measured at amortized
cost using the effective interest method.

Cash and cash equivalents are classified as held-for-trading. Accounts receivable and amounts due from joint venture partners
are classified as loans and receivables. Accounts payable and accrued liabilities are designated as other financial liabilities.

The Company does not have any hedges or derivative instruments, including embedded derivatives.

oil inventory

Oil inventory represents the volume of crude oil in storage, which is valued at the aggregate of average production costs and
depletion costs per barrel. Inventory is stated at the lower of cost and net realizable value.

Property, Plant and equipment

The Company follows the full cost method of accounting for oil and natural gas operations whereby all costs relating to the
acquisition of, exploration for and development of petroleum and natural gas properties are capitalized in cost centres on a
country-by-country basis. Such costs include lease acquisition costs, geological and geophysical expenditures, lease rentals,
costs of drilling and equipping productive and non-productive wells and certain overhead expenditures related to exploration
and development activities.

Overhead expenditures relating to petroleum and natural gas cost centres in the pre-production stage of development
are capitalized. Proceeds from the disposal of properties are applied as a reduction of the cost of the remaining assets except
where such a disposal would alter the depletion and depreciation rate by more than 20 percent, in which case a gain or loss
would be recognized.

The Company tests the impairment of producing cost centres using undiscounted future net revenue from proved reserves at
expected future product prices and production costs. Impairment is recognized when the carrying amount is greater than the
undiscounted future net revenues, at which time assets are written down to the fair value of proved and probable reserves
plus the cost of unproved properties, net of impairment allowances. Fair value is determined using expected future product
prices and production costs, and amounts are discounted using an adjusted interest rate.

The recoverability of new undeveloped cost centres is assessed annually based on results of geological and geophysical
assessments, drilling activity and planned operations.

Depletion and Depreciation

Capitalized costs of properties, including a provision for future costs to develop proved reserves, are amortized through
depletion and depreciation charges using the unit of production method based on estimated proved crude oil and natural gas
reserves in that cost centre. For purposes of these calculations, production of crude oil, natural gas liquids, natural gas, and
proved reserves before royalties is converted to a common unit of measure on the basis of each commodity’s approximate
relative energy content. 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.

2010 Annual Report

notes to the consolidated Financial statements
(Financial figures expressed in thousands of United States Dollars) December 31, 2010 and 2009

Other capital assets are depreciated using the declining balance method based on the estimated service lives of the assets,
which vary from three to five years.

income taxes

The Company follows the liability method of accounting for income taxes. Under this method, future 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
substantively 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. Future income tax assets are evaluated and if realization is not considered “more likely
than not”, a valuation allowance is provided.

The Company’s contractual arrangements in Yemen stipulate that income taxes are paid by the respective government out
of its share of production sharing oil. Such amounts are included in income tax expense at the statutory rate in effect at the
time of production.

earnings Per share

Basic earnings per share is calculated based on net earnings or loss for the year divided by the weighted average number of
shares outstanding during the year. The Company follows the treasury stock method in calculating diluted earnings per share.
Under this method, the diluted weighted average number of shares is calculated assuming the proceeds from the exercise of
options and warrants are used to purchase common shares at the average market price for the year.

stock-Based compensation

The fair value of options and warrants granted is estimated at the date of the grant using the Black-Scholes valuation model.
Stock-based compensation is recognized over the vesting period of the options granted. Stock-based compensation expense
is recorded with a corresponding increase recorded to contributed surplus. Upon the exercise of the options and warrants,
consideration paid by employees, consultants or directors together with the amount previously recognized in contributed
surplus is recorded as an increase to share capital. The Company does not incorporate an estimated forfeiture rate for stock
options that will not vest. Forfeitures are accounted for as they occur.

3. changes in accounting Policies

new accounting standards

International Financial Reporting Standards (IFRS)

In February 2008, the Accounting Standards Board confirmed that all Canadian publicly accountable enterprises will be required
to adopt IFRS for interim and annual reporting purposes for fiscal years beginning on or after January 1, 2011. Calvalley is
currently assessing the impact of the convergence of Canadian GAAP with IFRS on the Company’s results of operations,
financial position and disclosures. The significant impact to Calvalley’s results of operations, financial position and disclosures
will be on property, plant and equipment, as it relates to the Company’s policy of full-cost accounting for its exploration assets
and the continued ability to utilize this policy, how these assets are ultimately depreciated, and how impairment is ultimately
determined and measured. Other areas of potential impact include stock-based compensation.

4. cash and cash equivalents

Cash and cash equivalents at December 31, 2010 include various short-term deposits of $13,403 (December 31, 2009 –
$16,664), bearing interest at 0.18% (December 31, 2009 – 0.20% to 0.28%) and maturing from January 20-23, 2011, and $6,170
(December 31, 2009 – $3,379) of cash.

Calvalley Petroleum Inc.

notes to the consolidated Financial statements
(Financial figures expressed in thousands of United States Dollars) December 31, 2010 and 2009

5. guaranteed investment certificates

Guaranteed investment certificates (GICs) with original maturities in excess of 90 days at December 31, 2010 are as follows:

Maturity

October 7, 2011

November 12, 2011

Face Value

47,692

5,656

Interest Rate

0.85%

0.60%

The GICs are carried at cost plus interest, which approximates fair value and can be redeemed at any time without penalty.

6. oil inventory

Inventory sold is expensed through production and depletion expenses in the period when it is sold. During 2010, $225
(2009 – $2,995) was expensed with respect to oil which was sold.

7. Due from Joint Venture Partners

Amounts due from joint venture partners are comprised primarily of amounts due for operating costs and capital expenditures.
The balances are due under normal trade terms. During 2010, there were no adjustments to the amounts due from joint
venture partners. During 2009, the Company assumed and recorded as additions to property, plant and equipment certain
costs previously billed to its joint venture partners in the amount of $3,221.

8. Property, Plant and equipment

December 31, 2010

Yemen:

Oil and natural gas properties

Ethiopia:

Oil and natural gas properties

Canada:

Oil and natural gas properties

Other capital assets

Accumulated
Depletion and
Depreciation

Cost

Net
Book
Value

146,358

45,984

100,374

1,206

–

1,206

129

335

464

191

281

144

183

148,028

46,265

101,763

2010 Annual Report

notes to the consolidated Financial statements
(Financial figures expressed in thousands of United States Dollars) December 31, 2010 and 2009

December 31, 2009

Yemen:

Oil and natural gas properties

Ethiopia:

Oil and natural gas properties

Canada:

Oil and natural gas properties

Other capital assets

ceiling test

Accumulated
Depletion and
Depreciation

Cost

Net
Book
Value

125,889

36,653

89,236

639

130

294

424

–

153

233

639

141

191

126,952

36,886

90,066

The Company performed a ceiling test as at December 31, 2010 to assess the recoverable value of its property, plant and
equipment. The crude oil future prices are based on December 31, 2010 commodity prices forecast by independent reserve
engineers adjusted for differentials specific to the Company’s reserves. The following table summarizes the benchmark
prices used in the ceiling test calculation. Based on these assumptions, the value of future net revenues from the Company’s
reserves exceeded the carrying value of property, plant and equipment at December 31, 2010.

Year

2011

2012

2013

2014

2015

2016

Thereafter

yemen

Dated Brent Adjusted Crude Oil Price US$/bbl

85.00

87.20

89.50

92.30

95.20

98.30

The Company has a 50% working interest in the Malik Block 9 Joint Venture in Yemen. The Company’s right to produce
crude oil under the Production Sharing Agreement (PSA) continues to 2025, with a provision for a five-year extension. The
ownership of all assets, tangible and intangible, remains with the Yemen authority.

During the year, the Company capitalized overhead costs relating to oil and natural gas exploration and development activities
of $1,995 (2009 – $1,242).

ethiopia

During 2008, the Company signed a Production Sharing Contract (PSC) with the government of the Federal Democratic
Republic of Ethiopia on the Metema and Gimbi Blocks covering a total area of 11.5 million acres.

Costs incurred during 2010 and 2009 related to initial exploration efforts. Costs incurred during 2008 were related to the
signing of the PSC. Properties in Ethiopia are unproved and the costs incurred of $1,206 (December 31, 2009 – $639) have
been excluded from costs subject to depletion and depreciation.

Calvalley Petroleum Inc.

notes to the consolidated Financial statements
(Financial figures expressed in thousands of United States Dollars) December 31, 2010 and 2009

9. sHaRe caPital

(a.) common shares

Authorized:

Unlimited number of Class A Common Voting Shares.

Issued:

Year Ended December 31, 2010

Class A Common Voting Shares

Shares outstanding, beginning of year
Issued on the exercise of options (i)
Contributed surplus reclassified on exercise of options (i)
Repurchased and cancelled (ii)

Balance, end of year

Number

Amount ($)

98,217,984

214,958

–

(718,662)

97,714,280

116,387

393

214

(854)

116,140

(i)

During 2010, the Company issued 214,958 Class A shares upon the exercise of options for proceeds of $393. An amount of $214 related to
stock-based compensation expensed in prior periods was reclassified from contributed surplus to share capital in connection with options
exercised.

(ii) During 2010, the Company repurchased 718,662 of its common shares pursuant to its Normal Course Issuer Bid at a cost of $2,189. The cost

to repurchase common shares at prices in excess of their average book value has been charged to retained earnings.

Year ended December 31, 2009

Class A Common Voting Shares

Shares outstanding, beginning of year
Issued on the exercise of options (i)
Contributed surplus reclassified on exercise of options (i)
Repurchased and cancelled (ii)

Balance, end of year

Number

Amount ($)

100,265,602

563,300

–

(2,610,918)

98,217,984

118,243

776

452

(3,084)

116,387

(i)

The Company issued 563,300 Class A Common Voting Shares upon the exercise of options for proceeds of $776. An amount of $452 related
to stock-based compensation expensed in prior years was reclassified from contributed surplus to share capital in connection with options
exercised in 2009.

(ii) The Company repurchased 2,610,918 of its common shares pursuant to its Normal Course Issuer Bid at a cost of $3,342. The cost to
repurchase common shares at prices in excess of their average book value has been charged to retained earnings and contributed surplus.
The cost to repurchase shares at prices below their average book value has been credited to contributed surplus.

2010 Annual Report

notes to the consolidated Financial statements
(Financial figures expressed in thousands of United States Dollars) December 31, 2010 and 2009

(b.) stock options

The Company’s restated stock option plan, as approved effective May 11, 2010, provides for the issue of stock options to
directors, officers, employees and consultants. Vesting terms are determined by the Board of Directors as they are granted and
currently include periods ranging from immediately to evenly over three or five years. The options’ maximum term is five years
(10 years for options granted prior to October 1, 2001).

At December 31, 2010 a total of 9,771,428 (December 31, 2009 – 9,821,798) shares were reserved for issue under this
plan. Options which are forfeited are available for reissue.

The following is a continuity of stock options outstanding:

Price C$

Opening balance

Granted

Forfeited/expired

Exercised

Ending balance

Year ended December 31, 2010

Year ended December 31, 2009

Options
(000s)

Weighted Average
Exercise Price C$

4,095

1,310

(388)

(215)

4,802

3.53

3.57

3.67

1.77

3.60

Options
(000s)

4,358

945

(645)

(563)

4,095

Weighted Average
Exercise Price C$

3.66

1.76

3.52

1.58

3.53

Stock options outstanding at December 31, 2010 were as follows:

Number of Options (000s)

Granted

Exercisable

Weighted average

Exercise price – C$

680

160

1,420

357

570

200

1,290

4,802

680

160

1,246

235

290

300

3,103

4.13

0.90

6.86

7.61

4.32

1.61

1.65

2.22

3.57

Year of expiry

2011

2012

2013

2014

2015

During 2010, stock-based compensation costs of $1,530 (2009 – $928) were expensed and credited to contributed
surplus. The fair value of the options granted during 2010 was C$2,745 (2009 – C$910) or C$2.10 per option (2009 –
C$0.96 per option) using the Black-Scholes option pricing model with the following assumptions:

Risk-free interest rate

Expected hold period to exercise

Volatility in the price of the Company’s shares

Dividend yield

2010

2009

2.29 to 2.59%

1.6 to 2.5%

5 years

66 to 67%

Nil

5 years

70 – 71%

Nil

Calvalley Petroleum Inc.

notes to the consolidated Financial statements
(Financial figures expressed in thousands of United States Dollars) December 31, 2010 and 2009

10. contributed surplus

Year ended December 31

Opening balance

Stock-based compensation

Stock-based compensation associated with exercised options

Shares repurchased and cancelled

Closing balance

11. capital Disclosure

The Company defines and computes its capital employed as follows:

December 31

Shareholders’ equity

Long-term debt

Cash and cash equivalents

GICs

Total capital

2010

7,146

1,530

(214)

–

8,462

2010

171,446

–

(19,573)

(53,447)

98,426

2009

6,772

928

(452)

(102)

7,146

2009

160,771

–

(20,043)

(50,383)

90,345

The Company’s objectives in managing capital are to safeguard the Company’s ability to continue as a going concern, so that
it can continue to provide returns for shareholders and benefits for other stakeholders. The Company sets the amount of
capital in proportion to risk. The Company manages the capital structure and makes adjustments to it in the light of changes in
economic conditions and the risk characteristics of the underlying assets. In order to maintain or adjust the capital structure,
the Company may adjust the amount of dividends paid to shareholders, return capital to shareholders, issue or repurchase
shares, incur debt or sell assets to reduce debt.

The Company currently has no requirement for debt financing and has not required debt financing over the last two completed
fiscal years. The objectives and strategy for utilizing capital are monitored to provide the appropriate capital structure for the
risk profile of corporate objectives.

The Company has no debt and therefore has no financial covenants.

2010 Annual Report

notes to the consolidated Financial statements
(Financial figures expressed in thousands of United States Dollars) December 31, 2010 and 2009

12. income taxes

The provision for income taxes differs from the calculated tax obtained by applying the combined statutory Canadian federal
and provincial tax rate to the loss before income taxes as follows:

Applicable tax rate

Provision for income taxes computed at the Canadian statutory rate

Increase (decrease) in taxes resulting from:

Non-deductible stock-based compensation

Change in valuation allowance net of foreign exchange

Difference in foreign jurisdiction tax rate

Recognition of cost recovery pool

Other

Income tax expense

2010

28.0%

4,167

428

339

1,308

(2,025)

(277)

3,940

2009

29.0%

1,767

269

(431)

928

537

3,143

The Company has non-capital losses of $16,774 available to carry forward for deduction against future years’ Canadian
taxable income. These losses, the benefit of which has not been recognized in these financial statements, expire in the
following years:

2014

2015

2026

2027

2028

2030

The significant components of the Company’s Canadian future income tax assets are as follows:

Differences between tax bases and reported amounts of
depreciable assets and resource properties

Non-capital loss carry-forwards

Share issue costs

Total future tax assets

Less: valuation allowance

Future income taxes

2010

4,308

4,194

–

8,502

(8,502)

–

943

937

2,745

4,356

3,840

3,953

16,774

2009

4,092

3,372

316

7,780

(7,780)

–

Calvalley Petroleum Inc.

notes to the consolidated Financial statements
(Financial figures expressed in thousands of United States Dollars) December 31, 2010 and 2009

13. supplemental cash Flow information

Changes in non-cash working capital:

Accounts receivable

Due from joint venture partners

Oil inventory

Prepaid expenses

Accounts payable and accrued liabilities

Deferred revenue

Changes in non-cash working capital:

Operating activities

Investing activities

2010

(1,790)

(1,713)

(30)

7,005

–

3,520

(323)

3,843

3,520

2009

472

6,086

1,561

(60)

2,527

(3,255)

7,331

371

6,960

7,331

During the year ended December 31, 2010, the Company incurred cash outlays of $Nil for interest (2009 – $Nil) and $Nil for
taxes (2009 – $Nil). Yemen income taxes in the amount of $3,940 (2009 – $3,143) were remitted to the government through
its allocation of oil under the PSA.

14. geographical information

The Company has defined its continuing operations as oil and natural gas operations. The majority of the Company’s oil and
natural gas operations are located in Yemen with lesser operations in Ethiopia and Canada.

Revenue for each segment is as follows:

Year ended December 31

Yemen

Ethiopia

Canada

Total

2010

64,173

–

560

64,733

2009

51,086

–

940

52,026

2010 Annual Report

notes to the consolidated Financial statements
(Financial figures expressed in thousands of United States Dollars) December 31, 2010 and 2009

15. Per share amounts

In calculating basic and diluted earnings per share, the following weighted average numbers of shares were used:

Weighted average number of shares outstanding

Dilutive effect of stock options

Weighted average number of diluted shares outstanding

2010

97,947

597

98,544

2009

98,926

201

99,127

A total of 3,525,000 (2009 – 2,915,000) options were not in the money and were excluded from the dilutive calculation.

16. Financial instruments and Risk Management

carrying Values and estimated Fair Values of Financial assets and liabilities

The Company has classified its cash and cash equivalents and GICs as assets held for trading which are measured at fair value
with changes being recognized in net income. Accounts receivable and amounts due from joint venture partners are classified
as loans and receivables, which are measured at amortized cost. Accounts payable and accrued liabilities are classified as
other financial liabilities and are measured at amortized cost.

The carrying value and fair value of financial assets and liabilities are summarized as follows:

Classification

Financial assets held for trading

Loans and receivables

Accounts payable and accrued liabilities

credit Risk

Carrying Value ($)

Fair Value ($)

73,020

15,436

19,264

73,020

15,436

19,264

The majority of the accounts receivable are in respect of oil and natural gas operations and are due from the Company’s joint
venture partners or its customer for oil sales. Management believes the risk is mitigated by the size and reputation of the
companies to which the Company extends credit. The Company has not experienced any material credit loss in the collection
of accounts receivable to date.

The Company is under contract to sell its production to one purchaser. The selling price is based on the quoted Dated Brent
price on the date of shipment adjusted for the official selling price differential posted by the Government of Yemen. At
December 31, 2010, $4,530 (2009 – $2,771) was receivable under the contract. Payment is secured by a guarantee issued by
the purchaser’s parent company.

The Company funds capital and operating costs and bills joint venture partners their share of those costs. In the event that a
joint venture partner was incapable of fulfilling its obligation to pay its share of the costs, the Company could, under the terms
of the joint operating agreement, recover the costs from the joint venture partner’s share of proceeds from crude oil sales.

Calvalley Petroleum Inc.

notes to the consolidated Financial statements
(Financial figures expressed in thousands of United States Dollars) December 31, 2010 and 2009

Trade and other receivables from continuing operations are analyzed in the table below. With respect to the trade and other
receivables that are neither impaired nor past due, there are no indications as of the reporting date that the debtors will not
meet their payment obligations.

Trade and other receivables at December 31, 2010

Neither impaired nor past due

Impaired (net of valuation allowance)

Not impaired and past due in the following period:

Within 30 days

31-60 days

61-90 days

Over 90 days

interest Rate Risk

$ 13,562

–

1,874

–

The Company has exposure to interest rate risk as it relates to investments in GICs. Interest rate risk relates to the risk that
the fair value of future cash flows of a financial instrument will fluctuate because of changes in market interest rates. The
Company incurs interest rate risk on its cash and cash equivalents, and GICs. All cash balances are current and available
immediately. The Company does not hedge its exposure to interest rate risk. A 100-basis-point increase in interest rates
during 2010 would have increased net income by approximately $682 ($0.01/share).

liquidity Risk

Liquidity risk is the risk that the Company will not be able to meet its financial obligations as they become due. Liquidity
describes a company’s ability to access cash. Companies operating in the upstream oil and natural gas industry require
sufficient cash in order to fund capital programs necessary to maintain and increase production and proved reserves, to
acquire strategic oil and natural gas assets, and to repay debt. The Company actively monitors its cash requirements to
ensure it has sufficient available funds to meet current and foreseeable financial requirements at a reasonable cost. The
Company prepares annual capital expenditure budgets, which are regularly monitored and updated as considered necessary.
The Company also utilizes authorizations for expenditures to further manage capital expenditures.

The Company’s obligations coming due in the next 12 months are accounts payable and accrued liabilities of $19,264. In
addition, the Company has commitments under existing agreements as described in note 17. Given the Company’s working
capital position, management assesses liquidity risk as being low.

In determining the fair value of financial instruments, the Company maximizes the use of observable inputs and minimizes the
use of unobservable inputs. Observable inputs reflect market-driven or market-based information obtained from independent
sources, while unobservable inputs reflect the Company’s estimate about market data. Based on the observability of significant
inputs used, the Company classifies its fair value measurements in accordance with a three-level hierarchy. This hierarchy is
based on the quality and reliability of the information used to determine fair value, as follows:

Level 1:

Valuations are based on quoted prices in active markets for identical assets or liabilities. Since the valuations
are based on quoted prices that are readily available in an active market, they are not subject to significant
measurement uncertainty.

Level 2:

Valuations are based on observable inputs other than quoted prices.

Level 3:

Valuations are based on at least one unobservable input that is supported by little or no market activity and is
significant to the fair value measurement.

2010 Annual Report

notes to the consolidated Financial statements
(Financial figures expressed in thousands of United States Dollars) December 31, 2010 and 2009

In assigning financial instruments to the appropriate levels, the Company performs detailed analysis. In certain cases, the
inputs used to measure fair value may fall into different levels of the fair value hierarchy. The level within which the fair
value measurement is categorized is based on the lowest-level input that is significant to the fair value measurement in
its entirety.

The Company’s fair value measurement of held for trading financial assets was conducted using Level 1 of the hierarchy.

commodity Price Risk Management

While the Company is exposed to business risk associated with fluctuations in the price of crude oil, the Company does not
hold financial instruments whose fair values are susceptible to variability resulting from changes in the price of crude oil.

Foreign exchange Risk

The Company holds substantially all of its cash and cash equivalents and GICs at one financial institution in Canada. The
Company invests its cash reserves in GICs issued by an Alberta credit union which deposits are guaranteed by the Province of
Alberta. Approximately $1,363 of the $19,573 in cash and cash equivalents is held in Canadian-dollar-denominated accounts.
As such, the Company is exposed to foreign currency risk. The impact to net income of a 10% change in the foreign
exchange rates between the Canadian and United States dollars at December 31, 2010 would have been approximately $104
($0.00/share).

17. commitments

The Company is committed to operating leases for office space with payments due and to its proportionate share of various
allowances and bonus payments to the Government of Yemen.

2011

2012

2013

2014

2015

$ 513

$ 492

$ 410

$ 225

In addition to the payments indicated above, the Company is obligated to pay to the Government of Yemen its 50% proportionate
share of a $2,000, a $3,000 and a $4,000 bonus payment when sustainable production exceeds 25,000, 75,000 and
100,000 barrels of oil per day, respectively.

The Company is also committed to pay a royalty of $1.25 per barrel of oil produced from the Yemen properties to an arm’s-
length party until its commitment to pay these royalties has been satisfied. The total commitment outstanding at December
31, 2010 under this obligation is approximately $2,217 (December 31, 2009 – $2,777).

As part of the Production Sharing Contract with the Government of Ethiopia, the Company has entered into certain commitments
to spend approximately $8.5 million during the first four years of its work program. The Company has incurred approximately
$1,206 in respect of this commitment.

Calvalley Petroleum Inc.

notes to the consolidated Financial statements
(Financial figures expressed in thousands of United States Dollars) December 31, 2010 and 2009

18. contingencies

The Company has been named in a claim filed in the Commercial Court of Yemen by a Saudi Arabian company. The claimant
alleges that, pursuant to an agency agreement entered into in 1996, it is entitled to a percentage of the net profit attributable
to the Company. Over the past several years this issue has been before the Commercial Court of Yemen, the Yemeni Court
of Appeal and the Supreme Court of Yemen on a number of procedural issues and has now been sent back to the Supreme
Court of Yemen for reassessment. Interim judgments have been issued and both parties appealed an initial ruling which
limited the plaintiff’s entitlement to an interest on the net profit from profit oil production prior to February, 2008. Calvalley has
cross-appealed on a number of matters of substance and procedure.

The Company’s legal advisors in Sana’a and Calgary are pursuing the appeal jointly. The outcome of the action in the Supreme
Court of Yemen is undeterminable at this time and the Company is exploring both judicial, and extra judicial, resolution.
No amounts have been accrued in the consolidated financial statements for the periods ended December 31, 2010 as the
ultimate resolution is uncertain. The Company will record any amounts due, if any, once the outcome of the contingency is
likely and reasonably estimated.

Between 2004 and 2007, the Company billed its Block 9 joint venture partners (JV Partners) for fees in accordance with
the terms of the PSA which governs the joint venture operating activities on Block 9. The JV Partners contend that certain
of these fees are not billable under the terms of the Joint Operating Agreement (JOA) between the Company and the JV
Partners. Pending resolution of this matter, the Company has not charged the JV Partners for the fees in question during 2008
and 2009. The Company and its JV Partners have now agreed to enter into a binding expert determination in London, England
to interpret the terms of the JOA and to obtain a ruling on whether the fees in question are billable. While management is
not able to determine the likelihood of a positive or negative outcome, the maximum liability to the Company related to fees
charged from 2004 to 2007 is $1,012. Conversely, should the fees be deemed billable, the Company would recover fees
which have not previously been recorded in the accounts in the amount of $927.

In the normal course of operations, the Company may be subject to litigation and claims. In the opinion of management, other
than as disclosed above, no such litigation or claim, individually or in aggregate, would result in a liability that would have a
significant adverse effect on the financial position or results of operations of the Company.

19. Related Party transactions

On June 10, 2009, the Company advanced $113 to a member of its Board of Directors. The advance was included in accounts
receivable, was non-interest-bearing, repayable within 90 days, and was secured by shares of the Company. The advance
was repaid in full during August 2009.

2010 Annual Report

abbreviations

Bbls

barrels of oil

Mbbls

thousand barrels

Bopd

barrels of oil per day

kilometre

Km2

square kilometre

Mmcf million cubic feet

Mmcf/d million cubic feet per day

Forward-Looking Statements
This Annual Report contains certain forward-looking statements. Some of the statements
contained herein including, without limitation, financial and business prospects and
financial outlooks of the Company, may be forward-looking statements which reflect
management’s expectations regarding future plans and intentions, growth, results of
operations, performance and business prospects and opportunities. Words such as
“may”, “will”, “should”, “could”, “anticipate”, “believe”, “expect”, “intend”, “plan”,
“potential”, “continue”, and similar expressions have been used to identify these
forward-looking statements. These statements reflect management’s current beliefs and
are based on information currently available to management. Forward-looking statements
involve significant risk and uncertainties. A number of factors could cause actual results
to differ materially from the results discussed in the forward-looking statements including,
but not limited to, changes in general economic, political and market conditions and other
risk factors. Although the forward-looking statements contained herein are based upon
what management believes to be reasonable assumptions, management cannot assure
that actual results will be consistent with these forward-looking statements. Investors
should not place undue reliance on forward-looking statements. These forward-looking
statements are made as of the date hereof.

Forward-looking statements and other information contained herein concerning the oil
and natural gas industry and Calvalley’s general expectations concerning this industry are
based on estimates prepared by management using data from publicly available industry
sources as well as from reserve reports, market research and industry analysis and on
assumptions based on data and knowledge of this industry which Calvalley believes to
be reasonable. However, this data is inherently imprecise, although generally indicative of
relative market positions, market shares and performance characteristics. While Calvalley
is not aware of any misstatements regarding any industry data presented herein, the
industry involves risks and uncertainties and is subject to change based on various factors.
See “Risk Factors.”

Calvalley does not undertake any obligation to update publicly or revise any forward-
looking statements contained in this or in any other document filed with Canadian
securities regulatory authorities, whether as a result of new information, future events or
otherwise, except as required by applicable securities laws.

Calvalley Petroleum Inc.

CORPORATE INFORMATION

STOCK LISTING

Toronto Stock Exchange
CVI.A

BANKERS

Scotiabank

First Calgary Savings &
Credit Union Ltd.

LEGAL COUNSEL

Macleod Dixon LLP

Auditors

Deloitte & Touche LLP

TRANSFER AGENT

Computershare
Trust Company of Canada

CORPORATE OFFICE

Suite 700, 600 - 6th Avenue S.W.
Calgary, Alberta T2P 0S5
Ofﬁce: +1 (403) 297-0490
+1 (403) 297-0499
Fax:

Sana’a Ofﬁce
P.O. Box 7090 Hadda Area,
Sana’a Republic of Yemen
Ofﬁce: +9671 41 5555
+9671 42 3580
Fax:

www.calvalleypetroleum.com

DIRECTORS

Edmund M. Shimoon
Calgary, Alberta

Gary Robertson (1)
Montreal, Quebec

Kenneth M. Stephenson (1) (2)
Calgary, Alberta

Memet Kont (2)
Calgary, Alberta

Thomas H. Skupa (1) (2)
Calgary, Alberta

Thomas E. Valentine
Calgary, Alberta

(1) Member of Audit Committee
(2) Member of Reserves Committee

OFFICERS

Edmund M. Shimoon
Chairman and Chief Executive Ofﬁcer

Memet Kont
President and Chief Operating Ofﬁcer

Zacharie J. Magnan
Vice President, Finance and
Acting Chief Financial Ofﬁcer

Thomas E. Valentine
Corporate Secretary

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CALVALLEY PETROLEUM INC.

Calgary Ofﬁce:
Suite 700, 600 - 6th Avenue S.W. Calgary, Alberta T2P 0S5
Ofﬁce:
Fax:

(403) 297-0490
(403) 297-0499

CALVALLEY PETROLEUM (CYPRUS) LTD.

Yemen Ofﬁce:
P.O. Box 7090 Hadda Area, Sana’a Republic of Yemen
Ofﬁce: +9671 41 5555
+9671 42 3580
Fax: