Paramount Resources Ltd.
Annual Report 2010

Plain-text annual report

2 0 1 0 A N N U A L R E P O R T President’s Message Principal Properties Strategic Investments Management’s Discussion & Analysis Financial Statements Corporate Information 1 4 18 23 52 IBC ANNUAL MEETING OF SHAREHOLDERS Shareholders are cordially invited to attend the Annual Meeting of Shareholders to be held Wednesday, May 18, 2011 at 10:30 AM MDT at Centrium Place in the Conference Centre, 332 6th Avenue S.W., Calgary, Alberta. FINANCIAL AND OPERATING HIGHLIGHTS(1) ($ millions, except as noted) Financial Petroleum and natural gas sales Funds flow from operations Per share – diluted ($/share) Net loss Per share – diluted ($/share) Exploration and development expenditures(2) Investments in other entities – market value(3) Total assets Net debt(4) Common shares outstanding (thousands) Operating Sales volumes Natural gas (MMcf/d) Oil and NGLs (Bbl/d) Total (Boe/d) Gas weighting Average realized price Natural gas ($/Mcf) Oil and NGLs ($/Bbl) Net natural gas and oil wells drilled Net oil sands evaluation drilled Reserves(5) Proved plus probable Natural gas (Bcf) Crude oil and NGLs (MBbl) Total (MBoe) Finding and development costs (proved plus probable) ($/Boe) Reserves replacement (proved plus probable) Estimated future net revenue before tax @ 10% Proved Proved plus probable Net undeveloped land (thousands of acres) Year ended December 31 2010 2009 Change % 184.4 86.9 1.19 (122.5) (1.68) 199.0 502.9 1,377.2 295.2 75,034 57.7 3,417 13,029 74% 4.50 71.83 43 45 181.8 9,782 40,087 26.91 160% 397.8 556.0 1,198 161.7 60.3 .90 (97.9) (1.46) 93.4 342.9 1,102.0 50.9 72,058 51.8 3,580 12,207 71% 4.44 59.50 14 7 155.0 8,667 34,493 26.76 58% 365.5 549.6 1,151 14 44 32 (25) (15) 113 47 25 480 4 11 (5) 7 1 21 207 543 17 13 16 1 9 1 4 (1) Readers are referred to the advisories concerning non-GAAP measures and oil and gas measures and definitions under the heading “Advisories” in Management’s Discussion and Analysis. (2) Exploration and development expenditures are presented after the deduction of $11.4 million (2009 - $3.8 million) of Alberta Drilling Royalty credits. (3) Based on the period-end closing prices of publicly traded enterprises and book value of the remaining investments. (4) Net debt is a non-GAAP measure, it is calculated and defined in the Liquidity and Capital Resources section of Management’s Discussion and Analysis. (5) Working interest reserves before royalty deductions, using forecast prices and costs.  PRESIDENT’S MESSAGE 2010 has been an exciting year for Paramount, as we have seen significant progress in almost every area of the Company. The transition from concept stage to significant production ramp-up is occurring in our Kaybob Deep Basin Cretaceous and Grande Prairie Montney horizontal multi-stage completion plays, our investment portfolio has appreciated rapidly in value and the preparatory work necessary for our oilsands development application at Hoole is nearing completion. During 2010, Paramount produced 13,029 Boe/d versus our guidance of 13,425 Boe/d. Substantial improvements to the Company’s cost structure were achieved during the year, with both operating costs and general and administrative costs decreasing 16% to $10.70/Boe and $3.24/Boe, respectively. We expect further cost reductions in 2011. Paramount invested $199 million on its exploration and development program in 2010, accelerating activities in the Kaybob and Grande Prairie areas based on positive drilling results. Paramount also invested $83 million on undeveloped lands during the year, principally in the Kaybob area, capturing what we believe is a very large liquids-rich gas opportunity in the Montney formation. The Company generated funds flow from operations of $87 million, a 44% increase year over year, despite the ongoing low natural gas price environment. Net debt increased to $295 million at year end, principally comprised of $300 million of new Canadian term debt, which is not due until 2017. In early 2011, the Company issued an additional $70 million of the same term debt. Paramount tested horizontal multi-stage frac technology on three new wells in the Kaybob area in late 2009 and early 2010 with very exciting results. These initial wells tested at rates of 10 MMcf/d to over 20 MMcf/d, and when placed on production, exhibited much lower decline profiles than anticipated. As a result, Paramount embarked on an accelerated program to drill over 30 new horizontal wells through the remainder of 2010 and 2011. The next four wells were placed on production at rates of 7 to 10 MMcf/d, consistent with the range of results from the previous wells. An additional nine wells have been drilled, many of which are testing new areas and formations, of which five are expected to be completed and tied-in before spring break-up; and the remaining four are scheduled to be completed and placed on production during the third quarter. Paramount is currently constructing a new 100% owned 50 MMcf/d facility at Musreau and has committed to participate for 50 MMcf/d of a 200 MMcf/d expansion to the third party operated Smoky plant, planned to be completed in mid-2012. Additional facilities are already being planned in response to the continued success we are seeing in our drilling program. Paramount executed a successful Montney zone recompletion at Musreau in June 2010. This led to Paramount accumulate 100,000 net acres of land for the Montney formation in the greater Musreau, Resthaven and Kakwa areas. Paramount believes that it has captured a very significant liquids rich gas resource and has budgeted for five horizontal wells throughout 2011 to evaluate this new play. Having met with considerable success drilling horizontal wells and utilizing multi-stage frac completions in the Montney formation at Karr-Gold Creek, Paramount moved forward with the construction of new processing facilities to handle an initial 20 MMcf/d of raw gas production. The new facility was brought on-stream in late December 2010, and Paramount is expanding the facility to handle a total of 40 MMcf/d in mid-2011. Of the 15 wells drilled to date at Karr-Gold Creek, three are producing, four are being restarted after being shut down due to insufficient processing capacity, five are in the process of being tied-in, and the remaining three are awaiting completion and tie-in. The 2011 capital budget for Karr-Gold Creek includes 10 new wells that, when combined Paramount Resources Ltd. 2010 President's Message 1 with the current inventory of wells in progress, are expected to increase total production to 48 MMcf/d of raw gas and up to 50 Bbl/MMcf of associated liquids by the end of the year. At Valhalla, Paramount successfully drilled four new horizontal wells into the lower Montney formation, achieving continually improving results; the last wells were tested at over 10 MMcf/d with high flowing pressures. As a result, Paramount has commenced construction of new facilities to handle up to 15 MMcf/d of raw gas production and is planning an expansion later in 2011 or in early 2012. Paramount’s Valhalla lands offset considerable proven industry success in the lower Doig formation, which Paramount believes extends across much of its land base. The Company has recently completed its first horizontal well drilled into the Upper Montney, which tested at approximately 6 MMcf/d. With three considerable resource targets in the Upper and Lower Montney and Doig formations, Paramount expects this to be an exciting area of production and reserve expansion for the next several years. Paramount was also successful in early 2011 in testing a new Montney horizontal oil play at Ante Creek. The initial well tested at approximately 1,000 Bbl/d with some associated gas and is currently being tied-in for production. Paramount estimates there are 42 additional low risk development locations on its 50% working interest lands across the play. In the Southern area, Paramount was successful in establishing two new oil developments in the Arcs formation at Enchant, and in the lower Mannville formation at Chain. Up to eight development wells are planned through 2011. In North Dakota, the initial three wells drilled on the joint venture lands were not as successful as anticipated. The operator is expected to resume drilling in April 2011 and Paramount is optimistic that results will improve. In early 2011, Paramount sold approximately 6,000 net acres of land for approximately US$40 million, representing a very high $6,700/acre price. Through its 2010 capital expenditure program and acquisitions, Paramount added 7.4 million Boe of proved reserves and 11.4 million Boe of proved plus probable reserves, a reserves replacement of 157% on a proved basis and 240% on a proved plus probable basis. Paramount was able to add reserves at a finding and development cost of $21.04/Boe on a proved basis and $20.76/Boe on a proved plus probable basis, excluding the significant investments made in facilities during 2010 and the impact of acquisitions. Including the facilities costs, finding and development costs were $27.45/Boe on a proved basis and $26.91/Boe on a proved plus probable basis. As the majority of Paramount’s 2011 drilling program is focused on continuing to exploit its Montney horizontal developments at Kaybob and Grande Prairie, Paramount expects continued improvement in these costs through 2011. The value of Paramount’s investments in other entities has increased dramatically through 2010 and early 2011. The most significant Paramount holdings include: 24.1 million shares of Trilogy Energy Corp., 3.7 million shares of MEG Energy Corp., and three drilling rigs which operate under Fox Drilling and Paramount Drilling U.S. The total value of Paramount’s portfolio has increased to over $700 million at the end of February, which represents about $10 per Paramount share. Paramount is excited about the prospects of its investees and looks forward to continued execution of their business plans and increases in Paramount shareholder value. Paramount drilled an additional 45 delineation wells at its Hoole oilsands property in 2010 and has just completed an additional 15 wells in 2011, including source water and disposal testing necessary for a commercial development. Work is nearing completion on the engineering, environmental and socioeconomic Paramount Resources Ltd. 2010 President's Message 2 assessment, reservoir simulation, and financial modeling necessary to move forward with an application for development to the Energy Resources Conservation Board in 2011. In May 2010, Paramount received an updated assessment of the contingent resources and economic value from its independent engineers, which estimated the best (most likely) resource recoverable to be 634 million barrels of bitumen with a net present value of future net revenue (before tax at 10 percent) of $1.9 billion. Paramount expects to have this analysis updated during 2011. As well, Paramount is currently drilling up to 15 delineation wells into its Saleski project area, which it believes to be prospective for bitumen in the Grosmont carbonates reservoirs. The business environment in which Paramount operates has changed dramatically in the last few years. New technologies have provided seemingly unlimited opportunities to produce natural gas. In the current price environment it appears that only the best, lowest-cost opportunities can be pursued. Paramount believes it has captured and now controls some of the best and most economic natural gas prospects available. Prices for oil have behaved much differently than those for natural gas, with a tightening supply/demand balance and geopolitical pressures increasing crude oil market prices to over $100/Bbl. These strong liquids prices will benefit Paramount greatly with its growing natural gas liquids production and the new Montney oil development at Ante Creek. We expect that the large disparity between natural gas prices and oil prices will subside with time as end-users capitalize on the low cost of natural gas, thereby increasing the demand for gas at the expense of oil and coal. This demand-based recovery will take time, but Paramount is confident that it can capitalize on its opportunities and generate high margins and returns on its invested capital in the current price environment. As prices improve, this will only serve to further Paramount’s competitive advantage. Paramount’s 2011 guidance forecasts a 54% increase in production to 20,000 Boe/d based on a capital expenditure budget of $450 million, with operating costs of about $10.00/Boe. In addition to expected 2011 cash flows, the Company has funded its aggressive capital program in advance through the equity issuance in late 2010 and the term debt issuances in late 2010 and early 2011. The 2011 capital program is anticipated to generate an exit production rate of as much as 25,000 Boe/d and provide for continued production growth into 2012. J.H.T. Riddell President and Chief Operating Officer March 11, 2011 Paramount Resources Ltd. 2010 President's Message 3 2010 HIGHLIGHTS Principal Properties (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) The Company replaced 160 percent of the reserves produced in 2010. Proved plus probable finding and development costs, excluding facilities and gathering construction costs, were $20.76/Boe. Funds flow from operations increased 44 percent to $86.9 million. Netback increased 35 percent to $95.1 million despite low gas prices. Operating expenses per Boe decreased by 16 percent. Production increased seven percent to 13,029 Boe/d in 2010 compared to 12,207 Boe/d in 2009. In early 2011, Paramount and its partner drilled and completed an exploratory horizontal Montney oil well in the West Ante Creek area, believed to be a significant light oil discovery. In February 2011, Paramount sold approximately 6,000 net acres of undeveloped land in North Dakota, unrelated to the farm-out lands, for cash proceeds of US$40 million. Strategic Investments (cid:2) (cid:2) (cid:2) In May 2010, Paramount received an updated independent evaluation of its Grand Rapids oil sands resource at Hoole, having a before-tax net present value of future net revenue of $1.9 billion, discounted at ten percent (Best Estimate (P50)). Paramount intends to file a regulatory application for commercial development in 2011. In August 2010 MEG Energy Corp. ("MEG") completed its initial public offering on the Toronto Stock Exchange. As a result, Paramount now carries its MEG investment at market value, and the December 31, 2010 carrying value was increased to $168.3 million or $45.49 per share, compared to $101.8 million or $27.50 per share in the prior year. In February 2011, Trilogy Energy Corp. ("Trilogy") announced a significant Montney oil discovery. As of February 28, 2011, the market value of Paramount’s investment in 24.1 million Trilogy shares was $487.5 million, 64 percent higher than at December 31, 2010. Corporate (cid:2) (cid:2) The Company raised $430 million in a series of financing transactions between November 2010 and February 2011 in preparation for its 2011 capital program, focused on liquids rich gas developments in the Kaybob Deep Basin and at Karr-Gold Creek. General and administrative expense per Boe decreased by 16 percent compared to 2009. Paramount Resources Ltd. 2010 Principal Properties 4 PRINCIPAL PROPERTIES Kaybob Sales volumes (Boe/d) E & D expenditures ($ millions) Net undeveloped land (000’s of acres) Grande Prairie Sales volumes (Boe/d) E & D expenditures ($ millions) Net undeveloped land (000’s of acres) Southern Sales volumes (Boe/d) E & D expenditures ($ millions) Net undeveloped land (000’s of acres) Northern Sales volumes (Boe/d) E & D expenditures ($ millions) Net undeveloped land (000’s of acres) 2010 2009 4,495 76.2 163.1 3,012 110.4 248.7 2,973 11.6 200.1 2,549 12.2 381.1 3,615 38.9 87.4 2,204 44.0 233.1 3,382 6.9 201.7 3,006 7.4 433.7 Total Principal Properties Sales volumes (Boe/d) E & D expenditures ($ millions) (1) 13,029 199.0 12,207 93.4 (1) Includes Alberta Drilling Royalty Credits and other amounts not allocated to the individual corporate operating units. KAYBOB KAYBOB Sales Volumes Natural Gas (MMcf/d) Crude Oil & NGLs (Bbl/d) Total (Boe/d) Exploration and Development Expenditures(1)($ millions) Exploration, drilling, completions and tie-ins Facilities and gathering Undeveloped Land (000’s of acres) Wells drilled Wells placed on production (1) Before the deduction of Alberta Drilling Royalty credits. 2010 2009 Change 23.5 573 4,495 61.8 14.4 76.2 18.9 470 3,615 31.1 7.8 38.9 4.6 103 880 30.7 6.6 37.3 Gross Net Gross Net 271.2 163.1 171.7 87.4 16 14 7 6 13 15 6 9 Paramount Resources Ltd. 2010 Principal Properties 6 The Kaybob corporate operating unit ("COU") operates in West Central Alberta, where significant liquids rich natural gas producing areas include Musreau, Smoky and Resthaven. The Kaybob COU pursues multiple Deep Basin gas horizons primarily focusing on the Fahler, Dunvegan and Cadotte, which are high pressure, liquids rich, tight gas formations with large reserves potential. To access these deep formations, the Company is drilling mostly horizontal wells to measured depths of 2,500 to 4,600 meters, and completing them with 13 to 18 fracture stages. Four wells per pool per section are permitted and productive zones are being commingled in a single wellbore to enhance recoveries. The Company believes greater well density will be required in order to fully recover the gas resource. Regulatory approval has been obtained to increase well density to eight wells per pool per section for an initial seven sections, and the Company has submitted applications to increase well density for an additional 13 sections. The Kaybob COU has identified in excess of 100 additional drilling locations targeting formations where the Company has had success, and additional formations are actively being explored. The Kaybob COU achieved promising drilling results with its horizontal wells in the 2009/2010 winter drilling program, and in the fourth quarter of 2010 the Company accelerated its Deep Basin development activities. A total of 13 (8.2 net) wells were drilled between November 2010 and February 2011, of which four (1.7 net) wells have been put on production with initial gross flow rates of 7-10 MMcf/d, consistent with the range of results from horizontal wells the Company has drilled previously in the area. Of the remaining nine (6.5 net) wells, five (3.8 net) wells are expected to be completed and put on production prior to spring break-up and four (2.7 net) wells are expected to be completed and tied-in during the third quarter of 2011. In June 2010, the Kaybob COU recompleted an existing upper Montney formation vertical wellbore at Musreau with encouraging results. Since then, the Company has been actively acquiring additional Montney mineral rights underlying and offsetting much of its core lands in the Musreau, Smoky and Resthaven areas, and currently holds approximately 105,000 (100,000 net) acres of Montney rights. The Kaybob COU recently spudded its first horizontal well targeting the upper Montney formation at Musreau, and expects to drill an additional three horizontal wells in 2011, assuming drilling results continue to meet expectations. The Kaybob COU plans to drill a total of up to 28 (16.8 net) wells in 2011. The majority of the wells will be drilled from existing leases or new multiple-well pads, reducing per-well drilling costs by minimizing mobilization and demobilization activities and allowing surface equipment and pipelines to be shared. Where two or more wells are drilled from a single lease, the Company is striving to drill and complete wells back-to-back, increasing equipment and personnel efficiencies and reducing per-well completion costs. To help ensure the Company will have adequate processing capacity available in the future, Paramount has commenced the construction of a 100 percent owned, $38 million processing plant at Musreau, with a design capacity of 50 MMcf/d of raw gas, anticipated to be operational in the third quarter of 2011. The Company has also nominated for 50 MMcf/d of new capacity as part of an expansion of the non-operated Smoky processing plant, at an expected cost to Paramount of between $47 million and $57 million. The expansion is anticipated to be operational in late 2012. Once completed, the Kaybob COU will own 60 MMcf/d of the total 300 MMcf/d processing capability at the expanded Smoky processing plant. Expenditures on facilities and gathering systems of $14.4 million in 2010 primarily related to engineering costs and payments on long lead time equipment for the new Musreau and Smoky plants. Other costs were incurred to begin construction of 48 km of pipelines for major gathering system expansions and natural gas and NGLs sales pipelines for the new Musreau plant. Major infrastructure plans for 2011 include completing the construction of the new Musreau plant, the new Smoky plant expansion and construction of the associated gathering systems, sales pipelines and additional field compression. Paramount Resources Ltd. 2010 Principal Properties 7 GRANDE PRAIRIE Paramount Resources Ltd. 2010 Principal Properties 8 GRANDE PRAIRIE Sales Volumes Natural Gas (MMcf/d) Crude Oil & NGLs (Bbl/d) Total (Boe/d) Exploration and Development Expenditures(1)($ millions) Exploration, drilling, completions and tie-ins Facilities and gathering Undeveloped Land (000’s of acres) Wells drilled Wells placed on production (1) Before the deduction of Alberta Drilling Royalty credits. 2010 2009 Change 12.4 951 3,012 81.6 28.8 110.4 7.5 960 2,204 35.2 8.8 44.0 4.9 (9) 808 46.4 20.0 66.4 Gross 343.7 Net Gross Net 248.7 311.1 233.1 16 10 14 8 6 8 5 7 The Grande Prairie COU operates in the Peace River Arch area of Alberta. Core natural gas producing areas include Karr-Gold Creek, Mirage and Valhalla. The COU’s primary crude oil producing property is in the deep, light, sweet oil trend at Crooked Creek. The Grande Prairie COU’s most significant development projects are at Karr-Gold Creek and at Valhalla. Karr-Gold Creek is located 50 km southwest of Grande Prairie, where Paramount has assembled a land position of approximately 115,000 (95,000 net) acres, including 48,000 (24,000 net) acres of land added through the acquisition of Redcliffe Exploration Inc. ("Redcliffe") in June 2010. Paramount currently has regulatory approval to drill two wells per section in this area, and plans to seek approval for greater well density should well performance demonstrate that it is required to optimize reserve recoveries. The Company estimates that up to ten wells per year can be drilled at Karr-Gold Creek over the next five years. Paramount began its development at Karr-Gold Creek in 2008 and 2009, drilling six (6.0 net) horizontal wells prior to having sufficient infrastructure in place to process and transport production from the wells. During the drilling of these initial wells, the Company focused on developing effective drilling and completion techniques, including the length of the horizontal section of the wellbore, fracturing density and the quantity of fracturing fluids. At the conclusion of the production tests, these wells were shut-in pending the installation of a gathering system and adequate dehydration and compression facilities. As the Company improved its completion techniques, later wells tested at rates between 9 MMcf/d and 13 MMcf/d of raw gas and approximately 50 Bbl/MMcf of NGLs. Marketable gas sales volumes are expected to be 25 percent lower due to shrinkage and processing. Based on these encouraging drilling results, the Company accelerated its drilling program, drilling nine (8.2 net) wells in 2010. In early 2010, Paramount acquired and upgraded a small compression facility at Karr-Gold Creek, which is capable of processing 8 MMcf/d of raw gas. Wells were alternately placed on production at the new facility and then shut-in because of capacity constraints. The Company also commenced the construction of a large compression and dehydration facility capable of processing 40 MMcf/d of raw gas, which is being built in two phases. The initial 20 MMcf/d phase went on-stream in late December 2010, and the second 20 MMcf/d phase is expected to commence operations in mid-2011. In addition, Paramount is expanding sweet infrastructure in Paramount Resources Ltd. 2010 Principal Properties 9 the area to accommodate both sweet sales gas and fuel gas required in facilities operations. Paramount expects to have processing capacity for 8 MMcf/d of raw sweet gas by mid-2011, which can be expanded as the area develops. Weather conditions in the fall of 2010 were extremely wet in the Karr-Gold Creek area, and although the first 20 MMcf/d phase of the processing facility went on-stream in late December, it was not operating at full capacity as commissioning was still underway. The conditions also delayed well completions and tie-ins. Of the 15 (14.2 net) wells drilled at Karr Gold Creek to date, three are currently producing, four are in the process of being restarted after being shut-in, five are scheduled to be tied-in during the first quarter of 2011 and three are expected to be completed and tied-in by the second quarter of 2011. The Company has been working to restore production from the shut-in wells, as operational challenges have been encountered in achieving previous production levels. Paramount believes these challenges are not atypical in the start-up phase of a new development and they will be overcome, however, the reserves assigned to Karr- Gold Creek at December 31, 2010 were negatively impacted. The Company anticipates that reserves estimates for Karr-Gold Creek will increase as the restarted wells return to normal production levels, additional wells are completed and tied-in and the new facility is optimized to operate at design capacity. The 2011 capital budget for Karr-Gold Creek includes drilling up to 10 wells and the completion of the second phase of the new facility, which will bring total dehydration and processing capacity for the area to 48 MMcf/d. Paramount expects that all of the wells drilled and completed to March 31, 2011 will be tied-in and brought on production in 2011, as sufficient processing and transmission capacity will be available. The Valhalla development is located approximately 120 km northwest of Karr-Gold Creek. Paramount has acquired approximately 43,000 (30,000 net) acres of land in this area which has multi-zone potential, including the Montney and Lower Doig formations. The Company has drilled a number of exploratory horizontal wells on the lands to date. Progressively better results have been achieved with each well, the latest three having tested between 9 MMcf/d and 11 MMcf/d of raw gas, with high flowing pressures. Marketable sales gas volumes from these wells are expected to be 15 percent lower due to shrinkage and processing. Paramount’s development plan in Valhalla includes drilling up to four horizontal wells per section in each prospective Montney zone, for a total of twelve laterals in every fully developed section. The Company is also evaluating opportunities to target other formations in Valhalla to increase liquids recoveries and enhance returns. The Company’s 2010 development activities at Valhalla included drilling and completing four (3.0 net) wells. Construction of a gas gathering system with capacity for up to 15 MMcf/d of raw gas is progressing with the system expected to be operational in mid-2011. As with Karr-Gold Creek, construction has been delayed by wet weather. The wells drilled and completed at Valhalla in 2010 will be tied-in and placed on production when the new facility enters service. In early 2011, Paramount and its partner drilled and completed an exploratory horizontal Montney oil well at the Company’s non-operated West Ante Creek property, believed to be a significant light oil discovery. Following recovery of the completion load fluid, the well flowed at an average test rate of approximately 1,000 Bbl/d plus associated natural gas over a three-day test period. Follow-up wells are planned for later in the year to further delineate this discovery. Paramount holds a 50 percent working interest in 6,400 gross acres at West Ante Creek prospective for Montney oil development, with the potential for 42 wells on a fully developed basis. Paramount Resources Ltd. 2010 Principal Properties 10 SOUTHERN Alberta North Dakota Paramount Resources Ltd. 2010 Principal Properties 11 SOUTHERN Sales Volumes Natural Gas (MMcf/d) Crude Oil & NGLs (Bbl/d) Total (Boe/d) Exploration and Development Expenditures(1)($ millions) Exploration, drilling, completions and tie-ins Facilities and gathering Undeveloped Land (000’s of acres) Wells drilled Wells placed on production (1) Before the deduction of Alberta Drilling Royalty credits. 2010 2009 Change 9.3 1,422 2,973 9.3 2.3 11.6 10.7 1,602 3,382 6.2 0.7 6.9 (1.4) (180) (409) 3.1 1.6 4.7 Gross Net Gross Net 261.6 200.1 263.4 201.7 27 13 17 10 2 6 – 5 The Southern COU operates in Southern Alberta, Saskatchewan, North Dakota and Montana. Core areas comprise the natural gas producing Chain/Craigmyle field near Drumheller, Alberta and the oil producing area near Medora, North Dakota. The Southern COU drilled 13 (10.1 net) coal bed methane ("CBM") wells and 12 (5.4 net) oil wells during the year. Three of the CBM wells have been put on production and the final ten CBM wells will be tied into existing facilities by the second quarter of 2011. A new Mannville formation oil well was also brought on production at Chain, and this trend will be explored further with an additional well late in 2011. Paramount entered into a joint development agreement in southern Saskatchewan in 2010 with a Canadian exploration and development company. Under the agreement, the partner has committed to carry out a multiple well Viking formation drilling program in order to earn a post-payout interest of 55 percent in certain properties. Three oil wells have been drilled to date under this agreement. Additional drilling is planned for this play in 2011. At Enchant, a new Arcs formation oil well was brought on production in the fourth quarter. This discovery will be explored further in the first half of 2011 with three additional wells. Further development opportunities will be evaluated based on the results of the 2011 drilling program. In the United States, Paramount operates through its wholly-owned subsidiary, Summit Resources Inc. ("Summit"). In April 2010, Summit entered into a joint development agreement with a United States exploration and development company which has significant operations and experience in the Bakken play in North Dakota. Under the agreement, which covers approximately 39,900 net acres of Summit’s undeveloped Bakken lands in North Dakota, the US company is carrying out a multiple well Bakken horizontal drilling program using multi- stage fracture technology in order to earn an undivided 50 percent of Summit’s interest in these lands (19,950 net acres). The North Dakota joint development partner has drilled and completed three horizontal wells to date. The wells have not performed as expected, with the first two producing at nominal rates. In February 2011, Paramount sold approximately 6,000 net acres of undeveloped land in North Dakota, unrelated to the farm-out lands, for cash proceeds of US$40 million. Paramount Resources Ltd. 2010 Principal Properties 12 NORTHERN Northwest Territories Alberta Grande Prairie 14 NORTHERN Sales Volumes Natural Gas (MMcf/d) Crude Oil & NGLs (Bbl/d) Total (Boe/d) Exploration and Development Expenditures(1)($ millions) Exploration, drilling, completions and tie-ins Facilities and gathering Undeveloped Land (000’s of acres) Wells drilled Wells placed on production (1) Before the deduction of Alberta Drilling Royalty credits. 2010 2009 Change 12.5 471 2,549 11.1 1.1 12.2 14.7 548 3,006 4.5 2.9 7.4 (2.2) (77) (457) 6.6 (1.8) 4.8 Gross Net Gross Net 532.7 381.1 611.6 433.7 5 – 5 – 3 4 3 3 The Northern COU operates in Northern Alberta, Northeast British Columbia and the Cameron Hills and Fort Liard areas of the Northwest Territories. Northern’s primary focus is at Cameron Hills, and other significant properties are located at Clarke Lake in Northeast British Columbia. Capital expenditures for the Northern COU in 2010 related to drilling and completing five (4.9 net) wells in the Cameron Hills area. One of the wells from the 2010 program is expected to be brought on production early in 2011. The remaining wells were suspended. During the first quarter of 2011, Northern plans to drill and complete three (2.6 net) oil wells in the Cameron Hills area. Production and follow-up development drilling associated with these wells will take place in subsequent years, pending an evaluation of the 2011 drilling results. Paramount Resources Ltd. 2010 Principal Properties 13 RESERVES Paramount’s estimated proved plus probable reserve volumes increased by 16 percent to 40,087 MBoe at December 31, 2010 compared to 34,493 MBoe in the prior year, and the Company replaced 160 percent of the reserves produced in the year. New reserves were added primarily at Smoky, Resthaven and Musreau in the Kaybob COU and at Karr-Gold Creek in the Grande Prairie COU and from the Redcliffe acquisition, partially offset by natural declines, negative price revisions due to a 28 percent decline in forecast prices compared to December 2009 and technical revisions due to well performance in certain properties. Paramount’s reserves for the year ended December 31, 2010 were evaluated by McDaniel and prepared in accordance with the National Instrument 51-101 definitions, standards and procedures. The Company’s working interest reserves and before tax net present value of future net revenues for the year ended December 31, 2010 using forecast prices and costs are as follows: Gross Proved plus Probable Reserves(1) Natural Gas Light & Medium Crude Oil Natural Gas Liquids (Bcf) (MBbl) (MBbl) Total (MBoe)(2) Before Tax Net Present Value(1) ($ millions) Discount Rate 0% 10% 15% Reserves Category Canada Proved Developed Producing Developed Non-producing Undeveloped Total Proved Total Probable Total Proved plus Probable Canada United States Proved Developed Producing Developed Non-producing Undeveloped Total Proved Total Probable Total Proved plus Probable USA Total Company Total Proved Total Probable 84.7 18.6 8.2 111.5 69.6 181.2 0.5 - - 0.5 0.2 0.7 2,186 77 18 2,281 1,050 3,331 2,703 - - 2,703 777 3,480 1,441 288 119 1,848 1,025 2,873 17,750 3,472 1,497 22,719 13,677 36,396 73 - - 73 26 99 2,856 1 - 2,857 834 3,691 112.0 69.8 4,984 1,826 1,922 1,050 25,576 14,511 Total Proved plus Probable (1) Columns may not add due to rounding. (2) Refer to the oil and gas measures and definitions in the "Advisories" section of this document. 6,810 2,972 181.8 40,087 Natural Gas Reserves Proved and Probable (Bcf) 190 170 150 130 Liquids Reserves Proved and Probable (MBbl) 10,000 9,000 8,000 7,000 6,000 407.5 48.4 26.9 482.8 287.1 769.9 96.9 (0.4) - 96.5 41.9 138.4 296.6 28.1 17.0 341.6 142.9 484.5 56.6 (0.3) - 56.2 15.2 71.4 261.7 24.0 13.8 299.5 108.6 408.1 47.2 (0.3) - 46.9 11.1 58.0 579.3 329.0 908.3 397.8 158.1 556.0 346.5 119.7 466.1 Total Reserves Proved and Probable (MBoe) 40,000 35,000 30,000 25,000 2008 2009 2010 2008 2009 2010 2008 2009 2010 Paramount Resources Ltd. 2010 Principal Properties 14 Reserves Reconciliation Proved Reserves(2) Probable Reserves(2) Proved & Probable Reserves(2) Natural Gas Oil and NGLs Total Natural Gas Oil and NGLs Total Natural Gas Oil and NGLs Total (Bcf) (MBbl) (MBoe)(3) 90.5 28.3 8.9 (1.1) 6.5 6,245 21,328 1,002 289 (31) 5,717 1,780 (221) 647 1,728 (21.1) (1,247) (4,756) (Bcf) 64.5 14.1 (6.0) (6.2) 3.4 – (MBbl) (MBoe)(3) (Bcf) (MBbl) (MBoe)(3) 2,422 13,165 155.0 8,667 34,493 546 2,893 42.4 1,548 8,610 (573) (1,573) 2.9 (284) 207 14 (1,011) (7.3) (17) (1,232) 469 1,037 9.9 1,115 2,765 – – (21.1) (1,247) (4,756) January 1, 2010 Extensions and discoveries Technical revisions Economic factors Acquisitions Production (1) December 31, 2010 (1) Excludes royalty interest production. (2) Columns and rows may not add due to rounding. (3) Refer to the oil and gas measures and definitions in the "Advisories" section of this document. 25,576 6,906 112.0 69.8 2,876 Capital Expenditures Year ended December 31 ($ millions) Geological and geophysical Drilling, completions and tie-ins Facilities and gathering Exploration and development expenditures(1) Land and property acquisitions Principal Properties Strategic Investments Corporate 14,511 181.8 9,782 40,087 2010 7.6 144.8 46.6 199.0 82.7 281.7 16.3 0.2 2009 5.2 68.0 20.2 93.4 6.4 99.8 17.6 0.1 Net capital expenditures (1) Exploration and development expenditures are presented after the deduction of $11.4 million (2009 - $3.8 million) of Alberta Drilling Royalty credits 298.2 117.5 Finding and Development Costs Exploration & Development Capital(1) Reserve Additions(2) Finding & Development Costs(2) Proved Plus Probable Proved Plus Probable Proved Proved Proved Plus Probable Proved Exploration, drilling, completions and tie-ins Change in future capital Total - excluding facilities and gathering Facilities and gathering ($ millions) 152.4 ($ millions) 152.4 0.7 153.1 46.6 5.1 157.5 46.6 (Mboe) (Mboe) ($/Boe) ($/Boe) 7,276 – 7,585 – 21.04 – 20.76 – Total (1) The aggregate of the exploration and development costs incurred in the most recent financial year and the change during that year in estimated future 199.7 7,585 204.1 27.45 7,276 26.91 development costs generally will not reflect total finding and development costs related to reserve additions for that year. (2) Refer to the oil and gas measures and definitions in the "Advisories" section of this document. Paramount Resources Ltd. 2010 Principal Properties 15 Finding and development costs in 2010 were impacted by lower than expected reserve estimates for the Karr- Gold Creek development due to limited production data as the new processing facility entered service in late December 2010 and shut-in wells were not fully restored to expected production levels. Lower forecasted natural gas prices at December 31, 2010 also impacted finding and development costs, as downward economic revisions were recorded in respect of Liard in the Northern COU and various other properties. Total finding and development costs ($/Boe) 2010 2009 2008 3 Year Average Proved Proved plus Probable 27.45 26.91 24.05 26.76 129.24 334.80 37.81 42.61 DRILLING AND LAND Over the past five years Paramount has focused on identifying key development areas, acquiring significant land holdings around those areas and refining the Company’s geological understanding of the plays. New drilling and fracture stimulation technologies were tested and refined to improve the efficiencies of the wells. Resources are being allocated to the highest quality assets with the highest expected rates of return, and the Company is positioned for material production and reserve growth over the next few years. Drilling (wells) Gas Coal bed methane Oil Oil Sands evaluation Dry and abandoned 2010 2009 Gross(1) 34 13 13 45 4 110 Net(2) 23 10 6 45 4 88 Gross(1) 22 – 2 7 – 31 Net(2) 13 – 1 7 – 21 (1) Gross is the number of wells in which Paramount has a working interest or a royalty interest that may be converted to a working interest. (2) Net is the aggregate number of wells obtained by multiplying each gross well by Paramount’s percentage of working interest. Hoole Oil Sands 45 Wells Drilled (net) Kaybob 7 Grande Prairie 14 Southern 17 Northern 5 Paramount Resources Ltd. 2010 Principal Properties 16 Today, Paramount enjoys a large contiguous liquids rich land position in a number of plays with a significant inventory of drilling locations. Land (000’s of acres, except as noted) Undeveloped land Acreage assigned reserves 2010 2009 Gross Net 1,682.0 579.7 1,198.0 310.7 Average Working Interest 71% 54% Gross Net 1,620.3 588.4 1,151.1 304.5 Average Working Interest 71% 52% 2,261.7 1,508.7 67% 2,208.7 1,455.6 66% Value of undeveloped land(1) ($ millions) $ 236.3 $145.1 (1) Based on McDaniel & Associates Consultants Ltd.’s ("McDaniel") evaluation of unproven acreage interests. CONTINUOUS IMPROVEMENT The Company has also made substantial efforts to control costs, which has been evident in significant reductions in operating and general and administrative costs, both in aggregate and per Boe of production, over the past five years. Operating Costs General and Administrative Costs $MM 90 70 50 30 10 $/Boe 16 $MM 35 14 12 10 8 25 15 5 $/Boe 8 6 4 2 2006 2007 2008 2009 2010 2006 2007 2008 2009 2010 – $MM $/Boe – $MM $/Boe Paramount Resources Ltd. 2010 Principal Properties 17 STRATEGIC INVESTMENTS Oil Sands Paramount’s oil sands land position includes approximately 180,000 (177,000 net) acres of oil sands leases, prospective for oil sands bitumen and carbonate bitumen. Hoole Grand Rapids Oil Sands Project The Hoole area of Alberta is situated within the western portion of the Athabasca Oil Sands region. Paramount owns 100 percent of approximately 39,000 acres of in-situ oil sands leases in this region. The Hoole Oil Sands Project continued to progress in 2010, with ongoing design work being performed to support a regulatory application for commercial development in the third quarter of 2011. Paramount also spent $9.9 million to drill 45 oil sands evaluation wells to further delineate the reservoir and bitumen resources. Paramount Resources Ltd. 2010 Strategic Investments 18 In May 2010, Paramount received an updated evaluation of its Grand Rapids resource at Hoole from McDaniel, the Company’s independent reserves evaluator, with an evaluation date of April 30, 2010. A summary of the results of the McDaniel evaluation is as follows: Category / Level of Certainty(1) High estimate Best estimate Low estimate Contingent Resources(2)(3) (MBbl) (4) 786,394 634,102 458,893 First Year Production(5) (Bbl/d) 22,320 21,120 20,700 Fully Developed NPV(6) of Future Net Revenue Discounted @ 10% Production(5) 85,000 70,000 50,000 (Bbl/d) ($MM) (7)(8) 2,934 1,908 967 (1) A low estimate means high certainty (P90), a best estimate means most likely (P50) and a high estimate means low certainty (P10). (2) Represents the Company’s share of recoverable volumes before deduction of royalties. (3) Contingent resources are those quantities of bitumen estimated, as of a given date, to be potentially recoverable from known accumulations using established technology or technology under development, but are classified as a resource rather than a reserve due to one or more contingencies, such as the absence of regulatory approvals, detailed design estimates or near term development plans. (4) Thousands of barrels (5) These estimates assume that initial production will commence in 2015 and fully developed production will be reached in 2016 for the low estimate, 2017 for the best estimate, and 2018 for the high estimate. (6) NPV means net present value and represents the Company’s share of future net revenue, before the deduction of income tax and does not represent fair value. The calculation considers such items as revenues, royalties, operating costs, abandonment costs and capital expenditures. Royalties have been calculated based on Alberta’s Royalty Framework applicable to oil sands projects in Alberta. The calculation does not consider financing costs and general and administrative costs. All NPVs are calculated assuming natural gas is used as a fuel for steam generation. Revenues and expenditures were calculated based on the reserve evaluator’s forecast prices and costs as of April 1, 2010. (7) Millions of Canadian dollars (8) See Paramount’s 2010 AIF for a full description of the Hoole Oil Sands Resource. In 2011, Paramount plans to spend $7 million to drill an additional 15 oil sands evaluation wells and complete a 25 km seismic program. The Company has invested an aggregate of $25.5 million (2009 - $11.1 million) in the project to date. Paramount plans to obtain an updated resource evaluation from McDaniel in 2011 incorporating the results of the drilling and seismic programs. Carbonate Bitumen The Carbonate bitumen trend is differentiated from conventional oil sands in that the bitumen is contained within Devonian-aged dolomites and limestone rocks, as opposed to the Cretaceous sands currently being exploited. The difference in the reservoirs results in production challenges that require different recovery techniques. Though there are currently no economic projects producing this resource, it is receiving a great deal of industry interest, including an operating pilot presently underway. The bitumen reserves hosted within this carbonate trend are believed to exceed 420 billion barrels, resulting in compelling opportunities for entities with holdings on the trend. In the first quarter of 2011, Paramount will begin assessing this potentially significant resource with a 15 well drilling and delineation program at Saleski, the most prospective of the Company’s carbonate leases. The program will target the Grosmont formation, and the core samples obtained will be incorporated into a detailed analysis of the property. Paramount Resources Ltd. 2010 Strategic Investments 19 Shale Gas Paramount land. Properties purchased in land sales. Certain of these lands are owned by Paramount but have not been identified as such for competitive reasons. Paramount’s shale gas land position encompasses 175,000 (147,000 net) acres in Northeast British Columbia and the Northwest Territories prospective for shale gas from the Horn River Basin and the Liard Basin. The Company is in the early stages of evaluating the potential of its acreage in these emerging shale plays. Paramount has been actively monitoring industry activities in the Horn River and Liard Basins where operators are applying multi-stage fracturing technology to maximize production rates and reserves recoveries and commencing the development of infrastructure to process and transport production. Paramount plans to drill its first shale gas well in the Liard Basin in the first quarter of 2012. Paramount Resources Ltd. 2010 Strategic Investments 20 Investment in Other Entities Market Value(1) Year ended December 31 Trilogy Energy Corp. MEG Energy Corp. MGM Energy Corp. Other(2) Total Shares (000’s) 24,144 3,700 43,834 2010 ($ millions) $297.0 168.3 8.8 28.8 $502.9 ($/share) 12.30 45.49 0.20 Shares (000’s) 23,995 3,700 43,834 2009 ($ millions) 206.1 101.8 12.5 22.5 $342.9 ($/share) 8.59 27.50 0.29 (1) Based on the period-end closing price of publicly traded investments and book value of remaining investments. (2) Includes NuLoch Resources Inc., Paxton Corporation, and other public and private corporations. $ MM 500 400 300 200 100 Market Value of Investments (1) $/POU Share 10 8 6 4 2 2006 2007 2008 2009 2010 $MM $/POU Share – (1) 2006 includes the investment in North American Oil Sands Corp. which was sold in 2007 for $682 million. Trilogy Energy Corp. is a Canadian energy corporation formed through a spinout of assets from Paramount in April 2005. Originally an income trust, Trilogy converted to a corporate structure in February 2010. Trilogy’s geographically concentrated assets are primarily low-risk, high working interest, lower-decline properties that provide abundant infill drilling opportunities and good access to infrastructure and processing facilities, many of which are operated and controlled by Trilogy. Advances made in horizontal drilling and completion techniques have provided Trilogy with the opportunity to confidently exploit additional tight gas reservoirs on its acreage at attractive finding and development costs. Trilogy plans to continue its strategy of capitalizing on its core assets, focusing on tight gas reservoirs where horizontal technology can be used to add low cost reserves and grow production efficiently. MEG Energy Corp. is a public energy company based in Calgary, Alberta that is focused on oil sands development in the Athabasca region of Alberta, Canada. MEG has identified two commercial SAGD projects, the Christina Lake Project and the Surmont Project. The initial phases of the Paramount Resources Ltd. 2010 Strategic Investments 21 Christina Lake Project are on-stream with production exceeding 25,000 Bbl/d. Phase 2B, designed to add 35,000 Bbl/d, with first production scheduled for 2013 and Phase 3, designed to add 150,000 Bbl/d, is at the regulatory approval stage. Paramount acquired its ownership interest in MEG in 2007 as partial consideration for the sale of certain oil sands leases and related properties to MEG. MGM Energy Corp. ("MGM Energy") is a Canadian energy company focused on the acquisition and development of hydrocarbon resources in the Northwest Territories. The company's business strategy is to acquire interests in prospective lands and existing discoveries in the Canadian North, and to employ current technology in exploring those lands, with the ultimate intention of developing projects that will ship hydrocarbons through the Mackenzie Valley pipeline, when built. MGM Energy is currently active in two areas: the Mackenzie Delta, where it owns interests in six discoveries and the Colville Lake/Sahtu region of the Central Mackenzie Valley, where it owns interests in two discoveries. MGM Energy land holdings include both Federal Lands and First Nations Oil and Gas Concessions. MGM Energy was formed through the 2007 spinout by Paramount of certain farm-in rights and other assets in the Northwest Territories. Paramount has invested $45 million to build three custom built triple-sized drilling rigs with diesel electric power, top drives and dual mud pumps. They are designed to drill the deep horizontal wells the industry is drilling today. Two of the rigs are being used in the Company’s drilling programs in the Grande Prairie and Kaybob COUs and the third drilled for a third party in North Dakota for the duration of 2010. A total of 16 wells were drilled in 2010 over 658 drilling days and US$3.1 million was earned in external revenue. Paramount Resources Ltd. 2010 Strategic Investments 22 MANAGEMENT’S DISCUSSION & ANALYSIS This Management’s Discussion and Analysis ("MD&A"), dated March 3, 2011, should be read in conjunction with the audited Consolidated Financial Statements of Paramount Resources Ltd. ("Paramount" or the "Company") for the year ended December 31, 2010. The Company’s Consolidated Financial Statements and the financial information included in this MD&A are presented in accordance with Generally Accepted Accounting Principles ("GAAP") in Canada. Certain comparative figures have been reclassified to conform to the current year’s presentation. This document contains forward-looking information, non-GAAP measures, disclosures of barrels of oil equivalent volumes and disclosures concerning contingent resources. Readers are referred to the "Advisories" section at the end of this document concerning such matters. Additional information concerning Paramount, including its Annual Information Form, can be found on the SEDAR website at www.sedar.com. Paramount is an independent Canadian energy company involved in the exploration, development, production, processing, transportation and marketing of natural gas, crude oil and natural gas liquids ("NGLs"). Management’s strategy is to maintain a balanced portfolio of opportunities, to grow reserves and production in Paramount’s Principal Properties while maintaining a large inventory of undeveloped acreage, and to selectively pursue higher risk/higher return prospects. Paramount has spun-out three public entities: (i) Paramount Energy Trust, now Perpetual Energy Inc., in February, 2003; (ii) Trilogy Energy Trust, now Trilogy Energy Corp. ("Trilogy"), in April, 2005; and (iii) MGM Energy Corp. ("MGM Energy") in January, 2007. Paramount continues to hold investments in the securities of Trilogy and MGM Energy in its portfolio of Strategic Investments. Paramount’s operations are divided into three business segments, established by management to assist in resource allocation, to assess operating performance and to achieve long-term strategic objectives: i) Principal Properties; ii) Strategic Investments; and iii) Corporate. Paramount’s Principal Properties are divided into four Corporate Operating Units ("COUs") as follows: (cid:2) (cid:2) (cid:2) (cid:2) the Kaybob COU, which includes properties in West Central Alberta; the Grande Prairie COU, which includes properties in the Peace River Arch area of Alberta; the Southern COU, which includes properties in Southern Alberta, Saskatchewan, Montana and North Dakota; and the Northern COU, which includes properties in Northern Alberta, the Northwest Territories and Northeast British Columbia. Strategic Investments include: (i) investments in other entities, including affiliates; (ii) investments in development stage assets where there is no near-term expectation of production, but a longer-term value proposition based on spin-outs, dispositions, or future revenue generation; and (iii) three drilling rigs owned by Fox Drilling Inc. ("Fox Drilling") and Paramount Drilling U.S. L.L.C. ("Paramount Drilling"). The Corporate segment is comprised of income and expense items, including general and administrative expense and interest expense, which have not been specifically allocated to Principal Properties or Strategic Investments. Paramount Resources Ltd. 2010 Management's Discussion & Analysis 23 HIGHLIGHTS(1) FINANCIAL ($ millions, except as noted) Petroleum and natural gas sales Funds flow from operations per share – basic and diluted ($/share) Net loss per share – basic and diluted ($/share) Exploration and development expenditures Investments in other entities – market value(2) Total assets Long-term debt Net debt OPERATIONAL Sales volumes Natural gas (MMcf/d) Oil and NGLs (Bbl/d) Total (Boe/d) Net wells drilled (excluding oil sands evaluation) Net oil sands evaluation wells drilled FUNDS FLOW FROM OPERATIONS ($/Boe) Petroleum and natural gas sales Royalties Operating expense and production tax Transportation Netback Financial commodity contract settlements Netback including commodity contract settlements General and administrative Interest Distributions from investments Asset retirement obligation expenditures Other 2010 2009 2008 184.4 86.9 1.19 (122.5) (1.68) 199.0 502.9 161.7 60.3 0.90 (97.9) (1.46) 93.4 342.9 318.1 179.6 2.65 (116.6) (1.72) 170.8 249.9 1,377.2 1,102.0 1,144.6 294.2 295.2 93.7 50.9 109.5 97.5 57.7 3,417 13,029 43 45 38.77 (4.46) (10.70) (3.62) 19.99 2.72 22.71 (3.24) (2.79) 2.73 (0.67) (0.48) 18.26 51.8 3,580 12,207 14 7 36.29 (4.64) (12.72) (3.11) 15.82 2.89 18.71 (3.86) (2.52) 3.37 (0.91) (1.26) 13.53 61.0 3,594 13,764 38 – 63.14 (9.49) (14.31) (3.12) 36.22 3.45 39.67 (5.15) (1.97) 4.28 (1.67) 0.48 35.64 (1) Readers are referred to the advisories concerning non-GAAP measures and oil and gas measures and definitions in the "Advisories" section of this document. (2) Based on the period-end prices of publicly traded enterprises and book value of the remaining investments. Paramount Resources Ltd. 2010 Management's Discussion & Analysis 24 2010 OVERVIEW (cid:2) (cid:2) Funds flow from operations in 2010 increased by 44 percent to $86.9 million from $60.3 million in 2009, primarily due to the impact of higher revenues and lower operating and general and administrative expenses, partially offset by higher transportation and interest expense. Paramount’s net loss increased $24.6 million to $122.5 million in 2010 compared to $97.9 million in 2009, primarily due to higher stock-based compensation and depletion, depreciation and accretion expenses, partially offset by higher revenue and income from investments. Principal Properties (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) Paramount focused on its major developments in the Kaybob and Grande Prairie COUs in 2010, investing $144.8 million in extensive drilling programs and $46.6 million in gathering and processing facilities. The Company’s 2010 exploration and development expenditures exceeded the original budget of $130 million as the Company accelerated development plans in the Deep Basin program in the Kaybob COU and at Karr-Gold Creek and Valhalla in the Grande Prairie COU based on favorable results from the 2009/2010 winter drilling program. The Company expects to add production from the 2010 drilling programs in 2011 when the new infrastructure is in place and all of the wells are completed and placed on production. Paramount invested $82.7 million to acquire additional undeveloped acreage, primarily in the Kaybob and Grande Prairie COUs, and solidified its significant Peace River Arch land position targeting the liquids rich Montney and Nikanassin formations at Karr-Gold Creek with the acquisition of Redcliffe Exploration Inc. ("Redcliffe"). Production increased seven percent to 13,029 Boe/d in 2010 compared to 12,207 Boe/d in 2009, due primarily to new well production in the Kaybob and Grande Prairie COUs and the impact of acquisitions, partially offset by natural declines. Netback increased 35 percent to $95.1 million in 2010 from $70.5 million in the prior year, primarily due to higher revenue and lower operating expenses. The Kaybob COU drilled 16 (6.5 net) wells and confirmed plans for major processing capacity expansions, including the construction of a 50 MMcf/d processing plant at Musreau and nominating for an additional 50 MMcf/d of processing capacity in a third party facility expansion at Smoky. The Grande Prairie COU drilled 16 (13.7 net) wells and completed the construction of the first phase of the Karr-Gold Creek compression/dehydration plant. Commissioning of the new plant commenced in mid-December and previously shut-in wells are being tied-in and re-started. The North Dakota joint development partner has drilled and completed three horizontal wells to date. The wells have not performed as expected, with the first two producing at nominal rates. Subsequent to December 31, 2010, Paramount sold approximately 6,000 net acres of undeveloped land in North Dakota, unrelated to the farm-out lands, for cash proceeds of US$40 million. Paramount Resources Ltd. 2010 Management's Discussion & Analysis 25 Strategic Investments (cid:2) (cid:2) In May 2010, Paramount received an updated independent evaluation of its Grand Rapids oil sands resource at Hoole, having a before-tax net present value of future net revenue of $1.9 billion, discounted at ten percent (Best Estimate (P50)). Paramount expects to file a regulatory application for commercial development in the third quarter of 2011. In August 2010, MEG Energy Corp. ("MEG") completed its initial public offering on the Toronto Stock Exchange. As a result, Paramount now carries its MEG investment at market value, and the December 31, 2010 carrying value was increased to $168.3 million or $45.49 per share, compared to $101.8 million or $27.50 per share in the prior year. Corporate (cid:2) (cid:2) (cid:2) In July 2010, following the acquisition of Redcliffe, the borrowing base and lender commitments under the Company’s credit facility were increased from $125 million to $160 million. Paramount was active in the capital markets late in 2010 raising funds in preparation for the acceleration of its Principal Properties developments in 2011: o o In November 2010, Paramount closed a public offering and a private placement of an aggregate 2.3 million flow-through common shares for gross proceeds of $59.1 million. In December 2010, Paramount closed a public offering of $300 million principal amount of 8.25 percent senior unsecured notes ("Senior Notes") at par and, in February 2011, the Company closed an additional public offering of $70 million principal amount of Senior Notes at a premium price of $1,030 per $1,000 principal amount. A portion of the proceeds were used to repay and redeem the remaining US$90.2 million of US Senior Notes and to initially repay the outstanding balance on the credit facility. The Company continued its focus on cost control, including general and administrative expenses. Salary costs in 2010 were consistent with the prior year, with an overall decrease in general and administrative expenses resulting from increased recoveries related to higher capital spending. Paramount Resources Ltd. 2010 Management's Discussion & Analysis 26 CONSOLIDATED RESULTS Net Loss Year ended December 31 ($ millions) Principal Properties Strategic Investments Corporate Taxes Net Loss 2010 (113.1) (14.9) (66.8) 72.3 (122.5) 2009 (106.9) (18.0) (27.6) 54.6 (97.9) 2008 33.6 (96.4) (39.1) (14.7) (116.6) The 2010 net loss increased by $24.6 million compared to 2009 primarily as a result of: (cid:2) (cid:2) An increase of $41.2 million in stock-based compensation due to the appreciation of the trading price of the Company’s shares; and An increase of $36.4 million in depletion, depreciation and accretion due to a 2009 change in the pricing methodology for proved reserves used in the calculation of depletion rates, higher lease expiries and increased production in 2010; Partially offset by: (cid:2) (cid:2) An increase in petroleum and natural gas sales of $22.7 million due to higher realized prices for oil and NGLs and increased natural gas production volumes; and Income from investments of $8.2 million in 2010 compared to a loss of $7.3 million in 2009, increasing earnings by $15.5 million. The 2009 net loss decreased by $18.7 million compared to 2008 primarily as a result of: (cid:2) (cid:2) (cid:2) An $86.0 million decrease in losses from investments, primarily due to write-downs of the Company’s investments in MEG and MGM Energy in 2008; An income tax recovery of $54.6 million in 2009 compared to income tax expense of $14.7 million in 2008; and A $35.7 million decrease in petroleum and natural gas asset impairments and goodwill write-downs; Partially offset by: (cid:2) (cid:2) A decrease in petroleum and natural gas sales of $156.4 million due to lower realized prices and lower production volumes; and A $28.9 million decrease in financial commodity contract gains. Paramount Resources Ltd. 2010 Management's Discussion & Analysis 27 Funds Flow from Operations The following is a reconciliation of funds flow from operations to the nearest GAAP measure: Year ended December 31 ($ millions, except as noted) Cash from operating activities Change in non-cash working capital Funds flow from operations Funds flow from operations ($/Boe) 2010 63.4 23.5 86.9 18.26 2009 72.1 (11.8) 60.3 13.53 2008 194.9 (15.3) 179.6 35.64 (cid:2) (cid:2) Funds flow from operations in 2010 increased by $26.6 million from the prior year, primarily due to the impact of higher petroleum and natural gas sales and lower operating and general and administrative expenses, partially offset by higher transportation and interest expenses. Funds flow from operations in 2009 decreased by $119.3 million from 2008 due primarily to the impact of lower realized commodity prices and lower production, partially offset by lower royalties, operating costs and general and administrative expenses. PRINCIPAL PROPERTIES Netback and Segment Loss Year ended December 31 ($ millions, except as noted) Petroleum and natural gas sales Royalties Operating expense and production tax Transportation Netback Financial commodity contract settlements Netback including financial commodity contract settlements Other principal property items (see below) Segment loss Petroleum and Natural Gas Sales 184.4 (21.2) (50.9) (17.2) 95.1 12.9 108.0 (221.1) (113.1) Year ended December 31 ($ millions, except as noted) Natural gas Oil and NGLs 2010 94.8 89.6 184.4 2010 2009 ($/Boe) 38.77 (4.46) (10.70) (3.62) 19.99 2.72 22.71 2009 83.9 77.8 161.7 ($/Boe) 36.29 (4.64) (12.72) (3.11) 15.82 2.89 18.71 161.7 (20.7) (56.7) (13.8) 70.5 12.9 83.4 (190.3) (106.9) % Change 13 15 14 Revenue from natural gas, oil and NGLs sales in 2010 was $184.4 million, an increase of $22.7 million from 2009 due primarily to the impact of higher liquids prices and higher natural gas sales volumes. Paramount Resources Ltd. 2010 Management's Discussion & Analysis 28 The impact of changes in prices and volumes on petroleum and natural gas sales revenue are as follows: ($ millions) Year ended December 31, 2009 Effect of changes in prices Effect of changes in sales volumes Year ended December 31, 2010 Sales Volumes Natural gas 83.9 1.3 9.6 94.8 Oil and NGLs 77.8 16.0 (4.2) 89.6 Total 161.7 17.3 5.4 184.4 Kaybob Grande Prairie Southern Northern Total Natural Gas (MMcf/d) 2009 18.9 7.5 10.7 14.7 51.8 Change 4.6 4.9 (1.4) (2.2) 5.9 2010 23.5 12.4 9.3 12.5 57.7 Oil and NGLs (Bbl/d) 2009 470 960 1,602 548 3,580 Change 103 (9) (180) (77) (163) 2010 573 951 1,422 471 3,417 Total (Boe/d) 2009 3,615 2,204 3,382 3,006 12,207 Change 880 808 (409) (457) 822 2010 4,495 3,012 2,973 2,549 13,029 Natural gas sales volumes increased to 57.7 MMcf/d in 2010 compared to 51.8 MMcf/d in 2009. Crude oil and NGLs sales volumes decreased to 3,417 Bbl/d in 2010 compared to 3,580 Bbl/d in 2009. The overall increase in 2010 sales volumes to 13,029 Boe/d was primarily a result of production from new wells drilled in the 2010 capital program at Resthaven, Musreau and Smoky in the Kaybob COU and at Karr-Gold Creek in the Grande Prairie COU, and from wells acquired through the Redcliffe acquisition. These increases were partially offset by declines at Bistcho and Cameron Hills in the Northern COU where limited investments were made in 2010. Annual production of 13,029 Boe/d in 2010 was below expectations of 13,425 Boe/d due to prolonged wet weather in the fall, which delayed planned well completions, well tie-ins and facilities construction, including the commissioning of the Company’s new 20 MMcf/d plant at Karr-Gold Creek, which did not go on-stream until late December. Average Realized Prices Year ended December 31 Natural gas ($/Mcf) Oil and NGLs ($/Bbl) Total ($/Boe) 2010 4.50 71.83 38.77 2009 4.44 59.50 36.29 % Change 1 21 7 Paramount Resources Ltd. 2010 Management's Discussion & Analysis 29 Commodity Prices Key monthly average commodity price benchmarks and foreign exchange rates are as follows: Year ended December 31 Natural Gas AECO (Cdn$/GJ) New York Mercantile Exchange (Henry Hub US$/MMbtu) Crude Oil Edmonton par (Cdn$/Bbl) West Texas Intermediate (US$Bbl) Foreign Exchange $Cdn / 1 $US 2010 3.91 4.40 76.80 78.39 1.04 2009 % Change 3.93 4.00 65.70 61.68 1.14 (1) 10 17 27 (9) Paramount’s average realized natural gas price for 2010, before financial commodity contract impacts, was $4.50/Mcf compared to $4.44/Mcf in 2009. Paramount’s natural gas sales portfolio primarily consists of sales priced at the Alberta spot market, Eastern Canadian markets, and California markets and is sold in a combination of daily and monthly contracts. The average realized oil and NGLs price for 2010, before financial commodity contracts impacts, increased to $71.83/Bbl compared to $59.50/Bbl in 2009. Paramount's Canadian oil and NGLs sales portfolio primarily consists of sales priced relative to Edmonton Par, adjusted for transportation and quality differentials. The Company’s United States oil and NGLs sales portfolio is sold at the well head with differentials negotiated relative to West Texas Intermediate crude oil prices. Commodity Price Management From time to time Paramount uses financial and physical commodity price contracts to manage exposure to commodity price volatility. Paramount has not designated any of its financial commodity contracts as hedges, and as a result, changes in the fair value of these contracts are recognized in earnings. Receipts from the settlement of natural gas financial contracts are as follows: Year ended December 31 ($ millions) Gas contracts 2010 12.9 2009 12.9 At December 31, 2010, Paramount had the following financial commodity sales contract outstanding: Instrument Crude Oil – NYMEX Swap Notional 500 Bbl/d Fixed Price USD$89.95/Bbl Fair Value ($ millions) (0.7) Remaining Term January 2011 – December 2011 Subsequent to December 31, 2010, the Company entered into an additional financial commodity sales contract: Instrument Crude Oil– NYMEX Swap Notional 500 Bbl/d Fixed Price USD$97.50/Bbl Remaining Term March 2011 – December 2011 Paramount Resources Ltd. 2010 Management's Discussion & Analysis 30 Royalties Year ended December 31 ($ millions, except as noted) Natural gas Oil and NGLs Total 2010 4.6 16.6 21.2 Royalty rate 4.8 % 18.6 % 11.5 % 2009 3.7 17.0 20.7 Royalty rate 4.4 % 21.8 % 12.8% Natural gas royalties increased by $0.9 million in 2010 compared to the prior year, primarily due to higher natural gas production. Oil and NGLs royalties decreased $0.4 million compared to the prior year due to lower rates as a result of an increase in NGLs production from new wells which benefit from the first year maximum 5 percent royalty rate and deep gas royalty credit program. Operating Expense and Production Tax Year ended December 31 ($ millions, except as noted) Operating expense Production tax Total 2010 48.6 2.3 50.9 2009 54.5 2.2 56.7 % Change (11) 5 (10) Operating expenses decreased by $5.9 million or 11 percent compared to the prior year, primarily due to lower expenses in the Northern COU due to lower current year production and lower maintenance and well suspension activities compared to 2009. Operating expenses were lower in the Kaybob COU, although production was 24 percent higher, due to the addition of new wells with low operating costs and lower current year suspension activities and processing fees. The decreases in operating costs were partially offset by additional costs related to new well production at Karr-Gold Creek in the Grande Prairie COU and wells added through the Redcliffe acquisition. Transportation Expense Year ended December 31 ($ millions, except as noted) Transportation expense 2010 17.2 2009 13.8 % Change 25 Transportation expense increased to $17.2 million in 2010 compared to $13.8 million in 2009 primarily due to increased tolls and higher production volumes. Transportation expenses include the costs of shipping natural gas to sales points in California and the United States east coast. Other Principal Property Items Year ended December 31 ($ millions) Depletion, depreciation and accretion Exploration and dry hole expenses Gain on sale of property plant and equipment Commodity contracts – net of settlements Write-down of petroleum and natural gas assets Other Total 2010 175.9 18.2 (0.2) 2.9 25.3 (1.0) 221.1 2009 140.4 29.4 (0.5) 7.6 14.9 (1.5) 190.3 Depletion, depreciation, and accretion increased to $175.9 million or $36.98 per Boe in 2010 compared to $140.4 million or $31.51 per Boe in the prior year. The increase was primarily due to a full year of increased depletion rates in 2010 resulting from the fourth quarter 2009 change in pricing methodology for proved reserves used in the calculation of depletion rates, higher lease expiries and increased current year production. Paramount Resources Ltd. 2010 Management's Discussion & Analysis 31 Exploration and dry hole expenses include $7.8 million of costs related to unsuccessful wells drilled in the first quarter of 2010 at Cameron Hills in the Northern COU. The 2010 write-down of petroleum and natural gas assets related primarily to conventional reserves in the Liard and Haro areas in the Northern COU, the Puskwa area in the Grande Prairie COU and various others where the property’s carrying value exceeded its expected discounted cash flows from the production of estimated proved and probable reserves. Reserve estimates for Liard and Haro were impacted by downward revisions to estimated net cash flows due to lower estimated future natural gas prices. Reserve estimates for Puskwa were impacted by declining well performance. STRATEGIC INVESTMENTS Year ended December 31 ($ millions) Income (loss) from investments Drilling rig revenue Drilling rig expense General and administrative Stock-based compensation Interest Other (expense) income Segment Loss 2010 8.2 3.9 (2.7) (3.6) (18.0) (1.2) (1.5) (14.9) 2009 (7.3) 0.4 (2.9) (2.5) (4.6) (0.5) (0.6) (18.0) Strategic Investments at December 31, 2010 include: (cid:2) (cid:2) (cid:2) (cid:2) investments in the shares of Trilogy, MEG, MGM Energy, NuLoch Resources Inc. ("NuLoch"), Paxton Corporation, and other public and private corporations; oil sands resources at Hoole, situated within the western portion of the Athabasca Oil Sands region, and carbonate bitumen holdings in Northeast Alberta, including at Saleski; shale gas holdings in the Horn River and Liard Basins in Northeast British Columbia and the Northwest Territories; and three drilling rigs operating by Paramount’s wholly-owned subsidiaries: Fox Drilling in Canada and Paramount Drilling in the United States. Income from investments in 2010 includes $0.4 million of equity earnings, dilution gains of $4.3 million and a gain of $3.5 million related to the reclassification of gains on the investment in Redcliffe previously recognized in other comprehensive income. The prior year includes $17.4 million of equity losses, a net dilution gain of $6.9 million and a $3.2 million gain realized on the disposition of shares in Nuloch. Stock-based compensation increased $13.4 million due to the appreciation of the trading price of the Company’s shares. In August 2010, MEG completed its initial public offering on the Toronto Stock Exchange. As a result, Paramount now carries its investment in MEG at market value, and the December 31, 2010 carrying value was increased to $168.3 million or $45.49 per share, compared to $101.8 million or $27.50 per share in 2009. The Paramount Resources Ltd. 2010 Management's Discussion & Analysis 32 increase in carrying value resulted in a gain of $66.5 million, which was recorded in other comprehensive income. The Company’s investments in other entities are as follows: Carrying Value Year ended December 31 2010 ($ millions) 103.0 Trilogy 168.3 MEG MGM Energy 5.2 Other(2) 28.8 Total 305.3 (1) Based on the period-end closing price of publicly-traded investments and book value of remaining investments. (2) Includes investments in NuLoch, Paxton, Redcliffe (2009 only), and other public and private corporations. 2009 104.5 101.8 5.9 22.4 234.6 Market Value(1) 2010 297.0 168.3 8.8 28.8 502.9 2009 206.1 101.8 12.5 22.5 342.9 The Hoole oil sands project continued to progress in 2010. In the first quarter, the Company invested $9.9 million to drill 45 oil sands evaluation wells to further delineate the reservoir and bitumen resource, and design work continued throughout the year. In May 2010, Paramount received an updated independent evaluation of its Grand Rapids resource at Hoole from McDaniel, with an evaluation date of April 30, 2010, incorporating the results of the drilling program. The report estimated contingent bitumen resources at 634 million barrels (Best Estimate (P50)), having a before-tax net present value of future net revenue of $1.9 billion, discounted at ten percent (Best Estimate (P50)). A full description of the estimated resources at the Hoole property is available in the Company's 2010 Annual Information Form on the SEDAR website at www.sedar.com. During 2011, the Company plans to continue design and other necessary work to prepare for a regulatory application for commercial development, which is expected to be filed in the third quarter. In support of this, in the first quarter of 2011 Paramount plans to invest $7 million to drill an additional 15 oil sands evaluation wells and complete a 25 km seismic program, after which the Company plans to obtain an updated resource evaluation from McDaniel. The Company has invested an aggregate of $25.5 million in the Hoole project to December 31, 2010 (2009 - $11.3 million). In the first quarter of 2011, Paramount plans to begin the delineation of its Carbonate bitumen resource. The Carbonate bitumen trend is differentiated from conventional oil sands in that the bitumen is contained within Devonian-aged dolomites and limestone rocks, as opposed to the Cretaceous sands currently being exploited. Paramount has allocated $8 million for a 15 well drilling and delineation program targeting the Grosmont formation to provide data for a detailed analysis of the property. Paramount Resources Ltd. 2010 Management's Discussion & Analysis 33 CORPORATE Year ended December 31 ($ millions) General and administrative Stock-based compensation Depletion and depreciation Interest and financing Foreign exchange Debt extinguishment Other (income) expense Corporate costs 2010 11.8 40.7 1.0 12.3 (0.8) 1.7 0.1 66.8 2009 14.7 12.9 1.0 10.7 (11.5) – (0.2) 27.6 Corporate segment net costs increased $39.2 million to $66.8 million in 2010, compared to $27.6 million in 2009, primarily due to the impact of higher stock-based compensation and changes in foreign exchange rates, partially offset by lower general and administrative expenses. Salary costs in 2010 were consistent with the prior year, and general and administrative expenses decreased overall due to increased cost recoveries related to increased capital spending. Costs of $0.3 million related to the Redcliffe acquisition were included in 2010 general and administrative expenses. Capital Expenditures Year ended December 31 ($ millions) Geological and geophysical Drilling, completion and tie-ins Facilities and gathering Exploration and development expenditures Land and property acquisitions Principal Properties Strategic Investments Corporate Capital expenditures 2010 7.6 144.8 46.6 199.0 82.7 281.7 16.3 0.2 298.2 2009 5.2 68.0 20.2 93.4 6.4 99.8 17.6 0.1 117.5 Exploration and development expenditures in 2010 were $199.0 million compared to $93.4 million in 2009. Spending in 2010 focused on drilling and completing wells and constructing/expanding facilities and gathering systems for the Karr-Gold Creek deep gas project in the Grande Prairie COU and the Deep Basin development at Musreau, Smoky and Resthaven in the Kaybob COU. Exploration and development expenditures in 2010 were reduced by $11.4 million (2009 - $3.8 million) as a result of the Alberta Drilling Royalty Credit program. Land and property acquisitions include undeveloped land purchases of $36.0 million in the Deep Basin at Musreau, Resthaven and Smoky, $10.2 million at Valhalla and $8.6 million in North Dakota. In the United States, Paramount operates through Summit Resources Inc. ("Summit"), a wholly owned subsidiary. In April 2010, Summit entered into a joint development agreement with a United States exploration and development company that has significant operations and experience in the Bakken play in North Dakota. Under the agreement, which covers approximately 39,900 net acres of Summit's undeveloped Bakken lands in North Dakota, the U.S. company is carrying out a multiple well horizontal drilling program using multi-stage fracture technology in order to earn an undivided 50 percent of Summit's interests in these lands (19,950 net acres). The North Dakota joint development partner has drilled and completed three horizontal wells. The wells have not performed as expected, with the first two producing at nominal rates. Paramount Resources Ltd. 2010 Management's Discussion & Analysis 34 Subsequent to December 31, 2010, Paramount sold approximately 6,000 net acres of undeveloped land in North Dakota, unrelated to the farm-out lands, for cash proceeds of US$40 million. Strategic investments capital expenditures in 2010 consist primarily of $14.2 million related to the Hoole Oil Sands Project, including $9.9 million for drilling and delineation. Wells drilled are as follows: (wells drilled) 2010 2009 Gas Coal bed methane Oil Oil sands evaluation Dry and abandoned Total (1) Gross is the number of wells in which Paramount has a working interest or a royalty interest that may be converted to a working interest. (2) Net is the aggregate number of wells obtained by multiplying each gross well by Paramount’s percentage of working interest. Gross(1) 34 13 13 45 4 109 Net(2) 23 10 6 45 4 88 Gross(1) 22 – 2 7 – 31 Net(2) 13 – 1 7 – 21 OUTLOOK Based on encouraging drilling and completion results, Paramount accelerated 2010 development plans in the Kaybob and Grande Prairie COUs, increasing total exploration and development spending to $199.0 million. Paramount expects to invest $425 million in its Principal Properties in 2011, excluding land acquisitions. The 2011 Principal Properties capital program will focus on drilling and facility construction at Musreau, Smoky and Resthaven in the Kaybob COU and at Karr-Gold Creek and Valhalla in the Grande Prairie COU. The Company plans to invest an additional $25 million in the Hoole oil sands and Saleski carbonate bitumen areas. Paramount has flexibility within its current capital plan to increase or decrease spending, depending upon future economic conditions, among other factors. Based on current production levels, market conditions, and the current exploration and development budget, 2011 annual average production is expected to be approximately 20,000 Boe/d, with an anticipated 2011 exit rate of 25,000 Boe/d. LIQUIDITY AND CAPITAL RESOURCES Paramount manages its capital structure to support current and future business plans and periodically adjusts the structure in response to changes in economic conditions and the risk characteristics of the Company’s underlying assets and operations. Paramount may adjust its capital structure by issuing or repurchasing shares, altering debt levels, modifying capital programs, acquiring or disposing of assets and participating in joint ventures. Paramount Resources Ltd. 2010 Management's Discussion & Analysis 35 As at December 31 ($ millions) Working capital deficit (surplus)(1) Senior Notes(2) US Senior Notes(2) Net debt(3) Share capital Contributed surplus Retained earnings Accumulated other comprehensive income Total Capital (1) Excludes risk management assets and liabilities and stock-based compensation liabilities. (2) Excludes unamortized financing costs. (3) 2010 Net debt excludes the $19.8 million deposit on account with the CRA, pending resolution of the Company’s notices of objection. 2010 (4.8) 300.0 – 295.2 458.9 3.9 251.3 71.6 1,080.9 2009 (43.5) – 94.4 50.9 393.1 2.9 373.7 3.2 823.8 Change 38.7 300.0 (94.4) 244.3 65.8 1.0 (122.4) 68.4 257.1 Working Capital Paramount’s working capital surplus at December 31, 2010 was $4.8 million compared to a surplus of $43.5 million at December 31, 2009. Working capital at December 31, 2010 included $74.7 million of cash and cash equivalents, $33.3 million of accounts receivable and $78.8 million of accounts payable and accrued liabilities. The decrease in working capital is primarily a result of capital spending, the Redcliffe acquisition and the repayment of the Company’s 8.5 percent US Senior Notes, partially offset by proceeds from the Senior Notes offering, the equity offerings and funds flow from operations. Principal payments of $2.5 million were made on the drilling rig loan in 2010. Paramount expects to fund its 2011 operations, obligations, and capital expenditures with existing cash and cash equivalents, funds flow from operations, drawings under its bank credit facility, and by accessing the capital markets, if required. Bank Credit Facility In April 2010, Paramount renewed its credit facility with the borrowing base and lender commitments remaining at $125 million. In July 2010, following the acquisition of Redcliffe, the borrowing base and lender commitments under the credit facility were increased from $125 million to $160 million. The credit facility is secured by a first fixed and floating charge over substantially all of the assets of Paramount, excluding assets securing the drilling rig loan. The maximum amount that Paramount may borrow under the credit facility is subject to semi-annual review, and is dependent upon the Company’s reserves and lenders’ projections of future commodity prices, among other factors. The credit facility is available on a revolving basis to April 30, 2011. The Company has requested an extension to the revolving term of its credit facility and expects to finalize details of the extension before April 30, 2011. In the event the revolving period is not extended, the credit facility would be available on a non-revolving basis for an additional year, at which time it would be due and payable. At December 31, 2010, no balance was drawn on the credit facility. Paramount had undrawn letters of credit outstanding at December 31, 2010 of $24.1 million that reduce the amount available to the Company. Senior Notes In December 2010, Paramount completed a public offering of $300 million principal amount of senior unsecured notes ("Senior Notes") at par, of which $11.4 million principal amount was purchased by certain directors, associates, officers, and management of the Company. The Senior Notes bear interest at 8.25 percent per annum, payable semi-annually in arrears on June 13 and December 13 in each year and mature on December Paramount Resources Ltd. 2010 Management's Discussion & Analysis 36 13, 2017. The Senior Notes are direct senior unsecured obligations of Paramount and rank equally with all other senior unsecured indebtedness of the Company. A portion of the proceeds of the Senior Notes were used to purchase/redeem the remaining outstanding balance of the Company’s US Senior Notes. The Company may redeem all or any portion of the Senior Notes at any time on or prior to December 13, 2013 at par, plus accrued and unpaid interest, plus a redemption premium equal to the greater of: (i) one percent; and (ii) a make-whole amount based on the then current yield of a Government of Canada bond with a similar maturity. Paramount may also redeem up to an aggregate of 35 percent of the Senior Notes with the net cash proceeds of an equity offering at any time prior to December 13, 2013, at par plus a redemption premium of 8.25 percent. On or after December 13, 2013, the Company may redeem some or all of the Senior Notes at par plus a redemption premium, if applicable, of up to 4.125 percent depending on when redeemed, plus accrued and unpaid interest. In February 2011, Paramount closed a public offering of an additional $70 million principal amount of its 8.25 percent Senior Notes at a premium price of $1,030 per $1,000 principal amount, of which $1.4 million principal amount was purchased by an entity that is associated with the Company’s Chairman and Chief Executive Officer. US Senior Notes During the fourth quarter of 2010, Paramount’s obligations under the indenture governing its US$90.2 million principal amount of US Senior Notes were discharged as a result of Paramount: (i) purchasing US$64.2 million principal amount of US Senior Notes pursuant to a tender offer; (ii) delivering all US Senior Notes held by the Company to the trustee for cancellation; (iii) issuing a redemption notice for US$26.0 million principal amount of US Senior Notes not tendered under the tender offer (the "Redeemed Notes"); and (iv) irrevocably depositing sufficient cash with the trustee to pay all amounts due on the Redeemed Notes on the January 31, 2011 redemption date. As a result, the 12.8 million Trilogy common shares held by the trustee as security were released to the Company. Share Capital In April 2010, Paramount received regulatory approval under Canadian securities laws to purchase Common Shares under a normal course issuer bid ("NCIB") commencing April 13, 2010 for a 12-month period. Under the NCIB, Paramount is permitted to purchase for cancellation up to 3,626,476 Common Shares. No shares have been purchased under the NCIB to March 3, 2011. In November 2010, Paramount issued 1,100,000 Canadian Exploration Expense ("CEE") flow-through Common Shares for gross proceeds of $30.0 million through a public offering. Concurrently, Paramount also issued 1,020,000 Canadian Development Expense ("CDE") flow-through Common Shares and 150,000 CEE flow- through Common Shares through a private placement for aggregate gross proceeds of $29.1 million to the Company’s Chairman and Chief Executive Officer and certain other members of management, and companies controlled by them. The Company is committed to renounce $59.1 million of qualifying expenditures related to the 2010 CEE and CDE flow-through Common Shares issued, and is required to incur these expenditures by December 31, 2011. Paramount has incurred sufficient qualifying expenditures to satisfy its commitments associated with flow- through shares issued in October and November 2009. Paramount Resources Ltd. 2010 Management's Discussion & Analysis 37 At February 28, 2011, Paramount had 75,360,174 Common Shares and 4,829,550 Stock Options outstanding (1,190,551 exercisable). QUARTERLY INFORMATION ($ millions, except as noted) Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 2010 2009 Petroleum and natural gas sales Funds flow from operations per share – basic and diluted ($/share) Net loss per share – basic and diluted ($/share) 46.0 19.9 0.27 (75.5) (1.03) 44.9 44.6 48.9 45.0 36.3 40.2 40.2 23.2 0.32 (3.7) (0.05) 22.1 0.31 (28.8) (0.40) 21.6 0.30 (14.5) (0.20) 18.8 0.27 (46.4) (0.67) 10.2 0.15 (25.2) (0.38) 13.7 0.21 (2.6) (0.04) 17.6 0.27 (23.7) (0.36) Sales volumes Natural gas (MMcf/d) Oil and NGLs (Bbl/d) Total (Boe/d) Average realized price Natural gas ($/Mcf) Oil and NGLs ($/Bbl) 60.4 3,387 13,461 62.9 3,480 13,967 57.0 3,287 12,787 50.2 3,514 11,875 47.0 3,673 11,514 49.9 3,733 12,046 59.1 3,512 13,362 51.1 3,398 11,912 4.04 75.48 4.12 65.85 4.49 71.32 5.59 74.78 4.85 71.00 3.24 62.33 4.03 57.83 5.73 45.38 Significant Items Impacting Quarterly Results Quarterly earnings variances include the impacts of changing production volumes and market prices. (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) Fourth quarter 2010 earnings include $35.7 million of stock-based compensation charges and a $25.3 million write-down of petroleum and natural gas properties. Third quarter 2010 earnings include a future income tax recovery of $37.0 million, increased depletion, depreciation and accretion expense and $8.1 million of stock-based compensation charges. Second quarter 2010 earnings include increased depletion, depreciation and accretion expense and $7.3 million of stock-based compensation charges. First quarter 2010 earnings include $8.2 million of dry hole expenses and $7.7 million of stock-based compensation charges. Fourth quarter 2009 earnings include $24.3 million of dry hole expenses related to suspended exploratory well costs and a $14.9 million write-down of petroleum and natural gas properties. Third quarter 2009 earnings include higher stock-based compensation charges, and lower earnings from Strategic Investments. Second quarter 2009 earnings include increased future income tax recoveries and lower operating expenses. Paramount Resources Ltd. 2010 Management's Discussion & Analysis 38 (cid:2) First quarter 2009 earnings include lower Corporate costs and Strategic Investments losses. Fourth Quarter Review Netback Three months ended December 31 ($ millions, except as noted) Petroleum and natural gas sales Royalties Operating expense and production tax Transportation Netback Financial commodity contract settlements Netback including financial commodity contract settlements Netback including financial commodity contract settlements ($/Boe) Funds Flow from Operations Three months ended December 31 ($ millions, except as noted) Cash flow from operating activities Change in non-cash working capital Funds flow from operations Funds flow from operations ($/Boe) Sales Volumes 2010 46.0 (4.4) (12.8) (4.3) 24.5 1.8 26.3 21.22 2010 11.1 8.8 19.9 16.10 2009 45.0 (7.4) (12.5) (3.4) 21.7 1.7 23.4 22.13 2009 21.3 (2.5) 18.8 17.75 Three months ended December 31 Kaybob Grande Prairie Southern Northern Total 28.8 11.4 9.1 11.1 60.4 19.0 5.7 9.7 12.6 47.0 Natural Gas (MMcf/d) 2009 2010 Change 9.8 5.7 (0.6) (1.5) 13.4 Oil and NGLs (Bbl/d) 2009 473 1,046 1,563 591 3,673 2010 713 761 1,455 458 3,387 Change 240 (285) (108) (133) (286) Total (Boe/d) 2009 3,636 1,993 3,198 2,687 11,514 2010 5,506 2,667 2,976 2,312 13,461 Change 1,870 674 (222) (375) 1,947 Paramount’s fourth quarter sales volumes of 13,461 Boe/d consisted of 60.4 MMcf/d of natural gas and 3,387 Bbl/d of oil and NGLs, generating revenue of $46.0 million, an increase of $1.0 million from the prior year comparable quarter due to higher natural gas volumes and higher oil and NGLs prices, partially offset by lower natural gas prices and lower oil and NGLs production volumes. Production levels in the Grande Prairie COU in the fourth quarter of 2010 were impacted by the commissioning of the new Karr-Gold Creek plant, which temporarily shut-in some wells while they were being tied-in to the new facility, and by drilling new wells on pad sites, requiring producing wells on the pads to be shut-in during drilling operations. Fourth quarter royalties decreased to $4.4 million in 2010 compared to $7.4 million in 2009, primarily as a result of production from new wells which benefit from the first year maximum five percent royalty rate and deep natural gas royalty holidays. Operating expenses were $0.3 million higher in the fourth quarter of 2010 compared to the prior year primarily due to higher production volumes in the Grande Prairie and Kaybob COUs. Funds flow from operations in the fourth quarter of 2010 increased by $1.1 million to $19.9 million compared to $18.8 million in 2009, primarily due to lower royalties, partially offset by higher interest expenses. Paramount Resources Ltd. 2010 Management's Discussion & Analysis 39 Fourth quarter exploration and development expenditures of $78.1 million were primarily related to the Grande Prairie COU’s Karr-Gold Creek deep gas program and the Deep Basin development in the Kaybob COU. OTHER INFORMATION Significant Equity Investee The following table summarizes the assets, liabilities and results of operations of Trilogy. The amounts summarized have been derived directly from Trilogy’s financial statements as at and for the periods ended December 31, 2010 and 2009, and do not include Paramount’s adjustments in applying the equity method of investment accounting. As a result, the amounts included in the table below cannot be used to derive Paramount’s equity income and net investment in Trilogy. As at December 31 ($ millions) Current assets Long term assets Current liabilities Long term liabilities Equity 2010 51.6 960.5 84.1 493.4 434.6 2009 54.1 839.1 63.8 394.8 434.6 Year ended December 31 (millions, except as noted) Revenue Expenses Tax expense (recovery) Net earnings (loss) Shares/units outstanding at December 31(thousands) Paramount’s equity interest at December 31(1) (1) Readers are cautioned that Paramount does not have any direct or indirect interest in or right to Trilogy’s assets or revenue, nor does Paramount have any direct or indirect obligation in 261.0 248.4 3.2 9.4 115,037 21.0% 2009 220.8 260.1 (5.9) (33.4) 110,490 21.7% 2010 respect of or liability for Trilogy’s expenses or obligations. Trilogy had 5.9 million stock options outstanding (1.8 million exercisable) at December 31, 2010 at exercise prices ranging from $4.85 to $12.88 per share. Related Party Transactions Service Agreements In 2010 Paramount charged $0.5 million (2009 – $0.6 million) for certain operational and administrative services that the Company provided to Trilogy. Paramount also has transactions with Trilogy, MGM Energy and Perpetual Energy Inc. in the normal course of business, including joint venture operations. Trilogy, Perpetual Energy Inc., MGM Energy and Paramount are related by common significant influence. All transactions between the entities are recorded at their exchange amounts. Paramount Resources Ltd. 2010 Management's Discussion & Analysis 40 Contractual Obligations Paramount had the following contractual obligations at December 31, 2010: ($ millions) Senior Notes, including interest 2011 24.8 2012-2013 2014-2015 After 2015 Total 49.5 49.5 Drilling rig loan, including interest Pipeline transportation commitments (1) Operating leases Total (1) Certain of the pipeline transportation commitments are secured by $10.4 million of outstanding letters of credit million at December 31, 2010. 1.9 91.2 – 88.2 2.3 46.7 12.9 11.7 14.5 28.1 25.8 5.1 348.3 – 67.1 – 415.4 472.1 29.7 135.5 4.2 641.5 Contingencies Paramount is party to various legal claims associated with the ordinary conduct of business. Paramount does not anticipate that these claims will have a material impact on its financial position. Tax and royalty legislation and regulations, and government interpretation and administration thereof, continually changes. As a result, there are often tax and royalty matters under review by relevant government authorities. All tax filings are subject to subsequent government audit and potential reassessments. Accordingly, the final liability may differ materially from amounts estimated and recorded. In October 2010, the Company received reassessments from the Canada Revenue Agency (the "CRA") and provincial tax authorities of its income taxes relating to a prior year transaction (the "Reassessments"). Paramount disagrees with the Reassessments and has filed notices of objection with the CRA and provincial tax authorities. Despite its disagreement, and as a condition of its right to proceed with its objection to the Reassessments, the Company was required to deposit approximately $19.8 million with the CRA, which amount will remain on account until the dispute is resolved. Crown royalties for Paramount’s production in the Northwest Territories have been accrued based on the Company’s interpretation of the relevant legislation and regulations. To date, Paramount has not received assessments from the Government of Canada of its liability under such legislation and regulations for its past filings. Although Paramount believes that its interpretations of the relevant legislation and regulations have merit, Paramount is unable to predict the ultimate outcome of audits and/or assessments by the Government of Canada. Additional material amounts could potentially become payable. As a result of flow through share issuances in the fourth quarter of 2010, Paramount is required to incur and renounce $34.1 million of Canadian Exploration Expense and $25.0 million of Canadian Development Expense. The Company is required to incur all qualifying expenditures by December 31, 2011. Critical Accounting Estimates The preparation of financial statements in accordance with GAAP requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent assets and liabilities. The following is a discussion of the accounting estimates that are considered critical. Paramount Resources Ltd. 2010 Management's Discussion & Analysis 41 Property, Plant and Equipment Paramount follows the successful efforts method of accounting for its petroleum and natural gas operations. The application of the successful efforts method of accounting requires the use of judgment to determine, among other things, the designation of wells as development or exploratory and whether exploratory wells have discovered economically recoverable quantities of reserves. All costs of development wells are capitalized. Costs of drilling exploratory wells are initially capitalized, pending evaluation of reserves. If economically recoverable reserves are not found, such costs are charged to earnings. Effective October 1, 2009, for purposes of calculating depletion, the Company adopted the Financial Accounting Standards Board update for Oil and Gas Reserve Estimation and Disclosures applicable to Accounting Standards Codification Topic 932 ("ASC 932"). The ASC 932 update changes the pricing methodology for proved reserves from period end pricing to an average of first day of month pricing for 12 months, consistent with the modernized US Securities and Exchange Commission reserves definition. The effect of adopting ASC 932 for the year ended December 31, 2009 was to increase depletion expense by $7.2 million, decrease future income tax expense by $1.9 million, decrease net earnings by $5.3 million, and decrease basic and diluted earnings per share by $0.08. Paramount recognizes Alberta drilling royalty credits as a reduction to property plant and equipment. The credits are recognized as they are earned, as determined by well depth, to the extent the Company anticipates being able to use the credits to reduce crown royalties. Reserve Estimates Reserve engineering is an inherently complex and subjective process of estimating underground accumulations of petroleum and natural gas. The process relies on interpretations of available geological, geophysical, engineering and production data. The accuracy of a reserves estimate is a function of the quality and quantity of available data, the interpretation of that data, the accuracy of various economic assumptions and the judgment of those preparing the estimate. In 2010, all of Paramount’s reserves were evaluated by a qualified independent reserves evaluator. Because these estimates depend on many assumptions, all of which may differ from actual results, reserves estimates and estimates of future net revenue may be different from the sales volumes ultimately recovered and net revenues actually realized. The results of changes in market conditions, regulatory changes, subsequent drilling, testing and production may require revisions to the original estimates. Estimates of reserves impact: (i) the assessment of whether or not an exploratory well has found economically recoverable reserves; (ii) depletion rates; and (iii) impairment assessments of oil and gas properties, all of which could have a material impact on earnings. Impairment of Petroleum and Natural Gas Properties Proved properties are reviewed for impairment annually, or as economic events dictate, on a field basis. An impairment provision is recorded when the carrying value of a field exceeds its estimated expected future cash flows from proved and probable reserves. Reserve estimates, as well as estimates for petroleum and natural gas prices, royalties, transportation and production costs, may change and there can be no assurance that additional impairment provisions will not be required in the future. Paramount Resources Ltd. 2010 Management's Discussion & Analysis 42 If an exploratory well encounters hydrocarbons, but further appraisal activity is required to conclude whether reserves are economically recoverable, the well costs remain capitalized as long as sufficient progress is being made in assessing the reserves and the economic and operating viability of the well. The concept of "sufficient progress" is a judgmental area, where the accounting rules prohibit the continued capitalization of suspended well costs on the chance that future market conditions will improve or new technologies will be found that would make the project’s development economically profitable. For certain exploratory projects, it is possible to have exploratory costs remain capitalized for several years while additional drilling is performed, or the Company seeks government, regulatory or partner approval of development plans. Management reviews suspended well costs regularly and expenses the suspended well costs when the project does not warrant further development. Criteria utilized in making this determination include evaluation of the reservoir characteristics and hydrocarbon properties, expected development costs, and regulations. Purchase Price Allocations Business acquisitions are accounted for using the acquisition method of accounting, where all of the assets acquired and liabilities assumed are recorded at fair value. Any excess of purchase price over the fair value of identifiable assets and liabilities acquired is recorded as goodwill. Determinations of fair value often require management to make assumptions and estimates about future events. Changes in any of the assumptions or estimates used in determining the fair value of acquired assets and liabilities could impact the amounts assigned to property, plant and equipment, working capital and goodwill in the purchase price allocation. Asset Retirement Obligations Paramount recognizes the fair value of an asset retirement obligation in the period in which it is incurred and when a reasonable estimate of the fair value can be made. The accumulated asset retirement obligation is adjusted for the passage of time, which is recognized as accretion expense, and for revisions in either the timing or the amount of the estimated cash flows associated with the liability. Estimates of asset retirement costs are subject to uncertainty associated with the method, timing, economic environment and regulatory standards that exist at the time assets are retired. Accordingly, actual payments to settle the obligations may differ materially from amounts estimated. Carrying Value of Investments The carrying value of investments is assessed for impairment at least annually. The Company estimates fair value based on factors including the expected future cash flows from the investment and public trading prices of investees’ shares. If the carrying value of an investment exceeds its estimated fair value and the impairment is assessed to be other than temporary, an impairment loss is recognized and the carrying value is written down to the fair value estimate. The process of assessing investments for impairment requires the application of various assumptions and judgments, including assessing whether the fair value of an investment will return to its carrying value in a reasonable period and estimating the duration the investment will be held. Carrying Value of Goodwill Goodwill is tested for impairment at least annually using the expected future cash flows of the respective reporting unit to determine its fair value. Impairment is assessed based on the difference between the fair value of each reporting unit and its carrying value, including goodwill. Any excess of the carrying value of the Paramount Resources Ltd. 2010 Management's Discussion & Analysis 43 reporting unit over the fair value is charged to earnings. The process of assessing goodwill for impairment requires estimates of fair values involving various assumptions and judgments. Income Taxes The Company follows the liability method of accounting for income taxes, whereby future income taxes are recognized based on the difference between the carrying amount of an asset or liability reported in the financial statements and its respective tax basis, using substantively enacted income tax rates. Accounting for income taxes is a complex process requiring management to interpret frequently changing laws and regulations and make judgments related to the application of tax law, estimate the timing of temporary difference reversals, and estimate the realization of tax assets. All tax filings are subject to subsequent government audit and potential reassessment. These interpretations and judgments and changes related to them impact the current and future tax provisions, future income tax assets and liabilities and net earnings. Change in Accounting Policy Effective January 1, 2010, Paramount early adopted CICA Handbook section 1582 – "Business Combinations", which replaces the previous business combinations standard. The new standard requires that all of the assets acquired and the liabilities assumed in a business combination be recorded at fair value, which was not the case under the previous standard. The new standard also requires that previously held ownership interests be remeasured to the acquisition date fair value, rather than being restated to cost. In addition, the new standard requires that all acquisition costs associated with the acquisition be expensed, rather than capitalized as part of the acquisition, that contingent liabilities be recognized at fair value at the acquisition date and subsequently re- measured to fair value with changes recognized in earnings, and that a bargain purchase be recognized in earnings rather than being allocated to non-monetary assets. This new standard was applied to the Company’s acquisition of Redcliffe in 2010. Effective January 1, 2010, Paramount also early adopted CICA Handbook sections 1601 – "Consolidations" and 1602 - "Non-controlling Interests", which together replaced section 1600 – "Consolidations". Section 1601 establishes standards for the preparation of consolidated financial statements. Section 1602 requires non- controlling interests to be presented within equity. There was no impact on the Consolidated Financial Statements from the adoption of these standards. Future Accounting Changes International Financial Reporting Standards Accounting standards in Canada, as used by publicly accountable enterprises, will be converted to International Financial Reporting Standards ("IFRS") for fiscal years beginning on or after January 1, 2011. Paramount’s IFRS conversion project is proceeding according to plan and the Company expects to be ready for the transition in the first quarter of 2011. Significant components of Paramount’s IFRS conversion project completed to date include: (cid:2) (cid:2) compilation of a diagnostic analysis that identified key differences between existing Canadian GAAP and IFRS, as they relate to the Company; preparation of Company specific draft accounting position papers; Paramount Resources Ltd. 2010 Management's Discussion & Analysis 44 (cid:2) (cid:2) (cid:2) implementation of modifications to information systems required to accumulate and process information in order to generate IFRS financial information; preparation of draft IFRS financial statement disclosures; and identification of changes to internal controls over financial reporting and disclosure controls and procedures. Accounting Policy Changes The following describes certain changes that Paramount expects to make upon transition to IFRS: Property, Plant and Equipment The transition to IFRS requires certain policy, process and disclosure changes, including exploration phase accounting and impairment testing levels and methodologies. Exploration and evaluation ("E&E") costs are those expenditures for an area or project for which technical feasibility and commercial viability have not yet been determined. Paramount’s E&E asset balance will primarily consist of costs related to undeveloped land and incomplete exploratory drilling projects. Under IFRS, Paramount will initially capitalize these costs as E&E assets on the balance sheet. When the area or project is determined to be technically feasible and commercially viable, the costs will be, subject to an impairment evaluation, transferred to property, plant and equipment. Costs related to unsuccessful projects will be expensed. The Company expects to reclassify approximately $150 million to E&E assets from property, plant and equipment in its opening IFRS balance sheet as of January 1, 2010. Under Canadian GAAP, impairment of the Company’s petroleum and natural gas properties is assessed on a property-by-property basis. Under IFRS, assets are grouped together in cash-generating units ("CGUs"), which consist of the smallest group of assets that generate cash inflows that are largely independent of the cash inflows of other assets or groups of assets. Paramount expects to group its properties into ten cash generating units which will be used in the impairment assessment upon transition to IFRS. IFRS requires an impairment to be recognized when the carrying value of a CGU exceeds its recoverable amount. The recoverable amount of a CGU is defined as the greater of its value in use and its fair value less costs to sell. Under Canadian GAAP, a two step approach to determining an impairment is applied: (i) the carrying value of a property is compared to its expected undiscounted before-tax cash flows, and (ii) where the carrying value is found to exceed its expected undiscounted cash flows, an impairment charge is calculated based on the difference between the property’s carrying amount and its expected discounted before-tax cash flows. The IFRS method of determining impairments will generally result in higher impairment charges. The Company expects to record an impairment charge relating to certain CGUs on conversion to IFRS, the extent of which has not yet been finalized. Paramount expects to apply the IFRS 1 "First Time Adoption of International Reporting Standards" exemption to measure certain CGUs at fair value on transition to IFRS and to subsequently deem that fair value to be historical cost. Stock-based Compensation Under Canadian GAAP, the Company’s stock option plan liability is revalued each period using the intrinsic value method, where a liability is calculated based on the amount by which the market price of the Company’s shares Paramount Resources Ltd. 2010 Management's Discussion & Analysis 45 exceeds the exercise price of an option. Under IFRS, the stock option plan liability must be remeasured each period using a fair value option pricing model, and Paramount has determined that it will use the Black-Scholes- Merton model. As a result of the change in valuation method, Paramount’s stock-based compensation liability is expected to increase by approximately $3 million in its opening IFRS balance sheet as of January 1, 2010. The Company intends to utilize the IFRS 1 exemption under which amounts recorded in respect of options settled prior to January 1, 2010 will not be retrospectively restated. Asset Retirement Obligations Under Canadian GAAP, the discount rate applied to calculate the present value of asset retirement obligations ("ARO") is determined when the liability is initially recognized and is not adjusted for changes in discount rates in future periods. Canadian GAAP permits the use of credit-adjusted rates in the present value calculations. Under IFRS, the present value of ARO liabilities is determined using the relevant period end risk-free rate at each reporting date. As a result, the Company expects to recognize an increase in the ARO liability of approximately $90 million in the opening IFRS balance sheet. Generally, the change in discount rates results in a balance being added to or deducted from property, plant and equipment. Foreign Exchange Translation Under Canadian GAAP, the assets and liabilities of the Company’s integrated foreign operations are translated into Canadian dollars using the temporal method, where non-monetary items are translated at historical exchange rates. Changes in the carrying value of monetary assets and liabilities are recognized in earnings. Under IFRS, all assets and liabilities of subsidiaries with functional currencies that are not the Canadian dollar will be translated at the exchange rate in effect at the end of the reporting period and all resulting exchange differences will be recognized in other comprehensive income. This change in translation is expected to result in a decrease in the carrying amount of Paramount’s property, plant and equipment assets of approximately $5 million in the opening IFRS balance sheet. The Company expects to apply the IFRS 1 exemption to deem the cumulative translation difference as of January 1, 2010 to be nil. Flow-Through Shares Under Canadian GAAP, when flow-through shares are issued they are recorded based on proceeds received. Upon filing the renouncement documents with the tax authorities, a future tax liability is recognized and shareholders’ equity is reduced for the tax effect of expenditures renounced to subscribers. Under IFRS, the Company expects to allocate the proceeds from the issuance of flow-through shares between the sale of the shares, which are allocated to share capital, and the sale of the tax benefits, which are accrued as a liability. The allocation is made based on the difference between the issue price of flow-through shares and the market price of the Common Shares. A liability is recognized for this difference, which is reversed upon the renunciation of the qualifying expenditures to subscribers. The difference between the liability recognized and the deferred tax liability recorded upon renunciation is recognized as income tax expense. The IFRS adjustment associated with flow-through shares in the opening IFRS balance sheet as of January 1, 2010 is expected to increase share capital by approximately $25 million, reduce retained earnings by $21 million and increase accrued liabilities by $4 million. Paramount Resources Ltd. 2010 Management's Discussion & Analysis 46 Income Taxes The Company’s future income tax asset and liability balances will be adjusted to reflect the tax impacts of the IFRS adjustments as described in the preceding discussion. Business Combinations Paramount elected to early adopt CICA handbook section 1582 "Business Combinations" with respect to the acquisition of Redcliffe. This new Canadian standard is substantially converged with IFRS 3 "Business Combinations" and, as a result, no adjustments are expected on transition to IFRS. Paramount expects to apply the IFRS 1 exemption which allows an entity to elect not to apply IFRS 3 to past business combinations. Implementation The Company is currently focused on the following activities: (cid:2) (cid:2) (cid:2) finalizing the opening balance sheet adjustments including future income tax; preparing comparative IFRS adjustments to the 2010 quarterly Canadian GAAP financial statement balances; and finalizing Paramount’s IFRS policy choices, IFRS 1 elections and IFRS disclosures for publication in 2011. As IFRS accounting policies and processes are being finalized, corresponding changes to internal controls over financial reporting and to disclosure controls and procedures are being identified to ensure controls remain effective. Paramount does not anticipate making significant changes to control processes and procedures. Business Activities The borrowing base under Paramount’s credit facility is based on the value of the Company’s reserves, and, as a result, changes to the carrying value of its assets are not expected to have a significant impact on the Company’s debt structure or agreements. Paramount’s renewed credit facility agreement incorporates provisions regarding changes in accounting policies, including the adoption of IFRS. The indenture governing the new Senior Notes issued in November 2010 contains provisions that permit the modification of accounting terms and calculations included therein should a change in GAAP (including the adoption of IFRS) cause any of the accounting terms or calculations to be materially different than using Canadian GAAP as at the date of the indenture. As a result, the Company does not expect the adoption of IFRS will have a material impact on the Company under the indenture. Disclosure Controls and Procedures As of the year ended December 31, 2010, an evaluation of the effectiveness of Paramount’s disclosure controls and procedures, as defined by the rules of the Canadian Securities Administrators, was performed by the Company’s management with the participation of the chief executive officer and chief financial officer. Based upon that evaluation, the Company’s chief executive officer and chief financial officer have concluded that as of the end of that fiscal year, the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company is (i) recorded, processed, summarized and reported Paramount Resources Ltd. 2010 Management's Discussion & Analysis 47 within the time periods specified in Canadian securities law and (ii) accumulated and communicated to the Company’s management, including its chief executive officer and chief financial officer, to allow timely decisions regarding required disclosure. It should be noted that while the Company’s chief executive officer and chief financial officer believe that the Company’s disclosure controls and procedures provide a reasonable level of assurance that they are effective, they do not expect that the Company’s disclosure controls and procedures or internal control over financial reporting will prevent all errors and fraud. A control system, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Internal Controls Over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over the Company’s financial reporting. The Company’s internal control system was designed to provide reasonable assurance that all transactions are accurately recorded, that transactions are recorded as necessary to permit preparation of financial statements in accordance with Generally Accepted Accounting Principles, and that the Company’s assets are safeguarded. Management has assessed the effectiveness of the Company’s internal control over financial reporting as at December 31, 2010. In making its assessment, management used the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") framework in Internal Control – Integrated Framework to evaluate the effectiveness of the Company’s internal control over financial reporting. Based on this assessment, management has concluded that the Company’s internal control over financial reporting was effective as of December 31, 2010. Internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedure may deteriorate. Changes in Internal Controls Over Financial Reporting During the fiscal year and quarter ended December 31, 2010, there were no changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Paramount Resources Ltd. 2010 Management's Discussion & Analysis 48 Advisories Forward-looking Information Certain statements in this document constitute forward-looking information under applicable securities legislation. Forward-looking information typically contains statements with words such as "anticipate", "believe", "estimate", "expect", "plan", "intend", "propose", or similar words suggesting future outcomes or an outlook. Forward looking information in this document includes, but is not limited to: (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) expected production volumes and the timing thereof; planned exploration and development expenditures and the timing thereof; exploration and development plans and strategies; budget allocations and capital spending flexibility; adequacy of facilities to process natural gas production; estimated reserves and resources and the undiscounted and discounted present value of future net revenues from such reserves and resources (including the forecast prices and costs and the timing of expected production volumes and future development capital); timing of regulatory applications; (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) ability to fulfill future pipeline transportation commitments; undeveloped land lease expiries; timing and cost of future abandonment and reclamation; business strategies and objectives; sources of and plans for financing; acquisition and disposition plans; operating and other costs and royalty rates; expected accounting policies under IFRS and the related impact on the Company's financial statement balances; expected drilling programs, well tie-ins, facility construction and expansions, completions and the timing thereof; and the outcome of any legal claims, audits, assessments or other regulatory matters or proceedings. Such forward-looking information is based on a number of assumptions which may prove to be incorrect. The following assumptions have been made, in addition to any other assumptions identified in this document: (cid:2) (cid:2) (cid:2) (cid:2) future oil and gas prices and general economic and business conditions; the ability of Paramount to obtain required capital to finance its exploration, development and operations; the ability of Paramount to obtain equipment, services, supplies and personnel in a timely manner to carry out its activities; the ability of Paramount to market its oil and natural gas successfully to current and new customers; (cid:2) (cid:2) (cid:2) (cid:2) the ability of Paramount to secure adequate product transportation and storage; the ability of Paramount and its industry partners to obtain drilling success consistent with expectations; the timely receipt of required regulatory approvals; and currency exchange and interest rates. Although Paramount believes that the expectations reflected in such forward looking information is reasonable, undue reliance should not be placed on it as Paramount can give no assurance that such expectations will prove to be correct. Forward-looking information is based on expectations, estimates and projections that involve a number of risks and uncertainties which could cause actual results to differ materially from those anticipated by Paramount and described in the forward looking information. The material risks and uncertainties include, but are not limited to: (cid:2) (cid:2) fluctuations in crude oil, natural gas and NGLs prices, foreign currency exchange rates and interest rates; the uncertainty of estimates and projections relating to future production, costs and (cid:2) (cid:2) (cid:2) changes to the status or interpretation of laws, regulations or policies; changes in environmental laws including emission reduction obligations; the timing of governmental or regulatory approvals; Paramount Resources Ltd. 2010 Management's Discussion & Analysis 49 (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) expenses; the ability to secure adequate product processing, transportation and storage; the uncertainty of exploration, development and drilling; operational risks in exploring for, developing and producing crude oil and natural gas, and the timing thereof; the ability to obtain equipment, services, supplies and personnel in a timely manner; potential disruption or unexpected technical difficulties in designing, developing or operating new or existing facilities; risks and uncertainties involving the geology of oil and gas deposits; the uncertainty of reserves and resource estimates; the ability to generate sufficient cash flow from operations and other sources of financing at an acceptable cost to meet current and future obligations; (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) (cid:2) changes in general business and economic conditions; uncertainty regarding aboriginal land claims and co- existing with local populations; the effects of weather; the ability to fund exploration, development and operational activities and meet current and future obligations; the timing and cost of future abandonment and reclamation activities; cleanup costs or business interruptions due environmental damage and contamination; the ability to enter into or continue leases; existing and potential lawsuits and regulatory actions; and other risks and uncertainties described elsewhere in this document and in Paramount’s most recent Annual Information Form. The foregoing list of risks is not exhaustive. Additional information concerning these and other factors which could impact Paramount are included in Paramount’s most recent Annual Information Form. The forward-looking information contained in this document is made as of the date hereof and, except as required by applicable securities law, Paramount undertakes no obligation to update publicly or revise any forward-looking statements or information, whether as a result of new information, future events or otherwise. Non-GAAP Measures In this document "Funds flow from operations", "Funds flow from operations - per Boe", "Funds flow from operations per share - diluted", "Netback", "Netback including settlements of financial commodity contracts", "Net Debt", "Exploration and development expenditures" and "Investments in other entities – market value", collectively the "Non-GAAP measures", are used and do not have any standardized meanings as prescribed by GAAP. They are used to assist management in measuring the Company’s ability to finance capital programs and meet financial obligations. Funds flow from operations refers to cash flows from operating activities before net changes in operating working capital. Netback equals petroleum and natural gas sales less royalties, operating costs, production taxes and transportation costs. Refer to the calculation of Net Debt in the liquidity and capital resources section of this document. Exploration and development expenditures refers to capital expenditures incurred by the Company’s COUs excluding land and property acquisitions. Investments in other entities – market value reflects the Company’s investments in enterprises whose securities trade on a public stock exchange at their period end closing price (e.g. Trilogy, MEG, MGM Energy and others at December 31, 2010), and all other investments in other entities at book value. Paramount provides this information in its MD&A because the market values of equity accounted investments, which are significant assets of the Company, are often materially different than their carrying values. Non-GAAP measures should not be considered in isolation or construed as alternatives to their most directly comparable measure calculated in accordance with GAAP, or other measures of financial performance calculated in accordance with GAAP. The Non-GAAP measures are unlikely to be comparable to similar measures presented by other issuers. Paramount Resources Ltd. 2010 Management's Discussion & Analysis 50 Oil and Gas Measures and Definitions This document contains disclosure expressed as "Boe", and "Boe/d". All oil and natural gas equivalency volumes have been derived using the ratio of six thousand cubic feet of natural gas to one barrel of oil. Equivalency measures may be misleading, particularly if used in isolation. A conversion ratio of six thousand cubic feet of natural gas to one barrel of oil is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the well head. This document contains disclosure of the results of an updated evaluation of the Company’s contingent bitumen resources from the Grand Rapids formation at Hoole, Alberta. Contingent resources are those quantities of bitumen estimated, as of a given date, to be potentially recoverable from known accumulations using established technology or technology under development, but are classified as a resource rather than a reserve due to one or more contingencies, such as the absence of regulatory approvals, detailed design estimates or near term development plans. A low estimate means high certainty (P90), a best estimate means most likely (P50) and a high estimate means low certainty (P10). The before tax net present value of contingent bitumen resources disclosed represents the Company's share of future net revenue, before the deduction of income tax and does not represent fair value. The calculation considers such items as revenues, royalties, operating costs, abandonment costs and capital expenditures. Royalties have been calculated based on Alberta's Royalty Framework applicable to oil sands projects in Alberta. The calculation does not consider financing costs and general and administrative costs. The net present value was calculated assuming natural gas is used as a fuel for steam generation. Revenues and expenditures were calculated based on the reserve evaluator’s forecast prices and costs as of April 1, 2010. Paramount Resources Ltd. 2010 Management's Discussion & Analysis 51 FINANCIAL STATEMENTS Management’s Report The accompanying Consolidated Financial Statements of Paramount Resources Ltd. (the "Company") are the responsibility of Management and have been approved by the Board of Directors. The Consolidated Financial Statements have been prepared by Management in Canadian dollars in accordance with Canadian Generally Accepted Accounting Principles and include certain estimates that reflect Management’s best judgments. When alternative accounting methods exist, Management has chosen those it considers most appropriate in the circumstances. Financial information contained throughout the Company’s annual report is consistent with these Consolidated Financial Statements. Management is also responsible for establishing and maintaining adequate internal control over the Company’s financial reporting. The Company’s internal control system was designed to provide reasonable assurance that all transactions are accurately recorded, that transactions are recorded as necessary to permit preparation of financial statements in accordance with Generally Accepted Accounting Principles, and that the Company’s assets are safeguarded. The Board of Directors is responsible for ensuring that Management fulfills its responsibilities for financial reporting and internal control. The Board of Directors exercises this responsibility through the Audit Committee. The Audit Committee meets regularly with Management and the independent auditors to ensure that Management’s responsibilities are properly discharged and to review the Consolidated Financial Statements. The Audit Committee reports its findings to the Board of Directors for consideration when approving the annual Consolidated Financial Statements for issuance to the shareholders. The Audit Committee also considers, for review by the Board of Directors and approval by the shareholders, the engagement or re-appointment of the external auditors. The Audit Committee of the Board of Directors is comprised entirely of non-management directors. Ernst & Young LLP, independent auditors appointed by the shareholders of the Company, conducts an examination of the Consolidated Financial Statements in accordance with Canadian Generally Accepted Auditing Standards. Ernst & Young LLP has full and free access to the Audit Committee and Management. /s/ Clayton H. Riddell Clayton H. Riddell Chief Executive Officer March 3, 2011 /s/ Bernard K. Lee Bernard K. Lee Chief Financial Officer Paramount Resources Ltd. 2010 Financial Statements 52 INDEPENDENT AUDITORS’ REPORT To the shareholders of Paramount Resources Ltd.: We have audited the accompanying consolidated financial statements of Paramount Resources Ltd. (the "Company") which comprise the consolidated balance sheets as at 31 December 2010 and 2009 and the consolidated statements of loss, cash flows, shareholders’ equity and comprehensive loss 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 of Paramount Resources Ltd. 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. Auditors’ 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 audit 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 auditors’ 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 the Company as at 31 December 2010 and 2009 and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles. Calgary, Canada 2 March 2011 Chartered Accountants Paramount Resources Ltd. 2010 Financial Statements 53 PARAMOUNT RESOURCES LTD. Consolidated Balance Sheets ($ thousands) As at December 31 ASSETS (Note 7) Current assets Cash and cash equivalents (Note 14) Accounts receivable (Note 12) Risk management (Note 12) Prepaid expenses and other Deposit (Note 11) Property, plant and equipment, net (Note 4) Investments (Note 5) Future income taxes (Note 11) Goodwill (Note 2) LIABILITIES AND SHAREHOLDERS’ EQUITY Current liabilities Drilling rig loan (Note 6) Accounts payable and accrued liabilities Risk management (Note 12) Current portion of stock-based compensation liability (Note 10) Long-term debt (Note 7) Asset retirement obligations (Note 8) Stock-based compensation liability (Note 10) Future income taxes (Note 11) Commitments and contingencies (Note 16) Shareholders’ equity Share capital (Note 9) Contributed surplus Retained earnings Accumulated other comprehensive income 2010 2009 $ 74,659 33,280 – 2,572 110,511 19,788 884,525 305,288 48,489 8,623 $ 1,377,224 $ 26,880 78,806 693 45,232 151,611 294,205 130,564 15,110 – 591,490 $ 93,238 23,488 2,187 2,301 121,214 – 716,235 234,586 29,940 – $ 1,101,975 $ 29,380 46,162 – 11,441 86,983 93,655 103,462 3,771 41,194 329,065 458,895 3,940 251,277 71,622 785,734 $ 1,377,224 393,087 2,890 373,745 3,188 772,910 $ 1,101,975 See the accompanying notes to these Consolidated Financial Statements. On behalf of the Board /s/ J.H.T. Riddell J.H.T. Riddell Director /s/ J.C. Gorman J.C. Gorman Director Paramount Resources Ltd. 2010 Financial Statements 54 PARAMOUNT RESOURCES LTD. Consolidated Statement of Loss ($ thousands, except as noted) Year ended December 31 Revenue Petroleum and natural gas sales Gain on financial commodity contracts (Note 12) Royalties Expenses Operating expense and production tax Transportation General and administrative Stock-based compensation Depletion, depreciation and accretion Exploration Dry hole (Note 4) Gain on sale of property, plant and equipment Write-down of petroleum and natural gas assets (Note 4) Interest and financing Foreign exchange Debt extinguishment Income (loss) from investments (Note 5) Other income (loss) Loss before tax Income tax expense (recovery) (Note 11) Current Future Net loss Net loss per common share ($/share) (Note 9) Basic and diluted See the accompanying notes to these Consolidated Financial Statements. 2010 2009 $ $ $ 184,395 10,047 (21,227) 173,215 50,892 17,219 15,417 58,764 178,007 8,829 9,492 (3) 25,332 13,560 (801) 1,708 378,416 8,227 2,184 (194,790) 213 (72,535) (72,322) (122,468) (1.68) $ $ $ 161,671 5,277 (20,659) 146,289 56,669 13,842 17,217 17,599 141,597 5,316 24,343 (534) 14,939 11,214 (11,503) – 290,699 (7,333) (773) (152,516) (889) (53,743) (54,632) (97,884) (1.46) Paramount Resources Ltd. 2010 Financial Statements 55 PARAMOUNT RESOURCES LTD. Consolidated Statement of Cash Flows ($ thousands) Year ended December 31 2010 2009 Operating activities Net loss Add (deduct) Items not involving cash (Note 14) Asset retirement obligation expenditures (Note 8) Exploration and dry hole expenses Debt extinguishment costs Stock incentive plan Change in non-cash working capital (Note 14) Cash from operating activities Financing activities Drilling rig loan, net (Note 6) Repayment/Redemption of US Senior Notes (Note 7) Proceeds from Senior Notes, net of issue costs (Note 7) Repayment of debt assumed on Redcliffe acquisition (Note 2) Settlement of foreign exchange contract Common shares issued, net of issue costs Common shares repurchased (Note 9) Cash from financing activities Investing activities Property, plant and equipment and exploration Redcliffe acquisition (Note 2) Proceeds on sale of property, plant and equipment Proceeds on sale of investment Investments in other entities Deposit Change in non-cash working capital (Note 14) Cash used in investing activities Net (decrease) increase in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year Supplemental cash flow information (Note 14) See the accompanying notes to these Consolidated Financial Statements. $ (122,468) $ (97,884) 195,399 (3,209) 18,321 1,708 (2,901) 86,850 (23,467) 63,383 (2,500) (92,234) 294,171 (10,521) – 62,989 – 251,905 (298,141) (46,172) 1,196 – (11,100) (19,788) 40,138 (333,867) (18,579) 93,238 74,659 $ 134,318 (4,050) 29,659 – (1,775) 60,268 11,797 72,065 29,307 – – – 12,205 91,170 (4,219) 128,463 (117,510) – 791 4,605 (20,005) – (29,302) (161,421) 39,107 54,131 93,238 $ Paramount Resources Ltd. 2010 Financial Statements 56 PARAMOUNT RESOURCES LTD. Consolidated Statement of Shareholders’ Equity ($ thousands, except as noted) Year ended December 31 Share Capital Balance, beginning of year Issued, net of issuance costs Issued on exercise of stock options Tax effect of flow-through share renunciations Common shares repurchased Change in unvested common shares for stock incentive plan Balance, end of year Contributed Surplus Balance, beginning of year Change in value of unvested common shares for stock incentive plan Stock-based compensation expense on investees’ options Balance, end of year Retained Earnings Balance, beginning of year Net loss Common shares repurchased Change in value of unvested common shares for stock incentive plan Balance, end of year Accumulated Other Comprehensive Income Balance, beginning of year Other comprehensive income, net of tax Balance, end of year Total Shareholders’ Equity See the accompanying notes to these Consolidated Financial Statements. 2010 2009 Shares (000’s) Shares (000’s) 72,058 2,270 678 – – 28 75,034 $ 393,087 57,984 14,862 (6,940) – (98) $ 458,895 66,741 6,000 111 – (616) (178) 72,058 $ 302,727 91,227 1,540 – (2,815) 408 $ 393,087 $ 2,890 455 595 3,940 $ $ 373,745 (122,468) – – $ 251,277 $ 3,188 68,434 $ 71,622 $ 785,734 $ $ 2,398 – 492 2,890 $ 473,362 (97,884) (1,404) (329) $ 373,745 $ – 3,188 3,188 $ $ 772,910 Consolidated Statement of Comprehensive Loss ($ thousands) Year ended December 31 Net loss Other comprehensive income, net of tax Change in unrealized gain on available-for-sale investments, net of tax Reclassification of accumulated (gains) to earnings, net of tax Comprehensive loss See the accompanying notes to these Consolidated Financial Statements. 2010 (122,468) $ 71,602 (3,168) (54,034) $ 2009 (97,884) 6,381 (3,193) (94,696) $ $ Paramount Resources Ltd. 2010 Financial Statements 57 Notes to Consolidated Financial Statements ($ thousands, except as noted) 1. Summary of Significant Accounting Policies Paramount Resources Ltd. ("Paramount" or the "Company") is an independent Canadian energy company that explores for, develops, produces, processes, transports, and markets natural gas, crude oil and natural gas liquids ("NGLs"). Paramount’s properties are located in Alberta, the Northwest Territories, British Columbia, and Saskatchewan in Canada, and in North Dakota and Montana in the United States. These Consolidated Financial Statements are stated in Canadian dollars and have been prepared in accordance with Canadian Generally Accepted Accounting Principles ("GAAP"). a) Principles of Consolidation These Consolidated Financial Statements include the accounts of Paramount and its wholly owned subsidiaries, including Summit Resources, Inc., Paramount Drilling U.S. LLC ("Paramount Drilling") and Fox Drilling Inc. ("Fox Drilling"). Investments in jointly controlled partnerships and unincorporated joint ventures are accounted for using the proportionate consolidation method, whereby only Paramount’s proportionate share of revenues, expenses, assets, and liabilities are included in the Consolidated Financial Statements. Investments in entities in which Paramount does not have direct or joint control over the strategic operating, investing, and financing decisions, but over which it has significant influence are accounted for using the equity method. All other investments are accounted for as available-for-sale financial instruments. b) Measurement Uncertainty The timely preparation of these Consolidated Financial Statements in conformity with GAAP requires that management make estimates and assumptions and use judgment regarding the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Such estimates primarily relate to fair value measurements and unsettled transactions and events as of the date of the Consolidated Financial Statements. Actual results could materially differ from these estimates. Depletion, depreciation and accretion, asset retirement obligation, and impairment calculations are based on estimates of reserves, future costs, petroleum and natural gas prices and other relevant assumptions. Fair values of the Company’s investments are highly dependent on economic conditions, oil and natural gas prices, and the results of investees’ operations, among other factors. Assessments of the fair value of the Company’s investments are based on management’s interpretation of such information, and where available, publicly quoted trading prices of the investees’ securities. By their nature, these estimates are subject to measurement uncertainty, and the impact of changes in these estimates and assumptions on the Consolidated Financial Statements of future periods could be material. Crown royalties for Paramount’s production in the Northwest Territories have been accrued based on the Company’s interpretation of the relevant legislation and regulations. To date, Paramount has not received assessments from the Government of Canada of its liability under such legislation and regulations for its past filings. Although Paramount believes that its interpretations of the relevant legislation and regulations have Paramount Resources Ltd. 2010 Financial Statements 58 Notes to Consolidated Financial Statements ($ thousands, except as noted) merit, Paramount is unable to predict the ultimate outcome of audits and/or assessments by the Government of Canada. Additional material amounts could potentially become payable. Tax legislation, regulations, and the interpretation thereof in the various jurisdictions in which the Company operates are complex and subject to change. In addition, the Company’s income tax filings are subject to audit and reassessment by tax authorities from time to time. As such, the Company’s provision for income taxes are subject to measurement uncertainty. c) Revenue Recognition Revenues from the sale of Paramount’s natural gas, crude oil and NGLs are recognized when title passes to third parties. Revenues from the Company’s drilling rigs (the "Rigs") are recognized as services are rendered and collectability is reasonably assured. When the Rigs drill on a property owned by the Company, Paramount capitalizes its working interest share of the drilling expenses, and eliminates the intercompany drilling revenue and profit. d) Cash and Cash Equivalents Cash and cash equivalents are recorded at amortized cost and include short-term investments with original maturities of three months or less. e) Property, Plant and Equipment Paramount follows the successful efforts method of accounting for its petroleum and natural gas operations. Under this method, all development costs, including property acquisitions and costs of drilling and equipping development wells are capitalized. Costs of drilling exploratory wells are initially capitalized, pending determination of proved reserves. If economically recoverable reserves are not found, such costs are charged to earnings as dry hole expense. If hydrocarbons are found, but further appraisal activity is required to conclude whether they are economically recoverable, the costs continue to be carried as an asset. All such costs are subject to management review at least once per year to confirm that sufficient progress is being made to develop the discovery. Exploratory geological and geophysical costs and annual lease rentals are expensed as incurred. Producing areas and significant unproved properties are assessed annually, or more frequently as economic events dictate, for potential impairment. If the carrying value of the oil and gas assets is assessed not to be fully recoverable, an impairment loss is recognized to the extent that the carrying value exceeds the aggregate discounted cash flows expected from the production of proved plus probable reserves. Paramount recognizes Alberta drilling royalty credits as a reduction to property plant and equipment. The credits are recognized as they are earned, as determined by well depth, to the extent the Company anticipates being able to use the credits to reduce crown royalties. Paramount’s Rigs are recorded at cost, including costs of direct material, labour, and overhead. Costs incurred to extend the useful life of the Rigs or to increase their capabilities are capitalized. Costs incurred to maintain and repair the Rigs are expensed as incurred. Paramount Resources Ltd. 2010 Financial Statements 59 Notes to Consolidated Financial Statements ($ thousands, except as noted) f) Depletion and Depreciation Capitalized costs of proved oil and gas properties are depleted using the unit-of-production method. For purposes of these calculations, natural gas production and reserves are converted to barrels of oil equivalent on the basis of six thousand cubic feet per barrel. Depletion rates are revised annually, or more frequently when events dictate. Costs of drilling exploratory wells and unproved properties are not depleted while under active evaluation for commercial reserves. Capitalized costs of gas plants, gathering systems and production equipment are depreciated on a unit-of- production basis over the proved developed reserves of the field to which they relate. The Rigs and significant components are depreciated over their expected useful lives, varying from 1,095 to 3,650 drilling days. Leasehold improvements are amortized over the term of the lease. Other assets are depreciated on a declining balance method at rates varying from 35 to 50 percent. Change in Estimate Effective December 31, 2009, the Company adopted the Financial Accounting Standards Board update for Oil and Gas Reserve Estimation and Disclosures applicable to Accounting Standards Codification Topic 932 (“ASC 932”). The ASC 932 update changes the pricing methodology for proved reserves used in calculating depletion from end of period pricing to an average of first day of month pricing for 12 months, consistent with the modernized US Securities and Exchange Commission reserves definition. ASC 932 is considered a change in accounting estimate and therefore was adopted prospectively and applied to the quarter ended December 31, 2009 and thereafter, consistent with the Company’s policy. g) Asset Retirement Obligations Asset retirement obligations include those legal obligations where Paramount will be required to retire tangible long-lived assets. The Company recognizes the present value of an asset retirement obligation in the period in which it is incurred and when its fair value can be reasonably estimated. The estimated fair value of asset retirement costs are capitalized as part of the related long-lived asset and depreciated on the same basis as the underlying asset. The asset retirement obligation is adjusted for the passage of time, which is recognized as accretion expense, and for revisions to the timing or the amount of the estimated liability. Actual costs incurred are charged against the asset retirement obligation to the extent of the liability recorded. Differences between the actual costs incurred and the liability are recognized in earnings when reclamation of the field is completed. h) Goodwill Goodwill is not amortized, but is assessed by Paramount for impairment at least annually. Impairment is assessed based on a comparison of the fair value of each reporting unit to its carrying value, including goodwill. Any excess of the carrying value of the properties, including goodwill, over the fair value is written off as an impairment charge. Paramount Resources Ltd. 2010 Financial Statements 60 Notes to Consolidated Financial Statements ($ thousands, except as noted) i) Foreign Currency Translation Paramount’s functional currency is the Canadian dollar. The Company’s foreign operations are integrated and therefore, translated into Canadian dollars using the temporal method. Monetary assets and liabilities denominated in foreign currencies are translated into Canadian dollars at exchange rates in effect at the balance sheet date. Non-monetary assets are translated at rates in effect on the dates the assets were acquired. Results of foreign operations are translated into Canadian dollars at the monthly average exchange rates for revenues and expenses, except for depreciation and depletion, which are translated at the rate of exchange applicable to the related assets. Resulting translation gains and losses are included in earnings. j) Financial Instruments, Comprehensive Income and Hedges Financial Instruments Financial instruments are measured at fair value on initial recognition. Measurement in subsequent periods is dependent upon whether the financial instrument has been classified as "held-for-trading", "available-for-sale", "held-to-maturity", "loans and receivables", or "other financial liabilities" as defined by GAAP. Held-for-trading financial assets and financial liabilities are measured at fair value, with changes in fair values recognized in earnings. Available-for-sale financial assets are measured at fair value, with changes in fair values recognized in other comprehensive income ("OCI"), net of tax. Held-to-maturity financial assets, loans and receivables and other financial liabilities, including transaction costs, are measured at amortized cost using the effective interest method of amortization. Derivative financial instruments are classified as held-for-trading unless designated for hedge accounting. Where Paramount designates and documents a contract as a "normal sales exception", its fair value is not recognized in the Consolidated Financial Statements prior to settlement. Where a contract is not designated as a "normal sales exception", it is measured at fair value and changes in its fair value are recognized in earnings. Paramount recognizes earnings and cash flow effects of derivatives with the related underlying items. A three-level hierarchy is used by Paramount for fair value measurements, based on the transparency of inputs to the valuation of financial instruments recognized at fair value. These three levels are defined as follows: (cid:2) Level 1 – Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. (cid:2) Level 2 – Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. (cid:2) Level 3 – Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Paramount Resources Ltd. 2010 Financial Statements 61 Notes to Consolidated Financial Statements ($ thousands, except as noted) At December 31, 2010, Paramount’s publicly traded investments were classified as level 1 fair values and risk management liabilities were classified as level 2 fair values. The carrying value of all other financial instruments approximates their fair value due to their short-term maturities. Other Comprehensive Income For Paramount, other comprehensive income ("OCI") is comprised of changes in the market value of available- for-sale investments. OCI is presented in the Consolidated Statement of Comprehensive Loss. The cumulative changes in OCI are included in accumulated other comprehensive income, which is presented within shareholders’ equity. Hedges Paramount does not presently employ hedge accounting for any of its financial instruments. k) Income Taxes Paramount follows the liability method of accounting for income taxes. Under this method, future income taxes are recognized for the effect of any difference between the carrying amount of an asset or liability reported in the Consolidated Financial Statements and its respective tax basis, using substantively enacted income tax rates. Accumulated future income tax balances are adjusted to reflect changes in substantively enacted income tax rates, with adjustments being recognized in earnings in the period in which the change occurs. l) Flow-Through Shares As permitted under the Income Tax Act (Canada), the tax attributes of eligible expenditures incurred with the proceeds of flow-through share issuances are renounced to subscribers. On the date that Paramount files the renouncement documents with the tax authorities, a future income tax liability is recognized and shareholders’ equity is reduced for the tax effect of expenditures renounced to subscribers. m) Stock-Based Compensation Stock Options Paramount uses the intrinsic value method to recognize compensation expense for stock options, whereby a liability and expense are recorded over the vesting period of the options, based on the difference between the market price of the underlying securities and the option exercise price. When options are surrendered for cash, the cash settlement paid reduces the outstanding liability. When options are exercised for Common Shares, the consideration paid by the option holder and the previously recognized liability associated with the options are recorded as an increase to share capital. Stock Appreciation Rights Stock Appreciation Rights ("SARs") entitled the holder to receive a cash payment equal to the difference between the fair market value and the stated exercise price of an underlying security or notional security on the date of surrender, and were accounted for using the intrinsic value method. Paramount Resources Ltd. 2010 Financial Statements 62 Notes to Consolidated Financial Statements ($ thousands, except as noted) Stock Incentive Plan Paramount’s stock incentive plan provides that rights to Common Shares may be awarded to employees annually. Common Shares are purchased in the open market and held by an independent trustee until the completion of the vesting period. Generally, one third of an award vests immediately, with the remaining tranches vesting annually over two years. The unvested Common Shares balance is recorded as a reduction of share capital. The fair value of the Common Shares awarded is recognized in stock-based compensation over the vesting period, with a corresponding charge to equity. n) Comparative Figures Certain comparative figures have been reclassified to conform to the current year’s financial statement presentation. o) Changes in Accounting Policies Effective January 1, 2010, Paramount early adopted CICA Handbook section 1582 – "Business Combinations", which replaces the previous business combinations standard. The new standard requires that all of the assets acquired and the liabilities assumed in a business combination be recorded at fair value, which was not the case under the previous standard. The new standard also requires that previously held ownership interests be remeasured to the acquisition date fair value, rather than being restated to cost. In addition, the new standard requires that all acquisition costs associated with the acquisition be expensed, rather than capitalized as part of the acquisition, that contingent liabilities be recognized at fair value at the acquisition date and subsequently re- measured to fair value with changes recognized in earnings, and that a bargain purchase be recognized in earnings rather than being allocated to non-monetary assets. This new standard was applied to the Company’s acquisition of Redcliffe Exploration Inc. ("Redcliffe") in 2010. Effective January 1, 2010, Paramount also early adopted CICA Handbook sections 1601 – "Consolidations" and 1602 - "Non-controlling Interests", which together replaced section 1600 – "Consolidations". Section 1601 establishes standards for the preparation of consolidated financial statements. Section 1602 requires non- controlling interests ("NCI") to be presented within equity. There is no impact on the Consolidated Financial Statements from the adoption of these standards. International Financial Reporting Standards Accounting standards in Canada, as used by publicly accountable enterprises, will be converted to International Financial Reporting Standards for fiscal years beginning on or after January 1, 2011. Paramount’s IFRS conversion project is proceeding according to plan and the Company expects to be ready for the transition. The project team has identified key differences, including accounting for property, plant and equipment, stock-based compensation, foreign currency transactions, and asset retirement obligations, among others, has developed IFRS accounting policies and is in the process of drafting new financial statement disclosures. The Company continues to monitor the development of the standards. Paramount Resources Ltd. 2010 Financial Statements 63 Notes to Consolidated Financial Statements ($ thousands, except as noted) 2. Acquisition of Redcliffe Exploration Inc. On June 29, 2010, Paramount acquired, for cash consideration of $46.2 million, all 109.9 million issued and outstanding Class A shares of Redcliffe that it did not already own, including 340,000 Class A shares owned by certain officers of Paramount. Immediately prior to the acquisition, Paramount owned 23.5 million Class A shares of Redcliffe. Redcliffe was a Calgary based company with interests in petroleum and natural gas properties primarily in the Karr-Gold Creek and Greater Pembina areas of Alberta. These financial statements include the results of operations of the acquired business for the period following the closing of the transaction on June 29, 2010. The acquisition of Redcliffe was accounted for using the acquisition method whereby all of the assets acquired and liabilities assumed were recorded at fair value. The following table summarizes the net assets acquired: Property, plant, and equipment Goodwill Working capital deficit Bank debt Asset retirement obligations Future income tax liability Net assets acquired Cash purchase price Fair value of Redcliffe shares previously held Total $ $ $ $ 66,943 8,623 (706) (10,521) (4,581) (3,710) 56,048 46,172 9,876 56,048 Upon the acquisition of Redcliffe, a gain of $3.5 million previously recorded in Paramount’s OCI related to its investment in Redcliffe was reclassified to income from investments. Goodwill recorded on the acquisition of Redcliffe is not deductible for tax purposes. The net assets acquired, including goodwill, have been allocated to the Principal Properties business segment. Paramount incurred $0.3 million of transaction costs related to the Redcliffe acquisition, which were recognized in general and administrative expense. If the acquisition of Redcliffe had been completed on January 1, 2010, Paramount’s petroleum and natural gas sales for the twelve months ended December 31, 2010 would have been $190.6 million (unaudited). From the date of acquisition to December 31, 2010, petroleum and natural gas sales related to properties acquired through the Redcliffe acquisition were $4.2 million (unaudited). The impact of the acquisition on net income for the period January 1 to December 31, 2010 and June 29 to December 31, 2010 is impracticable to determine. 3. Segmented Information Paramount’s operations are divided into three business segments established by management to assist in resource allocation, to assess operating performance and to achieve long-term strategic objectives: (cid:2) Principal Properties: Principal properties consist of: (i) the Kaybob Corporate Operating Unit ("COU"), which includes properties in West Central Alberta; (ii) the Grande Prairie COU, which includes properties Paramount Resources Ltd. 2010 Financial Statements 64 Notes to Consolidated Financial Statements ($ thousands, except as noted) in the Peace River Arch area of Alberta; (iii) the Northern COU, which includes properties in Northern Alberta, the Northwest Territories and Northeast British Columbia; and (iv) the Southern COU, which includes properties in Southern Alberta, Saskatchewan, Montana and North Dakota. (cid:2) (cid:2) Strategic Investments: Strategic investments include: (i) investments in other entities, including affiliates; (ii) investments in development stage assets where there is no near-term expectation of production, but a longer-term value proposition based on spin-outs, dispositions, or future revenue generation; and (iii) three Rigs owned by Fox Drilling and Paramount Drilling. Corporate: Corporate is comprised of income and expense items, including general and administrative expense and interest expense, that have not been specifically allocated to Principal Properties or Strategic Investments. Year ended December 31, 2010 Revenue Petroleum and natural gas sales, net of royalties Gain on financial commodity contracts Expenses Operating expense, production tax and transportation General and administrative Stock-based compensation Depletion, depreciation and accretion Exploration and dry hole (Gain) loss on sale of property, plant and equipment Write-down of petroleum and natural gas assets Interest and financing charges Foreign exchange Debt extinguishment Income from investments Other income (expense) Drilling rig revenue Drilling rig expense Inter-segment eliminations Segment loss Income tax recovery Net loss Principal Properties Strategic Investments Corporate Inter-segment Eliminations Total $ 163,168 10,047 173,215 68,111 – – 175,879 18,244 (227) 25,332 – – – 287,339 – 1,066 – – (113,058) – $ (113,058) $ $ – – – $ – – – – – – – 3,602 18,048 3,929 77 224 – 1,243 – – 27,123 8,227 – 13,425 (8,001) (13,472) (1,441) (14,913) – 11,815 40,716 955 – – – 12,317 (801) 1,708 66,710 – (109) – – (66,819) – (66,819) $ $ – – – (2,756) – – – – – – (2,756) – – (9,534) 5,337 (1,441) 1,441 – $ $ 163,168 10,047 173,215 68,111 15,417 58,764 178,007 18,321 (3) 25,332 13,560 (801) 1,708 378,416 8,227 957 3,891 (2,664) (194,790) – (194,790) (72,322) $ (122,468) Paramount Resources Ltd. 2010 Financial Statements 65 Notes to Consolidated Financial Statements ($ thousands, except as noted) Year ended December 31, 2009 Revenue Petroleum and natural gas sales, net of royalties Gain on financial commodity contracts Expenses Operating expense, production tax and transportation General and administrative Stock-based compensation Depletion, depreciation and accretion Exploration and dry hole Gain on sale of property, plant and equipment Write-down of petroleum and natural gas assets Interest and financing charges Foreign exchange Loss from investments Other income Drilling rig revenue Drilling rig expense Inter-segment eliminations Segment loss Income tax recovery Net loss Capital Expenditures Year ended December 31 Principal Properties Strategic Investments Corporate Total Assets As at December 31 Principal Properties Strategic Investments Corporate Principal Properties Strategic Investments Corporate Inter-segment Eliminations Total $ $ 141,012 5,277 146,289 $ – – – $ – – – – – – $ 141,012 5,277 146,289 70,511 – – 140,388 29,389 (534) 14,939 – – 254,693 – 1,500 – – (106,904) – $ (106,904) – 2,510 4,644 1,154 270 – – 489 – 9,067 (7,333) – 4,768 (5,640) (17,272) (735) $ (18,007) – 14,707 12,955 959 – – – 10,725 (11,503) 27,843 – 238 – – (27,605) – $ (27,605) – – – (904) – – – – – (904) – – (4,388) 2,749 (735) 735 – $ 70,511 17,217 17,599 141,597 29,659 (534) 14,939 11,214 (11,503) 290,699 (7,333) 1,738 380 (2,891) (152,516) – (152,516) (54,632) $ (97,884) 2010 274,106 15,703 160 289,969 $ $ 2009 94,692 17,543 79 112,314 $ $ $ 2010 881,510 370,553 125,161 $ 1,377,224 $ 2009 685,108 291,083 125,784 $ 1,101,975 Capital expenditures for Principal Properties during the year ended December 31, 2010 include $5.3 million (2009 – $2.2 million) of drilling expenses for services provided by Paramount Drilling and Fox Drilling. Paramount Resources Ltd. 2010 Financial Statements 66 Notes to Consolidated Financial Statements ($ thousands, except as noted) Geographical Information 2010 Canada United States Total 2009 Canada United States Total Property, Plant and Equipment 812,977 71,548 884,525 $ $ Property, Plant and Equipment 641,163 75,072 716,235 $ $ Goodwill 8,623 – 8,623 $ $ Revenue 157,292 27,103 184,395 $ $ Capital Expenditures $ $ 279,012 10,957 289,969 Goodwill – – – $ $ Revenue 135,427 26,244 161,671 $ $ Capital Expenditures 101,028 11,286 112,314 $ $ 4. Property, Plant and Equipment Petroleum and natural gas assets Drilling rigs Other 2010 Accumulated Depletion and Depreciation Net Book Value $ (1,336,033) (8,307) (17,895) $ 842,926 39,585 2,014 $ Cost 2,178,959 47,892 19,909 $ 2,246,760 $ (1,362,235) $ 884,525 2009 Net Book Value $ 668,997 44,633 2,605 $ 716,235 Capitalized costs of $300.7 million at December 31, 2010 were not subject to depletion (2009 - $165.3 million), including $199.5 million for undeveloped land (2009 - $132.1 million). At December 31, 2010, the Company recorded an impairment write-down related to its petroleum and natural gas assets of $25.3 million (2009 – $14.9 million). The write-down was primarily related to the Liard and Haro areas in the Northern COU and the Puskwa area in the Grande Prairie COU where the carrying value of properties exceeded their expected discounted cash flows from the production of estimated proved and probable reserves. Continuity of Suspended Exploratory Well Costs Balance, beginning of year Additions pending the determination of proved reserves Reclassifications to proved reserves Well costs charged to dry hole expense Balance, end of year Aging of Capitalized Exploratory Well Costs Exploratory well costs capitalized for one year or less Exploratory well costs capitalized for greater than one year Balance, end of year Number of projects capitalized for more than one year $ $ $ $ 2010 19,391 59,646 (5,356) (3,132) 70,549 2010 59,768 10,781 70,549 12 $ $ $ $ 2009 39,575 18,715 (15,264) (23,635) 19,391 2009 13,059 6,332 19,391 20 Paramount Resources Ltd. 2010 Financial Statements 67 Notes to Consolidated Financial Statements ($ thousands, except as noted) At December 31, 2010, capitalized costs of suspended exploratory wells primarily relate to wells, that have not been completed, that have not been assigned proved reserves and projects where Paramount is continuing to assess the reserves and their potential development. At December 31, 2010, the Company recorded dry hole expenses on suspended exploratory wells costs of $1.7 million (2009 – $24.3 million) related to wells that have been suspended for more than one year, and where it was determined that sufficient progress was no longer being made in assessing reserves. 5. Investments As at December 31 Equity accounted investments: Trilogy Energy Corp. ("Trilogy") MGM Energy Corp. ("MGM Energy") Paxton Corporation Other Available-for-sale investments: MEG Energy Corp. ("MEG") NuLoch Resources Inc. Other 2010 2009 (Shares) (000’s) 24,144 43,834 1,750 3,700 6,579 $ 103,003 5,237 4,338 2,993 115,571 168,313 13,684 7,720 $ 305,288 (Shares) (000’s) 23,995 43,834 1,750 3,700 6,579 $ 104,472 5,876 4,574 4,280 119,202 101,750 5,921 7,713 $ 234,586 Income (loss) from investments is composed of the following: Year ended December 31 Trilogy MGM Energy Paxton Corporation Other Reclassification of gains from OCI Equity income (loss) 2010 Dilution gain $ $ 2,069 (1,067) (236) (356) 410 $ $ 4,109 209 – – 4,318 Total $ $ 6,178 (858) (236) (356) 4,728 3,499 8,227 Equity income (loss) (16,215) (1,192) (310) 281 (17,436) $ $ 2009 Dilution gain (loss) $ $ 8,458 (1,548) – – 6,910 Total (7,757) (2,740) (310) 281 (10,526) 3,193 (7,333) $ $ The carrying value of Paramount’s investment in Trilogy includes $23.0 million (2009 – $25.0 million) related to the unamortized excess of the aggregate purchase price over the underlying net book value of Trilogy’s assets at various acquisition dates, of which $12.6 million is attributable to property, plant and equipment and $10.4 million is attributable to goodwill. The excess attributed to the value of property, plant and equipment is amortized over the estimated reserve life of Trilogy’s proved reserves. The excess attributable to goodwill is not subject to amortization. On February 5, 2010, Trilogy Energy Trust converted from an income trust to a corporation, named Trilogy Energy Corp., through a business combination with a private company. Paramount’s 24.1 million Trilogy Energy Paramount Resources Ltd. 2010 Financial Statements 68 Notes to Consolidated Financial Statements ($ thousands, except as noted) Trust units (as of February 5, 2010) were converted into 12.8 million common shares of Trilogy Energy Corp., and 11.3 million non-voting shares of Trilogy Energy Corp. The non-voting shares convert to Trilogy common shares on a one-for-one basis if: i) beneficial ownership of the non-voting shares are transferred to any person that is not related to or affiliated with Paramount; or ii) Trilogy exercises its right to convert the non-voting shares to common shares. As a result of the conversion and issuance of Trilogy shares to the shareholder of the private company, Paramount recognized a dilution gain of $4.1 million. Following the Company’s 2010 distribution reinvestment plan purchase and the conversion, Paramount owned approximately 21 percent of Trilogy’s equity (22 percent at December 31, 2009) and approximately 15 percent of its voting shares. In August 2010 MEG completed its initial public offering on the Toronto Stock Exchange. As a result, Paramount’s basis of accounting for its investment in MEG changed from historical cost net of impairments to fair value and, for the year ended December 31, 2010, an unrealized gain of $66.6 million was recorded in other comprehensive income. 6. Drilling Rig Loan During 2009, Paramount entered into a $30.4 million demand loan facility (the "Drilling Rig Loan") with a Canadian bank. Interest is payable at the bank’s prime lending rate or bankers acceptance rate, as selected at the discretion of the Company, plus an applicable margin. At December 31, 2010, $26.9 million (2009 - $29.4 million) was outstanding on the drilling rig loan. Recourse and security for the Drilling Rig Loan is limited to three drilling rigs and drilling contracts guaranteed by Paramount. The current carrying value of the rigs is $39.6 million. The effective interest rate on the loan for the period ended December 31, 2010 was 4.2 percent. During 2010, Paramount made principal repayments of $2.5 million. Unless demanded by the bank, the remaining annual scheduled principal repayments are as follows: 2011 - $4.0 million; 2012 - $5.1 million; 2013 - $5.1 million and 2014 - $12.7 million. 7. Long-Term Debt As at December 31 Canadian Dollar Denominated Debt Bank credit facility 8 ¼ percent Senior Notes due 2017 U.S. Dollar Denominated Debt 8 ½ percent US Senior Notes due 2013 Unamortized debt financing costs Bank Credit Facility 2010 2009 $ – 300,000 – 300,000 (5,795) 294,205 $ $ $ – – 94,394 94,394 (739) 93,655 In April 2010, Paramount renewed its credit facility with the borrowing base and lender commitments remaining at $125 million. In July 2010, following the acquisition of Redcliffe, the borrowing base and lender commitments under the credit facility were increased from $125 million to $160 million. The credit facility is secured by a first fixed and floating charge over substantially all of the assets of Paramount, excluding assets securing the drilling rig loan. The maximum amount that Paramount may borrow under the credit facility is subject to semi-annual Paramount Resources Ltd. 2010 Financial Statements 69 Notes to Consolidated Financial Statements ($ thousands, except as noted) review, and is dependent upon the Company’s reserves and lenders’ projections of future commodity prices, among other factors. The credit facility is available on a revolving basis to April 30, 2011. The Company has requested an extension to the revolving term of its credit facility and expects to finalize details of the extension before April 30, 2011. In the event the revolving period is not extended, the credit facility would be available on a non-revolving basis for an additional year, at which time it would be due and payable. At December 31, 2010, no balance was drawn on the credit facility. Paramount had undrawn letters of credit outstanding at December 31, 2010 of $24.1 million that reduce the amount available to the Company. Senior Notes In December 2010, Paramount completed a public offering of $300 million principal amount of senior unsecured notes ("Senior Notes") at par, of which $11.4 million principal amount was purchased by certain directors, associates, officers, and management of the Company. The Senior Notes bear interest at 8.25 percent per annum, payable semi-annually in arrears on June 13 and December 13 in each year and mature on December 13, 2017. The Senior Notes are direct senior unsecured obligations of Paramount and rank equally with all other senior unsecured indebtedness of the Company. A portion of the proceeds of the Senior Notes were used to purchase/redeem the remaining outstanding balance of the Company’s US Senior Notes. The Company may redeem all or any portion of the Senior Notes at any time on or prior to December 13, 2013 at par, plus accrued and unpaid interest, plus a redemption premium equal to the greater of: (i) one percent; and (ii) a make-whole amount based on the then current yield of a Government of Canada bond with a similar maturity. Paramount may also redeem up to an aggregate of 35 percent of the Senior Notes with the net cash proceeds of an equity offering at any time prior to December 13, 2013, at par plus a redemption premium of 8.25 percent. On or after December 13, 2013, the Company may redeem some or all of the Senior Notes at par plus a redemption premium, if applicable, of up to 4.125 percent depending on when redeemed, plus accrued and unpaid interest. In February 2011, Paramount closed a public offering of an additional $70 million principal amount of its 8.25 percent Senior Notes at a premium price of $1,030 per $1,000 principal amount, of which $1.4 million principal amount was purchased by an entity that is associated with the Company’s Chairman and Chief Executive Officer. US Senior Notes During the fourth quarter of 2010, Paramount’s obligations under the indenture governing its US$90.2 million principal amount of US Senior Notes were discharged as a result of Paramount: (i) purchasing US$64.2 million principal amount of US Senior Notes pursuant to a tender offer; (ii) delivering all US Senior Notes held by the Company to the trustee for cancellation; (iii) issuing a redemption notice for US$26.0 million principal amount of US Senior Notes not tendered under the tender offer (the "Redeemed Notes"); and (iv) irrevocably depositing sufficient cash with the trustee to pay all amounts due on the Redeemed Notes on the January 31, 2011 redemption date. As a result, the 12.8 million Trilogy common shares held by the trustee as security were released to the Company. Paramount Resources Ltd. 2010 Financial Statements 70 Notes to Consolidated Financial Statements ($ thousands, except as noted) 8. Asset Retirement Obligations Year ended December 31 Asset retirement obligations, beginning of year Liabilities incurred Liabilities settled Disposal of properties Accretion expense Revision in estimated costs of abandonment Assumed on Redcliffe acquisition Foreign exchange Asset retirement obligations, end of year 2010 103,462 6,823 (3,209) (327) 9,105 10,314 4,581 (185) 130,564 $ $ 2009 87,237 2,693 (4,050) (88) 8,603 9,334 – (267) 103,462 $ $ The undiscounted asset retirement obligations at December 31, 2010 total $284.3 million (2009 – $227.4 million). The asset retirement obligation has been determined using credit-adjusted risk-free rates between 7 7/8 percent and 9 1/2 percent and an inflation rate of 3 percent. These obligations will be settled over the useful lives of the assets, which extend up to 43 years. 9. Share Capital Authorized Paramount’s authorized capital is comprised of an unlimited number of voting Class A common shares ("Common Shares") and an unlimited number of non-voting Preferred Shares issuable in series, both of such classes of shares being without par value. At December 31, 2010, 149,763 (2009 – 178,131) Common Shares relating to the Company’s Stock Incentive Plan were held by a trustee on behalf of Paramount’s employees. Normal Course Issuer Bid In April 2010, Paramount received regulatory approval under Canadian securities laws to purchase Common Shares under a normal course issuer bid, commencing April 13, 2010 for a twelve month period (the "2010 NCIB"). Under the 2010 NCIB, Paramount is permitted to purchase for cancellation up to 3,626,476 Common Shares, of which no shares have been purchased to March 3, 2011. In November 2008, Paramount received regulatory approval under Canadian securities laws to purchase Common Shares under a normal course issuer bid, commencing November 20, 2008 for a twelve month period (the "2008 NCIB"). Under the 2008 NCIB, Paramount was permitted to purchase for cancellation up to 3,387,456 Common Shares. During 2009, Paramount purchased 615,600 Common Shares under the 2008 NCIB for $4.2 million, of which $2.8 million was charged to share capital and $1.4 million was charged to retained earnings. Including purchases made in 2008, a total of 1,623,900 Common Shares were purchased under the 2008 NCIB for a total cost of $11.4 million. Paramount Resources Ltd. 2010 Financial Statements 71 Notes to Consolidated Financial Statements ($ thousands, except as noted) Share Issuances In November 2010, Paramount issued 1,100,000 Canadian Exploration Expense flow-through Common Shares at a price of $27.25 per share for gross proceeds of $30.0 million through a public offering. Paramount also concurrently issued 1,020,000 Canadian Development Expense flow-through Common Shares at a price of $24.50 per share and 150,000 Canadian Exploration Expense flow-through Common Shares at a price of $27.25 per share for aggregate gross proceeds of $29.1 million through a private placement to certain officers and management of the Company, and companies controlled by them. Costs for the 2010 share issuances were $1.1 million, net of $0.4 million future tax benefits. In October 2009, Paramount issued 1,000,000 Canadian Development Expense flow-through Common Shares for gross proceeds of $16.9 million to a company controlled by Paramount’s Chairman and Chief Executive Officer. In November 2009, Paramount issued 500,000 Canadian Exploration Expense flow-through Common Shares for gross proceeds of $9.4 million through a private placement, and 4,500,000 Common Shares for gross proceeds of $67.5 million through a public offering. The Company has incurred sufficient qualifying expenditures to satisfy its commitment associated with the flow-through shares issued in October and November 2009. Costs for the 2009 share issuances were $2.5 million, net of $0.9 million future tax benefits. Weighted Average Shares Outstanding (Thousands) Weighted average Common Shares outstanding – Basic and diluted 2010 72,705 2009 67,039 10. Stock-Based Compensation Paramount Options Paramount has a stock option plan that enables the Board of Directors or its Compensation Committee to grant to key employees and directors options to acquire Common Shares of the Company ("Paramount Options"). The exercise price of a Paramount Option is equal to the closing market price of the Common Shares on the day preceding the grant date. Paramount Options generally vest over five years and expire within six years after the grant date. Paramount Resources Ltd. 2010 Financial Statements 72 Notes to Consolidated Financial Statements ($ thousands, except as noted) 2010 2009 Weighted Average Exercise Price ($/share) $ 8.61 28.98 7.90 8.74 $ 13.90 8.13 $ Number 4,571,500 1,276,500 (683,700) (158,000) 5,006,300 1,367,301 Weighted Average Exercise Price ($/share) $ 14.48 9.73 7.89 18.86 8.61 7.51 $ $ Number 6,117,700 2,344,000 (121,500) (3,768,700) 4,571,500 1,208,834 Balance, beginning of year Granted Exercised Cancelled or surrendered Balance, end of year Options exercisable, end of year Additional information about Paramount Options outstanding at December 31, 2010 is as follows: Outstanding Weighted Average Contractual Life (years) 2.9 4.0 4.9 3.6 Weighted Average Exercise Price ($ / share) $ 7.34 13.37 29.27 $ 13.90 Exercisable Weighted Average Exercise Price ($ / share) $ $ 7.34 13.34 21.55 8.13 Number 1,195,801 165,500 6,000 1,367,301 Number 2,841,800 922,000 1,242,500 5,006,300 Exercise Prices $ 6.87-$10.00 $10.01-$20.00 $20.01-$29.46 Total Stock Appreciation Rights In 2008, the Company issued 1,280,000 SARs to certain employees, which entitled the holder to receive a cash payment equal to the difference between the market price of the Company’s Common Shares and the exercise price on date of surrender. The SARs had a weighted average contractual life of five years at December 31, 2008 and a vesting period of four years. The exercise price per SAR of $7.34 was equal to the closing market price of the Common Shares on the grant date. In February 2009, the SARS were surrendered and cancelled in exchange for the same number of Paramount Options with the same exercise price and vesting terms. Paramount Resources Ltd. 2010 Financial Statements 73 Notes to Consolidated Financial Statements ($ thousands, except as noted) 11. Income Taxes The following table reconciles income taxes calculated at the Canadian statutory rate to Paramount’s recorded income tax recovery: Year ended December 31 Earnings (loss) before tax Effective Canadian statutory income tax rate Expected income tax expense (recovery) Increase (decrease) resulting from: Statutory and other rate differences Non-taxable portion of (gain) loss (Income) from investments and other De-recognition of future tax assets Stock-based compensation Change in estimate Other 2010 2009 $ (194,790) $ (152,516) 28.10% $ (54,736) $ 29.15% (44,458) 906 (3,859) (1,088) 755 4,631 (10,896) (623) (54,632) (14,985) (1,460) (4,934) 627 15,346 (11,737) (443) (72,322) $ Income and other tax expense (recovery) $ Components of Future Income Tax Asset (Liability) Future income tax asset (liability) Timing of partnership items Property, plant and equipment Investments Asset retirement obligations Non-capital and net operating losses Other 2010 2009 $ $ (38,808) (1,382) (3,308) 33,359 47,707 10,921 48,489 $ $ (31,370) (13,087) (400) 26,572 22,050 (15,019) (11,254) Paramount has $148.9 million (2009 - $136.0 million) of unused tax losses expiring between 2014 and 2030. In addition, Paramount has $179.6 million (2009 – $227.6 million) of deductible temporary differences in respect of investments for which no future income tax asset has been recognized. In October 2010, the Company received reassessments from the Canada Revenue Agency (the "CRA") and provincial tax authorities of its income taxes relating to a prior year transaction (the "Reassessments"). Paramount disagrees with the Reassessments and has filed notices of objection with the CRA and provincial tax authorities. Despite its disagreement, and as a condition of its right to proceed with its objection to the Reassessments, the Company was required to deposit approximately $20 million with the CRA, which amount will remain on account until the dispute is resolved. Paramount Resources Ltd. 2010 Financial Statements 74 Notes to Consolidated Financial Statements ($ thousands, except as noted) 12. Financial Instruments and Risk Management Financial Instruments Financial instruments at December 31, 2010 consisted of cash and cash equivalents, accounts receivable, available-for-sale investments, the Drilling Rig Loan, accounts payable and accrued liabilities, risk management assets/liabilities, and long-term debt. Fair Values of Financial Assets and Liabilities Risk management assets and liabilities are carried at fair value, which are based on forward market curves and compared to quotes provided by financial institutions. The carrying value of Paramount’s long-term debt is measured at amortized cost. The Senior Notes had a market value of 100.3 percent of their principal amount at December 31, 2010. Available-for-sale investments are carried at market value. Paramount’s investment in MEG was carried at historical cost, net of impairment, prior to MEG’s initial public offering in August 2010, as it was a private corporation and its shares were not traded in an active market. Subsequent to MEG’s initial public offering, Paramount’s investment in MEG is now carried at market value. The Company has no immediate plans to dispose of its available-for-sale investments. At December 31, 2010, Paramount had the following financial commodity sales contract outstanding: Instrument Oil – NYMEX Swap Notional 500 Bbl/d Fixed Price Fair Value Remaining Term USD $89.95/Bbl $ (693) January 2011 – December 2011 Changes in fair value of risk management assets and liabilities are as follows: 2010 Foreign Exchange – $ – – – $ Commodity 2,187 $ 10,047 (12,927) (693) $ Total $ $ 2,187 10,047 (12,927) (693) Commodity 9,807 $ 5,277 (12,897) 2,187 $ Fair value, beginning of year Changes in fair value Settlements (received) Fair value, end of year Risk Management 2009 Foreign Exchange 9,883 2,322 (12,205) – $ $ Total $ 19,690 7,599 (25,102) 2,187 $ Paramount is exposed to market risks where the fair values or future cash flows of financial instruments fluctuate because of underlying changes in market prices. The principal market risks impacting Paramount are commodity price risk, foreign currency risk, interest rate risk, equity price risk, credit risk and liquidity risk. Paramount periodically uses derivative instruments such as forwards, futures, swaps and options to manage its exposure to fluctuations in crude oil and natural gas prices, foreign exchange rates, and interest rates. Paramount Resources Ltd. 2010 Financial Statements 75 Notes to Consolidated Financial Statements ($ thousands, except as noted) Commodity Price Risk At December 31, 2010, assuming all other variables are held constant, a 10 percent increase or decrease in the applicable forward market curves would have had the following impact on Paramount’s net earnings from changes in the fair value of financial commodity contracts: Crude Oil Foreign Currency Risk 10% increase $ (1,211) 10% decrease $ 1,211 Paramount is exposed to foreign currency risk on financial instruments denominated in US dollars including cash and cash equivalents, accounts receivable, risk management assets and liabilities, and accounts payable and accrued liabilities. Sales prices of natural gas, crude oil, and NGLs are determined with reference to US benchmark prices, therefore a strengthening of the Canadian dollar relative to the US dollar will decrease the revenue received for natural gas, crude oil, and NGLs. Paramount’s expenditures are primarily in Canadian dollars but include capital and operating expenditures in US dollars, largely related to the Company’s US operations. Interest Rate Risk Paramount is exposed to interest rate risk from time to time on outstanding balances on its floating rate bank credit facility and the Drilling Rig Loan, and on interest bearing cash and cash equivalents. Paramount’s Senior Notes bear interest at a fixed rate and are subject to fair value changes as market interest rates change. Equity Price Risk Paramount is exposed to equity price risk associated with changes in the market value of its investments. Credit Risk Paramount is exposed to credit risk on its financial instruments where a financial loss would be experienced if a counterparty to a financial asset failed to meet its obligations. The Company manages credit risk by endeavoring to enter into contracts with counterparties that possess high credit ratings, employ net settlement agreements, employ letters of credit, and limiting available credit when necessary. The maximum credit risk exposure at December 31, 2010 is limited to the carrying values of cash and cash equivalents, and accounts receivable. Accounts receivable include balances due from customers and joint venture partners in the oil and gas industry and are subject to normal industry credit risk. At December 31, 2010, Paramount had balances due from one joint venture partner that represented approximately 14 percent of the Company’s total accounts receivable, and one sales customer that represented approximately 13 percent of the Company’s total accounts receivable. Liquidity Risk Liquidity risk is the risk that Paramount will be unable to meet its financial obligations. The Company manages liquidity risk by ensuring that it has sufficient cash and cash equivalents, credit facilities and other financial resources available to meet its obligations. Paramount Resources Ltd. 2010 Financial Statements 76 Notes to Consolidated Financial Statements ($ thousands, except as noted) The Company forecasts cash flows for a period of at least 12 months to identify financial requirements. These requirements are met through a combination of cash flows from operations, credit facilities, dispositions of assets, and accessing capital markets. In addition to commitments disclosed in note 16, contractual obligations related to financial liabilities are as follows: Drilling rig loan, including interest Accounts payable and accrued liabilities Risk management liabilities Senior Notes, including interest 2011 $ 5,081 78,806 693 24,750 $ 109,330 2012 $ 5,934 – – 24,750 $ 30,684 2013 $ 5,726 – – 24,750 $ 30,476 2014 $ 12,937 – – 24,750 $ 37,687 2015 $ – – – 24,750 $ 24,750 Thereafter $ – – – 348,347 $ 348,347 Total $ 29,678 78,806 693 472,097 $ 581,274 13. Capital Structure Paramount’s primary objectives in managing its capital structure are to: (i) maintain a flexible capital structure which optimizes the cost of capital at an acceptable level of risk; (ii) maintain sufficient liquidity to support ongoing operations, capital expenditure programs, strategic initiatives, and the repayment of debt obligations when due; and (iii) maximize shareholder returns. Paramount manages its capital structure to support current and future business plans and periodically adjusts the structure in response to changes in economic conditions and the risk characteristics of the Company’s underlying assets and operations. Paramount monitors metrics such as the Company’s debt-to-equity and debt- to-cash flow ratios as calculated in accordance with the Company’s Senior Notes indenture, among others, to measure the status of its capital structure. The Company has not established fixed quantitative thresholds for such metrics. The capital structure may be adjusted by issuing or repurchasing shares, issuing or repurchasing debt, refinancing existing debt, modifying capital spending programs, and disposing of assets, the availability of any such means being dependent upon market conditions. Paramount’s capital structure consists of the following: Working capital(1) Senior Notes(2) US Senior Notes(2) Net Debt(3) Share capital Contributed surplus Retained earnings Accumulated other comprehensive income Total Capital (1) (2) (3) Excludes risk management assets and liabilities, and stock-based compensation liabilities Excludes unamortized financing costs 2010 Net Debt excludes the $19.8 million deposit on account with the CRA, pending resolution of the Company’s Notice of Objection (see Note 11) 2010 (4,825) 300,000 – 295,175 458,895 3,940 251,277 71,622 1,080,909 $ $ 2009 (43,485) – 94,394 50,909 393,087 2,890 373,745 3,188 823,819 $ $ Paramount Resources Ltd. 2010 Financial Statements 77 Notes to Consolidated Financial Statements ($ thousands, except as noted) Paramount is subject to covenants under its credit facility, the Drilling Rig Loan, and Senior Notes agreements which contain certain restrictions on Paramount’s ability to repurchase equity, issue or refinance debt, acquire or dispose of assets, and pay dividends. 14. Consolidated Statements of Cash Flows – Selected Information Items not involving cash Year ended December 31 Financial commodity contracts Stock-based compensation Depletion, depreciation and accretion Gain on sale of property, plant and equipment Write-down of petroleum and natural gas assets Foreign exchange Distributions in excess of equity earnings and dilution Gain on available-for-sale investments Future income tax Other Changes in non-cash working capital Year ended December 31 Accounts receivable Prepaid expenses and other Account payable and accrued liabilities Operating activities Investing activities Supplemental cash flow information Year ended December 31 Interest paid Current tax paid Components of cash and cash equivalents Year ended December 31 Cash Banker’s acceptances 2010 2009 $ $ $ $ $ $ 2,880 58,703 178,007 (3) 25,332 (2,137) 8,258 (3,499) (72,535) 393 195,399 2010 (7,807) 387 24,091 16,671 (23,467) 40,138 16,671 $ $ $ $ $ $ 7,620 17,553 141,597 (534) 14,939 (15,274) 25,559 (3,193) (53,743) (206) 134,318 2009 19,716 (570) (36,651) (17,505) 11,797 (29,302) (17,505) 2010 15,615 368 $ $ 2009 $ $ 11,640 159 2010 $ $ 29,679 44,980 74,659 2009 23,250 69,988 93,238 $ $ Paramount Resources Ltd. 2010 Financial Statements 78 Notes to Consolidated Financial Statements ($ thousands, except as noted) 15. Related Party Transactions Service Agreements In addition to the debt and equity instruments issued to related parties, in 2010 Paramount charged $0.5 million (2009 – $0.6 million) for certain operational and administrative services that the Company provided to Trilogy. Paramount also has transactions with Trilogy, MGM Energy and Perpetual Energy Corp. in the normal course of business, including joint venture operations. Trilogy, Perpetual Energy Inc., MGM Energy and Paramount are related by common significant influence. All transactions between the entities are recorded at their exchange amounts. 16. Commitments and Contingencies Commitments Paramount had the following commitments as at December 31, 2010: Pipeline transportation commitments (1) Operating leases Total (1) 2011 $ 14,501 2,299 $ 16,800 2012 $ 14,529 1,855 $ 16,384 2013 $ 13,560 – $ 13,560 2014 $ 13,835 – $ 13,835 2015 $ 12,011 – $ 12,011 After 2015 $ 67,163 – $ 67,163 Certain of the pipeline transportation commitments are secured by outstanding letters of credit totaling $10.4 million at December 31, 2010. Flow-Through Shares As a result of flow through share issuances in the fourth quarter of 2010, Paramount is required to incur and renounce $34.1 million of Canadian Exploration Expense and $25.0 million of Canadian Development Expense. The Company is required to incur all qualifying expenditures by December 31, 2011. Contingencies Paramount is a party to various legal claims associated with the ordinary conduct of business. Paramount does not anticipate that these claims will have a material impact on its financial position. Tax and royalty legislation and regulations, and government interpretation and administration thereof, continually changes. As a result, there are often tax and royalty matters under review by relevant government authorities. All tax filings are subject to subsequent government audit and potential reassessments. Accordingly, the final liability may differ materially from amounts estimated and recorded. Crown royalties for Paramount’s production from frontier lands in the Northwest Territories have been recognized in the Consolidated Financial Statements based on the Company’s interpretation of the relevant legislation and regulations. Although Paramount believes that its interpretation of the relevant legislation and regulations has merit, Paramount is unable to predict the ultimate outcome of ongoing audits and/or assessments by the Government of Canada. Additional material amounts could potentially become payable. Paramount Resources Ltd. 2010 Financial Statements 79 Notes to Consolidated Financial Statements ($ thousands, except as noted) 17. Subsequent Events (cid:2) (cid:2) (cid:2) In February 2011, Paramount closed a public offering of an additional $70 million principal amount of Senior Notes (see Note 7). Subsequent to December 31, 2010, the Company entered into an additional financial commodity sales contract: Instrument Crude Oil– NYMEX Swap Total Notional 500 Bbl/d Average Fixed Price USD$97.50/Bbl Remaining Term March 2011 – December 2011 Subsequent to December 31, 2010, the Company sold approximately 6,000 net acres of undeveloped land in North Dakota, unrelated to the farm-out lands, for cash proceeds of US$40 million. Paramount Resources Ltd. 2010 Financial Statements 80 C O R P O R A T E I N F O R M A T I O N OFFICERS DIRECTORS HEAD OFFICE C. H. Riddell Chairman of the Board and Chief Executive Officer J. H. T. Riddell President and Chief Operating Officer B. K. Lee Chief Financial Officer E. M. Shier Corporate Secretary L. M. Doyle Corporate Operating Officer G. W. P. McMillan Corporate Operating Officer D. S. Purdy Corporate Operating Officer J. Wittenberg Corporate Operating Officer P. R. Kinvig Controller L. A. Friesen Assistant Corporate Secretary 4700 Bankers Hall West 888 Third Street S.W. Calgary, Alberta Canada T2P 5C5 Telephone: (403) 290-3600 Facsimile: (403) 262-7994 www.paramountres.com CONSULTING ENGINEERS McDaniel & Associates Consultants Ltd. Calgary, Alberta AUDITORS Ernst & Young LLP Calgary, Alberta BANKERS Bank of Montreal Calgary, Alberta The Bank of Nova Scotia Calgary, Alberta Royal Bank of Canada Calgary, Alberta ATB Financial Calgary, Alberta HSBC Bank Canada Calgary, Alberta REGISTRAR AND TRANSFER AGENT Computershare Trust Company of Canada Calgary, Alberta Toronto, Ontario STOCK EXCHANGE LISTING The Toronto Stock Exchange (“POU”) C. H. Riddell (3) Chairman of the Board and Chief Executive Officer Paramount Resources Ltd. Calgary, Alberta J. H. T. Riddell President and Chief Operating Officer Paramount Resources Ltd. Calgary, Alberta T. E. Claugus (4) President, GMT Capital Corp. Atlanta, Georgia J. C. Gorman (1) (3) (4) Retired Calgary, Alberta D. Jungé C.F.A. (2) (4) Chairman of the Board and Chief Executive Officer Pitcairn Trust Company Bryn Athyn, Pennsylvania D. M. Knott (4) Managing General Partner Knott Partners, L.P. Syosset, New York S. L. Riddell Rose President and Chief Executive Officer Perpetual Energy Inc. Calgary, Alberta V. S. A. Riddell Business Executive Calgary, Alberta J. B. Roy (1) (2) (3) (4) Independent Businessman Calgary, Alberta A. S. Thomson (1) (4) Retired Sidney, British Columbia B. M. Wylie (2) Business Executive Calgary, Alberta (1) Member of Audit Committee (2) Member of Environmental, Health and Safety Committee (3) Member of Compensation Committee (4) Member of Corporate Governance Committee 4700 Bankers Hall West 888 Third Street S.W. Calgary, Alberta Canada T2P 5C5 Telephone: (403) 290-3600 Facsimile: (403) 262-7994 www.paramountres.com 

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