• our business strategy,

• estimated quantities of oil and gas reserves,

• uncertainty of commodity prices in oil and gas,

• continued disruption of credit and capital markets,

• our financial position,

• our cash flow and liquidity,

• replacing our oil and gas reserves,

• our inability to retain and attract key personnel,

• uncertainty regarding our future operating results,

• uncertainties in exploring for and producing oil and gas,

• high costs, shortages, delivery delays or unavailability of drilling rigs, equipment, labor or other services,

• disruptions to, capacity constraints in or other limitations on the pipeline systems which deliver our gas and other processing and transportation considerations,

• our inability to obtain additional financing necessary to fund our operations and capital expenditures and to meet our other obligations,

• competition in the oil and gas industry,

• marketing of oil, gas and natural gas liquids,

• exploitation of our current asset base or property acquisitions,

• the effects of government regulation and permitting and other legal requirements,

• plans, objectives, expectations and intentions contained in this report that are not historical, and

• other factors discussed in our Annual Report on Form 10-K for the year ended December 31, 2008 filed with the SEC on March 13, 2009 and in this Quarterly Report on Form 10-Q.

Overview
We are an independent energy company engaged in the exploration, development, production and acquisition of unconventional natural gas and oil properties. We focus on natural gas and oil reserves in tight sands and shale and have assembled leasehold interests aggregating approximately 302,570 gross (200,398 net) acres as of March 31, 2009. We operate in Texas, Kentucky and New Mexico and have non-operated interests in British Columbia.
At December 31, 2008, we had estimated proved reserves of approximately 211.1 Bcfe. At March 31, 2009, we owned working interests in 468 producing oil and gas wells and were producing 28.1 million cubic feet of natural gas equivalent per day ("MMcfe/d"), based on production for the first quarter of 2009. Our estimated average daily net production for the month of April 2009 was 25.7 MMcfe/d. Production for the month of April 2009 was negatively impacted by partial curtailment over approximately four days in Ozona Northeast due to scheduled maintenance at a downstream NGL fractionation facility. Our financial results depend upon many factors, particularly the price of oil and gas. Commodity prices are affected by changes in market demand, which is impacted by overall economic activity, weather, pipeline capacity constraints, estimates of inventory storage levels, commodity price differentials and other factors. A factor potentially impacting the future natural gas supply balance is the recent increase in the United States LNG import capacity. Significant LNG capacity increases have been announced that may

result in increased downward pressure on natural gas prices. As a result, we cannot accurately predict future oil and gas prices, and therefore, we cannot determine what effect increases or decreases will have on our capital program, production volumes and future revenues. A substantial or extended decline in oil and gas prices could have a material adverse effect on our business, financial condition, results of operations, quantities of oil and gas reserves that may be economically produced and liquidity that may be accessed through our borrowing base under our revolving credit facility and through the capital markets. We enter into financial swaps and collars to partially mitigate the risk of market price fluctuations related to future oil and gas production.
In addition to production volumes and commodity prices, finding and developing sufficient amounts of oil and gas reserves at economical costs are critical to our long-term success. Future finding and development costs are subject to changes in the industry, including the costs of acquiring, drilling and completing our projects. We focus our efforts on increasing oil and gas reserves and production while controlling costs at a level that is appropriate for long-term operations. Our future cash flow from operations will depend on our ability to manage our overall cost structure.
Like all oil and gas production companies, we face the challenge of natural production declines. Oil and gas production from a given well naturally decreases over time. Additionally, our reserves have a rapid initial decline. We generally will attempt to overcome this natural decline by drilling to develop and identify additional reserves, farm-ins or other joint drilling ventures, and by acquisitions. However, during times of severe price declines, we may from time to time reduce current capital expenditures and curtail drilling operations in order to preserve net asset value of our existing proved reserves. See Item 2., "Management's discussion and analysis of financial condition and results of operations - Capital expenditures for 2009." A material reduction in capital expenditures and drilling activities could materially reduce our production volumes and revenues from pre-2009 levels and increase future expected costs necessary to develop existing reserves. Notwithstanding these periods of reduced capital expenditures or curtailed production, our future growth will depend upon our ability over the long term to continue to add oil and gas reserves in excess of production at a reasonable cost. We intend to maintain our focus on the costs of adding reserves through drilling and acquisitions as well as the costs necessary to produce such reserves. We also face the challenge of financing future acquisitions. We believe we have adequate unused borrowing capacity under our revolving credit facility for possible acquisitions, temporary working capital needs and expansion of our drilling program. Funding for future acquisitions also may require additional sources of financing, which may not be available.

Results of operations

                                                              Three Months Ended
                                                                  March 31,
                                                              2009          2008

     Revenues (in thousands):
     Gas                                                    $  6,610     $ 14,872
     Oil                                                       2,028        3,085
     NGLs                                                      1,427        1,061

     Total oil and gas sales                                  10,065       19,018

     Realized gain on commodity derivatives                    3,181           61

     Total oil and gas sales including derivative impact    $ 13,246     $ 19,079


     Production:
     Gas (MMcf)                                                1,770        1,666
     Oil (MBbls)                                                  59           32
     NGLs (MBbls)                                                 68           21

     Total (MMcfe)                                             2,532        1,979
     Total (MMcfe/d)                                           28.13        21.75

     Average prices:
     Gas (per Mcf)                                          $   3.73     $   8.93
     Oil (per Bbl)                                             34.37        97.91
     NGLs (per Bbl)                                            20.99        50.95

     Total (per Mcfe)                                       $   3.98     $   9.61

     Realized gain on commodity derivatives (per Mcfe)          1.26         0.03

     Total including derivative impact (per Mcfe)           $   5.24     $   9.64

     Costs and expenses (per Mcfe):
     Lease operating                                        $   0.94     $   0.71
     Severance and production taxes                             0.17         0.38
     Exploration                                                   -         0.25
     General and administrative                                 1.11         0.98
     Depletion, depreciation and amortization                   2.74         2.64



Bbl.     One stock
         tank barrel,
         of 42 U.S.
         gallons
         liquid
         volume, used
         herein to
         reference
         oil,
         condensate
         or NGLs.

MBbl.    Thousand
         barrels of
         oil,
         condensate
         or NGLs.

Mcf.     Thousand
         cubic feet
         of natural
         gas.

Mcfe.    Thousand
         cubic feet
         equivalent,
         determined
         using the
         ratio of six
         Mcf of
         natural gas
         to one Bbl
         of oil,
         condensate
         or NGLs.

MMcf.    Million
         cubic feet
         of natural
         gas.

MMcfe.   Million
         cubic feet
         equivalent,
         determined
         using the
         ratio of six
         Mcf of
         natural gas
         to one Bbl
         of oil,
         condensate
         or NGLs.

NGLs.    Natural gas
         liquids.

/d.      "Per day"
         when used
         with
         volumetric
         units or
         dollars.

Three months ended March 31, 2009 compared to three months ended March 31, 2008 Oil and gas production. Production for the three months ended March 31, 2009 totaled 2.5 Bcfe (28.1 MMcfe/d), compared to 2.0 Bcfe (21.7 MMcfe/d) produced in the prior year period, an increase of 28%. Production for the three months ended March 31, 2009 was 70% natural gas and 30% oil and NGLs, compared to 84% natural gas and 16% oil and NGLs in prior year period.
Oil and gas sales. Oil and gas sales decreased $8.9 million, or 47.1%, for the three months ended March 31, 2009 to $10.1 million from $19.0 million for the three months ended March 31, 2008. The decrease in oil and gas sales principally resulted from sharp decreases in the price we received for our natural gas, oil and NGL production. The decrease in oil and gas sales was partially offset by the continued development of our Cinco Terry field. Cinco Terry production increased by 706 MMcfe compared to the prior period. The average price per Mcfe we received for our production (before the effect of commodity derivatives) decreased from $9.61 to $3.98 per Mcfe as oil and gas prices decreased significantly between the two periods. Of the $8.9 million decrease in revenues, approximately $11.3 million was attributable to a decrease in oil and gas prices, which was partially offset by approximately $2.4 million that was attributable to growth in production volume from the continued development of Cinco Terry.
Commodity derivative activities. Realized gains from our commodity derivative activity increased our earnings by $3.2 million and by $61,000 for the three months ended March 31, 2009 and 2008, respectively. Our average realized price, including the effect of commodity derivatives, was $5.24 per Mcfe for the three months ended March 31, 2009, compared to $9.64 per Mcfe for the three months ended March 31, 2008. Realized gains and losses on commodity derivatives are derived from the relative movement of gas prices in relation to the range of prices in our collars or the fixed notional pricing in our fixed price swaps for the applicable periods. The unrealized gain on commodity derivatives was $2.1 million for the three months ended March 31, 2009 and the unrealized loss on commodity derivatives was $4.9 million for the three months ended March 31, 2008. As natural gas commodity prices increase, the fair value of the open portion of those positions decreases. As natural gas commodity prices decrease, the fair value of the open portion of those positions increases. Historically, we have not designated our derivative instruments as cash-flow hedges. We record our open derivative instruments at fair value on our consolidated balance sheets as either unrealized gains or losses on commodity derivatives. We record changes in such fair value in earnings on our consolidated statements of operations under the caption entitled "unrealized gain (loss) on commodity derivatives." Lease operating expense. Our lease operating expenses, or LOE, increased $1.0 million, or 69.6%, for the three months ended March 31, 2009 to $2.4 million ($0.94 per Mcfe) from $1.4 million ($0.71 per Mcfe) for the three months ended March 31, 2008. The increase in LOE over the prior year period was primarily a result of increased activities in our Cinco Terry field. Initial compression was installed in Cinco Terry during the first quarter of 2008 and has increased as a result of additional facilities required to compress and treat the natural gas produced from Cinco Terry. Compression and treating costs also included higher repair and maintenance costs attributable to the compression and treating facilities in both Cinco Terry and Ozona Northeast. In addition, the increase in LOE during the three months ended March 31, 2009 was partially attributable to a rise in estimated ad valorem taxes and actual well-related repair and maintenance costs. We do not expect the level of LOE for the balance of 2009 to differ materially from the first quarter of 2009. Following is a summary of lease operating expenses (per Mcfe):

                                          Three Months Ended
                                               March 31,
                                          2009           2008       Change       % Change
   Compression and gas treating         $    0.37       $  0.17     $  0.20          117.6 %
   Ad valorem taxes                          0.24          0.15        0.09           60.0
   Pumpers and supervision                   0.14          0.14           -              -
   Water hauling, insurance and other        0.10          0.14       (0.04 )        (28.6 )
   Well repairs and maintenance              0.08          0.05        0.03           60.0
   Workovers                                 0.01          0.06       (0.05 )        (83.3 )

   Total                                $    0.94       $  0.71     $  0.23           32.4 %

Severance and production taxes. Our production taxes decreased $323,000, or 42.9%, for the three months ended March 31, 2009 to $430,000 from $753,000 for the three months ended March 31, 2008. The decrease in production taxes was a function of the decrease in oil and gas sales between the two periods. Severance and productions taxes amounted to approximately 4.3% and 4.0% of oil and gas sales for the respective periods.
Exploration. We recorded $491,000 of exploration expense for the three months ended March 31, 2008 from the drilling of one dry hole in Ozona Northeast. General and administrative. Our general and administrative, or G&A, expenses increased $864,000, or 44.4%, to $2.8 million ($1.11 per Mcfe) for the three months ended March 31, 2009 from $1.9 million ($0.98 per Mcfe) for the three months ended March 31, 2008. G&A expenses for 2009 included higher share-based compensation resulting from timing of payment of 2009 annual director fees, as well as higher salaries and related employee benefit costs attributable to our increase in staff from the prior year period. Except for $377,000 in non-cash, share-based compensation expense for 2009 annual director fees incurred in the first quarter of 2009, we do not expect the level of G&A expenses for the balance of 2009 to differ materially from the first quarter of 2009. Following is a summary of G&A expenses (in millions and per Mcfe):

                                       Three Months Ended
                                            March 31,
                                    2009                 2008                 Change              %
                               $MM       Mcfe       $MM       Mcfe       $MM        Mcfe       Change
   Salaries and benefits      $ 1.1     $ 0.42     $ 0.8     $ 0.39     $  0.3     $  0.03         7.7 %
   Share-based compensation     0.7       0.29       0.2       0.11        0.5        0.18       163.6
   Professional fees            0.4       0.17       0.5       0.23       (0.1 )     (0.06 )     (26.1 )
   Other                        0.6       0.23       0.4       0.25        0.2       (0.02 )      (8.0 )

   Total                      $ 2.8     $ 1.11     $ 1.9     $ 0.98     $  0.9     $  0.13        13.3 %

Depletion, depreciation and amortization. Our depletion, depreciation and amortization, or DD&A, expenses increased $1.7 million, or 33.2%, to $6.9 million for the three months ended March 31, 2009 from $5.2 million for the three months ended March 31, 2008. Our DD&A expenses per Mcfe increased by $0.10, or 4%, to $2.74 per Mcfe for the three months ended March 31, 2009, compared to $2.64 per Mcfe for the three months ended March 31, 2008. The increase in DD&A expenses was primarily attributable to increased production and higher capital costs, partially offset by an increase in our estimated proved reserves at December 31, 2008. The higher DD&A expense per Mcfe was primarily attributable to higher capital costs incurred in North Bald Prairie and reserve revisions in Ozona Northeast at December 31, 2008. In North Bald Prairie, we paid capital costs attributable to the 50% working

interest owned by our working interest partner under our carry and earning agreement on the first five wells drilled.
Interest expense, net. Our interest expense increased $297,000, or 200.7%, to $445,000 for the three months ended March 31, 2009 from $148,000 for the three months ended March 31, 2008. This increase was substantially the result of our higher average debt level in the 2009 period.
Income taxes. Our provision for income taxes was $1.5 million for the three months ended March 31, 2009 and 2008. Our effective income tax rate for the three months ended March 31, 2009 was 63.7%, compared with 35% for the three months ended March 31, 2008. The increase in the effective rate resulted primarily from a change in our estimated income tax expenses for the year ended December 31, 2008, along with an increased impact of permanent differences between book and taxable income and increased effective state income tax rates. We expect the effective income tax rate to be approximately 39% for the remainder of 2009.
Liquidity and capital resources
We generally will rely on cash generated from operations, borrowings under our revolving credit facility, private placements of equity, and, to the extent that credit and capital market conditions will allow, future public equity and debt offerings to satisfy our liquidity needs. Our ability to fund planned capital expenditures and to make acquisitions depends upon our future operating performance, availability of borrowings under our revolving credit facility, and more broadly, on the availability of equity and debt financing, which is affected by prevailing economic conditions in our industry and financial, business and other factors, some of which are beyond our control. Given the current conditions of credit and capital markets, we cannot predict whether additional liquidity from debt or equity financings beyond our revolving credit facility will be available on acceptable terms, or at all, in the foreseeable future.
Our cash flow from operations is driven by commodity prices and production volumes and the effect of commodity derivatives. Prices for oil and gas are affected by national and international economic and political environments, national and global supply and demand for hydrocarbons, seasonal influences of weather and other factors beyond our control. Our working capital is significantly influenced by changes in commodity prices and significant declines in prices will cause a decrease in our exploration and development expenditures and production volumes. Cash flows from operations are primarily used to fund exploration and development of our oil and gas properties.
The following table summarizes our sources and uses of funds for the periods noted (in thousands):