Emerge Oil & Gas Inc. Announces Third Quarter 2010 Results

CALGARY, ALBERTA -- (Marketwire - Nov. 10, 2010) - Emerge Oil & Gas Inc. ("Emerge" or the "Company") (TSX: EME) is pleased to announce its operating and financial results for the three and nine months ended September 30, 2010.

Highlights:

- Increased average production volumes to 5,592 boe/d, up 1,060 boe/d or 23% from Q2 2010, and up 4,172 boe/d or 294% from Q3 2009; exited the quarter producing approximately 5,900 boe/d;

- Increased average sales volumes to 4,993 boe/d, up 529 boe/d or 12% from Q2 2010, and up 3,573 boe/d or 252% from Q3 2009; inventory build was significant in Q3 2010 due to a large number of new wells placed on production to single-well batteries, explaining the variance between production and sales volumes;

- Generated funds flow from operations of $7.3 million ($0.09 per share), up 15% from $6.4 million ($0.08 per share) in Q2 2010, and up 292% from $1.9 million ($0.04 per share) in Q3 2009 (all per share amounts are basic and diluted);

- Achieved operating and funds flow netbacks of $19.33/boe and $15.98/boe, respectively, as compared to $20.23/boe and $15.78/boe, respectively, in Q2 2010 on account of lower realized pricing and lower general and administrative expenses;

- Drilled 24 (24.0 net) oil wells at a 100% success rate;

- Invested $28 million in the Company's exploration and development program, including $8 million on drilling and completion activities, $5 million on well reactivations and optimizations, $10 million on wellsite equipment, $3 million on facilities and $2 million on undeveloped land and seismic;

- Received an increase in the Company's credit facilities to $60.0 million (up from $52.5 million in Q2 2010) on continued production and reserves growth following the Company's semi-annual review with its lender; ended the quarter with approximately $52.8 million of net debt; and

- Entered into a farm-in agreement that provides Emerge with access to approximately 41.5 gross (38.5 net) sections of undeveloped land with a minimal capital commitment. The farm-in lands, which are prospective for both Mannville and Birdbear heavy oil, are in close proximity to the Company's existing operations, including the Reward and Ear Lake properties acquired in June 2010.

Subsequent to quarter-end:

- Entered into two financial commodity price contracts to hedge a total of 2,000 bbls/d of 2011 production at an average price of $72.00/bbl (WCS heavy oil price);

- On October 14, 2010, closed a bought-deal equity financing of 8.85 million common shares at $3.40 per share for gross proceeds of $30.1 million (approximately $28.2 million net after issuance costs);

- Completed the drilling of the remaining 8 wells of the Company's 55-well drilling program with 100% success; and

- Increased production to 6,600 boe/d (based on field estimates) on continued drilling and reactivation success.




Three months ended Nine months ended
September 30, September 30,
HIGHLIGHTS: 2010 2009 2010 2009
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FINANCIAL (all amounts
in $000s, except per share
amounts and share data)
Petroleum and natural gas
revenue 27,047 6,899 76,307 11,455
Funds flow from operations
(1) 7,342 1,872 24,064 2,602
Per share
- basic and diluted ($) (1) 0.09 0.04 0.29 0.06
Net loss (5,698) (941) (14,720) (2,286)
Per share
- basic and diluted ($) (0.07) (0.02) (0.18) (0.05)
Exploration and development
expenditures 28,278 9,596 51,648 14,639
Acquisitions
(net of dispositions) - - 9,694 21,809
Total capital expenditures 28,278 9,596 61,342 36,448
Ending net debt (1) 52,758 5,282 52,758 5,282
Securities outstanding
Weighted average common
shares outstanding for the
period
- basic and diluted (2) 83,070,245 41,700,100 83,009,117 41,700,100
End of period
Common shares 83,076,767 41,700,100 83,076,767 41,700,100
Stock options 7,409,000 3,490,000 7,409,000 3,490,000
Fully diluted 90,485,767 45,190,100 90,485,767 45,190,100
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OPERATIONAL
(units as noted) (3)
Average daily production
(boe/d) 5,592 1,420 4,893 840
Average daily sales
Oil and NGL (bbl/d) 4,839 1,121 4,443 618
Natural gas (mcf/d) 923 1,794 559 1,333
Total (boe/d) 4,993 1,420 4,536 840
% oil and NGL 97% 79% 98% 74%
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Average realized prices
Oil and NGL ($/bbl) 60.05 62.07 62.39 60.58
Natural gas ($/mcf) 3.68 3.03 4.12 3.38
Combined ($/boe) 58.88 52.82 61.62 49.92
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Reference prices
Crude oil - WTI Cushing
(US$/bbl) 76.06 68.19 77.54 56.86
Crude oil - WTI Cushing
(C$/bbl) 79.02 74.79 80.29 66.27
Heavy oil - WCS (C$/bbl) 62.67 63.73 66.91 55.65
Heavy oil differential
(WCS to C$ WTI Cushing) -21% -15% -17% -16%
Natural gas - AECO C
Daily Spot (C$/mcf) 3.55 2.98 4.13 3.79
Exchange rate (C$/US$) 0.9626 0.9117 0.9657 0.8580
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Netbacks ($/boe)
Oil and natural gas sales 58.88 52.82 61.62 49.92
Royalties expense (11.74) (9.40) (12.48) (8.67)
Operating expenses (24.86) (21.77) (23.09) (21.65)
Transportation expenses (2.95) (3.21) (2.98) (2.65)
Operating netback (1) 19.33 18.44 23.07 16.95
Other income 0.17 0.59 0.19 1.18
General and administrative
expenses (2.85) (4.70) (3.35) (6.79)
Interest expense (0.67) - (0.46) -
Funds flow netback (1) 15.98 14.33 19.45 11.34
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Wells drilled - gross (net) 24 (24.0) 5 (4.1) 47 (47.0) 5 (4.1)
Net success rate (%) 100 100 98 100
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(1) "Funds flow from operations" and "funds flow from operations per
share", "net debt" and "netbacks" are not recognized measures under
Canadian generally accepted accounting principles ("GAAP") and should
not be considered more meaningful than measures determined under
Canadian GAAP. Moreover, the reader is cautioned that the Company's
calculations of these non-GAAP measures may not be directly
comparative to measures for other companies where similar terminology
is used. The methods of computation of these non-GAAP measures can
be found in the Company's related Management's Discussion and Analysis
for the three and nine months ended September 30, 2010 and 2009 under
the heading "Non-GAAP Measures."


(2) Due to the anti-dilutive effect of Emerge's net loss for all periods
presented, the diluted number of shares is equivalent to the basic
number of shares.


(3) Where amounts are expressed in barrels of oil equivalent ("boe"),
natural gas volumes have been converted to barrels of oil equivalent
on a basis of 6,000 cubic feet of natural gas to one barrel of oil
(6:1). The reader is cautioned that barrel of oil equivalent
("boe") amounts may be misleading, particularly if used in isolation.



Letter to Shareholders

Operational Review

Emerge was very active in Q3 2010, investing $28.3 million in our largest quarterly program to date despite continued periods of wet weather. The wet conditions resulted in municipal road bans being reinstated in some areas of greater Lloydminster which delayed moving our drilling and service rigs and also affected production as certain wells were shut in or slowed down to accommodate the road bans. Certain capital projects were delayed, including drilling and completions, production equipment setups, facilities construction and flowline projects, and accordingly these activities are expected to be completed in the coming months.

Emerge drilled 24 oil wells during the quarter with a 100% working interest and 100% success rate. This brings our total to the end of Q3 2010 to 47 (47.0 net) wells drilled with a 98% success rate. Initial production rates of 45 to 50 boe/d for the new wells are in line with management's expectations. Emerge has identified 260 drilling locations on its lands in the greater Lloydminster and Battlebend areas targeting multiple heavy and medium oil formations. To the date of this report, Emerge has completed its budgeted 55-well drilling program. The Company plans to drill an additional 9 to 12 wells in Q4 2010 to accelerate and ensure our Q1 2011 drilling program can be completed.

Emerge also continued with its well reactivation and optimization program in Q3 2010 with 52 reactivations/under-balanced foam stimulations performed during the quarter. The Company added approximately 870 boe/d from these under-balanced foam stimulations for an average of 17 boe/d of initial production per reactivation, which is in line with management's estimates. To date, Emerge has more than doubled production to 950 boe/d at its recently acquired Reward/Ear Lake property (from the 400 boe/d acquired in late June 2010) solely from reactivating standing wells using the under-balanced foaming technique. Emerge currently has 50 to 60 foam reactivation candidates in Reward/Ear Lake and approximately 185 reactivation candidates in its corporate inventory.

Emerge averaged 5,592 boe/d of production for Q3 2010, up 1,060 boe/d or 23% from 4,532 boe/d in Q2 2010. The first week of November has production averaging 6,600 boe/d based on field reports. Emerge plans to achieve average production of 5,200 to 5,400 boe/d for 2010 and is maintaining its forecasted 2010 exit production of 7,700 to 8,000 boe/d.

Emerge was very active on the facility construction front in Q3 2010. Three produced water disposal/injection facilities were commissioned at Freemont, Furness and Reward/Ear Lake. The Freemont facility is expected to have capacity to inject 9,500 bbl/d of produced water, the Furness facility is expected to have capacity to inject 8,500 bbl/d of produced water, and the Reward/Ear Lake injection facility has injection capacity of approximately 8,000 bbl/d. These disposal/injection facilities projects are anticipated to reduce our operating costs by $2.00 per boe in these areas.

Emerge invested in its undeveloped land base during the quarter through Crown sales and the farm-in announced in July, increasing our acreage position within existing core operating areas and establishing a position in new areas with significant exploration potential. As of November 1, 2010 Emerge has access to 148,483 gross acres and 118,674 net acres of land. Emerge also continued its 2D seismic programs for 2010 which are expected to be completed later this year.

To facilitate the rapid growth in the Company's production volumes, Emerge is continuing with the expansion of its Silverdale central oil battery increasing oil handling capacity to 12,000 bbl/d from 3,000 bbl/d currently. Emerge also commissioned the Silverdale sales pipeline into the Manitou pipeline system in early November. The sales pipeline was constructed by a third party at no capital cost to Emerge, but rather a small throughput volume commitment. Emerge has shipped volumes as high as 4,300 bbl/d down the line in the first week of service. All oil sales volumes were trucked to market prior to the commissioning of the line, and this pipeline is expected to lower operating costs and improve operating netbacks. Emerge will continue to truck sales oil from some of its areas to enter into different markets or where logistics make the economics more favourable.

Financial Review

Emerge executed an effective capital program including 24 (24.0 net) wells drilled with 100% success, 52 well reactivations and the completion of numerous production optimization and disposal facility projects. In total Emerge invested $28.3 million in Q3 2010, including $13.7 million in its drilling program (including completion and production equipment), $8.9 million in well reactivations and workovers, $3.5 million in facilities and $2.0 in land and seismic. These activities were successful in adding over 1,000 boe/d of average production from Q2 2010 to the Q3 2010 average of 5,592 boe/d and the Q3 2010 exit of approximately 5,900 boe/d. Emerge brought a significant number of wells onto production in the quarter to single-well batteries, which require produced volumes to build inventory before the heavy oil volumes can be trucked to sale. Accordingly, Q3 2010 average sales volumes of 4,993 boe/d lagged production volumes but represent solid growth of 12% from the previous quarter and 252% from the comparative quarter of 2009.

Emerge generated strong funds flow from operations of $7.3 million ($0.09 per share) in Q3 2010, representing a 14% improvement from $6.4 million ($0.08 per share) reported in Q2 2010. Revenues grew 11% on 12% higher sales volumes offset by slightly lower heavy oil prices. Heavy oil differentials (price discount of heavy crude to light crude) widened from August through October related to certain third party pipeline shutdowns and seasonal refinery turnarounds which created a backlog of Canadian heavy crude. These issues were resolved by late September and although the October WCS reference price remained weak at a 27% discount (WCS to C$ WTI), the differential has since recovered to the 18%-20% range. Emerge expects the heavy differential to average 18%-20% for the full year 2010, which compares favourably to historical levels. The price variance resulted in a slightly lower Q3 2010 operating netback of $19.33/boe as compared to Q2 2010, however lower G&A expenses resulted in an improved funds flow netback of $15.98/boe.

Emerge received an increase in its revolving operating credit facility to $50.0 million from $42.5 million previously, on substantially the same terms with its lender, reflecting production and reserve additions from the Company's 2010 capital program. This line is supplemented with a $10 million restricted acquisition/development credit facility with its lender, bringing total facilities to $60.0 million. Emerge also accessed the equity markets by entering into a bought deal equity financing in September 2010 to improve financial flexibility and support the Company's ongoing growth plans. The common share financing was completed with a group of underwriters on October 14, 2010 in which the Company raised $30.1 million gross (approximately $28.2 million net) proceeds through the issuance of 8.85 million shares at $3.40 per share. The funds were used to initially reduce bank debt and will subsequently be used to further the Company's capital plans and for general corporate purposes. Emerge's net debt is currently estimated at $25.0 million on total credit facilities of $60.0 million, and equates to 0.85 times trailing funds flow from operations. Emerge's solid balance sheet has positioned the Company to hit the ground running in the execution of its 2011 capital budget, details of which will be announced following board approval which is expected for later in Q4 2010.

On the risk management front, Emerge was successful in executing two financial commodity price hedges totalling 2,000 bbl/d for the calendar year 2011 at an average WCS heavy oil price of C$72.00/bbl. This represents an 8% premium to the 2010 year-to-date average WCS price of C$66.91/bbl, and is expected to reduce cash flow variability thereby protecting a portion of the Company's 2011 capital expenditure program.

Outlook

With the added financial resources from the Company's recently completed equity financing, the Company has received board approval to accelerate its Q1 2011 development plans into Q4 2010, thereby expanding its 2010 capital program by 9 to 12 drills, 20 to 30 reactivations and further expansion of the Silverdale central battery. Expansion of the battery, which is anticipated to be completed at the end of January 2011, is expected to be a key driver toward reducing our operating expenses in 2011. The Company now expects to drill a total of 64 to 67 wells and reactivate and recomplete 120 to 130 wells in 2010, with capital expenditures totalling approximately $85 million (including the $10 million property acquisition completed in Q2 2010). Based on the Company's exit guidance of 7,700 to 8,000 boe/d, Emerge will add production at an attractive cost of $15,000 to $20,000 per boe/d this year, highlighting the Company's compelling capital efficiencies.

The Company's plans for Q4 2010 include:

- Continue with phase III of our Silverdale oil battery expansion. Equipment has been procured and our 12' x 70' treater is under construction with completion estimated on or around January 31, 2011;

- Kick off construction of 34 kilometers of produced water gathering and fuel gas systems in Lashburn, Freemont, Silverdale and Reward/Ear Lake. These gathering systems are expected to reduce our operating costs by $3.00/boe and reduce truck traffic in these areas;

- Drill 17 to 20 wells targeting multiple heavy and medium oil zones in our greater Lloydminster and Battlebend areas;

- Continue with our 2010 standing well reactivating program, where we plan to reactivate 30 to 40 wells, largely using underbalanced foam stimulation;

- Complete our 2D seismic program for 2010. The seismic is to be shot, processed and interpreted through the remainder of Q4 2010 for our 2011 drilling program. Emerge has shot a total of 200 kilometers of 2D seismic data in 2010 and uses seismic extensively in picking our new drilling locations. Emerge expects to shoot an additional 52 kilometers of 2D data and 6 kilometers of 3D data by year-end.

Tom Greschner, Chairman, President and Chief Executive Officer

About Emerge Oil & Gas Inc.

Emerge is engaged in the exploration for and development and production of oil and natural gas in Western Canada. The Company currently operates within two principal areas, namely, the Lloydminster area of West-Central Saskatchewan and East-Central Alberta and the Battlebend area of East-Central Alberta. Emerge is headquartered in Calgary, Canada.

Barrel of Oil Equivalent

The Company may present petroleum and natural gas production and reserve volumes in barrel of oil equivalent ("boe") amounts. For purposes of computing such units, a conversion rate of 6,000 cubic feet of natural gas to one barrel of oil equivalent (6:1) is used. The conversion ratio of 6:1 is based on an energy equivalency conversion method which is primarily applicable at the burner tip and does not represent value equivalence at the wellhead. Readers are cautioned that boe figures may be misleading, particularly if used in isolation.

Forward-Looking Statements

Certain statements contained in this news release constitute "forward-looking statements" under applicable securities laws. These statements relate to future events or future performance and are based on the Company's current expectations, estimates, projections, assumptions and beliefs. Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, there can be no assurance that such expectations will prove to be correct. Accordingly, undue reliance should not be placed on these forward-looking statements. The use of any of the words "expect", "anticipate", "continue", "estimate", "objective", "ongoing", "may", "will", "project", "should", "believe", "plans", "intends" and similar expressions are intended to identify forward-looking statements. In particular, but without limiting the foregoing, this news release contains forward-looking information pertaining to the following: drilling, completion, reactivation, workover, facility, tie-in and other capital expenditure plans, including the timing of such plans; plans for facilities construction and timing of completion of such construction; anticipated production volumes and timing of commencement of production; drilling, completion, facility and other capital costs; methods of financing capital expenditures and ability to fund financial liabilities; use of proceeds from the Company's equity financing; supply and demand for the Company's products; prices for oil and natural gas, and in particular heavy oil; operating, transportation, general and administrative and other costs and expenses, and the Company's ability to reduce such costs; and expectations regarding the Company's ability to add reserves through exploration, development and acquisitions.

All such forward-looking statements involve known and unknown risks and uncertainties, certain of which are beyond the control of the Company. Such risks and uncertainties include, without limitation: risks associated with oil and natural gas exploration, development, exploitation, production, transportation and marketing; general economic conditions in North America and globally; changes in the demand for Emerge's products; volatility in market prices for oil and gas, and in particular heavy oil; unanticipated fluctuations or declines in production; the effects of adverse weather conditions; changes in foreign currency exchange and interest rates; changes in tax or environmental laws, royalty rates or other regulatory matters affecting the Company and its operations; inaccurate estimation of Emerge's oil and natural gas reserves; ability to attract and retain qualified personnel; increased debt levels or debt service requirements; limited, unfavorable or lack of access to capital markets; and the impact of competitors. The forward-looking statements contained in this news release are made as of the date hereof and the Company does not intend, and does not assume any obligation, to update or revise any forward-looking statements whether as a result of new information, future events or otherwise, except as required by applicable securities laws.

EMERGE OIL & GAS INC.

MANAGEMENT'S DISCUSSION AND ANALYSIS

Three and nine months ended September 30, 2010 and 2009 (unaudited)

The following Management's Discussion and Analysis ("MD&A"), which is dated November 10, 2010, should be read in conjunction with the Company's unaudited interim financial statements for the period ended September 30, 2010, the MD&A and unaudited interim financial statements for the period ended June 30, 2010, the MD&A and unaudited interim financial statements for the period ended March 31, 2010 and the MD&A and audited financial statements for the year ended December 31, 2009, all of which have been prepared in accordance with Canadian generally accepted accounting principles ("GAAP") and can be found on SEDAR at www.sedar.com. This MD&A compares the results of the three months ended September 30, 2010 ("Q3 2010") to the three months ended September 30, 2009 ("Q3 2009") and where meaningful, to the three months ended June 30, 2010 ("Q2 2010"). This MD&A also compares the results of the nine months ended September 30, 2010 ("YTD 2010") to the nine months ended September 30, 2009 ("YTD 2009"). All dollar amounts are stated in Canadian dollars unless otherwise indicated.

CAUTIONARY STATEMENT

Readers are cautioned that this MD&A should be read in conjunction with Company's advisories on BOE Conversion, Non-GAAP Measures and Forward-Looking Statements, which can be found at the end of this MD&A under the heading "Advisories."

OVERVIEW

Emerge is a growth-oriented junior oil and gas company operating in Saskatchewan and Alberta. The Company's business strategy is to acquire large oil and gas in-place assets with upside for production and reserves growth through low-risk well and facility optimization and development drilling. In executing this strategy, the Company has developed a concentrated asset base in two core focus areas: the Greater Lloydminster heavy oil region of west-central Saskatchewan and east-central Alberta, and the Battlebend medium oil area of east-central Alberta. The Company's 2010 capital budget is largely focused on drilling and optimization of the heavy oil properties in Greater Lloydminster. The Company's shares became listed for trading on the Toronto Stock Exchange on January 27, 2010 under the symbol "EME".

Emerge's growth in sales volumes for the most recent eight quarters is as follows:




(units as
noted, sales Q3 Q2 Q1 Q4 Q3 Q2 Q1 Q4
volumes) 2010 2010 2010 2009 2009 2009 2009 2008
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Oil and NGL (bbl/d) 4,839 4,404 4,078 2,232 1,121 653 69 105
Natural gas (mcf/d) 923 357 392 1,250 1,794 2,055 130 -
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Total (boe/d) 4,993 4,464 4,143 2,440 1,420 996 91 105
% oil and NGL 97% 99% 98% 91% 79% 66% 76% 100%
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RESULTS OF OPERATIONS


Production and Sales Volumes


Three months ended Nine months ended
September 30, September 30,
(units as noted) 2010 2009 2010 2009
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Average daily production
(boe/d) 5,592 1,420 4,893 840


Average daily sales by product
Oil and NGL (bbl/d) 4,839 1,121 4,443 618
Natural gas (mcf/d) 923 1,794 559 1,333
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Total (boe/d) 4,993 1,420 4,536 840
% oil and NGL 97% 79% 98% 74%
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Daily average production and sales volumes increased in Q3 2010 and YTD 2010 from the comparative periods of 2009 as the result of asset acquisitions in November 2009 (Lloydminster and Battlebend) and June 2010 (Ear Lake and Reward) and the subsequent development programs on these assets and on the Lloydminster assets acquired corporately from Ivory Energy Inc. in March 2009. The greater Lloydminster area contributed 88% of the Q3 2010 sales volumes with the Battlebend area contributing the remaining 12%. The increased composition of Emerge's production to oil and NGL in Q3 2010 and YTD 2010 reflects the divesture of the Company's non-operated Obed natural gas property in December 2009 which was Emerge's only significant natural gas property.

Sales volumes lagged production volumes by approximately 600 boe/d in Q3 2010 and 350 boe/d YTD 2010 due to inventory build arising from new heavy oil production. The majority of Emerge's heavy oil is first produced to 2-tank single-well batteries at the wellsite and is trucked to sales point when certain minimum levels are reached in the sales tank. The variance between production and sales volumes widened in Q3 2010 due to a large number of new wells coming onto production from the Company's drilling and reactivation programs coupled with temporary capacity constraints at certain sales terminals at the end of the quarter. Although certain minimum levels of inventory will continue to be maintained, the Company expects the production-sales variance to diminish over time as overall corporate volumes grow and excess oil in inventory is sold. The per boe calculations in this MD&A are calculated by dividing revenues and expenses by total sales volumes.

Q3 2010 production and sales volumes increased 23% and 12%, respectively, to 5,592 boe/d and 4,993 boe/d from 4,532 boe/d and 4,464 boe/d reported in Q2 2010 on account of the continued success of the Company's drilling and well reactivation programs.

Production at the date of this report is approximately 6,600 boe/d, based on field estimates. With additional production from drilling, reactivation and optimization activities planned for Q4 2010, Emerge expects that 2010 full year production will average approximately 5,200 to 5,400 boe/d with sales of 4,800 to 5,000 boe/d.




Pricing
Three months ended Nine months ended
September 30, September 30,
(units as noted) 2010 2009 2010 2009
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Company average realized prices
Oil and NGL ($/bbl) 60.05 62.07 62.39 60.58
Natural gas ($/mcf) 3.68 3.03 4.12 3.38
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Combined ($/boe) 58.88 52.82 61.62 49.92


C$/US$ exchange rate 0.9626 0.9117 0.9657 0.8580
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Reference average prices
Crude oil - WTI Cushing
(US$/bbl) 76.06 68.19 77.54 56.86
Crude oil - WTI Cushing
(C$/bbl) 79.02 74.79 80.29 66.27
Heavy oil - WCS (C$/bbl) 62.67 63.73 66.91 55.65
Natural gas - AECO C
Daily Spot (C$/mcf) 3.55 2.98 4.13 3.79
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Differentials
WCS to C$ WTI Cushing -21% -15% -17% -16%
Company realized oil &
NGL price to C$ WTI Cushing -24% -17% -22% -9%
Company realized oil &
NGL price to WCS -4% -3% -7% 9%
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Reference Prices

WTI light oil prices have remained strong and relatively stable YTD 2010 in the US$74/bbl to US$84/bbl range. WTI averaged US$76.06/bbl and US$77.54/bbl in Q3 2010 and YTD 2010, respectively, up from US$68.19/bbl and $56.86/bbl in the comparative periods of 2009.

Heavy oil prices were fairly stable in Q1 2010 but experienced some weakness in Q2 2010, and further variability late in Q3 2010 (and early Q4 2010) which was caused by the shutdown of two major pipelines in the United States by a third-party company, as well as third-party refinery/upgrader maintenance. Heavy oil differentials, representing the discount of heavy crude to light crude, widened from August to October but have since recovered to the 18%-20% range. Heavy differentials continue to remain low compared to historical levels, with the WCS to C$ WTI differentials averaging 21% and 17% in Q3 2010 and YTD 2010, respectively, as compared to 15% and 16% in the comparable periods of 2009.

Natural gas prices have remained weak throughout 2010 on the continued view of over-supply of the North American natural gas market. The AECO C Daily Spot price averaged $3.55/mcf and $4.13/mcf in Q3 2010 and YTD 2010, respectively, up slightly from $2.98/mcf and $3.79/mcf in the comparative periods of 2009.

Realized Prices

The majority of Emerge's production consists of heavy oil in the Lloydminster area of Saskatchewan and Alberta. Heavy oil sells at a discount to light oil due to the costs of blending and processing required for a heavy barrel. While the price the Company receives from its oil production is ultimately driven by changes in the price of WTI, the Company's realized price is more closely correlated to the WCS (Western Canadian Select) reference price for heavy crude. The quality of Emerge's heavy oil ranges from 12o to 16o API crude and accordingly the Company typically receives a slight discount to the WCS reference price which is based on 20.5o API crude. The Company's realized prices are reflected net of blending costs.

On a total boe basis, Emerge realized an overall price increase of 11% in Q3 2010 over Q3 2009 and 23% YTD 2010 over YTD 2009, reflecting a greater shift to oil production which has received more favourable pricing to natural gas.

Despite a higher WTI, Emerge's realized oil and NGL price decreased to $60.05/bbl in Q3 2010 from $62.07/bbl in Q3 2009 due to a stronger Canadian dollar and wider heavy differential. The Company's realized oil and NGL price increased YTD 2010 to $62.39/bbl from $60.58/bbl YTD 2009 due to higher average WTI prices. The Company's realized oil and NGL price declined a negligible 1% in Q3 2010 from $60.65/bbl realized in Q2 2010 on wider heavy differentials.

The Company may receive a premium or discount to the AECO reference price on its natural gas sales depending on the specific quality (heat-content) of the natural gas. Natural gas production represented only 3% of the Company's sales volumes in Q3 2010 and 2% of the Company's sales volumes YTD 2010, and accordingly natural gas sales in these periods were minimal.

All of the Company's sales were made on the spot market in 2009 and YTD 2010, and are expected to be made on the spot market for the remainder of 2010. Accordingly Emerge's realized prices are expected to continue to correlate to the reference prices throughout the remainder of 2010.

Risk Management

The Company may enter into hedging instruments from time to time to manage its exposure to commodity price volatility. Subsequent to Q3 2010, Emerge entered into two financial commodity price contracts totalling 2,000 bbl/d of 2011 production at an average swap price of C$72.00/bbl (WCS heavy oil price) thereby protecting a portion of the Company's cash flows for its 2011 capital expenditure program. Details of these contracts are as follows:




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Commodity Type Term Volume Price Index
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Heavy oil Fixed price Calendar 2011 1,000 bbl/d C$70.00/bbl WCS
Heavy oil Fixed price Calendar 2011 1,000 bbl/d C$74.00/bbl WCS
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Revenue
Three months ended Nine months ended
September 30, September 30,
($000) 2010 2009 2010 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Oil and NGL sales 26,735 6,399 75,679 10,226
Natural gas sales 312 500 628 1,229
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Total petroleum and
natural gas revenue 27,047 6,899 76,307 11,455
Other income 77 77 238 271
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Total revenue 27,124 6,976 76,545 11,726
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Petroleum and natural gas revenue increased 292% to $27.0 million in Q3 2010 from $6.9 million in Q3 2009 on a 252% increase in sales volumes combined with an 11% increase in realized price. Petroleum and natural gas revenue increased 566% to $76.3 million YTD 2010 from $11.5 million YTD 2009 on a 440% increase in sales volumes combined with a 23% increase in realized price.

Petroleum and natural gas revenue increased 11% in Q3 2010 from $24.4 million in Q2 2010 on 12% higher sales volumes offset by a 1% decline in realized price.

The Company generates other income at its water disposal facilities where it processes third party volumes, from time to time, for a contracted fee.




Royalties Expense
Three months ended Nine months ended
September 30, September 30,
($000, except per boe amounts) 2010 2009 2010 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Crown royalties 4,268 941 12,354 1,510
Freehold and gross overriding
royalties 1,124 286 3,104 479
----------------------------------------------------------------------------
Total royalties expense 5,392 1,227 15,458 1,989
$ Per boe 11.74 9.40 12.48 8.67
Royalties expense as a % of
petroleum and natural gas
revenue
Crown royalties 16% 14% 16% 13%
Freehold and gross overriding
royalties 4% 4% 4% 4%
----------------------------------------------------------------------------
Total royalty rate 20% 18% 20% 17%
----------------------------------------------------------------------------
----------------------------------------------------------------------------



Royalties are paid to mineral owners, which may include various governments (Crown), freehold landowners and other third parties by way of contractual overriding royalties. Royalty rates are generally dependent on commodity prices and well productivity, with a "sliding-scale" effect of generally lower rates applied in low commodity price environments and to lower-productivity wells. The majority of the Company's royalties consist of Crown royalties paid in Saskatchewan. Also included in Crown royalties is the Saskatchewan Resource Surcharge levied on resource sales in Saskatchewan which represents approximately 2% of the Crown royalty rate.

The increase in Emerge's total royalty rate to 20% in Q3 2010 and YTD 2010 from 18% and 17% in Q3 2009 and YTD 2009, respectively, reflects higher realized pricing and production rates in the 2010 periods. This is also the primary reason for the corresponding increases in expense on a per boe basis in the 2010 periods as compared to the 2009 periods.

Emerge's Q3 2010 royalty rate of 20% was relatively consistent with the 21% royalty rate reported in Q2 2010, and the Company anticipates its royalty rate to remain in the 20%-25% range for the remainder of 2010 given its production profile and commodity price outlook.




Operating and Transportation Expenses

Three months ended Nine months ended
September 30, September 30,
($000, except per boe amounts) 2010 2009 2010 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Operating expenses 11,420 2,844 28,600 4,968
Transportation expenses 1,355 419 3,695 609
----------------------------------------------------------------------------
Total operating and transportation
expenses 12,775 3,263 32,295 5,577


$ Per boe
Operating expenses 24.86 21.77 23.09 21.65
Transportation expenses 2.95 3.21 2.98 2.65
----------------------------------------------------------------------------
Total operating and
transportation expenses 27.81 24.98 26.07 24.30
----------------------------------------------------------------------------
----------------------------------------------------------------------------



The most significant components of Emerge's operating expenses are trucking water and emulsion, fuel and power, equipment maintenance and repairs, and well servicing and minor workovers.

Q3 2010 operating expenses increased 14% to $24.86/boe from $21.77/boe in Q3 2009, and are up 3% from $24.17/boe in Q2 2010 due to the start-up of new heavy oil operations at Ear Lake and Reward and increased well servicing and maintenance costs on existing heavy oil wells. By the end of Q3 2010, the Ear Lake and Reward areas were running more efficiently and coupled with the production growth, the Company expects to see lower operating costs for this area in Q4 2010. YTD 2010 operating costs increased 7% to $23.09/boe from $21.65/boe YTD 2009 on account of higher trucking and well servicing costs.

The Company incurs transportation expenses to transport its products to their respective points of sale. These expenses include clean oil trucking, pipeline tariffs for oil and NGL transportation and gas transportation fees. Q3 2010 transportation expenses decreased 8% to $2.95/boe from $3.21/boe in Q3 2009, and are down 7% from $3.17/boe in Q2 2010 due to lower clean oil trucking costs, which vary depending on distances trucked, trucking rates charged by carriers and wait times at terminals.

The Company's capital projects aimed at reducing operating and transportation costs were delayed in Q3 2010 due to continued periods of wet weather. The sales line at Emerge's Silverdale central battery which was scheduled to be commissioned by a third party in early September 2010 was instead completed in early November 2010, and is expected to reduce oil trucking costs. The expansion of Emerge's Silverdale central battery is now scheduled to be completed early in Q1 2011, and is expected to reduce trucking and treating costs. The Company is also planning flow-line construction for later in Q4 2010 in certain fields, which is expected to reduce water trucking costs.




General and Administrative Expenses

Three months ended Nine months ended
September 30, September 30,
($000, except per boe amounts) 2010 2009 2010 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Gross expenses 1,909 894 5,415 2,178
Capitalized amounts (602) (280) (1,261) (620)
----------------------------------------------------------------------------
Net general and administrative
expenses 1,307 614 4,154 1,558


$ Per boe
Gross expenses 4.16 6.85 4.37 9.49
Capitalized amounts (1.31) (2.15) (1.02) (2.70)
----------------------------------------------------------------------------
Net general and administrative
expenses 2.85 4.70 3.35 6.79
----------------------------------------------------------------------------
----------------------------------------------------------------------------



The main components of the Company's general and administrative ("G&A") expenses are salaries and benefits, office rent, computer services and licenses, consulting fees and professional fees.

Gross G&A expenses increased in the 2010 periods from the comparative 2009 periods due to higher staff levels required to execute the Company's growth and the associated higher compensation levels in 2010 relative to 2009. Gross G&A expenses decreased on a per boe basis in the 2010 periods from the 2009 comparative periods due to higher sales volumes. Q3 2010 gross G&A expenses decreased 4% on an absolute basis and 2% on a per boe basis from $2.0 million and $4.24/boe reported in Q2 2010, respectively, due to lower credit facility renewal and professional fees, and higher sales volumes.

The Company capitalizes certain general and administrative expenses related to exploration and development activities. Emerge capitalizes a portion of salaries and benefits directly related to its exploration and development department, and charges an industry standard overhead rate per capital project to capitalize a portion of engineering, land, accounting and operations time spent on capital projects. Capitalized amounts increased in the 2010 periods from the comparative 2009 periods resulting from increased staff levels and capital activity, and capitalized amounts decreased on a per boe basis in the 2010 periods from the 2009 comparative periods resulting from higher sales volumes. The Company capitalized a proportionately higher amount of its gross expenses in Q3 2010 as compared to Q2 2010 due to increased capital activity.




Interest Expense
Three months ended Nine months ended
September 30, September 30,
($000, except per boe amounts) 2010 2009 2010 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Interest expense 308 - 574 -
$ Per boe 0.67 - 0.46 -
----------------------------------------------------------------------------
----------------------------------------------------------------------------



Interest expense is incurred on Emerge's bank borrowings and is determined by the level of bank debt carried by the Company, the bank's prime lending rate and the Company's credit spread.

Q3 2010 interest expense increased 81% to $0.31 million from $0.17 million recorded in Q2 2010 due to higher average debt levels and higher interest rates. Emerge had $40.4 million of bank debt outstanding at September 30, 2010 as compared to $29.6 million outstanding at June 30, 2010. The Company's effective interest rate increased to 3.7% in Q3 2010 as compared to 3.2% in both Q2 2010 and Q1 2010. Emerge had no interest expense in Q3 2009 and YTD 2009 as it had no bank debt.




Netbacks
Three months ended Nine months ended
September 30, September 30,
($ Per boe) 2010 2009 2010 2009
----------------------------------------------------------------------------
Average realized sales price 58.88 52.82 61.62 49.92
Royalties expense (11.74) (9.40) (12.48) (8.67)
Operating expenses (24.86) (21.77) (23.09) (21.65)
Transportation expenses (2.95) (3.21) (2.98) (2.65)
----------------------------------------------------------------------------
Operating netback 19.33 18.44 23.07 16.95
Other income 0.17 0.59 0.19 1.18
General and administrative
expenses (2.85) (4.70) (3.35) (6.79)
Interest expense (0.67) - (0.46) -
----------------------------------------------------------------------------
Funds flow netback 15.98 14.33 19.45 11.34
----------------------------------------------------------------------------
----------------------------------------------------------------------------



Emerge's Q3 2010 and YTD 2010 operating netbacks improved to $19.33/boe and $23.07/boe, respectively, from $18.44/boe and $16.95/boe in Q3 2009 and YTD 2009 on account of higher commodity prices. The Company's Q3 2010 operating netback was down 4% from $20.23/boe recorded in Q2 2010 on slightly lower prices and higher operating costs per boe.

Emerge's Q3 2010 and YTD 2010 funds flow netbacks improved to $15.98/boe and $19.45/boe, respectively, from $14.33/boe and $11.34/boe in Q3 2009 and YTD 2009 on account of lower general and administrative expenses offset by lower interest income and higher interest expense per boe. The Company's Q3 2010 funds flow netback was up 1% from $15.78/boe recorded in Q2 2010 on lower general and administrative expenses per boe.




Stock-based Compensation Expense


Three months ended Nine months ended
September 30, September 30,
($000, except per boe amounts) 2010 2009 2010 2009
----------------------------------------------------------------------------
Gross expense 677 175 1,631 476
Capitalized (92) (60) (256) (176)
----------------------------------------------------------------------------
Net stock-based compensation expense 585 115 1,375 300
$ Per boe 1.27 0.88 1.11 1.31
----------------------------------------------------------------------------
----------------------------------------------------------------------------



Stock-based compensation expense, which is a non-cash expense, represents the straight-line amortization of the expense associated with the fair value of stock options granted under the Company's stock option plan. The fair value of the option grants is calculated using the Black-Scholes option pricing model at the grant date, incorporating the following assumptions: expected life of stock options; vesting period of stock options; expected stock price volatility; risk-free interest rate; and expected dividend yield.

Net stock-based compensation expense increased on an absolute basis to $0.6 million and $1.4 million in Q3 2010 and YTD 2010, respectively, from $0.1 million and $0.3 million in Q3 2009 and YTD 2009. The increases in both 2010 periods reflect a larger number of stock options granted, higher calculated fair values and the continuing amortization of expense related to all options granted in previous 2009 and 2008 periods. The decrease in net stock-based compensation expense on a per boe basis in the 2010 periods over the 2009 periods reflects higher sales volumes.

The following table presents the weighted-average assumptions used in determining the fair value of stock option grants:




Three months ended Nine months ended
September 30, September 30,
(units as noted) 2010 2009 2010 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Number of stock options
granted 675,000 - 4,330,000 790,000
Expected life of stock
options (years) 5 - 5 5
Vesting period of stock
options (years) 3 - 3 3
Expected volatility (%) 63.8 - 64.1 70.0
Risk-free interest rate (%) 2.1 - 2.4 2.0
Expected dividend yield (%) - - - -
----------------------------------------------------------------------------
Calculated fair value per
option ($) 1.82 - 1.46 0.59
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Depletion, Depreciation and Accretion Expense


Three months ended Nine months ended
September 30, September 30,
($000, except per boe amounts) 2010 2009 2010 2009
----------------------------------------------------------------------------
Depletion and depreciation
expense 12,066 2,633 36,376 4,452
Accretion of asset retirement
obligations 389 65 1,033 136
----------------------------------------------------------------------------
Total depletion, depreciation
and accretion expense 12,455 2,698 37,409 4,588


$ Per boe
Depletion and depreciation
expense 26.27 20.16 29.38 19.40
Accretion of asset retirement
obligations 0.84 0.50 0.83 0.59
----------------------------------------------------------------------------
Total depletion, depreciation
and accretion expense 27.11 20.66 30.21 19.99
----------------------------------------------------------------------------
----------------------------------------------------------------------------



Depletion and depreciation expense related to oil and gas assets is calculated using the unit-of-production method and is based on capital expenditures, production and proved reserves. The Company estimates depletion and depreciation on a quarterly basis using management estimates and independent inputs (such as reserve reports) when available.

Depletion and depreciation expense increased to $12.1 million or $26.27/boe in Q3 2010 from $2.6 million or $20.16/boe in Q3 2009. Depletion and depreciation expense increased to $36.4 million or $29.38/boe YTD 2010 from $4.5 million or $19.40/boe YTD 2009. The increase on an absolute basis in both 2010 periods reflects significantly higher production, proved reserves and depletable costs. The increase on a per boe basis reflects the Company's property acquisitions in November 2009 and June 2010 which carried a higher cost per proved barrel compared to the Company's existing properties. Emerge added both proved and probable reserves to its asset base on these acquisitions but only recognizes proved reserves for purposes of the depletion calculation.

The Company's depletion and depreciation rate decreased 11% to $26.27/boe in Q3 2010 from $29.50/boe in Q2 2010 due to an increase in estimated proved reserves additions arising from the Company's drilling and well reactivation programs.

The present value of the Company's asset retirement obligations is reported on the Company's balance sheet and is increased each reporting period due to the passage of time and the amount of accretion is charged to the statement of operations in the period. Accretion expense increased to $0.4 million or $0.84/boe in Q3 2010 from $0.07 million or $0.50/boe in Q3 2009. Accretion expense increased to $1.0 million or $0.83/boe YTD 2010 from $0.1 million or $0.59/boe YTD 2009. The increase on an absolute basis in both 2010 periods is due to a greater number of wells and facilities subject to abandonment. The increase on a per boe basis primarily reflects the additional accretion expense related to abandoning certain wells and facilities acquired in the Company's November 2009 and June 2010 property acquisitions with no associated production volumes.

Taxes

Emerge did not incur cash income tax in YTD 2010 or 2009. The Company does not expect to pay cash income taxes in 2010 or 2011 based on current commodity prices, existing tax pools, planned capital expenditures and forecast taxable income. Taxes payable beyond 2011 will primarily be a function of capital expenditures and cash flows. At September 30, 2010, Emerge had estimated tax pools of approximately $205 million, as follows:




Maximum annual
Classification Amount ($000) deduction
----------------------------------------------------------------------------
Canadian oil and gas property expense (COGPE) 78,007 10%
Canadian development expense (CDE) 26,390 30%
Canadian exploration expense (CEE) 8,320 100%
Undepreciated capital cost (UCC) 53,221 Primarily 25%
Non-capital losses (expire between 2010 and 2029) 12,058 100%
SR&ED and ITC (1) 21,977 100%
Share issue costs and other 4,823 20%
----------------------------------------------------------------------------
204,796
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) "SR&ED" = "Scientific Research and Experimental Development";
"ITC" = "Investment Tax Credits"



The Company has calculated a future income tax asset on the value of its tax pools, however no tax asset has been recorded in the financial statements as the Company does not believe it currently meets the recognition criteria of the losses being utilized as "more likely than not."




Funds Flow from Operations and Net Loss


Three months ended Nine months ended
($000, except share September 30, September 30,
and per share amounts) 2010 2009 2010 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Cash flow from operating
activities - GAAP 9,425 1,695 25,197 1,319
Changes in non-cash operating
working capital (2,267) 177 (1,453) 1,283
Asset retirement expenditures 184 - 320 -
----------------------------------------------------------------------------
Funds flow from operations
- Non-GAAP 7,342 1,872 24,064 2,602
Per share - basic and diluted 0.09 0.04 0.29 0.06


Net loss (5,698) (941) (14,720) (2,286)
Per share - basic and diluted (0.07) (0.02) (0.18) (0.05)


Weighted average common
shares outstanding (1)
Basic and diluted (2) 83,070,245 41,700,100 83,009,117 41,700,100
----------------------------------------------------------------------------
----------------------------------------------------------------------------


(1) In accordance with Canadian accounting guidelines, the weighted average
number of the Company's special warrants outstanding is included in the
calculation of weighted average basic common shares outstanding in the
YTD 2010 period.


(2) Due to the anti-dilutive effect of Emerge's net loss in all periods
presented, the diluted number of shares is equivalent to the basic
number of shares.



Q3 2010 funds flow from operations increased to $7.3 million or $0.09 per share from $1.9 million or $0.04 per share in Q3 2009. YTD 2010 funds flow from operations increased to $24.1 million or $0.29 per share from $2.6 million or $0.06 per share YTD 2009. The increase in funds flow from operations in both 2010 periods reflects higher production levels and corresponding net revenues after cash costs. Q3 2010 funds flow from operations increased 14% from $6.4 million ($0.08 per share) in Q2 2010 on 12% higher sales volumes combined with a 1% improvement in funds flow netback.

The Company's Q3 2010 net loss increased to $5.7 million or $0.07 per share from $1.0 million or $0.02 per share in Q3 2009. The Company's YTD 2010 net loss increased to $14.7 million or $0.18 per share from $2.3 million or $0.05 per share YTD 2009. The increase in net loss in both periods reflects higher depletion, depreciation, accretion and stock-based compensation expenses. The Company's Q3 2010 net loss decreased 10% from $6.4 million ($0.08 per share) in Q2 2010 on increased funds flow.




Capital Expenditures
Three months ended Nine months ended
September 30, September 30,
($000) 2010 2009 2010 2009
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Land and lease 1,532 1,132 3,936 1,681
Geological and seismic 447 640 840 696
Drilling and completions 8,330 2,144 14,704 2,553
Workovers and recompletions 4,553 1,251 9,356 2,526
Well equipment 9,784 2,884 17,900 4,349
Facilities and gathering systems 3,472 1,331 4,173 2,262
Other 160 214 739 572
----------------------------------------------------------------------------
Exploration and development
expenditures 28,278 9,596 51,648 14,639
Property acquisitions
(net of dispositions) (1) - - 9,694 178
Corporate acquisition (2) - - - 21,631
----------------------------------------------------------------------------
Total capital expenditures 28,278 9,596 61,342 36,448
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(1) Amounts are net of post-closing adjustments


(2) Represents total cost of the acquisition, including consideration paid
and net debt assumed



The majority of the Company's $28.3 million of capital expenditures in Q3 2010 were invested in the Company's drilling and well reactivation programs. Emerge invested $13.7 million in the drilling, completion and equipping of 24 (24.0 net) oil wells in the Company's greater Lloydminster focus area at Epping, Lashburn, Silverdale, Furness and Maidstone. Emerge invested a further $8.9 million (including related well equipment) in 52 wells in the Company's well reactivation and optimization program, largely spent at the Company's new Ear Lake and Reward fields. The Company also incurred $3.5 million on disposal well facilities at Freemont and Furness and preliminary costs on the Silverdale central oil battery expansion. The Company incurred only $9.6 million of capital expenditures in Q3 2009 due to an overall smaller asset base, including only 5 (4.1 net) drills.

Capital expenditures totalled $61.3 million YTD 2010 consisting of $51.6 million invested in Emerge's exploration and development program and the $9.9 million Ear Lake/Reward property acquisition in June 2010 offset by a small $0.2 million property disposition in January 2010. The most significant components of the YTD 2010 expenditures include $23.6 million on the drilling of 47 (47.0 net) oil wells and completion and equipping costs of 46 (46.0 net) wells drilled in the YTD 2010 period, plus $18.4 million (including related well equipment) incurred on well reactivations, recompletions and optimizations. The most significant component of the Company's $36.4 million of total capital expenditures in YTD 2009 was the $21.6 acquisition cost of Ivory Energy Inc. in March 2009.




Emerge's drilling results are as follows:


Oil Gas D&A Total Net success
Gross Net Gross Net Gross Net Gross Net rate (%)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Q1 2010 17 17.0 - - 1 1.0 18 18.0 94
Q2 2010 5 5.0 - - - - 5 5.0 100
Q3 2010 24 24.0 - - - - 24 24.0 100
----------------------------------------------------------------------------
Total September
30, 2010 46 46.0 - - 1 1.0 47 47.0 98
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Q1 2009 - - - - - - - - -
Q2 2009 - - - - - - - - -
Q3 2009 4 4.0 1 0.1 - - 5 4.1 100
Q4 2009 14 14.0 - - - - 14 14.0 100
----------------------------------------------------------------------------
Total 2009 18 18.0 1 0.1 - - 19 18.1 100
----------------------------------------------------------------------------
----------------------------------------------------------------------------



The Company has drilled a further 10 wells subsequent to September 30, 2010, bringing the total to 57 wells drilled to date.

Emerge reviewed its capital assets at September 30, 2010 for indicators of impairment, and it was determined that there was no impairment of the Company's capital assets at September 30, 2010.

COMMITMENTS

The Company is committed under operating leases for office space, office equipment and vehicles. Emerge does not occupy all of the office space it leases and has sublet excess space to arms' length parties on a basis that recovers a portion of its rental costs. At September 30, 2010, the Company is committed to future payments under operating leases as follows:




----------------------------------------------------------------------------
----------------------------------------------------------------------------
Year: Oct.-Dec.
($000) 2010 2011 2012 2013 2014 Thereafter
----------------------------------------------------------------------------
Office space
Gross lease payments (including
an estimate of operating costs) 365 1,448 1,415 1074 924 77
Sublease recoveries (96) (379) (379) (95) - -
----------------------------------------------------------------------------
Net lease payments 269 1,069 1,036 979 924 77
Office equipment and vehicles 21 57 23 9 - -
----------------------------------------------------------------------------
Total 290 1,126 1,059 988 924 77
----------------------------------------------------------------------------
----------------------------------------------------------------------------



RELATED PARTY TRANSACTIONS

The Company's Corporate Secretary and director is a partner at a law firm that provides legal services to the Company. Emerge incurred $7 thousand and $0.2 million in Q3 2010 and YTD 2010, respectively, on services obtained from the firm, which is included in general and administrative expenses and share issuance costs in the financial statements. These services are conducted in the normal course of business operations and are measured at the exchange amount, which is established and agreed to by the related parties based on standard rates, time spent and costs incurred. At September 30, 2010, accounts payable and accrued liabilities included $nil (December 31, 2009: $0.4 million) relating to these services. Emerge expects to continue using the firm's services in the future.

LIQUIDITY AND CAPITAL RESOURCES

In order to support the Company's growth-oriented business plan, Emerge's strategy is to fund its capital expenditure program with cash flows from operating activities, bank debt and equity financings to the extent required and available.

Bank Debt

At September 30, 2010 and at the date of this report, the Company has credit facilities totalling $60.0 million with a Canadian chartered bank. The facilities are comprised of a $50.0 million revolving operating demand loan facility bearing interest at the bank's prime rate plus a range of 0.75% to 2.50% per annum, and a $10.0 million non-revolving acquisition/development demand loan facility bearing interest at the bank's prime rate plus a range of 1.25% to 3.00% per annum. The range of interest rates on the facilities are based on a grid system which is dependent on the Company's trailing debt to funds flow ratios ranging from less than 1.0:1 to greater than 3.0:1. The Company also incurs standby fees on the undrawn portion of the facilities of 0.20% to 0.45% per annum based on the same grid system, and both interest and standby fees are payable monthly. The facilities are secured by a general assignment of book debts and a $100 million debenture with a floating charge over all assets of the Company with a negative pledge and undertaking to provide fixed charges on the Company's producing properties at the request of the bank. At September 30, 2010, the Company had bank debt outstanding of $40.4 million.

The Company's facilities were increased to $60.0 million in Q3 2010 from $52.5 million available in Q2 2010 as a result of the Company's scheduled semi-annual review with its lender. The next review is scheduled for February 2011 upon completion of the Company's external reserves evaluation. As the available lending limits of the facilities are based on the bank's interpretation of the Company's reserves and future commodity prices there can be no assurance as to the amount of available facilities that will be determined at each scheduled review.

The Company's credit facilities include certain financial and non-financial covenants, including maintaining a Working Capital Ratio of at least 1.0:1. The calculation of Working Capital Ratio is defined in the credit facility agreement, and the Company is in compliance with the ratio at the date of this report.

Working Capital

The Company defines its working capital to be the net balance of current assets and current liabilities excluding bank debt. At September 30, 2010, the most significant component of the Company's current assets is accounts receivable from marketers in respect of the Company's oil and natural gas sales for the month of September 2010, and these receivables were subsequently collected on October 25, 2010. The most significant component of the Company's current liabilities are trade payables and capital and operating cost accruals, and these amounts are generally paid within 45 days of the invoice date. At September 30, 2010, the Company had a working capital deficiency of $12.4 million. Emerge expects to have a continued working capital deficiency to support ongoing capital expenditures.

Net Debt

The Company uses the term "net debt" to combine its working capital with its bank debt position to analyze total net debt. Emerge's net debt at September 30, 2010 was $52.8 million ($40.4 million of bank debt plus a $12.4 million working capital deficiency) compared to credit facilities totalling $60.0 million. The Company targets a net debt to annualized funds flow from operations of no more than 2.0:1, and at September 30, 2010, the Company's net debt to Q3 2010 annualized funds flow from operations was within this range at 1.8:1.




The following table summarizes changes in Emerge's net debt:


Nine months ended Year ended
($000) September 30, 2010 December 31, 2009
----------------------------------------------------------------------------
Net debt (surplus), beginning of period 15,725 (28,587)
Funds flow from operations (24,064) (4,966)
Capital expenditures (cash portion) 61,342 88,960
Issuance of capital stock for cash
(net of issuance costs) 249 (61,337)
Asset retirement expenditures 320 -
Non-cash portion of inventory valuation (814) -
Corporate acquisition - 9,584
Net debt acquired on corporate acquisition - 12,071
----------------------------------------------------------------------------
Net debt, end of period 52,758 15,725
----------------------------------------------------------------------------
----------------------------------------------------------------------------



Emerge's net debt was subsequently reduced to approximately $25 million in mid-October following the Company's equity financing as described below. In light of the equity financing, Emerge anticipates a Q4 2010 capital program of $12 to $18 million which the Company currently plans to finance from anticipated funds flow from operations of $10 million with the remainder financed with bank debt. The Company currently has approximately $25 million of available room on its revolving operating credit facility, and has a $10 million acquisition/development line (available for specified expenditures) which is currently undrawn.

Equity

Emerge entered into a bought deal equity financing agreement in September 2010 upon review of its growth plans and to provide additional financial flexibility. On October 14, 2010, the Company closed the bought deal equity financing with a group of underwriters (the "Underwriters"), by way of a short form prospectus in which the Underwriters sold 8.85 million common shares at $3.40 per share for gross proceeds of $30.1 million. The net proceeds of approximately $28.2 million (after Underwriters fees and other issuance costs) were used by the Company to initially reduce bank debt and subsequently to fund the Company's capital program and for general corporate purposes.

The Company's equity structure currently consists of common shares outstanding and stock options outstanding to acquire common shares on a one for one basis. The weighted average exercise price of the Company's 7.4 million stock options outstanding at September 30, 2010 was $1.90 per share. At September 30, 2010, 1.8 million stock options were exercisable (vested) at a weighted average exercise price of $0.79/share. Further details of Emerge's equity structure are presented below:




Common Shares Number
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Balance, December 31, 2009 50,200,100
Conversion of special warrants to common shares 32,775,000
Issued for cash on exercise of stock options 101,667
----------------------------------------------------------------------------
Balance, September 30, 2010 83,076,767
Issued for cash on exercise of stock options 266,666
----------------------------------------------------------------------------
Balance, November 10, 2010 83,343,433
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Special Warrants Number
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Balance, December 31, 2009 32,775,000
Conversion of special warrants to common shares (32,775,000)
----------------------------------------------------------------------------
Balance, September 30, 2010 and November 10, 2010 -
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Stock Options Number
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Balance, December 31, 2009 3,910,000
Granted 4,330,000
Exercised (101,667)
Forfeited (729,333)
----------------------------------------------------------------------------
Balance, September 30, 2010 7,409,000
Granted 120,000
Exercised (266,666)
Forfeited -
----------------------------------------------------------------------------
Balance, November 10, 2010 7,262,334
----------------------------------------------------------------------------
----------------------------------------------------------------------------


OFF-BALANCE SHEET ARRANGEMENTS


The Company has no off-balance sheet arrangements.


SELECTED QUARTERLY INFORMATION
Q3 Q2 Q1
(units as noted) 2010 2010 2010
----------------------------------------------------------------------------
----------------------------------------------------------------------------
FINANCIAL
Petroleum and natural gas revenue
($000) 27,047 24,423 24,837
----------------------------------------------------------------------------
Funds flow from operations ($000) 7,342 6,412 10,309
Per share - basic and diluted ($) 0.09 0.08 0.12
----------------------------------------------------------------------------
Net loss ($000) (5,698) (6,357) (2,665)
Per share - basic and diluted ($) (0.07) (0.08) (0.03)
----------------------------------------------------------------------------
Weighted average common shares
Basic and diluted (000) 83,070 82,981 82,975
----------------------------------------------------------------------------
Securities outstanding (000)
Common shares 83,077 83,042 82,975
Special warrants - - -
Stock options 7,409 6,929 6,535
----------------------------------------------------------------------------
Capital expenditures ($000) 28,278 20,886 14,655
Total assets ($000) 173,345 154,731 146,813
Net debt (surplus) ($000) 52,758 31,803 19,064
----------------------------------------------------------------------------
----------------------------------------------------------------------------
OPERATING
Daily average sales volumes (boe/d) 4,993 4,464 4,143
----------------------------------------------------------------------------
OPERATING NETBACK ($/boe)
Petroleum and natural gas revenue 58.88 60.13 66.61
Royalties expense (11.74) (12.56) (13.32)
Operating expenses (24.86) (24.17) (19.74)
Transportation expenses (2.95) (3.17) (2.83)
Operating netback 19.33 20.23 30.72
----------------------------------------------------------------------------
Wells drilled - gross (net) 24 (24.0) 5 (5.0) 18 (18.0)
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Q4 Q3 Q2 Q1 Q4
(units as noted) 2009 2009 2009 2009 2008
----------------------------------------------------------------------------
----------------------------------------------------------------------------
FINANCIAL
Petroleum and natural gas revenue
($000) 13,415 6,899 4,264 292 393
----------------------------------------------------------------------------
Funds flow from operations ($000) 2,363 1,872 967 (237) (124)
Per share - basic and diluted ($) 0.04 0.05 0.02 (0.00) (0.00)
----------------------------------------------------------------------------
Net loss ($000) (4,189) (941) (849) (496) (391)
Per share - basic and diluted ($) (0.08) (0.03) (0.02) (0.01) (0.01)
----------------------------------------------------------------------------
Weighted average common shares
Basic and diluted (000) 56,057 41,700 41,700 41,700 41,700
----------------------------------------------------------------------------
Securities outstanding (000)
Common shares 50,200 41,700 41,700 41,700 41,700
Special warrants 32,775 - - - -
Stock options 3,910 3,490 3,490 2,900 2,700
----------------------------------------------------------------------------
Capital expenditures ($000) 100,991 9,722 4,212 25,137 273
Total assets ($000) 141,147 42,164 38,353 38,714 32,731
Net debt (surplus) ($000) 15,725 5,282 (2,449) (5,622) (28,587)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
OPERATING
Daily average sales volumes
(boe/d) 2,440 1,420 996 91 105
----------------------------------------------------------------------------
OPERATING NETBACK ($/boe)
Petroleum and natural gas revenue 59.75 52.82 47.03 35.61 40.54
Royalties expense (13.26) (9.40) (7.72) (7.53) (5.88)
Operating expenses (25.60) (21.77) (20.80) (29.19) (38.26)
Transportation expenses (3.99) (3.21) (1.84) (2.82) (1.53)
Operating netback 16.90 18.44 16.67 (3.93) (5.13)
----------------------------------------------------------------------------
Wells drilled - gross (net) 14 (14.0) 5 (4.1) - - -
----------------------------------------------------------------------------
----------------------------------------------------------------------------



OUTLOOK

The Company's plans for Q4 2010 include:

- Drill 17 to 20 wells targeting multiple heavy and medium oil zones in our greater Lloydminster and Battlebend areas;

- Continue with our 2010 standing well reactivating program, where we plan to reactivate 30 to 40 wells, largely using underbalanced foam stimulation;

- Continue with phase III of our Silverdale oil battery expansion. Equipment has been procured and our 12' x 70' treater is under construction with completion estimated on or around January 31, 2011;

- Kick off construction of 34 kilometers of produced water gathering systems in Lashburn, Freemont, Silverdale and Reward/Ear Lake. These gathering systems are expected to reduce our operating costs by $3.00/boe and reduce truck traffic in these areas; and

- Complete our 2D seismic program for 2010. The seismic is to be shot, processed and interpreted through the remainder of Q4 2010 for our 2011 drilling program. Emerge has shot a total of 200 kilometers of 2D seismic data in 2010 and uses seismic extensively in picking our new drilling locations. Emerge expects to shoot an additional 52 kilometers of 2D data and 6 kilometers of 3D data by year-end.

DISCLOSURE CONTROLS AND PROCEDURES

Emerge's disclosure controls and procedures ("DC&P"), as defined in National Instrument 52-109, have been designed by the Company's Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), or caused to be designed under their supervision, to provide reasonable assurance that information required to be disclosed by the Company in its annual filings, interim filings and other reports filed or submitted under securities legislation is recorded, processed and reported within the time periods specified in the securities legislation. DC&P include those controls and procedures designed to ensure that information required to be disclosed by Emerge in its annual filings, interim filings and other reports filed or submitted under securities legislation is communicated to the Company's management, including its certifying officers, as appropriate to allow timely decisions regarding required disclosure. The Company has evaluated the design of its DC&P and has concluded that its D&CP have been properly designed at September 30, 2010. It should be noted that while the Company's CEO and CFO believe that DC&P provide a reasonable level of assurance that they are designed appropriately, they do not expect that the DC&P would prevent all error 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

Emerge's internal controls over financial reporting ("ICOFR"), as defined in National Instrument 52-109, have been designed by the Company's CEO and CFO, or caused to be designed under their supervision, to provide reasonable assurance that all assets are safeguarded, transactions are appropriately authorized and to facilitate the preparation of relevant, reliable and timely information resulting in the preparation of financial statements for external purposes which are in accordance with Canadian GAAP. The Company has evaluated the design of its ICOFR and has concluded that its ICOFR have been properly designed at September 30, 2010. It should be noted that, because of their inherent limitations, ICOFR may not prevent or detect misstatements, errors or 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.

The Board of Directors and Audit Committee have reviewed and approved the interim financial statements and this MD&A.

CHANGES IN ACCOUNTING POLICIES

There have been no newly adopted accounting policies or changes in accounting policies from those outlined in the Company's annual financial statements for the year ended December 31, 2009, other than the adoption of the Company's crude oil inventory policy as disclosed in the notes to the interim financial statements for the three and nine months ended September 30, 2010.

FUTURE CHANGES IN ACCOUNTING POLICIES

International Financial Reporting Standards

On January 1, 2011, International Financial Reporting Standards ("IFRS") will become the generally accepted accounting principles in Canada. The adoption date of January 1, 2011 will require the restatement, for comparative purposes, of amounts reported by Emerge for the year ended December 31, 2010, including the opening balance sheet as at January 1, 2010. Although IFRS is principles-based and uses a conceptual framework similar to current Canadian GAAP, there are significant differences and choices in accounting policies as well as increased disclosure requirements under IFRS. As a result, the transition from current Canadian GAAP to IFRS is a significant undertaking that may materially affect the Company's reported financial position and results of operations.

The transition to IFRS includes the following three key phases: scoping and diagnostic; impact analysis and evaluation; and implementation. A wholesome description of these phases and the Company's progress to the end of 2009 is contained within Emerge's MD&A for the year ended December 31, 2009.

Emerge has completed the scoping and diagnostic phase and is in the final stages of completing the impact analysis and evaluation phase. During Q3 2010, the Company made most of its accounting policy decisions and is now finalizing those policies in conjunction with the Company's auditors and audit committee. Emerge also made progress during Q3 2010 with its implementation phase, including the preparation of the Company's opening balance sheet and the implementation of the accounting system updates in a test database to facilitate the accounting for fixed assets under IFRS. Internal staff within the financial accounting group continue to lead the conversion project, supplemented with consultants as needed, and continue to participate in various seminars regarding the application of current IFRSs and potential future changes to the standards.

Management has not yet finalized its IFRS accounting policies, and as such is unable to quantify the impact of adopting IFRS on the financial statements.

IFRS Accounting Policies

Most adjustments required on transition to IFRS will be made retrospectively against the Company's opening deficit as at January 1, 2010 based on the IFRS applicable at that time. IFRS 1, "First-Time Adoption of International Financial Reporting Standards", provides entities adopting IFRS for the first time with certain optional exemptions and mandatory exceptions to the general requirement for full retrospective application of IFRS. Following is a discussion of the areas management has identified as having a significant impact to Emerge's accounting policies and financial statements, with related discussion of IFRS 1 where applicable.

- Property and equipment - Property and equipment will be one of the most significant areas impacted by the adoption of IFRS. Under Canadian GAAP, the Company follows the CICA's Accounting Guideline 16 on full cost accounting, while IFRS has no equivalent guideline. Emerge will be required to adopt different accounting policies for pre-exploration activities, exploration and evaluation costs, developed assets, the accounting for gains and losses on divestitures and depletion, depreciation and amortization.

Emerge will apply IFRS 1 which provides an option to entities who follow the full cost accounting guideline to value their oil and gas property and equipment on the date of transition to IFRS at its deemed cost, defined as the carrying value assigned to these assets under Canadian GAAP at the date of transition, January 1, 2010. Without this exemption, the Company would have been required to retrospectively determine the carrying amount of oil and natural gas assets at the date of transition, or use the fair value or revaluation amount as the new deemed cost under IFRS. Under IFRS, Emerge's property and equipment must be divided into multiple cash-generating units ("CGUs"), which is unlike full cost accounting where all oil and gas assets are accumulated into one cost centre. Emerge plans to allocate the deemed cost of its oil and gas properties and equipment to two CGUs based on proved plus probable reserve values at January 1, 2010. These CGUs are aligned with the two focus regions in which Emerge operates and could change in the future as a result of acquisitions or dispositions. The assets are required to be assessed for impairment upon transition to IFRS. Emerge does not currently expect to record any impairment of oil and gas assets on transition to IFRS.

- Impairment - Under IFRS, assets will be assessed for impairment when indicators suggest the possibility of impairment. This could result in more frequent impairments of assets under IFRS. Future cash flows will be discounted in the impairment test under IFRS, whereas future cash flows are currently not discounted for the first step of the impairment test under Canadian GAAP. In addition, property and equipment impairment testing will be performed at the CGU level under IFRS, rather than at the country cost centre level which is current practice under Canadian GAAP. The impairment calculations under IFRS may be performed using either total proved or proved plus probable reserves. The Company intends to test impairment using proved plus probable reserves. Under Canadian GAAP, reversal of impairment losses is prohibited, whereas under IFRS, if the conditions giving rise to impairment have reversed, impairment losses previously recorded would be partially or fully reversed.

- Pre-exploration costs - Pre-exploration costs are expenditures incurred prior to the Company obtaining the legal right to explore in an area and must be expensed under IFRS. Under Canadian GAAP, Emerge capitalizes and depletes such costs within the full cost pool. The Company does not anticipate that this accounting policy difference will have a significant impact on its financial statements.

- Exploration and evaluation ("E&E") assets - The Company capitalizes costs related to exploration and evaluation ("E&E") projects under Canadian GAAP. Under IFRS, the Company has the option to either continue to capitalize these costs until technical feasibility and commercial viability of the project is determined, or to expense these costs as incurred. The Company intends to capitalize E&E costs. On transition to IFRS, Emerge will reclassify all E&E expenditures that are currently included in the property and equipment balance on the balance sheet. This will consist of the book value of undeveloped land and unevaluated seismic data that relates to exploration properties. Emerge anticipates that it will not deplete its E&E assets but rather will assess the assets for impairment when indicators of impairment exist. These assets are required to be assessed for impairment upon transition to IFRS. Emerge does not currently expect to record any impairment of its E&E assets on transition to IFRS.

- Developed and producing assets ("D&P") - D&P assets are the expenditures incurred for an area or property where technical and commercial feasibility have been determined (including amounts transferred from E&E). Emerge will continue to capitalize these costs. Under Canadian GAAP, these costs are depleted on a unit-of-production basis at a country cost centre level, whereas under IFRS these costs must be depleted at a lower unit of account, known as a "component." Under IFRS, Emerge has the option to calculate depletion using a reserve base of total proved or proved plus probable reserves, as compared to the current Canadian GAAP method of using only proved reserves. The Company intends to use proved plus probable reserves as a basis for depletion, which will include the related future development costs related to proved plus probable reserves in the depletable cost base.

- Divestitures - Divestitures of an oil and gas property under IFRS will generally result in a gain or loss recognized in the statement of operations. Under current Canadian GAAP, proceeds of divestitures are deducted from the full cost pool without a recognition of a gain or loss unless such a deduction resulted in a change to the Company's depletion rate of 20% of greater.

- Decommissioning liabilities (currently known as "asset retirement obligations" under Canadian GAAP) - Under Canadian GAAP, the Company recognizes a liability for the estimated fair value of future retirement obligations associated with PP&E. Under IFRS, these liabilities are known as "decommissioning liabilities" and are included in the scope of IAS 37 "Provisions, Contingent Liabilities and Contingent Assets." IFRS 1 has an election which the Company plans to adopt, whereby the liability will be measured at transition in accordance with IAS 37, and any difference between that amount and the Canadian GAAP carrying amount of those liabilities at the date of transition will be recorded in the Company's deficit.

The significant difference between current Canadian GAAP and IFRS appears to be the discount rate used to measure the liabilities. IFRS uses a current liability-specific discount rate to the future cash flows, which can generally be interpreted to mean the current risk-free rate of interest, whereas under Canadian GAAP the Company applies a credit-adjusted risk-free rate of interest. Based on preliminary calculations, the Company expects its decommissioning liability to be higher under IFRS.

- Stock-based compensation - Under IFRS, a forfeiture rate must be included in the expense calculation and adjusted prospectively if required, rather than accounting for forfeitures as they occur which is the Company's current practice under Canadian GAAP. In addition, under IFRS, each tranche of stock options that vests is required to be treated as a separate arrangement, as graded vesting must be used. This will accelerate the expense recorded in comparison to current Canadian GAAP which allows the expense to be recognized on a straight-line basis over the total period until the options become fully vested. While the carrying value for each reporting period will be different under IFRS, the cumulative expense recognized over the life of the instrument under both methods will be the same.

- Income taxes - both Canadian GAAP and IFRS follow the liability method of accounting for income taxes whereby tax liabilities and assets are recognized on temporary differences. IFRS requires that all future taxes be disclosed as noncurrent assets or liabilities and be described as deferred taxes.

Other Considerations

Business activities - Based on the expected changes to Emerge's accounting policies at this time, no issues are expected with the existing wording of debt covenants and related agreements as a result of the conversion to IFRS.

Employees and training - Company employees involved in financial accounting and reporting roles have been engaged and involved in the IFRS transition process since early 2009, and will continue to be involved throughout 2010 and 2011. These employees have attended on-going training sessions and courses and the Company has engaged external consultants to assist in the transition process. Training of key operational staff is planned for later this year.

Information systems - The Company has implemented the system updates required in order to ready the Company for IFRS reporting in a test database and expects to implement the live database later in Q4 2010. The modifications, while not significant, are required in order to allow for reporting of both Canadian GAAP in 2010 and future IFRS statements in 2011 with 2010 comparatives as well as the modifications required to track property and equipment and E&E costs at a more granular level. The Company will continue to make modifications to its accounting systems throughout 2010 as new policy choices may require.

Internal control over financial reporting and disclosure controls and procedures - Changes may be required to control systems with the implementation and ongoing compliance with IFRS. As an example, additional controls will be implemented surrounding the process for reclassifying Emerge's E&E assets to D&P assets. It is also expected that there will be increased note disclosures as compared to what is currently required under Canadian GAAP. It will be an ongoing process through 2010 to ensure changes in accounting policies include the appropriate additional controls and procedures for future IFRS reporting requirements.

CRITICAL ACCOUNTING ESTIMATES

Management is often required to make judgments, assumptions and estimates in the application of GAAP that may have a significant impact on the financial results of the Company. The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The most significant estimates made by management relate to the amounts recorded for depletion and depreciation expense, accretion expense, asset retirement obligations, stock-based compensation expense, ceiling test calculations, future income tax calculations, crude oil inventory valuations and purchase price allocations. By their nature, these estimates are subject to measurement uncertainty, and actual results could differ from these estimates. A more detailed discussion of critical accounting estimates can be found under the heading "Critical Accounting Estimates" in the Company's annual MD&A for the year ended December 31, 2009. There were no significant changes to the Company's critical accounting estimates in Q3 2010 and YTD 2010.

RISK FACTORS

The business of acquisition, development, exploration and production of oil and gas reserves involves a number of business risks which may impact Emerge's results and several of which are beyond the control of the Company. A detailed discussion of risk factors can be found under "Risk Factors" in the Company's annual MD&A for the year ended December 31, 2009 and in the Company's Annual Information Form for the year ended December 31, 2009, both of which are available at www.sedar.com.

ADVISORIES

BOE Conversion

Where amounts are expressed in barrels of oil equivalent ("boe") in this MD&A, natural gas volumes have been converted to barrels of oil equivalent on a basis of 6,000 cubic feet of natural gas to one barrel of oil (6:1). The boe conversion of 6:1 is based on an energy equivalency conversion method primarily applicable at the burner tip and does not necessarily represent value equivalency at the wellhead. The reader is cautioned that boe amounts may be misleading, particularly if used in isolation.

Non-GAAP Measures

Emerge's management uses and reports certain measures not prescribed by GAAP in the evaluation of operating and financial performance, referred to as "non-GAAP measures." The reader is cautioned that these amounts may not be directly comparable to measures for other companies where similar terminology is used.

"Funds flow from operations" and "funds flow from operations per share" are used by the Company to analyze operating performance and liquidity. Funds flow from operations is calculated as cash flow from operating activities (as determined in accordance with GAAP) before asset retirement expenditures and the net change in non-cash operating working capital. The reconciliation of the GAAP measurement and the non-GAAP measurement can be found in the table under the heading "Funds Flow from Operations and Net Loss" in this MD&A. Funds flow from operations per share is calculated using the weighted average basic and diluted shares used in calculating net loss per share. Funds flow from operations should not be considered an alternative to, or more meaningful than cash flow from operating activities as determined in accordance with GAAP.

The Company uses "operating netback" and "funds flow netback" as indicators of operating performance and profitability relative to current commodity prices, calculated on a per boe basis. Operating netback is calculated as average realized sales price less royalties, operating expenses and transportation expenses. Funds flow netback is calculated as operating netback plus other income, less general and administrative expenses and interest expense. There is no GAAP measure that is reasonably comparable to netbacks.

"Net debt" is calculated as bank debt plus other current liabilities less current assets, and is used by the Company to assess liquidity and general financial strength. Net debt should not be considered an alternative to, or more meaningful than current assets or current liabilities as determined in accordance with GAAP.

Forward-Looking Statements

This MD&A contains certain forward-looking statements under applicable securities laws. These statements relate to future events or future performance and are based on the Company's current expectations, estimates, projections, assumptions and beliefs. Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, there can be no assurance that such expectations will prove to be correct. Accordingly, undue reliance should not be placed on these forward-looking statements. The use of any of the words "expect", "anticipate", "continue", "estimate", "objective", "ongoing", "may", "will", "project", "should", "believe", "plans", "intends" and similar expressions are intended to identify forward-looking statements. In particular, but without limiting the foregoing, this MD&A contains forward-looking information pertaining to the following:

- drilling plans and timing of drilling, completion, reactivation, workover and tie-in of wells;

- plans for facilities construction and timing of completion of such construction;

- anticipated production volumes and timing of commencement of production;

- drilling, completion, facility and other capital costs;

- methods of financing capital expenditures and ability to fund financial liabilities;

- supply and demand for the Company's products;

- prices for oil and natural gas, and in particular heavy oil;

- expected levels of royalty rates;

- operating, general and administrative and other costs and expenses, and the Company's ability to reduce such costs;

- expectations regarding the Company's ability to add reserves through exploration, development and acquisitions;

- the future impact of Canadian federal and provincial government regulation on the Company;

- the tax horizon of the Company; and

- timing of IFRS conversion project implementation and the impact of adoption of IFRS and other accounting policies.

All such forward-looking statements involve known and unknown risks and uncertainties, certain of which are beyond the control of the Company. Such risks and uncertainties include, without limitation:

- risks associated with oil and natural gas exploration, development, exploitation, production, transportation and marketing;

- general economic conditions in North America and globally;

- changes in the demand for Emerge's products;

- volatility in market prices for oil and gas, and in particular heavy oil;

- unanticipated fluctuations or declines in production;

- the effects of adverse weather conditions;

- changes in foreign currency exchange and interest rates;

- changes in tax or environmental laws, royalty rates or other regulatory matters affecting the Company and its operations;

- inaccurate estimation of Emerge's oil and natural gas reserves;

- ability to attract and retain qualified personnel;

- increased debt levels or debt service requirements;

- limited, unfavorable or lack of access to capital markets;

- the impact of competitors; and

- certain other risks as detailed from time to time in Emerge's public disclosure documents (including, without limitation, those risk factors identified in the Company's 2009 Annual Information Form).

The forward-looking statements contained in this MD&A are made as of the date of this MD&A, and the Company does not intend, and does not assume any obligation, to update or revise any forward-looking statements whether as a result of new information, future events or otherwise, except as required by applicable securities laws.

ADDITIONAL INFORMATION

Additional information relating to Emerge, including the Company's Annual Information Form, can be found on SEDAR at www.sedar.com. Information can also be obtained by contacting Emerge Oil & Gas Inc., Suite 1800, 250 - 2nd Street SW, Calgary, Alberta, T2P 0C1, or at www.emergeoilandgas.com.




EMERGE OIL & GAS INC.
Balance Sheets


----------------------------------------------------------------------------
----------------------------------------------------------------------------
September 30, December 31,
(unaudited) ($000) 2010 2009
----------------------------------------------------------------------------


ASSETS
Current assets
Cash and cash equivalents - 250
Accounts receivable 10,094 7,326
Crude oil inventory (note 2) 1,607 -
Prepaid expenses and deposits 1,789 755
----------------------------------------------------------------------------
13,490 8,331


Property and equipment (note 4) 159,733 132,517
Deferred costs 122 299


----------------------------------------------------------------------------
173,345 141,147
----------------------------------------------------------------------------
----------------------------------------------------------------------------


LIABILITIES
Current liabilities
Accounts payable and accrued liabilities 25,896 13,801
Bank debt (note 5) 40,352 10,255
----------------------------------------------------------------------------
66,248 24,056


Asset retirement obligations (note 6) 16,204 12,683


----------------------------------------------------------------------------
82,452 36,739
----------------------------------------------------------------------------


SHAREHOLDERS' EQUITY
Share capital (note 7(b)) 110,749 49,602
Special warrants (note 7(c)) - 61,337
Contributed surplus (note 7(f)) 1,907 512
Deficit (21,763) (7,043)
----------------------------------------------------------------------------
90,893 104,408
----------------------------------------------------------------------------


Commitments (note 11)
Subsequent events (note 13)
----------------------------------------------------------------------------
173,345 141,147
----------------------------------------------------------------------------
----------------------------------------------------------------------------


See accompanying notes to interim financial statements.





EMERGE OIL & GAS INC.
Statements of Operations, Comprehensive Loss and Deficit


----------------------------------------------------------------------------
----------------------------------------------------------------------------
(unaudited) Three months ended Nine months ended
($000, except September 30, September 30,
per share amounts) 2010 2009 2010 2009
----------------------------------------------------------------------------


REVENUE
Petroleum and natural gas 27,047 6,899 76,307 11,455
Royalties expense (5,392) (1,227) (15,458) (1,989)
Other income 77 77 238 271
----------------------------------------------------------------------------
21,732 5,749 61,087 9,737
EXPENSES
Operating 11,420 2,844 28,600 4,968
Transportation 1,355 419 3,695 609
General and administrative 1,307 614 4,154 1,558
Interest 308 - 574 -
Stock-based compensation
(note 7(e)) 585 115 1,375 300
Depletion, depreciation
and accretion 12,455 2,698 37,409 4,588
----------------------------------------------------------------------------
27,430 6,690 75,807 12,023


----------------------------------------------------------------------------
Net loss and
comprehensive loss (5,698) (941) (14,720) (2,286)
Deficit, beginning
of period (16,065) (1,913) (7,043) (568)
----------------------------------------------------------------------------
Deficit, end of period (21,763) (2,854) (21,763) (2,854)
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Net loss per share - basic
and diluted (note 7(g)) (0.07) (0.02) (0.18) (0.05)
----------------------------------------------------------------------------
----------------------------------------------------------------------------


See accompanying notes to interim financial statements.





EMERGE OIL & GAS INC.
Statements of Cash Flows


----------------------------------------------------------------------------
----------------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
(unaudited) ($000) 2010 2009 2010 2009
----------------------------------------------------------------------------


CASH PROVIDED BY (USED IN):


OPERATING ACTIVITIES
Net loss for the period (5,698) (941) (14,720) (2,286)
Items not affecting cash:
Stock-based compensation 585 115 1,375 300
Depletion, depreciation
and accretion 12,455 2,698 37,409 4,588
Asset retirement
expenditures (note 6) (184) - (320) -
Net change in non-cash
operating working capital
(note 12) 2,267 (177) 1,453 (1,283)
----------------------------------------------------------------------------
9,425 1,695 25,197 1,319
----------------------------------------------------------------------------


FINANCING ACTIVITIES
Increase in bank debt 10,787 - 30,097 -
Issuance of common shares 35 - 102 -
Share issuance costs - - (351) -
Repayment of debt acquired
through corporate
acquisition - - - (10,880)
Net change in non-cash
financing working capital
(note 12) (11) (36) (617) (19)
----------------------------------------------------------------------------
10,811 (36) 29,231 (10,899)
---------------------------------------------------------------------------


INVESTING ACTIVITIES
Capital expenditures (28,278) (9,596) (51,648) (14,639)
Property acquisitions (note
3) - - (9,855) (178)
Proceeds on property
dispositions - - 161 -
Corporate acquisition (net
of cash acquired) (note 3) - - - (9,584)
Net change in non-cash
investing working capital
(note 12) 8,042 3,620 6,664 5,381
----------------------------------------------------------------------------
(20,236) (5,976) (54,678) (19,020)
----------------------------------------------------------------------------


Change in cash and cash
equivalents - (4,317) (250) (28,600)
Cash and cash equivalents,
beginning of period - 4,388 250 28,671
----------------------------------------------------------------------------
Cash and cash equivalents,
end of period - 71 - 71
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Cash interest paid 305 - 560 -
----------------------------------------------------------------------------
----------------------------------------------------------------------------


See accompanying notes to interim financial statements.



EMERGE OIL & GAS INC.

Notes to Interim Financial Statements

Three and nine months ended September 30, 2010 and 2009 (unaudited)

1. NATURE OF BUSINESS AND BASIS OF PRESENTATION

Emerge Oil & Gas Inc. (the "Company" or "Emerge") was incorporated as 4213181 Canada Inc. on December 24, 2003 and commenced commercial operations on August 18, 2008 upon completion of a corporate reorganization and recapitalization. On January 27, 2010, the Company's common shares became listed on the Toronto Stock Exchange under the trading symbol "EME". The Company is based in Calgary, Alberta and is engaged in the acquisition, exploration, development and production of oil and natural gas reserves in Western Canada.

These interim financial statements are stated in Canadian dollars and have been prepared by management in accordance with Canadian generally accepted accounting principles ("GAAP"). The preparation of financial statements in conformity with Canadian GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from these estimates.

2. SIGNIFICANT ACCOUNTING POLICIES

These unaudited interim financial statements have been prepared following the same accounting policies and methods of computation as the audited financial statements for the year ended December 31, 2009, except as described below. These notes are incremental to, and should be read in conjunction with, the audited financial statements and notes thereto for the year ended December 31, 2009.

Crude oil inventory

Crude oil inventory consists of amounts produced and in storage tanks or in transit, and is recorded at the lower of cost, determined on a weighted-average basis, and net realizable value. Costs include direct and indirect costs incurred in bringing the crude oil to its existing condition and location.

3. ACQUISITIONS

(a) Property Acquisition - Reward and Ear Lake Properties

On June 18, 2010, the Company acquired certain properties located in the Reward and Ear Lake areas of Saskatchewan for an adjusted purchase price of $9.9 million (after standard industry purchase price adjustments), paid by cash. The Company assumed asset retirement obligations totalling $1.9 million on the acquisition.

(b) Property Acquisition - Lloydminster and Battlebend Properties

On November 30, 2009, the Company acquired certain properties located in the Lloydminster and Battlebend areas of Saskatchewan and Alberta for an adjusted purchase price of $85.8 million (after standard industry purchase price adjustments). The acquisition was paid by $68.8 million in cash and $17.0 million by the issuance of 8.5 million common shares of Emerge at a price of $2.00 per share. The Company assumed asset retirement obligations totalling $8.4 million on the acquisition.

(c) Corporate Acquisition - Ivory Energy Inc.

On March 26, 2009, the Company acquired all of the issued and outstanding shares and convertible debentures of Ivory Energy Inc. ("Ivory"), a publicly-traded oil and gas company with properties in Saskatchewan and Alberta, by way of a Plan of Arrangement. Consideration paid to the shareholders and debentureholders of Ivory totaled approximately $8.3 million, and the convertible debentures were cancelled. Total cost of the acquisition including the assumption of Ivory's debt and working capital deficiency was approximately $21.6 million. Ivory's publicly-traded securities were delisted from the TSX Venture Exchange shortly after closing. Ivory's assets and liabilities were transferred to and assumed by the Company and Ivory was dissolved. The acquisition was accounted for as a business combination using the purchase method of accounting, and the operations of Ivory were included in the Company's accounts effective March 26, 2009. The following table details the purchase price allocation for the business combination:




----------------------------------------------------------------------------
----------------------------------------------------------------------------
($000)
Consideration paid:
Cash 8,271
Transaction costs 1,478
----------------------------------------------------------------------------
9,749
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Net assets acquired:
Property and equipment 23,828
Working capital deficiency (includes $165 of cash) (1,002)
Bank and other short-term debt (10,880)
Obligations under capital leases (24)
Asset retirement obligations (2,173)
----------------------------------------------------------------------------
9,749
----------------------------------------------------------------------------
----------------------------------------------------------------------------





4. PROPERTY AND EQUIPMENT


----------------------------------------------------------------------------
----------------------------------------------------------------------------
September 30, December 31,
($000) 2010 2009
----------------------------------------------------------------------------
Petroleum and natural gas properties
and equipment 207,307 143,263
Accumulated depletion and depreciation (48,128) (11,047)
----------------------------------------------------------------------------
159,179 132,216


Office equipment and other 745 383
Accumulated depreciation (191) (82)
----------------------------------------------------------------------------
554 301


----------------------------------------------------------------------------
Property and equipment, net book value 159,733 132,517
----------------------------------------------------------------------------
----------------------------------------------------------------------------



At September 30, 2010, the cost of unproved properties of $6.2 million (December 31, 2009: $1.9 million) and salvage values of $19.6 million (December 31, 2009: $12.4 million) were excluded, and future development costs of $15.1 million (December 31, 2009: $16.0 million) were included, in the costs subject to depletion and depreciation.

The Company capitalized general and administrative costs and stock-based compensation related to exploration and development activities as follows:




----------------------------------------------------------------------------
----------------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
($000) 2010 2009 2010 2009
----------------------------------------------------------------------------
General and administrative 602 280 1,261 620
Stock-based compensation 92 60 256 176
----------------------------------------------------------------------------
694 340 1,517 796
----------------------------------------------------------------------------
----------------------------------------------------------------------------



5. BANK DEBT

At September 30, 2010, the Company has credit facilities totalling $60.0 million with a Canadian chartered bank. The facilities are comprised of a $50.0 million revolving operating demand loan facility bearing interest at the bank's prime rate plus a range of 0.75% to 2.50% per annum, and a $10.0 million non-revolving acquisition/development demand loan facility bearing interest at the bank's prime rate plus a range of 1.25% to 3.00% per annum. The range of interest rates on the facilities are based on a grid system which is dependent on the Company's trailing debt to funds flow ratios ranging from less than 1.0:1 to greater than 3.0:1. The Company also incurs standby fees on the undrawn portion of the facilities of 0.20% to 0.45% per annum based on the same grid system, and both interest and standby fees are payable monthly. The facilities are secured by a general assignment of book debts and a $100 million debenture with a floating charge over all assets of the Company with a negative pledge and undertaking to provide fixed charges on the Company's producing properties at the request of the bank. At September 30, 2010, the Company had $40.4 million drawn against the credit facilities (December 31, 2009: $10.3 million).

The Company's facilities were increased to $60.0 million in September 2010 from $52.5 million available at June 30, 2010 under similar terms and conditions, as a result of the Company's scheduled semi-annual review with its lender. The Company's next scheduled review is planned for late February 2011. As the available lending limits of the facilities are based on the bank's interpretation of the Company's reserves and future commodity prices there can be no assurance as to the amount of available facilities that will be determined at each scheduled review.

6. ASSET RETIREMENT OBLIGATIONS

The total future retirement obligations are estimated by management based on the Company's net ownership interests in oil and natural gas wells and facilities, estimated costs to abandon and reclaim the wells and facilities, and the estimated timing of the costs to be incurred in future periods. Management estimates the total undiscounted amount of future cash flows required to settle these obligations to be approximately $48.9 million (December 31, 2009: $37.7 million), to be incurred in the next 19 years with the majority of costs expected to be incurred from 2023 to 2025. The Company used a credit-adjusted risk-free rate of 10% (2009: 10%) and an inflation rate of 2% (2009: 2%) to calculate the present value of the asset retirement obligations.

The following table presents changes in the Company's asset retirement obligations:




----------------------------------------------------------------------------
----------------------------------------------------------------------------
Nine months
ended Year ended
September 30, December 31,
($000) 2010 2009
----------------------------------------------------------------------------
Balance, beginning of period 12,683 208
Liabilities acquired (net of dispositions) 1,903 10,769
Liabilities incurred 859 247
Asset retirement expenditures (320) -
Changes in estimates 46 1,203
Accretion expense 1,033 256
----------------------------------------------------------------------------
Balance, end of period 16,204 12,683
----------------------------------------------------------------------------
----------------------------------------------------------------------------



7. SHARE CAPITAL

(a) Authorized

Unlimited number of voting common shares

Unlimited number of non-voting preferred shares (of which none have been issued)




(b) Issued and outstanding


----------------------------------------------------------------------------
----------------------------------------------------------------------------
Number of
common shares Amount ($000)
----------------------------------------------------------------------------
Balance, December 31, 2008 41,700,100 32,602
Issued on property acquisition (note 3(b)) 8,500,000 17,000
----------------------------------------------------------------------------
Balance, December 31, 2009 50,200,100 49,602
Converted from special warrants (i) 32,775,000 61,337
Issued for cash on exercise of stock options 101,667 102
Transferred from contributed surplus on
exercise of stock options - 59
Share issuance costs - (351)
----------------------------------------------------------------------------
Balance, September 30, 2010 83,076,767 110,749
----------------------------------------------------------------------------
----------------------------------------------------------------------------





(c) Special warrants


----------------------------------------------------------------------------
----------------------------------------------------------------------------
Number of
special
warrants Amount ($000)
----------------------------------------------------------------------------
Balance, December 31, 2008 - -
Issued for cash on private placement (i) 32,775,000 65,550
Special warrant issue costs - (4,213)
----------------------------------------------------------------------------
Balance, December 31, 2009 32,775,000 61,337
Converted to common shares (i) (32,775,000) (61,337)
----------------------------------------------------------------------------
Balance, September 30, 2010 - -
----------------------------------------------------------------------------
----------------------------------------------------------------------------


(i) On November 19, 2009, the Company completed a private placement
financing of subscription receipts with a syndicate of underwriters
pursuant to prospectus exemptions under applicable securities
legislation. The Company issued 32.775 million subscription receipts
at an issue price of $2.00 per subscription receipt for gross proceeds
of $65.55 million. The gross proceeds were deposited into escrow until
the satisfaction of certain escrow release conditions, including
completion of the property acquisition described in note 3(b). On
November 30, 2009, the escrow release conditions were satisfied. The
net proceeds (after underwriters' fees of $3.6 million) were released
to the Company to fund the property acquisition and the subscription
receipts were automatically converted, for no additional consideration,
into special warrants of Emerge. The special warrants were subsequently
converted, for no additional consideration, into common shares of
Emerge on January 21, 2010 following receipt of a final prospectus
filed with securities regulators.



(d) Stock options

The Company has established a stock option plan whereby officers, directors, employees and certain consultants may be granted options to purchase one common share for each option granted. Under this plan, the Company is authorized to grant options to purchase common shares up to the equivalent of 10% of the number of common shares outstanding at the time of grant. Stock options granted under this plan vest in equal thirds on the first, second and third anniversary dates following the date of grant, and expire after a five year term.

The following tables summarize information about stock options outstanding at September 30, 2010:




----------------------------------------------------------------------------
----------------------------------------------------------------------------
Weighted average
Number of exercise price per
options share ($)
----------------------------------------------------------------------------
Balance, December 31, 2008 2,700,000 0.78
Granted 1,210,000 1.35
----------------------------------------------------------------------------
Balance, December 31, 2009 3,910,000 0.96
Granted 4,330,000 2.64
Exercised (101,667) 1.00
Forfeited (729,333) 1.41
----------------------------------------------------------------------------
Balance, September 30, 2010 7,409,000 1.90
----------------------------------------------------------------------------
----------------------------------------------------------------------------





----------------------------------------------------------------------------
Options Outstanding Options Exercisable
------------------------------ --------------------------------
Weighted Weighted
Weighted average Weighted average
Exercise Number average remaining Number average remaining
price per of exercise life of exercise life
share ($) options price ($) (years) options price ($) (years)
---------------------------------------------------------------------------
0.25 780,000 0.25 2.5 519,998 0.25 2.5
1.00 2,175,000 1.00 3.0 1,311,665 1.00 3.0
2.00 2,453,000 2.00 4.3 - - -
2.01 - 3.05 66,000 2.90 4.4 - - -
3.06 - 4.10 1,935,000 3.40 4.7 - - -
----------------------------------------------------------------------------
0.25 - 4.10 7,409,000 1.90 3.8 1,831,663 0.79 2.9
----------------------------------------------------------------------------
----------------------------------------------------------------------------



(e) Stock-based compensation

The fair value of each stock option grant is estimated using the Black-Scholes option pricing model and considers, at the date of grant: exercise price, expected life, risk-free interest rate, expected volatility and expected dividend yield. The weighted average assumptions and resulting weighted average fair value of options granted are as follows:




----------------------------------------------------------------------------
----------------------------------------------------------------------------
Nine months
ended Year ended
September 30, December 31,
2010 2009
----------------------------------------------------------------------------
Number of stock options granted 4,330,000 1,210,000
Expected life of stock options (years) 5 5
Vesting period of stock options (years) 3 3
Expected volatility (%) 64.1 70.0
Risk-free interest rate (%) 2.4 2.1
Expected dividend yield (%) - -
----------------------------------------------------------------------------
Fair value of options granted during the
period ($/share) 1.46 0.79
----------------------------------------------------------------------------
----------------------------------------------------------------------------



The total estimated fair value of the options is expensed on a straight-line basis over the vesting period of the options. During the three months ended September 30, 2010, the Company recorded stock-based compensation expense on the statement of operations of $0.6 million (three months ended September 30, 2009: $0.1 million), and capitalized $0.1 million of stock-based compensation to exploration and development costs (three months ended September 30, 2009: $60 thousand). During the nine months ended September 30, 2010, the Company recorded stock-based compensation expense on the statement of operations of $1.4 million (nine months ended September 30, 2009: $0.3 million), and capitalized $0.3 million of stock-based compensation to exploration and development costs (nine months ended September 30, 2009: $0.2 million).

(f) Contributed surplus

The following table summarizes the changes in contributed surplus:




----------------------------------------------------------------------------
----------------------------------------------------------------------------
Nine months
ended Year ended
September 30, December 31,
($000) 2010 2009
----------------------------------------------------------------------------
Balance, beginning of period 512 83
Stock-based compensation expensed 1,375 436
Stock-based compensation capitalized 256 228
Transferred to share capital on exercise of
stock options (59) -
Amortization of deferred costs (177) (235)
----------------------------------------------------------------------------
Balance, end of period 1,907 512
----------------------------------------------------------------------------
----------------------------------------------------------------------------



(g) Per share amounts

Per share amounts have been calculated using the weighted average number of basic and diluted shares outstanding. For purposes of the calculation of weighted average basic shares outstanding for the three and nine months ended September 30, 2010, and in accordance with CICA Handbook guidance, the weighted average number of special warrants outstanding has been added to the weighted average number of basic shares outstanding. The following table summarizes the weighted average shares outstanding:




----------------------------------------------------------------------------
----------------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
2010 2009 2010 2009
----------------------------------------------------------------------------
Weighted average common
shares outstanding
Basic and diluted 83,070,245 41,700,100 83,009,117 41,700,100
----------------------------------------------------------------------------
----------------------------------------------------------------------------



During the three and nine months ended September 30, 2010 and 2009, nil shares were added to the weighted average number of basic shares outstanding for the dilutive effect of stock options, as the result would be anti-dilutive.

(h) Shares in escrow

At September 30, 2010, 150,000 (December 31, 2009: 9,750,000) of the issued and outstanding common shares were held in escrow, with an expected release date of June 1, 2011.

8. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT

The Company is exposed to financial and market risk in a range of financial instruments including cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities and bank debt. The Company manages its risk through its policies and processes, but the Company has not used derivative financial instruments to manage these risks.

(a) Market risk

Market risk is the risk that changes in market prices, such as commodity prices, foreign exchange rates and interest rates, will affect the Company's net earnings or the value of financial instruments. The objective of market risk management is to manage and control market risk exposures within acceptable limits, while maximizing returns.

Commodity price risk is the risk that the fair value of future cash flows will fluctuate as a result of changes in commodity prices. Commodity prices for crude oil, natural gas and natural gas liquids are impacted by not only the relationship between the Canadian and United States dollar, as described below, but also by North American and worldwide economic events and natural phenomena such as the weather, all of which influence the levels of supply and demand. Changes in crude oil and natural gas prices may significantly affect the Company's results of operations and cash flows, capital spending and the Company's ability to meet its obligations. The Company's production is currently sold under short-term contracts, and consequently Emerge is at risk to near term price movements. The Company manages this risk by monitoring commodity prices and factoring them into operational decisions, such as contracting or expanding its capital expenditures program. The Company did not use derivative financial instruments as at or during the three and nine months ended September 30, 2010 to manage its exposure to this risk. Subsequent to September 30, 2010, the Company entered into two financial commodity price contracts as described in note 13(a).

Foreign currency exchange rate risk is the risk that the fair value of future cash flows will fluctuate as a result of changes in foreign exchange rates. Although all of the Company's petroleum and natural gas sales are denominated in Canadian dollars, the underlying market prices in Canada for petroleum and natural gas are impacted by changes in the exchange rate between the Canadian and United States currency. The Company did not use derivative financial instruments as at or during the three and nine months ended September 30, 2010 to manage its exposure to this risk.

Interest rate risk is the risk that the fair value of future cash flows will fluctuate as a result of changes in market interest rates. The Company is exposed to interest rate fluctuations on its bank debt which bears a floating rate of interest. The Company did not use derivative financial instruments as at or during the three and nine months ended September 30, 2010 to manage its exposure to this risk.

Sensitivities

The following table presents the increase to the Company's net loss for each of the market risks, with all other variables held constant:




----------------------------------------------------------------------------
----------------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
($000) 2010 2009 2010 2009
----------------------------------------------------------------------------
Commodity price risk
Decrease WTI US$1.00/bbl 461 110 1,253 190
Foreign currency exchange
rate risk
Increase $US/$CDN
exchange rate 0.01 361 82 995 124
Interest rate risk
Increase interest rate 1% 84 - 154 -
----------------------------------------------------------------------------
----------------------------------------------------------------------------



(b) Credit risk

Credit risk is the risk of financial loss if a customer or counterparty to a financial instrument fails to meet its contractual obligations, and arises primarily from the Company's receivables from marketers of the Company's crude oil, natural gas and natural gas liquids and from joint interest partners.

Receivables from the marketers of the Company's crude oil, natural gas and natural gas liquids are normally collected on the 25th of the day of the month following production. The Company mitigates this risk by assessing the financial strength of its counterparties and entering into relationships with large purchasers with established credit history. The Company did not experience any collection issues with its marketers during the three and nine months ended September 30, 2010. Joint interest receivables are normally collected within one to three months of the joint interest bill being issued to the partner. To mitigate the risk of non-payment from joint interest partners, the Company can require partners to pay certain capital costs in advance. As well, the Company has the ability to withhold production from partners in the event of non-payment. The Company did not experience any significant collection issues with joint interest partners during the three and nine months ended September 30, 2010.

The components of the Company's accounts receivable are as follows:




----------------------------------------------------------------------------
----------------------------------------------------------------------------
September 30, December 31,
($000) 2010 2009
----------------------------------------------------------------------------
Petroleum and natural gas sales and accrual 9,158 6,452
Joint interest 495 73
Input tax credits and other receivables 451 811
Less: allowance for doubtful accounts (10) (10)
----------------------------------------------------------------------------
10,094 7,326
----------------------------------------------------------------------------
----------------------------------------------------------------------------



The Company typically does not obtain collateral or security from its oil and gas marketers or its joint interest partners. The carrying amounts of accounts receivable represent the maximum credit exposure. The Company considers its receivables to be aged as follows:




----------------------------------------------------------------------------
----------------------------------------------------------------------------
September 30, December 31,
($000) 2010 2009
----------------------------------------------------------------------------
Not past due (less than 90 days) 9,860 7,277
Past due (over 90 days) 234 49
----------------------------------------------------------------------------
10,094 7,326
----------------------------------------------------------------------------
----------------------------------------------------------------------------



(c) Liquidity risk

Liquidity risk is the risk that the Company will be unable to meet its financial obligations as they become due. The Company uses operating cash flows, credit facilities and equity financings to fund its ongoing capital and operating requirements. The Company prepares annual capital expenditures budgets which are regularly monitored and updated as considered necessary, and the Company uses prudent cash and debt management to mitigate the likelihood of encountering difficulties in meeting its financial obligations. As disclosed in note 9, the Company targets a net debt to annualized funds from operations ratio of no more than 2.0:1 to manage the Company's overall liquidity risk.

The Company anticipates it will continue to have adequate liquidity to fund its payables and other financial liabilities through its future cash flows and available credit facilities. The components of the Company's accounts payable and accrued liabilities are as follows:




----------------------------------------------------------------------------
----------------------------------------------------------------------------
September 30, December 31,
($000) 2010 2009
----------------------------------------------------------------------------
Trade payables 17,191 9,453
Joint interest 84 394
Capital and operating accruals 8,370 2,546
Other payables 251 1,408
----------------------------------------------------------------------------
25,896 13,801
----------------------------------------------------------------------------
----------------------------------------------------------------------------



The Company has had no defaults or breaches on its bank debt or other financial liabilities. The following are the contractual maturities of financial liabilities as at September 30, 2010:




----------------------------------------------------------------------------
----------------------------------------------------------------------------
Less than 1 1 to 2
($000) year years Total
----------------------------------------------------------------------------
Accounts payable and
accrued liabilities 25,896 - 25,896
Bank debt (1) 40,352 - 40,352
----------------------------------------------------------------------------
Total 66,248 - 66,248
----------------------------------------------------------------------------
----------------------------------------------------------------------------


(1) Amount is drawn against the Company's operating revolving demand loan
facility. As the facility is demand in nature, amounts outstanding are
classified as current liabilities implying they are due in one year or
less. Management fully expects the term of the facility to be extended.



(d) Fair value of financial instruments

The Company's financial instruments reflected on the balance sheet as at September 30, 2010 and December 31, 2009 consist of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities and bank debt. The fair value of these instruments approximates their carrying amount due to their short terms to maturity.

9. CAPITAL MANAGEMENT

The Company's objective when managing its capital is to maintain financial flexibility which will allow the Company to meet its financial obligations as they become due, execute on its capital program and sustain future growth of the business including potential property or corporate acquisitions.

The Company considers its capital structure to include shareholders' equity, bank debt and working capital. In order to maintain or adjust the capital structure, the Company may from time to time issue additional common shares and adjust its capital spending to manage current and forecast debt levels. However, there can be no assurance that the Company will be able to access the capital markets to issue new equity on acceptable terms, and there can be no assurance as to the amount of the borrowing base under the Company's credit facilities at each period review, since this amount is based on the bank's interpretation of the Company's oil and natural gas reserves, commodity prices and other factors. The Company will adjust its capital spending if access to external sources of debt and equity are unavailable.

The Company manages its capital and financing requirements using the non-GAAP financial metric of the net debt to annualized funds from operations ratio. This ratio is calculated as net debt (defined as outstanding bank debt plus other current liabilities minus current assets), divided by annualized funds from operations (defined as the most recent calendar quarter's cash flow from operating activities before asset retirement expenditures and the net change in non-cash operating working capital, multiplied by four). Management's strategy is to maintain a ratio of no more than 2.0:1. This ratio may increase at certain times as a result of acquisitions or during periods of significant capital activity. This ratio is calculated as follows:




----------------------------------------------------------------------------
----------------------------------------------------------------------------
September 30, December 31,
($000, except ratio) 2010 2009
----------------------------------------------------------------------------
Bank debt 40,352 10,255
Current liabilities (not including bank debt) 25,896 13,801
Current assets (13,490) (8,331)
----------------------------------------------------------------------------
Net debt 52,758 15,725
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Quarterly funds from operations 7,342 2,363
----------------------------------------------------------------------------
Annualized funds from operations 29,368 9,452
----------------------------------------------------------------------------
----------------------------------------------------------------------------


----------------------------------------------------------------------------
Net debt to annualized funds
from operations ratio 1.8:1 1.7:1
----------------------------------------------------------------------------
----------------------------------------------------------------------------



As at September 30, 2010, the Company's ratio of net debt to annualized funds from operations was within the acceptable range established by the Company. To facilitate the calculation of this ratio and capital management overall, the Company prepares an annual capital and operating budget. This budget is reviewed regularly and updated as required. The Company's 2010 budget, which has been approved by its board of directors, targets the Company's capital expenditure program to be funded primarily from funds from operations and supplemented with bank debt.

The Company's credit facilities include certain financial and non-financial covenants, including maintaining a Working Capital Ratio of at least 1.0:1. The calculation of Working Capital Ratio is defined in the credit facility agreement, and the Company is in compliance with the ratio at the date of this report.

The Company's share capital is not subject to external restrictions except as disclosed in note 7(h), and the Company has not paid or declared any dividends since its reorganization.

There were no changes in the Company's approach to capital management during the three and nine months ended September 30, 2010.

10. RELATED PARTY TRANSACTIONS

The Company's Corporate Secretary and director is a partner at a law firm that provides legal services to the Company. During the three and nine months ended September 30, 2010, the Company incurred $7 thousand and $0.2 million, respectively (three and nine months ended September 30, 2009: $22 thousand and $0.3 million, respectively) on services obtained from the firm, which has been included in general and administrative expenses and share issuance costs. These services are conducted in the normal course of business operations and are measured at the exchange amount, which is established and agreed to by the related parties. At September 30, 2010, accounts payable and accrued liabilities included $nil (December 31, 2009: $0.4 million) relating to these services.

11. COMMITMENTS

The Company is committed under operating leases for office space, office equipment and vehicles. The Company does not occupy all of the office space it leases and has sublet excess space to arms' length parties on a basis that recovers a portion of its rental costs. At September 30, 2010, the Company is committed to future payments under operating leases as follows:




----------------------------------------------------------------------------
----------------------------------------------------------------------------
Oct.-
Dec. There-
Year: ($000) 2010 2011 2012 2013 2014 after
----------------------------------------------------------------------------
Office space
Gross lease payments
(including an estimate
of operating costs) 365 1,448 1,415 1074 924 77
Sublease recoveries (96) (379) (379) (95) - -
----------------------------------------------------------------------------
Net lease payments 269 1,069 1,036 979 924 77
Office equipment and
vehicles 21 57 23 9 - -
----------------------------------------------------------------------------
Total 290 1,126 1,059 988 924 77
----------------------------------------------------------------------------
----------------------------------------------------------------------------





12. CHANGES IN NON-CASH WORKING CAPITAL ITEMS


----------------------------------------------------------------------------
----------------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
($000) 2010 2009 2010 2009
----------------------------------------------------------------------------
Change in:
Current assets (1,875) (1,097) (4,595) (3,590)
Current liabilities (not
including bank debt) 12,173 4,504 12,095 8,836
Working capital
deficiency acquired - - - (1,167)
----------------------------------------------------------------------------
10,298 3,407 7,500 4,079
Changes relating to:
Operating activities 2,267 (177) 1,453 (1,283)
Financing activities (11) (36) (617) (19)
Investing activities 8,042 3,620 6,664 5,381
----------------------------------------------------------------------------
10,298 3,407 7,500 4,079
----------------------------------------------------------------------------
----------------------------------------------------------------------------



13. SUBSEQUENT EVENTS

(a) Commodity price contract

Subsequent to September 30, 2010, the Company entered into the following financial commodity price contracts:




----------------------------------------------------------------------------
----------------------------------------------------------------------------
Commodity Type Term Volume Price Index
----------------------------------------------------------------------------
Heavy oil Fixed price Calendar 2011 1,000 bbl/d C$70.00/bbl WCS
Heavy oil Fixed price Calendar 2011 1,000 bbl/d C$74.00/bbl WCS
----------------------------------------------------------------------------
----------------------------------------------------------------------------



(b) Bought deal equity financing

On October 14, 2010, the Company closed a bought deal equity financing with a group of underwriters by way of a short form prospectus for 8.85 million common shares at $3.40 per share for gross proceeds of $30.1 million. The net proceeds of approximately $28.2 million (after Underwriters fees and other issuance costs) will be used to initially reduce bank debt and subsequently to fund the Company's capital program and for general corporate purposes.

For more information, please contact
Emerge Oil & Gas Ltd.
Thomas J. Greschner
Chairman, President & CEO
403-718-3852
tomg@emergeoilandgas.com

or

Emerge Oil & Gas Ltd.
Anita Tonn
Vice President, Finance & CFO
403-718-3855
anitat@emergeoilandgas.com

or

Emerge Oil & Gas Ltd.
1800, 250 - 2nd Street SW
Calgary, AB T2P 0C1
403-718-3850
403-718-3851 (FAX)
www.emergeoilandgas.com