UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended February 28, 2009
For the quarterly period ended August 31, 2009
OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ~~____________~~ to ~~____________~~

Commission file number: 000-52106

SOUTHERN STAR ENERGY INC.

(Exact Name of Registrant as Specified in its Charter)

NEVADA		2032-~~2514234~~0027992
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
110 Cypress Station Drive, Suite 152
Houston, Texas		77090
(Address of Principal Executive Offices)		(Zip Code)

(832) 375-0330

(Registrant’s Telephone Number, including Area Code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days. Yes No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer Accelerated filer Non-accelerated filer Smaller Reporting Company

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes No

Number of Shares outstanding at ~~April~~October 1013, 2009: 45,347,~~279~~280

INDEX

		Page No.(s)
PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements	13
	Consolidated Balance Sheets as of February 28, 2009 (unaudited) and	2
	Consolidated Balance Sheets as of August 31, 2009 (unaudited) and	4
	May 31, 2008 (audited)
	May 31, 2009 (audited)
	Consolidated Statements of Operations for the three months and nine months ended February	3
	Consolidated Statements of Operations for the three months ended August 31,	5
	28, 2009 and February 29, 2008 (unaudited) and the period accumulated from February 7, 2005 (date of inception) to February 28, 2009 (unaudited)
	2009 and 2008 (unaudited) and the period accumulated from February 7, 2005 (date of inception) to August 31, 2009 (unaudited)
	Consolidated Statements of Cash Flows for the nine months ended February	4
	Consolidated Statements of Cash Flows for the three months ended August 31,	6
	28, 2009 and February 29, 2008 (unaudited) and the period accumulated from February 7, 2005 (date of inception) to February 28, 2009 (unaudited)
	2009 and 2008 (unaudited) and the period accumulated from February 7, 2005 (date of inception) to August 31, 2009 (unaudited)
	Consolidated Statement of Stockholders’ Equity (Deficit) for the nine months ended February 28, 2009 (unaudited)	5
	Consolidated Statement of Stockholders’ Equity for the three months ended August 31, 2009 (unaudited)	7
	Notes to Consolidated Financial Statements	68
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	1315
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	26
Item 4T.	Controls and Procedures	26
Item 4.	Disclosure Controls and Procedures	26
PART II - OTHER INFORMATION		27
Item 1.	Legal Proceedings	27
Item 1A.	Risk Factors	27
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	27
Item 3.	Defaults Upon Senior Securities	27
Item 4.	Submission of Matters to Vote of Security Holders	27
Item 5.	Other Information	27
Item 6.	Exhibits	2827
SIGNATURES		2928

i 2

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

NOTE: These consolidated financial statements reflect the Company’s Consolidated Balance Sheets at February 28, 2009 (unaudited) and May 31, 2008 (audited), the unaudited Consolidated Statements of Operations for the three months and nine months ended February 28, 2009 and February 29, 2008, and for the period accumulated from February 7, 2005 (date of inception) to February 28, 2009, unaudited Consolidated Statements of Cash Flows for the nine months ended February 28, 2009 and February 29, 2008, and for the period accumulated from February 7, 2005 (date of inception) to February 28, 2009, and the unaudited Consolidated Statement of Stockholders’ Equity (Deficit) for the period from May 31, 2008 to February 28, 2009, including entries that resulted from a restatement of the Company’s consolidated financial statements for prior periods.3

Southern Star Energy Inc.

(An Exploration Stage Company)

Consolidated Balance Sheets

(in thousands)

	February 28, 2009 $	May 31, 2008 $
	August 31, 2009 $ (unaudited)	May 31, 2009 $ (audited)
	(unaudited)
ASSETS
Current Assets
Cash	21,~~834~~603	1,~~436~~301
Accounts Receivable	~~391~~810	~~336~~1,000
Prepaids and other current assets	208	38
Accrued Revenue	218	352
Total Current Assets	3,433	1,810
Prepaids and other current assets	89	171
Deferred Financing Costs, net	2,231	−
Total Current Assets	2,720	2,824
Property and Equipment	22	20
Deferred Financing Costs (Note 4)	1,756	1,993
Surety Bond	10	10
Property and Equipment	13	15
Oil and Gas Property (full cost method)		−
Surety Bond	11	11
Proved	10,339	6,597
Oil and Gas Properties (full cost method) (Note 2)
Unproved	2,588	−
Proved	10,664	10,653
Gross Oil and Gas Property	12,927	6,597
Unproved	3,801	3,771
Less – Accumulated Depreciation, Depletion and Amortization	(8,133)	(109)
Gross Oil and Gas Properties	14,465	14,424
Oil and Gas Property, net (Note 2)	4,794	6,488
Less – Accumulated Depreciation, Depletion and Amortization	(9,068)	(9,018)
Total Assets	10,490	8,328
	5,397	5,406
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Total Assets	9,897	10,249
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
Accounts Payable and Accrued Liabilities	25,~~104~~492	15,~~555~~985
Revenue Payable	857	599
Net Revenue Payable	1,018	847
Exploration Advances (Note 2)	5,332	266
Exploration Advances	3,761	2,925
Other Current Liabilities	203	−
Bank Debt (Note 4)	5,000	5,000
Bank Debt (Note 4)	5,000	−
Other Current Liabilities	27	116
Loan Payable, less unamortized discount of $425 (Note 4)	−	1,575
Due to Related Party (Note 5)	30	56
Due to Related Party (Note 5)	49	32
Total Current Liabilities	15,328	14,929
Total Current Liabilities	13,545	4,027
Asset Retirement Obligations (Note 3)	101	98
Asset Retirement Obligations (Note 3)	96	54
Total Liabilities	15,429	15,027
Total Liabilities	13,641	4,081
Contingency and Commitments (Notes 1 and 8)
Stockholders’ Equity (Deficit)
Stockholders’ Equity
Common Stock (Note 7) Authorized: 843,750 shares, par value $0.001 Issued: 45,347 shares (May 31, 2008 – 44,801 shares)	45	45
Common Stock (Note 7) Authorized: 843,750 shares, par value $0.001 Issued: 45,347 shares (May 31, 2009 – 45,347 shares)	45	45
Additional Paid-In Capital	1314,~~735~~286	914,~~852~~010
Common Stock Subscribed	35	35
Deficit Accumulated During the Exploration Stage	(19,863)	(18,833)
Deficit Accumulated During the Exploration Stage	(16,966)	(5,685)
Total Stockholders’ Equity	(5,532)	(4,778)
Total Stockholders’ Equity (Deficit)	(3,151)	4,247
Total Liabilities and Stockholders’ Equity	9,897	10,249
Total Liabilities and Stockholders’ Equity (Deficit)	10,490	8,328

The accompanying notes are an integral part of these consolidated financial statements.

Southern Star Energy Inc.

(An Exploration Stage Company)

Consolidated Statements of Operations

(unaudited)

(in thousands, except per share amounts)

	Accumulated From February 7, 2005 (Date of Inception) to February 28,	Three Months Ended February 28,	Three Months Ended February 29,	Nine Months Ended February 28,	Nine Months Ended February 29,
	Accumulated From February 7, 2005 (Date of Inception) to August 31,	Three Months Ended August 31,	Three Months Ended August 31,
	2009	2009	2008	~~2009~~	~~2008~~
	$	$	$	$	$
Revenue	12,~~862~~124	~~231~~97	~~129~~776	~~1,236~~	~~152~~
Operating Expenses
Depletion, depreciation and amortization (Note 2)	89,~~142~~085	~~5,379~~53	222,535	~~8,030~~	88
General and administrative	5,353	834	909	2,771	1,258
General and administrative (Note 6)	6,674	676	990
Lease operating expenses	685	162	17	482	38
Lease Operating Costs	932	83	140
Production taxes	148	18	-	55	-
Production Taxes	167	8	22
Total Operating Expenses	1416,~~328~~858	~~6,393~~820	~~948~~3,687	~~11,338~~	~~1,384~~
Loss Before the Following Items	(1214,~~466~~734)	(~~6,162~~723)	(~~819~~2,921)	~~(10,102)~~	~~(1,232)~~
Other Expenses
Accretion of discount on debt (Note 4)	(1,646)	-	-	(425)	(1,082)
Accretion of discount on debt	(1,646)	−	(425)
Financing costs (Note 4)	(2,~~512~~988)	(~~233~~238)	-(132)	~~(600)~~	~~(406)~~
Interest on loans and convertible debentures (Note 4)	(~~321~~474)	(69)	-(43)	~~(154)~~	~~(87)~~
Total Other Expenses	(45,~~479~~108)	(~~302~~307)	-(600)	~~(1,179)~~	~~(1,575)~~
Loss Before Discontinued Operations	(1619,~~945~~842)	(61,~~464~~030)	(~~819~~3,521)	~~(11,281)~~	~~(2,807)~~
Discontinued operations	(21)	-–	-–	-	-
Net Loss	(1619,~~966~~863)	(61,~~464~~030)	(~~819~~3,521)	~~(11,281)~~	~~(2,807)~~
Net Loss Per Share – Basic and Diluted		(0.14)	(0.02)	(0.25)	(0.08)
Net Income (Loss) Per Share
Weighted Average Number of Shares Outstanding – Basic and Diluted		45,070	37,620	44,909	33,069
Continuing Operations – Basic and Diluted		(0.02)	(0.08)
Discontinued Operations – Basic and Diluted		–	–
		(0.02)	(0.08)
Weighted Average Number of Shares Outstanding – Basic and Diluted		45,347	44,827

The accompanying notes are an integral part of these consolidated financial statements.

Southern Star Energy Inc.

(An Exploration Stage Company)

Consolidated Statements of Cash Flows

(unaudited)

(in thousands)

	Accumulated From February 7, 2005 (Date of Inception) to August 31,	Three Months Ended August 31,	Three Months Ended August 31,
	2009	2009	2008
	$	$	$

Operating Activities

Net loss	(19,863)	(1,030)	(3,521)

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Accretion of debt discount	1,646	−	425
Common stock subscribed	35	–	–
Depreciation, depletion and accretion	9,085	53	2,277
Intrinsic value of convertible units and fair value warrants issued as finance fees	1,775	–	−
Interest accrued on convertible debt	4	–	−
Shares issued for consulting services	16	−	25
Stock-based compensation	2,404	276	341
Amortization of deferred financing costs	1,076	238	132

Changes in operating assets and liabilities

Accounts receivable	(18)	324	(1,575)
Prepaids	180	(6)	26
Accounts payable and accrued liabilities	1,411	294	646
Deferred revenue	19	–	–
Due to related parties	3	(27)	(21)
Exploration advances	3,161	836	390

Net Cash Provided by ( Used in) Continuing Operations	934	958	(854)
Discontinued operations	(38)	–	–

Net Cash Provided by (Used in) Operating Activities	896	958	(854)

Investing Activities
Acquisition of property and equipment	(30)	–	–
Surety bond	(10)	–	–
Oil and gas property expenditures	(9,717)	(656)	(222)

Net Cash Used in Investing Activities	(9,757)	(656)	(222)

Financing Activities
Deferred financing costs	(161)	−	(161)
Proceeds from issuance of common stock	288	–	–
Proceeds from common stock subscribed	1,850	–	–
Proceeds from bank debt	5,000	−	1,407
Proceeds from convertible units	580	–	−
Advances from related parties	6	–	–
Proceeds from issuance of convertible debentures	2,700	–	–

Net Cash Provided by Financing Activities	10,468	−	1,246

Effect of exchange rate on cash	(4)	–	–

Change in Cash	1,603	302	169

Cash – Beginning	–	1,301	1,436

Cash – Ending	1,603	1,603	1,604

Supplemental Disclosures:
Oil and gas property expenditures recorded in prepaids	–	–	−
Oil and gas property expenditures recorded in accounts payable and accrued liabilities	5,283	5,283	2,058
Cash paid for:
Interest	312	69	43
Income taxes	–	–	–

	Accumulated From February 7, 2005 (Date of Inception) to February 28, 2009 $	Nine Months Ended February 28, 2009 $	Nine Months Ended February 28, 2008 $
Operating Activities
Net loss	(16,966)	(11,281)	(2,807)
Adjustments to reconcile net loss to net cash provided by (used in)operating activities:
Accretion of debt discount	1,646	425	1,082
Common stock subscribed	35	−	20
Depreciation, depletion and accretion	8,142	8,030	1
Intrinsic value of convertible units and fair value warrants issued as finance fees	1,775	−	406
Interest accrued on convertible debt	4	−	(75)
Shares issued for consulting services	51	36
Stock-based compensation	1,854	973	624
Amortization of deferred financing costs	600	600	−
Changes in operating assets and liabilities
Accounts receivable	(381)	(55)	(91)
Prepaids and other	234	30	209
Accounts payable and accrued liabilities	1,028	61	214
Deferred revenue	19	−	−
Due to related parties	21	16	47
Exploration advances	5,332	5,066	1,756
Net Cash Provided By (Used in) Continuing Operations	3,394	3,901	1,386
Discontinued operations	(38)	−	−
Net Cash Provided By (Used in) Operating Activities	3,356	3,901	1,386
Investing Activities
Acquisition of property and equipment	(28)	−	−
Surety bond	(10)	−	−
Oil and gas property expenditures	(10,948)	(5,547)	(2,201)
Net Cash Used in Investing Activities	(10,986)	(5,547)	(2,201)
Financing Activities
Deferred costs	(161)	(161)	(25)
Proceeds from issuance of common stock	493	205	−
Proceeds from common stock subscribed	1,850	−	−
Proceeds from loan payable	5,000	3,000	−
Proceeds from convertible units	580	−	580
Advances from related parties	6	−	−
Proceeds from issuance of convertible debentures	2,700	−	1,300
Net Cash Provided by Financing Activities	10,468	3,044	1,855
Effect of exchange rate on cash	(4)	−	−
Change in Cash	2,834	1,398	1,040
Cash – Beginning	−	1,436	738
Cash – Ending	2,834	2,834	1,778
Supplemental Disclosures:
Oil and gas property expenditures recorded in accounts payable and accrued liabilities	2,115	2,115	920
Issuance of warrants for financing fees	4,930	2,670	−
Asset retirement obligations recorded in oil and gas property	96	41	31
Cash paid for:
Interest	158	154	−
Income taxes	−	−	−

The accompanying notes are an integral part of these consolidated financial statements.

Southern Star Energy Inc.

(An Exploration Stage Company)

Consolidated Statement of Stockholders’ Equity ~~(Deficit)~~

Period from May 31, ~~2008~~2009 to ~~February~~August 2831, 2009

(unaudited)

(in thousands~~, except share amounts~~)

			Common Shares					Additional Paid-in		Accumulated			Total Stockholders' Equity
	Common Shares Number Amount		Additional Paid-in Capital	Common Stock Subscribed	Accumulated Deficit	Total Stockholders’ Equity (Deficit)
		$	$	$	$	$
			Number			Amount		Capital		Deficit			(Deficit)
Balance – May 31, 2008	44,800,944	45	9,852	35	(5,685)	4,246
			$			$		$		$			$
Shares issued for consulting services (Note 7)	46,335	−	36	−	−	36
Balance – May 31, 2009				45,347			45		14,010		(18,833	)		(4,778	)
Fair value of warrants issued for financing fees (Notes 4 and 6)			1,729	−	−	1,729
Stock-based compensation
Fair value of warrants issued for financing fees (Notes 4 and 6)			941	−	−	941
(Note 6)				–			–		276		–			276
Stock-based compensation (Note 6)			972	−	−	972
Net loss for the year				–			–		–		(1,030	)		(1,030	)
Shares issued to director	500,000	−	205			205
Balance – August 31, 200				45,347			45		14,286		(19,863	)		(5,532	)
Net loss for the period					(11,281)	(11,281)
Balance – February 28, 2009	45,347,279	45	13,735	35	(16,966)	(3,151)

On November 13, 2006, the Company effected a 7.5:1 forward stock split of the authorized, issued and outstanding common stock. On March 22, 2007, the Company effected a 1.5:1 forward stock split of the authorized, issued and outstanding common stock. All share amounts have been retroactively adjusted for all periods presented.

The accompanying notes are an integral part of these consolidated financial statements.

Southern Star Energy Inc.

(An Exploration Stage Company)

Notes to the Consolidated Financial Statements

1.	Nature of Operations and Continuance of Business

Southern Star Energy Inc. was incorporated in the State of Nevada on February 7, 2005 under the name Surge Enterprises, Inc. Pursuant to a Restructuring Agreement dated November 6, 2006, the Company disposed of its interest in the Company’s wholly-owned subsidiary, Surge Marketing Corp. (“Surge Marketing”) (Note 9). On November 13, 2006 the Company changed its name to Southern Star Energy Inc.

On November 2, 2006, the Company commenced the business of the acquisition, exploration and development of oil and gas resources with the acquisition of an initial 20% interest in certain oil and gas leases located in Louisiana. The Company previously focused its business efforts on software sales and website development.

The Company has been in the exploration stage since completion of its restructuring in November, 2006 and has not yet realized any significant revenues from its planned operations. Previously, it was in the development stage, pursuant to Statements of Financial Accounting Standards (“SFAS”) No. 7 “Accounting and Reporting by Development Stage Enterprises”, and had not generated or sustained significant revenues. These financial statements have been prepared on a going concern basis, which implies the Company will continue to realize its assets and discharge its liabilities in the normal course of business. The Company is unlikely to pay dividends or generate significant earnings in the immediate or foreseeable future. The continuation of the Company as a going concern and the ability of the Company to emerge from the exploration stage are dependent upon its successful efforts to raise additional equity or debt financing to continue operations and generate sustainable significant revenue. There is no guarantee that the Company will be able to raise adequate equity ~~financing~~financings or generate profitable operations. As ofat ~~February~~August 2831, 2009, the Company has a working capital deficit of $1012,~~112~~608,000 and has incurred losses of $1619,~~966~~863,000 since inception. These factors raise substantial doubt regarding the Company’s ability to continue as a going concern. These financial statements do not include any adjustments to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. Management of the Company has undertaken steps as part of a plan with the goal of sustaining Company operations for the remainder of the fiscal year and beyond. These steps include: (a) continuing efforts to raise additional capital and/or other forms of financing; and (b) controlling overhead and expenses. There can be no assurance that any of these efforts will be successful.

The unaudited interim consolidated financial statements have been prepared by the Company in accordance with generally accepted accounting principles in the United States for interim financial information and conforms with instructions to Form 10-Q of Regulation S-X and reflects all adjustments (all of which are normal and recurring in nature) that, in the opinion of management, are necessary for fair presentation of the interim periods presented. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for any subsequent quarter or for the entire year ending May 31, ~~2009~~2010. The preparation of consolidated financial statements in accordance with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions that affect the amounts reported. Actual results could differ from these estimates. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States have been condensed or omitted. These unaudited interim consolidated financial statements and notes included herein should be read in conjunction with the Company’s audited consolidated financial statements and notes for the year ended May 31, ~~2008~~2009, included in the Company’s Annual Report on Form 10-~~KSB as filed with the SEC on August 29, 2008~~K. The accounting principles applied in the preparation of these interim consolidated financial statements are consistent with those applied for the year ended May 31, ~~2008~~2009. Certain reclassifications have been made to prior period amounts to conform to current period presentation.

2. Oil and Gas ~~Property~~Properties

The Company’s ~~portion~~utilizes the full-cost method of accounting for petroleum and natural gas properties. Under this method, the Company capitalizes all costs associated with acquisition, exploration and development of oil and natural gas reserves, including leasehold acquisition costs, ~~incurred~~geological ~~during~~and geophysical expenditures, lease rentals on undeveloped properties and costs of drilling of productive and non-productive wells into the ~~quarter~~full ~~ended~~cost ~~February~~pool 28on a country by country basis. When the Company obtains proven oil and gas reserves, ~~2009~~capitalized costs, ~~was~~including $2estimated future costs to develop the reserves proved and estimated abandonment costs,~~535~~ net of salvage,~~000~~ will be depleted on the units-of-production method using estimates of proved reserves. The costs of unproved properties are not amortized until it is determined whether or not proved reserves can be assigned to the properties. Until such determination is made the Company assesses annually whether impairment has occurred, and includes in the amortization base costs of drilling exploratory dry holes associated with unproved properties.

The Company recorded an impairment of oil and gas properties in the amount of $5,196,000 for the three months ended February 28, 2009 as a result of the full cost ceiling test at February 28, 2009. In determining the future cash flows used in performing the full cost ceiling test, the Company utilized a natural gas price of $3.39 per Mcf and an oil price of $51.05 per barrel, which represented spot prices in April 2009. Had the Company utilized the spot prices on February 28, 2009, the impairment recorded at February 28, 2009, would have been $6,452,000. Additionally, 8

Southern Star Energy Inc.

(An Exploration Stage Company)

Notes to the Consolidated Financial Statements

~~the~~The Company ~~recorded~~applies ana ~~impairment~~ceiling oftest ~~oil~~to ~~and~~the ~~gas~~capitalized ~~properties~~cost in the ~~amount~~full ofcost $2pool. The ceiling test limits such cost to the estimated present value,~~202~~ using a ten percent discount rate,~~000~~ atof ~~August~~the 31future net revenue from proved reserves, ~~2008~~based on current economic and operating conditions. Specifically, the Company computes the ceiling test so that capitalized cost, less accumulated depletion and related deferred income tax, do not exceed an amount (the ceiling) equal to the sum of: (A) The ~~weighted~~present ~~average~~value ~~natural~~of estimated future net revenue computed by applying current prices of oil and gas reserves (with consideration of price ~~utilized~~changes ~~for~~only to the extent provided by contractual arrangements) to estimated future production of proved oil and gas reserves as of the date of the latest balance sheet presented, less estimated future expenditures (based on current cost) to be incurred in developing and producing the proved reserves computed using a discount factor of ten percent and assuming continuation of existing economic conditions; plus (B) the cost of property not being amortized; plus (C) the lower of cost or estimated fair value of unproven properties included in the costs being amortized; less (D) income tax effects related to differences between the book and tax basis of the property. For the quarter ended August 31, ~~2008~~2009, ~~ceiling~~the ~~impairment~~Company ~~evaluation~~utilized ~~was~~a natural gas price of $83.22 55 per ~~Mcf,~~mcf ~~held~~and ~~constant,~~an asoil ~~compared~~price toof $1066.6778 ~~for~~per ~~the~~barrel ~~May~~in ~~31,~~performing ~~2008~~its ceiling ~~impairment~~test evaluation,. atSuch ~~which~~prices ~~time~~represented ~~there~~prices ~~was~~subsequent noto ~~impairment.~~August ~~There~~31, ~~was~~2009, and resulted in no ~~impairment~~ceiling test impairments being recorded. ~~during~~Had prices in effect at August 31, 2009 been used in the ~~nine-month~~ ~~ended~~ceiling ~~February~~test, 29impairments of approximately $843,000 ~~2008~~would have been recorded and included in depletion, depreciation and amortization expense.

AtFor ~~February~~unproven 28properties, ~~2009,~~ the Company’s ~~working~~excludes ~~interest~~from ~~partners~~capitalized ~~have~~costs ~~prepaid~~subject $5to depletion,~~332,000~~ ~~towards~~all ~~future~~ costs ~~which~~directly ~~have~~associated ~~been~~with ~~recorded~~the asacquisition ~~exploration~~and ~~advances~~evaluation onof the ~~balance~~unproved ~~sheet~~property until it is determined whether or not proved reserves can be assigned to the property. AtUntil ~~February~~such ~~28,~~a ~~2009~~determination is made, the Company ~~recorded~~assesses ~~$391,000~~the ~~receivable~~property ~~from~~at ~~oil~~least ~~and~~annually ~~gas~~to ~~sales~~ascertain whether impairment has occurred. In assessing impairment the Company considers factors such as historical experience and ~~$857~~other data such as primary lease terms of the property,~~000~~ average holding periods of ~~oil~~unproved property, and ~~gas~~geographic ~~sales~~and ~~payable~~geologic data. The Company adds the amount of impairment assessed to ~~its~~the ~~working~~cost ~~interest~~to ~~partners~~be ~~and~~amortized ~~royalty~~subject ~~owners~~to the ceiling test.

During the drilling of the Boyce Pate 16-1 well, the Company incurred additional costs of approximately $1,716,000 resulting from a vendor using inappropriate cement while setting a plug after the drilling of the well. The vendor has agreed to reimburse us for the additional costs, of which our share totals approximately $686,000. The Company has been reimbursed $1,716,000 from the vendor and, accordingly, oil and gas property balances as August 31, 2009, have been reduced by approximately $686,000 for our share of amounts received.

3.	Asset Retirement Obligation

The Company’s asset retirement obligations (“ARO”) in regards to Sentell Field ~~relate~~relates to site restoration.

A reconciliation between the opening and closing ARO balance is provided below:

	February 28, 2009 $
	August 31, 2009 $
Asset retirement obligations – beginning of period	54,000
Beginning asset retirement obligations	98,000
Liabilities incurred	~~37,000~~−
Liabilities settled	-−
Accretion	53,000
Total asset retirement obligations	96101,000

In accordance with ~~Statement~~SFAS ~~of Financial Accounting Standards~~ No. 143 “Accounting for Asset Retirement Obligations,” the Company measured the ARO’s at fair value and ~~properly~~ capitalized this to the oil and gas property ~~accounts~~. The ARO’s will accrete to $171,000 ~~over~~until athe ~~period~~time ~~of seven years~~ at which it is expected to be settled, being 7 years. A discount rate of 10% ~~and~~was ~~an inflation rate of 2.5% were~~ used to calculate the present value of the ARO’s. The corresponding accretion at ~~February~~August 2831, 2009, ofbeing $53,000 has been included in depletion, depreciation and amortization. Actual retirement costs will be recorded against the ARO’s when incurred. Any difference between the recorded ARO’s and the actual retirement costs incurred will be recorded as a gain or loss in the period of settlement.

~~4. Bank Debt~~9

On May 16, 2008, the Company and Macquarie Bank Limited (“Macquarie”) entered into a credit agreement (the “Macquarie Credit Agreement”) to receive advances up to $2,000,000 with a maturity date of September 13, 2008, which the Company received in full on May 20, 2008. The advances accrued interest at the lesser of the prime rate plus 2% and the highest lawful rate with interest payable on the last day of each month. Pursuant to the terms of the agreement, all proceeds from the sale of oil and gas by the Company were assigned to Macquarie until all amounts outstanding are paid in full. In connection with the Macquarie Credit Agreement, the Company issued the lender a warrant to purchase 750,000 shares of common stock at $1.00 per share until May 16, 2013. The Company recorded the fair value of the warrant of $486,000 as additional paid-in capital and recorded an equivalent discount, which will be expensed over the term of the agreement.

On July 11, 2008, the Company and Macquarie entered into a credit agreement (the “Amended Macquarie Credit Agreement”) to receive advances up to $25,000,000 with an initial borrowing base of $5,000,000. The Amended Macquarie Credit Agreement amends and restates the previous credit agreement described above in its entirety. On July 16, 2008, the Company received an advance of approximately $2,500,000 and received advances for the remaining $2,500,000 throughout the nine months ended February 28, 2009. The advances accrue interest at the lesser of the prime rate plus 2% and the highest lawful rate. Interest payments must be made on the last day of each month and all interest and advances must be repaid by July 11, 2011, the maturity date. Pursuant to the terms of the Amended Macquarie Credit Agreement, all proceeds from the sale of oil and gas by the Company will be assigned to Macquarie while amounts are outstanding under the agreement.

Southern Star Energy Inc.

(An Exploration Stage Company)

Notes to the Consolidated Financial Statements

~~The~~4. ~~Amended~~Bank Macquarie Credit Agreement contains various positive covenants, including interest coverage ratio, current ratio and adjusted present value ratio covenants (as defined in the agreement), and certain negative covenants which prevent us from carrying out certain actions, including incurring specified debt or guaranties, suffering any change of control, merging into or consolidating with any other entity and declaring or paying any cash dividends or distributions.Debt

AtOn ~~February~~May 2816, ~~2009~~2008, the Company ~~was~~and ~~not~~Macquarie inBank ~~compliance~~Limited ~~with~~(“Macquarie”) ~~its~~entered ~~current~~into ~~ratio~~a ~~covenant.~~credit Toagreement (the “Macquarie Credit Agreement”) to receive advances up to $2,000,000 with a maturity date of September 13, ~~Macquarie~~2008, ~~has~~which ~~not~~the ~~taken~~Company ~~any~~received ~~adverse~~in ~~actions~~full ~~related~~on toMay 20, 2008. The advances accrued interest at the ~~non-compliance~~lesser of the prime rate plus 2% and ~~has~~the ~~continued~~highest lawful rate with interest payable on the last day of each month. Pursuant to ~~fulfill~~the ~~funding~~terms ~~requests~~of ~~knowing~~the agreement, all proceeds from the sale of oil and gas by the Company were isto ~~not~~be inremitted ~~compliance~~to Macquarie while amounts are outstanding under the agreement. ~~The~~ In connection with the Macquarie Credit Agreement, the Company ~~has~~issued ~~initiated~~the ~~and~~lender ~~continues~~a warrant to ~~pursue~~purchase ~~efforts~~750,000 toshares ~~remedy~~of common stock at $1.00 per share until May 16, 2013. The Company recorded the ~~noncompliance~~fair value of the warrant of $486,000 as additional paid-in capital and ~~expects~~recorded ~~such~~an ~~efforts~~equivalent discount, which to be ~~successful~~ expensed over the term of the agreement.

On July 11, 2008, the Company and Macquarie entered into a credit agreement (the “Amended Macquarie Credit Agreement”) to receive advances up to $25,000,000 with an initial borrowing base of $5,000,000. The Amended Macquarie Credit Agreement amends and restates the previous credit agreement described above in its entirety. On July 16, 2008, the Company received an advance of approximately $2,500,000 and received advances for the remaining $2,500,000 throughout the nine months ended February 28, 2009. The advances accrue interest at the lesser of the prime rate plus 2% and the highest lawful rate (5.25% at August 31, 2009). Interest payments must be made on the last day of each month and all interest and advances must be repaid by July 11, 2011, the maturity date. Pursuant to the terms of the Amended Macquarie Credit Agreement, all proceeds from the sale of oil and gas by the Company will be remitted to Macquarie while amounts are outstanding under the agreement.

The Amended Macquarie Credit Agreement is secured by a lien on substantially all of the Company’s assets, including the Company’s oil and gas properties and contains various positive covenants, including interest coverage ratio, current ratio and adjusted present value ratio covenants (as defined in the agreement), and certain negative covenants which prevent us from carrying out certain actions, including incurring specified debt or guaranties, suffering any change of control, merging into or consolidating with any other entity and declaring or paying any cash dividends or distributions. As of May 31, 2009, we were not in compliance with certain of these financial covenants.

On May 29, 2009, the Company and Macquarie executed a waiver letter amending the Credit Agreement (“Waiver Letter”). Under the terms of the Waiver Letter, until June 30, 2009, the Lender agreed to waive the Company’s compliance with certain sections of the Credit Agreement, which pertain to interest coverage ratio, current ratio, and adjusted PV ratio.

In consideration of this waiver, the Company agreed to pay Macquarie one hundred percent (100%) of the Net Operating Cash Flow (as defined in the Credit Agreement), to be applied against the entire outstanding balance of the loan until such time as the outstanding balance of the loan is paid off. The Company also agreed to obtain the written consent of Macquarie prior to incurring or agreeing to incur any cost or expense for capital expenditures of any kind. Finally, the Company released Macquarie from any action or failure to act in connection with the Credit Agreement or related documents occurring any time prior to May 29, 2009. The Waiver Letter expired June 30, 2009. The Company remains out of compliance with its interest coverage ratio, current ratio and adjusted present value ratio covenants.

In connection with the Amended Macquarie Credit Agreement, the Company issued the lender a warrant to purchase 750,000 shares of common stock at $1.00 per share until July 11, 2013 in exchange for the warrant to purchase 750,000 shares of common stock at $1.00 issued in connection with the Macquarie Credit Agreement. Also in connection with the credit agreement, the Company issued the lender a warrant to purchase 1,897,419 shares of common stock at $1.00 per share until July 11, 2013.

Pursuant to a financial services agreement and in connection with the Macquarie Credit Agreement, the Company paid Imperial Capital, LLC (“Imperial”) $60,000 of financing fees, $50,000 in additional expenses and was obligated to issue a warrant exercisable to purchase 100,000 shares of common stock at $1.00. per share. Additionally, in connection with the Amended Macquarie Credit Agreement, the Company paid Imperial a cash fee of $90,000 and issued a warrant to purchase 1,250,000 shares of the Company’s common stock at $1.00 per share until July 11, 2013. Furthermore, the Company will owe Imperial the amount of 3% of the gross proceeds of each funding in excess of the initial $5,000,000 borrowing base the Company ~~receive~~receives under the Amended Macquarie Credit Agreement until Imperial has received the total fee of $750,000, of which $150,000 has been paid.

The issuance-date fair value of the warrants issued to Macquarie ($1,728,852) and Imperial ($940,908) have been recorded as deferred financing costs with a related adjustment to additional paid-in capital. Additionally, the Company incurred an additional $161,337 in legal and other direct costs in connection with the Amended Macquarie Credit Agreement that have been recorded as deferred financing costs. Such deferred financing costs are being amortized to financing costs over the three-year term of the agreement using a method that approximates the interest method.10

5. Related Party Transactions

During the three-month and nine-month periods ended February 28, 2009, the Company incurred $151,000 and $343,000, respectively, for consultation services payable to a company wholly-owned by a director of the Company, of which $49,000 remained unpaid at February 28, 2009. In addition, the Company paid $45,000 and $117,000 for the three-month and nine-month periods ended February 28, 2009, respectively, to a company for consulting services rendered to the Company by a director of the Company. These transactions are in the normal course of business and are recorded at the exchange amount, which is the consideration agreed to by the related parties.

6. Stock Options and Warrants

Stock Options

On October 31, 2007, the Company approved the 2007 Stock Option Plan (the “Plan”) to issue up to 3,000,000 shares to eligible employees, officers, directors and consultants. Pursuant to the Plan, the Company has granted stock options to certain directors and consultants. On June 4, 2008, the Company amended the Plan to increase the number of shares issuable to 5,000,000.

Southern Star Energy Inc.

(An Exploration Stage Company)

Notes to the Consolidated Financial Statements

OnThe ~~June~~issuance-date 4,fair ~~2008,~~value of the ~~Company~~warrants ~~entered~~issued ~~into~~to aMacquarie ~~stock~~($1,728,852) ~~option~~and ~~agreement~~Imperial ($940,908) have been recorded as deferred financing costs with ~~the~~a ~~President~~related ~~and~~adjustment ~~CEO~~to ofadditional ~~the~~paid-in ~~Company~~capital. ~~whereby~~Additionally, the Company ~~granted~~incurred ~~options~~an toadditional ~~purchase~~$161,337 upin tolegal anand ~~aggregate~~other ofdirect ~~1,000,000~~costs ~~shares~~in ofconnection ~~common~~with ~~stock~~the atAmended ~~$1.00~~Macquarie ~~per~~Credit ~~share~~Agreement ~~for~~that 5have ~~years~~been recorded as deferred financing costs. Such ~~One-third~~deferred offinancing ~~the~~costs ~~options~~are ~~vest~~being ~~each~~amortized onto ~~June~~financing 4,costs ~~2009,~~over ~~June~~the 4,three-year ~~2010~~term ~~and~~of ~~June~~the 4,agreement ~~2011~~using a method that approximates the interest method.

On June 16, 2008, the Company entered into a stock option agreement with an employee who will provide operations management services whereby the Company granted options to purchase 250,000 shares of the Company’s common stock at $1.00 per share for 5 ~~years~~. ~~One-third~~Related ofParty ~~the options vest each on June 16, 2009, June 16, 2010 and June 16, 2011.~~Transactions

~~Effective~~During ~~September~~the 22quarter ended August 31, ~~2008~~2009, the Company ~~entered~~incurred ~~into~~$40,000 afor ~~stock~~consultation ~~option~~services ~~agreement~~payable ~~with~~to ~~the~~a ~~chief~~company ~~financial~~wholly ~~officer~~owned by a director of the Company, ~~whereby~~of which $20,000 remained unpaid at August 31, 2009. In addition, the Company ~~granted~~paid ~~options~~$30,000 to ~~purchase~~a ~~350,000~~company ~~shares~~for consulting services rendered to the Company by a director of the Company’s. ~~common~~Furthermore, ~~stock~~the atCompany has accrued a liability in the amount of $~~0.82~~10,000 ~~per~~payable ~~share~~to a director of the Company for 5consulting ~~years.~~services ~~One-third~~rendered ofto the ~~options~~Company. ~~vest~~These ~~each~~transactions onare ~~September~~are ~~22,~~recorded ~~2009,~~at ~~September~~the 22exchange amount, ~~2010~~which ~~and~~is ~~September~~the ~~22,~~consideration ~~2011~~agreed to by the related parties.

Effective October 27, 2008, the Company entered into a stock option agreement with an employee of the Company whereby the Company granted options to purchase 100,000 shares of the Company’s common stock at $06.60 ~~per~~Stock ~~share for 5 years. One-third of the options vest each on October 27, 2009, October 27, 2010 and October 27, 2011.~~Options

~~During~~On ~~the~~October ~~three-month and nine-month periods ended February 28~~31, ~~2009~~2007, the Company ~~recorded~~approved ~~stock-based~~the ~~compensation~~2007 ~~expense~~Stock ofOption ~~$272,000~~Plan ~~and~~(the ~~$973,000,~~“Plan”) ~~respectively. As~~to ofissue ~~February~~up ~~28,~~to ~~2009~~3, ~~there was $2~~000,~~153,~~000 ofshares ~~total unrecognized compensation costs related~~ to ~~nonvested~~eligible ~~share-based compensation arrangements granted under the Plan~~employees, ~~which are expected to be recognized over a weighted-average period of 2.0 years. The weighted-average grant-date fair value of stock options granted during the nine-months ended February 28~~officers, ~~2009~~directors ~~was~~and $0consultants.68 ~~per~~Pursuant ~~share.~~to ~~No stock options were exercised during~~ the ~~nine months ended February 28~~Plan, ~~2009 and 2008. The fair value of each option award is estimated on~~ the ~~date of grant using the Black-Scholes-Merton model using assumptions discussed below. The weighted-average expected volatility of 112% at the grant date was based on the volatility of the~~ Company’s ~~stock~~has ~~price. The expected term of the options~~ granted ofstock ~~3.5 years is based on the time period the~~ options ~~are expected~~ to becertain ~~outstanding.~~directors ~~The risk-free interest rate of between 1.83%~~ and 3consultants.~~73%~~ isOn ~~based~~June on4, 2008, the ~~U.S.~~Company ~~Treasury~~amended ~~rate of a note with~~ the ~~expected~~Plan ~~maturity~~to ofincrease the ~~expected~~number ~~term~~ of ~~the~~shares ~~options.~~issuable ~~The~~to ~~Company has not considered a dividend payment in its calculation and believes that forfeitures will not be significant~~5,000,000.

~~Warrants~~During the quarter ended August 31, 2009, no stock options were granted, exercised or forfeited. The Company recognized $276,000 in stock-based compensation expense during the quarter ended August 31, 2009, related to stock options previously issued.

On July 11, 2008, pursuant to the Amended Macquarie Credit Agreement, the Company issued a warrant to purchase 750,000 shares of common stock at $1.00 per share until July 11, 2013 in exchange for the warrant to purchase 750,000 shares of common stock at $1.00 previously issued to Macquarie. Also in connection with the Amended Macquarie Credit Agreement, the Company issued Macquarie a warrant to purchase 1,897,419 shares of common stock at $1.00 per share until July 11, 2013 and issued Imperial a warrant to purchase 1,250,000 shares of the Company's common stock at $1.00 per share until July 11, 2013.

7.	Common Stock

a) On November 13, 2006, the Company completed a 7.5:1 forward stock split on the basis of 7.5 new shares of common stock in exchange for every one old share of common stock outstanding. On March 22, 2007, the Company effected a 1.5:1 forward stock split of the authorized, issued and outstanding common stock. All per share amounts have been retroactively restated to reflect the forward stock ~~splits~~split.

~~b) During the nine months ended February 28, 2009, the Company issued 46,335 shares of common stock with a fair value of $36,000 pursuant to a marketing agreement, which was subsequently terminated~~8. Commitments

ca) On January 211, ~~2009~~2008, the Company ~~issued~~entered ~~500,000~~into ~~shares~~a ofconsulting ~~common~~agreement ~~stock~~with tothe aformer ~~director~~CEO of the Company ~~for~~to ~~proceeds~~provide ofconsulting services in exchange for $~~205~~10,000 per month for an indefinite period.

9b) On February 4, 2008, the Company entered into a lease agreement commencing May 1, 2008 for office premises for a 3 year term expiring May 1, 2011. Annual rent under the new lease is payable at $35,000 for the first year, $35,000 for the second year and $36,000 for the final year. The Company must also pay its share of building operating costs and taxes. Future minimum lease payments over the next two fiscal years are as follows:

2010	$	26,000
2011		33,000

	$	59,000

On May 20, 2008, the Company entered into a consulting agreement with an investor communications consulting firm to provide investor communications services on behalf of the Company in consideration of a minimum of $3,000 per month for an initial period of one year. This agreement was terminated during the quarter ended August 31, 2009.

On May 3, 2007, the Company entered into a marketing agreement with RedChip Companies Inc. (“RedChip”) for an initial term of 12 months in consideration of $7,500 per month, and

Southern Star Energy Inc.

(An Exploration Stage Company)

Notes to the Consolidated Financial Statements

8d) On May 3, 2007, the Company entered into a marketing agreement with RedChip Companies Inc. ~~Commitments~~(“RedChip”) for an initial term of 12 months in consideration of $7,500 per month, and commencing August 1, 2007, an equivalent value of $5,000 per month payable in shares of the Company’s common stock, the value of which will be determined based upon the closing price of the shares as reported by StockWatch Inc. on the first business day of each quarterly period. The shares were to be issued by the Company to RedChip on a quarterly basis no later than ten days after the first day of each subsequent quarter. On December 11, 2007, the Company issued 18,750 for $15,000 of consulting services shares pursuant to the consulting agreement and at May 31, 2008, $35,000 was included in common stock subscribed. During the year ended May 31, 2009, the Company issued 46,335 shares pursuant to this agreement before terminating the agreement.

ae) On ~~January~~February 127, ~~2008~~2007, the Company entered into a ~~consulting~~services agreement with a consultant who will provide consulting services in consideration for $140 per hour of services and 375,000 shares of the ~~former~~Company’s ~~CEO~~common stock. The Company is to issue 187,500 shares upon the generation of revenues from Sentell Field in excess of all costs reasonably incurred in relation to the drilling of the well. The Company is also obligated to ~~provide~~issue ~~consulting~~187,500 ~~services~~shares to be held in ~~exchange~~escrow for a period of one year upon Sentell Field generating more than 15 billion cubic feet equivalent of natural gas or having reserves greater than $1075,000,000 ~~per~~calculated ~~month~~on ~~for~~a an10% ~~indefinite~~discounted ~~period~~cash flow basis. As at May 31, 2009, no shares have been issued under this services agreement.

bf) On February 415, ~~2008~~2007, the Company entered into a ~~lease~~services agreement ~~commencing~~with ~~May~~a 1,consultant ~~2008~~who ~~for~~will ~~office~~provide ~~premises~~consulting services in consideration for a$75 3per ~~year~~hour ~~term~~of ~~expiring~~services ~~May~~and 1375,000 ~~2011.~~shares ~~Annual~~of ~~rent~~the ~~under~~Company’s ~~the~~common ~~new~~stock. ~~lease~~The Company is ~~payable~~to atissue ~~$35~~187,~~000~~500 ~~for~~shares upon the ~~first~~generation ~~year,~~of ~~$35,000~~revenues ~~for~~from ~~the~~Sentell ~~second~~Field ~~year~~in ~~and~~excess ~~$36,000~~of ~~for~~all costs reasonably incurred in relation to the ~~final~~drilling ~~year~~of the well. The Company ~~must~~is also ~~pay~~obligated ~~its~~to ~~share~~issue 187,500 shares to be held in escrow for a period of ~~building~~one ~~operating~~year ~~costs~~upon ~~and~~Sentell ~~taxes~~Field generating more than 15 billion cubic feet equivalent of natural gas or having reserves greater than $75,000,000 calculated on a 10% discounted cash flow basis. ~~Future~~As ~~minimum~~at ~~lease~~May ~~payments~~31, ~~over~~2009, ~~the~~no ~~next~~shares ~~three~~have ~~fiscal~~been ~~years~~issued ~~are~~under asthis ~~follows:~~services agreement.

		$
2009		9,000
2010		35,000
2011		33,000
		77,000

On November 22, 2007, the Company entered into a consulting agreement with a company wholly owned by a director of the Company that will provide consulting services in consideration for $10,000 per month, options to purchase 750,000 shares of the Company’s common stock at $1.09 per share for 4 years and $60,000 upon the commercial production of each new well. The options granted had a grant-date fair value of approximately $611,000. One-third of the options granted will vest on each of the first three anniversaries of November 22, 2007. On February 26, 2008, the Company reduced the exercise price of the options to $0.70 per share which resulted in an increase to the fair value of the options in the amount of approximately $34,000. Approximately $3,000 of such increase was recognized immediately with the remaining $31,000 to be recognized ratably over the remaining vesting period. In addition, if during the term of this agreement, the Company identifies an oil and gas property interest or well for potential exploration by the Company and retains the consultant, the consultant will be granted an overriding royalty of: 2% for leases where the Company has acquired a working interest of greater than 80%, 1.75% for leases where the Company has acquired a working interest of greater than 78% but less than 80%, 1.5% for leases where the Company has acquired a working interest of greater than 75% but less than 78%, 1.0% for leases where the Company has acquired a working interest of less than 75%.

ch) On ~~May~~November 2022, ~~2008~~2007, the Company entered into a consulting agreement with ana ~~investor~~consultant ~~communications~~who will provide consulting ~~firm~~services toin ~~provide~~consideration ~~investor~~for ~~communications~~$175 per hour of services, onoptions ~~behalf~~to purchase 500,000 shares of the Company’s incommon ~~consideration~~stock at $1.09 per share for 2 years and $25,000 upon the successful completion of three of the Company’s wells. The options granted had a ~~minimum~~grant-date ~~fee~~fair value of approximately $3315,000. One-half of the options granted vested immediately and the remaining half vests on the first anniversary of November 22, 2007. On February 26, 2008, the Company reduced the exercise price of the options to $0.70 per ~~month~~share ~~for~~which resulted in an ~~initial~~increase ~~period~~to the fair value of ~~one~~the ~~year~~options in the amount of approximately $36,000. Approximately $21,000 of such increase was recognized immediately with the remaining $15,000 was recognized ratably over the remaining vesting period.

d) On February 27, 2007 the Company entered into a services agreement with a consultant to provide consulting services in consideration for $140 per hour of services and 375,000 shares of the Company’s common stock. The Company is to issue 187,500 shares upon the generation of revenues from Sentell Field in excess of all costs reasonably incurred in relation to the drilling of the well. The Company is also obligated to issue 187,500 shares to be held in escrow for a period of one year upon Sentell Field generating more than 15 billion cubic feet equivalent of natural gas or having reserves greater than $75,000,000 calculated on a 10% discounted cash flow basis. As of February 28, 2009, no shares have been issued under this services agreement.12

e) On February 15, 2007, the Company entered into a services agreement with a consultant to provide consulting services in consideration for $75 per hour of services and 375,000 shares of the Company’s common stock. The Company is to issue 187,500 shares upon the generation of revenues from Sentell Field in excess of all costs reasonably incurred in relation to the drilling of the well. The Company is also obligated to issue 187,500 shares to be held in escrow for a period of one year upon Sentell Field generating more than 15 billion cubic feet equivalent of natural gas or having reserves greater than $75,000,000 calculated on a 10% discounted cash flow basis. As of February 28, 2009, no shares have been issued under this services agreement.

f) On November 22, 2007, the Company entered into a consulting agreement with a company wholly owned by a director of the Company to provide consulting services in consideration for $10,000 per month, options to purchase 750,000 shares of the Company’s common stock at $1.09 per share for 4 years and $60,000 upon the commercial production of each new well. On February 26, 2008, the Company reduced the exercise price of the options to $0.70 per share. In addition, if during the term of this agreement, the Company identifies an oil and gas property interest or well for potential exploration by the Company and retains the consultant, the consultant will be granted an overriding royalty of: 2% for leases where the Company has acquired a working interest of greater than 80%, 1.75% for leases where the Company has acquired a working interest of greater than 78% but less than 80%, 1.5% for leases where the Company has acquired a working interest of greater than 75% but less than 78%, 1.0% for leases where the Company has acquired a working interest of less than 75%.

g) On November 22, 2007, the Company entered into a consulting agreement with a consultant to provide consulting services in consideration for $175 per hour of services, options to purchase 500,000 shares of the Company’s common stock at $1.09 per share for 2 years and $25,000 upon the successful completion of three of the Company’s wells. On February 26, 2008, the Company

Southern Star Energy Inc.

(An Exploration Stage Company)

Notes to the Consolidated Financial Statements

reduced the exercise price of the options to $0.70 per share. During fiscal 2008, the Company paid $75,000 to the consultant for the completion of certain wells on Sentell Field.

9.	Restructuring Agreement

On November 6, 2006, the Company entered into a restructuring agreement (the “Restructuring Agreement”) with Southern Star Operating, Big Sky, Eric Boehnke (“Boehnke”), Troy Mutter (“Mutter”) and Frank Hollmann (“Hollmann”). Boehnke is the former President of the Company, and Mutter and Hollmann are former officers. Pursuant to the terms of the Restructuring Agreement, as amended, Big Sky, a private British Columbia company wholly-owned by Boehnke, agreed to assign to the Company its rights under a prospect acquisition agreement to purchase a 20% working interest in Sentell Field (Note 4). Prior to entering into the Restructuring Agreement, Big Sky had not made any payments or acquired any property pursuant to the prospect acquisition agreement. In conjunction with the Restructuring Agreement, the Company transferred its wholly-owned subsidiary, Surge Marketing, to Mutter and Hollmann in consideration for the transfer of 9,000,000 split-adjusted shares of common stock of the Company to Boehnke, and the return and cancellation of an aggregate of 54,937,500 split-adjusted shares of common stock of the Company held by Mutter and Hollman. On April 5, 2007, the shares were returned to treasury and cancelled.

10. ~~Accounting~~Legal ~~Pronouncements~~Proceedings

~~Effective~~On June 19, ~~2008~~2009, ~~the~~one ~~Company adopted Statement~~ of ~~Financial~~our ~~Accounting~~vendors, ~~Standards~~Coastal ~~No.~~Chemical ~~157~~Co., ~~Fair~~LLC ~~Value~~filed ~~Measurements~~suit ~~(SFAS~~in ~~No.~~the ~~157),~~113th ~~which~~Judicial ~~established~~District aof ~~framework~~Harris ~~for~~County, ~~measuring~~Texas ~~fair~~related ~~value~~to inapproximately ~~generally~~$104,000 ~~accepted~~in ~~accounting~~claimed ~~principles,~~unpaid ~~clarified~~invoices. ~~the~~In ~~definition~~addition, as of ~~fair~~August ~~value~~31, ~~within~~2009, ~~that~~several ~~framework,~~vendors ~~and~~have ~~expanded~~filed ~~disclosures~~liens ~~about~~against the ~~use~~Company ofrelated ~~fair~~to ~~value measurements.~~claims ~~SFAS~~for ~~No.~~unpaid ~~157~~invoices ~~is effective~~ for ~~fiscal~~goods ~~years~~and ~~beginning~~services ~~after~~provided ~~November~~to ~~15,~~the ~~2007.~~Company ~~However,~~ in ~~February~~Bossier ~~2008~~Parish, ~~the~~Louisiana ~~Financial~~and ~~Accounting~~in ~~Standards~~the state ~~Board~~of ~~(FASB) issued FASB Staff Position No~~Texas. ~~FA5~~Total ~~157-2,~~claims ~~Effective~~related ~~Date~~to ofthese ~~FASB~~liens ~~Statement~~are ~~No.~~approximately ~~157 (FSP No~~$3,696,000. ~~157-2),~~The ~~which~~suit ~~deferred~~and ~~the~~liens ~~effective~~are ~~date~~all ofbased ~~SFAS~~upon ~~No.~~claims ~~157~~ for ~~one year for~~ non-~~financial~~payment ~~assets and liabilities, except~~ for ~~certain~~amounts ~~items~~which ~~that~~have ~~are~~been ~~recognized~~reflected ~~or disclosed at fair value~~ in the ~~financial~~Company’ ~~statements~~accounts onpayable ~~a recurring basis (at least annually)~~balances.

~~SFAS No~~11. ~~157~~Accounting defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS No. 157 provides a framework for measuring fair value, establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date and requires consideration of the Company’s creditworthiness when valuing certain liabilities. Pronouncements

Effective this quarter, we implemented Statement of Financial Accounting Standards No. 165, Subsequent Events, or SFAS 165. The ~~three-level~~standard ~~fair~~establishes ~~value~~general ~~hierarchy~~standards of accounting for and disclosure of ~~fair~~events ~~value~~that ~~measurements~~occur ~~defined~~after bythe balance sheet date but before the financial statements are issued. The adoption of SFAS No165 did not impact our financial position or results of operations. ~~157~~We isevaluated asall ~~follows:~~events or transactions that occurred after June 30, 2009 up through the date we issued these financial statements on October 15, 2009.

Level 1	—	Quoted prices for identical instruments in active markets at the measurement date.
Level 2	—	Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets at the measurement date and for the anticipated term of the instrument.
Level 3	—	Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.

In December 2007, the FASB issued SFAS No. 141R, “Business Combinations”. This statement replaces SFAS 141 and defines the acquirer in a business combination as the entity that obtains control of one or more businesses in a business combination and establishes the acquisition date as the date that the acquirer achieves control. SFAS 141R requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date. SFAS 141R also requires the acquirer to recognize contingent consideration at the acquisition date, measured at its fair value at that date. This statement is effective for fiscal years and interim periods within those fiscal years, beginning on or after December 15, 2008 and earlier adoption is prohibited. The adoption of this statement did not have a material effect on the Company’s consolidated financial statements.

~~The~~In ~~adoption~~December of2007, the FASB issued SFAS No. ~~157~~160, “Noncontrolling Interests in Consolidated Financial Statements Liabilities –an Amendment of ARB No. 51”. This statement amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This statement is effective for fiscal years and interim periods within those fiscal years, beginning on or after December 15, 2008 and earlier adoption is prohibited. The adoption of this statement did not have a material effect on the Company’s consolidated financial statements.

11In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles”. SFAS No. 162 is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with U.S. generally accepted accounting principles for nongovernmental entities. SFAS No. 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board Auditing amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles”.

Southern Star Energy Inc.

(An Exploration Stage Company)

Notes to the Consolidated Financial Statements

In ~~March~~May 2008, the ~~Financial Accounting Standards Board (“~~FASB”) issued ~~SFAS~~FSP ~~No.~~14-1 ~~161,~~ “~~Disclosures~~Accounting ~~about~~for ~~Derivative~~Convertible Debt Instruments ~~and~~That ~~Hedging~~May ~~Activities~~Be –Settled anin ~~amendment~~Cash toupon ~~FASB~~Conversion ~~Statement~~(Including ~~No.~~Partial ~~133”.~~Cash ~~SFAS~~Settlement) No“. ~~161~~FSP is14-1 ~~intended~~requires tothe ~~improve~~issuer ~~financial~~of ~~standards~~certain ~~for~~convertible ~~derivative~~debt instruments ~~and~~that ~~hedging~~may ~~activities~~be bysettled ~~requiring~~in ~~enhanced disclosures~~cash to(or ~~enable~~other ~~investors~~assets) ~~to better understand their effects~~ on anconversion ~~entity’s financial position, financial performance, and cash flows. Entities are required~~ to ~~provide~~separately ~~enhanced~~account ~~disclosures~~for ~~about:~~the ~~(a)~~liability ~~how and why an entity uses derivative instruments;~~ (bdebt) ~~how derivative instruments~~ and ~~related~~equity ~~hedged items are accounted for under Statement 133 and its related interpretations; and~~ (cconversion option) ~~how~~components ~~derivative~~of ~~instruments~~the instrument ~~and~~in ~~related~~a ~~hedged~~manner ~~items~~that ~~affect~~reflects anthe ~~entity~~issuer’s ~~financial position,~~non-convertible ~~financial~~debt ~~performance,~~borrowing ~~and cash flows~~rate. ItFSP 14-1 is effective for ~~financial statements issued for~~ fiscal years beginning after ~~November~~December 15, 2008, ~~with~~on ~~early~~a ~~adoption~~retroactive ~~encouraged~~basis. The ~~Company is currently evaluating the impact of SFAS No. 161 on its consolidated financial statements, and the~~ adoption of this statement isdid not ~~expected to~~ have a material effect on the Company’s consolidated financial statements.

In December 2007, the FASB issued SFAS No. 141R, “Business Combinations”. This statement replaces SFAS 141 and defines the acquirer in a business combination as the entity that obtains control of one or more businesses in a business combination and establishes the acquisition date as the date that the acquirer achieves control. SFAS 141R requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date. SFAS 141R also requires the acquirer to recognize contingent consideration at the acquisition date, measured at its fair value at that date. This statement is effective for fiscal years and interim periods within those fiscal years, beginning on or after December 15, 2008 and earlier adoption is prohibited. The adoption of this statement is not expected to have a material effect on the Company’s consolidated financial statements.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements Liabilities –an Amendment of ARB No. 51”. This statement amends ARB 51 to establish accounting and reporting standards for the Noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This statement is effective for fiscal years and interim periods within those fiscal years, beginning on or after December 15, 2008 and earlier adoption is prohibited. The adoption of this statement is not expected to have a material effect on the Company’s consolidated financial statements.

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles”. SFAS No. 162 is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with U.S. generally accepted accounting principles for nongovernmental entities. SFAS No. 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board Auditing amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles”.

In May 2008, the FASB issued FSP 14-1 “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement) “. FSP 14-1 requires the issuer of certain convertible debt instruments that may be settled in cash (or other assets) on conversion to separately account for the liability (debt) and equity (conversion option) components of the instrument in a manner that reflects the issuer’s non-convertible debt borrowing rate. FSP 14-1 is effective for fiscal years beginning after December 15, 2008, on a retroactive basis. The Company has not yet determined the impact that the implementation of FSP 14-1 will have on its consolidated financial statements.

On December 31, 2008, the SEC published the final rules and interpretations updating its oil and gas reporting requirements. Many of the revisions are updates to definitions in the existing oil and gas rules to make them consistent with the petroleum resource management system, which is a widely accepted standard for the management of petroleum resources that was developed by several industry organizations. Key revisions include changes to the pricing used to estimate reserves utilizing a 12-month average price rather than a single day spot price which eliminates the ability to utilize subsequent prices to the end of a reporting period when the full cost ceiling was exceeded and subsequent pricing exceeds pricing at the end of a reporting period, the ability to include nontraditional resources in reserves, the use of new technology for determining reserves, and permitting disclosure of probable and possible reserves. The SEC will require companies to comply with the amended disclosure requirements for registration statements filed after January 1, 2010, and for annual reports on Form 10-K for fiscal years ending on or after December 15, 2009. Early adoption is not permitted. The Company is currently assessing the impact that the adoption will have on the Company’s disclosures, operating results, financial position and cash flows.

Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA, and the SEC did not, or are not believed by management to, have a material impact on the Company’s present or future consolidated financial statements.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

As used in this ~~annual~~Quarterly ~~report~~Report, and unless otherwise indicated, the terms “we”, “us”, “our” and “the Company” refer to Southern Star Energy Inc. (“Southern Star Energy”) and our wholly-owned subsidiary, Southern Star Operating Inc. (“Southern Star Operating”).

Forward-Looking Statements

The information in this Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (“Exchange Act”). These forward-looking statements involve risks and uncertainties, including statements regarding our capital needs, business plans and expectations. Such forward-looking statements involve risks and uncertainties regarding the anticipated results and developments in our operations in future periods, planned exploration and development of our property, plans related to our business, matters that may occur in the future and other factors. Forward-looking statements are made, without limitation, in relation to operating plans, property exploration, availability of funds, environmental issues and operating costs. ~~Any~~ Any statements contained herein that are not statements of historical facts may be deemed to be forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may”, “will”, “should”, “expect”, “plan”, “intend”, “anticipate”, “believe”, “estimate”, “predict”, “potential” or “continue”, the negative of such terms or other comparable terminology. Actual events or results may differ materially. In evaluating these statements, you should consider various factors, including the risks we outline from time to time in other reports we file with the Securities and Exchange Commission (“SEC”). These factors may cause our actual results to differ materially from any forward-looking statement. We disclaim any obligation to publicly update these statements, or disclose any difference between our actual results and those reflected in these statements. The information constitutes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Given these uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

Cautionary Note Regarding Management’s Discussion and Analysis

This discussion and analysis should be read in conjunction with the accompanying consolidated financial statements and related notes. The discussion and analysis of the financial condition and results of operations are based upon the consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of any contingent liabilities at the financial statement date and reported amounts of revenue and expenses during the reporting period. On an on-going basis the Company reviews its estimates and assumptions. The estimates were based on historical experience and other assumptions that the Company believes to be reasonable under the circumstances. Actual results are likely to differ from those estimates under different assumptions or conditions, but the Company does not believe such differences will materially affect our financial position or results of operations. Critical accounting policies, the policies the Company believes are most important to the presentation of its financial statements and require the most difficult, subjective and complex judgments, are outlined below in “Critical Accounting Policies,” and have not changed significantly.

Overview

We are an exploration stage company engaged in the acquisition, exploration and exploitation of prospective oil and gas properties. We currently hold a 40% working interest in approximately 54,~~400~~700 acres in an area north of Shreveport in Bossier Parish, Louisiana, commonly referred to as the Sentell Field. Initial drilling in the field has resulted in proved reserves of approximately 10 2.2 Bcfe (billions of cubic-feet equivalent) and net production of ~~600~~500 MCFED (thousand cubic-feet equivalent per day). Southern Star Operating, our wholly owned subsidiary, is the operator of the field by virtue of a contract operating agreement. We are undertaking exploration activities and are in the early stages of developing the properties pursuant to the leasehold rights we have acquired within the Sentell Field. As partial owner of the working interest in and to the leasehold rights, we, together with the other interest holders, have the exclusive right to explore and exploit any oil and gas and mineral resources contained in the Sentell Field.

Through the contractual arrangements governing the acquisition of leasehold interests in Sentell Field, Meagher Oil and Gas, an independent leasing agent, acquired, then reassigned the 100% working interest in the leasehold positions covering the Sentell Field to the following non-affiliated parties: Dynamic Resources Corp. holds a 20% working interest; Southern Star Energy holds a 40% working interest; and Ramshorn Investments, Inc. holds the

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positions covering the Sentell Field to the following non-affiliated parties: Dynamic Resources Corp. holds a 20% working interest; Southern Star Energy holds a 40% working interest; and Ramshorn Investments, Inc. holds the remaining 40% working interest. The leases in the field are subject to a royalty interest of approximately 24%. As a result, the holders of the working interests are entitled to receive approximately 76% of any gross production revenues from the field and the holders of the royalty interest are entitled to the remaining 24%. The royalty interests are held by various individual lessors and other entities. The royalty interest holders are not responsible for any exploration, development or operating costs.

Fiscal Year ~~2009~~2010 Plan of Operations

We are an exploration stage oil and gas company. We estimate our ~~general~~ operating expenditures for the ~~remainder of this~~ fiscal year ending May 31, ~~2009~~2010, to be as follows:

Estimated Operating Expenditures For the Remainder of this Fiscal Year
Estimated Operating Expenditures For the 2010 Fiscal Year
Operating Expenditures	($000)
Drilling Costs	$840,000
Capital Expenditures	$1,700
General and Administrative Expenditures	~~540~~1,~~000~~800
Debt Service	~~66,000~~263
Total	$13,~~446,000~~763

We do not currently have sufficient capital to fund our estimated expenditures for the remainder of the fiscal year and intend to fund the expenditures through ~~operating revenue and~~ debt and/or equity financing and operating revenue. There can be no assurance that such financing will be available on acceptable terms, if at all. See, “Liquidity and Capital Resources,” below.

~~Drilling~~Capital ~~Costs~~Expenditures

By the close of fiscal 2008, our company had drilled six wells, including five successful Cotton Valley formation test wells, all of which are producing. We have also laid a 15,000 foot gathering system and central processing and metering facility to service the five producers.

Based on the satisfactory results of our deep Cotton Valley wells, the Company ~~has~~ embarked on our 2009 program to continue to drill additional wells to define the core productive outlines of the Cotton Valley formation within our acreage. An additional critical objective of this program is to assess the presence and potential of the Haynesville Shale within our acreage position.

In late August 2008, the first of the new wells, the Cash Pointe Plantation 30-1 reached a total depth of 9,500 feet and successfully logged the Cotton Valley . Production casing has been run to total depth and the well is currently awaiting extension of the field gathering system prior to completion.

Following the successful drilling of the Cash Pointe well, the rig moved to our second location, the Atkins-Lincoln 17-2 well. This well was designed to assess both Cotton Valley as well as Haynesville potential. In October 2008, the Company announced that the Atkins-Lincoln 17-2 had reached a depth of 9,500 feet and encountered 68 feet of net effective gas pay in the Cotton Valley Formation. Subsequently, casing was set at 9,500 feet and we continued to drill to a total depth of 11,300 feet where we successfully logged the targeted Haynesville interval. The well encountered a gross productive interval of 327 feet of gas-filled porosity, indicating a thickening of the Haynesville productive interval under our leasehold.

After the successful discovery in the Haynesville Shale at the Atkins-Lincoln 17-2 location, we moved the rig approximately 1.5 miles south-southwest to the A.S. Burt 20-1 location. The Burt well was also designed as a combination Cotton Valley and Haynesville delineation well. At intermediate pipe depth, the results of the A.S. Burt 20-1 location were consistent with the Company’s earlier Cotton Valley locations. In November 2008, we reached total depth of 11,220 feet where once again we successfully logged the targeted Haynesville interval. The well encountered a gross productive interval of 249 feet of gas-filled porosity, further confirming the presence of a thick productive interval in the Haynesville Shale under our leasehold.

Each of the Company’s eight Cotton Valley wells has similar log characteristics, and six of these wells are currently flowing into sales lines. The sixth well is awaiting a pipeline connection. Both the A.S. Burt 20-1 and the Atkins-Lincoln 17-2 will be completed in the Haynesville Shale, pending thorough analysis and completion design.

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In December 2008, we spud the Moore 20-1 well, the fourth well in our ~~2008~~2009 development program. The well successfully logged the Cotton Valley interval and came on production in late February 2009.

Based on the petrophysical results over the Haynesville Shale intervals in the Atkins-Lincoln 17-2 and the A.S. Burt 20-1 wells, the company revised its near term strategy to focus on exploiting these discoveries and follow up with a third location to further define the Haynesville potential. This caused and will cause our near-term attention to be re-directed to the Haynesville completions as well as increasing our pipeline capacity in the field. This program will have the additional benefit of continuing to secure our leasehold position while allowing us to defer Cotton Valley development plans until oil and natural gas prices improve.

On February 19, 2009, the Company spud its third Haynesville delineation well, the Boyce Pate 16-1. This well successfully encountered its Cotton Valley target, logging 66 feet of net gas pay in the Davis Sand intervals before the Company drilled ahead to further evaluate the well’s Haynesville potential. The Boyce Pate 16-1 well reached total depth of 11,200 feet on March 21, 2009. Wireline logging and mud log shows indicate the Boyce Pate 16-1 well encountered 177 feet of net porous Haynesville Shale over a gross interval of 395 feet.

~~After~~We ~~these delineation wells are completed and tested, we~~ intend to continue developing the Sentell Field at a pace appropriate to conditions and capital constraints. Our 54,~~400~~700-acre Sentell Field has the potential for about 3550 Cotton Valley and 3550 Haynesville wells positioned on 160-acre spacing. Numerous vertical and horizontal wells have been drilled, logged and put into production from the Haynesville formation within a 30-mile radius of our acreage in the Sentell Field. However, until we determine the extent of the productive limits of the project, we will not know the full extent of development costs to bring the acreage to production. We intend to complete step-out drilling to extend the productive limits of acreage. We estimate that our exploration costs for the remainder of the fiscal year will be approximately $840,000, consisting of concluding drilling operations on the Boyce Pate 16-1, additional stimulation work on certain Cotton Valley wells and infrastructure improvements. See, “Capital Expenditures,” below.

Given the current pricing environment for oil and natural gas and the lack of available capital, our near-term attention will be directed at securing our leasehold position, allowing us to defer Haynesville and Cotton Valley development plans until oil and natural gas prices improve and the necessary capital becomes available. We estimate that our capital expenditures for the fiscal year ending May 31, 2010 will be approximately $1,700,000, consisting of concluding drilling operations on certain Cotton Valley and Haynesville wells, commencement of drilling an additional Haynesville well, additional stimulation work on certain Cotton Valley wells, infrastructure improvements, and leasehold acquisitions.

General and Administrative Expenses

We expect to incur general and administrative costs in the amount of approximately $~~540~~1,800,000 during ~~the remainder of our~~ fiscal year 2010. General and administrative costs primarily include compensation arrangements with our employees and consultants, which are described in more detail below. Further, general and administrative costs including on-going legal, accounting and audit expenses to comply with our reporting responsibilities as a public company under the Exchange Act, insurance, rent, software, office supplies and office equipment.

Our company is operated by William David Gibbs as Chief Executive Officer, President, Secretary and Treasurer, Bruce Ganer as Vice President of Exploration and Development, and Christopher H. Taylor, as Chief Financial Officer,. ~~and~~On ~~Douglas~~September ~~Harwell~~10, ~~as Operations Manager. Mr. Gibbs~~2009, Mr. ~~Taylor~~ ~~and~~Doug ~~Mr.~~ Harwell ~~are~~submitted ~~employees of the Company and Mr. Ganer provides~~ his ~~services~~ ~~through~~resignation aas ~~management~~operations ~~company~~manager ~~pursuant~~ to athe ~~written agreement~~Company, ~~the~~effective ~~terms~~September ~~of which are described below. To reduce costs~~30, ~~we intend to continue to outsource our professional and personnel requirements when practical by retaining consultants on an as-needed basis~~2009. Mr. ~~Although~~Harwell's resignation wewas ~~enter~~not ~~into consulting agreements periodically, we have entered into several long term employment and consulting agreements,~~ the ~~terms~~result of ~~which~~any ~~are~~disagreements ~~described~~with ~~below.~~the Company.

InMr. ~~November 2007, the Company entered into a consulting agreement with William David~~ Gibbs toand ~~serve~~Mr. asTaylor ~~the~~are ~~CEO~~employees ~~and president~~ of the Company and ~~provide~~Mr. ~~consulting~~Ganer ~~services~~provides inhis ~~consideration for $200 per hour of~~ services tothrough a ~~maximum~~management ofcompany ~~$1,500~~pursuant ~~per day and $30,000 per month and options exercisable~~ to ~~purchase~~a ~~1,500,000~~written ~~shares of the Company’s common stock at $1.20 per share for 5 years (one-third of the options vest on each of the first three anniversaries of November 27~~agreement, ~~2007). On February 26, 2008,~~ the ~~Company~~terms ~~reduced the exercise price~~ of ~~the~~which ~~options~~are todescribed $0below.70 To ~~per~~reduce ~~share~~costs, ~~resulting~~we inintend ~~an increase~~ to ~~stock-based~~continue ~~compensation expense. On May 1, 2008, Mr. Gibbs ceased~~ to beoutsource aour ~~consultant~~professional and ~~entered~~personnel ~~into~~requirements anwhen ~~employment~~practical ~~agreement~~by ~~with~~retaining ~~the~~consultants ~~Company~~on toan ~~serve~~ as-needed ~~the Company’s president and CEO~~basis. Although ~~Mr. Gibbs~~we ~~will~~enter ~~be retained as CEO and~~into ~~president~~ consulting inagremeents ~~consideration for~~periodically, ~~among other things, a base salary of $240,000 per year and incentive bonuses as set forth in the employment agreement. On June 4, 2008,~~ we have entered into aseveral ~~stock~~long ~~option~~term ~~agreement~~employment ~~with~~and ~~Mr. Gibbs~~consulting ~~granting him the right to purchase up to an aggregate of 1~~agreements,~~000,000~~ ~~shares of our common stock at an exercise price of $1.00 per share exercisable for a period of five years pursuant to our Stock Option Plan (one-third of~~ the ~~options~~terms ~~vest on each~~ of ~~the~~ ~~first~~which ~~three~~are ~~anniversaries~~described ~~of June 4, 2008)~~below. On January 5, 2009, the Company awarded to Mr. Gibbs a bonus payment of $60,000, less any applicable statutory deductions, in order to recognize Mr. Gibbs’ contribution to the Company as its president and the progress made by the Company in 2008.

On February 15, 2007, the Company entered into a services agreement with Rylar & Associates, Inc., a consultant who provides consulting services in partial consideration for 375,000 shares of Common Stock. The Company is to issue 187,500 shares upon the generation of revenues from the Company’s Sentell Field property in excess of all costs reasonably incurred in relation to the drilling of the wells. The Company is also obligated to issue 187,500 shares to be held in escrow for a period of one year upon the Sentell Field generating more than 15 billion cubic feet equivalent of natural gas or having reserves greater than $75,000,000 calculated on a 10% discounted cash flow basis. As of August 31, 2009, no shares have been issued under this services agreement.

On February 27, 2007 the Company entered into a services agreement with Sierra Pine Resources (a company wholly-owned by Bruce Ganer, our Vice President of Exploration and Development), a consultant who provides consulting services in consideration for $140 per hour of services and 375,000 shares of the Company’s common stock. The Company is to issue 187,500 shares upon the generation of revenues from the Sentell Field in excess of all costs reasonably incurred in relation to the drilling of the well. The Company is also obligated to issue 187,500 shares to be held in escrow for a period of one year upon the Sentell Field generating more than 15 billion cubic feet

equivalent of natural gas or having reserves greater than $75,000,000 calculated on a 10% discounted cash flow basis. As of August 31, 2009, no shares have been issued under this services agreement.

On May 3, 2007, the Company entered into a marketing agreement with RedChip Companies Inc. (“RedChip”) for an initial term of 12 months in consideration of $7,500 per month, and commencing August 1, 2007, an equivalent value of $5,000 per month payable in shares of the Company’s common stock, the value of which was to be determined based upon the closing price of the shares as reported by StockWatch Inc. on the first business day of each quarterly period. The shares were to be issued by the Company to RedChip on a quarterly basis no later than ten days after the first day of each subsequent quarter. On December 11, 2007, the Company issued 18,750 for $15,000 of consulting services shares pursuant to the consulting agreement and at May 31, 2008, $35,000 was included in common stock subscribed. During the year ended May 31, 2009, the Company issued 46,335 shares of common stock with a fair value of $36,000 pursuant to the agreement and subsequently terminated this agreement.

On June 18, 2007, the Company entered into a services agreement with Imperial Capital Ltd. (“Imperial”), a financial advisor, to provide services related to assisting the Company in financing activities. Upon entering into the $2,000,000 Credit Agreement with Macquaire Bank Limited (“Macquarie”) in May 2008, the Company paid $60,000 of financing fees and was obligated to issue a warrant exercisable to purchase 100,000 shares of common stock at $1.00 per share. Additionally, in connection with the Amended Credit Agreement with Macquarie, the Company paid to Imperial $90,000 in cash, agreed to pay Imperial in cash the amount of 3% of the gross proceeds of each funding in excess of the initial $5 million borrowing base which the Company receives under the Macquarie credit agreement until Imperial has received $750,000 ($150,000 of which has been paid), and issued to Imperial a warrant to purchase 1,250,000 shares of common stock of the Company. On August 8, 2008, the Company terminated this agreement.

On October 1, 2007, we appointed Bruce Ganer as our Vice President of Exploration and Development. Effective November 22, 2007, we entered into a consulting agreement between our company and Sierra Pine Resources International, Inc., a company wholly-owned by Bruce Ganer, whereby Sierra Pine agreed to provide consulting services to our company in consideration for, among other things, the payment of $10,000 per month, certain incentive bonuses as set forth in the consulting agreement and the grant of a stock option to purchase up to 750,000 shares of our common stock at a price of $1.09 per share, exercisable until November 22, 2011 (one-third of the options will vest on each of the first three anniversaries of November 22, 2007). On February 26, 2008, the Company reduced the exercise price of the options to $0.70 per share, resulting in an increase to stock-based compensation expense.

~~Effective~~In ~~June~~November 162007, ~~2008,~~the weCompany entered into ana consulting agreement with ~~Douglas~~William MDavid Gibbs to serve as the CEO and president of the Company and provide consulting services in consideration for $200 per hour of services to a maximum of $1,500 per day and $30,000 per month and options exercisable to purchase 1,500,000 shares of the Company’s common stock at $1.20 ~~Harwell~~per share for 5 years (one-third of the options vest on each of the first three anniversaries of November 27, ~~whereby~~2007). weOn ~~agreed~~February 26, 2008, the Company reduced the exercise price of the options to ~~employ~~$0.70 per share, resulting in an increase to stock-based compensation expense. On May 1, 2008, Mr. ~~Harwell~~Gibbs ceased to be a consultant and entered into an employment agreement with the Company to serve as ~~our~~the ~~operations~~Company’s ~~manager~~president and CEO. Mr. ~~Harwell~~Gibbs will be retained as ~~our~~CEO ~~operations~~and ~~manager~~president in consideration for, among other things:, ~~(i)~~ a base salary of $~~160~~240,000 per year; ~~(ii)~~and incentive bonuses as set forth in the employment agreement;. ~~and (iii)~~On ~~the~~June ~~grant~~4, of2008, we entered into a stock option agreement with Mr. Gibbs granting him the right to purchase up to ~~250~~an aggregate of 1,000,000 shares of our common stock at aan exercise price of $1.00 per share, exercisable ~~until~~for ~~June~~a ~~16,~~period ~~2013~~of five years pursuant to our Stock Option Plan (one-third of the options ~~will~~ vest on each of the first three anniversaries of June 164, 2008). On January 5, 2009, the Company awarded to Mr. Gibbs a bonus payment of $60,000, less any applicable statutory deductions, in order to recognize Mr. Gibbs’ contribution to the Company as its president and the progress made by the Company in 2008.

On November 22, 2007, we entered into a consulting agreement with Larry Keller, whereby Larry Keller agreed to provide consulting services to our company for a consulting fee of $175 per hour and the grant of a stock option to purchase up to 500,000 shares of our common stock at a price of $1.09 per share, exercisable until November 22, 2009 (half of the options vested on November 22, 2007 and half vested on November 22, 2008). On May 30, 2008, we paid a cash bonus of approximately $25,000 per well upon the successful completion of our company’s following three wells: Atkins-Lincoln 18-1; Atkins et al. 8-1; and Atkins-Lincoln 18-2.

On January 1, 2008, we entered into a consulting agreement with Big Sky Management Ltd., whereby Big Sky Management agreed to provide management services to our company. Big Sky Management has agreed to provide the services through its employee and our director Eric Boehnke in consideration for the payment, by our Company, of $10,000 per month.

On May 20, 2008, the Company entered into a consulting agreement with Enercom, Inc., an investor communications consulting firm that will provide investor communications services on behalf of the Company in consideration for a minimum of $3,000 per month. This agreement was cancelled effective June 30, 2009.

Effective June 16, 2008, we entered into an agreement with Douglas M. Harwell, whereby we agreed to employ Mr. Harwell as our operations manager. Mr. Harwell will be retained as our operations manager in consideration for, among other things: (i) a base salary of $160,000 per year; (ii) incentive bonuses as set forth in the employment agreement; and (iii) the grant of a stock option to purchase up to 250,000 shares of our common stock at a price of $1.00 per share, exercisable until June 16, 2013 (one-third of the options will vest on each of the first three anniversaries of June 16, 2008). Effective September 30, 2009, Mr. Harwell resigned his position as operations manager of the Company. Mr. Harwell’s resignation had the effect of terminating his employment agreement and stock option agreement and rendering his stock options void and of no effect. At the time of Mr. Harwell’s resignation, none of the stock options had been exercised.

Effective September 22, 2008, we entered into an agreement with Christopher H. Taylor, whereby we agreed to employ Mr. Taylor as our chief financial officer. Mr. Taylor will be retained as our chief financial officer in consideration for, among other things: (i) a base salary of $180,000 per year; (ii) incentive bonuses as set forth in the employment agreement; and (iii) the grant of a stock option to purchase up to 350,000 shares of our common stock at a price of $0.82 per share, exercisable until September 22, 2013 (one-third of the options will vest on each of the first three anniversaries of September 22, 2008).

Effective October 27, 2008, we entered into an agreement with Deborah Null, whereby we agreed to employ Ms. Null as our land manager. Ms. Null was retained as our land manager in consideration for, among other things: (i) a base salary of $130,000 per year; (ii) incentive bonuses as set forth in the employment agreement; and (iii) the grant of stock options exercisable to purchase up to 100,000 shares of our common stock at a price of $0.60 per share, exercisable until October 27, 2013. Effective December 18, 2008, Ms. Null resigned her position as land manager of the Company. Ms. Null’s resignation had the effect of terminating her employment agreement and stock option agreement and rendering her stock options void and of no effect. At the time of Ms. Null’s resignation, none of the stock options had vested.

On November 22, 2007, we entered into a consulting agreement with Larry Keller, whereby Larry Keller agreed to provide consulting services to our company for a consulting fee of $175 per hour and the grant of a stock option to purchase up to 500,000 shares of our common stock at a price of $1.09 per share, exercisable until November 22, 2009(half of the options vested on November 22, 2007 and half vested on November 22, 2008). On May 30, 2008, we paid a cash bonus of approximately $25,000 per well upon the successful completion of our company’s following three wells: Lincoln Atkins 18-1; Lincoln Atkins 8-1; and Atkins 18-2.

On June 18, 2007, the Company entered into a services agreement with Imperial Capital Ltd. (“Imperial”), a financial advisor, to provide services related to assisting the Company in future financing activities in consideration of a 8% cash fee and a warrant to purchase the higher of 8% of the dollar amount or the number of equity securities issued in the financing or 8% of the face value of any debt securities sold in the financing on at least the following minimum terms and conditions: (i) purchase price of $0.01, (ii) exercise price set at the closing price of the Company’s common stock on the closing date of the financing; (iii) warrant term of 3 years; and (iv) the Company has the right on 15 days written notice to require the Imperial to exercise the warrant so long as the closing price of

the common shares of the Company equals or exceeds $1.75 per common share for at least 20 consecutive trading days prior to the date of the call notice. The Company paid an initial cash deposit of $25,000 to be set against expenses of the advisor, of which $24,396 had been expensed and $604 had been recorded as a deferred cost at May 31, 2008. Upon successful completion of the future financing, this cost will be recorded as a reduction of additional paid-in capital. If the future financing is not successfully completed, this cost will be charged to the consolidated statement of operations. On April 23, 2008, the Company amended this agreement. The Company agreed to pay a cash fee on future financings equal to 3.0% of the face amount of senior first lien debt securities, 4.0% of the face amount of other senior or mezzanine debt securities, 6.0% of the face amount of equity securities. The Company will also grant a warrant to purchase the higher of 5% of the dollar amount or the number of equity securities issued or 5% of the face amount of any debt securities at a purchase price of $0.01 with an exercise price equal to the closing price of the Company’s common stock on the closing date of the financing for 3 years. Upon entering into the $2,000,000 Credit Agreement with Macquaire Bank Limited (“Macquarie”) in May 2008, the Company paid $60,000 of financing fees and issued 100,000 warrants with a fair value of $85,758. Additionally, in connection with the Amended Credit Agreement with Macquarie, the Company paid to Imperial $90,000 in cash, agreed to pay Imperial in cash the amount of 3% of the gross proceeds of each funding in excess of the initial $5 million borrowing base which the Company receives under the Macquarie credit agreement until Imperial has received $750,000, and issued to Imperial a warrant to purchase 1,250,000 shares of common stock of the Company. On August 8, 2008, the Company terminated this agreement.

On May 3, 2007, the Company entered into a marketing agreement with RedChip Companies Inc. (“RedChip”) for an initial term of 12 months in consideration of $7,500 per month, and commencing August 1, 2007, an equivalent value of $5,000 per month payable in shares of the Company’s common stock, the value of which was to be determined based upon the closing price of the shares as reported by StockWatch Inc. on the first business day of each quarterly period. The shares were to be issued by the Company to RedChip on a quarterly basis no later than ten days after the first day of each subsequent quarter. On December 11, 2007, the Company issued 18,750 for $15,000 of consulting services shares pursuant to the consulting agreement and at May 31, 2008, $35,000 was included in common stock subscribed. During the nine months ended February 28, 2009, the Company issued 46,335 shares of common stock with a fair value of $36,000 pursuant to the agreement and subsequently terminated this agreement.

On February 15, 2007, the Company entered into a services agreement with Rylar & Associates, Inc., a consultant who provides consulting services in partial consideration for 375,000 shares of Common Stock. The Company is to issue 187,500 shares upon the generation of revenues from the Company’s Sentell Field property in excess of all costs reasonably incurred in relation to the drilling of the wells. The Company is also obligated to issue 187,500 shares to be held in escrow for a period of one year upon the Sentell Field generating more than 15 billion cubic feet equivalent of natural gas or having reserves greater than $75,000,000 calculated on a 10% discounted cash flow basis. As of February 28, 2009, no shares have been issued under this services agreement.

Debt Service

We expect to incur $66263,000 in interest expenses for the ~~remainder of the~~ fiscal year ending May 31, ~~2009~~2010. These interest expenses are related to debt outstanding under our credit facility with Macquarie Bank Limited and assume the interest rate remains 5.25%, our current interest rate . Should we be determined to be in default under our credit facility, our interest rate ~~will~~could increase to 9.25%. We remain out of compliance with our interest coverage ratio, current ratio and adjusted present value ratio covenants under our credit facility. We do not anticipate paying any principal on the credit facility until the maturity date of July 11, 2011. We expect interest expense to increase if we obtain additional debt financing in the future.

Results of Operations

The Company has been in the exploration stage since completion of its restructuring in November 2006 and has not yet realized any significant revenues from its planned operations. The Company is unlikely to generate significant earnings in the immediate or foreseeable future. The continuation of the Company as a going concern and the ability of the Company to emerge from the exploration stage are dependent upon its successful efforts to raise additional equity financing to continue operations and generate sustainable significant revenue. There is no guarantee that the Company will be able to raise adequate equity or debt financings or generate profitable operations.

17Quarter ended August 31, 2009 compared to quarter ended August 31, 2008

~~earnings~~Net inLoss. ~~the~~We ~~immediate~~reported ora ~~foreseeable~~net ~~future.~~loss ~~The~~of ~~continuation~~$1,030,000 offor the ~~Company~~quarter asended aAugust ~~going~~31, ~~concern~~2009 ~~and~~compared ~~the~~to ~~ability~~a net loss of $3,521,000 for the ~~Company~~quarter toended ~~emerge~~August ~~from~~31, ~~the~~2008. ~~exploration~~The ~~stage~~decrease ~~are~~in ~~dependent~~net ~~upon~~loss ~~its~~is ~~successful~~due ~~efforts~~primarily to ~~raise~~full ~~additional~~cost ~~equity~~ceiling ~~financing~~impairments toin ~~continue~~the ~~operations~~amount ~~and~~of ~~generate~~$1,949,000 ~~sustainable~~recognized ~~significant~~in ~~revenue.~~the ~~There~~quarter isended noAugust ~~guarantee~~31, ~~that~~2008, ~~the Company~~as ~~will~~well beas ~~able~~decreases toin ~~raise~~production ~~adequate~~costs, general ~~equity~~and oradministrative ~~debt~~costs ~~financings~~and oraccretion ~~generate~~of ~~profitable~~debt ~~operations~~costs.

~~Three~~Revenues. ~~months~~We reported revenues from the production of oil and natural gas of $97,000 for the quarter ended ~~February~~August 2831, 2009, compared to ~~three~~$776,000 ~~months~~in revenues for the quarter ended ~~February~~August 2931, 2008. The decrease in revenues is attributable to significant declines in oil and natural gas prices accompanied by decreases in oil and natural gas production volumes.

Net Loss. We reported a net loss of $6,464,000 for the three months ended February 28, 2009 compared to a net loss of $819,000 for the three months ended February 28, 2008. The increase in net loss is due primarily to a full cost ceiling impairment in the amount of $5,196,000 described more fully below as well as increases in production costs.

Revenues. We reported revenues from the production of oil and natural gas of $231,000 for the three months ended February 28, 2009 compared to revenues of $129,000 for the three months ended February 29, 2008. The increase in revenues is attributable to the successful drilling and completion of six wells in the Sentell Field. Revenues decreased by $7,000 for the three months ended February 28, 2009 compared to the three months ended November 30, 2008, primarily a result of lower product prices.

Depletion, depreciation and amortization. Depletion, depreciation and amortization for the period was $5,379,000 for the three months ended February 28, 2009 compared to depletion, depreciation and amortization of $22,000 for the three months ended February 29, 2008. Included in this amount are impairments of oil and gas properties totaling $5,196,000 as a result of the ceiling test requirements. In determining the future cash flows used in performing the full cost ceiling test, the Company utilized a natural gas price of $3.39 per Mcf and an oil price of $51.05 per barrel, which represented spot prices in April 2009. Had the Company utilized the spot prices on February 28, 2009, the impairment recorded at February 28, 2009, would have been $6,452,000.

General and administrative. For the three months ended February 28, 2009, we recorded general and administrative expenses of $562,000 compared to $443,000 for the three months ended February 29, 2008. The increases were primarily attributable to increased business activity related to development of our properties; hiring a chief financial officer and operations manager between February 29, 2008, and February 28, 2009; implementing improvements to our corporate governance and public company reporting and exploring business development opportunities. We anticipate that our general and administrative expenses will continue at these levels and anticipate that our business activities may increase in future periods.

Additionally, for the three months ended February 28, 2009, we recorded stock-based compensation expenses of $272,000 compared to $466,000 for the three months ended February 29, 2008. The decrease is primarily attributable to certain options vesting in November 2008 and the recording of costs in the 2008 period related to the repricing of certain options in February 2008.

Production costs. We recorded production costs of $162,000 for the three months ended February 28, 2009 compared to $17,000 in production costs for the three months ended February 29, 2008. The increase in production costs is attributable to production resulting from the successful drilling and completion of six wells in the Sentell Field. Production costs may increase in future periods as a result of our current drilling program, under which we project we will drill additional wells, assuming adequate financing is available on acceptable terms, if at all.

Financing costs. We also recognized financing costs of $233,000 in the quarter ended February 28, 2009, which represents a portion of the financing costs related the $25,000,000 Credit Agreement entered into in July 2008. The Credit Agreement is discussed further under ‘Liquidity and Capital Resources’ below. In connection with the Credit Agreement, we recorded deferred financing costs of $2,831,000 which will be amortized to financing costs using a method approximating the interest method over the three-year term of the Credit Agreement. There were no financing costs for the same period in 2008. We anticipate we will raise additional capital during the fourth quarter of the fiscal year ending May 31, 2009, which will result in an increase in financing costs. There can be no assurance that additional financing will be available on acceptable terms, if at all

Interest expense. For the three months ended February 28, 2009, we recognized $69,000 in interest expense related to debt outstanding under our agreement with Macquarie Bank Limited. For the three months ended February 29, 2008, we recorded no interest expense as no debt was outstanding. Interest expense is expected to increase during the last quarter of the fiscal year ending May 31, 2009, if we obtain additional debt financing. There can be no assurance that additional debt financing will be available on acceptable terms, if at all, or that our borrowing base with Macquarie will be increased (see “Liquidity and Capital Resources,” below).

Nine months ended February 28, 2009 compared to nine months ended February 29, 2008

Net Loss. We reported a net loss of $11,281,000 for the nine months ended February 28, 2009 compared to a net loss of $2,807,000 for the three months ended February 28, 2008. The increase in net loss is due primarily to full cost ceiling impairments in the amount of $7,398,000 described more fully below as well as increases in production costs.

Revenues. We reported revenues from the production of oil and natural gas of $1,236,000 for the nine months ended February 28, 2009 compared to $152,000 in revenues for the nine months ended February 29, 2008. The increase in revenues is attributable to the successful drilling and completion of six wells in the Sentell Field.

Depletion, depreciation and amortization. Depletion, depreciation and amortization for the nine-month period ended February 28, 2009 was $8,030,000. Included in this amount are impairments of oil and gas properties totaling $7,398,000 as a result of the ceiling test impairments as of February 28, 2009 ($5,196,000) and August 31, 2008 ($2,202,000). In determining the future cash flows used in performing the full cost ceiling test at February 28, 2009, the Company utilized a natural gas price of $3.39 per Mcf and an oil price of $51.05 per barrel, which represented spot prices in April 2009. Had the Company utilized the spot prices on February 28, 2009, the impairment recorded at February 28, 2009, would have been $6,452,000. There was depletion, depreciation and amortization recorded in the amount of $88,000 during the nine months ended February 29, 2008.

General and administrative. For the nine months ended February 28, 2009, we recorded general and administrative expenses of $2,771,000 compared to $1,258,000 for the nine months ended February 29, 2008. The increases were primarily attributable to increased business activity related to development of our properties; hiring a chief executive officer, chief financial officer, operations manager and land manager between February 29, 2008, and February 28, 2009; stock-based compensation; implementing improvements to our corporate governance and public company reporting and exploring business development opportunities. We anticipate that our general and administrative expenses will continue at or above these levels as we anticipate that our business activities may increase in future periods.

Production costs. We recorded production costs of $482,000 for the nine months ended February 28, 2009 compared to $38,000 in production costs for the three months ended February 29, 2008. The increase in production costs is attributable to production resulting from the successful drilling and completion of six wells in the Sentell Field. Production costs may increase in future periods as a result of our current drilling program, under which we project we will drill additional wells, assuming adequate financing is available on acceptable terms, if at all.

Accretion of discount on debt. In the nine months ended February 28, 2009, we recorded accretion of discount on debt of $425,250, which represents the remainder of the discount recorded in connection with the $2,000,000 credit agreement entered into in May 2008 with Macquarie Bank Limited. In the nine months ended February 29, 2008, we recorded accretion of discount on convertible debentures of $1,082,000; the convertible debentures have since been converted into shares of the Company.

Financing costs. We also recognized financing costs of $600,000 in the nine months ended February 28, 2009, which represents a portion of the financing costs related to the $25,000,000 Credit Agreement entered into in July 2008. The Credit Agreement is discussed further under ‘Liquidity and Capital Resources’ below. In connection with the Credit Agreement, we recorded deferred financing costs of $2,831,000 which will be amortized to financing costs using a method approximating the interest method over the three-year term of the Credit Agreement. We recorded no financing costs for the same period in 2008. We anticipate we will raise additional capital during the fourth quarter of the fiscal year ending May 31, 2009, which will result in an increase in financing costs. There can be no assurance that additional financing will be available on acceptable terms, if at all.

Interest expense. For the nine months ended February 28, 2009, we recognized $154,000 in interest expense related to debt outstanding under our agreements with Macquarie Bank Limited. For the nine months ended February 29, 2008, we recorded interest expense of $87,000. Interest expense may increase during the fourth quarter of the fiscal year ending May 31, 2009, if we obtain additional debt financing. There can be no assurance that our borrowing base with Macquarie will be increased (see “Liquidity and Capital Resources,” below), or that additional debt financing will be available on acceptable terms, if at all.

Depletion, depreciation and amortization. Depletion, depreciation and amortization for the quarter period ended August 31, 2009 was $53,000. Depletion, depreciation and amortization recorded for the quarter ended August 31, 2008 was $2,277,000, including impairments of oil and gas properties of $2,202,000 as a result of the ceiling test evaluation.

General and administrative. For the quarter ended August 31, 2009, we recorded general and administrative expenses of $676,000 compared to $990,000 for the quarter ended August 31, 2008. The decrease was primarily attributable to decreases in professional fees and stock-based compensation. We anticipate that our general and administrative expenses will continue at or above these levels as we anticipate that our business activities may increase in future periods.

Production costs. We recorded production costs of $91,000 for the quarter ended August 31, 2009 compared to $280,000 in production costs for the quarter ended August 31, 2008. The decrease in production costs is primarily attributable to decreased water disposal costs. Production costs may increase in future periods as a result of our current drilling program, under which we project we will drill additional wells, assuming adequate financing is available on acceptable terms, if at all.

Accretion of discount on debt. In the quarter ended August 31, 2009, no accretion of discount on debt was recorded. In the quarter ended August 31, 2008, we recorded accretion of discount on debt of $425,000, which represents the remainder of the discount recorded in connection with the $2,000,000 credit agreement entered into in May 2008 with Macquarie Bank Limited.

Financing costs. We also recognized financing costs of $238,000 in the quarter ended August 31, 2009, which represents a portion of the financing costs related to the $25,000,000 Credit Agreement entered into in July 2008. The Credit Agreement is discussed further under ‘Liquidity and Capital Resources’ below. In connection with the Credit Agreement, we recorded deferred financing costs of $2,831,000 which will be amortized to financing costs using a method approximating the interest method over the three-year term of the Credit Agreement. We recorded financing costs of $132,000 for the quarter ended August 31, 2008. We anticipate we will raise additional capital during the fiscal year ending May 31, 2010, which could result in an increase in financing costs. There can be no assurance that additional financing will be available on acceptable terms, if at all.

Interest expense. For the quarter ended August 31, 2009, we recognized $69,000 in interest expense related to debt outstanding under our agreement with Macquarie Bank Limited. For the quarter ended August 31, 2008, we recorded interest expense of $43,000. Interest expense may increase during the fiscal year ending May 31, 2010, if we obtain additional debt financing. There can be no assurance that our borrowing base with Macquarie will be increased (see “Liquidity and Capital Resources,” below), or that additional debt financing will be available on acceptable terms, if at all.

Liquidity and Capital Resources

As of ~~February~~August 2831, 2009, we had a working capital deficiency of approximately $1012,~~112~~608,000 and had incurred losses of $1619,~~966~~682,000 since inception. As of ~~February~~August 2831, 2009, we had current assets of $32,~~433~~720,000 and current liabilities of $1315,~~545~~328,000. The current liabilities consisted of accounts payable and accrued liabilities, net revenue payable to working interest partners and royalty interest owners, exploration advances, bank debt and amounts due to related parties.

To date, we have had negative cash flows from operations and we have been dependent on sales of our equity securities and debt financing to meet our cash requirements. Declining gas prices are anticipated to have an adverse effect on revenue and cash flow. We expect this situation to continue for the foreseeable future. We anticipate that we will have negative cash flows during the next twelve month period.

From September through November 2007, several debt holders converted certain convertible debentures which eliminated our interest payable on such securities. On September 18, 2007, we issued a 10% $1,300,000 convertible debenture to Gobbet Management Inc. The debenture, which was due September 18, 2009, was converted into shares of common stock of our company at a conversion price of $0.50 per share. On November 16, 2007, Gobbet Management converted the principal amount of $1,300,000 plus $21,306 in interest into 2,642,611 shares of common stock of our company. We issued the 2,624,611 shares of common stock on December 21, 2007 and the remaining 18,000 shares of common stock on April 14, 2008. On November 16, 2007, Sovereign Services Limited converted the principal amount of $800,000 plus interest of $77,778 pursuant to a 10% convertible debenture due December 1, 2008, into 2,633,333 shares of common stock of our company. We issued the 2,633,333 shares of common stock on December 21, 2007. On November 16, 2007, Sovereign Services converted the principal amount of $600,000 plus interest of $63,333 pursuant to a 10% convertible debenture due November 1, 2008, into 265,333 shares of common stock of our company. We issued the 265,333 shares of common stock on December 21, 2007.

converted the principal amount of $800,000 plus interest of $77,778 pursuant to a 10% convertible debenture due December 1, 2008, into 2,633,333 shares of common stock of our company. We issued the 2,633,333 shares of common stock on December 21, 2007. On November 16, 2007, Sovereign Services converted the principal amount of $600,000 plus interest of $63,333 pursuant to a 10% convertible debenture due November 1, 2008, into 265,333 shares of common stock of our company. We issued the 265,333 shares of common stock on December 21, 2007.

Credit Facility

On July 11, 2008, the Company entered into a senior secured revolving credit agreement with Macquarie Bank Limited and certain lenders to receive advances up to $25,000,000 with an initial borrowing base of $5,000,000. This Amended and Restated Senior First Lien Secured Credit Agreement (dated July 11, 2008) (“Credit Agreement”) amended and restated the $2,000,000 Senior First Lien Secured Credit Agreement between the Company and Macquarie Bank Limited, dated May 16, 2008, in its entirety.

On July 16, 2008, we closed the first draw down under the Credit Agreement with Macquarie Bank Limited (individually and as Administrative Agent) (“Administrative Agent”) and the various participating lenders (the “Lenders”). The Credit Agreement matures on July 11, 2011.

Borrowings under the Credit Agreement may be used exclusively for the development of the properties listed in the Credit Agreement, general corporate purposes (as approved by the Administrative Agent), and the payment of the Administrative Agent’s costs associated with the loan. Upon closing, we drew an advance of $2.5 million, leaving $2.5 million available under the initial borrowing base. Prior to the advance, we had a working capital deficit of approximately $2,218,~~117~~000, incurred primarily due to drilling expenses on two wells and a workover program on three other wells during the fiscal year ended May 31, 2008. We used the initial advance of $2.5 million to pay off the working capital deficit accumulated from that program. In the period from August 2008 to January 2009, we drew down an additional $2.5 million against the initial borrowing base to fund our 40% working interest share of the estimated costs of drilling and completing new Sentell Field wells. At ~~February~~August 2831, 2009, we had no availability remaining under the initial borrowing base of the credit facility. The borrowing base will be redetermined no less than every six months, based upon the Administrative Agent’s review of the most recent reserve report (prepared by our engineers and setting forth our projected recoverable reserves of our company). Reserve reports are due to the Administrative Agent on or before each January 15 and July 15 until the maturity date. Within 30 days following receipt of the reserve report, the Administrative Agent will, in its sole discretion, make a determination of the borrowing base, which will be effective until the next redetermination date. The Administrative Agent will determine the borrowing base in accordance with its customary lending practices based on the maximum revolving loan amount supportable by our properties.

Under the terms of the Credit Agreement, advances comprising the revolving loan accrue interest at the applicable contract rate on the outstanding borrowed and unpaid principal amount of the loan. The contract rate is a per annum rate equal to the lesser of prime rate plus 2% or the highest lawful rate. The prime rate means the greater of (i) the prime rate of interest specified by the Wall Street Journal and (ii) the Federal Funds Rate plus 0.50% per annum. The contract rate was 5.25% at August 31, 2009.

Pursuant to the terms of the Credit Agreement, all proceeds from the sale of oil and gas from our properties, if any, will be ~~assigned~~remitted to the Administrative Agent via payment into a project account. The Administrative Agent will then create a sub-account on its internal books and credit to that account all funds deposited as payments into the project account. We have authorized the Administrative Agent to debit the sub-account for the payment of all obligations under the Credit Agreement when due.

As collateral security for all of our obligations to the Administrative Agent and each of the Lenders under the Credit Agreement and other related documents, we granted to the Administrative Agent (for the benefit of the Lenders) a first priority mortgage lien in all of our real and personal property subject to certain permitted encumbrances.

The Credit Agreement contains various positive covenants, including interest coverage ratio, current ratio and adjusted present value ratio covenants (as defined in the Credit Agreement), and certain negative covenants which prevent us from carrying out certain actions, including incurring specified debt or guaranties, suffering any change of control, merging into or consolidating with any other entity, declaring or paying any cash dividends or distributions. At ~~February~~August 2831, 2009, the Company was not in compliance with its interest coverage ratio, current ratio ~~covenant~~and adjusted present value ratio covenants. We have notified Macquarie of these deficiencies and Macquarie has continued to fulfill our monthly funding requests knowing we are out of compliance. The Company has initiated and continues to pursue efforts to remedy the noncompliance. While we expect such efforts to be successful, there can be no assurance that we will be able to remedy the noncompliance.

We incurred a net loss of $11,281,000 for the nine months ended February 28, 2009 as compared to a net loss of $2,807,000 for the nine months ended February 29, 2008. We anticipate that losses will continue in the quarter ending May 31, 2009 due to lower oil and gas prices. We had current cash on hand as at February 28, 2009 of approximately $2,834,000. 21

Ascontinues ~~we anticipate that our estimated operating expenditures for the remainder of this fiscal year will be $1,446,000, we do not have sufficient working capital~~ to ~~enable~~pursue usefforts to ~~complete~~remedy ~~our drilling program of exploration wells or to finance our normal operations for~~ the ~~remainder of the fiscal year~~noncompliance. ~~Accordingly,~~While we ~~plan~~expect onsuch ~~undertaking~~efforts additional financing activities throughout the course of the fiscal year. We estimate that approximately $130,000 will be derived from Sentell Field production revenues. However, the decrease in oil and natural gas prices has adversely affected our revenues and may continue to ~~do so, which may increase our reliance on debt and equity financing. Additionally, we estimate that we will~~ be ~~required to raise approximately $8~~successful,~~000,000~~ ~~through~~there the issuance of equity securities or through additional debt financing. Additional draw-downs on the credit facility with Macquarie Bank will depend upon the success of our future financings and the availability of additional credit under the credit facility pursuant to the terms of the Credit Agreement. There can be no assurance that we will be ~~successful~~able into ~~raising~~remedy the ~~required capital or that actual cash requirements will not exceed our estimates~~noncompliance.

~~Additionally,~~On weMay ~~estimate~~29, ~~that~~2009, wethe ~~will~~Company beand ~~required~~Macquarie toexecuted ~~raise~~a ~~approximately~~waiver ~~$8,000,000~~letter ~~through~~amending the ~~issuance~~Credit ofAgreement ~~equity~~(“Waiver ~~securities or through additional debt financing~~Letter”). WeUnder ~~anticipate drawing down~~ the ~~remainder~~terms of the ~~available~~Waiver ~~credit~~Letter, inuntil ~~our~~June ~~revolving~~30, ~~credit~~2009, ~~agreement with Macquarie Bank in~~ the ~~next~~Lender ~~few~~agreed ~~months~~ to ~~fund~~waive ~~additional drilling. Additional draw-downs on~~ the ~~credit~~Company’s ~~facility~~compliance ~~will~~with ~~depend~~certain ~~upon~~sections ~~the success~~ of ~~our future financings and~~ the ~~availability~~Credit ofAgreement, ~~credit~~which ~~under~~pertain ~~the credit facility. We are seeking~~ to ~~increase~~interest ~~our~~coverage ~~borrowing~~ratio, ~~base~~current ~~under~~ratio, ~~the credit facility~~ and ~~expect~~adjusted aPV ~~determination in the next few months~~ratio. ~~There can be no assurance that we will be successful in raising the required capital or that actual cash requirements will not exceed our estimates.~~

~~Given~~In ~~that~~consideration weof ~~have~~this ~~not~~waiver, ~~achieved~~the ~~profitable~~Company ~~operations~~agreed to ~~date,~~pay ~~our~~the ~~cash~~Macquarie ~~requirements~~one ~~are~~hundred ~~subject~~percent to(100%) ~~numerous~~of ~~contingencies~~the ~~and~~Net ~~risk~~Operating ~~factors~~Cash ~~beyond~~Flow ~~our~~(as ~~control~~defined in the Credit Agreement), ~~including~~to ~~operational~~be ~~and~~applied ~~development~~against ~~risks,~~the ~~competition~~entire ~~from~~outstanding ~~well-funded~~balance ~~competitors,~~of ~~and~~the ~~our~~loan ~~ability~~until tosuch ~~manage~~time ~~growth~~as the outstanding balance of the loan is paid off. WeThe ~~can~~Company ~~offer~~also noagreed ~~assurance~~to ~~that~~obtain ~~our~~the ~~company~~written consent of the Macquarie prior to ~~will~~ incurring ~~generate~~or ~~cash~~agreeing ~~flow~~to ~~sufficient~~incur any cost or expense for capital expenditures of any kind. Finally, the Company released Macquarie from any action or failure to ~~achieve~~act ~~profitable~~in ~~operations~~connection with the Credit Agreement or ~~that~~related ~~our~~documents ~~expenses~~occurring ~~will~~any ~~not~~time ~~exceed~~prior ~~our~~to ~~projections~~May 29, 2009. IfThe ~~our~~Waiver ~~expenses~~Letter ~~exceed~~expired ~~estimates~~June 30, we2009. ~~will~~The ~~require~~Company ~~additional~~remains ~~monies~~out ~~during~~of ~~the~~compliance ~~next~~with ~~six~~its ~~months~~interest tocoverage ~~execute~~ratio, ~~our~~current ~~business~~ratio ~~plan~~and adjusted present value ratio covenants.

Available Capital

We incurred a net loss of $1,030,000 for the quarter ended August 31, 2009 as compared to a net loss of $3,521,000 for the quarter ended August 31, 2008. We anticipate that losses will continue in the fiscal year ending May 31, 2010 due to lower oil and gas prices. We had current cash on hand as at August 31, 2009 of approximately $1,603,000.

As we anticipate that our estimated operating expenditures for the coming fiscal year will be $3,763,000, we do not have sufficient working capital to enable us to complete our drilling program of exploration wells or to finance our normal operations for the next fiscal year. Accordingly, we plan on undertaking additional financing activities throughout the course of the fiscal year. We estimate that approximately $700,000 will be derived from operations in the Sentell Field. However, the decrease in oil and natural gas prices has adversely affected our revenues and may continue to do so, which may increase our reliance on debt and equity financing.

Additionally, we estimate that we will be required to raise at least $3,100,000 through the issuance of equity securities or through additional debt financing. Additional draw-downs on the credit facility will depend upon the success of our future financings and the availability of credit under the credit facility. We are seeking to increase our borrowing base under the credit facility. There can be no assurance that we will be successful in raising the required capital or that actual cash requirements will not exceed our estimates.

Given that we have not achieved profitable operations to date, our cash requirements are subject to numerous contingencies and risk factors beyond our control, including operational and development risks, competition from well-funded competitors, and our ability to manage growth. We can offer no assurance that our company will generate cash flow sufficient to achieve profitable operations or that our expenses will not exceed our projections. If our expenses exceed estimates, we will require additional monies during the next fiscal year to execute our business plan.

There are no assurances that we will be able to obtain funds required for our continued operation. There can be no assurance that additional financing will be available to us when needed or, if available, that it can be obtained on commercially reasonable terms. Unprecedented disruptions in the current credit and financial markets have had a significant material adverse impact on a number of financial institutions and have limited access to capital and credit for many companies. These disruptions could, among other things, make it more difficult for the Company to obtain, or increase its cost of obtaining, capital and financing for its operations.

If we are not able to obtain additional financing on a timely basis, we will not be able to meet our other obligations as they become due and we will be forced to scale down or perhaps even cease the operation of our business.

There is substantial doubt about our ability to continue as a going concern as the continuation of our business is dependent upon obtaining further long-term financing, successful exploration and development of our oil and gas properties and, finally, achieving a profitable level of operations. The issuance of additional equity securities by us could result in a significant dilution in the equity interests of our current stockholders. Obtaining additional commercial loans, assuming those loans would be available, or drawing on our revolving credit agreement with ~~Macquarie Bank Limited, will increase our liabilities and future cash commitments.~~

2122

Macquarie Bank Limited, will increase our liabilities and future cash commitments.

Future Financings

The recent unprecedented events in global financial markets have had a profound impact on the global economy. Many industries, including the oil and natural gas industry, are impacted by these market conditions. Some of the key impacts of the current financial market turmoil include contraction in credit markets resulting in a widening of credit risk, devaluations and high volatility in global equity, commodity, natural resources and foreign exchange markets, and a lack of market liquidity. A continued or worsened slowdown in the financial markets or other economic conditions, including but not limited to, consumer spending, employment rates, business conditions, inflation, fuel and energy costs, consumer debt levels, lack of available credit, the state of the financial markets, interest rates, and tax rates may adversely affect the Company’s growth and profitability.

Specifically:

• ~~the~~The global credit/liquidity crisis could impact the cost and availability of financing and our overall liquidity; • volatility of petroleum prices, which could adversely affect sales and revenues in the oil and natural gas sector; and • the devaluation and volatility of global stock markets could impact the valuation of, and market in, our equity securities.

•

Volatility of petroleum prices, which could adversely affect sales and revenues in the oil and natural gas sector; and

•

The devaluation and volatility of global stock markets could impact the valuation of, and market in, our equity securities.

These factors could have a material adverse effect on the Company’s financial condition and results of operations.

We anticipate that additional funding, when required, will be in the form of equity financing from the sale of our common stock or through debt financing. However, we cannot provide investors with any assurance that we will be able to raise sufficient funding from the sale of our common stock or through debt financing on commercially reasonable terms to fund operations. We do not currently have any arrangements in place for any future equity financing. For debt financing, the Company has a credit agreement with Macquarie Bank Limited that currently has ana ~~initial~~ borrowing base of $5,000,000, none of which is available as of ~~February~~August 2831, 2009, and a maximum limit of $25,000,000, as disclosed above under “Liquidity and Capital Resources”.

Capital Expenditures

We control our capital expenditures as the operator of the Sentell Field, which allows us to monitor and pace capital expenditures. ~~Based~~In onresponse ~~the~~to ~~success of our initial Haynesville delineation wells tempered by~~ the global decline in product prices and restricted capital availability, we have ~~extensively~~curtailed ~~revised~~ our ~~2009~~ 2010 capital program. For the ~~remainder~~fiscal ofyear ~~fiscal~~ending ~~2009~~May 31, 2010, our current plans include:

1. ~~Concluding~~Drilling ~~drilling~~and ~~operations~~completion onactivities ~~our third Haynesville delineation well~~ at an estimated ~~net~~ cost of $~~640~~1,~~000; 2. Additional stimulation work on two of Cotton Valley wells at an estimated net cost of $100~~500,000; and ~~3. Gathering system and road infrastructure improvements in Sentell Field at an estimated net cost of $100,000.~~

~~Critical~~2. ~~Accounting~~Field ~~Policies~~infrastructure and ~~Estimates~~leasehold acquisition for an estimated net cost of $200,000.

~~The~~Off-Balance ~~preparation~~Sheet of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying disclosures of our company. Although these estimates are based on management’s knowledge of current events and actions that our company may undertake in the future, actual results may differ from such estimates. The following are critical accounting policies and estimates which we believe are important to understanding our financial results. Arrangements

Our company has no outstanding derivative financial instruments, off-balance sheet guarantees, interest rate swap transactions or foreign currency contracts. Our company does not engage in trading activities involving non-exchange traded contracts.

Critical Accounting Policies

The preparation of financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying disclosures of our company. Although these estimates are based on management’s knowledge of current events and actions that our company may undertake in the future, actual results may differ from such estimates.

Going Concern

2223

pursuant to Statements of Financial Accounting Standards (“SFAS”) No. 7 “Accounting and Reporting by Development Stage Enterprises”, and had not generated or sustained significant revenues. ~~These~~The accompanying financial statements have been prepared on a going concern basis, which implies the Company will continue to realize its assets and discharge its liabilities in the normal course of business. The Company is unlikely to pay dividends or generate significant earnings in the immediate or foreseeable future. The continuation of the Company as a going concern and the ability of the Company to emerge from the exploration stage are dependent upon its successful efforts to raise additional equity ~~or debt~~ financing to continue operations and generate sustainable significant revenue. There is no guarantee that the Company will be able to raise adequate equity ~~financing~~financings or generate profitable operations. As ofat ~~February~~August 2831, 2009, the Company has a working capital deficit of $1012,~~112~~608,000 and has incurred losses of $1619,~~966~~863,000 since inception. ~~These~~The ~~factors~~accompanying ~~raise substantial doubt regarding the Company’s ability to continue as a going concern. These~~ financial statements do not include any adjustments to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. ~~Management~~These offactors ~~the~~raise ~~Company~~substantial ~~has~~doubt regarding ~~undertaken steps as part of a plan with~~ the ~~goal of sustaining~~ Company’s ~~operations~~ability ~~for~~to ~~the~~continue ~~remainder~~as ~~of the fiscal year and beyond. These steps include: (~~a) ~~continuing efforts~~going ~~to raise additional capital and/or other forms of financing; and (b) controlling overhead and expenses~~concern. ~~There can be no assurance that any of these efforts will be successful.~~

These financial statements do not include any adjustments to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

Oil and Gas Properties

The Company utilizes the full-cost method of accounting for petroleum and natural gas properties. Under this method, the Company capitalizes all costs associated with acquisition, exploration and development of oil and natural gas reserves, including leasehold acquisition costs, geological and geophysical expenditures, lease rentals on undeveloped properties and costs of drilling of productive and non-productive wells into the full cost pool on a country by country basis. When the Company obtains proven oil and gas reserves, capitalized costs, including estimated future costs to develop the reserves proved and estimated abandonment costs, net of salvage, will be depleted on the units-of-production method using estimates of proved reserves. The costs of unproved properties are not amortized until it is determined whether or not proved reserves can be assigned to the properties. Until such determination is made the Company assesses annually whether impairment has occurred, and includes in the amortization base drilling exploratory dry holes associated with unproved properties.

The Company applies a ceiling test to the capitalized cost in the full cost pool. The ceiling test limits such cost to the estimated present value, using a ten percent discount rate, of the future net revenue from proved reserves, based on current economic and operating conditions. Specifically, the Company computes the ceiling test so that capitalized cost, less accumulated depletion and related deferred income tax, do not exceed an amount (the ceiling) equal to the sum of: (A) The present value of estimated future net revenue computed by applying current prices of oil and gas reserves (with consideration of price changes only to the extent provided by contractual arrangements) to estimated future production of proved oil and gas reserves as of the date of the latest balance sheet presented, less estimated future expenditures (based on current cost) to be incurred in developing and producing the proved reserves computed using a discount factor of ten percent and assuming continuation of existing economic conditions; plus (B) the cost of property not being amortized; plus (C) the lower of cost or estimated fair value of unproven properties included in the costs being amortized; less (D) income tax effects related to differences between the book and tax basis of the property.

For unproven properties, the Company excludes from capitalized costs subject to depletion, all costs directly associated with the acquisition and evaluation of the unproved property until it is determined whether or not proved reserves can be assigned to the property. Until such a determination is made, the Company assesses the property at least annually to ascertain whether impairment has occurred. In assessing impairment the Company considers factors such as historical experience and other data such as primary lease terms of the property, average holding periods of unproved property, and geographic and geologic data. The Company adds the amount of impairment assessed to the cost to be amortized subject to the ceiling test.

Share-Based Compensation

The Company accounts for share-based compensation pursuant to SFAS No. 123R. Accordingly, the Company records the grant date fair value of share-based compensation arrangements as compensation cost using a straight-line method over the service period. Share-based compensation is expensed or capitalized based on the nature of the employee’s activities.

Inherent in expensing stock options and other share-based compensation under SFAS No. 123R are several judgments and estimates that must be made. These include determining the underlying valuation methodology for share-based compensation awards and the related inputs utilized in each valuation, such as our expected stock price volatility, expected term of the employee option, expected dividend yield, the expected risk-free interest rate, the underlying stock price and the exercise price of the option. Changes to these assumptions could result in different valuations for individual share awards. For option valuations, the Company utilizes the Black-Scholes option pricing model.

Recent Accounting Pronouncements

Effective ~~June~~this 1quarter, ~~2008,~~we ~~the~~implemented ~~Company adopted~~ Statement of Financial Accounting Standards No. ~~157~~165, ~~Fair~~Subsequent ~~Value~~Events, ~~Measurements~~or (SFAS No165. ~~157),~~The ~~which~~standard establishes ageneral ~~framework~~standards ~~for~~of ~~measuring fair value in generally accepted~~ accounting ~~principles,~~for ~~clarifies~~and ~~the~~disclosure ~~definition~~ of ~~fair~~events ~~value within~~ that ~~framework,~~occur ~~and~~after ~~expands disclosures about~~ the ~~use~~balance ofsheet ~~fair~~date ~~value~~but ~~measurements.~~before ~~SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. However, in February 2008,~~ the ~~Financial~~financial ~~Accounting~~statements ~~Standards~~are ~~Board (FASB)~~ issued ~~FASB Staff Position No~~. ~~FA5~~The ~~157-2,Effective~~adoption ~~Date~~ of ~~FASB~~SFAS ~~Statement~~165 ~~No.~~did ~~157~~not ~~(FSP~~impact ~~No.~~our ~~157-2),~~financial ~~which~~position ~~deferred~~or ~~the~~results ~~effective date~~ of ~~SFAS~~ Nooperations. We ~~157~~evaluated ~~for~~all ~~one~~events ~~year~~or ~~for~~transactions ~~non-financial~~that ~~assets~~occurred ~~and~~after ~~liabilities~~June 30, ~~except~~2009 ~~for~~up ~~certain~~through ~~items~~the ~~that~~date ~~are~~we ~~recognized~~issued orthese ~~disclosed at fair value in the~~ financial statements on aOctober ~~recurring~~15, ~~basis (at least annually)~~2009.

In December 2007, the FASB issued SFAS No. ~~157~~141R, ~~defines~~“Business ~~fair~~Combinations”. ~~value~~This asstatement replaces SFAS 141 and defines the ~~price~~acquirer ~~that~~in ~~would~~a bebusiness ~~received~~combination toas ~~sell~~the anentity ~~asset~~that obtains control of one or ~~paid~~more tobusinesses ~~transfer~~in a ~~liability~~business incombination anand ~~orderly~~establishes ~~transaction~~the ~~between~~acquisition ~~market~~date ~~participants~~as atthe date that the ~~measurement~~acquirer ~~date~~achieves control. SFAS ~~No.~~141R ~~157~~requires ~~provides~~an aacquirer ~~framework~~to ~~for~~recognize the ~~measuring~~assets ~~fair value~~acquired, ~~establishes~~the aliabilities ~~three-level~~assumed, ~~hierarchy~~and ~~for~~any ~~fair~~noncontrolling ~~value measurements~~interest ~~based~~in ~~upon~~ the ~~transparency~~acquiree ofat ~~inputs to~~ the ~~valuation~~acquisition ofdate, anmeasured ~~asset~~at ortheir ~~liability~~fair values as of ~~the~~that ~~measurement~~ date. ~~and~~SFAS ~~requires~~141R ~~consideration~~also ofrequires the ~~Company’s~~acquirer ~~creditworthiness~~to ~~when valuing certain liabilities.~~

The three-level fair value hierarchy for disclosure of fair value measurements defined by SFAS No. 157 is as follows:

Level 1	—	Quoted prices for identical instruments in active markets at the measurement date.
Level 2	—	Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets at the measurement date and for the anticipated term of the instrument.
Level 3	—	Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.

The adoption of SFAS No. 157 did not have a material effect on the Company’s financial statements.

In March 2008, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment to FASB Statement No. 133”. SFAS No. 161 is intended to improve financial standards for derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial

~~performance,~~recognize ~~and~~contingent ~~cash~~consideration ~~flows.~~at ~~Entities~~the ~~are~~acquisition ~~required~~date, tomeasured ~~provide~~at ~~enhanced~~its ~~disclosures~~fair ~~about:~~value ~~(a)~~at ~~how~~that ~~and~~date. ~~why~~This anstatement ~~entity~~is ~~uses~~effective ~~derivative instruments; (b) how derivative instruments and related hedged items are accounted~~ for ~~under~~fiscal ~~Statement~~years ~~133~~ and ~~its~~interim ~~related~~periods ~~interpretations;~~within ~~and~~those (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years, beginning on or after ~~November~~December 15, 2008, ~~with~~and ~~early~~earlier adoption ~~encouraged. The Company~~ is ~~currently evaluating the impact of SFAS No~~prohibited. ~~161~~The ~~on its consolidated financial statements, and the~~ adoption of this statement isdid not ~~expected to~~ have a material effect on the Company’s consolidated financial statements.

In December 2007, the FASB issued SFAS No. ~~141R~~160, “~~Business~~Noncontrolling ~~Combinations”.~~Interests ~~This statement replaces SFAS 141 and defines the acquirer~~ in aConsolidated ~~business~~Financial ~~combination~~Statements asLiabilities ~~the~~–an ~~entity~~Amendment ~~that obtains control~~ of ~~one~~ARB orNo. ~~more businesses in a business combination and establishes the acquisition date as the date that the acquirer achieves control~~51”. ~~SFAS~~This ~~141R~~statement ~~requires~~amends anARB ~~acquirer~~51 to ~~recognize~~establish ~~the~~accounting ~~assets~~and ~~acquired,~~reporting ~~the~~standards ~~liabilities~~for ~~assumed,~~the ~~and any~~ noncontrolling interest in ~~the~~a ~~acquiree~~subsidiary atand for the ~~acquisition~~deconsolidation ~~date, measured at their fair values as~~ of ~~that~~a ~~date~~subsidiary. ~~SFAS 141R also requires the acquirer to recognize contingent consideration at the acquisition date, measured at its fair value at that date.~~ This statement is effective for fiscal years and interim periods within those fiscal years, beginning on or after December 15, 2008 and earlier adoption is prohibited. The adoption of this statement isdid not ~~expected to~~ have a material effect on the Company’s consolidated financial statements.

In ~~December~~May ~~2007~~2008, the FASB issued SFAS No. ~~160~~162, “~~Noncontrolling~~The ~~Interests~~Hierarchy inof ~~Consolidated~~Generally ~~Financial~~Accepted ~~Statements~~Accounting ~~Liabilities~~Principles”. ~~–an~~SFAS ~~Amendment of ARB~~ No. ~~51”.~~162 ~~This~~is ~~statement~~intended ~~amends~~to ~~ARB~~improve 51financial toreporting ~~establish~~by ~~accounting~~identifying ~~and~~a ~~reporting~~consistent ~~standards~~framework, or hierarchy, for ~~the Noncontrolling~~selecting ~~interest~~accounting inprinciples ato ~~subsidiary~~be ~~and~~used ~~for~~in ~~the~~preparing ~~deconsolidation~~financial ofstatements athat ~~subsidiary.~~are ~~This~~presented ~~statement~~in isconformity ~~effective~~with ~~for~~U.S. ~~fiscal~~generally ~~years~~accepted ~~and~~accounting principles ~~interim~~for ~~periods~~nongovernmental ~~within~~entities. ~~those~~SFAS ~~fiscal~~No. ~~years,~~162 ~~beginning~~is oneffective or60 ~~after~~days ~~December~~following ~~15,~~the ~~2008~~SEC’s ~~and~~approval ~~earlier~~of ~~adoption~~the isPublic ~~prohibited.~~Company ~~The~~Accounting ~~adoption~~Oversight ofBoard ~~this~~Auditing ~~statement~~amendments isto ~~not~~AU ~~expected~~Section to411, ~~have~~“The aMeaning ~~material~~of ~~effect~~Present onFairly ~~the~~in ~~Company’s~~Conformity ~~consolidated~~with ~~financial~~Generally ~~statements~~Accepted Accounting Principles”.

In May 2008, the FASB issued ~~SFAS~~FSP ~~No.~~14-1 ~~162,~~ “~~The~~Accounting ~~Hierarchy~~for ofConvertible ~~Generally~~Debt ~~Accepted~~Instruments ~~Accounting~~That ~~Principles”.~~May ~~SFAS~~Be ~~No.~~Settled ~~162~~in isCash ~~intended~~upon toConversion ~~improve~~(Including ~~financial~~Partial ~~reporting~~Cash bySettlement) ~~identifying~~“. aFSP ~~consistent~~14-1 ~~framework,~~requires orthe ~~hierarchy,~~issuer ~~for~~of ~~selecting~~certain ~~accounting principles~~convertible todebt beinstruments ~~used~~that inmay ~~preparing~~be ~~financial~~settled ~~statements~~in ~~that~~cash ~~are~~(or ~~presented~~other inassets) ~~conformity~~on ~~with~~conversion ~~U.S.~~to ~~generally~~separately ~~accepted~~account ~~accounting~~for ~~principles~~the liability (~~GAAP~~debt) ~~for~~and ~~nongovernmental~~equity ~~entities.~~(conversion ~~SFAS~~option) components ~~No.~~of ~~162~~the isinstrument ~~effective~~in 60a ~~days~~manner ~~following~~that reflects the ~~SEC~~issuer’s ~~approval~~non-convertible ofdebt ~~the~~borrowing ~~Public~~rate. ~~Company~~FSP ~~Accounting~~14-1 ~~Oversight~~is ~~Board~~effective ~~Auditing~~for ~~amendments~~fiscal toyears AUbeginning ~~Section~~after ~~411~~December 15, “2008, on a retroactive basis. The ~~Meaning~~adoption of ~~Present~~this ~~Fairly~~statement indid ~~Conformity~~not ~~with~~have ~~Generally~~a ~~Accepted Accounting~~material ~~Principles”.~~effect on the Company’s consolidated financial statements.

Summary of any product research and development that the Company will perform for the term of the plan.

We do not anticipate performing any product research and development under our plan of operation.

Expected purchase or sale of plant and significant equipment.

We do not anticipate any significant equipment purchases or sales.

Significant changes in number of employees.

As of ~~February~~August 2831, 2009, we employed William David Gibbs as our President, Chief Executive Officer (“CEO”), ~~Secretary, Treasurer~~ and Director, Christopher H. Taylor as our Chief Financial Officer, Douglas M. Harwell as our Operations Manager, and Rae Lynn Wertz as our Manager of Administration. WeSubsequent to August 31, 2009, Mr. Harwell resigned his position as Operations Manager effective September 30, 2009. We have no other employees and conduct most of our business through agreements with consultants and third parties. We do not anticipate any significant changes to the number of Company employees.

~~Off-Balance Sheet Arrangements~~ 25

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

Contractual Obligations

The Company has had no material changes to its contractual obligations as disclosed in the Company’s Annual Report on Form 10-~~KSB~~K for the year ended May 31, ~~2008~~2009.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not Applicable.

Item 4T4. Disclosure Controls and Procedures

~~Disclosure~~At ~~Controls~~the end of the period covered by this report on Form 10-Q for the quarter ended August 31, 2009, an evaluation was carried out under the supervision of and ~~Procedures~~with the participation of the Company’s management, including the CEO and CFO, of the effectiveness of the design and operations of the Company’s disclosure controls and procedures (as defined in Rule 13a - 15(e) and Rule 15d - 15(e) under the Exchange Act). Based on that evaluation the CEO and the CFO have concluded that the Company’s disclosure controls and procedures were adequately designed and effective in ensuring that: (i) information required to be disclosed by the Company in reports that it files or submits to the SEC under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in applicable rules and forms and (ii) material information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow for accurate and timely decisions regarding required disclosure.

AtChanges ~~the~~in ~~end~~Internal ofControl ~~the~~over period covered by this report on Form 10-Q for the three months ended February 28, 2009, an evaluation was carried out under the supervision of and with the participation of the Company’s management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of the design and operations of the Company’s disclosure controls and procedures (as defined in Rule 13a - 15(e) and Rule 15d - 15(e) under the Exchange Act). Based on that evaluation the CEO and the CFO have concluded that the Company’s disclosure controls and procedures were adequately designed and effective in ensuring that: (i) information required to be disclosed by the Company in reports that it files or submits to the Securities and Exchange Commission under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in applicable rules and forms and (ii) material information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow for accurate and timely decisions regarding required disclosure.Reporting

~~Changes~~There were no changes in ~~Internal~~our ~~Control~~internal control over ~~Financial~~financial ~~Reporting~~reporting (as defined in Rule 13(a)-15(f) or 15(d)-15(f)) that occurred during the period covered by this quarterly report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.26

26PART II — OTHER INFORMATION

~~PART~~Item II1. —Legal ~~OTHER INFORMATION~~Proceedings

~~Item~~On 1June 9, 2009, one of our vendors, Coastal Chemical Co., ~~Legal~~LLC ~~Proceedings~~filed suit in the 113th Judicial District of Harris County, Texas related to approximately $104,000 in claimed unpaid invoices. In addition, since May 31, 2009, several vendors have filed liens against the Company related to claims for unpaid invoices for goods and services provided to the Company in Bossier Parish, Louisiana and the state of Texas. Total claims related to these liens are approximately $3,696,000.

~~None~~Except for the above, we are not involved as a plaintiff in any material proceeding or pending litigation. There are no proceedings in which any of our directors, officers or affiliates, or any registered or beneficial shareholder, is an adverse party or has a material interest adverse to our interest.

Item 1A. Risk Factors

~~Not~~There ~~Applicable~~have been no material changes from the risk factors as previously disclosed in our Form 10-K for the year ended May 31, 2009 which was filed with Securities and Exchange Commission on August 31, 2009.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

~~All of the Company’s unregistered sales of equity securities were disclosed on Current Reports on Form 8-K as filed with the SEC on the following dates: January 21, 2009~~None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Submission of Matters to a Vote of Security Holders

None.

Item 5. Other Information

None.

27Item 6. Exhibits

~~Item~~(10) 6.Material ~~Exhibits~~Contracts

~~(31)~~10.1 ~~Rule~~Waiver ~~13a-14(a)/15d-14(a)~~Letter ~~Certifications~~between the Registrant and Macquarie Bank Limited dated May 29, 2009

(31.1) ~~Certification of Chief Executive Officer pursuant to~~ Rule 13a-14 ~~and Rule~~ (a)/15d-14(a), ~~promulgated under the Securities and Exchange Act of 1934, as amended~~Certifications

31.21 Certification of Chief ~~Financial~~Executive Officer pursuant to Rule 13a-14 and Rule 15d-14(a), promulgated under ~~the Securities and Exchange Act of 1934, as amended~~

~~(32)~~the ~~Section~~Securities ~~1350~~and ~~Certifications~~Exchange Act of 1934, as amended

3231.12 Certification of Chief ~~Executive~~Financial Officer pursuant to ~~Section~~Rule ~~906~~13a-14 ofand ~~the~~Rule ~~Sarbanes~~15d-~~Oxley~~14(a), ~~Act~~promulgated under the

~~32.2~~Securities ~~Certification~~and ofExchange ~~Chief~~Act ~~Financial Officer pursuant to Section 906~~ of ~~the~~1934, ~~Sarbanes-Oxley~~as ~~Act~~amended

28(32) Section 1350 Certifications

~~SIGNATURES~~32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act

~~Pursuant~~32.2 toCertification ~~the requirements~~ of the ~~Securities~~Chief ~~Exchange~~Financial ~~Act~~Officer ofpursuant ~~1934, the Company has duly caused this report~~ to beSection ~~signed~~906 onof ~~its behalf by~~ the ~~undersigned,~~Sarbanes-Oxley ~~thereunto duly authorized.~~Act

~~SOUTHERN STAR ENERGY INC.~~27

~~By: /s/ William David Gibbs~~ SIGNATURES

~~William~~Pursuant ~~David~~to ~~Gibbs~~the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

~~Chief~~SOUTHERN ~~Executive~~STAR ~~Officer~~ENERGY INC.

~~(On~~By: ~~behalf~~/s/ ofWilliam ~~the~~David ~~Company and as Principal Executive Officer)~~Gibbs

~~Date: April~~William ~~14,~~David ~~2009~~Gibbs

~~By: /s/~~Chief ~~Christopher~~Executive ~~H. Taylor~~ Officer

~~Christopher~~(On H.behalf ~~Taylor~~of the Company and as Principal Executive Officer)

~~Chief~~Date: October ~~Financial~~15, ~~Officer~~2009

~~(Principal~~By: ~~Financial~~/s/ ~~and~~Christopher ~~Accounting~~H. ~~Officer)~~Taylor Christopher H. Taylor

~~Date: April~~Chief ~~14,~~Financial ~~2009~~Officer

29(Principal Financial and Accounting Officer)

Date: October 15, 2009

Filing Compare · SOUTHERN STAR ENERGY INC.