Oilsands Quest files form 10-Q Quarterly Report

Dec 07, 2010, 08:00 ET from Oilsands Quest Inc.

                                                        CUSIP# 678046 10 3
                                                              NYSE Amex:   BQI

CALGARY, Dec. 7 /PRNewswire-FirstCall/ - Oilsands Quest Inc. (NYSE Amex: BQI) ("Oilsands Quest", "OQI" or "the Company") filed its Form 10-Q Quarterly Report for the quarter ended October 31, 2010 with the United States Securities and Exchange Commission on December 6, 2010. The full document is available online at www.sec.gov and www.sedar.com; the Management's Discussion and Analysis (MD&A) is presented below.

Commenting on the quarter and current operations, Oilsands Quest Acting Chief Executive Officer Brian MacNeill said, "While the strategic alternatives process is active and proceeding as expected, we are continuing to advance our oil sands prospects toward development. We are optimistic that our upcoming winter drilling program at Wallace Creek will confirm the potential for a second commercial oil sands project. We are striving to add value to the more than three billion barrels of discovered bitumen resources that Oilsands Quest has in the ground, in an environment where market interest in oil sands assets remains strong."

    Management's Discussion and Analysis
    ------------------------------------

The following discussion addresses material changes in our results of operations and capital resources and uses for the three and six months ended October 31, 2010, compared to the three and six months ended October 31, 2009, and our financial condition and liquidity since April 30, 2010. It is presumed that readers have read or have access to our 2010 Annual Report on Form 10-K/A, which includes disclosure regarding critical accounting policies and estimates as part of Management's Discussion and Analysis of Financial Condition and Results of Operation. Unless otherwise stated, all dollar amounts are expressed in U.S. dollars. All future payments in Canadian dollars have been converted to U.S. dollars using an exchange rate of $1.00 U.S. = $1.0188 CDN, which was the October 31, 2010 exchange rate.

Overview

Three Months Ended October 31, 2010

    -   On August 17, 2010, we announced that we had initiated a process to
        explore strategic alternatives for enhancing shareholder value. The
        process will be overseen by a Special Committee of the Board of
        Directors to consider all alternatives to increase shareholder value,
        including financing opportunities, asset divestitures, joint ventures
        and/or a corporate sale, merger or other business combination. We
        retained TD Securities Inc. as a financial advisor to assist us with
        this process.
    -   We completed laboratory testing of the glacial till. The results of
        the testing indicate that the glacial till has the characteristics
        required to act as a steam containment cap for an in-situ SAGD
        operation.
    -   We announced changes to the management team on September 2, 2010.
        Brian MacNeill was appointed Acting CEO to oversee the operations
        during the review of the strategic alternatives, T. Murray Wilson
        assumed a new role as Executive Deputy Chairman to advise the Special
        Committee and Sue MacKenzie resigned as the Chief Operating Officer.
    -   We announced our intention to dispose of our non-core assets, the
        Eagles Nest oil sands lease and Pasquia Hills oil shale permits.
    -   We completed a re-abandonment program of 18 coreholes. 14 of the core
        holes were successfully re-abandoned. The re-abandonment of the 4
        core holes that we were not able to re-abandon occurred early in the
        program; they will be converted to observation holes.
    -   At the end of October 2010, we announced a public offering and on
        November 5, 2010, we completed a financing for 20.8 million common
        shares at a price of $0.45 per share and 7.1 million common shares on
        a flow-through basis at a price of $0.50 per share for total gross
        proceeds of approximately $12.9 million USD.

Six Months Ended October 31, 2010

    -   We completed a non-brokered private financing for 10.5 million flow-
        through shares at $1.00 CDN ($0.995 USD) and 9.2 million common
        shares at $0.85 per share for gross proceeds of $18.6 million CDN
        ($18.1 million USD).
    -   We filed an application to the Saskatchewan Ministry of Environment
        (SME) for the approval of a 30,000 BPD commercial project at Axe
        Lake.
    -   We were granted a one year extension, to May 31, 2011, of our oil
        sands permits in northwest Saskatchewan.
    -   We announced an updated independent third party resource estimate for
        our properties.
    -   We completed the engineering design to modify the existing facilities
        for the SAGD pilot and the procurement of materials with certain long
        lead times for the facilities and horizontal wells.
    -   We drilled four additional delineation wells in the Axe Lake area in
        order to meet minimum commitments for certain permit retention as
        well as increase resource understanding.
    -   We provided an update of our progress at the TD Newcrest
        Unconventional Oil Forum held in Calgary on July 14, 2010.
    -   We announced the cancellation of the sale of our non-core assets at
        Pasquia Hills to Canshale Corp.
    -   We announced our intention to dispose of our non-core assets, the
        Eagles Nest oil sands lease and Pasquia Hills oil shale permits.
    -   We received approval from the SMER for a steam-assisted gravity
        drainage (SAGD) pilot at Axe Lake's Test Site 1.

Operations Summary:

Exploration Programs

During the six months ended October 31, 2010, we focused on developing our plans for drilling 11 new core holes in the Wallace Creek area in January and February of 2011. This drilling program is a follow up to our successful drilling program of early 2010 and we expect to increase our resource base and qualify additional lands on this permit for a potential conversion to a lease.

We are planning to drill these core holes as part of a combined drilling program with an operator from an adjacent oil sands property. By combining our operations in the area, we expect to realize significant operating efficiencies and secure the rigs and services required to complete the program.

We filed for and received approval for the second of three one-year extensions of our Saskatchewan oil sands permits. We may seek and be granted an additional one year extension of each permit if the Company continues to meet its obligations under the terms of the permits and the Oil and Gas Conservation Regulations, 1985.

We also relinquished our two northernmost land permits in Saskatchewan (permits 213 and 215) as we focus our exploration and development opportunities to include only those lands that recent exploration activity has demonstrated to be prospective. The relinquishment of these permits did not impact our resource estimates or development plans. Please see below under the section titled "Outlook" for a more detailed description of the Company's land strategy.

Axe Lake Area - Reservoir Development Activities

In July 2010, we drilled 4 wells to confirm the extent of the reservoir at Axe Lake and to satisfy our permit retention work obligations on the Saskatchewan permits. The objective of these wells was to provide additional information on the geology in the area and will not have a significant impact on our assessment of the resource in the Axe Lake area.

During the six months ended October 31, 2010 we completed testing of the steam containment characteristics of the glacial till. The laboratory tests indicate that the glacial till cap will support the proposed SAGD pilot at Axe Lake at chamber pressures of between 1,750 to 2,500 kPa.

We are continuing with the additional processing and interpretation of the 1,847 kilometres (1,149 miles) of 2-D and 3-D seismic data in order to correlate this information to the results of the overburden drilling program and the summer 2010 drilling program at Axe Lake. This interpretation of the seismic data and the correlation of the well information will be used to assist in the placement of the well pads for commercial development as well as mapping the glacial till overburden over areas where we currently lack well control.

We filed a proposal to the Saskatchewan Ministry of Environment (SME) for approval to produce up to 30,000 barrels per day of bitumen using SAGD. Filing with the SME is the first step in a two-stage process to apply for approval of a commercial lease for oil sands development. This proposal provides the complete vision for the project, giving the regulator helpful context when approving testing activity and giving all stakeholders clarity around the long-term development plans. The second stage of the process consists of an application for commercial project approval to SMER that will be submitted following the successful completion of the SAGD pilot.

The proposed project includes components typical of SAGD operations such as multi-well production pads of horizontal well pairs, and a central processing and bitumen treatment facility that includes produced fluid separation, water recycling, steam generation and tank storage facilities. Options for site access, utility service corridors, bitumen transportation, electricity and natural gas supplies are also being evaluated.

We received approval for a SAGD pilot at Test Site 1. The pilot, as proposed, will consist of one 100 meter long horizontal well pair, with the upper well placed five meters below the glacial till cap, or overburden, and was designed to make use of the existing surface facilities. The SAGD pilot will demonstrate the steam containment properties of the glacial till cap and provide information essential for the front-end engineering design for the commercial development. Further activity on the pilot project has been suspended pending the outcome of the review of the strategic alternatives described in the Corporate section below.

Development of a commercial project remains subject to financing, regulatory and other contingencies such as successful reservoir tests, board of directors' approvals, and other risks inherent in the oil sands industry (See "Risk Factors" section of our Form 10-K/A for the year ended April 30, 2010 and see Item 1A. "Risk Factors" below).

Environmental and Regulatory

Our Saskatchewan oil sands permits were granted in 2004 and are for five year terms ending in 2009. Each permit allows for an option to request three additional year long extensions. On June 21, 2010, we received approval for the second of the possible three one-year extensions. The Company may elect to seek an additional one-year extension for the oil sands permits in May 2011, and may elect to convert these permits to lease prior to the expiry of these permits. While we expect that our application for extension will be granted, approval requires that certain conditions are met and that the Company is in compliance with the Oil and Gas Conservation Regulations, 1985. Please see below under the section titled "Outlook" for further detail on the Company's land strategy.

The Company is in discussion with SME to assess a re-abandonment issue relating to the abandonment of early exploration core holes. We have drilled 355 exploration core holes in Saskatchewan and during a review of our development plans and well records, we determined that 223 of the early-year wells were not abandoned to meet our thermal development requirements or were not abandoned in accordance with the regulatory requirements.

We have applied for waivers on 99 core holes, the majority of which are located outside the current potential commercial development area and the regulator has indicated that they are willing to consider such waivers on a case by case basis. Our waiver applications are based on the fact that these core holes fall outside the current commercial development area and are therefore located in areas that are not expected to be economically recoverable. We have included approximately 124 core holes in our management best estimate of the re-abandonment costs as described in our financial statements.

During the six months ended October 31, 2010, we completed an 18 hole re-abandonment program. We successfully re-abandoned 14 core holes and were partially unsuccessful in our attempt to re-abandon the other 4 core holes as these core holes may still contain conduits which will require the Company to undertake further monitoring should a SAGD project be implemented within the vicinity of these core holes. The re-abandonment of these 4 core holes occurred early in the program.

The remaining 106 core holes are comprised of a combination of locations that are in or adjacent to the commercial development area plus a portion of the core holes for which we intend to seek waivers. Our best estimate of the cost to complete this program over the next four years is $20.8 million.

Pasquia Hills Oil Shale Area

Pasquia Hills Oil Shale Permit Area

In September and October 2009, we drilled and logged 12 exploration test holes on our oil shale prospect in eastern Saskatchewan with ten out of twelve holes drilled experiencing meaningful intercepts of oil shale of up to 37.0 meters in thickness. A geologic assessment, including an estimate of Petroleum Initially-in-Place, of our permit lands based on the drill results and data obtained from legacy drilling was prepared by Norwest Corp.

On July 30, 2010, we cancelled a transaction to sell the Pasquia Hills assets to Canshale Corp. as they were unable to meet the minimum financing requirement that was a condition for the transaction to close.

Corporate

On August 17, 2010, we announced that we had initiated a process to explore strategic alternatives for enhancing shareholder value. The Board's decision reflects careful consideration of our current financial position and the capital required to execute the business plan. In light of the significant incremental capital required to advance the exploration and development of the oil sands assets in Saskatchewan and Alberta, the Board determined that it is in the best interests of shareholders to engage financial advisors and formally explore all alternatives. The process of exploring and evaluating strategic alternatives will be overseen by a Special Committee chaired by Ronald Blakely, and including Brian MacNeill and Paul Ching. The Special Committee will consider all alternatives to increase shareholder value, including strategic financing opportunities, asset divestitures, joint ventures and/or a corporate sale, merger or other business combination, and will ultimately recommend a course of action to the Company's full Board. We have retained TD Securities Inc. as a financial advisor to assist us with this process.

Upon developing the multi-year capital program for all of these plans and assessing its options to ensure near-term liquidity in the current market environment, we have decided to put our SAGD pilot on hold to preserve capital while pursuing strategic alternatives and seeking additional capital.

We also announced our intention to divest our Eagles Nest oil sands lease and Pasquia Hills oil shale permits. The Eagles Nest property is geographically distant from our other oil sands discoveries and is largely unexplored. We have also recognized for some time that retaining and developing the Pasquia Hills oil shale deposits would require considerable time, effort and financial resources while were in the process of exploring and developing our significant portfolio of oil sands assets. We are optimistic that a sale of one or both of these non-core assets will be completed by early 2011 and will improve our near-term liquidity and increase our flexibility in pursuing the strategic review process.

There can be no assurance that the review of strategic alternatives will result in a financing or a sale of the company or in any other transaction. There is no timetable for the review, and the Company does not intend to comment further regarding the evaluation of strategic alternatives unless the Board agrees to a definitive transaction or the process is concluded. The Company may continue to seek interim financing while the strategic alternatives process unfolds.

Outlook

Our reservoir development and exploration activities over the next few months will be focused on the Wallace Creek drilling program and a review of our lands to optimize our land base and in preparation for the application to extend our permits in Saskatchewan.

At this time, we anticipate that our activities will focus on the retention of portions of PS00208 and PS00210 in the Axe Lake area and their conversion to leases. The permits are currently held under the Oil Shale Regulations, 1964 (1964 Regulations). The conversion to lease requirements under the 1964 Regulations are more stringent then under the Petroleum and Natural Gas Regulations, 1969 (1969 Regulations) and we are currently working with SMER to allow us to transfer our oil sands permits from the 1964 Regulations to the 1969 Regulations in order to take advantage of the less stringent conversion from permit to lease rules. The outcome of these discussions is not a certainty.

We would also expect high likelihood of relinquishment of the balance of our lands in Saskatchewan as we do not believe that the lands to the south of the Axe Lake area are prospective, either due to the presence of interbedded water in the reservoirs that would not allow for commercial development or lack of bitumen in the reservoirs in the licenses in the southern portion of our Saskatchewan lands. Our assessment of the Saskatchewan Oil Sands Licenses has resulted in the recognition of an impairment of $2.5 million ($1.8 million net of tax) in the financial statements as of and for the six months ended October 31, 2010. Further, we have found interbedded water areas in our East Raven Ridge area. Further analysis of these lands' prospectivity is underway and may result in relinquishment of certain of our East Raven Ridge lands in Alberta. The relinquishment of these lands will have no impact on the Company's current resource estimates or development plans.

Over the next twelve months, we plan to continue the analytical activities necessary to evaluate the recoverability of our oil sands resources at Axe Lake, Wallace Creek and Raven Ridge. Further delineation drilling is required in the northern and eastern Wallace Creek area, and the southern Raven Ridge area in order to satisfy permit retention requirements. Whether or not the Company is able to complete this delineation drilling and retain certain portions of these permits not yet delineated is subject to the availability of capital and regulatory approvals.

Based on the delineation drilling results to date and our knowledge of the regional geology, we believe there is good potential for that project area to ultimately support an additional 30,000 barrels per day commercial project at Wallace Creek. This assessment is subject to a further delineation drilling, the availability of capital to complete this drilling and regulatory approvals.

Based on our review of publicly available drilling data and an analysis of our own delineation drilling to date, the reservoir in our West Raven Ridge area adjacent to Cenovus Energy Inc.'s ("Cenovus") Borealis Project appears to be very similar geologically. Both reservoirs have relatively thick net bitumen pay and significant amounts of top and bottom water associated with them. Cenovus has submitted an application to the Energy Resources Conservation Board of Alberta to develop their property and, while we do not yet have the commercial or technical wherewithal to commercially develop our West Raven Ridge area, the reservoir may be developed using a similar recovery scheme as is planned by Cenovus.

Liquidity and Capital Resources

At October 31, 2010, the Company held cash and cash equivalents totaling $17.8 million.

On May 10, 2010, the Company issued 10.5 million flow-through shares at $1.00 CDN ($0.995 USD) and 9.2 million common shares at $0.85 USD per share for gross proceeds of $18.6 million CDN ($18.1 million USD) pursuant to a non-brokered private placement.

On November 5, 2010, the Company completed a public offering for 20.8 million common shares at a price of $0.45 per share and 7.1 million common shares on a flow-through basis at a price of $0.50 per share for total gross proceeds of approximately $12.9 million USD.

Management anticipates that the Company will be able to fund its activities through September 2011 with its current cash and cash equivalents as at October 31, 2010 and including the net proceeds of the November 5, 2010 public offering. Accordingly, significant uncertainty remains about our ability to continue as a going concern. This means that without additional funding, we may not be able to continue our operations beyond the next twelve months. Additional financing will also be required if our activities are changed in scope or if actual costs differ from estimates of current plans.

There is no assurance that debt or equity financing or joint venture partner arrangements will be available to us on acceptable terms, if at all, to meet our requirements. The Company has no revenues, and its operating results, profitability and the future rate of growth depend solely on management's ability to successfully implement the business plans and on the ability to raise additional capital. See "Outlook" above.

The consolidated financial statements have been prepared assuming that we will continue as a going concern.

Results of Operations

Net loss

Three months ended October 31, 2010 as compared to three months ended October 31, 2009. The Company experienced a net loss of $9.1 million or $0.03 per share for the three months ended October 31, 2010 as compared to a net loss of $13.2 million or $0.04 per share for the three months ended October 31, 2009. The decline in the net loss in the current period as compared to the prior period is due to the reduction in exploration activity and a reduction in stock-based compensation expense which were partially offset by increased corporate expenses due to costs resulting from employee terminations, advisory costs incurred as a result of the strategic alternatives review and a decrease in the deferred income tax benefit.

Six months ended October 31, 2010 as compared to six months ended October 31, 2009. The Company experienced a net loss of $25.1 million or $0.08 per share for the six months ended October 31, 2010 as compared to a net loss of $18.0 million or $0.06 per share for the six months ended October 31, 2009. The increase in the net loss as compared to the prior year is caused by $8.1 million ($5.9 million net of tax) of cost revisions related to asset retirement obligations to re-abandon coreholes in the Axe Lake area and reclaim the airstrip, camp site, access roads and reservoir test site at the Company's properties. In addition, the Company recognized an impairment of $2.5 million ($1.8 million net of tax) on the Saskatchewan Oil Sands Licenses due to the high likelihood of relinquishment and incurred $2.0 million of additional corporate expenses resulting from employee retention and termination costs and advisory costs incurred as part of the strategic alternatives review process. The increase is also caused by foreign exchange, whereas a gain of $3.1 million was recorded during the six months ended October 31, 2009 as a result of holding Canadian funds with an appreciation of the Canadian dollar value versus the US dollar, compared to a loss of $0.2 million recorded during the current period. The increase in the net loss during the six month period ended October 31, 2010 compared to the prior year was partially offset by a reduction of $1.8 million in stock-based compensation expense and an increase of $1.1 million of income tax benefit.

The Company expects to continue to incur operating losses and will continue to be dependent on additional sales of equity or debt securities and/or property sales or joint ventures to fund its activities in the future.

Net loss from continuing operations

Three months ended October 31, 2010 as compared to three months ended October 31, 2009. The Company experienced a net loss from continuing operations of $8.9 million or $0.03 per share for the three months ended October 31, 2010 as compared to a net loss of $12.6 million or $0.04 per share for the three months ended October 31, 2009. The decline in the net loss in the current period as compared to the prior period is due to the reduction in exploration activity and a reduction in stock-based compensation which were partially offset by increased corporate expenses due to costs resulting from employee terminations, advisory costs incurred as a result of the strategic alternatives review and a decrease in the deferred income tax benefit.

Six months ended October 31, 2010 as compared to six months ended October 31, 2009. The Company experienced a net loss from continuing operations of $24.9 million or $0.08 per share for the six months ended October 31, 2010 as compared to a net loss from continuing operations of $17.2 or $0.06 per share for the six months ended October 31, 2009. The increase in the net loss as compared to the prior year is mainly caused by $8.1 million ($5.9 million net of tax) of cost revisions related to asset retirement obligations to re-abandon a certain number of wells in the Axe Lake area and reclaim the airstrip, camp site, access roads and reservoir test site at the Company's properties. In addition, the Company recognized an impairment of $2.5 million ($1.8 million net of tax) on the Saskatchewan Oil Sands Licenses due to the high likelihood of relinquishment and incurred $2.0 million of additional corporate expenses resulting from employee retention and termination costs and advisory costs incurred as part of the strategic alternatives review process. The increase is also caused by foreign exchange, whereas a gain of $3.1 million was recorded during the six months ended October 31, 2009 as a result of holding Canadian funds with an appreciation of the Canadian dollar value versus the US dollar, compared to a loss of $0.2 million recorded during the current period. The increase in the net loss during the six month period ended October 31, 2010 compared to the prior year was partially offset by a reduction of $1.8 million in stock-based compensation expense and an increase of $1.1 million of income tax benefit.

Net loss from discontinued operations

Three and six months ended October 31, 2010 as compared to three and six months ended October 31, 2009. Net loss from discontinued operations for the three months ended October 31, 2010 was $0.2 million or $nil per share compared to $0.6 million or $nil per share for the three months ended October 31, 2009. Net loss from discontinued operations for the six months ended October 31, 2010 was $0.2 million or $nil per share compared to $0.8 million or $nil per share for the six months ended October 31, 2009. The activities related to the oil shale program at Pasquia Hills and the oil sands lease at Eagles Nest have been reported as discontinued operations in the consolidated income statement following the Company's announcement on September 22, 2010 that it was initiating a process to divest these properties. These properties were determined to be non-core assets as both properties are located outside the Company's primary project and discovery areas of Axe Lake, Wallace Creek and Raven Ridge.

Exploration costs

Three and six months ended October 31, 2010 as compared to three and six months ended October 31, 2009. Exploration costs for the three months ended October 31, 2010 were $1.7 million (2009 - $8.1 million). Exploration costs for the six months ended October 31, 2010 were $13.1 million (2009 - $11.4 million). Exploration expenditures in the three months ended October 31, 2010 decreased due to a reduction in drilling and exploration activity during the period compared to the same period in the previous year. The increase in exploration costs during the six month period ended October 31, 2010 is due to $8.1 million of cost revisions related to asset retirement obligations to re-abandon a certain number of wells in the Axe Lake area and reclaim the airstrip, camp site, access roads and reservoir test site at the Company's properties. This is partially offset by a decrease in exploration and drilling activity during the six months ended October 31, 2010 compared to the same period last year. The Operations Summary above provides a summary of the exploration activities conducted in the three and six months ended October 31, 2010.

General and administrative

Corporate

Three and six months ended October 31, 2010 as compared to three and six months ended October 31, 2009. General and administrative expenses settled with cash for the three months ended October 31, 2010 were $5.3 million (2009 - $3.3 million). General and administrative expenses settled with cash for the six months ended October 31, 2010 were $9.0 million (2009 - $7.0 million). Expenditures in the three month period ended October 31, 2010 consist of salaries ($2.4 million), legal and other professional fees ($1.7 million) and general office costs ($1.2 million). Expenditures in the six month period ended October 31, 2010 consist of salaries ($3.9 million), legal and other professional fees ($2.9 million) and general office costs ($2.2 million). General and administrative expenses in the three months ended October 31, 2009 consist of salaries ($1.4 million), legal and other professional fees ($0.7 million) and general office costs ($1.2 million). General and administrative expenses in the six months ended October 31, 2009 consist of salaries ($3.6 million), legal and other professional fees ($1.4 million) and general office costs ($2.0 million). At October 31, 2010, there were 32 employees including 5 seasonal field employees, and at October 31, 2009 there were 53 employees including 13 seasonal field employees. The increase in salaries and wages during the three and six months ended October 31, 2010 occurred as result of severances that were paid during the period and the recognition of a liability of $0.5 million for employee benefit arrangements related to a termination plan in connection with the review of strategic alternatives. The increase in professional fees during the three and six months ended October 31, 2010 is related to additional costs incurred as part of the strategic alternatives review process.

Stock-based compensation

Three and six months ended October 31, 2010 as compared to three and six months ended October 31, 2009. Stock-based compensation expense for the three months ended October 31, 2010 was a recovery of $0.001 million (2009 - $1.1 million) and $1.0 million for six months ended October 31, 2010 (2009 - $2.8 million) and consists of stock-based compensation related to the issuance of options to directors, officers and employees. The decrease during the current period compared to the same period in the prior year is due to 2.1 million of unvested options that were forfeit as a result of employee terminations during the six months ended October 31, 2010. A total of 4.2 million options were forfeited during the six months ended October 31, 2010.

Foreign exchange loss (gain)

Three and six months ended October 31, 2010 as compared to three and six months ended October 31, 2009. A foreign exchange gain of $0.1 million (2009 - loss of $0.1 million) during the three months ended October 31, 2010 resulted from holding Canadian funds in the parent company when the value of the Canadian dollar appreciated slightly against the U.S dollar. For the six months ended October 31, 2010, a foreign exchange loss of $0.2 million (2009 - gain of $3.1 million) resulted from holding Canadian funds in the parent company when the value of the Canadian dollar depreciated against to the U.S. dollar.

Depreciation and accretion

Three and six months ended October 31, 2010 as compared to three and six months ended October 31, 2009. Depreciation and accretion expense for the three months ended October 31, 2010 was $1.1 million (2009 - $0.6 million) and $2.2 million for the six months ended October 31, 2010 (2009 - $1.0 million). Depreciation expense relates to camp facilities, equipment and corporate assets which are being depreciated over their useful lives of three to five years. Accretion expense relates to the asset retirement obligation recognized on the re-abandonment of a certain number of wells in the Axe Lake area and on the airstrip, camp site, access roads and reservoir test sites which are being brought into income over a period of one to thirty years. The increase during the three and six month period ended October 31, 2010 compared to the same periods last year is due to the additional accretion on asset retirement obligation resulting from the re-abandonment of a certain number of wells in the Axe Lake area that was identified in the previous fiscal year.

Impairment

Three and six months ended October 31, 2010 as compared to three and six months ended October 31, 2009. The impairment for the three months ended October 31, 2010 was $0.06 million (2009 - $nil) and $2.5 million for the six months ended October 31, 2010 (2009 - $nil). This impairment is recognized on the Saskatchewan Oil Sands Licenses due to their high likelihood of relinquishment at October 31, 2010.

Interest and other income

Three and six months ended October 31, 2010 as compared to three and six months ended October 31, 2009. Interest income for the three months ended October 31, 2010 was $0.03 million (2009 - $0.01 million) and $0.04 million for the six months ended October 31, 2010 (2009 - $0.07 million). Interest income is earned because the Company pre-funds its activities and the resulting cash on hand which is invested in short-term deposits. The increase during the three month period as compared to the same period last year reflects the increase in market interest rates over the intervening period. Accordingly, the decrease in interest income during the six months ended October 31, 2010 compared to the same period in the prior year reflects the decrease in short term investments and the decrease in market interest rates over the intervening period.

Deferred income tax expense (benefit)

Three months ended October 31, 2010 as compared to three months ended October 31, 2009. The deferred income tax expense for the three months ended October 31, 2010 was $0.9 million (2009 - benefit of $0.5 million). The decrease in the deferred tax benefit is due to a reduction in exploration activity, the renunciation of $3.2 million of flow through expenditures corresponding to a reduction of $0.4 million in tax benefit and the recording of $3.7 million of asset retirement liabilities settled during the period and resulting in the reversal of $1.0 million of tax benefits previously recognized on asset retirement obligations.

Six months ended October 31, 2010 as compared to six months ended October 31, 2009. The deferred income tax benefit for the six months ended October 31, 2010 was $3.0 million (2009 - $1.9 million). The increase in the deferred tax benefit includes $2.2 million of tax benefits related to $8.1 million of additional asset retirement obligations that were recorded during the period. It also includes $0.7 million of tax benefits related to the $2.5 million impairment of the Saskatchewan Oil Sands Licenses. This increase in the deferred tax benefit is partially offset by the reduction in exploration activity during the period, the renunciation of $3.2 million of flow through expenditures corresponding to a reduction of $0.4 million in tax benefit and the recording of $4.4 million of asset retirement liabilities settled during the period and resulting in the reversal of $1.2 million of tax benefits previously recognized on asset retirement obligations.

The Company has generated deferred tax benefits by expensing all exploration costs for accounting purposes while capitalizing these costs for income tax purposes. This results in a higher tax basis for the Company's property and equipment when compared to their carrying value. The deferred tax liability reported on the balance sheet is mainly related to the book value of property which will not be deductible for tax purposes and is related to the Company's 2006 acquisition of the minority interest in OQI Sask.

Recently Issued Accounting Standards Not Yet Adopted

There are no relevant recently issued accounting standards that would impact the Company.

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or further effect on its financial condition, changes in financial condition, revenues or expenses, results of operations liquidity, capital expenditures or capital resources that are material to investors.

Cautionary statement about forward-looking statements

The following includes certain statements that may be deemed to be "forward-looking statements." All statements, other than statements of historical facts, included in this Form 10-Q that address activities, events or developments that our management expects, believes or anticipates will or may occur in the future are forward-looking statements. Such forward-looking statements include discussion of such matters as:

    -   the amount and nature of future capital, exploration and development
        expenditures;
    -   the extent and timing of exploration and development activities;
    -   business strategies and development of our business plan and
        exploration programs;
    -   potential relinquishment of certain of our oil sands permits and
        licenses;
    -   anticipated cost of our asset retirement obligations, including the
        extent and timing of our corehole re-abandonment program;
    -   our plans to negotiate with the Saskatchewan Ministry of Energy and
        Resources (SMER) respecting the transfer of our Saskatchewan oil
        sands permits from the Oil Shale Regulations to the Petroleum and
        Natural Gas Regulations; and the outcome of our process to explore
        strategic alternatives.

Forward-looking statements also typically include words such as "anticipate", "estimate", "expect", "potential", "could" or similar words suggesting future outcomes. Readers are cautioned that forward-looking statements are not guarantees of future performance and that actual results or developments may differ materially from those expressed or implied in the forward-looking statements. The Company is under no duty to update any of these forward-looking statements after the date of this report. You should not place undue reliance on these forward-looking statements.

About Oilsands Quest

Oilsands Quest Inc. (www.oilsandsquest.com) is exploring and developing oil sands permits and licences, located in Saskatchewan and Alberta, and developing Saskatchewan's first commercial oil sands discovery. It is leading the establishment of the province of Saskatchewan's emerging oil sands industry.

SOURCE Oilsands Quest Inc.