News Column

FX ENERGY INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

August 11, 2014

Introduction

The majority of our operations are in Poland, and we have devoted most of our technical talent and capital expenditures in the last several years to our operations in that country. The decision to devote most of our available capital to this area drives most of our operating results and the changes to our balance sheet and liquidity. Our operations in Poland are a combination of existing production and substantial exploration. Oil and gas production, oil and gas revenues, cash flow, earnings, oil and gas reserves, and oil and gas expenditures have grown significantly over the last several years.

Our U.S. operations also have an impact. Our U.S. operations are smaller than our operations in Poland and do not present the same level of opportunities for expansion; however, our U.S. operations are a relatively stable source of cash flow. This, too, is reflected in our operating results.

Results of Operations by Business Segment

Quarter Ended June 30, 2014, Compared to the Same Period of 2013

Exploration and Production Segment

Gas Revenues. Revenues from gas sales were $7.8 million during the second quarter of 2014, compared to $7.2 million during the same quarter of 2013. Higher prices in the 2014 quarter led to the increase in natural gas revenues.

A summary of the amount and percentage change, as compared to the respective prior-year period, for gas revenues, average gas prices, and gas production volumes for the quarters ended June 30, 2014 and 2013, is set forth in the following table: For the Quarter Ended June 30, 2014 2013 Change Gas revenues $7,799,000$7,231,000 +8% Average price (per thousand cubic feet) $7.56$6.97 +9%



Production volumes (thousand cubic feet) 1,031,000 1,038,000 -1%

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Daily gas production was 11.3 million cubic feet of natural gas per day, or MMcfd, in the second quarter of 2014, compared to 11.4 MMcfd in the second quarter of 2013. Production declines at our Roszkow and Zaniemysl wells were mostly offset by increases at our Winna Gora and Lisewo-1 wells. Our Winna Gora well was shut-in for two weeks for annual maintenance and pressure testing. In addition, production was stopped for 40 days at our Kromolice-1 well for some unexpected flow line repairs, now completed, which reduced our quarterly production by approximately 900,000 cubic feet per day. At June 30, 2014, our daily production was 12.3 MMcfd. We expect production to begin at our Lisewo-2 well in the fourth quarter of this year.

Natural gas prices were higher during the 2014 second quarter. Two factors contributed to the increase in average prices. First, the Polish low-methane tariff, which serves as the reference price for our gas sales agreements, was 3.1% higher during the second quarter of 2014. Second, period-to-period weakness in the U.S. dollar against the Polish zloty increased our dollar-denominated gas prices. The average exchange rate during the second quarter of 2014 was 3.04 zlotys per dollar. The average exchange rate during the second quarter of 2013 was 3.21 zlotys per dollar, a change of approximately 5%.

Oil Revenues. Oil revenues were $1.0 million for the second quarter of 2014, a 5% increase from $952,000 received during the second quarter of 2013. Production levels decreased approximately 3% from 2013 to 2014, due to normal production declines. Higher oil prices in the second quarter of 2014 offset the production decline. Our average oil price during the second quarter of 2014 was $83.62 per barrel, an 8% increase from $77.30 per barrel received during the same quarter of 2013.

A summary of the amount and percentage change, as compared to the respective prior-year period, for oil revenues, average oil prices, and oil production volumes for the quarters ended June 30, 2014 and 2013, is set forth in the following table:

For the Quarter Ended June 30, 2014 2013 Change Oil revenues $1,003,000$952,000 +5% Average price (per barrel) $83.62$77.30 +8% Production volumes (barrels) 11,997 12,315 -3%



Lease Operating Costs. Lease operating costs increased $338,000, or 40%, from the second quarter of 2013 to 2014. Poland operating costs increased approximately $233,000, or 78%, from quarter to quarter, with a portion of the increase attributable to new production at our Lisewo-1 and Komorze-3K wells, along with workover costs at our Komorze and Winna Gora wells. Operating costs and production taxes in the United States increased by approximately $105,000, or 19%, from 2013 to 2014 as we performed extensive workovers at our Montana properties, with a view to increasing production.

Exploration Costs. Our exploration costs consist of geological and geophysical costs and the costs of exploratory dry holes. Exploration costs were $3.6 million during the second quarter of 2014, compared to $4.0 million during the same period of 2013, a decrease of 11%. Second quarter 2014 exploration costs included approximately $2.9 million of dry-hole costs, primarily associated with our Szymanowice well, which was plugged during the quarter following an unsuccessful workover, and $700,000 associated with three-dimensional, or 3-D, and two-dimensional, or 2-D, seismic surveys at both our Fences and Edge project areas in Poland.

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Second quarter 2013 exploration costs included approximately $2.2 million of dry-hole costs, including $736,000 associated with our Mieczewo well, which was plugged at the end of the first quarter of the year, $1.3 million associated with the unsuccessful fracture stimulation of our Plawce-2 well, and $200,000 associated with a dry-hole drilled at the Dry Lake prospect in Nevada. In addition, we spent $1.8 million associated with 3-D and 2-D seismic surveys and other costs at our various project areas in Poland.

Property Impairments. During the second quarter of 2014, we recorded property impairment costs of $3.7 million, essentially all of which were prior-year costs associated with our Szymanowice well, which was plugged during the quarter following an unsuccessful sidetrack operation. During the second quarter of 2013, we recorded property impairment costs of $5.4 million. We impaired $4.7 million of prior-year costs associated with our Plawce-2 well, following its unsuccessful fracture stimulation. In addition, our Zaniemysl-3 well ceased production during the quarter, causing us to charge its remaining net book value of $366,000 to impairment expense. Finally, we recorded an impairment charge of $474,000 related to concession costs in our Northwest project area, where we determined to cease all exploration efforts.

DD&A Expense - Exploration and Production. DD&A expense for producing properties was $975,000 for the second quarter of 2014, an increase of 11%, compared to $875,000 during the same period of 2013. Higher DD&A expense in 2014 was due to increased depreciation expense at our Lisewo-1 and Komorze-3K, reflecting higher and new production in 2014.

Accretion Expense. Accretion expense was $23,000 and $22,000 for the second quarters of 2014 and 2013, respectively. Accretion expense is related entirely to our asset retirement obligation associated with expected future plugging and abandonment costs.

Oilfield Services Segment

Oilfield Services Revenues. Oilfield services revenues were $1.4 million during the second quarter of 2014, compared to $20,000 for the second quarter of 2013. During the second quarter of 2013, our drilling rig was largely inactive. During the second quarter of 2014, we drilled four wells for third parties. Oilfield services revenues will continue to fluctuate from period to period based on market demand, weather, the number of wells drilled, downtime for equipment repairs, the degree of emphasis on utilizing our oilfield servicing equipment on our Company-owned properties, and other factors.

Oilfield Services Costs. Oilfield services costs were $917,000 during the second quarter of 2014, compared to $116,000 during the same period of 2013. Oilfield services costs will also continue to fluctuate period to period based on market demand, weather, the number of wells drilled, downtime for equipment repairs, the degree of emphasis on utilizing our oilfield servicing equipment on our Company-owned properties, and other factors.

DD&A Expense - Oilfield Services. DD&A expense for oilfield services was $247,000 during the second quarter of 2014, compared to $238,000 during the same period of 2013. DD&A expense increased from quarter to quarter as new assets began to be depreciated.

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Nonsegmented Information

G&A Costs. G&A costs were $2.0 million during the second quarter of 2014, compared to $2.8 million during the second quarter of 2013. The decrease is primarily due to lower compensation costs. During the second quarter of 2013, compensation costs included the payment of incentive awards totaling approximately $852,000, of which approximately $500,000 related to 2008, which had been deferred until the Company met certain performance benchmarks. There were no incentive compensation payments made during the second quarter of 2014.

Stock Compensation (G&A). For the three-month periods ended June 30, 2014 and 2013, we recognized $687,000 and $693,000, respectively, of stock compensation expense related to the amortization of unexercised options and restricted stock.

Interest and Other Income (Expense). Interest and other income was $12,000 during the second quarter of 2014, a decrease of $244,000, compared to $256,000 during the same period of 2013. The decrease was due to the recognition of $204,000 in insurance proceeds during the second quarter of 2013, combined with lower cash balances available for investment. During the second quarter of 2014, we incurred $685,000 in interest expense, which included $128,000 of amortization of previously incurred loan fees and $61,000 in commitment fees. During the second quarter of 2013, we incurred $626,000 in interest expense, which included $127,000 of amortization of previously incurred loan fees and $74,000 in commitment fees.

Foreign Exchange Gain (Loss). During the second quarter of 2014, we recorded foreign currency transaction losses of approximately $720,000, principally attributable to increases in the amount of Polish zlotys necessary to satisfy outstanding intercompany dollar-denominated loans. We recorded foreign exchange losses of approximately $3.4 million during the same quarter of 2013, which were also principally related to our intercompany loans. Two factors contributed to the lower foreign exchange loss during the 2014 quarter. First, during 2013, we converted approximately $45 million of loans to FX Energy Poland from FX Energy, Inc., to equity. The conversion was necessary in order to make future interest payments from FX Energy Poland to FX Energy, Inc., tax deductible in Poland. Second, exchange-rate fluctuation from March 31 to June 30, 2014, of 1% was less than the exchange-rate fluctuation during the same period of 2013 of 2%. The lower amounts of intercompany loans outstanding and the decrease in exchange-rate volatility resulted in a lower foreign exchange impact in 2014 compared to 2013, a trend that is likely to continue for the balance of 2014.

Six Months Ended June 30, 2014, Compared to the Same Period of 2013

Exploration and Production Segment

Gas Revenues. Revenues from gas sales were $16.4 million during the first half of 2014, compared to $15.8 million during the same period of 2013. Higher natural gas prices offset a slight production decline to produce the higher revenues.

A summary of the amount and percentage change, as compared to the respective prior-year period, for gas revenues, average gas prices, and gas production volumes for the six months ended June 30, 2014 and 2013, is set forth in the following table: For the Six Months Ended June 30, 2014 2013 Change Revenues $16,387,000$15,777,000 +4% Average price (per thousand $7.49$7.08 +6% cubic feet) Production volumes (thousand 2,188,000 2,228,000 -2% cubic feet) 18



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Daily gas production for the first half of 2014 was 12.1 MMcfd, compared to 12.3 MMcfd during the same period of 2013. New and full period production from our Lisewo-1, Winna Gora, and Komorze-3K wells added 497,000 cubic feet of natural gas over 2013 first half levels. These increases helped offset production declines at our Zaniemysl-3 and Roszkow wells. In addition, production was stopped for 40 days at our Kromolice-1 well for some unexpected flow line repairs, now completed, which reduced our first half production by approximately 466,000 cubic feet per day.

Natural gas prices were higher during the 2014 first half. Two factors contributed to the increase in average prices. First, the Polish low-methane tariff, which serves as the reference price for our gas sales agreements, was 3.1% higher beginning in February of 2014. Second, period-to-period weakness in the U.S. dollar against the Polish zloty increased our dollar-denominated gas prices. The average exchange rate during the first half of 2014 was 3.05 zlotys per dollar. The average exchange rate during the first half of 2013 was 3.18 zlotys per dollar, a change of approximately 4%.

During the third quarter of 2014, our Kromolice-1, Sroda-4, and Kromolice-2 wells are scheduled to be shut-in for up to two weeks for annual maintenance and pressure testing, which will reduce our third-quarter and nine-month production and revenues.

Oil Revenues. Oil revenues were just over $1.9 million for the first half of 2014, a 4% increase from the oil revenues received during the first half of 2013. Production from our U.S. properties declined 1% during the first half of 2014, due to normal production declines. The decline in production was more than offset by higher oil prices received during the first half of 2014. Our average oil price during the first half of 2014 was $80.27 per barrel, a 4% increase from $76.89 per barrel received during the same period of 2013.

A summary of the amount and percentage change, as compared to the respective prior-year period, for oil revenues, average oil prices, and oil production volumes for the six months ended June 30, 2014 and 2013, is set forth in the following table:

For the Six Months Ended June 30, 2014 2013 Change Revenues $1,923,000$1,852,000 +4% Average price (per barrel) $80.27$76.89 +4% Production volumes (barrels) 23,962 24,087 -1%



Lease Operating Costs. Lease operating costs increased $572,000, or 33%, from the first half of 2013 to 2014. Poland operating costs increased approximately $289,000, or 46%, from year to year, with a portion of the increase attributable to new production at our Lisewo-1 and Komorze-3K wells, along with workover costs at our Komorze and Winna Gora wells. Operating costs and production taxes in the United States increased by approximately $283,000, or 26%, from 2013 to 2014 as we performed extensive workovers at our Montana properties, with a view to increasing production.

Exploration Costs. Our exploration costs consist of geological and geophysical costs and the costs of exploratory dry holes. Exploration costs were $6.9 million during the first half of 2014, compared to $10.2 million during the same period of 2013, a decrease of 32%. First half 2014 exploration costs included approximately $2.9 million of dry-hole costs, primarily associated with our Szymanowice well, which was plugged following an unsuccessful workover, and $4.0 million associated with 3-D and 2-D seismic surveys at both our Fences and Edge project areas in Poland.

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First half 2013 exploration costs included approximately $5.2 million of dry-hole costs, including approximately $3.7 million associated with our Mieczewo well, which was plugged at the end of the first quarter of the year, approximately $1.3 million associated with the unsuccessful fracture stimulation of our Plawce-2 well, and $200,000 associated with a dry hole drilled at the Dry Lake prospect in Nevada. In addition, we spent $5.0 million associated 3-D and 2-D seismic surveys and other costs at our various project areas in Poland.

Property Impairments. During the first half of 2014, we recorded property impairment costs of $3.7 million, essentially all of which were prior-year costs associated with our Szymanowice well, which was plugged during the first half following an unsuccessful sidetrack operation. During the first half of 2013, we recorded property impairment costs of $5.6 million. We impaired $4.7 million of prior-year costs associated with our Plawce-2 well following its unsuccessful fracture stimulation, along with approximately $200,000 of prior-year costs associated with our Mieczewo well. In addition, our Zaniemysl-3 well ceased production during the second quarter of 2013, causing us to charge its remaining net book value of $366,000 to impairment expense. Finally, we recorded an impairment charge of $474,000 related to concession costs in our Northwest project area, where we determined to cease all exploration efforts.

DD&A Expense - Exploration and Production. DD&A expense for producing properties was $2.1 million for the first half of 2014, compared to $1.9 million during the same period of 2013. Higher DD&A expense in 2014 was due to increased depreciation expense at our Lisewo-1 and Komorze-3K, reflecting higher and new production in 2014.

Accretion Expense. Accretion expense was $47,000 and $45,000 for the first half of 2014 and 2013, respectively. Accretion expense is related entirely to our asset retirement obligation.

Oilfield Services Segment

Oilfield Services Revenues. Oilfield services revenues were $1.4 million during the first half of 2014, compared to $62,000 for the first half of 2013. During the first half of 2013, we performed limited services for third parties. During the first half of 2014, we drilled four wells for third parties, along with additional well service work. Oilfield services revenues will continue to fluctuate from period to period based on market demand, weather, the number of wells drilled, downtime for equipment repairs, the degree of emphasis on utilizing our oilfield servicing equipment on our Company-owned properties, and other factors.

Oilfield Services Costs. Oilfield services costs were $1.0 million during the first half of 2014, compared to $248,000 during the same period of 2013. Oilfield services costs will also continue to fluctuate period to period based on market demand, weather, the number of wells drilled, downtime for equipment repairs, the degree of emphasis on utilizing our oilfield servicing equipment on our Company-owned properties, and other factors.

DD&A Expense - Oilfield Services. DD&A expense for oilfield services was $491,000 during the first half of 2014, compared to $476,000 during the same period of 2013. DD&A expense increased from quarter to quarter as new assets began to be depreciated.

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Nonsegmented Information

G&A Costs. G&A costs were $3.9 million during the first half of 2014, compared to $4.6 million during the first half of 2013, a decrease of $678,000. The decrease is primarily due to lower compensation costs. During the first half of 2013, compensation costs included the payment of incentive awards totaling approximately $852,000, of which approximately $500,000 related to 2008, which had been deferred until the Company met certain performance benchmarks. There were no incentive compensation payments made during the first half of 2014. We do not expect to make any further incentive payments related to our 2013 performance.

Stock Compensation (G&A). For the six-month periods ended June 30, 2014 and 2013, we recognized $1.4 million for both periods of stock compensation expense related to the amortization of unexercised options and restricted stock purchase rights.

Interest and Other Income (Expense). Interest and other income was $26,000 during the first half of 2014, a decrease of $282,000, compared to $308,000 during the same period of 2013. The decrease was due to the recognition of $204,000 in insurance proceeds during the first half of 2013 combined with lower cash balances available for investment. During the first half of 2014, we incurred $1.3 million in interest expense, which included $255,000 of amortization of previously incurred loan fees and $165,000 in commitment fees. During the first half of 2013, we incurred $1.3 million in interest expense, which included $257,000 of amortization of previously incurred loan fees and $154,000 in commitment fees.

Foreign Exchange Loss. As discussed in Note 10 to the financial statements, during the first half of 2014, we recorded foreign currency transaction losses of approximately $1.9 million, principally attributable to increases in the amount of Polish zlotys necessary to satisfy outstanding intercompany dollar-denominated loans and unpaid interest to FX Energy, Inc. During the first half of 2014, the U.S. dollar strengthened by approximately 1% against the Polish zloty from the beginning to the end of the period, which caused us to recognize foreign currency transaction losses. During the first half of 2013, the U.S. dollar strengthened by approximately 7% against the Polish zloty from the beginning to the end of the period, which caused us to recognize foreign currency transaction losses of $12.6 million. During 2013, we converted approximately $45 million of loans to FX Energy Poland from FX Energy, Inc., to equity. The conversion was necessary in order to make future interest payments from FX Energy Poland to FX Energy, Inc., tax deductible in Poland. The lower amounts of intercompany loans outstanding and the decrease in exchange-rate volatility resulted in a lower foreign exchange impact in 2014 compared to 2013, a trend that is likely to continue for the balance of 2014.

Liquidity and Capital Resources

For much of our history, we have financed our operations principally through the sale of equity securities, bank borrowings, and agreements with industry participants that funded our share of costs in certain exploratory activities in return for an interest in our properties. However, as our gas production and prices have increased in Poland in the last several years and as higher oil prices have improved the profitability of our U.S. production, our internally generated cash flow has become a significant source of operations financing.

2014 Liquidity and Capital

Working Capital (current assets less current liabilities). Our working capital was $10.4 million as of June 30, 2014, down from $11.3 million at December 31, 2013.

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Our current assets at June 30, 2014, included approximately $6.8 million in cash and cash equivalents, $5.1 million in accrued oil and gas sales from both the United States and Poland, and $2.6 million in receivables from our joint interest partners in both the United States and Poland. At June 30, 2014, $4.1 million of our cash and cash equivalents were held in Poland at ING Bank N.V. We have not historically repatriated, and do not plan in the foreseeable future to repatriate, any cash held in Poland to the United States. Consequently, we do not expect to incur repatriation taxes in the foreseeable future. Most of the joint interest receivables at June 30, 2014, was due from Polskie GÓrnictwo Naftowe i Gazownictwo, or PGNiG, all of which are related to joint projects in which we act as the operator. Our current liabilities at quarter-end included approximately $3.3 million payable by us for various drilling and development operations in Poland. Our total outstanding long-term debt at quarter-end was $50 million.

Operating Activities. Net cash provided by operating activities was $3.7 million during the first six months of 2014, compared to $4.2 million during the first six months of 2013.

Investing Activities. During the first six months of 2014, we used cash of $13.6 million in investing activities. We used $13.1 million for capital additions in Poland and $522,000 for capital additions in our office and drilling equipment. During the first six months of 2013, we used cash of $13.6 million in investing activities. We used $13.1 million for capital additions in Poland and $484,000 for capital additions in our office and drilling equipment.

Financing Activities. During the first half of 2014, we increased our outstanding debt by $5.0 million. We also sold 163,639 shares of common stock under our at-the-market agreement, in connection with our existing shelf registration. Net proceeds from the stock sale were approximately $615,000, after deducting associated costs of approximately $27,000. There were no financing transactions during the first half of 2013.

Our Capital Resources and Future Expenditures

Our anticipated sources of liquidity and capital for 2014 include our working capital of $10.4 million at June 30, 2014, available credit under our credit facility, and cash available from our operations.

In July 2014, we closed an underwritten public offering of 800,000 shares of our 9.25% Series B Cumulative Convertible Preferred Stock (the "Series B Preferred Stock") at a public offering price of 25.00 per share. The aggregate gross proceeds from the offering were $20 million, with net proceeds after deducting estimated underwriting discounts and commissions and offering expenses, of approximately $18.4 million. Cumulative dividends of 9.25%, or $1.9 million per year are payable out of funds legally available therefor. We intend to use funds available to accelerate exploration efforts in our Edge concession in Poland and for general corporate purposes, including declaring and paying dividends on our Series B Preferred Stock.

In July 2013, we finalized a new, five-year, up to $100 Million Senior Reserve Based Lending Facility with BNP Paribas (Suisse) SA and ING Bank N.V. The initial commitment of the facility amounts to $65 million. We can seek to increase the commitment up to $100 million under certain conditions via an embedded accordion mechanism. Initial proceeds from the facility were used to repay our previously existing facility. Payment of the credit facility is secured by our assets in Poland and guaranteed by us.

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The credit facility calls for a periodic interest rate of LIBOR, plus an interest margin of 3.75% for the first three years of the facility and 4.00% for the final two years. The facility has a term of five years, with semiannual borrowing base reductions of $13 million beginning on June 30, 2016. There are no financial covenants associated with the new credit facility. As of June 30, 2014, we had $50 million outstanding under the facility and $15 million of available credit.

We expect to generate cash from our operating activities as well to help fund our exploration and development activities in 2014. We expect that our 2014 production will approximate or be higher than our 2013 production with the addition of production at our Lisewo-2 and Komorze-3K wells. Production began at Komorze-3K in late February of 2014. Production is expected to begin at Lisewo-2 during the second half of 2014. We currently expect to receive 86% of the published low-methane tariff, adjusted for energy content, for each of the two new wells. The amount of revenue from this increased production will depend on applicable gas sales prices and prevailing currency exchange rates.

We have an effective Securities Act universal shelf registration statement under which we may sell up to $200 million of equity or debt securities of various kinds. As discussed above, we closed a $20 million preferred stock offering in July 2014, which was made under the shelf registration. Any additional stock issued to cover over-allotments will also be issued under the shelf registration.

In June 2012, we entered into an agreement to possibly sell up to $50 million in common stock in at-the-market transactions. During the first half of 2014, we sold approximately $0.7 million of common stock under that agreement. Currently, we have approximately $179.3 million of securities available for sale at any time under the registration statement, $49.3 million of which is covered by the at-the-market facility. Future issuances of stock under the shelf registration to finance our exploration and development plans in Poland and for other corporate purposes are subject to market conditions and our ability to access the capital markets.

At June 30, 2014, we were in the process of constructing pipeline and production facilities at our Lisewo-2 well. Total remaining costs for these facilities and the well once production begins and drilling is completed are expected to be approximately $1.0 million. We had no other firm commitments for future capital and exploration costs at June 30, 2014.

We expect our primary use of cash for 2014 will be for our exploration and development activities in Poland. Our board of directors has approved projects whose costs are expected to range from $50 million to $60 million for production facilities for existing discoveries, exploration and development wells, capital additions for our drilling rigs, and 2-D and 3-D seismic data acquisition and analysis, including those items noted above. All of the approved projects may not be completed during 2014, but we do expect to start work on all of them during 2014. In 2013, we approved a capital budget of similar size. Our actual costs in 2013 were approximately $50.0 million.

The actual amount of our expenditures will depend on ongoing exploration results; the pace at which PGNiG, our operating partner in the Fences project area, wishes to proceed or the extent it wishes to continue to participate with us in concessions we operate; the pace at which we explore our 100%-owned concessions following our recent discovery, the availability of drilling and other exploration services; and the amount of capital we obtain from the various sources discussed above. Our various sources of liquidity and capital outlined above should more than enable us to meet our capital needs in Poland and the United States for the next 12 months. We have the ability to control the timing and amount of most of our future capital and exploration costs.

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We may continue to incur operating losses in future periods, and we continue to fund substantial exploration and development in Poland. We have a history of operating losses. From our inception in January 1989 through June 30, 2014, we have incurred cumulative net losses of approximately $203 million. Despite our recent and expected future increases in production and revenues, our exploration and production activities may continue to result in net losses in future years, depending on the success of our drilling activities in Poland and the United States and whether we generate sufficient revenues to cover related operating expenses.

We may also seek to obtain additional funds for future capital investments from the sale of partial property interests or arrangements, such as those negotiated in prior years for our Kutno and Warsaw South project areas in which industry participants agreed to bear specified exploration costs to earn an interest in the project or other arrangements, all of which may dilute the interests of our existing stockholders or our interest in the specific project financed.

We will allocate our existing capital, as well as funds we may obtain in the future, among our various projects at our discretion. We may change the allocation of capital among the categories of anticipated expenditures depending upon future events. For example, we may change the allocation of our expenditures based on the actual results and costs of future exploration, appraisal, development, production, property acquisition, and other activities. In addition, we may have to change our anticipated expenditures if costs of placing any particular discovery into production are higher, if the field is smaller, or if the commencement of production takes longer than expected.

New Accounting Pronouncements

On May 28, 2014, the Financial Accounting Standards Board issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09 will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective on January 1, 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. We are evaluating the effect that ASU 2014-09 will have on our consolidated financial statements and related disclosures. We have not yet selected a transition method or determined the effect of the standard on our ongoing financial reporting.

We have reviewed all other recently issued, but not yet adopted, accounting standards in order to determine their effects, if any, on our consolidated results of operations, financial position, and cash flows. Based on that review, we believe that none of these pronouncements will have a significant effect on current or future earnings or operations.

Critical Accounting Policies

A summary of our significant accounting policies is included in Note 1 of our Consolidated Financial Statements contained in our annual report on Form 10-K for the year ended December 31, 2013. We believe the application of these accounting policies on a consistent basis enables us to provide financial statement users with useful, reliable, and timely information about our earnings results, financial condition, and cash flows.

The preparation of financial statements in accordance with GAAP requires our management to make judgments, estimates, and assumptions regarding uncertainties that affect the reported amounts presented and disclosed in the financial statements. Our management reviews these estimates and assumptions, which are based on historical experience, changes in business conditions, and other relevant factors that it believes to be reasonable under the circumstances. In any given reporting period, actual results could differ from the estimates and assumptions used in preparing our financial statements.

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Critical accounting policies are those that may have a material impact on our financial statements and also require management to exercise significant judgment due to a high degree of uncertainty at the time the estimate is made. Our senior management has discussed the development and selection of our accounting policies, related accounting estimates, and the disclosures set forth below with the Audit Committee of our board of directors. We believe our critical accounting policies include those addressing the recoverability and useful lives of assets, the retirement obligations associated with those assets, and the estimates of oil and gas reserves.

Forward-Looking Statements

This report contains statements about the future, sometimes referred to as "forward-looking" statements. Forward-looking statements are typically identified by the use of the words "believe," "may," "could," "should," "expect," "anticipate," "estimate," "project," "propose," "plan," "intend," and similar words and expressions. We intend that the forward-looking statements will be covered by the safe harbor provisions for forward-looking statements contained in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Statements that describe our future strategic plans, goals, or objectives are also forward-looking statements.

Readers of this report are cautioned that any forward-looking statements, including those regarding us or our management's current beliefs, expectations, anticipations, estimations, projections, proposals, plans, or intentions, are not guarantees of future performance or results of events and involve risks and uncertainties, such as the future timing and results of drilling individual wells and other exploration and development activities; future variations in well performance as compared to initial test data; future events that may result in the need for additional capital; the prices at which we may be able to sell oil or gas; fluctuations in prevailing prices for oil and gas; our ability to complete the acquisition of targeted new or expanded exploration or development prospects; uncertainties of certain terms to be determined in the future relating to our oil and gas interests, including exploitation fees, royalty rates, and other matters; future drilling and other exploration schedules and sequences for various wells and other activities; uncertainties regarding future political, economic, regulatory, fiscal, taxation, and other policies in Poland; the cost of additional capital that we may require and possible related restrictions on our future operating or financing flexibility; our future ability to attract strategic participants to share the costs of exploration, exploitation, development, and acquisition activities; and future plans and the financial and technical resources of strategic participants.

The forward-looking information is based on present circumstances and on our predictions respecting events that have not occurred, that may not occur, or that may occur with different consequences from those now assumed or anticipated. Actual events or results may differ materially from those discussed in the forward-looking statements as a result of various factors. The forward-looking statements included in this report are made only as of the date of this report. We disclaim any obligation to update any forward-looking statements whether as a result of new information, future events, or otherwise.


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