Oil and Gas Properties

9 Months Ended

Sep. 30, 2011

4.	Oil and Gas Properties

As of September 30, 2011 and December 31, 2010, all of the Company's investments in oil and gas properties are divided into two cost pools; one pool that is subject to amortization because drilling activities have commenced and proven reserves have been identified, and one pool that is not subject to amortization because no proven reserves have been assigned to the properties. The two cost pools are further split into cost centers based on the geographical location of the properties included in the pools.

As of September 30, 2011 and December 31, 2010, the net costs included in the Company’s cost centers were as follows:

	September 30, 2011				December 31, 2010
	Amortizable		Non-Amortizable		Amortizable		Non-Amortizable
United States	$	2,832,004	$	2,155,206	$	-	$	2,820,301
Canada		2,162,063		-		965,848		-
Total	$	4,994,067	$	2,155,206	$	965,848	$	2,820,301

The Company has entered into participation agreements in a number exploratory oil and gas properties. Unproven exploratory prospects are excluded from its respective amortizable cost pool until such a time when proven reserves are identified. Each prospect’s costs are transferred into the amortization base on an ongoing (well by well or property by property) basis as the prospect is evaluated and proved reserves are established or impairment is determined.

Spyglass Property

During the period from February 1, 2010 through June 18, 2010, the Company acquired oil and gas leases covering approximately 6,239 net acres located in Divide County, North Dakota (the “Spyglass Property”). On June 18, 2010, the Company sold 50% of its interest in these oil and gas leases to Eternal Energy Corp. (“Eternal Energy”) and received, in exchange, a 50% working interest in approximately 4,480 acres located in southeastern Saskatchewan, Canada (the “Hardy Property”). The Company reclassified 50% of the then carrying value of its investment in the Spyglass Property to the Hardy Property at the time of the exchange. During the period from June 19, 2010 through May 27, 2011, the Company, along with its working interest partner, Eternal Energy, continued to acquire additional oil and gas leases within the Spyglass Property.

On May 27, 2011, the Company sold half of its working interest in the Spyglass Property to a third party. Because the Company’s interest in the Spyglass Property represented a significant portion of the full cost pool, not subject to amortization, the Company has allocated the total cost of the full cost pool, not subject to amortization, among the individual prospects included within the pool, based on their estimated relative fair market values as of the date that the sale occurred. Net cash consideration received by the Company from the sale totaled $3,823,963, of which, $46,710 was outstanding as of September 30, 2011. The allocated basis attributed to the portion of the Spyglass Property that was sold was $1,692,166, resulting in a gain of $2,131,704 on the transaction.

As of September 30, 2011, the Company still owns an undivided 25% working interest in approximately 185,500 gross acres (2,745 net acres) which is held by approximately 420 leases, with expiration dates ranging from February 2013 to August 2016.

The Company has elected to participate in the drilling of seven successful wells within the Spyglass Property. The Company’s working interests in these wells ranges from 0.17% to 14.25%. Because proven reserves were identified during the period, the Spyglass Property has been re-assigned to the full cost pool that is subject to amortization. The Spyglass Property is evaluated for impairment during each reporting period. There were no impairments evident as of September 30, 2011.

A summary of the Company’s working interest in the Spyglass wells and the status of each well as of September 30, 2011 is as follows:

Well Name	Operator	Working Interest	Actual or Anticipated Spud Date	Current Status
Wolter 13-9H-163N-100W	SM Energy Company	2.98%	June 26, 2011	Flowing approximately 600 BOPD
Riede 4-14H-163N-100W	SM Energy Company	0.17%	January 30, 2011	Flowing approximately 575 BOPD
Torgeson 1-15H-163N-100W	SM Energy Company	3.60%	March 6, 2011	Flowing approximately 510 BOPD
Bagley 4-30H-163N-100W	SM Energy Company	2.27%	April 3, 2011	Pumping approximately 400 BOPD
Legaard 4-25H-163N-101W	SM Energy Company	2.02%	July 19, 2011	Waiting to be fractured
Nomad 6-7-163N-99W	Samson Resources Company	14.25%	October 26, 2011	Drilling
Thomte 8-5-163N-99W	Samson Resources Company	1.59%	August 22, 2011	Waiting to be fractured

Hardy Property

As noted above, on June 18, 2010, the Company sold 50% of its working interest in the Spyglass Property to Eternal Energy in exchange for a 50% working interest in approximately 4,680 net acres located in Southeastern Saskatchewan, which included related equipment valued at approximately $238,681. At the time, the Hardy Property contained one existing oil well (the Hardy 7-9 well) that, at acquisition, was shut in due to mechanical issues. As a result, the Company reclassified $766,620 (half of the carrying value of its Spyglass Prospect at that time) to the newly acquired Hardy Property, which is part of the full cost pool that is subject to amortization. The Company and Eternal Energy have agreed that Eternal Energy will oversee all future exploration and operational activities associated with their shared acreage. The Company is obligated to pay 50% of the cost of any exploration or development costs incurred for wells in which it elects to participate.

During July 2010, Eternal Energy performed a workover and recompletion of the Hardy 7-9 well at an aggregate cost of $475,274. The Company’s portion of the recompletion cost was $237,637. The well was returned to production in September 2010. In January 2011, the Hardy 7-9 well was taken off of production due to a parted rod string. The well was returned to production in March 2011, after repairs were made to replace the parted rod string. However, the well was again shut in during May and June 2011 due to weather conditions in the area.

On May 2, 2011, the Company and its working interest partner, Eternal Energy, entered into a farm-out agreement with Passport Energy, whereby Passport agreed to fund 38.5% of the drilling, completion and equipping costs of up to two future wells located within the Hardy Property in exchange for a 25% working interest in the each well. The remaining working interest will be shared equally between the Company and Eternal Energy.

During May and June 2011, the Company, along with its working interest partners, drilled and completed an offset well within the Hardy Property (the “Hardy 4-16” well). The well was fracture stimulated in July 2011 and placed on production during September 2011.

The net capitalized cost of the Hardy Property as of September 30, 2011 and December 31, 2010 is summarized below:

	September 30,			December 31,
	2011			2010
Acquisition costs	$	785,652		$	785,652
Development costs		1,545,397			293,492
		2,331,049			1,079,444
Cumulative depletion		(168,986	)		(113,596	)
Net capitalized cost	$	2,162,063		$	965,848

Using the units-of-production method to calculate depletion expense associated with its producing properties, the Company recognized depletion expense totaling $26,908 and $55,390 for the three-month and nine-month periods ended September 30, 2011. The Company did not recognize any depletion expense during the comparable periods in 2010 because it had no producing wells at the time.

As of September 30, 2011, the Company owns a 50% working interest in approximately 4,680 gross acres (4,680 net acres). The acreage is secured by 6 leases, each of which is scheduled to expire on April 1, 2014.

Well Summary

The following table summarizes the Company’s wells and drilling activity for the three-month periods ended September 30, 2011 and 2010:

	2011				2010
	U.S.		Canada		U.S.		Canada
Exploratory wells:

Beginning of period		-		-		-		-
Purchased / acquired		-		-		-		-
Drilled		-		-		-		-
Abandoned		-		-		-		-
End of period		-		-		-		-

Development wells:

Beginning of period		4		2		-		-
Purchased / acquired		-		-		-		1
Drilled		3		-		-		-
Abandoned		-		-		-		-
End of period		7		2		-		1

The following table summarizes the Company’s wells and drilling activity for the nine-month periods ended September 30, 2011 and 2010:

	2011				2010
	U.S.		Canada		U.S.		Canada
Exploratory wells:

Beginning of period		-		-		-		-
Purchased / acquired		-		-		-		-
Drilled		-		-		-		-
Abandoned		-		-		-		-
End of period		-		-		-		-

Development wells:

Beginning of period		-		1		-		-
Purchased / acquired		-		-		-		1
Drilled		7		1		-		-
Abandoned		-		-		-		-
End of period		7		2		-		1

The Company did not drill any dry exploratory or developmental wells during the three-month and nine-month periods ended September 30, 2011 and 2010.

Exploratory Prospects

Glacier Prospect

In January 2011, the Company acquired an undivided 66.67% working interest in approximately 47,392 net acres located in Toole Country, Montana (the “Glacier Prospect”) for cash consideration of $1,195,624. Subsequently, the Company sold one-half of its working interest to FX Energy, Inc. (“FX Energy”) for $597,812, which represents 50% of the original purchase price.

As of September 30, 2011, the Company owns a 33% undivided working interest in approximately 63,630 gross acres (21,210 net acres) that is held by approximately 400 leases, with expiration dates ranging from May 2012 to June 2015.

Because no proven reserves have yet been identified, the Glacier Prospect has been assigned to the full cost pool that is not subject to amortization. Management is currently in the process of developing its exploration strategy relative to the Glacier Prospect. The Company is evaluating the results of nearby wells drilled by other companies in order to make a determination on the future of the Glacier Prospect. The Glacier Prospect is evaluated for impairment during each reporting period. There were no impairments evident as of September 30, 2011.

West Spyglass Prospect

In June, 2011, the Company began acquiring interests in oil and gas leases located in an area adjacent to the existing Spyglass Prospect. The Company’s management refers to the adjacent acreage as the West Spyglass Prospect.

As of September 30, 2011, the Company owns a 50% working interest in approximately 139,194 gross acres (3,993 net acres) located within the West Spyglass Prospect. The net acres are held by 82 leases, with expiration dates ranging from April 2014 to April 2016. The Company’s management is currently evaluating this prospect. No formal determination of the ultimate viability of this prospect is expected during the next twelve months. Management has reviewed the carrying value of this property and determined that no impairment exists as of September 30, 2011.

Musta Prospect

During December 2009 and January 2010, the Company incurred $10,995 of brokerage costs related to potential lease acquisitions, in Divide County, North Dakota (the “Musta Prospect”). The Company has not yet entered into any oil and gas leases within the Musta Prospect. As part of the reallocation of total costs included in the full cost pool, not subject to amortization, associated with the partial sale of the Company’s interest in the Spyglass Prospect, the estimated fair market value assigned to the Musta Prospect was zero. Management considers the Musta Prospect to be fully impaired as of September 30, 2011.

Mississippi and Texas Prospects

In January 2010, the Company entered into two assignment agreements with Murrayfield Limited, a United Kingdom company, pursuant to which the Company paid $150,000 in cash to acquire a 15% working interest in a contemplated well located in Wilkinson County, Mississippi (the “Mississippi Prospect”) and $137,500 in cash to acquire a 12.5% working interest in an oil and gas lease located in Willacy County, Texas (the “Texas Prospect”). In June 2010, the Company resold its interest in the Mississippi Prospect to the original seller. Net proceeds from the sale totaled $144,063, which represent the original purchase price of $150,000, less preliminary drilling costs incurred to date of $5,937.

To date, no drilling activities have occurred within the Texas Prospect nor are any drilling plans being considered in the near future. As part of the reallocation of total costs included in the full cost pool, not subject to amortization, associated with the partial sale of the Company’s interest in the Spyglass Prospect, the estimated fair market value assigned to the Texas Prospect was zero. Management considers the Texas Prospect to be fully impaired as of September 30, 2011.

Sidney North Prospect

In 2010, the Company acquired a 100% working interest in oil and gas leases on approximately 1,680 gross (399 net acres located in Richland County, Montana (the “Sidney North Prospect”) at an aggregate cost of $215,041. The acreage is held by approximately 13 leases, with expiration dates ranging from July 2013 to October 2015, ratably. The Company’s management is currently evaluating this prospect. No formal determination of the ultimate viability of this prospect is expected during the next twelve months. Management has reviewed the carrying value of this property and determined that no impairment exists as of September 30, 2011.

Oil and Gas Concepts Purchased with Stock Options

On December 30, 2010, the Company granted options to purchase 2,141,842 shares of its common stock to four individuals, two of which are the Company’s officers, in connection with their contribution of certain intellectual property related to exploratory opportunities and transactions to the Company. The intellectual property was initially assigned a value of $1,247,195, which equaled the value of the options granted as calculated using the Black-Scholes model. The value of the contributed oil and gas concepts has subsequently been reassessed in connection with the reallocation of total costs included in the full cost pool, not subject to amortization, associated with the partial sale of the Company’s interest in the Spyglass Prospect.

American Eagle Energy Inc. 10-Q