Exhibit 10.3

SUPPLEMENT NO. 2  dated as of March 6, 2007 (the “Supplement”), to the Security
Agreement dated as of November 29, 2005 (as heretofore amended, supplemented or
otherwise modified from time to time, the “Security Agreement”), by and among
CANO PETROLEUM, INC., a Delaware corporation (“Borrower”), each subsidiary of
Borrower signatory thereto (together with the Borrower, the “Grantors” and
individually, a “Grantor”) and Union Bank of California, N.A. as Collateral
Trustee under the Collateral Trust Agreement (as hereinafter defined) for the
benefit of itself and the Secured Parties (as hereinafter defined).

A.            Reference is made to the following documents related to extension
of credit to the Borrower:

(i)            that certain Credit Agreement dated as of November 29, 2005 (as
heretofore and hereafter amended, restated or otherwise modified from time to
time, the “Senior Credit Agreement”) by and among the Borrower, the lenders
party thereto from time to time (the “Senior Lenders”), and Union Bank of
California, N.A., as administrative agent for such Senior Lenders (the “Senior
Agent”); and

(iii)          those Hedge Contracts (as defined in the Senior Credit Agreement)
that the Borrower, the Guarantors (as defined in the Senior Credit Agreement),
or any of their Subsidiaries may from time to time enter into one or more with a
Senior Lender or one of their Affiliates (a “Swap Counterparty”, and together
with the Collateral Trustee, the Senior Agent, the Issuing Lender and the Senior
Lenders, the “Secured Parties”).

B.            In connection with the Senior Credit Agreement, the Senior Agent,
the Senior Lenders, the Collateral Trustee, the Borrower, and other parties
thereto, have entered into that certain Collateral Trust and Intercreditor
Agreement dated as November 29, 2005 (as it may be amended, restated, or
otherwise modified from time to time, the “Collateral Trust Agreement”), to
among other things, appoint the Collateral Trustee as collateral trustee for all
of the Secured Parties under the security documents executed in connection with
the Credit Agreement, including the Security Agreement, and set forth the rights
and remedies of the Secured Parties with respect thereto.

C.            Capitalized terms used herein and not otherwise defined herein
shall have the meanings assigned to such terms in the Security Agreement and the
Senior Credit Agreement.

D.            The Grantors have entered into the Security Agreement in order to
induce the Senior Lenders and to make loans and the Issuing Lender to issue
letters of credit under the Senior Credit Agreement.  Pursuant to Section 6.15
of the Senior Credit Agreement, each Subsidiary of the Borrower that was not in
existence on the date of the Senior Credit Agreement is required to enter into
the Security Agreement as a Grantor upon becoming a Subsidiary.  Section 17(j)
of the Security Agreement provides that additional Subsidiaries of the Borrower
may become Grantors under the Security Agreement by execution and delivery of an
instrument in the form of this Supplement.  The undersigned Subsidiary of the
Borrower (the “New Grantor”) is executing this Supplement in accordance with the
requirements of the Senior Credit Agreement to become a Grantor under the
Security Agreement in order to induce the Senior Lenders to make additional
loans and the Issuing Lender to issue additional letters of credit and as
consideration for loans previously made and letters of credit previously issued.

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Accordingly, the Collateral Trustee and the New Grantor agree as follows:

SECTION 1.           In accordance with Section 17(j) of the Security Agreement,
the New Grantor by its signature below becomes a Grantor under the Security
Agreement with the same force and effect as if originally named therein as a
Grantor and the New Grantor hereby agrees (a) to all the terms and provisions of
the Security Agreement applicable to it as a Grantor thereunder and
(b) represents and warrants that the representations and warranties made by it
as a Grantor thereunder are true and correct on and as of the date hereof in all
material respects.  In furtherance of the foregoing, the New Grantor, as
security for the payment and performance in full of the Secured Obligations (as
defined in the Security Agreement), does hereby create and grant to the
Collateral Trustee, its successors and assigns, for the benefit of the Secured
Parties, their successors and assigns, a continuing security interest in and
lien on all of the New Grantor’s right, title and interest in and to the
Collateral (as defined in the Security Agreement) of the New Grantor.  Each
reference to a “Grantor” in the Security Agreement shall be deemed to include
the New Grantor.  The Security Agreement is hereby incorporated herein by
reference.

SECTION 2.           The New Grantor represents and warrants to the Collateral
Trustee and the other Secured Parties that this Supplement has been duly
authorized, executed and delivered by it and constitutes its legal, valid and
binding obligation, enforceable against it in accordance with its terms (subject
to applicable bankruptcy, reorganization, insolvency, moratorium or similar laws
affecting creditors’ rights generally and subject, as to enforceability, to
equitable principles of general application (regardless of whether enforcement
is sought in a proceeding in equity or at law)).

SECTION 3.           This Supplement may be executed in counterparts, each of
which shall constitute an original, but all of which when taken together shall
constitute a single contract.  This Supplement shall become effective when the
Collateral Trustee shall have received counterparts of this Supplement that,
when taken together, bear the signatures of the New Grantor and the Collateral
Trustee.  Delivery of an executed signature page to this Supplement by facsimile
transmission shall be as effective as delivery of a manually signed counterpart
of this Supplement.

SECTION 4.           The New Grantor hereby represents and warrants that set
forth on Schedule 1 attached hereto are (a) its sole jurisdiction of formation
and type of organization, (b) the location of all records concerning its
Accounts, General Intangibles, or any other Collateral, (c) its federal tax
identification number and the organizational number, and (d) all names used by
it during the last five years prior to the date of this Supplement.

SECTION 5.           Except as expressly supplemented hereby, the Security
Agreement shall remain in full force and effect.

SECTION 6.           THIS SUPPLEMENT SHALL BE GOVERNED BY AND CONSTRUED AND
ENFORCED IN ACCORDANCE WITH THE LAWS OF THE STATE OF TEXAS, EXCEPT TO THE EXTENT
THAT THE VALIDITY OR PERFECTION OF THE SECURITY INTERESTS HEREUNDER, OR REMEDIES
HEREUNDER, IN RESPECT OF ANY PARTICULAR PLEDGED COLLATERAL ARE GOVERNED BY THE
LAWS OF A JURISDICTION OTHER THAN THE STATE OF TEXAS.

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SECTION 7.           In case any one or more of the provisions contained in this
Supplement should be held invalid, illegal or unenforceable in any respect,
neither party hereto shall be required to comply with such provision for so long
as such provision is held to be invalid, illegal or unenforceable, but the
validity, legality and enforceability of the remaining provisions contained
herein and in the Security Agreement shall not in any way be affected or
impaired.  The parties hereto shall endeavor in good-faith negotiations to
replace the invalid, illegal or unenforceable provisions with valid provisions
the economic effect of which comes as close as possible to that of the invalid,
illegal or unenforceable provisions.

SECTION 8.           All communications and notices hereunder shall be in
writing and given as provided in the Security Agreement.  All communications and
notices hereunder to the New Grantor shall be given to it at the address set
forth under its signature hereto.

SECTION 9.           The New Grantor agrees to reimburse the Collateral Trustee
for its reasonable out-of-pocket expenses in connection with this Supplement,
including the reasonable fees, other charges and disbursements of counsel for
the Collateral Trustee.

THIS SUPPLEMENT, THE SECURITY AGREEMENT, THE COLLATERAL TRUST AGREEMENT AND THE
OTHER LOAN DOCUMENTS, REPRESENT THE FINAL AGREEMENT AMONG THE PARTIES AND MAY
NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL
AGREEMENTS OF THE PARTIES.

THERE ARE NO UNWRITTEN ORAL AGREEMENTS AMONG THE PARTIES HERETO.

[SIGNATURES BEGIN ON NEXT PAGE]

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IN WITNESS WHEREOF, the New Grantor and the Collateral Trustee have duly
executed this Supplement to the Security Agreement as of the day and year first
above written.

 

 

NEW GRANTOR:

 

 

 

 

CANO PETRO OF NEW MEXICO, INC.

 

 

 

 

By:

/s/ S. Jeffrey Johnson

 

 

 

Name:

 S. Jeffrey Johnson

 

 

 

Title:

 President

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Address of New Guarantor:

 

 

 

801 Cherry Street, Unit 25

 

 

 

Suite 3200

 

 

 

Fort Worth, Texas 76102

 

 

 

COLLATERAL TRUSTEE:

 

 

 

UNION BANK OF CALIFORNIA, N.A., as Administrative Agent

 

 

 

By:

/s/ Kimberly Coil

 

 

 

 

Kimberly Coil

 

 

 

 

Vice President

 

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Exhibit 10.3

Schedule 1

Supplement No. 2

to the Security Agreement

New Grantor:

 

Cano Petro of New Mexico, Inc.

Jurisdiction of Formation / Filing:

 

Texas

Type of Organization:

 

corporation

Address where records for

 

 

Collateral are kept:

 

801 Cherry Street, Unit 25
Suite 3200
Fort Worth, Texas 76102

Organizational Number:

 

TX 800782069

Federal Tax Identification Number:

 

 

Prior Names:

 

None.

 

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