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.


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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.