**Exhibit 99.3**

** **

**MANAGEMENT’S REPORT**

 

The consolidatedfinancial statements of Penn West Energy Trust were prepared by management inaccordance with accounting principles generally accepted in Canada. Inpreparing the consolidated financial statements, management has made estimatesbecause a precise determination of certain assets and liabilities is dependenton future events. The financial and operating information presented in thisreport is consistent with that shown in the consolidated financial statements.

 

Managementmaintains a system of internal controls to provide reasonable assurance thatall assets are safeguarded and to facilitate the preparation of relevant,reliable and timely financial records for the preparation of statements.

 

The consolidated financialstatements have been examined by the external auditors and approved by theBoard of Directors. The Board of Directors’ financial statement relatedresponsibilities are fulfilled through the Audit Committee. The Audit Committeeis composed entirely of independent directors. The Audit Committee recommendsappointment of the external auditors to the Board of Directors, ensures theirindependence, and approves their fees. The Audit Committee meets regularly withmanagement and the external auditors to discuss reporting and control issuesand to ensure each party is properly discharging its responsibilities. Theexternal auditors have full and unrestricted access to the Audit Committee todiscuss their audit and their related findings as to the integrity of thefinancial reporting process.

 

 
| [signed] “William  E. Andrew” |   | [signed] “Murray  R. Nunns” |   | [signed] “Todd  H.Takeyasu” |
|-----------------------------------------|--------|---------------------------------------|--------|---------------------------------------|
| William E.  Andrew                      |   | Murray R. Nunns                       |   | Todd H.Takeyasu                       |
| Chief Executive  Officer                |   | President and  COO                    |   | Executive Vice  President and CFO     |
|                                    |   |                                  |   |                                  |
| March 26,  2009                    |   |                                  |   |                                  |

 

1

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

 

**To the Unitholders of Penn West Energy Trust**

 

We have audited the consolidated balance sheets of Penn West Energy Trust****(“theTrust”) as at December 31, 2008 and 2007 and the consolidated statementsof operations and retained earnings and cash flows for the years then ended.These financial statements are the responsibility of the Trust’s management.Our responsibility is to express an opinion on these financial statements basedon our audits.

 

We conducted our audits in accordance with Canadian generally acceptedauditing standards and the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform anaudit to obtain reasonable assurance whether the financial statements are freeof material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation.

 

In our opinion, these consolidated financial statements present fairly, in all material respects,the financial position of the Trust as at December 31, 2008 and 2007 andthe results of its operations and its cash flows for the years then ended in accordance with Canadian generallyaccepted accounting principles.

 

We also have audited, in accordance with the standards of the PublicCompany Accounting Oversight Board (United States), the Trust’s internalcontrol over financial reporting as of December 31, 2008, based on the criteria established in InternalControl—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO), and our report dated March 26,2009 expressed an unqualified opinionon the effectiveness of the Trust’s internal control over financial reporting.

 

 

[signed] “KPMG LLP”

Chartered Accountants

Calgary, Canada

March 26, 2009

 

2

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

 

**To the Board of Directors of Penn West PetroleumLtd., the administrator of Penn West Energy Trust**

 

We have audited Penn West Energy Trust’s (“the Trust”) internal controlover financial reporting as of December 31, 2008, based on the criteria established in InternalControl—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). The Trust’s managementis responsible for maintaining effective internal control over financialreporting and for its assessment of the effectiveness of internal control overfinancial reporting, included in the accompanying management’s report. Ourresponsibility is to express an opinion on the Trust’s internal control overfinancial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of internalcontrol over financial reporting, assessing the risk that a material weaknessexists, and testing and evaluating the design and operating effectiveness ofinternal control based on the assessed risk. Our audit also included performingsuch other procedures as we considered necessary in the circumstances. Webelieve that our audit provides a reasonable basis for our opinion.

 

An entity’s internal control over financial reporting is a processdesigned to provide reasonable assurance regarding the reliability of financialreporting and the preparation of consolidated financial statements for externalpurposes in accordance with generally accepted accounting principles. An entity’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the entity; (2) provide reasonable assurancethat transactions are recorded as necessary to permit preparation ofconsolidated financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the entity arebeing made only in accordance with authorizations of management and directorsof the entity; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of theentity’s assets that could have a material effect on the consolidated financialstatements.

 

Because of its inherent limitations, internal control over financialreporting may not prevent or detect misstatements. Also, projections of anyevaluation of effectiveness to future periods are subject to the risk thatcontrols may become inadequate because of changes in conditions, or that thedegree of compliance with the policies or procedures may deteriorate.

 

In our opinion, the Trust maintained,in all material respects, effective internal control over financial reportingas of December 31, 2008, based on the criteria established in Internal Control—Integrated Framework issued bythe Committee of Sponsoring Organizations of the Treadway Commission (COSO).

 

We also have conducted our audits on the consolidated financial statements in accordancewith Canadian generally accepted auditing standards. With respect to the yearsended December 31, 2008 and 2007, we also have conducted our audits inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Our reportdated March 26, 2009**expressed an unqualified opinion on those**consolidated**financialstatements.

 

 

[signed] “KPMG LLP”

Chartered Accountants

Calgary, Canada

March 26, 2009

 

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**Penn West Energy Trust**

**Consolidated Balance Sheets**

 
| ** **                                                                                                | ** ** | **As at December 31** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| **(CAD millions)**                                                                                   | ** ** | **2008**                             | ** ** | **2007** | ** ** |
|                                                                                                      |       |                                 |       |   |   |
| **Assets**                                                                                                |       |                                 |       |   |   |
| Current                                                                                                   |       |                                 |       |   |   |
| Accounts  receivable (note 17)                                                                            | ** ** | **$**                                | **386**    |   | $ | 277 |   |
| Risk management  (note 13)                                                                                | ** ** | **448**                              |       | — |   |
| Other (note 17)                                                                                           | ** ** | **106**                              |       | 46 |   |
| Future income  taxes (note 9)                                                                             | ** ** | **—**                           |       | 45 |   |
| ** **                                                                                                |       | **940**                              |       | 368 |   |
| Property, plant  and equipment (note 4)                                                                   | ** ** | **12,452**                           |       | 7,413 |   |
| Goodwill (note  5)                                                                                        | ** ** | **2,020**                            |       | 652 |   |
| ** **                                                                                                |       | **14,472**                           |       | 8,065 |   |
| ** **                                                                                                |       | **$**                                | **15,412** |   | $ | 8,433 |   |
|                                                                                                      |       |                                 |       |   |   |
| **Liabilities  and unitholders’ equity**                                                             |       |                                 |       |   |   |
| Current                                                                                                   |       |                                 |       |   |   |
| Accounts payable  and accrued liabilities (note 17)                                                       | ** ** | **$**                                | **630**    |   | $ | 359 |   |
| Distributions  payable                                                                                    | ** ** | **132**                              |       | 82 |   |
| Risk management  (note 13)                                                                                | ** ** | **—**                           |       | 148 |   |
| Convertible  debentures (note 7)                                                                          | ** ** | **7**                                |       | — |   |
| Future income  taxes (note 9)                                                                             | ** ** | **132**                              |       | — |   |
| ** **                                                                                                |       | **901**                              |       | 589 |   |
| Long-term debt  (note 6)                                                                                  | ** ** | **3,854**                            |       | 1,943 |   |
| Convertible  debentures (note 7)                                                                          | ** ** | **289**                              |       | — |   |
| Risk management  (note 13)                                                                                | ** ** | **6**                                |       | — |   |
| Asset retirement  obligations (note 8)                                                                    | ** ** | **614**                              |       | 413 |   |
| Future income  taxes (note 9)                                                                             | ** ** | **1,368**                            |       | 918 |   |
| ** **                                                                                                |       | **7,032**                            |       | 3,863 |   |
| **Unitholders’  equity**                                                                             |       |                                 |       |   |   |
| Unitholders’  capital (note 10) (Units outstanding 2008 – 386,504,586, 2007 – 242,663,164) | ** ** | **7,976**                            |       | 3,877 |   |
| Contributed  surplus (note 10)                                                                            | ** ** | **75**                               |       | 35 |   |
| Retained  earnings                                                                                        | ** ** | **329**                              |       | 658 |   |
| ** **                                                                                                |       | **8,380**                            |       | 4,570 |   |
| ** **                                                                                                |       | **$**                                | **15,412** |   | $ | 8,433 |   |

 

Contractual obligations and commitments (note 15)

Subsequent events (note 20)

 

See accompanying notes to the audited consolidated financialstatements.

 

Approved on behalf of Penn West Energy Trust, by Penn West PetroleumLtd. as Administrator:

 

 
| [signed] “John A. Brussa” |   | [signed] “James C. Smith” |
|-------------------------------------|--------|-------------------------------------|
| John A. Brussa                      |   | James C. Smith                      |
| Chairman                            |   | Director                            |

 

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**Penn West Energy Trust**

**Consolidated Statements of Incomeand Retained Earnings**

** **
| ** **                                                           | ** ** | **Years ended December 31** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------|------------|
| **(CAD millions, except per unit amounts)** | ** ** | **2008**                                   | ** ** | **2007** | ** ** |
|                                                                 |       |                                       |       |   |   |
| **Revenues**                                                         |       |                                       | ** ** |   |   |
| Oil and natural  gas                                                 | ** ** | **$**                                      | **4,947**  | ** ** | $ | 2,459 |   |
| Royalties                                                            | ** ** | **(898**                                   | **)**      | (451 | ) |
| ** **                                                           |       | **4,049**                                  | ** ** | 2,008 |   |
|                                                                 |       |                                       | ** ** |   |   |
| Risk management  gain (loss) (note 13)                               |       |                                       | ** ** |   |   |
| Realized                                                             | ** ** | **(296**                                   | **)**      | 3 |   |
| Unrealized                                                           | ** ** | **660**                                    | ** ** | (182 | ) |
| ** **                                                           |       | **4,413**                                  |       | 1,829 |   |
| **Expenses**                                                         |       |                                       | ** ** |   |   |
| Operating (note  11)                                                 | ** ** | **865**                                    | ** ** | 518 |   |
| Transportation                                                       | ** ** | **34**                                     | ** ** | 24 |   |
| General and  administrative (note 11)                                | ** ** | **158**                                    | ** ** | 65 |   |
| Financing (note  6)                                                  | ** ** | **204**                                    | ** ** | 93 |   |
| Depletion,  depreciation and accretion                               | ** ** | **1,594**                                  | ** ** | 897 |   |
| Unrealized risk  management (gain) loss (note 13)                    | ** ** | **(1**                                     | **)**      | 20 |   |
| Unrealized  foreign exchange (gain) loss                             | ** ** | **203**                                    | ** ** | (38 | ) |
| ** **                                                           |       | **3,057**                                  |       | 1,579 |   |
| **Income  before taxes**                                             | ** ** | **1,356**                                  | ** ** | 250 |   |
|                                                                 |       |                                       | ** ** |   |   |
| **Taxes**                                                            |       |                                       | ** ** |   |   |
| Future income  tax expense (note 9)                                  | ** ** | **135**                                    | ** ** | 75 |   |
|                                                                 |       |                                       | ** ** |   |   |
| **Net and  comprehensive income**                                    | ** ** | **1,221**                                  | ** ** | 175 |   |
|                                                                 |       |                                       | ** ** |   |   |
| **Retained  earnings, beginning of year**                            | ** ** | **658**                                    | ** ** | 1,460 |   |
| Distributions  declared                                              | ** ** | **(1,550**                                 | **)**      | (977 | ) |
| **Retained  earnings, end of year**                                  | ** ** | **$**                                      | **329**    | ** ** | $ | 658 |   |
|                                                                 |       |                                       | ** ** |   |   |
| **Net  income per unit (note 14)**                                   |       |                                       | ** ** |   |   |
| Basic                                                                | ** ** | **$**                                      | **3.25**   | ** ** | $ | 0.73 |   |
| Diluted                                                              | ** ** | **$**                                      | **3.22**   | ** ** | $ | 0.73 |   |
| **Weighted  average units outstanding (millions)**                   |       |                                       | ** ** |   |   |
| Basic                                                                | ** ** | **375.6**                                  | ** ** | 239.4 |   |
| Diluted                                                              | ** ** | **382.9**                                  | ** ** | 241.5 |   |

 

See accompanying notes to the audited consolidated financialstatements.

 

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**Penn West Energy Trust**

**Consolidated Statements of CashFlows**

** **
| ** **                                        | ** ** | **Years ended December 31** | ** ** |
|---------------------------------------------------|------------|--------------------------------------------|------------|
| **(CAD millions)**                           | ** ** | **2008**                                   | ** ** | **2007** | ** ** |
|                                              |       |                                       | ** ** |   |   |
| **Operating  activities**                         |       |                                       | ** ** |   |   |
| Net income                                        | ** ** | **$**                                      | **1,221**  | ** ** | $ | 175 |   |
| Depletion,  depreciation and accretion            | ** ** | **1,594**                                  | ** ** | 897 |   |
| Future income  tax expense (note 9)               | ** ** | **135**                                    | ** ** | 75 |   |
| Unit-based  compensation (note 11)                | ** ** | **45**                                     | ** ** | 21 |   |
| Unrealized risk  management (gain) loss (note 13) | ** ** | **(661**                                   | **)**      | 202 |   |
| Unrealized  foreign exchange (gain) loss          | ** ** | **203**                                    | ** ** | (38 | ) |
| Asset retirement  expenditures                    | ** ** | **(85**                                    | **)**      | (52 | ) |
| Change in  non-cash working capital (note 16)     | ** ** | **(196**                                   | **)**      | (38 | ) |
| ** **                                        |       | **2,256**                                  | ** ** | 1,242 |   |
|                                              |       |                                       | ** ** |   |   |
| **Investing  activities**                         |       |                                       | ** ** |   |   |
| Acquisition of  property, plant and equipment     | ** ** | **(17**                                    | **)**      | (576 | ) |
| Disposition of  property, plant and equipment     | ** ** | **67**                                     | ** ** | 133 |   |
| Additions to  property, plant and equipment       | ** ** | **(1,095**                                 | **)**      | (697 | ) |
| Acquisition  costs (note 3)                       | ** ** | **(29**                                    | **)**      | — |   |
| Change in  non-cash working capital (note 16)     | ** ** | **25**                                     | ** ** | 15 |   |
| ** **                                        |       | **(1,049**                                 | **)**      | (1,125 | ) |
|                                              |       |                                       | ** ** |   |   |
| **Financing  activities**                         |       |                                       | ** ** |   |   |
| Proceeds from  issuance of notes (note 6)         | ** ** | **619**                                    | ** ** | 509 |   |
| Redemption /  maturity of convertible debentures  | ** ** | **(61**                                    | **)**      | — |   |
| Repayment of  Canetic, Vault and Endev facilities | ** ** | **(1,600**                                 | **)**      | — |   |
| Increase in bank  loan                            | ** ** | **1,089**                                  | ** ** | 187 |   |
| Issue of equity                                   | ** ** | **59**                                     | ** ** | 32 |   |
| Distributions  paid                               | ** ** | **(1,313**                                 | **)**      | (845 | ) |
| ** **                                        |       | **(1,207**                                 | **)**      | (117 | ) |
|                                              |       |                                       | ** ** |   |   |
| **Change  in cash**                               | ** ** | **—**                                 | ** ** | — |   |
| **Cash,  beginning of year**                      | ** ** | **—**                                 | ** ** | — |   |
| **Cash,  end of year**                            | ** ** | **$**                                      | **—** | ** ** | $ | — |   |
|                                              |       |                                       | ** ** |   |   |
| Interest paid                                     | ** ** | **$**                                      | **200**    | ** ** | $ | 95 |   |
| Income taxes  paid (recovered)                    | ** ** | **$**                                      | **5**      | ** ** | $ | (2 | ) |

 

See accompanying notes to the audited consolidated financialstatements.

 

6

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**Penn West Energy Trust**

**Notesto the Consolidated Financial Statements**

** **

*(All tabular amounts are in millionsexcept numbers of units, per unit amounts, percentages and various figures inNote 13)*

* *

**1. Structure of Penn West**

** **

Penn West Energy Trust (“Penn West” or the “Trust”) is an open-ended,unincorporated investment trust governed by the laws of the Province ofAlberta, Canada. The business of Penn West is to indirectly explore for,develop and hold interests in petroleum and natural gas properties throughinvestments in securities of subsidiaries and royalty interests in oil andnatural gas properties. Penn West owns 100 percent of the equity, directly orindirectly, of the entities that carry on the oil and natural gas business ofPenn West. The activities of these entities are financed through interest-bearingnotes from Penn West and third-party debt as described in the notes to theaudited consolidated financial statements.

 

Pursuant to the terms of net profit interest agreements (the “NPIs”),Penn West is entitled to payments from certain subsidiary entities equal toessentially all of the proceeds of the sale of oil and natural gas productionless certain deductions. Under the terms of the NPIs, the deductions, which arein part discretionary, include the requirement to fund capital expenditures andasset acquisitions and are subject to certain adjustments for assetdispositions.

 

Under the terms of its current trust indenture, Penn West is requiredto make distributions to unitholders in amounts at least equal to its taxableincome consisting of interest on notes, the NPIs, and any inter-corporatedistributions and dividends received, less certain expenses and deductions.

 

On June 2, 2005, the trust units commenced trading on the TSXunder the symbol “PWT.UN”. On June 22, 2006, the trust units commencedtrading on the NYSE under the symbol “PWE”.

 

**2. Significant accountingpolicies**

** **

The consolidated financial statements have been prepared in accordancewith Canadian generally accepted accounting principles (“GAAP”).

 

**a) Principles of consolidation**

 

The consolidated financial statements include the accounts of Penn Westand all its wholly owned subsidiaries and partnerships. Results fromacquisitions are included in Penn West’s reported results from the date ofclose.

 

**b) Other current assets**

 

Other current assets include deposits, prepayments and inventory.Inventories are valued at the lower of cost and net realizable value.

 

**c) Property, plant and equipment**

 

**i)Capitalized costs**

The full cost method ofaccounting for oil and natural gas operations is followed, whereby all costs ofacquiring, exploring for and developing oil and natural gas reserves arecapitalized. These costs include lease acquisition, geological and geophysical,exploration and development and related equipment costs. Proceeds from thedisposition of oil and natural gas properties are accounted for as a reductionof capitalized costs, with no gain or loss recognized unless such dispositionresults in a 20 percent or more change in the depletion and depreciation rate.

 

7

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**ii)  Depletion and depreciation**

Depletion anddepreciation of resource properties is calculated using the unit-of-productionmethod based on production volumes before royalties in relation to total provedreserves as estimated or audited by independent petroleum engineers. Naturalgas volumes are converted to equivalent oil volumes based upon the relativeenergy content of six thousand cubic feet of natural gas to one barrel of oil.In determining its depletion base, the Trust includes estimated future costs tobe incurred in developing proved reserves and excludes estimated equipmentsalvage values and the lower of cost and market of unevaluated properties.Significant natural gas processing facilities, net of estimated salvage values,are depreciated using the declining balance method over the estimated usefullives of the facilities.

 

**iii)Ceiling test**

The recoverability ofaccumulated costs in a cost centre is assessed based on undiscounted futurecash flows from proved reserves, using forecast prices, and the cost ofunproved properties. If accumulated costs are assessed to be not fullyrecoverable, the cost centre is written down to its fair value estimated as thepresent value of expected future cash flows, using forecast prices, from provedand probable reserves and the cost of unproved properties. Expected future cashflows are discounted at the Trust’s estimated risk free rate.

 

**iv) Assetretirement obligations**

The fair value of legalobligations for property abandonment and site restoration is recognized as aliability on the balance sheet as incurred with a corresponding increase to thecarrying amount of the related asset. The recorded liability increases overtime to its future amount through accretion charges included in depletion,depreciation and accretion. Revisions to the estimated amount or timing of theobligations are reflected as increases or decreases to the recorded liability.Actual asset retirement expenditures, up to the recorded liability at the time,are charged to the liability. Amounts capitalized to the related assets areamortized to income consistent with the depletion or depreciation of theunderlying asset.

 

The estimates in ii) andiii) and iv) are based on volumes and reserves calculated based on forecastsales prices, costs and regulations expected at the end of the fiscal year(except for significant natural gas processing facilities).

 

**d) Joint operations**

 

Some of the Trust’s exploration and development activities areconducted jointly with others. The accounts reflect only the Trust’sproportionate interest in such activities.

 

**e) Financial instruments**

 

The Trust has policies and procedures in place with respect to therequired documentation and approvals for the use of derivative financialinstruments and their use is limited to mitigating market price risk associatedwith expected cash flows.

 

Financial instruments are measured at fair value on the balance sheetupon initial recognition of the instrument. Measurement in subsequent years dependson whether the financial instrument has been classified in one of the followingcategories: held-for-trading, available-for-sale, held-to-maturity, loans andreceivables, or other financial instruments.

 

Subsequent measurement and changes in fair value will depend on initialclassification, as follows: held-for-trading financial assets are measured atfair value and changes in fair value are recognized in net income;available-for-sale financial instruments are measured at fair value withchanges in fair value recorded in Other Comprehensive Income (“OCI”) until theinstrument or a portion thereof is derecognized or impaired at which time theamounts would be recorded in net income; and held to maturity financial assets,loans and receivables and other financial liabilities are measured at amortizedcost. The Trust currently has no items requiring separate disclosure as OCI.

 

8

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Cash and cash equivalents are designated as held-for-trading and aremeasured at carrying value, which approximates fair value due to the short-termnature of these instruments. Accounts receivable and accrued revenues aredesignated as loans and receivables. Accounts payable and accrued liabilities,distributions payable, convertible debentures and long-term debt are designatedas other financial liabilities. All risk management assets and liabilities arederivative financial instruments designated as held-for-trading.

 

**f) Enhanced oil recovery**

 

The value of proprietary injectants is not recognized as revenue untilreproduced and sold to third parties. The cost of injectants purchased fromthird parties for miscible flood projects is included in property, plant andequipment. These injectant costs are amortized as depletion and depreciationover the period of expected future economic benefit on a unit-of-productionbasis. Costs associated with the production of proprietary injectants areexpensed.

 

**g) Foreign currency translation**

 

Monetary items, such as receivables and long-term debt, are translatedto Canadian dollars at the rate of exchange in effect at the balance sheetdate. Non-monetary items, such as property, plant and equipment, are translatedto Canadian dollars at the rate of exchange in effect when the transactionoccurred. Revenues and expenses denominated in foreign currencies aretranslated at the average exchange rate in effect during the period. Foreignexchange gains or losses on translation are included in income.

 

**h) Unit-based compensation**

 

The Trust has a Trust Unit Rights Incentive Plan, as outlined in note11. Compensation expense for the plan is based on the fair value of rightsgranted, amortized over the remaining vesting periods on a straight-line basis.A Binomial Lattice option-pricing model is used to determine the fair value ofrights when granted. Costs in respect of the Employee Retirement Savings Planare expensed as incurred.

 

**i) Revenue recognition**

 

Revenues from the sale of crude oil, natural gas liquids and naturalgas are recognized when title passes from Penn West Petroleum Ltd. (“theCompany”) to the purchaser.

 

**j) Income taxes**

 

Penn West uses the asset and liability method of accounting for futureincome taxes. Temporary differences are calculated assuming that the financialassets and liabilities will be settled at their carrying amount. Future incometaxes are computed on temporary differences using substantively enacted incometax rates expected to apply when future income tax assets and liabilities arerealized or settled. Penn West is taxable on income in excess of distributionsto unitholders.

 

9

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**k) Goodwill**

 

Goodwill is recorded on a business combination when the total purchaseconsideration exceeds the fair value of the net identifiable assets andliabilities of the acquired entity. Goodwill is not amortized and the balanceis assessed for impairment on an annual basis, at December 31, or morefrequently if circumstances arise that indicates impairment may have occurred.If impairment exists, the impairment amount is charged to income and isconsidered to be non-deductible for future income tax purposes.

 

The impairment test consists of two steps. First, the fair value of theTrust is compared to the carrying amount, including goodwill, to identify apotential impairment. If the fair value is greater than the carrying amount,goodwill is considered not impaired and the second step is not required. Whenthe carrying amount exceeds the fair value, the second step requires theimplied fair value of the goodwill to be compared to its carrying amount. Theimplied fair value of goodwill is computed by assigning fair values to theidentifiable assets and liabilities of the Trust as if it had been acquired ina business combination. If the carrying amount of goodwill exceeds its impliedfair value, an impairment loss equal to the excess is recognized in the period.

 

**l) Measurement uncertainty**

 

The preparation of financial statements in conformity with generallyaccepted accounting principles requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities and disclosureof any contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses for the period.Actual results may differ materially from those estimates.

 

Significant estimates are included in the determination of theprovisions for depletion and depreciation of petroleum and natural gas assetsand the asset retirement liability and the accretion thereof. Depletion and theceiling test are based on estimates of reserves, which by their nature includeestimates of future production rates, oil and gas prices and costs, as well asother assumptions. These and other estimates are subject to measurementuncertainty and the effect on the financial statements of changes in theseestimates could be material.

 

**m) Transportation expense**

 

Transportationrelates to costs paid by the Trust for the shipping of natural gas, crude oiland NGLs from the wellhead to the point of title transfer. These costs arerecognized when the transportation is provided.

 

**n) Per unitcalculations**

 

Penn West followsthe treasury stock method to compute the dilutive impact of unit rights. Thetreasury stock method assumes that the proceeds received from the pro formaexercise of in-the-money trust unit rights are used to purchase trust units ataverage market prices.

 

Penn West followsthe “if converted” method to compute the dilutive impact of the convertibledebentures which assumes the outstanding debentures have been converted at thelater of the beginning of the period or issuance.

 

**o) Embedded derivatives**

 

An embedded derivative is a component of a contract that affects theterms in relation to another factor, for example rent costs that fluctuate withoil prices. These “hybrid” contracts are considered to consist of a “host” contractplus an embedded derivative. The embedded derivative is separated from the hostcontract and accounted for as a derivative only if certain conditions are met.These include:

 

10

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·                  the economiccharacteristics and risks of the embedded derivative are not closely related tothe economic characteristics and risks of the host contract,

·                  if the embeddedderivative separated meets the definition of a derivative,

·                  the hybridcontract is not measured at fair value or designated as held for trading.

 

The Trust currently has no material embedded derivatives.

 

**p)Comprehensive income**

 

Comprehensiveincome is defined as the change in equity from transactions and other eventsfrom non-owner sources and consists of net income and OCI. OCI refers to itemsrecognized in comprehensive income that are excluded from net income calculatedin accordance with generally accepted accounting principles. The Trustcurrently has no items requiring separate disclosure as OCI on a statement ofComprehensive Income.

 

**q)Transaction costs**

 

Transaction costsare capitalized when related to acquisitions and divestiture activities andcharged to net income as incurred for financing transactions.

 

**Changesin accounting policies**

 

Effective January 1, 2008, the Trust adopted the new Canadianaccounting standards “Capital Disclosures”, “Financial Instruments —Disclosures” and “Financial Instruments — Presentation”. The adoption of thesestandards had no material impact on the Trust’s net income or cash flow fromoperating activities.

 

Capital Disclosures

 

This section outlines disclosures relating to the management of anentity’s capital and additional qualitative and quantitative information on theobjectives, policies and processes over capital. Refer to note 18 fordiscussion.

 

Financial Instruments - Disclosures / Presentation

 

These sections outline more comprehensive disclosures with regard torisks related to financial instruments, the significance of financial instrumentson an entity’s financial position and performance, and the classification offinancial instruments. Refer to note 13 for discussion.

 

**FutureAccounting Pronouncements**

 

In December 2008,the CICA issued new accounting standards for “Business Combinations”, “Non-Controllinginterests” and “Consolidated Financial Statements”. The “Business Combinations”standard outlines new guidance which states that the purchase price is to bebased on trading data at the closing date of the acquisition and not theannouncement date of the acquisition as under previous guidance. In addition,most acquisition costs are to be expensed as incurred. These standards becomeeffective on January 1, 2011 and early adoption is permitted. Thesestandards will require the Trust to change its accounting policies for any newbusiness combinations subsequent to January 1, 2011.

 

In February 2008, the CICA issued a new accounting standard for “Goodwilland Intangible Assets”. This standard outlines guidelines for the recognition,measurement, presentation and disclosure of goodwill and intangible assetssubsequent to their initial recognition. This new standard becomes effective January 1,2009. The implementation of this section is expected to have no impact on theTrust’s financial statements.

 

11

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In January 2006, the Canadian Accounting Standards Board (the “AcSB”)announced its decision to replace Canadian GAAP with International FinancialReporting Standards (“IFRS”) for all Canadian Publicly Accountable Enterprises(“PAEs”), including Penn West. On February 13, 2008, the AcSBconfirmed January 1, 2011 as the changeover date for PAEs to commencereporting under IFRS. Although IFRS is principles-based and uses aconceptual framework similar to Canadian GAAP, there are significantdifferences and choices in accounting policies, as well as increased disclosurerequirements under IFRS.

 

We are currently assessing the impact of the conversion from CanadianGAAP to IFRS on our results of operations, financial position and disclosures.A project team and steering committee have been set up to manage thistransition and to ensure successful implementation within the requiredtimeframe. Employees involved in the project have attended a number of trainingcourses and education sessions. Additionally, an external advisor has beenengaged to assist with the implementation.

 

Communication is ongoing with many areas of the organization andregular updates are provided to senior management and the Audit Committee.Based on work completed to date, the accounting differences that will lead tothe largest changes include property, plant and equipment and businesscombinations. We will provide disclosures of the key elements of our plan andprogress on the project as the information becomes available during thetransition period.

 

**3. Business combinations**

 

Reported results of operations, funds flow and net income include theacquisitions of Canetic Resources Trust (“Canetic”) from the closing date of January 11,2008, Vault Energy Trust (“Vault”) from the closing date of January 10,2008 and Endev Energy Inc. (“Endev”) from the closing date of July 22,2008.

 

**Canetic Acquisition**

 

On January 11, 2008, Penn West closed its acquisition of Caneticfor a total acquisition cost of approximately $3.6 billion, funded through theissuance of approximately 124.3 million trust units, calculated based on thevolume weighted average trading price of the units around the date of theannouncement, discounted by five percent to reflect normal equity issuancecosts. The acquisition by Penn West was accounted for using the purchasemethod. The allocation of the consideration paid to the fair value of theidentifiable assets and liabilities was as follows:

 
| **Purchase price**                     | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|------------|------------|
| 124.3 million  Penn West trust units issued |       | $          | 3,573      |   |
| Transaction  costs                          |       | 22         |       |
|                                        |       | $          | 3,595      |   |

 
| **Allocation of purchase price** | ** ** | ** ** | ** ** |
|-------------------------------------------------|------------|------------|------------|
| Property, plant  and equipment                  |       | $          | 4,979      |   |
| Goodwill                                        |       | 1,348      |       |
| Working capital  deficiency                     |       | (274       | )          |
| Bank debt                                       |       | (1,443     | )          |
| Convertible  debentures                         |       | (261       | )          |
| Risk management  liability                      |       | (65        | )          |
| Future income  taxes                            |       | (511       | )          |
| Asset retirement  obligations                   |       | (178       | )          |
|                                            |       | $          | 3,595      |   |

 

12

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**Vault Acquisition**

 

On January 10, 2008, Penn West closed its acquisition of Vault fora total acquisition cost of approximately $164 million funded through theissuance of approximately 5.6 million trust units. The trust unit value wascalculated based on the volume weighted average trading price of the unitsaround the date of the announcement, discounted by five percent to reflectnormal equity issuance costs. The acquisition by Penn West was accounted forusing the purchase method. The allocation of the consideration paid to the fairvalue of the identifiable assets and liabilities was as follows:

 
| **Purchase price**                   | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|------------|------------|
| 5.6 million Penn  West trust units issued |       | $          | 158        |   |
| Transaction  costs                        |       | 6          |       |
|                                      |       | $          | 164        |   |

 
| **Allocation of purchase price** | ** ** | ** ** | ** ** |
|-------------------------------------------------|------------|------------|------------|
| Property, plant  and equipment                  |       | $          | 346        |   |
| Goodwill                                        |       | 20         |       |
| Working capital                                 |       | 2          |       |
| Future income  taxes                            |       | 47         |       |
| Bank debt                                       |       | (114       | )          |
| Convertible  debentures                         |       | (99        | )          |
| Risk management  liability                      |       | (2         | )          |
| Asset retirement  obligations                   |       | (36        | )          |
|                                            |       | $          | 164        |   |

 

**Endev Acquisition**

 

On July 22, 2008, the acquisitionof Endev was successfully completed. As a result of the acquisition, Penn Westissued approximately 3.6 milliontrust units for a total consideration of $115 million and assumed approximately$45 million of debt and working capital. The acquisition was accomplished through aPlan of Arrangement wherein Endev shareholders received 0.041 of a Penn Westtrust unit for each Endev share.

 

**4. Property, plant andequipment**

 
| ** **                                                                     | ** ** | **As at December 31** | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                     | ** ** | **2008**                             | ** ** | **2007** | ** ** |
| Oil and natural  gas properties, including production and processing equipment | ** ** | **$**                                | **17,520** | ** ** | $ | 10,925 |   |
| Accumulated  depletion and depreciation                                        | ** ** | **(5,068**                           | **)**      | (3,512 | ) |
| Net book value                                                                 | ** ** | **$**                                | **12,452** | ** ** | $ | 7,413 |   |

 

Other than Penn West’s net share of capital overhead recoveries, nogeneral and administrative expenses are capitalized. In 2008, additions toproperty, plant and equipment included a $25 million (2007 - $97 million)increase related to additions to asset retirement obligations; and an $11million (2007 - $5 million) addition for future income taxes recorded on minorproperty acquisitions. The lower of cost and market of unevaluated propertyexcluded from the depletion base as at December 31, 2008 was $490 million(December 31, 2007 - $303 million). The depletion and depreciationcalculation includes future capital costs to develop proved reserves of $1,120million (2007 - $729 million).

 

13

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An impairment test was performed on the costs capitalized to oil andnatural gas properties at December 31, 2008 and 2007. The estimatedundiscounted future net cash flows from proved reserves, using forecast prices,was in excess of the carrying amount of the oil and natural gas propertyinterests less the cost of unproved properties.

 

The following table outlines benchmark prices used in the impairmenttest:

 
| ** **                         | ** ** | **WTI ($US/ bbl)** | ** ** | **AECO ($CAD/mcf)** | ** ** | **Exchange rate ($US  equals $1 CAD)** | ** ** |
|------------------------------------|------------|------------------------------|------------|--------------------------|------------|------------------------------------------------------------|------------|
| 2009                               |       | $                            | 55.62      |                     | $          | 7.20                                                       |       | 0.81 |   |
| 2010                               |       | 65.71                        |       | 7.75                     |       | 0.85                                                       |       |
| 2011                               |       | 71.76                        |       | 8.09                     |       | 0.86                                                       |       |
| 2012                               |       | 82.30                        |       | 8.54                     |       | 0.91                                                       |       |
| 2013 – 2018                   |       | $                            | 96.74      |                     | $          | 9.59                                                       |       | 0.95 |   |
| Thereafter  (inflation percentage) |       | 2.0                          |       | 2.0                      |       | —                                                     |       |

 

**5. Goodwill**

 
| ** **                  | ** ** | **Year ended December 31** | ** ** |
|-----------------------------|------------|-------------------------------------------|------------|
| ** **                  | ** ** | **2008**                                  | ** ** | **2007** | ** ** |
| Balance,  beginning of year | ** ** | **$**                                     | **652**    |   | $ | 652 |   |
| Canetic  acquisition        | ** ** | **1,348**                                 |       | — |   |
| Vault  acquisition          | ** ** | **20**                                    |       | — |   |
| Balance, end of  year       | ** ** | **$**                                     | **2,020**  |   | $ | 652 |   |

 

The goodwill impairment test consists of two parts. Under part 1, ifthe fair value of the reporting entity is less than its book value, part 2 ofthe test must be performed. Asat December 31, 2008, due to the widespread decline in equity markets,Penn West proceeded to part 2 of the test where a reporting entity is requiredto calculate a purchase equation on its assets and liabilities at fair value onthe balance sheet date. Under part 2, an equity control premium of 20 percentwas used and the fair value of property, plant and equipment was estimatedusing forward strip commodity prices at year-end escalated at two percent peryear subsequent to the end of available market data and a discount rate of 15percent. Penn West determined there was no goodwill impairment at December 31,2008 and 2007. Further declines in the equity markets since December 31,2008, increase the potential of an impairment charge in the future.

 

14

----

 

**6. Long-term debt**

 
| ** **                                                | ** ** | **As at December 31** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                | ** ** | **2008**                             | ** ** | **2007** | ** ** |
| Bankers’  acceptances and prime rate loans           | ** ** | **$**                                | **2,561**  |   | $ | 1,472 |   |
|                                                      |       |                                 |       |   |   |
| U.S. Senior  unsecured notes – 2007 Notes            |       |                                 |       |   |   |
| 5.68%, US$160  million, maturing May 31, 2015        | ** ** | **195**                              |       | 158 |   |
| 5.80%, US$155  million, maturing May 31, 2017        | ** ** | **189**                              |       | 154 |   |
| 5.90%, US$140  million, maturing May 31, 2019        | ** ** | **170**                              |       | 139 |   |
| 6.05%, US$20  million, maturing May 31, 2022         | ** ** | **24**                               |       | 20 |   |
|                                                      |       |                                 |       |   |   |
| U.S. Senior  unsecured notes – 2008 Notes            |       |                                 |       |   |   |
| 6.12%, US$153  million, maturing May 29, 2016        | ** ** | **186**                              |       | — |   |
| 6.16%, CAD$30  million, maturing May 29, 2018        | ** ** | **30**                               |       | — |   |
| 6.30%, US$278  million, maturing May 29, 2018        | ** ** | **339**                              |       | — |   |
| 6.40%, US$49  million, maturing May 29, 2020         | ** ** | **59**                               |       | — |   |
|                                                      |       |                                 |       |   |   |
| UK Senior  unsecured notes – UK Notes                |       |                                 |       |   |   |
| 6.95%, £57  million, maturing July 31, 2018 (1) | ** ** | **101**                              |       | — |   |
| Total long-term  debt                                     | ** ** | **$**                                | **3,854**  |   | $ | 1,943 |   |

 

----

(1) Initial interest rate was 7.78 percent, however, contractswere entered into which fixed the interest rate at 6.95 percent.

 

At December 31, 2008, Penn West Petroleum Ltd. (the “Company”) hadan unsecured, revolving, syndicated bank facility with an aggregate borrowinglimit of $4.0 billion which must be renewed prior to January 11, 2011. Thefacility consists of two revolving tranches; tranche one of the facility is$3.25 billion and extendible and tranche two is $750 million andnon-extendible. The credit facility contains provisions for stamping fees onbankers’ acceptances and LIBOR loans and standby fees on unutilized creditlines that vary depending on certain consolidated financial ratios. As at December 31,2008, approximately $1.4 billion of unused credit capacity was available.

 

The interest rates on the balance of the Company’s bank debt aresubject to fluctuations in the short-term money market rates as bank debt isgenerally held in short-term, floating interest rate debt instruments. As at December 31,2008, 28 percent (2007 — 65 percent) of our long-term debt instruments wereexposed to changes in short-term interest rates and 72 percent (2007 — 35percent) of our long-term debt instruments contained fixed interest rates(including the effects of interest rate swaps).

 

Letters of credit totalling $1 million were outstanding on December 31,2008 (December 31, 2007 - $nil) that reduced the amount otherwiseavailable to be drawn on the syndicated facility.

 

Financing costs including interest expense on the syndicated creditfacility, the senior unsecured notes and convertible debentures were $53million for the fourth quarter of 2008 (2007 - $27 million) and $204 millionfor the year ended December 31, 2008 (2007 - $93 million).

 

The US$475 million senior unsecured notes (the “2007 Notes”) aresubject to the financial covenant that consolidated total debt to consolidatedcapitalization shall not exceed 55 percent except in the event of a materialacquisition where it is not to exceed 60 percent. The estimated fair value ofthe principal and interest obligations under the notes at December 31,2008 was $495 million (December 31, 2007 - $458 million).

 

15

----

 

On May 29, 2008, the Company closed the issuance of seniorunsecured notes (the “2008 Notes”), on a private placement basis primarily inthe United States, with aggregate principal amounts of US$480 million plusCAD$30 million. The 2008 Notes will mature in eight years to 12 years and bearinterest at rates between 6.12 percent and 6.40 percent with an average rate ofapproximately 6.25 percent and an average term of 9.6 years. The 2008 Notescontain covenants on total debt to capitalization, total debt to income beforeinterest, taxes and depreciation and depletion (“EBITDA”), set priority debtlimitations and contain change of control provisions. The estimated fair valueof the principal and interest obligations under the notes at December 31,2008 was $536 million (December 31, 2007 — n/a).

 

On July 31, 2008, the Company issued £57 million of senior,unsecured notes (the “UK Notes”) through a private placement in the UnitedKingdom maturing in 2018 and bearing interest of 7.78 percent. In conjunctionwith the issue of these notes, the Company entered into contracts to fix theprincipal and interest payments at approximately $114 million bearing interestin Canadian dollars at 6.95 percent. The financial covenants of the UK Notesare similar to the 2008 Notes. The estimated fair value of the principal andinterest obligations under the notes at December 31, 2008 was $92 million(December 31, 2007 — n/a).

 

**7. Convertible debentures**

 

Penn West assumed the following unsecuredsubordinated convertible debentures through the Canetic acquisition closing on January 11,2008 and the Vault acquisition closing on January 10, 2008 as discussed inNote 3. On the assumption of the convertible debentures, no amount wasallocated to the fair value of the equity conversion features.

 
| **Description of security** | ** ** | **Symbol** | ** ** | **Maturity  date** | ** ** | **Conversion  price  (per unit)** | ** ** | **Redemption prices  (per $1,000 face value)** | ** **                                                                                 |
|---------------------------------------|------------|------------|------------|--------------------|------------|----------------------------------------|------------|--------------------------------------------------------------------|--------------------------------------------------------------------------------------------|
| 9.4% Convertible                      |       | PWT.DB.A   |       | Jul. 31, 2008 |       | $                                      | 31.11      |                                                               | Matured Jul. 31, 2008                                                                 |   |
| 8.0% Convertible  extendible          |       | PWT.DB.B   |       | Aug. 31, 2009 |       | $                                      | 30.21      |                                                               | $1,025 Aug. 31, 2008 to maturity                                                      |   |
| 8.0% Convertible  (1)                 |       | PWT.DB.C   |       | Jun. 30, 2010 |       | $                                      | 82.14      |                                                               | $1,050 Jun. 30, 2008 – Jun. 29, 2009  $1,025 Jun. 30, 2009 to maturity |   |
| 6.5% Convertible  extendible          |       | PWT.DB.D   |       | Jul. 31, 2010 |       | $                                      | 36.82      |                                                               | $1,050 Jul. 31, 2008 – Jul. 30, 2009  $1,025 Jul. 31, 2009 to maturity |   |
| 7.2% Convertible                      |       | PWT.DB.E   |       | May 31, 2011  |       | $                                      | 75.00      |                                                               | $1,050 May 31, 2009 – May 30, 2010 $1,025  May 31, 2010 to maturity    |   |
| 6.5% Convertible  extendible          |       | PWT.DB.F   |       | Dec. 31, 2011 |       | $                                      | 51.55      |                                                               | $1,050 Dec. 31, 2009 – Dec. 30, 2010 $1,025  Dec. 31, 2010 to maturity |   |

 

----

(1) Redeemable at the debenture holder’s option.

 

During 2008, changes to convertible debentures were as follows:

 
| ** **    | ** ** | **Balance,  Dec. 31,  2007** | ** ** | **Acquired** | ** ** | **Converted** | ** ** | **Redeemed** | ** ** | **Matured** | ** ** | **Balance,  Dec. 31,  2008** | ** ** |
|---------------|------------|-----------------------------------|------------|--------------|------------|---------------|------------|--------------|------------|-------------|------------|-----------------------------------|------------|
| 9.4% PWT.DB.A |       | $                                 | —     |         | $          | 6             |       | $            | (1         | )           | $          | —                            |       | $ | (5 | ) | **$** | **—** | ** ** |
| 8.0% PWT.DB.B |       | —                            |       | 8            |       | (1            | )          | —       |       | —      | ** ** | **7**                             | ** ** |
| 8.0% PWT.DB.C |       | —                            |       | 49           |       | (1            | )          | (32          | )          | —      | ** ** | **16**                            | ** ** |
| 6.5% PWT.DB.D |       | —                            |       | 18           |       | —        |       | —       |       | —      | ** ** | **18**                            | ** ** |
| 7.2% PWT.DB.E |       | —                            |       | 50           |       | —        |       | (24          | )          | —      | ** ** | **26**                            | ** ** |
| 6.5% PWT.DB.F |       | —                            |       | 229          |       | —        |       | —       |       | —      | ** ** | **229**                           | ** ** |
| Total         |       | $                                 | —     |         | $          | 360           |       | $            | (3         | )           | $          | (56                               | )          | $ | (5 | **)** | **$** | **296** | ** ** |

 

16

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As at December 31, 2008, the current portion of the convertibledebentures totalled $7 million (2007 - $nil) and the remaining $289 million(2007 - $nil) was classified as long-term. The fair value of the convertibledebentures at December 31, 2008, based on quoted market value was $248million.

 

**8. Asset retirementobligations**

** **

Total assetretirement obligations are based upon the present value of Penn West’s netshare of estimated future costs to abandon and reclaim all wells andfacilities. The estimates were made by management using external consultantsassuming current costs, technology and enacted legislation.

 

The total inflated and undiscounted amount to settle Penn West’s assetretirement obligations at December 31, 2008 was $4.2 billion (December 31,2006 - $2.6 billion). The asset retirement obligation was determined byapplying an inflation factor of 2.0 percent (2007 - 2.0 percent) and the inflatedamount was discounted using credit-adjusted rates between 7.0 — 9.0 percent(2007 - 7.0 percent) over the expected useful life of the underlying assets,currently extending up to 50 years into the future with an average life of 24years. The well reclamation cost assumptions were revised upwards in 2008 toreflect the overall increases in costs experienced. Future cash flows fromoperating activities are expected to fund the obligations.

 

Changes to asset retirement obligations were as follows:

 
| ** **                                            | ** ** | **Year ended December 31** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                            | ** ** | **2008**                                  | ** ** | **2007** | ** ** |
| Balance,  beginning of year                           | ** ** | **$**                                     | **413**    |   | $ | 339 |   |
| Liabilities  incurred during the year                 | ** ** | **21**                                    |       | 36 |   |
| Increase in  liability due to change in estimate      | ** ** | **4**                                     |       | 61 |   |
| Liabilities  settled during the year                  | ** ** | **(85**                                   | **)**      | (52 | ) |
| Canetic, Vault and Endev liabilities acquired in year | ** ** | **223**                                   |       | — |   |
| Accretion charges                                     | ** ** | **38**                                    |       | 29 |   |
| Balance, end of year                                  | ** ** | **$**                                     | **614**    |   | $ | 413 |   |

 

**9. Income taxes**

** **

As at December 31, 2008, the total future income tax liability of$1,500 million (December 31, 2007 - $873 million) consisted of a $132million current future income tax liability (December 31, 2007 - $45million current future income tax asset) and a $1,368 million long-term futureincome tax liability (December 31, 2007 - $918 million). The significantincrease in the liability from the prior year is due primarily to future incometaxes recognized on the Canetic acquisition of $511 million in addition to $198million of future income taxes attributable to the unrealized risk managementgain incurred by the Trust during the year.

 

The current portion of future income taxes represents income taxesattributable to the $448 million unrealized risk management asset or liability.

 

On June 12, 2007, the Government of Canada enacted new taxlegislation (the“SIFT Tax”) on publicly tradedincome trusts, effective for the 2011 tax year. As a result of the enactment,an additional $326 million future income tax liability and future income taxexpense was recorded in the second quarter of 2007 to reflect the Trust’stemporary differences between the accounting and tax values of assets andliabilities expected to be remaining in 2011. In accordance with GAAP, prior tothe enactment, the Trust’s temporary differences were not recorded as futureincome taxes. The majority of the temporary differences at the Trust levelarose on the Petrofund Energy Trust acquisition that closed on June 30,2006.

 

17

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Future income tax assets (liabilities) arose from temporary differencesas follows:

 
| ** **                      | ** ** | **As at December 31** | ** ** |
|---------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **2008**                             | ** ** | **2007** | ** ** |
| Property, plant  and equipment  | ** ** | **$**                                | **(1,522** | **)** | $ | (1,028 | ) |
| Risk management                 | ** ** | **(132**                             | **)**      | 45 |   |
| Asset retirement obligations    | ** ** | **154**                              | ** ** | 110 |   |
| Net future income tax liability | ** ** | **$**                                | **(1,500** | **)** | $ | (873 | ) |
| Future income tax asset         | ** ** | **—**                           | ** ** | 45 |   |
| Future income tax liability     | ** ** | **$**                                | **(1,500** | **)** | $ | (918 | ) |

 

The Trustcurrently maintains an income tax status that permits it to deductdistributions to unitholders in addition to other items.

 

The provision forincome taxes reflects an effective tax rate that differs from the combinedfederal and provincial statutory tax rate as follows:

 
| ** **                            | ** ** | **Year ended December 31** | ** ** |
|---------------------------------------|------------|-------------------------------------------|------------|
| ** **                            | ** ** | **2008**                                  | ** ** | **2007** | ** ** |
| Income before  taxes                  | ** ** | **$**                                     | **1,356**  |   | $ | 250 |   |
| Combined  statutory tax rate          | ** ** | **30.1**                                  | **%**      | 32.8 | % |
| Computed income tax provision         | ** ** | **$**                                     | **408**    |   | $ | 82 |   |
| Increase (decrease)  resulting from:  |       |                                      |       |   |   |
| Net Income  attributable to the trust | ** ** | **(338**                                  | **)**      | (204 | ) |
| Tax rate reductions                   | ** ** | **—**                                |       | (129 | ) |
| Effect of SIFT tax                    | ** ** | **—**                                |       | 326 |   |
| Unit-based compensation               | ** ** | **13**                                    |       | 5 |   |
| Unrealized foreign exchange           | ** ** | **51**                                    |       | (5 | ) |
| Other                                 | ** ** | **1**                                     |       | — |   |
| Future income tax expense             | ** ** | **$**                                     | **135**    |   | $ | 75 |   |

 

**10. Unitholders’ equity**

** **

**a) Authorized**

 

i)   An unlimited number ofVoting Trust Units, which are redeemable at the option of the unitholder.

 

ii) An unlimited number of Special Voting Units, which enable the Trustto provide voting rights to holders of any exchangeable shares that may beissued by any direct or indirect subsidiaries of the Trust. Except for theright to vote, the Special Voting Units do not confer any rights.

 

Trust units are redeemable at any time at the option of the unitholder.The redemption price is equal to the least of 95 percent of the closing marketprice on the date the units were tendered for redemption, 95 percent of thevolume weighted average market price for the 10 days immediately after the datethe units were tendered for redemption, or 95 percent of the closing marketprice on the date of redemption. Total redemptions are limited to $250,000 inany calendar month, subject to waiver at the discretion of the administrator.If the limitation is not waived, the amount payable in excess of the $250,000will be settled by the distribution of redemption notes to the redeemingunitholders by the Trust.

 

18

----

 

Penn West has a Distribution Reinvestment and Optional Trust UnitPurchase Plan (the “DRIP”) that provides eligible unitholders the opportunityto reinvest monthly cash distributions into additional units at a potentialdiscount. Units are issued from treasury at 95 percent of the 10-dayvolume-weighted average market price when available. When units are notavailable from treasury they are acquired in the open market at prevailingmarket prices.

 

Unitholders who participate in the DRIP may also purchase additionalunits, subject to a monthly maximum of $5,000 and a minimum of $500. Optionalcash purchase units are acquired, without a discount, in the open market atprevailing market prices or issued from treasury at the 10-day volume-weightedaverage market price.

 

**b) Issued**

** **
| **Voting Trust Units**             | ** ** | **Units**       | ** ** | **Amount** | ** ** |
|----------------------------------------------|------------|-----------------|------------|------------|------------|
| Balance,  December 31, 2006             |       | 237,126,219     |       | $          | 3,712      |   |
| Issued on  exercise of trust unit rights (1) |       | 665,155         |       | 17         |       |
| Issued to  employee retirement savings plan  |       | 532,840         |       | 17         |       |
| Issued to  distribution reinvestment plan    |       | 4,338,950       |       | 131        |       |
| Balance,  December 31, 2007             | ** ** | **242,663,164** | ** ** | **3,877**  | ** ** |
| Issued on  exercise of trust unit rights (1) | ** ** | **1,319,377**   | ** ** | **31**     | ** ** |
| Issued to  employee retirement savings plan  | ** ** | **1,223,514**   | ** ** | **33**     | ** ** |
| Issued to  distribution reinvestment plan    | ** ** | **7,678,507**   | ** ** | **187**    | ** ** |
| Issued on  conversion of debentures          | ** ** | **85,975**      | ** ** | **3**      | ** ** |
| Issued on  Canetic acquisition               | ** ** | **124,348,001** | ** ** | **3,573**  | ** ** |
| Issued on Vault  acquisition                 | ** ** | **5,550,923**   | ** ** | **158**    | ** ** |
| Issued on Endev  acquisition                 | ** ** | **3,635,125**   | ** ** | **114**    | ** ** |
| Balance,  December 31, 2008             | ** ** | **386,504,586** | ** ** | **$**      | **7,976**  | ** ** |

 

----

(1) Theexercise of trust unit rights is reflected as a reduction of contributedsurplus and an increase to unitholders’ capital.

 

In June 2008, the Company completed all requirements to enable thesale of trust units by way of “at-the-market distributions” on both the TSX andthe NYSE. Penn West may issue and sell up to 20,000,000 trust units from timeto time at its discretion during a period of up to 25 months. The trust unitswill be distributed at the current market price at the time of sale. The netproceeds from the sale of trust units under the facility, if any, will be usedto repay debt or fund future growth opportunities. At December 31, 2008 nounits had been issued under the facility.

 

**Special Voting Units**

 

No Special Voting Units were issued.

 

**c) Contributed Surplus**

** **
| ** **                       | ** ** | **Year ended December 31** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| ** **                       | ** ** | **2008**                                  | ** ** | **2007** | ** ** |
| Balance,  beginning of year      | ** ** | **$**                                     | **35**     |   | $ | 16 |   |
| Unit-based  compensation expense | ** ** | **45**                                    |       | 21 |   |
| Benefit on  rights exercised (1) | ** ** | **(5**                                    | **)**      | (2 | ) |
| Balance, end of  year            | ** ** | **$**                                     | **75**     |   | $ | 35 |   |

 

----

(1) Theexercise of trust unit rights is reflected as a reduction of contributedsurplus and an increase to unitholders’ capital.

 

19

----

** **

**11. Unit-basedcompensation**

** **

**Trust Unit Rights Incentive Plan**

 

Penn West has a unit rights incentive plan that allows Penn West toissue rights to acquire trust units to directors, officers, employees and otherservice providers. Under the terms of the plan, the number of trust unitsreserved for issuance shall not exceed 10 percent of the aggregate number ofissued and outstanding trust units of Penn West. The grant price of unit rightsis administered to be equal to the volume-weighted average trading price of thetrust units on the Toronto Stock Exchange for a five trading day periodsubsequent to the date of entitlement. If certain conditions are met, theexercise price per unit may be reduced by deducting from the grant price theaggregate of all distributions, on a per unit basis, paid by Penn West afterthe grant date. Rights granted under the plan prior to November 13, 2006vest over a five-year period and expire six years after the date of thegrant.  Rights granted subsequent to thisdate generally vest over a three-year period and expire four years after thedate of the grant.

 
| **Trust unit rights**                     | ** ** | **Number  Outstanding** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Weighted Average  Grant Date Fair Value** | ** ** |
|-----------------------------------------------------|------------|-------------------------|------------|------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| Outstanding,  December 31, 2006                |       | 11,284,872              |       | $                                              | 27.76      |                                                            | $          | 4.21 |   |
| Granted                                             |       | 5,189,346               |       | 33.24                                          |       | 6.38                                                            |       |
| Exercised                                           |       | (665,155                | )          | 21.91                                          |       | 2.69                                                            |       |
| Forfeited                                           |       | (1,322,979              | )          | 29.88                                          |       | 5.73                                                            |       |
| Balance before  reduction of exercise price         |       | 14,486,084              |       | 29.80                                          |       | 4.91                                                            |       |
| Reduction of  exercise price for distributions paid |       | —                  |       | (4.11                                          | )          | —                                                          |       |
| Outstanding,  December 31, 2007                | ** ** | **14,486,084**          |       | **$**                                          | **25.69**  |                                                            | **$**      | **4.91** | ** ** |
| Granted                                             | ** ** | **15,224,042**          |       | **26.96**                                      |       | **5.09**                                                        | ** ** |
| Exercised                                           | ** ** | **(1,319,377**          | **)**      | **19.95**                                      |       | **3.27**                                                        | ** ** |
| Forfeited                                           | ** ** | **(2,572,369**          | **)**      | **25.78**                                      |       | **5.42**                                                        | ** ** |
| Balance before  reduction of exercise price         | ** ** | **25,818,380**          |       | **26.72**                                      |       | **5.05**                                                        | ** ** |
| Reduction of  exercise price for distributions paid | ** ** | **—**              |       | **(3.84**                                      | **)**      | **—**                                                      | ** ** |
| Outstanding,  December 31, 2008                | ** ** | **25,818,380**          |       | **$**                                          | **22.88**  |                                                            | **$**      | **5.05** | ** ** |

 

At December 31, 2008, exercisable trust units totaled 5,254,620 (2007 –2,742,359) for a weighted average exercise price of $21.18 (2007 - $22.53) anda weighted average grant date fair value of $4.77 (2007 - $3.75).

 

20

----

 
| ** **                               | ** ** | ** **              | ** ** | **Unit Rights Outstanding**           | ** ** | **Unit Rights Exercisable**                            | ** ** |
|------------------------------------------|------------|-------------------------|------------|-------------------------------------------------|------------|------------------------------------------------------------------|------------|
| **Range of Grant Prices** | ** ** | **Number  Outstanding** | ** ** | **Weighted  Average  Exercise  Price (1)** | ** ** | **Weighted  Remaining  Contractual Life  (years) (2)** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise  Price (1)** | ** ** |
| $18.00 - $24.99                          |       | 1,185,270               |       | $                                               | 19.82      |                                                             | 4.0        |   | — |   | $ | — |   |
| $25.00 - $29.99                          |       | 15,671,595              |       | 21.02                                           |       | 3.1                                                              |       | 2,231,699 |   | 14.80 |   |
| $30.00 - $34.99                          |       | 6,844,918               |       | 25.42                                           |       | 2.8                                                              |       | 2,114,299 |   | 23.98 |   |
| $35.00 - $39.99                          |       | 900,497                 |       | 28.66                                           |       | 2.9                                                              |       | 338,072 |   | 28.62 |   |
| $40.00 - $44.99                          |       | 1,216,100               |       | 31.40                                           |       | 3.6                                                              |       | 570,550 |   | 31.29 |   |
| ** **                               | ** ** | **25,818,380**          | ** ** | **$**                                           | **22.88**  | ** **                                                       | **3.1**    | ** ** | **5,254,620** | ** ** | **$** | **21.18** | ** ** |
|                                          |            |                         |            |                                                 |            |                                                                  |            |  |  |  |  |  |  |  |  |

 

----

| (1) |   | Exercise prices are  adjusted for distributions if certain conditions are met.                                                             |
|-----|--------|--------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Rights granted under the  plan prior to November 13, 2006 expire after 6 years, rights granted  after this date expire after 4 years. |

 

Penn West recorded unit-based compensation expense of $45 million forthe year ended December 31, 2008, of which $11 million was charged tooperating expense and $34 million was charged to general and administrativeexpense (2007 - $21 million, $6 million and $15 million respectively). Unit-basedcompensation expense is based on the fair value of rights issued and isamortized over the remaining vesting periods on a straight-line basis.

 

The Binomial Lattice option-pricing model was used to determine thefair value of trust unit rights granted with the following weighted averageassumptions:

 
| ** **                                                  | ** ** | **Year ended December 31** | ** ** |
|-------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                  | ** ** | **2008**                                  | ** ** | **2007** | ** ** |
| Average fair  value of trust unit rights granted (per unit) | ** ** | **$**                                     | **5.09**   | ** ** | $ | 6.38 |   |
| Expected life of  trust unit rights (years)                 | ** ** | **3.0**                                   | ** ** | 3.0 |   |
| Expected  volatility (average)                              | ** ** | **27.0**                                  | **%**      | 24.9 | % |
| Risk-free rate  of return (average)                         | ** ** | **3.0**                                   | **%**      | 4.2 | % |
| Distribution  yield (1)                                     | ** ** | **18.1**                                  | **%**      | 13.1 | % |
|                                                             |            |                                           |            |  |  |  |  |

 

----

| (1) |   | Represents distributions  declared as a percentage of the market price of trust units and does not  account for any portion of distributions that represent a return of capital. |
|-----|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

The expectedvolatility of the trust unit rights was based on the historical unit pricevolatility of the Trust. The expected life of the trust unit rights was basedon expected exercise patterns and the forfeiture rate was based on historicalemployee forfeiture patterns.

 

**Employee Retirement Savings Plan**

 

Penn West has an employee trust unit savings plan for the benefit ofall employees. Under the savings plan, employees may elect to contribute up to10 percent of their salary and Penn West matches these contributions at a rateof $1.50 for each $1.00. Both the employee’s and Penn West’s contribution areused to acquire Penn West trust units. These trust units may be issued fromtreasury at the five-day volume weighted average month-end trading price on theToronto Stock Exchange or purchased in the open market at prevailing marketprices. During 2008, 1,223,514 treasury units (2007 – 532,840) were contributedto the plan at an average of $26.72 per unit (2007 – $32.86) and a total costof $33 million (2007 – $17 million). No trust units have been purchased in theopen market since the trust conversion.

 

21

----

 

**12. Distributions payableto unitholders**

** **

Under the terms ofits trust indenture, Penn West is required to make distributions to unitholdersin amounts at least equal to its taxable income consisting of interest onnotes, the NPIs, and any inter-corporate distributions and dividends received,less certain expenses. Distributions may be monthly or special and in cash orin trust units at the discretion of the Board of Directors. Distributionspayable to unitholders is the amount declared and payable by the Trust.

 
| ** **                                                  | ** ** | **Year ended December 31** | ** ** |
|-------------------------------------------------------------|------------|-------------------------------------------|------------|
| **Accumulated Cash Distributions**                | ** ** | **2008**                                  | ** ** | **2007** | ** ** |
| Balance,  beginning of year                                 | ** ** | **$**                                     | **2,110**  |   | $ | 1,133 |   |
| Distributions  declared                                     | ** ** | **1,550**                                 |       | 977 |   |
| Balance, end of  year                                       | ** ** | **$**                                     | **3,660**  |   | $ | 2,110 |   |
|                                                        |       |                                      |       |   |   |
| Distributions  per unit (1)                                 | ** ** | **$**                                     | **4.08**   |   | $ | 4.08 |   |
| Accumulated cash  distributions per unit, beginning of year | ** ** | **10.10**                                 |       | 6.02 |   |
| Accumulated cash  distributions per unit, end of year       | ** ** | **$**                                     | **14.18**  |   | $ | 10.10 |   |

 

----

(1) Distributionsper unit are the sum of the per unit amounts declared monthly to unitholders.

 

**13. Risk management**

** **

Financial instruments included in the balance sheets consist ofaccounts receivable, fair values of derivative financial instruments, currentliabilities (excluding future income taxes), convertible debentures andlong-term debt. Except for the U.S. Senior notes and the UK notes described inNote 6 and the convertible debentures described in Note 7, the fair values ofthese financial instruments approximate their carrying amounts due to theshort-term maturity of the instruments, the mark to market values recorded forthe financial instruments and the market rate of interest applicable to thebank debt.

 

A detaileddiscussion of the key business risks faced by Penn West, which includes marketrisk, commodity price risk, foreign currency rate risk, credit risk, interestrate risk and liquidity risk, is included in the year ended December 31,2008, Management’s Discussion and Analysis under the heading “Business Risks”.The disclosure under that heading is hereby incorporated by reference into, andforms an integral part of, these financial statements. A quantitative analysisof risks is included in the Management’s Discussion and Analysis under theheading “Sensitivity Analysis”.

 

Nearly all of theaccounts receivable are with customers in the oil and natural gas industry andare subject to normal industry credit risk. Penn West, from time to time, usesvarious types of financial instruments to reduce its exposure to fluctuatingoil and natural gas prices, electricity costs, exchange rates and interestrates. The use of these instruments exposes Penn West to credit risksassociated with the possible non-performance of counterparties to derivativeinstruments. Penn West limits this risk by transacting primarily withcounterparties who are members of our banking syndicate or who have investmentgrade ratings.

 

Penn West’srevenue from the sale of crude oil, natural gas liquids and natural gas isdirectly impacted by changes to the underlying commodity prices. To ensure thatfunds flows are sufficient to fund planned capital programs and distributions,collars or other financial instruments may be utilized. Collars ensure thatcommodity prices realized will fall into a contracted range for a contractedsales volume. Forward power contracts fix a portion of future electricity costsat levels determined to be economic by management.

 

22

----

 

Variations ininterest rates directly impact interest costs. From time to time, Penn West mayincrease the certainty of future interest rates using financial instruments toswap floating interest rates for fixed rates or by transactions in fixed rateinstruments.

 

Crude oil salesare referenced to or denominated in US dollars. Crude oil prices realized inCanadian dollars are accordingly impacted directly by Canadian to US exchange rates.Penn West currently has a portion of long-term debt held in US dollars and UKPounds which is also affected by foreign exchange fluctuations. From time totime, Penn West may use financial instruments to fix future exchange rates.

 

Changes in the fair value of all outstanding financial commodity,power, interest rate and foreign exchange contracts are reflected on thebalance sheet with a corresponding unrealized gain or loss in income.

 

The following table reconciles the changes in the fair value offinancial instruments outstanding:

 
| ** **                                        | ** ** | **Year ended December 31** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------|------------|
| **Risk management**                          | ** ** | **2008**                                  | ** ** | **2007** | ** ** |
| Balance,  beginning of year                       | ** ** | **$**                                     | **(148**   | **)** | $ | 54 |   |
| Canetic, Vault  and Endev liabilities acquired    | ** ** | **(71**                                   | **)**      | — |   |
| Unrealized gain  (loss) on financial instruments: |       |                                      | ** ** |   |   |
| Commodity  collars                                | ** ** | **660**                                   | ** ** | (182 | ) |
| Electricity  swaps                                | ** ** | **3**                                     | ** ** | (18 | ) |
| Interest rate  swaps                              | ** ** | **(43**                                   | **)**      | — |   |
| Foreign exchange  forwards                        | ** ** | **63**                                    | ** ** | (2 | ) |
| Cross currency  swaps                             | ** ** | **(22**                                   | **)**      | — |   |
| Fair value, end  of year                          | ** ** | **$**                                     | **442**    | ** ** | $ | (148 | ) |
|                                              |       |                                      | ** ** |   |   |
| Total fair value  consists of the following:      |       |                                      | ** ** |   |   |
| Fair value, end  of year – current portion   | ** ** | **$**                                     | **448**    | ** ** | $ | (148 | ) |
| Fair value, end  of year – long-term portion | ** ** | **(6**                                    | **)**      | — |   |
| Total fair  value, end of year                    | ** ** | **$**                                     | **442**    | ** ** | $ | (148 | ) |

 

23

----

 

Penn West had thefollowing financial instruments outstanding as at December 31, 2008. Fairvalues are determined using external counterparty information, which iscompared to observable market data.

 
| ** **                                | ** ** | **Notional  volume** | ** ** | **Remaining  term**  | ** ** | **Pricing**             | ** ** | **Market  value** | ** ** |
|-------------------------------------------|------------|----------------------|------------|----------------------|------------|-------------------------|------------|-------------------|------------|
| **Crude  oil**                            |       |                 |       |                 |       |                    |       |              |       |
| WTI Swaps                                 |       | 500 bbls/d           |       | Jan/09 – Dec/09 |       | US$72.68/bbl            |       | $                 | 3          |   |
| WTI Collars                               |       | 30,000 bbls/d        |       | Jan/09 – Dec/09 |       | US$80.00 to $110.21/bbl |       | 369               |       |
|                                      |       |                 |       |                 |       |                    |       |              |       |
| **Natural  gas**                          |       |                 |       |                 |       |                    |       |              |       |
| AECO Collars                              |       | 170,000 GJ/d         |       | Jan/09 – Mar/09 |       | $7.38 to $9.76/GJ       |       | 22                |       |
| AECO Collars                              |       | 100,000 GJ/d         |       | Apr/09 – Oct/09 |       | $8.25 to $12.37/GJ      |       | 50                |       |
|                                      |       |                 |       |                 |       |                    |       |              |       |
| **Electricity  swaps**                    |       |                 |       |                 |       |                    |       |              |       |
| Alberta Power Pool  Swaps                 |       | 50 MW                |       | Jan/09 – Dec/10 |       | $77.82/MWh              |       | 2                 |       |
|                                      |       |                 |       |                 |       |                    |       |              |       |
| **Interest  rate swaps**                  |       |                 |       |                 |       |                    |       |              |       |
|                                      |       | $100                 |       | Jan/09 – Nov/10 |       | 4.26                    | %          | (6                | )          |
|                                      |       | $100                 |       | Jan/09 – Jun/10 |       | 3.68                    | %          | (4                | )          |
|                                      |       | $100                 |       | Jan/09 – Jun/11 |       | 3.82                    | %          | (7                | )          |
|                                      |       | $150                 |       | Jan/09 – Aug/10 |       | 3.10                    | %          | (5                | )          |
|                                      |       | $200                 |       | Jan/09 – Aug/11 |       | 3.30                    | %          | (11               | )          |
|                                      |       | $250                 |       | Jan/09 – Nov/10 |       | 2.27                    | %          | (5                | )          |
|                                      |       | $500                 |       | Jan/09 – Dec/11 |       | 1.61                    | %          | (5                | )          |
| ** **                                |       |                 |       |                 |       |                    |       |              |       |
| **Foreign  exchange forwards**            |       |                 |       |                 |       |                    |       |              |       |
| 1-year term                               |       | US$720               |       | Jan/09 – Dec/09 |       | 1.24875 CAD/USD         |       | 23                |       |
| 8-year term                               |       | US$80                |       | 2015                 |       | 1.00934 CAD/USD         |       | 12                |       |
| 10-year term                              |       | US$80                |       | 2017                 |       | 1.00165 CAD/USD         |       | 12                |       |
| 12-year term                              |       | US$70                |       | 2019                 |       | 0.99125 CAD/USD         |       | 11                |       |
| 15-year term                              |       | US$20                |       | 2022                 |       | 0.98740 CAD/USD         |       | 3                 |       |
| ** **                                |       |                 |       |                 |       |                    |       |              |       |
| **Cross  currency / interest rate swaps** |       |                 |       |                 |       |                    |       |              |       |
| 10-year term                              |       | £57             |       | 2018                 |       | 2.0075 CAD/GBP 6.95     | %          | (22               | )          |
| **Total**                                 |       |                 |       |                 |       |                    |       | $                 | 442        |   |

 

In October 2008, Penn West received approximately $123 million incash as a result of monetizing a portion of crude oil financial contracts. Thisincluded lowering the floor on its 2009 WTI collars from US$85.00 per barrel toUS$80.00 per barrel as well as monetizing all 2010 WTI collars. The proceeds wereused to repay advances on our syndicated credit facility.

 

A realized gain of $6 million (2007 - $11 million) on the electricitycontracts has been included in operating costs.

 

Realized gains and losses on the interest rate swaps are charged tointerest expense. During the year, the fixed rate and the floating rate wereapproximately equal, resulting in no reportable gain or loss being charged tointerest rate expense in relation to the interest rate swaps.

 

24

----

** **

**14. Per unit amounts**

** **

The number of incremental units included in diluted earnings per unitis computed using the average volume-weighted market price of trust units foreach interim period. In addition, contracts that could be settled in cash or trustunits are assumed to be settled in trust units if unit settlement is moredilutive.

 

The weighted average number of trust units used to calculate per unitamounts was:

 
| ** **     | ** ** | **Year ended December 31** | ** ** |
|----------------|------------|-------------------------------------------|------------|
| ** **     | ** ** | **2008**                                  | ** ** | **2007** | ** ** |
| Basic          | ** ** | **375,613,697**                           |       | 239,374,970 |   |
| Diluted Impact | ** ** | **7,299,138**                             |       | 2,134,221 |   |
| Diluted        | ** ** | **382,912,835**                           |       | 241,509,191 |   |

 

For the year ended December 31, 2008, 13.5 million trust unitrights (2007 – 7.0 million) and 0.6 million units that would be issued on theconversion of the convertible debentures (2007 – nil) were excluded incalculating the weighted average number of diluted trust units outstanding asthey were considered anti-dilutive. At December 31, 2008, as a portion ofthe convertible debentures are considered dilutive, the corresponding interestexpense of $12 million for the year ended 2008 (2007 – $nil) is excluded fromthe earnings per share calculation.

 

**15. Contractualobligations and commitments**

** **

The following is a summary of the contractual obligations due in thenext five years and thereafter:

 
| ** **                | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **2013** | ** ** | **Thereafter** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|
| Long-term debt            | ** ** | **$**    | **—** |     | $          | —   |       | $        | 2,561      |     | $          | —         |       | $ | — |   | $ | 1,293 |   |
| Transportation            | ** ** | **24**   |       | 13       |       | 7        |       | 1        |       | —   |       | —         |       |
| Transportation  ($US)     | ** ** | **4**    |       | 4        |       | 4        |       | 4        |       | 4        |       | 7              |       |
| Power  infrastructure     | ** ** | **19**   |       | 7        |       | 7        |       | 7        |       | 7        |       | 4              |       |
| Drilling rigs             | ** ** | **12**   |       | 5        |       | —   |       | —   |       | —   |       | —         |       |
| Purchase  obligations (1) | ** ** | **13**   |       | 13       |       | 13       |       | 13       |       | 13       |       | 29             |       |
| Interest  obligations     | ** ** | **156**  |       | 155      |       | 97       |       | 80       |       | 80       |       | 311            |       |
| Office lease (2)          | ** ** | **$**    | **28**     |     | $          | 56       |       | $        | 71         |     | $          | 68             |       | $ | 67 |   | $ | 616 |   |

 

----

| (1) |   | These amounts represent estimated commitments of $73  million for CO2 purchases and $21 million for processing fees  related to interests in the Weyburn Unit. |
|-----|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Future office lease commitments are shown prior to  sublease recoveries of approximately $387 million.                                                              |

 

Our syndicated credit facility expires on January 11, 2011. If wewere not successful in renewing or replacing the facility, we could be requiredto repay all amounts then outstanding on the facility or enter term bank loans.In addition, we have US$475 million of fixed-term notes expiring between 2015and 2022, US$480 million and CAD$30 million of fixed-term notes expiringbetween 2016 and 2020 and £57 million (swapped to approximately CAD$114million) of fixed-term notes expiring in 2018. As we strive to maintain ourleverage ratios at relatively modest levels, we believe we will be successfulin renewing or replacing our credit facility on acceptable terms.

 

Convertible debentures with an aggregate principal amount of $296million (2007 - $nil) outstanding on December 31, 2008, and a significantportion of the interest payable on convertible debentures may, at the option ofthe Trust, be settled by the issuance of trust units. For a schedule ofconvertible debenture maturities, please refer to the “Liquidity and CapitalResources” section of the MD&A and note 7.

 

25

----

 

**16. Changes in non-cashworking capital (increase) decrease**

** **
| ** **                                | ** ** | **Year ended December 31** | ** ** |
|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                  | ** ** | **2007** | ** ** |
| Accounts  receivable                      | ** ** | **$**                                     | **(109**   | **)** | $ | (9 | ) |
| Other current  assets                     | ** ** | **(60**                                   | **)**      | 11 |   |
| Accounts payable  and accrued liabilities | ** ** | **271**                                   | ** ** | (25 | ) |
| Acquisitions                              | ** ** | **(273**                                  | **)**      | — |   |
| ** **                                |       | **(171**                                  | **)**      | (23 | ) |
| Operating  activities                     | ** ** | **(196**                                  | **)**      | (38 | ) |
| Investing  activities                     | ** ** | **25**                                    | ** ** | 15 |   |
| Financing  activities                     | ** ** | **—**                                | ** ** | — |   |
| ** **                                |       | **$**                                     | **(171**   | **)** | $ | (23 | ) |

** **

**17. Working capitalcomponents**

** **
| ** **                                              | ** ** | **As at December 31** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                              | ** ** | **2008**                             | ** ** | **2007** | ** ** |
| Components of  accounts receivable                      |       |                                 |       |   |   |
| Trade                                                   | ** ** | **$**                                | **123**    |   | $ | 54 |   |
| Accruals                                                | ** ** | **259**                              |       | 221 |   |
| Other                                                   | ** ** | **4**                                |       | 2 |   |
| ** **                                              |       | **$**                                | **386**    |   | $ | 277 |   |
| Components of  other assets                             |       |                                 |       |   |   |
| Prepaid expenses                                        | ** ** | **$**                                | **82**     |   | $ | 24 |   |
| Inventory                                               | ** ** | **24**                               |       | 22 |   |
| ** **                                              |       | **$**                                | **106**    |   | $ | 46 |   |
| Components of  accounts payable and accrued liabilities |       |                                 |       |   |   |
| Accounts payable                                        | ** ** | **$**                                | **261**    |   | $ | 99 |   |
| Royalty payable                                         | ** ** | **90**                               |       | 68 |   |
| Capital accrual                                         | ** ** | **208**                              |       | 113 |   |
| Operating  accrual                                      | ** ** | **11**                               |       | 53 |   |
| Other                                                   | ** ** | **60**                               |       | 26 |   |
| ** **                                              |       | **$**                                | **630**    |   | $ | 359 |   |

 

**18. Capital management**

 

The Trust manages its capital to provide a flexible structure tosupport its growth and operational strategies while maintaining a strongfinancial position in order to capture business opportunities and maintain astable distribution profile to its unitholders.

 

Penn West defines unitholders’ equity, long-term debt and convertibledebentures as capital. Unitholders’ equity includes unitholders’ capital,contributed surplus and retained earnings. Long-term debt includes bank loans,the 2007 Notes, the 2008 Notes and the UK Notes.

 

Management continuously reviews the Trust’s capital structure to ensurethe objectives and strategies of the Trust are met. The capital structure isreviewed based on a number of key factors including, but not limited to, thecurrent market conditions, trailing and forecast debt to capitalization ratiosand debt to funds flow and other economic risk factors identified by the Trust.Under the terms of its current trust indenture, the Trust is required to makedistributions to unitholders in amounts at least equal to its taxable income.Distributions may be monthly or special and in cash or in trust units at thediscretion of our Board of Directors.

 

26

----

 

In January 2008, Penn West closed its acquisition of Caneticthrough the issuance of approximately 124.3 million trust units for a totalacquisition cost of $3.6 billion and assumed $1.7 billion of long-term debt andconvertible debentures. In addition, Penn West closed its acquisition of Vaultin January 2008 issuing approximately 5.6 million trust units for a totalacquisition cost of $164 million and assumed $212 million of long-term debt andconvertible debentures. In July 2008, Penn West closed its acquisition ofEndev through the issuance of approximately 3.6 million trust units for a totalacquisition cost of $115 million and assumed $43 million of long-term debt.These transactions led to a material increase in the amount of recordedunitholders’ equity.

 

The Company is subject to certain financial covenants under itsunsecured, syndicated credit facility and the 2007 Notes, the 2008 Notes andthe UK Notes. As at December 31, 2008, the Company was in compliance withall financial covenants; as follows:

 
| ** **                                          | ** ** | **Pro forma year ended December 31 (1)** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| **(millions, except ratio amounts)** | ** ** | **2008**                                                               | ** ** | **(unaudited)  2007** | ** ** |
| Components of  capital                              |       |                                                                   | ** ** |   |   |
| Unitholders’  equity                           | ** ** | **$**                                                                  | **8,380**  | ** ** | $ | 4,570 |   |
| Long-term debt                                      | ** ** | **$**                                                                  | **3,854**  | ** ** | $ | 1,943 |   |
| Convertible  debentures                             | ** ** | **$**                                                                  | **296**    | ** ** | $ | — |   |
| Ratios                                              |       |                                                                   | ** ** |   |   |
| Senior debt to  pro forma EBITDA (2)                | ** ** | **1.4**                                                                | ** ** | 1.5 |   |
| Total debt  (9) to pro forma EBITDA (3)        | ** ** | **1.4**                                                                | ** ** | 1.5 |   |
| Senior debt to  capitalization (4)                  | ** ** | **31**                                                                 | **%**      | 30 | % |
| Total debt  (9) to capitalization (5)          | ** ** | **31**                                                                 | **%**      | 30 | % |
| Total debt  (10)  to capitalization (5)        | ** ** | **33**                                                                 | **%**      | 33 | % |
| Priority debt to  consolidated tangible assets (6)  | ** ** | **—**                                                             | ** ** | — |   |
| Pro forma EBITDA                                    | ** ** | **$**                                                                  | **2,762**  | ** ** | $ | 2,333 |   |
|                                                |       |                                                                   | ** ** |   |   |
| Credit facility  debt and senior notes              | ** ** | **$**                                                                  | **3,854**  | ** ** | $ | 3,510 |   |
| Letters of  credit                                  | ** ** | **1**                                                                  | ** ** | 4 |   |
| Total senior  debt                                  | ** ** | **3,855**                                                              | ** ** | 3,514 |   |
| Convertible  debentures (7)                         | ** ** | **42**                                                                 | ** ** | 99 |   |
| Total debt (9)                                      | ** ** | **3,897**                                                              | ** ** | 3,613 |   |
| Convertible  debentures (8)                         | ** ** | **254**                                                                | ** ** | 261 |   |
| Total debt (10)                                     | ** ** | **4,151**                                                              | ** ** | 3,874 |   |
| Total  unitholders’ equity                     | ** ** | **8,380**                                                              | ** ** | 8,300 |   |
| Total  capitalization                               | ** ** | **$**                                                                  | **12,531** | ** ** | $ | 12,174 |   |

 

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| (1)  |   | Pro forma includes  significant acquisitions and dispositions in the period.                                                                                                                                            |
|------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)  |   | Less than 3:1 and not to  exceed 3.5:1 in the event of a material acquisition.                                                                                                                                          |
| (3)  |   | Less than 4:1.                                                                                                                                                                                                          |
| (4)  |   | Not to exceed 50 percent  except in the event of a material acquisition when the ratio is not to exceed  55 percent.                                                                                                    |
| (5)  |   | Not to exceed 55 percent  except in the event of a material acquisition when the ratio is not to exceed  60 percent.                                                                                                    |
| (6)  |   | Priority debt not to exceed  15% of consolidated tangible assets.                                                                                                                                                       |
| (7)  |   | Convertible debentures not  meeting the requirements for equity classification under lending agreements.                                                                                                                |
| (8)  |   | Convertible debentures not  meeting the requirements for equity classification under the 2007 Notes.                                                                                                                    |
| (9)  |   | Total debt as defined in  the 2008 Notes, UK Notes and the syndicated bank facility agreements, which  includes convertible debentures that do not meet the requirement for equity  classification in these agreements. |
| (10) |   | Total debt as defined in  the 2007 Notes agreement, which includes convertible debentures that do not  meet the requirements for equity classification in this agreement.                                               |

 

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**19. Related-partytransactions**

** **

During 2008, Penn West paid $5 million (2007 – $1 million) of legalfees in the normal course of business to a law firm of which a partner is alsoa director of Penn West.

 

**20. Subsequent events**

 

On February 5, 2009, Penn West closed the issuance of 17,731,000trust units on a bought-deal basis with a syndicate of underwriters at $14.10per trust unit for total gross proceeds of approximately $250 million ($238million net). Additionally, Penn West****sold grossoverriding royalties for total proceeds of approximately $40 million in March 2009.This transaction is in addition to the previously announced dispositions withtotal proceeds of approximately $150 million. The proceeds from thesetransactions will be used to repay a portion of our bank facility.

 

On March 10, 2009, Penn West entered into an arrangement agreementwith Reece Energy Exploration Corp. (“Reece”) whereby Penn West intends topurchase all of the outstanding shares of Reece. The acquisition will becompleted through a plan of arrangement whereby each share of Reece will beexchanged for 0.125 of a Penn West trust unit. The total acquisition cost isexpected to be approximately $92 million with approximately 2,100 barrels ofoil equivalent per day to be added to our current production base.

 

On March 12, 2009, the Government of Canada enacted the amendmentsto the provincial component of the SIFT Tax, which was announced on June 9,2008. These changes provide that the provincial component of the SIFT Tax is tobe based on provincial corporate income tax rates where the SIFT has permanentestablishments, rather than using a 13 percent flat rate as originallylegislated. As a result of this enactment, Penn West estimates it will record afuture tax recovery of approximately $65 million in the first quarter of 2009.

 

In March 2009, Penn West restructured its natural gas collars byreducing the floor price on its April 2009 to October 2009 naturalgas collars and entered into new collars for the latter part of 2009 andthroughout 2010. In addition, Penn West entered into WTI costless collars of15,000 barrels per day for 2010. The new financial instruments are as follows:

 
| ** **       | ** ** | **Notional volume** | ** ** | **Remaining term** | ** ** | **Pricing**            | ** **        |
|------------------|------------|--------------------------|------------|-------------------------|------------|------------------------|-------------------|
| **Natural  Gas** |       |                     |       |                    |       |                   |              |
| AECO Collars     |       | 100,000 GJ/d             |       | Apr/09 – Oct/09    |       | $                      | 6.50 to $12.37/GJ |   |
| AECO Collars     |       | 63,000 GJ/d              |       | Nov/09 – Oct/10    |       | $                      | 6.50 to $9.50/GJ  |   |
| **Crude  Oil**   |       |                     |       |                    |       |                   |              |
| WTI Collars      |       | 15,000 bbls/d            |       | Jan/10 – Dec/10    |       | US$51.93 to $68.30/bbl |              |

 

On March 26, 2009, our Board of Directors approved a reduction toour monthly distribution to unitholders from $0.23 per unit to $0.15 per unitfor April, subject to changes in commodity prices, production levels andcapital expenditures.  The April 2009distribution of $0.15 per unit is payable on May 15, 2009, to unitholdersof record on April 30, 2009.  Theex-distribution date is April 28, 2009.

 

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