| **UNITED STATES SECURITIES AND EXCHANGE                            COMMISSION**                                     |
|---------------------------------------------------------------------------------------------------------------------|
| **Washington, D.C. 20549**                                                                                          |
|                                                                                                                |
| **FORM 10-K**                                                                                                       |
|                                                                                                                |
| **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE                            SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                |
| **For the fiscal year ended December 31,                            2007**                                          |
|                                                                                                                |
| **Commission File Number: 000-25386**                                                                               |
|                                                                                                                |
| **FXENERGY,INC.**                                                                                                   |
| (Exact name of registrant as specified in its                            charter)                                   |
|                                                                                                                |   |
| **Nevada**                                                                                                          | **87-0504461** |
| (State or other jurisdiction of                                                                                     | (I.R.S. Employer |
| incorporation or organization)                                                                                      | Identification No.) |
|                                                                                                                |   |
| **3006 Highland Drive, Suite 206, Salt Lake City,                            Utah**                                 | **84106** |
| (Address of principal executive offices)                                                                            | (Zip Code) |
|                                                                                                                |
| Registrant’s telephone number, including area                            code:                                | **Telephone (801) 486-5555** |   |
|                                                                                                                | **Facsimile (801) 486-5575** |   |
|                                                                                                                |   |
| Securities registered pursuant to Section 12(b) of the                            Act:                              |
| Title of each class                                                                                                 | Name of each exchange on which registered |
| **Common Stock, Par Value $0.001**                                                                                  | **NASDAQ Global Market** |
|                                                                                                                |
| Securities registered pursuant to Section 12(g) of the                            Act:                              |
| **None**                                                                                                            |
| (Title of Class)                                                                                                    |

 

Indicate by check mark if the registrant is a well-known seasoned            issuer, as defined in Rule 405 of the Securities Act.

| Yes o | No **x** |
|------------|---------------|

Indicate by check mark if the registrant is not required to file reports            pursuant to Section 13 or 15(d) of the Act.

| Yes o | No **x** |
|------------|---------------|

Indicate by check mark whether the registrant (1) has filed all reports            required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934            during the preceding 12 months (or for such shorter period that the registrant was            required to file such reports), and (2) has been subject to such filing requirements            for the past 90 days.     Yes **x**No o

Indicate by check mark if disclosure of delinquent filers pursuant to            Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and            will not be contained, to the best of registrant’s knowledge, in definitive proxy            or information statements incorporated by reference in Part III of this Form 10-K or            any amendment to this Form 10-K.**x**

Indicate by check mark whether the registrant is a large accelerated            filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.            See the definitions of “large accelerated filer,” “accelerated            filer” and “smaller reporting company” in Rule 12b-2 of the Exchange            Act.

| Large accelerated filer o | Accelerated filer **x**     |
|--------------------------------|----------------------------------|
| Non-accelerated filer o   | Smaller reporting company o |

| Indicate by check mark whether the registrant is a shell                            company (as defined in Rule 12b-2 of the Act). Yes o | No **x** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|---------------|

State the aggregate market value of the voting and non-voting common            equity held by non-affiliates computed by reference to the price at which the common            equity was last sold, or the average bid and asked price of such common equity, as of            the last business day of the registrant’s most recently completed second fiscal            quarter.**As of June 29, 2007, the aggregate market value of            the voting and nonvoting common equity held by nonaffiliates of the registrant was            $321,319,000.**

Indicate the number of shares outstanding of each of the            registrant’s classes of common stock, as of the latest practicable date.**As of March 3, 2008, FX Energy had outstanding 40,296,447 shares of            its common stock, par value $0.001.**

DOCUMENTS INCORPORATED BY REFERENCE.**FX            Energy’s definitive Proxy Statement in connection with the 2008 Annual Meeting of            Stockholders is incorporated by reference in response to Part II, Item 5, and Part III            of this Annual Report.**

 

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**FX            ENERGY, INC.**

**Form 10-K for the fiscal year ended December 31, 2007**

 

 

**TABLE OF CONTENTS**

 

 

| **Item** |   |                                                                                                                                           | **Page** |
|----------|--------|------------------------------------------------------------------------------------------------------------------------------------------------|----------|
|     |   | **Part I**                                                                                                                                     |     |
| --       |   | Special Note on Forward-Looking Statements                                                                                                     | 3        |
| 1        |   | Business                                                                                                                                       | 4        |
| 1A       |   | Risk Factors                                                                                                                                   | 10       |
| 1B       |   | Unresolved Staff Comments                                                                                                                      | 16       |
| 2        |   | Properties                                                                                                                                     | 17       |
| 3        |   | Legal Proceedings                                                                                                                              | 26       |
| 4        |   | Submission of Matters to a Vote of Security                            Holders                                                                 | 27       |
|     |   |                                                                                                                                           |     |
|     |   | **Part II**                                                                                                                                    |     |
| 5        |   | Market for Registrant’s Common Equity, Related                            Stockholder Matters

and Issuer Purchases of Equity Securities | 27       |
| 6        |   | Selected Financial Data                                                                                                                        | 28       |
| 7        |   | Management’s Discussion and Analysis of Financial                            Condition and Results of Operation                          | 29       |
| 7A       |   | Quantitative and Qualitative Disclosures about Market                            Risk                                                          | 39       |
| 8        |   | Financial Statements and Supplementary Data                                                                                                    | 39       |
| 9        |   | Changes in and Disagreements with Accountants on                            Accounting and Financial Disclosure                                | 39       |
| 9A       |   | Controls and Procedures                                                                                                                        | 40       |
| 9B       |   | Other Information                                                                                                                              | 40       |
|     |   |                                                                                                                                           |     |
|     |   | **Part III**                                                                                                                                   |     |
| 10       |   | Directors, Executive Officers and Corporate                            Governance                                                              | 41       |
| 11       |   | Executive Compensation                                                                                                                         | 42       |
| 12       |   | Security Ownership of Certain Beneficial Owners and                            Management and Related

Stockholder Matters                     | 42       |
| 13       |   | Certain Relationships and Related Transactions, and                            Director Independence                                           | 42       |
| 14       |   | Principal Accountant Fees and Services                                                                                                         | 42       |
|     |   |                                                                                                                                           |     |
|     |   | **Part IV**                                                                                                                                    |     |
| 15       |   | Exhibits and Financial Statement Schedules                                                                                                     | 43       |
| --       |   | Signatures                                                                                                                                     | 47       |
| --       |   | Management’s Report on Internal Control over                            Financial Reporting                                              | F-1      |
| --       |   | Report of Independent Registered Public Accounting                            Firm                                                             | F-2      |

 

 

2

 

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**SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS**

 

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

 

Readers of this report are cautioned that any forward-looking            statements, including those regarding us or our management’s current beliefs,            expectations, anticipations, estimations, projections, strategies, proposals, plans, or            intentions, are not guarantees of future performance or results of events and involve            risks and uncertainties, such as:

|   | **•** | whether we will be able to discover and produce oil or                            gas in commercial quantities from any exploration prospect; |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | whether the quantities of oil or gas we discover will be                            as large as our initial estimate of an exploration target area’s                            gross unrisked potential; |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | whether actual exploration risks will be consistent with                            our forecasts; |
|--------|------------|----------------------------------------------------------------------------------------------------|

|   | **•** | future drilling and other exploration schedules and                            sequences for wells and other activities; |
|--------|------------|--------------------------------------------------------------------------------------------------------------------------|

|   | **•** | the future results of drilling individual wells and                            other exploration and development activities; |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | future variations in well performance as compared to                            initial test data; |
|--------|------------|----------------------------------------------------------------------------------------------------|

|   | **•** | the ability to economically develop and market                            discovered reserves; |
|--------|------------|------------------------------------------------------------------------------------------------|

|   | **•** | the prices at which we may be able to sell oil or                            gas; |
|--------|------------|-----------------------------------------------------------------------------------|

|   | **•** | foreign currency exchange rate fluctuations; |
|--------|------------|----------------------------------------------|

|   | **•** | exploration and development priorities and the financial                            and technical resources of the Polish Oil and Gas Company, our                            principal joint venture and strategic partner in Poland; |
|--------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | uncertainties inherent in estimating quantities of                            proved reserves and actual production rates and associated                            costs; |
|--------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | future events that may result in the need for additional                            capital; |
|--------|------------|----------------------------------------------------------------------------------------------|

|   | **•** | the cost and availability of additional capital that we                            may require and possible related restrictions on our future operating                            or financing flexibility; |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | our future ability to attract industry or financial                            participants to share the costs of exploration, exploitation,                            development, and acquisition activities; |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | future plans and the financial and technical resources                            of industry or financial participants; |
|--------|------------|--------------------------------------------------------------------------------------------------------------------------|

|   | **•** | uncertainties of certain terms to be determined in the                            future relating to our oil and gas interests, including exploitation                            fees, royalty rates, and other matters; |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | uncertainties regarding future political, economic,                            regulatory, fiscal, taxation, and other policies in Poland and the                            European Union; and |
|--------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | other factors that are not listed above. |
|--------|------------|------------------------------------------|

 

The forward-looking information is based on present circumstances and on            our predictions respecting events that have not occurred, that may not occur, or that            may occur with different consequences from those now assumed or anticipated. Actual            events or results may differ materially from those discussed in the forward-looking            statements. The forward-looking statements included in this report are made only as of            the date of this report.

 

3

 

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**PART I**

 

**ITEM 1. BUSINESS**

 

**Introduction**

 

We are an independent oil and gas exploration and production company            headquartered in Salt Lake City, Utah. Our principal production, reserves, and            exploration activities are in Poland, although we have a modest oil presence in the            U.S. We hold 3.7 million gross acres (3.2 million net) in Poland. We believe Poland            represents a unique international exploration opportunity. Relatively little gas has            been discovered in Poland’s sector of the North European Permian Basin, compared            to the discoveries in the United Kingdom, Dutch, and German sectors. For most of the            20th Century, the country was closed to exploration by foreign oil and gas companies.            Consequently, we think the Polish Permian Basin is underexplored and            underexploited.

 

Independent engineers estimated our total oil and gas reserves at 34.1            billion cubic feet of gas equivalents, or “Bcfe.” Our total oil and gas            reserves increased approximately 50% from year end 2006 to 2007. Our production more            than doubled from 2006 to 2007. In both cases, the increase was virtually all            attributable to our exploration in Poland. See Item 7, Management’s Discussion            and Analysis, for further information.

 

References to us in this report include FX Energy, Inc., our            subsidiaries, and the entities or enterprises organized under Polish law in which we            have an interest and through which we conduct our activities in that country. See            “Oil and Gas Terms” at the end of Item 2, Properties, for definitions of            certain industry terms.

 

**Corporate Strategy**

 

We hold substantial acreage in productive fairways or geological trends,            primarily in Poland, that we consider underexplored and underdeveloped, where we            believe we have the opportunity to find significant gas and oil reserves while            mitigating risk through the application of new exploration technology. Our strategy is            to:

 

|   | **•** | increase production and reserves in our core                            area; |
|--------|------------|-------------------------------------------------------------------------------|

             

|   | **•** | utilize revenues from our core area to support high                            potential exploration on our substantial non-core acreage. |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------|

 

Relatively little gas has been discovered in Poland’s sector of            the North European Permian Basin compared to the discoveries in the United Kingdom,            Dutch, and German sectors. We believe Poland has substantial undiscovered hydrocarbon            potential. We think the Polish portion of the Permian Basin is underexplored and            underdeveloped today because the country was closed to competition and capital from            foreign oil and gas companies for many decades. The continuous advances in exploration            technology around the world were not immediately applied in Poland during the period it            was behind the “Iron Curtain.”

 

Acting on this thesis, we have accumulated a large land position in            known productive regions or geologic trends and in selected “rank wildcat”            areas in Poland. We have assembled a sophisticated technical team with modern            exploration tools and generated a number of attractive gas prospects. This has already            begun to bear fruit with several new discoveries on which to build a production base to            support our ongoing exploration program in Poland.

 

Some of our Polish operations are conducted in partnership with the            Polish Oil and Gas Company, or POGC. POGC is a fully integrated oil and gas company,            which is largely owned by the Treasury of the Republic of Poland. POGC is            Poland’s principal domestic oil and gas exploration, production, transportation            and distribution entity. Under our existing agreements, POGC has provided us with            access to exploration opportunities, previously collected exploration data, and            technical and operational support. We also use geophysical and drilling services            provided by POGC and sell our gas production to POGC.

 

4

 

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**Current Activities and Assets in Poland**

 

We focus our exploration efforts in Poland primarily on the Rotliegend            sandstones of the Permian Basin. We were attracted to the Rotliegend sandstones in            Poland by two observations:

 

|   | **•** | Since the 1960s, the dozens of western exploration                            companies working in the North Sea and onshore Europe portions of the                            Basin have identified approximately 200 trillion cubic feet, or Tcf, of                            Rotliegend gas. While the Permian Basin extends well into Poland, only                            5 Tcf of Rotliegend gas has been discovered in Poland. We believe                            political and capital restraints impaired POGC’s ability to                            explore and develop the Polish portion of the Basin. |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

             

|   | **•** | In the last 20 years very little exploration focused on                            the Rotliegend has been conducted in Poland. |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------------|

 

We have identified a core area consisting of approximately 852,000 gross            acres surrounding the Radlin field. This 390 billion cubic feet, or Bcf, Rotliegend gas            field was discovered in the 1980s by our joint venture partner, POGC, which owns and            produces gas from it. We have emphasized improved seismic data acquisition and            processing in our exploration, using technology developed for Rotliegend exploration in            the Southern North Sea. With this approach we have made commercially successful            discoveries in four of the five wells we have drilled on Rotliegend structural targets            using new two-dimensional, or 2-D, seismic data.

 

We have made commercial discoveries in the course of our Polish            exploration which, at December 31, 2007, were estimated to total 31 Bcf of gas and            14,000 barrels, or Bbls, of light crude oil, net to our interest. Future net revenues,            discounted to present value at 10% per annum, or PV-10 value, were estimated at            approximately $103 million after taxes. These figures exclude all of our historical            Polish production and cash flows through December 31, 2007.

 

Based on these discoveries and associated technical work, we have            identified a subset of our acreage, the Sroda area, as having significant natural gas            potential and low drilling risk. Within the Sroda area we have acquired            three-dimensional, or 3-D, seismic data over several hundred square kilometers. Using            this data, we have identified a number of possible structural traps. We believe the 3-D            seismic data gives us better definition of the targets and might further reduce our            drilling risk. We have scheduled two rigs for the Sroda area to carry out a multi-year            exploration, appraisal, and development drilling program. Our operations in the Sroda            area focus on the first element of our general strategy–increase production and            reserves in our core area.

 

While maintaining our focus on the Rotliegend structural trap            exploration model in our core area, we are also carrying out exploration work on other            potential exploration models. These include non-Rotliegend prospects in our core area            on various exploration opportunities on our 2.8 million net acres outside our core            area. For example, we are currently drilling a well, the Grundy-1, to test a Zechstein            carbonate prospect in our core concession. Outside our core concession we are acquiring            seismic data on several possible leads in our Northwest concession block. We anticipate            continuing exploration work on our non-core acreage and on the secondary exploration            targets in our core area. However, the Rotliegend structural trap gas prospects in our            core area will continue to receive the greatest portion of our efforts and capital            resources.

 

**Key Personnel for Poland**

 

Our chief technical advisor is Richard Hardman, CBE. He also serves on            our board of directors. Mr. Hardman has built a career in international exploration            over the past 40 years in the upstream oil and gas industry as a geologist in Libya,            Kuwait, Colombia, and Norway. In the United Kingdom, his career encompasses almost the            whole of the exploration history of the North Sea – 1969 to the present. With            Amerada Hess from 1983 to 2002 as Exploration Director and later Vice President of            Exploration, he was responsible for key Amerada North Sea and international            discoveries, including the Valhall, Scott, and South Arne fields. Mr. Hardman was made            Commander of the British Empire in the New Year Honours, 1998, and has served as the            Chairman of the Petroleum Society of Great Britain, President of the Geological            Society, and President of the European Region of AAPG Europe. Mr. Hardman was appointed            to our board of directors in October 2003 and is Chairman of our Technical and Advisory            Panel.

 

5

 

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            Jerzy            Maciolek is a director of the Company and, as Vice President of International            Exploration, heads our exploration team. He joined the Company in 1995 specifically to            lead it into Poland where he had identified the exploration opportunity that today is            the Company’s core asset. Mr. Maciolek has over 25 years’ experience as a            geophysicist with POGC, Gulf Oil Research, and as an independent consultant. He            received an M.S. in exploration geophysics from the Mining and Metallurgical Academy in            Krakow, Poland.

 

Our Country Manager in Poland is Zbigniew Tatys, the former General            Director of POGC’s Upstream Exploration and Production Division. During his            20-year career with POGC, he rose through the ranks as a production engineer and was            serving as Vice Chairman of POGC at the time of his retirement. Mr. Tatys has unique            qualifications to lead us through our transition from a pure exploration company to an            oil and natural gas producer in Poland.

 

**Our U.S. Presence**

 

Unlike our position in Poland, the U.S. operation does not have            substantial exploration potential. It is fairly mature. It provides a modest amount of            cash flow and is not capital intensive. It consists mostly of shallow, oil-producing            wells in the Cut Bank oil field of Montana. As of December 31, 2007, our U.S. reserves            were estimated at 482,000 barrels of crude oil with a PV-10 value of approximately $11            million.

 

**Exploration, Development and Production Activities**

 

***Polish Exploration Rights***

             

As of December 31, 2007, we held oil and gas exploration rights in            Poland in the following gross acreage components:

 

|                               | **Operator**  |   | **Gross** |   | **Working** |
|------------------------------------|---------------|--------|-----------|--------|-------------|
|                               | **FX Energy** |   | **POGC**  |   | **Acreage** |   | **Interest** |
| **Concession Area:**               |          |   |      |   |        |   |   |
| Fences project area                |          |   | X         |   | 852,000     |   | 49%(1) |
| Wilga project area                 | X             |   |      |   | 250,000     |   | 82% |
| Northwest project area             | X             |   |      |   | 1,167,000   |   | 100% |
| Kutno project area                 | X             |   |      |   | 284,000     |   | 100% |
| Lublin / Warsaw South project area | X             |   |      |   | 935,000     |   | 100% |
| Block 287 project area             | X             |   |      |   | 213,000     |   | 100% |
| Total gross acreage                |          |   |      |   | 3,701,000   |   |   |

_______________

| (1) | Except for 45,000 acres in which we hold a 24.5% working                            interest. |
|-----|-----------------------------------------------------------------------------------------------|

 

As we explore and evaluate our acreage in Poland, we expect to            increasingly focus our operational and financial efforts on higher potential areas. As            we do so, we may add new concessions that we believe have high potential and relinquish            acreage that we believe has lower potential. See “Wells and Acreage” below            for further information.

 

***Exploratory Activities in Poland***

             

Our ongoing activities in Poland are conducted in six areas: Fences,            Northwest, Kutno, Warsaw South, Block 255, and Block 287. Our exploration activities            are currently focused primarily on the core Fences area, where the gas-bearing            Rotliegend sandstone reservoir rock is a direct analog to the Southern North Sea gas            basin offshore the United Kingdom. We are focused on this core area because substantial            gas reserves have already been discovered and developed by POGC, we have made five            commercial gas discoveries, together with POGC, containing proved gas reserves of            approximately 72 Bcf gross (31 Bcf net to our interest), and we have concluded that            there is likely to be substantial additional natural gas in the same geologic            horizon.

 

6

 

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*Fences Area*

             

The Fences concession area is 852,000 gross acres (3,450 sq. km.) in            western Poland’s Permian Basin surrounding POGC’s Radlin gas field. The            Radlin field and several other POGC gas fields located in the Fences area are            “fenced off” or excluded from our exploration acreage. These fields,            discovered by POGC between 1974 and 1982, produce from structural traps in the            Rotliegend sandstone.

 

We hold a 49% interest in approximately 807,000 acres and a 24.5%            interest in the remaining 45,000 acres in the Fences area.

 

The Rotliegend is the primary target horizon throughout most of the            Fences concession area, at depths from approximately 2,500 to 4,000 meters. There are            two types of Rotliegend traps in the region: structural traps and stratigraphic            (“pinch-out”) traps. Both of these trap types are known to produce gas in            the region. In addition, we have identified what appear to be carbonates in the            Zechstein, a third type of trap that is known to produce both oil and gas in the            region.

 

*      Fences Area: Structural            Traps*

             

Based on our drilling experience since 2000 in the Fences area, we have            emphasized the use of acquisition, processing, and interpretation techniques that have            been used successfully in the Rotliegend gas fields of the United Kingdom’s            offshore Southern Gas Basin. With Rotliegend structures as our target, and utilizing            improved seismic data processing and acquisition techniques, we have drilled six wells            targeting Rotliegend structures. Five of these wells are commercial, with aggregate            proved gas reserves of approximately 71 Bcf gross (31 Bcf net to our            interest).

 

In January 2007, we completed the Winna Gora well as a commercial            success (with production anticipated to begin at the end of 2009). At year-end, gross            proved reserves for the well were estimated at approximately 7.5 Bcf of gas (3.7 Bcf            net to our 49% interest). 3-D seismic data in the Winna Gora area will be available            during 2008 and should assist us in determining whether to produce the existing            vertical well or, alternatively, drill a horizontal well in this structure.

 

In May 2007, we completed the Roszkow-1 well as a commercial success            (with initial production in late 2008 or early 2009). At December 31, 2007, gross            proved reserves for the well were estimated at approximately 29.1 Bcf of gas (14.3 Bcf            net to our 49% interest).

 

Three more wells targeting Rotliegend structural traps are scheduled to            start drilling in 2008. Each well targets an as-yet undrilled structure in the area of            the Sroda-4 and Sroda-5 wells. The structural targets are named: Kromolice-N,            Kromolice-S, and Sroda City. These three wells will be located with the help of our            recently completed 3-D seismic data.

 

As part of our focus on that part of the Fences area that is prone to            Rotliegend structural traps, we have acquired several hundred square kilometers of 3-D            seismic data and plan to acquire an additional 200 square kilometers of 3-D seismic            data in 2008 in the area where the Sroda-4, Sroda-5, and Winna Gora wells are located            and along the trend to the southeast. We also plan to acquire approximately 200            kilometers of 2-D seismic data over a lead, Taczanow, that lies on the trend southeast            from the Zaniemysl and Roszkow wells, our two biggest discoveries to date.

 

Finally, in the northern-most part of our Fences concession and lying            within the area covered by our recent 3-D seismic data, we have identified a very large            upthrown block, or horst, of Rotliegend sandstone that encompasses approximately 50            square kilometers, or 12,000 acres, within our Fences concession, and continues into            the area north of our concession. One well, the 1984 Plawce-1, was drilled on this            Rotliegend block within what is now our Fences concession. Five other wells have been            drilled in this block north of our concession boundary, all but one of them more than            20 years ago. All six of these wells had substantial gas columns, and all but the most            recent well were plugged due to relatively tight reservoir rocks. The one new well,            Trzek-1, located about 6 kilometers north of our concession, was drilled in 2007 and            reportedly tested gas at rates between 2.5 and 7.5 million cubic feet of natural gas            per day, or MMcfD, after hydraulic fracturing.

 

7

 

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            We            are currently working with service companies that specialize in production from tight            Rotliegend reservoirs in the southern United Kingdom gas basin and in Germany. Over the            next few months we will prepare a plan to appraise and develop the gas resource in the            Plawce area. We have scheduled additional field work in 2008 that will enhance the            quality of our 3-D seismic and appraisal data in the Plawce area.

 

*       Fences Area: Stratigraphic            Traps*

             

In the southwestern portion of the Fences concession, outside the area            prone to Rotliegend structures, there is potential for stratigraphic trapping, or            pinch-outs, in the Rotliegend. Based on data from the Rusocin-1 and the Lugi-1 wells we            drilled in 2005, and on the presence of wells that produce from stratigraphic traps            further to the west from our concession, we plan to acquire 3-D data in 2009 that will            help us determine the next steps in exploring the pinch-out area.

 

*      Fences Area: Carbonate (Reef)            Traps*

             

In the northeastern portion of the Fences concession, also outside the            area prone to Rotliegend structures, we have identified what appear to be carbonate            (reef) targets in the Zechstein (Ca2) horizon of the lower Permian, just above the            Rotliegend. In February 2008 we began drilling the Grundy-1 well to test a possible Ca2            reef build-up identified on 2-D seismic. The Grundy-1 is located approximately 30            kilometers east of the Company’s Sroda area. The nearest significant Ca2            producing fields, the BMB and Miedzychód-Lubiatow-Grotów            (“MLG”) oil and gas fields owned by POGC, are located approximately 60 to            80 kilometers northwest of the Grundy well location and reportedly contain            approximately 125 million barrels of oil and 500 Bcf of gas.

 

*Northwest Concession Area*

             

In 2006, the Company acquired a 100% interest in a concession in            west-central Poland covering 1.6 million acres. The concession is in Poland’s            Permian Basin directly north of POGC’s BMB and MLG oil and gas fields. As in the            Company’s Fences concession, the Northwest concession has three separate possible            exploration models: Rotliegend sands trapping gas in structural closures; Rotliegend            sands trapping gas in stratigraphic traps or pinchouts; and Zechstein Ca2 dolomitic            sands, reefs, and talus trapping oil and gas.

 

During 2007 the Company’s technical team reviewed the existing            sparse, 20 year old geological and geophysical data from the area. In an area of 1.6            million acres, there were only about 2,500 kilometers of 2-D seismic data and only            three wells drilled to target depths. As a result of this review, we elected to            relinquish approximately 500,000 acres from the northeast corner of this concession,            retaining approximately 1.1 million acres. In January 2008, we initiated field work to            acquire just over 200 kilometers of new 2-D seismic over several of the leads            identified the previous year. We plan to seek industry participation while continuing            to carry out early stage exploration work on our own.

 

*Kutno Concession Area*

             

In 2007, we acquired a 100% interest in a concession in central Poland            covering 284,000 acres. The area encompasses a Rotliegend mega-structure            (“Kutno”) with projected four-way dip closure. The interpreted gas column            is 280 meters over an area of 143 square kilometers. With expected porosity of between            5% and 15%, the structure has a calculated potential gross volume of up to 19 trillion            cubic feet. Depth of the structure is estimated at approximately 6,000 meters (19,200            feet). In view of the depth and cost, we are seeking industry participation to drill            Kutno.

 

*Warsaw South Concession Area*

             

In 2007, we acquired a 100% interest in a concession in east central            Poland covering approximately 935,000 acres. The Warsaw South concession has several            possible exploration opportunities, including carboniferous sands with structural or            truncation trapping and Zechstein reefs trapped by overlying evaporates and salt.            During 2007, our technical group reviewed the geological and geophysical data from the            area. The team identified a dozen carboniferous leads and two possible Zechstein reef            targets. We plan to seek industry participation while continuing to carry out early            stage exploration work on our own.

 

8

 

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*Block 255 Concession Area*

             

The Block 255/Wilga concession area in east central Poland consists of            an 82% working interest in approximately 250,000 gross acres. We have one producing            well, Wilga-2, in Block 255, the result of an exploration project conducted several            years ago by us and Apache Corporation. As of December 31, 2007, the Wilga well            had remaining gross proved reserves of approximately 0.55 Bcf of gas and 16,900 barrels            of light crude oil (0.45 Bcf and 14,000 barrels, net to our interest). Wilga-2 is            currently producing approximately 1 MMcfD of high methane gas and 20 barrels of light            crude oil per day from sands in the Carboniferous.

 

*Block 287 Concession Area*

             

The Block 287 concession area is 213,000 acres (863 sq. km.) located            approximately 25 miles south of the Fences concession area. We own 100% of the            exploration rights. Block 287 was part of a larger concession area which we            relinquished in 2007 based on our technical evaluation and on a 2006 dry hole that we            drilled.

 

Within Block 287 there are three Rotliegend gas wells known as the            Grabowka wells. Originally drilled by POGC in 1983-85, these three wells tested gas but            never produced commercially. In early 2007, we entered into a joint venture agreement            with an unrelated party, PL Energia S.A., headquartered in Krzywoploty, Poland, under            which all costs of re-entering and completing the three Grabowka wells and building            production facilities will be paid by our joint venture partner in exchange for            discounted pricing on gas. If our re-entry of these wells is commercial, the project is            expected to come on-stream in the second half of 2008. We do not plan to conduct            further technical work on Block 287.

 

*Additional Concession Acreage*

             

We have applied for additional concession blocks in Poland that have not            yet been issued. We may apply for yet more concession blocks in Poland in 2008. We will            allocate modest technical and financial resources to these areas during 2008, primarily            in the form of data collection and seismic reprocessing, with a view to ascertaining            relative hydrocarbon potential and exploration risk.

 

***Activities and Assets in the United States***

             

*Nevada*

             

During 2007, we did not drill any wells. We may drill one or two            exploratory wells in 2008 on land that is near our existing producing properties in            Nevada.

 

*Montana*

             

During 2007, we did not drill any wells in Montana. We may drill one or            two exploratory wells in 2008 using our own drilling rig.

 

**Segment Information**

 

Further information concerning our financial and geographic segments can            be found in the footnotes to the consolidated financial statements.

 

**Available Information**

 

We make available, free of charge, either on our website            (www.fxenergy.com) or by contacting our main office in Salt Lake City, Utah at (801)            486-5555, our annual report on Form 10-K, quarterly reports on Form 10-Q, current            reports on Form 8-K, and amendments to those reports filed or furnished pursuant to            Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably            practicable as we file such material with, or furnish it to, the Securities and            Exchange Commission. 

 

 

9

 

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**ITEM 1A. RISK FACTORS**

 

**Risk Factors**

 

Our business is subject to a number of material risks, including, but            not limited to, the following factors related directly and indirectly to our business            activities in the United States and Poland.

 

***Risks Relating to our Business***

             

*Our success depends largely on our discovery of economic quantities            of oil or gas in Poland.*

             

We currently have a limited amount of production in the United States            and Poland. While during 2008 we anticipate that we will generate revenues in excess of            our general and administrative costs, these revenues are not sufficient to cover all of            our exploration and development costs, and we will continue to rely on existing working            capital and possibly on funds from external sources to cover these costs. Our            exploration programs in Poland are based on interpretations of geological and            geophysical data. The factors listed below, most of which are outside our control, may            prevent us from establishing additional commercial production or substantial reserves            as a result of our exploration, appraisal, and development activities in            Poland:

 

|   | **•** | whether we will be able to discover and produce oil or                            gas in commercial quantities from any exploration prospect; |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------|

             

|   | **•** | whether the quantities of oil or gas we discover will be                            as large as our initial estimate of an exploration target area’s                            gross unrisked potential; |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

             

|   | **•** | whether actual exploration risks will be consistent with                            our forecasts; |
|--------|------------|----------------------------------------------------------------------------------------------------|

             

|   | **•** | we cannot assure that any future well will encounter                            commercial quantities of oil or gas; |
|--------|------------|----------------------------------------------------------------------------------------------------------------------|

             

|   | **•** | there is no method to predict in advance of drilling and                            testing whether any prospect encountering oil or gas will yield oil or                            gas in sufficient quantities to cover drilling or completion costs or                            to be economically viable; |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

             

|   | **•** | one or more appraisal wells may be required to confirm                            the commercial potential of an oil or gas discovery; |
|--------|------------|----------------------------------------------------------------------------------------------------------------------------------------|

             

|   | **•** | we may continue to incur exploration costs in specific                            areas even if initial appraisal wells are plugged and abandoned or, if                            completed for production, do not result in production of commercial                            quantities of oil or gas; and |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

             

|   | **•** | drilling operations may be curtailed, delayed or                            canceled as a result of numerous factors, including operating problems                            encountered during drilling, weather conditions, compliance with                            governmental requirements, shortages or delays in the delivery of                            equipment or availability of services, and other factors. |
|--------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

             

10

 

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*We have limited control over our exploration and development            activities in Poland.*

             

Our partner, POGC, holds the majority interest and is operator of our            Fences project area and has a minority interest in our Wilga project area. As a paying            partner, we rely to a significant extent on the financial capabilities of POGC. If POGC            were to fail to perform its obligations under contracts with us, it would most likely            have a material adverse effect on us. In particular, we have prepared our exploration            budget through 2008 and beyond based on the participation of and funding to be provided            by POGC. Although we have rights to participate in exploration and development            activities on some POGC-controlled acreage, we have limited rights to initiate such            activities. Further, we have no direct interest in some of the underlying agreements,            licenses, and grants from the Polish agencies governing the exploration, exploitation,            development, or production of acreage controlled by POGC. Thus, our program in Poland            involving POGC-controlled acreage would be adversely affected if POGC should elect not            to pursue activities on such acreage, if the relationship between us and POGC should            deteriorate or terminate, or if POGC or the governmental agencies should fail to            fulfill the requirements of or elect to terminate such agreements, licenses, or            grants.

 

*We cannot assure the exploration models we are using in Poland will            lead to finding oil or gas in Poland.*

             

We cannot assure the exploration models we and POGC have developed will            provide a useful or effective guide for selecting exploration prospects and drilling            targets. We will have to revise or replace these exploration models as a guide to            further exploration if ongoing drilling results do not confirm their validity. These            exploration models may be based on incomplete or unconfirmed data and theories that            have not been fully tested. The seismic data, other technologies, and the study of            producing fields in the area do not enable us to know conclusively prior to drilling            that oil or gas will be present in commercial quantities. We cannot assure that the            analogies that we draw from available data from other wells, more fully explored            prospects, or producing fields will be applicable to our drilling prospects.

 

*We cannot accurately predict the size of exploration targets or            foresee all related risks.*

             

Notwithstanding the accumulation and study of 2-D and 3-D seismic data,            drilling logs, production information from established fields, and other data, we            cannot predict accurately the oil or gas potential of individual prospects and drilling            targets or the related risks. We sometimes predict the gross potential oil or gas in a            particular area as part of our evaluation of the exploration potential and related            risks. Our predictions are only rough, preliminary geological estimates of the            forecasted volume and characteristics of possible reservoirs and the calculated            potential oil or gas that could be contained if present. Such forecasts are not an            assurance that our exploration will be successful or we will be able to establish            reserves equal to such forecasts. In some cases, our estimates may be based on a review            of data from other exploration or producing fields in the area that ultimately may be            found not to be similar to our exploration prospects. We may require several test wells            and long-term analysis of test data and history of production to determine the oil or            gas potential of individual prospects.

 

*We have had limited exploratory success in Poland.*

             

We have participated in drilling 25 exploratory wells in Poland,            including six commercial discoveries (the Wilga 2, Kleka 11, Zaniemysl-3, Sroda-4,            Winna Gora-1, and Roszkow-1), and nineteen non-commercial wells. Of our six commercial            successes in Poland, we were producing gas at our Wilga 2, Zaniemysl-3, and Kleka 11            wells as of December 31, 2007.

 

*We may not achieve the results anticipated in placing our current or            future discoveries into production.*

             

We may encounter delays in commencing the production and the sale of gas            in Poland, including our recent gas discoveries and other possible future discoveries.            The possible delays may arise in obtaining rights-of-way to connect to the POGC            pipeline system, obtaining construction permits, availability of materials and            contractors, the signing of oil or gas purchase/sales contracts, and other factors.            Such delays would correspondingly delay the commencement of cash flow and may require            us to obtain additional short-term financing pending commencement of production.            Further, we may design proposed surface and pipeline facilities based on possible            estimated results of additional drilling. We cannot assure that additional drilling            will establish additional reserves or production that will provide an economic return            for planned expenditures for facilities. We may have to change our anticipated            expenditures if costs of placing a particular discovery into production are higher, if            the project is smaller, or if the commencement of production takes longer than            expected.

 

11

 

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*Privatization/Nationalization of POGC could affect our relationship            and future opportunities in Poland.*

             

Our activities in Poland have benefited from our relationship with POGC,            which has provided us with exploration acreage, seismic data, and production data under            our agreements. The Polish government commenced the privatization of POGC by selling            POGC’s refining assets and by successfully completing an initial public offering            of approximately 15% of its stock. Complete privatization or a re-nationalization of            POGC may result in new policies, strategies, or ownership that could adversely affect            our existing relationship and agreements, as well as the availability of opportunities            with POGC in the future.

 

*We have a history of operating losses and may require additional            capital in the future to fund our operations.*

             

From our inception in January 1989 through December 31, 2007, we have            incurred cumulative net losses of approximately $105 million. We expect that our            exploration and production activities may continue to result in net losses through 2008            and possibly beyond, depending on whether our activities in Poland and the United            States result in sufficient revenues to cover related operating expenses.

 

Until sufficient cash flow from operations can be obtained, we expect we            will need additional capital to fully fund our ongoing planned exploration, appraisal,            development, and property acquisition programs in Poland. We may seek required funds            from the issuance of additional debt, equity or hybrid securities, project financing,            strategic alliances, or other arrangements. Obtaining additional financing may dilute            the interest of our existing stockholders or our interest in the specific project being            financed. We cannot assure that additional funds could be obtained or, if obtained,            would be on terms favorable to us. In addition to planned activities in Poland, we may            require additional funds for general corporate purposes.

 

*The loss of key personnel could have an adverse impact on our            operations.*

             

We rely on our officers and key employees and consultants and their            expertise, particularly David N. Pierce, President and Chief Executive Officer; Thomas            B. Lovejoy, Chairman of the Board and Executive Vice President; Andrew W. Pierce,            Vice President-Operations; Jerzy B. Maciolek, Vice President-Exploration; Zbigniew            Tatys, Poland Country Manager; and Richard Hardman, Director and Chairman of our            technical committee. The loss of the services of any of these individuals may            materially and adversely affect us. We have entered into employment agreements with our            key executives. We do not maintain key-man insurance on any of our            employees.

 

*The price we receive for gas we sell will likely be lower than free            market gas prices in western Europe.*

             

Our limited number of wells and reserves means we cannot assure            uninterruptible supply in sufficient quantities to meet the anticipated requirements of            industrial users, so we currently are dependent on selling gas to POGC at prices            generally lower than prevailing in western Europe. The market for the sale of gas in            Poland is open to competition, but there are not yet many participants. Accordingly, we            expect that the prices we receive for the gas we produce will be lower than would be            the case in a fully competitive setting and may be lower than prevailing western            European prices, at least until a fully competitive market develops in Poland or until            we are able to assure potential purchasers other than POGC that we have sufficient            wells and reserves to assure an uninterruptible supply in sufficient quantities.            Further, there is no established market relationship between gas prices in short-term            and long-term sales agreements. Notwithstanding the strong demand for gas in Poland,            the availability of abundant quantities of gas from former members of the Soviet Union            and the low cost of electricity from coal-fired generating facilities may also tend to            depress gas prices in Poland.

 

*Substantially all of the oil and gas currently produced in Poland is            sold to a single customer or its affiliates.*

             

We currently sell substantially all of the oil and gas produced in            Poland to POGC or one of its affiliates. If POGC were to fail to perform its            obligations under contracts with us, it would most likely have a material adverse            effect on us. As discussed previously, the market for the sale of gas in Poland is open            to competition, but there are not yet many participants. While our contracts provide us            with the ability to market gas to other purchasers, including those outside of Poland,            it may take a considerable amount of time to replace POGC as our primary            customer.

 

12

 

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*Oil and gas price decreases and volatility could adversely affect our            operations and our ability to obtain financing.*

             

Oil and gas prices have been and are likely to continue to be volatile            and subject to wide fluctuations in response to the following factors:

 

|   | **•** | the market and price structure in local                            markets; |
|--------|------------|-----------------------------------------------------------------------------|

             

|   | **•** | changes in the supply of and demand for oil and                            gas; |
|--------|------------|---------------------------------------------------------------------------------|

             

|   | **•** | market uncertainty; |
|--------|------------|---------------------|

             

|   | **•** | political conditions in international oil and gas                            producing regions; |
|--------|------------|-------------------------------------------------------------------------------------------------|

             

|   | **•** | the extent of production and importation of oil and gas                            into existing or potential markets; |
|--------|------------|------------------------------------------------------------------------------------------------------------------------|

             

|   | **•** | the level of consumer demand; |
|--------|------------|-------------------------------|

             

|   | **•** | weather conditions affecting production, transportation,                            and consumption; |
|--------|------------|------------------------------------------------------------------------------------------------------|

             

|   | **•** | the competitive position of oil or gas as a source of                            energy, as compared with coal, nuclear energy, hydroelectric power, and                            other energy sources; |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

             

|   | **•** | the availability, proximity, and capacity of gathering                            systems, pipelines, and processing facilities; |
|--------|------------|----------------------------------------------------------------------------------------------------------------------------------|

             

|   | **•** | the refining and processing capacity of prospective oil                            or gas purchasers; |
|--------|------------|-------------------------------------------------------------------------------------------------------|

             

|   | **•** | the effect of governmental regulation on the production,                            transportation, and sale of oil and gas; and |
|--------|------------|----------------------------------------------------------------------------------------------------------------------------------|

             

|   | **•** | other factors beyond our control. |
|--------|------------|-----------------------------------|

 

We            have not entered into any agreements to protect us from price fluctuations and may or            may not do so in the future.

 

*Our industry is subject to numerous operating risks. Insurance may            not be adequate to protect us against all these risks.*

             

Our oil and gas drilling and production operations are subject to            hazards incidental to the industry. These hazards include blowouts, cratering,            explosions, uncontrollable flows of oil, gas or well fluids, fires, pollution, releases            of toxic gas, and other environmental hazards and risks. These hazards can cause            personal injury and loss of life, severe damage to and destruction of property and            equipment, pollution or environmental damage, and suspension of operations. To lessen            the effects of these hazards, we maintain insurance of various types to cover our            domestic and international operations. We cannot assure that the insurance policies            carried by us or by POGC, as operator of the Fences area, can continue to be obtained            on reasonable terms. While we do carry limited third-party liability and all-risk            insurance in Poland, we do not plan to purchase well control insurance on wells we            drill in the Fences project area and may elect not to purchase such insurance on wells            drilled in other areas in Poland as well. The current level of insurance does not cover            all of the risks involved in oil and gas exploration, drilling and production. Where            additional insurance coverage does exist, the amount of coverage may not be sufficient            to pay the full amount of such liabilities. We may not be insured against all losses or            liabilities that may arise from all hazards because such insurance is unavailable at            economic rates, because of limitations on existing insurance coverage, or other            factors. For example, we do not maintain insurance against risks related to violations            of environmental laws. We would be adversely affected by a significant adverse event            that is not fully covered by insurance. Further, we cannot assure that we will be able            to maintain adequate insurance in the future at rates we consider            reasonable.

 

13

 

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***Risks Relating to Conducting Business in Poland***

             

*Polish laws, regulations and policies may be changed in ways that            could adversely impact our business.*

             

Our oil and gas exploration, development, and production activities in            Poland are and will continue to be subject to ongoing uncertainties and risks,            including:

 

|   | **•** | possible changes in government personnel, the                            development of new administrative policies, and practices and political                            conditions in Poland that may affect the administration of agreements                            with governmental agencies or enterprises; |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

             

|   | **•** | possible changes to the laws, regulations, and policies                            applicable to us and our partners or the oil and gas industry in Poland                            in general; |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

             

|   | **•** | uncertainties as to whether the laws and regulations                            will be applicable in any particular circumstance; |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------|

             

|   | **•** | uncertainties as to whether we will be able to enforce                            our rights in Poland; |
|--------|------------|---------------------------------------------------------------------------------------------------------|

             

|   | **•** | uncertainty as to whether we will be able to                            demonstrate, to the satisfaction of the Polish authorities, our and                            POGC’s compliance with governmental requirements respecting                            exploration expenditures, results of exploration, environmental                            protection matters, and other factors; |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

             

|   | **•** | the inability to recover previous payments to the Polish                            government made under the exploration rights or any other costs                            incurred respecting those rights if we were to lose or cancel our                            exploration and exploitation rights at any time; |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

             

|   | **•** | political instability and possible changes in                            government; |
|--------|------------|--------------------------------------------------------------------------------------|

             

|   | **•** | export and transportation tariffs; |
|--------|------------|------------------------------------|

             

|   | **•** | local and national tax requirements; |
|--------|------------|--------------------------------------|

             

|   | **•** | expropriation or nationalization of private enterprises                            and other risks arising out of foreign government sovereignty over our                            acreage in Poland; and |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

             

|   | **•** | possible significant delays in obtaining opinions of                            local authorities or satisfying other governmental requirements in                            connection with a grant of permits to conduct exploration and                            production activities. |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

             

*Poland has a developing regulatory regime, regulatory policies and            interpretations.*

             

Poland has a regulatory regime governing exploration and development,            production, marketing, transportation, and storage of oil and gas. These provisions            were promulgated during the past two decades and are relatively untested. Therefore,            there is little or no administrative or enforcement history or established practice            that can aid us in evaluating how the regulatory regime will affect our operations. It            is possible those governmental policies will change or that new laws and regulations,            administrative practices or policies, or interpretations of existing laws and            regulations will materially and adversely affect our activities in Poland. For example,            Poland’s laws, policies, and procedures were changed to conform to the            requirements that had to be met before Poland was admitted as a full member of the            European Union.

 

14

 

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*Our oil and gas operations are subject to changing environmental laws            and regulations that could have a negative impact on our operations.*

             

Operations on our project areas are subject to environmental laws and            regulations in Poland that provide for restrictions and prohibitions on spills,            releases, or emissions of various substances produced in association with oil and gas            exploration and development. Additionally, if significant quantities of gas are            produced with oil, regulations prohibiting the flaring of gas may inhibit oil            production. In such circumstances, the absence of a gas gathering and delivering system            may restrict production or may require significant expenditures to develop such a            system prior to producing oil and gas. We are required to prepare and obtain approval            of environmental impact assessments by governmental authorities in Poland prior to            commencing oil or gas production, transportation, and processing functions. We are also            subject to the requirements of Natura 2000, which is an ecological network in the            territory of the European Union. In May 1992, governments of the European Union adopted            legislation designed to protect the most seriously threatened habitats and species            across Europe.

 

We and our partners cannot assure that we have complied with all            applicable laws and regulations in drilling wells, acquiring seismic data, or            completing other activities in Poland to date. The Polish government may adopt more            restrictive regulations or administrative policies or practices. The cost of compliance            with current regulations or any changes in environmental regulations could require            significant expenditures. Further, breaches of such regulations may result in the            imposition of fines and penalties, any of which may be material. These environmental            costs could have an adverse effect on our financial condition, results of operations,            or cash flows in the future.

 

*Certain risks of loss arise from our need to conduct transactions in            foreign currency.*

             

The amounts in our agreements relating to our activities in Poland are            sometimes expressed and payable in United States dollars and sometimes in Polish            zlotys. Conversions between United States dollars and Polish zlotys are typically made            on the date amounts are paid or received. In the future, our financial results and cash            flows in Poland may be affected by fluctuations in exchange rates between the Polish            zloty and the United States dollar. We have not hedged our foreign currency activities            in the past and do not plan to do so. Currencies used by us may not be convertible at            satisfactory rates. In addition, the official conversion rates between United States            and Polish currencies may not accurately reflect the relative value of goods and            services available or required in Poland. Further, inflation may lead to the            devaluation of the Polish zloty.

 

*The interests that we hold in concessions and usufructs owned in the            name of POGC may be jeopardized or lost, without compensation to us, in the event of            POGC’s bankruptcy, persistent breaches of laws such as environmental            requirements, winding up, or other circumstances.*

             

The Poland Ministry of the Environment, which administers the Geologic            and Mining Law, has the authority to terminate concessions and usufructs in the name of            POGC and in which we have a fractional undivided interest if POGC is declared bankrupt,            persistently violates environmental regulations or other laws, is wound up, rescinds            the concession, or otherwise breaches material usufruct or concession terms. There can            be no assurance that POGC’s current 85% government ownership will continue or            that the Poland government will in any circumstance intervene to prevent POGC’s            insolvency or bankruptcy. We may not be able to implement effective measures to            preserve and protect our property interests by curing any concession or usufruct            default by POGC, assuring fair compensation in the event of any such loss, or            implementing new legal strategies that would insulate our interests from loss due to            POGC’s actions or condition.

 

15

 

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***Risks Related to an Investment in our Common            Stock***

             

*Our stockholder rights plan and bylaws discourage unsolicited            takeover proposals and could prevent our stockholders from realizing a premium on our            common stock.*

             

We have a stockholder rights plan that may have the effect of            discouraging unsolicited takeover proposals. The rights issued under the stockholder            rights plan would cause substantial dilution to a person or group that attempts to            acquire us on terms not approved in advance by our board of directors. In addition, our            articles of incorporation and bylaws contain provisions that may discourage unsolicited            takeover proposals that our stockholders may consider to be in their best interests            that include:

 

|   | **•** | provisions that members of the board of directors are                            elected and retire in rotation; and |
|--------|------------|----------------------------------------------------------------------------------------------------------------------|

             

|   | **•** | the ability of the board of directors to designate the                            terms of, and to issue new series of, preferred shares. |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------|

 

Together, these provisions and our stockholder rights plan may            discourage transactions that otherwise could involve payment to our stockholders of a            premium over prevailing market prices for our common shares.

 

*Our common stock price has been and may continue to be extremely            volatile.*

             

Our common stock has traded as low as $4.41 and as high as $10.60 during            intraday trading between January 1, 2007, and the date of this report. Some of the            factors leading to this volatility include:

 

|   | **•** | the outcome of individual wells or the timing of                            exploration efforts in Poland; |
|--------|------------|------------------------------------------------------------------------------------------------------------|

             

|   | **•** | the potential sale by us of newly issued common stock to                            raise capital or by existing stockholders of restricted                            securities; |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

             

|   | **•** | price and volume fluctuations in the general securities                            markets that are unrelated to our results of operations; |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------------------------|

             

|   | **•** | the investment community’s view of companies with                            assets and operations outside the United States in general and in                            Poland in particular; |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

             

|   | **•** | actions or announcements by POGC that may affect                            us; |
|--------|------------|---------------------------------------------------------------------------------|

             

|   | **•** | prevailing world prices for oil and gas; |
|--------|------------|------------------------------------------|

             

|   | **•** | the potential of our current and planned activities in                            Poland; and |
|--------|------------|-----------------------------------------------------------------------------------------------|

             

|   | **•** | changes in stock market analysts’ recommendations                            regarding us, other oil and gas companies, or the oil and gas industry                            in general. |
|--------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Exploration failures in Poland may adversely affect the trading prices            for our common stock.

 

 

**ITEM 1B. UNRESOLVED STAFF COMMENTS**

 

|   | None. |
|--------|-------|

 

 

16

 

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**ITEM 2. PROPERTIES**

 

**The Republic of Poland**

 

The Republic of Poland is located in central Europe, has a population of            approximately 39 million people, and covers an area comparable in size to New Mexico.            During 1989, Poland peacefully asserted its independence and became a parliamentary            democracy. Since 1989, Poland has enacted comprehensive economic reform programs and            stabilization measures that have enabled it to form a free-market economy and turn its            economic ties from the east to the west, with most of its current international trade            with the countries of the European Union and the United States. The economy has            undergone extensive restructuring in the post-communist era. The Polish government            credits foreign investment as a forceful growth factor in successfully creating a            stable, free-market economy.

 

Since its transition to a market economy and a parliamentary democracy,            Poland has experienced significant economic growth and political change. Poland has            developed and is refining legal, tax, and regulatory systems characteristic of            parliamentary democracies with interpretation and procedural safeguards. The Polish            government has taken steps to harmonize Polish legislation with that of the European            Union, which it joined in May of 2004.

 

Poland has created an attractive legal framework and fiscal regime for            oil and gas exploration by actively encouraging investment by foreign companies to            offset its lack of capital to further explore its oil and gas resources. In July 1995,            Poland’s Council of Ministers approved a program to restructure and privatize the            Polish petroleum sector. So far under this plan, a refinery located in Plock has been            privatized as a publicly held company with its stock trading on the London and Warsaw            stock exchanges. In September of 2005, POGC sold 15% of its stock in an initial public            offering on the Warsaw Stock Exchange, raising a total of 2.7 billion Polish zlotys            (approximately US$900 million).

 

Prior to becoming a parliamentary democracy during 1989, the exploration            and development of Poland’s oil and gas resources were hindered by a combination            of foreign influence, a centrally controlled economy, limited financial resources, and            a lack of modern exploration technology. As a result of these and other factors, Poland            is currently a net energy importer. Oil is imported primarily from countries of the            former Soviet Union and the Middle East, and gas is imported primarily from            Russia.

 

**Polish Properties**

 

***Legal Framework***

             

*General Usufruct and Concession Terms*

             

All of our rights in Poland have been awarded to us or to POGC pursuant            to the Geological and Mining Law, which specifies the process for obtaining domestic            exploration and exploitation rights. Under the Geological and Mining Law, the            concession authority enters into mining usufruct (lease) agreements that grant the            holder the exclusive right to explore for oil and gas in a designated area or to            exploit the designated oil and/or gas field for a specified period under prescribed            terms and conditions. The holder of the mining usufruct covering exploration must also            acquire an exploration concession by applying to the concession authority and providing            the opportunity for comment by local governmental authorities. The usufruct agreements            include provisions that give the usufruct holder a claim for an extension of the            usufruct (and the underlying concession), subject to having fulfilled all obligations            under the usufruct and/or concession agreements.

 

Under current law, the concession authority requires that concessions            and related usufructs be owned by a single entity, without recognizing any minority            record ownership such as would reflect our interest in those areas in which we            previously have been granted a minority ownership. As such, our ownership is subject to            continued compliance with applicable law, the usufruct and concession terms, and            solvency of POGC as the record owner.

 

17

 

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            The            concession authority has granted us oil and gas exploration rights on the Block 287 and            Wilga project areas, and has granted POGC oil and gas exploration rights on the Fences            project areas. The agreements divide these areas into blocks, generally containing            approximately 250,000 acres each. Concessions have been acquired for exploration in all            areas that lie within existing usufructs. The exploration period begins after the date            of the last concession signed under each respective usufruct. We believe all material            concession terms have been satisfied to date.

 

If commercially viable oil or gas is discovered, the concession owner,            during the first two years of production, then applies for an exploitation concession,            as provided by the usufructs, generally with a term of 25 to 30 years or as long as            commercial production continues. Upon the grant of the exploitation concession, the            concession owner may become obligated to pay a fee, to be negotiated, but expected to            be less than 1% of the market value of the estimated recoverable reserves in place. The            concession owner would also be required to pay a royalty on any production, the amount            of which will be set by the Council of Ministers, within a range established by            legislation for the mineral being extracted. The royalty rate for high-methane gas is            currently less than $0.07 per thousand cubic feet, or Mcf. This rate could be increased            or decreased by the Council of Ministers to a rate between $0.02 and $0.10 per Mcf (the            current statutory minimum and maximum royalty rates). Local governments will receive            60% of any royalties paid on production. The holder of the exploitation concession must            also acquire rights to use the land from the surface owner and could be subject to            significant delays in obtaining the consents of local authorities or satisfying other            governmental requirements prior to obtaining an exploitation concession.

 

*Existing Project Areas*

             

*Fences Project Area*

             

The Fences project area consists of six oil and gas exploration            concessions controlled by POGC, including two that were obtained as a result of a            public tender in 2007. Three producing fields (Radlin, Kleka, and Kaleje) lie within            the concession boundary, but are excluded from the Fences concessions. The original            four concessions have expiration dates ranging from July 2008 to September 2012.            Remaining work commitments in the aggregate for the four original concessions include            acquiring: 200 kilometers of 2-D seismic data, 180 sq. km. of 3-D seismic data, and            drilling two wells. POGC has filed an extension for the concession expiring in 2008            which we expect to be granted. The exploration period for the two new concessions will            start after they are granted in 2008. The total work commitment for the two concessions            is outlined in two phases: Phase I – three years: 260 kilometers of 2-D seismic            data; Phase II – three years: drilling two wells.

 

*Block 287 Project Area*

             

The Block 287 project area consists of a single oil and gas exploration            concession held by us. Several producing fields also lie within this concession’s            boundaries, but are excluded from the Block 287 project area. The concession is for a            period of six years ending in December 2009. Work commitments included acquiring 100            kilometers of new 2-D seismic data or drilling one well, which was satisfied by the            drilling of the Drozdowice-1 well, and analysis and interpretation of existing well            data. Beginning in the fourth year, there is a drilling requirement of a second well            that will be satisfied by re-entering and producing the Grabowka gas field.

 

*Wilga/Block 255 Project Area*

             

The Wilga project area consists of a single oil and gas exploration            concession held by us that expires in August 2009. The remaining period carries a work            commitment of trial production of the Wilga gas-condensate field and 165 kilometers of            2-D seismic data.

 

18

 

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*Northwest Project Area*

             

The Northwest project area consists of seven blocks originally awarded            in October 2006, and four additional blocks that were awarded as part of a public            tender in 2007. The total work commitment for the original seven blocks was outlined in            three phases: Phase I - one year: reprocessing and reinterpretation of existing data;            Phase II - two years: acquiring 960 kilometers of new 2-D seismic data; Phase III            – three years: drilling seven wells. As a result of our analysis of existing data            during Phase I, we dropped two of the original seven blocks in 2007. In January 2008,            we began the acquisition of 220 kilometers of 2-D seismic data in three of the            remaining five blocks. For the four new blocks, the exploration period will start after            the concessions are granted in 2008. The total work commitment for the four new blocks            is outlined in two phases: Phase I – three years: 280 kilometers of 2-D seismic            data; Phase II – three years: drilling four wells.

 

*Project areas added in 2007*

             

*Lublin/Warsaw South Project Area*

             

This project area is adjacent to Block 255 and consists of five single            exploration concessions granted in June, July, and September of 2007 for a period of            six years. The total work commitment for the five concessions is outlined in three            phases: Phase I – one year: reprocessing and reinterpretation of existing data;            Phase II – two years: acquiring 630 kilometers of new 2-D seismic data; Phase III            – three years: drilling five wells.

 

*Kutno Concession*

             

The Kutno concession consists of a single oil and gas exploration            concession granted in March 2007 for a period of six years. The total work commitment            is outlined in three phases: Phase I – one and one half years: reprocessing and            reinterpretation of existing data; Phase II – two years: drilling one well; Phase            III – two and one half years: drilling one well.

 

As of December 31, 2007, all required usufruct/concession payments had            been made for each of the above project areas. Usufruct/concession payments on new            concessions obtained beginning in 2006 are payable in annual installments over a            three-year period.

 

***Production, Transportation and Marketing***

             

The following table sets forth our net daily gas and oil production,            average sales price, and average production costs associated with our Polish production            during 2007, 2006, and 2005:

 

|                                                                  |   | **2007** |   | **2006** |   | **2005** |
|-----------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|
|                                                                  |   |     |   |     |   |     |
| Average daily net gas production                            (Mcf)(1)  |   | 5,039    |   | 837      |   | --       |
| Average sales price per Mcf                                           | $      | 4.95     | $      | 3.88     | $      | --       |
|                                                                  |   |     |   |     |   |     |
| Average daily net oil production                            (Bbls)(1) |   | 69       |   | 106      |   | --       |
| Average sales price per Bbl                                           | $      | 58.68    | $      | 56.58    | $      | --       |
|                                                                  |   |     |   |     |   |     |
| Average daily net Mcfe                            production(1)       |   | 5,453    |   | 1,473    |   | --       |
| Average production costs per                            Mcfe(2)       | $      | 0.58     | $      | 0.56     | $      | --       |

_______________

| (1) | Average daily net production amounts shown are                            calculated based on days of actual production. |
|-----|--------------------------------------------------------------------------------------------------------------------------|

| (2) | Production costs include lifting costs (electricity,                            fuel, water, disposal, repairs, maintenance, transportation, and                            similar items), and contract operator fees. Production costs do not                            include such items as general and administrative costs; depreciation,                            depletion and amortization; or Polish income taxes. |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Poland has a network of gas pipelines and crude oil pipelines traversing            the country serving major metropolitan, commercial, industrial, and gas production            areas, including significant portions of our acreage. Poland has a well-developed            infrastructure of hard-surfaced roads and railways over which oil and/or light crude            oil produced can be transported for sale. There are refineries in Gdansk and Plock in            Poland and one in Germany near the western Polish border that we believe could process            crude oil produced in Poland. Should we choose to export any oil or gas we produce, we            will be required to obtain prior governmental approval.

 

19

 

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            We            are currently selling all of our oil and gas production in Poland to POGC or one of its            affiliates. Gas is sold pursuant to long-term sales contracts, typically for the life            of each well, which obligate POGC to purchase all gas produced. Individual oil sales            are negotiated with POGC-affiliated entities and are not subject to sales            contracts.

 

**United States Properties**

 

***Producing Properties***

             

In the United States, we currently produce oil in Montana and Nevada.            All of our producing properties, except for the Rattlers Butte field (an exploratory            discovery during 1997), were purchased during 1994. A summary of our average daily            production, average working interest, and net revenue interest for our United States            producing properties during 2007 follows:

 

|                                     | **Average Daily Production (Bbls)** |   | **Average Working** |   | **Average**

**Net Revenue** |
|------------------------------------------|-------------------------------------|--------|---------------------|--------|------------------------------|
|                                     | **Gross**                           |   | **Net**             |   | **Interest**                 |   | **Interest** |
| **United States producing properties:**  |                                |   |                |   |                         |   |   |
| **Montana:**                             |                                |   |                |   |                         |   |   |
| Cut Bank                                 | 201                                 |   | 173                 |   | 99.6%                        |   | 86.4% |
| Bears Den                                | 7                                   |   | 5                   |   | 98.0                         |   | 78.3 |
| Rattlers Butte                           | 6                                   |   | 0                   |   | 6.3                          |   | 5.1 |
| Total                                    | 214                                 |   | 178                 |   |                         |   |   |
| **Nevada:**                              |                                |   |                |   |                         |   |   |
| Trap Springs                             | 6                                   |   | 1                   |   | 21.6                         |   | 18.9 |
| Munson Ranch                             | 29                                  |   | 9                   |   | 36.0                         |   | 34.0 |
| Bacon Flat                               | 23                                  |   | 4                   |   | 16.9                         |   | 12.5 |
| Total                                    | 58                                  |   | 14                  |   |                         |   |   |
| Total United States producing properties | 272                                 |   | 192                 |   |                         |   |   |

 

In Montana, we operate the Cut Bank and Bears Den fields and have an            interest in the Rattlers Butte field, which is operated by an industry partner.            Production in the Cut Bank field, producing since the 1940s from an average depth of            approximately 2,900 feet, is from a waterflood program with 120 producing oil wells, 29            active injection wells, and one active water supply well. The Bears Den field, under            waterflood since 1990, is producing oil from five wells at a depth of approximately            2,430 feet, with one active water injection well. In the Rattlers Butte field,            discovered during 1997, we own a 6.3% working interest in two oil wells producing at a            depth of approximately 5,800 feet and one active water injection well.

 

In Nevada, we operate the Trap Springs and Munson Ranch fields and have            an interest in the Bacon Flat field, which is operated by an industry partner. In the            Trap Springs field, discovered in 1976, we produce oil from a depth of approximately            3,700 feet from one well. In the Munson Ranch field, discovered in 1988, we produce oil            at an average depth of 3,800 feet from five wells. In the Bacon Flat field, discovered            in 1981, we produce oil from one well at a depth of approximately 5,000            feet.

 

***Production, Transportation and Marketing***

             

The following table sets forth our average net daily oil production,            average sales price and average production costs associated with our United States oil            production during 2007, 2006, and 2005:

 

|                                                           | **Years Ended December 31,** |
|----------------------------------------------------------------|------------------------------|
|                                                           | **2007**                     |   | **2006** |   | **2005** |
| **United States producing property data:**                     |                         |   |   |   |   |
| Average daily net oil production (Bbls)                        | 192                          |   | 209 |   | 217 |
| Average sales price per Bbl                                    | $61.75                       |   | $56.07 |   | $48.09 |
| Average production costs per                            Bbl(1) | $34.12                       |   | $27.65 |   | $26.79 |

_______________

| (1) | Production costs include lifting costs (electricity,                            fuel, water, disposal, repairs, maintenance, pumper, transportation,                            and similar items) and production taxes. Production costs do not                            include such items as general and administrative costs; depreciation,                            depletion and amortization; state income taxes, or federal income                            taxes. |
|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

20

 

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            We            sell oil at posted field prices to one of several purchasers in each of our production            areas. We sell all of our Montana production, which represents over 94% of our total            oil sales, to CENEX, a regional refiner and marketer. Posted prices are generally            competitive among crude oil purchasers. Our crude oil sales contracts may be terminated            by either party upon 30 days’ notice.

 

***Oilfield Services – Drilling Rig and Well-Servicing            Equipment***

             

In Montana, we perform, through our drilling subsidiary, FX Drilling            Company, Inc., a variety of third-party contract oilfield services, including drilling,            workovers, location work, cementing, and acidizing. We currently have a drilling rig            capable of drilling to a vertical depth of 6,000 feet, a workover rig, two service            rigs, cementing equipment, acidizing equipment, and other associated oilfield servicing            equipment.

 

**Proved Reserves**

 

Proved reserves are the estimated quantities of crude oil and natural            gas that geological and engineering data demonstrate with reasonable certainty to be            recoverable in future years from known reserves under existing economic and operating            conditions. Our proved oil and gas reserve quantities and values are based on estimates            prepared by independent reserve engineers in accordance with guidelines established by            the Securities and Exchange Commission, or SEC. Operating costs, production taxes, and            development costs were deducted in determining the quantity and value information. Such            costs were estimated based on current costs and were not adjusted to anticipate            increases due to inflation or other factors. No price escalations were assumed, and no            amounts were deducted for general overhead, depreciation, depletion and amortization,            and interest expense. The proved reserve quantity and value information is based on the            weighted average price on December 31, 2007, of $93.68 per Bbl of oil and $5.61 per Mcf            of gas in Poland and $81.07 per Bbl for oil in the United States. The determination of            oil and gas reserves is based on estimates and is highly complex and interpretive, as            there are numerous uncertainties inherent in estimating quantities and values of proved            reserves, projecting future rates of production, and the timing and amount of            development expenditures. The estimated present value, discounted at 10% per annum, of            the future net cash flows, the Standardized Measure of Future Net Cash Flows            (“SMOG”), or PV-10 Value, was determined in accordance with Statement of            Financial Accounting Standards (“SFAS”) No. 69, “Disclosure About Oil            and Gas Activities,” and SEC guidelines. Our proved reserve estimates are subject            to continuing revisions as additional information becomes available or assumptions            change.

 

Estimates of our proved United States oil reserves were prepared by            Larry Krause Consulting, an independent engineering firm in Billings, Montana.            Estimates of our proved Polish gas reserves were prepared by RPS Energy, an independent            engineering firm in the United Kingdom. No estimates of our proved reserves were filed            with or included in any report to any other federal agency during 2007.

 

The following summary of proved reserve information as of December 31,            2007, represents discounted, after tax estimates net to us only, and should not be            construed as exact:

 

|            |   | **Poland**  |   | **United States** |   | **Total**          |
|-----------------|--------|-------------|--------|-------------------|--------|--------------------|
|            |   | **Oil**     |   | **Gas**           |   | **PV-10 Value**    |   | **Oil** |   | **PV-10 Value** |   | **PV-10 Value** |
|            |   | **(MBbls)** |   | **(MMcf)**        |   | **(In thousands)** |   | **(MBbls)** |   | **(In thousands)** |   | **(In thousands)** |
| Proved reserves |   | 14          |   | 31,116            |   | $91,501            |   | 482 |   | $11,467 |   | $102,968 |

 

 

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**Drilling Activities**

 

The following table sets forth the exploratory wells that we drilled            during the years ended December 31, 2007, 2006, and 2005:

 

|                              | **Years Ended December 31,** |
|-----------------------------------|------------------------------|
|                              | **2007**                     |   | **2006** |   | **2005** |
|                              | **Gross**                    |   | **Net** |   | **Gross** |   | **Net** |   | **Gross** |   | **Net** |
| **Exploratory productive wells:** |                         |   |   |   |   |   |   |   |   |   |   |
| Poland                            | 2.0                          |   | 1.0 |   | -- |   | -- |   | 2.0 |   | 0.7 |
| United States                     | --                           |   | -- |   | -- |   | -- |   | -- |   | -- |
| Total                             | 2.0                          |   | 1.0 |   | -- |   | -- |   | 2.0 |   | 0.7 |
|                              |                         |   |   |   |   |   |   |   |   |   |   |
| **Exploratory dry holes:**        |                         |   |   |   |   |   |   |   |   |   |   |
| Poland                            | --                           |   | -- |   | 1.0 |   | 1.0 |   | 2.0 |   | 1.0 |
| United States                     | --                           |   | -- |   | 2.0 |   | 1.5 |   | 4.0 |   | 2.0 |
| Total                             | --                           |   | -- |   | 3.0 |   | 2.5 |   | 6.0 |   | 3.0 |
|                              |                         |   |   |   |   |   |   |   |   |   |   |
| **Total wells drilled**           | 2.0                          |   | 1.0 |   | 3.0 |   | 2.5 |   | 8.0 |   | 3.7 |

 

**Wells and Acreage**

 

|   | As of December 31, 2007, our producing gross and net                            well count consisted of the following: |
|--------|------------------------------------------------------------------------------------------------------------------------|

 

|             | **Number of Wells** |
|------------------|---------------------|
|             | **Gross**           |   | **Net** |
| **Well count:**  |                |   |   |
| Poland           | 3.0                 |   | 1.6 |
| United States(1) | 133.0               |   | 127.0 |
| Total            | 136.0               |   | 128.6 |

_______________

| (1) | All of our producing United States wells are oil wells.                            We have no gas production in the United States. |
|-----|------------------------------------------------------------------------------------------------------------------------------------|

 

The following table sets forth our gross and net acres of developed and            undeveloped oil and gas acreage as of December 31, 2007:

 

|                               | **Developed** |   | **Undeveloped** |
|------------------------------------|---------------|--------|-----------------|
|                               | **Gross**     |   | **Net**         |   | **Gross** |   | **Net** |
|                               |          |   |            |   |   |   |   |
| **Poland:**(1)                     |          |   |            |   |   |   |   |
| Fences project area                | 225           |   | 110             |   | 852,000 |   | 406,000 |
| Block 287                          | --            |   | --              |   | 213,000 |   | 213,000 |
| Wilga project area                 | 543           |   | 441             |   | 250,000 |   | 205,000 |
| Kutno project area                 | --            |   | --              |   | 284,000 |   | 284,000 |
| Lublin / Warsaw South project area |          |   |            |   | 935,000 |   | 935,000 |
| Northwest project area             | --            |   | --              |   | 1,167,000 |   | 1,167,000 |
| Total Polish acreage               | 768           |   | 551             |   | 3,701,000 |   | 3,210,000 |
|                               |          |   |            |   |   |   |   |
| **United States:**                 |          |   |            |   |   |   |   |
| Montana                            | 10,732        |   | 10,418          |   | 4,510 |   | 4,417 |
| Nevada                             | 400           |   | 128             |   | 9,332 |   | 6,351 |
| Total                              | 11,132        |   | 10,546          |   | 13,482 |   | 10,768 |
|                               |          |   |            |   |   |   |   |
| **Total Acreage**                  | 11,900        |   | 11,097          |   | 3,714,482 |   | 3,220,768 |

_______________

| (1) | All gross and net undeveloped Polish acreage is rounded                            to the nearest 1,000 acres. |
|-----|----------------------------------------------------------------------------------------------------------------|

 

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**Government Regulation**

 

***Poland***

             

Our activities in Poland are subject to political, economic, and other            uncertainties, including the adoption of new laws, regulations, or administrative            policies that may adversely affect us or the terms of our exploration or production            rights; political instability and changes in government or public or administrative            policies; export and transportation tariffs and local and national taxes; foreign            exchange and currency restrictions and fluctuations; repatriation limitations;            inflation; environmental regulations; and other matters. These operations in Poland are            subject to the Geological and Mining Law dated as of September 4, 1994 (as amended),            and the Protection and Management of the Environment Act dated as of January 31, 1980            (as amended), which are the current primary statutes governing environmental            protection. Agreements with the government of Poland respecting our areas create            certain standards to be met regarding environmental protection. Participants in oil and            gas exploration, development, and production activities generally are required to:            (1) adhere to good international petroleum industry practices, including practices            relating to the protection of the environment; and (2) prepare and submit            geological work plans, with specific attention to environmental matters, to the            appropriate agency of state geological administration for its approval prior to            engaging in field operations such as seismic data acquisition, exploratory drilling,            and field-wide development. Poland’s regulatory framework respecting            environmental protection is not as fully developed and detailed as that which exists in            the United States. We intend to conduct our operations in Poland in accordance with            good international petroleum industry practices and, as they continue to develop,            Polish requirements.

 

***United States***

             

*State and Local Regulation of Drilling and Production*

             

Our exploration and production operations are subject to various types            of regulation at the federal, state, and local levels. Such regulation includes            requiring permits for the drilling of wells, maintaining bonding requirements in order            to drill or operate wells and regulating the location of wells, the method of drilling            and casing wells, the surface use and restoration of properties upon which wells are            drilled, and the plugging and abandoning of wells. Our operations are also subject to            various conservation laws and regulations. These include the regulation of the size of            drilling and spacing units or proration units and the density of wells that may be            drilled and the unitization or pooling of oil and gas properties. In this regard, some            states allow the forced pooling or integration of tracts to facilitate exploration            while other states rely on voluntary pooling of lands and leases. In addition, state            conservation laws establish maximum rates of production from oil and gas wells,            generally prohibit the venting or flaring of gas, and impose certain requirements            regarding the ratability of production.

 

Our oil production is affected to some degree by state regulations.            States in which we operate have statutory provisions regulating the production and sale            of oil and gas, including provisions regarding deliverability. Such statutes and            related regulations are generally intended to prevent waste of oil and gas and to            protect correlative rights to produce oil and gas between owners of a common reservoir.            Certain state regulatory authorities also regulate the amount of oil and gas produced            by assigning allowable rates of production to each well or proration unit.

 

*Environmental Regulations*

             

The federal government and various state and local governments have            adopted laws and regulations regarding the control of contamination of the environment.            These laws and regulations may require the acquisition of a permit by operators before            drilling commences; restrict the types, quantities, and concentration of various            substances that can be released into the environment in connection with drilling and            production activities; limit or prohibit drilling activities on certain lands lying            within wilderness, wetlands, and other protected areas; and impose substantial            liabilities for pollution resulting from our operations. These laws and regulations may            also increase the costs of drilling and operating wells. We may also be held liable for            the costs of removal and damages arising out of a pollution incident to the extent set            forth in the Federal Water Pollution Control Act, as amended by the Oil Pollution Act            of 1990, or OPA ‘90. In addition, we may be subject to other civil claims arising            out of any such incident. As with any owner of property, we are also subject to            clean-up costs and liability for hazardous materials, asbestos, or any other toxic or            hazardous substance that may exist on or under any of our properties. We believe that            we are in compliance in all material respects with such laws, rules, and regulations            and that continued compliance will not have a material adverse effect on our operations            or financial condition. Furthermore, we do not believe that we are affected in a            significantly different manner by these laws and regulations than our competitors in            the oil and gas industry.

 

23

 

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The Comprehensive Environmental Response, Compensation and Liability            Act, or CERCLA, also known as the “Superfund” law, imposes liability,            without regard to fault or the legality of the original conduct, on certain classes of            persons that are considered to be responsible for the release of a “hazardous            substance” into the environment. These persons include the owner or operator of            the disposal site or sites where the release occurred and companies that disposed or            arranged for the disposal of the hazardous substances. Under CERCLA, such persons may            be subject to joint and several liability for the costs of cleaning up the hazardous            substances that have been released into the environment, for damages to natural            resources, and for the costs of certain health studies. Furthermore, it is not uncommon            for neighboring landowners and other third parties to file claims for personal injury            and property damage allegedly caused by hazardous substances or other pollutants            released into the environment.

 

The Resource Conservation and Recovery Act, or RCRA, and regulations            promulgated thereunder govern the generation, storage, transfer, and disposal of            hazardous wastes. RCRA, however, excludes from the definition of hazardous wastes            “drilling fluids, produced waters, and other wastes associated with the            exploration, development, or production of crude oil, gas, or geothermal energy.”            Because of this exclusion, many of our operations are exempt from RCRA regulation.            Nevertheless, we must comply with RCRA regulations for any of our operations that do            not fall within the RCRA exclusion.

 

The OPA ‘90 and related regulations impose a variety of            regulations on responsible parties related to the prevention of oil spills and            liability for damages resulting from such spills. OPA ‘90 establishes strict            liability for owners of facilities that are the site of a release of oil into            “waters of the United States.” While OPA ‘90 liability more typically            applies to facilities near substantial bodies of water, at least one district court has            held that OPA ‘90 liability can attach if the contamination could enter waters            that may flow into navigable waters.

 

Stricter standards in environmental legislation may be imposed on the            oil and gas industry in the future, such as proposals made in Congress and at the state            level from time to time, that would reclassify certain oil and gas exploration and            production wastes as “hazardous wastes” and make the reclassified wastes            subject to more stringent and costly handling, disposal, and clean-up requirements. The            impact of any such changes, however, would not likely be any more burdensome to us than            to any other similarly situated company involved in oil and gas exploration and            production.

 

*Federal and Indian Leases*

             

A substantial part of our producing properties in Montana consists of            oil and gas leases issued by the Bureau of Land Management or by the Blackfeet Tribe            under the supervision of the Bureau of Indian Affairs. Our activities on these            properties must comply with rules and orders that regulate aspects of the oil and gas            industry, including drilling and operating on leased land and the calculation and            payment of royalties to the federal government or the governing Indian nation. Our            operations on Indian lands must also comply with applicable requirements of the            governing body of the tribe involved including, in some instances, the employment of            tribal members. We believe we are currently in full compliance with all material            provisions of such regulations.

 

*Safety and Health Regulations*

             

We must also conduct our operations in accordance with various laws and            regulations concerning occupational safety and health. Currently, we do not foresee            expending material amounts to comply with these occupational safety and health laws and            regulations. However, since such laws and regulations are frequently changed, we are            unable to predict the future effect of these laws and regulations.

 

**Title to Properties**

 

We rely on sovereign ownership of exploration rights and mineral            interests by the Polish government in connection with our activities in Poland and have            not conducted and do not plan to conduct any independent title examination. We            regularly consult with our Polish legal counsel when doing business in            Poland.

 

24

 

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            Nearly            all of our United States working interests are held under leases from third parties. We            typically obtain a title opinion concerning such properties prior to the commencement            of drilling operations. We have obtained such title opinions or other third-party            review on all of our producing properties, and we believe that we have satisfactory            title to all such properties sufficient to meet standards generally accepted in the oil            and gas industry. Our United States properties are subject to typical burdens,            including customary royalty interests and liens for current taxes, but we have            concluded that such burdens do not materially interfere with the use of such            properties. Further, we believe the economic effects of such burdens have been            appropriately reflected in our acquisition cost of such properties and reserve            estimates. Title investigation before the acquisition of undeveloped properties is less            thorough than that conducted prior to drilling, as is standard practice in the            industry.

 

**Employees and Consultants**

 

As of December 31, 2007, we had 40 employees, consisting of nine in Salt            Lake City, Utah; 20 in Oilmont, Montana; one in Greenwich, Connecticut; three in            Houston, Texas; and seven in Poland. Our employees are not represented by a collective            bargaining organization. We consider our relationship with our employees to be            satisfactory. We also regularly engage technical consultants to provide specific            geological, geophysical, and other professional services. Our executive officers and            other management employees regularly travel to Poland to supervise activities conducted            by our staff and others under contract on our behalf.

 

**Offices and Facilities**

 

Our corporate offices, located at 3006 Highland Drive, Salt Lake City,            Utah, contain approximately 3,500 square feet and are rented at $3,400 per month under            a month-to-month agreement. In Montana, we own a 16,160 square foot building located at            the corner of Central and Main in Oilmont. We also have an office in Warsaw, Poland,            located at Ul. Chalubinskiego 8, which we rent for approximately $4,300 per            month.

 

**Oil and Gas Terms**

 

|   | The following terms have the indicated meaning when used                            in this report: |
|--------|-----------------------------------------------------------------------------------------------------|

 

**“Appraisal well**” means a well            drilled following a successful exploratory well used to determine the physical extent,            reserves and likely production rate of a field.

             

**“Bbl”**means oilfield            barrel.

             

**“Bcf”**means billion cubic feet            of natural gas.

             

**“Bcfe”**means billion cubic feet            of natural gas equivalent using a ratio of one barrel of oil to 6,000 cubic feet of            natural gas.

             

**“Development well”**means a well            drilled within the proved area of an oil or gas reservoir to the depth of a            stratigraphic horizon known to be productive.

             

**“Exploratory well”**means a well            drilled to find and produce oil or gas in an unproved area, to find a new reservoir in            a field previously found to be productive of oil or gas in another reservoir, or to            extend a known reservoir.

             

**“Field”**means an area            consisting of a single reservoir or multiple reservoirs all grouped on or related to            the same individual geological structural feature and/or stratigraphic            conditions.

             

**“Gross” acres and “gross” wells**mean the total number of acres or wells, as the case may be, in which an            interest is owned, either directly or through a subsidiary or other Polish enterprise            in which we have an interest.

             

**“Horizon”**means an underground            geological formation that is the portion of the larger formation that has sufficient            porosity and permeability to constitute a reservoir.

             

“**LCO**”            means light crude oil.

 

25

 

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**“MBbls”**means thousand oilfield            barrels.

             

**“Mcf”**means thousand cubic feet            of natural gas.

             

**“Mcfe”**means thousand cubic            feet of natural gas equivalent using a ratio of one barrel of oil to 6,000 cubic feet            of natural gas.

             

**“MMcf”**means million cubic feet            of natural gas.

             

**“MMcfD”**means million cubic            feet of natural gas per day.

             

**“Net”**means, when referring to            wells or acres, the fractional ownership working interests held by us, either directly            or through a subsidiary or other Polish enterprise in which we have an interest,            multiplied by the gross wells or acres.

             

**“Proved reserves”**means the            estimated quantities of crude oil, gas and gas liquids that geological and engineering            data demonstrate with reasonable certainty to be recoverable in future years fromknown            reservoirs under existing economic and operating conditions,*i.e.,*prices and costs as of the date the            estimate is made. “Proved reserves” may be developed or            undeveloped.

             

**“PV-10 Value”**means the            estimated future net revenue to be generated from the production of proved reserves            discounted to present value using an annual discount rate of 10.0%, the Standardized            Measure of Future Net Cash Flows (“SMOG”). These amounts are calculated net            of estimated production costs, future development costs and future income taxes, using            prices and costs in effect as of a certain date, without escalation and without giving            effect to non property-related expenses, such general and administrative costs, debt            service, and depreciation, depletion and amortization.

             

**“Reservoir”**means a porous and            permeable underground formation containing a natural accumulation of producible oil            and/or gas that is confined by impermeable rock or water barriers and that is distinct            and separate from other reservoirs.

             

“**Tcf**”            means trillion cubic feet of natural gas.

             

“**Usufruct**”            means the Polish equivalent of a U.S. oil and gas lease.

             

             

**ITEM 3. LEGAL PROCEEDINGS**

 

We are not a party to any material legal proceedings, and no material            legal proceedings have been threatened by us or, to the best of our knowledge, against            us, except as follows:

 

In November and December 2007, three actions were filed in the United            States District Court for the District of Utah against us and officers or directors            David N. Pierce, Clay Newton, Thomas B. Lovejoy, Andrew W. Pierce, and Richard Hardman,            by three separate plaintiffs, each seeking class certification to proceed on behalf of            all others similarly situated and alleging violations by the defendants of the            antifraud provisions of the federal securities laws set forth in Section 10(b) of the            Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder relating to our            public statements about our oil and gas activities and prospects in Poland between            March 2004 and January 2006. The complaints seek damages to be determined at trial,            interest, and costs, together with such other relief as the court may deem appropriate.            The three actions have now been consolidated into a single matter, and the lead            plaintiffs and counsel have been specified. The consolidated actions have not been            certified to proceed as a class action. No responsive pleading from the defendants will            be due until an amended complaint is filed. We propose to defend vigorously this action            on behalf of all defendants.

 

26

 

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**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY            HOLDERS**

 

No matter was submitted to a vote of our security holders during the            fourth quarter of the fiscal year ended December 31, 2007.

 

**PART II**

 

 

**ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY,**

**RELATED STOCKHOLDER MATTERS AND**

**ISSUER PURCHASES OF EQUITY SECURITIES**

 

**Price Range of Common Stock and Dividend Policy**

 

The following table sets forth, for the periods indicated, the high and            low closing prices for our common stock as quoted under the symbol “FXEN”            on the NASDAQ Global Market, or its predecessor, Nasdaq National Market:

 

|                                  | **Low** |   | **High** |
|---------------------------------------|---------|--------|----------|
| **2008:**                             |    |   |     |
| First Quarter (through March 3, 2008) | $ 4.50  |   | $ 5.94   |
|                                  |    |   |     |
| **2007:**                             |    |   |     |
| Fourth Quarter                        | 5.68    |   | 8.19     |
| Third Quarter                         | 6.03    |   | 9.29     |
| Second Quarter                        | 7.79    |   | 10.39    |
| First Quarter                         | 5.83    |   | 7.88     |
|                                  |    |   |     |
| **2006:**                             |    |   |     |
| Fourth Quarter                        | 4.72    |   | 7.00     |
| Third Quarter                         | 4.19    |   | 5.48     |
| Second Quarter                        | 3.98    |   | 5.71     |
| First Quarter                         | 4.04    |   | 8.37     |

 

We have never paid cash dividends on our common stock and do not            anticipate that we will pay dividends in the foreseeable future. We intend to reinvest            any future earnings to further expand our business. We estimate that, as of March 2,            2008, we had approximately 10,000 stockholders.

 

**Equity Compensation Plans**

 

The information from the definitive proxy statement for the 2008 annual            meeting of stockholders under the caption “Equity Compensation Plans” is            incorporated herein by reference.

 

**Recent Sales of Unregistered Securities**

 

|   | None. |
|--------|-------|

 

 

27

 

----

                                                                                                                                                                                                                                         

             

**ITEM 6. SELECTED FINANCIAL DATA**

 

The following selected financial data for the five years ended December            31, 2007, are derived from our audited consolidated financial statements and notes            thereto, certain of which are included in this report. The selected financial data            should be read in conjunction with Management’s Discussion and Analysis of            Financial Condition and Results of Operations and our consolidated financial statements            and the notes thereto included elsewhere in this report:

 

|                                                                | **Years Ended December 31,**                                            |   |
|---------------------------------------------------------------------|-------------------------------------------------------------------------|--------|
|                                                                | **2007**                                                                |   | **2006** |   | **2005** |   | **2004** |   | **2003** |   |
|                                                                | **(In thousands, except per share                            amounts)** |   |
| **Statement of Operations Data:**                                   |                                                                    |   |
| **Revenues:**                                                       |                                                                    |   |   |   |   |   |   |   |   |
| Oil and gas sales                                                   | $ 14,903                                                           |   | $ 6,533  |   | $ 3,805  |   | $ 3,096  |   | $ 2,230  |
| Oilfield services                                                   | 3,093                                                              |   | 1,696  |   | 2,132  |   | 710  |   | 98  |
| Total revenues                                                      | 17,996                                                             |   | 8,229  |   | 5,937  |   | 3,806  |   | 2,328  |
| **Operating costs and expenses:**                                   |                                                                    |   |   |   |   |   |   |   |   |
| Lease operating expenses (1)                                        | 3,538                                                              |   | 2,647  |   | 2,462  |   | 1,946  |   | 1,546  |
| Exploration costs (2)                                               | 10,624                                                             |   | 5,608  |   | 8,369  |   | 3,013  |   | 523  |
| Recovery of previously expensed                                     |                                                                    |   |   |   |   |   |   |   |   |
| Input VAT                                                           | --                                                                 |   | --  |   | (2,121) |   | --  |   | --  |
| Impairment of oil and gas properties                            (3) | 2,299                                                              |   | 3,583  |   | --  |   | --  |   | 161  |
| Oilfield services costs                                             | 1,998                                                              |   | 1,245  |   | 1,689  |   | 551  |   | 190  |
| Depreciation, depletion and                                         |                                                                    |   |   |   |   |   |   |   |   |
| amortization                                                        | 2,064                                                              |   | 1,290  |   | 903  |   | 636  |   | 599  |
| Accretion expense                                                   | 78                                                                 |   | 53  |   | 45  |   | 41  |   | 37  |
| Amortization of deferred                                            |                                                                    |   |   |   |   |   |   |   |   |
| compensation (G&A)                                              | 2,604                                                              |   | 2,759  |   | 125  |   | --  |   | --  |
| Stock compensation (G&A) (4)                                    | --                                                                 |   | --  |   | 76  |   | 5,859  |   | --  |
| General and administrative (G&A)                                | 6,915                                                              |   | 5,606  |   | 6,592  |   | 4,909  |   | 3,253  |
| Total operating costs and expenses                                  | 30,120                                                             |   | 22,791  |   | 18,140  |   | 16,955  |   | 6,309  |
|                                                                |                                                                    |   |   |   |   |   |   |   |   |
| **Operating loss**                                                  | (12,124)                                                                |   | (14,562) |   | (12,203) |   | (13,149) |   | (3,981) |
|                                                                |                                                                    |   |   |   |   |   |   |   |   |
| **Other income (expense):**                                         |                                                                    |   |   |   |   |   |   |   |   |
| Interest and other income                                           | 818                                                                |   | 795  |   | 780  |   | 529  |   | 36  |
| Interest expense                                                    | (385)                                                                   |   | --  |   | --  |   | --  |   | (788) |
| Total other income (expense)                                        | 433                                                                |   | 795  |   | 780  |   | 529  |   | (752) |
|                                                                |                                                                    |   |   |   |   |   |   |   |   |
| **Loss before cumulative effect of**                                |                                                                    |   |   |   |   |   |   |   |   |
| **change in accounting principle**                                  | (11,691)                                                                |   | (13,767) |   | (11,423) |   | (12,620) |   | (4,733) |
|                                                                |                                                                    |   |   |   |   |   |   |   |   |
| Cumulative effect of change in                                      |                                                                    |   |   |   |   |   |   |   |   |
| accounting principle                                                | --                                                                 |   | --  |   | --  |   | --  |   | 1,800  |
|                                                                |                                                                    |   |   |   |   |   |   |   |   |
| **Net loss**                                                        | $ (11,691)                                                              |   | $ (13,767) |   | $ (11,423) |   | $ (12,620) |   | $ (2,933) |
|                                                                     |                                                                         |        |  |  |  |  |  |  |  |  |  |  |

 

**– Continued –**

 

28

 

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|                                                                           | **Years Ended December 31,** |   |
|--------------------------------------------------------------------------------|------------------------------|--------|
|                                                                           | **2007**                     |   | **2006** |   | **2005** |   | **2004** |   | **2003** |   |
|                                                                           | **(In thousands)**           |   |
| **Basic and diluted net loss per share:**                                      |                         |   |   |   |   |   |   |   |   |
|                                                                           |                         |   |   |   |   |   |   |   |   |
|                                                                           |                         |   |   |   |   |   |   |   |   |
| **Basic and diluted loss per common share                            before**  |                         |   |   |   |   |   |   |   |   |
| **cumulative effect****of                            change in accounting**    |                         |   |   |   |   |   |   |   |   |
| **principle**                                                                  | $ (0.32)                     |   | $ (0.39) |   | $ (0.33) |   | $ (0.41) |   | $ (0.41) |
|                                                                           |                         |   |   |   |   |   |   |   |   |
| Cumulative effect of change in                                                 |                         |   |   |   |   |   |   |   |   |
| accounting principle                                                           | --                           |   | -- |   | -- |   | -- |   | 0.09 |
|                                                                           |                         |   |   |   |   |   |   |   |   |
| **Basic and diluted net loss per common                            share**     | $ (0.32)                     |   | $ (0.39) |   | $ (0.33) |   | $ (0.41) |   | $ (0.32) |
|                                                                           |                         |   |   |   |   |   |   |   |   |
| **Basic and diluted weighted average**                                         |                         |   |   |   |   |   |   |   |   |
| **shares outstanding**                                                         | 36,694                       |   | 35,163 |   | 34,733 |   | 30,691 |   | 19,885 |
|                                                                           |                         |   |   |   |   |   |   |   |   |
| **Cash Flow Statement Data:**                                                  |                         |   |   |   |   |   |   |   |   |
| Net cash used in operating activities                                          | $(1,581)                     |   | $(5,303) |   | $(10,105) |   | $ (5,886) |   | $ (5,561) |
| Net cash provided by (used in) investing                            activities | (13,152)                     |   | 8,135 |   | 4,656 |   | (41,492) |   | (1,446) |
| Net cash (used in) provided by financing                            activities | 14,351                       |   | (578) |   | 4,055 |   | 33,791 |   | 23,673 |
|                                                                           |                         |   |   |   |   |   |   |   |   |
| **Balance Sheet Data:**                                                        |                         |   |   |   |   |   |   |   |   |
| Working capital                                                                | $ 15,374                     |   | $ 11,967 |   | $ 27,715 |   | $ 33,777 |   | $ 16,032 |
| Total assets                                                                   | 46,369                       |   | 39,167 |   | 48,271 |   | 52,962 |   | 23,769 |
| Long-term debt                                                                 | --                           |   | -- |   | -- |   | -- |   | -- |
| Stockholders’ equity                                                     | 37,542                       |   | 31,965 |   | 42,280 |   | 48,556 |   | 21,459 |
|                                                                                |                              |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

_______________

| (1) | Includes lease operating expenses and production                            taxes. |
|-----|------------------------------------------------------------------------------------|

| (2) | Includes geophysical and geological costs, exploratory                            dry hole costs, and nonproducing leasehold impairments. |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------|

| (3) | Includes proved and unproved property write-downs                            relating to our properties in the United States and Poland. |
|-----|------------------------------------------------------------------------------------------------------------------------------------------|

| (4) | Includes noncash compensation charge of $5.8 million                            associated with the cashless exercise of certain employee stock                            options. |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

 

**ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION            AND RESULTS OF OPERATIONS**

 

***The following discussion of our historical financial condition and            results of operations should be read in conjunction with Item 6, Selected Consolidated            Financial Data, our consolidated financial statements and related notes contained in            this report.***

 

**Introduction**

 

As a result of the very different characteristics of our two major            operating areas (Poland and U.S.), our financial results show a distinct dichotomy. Our            Polish operations are early in their initial development and growth phase, while our            U.S. operations are relatively mature. Thus, in late 2006, our results began to show            substantial changes and improvement. See “Results of Operations by Business            Segment” below.

 

29

 

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            Through            2006, most of our oil and gas production, revenues, and lease operating expenses were            attributable to our U.S. operations. Our oilfield service revenues and costs have been            and will continue to be exclusively from the U.S. Our U.S. operations have historically            been the source of essentially all of our operating cash flow. These operations are            relatively stable, with only modest growth or decline on an annual basis.

 

Our 2007 operations reflect a major shift for us, as our exploration            efforts in Poland led to our first meaningful production there commencing in late 2006.            At that time, we began producing and selling gas from two more of our six commercial            discoveries, the Wilga and Zaniemysl wells. Revenues from our Polish properties became            the primary component of our revenue in 2007, and will increase further when three more            of our commercial wells begin production in 2009 and 2010.

 

Most of our exploration costs during the past several years have been            attributable to our efforts in Poland. We expect our Polish operations will continue to            represent the bulk of our exploration costs, reflecting the nature of our exploration            efforts there.

 

Following is a brief discussion concerning certain significant            operational and capital events that occurred during 2007 and the first quarter of            2008.

 

***Recent Operational Events***

             

As a result of our ongoing drilling and production successes in Poland,            2007 was a record year for the Company in terms of revenues, oil and gas production,            and year-end proved reserve volumes and values.

 

|                        | **2007**           |   | **2006** |   | **Change** |
|-----------------------------|--------------------|--------|----------|--------|------------|
| **Revenues**:               | **(In thousands)** |   |
| Oil & Gas Sales         | $ 14,903           |   | $6,533   |   | +128%      |
| Total Revenues              | $ 17,996           |   | $8,229   |   | +119%      |
|                        |               |   |     |   |       |
| **Production:**             |               |   |     |   |       |
| Gas Production (Mcf)        | 1,840              |   | 461      |   | +299%      |
| Oil Production (Bbls)       | 95                 |   | 85       |   | +12%       |
| Total Production (Mcfe)     | 2,412              |   | 968      |   | +149%      |
|                        |               |   |     |   |       |
| **Proved Reserve Volumes:** |               |   |     |   |       |
| Gas Reserves (Mcf)          | 31,116             |   | 19,264   |   | +62%       |
| Oil Reserves (Bbls)         | 496                |   | 584      |   | -15%       |
| Total Reserves (Mcfe)       | 34,092             |   | 22,768   |   | +50%       |
|                        |               |   |     |   |       |
| **Proved Reserve Values:**  |               |   |     |   |       |
| Gas Reserves Value          | $102,968           |   | $63,757  |   | +62%       |
|                             |                    |        |          |        |            |  |

 

In addition to these new benchmarks, we also saw significant improvement            in the areas of cash used in operating activities, liquidity (cash and working            capital), finding and development costs, and per unit operating costs. All of these            improvements are directly tied to the commencement of production in Poland in late            2006, as well as the successful completion of two new commercial wells in Poland in            2007.

 

While we expect most 2008 results will remain well above those of 2006            and prior periods, we expect to see a decline in oil and gas production and revenues            from 2007 to 2008. This is attributable to our Wilga well. (See Property Impairments            for additional information). However, we expect to see another upward trend in early            2009 as we anticipate bringing additional wells in Poland into production.

 

30

 

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***Recent Capital Events***

             

*2007 Common Stock Offering*. In July 2007,            we sold 1,500,000 shares of common stock to certain long-term institutional            shareholders at a price of $8.63 per share in a registered direct offering. After            offering costs, the proceeds to us were approximately $12.4 million. This funding            provided the critical resources for us to accelerate and expand our 3-D seismic program            in our core Fences area in Poland, allowing us to begin a 155 square kilometer            extension of the Sroda 3-D project. This 3-D seismic will cover our 2007 Winna Gora new            field discovery, as well as a number of additional Rotliegend sandstone structures            previously identified on 2-D seismic. Field work on the survey began in late            2007.

 

*2008 Warrant Exercises.*In February 2008,            warrant holders exercised a total of 1,990,000 outstanding warrants at a price of $3.60            per share, resulting in proceeds to us of $7.2 million. The warrants were issued in a            2003 offering of common stock and warrants and expired as of March 1, 2008.

 

*New $25 Million Credit Facility.*In            November of 2006, we entered into a $25 million Senior Facility Agreement (the            Facility) with The Royal Bank of Scotland plc (RBS). We believe our arrangement with            RBS is the first onshore gas project financing in Poland. The Facility is provided to            FX Energy Poland Sp. z o.o., a wholly owned subsidiary of FX Energy, Inc. Funds from            the Facility, which became available to us in March 2007, will cover infrastructure and            development costs at a variety of our Polish gas projects. The Facility is            collateralized by our commercial wells and production in Poland and is guaranteed by            us.

 

The Facility is significant to us on a number of levels. First, and            foremost, we view the Facility as a validation by a respected international financial            institution of the value of our reserves, production, and land in Poland. Second, it            provides us with the ability to leverage our balance sheet and finance the development            of our gas projects in Poland at a reasonable cost. Third, it provides us with a            potentially important initial relationship in the financial community. See Note 5 to            the consolidated financial statements for additional information on our            Facility.

 

***Property Impairments***

             

*Wilga*. Our Wilga well in eastern Poland is            unique, with no comparable wells to model. It produces both gas and light crude oil, or            LCO, or condensate, from three productive zones. The well began to experience            significant water encroachment from one of the productive zones in late 2007, and our            production engineering data suggest that we may see a sharp decline in oil and gas            production over the course of the next 12-18 months as a result. We are currently            evaluating alternative methods of sustaining production or slowing the anticipated            decline; however, we expect oil and gas revenues in 2008 to be adversely impacted from            20% to 30% by lower Wilga production than that recorded in 2007. As a consequence of            the water encroachment, the proved reserves at Wilga have been reduced accordingly,            resulting in an impairment of capitalized costs in the amount of $2.3 million in            2007.

 

*Rusocin*. During the second half of 2004, we            and POGC drilled the Rusocin-1 well, the first well intentionally focused on a            stratigraphic trap in the Rotliegend. We believe the well may have discovered            commercial quantities of natural gas. However, our exploration and production focus            primarily in the Sroda and other areas is to continue in the near term. Therefore,            during the fourth quarter of 2006, we determined to delay steps to place the Rusocin            well into production as we focus our exploration efforts on the Sroda area. In            accordance with the provisions of FASB Staff Position 19-1, “Accounting for            Suspended Well Costs,” the capitalized costs associated with this well of $3.4            million were charged to expense in the fourth quarter of 2006.

 

31

 

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**Results of Operations by Business Segment**

 

We operate within two segments of the oil and gas industry: the            exploration and production, or E&P, segment in Poland and the United States, and            the oilfield services segment in the United States. Direct revenues and costs,            including depreciation, depletion and amortization costs, or DD&A, general and            administrative costs, or G&A, and other income directly associated with their            respective segments are detailed within the following discussion. DD&A, G&A,            amortization of deferred compensation, interest income, other income, interest expense,            and other costs, which are not allocated to individual operating segments for            management or segment reporting purposes, are discussed in their entirety following the            segment discussion. The following table summarizes the results of operations by segment            for the years ended December 31, 2007, 2006, and 2005 (in thousands). See Footnote            12 to the consolidated financial statements for additional detail concerning our            segment results.

 

|                              | **Reportable Segments**                             |                                                   |    |
|-----------------------------------|-----------------------------------------------------|--------------------------------------------------------|---------|
|                              |                                                | **Oilfield                            Services**  |    |   |
|                              | **Exploration & Production**                    |                                                   |    |
|                              | **Poland**                                          | **U.S.**                                               |    | **Non-Segmented** | **Total** |
| **Year ended December 31, 2007:** |                                                |                                                   |    |   |   |
| Revenues                          | $ 10,567                                       | $ 4,336                                           | $ 3,093 | $         --  | $ 17,996  |
| Net income (loss)(1)              | (4,415)                                             | 1,102                                             | 828     | (9,206) | (11,691) |
|                              |                                                |                                                   |    |   |   |
| **Year ended December 31, 2006:** |                                                |                                                   |    |   |   |
| Revenues                          | $ 2,273                                        | $ 4,260                                           | $ 1,696 | $         --  | $ 8,229  |
| Net income (loss)(2)              | (6,779)                                             | 463                                               | 296     | (7,747) | (13,767) |
|                              |                                                |                                                   |    |   |   |
| **Year ended December 31, 2005:** |                                                |                                                   |    |   |   |
| Revenues                          | $       --  | $ 3,805                                           | $ 2,132 | $          --  | $ 5,937  |
| Net income (loss)(3)              | (6,238)                                             | (84)                                                   | 78      | (5,179) | (11,423) |

_______________

| (1) | Nonsegmented reconciling items for 2007 include $6,915                            of general and administrative costs, $2,604 of noncash stock                            compensation expense, $433 of other income, and $120 of corporate                            DD&A. |
|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| (2) | Nonsegmented reconciling items for 2006 include $5,606                            of general and administrative costs, $2,759 of noncash stock                            compensation expense, $795 of other income, and $177 of corporate                            DD&A. |
|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| (3) | Nonsegmented reconciling items for 2005 include $5,551                            of general and administrative costs, $201 of noncash stock compensation                            expense, $711 of other income, and $138 of corporate                            DD&A. |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

             

A            comparison of the results of operations by business segment and the information            regarding nonsegmented items for each of the years presented follows. Further            information concerning our business segments can be found in Note 11, Business            Segments, in the consolidated financial statements.

 

***Exploration and Production Segment***

             

*Gas Revenues*. As discussed previously, we            began gas production in Poland during late 2006, and the related gas revenues rapidly            became the primary component of our revenue. Revenues from gas sales were $9.1 million            during 2007, compared to $1.8 million and $0 in 2006 and 2005, respectively. Gas            production from our Wilga well contributed approximately 42% of our 2007 production            volumes and approximately 57% of our 2007 gas revenues.

 

32

 

----

            A            summary of the amount and percentage change, as compared to their respective prior-year            period, for gas revenues, average gas prices, gas production volumes, and lifting costs            per Mcf for the years ended December 31, 2007, 2006, and 2005, is set forth in the            following table:

 

|                             | **For the year ended December 31,** |
|----------------------------------|-------------------------------------|
|                             | **2007**                            |   | **2006** |   | **2005** |
| Revenues                         | $9,098,000                          |   | $1,790,000 |   | $-- |
| Percent change versus prior year | +408%                               |   | NA |   | -- |
| Average price (per Mcf )         | $4.95                               |   | $3.88 |   | $-- |
| Percent change versus prior year | +28%                                |   | NA |   | -- |
| Production volumes (Mcf)         | 1,839,504                           |   | 461,303 |   | -- |
| Percent change versus prior year | +299%                               |   | NA |   | -- |
| Lifting costs per Mcf (1)        | $0.63                               |   | $0.54 |   | $-- |
| Percent change versus prior year | +17%                                |   | NA |   | -- |

_______________

| (1) | Lifting costs per Mcf are computed by dividing the                            related lease operating expenses by the total volume of gas                            produced. |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

With the anticipated decline in production discussed earlier at our            Wilga well, we expect gas revenues in 2008 to be lower than those for 2007, but still            above those of 2006 and earlier. However, we expect to bring our Roszkow well, and            possibly other Polish wells, into production in 2009 and later. These wells are            expected to have a substantial positive impact on future production and            revenues.

 

*Oil Revenues*. Oil revenues were $5.8            million, $4.7 million, and $3.8 million for the years ended December 31, 2007,            2006, and 2005, respectively. Included in 2007 and 2006 revenues were approximately            $1.5 million and $483,000, respectively, related to the sale of LCO in Poland at our            Wilga well. With the anticipated decline in production discussed earlier at our Wilga            well, we expect LCO revenues in 2008 to be significantly reduced. All other oil            revenues during the three years were derived from our producing properties in the            United States. During these three years, oil revenues fluctuated primarily due to            volatile oil prices and changing production rates that are a function of normal            production declines. U.S. oil revenues in 2007 increased from 2006 levels by            approximately $398,000 due to higher oil prices, offset by approximately $322,000            related to production declines. Oil revenues in 2006 increased from 2005 levels by            approximately $607,000 due to higher oil prices, offset by approximately $151,000            related to production declines.

 

A summary of the amount and percentage change, as compared to their            respective prior-year period, for oil revenues, average oil prices, oil production            volumes, and lifting costs per barrel for the years ended December 31, 2007, 2006, and            2005, is set forth in the following table:

 

|                             | **For the year ended December 31,** |
|----------------------------------|-------------------------------------|
|                             | **2007**                            |   | **2006** |   | **2005** |
| Revenues                         | $5,804,000                          |   | $4,744,000 |   | $3,805,000 |
| Percent change versus prior year | +22%                                |   | +25% |   | +23% |
| Average price (per Bbl )         | $60.86                              |   | $56.13 |   | $48.45 |
| Percent change versus prior year | +8%                                 |   | +16% |   | +33% |
| Production volumes (Bbl)         | 95,242                              |   | 84,520 |   | 78,534 |
| Percent change versus prior year | +13%                                |   | +78% |   | -7% |
| Lifting costs per Bbl (1)        | $27.04                              |   | $25.23 |   | $26.79 |
| Percent change versus prior year | +7%                                 |   | -6% |   | +42% |

_______________

| (1) | Lifting costs per barrel are computed by dividing the                            related lease operating expenses by the total barrels of oil produced.                            LCO lifting costs in Poland are based on an allocation of total costs                            based on relative revenues between oil and gas. Lifting costs include                            production taxes incurred in the United States. |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Depending largely upon future oil prices, we expect that 2008 and future            oil revenues will be fairly stable compared to the future changes expected for gas            revenues. We do not expect major oil production changes similar to those for future gas            production.

 

33

 

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            *Lease Operating Costs.*Lease operating            costs were $3.5 million in 2007, $2.6 million in 2006, and $2.5 million in 2005. The            higher costs in 2007 are reflective of a full year’s production in Poland. Poland            operating costs rose from $289,000 in 2006 to $1.1 million in 2007. Operating costs            rose slightly from 2005 to 2006 as we commenced gas and LCO production at our Wilga            well in Poland. Lease operating costs at our Kleka and Zaniemysl wells were not            significant in 2006. We also recompleted nine producing wells in Montana during            2006.

 

*Exploration Costs*. Our exploration efforts            are focused in Poland, and the expenses consist of geological and geophysical costs as            well as the costs of exploratory dry holes. Exploration costs were $10.6 million, $5.6            million, and $8.4 million for the years ended December 31, 2007, 2006, and 2005,            respectively.

 

Geological and geophysical costs, or G&G costs, were $10.6 million,            $4.2 million, and $3.3 million for the years ended December 31, 2007, 2006, and            2005, respectively. During all three years, most of our G&G costs were spent on            acquiring, processing, and interpreting new seismic data on the Fences I and II            areas, including our new 3-D seismic survey in the Sroda area which began shooting in            late 2006, and on which we spent a total of $6.7 million in 2007.

 

Exploratory dry-hole costs were $0, $1.6 million, and $5.1 million for            the years ended December 31, 2007, 2006, and 2005, respectively. During 2007, both            of the wells we drilled in Poland were determined to be commercial, and were completed            for future production. Our 2006 exploration costs included approximately $800,000            associated with the Drozdowice-1 well in our Fences III prospect in Poland, along with            additional amounts for two dry holes in Montana and Nevada. During 2005, we plugged and            abandoned two wells in Poland, the Sroda-5 and Lugi 1 wells, for a total cost of            approximately $4.6 million. In addition, we plugged and abandoned four exploratory            wells in Nevada for a total cost of approximately $713,000.

 

Since different types of future exploration costs may either be            capitalized and depleted, or written off altogether, depending upon future exploration            results, it is not possible to provide especially meaningful forward-looking thoughts            on these expenses. However, the 2008 capital budget is substantially above that of            2007, which would indicate exploration costs might well be higher in the            future.

 

*Impairment Costs*. Impairments of oil and            gas properties were $2.3 million, $3.6 million, and $0 for the years ended            December 31, 2007, 2006, and 2005, respectively. As discussed previously, during            2007 we impaired $2.3 million related to our Wilga well, and in 2006 we impaired the            entire amount of capitalized costs associated with our Rusocin-1 well. There were no            similar impairments during 2005.

 

*DD&A Expense - Producing Operations*.            DD&A expense for producing properties was $1.7 million, $957,000, and $511,000 for            the years ended December 31, 2007, 2006, and 2005, respectively. The 78% increase            from 2006 to 2007 was a reflection of a full-year’s worth of production in            Poland, discussed earlier. DD&A expense in Poland was $935,000 in 2007. The            increase from 2005 to 2006 was due primarily to the commencement of production at our            properties in Poland, which accounted for $304,000 of the $446,000 increase. The            remaining increase is due to capital cost additions in 2006 at our Montana producing            properties.

 

Future DD&A costs are expected to generally, but not completely,            follow future production trends. However, future DD&A rates can be very different            depending upon future capitalized costs.

 

***Oilfield Services Segment***

             

*Oilfield Services Revenues*. Oilfield            services revenues were $3.1 million, $1.7 million, and $2.1 million for the years ended            December 31, 2007, 2006, and 2005, respectively. Activity in the contract drilling            industry where we operate increased significantly during 2005, slowed somewhat in 2006,            and increased again in 2007. Oilfield services revenues will continue to fluctuate from            period to period based on market demand, weather, the number of wells drilled, downtime            for equipment repairs, the degree of emphasis on using our oilfield services equipment            on our own properties, and other factors. We cannot accurately predict future oilfield            services revenues.

 

34

 

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            *Oilfield Services Costs.*Oilfield services            costs were $2.0 million, $1.2 million, and $1.7 million for the years ended December            31, 2007, 2006, and 2005, respectively, or 65%, 73%, and 79% of oilfield servicing            revenues, respectively. In general, oilfield servicing costs are directly associated            with oilfield services revenues. As such, oilfield services costs will continue to            fluctuate period to period based on the number of wells drilled, revenues generated,            weather, downtime for equipment repairs, the degree of emphasis on using our oilfield            services equipment on our own properties, and other factors.

 

*DD&A Expense – Oilfield Services.*DD&A expense for oilfield services was $267,000, $155,000, and            $243,000 for the years ended December 31, 2007, 2006, and 2005, respectively. We spent            $911,000, $295,000, and $264,000 on upgrading our oilfield servicing equipment during            2007, 2006, and 2005 respectively.

 

***Nonsegmented Items***

             

*G&A Costs - Corporate.*G&A costs            were $6.9 million, $5.6 million, and $6.6 million for the years ended December 31,            2007, 2006, and 2005, respectively. Higher employee compensation costs in 2007,            associated in part with an expansion of our Poland operations office, coupled with            higher legal, insurance, and software maintenance costs, resulted in an increase in            2007 G&A of $1.3 million. During 2006, we significantly reduced from 2005 levels            legal and consulting fees, reducing our G&A by approximately $612,000. Decreases in            other G&A areas were offset to some extent by higher employee costs, as we            increased headcount in our Poland office. During 2005, we opened a new office in            Warsaw, Poland, hiring five experienced individuals to assist in our expanding            exploration and production efforts.

 

*Stock Compensation (G&A)*. Stock            compensation expense recorded in 2005 represents the amortization of stock and options            issued to consultants prior to the adoption of SFAS No. 123R.

 

*Amortization of Deferred Compensation            (G&A*). As discussed above, we adopted the provisions of            SFAS No. 123R on January 1, 2006, using the modified prospective method. Under            this method, prior periods are not revised for comparative purposes. Stock-based awards            that were granted prior to the effective date continue to be accounted for in            accordance with SFAS No. 123, except that stock option expense for unvested            options must be recognized in the consolidated statement of operations. Stock            compensation expense recorded for 2007 represents $1.8 million of amortization related            to restricted stock granted in 2007, 2006, and 2005 and $842,000 of amortization of            unvested stock options granted prior to 2005, using the compensation cost calculated            for pro forma disclosure purposes under SFAS No. 123. Stock compensation expense            recorded for 2006 represents $1.1 million of amortization related to restricted stock            granted in 2006 and 2005 and $1.7 million of amortization of unvested stock options            granted prior to 2005, using the compensation cost calculated for pro forma disclosure            purposes under SFAS No. 123.

 

*Interest and Other Income (Expense) -            Corporate*. Interest and other income (expense) was $433,000,            $795,000, and $780,000 for the years ended December 31, 2007, 2006, and 2005,            respectively. During 2007, we began to amortize the fees incurred in securing our            Senior Credit Facility to interest expense as well as the semi-annual commitment fees            for the facility, totaling $386,000 in interest-related charges. These charges offset            interest income of $818,000, an increase over 2006 levels due to higher cash balances            available for investment. The increase in interest income for 2005 to 2006 was also due            to higher cash balances generally available for investment over the prior year, coupled            with rising interest rates.

 

*Income Taxes*. We incurred net losses of            $11.7 million, $13.8 million, and $11.4 million for the years ended December 31, 2007,            2006, and 2005, respectively. SFAS No. 109, “Accounting for Income Taxes,”            requires that a valuation allowance be provided if it is more likely than not that some            portion or all of a deferred tax asset will not be realized. Our ability to realize the            benefit of our deferred tax asset will depend on the generation of future taxable            income through profitable operations and the expansion of our exploration and            development activities. The market and capital risks associated with achieving the            above requirement are considerable, resulting in our conclusion that a full valuation            allowance be provided. Accordingly, we did not recognize any income tax benefit in our            consolidated statement of operations for these years.

 

35

 

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**Liquidity and Capital Resources**

 

To date, we have financed our operations principally through the sale of            equity securities, issuance of debt securities, and agreements with industry            participants that funded our share of costs in certain exploratory activities in return            for an interest in our properties. We believe our cash resources and marketable            securities at December 31, 2007, together with anticipated revenues in 2008 and            availability under our $25 million Senior Facility Agreement, are sufficient to cover            our planned exploration program and ongoing operations in the United States and Poland            for the next 12 months.

 

We may seek to obtain additional funds for future capital investments            from the sale of additional securities, project financing to help finance the            completion of successful wells, sale of partial property interests, or other            arrangements, all of which may dilute the interest of our existing stockholders or our            interest in the specific project financed. We will allocate our existing capital as            well as funds we may obtain in the future among our various projects at our discretion.            We may change the allocation of capital among the categories of anticipated            expenditures depending upon future events. For example, we may change the allocation of            our expenditures based on the actual results and costs of future exploration,            appraisal, development, production, property acquisition, and other activities. In            addition, we may have to change our anticipated expenditures if costs of placing any            particular discovery into production are higher, if the field is smaller, or if the            commencement of production takes longer than expected.

 

*Working Capital (current assets less current liabilities).*Our working capital was $15.3 million as of December 31, 2007, an            increase of $3.4 million from December 31, 2006. The increase is due primarily to the            proceeds of an equity financing during 2007, offset by costs associated with our            drilling and seismic activities during 2007. The exercise of warrants in early 2008 as            discussed above has further improved working capital.

 

*Operating Activities*. We used net cash of            $1.6 million, $5.3 million, and $10.1 million in our operating activities during 2007,            2006, and 2005, respectively, primarily as a result of the net losses, excluding            noncash charges, incurred in those years. Revenues from oil and gas sales in Poland,            which commenced in late 2006, helped us reduce the amount of cash used in operations in            both 2006 and 2007. Our current assets at year-end included approximately $1.9 million            in accrued oil and gas sales from both the United States and Poland, and $446,000 in            refundable Input VAT that we expect to receive during the first six months of 2008. Our            current liabilities at year-end included approximately $376,000 in costs related to our            exploration activities in Poland that were paid in early 2008.

 

*Investing Activities*. We used net cash in            investing activities of $13.1 million in 2007 and received net cash from investing            activities of $8.1 million and $4.7 million in 2006 and 2005, respectively. In 2007 we            received $4.9 million from the maturities of marketable securities. We invested $9.6            million in marketable securities. We spent $7.5 million for oil and gas property            additions, $7.0 million of which was related to our Polish drilling activities, with            the remainder being spent on our domestic properties. We also spent $73,000 upgrading            our office equipment and $893,000 adding to our oilfield services equipment.

 

In 2006 we received $16.8 million from the maturities of marketable            securities. We invested $782,000 in marketable securities. We spent $7.5 million for            oil and gas property additions, $6.9 million of which was related to our Polish            drilling activities, with the remainder being spent on our domestic properties. We also            spent $67,000 upgrading our office equipment and $295,000 adding to our oilfield            services equipment.

 

In 2005 we received $6.8 million from the sale of marketable securities            and $1.9 million from the recovery of previously capitalized Input VAT. We invested            $627,000 in marketable securities. We spent $3.8 million for oil and gas property            additions, $3.3 million of which was related to our Polish drilling activities, with            the remainder being spent on our domestic properties. We also spent $158,000 upgrading            our office equipment and $264,000 upgrading our oilfield services equipment.

 

36

 

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            *Financing Activities*. We received net cash            from financing activities of $14.4 million in 2007, used net cash in financing            activities of $578,000 in 2006, and received net cash of $4.1 million from our            financing activities during 2005. During 2007, we sold 1.5 million shares of stock in a            registered direct offering, resulting in net proceeds to us of $12.4 million. In            addition, 672,165 options and warrants were exercised during the year, resulting in            proceeds to us of an additional $1.9 million. All the cash used in financing activities            in 2006 was used to pay the loan origination fees and associated legal costs related to            our $25 million Senior Credit Facility. All of the proceeds in 2005 were from the            exercise of stock options and warrants. In 2004 we received a total of $20.7 million in            net proceeds from the sale of securities. In addition, the exercise of warrants and            options provided additional proceeds of $13.1 million.

 

**Contractual Obligations and Contingent Liabilities and            Commitments**

 

We had no significant contractual obligations or commitments as of            December 31, 2007. We are subject to certain work commitments with respect to our            exploration concessions that must be satisfied in order to maintain our interest in            those concessions. These work commitments are, however, optional on our            part.

 

Our oil and gas drilling and production operations are subject to            hazards incidental to the industry that can cause severe damage to and destruction of            property and equipment, pollution or environmental damage and suspension of operations,            personal injury, and loss of life. To lessen the effects of these hazards, we maintain            insurance of various types to cover our United States and Poland operations and also            rely on the insurance or financial capabilities of our exploration partners in Poland.            These measures do not cover risks related to violations of environmental laws or all            other risks involved in oil and gas exploration, drilling, and production. We would be            adversely affected by a significant adverse event that is not fully covered by            insurance or by our inability to maintain adequate insurance in the future at rates we            consider reasonable.

 

**New Accounting Pronouncements**

 

Effective January 1, 2007, we adopted Financial Accounting Standards            Board (“FASB”) Interpretation Number 48, “Accounting for Uncertainty            in Income Taxes – an interpretation of FASB Statement No. 109” (“FIN            48”), which clarifies the accounting for uncertainty in income taxes recognized            in a company’s financial statements in accordance with SFAS No. 109. The adoption            of this pronouncement did not have any effect on our financial statements.

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value            Measurements” (“SFAS No. 157”), which defines fair value, establishes            a framework for measuring fair value in accordance with accounting principles generally            accepted in the United States, and expands disclosures about fair value measurements.            SFAS No. 157 is effective for financial assets and liabilities for fiscal years            beginning after November 15, 2007. In February 2008, the FASB issued FSP FAS 157-2,            “Effective Date of FASB Statement No. 157.” FSP 157-2 delays the effective            date of SFAS No. 157 for all non-financial assets and non-financial liabilities that            are not re-measured at fair value on a recurring basis until fiscal years beginning            after November 15, 2008. Any amounts recognized upon adoption of this rule as a            cumulative effect adjustment will be recorded to the opening balance of retained            earnings in the year of adoption. We have evaluated SFAS No. 157 and have determined            that it will not have a material impact on our consolidated financial            statements.

 

On February 15, 2007, the FASB issued SFAS No. 159, “The Fair            Value Option for Financial Assets and Financial Liabilities - Including an Amendment of            FASB Statement No. 115” (“SFAS No. 159”), which permits an entity to            choose to measure eligible items at fair value at specified election dates. An entity            will report unrealized gains and losses on items for which the fair value option has            been elected in earnings at each subsequent reporting date. The fair value option: (a)            may be applied instrument by instrument, with a few exceptions, such as investments            otherwise accounted for by the equity method; (b) is irrevocable (unless a new election            date occurs); and (c) is applied only to entire instruments and not to portions of            instruments. SFAS No. 159 is effective for fiscal years that begin after November 15,            2007. We have evaluated SFAS No. 159 and have determined that it will not have a            material impact on our consolidated financial statements and we have not early            adopted.

 

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

 

37

 

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**Critical Accounting Policies**

 

***Oil and Gas Activities***

             

We follow the successful efforts method of accounting for our oil and            gas properties. Under this method of accounting, all property acquisition costs and            costs of exploratory and development wells are capitalized when incurred, pending            determination of whether the well has found proved reserves. If an exploratory well has            not found proved reserves, these costs plus the costs of drilling the well are            expensed. The costs of development wells are capitalized, whether productive or            nonproductive. Geological and geophysical costs on exploratory prospects and the costs            of carrying and retaining unproved properties are expensed as incurred. An impairment            allowance is provided to the extent that net capitalized costs of unproved properties,            on a property-by-property basis, are not considered to be realizable. An impairment            loss is recorded if the net capitalized costs of proved oil and gas properties exceed            the aggregate undiscounted future net cash flows determined on a property-by-property            basis. The impairment loss recognized equals the excess of net capitalized costs over            the related fair value, determined on a property-by-property basis. Gains and losses            are recognized on sales of entire interests in proved and unproved properties. Sales of            partial interests are generally treated as a recovery of costs and any resulting gain            or loss is recorded as other income. Revenues associated with oil and gas sales are            recorded when title passes, which is upon delivery to the pipeline or purchaser, and            are net of royalties. Oilfield service revenues are recognized when the related service            is performed. As a result of the foregoing, our results of operations for any            particular period may not be indicative of the results that could be expected over            longer periods.

 

***Oil and Gas Reserves***

             

Engineering estimates of our oil and gas reserves are inherently            imprecise and represent only approximate amounts because of the subjective judgments            involved in developing such information. There are authoritative guidelines regarding            the engineering criteria that have to be met before estimated oil and gas reserves can            be designated as “proved.” Proved reserve estimates are updated at least            annually and take into account recent production and technical information about each            field. In addition, as prices and cost levels change from year to year, the estimate of            proved reserves also changes. This change is considered a change in estimate for            accounting purposes and is reflected on a prospective basis in related depreciation,            depletion and amortization (“DD&A”) rates.

 

Despite the inherent imprecision in these engineering estimates, these            estimates are used in determining DD&A expense and impairment expense and in            disclosing the supplemental standardized measure of discounted future net cash flows            relating to proved oil and gas properties. DD&A rates are determined based on            estimated proved reserve quantities (the denominator) and capitalized costs of            producing properties (the numerator). Producing properties’ capitalized costs are            amortized based on the units of oil or gas produced. Therefore, assuming all other            variables are held constant, an increase in estimated proved reserves decreases our            DD&A expense. Also, estimated reserves are used to calculate future cash flows from            our oil and gas operations, which serve as an indicator of fair value in determining            whether a property is impaired or not. The larger the estimated reserves, the less            likely the property is impaired.

 

***Stock-based Compensation***

             

Effective January 1, 2006, we adopted the provisions of SFAS            No. 123R, “Share-Based Payments” (“SFAS No. 123R”). Under            SFAS No. 123R, share-based compensation cost is measured at the grant date, based on            the estimated fair value of the award, and is recognized as expense over the            employee’s requisite service period. We adopted SFAS No. 123R using the modified            prospective transition method. Under this method, prior periods are not revised for            comparative purposes. The provisions of SFAS No. 123R apply to new awards and to awards            that are outstanding on the effective date that are subsequently modified or cancelled.            Compensation expense for unvested awards at the effective date will be recognized over            the remaining requisite service period using the compensation cost calculated for pro            forma disclosure purposes under SFAS No. 123, “Accounting for Stock-Based            Compensation” (“SFAS No. 123”).

 

See notes 1 and 10 in the notes to the consolidated financial statements            for information on the adoption of SFAS 123(R), “Share-Based            Payments.”

 

 

38

 

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**ITEM 7A. QUANTITATIVE AND QUALITATIVE**

**DISCLOSURES ABOUT MARKET RISK**

 

**Price Risk**

 

Realized pricing for our oil production in the United States and Poland            is primarily driven by the prevailing worldwide price of oil, subject to gravity and            other adjustments for the actual oil sold. Historically, oil prices have been volatile            and unpredictable. Price volatility relating to our oil production is expected to            continue in the foreseeable future.

 

Our gas in Poland is sold to POGC or its subsidiaries under contracts            that extend for the life of each field. Prices are determined contractually and, in the            case of our Wilga and Zaniemysl wells, are tied to published tariffs. Gas sold at Kleka            is sold at a fixed price without regard to any published tariff or index. The currently            limited volumes and sources of our gas production mean we cannot assure uninterruptible            production or production in amounts that would be meaningful to industrial users, which            may depress the price we may be able to obtain by limiting our market for potential            customers. POGC is the primary purchaser of domestic gas in Poland. We expect that the            prices we receive in the short term for gas we produce will be lower than would be the            case in a more competitive setting and may be lower than prevailing western European            prices, at least until a fully competitive market develops in Poland.

 

We currently do not engage in any hedging activities to protect            ourselves against market risks associated with oil and gas price fluctuations, although            we may elect to do in the future.

 

**Foreign Currency Risk**

 

We have entered into various agreements in Poland denominated in the            Polish zloty. The Polish zloty is subject to exchange rate fluctuations that are beyond            our control. We do not currently engage in hedging transactions to protect ourselves            against foreign currency risks, nor do we intend to do so in the immediate future; our            policy is to use zloty-based revenues generated in Poland to pay for all zloty-based            invoices, supplemented as needed by transferring U.S. dollars to Poland to cover            invoices that exceed the generated revenues.

 

 

**ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

Our consolidated financial statements, including the independent            registered public accounting firm’s report on our consolidated financial            statements, are included beginning at page F-2 immediately following the signature page            of this report.

 

 

**ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING            AND FINANCIAL DISCLOSURE**

 

During the year ended December 31, 2007, we have not disagreed with our            independent registered public accounting firm on any items of accounting treatment or            financial disclosure.

 

39

 

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**ITEM 9A. CONTROLS AND PROCEDURES**

 

**Evaluation of Disclosure Controls and Procedures**

 

We maintain disclosure controls and procedures that are designed to            ensure that information required to be disclosed by us in the reports that we file or            submit to the Securities and Exchange Commission under the Securities Exchange Act of            1934, as amended, is recorded, processed, summarized, and reported within the periods            specified by the Securities and Exchange Commission’s rules and forms, and that            information is accumulated and communicated to our management, including our principal            executive and principal financial officers (whom we refer to in this periodic report as            our Certifying Officers), as appropriate to allow timely decisions regarding required            disclosure. Our management evaluated, with the participation of our Certifying            Officers, the effectiveness of our disclosure controls and procedures as of            December 31, 2007, pursuant to Rule 13a-15(b) under the Securities Exchange            Act. Based upon that evaluation, our Certifying Officers concluded that, as of            December 31, 2007, our disclosure controls and procedures were            effective.

 

**Internal Control over Financial Reporting**

 

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002,            management’s report on internal control over financial reporting and the report            of PricewaterhouseCoopers LLP, our independent registered public accounting firm, on            the effectiveness of internal control over financial reporting are included on pages            F-1 and F-2 of this report and are incorporated in this Item 9A by            reference.

 

**Changes in Internal Control over Financial Reporting**

 

There were no changes in our internal control over financial reporting            that occurred during our most recently completed fiscal quarter that have materially            affected, or are reasonably likely to materially affect, our internal control over            financial reporting.

 

 

**ITEM 9B. OTHER INFORMATION**

 

|   | None. |
|--------|-------|

 

 

**PART III**

 

 

**ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE            GOVERNANCE**

 

The information from the definitive proxy statement for the 2008 annual            meeting of stockholders under the captions “Corporate Governance,”            “Proposal 1. Election of Directors,” and “Section 16(a)            Beneficial Ownership Reporting Compliance” is incorporated herein by            reference.

 

 

40

 

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**ITEM 11. EXECUTIVE COMPENSATION**

 

The information from the definitive proxy statement for the 2008 annual            meeting of stockholders under the caption “Executive Compensation” is            incorporated herein by reference.

 

 

**ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND            MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

 

The information from the definitive proxy statement for the 2008 annual            meeting of stockholders under the caption “Principal Stockholders” is            incorporated herein by reference.

 

 

**ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR            INDEPENDENCE**

 

The information from the definitive proxy statement for the 2008 annual            meeting of stockholders under the captions “Certain Relationships and Related            Transactions” and “Director Independence” is incorporated herein by            reference.

 

 

**ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES**

 

The information from the definitive proxy statement for the 2008 annual            meeting of stockholders under the caption “Relationship with Independent            Auditors” is incorporated herein by reference.

 

 

41

 

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**PART IV**

 

 

**ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**

 

| (a) | The following documents are filed as part of this report                            or incorporated herein by reference. |
|-----|--------------------------------------------------------------------------------------------------------------------------|

 

|   | **1.** | **Financial Statements**. See                            the following beginning at page F-1: |
|--------|--------|-----------------------------------------------------------------------------------------------|

             

|                                                                                                                                            | Page        |
|-------------------------------------------------------------------------------------------------------------------------------------------------|-------------|
| Management’s Report                            on Internal Control over Financial Reporting                                               | F-1         |
| Report of Independent                            Registered Public Accounting Firm                                                              | F-2         |
| Consolidated Balance Sheets as of December 31, 2007 and                            2006                                                         | F-4         |
| Consolidated Statements of Operations for the Years                            Ended

December 31, 2007, 2006 and 2005                          |  

F-6 |
| Consolidated Statements of Comprehensive Loss for the                            Years Ended

December 31, 2007, 2006 and 2005                  | F-7         |
| Consolidated Statements of Cash Flows for the Years                            Ended

December 31, 2007, 2006 and 2005                          |  

F-8 |
| Consolidated Statement of Stockholders’ Equity                            (Deficit) for the Years

Ended December 31, 2007, 2006 and 2005 |  

F-9 |
| Notes to the Consolidated Financial                            Statements                                                                       | F-10        |

             

|   | **2.** | **Supplemental Schedules**. The                            supplemental schedules have been omitted because they are not                            applicable or the required information is otherwise included in the                            accompanying consolidated financial statements and the notes                            thereto. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

             

|   | **3.** | **Exhibits**. The following                            exhibits are included as part of this report: |
|--------|--------|------------------------------------------------------------------------------------------------------|

 

| **Exhibit**

**Number*** |   |  

**Title of Document**                                                                                                                                                                      |   |  

**Location**                                                                                                                                                                                                         |
|--------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                     |   |                                                                                                                                                                                               |   |                                                                                                                                                                                                                         |
| **Item 3**               |   | **Articles of Incorporation and Bylaws**                                                                                                                                                           |   |                                                                                                                                                                                                                         |
| 3.01                     |   | Restated and Amended Articles of                            Incorporation                                                                                                                          |   | Incorporated by reference from the quarterly report on                            Form 10-Q for the quarter ended September 30, 2000, filed November 7,                            2000.

                              |
| 3.02                     |   | Bylaws, as amended January 2, 2008                                                                                                                                                                 |   | This filing.

                                                                                                                                                                                                          |
| 3.03                     |   | Articles of Amendment to the Restated Articles of                            Incorporation of FX Energy, Inc.                                                                                      |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2005, filed March 14,                            2006. 

                               |
| 3.04                     |   | Amendment to Articles of Incorporation Revising and                            Restating Designation of Rights, Privileges, and Preferences of Series                            A Preferred Stock |   | Incorporated by reference from the quarterly report on                            Form 10-Q for the period ended June 30, 2007, filed August 8,                            2007.

                                      |

 

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| **Item 4**  |   | **Instruments Defining the Rights of Security                            Holders**                                                                                                                                                                                                                                                                                                  |   |                                                                                                                                                                                                                  |
|-------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.01        |   | Specimen Stock Certificate                                                                                                                                                                                                                                                                                                                                                          |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2006, filed March 13,                            2007.

                              |
| 4.04        |   | Rights Agreement dated as of April 4, 2007, between FX                            Energy, Inc. and Fidelity Transfer Corp.                                                                                                                                                                                                                                                          |   | Incorporated by reference from the quarterly report on                            Form 10-Q for the period ended June 30, 2007, filed August 8,                            2007.

                               |
| **Item 10** |   | **Material Contracts**                                                                                                                                                                                                                                                                                                                                                              |   |                                                                                                                                                                                                                  |
| 10.26       |   | Frontier Oil Exploration Company 1995 Stock Option and                            Award Plan**                                                                                                                                                                                                                                                                                      |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2003, filed March 15,                            2004.

                              |
| 10.27       |   | FX Energy, Inc. 1996 Stock Option and Award                            Plan**                                                                                                                                                                                                                                                                                                  |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2003, filed March 15,                            2004.

                              |
| 10.28       |   | FX Energy, Inc. 1997 Stock Option and Award                            Plan**                                                                                                                                                                                                                                                                                                  |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2003, filed March 15,                            2004.

                              |
| 10.29       |   | FX Energy, Inc. 1998 Stock Option and Award                            Plan**                                                                                                                                                                                                                                                                                                  |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2003, filed March 15,                            2004.

                              |
| 10.52       |   | Form of Indemnification Agreement between                            FX Energy, Inc. and certain directors, with related                            schedule**                                                                                                                                                                                                                 |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2003, filed March 15,                            2004.

                              |
| 10.53       |   | Agreement on Cooperation in Exploration of Hydrocarbons                            on Foresudetic Monocline dated April 11, 2000, between Polskie                            Gornictwo Naftowe I Gazownictwo S.A. (POGC) and FX Energy Poland,                            Sp. z o.o. relating to Fences I project area

                              |   | Incorporated by reference from the current report on                            Form 8-K filed May 2, 2000.                                                                                                           |
| 10.59       |   | Sales / Purchase Agreement Special Provisions between                            Plains Marketing Canada, L.P. and FX Drilling Company Inc. agreed April                            29, 2002                                                                                                                                                                                        |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2002, filed March 27,                            2003.

                              |
| 10.60       |   | Form of Non-Qualified Stock Option awarded August 14,                            2002, with related schedule**                                                                                                                                                                                                                                                                      |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2002, filed March 27,                            2003.

                              |
| 10.62       |   | Agreement Regarding Cooperation within the Poznan Area                            (Fences II) entered into January 8, 2003, by and between Polskie                            Gornictwo Naftowe i Gazownictwo S.A. and FX Energy Poland                            Sp. z o.o.

                                                                            |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2002, filed March 27,                            2003.                                     |

 

43

----

 

| 10.63 |   | Settlement Agreement Regarding the Fences I Area                            entered into January 8, 2003, by and between Polskie Gornictwo Naftowe                            i Gazownictwo S.A. and FX Energy Poland                            Sp. z o.o.

                                                                         |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2002, filed March 27,                            2003.                                     |
|-------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.64 |   | Farmout Agreement Entered into by and between                            FX Energy Poland Sp. z o.o. and CalEnergy Power (Polska)                            Sp. z o.o. Covering the “Fences Area” in the                            Foresudetic Monocline made as of January 9, 2003

                              |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2002, filed March 27,                            2003.                                     |
| 10.67 |   | FX Energy, Inc. 1999 Stock Option and Award                            Plan**                                                                                                                                                                                                                                                                             |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2003, filed March 15,                            2004.

                              |
| 10.68 |   | FX Energy, Inc. 2000 Stock Option and Award                            Plan**                                                                                                                                                                                                                                                                             |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2003, filed March 15,                            2004.

                              |
| 10.69 |   | FX Energy, Inc. 2001 Stock Option and Award                            Plan**                                                                                                                                                                                                                                                                             |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2003, filed March 15,                            2004.

                              |
| 10.70 |   | FX Energy, Inc. 2003 Long-Term Incentive                            Plan                                                                                                                                                                                                                                                                                  |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2003, filed March 15,                            2004.

                              |
| 10.74 |   | Greater Zaniemysl Area Agreement made as of March 12,                            2004, among FX Energy Poland Sp. z o.o. and CalEnergy                            Resources Poland Sp. z o.o.

                                                                                                                                       |   | Incorporated by reference from the quarterly report on                            Form 10-Q for the period ended March 31, 2004, filed May 11,                            2004.                                  |
| 10.75 |   | Form of Indemnification Agreement between                            FX Energy, Inc. and directors and officers with related                            schedule**

                                                                                                                                                                                 |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2006, filed March 13,                            2007.                                     |
| 10.76 |   | Supplemental Indemnification Agreement between FX                            Energy, Inc. and Dennis B. Goldstein**

                                                                                                                                                                                                                                     |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2004, filed March 15,                            2005.                                     |
| 10.77 |   | Description of compensation arrangement with executive                            officers and directors**

                                                                                                                                                                                                                                              |   | This filing.                                                                                                                                                                                                          |
| 10.78 |   | Form of Employment Agreement with related                            schedule**                                                                                                                                                                                                                                                                                |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2006, filed March 13,                            2007.

                              |

 

44

----

 

| 10.79       |   | Change in Control Compensation Agreement with related                            schedule**                                                                                                                                                                                                                                                       |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2006, filed March 13,                            2007.

                              |
|-------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.81       |   | FX Energy, Inc. 2004 Long-Term Incentive                            Plan**                                                                                                                                                                                                                                                                   |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2004, filed March 15,                            2005.

                              |
| 10.82       |   | Letter of Engagement, H. Allen Turner, dated February                            14, 2007                                                                                                                                                                                                                                                         |   | Incorporated by reference from the current report on                            Form 8-K filed February 20, 2007.

                                                                                              |
| 10.83       |   | US$25,000,000 Senior Facility Agreement among FX Poland                            Sp. z o.o., FX Energy, Inc., FX Energy Netherlands                            Partnership CV., FX Energy Netherlands BV., and The Royal Bank of                            Scotland PLC, dated November 17, 2006

                              |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2006, filed March 13,                            2007.                                     |
| 10.84       |   | Common Stock Purchase Warrant dated November 17,                            2006                                                                                                                                                                                                                                                             |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2006, filed March 13,                            2007.

                              |
| 10.85       |   | Agreement for Pledges over Shares in FX Energy Poland                            Sp. z o.o., dated December 18, 2006                                                                                                                                                                                                                    |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2006, filed March 13,                            2007.

                              |
| 10.86       |   | Subordination Deed dated December 21, 2006                                                                                                                                                                                                                                                                                                        |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2006, filed March 13,                            2007.

                              |
| 10.87       |   | Restated FX Energy, Inc. 401(k) Stock Bonus Plan                            dated January 25, 2007**                                                                                                                                                                                                                                         |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2006, filed March 13,                            2007.

                              |
| 10.88       |   | Agreement for the Sale of Natural Gas between                            FX Energy Poland Sp. z o.o. and Mazowiecka                            Spółka Gazownictwa Sp. z o.o., dated                            December 29, 2005

                                                                 |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2006, filed March 13,                            2007.                                     |
| 10.89       |   | Agreement No. PL/012216736/05-0030/DH/HB for the Sale of                            Natural Gas between FX Energy Poland Sp. z o.o. and Polskie                            Górnictwo Naftowe I Gazownictwo S.A., dated December 8,                            2005

                                                        |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2006, filed March 13,                            2007.                                     |
| 10.90       |   | Agreement for the Sale of Wellhead Natural Gas between                            FX Energy Poland Sp. z o.o. and PL Energia S.A., dated                            January 26, 2007                                                                                                                                                    |   | Incorporated by reference from the annual report on Form                            10-K for the period ended December 31, 2006, filed March 13,                            2007.

                              |
| 10.91       |   | Form of Stock Purchase Agreement                                                                                                                                                                                                                                                                                                                  |   | Incorporated by reference from the current report on                            Form 8-K filed July 5, 2007.

                                                                                                   |
|        |   |                                                                                                                                                                                                                                                                                                                                              |   |                                                                                                                                                                                                                  |
| **Item 21** |   | **Subsidiaries of the Registrant**                                                                                                                                                                                                                                                                                                                |   |                                                                                                                                                                                                                  |
| 21.01       |   | Schedule of Subsidiaries                                                                                                                                                                                                                                                                                                                          |   | This filing.                                                                                                                                                                                                          |
|        |   |                                                                                                                                                                                                                                                                                                                                              |   |                                                                                                                                                                                                                  |

 

45

----

 

| Item 23 |   | **Consents of Experts and Counsel**                                                                                                                                                                                                         |   |                                             |
|---------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------|
| 23.01   |   | Consent of PricewaterhouseCoopers LLP, independent                            registered public accounting firm

                                                                                                                      |   | This filing.                                     |
| 23.02   |   | Consent of Larry D. Krause, Petroleum                            Engineer                                                                                                                                                                   |   | This filing.

                              |
| 23.03   |   | Consent of RPS Energy, Petroleum Engineers                                                                                                                                                                                                  |   | This filing.

                              |
|    |   |                                                                                                                                                                                                                                        |   |                                             |
| Item 31 |   | **Rule 13a-14(a)/15d-14(a)                            Certifications**                                                                                                                                                                      |   |                                             |
| 31.01   |   | Certification of Chief Executive Officer Pursuant to                            Rule 13a-14

                                                                                                                                          |   | This filing.                                     |
| 31.02   |   | Certification of Chief Financial Officer Pursuant to                            Rule 13a-14

                                                                                                                                          |   | This filing.                                     |
|    |   |                                                                                                                                                                                                                                        |   |                                             |
| Item 32 |   | **Section 1350 Certifications**                                                                                                                                                                                                             |   |                                             |
| 32.01   |   | Certification of Chief Executive Officer Pursuant to 18                            U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the                            Sarbanes-Oxley Act of 2002

                              |   | This filing.                                     |
| 32.02   |   | Certification of Chief Financial Officer Pursuant to 18                            U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the                            Sarbanes-Oxley Act of 2002                                     |   | This filing.                                     |

                                                              

| * | All exhibits are numbered with the number preceding the                            decimal indicating the applicable SEC reference number in Item 601, and                            the number following the decimal indicating the sequence of the                            particular document. Omitted numbers in the sequence refer to documents                            previously filed as an exhibit, but no longer required. |
|---|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| ** | Identifies each management contract or compensatory plan                            or arrangement required to be filed as an exhibit, as required by Item                            15(a)(3) of Form 10-K. |
|----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

46

 

----

 

**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities            Exchange Act of 1934, the registrant has duly caused this report to be signed on its            behalf by the undersigned, thereunto duly authorized.

 

|   | FX ENERGY, INC. (Registrant) |
|--------|------------------------------|

 

 

| Dated: March 7, 2008 | By: | /s/ David N. Pierce |
|----------------------|-----|---------------------|

|   | David N. Pierce |
|--------|-----------------|

|   | President and Chief Executive Officer |
|--------|---------------------------------------|

 

 

| Dated: March 7, 2008 | By: | /s/ Clay Newton |
|----------------------|-----|-----------------|

|   | Clay Newton |
|--------|-------------|

|   | Principal Financial Officer |
|--------|-----------------------------|

 

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities            Exchange Act of 1934, the registrant has duly caused this report to be signed on its            behalf by the undersigned, thereunto duly authorized.

 

|                 | /s/ Thomas B. Lovejoy             |
|----------------------|-----------------------------------|
| Dated: March 7, 2008 | Thomas B. Lovejoy, Director       |
|                 | /s/ David N. Pierce               |
| Dated: March 7, 2008 | David N. Pierce, Director         |
|                 | /s/ Dennis B. Goldstein           |
| Dated: March 7, 2008 | Dennis B. Goldstein, Director     |
|                 | /s/ David L. Worrell              |
| Dated: March 7, 2008 | David L. Worrell, Director        |
|                 | /s/ Arnold S. Grundvig, Jr.       |
| Dated: March 7, 2008 | Arnold S. Grundvig, Jr., Director |
|                 | /s/ Jerzy B. Maciolek             |
| Dated: March 7, 2008 | Jerzy B. Maciolek, Director       |
|                 | /s/ Richard Hardman               |
| Dated: March 7, 2008 | Richard Hardman, Director         |
|                 | /s/ H. Allen Turner               |
| Dated: March 7, 2008 | H. Allen Turner, Director         |

 

 

47

 

----

 

 

**MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL            REPORTING**

 

Management of FX Energy, Inc., together with its consolidated            subsidiaries (the Company), is responsible for establishing and maintaining adequate            internal control over financial reporting. The Company’s internal control over            financial reporting is a process designed by the Company’s principal executive            and principal financial officers to provide reasonable assurance regarding the            reliability of financial reporting and the preparation of the Company’s financial            statements for external reporting purposes in accordance with U.S. generally accepted            accounting principles.

 

As of the end of the Company’s 2007 fiscal year, management            conducted an assessment of the effectiveness of the Company’s internal control            over financial reporting based on the framework established in*Internal Control* *— Integrated Framework*issued by the            Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this            assessment, management has determined that the Company’s internal control over            financial reporting as of December 31, 2007, was effective.

 

The Company’s internal control over financial reporting includes            policies and procedures that (1) pertain to the maintenance of records that, in            reasonable detail, accurately and fairly reflect transactions and dispositions of            assets; (2) provide reasonable assurance that transactions are recorded as            necessary to permit preparation of financial statements in accordance with U.S.            generally accepted accounting principles, and that receipts and expenditures are being            made only in accordance with authorizations of management and the directors of the            Company; and (3) provide reasonable assurance regarding prevention or timely            detection of unauthorized acquisition, use or disposition of the Company’s assets            that could have a material effect on the Company’s consolidated financial            statements.

 

The effectiveness of the Company’s internal control over financial            reporting as of December 31, 2007, has been audited by PricewaterhouseCoopers LLP,            independent registered public accounting firm, as stated in its report appearing on            pages F-2 and F-3.

 

F-1

 

----

 

 

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING            FIRM**

 

To the            Shareholders and Board of Directors

 of FX Energy, Inc. and its subsidiaries

 

In            our opinion, the accompanying consolidated balance sheets and the related consolidated            statements of operations, of comprehensive loss, of cash flows and of            stockholders’ equity (deficit) present fairly, in all material respects, the            financial position of FX Energy, Inc. and its subsidiaries at December 31, 2007 and            2006, and the results of their operations and their cash flows for each of the three            years in the period endedDecember 31, 2007in conformity with accounting principles            generally accepted in the United States of America. Also in our opinion, the Company            maintained, in all material respects, effective internal control over financial            reporting as of December 31, 2007, based on criteria established in*Internal Control - Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway            Commission (COSO). The Company's management is responsible for these financial            statements, for maintaining effective internal control over financial reporting and for            its assessment of the effectiveness of internal control over financial reporting,            included in the accompanying Management's Report on Internal Control over Financial            Reporting. Our responsibility is to express opinions on these financial statements and            on the Company's internal control over financial reporting based on our integrated            audits. We conducted our audits in accordance with the standards of the Public Company            Accounting Oversight Board (United States). Those standards require that we plan and            perform the audits to obtain reasonable assurance about whether the financial            statements are free of material misstatement and whether effective internal control            over financial reporting was maintained in all material respects. Our audits of the            financial statements included examining, on a test basis, evidence supporting the            amounts and disclosures in the financial statements, assessing the accounting            principles used and significant estimates made by management, and evaluating the            overall financial statement presentation. Our audit of internal control over financial            reporting included obtaining an understanding of internal control over financial            reporting, assessing the risk that a material weakness exists, and testing and            evaluating the design and operating effectiveness of internal control based on the            assessed risk. Our audits also included performing such other procedures as we            considered necessary in the circumstances. We believe that our audits provide a            reasonable basis for our opinions.

 

As            discussed in Note 1 to the consolidated financial statements, the Company changed the            manner in which it accounts for share-based compensation on January 1, 2006.

 

A            company’s internal control over financial reporting is a process designed to            provide reasonable assurance regarding the reliability of financial reporting and the            preparation of financial statements for external purposes in accordance with generally            accepted accounting principles. A company’s internal control over financial            reporting includes those policies and procedures that (i) pertain to the            maintenance of records that, in reasonable detail, accurately and fairly reflect the            transactions and dispositions of the assets of the company; (ii) provide            reasonable assurance that transactions are recorded as necessary to permit preparation            of financial statements in accordance with generally accepted accounting principles,            and that receipts and expenditures of the company are being made only in accordance            with authorizations of management and directors of the company; and (iii) provide            reasonable assurance regarding prevention or timely detection of unauthorized            acquisition, use, or disposition of the company’s assets that could have a            material effect on the financial statements.

 

F-2

 

----

Because of its inherent limitations, internal control over financial            reporting may not prevent or detect misstatements. Also, projections of any evaluation            of effectiveness to future periods are subject to the risk that controls may become            inadequate because of changes in conditions, or that the degree of compliance with the            policies or procedures may deteriorate.

 

/s/            PricewaterhouseCoopers LLP

 

Salt            Lake City, Utah

March 7, 2008

 

F-3

 

----

**FX            ENERGY, INC. AND SUBSIDIARIES**

**Consolidated Balance Sheets**

**As            of December 31, 2007 and 2006**

**(in thousands)**

 

 

|                                                                                 | **2007** |              | **2006** |
|--------------------------------------------------------------------------------------|----------|-------------------|----------|
| **ASSETS**                                                                           |     |              |     |   |   |
|                                                                                 |     |              |     |   |   |
| **Current assets:**                                                                  |     |              |     |   |   |
| Cash and cash equivalents                                                            | $        |  4,262  |     | $ | 4,644  |
| Marketable securities, available for sale                                            |     | 15,202       |     |   | 10,462  |
| Receivables:                                                                         |     |              |     |   |   |
| Accrued oil and gas sales                                                            |     | 1,906        |     |   | 1,615  |
| Joint interest and other receivables                                                 |     | 805          |     |   | 249  |
| Input VAT receivable                                                                 |     | 446          |     |   | 710  |
| Inventory                                                                            |     | 178          |     |   | 206  |
| Other current assets                                                                 |     | 365          |     |   | 322  |
| Total current assets                                                                 |     | 23,164       |     |   | 18,208  |
|                                                                                 |     |              |     |   |   |
| **Property and equipment, at cost:**                                                 |     |              |     |   |   |
| Oil and gas properties (successful efforts                            method):       |     |              |     |   |   |
| Proved                                                                               |     | 23,491       |     |   | 19,293  |
| Unproved                                                                             |     | 2,001        |     |   | 2,912  |
| Other property and equipment                                                         |     | 5,590        |     |   | 4,624  |
| Gross property and equipment                                                         |     | 31,082       |     |   | 26,829  |
| Less accumulated depreciation, depletion and                            amortization |     | (9,197)           |     |   | (7,134) |
| Net property and equipment                                                           |     | 21,885       |     |   | 19,695  |
|                                                                                 |     |              |     |   |   |
| **Other assets:**                                                                    |     |              |     |   |   |
| Certificates of deposit                                                              |     | 406          |     |   | 382  |
| Loan fees                                                                            |     | 914          |     |   | 882  |
| Total other assets                                                                   |     | 1,320        |     |   | 1,264  |
|                                                                                 |     |              |     |   |   |
| **Total assets**                                                                     | $        | 46,369       |     | $ | 39,167  |

 

 

 

**-Continued-**

 

**The accompanying notes are an integral part of these consolidated            financial statements.**

 

F-4

 

----

**FX            ENERGY, INC. AND SUBSIDIARIES**

**Consolidated Balance Sheets**

**As            of December 31, 2007 and 2006**

**(in thousands, except share data)**

**-Continued-**

 

 

|                                                                                                                                                                                                                                                                                          | **2007** |          | **2006** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------|---------------|----------|
| **LIABILITIES AND STOCKHOLDERS’                            EQUITY**                                                                                                                                                                                                                     |     |          |     |   |   |
|                                                                                                                                                                                                                                                                                          |     |          |     |   |   |
| **Current liabilities:**                                                                                                                                                                                                                                                                      |     |          |     |   |   |
| Accounts payable                                                                                                                                                                                                                                                                              | $        | 4,432    |     | $ | 5,234  |
| Accrued liabilities                                                                                                                                                                                                                                                                           |     | 3,358    |     |   | 1,007  |
| Total current liabilities                                                                                                                                                                                                                                                                     |     | 7,790    |     |   | 6,241  |
|                                                                                                                                                                                                                                                                                          |     |          |     |   |   |
| Asset retirement obligation                                                                                                                                                                                                                                                                   |     | 1,037    |     |   | 961  |
|                                                                                                                                                                                                                                                                                          |     |          |     |   |   |
| Total liabilities                                                                                                                                                                                                                                                                             |     | 8,827    |     |   | 7,202  |
|                                                                                                                                                                                                                                                                                          |     |          |     |   |   |
| **Commitments and Contingencies (Note 6)**                                                                                                                                                                                                                                                    |     |          |     |   |   |
|                                                                                                                                                                                                                                                                                          |     |          |     |   |   |
| **Stockholders’ equity:**                                                                                                                                                                                                                                                               |     |          |     |   |   |
| Preferred stock, $0.001 par value, 5,000,000 shares                            authorized as of

December 31, 2007 and 2006; no shares                            outstanding                                                                                                                 |     | --       |     |   | --  |
| Common stock, $0.001 par value, 100,000,000 shares                            authorized as of

December 31, 2007 and 2006; 38,196,357 and                            35,560,744 shares issued and outstanding as of December 31, 2007 and                            2006, respectively |     | 38       |     |   | 36  |
| Additional paid in capital                                                                                                                                                                                                                                                                    |     | 142,901  |     |   | 125,706  |
| Accumulated other comprehensive loss                                                                                                                                                                                                                                                          |     | (1)           |     |   | (72) |
| Accumulated deficit                                                                                                                                                                                                                                                                           |     | (105,396)     |     |   | (93,705) |
| Total stockholders’ equity                                                                                                                                                                                                                                                              |     | 37,542   |     |   | 31,965  |
| **Total liabilities and stockholders’                            equity**                                                                                                                                                                                                               | $        | 46,369   |     | $ | 39,167  |

 

 

 

**The accompanying notes are an integral part of these consolidated            financial statements.**

 

F-5

 

----

**FX            ENERGY, INC. AND SUBSIDIARIES**

**Consolidated Statements of Operations**

**For the years ended December 31, 2007, 2006 and 2005**

**(in thousands, except per share amounts)**

 

|                                                                                                        | **2007** |         | **2006** |   | **2005**     |
|-------------------------------------------------------------------------------------------------------------|----------|--------------|----------|--------|--------------|
| **Revenues:**                                                                                               |     |         |     |   |         |   |   |   |
| Oil and gas sales                                                                                           | $        | 14,903  |     | $      | 6,533   |   | $ | 3,805  |
| Oilfield services                                                                                           |     | 3,093   |     |   | 1,696   |   |   | 2,132  |
| Total revenues                                                                                              |     | 17,996  |     |   | 8,229   |   |   | 5,937  |
| **Operating costs and expenses:**                                                                           |     |         |     |   |         |   |   |   |
| Lease operating expenses                                                                                    |     | 3,538   |     |   | 2,647   |   |   | 2,462  |
| Exploration costs                                                                                           |     | 10,624  |     |   | 5,608   |   |   | 8,369  |
| Recovery of previously expensed Input VAT                                                                   |     | --      |     |   | --      |   |   | (2,121) |
| Impairment of oil and gas properties                                                                        |     | 2,299   |     |   | 3,583   |   |   | --  |
| Oilfield services costs                                                                                     |     | 1,998   |     |   | 1,245   |   |   | 1,689  |
| Depreciation, depletion and amortization                            (DD&A)                              |     | 2,064   |     |   | 1,290   |   |   | 903  |
| Accretion expense                                                                                           |     | 78      |     |   | 53      |   |   | 45  |
| Stock compensation (G&A)                                                                                |     | --      |     |   | --      |   |   | 76  |
| Amortization of deferred compensation                            (G&A)                                  |     | 2,604   |     |   | 2,759   |   |   | 125  |
| General and administrative costs (G&A)                                                                  |     | 6,915   |     |   | 5,606   |   |   | 6,592  |
| Total operating costs and expenses                                                                          |     | 30,120  |     |   | 22,791  |   |   | 18,140  |
| **Operating loss**                                                                                          |     | (12,124)     |     |   | (14,562)     |   |   | (12,203) |
|                                                                                                        |     |         |     |   |         |   |   |   |
| **Other income:**                                                                                           |     |         |     |   |         |   |   |   |
| Interest and other income                                                                                   |     | 433     |     |   | 795     |   |   | 780  |
| Total other income                                                                                          |     | 433     |     |   | 795     |   |   | 780  |
|                                                                                                        |     |         |     |   |         |   |   |   |
| **Net loss**                                                                                                | $        | (11,691)     |     | $      | (13,767)     |   | $ | (11,423) |
|                                                                                                        |     |         |     |   |         |   |   |   |
| **Basic and diluted net loss per common                            share**                                  | $        | (0.32)       |     | $      | (0.39)       |   | $ | (0.33) |
|  

**Basic and diluted weighted average number of                            shares**

**outstanding** |     | 36,694  |     |   | 35,163  |   |   | 34,733  |

 

 

 

 

**The accompanying notes are an integral part of these consolidated            financial statements.**

 

F-6

 

----

**FX            ENERGY, INC. AND SUBSIDIARIES**

**Consolidated Statements of Comprehensive Loss**

**For the years ended December 31, 2007, 2006 and 2005**

**(in thousands)**

 

 

 

|                                                                                                       |   | **2007** |   |   | **2006** |   | **2005** |
|------------------------------------------------------------------------------------------------------------|--------|----------|--------|--------|----------|--------|----------|
| **Net loss**                                                                                               | $      | (11,691) |   | $      | (13,767) |   | $        | (11,423) |
|                                                                                                       |   |     |   |   |     |   |     |   |
| **Other comprehensive income (loss)**                                                                      |   |     |   |   |     |   |     |   |
| Increase (decrease) in market value of available for                            sale marketable securities |   | 71  |   |   | (14)     |   |     | 281  |
| **Comprehensive loss**                                                                                     | $      | (11,620) |   | $      | (13,781) |   | $        | (11,142) |

 

 

 

 

 

 

**The accompanying notes are an integral part of these consolidated            financial statements.**

 

F-7

 

----

**FX            ENERGY, INC. AND SUBSIDIARIES**

**Consolidated Statements of Cash Flows**

**For the years ended December 31, 2007, 2006 and 2005**

**(in thousands)**

 

|                                                                                                    |   | **2007**     |   |   | **2006**     |   |   | **2005**    |
|---------------------------------------------------------------------------------------------------------|--------|--------------|--------|--------|--------------|--------|--------|-------------|
| **Cash flows from operating activities:**                                                               |   |         |   |   |         |   |   |        |
| Net loss                                                                                                | $      | (11,691)     |   | $      | (13,767)     |   | $      | (11,423)    |
| Adjustments to reconcile net loss to net cash used                            in

operating activities: |   |         |   |   |         |   |   |        |
| Depreciation, depletion and amortization                                                                |   | 2,064   |   |   | 1,290   |   |   | 903    |
| Impairment of oil and gas properties                                                                    |   | 2,299   |   |   | 3,583   |   |   | --     |
| Property abandonment                                                                                    |   | --      |   |   | --      |   |   | 242    |
| Accretion expense                                                                                       |   | 78      |   |   | 53      |   |   | 45     |
| (Gain) loss on property dispositions                                                                    |   | --      |   |   | --      |   |   | (18)        |
| Stock compensation (G&A)                                                                            |   | --      |   |   | --      |   |   | 76     |
| Amortization of deferred compensation                            (G&A)                              |   | 2,604   |   |   | 2,759   |   |   | 125    |
| Common stock issued for services (G&A)                                                              |   | 242     |   |   | 517     |   |   | 610    |
| Increase (decrease) from changes in working capital                            items:                   |   |         |   |   |         |   |   |        |
| Receivables                                                                                             |   | (583)        |   |   | 1,451   |   |   | (2,438)     |
| Inventory                                                                                               |   | 28      |   |   | (110)        |   |   | (4)         |
| Other current assets                                                                                    |   | (43)         |   |   | (52)         |   |   | (46)        |
| Other assets                                                                                            |   | (56)         |   |   | (25)         |   |   | 3      |
| Accounts payable and accrued liabilities                                                                |   | 3,479   |   |   | (995)        |   |   | 1,848  |
| Asset retirement obligation                                                                             |   | (2)          |   |   | (7)          |   |   | (28)        |
| Net cash used in operating activities                                                                   |   | (1,581)      |   |   | (5,303)      |   |   | (10,105)    |
|                                                                                                    |   |         |   |   |         |   |   |        |
| **Cash flows from investing activities:**                                                               |   |         |   |   |         |   |   |        |
| Additions to oil and gas properties                                                                     |   | (7,517)      |   |   | (7,521)      |   |   | (2,989)     |
| Additions to other property and equipment                                                               |   | (966)        |   |   | (362)        |   |   | (422)       |
| Recovery of previously capitalized VAT                                                                  |   | --      |   |   | --      |   |   | 1,921  |
| Additions to marketable securities                                                                      |   | (9,610)      |   |   | (782)        |   |   | (627)       |
| Proceeds from maturities of marketable                            securities                            |   | 4,941   |   |   | 16,800  |   |   | 6,750  |
| Proceeds from sale of assets                                                                            |   | --      |   |   | --      |   |   | 23     |
| Net cash provided by (used in) investing                            activities                          |   | (13,152)     |   |   | 8,135   |   |   | 4,656  |
|                                                                                                    |   |         |   |   |         |   |   |        |
| **Cash flows from financing activities:**                                                               |   |         |   |   |         |   |   |        |
| Payment of loan fees                                                                                    |   | --      |   |   | (578)        |   |   | --     |
| Proceeds from issuance of common stock , net of offering                            costs               |   | 12,436  |   |   | --      |   |   | --     |
| Proceeds from exercise of stock options and                            warrants                         |   | 1,915   |   |   | --      |   |   | 4,055  |
| Net cash provided by (used in) financing                            activities                          |   | 14,351  |   |   | (578)        |   |   | 4,055  |
|                                                                                                    |   |         |   |   |         |   |   |        |
| Net increase (decrease) in cash                                                                         |   | (382)        |   |   | 2,254   |   |   | (1,394)     |
| Cash and cash equivalents at beginning of                            year                               |   | 4,644   |   |   | 2,390   |   |   | 3,784  |
|                                                                                                    |   |         |   |   |         |   |   |        |
| **Cash and cash equivalents at end of                            year**                                 | $      | 4,262   |   | $      | 4,644   |   | $      | 2,390  |

 

 

**The accompanying notes are an integral part of these consolidated            financial statements.**

 

F-8

 

----

**FX            ENERGY, INC. AND SUBSIDIARIES**

**Consolidated Statement of Stockholders’ Equity            (Deficit)**

**For the years ended December 31, 2007, 2006 and 2005**

**(in thousands)**

 

|                                                                                           |          |   | **Common Stock** |   |           |   |             |   | **Accumulated**   |   |              |   |            |
|------------------------------------------------------------------------------------------------|---------------|--------|------------------|--------|----------------|--------|------------------|--------|-------------------|--------|-------------------|--------|-----------------|
|                                                                                           |          |   |             |   | **Par Value**  |   |             |   | **Additional**    |   | **Other**         |   |            |   | **Total** |
|                                                                                           | **Preferred** |   | **Shares**       |   | **$0.001 Per** |   | **Deferred**     |   | **Paid in**       |   | **Comprehensive** |   | **Accumulated** |   | **Stockholders’** |
|                                                                                           | **Stock**     |   | **Issued**       |   | **Share**      |   | **Compensation** |   | **Capital**       |   | **Income (Loss)** |   | **Deficit**     |   | **Equity (Deficit)** |
| **Balance as of December 31, 2004**                                                            | --            |   | 34,398           | $      | 34             | $      | --          | $      | 117,376      | $      | (339)             | $      | (68,515)        | $ | 48,556  |
| Common stock issued for services and other                                                     | --            |   | 58               |   | --             |   | --          |   | 610          |   | --           |   | --         |   | 610  |
| Exercise of stock options                                                                      | --            |   | 593              |   | 1              |   | --          |   |  3,874  |   | --           |   | --         |   | 3,875  |
| Stock compensation                                                                             | --            |   | --               |   | --             |   | --          |   | 76           |   | --           |   | --         |   | 76  |
| Deferred compensation                                                                          | --            |   | --               |   | --             |   | (3,100)          |   | 3,100        |   | --           |   | --         |   | --  |
| Amortization of deferred compensation                                                          | --            |   | --               |   | --             |   | 125         |   | --           |   | --           |   | --         |   | 125  |
| Exercise of warrants                                                                           | --            |   | 48               |   | --             |   | --          |   | 180          |   | --           |   | --         |   | 180  |
| Other comprehensive income                                                                     | --            |   | --               |   | --             |   | --          |   | --           |   | 281          |   | --         |   | 281  |
| Net loss for year                                                                              | --            |   | --               |   | --             |   | --          |   | --           |   | --           |   | (11,423)        |   | (11,423) |
| **Balance as of December 31, 2005**                                                            | --            |   | 35,097           | $      | 35             | $      | (2,975)          | $      | 125,216      | $      | (58)              | $      | (79,938)        | $ | 42,280  |
| Common stock issued for services and other                                                     | --            |   | 464              |   | 1              |   | --          |   | 706          |   | --           |   | --         |   | 707  |
| Elimination of deferred compensation upon adoption of                            SFAS No. 123R | --            |   | --               |   | --             |   | 2,975       |   | (2,975)           |   | --           |   | --         |   | --  |
| Amortization of deferred compensation                                                          | --            |   | --               |   | --             |   | --          |   | 2,759        |   | --           |   | --         |   | 2,759  |
| Other comprehensive loss                                                                       | --            |   | --               |   | --             |   | --          |   | --           |   | (14)              |   | --         |   | (14) |
| Net loss for year                                                                              | --            |   | --               |   | --             |   | --          |   | --           |   | --           |   | (13,767)        |   | (13,767) |
| **Balance as of December 31, 2006**                                                            | --            |   | 35,561           | $      | 36             | $      | --          | $      | 125,706      | $      | (72)              | $      | (93,705)        | $ | 31,965  |
| Common stock issued for services and other                                                     | --            |   | 463              |   | --             |   | --          |   | 242          |   | --           |   | --         |   | 242  |
| Exercise of stock options and warrants                                                         | --            |   | 672              |   | 1              |   | --          |   | 1,915        |   | --           |   | --         |   | 1,916  |
| Issuance of common stock                                                                       | --            |   | 1,500            |   | 1              |   | --          |   | 12,434       |   | --           |   | --         |   | 12,435  |
| Amortization of deferred compensation                                                          | --            |   | --               |   | --             |   | --          |   | 2,604        |   | --           |   | --         |   | 2,604  |
| Other comprehensive income                                                                     | --            |   | --               |   | --             |   | --          |   | --           |   | 71           |   | --         |   | 71  |
| Net loss for year                                                                              | --            |   | --               |   | --             |   | --          |   | --           |   | --           |   | (11,691)        |   | (11,691) |
| **Balance as of December 31, 2007**                                                            | --            |   | 38,196           | $      | 38             | $      | --          | $      | 142,901      | $      | (1)               | $      | (105,396)       | $ | 37,542  |

 

**The accompanying notes are an integral part of these consolidated            financial statements.**

F-9

 

----

**FX ENERGY, INC. AND SUBSIDIARIES**

**Notes to the Consolidated Financial Statements**

             

             

**Note 1: Summary of Significant Accounting Policies**

 

***Organization***

             

FX            Energy, Inc., a Nevada corporation, and its subsidiaries (collectively referred to            hereinafter as the “Company”), is an independent energy company with            activities concentrated within the upstream oil and gas industry. In Poland, the            Company has projects involving the exploration and exploitation of oil and gas            prospects in partnership with the Polish Oil and Gas Company (“POGC”),            other industry partners and for its own account. In the United States, the Company            explores for and produces oil from fields in Montana and Nevada and has an oilfield            services company in northern Montana that performs contract drilling and well servicing            operations.

 

***Principles of Consolidation***

             

The            consolidated financial statements include the accounts of the Company and its            wholly-owned subsidiaries and the Company’s undivided interests in Poland. All            significant inter-company accounts and transactions have been eliminated in            consolidation. At December 31, 2007, the Company owned 100% of the voting common stock            or other equity securities of its subsidiaries.

 

***Cash and Cash Equivalents***

             

The            Company considers all highly-liquid debt instruments purchased with an original            maturity of three months or less to be cash equivalents.

 

***Concentration of Credit Risk***

             

Excluding the receivable for Input VAT, which is due from the State            Treasury Office of Poland, the majority of the Company’s receivables are within            the oil and gas industry, primarily from the purchasers of its oil and gas, fees            generated from oilfield services and its industry partners. Substantially all of the            Company’s domestic receivables are with Cenex, a regional refiner and marketer,            and substantially all of the Company’s Polish receivables are with the Polish Oil            and Gas Company or one of its affiliates. The receivables are not collateralized. To            date, the Company has experienced minimal bad debts, and has no allowance for doubtful            accounts at December 31, 2007 and 2006. The majority of the Company’s cash            and cash equivalents are held by four financial institutions in Utah, Montana, New York            and Poland. The Company’s marketable securities are held by two financial            institutions in Utah and New York.

 

***Inventory***

             

Inventory consists primarily of tubular goods and production related            equipment and is valued at the lower of average cost or market.

 

F-10

 

----

**FX ENERGY, INC. AND SUBSIDIARIES**

**Notes to the Consolidated Financial Statements**

**- Continued -**

             

***Oil and Gas Properties***

             

The            Company follows the successful efforts method of accounting for its oil and gas            operations. Under this method of accounting, all property acquisition costs and costs            of exploratory and development wells are capitalized when incurred, pending            determination of whether an individual well has found proved reserves. If it is            determined that an exploratory well has not found proved reserves, or if the            determination that proved reserves have been found cannot be made within one year, or            if the Company is not making sufficient progress assessing the reserves and the            economic and operating viability of the project, the costs of the well are expensed.            The costs of development wells are capitalized whether productive or nonproductive.            Geological and geophysical costs on exploratory prospects and the costs of carrying and            retaining unproved properties are expensed as incurred. An impairment allowance is            provided to the extent that capitalized costs of unproved properties, on a            property-by-property basis, are not considered to be realizable. Depletion,            depreciation and amortization (“DD&A”) of capitalized costs of proved            oil and gas properties is provided on a field-by-field basis using the            units-of-production method. The computation of DD&A takes into consideration the            anticipated proceeds from equipment salvage. An impairment loss is recorded if the net            capitalized costs of proved oil and gas properties exceed the aggregate undiscounted            future net revenues determined on a field-by-field basis. The impairment loss            recognized equals the excess of net capitalized costs over the related fair value            determined on a property-by-property basis. Gains and losses are recognized on sales of            entire interests in proved and unproved properties. Sales of partial interests are            generally treated as a recovery of costs and any resulting gain or loss is recorded as            other income.

 

The            Wilga well in Poland began to experience significant water encroachment from one of its            three productive zones during the fourth quarter of 2007, and production engineering            data suggests that the well may experience a decline in oil and gas production over the            course of the next 12-18 months as a result. As a consequence of the water            encroachment, the proved reserves at Wilga have been reduced. According to the            provision of Statement of Financial Accounting Standards No. 144 (“SFAS No.            144”), Accounting for the Impairment and Disposal of Long-Lived Assets, the            Company recorded an impairment of capitalized costs in the amount of $2,299,534 in            2007. The impairment amount was calculated by reducing the net capitalized costs of the            well to its fair value at year-end. The fair value of the well was equal to its            remaining estimated  discounted future net cash flows.

 

The            following table reflects the net changes in capitalized exploratory well costs, which            are capitalized pending the determination of proved reserves, during 2007, 2006 and            2005.

 

|                                                                                                                          | **December 31,** |
|-------------------------------------------------------------------------------------------------------------------------------|------------------|
|                                                                                                                          | **2007**         |   | **2006** |   | **2005** |
|                                                                                                                          |             |   |   |   | **(In thousands)** |   |   |   |
| Beginning balance at January 1                                                                                                | $                | 2,386  |   | $ | 3,435  |   | $ | 8,779  |
| Additions to capitalized exploratory well costs pending                            the determination of proved reserves       |             | 669  |   |   | 2,386  |   |   | 313  |
| Reclassifications to wells, facilities and equipment                            based on the determination of proved reserves |             | (2,386) |   |   | --  |   |   | (5,559) |
| Capitalized exploratory well costs charged to                            expense                                              |             | --  |   |   | (3,435) |   |   | (98) |
| Ending balance at December 31                                                                                                 | $                | 669  |   | $ | 2,386  |   | $ | 3,435  |

 

The            2007 balance includes equipment costs incurred for the Grundy well in Poland, which            began drilling in early 2008. The 2006 balance includes costs associated with the Winna            Gora and Roszkow wells in Poland, which were in process at year end. Both wells were            completed in 2007 as successful gas wells. As a result of its focus in the Sroda area,            the Company determined in 2006 to delay assessing the reserves and the economic and            operating viability of its Rusocin well in Poland. The provisions of FASB Staff            Position No. 19-1, Accounting for Suspended Well Costs (FSP 19-1) required the costs            associated with this well, approximately $3.4 million, to be impaired at December 31,            2006.

 

The            2005 balance included only the costs associated with the Rusocin well in Poland, which            was under evaluation at year-end 2005.

 

F-11

 

----

**FX ENERGY, INC. AND SUBSIDIARIES**

**Notes to the Consolidated Financial Statements**

**- Continued -**

             

***Other Property and Equipment***

             

Other property and equipment, including oilfield servicing equipment, is            stated at cost. Depreciation of other property and equipment is calculated using the            straight-line method over the estimated useful lives (ranging from 3 to 40 years) of            the respective assets. The costs of normal maintenance and repairs are charged to            expense as incurred. Material expenditures that increase the life of an asset are            capitalized and depreciated over the estimated remaining useful life of the asset. The            cost of other property and equipment sold, or otherwise disposed of, and the related            accumulated depreciation are removed from the accounts and any gain or loss is            reflected in current operations.

 

The            historical cost of other property and equipment, presented on a gross basis with            accumulated depreciation, is summarized as follows:

 

|                              |               |        |            |   |           |   | **Estimated** |
|-----------------------------------|--------------------|-------------|-----------------|--------|----------------|--------|---------------|
|                              | **December 31,**   |        | **Useful Life** |
|                              | **2007**           |        | **2006**        |   | **(in years)** |
|                              | **(In thousands)** |        |            |
| **Other property and equipment:** |               |        |            |   |           |   |          |
| Drilling rigs                     | $                  | 4,180  |            | $      | 3,317     |   | 6             |
| Other vehicles                    |               | 320    |            |   | 290       |   | 5             |
| Building                          |               | 108    |            |   | 108       |   | 40            |
| Office equipment and furniture    |               | 982    |            |   | 909       |   | 3 to 6        |
| Total cost                        |               | 5,590  |            |   | 4,624     |   |          |
| Accumulated depreciation          |               | (4,250)     |            |   | (3,863)        |   |          |
| Net other property and equipment  | $                  | 1,340  |            | $      | 761       |   |          |
|                                   |                    |             |                 |        |                |        |               |  |

 

***Supplemental Disclosure of Cash Flow            Information***

             

Noncash investing and financing transactions not reflected in the            consolidated statements of cash flows include the following:

 

|                                                                                               |   | **Year Ended December 31,** |
|----------------------------------------------------------------------------------------------------|--------|-----------------------------|
|                                                                                               |   | **2007**                    |   | **2006** |   | **2005** |   |
|                                                                                               |   | **(In thousands)**          |
| **Noncash investing transactions:**                                                                |   |                        |   |   |   |   |   |
| Additions to properties included in current                            liabilities                 | $      | 428                         | $ |  2,359 | $ | 798 |   |
| Recovery of previously capitalized VAT included in Input                            VAT receivable |   | --                          |   | --    |   | 254 |   |
|                                                                                                    |        |                             |  |  |  |  |  |  |  |

 

Supplemental disclosure of cash paid for interest and income            taxes:

 

|                                       |   | **Year Ended December 31,** |
|--------------------------------------------|--------|-----------------------------|
|                                       |   | **2007**                    |   | **2006** |   | **2005** |   |
|                                       |   | **(In thousands)**          |
| **Supplemental disclosure:**               |   |                        |   |   |   |   |   |
| Cash paid during the year for interest     | $      | 125                         | $ | -- | $ | -- |   |
| Cash paid during the year for income taxes |   | --                          |   | -- |   | -- |   |
|                                            |        |                             |  |  |  |  |  |  |  |

 

Cash            paid for interest in 2007 includes $119,040 in commitment fees paid on the            Company’s Senior Facility Agreement.

 

F-12

 

----

**FX ENERGY, INC. AND SUBSIDIARIES**

**Notes to the Consolidated Financial Statements**

**- Continued -**

             

***Revenue Recognition***

             

Revenues associated with oil and gas sales are recorded when title            passes, which is upon delivery to the pipeline or purchaser, and are net of royalties.            Oilfield service revenues are recognized when the related service is            performed.

 

***Investments***

             

The            cost and estimated market value of marketable securities at December 31, 2007, are            as follows (in thousands):

 

|                  |   |     |   | **Gross**      |   | **Estimated** |
|-----------------------|--------|----------|--------|----------------|--------|---------------|
|                  |   |     |   | **Unrealized** |   | **Market**    |
|                  |   | **Cost** |   | **Losses**     |   | **Value**     |
| Marketable securities | $      | 15,203   | $      | (1)            | $      | 15,202        |

 

The            cost and estimated market value of marketable securities at December 31, 2006,            were as follows (in thousands):

 

|                  |   |     |   | **Gross**      |   | **Estimated** |
|-----------------------|--------|----------|--------|----------------|--------|---------------|
|                  |   |     |   | **Unrealized** |   | **Market**    |
|                  |   | **Cost** |   | **Losses**     |   | **Value**     |
| Marketable securities | $      | 10,534   | $      | (72)           | $      | 10,462        |

 

The            investments consist primarily of U.S. government agency bonds and notes, whose value            fluctuates with changes in interest rates. The Company believes all gross unrealized            losses are temporary. The investments have been classified as available-for-sale, and            are reported at fair value with unrealized gains and losses, if any, recorded as a            component of other comprehensive income (loss).

 

***Stock-Based Compensation***

 

The            Company maintains several share-based incentive plans. Under these plans, the Company            may issue options or restricted stock awards. Options are granted at an option price            equal to the market value of the stock at the date of grant, have terms ranging from            five to seven years and vest in three equal annual installments. Restricted stock            awards have similar terms and vesting requirements.

 

Effective January 1, 2006, the Company adopted the provisions of SFAS            No. 123R, “Share-Based Payments” (“SFAS No. 123R”). Under            SFAS No. 123R, share-based compensation cost is measured at the grant date, based on            the estimated fair value of the award, and is recognized as expense over the            employee’s requisite service period. The Company adopted SFAS No. 123R using the            modified prospective transition method. Upon adoption, deferred compensation of            $2,975,157 was eliminated against additional paid-in capital. Under this method, prior            periods are not revised for comparative purposes. The provisions of SFAS No. 123R apply            to new awards and to awards that are outstanding on the effective date that are            subsequently modified or cancelled. Compensation expense for unvested awards at the            effective date will be recognized over the remaining requisite service period using the            compensation cost calculated for pro forma disclosure purposes under SFAS No. 123,            “Accounting for Stock-Based Compensation” (“SFAS No.            123”).

 

F-13

 

----

**FX ENERGY, INC. AND SUBSIDIARIES**

**Notes to the Consolidated Financial Statements**

**- Continued -**

             

Prior to the adoption of SFAS No. 123R, the Company recorded            compensation expense for employee stock options and restricted stock awards based on            their intrinsic value on the date of grant pursuant to Accounting Principles Board            Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB            No. 25”), and related interpretations and provided the pro forma disclosures            required by SFAS No. 123. The pro forma effects of recognizing compensation expense            under the fair value method required by SFAS No. 123 on net loss and net loss per            common share were as follows (in thousands, except per share data):

 

|                                                                                                                                                                                                      | **2005**                                                                |                                                |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------|-----------------------------------------------------|--------|
|                                                                                                                                                                                                      | **(In thousands, except per share                            amounts)** |                                                |   |   |
| **Net loss:**                                                                                                                                                                                             |                                                                    |                                                |   |   |   |
| Net loss, as reported                                                                                                                                                                                     | $                                                                       | (11,423))                                           |   |   |   |
| Add: Stock-based employee compensation expense included                            in

reported net loss, net of any related tax                            effects                                       |                                                                    |  

201                               |   |   |   |
| Less: Total stock-based employee compensation                            expense

determined under the fair value based method for all                            awards,

net of any related tax effects |                                                                    |  

                             

(1,959) |   |   |   |
| Pro forma net loss                                                                                                                                                                                        | $                                                                       | (13,181)                                            |   |   |   |
| **Basic and diluted net loss per share:**                                                                                                                                                                 |                                                                    |                                                |   |   |   |
| As reported                                                                                                                                                                                               | $                                                                       | (0.33)                                              |   |   |   |
| Pro forma                                                                                                                                                                                                 |                                                                    | (0.38)                                              |   |   |   |

 

The            fair value of each option granted to employees and consultants during 2005 was            estimated on the date of grant using the Black-Scholes option pricing model. The            following weighted-average assumptions were utilized for the Black-Scholes valuation:            (1) expected volatility of 60% for 2005; (2) expected life of three years;            (3) risk-free interest rates at the date of grant ranging from 2.21% to 4.39%;            and, (4) dividend yield of zero for each year.

             

***Income Taxes***

             

Deferred income taxes are provided for the differences between the tax            bases of assets or liabilities and their reported amounts in the consolidated financial            statements. Such differences may result in taxable or deductible amounts in future            years when the asset or liability is recovered or settled, respectively.

 

The            Company adopted the provisions of Financial Accounting Standards Board, or FASB,            Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an            Interpretation of FASB Statement No. 109,” or FIN 48, effective January 1, 2007.            The Company did not have any unrecognized tax benefits, and there was no effect on its            financial condition or results of operations as a result of implementing FIN 48. The            Company is subject to audit by the IRS and various states for the prior three years.            The Company does not believe there will be any material changes in its unrecognized tax            positions over the next 12 months. The Company’s policy is that it recognizes            interest and penalties accrued on any unrecognized tax benefits as a component of            income tax expense. As of the date of adoption of FIN 48, the Company did not have any            accrued interest or penalties associated with any unrecognized tax benefits, nor was            any tax-related interest expense recognized during the year ended December 31,            2007.

 

F-14

 

----

**FX ENERGY, INC. AND SUBSIDIARIES**

**Notes to the Consolidated Financial Statements**

**- Continued -**

             

                ***New Accounting Standards***

 

In            September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”            ("SFAS No. 157") which defines fair value, establishes a framework for measuring fair            value in accordance with accounting principles generally accepted in the United States,            and expands disclosures about fair value measurements. SFAS No. 157 is effective for            financial assets and liabilities for fiscal years beginning after November 15, 2007. In            February 2008, the FASB issued FSP FAS 157-2, “Effective Date of FASB Statement            No. 157.” FSP 157-2 delays the effective date of SFAS No. 157 for all            non-financial assets and non-financial liabilities that are not re-measured at fair            value on a recurring basis until fiscal years beginning after November 15, 2008. Any            amounts recognized upon adoption of this rule as a cumulative effect adjustment will be            recorded to the opening balance of retained earnings in the year of adoption. The            Company has evaluated SFAS No. 157 and has determined that it will not have a material            impact on its Consolidated Financial Statements.

 

On            February 15, 2007, the FASB issued SFAS No. 159, “The Fair Value Option for            Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement            No. 115” ("SFAS No. 159") which permits an entity to choose to measure eligible            items at fair value at specified election dates. An entity will report unrealized gains            and losses on items for which the fair value option has been elected in earnings at            each subsequent reporting date. The fair value option: (a) may be applied instrument by            instrument, with a few exceptions, such as investments otherwise accounted for by the            equity method; (b) is irrevocable (unless a new election date occurs); and (c) is            applied only to entire instruments and not to portions of instruments. SFAS No. 159 is            effective for fiscal years that begin after November 15, 2007. The Company has            evaluated SFAS No. 159 and has determined that it will not have a material impact on            its Consolidated Financial Statements and the Company has not early adopted.

 

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

 

***Foreign Operations***

             

The            Company uses the U.S. dollar as its functional currency for its operations and            investments in Poland.

 

***Use of Estimates***

             

The            preparation of financial statements in conformity with accounting principles generally            accepted in the United States of America requires management to make estimates and            assumptions that affect the reported amounts of assets and liabilities and disclosure            of contingent assets and liabilities at the date of the financial statements and the            reported amounts of revenues and expenses during the reporting period. Actual results            could differ from those estimates. Significant estimates with regard to the            consolidated financial statements include the estimates of proved oil and gas reserve            quantities and the related future net cash flows.

             

***Net Loss per Share***

             

Basic earnings per share are computed by dividing the net loss            applicable to common shares by the weighted average number of common shares            outstanding. Diluted earnings per share is computed by dividing the net loss by the sum            of the weighted average number of common shares and the effect of dilutive unexercised            stock options, warrants, unvested restricted stock, and convertible preferred stock or            debt.

 

F-15

 

----

**FX ENERGY, INC. AND SUBSIDIARIES**

**Notes to the Consolidated Financial Statements**

**- Continued -**

             

Outstanding options, warrants and unvested restricted stock as of            December 31, 2007, 2006 and 2005, were as follows:

 

|                    | **Options, Warrants and Unvested Restricted                            Stock** |   | **Price Range** |
|-------------------------|--------------------------------------------------------------------------------|--------|-----------------|
| **Balance sheet date:** |                                                                           |   |            |
| December 31, 2007       | 6,320,602                                                                      |   | $0.00 - $10.65  |
| December 31, 2006       | 6,859,106                                                                      |   | $0.00 - $10.65  |
| December 31, 2005       | 6,997,656                                                                      |   | $0.00 - $10.65  |

 

The            Company had a net loss in 2007, 2006 and 2005. The above options, warrants and unvested            restricted stock were not included in the computation of diluted earnings per share for            the years presented because the effect would have been antidilutive.

 

**Note            2: Asset Retirement Obligation**

 

The            Company accounts for future site restoration costs according to Statement No. 143,            “Accounting for Asset Retirement Obligations” (“SFAS No. 143”).            Under SFAS No. 143, the fair value of asset retirement obligations is recorded as a            liability when incurred, which is typically at the time the assets are placed in            service. Amounts recorded for the related assets are increased by the amount of these            obligations. Over time, the liabilities are accreted for the change in their present            value and the initial capitalized costs are depreciated over the useful lives of the            related assets. The Company uses an expected cash flow approach to estimate its asset            retirement obligations under SFAS No. 143. The Company recorded accretion expense of            $78,087, $53,038 and $44,565 in 2007, 2006 and 2005, respectively. At December 31,            2007, there were no assets legally restricted for purposes of settling asset retirement            obligations.

 

Following is a reconciliation of the yearly changes in the asset            retirement obligation at December 31, 2007 and 2006:

 

|                              | **December 31,**   |
|-----------------------------------|--------------------|
|                              | **2007**           |   | **2006** |
|                              | **(In thousands)** |
| **Asset retirement obligations:** |               |   |   |   |   |
| Beginning balance                 | $                  | 961  |   | $ | 431  |
| Current year additions            |               | --  |   |   | 484  |
| Liabilities settled               |               | (2) |   |   | (7) |
| Accretion expense                 |               | 78  |   |   | 53  |
| Ending balance                    | $                  | 1,037  |   | $ | 961  |

 

**Note 3: Other Assets**

 

As            of December 31, 2007 and 2006, the Company had a replacement bond with a federal agency            in the amount of $463,000, which was collateralized by certificates of deposit totaling            $231,500. In addition, there are certificates of deposit totaling $175,000 covering            performance bonds in other states.

 

F-16

 

----

**FX ENERGY, INC. AND SUBSIDIARIES**

**Notes to the Consolidated Financial Statements**

**- Continued -**

             

**Note 4: Accrued Liabilities**

 

The            Company’s accrued liabilities as of December 31, 2007 and 2006, were comprised of            the following:

 

|                                   | **December 31,**   |
|----------------------------------------|--------------------|
|                                   | **2007**           |   | **2006** |
|                                   | **(In thousands)** |
| **Accrued liabilities:**               |               |   |   |   |   |
| Credit facility commitment fees        | $                  | 78 |   | $ | -- |
| Partner share of oil & gas revenue |               | 1,737 |   |   | 439 |
| Compensation-related costs             |               | 1,543 |   |   | 568 |
| Total                                  | $                  | 3,358 |   | $ | 1,007 |

 

**Note 5: Notes Payable**

 

In            November of 2006, the Company entered into a $25 million Senior Facility Agreement (the            Facility) with The Royal Bank of Scotland plc (RBS). The Facility is provided to FX            Energy Poland Sp. z o.o., a wholly owned subsidiary. Funds from the facility, which            became available to the Company in March, 2007, will cover infrastructure and            development costs at a variety of the Company’s Polish gas projects and are            collateralized by its commercial wells and production in Poland.

 

Under the terms of the Facility, the current commitment is for            approximately $18.6 million. The terms of the Facility call for interest payments only            through the end of 2010. The principal amount of the Facility will begin to be reduced            at that time, terminating at the end of 2012, unless the Company has been successful in            adding additional properties and/or reserves to its borrowing base. Interest will be            accrued at LIBOR plus an applicable margin, which is currently 1.25%.

 

In            consideration for the Facility, the Company paid a 1% origination fee and issued            warrants to purchase 110,000 shares of common stock, valid for 2 years at an exercise            price of $6.00 per share. The Black-Scholes value of these warrants (approximately            $305,000), along with the loan origination fee and associated legal fees, have been            capitalized as deferred financing costs, and are being amortized over the 6 year term            of the loan, beginning in 2007. An annual unused commitment fee of one-half of the            applicable margin is charged quarterly based on the average daily unused portion of the            Facility.

 

**Note 6: Commitments and Contingencies**

 

In            November and December 2007, three actions were filed in the United States District            Court for the District of Utah against the Company and officers or directors David N.            Pierce, Clay Newton, Thomas B. Lovejoy, Andrew W. Pierce, and Richard Hardman, by three            separate plaintiffs, each seeking class certification to proceed on behalf of all            others similarly situated and alleging violations by the defendants of the antifraud            provisions of the federal securities laws set forth in Section 10(b) of the Securities            Exchange Act of 1934 and Rule 10b-5 promulgated thereunder relating to our public            statements about the Company’s oil and gas activities and prospects in Poland            between March 2004 and January 2006.  The complaints seek damages to be determined            at trial, interest, and costs, together with such other relief as the court may deem            appropriate.  The three actions have now been consolidated into a single matter,            and the lead plaintiffs and counsel have been specified.  The consolidated actions            have not been certified to proceed as a class action.  No responsive pleading from            the defendants will be due until an amended complaint is filed.  The Company            proposes to defend vigorously this action on behalf of all defendants. 

 

F-17

 

----

**FX ENERGY, INC. AND SUBSIDIARIES**

**Notes to the Consolidated Financial Statements**

**- Continued -**

             

**Note 7: Value Added Tax Refund**

 

Throughout the Company’s operating history in Poland, until            October 2005, the Company had been unable to obtain a refund of most of the value-added            taxes paid in connection with goods and services purchased (Input VAT). Polish tax laws            had restricted the refund of Input VAT for exploration activities to concession            holders. In the Company’s case, the Polish Oil and Gas Company, or POGC, has            traditionally been the concession holder, while the Company is a working interest owner            by virtue of its agreements with POGC.

 

During 2004, Poland joined the European Union. This event caused changes            to several tax laws, including the law that precluded the Company from obtaining            refunds of Input VAT. In April 2005, the Company filed a refund application for            approximately 13.7 million Polish zlotys, representing all Input VAT paid since the            Company’s inception in Poland through March of 2005. The Polish taxing            authorities refunded the entire amount, which was approximately $4.2 million at            then-current exchange rates, in October 2005.

 

A            portion of the past Input VAT was related to capital costs, with the remainder            attributed to 2005 and prior years’ geological and geophysical costs, along with            overhead and other expenses. Accordingly, for the $4.2 million refund received in 2005,            the Company reduced its capital costs by approximately $1.9 million, 2005 expenses by            $0.1 million, with the remaining $2.1 million related to prior years’ expenses            shown as a Recovery of Previously Expensed Input VAT in the Consolidated Statements of            Operations. In addition, the Company recorded an Input VAT receivable at December 31,            2005 of approximately $2.0 million, representing Input VAT paid since April 2005. This            amount was collected in 2006. The Company expects to remain Input VAT neutral. The            input VAT receivable at December 31, 2007 and December 31, 2006 was $445,974 and            $709,858 respectively.

 

**Note 8: Income Taxes**

 

The            Company recognized no income tax benefit from the losses generated during 2007, 2006            and 2005. The components of the net deferred tax asset as of December 31, 2007 and 2006            are as follows:

 

|                                     | **December 31,**   |
|------------------------------------------|--------------------|
|                                     | **2007**           |   | **2006** |
|                                     | **(In thousands)** |
| **Deferred tax liability:**              |               |   |   |   |   |
| Property and equipment basis differences | $                  | (2,388) |   | $ | (3,637) |
| **Deferred tax asset:**                  |               |   |   |   |   |
| Net operating loss carryforwards:        |               |   |   |   |   |
| United States                            |               | 25,615  |   |   | 23,309  |
| Poland                                   |               | 9,252  |   |   | 9,379  |
| Oil and gas properties                   |               | 2,713  |   |   | 1,855  |
| Options issued for services              |               | 1,359  |   |   | 946  |
| Asset retirement obligation              |               | 387  |   |   | 176  |
| Valuation allowance                      |               | (36,938) |   |   | (32,028) |
| Total                                    | $                  | --   |   | $ | --  |

 

 

F-18

 

----

**FX ENERGY, INC. AND SUBSIDIARIES**

**Notes to the Consolidated Financial Statements**

**- Continued -**

             

The            change in the valuation allowance during 2007, 2006 and 2005 is as follows:

 

|                                                                          |   | **Year Ended December 31,** |
|-------------------------------------------------------------------------------|--------|-----------------------------|
|                                                                          |   | **2007**                    |   | **2006** |   | **2005** |   |
|                                                                          |   | **(In thousands)**          |   |
| **Valuation allowance:**                                                      |   |                        |   |   |   |   |   |
| Balance, beginning of year                                                    | $      | (32,028)                    | $ | (24,887) | $ | (23,209) |   |
| Change in property and equipment basis                            differences |   | (1,249)                     |   | 2,511  |   | (93) |   |
| Increase due to net operating loss                                            |   | (2,179)                     |   | (8,875) |   | (1,538) |   |
| Other                                                                         |   | (1,482)                     |   | (777) |   | (47) |   |
| Total                                                                         | $      | (36,938)                    | $ | (32,028) | $ | (24,887) |   |

 

SFAS            No. 109, “Accounting for Income Taxes,” requires that a valuation allowance            be provided if it is more likely than not that some portion or all of a deferred tax            asset will not be realized. The Company’s ability to realize the benefit of its            deferred tax asset will depend on the generation of future taxable income through            profitable operations and expansion of the Company’s oil and gas producing            activities. The risks associated with that growth requirement are considerable,            resulting in the Company’s conclusion that a full valuation allowance be provided            at December 31, 2007 and 2006.

 

***United States NOL***

             

At            December 31, 2007, the Company had net operating loss (“NOL”) carryforwards            in the United States of approximately $68,671,000 available to offset future taxable            income. The carryforwards begin to expire in 2008 and will fully expire in 2022. The            utilization of the NOL carryforwards against future taxable income in the United States            may become subject to an annual limitation if there is a change in ownership. The NOL            carryforwards in the United States include $20,531,000 relating to tax deductions            resulting from the exercise of stock options. The tax benefit from adjusting the            valuation allowance related to this portion of the NOL carryforward will be credited to            additional paid-in capital.

 

***Polish NOL***

             

As            of December 31, 2007, the Company had NOL carryforwards in Poland totaling            approximately $48,697,000. During 2006 the Company received a favorable ruling from the            Polish tax authorities which allows for a ten year carryover of prior years’            NOLs. This ruling allowed for the reinstatement of approximately $24 million of NOLs            which had previously expired under the normal carryover rules. The NOLs will begin to            expire in 2008 and will fully expire in 2016. The ruling allows a ten year carryover            period for losses incurred from 1997 to 2007. The normal carryforward period in Poland            is five years. However, no more than 50% of the NOL carryforward for any given year may            be applied against Polish income in succeeding years.

 

The            domestic and foreign components of the Company’s net loss are as            follows:

 

|     |   | **Year Ended December 31,** |
|----------|--------|-----------------------------|
|     |   | **2007**                    |   | **2006** |   | **2005** |   |
|     |   | **(In thousands)**          |
| Domestic | $      | (6,078)                     | $ | (6,764) | $ | (5,199) |   |
| Foreign  |   | (5,613)                     |   | (7,003) |   | (6,224) |   |
| Total    | $      | (11,691)                    | $ | (13,767) | $ | (11,423) |   |
|          |        |                             |  |  |  |  |  |  |  |

 

 

F-19

 

----

**FX ENERGY, INC. AND SUBSIDIARIES**

**Notes to the Consolidated Financial Statements**

**- Continued -**

             

**Note 9: Stockholders’ Equity**

 

During 2007, the Company sold 1.5 million shares of stock in a            registered direct offering, resulting in net proceeds to the Company of $12.4 million.            In addition, 672,165 options and warrants were exercised during the year, resulting in            proceeds to the Company of an additional $1.9 million.

 

The            Company received proceeds from the exercise of 668,066 stock options and warrants of            $4,054,646 during 2005.

 

**Note 10: Stock Options, Warrants and Restricted Stock**

 

***Equity Compensation Plans***

             

The            Company’s equity compensation consists of annual stock option and award plans            that are each subject to approval by the board of directors and are subsequently            presented for approval by the stockholders at the Company’s annual            meetings.

 

The            following table summarizes information regarding the Company’s stock option and            award plans as of December 31, 2007:

 

|                                                                               |  

**Number of Shares Authorized Under Plan** |   | **Weighted Average Exercise Price of Outstanding                            Options** |   | **Number of Options Available for Future                            Issuance** |
|------------------------------------------------------------------------------------|----------------------------------------------------|--------|---------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------|
| **Equity compensation plans approved by                            stockholders:** |                                               |   |                                                                                  |   |                                                                           |
| 1995 Stock Option and Award Plan                                                   | 500,000                                            |   | $7.49                                                                                 |   | --                                                                             |
| 1996 Stock Option and Award Plan                                                   | 500,000                                            |   | 3.55                                                                                  |   | --                                                                             |
| 1997 Stock Option and Award Plan                                                   | 500,000                                            |   | 5.87                                                                                  |   | --                                                                             |
| 1998 Stock Option and Award Plan                                                   | 500,000                                            |   | 5.63                                                                                  |   | 545                                                                            |
| 1999 Stock Option and Award Plan                                                   | 500,000                                            |   | 2.78                                                                                  |   | --                                                                             |
| 2000 Stock Option and Award Plan                                                   | 600,000                                            |   | 2.51                                                                                  |   | 17                                                                             |
| 2001 Stock Option and Award Plan                                                   | 600,000                                            |   | 3.22                                                                                  |   | 999                                                                            |
| 2003 Long Term Incentive Plan                                                      | 800,000                                            |   | 6.64                                                                                  |   | --                                                                             |
| 2004 Long Term Incentive Plan                                                      | 1,000,000                                          |   | 7.79                                                                                  |   | 314,525                                                                        |
| Total                                                                              | 5,500,000                                          |   | $5.19                                                                                 |   | 316,086                                                                        |

 

The            above table excludes 25,000 options that have been granted outside of stockholder            approved option plans.

 

All            stock option and award plans are administered by the Compensation Committee (the            “Committee”), consisting of members of the board of directors. At its            discretion, the Committee may grant stock, incentive stock options (“ISOs”)            or non-qualified options to any employee, including officers. The granted options have            terms ranging from five to seven years and vest in three equal annual installments.            Under terms of the stock option award plans, the Company may also issue restricted            stock.

 

F-20

 

----

**FX ENERGY, INC. AND SUBSIDIARIES**

**Notes to the Consolidated Financial Statements**

**- Continued -**

             

The            following table summarizes option activity for 2007, 2006 and 2005:

 

|                     | **2007**                                                               |   | **2006**                                           |   | **2005**                                                          |
|--------------------------|------------------------------------------------------------------------|--------|----------------------------------------------------|--------|-------------------------------------------------------------------|
|                     |  

                             

**Number of**

**Options** |   | **Weighted**

**Average**

**Exercise**

**Price** |   |  

                             

**Number of Options** |   | **Weighted**

**Average**

**Exercise**

**Price** |   |  

                             

**Number of**

**Options** |   | **Weighted**

**Average**

**Exercise**

**Price** |
| **Options outstanding:** |                                                                   |   |                                               |   |                                                              |   |   |   |   |   |   |
| Beginning of year        | 2,836,833                                                         |   | $5.08                                              |   | 3,193,333                                                    |   | $5.16 |   | 3,851,733  |   | $5.47 |
| Granted                  | --                                                                |   | .00                                                |   | --                                                           |   | .00 |   | 35,000  |   | 9.89 |
| Exercised                | (466,726)                                                              |   | 4.13                                               |   | --                                                           |   | .00 |   | (620,066) |   | 6.95 |
| Cancelled                | (54,666)                                                               |   | 8.42                                               |   | --                                                           |   | 5.82 |   | (73,334) |   | 8.27 |
| Expired                  | --                                                                |   | --                                                 |   | (356,500)                                                         |   | -- |   | --  |   | -- |
| End of year              | 2,315,441                                                         |   | $5.19                                              |   | 2,836,833                                                    |   | $5.08 |   | 3,193,333  |   | $5.16 |
|                     |                                                                   |   |                                               |   |                                                              |   |   |   |   |   |   |
| Exercisable at year-end  | 2,303,776                                                         |   | $5.16                                              |   | 2,497,177                                                    |   | $4.61 |   | 2,270,685  |   | $4.33 |

 

The            weighted average fair value per share of options granted during 2005 was            $9.72.

 

In            2007, the Company recognized $842,273 in expense related to unvested stock options            granted prior to the adoption of FAS 123R. Total unamortized expense at December 31,            2007 related to unvested options was $15,508.

 

During 2007, the Company issued 370,925 shares of restricted stock            resulting in deferred compensation of $2,284,991 which will be amortized ratably over            the three year vesting period. Expense recognized during 2007 totaled            $52,088.

 

In            December of 2006, the Company issued 318,400 shares of restricted stock resulting in            deferred compensation of $2,053,680 which will be amortized ratably over the three year            vesting period. Expense recognized for these shares during 2007 and 2006 totaled            $684,557 and $18,756 respectively.

 

In            November of 2005, the Company issued 298,950 shares of restricted stock resulting in            deferred compensation of $3,096,600 which will be amortized ratably over the three year            vesting period. Expense recognized for these shares during 2007 and 2006 totaled            $1,024,862 and $1,028,633 respectively.

 

The            following table summarizes information about stock options outstanding as of December            31, 2007:

 

|                                                                      | **Outstanding**                           |   | **Exercisable**                                                                            |
|---------------------------------------------------------------------------|-------------------------------------------|--------|--------------------------------------------------------------------------------------------|
|  

                             

**Exercise**

**Price Range** |  

**Number of Options Outstanding** |   | **Weighted Average Remaining Contractual                            Life**

**(in years)** |   |  

**Weighted Average Exercise Price** |   |  

**Number of Options Exercisable** |   |  

**Weighted Average Exercise Price** |
| $2.40 - $2.40                                                             | 435,000                                   |   | 1.62                                                                                       |   | 2.40 |   | 435,000 |   | 2.40 |
| $2.44 - $3.20                                                             | 386,000                                   |   | 1.11                                                                                       |   | 2.54 |   | 386,000 |   | 2.54 |
| $3.98 - $3.98                                                             | 587,109                                   |   | 2.82                                                                                       |   | 3.98 |   | 587,109 |   | 3.98 |
| $6.06 - $6.06                                                             | 4,167                                     |   | 3.07                                                                                       |   | 6.06 |   | 4,167 |   | 6.06 |
| $8.37 - $8.37                                                             | 843,165                                   |   | 3.67                                                                                       |   | 8.37 |   | 843,165 |   | 8.37 |
| $9.00 - $10.65                                                            | 60,000                                    |   | 3.86                                                                                       |   | 9.52 |   | 48,335 |   | 9.43 |
| Total                                                                     | 2,315,441                                 |   | 2.64                                                                                       |   | $5.19 |   | 2,303,776 |   | $5.16 |

 

The            aggregate intrinsic value of outstanding stock options at December 31, 2007 was            $3,632,921. The aggregate intrinsic value of unvested restricted stock at December 31,            2007 was $3,861,196. The aggregate intrinsic value represents the total pretax            intrinsic value, based on the Company’s stock price of $5.68 as of December 31,            2007, which would have been received by the restricted stock award and stock option            holders had all in-the-money restricted stock awards and options been exercised as of            that date.

 

F-21

 

----

**FX ENERGY, INC. AND SUBSIDIARIES**

**Notes to the Consolidated Financial Statements**

**- Continued -**

             

***Warrants***

             

The            following table summarizes warrant activity during 2007, 2006 and 2005:

 

|                                      | **2007**             |   | **2006**             |   | **2005**             |
|-------------------------------------------|----------------------|--------|----------------------|--------|----------------------|
|                                      | **Number of Shares** |   | **Price**

**Range** |   | **Number of Shares** |   | **Price**

**Range** |   | **Number of Shares** |   | **Price**

**Range** |
| **Warrants outstanding and exercisable:** |                 |   |                 |   |                 |   |   |   |   |   |   |
| Beginning of year                         | 3,615,373       |   | $3.60--$6.00         |   | 3,505,373            |   | $3.60--$3.75 |   | 3,553,373  |   | $3.60--$3.75 |
| Issued                                    | --              |   | --                   |   | 110,000              |   | $6.00 |   | --  |   | -- |
| Exercised                                 | (290,000)            |   | $3.60                |   | --                   |   | -- |   | (48,000) |   | $3.75 |
| End of year                               | 3,325,373       |   | $3.60--$6.00         |   | 3,615,373            |   | $3.60--$6.00 |   | 3,505,373  |   | $3.60--$3.75 |
|                                           |                      |        |                      |        |                      |  |  |  |  |  |  |  |

 

***Restricted Stock***

             

The            following table summarizes restricted stock activity during 2007, 2006 and            2005:

 

|                                       | **2007**             |   | **2006**             |   | **2005**             |   |
|--------------------------------------------|----------------------|--------|----------------------|--------|----------------------|--------|
|                                       | **Number of Shares** |   | **Number of Shares** |   | **Number of Shares** |   |
| **Unvested restricted stock outstanding:** |                 |   |                 |   |                 |   |
| Beginning of year                          | 516,900         |   | 298,950         |   | --                   |   |
| Issued                                     | 370,925         |   | 318,400         |   | 298,950              |   |
| Forfeited                                  | (4,020)              |   | (1,200)              |   | --                   |   |
| Vested                                     | (204,017)            |   | (99,250)             |   | --                   |   |
| End of year                                | 679,788         |   | 516,900         |   | 298,950              |   |

 

**Note            11: Quarterly Financial Data (Unaudited)**

 

Summary quarterly information for 2007 and 2006 is as            follows:

 

|                                        |   | **Quarter Ended**                                                       |
|---------------------------------------------|--------|-------------------------------------------------------------------------|
|                                        |   | **December 31**                                                         |   | **September 30** |   | **June 30** |   | **March 31** |
|                                        |   | **(In thousands, except per share                            amounts)** |
| **2007:**                                   |   |                                                                    |   |   |   |   |   |   |
| Revenues                                    | $      | 4,064                                                              | $ | 5,243  | $ | 4,511  | $ | 4,178  |
| Net operating loss                          |   | (6,728)                                                                 |   | (53) |   | (2,711) |   | (2,632) |
| Net income (loss)                           |   | (6,550)                                                                 |   | 166  |   | (2,682) |   | (2,625) |
| Basic and diluted net loss per common share | $      | (0.17)                                                                  | $ | (0.00) | $ | (0.08) | $ | (0.07) |
| **2006:**                                   |   |                                                                    |   |   |   |   |   |   |
| Revenues                                    | $      | 3,165                                                              | $ | 1,842  | $ | 2,137  | $ | 1,085  |
| Net operating loss                          |   | (6,037)                                                                 |   | (1,919) |   | (2,227) |   | (4,379) |
| Net loss                                    |   | (5,795)                                                                 |   | (1,728) |   | (2,054) |   | (4,190) |
| Basic and diluted net loss per common share | $      | (0.16)                                                                  | $ | (0.05) | $ | (0.06) | $ | (0.12) |

 

The            net operating loss for the fourth quarter of 2007 includes $2.3 million of impairment            loss associated with the Wilga well in Poland. The net operating loss for the fourth            quarter of 2006 includes $3.4 million of impairment loss associated with the Rusocin            well in Poland.

 

F-22

 

----

**FX ENERGY, INC. AND SUBSIDIARIES**

**Notes to the Consolidated Financial Statements**

**- Continued -**

             

**Note 12: Business Segments**

 

The            Company operates within two business segments of the oil and gas industry: exploration            and production (“E&P”) and oilfield services. The Company’s            revenues associated with its E&P activities are comprised of oil sales from its            producing properties in the United States and oil and gas sales from its producing            properties in Poland. Over 90% of the Company’s oil sales in the United States            were to Cenex during 2007, 2006 and 2005. During 2007 and 2006 all sales of oil and gas            in Poland were made to POGC or its affiliated companies. There were no oil and gas            sales in Poland during 2005 and 2004. The Company believes the purchasers of its oil            production in the United States could be replaced, if necessary, without a loss in            revenue. Gas sales in Poland are sold pursuant to long term sales contracts which            obligate the buyer to purchase all gas produced. Individual oil sales are negotiated            with POGC affiliated entities and are not subject to sales contracts.

 

E&P operating costs are comprised of: (1) exploration costs            (geological and geophysical costs, exploratory dry holes, and proved property and            non-producing leasehold impairments) and, (2) lease operating costs (lease            operating expenses and production taxes). Substantially all exploration costs are            related to the Company’s operations in Poland. The majority of lease operating            costs are related to the Company’s domestic production.

 

The            Company’s revenues associated with its oilfield services segment are comprised of            contract drilling and well servicing fees generated by the Company’s oilfield            servicing equipment in Montana. Oilfield servicing costs are comprised of direct costs            associated with its oilfield services.

 

DD&A directly associated with a respective business segment is            disclosed within that business segment. The Company does not allocate current assets,            corporate DD&A, general and administrative costs, amortization of deferred            compensation, interest income, interest expense, other income or other expense to its            operating business segments for management and business segment reporting purposes. All            material inter-company transactions between the Company’s business segments are            eliminated for management and business segment reporting purposes.

 

F-23

 

----

**FX ENERGY, INC. AND SUBSIDIARIES**

**Notes to the Consolidated Financial Statements**

**- Continued -**

             

Information on the Company’s operations by business segment for            2007, 2006 and 2005 is summarized as follows:

 

|                                                                    | **2007**                         |
|-------------------------------------------------------------------------|----------------------------------|
|                                                                    |                             |   |   | **Oilfield Services** |   | **Total**

**(In thousands)** |
|                                                                    | **Exploration & Production** |   |   |   |
|                                                                    | **U.S.**                         |   | **Poland** |   |   |   |   |
| **Operations summary:**                                                 |                             |   |   |   |   |   |   |   |   |   |   |
| Revenues                                                                | $                                | 4,336  |   | $ | 10,567  |   | $ | 3,093  |   | $ | 17,996  |
| Lease operating expense                                                 |                             | (2,390) |   |   | (1,148) |   |   | --  |   |   | (3,538) |
| Oilfield services costs                                                 |                             | --  |   |   | --  |   |   | (1,998) |   |   | (1,998) |
| Exploration expense                                                     |                             | (52) |   |   | (10,572) |   |   | --  |   |   | (10,624) |
| Impairment expense                                                      |                             | --  |   |   | (2,299) |   |   | --  |   |   | (2,299) |
| Accretion expense                                                       |                             | (50) |   |   | (28) |   |   | --  |   |   | (78) |
| DD&A expense                                                        |                             | (742) |   |   | (935) |   |   | (267) |   |   | (1,944) |
| Operating income (loss)                                                 | $                                | 1,102  |   | $ | (4,415) |   | $ | 828 |   | $ | (2,485) |
| **Identifiable net property and                            equipment:** |                             |   |   |   |   |   |   |   |   |   |   |
| Unproved properties                                                     | $                                | 61  |   | $ | 1,940  |   | $ | --  |   | $ | 2,001  |
| Proved properties                                                       |                             | 3,167  |   |   | 15,377  |   |   | --  |   |   | 18,544  |
| Equipment and other                                                     |                             | --  |   |   | --  |   |   | 1,178  |   |   | 1,178  |
| Total                                                                   | $                                | 3,228  |   | $ | 17,317  |   | $ | 1,178  |   | $ | 21,723  |
| **Net Capital Expenditures:**                                           |                             |   |   |   |   |   |   |   |   |   |   |
| Property and equipment                                                  | $                                | 494  |   | $ | 5,092  |   | $ | 893  |   | $ | 6,479  |
| Total                                                                   | $                                | 494  |   | $ | 5,092  |   | $ | 893  |   | $ | 6,479  |

 

 

|                                                                    | **2006**                         |
|-------------------------------------------------------------------------|----------------------------------|
|                                                                    |                             |   |   | **Oilfield Services** |   | **Total**

**(In thousands)** |
|                                                                    | **Exploration & Production** |   |   |   |
|                                                                    | **U.S.**                         |   | **Poland** |   |   |   |   |
| **Operations summary:**                                                 |                             |   |   |   |   |   |   |   |   |   |   |
| Revenues                                                                | $                                | 4,260  |   | $ | 2,273  |   | $ | 1,696  |   | $ | 8,229  |
| Lease operating expense                                                 |                             | (2,358) |   |   | (289) |   |   | --  |   |   | (2,647) |
| Oilfield services costs                                                 |                             | --  |   |   | --  |   |   | (1,245) |   |   | (1,245) |
| Exploration expense                                                     |                             | (739) |   |   | (4,869) |   |   | --  |   |   | (5,608) |
| Impairment expense                                                      |                             | --  |   |   | (3,583) |   |   | --  |   |   | (3,583) |
| Accretion expense                                                       |                             | (46) |   |   | (7) |   |   | --  |   |   | (53) |
| DD&A expense                                                        |                             | (654) |   |   | (304) |   |   | (155) |   |   | (1,113) |
| Operating income (loss)                                                 | $                                | 463  |   | $ | (6,779) |   | $ | 296  |   | $ | (6,020) |
| **Identifiable net property and                            equipment:** |                             |   |   |   |   |   |   |   |   |   |   |
| Unproved properties                                                     | $                                | --  |   | $ | 2,912  |   | $ | --  |   | $ | 2,912  |
| Proved properties                                                       |                             | 3,124  |   |   | 12,898  |   |   | --  |   |   | 16,022  |
| Equipment and other                                                     |                             | --  |   |   | 22  |   |   | 534  |   |   | 556  |
| Total                                                                   | $                                | 3,124  |   | $ | 15,832  |   | $ | 534  |   | $ | 19,490  |
| **Net Capital Expenditures:**                                           |                             |   |   |   |   |   |   |   |   |   |   |
| Property and equipment                                                  | $                                | 613  |   | $ | 9,008  |   | $ | 295  |   | $ | 9,916  |
| Total                                                                   | $                                | 613  |   | $ | 9,008  |   | $ | 295  |   | $ | 9,916  |

 

 

F-24

 

----

**FX ENERGY, INC. AND SUBSIDIARIES**

**Notes to the Consolidated Financial Statements**

**- Continued -**

             

 

|                                                                    | **2005**                         |
|-------------------------------------------------------------------------|----------------------------------|
|                                                                    |                             |   | **Oilfield Services** |   | **Total**

**(In thousands)** |
|                                                                    | **Exploration & Production** |   |   |
|                                                                    | **U.S.**                         |   | **Poland** |   |   |   |   |
|                                                                    |                             |   |   |   |   |   |   |   |   |   |   |
| **Operations summary:**                                                 |                             |   |   |   |   |   |   |   |   |   |   |
| Revenues                                                                | $                                | 3,805  |   | $ | --  |   | $ | 2,132  |   | $ | 5,937  |
| Lease operating expense                                                 |                             | (2,462) |   |   | --  |   |   | --  |   |   | (2,462) |
| Oilfield services costs                                                 |                             | --  |   |   | --  |   |   | (1,689) |   |   | (1,689) |
| Exploration expense                                                     |                             | (486) |   |   | (5,762) |   |   | --  |   |   | (6,248) |
| Accretion expense                                                       |                             | (45) |   |   | --  |   |   | --  |   |   | (45) |
| DD&A expense                                                        |                             | (511) |   |   | --  |   |   | (243) |   |   | (754) |
| Operating income (loss)                                                 | $                                | 301  |   | $ | (5,762) |   | $ | 200  |   | $ | (5,261) |
| **Identifiable net property and                            equipment:** |                             |   |   |   |   |   |   |   |   |   |   |
| Unproved properties                                                     | $                                | 143  |   | $ | 161  |   | $ | --  |   | $ | 304  |
| Proved properties                                                       |                             | 3,139  |   |   | 10,465  |   |   | --  |   |   | 13,604  |
| Equipment and other                                                     |                             | --  |   |   | 24  |   |   | 372  |   |   | 396  |
| Total                                                                   | $                                | 3,282  |   | $ | 10,650  |   | $ | 372  |   | $ | 14,304  |
| **Net Capital Expenditures:**                                           |                             |   |   |   |   |   |   |   |   |   |   |
| Property and equipment                                                  | $                                | 505  |   | $ | 3,783  |   | $ | 264  |   | $ | 4,552  |
| Total                                                                   | $                                | 505  |   | $ | 3,783  |   | $ | 264  |   | $ | 4,552  |
|                                                                         |                                  |  |  |  |  |  |  |  |  |  |  |  |

 

 

A            reconciliation of the segment information to the consolidated totals for 2007, 2006 and            2005 follows:

 

|                                                                         | **2007**           |         | **2006** |   | **2005**     |
|------------------------------------------------------------------------------|--------------------|--------------|----------|--------|--------------|
|                                                                         | **(In thousands)** |
| **Revenues:**                                                                |               |         |     |   |         |   |   |   |
| Reportable segments                                                          | $                  | 17,996  |     | $      | 8,229   |   | $ | 5,937  |
| Non-reportable segments                                                      |               | --      |     |   | --      |   |   | --  |
| Total revenues                                                               | $                  | 17,996  |     | $      | 8,229   |   | $ | 5,937  |
| **Net loss:**                                                                |               |         |     |   |         |   |   |   |
| Operating loss, reportable segments                                          | $                  | (2,485)      |     | $      | (6,020)      |   | $ | (5,261) |
| Expense or (revenue) adjustments:                                            |               |         |     |   |         |   |   |   |
| Corporate DD&A expense                                                   |               | (120)        |     |   | (177)        |   |   | (149) |
| General and administrative costs (G&A)                                   |               | (6,915)      |     |   | (5,606)      |   |   | (6,592) |
| Amortization of deferred compensation                            (G&A)   |               | (2,604)      |     |   | (2,759)      |   |   | (125) |
| Stock compensation (G&A)                                                 |               | --      |     |   | --      |   |   | (76) |
| Total net operating loss                                                     |               | (12,124)     |     |   | (14,562)     |   |   | (12,203) |
| Non-operating income                                                         |               | 433     |     |   | 795     |   |   | 780  |
| Net loss                                                                     | $                  | (11,691)     |     | $      | (13,767)     |   | $ | (11,423) |
| **Net property and equipment:**                                              |               |         |     |   |         |   |   |   |
| Reportable segments                                                          | $                  | 21,723  |     | $      | 19,490  |   | $ | 14,304  |
| Corporate assets                                                             |               | 162     |     |   | 205     |   |   | 336  |
| Net property and equipment                                                   | $                  | 21,885  |     | $      | 19,695  |   | $ | 14,640  |
| **Property and equipment capital                            expenditures:**  |               |         |     |   |         |   |   |   |
| Reportable segments                                                          | $                  | 6,479   |     | $      | 9,916   |   | $ | 4,552  |
| Corporate assets                                                             |               | 73      |     |   | 59      |   |   | 158  |
| Total property and equipment capital                            expenditures | $                  | 6,552   |     | $      | 9,975   |   | $ | 4,710  |

 

F-25

 

----

 

**FX ENERGY, INC. AND SUBSIDIARIES**

**Supplemental Information**

             

 

**Note 13: Subsequent Event**

 

In February 2008, warrant holders exercised a total of 1,960,000            outstanding warrants at a price of $3.60 per share and 30,000 outstanding warrants at a            price of $3.75 per share, resulting in proceeds to the Company of $7,168,500. The            warrants were issued in a 2003 offering of common stock and warrants with an expiration            date of March 1, 2008.

 

**Disclosure about Oil and Gas Properties and Producing Activities            (unaudited)**

 

***Capitalized Oil and Gas Property Costs***

             

Capitalized costs relating to oil and gas exploration and production            activities as of December 31, 2007 and 2006, are summarized as follows:

 

|                                                                                 |   | **United States** |   | **Poland**         |   | **Total**    |
|--------------------------------------------------------------------------------------|--------|-------------------|--------|--------------------|--------|--------------|
|                                                                                 |   |              |   | **(In thousands)** |   |         |
| **December 31, 2007:**                                                               |   |              |   |               |   |         |
| Proved properties                                                                    | $      | 5,986        | $      | 17,505        | $      | 23,491  |
| Unproved properties                                                                  |   | 61           |   | 1,940         |   | 2,001   |
| Total gross properties                                                               |   | 6,047        |   | 19,445        |   | 25,492  |
| Less accumulated depreciation, depletion and                            amortization |   | (2,819)           |   | (2,128)            |   | (4,947)      |
|                                                                                 | $      | 3,228        | $      | 17,317        | $      | 20,545  |
| **December 31, 2006:**                                                               |   |              |   |               |   |         |
| Proved properties                                                                    | $      | 5,552        | $      | 13,741        | $      | 19,293  |
| Unproved properties                                                                  |   | --           |   | 2,912         |   | 2,912   |
| Total gross properties                                                               |   | 5,552        |   | 16,653        |   | 22,205  |
| Less accumulated depreciation, depletion and                            amortization |   | (2,428)           |   | (843)              |   | (3,271)      |
|                                                                                 | $      | 3,124        | $      | 15,810        | $      | 18,934  |

 

***Results of Operations***

             

Results of operations are reflected in Note 12, Business Segments. There            is no tax provision as the Company is not likely to pay, nor has it received any            benefit from, any federal or local income taxes due to its operating losses. Total            production costs (in thousands) for 2007, 2006 and 2005 were $3,538, $2,647 and $2,462,            respectively.

 

***Property Acquisition, Exploration and Development            Activities***

             

Costs incurred in property acquisition, exploration and development            activities during 2007, 2006 and 2005, whether capitalized or expensed, are summarized            as follows:

 

|                               |   | **United States** |   | **Poland**               |   | **Total**                |
|------------------------------------|--------|-------------------|--------|--------------------------|--------|--------------------------|
|                               |   |              |   | **(In thousands)**       |   |                     |
| **Year ended December 31, 2007:**  |   |              |   |                     |   |                     |
| Acquisition of unproved properties | $      | 61                | $      |   744          | $      |   805          |
| Exploration costs                  |   | 77                |   |    14,884 |   |    14,961 |
| Development costs                  |   | 434               |   |   10           |   |   444          |
| Total                              | $      | 572               | $      | 15,638                   | $      | 16,210                   |
| **Year ended December 31, 2006:**  |   |              |   |                     |   |                     |
| Acquisition of unproved properties | $      | 4                 | $      |   366          | $      |   370          |
| Exploration costs                  |   | 932               |   |    11,159 |   |    12,091 |
| Development costs                  |   | 580               |   |    5,762  |   |    6,342  |
| Total                              | $      | 1,516             | $      | 17,287                   | $      | 18,803                   |

 

F-26

 

----

 

**FX ENERGY, INC. AND SUBSIDIARIES**

**Supplemental Information**

**--continued--**

             

 

 

|                               |   | **United States** |   | **Poland**         |   | **Total** |
|------------------------------------|--------|-------------------|--------|--------------------|--------|-----------|
|                               |   |              |   | **(In thousands)** |   |      |
| **Year ended December 31, 2005:**  |   |              |   |               |   |      |
| Acquisition of unproved properties | $      | 95                | $      | 30                 | $      | 125       |
| Exploration costs                  |   | 683               |   | 9,809              |   | 10,492    |
| Development costs                  |   | 366               |   | 520                |   | 886       |
| Total                              | $      | 1,144             | $      | 10,359             | $      | 11,503    |

 

***Impairment of Oil and Gas Properties***

             

The            Company recorded impairment charges in its E&P segment related to oil and gas            properties as follows (in thousands):

 

|                     | **2007** |   | **2006** |   | **2005**        |
|--------------------------|----------|--------|----------|--------|-----------------|
| Impairment of properties | $2,299   |   | $3,583   |   | $  -- |

 

***Exploratory dry hole costs***

             

There were no dry holes drilled in 2007. During 2006, the Company            plugged and abandoned the Drozdowice well in Poland, the Teton River well in Montana            and the West Bacon Flat well in Nevada, incurring total dry hole costs of $1,572,749.            During 2005, the Company plugged and abandoned the Lugi, Sroda 5 and four wells in the            Inselberg and Radio prospects in Nevada, incurring total dry hole costs of            $5,065,586.

 

**Summary Oil and Gas Reserve Data (Unaudited)**

 

***Estimated Quantities of Proved Reserves***

             

Proved reserves are the estimated quantities of crude oil and natural            gas that geological and engineering data demonstrate with reasonable certainty to be            recoverable in future years from known reserves under existing economic and operating            conditions. The Company’s proved oil and gas reserve quantities and values are            based on estimates prepared by independent reserve engineers in accordance with            guidelines established by the Securities and Exchange Commission. Operating costs,            production taxes and development costs were deducted in determining the quantity and            value information. Such costs were estimated based on current costs and were not            adjusted to anticipate increases due to inflation or other factors. No price            escalations were assumed and no amounts were deducted for general overhead,            depreciation, depletion and amortization, and interest expense. The proved reserve            quantity and value information is based on the weighted average price on December 31,            2007, of $81.07 per bbl for oil in the United States and $93.68 per bbl of oil and            $5.61 per Mcf of gas in Poland. The determination of oil and gas reserves is based on            estimates and is highly complex and interpretive, as there are numerous uncertainties            inherent in estimating quantities and values of proved reserves, projecting future            rates of production and timing of development expenditures. The estimates are subject            to continuing revisions as additional information becomes available or assumptions            change.

 

F-27

 

----

 

**FX ENERGY, INC. AND SUBSIDIARIES**

**Supplemental Information**

**--continued--**

             

 

Estimates of the Company’s proved domestic reserves were prepared            by Larry Krause Consulting, an independent engineering firm in Billings, Montana.            Estimates of the Company’s proved Polish reserves were prepared by RPS Energy, an            independent engineering firm in the United Kingdom.

 

**Proved Developed Reserves:**

 

The            following unaudited summary of proved developed reserve quantity information represents            estimates only and should not be construed as exact:

 

|              | **Crude Oil**                    |   | **Natural Gas**                 |
|-------------------|----------------------------------|--------|---------------------------------|
|              | **United States**                |   | **Poland**                      |   | **United States** |   | **Poland** |
|              | **(In thousand barrels of oil)** |   | **(In millions of cubic feet)** |
|              |                             |   |                            |   |   |   |   |
| December 31, 2007 | 482                              |   | 14                              |   | -- |   |  5,288 |
| December 31, 2006 | 382                              |   | 202                             |   | -- |   |  11,382 |
| December 31, 2005 | 408                              |   | --                              |   | -- |   | 974 |

 

**Total Proved Reserves:**

 

The            following unaudited summary of proved developed and undeveloped reserve quantity            information represents estimates only and should not be construed as exact:

 

|                             | **Crude Oil**                    |   | **Natural Gas**                 |
|----------------------------------|----------------------------------|--------|---------------------------------|
|                             | **United States**                |   | **Poland**                      |   | **United States** |   | **Poland** |
|                             | **(In thousand barrels of oil)** |   | **(In millions of cubic feet)** |
| **December 31, 2007:**           |                             |   |                            |   |   |   |   |
| Beginning of year                | 382                         |   | 202                        |   | -- |   | 19,264  |
| Extensions or discoveries        | --                          |   | --                         |   | -- |   | 17,939  |
| Revisions of previous estimates  | 170                         |   | (163)                           |   | -- |   | (4,247) |
| Production                       | (70)                             |   | (25)                            |   | -- |   | (1,840) |
| End of year                      | 482                         |   | 14                         |   | -- |   | 31,116  |
| **December 31, 2006:**           |                             |   |                            |   |   |   |   |
| Beginning of year                | 408                         |   | 209                        |   | -- |   | 19,788  |
| Revisions of previous estimates  | 50                          |   | 2                          |   | -- |   | (63) |
| Production                       | (76)                             |   | (9)                             |   | -- |   | (461) |
| End of year                      | 382                         |   | 202                        |   | -- |   | 19,264  |
| **December 31, 2005:**           |                             |   |                            |   |   |   |   |
| Beginning of year                | 809                         |   | 111                        |   | -- |   | 10,198  |
| Extensions or discoveries        | --                          |   | --                         |   | -- |   | 7,882  |
| Acquisition of minerals in place | --                          |   | 98                         |   | -- |   | 2,199  |
| Revisions of previous estimates  | (322)                            |   | --                         |   | -- |   | (491) |
| Production                       | (79)                             |   | --                         |   | -- |   | --  |
| End of year                      | 408                         |   | 209                        |   | -- |   | 19,788  |

 

See            Note 1. Summary of Significant Accounting Policies, Oil and Gas Properties, for further            information concerning the Company’s Poland gas revisions.

 

F-28

 

----

 

**FX ENERGY, INC. AND SUBSIDIARIES**

**Supplemental Information**

**--continued--**

             

 

***Standardized Measure of Discounted Future Net Cash Flows            (“SMOG”) and Changes Therein Relating to Proved Oil            Reserves***

             

Estimated discounted future net cash flows and changes therein were            determined in accordance with SFAS No. 69, “Disclosures about Oil and Gas            Activities.” Certain information concerning the assumptions used in computing the            valuation of proved reserves and their inherent limitations are discussed below. The            Company believes such information is essential for a proper understanding and            assessment of the data presented. The assumptions used to compute the proved reserve            valuation do not necessarily reflect the Company’s expectations of actual            revenues to be derived from those reserves nor their present worth. Assigning monetary            values to the reserve quantity estimation process does not reduce the subjective and            ever-changing nature of such reserve estimates. Additional subjectivity occurs when            determining present values because the rate of producing the reserves must be            estimated. In addition to errors inherent in predicting the future, variations from the            expected production rates also could result directly or indirectly from factors outside            the Company’s control, such as unintentional delays in development, environmental            concerns and changes in prices or regulatory controls. The reserve valuation assumes            that all reserves will be disposed of by production. However, if reserves are sold in            place, additional economic considerations also could affect the amount of cash            eventually realized. Future development and production costs are computed by estimating            expenditures to be incurred in developing and producing the proved oil reserves at the            end of the period, based on period-end costs and assuming continuation of existing            economic conditions. A discount rate of 10.0% per year was used to reflect the timing            of the future net cash flows. The future net cash flows for the Company’s Polish            reserves are based on a gas and condensate sales contract the Company has with            POGC.

 

The            components of SMOG are detailed below:

 

|                                                                              |   | **United States** |   | **Poland**         |   | **Total**     |
|-----------------------------------------------------------------------------------|--------|-------------------|--------|--------------------|--------|---------------|
|                                                                              |   |              |   | **(In thousands)** |   |          |
| **December 31, 2007:**                                                            |   |              |   |               |   |          |
| Future cash flows                                                                 | $      | 39,056       | $      | 179,698       | $      | 218,754  |
| Future production costs                                                           |   | (22,459)          |   | (15,051)           |   | (37,510)      |
| Future development costs                                                          |   | --           |   | (10,029)           |   | (10,029)      |
| Future income tax expense                                                         |   | --           |   | (16,835)           |   | (16,835)      |
| Future net cash flows                                                             |   | 16,597       |   | 137,783       |   | 154,380  |
| 10% annual discount for estimated timing of cash                            flows |   | (5,130)           |   | (46,282)           |   | (51,412)      |
| Discounted net future cash flows                                                  | $      | 11,467       | $      | 91,501        | $      | 102,968  |
| **December 31, 2006:**                                                            |   |              |   |               |   |          |
| Future cash flows                                                                 | $      | 19,719       | $      | 103,903       | $      | 123,622  |
| Future production costs                                                           |   | (13,511)          |   | (12,046)           |   | (25,557)      |
| Future development costs                                                          |   | --           |   | (2,502)            |   | (2,502)       |
| Future income tax expense                                                         |   | --           |   | (4,595)            |   | (4,595)       |
| Future net cash flows                                                             |   | 6,208        |   | 84,760        |   | 90,968   |
| 10% annual discount for estimated timing of cash                            flows |   | (1,643)           |   | (25,568)           |   | (27,211)      |
| Discounted net future cash flows                                                  | $      | 4,565        | $      | 59,192        | $      | 63,757   |
| **December 31, 2005:**                                                            |   |              |   |               |   |          |
| Future cash flows                                                                 | $      | 20,833       | $      | 73,114        | $      | 93,947   |
| Future production costs                                                           |   | (12,808)          |   | (2,504)            |   | (15,312)      |
| Future development costs                                                          |   | --           |   | (7,658)            |   | (7,658)       |
| Future income tax expense                                                         |   | --           |   | (7,742)            |   | (7,742)       |
| Future net cash flows                                                             |   | 8,025        |   | 55,210        |   | 63,235   |
| 10% annual discount for estimated timing of cash                            flows |   | (2,189)           |   | (19,131)           |   | (21,320)      |
| Discounted net future cash flows                                                  | $      | 5,836        | $      | 36,079        | $      | 41,915   |

 

 

F-29

 

----

 

**FX ENERGY, INC. AND SUBSIDIARIES**

**Supplemental Information**

**--continued--**

             

 

The            principal sources of changes in SMOG are detailed below:

 

|              |                                                                                       | **Year Ended December 31,** |          |
|-------------------|--------------------------------------------------------------------------------------------|-----------------------------|---------------|
|              |                                                                                       | **2007**                    |          | **2006** |   | **2005** |   |
|              |                                                                                       |                        |          | **(In thousands)** |   |   |   |
| **SMOG sources:** |                                                                                       |                        |          |   |   |   |   |
|              | Balance, beginning of year                                                                 | $                           | 63,757   | $ | 41,915  | $ | 18,225  |
|              | Sale of oil and gas produced, net of production                            costs           |                        | (11,364)      |   | (3,886) |   | (1,343) |
|              | Net changes in prices and production costs                                                 |                        | 7,866    |   | 16,111  |   | 14,423  |
|              | Acquisition of minerals in place                                                           |                        | --       |   | --  |   | 4,391  |
|              | Extensions and discoveries, net of future                            costs                 |                        | 62,343   |   | --  |   | 16,243  |
|              | Changes in estimated future development costs                                              |                        | (5,022)       |   | 3,953  |   | (3,232) |
|              | Previously estimated development costs incurred during                            the year |                        | 420      |   | 580  |   | 886  |
|              | Revisions in previous quantity estimates                                                   |                        | (13,561)      |   | (169) |   | (4,384) |
|              | Accretion of discount                                                                      |                        | 6,376    |   | 4,192  |   | 1,823  |
|              | Net change in income taxes                                                                 |                        | (8,008)       |   | 1,911  |   | (5,131) |
|              | Changes in rates of production and other                                                   |                        | 161      |   | (850) |   | 14  |
|              | Balance, end of year                                                                       | $                           | 102,968  | $ | 63,757  | $ | 41,915  |
|                   |                                                                                            |                             |               |  |  |  |  |  |  |  |  |  |  |

 

 

F-30