**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

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**FORM 10-Q**

**(Mark One)**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe quarterly period ended September 30, 2006**

**Or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transition period from**         to         

**CommissionFile Number 1-13515**

**FOREST OIL CORPORATION**

(Exact name of registrantas specified in its charter)

| **New York**                                                     |   | **25-0484900**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |

 

| **707 17****th Street, Suite 3600 Denver, Colorado** |   | **80202**  |
|----------------------------------------------------------------|--------|------------|
| (Address of  principal executive offices)                      |   | (Zip Code) |

 

Registrant’s telephonenumber, including area code: **(303) 812-1400**

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Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past90 days.               xYes  oNo

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the ExchangeAct. (Check one):

| Large accelerated filer  x |   | Accelerated filer  o |   | Non-accelerated filer  o |
|--------------------------------------|--------|--------------------------------|--------|------------------------------------|

 

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

As of October 31, 2006 there were 62,931,547shares of the registrant’s commonstock, par value $.10 per share, outstanding.

 

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**FORESTOIL CORPORATIONINDEX TO FORM 10-QSeptember 30, 2006**

| Part I—FINANCIAL  INFORMATION                                                                               |   |   |
|-----------------------------------------------------------------------------------------------------------------------|--------|--------|
| Item  1—Financial Statements                                                                                     |   |   |
| Condensed Consolidated Balance Sheets as of  September 30, 2006 and December 31, 2005                       |   | 1      |
| Condensed Consolidated Statements of Operations for  the Three and Nine Months Ended September 30, 2006 and 2005 |   | 2      |
| Condensed Consolidated Statement of Shareholders’  Equity for the Nine Months Ended September 30, 2006      |   | 3      |
| Condensed Consolidated Statements of Cash Flows for  the Nine Months Ended September 30, 2006 and 2005           |   | 4      |
| Notes to Condensed Consolidated Financial Statements                                                                  |   | 5      |
| Item 2—Management’s Discussion and Analysis of  Financial Condition and Results of Operations               |   | 20     |
| Item 3—Quantitative and Qualitative Disclosures About  Market Risk                                               |   | 35     |
| Item 4—Controls and Procedures                                                                                   |   | 38     |
| Part II—OTHER  INFORMATION                                                                                  |   | 38     |
| Item  1—Legal Proceedings                                                                                        |   | 38     |
| Item  6—Exhibits                                                                                                 |   | 38     |
| Signatures                                                                                                            |   | 40     |

 

ii

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**PART I -FINANCIAL INFORMATION**

**Item 1. FINANCIALSTATEMENTS**

**FOREST OIL CORPORATION**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

**(In Thousands,Except Share Data)**

| ** **                                                                                              | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                              | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| **ASSETS**                                                                                              |       |                   |       |                  |       |   |   |   |   |
| Current assets:                                                                                         |       |                   |       |                  |       |   |   |   |   |
| Cash and cash equivalents                                                                               |       |                   | $          | 11,402                |       |   |   | 7,231 |   |   |
| Accounts receivable                                                                                     |       |                   | 119,918    |                  |       |   | 178,124 |   |   |
| Derivative instruments                                                                                  |       |                   | 37,499     |                  |       |   | 941 |   |   |
| Deferred tax assets                                                                                     |       |                   | —     |                  |       |   | 77,346 |   |   |
| Other current assets                                                                                    |       |                   | 34,588     |                  |       |   | 52,283 |   |   |
| Total current assets                                                                                    |       |                   | 203,407    |                  |       |   | 315,925 |   |   |
| Property and equipment,  at cost:                                                                       |       |                   |       |                  |       |   |   |   |   |
| Oil and gas properties, full cost method of  accounting:                                                |       |                   |       |                  |       |   |   |   |   |
| Proved, net of  accumulated depletion of $2,220,480 and $3,059,031                                      |       |                   | 2,435,869  |                  |       |   | 2,898,774 |   |   |
| Unproved                                                                                                |       |                   | 259,842    |                  |       |   | 275,684 |   |   |
| Net oil and gas  properties                                                                             |       |                   | 2,695,711  |                  |       |   | 3,174,458 |   |   |
| Other property and  equipment, net of accumulated depreciation and amortization of $31,329 and  $32,527 |       |                   | 31,850     |                  |       |   | 25,560 |   |   |
| Net property and  equipment                                                                             |       |                   | 2,727,561  |                  |       |   | 3,200,018 |   |   |
| Derivative instruments                                                                                  |       |                   | 19,413     |                  |       |   | — |   |   |
| Goodwill                                                                                                |       |                   | 86,880     |                  |       |   | 87,072 |   |   |
| Other assets                                                                                            |       |                   | 34,108     |                  |       |   | 42,531 |   |   |
|                                                                                                    |       |                   | $          | 3,071,369             |       |   |   | 3,645,546 |   |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                          |       |                   |       |                  |       |   |   |   |   |
| Current liabilities:                                                                                    |       |                   |       |                  |       |   |   |   |   |
| Accounts payable                                                                                        |       |                   | $          | 231,150               |       |   |   | 312,076 |   |   |
| Accrued interest                                                                                        |       |                   | 18,242     |                  |       |   | 4,260 |   |   |
| Derivative instruments                                                                                  |       |                   | 14,781     |                  |       |   | 151,678 |   |   |
| Asset retirement obligations                                                                            |       |                   | 1,800      |                  |       |   | 33,329 |   |   |
| Deferred income taxes                                                                                   |       |                   | 4,183      |                  |       |   | — |   |   |
| Other current liabilities                                                                               |       |                   | 14,745     |                  |       |   | 21,573 |   |   |
| Total current liabilities                                                                               |       |                   | 284,901    |                  |       |   | 522,916 |   |   |
| Long-term  debt                                                                                         |       |                   | 1,096,076  |                  |       |   | 884,807 |   |   |
| Asset retirement  obligations                                                                           |       |                   | 58,948     |                  |       |   | 178,225 |   |   |
| Other liabilities                                                                                       |       |                   | 43,436     |                  |       |   | 45,691 |   |   |
| Deferred income  taxes                                                                                  |       |                   | 180,800    |                  |       |   | 329,385 |   |   |
| Total liabilities                                                                                       |       |                   | 1,664,161  |                  |       |   | 1,961,024 |   |   |
| Shareholders’ equity:                                                                              |       |                   |       |                  |       |   |   |   |   |
| Preferred stock,  none issued                                                                           |       |                   | —     |                  |       |   | — |   |   |
| Common stock, 62,927,258 and 64,548,229 shares issued  and outstanding                                  |       |                   | 6,293      |                  |       |   | 6,455 |   |   |
| Capital surplus                                                                                         |       |                   | 1,211,519  |                  |       |   | 1,529,102 |   |   |
| Retained earnings                                                                                       |       |                   | 106,947    |                  |       |   | 217,293 |   |   |
| Accumulated other comprehensive income (loss)                                                           |       |                   | 82,449     |                  |       |   | (18,220 | ) |   |
| Treasury stock, at cost, 1,861,143 shares held in  2005                                                 |       |                   | —     |                  |       |   | (50,108 | ) |   |
| Total shareholders’ equity                                                                         |       |                   | 1,407,208  |                  |       |   | 1,684,522 |   |   |
|                                                                                                    |       |                   | $          | 3,071,369             |       |   |   | 3,645,546 |   |   |

 

See accompanying Notes to Condensed Consolidated Financial Statements.

1

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**FOREST OILCORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(Unaudited)**

| ** **                                                       | ** ** | **Three Months Ended  September 30,**                  | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                       | ** ** | **2006**                                                              | ** ** | **2005**                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                       | ** ** | **(In Thousands, Except Per Share Amounts)** | ** ** |
| Revenue:                                                         |       |                                                                  |       |                                           |       |   |   |   |   |
| Oil and gas sales:                                               |       |                                                                  |       |                                           |       |   |   |   |   |
| Natural gas                                                      |       | $                                                                     | 90,296     |                                           | 156,070    |   | 312,102 |   | 470,711 |   |
| Oil, condensate, and natural gas liquids                         |       | 110,624                                                               |       | 110,080                                        |       | 318,137 |   | 323,664 |   |
| Total oil and gas sales                                          |       | 200,920                                                               |       | 266,150                                        |       | 630,239 |   | 794,375 |   |
| Marketing, processing, and other                                 |       | 1,919                                                                 |       | 2,086                                          |       | 5,899 |   | 5,207 |   |
| Total revenue                                                    |       | 202,839                                                               |       | 268,236                                        |       | 636,138 |   | 799,582 |   |
| Operating expenses:                                              |       |                                                                  |       |                                           |       |   |   |   |   |
| Lease operating expenses                                         |       | 34,963                                                                |       | 51,576                                         |       | 115,823 |   | 145,219 |   |
| Production and property taxes                                    |       | 8,974                                                                 |       | 10,914                                         |       | 30,699 |   | 31,358 |   |
| Transportation costs                                             |       | 5,494                                                                 |       | 4,597                                          |       | 15,865 |   | 14,352 |   |
| General and administrative (including stock-based  compensation) |       | 10,548                                                                |       | 9,847                                          |       | 38,755 |   | 31,694 |   |
| Depreciation and depletion                                       |       | 62,505                                                                |       | 91,029                                         |       | 203,426 |   | 284,554 |   |
| Accretion of asset retirement obligations                        |       | 1,226                                                                 |       | 4,352                                          |       | 5,879 |   | 12,951 |   |
| Impairments and other                                            |       | —                                                                |       | 4,002                                          |       | 2,078 |   | 6,926 |   |
| Spin-off and merger costs                                        |       | —                                                                |       | —                                         |       | 5,416 |   | — |   |
| Total operating expenses                                         |       | 123,710                                                               |       | 176,317                                        |       | 417,941 |   | 527,054 |   |
| Earnings from operations                                         |       | 79,129                                                                |       | 91,919                                         |       | 218,197 |   | 272,528 |   |
| Other income and expense:                                        |       |                                                                  |       |                                           |       |   |   |   |   |
| Interest expense                                                 |       | 19,122                                                                |       | 15,664                                         |       | 51,613 |   | 46,224 |   |
| Unrealized (gains) losses on derivative instruments,  net        |       | (77,914                                                               | )          | 72,095                                         |       | (68,178 | ) | 74,365 |   |
| Realized losses (gains) on derivative instruments,  net          |       | 12,883                                                                |       | 38                                             |       | 30,496 |   | (280 | ) |
| Unrealized foreign currency exchange loss                        |       | 766                                                                   |       | —                                         |       | 766 |   | — |   |
| Other (income) expense, net                                      |       | (950                                                                  | )          | 341                                            |       | (200 | ) | 4,251 |   |
| Total other income and expense                                   |       | (46,093                                                               | )          | 88,138                                         |       | 14,497 |   | 124,560 |   |
| Earnings before income taxes and discontinued  operations        |       | 125,222                                                               |       | 3,781                                          |       | 203,700 |   | 147,968 |   |
| Income tax expense:                                              |       |                                                                  |       |                                           |       |   |   |   |   |
| Current                                                          |       | (743                                                                  | )          | (203                                           | )          | 2,078 |   | 1,971 |   |
| Deferred                                                         |       | 49,031                                                                |       | 719                                            |       | 66,391 |   | 51,660 |   |
| Total income tax expense                                         |       | 48,288                                                                |       | 516                                            |       | 68,469 |   | 53,631 |   |
| Earnings from continuing operations                              |       | 76,934                                                                |       | 3,265                                          |       | 135,231 |   | 94,337 |   |
| Income from discontinued operations, net of tax                  |       | —                                                                |       | —                                         |       | 2,422 |   | — |   |
| Net earnings                                                     |       | $                                                                     | 76,934     |                                           | 3,265      |   | 137,653 |   | 94,337 |   |
| Basic earnings per common  share:                                |       |                                                                  |       |                                           |       |   |   |   |   |
| Earnings from continuing operations                              |       | $                                                                     | 1.24       |                                           | .05        |   | 2.17 |   | 1.54 |   |
| Income from discontinued operations, net of tax                  |       | —                                                                |       | —                                         |       | .04 |   | — |   |
| Net earnings per common share                                    |       | $                                                                     | 1.24       |                                           | .05        |   | 2.21 |   | 1.54 |   |
| Diluted earnings per  common share:                              |       |                                                                  |       |                                           |       |   |   |   |   |
| Earnings from continuing operations                              |       | $                                                                     | 1.21       |                                           | .05        |   | 2.13 |   | 1.50 |   |
| Income from discontinued operations, net of tax                  |       | —                                                                |       | —                                         |       | .04 |   | — |   |
| Net earnings per  common share                                   |       | $                                                                     | 1.21       |                                           | .05        |   | 2.17 |   | 1.50 |   |

 

See accompanying Notes to Condensed Consolidated Financial Statements.

2

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**FOREST OIL CORPORATIONCONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY(Unaudited)**

| ** **                                                           | ** ** | **Common Stock**   | ** ** | **Capital** | ** ** | **Retained** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Treasury**           | ** ** | **Total  Shareholders’** | ** ** |
|----------------------------------------------------------------------|------------|-------------------------|------------|-------------|------------|--------------|------------|---------------------------------------|------------|------------------------|------------|-------------------------------|------------|
| ** **                                                           | ** ** | **Shares**              | ** ** | **Amount**  | ** ** | **Surplus**  | ** ** | **Earnings**                          | ** ** | **(Loss) Income** | ** ** | **Stock**                     | ** ** | **Equity** | ** ** |
| ** **                                                           | ** ** | **(In Thousands)** | ** ** |
| Balances at January 1, 2006                                     |       |                    | 64,548     |        |       |         | $          | 6,455                                 |       |                   | 1,529,102  |                          |       | 217,293 |   |   |   | (18,220 | ) |   |   | (50,108 | ) |   |   | 1,684,522 |   |   |
| Exercise of stock options                                            |       |                    | 218        |        |       |         | 22         |                                  |       | 4,649                  |       |                          | (8         | ) |   |   | — |   |   |   | 27 |   |   |   | 4,690 |   |   |
| Tax benefit of stock options exercised                               |       |                    | —     |        |       |         | —     |                                  |       | 40                     |       |                          | —     |   |   |   | — |   |   |   | — |   |   |   | 40 |   |   |
| Employee stock purchase plan                                         |       |                    | 20         |        |       |         | 2          |                                  |       | 553                    |       |                          | —     |   |   |   | — |   |   |   | — |   |   |   | 555 |   |   |
| Restricted stock issued, net of forfeitures                          |       |                    | 1          |        |       |         | —     |                                  |       | —                 |       |                          | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Retirement of treasury stock                                         |       |                    | (1,860     | )           |       |         | (186       | )                                     |       | (49,895                | )          |                          | —     |   |   |   | — |   |   |   | 50,081 |   |   |   | — |   |   |
| Amortization of stock-based compensation                             |       |                    | —     |        |       |         | —     |                                  |       | 17,017                 |       |                          | —     |   |   |   | — |   |   |   | — |   |   |   | 17,017 |   |   |
| Tax benefit of acquired net operating losses                         |       |                    | —     |        |       |         | —     |                                  |       | 8,405                  |       |                          | —     |   |   |   | — |   |   |   | — |   |   |   | 8,405 |   |   |
| Pro rata distribution of MERI common stock to  shareholders (Note 2) |       |                    | —     |        |       |         | —     |                                  |       | (298,352               | )          |                          | (247,991   | ) |   |   | 7,549 |   |   |   | — |   |   |   | (538,794 | ) |   |
| Comprehensive earnings:                                              |       |                    |       |        |       |         |       |                                  |       |                   |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net earnings                                                         |       |                    | —     |        |       |         | —     |                                  |       | —                 |       |                          | 137,653    |   |   |   | — |   |   |   | — |   |   |   | 137,653 |   |   |
| Unrealized gain on effective derivative instruments,  net of tax     |       |                    | —     |        |       |         | —     |                                  |       | —                 |       |                          | —     |   |   |   | 77,074 |   |   |   | — |   |   |   | 77,074 |   |   |
| Amortization of deferred hedging loss, net of tax                    |       |                    | —     |        |       |         | —     |                                  |       | —                 |       |                          | —     |   |   |   | 2,411 |   |   |   | — |   |   |   | 2,411 |   |   |
| Decrease in unfunded pension liability, net of tax                   |       |                    | —     |        |       |         | —     |                                  |       | —                 |       |                          | —     |   |   |   | 83 |   |   |   | — |   |   |   | 83 |   |   |
| Foreign currency translation                                         |       |                    | —     |        |       |         | —     |                                  |       | —                 |       |                          | —     |   |   |   | 13,552 |   |   |   | — |   |   |   | 13,552 |   |   |
| Total comprehensive earnings                                         |       |                    |       |        |       |         |       |                                  |       |                   |       |                          |       |   |   |   |   |   |   |   |   |   |   |   | 230,773 |   |   |
| Balances at  September 30, 2006                                 |       |                    | 62,927     |        |       |         | $          | 6,293                                 |       |                   | 1,211,519  |                          |       | 106,947 |   |   |   | 82,449 |   |   |   | — |   |   |   | 1,407,208 |   |   |

 

See accompanying Notes to Condensed Consolidated Financial Statements.

3

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**FORESTOIL CORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)**

| ** **                                                                                     | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                     | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| ** **                                                                                     | ** ** | **(In Thousands)**                             | ** ** |
| Operating activities:                                                                          |       |                                                |       |   |   |
| Net earnings                                                                                   |       | $                                                   | 137,653    |   | 94,337 |   |
| Adjustments to reconcile  net earnings to net cash provided by operating activities:           |       |                                                |       |   |   |
| Depreciation and depletion                                                                     |       | 203,426                                             |       | 284,554 |   |
| Accretion of asset retirement obligations                                                      |       | 5,879                                               |       | 12,951 |   |
| Stock-based compensation                                                                       |       | 11,384                                              |       | 426 |   |
| Impairments                                                                                    |       | 2,078                                               |       | 2,924 |   |
| Unrealized (gains) losses on derivative instruments,  net                                      |       | (68,178                                             | )          | 74,365 |   |
| Amortization of deferred derivative losses                                                     |       | 15,204                                              |       | — |   |
| Unrealized foreign currency exchange loss                                                      |       | 766                                                 |       | — |   |
| Deferred income tax expense                                                                    |       | 67,617                                              |       | 51,660 |   |
| Other, net                                                                                     |       | (2,565                                              | )          | 1,883 |   |
| Changes in operating  assets and liabilities, net of effects of acquisitions and divestitures: |       |                                                |       |   |   |
| Accounts receivable                                                                            |       | 966                                                 |       | (645 | ) |
| Other current assets                                                                           |       | (23,330                                             | )          | (3,956 | ) |
| Accounts payable                                                                               |       | (1,131                                              | )          | (6,859 | ) |
| Accrued interest and other current liabilities                                                 |       | (3,153                                              | )          | 6,792 |   |
| Net cash provided by operating activities                                                      |       | 346,616                                             |       | 518,432 |   |
| Investing activities:                                                                          |       |                                                |       |   |   |
| Capital expenditures for  property and equipment:                                              |       |                                                |       |   |   |
| Exploration, development, and acquisition costs                                                |       | (741,495                                            | )          | (548,133 | ) |
| Other fixed assets                                                                             |       | (9,718                                              | )          | (9,659 | ) |
| Proceeds from sales of assets                                                                  |       | 1,367                                               |       | 23,668 |   |
| Other, net                                                                                     |       | 120                                                 |       | (4,273 | ) |
| Net cash used by investing activities                                                          |       | (749,726                                            | )          | (538,397 | ) |
| Financing activities:                                                                          |       |                                                |       |   |   |
| Proceeds from bank borrowings                                                                  |       | 2,444,963                                           |       | 1,630,000 |   |
| Repayments of bank borrowings                                                                  |       | (2,055,924                                          | )          | (1,663,000 | ) |
| Repayments of bank debt assumed in acquisition                                                 |       | —                                              |       | (35,000 | ) |
| Proceeds from Spin-off (Note 2)                                                                |       | 21,670                                              |       | — |   |
| Proceeds from the exercise of options and warrants  and employee stock purchases               |       | 5,246                                               |       | 41,806 |   |
| Other, net                                                                                     |       | (8,599                                              | )          | (1,723 | ) |
| Net cash provided (used) by financing activities                                               |       | 407,356                                             |       | (27,917 | ) |
| Effect of exchange rate changes on cash                                                        |       | (75                                                 | )          | (780 | ) |
| Net increase (decrease) in cash and cash equivalents                                           |       | 4,171                                               |       | (48,662 | ) |
| Cash and cash equivalents at beginning of period                                               |       | 7,231                                               |       | 55,251 |   |
| Cash and cash equivalents at end of period                                                     |       | $                                                   | 11,402     |   | 6,589 |   |
| Cash paid during the  period for:                                                              |       |                                                |       |   |   |
| Interest                                                                                       |       | $                                                   | 42,819     |   | 35,235 |   |
| Income taxes                                                                                   |       | 5,243                                               |       | 5,128 |   |

 

See accompanying Notes to Condensed Consolidated Financial Statements.

4

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**FOREST OILCORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

**(1)**                               BASISOF PRESENTATION

The Condensed Consolidated Financial Statementsincluded herein are unaudited and include the accounts of Forest OilCorporation and its consolidated subsidiaries (collectively, “Forest” or the “Company”).In the opinion of management, all adjustments, consisting of normal recurringaccruals, have been made which are necessary for a fair presentation of thefinancial position of Forest at September 30, 2006, the results of itsoperations for the three and nine months ended September 30, 2006 and2005, and its cash flows for the nine months ended September 30, 2006 and2005. Interim results are not necessarily indicative of expected annual resultsbecause of the impact of fluctuations in prices received for liquids (oil,condensate, and natural gas liquids) and natural gas and other factors.

In the course of preparing the Condensed ConsolidatedFinancial Statements, management makes various assumptions, judgments, andestimates to determine the reported amount of assets, liabilities, revenue, andexpenses, and in the disclosures of commitments and contingencies. Changes inthese assumptions, judgments, and estimates will occur as a result of the passageof time and the occurrence of future events and, accordingly, actual resultscould differ from amounts initially established.

The more significant areas requiring the use ofassumptions, judgments, and estimates relate to volumes of oil and gas reservesused in calculating depletion, the amount of future net revenues used incomputing the ceiling test limitations, and the amount of future capital costsand abandonment obligations used in such calculations. Assumptions, judgments,and estimates are also required in determining impairments of undevelopedproperties, valuing deferred tax assets, and estimating fair values ofderivative instruments.

Certain amounts in the prior year financial statementshave been reclassified to conform to the 2006 financial statement presentation.

For a more completeunderstanding of Forest’s operations, financial position, and accountingpolicies, reference is made to the consolidated financial statements of Forest,and related notes thereto, filed with Forest’s annual report on Form 10-Kfor the year ended December 31, 2005, previously filed with the Securitiesand Exchange Commission.

**(2)**                               ACQUISITIONSAND DIVESTITURES

***Acquisitions***

On March 31, 2006,Forest completed the acquisition of oil and gas properties located primarily inthe Cotton Valley trend in East Texas. Forest paid approximately $255 million,as adjusted to reflect an economic effective date of February 1, 2006, forproperties with an estimated 110 Bcfe of estimated proved reserves at the timethe acquisition was announced in February 2006 and production thataveraged 13 MMcfe per day in January 2006. Forest acquired approximately26,000 net acres in the fields, of which approximately 14,000 net acres wereundeveloped. Forest funded this acquisition utilizing its bank creditfacilities.

***Divestitures***

*Spin-off and Mergerof Offshore Gulf of Mexico Operations*

On March 2, 2006, Forest completed the spin-offof its offshore Gulf of Mexico operations by means of a special dividend, whichconsisted of a pro rata spin-off (the “Spin-off”) of all outstanding shares ofForest Energy Resources, Inc. (hereinafter known as Mariner EnergyResources, Inc. or “MERI”), a total 

5

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**(2)          ACQUISITIONS AND DIVESTITURES(Continued)**

of 50,637,010 shares ofcommon stock, to holders of record of Forest common stock as of the close ofbusiness on February 21, 2006. Immediately following the Spin-off, MERIwas merged with a subsidiary of Mariner Energy, Inc. (“Mariner”) in astock for stock transaction (the “Merger”). Mariner’s common stock commencedtrading on the New York Stock Exchange on March 3, 2006.

The Spin-off was a tax-free transaction for federalincome tax purposes. Prior to the Merger, as part of the Spin-off, MERI paidForest approximately $176.1 million. The $176.1 million was drawn on a newlycreated bank credit facility established by MERI immediately prior to theSpin-off. This credit facility and associated liability was included in theSpin-off. Subsequent to the closing, Forest received additional net cashproceeds of $21.7 million from MERI for a total of $197.8 million. As of October 31,2006, in accordance with the transaction agreements, Forest and MERI hadsubmitted post-closing adjustments from which Forest has determined it owesMERI approximately $5.8 million, which is subject to further adjustment.

Thetable below sets forth the effect of the Spin-off on the Company’s balancesheet:

| ** **                                                           | ** ** | **Change in Balance  Sheet Accounts** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                           | ** ** | **(In Thousands)**                              | ** ** |
| **Assets (Increase/(Decrease))**                                     | ** ** |                                                 | ** ** | ** ** |   |
| Cash                                                                 |       |                                                 | $          | (10 | ) |   |
| Accounts receivable—Due from MERI                               |       |                                                 | 15,953     |   |   |
| Accounts receivable—third parties                               |       |                                                 | (54,078    | ) |   |
| Other current assets                                                 |       |                                                 | (44,837    | ) |   |
| Proved oil and gas properties, net of accumulated  depletion         |       |                                                 | (1,033,289 | ) |   |
| Unproved oil and gas properties                                      |       |                                                 | (38,523    | ) |   |
| Other assets                                                         |       |                                                 | (7,919     | ) |   |
| **Liabilities and Shareholders’  Equity ((Increase)/Decrease)** |       |                                                 |       |   |   |
| Current liabilities                                                  |       |                                                 | 96,142     |   |   |
| Derivative instruments                                               |       |                                                 | 17,087     |   |   |
| MERI credit facility                                                 |       |                                                 | 176,102    |   |   |
| Asset retirement obligations                                         |       |                                                 | 150,182    |   |   |
| Deferred income taxes                                                |       |                                                 | 184,396    |   |   |
| Accumulated other comprehensive income                               |       |                                                 | (7,549     | ) |   |
| Net decrease to capital  surplus and retained earnings               |       |                                                 | $          | (546,343 | ) |   |

 

*Sale of ProMark—DiscontinuedOperations*

On March 1, 2004, theCompany sold the assets and business operations of ProducersMarketing, Ltd. (“ProMark”) to Cinergy Canada, Inc. (“Cinergy”) for$11.2 million CDN. As a result of the sale, ProMark’s results ofoperations were reported as discontinued operations in the historical financialstatements. Under the terms of the purchase and sale agreement, Forest mayreceive additional contingent consideration over a period of five years throughFebruary 2009. During the nine months ended September 30, 2006,Forest recognized an additional $3.6 million contingent payment ($2.4 millionnet of tax), which has been reflected as income from discontinued operations inthe Condensed Consolidated Statements of Operations.

6

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**(3)**                               EARNINGSPER SHARE AND COMPREHENSIVE EARNINGS (LOSS)

***Earnings per Share***

Basic earnings per shareis computed by dividing net earnings attributable to common stock by theweighted average number of common shares outstanding during each period,excluding treasury shares.

Dilutedearnings per share is computed by adjusting the average number of common sharesoutstanding for the dilutive effect, if any, of stock options, unvestedrestricted stock grants, unvested phantom stock units, and warrants. Thefollowing sets forth the calculation of basic and diluted earnings per share:

| ** **                                                                                                 | ** ** | **Three Months Ended  September 30,**                  | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2006**                                                              | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                                                 | ** ** | **(In Thousands, Except Per Share Amounts)** | ** ** |
| Earnings from  continuing operations                                                                       |       | $76,934                                                               |       | 3,265                                               |       | 135,231 |   | 94,337 |   |
| Income from  discontinued operations, net of tax                                                           |       | —                                                                |       | —                                              |       | 2,422 |   | — |   |
| Net earnings                                                                                               |       | $76,934                                                               |       | 3,265                                               |       | 137,653 |   | 94,337 |   |
| Weighted average  common shares outstanding during the period                                              |       | 62,250                                                                |       | 61,946                                              |       | 62,187 |   | 61,198 |   |
| Add dilutive  effects of stock options, unvested restricted stock grants, and unvested phantom stock units |       | 1,234                                                                 |       | 1,194                                               |       | 1,194 |   | 1,077 |   |
| Add dilutive  effects of warrants                                                                          |       | —                                                                |       | —                                              |       | — |   | 432 |   |
| Weighted average  common shares outstanding, including the effects of dilutive securities                  |       | 63,484                                                                |       | 63,140                                              |       | 63,381 |   | 62,707 |   |
| Basic earnings  per share:                                                                                 |       |                                                                  |       |                                                |       |   |   |   |   |
| From continuing operations                                                                                 |       | $1.24                                                                 |       | .05                                                 |       | 2.17 |   | 1.54 |   |
| From discontinued operations                                                                               |       | —                                                                |       | —                                              |       | .04 |   | — |   |
| Basic earnings per share                                                                                   |       | $1.24                                                                 |       | .05                                                 |       | 2.21 |   | 1.54 |   |
| Diluted earnings  per share:                                                                               |       |                                                                  |       |                                                |       |   |   |   |   |
| From continuing operations                                                                                 |       | $1.21                                                                 |       | .05                                                 |       | 2.13 |   | 1.50 |   |
| From discontinued operations                                                                               |       | —                                                                |       | —                                              |       | .04 |   | — |   |
| Diluted earnings  per share                                                                                |       | $1.21                                                                 |       | .05                                                 |       | 2.17 |   | 1.50 |   |

 

***ComprehensiveEarnings (Loss)***

Comprehensiveearnings (loss) is a term used to refer to net earnings plus othercomprehensive income (loss). Other comprehensive income (loss) is comprised ofrevenues, expenses, gains, and losses that under generally accepted accountingprinciples are reported as separate components of shareholders’ equity insteadof net earnings. Items included in Forest’s other comprehensive income (loss)for the three and nine months ended September 30, 2006 and 2005 areforeign currency gains related to the translation of the assets and liabilitiesof Forest’s Canadian operations, changes in the unfunded pension liability, andnet hedging losses.

The components of comprehensiveearnings (loss) are as follows:

| ** **                                                    | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                    | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                    | ** ** | **(In Thousands)**                              | ** ** |
| Net earnings                                                  |       | $76,934                                              |       | 3,265                                               |       | 137,653 |   | 94,337 |   |
| Other  comprehensive income (loss):                           |       |                                                 |       |                                                |       |   |   |   |   |
| Foreign currency translation gains                            |       | 294                                                  |       | 18,257                                              |       | 13,552 |   | 11,367 |   |
| Unfunded pension liability, net of tax                        |       | —                                               |       | —                                              |       | 83 |   | (149 | ) |
| Unrealized gain (loss) on derivative instruments,  net of tax |       | 1,381                                                |       | (56,454                                             | )          | 79,485 |   | (104,713 | ) |
| Total comprehensive  earnings (loss)                          |       | $78,609                                              |       | (34,932                                             | )          | 230,773 |   | 842 |   |

 

7

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**(4)**                               STOCK-BASEDCOMPENSATION

Prior to January 1, 2006, the Company accountedfor stock-based compensation using the intrinsic value method prescribed inAccounting Principles Board (“APB”) Opinion No. 25, *Accountingfor Stock Issued to Employees*, and related interpretations. UnderAPB Opinion No. 25, no compensation expense was recognized for stockoptions issued to employees if the grant price equaled or was above the marketprice on the date of the option grant. Effective January 1, 2006, theCompany adopted the provisions of Statement of Financial Accounting Standards (“SFAS”)No. 123 (Revised), *Share-Based Payment*(“SFAS 123(R)”) using the modified prospective method. Under this method, compensation cost is recorded for all unvestedstock options, restricted stock, and phantom stock units beginning in theperiod of adoption and prior period financial statements are not restated. Underthe fair value recognition provisions of SFAS 123(R), stock-based compensation ismeasured at the grant date based on the value of the awards and the value isrecognized on a straight-line basis over the requisite service period (usuallythe vesting period).

The table below sets forthtotal stock-based compensation recorded during the three and nine months ended September 30,2006 under the provisions of SFAS 123(R), the remaining unamortized amounts andthe weighted average amortization period remaining as of September 30,2006. Approximately $9.7 million of the $18.7 million of total stock-basedcompensation for the nine months ended September 30, 2006 was attributableto a partial settlement of the Company’s restricted stock awards and phantomstock unit awards in connection with the Spin-off.

| ** **                                                           | ** ** | **Stock  Options**      | ** ** | **Restricted  Stock** | ** ** | **Phantom  Stock Units** | ** ** | **Total **(1) | ** ** |
|----------------------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|-------------------------------|------------|--------------------|------------|
| ** **                                                           | ** ** | **(In Thousands)** | ** ** |
| **Three months ended September  30, 2006:**                          | ** ** | ** **              | ** ** | ** **            | ** ** |                          | ** ** | ** **         |       | ** ** | ** ** |
| Total stock-based compensation costs                                 |       | $                       | 961        |                  | 1,305      |                          |       | 162                |       |   | 2,428 |   |
| Less: stock-based compensation costs capitalized                     |       | (425                    | )          | (398                  | )          |                          | (96        | )                  |       | (919 | ) |
| Stock-based compensation costs expensed                              |       | $                       | 536        |                  | 907        |                          |       | 66                 |       |   | 1,509 |   |
| **Nine  months ended September 30, 2006:**                           | ** ** | ** **              | ** ** | ** **            | ** ** |                          | ** ** | ** **         |       | ** ** | ** ** |
| Total stock-based compensation costs                                 |       | $                       | 3,983      |                  | 12,827     |                          |       | 1,682              |       |   | 18,492 |   |
| Less: stock-based  compensation costs capitalized                    |       | (1,135                  | )          | (4,684                | )          |                          | (944       | )                  |       | (6,763 | ) |
| Stock-based compensation  costs expensed                             |       | $                       | 2,848      |                  | 8,143      |                          |       | 738                |       |   | 11,729 |   |
| Unamortized stock-based  compensation costs as of September 30, 2006 |       | $                       | 7,021      |                  | 13,680     |                          |       | 2,456              | (2)        |   | 23,157 |   |
| Weighted average  amortization period remaining                      |       | 1.1 years               |       | 2.1 years             |       |                          | 2.3 years  |               |       | 1.8 years |   |

 

----

(1)        TheCompany also maintains an employee stock purchase plan (which is not includedin the table above) under which $.1 million and $.2 million ofcompensation cost was recognized for the three and nine months ended September 30,2006, respectively under the provisions of SFAS 123(R).

(2)        Based on the closing price of the Company’s commonstock on September 30, 2006.

SFAS 123(R) requiredthe Company to estimate forfeitures in calculating the cost related to stock-basedcompensation as opposed to recognizing forfeitures and the correspondingreduction in expense as the forfeitures occur. The cumulative adjustmentrecorded related to this change of approximately $.1 million was recorded as areduction in general and administrative expense and capitalized oil and gasproperties in the first quarter of 2006 and was not presented separately in theCondensed Consolidated Statement of Operations. The impact of adopting SFAS 123(R) asof January 1, 2006 resulted in a decrease to net income of approximately$1.9 million, or $.03 per basic and diluted share for the nine month periodending September 30, 2006.

8

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**(4)          STOCK-BASED COMPENSATION(Continued)**

***Equity IncentivePlans***

In 2001, the Companyadopted the Forest Oil Corporation 2001 Stock Incentive Plan (the “2001 Plan”)under which non-qualified stock options, incentive stock options, restrictedstock, phantom stock units, and other awards may be granted to employees,consultants, and non-employee directors. In 2003, the Company amended the 2001Plan to increase the number of shares of the Company’s common stock, at parvalue $.10 per share (“Common Stock”), reserved for issuance. The aggregatenumber of shares of Common Stock that the Company may issue under the 2001 Planmay not exceed 5,012,074 shares. Options have historically been granted atan exercise price equal to the fair market value of one share of Common Stockon the date of grant. Options granted to employees under the 2001 Plangenerally vest in increments of 25% on each of the first four anniversary datesof the date of grant and have a term of ten years. Options granted tonon-employee directors vest immediately and have a term of ten years. Inconnection with the Spin-off, the shares available for grant and outstandingstock options under the 2001 Plan wereadjusted to reflect the economic effect of the Spin-off by reducing theexercise price and increasing the number of underlying shares. As of September 30,2006, the Company had 649,728 shares available for issuance under the 2001Plan.

The Company also had aStock Incentive Plan (the “1996 Plan”) that expired on March 5, 2002 underwhich non-qualified stock options and restricted stock were granted toemployees and director stock awards were granted to non-employee directors.Options granted under the 1996 Plan generally vested in increments of 20%commencing on the date of grant and on each of the first four anniversaries ofthe date of the grant and generally had a term of ten years.

The Company hashistorically issued new shares of Common Stock or treasury stock to settle itsequity-based awards. In May 2006, Forest retired the Company’s treasurystock. As a result of the retirement, settlements on equity-based awardssubsequent to May 2006 will be from issuances of new shares of CommonStock.

9

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**(4)          STOCK-BASED COMPENSATION (Continued)**

***Stock Options***

The following tablesummarizes stock option activity in the Company’s stock-basedcompensation plans for the nine months ended September 30, 2006. Thenumber of shares and the exercise price of the outstanding stock options wereadjusted so that the fair value of each award was the same immediately beforeand after the Spin-off, in accordance with the anti-dilution provisions in the2001 Plan and 1996 Plan.

| ** **                              | ** ** | **Number of  Options** | ** ** | **Weighted  Average  Exercise Price  Per Share** | ** ** | **Aggregate   Intrinsic Value**(In Thousands)(1) | ** ** | **Number of  Shares  Exercisable** | ** ** |
|-----------------------------------------|------------|-----------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|-----------------------------------------|------------|
| Outstanding at  January 1, 2006    |       | 2,578,235                   |       |                                                       | $          | 27.78                                                           |       |                                    |       | $ | 45,889 |   |   | 1,348,599 |   |
| Granted                                 |       | —                      |       |                                                       | —     |                                                            |       |                                    |       |   |   |   |   |
| Exercised                               |       | (58,337                     | )          |                                                       | 28.71      |                                                            |       |                                    | 1,255      |   |   |   |   |
| Cancelled                               |       | (98,587                     | )          |                                                       | 30.91      |                                                            |       |                                    |       |   |   |   |   |
| Outstanding at  March 2, 2006      |       | 2,421,311                   |       |                                                       | 27.63      |                                                            |       |                                    | 55,723     |   |   |   |   |
| Adjustment to give  effect to Spin-off  |       | 1,176,804                   |       |                                                       | —     |                                                            |       |                                    |       |   |   |   |   |
| Granted                                 |       | 50,000                      |       |                                                       | 36.95      |                                                            |       |                                    |       |   |   |   |   |
| Exercised                               |       | (160,837                    | )          |                                                       | 18.75      |                                                            |       |                                    | 2,536      |   |   |   |   |
| Cancelled                               |       | (74,979                     | )          |                                                       | 20.87      |                                                            |       |                                    |       |   |   |   |   |
| Outstanding at  September 30, 2006 |       | 3,412,299                   |       |                                                       | 18.80      |                                                            |       |                                    | 43,771     |   |   | 2,205,889 |   |

 

----

(1)        Theintrinsic value of a stock option is the amount by which the current marketvalue of the underlying stock exceeds the exercise price of the option.

Stock options are grantedat the fair market value of one share of Common Stock on the date of grant.Options granted to non-employee directors vest immediately and options grantedto officers and other employees vest ratably over four years. All outstandingoptions had a term of ten years at the date of grant.

Thefair value of stock options granted during 2006 was estimated using the Black-Scholesoption pricing model. The following weighted average assumptions were used tocompute the fair market value of stock options granted in the nine months endedSeptember 30, 2006 and 2005:

| ** **                                                               | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                               | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| Expected life of  options                                                |       |                                                | 10 years   |   |   | 5  years |   |
| Risk free  interest rates                                                |       |                                                | 5.13%      |   |   | 3.64%  to 4.28% |   |
| Estimated  volatility                                                    |       |                                                | 45%        |   |   | 31%  to 35% |   |
| Dividend yield                                                           |       |                                                | 0.0%       |   |   | 0.0% |   |
| Weighted average fair  market value of options granted during the period |       |                                                | $23.60     |   |   | $9.34 |   |

 

The expected life of theoptions is based, in part, on historical exercise patterns of the holders ofoptions with similar terms, with consideration given to how historical patternsmay differ from future exercise patterns based on current or expected marketconditions and employee turnover. The risk free interest rate was based on theU.S. Treasury yield curve in effect at the time of grant. The expectedvolatility was based on the historical volatility of the Company’s stock.

10

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**(4)**                               STOCK-BASEDCOMPENSATION (Continued)

The following tablesummarizes information about options outstanding at September 30, 2006:

| ** **                              | ** ** | **Stock Options Outstanding** | ** ** | **Stock Options Exercisable**                          | ** ** |
|-----------------------------------------|------------|-----------------------------------------|------------|------------------------------------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Number**

**of Options**         | ** ** | **Weighted  Average  Remaining  Contractual  Life (Years)** | ** ** | **Weighted**

**Average**

**Exercise**

**Price** | ** ** | **Aggregate**

**Intrinsic**

**Value**

**(In**

**Thousands)** | ** ** | **Number**

**Exercisable** | ** ** | **Weighted**

**Average**

**Exercise**

**Price** | ** ** | **Aggregate**

**Intrinsic**

**Value(In**

**Thousands)** | ** ** |
| $8.41 – 16.55                      |       | 685,952                                 |       |                                                             | 5.95       |   |   |   | $ | 14.82 |   |   |   | $ | 11,547 |   |   | 536,330 |   |   | $ | 14.66 |   |   |   | $ | 9,056 |   |   |
| 16.74 – 16.85                      |       | 815,318                                 |       |                                                             | 6.83       |   |   |   | 16.84 |   |   |   | 12,072 |   |   | 524,833 |   |   | 16.83 |   |   |   | 7,726 |   |   |
| 16.88 – 20.02                      |       | 709,335                                 |       |                                                             | 4.92       |   |   |   | 18.91 |   |   |   | 9,022 |   |   | 671,450 |   |   | 18.98 |   |   |   | 8,444 |   |   |
| 20.19 – 20.47                      |       | 28,606                                  |       |                                                             | 7.52       |   |   |   | 20.32 |   |   |   | 323 |   |   | 12,261 |   |   | 20.35 |   |   |   | 137 |   |   |
| 20.60 – 36.95                      |       | 1,173,088                               |       |                                                             | 7.96       |   |   |   | 22.40 |   |   |   | 10,807 |   |   | 461,015 |   |   | 23.60 |   |   |   | 3,666 |   |   |
| $8.41 – 36.95                      |       | 3,412,299                               |       |                                                             | 6.65       |   |   |   | 18.80 |   |   |   | $ | 43,771 |   |   | 2,205,889 |   |   | 18.39 |   |   |   | $ | 29,029 |   |   |

 

***Restricted Stock and Phantom Stock Units***

Thefollowing table summarizes the restricted stock and phantom stock unit activityduring the nine months ended September 30, 2006. The grant date fair valueof the restricted stock and phantom stock units was determined by reference tothe average of the high and low stock price of a share of Common Stock aspublished by the NYSE on the date of grant.

 
|                                      | ** ** | **Restricted Stock**  | ** ** | **Phantom Stock Units**                          | ** ** |
|--------------------------------------|------------|----------------------------|------------|------------------------------------------------------------|------------|
| ** **                           | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Grant Date  Fair Value**(1) | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Grant Date  Fair Value**(1) | ** ** |
| Unvested at  January 1, 2006    |       |                       | 634,000    |                                                       |       |   | $ | 43.72 |   |   |   | 72,350 |   |   |   | $ | 46.07 |   |   |
| Granted                              |       |                       | 32,500     |                                                       |       |   | 40.45 |   |   |   | 13,700 |   |   |   | 46.72 |   |   |
| Vested                               |       |                       | (200       | )                                                          |       |   | 46.07 |   |   |   | — |   |   |   | — |   |   |
| Forfeited                            |       |                       | (31,950    | )                                                          |       |   | 46.03 |   |   |   | (8,300 | ) |   |   | 46.07 |   |   |
| Unvested at  September 30, 2006 |       |                       | 634,350    |                                                       |       |   | 43.44 |   |   |   | 77,750 |   |   |   | 46.18 |   |   |

----

(1)                 Theseper-share fair values represent the actual grant date fair value and have notbeen adjusted to give effect to the Spin-off. In connection with the Spin-off,holders of restricted stock awards received .8093 unrestricted shares of MERIfor each share of restricted stock. Accordingly, compensation cost ofapproximately $8.4 million was recorded in the first quarter of 2006 as apartial settlement of the restricted stock award, or approximately $13.00 pershare. In addition, cash bonuses totaling $1.2 million were paid to Canadianemployees in the first quarter of 2006 who held phantom stock units on thatdate representing the per-share value of the MERI shares received by eachholder of restricted stock.

During the year ended 2005, Forest granted 72,350phantom stock units valued at $3.3 million as compensation exclusively toCanadian employees. The phantom stock units can be settled in cash, shares ofCommon Stock, or a combination of both. The phantom stock units have beenaccounted for as a liability within the Condensed Consolidated FinancialStatements. As of September 30, 2006, the Company’s fair value liabilityfor the phantom stock units totaled $2.5 million.

The restricted stock andphantom stock units generally vest on the third anniversary of the date of theaward, but may vest earlier upon a qualifying disability, death, retirement, ora change in control of the Company in accordance with the term of theunderlying agreement.

11

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**(4)          STOCK-BASED COMPENSATION (Continued)**

***Employee StockPurchase Plan***

The Company has a 1999Employee Stock Purchase Plan (the “ESPP”), under which it is authorized toissue up to 300,000 shares of Common Stock. Employees who are regularlyscheduled to work more than 20 hours per week and more than five months inany calendar year may participate in the ESPP. Under the terms of the ESPP,employees may elect each quarter to have up to 15% of their annual baseearnings withheld to purchase shares of Common Stock, up to a limit of $25,000of Common Stock per calendar year. The ESPP currently provides for fouroffering periods during the year which coincide with the calendar quarters. Thepurchase price of a share of Common Stock purchased under the ESPP is equal to85% of the lower of the beginning-of-quarter or end-of-quarter market price.ESPP participants are restricted from selling the shares of Common Stockpurchased under the ESPP for a period of six months after purchase. As of September 30,2006, the Company had 168,816 shares available for issuance under the ESPP.

***Pro Forma Effects***

HadForest recognized compensation expense for all stock-based awards based uponthe estimated fair value on the grant date under the fair value methodologyprescribed by SFAS 123, as amended by SFAS 148 and SFAS 123(R), its pro formanet earnings and earnings per common sharefor the three and nine month periods ended September 30, 2005 would havebeen as follows:

| ** **                                                                                                           | ** ** | **Three Months Ended  September 30, 2005**        | ** ** | **Nine Months Ended  September 30, 2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                                                           | ** ** | **(In Thousands, Except Per Share Amounts)** | ** ** |
| Net earnings, as  reported                                                                                           |       |                                                                  | $          | 3,265                                                         |       |   |   | 94,337 |   |   |
| Add: Stock-based  compensation included in reported net income, net of tax                                           |       |                                                                  | 78         |                                                          |       |   | 252 |   |   |
| Deduct: Total stock-based  compensation expense determined under fair value based method for all awards,  net of tax |       |                                                                  | (637       | )                                                             |       |   | (2,095 | ) |   |
| Pro forma net earnings                                                                                               |       |                                                                  | $          | 2,706                                                         |       |   |   | 92,494 |   |   |
| Basic earnings per  common share:                                                                                    |       |                                                                  |       |                                                          |       |   |   |   |   |
| As reported                                                                                                          |       |                                                                  | $          | .05                                                           |       |   |   | 1.54 |   |   |
| Pro forma                                                                                                            |       |                                                                  | $          | .04                                                           |       |   |   | 1.51 |   |   |
| Diluted earnings per  common share:                                                                                  |       |                                                                  |       |                                                          |       |   |   |   |   |
| As reported                                                                                                          |       |                                                                  | $          | .05                                                           |       |   |   | 1.50 |   |   |
| Pro forma                                                                                                            |       |                                                                  | $          | .04                                                           |       |   |   | 1.48 |   |   |

 

**(5)**                               LONG-TERMDEBT

Components oflong-term debt are as follows:

| ** **                       | ** ** | **September 30, 2006** | ** ** | **December 31, 2005**    | ** ** |
|----------------------------------|------------|----------------------------------|------------|------------------------------------|------------|
| ** **                       | ** ** | **Principal**                    | ** ** | **UnamortizedPremium  (Discount)** | ** ** | **Other**(1) | ** ** | **Total** | ** ** | **Principal** | ** ** | **UnamortizedPremium  (Discount)** | ** ** | **Other**(1) | ** ** | **Total** | ** ** |
| ** **                       | ** ** | **(In Thousands)**          | ** ** |
| U.S. Credit  Facility            |       | $                                | 280,000    |                               |       | — |   |   |   | — |   |   | 280,000 |   |   | 97,000 |   |   |   | — |   |   |   | — |   |   | 97,000 |   |
| Canadian Credit  Facility        |       | 89,470                           |       |                               | —     |   |   |   | — |   |   | 89,470 |   |   | 56,806 |   |   |   | — |   |   |   | — |   |   | 56,806 |   |
| 8% Senior Notes  Due 2008        |       | 265,000                          |       |                               | (171       | ) |   |   | 3,932 |   |   | 268,761 |   |   | 265,000 |   |   |   | (244 | ) |   |   | 5,652 |   |   | 270,408 |   |
| 8% Senior Notes  Due 2011        |       | 285,000                          |       |                               | 6,781      |   |   |   | 4,365 |   |   | 296,146 |   |   | 285,000 |   |   |   | 7,750 |   |   |   | 4,992 |   |   | 297,742 |   |
| 73¤4% Senior Notes Due 2014 |       | 150,000                          |       |                               | (1,810     | ) |   |   | 13,509 |   |   | 161,699 |   |   | 150,000 |   |   |   | (1,990 | ) |   |   | 14,841 |   |   | 162,851 |   |
|                             |       | $                                | 1,069,470  |                               |       | 4,800 |   |   |   | 21,806 |   |   | 1,096,076 |   |   | 853,806 |   |   |   | 5,516 |   |   |   | 25,485 |   |   | 884,807 |   |

----

(1)                 Representsthe unamortized portion of gains realized upon termination of interest rateswaps that were accounted for as fair value hedges. The gains are beingamortized as a reduction of interest expense over the terms of the notes.

12

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**(6)**                               PROPERTYAND EQUIPMENT

Forest uses the full cost method of accounting for oiland gas properties. Separate cost centers are maintained for each country inwhich Forest has operations. During the periods presented, Forest’s primary oiland gas operations were conducted in the United States and Canada. All costsincurred in the acquisition, exploration, and development of properties(including costs of surrendered and abandoned leaseholds, delay lease rentals,dry holes, and overhead related to exploration and development activities) andthe fair value of estimated future costs of site restoration, dismantlement,and abandonment activities are capitalized.

Investments in unproved properties, including relatedcapitalized interest costs, are not depleted pending determination of theexistence of proved reserves. Unproved properties are assessed periodically toascertain whether impairment has occurred. Unproved properties whose costs areindividually significant are assessed individually by considering the primarylease terms of the properties, the holding period of the properties, andgeographic and geologic data obtained relating to the properties. Where it isnot practicable to assess individually the amount of impairment of propertiesfor which costs are not individually significant, such properties are groupedfor purposes of assessing impairment. The amount of impairment assessed isadded to the costs to be amortized, or is reported as a period expense, asappropriate. During the second quarterof 2006, the Company recorded an impairment of $2.1 million related to Gabon. TheGabon impairment was related to historical costs impaired to reflect a drilleddry hole. In the first quarter of 2005, the Company recorded an impairment of$2.9 million related to various international properties, principally relatedto its properties in Romania.

Pursuant to full costaccounting rules, the Company must perform a ceiling test each quarter on itsproved oil and gas assets. The ceiling test provides that capitalized costsless related accumulated depletion and deferred income taxes for each costcenter may not exceed the sum of (1) the present value of future netrevenue from estimated production of proved oil and gas reserves using currentprices, including the effects of derivative instruments but excluding thefuture cash outflows associated with settling asset retirement obligations thathave been accrued on the balance sheet, at a discount factor of 10%; plus (2) thecost of properties not being amortized, if any; plus (3) the lower of costor estimated fair value of unproved properties included in the costs beingamortized, if any; less (4) income tax effects related to differences inthe book and tax basis of oil and gas properties. Gain or loss is notrecognized on the sale of oil and gas properties unless the sale significantlyalters the relationship between capitalized costs and estimated proved oil andgas reserves attributable to a cost center. Should the net capitalized costsfor a cost center exceed the sum of the components noted above, an impairmentcharge would be recognized to the extent of the excess capitalized costs. Therewere no ceiling test impairments of oil and gas properties in 2006 or 2005,although the Company’s Canadian full cost pool, in particular, could beadversely impacted by moderate declines in commodity prices.

At September 30,2006, the spot price that Forest used for its Canadian natural gas in computingits cost center ceiling was temporarily depressed to a level at which Forest’scapitalized costs in its Canadian cost center would have exceeded the costcenter ceiling, as described above, by approximately $66.9 million.Subsequent to September 30, 2006 and before the release of these quarterlyfinancial statements, the spot price of Canadian natural gas increased tolevels such that Forest’s Canadian cost center ceiling exceeded its capitalizedcosts. As such, no impairment adjustment to the Canadian cost center wasnecessary as of September 30, 2006.

Depletion of proved oiland gas properties is computed on the units-of-production method, wherebycapitalized costs, as adjusted for future development costs and assetretirement obligations, are amortized over the total estimated proved reserves.Furniture and fixtures, computer hardware and software, and 

13

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**(6)          PROPERTY AND EQUIPMENT(Continued)**

otherequipment are depreciated on the straight-line or declining balance method,based upon estimated useful lives of the assets ranging from three to12 years.

**(7)**                               ASSETRETIREMENT OBLIGATIONS

Forest records estimatedfuture asset retirement obligations pursuant to the provisions of Statement ofFinancial Accounting Standards No. 143, *Accountingfor Asset Retirement Obligations* (“SFAS No. 143”). SFAS No. 143requires entities to record the fair value of a liability for an assetretirement obligation in the period in which it is incurred with acorresponding increase in the carrying amount of the related long-lived asset. Subsequentto initial measurement, the asset retirement liability is required to beaccreted each period to its present value. Capitalized costs are depleted as acomponent of the full cost pool using the units-of-production method. Forest’sasset retirement obligations consist of costs related to the plugging of wells,the removal of facilities and equipment, and site restoration on oil and gasproperties.

The following tablesummarizes the activity for Forest’s asset retirement obligations for thenine months ended September 30, 2006 and 2005:

| ** **                                           | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| ** **                                           | ** ** | **(In Thousands)**                             | ** ** |
| Asset retirement  obligations at beginning of period |       | $                                                   | 211,554    |   | 210,176 |   |
| Accretion expense                                    |       | 5,879                                               |       | 12,951 |   |
| Liabilities  incurred                                |       | 1,231                                               |       | 4,181 |   |
| Liabilities  assumed                                 |       | 1,009                                               |       | 705 |   |
| Liabilities  included in the Spin-off                |       | (150,182                                            | )          | — |   |
| Liabilities  settled                                 |       | (6,647                                              | )          | (19,599 | ) |
| Revisions of estimated  liabilities                  |       | (2,585                                              | )          | 3,002 |   |
| Impact of foreign  currency exchange rate            |       | 489                                                 |       | 433 |   |
| Asset retirement  obligations at end of period       |       | 60,748                                              |       | 211,849 |   |
| Less: Current  asset retirement obligations          |       | (1,800                                              | )          | (34,733 | ) |
| Long-term asset  retirement obligations              |       | $                                                   | 58,948     |   | 177,116 |   |

 

**(8)**                               EMPLOYEEBENEFITS

Thefollowing table sets forth the components of the net periodic cost of Forest’sdefined benefit pension plans and postretirement benefits in the United Statesfor the three and nine months ended September 30, 2006 and 2005:

| ** **                     | ** ** | **Pension  Benefits**                            | ** ** | **Postretirement  Benefits**                     | ** ** | **Pension  Benefits**                           | ** ** | **Postretirement  Benefits**                    | ** ** |
|--------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                     | ** ** | **Three Months  Ended  September 30,** | ** ** | **Three Months  Ended  September 30,** | ** ** | **Nine Months  Ended  September 30,** | ** ** | **Nine Months  Ended  September 30,** | ** ** |
| ** **                     | ** ** | **2006**                                         | ** ** | **2005**                                         | ** ** | **2006**                                        | ** ** | **2005**                                        | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                     | ** ** | **(In Thousands)**                          | ** ** |
| Service cost                   |       | $                                                | —     |                                             | —     |                                            |       | 137                                             |       |   |   | 167 |   |   | — |   | — |   | 443 |   |   | 501 |   |   |
| Interest cost                  |       | 548                                              |       | 581                                              |       |                                            | 101        |                                            |       |   | 113 |   |   | 1,644 |   | 1,743 |   | 320 |   |   | 339 |   |   |
| Curtailment gain(1)            |       | —                                           |       | —                                           |       |                                            | —     |                                            |       |   | — |   |   | — |   | — |   | (1,851 | ) |   | — |   |   |
| Expected return on plan assets |       | (607                                             | )          | (586                                             | )          |                                            | —     |                                            |       |   | — |   |   | (1,823 | ) | (1,758 | ) | — |   |   | — |   |   |
| Recognized actuarial loss      |       | 227                                              |       | 188                                              |       |                                            | —     |                                            |       |   | — |   |   | 682 |   | 564 |   | — |   |   | — |   |   |
| Total net periodic  expense    |       | $                                                | 168        |                                             | 183        |                                            |       | 238                                             |       |   |   | 280 |   |   | 503 |   | 549 |   | (1,088 | ) |   | 840 |   |   |

----

(1)                 Forest recognizeda $1.9 million curtailment gain in connection with the Spin-off on March 2,2006. This gain was recorded as a reduction in general and administrativeexpense for the nine months ended September 30, 2006.

14

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**(9)**                               FINANCIALINSTRUMENTS

Forest periodically entersinto derivative instruments such as swap, basis swap, and collar agreements inorder to provide a measure of stability to Forest’s cash flows in anenvironment of volatile oil and gas prices and to manage the exposure tocommodity price risk. Forest’s commodity derivative instruments generally serveas effective economic hedges of commodity price exposure; however, variouscircumstances can cause commodity hedges to not qualify for cash flow hedgeaccounting either at the inception of the hedge or during the term of thehedge. When the criteria for cash flow hedge accounting are not met or whencash flow hedging is not elected, realized gains and losses (i.e., cashsettlements) are recorded in other income and expense in the CondensedConsolidated Statements of Operations. Similarly, changes in the fair value ofthe derivative instruments are recorded as unrealized gains or losses in theCondensed Consolidated Statements of Operations. In contrast, cash settlementsfor derivative instruments that qualify for hedge accounting are recorded asadditions to or reductions of oil and gas revenues while changes in fair valueof cash flow hedges are recognized, to the extent the hedge is effective, inother comprehensive income until the hedged item is recognized in earnings.

***Discontinuance ofHedge Accounting***

As a result of productiondeferrals experienced in the Gulf of Mexico related to hurricanes Katrina andRita, Forest was required to discontinue cash flow hedge accounting on some ofits natural gas and oil hedges during the third and fourth quarters of 2005. Additionally,as a result of the Spin-off on March 2, 2006, additional commodity swapsand collars formerly designated as cash flow hedges of offshore Gulf of Mexicoproduction also no longer qualified for hedge accounting.

Because a significantportion of the Company’s derivatives no longer qualified for hedge accountingand to increase clarity in its financial statements, the Company elected todiscontinue hedge accounting prospectively for all of its remaining commodityderivatives beginning in March 2006. This change in reporting has not impacted theCompany’s reported cash flows, although the results of operations have beenaffected by mark-to-market gains and losses, which fluctuate with volatile oiland gas prices. Subsequent to March 2006, the Company has recognized allmark-to-market gains and losses in earnings, rather than deferring such amountsin accumulated other comprehensive income included in shareholders’ equity.

The net mark-to-marketloss on the Company’s remaining swaps and collars that qualified for cash flowhedge accounting at the date the decision was made to discontinue hedgeaccounting were deferred in accumulated other comprehensive income and wereamortized into oil and gas revenues as the original forecasted hedged oil andgas production occurred in 2006. Amortization of the remaining $3.2 million ofnet deferred losses will be recorded in the fourth quarter of 2006.

15

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**(9)          FINANCIAL INSTRUMENTS(Continued)**

The table below summarizesthe realized and unrealized losses (gains) Forest incurred related to itsderivative instruments for the periods indicated.

| ** **                                                                      | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                      | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                      | ** ** | **(In Thousands)**                              | ** ** |
| Realized losses  on derivatives designated as cash flow hedges(1)               |       | $                                                    | 2,250      |                                                | 64,313     |   | 40,607 |   | 118,663 |   |
| Realized losses  (gains) on derivatives not designated as cash flow hedges(2)   |       | 12,883                                               |       | 38                                                  |       | 30,496 |   | (280 | ) |
| Ineffectiveness  recognized on derivatives designated as cash flow hedges(2)    |       | —                                               |       | 6,296                                               |       | (5,573 | ) | 5,504 |   |
| Unrealized  (gains) losses on derivatives not designated as cash flow hedges(2) |       | (77,914                                              | )          | 65,799                                              |       | (62,605 | ) | 68,861 |   |
| Total realized and  unrealized (gains) losses recorded                          |       | $                                                    | (62,781    | )                                                   | 136,446    |   | 2,925 |   | 192,748 |   |

----

(1)                 Includedin oil and gas sales in the Condensed Consolidated Statements of Operations.

(2)                 Includedin other income and expense in the Condensed Consolidated Statements ofOperations.

The tables below set forthForest’s outstanding commodity swaps and collars as of September 30, 2006:

| ** **           | ** ** | **Swaps**                                 | ** ** |
|----------------------|------------|-------------------------------------------|------------|
| ** **           | ** ** | **Natural Gas (NYMEX HH)** | ** ** | **Oil (NYMEX WTI)** | ** ** |
| ** **           | ** ** | **Bbtu  per Day**                    | ** ** | **Weighted Average  Hedged Price  per MMBtu** | ** ** | **Barrels  per Day** | ** ** | **Weighted Average  Hedged Price  per Bbl** | ** ** |
| Fourth Quarter  2006 |       |                                      | 10.0       |   |   |   | $ | 5.51 |   |   |   | 7,500 |   |   |   | $ | 51.18 |   |   |
| Fiscal 2007          |       |                                      | —     |   |   |   | — |   |   |   | 3,500 |   |   |   | 73.16 |   |   |
| Fiscal 2008          |       |                                      | —     |   |   |   | — |   |   |   | 3,000 |   |   |   | 73.02 |   |   |
| Fiscal 2009          |       |                                      | —     |   |   |   | — |   |   |   | 2,500 |   |   |   | 73.02 |   |   |
| Fiscal 2010          |       |                                      | —     |   |   |   | — |   |   |   | 2,000 |   |   |   | 73.15 |   |   |

 

| ** **           | ** ** | **Costless Collars**                 | ** ** |
|----------------------|------------|-------------------------------------------|------------|
| ** **           | ** ** | **Natural Gas (NYMEX HH)** | ** ** | **Oil (NYMEX WTI)** | ** ** |
| ** **           | ** ** | **Bbtu  per Day**                    | ** ** | **Weighted Average  Hedged Floor and  Ceiling Price  per MMBtu** | ** ** | **Barrels  per Day** | ** ** | **Weighted Average  Hedged Floor and  Ceiling Price per Bbl** | ** ** |
| Fourth Quarter  2006 |       |                                      | 50.0       |   |   |   | $ | 7.43/11.88 |   |   |   | 5,500 |   |   |   | $ | 46.73/65.87 |   |   |
| Fiscal 2007          |       |                                      | 35.0       |   |   |   | 8.76/11.70 |   |   |   | 4,000 |   |   |   | 65.81/87.18 |   |   |

 

The Company also uses basis swaps in connection with natural gas swaps inorder to fix the price differential between the NYMEX price and the index priceat which the natural gas production is sold. At September 30, 2006, therewas a basis swap in place covering 15.0 Bbtu per day in 2007.

16

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**(9)          FINANCIAL INSTRUMENTS (Continued)**

At September 30, 2006, the fair value of Forest’scommodity derivative contracts was a current liability of $14.8 million and aderivative asset of $56.9 million (of which $37.5 million was classified ascurrent). Forest is exposed to risks associated with swap and collar agreementsarising from movements in the prices of oil and natural gas and from theunlikely event of non-performance by the counterparties to the swap and collaragreements.

In October 2006,the Company entered into two additional swap agreements. The table below setsforth the weighted average terms of the agreements.

| ** **  | ** ** | **Swaps**                                 | ** ** |
|-------------|------------|-------------------------------------------|------------|
| ** **  | ** ** | **Natural Gas (NYMEX HH)** | ** ** |
| ** **  | ** ** | **Bbtu  per Day**                    | ** ** | **Weighted Average  Hedged Price  per MMBtu** | ** ** |
| Fiscal 2007 |       |                                      | 20.0       |   |   |   | $ | 8.10 |   |   |
|             |            |                                           |            |  |  |  |  |  |  |  |

 

In October 2006, theCompany entered into an additional basis swap agreement covering 10.0 Bbtu perday for 2007.

**(10)**                        BUSINESSAND GEOGRAPHICAL SEGMENTS

Segmentinformation has been prepared in accordance with Statement of FinancialAccounting Standards No. 131, *DisclosuresAbout Segments of an Enterprise and Related Information*. At September 30,2006, Forest conducts operations in one industry segment, that being the oiland gas exploration and production industry, and had three reportablegeographical business segments:  UnitedStates, Canada and International. Forest’s remaining activities are notsignificant and therefore are not reported as a separate segment, but areincluded as a reconciling item in the information below. The segments weredetermined based upon the type of operations in each business segment and thegeographical location of each. The segment data presented below was prepared onthe same basis as the Condensed Consolidated Financial Statements. Effective inthe first quarter of 2006, Forest ceased allocating general and administrativeexpenses to the business segments to correspond with its decision to monitorand evaluate general and administrative expenses at the corporate level. Effectivein the third quarter of 2006, Forest decreased the number of reportablesegments from five to three to correspond to the same number of cost centersunder the full cost accounting rules. Segment information previously reportedhas been modified to conform to the current presentation.

| ** **                                | ** ** | **Oil and Gas Operations**                          | ** ** |
|-------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                | ** ** | **Three Months Ended September 30, 2006** | ** ** | **Nine Months Ended September 30, 2006** | ** ** |
| ** **                                | ** ** | **U.S.**                                                           | ** ** | **Canada** | ** ** | **International** | ** ** | **Total  Company** | ** ** | **U.S.** | ** ** | **Canada** | ** ** | **International** | ** ** | **Total  Company** | ** ** |
| ** **                                | ** ** | **(In Thousands)**                                            | ** ** |
| Revenue                                   |       | $                                                                  | 157,452    |   |   | 43,468 |   |   |   | — |   |   |   | 200,920 |   |   | 498,187 |   |   | 132,052 |   |   |   | — |   |   |   | 630,239 |   |   |
| Expenses:                                 |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Lease operating expenses                  |       | 27,237                                                             |       |   | 7,726 |   |   |   | — |   |   |   | 34,963 |   |   | 94,420 |   |   | 21,403 |   |   |   | — |   |   |   | 115,823 |   |   |
| Production and property taxes             |       | 8,248                                                              |       |   | 726 |   |   |   | — |   |   |   | 8,974 |   |   | 28,520 |   |   | 2,179 |   |   |   | — |   |   |   | 30,699 |   |   |
| Transportation costs                      |       | 2,624                                                              |       |   | 2,870 |   |   |   | — |   |   |   | 5,494 |   |   | 8,908 |   |   | 6,957 |   |   |   | — |   |   |   | 15,865 |   |   |
| Depletion                                 |       | 43,884                                                             |       |   | 17,750 |   |   |   | — |   |   |   | 61,634 |   |   | 144,650 |   |   | 56,237 |   |   |   | — |   |   |   | 200,887 |   |   |
| Accretion of asset retirement obligations |       | 951                                                                |       |   | 263 |   |   |   | 12 |   |   |   | 1,226 |   |   | 5,069 |   |   | 776 |   |   |   | 34 |   |   |   | 5,879 |   |   |
| Impairments and other                     |       | —                                                             |       |   | — |   |   |   | — |   |   |   | — |   |   | — |   |   | — |   |   |   | 2,078 |   |   |   | 2,078 |   |   |
| Earnings (loss) from operations           |       | $                                                                  | 74,508     |   |   | 14,133 |   |   |   | (12 | ) |   |   | 88,629 |   |   | 216,620 |   |   | 44,500 |   |   |   | (2,112 | ) |   |   | 259,008 |   |   |
| Capital expenditures                      |       | $                                                                  | 143,194    |   |   | 43,471 |   |   |   | 774 |   |   |   | 187,439 |   |   | 676,032 |   |   | 118,286 |   |   |   | 6,337 |   |   |   | 800,655 |   |   |
| Goodwill                                  |       | $                                                                  | 71,377     |   |   | 15,503 |   |   |   | — |   |   |   | 86,880 |   |   | 71,377 |   |   | 15,503 |   |   |   | — |   |   |   | 86,880 |   |   |

 

17

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**(10)**     BUSINESS AND GEOGRAPHICALSEGMENTS (Continued)

A reconciliation ofsegment earnings (loss) from operations to consolidated earnings before incometaxes and discontinued operations is as follows:

| ** **                                                               | ** ** | **Three Months Ended  September 30, 2006** | ** ** | **Nine Months Ended  September 30, 2006** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                               | ** ** | **(In Thousands)**                                        | ** ** |
| Earnings from  operations for reportable segments                        |       |                                                           | $          | 88,629                                                        |       |   |   | 259,008 |   |   |
| Marketing,  processing, and other                                        |       |                                                           | 1,919      |                                                          |       |   | 5,899 |   |   |
| General and  administrative expense (including stock-based compensation) |       |                                                           | (10,548    | )                                                             |       |   | (38,755 | ) |   |
| Administrative  asset depreciation                                       |       |                                                           | (871       | )                                                             |       |   | (2,539 | ) |   |
| Spin-off and  merger costs                                               |       |                                                           | —     |                                                          |       |   | (5,416 | ) |   |
| Interest expense                                                         |       |                                                           | (19,122    | )                                                             |       |   | (51,613 | ) |   |
| Unrealized gains  on derivative instruments, net                         |       |                                                           | 77,914     |                                                          |       |   | 68,178 |   |   |
| Realized losses  on derivative instruments, net                          |       |                                                           | (12,883    | )                                                             |       |   | (30,496 | ) |   |
| Unrealized  foreign currency exchange loss                               |       |                                                           | (766       | )                                                             |       |   | (766 | ) |   |
| Other income, net                                                        |       |                                                           | 950        |                                                          |       |   | 200 |   |   |
| Earnings before income  taxes and discontinued operations                |       |                                                           | $          | 125,222                                                       |       |   |   | 203,700 |   |   |

 

 

** **

| ** **                                | ** ** | **Oil and Gas Operations**                          | ** ** |
|-------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                | ** ** | **Three Months Ended September 30, 2005** | ** ** | **Nine Months Ended September 30, 2005** | ** ** |
| ** **                                | ** ** | **U.S.**                                                           | ** ** | **Canada** | ** ** | **International** | ** ** | **Total  Company** | ** ** | **U.S.** | ** ** | **Canada** | ** ** | **International** | ** ** | **Total  Company** | ** ** |
| ** **                                | ** ** | **(In Thousands)**                                            | ** ** |
| Revenue                                   |       | $                                                                  | 218,192    |   |   | 47,958 |   |   |   | — |   |   |   | 266,150 |   |   | 677,215 |   |   | 117,160 |   |   |   | — |   |   |   | 794,375 |   |   |
| Expenses:                                 |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Lease operating expenses                  |       | 46,767                                                             |       |   | 4,809 |   |   |   | — |   |   |   | 51,576 |   |   | 130,687 |   |   | 14,532 |   |   |   | — |   |   |   | 145,219 |   |   |
| Production and property taxes             |       | 10,355                                                             |       |   | 559 |   |   |   | — |   |   |   | 10,914 |   |   | 29,354 |   |   | 2,004 |   |   |   | — |   |   |   | 31,358 |   |   |
| Transportation costs                      |       | 3,252                                                              |       |   | 1,345 |   |   |   | — |   |   |   | 4,597 |   |   | 9,883 |   |   | 4,469 |   |   |   | — |   |   |   | 14,352 |   |   |
| Depletion                                 |       | 73,648                                                             |       |   | 16,349 |   |   |   | — |   |   |   | 89,997 |   |   | 236,482 |   |   | 45,354 |   |   |   | — |   |   |   | 281,836 |   |   |
| Accretion of asset retirement obligations |       | 4,105                                                              |       |   | 236 |   |   |   | 11 |   |   |   | 4,352 |   |   | 12,255 |   |   | 675 |   |   |   | 21 |   |   |   | 12,951 |   |   |
| Impairments and other                     |       | 4,002                                                              |       |   | — |   |   |   | — |   |   |   | 4,002 |   |   | 4,002 |   |   | — |   |   |   | 2,924 |   |   |   | 6,926 |   |   |
| Earnings (loss) from operations           |       | $                                                                  | 76,063     |   |   | 24,660 |   |   |   | (11 | ) |   |   | 100,712 |   |   | 254,552 |   |   | 50,126 |   |   |   | (2,945 | ) |   |   | 301,733 |   |   |
| Capital expenditures                      |       | $                                                                  | 117,092    |   |   | 31,684 |   |   |   | 1,135 |   |   |   | 149,911 |   |   | 575,860 |   |   | 77,539 |   |   |   | 2,389 |   |   |   | 655,788 |   |   |
| Goodwill                                  |       | $                                                                  | 86,081     |   |   | 15,509 |   |   |   | — |   |   |   | 101,590 |   |   | 86,081 |   |   | 15,509 |   |   |   | — |   |   |   | 101,590 |   |   |

 

18

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**(10)**     BUSINESS AND GEOGRAPHICALSEGMENTS (Continued)

A reconciliation ofsegment earnings (loss) from operations to consolidated earnings before incometaxes and discontinued operations is as follows:

| ** **                                                               | ** ** | **Three Months Ended  September 30, 2005** | ** ** | **Nine Months Ended  September 30, 2005** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                               | ** ** | **(In Thousands)**                                        | ** ** |
| Earnings from  operations for reportable segments                        |       |                                                           | $          | 100,712                                                       |       |   |   | 301,733 |   |   |
| Marketing,  processing, and other                                        |       |                                                           | 2,086      |                                                          |       |   | 5,207 |   |   |
| General and  administrative expense (including stock-based compensation) |       |                                                           | (9,847     | )                                                             |       |   | (31,694 | ) |   |
| Administrative  asset depreciation                                       |       |                                                           | (1,032     | )                                                             |       |   | (2,718 | ) |   |
| Interest expense                                                         |       |                                                           | (15,664    | )                                                             |       |   | (46,224 | ) |   |
| Unrealized losses  on derivative instruments, net                        |       |                                                           | (72,095    | )                                                             |       |   | (74,365 | ) |   |
| Realized (losses)  gains on derivative instruments, net                  |       |                                                           | (38        | )                                                             |       |   | 280 |   |   |
| Other expense,  net                                                      |       |                                                           | (341       | )                                                             |       |   | (4,251 | ) |   |
| Earnings before income  taxes and discontinued operations                |       |                                                           | $          | 3,781                                                         |       |   |   | 147,968 |   |   |

 

**(11)**     RECENT ACCOUNTINGPRONOUNCEMENTS

Financial Accounting Standards Board (“FASB”)Interpretation No. 48  (“FIN 48”), *“Accountingfor Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109*”,was issued in July 2006 and will be effective for the Company on January 1,2007. FIN 48 defines the threshold for recognizing the benefits of uncertaintax return positions in the financial statements. The Company has not yetdetermined the impact this Interpretation will have on its financial position,results of operations or cash flows.

In September 2006,the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157,“*Fair Value Measurements*” (“SFAS No. 157”).This statement clarifies the definition of fair value, establishes a frameworkfor measuring fair value, and expands the disclosures on fair valuemeasurements. SFAS No. 157 is effective for fiscal years beginning after November 15,2007. We have not determined the effect, if any, the adoption of this statementwill have on our results of operations or financial position.

In September 2006,the FASB adopted SFAS No. 158, “*Employers’ Accounting forDefined Benefit Pension and Other Postretirement Plans, an amendment of FASBStatements No. 87, 106, and 132(R).*” SFAS No. 158requires companies to recognize a net liability or asset and an offsettingadjustment to accumulated other comprehensive income to report the fundedstatus of defined benefit pension and other postretirement benefit plans.SFAS No. 158 requires prospective application, and the recognitionand disclosure requirements are effective for the Company’s fiscal year ending December 31,2006. Additionally, SFAS No. 158 requires companies to measure planassets and obligations at their year-end balance sheet date. This requirementis effective for our fiscal year ending December 31, 2008. We have notdetermined the effect, if any, the adoption of this statement will have on ourresults of operations or financial position.

In September 2006, the Securities and ExchangeCommission issued Staff Accounting Bulletin No. 108, “*Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements*” (“SAB 108”).SAB 108 provides guidance on how prior year misstatements should be takeninto consideration when quantifying misstatements in current year financialstatements for purposes of determining whether the current year’s financialstatements are materially misstated. SAB 108 becomes effective during our2007 fiscal year. We do not expect the adoption of SAB 108 to have amaterial impact on our financial statements.

19

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**Item 2.**                        MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forest is an independent oil and gas company engagedin the acquisition, exploration, development, and production of natural gas andliquids in North America and selected international locations. Forest wasincorporated in New York in 1924, as the successor to a company formed in 1916,and has been a publicly held company since 1969.

The following discussionand analysis should be read in conjunction with Forest’s Condensed ConsolidatedFinancial Statements and Notes thereto, the information under the heading“Forward-Looking Statements” below, and the information included in Forest’s2005 Annual Report on Form 10-K under the heading “Risk Factors”,and “Management’s Discussion and Analysis of Financial Condition and Results ofOperations—Critical Accounting Policies, Estimates, Judgments, andAssumptions.”  Unless the contextotherwise indicates, references in this quarterly report on Form 10-Qto “Forest,”  “we,” “ours,” “us,” or liketerms refer to Forest Oil Corporation and its subsidiaries.

**2006 OVERVIEW**

***Spin-off of Offshore Gulf of Mexico Operations***

On March 2, 2006, Forest completed the spin-offof its offshore Gulf of Mexico operations by means of a stock dividend, whichconsisted of a pro rata spin-off (the “Spin-off”) of all outstanding shares ofForest Energy Resources, Inc. (hereinafter known as Mariner EnergyResources, Inc. or “MERI”), a total of 50,637,010 shares of common stock,to holders of record of Forest common stock as of the close of business onFebruary 21, 2006. Immediately following the Spin-off, MERI was mergedwith a subsidiary of Mariner Energy, Inc. (“Mariner”) in a stock for stocktransaction (the “Merger”). Mariner’s common stock commenced trading on the NewYork Stock Exchange on March 3, 2006.

The Spin-off was completedwithout the payment of consideration by Forest shareholders and consisted of aspecial dividend of .8093 shares of MERI for each outstanding share of Forestcommon stock. The Merger was accomplished by the exchange of all issued andoutstanding shares of MERI for shares of common stock of Mariner, with eachwhole share of MERI exchanged for one share of Mariner common stock. TheSpin-off was a tax-free transaction for federal income tax purposes. Prior tothe Merger, as part of the Spin-off, MERI paid Forest an initial cash amountequal to approximately $176.1 million. Subsequentto the closing, Forest received additional net cash proceeds of $21.7 millionfrom MERI for a total of $197.8 million. As of October 31, 2006, inaccordance with the transaction agreements, Forest and MERI had submittedpost-closing adjustments from which Forest has determined it owes MERIapproximately $5.8 million, which is subject to further adjustment.

***Cotton Valley Acquisition***

On March 31, 2006,Forest completed the acquisition of oil and gas properties located primarily inthe Cotton Valley trend in East Texas. Forest paid approximately $255 million,as adjusted to reflect an economic effective date of February 1, 2006, forproperties with an estimated 110 Bcfe of estimated proved reserves at the timethe acquisition was announced in February 2006 and production thataveraged 13 MMcfe per day in January 2006. Forest obtained approximately26,000 net acres in the fields, of which approximately 14,000 net acres wereundeveloped. This acquisition is expected to provide another core area ofgrowth and add significant onshore activity to the Southern business unit. Forestfunded this acquisition utilizing its bank credit facilities.

20

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***Katy Field***

Effective August 1,2006, Forest took over as operator of the Katy field. Gross field productionincreased 31% to 17 MMcfe per day during the third quarter of 2006 from 13MMcfe per day achieved through the first six months of the year. The field has33,000 gross acres and a six well shallow Frio drilling program is planned forthe fourth quarter along with two deeper Wilcox tests. The capital activity inthis field is expected to increase as 31 development locations have beenidentified. Forest is undertaking a field study including all 131 existingwellbores with a goal to propose a recompletion, workover and drilling programin 2007.

***Barnett Shale***

In July 2006, Forestentered into a joint exploration agreement with a third party which increasesits gross acreage position in the Barnett Shale to approximately 20,000 acres.The joint exploration agreement involved approximately 14,000 acres in HillCounty, Texas. Each party will participate with approximately 50% workinginterest in this joint area. The first horizontal well commenced drilling inthe third quarter of 2006.

***Production Increase***

Production from theRetained Properties (see definition below) increased 17% during the threemonths ended September 30, 2006 from the corresponding period in 2005 andincreased 14% during the nine months ended September 30, 2006 from thesame period in 2005. The production increase is discussed further in Results ofOperations, *Oil and Gas Production and Revenues*,below.

***Formation of New Subsidiary and Plans for RelatedFinancing***

As of October 31, 2006, Forest transferred themajority of the assets associated with its Alaska business unit to a newsubsidiary, Forest Alaska Operating LLC (“Alaska”). Alaska holds the oil and gasinterests of Forest in the Cook Inlet region of the State of Alaska and it willenter into a service agreement with Forest for the operation of those assets. Theactivities of Alaska are intended to focus on the exploitation of its assetsand participation in the proposed development program in the McArthur RiverField over the next several years.

The new subsidiary intendsto attempt to obtain $375 million of term loan financing to fund a $350 milliondistribution to Forest and provide initial working capital for Alaska’soperations. Forest indirectly owns 100% of the interests in the new subsidiary,and the term loans will be secured by the subsidiary’s assets and will benon-recourse to Forest.

**RESULTS OFOPERATIONS**

As a result of the Spin-off discussed above, therevenues and expenses associated with our offshore Gulf of Mexico operations areonly included in our consolidated results of operations through February 28,2006. As a result, the operational results for the three and nine month periodsof 2006 presented are not comparable to the corresponding periods in 2005.

Our reported earnings of $76.9 million for the thirdquarter of 2006, or $1.21 per diluted share, were $73.7 million higher than netearnings of $3.3 million, or $.05 per diluted share, for the same period in2005. Reported earnings for the nine months ended September 30, 2006 of$137.7 million, or $2.17 per diluted share, were $43.3 million higher than netearnings of $94.3 million, or $1.50 per diluted share, for the same period in2005. The three and nine month period increases in net earnings were primarilyattributable to changes in the mark-to-market value of our derivatives offsetby decreased oil and gas sales as a result of the Spin-off transactiondiscussed above.

21

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In the followingdiscussions, revenues and expenses directly attributable with the propertiesincluded in the Spin-off (the “Spin-off Properties”) and those retained (the “RetainedProperties”) are discussed separately.

***Oil and Gas Production and Revenues***

Productionvolumes, oil and gas sales revenue, and average sales prices for the threemonths ended September 30, 2006 and 2005 were as follows:

| ** **                           | ** ** | **Three Months Ended September 30,** | ** ** |
|--------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                                 | ** ** | **2005** | ** ** |
| ** **                           | ** ** | **Gas**                                                  | ** ** | **Oil** | ** ** | **NGLs** | ** ** | **Total** | ** ** | **Gas** | ** ** | **Oil** | ** ** | **NGLs** | ** ** | **Total** | ** ** |
| ** **                           | ** ** | **(MMcf)**                                               | ** ** | **(MBbls)** | ** ** | **(MBbls)** | ** ** | **(MMcfe)** | ** ** | **(MMcf)** | ** ** | **(MBbls)** | ** ** | **(MBbls)** | ** ** | **(MMcfe)** | ** ** |
| Production volumes:                  |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Retained  Properties:                |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| United States                        |       | 10,838                                                   |       |   | 1,264 |   |   |   | 431 |   | ** ** | **21,008** |   | 8,404 |   | 1,308 |   |   | 281 |   | ** ** | **17,938** | ** ** |
| Canada                               |       | 6,075                                                    |       |   | 185 |   |   |   | 100 |   | ** ** | **7,785** |   | 4,821 |   | 203 |   |   | 103 |   | ** ** | **6,657** | ** ** |
| Total Retained Properties            |       | 16,913                                                   |       |   | 1,449 |   |   |   | 531 |   | ** ** | **28,793** |   | 13,225 |   | 1,511 |   |   | 384 |   | ** ** | **24,595** | ** ** |
| Spin-off Properties                  |       | —                                                   |       |   | — |   |   |   | — |   | ** ** | **—** |   | 11,444 |   | 525 |   |   | 150 |   | ** ** | **15,494** | ** ** |
| Totals                               |       | 16,913                                                   |       |   | 1,449 |   |   |   | 531 |   | ** ** | **28,793** |   | 24,669 |   | 2,036 |   |   | 534 |   | ** ** | **40,089** | ** ** |
| Revenues (in  thousands):            |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Retained  Properties:                |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| United States                        |       | $                                                        | 59,721     |   |   | 85,067 |   |   |   | 14,914 |   | ** ** | **159,702** |   | 59,955 |   | 78,451 |   |   | 8,566 |   | ** ** | **146,972** | ** ** |
| United States hedging gains (losses) |       | 2,445                                                    |       |   | (4,695 | ) |   |   | — |   | ** ** | **(2,250** | **)** | (8,587 | ) | (12,583 | ) |   | — |   | ** ** | **(21,170** | **)** |
| Canada                               |       | 28,130                                                   |       |   | 10,785 |   |   |   | 4,553 |   | ** ** | **43,468** |   | 33,558 |   | 10,359 |   |   | 4,041 |   | ** ** | **47,958** | ** ** |
| Total Retained Properties            |       | 90,296                                                   |       |   | 91,157 |   |   |   | 19,467 |   | ** ** | **200,920** |   | 84,926 |   | 76,227 |   |   | 12,607 |   | ** ** | **173,760** | ** ** |
| Spin-off Properties                  |       | —                                                   |       |   | — |   |   |   | — |   |   | — |   | 99,411 |   | 31,136 |   |   | 4,986 |   | ** ** | **135,533** | ** ** |
| Spin-off Properties hedging losses   |       | —                                                   |       |   | — |   |   |   | — |   |   | — |   | (28,267 | ) | (14,876 | ) |   | — |   | ** ** | **(43,143** | **)** |
| Total Spin-off Properties            |       | —                                                   |       |   | — |   |   |   | — |   |   | — |   | 71,144 |   | 16,260 |   |   | 4,986 |   | ** ** | **92,390** | ** ** |
| Totals                               |       | $                                                        | 90,296     |   |   | 91,157 |   |   |   | 19,467 |   | ** ** | **200,920** |   | 156,070 |   | 92,487 |   |   | 17,593 |   | ** ** | **266,150** | ** ** |
| Average sales  price:                |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Retained  Properties:                |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| United States                        |       | $                                                        | 5.51       |   |   | 67.30 |   |   |   | 34.60 |   | ** ** | **7.60** |   | 7.13 |   | 59.98 |   |   | 30.48 |   | ** ** | **8.19** | ** ** |
| United States hedging gains (losses) |       | .23                                                      |       |   | (3.71 | ) |   |   | — |   | ** ** | **(.11** | **)** | (1.02 | ) | (9.62 | ) |   | — |   | ** ** | **(1.18** | **)** |
| Canada                               |       | 4.63                                                     |       |   | 58.30 |   |   |   | 45.53 |   | ** ** | **5.58** |   | 6.96 |   | 51.03 |   |   | 39.23 |   | ** ** | **7.20** | ** ** |
| Total Retained Properties            |       | 5.34                                                     |       |   | 62.91 |   |   |   | 36.66 |   | ** ** | **6.98** |   | 6.42 |   | 50.45 |   |   | 32.83 |   | ** ** | **7.06** | ** ** |
| Spin-off Properties                  |       | —                                                   |       |   | — |   |   |   | — |   |   | — |   | 8.69 |   | 59.31 |   |   | 33.24 |   | ** ** | **8.75** | ** ** |
| Spin-off Properties hedging losses   |       | —                                                   |       |   | — |   |   |   | — |   |   | — |   | (2.47 | ) | (28.34 | ) |   | — |   | ** ** | **(2.78** | **)** |
| Total Spin-off Properties            |       | —                                                   |       |   | — |   |   |   | — |   |   | — |   | 6.22 |   | 30.97 |   |   | 33.24 |   | ** ** | **5.97** | ** ** |
| Totals                               |       | $                                                        | 5.34       |   |   | 62.91 |   |   |   | 36.66 |   | ** ** | **6.98** |   | 6.33 |   | 45.43 |   |   | 32.95 |   | ** ** | **6.64** | ** ** |

 

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Productionvolumes, oil and gas sales revenue, and average sales prices for the ninemonths ended September 30, 2006 and 2005 were as follows:

| ** **                         | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| ** **                         | ** ** | **Gas**                                                 | ** ** | **Oil** | ** ** | **NGLs** | ** ** | **Total** | ** ** | **Gas** | ** ** | **Oil** | ** ** | **NGLs** | ** ** | **Total** | ** ** |
| ** **                         | ** ** | **(MMcf)**                                              | ** ** | **(MBbls)** | ** ** | **(MBbls)** | ** ** | **(MMcfe)** | ** ** | **(MMcf)** | ** ** | **(MBbls)** | ** ** | **(MBbls)** | ** ** | **(MMcfe)** | ** ** |
| Production volumes:                |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Retained  Properties:              |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| United States                      |       | 31,632                                                  |       | 3,786 |   |   | 1,116 |   | ** ** | **61,044** |   | 24,822 |   | 4,047 |   |   | 816 |   | ** ** | **54,000** | ** ** |
| Canada                             |       | 17,768                                                  |       | 557 |   |   | 304 |   | ** ** | **22,934** |   | 13,676 |   | 638 |   |   | 318 |   | ** ** | **19,412** | ** ** |
| Total Retained Properties          |       | 49,400                                                  |       | 4,343 |   |   | 1,420 |   | ** ** | **83,978** |   | 38,498 |   | 4,685 |   |   | 1,134 |   | ** ** | **73,412** | ** ** |
| Spin-off Properties                |       | 6,378                                                   |       | 193 |   |   | 82 |   | ** ** | **8,028** |   | 41,442 |   | 1,845 |   |   | 628 |   | ** ** | **56,280** | ** ** |
| Totals                             |       | 55,778                                                  |       | 4,536 |   |   | 1,502 |   | ** ** | **92,006** |   | 79,940 |   | 6,530 |   |   | 1,762 |   | ** ** | **129,692** | ** ** |
| Revenues (in  thousands):          |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Retained  Properties:              |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| United States                      |       | $                                                       | 188,996    |   | 244,707 |   |   | 36,482 |   | ** ** | **470,185** |   | 154,336 |   | 208,903 |   |   | 22,075 |   | ** ** | **385,314** | ** ** |
| United States hedging losses       |       | (2,549                                                  | )          | (15,738 | ) |   | — |   | ** ** | **(18,287** | **)** | (12,456 | ) | (22,365 | ) |   | — |   | ** ** | **(34,821** | **)** |
| Canada                             |       | 88,606                                                  |       | 29,561 |   |   | 13,885 |   | ** ** | **132,052** |   | 79,733 |   | 26,564 |   |   | 10,863 |   | ** ** | **117,160** | ** ** |
| Total Retained Properties          |       | 275,053                                                 |       | 258,530 |   |   | 50,367 |   | ** ** | **583,950** |   | 221,613 |   | 213,102 |   |   | 32,938 |   | ** ** | **467,653** | ** ** |
| Spin-off Properties                |       | 53,975                                                  |       | 11,614 |   |   | 3,020 |   | ** ** | **68,609** |   | 296,124 |   | 95,887 |   |   | 18,553 |   | ** ** | **410,564** | ** ** |
| Spin-off Properties hedging losses |       | (16,926                                                 | )          | (5,394 | ) |   | — |   | ** ** | **(22,320** | **)** | (47,026 | ) | (36,816 | ) |   | — |   | ** ** | **(83,842** | **)** |
| Total Spin-off  Properties         |       | 37,049                                                  |       | 6,220 |   |   | 3,020 |   | ** ** | **46,289** |   | 249,098 |   | 59,071 |   |   | 18,553 |   | ** ** | **326,722** | ** ** |
| Totals                             |       | $                                                       | 312,102    |   | 264,750 |   |   | 53,387 |   | ** ** | **630,239** |   | 470,711 |   | 272,173 |   |   | 51,491 |   | ** ** | **794,375** | ** ** |
| Average sales  price:              |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Retained  Properties:              |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| United States                      |       | $                                                       | 5.97       |   | 64.63 |   |   | 32.69 |   | ** ** | **7.70** |   | 6.22 |   | 51.62 |   |   | 27.05 |   | ** ** | **7.14** | ** ** |
| United States hedging losses       |       | (.08                                                    | )          | (4.16 | ) |   | — |   | ** ** | **(.30** | **)** | (.50 | ) | (5.53 | ) |   | — |   | ** ** | **(.64** | **)** |
| Canada                             |       | 4.99                                                    |       | 53.07 |   |   | 45.67 |   | ** ** | **5.76** |   | 5.83 |   | 41.64 |   |   | 34.16 |   | ** ** | **6.04** | ** ** |
| Total Retained Properties          |       | 5.57                                                    |       | 59.53 |   |   | 35.47 |   | ** ** | **6.95** |   | 5.76 |   | 45.49 |   |   | 29.05 |   | ** ** | **6.37** | ** ** |
| Spin-off Properties                |       | 8.46                                                    |       | 60.18 |   |   | 36.83 |   | ** ** | **8.55** |   | 7.15 |   | 51.97 |   |   | 29.54 |   | ** ** | **7.30** | ** ** |
| Spin-off Properties hedging losses |       | (2.65                                                   | )          | (27.95 | ) |   | — |   | ** ** | **(2.78** | **)** | (1.13 | ) | (19.95 | ) |   | — |   | ** ** | **(1.49** | **)** |
| Total Spin-off Properties          |       | 5.81                                                    |       | 32.23 |   |   | 36.83 |   | ** ** | **5.77** |   | 6.02 |   | 32.02 |   |   | 29.54 |   | ** ** | **5.81** | ** ** |
| Totals                             |       | $                                                       | 5.60       |   | 58.37 |   |   | 35.54 |   | ** ** | **6.85** |   | 5.89 |   | 41.68 |   |   | 29.22 |   | ** ** | **6.13** | ** ** |

 

Net oil and gas production from the RetainedProperties in the third quarter of 2006 was 28.8 Bcfe or an average of 313MMcfe per day, a 17% increase from 24.6 Bcfe or an average of 267 MMcfe per dayin the third quarter of 2005. Net oil and gas production from the RetainedProperties in the first nine months of 2006 was 84.0 Bcfe or an average of 308MMcfe per day, a 14% increase from 73.4 Bcfe or an average of 269 MMcfe per dayin the same period of 2005. The net increase in oil and gas production in eachperiod 

23

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was primarily attributableto increases at the Buffalo Wallow field and the recently acquired East Texasproperties in the United States and the Wild River field in Canada.

Oil and natural gas revenues from the RetainedProperties were $200.9 million during the three months ended September 30,2006, a 16% increase as compared to $173.8 million for the same period in theprior year. The increase in oil and natural gas revenues for the three monthperiod was due to a 17% increase in production offset by a 1% decrease in theaverage realized sales price per Mcfe from $7.06 in 2005 to $6.98 in 2006. Oiland natural gas revenues from the Retained Properties were $584.0 millionduring the nine months ended September 30, 2006, a 25% increase ascompared to $467.7 million for the same period in the prior year. The increasein oil and natural gas revenues for the nine month period was due to a 14%increase in production as well as a 9% increase in the average realized salesprice per Mcfe to $6.95 in 2006 from $6.37 in 2005.

No oil and gas production or revenue was recognized inthe third quarter of 2006 related to the Spin-off Properties as a result of thecompletion of the Spin-off transaction on March 2, 2006. Oil and gasproduction from the Spin-off Properties during the third quarter of 2005 was15.5 Bcfe or an average of 168.4 MMcfe per day. Net oil and gas production fromthe Spin-off Properties in the nine month period of 2006 was 8.0 Bcfe comparedto 56.3 Bcfe in the same period in 2005. The decrease in total production wasprimarily due the fact that the nine month period of 2006 only includes twomonths of offshore production from the Spin-off properties. During the quarterended September 30, 2005 oil and gas revenues from the Spin-off Propertiestotaled $92.4 million resulting in an average price per Mcfe of $5.97. Oil andnatural gas revenues from the Spin-off Properties totaled $46.3 million, or$5.77 per Mcfe, during the nine months ended September 30, 2006, ascompared to $326.7 million, or $5.81 per Mcfe, for the same period in the prioryear. The decrease in total oil and gas revenues was due to the fact that thenine month period of 2006 includes only two months of offshore production fromthe Spin-off properties.

The average realized salesprices for the periods presented include losses that we recognized on ourderivative instruments designated as cash flow hedges. For the three monthsended September 30, 2006, Forest recognized hedging losses of $2.3 millioncompared to hedging losses of $64.3 million during the same period in the prioryear. For the nine months ended September 30, 2006, Forest recognizedhedging losses of $40.6 million compared to hedging losses of $118.7 millionduring the same period in the prior year. Therecognized losses in the first nine months of 2006 include $15.2 millionin hedge losses settled in the fourth quarter of 2005 but recognized in thefirst quarter of 2006 to correspond with the timing of the production that wasdeferred by hurricanes Katrina and Rita. See *Realized and UnrealizedGains and Losses on Derivative Instruments* below forinformation on gains and losses recognized on derivative instruments notdesignated as cash flow hedges during the three and nine months ended September 30,2006 and 2005.

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***Oil and Gas Production Expense***

Thetables below set forth the detail of oil and gas production expense, for thethree and nine months ended September 30, 2006 and 2005:

| ** **                                   | ** ** | **Three Months Ended September 30,**          | ** ** |
|----------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                   | ** ** | **2006**                                                          | ** ** | **2005** | ** ** |
| ** **                                   | ** ** | **Retained  Properties**                                          | ** ** | **Spin-off  Properties** | ** ** | **Total** | ** ** | **Retained  Properties** | ** ** | **Spin-off  Properties** | ** ** | **Total** | ** ** |
| ** **                                   | ** ** | **(In Thousands, Except per Mcfe Data)** | ** ** |
| Lease operating expenses  (“LOE”): |       |                                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Direct operating expense  and overhead       |       |                                                              | $          | 31,382 |   |   |   | — |   | ** ** | **31,382** |   |   | 26,578 |   |   |   | 17,149 |   | ** ** | **43,727** | ** ** |
| Workover expense                             |       |                                                              | 3,581      |   |   |   | — |   | ** ** | **3,581** |   |   | 3,391 |   |   |   | 3,539 |   | ** ** | **6,930** | ** ** |
| Hurricane repairs                            |       |                                                              | —     |   |   |   | — |   | ** ** | **—** |   |   | — |   |   |   | 919 |   | ** ** | **919** | ** ** |
| Total LOE                                    |       |                                                              | $          | 34,963 |   |   |   | — |   | ** ** | **34,963** |   |   | 29,969 |   |   |   | 21,607 |   | ** ** | **51,576** | ** ** |
| LOE per Mcfe                                 |       |                                                              | $          | 1.21 |   | ** ** | ** ** | — |   |   | **1.21** |   |   | 1.22 |   | ** ** | ** ** | 1.39 |   | ** ** | **1.29** | ** ** |
| Production and property  taxes               |       |                                                              | $          | 8,974 |   |   |   | — |   | ** ** | **8,974** |   |   | 10,249 |   |   |   | 665 |   | ** ** | **10,914** | ** ** |
| Production and property  taxes per Mcfe      |       |                                                              | $          | .31 |   |   |   | — |   | ** ** | **.31** |   |   | .42 |   |   |   | .04 |   | ** ** | **.27** | ** ** |
| Transportation costs                         |       |                                                              | $          | 5,494 |   |   |   | — |   | ** ** | **5,494** |   |   | 3,974 |   |   |   | 623 |   | ** ** | **4,597** | ** ** |
| Transportation costs per Mcfe                |       |                                                              | $          | .19 |   |   |   | — |   | ** ** | **.19** |   |   | .16 |   |   |   | .04 |   | ** ** | **.11** | ** ** |

 

| ** **                                  | ** ** | **Nine Months Ended September 30,**           | ** ** |
|---------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                  | ** ** | **2006**                                                          | ** ** | **2005** | ** ** |
| ** **                                  | ** ** | **Retained  Properties**                                          | ** ** | **Spin-off  Properties** | ** ** | **Total** | ** ** | **Retained  Properties** | ** ** | **Spin-off  Properties** | ** ** | **Total** | ** ** |
| ** **                                  | ** ** | **(In Thousands, Except per Mcfe Data)** | ** ** |
| Lease operating expenses (“LOE”): |       |                                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Direct operating expense  and overhead      |       |                                                              | $          | 89,123 |   |   |   | 9,377 |   | ** ** | **98,500** |   |   | 76,481 |   |   |   | 46,336 |   | ** ** | **122,817** | ** ** |
| Workover expense                            |       |                                                              | 8,386      |   |   |   | 8,761 |   | ** ** | **17,147** |   |   | 11,307 |   |   |   | 10,119 |   | ** ** | **21,426** | ** ** |
| Hurricane repairs                           |       |                                                              | 18         |   |   |   | 158 |   | ** ** | **176** |   |   | — |   |   |   | 976 |   | ** ** | **976** | ** ** |
| Total LOE                                   |       |                                                              | $          | 97,527 |   |   |   | 18,296 |   | ** ** | **115,823** |   |   | 87,788 |   |   |   | 57,431 |   | ** ** | **145,219** | ** ** |
| LOE per Mcfe                                |       |                                                              | $          | 1.16 |   |   |   | 2.28 |   | ** ** | **1.26** |   |   | 1.20 |   |   |   | 1.02 |   | ** ** | **1.12** | ** ** |
| Production and property  taxes              |       |                                                              | $          | 30,548 |   |   |   | 151 |   | ** ** | **30,699** |   |   | 29,410 |   |   |   | 1,948 |   | ** ** | **31,358** | ** ** |
| Production and property  taxes per Mcfe     |       |                                                              | $          | .36 |   |   |   | .02 |   | ** ** | **.33** |   |   | .40 |   |   |   | .03 |   | ** ** | **.24** | ** ** |
| Transportation costs                        |       |                                                              | $          | 15,521 |   |   |   | 344 |   | ** ** | **15,865** |   |   | 11,868 |   |   |   | 2,484 |   | ** ** | **14,352** | ** ** |
| Transportation costs per Mcfe               |       |                                                              | $          | .18 |   |   |   | .04 |   | ** ** | **.17** |   |   | .16 |   |   |   | .04 |   | ** ** | **.11** | ** ** |

 

*Lease OperatingExpenses*

Lease operating expenses in the third quarter of 2006for the Retained Properties increased 17%, or $5.0 million, to $35.0 millionfrom $30.0 million in the third quarter of 2005. On a per-Mcfe basis, LOEdecreased 1% to $1.21 per Mcfe in the third quarter of 2006 from $1.22 per Mcfein the third quarter of 2005. Lease operating expenses in the first nine monthsof 2006 attributable to the Retained Properties increased 11%, or $9.7 million,to $97.5 million from $87.8 million during the same period in 2005. On aper-Mcfe basis, LOE decreased 3% to $1.16 per Mcfe in first nine months of 2006from $1.20 per Mcfe in the corresponding period in 2005.

Lease operating expenses for the Spin-off Propertiesduring the nine month period ended September 30, 2006 were $18.3 millioncompared to $57.4 million in 2005. On a per-Mcfe basis, LOE 

25

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increased$1.26 per Mcfe in 2006 to $2.28 per Mcfe from $1.02 per Mcfe in 2005. Theprimary reason for the $1.26 increase in LOE on a per-Mcfe basis for theSpin-off Properties was due to an increase in workover expenses.

*Production andProperty Taxes*

Production and propertytaxes on the Retained Properties decreased by 12% or $1.3 million during thethird quarter of 2006 as compared to the prior year’s third quarter. Thedecrease from the prior year is primarily attributed to severance taxincentives provided in Texas. Production and property taxes on the RetainedProperties increased by 4% or $1.1 million during the nine month period ending September 30,2006 as compared to the corresponding period in the prior year. The increaseduring the comparable nine month periods is a result of the higher realized oiland gas revenues and higher assessed property valuations offset by severancetax incentives provided in Texas.

Production and propertytaxes incurred on the Spin-off Properties were $.2 million during the firstnine months of 2006 as compared to $1.9 million during the same period of theprior year. Thedecrease in the Spin-off Properties’ production and property taxes was due tothe fact that the first nine months of 2006 includes only two months ofactivity.

*Transportation Costs*

Transportation costs for the Retained Propertiesincreased to $5.5 million or $.19 per Mcfe in the three months ended September 30,2006 from $4.0 million or $.16 per Mcfe for the corresponding 2005 period. Transportationcosts for the Retained Properties increased $3.7 million to $15.5 million inthe nine months ended September 30, 2006 from $11.9 million for thecorresponding 2005 period. Transportation costs for the Retained Properties ona per-Mcfe basis were $.18 per Mcfe and $.16 per Mcfe for the nine monthperiods ended September 30, 2006 and 2005, respectively. The increase intransportation costs in each period was primarily due to higher transportationand processing costs in Canada and Alaska.

Transportation costs for the Spin-off Properties on aper-Mcfe basis were $.04 per Mcfe for the quarter ended September 30, 2005.Transportation costs for the Spin-off Properties on a per-Mcfe basis were $.04per Mcfe for each of the nine month periods ended September 30, 2006 and2005.

***General and Administrative Expense***

The following table summarizes the components ofgeneral and administrative expense and stock-based compensation expenseincurred during the three and nine month periods ending September 30, 2006and 2005:

| ** **                                                               | ** ** | **Three Months Ended  September 30,**              | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                               | ** ** | **2006**                                                          | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                               | ** ** | **(In Thousands, Except per Mcfe Data)** | ** ** |
| Total general and administrative costs                                   |       | $                                                                 | 14,688     |                                                | 16,672     |   | 44,127 |   | 50,637 |   |
| General and administrative costs capitalized                             |       | (5,713                                                            | )          | (6,969                                              | )          | (17,297 | ) | (19,369 | ) |
| General and administrative expense                                       |       | $                                                                 | 8,975      |                                                | 9,703      |   | 26,830 |   | 31,268 |   |
| General and administrative expense per Mcfe                              |       | $                                                                 | .31        |                                                | .24        |   | .29 |   | .24 |   |
| Total stock-based compensation costs                                     |       | $                                                                 | 2,492      |                                                | 240        |   | 18,688 |   | 710 |   |
| Stock-based compensation costs capitalized                               |       | (919                                                              | )          | (96                                                 | )          | (6,763 | ) | (284 | ) |
| Stock-based compensation expense                                         |       | $                                                                 | 1,573      |                                                | 144        |   | 11,925 |   | 426 |   |
| Stock-based compensation  expense per Mcfe                               |       | $                                                                 | .05        |                                                | —     |   | .13 |   | — |   |
| Total general administrative expense including  stock-based compensation |       | $                                                                 | 10,548     |                                                | 9,847      |   | 38,755 |   | 31,694 |   |

 

 

26

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*General and Administrative Expenses*

The decrease in generaland administrative costs from 2005 to 2006 in both the three and nine monthperiods was primarily related to salary and benefit savings related toemployees that were terminated subsequent to the Spin-off. The decrease intotal general and administrative costs and general and administrative costsexpensed in the nine month period was also due to a $1.9 million reduction inour post-retiree medical benefit liability caused by a curtailment in the post-retireemedical benefit plan as a result of the Spin-off.

*Stock-Based Compensation Expense*

The significant increasein stock-based compensation in 2006 is due to the implementation of Statementof Financial Accounting Standards (“SFAS”) No. 123 (Revised), “*Share-Based Payment”* (“SFAS 123(R)”). Under this method ofaccounting, compensation cost is recordedfor all unvested stock options, restricted stock, and phantom stock unitsbeginning in the period of adoption and prior financial statements are not restated.Under the fair value recognition provisions of SFAS 123(R), stock-basedcompensation is measured at the grant date based on the value of the awards andis recognized over the requisite service period (usually the vesting period). Priorto January 1, 2006, we accounted for stock-based compensation using theintrinsic value method prescribed in Accounting Principles Board (“APB”)Opinion No. 25, “*Accounting for StockIssued to Employees*,” and related interpretations. Under APB OpinionNo. 25, no compensation expense was recognized for stock options issued toemployees because the grant price equaled or was above the market price on thedate of the option grant.

In accordance with theprovisions of SFAS 123(R), stock-based compensation cost in the amount of $2.5million was recorded in the three months ended September 30, 2006. Of thisamount, $1.6 million was recorded as compensation expense and $.9 million wascapitalized to oil and gas properties in accordance with the full cost methodof accounting. Stock-based compensation cost in the amount of $18.7 million wasrecorded in the nine months ended September 30, 2006 of whichapproximately $9.7 million is attributed to a partial settlement of Forest’srestricted stock awards and phantom stock unit awards in connection with theSpin-off. Of this amount, $11.9 million was recorded as compensation expenseand $6.8 million was capitalized to oil and gas properties in accordance withthe full cost method of accounting.

***Depreciation andDepletion***

Depreciation, depletionand amortization expense (“DD&A”) for the three months ended September 30,2006 was $62.5 million compared to $91.0 million for the same period in 2005. Onan equivalent Mcf basis, DD&A expense was $2.17 per Mcfe for the threemonths ended September 30, 2006 compared to $2.27 per Mcfe for the sameperiod in the prior year. DD&A for the nine months ended September 30,2006 was $203.4 million compared to $284.6 million for the same period in 2005.On an equivalent Mcf basis, DD&A expense was $2.21 per Mcfe for the ninemonths ended September 30, 2006 compared to $2.19 per Mcfe for the sameperiod in the prior year.

***Interest Expense***

Interest expense in thethird quarter of 2006 totaled $19.1 million compared to $15.7 million in thethird quarter of 2005. Interest expense during the first nine months of 2006totaled $51.6 million compared to $46.2 million in the same period of 2005. Theincrease in interest expense during each period in 2006 compared to thecorresponding periods in 2005 was due to a combination of higher interest ratesand increased average debt balances.

***Realized andUnrealized Gains and Losses on Derivative Instruments***

Realized and unrealizedgains and losses on derivative instruments are primarily related to derivativeswhich did not qualify for cash flow hedge accounting either at their inceptionor where hedge accounting 

27

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wasdiscontinued during their term. When the criteria for cash flow hedgeaccounting is not met or when cash flow hedge accounting is not elected,realized gains and losses (i.e., cash settlements) are recorded in other incomeand expense in the Condensed Consolidated Statements of Operations. Similarly,changes in the fair value of the derivative instruments are recorded asunrealized gains or losses in the Condensed Consolidated Statements ofOperations. In contrast, cash settlements for derivative instruments thatqualify for hedge accounting are recorded as additions to or reductions of oiland gas revenues, while changes in fair value of cash flow hedges are recognized,to the extent the hedge is effective, in other comprehensive income until thehedged item is recognized in earnings.

Thetable below sets forth realized and unrealized gains and losses recognizedunder “Other income and expense” in our Condensed Consolidated Statements ofOperations principally related to our derivatives where cash flow hedgeaccounting was not employed for the periods indicated.

| ** **                 | ** ** | **Three Months  Ended  September 30,** | ** ** | **Nine Months  Ended  September 30,** | ** ** |
|----------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                 | ** ** | **2006**                                         | ** ** | **2005**                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                 | ** ** | **(In Thousands)**                          | ** ** |
| Unrealized  (gains) losses |       | $                                                | (77,914    | )                                               | 72,095     |   | (68,178 | ) | 74,365 |   |
| Realized losses (gains)    |       | 12,883                                           |       | 38                                              |       | 30,496 |   | (280 | ) |
|                            |            |                                                  |            |                                                 |            |  |  |  |  |  |

 

Forcomparative purposes, the following table sets forth, for the periodsindicated, realized losses on derivative instruments that met the criteria forhedge accounting, which were recorded as reductions of oil and gas revenues.

| ** **                                       | ** ** | **Three Months  Ended  September 30,** | ** ** | **Nine Months  Ended  September 30,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                       | ** ** | **2006**                                         | ** ** | **2005**                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                       | ** ** | **(In Thousands)**                          | ** ** |
| Realized losses  included in oil and gas revenue |       | $                                                | 2,250      |                                            | 64,313     |   | 40,607 |   | 118,663 |   |
|                                                  |            |                                                  |            |                                                 |            |  |  |  |  |  |

 

***Discontinuance of Hedge Accounting***

Because a significantportion of our derivatives no longer qualified for hedge accounting and toincrease clarity in our financial statements, Forest elected to discontinuehedge accounting for all of its remaining commodity derivatives beginning in March 2006.Subsequent to March 2006, Forest has recognized mark-to-market gains andlosses in earnings, rather than deferring such amounts in accumulated othercomprehensive income included in shareholders’ equity. The net mark-to-marketlosses on our outstanding derivatives at the time Forest discontinued hedgeaccounting are deferred in accumulated other comprehensive income, and areamortized to earnings as the original hedged transactions occur in 2006. Thischange in reporting has had no impact on Forest’s reported cash flows, althoughresults of operations have been affected by mark-to-market gains and losses,which fluctuate with volatile oil and gas prices.

***Current andDeferred Income Tax Expense***

Forest recorded income taxexpense of $48.3 million in the three months ended September 30, 2006,compared to $.5 million in the comparable period of 2005.  The increase in tax expense was primarily dueto an increase in net income before tax.

Forest recorded income taxexpense of $68.5 million in the nine months ended September 30, 2006compared to $53.6 million in the comparable period of 2005. The increase in taxexpense was primarily due to an increase in net income before tax. However, taxexpense recorded for the nine month period ended September 30, 2006 alsoreflects a net decrease of approximately $10.0 million related to statutoryrate reductions enacted in Canada and changes in the Texas income tax law, netof tax increases due to the 

28

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effectsof the Spin-off (which include tax effects of non-deductible spin-off costs andan increase in Forest’s combined state income tax rates following theSpin-off).

***DiscontinuedOperations***

On March 1, 2004,Forest sold the assets and business operations of ProducersMarketing, Ltd. (“ProMark”) to Cinergy Canada, Inc. (“Cinergy”) for$11.2 million CDN. As a result of the sale, ProMark’s results ofoperations were reported as discontinued operations in the historical financialstatements. Under the terms of the purchase and sale agreement, Forest mayreceive additional contingent consideration payments over a period of fiveyears through February 2009. During the nine months ended September 30,2006, Forest recognized an additional $3.6 million contingent payment ($2.4million net of tax) due under the agreement, which has been reflected as incomefrom discontinued operations in the Condensed Consolidated Statements ofOperations.

***Impairments***

During the nine monthperiod ended September 30, 2006, Forest recorded an impairment of $2.1million in the second quarter of 2006 related to Gabon. The Gabon impairmentwas related to historical costs impaired to reflect a drilled dry hole. Duringthe nine months ended September 30, 2005, Forest recorded an impairment of$2.9 million related to various international properties, principally relatedto its properties in Romania. The Romania impairment was recorded in the firstquarter of 2005 in connection with our decision to exit the country as we rationalizedour international assets to concentrate on fewer areas.

***Liquidity andCapital Resources***

In 2006, as in 2005, weexpect our cash flow from operations to be our primary source of liquidity tomeet operating expenses and fund capital expenditures other than largeacquisitions. Any remaining cash flow from operations will be available foracquisitions, in whole or in part, or other corporate purposes, including therepayment of indebtedness.

The prices we receive for our oil and natural gasproduction have a significant impact on operating cash flows. While significantprice declines in 2006 would adversely affect the amount of cash flow generatedfrom operations, we utilize a hedging program to partially mitigate that risk. Asof November 1, 2006, Forest has hedged approximately 12.7 Bcfe of itsfourth quarter production for 2006 and 36.5 Bcfe of its 2007 production. Thislevel of hedging provides a measure of certainty of the cash flow we willreceive for a large portion of our production through 2007. Depending onchanges in oil and gas futures markets and management’s view of underlying oiland natural gas supply and demand trends, we may increase or decrease ourcurrent hedging positions. For further information concerning our 2006 and 2007hedging contracts, see Item 3—“Quantitative and Qualitative Disclosures aboutMarket Risk—Commodity Price Risk,” below.

Our $600 million revolving bank creditfacilities, which we entered into in September 2004, provide anothersource of liquidity. These credit facilities, which mature in September 2009,are used to fund daily operating activities and acquisitions in the UnitedStates and Canada as needed. On November 2, 2006, Forest announced that ithad formed a new subsidiary, Forest Alaska Operating LLC, and the subsidiary intendsto attempt to obtain $375 million of secured term loan financing. See “BankCredit Facilities” below for details.

On March 2, 2006, we completed the Spin-off ofour offshore Gulf of Mexico operations. As a result of the Spin-off, we expectfuture cash flows from operations to be significantly lower; however, we alsoexpect a significant decrease in offshore capital expenditures and payments forasset retirement obligations. Prior to the Merger, as part of the Spin-off, wereceived approximately $176.1 million from 

29

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MERI, which we used to paydown our credit facilities. MERI obtained these funds from a bank creditfacility it established immediately prior to the Spin-off. Subsequent to the closing, Forest receivedadditional net cash proceeds of $21.7 million from MERI for a total of $197.8million. As of October 31, 2006, in accordance with the transactionagreements, Forest and MERI had submitted post-closing adjustments from whichForest has determined it owes MERI approximately $5.8 million, which is subjectto further adjustment. We do not believe the Spin-off will have amaterial effect on our liquidity and capital resources nor do we believe itwill materially adversely affect our ability to access the capital markets.

The public capital markets have been our principalsource of funds to finance large acquisitions. We have issued debt and equitysecurities in both public and private offerings in the past, and we expect thatthese sources of capital will continue to be available to us in the future foracquisitions. In July 2004, we filed a shelf registration statement thatallows Forest to issue equity and debt securities of up to $600 million,all of which is still available. Nevertheless, ready access to capital onreasonable terms can be impacted by our debt ratings assigned by independentrating agencies and are subject to many uncertainties, including restrictionscontained in our bank credit facilities and indentures for our senior notes,macroeconomic factors outside of our control, and other risks as explained in Part 1,Item 1A—”Risk Factors” of our 2005 Annual Report on Form 10-K.

We believe that ouravailable cash, cash provided by operating activities, and funds availableunder our bank credit facilities will be sufficient to fund our operating,interest, and general and administrative expenses, our capital expenditurebudget, and our short-term contractual obligations at current levels for theforeseeable future.

***Bank Credit Facilities***

We currently have credit facilities totaling$600 million, consisting of a $500 million U.S. credit facilitythrough a syndicate of banks led by JPMorgan Chase and a $100 millionCanadian credit facility through a syndicate of banks led by JPMorgan ChaseBank, Toronto Branch. The credit facilities mature in September 2009.Subject to the agreement of Forest and the applicable lenders, the size of thecredit facilities may be increased by $200 million in the aggregate.

Availability under the credit facilities will be basedeither on certain financial covenants included in the credit facilities or onthe loan value assigned to Forest’s oil and gas properties. If Forest’scorporate credit rating by Moody’s is “Ba1” or higher and “BB+” or higher byS&P, the credit facilities may be governed by certain financial covenants.Alternatively, if Forest’s corporate credit rating is “Ba2” or lower by Moody’sor “BB” or lower by S&P, availability under the credit facilities will begoverned by a borrowing base (“Global Borrowing Base”). Currently, the amountavailable under the credit facilities is determined by the Global BorrowingBase. On September 29, 2006 the Global Borrowing Base was increased from$850 million to $900 million; however, the size of the commitments remainedunchanged with $500 million allocated to the U.S. credit facility and $100million allocated to the Canadian facility.

At October 31, 2006, there were outstandingborrowings of $311.0 million under the U.S. credit facility at a weightedaverage interest rate of 6.9%, and there were outstanding borrowings of$81.9 million under the Canadian credit facility at a weighted averageinterest rate of 5.9%. We also had used the credit facilities for approximately$2.8 million in letters of credit, leaving an unused borrowing amountunder the Global Borrowing Base of approximately $204.3 million at October 31,2006.

Effective October 31, 2006, Forest and thelenders under the credit facilities entered into a third amendment to thecredit facilities.  The amendment allowedForest to transfer the majority of the assets associated with its Alaskabusiness unit to a newly formed subsidiary, Forest Alaska Operating LLC, andrelease the liens filed against the Alaska properties.  On November 2,2006, Forest announced that the new subsidiary intends to attempt to obtain$375 million of term loan financing to fund a $350 million distribution toForest and to provide working capital for the new subsidiary.  The term loans will be 

30

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secured by the subsidiary’sassets and will be non-recourse to Forest. Forest intends to use the funds tobe distributed upon closing the term loans to reduce its borrowings under itsU.S. credit facility.   In connection with the third amendment, nochanges were made to the Global Borrowing Base.

The determination of the Global Borrowing Base is madeby the lenders taking into consideration the estimated value of Forest’s oiland gas properties in accordance with the lenders’ customary practices for oiland gas loans. This process involves reviewing Forest’s estimated provedreserves and their valuation. While the Global Borrowing Base is in effect, itis redetermined semi-annually, and the available borrowing amount could beincreased or decreased as a result of such redeterminations. In addition,Forest and the lenders each have discretion at any time, but not more oftenthan once during any calendar year, to have the Global Borrowing Baseredetermined. A revision to Forest’s reserves may prompt such a request on thepart of the lenders, which could possibly result in a reduction in the GlobalBorrowing Base and availability under the credit facilities. If outstandingborrowings under either of the credit facilities exceed the applicable portionof the Global Borrowing Base, Forest would be required to repay the excess amountwithin a prescribed period. If we are unable to pay the excess amount, it wouldcause an event of default.

The credit facilities include terms and covenants thatplace limitations on certain types of activities, including restrictions orrequirements with respect to additional debt, liens, asset sales, hedgingactivities, investments, dividends, mergers, and acquisitions. The creditfacilities also include several financial covenants. Availability, interestrates, security requirements, and other terms of borrowing under the creditfacilities will vary based on Forest’s credit ratings and financial condition,as determined by certain financial tests. In particular, any time thatavailability is not determined by the Global Borrowing Base, the amount availableand our ability to borrow under the credit facilities is determined by certainfinancial covenants. Also, even when availability is determined by the GlobalBorrowing Base, certain financial covenants may affect the amount available andForest’s ability to borrow amounts under the credit facilities.

The credit facilities arecollateralized by a portion of our assets. We are required to mortgage, andgrant a security interest in, 75% of the present value of our consolidatedproved oil and gas properties. We have also pledged the stock of severalsubsidiaries to the lenders to secure the credit facilities. Under certaincircumstances, we could be obligated to pledge additional assets as collateral.If our corporate credit ratings by Moody’s and S&P improve and meetpre-established levels, the collateral requirements would not apply and, at ourrequest, the banks would release their liens and security interests on ourproperties.

***Cash Flow***

Netcash provided by operating activities, net cash used by investing activities,and net cash provided (used) by financing activities for the nine months ended September 30,2006 and 2005 were as follows:

| ** **                                        | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                        | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| ** **                                        | ** ** | **(In Thousands)**                             | ** ** |
| Net cash provided  by operating activities        |       | $                                                   | 346,616    |   | 518,432 |   |
| Net cash used by  investing activities            |       | (749,726                                            | )          | (538,397 | ) |
| Net cash provided (used)  by financing activities |       | 407,356                                             |       | (27,917 | ) |
|                                                   |            |                                                     |            |  |  |  |

 

The decrease in net cashprovided by operating activities in the nine months ended September 30,2006 compared to the same period of 2005 was due primarily to lower oil and gasrevenues due to the Spin-off. The increase in cash used by investing activitiesin the nine months ended September 30, 2006 was due primarily to increasedcapital expenditures for exploration and development in the nine months ended 

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September 30,2006 compared to the same period in 2005. Net cash provided by financingactivities in the nine months ended September 30, 2006 included net bankproceeds of $389.0 million and proceeds from the exercise of stock optionsand employee stock purchases of $5.2 million. Of the $389.0 million in net bankproceeds for the nine month period of 2006, $176.1 million was drawn on a bankcredit facility established by MERI in March 2006, immediately prior tothe Spin-off. This credit facility and associated liability was included in theSpin-off. The 2005 period included proceeds from the exercise of stock optionsand warrants and employee stock purchases of approximately $41.8 million offsetby net bank debt repayments of $68.0 million.

***Capital Expenditures***

Expendituresfor property acquisition, exploration, and development were as follows:

| ** **                                                                               | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                               | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| ** **                                                                               | ** ** | **(In Thousands)**                             | ** ** |
| Property acquisition  costs(1):                                                          |       |                                                |       |   |   |
| Proved properties                                                                        |       | $                                                   | 260,029    |   | 242,997 |   |
| Unproved properties                                                                      |       | 51,700                                              |       | 69,350 |   |
|                                                                                     |       | 311,729                                             |       | 312,347 |   |
| Exploration costs:                                                                       |       |                                                |       |   |   |
| Direct costs                                                                             |       | 151,125                                             |       | 96,690 |   |
| Overhead capitalized                                                                     |       | 9,933                                               |       | 9,710 |   |
|                                                                                     |       | 161,058                                             |       | 106,400 |   |
| Development costs:                                                                       |       |                                                |       |   |   |
| Direct costs                                                                             |       | 313,742                                             |       | 227,098 |   |
| Overhead capitalized                                                                     |       | 14,126                                              |       | 9,943 |   |
|                                                                                     |       | 327,868                                             |       | 237,041 |   |
| Total capital  expenditures for property acquisition, exploration, and development(1)(2) |       | $                                                   | 800,655    |   | 655,788 |   |

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(1)             Totalcapital expenditures include both cash expenditures and accrued expenditures.

(2)             Doesnot include the effect of estimated additional asset retirement obligations.

For the nine months ended September 30,2006, expenditures for exploration and development activities totaled $489million ($453 million attributable to the Retained Properties and $36 millionattributable to the Spin-off Properties), exclusive of costs for propertyacquisitions. Forest anticipates expenditures for exploration and developmentactivities in 2006 will approximate $580 million. Some of the factors impactingthe level of capital expenditures in 2006 include crude oil and natural gasprices, the volatility in these prices, the cost and availability of oil fieldservices, and weather disruptions.

***Forward-Looking Statements***

The information in this Form 10-Q includes “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933 and Section 21E of the Securities Exchange Act of 1934. Allstatements, other than statements of historical facts or present facts, thataddress activities, events, outcomes, and other matters that Forest plans,expects, intends, assumes, believes, budgets, predicts, forecasts, projects,estimates, or anticipates (and other similar expressions) will, should, or mayoccur in the future are forward-looking statements. These forward-lookingstatements are based on our current expectations and assumptions about futureevents and are based on currently available information as to the outcome andtiming of future events. When considering forward-looking statements, youshould keep 

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in mind the risk factors,and other cautionary statements described under the heading “Risk Factors”included in Part I of our 2005 Annual Report on Form 10-K.

These forward-lookingstatements appear in a number of places and include statements with respect to,among other things:

·       estimatesof our oil and gas reserves;

·       estimatesof our future natural gas and liquids production, including estimates of anyincreases in oil and gas production;

·       theamount, nature and timing of capital expenditures, including future developmentcosts, and availability of capital resources to fund capital expenditures;

·       ouroutlook on oil and gas prices;

·       theimpact of political and regulatory developments;

·       ourfuture financial condition or results of operations and our future revenues andexpenses; and

·       ourbusiness strategy and other plans and objectives for future operations.

We caution you that these forward-lookingstatements are subject to all of the risks and uncertainties, most of which aredifficult to predict and many of which are beyond our control, incident to theexploration for and development, production, and sale of oil and gas. Theserisks include, but are not limited to, commodity price volatility, inflation,lack of availability of drilling and production equipment and services,environmental risks, drilling and other operating risks, regulatory changes,the uncertainty inherent in estimating proved oil and natural gas reserves andin projecting future rates of production, cash flow and access to capital, thetiming of development expenditures, and the other risks described in the Form 10-Kunder the caption “Risk Factors.” The financial results of our foreignoperations are also subject to currency exchange rate risks.

Reserve engineering is a process of estimatingunderground accumulations of oil and natural gas that cannot be measured in anexact way. The accuracy of any reserve estimate depends on the quality ofavailable data, the interpretation of such data, and price and cost assumptionsmade by our reservoir engineers. In addition, the results of drilling, testing,and production activities may justify revisions of estimates that were madepreviously. If significant, such revisions would change the schedule of any furtherproduction and development drilling. Accordingly, reserve estimates may differsignificantly from the quantities of oil and natural gas that are ultimatelyrecovered.

Should one or more of the risks or uncertaintiesdescribed above or elsewhere in this Form 10-Q occur, or shouldunderlying assumptions prove incorrect, our actual results and plans coulddiffer materially from those expressed in any forward-looking statements.

All forward-lookingstatements, expressed or implied, included in this Form 10-Q andattributable to Forest are expressly qualified in their entirety by thiscautionary statement. This cautionary statement should also be considered inconnection with any subsequent written or oral forward-looking statements thatForest or persons acting on its behalf may issue. Forest does not undertake toupdate any forward-looking statements to reflect events or circumstances afterthe date of filing this Form 10-Q with the Securities and ExchangeCommission, except as required by law.

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**Item 3.**                        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk, including the effectsof adverse changes in commodity prices, foreign currency exchange rates, andinterest rates as discussed below.

***Commodity Price Risk***

We produce and sell natural gas, crude oil, andnatural gas liquids for our own account in the United States and Canada. As aresult, our financial results are affected when prices for these commoditiesfluctuate. Such effects can be significant. In order to reduce the impact offluctuations in prices on our revenues, or to protect the economics of propertyacquisitions, we make use of an oil and gas hedging strategy. Under our hedgingstrategy, we enter into commodity swaps, collars, and other financialinstruments with counterparties who, in general, are participants in our creditfacilities. These arrangements, which are based on prices available in thefinancial markets at the time the contracts are entered into, are settled incash and do not require physical deliveries of hydrocarbons.

***Swaps***

In atypical commodity swap agreement, we receive the difference between a fixedprice per unit of production and a price based on an agreed upon published,third-party index if the index price is lower than the fixed price. If theindex price is higher, we pay the difference. By entering into swap agreements,we effectively fix the price that we will receive in the future for the hedgedproduction. Our current swaps are settled in cash on a monthly basis. As ofSeptember 30, 2006, we had entered into the following swaps:

| ** **           | ** ** | **Swaps**                                 | ** ** |
|----------------------|------------|-------------------------------------------|------------|
| ** **           | ** ** | **Natural Gas (NYMEX HH)** | ** ** | **Oil (NYMEX WTI)** | ** ** |
| ** **           | ** ** | **Bbtu  per  Day**                        | ** ** | **Weighted  Average Hedged  Price per  MMBtu** | ** ** | **Fair Value  (In Thousands)** | ** ** | **Barrels  per  Day** | ** ** | **Weighted  Average Hedged  Price per Bbl** | ** ** | **Fair Value  (In Thousands)** | ** ** |
| Fourth Quarter  2006 |       | 10.0                                      |       |   | $ | 5.51 |   |   |   | $ | (191 | ) |   |   | 7,500 |   |   |   | $ | 51.18 |   |   |   | $ | (9,008 | ) |   |
| Fiscal 2007          |       | —                                    |       |   | — |   |   |   | — |   |   |   | 3,500 |   |   |   | 73.16 |   |   |   | 6,267 |   |   |
| Fiscal 2008          |       | —                                    |       |   | — |   |   |   | — |   |   |   | 3,000 |   |   |   | 73.02 |   |   |   | 4,220 |   |   |
| Fiscal 2009          |       | —                                    |       |   | — |   |   |   | — |   |   |   | 2,500 |   |   |   | 73.02 |   |   |   | 4,483 |   |   |
| Fiscal 2010          |       | —                                    |       |   | — |   |   |   | — |   |   |   | 2,000 |   |   |   | 73.15 |   |   |   | 4,541 |   |   |

 

Forest also uses basisswaps in connection with natural gas swaps in order to fix the pricedifferential between the NYMEX price and the index price at which the hedgedgas is sold. At September 30, 2006, there was a basis swap in placecovering 15.0 Bbtu per day in 2007 with a fair market value of $(.4) million.

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***Collars***

Forestalso enters into collar agreements with third parties. A collar agreement issimilar to a swap agreement, except that we receive the difference between thefloor price and the index price only if the index price is below the floorprice; and we pay the difference between the ceiling price and the index priceonly if the index price is above the ceiling price. As of September 30,2006, we had entered into the following collars:

|                      | ** ** | **Collars**                               | ** ** |
|----------------------|------------|-------------------------------------------|------------|
| ** **           | ** ** | **Natural Gas (NYMEX HH)** | ** ** | **Oil (NYMEX WTI)** | ** ** |
| ** **           | ** ** | **Bbtu  per  Day**                        | ** ** | **Weighted  Average  Hedged Floor  and Ceiling  Price per  MMBtu** | ** ** | **Fair Value  (In Thousands)** | ** ** | **Barrels  per Day** | ** ** | **Weighted  Average  Hedged Floor  and Ceiling  Price per Bbl** | ** ** | **Fair Value  (In Thousands)** | ** ** |
| Fourth Quarter  2006 |       | 50.0                                      |       | $ | 7.43/11.88 |   |   | $ | 9,392 |   |   |   | 5,500 |   |   | $ | 46.73/65.87 |   |   | $ | (1,825 | ) |   |
| Fiscal 2007          |       | 35.0                                      |       | 8.76/11.70 |   |   | 19,775 |   |   |   | 4,000 |   |   | 65.81/87.18 |   |   | 4,887 |   |   |
|                      |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The fair value of our derivative instruments based onthe futures prices quoted on September 30, 2006 was a net asset ofapproximately $42.1 million.

In October 2006,we entered into two additional swap agreements. The table below sets forth theweighted average terms of the agreements.

|             | ** ** | **Swaps**                                 | ** ** |
|-------------|------------|-------------------------------------------|------------|
| ** **  | ** ** | **Natural Gas (NYMEX HH)** | ** ** |
| ** **  | ** ** | **Bbtu per  Day**                    | ** ** | **Weighted  Average Hedged  Price per  MMBtu** | ** ** |
| Fiscal 2007 |       |                                      | 20.0       |   |   |   | $ | 8.10 |   |   |
|             |            |                                           |            |  |  |  |  |  |  |  |

 

In October 2006, we also entered into anadditional basis swap agreement covering 10.0 Bbtu per day for 2007.

Thefollowing table reconciles the changes that occurred in the fair values of ouropen derivative contracts during the nine months ended September 30, 2006,beginning with the fair value of our commodity contracts on December 31,2005:

|                                                                         | ** ** | **Fair Value of  Derivative  Contracts** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                              | ** ** | **(In Thousands)**                            | ** ** |
| Unrealized losses  on derivative contracts as of December 31, 2005 |       |                                               | $          | (150,737 | ) |   |
| Net increase in  fair value                                             |       |                                               | 104,678    |   |   |
| Fair value of  derivatives transferred in Spin-off                      |       |                                               | 17,087     |   |   |
| Net contract  losses recognized                                         |       |                                               | 71,103     |   |   |
| Unrealized gains on  derivative contracts as of September 30, 2006 |       |                                               | $          | 42,131 |   |   |

 

**Foreign CurrencyExchange Risk**

We conduct business inseveral foreign currencies and thus are subject to foreign currency exchangerate risk on cash flows related to sales, expenses, financing, and investingtransactions. In the past, we have not entered into any foreign currencyforward contracts or other similar financial instruments to manage this risk. Expendituresincurred relative to the foreign concessions held by Forest outside of NorthAmerica have been primarily United States dollar-denominated, as have cashproceeds related to property 

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salesand farmout arrangements. Substantially all of our Canadian revenues and costsare denominated in Canadian dollars. While the value of the Canadian dollardoes fluctuate in relation to the U.S. dollar, we believe that any currencyrisk associated with our Canadian operations would not have a material impacton our results of operations.

**Interest Rate Risk**

Thefollowing table presents principal amounts and related weighted average fixedinterest rates by year of maturity for Forest’s debt obligations and the fairvalue of our debt obligations at September 30, 2006:

|                            | ** ** | **2008**                                         | ** ** | **2009** | ** ** | **2011** | ** ** | **2014** | ** ** | **Total** | ** ** | **Fair Value** | ** ** |
|----------------------------|------------|--------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|-----------|------------|---------------------|------------|
| ** **                 | ** ** | **(Dollar Amounts in Thousands)** | ** ** |
| Bank credit facilities:    |       |                                             |       |     |       |     |       |     |       |      |       |                |       |
| Variable rate              |       | $                                                | —     |     | 369,470    |     | —     |     | —     |      | 369,470    |                | 369,470    |   |
| Average interest rate(1)   |       | —                                           |       | 6.72     | %          | —   |       | —   |       | 6.72      | %          |                |       |
| Long-term debt:            |       |                                             |       |     |       |     |       |     |       |      |       |                |       |
| Fixed rate                 |       | $                                                | 265,000    |     | —     |     | 285,000    |     | 150,000    |      | 700,000    |                | 718,431    |   |
| Coupon interest rate       |       | 8.00                                             | %          | —   |       | 8.00     | %          | 7.75     | %          | 7.95      | %          |                |       |
| Effective interest rate(2) |       | 7.13                                             | %          | —   |       | 7.71     | %          | 6.56     | %          | 7.24      | %          |                |       |

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(1)             Asof September 30, 2006.

(2)             The effective interestrates on the 8% Senior Notes due 2008, the 8% Senior Notes due 2011, and the 73¤4% Senior Notesdue 2014 are reduced from the coupon rate as a result of amortization of thegains related to termination of the related interest rate swaps, and amortizationof premiums and discounts. 

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**Item 4.**                        CONTROLSAND PROCEDURES

***Evaluation of Disclosure Controls and Procedures***

We have established disclosure controls and proceduresto ensure that material information relating to Forest and its consolidatedsubsidiaries is made known to the Officers who certify Forest’s financialreports and the Board of Directors.

Our Chief ExecutiveOfficer, H. Craig Clark, and our Chief Financial Officer, David H.Keyte, evaluated the effectiveness of our disclosure controls and procedures,as defined in Rules 13a—15(e) and 15d—15(e) under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”), as of the end of thequarterly period ended September 30, 2006 (the “Evaluation Date”). Basedon this evaluation, they believe that as of the Evaluation Date our disclosurecontrols and procedures were effective to ensure that information required tobe disclosed by us in the reports we file or submit under the SecuritiesExchange Act of 1934 is recorded, processed, summarized, and reported withinthe time periods specified in the SEC’s rules and forms.

***Changes in Internal Control Over Financial Reporting***

There has not been anychange in our internal control over financial reporting that occurred duringour quarterly period ended September 30, 2006 that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

**PART II—OTHERINFORMATION**

**Item 1.**                        LEGALPROCEEDINGS

On September 12, 2006Forest paid an aggregate of $813,000 in civil penalties to the U.S.Environmental Protection Agency to settle enforcement proceedings related topast wastewater discharge violations at a platform owned and operated by Forestlocated in federal waters of the Cook Inlet off the coast of Alaska. The wastewaterproblems stemmed from ineffective treatment systems that Forest purchased forthe platform.

**Item 6.**                        EXHIBITS

(a)           Exhibits.

| 10.1* |   | Third Amendment to the Amended and Restated combined  Credit Agreements, dated effective as of October 31, 2006, among Forest  Oil Corporation, Canada Forest Oil, each of the lenders that is a party  thereto, Bank of America, N.A. and Citibank N.A., as Co-Global Syndication Agents,  BNP Paribus and Harris Nesbitt Financing, Inc., as Co-U.S. Documentation  Agents, and Bank of Montreal and the Toronto-Dominion Banks, as Co-Canadian  Documentation Agents, JP Morgan Chase Bank, N.A., Toronto Branch, as Canadian  Administrative Agent and JP Morgan Chase Bank, N.A., as Global Administrative  Agent. |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1* |   | Certification of  Principal Executive Officer of Forest Oil Corporation as required by  Rule 13a-14(a) of the Securities Exchange Act of 1934, as  amended.                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 31.2* |   | Certification of Principal  Financial Officer of Forest Oil Corporation as required by Rule 13a-14(a) of  the Securities Exchange Act of 1934, as amended.                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 32.1+ |   | Certification of Chief  Executive Officer of Forest Oil Corporation pursuant to 18 U.S.C. §1350.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |

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| 32.2+ |   | Certification of Chief  Financial Officer of Forest Oil Corporation pursuant to 18 U.S.C. §1350. |
|-------|--------|-------------------------------------------------------------------------------------------------------|

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*                     Filedherewith.

+                  Notconsidered to be “filed” for purposes of Section 18 of the SecuritiesExchange Act of 1934 or otherwise subject to the liabilities of that section.

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                       |     |     | FOREST OIL CORPORATION |
|-----------------------|----------|----------|------------------------|
|                  |     |     | (Registrant)           |
| November 9, 2006 |     |     | By:                    | /s/**DAVID H. KEYTE | * * |
|                  |     |     |                   | David H. Keyte |
|                  |     |     |                   | *Executive Vice President and  Chief Financial Officer  (on behalf of the Registrant and as  Principal Financial Officer)* |
| * *              |     |     | By:                    | /s/ VICTOR A. WIND | * * |
| * *              | * * | * * | * *               | Victor A. Wind |
| * *              | * * | * * | * *               | *Corporate Controller  (Principal Accounting Officer)* |

 

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**Exhibit Index**

| Exhibit Number | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | ** ** | ** ** |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| 10.1*               |       | Third Amendment to the  Amended and Restated combined Credit Agreements, dated effective as of  October 31, 2006, among Forest Oil Corporation, Canada Forest Oil, each  of the lenders that is a party thereto, Bank of America, N.A. and Citibank  N.A., as Co-Global Syndication Agents, BNP Paribus and Harris Nesbitt  Financing, Inc., as Co-U.S. Documentation Agents, and Bank of Montreal  and the Toronto-Dominion Banks, as Co-Canadian Documentation Agents, JP  Morgan Chase Bank, N.A., Toronto Branch, as Canadian Administrative Agent and  JP Morgan Chase Bank, N.A., as Global Administrative Agent. |
| 31.1 *              |       | Certification of  Principal Executive Officer of Forest Oil Corporation as required by Rule 13a-14(a) of  the Securities Exchange Act of 1934, as amended.                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 31.2 *              |       | Certification of  Principal Financial Officer of Forest Oil Corporation as required by  Rule 13a-14(a) of the Securities Exchange Act of 1934, as  amended.                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 32.1 +              |       | Certification of  Chief Executive Officer of Forest Oil Corporation, pursuant to  18 U.S.C. §1350.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 32.2 +              |       | Certification of  Chief Financial Officer of Forest Oil Corporation, pursuant to  18 U.S.C. §1350.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |

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*                     Filed herewith.

+                  Not considered to be “filed” for purposes of Section 18of the Securities Exchange Act of 1934 or otherwise subject to the liabilitiesof that section.

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