---

UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, DC
20549

FORM 20-F

[   ] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b)
or 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For The Fiscal Year Ended December 31, 2016

OR

[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

[   ] SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

Commission file number 333-179957

MILLAR WESTERN FOREST PRODUCTS
LTD.(Exact Name of the Registrant as Specified in
its Charter)

Canada(Jurisdiction of
Incorporation or Organization)

16640 - 111 Avenue, Edmonton, Alberta, T5M 2S5(Address of Principal Executive Offices)

David AndersonMillar
Western Forest Products Ltd.16640  111 AvenueEdmonton,
Alberta T5M 2S5(780) 486-8200(Name, Telephone,
E-mail and/or Facsimile number and Address of Company Contact Person)

Securities registered or to be registered pursuant to Section
12(b) of the Act:

NONE

Securities registered or to be registered pursuant to Section
12(g) of the Act:

NONE

Securities for which there is a reporting obligation pursuant
to Section 15(d) of the Act:

NONE

---

Indicate the number of outstanding shares of each of the
issuers classes of capital or common stock as of the close of the period
covered by the annual report.

15,000,002 Common Shares

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

YES [   ]       
NO [X]

Indicate by check mark if the registrant is not required to
file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934.

YES [X]        NO
[   ]

Indicate by check mark whether the registrant: (1) has filed
all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days.*

YES [   ]       
NO [   ]

Indicate by check mark whether the registrant has submitted
electronically and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation
S-T during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).

YES [   ]       
NO [   ]

Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated filer.

|Large Accelerated Filer [   ] | Accelerated Filer [   ] | Non-Accelerated Filer [X]
|----------------------------- | ----------------------- | -------------------------

Indicate by check mark which basis of accounting the registrant
has used to prepare the financial statements included in this filing:

U.S. GAAP [   ]International Financial Reporting
Standards as issued by the International Accounting Standards Board [X]Other
[   ]

If this is an annual report, indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).

YES [   ]       
NO [X]

Indicate by check mark whether the registrant has filed all
documents and reports required to be filed by Sections 12, 13 or 15 (d) of the
Securities Exchange Act of 1934 subsequent to the distribution of securities
under a plan confirmed by a court.

NOT APPLICABLE

* Millar Western Forest Products Ltd. is a voluntary filer
and is submitting this Form 20-F to satisfy its reporting obligations under the
indenture relating to its 8.50% Senior Notes due 2021.

---

TABLE OF CONTENTS

|PRESENTATION OF FINANCIAL INFORMATION             | 1      
|------------------------------------------------- | -------
|                                                  |        
|NON-GAAP FINANCIAL MEASURES                       | 1      
|                                                  |        
|SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS | 1      
|                                                  |        
|GLOSSARY OF CERTAIN TERMS AND DEFINITIONS         | 2      
|                                                  |        
|PART I                                            |        
|                                                  | ITEM 1:
|                                                  | ITEM 2:
|                                                  | ITEM 3:
|                                                  |        
|                                                  |        
|                                                  |        
|                                                  |        
|                                                  | ITEM 4:
|                                                  |        
|                                                  |        
|                                                  |        
|                                                  |        
|                                                  | ITEM 5:
|                                                  |        
|                                                  |        
|                                                  |        
|                                                  |        
|                                                  |        
|                                                  |        
|                                                  |        
|                                                  | ITEM 6:
|                                                  |        
|                                                  |        
|                                                  |        
|                                                  |        
|                                                  |        
|                                                  | ITEM 7:
|                                                  |        
|                                                  |        
|                                                  |        
|                                                  | ITEM 8:
|                                                  |        
|                                                  |        
|                                                  | ITEM 9:
|                                                  |        
|                                                  |        
|                                                  |        
|                                                  |        
|                                                  |        
|                                                  |        

i

---

|         | ITEM 10: | ADDITIONAL
    INFORMATION                                                                                             | 50                                                                                          
|-------- | -------- | ---------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------
|         |          | A.                                                                                                                     | Share Capital                                                                               
|         |          | B.                                                                                                                     | Memorandum
      and Articles of Association                                                
|         |          | C.                                                                                                                     | Material Contracts                                                                          
|         |          | D.                                                                                                                     | Exchange
      Controls                                                                     
|         |          | E.                                                                                                                     | Taxation                                                                                    
|         |          | F.                                                                                                                     | Dividends
      and Paying Agents                                                           
|         |          | G.                                                                                                                     | Statements by Experts                                                                       
|         |          | H.                                                                                                                     | Documents on
      Display                                                                  
|         |          | I.                                                                                                                     | Subsidiary Information                                                                      
|         | ITEM 11: | QUANTITATIVE
    AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                         | 53                                                                                          
|         |          | A.                                                                                                                     | Commodity Prices                                                                            
|         |          | B.                                                                                                                     | Foreign
      Exchange                                                                      
|         |          | C.                                                                                                                     | Interest Rates                                                                              
|         | ITEM 12: | DESCRIPTION
    OF SECURITIES OTHER THAN EQUITY SECURITIES                                                             | 53                                                                                          
|         |          |                                                                                                                        |                                                                                             
|PART II  | 54      
|         | ITEM 13: | DEFAULTS, DIVIDEND
      ARREARAGES AND DELINQUENCIES MATERIAL MODIFICATIONS TO THE RIGHTS OF
    SECURITY HOLDERS AND | 54                                                                                          
|         | ITEM 14: | USE OF
    PROCEEDS                                                                                                    | 54                                                                                          
|         | ITEM 15: | CONTROLS AND PROCEDURES                                                                                                | 54                                                                                          
|         | ITEM 16  |                                                                                                                        |                                                                                             
|         |          | A.                                                                                                                     | AUDIT COMMITTEE FINANCIAL
      EXPERT                                                      
|         |          | B.                                                                                                                     | CODE OF
      ETHICS                                                                        
|         |          | C.                                                                                                                     | PRINCIPAL ACCOUNTANT FEES
      AND SERVICES EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT
|         |          | D.                                                                                                                     | COMMITTEES                                                                                  
|         |          |                                                                                                                        | PURCHASES OF EQUITY
      SECURITIES BY THE ISSUER AND STANDARDS FOR AUDIT COMMITTEES       
|         |          | E.                                                                                                                     | AFFILIATED
      PURCHASERS                                                                 
|         |          | F.                                                                                                                     | CHANGE IN REGISTRANTS
      CERTIFYING ACCOUNTANT                                          
|         |          | G.                                                                                                                     | CORPORATE
      GOVERNANCE                                                                  
|         |          | H.                                                                                                                     | MINE SAFETY DISCLOSURE                                                                      
|         |          |                                                                                                                        |                                                                                             
|PART III | 56      
|         | ITEM 17: | FINANCIAL
    STATEMENTS                                                                                               | 56                                                                                          
|         | ITEM 18: | FINANCIAL STATEMENTS                                                                                                   | 56                                                                                          
|         | ITEM 19: | EXHIBITS                                                                                                               | 56                                                                                          

ii

---

As used in this annual report on Form 20-F (this annual
report), unless the context otherwise indicates, the term we, our, Millar
Western or the Company means Millar Western Forest Products Ltd.

PRESENTATION OF FINANCIAL INFORMATION

We prepare our financial statements in accordance with
International Financial Reporting Standards as issued by the International
Accounting Standards Board, which we refer to as IFRS. Readers should be aware
that financial statements prepared in accordance with IFRS may differ in certain
respects from financial statements prepared in accordance with U.S. generally
accepted accounting principles, which we refer to as U.S. GAAP.

We present our financial statements in Canadian dollars. Except
where otherwise indicated, all dollar amounts are expressed in Canadian dollars,
references to $ or dollars are to Canadian dollars and references to US$
and U.S. dollars are to United States dollars. See Item 3, Key Information,
for exchange rate information between the Canadian dollar and the United States
dollar.

Refer to the audited financial statements and the accompanying
notes included elsewhere in this annual report for disclosure of matters in
response to changes in significant accounting policies inclusive of future
pronouncements and measurement assumptions, subsequent events, related party
transactions, financial instruments and material changes in in estimates and
accounting methods.

NON-GAAP FINANCIAL MEASURES

We define Adjusted EBITDA as operating earnings plus unrealized
other income or expense, depreciation and amortization. Operating earnings is
net income plus finance expenses, income tax expense or recovery and the foreign
exchange gain or loss on debt. Other income or expense includes both realized
and unrealized gains and losses on foreign exchange and/or commodity hedging and
the foreign-exchange impact on working capital balances. Only the realized
portion of such income or expense is included in Adjusted EBITDA, whereas both
the realized and unrealized portions are included in the determination of
operating earnings.

Adjusted EBITDA is not a measure of operating performance or
liquidity under IFRS or U.S. GAAP. Such terms, as used in this annual report,
are not necessarily comparable with similarly titled measures of other
companies. Management believes that Adjusted EBITDA may be useful in assessing
our operating performance and as an indicator of our ability to service or incur
indebtedness, make capital expenditures and finance working capital
requirements. The items excluded from Adjusted EBITDA are significant in
assessing our operating results and liquidity. Therefore, Adjusted EBITDA should
not be considered in isolation or as an alternative to operating earnings, cash
flow from operating activities or other combined income or cash flow data
prepared in accordance with IFRS or U.S. GAAP. See Item 5, Operating and
Financial Review and Prospects, for a reconciliation of Adjusted EBITDA to Net
Earnings (Loss).

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements in this annual report are forward-looking
statements within the meaning of the United States Private Securities
Litigation Reform Act of 1995. These forward-looking statements are not based on
historical facts but, rather, on our current expectations and our projections
about future events, including our current expectations regarding:

- the implementation and completion of the Note Exchange Transaction (as
  defined herein) and the Share Exchange Transaction (as defined herein) and the
  anticipated benefits and consequences of such transactions;
- the timing of the Meeting (as defined herein), the Courts approval of the
  Plan of Arrangement and the consummation of the Note Exchange Transaction and
  the Share Exchange Transaction;
- the future demand for, and sales volumes of, our lumber and pulp products;
- future production volumes, efficiencies and operating costs;
- increases or decreases in the prices of our products;
- our future stability and growth prospects;
- our business strategies, the measures to implement those strategies and
  the benefits to be derived therefrom;

5

---

- our future profitability and capital needs, including capital
  expenditures;
- the outlook for and other future developments in our affairs or in the
  industries in which we participate; and
- the effect on us of new accounting releases.

These forward-looking statements generally can be identified by
the use of statements that include words such as believe, expect,
anticipate, intend, plan, likely, will, predicts, estimates,
forecasts or other similar words or phrases. Similarly, statements that
describe our objectives, plans or goals are or may be forward-looking
statements. These forward-looking statements are subject to various risks,
uncertainties and other factors that could cause our actual results to differ
materially from the future results expressed or implied by the forward-looking
statements. These risks and uncertainties are described under Risk Factors in
Item 3, Key Information.

Any written or oral forward-looking statements made by us or on
our behalf are subject to these factors. In light of these risks, uncertainties
and assumptions, the forward-looking events discussed in this annual report on
Form 20-F may not occur. Actual results could differ materially from those
expressed in any of our forward-looking statements. Other unknown or
unpredictable factors also could harm our future results. Given these
uncertainties, prospective investors are cautioned not to place undue reliance
on such forward-looking statements. The forward-looking statements included in
this annual report are made only as at the date of this annual report. We do not
intend, and do not assume any obligation, to update these forward-looking
statements, except as required by law.

GLOSSARY OF CERTAIN TERMS AND DEFINITIONS

The following terms have the following meanings in this annual
report:

AAC means annual allowable cut, being the amount of
timber that may be harvested in any one year as stipulated in the pertinent
forest management plan for a Forest Management Unit as approved by the Minister
of Agriculture and Forestry of Alberta;

admt means air dried metric tonne, a unit of
measurement of pulp volume, and madmt means one thousand air dried
metric tonnes;

BCTMP means bleached chemi-thermo-mechanical pulp,
which is pulp produced in a process that uses mild chemicals, heat and
mechanical action to separate cellulose fibers;

BEK means bleached eucalyptus kraft pulp;

BEPmeans Bioenergy Effluent Project;

coniferous means a type of tree that is cone-bearing
and has needles or scale-like leaves, such as spruce, pine or fir;

Coniferous Timber Quota means the right to harvest a
percentage share of the AAC of coniferous timber within a Forest Management
Unit, as approved by the Alberta Minister of Agriculture and Forestry, allocated
on a 20-year basis and renewable thereafter for additional 20-year periods;

deciduous means a type of tree with broad leaves that
usually shed annually, such as aspen;

Deciduous Timber Allocation means the right to harvest
a specified volume of deciduous timber within a designated area, as approved by
the Alberta Minister of Agriculture and Forestry, allocated on a 20-year basis
and renewable thereafter for additional 20-year periods;

dimension lumber means standard commodity lumber,
ranging, in the case of Millar Western, from 1 x 3s to 2 x 10s in varying
lengths, usually 8 to 16;

6

---

dressed lumbermeans lumber that has been planed
smooth on four sides and trimmed for length in a planer mill, after being
produced as rough lumberin a sawmill; the majority of rough lumber
output from our three sawmill operations is processed as dressed lumber in each
operations planer mill, though we do sell volumes of rough lumber in addition
to dressed product.

EPCmeans Engineering, Procurement and Construction, a
form of contracting agreement; an EPC contractor will typically carry out the
detailed engineering design of a project, procure all necessary equipment and
materials, and construct to deliver a functioning facility to the client;

FMA means a Forest Management Agreement between the
Alberta Minister of Agriculture and Forestry and a forest company, generally
having a term of 20 years and renewable thereafter for additional 20-year
periods, and providing rights to manage, establish, grow, harvest and remove
timber in a specified area;

foot board measure or fbm or board
foot means a measure of lumber volume equivalent to a one-foot square
board, one inch thick; mfbm is one thousand board feet; and
mmfbm is one million board feet;

Forest Management Unit means an area of forest land
designated by the Minister of Agriculture and Forestry of Alberta as a
management unit;

FSC means the Forest Stewardship Council, a voluntary,
international certification and labeling system that promotes responsible forest
management and fiber procurement through its sustainable forest management and
chain of custody standards;

hardwood is wood obtained from deciduous species of
trees, such as aspen;

Industries means Millar Western Industries Ltd., the
parent company of Millar Western Forest Products Ltd.;

ISO means the International Organization for
Standardization, a worldwide federation of national standards bodies from
approximately 120 countries; ISO 14001 is an international set of
standards that provide a common approach for documenting and maintaining an
environmental management system;

J-grade is a common name for the highest quality of
SPF dimension lumber, preferred in the Japan market;

kraft pulp means pulp produced in a process that uses
strong chemicals to separate cellulose fibers;

Millar Western FMA means the FMA between the Minister
of Agriculture and Forestry of Alberta and Millar Western commencing May 14,
1997, in effect for 20 years and renewable thereafter for additional 20-year
periods, pursuant to which the Minister has granted rights to us to manage,
establish, grow, harvest and remove timber on a perpetual sustained yield basis
in the Millar Western forest management area;

Millar Western forest management area means the tract
of forested land over which we have been given rights to manage, establish,
grow, harvest and remove timber on a perpetual sustained yield basis for the
term of the Millar Western FMA;

MSR means machine stress rated, which is a rating
given to lumber in North America that describes its load bearing capability;

NBSK means northern bleached softwood kraft pulp;

Notes and Senior Notes, unless specified as
referring to notes appended to our financial statements or to previously issued
Senior Notes, mean the Companys 8.50% Senior Notes, issued in 2011 and due in
2021;

PEFC means the Programme for the Endorsement of Forest
Certification, a Europe-based umbrella organization that assesses and endorses
national forest certification systems for their consistency with international
standards, as well as maintaining its own chain-of-custody standard;

7

---

perpetual sustained yield means the yield of timber
that a forest can produce continuously at a given intensity of management
without impairment of the productivity of the land;

PPAmeans Power Purchase Arrangement, an agreement
defining rights and responsibilities associated with the purchase of electricity
output from certain generating units in the province of Alberta.

rough lumbermeans timber sawn into boards and
constitutes the output of a sawmill; the majority of rough lumber output from
our three sawmill operations is further processed as dressed lumberin
each operations planer mill, though we do sell volumes of rough lumber in
addition to dressed product.

SFI means the Sustainable Forestry Initiative, a
voluntary, third-party, North America-based forest certification program
established in 1994. SFI is based on principles and measures that promote
sustainable forest management and consider all forest values. It is managed by
SFI Inc., an independent, non-profit organization responsible for maintaining,
overseeing and improving the sustainable forestry certification program. SFI is
endorsed by PEFC;

softwood is wood obtained from coniferous species of
trees, such as spruce, pine or fir;

SPFmeans spruce, pine and fir, a major category of
softwood lumber; and

wood chips means pieces of wood approximately one inch
square by one-quarter inch thick resulting from the cutting of logs in chippers,
or as a by-product of the lumber manufacturing process, that are typically used
as a feedstock in the pulp making process.

8

---

PART I

ITEM 1: IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND
ADVISERS.

Not applicable.

ITEM 2: OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

ITEM 3: KEY INFORMATION

A.      Selected Financial Data

The selected historical financial data presented below as at
December 31, 2016, and 2015, and for each of the years in the three-year period
ended December 31, 2016, have been derived from, and should be read together
with, our audited financial statements and the accompanying notes included
elsewhere in this annual report. Our audited financial statements are presented
in Canadian dollars and have been prepared in accordance with IFRS. The selected
historical financial data presented below as at December 31, 2014, 2013, and
2012, and for the years ended December 31, 2013 and 2012, are also presented in
accordance with IFRS and have been derived from, and should be read together
with, our audited financial statements corresponding to such periods, which are
not included in this annual report.

The selected historical financial data presented below are
qualified in their entirety by the more detailed information appearing in our
financial statements and the related notes, as well as Item 5, Operating and
Financial Review and Prospects, and other financial information included
elsewhere in this annual report. Historical results are not necessarily
indicative of results expected for any future period.

9

---

Year ended December 31,2016
    
    
    2015
    
    
    2014
    
    
    2013
    
    
    2012Statements of earnings data:
    
    
    
    
    
    
    
    (in
      thousands)Revenue
    $
    385,117
    
    $
    378,598
    
    $
    405,123
    
    $
    382,938
    
    $
    332,401Cost of products sold
    
    268,562
    
    
    280,884
    
    
    273,852
    
    
    259,155
    
    
    241,039Freight and other
      distribution costs
    
    64,203
    
    
    63,961
    
    
    59,767
    
    
    53,438
    
    
    53,222Depreciation and amortization
    
    10,345
    
    
    14,568
    
    
    14,272
    
    
    13,996
    
    
    13,641General and administration
    
    18,269
    
    
    15,781
    
    
    18,748
    
    
    19,061
    
    
    13,781Other expense (income)(1)
    
    293
    
    
    3,869
    
    
    (2,679
    )
    
    (11,869
    )
    
    7,650Loss on termination of Power
      Purchase Arrangement (PPA)
    
    26,624
    
    
    -
    
    
    -
    
    
    -
    
    
    -Gain on sale of Boyle assets and liabilities
    
    -
    
    
    (17,622
    )
    
    -
    
    
    -
    
    
    -Operating (loss) earnings
    
    (3,179
    )
    
    17,157
    
    
    41,163
    
    
    49,157
    
    
    3,068Foreign exchange gain (loss) on borrowings
    
    8,673
    
    
    (47,019
    )
    
    (20,265
    )
    
    (14,425
    )
    
    4,641Finance expenses, net(2)
    
    (21,098
    )
    
    (23,295
    )
    
    (22,086
    )
    
    (20,892
    )
    
    (20,425
    )(Loss) earnings before income taxes
    
    (15,604
    )
    
    (53,157
    )
    
    (1,188
    )
    
    13,840
    
    
    (12,716
    )Income taxes (recovery)
      expense
    
    (7,213
    )
    
    (402
    )
    
    3,993
    
    
    7,220
    
    
    (4,457
    )Net (loss) earnings for the year
    $
    (8,391
    )
    $
    (52,755
    )
    $
    (5,181
    )
    $
    6,620
    
    $
    (8,259
    )Actuarial (gains) losses -
      net of tax
    
    (353
    )
    
    175
    
    
    1,455
    
    
    (577
    )
    
    317Comprehensive (loss) income for the year
    $
    (8,038
    )
    $
    (52,930
    )
    $
    (6,636
    )
    $
    7,197
    
    $
    (8,576
  )


Year ended December 31,2016
    
    
    2015
    
    
    2014
    
    
    2013
    
    
    2012Balance sheets data:
    
    
    
    
    
    
    
    (in
      thousands)Cash
    $
    40,237
    
    $
    16,773
    
    $
    47,425
    
    $
    47,219
    
    $
    24,674Restricted cash
    $
    -
    
    $
    -
    
    $
    -
    
    $
    7,977
    
    $
    18,824Total assets
    $
    381,917
    
    $
    412,583
    
    $
    420,112
    
    $
    396,274
    
    $
    382,175Financial liabilities - borrowings
    $
    303,671
    
    $
    317,500
    
    $
    263,761
    
    $
    240,181
    
    $
    222,745Shareholder's equity
    $
    7,713
    
    $
    15,751
    
    $
    69,431
    
    $
    78,317
    
    $
    72,620


|(1) | Other (income) expenses includes the gain or loss on
      insurance proceeds, foreign exchange gains or losses on U.S. dollar cash
      and working capital, and realized and unrealized gains or losses on
      derivative contracts. See our audited financial statements included
      elsewhere in this annual report, including note 18, referring to the
      three-year period ended December 31, 2016.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                    
|(2) | Finance expenses consist of interest expense, net of
      interest income. See note 19 to our audited financial statements included
      elsewhere in this annual report, referring to the three-year period ended
      December 31, 2016.                                                                                                                                                                      

10

---

EXCHANGE RATE DATA

The following table sets forth, for each period indicated, the
low and high exchange rates for Canadian dollars expressed in U.S. dollars, the
exchange rate at the end of such period and the average of such exchange rates
on the last day of each month during such period, based on the Bank of Canadas
closing rate on such dates:

2016
    2015
    2014
    2013
    2012Low
    0.6821
    0.7141
    0.8568
    0.9314
    0.9576High
    0.8002
    0.8562
    0.9444
    1.0188
    1.0377Period End
    0.7448
    0.7225
    0.8620
    0.9402
    1.0051Average
    0.7550
    0.7821
    0.9053
    0.9710
    1.0004


The following table sets forth, for each of the last six
months, for Canadian dollars expressed in U.S. dollars, the low and high
exchange rates based on the closing rate as described above:

Last six monthsFebruary
    January
    December
    November
    October
    SeptemberLow
    0.7520
    0.7427
    0.7354
    0.7359
    0.7444
    0.7530High
    0.7704
    0.7645
    0.7645
    0.7520
    0.7689
    0.7798


On March 1st, 2017, the Bank of Canadas noon rate
was US$0.7493 = $1.00.

B.      Capitalization and
Indebtedness

Not applicable.

C.      Reasons for the Offer and
Use of Proceeds

Not applicable.

D.      Risk Factors

You should carefully consider the following factors in
addition to the other information set forth in this annual report. The following
risks, including both those common within our industry and those specific to our
company, could materially and adversely affect our business, our financial
condition or results of operations, or our ability to make payments under our
outstanding indebtedness.

Industry-related Risks

Our business is of a cyclical nature, and prices of and
demand for our products, and our results of operations, may fluctuate
significantly based on market factors.

Our financial performance is principally dependent on the
selling prices of, and the demand for, the pulp and lumber products we sell.
Prices and demand for such products have fluctuated significantly in the past
and may fluctuate significantly in the future. The markets for pulp and lumber
are highly cyclical and affected by such factors as global economic conditions,
demand for pulp and paper, residential and commercial construction in North
America and Asia, changes in industry production capacity and inventory levels
and other factors beyond our control. Market conditions, demand and selling
prices for our products may decline from current levels. Any prolonged or severe
weakness in the market for any of our principal products would adversely affect
our business, financial condition, results of operations and cash flows.

11

---

Intense global competition could limit our ability to
effectively market our products, which could have a negative impact on our
revenue and profitability.

We compete in North American and overseas export markets with
numerous forest products companies, including very large integrated firms that
have greater financial resources than we do. Our lumber segment also competes
indirectly with firms that manufacture substitutes for wood building materials.
While the principal basis for competition is price, we also compete on the basis
of customer service, quality and product type. Our competitive position is
influenced by the availability, quality and cost of fiber, energy and labor,
plant efficiencies and productivity and foreign currency fluctuations. Some of
our competitors may have lower costs, or less stringent environmental and other
governmental regulations to comply with, than we do. Some competitors may be
less leveraged than we are and, therefore, have greater financial flexibility
than we do. In addition, variations in the exchange rates between the Canadian
dollar and the U.S. dollar, and between the U.S. dollar and local currencies in
each of our export markets, also affect the relative competitive position of our
products when compared to our competitors outside of Canada. Our ability to
compete in the markets to which we export our products is also dependent upon
free access and transportation costs to such markets. If we are unable to
compete effectively, our revenue could decline, which would have a material
adverse effect on our business, financial condition, results of operations and
cash flows.

We are exposed to currency exchange risk that could
reduce cash flow available to fund our operations and cause our reported
earnings to fluctuate materially.

Our operating results are sensitive to fluctuations in the
exchange rate of the Canadian dollar to the U.S. dollar, as prices for our
products are largely denominated in U.S. dollars or linked to prices quoted in
U.S. dollars, while most of our operating costs are incurred in Canadian
dollars. Therefore, an increase in the value of the Canadian dollar relative to
the U.S. dollar reduces the amount of revenue we realize, in Canadian dollar
terms, from sales made in U.S. dollars, which reduces our operating margin and
the cash flow available to fund our operations.

In addition, we are exposed to currency exchange risk on our
debt, including the Senior Notes and interest thereon, and current assets
denominated in U.S. dollars. Since we present our financial statements in
Canadian dollars, any change in the value of the Canadian dollar relative to the
U.S. dollar during a given financial reporting period would result in a foreign
currency loss or gain on the translation of our U.S.-dollar-denominated debt and
assets into Canadian dollars. Consequently, our reported earnings could
fluctuate materially as a result of foreign-exchange translation gains or
losses.

To mitigate the impact of foreign-exchange volatility on our
earnings, we may enter into currency contracts to partially hedge our exposure
to fluctuations in exchange rates. However, hedging transactions may not be
successful in materially reducing our exposure to exchange rate
fluctuations.

Trade actions that may be taken against Canadian softwood
lumber shipments to the United States following the expiry of the Softwood
Lumber Agreement and its standstill provision period could have a negative
effect on our profitability.

The 2006 Softwood Lumber Agreement (SLA) resolved litigation
arising from, and trade measures imposed following, the March 2001 expiry of a
prior softwood lumber trade agreement between Canada and the United States.
Effective for a term of seven years commencing in October 2006 and then extended
for two additional years to October 2015, the SLA brought about the revocation
of American countervailing and anti-dumping duties on Canadian lumber shipments
to the U.S.

Under the SLA, export charges were imposed on Canadian lumber
shipments to the U.S. in months when the market price of lumber was at or below
US$355 per thousand board feet, and additional surge penalties were imposed on
shipments from certain regions, including Alberta, when shipments from that
region exceed a prescribed level in a given month. The export charges varied
according to the market price of lumber, and ranged from 0 to 15%; the
additional surge penalties, when applied, were set at 50% of the current export
charge and so ranged from 0 to 7.5% .

The SLA expired on October 12, 2015, commencing a 12-month
period during which no trade measures could be imposed, in accordance with the
terms of a standstill provision included in the agreement. In November 2016, a
coalition of U.S. lumber producers filed a petition asking the U.S. Department
of Commerce to investigate Canadian lumber shipments with a view to potentially
implementing new trade actions. This investigation is expected to result in
countervailing or anti-dumping duties, the magnitude of which are uncertain,
being applied to shipments of Canadian lumber to the U.S.

12

---

Sales of lumber to the U.S. represent a significant source of
our revenue, accounting for approximately 34% of lumber segment revenue in 2016.
Any new trade measures imposed by the U.S., such as export duties, could
therefore have a material adverse effect on our business, financial condition,
results of operations and cash flows.

An increase in our fiber costs could have a negative
impact on our earnings.

The availability of an economic fiber supply is one of the most
important factors affecting the performance of forest products companies. The
costs of our fiber, including fees charged by government, logging and
transportation costs, and market prices for purchased fiber, have historically
fluctuated and could increase in the future. Any significant increase in the
cost of fiber could have a material adverse effect on our business, financial
condition, results of operations and cash flows.

The government imposes fees, referred to as stumpage, on all
timber harvested on government-owned land and also holds companies responsible
for reforestation and reclamation costs. Amendments to government legislation or
regulatory regimes may change stumpage-fee structures payable in relation to the
harvesting of timber and could increase costs through the imposition of
additional or more stringent reforestation and silvicultural standards. A
material increase to the stumpage rates applicable to the Millar Western FMA,
our Coniferous Timber Quotas or our Deciduous Timber Allocations could have a
material adverse effect on our business, financial condition, results of
operations and cash flows.

While approximately 82% of our fiber requirements are met
through our government timber allocations and fiber exchange and supply
agreements with other companies, we purchase the balance of our fiber
requirements on the open market. Accordingly, our operations could be affected
by changes in the supply and demand for, and the prices of, purchased fiber.

We rely on independent contractors to harvest timber and haul
logs from the forest to our operations. Contractor compensation and availability
could negatively affect costs and also could impede our ability to maintain
sufficient log supplies in our yards to sustain current mill operating rates.
Delivered timber costs are also affected by variable fuel prices and log-haul
distances. Higher fiber costs could have a material adverse effect on our
business, financial condition, results of operations and cash flows.

Our ability to harvest timber is subject to natural
events that are beyond our control and that could have a negative impact on our
operations.

Our ability to harvest timber is subject to natural events such
as forest fires, adverse weather conditions, insect infestation, disease and
prolonged drought. The occurrence of any of these events could adversely affect
our ability to harvest timber, which could have a material adverse effect on our
business, financial condition, results of operations and cash flows.

In response to a mountain pine beetle infestation, the Alberta
government and forest industry have implemented an action plan that has been
effective to date in curbing beetle spread and mitigating associated damage.
However, the infestation remains an ongoing risk to the health of mature pine
stands in our operating area. Any significant impacts on merchantable pine
stands in our area could affect our fiber supply and have a material adverse
effect on our business, financial condition, results of operations and cash
flows.

If environmental or other regulatory approvals, licenses
or permits are delayed, restricted or not renewed, a variety of operations on
our timberlands or at our facilities could be delayed or restricted.

In connection with a variety of operations on our properties,
we are required to make regulatory filings with governmental agencies. Any of
these agencies could delay review of or reject any of our filings, which could
delay or restrict our manufacturing or logging operations, potentially resulting
in an adverse effect on our operating results. For example, our pulp mill
operates under an environmental permit that is due to expire on November 1,
2017, if not renewed on or before that date. We have initiated the renewal
procedure for our pulp mill operating permit and expect to obtain the renewal on
a timely basis, but if we are unable to renew or extend this or any other
material approval, license, permit or certificate, or if we are delayed in doing
so, our business, financial condition, results of operations and cash flows
could be materially adversely affected.

13

---

Our ability to sell our products could be compromised if
environmental certifications are not achieved or renewed, which could have a
negative impact on our business, financial condition, results of operations and
cash flows.

Sales of our products, especially pulp, are increasingly
dependent upon our ability to achieve and maintain certification under
internationally recognized standards for sustainable forest management and
wood-fiber chain of custody. Certifications that we currently hold may be
terminated for failure to meet the requirements of the certification standard,
which could result in lost product sales. As well, existing standards could
become more onerous or new certifications may be deemed necessary in order to
meet customer requirements, resulting in additional costs. Any of these
developments could cause our business, financial condition, results of
operations and cash flows to be materially adversely affected. For more details
regarding our certifications, see Item 4, Business Overview  Government
regulation  Forest certification.

Company-specific Risks

We may not have the capital required to maintain our
facilities and grow our operations.

Facilities for producing lumber and pulp are capital intensive.
Our annual capital expenditures may increase due to changes in requirements for
maintenance, unforeseen events, and changes to environmental or other
regulations that require capital for compliance. Although we maintain our
production equipment with regular, scheduled maintenance, key pieces of
equipment in our various production processes may need to be repaired or
replaced before such repair or replacement is scheduled. If we do not have
sufficient funds or such repairs or replacements are delayed, the costs of
repairing or replacing such equipment and the associated downtime of the
affected production line could have a material adverse effect on our business,
financial condition, results of operations and cash flows.

We may not realize all savings and revenues expected to
result from the Bioenergy Effluent Project.

Our Whitecourt pulp mill has substantially completed and is
currently commissioning a project (the Bioenergy Effluent Project, or BEP) that
has installed new technology to produce a biogas used to generate renewable
energy that will displace a portion of the purchased electricity and natural gas
used in our mill operations. The project was implemented to enhance pulp mill
environmental performance, in part by reducing greenhouse gas emissions, and to
strengthen mill economic performance, by cutting operating costs and increasing
revenues. Project costs as of December 31, 2016, net of $27.7 million in
government grants and a $7.8 million letter of credit recovered from the
original EPC contractor, were $86.8 million. We expect to spend an additional
net amount of approximately $1.0 million on the project in 2017, funded through
cash from operations.

A reduction in our fiber supply could affect our ability
to operate.

Fiber is the primary raw material in our products, and
maintaining long-term fiber security is therefore important to our business. We
obtain approximately 56% of our fiber requirements, based on current production
capacity, from a Forest Management Agreement (FMA), Coniferous Timber Quotas and
Deciduous Timber Allocations issued by the Alberta Minister of Agriculture and
Forestry, each of which is issued for a period of 20 years and is renewable,
provided agreement obligations are met. Our FMA is in effect until 2034. Our
quotas and allocations have expiry dates ranging between 2021 and 2028. The FMA,
quotas and allocations may not be renewed or extended on acceptable terms. In
addition, the FMA, quotas and allocations contain terms or conditions that
could, under certain circumstances, result in a reduction in the amount of fiber
available to us. Any significant reductions to fiber available under our FMA,
quotas and allocations could affect our ability to maintain current mill
operating rates.

The Millar Western FMA provides that the Minister may withdraw
from the forest management area (i) any land which cannot be harvested without
causing substantial harm to the environment, (ii) any land determined to be
required for human or physical resource development of the Province of Alberta,
(iii) any land required for commercial and industrial facilities and (iv) any
land that is not capable of producing timber. In the event of such withdrawal,
the government may compensate the holder for certain costs and losses associated
with such withdrawal. There have been no material withdrawals of land from the
Millar Western FMA since its inception.

14

---

In 2005, the Government of Alberta introduced the Healthy Pine
Strategy, which called for increased harvesting levels in mature and over-mature
pine stands to reduce their vulnerability to infestation by the mountain pine
beetle and to improve overall forest health. Under the strategy, companies have
been permitted to harvest volumes in excess of historical annual allowable cut
(AAC) volumes to address the infestation concern; however, to ensure long-term
sustainability of the forest resources, companies employing these surge cuts are
expected to undergo a reduction in their AAC in future years. In the 2007-2016
period, AAC for our Whitecourt and Fox Creek tenure areas was adjusted to
reflect the Healthy Pine Strategy, resulting in AAC increases of an average of
40% in our FMA and six of our Coniferous Timber Quotas. AAC reductions are
expected to begin taking effect in our FMA area in 2017 and in the affected
Coniferous Timber Quotas during the period 2024 to 2028, with the amount of
these reductions yet to be determined. To mitigate these potential reductions,
we have implemented a series of intensive forest management practices to improve
forest growth and yield; however, we expect to have to supplement our existing
timber supply with additional open-market timber purchases starting in 2017, the
availability and cost of which are unknown at this time.

The Government of Alberta has initiated the Land-Use Framework
process to manage competing land-use pressures. The government has divided the
province into seven regions and intends to develop land-use plans for each, with
the aim of balancing economic, environmental and social demands. While we view
this process as potentially beneficial in providing greater long-term certainty
regarding resource development, it presents a risk in that the government could
reduce the amount of land allocated to the forest products industry for timber
production and may not compensate us for any volume reductions that result. A
significant loss of fiber supply resulting from this process, whether directly
or through reductions in fiber available for purchase on the open market, could
have a material adverse effect on our business, financial condition, results of
operation and cash flows.

The Government of Canada has enacted legislation aimed at
protecting species at risk, including woodland caribou. Woodland caribou ranges
overlap forest management areas in which some of our Coniferous Timber Quotas
are embedded. Caribou range planning processes currently being undertaken by the
Alberta government, in consultation with industry and other stakeholders and in
consideration of both federal and provincial legislative requirements, have the
potential to reduce the supply of timber available from these areas. Any
significant loss of fiber supply resulting from this process, whether directly
or through reductions in fiber available for purchase on the open market, could
have a material adverse effect on our business, financial condition, results of
operation and cash flows.

In addition to fiber from government tenures, we also rely on
fiber acquired through multi-year exchange and supply contracts to satisfy
approximately 26% of our requirements. These multi-year fiber agreements expire
between 2019 and 2021. While all are renewable, we may not be able to extend
these contracts beyond their expiry. If these contracts are not renewed or are
modified due to government policy or regulatory changes, we may be without
sufficient fiber to maintain current production levels, which could have a
material adverse effect on our business, financial condition, results of
operation and cash flows. On April 27, 2016, we received notice of force majeure
related to a log-chip exchange agreement we have in place with another forest
company under which we have received a total of 665,000 cubic meters per year of
logs from the other company's Forest Management Agreement area. In the notice of
force majeure, we were advised this log volume will be reduced to 500,000 cubic
meters per year, effective May 1, 2016. Under the same exchange agreement,
Millar Western has delivered 170,000 bone dry units per year of chips to the
other company; with force majeure invoked, this volume will be reduced to
135,000 bone dry units.

While we do not expect this change to affect our operations in
the near-term, it could affect our long-term fiber supply. We are pursuing
options to purchase fiber on the open market and will manage our internal
allocations to ensure the least disruption to our operations. We have secured
sales for the excess chip volume in the short-term and are pursuing options to
address the excess volume over a longer time frame.

Under the terms of the multi-year fiber exchange and supply
contracts, we provide other companies with wood residuals. If these contracts
are not renewed upon expiry, we could incur revenue reductions and/or additional
disposal costs. Fiber availability or manufacturing disruptions could also
impair our ability to provide these residuals in specified quantities and put us
in breach of contractual obligations. These outcomes could have a material
adverse effect on our business, financial condition, results of operations and
cash flows.

15

---

Exposure to fluctuations in electricity prices could
adversely affect our profitability.

On January 1, 2001, we entered into two Power Syndicate
Agreements (Battle River and Sundance C, respectively) with an affiliate of
Capital Power Corporation (formerly EPCOR Utilities Inc.) and three other
industrial participants in Alberta for the purpose of sharing the rights and
responsibilities defined in two corresponding Power Purchase Arrangements, which
we referred to as our power purchase rights. In May 2006, we consolidated our
power purchase rights by swapping our interest in the Battle River agreement for
an increased interest in the Sundance C agreement and the corresponding Power
Purchase Arrangement, which we refer to as the PPA. On March 24, 2016, Capital
Power Corporation gave notice of its intent to terminate its role as buyer of
the Sundance C PPA, citing significant changes to the Specified Gas Emitters
Regulation in Alberta that had impaired its ability to realize benefits from the
arrangement. As a result of this termination, our role as a party to the PPA
syndicate was also terminated. The Government of Alberta subsequently challenged
the termination and entered into related negotiations with Capital Power
Corporation. On November 28, 2016, Capital Power Corporation announced it had
reached an agreement with the Government of Alberta to settle the PPA dispute.
Under the settlement, the government accepted the termination of the PPA,
thereby ending all of our benefits and obligations associated with the PPA.

The PPA had reduced our exposure to fluctuations in market
electricity rates. With its termination, we became exposed to these
fluctuations, which could have a material adverse effect on our business,
financial condition, results of operations and cash flows.

Environmental and other government legislation and
regulations could increase our cost of doing business or restrict our ability to
conduct our business.

We are subject to a wide range of general and industry-specific
environmental and other laws and regulations imposed by federal, provincial and
local authorities in Canada, including those governing the use, storage,
handling, generation, treatment, emission, release, discharge and disposal of
certain hazardous materials and wastes, the remediation of contaminated soil and
groundwater, and the health and safety of employees. We are also subject to
reforestation requirements and had an accrued liability of $11.7 million at
December 31, 2016 (2015  $12.4 million, 2014  $14.6 million), for future
reforestation obligations.

Our failure to comply with applicable environmental and safety
laws and regulations, and associated permit requirements, could result in civil
or criminal fines or penalties or enforcement actions, including regulatory or
judicial orders enjoining or curtailing operations or requiring corrective
measures, installation of equipment or remedial actions, any of which could
result in significant capital expenditures or reduced results of operations. In
addition, future events, such as any changes in environmental or other laws and
regulations, including any new legislation that might arise or any change in
interpretation or enforcement of laws and regulations, may result in additional
expenditures or liabilities. These could have a material adverse effect on our
business, financial condition, results of operations and cash flows.

In the province of Alberta, power consumers are responsible for
electricity distribution and transmission costs. Given that we are a major
electricity consumer, recent and projected investments in transmission
infrastructure could result in significant escalation of our transmission
costs.

Under the Climate Change and Emissions Management Act, the
Government of Alberta has set out intensity-based carbon emissions reduction
targets. Facilities that release 50,000 to 100,000 tonnes of CO2equivalent (CO2e) per year are required to report their
emissions but are not currently subject to reduction requirements. Large
emitters, defined as those producing more than 100,000 tonnes of CO2e
per year, are required to reduce their emissions intensity by 15% in 2017 and
20% in 2018, compared to 2007 levels. In lieu of reductions, organizations can
remit to a technology fund the amount of $20 during 2017 and $30 beginning in
2018 for every tonne of CO2e generated over a specified limit or buy an
equivalent amount of provincially-approved offset credits. In recent years, our
Whitecourt pulp mill has released approximately 75,800 tonnes of CO2e
per year, making us responsible for reporting our emissions, though not
currently subject to a requirement to reduce the emissions or to pay penalties
or purchase offsets in association with them.

Our PPA was linked to a coal-fired electricity plant that
qualified as a large emitter, making us responsible, during the period of the
agreement, for a portion of penalties associated with its CO2e
emissions. In 2016, we were responsible for approximately 28,779 tonnes of CO2e
emissions associated with the PPA. In some previous years, we addressed this
obligation by applying offset credits earned through an energy-reduction project
conducted in our mill operations and independently verified and registered with
provincial authorities. In 2016, we elected to pay the $20/tonne penalty and to
bank offset credits for use in future periods, when carbon penalties are
expected to rise in accordance with plans announced by the Government of
Alberta.

16

---

In 2015, the Alberta government announced that it would
increase the levy paid by large emitters from $15/tonne of CO2e
emitted to $20/tonne, starting in 2017, and that it would introduce a
province-wide carbon levy of $20/tonne in 2017 and increase the levy to
$30/tonne in 2018. Associated costs may have a material adverse effect on our
business, financial condition, results of operations and cash flows. The
government may take additional future measures that could negatively affect us,
for example, by lowering the emissions threshold defining large emitters,
which could require our pulp mill not only to report but to reduce, pay for or
offset emissions over a specified threshold, or by further increasing the
penalties that apply to these emissions. Such regulatory changes could increase
our costs and have a material adverse effect on our business, financial
condition, results of operations and cash flows.

Our business is subject to many operational risks for
which we may not be adequately insured.

Our business is subject to the risks associated with operating
pulp mills and sawmills and with logging, such as unforeseen equipment
breakdowns, power failures, fires, floods, environmental issues, severe weather
and other events that could result in a temporary or prolonged shutdown of any
of our operations. A shutdown at any of our operations could materially
adversely affect our business, financial condition, results of operations and
cash flows. Although we maintain insurance, including business interruption
insurance, we may incur losses beyond the limits of, or outside the coverage of,
such insurance. From time to time, various types of insurance for companies in
the pulp and lumber industries have not been available on commercially
acceptable terms or, in some cases, have been unavailable. For example, we
cannot insure against losses of standing timber from any cause, including fire,
and insurance against certain environmental risks may not be available on
commercially acceptable terms. In addition, premiums for our existing coverage
may increase substantially, and we may be unable to maintain our current
insurance coverage.

We have significant indebtedness, which could weaken our
financial condition and limit our ability to fulfill our obligations under our
outstanding indebtedness.

We have a significant amount of indebtedness and significant
debt service obligations. This high degree of leverage could have important
consequences. For example, it could:

- make it more difficult for us to satisfy our obligations with respect to
  our outstanding indebtedness;
- increase our vulnerability to adverse economic and industry conditions;
- require us to dedicate a substantial portion of cash from operations to
  the payment of debt service, thereby reducing the availability of cash to fund
  working capital, capital expenditures and other general corporate purposes;
- limit our ability to obtain financing for working capital, capital
  expenditures, general corporate purposes or acquisitions;
- place us at a disadvantage compared to our competitors that have a lower
  degree of leverage; and
- limit our flexibility in planning for, or reacting to, changes in our
  business and in the forest products industry.

We may not generate cash flow sufficient to service all
of our obligations.

Our ability to make payments on and to refinance our
indebtedness, and to fund our operations, working capital and capital
expenditures, depends on our ability to generate cash in the future. Our cash
flow is subject to general economic, industry, financial, competitive,
operating, regulatory and other factors that are beyond our control. Our
business may not generate cash flow in an amount sufficient to enable us to
repay our indebtedness or to fund our other liquidity needs. We may need to
refinance all or a portion of our indebtedness on or before maturity. Our
ability to refinance our indebtedness or obtain additional financing will depend
on, among other things:

- our financial condition at the time;
- restrictions in the indenture governing our Senior Notes and the terms
  governing our revolving credit facility; and

17

---

- other factors, including the condition of the financial markets or the
  forest products industry.

If we do not generate sufficient cash flow from operations, and
if additional borrowing, refinancing, or proceeds of asset sales are not
available to us, then we may not have sufficient cash to enable us to meet all
of our obligations.

We may be able to incur additional indebtedness, which
could further exacerbate the risks associated with our substantial indebtedness.

Although the terms governing our revolving credit facility and
the indenture governing the Senior Notes (the indenture) contain restrictions
on the incurrence of additional indebtedness, additional indebtedness incurred
in compliance with these restrictions could be substantial. As at December 31,
2016, we would have been permitted to borrow up to $38.1 million under our
revolving credit facility. In addition, the indenture does not prevent us from
incurring obligations, such as trade payables and operating leases, that do not
constitute indebtedness. If we incur additional indebtedness or other
obligations, the related risks could be magnified.

The agreements governing our indebtedness contain
significant restrictions that limit our operating and financial flexibility.

The agreements governing our indebtedness contain covenants
that, among other things, limit our ability to:

- incur additional indebtedness;
- pay dividends and make distributions;
- repurchase stock;
- make certain investments;
- transfer or sell assets;
- create liens;
- enter into transactions with affiliates;
- issue or sell stock of subsidiaries;
- create dividend or other payment restrictions affecting restricted
  subsidiaries; and
- merge, consolidate, amalgamate or sell all or substantially all of our
  assets to another person.

In addition, our revolving credit facility requires us to
maintain specified financial ratios, and we may be unable to meet such ratios.
All of these covenants may limit our ability to execute our business strategy.
Moreover, we may be unable to comply with these covenants. If that occurs, our
lenders could accelerate our indebtedness, in which case, we may not be able to
repay all of our indebtedness.

Our sole shareholder has the ability to direct our
operations, and its interests may conflict with the interests of the Senior
Noteholders.

Our parent, Industries, holds, directly and of record, all of
our outstanding common shares. Millar Western Industries Ltd. is wholly owned by
Hualkeith Investments Ltd., a corporation owned by our co-chairmen of the board
of directors, brothers James B. Millar and H. MacKenzie Millar, and other
members of the Millar family. James B. Millar and H. MacKenzie Millar together
control 55.6% of the outstanding equity of Hualkeith. The Millar family may have
interests that differ from those of the Senior Noteholders and, therefore, may
make decisions that are adverse to their interests.

The ability to enforce civil liabilities in Canada under
U.S. securities laws may be limited.

We are incorporated under the federal laws of Canada and
substantially all of our assets are located in Canada. All of our directors and
officers reside in Canada, and most of their assets are located in Canada. It
may not be possible, therefore, to effect service of process within the United
States upon us or our directors and officers. There is uncertainty as to the
enforceability (1) in an original action in Canadian courts, of liabilities
predicated solely upon United States federal securities laws and (2) of
judgments of United States courts obtained in actions predicated upon the civil
liability provisions of United States federal securities laws in Canadian
courts. Therefore, persons in the United States may not be able to secure
judgment against us or our directors and officers in a Canadian court or, if successful in securing a judgment against us or them in a
U.S. court, may not be able to enforce such judgment in Canada.

18

---

Risks Related to the Note Exchange Transaction

The consummation of the Note Exchange Transaction may not
occur for a number of reasons, including as a result of a termination of the
Support Agreement

The Company will not complete the Note Exchange Transaction
unless and until all conditions precedent to the Note Exchange Transaction, some
of which are not under the Companys control, are satisfied or waived. Even if
the Note Exchange Transaction is completed, it may not be completed on the
schedule or in the manner currently anticipated. If the Note Exchange
Transaction is not completed on the timeline anticipated or on the terms
currently anticipated, the Company may incur additional expenses.

Although the Supporting Noteholder has agreed to vote in favor
of the Note Exchange Transaction, there can be no assurance that other
creditors, securityholders or third parties will not seek to challenge, oppose
or delay the Note Exchange Transaction, or the ability to implement the Note
Exchange Transaction under the CBCA, nor can there be any assurance that such
parties would not be successful in such challenge, opposition or delay.

The Support Agreement may be terminated by the Company or the
Supporting Noteholder in certain circumstances. Accordingly, there is no
certainty, nor can the Company provide any assurance, that the Support Agreement
will not be terminated by either the Company or the Supporting Noteholder before
the completion of the Note Exchange Transaction, which may result in the Note
Exchange Transaction not proceeding.

The Note Exchange Transaction may not improve the
Companys financial condition to the extent anticipated

The Note Exchange Transaction is intended to enhance the
Companys capital structure and liquidity and provide it with continued
financial flexibility. However, the foregoing is contingent on many assumptions
that may prove to be incorrect, including without limitation:

- the ability of the Company to succeed in continuing to implement its
  business plan;
- that general economic conditions will not deteriorate beyond currently
  anticipated levels;
- that the Companys sales and relationships with suppliers, customers and
  contractors will not be materially adversely affected while the Note Exchange
  Transaction is underway or as a result of such Note Exchange Transaction; and
- the Companys ability to manage costs.

Should any of those assumptions not materialize, the Note
Exchange Transaction may not have the effect of providing the Company with the
financial flexibility expected or required to implement its business plan.

The Company currently expects to pursue an alternative
transaction if the Note Exchange Transaction is not completed

In the event that the Company does not complete the Note
Exchange Transaction, the Company currently expects that it will enter into an
alternative deleveraging transaction with the Supporting Noteholder involving an
exchange of the Notes held by the Supporting Noteholder into new secured notes
of the Company. Any such new secured notes issued to the Supporting Noteholder
would be effectively senior to the Notes to the extent of the value of the
collateral securing such new secured notes. As a result, any such alternative
transaction could have a material and adverse impact on the value of the Notes.

The non-implementation of the Note Exchange Transaction
could create liquidity risks and force the Company to pursue other alternatives
that could have a negative effect on the Company

If the Note Exchange Transaction is not implemented and
business operations of the Company continue at their current levels, the Company
may not be able to generate sufficient cash flows to repay or refinance its
outstanding indebtedness when it matures without raising additional
capital. In the current market conditions and the Companys financial condition,
the Company can give no assurance that additional capital will be available on
favorable terms, or at all. If the Company defaults under the terms of certain
of its indebtedness, the Noteholders could declare all outstanding principal and
interest to be due and payable, our lenders could terminate their commitments
under our credit agreement to loan money and foreclose against the assets
securing such borrowings and the Company could be forced into bankruptcy or
liquidation. Further, in the event that the Note Exchange Transaction is not
implemented, the Company may be required to pursue other alternatives that could
have a more negative effect on the Company and its stakeholders, including
non-consensual proceedings under creditor protection legislation.

19

---

ITEM 4: INFORMATION ON THE COMPANY

A.      History and Development of
the Company

We were incorporated as Millar Western Forest Products Ltd.
under the Business Corporations Act(Alberta) on September 8, 1997, and
on February 28, 2017 we were continued under the Canada Business Corporations
Act. On May 13, 1998, we acquired all of the forest products operations of
our parent company, Millar Western Industries Ltd. (Industries) and its
subsidiaries. The predecessor of Industries was first incorporated in 1919 and
began lumber operations in the Whitecourt area in 1922. Industries completed
construction of the Whitecourt pulp mill in 1988 and acquired the Boyle sawmill
in 1993. We completed construction of the current Whitecourt sawmill in 2001. We
acquired the Fox Creek sawmill in 2007, and rebuilt it in 2010-11 at a cost of
approximately $60 million, $38 million of which was provided through an
insurance settlement. We sold the Boyle sawmill and associated assets in
December 2015, for a total value of $32.2 million, which included $1.5 million
of working capital and $2.2 million of accrued reforestation liability
transferred to the purchaser. We have substantially completed construction of a
bioenergy facility at our Whitecourt pulp mill and, at December 31, 2016, had
spent a total of $86.8 million on the project, net of government grants and a
letter of credit recovered from the original EPC contractor. We expect to spend
an additional $1.0 million in 2017, funded through cash from operations.

Our head office is located at 16640 - 111 Avenue, Edmonton,
Alberta, T5M 2S5, and our registered office is located at Goodmans LLP, Bay
Adelaide Centre, 333 Bay Street, Suite 3400, Toronto, Ontario, M5H 2S7. Our
telephone and facsimile numbers are (780) 486-8200 and (780) 486-8282,
respectively. Our authorized capital consists of an unlimited number of common
shares, of which 15,000,002 were issued and outstanding as at December 31,
2016.

Our agent for service of process in the United States is CT
Corporation System, 111 8th Avenue, New York, New York 10011, (212)
894-8700.

B.      Business Overview

We are an integrated forest products company active in Alberta,
Canada, that produces and markets softwood lumber and hardwood and softwood
bleached chemi-thermo-mechanical pulp, or BCTMP. We own and operate three
production facilities in Alberta, including a sawmill and a BCTMP mill at an
integrated complex in Whitecourt and a sawmill in Fox Creek. We previously owned
and operated a sawmill at Boyle, Alberta; that facility was sold to a third
party effective December 22, 2015, and we continued to operate it until February
19, 2016, when the processing of existing log and lumber inventories was
completed. We are currently completing commissioning and startup of a newly
constructed bioenergy project (the BEP) at the Whitecourt BCTMP mill that will
convert organic matter in pulp mill waste into renewable energy for consumption
by our pulp operations. The project is expected to be fully operational in the
second quarter of 2017.

Our sawmills produce kiln-dried dimension lumber from spruce,
pine and fir, or SPF, timber for the residential and commercial construction
industries. We also produce higher-margin grades, such as machine-stress-rated,
or MSR, lumber for load-bearing applications, as well as specialty products,
such as decking. Under our current operating strategy, our sawmills have a
combined annual capacity of 450 million foot board measure (mmfbm), with the
Whitecourt and Fox Creek facilities having individual annual capacities of 330
mmfbm and 120 mmfbm, respectively. Our Boyle sawmill, sold in December 2015, had
operated at rate of 80 mmfbm per year. Our lumber is sold principally in Canada
and the United States; China is also a regular destination for our products, and
a small volume of certain higher-margin grades is shipped to Japan.

20

---

Our Whitecourt pulp mill produces hardwood, softwood and
blended grades of pulp and has an annual production capacity of 320,000 air
dried metric tonnes (admt). Our BCTMP is sold internationally for use in the
production of a diverse range of paper products, including coated and uncoated
printing and writing papers, paperboard, specialty papers, tissue and
toweling.

Recent Developments

On March 7, 2017, the Board of Directors of the Company (the
Board of Directors) approved a transaction (the Note Exchange Transaction)
whereby the Companys existing $210 million aggregate principal amount of 8.50%
senior notes due 2021 (the Existing Notes) would be exchanged for 9.0% senior
secured notes due 2022 to be issued by the Company (the New Secured Notes). In
connection with the Note Exchange Transaction, the Board of Directors also
approved an agreement with certain funds affiliated with Atlas Holdings, LLC
(collectively, the Supporting Noteholder), which beneficially owns
approximately 36% of the Existing Notes, pursuant to which the Supporting
Noteholder would, among other things, support the Note Exchange Transaction and
to vote in favor of the Note Exchange Transaction at the Meeting (as defined
below).

If the Note Exchange Transaction is consummated, each
Noteholder would receive, on the implementation of the Note Exchange
Transaction, New Secured Notes in a principal amount equal to 50% of the
principal amount of Existing Notes held by such Noteholder as at the voting
record date. In addition, each Noteholder that votes in favor of the Note
Exchange Transaction on or before March 31, 2017 would receive additional New
Secured Notes (the Early Consent Notes) in a principal amount equal to 5% of
the principal amount of Existing Notes held by such Noteholder as at the voting
record date. The New Secured Notes would be secured by a first lien on
substantially all of the assets and property of the Company, with the exception
of accounts receivable and inventory (the Priority Collateral). The New
Secured Notes would also be secured by a second lien on the Priority Collateral,
which Priority Collateral would continue secure the companys revolving credit
facility on a first-lien basis.

It is a condition to the implementation of the Note Exchange
Transaction that the Supporting Noteholder will agree to exchange the
approximately US$41.7 million aggregate principal amount of New Secured Notes it
receives pursuant to the Note Exchange Transaction for 80% of the common shares
of the Company (the Share Exchange Transaction). If the Note Exchange
Transaction and the Share Exchange Transaction are consummated, the long-term
indebtedness of the Company would be reduced from US$210 million of Existing
Notes to approximately US$71 million of New Secured Notes. In addition, annual
cash interest costs in respect of the Companys long-term indebtedness would be
reduced from approximately US$18 million per year to approximately US$6 million
per year.

The Note Exchange Transaction would be implemented by way of
the Plan of Arrangement under the CBCA and would be expected to be completed by
the end of April, 2017.

Completion of the Note Exchange Transaction will initially be
subject to the Ontario Superior Court of Justice (Commercial List) (the Court)
issuing an interim order authorizing, among other things, the holding of a
meeting of Noteholders to vote on the Plan of Arrangement (the Meeting), the
mailing of information packages to Noteholders, the procedure for submitting
voting instructions in respect of the Plan of Arrangement, eligibility
requirements to receive Early Consent Notes, and certain other procedural
matters.

Provided the interim order is granted by the Court, the Note
Exchange Transaction would then be subject to, among other things, approval of
the Plan of Arrangement by the affirmative vote of at least 662/3% of the votes
cast by Noteholders present in person or by proxy at the Meeting, approval of
the Plan of Arrangement by the Court, the receipt of all necessary regulatory
approvals, if any, and the satisfaction or waiver of other conditions pursuant
to the Plan of Arrangement. If all requisite approvals are obtained, the Plan of
Arrangement will bind all Noteholders.

In connection with the transactions described above, on March
7, 2017, the Board of Directors also approved a consent acknowledgment (the
Consent Acknowledgment) with the lender under our revolving credit facility
(the Bank Lender) pursuant to which the Bank Lender would consent to, and
waive any default under our revolving credit facility in respect of, the Note
Exchange Transaction and the Share Exchange Transaction, and the Company would
agree to grant the Bank Lender a second-lien security interest in substantially
all of our assets and property other than the Priority Collateral. Pursuant to
the Consent Acknowledgment, the Company and the Bank Lender would also agree to
certain amendments to our revolving credit facility, including certain financial
covenants.

21

---

Principal markets

Our production of both pulp and lumber provides a diversified
revenue base. From 2012 to 2016, 50% of our total revenue came from pulp sales
and 50% came from lumber sales. This balance of pulp and lumber production has
enabled us to weather cyclical swings in each of the two distinct markets. In
addition, the geographic and product-line diversity of our customers mitigates
the impact of a downturn in demand in any one region or product category.

The geographic distribution of our revenue for the periods
indicated is shown in the following table.

Distribution of Sales Revenue, by Geographic Region

|              | 2016 | 2015 | 2014
|------------- | ---- | ---- | ----
|              |      |      |     
|Canada        | 26%  | 31%  | 30% 
|China         | 29%  | 24%  | 25% 
|United States | 23%  | 23%  | 22% 
|Other Asia    | 14%  | 14%  | 14% 
|Europe        | 6%   | 7%   | 7%  
|Other         | 2%   | 1%   | 2%  

Lumber

Our sawmills produce kiln-dried SPF dimension lumber for use in
residential and commercial construction, as well as higher-margin grades, such
as MSR, J-grade and appearance grade, and specialty products, such as rough
decking and fencing. In recent years, we have focused on developing specialty
products that are less subject to commodity price fluctuations. These products
currently represent approximately 12% of our total production and are sold
directly to end users. The remainder of our production is sold through a supply
chain that includes retail stores, stocking distributors and wholesale
companies.

The following table shows the approximate distribution of our
lumber sales by grade.

Distribution of Lumber Sales, by Grade

|                     | 2016 | 2015 | 2014
|-------------------- | ---- | ---- | ----
|                     |      |      |     
|Commodity            | 74%  | 74%  | 74% 
|J-grade & appearance | 8%   | 10%  | 10% 
|MSR                  | 6%   | 4%   | 3%  
|Specialties          | 12%  | 12%  | 13% 

The principal markets for our lumber products are Canada, the
United States, China and Japan. Lumber sales within North America are handled by
sales staff located in our Edmonton corporate office. All offshore sales are
conducted through an international marketing consortium, Interex Forest Products
Ltd. of Vancouver, of which we are a 25% owner.

The following table shows the approximate distribution of our
lumber sales by geographic region.

Distribution of Lumber Sales, by Geographic Region

|       | 2016 | 2015 | 2014
|------ | ---- | ---- | ----
|       |      |      |     
|Canada | 59%  | 57%  | 56% 
|U.S.   | 31%  | 35%  | 36% 
|China  | 7%   | 5%   | 6%  
|Japan  | 1%   | 3%   | 2%  

22

---

In 2016, our five largest lumber customers represented
approximately 48% of all the lumber we sold.

Pulp

Our type of pulp, BCTMP, is sold for use in a wide variety of
applications, including paperboard, coated and uncoated papers, tissue and
towels, and specialty and other papers. Our corporate marketing staff, supported
by an international network of independent sales agents, sells pulp to all major
pulp consuming regions, including Europe, Asia, and North America.

The following table shows the approximate distribution of our
pulp sales by end product.

Distribution of Pulp Sales, by End Product

|                         | 2016 | 2015 | 2014
|------------------------ | ---- | ---- | ----
|                         |      |      |     
|Paperboard               | 64%  | 63%  | 61% 
|Coated & uncoated papers | 22%  | 24%  | 26% 
|Tissue & towel           | 5%   | 5%   | 6%  
|Specialty & other        | 9%   | 8%   | 7%  

BCTMP is used by papermakers in combination with kraft pulps,
primarily to add bulk and opacity to the paper sheet. In recent years, there has
been significant growth in the sale of our pulp for use in multi-ply paperboard.
This increased use of BCTMP in the manufacture of paperboard has also been
evident in rising sales to Asia, a region that has seen strong growth in
paper-making capacity and, particularly, in paperboard capacity.

The following table shows the approximate distribution of our
pulp sales by geographic region.

Distribution of Pulp Sales, by Geographic Region

|              | 2016 | 2015 | 2014
|------------- | ---- | ---- | ----
|              |      |      |     
|China         | 54%  | 52%  | 49% 
|Other Asia    | 28%  | 28%  | 22% 
|Europe        | 10%  | 11%  | 13% 
|North America | 6%   | 6%   | 7%  
|Other         | 2%   | 2%   | 9%  

In 2016, our five largest pulp customers represented
approximately 46% of all the pulp we sold.

Seasonality

We conduct a significant amount of our log harvesting and
hauling in the winter months, creating a seasonal buildup of working capital.
Harvesting usually begins in the fourth quarter, with the balance of harvesting
and most hauling activities occurring in the first quarter of the following
year. The build-up of log inventory over this period is typically valued at
$25-$30 million, with $4-$8 million worth of logs accumulated in the fourth
quarter, depending on weather conditions, and the rest realized in the following
years first quarter. These log inventories are consumed through the year and
reach minimum levels in the third quarter. This seasonal working capital
build-up and reduction has a significant impact on our liquidity through the
year.

Sources and availability of raw material

Fiber

The availability of a secure and economic fiber supply is one
of the most important factors affecting the performance of forest products
companies. Fiber supply self-sufficiency is a key competitive element, because
direct control and management of timber resources largely insulates an
operator from fluctuations in the market price of fiber. Approximately 82% of
the fiber requirement for our pulp mill and sawmill facilities is supplied under
long-term agreements with the Government of Alberta and multiple-year agreements
with other forest products companies. Our agreements with the Alberta government
include a Forest Management Agreement (FMA), Coniferous Timber Quotas and
Deciduous Timber Allocations; our agreements with other forest companies include
a variety of fiber exchange and supply contracts. We purchase the balance of our
fiber requirements on the open market. Our fiber costs are subject to variation
depending on factors including the periods harvesting locations and delivery
distances from forest to mill, weather conditions, and normal competitive market
pressures related to our harvesting and hauling contractors. We pay fees,
referred to as stumpage, to the Alberta government for all fiber harvested from
government-owned lands.

23

---

In May 1997, we entered into an FMA with the Alberta Minister
of Agriculture and Forestry, which we refer to as the Millar Western FMA,
pursuant to which the Minister has granted us rights to manage, establish, grow,
harvest and remove timber on a perpetual sustained yield basis in a designated
area, which we refer to as the Millar Western forest management area. The Millar
Western FMA is in effect for 20 years and is renewable every 10 years thereafter
for additional 20-year terms; the FMA was renewed in 2014 and is currently in
effect until April 30, 2034. The following table sets out our annual allowable
cut (AAC) under our current long-term provincial tenure and fiber available
annually under our other fiber agreements:

Annual Allowable Cut

|                                            |  | Coniferous     |  |  | Deciduous | 
|------------------------------------------- |  | -------------- |  |  | --------- | 
|                                            |  | (cubic meters) | 
|                                            |  |                |  |  |           | 
|Forest Management Agreement
      (1)       |  | 396,000        |  |  | 273,000   | 
|Coniferous Timber Quotas (2)                |  | 533,000        |  |  |          | 
|Deciduous Timber Allocations
      (3)      |  |               |  |  | 154,000   | 
|Exchange agreement and supply contracts (4) |  | 500,000        |  |  | 140,000   | 
|Total annual fiber supply:                  |  | 1,429,000      |  |  | 567,000   | 

| | (1) | Net of third-party allocations. Expires 2034 and is
      renewable every 10 years for additional terms of 20 years. FMA AAC is
      defined within 10-year detailed forest management plans (DFMPs); a new
      DFMP will be submitted to the Government of Alberta in the first quarter
      of 2017 and, once approved, will determine AAC for the 2017-2026
    period
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (2) | Expire 2021 to 2028 and are renewable for additional
      terms of 20 years.                                                                                                                                                                                                                                                                                                
| | (3) | Expire 2027 and are renewable for additional terms of 20
      years.                                                                                                                                                                                                                                                                                                        
| | (4) | Exchange and purchase agreements expire 2019 to
    2021.                                                                                                                                                                                                                                                                                                                    

In addition to deciduous logs, the Whitecourt pulp mill
requires approximately 90,000 bone dry units of coniferous chips per year. This
requirement is supplied entirely by chip residuals from our Whitecourt sawmill,
and the sawmills surplus chips are sent to other manufacturers under multi-year
fiber-exchange agreements.

Electricity

Because electricity represents a significant portion of our
input costs, we took steps at the time of the deregulation of Albertas
electricity market to acquire long-term power purchase rights in order to
insulate our pulp and lumber operations from anticipated market volatility. In
2001, we became a party to a Power Purchase Arrangement (PPA) syndicate led by
Capital Power Corporation. On March 24, 2016, Capital Power Corporation gave
notice of its intent to terminate its role as buyer of the Sundance C Power
Arrangement, citing significant changes to the Specified Gas Emitters Regulation
in Alberta that had impaired its ability to realize benefits from the
arrangement. As a result of this termination, the Companys role as a party to
the Power Purchase Arrangement (PPA) syndicate was also terminated. The
Government of Alberta subsequently challenged the legitimacy of the termination
and entered into negotiations with Capital Power Corporation. On November 28,
2016, Capital Power Corporation announced it had reached an agreement with the
Government of Alberta to settle the PPA dispute. Under the settlement, the
government accepted the termination of the PPA, thereby ending all of our
obligations associated with the PPA.

24

---

Other Commodities

Natural gas.The natural gas used at our facilities is
supplied under annual supply contracts that are subject to market prices. From
time to time, we manage our gas price exposure by entering into commodity price
forward contracts.

Water.Water is supplied under contract to our
Whitecourt facilities by the Town of Whitecourt. The Fox Creek mill supplies its
own water from onsite wells.

Chemicals.Our Whitecourt pulp mills requirements for
hydrogen peroxide, which is the main chemical used in our pulp bleaching
process, are supplied from a plant located in Alberta under an agreement that
provides us with relatively stable pricing over its term, and that will expire
December 31, 2020. Caustic soda, also used in the bleaching process, is provided
by a major producer under a contract that provides for market-based pricing and
that will expire December 31, 2017, but will be automatically renewed on an
annual basis unless cancelled by one of the parties. Other bleaching chemicals
used in our Whitecourt pulp mill are supplied by third parties under varying
contract terms. Magnesium sulphate used in our Whitecourt pulp mill is produced
and supplied by Industries, pursuant to a contract. See Item 7, Section B,
Related party transactions.

Government regulation

Environmental matters

Our operations are regulated primarily by the Environmental
Protection and Enhancement Act (Alberta), which we refer to as the AEPEA, and
the Pulp and Paper Effluent Regulations included within the Fisheries Act
(Canada). We have instituted environmental controls to monitor our operations to
confirm they are in compliance with regulated parameters of both provincial and
federal authorities. Under the AEPEA, our sawmills operate in accordance with
the terms of a code of practice that governs environmental aspects of their
activities, and our pulp mill operates in accordance with an environmental
permit that is due for renewal on or before November 1, 2017. We have initiated
the renewal procedure for the pulp mill operating permit and expect to obtain
the renewal on a timely basis.

Wood waste from the pulp mill and sawmills is transferred to a
third party for use in the manufacture of panelboard or sent to a local
biomass-fueled power station to generate renewable electricity.

The Whitecourt pulp mill has an extended aeration activated
biomass wastewater treatment system. The biomass, or sludge, produced as a waste
product from the system is used as a soil conditioner on agricultural lands. In
addition, the pulp mill has recently completed a bioenergy project in which
anaerobic hybrid digesters have been installed in advance of the existing
aerobic effluent treatment system. The digesters produce a biogas used to
generate renewable energy. In addition to reducing purchased energy costs and
allowing for pulp production increases, the project is expected to reduce
greenhouse gas emissions, freshwater intake and chemical usage, and to improve
the quality of treated wastewater discharged to a local river.

All forest areas we harvest are reforested to the standards
required under the Timber Management Regulations (Alberta). In the five-year
period 2012-2016, we spent $30.9 million on reforestation and as at December 31,
2016, had an accrued liability of $11.7 million for future reforestation.

Climate Change and Emissions Management Act

Under the Climate Change and Emissions Management Act the
Government of Alberta has set out intensity-based carbon emission reduction
targets. Facilities that release 50,000 to 100,000 tonnes of CO2equivalent (CO2e) per year are required to report their
emissions but are not currently subject to reduction requirements. Large
emitters, defined as those producing more than 100,000 tonnes of CO2e
per year, are required to reduce their emissions intensity by a specified
percentage, compared to 2007 levels, in each annual reporting period; the
required reduction was 15% in 2017 and will be 20% in 2018. In lieu of
reductions, organizations can remit to a technology fund a payment for every
tonne of CO2e generated over a specified limit or can buy an
equivalent amount of provincially-approved offset credits; in 2017, the payment
amount was $20/tonne and, in 2018, the amount will be $30/tonne.

25

---

Our Whitecourt pulp mill releases approximately 75,800 tonnes
of CO2e per year, making us responsible for reporting our emissions,
though not currently subject to a requirement to reduce the emissions or to pay
penalties or purchase offsets in association with them. Our PPA was linked to a
coal-fired electricity plant that qualifies as a large emitter, making us
responsible for a portion of penalties associated with its CO2e
emissions. In 2016, we were responsible for approximately 28,779 tonnes of
CO2e emissions associated with the PPA. In some previous years, we have addressed this obligation by applying offset credits
earned through an energy reduction project conducted in our mill operations and
independently verified and registered with provincial authorities. In 2016, we
elected to pay the penalty of $20/tonne and to bank offset credits for use in
future periods, when carbon penalties are expected to rise, in accordance with
plans announced by the Government of Alberta.

Forest certification

To provide independent verification of the sustainability of
our forest management activities and legality of our timber procurement systems,
we have sought certification under several third-party-audited, internationally
recognized environmental standards.

In 1995, our woodlands operations were certified to
FORESTCARE, a comprehensive code of practice developed by the Alberta
forest industry and one of North Americas earliest independently-audited forest
management standards. In 2005, our woodlands environmental management system was
certified to the ISO 14001 standard. Our Whitecourt FMA area was certified to
the Canadian Standards Associations CSA-Z809 standard for sustainable forest
management in 2006. In 2009, rather than renewing our CSA certification, we
elected to seek certification to the Sustainable Forest Initiative (SFI)
standard, due to its greater compatibility with our tenure system. All our
volume and land-based tenures are now certified to the SFI standard. To satisfy
different customer preferences, our operations are certified under two
international chain-of-custody standards: the Programme for the Endorsement of
Forest Certification (PEFC) and the Forest Stewardship Council (FSC).
Chain-of-custody certification assesses wood tracking systems to ensure
responsible timber sourcing.

Standard
    Type
    ExpiryFORESTCARE
    Comprehensive Code of Practices
    January 2018ISO 14001
    Environmental Management System
    January 8, 2018Sustainable Forestry Initiative (SFI)
    Sustainable Forest Management; Fiber Sourcing
    January 8, 2018Forest Stewardship Council (FSC)
    Chain of Custody
    March 27, 2019Programme for the Endorsement of Forest Certification
      (PEFC)
    Chain of Custody
    November 30, 2020


Provincial stumpage fees

The Government of Alberta imposes stumpage fees on all timber
harvested on government-owned land. The timber on such land is owned by the
Province of Alberta, and stumpage fees are a form of harvest tax that is
assessed on a market-based fee structure. Under the stumpage system for
coniferous timber, the amount of the stumpage fee increases or decreases with
the benchmark lumber price of kiln-dried, 2x4, Two-and-Better grade Western SPF.
The stumpage system applies to all logs harvested from the Millar Western FMA
and Coniferous Timber Quotas. Reduced stumpage rates apply to marginal timber,
pulpwood and timber affected by fire or insects. The governments stumpage
system for deciduous timber is also market-based. Stumpage rates do not apply to
wood harvested from private lands.

C. Organizational Structure

Not applicable.

D. Property, Plants and Equipment

We own and operate three production facilities in Alberta: a
sawmill and a BCTMP mill at an integrated complex in Whitecourt, and a sawmill
in Fox Creek. We previously owned and operated a sawmill in Boyle, Alberta,
which we sold to a third party in December 2015.

26

---

Lumber

We own and operate two sawmills, located at Whitecourt and Fox
Creek, Alberta. The sawmills have a combined annual capacity of 450 mmfbm of SPF
lumber, produced for North American and offshore markets in dimensions from 1 x
3 to 2 x 10 and lengths from 8 to 16. The mills products include
construction lumber for residential and commercial uses, MSR lumber for
engineered roofing and load-bearing applications and other higher-value grades,
including J-grade for the Japanese housing market, all sold in dressed form. We
also sell specialty products, including decking, fencing and timbers, in rough
form.

27

---

Sawmill Operating History



Our Whitecourt mill site has been home to a series of sawmills
since 1926. In June 2001, we completed construction of our current mill, at a
total cost of $42.6 million, which was funded from operating cash flow. This
project significantly improved the efficiency of the Whitecourt lumber
operation, increased the quality of its products and reduced its manufacturing
costs. In 2005-2006, we invested $16.6 million in the addition of a new drying
kiln and installation of a small-log line to further increase the efficiency of
processing the smaller-diameter logs that are a significant portion of the
mills total log supply. In addition to the sawmill, our Whitecourt lumber
operations comprise four natural-gas-fired drying kilns and a high-speed planer
mill.

We acquired lumber manufacturing and timber assets at Boyle in
1993, and we upgraded and reopened the facility in 1994 as a two-line sawmill
that had an 80 mmfbm/year-capacity when operating on a single-shift basis. We
sold the Boyle operation to a third party in December 2015 (see Results of
Operations  Year ended December 31, 2015 compared to year ended December 31,
2014, for more detail).

In August 2007, we purchased lumber manufacturing and timber
assets at Fox Creek, including a three-line, 45 mmfbm/year-capacity sawmill, a
planer mill, a kiln, log inventory, mobile equipment and 140,000 cubic
meters/year of timber in quotas and 65,000 cubic meters/year of timber available
through third-party agreements, for a net purchase price of $18 million. On
August 29, 2008, a fire destroyed the sawmill building and its contents. All
assets were covered by a fire insurance policy, which included a replacement
cost provision. In July 2010, we commenced construction of a replacement sawmill
at Fox Creek. The new sawmill, comprising two production lines capable of
producing 120 mmfbm of lumber annually on a one-shift basis, started operation
in late 2011, and was optimized over the course of 2012. We also invested in
other site upgrades, including new technology in the planer mill to increase
yields and lower costs. The total cost of the Fox Creek reconstruction project
was approximately $60 million, of which approximately $38 million was provided
through an insurance settlement.

Pulp

Our BCTMP mill, located at Whitecourt, Alberta, commenced
commercial production in July 1988. The pulp mill was constructed at a cost of
approximately $205 million and was designed to produce 210,000 admt per year.
Since start up, we have increased the production capacity of the plant by 52%,
to 320,000 admt per year, without significant capital investment but through a
focus on mill optimization and continuous improvement.

28

---

BCTMP Mill Operating History



The mill is a two-line facility that uses heat, mild chemicals
and mechanical action to produce totally chlorine-free hardwood (aspen),
softwood (SPF), and blended pulps for use in the production of paperboard,
coated and uncoated printing and writing papers, specialty paper, tissue and
toweling. All hardwood chips used in the pulping process are produced on site,
and all the softwood chips are supplied by the Whitecourt sawmill, located on
the same site.

We are currently completing commissioning of a newly
constructed bioenergy plant at the pulp mill. This project has installed
anaerobic hybrid digesters in advance of the mills existing aerobic effluent
treatment system, to produce a biogas used to generate renewable energy. In
addition to reducing purchased energy costs and allowing for pulp production
increases, the facility is designed to cut greenhouse gas emissions, reduce
freshwater intake and chemical consumption, and improve the quality of treated
wastewater discharged to a local river, among other benefits. Project costs to
December 31, 2016, net of $27.7 million in government grants and a $7.8 million
letter of credit recovered from the original EPC contractor, were $86.8million.
We expect to spend an additional net amount of approximately $1.0 million on the
project in 2017, funded through cash from operations.

29

---

ITEM 5: OPERATING AND FINANCIAL REVIEW AND PROSPECTS

This Managements Discussion and Analysis of our financial
condition and results of operations (MD&A), prepared as of March 7, 2017,
is based upon and should be read in conjunction with our audited financial
statements and the accompanying notes included elsewhere in this annual
report.

The MD&A contains historical information, descriptions of
circumstances and statements about future developments or anticipated financial
results. These forward-looking statements are based on certain assumptions or
expectations that, in turn, are subject to various risks or uncertainties. Such
statements are intended to help readers better understand our financial
performance, but readers should exercise caution in relying upon them in
anticipating our future financial performance. See Special Note Regarding
Forward-Looking Statements.

**A.**       **Results of Operations**

Year ended December 31, 2016 compared to year ended
December 31, 2015

The following table sets out our operating and financial
results for the periods indicated.

30

---

|                                                    |   | Twelve Months Ended |  
|--------------------------------------------------- | - | ------------------- | -
|                                                    |   | Dec.
      31/16    |  
|                                                    |   | (in millions)       |  
|                                                    |   |                     |  
|Statements of earnings
      data:                  |   |                     |  
|Revenue                                             | $ | 385.1               |  
|Cost of products sold                               |   | 268.6               |  
|Freight and other distribution costs                |   | 64.2                |  
|Depreciation and amortization                       |   | 10.3                |  
|General and administration                          |   | 18.3                |  
|Loss on termination of PPA                          |   | 26.6                |  
|Other expense (income)                              |   | 0.3                 |  
|Operating (loss) earnings                           | $ | (3.2                | )
|Foreign exchange gain (loss) on borrowings          |   | 8.7                 |  
|Finance expenses                                    |   | (21.1               | )
|Net loss before income taxes                        | $ | (15.6               | )
|Income taxes recovery                               |   | (7.2                | )
|Net loss                                            | $ | (8.4                | )
|Actuarial gains (losses), net
      of tax recovery |   | 0.4                 |  
|Net loss and comprehensive loss                     | $ | (8.0                | )
|                                                    |   |                     |  
|Reconciliation of Adjusted EBITDA
      data:       |   |                     |  
|Net loss                                            | $ | (8.4                | )
|(Subtract) add                                      |   |                     |  
|Income
      taxes recovery                         |   | (7.2                | )
|Foreign exchange (gain)
      loss on borrowings    |   | (8.7                | )
|Finance
      expenses                              |   | 21.1                |  
|Operating (loss) earnings                           | $ | (3.2                | )
|Depreciation and amortization                       |   | 10.3                |  
|Unrealized other expense
      (income)             |   | 2.4                 |  
|Adjusted EBITDA                                     | $ | 9.5                 |  
|                                                    |   |                     |  
|Other data:                                         |   |                     |  
|Average exchange rate (US$ per
      C$1.00)1       |   | 0.755               |  
|Period end exchange rate (US$
      per C$1.00)     |   | 0.745               |  

|(1) | Average exchange rates are the daily noon Bank of Canada
      foreign-exchange rates, averaged over the period. Period end exchange
      rates are the closing Bank of Canada rate on the last business day of the
      period. The rates are set forth as U.S. dollars per C$1.00 and are the
      inverse of rates quoted by the Bank of Canada for Canadian dollars per
      US$1.00.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our results for 2016 reflect the termination of the PPA to
which we were a party and the subsequent write-down of the PPA asset on our
balance sheet, as well as stronger market conditions in the lumber segment and
an improvement in pulp markets through the course of the year.

31

---

On March 24, 2016, Capital Power Corporation gave notice of its
intent to terminate its role as buyer of the Sundance C Power Purchase
Arrangement (PPA). As a result of this termination, the Companys role as a
party to the PPA syndicate was also terminated. Subsequently, and as reported in
our second quarter results, the Government of Albertas Balancing Pool advised
that it might challenge the validity or the effective date of the termination.
On November 28, 2016, Capital Power Corporation announced an agreement with the
Government of Alberta to settle the PPA dispute. Under the settlement, the
termination of the PPA was accepted, thereby ending all of our associated
obligations, and Capital Power Corporation and its syndicate partners agreed to
pay the Balancing Pool $39.0 million, of which our share was $4.4 million. This
payment was included in our fourth-quarter and year-end financial results as
Loss on termination of PPA. There was no change from the previous disclosures
related to the loans owing to Capital Power Corporation.

At $385.1 million, revenue was up 1.7% from the previous year,
as higher lumber prices and increased pulp shipments outweighed the effects of
lower pulp prices and a decrease in lumber production associated with the sale
of our Boyle sawmill in the fourth quarter of 2015.

Cost of products sold decreased in 2016, primarily due to lower
lumber shipments and reduced energy costs. Freight and other distribution costs
were essentially unchanged, as lower lumber shipments offset higher pulp
shipments.

Other income was down sharply from the amount recorded in 2015,
which had included $17.6 million in proceeds from the Boyle sawmill sale.

Depreciation and amortization declined, reflecting the sale of
the Boyle sawmill and the termination of the PPA. The loss recorded on the PPA
termination was $26.6 million, comprising a $22.2 million balance sheet
write-down and the $4.4 million cash payment to the Balancing Pool.

We posted an operating loss of $3.2 million for 2016, a
decrease from operating earnings of $17.2 million in 2015, with the difference
primarily due to the write-down of the PPA.

Our US$210 million in long-term debt was translated at the
exchange rate of US$0.745/C$ 1.00 on December 31, 2016, compared to US$0.723/C$
1.00 at December 31, 2015, resulting in a foreign exchange gain of $8.7 million
in the period. A $2.2 million decrease in financing expenses for 2016 was due to
the favorable impact of exchange rates on U.S-dollar-denominated interest
payments and the capitalization of $5.3 million of interest associated with the
Bioenergy Effluent Project (BEP) in 2016 compared to $4.0 million in 2015.

We realized a net loss before taxes of $15.6 million, compared
to a net loss of $53.1 million in 2015, which had included a $47.0 million
foreign exchange loss on borrowings. Our 2016 results were subject to income tax
at a statutory rate of 34%, up from 33% in 2015. The effective tax rate for 2016
varied significantly from the statutory rate because of the manufacturing and
processing profits deduction and the non-taxable portion of the unrealized
exchange gain on debt, the non-taxable portion of the losses associated with
termination of the PPA and the effect of future income tax rate reductions.

After a provision for income tax recovery of $7.2 million, we
recorded a net loss of $8.4 million in 2016, compared to a net loss of $52.7
million recorded in 2015.

Adjustments through comprehensive income are actuarial
valuation changes that are presented net of income tax in accordance with IAS
19R. We recorded an actuarial gain of $0.4 million related to changes in a
defined-benefit pension plan which resulted in a comprehensive loss of $8.0
million for the current year.

32

---

Lumber

|                                                    |   | Twelve Months Ended |  
|--------------------------------------------------- | - | ------------------- | -
|                                                    |   | Dec.
      31/16    |  
|                                                    |   | (in millions)       |  
|                                                    |   |                     |  
|Production (total sawmill) -
      SPF - mmfbm      |   | 459.9               |  
|Production (dressed lumber) - SPF - mmfbm           |   | 412.4               |  
|Shipments - SPF - mmfbm                             |   | 485.5               |  
|Benchmark price - SPF#2&Better - US$ per
      mfbm | $ | 306                 |  
|                                                    |   |                     |  
|Revenue                                             | $ | 191.8               |  
|Cost of products sold                               |   | 140.1               |  
|Freight and other distribution costs                |   | 19.8                |  
|Other realized income                               |   | (0.8                | )
|Adjusted EBITDA                                     | $ | 32.7                |  
|Adjusted EBITDA margin - %                          |   | 17%                 |  
|                                                    |   |                     |  
|Other unrealized expense                            |   | (1.0                | )
|Depreciation and amortization                       |   | (5.6                | )
|Operating earnings                                  | $ | 26.1                |  
|                                                    |   |                     |  
|Capital expenditures                                | $ | 1.5                 |  

The U.S. housing market continued its slow recovery in 2016,
with housing starts averaging just under 1.2 million units per year, and lumber
prices improving from 2015 levels. The average benchmark price was US$306 per
thousand board feet (mfbm), up 8.9% from US$281/mfbm in 2015. Lumber segment
revenue declined 1.9% year-over-year, however, due to lower production and
shipments resulting from the sale of the Boyle sawmill.

Lumber production of 459.9 mmfbm and shipments of 485.5 mmfbm
were both lower than 2015, reflecting the Boyle sale, but were both improved
from 2015 after adjusting for the loss of production and shipments from the
Boyle sawmill.

Freight and other distribution costs declined due to the
reduced shipments but remained unchanged on a per-unit basis.

We continue to recognize the strategic value of defensive
hedging on major inputs and, when appropriate, on product sales; however, our
hedging activities are limited to our capacity for physical consumption or
production of goods and are not entered into for speculative purposes. In 2016,
our lumber hedging program provided a benefit of $0.7 million, down from $1.8
million in 2015, and the amount was recorded in other realized income.

On a normalized basis, Adjusted EBITDA of $32.7 million
improved compared to last year, as the 2015 Adjusted EBITDA of $33.1 million had
included $14.1 million from the sale of the Boyle sawmill.

Segment capital expenditures of $1.5 million in 2016 were
limited to maintenance-of-business spending and were lower than expenditures of
$3.3 million in the previous year.

33

---

Pulp

|                                        |   | Twelve Months Ended |  
|--------------------------------------- | - | ------------------- | -
|                                        |   | Dec.
      31/16    |  
|                                        |   | (in millions)       |  
|                                        |   |                     |  
|Production - madmt                      |   | 321.5               |  
|Shipments - madmt                       |   | 330.1               |  
|                                        |   |                     |  
|Revenue                                 | $ | 192.9               |  
|Cost of products sold                   |   | 128.4               |  
|Freight and other distribution costs    |   | 44.5                |  
|Other realized (income)
      expense   |   | (0.8                | )
|Adjusted EBITDA                         | $ | 20.8                |  
|Adjusted EBITDA margin - %              |   | 11%                 |  
|                                        |   |                     |  
|Other unrealized (expense)
      income |   | (1.3                | )
|Depreciation and amortization           |   | (4.6                | )
|Operating earnings                      | $ | 14.9                |  
|                                        |   |                     |  
|Capital expenditures                    | $ | 9.9                 |  

After falling in late 2015, BCTMP prices recovered during the
course of 2016, as Chinese demand strengthened and pulp inventories were drawn
down to relatively low levels. Pulp production of 321.5 thousand tonnes (madmt)
was up sharply from 295.9 madmt in 2015, when output had been affected by
operational issues with the aerobic effluent treatment system and by an extended
maintenance shutdown that included work to complete BEP tie-ins. The effect of
lower average selling prices in 2016 was offset by increased shipments and
revenue rose to $192.9 million, up 5.6% from 2015.

Segment cost of products sold increased by $6.1 million in
total, but declined significantly on a per-unit basis, due to lower energy
costs.

Freight and other distribution costs were also higher in total,
due to increased shipments, but decreased on a per-unit basis as a result of
lower ocean freight costs.

Other realized income of $0.8 million for the year reflected
gains on working capital balances and contrasted with an expense of $4.0 million
in 2015 that had included losses associated with currency hedges.

In 2016, pulp segment power costs were $2.0 million above
market rates, due to the long-term pricing arrangement established under our
PPA, which affected our first quarter results but was subsequently terminated.
Based on per-segment consumption, 92% of the cost of the power purchase rights
was allocated to the pulp segment, and the balance was allocated to the lumber
segment. Power purchase rights had increased pulp segment costs by $1.3 million
in 2015.

The result of all factors was segment Adjusted EBITDA of $20.8
million, up from the $13.6 million achieved in 2015. We recorded an unrealized
expense of $1.3 million, primarily related to the revaluation of an embedded
derivative in a contract to dispose of our wood waste. Depreciation and
amortization was $4.6 million, with the decrease from $7.5 million in 2015
reflecting the write-down of the PPA. The segment recorded operating earnings of
$14.9 million in 2016, compared to earnings of $6.7 million in 2015.

Pulp segment capital expenditures of $9.9 million in 2016
included $7.1 million related to the BEP. Total net spending on the BEP at
December 31, 2016, was $86.7 million. We expect to spend an additional $1.0
million in 2017 to finish the project. The Combined Heat and Power (CHP)
component of the project is operational; construction of the Anaerobic Hybrid
Digester (AHD) component is complete and in the final stages of commissioning,
and we expect the project to be fully operational in the second quarter of
2017.

34

---

Corporate and other

|                              |   | Twelve Months Ended |  
|----------------------------- | - | ------------------- | -
|                              |   | Dec.
      31/16    |  
|                              |   | (in millions)       |  
|                              |   |                     |  
|Revenue                       | $ | 0.4                 |  
|General and administration    |   | 18.3                |  
|Loss on termination of PPA    |   | 26.6                |  
|Other realized income         |   | (0.4                | )
|Adjusted EBITDA               | $ | (44.1               | )
|Depreciation and amortization |   | (0.1                | )
|Operating loss                | $ | (44.2               | )
|                              |   |                     |  
|Capital expenditures          | $ | 0.7                 |  

Revenue for the corporate and other supporting cost center was
generated primarily from fees billed to our parent company for administrative
services. Corporate revenue was unchanged, year-to-year, at $0.4 million.
Increases in costs from 2015 reflect an increase in benefit costs, severance
payments associated with the elimination of corporate positions, and an increase
in consulting fees.

Year ended December 31, 2015 compared to year ended
December 31, 2014

The following table sets out our operating and financial
results for the periods indicated.

35

---

|                                              |   | Year
      ended December 31, |  
|--------------------------------------------- | - | ----------------------------- | -
|                                              |   | 2015                          |  
|                                              |   | (in millions)                 |  
|                                              |   |                               |  
|Statements of earnings
      data:            |   |                               |  
|Revenue                                       | $ | 378.6                         |  
|Cost of products sold                         |   | 280.9                         |  
|Freight and other distribution costs          |   | 64.0                          |  
|Depreciation and amortization                 |   | 14.6                          |  
|General and administration                    |   | 15.7                          |  
|Other income                                  |   | (13.8                         | )
|Operating earnings                            | $ | 17.2                          |  
|Foreign exchange loss on
      borrowings     |   | (47.0                         | )
|Finance expenses                              |   | (23.3                         | )
|Net loss before income taxes                  | $ | (53.1                         | )
|Income taxes (recovery) expense               |   | (0.4                          | )
|Net loss before income taxes                  | $ | (52.7                         | )
|Actuarial losses, net of tax recovery         | $ | (0.2                          | )
|Net loss and comprehensive
      loss         | $ | (52.9                         | )
|                                              |   |                               |  
|Reconciliation of adjusted
      EBITDA data: |   |                               |  
|Net loss for the year                         | $ | (52.7                         | )
|(Subtract)/add                                |   |                               |  
|Income taxes (recovery)
      expense         |   | (0.4                          | )
|Foreign
      exchange loss on borrowings     |   | 47.0                          |  
|Finance expenses                              |   | 23.3                          |  
|Operating earnings                            | $ | 17.2                          |  
|Depreciation &
      amortization             |   | 14.6                          |  
|Other
      unrealized (income) expense       |   | (0.3                          | )
|Adjusted EBITDA                               | $ | 31.5                          |  
|                                              |   |                               |  
|Other data:                                   |   |                               |  
|Average exchange rate
      (US$/C$1.00)1     |   | 0.783                         |  
|Period end exchange rate (US$/C$1.00)         |   | 0.723                         |  

36

---

|(1) | Average exchange rates are the daily noon Bank of Canada
      foreign-exchange rates, averaged over the period. Period end exchange
      rates are the closing Bank of Canada rate on the last business day of the
      period. The rates are set forth as U.S. dollars per C$1.00 and are the
      inverse of rates quoted by the Bank of Canada for Canadian dollars per
      US$1.00.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our results for 2015 reflected weaker market conditions, the
effects of a continued decline in the relative value of the Canadian dollar, and
the sale of our Boyle sawmill. At $378.6 million, revenue was down $26.5
million, or 6.5%, from the previous year, as lower pricing for lumber and pulp
and reduced pulp shipments outweighed the positive impact of exchange rates.

Cost of products sold rose in 2015, primarily due to severance
costs associated with the sale of the Boyle operation, which affected our lumber
segment, and lower contributions from our power purchase rights, which resulted
in higher power costs, primarily in our pulp segment. Freight and other
distribution costs were also higher, due to the effects of a weaker Canadian
dollar and an increase in the share of our lumber output that was sold on a
delivered basis.

Other income increased sharply in 2015, as a result of the sale
of our sawmill located in Boyle, Alberta. The sale price of $32.2 million
included the value of all mill assets, timber quotas, and log inventories in the
field, as well as the operations reforestation liability. The net result of the
sale was a gain of $17.6 million in other income, which was offset by losses on
currency hedges, resulting in total other income of $13.8 million.

We posted operating earnings of $17.2 million for 2015, a
decrease from $41.1 million in 2014, with the difference primarily a result of
the weaker commodity prices and increased costs.

Our US$210 million in long-term debt was translated at the
exchange rate of US$0.723/C$ 1.00 on December 31, 2015, compared to US$0.862/C$
1.00 at December 31, 2014, resulting in a foreign-exchange loss of $47.0 million
in the period. A $1.2 million increase in financing expenses for 2015 was also
attributable to the Canadian dollars decline.

We realized a net loss before taxes of $53.1 million, compared
to a net loss of $1.2 million in the previous year. The years results were
subject to income tax at a statutory rate of 33%, consistent with the rate
applied in 2014. The effective tax rate for 2015 varied significantly from the
statutory rate because of the manufacturing and processing profits deduction,
the non-taxable portion of the unrealized exchange loss on debt, the non-taxable
portion of capital gains and the effect of future income-tax rate reductions.

After a provision for income tax recovery of $0.4 million and
an actuarial loss of $0.2 million on assumptions related to a defined-benefit
pension plan, we recorded a net loss of $52.9 million in 2015, compared to a net
loss of $6.6 million recorded in 2014.

Adjustments through comprehensive income are actuarial
valuation changes that are presented net of income tax in accordance with IAS
19R. These adjustments resulted in a comprehensive loss of $52.9 million for the
current year.

37

---

Lumber

|                                                 |   | Year
      ended December 31, |  
|------------------------------------------------ | - | ----------------------------- | -
|                                                 |   | 2015                          |  
|                                                 |   | (in millions)                 |  
|                                                 |   |                               |  
|Production (total
      sawmill)-SPF-mmfbm       |   | 532.5                         |  
|Production (dressed lumber)-SPF-mmfbm            |   | 460.9                         |  
|Shipments -SPF-mmfbm                             |   | 526.8                         |  
|Benchmark price -SPF#2&Better-US$ per
      mfbm | $ | 281                           |  
|                                                 |   |                               |  
|Revenue                                          | $ | 195.5                         |  
|Cost of products sold                            |   | 158.6                         |  
|Freight and other distribution costs             |   | 21.2                          |  
|Other realized income                            |   | (17.4                         | )
|Adjusted EBITDA                                  | $ | 33.1                          |  
|Adjusted EBITDA margin - %                       |   | 17%                           |  
|                                                 |   |                               |  
|Other unrealized expense                         |   | (0.3                          | )
|Depreciation & amortization                      |   | (6.9                          | )
|Operating earnings                               | $ | 25.9                          |  
|                                                 |   |                               |  
|Capital expenditures                             | $ | 3.3                           |  

While the U.S. housing market continued its slow recovery in
2015, with housing starts averaging just over 1.1 million units per year, a
decrease in Chinese demand and increases in North American production put
pressure on lumber prices. The average benchmark price was US$281 per thousand
board feet (mfbm), down 19.7% from US$350/mfbm in 2014. However, lumber segment
revenue declined only 5.6% year-over-year, reflecting favorable exchange-rate
effects. Lumber pricing peaked at the start of the year, in line with normal,
seasonal demand, before falling to the years low in the second quarter, as
supply exceeded demand. Prices recovered briefly as buyers replenished
inventories early in the third quarter, but fell back to lower levels through
the fourth quarter.

Lumber production of 532.5 mmfbm was consistent with 2014
output, and shipments of 526.8 mmfbm were just under the record volume shipped
in 2014. At $158.6 million, segment cost of products sold rose $6.5 million,
primarily due to severance costs associated with the sale of the Boyle sawmill
and to a $1.2 million write down of log and lumber inventories.

Freight and other distribution costs increased in 2015,
primarily due to our continued shift from mill-basis to delivered-basis terms of
sale on a portion of our output, and these costs were largely offset by the
associated increase in revenues.

Relatively strong lumber prices in the first quarter provided
us an opportunity to enter into commodity derivative contracts as a hedge
against price exposure through the balance of the year. These lumber hedges
provided a benefit of $1.8 million in realized gains in 2015, recorded in other
realized income, which was higher than the $1.0 million realized in 2014. We
continue to recognize the strategic value of defensive hedging on major inputs
and, when appropriate, on product sales; however, our hedging activities are
limited to our capacity for physical consumption or production of goods and are
not entered into for speculative purposes.

The sale of the Boyle sawmill resulted in a gain of $17.6
million to other income; associated severance costs of $3.5 million were
included in cost of products sold. As a result, the lumber segment Adjusted
EBITDA and operating earnings of $33.1 million and $25.9 million, respectively,
each include a net contribution of $14.1 million related to the Boyle sale.

Segment capital expenditures of $3.3 million in 2015 were
limited to maintenance-of-business spending, and were lower than expenditures of
$5.0 million in the previous year.

38

---

Pulp

|                                           |   | Year
      ended December 31, |  
|------------------------------------------ | - | ----------------------------- | -
|                                           |   | 2015                          |  
|                                           |   | (in millions)                 |  
|                                           |   |                               |  
|Production-madmt                           |   | 295.9                         |  
|Shipments -madmt                           |   | 300.7                         |  
|Benchmark price - NBSK, US$
      per admt | $ | 972                           |  
|Benchmark price - BEK, US$ per admt        | $ | 785                           |  
|                                           |   |                               |  
|Revenue                                    | $ | 182.7                         |  
|Cost of products sold                      |   | 122.3                         |  
|Freight and other distribution costs       |   | 42.8                          |  
|Other realized expense
      (income)      |   | 4.0                           |  
|Adjusted EBITDA                            | $ | 13.6                          |  
|Adjusted EBITDA margin - %                 |   | 7%                            |  
|                                           |   |                               |  
|Other unrealized income
      (expense)    |   | 0.6                           |  
|Depreciation & amortization                |   | (7.5                          | )
|Operating earnings                         | $ | 6.7                           |  
|                                           |   |                               |  
|Capital expenditures                       | $ | 48.3                          |  

BCTMP prices declined in 2015, as Chinese demand weakened and
the re-start of the Paper Excellence pulp mill in Chetwynd, B.C., resulted in
increased supply. Pulp production was 295.9 thousand tonnes (madmt), with the
decrease from output of 329.7 madmt in 2014 reflecting operational issues with
the aerobic effluent treatment system and an extended maintenance shutdown that
included work to complete BEP tie-ins. The effects of lower selling prices and
decreased shipments were partially offset by the weaker Canadian dollar, and
revenue in 2015 was $182.7 million, compared to $197.5 million in 2014.

Segment cost of products sold increased by $0.5 million in
total, but was significantly higher on a per-unit basis. Periods of low and
stable electricity prices decrease the contribution of the PPA and limit the
effectiveness of other energy management programs employed in the pulp mill
which results in higher net energy costs.

Freight and other distribution costs were lower in the period
due to reduced shipments, but were higher on a per-unit basis as a result of the
weakening Canadian dollar, as most freight costs are denominated in US dollars.

Other realized expense of $4.0 million for the year reflected
losses on foreign-exchange contracts and contrasted with income of $2.3 million
in 2014.

In 2015, pulp segment power costs were $1.3 million above
market rates due to the long-term pricing arrangement resulting from our power
purchase agreement. Based on per-segment consumption, 91% of the cost of the
power purchase rights was allocated to the pulp segment, and the balance was
allocated to power costs in the lumber segment. In contrast, power purchase
rights provided cost savings of $5.8 million to the pulp segment in 2014, with
the greater contribution reflecting higher power-pool pricing and volatility in
that year.

The result of all factors was segment Adjusted EBITDA of $13.6
million, down from the $34.1 million achieved in 2014. After recording
unrealized income of $0.6 million related to gains on foreign-exchange, and
depreciation and amortization of $7.5 million, the segment recorded operating
earnings of $6.7 million in 2015, compared to earnings of $25.6 million in 2014.

Pulp segment capital expenditures of $48.3 million in 2015
included $46.3 million related to the BEP. Total net spending on the BEP at
December 31, 2015, was $77.1 million.

39

---

Corporate and other

|                            |   | 2015                |   |   | 2014  |  
|--------------------------- | - | ------------------- | - | - | ----- | -
|                            |   | (in
      millions) |  
|                            |   |                     |   |   |       |  
|Revenue                     | $ | 0.4                 |   | $ | 0.4   |  
|General & administration    |   | 15.7                |   |   | 18.8  |  
|Other realized income       |   | (0.1                | ) |   | -     |  
|Adjusted EBITDA             | $ | (15.2               | ) | $ | (18.4 | )
|Depreciation & amortization |   | (0.2                | ) |   | (0.2  | )
|Operating loss              | $ | (15.4               | ) | $ | (18.6 | )
|                            |   |                     |   |   |       |  
|Capital expenditures        | $ | 0.6                 |   | $ | 0.4   |  

Revenue for the corporate and other supporting cost center was
generated primarily from fees billed to our parent company for administrative
services. Corporate revenue was unchanged, year-to-year, at $0.4 million.

The corporate and other segment recorded negative Adjusted
EBITDA of $15.2 million in 2015, compared to the $18.4 million loss posted in
2014, with the difference due to changes in profit sharing provisions.

Results of Operations  Fourth Quarter of 2016

The following table sets out our operating and financial
results for the periods indicated.

|                                                    |   | Three months ended |  
|--------------------------------------------------- | - | ------------------ | -
|                                                    |   | Dec.
      31/16   |  
|                                                    |   | (in millions)      |  
|                                                    |   |                    |  
|Statements of earnings data:                        |   |                    |  
|Revenue                                             | $ | 94.8               |  
|Cost of products sold                               |   | 59.3               |  
|Freight and other distribution costs                |   | 15.4               |  
|Depreciation and amortization                       |   | 2.2                |  
|General and administration                          |   | 5.3                |  
|Loss on termination of PPA                          |   | 4.4                |  
|Other expense (income)                              |   | 1.6                |  
|Operating earnings (loss)                           | $ | 6.6                |  
|Foreign exchange (loss) gain on borrowings          |   | (6.5               | )
|Finance expenses                                    |   | (5.2               | )
|Net (loss) income before income taxes               | $ | (5.1               | )
|Income taxes expense (recovery)                     |   | 0.5                |  
|Net loss                                            | $ | (5.6               | )
|Actuarial gains (losses), net of tax
      recovery |   | 0.4                |  
|Net loss and comprehensive loss                     | $ | (5.2               | )
|                                                    |   |                    |  
|Reconciliation of Adjusted EBITDA data:             |   |                    |  
|Net loss                                            | $ | (5.6               | )
|Add (subtract)                                      |   |                    |  
|Income taxes expense
      (recovery)               |   | 0.5                |  
|Foreign exchange loss (gain) on borrowings          |   | 6.5                |  
|Finance expenses                                    |   | 5.2                |  
|Operating earnings (loss)                           | $ | 6.6                |  
|Depreciation and amortization                       |   | 2.2                |  
|Unrealized other expense (income)                   |   | 2.0                |  
|Adjusted EBITDA                                     | $ | 10.8               |  
|                                                    |   |                    |  
|Other data:                                         |   |                    |  
|Average exchange rate (US$ per C$1.00)1             |   | 0.750              |  
|Period end exchange rate (US$ per C$1.00)           |   | 0.745              |  

|(1) | Average exchange rates are the daily noon Bank of Canada
      foreign-exchange rates, averaged over the period. Period end exchange
      rates are the closing Bank of Canada rate on the last business day of the
      period. The rates are set forth as U.S. dollars per
C$1.00 and are the inverse of rates quoted by the Bank of Canada for Canadian
dollars per US$1.00.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

40

---

We recorded revenue of $94.8 million for the fourth quarter of
2016, up from the fourth quarter of 2015 on increased pulp shipments and higher
pulp prices but down from the prior quarter, primarily as a result of lower
lumber shipments.

Cost of products sold was down from the previous quarter on
lower shipments of both pulp and lumber, and per-unit costs decreased in the
lumber segment as a result of inventory adjustments and in the pulp segment due
to lower energy costs. Compared to the fourth quarter of 2015, cost of products
sold declined, despite increased pulp shipments, as a result of lower lumber
shipments and decreased per-unit costs in both segments.

Freight and other distribution costs were lower than the prior
quarter on decreased pulp and lumber shipments but higher than the fourth
quarter of 2015, as increased pulp shipments outweighed lower lumber shipments.

Depreciation and amortization were unchanged quarter-to-quarter
but lower than the fourth quarter of 2016, due to the write-down of the PPA and
the sale of the Boyle sawmill.

General and administration costs were higher than prior periods
as a result of higher benefit costs, severance payments associated with the
elimination of corporate positions, and an increase in consulting fees.

On November 28, 2016, Capital Power Corporation announced an
agreement with the Government of Alberta to settle the PPA dispute. Under the
settlement, the termination of the PPA was accepted, thereby ending all of our
obligations associated with the PPA. Capital Power Corporation and its syndicate
partners agreed to pay the balancing pool $39 million, of which our share was
$4.4 million. This payment was included in our fourth-quarter and year-end
financial results as Loss on termination of PPA. There was no change from the
previous disclosures related to the loans owing to Capital Power Corporation.

We recorded other expense of $1.6 million, primarily reflecting
the revaluation of an embedded derivative within our wood waste disposal
contract.

The Canadian dollar weakened relative to its value at the close
of the previous quarter, which resulted in a foreign exchange loss of $6.5
million.

After a provision for income tax expense of $0.5 million, we
recorded a net loss of $5.6 million for the quarter.

Adjustments through comprehensive income are actuarial
valuation changes that are presented net of income tax provision in accordance
with IAS 19R. We recorded a $0.4 million actuarial gain related to changes in
the defined benefit pension and this adjustment resulted in a comprehensive loss
of $5.2 million for the current quarter.

Lumber

41

---

|                                                    |   | Three months ended |  
|--------------------------------------------------- | - | ------------------ | -
|                                                    |   | Dec.
      31/16   |  
|                                                    |   | (in millions)      |  
|                                                    |   |                    |  
|Production (total sawmill) -
      SPF - mmfbm      |   | 103.8              |  
|Production (dressed lumber) - SPF - mmfbm           |   | 95.1               |  
|Shipments - SPF - mmfbm                             |   | 108.5              |  
|Benchmark price - SPF#2&Better - US$ per
      mfbm | $ | 315                |  
|                                                    |   |                    |  
|Revenue                                             | $ | 43.5               |  
|Cost of products sold                               |   | 29.3               |  
|Freight and other distribution costs                |   | 4.2                |  
|Other realized income                               |   | (0.1               | )
|Adjusted EBITDA                                     | $ | 10.1               |  
|Adjusted EBITDA margin - %                          |   | 23%                |  
|                                                    |   |                    |  
|Other unrealized (expense)
      income             |   | (0.9               | )
|Depreciation and amortization                       |   | (1.3               | )
|Operating earnings                                  | $ | 7.9                |  
|                                                    |   |                    |  
|Capital expenditures                                | $ | 0.7                |  

Shipments fell compared to the third quarter, reflecting the
normal seasonal reduction in sales activity toward year-end, and revenue fell to
$43.5 million from $53.0 million in the prior quarter. Shipments were also lower
than the fourth quarter of 2015, due to the sale of the Boyle sawmill, but
revenues were virtually unchanged, as higher pricing offset the reduced volume.

Production of 103.8 mmfbm was lower than third-quarter output
of 118.3 mmfbm, reflecting a reduced number of operating days during the holiday
season.

Segment cost of products sold declined from both comparable
periods, on lower shipments, and was also lower on a per-unit basis, due to
year-end log inventory adjustments.

Freight costs varied from prior periods, as a result of both
sales distributions and differences in the share of volumes sold on a mill-basis
and a delivered-basis.

Other realized income was down sharply from the $14.8 million
recorded in the fourth quarter of 2015, which included a $17.6 million gain
realized from the sale of the Boyle sawmill.

The segment generated Adjusted EBITDA $10.1 million in the
fourth quarter, which was higher than the third quarter but lower than the
fourth quarter of 2015, which had been affected by the sale of the Boyle
sawmill.

Other unrealized expense included the revaluation of an
embedded derivative within our waste disposal contract, and depreciation and
amortization were virtually unchanged from the third quarter.

The lumber segment had operating earnings of $7.9 million in
the quarter.

Segment capital expenditures of $0.7 million in the quarter
were limited to maintenance-of-business activities.

42

---

Pulp

|                                        |   | Three months ended |  
|--------------------------------------- | - | ------------------ | -
|                                        |   | Dec.
      31/16   |  
|                                        |   | (in millions)      |  
|                                        |   |                    |  
|Production - madmt                      |   | 82.0               |  
|Shipments - madmt                       |   | 81.7               |  
|                                        |   |                    |  
|Revenue                                 | $ | 51.2               |  
|Cost of products sold                   |   | 29.9               |  
|Freight and other distribution costs    |   | 11.2               |  
|Other realized (income)
      expense   |   | (0.1               | )
|Adjusted EBITDA                         | $ | 10.2               |  
|Adjusted EBITDA margin - %              |   | 20%                |  
|                                        |   |                    |  
|Other unrealized (expense)
      income |   | (1.0               | )
|Depreciation and amortization           |   | (0.9               | )
|Operating earnings                      | $ | 8.3                |  
|                                        |   |                    |  
|Capital expenditures                    | $ | 3.8                |  

Pulp production and shipments were lower than the third quarter
but increased from the fourth quarter of 2015, in which we had experienced
operational issues with our aerobic effluent treatment system.

BCTMP pricing maintained its strength in the fourth quarter and
revenue was higher than in both comparable periods.

At $29.9 million, segment cost of products sold declined
compared to the third quarter, on slightly reduced shipments and lower energy
costs. Freight and other distribution costs were higher than in the third
quarter, due to a decrease in the value of the Canadian dollar, which had a
negative effect on U.S.-dollar-denominated freight costs.

The pulp segment recorded Adjusted EBITDA of $10.2 million in
quarter.

The segments fourth quarter capital expenditure of $3.8
million was entirely related to the BEP.

Corporate and other

43

---

|                              |   | Three months ended |  
|----------------------------- | - | ------------------ | -
|                              |   | Dec.
      31/16   |  
|                              |   | (in millions)      |  
|                              |   |                    |  
|Revenue                       | $ | 0.1                |  
|General and administration    |   | 5.3                |  
|Loss on termination of PPA    |   | 4.4                |  
|Other realized income         |   | -                  |  
|Adjusted EBITDA               | $ | (9.6               | )
|Depreciation and amortization |   | -                  |  
|Operating loss                | $ | (9.6               | )
|                              |   |                    |  
|Capital expenditures          | $ | 0.1                |  

Our corporate and other supporting cost center recorded
negative Adjusted EBITDA of $9.6 million for the quarter, which included the
$4.4 million charge related to the final obligations under the PPA. Other
increases from the prior periods were primarily a result of increased benefit
costs and higher consulting fees.

Results of Operations  Fourth Quarter of 2015

The following table sets out our operating and financial
results for the periods indicated.

|                                                |   | Three months ended |  
|----------------------------------------------- | - | ------------------ | -
|                                                |   | Dec.
      31/15   |  
|                                                |   | (in millions)      |  
|                                                |   |                    |  
|Statements of earnings data:                    |   |                    |  
|Revenue                                         | $ | 83.4               |  
|Cost of products sold                           |   | 63.3               |  
|Freight and other
      distribution costs      |   | 14.3               |  
|Depreciation and amortization                   |   | 3.7                |  
|General and administration                      |   | 4.1                |  
|Other (income) loss                             |   | (14.9              | )
|Operating earnings (loss)                       | $ | 12.9               |  
|Foreign exchange loss on borrowings             |   | (10.4              | )
|Finance expenses                                |   | (5.9               | )
|Net loss before income taxes                    | $ | (3.4               | )
|Income taxes expense
      (recovery)           |   | 1.7                |  
|Net loss                                        | $ | (5.1               | )
|Actuarial losses, net of tax
      recovery     |   | (0.2               | )
|Net loss and comprehensive loss                 | $ | (5.3               | )
|                                                |   |                    |  
|Reconciliation of adjusted EBITDA
      data:   |   |                    |  
|Net loss                                        | $ | (5.1               | )
|Add (subtract)                                  |   |                    |  
|Income
      taxes expense (recovery)           |   | 1.7                |  
|Foreign exchange loss on
      borrowings       |   | 10.4               |  
|Finance
      expenses                          |   | 5.9                |  
|Operating earnings (loss)                       | $ | 12.9               |  
|Depreciation and amortization                   |   | 3.7                |  
|Unrealized other (income)
      expense         |   | (6.4               | )
|Adjusted EBITDA                                 | $ | 10.2               |  
|                                                |   |                    |  
|Other data:                                     |   |                    |  
|Average exchange rate (US$ per
      C$1.00)1   |   | 0.750              |  
|Period end exchange rate (US$
      per C$1.00) |   | 0.723              |  

44

---

|(1) | Average exchange rates are the daily noon Bank of Canada
      foreign-exchange rates, averaged over the period. Period end exchange
      rates are the closing Bank of Canada rate on the last business day of the
      period. The rates are set forth as U.S. dollars per C$1.00 and are the
      inverse of rates quoted by the Bank of Canada for Canadian dollars per
      US$1.00.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We recorded revenue of $83.4 million for the fourth quarter of
2015, down from both prior periods as a result of lower commodity prices and
reduced shipments of both lumber and pulp.

Cost of products sold was down from the previous quarter on
lower shipments, despite $3.5 million of severance costs associated with the
sale of the Boyle sawmill, and was unchanged from the same period of 2014. We
also recorded a net gain to other income of $17.6 million due to the sale, which
was partially offset by losses related to currency hedges and resulted in other
income of $14.9 million for the quarter.

We recorded a foreign exchange loss of $10.4 million on the
value of our U.S.-dollar-denominated debt, reflecting the continued weakening of
the Canadian dollar.

After a provision for income tax expense of $1.7 million and a
$0.2 million actuarial loss related to defined benefit pension assumptions, we
recorded a net loss of $5.3 million for the quarter, as compared to net losses
of $23.5 million and $8.4 million in the third quarter of 2015 and the fourth
quarter of 2014, respectively.

Adjustments through comprehensive income are actuarial
valuation changes that are presented net of income tax provision in accordance
with IAS 19R. These adjustments resulted in a comprehensive loss of $5.3 million
for the current quarter.

Lumber

|                                                    |   | Three months ended |  
|--------------------------------------------------- | - | ------------------ | -
|                                                    |   | Dec.
      31/15   |  
|                                                    |   | (in millions)      |  
|                                                    |   |                    |  
|Production (total sawmill) -
      SPF - mmfbm      |   | 130.7              |  
|Production (dressed lumber) - SPF - mmfbm           |   | 111.8              |  
|Shipments - SPF - mmfbm                             |   | 127.2              |  
|Benchmark price - SPF#2&Better - US$ per
      mfbm | $ | 276                |  
|                                                    |   |                    |  
|Revenue                                             | $ | 43.8               |  
|Cost of products sold                               |   | 37.1               |  
|Freight and other distribution costs                |   | 4.6                |  
|Other realized income                               |   | (14.8              | )
|Adjusted EBITDA                                     | $ | 16.9               |  
|Adjusted EBITDA margin - %                          |   | 39%                |  
|                                                    |   |                    |  
|Other unrealized income
      (expense)             |   | 1.2                |  
|Depreciation and amortization                       |   | (1.7               | )
|Operating earnings                                  | $ | 16.4               |  
|                                                    |   |                    |  
|Capital expenditures                                | $ | 0.7                |  

Although the average benchmark lumber price was slightly higher
than in the third quarter, our per-unit sales realizations declined, as we
reduced inventories of low-grade products. Shipments fell compared to the third
quarter, reflecting the normal, seasonal reduction in sales activity toward
year-end, and were also lower than in the same period in 2014, due to the timing
of certain shipments.

Production of 130.7 mmfbm was lower than third-quarter output
of 134.1 mmfbm, reflecting a reduced number of operating days due to the holiday
season, but was essentially unchanged from the same quarter of 2014.

45

---

Revenue was lower in the period compared to the third quarter,
due to lower shipments and a decline in per-unit sales realizations, and down
from the fourth quarter of last year, due to weaker pricing.

Segment cost of products sold declined compared to the third
quarter, despite including $3.5 million of severance costs related to the sale
of the Boyle sawmill, as those costs were offset by lower shipments and the
reversal of a portion of negative inventory valuations incurred in the third
quarter. Compared to the same period in 2014, cost of products sold was higher
as a result of the severance costs.

Freight costs varied from prior periods as a result of sales
distributions and differences in the share of volumes sold on a mill-basis and a
delivered-basis.

Other realized income of $14.8 million in the quarter included
the $17.6 million gain realized from the sale of the Boyle sawmill.

The segment generated EBITDA $16.9 million in the fourth
quarter, which was higher than in both the previous quarter and the fourth
quarter of 2014 as a result of the $14.1 million contribution from the sale.
Depreciation and amortization were virtually unchanged from the comparable
periods, and we recorded lumber segment operating earnings of $16.4 million in
the quarter.

Segment capital expenditures of $0.7 million in the quarter
were limited to maintenance-of-business activities.

Pulp

|                                           |   | Three months ended |  
|------------------------------------------ | - | ------------------ | -
|                                           |   | Dec.
      31/15   |  
|                                           |   | (in millions)      |  
|                                           |   |                    |  
|Production - madmt                         |   | 78.1               |  
|Shipments - madmt                          |   | 70.5               |  
|Benchmark price - NBSK, US$
      per admt | $ | 947                |  
|Benchmark price - BEK, US$ per admt        | $ | 788                |  
|                                           |   |                    |  
|Revenue                                    | $ | 39.5               |  
|Cost of products sold                      |   | 26.2               |  
|Freight and other distribution costs       |   | 9.7                |  
|Other realized expense
      (income)      |   | 6.2                |  
|Adjusted EBITDA                            | $ | (2.6               | )
|Adjusted EBITDA margin - %                 |   | -7%                |  
|                                           |   |                    |  
|Other unrealized income
      (expense)    |   | 5.1                |  
|Depreciation and amortization              |   | (2.0               | )
|Operating earnings                         | $ | 0.5                |  
|                                           |   |                    |  
|Capital expenditures                       | $ | 4.2                |  

Pulp production, at 78.1 madmt, was consistent with both
comparable periods, but shipments were down from the previous quarter due to
vessel-timing issues.

BCTMP pricing was under continued pressure in the quarter, and
the positive impact of a weaker Canadian dollar did not fully offset a decline
in U.S.-dollar-denominated market prices. This, in combination with lower
shipments, resulted in reduced revenue compared to both prior periods.

At $26.2 million, segment cost of products sold was lower than
the third quarter, on the decreased shipments and lower energy costs. Freight
and other distribution costs were also down compared to prior periods, as a
decrease in ocean freight rates more than offset negative currency effects.

46

---

During the quarter, the pulp segment recorded a realized
expense of $6.2 million and unrealized income of $5.1 million, reflecting in
part a reclassification of items between the two accounts. The reclassification
did not affect operating earnings, as both realized and unrealized portions of
other income are included; however, it did affect Adjusted EBITDA, which
excludes the unrealized portion of other income. As a result, Adjusted EBITDA in
the fourth quarter of 2015 showed a loss of $2.6 million, which was down from
both comparable quarters.

The segments fourth quarter capital expenditure of $4.2
million was entirely related to the BEP.

Corporate and other

|                              |   | Three months ended |  
|----------------------------- | - | ------------------ | -
|                              |   | Dec.
      31/15   |  
|                              |   | (in millions)      |  
|                              |   |                    |  
|Revenue                       | $ | 0.1                |  
|General and administration    |   | 4.1                |  
|Other realized income         |   | -                  |  
|Adjusted EBITDA               | $ | (4.0               | )
|Depreciation and amortization |   | -                  |  
|Operating loss                | $ | (4.0               | )
|                              |   |                    |  
|Capital expenditures          | $ | 0.1                |  

Our corporate and other supporting cost center recorded
negative Adjusted EBITDA of $4.0 million for the quarter, with the change from
comparable quarters primarily reflecting differences in the profit sharing
provision.

**B.**       **Liquidity
and Capital Resources**

**Liquidity and Capital Resources for 2016 compared to
2015**

Summary of Financial Position

|                                               |   | As
      at      |  |   | 
|---------------------------------------------- | - | ---------------- |  | - | 
|                                               |   | Dec.
      31/16 |  |   | 
|                                               |   | (in millions)    |  |   | 
|                                               |   |                  |  |   | 
|Cash                                           | $ | 40.2             |  |   | 
|Current assets                                 |   | 145.0            |  |   | 
|Current liabilities                            |   | 55.4             |  |   | 
|Ratio of current assets to current liabilities |   | 2.6              |  | x | 
|Financial liabilities - borrowings             |   | 297.2            |  |   | 
|Shareholder's equity                           |   | 7.7              |  |   | 

We ended 2016 with $40.2 million in cash. We expect capital
requirements in 2017 to be $5.6 million, of which $1.0 million will be
associated with the BEP. Financing expenses are expected to be $29.9 million and
to consist of interest payments on the long-term debt and interest and principal
payments on the BEP capital lease and the PPA loans. Upon completion of the BEP,
we do not expect any capital expenditures beyond normal maintenance of business
activities. Financing expenses will vary with changes in the value of the
Canadian dollar relative to the U.S. dollar.

In 2014, we renewed our $50.0 million revolving credit
facility, extending the expiration to July 15, 2018. The facility is subject to
a borrowing formula based on our levels of inventory and accounts receivable. On
December 31, 2016, the amount available under the facility was $50.0
million, with $11.9 million committed to letters of credit.

47

---

Selected Cash Flow Items

|                                                            |   | Twelve Months Ended |  
|----------------------------------------------------------- | - | ------------------- | -
|                                                            |   | Dec.
      31/16    |  
|                                                            |   | (in millions)       |  
|Selected cash flow items Operating
      activities:        |   |                     |  
|Cash provided by operating activities                       | $ | 27.9                |  
|Net reforestation                                           |   | 0.1                 |  
|Net change in non-cash working capital
      items          |   | 32.7                |  
|                                                            |   | 60.7                |  
|Investing activities:                                       |   |                     |  
|Additions to property plant and equipment                   |   | (8.1                | )
|Proceeds on disposal of property, plant and
      equipment |   | 0.1                 |  
|Receipt of government grants                                |   | 2.1                 |  
|Other                                                       |   | 0.2                 |  
|                                                            |   | (5.7                | )
|Financing activities:                                       |   |                     |  
|Increase in borrowings                                      |   | 10.0                |  
|Repayment of borrowings                                     |   | (15.3               | )
|Finance expenses paid                                       |   | (26.3               | )
|Dividends                                                   |   | -                   |  
|                                                            |   | (31.6               | )
|                                                            |   |                     |  
|Increase (decrease) in cash                                 | $ | 23.4                |  
|                                                            |   |                     |  
|Opening Cash                                                | $ | 16.8                |  
|Closing Cash                                                | $ | 40.2                |  
|                                                            |   |                     |  
|Total cash and cash equivalents                             | $ | 40.2                |  

We generated $60.7 million in cash from operations after
changes in working capital in 2016, an increase from the $9.1 million provided
in 2015, reflecting higher revenues associated with higher lumber prices and
increased pulp shipments.

Working capital generated $32.7 million in 2016, a significant
increase from the $6.0 million used in 2015, with the difference attributed to
lower inventories of logs, lumber and pulp.

Financing activities in 2016 were related to the draw of $10.0
million on our revolving credit facility in the first quarter, which was
subsequently repaid in the second quarter. Repayment of borrowings represented
this payment as well as payments on our power purchase loans and the BEP capital
lease. Borrowings in 2015 consisted of $8.2 million in interim BEP financing
that was subsequently converted into a capital lease.

Liquidity and Capital Resources for 2015 compared to
2014

48

---

Summary of Financial Position

|                                                     |   | As
      at December 31, | 
|---------------------------------------------------- | - | ------------------------ | 
|                                                     |   | 2015                     | 
|                                                     |   | (in millions)            | 
|                                                     |   |                          | 
|Cash                                                 | $ | 16.8                     | 
|Restricted cash                                      |   | -                        | 
|Current assets                                       |   | 156.0                    | 
|Current liabilities                                  |   | 57.1                     | 
|Ratio of current assets to current
      liabilities |   | 2.7 x                    | 
|Financial liabilities - borrowings                   | $ | 313.1                    | 
|Shareholder's equity                                 |   | 15.8                     | 

We ended 2015 with $16.8 million in cash. During the year ended
December 31, 2015, we increased borrowings by $8.2 million, received $27.5
million of cash from the sale of the Boyle sawmill and drew down cash balances
by $30.6 million, primarily to fund additions to property, plant and equipment,
and finance expenses and increases in working capital.

In 2014, we renewed our $50.0 million revolving credit
facility, extending the expiration to July 15, 2018. The facility is subject to
a borrowing formula based on our levels of inventory and accounts receivable. In
December 2015, we increased our credit facility to $70.0 million for the period
between February 1, 2016 and April 30, 2016, under the same terms and conditions
as the original credit facility. On December 31, 2015, the amount available
under the facility was $50.0 million, with $3.9 million committed to letters of
credit.

Selected Cash Flow Items

|                                                            |   | Year
      ended December 31, |  
|----------------------------------------------------------- | - | ----------------------------- | -
|                                                            |   | 2015                          |  
|                                                            |   | (in millions)                 |  
|Selected cash flow items Operating
      activities:        |   |                               |  
|Cash provided by operating activities                       | $ | 14.8                          |  
|Net reforestation                                           |   | 0.3                           |  
|Net change in non-cash working capital
      items          |   | (6.0                          | )
|                                                            |   | 9.1                           |  
|Investing activities:                                       |   |                               |  
|Additions to property plant and equipment                   |   | (47.8                         | )
|Proceeds on disposal of property, plant and
      equipment |   | 28.5                          |  
|Receipt of government grants                                |   | -                             |  
|Other                                                       |   | -                             |  
|                                                            |   | (19.3                         | )
|Financing activities:                                       |   |                               |  
|Increase in borrowings                                      |   | 8.2                           |  
|Repayment of borrowings                                     |   | (2.0                          | )
|Finance expenses paid                                       |   | (25.9                         | )
|Dividends                                                   |   | (0.7                          | )
|                                                            |   | (20.4                         | )
|                                                            |   |                               |  
|(Decrease) increase in cash                                 | $ | (30.6                         | )
|                                                            |   |                               |  
|Opening Cash                                                | $ | 47.4                          |  
|Closing Cash                                                | $ | 16.8                          |  
|                                                            |   |                               |  
|Total cash                                                  | $ | 16.8                          |  

We generated $9.1 million in cash from operations in 2015, a
decrease from the $44.4 million provided in 2014, reflecting lower revenues
associated with weaker prices in both lumber and pulp and lower pulp shipments.

49

---

Working capital used $6.0 million in 2015, down from $14.0
million in 2014, with the difference attributed to lower accounts receivable as
a result of discounting pulp sales letters of credit.

Financing activities in 2015 were related to the receipt of
$8.2 million in interim BEP financing, which was subsequently converted into a
capital lease. Repayment of borrowings represented payments on our power
purchase loans and the BEP capital lease. Borrowings in 2014 consisted of $4.0
million in interim BEP financing, and repayment of borrowings in that period
reflected principal payments on the power purchase loans.

**C.**       **Research
and Development**

We did not conduct significant research and development
activities in 2016.

**D.**       **Trend
Information**

Continued strength in the U.S. housing market contributed to
rising North American lumber prices through the course of 2016. Most analysts
expect further lumber price improvement in 2017 and 2018, based on expectations
of increased demand from the U.S., continued Chinese demand and a limited
response in terms of increased Canadian supply, due to reduced fiber
availability in British Columbia. Though we generally agree that domestic demand
and other fundamentals are favorable, our outlook is tempered by expected
increases in overall North American production and the effect of a trade dispute
with the U.S. related to Canadian softwood lumber imports.

On November 25, 2016 a coalition of U.S. lumber producers
petitioned the Department of Commerce and the U.S. International Trade
Commission to investigate alleged subsidies to Canadian producers and to impose
countervailing and anti-dumping duties against Canadian imports. The
investigation is ongoing and it is likely that some form of duties will be
imposed against Canadian softwood lumber exports to the U.S. The amount of such
duties is not known at this time and the preliminary determination of
countervailing duties and anti-dumping duties are expected in April 2017 and
June 2017 respectively. In addition, if the U.S. Department of Commerce
determines that critical circumstances apply, duties could be applied
retroactively up to 90 days prior to the preliminary determinations. Millar
Western was not chosen by the U.S department of Commerce as a mandatory
respondent in the investigations and will be subject to an all other rate
determined as a weighted average of the rates imposed upon companies that have
been chosen as mandatory respondents.

We deny the allegations of subsidies and dumping and are
actively participating in Canadian industry efforts to defend itself against the
allegations.

In 2016, the hardwood BCTMP market recovered, as demand rose on
increased buying by Chinese paperboard producers, while supply stayed relatively
unchanged. We expect the U.S.-dollar-denominated pricing to remain strong in the
first half of the year but, potentially, to come under pressure in the second
half of 2017, as the expected start-up of a new bleached hardwood kraft mill in
Indonesia would weigh on the pulp market generally.

In 2017, we expect our lumber facilities in Whitecourt and Fox
Creek to continue to run at operating rates similar to those achieved in 2016,
for combined production of approximately 455 million board feet. The pulp mill
is expected to produce approximately 325,000 tonnes, up slightly from 321,500
tonnes in 2016.

**E.**       **Off-Balance
Sheet Arrangements**

We had no material off-balance sheet arrangements, apart from
$11.9 million committed for standby letters of credit under our revolving credit
facility.

**F.**       **Tabular
Disclosure of Contractual Obligations**

The table below summarizes the Companys contractual
obligations (1)(4) as at December 31, 2016.

50

---

Payments due by period(in
      millions)MoreLess
    
    
    1-2
    
    
    3-5
    
    
    thanTotal
    
    
    than 1 year
    
    
    years
    
    
    years
    
    
    5 yearsLong-term debt
    $
    305.8
    
    $
    6.5
    
    $
    6.7
    
    $
    292.6
    
    $
    -Fixed-rate interest (2)
    $
    104.1
    
    $
    24.9
    
    $
    24.6
    
    $
    54.6
    
    $
    -Total
    $
    409.9
    
    $
    31.4
    
    $
    31.3
    
    $
    347.2
    
    $
    -


|(1) | Contractual obligations are stated as undiscounted
      amounts and are agreements related to debt, leases and enforceable
      agreements to purchase goods or services on specified terms but do not
      include reforestation obligations, accounts payable in the ordinary course
      of business or contingent amounts payable.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | Based on annual interest of US$17.9 million converted at
      a rate of US$0.7448/C$1.00.                                                                                                                                                                                                                                                
|(3) | Our net pension liability of $1.3 million is not included
      as we are uncertain about the timing and amount of
  liability.                                                                                                                                                                                                           

**G.**       **Safe
Harbor**

See Special Note Regarding Forward-Looking Statements.

51

---

ITEM 6: DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

**A.**       **Directors
and Officers**

The following table sets forth certain information with respect
to our directors and executive officers.

|                           |     | Years of   |                                                           
|-------------------------- | --- | ---------- | ----------------------------------------------------------
|                           |     | Industry   |                                                           
|Name                       | Age | Experience | Position                                                  
|James B. Millar            | 76  | 54         | Co-Chairman and
      Director                            
|H. MacKenzie Millar        | 70  | 47         | Co-Chairman and Director                                  
|J. Craig Armstrong         | 65  | 43         | President, Chief
      Executive Officer and Director     
|Carol Cotton, CPA, CA      | 59  | 29         | Senior Vice-President                                     
|Ronald J. Reis, Peng(4)    | 63  | 42         | Senior
      Vice-President, Pulp                         
|David Anderson, MBA, CFA   | 43  | 20         | Vice-President, Finance, and
      Chief Financial Officer
|Stefan Demharter           | 55  | 34         | Vice-President,
      Wood Products                       
|Brian McConkey             | 52  | 28         | Vice-President, Human Resources                           
|Robert J. Turner, QC (2)   | 70  |            | Secretary,
      General Counsel and Director             
|Gordon J. Clanachan (1)(3) | 62  |            | Director, Audit Committee Chair                           
|Donald R. Ching (1)(2)(3)  | 75  |            | Director                                                  
|W. Kenneth Davidson (3)(4) | 66  |            | Director                                                  
|Douglas G. Hall (1)(2)(3)  | 67  |            | Director                                                  

|(1) | Member of Audit Committee                 
|--- | ------------------------------------------
|(2) | Member of Executive Compensation Committee
|(3) | Member of Independent Directors Committee 
|(4) | Retired, effective December 31,
2016      

James B. Millarhas served as our Co-Chairman of
the Board and Director since July 2010, and had previously served as Chairman of
the Board and a Director since September 1997. Mr. Millar joined the family
business on a full-time basis in 1963, working in the construction and forest
products divisions of our parent, Industries. Mr. Millar is a past president of
the Alberta Roadbuilders Association and served on the board of trustees of the
University of Alberta Hospitals Foundation. Mr. Millar has a B.Sc. in Civil
Engineering from the University of Alberta. Mr. Millar is the brother of H.
MacKenzie Millar.

H. MacKenzie Millarhas served as our Co-Chairman
of the Board and Director since July 2010, and had previously served as
President and Chief Executive Officer and a Director since September 1997. Mr.
Millar joined the family business on a full-time basis in 1970. Mr. Millar is a
past president of the Alberta Forest Products Association and has served on the
boards of Forintek Canada, Canadian Wood Council, Alberta Research Council and
the Forest Sector Advisory Council to the Government of Canada. In 2010, Mr.
Millar was awarded an honorary membership in the Alberta Forest Products
Association. Mr. Millar has Bachelor of Arts and Bachelor of Commerce degrees
from the University of Alberta and has served on the Business Advisory Council
to the Faculty of Business of the University of Alberta. Mr. Millar is the
brother of James B. Millar.

J. Craig Armstronghas served as President, Chief
Executive Officer and Director since July 2010. Mr. Armstrong had previously
served as Executive Vice-President since July 1998. Prior to this, Mr. Armstrong
had served as our Senior Vice-President, Marketing, since September 1997. Mr.
Armstrong joined Industries in 1987 as Director of Sales and Marketing and was
appointed that companys Senior Vice-President, Marketing, in 1994. Prior to
1987, Mr. Armstrong spent 13 years with other forest products companies. Mr.
Armstrong is a past president of the Alberta Forest Products Association and
serves on the boards of the Forest Products Association of Canada and the
Sustainable Forestry Initiative. Mr. Armstrong has a Bachelor of Commerce degree
from the University of Saskatchewan.

David Anderson, MBA, CFAhas served as
Vice-President, Finance, and Chief Financial Officer since June 2015. Prior to
this, Mr. Anderson had served as Vice-President Finance and Business
Development; Manager, Lumber Sales; and Manager, Pulp Sales, since joining
Millar Western in 2005, and had previously held positions in another forest products company. Mr. Anderson holds a Bachelor of
Science in Forestry degree, a Masters in Business Administration degree and is
a CFA charterholder.

52

---

Carol Cotton, CPA, CA,was appointed Senior
Vice-President in April 2002. Prior to this, Ms. Cotton had served as our Senior
Vice-President and Chief Financial Officer since September 1997. Ms. Cotton
joined Industries in 1988 as Vice-President, Finance, and was appointed Senior
Vice-President and Chief Financial Officer in 1996. Ms. Cotton has been a member
of the Chartered Professional Accountants of Alberta since 1982 and has a
Bachelor of Commerce degree from the University of Alberta.

Ronald J. Reis, PEng,retired effective December
31, 2016, after having served as Senior Vice-President, Pulp, since 2006. Prior
to this, Mr. Reis had served as our Vice-President, Engineering and Technology,
since September 1997. Mr. Reis joined Industries in 1987 as Corporate Technical
Director and was appointed Vice President, Engineering and Technology in 1992.
Prior to 1987, Mr. Reis spent 12 years with another forest products company. Mr.
Reis has a Chemical Engineering degree from Lakehead University.

Stefan Demharter, AScT,has served as
Vice-President, Wood Products since July 2012. Prior to this, Mr. Demharter had
served as General Manager, Wood Products, since September 2004. Mr. Demharter
joined Millar Western in 2001 as Sawmill Manager and previously held positions
with another forest products company. Mr. Demharter has a Diploma of Technology
in Wood Products from the British Columbia Institute of Technology and a
Certified Applied Science Technologist designation from the Province of British
Columbia.

Brian McConkeyhas served as Vice-President,
Human Resources, since July 2012. Prior to this, Mr. McConkey had served as
Director Human Resources since June 2001. Mr. McConkey joined Millar Western in
1999 as Manager, Human Resources, and was previously employed by another forest
products company. Mr. McConkey has a Bachelor of Arts degree and a diploma in
Human Resource Management.

Robert J. Turner, QC,has served as our
Secretary, General Counsel and a Director since September 1997. Mr. Turner is a
Consultant of Dentons Canada LLP, a law firm, and was previously a Vice-Chair
and Consultant of Fraser Milner Casgrain LLP. Mr. Turner has served on boards
including Alberta YMCA, the University of Lethbridge, Edmonton Space and Science
Foundation and Edmonton Eskimo Football Club. Mr. Turner has a Bachelor of
Commerce degree from the University of Calgary and a Bachelor of Laws degree
from the University of Alberta.

Gordon J. Clanachan, FCA, ICD.D,was appointed a
director in August 2014, and serves as the chair of our audit committee.
Previously President and CEO of RaiLink Ltd. and a Senior Manager of Price
Waterhouse, Mr. Clanachan serves on boards including Melcor Developments Ltd.,
Chandos GP Corp. and the Edmonton Pipe Industry Pension Plan, and has previously
served on the boards of the University of Alberta and the Edmonton Regional
Airports Authority. A graduate of Glasgow University, Mr. Clanachan is a member
of the Institute of Corporate Directors and the Canadian Institute of Chartered
Accountants, and has been designated a Fellow of Chartered Accountants by the
Chartered Professional Accountants of Canada.

Donald R. Chingwas appointed a Director in
September 1997. Mr. Ching is an independent consultant and previously was
President and Chief Executive Officer of AREVA Resources Canada Inc., a uranium
mining company, from 2005 to 2007. From 1996 to 2004, Mr. Ching was President
and Chief Executive Officer of SaskTel, a communications company, and, before
that, was President of Crown Investments Corporation of Saskatchewan, and a
managing partner in a law firm.

W. Kenneth Davidson, MBA,retired effective
December 31, 2016. Mr. Davidson had been appointed a Director in September 1997.
Mr. Davidson is an independent consultant, and was previously Co-Chief Executive
Officer of Gordon Capital Corporation, from 1996 to 2001. Before that, he spent
20 years with the Canadian Imperial Bank of Commerce, serving as Executive
Vice-President, Risk Management, for the last five years of his term. Mr.
Davidson holds Bachelor of Science degrees in Mathematics and Business, both
from Concordia University, and a Masters in Business Administration degree from
McMaster University.

Douglas G. Hallwas appointed a Director in March
1999. Mr. Hall, a corporate director, was a Managing Director of RBC Dominion
Securities for 25 years. Mr. Hall has a Masters in Business Administration
degree from the University of Western Ontario and a Bachelor of Arts degree
from Queens University and is a Chartered Financial Analyst. Mr. Hall also
serves as a director of Pattern Energy Group, NexC Partners, Purpose
Investments, Stanfield's and Southwest Properties.

53

---

Certain of our directors and officers are also directors and
officers of Industries and are therefore in positions involving possible
conflicts of interest. Specifically, James B. Millar, Co-Chairman and a
Director, is also Chairman, Chief Executive Officer and a Director of
Industries; H. MacKenzie Millar, Co-Chairman and a Director, is also the
President and a Director of Industries; J. Craig Armstrong, President and Chief
Executive Officer and a Director, is also Executive Vice-President of
Industries; Carol Cotton, Senior Vice-President, is also Vice-President and
Chief Financial Officer of Industries, and Robert J. Turner, Secretary, General
Counsel and a Director, is also Secretary and General Counsel of Industries. Our
directors and officers are subject to fiduciary obligations to act in our best
interests. Individuals who are directors and officers of both Millar Western and
Industries have agreed with us that they will dedicate a substantial majority of
their time to us in order to perform their duties as our directors and
officers.

**B.**       **Compensation**

Executive officers are appointed annually and serve at the
discretion of the Board of Directors. The aggregate amount of compensation we
paid to all directors and officers as a group, for services in all capacities in
2016, was $4.5 million.

Our policy provides that each non-employee director is entitled
to receive an annual fee of $22,000 and a fee of $1,500 for each board or
committee meeting attended. The chair of the Audit Committee of the Board of
Directors is entitled to an additional $10,000 per annum, and the chair of each
other committee is entitled to an additional fee of $5,000 per annum. The total
compensation paid to non-employee directors for the year ended December 31,
2016, was $0.2 million.

We do not have a stock incentive plan and have never granted
stock appreciation rights to any of our directors, officers or employees. We
maintain a defined contribution pension plan for all of our employees. The
aggregate amount that we contributed to the pension plan on behalf of the
employees in 2016 was $2.6 million, of which $0.2 million represented
contributions on behalf of our officers. All of our employees are entitled to
participate on a voluntary basis in a retirement savings plan, or RSP, under
which we match each employees RSP contribution up to a fixed amount. The
aggregate amount of matching RSP contributions paid by us in 2016 was $0.9
million, of which less than $4,000 represented matching contributions on behalf
of our officers.

On January 1, 2000, we established a supplementary defined
benefit pension plan for our executives and certain key employees. Under this
plan, participants will be entitled to a target level of retirement benefits in
combination with the Canada Pension Plan and our other Registered Pension Plans.
The aggregate amount that we contributed to the supplementary pension plan on
behalf of the participants was $1.0 million in 2016.

Employee Profit Sharing Plan

All full-time employees participate in a profit sharing plan
that distributes to employees on an annual basis a percentage of earnings before
income taxes and unusual items, such as unrealized exchange gains or losses on
debt. The percentage of such earnings set aside for distribution under the
employee profit sharing plan is reviewed annually. For the years ended December
31, 2016, 2015, 2014, 2013 and 2012, the amount of such earnings set aside for
distribution was nil, nil, $2.5 million, $3.2 million and nil, respectively.

**C.**       **Board
Practices**

In accordance with our articles of incorporation and by-laws,
our Board of Directors may consist of up to ten directors, and our current Board
of Directors consists of eight directors. Each director holds office until the
next annual general shareholders meeting or until the election of his or her
successor, unless the director resigns or the office becomes vacant by reason of
the Directors death, removal or other cause. The start of each directors and
executive officers term of service is set forth in Item 6(A) above. No
directors have service contracts providing for benefits upon termination of
employment.

54

---

The Audit Committee of the Board of Directors currently
consists of three independent directors: Gordon J. Clanachan, Donald R. Ching
and Douglas G. Hall. The Audit Committee is responsible for reviewing our
financial statements and our internal controls, reviewing the work of our
independent auditors, monitoring other financial matters and making
recommendations for approval in respect thereof to the Board of Directors.

The Executive Compensation Committee currently consists of
three members: Douglas G. Hall, Donald R. Ching and Robert J. Turner. The
Executive Compensation Committee is responsible for reviewing compensation
levels of senior management and other executive compensation matters.

**D.**       **Employees**

As of December 31, 2016, we had 544 full-time employees, all of
whom were non-unionized.

|Location                  |  | Employees(1) | 
|------------------------- |  | ------------ | 
|Edmonton corporate office |  | 47           | 
|Whitecourt pulp mill      |  | 121          | 
|Whitecourt sawmill        |  | 274          | 
|                          |  |              | 
|Fox Creek sawmill         |  | 73           | 
|Woodlands                 |  | 29           | 
|Total                     |  | 544          | 

(1)Does not include part-time or seasonal
employees.

In addition to our full-time employees, we employed independent
contractors to provide logging, trucking, road building and forest regeneration
services.

**E.**       **Share Ownership**

As the Company is 100% owned by Industries, none of the
individuals described above owns shares in the Company or has options to
purchase any shares.

ITEM 7: MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

**A.**       **Principal
Shareholder**

Industries holds, directly and of record, 15,000,002 common
shares, representing 100% of our outstanding common shares. Industries is a
company with operations in chemicals and other businesses. Industries is owned
100% by Hualkeith Investments Ltd., or Hualkeith, a corporation indirectly owned
100% by James B. Millar, H. MacKenzie Millar and other members of the Millar
family. James B. Millar and H. MacKenzie Millar together control 55.6% of the
outstanding equity of Hualkeith. The registered office of Industries is located
at 2900 Manulife Place, 10180 -101 Street, Edmonton, Alberta, T5J 3V5, and its
executive offices are located at 16640 -111 Avenue, Edmonton, Alberta, T5M
2S5.

Except as disclosed elsewhere in this annual report, there are
no arrangements known to us that may at a subsequent date result in a change in
control of us. See Business Overview  Recent Developments.

By virtue of its ownership of all of our issued and outstanding
common shares, Industries acting alone can elect our entire board of directors
and can approve any transaction requiring shareholder approval.

55

---

**B.**       **Related
Party Transactions**

On May 13, 1998, we, Industries, and certain of our executive
officers entered into certain agreements, covering non-competition, trademark
licensing, corporate services, and magnesium sulphate supply. Management
believes that such agreements are equivalent to those that could have been
negotiated with unaffiliated, third parties.

Services Provided by Directors

Robert J. Turner, Secretary, General Counsel and a Director of
Millar Western, is a consultant at the law firm of Dentons LLP (formerly Fraser
Milner Casgrain LLP), which received fees of $241,872, $225,894 and $165,000 for
general corporate legal advice provided to us in 2016, 2015 and 2014,
respectively. Such compensation did not exceed 5% of the revenues of Dentons
during 2016, 2015 or 2014.

Indebtedness of Directors and Officers

There is no indebtedness outstanding to us by our directors or
executive officers.

**C.**       **Interests
of experts and counsel**

Not applicable.

ITEM 8: FINANCIAL INFORMATION

**A.**       **Consolidated
Statements and Other Financial Information**

See Item 17, Financial Statements.

**B.**       **Significant
Changes**

Not applicable.

ITEM 9: THE OFFER AND LISTING

**A.**       **Offer
and Listing Details**

There is no organized trading market, inside or outside the
United States, for the Notes covered by this annual report.

**B.**       **Plan
of Distribution**

Not applicable.

**C.**       **Markets**

The Notes covered by this annual report are not listed on any
stock exchange or other regulated market.

**D.**       **Selling
Shareholders**

Not applicable.

**E.**       **Dilution**

Not applicable.

**F.**       **Expenses
of the Issue**

Not applicable.

56

---

ITEM 10: ADDITIONAL INFORMATION

**A.**       **Share
Capital**

Not applicable.

**B.**       **Memorandum
and Articles of Association**

There are no provisions of the Companys articles or other
constituent documents that describe the Companys objects and purposes.

Under the CBCA, a director may vote on a proposal, arrangement
or contract in which he or she is interested, if the contract or transaction
is:

| | a. | an arrangement by way of security for money lent to or
      obligations undertaken by that director, or by a body corporate in which
      he has an interest, for the benefit of the Company or an
  affiliate,
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                  
| | b. | a contract or transaction relating primarily to that
      directors remuneration as a director, officer, employee or agent of the
      Company or an affiliate,                                               
| |    |                                                                                                                                                                                                                  
| | c. | a contract or transaction for indemnity or liability
      insurance, or                                                                                                                                         
| |    |                                                                                                                                                                                                                  
| | d. | a contract or transaction with an
  affiliate.                                                                                                                                                                   

In the absence of an independent quorum, a director may not
vote compensation to himself or herself.

The directors may, without authorization of the shareholders:

| | a. | borrow money on the credit of the Company,                                                                                                                                                         
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                    
| | b. | issue, reissue, sell or pledge debt obligations of the
      Company,                                                                                                                              
| |    |                                                                                                                                                                                                    
| | c. | subject to certain conditions, give a guarantee on behalf
      of the Company to secure performance of an obligation of any person,
      and                                                     
| |    |                                                                                                                                                                                                    
| | d. | mortgage, hypothecate, pledge or otherwise create a
      security interest in all or any property of the Company, owned or
      subsequently acquired, to secure any obligation of the
  Company.

Such borrowing powers can only be varied by a special
resolution of the shareholders (not less than two-thirds of the votes).

The Companys directors are not subject to any age limit
requirement, and no shares are required for directors qualification.

The following are the rights, preferences and restrictions
attaching to the Companys common shares:

Dividend Rights.The Board of Directors may from time to
time declare dividends payable to shareholders according to their respective
rights and interests in the share capital of the Company. Dividends may be paid,
in money or property or by issuing fully paid shares of the Company.

Subject to the rights of the holders of any shares of the
Company having rights or privileges superior to the common shares with respect
to any priority in the payment of dividends:

57

---

| | a. | each holder of a common share shall be entitled to
      receive dividends as and when declared and payable, and                            
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                             
| | b. | dividends may be declared and paid on the common shares
      to the complete exclusion of the other classes of shares of the
      Company.

Rights to Share in Profits or Surplus on Liquidation.Subject to the rights of the holders of any shares of the Company having
rights or privileges superior to the common shares with respect to priority of
distribution on a liquidation, dissolution or winding-up, each holder of a
common share shall be entitled to receive, on a proportionate basis, the
remaining property of the Company in the event of a liquidation, dissolution or
winding-up of the Company, whether voluntary or involuntary. Any remaining
property shall be paid or distributed in equivalent amount per share on each
outstanding common share and any shares of the Company whose entitlement on a
liquidation, dissolution or winding-up ranks equally with the common shares.

Rights of Retraction.Subject to holders of shares of a
class or series right to vote separately as a class or series, a special
resolution is required to change the rights of holders of shares of any class or
series of shares of the Company. These are no more significant than required by
law.

Shareholders Meeting.Subject to the CBCA, the annual
meeting of shareholders is held at such time, and on such day in each year, and
at such place or places as the board of directors, the chairman of the board,
the managing director, or the president may from time to time determine.

The board of directors has the power to call a special meeting
of shareholders at any time.

The only persons entitled to be present at a meeting of
shareholders shall be those entitled to vote thereat, the directors and auditors
of the Company, and others who, although not entitled to vote, are entitled or
required under any provision of the CBCA or articles or by-laws to be present at
the meeting. Any other person may be admitted only by invitation of the chairman
of the meeting, or with the consent of the meeting.

There are currently no limitations on the right of foreign or
non-resident owners of Notes to hold or vote such securities imposed by Canadian
law or the Companys articles or other constituent documents.

There are no provisions of the Companys articles or other
constituent documents that would delay, defer or prevent a change of control and
that would operate only with respect to a merger, acquisition or corporate
restructuring involving the Company.

There are no bylaw provisions governing the ownership threshold
above which shareholder ownership must be disclosed.

The Companys articles and other constituent documents do not
contain provisions governing changes in capital that are more stringent than
required by law.

**C.**       **Material
Contracts**

Not applicable.

**D.**       **Exchange
Controls**

There are currently no limitations imposed by Canadian laws,
decrees or regulations that restrict the import or export of capital, including
foreign exchange controls, or that affect the remittance of dividends, and
interest or other payments to nonresident holders of the Companys
securities.

**E.**       **Taxation**

Not applicable.

58

---

**F.**       **Dividends
and Paying Agents**

Not applicable.

**G.**       **Statements by Experts**

Not applicable.

**H.**       **Documents
on Display**

The Companys registration statement on Form F-4, its annual
and periodic reports and all other filings made with the U.S. Securities and
Exchange Commission may be inspected and copied at the Commissions public
reference facilities in Room 5080, 100F Street, N.E., Washington, D.C., 20549,
and at the regional offices of the Commission. The Commission may be reached at
1-800-SEC-0330 for further information on the public reference rooms. These
Commission filings are also available to the public from commercial document
retrieval services. Reports furnished by the Company with the Commission since
November 26, 2002, are also maintained electronically on the Commissions
website, www.sec.gov.

**I.**       **Subsidiary
Information**

Not applicable.

ITEM 11: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK

**A.**       **Commodity
Prices**

The markets for pulp and lumber are highly cyclical and
affected by such factors as global economic conditions, world-wide demand for
pulp and paper, residential and commercial construction in North America and
Asia, and changes in industry production capacity and inventory levels. All
these factors have a significant impact on selling prices for our products and
profitability. The following outlines the sensitivity of operating earnings over
the course of a year to changes in commodity prices.

|           |  | Changes in realized |  |   | Estimated impact on   | 
|---------- |  | ------------------- |  | - | --------------------- | 
|           |  | price(1)            |  |   | operating earnings(2) | 
|           |  |                     |  |   | (millions)            | 
|           |  |                     |  |   |                       | 
|Pulp (3)   |  | US$50/admt          |  | $ | 16.0                  | 
|Lumber (4) |  | US$50/mfbm          |  | $ | 23.0                  | 

|(1) | Assumed exchange rate of US$1.00 = C$1.00.
|--- | ------------------------------------------
|(2) | Before impact of profit sharing plan.     
|(3) | Based on annual shipments of 320 madmt.   
|(4) | Based on annual shipments of 460
mmfbm.   

**B.**       **Foreign
Exchange**

We sell the majority of our products (70% of 2016 revenue, 68%
of 2015 revenue and 67% of 2014 revenue) in U.S. dollars. Consequently, the
value of the Canadian dollar versus the U.S. dollar has a major impact on our
revenue and profitability. The value of the Canadian dollar was US$0.7448 at
December 31, 2016, compared to US$0.7225 at December 31, 2015, and US$0.8620 at
December 31, 2014.

The impact on earnings of fluctuations in currency rates is
partially offset by the corresponding fluctuations in our debt-service payments,
substantially all of which are denominated in U.S. dollars. To further reduce
the impact on earnings of fluctuations in currency rates, we periodically enter
into foreign-exchange forward contracts. We do not use any instruments to manage
our exposure to changes in foreign-currency rates with respect to the principal
value of our U.S.-dollar-denominated debt. We do not hold or issue
foreign-currency financial instruments for trading purposes. Based on sales
revenue for the year ended December 31, 2015, the effect of a US$0.01 change in
the value of the Canadian dollar over the course of the year would affect
operating earnings by approximately $2.1 million.

59

---

**C.**       **Interest Rates**

The interest rate on the majority of our existing long-term
debt, specifically the US$210.0 million aggregate principal amount of 8.50%
Senior Notes, due 2021, as well as our power purchase rights loan and BEP
capital lease are fixed. The interest rate on our existing revolving credit
facility varies with the prevailing prime rate of the facilitys provider. We do
not currently use any derivative instruments to manage our exposure to changes
in market interest rates.

ITEM 12: DESCRIPTION OF SECURITIES OTHER THAN EQUITY
SECURITIES

Not applicable.

60

---

PART II

ITEM 13: DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

Not applicable.

ITEM 14: MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY
HOLDERS AND USE OF PROCEEDS

Not applicable.

ITEM 15: CONTROLS AND PROCEDURES

Disclosure Controls and Procedures. Our principal
executive officer and principal financial officer, after evaluating the
effectiveness of our disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period
covered by this report, have concluded that, as at such date, our disclosure
controls and procedures were effective in timely alerting them to material
information relating to us required to be disclosed in our reports filed or
submitted under the Exchange Act. Notwithstanding the foregoing, there can be no
assurance that our disclosure controls and procedures will detect or uncover all
failures within our company to disclose all material information otherwise
required to be set forth in our periodic reports.

Managements Annual Report on Internal Control over
Financial Reporting.Our management is responsible for establishing and
maintaining adequate internal control over financial reporting as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over
financial reporting is a process designed to provide reasonable assurance
regarding the reliability of our financial reporting and the preparation of
financial statements for external purposes in accordance with International
Financial Reporting Standards as issued by the International Accounting
Standards Board. Management assessed the effectiveness of our internal control
over financial reporting as of December 31, 2016, based on the criteria set
forth in Internal Control - Integrated Framework (2013)issued by the
Committee of Sponsoring Organizations of the Treadway Commission. This
evaluation included review of the documentation of controls, evaluation of the
design effectiveness of controls, testing of the operating effectiveness of
controls and a conclusion on this evaluation. Based on this evaluation,
management has concluded that our internal control over financial reporting was
effective as of December 31, 2016.

Attestation Report of the Registered Public Accounting Firm.This annual report does not include a report of our independent auditor
regarding our internal control over financial reporting due to our not being an
accelerated filer or a large accelerated filer, as such terms are defined in
Rule 12b-2 under the Exchange Act.

Changes in Internal Control over Financial Reporting.There was no change in our internal control over financial reporting that
occurred during the period covered by this report that has materially affected,
or is reasonably likely to materially affect, our internal control over
financial reporting.

Our management, including our principal executive officer and
principal financial officer, does not expect that our disclosure controls and
procedures or internal controls and procedures will prevent all error and all
fraud. A control system, no matter how well conceived and operated, can provide
only reasonable, not absolute, assurance that the objectives of the control
system are met. Further, the design of a control system must reflect the fact
that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within the Company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. The design of any system of controls also is based in
part upon certain assumptions about the likelihood of future events, and there
can be no assurance that any design will succeed in achieving its stated goals
under all potential future conditions; over time, controls may become inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate.

61

---

Because of the inherent limitations in a cost-effective control
system, misstatements due to error or fraud may occur and not be detected.

ITEM 16

**A.**       **AUDIT
COMMITTEE FINANCIAL EXPERT**

Gordon J. Clanachan is an audit committee financial expert and
is independent (as defined under the rules and regulations of the New York Stock
Exchange).

The Securities and Exchange Commission has indicated that the
designation of a person as an audit committee financial expert does not make
such person an expert for any purpose, impose on such person any duties,
obligations or liability that are greater than those imposed on such person as a
member of the Companys Audit Committee and Board of Directors in the absence of
such designation and does not affect the duties, obligations or liability of any
other member of the Audit Committee or the Board of Directors.

**B.**       **CODE
OF ETHICS**

We have adopted a code of ethics that applies to our principal
executive officer, principal financial officer, principal accounting officer,
and persons fulfilling similar functions. The code of ethics is filed as an
exhibit to this annual report for the year ended December 31, 2016. A copy of
the code of ethics will be provided to any person without charge upon such
persons request in writing at the address set forth on the cover of this annual
report.

**C.**       **PRINCIPAL
ACCOUNTANT FEES AND SERVICES**

We paid the following fees to PricewaterhouseCoopers LLP in
each of the years ended December 31, 2016, 2015 and 2014, for professional
services:

|                   |   | 2016  |  |   | 2015           |  |   | 2014  | 
|------------------ | - | ----- |  | - | -------------- |  | - | ----- | 
|                   |   |       |  |   | (in thousands) |  |   |       | 
|Audit Fees (1)     | $ | 299.2 |  | $ | 345.4          |  | $ | 259.3 | 
|Audit-Related Fees | $ | -     |  | $ | -              |  | $ | -     | 
|Tax Fees (2)       | $ | 37.6  |  | $ | 34.1           |  | $ | 24.6  | 
|All Other Fees (3) | $ | 20.1  |  | $ | 19.7           |  | $ | 97.8  | 
|                   | $ | 356.9 |  | $ | 399.2          |  | $ | 381.7 | 

|(1) | Audit fees comprise professional services for the audit
      of our annual financial statements, review of our interim financial
      statements, and services normally provided in connection with our
      statutory and regulatory filings.         
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                           
|(2) | Tax fees comprise amounts paid for tax compliance and
      advisory services.                                                                                                                                                                            
|    |                                                                                                                                                                                                                                                           
|(3) | All other fees comprise amounts paid for the audit of
      expenditures under the Alberta governments Forest Resource Improvement
      Program, consultations on accounting developments and the accounting for
      potential corporate transactions.

Our Audit Committee approved 100% of the fees paid to
PricewaterhouseCoopers LLP in 2016, 2015 and 2014 and has a pre-approval policy
with respect to permitted non-audit services. Under this policy, subject to
certain conditions, specified audit-related services, tax compliance, audit
services and tax services may be presented to the Audit Committee for
pre-approval as a category of services on an annual or project basis. On an
annual basis, management is required to update the Audit Committee in respect of
the actual amount of fees in comparison to the pre-approved estimate. All
non-audit services not otherwise pre-approved by the Audit Committee must be
pre-approved by the Audit Committee on an individual basis.

No audit-related fees, tax fees or other non-audit fees were
approved by the Audit Committee pursuant to paragraph (c)(7)(i)(C) of Rule 2-01
of Regulation S-X.

62

---

**D.**       **EXEMPTIONS
FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES**

Not Applicable.

**E.**       **PURCHASES
OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS**

Not Applicable.

**F.**       **CHANGE IN REGISTRANTS CERTIFYING ACCOUNTANT**

Not Applicable.

**G.**       **CORPORATE
GOVERNANCE**

Not Applicable.

**H.**       **MINE SAFETY DISCLOSURE**

Not Applicable.

PART III

ITEM 17: FINANCIAL STATEMENTS

The Auditors Report and Financial Statements for the Company
are attached hereto as itemized under Item 19(a) and are incorporated herein by
reference. Such Financial Statements have been prepared on the basis of
International Financial Reporting Standards as issued by the International
Accounting Standards Board.

ITEM 18: FINANCIAL STATEMENTS

Not applicable. See Item 17, Financial Statements.

ITEM 19: EXHIBITS

(a)        Financial
Statements

(i) Independent Auditors Report.

(ii) Statements of Financial Position
as at December 31, 2016 and 2015.

(iii) Statements of Operations and
Comprehensive Income (Loss) for the years ended December 31, 2016, 2015 and
2014.

(iv) Statements of Changes in Equity
for the years ended December 31, 2016, 2015 and 2014.

(v) Statements of Cash Flows for the
years ended December 31, 2016, 2015 and 2014.

(vi) Notes to the Financial
Statements.

(vii) Financial Statement Schedules are
omitted because they are not applicable, not required or because the required
information is included in the Financial Statements filed herein.

(b)        Exhibits

63

---

|Exhibit | Description of Exhibit                                                                                                                                                                                                                                  
|------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number  |                                                                                                                                                                                                                                                         
|1.1(1)  | Certificate, Articles of Incorporation and Articles of
      Amendment.                                                                                                                                                                                 
|1.2    | Articles of Continuance.                                                                                                                                                                                                                                
|1.3(1)  | By-laws.                                                                                                                                                                                                                                                
|2.1(3)  | Indenture dated as of April 7, 2011, among the Company,
      The Bank of New York Mellon, as trustee, and BNY Trust Company of Canada
      as co-trustee.                                                                                             
|2.2(3)  | Registration Rights Agreement, dated as of April 7, 2011,
      among the Company and Goldman, Sachs & Co., HSBC Securities & Co.,
      HSBC Securities (USA) Inc. and KKR Capital Markets LLC.                                                        
|2.3(3)  | Form of Exchange Note (included in Exhibit 2.1).                                                                                                                                                                                                        
|2.4(3)  | Credit Facility Letter dated as of December 29, 2006,
      from HSBC Bank Canada to the Registrant.                                                                                                                                                    
|2.5(3)  | First Supplemental Credit Facility Letter dated as of
      September 12, 2007, from HSBC Bank Canada to the Registrant.                                                                                                                                
|2.6(3)  | Second Supplemental Credit Facility Letter dated as of
      March 26, 2008, from HSBC Bank Canada to the Registrant.                                                                                                                                   
|2.7(3)  | Third Supplemental Credit Facility Letter dated as of
      April 22, 2008, from HSBC Bank Canada to the Registrant.                                                                                                                                    
|2.8(3)  | Fourth Supplemental Credit Facility Letter dated as of
      August 13, 2009, from HSBC Bank Canada to the Registrant.                                                                                                                                  
|2.9(3)  | Fifth Supplemental Credit Facility Letter dated as of May
      25, 2010, from HSBC Bank Canada to the Registrant.                                                                                                                                      
|2.10(3) | Sixth Supplemental Credit Facility Letter dated as of
      September 17, 2010, from HSBC Bank Canada to the Registrant.                                                                                                                                
|2.11(3) | Seventh Supplemental Credit Facility Letter dated as of
      April 6, 2011, from HSBC Bank Canada to the Registrant.                                                                                                                                   
|2.12(5) | Credit Facility Letter dated as of April 16, 2012, from
      HSBC Bank Canada to the Registrant.                                                                                                                                                       
|2.13(5) | First Supplemental Credit Facility Letter dated as of
      August 27, 2012, from HSBC Bank Canada to the Registrant.                                                                                                                                   
|2.14(6) | Second Supplemental Credit Facility Letter dated as of
      June 19, 2014, from HSBC Bank Canada to the Registrant                                                                                                                                     
|2.15   | Third Supplemental Credit Facility Letter dated as of
    December 8, 2015, from HSBC Canada to the Registrant                                                                                                                                          
|2.16   | Loan Agreement dated as of June 30, 2016 between CP
      Energy Marketing L.P. and the Registrant.                                                                                                                                                     
|2.17(3) | Tax Loan Agreement dated as of February 22, 2007, between
      the Registrant and CP Energy Marketing LP (formerly known as EPCOR
      Merchant and Capital LP).                                                                                      
|2.18(3) | Letter of Understanding dated June 5, 2006, among the
      Registrant, CP Energy Marketing LP (formerly known as EPCOR Merchant and
      Capital LP) and Capital Power PPA Management Inc. (formerly known as EPCOR
      PPA Management Inc.).       
|4.1(1)  | Forest Management Agreement dated May 14, 1997, between
      the Minister of Environmental Protection of Alberta and the Registrant.                                                                                                                   
|4.2(1)  | Corporate Services Agreement dated May 13, 1998, between
      the Registrant and Millar Western Industries Ltd.                                                                                                                                        
|4.3(1)  | Non-Competition Agreement dated as of May 13, 1998, among
      the Registrant, Millar Western Industries Ltd., James B. Millar and H.
      MacKenzie Millar.                                                                                          
|4.4(3)  | Trademark Licensing Agreement dated May 13, 1998, between
      the Registrant and Millar Western Industries Ltd.                                                                                                                                       
|4.5(3)  | Fox Creek Site Land Lease dated as of December 10, 2010,
      between the Registrant and the Province of Alberta.                                                                                                                                      
|4.6(2)  | Power Syndicate Agreement (Sundance C) dated January 1,
      2001, among the Registrant, Capital Power Corporation (formerly known as
      EPCOR Utilities Inc.) and certain industry participants.                                                   
|4.7(3)  | Power Purchase Arrangement (Sundance C).                                                                                                                                                                                                                
|4.8(3)  | Millar Western PPI Swap and Purchase Agreement dated as
      of May 19, 2006, among the Registrant, CP Energy Marketing LP (formerly
      EPCOR Merchant and Capital LP) and Capital Power Corporation (formerly
      known as EPCOR Utilities Inc.).
|11.1(4) | Code of Ethics.                                                                                                                                                                                                                                         
|12.1   | Certification of the Chief Executive Officer, J. Craig
      Armstrong, required by 17 CFR 240.15d-14(a).                                                                                                                                               
|12.2   | Certification of the Chief Financial Officer, David
      Anderson, required by 17 CFR 240.15d-14(a).                                                                                                                                                   

64

---

|13.1 | Certification of the Chief Executive Officer, J. Craig
      Armstrong, required by 17 CFR 240.15d-14(b) and 18 U.S.C. Section 1350.
|----- | ------------------------------------------------------------------------------------------------------------------------------------
|13.2 | Certification of the Chief Financial Officer, David
    Anderson, required by 17 CFR 240.15d-14(b) and 18 U.S.C. Section 1350.      
|21   | Subsidiaries of the Registrant                                                                                                      

---------------

|(1) | Incorporated by reference from the Registrants Form F-4
      filed with the Securities and Exchange Commission (Commission File No.
      333-8960).                    
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | Incorporated by reference from the Registrants Form 20-F
      filed with the Securities and Exchange Commission on June 4, 2002
      (Commission File No. 333-08960).  
|(3) | Incorporated by reference from the Registrants Form F-4
      filed with the Securities and Exchange Commission (Commission File No.
      333-179957).                  
|(4) | Incorporated by reference from the Registrants Form 20-F
      filed with the Securities and Exchange Commission on March 5, 2013
      (Commission File No. 333-112898).
|(5) | Incorporated by reference from the Registrants Form 20-F
      filed with the Securities and Exchange Commission on March 5, 2014
      (Commission File No. 333-112898).
|(6) | Incorporated by reference from the Registrants Form 20-F
      filed with the Securities and Exchange Commission on March 4, 2015
      (Commission File No. 333-112898) 

 Filed herewith.

SIGNATURE

The registrant hereby certifies that it meets all of the
requirements for filing on Form 20-F and that it has duly caused and authorized
the undersigned to sign this annual report on its behalf.

MILLAR WESTERN FOREST PRODUCTS
LTD.

|Dated: March 8, 2017 | By: | /s/ David Anderson                                
|-------------------- | --- | --------------------------------------------------
|                     |     | David Anderson                                    
|                     |     | Vice-President, Finance, and
      Chief Financial
|                     |     | Officer                                           

65

---











Millar Western Forest
Products Ltd.

Financial StatementsDecember 31, 2016 and 2015





---

Independent Auditors Report

To the Shareholders of Millar Western Forest Products
Ltd.

We have audited the accompanying financial statements of Millar
Western Forest Products Ltd., which comprise the statements of financial
position as at December 31, 2016 and 2015 and the statements of changes in
equity, operations and comprehensive loss and cash flows for each of the three
years in the period ended December 31, 2016, and the related notes, which
comprise a summary of significant accounting policies and other explanatory
information.

Managements responsibility for the financial statementsManagement is responsible for the preparation and fair presentation of
these financial statements in accordance with International Financial Reporting
Standards as issued by the International Accounting Standards Board and for such
internal control as management determines is necessary to enable the preparation
of financial statements that are free from material misstatement, whether due to
fraud or error.

Auditors responsibilityOur responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits in accordance with Canadian generally accepted auditing
standards and the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free from
material misstatement. Canadian generally accepted auditing standards also
require that we comply with ethical requirements.

An audit involves performing procedures to obtain audit
evidence, on a test basis, about the amounts and disclosures in the financial
statements. The procedures selected depend on the auditors judgment, including
the assessment of the risks of material misstatement of the financial
statements, whether due to fraud or error. We were not engaged to perform an
audit of the companys internal control over financial reporting. Our audits
included consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
companys internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes evaluating the appropriateness of
accounting principles and policies used and the reasonableness of accounting
estimates made by management, as well as evaluating the overall presentation of
the financial statements.

We believe that the audit evidence we have obtained in our
audits is sufficient and appropriate to provide a basis for our audit opinion.

OpinionIn our opinion, the financial statements
present fairly, in all material respects, the financial position of Millar
Western Forest Products Ltd. as at December 31, 2016 and 2015 and its financial
performance and its cash flows for each of the three years in the period ended
December 31, 2016 in accordance with International Financial Reporting Standards
as issued by the International Accounting Standards Board.

(signed) "PricewaterhouseCoopers LLP"

Chartered Professional Accountants

Edmonton, Alberta 
March 7, 2017

---

|Millar Western Forest Products Ltd.
|-----------------------------------
|Statements of Financial Position   
|As at December
      31            
|(in thousands of Canadian dollars) 

|                                                         |  | 2016    |   |  | 2015    |  
|-------------------------------------------------------- |  | ------- | - |  | ------- | -
|                                                         |  | $       |   |  | $       |  
|                                                         |  |         |   |  |         |  
|Assets                                                   |  |         |   |  |         |  
|                                                         |  |         |   |  |         |  
|Current assets                                           |  |         |   |  |         |  
|Cash and cash equivalents (note 5)                       |  | 40,237  |   |  | 16,773  |  
|Accounts and other
      receivables (note 6)            |  | 32,738  |   |  | 34,136  |  
|Inventories (note 7)                                     |  | 63,328  |   |  | 92,868  |  
|Prepaid expenses                                         |  | 8,651   |   |  | 12,262  |  
|                                                         |  |         |   |  |         |  
|                                                         |  | 144,954 |   |  | 156,039 |  
|                                                         |  |         |   |  |         |  
|Property, plant and
      equipment(note 8)              |  | 225,174 |   |  | 222,836 |  
|Intangible assets(note 9)                                |  | 10,396  |   |  | 31,979  |  
|Other assets(note 10)                                    |  | 1,393   |   |  | 1,729   |  
|                                                         |  |         |   |  |         |  
|                                                         |  | 381,917 |   |  | 412,583 |  
|                                                         |  |         |   |  |         |  
|Liabilities                                              |  |         |   |  |         |  
|                                                         |  |         |   |  |         |  
|Current liabilities                                      |  |         |   |  |         |  
|Accounts payable and accrued liabilities
      (note 12) |  | 45,707  |   |  | 47,894  |  
|Financial liabilities 
      borrowings (note 13)       |  | 6,476   |   |  | 4,438   |  
|Reforestation obligations (note 14)                      |  | 3,210   |   |  | 4,749   |  
|                                                         |  |         |   |  |         |  
|                                                         |  | 55,393  |   |  | 57,081  |  
|                                                         |  |         |   |  |         |  
|Financial liabilities borrowings
      (note 13)        |  | 297,195 |   |  | 313,062 |  
|Asset retirement
      obligations(note 14)              |  | 1,316   |   |  | 1,446   |  
|Other obligations(note 15)                               |  | 4,324   |   |  | 2,285   |  
|Reforestation obligations(note 14)                       |  | 8,480   |   |  | 7,634   |  
|Deferred income taxes(note 20)                           |  | 6,194   |   |  | 12,853  |  
|Post-employment benefit
      obligation(note 21)        |  | 1,302   |   |  | 2,471   |  
|                                                         |  |         |   |  |         |  
|                                                         |  | 374,204 |   |  | 396,832 |  
|                                                         |  |         |   |  |         |  
|Shareholders Equity                                     |  |         |   |  |         |  
|                                                         |  |         |   |  |         |  
|Share capital(note
      16)                             |  | 65,500  |   |  | 65,500  |  
|Retained deficit                                         |  | (57,787 | ) |  | (49,749 | )
|                                                         |  |         |   |  |         |  
|                                                         |  | 7,713   |   |  | 15,751  |  
|                                                         |  |         |   |  |         |  
|                                                         |  | 381,917 |   |  | 412,583 |  

Approved by the Board of Directors

|(signed) "H. MacKenzie Millar"Director | (signed) "J. Craig Armstrong"Director
|-------------------------------------- | -------------------------------------

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

---



|Millar Western Forest Products Ltd.  
|-------------------------------------
|Statements of Changes in Equity      
|For the years
      ended December 31
|(in thousands of Canadian dollars)   

|                                                                            |  |         |  |  | Retained  |   |  |         |  
|--------------------------------------------------------------------------- |  | ------- |  |  | --------- | - |  | ------- | -
|                                                                            |  | Share   |  |  | (deficit) |   |  | Total   |  
|                                                                            |  | capital |  |  | earnings  |   |  | equity  |  
|                                                                            |  | $       |  |  | $         |   |  | $       |  
|                                                                            |  |         |  |  |           |   |  |         |  
|Balance  January 1,
      2014                                             |  | 65,500  |  |  | 12,817    |   |  | 78,317  |  
|                                                                            |  |         |  |  |           |   |  |         |  
|Net loss for the year                                                       |  | -       |  |  | (5,181    | ) |  | (5,181  | )
|                                                                            |  |         |  |  |           |   |  |         |  
|Remeasurement loss that will
      not be reclassified to net (loss) income |  | -       |  |  | (1,455    | ) |  | (1,455  | )
|                                                                            |  |         |  |  |           |   |  |         |  
|Dividends (note 16)                                                         |  | -       |  |  | (2,250    | ) |  | (2,250  | )
|                                                                            |  |         |  |  |           |   |  |         |  
|Balance  December 31,
      2014                                           |  | 65,500  |  |  | 3,931     |   |  | 69,431  |  
|                                                                            |  |         |  |  |           |   |  |         |  
|Net loss for the year                                                       |  | -       |  |  | (52,755   | ) |  | (52,755 | )
|                                                                            |  |         |  |  |           |   |  |         |  
|Remeasurement loss that will
      not be reclassified to net (loss) income |  | -       |  |  | (175      | ) |  | (175    | )
|                                                                            |  |         |  |  |           |   |  |         |  
|Dividends (note 16)                                                         |  | -       |  |  | (750      | ) |  | (750    | )
|                                                                            |  |         |  |  |           |   |  |         |  
|Balance  December 31,
      2015                                           |  | 65,500  |  |  | (49,749   | ) |  | 15,751  |  
|                                                                            |  |         |  |  |           |   |  |         |  
|Net loss for the year                                                       |  | -       |  |  | (8,391    | ) |  | (8,391  | )
|                                                                            |  |         |  |  |           |   |  |         |  
|Remeasurement gain that will
      not be reclassified to net loss          |  | -       |  |  | 353       |   |  | 353     |  
|                                                                            |  |         |  |  |           |   |  |         |  
|Balance  December 31,
      2016                                           |  | 65,500  |  |  | (57,787   | ) |  | 7,713   |  

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

---

|Millar Western Forest Products Ltd.                  
|-----------------------------------------------------
|Statements of Operations and Comprehensive
      Loss
|For the years
      ended December 31                
|(in thousands of Canadian dollars)                   

|                                                                                                                              |  | 2016    |   |  | 2015    |   |  | 2014    |  
|----------------------------------------------------------------------------------------------------------------------------- |  | ------- | - |  | ------- | - |  | ------- | -
|                                                                                                                              |  | $       |   |  | $       |   |  | $       |  
|                                                                                                                              |  |         |   |  |         |   |  |         |  
|Revenue                                                                                                                       |  | 385,117 |   |  | 378,598 |   |  | 405,123 |  
|                                                                                                                              |  |         |   |  |         |   |  |         |  
|Cost of products sold (excluding
      depreciation and amortization)                                                         |  | 268,562 |   |  | 280,884 |   |  | 273,852 |  
|Freight and other distribution costs                                                                                          |  | 64,203  |   |  | 63,961  |   |  | 59,767  |  
|Depreciation and amortization                                                                                                 |  | 10,345  |   |  | 14,568  |   |  | 14,272  |  
|General and administration                                                                                                    |  | 18,269  |   |  | 15,781  |   |  | 18,748  |  
|Other expense (income), net (note 18)                                                                                         |  | 293     |   |  | 3,869   |   |  | (2,679  | )
|Loss on termination of Power Purchase Arrangement (PPA)
      (note 13)                                                       |  | 26,624  |   |  | -       |   |  | -       |  
|Gain on sale of Boyle assets and
      liabilities (note 8)                                                                   |  | -       |   |  | (17,622 | ) |  | -       |  
|                                                                                                                              |  |         |   |  |         |   |  |         |  
|                                                                                                                              |  | 388,296 |   |  | 361,441 |   |  | 363,960 |  
|                                                                                                                              |  |         |   |  |         |   |  |         |  
|Operating (loss) earnings                                                                                                     |  | (3,179  | ) |  | 17,157  |   |  | 41,163  |  
|                                                                                                                              |  |         |   |  |         |   |  |         |  
|Foreign exchange gain (loss) on
      borrowings                                                                              |  | 8,673   |   |  | (47,019 | ) |  | (20,265 | )
|                                                                                                                              |  |         |   |  |         |   |  |         |  
|Finance expenses, net(note 19)                                                                                                |  | (21,098 | ) |  | (23,295 | ) |  | (22,086 | )
|                                                                                                                              |  |         |   |  |         |   |  |         |  
|Net loss before income taxes                                                                                                  |  | (15,604 | ) |  | (53,157 | ) |  | (1,188  | )
|                                                                                                                              |  |         |   |  |         |   |  |         |  
|Income tax (recovery) expense(note
      20)                                                                                  |  | (7,213  | ) |  | (402    | ) |  | 3,993   |  
|                                                                                                                              |  |         |   |  |         |   |  |         |  
|Net loss for the year                                                                                                         |  | (8,391  | ) |  | (52,755 | ) |  | (5,181  | )
|                                                                                                                              |  |         |   |  |         |   |  |         |  
|Remeasurement gain (loss) that will not
      be reclassified to net loss net of tax of $118 (2015  $58;
      2014  $485) |  | 353     |   |  | (175    | ) |  | (1,455  | )
|                                                                                                                              |  |         |   |  |         |   |  |         |  
|Comprehensive loss for the year                                                                                               |  | (8,038  | ) |  | (52,930 | ) |  | (6,636  | )

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

---

|Millar Western Forest Products Ltd.  
|-------------------------------------
|Statements of Cash Flows             
|For the years
      ended December 31
|(in thousands of Canadian dollars)   

|                                                                       |  | 2016    |   |  | 2015    |   |  | 2014    |  
|---------------------------------------------------------------------- |  | ------- | - |  | ------- | - |  | ------- | -
|                                                                       |  | $       |   |  | $       |   |  | $       |  
|                                                                       |  |         |   |  |         |   |  |         |  
|Cash provided by (used in)                                             |  |         |   |  |         |   |  |         |  
|                                                                       |  |         |   |  |         |   |  |         |  
|Operating activities                                                   |  |         |   |  |         |   |  |         |  
|Net loss for the year                                                  |  | (8,391  | ) |  | (52,755 | ) |  | (5,181  | )
|Adjustments for                                                        |  |         |   |  |         |   |  |         |  
|Finance expenses                                                       |  | 21,098  |   |  | 23,295  |   |  | 22,086  |  
|Depreciation and amortization                                          |  | 10,345  |   |  | 14,568  |   |  | 14,272  |  
|Deferred income
      tax (recovery) expense                           |  | (6,777  | ) |  | (278    | ) |  | 4,245   |  
|Unrealized exchange (gain) loss on borrowings                          |  | (8,673  | ) |  | 47,019  |   |  | 20,265  |  
|Unrealized loss on
      derivative contracts                          |  | 1,516   |   |  | 993     |   |  | 2,074   |  
|Reforestation expense                                                  |  | 3,514   |   |  | 7,235   |   |  | 7,151   |  
|Loss on disposal
      of property, plant and equipment                |  | 260     |   |  | 423     |   |  | 49      |  
|Loss on termination of PPA assets (note 13)                            |  | 20,620  |   |  | -       |   |  | -       |  
|Increase
      in demand loan value on termination of PPA (note 13)    |  | 1,595   |   |  | -       |   |  | -       |  
|Gain on sale of Boyle assets and liabilities                           |  | -       |   |  | (17,622 | ) |  | -       |  
|Inventory
      valuation to net realizable value                      |  | (1,157  | ) |  | 1,157   |   |  | -       |  
|Greenhouse gas credits (note 10)                                       |  | (1,708  | ) |  | (1,413  | ) |  | -       |  
|Other                                                                  |  | (833    | ) |  | (679    | ) |  | (117    | )
|Reforestation expenditures                                             |  | (3,374  | ) |  | (6,917  | ) |  | (6,466  | )
|                                                                       |  |         |   |  |         |   |  |         |  
|                                                                       |  | 28,035  |   |  | 15,026  |   |  | 58,378  |  
|                                                                       |  |         |   |  |         |   |  |         |  
|Net change in non-cash working capital
      items (note 26)           |  | 32,731  |   |  | (5,967  | ) |  | (14,012 | )
|                                                                       |  |         |   |  |         |   |  |         |  
|                                                                       |  | 60,766  |   |  | 9,059   |   |  | 44,366  |  
|                                                                       |  |         |   |  |         |   |  |         |  
|Investing activities                                                   |  |         |   |  |         |   |  |         |  
|Additions to property, plant and equipment (note 26)                   |  | (8,121  | ) |  | (47,826 | ) |  | (24,326 | )
|Receipt of government grants (note 8)                                  |  | 2,175   |   |  | -       |   |  | 1,500   |  
|Proceeds on disposal of property, plant and equipment                  |  | 131     |   |  | 28,535  |   |  | 28      |  
|Decrease in other assets (note 10)                                     |  | 201     |   |  | 7       |   |  | 42      |  
|                                                                       |  |         |   |  |         |   |  |         |  
|                                                                       |  | (5,614  | ) |  | (19,284 | ) |  | (22,756 | )
|                                                                       |  |         |   |  |         |   |  |         |  
|Financing activities                                                   |  |         |   |  |         |   |  |         |  
|Increase in borrowings                                                 |  | 10,000  |   |  | 8,235   |   |  | 4,037   |  
|Repayment of borrowings                                                |  | (15,407 | ) |  | (2,013  | ) |  | (1,220  | )
|Finance expenses paid                                                  |  | (26,281 | ) |  | (25,899 | ) |  | (21,971 | )
|Dividends                                                              |  | -       |   |  | (750    | ) |  | (2,250  | )
|                                                                       |  |         |   |  |         |   |  |         |  
|                                                                       |  | (31,688 | ) |  | (20,427 | ) |  | (21,404 | )
|                                                                       |  |         |   |  |         |   |  |         |  
|Increase (decrease) in cash and cash
      equivalents during the year |  | 23,464  |   |  | (30,652 | ) |  | 206     |  
|                                                                       |  |         |   |  |         |   |  |         |  
|Cash and cash equivalents  Beginning of
      year                    |  | 16,773  |   |  | 47,425  |   |  | 47,219  |  
|                                                                       |  |         |   |  |         |   |  |         |  
|Cash and cash equivalents  End of
      year                          |  | 40,237  |   |  | 16,773  |   |  | 47,425  |  

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

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

|1 | General information                                                                                                                                                                                                                                                                                                                                                                               
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                   
|  | Millar Western Forest Products Ltd. (the Company) is
      incorporated and located in Canada. The address of the Companys corporate
      office is 16640  111 Avenue, Edmonton, Alberta, Canada T5M 2S5.                                                                                                                                                                                      
|  |                                                                                                                                                                                                                                                                                                                                                                                                   
|  | The Company is a subsidiary of Millar Western Industries
      Ltd., with the ultimate parent being Hualkeith Investments Ltd.                                                                                                                                                                                                                                                                    
|  |                                                                                                                                                                                                                                                                                                                                                                                                   
|  | The Company is an integrated forest products company with
      facilities in Canada producing lumber and pulp. The lumber segment
      consists of two sawmill operations that produce and market dimension
      lumber. The pulp segment consists of a pulp operation that manufactures
      and markets a number of different grades of bleached
      chemi-thermo-mechanical pulp (BCTMP).
|  |                                                                                                                                                                                                                                                                                                                                                                                                   
|2 | Summary of significant accounting
  policies                                                                                                                                                                                                                                                                                                                                                      
|  |                                                                                                                                                                                                                                                                                                                                                                                                   
|  | Statement of compliance                                                                                                                                                                                                                                                                                                                                                                           
|  |                                                                                                                                                                                                                                                                                                                                                                                                   
|  | These financial statements and the notes thereto have
      been prepared in accordance with International Financial Reporting
      Standards (IFRS), as issued by the International Accounting Standards
      Board (IASB).                                                                                                                                                                    
|  |                                                                                                                                                                                                                                                                                                                                                                                                   
|  | These financial statements were approved by the Companys
      board of directors on March 7, 2017.                                                                                                                                                                                                                                                                                              
|  |                                                                                                                                                                                                                                                                                                                                                                                                   
|  | The significant accounting policies used in the
      preparation of these financial statements are as follows:                                                                                                                                                                                                                                                                                   
|  |                                                                                                                                                                                                                                                                                                                                                                                                   
|  | Basis of measurement                                                                                                                                                                                                                                                                                                                                                                              
|  |                                                                                                                                                                                                                                                                                                                                                                                                   
|  | These financial statements have been prepared on the
      historical cost basis, unless otherwise noted.                                                                                                                                                                                                                                                                                         
|  |                                                                                                                                                                                                                                                                                                                                                                                                   
|  | Foreign currency                                                                                                                                                                                                                                                                                                                                                                                  

| | i)  | Functional and presentation currency                                                                                                                                                                                                                                                                                                                                                                                                                                
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |     | Items included in the financial statements of the Company
      are measured using the Canadian dollar, which is the Companys functional
      currency.                                                                                                                                                                                                                                                                                                           
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |     | The Company has no operations outside of Canada; however,
      the Company does have significant exposure to foreign currency exchange
      rate movements as a result of its long-term debt, which is denominated in
      US dollars, and its export sales, which are denominated primarily in US
      dollars (note 23).                                                                                                                                      
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | ii) | Transactions and balances                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |     | Foreign currency transactions are translated into
      Canadian dollars by applying exchange rates in effect at the transaction
      date. At each reporting year-end, monetary assets and liabilities
      denominated in foreign currencies are converted into Canadian dollars at
      rates of exchange prevailing on that date. Gains and losses on exchange
      differences are recognized in the statements of operations and
      comprehensive loss.

1

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

Cash and cash equivalents

Cash and cash equivalents are defined
as cash on hand and short-term deposits held with banks and money market
instruments with original maturity dates of less than three months.

Financial instruments

| | i)   | Financial assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | ---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |      | The Company classifies its financial assets either at
      fair value through profit/loss (FVTPL) or as loans and receivables. The
      classification depends on the purpose for which the financial assets were
      acquired. Management determines the classification of its financial assets
      at initial recognition.                                                                                                                                                                                                                                                                                                                                                                       
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |      | Financial assets at FVTPL are financial assets held for
      trading and include derivative instruments for which cash flow hedging has
      not been applied. Financial assets at FVTPL are carried at fair value,
      with changes in fair value recorded in other income.                                                                                                                                                                                                                                                                                                                                                                                                                         
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |      | Loans and receivables are non-derivative financial assets
      with fixed or determinable payments that are not quoted in an active
      market, and include cash and cash equivalents, and accounts and other
      receivables. Loans and receivables are recognized initially at their face
      amount, except when fair value is materially different, and are
      subsequently measured at amortized cost using the effective interest
      method, less a provision for impairment. A provision for impairment is
      established when there is objective evidence the Company will not be able
      to collect all amounts due, according to the original terms of the
      instrument.
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |      | The Company may enter into transactions to sell trade
      receivables to third parties. If the risks and rewards of ownership of the
      receivables are transferred to the purchaser, the transaction is accounted
      for as a sale, and the receivables are derecognized. If the risks and
      rewards of ownership of the receivables are neither transferred nor
      retained and if control is not retained over the receivables, the
      transaction is accounted for as a sale.                                                                                                                                                                                                      
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | ii)  | Financial liabilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |      | Accounts payable and accrued liabilities are non-interest
      bearing and are recognized initially at their face amount, except when
      fair value is materially different, and are subsequently measured at
      amortized cost using the effective interest method. Borrowings are
      recognized initially at fair value, net of any directly attributable
      transaction costs, and are subsequently measured at amortized cost using
      the effective interest method.                                                                                                                                                                                                                
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | iii) | Derivative financial instruments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |      | From time to time, the Company enters into foreign
      exchange instruments to hedge a portion of its expected foreign currency
      denominated revenue over periods of up to 12 months into the future. The
      Company also enters into forward sales contracts for pulp or lumber, in
      order to reduce the impact of market volatility on its product sales, and
      enters into forward purchase contracts for natural gas, in order to reduce
      the impact of market volatility on its gas purchases. These contracts are
      classified as derivative instruments.                                                                                                              

2

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

Derivatives are recognized at fair
value on the date the Company becomes a party to the contract and are
subsequently remeasured at fair value. The Company does not enter into
speculative contracts and does not apply hedge accounting; therefore, unrealized
gains and losses on derivatives are recorded in earnings at each year-end.

The Company has reviewed all
significant contractual agreements and determined there is one embedded
derivative within other obligations (note 15) that must be separated from the
host contract and recorded at fair value.

Details of the Companys
classification of financial instruments are provided in note 23.

Impairment of financial assets

At each reporting date, the Company
assesses whether there is objective evidence that a financial asset carried at
amortized cost is impaired. If such evidence exists, the Company recognizes an
impairment loss, with the loss being the difference between the amortized cost
of the asset and the recoverable amount. The carrying amount of the asset is
reduced by this amount, either directly or indirectly, through the use of an
allowance account.

Impairment losses on financial assets
carried at amortized cost are reversed in subsequent periods if the amount of
the loss decreases and the decrease can be related objectively to an event
occurring after the impairment was recognized.

Inventories

The Companys inventories include logs,
pulp, lumber and operating and maintenance supplies.

Pulp, lumber, and log inventories are
recorded at the lower of cost and net realizable value (NRV). Cost is determined
using average cost and comprises raw materials, direct labour and other direct
costs, and related production overheads consistent with the normal level of
production. NRV represents the estimated selling price for inventories in the
ordinary course of business, less the estimated costs of completion and selling
expenses.

Processing materials and supplies are
recorded at weighted average cost, recalculated at each transaction date.

Cost of products sold, as presented in
the statements of comprehensive loss, includes all inventories expensed in the
year, as well as changes in inventory valuation provisions. When reasons for a
write down of inventory have ceased to exist, the write down is reversed.

Property, plant and equipment

Property, plant and equipment are
stated at cost less accumulated depreciation and accumulated impairment losses.
Cost includes expenditures that are directly attributable to the acquisition or
construction of the asset, including commissioning costs and borrowing costs.
Subsequent costs are included in the assets carrying value or are recognized as
a separate asset, as appropriate, only when it is probable that future economic
benefits associated with the item will flow to the Company and the cost can be
measured reliably. The carrying amount of a replaced asset is removed when the
item is replaced. Repair and maintenance costs are charged to the statements of
operations and comprehensive loss during the year in which they are incurred.
Depreciation is recognized on a straight-line basis.

The estimated useful lives of the
various components of the Companys major asset classes are as follows:

3

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

Buildings  sawmill
    20  60 yearsBuildings  pulp mill
    15  60 yearsBuildings  other
    8  15 yearsProcess equipment - sawmill
    5  50 yearsProcess equipment  pulp mill
    5  50 yearsMobile equipment
    3  10 yearsAncillary equipment
    5  15 yearsFurniture, office and computer equipment
    5  50 yearsBridges
    10  50 yearsRoads and yards
    10  50 years


The Company allocates the amount
initially recognized in respect of an item of property, plant and equipment to
its significant components and depreciates each component separately. Assets
under construction are recognized at cost and are not depreciated until the
assets are available for use. Residual values and useful lives of the assets are
reviewed annually and adjusted if appropriate.

Gains and losses on disposal of
property, plant and equipment are determined by comparing the proceeds with the
carrying amount of the assets and are included as part of other income in the
statements of operations and comprehensive loss.

Intangible assets

The Companys intangible assets include
timber rights, computer software and power purchase rights. These assets are
capitalized and amortized in the statements of operations and comprehensive
loss, on a straight-line basis over the period of their expected useful lives,
as follows:

Timber rights
    10  60 yearsComputer software
    5  15 yearsPower purchase rights (note 13)
    20 years


Assets under construction are
recognized at cost and are not depreciated until the assets are available for
use.

Impairment of non-financial assets

Property, plant and equipment and
intangible assets with finite useful lives are tested for impairment when events
or changes in circumstances indicate the carrying amount may not be recoverable.
If any such indications exist, the recoverable amount of the asset is
determined. For the purposes of measuring recoverable amounts, assets are
grouped at the lowest levels for which there are separately identifiable cash
flows (cash generating units or CGUs). The recoverable amount is the higher of
an assets fair value, less costs of disposal, and its value in use, which is
defined as the present value of the expected future cash flows of the relevant
assets or CGU. An impairment loss is recognized for the amount by which the
assets carrying amount exceeds its recoverable amount.

The Company evaluates impairment losses
for potential reversals when events or circumstances warrant such consideration.
An impairment loss is reversed only to the extent that the assets carrying
amount does not exceed the carrying amount that would have been determined, net
of amortization, if no impairment loss had been recognized.

4

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

Greenhouse gas credits

The Company earns greenhouse gas (GHG)
credits by creating projects that reduce greenhouse gas emissions. To the extent
not utilized to offset GHG penalties incurred, credits are recorded at their
estimated fair value. Credits are subsequently measured at FVTPL.

Borrowing costs

Borrowing costs attributable to the
acquisition, construction or production of qualifying assets are added to the
cost of those assets, until such time as the assets are ready for their intended
use. Transaction costs related to debt refinancing are deferred and amortized
over the life of the associated debt. All other borrowing costs are recognized
as finance expenses in the statements of operations and comprehensive loss in
the period in which they are incurred.

Employee benefits

| | i)   | Pension obligations                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | ---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |      | The Company has defined contribution plans providing
      pension benefits to most of its employees, and for certain key employees
      the Company has a supplementary defined benefit pension plan.                                                                                                                                                                                                                                                                                  
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |      | The cost of defined contribution pension plans is charged
      to expense as the contributions become payable.                                                                                                                                                                                                                                                                                                                                                                          
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |      | The cost of defined benefit plans is determined using the
      projected benefit method, prorated on service and managements best
      estimates of expected plan investment performance, salary increases and
      retirement ages of employees in the plan. The related pension liability
      recognized in the statements of financial position is the present value of
      the defined benefit obligation at the year-end date, less the fair value
      of the plan assets.
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |      | Actuarial valuations for defined benefit plans are
      carried out annually, or when any significant changes to the plan or
      membership may require a revaluation to be completed.                                                                                                                                                                                                                                                                                                
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |      | Actuarial gains and losses are recognized in the period
      in which they occur, in other comprehensive income (OCI), without
      recycling through earnings in subsequent periods. The costs of past
      service benefits are recognized as an expense in the statements of
      operations and comprehensive loss.                                                                                                                                                              
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | ii)  | Profit sharing                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |      | The Company recognizes a liability and an expense for
      profit sharing, based on a formula that takes into consideration the loss
      before taxes of the Company after certain adjustments.                                                                                                                                                                                                                                                                                       
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | iii) | Other obligations                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |      | The Company offers a supplemental vacation program for
      select employees. The employees can use the vacation at their discretion,
      and the vacation can be carried forward until the end of employment. The
      Company accrues for unused vacation at each
year-end.                                                                                                                                                                                                        

5

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

Provisions

Provisions for environmental
reclamation, restructuring costs and legal claims, where applicable, are
recognized when the Company has a present legal or constructive obligation as a
result of past events, when it is more likely than not that an outflow of
resources will be required to settle the obligation, and when the amount can be
reliably estimated. Provisions are measured at managements best estimate of the
expenditure required to settle the obligation at the end of the reporting
period, and are discounted to present value where the effect is material, using
a risk-free rate. The Company performs evaluations to identify onerous contracts
and, where applicable, records provisions for such contracts.

Forestry legislation in Alberta
requires the Company to incur the cost of reforestation of areas of land on
which timber is harvested under the terms of its quotas and forest management
agreement. Accordingly, the Company records a liability for the costs of
reforestation in the period in which the timber is harvested. In periods
subsequent to the initial measurement, changes in the liability resulting from
the passage of time and work performed and revisions to reforestation estimates
are recognized in the statements of operations and comprehensive loss as they
occur.

Income taxes

Income tax comprises current and
deferred tax. Income tax is recognized in the statements of operations and
comprehensive loss.

Current tax is the expected tax payable
on the taxable income for the year, using tax rates enacted or substantively
enacted at the end of the reporting period and any adjustment to tax payable in
respect of previous years.

Deferred income taxes are recognized
for the future tax consequences attributable to the differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred income tax liabilities or assets are
measured using substantively enacted rates anticipated to apply in the periods
in which the differences are expected to reverse. Deferred income tax assets are
recorded in the financial statements if realization is considered more likely
than not.

Deferred income tax assets and
liabilities are presented as non-current.

Investment tax credits are recognized
through income tax expense/recovery when it is considered probable the tax
credit will be utilized against taxable earnings.

Revenue

Revenue is derived from the sale of
pulp and lumber and from administrative services provided to related parties. It
is measured at the fair value of the consideration received or receivable, net
of claims, rebates, returns and discounts, for the sale of goods and services in
the ordinary course of the Companys business. Historical experience is used to
estimate and provide for discounts and returns. Volume discounts are assessed
based on anticipated annual purchases.

Revenue is recognized when the
significant risks and rewards of ownership have been transferred to the
customer, the sales price and costs can be measured reliably, and it is probable
that the economic benefits will flow to the Company. These criteria are
generally met at the time the product is shipped to the customer; title and risk
have passed to the customer; and acceptance of the product, when contractually
required, has been obtained.

6

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

|  | Government grants                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|  | Grants received under government incentive programs are
      recognized initially as deferred revenue at fair value when there is
      reasonable assurance they will be received and the Company will comply
      with the conditions associated with the grant. Grants that compensate the
      Company for the cost of an asset are deducted against the carrying amount
      of the asset.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|  | Segment reporting                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|  | Operating segments are reported in a manner consistent
      with the internal reporting provided to the chief operating decision
      maker. The chief operating decision maker has been identified as the
      Companys senior executive team, which collectively makes strategic
      decisions for the segments.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|3 | Critical accounting estimates and
  judgments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|  | The preparation of financial statements requires
      management to use judgment in applying its accounting policies and
      estimates and assumptions about the future. Estimates and other judgments
      are continually evaluated and are based on managements experience and
      other factors, including expectations about future events that are
      believed to be reasonable under the circumstances. The following discusses
      the most significant accounting judgments and estimates the Company has
      made in the preparation of the financial statements:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|  | Useful lives of timber rights                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|  | The Companys timber rights comprise various agreements
      and contracts that have fixed terms but contain renewal provisions that
      could extend the lives of the rights indefinitely. In estimating the
      useful lives of timber rights, management has generally assumed that
      renewals will occur in the normal course of business, with useful lives
      not to exceed 60 years. If the Company was unable to obtain a renewal in
      the future for a material agreement, this would have an impact on
      amortization, as well as in the determination of discounted cash flows
      used in impairment tests for other long-lived assets.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|  | Reforestation obligation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|  | The Company is required to reforest the areas of land on
      which timber is harvested under the terms of its quotas and forest
      management agreements. Accordingly, the Company records a liability for
      the estimated costs of reforestation in the period in which the timber is
      harvested (note 14) with any changes in initial measurement recognized in
      the statements of operations and comprehensive loss as they occur. The
      timing of the reforestation payments is based on the estimated period
      required to attain free-to-grow status in a given area, which is generally
      between 12 to 15 years. Due to the general, long-term nature of the
      liability, the most significant areas of uncertainty in estimating the
      provision are the amount and timing of future costs that will be incurred
      as, depending on the location and environment of the land, the
      reforestation costs can vary significantly.                                                                                                                                                                                                                                                                                                                                                                                         
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|  | Long-term derivative liability                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|  | The Companys long-term derivative liability  Biomass
      agreement arises from a long-term contract for the supply of biomass to
      Whitecourt Power Limited Partnership (WPLP) (note 15). The underlying
      formula that determines the amount the Company pays or receives on a
      quarterly basis contains many variables and meets the definition of an
      embedded derivative, requiring its carrying cost to be recorded at
      fair value with all measurements recognized in the statement of operations
      and comprehensive loss. The embedded derivative is included in level 2 of
      the fair value hierarchy as it has been valued using a discounted cash
      flow model. Due to the long-term nature of the liability, the most
      significant areas of uncertainty in estimating the current fair value are
      future expectations of estimated monthly total units of power generation
      by WPLP, the estimated monthly proportion of WPLPs biomass consumption
      that is transported from the Company, Alberta Consumer Price Index
      metrics, monthly Alberta Pool Price projections from the Alberta Electric
      System Operator and Canadian dollar discount curves. Depending on
      fluctuations in these underlying variables the estimated fair value of the
      instrument can vary significantly.

7

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

|  | Functional currency                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|  | The functional currency of the Company is the currency of
      the primary economic environment in which the entity operates. The Company
      has determined that its functional currency is the Canadian dollar.
      Determination of functional currency involves certain judgments to
      determine the primary economic environment and the Company reconsiders its
      functional currency whenever there is a change in events and conditions
      which determined the primary economic environment. There have been no such
      changes during the year ended December 31, 2016.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|4 | Changes in accounting policies                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|  | The IASB periodically issues new standards and amendments
      or interpretations to existing standards. The new pronouncements listed
      below are those that the Company considers relevant to its financial
      reporting.                                                                                                                                                                                                                                                                                                                                                                 
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|  | The following standards have been issued but not yet
      applied.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

| |  | IFRS 9, Financial Instruments  In November 2009, IFRS 9
      was issued and in October 2010 was further amended. IFRS 9 addresses
      classification and measurement of financial assets and replaces the
      multiple category and measurement models in International Accounting
      Standards (IAS) 39 - Financial Instruments: Recognition and Measurement,
      for debt instruments with a new mixed measurement model having only two
      categories: amortized cost and fair value through profit or loss. IFRS 9
      also replaces the models for measuring equity instruments and such
      instruments are either recognized at fair value through profit or loss or
      at fair value through other comprehensive earnings. This standard is
      effective for annual periods beginning on or after January 1, 2018. The
      Company is in the process of assessing the impact of this new standard.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | IFRS 15, Revenue from Contracts with Customers  In May
      2014, IFRS 15 was issued. This standard addresses revenue recognition and
      establishes principles for reporting information about the nature, amount,
      timing and uncertainty of revenue and cash flows arising from an entitys
      contracts with customers. Revenue is recognized when a customer obtains
      control of a good or service and thus has the ability to control its use
      and obtain the benefits from the good or service. The standard replaces
      IAS 18 - Revenue, IAS 11 - Construction Contracts and the related
      interpretations. The standard is effective for annual periods beginning on
      or after January 1, 2018 with earlier application permitted. The Company
      is in the process of assessing the impact of this new standard.                                                                   
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |  | IFRS 16, Leases  On January 13, 2016, IFRS 16 was issued
      which requires, among other things, lessees to recognize leases
      traditionally recorded as operating leases in the same manner as financing
      leases. The standard is effective for annual periods beginning on or after
      January 1, 2019 with earlier application permitted. The Company has not
      yet assessed the impact of the new standard.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

8

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

| |  | IAS 12 amendment, Recognition of deferred tax assets for
      unrealized losses - The amendments made to IAS 12 in January 2016 clarify
      the accounting for deferred tax where an asset is measured at fair value
      and that fair value is below the assets tax base. These amendments become
      effective on January 1, 2017, and the Company is in the process of
      completing an initial assessment of the potential impact of their
      adoption.                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |  | IAS 7 amendment, Disclosure initiative - Going forward,
      entities will be required to explain changes in their liabilities arising
      from financing activities. This includes changes arising from cash flows
      (e.g. drawdowns and repayments of borrowings) and non-cash changes such as
      acquisitions, disposals, accretion of interest and unrealized exchange
      differences. Changes in financial assets must be included in this
      disclosure if the cash flows were, or will be, included in cash flows from
      financing activities. These amendments become effective on January 1,
      2017, and their adoption will result in additional disclosures as
      explained above.

There are no other standards or
amendments or interpretations to existing standards issued but not yet effective
that are expected to have a material impact on the financial statements.

|5 | Cash and cash equivalents                                                                                                                                                                                                                                 
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                           
|  | Cash on deposit at Canadian banks earns interest at the
      banks prime rate minus 1.95%. The banks prime rate as at December 31,
      2016 was 2.70% (2015  2.70%). As of December 31, 2016 the Company had no
      restricted cash (2015 - $nil).
|  |                                                                                                                                                                                                                                                           
|6 | Accounts and other
receivables                                                                                                                                                                                                                            

| |                                       |  | 2016   |  |  | 2015   | 
| | ------------------------------------- |  | ------ |  |  | ------ | 
| |                                       |  | $      |  |  | $      | 
| |                                       |  |        |  |  |        | 
| | Trade receivables                     |  | 26,229 |  |  | 23,610 | 
| | Intercompany receivables (note 22(a)) |  | 190    |  |  | 145    | 
| | Other receivables                     |  | 6,319  |  |  | 10,381 | 
| |                                       |  |        |  |  |        | 
| |                                       |  | 32,738 |  |  | 34,136 | 

|  | Current trade and other receivables are unsecured and
      non-interest bearing. Normal payment terms for the Company are 30 days
      (see also note 23).
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                             
|7 | Inventories                                                                                                                                                 

| |                                    |  | 2016   |  |  | 2015   | 
| | ---------------------------------- |  | ------ |  |  | ------ | 
| |                                    |  | $      |  |  | $      | 
| |                                    |  |        |  |  |        | 
| | Logs                               |  | 19,542 |  |  | 34,858 | 
| | Pulp                               |  | 16,181 |  |  | 21,584 | 
| | Lumber                             |  | 14,425 |  |  | 22,867 | 
| | Operating and maintenance supplies |  | 13,180 |  |  | 13,559 | 
| |                                    |  |        |  |  |        | 
| |                                    |  | 63,328 |  |  | 92,868 | 

In 2016, the Company reversed a $1.2
million inventory write down recorded at December 31, 2015. The amount reversed
was included in cost of products sold.

9

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

|8 | Property, plant and
equipment
|- | -----------------------------

ProcessLand
    
    
    Buildings
    
    
    equipment
    
    
    Other
    
    
    Total$
    
    
    $
    
    
    $
    
    
    $
    
    
    $Year ended December 31, 2015As
      at January 1, 2015
    
    2,463
    
    
    43,070
    
    
    139,222
    
    
    7,851
    
    
    192,606Additions
    
    -
    
    
    1,244
    
    
    50,006
    
    
    247
    
    
    51,497Disposals
    
    (355
    )
    
    (1,454
    )
    
    (8,495
    )
    
    (1,319
    )
    
    (11,623
    )Depreciation for the year
    
    -
    
    
    (1,718
    )
    
    (6,634
    )
    
    (1,292
    )
    
    (9,644
    )As at December 31, 2015
    
    2,108
    
    
    41,142
    
    
    174,099
    
    
    5,487
    
    
    222,836As at December 31, 2015Cost
    
    2,108
    
    
    79,994
    
    
    375,029
    
    
    14,862
    
    
    471,993Accumulated depreciation
    
    -
    
    
    (38,852
    )
    
    (200,930
    )
    
    (9,375
    )
    
    (249,157
    )Net book value
    
    2,108
    
    
    41,142
    
    
    174,099
    
    
    5,487
    
    
    222,836Year ended December 31, 2016As at January 1, 2016
    
    2,108
    
    
    41,142
    
    
    174,099
    
    
    5,487
    
    
    222,836Additions
    
    -
    
    
    10
    
    
    10,830
    
    
    711
    
    
    11,551Reclassification of costs
    
    -
    
    
    29,375
    
    
    (29,375
    )
    
    -
    
    
    -Disposals
    
    -
    
    
    (50
    )
    
    (27
    )
    
    (315
    )
    
    (392
    )Depreciation for the year
    
    -
    
    
    (1,621
    )
    
    (6,248
    )
    
    (952
    )
    
    (8,821
    )As at December 31, 2016
    
    2,108
    
    
    68,856
    
    
    149,279
    
    
    4,931
    
    
    225,174As at December 31, 2016Cost
    
    2,108
    
    
    109,309
    
    
    356,404
    
    
    14,924
    
    
    482,745Accumulated depreciation
    
    -
    
    
    (40,453
    )
    
    (207,125
    )
    
    (9,993
    )
    
    (257,571
    )Net book value
    
    2,108
    
    
    68,856
    
    
    149,279
    
    
    4,931
    
    
    225,174


Included in the above net book values
are assets under construction, and therefore not being depreciated, in the
amount of $2.1 million as at December 31, 2016 (2015  $77.1 million).

During 2016, the Company completed
construction of a bioenergy effluent project (BEP) at its BCTMP mill at
Whitecourt, Alberta. The project involved the construction and integration of
three anaerobic hybrid digesters into the BCTMP mills existing aerobic effluent
treatment system, and the installation of a biogas-fueled power plant and other
project components. The project qualified for a total of $27.7 million in
government grants, of which $27.7 million (2015 - $25.5 million) had been
received by the Company and expended on the project as at December 31, 2016. On
completion, the Company reclassified $29.4 million from process equipment to
buildings.

Total expenditures on the project to
December 31, 2016 were $122.2 million, resulting in a net expenditure of $86.7
million, after receipt of the above grants and $7.8 million retained from the
EPC contractor. The Company received $20.2 million (2015  $20.2 million) in
interim financing (note 13) to partially fund project costs. On September 15,
2015, the interim financing loan converted into a capital lease.

10

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

|  | In 2016, borrowing costs of $5.3 million (2015  $4.0
      million) were capitalized for the construction of the BEP based on an
      average annual interest rate of 8.4% (2015  8.7%).                                                                                                                                                                                                                                                                                                            
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|  | Effective December 22, 2015, the Company sold the Boyle,
      Alberta sawmill assets and liabilities to a third party. The sale price of
      $32.2 million included the value of all mill assets, timber quotas, and
      log inventories in the field, as well as the operations reforestation
      liability. The gain on sale included in income was $17.6 million. As of
      December 31, 2016, $1.0 million remained in the other receivables balance
      relating to the sale proceeds.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|9 | Intangible assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

| |                                |  |        |   |  |          |   |  | Power    |   |  |         |  
| | ------------------------------ |  | ------ | - |  | -------- | - |  | -------- | - |  | ------- | -
| |                                |  | Timber |   |  | Computer |   |  | purchase |   |  |         |  
| |                                |  | rights |   |  | software |   |  | rights   |   |  | Total   |  
| |                                |  | $      |   |  | $        |   |  | $        |   |  | $       |  
| |                                |  |        |   |  |          |   |  |          |   |  |         |  
| | Year ended December 31, 2015   |  |        |   |  |          |   |  |          |   |  |         |  
| | As at January 1,
      2015    |  | 10,468 |   |  | 644      |   |  | 26,045   |   |  | 37,157  |  
| | Additions                      |  | 523    |   |  | 187      |   |  | -        |   |  | 710     |  
| | Disposals                      |  | (860   | ) |  | (103     | ) |  | -        |   |  | (963    | )
| | Amortization for the period    |  | (450   | ) |  | (134     | ) |  | (4,341   | ) |  | (4,925  | )
| |                                |  |        |   |  |          |   |  |          |   |  |         |  
| | As at December 31, 2015        |  | 9,681  |   |  | 594      |   |  | 21,704   |   |  | 31,979  |  
| |                                |  |        |   |  |          |   |  |          |   |  |         |  
| | As at December 31, 2015        |  |        |   |  |          |   |  |          |   |  |         |  
| | Cost                           |  | 16,807 |   |  | 10,055   |   |  | 67,783   |   |  | 94,645  |  
| | Accumulated amortization       |  | (7,126 | ) |  | (9,461   | ) |  | (46,079  | ) |  | (62,666 | )
| |                                |  |        |   |  |          |   |  |          |   |  |         |  
| | Net book value                 |  | 9,681  |   |  | 594      |   |  | 21,704   |   |  | 31,979  |  
| |                                |  |        |   |  |          |   |  |          |   |  |         |  
| | Year ended December 31, 2016   |  |        |   |  |          |   |  |          |   |  |         |  
| | As at January 1,
      2016    |  | 9,681  |   |  | 594      |   |  | 21,704   |   |  | 31,979  |  
| | Additions                      |  | 559    |   |  | -        |   |  | -        |   |  | 559     |  
| | Disposals /
      terminations |  | -      |   |  | -        |   |  | (20,619  | ) |  | (20,619 | )
| | Amortization for the period    |  | (305   | ) |  | (133     | ) |  | (1,085   | ) |  | (1,523  | )
| |                                |  |        |   |  |          |   |  |          |   |  |         |  
| | Closing net book value         |  | 9,935  |   |  | 461      |   |  | -        |   |  | 10,396  |  
| |                                |  |        |   |  |          |   |  |          |   |  |         |  
| | As at December 31, 2016        |  |        |   |  |          |   |  |          |   |  |         |  
| | Cost                           |  | 17,366 |   |  | 10,055   |   |  | -        |   |  | 27,421  |  
| | Accumulated amortization       |  | (7,431 | ) |  | (9,594   | ) |  | -        |   |  | (17,025 | )
| |                                |  |        |   |  |          |   |  |          |   |  |         |  
| | Net book value                 |  | 9,935  |   |  | 461      |   |  | -        |   |  | 10,396  |  

Included in the above net book values
are assets under construction, and therefore not being amortized, in the amount
of $1.3 million as at December 31, 2016 (2015  $0.7 million).

Power purchase rights

In 2001 and 2006, the Company entered
into agreements to acquire the rights to a portion of the electricity generated
from certain power plants in Alberta. In the first quarter of 2016, this
arrangement was terminated (note 13).

11

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

|10 | Other assets
|-- | ------------

| |                        |  | 2016  |  |  | 2015  | 
| | ---------------------- |  | ----- |  |  | ----- | 
| |                        |  | $     |  |  | $     | 
| |                        |  |       |  |  |       | 
| | Greenhouse gas credits |  | 1,278 |  |  | 1,413 | 
| | Other                  |  | 115   |  |  | 316   | 
| |                        |  |       |  |  |       | 
| |                        |  | 1,393 |  |  | 1,729 | 

|   | The Company holds approximately 66,974 Alberta-based
      carbon offset credits verified by an independent party and registered with
      the Alberta government. These credits are valued at fair value and, with
      the emergence of a secondary market for greenhouse credits, have been
      recorded at valuation of $19 per credit. $1.0 million was paid during the
      year in order to satisfy the requirements outlined in the Specified Gas
      Emitters Regulation in Alberta. Additionally, effective June 30, 2016, the
      Company sold 96,922 greenhouse gas credits for $1.8 million in an emission
      offset purchase agreement (note 13).                                                                                                                                                                                                                                            
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|11 | Revolving credit facility                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | The Company has a $50 million revolving credit facility
      maturing July 15, 2018. The credit facility was undrawn as at December 31,
      2016, and December 31, 2015. The facility is subject to a borrowing
      formula based on the Companys levels of inventory and accounts
      receivable. The amount available as at December 31, 2016 under the
      facility was $50.0 million (2015  $50.0 million), of which $11.9 million
      (2015  $3.9 million) was committed to letters of credit. The interest
      rate on this facility is floating and may, at the Companys option, be
      based on the Canada bank prime rate or US base rate, plus a spread of
      2.00%. The Company has the option of basing the rate on LIBOR plus a
      spread of 3.25%. Collateral pledged for the facility is a first charge on
      all accounts receivable and domestic inventory of the Company.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|12 | Accounts payable and accrued
  liabilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

| |                                         |  | 2016   |  |  | 2015   | 
| | --------------------------------------- |  | ------ |  |  | ------ | 
| |                                         |  | $      |  |  | $      | 
| |                                         |  |        |  |  |        | 
| | Trade payables                          |  | 19,814 |  |  | 20,681 | 
| | Payable to related parties (note 22(b)) |  | 464    |  |  | 238    | 
| | Accrued expenses                        |  | 22,921 |  |  | 26,433 | 
| | Customer deposits                       |  | 2,494  |  |  | -      | 
| | Derivative contracts                    |  | 14     |  |  | 542    | 
| |                                         |  |        |  |  |        | 
| |                                         |  | 45,707 |  |  | 47,894 | 

12

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

|13 | Financial liabilities 
  borrowings
|-- | ------------------------------------

| |                                         |  | 2016    |   |  | 2015    |  
| | --------------------------------------- |  | ------- | - |  | ------- | -
| |                                         |  | $       |   |  | $       |  
| |                                         |  |         |   |  |         |  
| | Unsecured Senior notes  US$210 million |  | 281,967 |   |  | 290,640 |  
| | Less: Financing expenses                |  | (2,116  | ) |  | (2,613  | )
| | Power purchase rights loan #1           |  | -       |   |  | 8,345   |  
| | Power purchase rights loan #2           |  | -       |   |  | 1,592   |  
| | Capital Power loan                      |  | 7,201   |   |  | -       |  
| | BEP capital lease obligation (note 8)   |  | 16,619  |   |  | 19,536  |  
| |                                         |  |         |   |  |         |  
| |                                         |  | 303,671 |   |  | 317,500 |  
| | Less: Current portion                   |  | 6,476   |   |  | 4,438   |  
| |                                         |  |         |   |  |         |  
| |                                         |  | 297,195 |   |  | 313,062 |  

Principal repayments required are as
follows:

$2017
    
    6,4762018
    
    6,7232019
    
    3,0842020
    
    7,5372021
    
    281,967


Unsecured Senior Notes

On April 1, 2011, the Company issued
US$210 million in Senior Notes due April 1, 2021, bearing interest at 8.5%,
payable semi-annually, on April 1 and October 1 of each year. The notes are
unsecured obligations of the Company and rank equally and rateably with all
existing and future unsecured indebtedness of the Company.

The Company incurred $5.0 million of
financing costs relating to the issuance, which are offset against the
borrowings and are amortized over the expected ten-year term of the notes.

The indenture governing the unsecured
Senior Notes contains certain restrictions on the ability of the Company to
incur additional indebtedness, pay dividends or distributions, make investments,
issue or repurchase share capital, create liens, or engage in sale and leaseback
transactions, mergers, consolidations and sales of assets and transactions with
affiliates. As at December 31, 2016, the Company was not in violation of any of
these restrictions.

Power Purchase Rights and Related
Loans

Effective March 24, 2016, Capital Power
Corporation gave notice of its intent to terminate its role as buyer of the
Sundance C Power Purchase Arrangement. As a result of this termination, the
Companys role as a party to the Power Purchase Arrangement (PPA) syndicate was
also terminated. The Company had $9.4 million in loans related to the
acquisition of its share of the PPA, which were recorded at fair value and
amortized using the effective interest rate method. As a result of the PPA
termination, the loans cash value of $11.0 million became due and payable to
Capital Power on June 30, 2016. The differential, a loss of $1.6
      million, was recorded along with the $20.6 million loss on termination of
      the PPA asset.

13

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

|   | Effective June 30, 2016, the Company entered into an
      emission offset purchase agreement, whereby 96,922 greenhouse gas credits
      were sold to Capital Power for the purchase price of $1.8 million, which
      partially offset the $10.7 million of principal remaining on the loans at
      the end of June. This resulted in a gain of $0.4 million on the sale of
      the greenhouse credits over the recorded value amount of $1.4 million. The
      remaining loan balance of $8.9 million will be paid in equal monthly
      payments of $0.3 million from July 31, 2016 to December 31, 2018, with
      interest accrued at an effective annual rate of 5.48%. The loan is secured
      by a letter of credit, which will be periodically reduced as the loan is
      repaid. As of December 31, 2016, the remaining balance of the letter of
      credit to Capital Power was $7.5 million.
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | Subsequent to Capital Powers announcement of its intent
      to terminate the PPA, and as disclosed by the Company in its second
      quarter earnings results, the Government of Albertas Balancing Pool
      advised that it might challenge the validity or the effective date of the
      termination. On November 28, 2016, Capital Power Corporation announced an
      agreement with the Government of Alberta to settle the PPA dispute. Under
      the settlement, the termination of the PPA was accepted, thereby ending
      all Company obligations associated with the PPA. Capital Power Corporation
      and its syndicate partners agreed to pay the balancing pool $39 million,
      of which the Companys share was $4.4 million. This payment was included
      in the fourth quarter and year-end financial results as Loss on
      termination of PPA.                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | BEP Capital Lease Obligation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | In 2012, the Company obtained interim financing capacity
      in the amount of $20.2 million, bearing interest at the Canada bank prime
      rate plus 2%, to procure key components of the BEP (note 8). On September
      15, 2015, the interim financing loan converted into a capital lease,
      bearing interest of 4.45% over a 60-month period. At the end of the lease
      term, the Company will have the option to purchase the equipment for a
      defined option price embedded in the lease agreement.                                                                                                                                                                                                                                                                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|14 | Reforestation and asset retirement
    obligations                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

| |                              |  |               |   |  | Asset       |   |  |        |  
| | ---------------------------- |  | ------------- | - |  | ----------- | - |  | ------ | -
| |                              |  | Reforestation |   |  | retirement  |   |  |        |  
| |                              |  | obligation    |   |  | obligations |   |  | Total  |  
| |                              |  | $             |   |  | $           |   |  | $      |  
| |                              |  |               |   |  |             |   |  |        |  
| | As at December 31, 2014      |  | 14,574        |   |  | 2,004       |   |  | 16,578 |  
| | Change in accrual            |  | 4,771         |   |  | (585        | ) |  | 4,186  |  
| | Change in provision          |  | (45           | ) |  | 27          |   |  | (18    | )
| | Expenditures during the year |  | (6,917        | ) |  | -           |   |  | (6,917 | )
| |                              |  |               |   |  |             |   |  |        |  
| | As at December 31, 2015      |  | 12,383        |   |  | 1,446       |   |  | 13,829 |  
| | Less: Current portion        |  | 4,749         |   |  | -           |   |  | 4,749  |  
| |                              |  |               |   |  |             |   |  |        |  
| | As at December 31, 2015      |  | 7,634         |   |  | 1,446       |   |  | 9,080  |  
| |                              |  |               |   |  |             |   |  |        |  
| |                              |  |               |   |  |             |   |  |        |  
| |                              |  |               |   |  |             |   |  |        |  
| | As at December 31, 2015      |  | 12,383        |   |  | 1,446       |   |  | 13,829 |  
| | Change in accrual            |  | 2,781         |   |  | -           |   |  | 2,781  |  
| | Change in provision          |  | (100          | ) |  | (130        | ) |  | (230   | )

14

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

| |                              |  |               |   |  | Asset       |  |  |        |  
| | ---------------------------- |  | ------------- | - |  | ----------- |  |  | ------ | -
| |                              |  | Reforestation |   |  | retirement  |  |  |        |  
| |                              |  | obligation    |   |  | obligations |  |  | Total  |  
| |                              |  | $             |   |  | $           |  |  | $      |  
| |                              |  |               |   |  |             |  |  |        |  
| | Expenditures during the year |  | (3,374        | ) |  | -           |  |  | (3,374 | )
| |                              |  |               |   |  |             |  |  |        |  
| | As at December 31, 2016      |  | 11,690        |   |  | 1,316       |  |  | 13,006 |  
| | Less: Current portion        |  | 3,210         |   |  | -           |  |  | 3,210  |  
| |                              |  |               |   |  |             |  |  |        |  
| | As at December 31, 2016      |  | 8,480         |   |  | 1,316       |  |  | 9,796  |  

|   | The estimated undiscounted cash flows required to settle
      the reforestation obligations as at December 31, 2016 were $12.1 million
      (2015  $12.7 million), with payments spread over 14 years. The most
      significant area of uncertainty is the estimate of future costs to be
      incurred. The estimated cash flows have been adjusted for inflation and
      discounted using the risk free-rates, ranging from 0.73% to 2.21% as at
      December 31, 2016.
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   | The asset retirement obligations are to reclaim land
      leased from the Province of Alberta. These obligations represent estimated
      undiscounted future payments of $5.2 million to reclaim the land. The
      payments are expected to occur at least 60 years into the future and have
      been discounted at a risk-free rate of 2.31%.                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|15 | Other obligations                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

| |                                                          |  | 2016  |  |  | 2015  | 
| | -------------------------------------------------------- |  | ----- |  |  | ----- | 
| |                                                          |  | $     |  |  | $     | 
| |                                                          |  |       |  |  |       | 
| | Long-term derivative liability  Biomass
      agreement |  | 4,324 |  |  | 2,280 | 
| | Other                                                    |  | -     |  |  | 5     | 
| |                                                          |  |       |  |  |       | 
| |                                                          |  | 4,324 |  |  | 2,285 | 

On March 2, 2015, the Company and WPLP
entered into a 15-year biomass supply agreement effective January 1, 2015. On
the day that is 180 days before the tenth anniversary of the commencement date,
the Company and WPLP have the option to extend the agreement for five additional
years.

Pursuant to the agreement, the Company
supplies WPLP with 100% of the biomass that WPLP needs to run its power
generation facility. WPLP has no obligation to pay any compensation for the
acquisition of the biomass other than transportation costs. However, WPLP, or
the Company, may have to compensate the other party quarterly based on a formula
that considers the quarterly weighted average of the monthly Alberta Pool Price
as well as sharing net revenues from compliance environment attributes received
by WPLP related to power generation. If power prices fall below a certain
threshold, the Company is required to pay based on the formula, and if the
prices are above another threshold, the Company will receive payment from WPLP.

The underlying quarterly mechanism
within the agreement meets the definition of an embedded derivative requiring
its initial measurement at fair value, with any subsequent re-measurements to
fair value being recognized in the statement of operations and comprehensive
loss. At December 31, 2016 the estimated fair value of the embedded derivative
using a discounted cash flow model, based on the factors and estimates described
in note 3, was $4.3 million (2015  $2.3 million).

Actual payments in the year ended
December 31, 2016 resulting from the agreement were $8.5 million (2015 - $4.3
million) and are recorded in cost of products sold.

15

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

|16 | Share capital
|-- | -------------

Authorized
              
Unlimited number of common shares, no par value

Issued and fully paid

| |                          |  | 2016   |  |  | 2015   | 
| | ------------------------ |  | ------ |  |  | ------ | 
| |                          |  | $      |  |  | $      | 
| |                          |  |        |  |  |        | 
| | 15,000,002 common shares |  | 65,500 |  |  | 65,500 | 

The Company declared and paid dividends
of $nil in 2016 (2015 - $0.8 million, 2014 - $2.3 million).

|17 | Expenses by nature
|-- | ------------------

| |                                                                      |  | 2016    |  |  | 2015    |  |  | 2014    |  
| | -------------------------------------------------------------------- |  | ------- |  |  | ------- |  |  | ------- | -
| |                                                                      |  | $       |  |  | $       |  |  | $       |  
| |                                                                      |  |         |  |  |         |  |  |         |  
| | Changes in inventories of finished goods
      and work- in-progress |  | 12,680  |  |  | 1,117   |  |  | (6,805  | )
| | Raw materials and consumables used                                   |  | 167,731 |  |  | 179,242 |  |  | 184,801 |  
| | Depreciation and amortization                                        |  | 10,345  |  |  | 14,568  |  |  | 14,272  |  
| | Wages and employee benefits expense                                  |  | 62,727  |  |  | 72,381  |  |  | 67,140  |  
| | Transportation                                                       |  | 64,203  |  |  | 63,961  |  |  | 59,767  |  
| | Loss on termination of PPA                                           |  | 26,624  |  |  | -       |  |  | -       |  
| | Other expenses                                                       |  | 43,986  |  |  | 30,172  |  |  | 44,785  |  
| |                                                                      |  |         |  |  |         |  |  |         |  
| |                                                                      |  | 388,296 |  |  | 361,441 |  |  | 363,960 |  

|18 | Other (expense) income,
net
|-- | ---------------------------

| |                                                                             |  | 2016   |   |  | 2015   |   |  | 2014   |  
| | --------------------------------------------------------------------------- |  | ------ | - |  | ------ | - |  | ------ | -
| |                                                                             |  | $      |   |  | $      |   |  | $      |  
| |                                                                             |  |        |   |  |        |   |  |        |  
| |                                                                             |  |        |   |  |        |   |  |        |  
| | Loss on disposal of property, plant and
      equipment                     |  | (260   | ) |  | (423   | ) |  | (49    | )
| | Gain on sale of greenhouse gas credits (note 13)                            |  | 388    |   |  | -      |   |  | -      |  
| | Foreign exchange gain                                                       |  | 53     |   |  | 4,872  |   |  | 4,697  |  
| | Insurance proceeds                                                          |  | -      |   |  | 73     |   |  | -      |  
| | Change in unrealized gain (loss) on
      derivative contracts              |  | 528    |   |  | 1,287  |   |  | (2,074 | )
| | Change in unrealized loss on long-term derivative liability
      (note 15) |  | (2,044 | ) |  | (2,280 | ) |  | -      |  
| | Realized gain (loss) on derivative
      contracts                          |  | 960    |   |  | (7,398 | ) |  | 105    |  
| | Other gains                                                                 |  | 82     |   |  | -      |   |  | -      |  
| |                                                                             |  |        |   |  |        |   |  |        |  
| |                                                                             |  | (293   | ) |  | (3,869 | ) |  | 2,679  |  

16

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

|19 | Finance expenses, net
|-- | ---------------------

| |                                                 |  | 2016   |   |  | 2015   |   |  | 2014   |  
| | ----------------------------------------------- |  | ------ | - |  | ------ | - |  | ------ | -
| |                                                 |  | $      |   |  | $      |   |  | $      |  
| |                                                 |  |        |   |  |        |   |  |        |  
| | Interest expense on borrowings                  |  | 25,418 |   |  | 26,578 |   |  | 22,527 |  
| | Less: Interest capitalized on qualifying assets |  | 5,279  |   |  | 4,032  |   |  | 798    |  
| |                                                 |  |        |   |  |        |   |  |        |  
| | Net interest expense on borrowings              |  | 20,139 |   |  | 22,546 |   |  | 21,729 |  
| | Other interest and bank charges                 |  | 1,063  |   |  | 891    |   |  | 683    |  
| | Interest income                                 |  | (104   | ) |  | (142   | ) |  | (326   | )
| |                                                 |  |        |   |  |        |   |  |        |  
| |                                                 |  | 21,098 |   |  | 23,295 |   |  | 22,086 |  

|20 | Income tax (recovery) expense                                                                                                                                                            
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                          
|   | The following analysis describes the difference between
      the effective tax rate reflected in the provision for income taxes and the
      statutory rates applicable to the Company.

| |                                                                                                                                           |  | 2016    |   |  | 2015    |   |  | 2014   |  
| | ----------------------------------------------------------------------------------------------------------------------------------------- |  | ------- | - |  | ------- | - |  | ------ | -
| |                                                                                                                                           |  | $       |   |  | $       |   |  | $      |  
| |                                                                                                                                           |  |         |   |  |         |   |  |        |  
| | Loss before income taxes                                                                                                                  |  | (15,604 | ) |  | (53,157 | ) |  | (1,188 | )
| |                                                                                                                                           |  |         |   |  |         |   |  |        |  
| | Income taxes based on combined federal and
      provincial
      income            tax
      rates of 34.0% (2015  33.0%; 2014  32.0%) |  | (5,305  | ) |  | (17,547 | ) |  | (380   | )
| |                                                                                                                                           |  |         |   |  |         |   |  |        |  
| | Increase (decrease) resulting from                                                                                                        |  |         |   |  |         |   |  |        |  
| | Manufacturing
      and processing deduction of 7%                                                                                        |  | 1,092   |   |  | 3,721   |   |  | 83     |  
| | Non-taxable
      portion of unrealized (gain) loss on debt                                                                               |  | (1,171  | ) |  | 6,115   |   |  | 2,533  |  
| | Non-taxable
      portion of capital gains                                                                                                |  | -       |   |  | (84     | ) |  | -      |  
| | Non-deductible
      income (taxable) and other items                                                                                     |  | 85      |   |  | 72      |   |  | (141   | )
| | SRED investment
      tax credits - net                                                                                                   |  | (743    | ) |  | (95     | ) |  | (635   | )
| | Impact of enacted rates                                                                                                                   |  | -       |   |  | 544     |   |  | -      |  
| | Change
      in unrealized tax capital losses for which
      no                       deferred
      tax asset was recognized            |  | (1,171  | ) |  | 6,872   |   |  | 2,533  |  
| |                                                                                                                                           |  |         |   |  |         |   |  |        |  
| | Income tax (recovery) expense                                                                                                             |  | (7,213  | ) |  | (402    | ) |  | 3,993  |  
| |                                                                                                                                           |  |         |   |  |         |   |  |        |  
| | Current income tax recovery                                                                                                               |  | (436    | ) |  | (124    | ) |  | (252   | )
| | Deferred income tax (recovery) expense                                                                                                    |  | (6,777  | ) |  | (278    | ) |  | 4,245  |  
| |                                                                                                                                           |  |         |   |  |         |   |  |        |  
| | Income tax (recovery) expense                                                                                                             |  | (7,213  | ) |  | (402    | ) |  | 3,993  |  

17

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

The weighted average applicable tax
rate was 34.0% (2015  33.0%; 2014  32.0%) .

Current income tax recovery includes no
(2015  $0.1 million recovery; 2014  $0.3 million recovery) prior year
adjustments.

The Company did not recognize a
deferred income tax asset of $10.9 million (2015  $12.1 million; 2014  $5.3
million) in respect of unrealized foreign exchange losses on long-term debt.

As at December 31, 2016, the Company
had approximately $34.2 million of federal and $39.5 million of provincial
non-capital losses available to reduce future years income for tax purposes,
subject to confirmation by taxation authorities. The losses for both
jurisdictions commence expiry in the December 31, 2032 taxation year.

The movement in the deferred income tax
account is as follows:

| |                                                                              |  | 2016   |   |  | 2015   |  
| | ---------------------------------------------------------------------------- |  | ------ | - |  | ------ | -
| |                                                                              |  | $      |   |  | $      |  
| |                                                                              |  |        |   |  |        |  
| |                                                                              |  |        |   |  |        |  
| | As at January 1                                                              |  | 12,853 |   |  | 13,189 |  
| | Credit to the statements of operations and comprehensive
      loss          |  | (6,777 | ) |  | (278   | )
| | Tax credit (charge) relating to components
      of other comprehensive loss |  | 118    |   |  | (58    | )
| |                                                                              |  |        |   |  |        |  
| | As at December 31                                                            |  | 6,194  |   |  | 12,853 |  

Significant components of the Companys
deferred income tax assets and liabilities are as follows:

| |                                              |  | 2016    |   |  | 2015    |  
| | -------------------------------------------- |  | ------- | - |  | ------- | -
| |                                              |  | $       |   |  | $       |  
| |                                              |  |         |   |  |         |  
| | Deferred income tax assets                   |  |         |   |  |         |  
| | Reforestation
      costs                    |  | 2,795   |   |  | 2,757   |  
| | Capital lease obligation                     |  | 4,487   |   |  | 5,275   |  
| | Research and
      development expenditures  |  | 3,681   |   |  | 2,765   |  
| | Non-capital loss available for carry forward |  | 9,871   |   |  | 5,967   |  
| | Investment tax
      credits                 |  | 2,754   |   |  | 2,451   |  
| | Other accrued liabilities                    |  | 1,969   |   |  | 1,874   |  
| |                                              |  |         |   |  |         |  
| |                                              |  | 25,557  |   |  | 21,089  |  
| |                                              |  |         |   |  |         |  
| | Deferred income tax liabilities              |  |         |   |  |         |  
| | Property, plant
      and equipment          |  | (31,751 | ) |  | (33,947 | )
| | Long-term debt                               |  | -       |   |  | 5       |  
| |                                              |  |         |   |  |         |  
| |                                              |  | (31,751 | ) |  | (33,942 | )
| |                                              |  |         |   |  |         |  
| | Net deferred income tax liability            |  | (6,194  | ) |  | (12,853 | )

18

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

| |                                                 |  | 2016    |   |  | 2015    |  
| | ----------------------------------------------- |  | ------- | - |  | ------- | -
| |                                                 |  | $       |   |  | $       |  
| |                                                 |  |         |   |  |         |  
| | Deferred income tax assets                      |  |         |   |  |         |  
| | To be recovered
      after more than 12 months |  | 25,051  |   |  | 20,393  |  
| | To
      be recovered within 12 months          |  | 506     |   |  | 696     |  
| |                                                 |  |         |   |  |         |  
| | Deferred income tax liabilities                 |  |         |   |  |         |  
| | To be incurred
      after more than 12 months  |  | (31,751 | ) |  | (33,942 | )
| |                                                 |  |         |   |  |         |  
| | Net deferred income tax liability               |  | (6,194  | ) |  | (12,853 | )

|21 | Employee benefit plans
|-- | ----------------------

| |                                                                          |  | 2016  |   |  | 2015  |  
| | ------------------------------------------------------------------------ |  | ----- | - |  | ----- | -
| |                                                                          |  | $     |   |  | $     |  
| |                                                                          |  |       |   |  |       |  
| | Statements of financial position
      obligations for                   |  |       |   |  |       |  
| | Defined benefit
      pension plan                                       |  | 1,302 |   |  | 2,471 |  
| | Post-employment benefits                                                 |  | 5     |   |  | 23    |  
| | Supplemental
      vacations                                             |  | 1,510 |   |  | 1,609 |  
| |                                                                          |  |       |   |  |       |  
| | Statements of operations and comprehensive loss (charges)
      recovery |  |       |   |  |       |  
| | Defined benefit pension plan                                             |  | (302  | ) |  | (312  | )
| | Post-employment
      medical benefits                                   |  | 18    |   |  | 81    |  
| | Supplemental vacations                                                   |  | 99    |   |  | (21   | )

Defined contribution plans

The total expense for the Companys
defined contribution pension benefits is as follows:

| |                                                             |  | 2016  |  |  | 2015  | 
| | ----------------------------------------------------------- |  | ----- |  |  | ----- | 
| |                                                             |  | $     |  |  | $     | 
| |                                                             |  |       |  |  |       | 
| | Plans providing defined contribution
      pension benefits |  | 3,462 |  |  | 3,928 | 

Defined benefit pension plan

On January 1, 2000, the Company
established a supplementary defined benefit pension plan for certain key
employees. Contributions by the Company are made in accordance with independent
actuarial valuations. The effective date for the last actuarial valuation was
December 31, 2016.

19

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

Information regarding the defined
benefit pension plan is as follows:

| |                                       |  | 2016  |   |  | 2015  |  
| | ------------------------------------- |  | ----- | - |  | ----- | -
| |                                       |  | $     |   |  | $     |  
| |                                       |  |       |   |  |       |  
| | Change in benefit obligation          |  |       |   |  |       |  
| | Obligation 
      Beginning of year  |  | 9,390 |   |  | 9,050 |  
| | Actuarial (gain) loss                 |  | (450  | ) |  | 84    |  
| | Current service
      cost            |  | 225   |   |  | 214   |  
| | Past service cost                     |  | -     |   |  | -     |  
| | Benefits paid                         |  | (633  | ) |  | (305  | )
| | Interest cost                         |  | 360   |   |  | 347   |  
| |                                       |  |       |   |  |       |  
| | Obligation  End of year              |  | 8,892 |   |  | 9,390 |  
| |                                       |  |       |   |  |       |  
| | Change in plan assets at fair value   |  |       |   |  |       |  
| | Plan assets 
      Beginning of year |  | 6,919 |   |  | 6,124 |  
| | Employer contributions                |  | 1,000 |   |  | 1,000 |  
| | Actual return on
      plan assets    |  | 304   |   |  | 100   |  
| | Benefits paid                         |  | (633  | ) |  | (305  | )
| |                                       |  |       |   |  |       |  
| | Plan assets  End of year             |  | 7,590 |   |  | 6,919 |  
| |                                       |  |       |   |  |       |  
| | Net plan liability                    |  | 1,302 |   |  | 2,471 |  

| |                               |  | 2016 |  |  | 2015 |  |  | 2014 | 
| | ----------------------------- |  | ---- |  |  | ---- |  |  | ---- | 
| |                               |  | $    |  |  | $    |  |  | $    | 
| | Components of pension expense |  |      |  |  |      |  |  |      | 
| | Interest expense              |  | 77   |  |  | 98   |  |  | 58   | 
| | Current service
      costs   |  | 225  |  |  | 214  |  |  | 148  | 
| | Past service costs            |  | -    |  |  | -    |  |  | 100  | 
| |                               |  |      |  |  |      |  |  |      | 
| | Net expense                   |  | 302  |  |  | 312  |  |  | 306  | 

| |                                                                                                                        |  | 2016 |   |  | 2015  |   |  | 2014   |  
| | ---------------------------------------------------------------------------------------------------------------------- |  | ---- | - |  | ----- | - |  | ------ | -
| |                                                                                                                        |  | $    |   |  | $     |   |  | $      |  
| | Components of remeasurement gain (loss)                                                                                |  |      |   |  |       |   |  |        |  
| | Demographic assumptions                                                                                                |  | 147  |   |  | -     |   |  | (834   | )
| | Financial
      assumptions                                                                                            |  | (58  | ) |  | (64   | ) |  | (1,021 | )
| | Experience assumptions                                                                                                 |  | 361  |   |  | (20   | ) |  | (32    | )
| | Return on
      plan assets, excluding amounts
      included                       in
      interest expense (income) |  | 21   |   |  | (149  | ) |  | (53    | )
| | Net of tax                                                                                                             |  | (118 | ) |  | 58    |   |  | 485    |  
| |                                                                                                                        |  |      |   |  |       |   |  |        |  
| | Net impact on comprehensive loss                                                                                       |  | 353  |   |  | ( 175 | ) |  | (1,455 | )

20

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

| |                               |  | 2016 |  |  | 2015 |  |  | 2014 | 
| | ----------------------------- |  | ---- |  |  | ---- |  |  | ---- | 
| |                               |  | %    |  |  | %    |  |  | %    | 
| |                               |  |      |  |  |      |  |  |      | 
| | Plan assets by asset category |  |      |  |  |      |  |  |      | 
| | Equity securities             |  | 31   |  |  | 31   |  |  | 31   | 
| | Debt securities               |  | 14   |  |  | 14   |  |  | 13   | 
| | Other                         |  | 55   |  |  | 55   |  |  | 56   | 
| |                               |  |      |  |  |      |  |  |      | 
| |                               |  | 100  |  |  | 100  |  |  | 100  | 

The overall expected rate of return is
based on the actuarys median annualized future return, which is, in turn, based
on the target asset mix and equity risk premium, less allowances for investment
expenses and active equity management.

The actuarial assumptions to determine
the benefit obligation at the end of the year are as follows:

| |                                                |  | 2016 |  |  | 2015 | 
| | ---------------------------------------------- |  | ---- |  |  | ---- | 
| |                                                |  | %    |  |  | %    | 
| | To determine benefit obligation at end of year |  |      |  |  |      | 
| | Discount rate                                  |  | 3.80 |  |  | 3.90 | 
| | Rate of
      compensation increase            |  | 3.50 |  |  | 3.50 | 
| | Rate of price inflation                        |  | 2.00 |  |  | 2.00 | 

The assumed discount rate has a
significant effect on the benefit obligation. A change in this assumption would
have the following effect on the 2016 obligation:

| |               |  | 0.5% increase |   |  | 0.5% decrease |  
| | ------------- |  | ------------- | - |  | ------------- | -
| |               |  |               |   |  |               |  
| | Discount rate |  | (513          | ) |  | (536          | )

|22 | Related party transactions                                                                                      
|-- | ----------------------------------------------------------------------------------------------------------------
|   |                                                                                                                 
|   | The Company enters into transactions with Millar Western
      Industries Ltd. (Industries), its parent
company.

| | a) | The Company earned revenue from Industries as
    follows:
| | -- | ----------------------------------------------------------

| |                                                                      |  | 2016 |  |  | 2015 |  |  | 2014 | 
| | -------------------------------------------------------------------- |  | ---- |  |  | ---- |  |  | ---- | 
| |                                                                      |  | $    |  |  | $    |  |  | $    | 
| |                                                                      |  |      |  |  |      |  |  |      | 
| | Administration fees                                                  |  | 388  |  |  | 382  |  |  | 378  | 
| |                                                                      |  |      |  |  |      |  |  |      | 
| | Other fees                                                           |  | 155  |  |  | 110  |  |  | 156  | 
| |                                                                      |  |      |  |  |      |  |  |      | 
| | Included in accounts receivable relating to
      these transactions |  | 190  |  |  | 145  |  |  | 194  | 

Administration fees are established at
the cost to the Company plus a 5% mark up.

21

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

| | b) | The Company incurred costs charged by Industries as
      follows:
| | -- | ------------------------------------------------------------------

| |                                |  | 2016  |  |  | 2015  |  |  | 2014  | 
| | ------------------------------ |  | ----- |  |  | ----- |  |  | ----- | 
| |                                |  | $     |  |  | $     |  |  | $     | 
| |                                |  |       |  |  |       |  |  |       | 
| | Chemical purchases             |  | 970   |  |  | 935   |  |  | 1,100 | 
| |                                |  |       |  |  |       |  |  |       | 
| | Other services                 |  | 2,523 |  |  | 2,287 |  |  | 2,584 | 
| |                                |  |       |  |  |       |  |  |       | 
| | Accounts payable to Industries |  | 464   |  |  | 238   |  |  | 245   | 

| |    | Chemical purchases are charged to the Company at the same
      prices used for arms-length parties; facility and equipment transactions
      are charged at the cost to Industries.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                       
| | c) | Key management compensation is as follows:                                                                                                                                            
| |    |                                                                                                                                                                                       
| |    | Key management includes members of the executive and
      officers of the Company. The compensation for services of key management
      is as follows:                              

| |                          |  | 2016  |  |  | 2015  |  |  | 2014  | 
| | ------------------------ |  | ----- |  |  | ----- |  |  | ----- | 
| |                          |  | $     |  |  | $     |  |  | $     | 
| |                          |  |       |  |  |       |  |  |       | 
| | Short-term benefits      |  | 3,299 |  |  | 3,229 |  |  | 4,824 | 
| | Post-employment benefits |  | 1,178 |  |  | 1,172 |  |  | 1,206 | 
| |                          |  |       |  |  |       |  |  |       | 
| |                          |  | 4,477 |  |  | 4,401 |  |  | 6,030 | 

Short-term benefits include salaries,
current benefits and profit shares paid or payable.

|23 | Financial instruments and financial risk
      factors             
|-- | -------------------------------------------------------------------
|   |                                                                    
|   | Carrying and fair value of financial instruments by
      category:

2016Loans
    
    
    OtherHeld for
    
    
    and
    
    
    financial
    
    
    Carryingtrading
    
    
    receivables
    
    
    liabilities
    
    
    value
    
    
    Fair value$
    
    
    $
    
    
    $
    
    
    $
    
    
    $Financial assetsCash
      and cash equivalents
    
    -
    
    
    40,237
    
    
    -
    
    
    40,237
    
    
    40,237Accounts receivableTrade
      and other
    
    -
    
    
    32,738
    
    
    -
    
    
    32,738
    
    
    32,738Other assets
    
    -
    
    
    1,393
    
    
    -
    
    
    1,393
    
    
    1,393-
    
    
    74,368
    
    
    -
    
    
    74,368
    
    
    74,368Financial liabilitiesAccounts payableTrade and other
    
    14
    
    
    -
    
    
    45,693
    
    
    45,707
    
    
    45,707Borrowings
    
    -
    
    
    -
    
    
    303,671
    
    
    303,671
    
    
    190,180Other obligations
    
    4,324
    
    
    -
    
    
    -
    
    
    4,324
    
    
    4,3244,338
    
    
    -
    
    
    349,364
    
    
    353,702
    
    
    240,211


22

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted



2015Loans
    
    
    OtherHeld for
    
    
    and
    
    
    financial
    
    
    Carryingtrading
    
    
    receivables
    
    
    liabilities
    
    
    value
    
    
    Fair value$
    
    
    $
    
    
    $
    
    
    $
    
    
    $Financial assetsCash
      and cash equivalents
    
    -
    
    
    16,773
    
    
    -
    
    
    16,773
    
    
    16,773Accounts receivableTrade
      and other
    
    -
    
    
    34,136
    
    
    -
    
    
    34,136
    
    
    34,136Other assets
    
    -
    
    
    1,729
    
    
    -
    
    
    1,729
    
    
    1,729-
    
    
    52,638
    
    
    -
    
    
    52,638
    
    
    52,638Financial liabilitiesAccounts payableTrade
      and other
    
    542
    
    
    -
    
    
    47,352
    
    
    47,894
    
    
    47,894Borrowings
    
    -
    
    
    -
    
    
    317,500
    
    
    317,500
    
    
    175,635Other obligations
    
    2,280
    
    
    -
    
    
    5
    
    
    2,285
    
    
    2,2852,822
    
    
    -
    
    
    364,857
    
    
    367,679
    
    
    225,814


The estimated fair value of financial
instruments is based on relevant market prices and information available at the
year-end.

The fair value of short-term financial
assets and liabilities, which include cash and cash equivalents, accounts and
other receivables, other assets, accounts payable and accrued liabilities,
approximates their carrying value, due to the short-term nature of these
financial assets and liabilities.

The fair value of the Senior Notes
included in borrowings as at December 31, 2016 was estimated to be US$123.9
million (2015  US$107.4 million), based on the most recent bid price.

Financial assets and liabilities that
are recognized on the statements of financial position at fair value are
classified in a hierarchy that is based on the significance of the inputs used
in making the measurements. The three levels of the hierarchy are:

Level 1  unadjusted quoted prices in
active markets for identical assets or liabilities;

Level 2  inputs other than quoted
prices that are observable for the asset or liability, either directly (that is,
as prices) or indirectly (that is, as derived from prices); and

23

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

Level 3  inputs that are not based on
observable market data.

Derivative instruments are included in
Level 2 of the fair value hierarchy as they are valued using pricing models or
discounted cash flow models. These models require a variety of inputs,
including, but not limited to, contractual terms, market prices, forward price
curves, yield curves, and credit spreads. These inputs are obtained from or
corroborated with the market where possible.

The fair value of fixed commodity
forward sale and purchase contracts is calculated using a discounted cash flow
method, based on forward commodity prices. The fair value of forward exchange
contracts is calculated using a forward pricing model (Level 3).

Financial risk management

The Companys activities expose it to a
variety of financial risks: market risk, foreign currency risk, interest rate
risk, liquidity risk and credit risk. The Companys risk management strategy
focuses on the unpredictability of financial and commodity markets and seeks to
reduce related potential adverse effects on the Companys financial performance.

The Companys risk management policies
require that significant risks are reviewed with the Companys board of
directors. The Companys methods for managing financial risks, outlined below,
remain unchanged for the year ended December 31, 2016.

| | i)  | Market risk                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |     | From time to time, the Company enters into forward
      contracts for both lumber and pulp to reduce commodity price risk. The
      Company does not enter into such agreements for speculative or trading
      purposes. These contracts are generally settled financially but may, at
      the Companys discretion, be settled by physical delivery of the finished
      product. Contracts outstanding at the end of the year are recorded at
      their fair value, and any unrealized gains or losses are included in other
      income. As at December 31, 2016, the Company had $nil
      US-dollar-denominated forward lumber commodity contracts outstanding (2015
       $nil; 2014  $nil). In 2016, the Company had a realized gain on
      commodity contracts of $0.7 million (2015  gain of $1.8 million; 2014 
      gain of $1.5 million) in other income.
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | ii) | Foreign currency risk                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |     | A foreign currency risk arises when future commercial
      transactions or recognized assets or liabilities are denominated in a
      currency that is not the Companys functional currency. The Company is
      exposed to foreign currency risk on sales, purchases and the maturity of
      its $210 million in long-term debt which is denominated in US
    dollars.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |     | A significant portion of the Companys sales,
      approximately 70% of its 2016 revenue (2015  68%; 2014  67%), was
      denominated in US currency, and as at December 31, 2016, the Company had
      $23.4 million (2015  $21.5 million; 2014  $30.1 million) in US dollar
      denominated accounts receivable. Consequently, the Company is exposed to
      foreign currency exchange risk, as changes in foreign currency rates
      affect the future cash flows of accounts
receivable.                                                                                                                                                                                                                                                                                                                                                                               

24

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

| |      | The impact on earnings of fluctuations in currency rates
      is partially offset by the corresponding fluctuation in interest payments,
      substantially all of which are denominated in US dollars. To further
      reduce the impact on earnings of fluctuations in currency rates, the
      Company may enter into currency contracts to hedge US dollar positions,
      but does not hold or issue foreign currency financial instruments for
      speculative or trading purposes. As at December 31, 2016, the Company had
      US$12.0 million (2015  US$6.0 million; 2014  US$49.0 million) in
      outstanding forward exchange contracts, with a weighted average contract
      rate of C$1.3409/US$1.00 (2015  C$1.3425/US$1.00; 2014 
      C$1.1282/US$1.00). The Company had no (2015  US$9.0 million; 2014  $1.0
      million) outstanding collar options contracts. The Company recorded the
      amount of unrealized gain on these currency contracts for the year ended
      December 31, 2016, of $0.5 million (2015  $1.3 million gain; 2014  $1.8
      million loss) in other expense (income).
| | ---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |      | A significant portion of the Companys products are sold
      at prices denominated in US dollars or based on prevailing US dollar
      prices, and a significant portion of operational costs and expenses are
      incurred in Canadian dollars. Therefore, an increase in the value of the
      Canadian dollar relative to the US dollar reduces the revenue in Canadian
      dollar terms realized by the Company from sales made in US dollars, which
      reduces operating margin and the cash flow available to fund operations.
      The Companys US dollar denominated long-term debt provides a partial
      offset to exchange exposure. The Company has not entered into any
      financial instruments to mitigate the foreign currency risk associated
      with the long-term debt.                                                                                                                                                                                                                                                                                                                              
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |      | The US dollar financial position exposure as at December
      31, 2016 was US$28.7 million (2015  US$19.6 million) in net working
      capital and US$210.0 million (2015  US$210.0 million) in long-term debt.
      Based on these balances, with other variables unchanged, a $0.01 change in
      the exchange rate for one US dollar into Canadian currency would have
      resulted in a $2.0 million (2015  $2.1 million; 2014 $2.5 million)
      change in earnings.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | iii) | Interest rate risk                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |      | The interest rates on the majority of the Companys
      long-term debt are fixed; consequently, the Company is not significantly
      exposed to fair value changes on long-term debt when the market rate of
      interest changes. The interest rate on the Companys revolving credit
      facility does fluctuate with the market; however, there was no balance
      drawn on the facility as at December 31, 2016. Interest rate exposure
      mainly relates to interest receipts on the Companys cash balance of $40.2
      million (2015 - $16.8 million) at the end of the year. The Company does
      not currently use any derivative instruments to manage its exposure to
      changes in market interest rates.                                                                                                                                                                                                                                                                                                                                                                                                    
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | iv)  | Credit risk                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |      | Credit risk is the risk customers or counterparties to
      certain financial contracts will fail to pay amounts due or perform their
      obligations under a contract. The Company is exposed to credit risk
      primarily through its accounts receivable. The Company manages this risk
      through the establishment of credit policies and limits that are applied
      in the selection of counterparties and through ongoing management review
      of all receivable balances past due, with the objective of identifying at
      an early stage matters that could potentially delay the collection of
      funds.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |      | To mitigate the risk associated with customer or
      counterparty failure to meet obligations, the Company insures most trade
      receivables to 90% of the value of the invoice. The proportion of accounts
      thus insured amounted, as at December 31, 2016, to 90% of the Companys
      total trade receivables; the remaining balance was predominantly
      represented by receivables with other forest products companies relating
      to fibre agreements, for which the Company held outstanding payables in
      similar amounts. The maximum exposure to credit risk for receivables as at
      December 31, 2016 was $33 million. The Company and the insurer work in
      concert to regularly review the creditworthiness of existing and future
      customers and establish that credit limits are commensurate with credit
      risk. All new trade customers must be insurable under the terms of the
      policy.                                                                                                                                                                                      

25

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

The concentration of credit risk of
accounts receivable is limited, as accounts receivable are widely distributed
among customers and geographic locations. A summary of accounts and other
receivables is as follows:

| |                           |  | 2016   |  |  | 2015   | 
| | ------------------------- |  | ------ |  |  | ------ | 
| |                           |  | $      |  |  | $      | 
| |                           |  |        |  |  |        | 
| | Current                   |  | 24,931 |  |  | 21,589 | 
| | 30  60 days              |  | 1,298  |  |  | 2,003  | 
| | 61  90 days              |  | -      |  |  | 18     | 
| | 91  120 days             |  | -      |  |  | -      | 
| | Greater than 120 days     |  | -      |  |  | -      | 
| |                           |  |        |  |  |        | 
| | Total trade receivables   |  | 26,229 |  |  | 23,610 | 
| | Other receivables         |  | 6,509  |  |  | 10,526 | 
| |                           |  |        |  |  |        | 
| | Total accounts receivable |  | 32,738 |  |  | 34,136 | 

| |    | During 2016, the Company recorded $0.1 million in bad
      debt expense (2015  $0.2 million).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |    | Periodically, the Company enters into agreements with
      third parties for the sale of certain trade receivables arising from pulp
      export sales to China. Total receivables sold during the year ended
      December 31, 2016 were US$54.5 million (2015  US$63.1 million). As the
      risks and rewards of ownership over the receivables were transferred, the
      receivables were derecognized at the date of the transaction and no gain
      or loss was recognized. Related fees in the amount of $0.2 million (2015 
      $0.3 million) were shown as a reduction in revenue.                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | v) | Liquidity risk                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |    | Liquidity risk arises from the possibility the Company
      will not be able to meet its financial obligations as they fall due. The
      Company manages liquidity risk by forecasting cash flows to identify
      potential financing requirements, and by maintaining access to additional
      financing in the form of a working capital supported revolving credit
      facility in the amount of $50 million (note 11), which is due July 15,
      2018. This credit facility requires the Company to meet certain covenants.
      The Company was in compliance with these covenants as at December 31,
      2016.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |    | The following are contractual cash flow maturities
      (including interest) of financial liabilities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

<1 year
    
    
    1-2 years
    
    
    3-5 years
    
    
    >5 years
    
    
    Total$
    
    
    $
    
    
    $
    
    
    $
    
    
    $Borrowings
    
    31,428
    
    
    31,350
    
    
    347,157
    
    
    -
    
    
    409,935Accounts payable and accrued liabilities
    
    45,707
    
    
    -
    
    
    -
    
    
    -
    
    
    45,70777,135
    
    
    31,350
    
    
    347,157
    
    
    -
    
    
    455,642


26

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

|24 | Capital management                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | The Company is privately owned and, accordingly,
      management defines capital as cash and shareholders equity, with the
      source of its capital being operations. It is the Companys objective to
      manage its capital to ensure adequate resources exist to support
      operations while maintaining business growth. The Companys financial
      results are primarily influenced by the prevailing market prices for pulp
      and lumber and the relative value of the Canadian and US dollars;
      therefore, it manages and adjusts its capital structure as needed, in
      light of the economic conditions and the risk characteristics of the
      underlying assets. To maintain or adjust the capital structure, the
      Company may issue new debt to replace existing debt with different
      characteristics.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | The Company does not have any externally imposed capital
      requirements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|25 | Segmented information                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | The Companys operations are located in Canada. The
      Companys reportable segments are strategic business units that
      manufacture and sell different products. The business units are managed
      separately, as each business requires different manufacturing technology
      and marketing strategies. The Company has two reportable segments: lumber
      and pulp; and one supporting cost centre: corporate and other. The lumber
      segment manufactures dimension lumber for sale primarily in Canada, the
      United States and Asia. The pulp segment manufactures bleached
      chemi-thermo-mechanical pulp for sale to papermakers worldwide. Included
      in corporate and other are the combined results from the Companys
      management fees and unallocated corporate and other expenses.                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | The accounting policies applied to the reporting segments
      are as described in note 2. The Company evaluates the performance of each
      segment based on operating earnings. The Company does not allocate
      financing expenses or income taxes to its business segments. The Company
      accounts for intersegment revenue and transfers as if the transfers were
      to third parties at current market prices.                                                                                                                                                                                                                                                                                                                                                                                                                      
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | Product segments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

| | Lumber                                       |  | 2016     |   |  | 2015     |   |  | 2014     |  
| | -------------------------------------------- |  | -------- | - |  | -------- | - |  | -------- | -
| |                                              |  | $        |   |  | $        |   |  | $        |  
| |                                              |  |          |   |  |          |   |  |          |  
| | Revenue from external customers              |  | 191,815  |   |  | 195,528  |   |  | 207,272  |  
| | Cost of products sold                        |  | (140,133 | ) |  | (158,525 | ) |  | (152,139 | )
| | Freight and other distribution costs         |  | (19,780  | ) |  | (21,235  | ) |  | (15,764  | )
| | Depreciation and amortization                |  | (5,588   | ) |  | (6,942   | ) |  | (6,838   | )
| | Other (expense) income                       |  | (244     | ) |  | (455     | ) |  | 1,599    |  
| | Gain on sale of Boyle assets and liabilities |  | -        |   |  | 17,622   |   |  | -        |  
| |                                              |  |          |   |  |          |   |  |          |  
| | Operating earnings                           |  | 26,070   |   |  | 25,993   |   |  | 34,130   |  

27

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

| | Pulp                                 |  | 2016     |   |  | 2015     |   |  | 2014     |  
| | ------------------------------------ |  | -------- | - |  | -------- | - |  | -------- | -
| |                                      |  | $        |   |  | $        |   |  | $        |  
| |                                      |  |          |   |  |          |   |  |          |  
| | Revenue from external customers      |  | 192,914  |   |  | 182,688  |   |  | 197,473  |  
| | Cost of products sold                |  | (128,368 | ) |  | (122,291 | ) |  | (121,671 | )
| | Freight and other distribution costs |  | (44,423  | ) |  | (42,726  | ) |  | (44,003  | )
| | Depreciation and amortization        |  | (4,663   | ) |  | (7,482   | ) |  | (7,263   | )
| | Other (expense) income               |  | (518     | ) |  | (3,464   | ) |  | 1,080    |  
| |                                      |  |          |   |  |          |   |  |          |  
| | Operating earnings                   |  | 14,942   |   |  | 6,725    |   |  | 25,616   |  

| | Corporate and other           |  | 2016    |   |  | 2015    |   |  | 2014    |  
| | ----------------------------- |  | ------- | - |  | ------- | - |  | ------- | -
| |                               |  | $       |   |  | $       |   |  | $       |  
| |                               |  |         |   |  |         |   |  |         |  
| | Revenue from related parties  |  | 388     |   |  | 382     |   |  | 378     |  
| | Cost of products sold         |  | (61     | ) |  | (68     | ) |  | (42     | )
| | General and administration    |  | (18,269 | ) |  | (15,781 | ) |  | (18,748 | )
| | Depreciation and amortization |  | (94     | ) |  | (144    | ) |  | (171    | )
| | Other income                  |  | 469     |   |  | 50      |   |  | -       |  
| | Loss on termination of PPA    |  | (26,624 | ) |  | -       |   |  | -       |  
| |                               |  |         |   |  |         |   |  |         |  
| | Operating loss                |  | (44,191 | ) |  | (15,561 | ) |  | (18,583 | )

| |                                                           |  | 2016     |   |  | 2015     |   |  | 2014     |  
| | --------------------------------------------------------- |  | -------- | - |  | -------- | - |  | -------- | -
| |                                                           |  | $        |   |  | $        |   |  | $        |  
| |                                                           |  |          |   |  |          |   |  |          |  
| | Revenue from external customers and related
      parties |  | 385,117  |   |  | 378,598  |   |  | 405,123  |  
| | Cost of products sold and general and administration      |  | (286,831 | ) |  | (296,665 | ) |  | (292,600 | )
| | Freight and other distribution costs                      |  | (64,203  | ) |  | (63,961  | ) |  | (59,767  | )
| | Depreciation and amortization                             |  | (10,345  | ) |  | (14,568  | ) |  | (14,272  | )
| | Other (expense) income                                    |  | (293     | ) |  | (3,869   | ) |  | 2,679    |  
| | Loss on termination of PPA                                |  | (26,624  | ) |  | -        |   |  | -        |  
| | Gain on sale of Boyle assets and
      liabilities        |  | -        |   |  | 17,622   |   |  | -        |  
| |                                                           |  |          |   |  |          |   |  |          |  
| | Operating (loss) earnings                                 |  | (3,179   | ) |  | 17,157   |   |  | 41,163   |  

Cost of products sold for the lumber
segment is net of chip transfers to the pulp segment of $6.6 million (2015 
$5.8 million; 2014  $6.5 million).

28

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

Expenditures on property, plant and
equipment and intangible assets

| |                     |  | 2016   |  |  | 2015   | 
| | ------------------- |  | ------ |  |  | ------ | 
| |                     |  | $      |  |  | $      | 
| |                     |  |        |  |  |        | 
| | Lumber              |  | 1,501  |  |  | 3,262  | 
| | Pulp                |  | 9,912  |  |  | 48,310 | 
| | Corporate and other |  | 697    |  |  | 634    | 
| |                     |  |        |  |  |        | 
| |                     |  | 12,110 |  |  | 52,206 | 

Expenditures on property, plant and
equipment and intangible assets are net of government grant funding of $2.2
million (2015  nil; 2014  $1.5 million).

Identifiable assets

| |                     |  | 2016    |  |  | 2015    | 
| | ------------------- |  | ------- |  |  | ------- | 
| |                     |  | $       |  |  | $       | 
| |                     |  |         |  |  |         | 
| | Lumber              |  | 164,281 |  |  | 199,223 | 
| | Pulp                |  | 175,255 |  |  | 194,149 | 
| | Corporate and other |  | 42,381  |  |  | 19,211  | 
| |                     |  |         |  |  |         | 
| |                     |  | 381,917 |  |  | 412,583 | 

The Companys assets are all located in
Canada. Revenue is attributed to geographic locations based on shipping
destination as follows:

Geographic sales revenue

| |               |  | 2016    |  |  | 2015    |  |  | 2014    | 
| | ------------- |  | ------- |  |  | ------- |  |  | ------- | 
| |               |  | $       |  |  | $       |  |  | $       | 
| |               |  |         |  |  |         |  |  |         | 
| | Canada        |  | 100,967 |  |  | 115,597 |  |  | 122,859 | 
| | United States |  | 89,355  |  |  | 85,838  |  |  | 90,085  | 
| | Europe        |  | 23,255  |  |  | 25,387  |  |  | 25,773  | 
| | China         |  | 110,506 |  |  | 91,548  |  |  | 100,450 | 
| | Other Asia    |  | 55,035  |  |  | 54,847  |  |  | 58,603  | 
| | Other         |  | 5,999   |  |  | 5,381   |  |  | 7,353   | 
| |               |  |         |  |  |         |  |  |         | 
| |               |  | 385,117 |  |  | 378,598 |  |  | 405,123 | 

29

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

|26 | Supplementary cash flow information
      Net change in non-cash working capital items
|-- | --------------------------------------------------------------------------------------

| |                                          |  | 2016   |   |  | 2015   |   |  | 2014    |  
| | ---------------------------------------- |  | ------ | - |  | ------ | - |  | ------- | -
| |                                          |  | $      |   |  | $      |   |  | $       |  
| |                                          |  |        |   |  |        |   |  |         |  
| | Accounts receivable and other            |  | 1,398  |   |  | 8,768  |   |  | (2,540  | )
| | Inventories                              |  | 30,697 |   |  | (6,218 | ) |  | (13,654 | )
| | Prepaid expenses                         |  | 2,778  |   |  | 115    |   |  | (2,468  | )
| | Accounts payable and accrued liabilities |  | (2,142 | ) |  | (8,632 | ) |  | 4,650   |  
| |                                          |  |        |   |  |        |   |  |         |  
| |                                          |  | 32,731 |   |  | (5,967 | ) |  | (14,012 | )

| |                                                                        |  | 2016    |   |  | 2015    |   |  | 2014    |  
| | ---------------------------------------------------------------------- |  | ------- | - |  | ------- | - |  | ------- | -
| |                                                                        |  | $       |   |  | $       |   |  | $       |  
| |                                                                        |  |         |   |  |         |   |  |         |  
| | Additions to property, plant
      and equipment and intangible assets |  | (14,285 | ) |  | (52,206 | ) |  | (30,479 | )
| | Changes in working capital for investing
      activities              |  | 885     |   |  | 348     |   |  | 5,355   |  
| | Interest capitalized on
      qualifying assets                        |  | 5,279   |   |  | 4,032   |   |  | 798     |  
| |                                                                        |  |         |   |  |         |   |  |         |  
| |                                                                        |  | (8,121  | ) |  | (47,826 | ) |  | (24,326 | )

| |                       |  | 2016   |   |  | 2015   |   |  | 2014   |  
| | --------------------- |  | ------ | - |  | ------ | - |  | ------ | -
| |                       |  | $      |   |  | $      |   |  | $      |  
| |                       |  |        |   |  |        |   |  |        |  
| | Interest paid         |  | 25,323 |   |  | 25,150 |   |  | 21,614 |  
| |                       |  |        |   |  |        |   |  |        |  
| | Income taxes refunded |  | (436   | ) |  | (124   | ) |  | (252   | )

30

---

|Millar Western Forest Products Ltd.                                                                                
|-------------------------------------------------------------------------------------------------------------------
|Notes to Financial Statements                                                                                      
|For the years
      ended December 31                                                                              
|                                                                                                                   
|All amounts in text and tabular format are expressed in
      thousands of Canadian dollars, unless otherwise noted

|27 | Subsequent event                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | On March 7, 2017, the Board of Directors of the Company
      approved an agreement by the Company with a supporting noteholder (the
      Supporting Noteholder) to pursue a transaction (the Note Exchange
      Transaction) whereby all of the existing unsecured senior notes in the
      amount of US$210 million (Existing Notes) (note 13) would be exchanged for
      9.0% senior secured notes due 2022 to be issued by the Company (New
      Secured Notes).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | If the Note Exchange Transaction is consummated, each
      Noteholder shall receive, on the implementation of the Note Exchange
      Transaction, New Secured Notes in a principal amount equal to 50% of the
      principal amount of Existing Notes held by such Noteholder as at the
      voting record date. In addition, each Noteholder that votes in favor of
      the Note Exchange Transaction on or before March 31, 2017 would receive
      additional New Secured Notes (the Early Consent Notes) in a principal
      amount equal to 5% of the principal amount of Existing Notes held by such
      Noteholder as at the voting record date. The New Secured Notes will be
      secured by a first position on substantially all of the assets and
      property of the Company, with the exception of accounts receivable and
      inventory (the Priority Collateral). The Company will also provide a
      second position in respect of the New Secured Notes on the Priority
      Collateral, which will continue to be pledged as collateral on a first
      priority basis in respect of the revolving credit facility (note
    11).
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | It is a condition to the implementation of the Note
      Exchange Transaction that the Supporting Noteholder will agree to exchange
      approximately US$41.7 million principal amount of New Secured Notes it
      receives pursuant to the Note Exchange Transaction for 80% of the equity
      of the Company (the Share Exchange Transaction). If the Note Exchange
      Transaction and the Share Exchange Transaction are consummated, the
      indebtedness of the Company would be reduced from US$210 million to
      approximately US$71 million. Annual cash interest costs in respect of the
      Companys note indebtedness would be reduced from approximately US$18
      million per year to approximately US$6 million per year.                                                                                                                                                                                                                                                                                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | The Note Exchange Transaction would be implemented by way
      of the Plan of Arrangement under the CBCA and would be expected to be
      completed by the end of April, 2017.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | Completion of the Note Exchange Transaction will
      initially be subject to the Ontario Superior Court of Justice (Commercial
      List) (the Court) issuing an interim order authorizing, among other
      things, the holding of a meeting of Noteholders to vote on the Plan of
      Arrangement (the Meeting), the mailing of information packages to
      Noteholders, the procedure for submitting voting instructions in respect
      of the Plan of Arrangement, eligibility requirements to receive Early
      Consent Notes, and certain other procedural matters.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | Provided the interim order is granted by the Court, the
      Note Exchange Transaction would then be subject to, among other things,
      approval of the Plan of Arrangement by the affirmative vote of at least
      662/3% of the votes cast by Noteholders present in person or by proxy at
      the Meeting, approval of the Plan of Arrangement by the Court, the receipt
      of all necessary regulatory approvals, if any, and the satisfaction or
      waiver of other conditions pursuant to the Plan of Arrangement. If all
      requisite approvals are obtained, the Plan of Arrangement will bind all
      Noteholders.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   | In connection with the transactions described above, on
      March 7, 2017, the Board of Directors of the Company also approved the
      entering into by the Company of a consent acknowledgment (Consent
      Acknowledgment) with the lender under our revolving credit facility (Bank
      Lender) pursuant to which the Bank Lender would consent to, and waive any
      default under our revolving credit facility in respect of, the Note
      Exchange Transaction and the Share Exchange Transaction, and the Company
      would agree to grant the Bank Lender a second-lien security interest in
      substantially all of our assets and property other than the Priority
      Collateral. Pursuant to the Consent Acknowledgment, the Company and the
      Bank Lender would also agree to certain amendments to our revolving credit
      facility, including certain financial covenants.                                                                                                                                                                                                                                                   

31

---