UNITED STATES SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C.  20549


FORM 10-Q





T
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


For the quarterly period ended July 31, 2011


OR


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


For the transition period from _________ to ___________.





COMMISSION FILE NUMBER:  001-32994





OILSANDS QUEST INC.


(Exact name of issuer as specified in its charter)





Colorado

98-0461154(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)





800, 326 - 11th Avenue SW, Calgary, Alberta, Canada T2R 0C5


(Address of principal executive offices)





(403) 263-1623


(Issuer's telephone number)





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 T                No o





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 (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).





Yes o               No o


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





Large accelerated filer: £
Accelerated filer: T
Non-accelerated filer: £
Smaller reporting company: £(Do not check if smaller reporting company)





Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes £   No T





As of September 7, 2011 there were 348,698,837 shares of common stock issued and outstanding.







OILSANDS QUEST INC.


FORM 10Q FOR THE QUARTER ENDED


July 31, 2011





Part I.  Financial InformationForward-Looking StatementsItem 1.

Financial StatementsUnaudited Consolidated Balance Sheets as of July 31, 2011 and April 30, 2011
3Unaudited Consolidated Statements of Operations for the Three Months Ended July 31, 2011 and 2010 and for the Period from Inception on April 3, 1998 to July 31, 2011
4Unaudited Consolidated Statements of Stockholders’ Equity for the Three Months Ended July 31, 2011 and 2010, for the Years Ended April 30, 2011 and 2010, and for the Period from Inception on April 3, 1998 to April 30, 2009
5Unaudited Consolidated Statements of Comprehensive Loss for the Three Months Ended July 31, 2011 and 2010 and for the Period from Inception on April 3, 1998 to July 31, 2011
9Unaudited Consolidated Statements of Cash Flows for the Three Months Ended July 31, 2011 and 2010 and for the Period from Inception on April 3, 1998 to July 31, 2011
10Unaudited Notes to Consolidated Financial Statements
11Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations
18Item 3.

Quantitative and Qualitative Disclosures About Market Risk
20Item 4.

Controls and Procedures
20Part II  Other Information
21Item 1.

Legal Proceedings
21Item 1A.

Risk FactorsItem 2.

Unregistered Sales of Equity Securities and Use of Proceeds
26Item 3.

Defaults Upon Senior Securities
26Item 4.

(Removed and Reserved)
26Item 5.

Other Information
26Item 6.

Exhibits
26Signatures
27






Cautionary Statement about Forward-Looking Statements


The following includes certain statements that may be deemed to be "forward-looking statements."  All statements, other than statements of historical facts, included in this Form 10-Q that address activities, events or developments that our management expects, believes or anticipates will or may occur in the future are forward-looking statements.  Such forward-looking statements include discussion of such matters as:




·
our ability to maintain sufficient cash to accomplish our business objectives, including our ability to continue as a going concern;


·
the amount and nature of future capital, exploration and development expenditures;


·
the extent and timing of exploration and development activities;


·
business strategies and development of our business plan and exploration programs;


·
potential relinquishment of certain of our oil sands permits and licenses;


·
anticipated cost of our asset retirement obligations, including the extent and timing of our core hole re-abandonment program; and


·
our ability to secure additional funds through the sale of assets or equity.







Forward-looking statements also typically include words such as "anticipate", "estimate", "expect", "potential", "could" or similar words suggesting future outcomes.  Readers are cautioned that forward-looking statements are not guarantees of future performance and that actual results or developments may differ materially from those expressed or implied in the forward-looking statements.





The Company is under no duty to update any of these forward-looking statements after the date of this report.  You should not place undue reliance on these forward-looking statements.





It is presumed that readers have read or have access to our 2011 Annual Report filed on Form 10-K/A which includes disclosures regarding critical accounting policies as part of Management’s Discussion and Analysis of Financial Condition and Results of Operations.  All future payments in Canadian dollars have been converted to United States dollars using an exchange rate of $1.00 U.S. = $0.9538 CDN, which was the July 31, 2011 exchange rate.  Unless otherwise stated, all dollar amounts are expressed in U.S. dollars.





2


OILSANDS QUEST INC.


(A Development Stage Company)


Consolidated Balance Sheets


(Unaudited)


(in thousands, except share data)








July 31, 2011

April 30, 2011ASSETSCurrent Assets:Cash and cash equivalents

$
9,392


$
15,984Restricted cash (note 4)


1,852



1,862Accounts receivable


253



921Prepaid expenses


1,049



630Total Current Assets


12,546



19,397Property and Equipment (notes 5 and 6)


154,339



153,795Total Assets

$
166,885


$
173,192LIABILITIES AND STOCKHOLDERS’ EQUITYCurrent Liabilities:Accounts payable

$
548


$
561Accrued liabilities


4,824


5,696Current portion of asset retirement obligation (note 7)


7,641


7,297Total Current Liabilities


13,013


13,554Obligation under sublease contract


538


550Asset Retirement Obligation(note 7)


20,434


19,585Stockholders’ Equity:Capital StockPreferred Stock, par value of $0.001 each, 10,000,000 shares authorized, 1 Series B Preferred share outstanding (note 9)


-


-Common Stock, par value of $0.001 each, 750,000,000 shares authorized, 348,698,837 and 348,495,556 shares outstanding at July 31, 2011 and April 30, 2011 respectively (note 10)


348


348Additional Paid-in Capital


789,713


789,738Deficit Accumulated During Development Stage


(717,275)


(711,435)Accumulated Other Comprehensive Income


60,114


60,852Total Stockholders’ Equity


132,900


139,503Total Liabilities and Stockholders’ Equity

$
166,885


$
173,192





Going concern(note 1)


Contingencies and commitments(note 13)


Subsequent events(notes 5b, 5c and 14)





See Notes to Consolidated Financial Statements




3


OILSANDS QUEST INC.


(A Development Stage Company)


Consolidated Statements of Operations


(Unaudited)


(in thousands, except share data and per share amounts)





Three Months Ended

July 31,


From

Inception on

April 3, 1998

through to2011


2010


July 31, 2011Expenses:Exploration

$
535


$
11,679


$
278,860General and administrative:Corporate


4,095



3,793



80,184Stock-based compensation (notes 8 and 11)


(25
)


968



148,094Foreign exchange (gain) loss


(98
)


284



(286
)Depreciation and accretion


1,348



1,104



11,423Impairment of property and equipment (note 6)


-



2,025



346,663Total Expenses


5,855



19,853



864,938Other Items:Interest income


(15
)


(14
)


(6,583
)Loss before income tax


5,840



19,839



858,355Deferred income tax benefit


-



(3,858
)


(133,386
)Net loss


5,840



15,981



724,969Net loss attributable to non-controlling interest


-



-



(7,694
)Net loss attributable to common stockholders

$
5,840


$
15,981


$
717,275Net loss attributable to common stockholders per share –Basic and Diluted

$
0.02


$
0.05Weighted Average Number of Common Shares Outstanding


367,624,793



331,628,490





See Notes to Consolidated Financial Statements








4


OILSANDS QUEST INC.


(A Development Stage Company)


Consolidated Statements of Stockholders' Equity


(in thousands, except shares)





Additional Paid in Capital


Accumulated Other Comprehensive Income

(Loss)


Deficit Accumulated During the Development Stage


Total Stockholders’ EquityCommon Stock


Preferred StockShares


Par Value


Shares


Par ValueBalance, April 30, 2011


348,495,556


$
348



1


$
-


$
789,738


$
60,852


$
(711,435)


$
139,503Exchange of OQI Sask Exchangeable shares


203,281



-



-



-



-



-



-



-Stock-based compensation cost


-



-



-



-



(25)



-



-



(25)Other comprehensive incomeForeign exchange loss on translation


-



-



-



-



-



(738)



-



(738)Net loss


-



-



-



-



-



-



(5,840)



(5,840)Balance July 31, 2011


348,698,837


$
348



1


$
-


$
789,713


$
60,114


$
(717,275)


$
132,900








Additional Paid in Capital


Accumulated Other Comprehensive Income

(Loss)


Deficit Accumulated During the Development Stage


Total Stockholders’ EquityCommon Stock


Preferred StockShares


Par Value


Shares


Par ValueBalance, April 30, 2010


292,491,188


$
292



1


$
-


$
758,007


$
35,612


$
(395,196)


$
398,715Common stock issued for :Cash


19,688,058



20



-



-



18,089



-



-



18,109Exchange of OQI Sask Exchangeable shares


316,855



-



-



-



-



-



-



-Stock-based compensation cost


-



-



-



-



968



-



-



968Share issue costs


-



-



-



-



(165)



-



-



(165)Premium on flow-through shares


-



-



-



-



(1,584)



-



-



(1,584)Proceeds from exercise of OQI Options


-



-



-



-



112



-



-



112Other comprehensive incomeForeign exchange loss on translation


-



-



-



-



-



(7,462)



-



(7,462)Net loss


-



-



-



-



-



-



(15,981)



(15,981)Balance July 31, 2010


312,496,101


$
312



1


$
-


$
775,427


$
28,150


$
(411,177)


$
392,712


See Notes to Consolidated Financial Statements


5





OILSANDS QUEST INC.


(A Development Stage Company)


Consolidated Statements of Stockholders' Equity


(in thousands, except shares)





Additional Paid in Capital


Accumulated Other Comprehensive Income


Deficit Accumulated During the Development Stage


Total Stockholders’ EquityCommon Stock


Preferred StockShares


Par Value


Shares


Par ValueBalance, April 30, 2010


292,491,188


$
292



1


$
-


$
758,007


$
35,612


$
(395,196)


$
398,715Common stock issued for:Cash


53,126,995



53



-



-



34,155



-



-



34,208Premium on flow-through shares


-



-



-



-



(1,851)



-



-



(1,851)Exchange of OQI Sask Exchangeable shares


2,877,373



3



-



-



(3)



-



-



-Stock-based compensation cost


-



-







-



1,292



-



-



1,292Share issue costs


-



-



-



-



(2,074)



-



-



(2,074)Proceeds from exercise of OQI Sask options


-



-



-



-



212



-



-



212Other comprehensive incomeForeign exchange gain on translation


-



-



-



-



-



25,240



-



25,240Net loss


-



-



-



-



-



-



(316,239)



(316,239)Balance April 30, 2011


348,495,556


$
348



1


$
-


$
789,738


$
60,852


$
(711,435)


$
139,503





See Notes to Consolidated Financial Statements











6


OILSANDS QUEST INC.


(A Development Stage Company)


Consolidated Statements of Stockholders' Equity


(in thousands, except shares)





Additional Paid in Capital


Accumulated Other Comprehensive Income (Loss)


Deficit Accumulated During the Development Stage


Total Stockholders’ EquityCommon Stock


Preferred StockShares


Par Value


Shares


Par ValueBalance, April 30, 2009


241,559,549


$
242



1


$
-


$
713,591


$
(26,022)


$
(330,715)


$
357,096Common stock issued for:Cash


44,789,313



45



-



-



39,969



-



-



40,014Stock option exercises


964,769



-



-



-



782



-



-



782Exchange of OQI Sask Exchangeable shares


5,177,557



5



-



-



(5)



-



-



-Stock-based compensation cost


-



-







-



5,584



-



-



5,584Share issue costs


-



-



-



-



(2,096)



-



-



(2,096)Proceeds from exercise of OQI Sask options


-



-



-



-



182



-



-



182Other comprehensive incomeForeign exchange gain on translation


-



-



-



-



-



61,634



-



61,634Net loss


-



-



-



-



-



-



(64,481)



(64,481)Balance April 30, 2010


292,491,188


$
292



1


$
-


$
758,007


$
35,612


$
(395,196)


$
398,715





See Notes to Consolidated Financial Statements


7


OILSANDS QUEST INC.


(A Development Stage Company)


Consolidated Statements of Stockholders' Equity


(in thousands, except shares)








Common Stock


Preferred Stock


Additional  Paid in


Accumulated Other Comprehensive Income


Deficit Accumulated During the Development


Non-Controlling


Total Stockholders'Shares


Par Value


Shares


Par Value


Capital


(Loss)


Stage


Interest


EquityCommon stock issued at inception on April 3, 1998 for assets


6,000,000


$
6



-


$
-


$
92


$
-


$
-


$
-


$
98Common stock issued for:Subscription


77,500



-



-



-



36



-



-



-



36Property


18,796,604



18



-



-



12,815



-



-



-



12,833Cash


114,665,547



116



-



-



340,013



-



-



-



340,129Cashless exercise of warrants and options


13,184,966



13



-



-



(13
)


-



-



-



-Stock based compensation


44,000



-



-



-



116



-



-



-



116Services


17,973,611



18



-



-



10,836



-



-



-



10,854Settlement of debt


32,490,383



33



-



-



28,294



-



-



-



28,327Premium on flow-through shares


-



-



-



-



(8,717
)


-



-



-



(8,717
)Preferred shares issued on reorganization (note 9)


-



-



1



-



223,579



-



-



-



223,579Stock option exercises


35,000



-



-



-



165



-



-



-



165Exchange of OQI Sask exchangeable shares


38,291,938



38



-



-



(38
)


-



-



-



-Share issue costs


-



-



-



-



(13,082
)


-



-



-



(13,082
)Stock-based compensation cost


-



-



-



-



94,395



-



-



-



94,395Proceeds from exercise of OQI Sask options and warrants


-



-



-



-



4,177



-



-



-



4,177Beneficial conversion feature of Convertible debenture and warrants


-



-



-



-



20,923



-



-



-



20,923Non-controlling interest:Shares issued to non-controlling interest


-



-



-



-



-



-



-



13



13Net loss attributable to non-controlling interest


-



-



-



-



-



-



-



(7,694
)


(7,694
)Increase in interest arising from share issuance by OQI Sask






























24,433



24,433Shares purchased from non-controlling interest






























(16,752
)


(16,752
)Other comprehensive loss:Foreign exchange loss on translation


-



-



-



-



-



(26,022
)


-



-



(26,022
)Net loss


-



-



-



-



-



-



(330,715
)


-



(330,715
)Balance April 30, 2009


241,559,549


$
242



1


$
-


$
713,591


$
(26,022
)

$
(330,715
)

$
-


$
357,096





See Notes to Consolidated Financial Statements








8






OILSANDS QUEST INC.


(A Development Stage Company)


Consolidated Statements of Comprehensive Loss


(Unaudited)


(in thousands)








Three Months Ended

July 31,


From Inception on April 3, 1998 through to July 31,2011


2010


2011Net Loss

$
5,840


$
15,981


$
724,969Foreign exchange loss (gain) on translation


738



7,462



(60,114)Comprehensive loss

$
6,578


$
23,443


$
664,855Comprehensive loss attributable to non-controlling interest


-



-



(7,694)Comprehensive loss attributable to common stockholders

$
6,578


$
23,443


$
657,161










9
















OILSANDS QUEST INC.


(A Development Stage Company)


Consolidated Statements of Cash Flows


(Unaudited)


(in thousands)





Three Months Ended

July 31,


From Inception on April 3, 1998 through to July 31,2011


2010


2011Operating ActivitiesNet loss

$
(5,840)


$
(15,981)


$
(724,969)Non-cash adjustments to net lossStock-based compensation


(25)



968



148,094Deferred income tax benefit


-



(3,858)



(133,386)Depreciation and accretion


1,348



1,104



11,423Asset retirement obligation expensed


537



8,051



25,408Impairment of property and equipment


-



2,025



346,663Other non-cash items


3



-



1,788Asset retirement expenditures


-



(723)



(4,585)Net lease expenditures


(26)



-



(26)Changes in Non-Cash Working CapitalAccounts receivable and prepaid expenses


217



829



(535)Accounts payable and accrued liabilities


(831)



2,730



9,786Cash Used in Operating Activities


(4,617)



(4,855)



(320,339)Investing ActivitiesProperty and equipment expenditures


(1,909)



(1,702)



(86,119)Short-term investment


-



-



-Restricted cash


-



(905)



(1,862)Other investments


-



-



(548)Cash Used in Investing Activities


(1,909)



(2,607)



(88,529)Financing ActivitiesIssuance of shares for cash, net of issue costs


-



17,944



398,396Shares issued on exercise of subsidiary options and warrants


-



112



4,505Shares issued by subsidiary to non-controlling interest


-



-



7,664Convertible debentures


-



-



8,384Cash Provided by Financing Activities


-



18,056



418,949Inflow (Outflow) of cash and cash equivalents


(6,526)



10,594



10,081Effects of exchange rate changes on cash and cash equivalents


(66)



236



(689)Cash and cash equivalents, Beginning of Period


15,984



18,642



-Cash and cash equivalents, End of Period

$
9,392


$
29,472


$
9,392Non-Cash Financing ActivitiesCommon stock issued for properties

$
-


$
-


$
10,848Warrants issued for properties

$
-


$
-


$
1,764Common stock issued for services

$
-


$
-


$
10,505Common stock issued for debt settlement

$
-


$
-


$
28,401








See Notes to Consolidated Financial Statements





10


OILSANDS QUEST INC.


(A Development Stage Company)


Notes to Consolidated Financial Statements


(Unaudited)





1.           GOING CONCERN





To date, the Company has not earned revenue from any of its natural resource properties, and none of its estimated resources have been classified as proved reserves. The Company expects that significant additional exploration and development activities will be necessary to establish proved reserves, and to develop the infrastructure necessary to facilitate production, if any, from the estimated resources.  As at July 31, 2011, the Company had negative working capital of $2.3 million, including cash and cash equivalents of $9.4 million, and a deficit accumulated during the development phase of $717.3 million.





These financial statements have been prepared on a going concern basis in accordance with generally accepted accounting principles in the United States of America (“US GAAP”). The going concern basis assumes that the Company will continue its operations for the foreseeable future and realize its assets and discharge its liabilities in the normal course of business for the foreseeable future.  Future operations are dependent on the continued ability of the Company to raise funds through financings such as public offerings or private placements of debt or equity securities.  Management anticipates that the Company will be able to fund its activities at a reduced level
through October 2011 with its cash and cash equivalents as at July 31, 2011.  Accordingly, there is substantial doubt about the Company’s ability to continue as a going concern and without additional funding, it may not be able to maintain operations beyond that date.





In June 2011, the Company concluded a formal process to explore strategic alternatives, including strategic financing opportunities, asset divestitures, joint ventures and/or a corporate sale, merger or other business combination.  This process was overseen by a Special Committee to the Board of Directors.  The discussions and negotiations throughout this process have illustrated that potential future partners or acquirers would need to see a further level of development and de-risking of the assets in order to be prepared to make a substantial investment.In light of the feedback received through the strategic alternatives process,
the Special Committee recommended that the Company conclude the formal review and proceed to raise the funds required to advance the development of the assets. The Company commenced a rights offering under which the existing shareholders were given the right to purchase additional shares in the Company based on their pro-rata share ownership. The Company is currently negotiating a letter of intent from a third-party interest (the "Letter of Intent") for the sale of the Wallace Creek assets. The rights offering was terminated on September 12, 2011 and the Company may conduct a new, smaller, rights offering following the execution of any Letter of Intent.  The proceeds from the new rights offering will be
used to continue with the development and delineation of the Axe Lake assets and for general corporate purposes.




There can be no assurance that the Letter of Intent (or subsequent definitive agreements) will be signed. Even if executed, there can be no assurance that any funds received as a consequence of the Letter of Intent, or funds received from future rights offerings or other sources of financing will result in the Company raising sufficient funds to carry out its exploration and development plans.  The Company may continue to seek other sources of financing or asset sales. The Company will monitor its cash flow requirements and continue to operate in a prudent manner to preserve cash while working towards financing alternatives.














These financial statements do not include any adjustments to the recoverability and classification of recorded assets and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.





2.
DESCRIPTION OF BUSINESS AND NATURE OF OPERATIONS





On October 31, 2006, CanWest Petroleum Corporation changed its name to Oilsands Quest Inc. (“OQI”).  At the same time the name of the Company’s main operating subsidiary was changed from Oilsands Quest Inc. to Oilsands Quest Sask Inc. (“OQI Sask”).





Oilsands Quest Inc. (“OQI”) together with its subsidiaries, (collectively the “Company”) is in the development stage and follows the guidance for a development stage company as defined in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 915-10. The principal business activity is the acquisition, exploration and development of natural resource properties in Canada.





These consolidated financial statements include the accounts of OQI and all of its wholly-owned Canadian subsidiaries (directly and indirectly) including  OQI Sask,Township Petroleum Corporation (“Township”), Western Petrochemicals Corporation, 1291329 Alberta Limited, Oilsands Quest Technology Inc. and Stripper Energy Services, Inc. (“Stripper”).





All inter-company transactions and balances have been eliminated.





3.
BASIS OF PRESENTATION





These consolidated financial statements have been prepared in accordance with US GAAP and reflect all adjustments (all of which are normal and recurring in nature) that, in the opinion of management, are necessary for fair presentation of the interim financial information. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for any subsequent quarter or for the entire year ending April 30, 2012. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with US GAAP have been condensed or omitted. These unaudited consolidated financial statements and notes included herein have been
prepared on a basis consistent with and should be read in conjunction with the Company’s audited consolidated financial statements and notes for the year ended April 30, 2011 as filed in its annual report on Form 10-K/A. Certain comparative figures have been reclassified to conform to current financial statement presentation.





The U.S. dollar is the functional currency for OQI (the parent company).  The Canadian dollar (CDN) is the functional currency for OQI’s Canadian subsidiaries.  The assets and liabilities of OQI’s Canadian subsidiaries are translated into U.S. dollars based on the current exchange rate in effect at the balance sheet dates.  Canadian income and expenses are translated at weighted average rates for the periods in which those elements are recognized.  Foreign currency translation adjustments have no effect on net loss and are included in accumulated other comprehensive loss in stockholders’ equity.  The only component of accumulated other
comprehensive loss is foreign currency translation adjustments.  Deferred income taxes are not provided on cumulative foreign currency translation gains and losses where OQI expects undistributed earnings of a foreign operation to be indefinitely reinvested.





Gains and losses arising from transactions denominated in currencies other than the functional currency are included in the results of operations of the period in which they occur. Monetary assets and liabilities denominated in foreign currencies at the balance sheet date are translated to the reporting currency using the rate in effect on that date.  Non-monetary assets and liabilities are translated at the rates of exchange prevailing at the time the asset was acquired or the liability was incurred.





11
  OILSANDS QUEST INC.
 (A Development Stage Company)
 Notes to Consolidated Financial Statements
 (Unaudited)
  Recent Accounting Pronouncements
 
 There have been no recent accounting pronouncements or changes in accounting pronouncements during the three months ended July 31, 2011, as compared to the recent accounting pronouncements described in the Company’s Annual Report on Form 10-K/A, that are of significance, or potential significance to the Company.
 
 4.
RESTRICTED CASH
 
 Restricted cash represents amounts on deposit with the Saskatchewan Ministry of Energy and Resources as collateral for unfunded liability under the Saskatchewan Oil and Gas Orphan Fund and the Licensee Liability Rating Program.  The restricted cash is in the form of a letter of guarantee maturing April 29, 2012.
  5.
PROPERTY AND EQUIPMENT


July 31,

2011


April 30,

2011(in thousands)


(in thousands)Saskatchewan Oil Sands RightsPermits and Leases

$
429,265


$
430,174Licenses


2,686



2,701Alberta Oil Sands RightsPermits


37,796



38,003Leases


8,359



8,405Saskatchewan Oil Shale Rights (Permits)


11,862



11,927Equipment


15,704



15,780Assets Under Construction


3,271



2,786508,943



509,776Less: Accumulated Depreciation and Impairment (Note 6)


(354,604)



(355,981)Net Book Value

$
154,339


$
153,795





a)
Saskatchewan Oil Sands Permits





As at April 30, 2011, the Saskatchewan permits comprised an area of approximately 406,274 acres.  At July 31, 2011, all Saskatchewan oil sands permits except PS00208 and PS00210 have been relinquished.  The remaining permits total 160,632 acres.  Relinquishing these permits did not impact the Company’s resource estimates or development plans.  The permits were granted by the Province of Saskatchewan in 2004 under The Oil Shale Regulations, 1964 as amended, revised or substituted from time to time. The permits provide for the right to explore and work the
permit lands but not to remove, produce or recover, except for test purposes, oil products until a lease, pursuant to these regulations has been granted.The initial five-year term of the permits expired on May 31, 2009 and the Company applied for and received the third of three one-year extensions to May 31, 2012 for the two permits that include the Axe Lake Discovery, PS00208 and PS00210, as allowed under the regulation.





The permits, when granted, were subject to annual rental payments and certain levels of expenditures annually pursuant to the terms of the permits and government regulations. The annual rentals were payable in advance as to $0.02 ($0.02 CDN) per acre for the first year and escalating to $0.10 ($0.10 CDN) per acre in the fifth year. On May 7, 2007, the province updated the Oil Shale Regulations, 1964 requiring an increase to annual rentals of $0.10 ($0.10 CDN) per acre for the remaining term of the permits.  The required exploration expenditures to hold the permits were also increased to $0.85 (0.81 CDN) per acre for each of the remaining years of
the permits and $1.27 ($1.21 CDN) per acre for each year that the permits are extended.





On July 15, 2011, the Company received approval from the Government of Saskatchewan to convert the Axe Lake permits PS00208 and PS00210 to 15 year leases. The leases will give the Company certainty of land tenure needed for commercial development of the property.  The leases require annual rental payments of $63,986 ($61,030 CDN) for the term of the leases.


The Company is currently working with the regulators to assess an issue relating to the re-abandonment of early exploration core holes.  As indicated by the Ministry of Energy and Resources, it is possible that the outcome of such assessment could result in cancellation of the Axe Lake permits if the Company does not comply with the governing regulations (See note 7).


b)
Saskatchewan Oil Sands Licenses





On August 13, 2007, the Company acquired five oil sands licenses totaling 109,920 acres granted under The Petroleum and Natural Gas Regulations, 1969, as amended revised or substituted from time to time, for a term of five years for an aggregate cost of $2,140,233 ($2,249,089 CDN).   The licenses provide for the exclusive right to search for oil sands on the lands granted and to win, recover, extract, carry off, dispose of and sell the oils sands products found on the license lands.  The oil sands licenses provide the opportunity to convert up to 100% of the licenses to a production lease following the completion of specified work
requirements. Licenses require annual rental payments of $0.74 ($0.71 CDN) per acre. The licenses were relinquished on August 12, 2011 due to their low prospectivity.





c)
Alberta Oil Sands Permits





As at April 30, 2007, the Alberta oil sands permits comprised an area totaling 67,053 acres (“Raven Ridge Prospect”).  The permits were granted by the Province of Alberta under the terms of theMines and Minerals Act, Alberta. The permits provide the opportunity to convert up to 100% of the permits to a production lease following the completion of specified work requirements.  Permits are granted for five year primary terms which expire on August 9, 2011 – 11,386 acres and March 21, 2012 – 55,667 acres, and require annual rental payments of $1.49 ($1.42 CDN) per acre. On August 9, 2011, permit 7006080098 expired
totaling 11,386 acres.





On January 23, 2008, the Company acquired two oil sands permits totaling 45,546 acres (“Wallace Creek Prospect”) in a public offering of Crown Oil Sands Rights. The total consideration paid for these permits was $9,732,500 ($10,010,880 CDN). The permits were granted by the Province of Alberta under the terms of theMines and Minerals Act, Alberta. The permits provide the opportunity to convert up to 100% of the permits to a production lease following the completion of specified work requirements.  Permits are granted for a five year primary term which expires January 23, 2013.  On June 27, 2011, the Company received approval
from Alberta Energy to extend the Wallace Creek permits for an additional 67 days to March 31, 2013.  Annual rental payments of $1.49 ($1.42 CDN) per acre are required. Following the acquisition, the Alberta permit lands comprised an area totaling 112,599 acres.  The Company is currently negotiating a Letter of Intent from a third-party interest for the sale of the Wallace Creek assets.





12




OILSANDS QUEST INC.
 (A Development Stage Company)
 Notes to Consolidated Financial Statements
 (Unaudited)





d)
Alberta Oil Sands Lease
 
 On June 1, 2005, Township acquired one lease consisting of approximately 22,773 acres (the “Eagles Nest Prospect”) via a joint venture arrangement.
  As part of the acquisition of the lease, Township granted royalties as to $0.0061 ($0.0058 CDN) (net after a buy back) on each barrel of crude bitumen produced, saved and sold from the Eagles Nest Prospect.  Royalties are payable to the original joint venture partners.
 
 The annual lease rental payable to the Province of Alberta for the Eagles Nest Prospect is $33,818 ($32,256 CDN) per year.




e)
Saskatchewan Oil Shale Permits





As at April 30, 2011 and July 31, 2011, the Company held seven oil shale exploration permits near Hudson Bay, Saskatchewan covering 405,961 acres granted under The Oil Shale Regulations, 1964 (Saskatchewan) as amended, revised or substituted from time to time for a term of five years which expire in September and October 2011. The Permits provide for the right to explore and work the permit lands but not to remove, produce or recover, except for test purposes, oil products until a lease, pursuant to these regulations, has been granted. The term of the permits may be extended for up to three one-year extensions subject to regulatory approvals, as
required.





Annual rentals are payable in advance in the amount of $0.10 ($0.10 CDN) per acre during the term of the permit. Required exploration expenditures to hold the permits are $0.85 ($0.81 CDN) per acre for the remaining years of the permits and $1.27 ($1.21 CDN) per acre for each year that the permit is extended, as required.





As at April 30, 2011 and July 31, 2011, the Company held one oil shale exploration permit granted under The Petroleum and Natural Gas Regulations, 1969 (Saskatchewan) as amended, revised or substituted from time to time for a term of five years totaling 83,769 acres in the same area near Hudson Bay, Saskatchewan. The permit provides for the right, license, privilege and authority to explore for oil shale within the permit lands and expires on August 12, 2012.





The term of the permits may be extended for up to three one-year extensions subject to regulatory approvals, if required. This oil shale permit was acquired under a land sale work commitment bid for the first two years of the permit. The Company bid a total work commitment of $316,175 ($301,568 CDN) to be incurred during the first two years of the permit and the permit requires a further work commitment of $0.85 ($0.81 CDN) per acre for the last three years and $1.27 ($1.21 CDN) for each extension year plus annual rental payments of $0.10 ($0.10 CDN) per acre. Through the exploration program conducted during the year ended April 30, 2009, the Company has fulfilled its work commitment for the term of the
permit.





f)
Assets under construction





During the period ended July 31, 2011, the Company incurred costs to construct facilities required for the steam assisted gravity drainage (SAGD) pilot.  The construction of these facilities was still in progress at July 31, 2011.  The cost of property classified as “Assets under construction” is excluded from capitalized costs being depreciated. This amount represents property elements that are work-in-progress and not yet suitable to be placed into productive service as of the balance sheet date.


6.
IMPAIRMENT OF PROPERTY AND EQUIPMENT


July 31, 2011

(in thousands)


April 30, 2011

(in thousands)Book Value


Valuation Allowance


Accumulated Depreciation


Net Book Value


Net Book ValueSaskatchewan Oil Sands RightsPermits and leases

$
429,265

$
(294,537)

$
-

$
134,728

$
134,023Licenses


2,686


(2,686)


-


-


-Alberta Oil Sands RightsPermits


37,796


(27,082)


-


10,714


10,772Leases


8,359


(8,359)


-


-


-Saskatchewan Oil Shale Rights (Permits)


11,862


(11,862)


-


-


-Equipment


15,704


(1,106)


(8,972)


5,626


6,214Assets Under Construction


3,271


-


-


3,271


2,786Total Property and Equipment

$
508,943

$
(345,632)

$
(8,972)

$
154,339

$
153,795





The Company evaluates undeveloped properties periodically for impairment on a property-by-property basis considering a combination of time, geological and engineering factors as well as the Company’s current exploration plans and the ability to obtain necessary financing to complete the development of the properties. Where circumstances indicate impairment in value, a valuation allowance is provided. Property and equipment has a net book value of $154.3 million as at July 31, 2011 compared to $153.8 million as at April 30, 2011.





a)
Saskatchewan Oil Sands Permits





The Company initiated a strategic alternative review process on August 17, 2010 to consider all alternatives to increase shareholder value, including strategic financing opportunities, asset divestitures, joint ventures and/or corporate sale, merger or other business combination. The formal phase of the strategic alternative review process did not result in any firm proposals to the Company. The discussions and negotiations throughout the process have illustrated that potential future partners or acquirers would need to see a further level of development, reducing the remaining areas of uncertainty, in order to be prepared to make a substantial investment. The conclusion of the formal phase of the strategic
alternative review process indicated that the carrying value of the Saskatchewan Oil Sands Permits was greater than their fair value or estimated future net cash flows at April 30, 2011.





Potential partners or purchasers would negotiate a price that is dependent upon specific facts regarding the property, including the nature and extent of geological and geophysical data, the terms of the permits holding the acreage in the property and a level of asset development that would reflect the results of the Axe Lake reservoir testing efforts. We estimated the fair value of the property by calculating the property’s risk adjusted net present value. We categorize the measurement of fair value of the Saskatchewan Oil Sands Permits as Level 3 inputs. Since the Saskatchewan Oil Sands Permits are nonproducing undeveloped properties with no quoted market, their estimable cash flow streams involve
significant judgment and the results are based on estimated future events.  The property’s expected future cash flows were calculated on an estimate of contingent resources using a discount rate and price forecast selected by management. The property’s risk adjusted net present value gave effect to such factors as future production costs, drilling and completion costs, prevailing commodity prices, transportation systems for oil and gas production in the vicinity and other economic factors. We also used market data to support the risk adjusted net present value calculated by management.  The results of this assessment indicated impairment and the Company recorded a valuation allowance in the year ended April 30, 2011. There was no additional impairment recorded during the period ended July 31, 2011. The valuation allowance amounts to $294.5 million at July 31,
2011.


13




OILSANDS QUEST INC.
 (A Development Stage Company)
 Notes to Consolidated Financial Statements
 (Unaudited)




b)
Saskatchewan Oil Sands Licenses
 
 The Company has determined that the presence of extensive top-water in the reservoirs would not allow for commercial development in the near term.  Accordingly, an impairment provision on the full carrying value of the Saskatchewan Oil Sands Licenses was recorded in the year ended April 30, 2011.   The valuation allowance amounts to $2.7 million at July 31, 2011.
 
 c)
Alberta Oil Sands Permits
 
 The Company has recognized a full impairment on the Alberta Oil Sands Permits related to the Raven Ridge prospect at April 30, 2011. Following the conclusion of the formal phase of the strategic alternative review process, the Raven Ridge prospect has been excluded from the Company’s current and future exploration plans and no further development is expected. Accordingly, an impairment provision on the full carrying value of the Raven Ridge prospect was recorded in the year ended April 30, 2011. The valuation allowance amounts to $27.1 million at July 31, 2011.
 
 The Company performed a fair value assessment of the Alberta Oil Sands Permits at Wallace Creek at April 30, 2011 using best estimate of contingent resources of the prospect. The results of this assessment indicated that the fair value of the property was in excess of its carrying value, thus supporting its net book value at April 30, 2011 and July 31, 2011. The net book value of the Wallace Creek prospect is $10.7 million at July 31, 2011.




d)
Alberta Oil Sands Lease





The Company has recognized a full impairment on the Eagles Nest Prospect at April 30, 2011. Since the property is geographically distant from our other oil sands discoveries and is largely unexplored, the Company announced on September 22, 2010 its intention to divest the Eagles Nest oil sands lease. The Company did not receive any offers under financial terms that were acceptable and determined that it was in the best interest to retain these assets until an adequate offer is received or additional funds are available for the development of these longer-term assets. Following the conclusion of the formal phase of the strategic alternative review process, an impairment provision on the full carrying value of the
lease was recorded in the year ended April 30, 2011. The valuation allowance amounts to $8.4 million at July 31, 2011.





e)
Saskatchewan Oil Shale Permits





Due to the considerable time, effort and financial resources required for the exploration and development of the property, the Company recognized a full impairment on the property in the year ended April 30, 2011.  The Company has no plan to further develop the property. As at July 31, 2011, the cumulative impairment on the Pasquia Hills properties amounts to $11.9 million.





f)
Equipment





Based on an assessment of the carrying value of the leasehold improvements and office equipment related to the Calgary head office, the Company determined that it may not be able to recover the value and recorded an allowance for impairment of $1.1 million on these assets at April 30, 2011 and July 31, 2011.







7.
ASSET RETIREMENT OBLIGATION





The Company’s obligations with respect to asset retirement relate to reclamation of an airstrip, camp site, access roads and reservoir test wells. The obligation is recognized when incurred at the present value of the estimated future reclamation cost using a credit-adjusted risk-free rate of 7 to 13 percent (April 30, 2011 – 7 to 13 percent) and an inflation rate of 2.5 percent (April 30, 2011 – 2.5 percent). During the year ended April 30, 2010, the Company conducted a review of its development plans and well licenses and determined that a number of core holes were not abandoned to accommodate our thermal development plans or in accordance with regulatory requirements. We also evaluated the
core holes located outside the potential commercial development area and included a portion of these costs in the re-abandonment liability based on performing the obligation over a 5 year period. During the year ended April 30, 2011, the Company revised the estimated amounts and timing of the settlement of the asset retirement on the airstrip, campsite, access roads and reservoir test wells and conducted a core hole-by-core hole analysis to determine the number of core holes that management believes will require re-abandonment. The number of core holes to be re-abandoned increased as a result of this review.  Accordingly, $8.3 million of cost revisions were recorded in the re-abandondment liability during the year ended April 30, 2011. Subsequent cost revisions amounting to $0.5 million in relation to the re-abandonment liability were recorded during the period ending
July 31, 2011. The Company has submitted a re-abandonment program to the Saskatchewan Ministry of Energy and Resources that included cost estimates and a schedule of work. The uncertainty related to the timing and/or method of settlement that may be beyond the Company’s control is factored into the measurement of the liability.





At July 31, 2011, the total undiscounted inflation-adjusted future obligation was approximately $44.9 million.








Continuity of Asset Retirement Obligation (in thousands):

Three months ended July 31, 2011


Year ended April 30, 2011Present value of obligation, beginning of period

$
26,882


$
17,485Liabilities settled


-



(4,585)Accretion expense


784



2,076Revisions


537



10,185Foreign currency translation adjustment


(128)



1,721Present value of obligation, end of period

$
28,075


$
26,882Less: current portion of asset retirement obligation


(7,641)



(7,297)Long term portion of asset retirement obligation

$
20,434


$
19,585








14




OILSANDS QUEST INC.
 (A Development Stage Company)
 Notes to Consolidated Financial Statements
 (Unaudited)




8.
OQI SASK STOCK OPTIONS





OQI acquired the non-controlling shareholder interest in OQI Sask in August 2006 (“the reorganization”).  Certain stock options issued by OQI Sask remained outstanding after the reorganization.  On exercise, each OQI Sask option may be exchanged into 8.23 OQI Sask Exchangeable Shares which are exchangeable into OQI common shares.  Options in OQI Sask during the three months ended July 31, 2011 and OQI Sask options outstanding at July 31, 2011 are detailed below.





Number


Weighted Average Exercise Price (CDN)Issued and outstanding, April 30, 2011


946,667


$
23.01Expired (note 11)


(896,667)


$
21.50Issued and outstanding, July 31, 2011


50,000


$
50.00








Exercise Price (CDN)

Number

Outstanding at

July 31, 2011

Number Exercisable at

July 31, 2011


Weighted Average Remaining Contractual Life


Weighted Average Grant-Date Fair Value (CDN)


Aggregate Intrinsic Value at July 31, 2011 (CDN)$
50.00


50,000


50,000


0.00

$
34.60


-50,000


50,000


0.00




$
-





The 50,000 OQI Sask options outstanding at July 31, 2011 represent 411,500 OQI Sask Exchangeable Shares that would be issued on exercise of the OQI Sask options as a result of the completion of the acquisition of the non-controlling interest in OQI Sask (see note 9). These options expired on August 1, 2011.





As at July 31, 2011, the Company had no unrecognized stock option compensation expense related to the OQI Sask options.





9.
OQI SASK EXCHANGEABLE SHARES AND PREFERRED STOCK





Holders of OQI Sask common shares received Exchangeable Shares which can be exchanged into shares of OQI common stock at any time at each holder’s option or by the Company upon the occurrence of certain events or any time thereafter on August 14, 2013 if the holder has yet to exchange the shares.  Transactions in Exchangeable Shares during the three months ended July 31, 2011 are detailed below.  For voting purposes, holders of Exchangeable Shares are represented by one outstanding Series B preferred share which carries a number of votes equal to the number of Exchangeable Shares then outstanding.





OQI Sask Exchangeable Shares


OQI Sask Exchangeable Shares issuable on exercise of OQI Sask options


Total Exchangeable

SharesBalance, April 30, 2011

19,129,237


7,791,069


26,920,306OQI Sask options expired (note 8)

-


(7,379,569)


(7,379,569)Exchangeable Shares exchanged into OQI common shares

(203,281)


-


(203,281)Balance, July 31, 2011

18,925,956


411,500


19,337,456








10.
COMMON STOCK





As of January 17, 2011 the Company has entered into an equity distribution agreement.  Under the terms of the agreement the Company may offer and sell shares of its common stock by way of “at-the-market” (ATM) distributions, up to a maximum of $20 million until January 18, 2012.  Shares will be distributed at market prices prevailing at the time of each sale; prices may therefore vary between purchasers and during the period of distribution.  To date, 5,537,137 shares have been distributed under this arrangement for gross proceeds of $3.1 million.  No share issues occurred during the three month period ending July 31, 2011.  Funds raised from the ATM
program will be used to finance general corporate purposes. The ATM program was suspended during the rights offering period of August 2, 2011 to September 12, 2011.





11.
STOCK OPTIONS





Stock based compensation generally takes the form of equity classified stock options granted to employees and non-employees. Options are granted under the Company’s 2006 Stock Option Plan and vest over various terms – generally 18 months to three years. One set of option grants included a performance condition based upon achieving a defined bitumen in place barrel count. Two other sets of option grants included both a market condition based upon total shareholder return over a three year period and performance conditions based upon achieving a combination of defining a reservoir recovery configuration and achieving a defined bitumen in place barrel count.  The fair value of the options
containing the performance and market conditions were estimated at the date of grant and amortization of these amounts commences when satisfaction of the performance conditions becomes probable.  As of July 31, 2011, it was not probable that any of the conditions would be satisfied.





15





OILSANDS QUEST INC.
 (A Development Stage Company)
 Notes to Consolidated Financial Statements
 (Unaudited)




The following summarizes our stock option activity under the Company’s 2006 Stock Option Plan for the three months ended July 31, 2011:





Options


Weighted-

Average

Exercise Price


Weighted-Average

Grant-Date

Fair Value


Aggregate Intrinsic

ValueOutstanding at April 30, 2011

22,883,452


$
3.02


$
2.44


$
-Granted

100,000



0.29



0.19



-Forfeited

(910,208)



1.33



0.91



-Expired

(1,000,000)



6.75



5.82



-Outstanding at July 31, 2011

21,073,244


$
2.90


$
2.34



-Exercisable at July 31, 2011

14,834,410


$
3.69


$
3.04


$
-





Of the total number of outstanding options at July 31, 2011, 4,550,000 options are subject to market and performance conditions with a weighted average grant date fair value of $0.57 per option.  As of July 31, 2011 these options have not yet vested and no stock based compensation expense has been recognized as achievement of the required performance and market conditions is not probable.





The weighted-average remaining contractual term of vested and exercisable options at July 31, 2011 was 3.1 years.





In addition to the above, OQI Sask has 50,000 outstanding options which may be exercised and exchanged into OQI Sask Exchangeable Shares whereby up to an additional 411,500 OQI common shares may be issued (notes 8 and 9).





During the three months ended July 31, 2011, 100,000 (July 31, 2010 - 1,517,474) options were granted and accounted for using the Black-Scholes option-pricing model and nil (July 31, 2010 - 3,050,000) options were granted and accounted for using the trinomial option-pricing model.





The trinomial option-pricing model takes into account the same input assumptions as the Black-Scholes model; however, it also further incorporates into the fair-value determination, the possibility that the market condition may not be satisfied and the impact of the possible differing stock price paths.  The following weighted average assumptions were used to determine the fair value of the options granted during the three months ended July 31, 2011 and 2010:





Black Scholes

2011

2010Expected Life (years)

3.84

4.02Risk free interest rate

1.96%

2.62%Expected volatility

93.15%

97.27%Dividend yield

0%

0%





As at July 31, 2011, the Company had unrecognized stock option compensation cost of $235,670 which will be recorded in future periods as options vest. The expense is expected to be recognized over a weighted-average period of 1.3 years.  As at July 31, 2011, there were 6,238,834 unvested options with a weighted average grant date fair value of $0.68.  The weighted average grant date fair value of options that vested and were forfeited during the period was $0.54 and $0.82, respectively.




12.
RELATED PARTY TRANSACTIONS





The son of a director of the Company is a 50% shareholder of a company that facilitated local on-site kitchen labor and catering functions to the Company for field operations.  For the three months ended July 31, 2011, $nil (2010 – $24,952) has been included in exploration expense. These transactions are in the normal course of operations. As at July 31, 2011, $nil (April 30, 2011 - $nil) was payable to the above mentioned company. The contract with this company was terminated on March 31, 2010.








13.
CONTINGENCIES AND COMMITMENTS





Contingency





On February 24, 2010, a derivative action entitled Make a Difference Foundation Inc. v. Hopkins, et al., Case No.  10-CV-00408, was filed in United States District Court for the District of Colorado by plaintiff Make a Difference Foundation, Inc.  The derivative action names the following individual defendants:  Christopher H. Hopkins, T. Murray Wilson, Ronald Blakely, Paul Ching, Brian MacNeill, Ronald Phillips, John Read, Gordon Tallman, Pamela
Wallin, Thomas Milne and W. Scott Thompson.  In addition, the Company is named as a nominal defendant.  Plaintiff asserts, among other things, claims for waste and breaches of the fiduciary duty of loyalty and good faith by the defendants stemming from the Company's approval of the proposed sale of the Company's Pasquia Hills assets to Canshale Corp.  The plaintiff seeks unspecified damages on behalf of the Company, restitution on behalf of the Company, and reasonable costs and expenses including counsel fees and experts' fees.   The Company believes the claims are wholly without merit and filed a motion to dismiss the Complaint on May 18, 2010.  Before the motion to dismiss was ruled upon, Plaintiff filed an amended complaint and a second amended complaint on July 15, 2010 and September 20, 2010, respectively.  Defendants moved to
dismiss the second amended complaint on September 29, 2010.  On May 23, 2011, Plaintiff and Defendants filed a stipulated motion requesting stay of all case deadlines pending further negotiation of a settlement agreement that would resolve the litigation.   On August 11, 2011, the parties filed a Notice of Settlement Stipulation and Agreement.  Plaintiff filed a Motion for Order to Preliminarily Approve Derivative Litigation Settlement on September 2, 2011.  Among other things, the court is considering whether to preliminarily approve the settlement.  If approved, the court will set a schedule to conduct a fairness hearing with regard to the settlement.
 As previously disclosed, on February 24, 2011, a putative class action complaint (the "Original Complaint") was filed against the Company and certain current and former officers of the Company on behalf of investors who purchased or sold the Company's securities between August 14, 2006 and July 14, 2009, alleging claims of securities fraud under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and control person liability for such fraud under Section 20(a) of the same act, arising out of the Company's accounting for its acquisition of an interest in OQI Sask in August 2006.  On May 27, 2011,
the plaintiffs in that putative class action filed an amended complaint (the "Amended Complaint") alleging the same legal causes of action but making the following changes from the Original Complaint:  a) expanding the putative class period so that it runs from March 20 2006 to January 13, 2011; b) naming as additional defendants eight individuals who are current or former directors of the Company as well as two additional corporate defendants, McDaniel & Associates Consultants Ltd. and TD Securities, Inc.; and c) basing the claimed fraud on a new theory that the Company overstated the value of its mineral rights as a result of misstatements about, among other things, the potential for extracting bitumen from oil sands lands for which the Company had exploration and development permits.  The Amended Complaint seeks unspecified damages.  The Company believes the suit
is without merit and intends to defend itself vigorously.  On June 6, 2011, the Company filed a motion to dismiss the Amended Complaint.  On June 20, 2011, the plaintiffs filed their opposition to the motion to dismiss.  The Company filed its reply to the plaintiffs' opposition on June 27, 2011 and on July 29, 2011, the court heard oral arguments and reserved decision.
 
 On April 13, 2011, a derivative action entitled Proctor v. Wilson, et al., Case No 2011CV2769 was filed in District Court, Denver County, Colorado.  The derivative action names the following individual defendants:  T. Murray Wilson, Ronald Blakely, Paul Ching, Christopher H. Hopkins, Brian F. MacNeill, Ronald Philips, John Read, Gordon Tallman and Pamela Wallin.  In addition, the Company is named as a nominal defendant.  Plaintiff asserts, among other things, claims for breach of fiduciary duties, unjust enrichment, abuse of control, gross
mismanagement and waste against the defendants relating to the alleged failure to properly account for the Company’s acquisition of a minority interest in Oilsands Quest Sask Inc. and the Company’s restatement of its financial statements for certain periods.  The plaintiff seeks unspecified damages on behalf of the Company, restitution on behalf of the Company, unspecified disgorgement of profits, unspecified equitable relief and reasonable costs and expenses including counsel fees and experts' fees.   Plaintiff sought and obtained approval from the court to file an amended complaint on September 8, 2011.  The response to the amended complaint is due thirty days thereafter.  The Company believes the claims are wholly without merit and intends to vigorously defend against such claims.





16





OILSANDS QUEST INC.
 (A Development Stage Company)
 Notes to Consolidated Financial Statements
 (Unaudited)




Commitments





The Company is subject to annual lease rentals, minimum exploration expenditures and work commitments related to its exploration permits, licenses and lease assets. For details of these required expenditures, refer to note 7.





14.
SUBSEQUENT EVENTS





a)
On July 18, 2011, the Company announced a $60 million rights offering open to all holders of the Company’s common stock and OQI Sask Exchangeable Shares as of July 28, 2011 (the “Record Date”). Each holder of common stock and Exchangeable Shares on the Record Date received 0.816 subscription rights per share for a total of 300,000,000 rights.  The subscription price per full share of common stock was $0.20, which was a 40% discount to the closing share price on July 18, 2011. The rights offering was terminated on September 12, 2011.  The Company may conduct a new, smaller, rights offering.





b)
On August 1, 2011, 50,000 OQI Sask Options expired.  These options represented 411,500 OQI Sask Exchangeable Shares.  There are no remaining Sask Options.





c)
The Saskatchewan Oil Sands Licenses were relinquished on August 12, 2011.  On August 9, 2011, permit 7006080098 of the Alberta Oil Sands property at Raven Ridge totaling 11,386 acres expired.




d)
The Company is currently negotiating a Letter of Intent from a third-party for the sale of the Wallace Creek assets.  There is no assurance that any agreement will be signed.  One of the Company’s board members, Christopher Hopkins, is a director of this third-party interest.  He has recused himself from the Company's Board of Directors pending the completion of negotiations and has not participated, on behalf of the Company, in any of the negotiations relating to the Letter of Intent. The Company has formed a Special Committee of the Board of Directors
of independent directors that will be responsible for negotiating definitive agreements pursuant to the terms and agreements of the Letter of Intent, if executed.
 e)
On September 12, 2011 Oilsands Quest received notice from the staff of the NYSE Amex LLC (the “Exchange”) that, based on their review of the Company’s Form 10-K/A for the fiscal year ended April 30, 2011 and discussions and correspondence with management, the Company is not in compliance with certain of the Exchange’s continued listing standards as set forth in Part 10 of the Exchange’s Company Guide.  Specifically, the Exchange noted that the Company is not
in compliance with Section 1003(a)(iv) of the Company Guide because the Company has sustained losses which are so substantial in relation to the Company’s overall operations or its existing financial resources, or its financial condition has become so impaired that it appears questionable, in the opinion of the Exchange, as to whether the Company will be able to continue operations and/or meet its obligations as they mature.

In order to maintain listing of the Company’s common stock on the Exchange, the Company must submit a plan by October 12, 2011, addressing how the Company intends to regain compliance with Section 1003(a)(iv) by January 12, 2011.  The Company expects to submit such a plan by the October 12, 2011 deadline.  If the Exchange accepts the plan, then the Company may be able to continue its listing during the plan period, up to January 12, 2012, during which time the
Company will be subject to periodic reviews to determine whether it is making progress consistent with the plan.  If the plan is accepted but the Exchange determines that the Company is not making progress consistent with the plan or that the Company is not in compliance with all continued listing standards of the Company Guide by January 12, 2012, then the Company expects the Exchange will initiate delisting proceedings.  If the Company fails to submit a plan by October 12, 2011, or if the plan submitted is not acceptable to the Exchange, the Company expects the Exchange will initiate delisting proceedings at that time.



The Company’s common stock continues to trade on the Exchange under the symbol “BQI,” however, the Exchange has advised the Company that the Exchange is utilizing the financial status indicator fields in the Consolidated Tape Association’s Consolidated Tape System and Consolidated Quote Systems High Speed Tapes to identify companies that are in noncompliance with the Exchange’s continued listing standards. Accordingly, the Company will become subject to the
trading symbol extension “.BC” to denote its noncompliance.


17


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations





The following discussion addresses material changes in our results of operations and capital resources and uses for the three months ended July 31, 2011, compared to the three months ended July 31, 2010, and our financial condition and liquidity since April 30, 2011.  We presume that readers have read or have access to our 2011 Annual Report on Form 10-K/A, which includes disclosure regarding critical accounting policies and estimates as part of Management’s Discussion and Analysis of Financial Condition and Results of Operation.  Unless otherwise stated, all dollar amounts are expressed in U.S. dollars.  All future payments in Canadian dollars have been
converted to U.S. dollars using an exchange rate of $1.00 U.S. = $0.9538 CDN, which was the July 31, 2011 exchange rate.





Overview





Recent Events





·
The Company is currently negotiating a Letter of Intent from a third-party interest for the sale of the Wallace Creek assets.


·
The rights offering to all shareholders at July 28, 2011 was terminated on September 12, 2011.  The Company may conduct a new, smaller, rights offering in the event that the Letter of Intent is executed.


·
As previously announced, we have relinquished the licenses in Saskatchewan and the southernmost permits at Raven Ridge in Alberta as we did not view these areas as having the prospect for future development.  All of our activities in Saskatchewan will now be focused on the development of the Axe Lake leases.


Three Months Ended July 31, 2011





·
On May 17, 2011 we provided new resource estimates for Wallace Creek following the 2011 winter drilling program.


·
On June 27, 2011, we received an extension of our permits at Wallace Creek until March 31, 2013.


·
On July 6, 2011 we provided an update on the Strategic Alternatives Review Process and announced a $60 million rights offering to all stockholders at July 28, 2011. The rights offering was terminated on September 12, 2011.


·
We provided an operational update at the TD Unconventional Oil Conference in Calgary on July 6, 2011.


·
After analysis of available drilling and seismic data, we have concluded that the lands in the south part of Raven Ridge on Permit No. 7006080098 are not prospective and relinquished this permit in August 2011. Relinquishing this land will have no impact on the Company's current resource estimates or development plans.





Operations Summary:





Axe Lake Area – Reservoir Development Activities





We received approval from the Government of Saskatchewan to convert portions of the Axe Lake permits to 15-year leases. These leases, the first oil sands leases in Saskatchewan, are one of the key elements the Company needs in place to proceed to development of a commercial oil sands production facility.





The two leases, OSA00001 and 0SA00002, will give us the certainty of land tenure we need to underpin commercial development at Axe Lake and are governed under the terms of the Petroleum and Natural Gas Regulations, 1969 (“1969 Regulations”).  These leases expire on March 31, 2027 and may be continued beyond this date if they meet certain requirements of the 1969 Regulations.





We continued the procurement of services and materials for the planned steam-assisted-gravity drainage (“SAGD”) pilot. The proposed pilot will consist of one pair of 100 meter long horizontal wells, with the upper well placed five meters below the glacial till cap, or overburden, and is designed to make use of the existing surface facilities. The SAGD pilot will demonstrate the steam containment properties of the glacial till cap and provide information essential for the front-end engineering design for the commercial development. Further activity on the pilot project will be dependent on securing additional financing.




Development of a commercial project remains subject to financing, regulatory and other contingencies such as successful reservoir tests, board of directors’ approvals, and other risks inherent in the oil sands industry (See "Risk Factors" section of our Form 10-K/A for the year ended April 30, 2011 and see Item 1A. "Risk Factors" below).





Exploration





After analysis of available drilling and seismic data, we have concluded that the lands in the south part of Raven Ridge on Permit No. 7006080098 are not prospective and relinquished this permit in August 2011. Relinquishing this land will have no impact on the Company's current resource estimates or development plans.





On June 27, 2011, the Company received approval from Alberta Energy to extend the Wallace Creek permits for an additional 67 days to March 31, 2013. This extension will allow for two full seasons of winter exploration programs.





Environmental and Regulatory




The Company is in discussion with the Saskatchewan Ministry of Energy and Resources ("SMER") to assess a re-abandonment issue relating to the abandonment of early exploration core holes.  We have drilled 359 exploration core holes in Saskatchewan and during a review of our development plans and well records, we determined that 229 of the early-year wells were not abandoned to a standard that meets our thermal development requirements or were not abandoned in accordance with the regulatory requirements





We have applied for waivers on 83 core holes, the majority of which are located outside the current potential commercial development area and the regulator has indicated that they are willing to consider such waivers on a case by case basis.  Our waiver applications are based on the fact that these core holes fall outside the current commercial development area and are therefore located in areas that are not expected to be economically recoverable.  We have included approximately 146 core holes in our management best estimate of the re-abandonment costs as described in our financial statements.





During the year ended April 30, 2011, we completed an 18 hole re-abandonment program.  We successfully re-abandoned 14 core holes and were only partially successful in our attempt to re-abandon the other four core holes. Those four core holes may still contain conduits which will require the Company to undertake further monitoring should a SAGD project be implemented within the vicinity of these core holes. The re-abandonment of these four core holes occurred early in the program, and we anticipate high success rates on the re-abandonments still to come.





The remaining 128 core holes are comprised of a combination of locations that are in or adjacent to the commercial development area plus a portion of the core holes for which we are seeking waivers.  Our best estimate of the undiscounted/gross costs to complete this program over the next four years is $26.8 million.





Corporate





On August 17, 2010, we announced that we had initiated a process to explore strategic alternatives for enhancing shareholder value.  The Board’s decision reflected careful consideration of our financial position and the capital required to execute the business plan.  In light of the significant incremental capital required to advance the exploration and development of the oil sands assets in Saskatchewan and Alberta, the Board determined that it was in the best interests of shareholders to engage financial advisors and formally explore all alternatives.  The process of exploring and evaluating strategic alternatives was overseen by a Special Committee chaired by Brian MacNeill,
and included Ronald Blakely and Paul Ching.





The Special Committee considered all alternatives to increase shareholder value, including strategic financing opportunities, asset divestitures, joint ventures and/or a corporate sale, merger or other business combination. We retained TD Securities Inc. (“TD”) as a financial advisor to assist us with this process.





Feedback from parties in the process has illustrated that potential future partners or acquirers require a further level of development, reducing the remaining areas of uncertainty, in order to be prepared to make a substantial investment. The Company is therefore seeking funding to advance its assets toward commercial development, while remaining open to offers of joint venture opportunities, asset sales or other alternatives.





On July 18, 2011 we announced a rights offering, under which all existing shareholders were eligible to purchase, on an equal, proportional basis, additional shares of the Company. The rights offering was terminated on September 12, 2011, and all proceeds received from shareholders who had subscribed to the rights offering will be returned to them.  The Company is considering a future rights offering, the proceeds of which would be used to advance the Company’s development plan and advnace the Wallace Creek project through additional delineation programs. The key operational priorities are to operate the planned pilot project at Axe Lake in order to demonstrate that the Axe Lake reservoir
can be produced using proven SAGD technology and conduct additional overburden testing in order to further refine the aerial extent of the glacial till that overlies the reservoir and demonstrate its extent and integrity as a cap for SAGD production.





18





Outlook





Assuming we have the necessary capital resources, our reservoir development and exploration activities over the next few months will be focused on preparing to execute the SAGD pilot at Axe Lake and designing and executing a seismic program at Wallace Creek. All of these plans are subject to our receipt of the necessary financing.  See "Risks Related to Our Business - Due to our history of operating losses, we are uncertain that we will be able to maintain sufficient cash to accomplish our business objectives".





The next phase of testing, subject to regulatory approvals, will be a SAGD pilot at Test Site 1.  This will include the drilling of a new SAGD well pair in close proximity to the existing wells at Test Site 1 to build on our growing knowledge of the reservoir and cap rock characteristics and test the commercial viability of SAGD at Axe Lake.  The test plan will use one 100 meter long horizontal well pair, with the upper well placed five meters below the top of the interface between the overburden and the oil sands, and will also make use of the existing surface facilities.  SAGD has been the most widely used, and therefore best understood, in situ recovery technique for the production
of immobile bitumen (at initial reservoir conditions) in the McMurray/Dina formations.





The objectives of the pilot are to:





·
test the effects of steam contact on the glacial till overburden at Axe Lake and demonstrate that the cap will perform as a competent steam containment barrier in SAGD operations;


·
confirm early stage SAGD production and steam rates with a scalable well length in order to improve forecasting for a commercial project;


·
determine the optimal producing pressure for a commercial project;


·
establish gas production rates and composition and produced water composition for facility design; and


·
better understand the initial critical water saturation (minimum saturation at which water becomes mobile) in bitumen rich zones for use in forecast model.





Following the successful completion and interpretation of the initial steam test results, we may submit an application to continue the test for up to another six months in order to further evaluate injection pressures to help determine the optimal operational pressure for designing a commercial project.





Based on the drilling results at Wallace Creek and our knowledge of the regional geology, we believe there is good potential for that project area to support a commercial SAGD project. Further seismic work or delineation drilling is required to confirm this potential and retain certain portions of these permits.





The Company may offer and sell shares of common stock by way of "at-the-market" ("ATM") distributions on NYSE Amex, until January 18, 2012. Funds raised from the ATM program will be used for general corporate purposes.  In addition, the Company may conduct a new, smaller, rights offering as described above under the "Corporate" section.





The Company does not currently have sufficient capital resources to carry out the exploration and development plans described above.  See "Liquidity and Capital Resources" below.





Liquidity and Capital Resources





The following discussion of liquidity and capital resources should be read in conjunction with the consolidated financial statements included in Part I, Item 1. “Financial Statements”. The consolidated financial statements have been prepared assuming that we will continue as a going concern.





At July 31, 2011, the Company held cash and cash equivalents totaling $9.4 million (April 30, 2011 - $16.0 million).





During the three months ended July 31, 2011, the Company expended $4.6 million on operating activities and $1.9 million on property and equipment. Management anticipates that the Company will be able to fund its activities at a reduced level through October 2011 with its cash and cash equivalents as at July 31, 2011. Accordingly, there is substantial doubt about our ability to continue as a going concern and without additional funding, we may not be able to maintain operations beyond that date. Additional financing will also be required if our activities are changed in scope or if actual costs differ from estimates of current plans. To fund operations, the Company conducted a rights offering under which the
existing shareholders were  given the right to purchase additional shares in the Company based on their pro-rata share ownership. During the rights offering, the Company received a Letter of Intent from a third-party interest to purchase the Wallace Creek assets and the rights offering was terminated on September 12, 2011.  The Company is continuing to negotiate the terms of the Letter of Intent.  The Company may conduct a new, smaller, rights offering in the event that the Letter of Intent is executed. The proceeds from any agreements entered into pursuant to the Letter of Intent and any new rights offering will be used to continue with the delineation and development of the Axe Lake assets (as described more fully in the Outlook section), and for general corporate purposes. Our development strategy will also consider other sources of financing, asset
sales or seeking partners on a joint venture basis on our specific projects to fund the development of such projects in a timely and responsible manner.




There can be no assurance that any agreements entered into pursuant to any Letter of Intent and any new rights offering will result in the Company raising sufficient funds to carry out its exploration and development plans. There is also no assurance that debt or equity financing or joint venture partner arrangements will be available to us on acceptable terms, if at all, to meet these requirements.  The Company has no revenues, and its operating results, profitability and the future rate of growth depend solely on management’s ability to successfully implement the business plans and on the ability to raise additional capital. See “Outlook” above.





As of January 17, 2011, the Company has entered into an equity distribution agreement (“Agreement”) with Knight Capital Americas, L.P. (“KCA”), a subsidiary of Knight Capital Group, Inc. Under the terms of the Agreement, the Company may offer and sell shares of common stock by way of “at-the-market” (ATM) distributions on NYSE Amex, up to a maximum of US$20 million until January 18, 2012, through KCA as sales agent. The shares are distributed at market prices prevailing at the time of each sale and the timing, price and number of shares sold are at our discretion.  The number of shares sold on any given day is expected to be relatively small compared to the total
volume of shares traded. As of July 31, 2011, 5,537,137 shares have been distributed under this arrangement for gross proceeds of $3.1 million.  Funds raised from the ATM program are used to finance general corporate purposes. The ATM program was suspended during the Rights Offering period until September 12, 2011, and  is expected to be suspended during any future rights offering where KCA or any of its affiliates acts as the dealer manager.





Results of Operations





Net loss





Three months ended July 31, 2011 as compared to three months ended July 31, 2010.The Company experienced a net loss of $5.8 million or $0.02 per share for the three months ended July 31, 2011 as compared to a net loss of $16.0 million or $0.05 per share for the three months ended July 31, 2010.  The decline in the net loss in the current period as compared to the prior period is primarily due to the reduction in exploration activity, a reduction in impairment of property that was recognized in 2010 on our Saskatchewan Oil Sands Licenses, a reduction in stock-based compensation expense activity and an increase in foreign exchange
gain which were partially offset by an increase in depreciation and accretion.





The Company expects to continue to incur operating losses and will continue to be dependent on additional sales of equity or debt securities and/or property sales or joint ventures to fund its activities in the future.





Exploration costs





Three  months ended July 31, 2011 as compared to three  months ended July 31, 2010.Exploration costs for the three months ended July 31, 2011 were $0.5 million (2010 - $11.7 million).    Exploration expenditures in the three months ended July 31, 2011 include $0.5 million of additional asset retirement obligations that were revised during the current period in relation to the re-abandonment of a certain number of core holes at Axe Lake. Compared to the same period in the previous year, exploration expenditures decreased due to a reduction in drilling and exploration activity during the current
period.





General and administrative





Corporate





Three  months ended July 31, 2011 as compared to three months ended July 31, 2010.General and administrative expenses settled with cash for the three months ended July 31, 2011 were $4.1 million (2010 - $3.8 million).   Expenditures in the three month period ended July 31, 2011 consist of salaries ($1.6 million), legal and other professional fees ($1.8 million) and general office costs ($0.7 million).   General and administrative expenses in the three months ended July 31, 2010 consist of salaries ($1.5 million), legal and other professional fees ($1.2 million) and general office costs ($1.1
million).  At July 31, 2011, there were 16 employees and no seasonal field employees, and at July 31, 2010, there were 46 employees including 5 seasonal field employees.    Although total personnel levels have declined, salaries increased during the current period compared to the same period last year due to severance and termination payments. The increase in professional fees during the three months ended July 31, 2011 is related to additional costs incurred as part of the formal strategic alternative process. The decrease in general office costs during the three months ended July 31, 2011 is mainly caused by downsizing activities.





19





Stock-based compensation





Three  months ended July 31, 2011 as compared to three months ended July 31, 2010.  Stock-based compensation expense for the three months ended July 31, 2011 was a recovery of $0.025 million (2010 - $1.0 million) and consists of stock-based compensation related to the issuance of options to directors, officers and employees.  The decrease during the three month period compared to the same period in the prior year is due to fewer options remaining to vest including options forfeited caused by a reduction in the number of employees.  A total of 0.9 million options were forfeited and 1.0 million options expired during the
three months ended July 31, 2011.





Foreign exchange (gain) loss




Three months ended July 31, 2011 as compared to three months ended July 31, 2010.A foreign exchange gain of $0.1 million (2010 – loss of $0.3 million) during the three months ended July 31, 2011 resulted from holding more U.S. funds in the OQI Sask during the current period compared to the same period last year with increased volatility of the U.S. dollar against the Canadian dollar.




Depreciation and accretion




Three months ended July 31, 2011 as compared to three months ended July 31, 2010.Depreciation and accretion expense for the three months ended July 31, 2011 was $1.3 million (2010 - $1.1 million). Depreciation expense relates to camp facilities, equipment and corporate assets which are being depreciated over their useful lives of 3 to 5 years.  Accretion expense relates to the asset retirement obligation recognized on the re-abandonment of a certain number of wells in the Axe Lake area and on the airstrip, camp site, access roads and reservoir test sites which are being brought into income over a period of 1 to 30 years.  The
increase during the three month period ended July 31, 2011 compared to the same period last year is due to the additional accretion on asset retirement obligation resulting from the re-abandonment of a certain number of wells in the Axe Lake area that was identified in the year ended April 30, 2010.




Impairment





Three months ended July 31, 2011 as compared to three months ended July 31, 2010.  The impairment for the three months ended July 31, 2011 was $nil million (2010 - $2.0 million).   The impairment in 2010 was recognized on the Saskatchewan Oil Sands Licenses due to their high likelihood of relinquishment at July 31, 2010. These licenses were relinquished in August 2011.





Interest and other income





Three months ended July 31, 2011 as compared to three months ended July 31, 2010.Interest income for the three months ended July 31, 2011 was $0.02 million (2010 - $0.01 million).  Interest income is earned because the Company pre-funds its activities and the resulting cash on hand is invested in short-term deposits.





Deferred income tax benefit





Three months ended July 31, 2011 as compared to three months ended July 31, 2010.  The deferred income tax benefit for the three months ended July 31, 2011 was $nil million (2010 - $3.9 million).  During the three months ended July 31, 2011, no deferred income tax benefit was recognized since a full valuation allowance was taken on the taxable temporary differences associated with property and equipment capitalized on the balance sheet. At April 30, 2011, the deferred tax benefit associated with the impairment on undeveloped properties was recorded to the extent of the deferred tax liability amount on the balance sheet derived from
the excess appreciated asset value over the tax basis of the Company’s net assets. Therefore, in addition to recording a full valuation allowance on all non-capital losses incurred in accordance with the Company’s accounting policy, a valuation allowance is now taken on taxable temporary differences associated with property and equipment capitalized on the balance sheet.





Previously, the Company recognized a full valuation allowance on all non-capital losses and generated deferred tax benefits by expensing all exploration costs for accounting purposes while capitalizing these costs for income tax purposes.  This resulted in a higher tax basis for the Company’s property and equipment when compared to their carrying value.





Recently Issued Accounting Standards Not Yet Adopted





There have been no recent accounting pronouncements or changes in accounting pronouncements during the three months ended July 31, 2011, as compared to the recent accounting pronouncements described in the Company’s Annual Report on Form 10-K/A, that are of significance, or potential significance to the Company.




Off-Balance Sheet Arrangements





The Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or further effect on its financial condition, changes in financial condition, revenues or expenses, results of operations liquidity, capital expenditures or capital resources that are material to investors.





Item 3.  Quantitative and Qualitative Disclosures About Market Risk





There have been no material changes to our quantitative and qualitative disclosures about market risk set forth in our form 10-K/A.





Item 4.  Controls and Procedures





Disclosure Controls and Procedures





We carried out an evaluation under the supervision of, and with the participation of our Chief Executive Officer and our Vice President and Controller, Principal Accounting Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(e) under the Securities and Exchange Act of 1934, as amended.   Based on the evaluation as of July 31, 2011 our Chief Executive Officer and Vice President and Controller, Principal Accounting Officer concluded that our disclosure controls and procedures (as defined in Rule 13a-15e under the Securities Exchange Act of 1934) were effective.





Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and our Vice President and Controller, Principal Accounting Officer,
as appropriate, to allow timely decisions regarding required disclosure.





20





Changes in Internal Control Over Financial Reporting





We regularly review our system of internal control over financial reporting.  There were no changes in our internal control over financial reporting during the period covered by this report on Form 10-Q that have materially affected or is reasonably likely to materially affect, our internal control over financial reporting.





PART II - OTHER INFORMATION





Item 1.   Legal Proceedings





On February 24, 2010, a derivative action entitled Make a Difference Foundation Inc. v. Hopkins, et al., Case No.  10-CV-00408, was filed in United States District Court for the District of Colorado by plaintiff Make a Difference Foundation, Inc.  The derivative action names the following individual defendants:  Christopher H. Hopkins, T. Murray Wilson, Ronald Blakely, Paul Ching, Brian MacNeill, Ronald Phillips, John Read, Gordon Tallman, Pamela Wallin, Thomas Milne and W. Scott Thompson.  In addition, the Company is
named as a nominal defendant.  Plaintiff asserts, among other things, claims for waste and breaches of the fiduciary duty of loyalty and good faith by the defendants stemming from the Company's approval of the proposed sale of the Company's Pasquia Hills assets to Canshale Corp.  The plaintiff seeks unspecified damages on behalf of the Company, restitution on behalf of the Company, and reasonable costs and expenses including counsel fees and experts' fees.   The Company believes the claims are wholly without merit and filed a motion to dismiss the Complaint on May 18, 2010.  Before the motion to dismiss was ruled upon, Plaintiff filed an amended complaint and a second amended complaint on July 15, 2010 and September 20, 2010, respectively.  Defendants moved to dismiss the second amended complaint on September 29, 2010.  On May 23, 2011,
Plaintiff and Defendants filed a stipulated motion requesting stay of all case deadlines pending further negotiation of a settlement agreement that would resolve the litigation.   On August 11, 2011, the parties filed a Notice of Settlement Stipulation and Agreement.  Plaintiff filed a Motion for Order to Preliminarily Approve Derivative Litigation Settlement on September 2, 2011.  Among other things, the court is considering whether to preliminarily approve the settlement.  If approved, the court will set a schedule to conduct a fairness hearing with regard to the settlement.





As previously disclosed, on February 24, 2011, a putative class action complaint (the "Original Complaint") was filed against the Company and certain current and former officers of the Company on behalf of investors who purchased or sold the Company's securities between August 14, 2006 and July 14, 2009, alleging claims of securities fraud under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and control person liability for such fraud under Section 20(a) of the same act, arising out of the Company's accounting for its acquisition of an interest in OQI Sask in August 2006.  On May 27, 2011, the plaintiffs in that putative class action filed an amended complaint (the
"Amended Complaint") alleging the same legal causes of action but making the following changes from the Original Complaint:  a) expanding the putative class period so that it runs from March 20 2006 to January 13, 2011; b) naming as additional defendants eight individuals who are current or former directors of the Company as well as two additional corporate defendants, McDaniel & Associates Consultants Ltd. and TD Securities, Inc.; and c) basing the claimed fraud on a new theory that the Company overstated the value of its mineral rights as a result of misstatements about, among other things, the potential for extracting bitumen from oil sands lands for which the Company had exploration and development permits.  The Amended Complaint seeks unspecified damages.  The Company believes the suit is without merit and intends to defend itself vigorously.  On June 6,
2011, the Company filed a motion to dismiss the Amended Complaint.  On June 20, 2011, the plaintiffs filed their opposition to the motion to dismiss.  The Company filed its reply to the plaintiffs' opposition on June 27, 2011 and on July 29, 2011, the court heard oral arguments and reserved decision.





On April 13, 2011, a derivative action entitled Proctor v. Wilson, et al., Case No 2011CV2769 was filed in District Court, Denver County, Colorado.  The derivative action names the following individual defendants:  T. Murray Wilson, Ronald Blakely, Paul Ching, Christopher H. Hopkins, Brian F. MacNeill, Ronald Philips, John Read, Gordon Tallman and Pamela Wallin.  In addition, the Company is named as a nominal defendant.  Plaintiff asserts, among other things, claims for breach of fiduciary duties, unjust enrichment, abuse of control, gross mismanagement and waste against the defendants relating to the alleged failure
to properly account for the Company’s acquisition of a minority interest in Oilsands Quest Sask Inc. and the Company’s restatement of its financial statements for certain periods.  The plaintiff seeks unspecified damages on behalf of the Company, restitution on behalf of the Company, unspecified disgorgement of profits, unspecified equitable relief and reasonable costs and expenses including counsel fees and experts' fees.   The Plaintiff filed an amended complaint on September 8, 2011.  The response to the amended complaint is due thirty days thereafter.  The Company believes the claims are wholly without merit and intends to vigorously defend against such claims.





Item 1A.  Risk Factors





RISKS RELATED TO OUR BUSINESS









Due to our history of operating losses, we are uncertain that we will be able to maintain sufficient cash to accomplish our business objectives and to continue as a going concern




The consolidated financial statements have been prepared assuming that we will continue as a going concern. However, without additional funding, we may not be able to continue our operations beyond October  2011. During the fiscal years ended April 30, 2011 and 2010 we suffered net losses of $316 million and $64 million, respectively. At July 31, 2011, there was stockholders’ equity of $133 million, negative working capital of $2 million and a deficit accumulated during the development phase of $717 million. There is no assurance that we can generate net income, generate revenues or successfully explore and exploit our properties.




Significant amounts of capital will be required to explore and maintain in good standing the lands in Saskatchewan and Alberta. The only source of future funding presently available to us is through the sale of additional equity capital, borrowing funds, or selling a portion of our interests in our assets. There is no assurance that any additional equity capital or borrowings required will be obtainable on terms acceptable to us, if at all. Failure to obtain such additional financing, including the failure to complete the sale contemplated by the Letter of Intent or the failure of any future rights offering to be fully or sufficiently subscribed, could result in delays or indefinite postponement of further
exploration and development of our projects. Equity financing, if available, may result in substantial dilution to existing shareholders. Our financial statements do not include any adjustments relating to the recoverability and classification of assets or the amounts and classification of liabilities that might be necessary should we become unsuccessful in implementing these plans.





Our business activities, and the oil and gas industry in general, are subject to a variety of risks. If any of the following risk factors should occur, our profitability, financial condition or liquidity could be materially impacted. As a result, holders of our securities could lose part or all of their investment in Oilsands Quest Inc.





Government Regulations and Retention of Permits, Leases and Licenses





The business of resource exploration and development is subject to substantial regulation under Canadian federal, provincial and local laws relating to the exploration for, and the development, upgrading, marketing, pricing, taxation, and transportation of oil sands bitumen and related products and other matters. Amendments to current laws and regulations governing operations and activities of oil sands exploration and development operations could have a material adverse impact on our business. In addition, there can be no assurance that income tax laws, royalty regulations, environmental regulations and government incentive programs related to the permits in Saskatchewan, oil sands exploration licenses in
Saskatchewan, the permits in Alberta and the Eagles Nest Prospect and the oil sands industry generally, will not be changed in a manner which may adversely affect our progress and cause delays, or cause the inability to explore and develop, resulting in the abandonment of these interests.





Alberta's new Land-Use Framework, which is to be implemented under the Alberta Land Stewardship Act ("ALSA"), sets out the Government of Alberta's approach to managing Alberta's land and natural resources to achieve long-term economic, environmental and social goals.  ALSA contemplates the creation of regional plans which could amend or extinguish previously issued regulatory permits, licenses, approvals and authorizations in order to achieve or maintain an objective or policy resulting from the implementation of a regional plan.  The Government of Alberta is expected to develop a regional plan for each of seven regions in the province
and has identified the Lower Athabasca Regional Plan ("LARP") as a priority.  The Company's properties in Alberta are within the LARP's boundaries.  The LARP is expected to incorporate regional thresholds for air emissions, water use and land disturbance to control cumulative effects of industrial development, and guide future resource decisions while considering social and economic impacts.  The final LARP is expected to be sent to the Alberta Cabinet for approval in mid 2011.





In Saskatchewan, a new Environmental Management and Protection Act, 2010 has been passed by the Legislature but not yet proclaimed.  The new Act will include authority for the Saskatchewan Environmental Code, which adopts a new results-based regulatory framework for managing and protecting the environment.  It is anticipated that the Act and the Code will be proclaimed in 2011.





It is possible that the LARP in Alberta and the new Act and Code in Saskatchewan may negatively impact our ability to conduct operations on certain properties or limit or prohibit development due to environmental limits and thresholds.  In addition, enhanced operating practices required to be undertaken by us in response to the LARP and the new Act and Code may increase operating costs and such costs may further increase in the future if there are further changes to the prescribed operating Practices.





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The Species at Risk Act, or SARA, was enacted by the Government of Canada as a means to manage species of special concern to prevent them from becoming extinct, endangered or threatened.  The woodland caribou has been designated as a species under threat in the Province of Alberta. Pursuant to the SARA, lands that fall within our oilsands leases have been designated as sensitive habitat for caribou.  We have undertaken enhanced operating practices within the designated areas with a view to protecting the threatened caribou population.





Permits, leases, licenses and approvals are required from a variety of regulatory authorities at various stages of exploration and development. There can be no assurance that the various government permits, leases, licenses and approvals sought will be granted in respect of our activities or, if granted, will not be cancelled or will be renewed upon expiry. There is no assurance that such permits, leases, licenses and approvals will not contain terms and provisions which may adversely affect our exploration and development activities. Our exploration permits in Saskatchewan do not give us the right to produce and will require conversion to a lease prior to the expiry of the permits.





On May 27, 2011, we received approval for the third and final possible one-year extensions to May 31, 2012.  We are also in discussion with the crown to convert these permits to licenses under the 1969 regulations and then to lease prior to the expiry of these permits.  Currently, the Company is working with the regulators to assess an issue relating to the re-abandonment of early exploration core holes.   It is possible that the outcome of such assessment could result in cancellation of the permits if the Company does not comply with the governing regulations.   Further, if the Company cannot remediate these core holes to industry and regulatory standards, our ability to
commercially develop the Axe Lake reservoir may be limited.





Certain First Nations and Metis people have treaty and aboriginal rights, and claim aboriginal title, in relation to our permit and lease lands in Alberta and Saskatchewan and other lands that are potentially affected by our activities.   The Governments of Canada, Alberta and Saskatchewan have a duty to consult with those aboriginal people in relation to actions and decisions which may impact those rights and claims and, in certain cases, have a duty to accommodate their concerns.  These duties have the potential to adversely affect our ability to obtain permits, leases, licenses and other approvals, or the terms and conditions of those approvals, which could adversely impact our progress
and ability to explore and develop our properties.





Abandonment and Reclamation Obligations





We are responsible for compliance with terms and conditions of environmental and regulatory approvals and all laws and regulations regarding the abandonment of a project and reclamation of its lands at the end of its economic life, which abandonment and reclamation costs may be substantial. A breach of such approvals or laws may result in the issuance of remedial orders, the suspension of approvals, the seizure of posted security or the imposition of fines and penalties, including an order for cessation of operations at the site until satisfactory remedies are made. All delineation wells are abandoned and reclaimed immediately and these costs are included with our exploration costs incurred. Our estimated
abandonment and reclamation costs could change as the reclamation requirements will be a function of regulations in place at the time. Revisions to estimated asset retirement obligations can result from changes in retirement cost estimates and changes in the estimated timing of abandonment. In the future, we may determine it prudent or be required by applicable regulatory approvals or laws to establish and fund one or more reclamation funds to provide for payment of future abandonment and reclamation costs.





We record the fair value of a liability for an asset retirement obligation when there is a legal obligation associated with the retirement of a tangible long-lived asset and the liability can be reasonably estimated. The legal obligation to perform the asset retirement activity is unconditional even though uncertainty may exist about the timing and/or method of settlement that may be beyond the Company’s control. This uncertainty about the timing and/or method of settlement is factored into the measurement of the liability when sufficient information exists to reasonably estimate the fair value. The amount of asset retirement obligation recorded reflects the expected costs, taking into account the
probability of particular scenarios. The difference between the upper end of the range of these assumptions and the lower end of the range can be significant, and consequently changes in these assumptions could have a material effect on the fair value of asset retirement obligations and future losses in a period of change.





If the Company is unable to re-abandon the early exploration core holes to industry and regulatory standards, it could result in the cancellation of permits or limit our ability to develop the reservoir.





If we fail to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002, the price of our common shares may be affected





We are required to maintain effective internal control over financial reporting under the Sarbanes-Oxley Act of 2002 and related regulations. Any material weakness in our internal control over financial reporting that needs to be addressed, disclosure of management’s assessment of our internal control over financial reporting, or disclosure of our public accounting firm’s report on internal control over financial reporting that reports a material weakness in our internal control over financial reporting may reduce the price of our common shares.





The restatement of our consolidated financial statements may result in litigation and government enforcement actions





We have restated our consolidated financial statements and other financial information for the years ended April 30, 2008 and 2007 and the interim periods from July 31, 2008 through January 31, 2009 primarily with respect to the accounting treatment of our August 2006 acquisition of a non-controlling interest (35.92%) of OQI Sask which together with our 64.08% interest resulted in a 100% interest in OQI Sask.  We have also restated our consolidated financial statements and other financial information for the interim period ended July 31, 2009 with respect to accounting for stock-based compensation.  The restatement of our prior financial statements may expose us to risks associated with
litigation, regulatory proceedings and government enforcement actions, including the risk that the SEC may disagree with the manner in which we have accounted for and reported the financial impact of the restatement which could result in the Company having to further restate its prior financial statements, amend prior filings with the SEC, or take other actions not currently contemplated.





In addition, securities class action litigation has often been brought against companies who have been unable to provide current public information or who have restated previously filed financial statements.  Such litigation is complex and could result in substantial costs, divert management’s attention and resources, and harm our business, financial condition and results of operations.





Due to our history of operating losses, we are uncertain that we will be able to maintain sufficient cash to accomplish our business objectives





The consolidated financial statements have been prepared assuming that we will continue as a going concern. During the fiscal years ended April 30, 2011 and 2010 we suffered net losses of $316 million and $64 million, respectively. At July 31, 2011, there was stockholders’ equity of $133 million, negative working capital of $2 million and a deficit accumulated during the development phase of $717 million. There is no assurance that we can generate net income, generate revenues or successfully explore and exploit our properties.





Significant amounts of capital will be required to explore and develop the permit lands in Saskatchewan and Alberta, oil sands exploration licenses in Saskatchewan and the Eagles Nest area. The only source of future funding presently available to us is through the sale of additional equity capital and borrowing funds or selling a portion of our interest in our assets. There is no assurance that any additional equity capital or borrowings required will be obtainable on terms acceptable to us, if at all. Failure to obtain such additional financing could result in delays or indefinite postponement of further exploration and development of our projects. Equity financing, if available, may result in substantial
dilution to existing stockholders.





As a result of these risks we have concluded there is significant doubt related to our ability to continue as a going concern.  Our financial statements do not include any adjustments relating to the recoverability and classification of assets or the amounts and classification of liabilities that might be necessary should we become unsuccessful in implementing these plans.





The impact of disruptions in the global financial and capital markets on our ability to obtain financing





The market events and conditions that transpired in 2008 and 2009, including disruptions in the international credit markets and other financial systems and the deterioration of global economic conditions, have, among other things, caused significant volatility in commodity prices.  These events and conditions caused a loss of confidence in the broader U.S. and global credit and financial markets and resulted in the collapse of, and government intervention in, numerous major banks, financial institutions and insurers, and created a climate of greater volatility, less liquidity, widening of credit spreads, a lack of price transparency, increased credit losses and tighter credit conditions. Notwithstanding
various actions by governments, concerns about the general condition of the capital markets, financial instruments, banks, investment banks, insurers and other financial institutions caused the broader credit markets to further deteriorate and stock markets to decline substantially.  These factors have negatively impacted enterprise valuations and have impacted the performance of the global economy.  Although credit markets, equity markets, commodity markets and the United States and global economies have somewhat stabilized (and in some instances experienced substantial recoveries), some prominent government officials, economists and market commentators have expressed concerns regarding the durability of the recovery over the near and medium term, particularly as the fiscal stimulus that was utilized by the world's governments to combat the global financial crises
is withdrawn over time in the coming months and years.





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Although we expect to meet our near term liquidity needs with our working capital on hand, we will continue to need further funding to achieve our business objectives. In the past, the issuance of equity securities has been the major source of capital and liquidity for us. The recent conditions in the global financial and capital markets have limited the availability of this funding. If the disruptions in the global financial and capital markets continue, debt or equity financing may not be available to us on acceptable terms, if at all. If we are unable to fund future operations by way of financing, including public or private offerings of equity or debt securities, our business, financial condition and results
of operations will be adversely impacted.  Additionally, these factors, as well as other related factors, may cause decreases in asset values that are deemed to be other than temporary, which may result in impairment losses.





Status and Stage of Reservoir Test Program





The reservoir test program is currently at the early stages of its planned implementation schedule. There is a risk that the program will not be completed on time or on budget or at all. Additionally, there is a risk that the program may have delays, interruption of operations or increased costs due to many factors, including, without limitation: breakdown or failure of equipment or processes; construction performance falling below expected levels of output or efficiency; design errors; challenges to, or inability to access in a timely or economic fashion; contractor or operator errors; non-performance by third-party contractors; labour disputes, disruptions or declines in productivity; increases in materials or
labour costs; inability to attract sufficient numbers of workers; delays in obtaining, or conditions imposed by, regulatory approvals; changes in program scope; violation of permit requirements; disruption in the supply of energy; transportation accidents, disruption or delays in availability of transportation services or adverse weather conditions affecting transportation; unforeseen site surface or subsurface conditions; and catastrophic events such as fires, earthquakes, storms or explosions.





Our business plan is highly speculative and its success depends, in part, on exploration success on the permit, license and lease lands and the development of identified discoveries





Our business plan is focused primarily on the exploration for and development of oil sands deposits on our permitted, licensed and leased lands in the Provinces of Saskatchewan and Alberta.





Exploration itself is highly speculative. We are subject to all of the risks inherent in oil sands exploration and development, including identification of commercial projects, selection of optimal recovery processes for successful production, operation and revenue uncertainties, market sizes, profitability, market demand, commodity price fluctuations and the ability to raise further capital to fund activities. There can be no assurance that we will be successful in overcoming these risks.





Access to Infrastructure





Production from our lease, license, and permit lands will depend upon certain infrastructure that does not currently exist in close proximity to where we currently anticipate to locate our initial projects and such infrastructure, if put in place, may be operated by others. Such infrastructure will include, without limitation, the following: pipelines for the transportation of natural gas and certain feedstock to our site and the transportation of bitumen and other petroleum products we produce to upgrading facilities and markets for sale; and electricity transmission and distribution systems for the provision of electricity. The failure to have any of this infrastructure in place on economic terms will negatively
impact the operation of any potential commercial project and will adversely affect the ability to convert our resources into reserves.





Access to Markets





By the time we have a commercial project ready for start-up, it will likely have been preceded by other projects which began development at an earlier time and are more advanced in terms of production. As a result, preferred markets for our products may have already been taken up or upgraders or refiners may lack sufficient capacity to process our products in a timely or economic fashion.





Location of Discovery Areas





With the exception of Eagles Nest, all of Oilsands Quest’s prospective areas are located east of what has to date been considered the established bitumen resources that are exploitable by in situ production techniques in the Athabasca oil sands area.   Similar to some other bitumen accumulations within the eastern portion of Alberta, the Axe Lake, Raven Ridge and portions of the Wallace Creek areas lack a distinct overlying shale formation. The absence of this may preclude the use of certain high-pressure in situ recovery methods, but the quality of the reservoirs and high bitumen
saturations present at the Axe Lake Raven Ridge and Wallace Creek areas provide the potential for extraction using a number of recovery methods, including SAGD.  However, there can be no assurances that any such recovery method will be successful in enabling us to recover significant volumes of bitumen from our reservoirs.  See "Status and Stage of Reservoir Test Program".





Independent Reviews





Although third parties have prepared reviews, reports and projections relating to the evaluation, viability and expected performance of our resources and plans for development thereof, no assurance can be given that these reports, reviews and projections and the assumptions on which they are based will, over time, prove to be accurate.





Personnel





The design, development and construction of the reservoir test program and any subsequent pilot and commercial projects will require experienced executive and management personnel and operational employees and contractors with expertise in a wide range of areas. No assurance can be given that all of the required personnel and contractors with the necessary expertise will be available. Should other oil sands projects or expansions proceed in the same time frame as Oilsands Quest programs and projects, we will have to compete with these other projects and expansions for qualified personnel and such competition may result in increases to compensation paid to such personnel or in a lack of qualified personnel. Any
inability of Oilsands Quest to attract and retain qualified personnel may delay or interrupt the design, development and construction of, and commencement of operations at, the reservoir test program and any subsequent pilot and commercial projects. Sustained delays or interruptions could have a material adverse effect on the financial condition of Oilsands Quest.





Operational Hazards





Our exploration and development activities are subject to the customary hazards of operation in remote areas, such as fires, explosions, gaseous leaks, migration of harmful substances, blowouts and spills. A casualty occurrence might result in the loss of equipment or life, as well as injury, property damage or other liability. While we maintain limited insurance to cover current operations, our property and liability insurance may not be sufficient to cover any such casualty occurrences or disruptions. Equipment failures could result in damage to our facilities and liability to third parties against which we may not be able to fully insure or may elect not to insure because of high premium costs or for other
reasons. Our operations could be interrupted by natural disasters such as forest fires or other events beyond our control. Losses and liabilities arising from uninsured or under-insured events could have a material adverse effect on our business, our financial condition and results of our operations.





Competitive Risks





The Canadian and international petroleum industry is highly competitive in all aspects, including the exploration for, and the development of, new sources of supply, the acquisition of oil interests and the distribution and marketing of petroleum products.





The petroleum industry also competes with other industries in supplying energy, fuel and related products to consumers.  Some of these industries benefit from lighter regulation, lower taxes and subsidies.  In addition, certain of these industries are less capital intensive.





A number of competing companies are engaged in the oil sands business and are actively exploring for and delineating their resource bases. Some of our competitors have announced plans to begin production of synthetic crude oil, or to expand existing operations. If these plans are effected, they could materially increase the supply of synthetic crude oil and other competing crude oil products in the marketplace and adversely affect plans for development of our lands.





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The Loss of current management may make it difficult for us to operate





Investors must rely upon the ability, expertise, judgment, discretion, integrity and good faith of our management and directors. The Company’s success is dependent upon its management and key personnel. We do not maintain key-man insurance for any of our employees.  The unexpected loss or departure of any of our key officers and employees could be detrimental to our future success.





Fluctuations in U.S. and Canadian dollar exchange rates may have a material adverse impact





Commodity prices and costs related to the Company’s activities, if and when applicable, will generally be based on a U.S. dollar market price. Fluctuations in the U.S. and Canadian dollar exchange rate may cause a negative impact on revenue and costs and could have a material adverse impact on the Company.





THE BUSINESS OF OIL SANDS EXPLORATION IS SUBJECT TO MANY RISKS





Nature of Oil Sands Exploration and Development





Oil sands exploration and development are very competitive and involve many risks that even a combination of experience, knowledge and careful evaluation may not be able to overcome. As with any petroleum property, there can be no assurance that commercial deposits of bitumen will be produced from our permit lands in Saskatchewan and Alberta, oil sands exploration licenses in Saskatchewan, or the Eagles Nest Prospect. Furthermore, the marketability of any resource will be affected by numerous factors beyond our control. These factors include, but are not limited to, market fluctuations of prices, proximity and capacity of pipelines and processing equipment, equipment and labour availability and government
regulations (including, without limitation, regulations relating to prices, taxes, royalties, land tenure, allowable production, importing and exporting of oil and gas, land use and environmental protection). The extent of these factors cannot be accurately predicted, but the combination of these factors may result in us not receiving an adequate return on invested capital.





The viability of our business plan, business operations, and future operating results and financial condition are and will be exposed to fluctuating prices for oil, natural gas, oil products and chemicals





Prices of oil, natural gas, oil products and chemicals are affected by supply and demand, which can fluctuate significantly.  Factors that influence supply and demand include operational issues, natural disasters, weather, political instability, or conflicts, economic conditions and actions by major oil-exporting countries.  Price fluctuations can have a material effect on our ability to raise capital and fund our exploration activities, our potential future earnings, and our financial condition.  For example, in a low oil and gas price environment oil sands exploration and development may not be financially viable or profitable.  Prolonged periods of low oil and gas prices,
or rising costs, could result in our exploration projects being delayed or cancelled, as well as the impairment of certain assets.





Reserves and Resources





We have not yet established any reserves. There are numerous uncertainties inherent in estimating quantities of bitumen resources and reserves, including many factors beyond our control, and no assurance can be given that the recovery of bitumen will be realized. In general, estimates of resources and reserves are based upon a number of factors and assumptions made as of the date on which the resources and reserves estimates were determined, such as geological and engineering estimates which have inherent uncertainties, the assumed effects of regulation by governmental agencies and estimates of future commodity prices and operating costs, all of which may vary considerably from estimated results. All such
estimates are, to some degree, uncertain and classifications of resources and reserves are only attempts to define the degree of uncertainty involved. For these reasons, estimates of reserves and resources, the classification of such resources and reserves based on risk of recovery, prepared by different engineers or by the same engineers at different times, may vary substantially.





Investors are cautioned not to assume that all or any part of a resource is economically or legally extractable.





ENVIRONMENTAL AND REGULATORY COMPLIANCE MAY IMPOSE SUBSTANTIAL COSTS ON US





Our operations are or will be subject to stringent federal, provincial and local laws and regulations relating to improving or maintaining environmental quality. Environmental laws often require parties to pay for remedial action or to pay damages regardless of fault. Environmental laws also often impose liability with respect to divested or terminated operations, even if the operations were terminated or divested many years ago.





Our exploration activities and drilling programs are or will be subject to extensive laws and regulations governing prospecting, development, production, exports, taxes, labor standards, occupational health, waste disposal, land use, protection and remediation of the environment, protection of endangered and protected species, operational safety, toxic substances and other matters. Exploration and drilling is also subject to risks and liabilities associated with pollution of the environment and disposal of waste products. Compliance with these laws and regulations will impose substantial costs on us and will subject us to significant potential liabilities.  In addition, should there be changes to
existing laws or regulations, our competitive position within the oil sands industry may be adversely affected, as many industry players have greater resources than we do.





We are required to obtain various regulatory permits and approvals in order to explore and develop our properties.  The absence of a distinct overlying shale formation on portions of our leases may make it more difficult or costly to obtain regulatory approvals.  There is no assurance that regulatory approvals for exploration and development of our properties will be obtained at all or with terms and conditions acceptable to us.





Third Party Liability and Environmental Liability





The Company’s operations could result in liability for personal injuries, property damage, oil spills, discharge of hazardous materials, remediation and clean-up costs and other environmental damage. We could be liable for environmental damages caused by previous owners. As a result, substantial liabilities to third parties or governmental entities may be incurred, and the payment of such liabilities could have a material adverse effect on our financial condition and results of operations. The release of harmful substances in the environment or other environmental damages caused by our activities could result in us losing our operating and environmental permits or inhibit us from obtaining new permits or
renewing existing permits. We currently have a limited amount of insurance and, at such time as we commence additional operations, we expect to be able to obtain and maintain additional insurance coverage for our operations, including limited coverage for sudden environmental damages, but we do not believe that insurance coverage for environmental damage that occurs over time is available at a reasonable cost. Moreover, we do not believe that insurance coverage for the full potential liability that could be caused by environmental damage is available at a reasonable cost. Accordingly, we may be subject to liability or may lose substantial portions of our properties in the event of certain environmental damage. The Company could incur substantial costs to comply with environmental laws and regulations which could affect our ability to operate as planned.





Emissions Regulations





Development of our assets is expected to result in the emission of greenhouse gases ("GHGs") and other pollutants.





On April 26, 2007, the Government of Canada announced a Regulatory Framework for Air Emissions and Other Measures to Reduce Air Emissions, or the “Framework”, which outlined proposed new requirements governing the emission of GHGs and other industrial air pollutants, including sulphur oxides, volatile organic compounds, particulate matter and possibly additional sector-specific pollutants in accordance with the Notice. The Framework introduced further, but not full, detail on new GHG and industrial air pollutant limits and compliance mechanisms that will apply to various industrial sectors, including oil sands extraction, starting in 2010. The Framework proposed GHG emission-intensity reduction targets
of six percent per year from 2007 to 2010, followed by annual reductions of two percent through 2015. On March 10, 2008, the Canadian Federal Government elaborated on the Framework with the release of its "Turning the Corner" policy document. It was contemplated that new regulations would take effect January 1, 2010. Draft regulations were expected to be available for public comment in the Fall of 2008 but have not yet been released, and it is not known when they will be released or implemented.





The proposed regulatory framework provides that existing oil sands facilities in operation by 2004 will be subject to an 18% emission intensity reduction requirement commencing in 2010, with 2% additional annual reductions thereafter until 2020. Facilities commissioned between 2004 to 2011 or facilities existing prior to 2004 which between 2004 and 2011 have had a major expansion resulting in an increase of 25% or more in physical capacity or which undergo a significant change to processes will be exempt from the 2010 emissions intensity reduction target of 18% but will have to report their emissions each year.  After their third year of operation they will be required to reduce their emissions intensity
by 2% annually from a baseline emissions standard which is to be determined by reference to a sector-specific cleaner-fuel standard. For oil sands facilities, it is contemplated that there will be specific cleaner-fuel standards based on the use of natural gas for each of mining, in situ and upgrading. However, an incentive to deploy carbon capture and storage (CCS) has been included in the proposed regulatory framework. CCS is where carbon dioxide is separated from a facility’s process or exhaust gas emissions before they are emitted, transferred from the facility to a suitable storage location, and injected into deep underground geological formations and monitored to ensure they do not escape into the atmosphere. If a facility commissioned between 2004 and 2011 is built such that it is able or ready to undertake CCS, then
it will be exempt from the cleaner-fuel standard until 2018 and it will only be required to reduce its emission-intensity by 2% per year from its actual emissions. In situ oil sands projects and oil sands upgraders built after 2011 must have their GHG emissions profiles by 2018 equivalent to that of facilities employing CCS technology.





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The proposed regulatory framework further encourages widespread use of CCS by 2018 by crediting emitters that make use of CCS technology for investments in pre-certified CCS projects up to 100% of their regulatory obligations through 2017.





The proposed compliance mechanisms include an emissions credit trading system for GHGs and certain industrial air pollutants, and several options for companies to choose among to meet GHG emission intensity reduction targets and encourage the development of new emission reduction technologies, including the option of making payments into a technology fund, an emissions and offset trading system, limited credits for emission reductions created between 1992 and 2006, and international emission credits under the clean development mechanism under the Kyoto Protocol for up to 10% of each firm’s regulatory obligation.





On January 30, 2010, the Government of Canada submitted to the United Nations Framework on Climate Change a non-legally binding commitment under the Copenhagen Accord to reduce Canada’s emissions of GHGs by 17% from 2005 emission levels.  This is a significant change from previous international commitments of a 20% reduction in emissions from 2006 levels by 2020.  The Government of Canada signaled that a new proposed national emission reduction target is to be met.  It is not known whether the previously announced proposed regulatory Framework will proceed or be replaced with a new regulatory framework.  We believe that it is reasonably likely that new federal
legislation requiring emissions reductions similar to the Framework will be enacted in Canada around the same time as similar legislation is enacted in the United States.  We also believe that such federal legislation could have a material effect on the development of our assets.





On April 20, 2007, the Government of Alberta passed the Climate Change and Emissions Management Amendment Act establishing a framework for GHG emission reductions. The Specified Gas Emitters Regulation created under the Act requires facilities that emit more than 100,000 tonnes of carbon dioxide equivalent ("CO2e") annually to reduce their emission intensity starting July 1, 2007 by 12 percent from 2003-2005 levels. New facilities in operation less than eight years will be required to achieve these reductions over the fourth to eighth years of operation. These obligations may be met by in-house reductions, the purchase of certain
emission reductions or offset credits or a contribution of $15 per tonne of GHG emissions to a provincial technology fund.  We believe that the costs of complying with the Regulation could be material should our operations grow to emit more than 100,000 tonnes of CO2e annually.





On May 20, 2010, the Saskatchewan Legislature passedThe Management and Reduction of Greenhouse Gases Act but has yet to proclaim it a law.The Act sets a policy and regulatory framework for reducing GHG emissions in Saskatchewan and sets a provincial target of a 20% reduction in GHG emissions from 2006 levels by 2020.   The specific GHG emission reduction requirements, and the industries required to meet those reductions, as well as details on the methods by which reductions may be achieved, are to be set by further regulations.  It is expected that facilities which
emit 50,000 tonnes of  CO2e  per year will be required to reduce GHG emissions by 2% per year over a baseline emission level from 2010 to 2019.  New facilities constructed after 2006 that have emissions in excess of 50,000 tonnes of CO2e annually will also be required to achieve emission reduction targets.





Future legislated GHG and industrial air pollutant emission reduction requirements and emission intensity requirements, or GHG and industrial air pollutant emission reduction or intensity requirements in future regulatory approvals, may require the restriction or reduction of GHG and industrial air pollutant emissions or emissions intensity from our future operations and facilities, payments to technology funds or purchase of emission reductions or offset credits. The reductions may not be technically or economically feasible for our operations and the failure to meet such emission reduction or emission intensity reduction requirements or other compliance mechanisms may materially adversely affect our business and
result in fines, penalties and the suspension of operations. As well, equipment from suppliers which can meet future emission standards may not be available on an economic basis and other compliance methods of reducing emissions or emission intensity to levels required in the future may significantly increase our operating costs or reduce output. Emission reductions or offset credits may not be available for acquisition or may not be available on an economic basis. There is also the risk that provincial or federal governments, or both, could pass legislation which would tax such emissions.





American climate change legislation could negatively affect markets for crude and synthetic crude oil





Environmental legislation regulating carbon fuel standards in jurisdictions that import crude and synthetic crude oil in the United States could result in increased costs and/or reduced revenue.  For example, both California and the United States federal governments have passed legislation which, in some circumstances, considers the lifecycle greenhouse gas emissions of purchased fuel and which may negatively affect our business, or require the purchase of emissions credits, which may not be economically feasible.





Proposed Export Restrictions





The Government of Canada previously announced that it will review and may restrict exports from Canada of bitumen and bitumen blend products to countries with less stringent GHG emissions limits than those which apply in Canada.  Any export restrictions imposed with respect to bitumen or bitumen blend products may restrict the markets in which the Company may sell its bitumen and bitumen blend products, which may result in the Company receiving a lower price for its production, if and when applicable.





Royalty Regime





Any development of our resource assets will be directly affected by the royalty regime applicable. The economic benefit of future capital expenditures for the project is, in many cases, dependent on a satisfactory fiscal regime (royalties and taxes). The Government of Saskatchewan receives royalties on production of oil, gas and other minerals from lands in which it owns the relevant mineral rights. The Government of Saskatchewan owns the relevant mineral rights on the OQI Saskatchewan lands. The current royalty regime relating to bitumen production in Saskatchewan provides for a royalty of 1% of gross bitumen revenue and is payable until the project has recovered specified allowed costs. Once such allowed costs
are recovered, a net royalty of 20% of operating income is payable.





The Government of Alberta receives royalties on production of natural resources from lands in which it owns the mineral rights. On October 25, 2007, the Government of Alberta announced a new royalty regime. The new regime introduced new royalties for conventional oil, natural gas and bitumen that became effective January 1, 2009 and are linked to commodity prices and production levels and apply to both new and existing oil sands projects and conventional oil and gas activities.





Under the new regime, the Government of Alberta increased its royalty share from oil sands production by introducing price-sensitive formulas which are applied both before and after specified allowed costs have been recovered. The gross royalty starts at one percent of gross bitumen revenue and increased, for every dollar that world oil price, as reflected by the West Texas Intermediate (“WTI”) crude oil price, is above CDN$120 per barrel or higher. The net royalty on oil sands starts at 25 percent of net bitumen revenue and increases for every dollar the WTI crude oil price is above CDN$55 per barrel to 40 percent when the WTI crude oil price is CDN$120 per barrel or higher. Prior to the payout of
specified allowed costs, including certain exploration and development costs, operating costs and a return allowance, the gross royalty is payable. Once such allowed costs have been recovered, a royalty of the greater of: (a) the gross royalty and (b) the net royalty is payable. The Government of Alberta has announced that it intends to review and, if necessary, revise current rules and enforcement procedures with a view to clearly defining what expenditures will qualify as specified allowed costs.





There can be no assurance that the Governments of Alberta or Saskatchewan or the Government of Canada will not adopt a new fiscal regime or otherwise modify the existing fiscal regime (royalties and taxes) governing oil sands producers in a manner that could materially affect the financial prospects and results of operations of oil sands developers and producers in Alberta and Saskatchewan.





Title Risks





Aboriginal peoples have claimed aboriginal title and rights to a substantial portion of western Canada, and both First Nations and Metis peoples have commenced and could in the future commence actions claiming, among other things, aboriginal title to our Alberta and Saskatchewan lands and other lands located in the vicinity of those lands.  First Nations and Metis peoples have also stated that governments have not complied with their constitutionally mandated duty to consult with and accommodate First Nations and Metis in relation to decisions that enabled us to acquire and that are required to enable us to develop our Saskatchewan and Alberta lands, and have commenced and could in the future commence
actions asserting such claims.  Certain of these claims, if successful, could have a significant adverse effect on our ability to conduct our business, including impacting our ability to explore and develop by impacting our ability to obtain, retain or exercise rights under permits, leases, licenses and other approvals, and the terms of such approvals.





RISKS RELATING TO OUR COMMON STOCK





We have numerous outstanding options, warrants and commitments to issue shares, which may adversely affect the price of our common stock





As of July 31, 2011, we have reserved 21,073,244 shares of our common stock for issuance upon exercise of outstanding options under plans at prices as low as $0.29 per share. The Company has also reserved 1,388,567 shares of common stock to be issued on settlement of debt of a former subsidiary. Pursuant to the Reorganization Agreement with OQI Sask dated August 14, 2006, the Company is required to issue up to 65,887,603 shares of its common stock for all of the OQI Sask Exchangeable Shares (including warrants and options to acquire OQI Sask Exchangeable Shares) issued upon the closing (the “Reorganization”). As of July 31,
2011, 46,550,148 OQI Sask Exchangeable Shares have already been exchanged for shares of our common stock and up to an additional 19,337,455 OQI Sask Exchangeable Shares may be exchanged for common stock. Any sale into the public market of our common stock purchased privately at prices below the current market price could be expected to have a depressive effect on the market price of our common stock.


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Future sales of our common stock may cause our stock price to decline





Our stock price may decline due to future sales of our shares or the perception that such sales may occur.   The Board of Directors of the Company has discretion to determine the issue price and the terms of issue of shares of our common stock.  Such future issuances may be dilutive to investors.  Holders of shares of common stock have no pre-emptive rights under our articles of incorporation to participate in any future offerings of securities.





If we issue additional shares of common stock in private financings under an exemption from the registration requirements, then those shares will constitute “restricted shares” as defined in Rule 144 under the Securities Act of 1933 (the “1933 Act”). The restricted shares may only be sold if they are registered under the 1933 Act, or sold under Rule 144, or another exemption from registration under the 1933 Act.





Some of our outstanding restricted shares of common stock are either eligible for sale pursuant to Rule 144 or have been registered under the 1933 Act for resale by the holders. We are unable to estimate the amount, timing, or nature of future sales of outstanding common stock. Sales of substantial amounts of our common stock in the public market may cause the stock’s market price to decline.





Dividend Policy





The Company did not declare or pay cash or other dividends on its common stock during the past three fiscal years. Payment of dividends by the Company will depend upon the Company’s financial condition, results of operations, capital requirements and such other factors as the Board of Directors of the Company may deem relevant.





Our stock price can be extremely volatile





The trading price of our common stock has been and could continue to be subject to wide fluctuations in response to announcements of our business developments or those of our competitors, world commodity prices, periodic updates on our resource assessments, quarterly variations in operating results, and other events or factors. In addition, stock markets have experienced extreme price volatility in recent years. This volatility has had a substantial effect on the market prices of companies, at times for reasons unrelated to their operating performance. Such broad market fluctuations may adversely affect the price of our common stock.





Issuance of Preferred Stock and Our Anti-Takeover Provisions Could Delay or Prevent a Change in Control and May Adversely Affect our Common Stock





We are authorized to issue 10,000,000 shares of preferred stock which may be issued in series from time to time with such designations, rights, preferences and limitations as our Board of Directors may determine by resolution. The rights of the holders of our common stock will be subject to and may be adversely affected by the rights of the holders of any of our preferred stock that may be issued in the future. Issuance of a new series of preferred stock, or providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could make it more difficult for a third party to acquire, or discourage a third party from acquiring our outstanding shares of common stock.  Each term
for directors is three years. In addition to a staggered board, our Board of Directors adopted a stockholders rights plan in March 2006 and reserved 250,000 shares of Series A Junior Participating Preferred Stock. This stockholders rights plan could have the effect of discouraging, delaying or preventing an acquisition.




Item 2. Unregistered Sales of Equity Securities and Use of Proceeds





None.





Item 3.  Defaults Upon Senior Securities





None.





Item 4.  (Removed and Reserved)





None.





Item 5.  Other Information





On July 5, 2011, the Board accepted the resignations of Ronald Phillips and John Read effective September 6, 2011. As well, T. Murray Wilson informed the Board that he did not intend to stand for re-election at the 2011 annual general meeting of shareholders. Further, Leigh Peters, the Company’s Vice-President Legal and Corporate Secretary, left the Company on July 4, 2011.




On September 12, 2011 Oilsands Quest received notice from the staff of the NYSE Amex LLC (the “Exchange”) that, based on their review of the Company’s Form 10-K/A for the fiscal year ended April 30, 2011 and discussions and correspondence with management, the Company is not in compliance with certain of the Exchange’s continued listing standards as set forth in Part 10 of the Exchange’s Company Guide.  Specifically, the Exchange noted that the Company is not in compliance with Section 1003(a)(iv) of the Company Guide because the Company has sustained losses which are so substantial in relation to the Company’s overall operations or its existing financial resources, or
its financial condition has become so impaired that it appears questionable, in the opinion of the Exchange, as to whether the Company will be able to continue operations and/or meet its obligations as they mature.


In order to maintain listing of the Company’s common stock on the Exchange, the Company must submit a plan by October 12, 2011, addressing how the Company intends to regain compliance with Section 1003(a)(iv) by January 12, 2011.  The Company expects to submit such a plan by the October 12, 2011 deadline.  If the Exchange accepts the plan, then the Company may be able to continue its listing during the plan period, up to January 12, 2012, during which time the Company will be subject to periodic reviews to determine whether it is making progress consistent with the plan.  If the plan is accepted but the Exchange determines that the Company is not making progress consistent with
the plan or that the Company is not in compliance with all continued listing standards of the Company Guide by January 12, 2012, then the Company expects the Exchange will initiate delisting proceedings.  If the Company fails to submit a plan by October 12, 2011, or if the plan submitted is not acceptable to the Exchange, the Company expects the Exchange will initiate delisting proceedings at that time.
 
 The Company’s common stock continues to trade on the Exchange under the symbol “BQI,” however, the Exchange has advised the Company that the Exchange is utilizing the financial status indicator fields in the Consolidated Tape Association’s Consolidated Tape System and Consolidated Quote Systems High Speed Tapes to identify companies that are in noncompliance with the Exchange’s continued listing standards. Accordingly, the Company will become subject to the trading symbol extension “.BC” to denote its noncompliance.
 
 On September 14, 2011, the Company issued a press release announcing its receipt from the Exchange of notice of the Company’s failure to satisfy a continued listing standard. The full text of this press release is attached hereto as Exhibit 99.1.





Item 6.  Exhibits





31.1  Certification of CEO Pursuant to Exchange Act Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.





31.2  Certification of Vice President and Controller, Principal Accounting Officer Pursuant to Exchange Act Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.





32.1  Certification of CEO Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.





32.2  Certification of Vice President and Controller, Principal Accounting Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.













_______________




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SIGNATURES





Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized.





OILSANDS QUEST INC.Date:  September 14, 2011
By:
/s/ Garth WongGarth Wong, President and Chief Executive OfficerDate:  September 14, 2011
By:
/s/ Annie LamoureuxAnnie Lamoureux, Vice President and Controller, Principal Accounting Officer













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