UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549


FORM
10-Q





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





For the
quarterly period ended September 30, 2010





 ̈ 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:  000-50906







ETERNAL
ENERGY CORP.


(Exact
name of registrant as specified in its charter)





Nevada
                        20-0237026(State
      or other jurisdiction of incorporation or organization)
                        (I.R.S.
      Employer Identification
No.)





2549 West Main Street, Suite 202, Littleton,
      Colorado
                      80120(Address
      of principal executive offices)
                      (Zip
      Code)





(303)
      798-5235(Registrant’s
      telephone number, including area
code)




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





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





(Check
one):





Large
      accelerated filer  ̈
              Accelerated
      filer  ̈Non-accelerated
      filer  ̈
              Smaller
      reporting company x





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).


Yes  ̈ No x





Indicate
the number of shares outstanding of each of the issuer’s classes of common
equity, as of the latest practicable date:


41,005,822shares
of common stock issued and outstanding at November 22, 2010.








ETERNAL
ENERGY CORP.


FORM
10-Q


QUARTERLY
PERIOD ENDED SEPTEMBER 30, 2010





INDEX





A
      Note About Forward Looking Statements
                  
                  1PART
      I - FINANCIAL INFORMATIONItem
      1 – Condensed Consolidated Financial Statements
                  
                  2Condensed
      Consolidated Balance Sheets as of September 30, 2010 and December 31,
      2009
                  
                  F-1Condensed
      Consolidated Statements of Operations For Each of the Three-Month and
      Nine-Month Periods Ended September 30, 2010 and 2009
                  
                  F-2Condensed
      Consolidated Statements of Cash Flows For Each of the Three-Month and
      Nine-Month Periods Ended September 30, 2010 and 2009
                  
                  F-3Notes
      to the Condensed Consolidated Financial Statements
                  
                  F-5Item
      2 - Management’s Discussion and Analysis of Financial Condition and
      Results of Operations
                  
                  4Item
      4 - Controls and Procedures
                  
                  7PART
      II - OTHER INFORMATIONItem
      6 – Exhibits
                  
                  8Signatures
                  
                  11










A Note About Forward-Looking
Statements





This
Quarterly Report on Form 10-Q contains “forward-looking statements” within the
meaning of the Private Securities Litigation Reform Act of 1995 that are based
on management’s current expectations.  These statements may be identified
by their use of words like “plans,” “expect,” “aim,” “believe,” “projects,”
“anticipate,” “intend,” “estimate,” “will,” “should,” “could” and other
expressions that indicate future events and trends.  All statements that
address expectations or projections about the future, including statements about
our business strategy, expenditures, and financial results, are forward-looking
statements.  We believe that the expectations reflected in such
forward-looking statements are accurate.  However, we cannot assure you
that such expectations will occur.




Actual
results could differ materially from those in the forward looking statements due
to a number of uncertainties including, but not limited to, those discussed in
Management’s Discussion and Analysis of Financial Condition and Results of
Operations.  Factors that could cause future results to differ from these
expectations include general economic conditions; further changes in our
business direction or strategy; competitive factors; market uncertainties; and
an inability to attract, develop, or retain consulting or managerial agents or
independent contractors.  As a result, the identification and
interpretation of data and other information and their use in developing and
selecting assumptions from and among reasonable alternatives requires the
exercise of judgment.  To the extent that the assumed events do not occur,
the outcome may vary substantially from anticipated or projected results, and
accordingly, no opinion is expressed on the achievability of those
forward-looking statements.  No assurance can be given that any of the
assumptions relating to the forward-looking statements specified in the
following information are accurate, and we assume no obligation to update any
such forward-looking statements.  You should not unduly rely on these
forward-looking statements, which speak only as of the date of this Quarterly
Report.  Except as required by law, we are not obligated to release
publicly any revisions to these forward-looking statements to reflect events or
circumstances occurring after the date of this report or to reflect the
occurrence of unanticipated events.




1




PART I. FINANCIAL INFORMATION





ITEM
1. FINANCIAL STATEMENTS.


Eternal
Energy Corp.
  Condensed
Consolidated Financial Statements (Unaudited)
  As
of September 30, 2010 and December 31, 2009 and
 For
Each of the Three-Month and Nine-Month Periods Ended September 30, 2010 and
2009
  2
  Eternal
Energy Corp.
  Index
to the Condensed Consolidated Financial Statements
 (Unaudited)
 
 Condensed
      Consolidated Financial Statements of Eternal Energy Corp.:Condensed
      Consolidated Balance Sheets as of September 30, 2010 and December 31,
      2009
                                
                                F-1Condensed
      Consolidated Statements of Operations For Each of the Three-Month and
      Nine-Month Periods Ended September 30, 2010 and 2009
                                
                                F-2Condensed
      Consolidated Statements of Cash Flows For Each of the Nine-Month Periods
      Ended September 30, 2010 and 2009
                                
                                F-3Notes
      to the Condensed Consolidated Financial Statements
                                
                                F-5
  3
  Eternal
Energy Corp.
  Condensed
Consolidated Balance Sheets (Unaudited)
  
 September 30,
                                                      
                                                      
                                                      December 31,2010
                                                      
                                                      
                                                      2009ASSETSCurrent
      assets:Cash
                                                      
                                                      $
                                                      3,138,337
                                                      
                                                      
                                                      $
                                                      1,508,754Receivables
                                                      
                                                      
                                                      450,265
                                                      
                                                      
                                                      
                                                      120,927Prepaid
      expenses
                                                      
                                                      
                                                      30,028
                                                      
                                                      
                                                      
                                                      46,384Spud
      fees receivable
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      20,000Total
      current assets
                                                      
                                                      
                                                      3,618,630
                                                      
                                                      
                                                      
                                                      1,696,065Equipment
      and leasehold improvements, net of accumulated depreciation and
      amortization of $136,054 and $100,208
                                                      
                                                      
                                                      31,293
                                                      
                                                      
                                                      
                                                      49,809Oil
      and gas properties — subject to amortization
                                                      
                                                      
                                                      369,407
                                                      
                                                      
                                                      
                                                      -Oil
      and gas properties — not subject to amortization
                                                      
                                                      
                                                      425,424
                                                      
                                                      
                                                      
                                                      412,797Assets
      held for sale
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      57,000Marketable
      securities
                                                      
                                                      
                                                      925,503
                                                      
                                                      
                                                      
                                                      -Marketable
      securities - related party
                                                      
                                                      
                                                      149,964
                                                      
                                                      
                                                      
                                                      -Deposits
                                                      
                                                      
                                                      5,345
                                                      
                                                      
                                                      
                                                      5,345Total
      assets
                                                      
                                                      $
                                                      5,525,566
                                                      
                                                      
                                                      $
                                                      2,221,016LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Accounts
      payable and accrued liabilities
                                                      
                                                      $
                                                      399,182
                                                      
                                                      
                                                      $
                                                      138,664Accrued
      oil and gas interest
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      25,155Asset
      retirement obligation - current portion
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      65,258Total
      current liabilities
                                                      
                                                      
                                                      399,182
                                                      
                                                      
                                                      
                                                      229,077Asset
      retirement obligation - long term, net of discount of $36,720 as of
      December 31, 2009
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      177,697Total
      liabilities
                                                      
                                                      
                                                      399,182
                                                      
                                                      
                                                      
                                                      406,774Commitments
      and contingencies (Note 7)Stockholders'
      equity:Common
      stock, $.001 par value, 875,000,000 shares authorized, 44,550,000 issued
      as of September 30, 2010 and December 31, 2009,  and 40,711,000 and
      44,550,000 shares outstanding as of September 30, 2010 and December 31,
      2009
                                                      
                                                      
                                                      40,711
                                                      
                                                      
                                                      
                                                      44,550Additional
      paid-in capital
                                                      
                                                      
                                                      9,262,567
                                                      
                                                      
                                                      
                                                      9,524,308Accumulated
      deficit
                                                      
                                                      
                                                      (4,352,655
                                                      )
                                                      
                                                      
                                                      (7,754,616
                                                      )Other
      comprehensive income - unrealized gains on marketable
      securities
                                                      
                                                      
                                                      175,761
                                                      
                                                      
                                                      
                                                      -Total
      stockholders' equity
                                                      
                                                      
                                                      5,126,384
                                                      
                                                      
                                                      
                                                      1,814,242Total
      liabilities and stockholders' equity
                                                      
                                                      $
                                                      5,525,566
                                                      
                                                      
                                                      $
                                                      2,221,016
 
 The
accompanying notes are an integral part of the consolidated financial
statements.
  F-1
  Eternal
Energy Corp.
  Condensed
Consolidated Statements of Operations (Unaudited)
  
 FortheThree-MonthPeriod
                                                          
                                                          
                                                          FortheNine-MonthPeriodEnded September 30,
                                                          
                                                          
                                                          Ended September 30,2010
                                                          
                                                          
                                                          2009
                                                          
                                                          
                                                          2010
                                                          
                                                          
                                                          2009Oil
      and gas revenues
                                                          
                                                          $
                                                          10,842
                                                          
                                                          
                                                          $
                                                          7,524
                                                          
                                                          
                                                          $
                                                          85,327
                                                          
                                                          
                                                          $
                                                          12,057Gain
      on sale of oil and gas properties — subject to amortization, net of
      costs
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          509,934
                                                          
                                                          
                                                          
                                                          -Gain
      on sale of oil and gas properties — not subject to amortization, net of
      costs
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          4,735,253
                                                          
                                                          
                                                          
                                                          -Litigation
      settlement income
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          255,000
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          255,000Total
      revenue
                                                          
                                                          
                                                          10,842
                                                          
                                                          
                                                          
                                                          262,524
                                                          
                                                          
                                                          
                                                          5,330,514
                                                          
                                                          
                                                          
                                                          267,057Operating
      expenses:Oil
      and gas operating expenses
                                                          
                                                          
                                                          65,806
                                                          
                                                          
                                                          
                                                          8,382
                                                          
                                                          
                                                          
                                                          65,806
                                                          
                                                          
                                                          
                                                          41,716Impairment
      of oil and gas properties
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          3,393,998
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          3,393,998General
      and administrative
                                                          
                                                          
                                                          102,140
                                                          
                                                          
                                                          
                                                          128,477
                                                          
                                                          
                                                          
                                                          554,542
                                                          
                                                          
                                                          
                                                          517,522Stock
      based compensation
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          73,642
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          272,917Professional
      fees
                                                          
                                                          
                                                          88,150
                                                          
                                                          
                                                          
                                                          96,242
                                                          
                                                          
                                                          
                                                          326,576
                                                          
                                                          
                                                          
                                                          319,581Depreciation,
      amortization and depletion expense
                                                          
                                                          
                                                          12,266
                                                          
                                                          
                                                          
                                                          10,517
                                                          
                                                          
                                                          
                                                          35,846
                                                          
                                                          
                                                          
                                                          30,571Total
      operating costs
                                                          
                                                          
                                                          268,362
                                                          
                                                          
                                                          
                                                          3,711,258
                                                          
                                                          
                                                          
                                                          982,770
                                                          
                                                          
                                                          
                                                          4,576,305Total
      operating income (loss)
                                                          
                                                          
                                                          (257,520
                                                          )
                                                          
                                                          
                                                          (3,448,734
                                                          )
                                                          
                                                          
                                                          4,347,744
                                                          
                                                          
                                                          
                                                          (4,309,248
                                                          )Interest
      income
                                                          
                                                          
                                                          3,436
                                                          
                                                          
                                                          
                                                          (10,322
                                                          )
                                                          
                                                          
                                                          7,808
                                                          
                                                          
                                                          
                                                          16,692Accretion
      of discount on asset retirement obligation
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          (4,480
                                                          )
                                                          
                                                          
                                                          -Impairment
      of assets held for sale
                                                          
                                                          
                                                          (57,000
                                                          )
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          (57,000
                                                          )
                                                          
                                                          
                                                          -Income
      (loss before taxes
                                                          
                                                          
                                                          (311,084
                                                          )
                                                          
                                                          
                                                          (3,459,056
                                                          )
                                                          
                                                          
                                                          4,294,072
                                                          
                                                          
                                                          
                                                          (4,292,556
                                                          )Provision
      for income taxes
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          (892,112
                                                          )
                                                          
                                                          
                                                          -Net income
      (loss)
                                                          
                                                          $
                                                          (311,084
                                                          )
                                                          
                                                          $
                                                          (3,459,056
                                                          )
                                                          
                                                          $
                                                          3,401,960
                                                          
                                                          
                                                          $
                                                          (4,292,556
                                                          )Net
      income (loss) per common share:Basic
                                                          
                                                          $
                                                          (0.01
                                                          )
                                                          
                                                          $
                                                          (0.08
                                                          )
                                                          
                                                          $
                                                          0.08
                                                          
                                                          
                                                          $
                                                          (0.10
                                                          )Diluted
                                                          
                                                          $
                                                          (0.01
                                                          )
                                                          
                                                          $
                                                          (0.08
                                                          )
                                                          
                                                          $
                                                          0.08
                                                          
                                                          
                                                          $
                                                          (0.10
                                                          )Weighted
      average number of shares outstanding -Basic
                                                          
                                                          
                                                          41,576,076
                                                          
                                                          
                                                          
                                                          44,550,000
                                                          
                                                          
                                                          
                                                          43,217,803
                                                          
                                                          
                                                          
                                                          44,550,000Diluted
                                                          
                                                          
                                                          41,576,076
                                                          
                                                          
                                                          
                                                          44,550,000
                                                          
                                                          
                                                          
                                                          45,147,623
                                                          
                                                          
                                                          
                                                          44,550,000
 
 The
accompanying notes are an integral part of the consolidated financial
statements.
  F-2
  Eternal
Energy Corp.
  Condensed
Consolidated Statements of Cash Flows (Unaudited)
  
 For the Nine-Month PeriodEnded September 30,2010
                                                                                      
                                                                                      
                                                                                      2009Cash
      flows provided by (used in) operating activities:Net
      income (loss)
                                                                                      
                                                                                      $
                                                                                      3,401,960
                                                                                      
                                                                                      
                                                                                      $
                                                                                      (4,292,556
                                                                                      )Adjustments
      to reconcile net loss to net cash used by operating
      activities:Stock-based
      compensation
                                                                                      
                                                                                      
                                                                                      -
                                                                                      
                                                                                      
                                                                                      
                                                                                      272,917Depreciation,
      depletion and amortization
                                                                                      
                                                                                      
                                                                                      35,846
                                                                                      
                                                                                      
                                                                                      
                                                                                      30,571Accretion
      of discount on asset retirement obligation
                                                                                      
                                                                                      
                                                                                      4,480
                                                                                      
                                                                                      
                                                                                      
                                                                                      -Impairment
      of oil and gas properties
                                                                                      
                                                                                      
                                                                                      -
                                                                                      
                                                                                      
                                                                                      
                                                                                      3,391,965Gain
      on sale of oil and gas properties
                                                                                      
                                                                                      
                                                                                      (5,245,187
                                                                                      )
                                                                                      
                                                                                      
                                                                                      -Impairment
      of assets held for sale
                                                                                      
                                                                                      
                                                                                      57,000
                                                                                      
                                                                                      
                                                                                      
                                                                                      -Changes
      in operating assets and liabilities:Decrease
      in prepaid expense
                                                                                      
                                                                                      
                                                                                      16,356
                                                                                      
                                                                                      
                                                                                      
                                                                                      2,974Increase
      in other receivables
                                                                                      
                                                                                      
                                                                                      (291,838
                                                                                      )
                                                                                      
                                                                                      
                                                                                      (20,833
                                                                                      )Decrease
      in spud fees receivable
                                                                                      
                                                                                      
                                                                                      20,000
                                                                                      
                                                                                      
                                                                                      
                                                                                      730,000Increase
      in deposits
                                                                                      
                                                                                      
                                                                                      -
                                                                                      
                                                                                      
                                                                                      
                                                                                      (5,079
                                                                                      )Increase
      in accounts payable and accrued liabilities
                                                                                      
                                                                                      
                                                                                      260,518
                                                                                      
                                                                                      
                                                                                      
                                                                                      31,573Net
      cash used in operating activities
                                                                                      
                                                                                      
                                                                                      (1,740,865
                                                                                      )
                                                                                      
                                                                                      
                                                                                      141,532Cash
      flows used in investing activities:Proceeds
      from sale of oil and gas properties
                                                                                      
                                                                                      
                                                                                      4,125,000
                                                                                      
                                                                                      
                                                                                      
                                                                                      -Additions
      to oil and gas properties
                                                                                      
                                                                                      
                                                                                      (446,909
                                                                                      )
                                                                                      
                                                                                      
                                                                                      (575,791
                                                                                      )Additions
      to equipment and leasehold improvements
                                                                                      
                                                                                      
                                                                                      (17,330
                                                                                      )
                                                                                      
                                                                                      
                                                                                      (40,503
                                                                                      )Purchase
      of marketable securities - related party
                                                                                      
                                                                                      
                                                                                      (24,733
                                                                                      )
                                                                                      
                                                                                      
                                                                                      -Net
      cash used in investing activities
                                                                                      
                                                                                      
                                                                                      3,636,028
                                                                                      
                                                                                      
                                                                                      
                                                                                      (616,294
                                                                                      )Cash
      flows provided by financing activities:Repurchase
      and retirement of shares
                                                                                      
                                                                                      
                                                                                      (265,580
                                                                                      )
                                                                                      
                                                                                      
                                                                                      -Net
      cash provided by financing activities
                                                                                      
                                                                                      
                                                                                      (265,580
                                                                                      )
                                                                                      
                                                                                      
                                                                                      -Net
      increase in cash
                                                                                      
                                                                                      
                                                                                      1,629,583
                                                                                      
                                                                                      
                                                                                      
                                                                                      (474,762
                                                                                      )Cash
      - beginning of period
                                                                                      
                                                                                      
                                                                                      1,508,754
                                                                                      
                                                                                      
                                                                                      
                                                                                      727,701Cash
      - end of period
                                                                                      
                                                                                      $
                                                                                      3,138,337
                                                                                      
                                                                                      
                                                                                      $
                                                                                      252,939
 
 The
accompanying notes are an integral part of the consolidated financial
statements.
  F-3
  Eternal
Energy Corp.
  Condensed
Consolidated Statements of Cash Flows (Unaudited)
  
 For the Nine-Month PeriodEnded September 30,2010
                            
                            
                            2009Supplemental Disclosure of
      Cash Flow InformationCash
      paid during the nine-month period for:Interest
                            
                            $
                            -
                            
                            
                            $
                            -Income
      taxes
                            
                            $
                            892,112
                            
                            
                            $
                            -Non-Cash
      Investing and Financing ActivitiesMarketable
      securities acquired in sale of oil & gas properties
                            
                            $
                            874,973
                            
                            
                            $
                            -Unrealized
      gain on marketable securities
                            
                            $
                            175,761
                            
                            
                            $
                            -
 
 The
accompanying notes are an integral part of the consolidated financial
statements.
  F-4
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
  
  1.
              Description of
      Business
  Eternal
Energy Corp. (the “Company”) was incorporated in the state of Nevada in March
2003. The Company engages in the acquisition, exploration, development and
producing of oil and gas properties. At September 30, 2010, the Company has
entered into participation agreements related to oil and gas exploration
projects in the Pebble Beach and Spyglass Prospects, located in Divide County,
North Dakota, and Sheridan County, Montana and the Hardy Property, located in
southeastern Saskatchewan, Canada.  In addition, the Company owns
certain overriding royalty interests in oil and gas leases located in San Juan
County, Utah and San Miguel County, Colorado.
  2.
              Summary of Significant
      Accounting Policies
  Basis
of Presentation
  These
condensed consolidated financial statements are presented in United States
dollars and have been prepared in accordance with accounting principles
generally accepted in the United States for interim financial information and
with the instructions to Securities and Exchange Commission (“SEC”) Form 10-Q
and Article 8 of SEC Regulation S-X. The principles for interim financial
information do not require the inclusion of all the information and footnotes
required by generally accepted accounting principles for complete financial
statements. Therefore, these financial statements should be read in conjunction
with the Company’s Annual Report on Form 10-K for the year ended December 31,
2009. The condensed consolidated financial statements included herein are
unaudited; however, in the opinion of management, they contain all normal
recurring adjustments necessary for a fair statement of the results for the
interim periods. Operating results for the three-month and nine-month periods
ended September 30, 2010 are not necessarily indicative of the results that may
be expected for the year ending December 31, 2010.
  The
accompanying condensed consolidated financial statements include the accounts of
the Company and its wholly-owned Canadian subsidiary, EERG ULC, after
elimination of all material intercompany accounts, transactions, and
profits.  EERG ULC is used to operate the Hardy property.
  Revenue
Recognition
  The
Company records the sale of its interests in prospects as a reduction to the
cost pool when the terms of the transaction are final and the sales price is
determinable. Spud fee revenue is recognized when drilling
commences.  Working interest, royalty and net profit interests are
recognized as revenue when oil and gas is sold.
  F-5
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
  
  Concentration
of Credit Risk
  At
September 30, 2010, the Company had $2,854,657 on deposit that exceeded the
United States (FDIC) federally insurance limit of $250,000 per
bank.  $133,786 of these funds are insured by the
SIPC.  Funds held in Canadian accounts did not exceed the Canada
(CDIC) insured limit of $100,000 CAD per bank.  The Company believes
this credit risk is mitigated by the financial strength of the financial
institutions with which the Company has placed its funds on
deposit.
  Foreign
Currency Adjustments
  The
Company’s functional currency for all operations worldwide is the U.S. dollar.
Nonmonetary assets and liabilities are translated at historical rates and
monetary assets and liabilities are translated at exchange rates in effect at
the end of the year. Income statement accounts are translated at average rates
for the year. Gains and losses from translation of foreign currency financial
statements into U.S. dollars are included in current results of operations.
Gains and losses resulting from foreign currency transactions are also included
in current results of operations.
  Components of
Other Comprehensive Income
  Comprehensive
income consists of net income and other gains and losses affecting shareholders’
equity that, under generally accepted accounting principles, are excluded from
net income. For the Company, such items consisted solely of unrealized gains and
losses on marketable equity investments. The changes in other comprehensive
income for the three- and nine-month periods ended September 30, 2010 are
$171,142 and $175,761, respectively. There were no other components of other
comprehensive income in 2009.
  Receivables
  Receivables
are stated at the amount the Company expects to collect. The Company considers
the following factors when evaluating the collectability of specific receivable
balances: credit-worthiness of the debtor, past transaction history with the
debtor, current economic industry trends, and changes in debtor payment terms.
If the financial condition of the Company’s debtors were to deteriorate,
adversely affecting their ability to make payments, additional allowances would
be required.
  The
Company maintains an estimated allowance for doubtful accounts for estimated
losses resulting from the inability of its customers to make required payments.
Changes to the allowance for doubtful accounts made as a result of management’s
determination regarding the ultimate collectability of such accounts are
recognized as a charge to the Company’s earnings.  Specific receivable
balances that remain outstanding after the Company has used reasonable
collection efforts are written off through a charge to the valuation allowance
and a credit to receivable.
  At
September 30, 2010, the Company has determined that all receivable balances are
fully collectible and, accordingly, no allowance for doubtful accounts has been
recorded.
  F-6
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
  
  Equipment
and Leasehold Improvements
  Equipment
and leasehold improvements are recorded at cost. Expenditures for major
additions and improvements are capitalized and depreciated (or amortized) over
the estimated useful lives of the related assets using the straight line method
for financial reporting purposes. The Company uses other depreciation or
amortization methods (generally accelerated) for tax purposes, where
appropriate. The estimated useful lives for significant property and equipment
categories are as follows:
  Equipment
                    3
      yearsLeasehold
      improvements
                    lesser
      of useful life or lease
term
  When
equipment and improvements are retired or otherwise disposed of, the cost and
the related accumulated depreciation or amortization are removed from the
Company's accounts and any resulting gain or loss is included in the results of
operations for the respective period.  Expenditures for minor
replacements, maintenance and repairs are expensed as incurred.
  Oil
and Gas Properties
  The
Company follows the full-cost method of accounting for its investments in oil
and gas properties. Under the full-cost method, all costs associated with the
exploration of properties are capitalized into appropriate cost centers within
the full-cost pool.  Internal costs that are capitalized are limited
to those costs that can be directly identified with acquisition, exploration,
and development activities undertaken and do not include any costs related to
production, general corporate overhead, or similar activities.  Cost
centers are established on a country-by-country basis.
  Capitalized
costs within the cost centers are amortized on the unit-of-production basis
using proved oil and gas reserves.  The cost of investments in
unproved properties and major development projects are excluded from capitalized
costs to be amortized until it is determined whether or not proved reserves can
be assigned to the properties.  Until such a determination is made,
the properties are assessed annually to ascertain whether impairment has
occurred.  The costs of drilling exploratory dry holes are included in
the amortization base immediately upon determination that the well is
dry.
  F-7
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
  
 As of the
end of each reporting period, the capitalized costs of each cost center are
subject to a ceiling test, in which the costs shall not exceed the cost center
ceiling.  The cost center ceiling is equal to i) the present value of
estimated future net revenues computed by applying current prices of oil and gas
reserves (with consideration of price changes only to the extent provided by
contractual arrangements) to estimated future production of proved oil and gas
reserves as of the date of the latest balance sheet presented, less estimated
future expenditures (based on current costs) to be incurred in developing and
producing the proved reserves computed using a discount factor of ten percent
and assuming continuation of existing economic conditions; plus ii) the cost of
properties not being amortized; plus iii) the lower of cost or estimated fair
value of unproven properties included in the costs being amortized; less iv)
income tax effects related to differences between the book and tax basis of the
properties.  If unamortized costs capitalized within a cost center,
less related deferred income taxes, exceed the cost center ceiling, the excess
is charged to expense and separately disclosed during the period in which the
excess occurs.
  Asset
Retirement Obligations
  The
Company records asset retirement obligations in the period in which the
obligation is incurred and when a reasonable estimate of fair value can be
determined. The initial recording of an asset retirement obligation results in
an increase in the carrying amount of the related long-lived asset and the
creation of a liability.  The portion of the asset retirement
obligation expected to be realized during the next 12 month period is classified
as a current liability, while the portion of the asset retirement obligation
expected to be realized during subsequent periods is discounted and recorded at
its net present value.  The discount factor used to determine the net
present value of the Company’s asset retirement obligation is 10%, which is
consistent with the discount factor that is applied to oil and gas reserves when
performing the periodic ceiling tests.
  Changes
in the noncurrent portion of the asset retirement obligation due to the passage
of time are measured by applying an interest method of allocation. The amount of
change is recognized as an increase in the liability and an accretion expense in
the statement of operations. Changes in either the current or noncurrent portion
of the Company’s asset retirement obligation resulting from revisions to the
timing or the amount of the original estimate of undiscounted cash flows are
recognized as an increase or a decrease to the carrying amount of the liability
and the related long-lived asset.  Changes in the current and
noncurrent portion of the asset retirement obligation due to the disposal of
related long-lived assets are included in the calculation of the gain or loss on
the sale of the assets.
  F-8
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
  
 Stock
Repurchase Program
  The
Company has implemented a stock repurchase program and utilizes the cost method
to account for shares reacquired under the program.  Under the cost
method, common stock is reduced by the par value of the shares
repurchased.  The difference between the total consideration given to
reacquire the shares, including any broker commissions or other transaction
costs, is recorded as a reduction of additional paid in capital.  The
Company immediately retires all repurchased shares. As of November 1, 2010 the
Company ceased open market purchases of common stock.
  Fair
Value of Financial Instruments
  Fair
value is defined as the exchange price that would be received for an asset or
paid to transfer a liability (an exit price) in the principal or most
advantageous market for the asset or liability in an orderly transaction between
market participants on the measurement date. Valuation techniques used to
measure fair value must maximize the use of observable inputs and minimize the
use of unobservable inputs.
  The
Company utilizes the market approach to measure fair value for our financial
assets and liabilities. The market approach uses prices and other relevant
information generated by market transactions involving identical or comparable
assets or liabilities. The standard describes a fair value hierarchy based on
three levels of inputs, of which the first two are considered observable and the
last unobservable, that may be used to measure fair value which are the
following:
  Level
1:  Quoted prices (unadjusted) in active markets that are accessible
at the measurement date for assets or liabilities. The fair value hierarchy
gives the highest priority to Level 1 inputs.
  Level
2:  Observable prices that are based on inputs not quoted on active
markets, but corroborated by market data.
  Level
3:  Unobservable inputs are used when little or no market data is
available. The fair value hierarchy gives the lowest priority to Level 3
inputs.
  In
determining fair value, the Company utilizes valuation techniques that maximize
the use of observable inputs and minimize the use of unobservable inputs to the
extent possible as well as the consideration of counterparty credit risk in its
assessment of fair value.
  The
adoption of this statement did not have a material impact on our results of
operations and financial condition. The carrying values of our cash, cash
equivalents and marketable securities, carried at fair value as of September 30,
2010, are classified in the table below in one of the three categories described
above:
  F-9
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
  
 Fair
Value Measurements at September 30, 2010:
  Level1
                      
                      
                      Level2
                      
                      
                      Level3
                      
                      
                      TotalCash
      & equivalents
                      
                      $
                      3,138,337
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      $
                      3,138,337Marketable
      securities
                      
                      
                      1,075,467
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      1,075,467$
                      4,213,804
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      $
                      4,213,804
  Accounting
for Share-Based Compensation
  The
Company measures compensation cost for all stock based awards at fair value on
the date of grant and recognizes compensation expense in its statements of
operations over the service period that the awards are expected to vest. The
Company has elected to recognize compensation cost for all options with graded
vesting on a straight line basis over the vesting period of the entire
option.
  Basic
and Diluted Earnings (Loss) Per Share
  Basic
earnings (loss) per common share is computed by dividing net loss available to
common shareholders by the weighted average number of common shares outstanding
during the period. Diluted earnings (loss) per common share is computed in the
same way as basic earnings (loss) per common share except that the denominator
is increased to include the number of additional common shares that would be
outstanding if all potential common shares had been issued and if the additional
common shares were dilutive. Diluted loss per common share for the three-month
and nine-month periods ended September 30, 2009 is computed in the same way as
basic loss per common share, as the inclusion of additional common shares that
would be outstanding if all potential common shares had been issued would be
anti-dilutive.  See Note 8 for the calculation of basic and diluted
weighted average common shares outstanding for the three-month and nine-month
periods ended September 30, 2010 and 2009.
  Income
Taxes
  The
Company follows the liability method of accounting for income taxes. Under this
method, deferred income tax assets and liabilities are recognized for the future
tax benefits and consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax balances. Deferred income tax assets and liabilities are measured
using enacted or substantially enacted tax rates expected to apply to the
taxable income in the years in which those differences are expected to be
recovered or settled. The effect on deferred income tax assets and liabilities
of a change in tax rates is recognized in income in the period that includes the
date of enactment or substantive enactment.
  F-10
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
  
 Use
of Estimates and Assumptions
  The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires the use of estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses and disclosure of contingent obligations in the financial
statements and accompanying notes. The Company’s most significant assumptions
are the estimates used in the determination of the deferred income tax asset
valuation allowance and the allocation of proceeds received from the disposition
of certain oil and gas prospects to the remaining prospects included in the
Company’s full-cost pool.  The estimation process requires assumptions
to be made about future events and conditions, and as such, is inherently
subjective and uncertain. Actual results could differ materially from these
estimates.
  New
Accounting Pronouncements
  In June
2009, the FASB established the FASB Accounting Standards Codification (the
“Codification” or “ASC”) as the official single source of authoritative U.S.
generally accepted accounting principles (“GAAP”). All guidance contained in the
Codification carries an equal level of authority.  The Codification
also includes all relevant SEC guidance organized using the same topical
structure in separate sections within the Codification.  The
Codification is not intended to change GAAP, but it will change the way GAAP is
organized and presented.  Except for the disclosure requirements, the
adoption of this statement did not have an impact on the determination or
reporting of the Company’s financial statements.  The Company is
providing the Codification cross-reference alongside the references to the
standards issued and adopted prior to the adoption of the
Codification.
  In
January 2010, the FASB issued Accounting Standards Update 2010-06, Improving
Disclosures about Fair Value Measurements (“FASB 2010-06”), which amends ASC
820-10 and requires, among other things, new disclosures regarding the transfers
in and out of hierarchy levels 1 and 2 as well as the gross presentation of
changes in estimated measurements for level 3 measurements.  In
addition, FASB 2010-06 provides clarifying direction with respect to disclosures
regarding the various levels of disaggregation and about specific inputs and
valuation techniques.  FASB 2010-06 is effective for interim and
annual reporting periods beginning after December 31, 2009, except for the gross
presentation of level 3 measurement activities, which is effective for fiscal
years beginning after December 15, 2010.  The adoption of FASB 2010-06
is not expected to have a material effect on the Company’s financial
statements.
  ASC
808-10 requires certain income statement presentation of transactions with third
parties and of payments between parties to the collaborative arrangement, along
with disclosure about the nature and purpose of the arrangement.  ASC
808-10 is effective for the Company’s year beginning January 1,
2009.  The adoption of ASC 808-10 has not had a material impact on the
Company’s financial statements.
  F-11
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
  
 ASC 805
requires an acquiring company to recognize the assets acquired, the liabilities
assumed, and any non-controlling interest in the acquired entity at the
acquisition date, measured at their fair values as of that date, with limited
exceptions.  ASC 805 also requires the acquiring company in a business
combination achieved in stages to recognize the identifiable assets and
liabilities, as well as the non-controlling interest in the acquired company, at
the full amounts of their fair values.  ASC 805 makes various other
amendments to authoritative literature intended to provide additional guidance
or to confirm the guidance in that literature to that provided in this
Statement.  ASC 805 is effective for the Company’s financial
statements beginning January 1, 2009.  The adoption of ASC 805 has not
had a material impact on the Company’s financial statements.
  ASC
810-10-65 establishes accounting and reporting standards that require the
ownership interests in subsidiaries not held by the parent to be clearly
identified, labeled and presented in the consolidated statement of financial
position within equity, but separate from the parent's equity.  This
statement also requires the amount of consolidated net income attributable to
the parent and to the non-controlling interest to be clearly identified and
presented on the face of the consolidated statement of
income.  Changes in a parent's ownership interest while the parent
retains its controlling financial interest must be accounted for consistently,
and when a subsidiary is deconsolidated, any retained non-controlling equity
investment in the former subsidiary must be initially measured at fair
value.  The gain or loss on the deconsolidation of the subsidiary is
measured using the fair value of any non-controlling equity
investment.  The Statement also requires entities to provide
sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the non-controlling owners. This
Statement applies prospectively to all entities that prepare consolidated
financial statements and applies prospectively for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15, 2008
(January 1, 2009 for the Company).  The adoption of ASC 810-10-65 has
not had a material impact on the Company’s financial statements.
  Under ASC
855-10, as under previous practice, an entity must record the effects of
subsequent events that provide evidence about conditions that existed at the
balance sheet date and must disclose but not record the effects of subsequent
events which provide evidence about conditions that did not exist at the balance
sheet date. This standard added an additional required disclosure relative to
the date through which subsequent events have been evaluated and whether that is
the date on which the financial statements were issued. As it relates to the
Company, this standard was effective beginning April 1, 2009. The additional
disclosures required by this standard are included in Note 10.
  F-12
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
  
 In
February 2010, the FASB issued Accounting Standards Update 2010-09, Amendments
to Certain Recognition and Disclosure Requirements, which amended ASC 855 and
which requires issuers of financial statements to evaluate subsequent events
through the date on which the financial statements are issued.  FASB
2010-09 defines the term “SEC Filer” and eliminates the requirement that an SEC
filer disclose the date through which subsequent events have been
evaluated.  This change was made to alleviate potential conflicts
between ASC 855-10 and the reporting requirements of the SEC.  FASB
2010-09 is effective immediately, but is not expected to have a material effect
on the Company’s financial statements.
  In
January 2010, the FASB issued Accounting Standards Update 2010-03, Oil and Gas
Reserve Estimation and Disclosures (“FASB 2010-03”), which amended Extractive
Activities – Oil and Gas (Topic 932).  Among other things, FASB
2010-03 expands the definition of oil and gas producing activities and requires
companies to use a twelve-month average price, rather than a year-end price,
when estimating whether reserve quantities are economical to
produce.    In addition, FASB 2010-03 requires separate
reserve disclosures for geographical areas that contain more than fifteen
percent of an entity's total reserves and provides guidance with respect to the
applicability of reporting requirements for equity investments in oil and gas
producing entities.  FASB 2010-03 is effective for annual reporting
periods ending on or after December 31, 2009.  The adoption of FASB
2010-03 is not expected to have a material effect on the Company’s financial
statements.
  In April
2010, the FASB issued Accounting Standards Update 2010-14, Amendments to
Paragraph 932-10-S99-1 (FASB 2010-14), which amended AASC 805 requires an
acquiring company to recognize the assets acquired, the liabilities assumed, and
any non-controlling interest in the acquired entity at the acquisition date,
measured at their fair values as of that date, with limited
exceptions.  ASC 805 also requires the acquiring company in a business
combination achieved in stages to recognize the identifiable assets and
liabilities, as well as the non-controlling interest in the acquired company, at
the full amounts of their fair values.  ASC 805 makes various other
amendments to authoritative literature intended to provide additional guidance
or to confirm the guidance in that literature to that provided in this
Statement.  ASC 805 is effective for the Company’s financial
statements beginning January 1, 2009.  The adoption of ASC 805 has not
had a material impact on the Company’s financial statements.
  F-13
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
  ASC
810-10-65 establishes accounting and reporting standards that require the
ownership interests in subsidiaries not held by the parent to be clearly
identified, labeled and presented in the consolidated statement of financial
position within equity, but separate from the parent's equity.  This
statement also requires the amount of consolidated net income attributable to
the parent and to the non-controlling interest to be clearly identified and
presented on the face of the consolidated statement of income.  Changes in
a parent's ownership interest while the parent retains its controlling financial
interest must be accounted for consistently, and when a subsidiary is
deconsolidated, any retained non-controlling equity investment in the former
subsidiary must be initially measured at fair value.  The gain or loss on
the deconsolidation of the subsidiary is measured using the fair value of any
non-controlling equity investment.  The Statement also requires entities to
provide sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the non-controlling owners. This
Statement applies prospectively to all entities that prepare consolidated
financial statements and applies prospectively for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15, 2008
(January 1, 2009 for the Company).  The adoption of ASC 810-10-65 has not
had a material impact on the Company’s financial statements.
  Under ASC
855-10, as under previous practice, an entity must record the effects of
subsequent events that provide evidence about conditions that existed at the
balance sheet date and must disclose but not record the effects of subsequent
events which provide evidence about conditions that did not exist at the balance
sheet date. This standard added an additional required disclosure relative to
the date through which subsequent events have been evaluated and whether that is
the date on which the financial statements were issued. As it relates to the
Company, this standard was effective beginning April 1, 2009. The additional
disclosures required by this standard are included in Note 10.
  In
February 2010, the FASB issued Accounting Standards Update 2010-09, Amendments
to Certain Recognition and Disclosure Requirements, which amended ASC 855 and
which requires issuers of financial statements to evaluate subsequent events
through the date on which the financial statements are issued.  FASB
2010-09 defines the term “SEC Filer” and eliminates the requirement that an SEC
filer disclose the date through which subsequent events have been
evaluated.  This change was made to alleviate potential conflicts between
ASC 855-10 and the reporting requirements of the SEC.  FASB 2010-09 is
effective immediately, but is not expected to have a material effect on the
Company’s financial statements.
  F-14
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
  In
January 2010, the FASB issued Accounting Standards Update 2010-03, Oil and Gas
Reserve Estimation and Disclosures (“FASB 2010-03”), which amended Extractive
Activities – Oil and Gas (Topic 932).  Among other things, FASB 2010-03
expands the definition of oil and gas producing activities and requires
companies to use a twelve-month average price, rather than a year-end price,
when estimating whether reserve quantities are economical to produce. 
  In addition, FASB 2010-03 requires separate reserve disclosures for
geographical areas that contain more than fifteen percent of an entity's total
reserves and provides guidance with respect to the applicability of reporting
requirements for equity investments in oil and gas producing entities. 
FASB 2010-03 is effective for annual reporting periods ending on or after
December 31, 2009.  The adoption of FASB 2010-03 is not expected to have a
material effect on the Company’s financial statements.
  In April
2010, the FASB issued Accounting Standards Update 2010-14, Amendments to
Paragraph 932-10-S99-1 (FASB 2010-14), which amended ASC 932.  FASB 2010-14
revises the definitions of certain definitions contained in SEC Regulation
S-X.  FASB 2010-14 is effective for annual reporting periods beginning
after December 15, 2009.  The adoption of FASB 2010-14 is not expected to
have a material effect on the Company’s financial statements.SC 932.  FASB
2010-14 revises the definitions of certain definitions contained in SEC
Regulation S-X.  FASB 2010-14 is effective for annual reporting periods
beginning after December 15, 2009.  The adoption of FASB 2010-14 is not
expected to have a material effect on the Company’s financial
statements.
  3.
              Marketable
      Securities
  The
Company determines the appropriate classification of its investments in equity
securities at the time of purchase and reevaluates such determinations at each
balance-sheet date. Marketable equity securities not classified as
held-to-maturity or as trading are classified as available-for-sale, and are
carried at fair market value, with the unrealized gains and losses, net of tax,
included in the determination of comprehensive income and reported in
shareholders’ equity.
  The fair
value of substantially all securities is determined by quoted market prices. The
estimated fair value of securities for which there are no quoted market prices
is based on similar types of securities that are traded in the market. Warrants
to purchase common stock are calculated using the Black Scholes Option Pricing
Model.
  F-15
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
  Available-for-sale
marketable securities at September 30, 2010 consist of the
following:
  Gains in
                      
                      
                      Losses inAccumulated
                      
                      
                      AccumulatedEstimated
                      
                      
                      Other
                      
                      
                      OtherFair
                      
                      
                      Comprehensive
                      
                      
                      ComprehensiveValue
                      
                      
                      Income
                      
                      
                      IncomeNoncurrent
      assets:Common
      stock
                      
                      $
                      925,503
                      
                      
                      $
                      50,530
                      
                      
                      $
                      -Common
      stock and warrants - related party
                      
                      
                      149,964
                      
                      
                      
                      125,231
                      
                      
                      
                      -Total
      available-for-sale marketable securities
                      
                      $
                      1,075,467
                      
                      
                      $
                      175,761
                      
                      
                      $
                      -
  There
were no sales of marketable securities for the three-month or nine-month periods
ended September 30, 2010.
  4.
              Equipment and
      Leasehold Improvements
  The
following is a summary of equipment and improvements, at cost, as of September
30, 2010:
  Office
      equipment
                    
                    $
                    119,838Leasehold
      improvements
                    
                    
                    47,509Total
      equipment and improvements
                    
                    
                    167,347Less:
      accumulated depreciation and amortization
                    
                    
                    (136,054
                    )Equipment
      and improvements, net
                    
                    $
                    31,293
  Depreciation
and amortization expense for the three and nine-month periods ended September
30, 2010 and 2009 was $7,786, $35,846, $10,516 and $30,570,
respectively.
  The
Company purchased $19,000 of down-hole tools during 2009 and $38,000 of
down-hole tools during 2008.  Because the Company no longer possesses
exclusive rights to utilize the down-hole gas and water separation technology,
the Company has no plans to utilize the tools in the near future.  During
the three-month period ended September 30, 2010, the Company’s management ceased
actively marketing the tools to other exploration and development
companies.  Accordingly, the down-hole tools which were classified as
assets held for sale have been fully impaired as of September 30, 2010 and a
non-operational impairment loss was recorded during the three-month period
ending September 30, 2010.
  F-16
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
  5.
              Oil and Gas
      Properties
  As of
September 30, 2010 and December 31, 2009, the Company’s cost centers are as
follows:
  September30,2010
                    
                    
                    December31,2009Amortizable
                    
                    
                    Non-Amortizable
                    
                    
                    Amortizable
                    
                    
                    Non-AmortizableUnited
      States
                    
                    $
                    -
                    
                    
                    $
                    425,424
                    
                    
                    $
                    -
                    
                    
                    $
                    411,751Canada
                    
                    
                    369,407
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1,046Total
                    
                    $
                    369,407
                    
                    
                    $
                    425,424
                    
                    
                    $
                    -
                    
                    
                    $
                    412,797
  Producing
Properties
  Through
various transactions that occurred during 2007, the Company acquired a 75%
working interest in the South West Extension of the West Ranch Field (the “South
West Extension”), located in Jackson County, Texas.  In August 2009,
certain leases included in the West Ranch Field expired and, as a result, the
reserves associated with these leases contained in the Glasscock Reservoir are
no longer available to the Company.  These leases were pivotal to the
implementation of a waterflood program designed to stimulate production
throughout the South West Extension.  Because there was no reasonable
certainty that the Company would seek to extract the underlying reserves
associated with the remaining West Ranch leases, the economic value of these
reserves could not be used to evaluate the recoverability of the Company’s
investment in the West Ranch property.  Accordingly, the Company fully
impaired its full-cost pool, subject to amortization in August
2009.
  Because
the wells were shut-in, the Company recognized no depletion expense related to
the West Ranch property for the three-month and nine-month periods ended
September 30, 2010 and 2009.
  In June
2010, the Company sold its interest in the West Ranch property for $262,500 in
cash and the assumption, by the purchaser, of all plugging, abandonment and
environmental reclamation liabilities.  Because the Company had fully
impaired its investment in the West Ranch Field, and because the West Ranch
Field represented the only property in the US cost center of the full-cost pool,
subject to amortization, the Company recognized a gain on the transaction of
$509,934.
  F-17
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
  Exploratory
Prospects
  The
Company has entered into participation agreements in a number of exploratory oil
and gas properties. Unproven exploratory prospects are excluded from its
respective amortizable cost pool.  Each prospect’s costs are transferred
into the amortization base on an ongoing (well-by-well or property-by-property)
basis as the prospect is evaluated and proved reserves are established or
impairment is determined. Three exploratory prospects have been abandoned as of
September 30, 2010. The Company has a working interest and/or overriding royalty
interest in the wells on the remaining prospects, if they are successful. The
Company paid certain amounts upon execution of the agreements and is obligated
to share in the drilling costs of the exploratory wells. In addition, the
Company has agreed to issue shares of its common stock based upon the proven
reserves of the property.
  United
States
  Steamroller
Prospect
  The
Company currently owns various overriding royalty interests under approximately
20,172 net acres in Utah and Colorado, located within the Steamroller
Prospect.  In addition, the Company is entitled to receive an overriding
royalty interest on any additional leasehold interest acquired by its working
interest partners in an area of mutual interest (“AMI”) between the
parties.  The AMI covers approximately 3,571,200 gross acres.
  Pebble
Beach Prospect
  In 2006,
the Company entered into a series of agreements that resulted in the acquisition
of five percent of the capital stock of Pebble Petroleum, Inc. (“Pebble”), as
well as the following rights and interest in the Pebble Beach
Prospect:
  ·
              A
      $250,000 spud fee for each of the first eight wells drilled by
      Pebble;
  ·
              A
      five percent (5%) gross overriding royalty from each well drilled on
      certain acreage that Pebble holds rights to in SE Saskatchewan, Canada (no
      capital outlay or other expenses to be required by the Company);
      and
  ·
              A
      ten percent (10%) working interest in a joint venture with Rover
      Resources, Inc., (“Rover”), a subsidiary of Pebble; the joint venture will
      explore and develop certain prospects principally located in Divide
      County, North Dakota (the Company will pay 10% of all costs
      incurred).
  F-18
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
  The last
of the eight exploratory wells drilled by Pebble was completed in August
2008.  As of December 31, 2009, the Company had received all but $20,000 of
the spud fees related to the initial eight exploratory wells.  The
remaining $20,000 of spud fees was collected in March 2010.
  In April
2010, the Company sold its working interest in approximately 700 net acres
located within the Pebble Beach Prospect to Rover Resources for cash
consideration totaling $1 million.  Pursuant to full-cost accounting
guidelines, the Company allocated a portion of the gross gain from the sale
($277,355) to the remaining property in the US cost center of the full-cost
pool, not subject to amortization, based on the relative fair market values of
the properties at the time of the sale, and recognized a net gain on the sale of
$722,645.
  As of
September 30, 2010, the Company still owns a 10% working interest in
approximately 2,700 net acres located within the Pebble Peach Prospect. 
Management is currently in the process of developing its exploration strategy
relative to the remaining acreage within the Pebble Beach Prospect. 
Exploratory drilling on the Pebble Beach Prospect commenced during the fourth
quarter of 2010.  The Company has elected to participate in the drilling of
one well and has the option to participate in four other wells.  The
Company's interest in these wells would range from 0.0625% to 1.25%
  Spyglass
Prospect
  In June
2010, the Company sold 50% of its working interest in the Hardy Prospect to
American Eagle Energy Inc. in exchange for a 50% working interest in
approximately 6,851 net acres located within Divide County, North Dakota (the
“Spyglass Prospect”).  The Company reclassified 50% of the carrying value
of its investment in the Hardy Prospect ($126,029) to the Spyglass Prospect at
the time of the sale.  Because no proven reserves have been identified, the
Spyglass Prospect has been assigned to the full-cost pool that is not subject to
amortization as of September 30, 2010.  Management is currently in the
process of developing its exploration strategy relative to the Spyglass
Prospect.  The Company is evaluating the results of nearby wells drilled by
other companies in order to make a determination on the future of
Spyglass.
  Impairment
Reviews
  All of
the Company’s oil and gas properties are evaluated for impairment on a quarterly
basis.  There were no impairments evident at September 30,
2010.
  F-19
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
  Canada
  In June
2008, the Company acquired a five percent working interest in an additional
prospect located in Saskatchewan, Canada for $1,046.  The Company fully
impaired its investment in the Canada Prospect in June 2010 citing a lack of
proven reserves and no definitive exploration plans relative to the Canadian
Prospect.  The impairment was netted against the aforementioned gains from
the sale of oil and gas properties, not subject to amortization.
  Hardy
Property
  In April
2010, the Company sold certain gross overriding royalty interests in property
located in southeastern Saskatchewan to Ryland Oil Corporation (“Ryland”). 
Proceeds from the sale of the gross overriding royalty interest included cash
consideration of $2.9 million, 2,145,883 shares of Ryland’s common stock, valued
at $874,973 and an assignment of Ryland’s 100% working interest in approximately
4,480 net acres located in Saskatchewan (the “Hardy Property”), which included
related equipment valued at approximately $238,681.  Because the gross
overriding royalty interests sold represented the only property in the Canadian
cost center of the full-cost pool, not subject to amortization, the Company
recognized a gain on the full value of the sales proceeds received, totaling
$4,013,654.
  The Hardy
Property contained one existing oil well that was shut-in as of June 30, 2010
due to mechanical issues.  During the three-month period ended September
30, 2010, the Company commenced a workover operation to restore the Hardy well
to production.  The well was returned to commercial production in September
2010.  The well has produced an average of approximately 40 barrels of
oil and 200 barrels of water per day since returning to production.  The
Company has commissioned to have a reserve report performed, at which time the
Company will begin depleting the cost pool.
  6.
              Asset Retirement
      Obligation
  As of
December 31, 2009, the Company had recorded an aggregate asset retirement
obligation associated with its investment in the West Ranch Field in the amount
in the amount of $242,955.  The asset retirement obligation represented
estimated discounted future plugging and abandonment costs associated with each
of the thirty wells located within the Southwest Extension of the West Ranch
Field.  The estimated liability was based on the assumption that the wells
would have to be plugged and abandoned over a three-year period.
  The
following table summarized the estimated plugging liability by year in which, in
the absence of production, the respective wells were projected to be plugged and
abandoned:
  F-20
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
  Amount2010
                    
                    $
                    65,2582011
                    
                    
                    93,2252012
                    
                    
                    121,193Gross
      amount of liability
                    
                    
                    279,676Discount
      factor
                    
                    
                    (32,241
                    )Net
      present value of asset retirement obligation
                    
                    $
                    247,435
  As
discussed in Note 5, the Company sold its interest in the West Ranch Field in
June 2010.  Pursuant to the terms of the sale agreement, the purchaser
assumed all future plugging liabilities associated with the West Ranch
wells.  Accordingly, the Company has removed its asset retirement
obligation from its books and considered the extinguishment of this debt in
calculating the gross gain realized on the sale.  As of September 30, 2010,
the Company has not recorded any asset retirement obligations related to its
newly acquired Hardy Property nor its unproven prospects.
  7.
              Commitments and
      Contingencies
  Drilling
Obligations
  The
Company has an option to fund its share of future exploratory drilling costs
related to its 10% working interest in the Pebble Beach Prospect should any
exploratory wells be proposed by the other working interest owner.
  Employment
Agreements
  In August
2009, the Company renewed its two-year employment agreement with its Vice
President of Engineering.  The financial terms of the renewed employment
agreement were substantially the same as the previous employment agreements,
which provided for annual compensation of $144,000.  Effective November 1,
2010, the Vice President of Engineering's employment was terminated (Note
12).
  In
October 2009, the Company amended its employment agreement with its Chief
Financial Officer to extend the contract through September 1, 2010.  The
employment agreement provided for annual compensation in the amount of
$138,000.  The Chief Financial Officer's employment agreement was not
renewed and he was terminated effective November 1, 2010 (Note
12).
  F-21
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
  Effective
November 1, 2009, the Company renewed its two-year employment agreement with its
President and Chief Executive Officer.  The financial terms of the renewed
employment agreement are substantially the same as the previous employment
agreements, which provide for annual compensation of $174,000.
  Lease
Obligation
  In June
2007, the Company executed an agreement to lease certain office equipment from
Banc of America leasing.  The lease agreement expired in June
2010.
  Effective
January 1, 2009, the Company entered into an agreement to lease its current
office space.  The new lease has a term of 36 months and expires in
December 31, 2011. Future lease payments related to the Company’s office and
equipment leases are as follows:
  Amount2010
      (remaining)
                    
                    $
                    15,6342011
                    
                    
                    64,1402012
                    
                    
                    -2013
                    
                    
                    -2014
                    
                    
                    -Total
                    
                    $
                    79,774
  Copier
lease expense totaled $2,000, $4,056, $3,036 and $5,423 for the three-month and
nine-month periods ended September 30, 2010 and 2009.  Gross office rent
expense for each of the three-month and nine-month periods ended September 30,
2010 and 2009 was $19,418 and $58,255.  In 2009, the Company subleased
office space to two other entities.  Sublease income was $10,200 and
$28,600 for the three-month and nine-month periods ended September 30,
2009.  Sublease income is treated as a reduction in rent
expense.
  8.
              Loss Per
      Share
  The
following is a reconciliation of the number of shares used in the calculation of
basic loss per share and diluted loss per share for the three and nine-month
periods ended September 30, 2010 and 2009:
  F-22
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
 
 For the Three-Month
                    
                    
                    For the Nine-MonthPeriodEndedSeptember30,
                    
                    
                    PeriodEndedSeptember30,2010
                    
                    
                    2009
                    
                    
                    2010
                    
                    
                    2009Net
      income (loss)
                    
                    $
                    (311,084
                    )
                    
                    $
                    (3,459,056
                    )
                    
                    $
                    3,401,960
                    
                    
                    $
                    (4,292,556
                    )Weighted-average
      number of common shares outstanding
                    
                    
                    41,576,076
                    
                    
                    
                    44,550,000
                    
                    
                    
                    43,217,803
                    
                    
                    
                    44,550,000Incremental
      shares from the assumed exercise of dilutive stock options
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1,929,820
                    
                    
                    
                    -Diluted
      common shares outstanding
                    
                    
                    41,576,076
                    
                    
                    
                    44,550,000
                    
                    
                    
                    45,147,623
                    
                    
                    
                    44,550,000Net
      income (loss) per share:Basic
                    
                    $
                    (0.01
                    )
                    
                    $
                    (0.08
                    )
                    
                    $
                    0.08
                    
                    
                    $
                    (0.10
                    )Diluted
                    
                    $
                    (0.01
                    )
                    
                    $
                    (0.08
                    )
                    
                    $
                    0.08
                    
                    
                    $
                    (0.10
                    )
  In
periods where the Company incurred a loss, the following securities were not
included in the computation of diluted net loss per share as their effect would
have been anti-dilutive:
  2010
                    
                    
                    2009Stock
      options
                    
                    
                    6,000,000
                    
                    
                    
                    6,000,000
  9.
              Equity
      Transactions
  Stock
Repurchases
  In March
2010, the Company’s Board of Directors authorized implementation of a stock
repurchase program, pursuant to which the Company may repurchase up to $500,000
of its then outstanding common shares at prevailing market prices.  During
the three-month and nine-month periods ended September 30, 2010, the Company
repurchased and retired 1,958,000 and 3,839,000 shares, respectively, of its
previously issued and outstanding common stock at an average price of $0.07 per
share.  The aggregate cost associated with the repurchase of these shares
was $265,580.  As of September 30, 2010, the Company has 40,711,000 shares
of common stock outstanding.  As discussed in Note 12, the Company
discontinued the share repurchase program effective November 1,
2010.
  Issuance
and Cancellation of Restricted Stock and Cancellation of Stock
Options
  In
September 2009, the Company announced that it had granted 6,500,000 restricted
shares of common stock to its directors and officers in exchange for the return
and cancellation of 5,393,800 unexercised options to purchase shares of common
stock.  In October 2009, the Company’s board of directors rescinded the
grant of the restricted common shares, effective on the original grant
date.  Because the restricted stock certificates were never delivered to
the intended recipients, management has determined that the title to the shares
never transferred.  Accordingly, no stock-based compensation has been
recorded in connection with the issuance of the restricted shares.  The
stock options remained cancelled.
  F-23
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
  Issuance
of Stock Options
  In
October 2009, the Company granted 6,000,000 options to purchase shares of the
Company’s common stock to its directors and officers.  The stock options
have a five-year life, vest immediately and have an exercise price of $0.05,
which exceeded the volume weighted average closing price of the Company’s common
stock for the five-day period preceding the grant.  The Company accounted
for the new stock option grant as a modification of the previously outstanding
stock options and immediately recognized stock-based compensation expense of
$145,190 associated with the new grant and the remaining $67,071 of unamortized
stock-based compensation associated with the original stock options.  There
were no additional stock options granted during the nine-month period ended
September 30, 2010.  Accordingly, the Company did not recognize any
stock-based compensation expense for the nine-month period then
ended.
  A summary
of stock option activity for the year ended December 31, 2009 and the nine-month
period ended September 30, 2010 is presented below:
  WeightedWeighted
                      
                      
                      AverageAverage
                      
                      
                      Remaining
                      
                      
                      AggregateExercise
                      
                      
                      Contract
                      
                      
                      IntrinsicShares
                      
                      
                      Price
                      
                      
                      Term
                      
                      
                      ValueOutstanding
      at December 31, 2008
                      
                      
                      5,543,800
                      
                      
                      $
                      0.46
                      
                      
                      3.1
      years
                      
                      
                      
                      -Options
      forfeited
                      
                      
                      (5,543,800
                      )
                      
                      $
                      0.46
                      
                      
                      -
                      
                      
                      
                      -Options
      granted
                      
                      
                      6,000,000
                      
                      
                      $
                      0.05
                      
                      
                      -
                      
                      
                      
                      -Outstanding
      at December 31, 2009 and September 30, 2010
                      
                      
                      6,000,000
                      
                      
                      $
                      0.05
                      
                      
                      4.0 years
                      
                      
                      $
                      240,000Exercisable
      at September 30, 2010
                      
                      
                      6,000,000
                      
                      
                      $
                      0.05
                      
                      
                      4.0 years
                      
                      
                      $
                      240,000
  The
assumptions used in the Black-Scholes option pricing model for the stock options
granted during the year ended December 31, 2009 were as follows:
  Risk-free
      interest rate
                    
                    
                    2.37
                    %Expected
      volatility of common stock
                    
                    
                    101
                    %Dividend
      yield
                    
                    $
                    0.00Expected
      life of options
                    
                    5
      yearsWeighted
      average fair market value of options granted
                    
                    $
                    0.03
  Shares
Reserved for Future Issuance
  As of
September 30, 2010, the Company has reserved 6,000,000 shares for future
issuance upon exercise of outstanding options.
  F-24
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
  10.
              Income
      Taxes
  For the
nine-month period ended September 30, 2009, the Company incurred a net operating
loss and, accordingly, no provision for income taxes was recorded.  In
addition, no benefit for income taxes was recorded due to the uncertainty of the
realization of any tax assets.
  The
Company has recognized net income of $3,401,960 for the nine-month period ended
September 30, 2010.  However, as discussed below, the Company has
sufficient net operating loss carryforwards (“NOL’s”) to offset any current year
taxable income.  As a result, the Company has not recognized any US income
tax expense for the current period.
  As of
December 31, 2009, the Company had cumulative net loss carryforwards (“NOL’s”)
of approximately $6,453,000 available to offset future US taxable
earnings.  The NOL’s, if not utilized, will begin to expire in
2023.
  In June
2010, the Company remitted $892,112 to the Canadian Revenue Agency in connection
with the sale of certain gross overriding royalty interests.  A foreign tax
credit related to the payment of the Canadian taxes is available to reduce
future US tax liabilities, once the Company’s NOL’s have expired or fully
utilized.
  September 30,2010
                    
                    
                    December 31,(Unaudited)
                    
                    
                    2009Tax
      effect of NOL’s
                    
                    $
                    996,793
                    
                    
                    $
                    2,194,000Estimated
      foreign tax credits
                    
                    
                    892,000
                    
                    
                    
                    -Total
      deferred tax assets
                    
                    
                    1,888,793
                    
                    
                    
                    2,194,000Less:
      Valuation allowance
                    
                    
                    (1,888,793
                    )
                    
                    
                    (2,194,000
                    )Net
      deferred tax assets
                    
                    $
                    -
                    
                    
                    $
                    -
  Prior to
recognizing income for the nine-month period ended September 30, 2010, the
Company recognized net losses in each fiscal year since inception.  Based
on the Company’s history of net losses, management believes that it is more
likely than not that the net deferred tax assets will not be fully
realizable.  Accordingly, the Company has provided for a full valuation
allowance against its net deferred tax assets as of September 30,
2010.
  A
reconciliation between the amount of income tax (benefit) expense for the
nine-month periods ended September 30, 2010 and 2009, determined by applying the
applicable US statutory income tax rates, is as follows:
  F-25
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
 
 2010
                    
                    
                    2009US
      Net income (loss) before taxes
                    
                    $
                    3,535,269
                    
                    
                    $
                    (4,292,556
                    )US
      statutory tax rate
                    
                    
                    34
                    %
                    
                    
                    34
                    %Estimated
      tax expense (benefit)
                    
                    
                    1,201,991
                    
                    
                    
                    (1,459,469
                    )Provision
      for deferred taxes
                    
                    
                    (1,201,991
                    )
                    
                    
                    1,459,469Net
      income tax expense (benefit)
                    
                    $
                    -
                    
                    
                    $
                    -
  11.
              Asset and Royalty
      Purchases by Ryland Oil
Corporation
  In
November 2009, the Company entered into a letter agreement (the “Letter
Agreement”) with Ryland Oil Corporation (“Ryland”), a Canadian oil and gas
company whose shares are listed on the TSX Venture Exchange, whereby Ryland
proposed to acquire all of the then-outstanding shares of the Company’s common
stock in exchange for approximately 17,793,000 shares of Ryland’s common stock,
at a ratio of 0.352 shares of Ryland stock for every 1.000 share of the
Company’s stock.
  On March
26, 2010, the Company and Ryland mutually agreed to terminate the Letter
Agreement and, instead, entered into two new asset purchase agreements whereby
the Company agreed to sell to Ryland its interest in certain acreage located in
North Dakota, as well as its gross overriding royalty interest in certain lands
located in Saskatchewan.  The material terms of each agreement were as
follows:
  1.
              Purchase
      and Sale Agreement – Effective April 1, 2010, the Company sold its ten
      percent working interest in approximately 700 net acres located in North
      Dakota to Rover for $1 million
cash.
  2.
              Purchase
      of Royalty Agreement – Effective April 1, 2010 the Company sold to Ryland
      all of its gross overriding royalty interest in approximately 264,000 net
      acres within an area of mutual interest located in southeastern
      Saskatchewan for $2.9 million in cash, 2,145,883 shares of Ryland’s common
      stock, which were valued at approximately $874,973 and an assignment of
      Ryland’s 100% working interest in approximately 4,480 net acres located in
      Saskatchewan (the “Hardy Prospect”) and related machinery, valued at
      $238,681.
  F-26
  Eternal
Energy Corp.
  Notes
to the Condensed Consolidated Financial Statements
 (Unaudited)
  12.
              Subsequent
      Events
  Share
Repurchases
  During
the period from October 1, 2010 through October 27, 2010, the Company
repurchased an additional 731,000 shares of its previously outstanding common
stock on the open market pursuant to its stock repurchase program.  The
aggregate consideration paid for these shares totaled approximately $62,920,
resulting in an average repurchase price of $0.086 per acquired
share.  As of November 1, 2010, we ceased open market purchases of our
common stock.
  Departure
of Officers
  On
November 1, 2010, the Company notified Kirk Stingley, Chief Financial Officer,
and Craig Phelps, Vice President of Engineering, that their employment was being
terminated without cause.  The Vice President of Engineering received
a severance package consisting of six monthly payments to be made totaling
$72,000 and the Chief Financial Officer received a severance package consisting
of a one-time payment of $35,000.  Both individuals exercised their
outstanding stock options by effecting a cashless exercise which resulted in Mr.
Phelps being issued 615,333 shares of the Company's common stock in exchange for
his 1,384,500 stock options and Mr. Stingley being issued 410,489 shares of the
Company's common stock in exchange for his 923,600 stock options.  The
closing trading price of the Company's common stock on the day of the cashless
exercise was $0.09.  The stock options had an exercise price of
$0.05.
  F-27





ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.





THE
FOLLOWING PRESENTATION OF OUR MANAGEMENT'S DISCUSSION AND ANALYSIS SHOULD BE
READ IN CONJUNCTION WITH THE FINANCIAL STATEMENTS AND OTHER FINANCIAL
INFORMATION INCLUDED ELSEWHERE IN THIS REPORT.





A
Note About Forward-Looking Statements





This
Quarterly Report on Form 10-Q contains “forward-looking statements” within the
meaning of the Private Securities Litigation Reform Act of 1995 that are based
on current management's expectations. These statements may be identified by
their use of words like “plans,” “expect,” “aim,” “believe,” “projects,”
“anticipate,” “intend,” “estimate,” “will,” “should,” “could” and other
expressions that indicate future events and trends. All statements that address
expectations or projections about the future, including statements about our
business strategy, expenditures, and financial results are forward-looking
statements. We believe that the expectations reflected in such forward-looking
statements are accurate. However, we cannot assure you that such expectations
will occur.




Actual
results could differ materially from those in the forward looking statements due
to a number of uncertainties including, but not limited to, those discussed in
this section. Factors that could cause future results to differ from these
expectations include general economic conditions, further changes in our
business direction or strategy, competitive factors, oil and gas exploration
uncertainties, and an inability to attract, develop, or retain technical,
consulting or managerial agents or independent contractors. As a result, the
identification and interpretation of data and other information and their use in
developing and selecting assumptions from and among reasonable alternatives
requires the exercise of judgment. To the extent that the assumed events do not
occur, the outcome may vary substantially from anticipated or projected results,
and accordingly, no opinion is expressed on the achievability of those
forward-looking statements. No assurance can be given that any of the
assumptions relating to the forward-looking statements specified in the
following information are accurate, and we assume no obligation to update any
such forward-looking statements. You should not unduly rely on these
forward-looking statements, which speak only as of the date of this Quarterly
Report, except as required by law; we are not obligated to release publicly any
revisions to these forward-looking statements to reflect events or circumstances
occurring after the date of this report or to reflect the occurrence of
unanticipated events.





Industry
Outlook





The
petroleum industry is highly competitive and subject to significant volatility
due to numerous market forces. Crude oil and natural gas prices are affected by
market fundamentals such as weather, inventory levels, competing fuel prices,
overall demand and the availability of supply.





Oil
prices cannot be predicted with any certainty and have significantly affected
profitability and returns for upstream producers. Historically, the WTI price
has averaged approximately $47 per barrel over the past ten years. However,
during that time, the industry has experienced wide fluctuations in prices.
While local supply/demand fundamentals are a decisive factor affecting domestic
natural gas prices over the long term, day-to-day prices may be more volatile in
the futures markets, such as on the NYMEX and other exchanges, making it
difficult to forecast prices with any degree of confidence. Over the last ten
years, the NYMEX gas price has averaged approximately $5.67 per
mcf.





Results
of Operations for the Three-Month Period Ended September 30, 2010 vs.
2009





In
connection with our April 2010 transaction with Ryland Oil Corporation
(“Ryland”), we acquired a 100% working interest in approximately 4,480 net acres
located in southeastern Saskatchewan (the “Hardy Project”).  As a result of
a transaction with American Eagle Energy Inc., we now have a 50% undivided
interest in the Hardy Project.  In September, 2010, we, along with our
working interest partner, finished the mechanical workover of the Hardy
2D7-9-3D2-16-4-21 well and returned the well to production.  As of the end
of September, the well was producing approximately 40 barrels of oil and 200
barrels of water per day.  During the three-month period ended September
30, 2010, we began to recognize oil and gas revenues from the Hardy Project, in
an amount of $10,842.


Falling oil prices and
increasing production costs caused us to shut-in our West Ranch wells in June
2009.  The wells remained shut-in until the West Ranch property was sold in
June 2010. There were oil and gas operating expenses of $8,382 related to West
Ranch during the three-month period ended September 30, 2009. For the same
three-month period in 2010, we incurred $65,806 of oil and gas operation
expenses, all related to returning the Hardy well to
production.


4





General
and administrative expenses decreased from $128,477 for the three-month period
ended September 30, 2009 to $102,140 for the three-month period ended September
30, 2010, primarily as a result of a $30,000 decrease in legal fees from 2009
related to regulatory compliance issues.





Stock-based
compensation expense for the three-month period ended September 30, 2009 totaled
$73,642.  In September 2009, we cancelled all of our then-outstanding stock
options in connection with the issuance of restricted shares to the option
holders.  In October 2009, we rescinded the issuance of the restricted
shares and granted new stock options to the previous option holders. 
Pursuant to accounting rules, the granting of the new options was treated as a
modification of the terms of the cancelled options.  All stock-based
compensation attributable to the newly issued options was fully recognized at
the time of grant.  Further, all remaining, unamortized stock-based
compensation of the cancelled options was also recognized.  As a result, no
stock-based compensation expense was recognized during the three-month period
ended September 30, 2010, as all compensation related to our outstanding stock
options had already been recognized.





Professional
fees for the three-month period ended September 30, 2010 decreased by $8,092
from the same period in 2009, primarily due to accounting fees in 2009 related
to the regulatory compliance issues that were not necessary in
2010.





Depreciation,
depletion, and amortization expense for the three-month period ended September
30, 2010 increased by $1,749 from the same period in 2009 primarily due to the
normal accretion of our asset retirement obligations.  We wrote off our
remaining asset retirement obligations in June 2010 in connection with the sale
of the West Ranch property.





Interest
income for the three-month period ended September 30, 2010 totaled $3,436,
compared to $(10,322) for the three-month period ended September 30, 2009.
Interest income in 2010 is from earnings on furnds from the April 2010
transaction with Ryland Oil Corporation. The 2009 decrease to interest income
was due to an accrual adjustment resulting from the realization of the North Sea
deposit.





In June
2010, we remitted $892,112 in foreign taxes to the Canadian Revenue Agency in
connection with our sale of the Saskatchewan gross overriding royalties. 
The payment of the Canadian taxes created a foreign tax credit, which would be
available to reduce the Company’s US tax liability on future earnings, once the
Company’s net operating loss carryforwards have expired or been fully
utilized.





Results
of Operations for the Nine-Month Period Ended September 30, 2010 vs.
2009





In
connection with our April 2010 transaction with Ryland Oil Corporation
(“Ryland”), as discussed below, we acquired a 100% working interest in
approximately 4,480 net acres located in southeastern Saskatchewan (the “Hardy
Project”).  As a result of a transaction with American Eagle Energy Inc.,
we now have a 50% undivided interest in the Hardy Project.  In September,
2010, we, along with our working interest partner, finished the mechanical
workover of the Hardy 2D7-9-3D2-16-4-21 well and returned the well to
production.  As of the end of September, the well was producing
approximately 40 barrels of oil per day.





During
the nine-month period ended September 30, 2010, we began to recognize oil and
gas revenues from the Hardy Project. During the same period in 2009, and
continuing through April 2010, we received oil and gas revenues associated
with our 5% gross overriding royalty interest in certain properties located in
Saskatchewan that were sold to Ryland as part of the April 2010
transaction.  During the nine-month period ended September 30, 2010, our
oil and gas revenues totaled $85,327, of which approximately $74,500 were
associated with our 5% gross overriding royalty interest.  During the prior
year period, our 5% gross overriding royalty interest generated
$12,057.





In April
2010, we sold our 5% gross overriding royalty interest in certain lands located
in southeastern Saskatchewan to Ryland.  As a result of the sale, we
received cash consideration of $2,900,000, shares of Ryland’s common stock
valued at $874,973 as of the date of closing, and a 100% working interest in
approximately 4,480 net acres, also located in southeastern Saskatchewan (the
“Hardy Project”), valued at $238,681.  Because we have no other properties
in the Canadian cost center of our full-cost pool, not subject to amortization,
we recognized a full gain on the sale totaling $4,013,654.





Also in
April 2010, we sold our 10% working interest in approximately 7,000 gross acres
(700 net acres) located in Divide County, North Dakota, to Rover Resources Inc.,
a wholly owned subsidiary of Ryland.  Proceeds from the sale of the 700
acres totaled $1,000,000 in cash.  We allocated a portion of the proceeds
to reduce our 10% working interest in the remaining approximate 28,000 gross
acres (2,800 net acres) that we own in Divide County and recognized a gain on
the sale of the 700 acres, totaling $277,355.


5





In June
2010, we sold our 75% working interest in the West Ranch property.  Cash
proceeds from the sale totaled $262,500.  In addition, the purchaser agreed
to assume all plugging and abandonment liabilities related to the West Ranch
wells, which totaled $247,434.  Because we had fully impaired our
investment in the West Ranch property, and because we have no other properties
in the US cost center of our full-cost pool, subject to amortization, we
recognized a full gain on the sale totaling $509,934.




As a result of these transactions, we
recognized aggregate gains from the sale of certain oil and gas assets totaling
$5,245,187 for the nine-month period ended September 30, 2010.  We
did not sell any properties during 2009.





Falling oil prices and increasing production costs
caused us to shut-in our West Ranch wells in June 2009.  The wells remained
shut-in until the West Ranch property was sold in June 2010. Oil and
gas operating expenses for the nine-month period ended September 30, 2009 were
$41,716. Oil and gas operating expenses for the same period ended September 30,
2010 totaled $65,806, all of which was the result of returning the Hardy well to
production.




General
and administrative expenses increased from $517,522 for the nine-month period
ended September 30, 2009 to $554,542 for the nine-month period ended September
30, 2010, primarily as a result of the following:





·
            Amounts
      received from Roadrunner for shared CFO services and office space rental
      effectively reduced our 2009 general and administrative expenses by
      $59,600.  We did not provide such services or sublease any office
      space to Roadrunner in 2010.




·
            Accounting
      and legal fees for the period decreased by $66,000 as a result of filing
      responses to questions received from the SEC, as well as multiple Form
      8-K’s related to the sales transactions with
  Ryland.·
            Consulting
      fees for the period increased by $67,000 from 2009 to 2010, primarily as a
      result of additional landman and operational services being
      contracted.





Stock-based
compensation expense for the nine-month period ended September 30, 2009 totaled
$272,917.  We did not recognize any stock-based compensation expense during
the nine-month period ended September 30, 2010 as all compensation related to
our outstanding stock options has already been recognized.





Professional
fees for the nine-month period ended September 30, 2010 increased by $6,995 from
the same period in 2009.  The increase is primarily due to incurring
$49,850 in 2010 to obtain a fairness opinion related to the potential merger
with Ryland.  This amount was partially offset by a reduction of legal fees
due to the favorable settlement of our then-litigation with Zavanna Corp. in
July 2010.





Depreciation,
depletion and amortization expense for the nine-month period ended September 30,
2010 increased by $5,275 from the same period in 2009 primarily due to the
normal accretion of our asset retirement obligations.  We wrote off our
remaining asset retirement obligations in June 2010 in connection with the sale
of the West Ranch property.





Interest
income for the nine-month period ended September 30, 2010 totaled $7.808,
compared to $16,692 for the nine-month period ended September 30, 2009.  As
discussed above, the interest rates available to the Company for its short-term
investments had declined significantly since the middle of 2009.





In June
2010, we remitted $892,112 in foreign taxes to the Canadian Revenue Agency in
connection with our sale of the Saskatchewan gross overriding royalties. 
The payment of the Canadian taxes created a foreign tax credit, which would be
available to reduce the Company’s US tax liability on future earnings, once the
Company’s net operating loss carryforwards have expired or been fully
utilized.





Liquidity and Capital Resources





As of
September 30, 2010, our assets totaled $5,525,566, which included cash balances
of $3,138,337, accounts receivable of $450,265, and investments in marketable
securities valued at $1,075,467.  As of September 30, 2010, we have working
capital totaling $3,219,448 available to us to fund operations and potential
drilling activities.





We also
own working interests in prospective oil and gas leases located in North Dakota
and southeastern Saskatchewan which could be liquidated, in part or in total, if
necessary, to fund future operations.





Off-Balance
Sheet Arrangements





The
Company had no off-balance sheet arrangements at September 30,
2010.


6





ITEM 4. CONTROLS AND PROCEDURES.





The
Company, under the supervision and with the participation of its management,
including the Chief Executive Officer and the Principal Accounting Officer,
evaluated the effectiveness of the design and operation of the Company’s
“disclosure controls and procedures” (as defined in Rule 13a-15(e) under the
Securities Exchange Act of 1934, as amended, as of the end of the period covered
by this report.  Based on that evaluation, the Chief Executive Officer and
the Principal Accounting Officer concluded that the Company’s disclosure
controls and procedures were effective as of September 30, 2010.  There has
been no change in the Company’s internal control over financial reporting during
the quarter ended September 30, 2010, that has materially affected, or is
reasonably likely to materially affect, the Company’s internal control over
financial reporting.


7


PART II - OTHER INFORMATION




ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND
USE OF PROCEEDS.




In
connection with the November 1, 2010, terminations without cause of two members
of our management team, we sold and issued 410,489 and 615,333 shares of our
common stock.  Such shares were issued pursuant to those individuals’
exercising previously granted stock options utilizing net exercise provisions in
their respective severance agreements.  No underwriters or placement agents
were involved in either transaction.  We believe that the sales and
issuances were exempt from the registration requirements of the Securities Act
of 1933, as amended, under Section 4(2) thereof, as they did not involve a
public offering.  Further, we believe that exemption was available
because (i) no advertising or general solicitation was employed in offering the
securities, (ii) the offering and sales were made solely to two former members
of our management team; and (iii) transfer was restricted in accordance with the
requirements of the Securities Act of 1933, as amended (including by legending
of certificates representing the securities).




ITEM
6. EXHIBITS.





Exhibit
                  
                  Description of Exhibit3(i).1
                  
                  Articles
      of Incorporation filed with the Nevada Secretary of State on July 25,
      2003. (Incorporated by reference to Exhibit 3.1 of our Form 10-SB filed
      August 18, 2004.)3(i).2
                  
                  Certificate
      of Change filed with the Nevada Secretary of State effective November 7,
      2005. (Incorporated by reference to Exhibit 3(i).2 of our Current Report
      on Form 8-K filed November 9, 2005.)3(i).3
                  
                  Articles
      of Merger filed with the Nevada Secretary of State effective November 7,
      2005. (Incorporated by reference to Exhibit 3(i).3 of our Current Report
      on Form 8-K filed November 9, 2005.)3(ii).1
                  
                  Bylaws,
      adopted July 18, 2003. (Incorporated by reference to Exhibit 3.2 of our
      Form 10-SB filed August 18, 2004.)3(ii).2
                  
                  Amendment
      No. 1 to Bylaws, adopted November 4, 2005. (Incorporated by reference to
      Exhibit 3(ii) of our Current Report on Form 8-K filed November 9,
      2005.)10.1
                  
                  Agreement
      and Plan of Merger between Golden Hope Resources Corp. (renamed Eternal
      Energy Corp.) and Eternal Energy Corp., filed with the Nevada Secretary of
      State effective November 7, 2005. (Incorporated by reference to Exhibit
      10.1 of our Current Report on Form 8-K filed November 9,
      2005.)10.2
                  
                  Purchase
      and Sale Agreement by and between Eternal Energy Corp., PNP Petroleum I,
      LP., Cibolo Energy Operating, Inc. and Century Assets Corporation, dated
      June 25, 2010. (Incorporated by reference to Exhibit 10.2 of our Quarterly
      Report on Form 10-Q filed August 16, 2010.)10.3
                  
                  Purchase
      and Sale Agreement between Eternal Energy Corp. and American Eagle Energy
      Inc. dated June 18, 2010. (Incorporated by reference to Exhibit 10.3 of
      our Quarterly Report on Form 10-Q filed August 16,
  2010.)10.4
                  
                  Reserved
      for future use.10.5
                  
                  Reserved
      for future use.10.6
                  
                  Letter
      Agreement by and between Eternal Energy Corp. and International Frontier
      Resources Corporation. (Incorporated by reference to Exhibit 10.1 of our
      Current Report on Form 8-K filed December 5, 2005.)10.7
                  
                  Reserved
      for future use.10.8
                  
                  Reserved
      for future use.10.9
                  
                  Letter
      Agreement by and between Eternal Energy Corp. and International Frontier
      Resources Corporation Relating to Quad 41 and Quad 42 dated January 30,
      2006. (Incorporated by reference to Exhibit 10.1 of our Current Report on
      Form 8-K filed February 3,
2006.)




8





10.10
              
              Amended
      and Restated Letter Agreement by and between Eternal Energy Corp. and
      International Frontier Resources Corporation Relating to Quad 14 dated
      January 30, 2006. (Incorporated by reference to Exhibit 10.2 of our
      Current Report on Form 8-K filed February 3, 2006.)10.11
              
              Reserved
      for future use.10.12
              
              Reserved
      for future use.10.13
              
              Reserved
      for future use.10.14
              
              Reserved
      for future use.10.15
              
              Reserved
      for future use.10.16
              
              Letter
      Agreement effective as of May 19, 2006, by and among Eternal Energy Corp.,
      International Frontier Resources Corporation, Palace Exploration Company
      Limited, Oilexco Incorporated, and Challenger Minerals (North Sea)
      Limited. (Incorporated by reference to Exhibit 10.1 of our Current Report
      on Form 8-K filed May 23, 2006.)10.17**
              
              Letter
      Agreement dated October 15, 2006, by and among Eternal Energy Corp.,
      Fairway Exploration, LLC, Prospector Oil, Inc., and 0770890 B.C. Ltd.
      (Incorporated by reference to Exhibit 10.17 of our Registration Statement
      on Form 10-KSB filed April 16, 2007.)10.18**
              
              Letter
      Agreement dated October 26, 2006, by and among Eternal Energy Corp.,
      Fairway Exploration, LLC, Prospector Oil, Inc., 0770890 B.C. Ltd., and
      Rover Resources Inc. (Incorporated by reference to Exhibit 10.18 of our
      Registration Statement on Form 10-KSB filed April 16,
    2007.)10.19
              
              Letter
      Agreement dated February 28, 2007, by and among Eternal Energy Corp.,
      Pebble Petroleum Inc., Emerald Bay Holdings Ltd., and Heartland Resources
      Inc. (Incorporated by reference to Exhibit 10.19 of our Registration
      Statement on Form 10-KSB filed April 16, 2007.)10.20
              
              Agreement
      To Terminate DGWS Option. (Incorporated by reference to Exhibit 10.20 of
      our Quarterly Report on Form 10-Q filed May 15, 2009.)10.21
              
              Amended
      and Restated Employment Agreement by and between Eternal Energy Corp. and
      Craig Phelps dated August 1, 2007. (Incorporated by reference to Exhibit
      10.21 of our Quarterly Report on Form 10-Q filed May 15,
      2009.)10.22
              
              Employment
      Agreement by and between Eternal Energy Corp. and Kirk A. Stingley dated
      June 2, 2008. (Incorporated by reference to Exhibit 10.22 of our Quarterly
      Report on Form 10-Q filed May 15, 2009.)10.23
              
              Amended
      and Restated Employment Agreement by and between Eternal Energy Corp. and
      Bradley M. Colby dated November 1, 2009. (Incorporated by reference to
      Exhibit 10.23 of our Quarterly Report on Form 10-Q filed November 23,
      2009.)10.24
              
              First
      Amendment to the Amended and Restated Employment Agreement by and between
      Eternal Energy Corp. and Craig H. Phelps dated August 1, 2009.
      (Incorporated by reference to Exhibit 10.24 of our Quarterly Report on
      Form 10-Q filed November 23, 2009.)10.25
              
              First
      Amendment to the Employment Agreement by and between Eternal Energy Corp.
      and Kirk. A. Stingley dated October 30, 2009. (Incorporated by reference
      to Exhibit 10.25 of our Form Quarterly Report on Form 10-Q filed November
      23, 2009.)10.26
              
              Form
      Of Letter Agreement dated November 25, 2009, between the Registrant and
      Ryland Oil Corporation in respect of a potential acquisition of the
      registrant. (Incorporated by reference to Exhibit 10.26 of our Current
      Report on Form 8-K filed March 10, 2010.)10.27
              
              Lease
      Agreement dated January 2, 1009 by and between Eternal Energy Corp. and
      Oakley Ventures, LLC. (Incorporated by Reference to Exhibit 10.27 of our
      Annual Report on Form 10-K filed March 23, 2010.)10.28
              
              Purchase
      and Sale Agreement by and between Eternal Energy Corp. and Ryland Oil
      Corporation dated March 26, 2010. (Incorporated by reference to Exhibit
      10.28 of our Current Report on Form 8-K filed March 29,
    2010.)




9





10.29
              
              Purchase
      of Royalty Agreement by and between Eternal Energy Corp. and Ryland Oil
      Corporation dated March 26, 2010 (Incorporated by reference to Exhibit
      10.29 of our Current Report on Form 8-K filed March 29,
    2010.)10.29a
              
              Amending
      Agreement to the Ryland/Eternal Royalty Purchase Agreement by and between
      Eternal Energy Corp. and Ryland Oil Corporation dated April 20, 2010.
      (Incorporated by reference to Exhibit 10.29a of our Current Report on Form
      8-K filed March 29, 2010.)10.30
              
              Termination
      Agreement (of the US Pebble Acquisition Agreement) by and between Eternal
      Energy Corp., Fairway Exploration LLC, Prospector Oil, Inc., Pebble
      Petroleum Inc. and Rover Resources Inc. dated April 29, 2010.
      (Incorporated by reference to Exhibit 10.30 of our Quarterly Report on
      Form 10-Q filed May 17, 2010.)10.31
              
              Termination
      Agreement (of the Canadian Pebble Acquisition Agreement) by and between
      Eternal Energy Corp., Fairway Exploration LLC, Prospector Oil, Inc. and
      Pebble Petroleum Inc. dated April 29, 2010. (Incorporated by reference to
      Exhibit 10.31 of our Quarterly Report on Form 10-Q filed May 17,
      2010.)10.32
              
              Termination
      Agreement (of the US Prospect Acquisition Agreement) by and between
      Eternal Energy Corp., Fairway Exploration LLC, Prospector Oil, Inc.,
      Pebble Petroleum Inc., Rover Resources Inc., Steven Swanson, Richard L.
      Findley, Thomas G. Lantz and Ryland Oil Corporation dated May 11, 2010.
      (Incorporated by reference to Exhibit 10.32 of our Quarterly Report on
      Form 10-Q filed May 17, 2010.)10.33
              
              Termination
      Agreement (of the Canadian Prospect Acquisition Agreement) by and between
      Eternal Energy Corp., Fairway Exploration LLC, Prospector Oil, Inc.,
      Pebble Petroleum Inc., Steven Swanson, Richard L. Findley, Thomas G. Lantz
      and Ryland Oil Corporation dated May 11, 2010. (Incorporated by reference
      to Exhibit 10.33 of our Quarterly Report on Form 10-Q filed May 17,
      2010.)10.34
              
              Termination
      of Management Services Agreement by and between Eternal Energy Corp.,
      Ryland Oil Corporation and Brad Colby dated December 1, 2009.
      (Incorporated by reference to Exhibit 10.34 of our Quarterly Report on
      Form 10-Q filed May 17, 2010.)10.35
              
              Amendment
      to the Consulting Agreement by and between Eternal Energy Corp., Rover
      Resources Inc. and Brad Colby dated April 1, 2010. (Incorporated by
      reference to Exhibit 10.35 of our Quarterly Report on Form 10-Q filed May
      17, 2010.)31.1*
              
              Certification
      pursuant to Section 302 of the Sarbanes-Oxley Act of
      2002.32.1*
              
              Certification
      of President and Chief Executive Officer pursuant to 18 U.S.C. §1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.





*       Filed
herewith.


**    
Portions omitted pursuant to a request for confidential
treatment.


10


SIGNATURES





In
accordance with the requirements of the Exchange Act, the registrant caused this
Report to be signed on its behalf by the undersigned, thereunto duly
authorized.





ETERNAL
      ENERGY CORP.(Registrant)November
      22, 2010
                    /s/
      Bradley M. ColbyBradley
      M. ColbyPresident
      and Chief Executive Officer
                      (Principal
      Executive, Financial and Accounting
Officer)




11