2009 Annual Results & Operations Update Amendment

Frontera Resources Corporation and Subsidiaries

Consolidated Financial Statements

December 31, 2009 and 2008

Report of Independent Auditors.................................................................................................................. 1

Consolidated Financial Statements

Balance Sheets...................................................................................................................................... 2

Statements of Operations........................................................................................................................ 3

Statements of Stockholders' Deficit.......................................................................................................... 4

Statements of Cash Flows...................................................................................................................... 5

Notes to Consolidated Financial Statements........................................................................................ 6-22

Management's Discussion and Analysis of Financial Condition and Results of Operations............................. 23-32

Report of Independent Auditors

To the Board of Directors of

Frontera Resources Corporation:

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, stockholders' deficit and cash flows present fairly, in all material respects, the financial position of Frontera Resources Corporation and its subsidiaries (the "Company") at December 31, 2009 and 2008, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has suffered recurring losses from operations and has limited available funds as of December 31, 2009, which raises substantial doubt about its ability to continue as a going concern. Management's plans in regard to this matter are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

As discussed in Note 3 to the consolidated financial statements, the Company has changed its reserve estimates as a result of adopting new oil and gas reserve estimation and disclosure requirements effective December 31, 2009.

March 31, 2010

1. Nature of Operations

Frontera Resources Corporation, a Delaware corporation, and its subsidiaries (collectively "Frontera" or the "Company") are engaged in the development of oil and gas projects in emerging marketplaces. Frontera was founded in 1996 and is headquartered in Houston, Texas. The Company emphasizes development of reserves in known hydrocarbon-bearing basins, and is attracted to projects that have significant exploration upside. Since 2002, the Company has focused substantially all of its efforts on the exploration and development of oilfields within the Republic of Georgia ("Georgia"), a member of the Former Soviet Union.

In June 1997, the Company entered into a 25-year production sharing agreement with the Ministry of Fuel and Energy of Georgia and State Company Georgian Oil ("Georgian Oil"), which gives the Company the exclusive right to explore, develop and produce crude oil in a 5500 square kilometer area in eastern Georgia known as Block 12, hereafter referred to as the "Block 12 PSA". The Block 12 PSA can be extended if commercial production remains viable upon its expiration in June 2022.

Under the terms of the Block 12 PSA, the Company is entitled to conduct exploration and production activities and is entitled to recover its cumulative costs and expenses from the crude oil produced from Block 12. Following recovery of cumulative costs and expenses from Block 12 production, the remaining crude oil sales, referred to as Profit Oil, are allocated between Georgian Oil and Frontera in the proportion of 51% and 49%, respectively.

Under the terms of the Block 12 PSA, Frontera is exempt from all taxes imposed by the government of Georgia, and any taxes imposed on the Company are paid by Georgian Oil on behalf of the Company from Georgian Oil's 51% share of Profit Oil. Taxes are defined by the Block 12 PSA to mean all levies, duties, payments, fees, taxes or contributions payable to or imposed by any government agency, subdivision, municipal or local authorities within the government of Georgia.

Frontera's future revenues depend on operating results from its operations in the Republic of Georgia. The success of Frontera's operations is subject to various contingencies beyond management control. These contingencies include general and regional economic and political conditions, prices for crude oil, competition and changes in regulation. Frontera is subject to various additional political and economic uncertainties in Georgia which could include restrictions on transfer of funds, import and export duties, quotas and embargoes, domestic and international customs and tariffs, and changing taxation policies, foreign exchange restrictions, political conditions and regulations.

2. Liquidity and Capital Resources

The Company has incurred net losses and negative cash flows from operations in most fiscal periods since inception. Based on the Company's current operating plan, its existing working capital will not be sufficient to meet the cash requirements to fund the Company's planned operating expenses and capital expenditures through December 31, 2010 without additional sources of financing. Management plans to continue to reduce costs and raise additional financing to meet its cash needs for 2010 and has commenced discussions with various financial institutions to seek additional financing in order to facilitate the Company's 2010 operating plan. Throughout 2008 and 2009, there has been extreme volatility and disruption in the global capital and credit markets. While these market conditions persist, the Company's ability to access the capital and credit markets is likely to be adversely affected. Although the Company is encouraged about the prospects of raising capital, discussions are still preliminary and may not result in a successful financing.

Failure to generate sufficient operating cash flows, raise additional capital or further reduce spending will have a material adverse effect on the Company's ability to continue as a going concern and to achieve its intended business objectives. There can be no assurance that sufficient revenues will be generated in the future to sustain the Company's operations. These consolidated financial statements do not include any adjustments related to the outcome of this uncertainty.

Notwithstanding management's plan to reduce costs and raise additional financing, the Company's viability is dependent upon producing oil and gas in sufficient quantities and marketing such oil and gas at sufficient prices to provide positive operating cash flow to the Company. The Company is solely responsible for providing all of the funding for the development of Block 12 in Georgia and will require additional funding in order to obtain certain levels of production and generate sufficient cash flows to meet future capital and operating spending requirements. This is dependent upon, among other factors, achieving significant increases in production, production of oil and gas at costs that provide acceptable margins, reasonable levels of taxation from local authorities, and the ability to market the oil and gas produced at or near world prices.

Management's plan for addressing the above uncertainties is partially based on forward looking events which have yet to occur, including the completion of a successful development program, and accordingly, there is no assurance that those events will transpire as initially contemplated.

The following key financial measurements reflect the Company's financial position and capital resources as of December 31, 2009 and December 31, 2008 (dollars in thousands):

December 31, 2009 December 31, 2008

Cash and cash equivalents $ 814 $ 7,321

Working capital $ 5,383 $ 7,007

Total debt $ 113,584 $ 105,822

Debt to debt and equity 175% 137%

In September 2009, the Company issued 45,186,536 units ("Units") each comprised of one share of common stock and one common stock purchase warrant (a "Warrant") at an issue price of £0.103 per Unit, for gross proceeds of approximately $7.6 million, net of $0.3 million in fees associated with the issuance. Additionally, the Company issued 1,355,596 warrants to its financial advisor as part of its advisory fee. Of the total net proceeds, $7.1 million was collected in 2009 and $0.2 million is expected to be collected during the first quarter of 2010. Each Warrant entitles the holder to purchase from the Company one share of common stock for a period of two years following the transaction closing date at an exercise price of £0.15 per share. As described in Note 3, the Company has classified these Warrants as derivative warrant liabilities on the Consolidated Balance Sheet.

Operating cash flow is influenced mainly by the prices received for the Company's oil production; the quantity of oil produced and the success of the Company's development and exploration activities. Currently the Company does not generate sufficient operating cash flows to cover general corporate activities or planned capital expenditure programs. The principal factors that could adversely affect the amount and availability of internally generated cash flows from operations include:

·; Decline in the sales price of crude oil.

·; Decline in current production volumes or production volumes of future wells being less than anticipated.

·; Inability to attract outside financing to continue discretionary capital expenditures for future drilling.

3. Summary of Significant Accounting Policies

In June 2009, the Financial Accounting Standards Board ("FASB") issued "The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles", which establishes the FASB Accounting Standards Codification ("ASC") as the source of authoritative accounting principles recognized by the FASB to be applied in preparation of financial statements in conformity with GAAP. The ASC is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The Codification does not change or alter existing GAAP. The implementation had no impact to the Company's financial position or results of operations.

The Company follows the United States Security Exchange Commission's ("SEC") guidance related to the full cost method of accounting for oil and gas activities. In December 2008, the SEC issued a final rule, Modernization of Oil and Gas Reporting which is effective as of December 31, 2009. The new disclosure requirements permit the use of new technologies to determine proved reserves if those technologies have been demonstrated empirically to lead to reliable conclusions about reserve volumes. Currently, the SEC requires that reserve volumes are determined using prices on the last day of the reporting period; however, the new disclosure requirements provide for reporting and oil and natural gas reserves using a 12-month average price rather than the last day of reporting period prices. The new requirements also will allow companies to disclose their probable and possible reserves to investors. The new disclosure requirements also require companies to report the independence and qualifications of a reserve preparer or auditor. We adopted the provisions of the final rule in connection with our December 31, 2009 financial statements.

Principles of Consolidation

The consolidated financial statements include the accounts of Frontera Resources Corporation and its wholly and majority owned subsidiaries. All significant intercompany transactions and accounts have been eliminated in consolidation.

Reclassifications

Certain amounts in the consolidated financial statements have been reclassified in the prior period to conform with current period presentation. Reclassifications have no impact on the Company's financial position or results of operations.

Use of Estimates

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent asset and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Estimates of oil and natural gas reserves and their values, future production rates and future costs and expenses are inherently uncertain for numerous reasons, including many factors beyond the Company's control. Reservoir engineering is a subjective process of estimating underground accumulations of oil and natural gas that cannot be measured in an exact manner. The accuracy of any reserve estimate is a function of the quality of data available and of engineering and geological interpretation and judgment. In addition, estimates of reserves may be revised based on actual production, results of subsequent exploitation and development activities, prevailing commodity prices, operating costs and other factors. These revisions may be material and could materially affect the Company's future depletion, depreciation and amortization expenses.

The Company's revenue, profitability, and future growth are substantially dependent upon the prevailing and future prices for oil and natural gas, which are dependent upon numerous factors beyond its control such as economic, regulatory developments and competition from other energy sources. The energy markets have historically been volatile and there can be no assurance that oil and natural gas prices will not be subject to wide fluctuations in the future. A substantial or extended decline in oil and natural gas prices could have a material adverse effect on the Company's financial position, results of operations, cash flows and quantities of oil and natural gas reserves that may be economically produced.

Cash and Cash Equivalents

Cash and cash equivalents include all cash balances, money market accounts and certificates of deposit, all of which have original maturities of three months or less.

Restricted Cash

At December 31, 2009, the Company had $0.6 million of restricted cash which along with $10.0 million in face value of its investments served as collateral for a $9.5 million short-term note payable. At December 31, 2008 the company had $5.3 million of restricted cash, $5.0 million of which served as collateral for a $5.0 million line of credit that expired in 2009.

Derivative Stock Warrant Liabilities

In June 2008, the FASB issued authoritative guidance relating to financial instruments indexed to an entity's own stock. The adoption of this guidance required us to (1) evaluate our instrument's contingent exercise provisions and (2) evaluate the instrument's settlement provisions. Based upon applying this approach to instruments within the scope of the consensus, we determined that our warrants which were classified in stockholders' equity on December 31, 2008, no longer met the definition of "indexed to a company's own stock" provided in the guidance. Accordingly, we reclassified those Warrants, at their fair value as liabilities. The fair value of these liabilities is re-measured at the end of every reporting period with the change in value reported in the statement of operations. The difference between the amount the warrants were originally recorded in the financials and the fair value of the instruments on January 1, 2009 was considered a cumulative effect of a change in accounting principle and required an adjustment to the opening balance of retained earnings in the amount of $2.2 million and a reduction of common stock warrants of $3.1 million.

The fair value of the derivative stock warrant liabilities was $0.9 million at the remeasurement date of January 1, 2009. During September 2009, the Company issued additional warrants with a grant date fair value of $3.8 million (Note 2). The fair value of the combined derivative stock warrant liabilities on December 31, 2009 was $3.2 million. The change in the warrant liability resulted in derivative income of $1.5 million for the year ended December 31, 2009.

Investments

Investments consist of Municipal Short Term Auction Rate Securities ("M-STARS"). M-STARS are classified as available-for-sale and are carried at fair market value, as of the balance sheet date.

The auction process resets the applicable interest rates at prescribed calendar intervals and is intended to provide liquidity to the holders of auction rate securities by matching buyers and sellers in a market context, enabling the holders to gain immediate liquidity by selling such securities at par, or rolling over their investment. If there is an imbalance between buyers and sellers, there is a risk of a failed auction. Due to credit issues experienced by short-term funding markets, some of these securities, including our M-STARS, have failed at auction in 2008 and 2009; however, we liquidated $2.6 million and $13.0 million, of our M-STARS during 2009 and 2008, respectively. An auction failure is not a default, and in some cases it could reset the applicable interest rates to a higher rate as outlined by the security.

During the first quarter of 2010 the Company liquidated $10.0 million par value of the M-STARS for $8.1 million. The sale resulted in an other-than-temporary impairment loss of $1.9 million at December 31, 2009, and as such, the M-STARS were classified as a short-term investment. Liquidity in certain auction rate securities markets was also significantly reduced during 2009, resulting in wide-spread auction failures and increasing rates for auction rate securities. As a result, the Company assigned these securities to level 3 in the fair value hierarchy. In the absence of a secondary market, fair value was estimated based on a number of factors including the credit quality of the obligor, the credit quality of the bond insurer, the coupon, and the likelihood of refinancing by the issuer.

Fair Value Measurements

Frontera's financial instruments consist of cash investments, accounts receivable, accounts payable, derivatives, a line of credit and notes payable. The fair value of cash, accounts receivable and accounts payable are estimated to approximate the carrying value due to the liquid nature of these instruments. The fair value of the line of credit and notes payable was determined based upon discount rates which approximate variable interest rates for borrowings of a similar nature. The fair values of the debt instruments at December 31, 2009 and 2008 were approximately $89,870,000 and $66,010,000, respectively.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The guidance requires disclosure that establishes a framework for measuring fair value and expands disclosure about fair value measurements. The statement requires fair value measurements be classified and disclosed in one of the following categories:

Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2: Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability.

Level 3: Measured based on prices or valuation models that required inputs that are both significant to the fair value measurement and less observable for objective sources (i.e., supported by little or no market activity).

The Company classifies financial assets and liabilities based on the lowest level of input that is significant to the fair value measurement. The Company's assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of the fair value of assets and liabilities and their placement within the fair value hierarchy levels.

The following table summarizes the valuation of the Company's financial assets and liabilities by pricing levels as of December 31, 2009.

The table below sets forth a reconciliation for assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the year ended December 31:

Inventory

Inventory consists primarily of materials to be used in the Company's foreign oilfield operations and crude oil held in stock tanks. Inventory is valued using the first-in, first-out method and is stated at the lower of cost or market. Inventory consists of the following:

Property and Equipment

Property and equipment are stated at cost. Expenditures for major renewals and betterments, which extend the original estimated economic useful lives of applicable assets, are capitalized. Expenditures for normal repairs and maintenance are charged to expense as incurred. The costs and related accumulated depreciation of assets sold or retired are removed from the accounts, and any gain or loss thereon is reflected in operations. Depreciation of property and equipment is computed using the straight-line method over the estimated useful lives of the assets, ranging from three to seven years.

Oil and Gas Properties

The Company follows the full cost method of accounting for oil and gas properties. Accordingly, all costs associated with acquisition, exploration and development of oil and gas reserves, including directly related overhead costs, are capitalized.

All capitalized costs of oil and gas properties, including the estimated future costs to develop proved reserves, are depleted on the unit-of-production method using estimates of proved reserves. Investments in unproved properties and major development projects are not depleted until proved reserves associated with the projects can be determined or until impairment occurs. In addition, the capitalized costs are subject to a "ceiling test," which limits such costs to the aggregate of the future net revenues from proved reserves, based on current economic and operating conditions, discounted at a 10% interest rate, plus the lower of cost or fair market value of unproved properties. A ceiling test calculation is performed at each year-end. For the year ended December 31, 2009, the ceiling test calculation used a 12-month natural gas and oil average, as adjusted for basis or location differentials using a 12-month average, and held constant over the life of the reserves. For the year ended December 31, 2008, the ceiling test calculation used natural gas and oil prices in effect as of the balance sheet date, and held constant over the life of the reserves. The future cash outflows associated with future development or abandonment of wells are included in the computation of the discounted present value of future net revenues for purposes of the ceiling test calculation. For the years ended December 31, 2009 and 2008, the Company recorded ceiling test impairments of $1.1 million and $47.9 million, respectively related to its fields in Georgia.

Sales or other dispositions of oil and gas properties are accounted for as adjustments of capitalized costs with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves of oil and gas, in which case the gain or loss is recognized in earnings.

Costs Excluded

The costs associated with unproved properties, initially excluded from the amortization base, relate to unproved leasehold acreage, wells and production facilities in progress and wells pending determination of the existence of proved reserves, together with capitalized interest costs for these projects. Unproved leasehold costs are transferred to the amortization base with the costs of drilling the related well once a determination of the existence of proved reserves has been made or upon impairment of a lease. Costs of seismic data are allocated to various unproved leaseholds and transferred to the amortization base with the associated leasehold costs on a specific project basis. Costs associated with wells in progress and completed wells that have yet to be evaluated are transferred to the amortization base once a determination is made whether or not proved reserves can be assigned to the property. Costs of dry wells are transferred to the amortization base immediately upon determination that the well is unsuccessful.

Costs associated with unproved properties related to continuing operations of $47.6 million as of December 31, 2009 are excluded from amounts subject to amortization. The majority of the evaluation activities are expected to be completed within a three-year period. In addition, the Company's internal engineers evaluate all properties on an annual basis.

Costs Excluded by Year Incurred

Income Taxes

The Company recognizes deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statements and the tax basis of assets and liabilities using enacted rates in effect for the years in which the differences are expected to reverse. Valuation allowances are established, when appropriate, to reduce deferred tax assets to the amount expected to be realized.

The Company accounts for uncertain tax positions by reporting a liability for tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. The Company recognizes interest and penalties, if any, related to tax benefits in income tax expense.

Revenue Recognition

Oil and natural gas revenues are recorded when title passes to the customer, net of royalties, discounts and allowances, as applicable. Oil and natural gas sold is not significantly different from the Company's share of production.

Foreign Currency Transactions

The financial statements of the foreign subsidiaries are prepared in United States dollars, and the majority of transactions are denominated in United States dollars. Gains and losses on foreign currency transactions are the result of changes in the exchange rate between the time a foreign currency-denominated invoice is recorded and when it is ultimately paid and are included in operations. Foreign currency transaction gains and losses were not material for the years ended December 31, 2009 and 2008.

Concentrations of Credit Risk

Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash, investments and accounts receivable. The Company maintains its cash in bank deposits with various major financial institutions. These accounts, at times, may exceed federally insured limits. Deposits in the United States are guaranteed by the Federal Deposit Insurance Corporation up to $250,000. The Company monitors the financial condition of the financial institutions and does not anticipate any losses on such accounts.

For the year ended December 31, 2009, 100% of the Company's crude oil sales were to one unrelated customer.

Loss Per Share

Basic and diluted loss per share amounts is calculated based on the weighted average number of common stock outstanding during the year. Diluted loss per share is calculated using the weighted average number of shares of common stock outstanding during the year, including the dilutive effect of stock options, warrants and convertible notes. Basic and diluted loss per share for the years ended December 31, 2009 and 2008 are the same since the effect of all common stock equivalents would be antidilutive to the Company's net loss per share.

Stock-Based Compensation

The Company accounts for all share-based payments to employees, including grants of employee stock options, in the financial statements based on their grant-date fair values using a Black-Scholes fair valuation model. The Company estimated forfeiture rates for the year based on our historical experience of approximately 3%. At December 31, 2009 and 2008, there was $1,458,505 and $2,323,068, respectively, of total unrecognized compensation cost related to non-vested stock options. This compensation cost is expected to be recognized over a weighted-average period of approximately 0.6 and 0.7 years, respectively.

The Black-Scholes model incorporates assumptions to value stock-based awards. The risk-free rate of interest is the related U.S. Treasury yield curve for periods within the expected term of the option at the time of grant. The dividend yield on our common stock is assumed to be zero as we have historically not paid dividends and have no current plans to do so in the future. The expected volatility is based on historical volatility of the Company's common stock.

Due to the Company's net operating loss position; there are no anticipated windfall tax benefits upon exercise of options.

4. Accrued Liabilities

Accrued liabilities consist of the following:

5. Notes Payable

Line of Credit

In February 2009, the Company renewed a short-term note of approximately $9.5 million under an agreement with a bank, collateralized by its long-term investments in M-STARS. The note was due in May 2009. In May 2009, the note was renewed for six months and collateralized by $10.0 million in face value of the Company's investment in M-STARS, along with $0.6 million of restricted cash. The note was subsequently renewed until February 1, 2010, when it was repaid.

The Company previously held a $5.0 million line of credit with a commercial bank collateralized by $5.0 million of cash and cash equivalents. The line was primarily set up to support letters of credit issued by the Company from time to time in support of its oil and gas operations. The line of credit was paid in full upon expiration and the related $5.0 million of cash collateral was released during the second quarter of 2009.

6. Convertible Notes

During May 2007, the Company raised approximately $67.0 million through a private placement of convertible unsecured notes during May 2012. The notes were issued at par and bear interest at 10% per annum, payable quarterly in arrears in cash or in kind at the Company's discretion. The notes are convertible into shares of common stock at a conversion price of $1.67 per share. The notes will be automatically converted into common stock at the conversion price if the stock price exceeds two times the conversion price for at least 20 consecutive trading days. As part of the closing of the notes, debt issuance costs of approximately $2.7 million were incurred, of which approximately $1.5 million was paid in cash and $1.2 million of additional convertible notes and stock options were issued for the remainder.

On July 3, 2008, the Company raised $23.5 million through a private placement of convertible unsecured notes due July 2013. The notes were issued at par and bear interest at 10% per annum, payable quarterly in arrears in cash or in kind at the Company's discretion. The notes were initially convertible into common stock at a conversion price of $2.14 per share. The conversion price was subsequently reset to $1.71 per share, pursuant to the terms of the notes, since the price of the common stock closed at or below $1.71 per share for 10 out of 20 consecutive trading days. The notes will be automatically converted into common stock at the conversion price if the closing stock price exceeds two times the conversion price for at least 20 consecutive trading days.

The Company solicited consents from holders of its 10% convertible notes due 2012 to amend the note purchase agreements governing such notes to permit the issuance of the new notes and to release the remaining escrowed proceeds of $5.0 million from the May 2007 private placement. In connection with the solicitation, each consenting holder received a warrant exercisable into shares of common stock in an amount equal to 7.5% of the number of shares of common stock into which such consenting holder's existing notes were convertible. The warrants are exercisable for approximately 3,151,000 shares of common stock in the aggregate. Each warrant entitles the holder to purchase one share of common stock at a price of $3.50 per share, and includes a cashless exercise provision. The warrants have a five-year term and contain other customary terms and provisions. During 2009, due to anti-dillution provisions contained in the warrant agreements, the warrants became exercisable into 6,528,000 shares in the aggregate.

During 2009 and 2008, noteholders of the Company's convertible notes elected to convert $0.1 million and $5.7 million of convertible notes into 32,000 and 3,392,000 shares of common stock, respectively. During 2008, noteholders also elected to convert approximately $0.5 million of related interest into 279,000 shares of common stock.

During 2009 and 2008, the Company elected to pay the quarterly interest payments in kind on the convertible notes and issued approximately $9.8 million and $8.0 million in additional convertible notes in accordance with terms of the note purchase agreement, respectively.

7. Income Taxes

The Company has incurred losses since inception and, therefore, has not been required to pay federal income taxes. As of December 31, 2009, the Company has generated net operating loss ("NOL") carryforwards of approximately $88.1 million that may be available to reduce future income taxes. These carryforwards begin to expire in 2012 with a limited annual utilization. Several factors may further limit the Company's ability to utilize these carryforwards, including a lack of future taxable income, a change of Company ownership (as defined by federal income tax regulations) or the expiration of the utilization period allowed by federal income tax regulations.

During 2009 and 2008, the valuation allowance increased $9,683,708 and $26,656,407, respectively, primarily due to the Company's losses. The effective tax rate for 2009 and 2008 differs from the statutory tax rate due primarily to the valuation allowance. The components of the Company's deferred tax liabilities and assets at December 31, 2009 and 2008, are as follows:

The valuation allowance is primarily attributed to U.S. federal deferred tax assets. Management believes enough uncertainty exists regarding the realization of these items and has recorded a full valuation allowance.

Profits derived from oil and gas operating activities are subject to a profits tax on taxable income as defined by Georgian law. However, under the terms of the Block 12 PSA, Georgian Oil is responsible for paying the Company's profit tax liabilities with respect to income derived from these activities. Although the Company has incurred operating losses in Georgia, no adjustment with respect to deferred tax assets or a potentially related valuation allowance has been made, as any future benefit related to these operating losses would serve to reduce Georgian Oil's liability.

On January 1, 2007, the Company adopted the provisions of FIN 48. The Company has determined that no uncertain tax positions exist where the Company would be required to make additional tax payments. As a result, the Company has not recorded any additional liabilities for any unrecognized tax benefits as of December 31, 2009. The Company and its subsidiaries file income tax returns in the US federal jurisdiction. Tax years 2004 to present remain open for these taxing authorities due to the Company's net operating losses. The Company's accounting policy is to recognize penalties and interest related to unrecognized tax benefits as income tax expense. The Company does not have an accrued liability for the payment of penalties and interest at December 31, 2009.

8. Commitments and Contingencies

Operating Leases

The Company has noncancelable operating leases for office facilities and lodging. Approximate future minimum annual rental commitments under these operating leases are as follows:

Rental expense for the years ended December 31, 2009 and 2008 was approximately $640,000 and $588,000, respectively.

SOCAR Arbitration

In June 1998, Frontera Resources Azerbaijan Corporation, an indirect wholly owned subsidiary of the Company, entered into a production sharing agreement with the State Oil Company of the Azerbaijan Republic (SOCAR), hereafter referred to as the "Azerbaijan PSA". The Azerbaijan PSA covered the Kursangi and Karabagli onshore oilfields in an area of Azerbaijan known as the "K&K Block". The Company and an operating partner undertook an exploration and development program on the K&K Block. The Company's relationship with SOCAR deteriorated as a result of several disputes under the Azerbaijan PSA, and the Company was unsuccessful at reaching a settlement with SOCAR.

Frontera initiated binding arbitration against SOCAR in October 2003 related to claims resulting from SOCAR's halting of oil exports and seizure of oil from the K&K Block during the fourth quarter of 2000. The arbitration was held in Stockholm under the rules of the United Nations Commission on International Trade Law. In January 2006, the arbitral panel found that the seizure of crude oil from the K&K Block was in violation of the Azerbaijan PSA and awarded Frontera approximately $1.2 million plus interest from January 2001 until payment is made. Including interest, the amount of the award is approximately $2.0 million. The arbitral panel directed Frontera to pay approximately $0.3 million of SOCAR's costs and rejected all other claims and counterclaims between the parties. SOCAR refused to pay the award and filed an action in the Svea Court of Appeals in Stockholm to annul the award. A final hearing was held in March 2009, and in May 2009, the court upheld the original award and directed SOCAR to pay Frontera additional costs of approximately $0.3 million. The court's decision states that it is not subject to appeal. In June 2009, SOCAR paid the award and related costs in accordance with the ruling of the arbitral panel and the court of appeal.

The Company commenced an action in the United States District Court for the Southern District of New York in February 2006, seeking to enforce the award. In March 2007, the District Court granted SOCAR's motion to dismiss, and the Company appealed that decision in July 2007 to the United States Court of Appeals for the Second Circuit. The hearing on the appeal occurred in October 2008. In September 2009, the Second Circuit issued its opinion and remanded the case to the District Court for further consideration in view of its ruling. Upon stipulation by the parties, the District Court dismissed the case in October 2009.

GAC Arbitration

In June 2007, Frontera Resources Georgia Corporation, an indirect wholly owned subsidiary of the Company ("FRGC"), was served a notice of arbitration and claim by GAC Energy Company and an affiliated company (collectively, "GAC"). GAC and Frontera were parties to a farmout agreement dated June 2002 covering Block 12 (the "Farmout Agreement"), pursuant to which GAC would earn a 25% working interest in Block 12 and a 12.5% interest in Frontera Eastern Georgia Limited, an indirect consolidated subsidiary of the Company ("FEGL"), upon the fulfillment of certain financial and work program commitments. In September 2004, GAC reassigned its interest in Block 12 to Frontera as a result of GAC's default on its financial and work program commitments. The notice of arbitration and claim alleged, among other things, that GAC did not default on its obligations under the Farmout Agreement and should be awarded a 25% working interest in Block 12. The evidentiary hearing was held in July 2008, and the arbitrator's decision was announced in October 2008. The arbitrator found that GAC failed to complete its obligations under the Farmout Agreement and rejected GAC's claims for either an interest in Block 12 or $19.0 million in restitution and directed GAC to pay Frontera's arbitration costs of approximately $85,000. The arbitration, which is binding on the parties, resolves all claims and counterclaims between Frontera and GAC with respect to the Farmout Agreement.

ARAR Arbitration

In January 2008, FEGL, served a notice of arbitration and claim on ARAR, Inc. ("ARAR"), for breach of contract under a drilling services contract dated May 2007, specifically for, among other things, failure to commence work by the time specified in the contract, failure of the drilling rig to meet required specifications and failure to reconcile advance payments made by FEGL with work actually performed. FEGL terminated the contract after ARAR failed to mobilize the rig to the required location and failed to commence work as otherwise required under the contract. FEGL claimed damages of approximately $7.0 million in the arbitration. ARAR denied FEGL's claims and filed counterclaims against FEGL, seeking payments of approximately $7.1 million for, among other things, standby charges for the period of time the rig was undergoing inspection and repairs to bring it into contract specification, early termination fees and demobilization fees. The parties entered into a settlement agreement in December 2008 pursuant to which ARAR is required to make a series of payments to FEGL through December 2009. The settlement resolves all outstanding claims and counterclaims between Frontera and ARAR arising out of the drilling services contract. Beginning in August 2009, ARAR defaulted on its monthly payments and remains in default on payments due August - December 2009. The Company has applied to the arbitration panel for entry of an agreed award pursuant to the settlement agreement. The panel held a hearing on the Company's application on March 25, 2010, and its decision is pending.

9. Stockholders' Equity

Preferred Stock

The Company has the authority to issue up to 10,000,000 shares, par value $.00001, of serial preferred stock. No preferred stock is outstanding at December 31, 2009 and 2008. The Board of Directors may designate and authorize the issuance of such shares with such voting power and in such classes and series, and with such designation, preferences and relative participation, optional, or other special rights, qualifications, limitations, or restrictions as deemed appropriate by the Company's Board of Directors.

Common Stock

As of December 31, 2009, the Company is authorized to issue 300,000,000 shares of common stock, par value $.00004 per share. As of December 31, 2009 and 2008, the Company had 131,793,282 and 74,868,608 shares of common stock issued and outstanding, respectively. At December 31, 2009 and 2008, additional shares in the amount of 69,633,000 and 17,999,000, respectively, of common stock were reserved for the exercise of existing options and warrants.

Treasury Stock

As of December 31, 2009 and 2008, the Company had 5,739,855 shares of treasury stock, all held as common stock.

1998 Employee Stock Incentive Plan

In 1998, the Company's stockholders approved the 1998 Employee Stock Incentive Plan (the "Plan"), pursuant to which options may be granted to purchase up to 15% of the Company's common stock authorized to be issued by the Company, reduced by the total number of shares of stock subject to stock options and stock awards that have been granted under the Plan and the Frontera Resources Corporation 2000 Nonqualified Stock Option and Stock Award Plan at any given time. The Board of Directors has appointed Frontera's chief executive officer as administrator (the "Administrator") of the Plan. In this capacity, the Administrator determines which employees will receive options, the number of shares covered by any option agreement, and the exercise price and other terms of each such option. The Board of Directors is responsible for administering the Plan as it relates to options granted to the chief executive officer.

Under the terms of the Plan, any issued options expire ten years after the date of grant, with the exception of options granted to 10% stockholders which expire five years after the date of grant, or upon earlier termination of employment. Options granted vest over periods ranging from immediate vesting to vesting in equal increments over three years from the date of grant.

2000 Nonqualified Stock Option and Stock Award Plan

In 2000, the Company's Board of Directors approved the 2000 Nonqualified Stock Option and Stock Award Plan (the "Stock Award Plan"), pursuant to which options may be granted to purchase up to 15% of the Company's common stock authorized to be issued by the Company, reduced by the total number of shares of stock subject to stock options and stock awards that have been granted under the Stock Award Plan and the Frontera Resources Corporation 1998 Employee Stock Incentive Plan. The Board of Directors has appointed Frontera's chief executive officer as administrator (the "Administrator") of the Stock Award Plan. In this capacity, the Administrator determines which employees will receive options, the number of shares covered by any option agreement, and the exercise price and other terms of each such option. The Board of Directors is responsible for administering the Stock Award Plan as it relates to options granted to the chief executive officer.

Under the terms of the Stock Award Plan, any issued options expire ten years after the date of grant or upon earlier of termination of employment or affiliation relationship between the grantee and the Company. Options granted vest over periods ranging from immediate vesting to vesting in equal increments over three years from the date of grant.

A summary of the Company's stock option activity and related information is as follows:

The following table summarizes information about stock options outstanding at December 31, 2009:

Stock option information related to the nonvested options for the year ended December 31, 2009, was as follows:

The Company granted 7,875,000 options to employees during 2009 with exercise prices ranging from $0.24 to $0.37, which was at or above the market value of the Company's common stock at the time of grant. The weighted average fair value of the options granted in 2009 was $0.21. The fair value of the option grants were calculated using a Black-Scholes option pricing model, with the following weighted average assumptions: risk free interest rate of 2.36%; no dividend yield; volatility factor of 224%; and an expected option life of 9.60 years. At December 31, 2009 and 2008, the stock options outstanding had no intrinsic value.

During 2009 the Company completed a stock option exchange program for employees and directors of the Company pursuant to which, stock options previously granted at strike prices ranging from $1.00 to $2.87 were eligible to be exchanged on a three-for-one basis at a strike price equal to the closing price on September 29, 2009, the date the election period ended. All vesting and expiration dates of the options remained unchanged. As a result of the exchange program, approximately 7.8 million previously granted options were exchanged for approximately 2.6 million options with a strike price of £0.17 per share.

10. Related Party

In conjunction with the Company's private placement of approximately $23.5 million of convertible unsecured notes in July 2008, a director was paid a fee pursuant to the consulting agreement of approximately $0.5 million in cash. In addition to the fees noted above, this same director received consulting fees for the years ended December 31, 2009 and 2008 of $458,390 and $301,500, respectively, pursuant to the consulting agreement.

Introduction

The following discussion and analysis should be read in conjunction with the accompanying financial statements and related notes thereto. The following discussion contains forward-looking statements that reflect our future plans, estimates, beliefs and expected performance. The forward-looking statements are dependent upon events, risks and uncertainties that may be outside our control. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, market prices for natural gas and oil, economic and competitive conditions, regulatory changes, estimates of proved reserves, potential failure to achieve production from development projects, capital expenditures and other uncertainties, as well as those factors discussed below, particularly in "Risk Factors" and "Cautionary Statement Concerning Forward-Looking Statements," all of which are difficult to predict. In light of these risks, uncertainties and assumptions, the forward-looking events discussed may not occur.

Overview of Our Company

Frontera Resources Corporation, a Delaware corporation, and its subsidiaries (collectively "Frontera" or the "Company") are engaged in the development of oil and gas projects in emerging marketplaces. Frontera was founded in 1996 and is headquartered in Houston, Texas. The Company emphasizes development of reserves in known hydrocarbon-bearing basins, and is attracted to projects that have significant exploration upside. Since 2002, the Company has focused substantially all of its efforts on the exploration and development of oilfields within the country of Georgia ("Georgia"), a member of the Former Soviet Union. Prior to 2002, the Company's other significant operating focus was on the exploration and development of an oilfield within the Azerbaijan Republic ("Azerbaijan"), which was sold during 2002 and all operating activities in Azerbaijan ceased at that time.

During 2009 the Company shifted its focus to lower cost lower risk drilling in its Shallow Fields Production Unit, primarily in the Mirzaani and Mtsarekhevi fields. During 2010 the Company expects to continue this focus while seeking strategic partners to advance its work in the Tarabani and Basin Edge business units.

In accordance with full cost accounting rules, we are subject to a limitation on capitalized costs. The capitalized cost of natural gas and oil properties, net of accumulated depreciation, depletion and amortization, may not exceed the estimated future net cash flows from proved oil and gas reserves discounted at 10%, plus the lower of cost or fair market value of unproved properties as adjusted for related tax effects, which is known as the ceiling limitation. If capitalized costs exceed the ceiling limitation, the excess must be charged to expense. For the years ended December 31, 2009 and 2008, we recorded impairment provisions of $1.1 million and $47.9 million respectively, related to the Company's fields in Georgia.

Results of Operations

Twelve Months Ended December 31, 2009 Compared to Twelve Months Ended December 31, 2008

Revenue. Revenues for the twelve months ended December 31, 2009 decreased $0.7 million to $4.1 million from $4.8 million for the comparable 2008 period. The decrease was due mainly to decreases in commodity prices in the 2009 period.

Operating Costs and Expenses. Total operating costs and expenses decreased to $22.1 million for the twelve months ended December 31, 2009 compared to $74.6 million for the same period in 2008.

Field operating and project costs includes the costs associated with our exploration and production activities, including, but not limited to, drilling, field operating expense and processing costs. These costs decreased $2.3 million to $5.2 million during the twelve months ended December 31, 2009 as compared to $7.5 million for the twelve months ended December 31, 2008. The decrease was due to lower cost of oil sold in the 2009 period due to a lower of cost or market adjustment for December 31, 2008 quantities in inventory due to low year end 2008 oil prices that were subsequently sold in the 2009 period. Also a number of expatriate employee's were released in the 2009 period versus the 2008 period. Finally, an overall cost optimization program focused mainly on the Shallow Fields Production Unit lowered operating costs in the 2009 period versus the 2008 period.

Depreciation, depletion and amortization increased $0.2 million during the twelve months ended December 31, 2009 to $0.9 million as compared to $0.7 million for the twelve months ended December 31, 2008. The increase was primarily attributable to higher production volumes in the 2009 period versus the 2008 period. Impairment expensed decreased to $1.1 million for the twelve months ended December 31, 2009 from $47.9 million for the 2008 period, due to a large ceiling test write-down during the twelve months ended December 31, 2008 with less of an adjustment required in the 2009 period.

General and administrative expenses decreased $3.6 million to $14.9 million for the twelve months ended December 31, 2009 from $18.5 million for the comparable period in 2008. The decrease was generally attributable to a series of cost cutting measures instituted in the first quarter of 2009, primarily related to headcount reductions in Georgia and Houston.

Other Income (Expense). Total other expense increased to $10.6 million in the twelve month period ended December 31, 2009 from $9.1 million in the twelve month period ended December 31, 2008. The $1.5 million increase is primarily attributable to a $2.6 million realized loss on investments, an increase in interest expense of $1.9 million, a decrease in interest income of $0.8 million, partially offset by a $2.0 million arbitral award collected in the second quarter of 2009 and derivative income of $1.5 million.

Interest income decreased to $0.3 million for the twelve months ended December 31, 2009 from $1.1 million for the same period in 2008. This decrease was due to lower available cash for investment in the 2009 period as compared to the same period in 2008 primarily due to the $23.5 million convertible debt offering which occurred in July 2008.

Interest expense increased to $11.8 million for the twelve months ended December 31, 2009 from $9.9 million for the same period in 2008. This increase was primarily attributable to interest on the $23.5 million convertible debt offering in July 2008 being outstanding for a full twelve months in the 2009 period and to additional debt incurred by making interest payments in kind on the 2007 and 2008 convertible debt offerings.

Derivative income increased to $1.5 million for the twelve months ended December 31, 2009 from zero in 2008. The increase is due mainly to the required marking to market of 46.5 million warrants issued as part of the Company's September 2009 $7.6 million equity financing. See Note 2 and 3 of the accompanying financial statements for further discussion.

Three Months Ended December 31, 2009 Compared to Three Months Ended December 31, 2008

Revenue. Revenues for the three months ended December 31, 2009 increased to $2.4 million from $2.0 million during the same period in 2008. The increase is mainly due to higher volumes of oil sold in the 2009 period as compared to the 2008 period.

Operating Costs and Expenses. Total operating costs and expenses decreased to $4.2 million for the three months ended December 31, 2009 compared to $55.7 million for the same period in 2008.

Field operating and project costs includes the costs associated with our exploration and production activities, including, but not limited to, drilling, field operating expense and processing costs. These costs decreased $2.4 million to $1.1 million during the three months ended December 31, 2009 as compared to $3.5 million for the three months ended December 31, 2008. Approximately $1.0 million of the decrease relates to a Q4 2009 adjustment to allocate drilling personnel previously included in operaing expenses to 2009 drilling capital expenditures. The remaining $1.4 million decrease is mainly attributable to lower cost of crude sold in 2009 versus the 2008 period, and a charge for inventory writedown in the 2008 period with no like charge in the 2009 period.

Depreciation, depletion and amortization increased $0.1 million during the three months ended December 31, 2009 to $0.3 million as compared to $0.2 million for the three months ended December 31, 2008. The increase is mainly attributable to higher depletion expense incurred due to higher production volumes in the 2009 period versus the 2008 period. Impairment decreased $47.9 million during the three months ended December 31, 2009 to $0.0 million as compared to $47.9 million for the three months ended December 31, 2008. The decrease was primarily attributable to the $47.9 million ceiling test write-down during the fourth quarter of 2008 with no like adjustment required in the 2009 period.

General and administrative expenses decreased $1.4 million to $2.8 million for the three months ended December 31, 2009 from $4.2 million for the comparable period in 2008. The decrease was generally attributable to a series of cost cutting measures instituted in the first quarter of 2009, primarily related to headcount reductions in Georgia and Houston.

Other Income (Expense). Total other income increased to $0.1 million in the three month period ended December 31, 2009 from other expense of $3.0 million in the three month period ended December 31, 2008. The increase is primarily attributable to an increase in derivative income of $4.9 million, as a result of marking to market derivative stock warrant liabilities with no like transaction in the 2008 period. This was partially offset by a $1.9 million realized loss on investments in the 2009 period with no like amount for the 2008 period.

Interest income decreased to $0.1 million for the three months ended December 31, 2009 from $0.2 million for the same period in 2008. This decrease was due to lower available cash for investment in the 2009 period as compared to the same period in 2008 primarily due to the $23.5 million convertible debt offering which occurred in July 2008.

Interest expense increased to $3.1 million for the three months ended December 31, 2009 from $2.9 million for the same period in 2008. This increase was primarily attributable to interest on the additional debt incurred by making interest payments in kind on the 2007 and 2008 convertible debt offerings.

Derivative income increased to $4.9 million for the three months ended December 31, 2009 from zero for the same period in 2008. The increase is due mainly to the required marking to market of 46.5 million warrants issued as part of the Company's September 2009 $7.6 million equity financing. See Note 2 and 3 of the accompanying financial statements for further discussion.

Liquidity and Capital Resources

Summary

The Company has incurred net losses and negative cash flows from operations in most fiscal periods since inception. Based on the Company's current operating plan, its existing working capital will not be sufficient to meet the cash requirements to fund the Company's planned operating expenses and capital expenditures through December 31, 2010 without additional sources of financing. Management plans to continue to reduce costs and raise additional financing to meet its cash needs for 2010 and has commenced discussions with various financial institutions to seek additional financing in order to facilitate the Company's 2010 operating plan. Throughout 2008 and 2009, however, there has been extreme volatility and disruption in the global capital and credit markets. While these market conditions persist, the Company's ability to access the capital and credit markets is likely to be adversely affected. Although the Company is encouraged about the prospects of raising capital, discussions are still preliminary and may not result in a successful financing.

Failure to generate sufficient operating cash flows, raise additional capital or further reduce spending will have a material adverse effect on the Company's ability to continue as a going concern and to achieve its intended business objectives. There can be no assurance that sufficient revenues will be generated in the future to sustain the Company's operations. These consolidated financial statements do not include any adjustments related to the outcome of this uncertainty.

Notwithstanding management's plan to reduce costs and raise additional financing, the Company's viability is dependent upon producing oil and gas in sufficient quantities and marketing such oil and gas at sufficient prices to provide positive operating cash flow to the Company. The Company is solely responsible for providing all of the funding for the development of Block 12 in Georgia and will require additional funding in order to obtain certain levels of production and generate sufficient cash flows to meet future capital and operating spending requirements. This is dependent upon, among other factors, achieving significant increases in production, production of oil and gas at costs that provide acceptable margins, reasonable levels of taxation from local authorities, and the ability to market the oil and gas produced at or near world prices.

Management's plan for addressing the above uncertainties is partially based on forward looking events which have yet to occur, including the successful completion of its development program, and accordingly, there is no assurance that those events will transpire as initially contemplated.

The following key financial measurements reflect our financial position and capital resources as of December 31, 2009 and December 31, 2008 (dollars in thousands):

Our cash and cash equivalents consist of highly liquid investments in deposits we hold at major financial institutions.

Our operating cash flow is influenced mainly by the prices that we receive for our oil production, the quantity of oil we produce and the success of our development and exploration activities. Currently we do not generate sufficient operating cash flows to cover our general corporate activities or our planned capital expenditure programs. The principal factors that could adversely affect the amount and availability of our internally generated cash flows from operations include:

Decline in the sales price of crude oil.

Decline in current production volumes or production volumes of future wells being less than anticipated.

Inability to attract outside financing to continue discretionary capital expenditures for future drilling.

We have met all minimum expenditure requirements under our production sharing contract in Georgia and therefore our planned capital expenditure programs are entirely discretionary.

As of December 31, 2009, our cash and cash equivalents were $0.8 million, and our short term investments were $8.1 million. At December 31, 2009 the Company had $104.1 million of convertible long term debt outstanding. The Company also had a $9.5 million short term note payable to a bank which was collateralized by $10.0 million par value in long term investments in M-STARS and $0.6 million of restricted cash. The Company had no other outstanding debt at December 31, 2009.

Capital Expenditures

We have met all capital expenditure requirements under the terms of our production sharing agreement with Georgia and as a result, our capital expenditures are now discretionary. While we make and expect to continue to make substantial capital expenditures in the exploration, development, and production of natural gas and oil reserves, we are able to adjust our expenditures according to available capital resources.

Our total capital expenditures for the twelve months ended December 31, 2009 were approximately $8.4 million. Our 2009 capital expenditures represent a 74% decrease over actual 2008 capital expenditures during the same period. Our 2009 capital expenditures have been focused on growing and developing our reserves and production on our existing Block 12 acreage. Of our total $8.4 million of 2009 capital expenditures, substantially all was directed to exploration and production activities in the Shallow Fields Production units.

In order to fund discretionary capital expenditures planned for 2010, we will require additional outside financing. Throughout 2008 and 2009, there has been extreme volatility and disruption in the global capital and credit markets. While these market conditions persist, our ability to access the capital and credit markets is likely to be adversely affected.

The principal factors that could adversely affect the amount and availability of our internally generated cash flows from operations include:

Decline in the sales price of crude oil.

Decline in current production volumes or production volumes of future wells being less than anticipated.

Inability to attract outside financing to continue discretionary capital expenditures for future drilling.

The principal factors that could adversely affect our ability to obtain financing from external sources include:

Covenants contained in our 10% convertible notes.

Volatility in the markets for corporate debt, continued market instability, unavailability of credit or inability to access the capital markets as a result of global financial conditions.

Fluctuations in the market price of our common stock.

Cash Flow Activity

Operating Activities. Cash flows used in operating activities decreased $16.0 million to $10.2 million for the twelve months ended December 31, 2009 from $26.2 million for the twelve months ended December 31, 2008. The decrease was primarily attributable to higher non-cash charges and lower changes in operating assets and liabilities for the twelve months ended December 31, 2009 as compared to the same period in 2008.

Investing Activities. Cash flows used in investing activities decreased $9.8 million to $6.4 million in the twelve month period ended December 31, 2009 from $16.2 million in the 2008 period. The increase was primarily attributable to a net decrease of $11.1 million in investment redemptions. This was offset by a $20.9 million decrease in capital expenditures for the twelve months ended December 31, 2009 as compared to December 31, 2008 as the Company's drilling campaign was significantly reduced in the 2009 period.

Financing Activities. Since March 2005, we have used equity issuances, borrowings and, to a lesser extent, our cash flows from oil sales to fund our exploration and production costs and general corporate overhead. Cash provided by financing activities decreased $34.7 million to $10.1 million for the twelve months ended December 31, 2009 from $44.8 million for the twelve months ended December 31, 2008. Our primary financing activities for the 2009 period included $5.0 million of restricted cash that was released as collateral when the Company's $5.0 million line of credit was repaid in full and net proceeds of $7.1 million from an equity financing in September 2009. We used the net proceeds to fund our capital expenditure programs and for general corporate purposes.

Contractual Obligations and Commitments-

The following table outlines our contractual obligations and commitments by payment due dates as of September 30, 2009 (in millions):

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of our financial statements requires us to make assumptions and prepare estimates that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and revenues and expenses. We base our estimates on historical experience and various other assumptions that we believe are reasonable; however, actual results may differ. See Notes 1 and 3 ("Nature of Operations" and "Summary of Significant Accounting Policies") to our consolidated financial statements for a discussion of our significant accounting policies.

 Risk Factors

Risks Related to the Natural Gas and Oil Industry and Our Business

Our revenue, profitability and cash flow depend upon the prices and demand for natural gas and oil. The markets for these commodities are very volatile. Even relatively modest drops in prices can significantly affect our financial results and impede our growth. Changes in natural gas and oil prices have a significant impact on the value of our reserves and on our cash flow. Prices for natural gas and oil may fluctuate widely in response to relatively minor changes in the supply of and demand for natural gas and oil and a variety of additional factors that are beyond our control, such as:

the domestic and foreign supply of natural gas and oil;

the price of foreign imports;

worldwide economic conditions;

political and economic conditions in oil producing countries;

the ability of members of the Organization of Petroleum Exporting Countries to agree to and maintain oil price and production controls;

the level of consumer product demand;

weather conditions;

technological advances affecting energy consumption;

availability of pipeline infrastructure, treating, transportation and refining capacity;

domestic and foreign governmental regulations and taxes;

the price and availability of alternative fuels;

the inability to obtain financing on satisfactory terms.

Lower oil and natural gas prices may not only decrease our revenues on a per share basis, but also may reduce the amount of oil and natural gas that we can produce economically. This may result in our having to make substantial downward adjustments to our estimated proved reserves, and could result in a ceiling test writedown.

Our estimated reserves are based on many assumptions that may turn out to be inaccurate. Any significant inaccuracies in these reserve estimates or underlying assumptions will materially affect the quantities and present value of our reserves.

The present value of future net cash flows from our proved reserves will not necessarily be the same as the current market value of our estimated natural gas and oil reserves.

Unless we replace our natural gas and oil reserves, our reserves and production will decline, which would adversely affect our business, financial condition and results of operations.

Our potential drilling location inventories are scheduled over several years, making them susceptible to uncertainties that could materially alter the occurrence or timing of their drilling.

We will not know conclusively prior to drilling whether natural gas or oil will be present in sufficient quantities to be economically viable.

Our use of 2-D and 3-D seismic data is subject to interpretation and may not accurately identify the presence of natural gas and oil, which could adversely affect the results of our drilling operations.

Market conditions or operational impediments may hinder our access to natural gas and oil markets or delay our production.

We have a substantial amount of indebtedness, which may adversely affect our cash flow and our ability to operate our business.

Competition in the natural gas and oil industry is intense, which may adversely affect our ability to succeed.

Our operations expose us to potentially substantial costs and liabilities with respect to environmental, health and safety matters.

The volatility and disruptions in the global capital and credit markets have created conditions that may adversely affect the financial condition of our insurers, oil and natural gas purchasers and other counterparties with whom we deal. The inability of one or more of our customers or vendors to meet their obligations may adversely affect our financial results.

Our development and exploration operations require substantial capital and we may be unable to obtain needed capital or financing on satisfactory terms, which could lead to a loss of properties and a decline in our natural gas and oil reserves.

We are subject to commodity price risk on our production, and our liquidity may be adversely affected if commodity prices decline. A reduction in the demand for, and the resulting lower prices of, oil and gas could adversely affect our results of operations.

Foreign Operations

Frontera's future revenues depend on operating results from its operations in the Republic of Georgia. The success of Frontera's operations is subject to various contingencies beyond management control. These contingencies include general and regional economic and political conditions, prices for crude oil, competition and changes in regulation. Frontera is subject to various additional political and economic uncertainties in Georgia which could include restrictions on transfer of funds, import and export duties, quotas and embargoes, domestic and international customs and tariffs, relations with neighboring countries including the Russian Federation, and changing taxation policies, foreign exchange restrictions, political conditions and regulations.

Cautionary Statement Concerning Forward-Looking Statements

Various statements contained in this management's discussion and analysis (MD&A), including those that express a belief, expectation, or intention, as well as those that are not statements of historical fact, are forward-looking statements. These forward-looking statements may include projections and estimates concerning the timing and success of specific projects and our future production, revenues, income and capital spending. Our forward-looking statements are generally accompanied by words such as "estimate," "project," "predict," "believe," "expect," "anticipate," "potential," "could," "may," "foresee," "plan," "goal" or other words that convey the uncertainty of future events or outcomes. The forward-looking statements in this MD&A speak only as of the date of this MD&A; we disclaim any obligation to update these statements unless required by securities law, and we caution you not to rely on them unduly. We have based these forward-looking statements on our current expectations and assumptions about future events. While our management considers these expectations and assumptions to be reasonable, they are inherently subject to significant business, economic, political, competitive, regulatory and other risks, contingencies and uncertainties relating to, among other matters, the risks discussed under the heading "Risk Factors" and the following:

the volatility of natural gas and oil prices;

discovery, estimation, development and replacement of natural gas and oil reserves;

cash flow and liquidity;

financial position;

business strategy;

amount, nature and timing of capital expenditures, including future development costs;

availability and terms of capital;

timing and amount of future production of natural gas and oil;

availability of drilling and production equipment;

availability of oil field labor;

operating costs and other expenses;

prospect development and property acquisitions;

availability of pipeline infrastructure to transport natural gas production;

marketing of natural gas and oil;

competition in the natural gas and oil industry;

regional and worldwide political conditions and uncertainties;

governmental regulation and taxation of the natural gas and oil industry; and

developments in oil-producing and natural gas-producing countries.