Introduction

Our two major operating areas (Poland and the U.S.) have very different characteristics, which are reflected in the following discussion. Our Polish operations are early in their initial exploration and development. Our U.S. operations, which include both oil production and oilfield services, are relatively mature. See "Results of Operations by Business Segment" below.

Quarter Ended June 30, 2009, Compared to the Same Period of 2008

Exploration and Production Segment

Gas Revenues. Revenues from gas sales were $1.0 million during the second quarter of 2009, compared to $2.2 million during the same quarter of 2008. Production at our Wilga well continued to decline, with second quarter 2009 production some 83% lower than second quarter 2008 production. The production decline at Wilga, along with exchange rate changes, drove lower per-unit prices for the 2009 quarter. Gas produced from our Wilga well, due to its high methane content, receives a higher price than gas produced at our other properties. Lower production from Wilga results in lower weighted average sales prices in Poland.

Production at our Zaniemsyl well was also slightly lower during the 2009 quarter, as it was shut-in for several days of maintenance. Following the maintenance, the well resumed production at approximately 10 million cubic feet of natural gas per day, which was approximately the same rate as before the maintenance.

In addition to the Wilga and Zaniemsyl production declines, period-to-period weakness in the Polish zloty against the U.S. dollar resulted in lower U.S. dollar denominated gas revenues. Although the amount of Polish zlotys received per thousand cubic feet of production for each of our wells averaged more than 15% higher during the second quarter of 2009, compared to the second quarter of 2008, average U.S. dollar denominated gas prices related to our Poland production decreased 36% from the second quarter of 2008 to the second quarter of 2009. The average exchange rate during the second quarter of 2008 was 2.18 zlotys per U.S. dollar. The average exchange rate during the second quarter of 2009 dropped to 3.27 zlotys per U.S. dollar, a change of 50%.

A summary of the amount and percentage change, as compared to the respective prior-year period, for gas revenues, average gas prices, and gas production volumes for the quarters ended June 30, 2009 and 2008, is set forth in the following table:

                                           For the Quarter Ended June 30,
                                              2009               2008         Change
Revenues                                      $1,040,000         $2,212,000    -53%
Average price (per thousand cubic feet)            $4.44              $6.91    -36%
Production volumes (thousand cubic feet)         234,000            320,100    -27%

The Polish Energy Regulatory Office approved new gas tariffs on May 7, 2009. All tariffs are denominated in Polish zlotys. The new tariff for high-methane gas, which applies to our Wilga well, decreased by 9%. This price change will be effective for us beginning on July 1, 2009. The new tariff for low-methane gas, which applies to the remainder of our production in Poland, decreased by 5%. The price change was effective on June 1, 2009, for our Kleka production, and will be effective on July 1, 2009, for our Zaniemsyl production.

A summary of the amount and percentage change, as compared to the respective prior-year period, for oil revenues, average oil prices, and oil production volumes for the quarters ended June 30, 2009 and 2008, is set forth in the following table:

                              For the Quarter Ended June 30,
                                 2009               2008         Change
Revenues                          $793,000          $1,985,000    -60%
Average price (per barrel)          $50.45             $111.41    -55%
Production volumes (barrels)        15,700              17,800    -12%

Lease Operating Costs. Lease operating costs were $811,000 during the second quarter of 2009, a decrease of $80,000, or 9%, compared to the same period of 2008. Lower operating costs in 2009 were due primarily to exchange rate differences in Poland from quarter to quarter. In addition, operating costs at our Wilga well, specifically those related to chemicals, decreased significantly with the drop in oil production.

Exploration Costs. Our exploration costs consist of geological and geophysical costs and the costs of exploratory dry holes. Exploration costs were $1,265,000 during the second quarter of 2009, compared to $2,226,000 during the same period of 2008, a decrease of 43%. Two factors contributed to the quarter-to-quarter decline. First, exchange rate differences reduced the amount of U.S. dollars required to fund 2009 Polish expenditures; second, our level of activity was lower in 2009 than in 2008. Second quarter 2009 exploration costs included approximately $1,005,000 associated with our ongoing Fences concession area three-dimensional, or 3-D, seismic surveys, and the remainder associated with two-dimensional, or 2-D, seismic and other costs at both existing and new concessions. Second quarter 2008 exploration costs included approximately $1.3 million associated with seismic survey on our 100% owned acreage, approximately $600,000 associated with our Winna Gora 3-D seismic survey, and the remaining costs associated with ongoing 2-D seismic and other costs at our existing project areas.

DD&A Expense - Exploration and Production. DD&A expense for producing properties was $213,000 for the second quarter of 2009, a decrease of 66% compared to $620,000 during the same period of 2008. The 2008 year-end negative reserve revision due to low year-end oil prices, and subsequent impairment of capital costs, at our U.S. properties resulted in lower DD&A costs, as the bulk of the capital costs in the U.S. were removed from our depletion base.

Accretion Expense. Accretion expense was $8,000 and $21,000 for the second quarter of 2009 and 2008, respectively. Accretion expense is related entirely to our Asset Retirement Obligation.

Oilfield Services Revenues. Oilfield services revenues were $633,000 during the second quarter of 2009, a decrease of 37%, compared to $998,000 for the second quarter of 2008. We drilled seven wells for third parties during the second quarter of 2008, along with additional well service work. During the second quarter of 2009, we drilled 14 wells for third parties; however, each of these was a shallow well, which can be drilled in only two to three days. We expect to drill another 13 to 14 shallow wells, followed by two deeper, horizontal wells, during the third quarter of 2009. We expect oilfield services revenues to increase during that quarter. Oilfield services revenues will continue to fluctuate from period to period based on market demand, weather, the number of wells drilled, downtime for equipment repairs, the degree of emphasis on utilizing our oilfield servicing equipment on our Company-owned properties, and other factors.

Oilfield Services Costs. Oilfield services costs were $437,000 during the second quarter of 2009, compared to $710,000 during the same period of 2008. The quarter-to-quarter decrease was primarily due to the nature of our drilling activity in 2009 discussed above. Oilfield services costs will also continue to fluctuate period to period based on market demand, weather, the number of wells drilled, downtime for equipment repairs, the degree of emphasis on utilizing our oilfield servicing equipment on our Company-owned properties, and other factors.

DD&A Expense - Oilfield Services. DD&A expense for oilfield services was $149,000 during the second quarter of 2009, compared to $93,000 during the same period of 2008. The quarter-to-quarter increase was primarily due to new capital additions in 2008 being depreciated.

Nonsegmented Information

G&A Costs. G&A costs were $1,670,000 during the second quarter of 2009, compared to $1,654,000 during the second quarter of 2008, an increase of $16,000. Higher legal, insurance, and accounting costs were largely offset by lower employee compensation costs.

Stock Compensation (G&A). For the three-month periods ended June 30, 2009 and 2008, we recognized $444,000 and $619,000, respectively, of stock compensation expense related to the amortization of unexercised options and restricted stock purchase rights.

Interest and Other Income. Interest and other income was $8,000 during the second quarter of 2009, a decrease of $158,000, compared to $166,000 during the same period of 2008. The decrease was a reflection of lower cash balances available for investment. During the second quarter of 2009, we incurred $145,000 in interest expense, which included $43,000 of amortization of previously incurred loan fees. During the second quarter of 2008, we incurred $39,000 in quarterly commitment fees in connection with securing the Facility and $46,000 of amortization of loan fees, both of which were charged to interest expense.

Foreign Exchange Loss. As discussed in footnote 10 to the financial statements, during the second quarter of 2009 we recorded foreign currency transaction gains of approximately $13.8 million, principally attributable to decreases in the amount of Polish zlotys necessary to satisfy outstanding intercompany dollar-denominated loans and unpaid interest to FX Energy, Inc.

Exploration and Production Segment

Gas Revenues. Revenues from gas sales were $2.3 million during the first half of 2009, compared to $4.1 million during the same period of 2008. Production at our Wilga well continued to decline, with first half 2009 production some 74% lower than first half 2008 production. The production decline at Wilga, along with exchange rate changes, drove lower per-unit prices for the 2009 six months. Gas produced from our Wilga well, due to its high methane content, receives a higher price than gas produced at our other properties. Lower production from Wilga results in lower weighted average sales prices in Poland.

Production at our Zaniemsyl well was also slightly lower during the 2009 six months, as it was shut-in for several days of maintenance. Following the maintenance, the well resumed production at approximately 10 million cubic feet of natural gas per day, which was approximately the same rate as before the maintenance.

In addition to the Wilga and Zaniemsyl production declines, period-to-period weakness in the Polish zloty against the U.S. dollar resulted in lower U.S. dollar denominated gas revenues. Although the amount of Polish zlotys received per thousand cubic feet of production for each of our wells averaged more than 20% higher during the first half of 2009, compared to the same period of 2008, average U.S. dollar denominated gas prices related to our Poland production decreased 31% from the first half of 2008 to the first half of 2009. The average exchange rate during the first half of 2008 was 2.29 zlotys per U.S. dollar. The average exchange rate during the first half of 2009 dropped to 3.36 zlotys per U.S. dollar, a change of 47%.

A summary of the amount and percentage change, as compared to the respective prior-year period, for gas revenues, average gas prices, and gas production volumes for the six months ended June 30, 2009 and 2008, is set forth in the following table:

                                          For the Six Months Ended June 30,
                                               2009                2008          Change
Revenues                                       $2,259,000          $4,052,000     -44%
Average price (per thousand cubic feet)             $4.38               $6.34     -31%
Production volumes (thousand cubic feet)          516,100             639,400     -19%

Oil Revenues. Oil revenues were $1.3 million for the first half of 2009, a 61% decrease from the $3.4 million recognized during the first half of 2008. As with our gas production, oil production at Wilga also declined from the first half of 2008 to 2009. Production from our U.S. properties declined 1% during the first half of 2009. The most significant factor in the decline in oil revenues was the lower prices received during the first half of 2009. Our average oil price during the first half of 2009 was $42.08 per barrel, a 58% decrease from $99.19 per barrel received during the same period of 2008.

                               For the Quarter Ended June 30,
                                  2009               2008         Change
Revenues                          $1,319,000         $3,417,000    -61%
Average price (per barrel)            $42.08             $99.19    -58%
Production volumes (barrels)          31,700             34,400    -8%

Lease Operating Costs. Lease operating costs were $1,558,000 during the first half of 2009, a decrease of $210,000, or 12%, compared to the same period of 2008. Lower operating costs in 2009 were due primarily to exchange rate differences in Poland from year to year. In addition, operating costs at our Wilga well, specifically those related to chemicals, decreased significantly with the drop in oil production.

Exploration Costs. Our exploration costs consist of geological and geophysical costs and the costs of exploratory dry holes. Exploration costs were $3,385,000 during the first half of 2009, compared to $6,277,000 during the same period of 2008, a decrease of 46%. Two factors contributed to the year-to-year decline. First, exchange rate differences reduced the amount of U.S. dollars required to fund 2009 Polish expenditures; second, our level of activity was lower in 2009 than in 2008. First half 2009 exploration costs included approximately $2,600,000 associated with our ongoing Fences concession area 3-D seismic surveys, and the remainder associated with 2-D seismic and other costs at both existing and new concessions. First half 2008 exploration costs included approximately $4.2 million associated with seismic surveys on our 100% owned acreage, approximately $1.3 million associated with our Winna Gora 3-D seismic project, and the remaining costs associated with 2-D seismic and other costs at our existing project areas.

DD&A Expense - Exploration and Production. DD&A expense for producing properties was $432,000 for the first half of 2009, a decrease of 64% compared to $1.2 million during the same period of 2008. The 2008 year-end negative reserve revision due to low year-end oil prices, and subsequent impairment of capital costs, at our U.S. properties resulted in lower DD&A costs, as the bulk of the capital costs in the U.S. were removed from our depletion base.

Accretion Expense. Accretion expense was $16,000 and $42,000 for the first half of 2009 and 2008, respectively. Accretion expense is related entirely to our Asset Retirement Obligation.

Oilfield Services Segment

Oilfield Services Revenues. Oilfield services revenues were $653,000 during the first half of 2009, a decrease of 67%, compared to $1,951,000 for the first half of 2008. We drilled seven wells for third parties during the first half of 2008, along with additional well service work. During the first half of 2009, we drilled 14 wells for third parties; however, each of these was a shallow well, which can be drilled in only two to three days. We expect to drill another 13 to 14 shallow wells, followed by two deeper, horizontal wells, during the third quarter of 2009. Oilfield services revenues will continue to fluctuate from period to period based on market demand, weather, the number of wells drilled, downtime for equipment repairs, the degree of emphasis on utilizing our oilfield servicing equipment on our Company-owned properties, and other factors.

DD&A Expense - Oilfield Services. DD&A expense for oilfield services was $271,000 during the first half of 2009, compared to $173,000 during the same period of 2008. The period-to-period increase was primarily due to new capital additions in 2008 being depreciated.

Nonsegmented Information

G&A Costs. G&A costs were $3,402,000 during the first half of 2009, compared to $3,360,000 during the first half of 2008, an increase of $42,000. Higher legal, insurance, and accounting costs were largely offset by lower employee compensation costs.

Stock Compensation (G&A). For the six-month periods ended June 30, 2009, and June 30, 2008, we recognized $883,000 and $1,245,000, respectively, of stock compensation expense related to the amortization of unexercised options and restricted stock purchase rights.

Interest and Other Income. Interest and other income was $38,000 during the first half of 2009, a decrease of $236,000, compared to $275,000 during the same period of 2008. The decrease was a reflection of lower cash balances available for investment. During the first half of 2009, we incurred $310,000 in interest expense, which included $88,000 of amortization of previously incurred loan fees. During the first half of 2008, we incurred $79,000 in quarterly commitment fees in connection with securing the Facility and $91,000 of amortization of loan fees, both of which were charged to interest expense.

Foreign Exchange Loss. As discussed in footnote 10 to the financial statements, during the first half of 2009, we recorded foreign currency transaction losses of approximately $6.7 million, principally attributable to increases in the amount of Polish zlotys necessary to satisfy outstanding intercompany dollar-denominated loans and unpaid interest to FX Energy, Inc.

Liquidity and Capital Resources

To date, we have financed our operations principally through the sale of equity securities, issuance of debt securities, and agreements with industry participants that funded our share of costs in certain exploratory activities in return for an interest in our properties. With the establishment of proved reserves in Poland, in November 2006, we established a $25.0 million Senior Credit Facility with the Royal Bank of Scotland to fund infrastructure and development costs in Poland. As of December 31, 2008, we had drawn down the full $25.0 million available under this Facility. In addition, cash flows from our operations have been providing a portion of our overhead and capital needs for the past 24 months.

For the short-term, the primary source of funds will be existing cash balances and cash flow from operations. We expect our Roszkow well in Poland to be a significant contributor to our future operating cash flows. We anticipate cash flows will increase with the start of production from our Roszkow well, which we expect to begin producing during the fourth quarter of 2009. Our expected discretionary cash flow combined with our cash resources should enable us to meet our anticipated capital needs in Poland and the United States for the next 12 months.

We may seek to obtain additional funds for future capital expenditures from the sale of additional securities, project financing, sale of partial property interests, or other arrangements, all of which may dilute the interest of our existing stockholders or our interest in the specific project financed. We will allocate our existing capital as well as funds we may obtain in the future among our various projects at our discretion. We may change the allocation of capital among the categories of anticipated expenditures depending upon future events. For example, we may change the allocation of our expenditures based on the actual results and costs of future exploration, appraisal, development, production, property acquisition, and other activities.

Working Capital (current assets less current liabilities). Our working capital at June 30, 2009, was $4,667,000, a decrease of $9,298,000 from our working capital at December 31, 2008, of $13,965,000. As of June 30, 2009, our cash and cash equivalents and marketable securities totaled approximately $6.4 million.

Operating Activities. Net cash used in operating activities was $7,491,000 during the first half of 2009, compared to net cash used in operating activities of $7,512,000 during the first half of 2008.

Investing Activities. During the first six months of 2009, we used cash of $221,000 in investing activities. We received proceeds of $4,398,000 from maturities of marketable securities, purchased marketable securities of $10,000, used $2,195,000 for current year capital additions in Poland and $246,000 related to our proved properties in the United States, used $1,623,000 to pay accounts payable related to prior-year capital costs, and used $545,000 for capital additions in our office and drilling equipment. During the first half of 2008, we received $513,000 from investing activities. We received proceeds of $6,000,000 from maturities of marketable securities, purchased marketable securities of $204,000, used $3,670,000 for current year capital additions in Poland and $662,000 related to our proved properties in the United States, used $428,000 to pay accounts payable related to prior-year capital costs, and used $523,000 for capital additions in our office and drilling equipment.

New Accounting Pronouncements

As discussed in Note 11 to the financial statements, we have reviewed all recently issued, but not yet adopted, accounting standards in order to determine their effects, if any, on our consolidated results of operations, financial position, and cash flows. Based on that review, we believe that none of these pronouncements will have a significant effect on current or future earnings or operations.

Critical Accounting Policies

A summary of our significant accounting policies is included in Note 1 of our Consolidated Financial Statements contained in our annual report on Form 10-K for the year ended December 31, 2008. We believe the application of these accounting policies on a consistent basis enables us to provide financial statement users with useful, reliable, and timely information about our earnings results, financial condition, and cash flows.

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires our management to make judgments, estimates, and assumptions regarding uncertainties that affect the reported amounts presented and disclosed in the financial statements. Our management reviews these estimates and assumptions, which are based on historical experience, changes in business conditions, and other relevant factors that it believes to be reasonable under the circumstances. In any given reporting period, actual results could differ from the estimates and assumptions used in preparing our financial statements.

Critical accounting policies are those that may have a material impact on our financial statements and also require management to exercise significant judgment due to a high degree of uncertainty at the time the estimate is made. Our senior management has discussed the development and selection of our accounting policies, related accounting estimates, and the disclosures set forth below with the Audit Committee of our Board of Directors. We believe our critical accounting policies include those addressing the recoverability and useful lives of assets, the retirement obligations associated with those assets, and the estimates of oil and gas reserves.

Forward-Looking Statements

This report contains statements about the future, sometimes referred to as "forward-looking" statements. Forward-looking statements are typically identified by the use of the words "believe," "may," "could," "should," "expect," "anticipate," "estimate," "project," "propose," "plan," "intend," and similar words and expressions. We intend that the forward-looking statements will be covered by the safe harbor provisions for forward-looking statements contained in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Statements that describe our future strategic plans, goals, or objectives are also forward-looking statements.

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