The following discussion is intended to assist you in understanding our business and the results of our operations. It should be read in conjunction with the consolidated condensed financial statements and the related notes that appear elsewhere in this report as well as our Annual Report on Form 10-K for the year ended December 31, 2011. Certain statements made in our discussion may be forward-looking. Forward-looking statements involve risks and uncertainties and a number of factors could cause actual results or outcomes to differ materially from our expectations. Unless the context requires otherwise, when we refer to "we," "us" and "our," we are describing HKN, Inc. and its consolidated subsidiaries on a consolidated basis.

BUSINESS OVERVIEW

Our business strategy is focused on enhancing value for our shareholders through the development of a well-balanced portfolio of assets in the energy industry. Currently, the majority of the value of our assets is derived from our wholly-owned subsidiary, BriteWater International, Inc. ("BWI"), our investment in publicly-traded common shares of Global Energy Development PLC ("Global") and our notes receivable extended to Global. We consider these assets to be strategic for us, and our objective in 2012 is to build the value of our portfolio of assets through:

· Identifying, developing and marketing applications for the BWI OHSOL technology

· Pursuing opportunities to invest in or acquire undervalued assets or companies in the energy industry which we believe present significant near-term growth potential

· Providing management expertise and/or additional capital for our portfolio assets to enhance their value and accelerate growth

· Managing capital expenditures and selling, general and administrative costs

As a result of the sales of our oil and gas properties and the abandonment of our coalbed methane projects during 2011, all related oil and gas assets and liabilities and revenues and expenses are included as discontinued operations on the consolidated condensed balance sheets and consolidated condensed statements of operations, respectively, for all periods presented. The divestiture of these assets has given us the opportunity to redeploy capital into areas of the oil and gas industry which may generate greater value for our shareholders while bearing significantly lower operational and regulatory risks.

BriteWater International, Inc.

We have a wholly-owned subsidiary, BWI, which owns the patented oilfield emulsion breaking "OHSOL" technology. This is an environmentally-clean continuous process technology that can purify oilfield emulsions by breaking and separating the emulsions into oil, water and solids, thereby reducing the environmental impact and operating costs of the disposition of residual fuels and waste materials while recovering valuable oil. This technology has been successfully tested by pilot plants in multiple refineries as well as a mobile OHSOL unit in a demonstration in Prudhoe Bay, Alaska, all of which proved the effectiveness of the OHSOL emulsion breaking technology to recover valuable hydrocarbons and reduce wastes. BWI is currently designing standardized OHSOL modules which can be used for both upstream and downstream applications in the oil and gas industry, including oil field and refinery emulsions and oil spill remediation. BWI also has an existing purpose-built plant which can be used to break emulsions found in weathered lagoon pits. BWI continues to market this plant and hopes to deploy this plant to a location in North Africa or the Middle East during the second half of 2012.

BWI and its wholly-owned subsidiary, Arctic Star Alaska, Inc. ("Arctic Star") signed contracts during 2011 and 2012 which grant right of first refusal for oilfield emulsions generated in certain fields on the Alaska North Slope ("ANS"). Arctic Star has identified a location on the ANS on which it will locate one of the standardized plant designs. This plant will allow Arctic Star to recover saleable crude oil from oil field waste for sale into the market. Arctic Star anticipates that construction of the plant will begin during the second half of 2012.

International Energy Investment - Global Energy Development PLC

At March 31, 2012 and December 31, 2011, we held an investment in Global through our ownership of approximately 34% of Global's ordinary shares. We account for our ownership of Global shares as a cost method investment. Global is a petroleum exploration and production company focused on Latin America. Global's shares are traded on the Alternative Investment Market ("AIM"), a market operated by the London Stock Exchange.

On January 31, 2012, we executed a separate Loan Agreement (the "Global Loan") with Global which carries a principal amount of $12 million. The Global Loan is currently unsecured, but we can require Global to provide adequate collateral security in the event of a material adverse effect, determined at our sole discretion. The Global Loan is due and payable to us on or before September 30, 2013 and bears interest at 10.5% per annum. Accrued and unpaid interest on the outstanding principal amount is due and payable on the last day of each quarter, commencing March 31, 2012. Global also paid to us a 1.75% transaction fee of approximately $210 thousand, of which $189 thousand is deferred at March 31, 2012 and will be recognized over the term of the Global Loan.

During 2010, we issued a $5 million Senior Secured Loan and Security Agreement ("Global Note Receivable") to Global which carries an interest rate of 10.5% and a maturity date of September 2012. We extended this loan to Global in order to promote their development activities while earning a 10.5% annualized rate of return on our funds. The loan is secured by Global's oil-producing assets. In addition to financing opportunities, we continue to monitor our investment in Global in order to identify opportunities for divesting of shares or making additional investments in the company.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2011, the FASB issued guidance related to the "Presentation of Comprehensive Income". This new guidance requires entities to report components of comprehensive income in either a single continuous financial statement or in two separate but consecutive financial statements. This disclosure is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. We have included the required disclosures within our consolidated condensed financial statements.

The following is our discussion and analysis of significant components of our operations which have affected our operating results and balance sheet during the three months ended March 31, 2012 and 2011 included in the accompanying consolidated condensed financial statements.

Results of Continuing Operations for the Quarterly Periods Ended March 31, 2012 Compared to March 31, 2011

Our loss from continuing operations decreased from $919 thousand in the first quarter 2011 to $871 thousand for the first quarter 2012. The majority of the decrease was due to increased interest income from our related party in the current year which was offset by increased expenses at BWI. We sold our oil and gas properties, which have been removed from operations as a discontinued business for all periods presented, late in 2011. We are actively working to develop our BWI segment in order to begin generating operating revenues during 2012.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased slightly from $995 thousand for the first quarter 2011 to $1.2 million for the first quarter 2012 primarily due to additional personnel and consulting expenses as we further develop BWI and its technology during 2012. We anticipate that our selling, general and administrative expenses may increase in future periods as we dedicate additional resources to the commercial development of BWI. However, we continue to monitor and minimize our controllable costs.

Depreciation and Amortization Expense

Depreciation and amortization expense decreased 10% in the first quarter 2012 primarily due to a decrease in depreciation expense as a result of other property and equipment items becoming fully depreciated during 2011.

Interest and Other Income - Related Party

Interest and other income from our related party increased from $129 thousand in the first quarter 2011 to $362 thousand in the first quarter 2012, primarily as a result of the interest earned on the Global Loan which was issued in January 2012.

Interest and Other Income

Interest and other income remained relatively consistent decreasing from $14 thousand in the first quarter 2011 to $12 thousand in the first quarter 2012.

Deferred Income Tax Benefit

We recognized a deferred income tax benefit of $5 thousand in the first quarter 2012 due to the reversal of an accrued income tax liability.

Income (Loss) from Discontinued Operations

Our income (loss) from discontinued operations decreased from income of $239 thousand in the first quarter 2011 to a loss of $177 thousand for the first quarter 2012. The decrease in the current year is mainly due to additional legal costs resulting from the sale of the oil and gas properties and bad debt expense on a potentially uncollectible oil and gas receivable account.

Loss on Disposal of Discontinued Operations

We recognized an adjustment to the loss on the 2011 sales of our remaining Gulf Coast oil and gas properties of $82 thousand during the first quarter 2012 as a result of additional purchase price adjustments related to capital expenditures which were incurred prior to the effective date of the sales as well as anticipated increases in plugging and abandonment costs for retained liabilities.

LIQUIDITY AND CAPITAL STRUCTURE

Financial Condition

                               March 31,       December 31,
(Thousands of dollars)           2012              2011
Current ratio                  19.08 to 1         22.84 to 1
Working capital (1)           $    33,560     $       47,097
Total debt                    $         -     $            -
Total cash less debt          $    29,716     $       43,431
Total stockholders' equity    $    75,559     $       75,242
Total liabilities to equity     0.04 to 1          0.04 to 1

(1) Workng capital is the difference between current assets and current liabilities.

The decrease in our working capital as of March 31, 2012 as compared to December 31, 2011 is primarily due to the issuance of the $12 million long-term Global Loan in January 2012 and working capital used during the first quarter of approximately $1 million.

Cash on hand, generated from the rights offering along with proceeds from our oil and gas property divestitures during 2011, will be used to acquire or invest in energy-based businesses, securities, working interests and other oil, natural gas and energy-related investments, properties, products and technologies, which may include those we already own interests in, to assist in the development of projects to commercialize the OHSOL technology, as well as for general corporate purposes.

We used approximately $198 thousand for capital expenditures during the 2012 period, the majority of which were for capitalized general and administrative costs that are directly related to the two BWI plants currently under development.

We had a cash balance of approximately $29.7 million at March 31, 2012. We anticipate this cash balance on hand will adequately fund our 2012 operating cash flow, and other capital resources, if needed, will be available to fund our planned capital expenditures and other investing activity.

We may continue to deploy cash to acquire or invest in energy-related businesses, securities, or for discretionary capital expenditures. We may also seek to raise financing through the issuance of equity, debt and convertible debt instruments, if needed, for utilization of acquisition, development or investment opportunities as they arise. We may also reduce our ownership interests in any of our investments through strategic sales under certain conditions.

Capital Structure

At March 31, 2012, if our remaining convertible preferred stock were converted
we would be required to issue the following amounts of our common stock:

                                                                                    Shares of Common
                                                                                    Stock Issuable at
Instrument                                                Conversion Price (a)       March 31, 2012
Series G1 Preferred                                      $            280.00                       357
Series G2 Preferred                                      $             67.20                     1,488
Common Stock Potentially Issued Upon Conversion                                                  1,845

(a) Certain conversion prices are subject to adjustment under certain circumstances.

Significant Ownership of our Stock

As of March 31, 2012, Brean Murray Carret Group Inc. ("Brean") beneficially owned approximately 57.26% of the combined voting power of our outstanding common stock. This entity is beneficially owned by Wayne Quasha through the AQ, JQ and WQ Trusts. Mr. Alan Quasha, Chairman of the Board of Directors of HKN, is the brother of Wayne Quasha, who is deemed the beneficial owner of Brean, but Mr. Alan Quasha disclaims any beneficial ownership of these shares. Brean is in a position to exercise significant influence over the election of our Board of Directors and other matters.

Cash Flows

Net cash flow used by operating activities during the three months ended March 31, 2012 was $1.5 million, as compared to $974 thousand in the prior year period. Net cash used by continuing operations increased from $770 thousand to $1.4 million, primarily as a result of increased development costs at BWI. Cash used by discontinued operations slightly decreased from $204 thousand to $179 thousand. Our cash on hand at March 31, 2012 totaled approximately $29.7 million.

Net cash used by investing activities during the three months ended March 31, 2012 was $12 million, as compared to cash provided by of $7.3 million in the prior year period. This decrease was from the $11.8 million of net cash used to fund the Global Loan and $198 thousand used for capital expenditures, primarily related to the BWI plants currently under development. The 2011 cash flows contained cash generated of $7.3 million which was comprised of net sales proceeds from several of our oil and gas properties during the first quarter 2011 of approximately $7.5 million, reduced by capital expenditures for these properties of $192 thousand.

We had cash used by financing activities during the three months ended March 31, 2012 of $196 thousand related to treasury stock repurchases while 2011 had $95 thousand in cash used for costs related to the rights offering.

Obligations, Contingencies and Commitments

BWI Contingency -BWI has a contingent liability of $800 thousand related to an obligation which may be payable upon the conclusion of certain performance events related to BWI's equipment. There were no changes to the BWI liability recorded during the three months ended March 31, 2012.

IRS Examination - During 2008, we received a proposed adjustment to our federal tax liability for the calendar year 2005. The proposed adjustment relates to the calculation of the adjusted current earnings ("ACE") component of the alternative minimum tax and asserts that the Company recognized a gain for ACE purposes on the sale of the Global PLC stock in 2005. In its proposed adjustment, the IRS alleged we owe approximately $3.6 million in tax for the year ended December 31, 2005. Penalties and interest calculated through March 31, 2012 in the amount of approximately $2.8 million could also be assessed. ASC 740, Income Taxes, prescribes a recognition threshold of more-likely-than-not to be sustained upon examination. This guidance also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosures and transition. Utilizing the process outlined above, we have recorded an income tax contingency for this item, including interest and penalties, of $225 thousand in our consolidated condensed financial statements based, in part, on a preliminary indication of a fair value assessment of the Global stock.

We filed a formal protest with the IRS Appeals Office during 2008 and a supplement to the written protest which included a third party valuation report supporting the basis of our recognized gain recorded for ACE purposes during April 2009. In February 2011, the IRS requested and we agreed to extend the statute of limitations to April 2012. Also during 2011, the IRS prepared and sent an internal memorandum outlining its position regarding the basis of our gain recorded for ACE purposes. In response, HKN completed and finalized an additional third party valuation study as well as a rebuttal of the IRS internal memorandum, both of which provide additional support for our position. During April 2012, we agreed to and paid a tax settlement of $163 thousand with the IRS, including approximately $59 thousand in interest.

Environmental Contingencies - The Environmental Protection Agency ("EPA") visited our Main Pass facility and issued a report during April 2008 which detailed minor housekeeping violations, several of which were corrected during the course of the inspection. We responded to this report during June 2008 with explanations of how each violation was fully remediated. During May 2010, we received a follow-up letter from the EPA requesting a meeting to discuss our June 2008 response. We held a meeting with the EPA during July 2010 to discuss a settlement and we executed a settlement agreement with the EPA and paid fines of $28 thousand during the first quarter 2012.

Operational Contingencies - Our discontinued operations which consisted of the exploration, development and production of oil and gas assets were subject to various federal and state laws and regulations designed to protect the environment. Compliance with these regulations was part of our day-to-day operating procedures. Infrequently, accidental discharge of such materials as oil, natural gas or drilling fluids can occur and such accidents can require material expenditures to correct. We maintained levels of insurance we believed to be customary in the industry to limit our financial exposure.

Threatened litigation - Pursuant to a Purchase and Sale Agreement ("PSA") dated as of November 17, 2011 between our subsidiary XPLOR Energy SPV-I, Inc. ("XPLOR") and Texas Petroleum Investment Company ("TPIC"), we sold to TPIC our oil and gas production assets and related operations at our Main Pass 35 field. The closing of the transaction occurred on November 17, 2011 but was effective as of October 1, 2011. On November 21, 2011, TPIC informed us that they had discovered defects in the salt water disposal system at Main Pass resulting in a salt water spill in the Gulf of Mexico, which spill had been reported to regulatory authorities.

TPIC has asserted a claim in the amount of approximately $1.5 million against XPLOR for costs, fees and damages that TPIC allegedly incurred or suffered as a result of the alleged salt water system defects and in relation to repairing the facilities. Although due to the inherent uncertainties of threatened litigation, we cannot accurately predict the ultimate outcome of the matter, at March 31, 2012, we did not record a contingency related to TPIC's allegations as we do not currently believe that it is probable that HKN or XPLOR would be responsible for the costs, fees and damages incurred by TPIC as a result of the salt water disposal incident or third party or governmental claims, if any, resulting therefrom. We intend to vigorously defend any assertions related to the above alleged incident. The range of estimated loss related to the current threatened ligation by TPIC is currently estimated not to exceed $1.5 million.

Off-Balance Sheet Arrangements - As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities ("SPEs"), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of March 31, 2012, we were not involved in any unconsolidated SPE transactions and we have no off-balance sheet arrangements.

Treasury Stock - At March 31, 2012 and December 31, 2011, we held approximately 30 thousand shares and no shares, respectively, of treasury stock. During the three months ended March 31, 2012, we purchased approximately 84 thousand shares and retired approximately 54 thousand shares of our common stock. As of March 31, 2012, approximately 42 thousand shares remained available for repurchase under our repurchase program. Subsequently, in April 2012, an additional 1 million shares were approved for repurchase under this program. Following this approval, we repurchased approximately 791 thousand of our common shares for $2.4 million from a shareholder in a privately negotiated transaction pursuant to our repurchase program. Following this transaction, we are authorized to repurchase up to 206 thousand additional shares under our amended repurchase program.

Adequacy of Capital Sources and Liquidity

We believe that we will have the ability to provide for our operational needs, our planned capital expenditures and possible investments through projected operating cash flow and cash on hand. Our operating cash flow has been adversely affected by the sale of our oil and gas properties as well as the fact that BWI has not begun generating revenue. To address this challenge, we continue to minimize our controllable costs and generate low-risk interest income until BWI begins revenue generation. We expect to generate revenues from our BWI segment by the end of 2012. Should projected operating cash flow not materialize, we may reduce BWI capital expenditures and future investments and/or consider the issuance of debt, equity and convertible debt instruments, if needed, for utilization in BWI's planned capital expenditures and new energy-based investment opportunities. All of our BWI capital expenditures are purely discretionary and may be curtailed or delayed at any time. We may also reduce our ownership interest in Global's common shares through strategic sales under certain conditions.

We had no debt outstanding at March 31, 2012. If we seek to raise other equity or debt financing to fund capital expenditures or other acquisition and development opportunities, those transactions may be affected by the market value of our common stock. If the price of our common stock declines, our ability to utilize our stock either directly or indirectly through convertible instruments for raising capital could be negatively affected. Further, raising additional funds by issuing common stock or other types of equity securities could dilute our existing stockholders, which dilution could be substantial if the price of our common stock decreases. Any securities we issue may have rights, preferences and privileges that are senior to our existing equity securities. Borrowing money may also involve pledging some or all of our assets.