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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

[X]             ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended September 30, 2011

or

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

Commission File Number 1-5103

BARNWELL INDUSTRIES, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:  (808) 531-8400

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

o Yes     x No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

o Yes     x No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                                                           x Yes     o No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

x Yes     o No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.                                          x

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

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

The aggregate market value of the voting common stock held by non-affiliates of the registrant, computed by reference to the closing price of a share of common stock on March 31, 2011 (the last business day of the registrant’s most recently completed second fiscal quarter) was $32,151,000.

As of December 1, 2011 there were 8,277,160 shares of common stock outstanding.

Documents Incorporated by Reference

1.               Proxy statement to be forwarded to stockholders on or about January 20, 2012 is incorporated by reference in Part III hereof.

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GLOSSARY OF TERMS

Defined below are certain terms used in this Form 10-K:

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PART I

CAUTIONARY STATEMENT RELEVANT TO FORWARD-LOOKING INFORMATION

FOR THE PURPOSE OF “SAFE HARBOR” PROVISIONS OF THE

PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

This Form 10-K, and the documents incorporated herein by reference, contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  A forward-looking statement is one which is based on current expectations of future events or conditions and does not relate to historical or current facts.  These statements include various estimates, forecasts, projections of Barnwell Industries, Inc.’s (referred to herein together with its subsidiaries as “Barnwell,” “we,” “our,” “us” or the “Company”) future performance, statements of Barnwell’s plans and objectives and other similar statements.  Forward-looking statements include phrases such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “predicts,” “estimates,” “assumes,” “projects,” “may,” “will,” “will be,” “should,” or similar expressions.  Although Barnwell believes that its current expectations are based on reasonable assumptions, it cannot assure that the expectations contained in such forward-looking statements will be achieved.  Forward-looking statements involve risks, uncertainties and assumptions which could cause actual results to differ materially from those contained in such statements.  Investors should not place undue reliance on these forward-looking statements, as they speak only as of the date of filing of this Form 10-K, and Barnwell expressly disclaims any obligation or undertaking to publicly release any updates or revisions to any forward-looking statements contained herein.

Among the important factors that could cause actual results to differ materially from those in the forward-looking statements are domestic and international general economic conditions, such as recessionary trends and inflation; domestic and international political, legislative, economic, regulatory and legal actions, including changes in the policies of the Organization of Petroleum Exporting Countries or other developments involving or affecting oil-producing countries; military conflict, embargoes, internal instability or actions or reactions of the governments of the United States and/or Canada in anticipation of or in response to such developments; interest costs, restrictions on production, restrictions on imports and exports in both the United States and Canada, the maintenance of specified reserves, tax increases and retroactive tax claims, royalty increases, expropriation of property, cancellation of contract rights, environmental protection controls, environmental compliance requirements and laws pertaining to workers’ health and safety; the condition of Hawaii’s real estate market, including the level of real estate activity and prices, the demand for new housing and second homes on the island of Hawaii, the rate of increase in the cost of building materials and labor, the introduction of building code modifications, changes to zoning laws, the condition of Hawaii’s tourism industry and the level of confidence in Hawaii’s economy; levels of land development activity in Hawaii; levels of demand for water well drilling and pump installation in Hawaii; the potential liability resulting from pending or future litigation; the Company’s acquisition or disposition of assets; the effects of changed accounting rules under GAAP promulgated by rule-setting bodies; and the factors set forth under the heading “Risk Factors” in this Form 10-K, in other portions of this Form 10-K, in the Notes to Consolidated Financial Statements, and in other documents filed by Barnwell with the SEC.  In addition, unpredictable or unknown factors not discussed in this report could also cause actual results to materially and adversely differ from those discussed in the forward-looking statements.

Unless otherwise indicated, all references to “dollars” in this Form 10-K are to United States dollars.

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ITEM 1.                                      BUSINESS

Overview

Barnwell was incorporated in Delaware in 1956 and fiscal 2011 represented Barnwell’s 55th year of operations.  Barnwell operates in the following four principal business segments:

·                Oil and Natural Gas Segment.  Barnwell engages in oil and natural gas exploration, development, production and sales in Canada.

·                Land Investment Segment.  Barnwell invests in land interests in Hawaii.

·                Contract Drilling Segment.  Barnwell provides well drilling services and water pumping system installation and repairs in Hawaii.

·                Residential Real Estate Segment.  Barnwell develops homes for sale in Hawaii.

Oil and Natural Gas Segment

Overview

Through our wholly-owned subsidiary, Barnwell of Canada, we are involved in the acquisition, exploration and development of oil and natural gas properties.  Barnwell of Canada initiates and participates in exploratory and developmental operations for oil and natural gas on properties in which it has an interest, and evaluates proposals by third parties with regard to participation in such exploratory and developmental operations elsewhere.

Operations

Barnwell’s investments in oil and natural gas properties are located in Canada, principally in the province of Alberta, with lesser holdings in the provinces of Saskatchewan and British Columbia.  These property interests are principally held under governmental leases or licenses.  Under the typical Canadian provincial governmental lease, Barnwell must perform exploratory operations and comply with certain other conditions.  Lease terms vary with each province, but, in general, the terms grant Barnwell the right to remove oil, natural gas and related substances subject to payment of specified royalties on production.

All exploratory and developmental operations are overseen by Barnwell’s Calgary, Alberta staff and Barnwell’s Chief Operating Officer located in Honolulu, along with senior management and independent petroleum reserve engineers as necessary.  In fiscal 2011, Barnwell participated in exploratory and developmental operations in Alberta and Saskatchewan, although Barnwell does not limit its consideration of exploratory and developmental operations to these areas.

Natural gas prices are typically higher in the winter than at other times due to increased heating demand.  Oil prices are also subject to seasonal fluctuations, but to a lesser degree.  Oil and natural gas unit sales are based on the quantity produced from the properties by the properties’ operator.

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Key Property

Barnwell’s principal oil and natural gas property is located in the Dunvegan area of Alberta, Canada and is called the Dunvegan Unit.  Barnwell holds an 8.9% working interest in the Dunvegan Unit which, at September 30, 2011, had 215 producing natural gas wells.  In fiscal 2011, Barnwell participated in the drilling of seven gross (0.6 net) gas wells in the Dunvegan area of which all appear to be successful.  Capital expenditures at Dunvegan totaled $2,021,000 in fiscal 2011.

In fiscal 2011, Dunvegan contributed 64% of Barnwell’s net natural gas production, 88% of Barnwell’s net natural gas liquids production, and 1% of Barnwell’s net oil production, representing 54% of the Company’s total net production on a Boe basis (407,000 Boe of a total 759,000 Boe).  In fiscal 2011, Dunvegan contributed 36% of Barnwell’s oil and natural gas revenues.

Dunvegan’s proved natural gas reserves represented 8,800,000 gross (8,158,000 net) Mcf or 54% of our total proved natural gas reserves as of September 30, 2011.  Dunvegan’s proved oil and natural gas liquids reserves represented 373,000 gross (262,000 net) Bbl or 25% of our total proved oil and natural gas liquids reserves as of September 30, 2011.  In total, Dunvegan’s reserves represented 44% of the Company’s total net reserves on an Mcfe basis as of September 30, 2011.

Preparation of Reserves Estimates

Barnwell’s reserves are estimated by our independent petroleum reserve engineer, InSite.  All information with respect to the Company’s reserves in this Form 10-K is derived from the report of InSite.  A copy of the report issued by InSite is filed with this Form 10-K as Exhibit 99.1.  InSite has been the Company’s independent petroleum reserve engineer for over 20 years.

The preparation of data used by the independent petroleum reserve engineer to compile our oil and natural gas reserves estimates is completed in accordance with various internal control procedures which include verification of data input into reserves evaluation software, reconciliations and reviews of data provided to the independent petroleum reserve engineer to ensure completeness, and management review controls, including an independent internal review of the final reserve report for completeness and accuracy.

Barnwell has a Reserves Committee consisting of four independent directors, the Company’s President and Chief Operating Officer, and the Company’s Executive Vice President and Chief Financial Officer.  The Reserves Committee was established to oversee the reserves estimation and certification process.  The Chairman of our Reserves Committee is an independent oil and gas reservoir consultant, thereby possessing the experience requisite to effectively oversee the reserves estimation process.  The Reserves Committee is responsible for reviewing the annual reserve evaluation report prepared by the independent petroleum reserve engineering firm and ensuring that the reserves are reported fairly in a manner consistent with industry standards.  The Reserves Committee meets annually to discuss reserves issues and policies, and to meet with Company personnel and our independent petroleum reserve engineer.

Barnwell of Canada’s President and Chief Operating Officer has primary responsibility for overseeing the preparation of the Company’s reserves estimates by our independent petroleum reserve engineer; he is a licensed professional engineer with over 33 years of experience in all facets of the oil and natural gas industry both in Canada and internationally and is a member of the Association of Professional Engineers, Geologists, and Geophysicists of Alberta.

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Reserves

The amounts set forth in the following table, prepared by InSite, summarize our estimated proved reserves of oil (including natural gas liquids) and natural gas as of September 30, 2011 on all properties in which Barnwell has an interest.  All of Barnwell’s proved reserves are developed; Barnwell has no proved undeveloped reserves as of September 30, 2011.  All of our oil and natural gas reserves are located in Canada.  These reserves are before deductions for indebtedness secured by the properties and are based on constant dollars.  No estimates of total proved net oil or natural gas reserves have been filed with or included in reports to any federal authority or agency, other than the SEC, since October 1, 2010.

During fiscal 2011, Barnwell’s total net proved developed reserves, including proved developed producing reserves, of oil and natural gas liquids decreased by 88,000 Bbls (7%) and total net proved developed reserves of natural gas decreased by 2,924,000 Mcf (16%).

Standardized Measure of Discounted Future Net Cash Flows

The following table sets forth Barnwell’s “Estimated Future Net Revenues” from total proved oil, natural gas and natural gas liquids reserves and the present value of Barnwell’s “Estimated Future Net Revenues” (discounted at 10%).  Estimated future net revenues for total proved reserves are net of estimated future expenditures of developing and producing the proved reserves, and assume the continuation of existing economic conditions.  Net revenues have been calculated using the average first-day-of-the-month price during the 12-month period ending in the reporting period and current costs, after deducting all royalties, operating costs, future estimated capital expenditures (including abandonment costs), and income taxes.

*      This amount does not purport to represent, nor should it be interpreted as, the fair value of Barnwell’s natural gas and oil reserves.  An estimate of fair value would also consider, among other items, the value of Barnwell’s undeveloped land position, the recovery of reserves not presently classified as proved, anticipated future changes in oil and natural gas prices (these amounts were based on a natural gas price of $3.65 per Mcf and an oil price of $82.04 per Bbl for 2011) and costs, and a discount factor more representative of the time value of money and the risks inherent in reserve estimates.

Oil and Natural Gas Production

The following table summarizes (a) Barnwell’s net production for the last three fiscal years, based on sales of natural gas, oil and natural gas liquids, from all wells in which Barnwell has or had an interest, and (b) the average sales prices and average production costs for such production during the same periods.  Production amounts reported are net of royalties.  All of Barnwell’s net production in fiscal 2011, 2010 and 2009 was derived in Canada, primarily in Alberta.  For a discussion regarding

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our total annual production volumes, average sales prices, and related production costs, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Capital Expenditures

Barnwell invested $13,299,000 in oil and natural gas properties during fiscal 2011, of which $1,455,000 (11%) was for acquisition of oil and natural gas leases, $2,253,000 (17%) was for exploration costs and $9,591,000 (72%) was for development of oil and natural gas properties.

Capital expenditures totaled $2,021,000 in the Dunvegan area in fiscal 2011.  Seven gross (0.6 net) gas wells were drilled in fiscal 2011 of which all appear to be successful.

Capital expenditures totaled $6,854,000 in the Seagram Lakes area of Saskatchewan in fiscal 2011.  Barnwell acquired 2,560 net acres and drilled four gross (2.0 net) oil wells in fiscal 2011 of which two gross (1.0 net) wells were successful and producing at September 30, 2011 and two gross (1.0 net) wells were dry holes.  Of the two gross (1.0 net) wells that were dry holes, Barnwell expects to convert one gross (0.5 net) well into a water disposal well.

Capital expenditures totaled $904,000 in the Red Earth area in fiscal 2011.  One gross (0.2 net) oil well was drilled in fiscal 2011 which was successful and on production at September 30, 2011.

Capital expenditures totaled $951,000 in the Chauvin area in fiscal 2011.  Three gross (1.5 net) wells drilled in fiscal 2011 were successful and on production at September 30, 2011.

Well Drilling Activities

During fiscal 2011, Barnwell participated in the drilling of 17 development wells, 16 of which management believes should be capable of production and one which was a dry hole.  Barnwell participated in the drilling of one exploratory well, which was a dry hole, during fiscal 2011.  Of the 18 wells Barnwell participated in the drilling of in fiscal 2011, eight gross (3.6 net) wells were on prospects developed by Barnwell.

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The following table sets forth more detailed information with respect to the number of exploratory (“Exp.”) and development (“Dev.”) wells drilled for the fiscal years ended September 30, 2011, 2010 and 2009 in which Barnwell participated.  All wells were drilled in Canada.

At September 30, 2011, Barnwell was not in the process of drilling any oil or natural gas wells.

Productive Wells

As of September 30, 2011, Barnwell had interests in 739 gross (91.3 net) productive wells, of which 188 gross (30.4 net) were oil wells and 551 gross (60.9 net) were natural gas wells.  All wells were in Canada.  Seven natural gas wells and one oil well have dual or multiple completions.

Developed Acreage and Undeveloped Acreage

The following table sets forth the gross and net acres of both developed and undeveloped oil and natural gas leases which we hold as of September 30, 2011.

Thirty-eight percent of Barnwell’s undeveloped acreage is not subject to expiration at September 30, 2011.  The 62% of Barnwell’s leasehold interests in undeveloped acreage subject to expiration expire over the next fiscal years, if not developed, as follows: 45% expire during fiscal 2012; 13% expire during fiscal 2013; 3% expire during fiscal 2014; 9% expires during fiscal 2015; and 30% expire during fiscal 2016.  There can be no assurance that Barnwell will be successful in renewing its leasehold interests in the event of expiration.

Barnwell’s undeveloped acreage includes concentrations in Alberta at Thornbury (5,949 net acres), Doris (5,120 net acres), Bonanza/Balsam (3,128 net acres) and in Saskatchewan at Seagram Lakes (6,069 net acres).  During fiscal 2011, Barnwell acquired undeveloped land in Saskatchewan at Seagram Lakes (2,560 net acres) and Handel (3,200 net acres).

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Marketing of Oil and Natural Gas

Barnwell sells substantially all of its oil and natural gas liquids production under short-term contracts between itself and marketers of oil.  The price of oil and natural gas liquids is freely negotiated between the buyers and sellers and is largely determined by the world price for oil, which is principally denominated in U.S. dollars.

Natural gas sold by Barnwell is generally sold under both long-term and short-term contracts with prices indexed to market prices.  The price of natural gas and natural gas liquids is freely negotiated between buyers and sellers and is principally determined for Barnwell by western Canadian/Midwestern U.S. prices for natural gas.  In fiscal 2011 and 2010, Barnwell took virtually all of its oil and natural gas “in kind” where Barnwell markets the products instead of having the operator of a producing property market the products on Barnwell’s behalf.

Barnwell’s oil and natural gas segment derived 66% of its oil and natural gas revenues in fiscal 2011 from three individually significant customers, Shell Trading Canada (39%), ProGas Limited (16%) and Glencoe Resources Ltd. (11%).  A substantial portion of Barnwell’s natural gas production from Dunvegan and other properties is sold to aggregators and marketers under various short-term and long-term contracts, with the price of natural gas determined by negotiations between the aggregators and the final purchasers.  In fiscal 2011, 18% of Barnwell’s production was marketed by an agent acting on behalf of Barnwell where all products are sold directly to the final purchasers with the agent not taking title to the production.

In fiscal 2011, over 90% of Barnwell’s oil and natural gas revenues were from products sold at spot prices.

Governmental Regulation

The jurisdictions in which the oil and natural gas properties of Barnwell are located have regulatory provisions relating to permits for the drilling of wells, the spacing of wells, the prevention of oil and natural gas waste, allowable rates of production and other matters.  The amount of oil and natural gas produced is subject to control by regulatory agencies in each province that periodically assign allowable rates of production.  The province of Alberta and Government of Canada also monitor and regulate the volume of natural gas that may be removed from the province and the conditions of removal.

There is no current government regulation of the price that may be charged on the sale of Canadian oil or natural gas production.  Canadian natural gas production destined for export is priced by market forces subject to export contracts meeting certain criteria prescribed by Canada’s National Energy Board and the Government of Canada.

Different royalty rates are imposed by the provincial governments, the Government of Canada and private interests with respect to the production and sale of oil, natural gas and natural gas liquids.  In addition, provincial governments receive additional revenue through the imposition of taxes on oil and natural gas owned by private interests within the province.  Essentially, provincial royalties are calculated as a percentage of revenue and vary depending on production volumes, selling prices and the date of discovery.

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Ninety-three percent of Barnwell’s gross revenues are derived from properties located within Alberta.

The province of Alberta charges oil and natural gas producers a royalty for production in Alberta.  The province of Alberta determines its royalty share of natural gas and oil by using reference prices that average all natural gas sales and oil sales, respectively, in Alberta.  Barnwell also pays gross overriding royalties and leasehold royalties on a portion of its natural gas and oil sales to parties other than the province of Alberta.

Through December 31, 2008, royalty rates were calculated on a sliding scale basis, increasing as prices increased up to a maximum royalty rate of 35%.  On January 1, 2009, a New Royalty Framework (“NRF”) went into effect.  The NRF changed royalty rates on conventional oil and natural gas production to be both price-sensitive and production-sensitive, and may increase up to a maximum royalty rate of 50%.  The price-sensitive maximum is reached for oil when oil is selling at or above $120.00 Canadian dollars per barrel and for natural gas when natural gas is selling at or above $17.50 Canadian dollars per Mcf.  Effective January 1, 2011, the Government of Alberta modified Alberta’s royalty framework.  The modified framework reduced the maximum royalty rate of 50% for oil and natural gas production to 40% and 36%, respectively.  In fiscal 2011, 69% of royalties related to Alberta government charges and 26% of royalties related to freehold and override charges which are not directly affected by the NRF.  In fiscal 2010, 79% of royalties related to Alberta government charges and 21% of royalties related to freehold and override charges which are not directly affected by the NRF.

In November 2008, the Alberta government announced a one-time option of selecting new transitional rates or NRF rates when drilling a new natural gas or conventional oil well 1,000 to 3,500 meters in depth.  All wells drilled between January 1, 2009 and December 31, 2013 that adopt the transitional rates will be shifted to the NRF on January 1, 2014.  As of January 1, 2009, all of Barnwell’s wells in Alberta pay royalties under the NRF and all new commercial wells drilled since January 1, 2009 adopted the transitional royalty rates.

In fiscal 2011, the weighted-average royalty rate paid on all of Barnwell’s natural gas was 5%.  The weighted-average rate of all royalties paid to governments and others on natural gas from the Dunvegan Unit, Barnwell’s principal oil and natural gas property, was 3% in fiscal 2011.

In fiscal 2011, the weighted-average royalty rate paid on oil was 27%.

In 2009, the Alberta government announced a short-term incentive program which included a drilling royalty credit for new conventional oil and natural gas wells.  Under the program, the Canadian province of Alberta provided a temporary drilling royalty credit based on a fixed dollar amount per meter drilled to eligible companies which drilled new conventional oil and natural gas wells on Alberta crown lands from April 1, 2009 to March 31, 2011.  The drilling royalty credit program has ended.

During fiscal 2008, the Canadian government enacted reductions in the corporate tax rate from 20.5%, 20.0%, 19.0%, 18.5% and 18.5% in calendar years 2008, 2009, 2010, 2011 and 2012, respectively, to 19.5%, 19.0%, 18.0%, 16.5% and 15%, respectively.  There was no enactment of a reduction in Canadian tax rates during fiscal 2010 or 2011.

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Competition

The majority of Barnwell’s natural gas sales take place in Alberta, Canada.  Natural gas prices in Alberta are generally competitive with other major North American areas due to sufficient pipeline capacity into the United States.  Barnwell’s oil and natural gas liquids are sold in Alberta with prices determined by the world price for oil.

Barnwell competes in the sale of oil and natural gas on the basis of price and on the ability to deliver products.  The oil and natural gas industry is intensely competitive in all phases, including the exploration for new production and reserves and the acquisition of equipment and labor necessary to conduct drilling activities.  The competition comes from numerous major oil companies as well as numerous other independent operators.  There is also competition between the oil and natural gas industry and other industries in supplying the energy and fuel requirements of industrial, commercial and individual consumers.  Barnwell is a minor participant in the industry and competes in its oil and natural gas activities with many other companies having far greater financial, technical and other resources.

Land Investment Segment

Overview

Barnwell owns a 77.6% controlling interest in Kaupulehu Developments, a Hawaii general partnership that owns interests in leasehold land for property located approximately six miles north of the Kona International Airport in the North Kona District of the island of Hawaii.

Kaupulehu 2007, a Hawaii limited liability limited partnership 80%-owned by Barnwell, owns two residential parcels held for investment in the Lot 4A Increment I area located approximately six miles north of the Kona International Airport on the island of Hawaii.  See Residential Real Estate Segment for luxury residences for sale.

Barnwell, through wholly-owned Kaupulehu Mauka Investors, LLC, owns acquisition rights as to 14 lots within agricultural-zoned leasehold land in the upland area of Kaupulehu (“Mauka Lands”) situated between the Queen Kaahumanu Highway and the Mamalahoa Highway at Kaupulehu, on the island of Hawaii.  The acquisition rights give Barnwell the right to acquire 14 residential lots, currently estimated to be two to five acres in size, which may be developed on the Mauka Lands.  These lands are currently classified as agricultural by the state of Hawaii and, accordingly, the developer of these lands (Hualalai Investors) will need to pursue both state and county of Hawaii approvals for reclassification and rezoning to permit the development of residential lots and negotiate development terms.

Operations

In the 1980s, Kaupulehu Developments obtained the state and county zoning changes necessary to permit development of the Four Seasons Resort Hualalai at Historic Ka’upulehu and Hualalai Golf Club, which opened in 1996, a second golf course, and single-family and multi-family residential units.  These projects were developed by an unaffiliated entity on leasehold land acquired from Kaupulehu Developments.

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Between 1993 and 2001, Kaupulehu Developments obtained the state and county zoning changes necessary to permit development of single-family and multi-family residential units, a golf course and a limited commercial area on approximately 870 leasehold acres, zoned for resort/residential development, located adjacent to and north of the Four Seasons Resort Hualalai at Historic Ka’upulehu.

In 2004 and 2006, Kaupulehu Developments transferred its leasehold interest in the aforementioned approximately 870 acres in two increments (“Increment I” and “Increment II”) to WB and WBKD and received closing payments of $11,550,000 and $10,000,000, respectively.  WB and WBKD are entities not affiliated with Barnwell and its subsidiaries.  WB and WBKD are affiliated with RP-Hualalai Investors, LLC, a managing member of Hualalai Investors, and Westbrook Partners, developers of Kuki’o Resort located adjacent to Hualalai Resort.

Increment I is an area planned for approximately 80 single-family lots and a beach club on the portion of the property bordering the Pacific Ocean.  The lots within Increment I consist of two phases.  Phase I consists of 38 completed single-family lots (23 ocean front lots and 15 ocean view lots) and Phase II is planned for 42 single-family lots.  The Company cannot predict when WB will complete the single-family lots in Phase II and be permitted to begin marketing them.  The purchasers of the 80 single-family lots will have the right to apply for membership in the Kuki’o Golf and Beach Club, which is located adjacent to and south of the Four Seasons Resort Hualalai at Historic Ka’upulehu.  Increment II is the remaining portion of the approximately 870-acre property and is zoned for single-family and multi-family residential units and a golf course and clubhouse.  Increment II is not yet developed and is currently planned for approximately 350-400 residential units.

Kaupulehu Developments is entitled to receive payments from WB based on the following percentages of the gross receipts from WB’s sales of single-family residential lots in Increment I: 9% of the gross proceeds from single-family lot sales up to aggregate gross proceeds of $100,000,000; 10% of such aggregate gross proceeds greater than $100,000,000 up to $300,000,000; and 14% of such aggregate gross proceeds in excess of $300,000,000.  In fiscal 2011, three ocean front single-family lots were sold bringing the total amount of gross proceeds from single-family lot sales through September 30, 2011 to $145,000,000.  As of September 30, 2011, 22 of the 23 ocean front lots and seven of the 15 ocean view lots in Phase I of Increment I have been sold.

Kaupulehu Developments is entitled to receive payments from WBKD based on a percentage of the sales price of WBKD’s sales of residential lots or units in Increment II ranging from 8% to 10% of the price of improved or unimproved lots or 2.60% to 3.25% of the price of units constructed on a lot, to be determined in the future depending upon a number of variables, including whether the lots are sold prior to improvement.  Kaupulehu Developments is also entitled to receive up to $8,000,000 in additional payments after the members of WBKD have received distributions equal to the capital they invested in the project.

In addition, WB and/or WBKD have the exclusive right to negotiate with Kaupulehu Developments with respect to approximately 1,000 acres of vacant leasehold land zoned conservation in the Kaupulehu area located adjacent to Increment II (“Lot 4C”) until June 2015.  However, this right to negotiate will terminate in June 2013 if WB and/or WBKD have not completed all environmental assessments and surveys reasonably required to support a petition to the Hawaii State Land Use Commission for reclassification of Lot 4C.

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Competition

Barnwell’s land investment segment is subject to intense competition in all phases of its operations including the acquisition of new properties, the securing of approvals necessary for land rezoning, and the search for potential buyers of property interests presently owned.  The competition comes from numerous independent land development companies and other industries involved in land investment activities.  The principal factors affecting competition are the location of the project and pricing.  Barnwell is a minor participant in the land development industry and competes in its land investment activities with many other entities having far greater financial and other resources.

Contract Drilling Segment

Overview

Barnwell’s wholly-owned subsidiary, Water Resources, drills water, water monitoring and geothermal wells of varying depths in Hawaii, installs and repairs water pumping systems, and is the state of Hawaii’s distributor for Floway pumps and equipment.

Operations

Water Resources owns and operates one Spencer-Harris portable rotary drilling rig capable of drilling up to approximately 7,000 feet, an IDECO H-35 rotary drilling/workover rig, two GEFCO SS-40-T portable rotary drilling rigs, a National T-32 drilling rig, and other ancillary drilling equipment.  Water Resources also owns and operates one Walker Neer P-15-A and one Franks double drum service rig for deep set pump removal, installations and repairs.  Additionally, Water Resources leases a three-quarter of an acre maintenance facility in Honolulu, Hawaii, a one acre maintenance and storage facility with 2,800 square feet of interior space in Kawaihae, Hawaii, and a one acre equipment storage yard in Waimea, Hawaii, and maintains an inventory of drilling materials and pump supplies.

Water Resources currently operates in Hawaii and is not subject to seasonal fluctuations.  The demand for Water Resources’ services is primarily dependent upon land development activities in Hawaii.  Water Resources markets its services to land developers and government agencies, and identifies potential contracts through public notices, its officers’ involvement in community activities and referrals.  Contracts are usually fixed price per lineal foot drilled or day rate contracts and are negotiated with private entities or obtained through competitive bidding with private entities or local, state and federal agencies.  Contract revenues are not dependent upon the discovery of water, geothermal production zones or other similar targets, and contracts are not subject to renegotiation of profits or termination at the election of the governmental entities involved.  Contracts provide for arbitration in the event of disputes.

Water Resources derived 53% and 85% of its contract drilling revenues in fiscal 2011 and 2010, respectively, pursuant to federal, state of Hawaii and county contracts.  At September 30, 2011, Barnwell had accounts receivables from federal, state of Hawaii and county entities totaling $529,000.  Barnwell has lien rights on wells drilled and pumps installed for federal, state of Hawaii, county and private entities.

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In fiscal 2011, Water Resources started ten pump installation and repair contracts and completed three well drilling contracts and nine pump installation and repair contracts.  All of the completed well drilling contracts and six of the nine pump installation and repair contracts were started in the prior year.  Seventy-one percent of well drilling and pump installation and repair jobs, representing 53% of total contract drilling revenues in fiscal 2011, have been pursuant to government contracts.

At September 30, 2011, Water Resources had a backlog of 12 pump installation and repair contracts, eight of which were in progress as of September 30, 2011. There were no well drilling contracts in backlog at September 30, 2011.

The dollar amount of Water Resources’ backlog of firm well drilling and pump installation and repair contracts at December 1, 2011 and 2010 was as follows:

All of the contracts in backlog at December 1, 2011 are expected to be completed within fiscal year 2012.

Competition

Water Resources competes with other drilling contractors in Hawaii, some of which use drill rigs similar to Water Resources’ drilling rigs.  These competitors are also capable of installing and repairing vertical turbine and submersible water pumping systems in Hawaii.  These contractors compete actively with Water Resources for government and private contracts.  Pricing is Water Resources’ major method of competition; reliability of service is also a significant factor.

Competitive pressures are expected to remain high, thus there is no assurance that the quantity of available or awarded jobs which occurred in fiscal 2011 will continue.

Residential Real Estate Segment

Overview

Kaupulehu 2007 develops luxury residences for sale.

Operations

We began our homebuilding business in fiscal 2007 when Kaupulehu 2007 purchased two parcels in the Lot 4A Increment I area of Kaupulehu, North Kona, Hawaii located approximately six miles north of the Kona International Airport from WB.  Construction of the two homes commenced in fiscal 2007 and was completed in fiscal 2009.  At September 30, 2011, Kaupulehu 2007 owns two luxury residences that are available for sale and did not have any homes under construction.  One home is a fully furnished 5-bedroom, 6.5-bath ranch-style home and is 6,337 square feet in size.  The second home, currently unfurnished, is of similar design and is 6,275 square feet in size.

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Competition

Barnwell’s residential real estate segment is subject to intense competition in all phases of its operations including the acquisition of land, the building of residential homes, including the need for raw materials and skilled labor, and the search for potential purchasers of completed homes.  The competition comes from numerous independent real estate developers.  The principal factors affecting competition are the location of the project, reputation, design, quality and pricing.  Kaupulehu 2007 is a newcomer and a minor participant in the residential real estate industry and competes with many other entities having far greater financial and other resources.

Financial Information About Industry Segments and Geographic Areas

Note 12 in the “Notes to Consolidated Financial Statements” in Item 8 contains information on our segments and geographic areas.

Employees

As of December 1, 2011, Barnwell employed 40 individuals; 39 on a full time basis and 1 on a part time basis.

Environmental Costs

Barnwell is subject to extensive environmental laws and regulations.  Federal, state, and Canadian governmental agencies issue rules and regulations and enforce laws to protect the environment which are often difficult and costly to comply with and which carry substantial penalties for failure to comply, particularly in regard to the discharge of materials into the environment.  These laws, which are constantly changing, regulate the discharge of materials into the environment and maintenance of surface conditions and may require Barnwell to remove or mitigate the environmental effects of the disposal or release of petroleum or chemical substances at various sites.  Barnwell did not incur material environmental costs in fiscal 2011.

Available Information

We are required to file annual, quarterly and current reports and other information with the SEC.  These filings are not deemed to be incorporated by reference in this report.  You may read and copy any document filed by us at the Public Reference Room of the SEC, 100 F Street, N.E., Washington, D.C. 20549.  You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.  Our filings with the SEC are also available to the public through the SEC’s website at www.sec.gov.  Furthermore, we maintain an internet site at www.brninc.com.  We make available on our internet website free of charge our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports as soon as practicable after we electronically file such reports with, or furnish them to, the SEC.

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ITEM 1A.                           RISK FACTORS

The business of Barnwell and its subsidiaries face numerous risks, including those set forth below or those described elsewhere in this Form 10-K or in Barnwell’s other filings with the SEC.  The risks described below are not the only risks that Barnwell faces, nor are they necessarily listed in order of significance.  If any of the following risk factors should occur, our profitability, financial condition or liquidity could be materially impacted.

Risks Related to Oil and Natural Gas Segment

The oil and natural gas industry is highly competitive.

We compete for capital, acquisitions of reserves, undeveloped lands, skilled personnel, access to drilling rigs, service rigs and other equipment, access to processing facilities, pipeline capacity and in many other respects with a substantial number of other organizations, many of which may have greater technical and financial resources than we do.  Some of these organizations explore for, develop and produce oil and natural gas, carry on refining operations and market oil and other products on a worldwide basis.  As a result of these complementary activities, some of our competitors may have competitive resources that are greater and more diverse than ours.  Furthermore, many of our competitors may have a competitive advantage when responding to factors that affect demand for oil and natural gas production, such as changing prices and production levels, the cost and availability of alternative fuels and the application of government regulations.  If our competitors are able to capitalize on these competitive resources, it could adversely affect our revenues.

Oil and natural gas prices are volatile.  Our results of operations and financial condition are highly dependent on the prices of and demand for our oil and natural gas production.

Oil and natural gas prices are volatile and have fluctuated widely during recent years in response to many factors that are beyond our control.  These factors include, but are not limited to, changes in supply and demand, market uncertainty, weather, worldwide political instability, foreign supply of oil and natural gas, the level of consumer product demand, government regulations and taxes, the price and availability of alternative fuels and the overall economic environment.  Any decline in oil or natural gas prices may have a material adverse effect on our operations, financial condition, operating cash flows, borrowing ability, reserves, and the amount of capital that we are able to allocate for the development of oil and natural gas reserves and future growth.

Energy prices are also subject to other political and regulatory actions outside our control, which may include changes in the policies of the Organization of Petroleum Exporting Countries or other developments involving or affecting oil-producing countries, or actions or reactions of the government of the United States in anticipation of or in response to such developments.

If oil and natural gas prices decrease, we may be required to reduce the carrying value of our oil and natural gas properties.

We follow the full cost method of accounting for costs related to our oil and natural gas properties.  Under this method, the net book value of properties less related deferred income taxes, may not exceed a calculated “ceiling.”  The ceiling is the estimated after tax future net revenues from proved oil and natural gas properties, discounted at 10% per year.  In calculating discounted future net

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revenues, average first-day-of-the-month oil and natural gas prices during the 12-month period ending in the reporting period are held constant, except for changes which are fixed and determinable by existing contracts.  The excess, if any, of the net book value above the ceiling is required to be written off as an expense.  A sufficient decline in oil or natural gas prices or other factors, without other mitigating circumstances, could result in reductions of the carrying value of our oil and natural gas properties and an equivalent charge to earnings.

An increase in operating costs or a decline in our production level could have a material adverse effect on our results of operations and financial condition.

Higher operating costs for our properties will directly decrease the amount of cash flow received by us.  Electricity, supplies, and labor costs are a few of the operating costs that are susceptible to material fluctuation.  The need for significant repairs and maintenance of infrastructure may increase as our properties age.  A significant increase in operating costs could result in materially lower operating margin and cash flow.

The level of production from our existing properties may decline at rates greater than anticipated due to unforeseen circumstances, many of which are beyond our control.  A significant decline in our production could result in materially lower revenues and cash flow.

Our operating results are affected by our ability to market the oil and natural gas that we produce.

Our business depends in part upon the availability, proximity and capacity of natural gas gathering systems, pipelines and processing facilities.  Canadian federal and provincial, as well as United States federal and state, regulation of oil and natural gas production, processing and transportation, tax and energy policies, general economic conditions, and changes in supply and demand could adversely affect our ability to produce and market oil and natural gas.  If market factors change and inhibit the marketing of our production, overall production or realized prices may decline.

We are not the operator and have limited influence over the operations of the majority of our oil and natural gas properties.

We hold minority interests in the majority of our oil and natural gas properties.  As a result, we cannot control the pace of exploration or development, major decisions affecting the drilling of wells or the plan for development and production at non-operated properties, although contract provisions give Barnwell certain consent rights in some matters.  The operator’s influence over these matters can affect the pace at which we incur capital expenditures.  Additionally, as certain underlying joint venture data is not accessible to us, we depend on the operators at non-operated properties to provide us with reliable accounting information.

Our operations are subject to domestic and foreign government regulation and other risks, particularly in Canada and the United States.

Barnwell’s oil and natural gas operations are affected by political developments and laws and regulations, particularly in Canada and the United States, such as restrictions on production, restrictions on imports and exports, the maintenance of specified reserves, tax increases and retroactive tax claims, expropriation of property, cancellation of contract rights, environmental protection controls, environmental compliance requirements and laws pertaining to workers’ health and safety.  Further, the

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right to explore for and develop oil and natural gas on lands in Alberta, Saskatchewan and British Columbia is controlled by the governments of each of those provinces.  Changes in royalties and other terms of provincial leases, permits and reservations may have a substantial effect on Barnwell’s operations.  We derive a significant portion of our revenues from our operations in Canada.  In fiscal 2011, we derived 80% of our revenues from operations in Canada.

Additionally, our ability to compete in the Canadian oil and natural gas industry may be adversely affected by governmental regulations or other policies that favor the awarding of contracts to contractors in which Canadian nationals have substantial ownership interests.  Furthermore, we may face governmentally imposed restrictions or fees from time to time on the transfer of funds to the U.S.

Government regulations control and often limit access to potential markets and impose extensive requirements concerning employee safety, environmental protection, pollution control and remediation of environmental contamination.  Environmental regulations, in particular, prohibit access to some markets and make others less economical, increase equipment and personnel costs and often impose liability without regard to negligence or fault.  In addition, governmental regulations may discourage our customers’ activities, reducing demand for our products and services.

Compliance with foreign tax and other laws may adversely affect our operations.

Tax and other laws and regulations are not always interpreted consistently among local, regional and national authorities.  Income tax laws, other legislation or government incentive programs relating to the oil and natural gas industry may in the future be changed or interpreted in a manner that adversely affects us and our stockholders.  It is also possible that in the future we will be subject to disputes concerning taxation and other matters in Canada, including the manner in which we calculate our income for tax purposes, and these disputes could have a material adverse effect on our financial performance.

We are dependent upon future discoveries or acquisitions of oil and natural gas to maintain our reserves.

We actively explore for oil and natural gas reserves.  However, future exploration and drilling results are uncertain and may involve substantial costs.  Despite this uncertainty or potential cost, discoveries or acquisitions of additional reserves are needed to avoid a material decline in reserves and production.  As a result, future oil and natural gas reserves may be dependent on our success in exploiting existing properties and acquiring additional reserves.  If our access to capital becomes limited or unavailable, our ability to make the necessary capital investments to maintain or expand our oil and natural gas reserves will be impaired.  Additionally, we cannot guarantee that we will be successful in developing additional reserves or acquiring additional reserves on terms that meet our investment objectives.  Without these reserve additions, our reserves will deplete and as a consequence, either production from, or the average reserve life of, our properties will decline.

Actual reserves will vary from reserve estimates.

Estimating reserves is inherently uncertain and the reserves estimation process involves significant decisions and assumptions in the evaluation of available geological, geophysical, engineering and economic data.  The reserve data and standardized measures set forth herein are only estimates.  Ultimately, actual reserves attributable to our properties will vary from estimates, and those

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variations may be material.  The estimation of reserves involves a number of factors and assumptions, including, among others:

·                oil and natural gas prices as prescribed by the SEC;

·                historical production from our wells compared with production rates from similar producing wells in the area;

·                future commodity prices, production and development costs, royalties and capital expenditures;

·                initial production rates;

·                production decline rates;

·                ultimate recovery of reserves;

·                success of future development activities;

·                marketability of production;

·                effects of government regulation; and

·                other government levies that may be imposed over the producing life of reserves.

If these factors, assumptions and prices prove to be inaccurate, actual results may vary materially from reserve estimates.

Delays in business operations could adversely affect our distributions.

In addition to the usual delays in payment by purchasers of oil and natural gas to the operators of our properties, and the delays of those operators in remitting payment to us, payments between any of these parties may also be delayed by:

·                restrictions imposed by lenders;

·                accounting delays;

·                delays in the sale or delivery of products;

·                delays in the connection of wells to a gathering system;

·                blowouts or other accidents;

·                adjustments for prior periods;

·                recovery by the operator of expenses incurred in the operation of the properties; and

·                the establishment by the operator of reserves for these expenses.

Any of these delays could expose us to additional third party credit risks.

The industry in which we operate exposes us to potential liabilities that may not be covered by insurance.

Our operations are subject to all of the risks associated with the operation and development of oil and natural gas properties, including the drilling of oil and natural gas wells, and the production and transportation of oil and natural gas.  These risks include encountering unexpected formations or pressures, premature declines of reservoirs, blow-outs, equipment failures and other accidents, cratering, sour gas releases, uncontrollable flows of oil, natural gas or well fluids, adverse weather conditions, pollution, other environmental risks, fires and spills.  A number of these risks could result in personal injury, loss of life, or environmental and other damage to our property or the property of others.

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While we maintain reserves for anticipated liabilities and carry various levels of insurance, we could be affected by civil, criminal, regulatory or administrative actions, claims or proceedings.  We cannot fully protect against all of the risks listed above, nor are all of these risks insurable.  There is no assurance that any applicable insurance or indemnification agreements will adequately protect us against liability for the risks listed above.  We could face substantial losses if an event occurs for which we are not fully insured or are not indemnified against or a customer or insurer fails to meet its indemnification or insurance obligations.  In addition, there can be no assurance that insurance will continue to be available to cover any or all of these risks, or, even if available, that insurance premiums or other costs will not rise significantly in the future, so as to make the cost of such insurance prohibitive.

We may incur material costs to comply with or as a result of health, safety, and environmental laws and regulations.

The oil and natural gas industry is subject to extensive environmental regulation pursuant to local, provincial and federal legislation.  A violation of that legislation may result in the imposition of fines or the issuance of “clean up” orders.  Legislation regulating the oil and natural gas industry may be changed to impose higher standards and potentially more costly obligations.  For example, the 1997 Kyoto Protocol to the United Nation’s Framework Convention on Climate Change, known as the Kyoto Protocol, was ratified by the Canadian government in December 2002 and will require, among other things, significant reductions in greenhouse gases.  The impact of the Kyoto Protocol on us is uncertain and may result in significant additional costs for our future operations.  Although we have recorded a provision in our financial statements relating to our estimated future environmental and reclamation obligations that we believe is reasonable, we cannot guarantee that we will be able to satisfy our actual future environmental and reclamation obligations.

We are not fully insured against certain environmental risks, either because such insurance is not available or because of high premium costs.  In particular, insurance against risks from environmental pollution occurring over time, as opposed to sudden and catastrophic damages, is not available on economically reasonable terms.  Accordingly, any site reclamation or abandonment costs actually incurred in the ordinary course of business in a specific period could negatively impact our cash flow.  Should we be unable to fully fund the cost of remedying an environmental problem, we might be required to suspend operations or enter into interim compliance measures pending completion of the required remedy.

We may have difficulty financing our planned capital expenditures, which could have an adverse effect on our business.

We make and will continue to make substantial capital expenditures in our exploration and development projects.  Without adequate capital resources, our drilling and other activities may be limited and our business, financial condition and results of operations may suffer.  We may not be able to secure necessary financing on reasonable terms or at all and financing may not continue to be available to us under our existing financing arrangements.  If capital resources are unavailable, we may curtail our drilling, development and other activities or be forced to sell some of our assets under untimely or unfavorable terms.  Any such curtailment or sale could have a material adverse effect on our business, financial condition and results of operations.

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Unforeseen title defects may result in a loss of entitlement to production and reserves.

Although we conduct title reviews in accordance with industry practice prior to any purchase of resource assets or property, such reviews do not guarantee that an unforeseen defect in the chain of title will not arise and defeat our title to the purchased assets.  If such a defect were to occur, our entitlement to the production from such purchased assets could be jeopardized.

Risks Related to Land Investment Segment

The real estate investment industry continues to experience a slowdown that may persist for an indefinite period.  This downturn in economic conditions could adversely affect our business, results of operations and stockholders’ equity.

The real estate investment industry is cyclical in nature and is particularly vulnerable to shifts in local, regional, and national economic conditions outside of our control such as interest rates, housing demand, population growth, employment levels, job growth and property taxes.  Further, a weakening of the economic drivers in Hawaii, which include tourism, military spending, construction starts and employment, and a decrease in market demand adversely impacted the level of real estate activity in Hawaii.  The industry has experienced a significant decrease in demand for new homes since 2007 and this trend may continue for an extended period of time.  Conditions in both the United States and international economies remain weak, which puts continued pressure on consumer confidence for residential real estate.  These challenging market conditions are expected to continue for the foreseeable future and, in the near term, these conditions may further deteriorate.  We expect that continued weakness in the industry could adversely affect our business, results of operations and financial condition.

Considerable economic and political uncertainties currently exist that could have adverse effects on consumer buying habits, construction costs, availability of labor and materials and other factors affecting us and the real estate industry in general.  Significant expenditures associated with investment in real estate, such as real estate taxes, insurance, maintenance costs and debt payments, cannot generally be reduced even though changes in Hawaii’s or the nation’s economy may cause a decrease in revenues from our properties.

Our real estate business is concentrated in the state of Hawaii.  As a result, our financial results are dependent on the economic growth and health of Hawaii, particularly the island of Hawaii.

Barnwell’s land investment segment is impacted by the condition of Hawaii’s real estate market, which is affected by Hawaii’s economy and Hawaii’s tourism industry, as well as the United States and world economies in general.  Any future cash flows from Barnwell’s land development activities are subject to, among other factors, the level of real estate activity and prices, the demand for new housing and second homes on the island of Hawaii, the rate of increase in the cost of building materials and labor, the introduction of building code modifications, changes to zoning laws, and the level of confidence in Hawaii’s economy.

The occurrence of natural disasters in Hawaii could adversely affect our business.

The occurrence of a natural disaster in Hawaii such as, but not limited to, earthquakes, landslides, hurricanes, tornadoes, tsunamis, volcanic activity, droughts and floods, could have a material adverse effect on our ability to develop and sell properties or realize income from our projects.  The occurrence of a natural disaster could also cause property and flood insurance rates and deductibles to increase, which could reduce demand for our properties.

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Increases in interest rates, tightening of lending standards and decreases, limitations or restrictions in the availability of mortgage financing and other economic factors outside our control, such as consumer confidence and declines in employment levels could lead to slowed home sales, which could adversely affect our revenues and earnings.

The United States residential mortgage market continues to experience disruption.  Mortgage interest rates have been experiencing significant volatility and contributed to the challenging market conditions faced by us and the industry.  In addition, as a result of increased default rates and other factors, the willingness of many lenders to make home mortgage loans has decreased and lenders have tightened their lending standards.  The volatility in interest rates, the decrease in the willingness of lenders to make home mortgage loans, and the tightening of lending standards have made it more difficult for some potential buyers to finance the purchase of homes.  Potential buyers may not be able to obtain acceptable financing to purchase residential lots within the Kaupulehu area, leading to further declines in the market for homes.  Any limitations or restrictions on the availability of mortgage financing or increases in mortgage interest rates could reduce residential lot sales, thereby reducing our revenues and earnings.  Even if potential buyers do not need financing, changes in interest rates and mortgage availability could make it harder for them to sell their existing homes to potential buyers who need financing.  Any limitations or restrictions on the availability of mortgage financing or interest rate increases could adversely affect our sales, which would reduce our revenues.

Our business is subject to extensive regulation which makes it difficult and expensive for us to conduct our operations.

We are subject to a wide variety of federal, state and local laws and regulations relating to land use and development and to environmental compliance and permitting obligations, including those related to the use, storage, discharge, emission, and disposal of hazardous materials.  In most cases, approval to develop requires multiple permits which involve a long, uncertain and costly regulatory process.  Any failure to comply with these laws could result in capital or operating expenditures or the imposition of severe penalties or restrictions on operations that could adversely affect present and future operations, or jeopardize our ability to sell the leasehold interest currently held.

Receipt of future percentage of sales payments is dependent upon the developer’s continued efforts to develop and market the property.

We are entitled to receive future payments based on a percentage of the sales prices of residential homes and lots within approximately 870 acres in the Kaupulehu area.  However, in order to collect such percentage of sales payments we are reliant upon an unaffiliated third party developer to continue to develop and market the homes and lots.  The receipt of future percentage of sales payments could be jeopardized if the developer fails to proceed with development and marketing of the property.

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If required land use entitlements are not obtained at reasonable costs, or at all, our operating results could be adversely affected.

We hold the leasehold interest to approximately 1,000 acres of vacant land that is currently zoned conservation.  Our success in selling this interest may be contingent upon obtaining the necessary reclassification from the State of Hawaii Land Use Commission and county of Hawaii.  Obtaining the necessary reclassification and ministerial approvals is often difficult, costly and may take several years, or more, to complete.  Delays or failures to obtain the necessary reclassification approvals may adversely affect our financial results.

The value of our lot acquisition rights could be impaired if the developer of the property is unable to obtain required land use entitlements or successfully negotiate development terms and agreements.

We hold acquisition rights to 14 lots in agricultural-zoned leasehold lands in the upland area of Kaupulehu (“Mauka Lands”) situated between the Queen Kaahumanu Highway and the Mamalahoa Highway at Kaupulehu, North Kona, island and state of Hawaii.  The lot acquisition rights give us the right to purchase residential lots which may be developed on the Mauka Lands.  The ability to purchase residential lots and the value of such lots in the future is contingent upon the developer of the property obtaining the necessary land use reclassification, zoning and development approvals from regulatory entities.  Obtaining the necessary reclassification and ministerial approvals is often difficult, costly and may take several years, or more, to complete.  Delays or failures to obtain the necessary reclassification and rezoning approvals may adversely affect our financial results.  Our ability to purchase lots and the value of such lots is also contingent upon the ability of the developer of the property to successfully negotiate development terms and agreements within the Mauka Lands.  If the developer is unsuccessful in such negotiations, our ability to purchase residential lots in the Mauka Lands would be impaired.

The market value of our real estate interests could decline, which may require write-downs of the carrying value of our residential lots held for investment to its estimated fair value.  Any write-downs would negatively impact our results of operations.

The risk of owning undeveloped lots can be substantial and we may have bought lots which we cannot profitably sell.  The market value of residential lots can fluctuate significantly as a result of changing economic market conditions.  Prevailing market conditions may significantly influence the market value of our residential parcels held for investment.  In the event of changes in economic or market conditions, we may have to sell the residential lots at lower margins or at a loss.  Furthermore, if the market conditions continue to deteriorate, we may be required to record write-downs of the carrying value of our residential parcels held for investment.  Such write-downs would have a negative impact on our results of operations and financial condition.

Risks Related to Residential Real Estate Segment

The homebuilding industry continues to experience a slowdown that may persist for an indefinite period.  This downturn in economic conditions could adversely affect our business, results of operations and stockholders’ equity.

The homebuilding industry historically has been cyclical and is sensitive to changes in economic conditions such as employment levels, consumer confidence, consumer income, availability

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of financing and interest rate levels.  Adverse changes in any of these conditions generally, or in the market in which we operate, could decrease demand and pricing for new homes or result in customer cancellations of pending contracts, which could adversely affect the number of home deliveries we make or reduce the prices we can charge for homes, either of which could result in a reduction in our revenues or deterioration of our margins.

The homebuilding industry has experienced a significant and sustained downturn characterized by decreased demand for new homes, an oversupply of both new and resale home inventories, including foreclosed homes; aggressive price competition among homebuilders, including increased incentives for home sales; and a more restrictive mortgage lending environment.  Economic conditions in the United States and the world remain weak, which puts continued pressure on consumer confidence for residential real estate.  These challenging market conditions are expected to continue for the foreseeable future and, in the near term, these conditions may further deteriorate.  Continued weakness in the homebuilding industry could further adversely affect our business, results of operations and financial condition.

We are reliant upon sales of homes as a source of liquidity.  If we are unable to sell the homes within a reasonable timeframe, our revenues, operating results, cash inflows and financial condition could be materially impacted.

Barnwell currently owns two luxury residences that are available for sale in the Lot 4A Increment I area of Kaupulehu, North Kona, Hawaii.

The acquisition of the parcels and home construction costs on the luxury homes were originally financed through a bank revolving credit facility and subsequently refinanced via a non-revolving term loan with a new lender during fiscal 2011.  The loan is a seven year term loan with an interest rate that adjusts annually.

Monthly payments of principal and interest are due on the first day of each month and will change as a result of a change in the interest rate, the sale of a house or the sale of a residential parcel.  Upon the sale of a house or a residential parcel, we will be required to make a principal payment in the amount of the net sales proceeds of the house or residential parcel.  Any unpaid principal balance and accrued interest will be due and payable on April 1, 2018.

The timing and amount of residential home sales are unpredictable and may be sporadic.  The inability to sell the homes within a reasonable timeframe will lead to additional interest, maintenance, property taxes and other holding costs.  Furthermore, if estimated cash inflows from home sales are less than current expectations, our revenues, operating results, cash inflows and financial condition could be materially impacted.

We have limited experience in the homebuilding industry.

Homebuilding is a new business segment for us and we are relying to a material extent on our business partners to help us execute our business plan.

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We may need financing to fund our future real estate development activities.  If we are unable to obtain sufficient financing or such financing is obtained on adverse terms, we may not be able to operate our business as planned, which could adversely affect our results of operations and future growth.

The real estate development industry is capital intensive and homebuilding requires significant up-front expenditures to acquire land and begin development.  We will need to establish funding sources to finance any future land acquisition capital expenditures.  If such sources are not sufficient, we would seek additional capital in the form of debt or equity financing from a variety of potential sources, including additional bank financing, joint venture partner financing, and/or securities offerings.  The amount and types of indebtedness which we may incur are limited by the terms of the agreements governing our existing debt.  In addition, the availability of borrowed funds to be utilized for land acquisition, development and construction may be greatly reduced, and the lending community may require increased amounts of equity to be invested in a project by borrowers in connection with both new loans and the extension of existing loans.  The failure to obtain sufficient capital to fund our planned capital and other expenditures could have a material adverse effect on our business.

Our operating results from homebuilding are expected to be variable.

Due to the cyclical nature of the real estate development industry, we expect to experience variability in our future operating results on a quarterly and an annual basis.  Factors expected to contribute to this variability include, among other things:

·                the timing of land acquisitions and permitting;

·                the timing of home closings, land sales and level of home sales;

·                our ability to continue to acquire additional land or options thereon on acceptable terms;

·                the condition of the real estate market and the general economy; and

·                delays in construction due to natural disasters, adverse weather, reduced contractor availability and strikes.

For example, the timing of land acquisitions and permitting impacts our ability to pursue the development of new housing projects in accordance with our business plan.  If the timing of land acquisitions, zoning or regulatory approvals is delayed, we will be delayed in our ability to develop housing projects, which would likely decrease our backlog.  Furthermore, these delays could result in a decrease in our revenues and earnings for the periods in which the delays occur and possibly subsequent periods until the planned housing projects can be completed.  A delay in home closings due to natural disasters, adverse weather or contractor availability would have a similar impact on revenues and earnings for the period in which the delays occur.  Further, revenues may increase in subsequent periods over what would normally be expected as a result of increased home closings as the delays described above are resolved.

Changes in the government regulations applicable to homebuilders could restrict our business activities, increase our operating expenses and cause our revenues to decline.

Regulatory requirements applicable to homebuilders could cause us to incur significant liabilities and operating expenses and could restrict our business activities.  We are subject to local, state and federal statutes and rules regulating, among other things, certain developmental matters, building and site design, and matters concerning the protection of worker health and safety, and the

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environment.  Our operating expenses may be increased by governmental regulations, such as building permit allocation ordinances, impact and other fees and taxes, which may be imposed to defray the cost of providing certain governmental services and improvements.  Other governmental regulations, such as building moratoriums and “no growth” or “slow growth” initiatives, which may be adopted in communities which have developed rapidly, may cause delays in our home projects or otherwise restrict our business activities resulting in reductions in our revenues.  Any delay or refusal to grant us necessary licenses, permits or approvals from government agencies could cause substantial increases to development costs or cause us to abandon the project and to sell the affected land at a potential loss, which in turn could harm our operating results.

Our residential real estate segment is dependent on the continued availability and satisfactory performance of our building contractors, which, if unavailable, could have a material adverse effect on our business.

We conduct our construction operations through unaffiliated building contractors.  As a consequence, we depend on the continued availability of and satisfactory performance by the contractors for the construction of our homes.  There may not be sufficient availability of and satisfactory performance by the contractors.  If the contractors’ quality of work is not sufficient, our ability to construct homes on the schedule we have planned would be affected.  This could result in an increase in our costs to construct homes in a timely manner, which could result in an increase in our overall costs and thus a decline in our margins and in our net income.  Further, non-timely completion of work could affect our ability to sell homes based upon our projected timeline thus possibly affecting our ability to obtain additional financing to continue our homebuilding efforts.

Shortages of labor or materials and/or increases in the price of materials could delay construction or increase the cost of home construction thereby reducing our sales and earnings.

The homebuilding business has from time to time experienced building material and labor shortages, as well as volatility in the prices of certain materials, including lumber, framing, drywall and cement, which are significant components of home construction costs.  These labor and material shortages can be more severe during periods of strong demand for housing or during periods where the area in which we operate experiences natural disasters that have a significant impact on existing residential and commercial structures.  Shortages and price increases could cause delays in and increase our costs of home construction, which in turn could harm our operating results.

The market value of our real estate interests could decline, which may require write-downs of the carrying value of our real estate held for sale to its estimated fair value.  Any write-downs would negatively impact our results of operations.

The risk of owning developed and undeveloped land can be substantial for homebuilders. Homebuilding requires that we acquire land for replacement and expansion of land inventory within our existing and new markets.  The risks inherent in purchasing and developing land increase as consumer demand for housing decreases.  Thus, we may have bought and developed land which we cannot profitably sell or on which we cannot profitably build and sell homes.  The market value of land, buildable lots and housing inventories can fluctuate significantly as a result of changing economic market conditions.  It is possible that the measures we employ to manage inventory risks will not be successful and as a result our operations may suffer.  In addition, inventory carrying costs can be significant and can result in losses in a poorly performing market.  Prevailing market conditions may

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significantly influence the market value of our real estate held for sale.  In the event of changes in economic or market conditions, we may have to sell homes or land inventory at lower margins or at a loss.  Furthermore, if the market conditions continue to deteriorate, we will be required to record write-downs of the carrying value of our real estate held for sale.  Such write-downs would have a negative impact on our results of operations and financial condition.

Severe weather and other natural conditions or disasters may disrupt or delay construction and may impair the value of our real estate property.

Severe weather and other natural conditions or disasters, such as, but not limited to, earthquakes, landslides, hurricanes, tornadoes, tsunamis, volcanic activity, droughts, floods, and heavy or prolonged rain, can negatively affect our operations by requiring us to delay or halt construction or to perform potentially costly repairs to our projects under construction and to unsold homes.  Further, these conditions can delay home closings, adversely affect the cost or availability of materials or labor, or impair the value of the property on a temporary or permanent basis.  To the extent our insurance is not adequate to cover business interruption losses or repair costs resulting from these events, our total earned revenues and earnings may be adversely affected.

The homebuilding industry is highly competitive and, with more limited resources than some of our competitors, we may not be able to compete effectively.

The homebuilding industry is highly competitive.  We face competition from other developers on the island of Hawaii and from other luxury residential properties in Hawaii and the mainland United States.  In many cases, our competitors have greater financial and other resources, more established market positions, lower costs of capital, labor and material than we do.  Homebuilders compete for, among other things, desirable land, financing, raw materials, skilled labor and purchasers.  We compete for residential sales on the basis of a number of interrelated factors, including location, reputation, amenities, design, quality and price, with numerous homebuilders, including some homebuilders with greater financial resources and/or lower costs than us.  Increased competition could also reduce the number of homes we deliver, reducing our revenues, or cause us to accept reduced margins to maintain sales volumes.  A reduction in our revenue or margins due to competitive factors could affect our ability to service our debt, including the credit facilities.

Risks Related to Contract Drilling Segment

Demand for water well drilling and/or pump installation is volatile.  A decrease in demand for our services could adversely affect our revenues and results of operations.

Demand for services is highly dependent upon land development activities in the state of Hawaii.  As also noted above, the real estate development industry is cyclical in nature and is particularly vulnerable to shifts in local, regional, and national economic conditions outside of our control such as interest rates, housing demand, population growth, employment levels and job growth and property taxes.  A decrease in water well drilling and/or pump installation contracts will result in decreased revenues and operating results.

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A significant portion of our contract drilling business is dependent on municipalities and a decline in municipal spending could adversely impact our business.

A significant portion of our contract drilling division revenues is derived from water and infrastructure contracts with governmental entities or agencies.  Reduced tax revenues and governmental budgets may limit spending by local governments which in turn will affect the demand for our services.  Material reductions in spending by a significant number of local governmental agencies could have a material adverse effect on our business, results of operations, liquidity and financial position.

Our contract drilling operations face significant competition.

We face competition for our services from a variety of competitors.  Many of our competitors utilize drilling rigs that drill as quickly as our equipment but require less labor.  Our strategy is to compete based on pricing and to a lesser degree, quality of service.  If we are unable to compete effectively with our competitors, our financial results could be adversely affected.

The loss of or damage to key vendor, customer or sub-contractor relationships would adversely affect our operations.

Our business is dependent on our relationships with key vendors, customers and subcontractors.  The loss of or damage to any of our key relationships could negatively affect our business.

Awarding of contracts is dependent upon our ability to obtain contract bid and performance bonds from insurers.

Although the Company has not experienced difficulties in obtaining such bonds in the past, there can be no assurance that our ability to obtain such bonds will continue on the same basis as the past.  Additionally, bonding insurance rates may increase and have an impact on our ability to win competitive bids, which could have a corresponding material impact on contract drilling operating results.

The contracts in our backlog are subject to change orders and cancellation.

Our backlog consists of the uncompleted portion of services to be performed under contracts that have been started and new contracts not yet started.  Our contracts are subject to change orders and cancellations, and such changes could adversely affect our operations.

The occurrence of natural disasters in Hawaii could adversely affect our business.

The occurrence of a natural disaster in Hawaii such as, but not limited to, earthquakes, landslides, hurricanes, tornadoes, volcanic activity, droughts and floods, could have a material adverse effect on our ability to complete our contracts.

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Entity-Wide Risks

The continued economic slowdown may have impacts on our business and financial condition that we currently cannot predict.

The economic slowdown has affected demand for luxury real estate and water well drilling and pump installation services in the state of Hawaii, and demand for oil and natural gas.  The ongoing economic slowdown may have further impacts on our business and our financial condition, and we may face additional challenges if economic conditions do not improve.  Our ability to access the capital and credit markets may be restricted at a time when we would like, or need, to raise funds, which could have an impact on our flexibility to react to changing economic and business conditions.  A further deterioration or continuation of these conditions will have an adverse impact on our operations and financial condition and results.

We are reliant upon future cash flows from operations, land investment segment percentage of sales proceeds, and available credit as sources of liquidity.  If estimated cash inflows do not occur timely or are less than current expectations, our liquidity may be negatively impacted.

In addition to cash flows from oil and natural gas, residential real estate and contract drilling operations, we rely upon land investment segment percentage of sales payment proceeds as a source of liquidity.  However, oil and natural gas prices have been historically volatile and the timing and amount of land investment segment percentage of sales proceeds are unpredictable, may be sporadic, and are not under our control.

We also have a credit facility with a Canadian bank that is denominated in Canadian dollars.  Any decreases in currency exchange rates affect the amount of credit available to us.  Furthermore, our real estate loan agreement contains provisions requiring us to maintain compliance with certain covenants including a consolidated debt service coverage ratio of not less than 1.20 to 1, a consolidated total liabilities to tangible net worth ratio not to exceed 1.85 to 1, and a maximum loan to value ratio.  Noncompliance with any of the ratios could result in the need to pay down a portion of the outstanding borrowings.

Accordingly, if estimated cash inflows do not occur on a timely basis or are less than current expectations or if we are subject to reductions in available credit, our revenues, operating results, cash inflows and financial condition could be materially impacted.

Our future level of indebtedness and the terms of our financing arrangements may adversely affect our operations, financial condition and limit our growth.

At September 30, 2011, we had borrowings under our credit facility and real estate loan of approximately $24 million.  In the ordinary course of business, we may incur significant additional debt, to the extent permitted by our credit facility and loan, in order to fund future capital expenditures, acquisitions and homebuilding activities.

The terms of our credit facility and real estate loan impose restrictions on our ability and, in some cases, the ability of our subsidiaries to take a number of actions that we may otherwise desire to take, including one or more of the following:

·                incurring additional debt, including guarantees of indebtedness;

·                making investments;

·                creating liens on our assets; and

·                selling assets.

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Our level of indebtedness and the covenants contained in our financing agreements could have important consequences.  For example, they could:

·                limit our ability to obtain future financing, through equity offerings or debt financings, for working capital, capital expenditures, acquisitions, refinancing of indebtedness or general corporate and other activities;

·                require us to dedicate a substantial portion of our cash flow from operations to service our debt, thereby reducing our ability to use our cash flow for other purposes (i.e., working capital, capital expenditures, and other general business activities);

·                limit our flexibility in planning for, or reacting to, the changes in our business;

·                subject us to higher costs and more restrictive covenants in the future for working capital, capital expenditures, acquisitions, general corporate or other purposes, if additional financing is obtained;

·                make us vulnerable to increases in interest rates as our credit facilities are subject to variable interest rates;

·                detract from our ability to successfully withstand a downturn in our business or the economy generally;

·                place us at a competitive disadvantage because we have more debt than some of our competitors; and

·                make us more vulnerable to general economic downturns and adverse developments in our industries, especially declines in oil and natural gas prices, and the economy in general.

We may incur additional debt, including significant secured indebtedness, or issue additional stock in order to fund capital expenditures, make future acquisitions, and develop our properties.  A higher level of indebtedness increases the risk that we may default on our obligations.  Our ability to meet our debt obligations and to reduce our level of indebtedness depends on our future performance.  General economic conditions, oil and natural gas prices and financial, business and other factors affect our operations and our future performance.  Many of these factors are beyond our control.  Factors that will affect our ability to raise cash through a refinancing of our debt include financial market conditions, the value of our assets and our performance at the time we need capital.

In addition, our Canadian revolving credit facility is subject to periodic redetermination.  A decrease in the facility could require us to repay indebtedness in excess of the borrowing base, or we may need to further secure the lenders with additional collateral.

The price of our common stock has been volatile and could continue to fluctuate substantially.

The market price of our common stock has been volatile and could fluctuate based on a variety of factors, including:

·                fluctuations in commodity prices;

·                variations in results of operations;

·                announcements by us and our competitors;

·                legislative or regulatory changes;

·                general trends in the industry;

·                general market conditions; and

·                analysts’ estimates and other events in the oil and natural gas industry.

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Failure to retain key personnel could hurt our operations.

We require highly skilled and experienced personnel to operate our business.  In addition to competing in highly competitive industries, we compete in a highly competitive labor market.  Our business could be adversely affected by an inability to retain personnel or upward pressure on wages as a result of the highly competitive labor market.

A small number of stockholders, including our executive officers, own a significant amount of our common stock and have influence over our business regardless of the opposition of other stockholders.

As of September 30, 2011, two of our investors and our executive officers held approximately 45% of our common stock.  The interests of these stockholders may not always coincide with the interests of other stockholders.  These stockholders, acting together, have significant influence over all matters submitted to our stockholders, including the election of our directors, and could accelerate, delay, deter or prevent a change of control of us.  These stockholders are able to exercise significant control over our business, policies and affairs.

Adverse changes in actuarial assumptions used to calculate retirement plan costs due to economic or other factors, or lower returns on plan assets could adversely affect Barnwell’s results and financial condition.

Retirement plan cash funding obligations and plan expenses and obligations are subject to a high degree of uncertainty and could increase in future years depending on numerous factors, including the performance of the financial markets, specifically the equity markets, and the levels of interest rates.

We are involved as a passive minority-interest partner in joint ventures and are subject to risks associated with joint venture partnerships.

We are involved as a passive minority-interest partner in joint venture relationships and may initiate future joint venture projects.  Entering into a joint venture as a passive minority-interest partner involves certain risks which include:

·                the inability to exercise voting control over the joint venture;

·                economic or business interests which are not aligned with our venture partners, including the holding period and timing of ultimate sale of the ventures’ underlying assets; and

·                the inability for the venture partner to fulfill its commitments and obligations due to financial or other difficulties.

General economic conditions in the lodging industry could adversely affect our financial results.

We own a 1.5% passive minority interest in Hualalai Resort, which includes the Four Seasons Resort Hualalai at Historic Ka’upulehu, two golf courses and a clubhouse.  Soft economic conditions and reduced travel to North Kona, Hawaii could adversely affect these interests and, therefore, our financial results related to our investment.  The aforementioned properties are also subject to risks that generally relate to investments in commercial real estate, including governmental regulations, real estate, insurance, zoning, tax and eminent domain laws, the ongoing need for capital improvements to maintain or upgrade properties, fluctuations in real estate values, and the relative illiquidity of real estate compared to other investments.

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ITEM 1B.       UNRESOLVED STAFF COMMENTS

None.

ITEM 2.          PROPERTIES

Oil and Natural Gas, Land Investment and Residential Real Estate Properties

The location and character of Barnwell’s oil and natural gas properties, and its land investment and residential real estate properties, are described above under Item 1, “Business.”

Corporate Offices

Barnwell, through wholly-owned subsidiaries, owns the 29th floor of a commercial office building in downtown Honolulu that it uses as its corporate office and a unit in a high rise cooperative apartment in New York City that it utilizes as its New York office.

ITEM 3.          LEGAL PROCEEDINGS

Barnwell is occasionally involved in routine litigation and is subject to governmental and regulatory controls that are incidental to the business.  Barnwell’s management believes that routine claims and litigation involving Barnwell are not likely to have a material adverse effect on its financial position, results of operations or liquidity.

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PART II

ITEM 5.                                      MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

The principal market on which Barnwell’s common stock is being traded is the NYSE Amex under the ticker symbol “BRN.”  The following tables present the quarterly high and low sales prices, on the NYSE Amex, for Barnwell’s common stock during the periods indicated:

Holders

As of December 1, 2011, there were 8,277,160 shares of common stock, par value $0.50, outstanding.  There were approximately 950 holders of the common stock of the registrant as of December 1, 2011.

Dividends

No dividends were declared or paid during fiscal years 2011 or 2010.  The payment of future cash dividends will depend on, among other things, our financial condition, operating cash flows, the amount of cash inflows from land investment activities, and the level of our oil and natural gas capital expenditures.

Securities Authorized for Issuance Under Equity Compensation Plans

See the information included in Part III, Item 12, under the caption “Equity Compensation Plan Information.”

Stock Performance Graph and Cumulative Total Return

Disclosure is not required as Barnwell qualifies as a smaller reporting company.

ITEM 6.          SELECTED FINANCIAL DATA

Disclosure is not required as Barnwell qualifies as a smaller reporting company.

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ITEM 7.                                      MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion is intended to assist in the understanding of the Consolidated Balance Sheets of Barnwell Industries, Inc. and subsidiaries (collectively referred to herein as “Barnwell,” “we,” “our,” “us” or the “Company”) as of September 30, 2011 and 2010, and the related Consolidated Statements of Operations, Comprehensive Income, Cash Flows, and Equity for the years ended September 30, 2011 and 2010.  This discussion should be read in conjunction with the consolidated financial statements and related Notes to Consolidated Financial Statements included in this report.

Use of Estimates in the Preparation of Financial Statements

The preparation of the financial statements in conformity with U.S. GAAP requires management of Barnwell to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities.  Actual results could differ significantly from those estimates.

Critical Accounting Policies and Estimates

The Company considers an accounting estimate to be critical if the accounting estimate requires the Company to make assumptions that are difficult or subjective about matters that were highly uncertain at the time that the accounting estimate was made, and changes in the estimate that are reasonably likely to occur in periods subsequent to the period in which the estimate was made, or use of different estimates that the Company could have used in the current period, would have a material impact on the financial condition or results of operations.  The most critical accounting policies inherent in the preparation of the Company’s financial statements are described below.  We continue to monitor our accounting policies to ensure proper application of current rules and regulations.

Oil and natural gas properties - full cost ceiling calculation and depletion

Policy Description

We use the full cost method of accounting for our oil and natural gas properties under which we are required to conduct quarterly calculations of a “ceiling,” or limitation, on the carrying value of oil and natural gas properties.  The ceiling limitation is the sum of 1) the discounted present value (at 10%), using average first-day-of-the-month prices during the 12-month period ending in the reporting period on a constant basis, of Barnwell’s estimated future net cash flows from estimated production of proved oil and natural gas reserves, less estimated future expenditures to be incurred in developing and producing the proved reserves but excluding future cash outflows associated with settling asset retirement obligations accrued on the balance sheet; plus 2) the cost of major development projects and unproven properties not subject to depletion, if any; plus 3) the lower of cost or estimated fair value of unproven properties included in costs subject to depletion; less 4) related income tax effects.  If net capitalized costs exceed this limit, the excess is expensed.

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Judgments and Assumptions

The estimate of our oil and natural gas reserves is a major component of the ceiling calculation and represents the component that requires the most subjective judgments.  Estimates of reserves are forecasts based on engineering data, historical data, projected future rates of production and the timing of future expenditures.  The process of estimating oil and natural gas reserves requires substantial judgment, resulting in imprecise determinations, particularly for new discoveries.  Our reserve estimates are prepared annually by independent petroleum reserve engineers and quarterly by internal personnel.  The passage of time provides more quantitative and qualitative information regarding estimates of reserves, and revisions are made to prior estimates to reflect updated information.  In the last three fiscal years, annual revisions to our reserve volume estimates have averaged 3% of the previous year’s estimate.  However, there can be no assurance that more significant revisions will not be necessary in the future.  If future significant revisions are necessary that reduce previously estimated reserve quantities, such revisions could result in a write-down of oil and natural gas properties.  If reported reserve volumes were revised downward by 5% at the end of fiscal 2011, the ceiling limitation would have decreased approximately $2,492,000.  This decrease would not have resulted in a write-down during the fourth quarter of fiscal 2011.

In addition to the impact of the estimates of proved reserves on the calculation of the ceiling, estimated proved reserves are also a significant component of the quarterly calculation of depletion expense.  The lower the estimated reserves, the higher the depletion rate per unit of production.  Conversely, the higher the estimated reserves, the lower the depletion rate per unit of production.  If reported reserve volumes were revised downward by 5% as of the beginning of fiscal 2011, depletion for fiscal 2011 would have increased by approximately $466,000.

While the quantities of proved reserves require substantial judgment, the associated prices of oil, natural gas and natural gas liquids reserves and the applicable discount rate that are used to calculate the discounted present value of the reserves do not require judgment.  The ceiling calculation dictates that a 10% discount factor be used and that average first-day-of-the-month prices during the 12-month period ending in the reporting period are held constant.  Costs included in future net revenues are determined in a similar manner.  As such, the future net revenues associated with the estimated proved reserves are not based on our assessment of future prices or costs.

Impairment of Real Estate Held for Sale and Investment in Residential Parcels

Policy Description

Real estate held for sale and investment in residential parcels are recorded at the lower of cost or estimated fair value less costs to sell.  If an asset’s fair value less costs to sell, based on estimated future cash flows, management estimates or market comparisons, is less than its carrying amount, the asset is written down to its estimated fair value.

Judgments and Assumptions

Real estate held for sale and investment in residential parcels are reviewed for possible impairment when events or circumstances indicate that the carrying values may not be recoverable.  If the evaluation determines that the recorded value will not be recovered, the carrying value of real estate held for sale and investment in residential parcels are written down to its estimated fair value less costs to sell.  This evaluation requires management to make assumptions and apply considerable judgments based on market conditions and comparable sales transactions.  Changes in assumptions may require valuation adjustments that may materially impact the Company’s financial condition or its future operating results.

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Impairment of Investments in Land Interests

Policy Description

Investments in land interests are recorded at the lower of cost or estimated fair value.  If an asset’s fair value, based on estimated future cash flows, management estimates or market comparisons, is less than its carrying amount, the asset is written down to its estimated fair value.

Judgments and Assumptions

Investments in land interests are reviewed for possible impairment when events or circumstances indicate that the carrying values may not be recoverable.  The estimated future cash flows generated by the asset, management estimates or market comparisons are compared with the amount recorded to assess the recoverability of the carrying value of the asset.  If the evaluation determines that the recorded value will not be recovered, our investments in land interests are written down to its estimated fair value.  This evaluation requires management to make assumptions and apply considerable judgments to, among others, estimates of the timing and amount of future cash flows, uncertainty about future events, including changes in economic conditions, changes in the use of the assets, and ongoing cost of maintenance and improvements of the assets.  Changes in these and other assumptions may require valuation adjustments that may materially impact the Company’s financial condition or its future operating results.

Impairment of Investment in Joint Ventures

Policy Description

Joint venture investments are reviewed for possible impairment when events or circumstances indicate that there is an other-than-temporary loss in value.  An investment is written down to fair value if there is evidence of a loss in value which is other-than-temporary.

Judgments and Assumptions

The Company’s investment in joint ventures is reviewed for impairment whenever there is an indication of a loss in value.  An investment is written down to fair value if the impairment is other-than-temporary.  In determining the fair value of an investment and assessing whether any identified impairment is other-than-temporary, significant estimates and considerable judgment are involved.  In evaluating whether an impairment is other-than-temporary, the Company considers all available information, including the length of time and extent of the impairment, the financial condition and near-term prospects of the affiliate, the Company’s ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value, and projected industry and economic trends.  These estimates and judgments are based, in part, on the Company’s current and future evaluation of economic conditions, as well as a joint venture’s current and future plans to the extent that such plans are known to the Company.  Impairment calculations contain additional uncertainties because they require management to make assumptions and apply judgments to estimates of future cash flows, probabilities related to various cash flow scenarios, and appropriate discount rates.  Changes in these and other assumptions could affect the projected operational results of the unconsolidated affiliates and, accordingly, may require valuation adjustments to the Company’s investments that may materially impact the Company’s financial condition or its future operating results.

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Income taxes

Policy Description

Income taxes are determined using the asset and liability method.  Deferred tax assets and liabilities are recognized for the estimated future tax impacts of differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.  A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax asset will not be realized.

Barnwell recognizes the financial statement effects of tax positions when it is more likely than not that the position will be sustained by a taxing authority.

Judgments and Assumptions

We make estimates and judgments in determining our income tax expense for each reporting period.  Significant changes to these estimates could result in an increase or decrease in our tax provision in future periods.  We are also required to make judgments about the recoverability of deferred tax assets and when it is more likely than not that all or a portion of deferred tax assets will not be realized, a valuation allowance is provided.  Accordingly, changes in our business performance, unforeseen events, and changes in estimates of future taxable income could require a further increase in the valuation allowance or a reversal in the valuation allowance in future periods.  This could result in a charge to, or an increase in, income in the period such determination is made, and the impact of these changes could be material.

In addition, Barnwell operates within the U.S. and Canada and is subject to audit by taxing authorities in these jurisdictions.  Barnwell records accruals for the estimated outcomes of these audits, and the accruals may change in the future due to new developments in each matter.  Tax benefits are recognized when we determine that it is more likely than not that such benefits will be realized.  Management evaluates its potential exposures from tax positions taken that have or could be challenged by taxing authorities.  These potential exposures result because taxing authorities may take positions that differ from those taken by management in the interpretation and application of statutes, regulations and rules.  Management considers the possibility of alternative outcomes based upon past experience, previous actions by taxing authorities (e.g., actions taken in other jurisdictions) and advice from tax experts. Where uncertainty exists due to the complexity of income tax statutes and where the potential tax amounts are significant, we generally seek independent tax opinions to support our positions.  If our evaluation of the likelihood of the realization of benefits is inaccurate, we could incur additional income tax and interest expense that would adversely impact earnings, or we could receive tax benefits greater than anticipated which would positively impact earnings, either of which could be material.

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Management believes that Barnwell’s provision for uncertain tax positions is reasonable.  However, the ultimate resolution of tax treatments disputed by governmental authorities may adversely affect Barnwell’s current and deferred income tax amounts.

Asset Retirement Obligation

Policy Description

Barnwell records the fair value of a liability for an asset retirement obligation in the period in which it is incurred.  Barnwell’s estimated site restoration and abandonment costs of its oil and natural gas properties are capitalized as part of the carrying amount of oil and natural gas properties and depleted over the life of the related reserves.  The liability is accreted at the end of each period through charges to oil and natural gas operating expense.

Judgments and Assumptions

The asset retirement obligation is recorded at fair value in the period in which it is incurred along with a corresponding increase in the carrying amount of the related asset.  Barnwell has estimated fair value by discounting the estimated future cash outflows required to settle abandonment and restoration liabilities.  The present value calculation includes numerous estimates, assumptions and judgments regarding the existence of liabilities, the amount and timing of cash outflows required to settle the liability, what constitutes adequate restoration, inflation factors, credit adjusted discount rates, and consideration of changes in legal, regulatory, environmental and political environments.  Abandonment and restoration cost estimates are determined in conjunction with Barnwell’s reserve engineers based on historical information regarding costs incurred to abandon and restore similar well sites, information regarding current market conditions and costs, and knowledge of subject well sites and properties.  The process of estimating the asset retirement obligation requires substantial judgment and use of estimates, resulting in imprecise determinations.  Actual asset retirement obligations through the end of fiscal 2011 have not materially differed from our estimates.  However, because of the inherent imprecision of estimates as described above, there can be no assurance that material differences will not occur in the future.  A 20% increase in accretion and depletion of the asset retirement obligation would have increased Barnwell’s fiscal 2011 expenses before taxes by approximately $172,000.

Contractual Obligations

Disclosure is not required as Barnwell qualifies as a smaller reporting company.

Overview

Barnwell is engaged in the following lines of business: 1) exploring for, developing, producing and selling oil and natural gas in Canada (oil and natural gas segment), 2) investing in land interests in Hawaii (land investment segment),   3) drilling wells and installing and repairing water pumping systems in Hawaii (contract drilling segment), and 4) developing homes for sale in Hawaii (residential real estate segment).

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Oil and Natural Gas Segment

Barnwell is involved in the acquisition, exploration and development of oil and natural gas properties in Canada where we initiate and participate in exploratory and developmental operations for oil and natural gas on properties in which we have an interest, and evaluate proposals by third parties with regard to participation in such exploratory and developmental operations elsewhere.

Barnwell sells substantially all of its oil and natural gas liquids production under short-term contracts with marketers of oil.  Natural gas sold by Barnwell is generally sold under both long-term and short-term contracts with prices indexed to market prices.  The price of natural gas, oil and natural gas liquids is freely negotiated between the buyers and sellers.  Oil and natural gas prices are determined by many factors that are outside of our control.  Market prices for oil and natural gas products are dependent upon factors such as, but not limited to, changes in market supply and demand, which are impacted by overall economic activity, changes in weather, pipeline capacity constraints, inventory storage levels, and output.  Petroleum and natural gas prices are very difficult to predict and fluctuate significantly.  Natural gas prices tend to be higher in the winter than in the summer due to increased demand, although this trend has become less pronounced due to the increased use of natural gas to generate electricity for air conditioning in the summer and increased natural gas storage capacity in North America.

Oil and natural gas exploration, development and operating costs generally follow trends in product market prices, thus in times of higher product prices the cost of exploring, developing and operating the oil and natural gas properties will tend to escalate as well.  Capital expenditures are required to fund the exploration, development, and production of oil and natural gas.  Cash outlays for capital expenditures are largely discretionary, however, a minimum level of capital expenditures is required to replace depleting reserves.  Due to the nature of oil and natural gas exploration and development, significant uncertainty exists as to the ultimate success of any drilling effort.

Land Investment Segment

The land investment segment is comprised of the following three components:

1)   Barnwell owns a 77.6% controlling interest in Kaupulehu Developments, a Hawaii general partnership which owns interests in leasehold land for property located approximately six miles north of the Kona International Airport in the North Kona District of the island of Hawaii, adjacent to Hualalai Resort at Historic Ka’upulehu, between the Queen Kaahumanu Highway and the Pacific Ocean.  Kaupulehu Developments’ interests include the following:

·                The right to receive payments from WB and WBKD, entities not affiliated with Barnwell and its subsidiaries, resulting from the sale of lots and/or residential units within approximately 870 acres of the Kaupulehu Lot 4A area by WB and WBKD in two increments (“Increment I” and “Increment II”).  Increment I is an area planned for approximately 80 single-family lots and a beach club on the portion of the property bordering the Pacific Ocean.  The purchasers of the 80 single-family lots will have the right to apply for membership in the Kuki’o Golf and Beach Club, which is located adjacent to and south of the Four Seasons Resort Hualalai at Historic Ka’upulehu.  Increment II is the remaining portion of the approximately 870-acre property and is zoned for single-family and multi-family residential units and a golf course and clubhouse.  Increment II is not yet developed and is currently planned for approximately 350-400 residential units; and

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·                Approximately 1,000 acres of vacant leasehold land zoned conservation in the Kaupulehu Lot 4C area located adjacent to the 870-acre Lot 4A described above.  Kaupulehu Developments has an agreement which provides WB and/or WBKD the exclusive right to negotiate with Kaupulehu Developments with respect to these 1,000 acres.  This right expires in June 2015 or in June 2013 if WB and/or WBKD have not completed all environmental assessments and surveys reasonably required to support a petition to the Hawaii State Land Use Commission for reclassification of the 1,000 acres.

2)   Barnwell owns an 80% controlling interest in Kaupulehu 2007, a Hawaii limited liability limited partnership.  Kaupulehu 2007 owns two residential parcels in the Kaupulehu area.

3)   Barnwell, through wholly-owned Kaupulehu Mauka Investors, LLC, owns acquisition rights as to 14 lots within agricultural-zoned leasehold land in the upland area of Kaupulehu (“Mauka Lands”) situated between the Queen Kaahumanu Highway and the Mamalahoa Highway at Kaupulehu, on the island of Hawaii.  The acquisition rights give Barnwell the right to acquire 14 residential lots, currently estimated to be two to five acres in size, which may be developed on the Mauka Lands.  These lands are currently classified as agricultural by the state of Hawaii and, accordingly, the developer of these lands (Hualalai Investors) will need to pursue both state and county of Hawaii approvals for reclassification and rezoning to permit the development of residential lots and negotiate development terms.

Residential Real Estate Segment

Barnwell, through its 80%-owned real estate joint venture, Kaupulehu 2007, constructs and sells luxury single-family homes.  Kaupulehu 2007, in addition to the two parcels described above, owns two luxury residences in the Kaupulehu area that are available for sale.  Kaupulehu 2007 does not currently have any homes under construction.

Investment in Joint Ventures

Kaupulehu Investors, LLC, a limited liability company 80%-owned by Barnwell, owns 1.5% passive minority interests in Hualalai Investors JV, LLC and Hualalai Investors II, LLC, owners of Hualalai Resort, and a 1.5% passive minority interest in Kona Village Investors, LLC, owner of Kona Village Resort.

Contract Drilling Segment

Barnwell drills water, water monitoring and geothermal wells and installs and repairs water pumping systems in Hawaii.  Contract drilling results are highly dependent upon the quantity, dollar value and timing of contracts awarded by governmental and private entities and can fluctuate significantly.

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Business Environment

Our operations are located in Canada and in the state of Hawaii.  Accordingly, our business performance is directly affected by macroeconomic conditions in those areas, as well as general economic conditions of the U.S. domestic and world economies.  Current global economic conditions differentiate recent times from years past, and sluggish demand continues to impact all of the Company’s segments in both Hawaii and Canada.

Oil and Natural Gas Segment

Our revenue, profitability, and future rate of growth are substantially dependent on existing oil and natural gas prices.  Historically, oil and natural gas prices have been extremely volatile.  Natural gas prices for Barnwell, based on quarterly averages during the three years ended September 30, 2011, have ranged from a low of $2.70 per thousand cubic feet (the average price for the quarter ended September 30, 2009) to a high of $5.44 per thousand cubic feet (the average price for the quarter ended December 31, 2008).  Oil prices for Barnwell, based on quarterly averages for the period discussed above, ranged from a low of $35.20 per barrel (the average price for the quarter ended March 31, 2009) to a high of $98.03 per barrel (the average price for the quarter ended June 30, 2011).  Declines in oil and natural gas prices could have a material adverse effect on our financial condition, results of operations, liquidity and cash flows.

Since 2009, demand for natural gas has been weak according to Canada’s National Energy Board.  The key contributing factor to the decline in demand is the economic recession which has led to reduced worldwide natural gas consumption.  In addition, the discovery and availability of natural gas from shale has resulted in an oversupply of natural gas in North America.  The economic recession also continues to impact oil prices due to reduced demand.  Absent a sufficient increase in prices, it is unlikely that future oil and natural gas operating cash flows will be sufficient to fund the capital expenditure levels necessary to maintain current production and reserve levels.

Land Investment and Residential Real Estate Segments

Kaupulehu 2007’s two luxury homes are complete and available for sale.  One home is a fully furnished 5-bedroom, 6.5-bath ranch-style home, 6,337 square feet in size and is currently listed for sale.  The second home, currently unfurnished, is of similar design, 6,275 square feet in size and is available for sale.

Our ability to achieve our expectations regarding the sale of the completed residences and/or lots held for investment is contingent upon the strength of the luxury real estate market.  Actual future results could be lower than our current estimates.  Barnwell will have continuing cash outflows such as debt repayments, interest, maintenance, property taxes, and other holding costs until the homes and lots are sold.

During fiscal 2011, landscaping work in the Kaupulehu Lot 4A area continued, including the planting of trees and other groundscape materials.  Aside from the two houses built by our Kaupulehu 2007 residential real estate venture, three other houses have been completed in the area and one is under construction.

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The economic recession caused real estate sales prices and activity within the Kaupulehu area to decrease significantly in recent years.  Real estate sales results in the area near Kaupulehu continue to be mixed, with sporadic activity and wide variations in sales prices.  If future real estate activity in the Kaupulehu and surrounding areas is lower than management’s current expectations, our operating results, financial condition, liquidity and cash flows could be adversely affected.

Contract Drilling Segment

Demand for water well drilling and/or pump installation and repair services is volatile and dependent upon land development activities within the state of Hawaii.  The most recent University of Hawaii Economic Research Organization and State of Hawaii Department of Business, Economic Development and Tourism (“DBEDT”) forecasts suggest the construction industry remains somewhat depressed and near-term prospects remain limited.  This is evidenced by declines in both the value of permits issued for private development and the number of government contracts awarded.

Management currently estimates that well drilling activity for fiscal 2012 will be lower than that of fiscal 2011 based upon contracts in backlog and the uncertainty of future job availability.

Investment in Joint Ventures

According to DBEDT, Hawaii’s economy is slated for slow and gradual growth into 2012.  However, these estimates are cautiously optimistic and depend greatly on the recovery of both the national and international economies, especially the Japanese economy.  The March 2011 Japan earthquake and resulting tsunami and nuclear crisis have had and will continue to have negative impacts on tourism in Hawaii, which relies heavily on Japanese visitors, for the foreseeable future.  Both Hualalai Resort and Kona Village Resort sustained considerable damage from the tsunami that hit Hawaii.  Hualalai Resort reopened on May 1, 2011 after a shutdown to repair the damaged areas and Kona Village Resort is closed indefinitely.  As a result of Kona Village’s closure, we wrote off our remaining investment in Kona Village Investors, LLC during the second quarter of fiscal 2011.

Results of Operations

Summary

Barnwell incurred a net loss for fiscal 2011 of $109,000, a $3,949,000 decrease from net earnings of $3,840,000 in fiscal 2010.  This decrease was largely attributable to the following:

·                The prior year period included a $1,465,000 current income tax benefit from legislation which expanded the number of years Barnwell can carry back U.S. federal income tax losses;

·                A $1,213,000 decrease in land investment segment operating profit in the current year due to decreased receipts of percentage of sales payments resulting from decreased residential lot sales by the developer of the project partially offset by a decrease in the reduction of the carrying value of our investment in residential parcels; and

·                A $1,024,000 decrease in contract drilling operating results, before income taxes, due to fewer well drilling contracts, lower well drilling contract values and margins, and unforeseen difficulties experienced on certain contracts in the current year.

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General

Barnwell conducts operations in the U.S. and Canada.  Consequently, Barnwell is subject to foreign currency translation and transaction gains and losses due to fluctuations of the exchange rates between the Canadian dollar and the U.S. dollar.  The impact of fluctuations of the exchange rates between the Canadian dollar and the U.S. dollar may be material from period to period.  Barnwell cannot accurately predict future fluctuations between the Canadian and U.S. dollar.

The average exchange rate of the Canadian dollar to the U.S. dollar increased 6% in fiscal 2011, as compared to fiscal 2010, and the exchange rate of the Canadian dollar to the U.S. dollar decreased 1% at September 30, 2011, as compared to September 30, 2010.  Accordingly, the assets, liabilities, stockholders’ equity, and revenues and expenses of Barnwell’s subsidiaries operating in Canada have been adjusted to reflect the change in the exchange rates.  Barnwell’s Canadian dollar assets are greater than its Canadian dollar liabilities; therefore, increases or decreases in the value of the Canadian dollar to the U.S. dollar generate other comprehensive income or loss, respectively. Other comprehensive income and losses are not included in net (loss) earnings.  The other comprehensive loss due to foreign currency translation adjustments, net of taxes, for fiscal 2011 was $446,000, a $1,842,000 decrease from other comprehensive income due to foreign currency translation adjustments, net of taxes, of $1,396,000 in fiscal 2010.  There were no taxes on other comprehensive (loss) income due to foreign currency translation adjustments in fiscal 2011 and 2010 due to a full valuation allowance on the related deferred tax assets.

Realized foreign currency transaction gains or losses were inconsequential in fiscal 2011 and 2010.

The impact of fluctuations of the exchange rates between the Canadian dollar and the U.S. dollar may be material from period to period.  Barnwell cannot accurately predict future fluctuations between Canadian and U.S. dollars.

Oil and natural gas revenues

Selected Operating Statistics

The following tables set forth Barnwell’s annual average price per unit of production and annual net production volumes for fiscal 2011 as compared to fiscal 2010.  Production amounts reported are net of royalties.

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*  Natural gas price per unit is net of pipeline charges.

Effective January 1, 2011, the Government of Alberta modified Alberta’s royalty framework.  The modified framework reduced the maximum royalty rate for oil and natural gas production from 50% to 40% and 36%, respectively.

Oil and natural gas revenues increased $1,248,000 (5%) from $27,556,000 in fiscal 2010 to $28,804,000 in fiscal 2011, primarily due to increases in oil and natural gas liquids prices, which increased 22% and 23%, respectively, as compared to prices in fiscal 2010, and a 12% increase in net oil production.  The increase was partially offset by decreases in natural gas prices and production which declined 10% and 9%, respectively, as compared to fiscal 2010.

The increase in net oil production was due partly to increased activity and production from newer properties partially offset by natural declines in production from older properties.  Also contributing to the increase in net production was lower royalty rates on certain high production rate properties resulting from the aforementioned modification to the royalty framework effective January 1, 2011.  The decreases in royalty rates due to the modified royalty framework were partially offset by increased royalty rates due to higher oil prices.  Gross oil production increased 10% during fiscal 2011 as compared to fiscal 2010.

Net natural gas production decreased 9% during fiscal 2011, as compared to fiscal 2010.  Gross natural gas production decreased 14% during fiscal 2011, as compared to fiscal 2010.  The decrease in production was primarily due to natural declines, including the Dunvegan property where natural gas production on a gross basis decreased 10%.  The decrease in production on a net basis was partially offset by lower royalty rates resulting from the aforementioned modification to the royalty framework effective January 1, 2011 and lower natural gas prices.  At Dunvegan, natural gas production on a net basis decreased 59,000 Mcf or 3% and net natural gas production at all other properties decreased 18%.  Dunvegan contributed 64% of Barnwell’s net natural gas production in fiscal 2011, as compared to 60% in fiscal 2010.  In fiscal 2011, natural gas production from the Dunvegan Unit was responsible for 60% of Barnwell’s natural gas revenues, as compared to 57% in fiscal 2010.

Oil and natural gas operating expenses

Operating expenses increased $1,201,000 (12%) to $11,404,000 in fiscal 2011, as compared to $10,203,000 in fiscal 2010, due primarily to higher workover activity and repairs in the Dunvegan field and older fields due to corrosion and aging.  Also contributing to the increase was a 6% increase in the average exchange rate of the Canadian dollar to the U.S. dollar that increased oil and natural gas operating expenses $599,000.

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Sale of development rights and Sale of interest in leasehold land

Kaupulehu Developments received its final development rights option payment from Hualalai Investors, the owner and current developer of Hualalai Resort, in December 2010.  Revenues related to sales of development rights under option for the years ended September 30, 2011 and 2010 are summarized as follows:

All capitalized costs associated with Kaupulehu Developments’ development rights were expensed in previous years.

There are no remaining development rights options outstanding as of September 30, 2011.

The following table summarizes the percentage of sales payment revenues received from WB for the years ended September 30, 2011 and 2010:

WB sold three ocean front single-family lots in Increment I during the year ended September 30, 2011 as compared to nine single-family lots during the year ended September 30, 2010.  As of September 30, 2011, 22 of the 23 ocean front lots and seven of the 15 ocean view lots in Phase I of Increment I have been sold.  Forty-two single-family lots are planned for Phase II of Increment I, for a total of 80 single-family lots planned for Increment I.  The Company cannot predict when WB will complete the single-family lots in Phase II of Increment I and be permitted to begin marketing them.  There is no assurance with regards to the amounts of future payments to be received.

Contract drilling

Contract drilling revenues and costs are associated with well drilling and water pump installation, replacement and repair in Hawaii.

Contract drilling revenues decreased $2,662,000 (41%) to $3,855,000 in fiscal 2011, as compared to $6,517,000 in fiscal 2010, and contract drilling costs decreased $1,718,000 (31%) to $3,882,000 in fiscal 2011, as compared to $5,600,000 in fiscal 2010.  The contract drilling segment generated a $587,000 operating loss before general and administrative expenses during 2011, a decrease of $1,024,000 as compared to an operating profit before general and administrative expenses of $437,000 in fiscal 2010.  The decrease in operating results was due to fewer well drilling contracts, lower well drilling contract amounts and margins, and unforeseen difficulties experienced on certain well drilling and water pump contracts in the current year period.

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At September 30, 2011, there was a backlog of 12 pump installation and repair contracts, eight of which were in progress as of September 30, 2011.  There were no well drilling contracts in backlog at September 30, 2011.  The backlog of pump installation and repair contract revenues as of December 1, 2011 was approximately $570,000.  All of the contracts in backlog at December 1, 2011 are expected to be completed within fiscal year 2012.

Contract drilling revenues and costs are not seasonal in nature but can fluctuate significantly based on the awarding and timing of available contracts, which are determined by contract drilling customer demand.  There has been a significant decrease in demand for water well drilling contracts in the last two years due largely to the impact of the recession and continuing weak economic conditions on both private real estate development and governmental capital improvement budgets.  The Company is unable to predict the near-term and long-term availability of water well drilling and pump installation and repair contracts as the duration of the slowdown in construction activity is unknown.  Lack of availability of contracts may also result in increased competition for available contracts, which may result in lower estimated margins on awarded contracts.

Gas processing and other

Included in gas processing and other income were gains from drilling royalty credits of $1,424,000 and $1,323,000 in fiscal 2011 and 2010, respectively, due to the purchase of third-party drilling royalty credits by the oil and natural gas segment for less than par value.  Under a temporary incentive program, the Canadian province of Alberta provided a temporary drilling royalty credit based on a fixed dollar amount per meter drilled to eligible companies which drill new conventional oil and natural gas wells on Alberta crown lands.  Certain companies have earned drilling royalty credits which were in excess of a formulaic maximum based upon royalties paid, which resulted in such companies being unable to fully claim their drilling royalty credits.  Other companies who had limited drilling activity generated drilling royalty credits that were cumulatively less than the formulaic maximum.  Barnwell successfully acquired drilling royalty credits for less than par value from entities with excess drilling royalty credits, allowing Barnwell to realize these gains.

The drilling royalty credit program has ended and in the absence of legislation to renew the program, gains from purchased drilling royalty credits will not occur in future periods.

General and administrative expenses

General and administrative expenses increased $694,000 (8%) to $9,025,000 in fiscal 2011, as compared to $8,331,000 in fiscal 2010.  The increase was primarily attributable to a $473,000 increase in compensation costs, a $332,000 increase in stock appreciation rights expense due to an increase in Barnwell’s stock price, and a $172,000 increase in professional services expenses.  The increase was partially offset by a decrease in expenses related to the Company’s investment in joint ventures totaling $192,000 and a realized foreign currency transaction gain as a result of the repayment of U.S. dollar denominated debt using Canadian dollars totaling $119,000.

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Depletion, depreciation, and amortization

Depletion, depreciation and amortization increased $825,000 (9%) to $10,127,000 in fiscal 2011, as compared to $9,302,000 in fiscal 2010, as a result of a 9% increase in the depletion rate due to increases in Barnwell’s costs of finding and developing proven reserves and a 6% increase in the average exchange rate of the Canadian dollar to the U.S. dollar.  Barnwell’s costs of finding and developing proven reserves increased due primarily to activity in the Seagram Lakes area, where the Company spent $6,854,000; $759,000 on land, and $6,095,000 on drilling and development in fiscal 2011.  Of the four wells drilled in the Seagram Lakes area in fiscal 2011, one well was assigned proved reserves, one well was awaiting evaluation, and two wells were unsuccessful as of September 30, 2011.  All of the capital expenditures in this area were included in depletable costs for fiscal 2011.  The increase was partially offset by a 6% decrease in net production in Mcfe.

Reduction of carrying value of assets

During fiscal years 2011 and 2010, Barnwell reduced the carrying value of certain assets.  A breakdown of the reduction of the carrying value of assets as reported in the Consolidated Statements of Operations is as follows:

During the year ended September 30, 2010, due to changes in fair values for real estate in the Lot 4A Increment I area of Kaupulehu, North Kona, Hawaii, Barnwell recorded write-downs of $1,578,000 and $571,000 for its investment in residential parcels and real estate held for sale, respectively.  Barnwell recognized additional impairment losses of $689,000 and $418,000 during the year ended September 30, 2011 for its investment in residential parcels and real estate held for sale, respectively, primarily due to changes in fair values in the area of Kaupulehu 2007’s interests.

Kona Village Resort sustained considerable damage as a result of the March 11, 2011 tsunami generated by a 9.0-magnitude earthquake that took place off the coast of Japan and subsequently announced it would close indefinitely and lay off its employees.  As a result of the resort’s shutdown, Barnwell determined a write-off of its remaining investment in Kona Village Investors, LLC was necessary.  The write-off totaled $121,000 for the year ended September 30, 2011.  No reduction was necessary during the year ended September 30, 2010.

Interest expense

Interest expense decreased $137,000 (11%) to $1,088,000 in fiscal 2011, as compared to $1,225,000 in fiscal 2010, due primarily to lower average loan balances.

The majority of Barnwell’s debt is denominated in U.S. dollars.  Therefore, the increase in the average exchange rate of the Canadian dollar to the U.S. dollar had a minimal impact on interest expense.

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Income taxes

The components of earnings before income taxes, after adjusting earnings for non-controlling interests, are as follows:

Barnwell’s effective consolidated income tax rate for fiscal 2011, after adjusting earnings before income taxes for non-controlling interests, was 108%, as compared to 17% for fiscal 2010.  U.S. source losses do not shelter Canadian taxes on Canadian source income and potentially result in foreign tax credit carryovers. However, in the absence of sufficient U.S. source income such foreign tax credit carryovers are not more likely than not to result in a future tax benefit.  As such, the Company’s income taxes will likely continue to be a high percentage of consolidated pretax income in the near future in the absence of sufficient U.S. source income or unforeseen tax benefits.

Included in the income tax provision for fiscal 2011 is the impact of Canadian income taxes that are not estimated to have a current or future benefit as foreign tax credits or deductions for U.S. tax purposes.  Partially offsetting the expense was a $257,000 benefit primarily from the lapsing of the statute of limitations for a portion of uncertain tax positions related to Canadian income taxes.

Included in the income tax provision for fiscal 2010 is a $1,465,000 income tax benefit from the reversal of the valuation allowance on U.S. federal income tax losses due to a change in tax law enacted in November 2009 which expanded the number of years Barnwell can carry back such losses.  There was no such benefit in fiscal 2011.  Partially offsetting this benefit was the impact of the portion of Canadian income taxes that are not estimated to have a current or future benefit as foreign tax credits or deductions for U.S. tax purposes.

Uncertain tax positions consist primarily of Canadian federal and provincial audit issues that involve transfer pricing adjustments.  In November 2010, the Company settled and paid the province of Alberta’s reassessment of Canadian provincial taxes.  The Alberta provincial reassessment resulted from the Canada Revenue Agency’s examination of the Company’s fiscal 2005 and 2006 Canadian federal returns, which was settled in September 2010.  There was no material difference between the province of Alberta’s reassessment and the related uncertain tax provision previously recorded by the Company.  Because of a lack of clarity and uniformity regarding allowable transfer pricing valuations by differing jurisdictions, it is reasonably possible that the total amount of uncertain tax positions may significantly increase or decrease during the next 12 months, and the estimated range of any such variance is not currently estimable based upon facts and circumstances as of September 30, 2011.

Net earnings attributable to non-controlling interests

Earnings and losses attributable to non-controlling interests represent the non-controlling interests’ share of revenues and expenses related to the various partnerships and joint ventures in which Barnwell has interests.

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Net earnings attributable to non-controlling interests decreased $143,000 (31%) to $314,000 in fiscal 2011, as compared to $457,000 in fiscal 2010, due primarily to lower revenues reported by the land investment segment, partially offset by smaller write-downs of Barnwell’s assets, impacting non-controlling interests in fiscal 2011 as compared to fiscal 2010.

Inflation

The effect of inflation on Barnwell has generally been to increase its cost of operations, interest cost (as a substantial portion of Barnwell’s debt is at variable short-term rates of interest which tend to increase as inflation increases), general and administrative costs and direct costs associated with oil and natural gas production and contract drilling operations.  Oil and natural gas prices realized by Barnwell are essentially determined by world prices for oil and western Canadian/Midwestern U.S. prices for natural gas.

Impact of Recently Issued Accounting Standards on Future Filings

Fair Value Measurements and Related Disclosures

In May 2011, the FASB issued an accounting standards update that provides a uniform framework for fair value measurements and related disclosures between GAAP and International Financial Reporting Standards.  The amendments clarify or change the application of existing fair value measurements, including: (1) that the highest and best use and valuation premise in a fair value measurement are relevant only when measuring the fair value of nonfinancial assets; (2) that a reporting entity should measure the fair value of its own equity instrument from the perspective of a market participant that holds that instrument as an asset; (3) for Level 3 fair value measurements, quantitative information about the unobservable inputs used in a fair value measurement, a description of the valuation processes used by the entity, and a discussion about the sensitivity of the fair value measurements to changes in the unobservable inputs should be disclosed; (4) to permit an entity to measure the fair value of certain financial instruments on a net basis rather than based on its gross exposure when the reporting entity manages its financial instruments on the basis of such net exposure; (5) that in the absence of a Level 1 input, a reporting entity should apply premiums or discounts when market participants would do so when pricing the asset or liability consistent with the unit of account; (6) that premiums and discounts related to size as a characteristic of the reporting entity’s holding are not permitted in a fair value measurement; (7) for an entity’s use of a nonfinancial asset that is different from the asset’s highest and best use, the reason for the difference; and (8) for financial instruments not measured at fair value but for which disclosure of fair value is required, the fair value hierarchy level in which the fair value measurements were determined.  The standard is effective for fiscal years beginning after December 15, 2011.  We are currently evaluating its impact on our consolidated financial statements and disclosures.

Presentation of Comprehensive Income

In June 2011, the FASB issued an accounting standards update that eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity, among other updates to the presentation of comprehensive income.  Under this guidance, an entity has the option to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  In addition, an entity is required

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to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented.  The standard is effective for fiscal years beginning after December 15, 2011, with early adoption permitted.  Adoption of this standard will impact the presentation of the Company’s consolidated financial statements.  On October 12, 2011, the FASB issued a media advisory stating it is considering deferring certain aspects of this accounting standards update.

Liquidity and Capital Resources

Barnwell’s primary sources of liquidity are cash on hand, cash flows from operations, land investment segment proceeds and available credit.  At September 30, 2011, Barnwell had $9,834,000 in cash and cash equivalents, $5,441,000 in working capital, and $7,252,000 of available credit under its credit facility with its Canadian bank.  Barnwell’s future liquidity and ability to fund capital expenditures is dependent upon operating cash flows, existing working capital, available credit under its credit facility with its Canadian bank, and its ability to access debt markets.

Cash Flows

Cash flows provided by operations totaled $13,263,000 for fiscal 2011, as compared to $7,468,000 of cash flows provided by operations for the same period in fiscal 2010.  The $5,795,000 increase was primarily due to changes in working capital.

Net cash used in investing activities totaled $11,473,000 for fiscal 2011, as compared to $1,811,000 of cash flows provided by investing activities for the same period in fiscal 2010.  The $13,284,000 change was primarily attributable to a $10,258,000 increase in capital expenditures due to higher oil and natural gas capital expenditures and the purchase of an office in New York City by a subsidiary of the Company, and a $2,102,000 decrease in proceeds from land investment segment sales during fiscal 2011, as compared to the same period of the prior year.

Cash flows used in financing activities totaled $2,689,000 for fiscal 2011, as compared to $5,411,000 of cash flows used in financing activities for fiscal 2010.  The $2,722,000 decrease is primarily due to a $2,714,000 decrease in debt repayments in the current year period as compared to the comparable prior year period.

Credit Arrangements

In April 2011, Barnwell’s credit facility at Royal Bank of Canada, a Canadian bank, was renewed through April 2012 for $20,000,000 Canadian dollars, unchanged from the prior year amount, or US$19,252,000 at the September 30, 2011 exchange rate of 0.9626.  Borrowings under this facility were US$12,000,000 and unused credit available under this facility was US$7,252,000 at September 30, 2011.  The interest rate on this facility at September 30, 2011 was 3.0%.  The facility is available in U.S. dollars at LIBOR plus 2.75%, at the Royal Bank U.S. base rate plus 1.75%, or in Canadian dollars at the Royal Bank prime rate plus 1.75%.  A standby fee of 0.6875% per annum is charged on the unused facility balance.  Additionally, Barnwell paid a fee of $31,000 in April 2011 to renew the facility.

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In March 2011, Barnwell, together with its 80%-owned real estate joint venture, Kaupulehu 2007, refinanced its real estate loan with a new lender.  The loan is a non-revolving seven year term loan with an interest rate that adjusts annually.  Principal and interest are paid monthly and are determined annually based on a loan amortization schedule.

Monthly payments of principal and interest are due on the first day of each month and will change as a result of a change in the interest rate, the sale of a house or the sale of a residential parcel.  The monthly payment for the first year, based on a seven-year amortization schedule, is approximately $169,000 and the interest rate for the first year is 3.67%.  After the first year, the interest rate will adjust for each of the remaining six 1-year periods of the loan term.  The interest rate will be the lender’s then prevailing interest rate for similarly priced commercial mortgage loans or a floating rate equal to the lender’s base rate.  Kaupulehu 2007 paid a $32,000 fee to refinance the loan.  Any unpaid principal balance and accrued interest will be due and payable on April 1, 2018.