UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2008

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

For the transition period from                      to                     

ENCORE ACQUISITION COMPANY

(Exact name of registrant as specified in its charter)

Delaware		75-2759650
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
777 Main Street, Suite 1400, Fort Worth, Texas		76102
(Address of principal executive offices)		(Zip Code)

(817) 877-9955
(Registrant’s telephone number, including area code)

Not applicable
(Former name, former address and former fiscal year, if changed since last report)

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. Yes þ No o

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

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company o

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

Number of shares of common stock, $0.01 par value, outstanding as of October 28, 2008		52,764,231

 

 

ENCORE ACQUISITION COMPANY

INDEX

		Page
PART I. FINANCIAL INFORMATION			1
Item 1. Financial Statements			1
Consolidated Balance Sheets as of September 30, 2008 and December 31, 2007			1
Consolidated Statements of Operations for the three and nine months ended September 30, 2008 and 2007			2
Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2008			3
Consolidated Statements of Cash Flows for the nine months ended September 30, 2008 and 2007			4
Notes to Consolidated Financial Statements			5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			32
Item 3. Quantitative and Qualitative Disclosures About Market Risk			51
Item 4. Controls and Procedures			52
PART II. OTHER INFORMATION			52
Item 1. Legal Proceedings			52
Item 1A. Risk Factors			52
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			53
Item 6. Exhibits			53
Signature			54
EX-31.1
EX-31.2
EX-32.1
EX-32.2
EX-99.1

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

     Certain information included in this Quarterly Report on Form 10-Q (the “Report”) and other materials filed with the United States Securities and Exchange Commission (the “SEC”), or in other written or oral statements made or to be made by us, other than statements of historical fact, are forward-looking statements as defined by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements give our current expectations or forecasts of future events. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. These statements may include words such as “may,” “will,” “could,” “anticipate,” “estimate,” “expect,” “project,” “intend,” “plan,” “believe,” “should,” “predict,” “potential,” “pursue,” “target,” “continue,” and other words and terms of similar meaning. Readers are cautioned not to place undue reliance on such forward-looking statements, which speak only as of the date of this Report. Our actual results may differ significantly from the results discussed in the forward-looking statements. Such statements involve risks and uncertainties, including, but not limited to, the matters discussed in “Item 1A. Risk Factors” in our 2007 Annual Report on Form 10-K and in our other filings with the SEC. If one or more of these risks or uncertainties materialize (or the consequences of such a development changes), or should underlying assumptions prove incorrect, actual outcomes may vary materially from those forecasted or expected. We undertake no responsibility to update forward-looking statements for changes related to these or any other factors that may occur subsequent to this filing for any reason.

ENCORE ACQUISITION COMPANY

GLOSSARY

     The following are abbreviations and definitions of certain terms used in this Report. The definitions of proved developed reserves, proved reserves, and proved undeveloped reserves have been abbreviated from the applicable definitions contained in Rule 4-10(a)(2-4) of Regulation S-X.

	•		Bbl. One stock tank barrel, or 42 U.S. gallons liquid volume, used in reference to oil or other liquid hydrocarbons.
	•		Bbl/D. One Bbl per day.
	•		BOE. One barrel of oil equivalent, calculated by converting natural gas to oil equivalent barrels at a ratio of six Mcf of natural gas to one Bbl of oil.
	•		BOE/D. One BOE per day.
	•		Completion. The installation of permanent equipment for the production of oil or natural gas.
	•		Council of Petroleum Accountants Societies (“COPAS”). A professional organization of oil and gas accountants that maintains consistency in accounting procedures and interpretations, including the procedures that are part of most joint operating agreements. These procedures establish a drilling rate and an overhead rate to reimburse the operator of a well for overhead costs, such as accounting and engineering.
	•		Delay Rentals. Fees paid to the lessor of an oil and natural gas lease during the primary term of the lease prior to the commencement of production from a well.
	•		Development Well. A well drilled within the proved area of an oil or natural gas reservoir to the depth of a stratigraphic horizon known to be productive.
	•		Dry Hole. A well found to be incapable of producing hydrocarbons in sufficient quantities such that proceeds from the sale of such production would exceed production costs.
	•		Dry Gas. Natural gas comprised of over 90 percent methane and suitable for use by customers of local gas distribution companies.
	•		EAC. Encore Acquisition Company, a Delaware corporation, together with its subsidiaries.
	•		ENP. Encore Energy Partners LP, a publicly traded Delaware limited partnership, together with its subsidiaries.
	•		Exploratory Well. A well drilled to find and produce oil or natural gas in an unproved area, to find a new reservoir in a field previously producing oil or natural gas in another reservoir, or to extend a known reservoir.
	•		Field. An area consisting of a single reservoir or multiple reservoirs, all grouped on or related to the same individual geological structural feature and/or stratigraphic condition.
	•		Gross Acres or Gross Wells. The total acres or wells, as the case may be, in which an entity owns a working interest.
	•		Lease Operations Expense (“LOE”). All direct and allocated indirect costs of producing oil and natural gas after completion of drilling. Such costs include labor, superintendence, supplies, repairs, maintenance, and direct overhead charges.
	•		LIBOR. London Interbank Offered Rate.
	•		MBbl. One thousand Bbls.
	•		MBOE. One thousand BOE.
	•		Mcf. One thousand cubic feet, used in reference to natural gas.
	•		Mcf/D. One Mcf per day.
	•		MMcf. One million cubic feet, used in reference to natural gas.
	•		Natural Gas Liquids (“NGLs”). The combination of ethane, propane, butane, and natural gasolines that when removed from natural gas become liquid under various levels of higher pressure and lower temperature.
	•		Net Acres or Net Wells. Gross acres or wells, as the case may be, multiplied by the working interest percentage owned by an entity.
	•		Net Profits Interest (“NPI”). An interest that entitles the owner to a specified share of net profits from production of hydrocarbons.
	•		NYMEX. New York Mercantile Exchange.
	•		Oil. Crude oil, condensate, and NGLs.
	•		Operator. The entity responsible for the exploration, development, and production of an oil or natural gas well or lease.
	•		Production Margin. Oil and natural gas revenues less LOE and production, ad valorem, and severance taxes.
	•		Proved Developed Reserves. Proved reserves that can be expected to be recovered from existing wells with existing equipment and operating methods.
	•		Proved Reserves. The estimated quantities of crude oil, natural gas, and NGLs that geological and engineering data demonstrate with reasonable certainty are recoverable in future years from known reservoirs under existing economic and operating conditions.

ENCORE ACQUISITION COMPANY

	•		Proved Undeveloped Reserves. Proved reserves that are expected to be recovered from new wells on undrilled acreage for which the existence and recoverability of such reserves can be estimated with reasonable certainty, or from existing wells where a relatively major expenditure is required for recompletion. Proved undeveloped reserves included unrealized production response from enhanced recovery techniques that have been proved effective by actual tests in the area and in the same reservoir.
	•		Recompletion. The completion for production of an existing well bore in another formation from that in which the well has been previously completed.
	•		Reservoir. A porous and permeable underground formation containing a natural accumulation of producible oil and/or natural gas that is confined by impermeable rock or water barriers and is individual and separate from other reservoirs.
	•		Secondary Recovery. Enhanced recovery of oil or natural gas from a reservoir beyond the oil or natural gas that can be recovered by normal flowing and pumping operations. Secondary recovery techniques involve maintaining or enhancing reservoir pressure by injecting water, gas, or other substances into the formation. The purpose of secondary recovery is to maintain reservoir pressure and to displace hydrocarbons toward the wellbore. The most common secondary recovery techniques are gas injection and waterflooding.
	•		Successful Well. A well capable of producing oil and/or natural gas in commercial quantities.
	•		Tertiary Recovery. An enhanced recovery operation that normally occurs after waterflooding in which chemicals or natural gases are used as the injectant.
	•		Waterflood. A secondary recovery operation in which water is injected into the producing formation in order to maintain reservoir pressure and force oil toward and into the producing wells.
	•		Working Interest. An interest in an oil or natural gas lease that gives the owner the right to drill for and produce oil and natural gas on the leased acreage and requires the owner to pay a share of the production and development costs.
	•		Workover. Operations on a producing well to restore or increase production.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ENCORE ACQUISITION COMPANY

(in thousands, except share and per share amounts)

		September 30,				December 31,
		2008				2007
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	3,827			$	1,704
Accounts receivable, net of allowance for doubtful accounts of $6,045			163,970				134,880
Inventory			19,550				16,257
Derivatives			76,143				9,722
Deferred taxes			14,204				20,420
Income taxes receivable			29,442				2,661
Other			3,537				2,866
Total current assets			310,673				188,510
Properties and equipment, at cost — successful efforts method:
Proved properties, including wells and related equipment			3,305,270				2,845,776
Unproved properties			129,515				63,352
Accumulated depletion, depreciation, and amortization			(670,086	)			(489,004	)
			2,764,699				2,420,124
Other property and equipment			22,187				21,750
Accumulated depreciation			(11,443	)			(10,733	)
			10,744				11,017
Goodwill			60,606				60,606
Derivatives			34,971				34,579
Long-term receivables			75,144				40,945
Other			29,304				28,780
Total assets		$	3,286,141			$	2,784,561
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	32,112			$	21,548
Accrued liabilities:
Lease operations expense			19,988				15,057
Development capital			85,412				48,359
Interest			12,657				12,795
Production, ad valorem, and severance taxes			44,649				24,694
Marketing			2,889				8,721
Derivatives			87,989				39,337
Oil and natural gas revenues payable			16,731				13,076
Other			23,390				21,143
Total current liabilities			325,817				204,730
Derivatives			51,924				47,091
Future abandonment cost, net of current portion			32,478				27,371
Deferred taxes			416,528				312,914
Long-term debt			1,217,604				1,120,236
Other			2,398				1,530
Total liabilities			2,046,749				1,713,872
Commitments and contingencies (see Note 16)
Minority interest in consolidated partnership			125,181				122,534
Stockholders’ equity:
Preferred stock, $.01 par value, 5,000,000 shares authorized, none issued and outstanding			—				—
Common stock, $.01 par value, 144,000,000 shares authorized, 52,155,256 and 53,303,464 issued and outstanding, respectively			523				534
Additional paid-in capital			540,140				538,620
Treasury stock, at cost, none and 17,690 shares, respectively			—				(590	)
Retained earnings			573,395				411,377
Accumulated other comprehensive income (loss)			153				(1,786	)
Total stockholders’ equity			1,114,211				948,155
Total liabilities and stockholders’ equity		$	3,286,141			$	2,784,561

The accompanying notes are an integral part of these consolidated financial statements.

ENCORE ACQUISITION COMPANY

(in thousands, except per share amounts)
(unaudited)

		Three months ended								Nine months ended
		September 30,								September 30,
		2008				2007				2008				2007
Revenues:
Oil		$	268,543			$	159,295			$	776,001			$	377,514
Natural gas			66,772				32,439				182,973				110,548
Marketing			2,163				3,282				8,740				27,139
Total revenues			337,478				195,016				967,714				515,201
Expenses:
Production:
Lease operations			48,966				37,114				130,013				105,186
Production, ad valorem, and severance taxes			33,350				20,003				95,845				51,750
Depletion, depreciation, and amortization			58,545				49,026				159,114				136,372
Impairment of long-lived assets			26,292				—				26,292				—
Exploration			13,381				8,920				30,462				23,856
General and administrative			15,303				12,668				36,549				26,216
Marketing			1,855				4,089				9,362				27,607
Derivative fair value loss (gain)			(239,435	)			15,786				82,093				68,166
Other operating			4,073				6,351				9,805				13,667
Total expenses			(37,670	)			153,957				579,535				452,820
Operating income			375,148				41,059				388,179				62,381
Other income (expenses):
Interest			(18,124	)			(23,933	)			(54,669	)			(68,040	)
Other			1,553				857				3,090				1,889
Total other expenses			(16,571	)			(23,076	)			(51,579	)			(66,151	)
Income (loss) before income taxes and minority interest			358,577				17,983				336,600				(3,770	)
Income tax provision			(121,184	)			(8,986	)			(118,595	)			(1,490	)
Minority interest in loss (income) of consolidated partnership			(31,086	)			2,988				(16,198	)			2,988
Net income (loss)		$	206,307			$	11,985			$	201,807			$	(2,272	)
Net income (loss) per common share:
Basic		$	3.95			$	0.23			$	3.85			$	(0.04	)
Diluted		$	3.80			$	0.22			$	3.70			$	(0.04	)
Weighted average common shares outstanding:
Basic			52,258				53,198				52,466				53,140
Diluted			53,521				54,179				53,670				53,140

The accompanying notes are an integral part of these consolidated financial statements.

ENCORE ACQUISITION COMPANY

(in thousands)
(unaudited)

		Issued																								Accumulated
		Shares of								Additional				Shares of												Other				Total
		Common				Common				Paid-in				Treasury				Treasury				Retained				Comprehensive				Stockholders’
		Stock				Stock				Capital				Stock				Stock				Earnings				Income (Loss)				Equity
Balance at December 31, 2007			53,321			$	534			$	538,620				(18	)		$	(590	)		$	411,377			$	(1,786	)		$	948,155
Exercise of stock options and vesting of restricted stock			278				3				1,750				—				—				—				—				1,753
Repurchase and retirement of common stock			(1,398	)			(14	)			(13,687	)			—				—				(36,299	)			—				(50,000	)
Purchase of treasury stock			—				—				—				(28	)			(954	)			—				—				(954	)
Cancellation of treasury stock			(46	)			—				(465	)			46				1,544				(1,079	)			—				—
Non-cash equity-based compensation			—				—				10,320				—				—				—				—				10,320
ENP distributions to holders of management incentive units			—				—				—				—				—				(2,411	)			—				(2,411	)
Adjustment to reflect gain on issuance of ENP common units			—				—				3,458				—				—				—				—				3,458
Other			—				—				144				—				—				—				—				144
Components of comprehensive income:
Net income			—				—				—				—				—				201,807				—				201,807
Change in deferred hedge gain on interest rate swaps, net of tax of $103 and net of minority interest of $132			—				—				—				—				—				—				153				153
Amortization of deferred loss on commodity derivative contracts, net of tax of $1,071			—				—				—				—				—				—				1,786				1,786
Total comprehensive income																															203,746
Balance at September 30, 2008			52,155			$	523			$	540,140				—			$	—			$	573,395			$	153			$	1,114,211

The accompanying notes are an integral part of these consolidated financial statements.

ENCORE ACQUISITION COMPANY

(in thousands)
(unaudited)

		Nine months ended
		September 30,
		2008				2007
Cash flows from operating activities:
Net income (loss)		$	201,807			$	(2,272	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depletion, depreciation, and amortization			159,114				136,372
Impairment of long-lived assets			26,292				—
Non-cash exploration expense			27,699				22,511
Deferred taxes			109,653				1,374
Non-cash equity-based compensation expense			9,963				12,790
Non-cash derivative loss			38,203				87,108
Loss (gain) on disposition of assets			(691	)			5,918
Minority interest in income (loss) of consolidated partnership			16,198				(2,988	)
Other			7,349				6,055
Changes in operating assets and liabilities, net of effects from acquisitions:
Accounts receivable			(31,135	)			(31,064	)
Current derivatives			(12,196	)			(15,303	)
Other current assets			(30,745	)			(1,858	)
Long-term derivatives			(7,028	)			(22,301	)
Other assets			(2,094	)			(4,428	)
Accounts payable			(2,476	)			4,416
Other current liabilities			20,581				17,810
Other noncurrent liabilities			(1,507	)			(496	)
Net cash provided by operating activities			528,987				213,644
Cash flows from investing activities:
Proceeds from disposition of assets			1,230				291,339
Purchases of other property and equipment			(2,416	)			(2,443	)
Acquisition of oil and natural gas properties			(116,767	)			(839,945	)
Development of oil and natural gas properties			(384,864	)			(259,457	)
Net advances to working interest partners			(33,277	)			(22,644	)
Net cash used in investing activities			(536,094	)			(833,150	)
Cash flows from financing activities:
Proceeds from issuance of ENP common units, net of issuance costs			—				171,220
Repurchase of common stock			(50,000	)			—
Exercise of stock options and vesting of restricted stock, net of treasury stock purchases			799				1,053
Proceeds from long-term debt, net of issuance costs			1,070,238				1,269,291
Payments on long-term debt			(974,500	)			(805,428	)
ENP distributions			(19,525	)			—
Payment of commodity derivative contract premiums			(30,822	)			(19,219	)
Change in cash overdrafts			13,040				10,293
Net cash provided by financing activities			9,230				627,210
Increase in cash and cash equivalents			2,123				7,704
Cash and cash equivalents, beginning of period			1,704				763
Cash and cash equivalents, end of period		$	3,827			$	8,467

The accompanying notes are an integral part of these consolidated financial statements.

ENCORE ACQUISITION COMPANY

(unaudited)

Note 1. About EAC

     EAC is engaged in the acquisition and development of oil and natural gas reserves from onshore fields in the United States. Since 1998, EAC has acquired producing properties with proven reserves and leasehold acreage and grown the production and proven reserves by drilling, exploring, reengineering or expanding existing waterflood projects, and applying tertiary recovery techniques. EAC’s properties – and oil and natural gas reserves – are located in four core areas:

	•		the Cedar Creek Anticline (“CCA”) in the Williston Basin of Montana and North Dakota;
	•		the Permian Basin of West Texas and southeastern New Mexico;
	•		the Rockies, which includes non-CCA assets in the Williston, Big Horn, and Powder River Basins of Wyoming, Montana, and North Dakota, and the Paradox Basin of southeastern Utah; and
	•		the Mid-Continent area, which includes the Arkoma and Anadarko Basins of Oklahoma, the North Louisiana Salt Basin, and the East Texas Basin.

Note 2. Basis of Presentation

     EAC’s consolidated financial statements include the accounts of wholly owned and majority-owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation.

     In the opinion of management, the accompanying unaudited consolidated financial statements include all adjustments necessary to present fairly, in all material respects, EAC’s financial position as of September 30, 2008, results of operations for the three and nine months ended September 30, 2008 and 2007, and cash flows for the nine months ended September 30, 2008 and 2007. All adjustments are of a normal recurring nature. These interim results are not necessarily indicative of results for an entire year.

     Certain amounts and disclosures have been condensed or omitted from these consolidated financial statements pursuant to the rules and regulations of the SEC. Therefore, these consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes thereto included in EAC’s 2007 Annual Report on Form 10-K.

Minority Interest  

     In February 2007, EAC formed ENP to acquire, exploit, and develop oil and natural gas properties and to acquire, own, and operate related assets. In September 2007, ENP completed its initial public offering (“IPO”).  As of September 30, 2008 and December 31, 2007, EAC owned approximately 66.7 percent and 58.0 percent, respectively, of ENP’s common units, as well as all of the interests of Encore Energy Partners GP LLC (“GP LLC”), a Delaware limited liability company and ENP’s general partner, which is an indirect wholly owned non-guarantor subsidiary of EAC. Considering the presumption of control of GP LLC in accordance with Emerging Issues Task Force Issue No. 04-5, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights”, the financial position, results of operations, and cash flows of ENP are consolidated with those of EAC. EAC elected to account for gains on ENP’s issuance of common units as capital transactions as permitted by Staff Accounting Bulletin (“SAB”) Topic 5H, “Accounting for Sales of Stock by a Subsidiary”. See “Note 18. ENP” for additional discussion.

     As presented in the accompanying Consolidated Balance Sheets, “Minority interest in consolidated partnership” as of September 30, 2008 and December 31, 2007 of $125.2 million and $122.5 million, respectively, represents third-party ownership interests in ENP. As presented in the accompanying Consolidated Statements of Operations, “Minority interest in income of consolidated partnership” for the three and nine months ended September 30, 2008 of $31.1 million and $16.2 million, respectively, and “Minority interest in loss of consolidated partnership” for each of the three and nine months ended September 30, 2007 of $3.0 million represents the net income or loss of ENP attributable to third-party owners. 

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

Reclassifications

     Certain amounts in prior periods have been reclassified to conform to the current period presentation. In particular, income taxes receivable on the accompanying Consolidated Balance Sheets have been disaggregated from other current assets.

New Accounting Pronouncements

Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”)

     In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS 157, which: (1) standardizes the definition of fair value; (2) establishes a framework for measuring fair value in generally accepted accounting principles (“GAAP”); and (3) expands disclosures related to the use of fair value measures in financial statements. SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value, but does not require any new fair value measurements. SFAS 157 was prospectively effective for financial assets and liabilities for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. In February 2008, the FASB issued FASB Staff Position (“FSP”) No. FAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP FAS 157-2”), which delayed the effective date of SFAS 157 for one year for nonfinancial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). EAC elected a partial deferral of SFAS 157 for all instruments within the scope of FSP FAS 157-2, including but not limited to, its asset retirement obligations and indefinite lived assets. EAC will continue to evaluate the impact of SFAS 157 on these instruments during the deferral period. The adoption of SFAS 157 on January 1, 2008, as it relates to financial assets and liabilities, did not have a material impact on EAC’s results of operations or financial condition. See “Note 7. Fair Value Measurements” for additional discussion.

SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – including an amendment of FASB Statement No. 115” (“SFAS 159”)

     In February 2007, the FASB issued SFAS 159, which permits entities to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis. SFAS 159 also allows entities an irrevocable option to measure eligible items at fair value at specified election dates, with resulting changes in fair value reported in earnings. SFAS 159 was effective for fiscal years beginning after November 15, 2007. EAC did not elect the fair value option for eligible instruments and therefore, the adoption of SFAS 159 on January 1, 2008 did not have an impact on EAC’s results of operations or financial condition. EAC will assess the impact of electing the fair value option for any eligible instruments acquired in the future. Electing the fair value option for such instruments could have a material impact on EAC’s future results of operations or financial condition.

FSP Interpretation 39-1, “Amendment of FASB Interpretation No. 39” (“FSP FIN 39-1”)

     In April 2007, the FASB issued FSP FIN 39-1, which amends FASB Interpretation (“FIN”) No. 39, "Offsetting of Amounts Related to Certain Contracts” (“FIN 39”), to permit a reporting entity that is party to a master netting arrangement to offset the fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) against fair value amounts recognized for derivative instruments that have been offset under the same master netting arrangement in accordance with FIN 39. FSP FIN 39-1 was effective for fiscal years beginning after November 15, 2007. The adoption of FSP FIN 39-1 on January 1, 2008 did not have an impact on EAC’s results of operations or financial condition.

SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”)

     In December 2007, the FASB issued SFAS 141R, which replaces SFAS No. 141, “Business Combinations". SFAS 141R establishes principles and requirements for the reporting entity in a business combination, including: (1) recognition and measurement in the financial statements of the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; (2) recognition and measurement of goodwill acquired in the business combination or a gain from a bargain purchase; and (3) determination of the information to be disclosed to enable financial statement users to evaluate the nature and financial effects of the business combination. SFAS 141R is prospectively effective for business combinations consummated in fiscal years beginning on or after December 15, 2008 with early application prohibited. EAC is evaluating the impact SFAS 141R will have on its results of operations and financial condition and the reporting of future acquisitions in the

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

consolidated financial statements.

SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements – an amendment to ARB No. 51” (“SFAS 160”)

     In December 2007, the FASB issued SFAS 160, which amends Accounting Research Bulletin No. 51, "Consolidated Financial Statements” to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008. SFAS 160 clarifies that a noncontrolling interest in a subsidiary, which is sometimes referred to as minority interest, is an ownership interest in the consolidated entity that should be reported as a component of equity in the consolidated financial statements. Among other requirements, SFAS 160 requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest and the disclosure of consolidated net income attributable to the parent and to the noncontrolling interest on the face of the consolidated statement of operations. EAC is evaluating the impact SFAS 160 will have on its results of operations or financial condition.

SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133” (“SFAS 161”)

     In March 2008, the FASB issued SFAS 161, which amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”). SFAS 161 requires enhanced disclosures about: (1) how and why an entity uses derivative instruments; (2) how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations; and (3) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS 161 is effective for fiscal years beginning on or after November 15, 2008, with early application encouraged. The adoption of SFAS 161 will require additional disclosures regarding EAC’s derivative instruments; however, it will not impact EAC’s results of operations or financial condition.

SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”)

     In May 2008, the FASB issued SFAS 162, which identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with GAAP. SFAS 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles”. The adoption of SFAS 162 will not impact EAC’s results of operations or financial condition.

FSP No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (“FSP EITF 03-6-1”)

     In June 2008, the FASB issued FSP EITF 03-6-1, which addresses whether instruments granted in equity-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation for computing basic earnings per share (“EPS”) under the two-class method described by SFAS No. 128, “Earnings per Share”. FSP EITF 03-6-1 is retrospectively effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years, with early application prohibited. EAC is evaluating the impact the adoption of FSP EITF 03-6-1 will have on its EPS calculations.

Note 3. Acquisitions and Dispositions

Acquisitions

     In January 2007, EAC entered into a purchase and sale agreement with certain subsidiaries of Anadarko Petroleum Corporation (“Anadarko”) to acquire oil and natural gas properties and related assets in the Williston Basin of Montana and North Dakota. The closing of the Williston Basin acquisition occurred in April 2007. The Williston Basin acquisition was treated as a reverse like-kind exchange under Section 1031 of the Internal Revenue Code of 1986, as amended, (the “Code”) and I.R.S. Revenue Procedure 2000-37 with the Mid-Continent disposition discussed below. The total purchase price for the Williston Basin assets was approximately $392.1 million, including transaction costs of approximately $1.3 million.

     Also in January 2007, EAC entered into a purchase and sale agreement with certain subsidiaries of Anadarko to acquire oil and natural gas properties and related assets in the Big Horn Basin of Wyoming and Montana, which included oil and natural gas

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

properties and related assets in or near the Elk Basin field in Park County, Wyoming and Carbon County, Montana and oil and natural gas properties and related assets in the Gooseberry field in Park County, Wyoming. Prior to closing, EAC assigned the rights and duties under the purchase and sale agreement relating to the Elk Basin assets to Encore Energy Partners Operating LLC (“OLLC”), a Delaware limited liability company and wholly owned subsidiary of ENP, and the rights and duties under the purchase and sale agreement relating to the Gooseberry assets to Encore Operating, L.P. (“Encore Operating”), a Texas limited partnership and indirect wholly owned guarantor subsidiary of EAC. The closing of the Big Horn Basin acquisition occurred in March 2007. The total purchase price for the Big Horn Basin assets was approximately $393.6 million, including transaction costs of approximately $1.3 million.

     EAC financed the acquisitions of the Gooseberry assets and Williston Basin assets through borrowings under its revolving credit facility. ENP financed the acquisition of the Elk Basin assets through a $93.7 million contribution from EAC, $120 million of borrowings under a subordinated credit agreement with EAP Operating, LLC, a Delaware limited liability company and direct wholly owned guarantor subsidiary of EAC, and borrowings under OLLC’s revolving credit facility.

Dispositions

     In June 2007, EAC completed the sale of certain oil and natural gas properties in the Mid-Continent area, and in July 2007, additional Mid-Continent properties that were subject to preferential rights were sold. EAC received total net proceeds of approximately $294.8 million, after deducting transaction costs of approximately $3.6 million, and recorded a loss on sale of approximately $7.4 million. The disposed properties included certain properties in the Anadarko and Arkoma Basins of Oklahoma. EAC retained material oil and natural gas interests in other properties in these basins and remains active in those areas. Proceeds from the Mid-Continent asset disposition were used to reduce outstanding borrowings under EAC’s revolving credit facility.

Pro Formas

     The following pro forma condensed financial data was derived from the historical financial statements of EAC and from the accounting records of Anadarko to give effect to the Big Horn Basin and Williston Basin asset acquisitions and the Mid-Continent asset disposition as if they had each occurred on January 1, 2007. The pro forma condensed financial information has been included for comparative purposes only and is not necessarily indicative of the results that might have occurred had the Big Horn Basin and Williston Basin asset acquisitions and the Mid-Continent asset disposition taken place on January 1, 2007 and is not intended to be a projection of future results.

		Three months ended				Nine months ended
		September 30, 2007
		(in thousands, except per share amounts)
Pro forma total revenues		$	182,120			$	509,886
Pro forma net income (loss)		$	11,242			$	(6,683	)
Pro forma net income (loss) per common share:
Basic		$	0.21			$	(0.13	)
Diluted		$	0.21			$	(0.13	)

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

Note 4. Inventory

     Inventory is composed of materials and supplies and oil in pipelines, which are stated at the lower of cost (determined on an average basis) or market. Oil produced at the lease which resides unsold in pipelines is carried at an amount equal to its operating costs to produce. Oil in pipelines purchased from third parties is carried at average purchase price. Inventory consisted of the following as of the dates indicated:

		September 30,				December 31,
		2008				2007
		(in thousands)
Materials and supplies		$	14,034			$	11,567
Oil in pipelines			5,516				4,690
Total inventory		$	19,550			$	16,257

Note 5. Proved Properties

     Amounts shown in the accompanying Consolidated Balance Sheets as “Proved properties, including wells and related equipment” consisted of the following as of the dates indicated:

		September 30,				December 31,
		2008				2007
		(in thousands)
Proved leasehold costs		$	1,391,032			$	1,346,516
Wells and related equipment — Completed			1,748,063				1,408,512
Wells and related equipment — In process			166,175				90,748
Total proved properties		$	3,305,270			$	2,845,776

Note 6. Derivative Financial Instruments

     As of September 30, 2008, EAC had $76.3 million of deferred premiums payable of which $21.3 million was long-term and included in “Derivatives” in the non-current liabilities section of the accompanying Consolidated Balance Sheet and $55.0 million was current and included in “Derivatives” in the current liabilities section of the accompanying Consolidated Balance Sheet. The premiums relate to various oil and natural gas floor contracts and are payable on a monthly basis from October 2008 to January 2010. EAC recorded these premiums at their net present value at the time the contracts were entered into and accretes that value up to the eventual settlement price by recording interest expense each period. During the nine months ended September 30, 2008, EAC entered into deferred premium contracts valued at $53.4 million, which are non-cash financing activities.

Commodity Derivative Contracts – Mark-to-Market Accounting

     From time to time, EAC sells floors with a strike price below the strike price of the purchased floors in order to partially finance the premiums paid on the purchased floors. Together the two floors, known as a floor spread or put spread, have a lower premium cost than a traditional floor contract but provide price protection only down to the strike price of the short floor. As with EAC’s other commodity derivative contracts, these are marked-to-market each quarter through “Derivative fair value loss (gain)” in the accompanying Consolidated Statements of Operations. In the following tables, the purchased floor component of these floor spreads are shown net and included with EAC’s other floor contracts.

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

     The following tables summarize EAC’s open commodity derivative contracts as of September 30, 2008:

Oil Derivative Contracts

		Average				Weighted					Average				Weighted					Average				Weighted					Average				Weighted					Asset
		Daily				Average					Daily				Average					Daily				Average					Daily				Average					(Liability)
		Floor				Floor					Short Floor				Short Floor					Cap				Cap					Swap				Swap					Fair Market
Period		Volume				Price					Volume				Price					Volume				Price					Volume				Price					Value
		(Bbls)				(per Bbl)					(Bbls)				(per Bbl)					(Bbls)				(per Bbl)					(Bbls)				(per Bbl)					(in thousands)
Oct. — Dec. 2008																																						$	(4,737	)
			14,880			$	83.36					—			$	—					2,440			$	101.99					5,000			$	91.56
			6,000				71.67					—				—					2,000				96.65					—				—
			5,500				62.27					—				—					—				—					—				—
			3,000				56.67					(4,000	)			50.00					—				—					—				—
2009 (a)																																							56,118
			11,630				110.00					—				—					440				97.75					2,000				90.46
			8,000				80.00					(5,000	)			50.00					—				—					3,000				89.22
			—				—					—				—					—				—					1,000				68.70
2010																																							(8,226	)
			880				80.00					—				—					440				93.80					—				—
			2,000				75.00					—				—					1,000				77.23					—				—
2011																																							(4,731	)
			1,880				80.00					—				—					1,440				95.41					—				—
			1,000				70.00					—				—					—				—					—				—
																																						$	38,424

Natural Gas Derivative Contracts

		Average				Weighted					Average				Weighted					Average				Weighted					Average				Weighted
		Daily				Average					Daily				Average					Daily				Average					Daily				Average					Asset
		Floor				Floor					Short Floor				Short Floor					Cap				Cap					Swap				Swap					Fair Market
Period		Volume				Price					Volume				Price					Volume				Price					Volume				Price					Value
		(Mcf)				(per Mcf)					(Mcf)				(per Mcf)					(Mcf)				(per Mcf)					(Mcf)				(per Mcf)					(in thousands)
Oct. — Dec. 2008																																						$	4,986
			6,300			$	8.18					—			$	—					6,300			$	9.52					5,000			$	8.14
			11,300				7.38					—				—					7,500				8.35					5,000				7.47
			20,000				6.35					—				—					—				—					—				—
2009																																							1,969
			3,800				8.20					—				—					3,800				9.83					—				—
			3,800				7.20					—				—					—				—					—				—
2010																																							1,303
			3,800				8.20					—				—					3,800				9.58					—				—
			3,800				7.20					—				—					—				—					—				—
																																						$	8,258

Interest Rate Swaps

     In the first quarter of 2008, ENP entered into interest rate swaps whereby it swapped $100 million of floating rate debt on OLLC’s revolving credit facility to a weighted average fixed rate of 3.06 percent and an expected margin of 1.25 percent. These interest rate swaps were designated as cash flow hedges. The following table summarizes ENP’s open interest rate swaps as of September 30, 2008:

		Notional				Fixed				Floating
Term		Amount				Rate				Rate
		(in thousands)
October 2008-January 2011		$	50,000				3.1610	%		1-month LIBOR
October 2008-January 2011			25,000				2.9650	%		1-month LIBOR
October 2008-January 2011			25,000				2.9613	%		1-month LIBOR

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

     As of September 30, 2008, the fair market value of ENP’s interest rate swaps was a net asset of $0.8 million. During the three and nine months ended September 30, 2008, settlements of interest rate swaps increased EAC’s consolidated interest expense by approximately $0.1 million and $0.2 million, respectively.

Current Period Impact

     As a result of commodity derivative contracts that were previously designated as hedges, EAC recognized a pre-tax reduction in oil and natural gas revenues of $13.4 million during the three months ended September 30, 2007 and $2.9 million and $40.2 million during the nine months ended September 30, 2008 and 2007, respectively. EAC also recognized derivative fair value gains and losses related to: (1) changes in the market value of derivative contracts; (2) settlements on commodity derivative contracts; and (3) premium amortization. The following table summarizes the components of derivative fair value gains and losses for the periods indicated:

		Three months ended								Nine months ended
		September 30,								September 30,
		2008				2007				2008				2007
		(in thousands)
Mark-to-market loss (gain) on derivative contracts		$	(276,938	)		$	(3,007	)		$	(12,233	)		$	17,547
Premium amortization			14,773				11,681				47,579				29,370
Settlements on commodity derivative contracts			22,730				7,112				46,747				21,249
Total derivative fair value loss (gain)		$	(239,435	)		$	15,786			$	82,093			$	68,166

Accumulated Other Comprehensive Income (“AOCI”)

     At September 30, 2008, AOCI consisted entirely of deferred gains, net of tax, on ENP’s interest rate swaps that are designated as hedges of $0.2 million. At December 31, 2007, AOCI consisted entirely of deferred losses, net of tax, on commodity derivative contracts that were previously designated as hedges of $1.8 million.

     EAC expects to reclassify $0.7 million of deferred gains associated with ENP’s interest rate swaps from AOCI to offset interest expense during the twelve months ending September 30, 2009. EAC also expects to reclassify $0.1 million of income taxes associated with ENP’s interest rate swaps from AOCI to income tax benefit during the twelve months ending September 30, 2009.

Note 7. Fair Value Measurements

     As discussed in “Note 2. Basis of Presentation”, EAC adopted SFAS 157 on January 1, 2008, as it relates to financial assets and liabilities. SFAS 157 establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The three levels of the fair value hierarchy defined by SFAS 157 are as follows:

	•		Level 1 – Unadjusted quoted prices are available in active markets for identical assets or liabilities.
	•		Level 2 – Pricing inputs, other than quoted prices within Level 1, that are either directly or indirectly observable.
	•		Level 3 – Pricing inputs that are unobservable requiring the use of valuation methodologies that result in management’s best estimate of fair value.

     EAC’s assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of the financial assets and liabilities and their placement within the fair value hierarchy levels. The following methods and assumptions were used to estimate the fair values of EAC’s financial assets and liabilities that are accounted for at fair value on a recurring basis:

•

Level 2 – Fair values of oil and natural gas swaps were estimated using a combined income and market-based valuation methodology based upon forward commodity price curves obtained from independent pricing services reflecting broker market quotes. Fair values of interest rate swaps were estimated using a combined income and market-based valuation

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

			methodology based upon credit ratings and forward interest rate yield curves obtained from independent pricing services reflecting broker market quotes.
	•		Level 3 - Fair values of oil and natural gas floors and caps were estimated using pricing models and discounted cash flow methodologies based on inputs that are not readily available in public markets.

     The following table sets forth EAC’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of September 30, 2008:

						Fair Value Measurements at Reporting Date Using
						Quoted Prices in
						Active Markets for				Significant Other				Significant
						Identical Assets				Observable Inputs				Unobservable Inputs
Description		September 30, 2008				(Level 1)				(Level 2)				(Level 3)
		(in thousands)
Oil derivative contracts — swaps		$	(38,076	)		$	—			$	(38,076	)		$	—
Oil derivative contracts — floors and caps			76,500				—				—				76,500
Natural gas derivative contracts — swaps			1,347				—				1,347				—
Natural gas derivative contracts — floors and caps			6,911				—				—				6,911
Interest rate swaps			785				—				785				—
Total		$	47,467			$	—			$	(35,944	)		$	83,411

     The following table summarizes the changes in the fair value of EAC’s Level 3 financial assets and liabilities for the nine months ended September 30, 2008:

		Fair Value Measurements Using Significant
		Unobservable Inputs (Level 3)
		Oil Derivative				Natural Gas
		Contracts -				Derivative Contracts -
		Floors and Caps				Floors and Caps				Total
						(in thousands)
Balance at January 1, 2008		$	16,647			$	7,081			$	23,728
Total gains (losses):
Included in earnings			22,972				(3,845	)			19,127
Purchases, issuances, and settlements			36,881				3,675				40,556
Balance at September 30, 2008		$	76,500			$	6,911			$	83,411
The amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at the reporting date		$	22,972			$	(3,845	)		$	19,127

     Since EAC does not use hedge accounting for its commodity derivative contracts, all gains and losses on its Level 3 financial assets and liabilities are included in “Derivative fair value loss (gain)” in the accompanying Consolidated Statements of Operations. All fair values reflected in the tables above and in the accompanying Consolidated Balance Sheet have been adjusted for non-performance risk, resulting in a reduction of the net asset of approximately $1.1 million as of September 30, 2008.

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

Note 8. Asset Retirement Obligations

     EAC’s asset retirement obligations relate to future plugging and abandonment expenses on oil and natural gas properties and related facilities disposal. As of September 30, 2008 and December 31, 2007, EAC had $9.2 million and $6.7 million, respectively, held in escrow from which funds are released only for reimbursement of plugging and abandonment expenses on its Bell Creek properties, which is included in other long-term assets in the accompanying Consolidated Balance Sheets. The following table summarizes the changes in EAC’s asset retirement obligations for the nine months ended September 30, 2008 (in thousands):

Future abandonment liability at January 1, 2008		$	28,079
Wells drilled			287
Acquisition of properties			111
Accretion of discount			990
Plugging and abandonment costs incurred			(1,472	)
Revision of previous estimates			5,250
Future abandonment liability at September 30, 2008		$	33,245

     As of September 30, 2008, $32.5 million of EAC’s asset retirement obligations were long-term and recorded in “Future abandonment cost, net of current portion” and $0.8 million was current and included in “Other current liabilities” on the accompanying Consolidated Balance Sheets.

Note 9. Long-Term Debt

     EAC’s long-term debt consisted of the following as of the dates indicated:

		Maturity		September 30,				December 31,
		Date		2008				2007
				(in thousands)
Revolving credit facilities		3/7/2012		$	622,939			$	526,000
6.25% Senior Subordinated Notes		4/15/2014			150,000				150,000
6.0% Senior Subordinated Notes, net of unamortized discount of $4,082 and $4,440, respectively		7/15/2015			295,918				295,560
7.25% Senior Subordinated Notes, net of unamortized discount of $1,253 and $1,324, respectively		12/1/2017			148,747				148,676
Total				$	1,217,604			$	1,120,236

Encore Acquisition Company Senior Secured Credit Agreement

     EAC is party to a five-year amended and restated credit agreement dated March 7, 2007 (as amended, the “EAC Credit Agreement”). Effective February 7, 2008, EAC amended the EAC Credit Agreement to, among other things, provide that certain negative covenants in the EAC Credit Agreement restricting hedge transactions do not apply to any oil and natural gas hedge transaction that is a floor or put transaction not requiring any future payments or delivery by EAC or any of its restricted subsidiaries. Effective May 22, 2008, EAC amended the EAC Credit Agreement to, among other things, increase the margins applicable to the ratio of total outstanding borrowings to borrowing base, as noted in the table below, and increase the borrowing base to $1.1 billion.

     The following table represents the applicable margin for Eurodollar and base rate loans under the EAC Credit Agreement, as amended:

		Applicable Margin for				Applicable Margin for
Ratio of Total Outstanding Borrowings to Borrowing Base		Eurodollar Loans				Base Rate Loans
Less than .50 to 1			1.250	%			0.000	%
Greater than or equal to .50 to 1 but less than .75 to 1			1.500	%			0.250	%
Greater than or equal to .75 to 1 but less than .90 to 1			1.750	%			0.500	%
Greater than or equal to .90 to 1			2.000	%			0.750	%

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

     The aggregate amount of the commitments of the lenders under the EAC Credit Agreement is $1.25 billion. Availability under the EAC Credit Agreement is subject to a borrowing base, which is redetermined semi-annually and upon requested special redeterminations. As of September 30, 2008, the borrowing base was $1.1 billion and there were $482.9 million of outstanding borrowings and $617.1 million of borrowing capacity under the EAC Credit Agreement. As of September 30, 2008, EAC was in compliance with all covenants of the EAC Credit Agreement.

Encore Energy Partners Operating LLC Credit Agreement

     OLLC is a party to a five-year credit agreement dated March 7, 2007 (as amended, the “OLLC Credit Agreement”). The aggregate amount of the commitments of the lenders under the OLLC Credit Agreement is $300 million. Availability under the OLLC Credit Agreement is subject to a borrowing base, which is redetermined semi-annually and upon requested special redeterminations. As of September 30, 2008, the borrowing base was $240 million and there were $140 million of outstanding borrowings, $0.1 million of outstanding letters of credit, and $99.9 million of borrowing capacity under the OLLC Credit Agreement. As of September 30, 2008, OLLC was in compliance with all covenants of the OLLC Credit Agreement.

Note 10. Stockholders’ Equity

     In December 2007, EAC announced that its Board of Directors (the “Board”) approved a share repurchase program authorizing EAC to repurchase up to $50 million of its common stock. As of September 30, 2008, EAC had completed the share repurchase program by repurchasing and retiring 1,397,721 shares of its outstanding common stock at an average price of approximately $35.77 per share.

Note 11. Income Taxes

     The components of income tax provision were as follows for the periods indicated:

		Nine months ended
		September 30,
		2008				2007
		(in thousands)
Federal:
Current		$	(6,693	)		$	(116	)
Deferred			(104,436	)			(679	)
Total federal			(111,129	)			(795	)
State, net of federal benefit/expense:
Current			(2,249	)			—
Deferred			(5,217	)			(695	)
Total state			(7,466	)			(695	)
Income tax provision		$	(118,595	)		$	(1,490	)

     The following table reconciles EAC’s income tax provision with income tax at the Federal statutory rate for the periods indicated:

		Nine months ended
		September 30,
		2008				2007
		(in thousands)
Income (loss) before income taxes, net of minority interest		$	320,402			$	(782	)
Income tax at the Federal statutory rate		$	(112,141	)		$	274
State income taxes, net of federal benefit/expense			(7,556	)			19
Change in estimated future state tax rate			3				(597	)
Nondeductible deferred compensation expense			(782	)			(1,238	)
Permanent and other			1,881				52
Income tax provision		$	(118,595	)		$	(1,490	)

ENCORE ACQUISITION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)

     At September 30, 2008, EAC had net operating loss (“NOL”) carryforwards of $22.4 million, which are available to offset future regular taxable income, if any. At September 30, 2008, EAC also had alternative minimum tax (“AMT”) credits of $2.7 million, which are available to reduce future regular tax liabilities in excess of AMT. EAC believes it is more likely than not that the NOL carryforwards will offset future taxable income prior to their expiration. The AMT credits have no expiration. Therefore, a valuation allowance against these deferred tax assets is not considered necessary.

     As of September 30, 2008 and December 31, 2007, all of EAC’s tax positions met the “highly certain positions” threshold prescribed by FIN No. 48, “Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109”. As a result, no additional tax expense, interest, or penalties have been accrued. EAC includes interest assessed by taxing authorities and penalties related to income taxes in “Other expense” on its Consolidated Statements of Operations. For the nine months ended September 30, 2008, EAC recorded approximately $0.1 million of interest and penalties on certain tax positions. For the nine months ended September 30, 2007, EAC recorded only a nominal amount of interest and penalties on certain tax positions.

Note 12. EPS

     The following table reflects EAC’s EPS computations for the periods indicated:

		Three months ended								Nine months ended
		September 30,								September 30,
		2008				2007				2008				2007
		(in thousands, except per share data)
Numerator:
Numerator for basic EPS:
Net income (loss)		$	206,307			$	11,985			$	201,807			$	(2,272	)
Incremental minority interest from assumed conversion of ENP MIUs			(3,143	)			—				(3,461	)			—
Numerator for diluted EPS		$	203,164			$	11,985			$	198,346			$	(2,272	)
Denominator:
Denominator for basic EPS:
Weighted average shares outstanding			52,258				53,198				52,466				53,140
Effect of dilutive options (a)			721				464				668				—
Effect of dilutive restricted stock (b)			542				517				536				—
Denominator for diluted EPS			53,521				54,179				53,670				53,140
Net income (loss) per common share:
Basic		$	3.95			$	0.23			$	3.85			$	(0.04	)
Diluted		$	3.80			$	0.22			$	3.70			$	(0.04	)