SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2007

For the transition period from                        to                      

Commission file number 1-10262

HKN, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code (817)424–2424

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  þ No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yes o No þ

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. þ Yes    ¨ No.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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.         ¨

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 definition of “accelerated filer and large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer ¨         Accelerated filer þ         Non-accelerated filer ¨         Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

¨ Yes    þ No

The aggregate market value of the voting Common Stock, par value $0.01 per share, held by non affiliates of the Registrant as of June 30, 2007 was approximately $69 million. For purposes of the determination of the above stated amount only, all directors, executive officers and 5% or more stockholders of the Registrant are presumed to be affiliates.

The number of shares of Common Stock, par value $0.01 per share, outstanding as of February 1, 2008 was 9,747,537.

DOCUMENTS INCORPORATED BY REFERENCE

Specified portions of the registrant’s definitive Proxy Statement for the 2007 Annual Meeting of Shareholders, to be filed pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after the end of this fiscal year covered by this report, are incorporated by reference in Part III of this report.

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TABLE OF CONTENTS

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The following discussion is intended to assist you in understanding our business and the results of our operations.  It should be read in conjunction with the Consolidated Financial Statements and the related notes that appear elsewhere in this report.  Certain statements made in our discussion may be forward looking.  Forward-looking statements involve risks and uncertainties and a number of factors could cause actual results or outcomes to differ materially from our expectations.  Unless the context requires otherwise, when we refer to “we,” “us” and “our,” we are describing HKN, Inc. and its consolidated subsidiaries on a consolidated basis.

PART I

ITEM 1. BUSINESS

Overview

We are an independent energy company engaged both in the development and production of crude oil, natural gas and coalbed methane assets and in the active management of investments in energy industry securities and futures traded on domestic and international securities exchanges.  Our strategy includes:

·                  Deploying assets into energy-based opportunities that will build annual measurable value and/or cash flow,

·                  Optimizing the value of our assets through collective expectations and objectives, and;

·                  Monetizing assets that have reached their full potential, that do not have an expectation of near-term value enhancement or that represent a disproportionate concentration of value in one asset.

In June 2007, we effected a one-for-22.4 reverse stock split that has been retroactively reflected in this Annual Report.

We were incorporated in 1973 in the State of California and reincorporated in 1979 in the State of Delaware. Our corporate offices are located at 180 State Street, Suite 200, Southlake, Texas 76092. Our telephone number is (817) 424-2424, and our web site is accessed at www.hkninc.com. We make available, free of charge, on our website, our Code of Business Conduct and Ethics, Code of Ethics for Senior Financial Officers, Audit Committee Charter and Nominating and Corporate Governance Committee Charter as well as our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as is reasonably practical after such materials are electronically filed with, or furnished to, the Securities and Exchange Commission (SEC).

Oil and Gas Development and Production Operations

Our oil and gas operations consist of development and production efforts in the United States, principally in the onshore and offshore Gulf Coast regions of South Texas and Louisiana.  During the three years ended December 31, 2007, we drilled or participated in the drilling of 25 oil and gas wells in North America, completing 18 of the wells drilled. During 2007, we drilled or participated in the drilling of 5 exploratory and development wells and successfully completed 4 of those wells. As of December 31, 2007, we operate or own a non-operating working interest in 66 oil wells, 68 gas wells and 12 injection wells in the Gulf Coast area of the United States.  All of our proved oil and gas reserves are concentrated in the Gulf Coast region of Louisiana and Texas.

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Prospect Acreage - In addition to the producing property interests discussed above, we own, through certain wholly-owned subsidiaries, interests in a variety of domestic prospect acreage in the Creole, East Lake Verret and Lapeyrouse fields of Cameron, Assumption and Terrebonne Parishes, respectively, in Louisisana.

See Note 15 – “Other Information” in the Notes to Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K for financial information about our oil and gas interests.

Oil and Gas Customers

During 2007, three domestic customers, Shell, Chevron and Noble, purchased approximately 60% of our consolidated oil and gas sales. During 2006, two domestic customers, Shell and Chevron, purchased approximately 35% of our consolidated oil and gas sales. During 2005, two domestic customers, Shell and Cinergy, purchased approximately 17% of our consolidated sales.

Oil and Natural Gas Marketing

Generally, but not always, the demand for natural gas decreases during the summer months and increases during the winter months.  Seasonal anomalies such as mild winters or hot summers sometimes lessen this fluctuation.  The spot market for oil and gas is subject to volatility as supply and demand factors fluctuate.  We may periodically enter into financial hedging arrangement with a portion of our oil and gas production.  These activities are intended to support targeted price levels and to manage our exposure to price fluctuations.  See “Item 7A. Quantitative and Qualitative Disclosures About Market Risk.”

Oil and Gas Properties and Locations

Production and Revenues – See also Note 17 – “Oil and Gas Disclosures” in the Notes to Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K for certain information about our proved oil and gas reserves.  A summary of our ownership in our most significant producing properties at December 31, 2007 is as follows:

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The following table shows, for the periods indicated, operating information attributable to our North American oil and gas interests:

Acreage and Wells -- At December 31, 2007, we owned interests in the following oil and gas wells and acreage.

Drilling Activity - A well is considered “drilled” when it is completed. A productive well is completed when permanent equipment is installed for the production of oil or gas.  A dry hole is completed when it has been plugged as required and its abandonment is reported to the appropriate government agency. The following tables summarize certain information concerning our drilling activity:

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Coalbed Methane Prospects – Indiana and Ohio

At December 31, 2007, we currently hold three coalbed methane exploration and development agreements in Indiana and Ohio. Two prospects provide for an area of mutual interest of approximately 400,000 acres and one provides for approximately 20,000 acres. The agreements provide for a phased delineation, pilot and development program, with corresponding staged expenditures. Contracted third parties with a long track record in successful coalbed methane development provide expert advice for these projects.  We are actively continuing the development of these projects through pilot well projects and evaluation studies in accordance with the exploration and development agreements.

Other Energy-Based Investments

During 2007, through our treasury activities, we engaged in the active management of investments in energy industry securities traded on domestic securities exchanges.  We strive to obtain favorable investment returns by diversifying investment holdings within the energy sector and balancing risk exposures. As a result of our trading activities in 2007, we realized net trading gains of $862 thousand on the closed positions on our common stock and common stock derivatives. Also related to these trading activities, we received net cash proceeds of $2.0 million upon entering into new trading positions during the period.  At December 31, 2007, we had terminated all our common stock and common stock derivative contracts used for trading purposes; therefore we had no total potential obligations or exposure associated with such instruments. See “Note 2 - Investments” in the Notes to Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K for financial information regarding our trading activities.

International Energy Investment – Global Energy Development PLC

At December 31, 2007, we held an investment in Global Energy Development PLC (“Global”) through our ownership of approximately 34% of Global’s ordinary shares. We account for our ownership of Global shares as a cost method investment. Global is a petroleum exploration and production company focused on Latin America. Global’s shares are traded on the AIM, a market operated by the London Stock Exchange.  See “Note 2 - Investments” in the Notes to Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K for further information. Additional information regarding Global’s operations may be found on their website, www.globalenergydevelopmentplc.com.

Canadian Energy Investment – Spitfire Energy, Ltd.

In December 2006, we acquired 2.6 million common shares and 1.3 million warrants to acquire common shares of Spitfire Energy, Ltd. (“Spitfire”) through a private placement for investment purposes at a total cost of $2.3 million. During 2007, we acquired an additional 8.3 million shares of Spitfire common stock in the market and through a private placement for investment purposes for a total of $3.9 million.  At December 31, 2007, our common share holdings in Spitfire represent approximately 25% of the currently

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outstanding Spitfire common shares. Spitfire is an independent public company (TSX-V: SEL) actively engaged in the exploration, development and production of crude oil, natural gas and natural gas liquids in Western Canada.  Additional information may be found at the Spitfire website, www.spitfireenergy.com.  We are currently evaluating strategic alternatives regarding additional investments in Canadian junior oil and gas companies. See “Note 2 - Investments” in the Notes to Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K for further information.

Employees

At December 31, 2007, we had 17 employees. We have experienced no work stoppages or strikes as a result of labor disputes and consider relations with our employees to be satisfactory. We maintain group medical, dental, surgical and hospital insurance plans for our employees.

ITEM 1A.  RISK FACTORS

Because of the following factors, as well as other variables affecting our operating results, past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods.

Risk factors associated with our financial condition:

Our financial condition may suffer if estimates of our oil and gas reserve information are adjusted, and fluctuations in oil and gas prices and other factors affect our oil and gas reserves.

Our oil and gas reserve information is based upon criteria prepared in accordance with Rule 4-10 of Regulation S-X, and reflects only estimates of the accumulation of oil and gas and the economic recoverability of those volumes.  Our future production, revenues and expenditures with respect to such oil and gas reserves could be different from estimates, and any material differences may negatively affect our business, financial condition and results of operations.

Petroleum engineering is a subjective process of estimating underground accumulations of oil and gas that cannot be measured in an exact manner. Estimates of economically recoverable oil and gas reserves and of future net cash flows necessarily depend upon a number of variable factors and assumptions.

Because all reserve estimates are to some degree subjective, each of the following items may prove to differ materially from that assumed in estimating reserves:

·                  the quantities of oil and gas that are ultimately recovered,

·                  the production and operating costs incurred,

·                  the amount and timing of future development expenditures, and

·                  future oil and gas sales prices.

Furthermore, different reserve engineers may make different estimates of reserves and cash flow based on the same available data.

The estimated discounted future net cash flows described in this Annual Report for the year ended December 31, 2007 should not be considered as the current market value of the estimated oil and gas reserves attributable to our properties from proved reserves.  Such estimates are prepared in compliance with the Financial Accounting Standards Board’s Statement of Financial Accounting Standard No. 69, and, as such, are

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based on prices and costs as of the date of the estimate, while future prices and costs may be materially higher or lower.  The Standard requires that we report our oil and natural gas reserves using the price as of the last day of the year. Using lower values in forecasting reserves will result in a shorter life being given to producing oil and natural gas properties because such properties, as their production levels are estimated to decline, will reach an uneconomic limit, with lower prices, at an earlier date.  There can be no assurance that a decrease in oil and gas prices or other differences in our estimates of its reserve will not adversely affect our financial condition and results of operations.

If the market value of our investments in Global and Spitfire continue to decrease, the value of our common stock could be negatively impacted.

At December 31, 2007, we hold investments in both Global and Spitfire through our ownership of approximately 34% and 25%, respectively, of their outstanding ordinary shares.  Both investments represent a substantial part of our balance sheet at December 31, 2007.  The market value of both Global’s and Spitfire’s common shares decreased during 2007.  Even though we believe the decrease in the value of their common shares is temporary, there can be no assurance that their common stock will not continue to decline in the future. The potential decrease in the value of their common stock could adversely affect our financial statements and the value of our common stock.

One of our shareholders owns a significant amount of our common stock and exercises significant control over us.

As of December 31, 2007, Lyford Investments Enterprises Ltd. (“Lyford”) beneficially owned approximately 31% of the combined voting power of our outstanding common stock. Lyford is in a position to significantly influence decisions with respect to:

·                                          our direction and policies, including the election and removal of directors,

·                                          mergers or other business combinations,

·                                          the acquisition or disposition of our assets,

·                                          future issuances of our common stock or other securities,

·                                          our incurrence of debt, and

·                                          the payment of dividends, if any, on our common stock, and amendments to our certificate of incorporation and bylaws.

Lyford’s concentration of ownership may also have the effect of delaying, deferring or preventing a future change of control.

Risks associated with our crude oil and natural gas operations:

Our future success depends on our ability to find, develop and produce oil and gas reserves.

As is generally the case, our producing properties in the Gulf of Mexico and the onshore Gulf Coast often have high initial production rates, followed by steep declines. To maintain production levels, we must locate and develop or acquire new oil and gas reserves to replace those depleted by production. Without successful exploration or acquisition activities, our reserves, production and revenues will decline rapidly. We may be unable to find, develop or produce additional reserves at an acceptable cost. In addition, substantial capital is required to replace and grow reserves. If lower oil and gas prices or operating constraints or production difficulties result in our cash flow from operations being less than expected, we may be unable to expend the capital necessary to locate and develop or acquire new oil and gas reserves.

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Actual quantities of recoverable oil and gas reserves and future cash flows from those reserves most likely will vary from our estimates.

Estimating accumulations of oil and gas is complex. The process relies on interpretations of available geological, geophysical, engineering and production data. The extent, quality and reliability of this data can vary. The process also requires certain economic assumptions, some of which are mandated by the SEC, such as oil and gas prices, drilling and operating expenses, capital expenditures, taxes and availability of funds. The accuracy of a reserve estimate is a function of:

·                      the quality and quantity of available data;

·                      the interpretation of that data;

·                      the accuracy of various mandated economic assumptions; and

·                      the judgment of the persons preparing the estimate.

The proved reserve information set forth in this report is based on estimates we prepared In accordance with the definition of proved reserves set forth by Generally Accepted Accounting Principles.

Estimates prepared by others might differ materially from our estimates. Actual quantities of recoverable oil and gas reserves, future production, oil and gas prices, revenues, taxes, development expenditures and operating expenses most likely will vary from our estimates. Any significant variance could materially affect the quantities and net present value of our reserves. In addition, we may adjust estimates of proved reserves to reflect production history, results of exploration and development and prevailing oil and gas prices. Our reserves also may be susceptible to drainage by operators on adjacent properties.

 You should not assume that the present value of future net cash flows is the current market value of our estimated proved oil and gas reserves. In accordance with SEC requirements, we base the estimated discounted future net cash flows from proved reserves on prices and costs in effect at December 31. Actual future prices and costs may be materially higher or lower than the prices and costs we used.

Oil and gas price fluctuations in the market may adversely affect the results of our operations.

The results of our operations are highly dependent upon the prices received for our oil and natural gas production. Substantially all of our sales of oil and natural gas are made in the spot market, or pursuant to contracts based on spot market prices, and not pursuant to long-term, fixed-price contracts.  Accordingly, the prices received for our oil and natural gas production are dependent upon numerous factors beyond our control. These factors include the level of consumer product demand, governmental regulations and taxes, the price and availability of alternative fuels, the level of foreign imports of oil and natural gas and the overall economic environment.  Significant declines in prices for oil and natural gas could have a material adverse effect on our financial condition, results of operations and quantities of reserves recoverable on an economic basis.  Any significant decline in prices of oil or gas could have a material adverse effect on our financial condition and results of operations.  Recently, the price of oil and natural gas has been volatile.  For example, during 2007, based on NYMEX pricing, the price for a bbl of oil ranged from a high of $98.18 to a low of $50.48 and the price for a Mcf of gas ranged from a high of $8.42 to a low of $5.43.

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Our operations require significant expenditures of capital that may not be recovered.

We require significant expenditures of capital in order to locate and develop producing properties and to drill exploratory and exploitation wells.  In conducting exploration, exploitation and development activities from a particular well, the presence of unanticipated pressure or irregularities in formations, miscalculations or accidents may cause our exploration, exploitation, development and production activities to be unsuccessful, potentially resulting in abandoning the well.  This could result in a total loss of our investment.  In addition, the cost and timing of drilling, completing and operating wells is difficult to predict.

The oil and gas we produce may not be readily marketable at the time of production.

Crude oil, natural gas, condensate and other oil and gas products are generally sold to other oil and gas companies, government agencies and other industries.  The availability of ready markets for oil and gas that we might discover and the prices obtained for such oil and gas depend on many factors beyond our control, including:

·                                          the extent of local production and imports of oil and gas,

·                                          the proximity and capacity of pipelines and other transportation facilities,

·                                          fluctuating demand for oil and gas,

·                                          the marketing of competitive fuels, and

·                                          the effects of governmental regulation of oil and gas production and sales.

Natural gas associated with oil production is often not marketable due to demand or transportation limitations and is often flared at the producing well site.  Pipeline facilities do not exist in certain areas of exploration and, therefore, any actual sales of discovered oil and gas might be delayed for extended periods until such facilities are constructed.

We may encounter operating hazards that may result in substantial losses.

We are subject to operating hazards normally associated with the exploration and production of oil and gas, including blowouts, explosions, oil spills, cratering, pollution, earthquakes, hurricanes, labor disruptions and fires.  The occurrence of any such operating hazards could result in substantial losses to us due to injury or loss of life and damage to or destruction of oil and gas wells, formations, production facilities or other properties.  We maintain insurance coverage limiting financial loss resulting from certain of these operating hazards.  We do not maintain full insurance coverage for all matters that may adversely affect our operations, including war, terrorism, nuclear reactions, government fines, treatment of waste, blowout expenses and business interruptions.  Losses and liabilities arising from uninsured or underinsured events could reduce our revenues or increase our costs. There can be no assurance that any insurance will be adequate to cover losses or liabilities associated with operational hazards.  We cannot predict the continued availability of insurance, or its availability at premium levels that justify its purchase.

Oil and gas wells particularly in certain regions of the United States could be hindered by hurricanes, earthquakes and other weather-related operating risks.

Our operations in the Texas and Louisiana Gulf Coast area are subject to risks from hurricanes and other natural disasters. Damage caused by hurricanes, earthquakes or other operating hazards could result in substantial losses to us. In the past, our oil and gas operations have been affected by tropical storms and hurricanes on occasion resulting in reduced oil and gas volumes during those periods.  See “Risk Factors — We may encounter operating hazards that may result in substantial losses.”

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We face strong competition from larger oil and gas companies, which could result in adverse effects on our business.

The exploration and production business is highly competitive.  Many of our competitors have substantially larger financial resources, staffs and facilities.  Our competitors in the United States include numerous major oil and gas exploration and production companies.  Our investment in Global may be affected as a result of the competition faced by Global in Colombia, Peru and Panama that includes such major oil and gas companies as BP Amoco, Exxon/Mobil, Texaco/Shell and Conoco/Phillips. Major oil and gas companies are often better positioned to obtain the rights to exploratory acreage for which we compete.

Our operations are subject to various litigation that could have an adverse effect on our business.

From time to time our subsidiaries are defendants in various litigation matters. The nature of our and our subsidiaries’ operations expose us to further possible litigation claims in the future.  There is risk that any matter in litigation could be adversely decided against us or our subsidiaries, regardless of our belief, opinion and position, which could have a material adverse effect on our financial condition and results of operations. Litigation is highly costly and the costs associated with defending litigation could also have a material adverse effect on our financial condition.

Compliance with, or breach of, environmental laws can be costly and could limit our operations.

Our operations are subject to numerous and frequently changing laws and regulations governing the discharge of materials into the environment or otherwise relating to environmental protection.  We own or lease, and have in the past owned or leased, properties that have been used for the exploration and production of oil and gas and these properties and the wastes disposed on these properties may be subject to the Comprehensive Environmental Response, Compensation and Liability Act, the Oil Pollution Act of 1990, the Resource Conservation and Recovery Act, the Federal Water Pollution Control Act and analogous state laws.  Under such laws, we could be required to remove or remediate previously released wastes or property contamination.  Laws and regulations protecting the environment have generally become more stringent and, may in some cases, impose “strict liability” for environmental damage.  Strict liability means that we may be held liable for damage without regard to whether we were negligent or otherwise at fault.  Environmental laws and regulations may expose us to liability for the conduct of or conditions caused by others or for acts that were in compliance with all applicable laws at the time they were performed.  Failure to comply with these laws and regulations may result in the imposition of administrative, civil and criminal penalties.

Although we believe that our operations are in substantial compliance with existing requirements of governmental bodies, our ability to conduct continued operations is subject to satisfying applicable regulatory and permitting controls. Our current permits and authorizations and ability to get future permits and authorizations may be susceptible on a going forward basis, to increased scrutiny, greater complexity resulting in increased costs, or delays in receiving appropriate authorizations.

Risk factors associated with our investment activities:

Our investment activities may cause us to become a registered investment company

We hold investments in the common shares of both Global and Spitfire.  We are also involved in the active management of investments in energy industry securities traded on domestic securities exchanges.  We may become subject to registration under the Investment Company Act of 1940 if our ownership of investment securities should exceed a specified amount of our total assets.  Although we do not expect to become subject

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to this statute in the foreseeable future, becoming a registered investment company would restrict our ability to offer services to our portfolio investments, increase our administrative costs and otherwise adversely affect the ability to operate our business.

Changing conditions in financial markets and the economy could result in decreased trading revenues.

Changes in the financial markets or economic conditions in the United States and elsewhere in the world could adversely affect our business in many ways.  A market downturn could lead to a decline in the value of our investments and, therefore, to a decline in the trading revenues we receive from our investment trading activities.

Our trading activities expose us to risk of loss.

A portion of our revenues is derived from investment trading activities.  We may incur trading losses relating to the purchase, sale or short sale of high yield, international, convertible, and equity securities and futures. Additionally, we may have substantial investments of our capital in equity securities including investments managed by us and investments managed by third parties. In any period, we may experience losses as a result of price declines, lack of trading volume, and illiquidity. From time to time, we may engage in a large block trade in a single security or maintain large position concentrations in a single security, securities of a single issuer, or securities of issuers engaged in a specific industry, primarily the energy industry.  In general, because our investments are marked to market on a daily basis, any adverse price movement in these securities and futures could result in a reduction of our revenues and profits.

We may suffer losses through futures trading.

We invest capital in the trading of energy futures contracts. The results of these investments can be significantly impacted by factors such as the volatility of the relationship between the value of futures contracts and the cash prices of the underlying commodity, counterparty contract defaults, and general volatility of the capital markets.  The changes in the market value of such futures contracts may fluctuate significantly from time to time, and gains or losses on any particular futures contract may contribute to fluctuations in our quarterly results of operations.

We may suffer losses on our investments from exchange rate fluctuations.

We account for our investments in Global and Spitfire using the U.S. dollar as the functional currency.  The shares of common stock associated with our investments in Global and Spitfire are denominated in British sterling pounds and Canadian dollars, respectively.  We could suffer a loss in our investments if the value of the British sterling pound and the Canadian dollar were to drop relative to the value of the U.S. dollar.  Any substantial currency fluctuations could create a material adverse effect on the value of our investments.

Unauthorized hedging and related activities could result in significant losses.

Although we have adopted various internal policies and procedures designed to monitor these activities and positions to ensure that we maintain an overall position that is substantially balanced between our physical assets as compared to our trading activities. These policies and procedures are designed, in part, to prevent unauthorized purchases or sales of securities by our employees. We cannot assure, however, that these steps will detect and prevent all violations of our risk management policies and procedures, particularly if deception or other intentional misconduct is involved.

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Risks associated with market conditions:

Our stock price is volatile and the value of any investment in our common stock may fluctuate.

Our stock price has been and is highly volatile, and we believe this volatility is due to, among other things:

·                  the results of our drilling,

·                  current expectations of our future financial performance,

·                  commodity prices of oil and natural gas,

·                  the volatility of the market in general.

For example, our common stock price has fluctuated from a high of $21.28 per share to a low of $8.05 per share over the three years ended December 31, 2007.  This volatility may affect the market value of our common stock in the future.  See Part II, Item 5: Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Future sales of our common stock may affect the market price of our common stock.

There are currently several registration statements with respect to our common stock that are effective, pursuant to which certain of our stockholders may sell shares of common stock.  Any such sale of stock may also decrease the market price of our common stock.

Any conversions of our Series G1 Preferred, Series G2 Preferred or Series M Preferred Stock or exercise of warrants issued to holders of our Series L and Series M Preferred Stock involving a large issuance of shares of our common stock could result in a dilution of stockholders’ ownership percentage of our common stock and may result in a decrease in the market value of our common stock.  In addition, we may elect to issue a significant number of additional shares of common stock for financing or other purposes, which could result in a decrease in the market price of our common stock.

We have issued shares of preferred stock with greater rights than our common stock and may issue additional shares of preferred stock in the future.

We are permitted under our charter to issue up to 10 million shares of preferred stock.  We can issue shares of our preferred stock in one or more series and can set the terms of the preferred stock without seeking any further approval from our common stockholders.  Any preferred stock that we issue may rank ahead of our common stock in terms of dividend priority or liquidation premiums and may have greater voting rights than our common stock.  At December 31, 2007, we had outstanding 1,600 shares of Series G1 Preferred, 1,000 shares of Series G2 Preferred and 44,000 shares of Series M Preferred. These shares of preferred stock have rights senior to our common stock with respect to dividends and liquidation.  In addition, such preferred stock may be converted into shares of common stock, which could dilute the value of common stock to current stockholders and could adversely affect the market price of our common stock. At December 31, 2007, each share of Series G1 Preferred, Series G2 Preferred and Series M Preferred, may be converted into shares of common stock at conversion prices of $280.00, $67.20 and $13.22 per share of common stock, respectively, for each $100.00 liquidation value of a share of such preferred stock, plus the amount of any accrued and unpaid dividends.

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ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

See Item 1. “Business” for discussion of oil and gas properties and locations.

We have offices in Southlake and Houston, Texas. We lease approximately  4,062 square feet in Southlake, Texas, which lease runs through April 2008 and approximately 10,510 square feet of office space in Houston, Texas, which lease runs through January 1, 2012. The average annual cost of our leases is approximately $360 thousand. See “Liquidity and Capital Resources – Obligations and Commitments – Consolidated Contractual Obligations” contained in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

ITEM 3. LEGAL PROCEEDINGS

Exxon Litigation – Exxon Mobil Corporation v. XPLOR Energy SPV-I, Inc. filed in the 17^th Judicial District Court for the Parish of LaFourche, State of Louisiana; Case No. 106838.  On July 3, 2007, Exxon Mobil Corporation (“Exxon”) filed a Petition for Damages against XPLOR Energy SPV-I, Inc. (“Xplor”), alleging that Exxon is entitled to $960 thousand in interest related to an after payout working interest retained by Exxon in Xplor’s State Lease 14589 #2 well in the Lake Raccourci field.  As previously reported, in December 2006, Exxon undertook a joint interest audit of Xplor’s accounts related to the State Lease 14589 # 2 well.   We acquired our ownership in the State Lease 14589 #2 well in the Lake Raccourci field as part of our acquisition of Xplor in 1999.  Exxon had retained certain override and after payout interests on the State Lease 14589 #2 well pursuant to a 1995 Farmout Agreement and a 1998 Sublease Agreement with Xplor.

On January 2, 2007, we received from Exxon a letter setting forth the conclusions of the joint interest audit conducted by Exxon. Pursuant to the audit report, Exxon reported an underpayment of approximately $5.1 million related to the increased after-payout additional royalties and net revenues (including interest) in the well on the assumption that Exxon would elect to convert a portion of its override to an after payout working interest. We, as operator of the properties in question, retained our own outside accounting expert to conduct a separate joint interest audit of this matter. With the exception of minor interest calculations, our retained joint interest auditor verified the amounts of Exxon’s claim. We also retained a Louisiana law firm to conduct a legal analysis of the Exxon audit claim. All reviews conclude that neither we nor our co-lessees provided a formal written notice of payout to Exxon at the time that payout on the State Lease 14589 #2 well occurred (September 2000) or made payment for the corresponding increase in after payout net revenues and royalties due to Exxon.

In a letter dated April 17, 2007, Exxon formally notified us of its election to convert a portion of its override to an after-payout working interest.  In its letter Exxon acknowledges receipt of payment from us and the other working interest owners in the amount of $1.4 million representing escalated royalties from payout through November 2006.  Exxon claimed a net balance due of $4.1 million (including interest) and demanded payment thereof within 30 days. Of that amount, our working interest share of the claim was approximately $1.7 million (including interest), with the other working interest owners of the well sharing their respective responsibility for the remaining balance. During May 2007, we, subject to a reservation of rights, remitted payments in the total amount of $3.0 million constituting the remaining principal amount alleged by Exxon to be due.  All of the working interest owners in the State Lease 14589 #2 well have paid their proportionate share of the payments remitted to Exxon.

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On August 10, 2007 we filed and served on Exxon our Answer, Affirmative Defenses and Reconventional Demand (the “Answer”).  On January 30, 2008 Exxon and Xplor, on its behalf and on behalf of the working interest owners, reached a settlement with Exxon.  The settlement terms included Exxon’s agreement to dismiss the lawsuit and to release of all related claims in exchange for a one time lump sum payment of $800 thousand. Xplor’s net share of the settlement amount was approximately $320 thousand with the remaining working interests contributing their net share of the settlement payment.   The resolution of this matter did not have a material impact on our financial results.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of security holders during the fourth quarter of 2007.

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PART II

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

Price Range of Common Stock

Since March 1991 and until June 2007, our common stock has been listed on the American Stock Exchange and traded under the symbol HEC. In June 2007, the trading symbol of our common stock was changed to the symbol HKN. At December 31, 2007, there were 374 holders of record of our common stock.

The following table sets forth, for the periods indicated, the reported high and low closing sales prices of our common stock on the American Stock Exchange Composite Tape, as restated for the effect of the one-for-22.4 reverse stock split effected in June 2007.

Dividends

We have not paid any cash dividends on common stock since our organization, and we do not contemplate that any cash dividends will be paid on shares of our common stock in the foreseeable future. Dividends may not be paid to holders of common stock prior to all dividend obligations related to our Series G1 Preferred Stock, Series G2 Preferred Stock and Series M Preferred Stock being satisfied.

For discussion of dividends paid to holders of our preferred stock and the terms of our preferred stock outstanding, see Part II, Item 8, “Notes to Consolidated Financial Statements, Note 9 – Redeemable Preferred Stocks and Note 11 – Stockholders’ Equity.”

Equity Compensation Plans

We have no equity compensation plans. There are no shares currently authorized for issuance related to equity compensation.

Performance of the Common Stock

The following performance graph shall not be deemed incorporated by reference by any general statement incorporating by reference in the Annual Report on Form 10-K into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that we specifically incorporate this information by reference, and shall not otherwise be deemed filed under such Acts.

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The graph below compares the cumulative total stockholder return on the Common Stock for the last five fiscal years with the cumulative total return on the S&P 500 Index and the Dow Jones Exploration and Production Index over the same period (assuming the investment of $100 in the Common Stock, the S&P 500 Index and the Dow Jones Secondary Oils Stock Index on December 31, 2002 and reinvestment of all dividends).

Comparison of Cumulative Total Return

Assumes Initial Investment of $100 on December 31, 2002

Information on Share Repurchases

The following table provides information about purchases by us pursuant to our previously announced buyback program during the three months ended December 31, 2007, of our Common Stock:

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ITEM 6.  SELECTED FINANCIAL DATA

The information set forth below is not necessarily indicative of results of future operations, and should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”: and the consolidated financial statements and related notes thereto included in Item 8 of this Form 10-K to fully understand factors that may affect the comparability of the information presented below.

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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 you in understanding our business and the results of our operations.  It should be read in conjunction with the Consolidated Financial Statements and the related notes that appear elsewhere in this report.  Certain statements made in our discussion may be forward looking.  Forward-looking statements involve risks and uncertainties and a number of factors could cause actual results or outcomes to differ materially from our expectations.  See “Cautionary Statements” at the beginning of this report on Form 10-K for additional discussion of some of these risks and uncertainties.  Unless the context requires otherwise, when we refer to “we,” “us” and “our,” we are describing HKN, Inc. and its consolidated subsidiaries on a consolidated basis.

BUSINESS OVERVIEW

Our strategy is to enhance value for our stockholders through the development of a well-balanced portfolio of energy-based assets.  Our Gulf Coast oil and gas assets and our coalbed methane prospects provide a large inventory of both high and low-risk projects and high-potential exploration long-term opportunities.  Our active management of investments in energy industry securities and futures traded on domestic and international securities exchanges provided us with high-yield returns and cash flow in 2007.  In 2008, we will focus on:

·                  Deploying assets into energy-based opportunities that will build annual measurable value and/or cash flow

·                  Optimizing the value of our assets through collective expectations and objectives, and;

·                  Monetizing assets that have reached their full potential, that do not have an expectation of near-term value enhancement or that represent a disproportionate concentration of value in one asset.

Consistent with our strategy to deploy assets into energy-based opportunities, in 2007, we increased the level of our assets associated with our trading activities. We held approximately $8.8 million outstanding in average notional value in our trading portfolio during 2007. Also during 2007, we increased our level of ownership in Spitfire Energy Ltd. (“Spitfire”), a junior oil and gas exploration company in Canada.  We believe these actions enhanced the balance of our energy portfolio by adding additional energy-based diversified opportunities.

Consistent with our strategy to develop and optimize our longer-term assets, in 2007, we invested approximately $10 million and $1.0 million, respectively, of capital expenditures into our Gulf Coast oil and gas properties and coalbed methane prospects.  Our proved reserve volumes associated with our Gulf Coast oil and gas assets increased from 3.0 million barrels of oil equivalent (“boe”) at December 31, 2006 to 3.2 million boe at December 31, 2007. The discounted value of our proved reserves increased by over 84% to approximately $94 million at December 31, 2007 compared to the prior year period. The majority of the increase in value was associated with increased oil and gas pricing.

During 2007, we were able to monetize certain of our oil and gas properties at auction for net cash proceeds of approximately $1.3 million.  We believe these assets had reached full potential of their near-term value.

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Financial Highlights

Significant financial highlights in 2007 include the following:

§         Profitable operations accomplished with a net income of $3.2 million.

§         Successful trading activities earning realized trading gains of $862 thousand and an annualized rate of return of approximately 10%.

§         Improved discounted proved oil and gas reserve values of $94 million, an increase of 85% as compared to prior year.

§         Decreased depletion rate per unit as a result of increased reserve volumes.

§         Successful completion of the first phase of pilot wells at our Indiana-Posey coalbed methane prospect. This pilot tested one of six coal seam targets identified in the Posey area.  Pilot results indicated higher gas content and better permeability than our core work analysis completed in 2005.  Promising pilot results resulted in our election to proceed to the next phase of pilot wells.

§         Successful completion of first phase of core work on our Ohio-Triangle coalbed methane prospect.

§         Significant progress on increasing the profitability and value of our operated Main Pass 35 field.

Gulf Coast Oil and Gas Properties

During 2007, our results of operations reflect increased oil revenues through the benefit of increased oil production primarily from our Main Pass 35 field as well as strong oil commodity prices. Our natural gas revenues declined in 2007 compared to the prior year due to production losses as a result of lower than anticipated non-operated well workover and drilling activity from our partners. Substantially all of our production is concentrated in eight oil and gas fields along the onshore and offshore Texas and Louisiana Gulf Coast.

Our revenues are primarily derived from sales from our oil and gas properties. Approximately 56% of our production comes from our operated properties all located in the United States. These revenues are a function of the oil and gas volumes produced and the prevailing commodity price at the time of production, and certain quality and transportation discounts. The commodity prices for crude oil and natural gas as well as the timing of production volumes have a significant impact on our operating income. During 2007, our oil and gas revenues were comprised of approximately 61% oil sales and 39% natural gas production.  As of December 31, 2007, our net domestic production rate was averaging approximately 1,000 barrels of oil equivalent (“boe”) per day.

The following field data updates the status of our operations through December 31, 2007:

Main Pass, Plaquemines Parish – Louisiana

We have a 90% interest in Main Pass and are the field operator. This field contains a seven-platform facility complex including separation, injection, compression, processing and transportation terminals for oil, water and gas.  The field also contains 76 wellbores (69 oil and 7 saltwater disposal), of which 31 are active, and an eight mile oil transport line with pump facilities.  Our Main Pass 35 facility is located approximately two miles offshore in the Gulf Coast of Louisiana.  Production has been increased to approximately 525 gross boe per day in 2007.  The production increase is attributable to all compressors being operational and the

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successful completion of repairs to three wells. During 2007, we were able to increase certain production and handling fees associated with the throughput of third-party volumes into our Main Pass facility.  A third-party engineering firm has been assigned to assess additional operations to further increase production in the Field. We continue our geological and geophysical study in the area, utilizing our license to 21 square miles of 3D seismic data, covering the area held by production leases.

Lapeyrouse Field, Terrebonne Parish – Louisiana

We hold an average non-operated working interest of approximately 18.26 % in the production from nine wells in this field. Current gross field production is averaging approximately 800 boe per day.  In 2007, the operator of this field changed. The new operator began diagnostic efforts late in 2007 to return shut-in wells to production via possible recompletion designs. The first of two compression facilities were installed late in 2007.

Lake Raccourci Field, Lafourche Parish – Louisiana

We hold an average 40% operated working interest in each of our Lake Raccourci wells. Gross production for this field averaged 800 boe per day in 2007 as gas lift repair efforts late during the year proved successful in returning the major oil producing well back to uninterrupted production. Current gross field production is 750 boe per day.

Point-a-la-Hache Field, Plaquemines Parish – Louisiana

We maintain a 25% operated working interest in one producing well in this field. Average gross production for 2007 was 100 boe per day.

Creole Field, Terrebonne Parish - Louisiana

We acquired a 15% non-operated working interest in this offshore field in late 2006. The field included a producing dual-completed well with facilities which averaged 110 boe  per day as of December 31, 2007.

Both wells that were drilled in 2007 were tied in and began producing in the third quarter of 2007. Multiple stacked pays in these wells indicate favorable future recompletion potential. Gross daily production from the three wells (six completions) averaged 492 boe per day during the fourth quarter 2007.

East Lake Verret, Assumption Parish – Louisiana

We have an average 5% non-operated working interest in this field. Our first development well on this project was successfully completed and placed into production in the first quarter 2007 averaging 123 gross boe per day. A second well was spud at year-end 2006 and was also completed in the first quarter 2007. This well encountered multiple stacked pays and was tested in the initial zone for nearly 583 gross barrels of oil per day and was put on production in the second quarter 2007. Due to stacked pays, favorable recompletion potential is expected in the future productive life of these wells. The operator proposed the drilling of a third well in the third quarter, but we declined participation after deeming the prospect did not meet our risk/reward criteria. Gross daily production from both wells averaged 428 boe per day during the fourth quarter 2007.

Point-au-Fer Field, Terrebonne Parish – Louisiana

We own a 12.5% non-operated working interest in this approximate 56 square mile area. Gross production for this field is approximately 317 boe per day. Several prospects have been identified in the area, and we expect to have additional drilling and workover activity in 2008.

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BP 2D Texas Gulf Coast Project, Various Counties -  Texas

The first shallow Yegua well in the project, the Boquillas # 1, was spud early in the fourth quarter of 2007.  A number of other locations have been identified and a drilling program will be determined pending the results of this initial well.

An 85 square mile 3D seismic survey in the northeastern portion of the project area has been proposed, but we declined participation after deeming the 3D portion of the project did not meet our risk/reward criteria.

Allen Ranch Field, Colorado County – Texas

We own an 11.25% non-operated working interest in this area. Gross production for this field averaged 400 boe per day early in 2007 primarily from the  initial well, the Hancock Gas Unit # 1 which is the only well currently producing from the field. After demonstrating significant commercial production in several horizons, the Hancock Gas Unit #2, was damaged in the course of a remedial workover. Remedial activity to remove debris was performed early in 2007 and mechanical failures were determined. Despite this setback, we continue to be aggressive in further developing this field. As planned, the first of two field extension wells was drilled in the second quarter 2007 and completed in the third quarter 2007. Gas facilities/pipeline tie in efforts are underway with production to commence in first quarter 2008. Due to a change in operator, a fracture stimulation of this well is planned for first quarter 2008.

Oil and Gas Industry Outlook

During 2007, prices for crude oil increased to record or near-record levels.  Supply and geopolitical uncertainties resulted in significant price volatility.  New York Mercantile Exchange (NYMEX) futures price for Light Sweet crude oil averaged $71.47 per barrel for the year, with a high price of approximately $98.18 per barrel occurring in the fourth quarter of 2007. U.S. natural gas pricing remained steady during 2007.  NYMEX Henry Hub futures prices averaged $7.14 per million British thermal units (MMBtu) during 2007 as compared to $7.00 per MMBtu during 2006. NYMEX natural gas prices ended the year at $7.48 per MMBtu. The outlook for the commodity markets in 2008 calls for continued volatility. To mitigate uncertainties related to possible future price declines, we have entered into derivatives to hedge prices realized upon the sale of our future oil and gas production.

Coalbed Methane Prospects – Indiana and Ohio

We hold three significant exploration and development agreements in Indiana and Ohio, of which two prospects provide for an area of mutual interest of approximately 400,000 acres, and one provides for approximately 20,000 acres. The agreements provide for a phased delineation, pilot and development program, with corresponding staged expenditures. Contracted third parties with a long track record in successful Coalbed Methane development provide expert advice for these projects.

On the Indiana Posey Prospect, we have completed Phase I – Core Samples work on the Indiana Prospect which consisted of obtaining and analyzing coal samples. Based on the positive outcome of the coring analysis, we elected into Phase II which consists of exploratory work.  During 2007, we drilled the first five pilot wells. All five pilot wells were completed with production testing for pump-down and pressure monitoring. With all lines and facility equipment in place, pump-down for desorption began in all five pilot wells. Also, a water disposal well was drilled and completed with water injection initiated in late 2007.  Some gas production has begun and is being used throughout the field for fuel gas needs.  The extent of water influx is under evaluation to enhance desorption efforts.

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In October 2007, we elected to proceed with a second pilot well project. Following an evaluation period of these pilot wells, we will evaluate a Phase III – Development election and funding of a development well program as contemplated by the agreements.

On the Ohio Cumberland Prospect, we have completed Phase I – Core Samples work on the Ohio Prospect which consisted of obtaining and analyzing coal samples. With regard to Phase II, we made an additional $500 thousand prospect acquisition payment and intend to fund a $1.28 million project in 2008 for the first of two pilot well projects on the Cumberland Prospect.

On the Triangle Prospect Area in Ohio, the Phase I – Core Holes work was successfully completed during 2007. The core samples were desorbed, analyzed and permeability tested in late 2007. These results along with core results were evaluated by the operator and deemed to be positive in late 2007. We are currently evaluating a decision to proceed and fund a Phase II of pilot wells on this prospect in 2008.

INVESTMENT ACTIVITIES

During 2007, through our treasury activities, we engaged in the active management of investments in energy industry securities traded on domestic and international securities exchanges.  During 2007, we held a daily weighted average of approximately $8.8 million outstanding of notional value in a combination of exchange-traded common stock and options on futures contracts and common stocks.  At December 31, 2007, we had closed out of all open exchange-traded options and we had no notional value outstanding at year-end.  In 2008, we have continued our trading activity and entered into new positions in these financial instruments.

Common Stock and Futures Options

During the period ended December 31, 2007, we wrote exchange-traded options on securities and futures contracts associated with either the common stock of energy-related companies or price protection for company related oil and gas production. The options provide our counterparty with the right, but not the obligation,  to enter into a “long” position in the underlying security or futures contract, (in the case of a “call” option), or a “short” position in the underlying security or futures contract,  (in the  case  of a “put”  option),  at a fixed  price  up to a  stated expiration  date.  During the period ended December 31, 2007, we recognized net unrealized and realized gains of approximately $862 thousand for the writing of options and trading of common stocks. Also, related to these trading activities, we received net cash proceeds of $2.0 million upon entering into new trading positions during the year.

Also during the year ended December 31, 2007, we entered into exchange-traded options on futures contracts to provide price protection for our oil and gas production. During 2007, we recognized $182 thousand in net unrealized and realized losses on these instruments.

As the writer of an option on a securities and/or futures contract, however, we may be subject to initial margin requirements in connection with the option and are exposed to potential losses equal to the difference between the premium paid or received for the writing of the option plus or minus the option strike price and the current price of the underlying security or futures contract. Options on securities and futures contracts are traded on the same exchanges as the underlying security and futures contracts, and may only be entered into through brokers that are members of the relevant exchanges. Positions in options on securities and futures contracts are cleared through the relevant exchange clearinghouse, in the same manner.

Monitoring the Portfolio

We monitor our portfolio on a daily basis to verify that there is no market or liquidity exposure level we consider not acceptable. We recalculate our estimates of gross aggregate cash exposure on a daily basis so that total notional value outstanding and cash on hand does not exceed $20 million.  At any time though, we may reduce our portfolio exposure by selling or terminating our positions.

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INVESTMENT IN GLOBAL

At December 31, 2007 and 2006, we owned approximately 34% of Global’s ordinary shares. At December 31, 2007 and 2006, our investment in Global was equal to the market value of our 11.9 million shares of Global’s common stock as follows:

The foreign currency translation adjustment of $107 thousand and the unrealized loss on investment of $8.5 million for these changes in market value between the two periods are recorded to other comprehensive income in stockholders’ equity at December 31, 2007.

For information on Global’s operations and financial statements, visit their website at www.globalenergyplc.com.

INVESTMENT IN SPITFIRE

In December 2006, we acquired 2.6 million common shares and 1.3 million warrants to acquire common shares of Spitfire through a private placement for investment purposes at a total cost of $2.3 million.  During 2007, we continued purchasing shares of Spitfire common stock in the market by acquiring 307 thousand shares at a total cost of $212 thousand. In August 2007, we acquired an additional 8 million common shares of Spitfire through a private placement for investment purposes for $3.7 million, increasing our current ownership of Spitfire to 10,906,500 shares. Subsequent to the issuance of these common shares, our common share holdings represented approximately 25% of the outstanding Spitfire common shares. Also in conjunction with this private placement, Spitfire extended the expiry date of the warrants held by us to August 1, 2010, and we obtained two seats on their board of directors.

As a result of our 25% ownership of Spitfire’s outstanding common shares and our two seats (out of a total of seven) on Spitfire’s board of directors, we gained the ability to exert significant influence over Spitfire’s operating and financial policies. Accordingly, we now reflect our investment in Spitfire as an equity method investment and have retroactively reflected the effect of the change in the accounting for our investment in Spitfire prior periods to present Spitfire as a step acquisition of an equity method investment. No goodwill was recorded as a result of this acquisition as any excess purchase price has been allocated to Spitfire’s oil and gas properties.

For information on Spitfire’s operations and financial statements, visit their website at www.spitfireenergy.com.

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CRITICAL ACCOUNTING ESTIMATES AND ASSUMPTIONS

Our consolidated financial statements have been prepared in accordance with U.S. GAAP which requires us to use estimates and make assumptions that affect the reported amounts of assets, liabilities, revenues and expenses.  Our estimates and assumptions are based on historical experience, industry conditions and various other factors which we believe are appropriate. Actual results could vary significantly from our estimates and assumptions as additional information becomes known.  The more significant critical accounting estimates and assumptions are described below.

Full Cost Accounting Method – We account for the costs incurred in the acquisition, exploration and development of oil and gas reserves using the full cost accounting method. Under full cost accounting rules, the net capitalized costs of evaluated oil and gas properties shall not exceed an amount equal to the present value of future net cash flows from estimated production of proved oil and gas reserves, based on current economic and operating conditions, including the use of oil and gas prices as of the end of each quarter, after giving effect to the asset retirement obligation.  For a complete discussion of our proved oil and gas reserves, see Note 17 – “Oil and Gas Disclosures” in the Notes to the Consolidated Financial statements contained in Part II, Item 8 of the Annual Report of Form 10-K.

Fair Value of Financial Instruments – Financial instruments are stated at fair value as determined in good faith by management. Factors considered in valuing individual investments include, without limitation, available market prices, reported net asset values, type of security, purchase price, purchases of the same or similar securities by other investors, marketability, restrictions on disposition, current financial position and operating results, and other pertinent information.

We carry our financial instruments including cash, derivatives and our investment in ordinary shares of Global at their estimated fair values. The fair values of our securities and exchange-traded derivatives are based on prices quoted in the active market, and the fair values of our commodity derivatives are based on pricing provided by our counter parties.  The fair value of our warrants on common stock of Spitfire is estimated using the Black Scholes model.

With the exception of our investment in common shares of Spitfire, all of our investments in equity securities have been designated as available for sale. Our investment in Global is classified as a non-current asset in our accompanying balance sheets. The associated unrealized gains and losses on our available for sale investments are recorded to other comprehensive income until realized and are reclassified into earnings using specific identification.

Equity Method Investments – For investments in which we have the ability to exercise significant influence but do not control, we follow the equity method of accounting.  Initial investments are recorded at cost and adjusted by the proportionate share of the investee’s earnings and capital transactions.  Our share of investee earnings are recorded to our income statement and our share of their capital transactions are recorded in our shareholders’ equity.  We evaluate these investments for other-than-temporary declines in value each quarter; any impairment found would be recognized through earnings.

Translation of Non-U.S. Currency Amounts - Assets and liabilities of non-U.S. investees whose functional currency is not the U.S. dollar are translated into U.S. dollars at exchange rates in effect at each balance sheet date. Revenue and expense items are translated at average exchange rates prevailing during the periods. Translation adjustments are included in other comprehensive income until the investment is sold.

Fair Value of Derivatives - Fair values of our exchange-traded derivatives are generally determined from quoted market prices. We currently do not hold any over the counter derivatives that would be valued using valuation models. The end of day price quotations obtained from the third-party broker / dealer portfolio appraisal statement are used as the primary evidence for the fair value of these financial instruments. Our Spitfire warrants are not exchange-traded derivatives. Management estimates the fair value of these derivatives using the Black Scholes Valuation model.

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We have not designated any of our derivative instruments as hedges under Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities.” All gains and losses related to these positions are recognized in earnings.  At the end of each quarterly period, we evaluate for reasonableness the end of day price quotations in the broker’s portfolio appraisal statement by considering the following factors:

-              The end of day quoted settlement price set by an exchange on which the financial instrument are principally traded.

-              The mean between the last bid and the ask prices from the exchange on which the financial instrument is principally traded.

Subsequent to the above review, if we determine the broker / dealer appraisal prices to be unreliable, we may substitute a good-faith estimate of fair value.

Consolidation of variable interest entities - In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. (“FIN”) 46, “Consolidation of Variable Interest Entities” (“FIN 46”) and FIN46(R), which requires the primary beneficiary of a variable interest entity’s (“VIE”) activities to consolidate the VIE. FIN 46 defines a VIE as an entity in which the equity investors do not have substantive voting rights and there is not sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. The primary beneficiary is the party that absorbs a majority of the expected losses and/or receives a majority of the expected residual returns of the VIE’s activities.

As of December 31, 2007, we owned less than a majority of the common shares of Global and did not possess the legal power to direct the operating policies and procedures of Global through our direct ownership, combined with the ownership by Lyford Investments Enterprises Ltd. (“Lyford”) in Global shares. In addition, we have concluded that Global was not a VIE at December 31, 2007 as contemplated by FIN 46(R).

Proved Reserves - Our estimates of proved reserves are based on quantities of oil and gas reserves which current engineering data indicates are recoverable from known reservoirs under existing economic and operating conditions.  Estimates of proved reserves are key elements in determining our depletion and expense and our full cost ceiling limitation. Estimates of proved reserves are inherently imprecise because of uncertainties in projecting rates of production and timing of developmental expenditures, interpretations of geological, geophysical, engineering and production data and the quality and quantity of available data.  Changing economic conditions also may affect our estimates of proved reserves due to changes in developmental costs and changes in commodity prices that may impact reservoir economics.  We utilize independent reserve engineers to estimate our proved reserves annually.  See Note 17 - “Oil and Gas Disclosures” in the Notes to Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K.

Recent Accounting Pronouncements – In September 2006, the Financial Accounting Standards Board, (“FASB”) issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value under Generally Accepted Accounting Principles and requires enhanced disclosures about fair value measurements. It does not require any new fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. We will adopt this statement January 1, 2008. We do not expect the adoption of SFAS No. 157 to be material to our consolidated financial statements.

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During February 2007, FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” This statement allows for the measurement of certain financial assets and financial liabilities at fair value.  Under this statement, an entity may elect the fair value option on an instrument-by-instrument basis and measure the changes in the fair value as unrealized gains and losses in earnings.  This statement is effective for the first fiscal year beginning after November 15, 2007.  We are currently evaluating our options under this statement and any potential impact on earnings.

In December 2007, FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS 141R”), and SFAS No. 160, “Accounting and Reporting of Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB No. 51” (“SFAS 160”). SFAS 141R and SFAS 160 will significantly change the accounting for and reporting of business combination transactions and noncontrolling (minority) interests in consolidated financial statements. SFAS 141R retains the fundamental requirements in Statement 141 “Business Combinations” while providing additional definitions, such as the definition of the acquirer in a purchase and improvements in the application of how the acquisition method is applied. SFAS 160 will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests, and classified as a component of equity. These Statements become simultaneously effective January 1, 2009. Early adoption is not permitted. We are currently evaluating the impact this guidance will have on our consolidated financial statements.

RESULTS OF OPERATIONS

For the purposes of discussion and analysis, we are presenting a summary of our consolidated results of operations followed by more detailed discussion and analysis of our operating results.  The primary components of our net income / (net loss) from continuing operations for each of the years in the three year period ended December 31, 2007, were as follows (in thousands, except per-share data):