CHAIRMAN'S
LETTER

I am pleased to present our Annual Report for 2011 and provide an overview of the significant achievements made by our Company in the last 12 months.

As an industry, the Coal Seam Gas sector can no longer assume that there will be little public interest in CSG extraction. Communities have become closely involved in the industry's activities and are significant stakeholders. As a company,
Blue Energy is committed to securing a valid social licence to operate within the regions in which we hold exploration tenure. This has been done by engaging with the communities, and ensuring that we have a positive impact on the community regardless of exploration success. We need to explain the process of gas exploration, and appraisal and the impacts with all stakeholders.

From a concept in the mid 1990's when coal seam gas was viewed as an unreliable, potential domestic gas source, to an industry that in 2011 supplies gas to underpin 15% of Queensland electricity generation,
the CSG industry has spawned a totally new industry for Queensland which could potentially supply the world with up to 30 million tonnes per annum of cleaner burning LNG.

The diversification this new industry brings to the Queensland economy will be significant, as the State will not only be a part of the enormous Asian growth cycle through skyrocketing coal demand, but now will be able to de-risk its revenue reliance through the new LNG industry which will provide significant gas to those same
growth engines.

The rapid development of the CSG to LNG projects is something that continues to challenge industry, regulators and stakeholders. As the legislative rewrite of the Petroleum and Gas Act in 2004 was put in place before the CSG-LNG industry was conceived, it is understandable that there are requirements to adapt legislation to cope with
the significant change in activity levels that this industry brings.

It is clear that the rapid expansion of the industry is causing concerns in some sections of the rural community. The issues are complex, but largely centralise around principles of land access, compensation, potential impacts to aquifers in the Surat Basin area and disturbance of intensely cultivated ground. Whilst some of these issues are locality specific (eg. potential aquifer impact and intensive land use areas), others are applicable to all areas such as land access principles and compensation. Many of these issues can be addressed through improved communication, education and negotiation.

Under legislation in all states of Australia, established through common law principles from the mid 1800's, ownership of the subsurface resides with the Crown (ie. the States). This includes minerals, hydrocarbons and water. Companies are granted rights to explore for, and if successful, develop the mineral and hydrocarbon resources in the subsurface. For petroleum exploration, State Governments identify prospective areas within their boundaries and gazette these areas as exploration areas.
They encourage companies to submit applications for these areas and to expend funds in the search for these natural resources. The areas put up for exploration by government are solely controlled by the individual States. Companies locally pay a nominal annual rent to the governments for the right to explore these areas, and then should their exploration efforts prove successful, royalties are paid to the government based on the value of the commodity produced. Exploration however, is not always successful.

It is clear from the financial sanction of three massive LNG export plants in Gladstone that the gas business in Queensland is about to change dramatically.

Queensland currently produces approximately 610 TJ/day of gas. Of this, approximately 80 TJ/day is sent to southern markets. The Queensland Government has mandated that at least 15% of electricity generated in the state must be derived from gas.

The current 2P reserves position in Queensland is approximately 39,900 PJ. A significant amount (84%) of this reserve is earmarked for export LNG projects. With the Queensland Government stating that there will be no new coal-fired power generation built without Carbon Capture and Sequestration (CCS) technology, and the closing down of the Zerogen CCS trial, it is unlikely that growth in electricity demand will be met by new coal fired generation capacity. It is also unlikely that electricity supply from renewable energy sources, although growing at a phenomenal rate, and underpinned by government subsidy, can meet the growth in demand (approximately 6% pa over the last 10 years). Renewable energy production currently accounts for only 2.1% of total electricity production (wind plus solar pv) in Australia.
whilst hydro-electricity accounts for 5% of electricity generation in Australia, primarily in Tasmania and Victoria. There seems however, to be a reluctance to invest in dam infrastructure for either water storage or electricity generation. It therefore falls to gas to underpin the growth in electricity generation
in Australia.

Australia has an abundance of natural gas, and now with the CSG developments, this feed stock is relatively close to large demand centres and transmission infrastructure. The challenge will be to secure sufficient domestic gas supply from those 2P reserves, the majority of which are destined for the world market.

Australia has historically had some of the cheapest natural gas in the world, has a small, relatively affluent population and is significantly distant from trading markets. Consequently, Australia has not developed a large manufacturing base to utilise the abundant natural gas resource, and so the supply-demand equation has been firmly skewed to oversupply, leading to a history of low domestic gas prices.

With the advent of a global market for Australia's gas via the LNG industry, the demand side will now drive gas pricing at the export terminal.
This will also have an effect on domestic gas prices. As current domestic gas contracts roll off over the coming years, gas producers will have the opportunity to supply gas to the LNG exporters. We now see that gas previously earmarked for domestic gas supply, will supply the export LNG market with the corresponding higher net back pricing. Other gas producers will have the opportunity to achieve higher net back gas prices by offering gas to the Gladstone LNG projects. As a result, it is likely that there will be upward pressure on prices for domestic gas supply, through this convergence of export and domestic gas prices.

Blue Energy's exploration acreage is well situated to capitalise on the growing demand of both the domestic and export markets. The resource base that is being developed in ATP814P is receiving primary focus as it is strategically located in the Bowen Basin, adjacent to both an area of high energy demand as well as a supply source for a major LNG export project proposed for Gladstone.

In addition, the exploration acreage portfolio contains a variety of hydrocarbon plays, which with careful exploration, could deliver significant upside.

I therefore have faith that the continued diligence and hard work from the staff at Blue Energy will deliver the value to shareholders inherent in
the assets.

Peter Cockcroft
Chairman