EMPIRE PETROLEUM CORP (EP) FY 2021 MD&A

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

The following discussion should be read together
with the consolidated financial statements and notes to consolidated financial statements, which are included in this Annual Report on
Form 10-K in Item 8, Financial Statements and Supplementary Data and the information set forth in Part I, Item 1A – Risk Factors.

Overview

The Company's primary business is the exploration
and development of oil and gas interests. The Company has incurred significant losses from operations, and there is no assurance that
it will achieve profitability or obtain funds necessary to finance its future operations.

The Company seeks to increase shareholder value
by growing reserves, production, revenues, and cash flow from operating activities by executing its mission to use highly-skilled personnel
to thoughtfully and expertly spend capital to realize reserves on producing properties.

Management places emphasis on operating cash flow
in managing its business, as operating cash flow considers the cash expenses incurred during the period and excludes non-cash expenditures
not related directly to the Company’s operations.

Business Strategy

The Company’s business strategy is to obtain
long-term growth in reserves and cash flow on a cost-effective basis utilizing experienced personnel throughout the Company. Management
regularly evaluates potential acquisitions of properties that would enhance current core areas of operation.

2021 XTO Acquisition

On March 12, 2021 the Company, through its
wholly owned subsidiary Empire New Mexico, entered into a purchase and sale agreement with XTO Holdings, LLC (a subsidiary of ExxonMobil)
(the “Seller’) to acquire, among other things, certain oil and natural gas properties in New Mexico. The purchase price was
$17,800,000 subject to customary adjustments. The transaction closed on May 14, 2021 with an effective date of January 1, 2021. For more
information about the transaction, refer to the financial statements and footnotes incorporated by reference herein.

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Results of Operations

The following table reflects our summary operating
information. Because of normal production declines, increased or decreased drilling activity and the effects of acquisitions, the historical
information presented below should not be interpreted as indicative of future results.

Revenues

Revenues increased as a result of more volumes produced
from legacy assets due to successful execution of the Company’s mission to cost-effectively produce more volumes paired with the
XTO acquisition’s revenues and volumes brought online from efforts to make the field produce more volumes combined with favorable
pricing environments in the Company’s core operating areas. Approximately $11.2 million in oil revenues, $1.7 million in gas revenue,
and $3.1 million in NGL revenue was attributed to production acquired with the XTO acquisition.

Lease Operating Expense and Taxes

Lease operating expense rose with the XTO acquisition
and in response to the Company’s execution of its mission to increase production in its legacy assets. The Company has worked to
cost-effectively increase production throughout its asset base utilizing experienced personnel and third-party service providers. Production
and ad valorem taxes have increased as a direct result of the XTO acquisition’s properties and increased volumes produced and sold.
The acquisition of New Mexico assets accounted for approximately $5.0 million of the increase in lease operating expenses and $1.3 million
of the increase in production and ad valorem taxes.

Depreciation, Depletion, Amortization and Accretion
and Impairment

There were no indicators of impairment on the Company’s
properties at year-end, primarily due to favorable futures pricing at December 31, 2021. Due to favorable pricing realized throughout
2021 and the addition of PDP reserves in New Mexico, DD&A expense decline year-over-year from approximately 13% in 2020 to 6% in
2021.

General and Administrative Expense

The Company’s implemented a new Board of
Directors compensation plan in 2021 resulting in board compensation paid of approximately $475,000 in 2021, exclusive of stock-based
compensation received. Fees paid for legal and outsourced services increased by approximately $425,000 as a direct result of
acquisition-related work, SEC filings related to the Company’s operations, and the Company’s successful uplisting from
the OTCQB to be freely traded on the NYSE American. Outsourced accounting fees increased by approximately $375,000 as additional
work was required to integrate the New Mexico assets into the existing accounting system as well as additional resources required to
perform routine accounting services on the new assets. Also included in general and administrative expenses is $989,000 in non-cash
right to buy costs related to the unsecured notes payable discussed in the Related Party Transactions note below.

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The Company utilizes stock-based compensation to
compensate members of management and retain talented personnel. The Company anticipates stock-based compensation to continue to be utilized
in 2022 and beyond to attract and retain talented personnel.

Interest Expense

Cash-based interest expense declined with a
corresponding decrease in the Company’s Credit Facility. The Company has minimal interest-bearing vehicle and equipment notes payable.

Non-cash interest expense is fully attributable
to the related party notes payable as described in Related Party Transactions below.

Liquidity

As of December 31, 2021, the Company had approximately
$3.6 million cash on hand and approximately $300,000 available on its Credit Facility.  The Company expects to incur costs related
to future oil and natural gas acquisitions for the foreseeable future.  It is expected that management will use a combination of
cash flows from operations as well as seeking additional debt and equity funding for these acquisitions and to fund ongoing operations.

Working Capital

Working capital (presented below) was $1.1 million
as of December 31, 2021 compared to a deficit of $3.9 million as of December 31, 2020, representing a change of approximately $5 million.
This change is primarily a result of the acquisition of producing properties in New Mexico, which served to increase volumes sold for
the year ended December 31, 2021, as well as the stronger pricing environment in 2021.

Cash Flows

Cash Flows from Operating Activities

The Company incurred approximately $18.0 million
in non-cash expenses related to the convertible notes payable (See Related Party Transactions for more information) that contributed
to a net loss for financial reporting purposes. Ongoing operations from core assets contributed to cash flows provided by operating activities
for the year ended December 31, 2021.

Cash Flows from Investing Activities

Cash flows from investing activities primarily increased
due to the XTO acquisition that occurred in May 2021 and established the Company in the state of New Mexico, the Company’s largest
single acquisition to date that resulted in cash outflows of approximately $17.9 million. The Company also participated in the drilling
of four non-operated wells through its Empire North Dakota subsidiary that had a cash outflow of approximately $2.5 million for the year
ended December 31, 2021. As part of the XTO acquisition, the Company entered into an agreement to create a sinking fund for future plugging
liabilities, paying approximately $4.8 million into that fund for the year.

Cash
Flows from Financing Activities

The XTO acquisition and operations executing the
Company’s mission were funded by proceeds from debt issued of approximately $20.5 million as well as proceeds from stock and warrant
issuances of approximately $11.3 million. The Company has quarterly payment obligations related to its bank debt of $300,000 per quarter
in addition to minimal monthly payments for notes payable arising from the purchase of vehicles and equipment.

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Related Party Transactions

The issuance of the Secured Note and an Unsecured Note to Energy
Evolution as described below are related party transactions for accounting purposes, but are not required to be disclosed under Item 13
of this Form 10-K.

Senior Secured Convertible Note

On May 14, 2021, Empire New Mexico entered
into a Senior Secured Convertible Note Agreement (the “Secured Note”) in the amount of $16,250,000 with Energy Evolution
Master Fund, Ltd., a related party (“Energy Evolution”). The Secured Note was collateralized by all assets of Empire New
Mexico prior to its conversion to common stock in December 2021. Due to the terms of the Secured Note, the transaction had the following
non-cash elements for the year ended December 31, 2021:

On September 29, 2021 the parties entered into
a Loan Modification Agreement pursuant to which Energy Evolution exchanged $6,500,000 in principal under the Secured Note in exchange
for 1,326,302 shares of common stock, warrants to purchase 500,000 shares of the Company’s common stock at $5 per share and
amended certain terms of the remaining $5,700,000 of principal under the Secured Note.

On December 30, 2021, the Secured Note was
amended to allow full conversion of the remaining balance and Energy Evolution converted 100% of the remaining principal ($5.7 million)
and accrued interest ($55,000) outstanding at that date into 1,154,085 shares of the Company’s common stock.

Unsecured Convertible Notes

In May 2021 the Empire New Mexico entered into
$3,243,000 of Unsecured Convertible Notes (the “Unsecured Notes”) with a group of accredited investors, including the Company’s
related party Energy Evolution, constituting $1,500,000 of the total Unsecured Convertible Notes. The Unsecured Notes had a maturity
of May 9, 2022 with a single payment and interest at 5%. The Unsecured Note holders had the ability to convert their notes to common
stock of the Company at the lesser of $5 per share or the price per share offered by the Company if the Company has a future capital
raise for an aggregate 648,600 shares of common stock (without giving effect to any interest that may be converted). At December 31,
2021 $2,918,000 of the Unsecured Notes had been converted into 583,600 shares of common stock of the Company and 5,594 shares of common
stock have been issued as payment for accrued interest on the Unsecured Note. The remaining Unsecured Notes in the amount of $325,000
were repaid in September 2021. Amortization of these notes was recorded as a non-cash interest expense
of approximately $545,000.

The Company determined the embedded conversion
features of the Unsecured Notes were equity-classified financing instruments. The fair value of the conversion feature was determined
using a beneficial conversion model based on a 60-day weighted average stock price and the maximum number of shares to be received if
converted. As issuance, the amount recorded to additional paid in capital was $544,824. The discount associated with these transactions
is amortized under the interest method and resulted in interest expense of $544,824 for the year ended December 31, 2021.

As an inducement for investors to enter
into the Unsecured Convertible Notes, the Company’s Chief Executive Officer and President collectively offered to each investor
the right to purchase a number of shares of common stock equal to 40% of such investor’s principal balance under its Unsecured
Convertible Note at $3 per share (the “right to buy”). Energy Evolution exercised its right to buy 150,000 shares of the
Company’s common stock. In conjunction with the conversion of the Unsecured Notes, each of the Company’s Chief Executive
Officer and President partially exercised a warrant and options to purchase 160,900 shares at an exercise price of $1.00 and $1.32 respectively.
The Company determined that offering the “right to buy” shares resulted in a non-cash expense of $989,155 of the Company
based on the fair value of contributions made by the Company’s Chief Executive Officer and President on its behalf. The fair value
of the “right to buy” shares was determined using a Black-Scholes model. The expense is included in General and Administrative
in the Consolidated Statement of Operations.

Effective Tax Rate

For all periods presented, the Company's effective
tax rate is 0%. The Company has generated net operating losses since inception, which would normally reflect a tax benefit in the statement
of operations and a deferred asset on the balance sheet. However, because of the current uncertainty as to the Company's ability to achieve
profitability, a valuation reserve has been established that offsets the amount of any tax benefit available for each period presented
in the statements of operations.

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OFF-BALANCE SHEET ARRANGEMENTS

The Company does not have any off-balance sheet
arrangements.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements in conformity
with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting period. Because estimates and assumptions require significant
judgment, future actual results could differ from those estimates and could have a significant impact on the Company's results of operations,
financial position and cash flows. The Company re-evaluates its estimates and assumptions at least on a quarterly basis. The following
policies may involve a higher degree of estimation and assumption:

Oil and Natural Gas Properties

The Company uses the successful efforts method of
accounting for oil and natural gas operations. Under this method, costs to acquire oil and natural gas properties, drill successful exploratory
wells, drill and equip development wells, and install production facilities are capitalized. Exploration costs, including unsuccessful
exploratory wells, geological and geophysical are charged to operations as incurred. Depreciation, depletion and amortization of the
leasehold and development costs that are capitalized for proved oil and natural gas properties are computed using the units-of-production
method, at the field level, based on total proved reserves and proved developed reserves, respectively, as estimated by independent petroleum
engineers. Oil and natural gas properties are periodically assessed for impairment whenever changes in facts and circumstances indicate
a possible significant deterioration in the future cashflows expected to be generated by an asset group, but at least annually. Individual
assets are grouped for impairment purposes at the lowest level for which there are identifiable cash flows that are largely independent
of the cash flows of other groups of assets, generally on a state-by-state basis. All of our properties are located within the continental
United States.

All costs related to unsuccessful exploratory wells
are expensed when such wells are determined to be non-productive and other exploration costs, including geological and geophysical costs,
are expensed as incurred. The application of the successful efforts method of accounting requires management's judgment to determine
the proper designation of wells as either developmental or exploratory, which will ultimately determine the proper accounting treatment
of the costs incurred. The results from a drilling operation can take considerable time to analyze, and the determination that commercial
reserves have been discovered requires both judgment and application of industry experience. Wells may be completed that are assumed
to be productive and actually deliver oil and gas in quantities insufficient to be economic, which may result in the abandonment of the
wells at a later date. The evaluation of oil and gas leasehold acquisition costs requires management's judgment to estimate the fair
value of exploratory costs related to drilling activity in a given area.

Impairment of Oil and Gas Properties

Management’s assessment of the results of
commodity price outlooks, planned future sales or expiration of all or a portion of such leaseholds impact the amount and timing of impairment
provisions. An impairment expense could result if oil and gas prices decline in the future as it may not be economic to develop some
of these unproved properties.

Oil and Natural Gas Reserve Quantities

Reserve quantities and the related estimates of future
net cash flows affect periodic calculations of depletion, impairment of oil and natural gas properties, and asset retirement obligations.
Proved oil and natural gas reserves are the estimated quantities of oil, natural gas and NGLs which geological and engineering data demonstrate
with reasonable certainty to be recoverable in future periods from known reservoirs under existing economic and operating conditions.
Reserve quantities and future cash flows included in this report are prepared in accordance with guidelines established by the SEC and
the Financial Accounting Standards Board (“FASB”). The accuracy of reserve estimates is a function of:

Proved reserves information included in
this report is based on estimates prepared by independent petroleum engineers, Cawley Gillespie &Associates. The independent
petroleum engineers evaluated 100% of the Company’s estimated proved producing reserve quantities and their related future net
cash flows as of December 31, 2021. Estimates prepared by others may be higher or lower than these estimates. Because these
estimates depend on many assumptions, all of which may differ substantially from actual results, reserve estimates may be different
from the quantities of oil and natural gas that are ultimately recovered. Management may make revisions to reserve estimates
throughout the year as additional information becomes available. Management makes changes to depletion rates, impairment
calculations, and asset retirement obligations in the same period that changes to reserve estimates are made.

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Depreciation, Depletion and Amortization

The rate used to calculate and record DD&A is
dependent upon estimates of total proved developed reserves, which incorporate various assumptions and future projections. If the estimates
of total proved or proved developed reserves decline, DD&A expense increases. Such a decline in reserves may result from lower commodity
prices, which may make it uneconomic to operate wells due to higher cost fields. Management is unable to predict changes in reserve quantity
estimates as such quantities are dependent on the success of executing the Company’s mission as well as future economic conditions.

Asset Retirement Obligation

Asset retirement obligations (“AROs”)
consist primarily of estimated future costs associated with the plugging and abandonment of oil and natural gas wells, removal of equipment
and facilities from leased acreage, and land restoration in accordance with applicable local, state and federal laws. The discounted
fair value of an ARO liability is required to be recognized in the period in which it is incurred, with the associated asset retirement
cost capitalized as part of the carrying cost of the oil and natural gas asset. The recognition of an ARO requires that management make
numerous assumptions regarding such factors as the estimated probabilities, amounts and timing of settlements; the credit-adjusted risk-free
rate to be used; inflation rates; and future advances in technology. In periods subsequent to the initial measurement of the ARO, we
must recognize period-to-period changes in the liability resulting from the passage of time and revisions to either the timing or the
amount of the original estimate of undiscounted cash flows. Increases in the ARO liability due to passage of time impact net income as
accretion expense. The related capitalized cost, including revisions thereto, is charged to expense through DD&A over the life of
the field.

Stock-Based Compensation

The Company recognized stock-based compensation expense
associated with restricted stock units, which consists of time-based awards. The Company accounts for forfeitures of equity-based incentive
awards as they occur. Stock-based compensation expense related to time-based restricted stock units is based on the price of the Company’s
common stock, $0.001 par value per share on the grant date. The Company classifies grants to be settled in shares as equity awards.

Income Taxes and Uncertain Tax Positions

The Company’s tax provision is based upon the
tax laws and rates in effect in the applicable jurisdiction in which operations are conducted and income is earned. As part of the process
of preparing the consolidated financial statements, management is required to estimate the income tax provision. This process involves
estimating the actual current tax exposure together with assessing temporary differences resulting from differing treatment of items,
such as depreciation, amortization and certain accrued liabilities for tax and accounting purposes. The effective tax rate for financial
statement purposes is 0% for all periods presented.

Deferred tax expense or benefit represents the change
in the balance of deferred tax assets or liabilities. Valuation allowances are established to reduce deferred tax assets when it is more
likely than not that some portion or all of the deferred tax assets will not be realized. At December 31, 2021 and 2020, a valuation
allowance for deferred tax assets was recorded.

Management applies the accounting standards related
to uncertainty in income taxes. This accounting guidance clarifies the accounting for uncertainties in income taxes by prescribing a
minimum recognition threshold that a tax position is required to meet before being recognized in the consolidated financial statements.
It requires that we recognize in the consolidated financial statements the financial effects of a tax position, if that position is more
likely than not of being sustained upon examination, including resolution of any appeals or litigation processes, based upon the technical
merits of the position. It also provides guidance on measurement, classification, interest, penalties and disclosure. The Company has
no uncertain tax positions at either December 31, 2021 or December 31, 2020.

Revenue Recognition

The Company predominantly derives its revenue from
the sale of produced oil, natural gas and NGLs. Revenues are recognized when the recognition criteria of FASB ASC Topic 606, Revenue
from Contracts with Customers, are met, which generally occurs at the point in which title passes to the customers. We receive payment
from one to three months after delivery. At the end of each quarter, we estimate the amount of production delivered to purchasers and
the price we will receive. Variances between our estimated revenue and actual payment are recorded in the month the payment is received.
Historically, differences have been insignificant.

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