Arsenal Energy Inc.
TSX : AEI
FRANKFURT : A1E

Arsenal Energy Inc.

May 11, 2006 14:44 ET

Arsenal Announces First Quarter 2006 Operating and Financial Results

CALGARY, ALBERTA--(CCNMatthews - May 11, 2006) - Arsenal Energy Inc. ("Arsenal or the Company") (TSX:AEI) (FWB:A1E) is pleased to announce the results of operations for the three month period ended March 31, 2006.

FIRST QUARTER CORPORATE HIGHLIGHTS

- The corporate acquisition of Tiverton Petroleums Ltd., which closed March 14th.

- Completion of an 800 kilometer seismic acquisition program over the Nuqra concession in Egypt.

- Land sale success resulted in adding several sections of land at our new core area at Worsley.

- Spudded Tower Creek well in March, scheduled to reach total depth in late June of 2006.

- Cashflow of $0.02 per share during the first quarter.

- Drilled and Cased one well at Armada on the Tiverton lands acquired, and one well on Arsenal's Worsley prospect. These wells will be completed and tested immediately after break-up.



SELECTED FINANCIAL AND OPERATIONAL INFORMATION
------------------------------------------------------------------------
FINANCIAL Three Months Ended March 31
------------------------------------------------------------------------
2006 2005
------------------------------------------------------------------------
Financial
Funds from operations(1) 957,218 486,563
Per unit - basic 0.02 0.02
Per unit - diluted 0.02 0.02
Bank debt 11,128,145 7,601,583
Operating costs per boe 14.05 11.36
Operating netbacks per boe 16.74 15.62
Market
Shares outstanding
End of period 65,528,875 26,407,303
Weighted average - basic 46,466,361 20,134,963
Weighted average - diluted 47,598,407 21,454,309
Shares trading
High 1.88 1.92
Low 1.38 0.88
Close 1.41 1.48
Average daily volume 137,000 49,700
------------------------------------------------------------------------
OPERATIONS
------------------------------------------------------------------------
Daily production (average)
Crude oil (bbl) 1,333 758
NGLs (bbl) 40 31
Natural gas (mcf) 600 231
------------------------------------------------------------------------
Total (boe)(2) 1,474 828
Realized commodity prices ($Cdn.)
Total crude oil (bbl) 38.83 38.67
NGLs (bbl) 49.77 38.53
Natural gas (mcf) 9.00 7.46
------------------------------------------------------------------------
Average (boe)(2) 44.02 38.59
Reference pricing
WTI (U.S.$/bbl) 63.48 49.84
AECO gas ($Cdn./mcf) 8.79 6.63
Foreign Exchange ($U.S./$Cdn.) 1.15 1.23
------------------------------------------------------------------------
------------------------------------------------------------------------

(1) Funds from operations before change in non-cash working capital is
not a recognized measure under Canadian generally accepted
accounting principles. Management uses funds from operations before
change in non-cash working capital to analyze performance and
considers it a key measure as it demonstrates the Company's ability
to generate the cash necessary to fund future capital investments
and to repay debt. Funds from operations before change in non-cash
working capital has been defined by the Company as net earnings
(loss) plus the addback of non-cash items (depletion, depreciation
and accretion, stock-based compensation, future income taxes and
unrealized foreign exchange) and excludes the change in non-cash
working capital related to operating activities. Arsenal's
determination of funds from operations before change in non-cash
working capital may not be comparable to that reported by other
companies. Arsenal also presents funds from operations before
change in non-cash working capital per share whereby amounts per
share are calculated using weighted average shares outstanding
consistent with the calculation of earnings per share.

(2) The term barrels of oil equivalent ("boe") may be misleading,
particularly if used in isolation. A boe conversion ratio of six
thousand cubic feet per barrel (6mcf/bbl) of natural gas to barrels
of oil equivalence is based on an energy equivalency conversion
method primarily applicable at the burner tip and does not represent
a value equivalency at the wellhead. All boe conversions in the
report are derived from converting gas to oil in the ratio mix of
six thousand cubic feet of gas to one barrel of oil.


OPERATIONS IN REVIEW

The first quarter of 2006 was challenging for Arsenal from an operational perspective. Record industry activity levels left many junior exploration and production companies unable to secure drilling and service rigs. We were able to drill discoveries at Armada and Worsley at the end of the quarter, however, we were unable to implement the winter drilling program at House Mountain and Evi. Several wells at Lloydminster were shut in awaiting a service rig for several weeks during the quarter. These factors resulted in our production lagging our forecast. We were able to replace our production declines during the quarter, but were unable to increase production from the fourth quarter of 2005.

The Armada well on the Tiverton lands and the Worsley well on the Arsenal lands were cased prior to spring break-up and are waiting on completion. We will be completing both of these wells immediately after break-up. In addition, we anticipate drilling additional wells at Worsley and Kaybob and will participate in two wells at Alderson/Princess on the Tiverton lands. As well, we will move to tie-in the standing production acquired from Tiverton, estimated at approximately 250 barrels of oil equivalent per day.

NORTH DAKOTA

Production has remained stable throughout the first quarter at 385 barrels of oil equivalent per day. We are currently reviewing seismic to identify drilling locations for third quarter of 2006.

LLOYDMINISTER

Production at Lloydminster was impacted by service rig availability during the first quarter. We continue to actively pursue service rigs to regain our shut-in production after spring break-up and are reviewing alternative opportunities to provide a service rig during 2006.

WORSLEY

We were successful in adding to our land base through crown land sales and drilled and cased our first well at the end of the quarter just prior to spring break-up. This is a key growth area for the company as it has multi-zone potential and several other operators have drilled extremely prolific wells in the area during the past six months. During 2006 we intend to drill additional wells and shoot additional 3D seismic to expand on the potential identified by the first well. We will continue to add to our land position as opportunities are identified.

KAYBOB

We completed the seismic which has confirmed the existence of an anomaly and we will be drilling this structure in the second or third quarter subject to rig availability. If this well is successful, it will set up several additional locations with considerable upside potential.

EGYPT

An 800 km 2-D seismic acquisition program commenced in early January 2006 was completed during the first week of April. It is expected that the new data will be processed and mapped by the end of the second quarter. Arsenal, along with partners, are preparing for a two well exploration drilling program to commence in late 2006. Production casing, wellheads and other long lead time items have been ordered with deliveries scheduled for early in the third quarter. Tenders for a drilling rig are out for bid. We have fulfilled the Period One work commitments and will commit to the Period Two work commitments at the end of Period One on July 18, 2006. There is a mandatory relinquishment of 25% of the block at the end of Period One. Arsenal and partners are confident that our seismic data base will provide ample information to successfully high grade the lands in this concession and provide high quality drilling locations.

COMMODITY PRICING

Light sweet crude oil continues to test historical highs with increasing tension in the Middle East, and stagnant global production. It is anticipated in the market that West Texas Intermediate crude could remain above $60 US for the remainder of the year.

Natural gas remained well above historical averages for the past year, however it has recently weakened as inventories rose as a result of unseasonably warm weather, particularly in the north eastern United States. Natural gas futures for winter 2006 and 2007 deliveries are presently above $10 US on the NYMEX exchange.

The winter of 2005 and 2006 witnessed record heavy oil differentials in Canada, which had a significant impact on our corporate cashflow. The differential exceeded $25 US per barrel for the majority of the first quarter, however it has recently contracted and is approaching the historical average of 20% of WTI. As a significant portion of our revenue stream continues to be heavy crude, we should see material increases in cashflow as a result of the tightened differential this summer.

Exposure to the heavy oil differential was a motivating factor in Arsenal's acquisition of Tiverton. We intend to continue to aggressively pursue light oil and natural gas opportunities this year, to mitigate our exposure to the heavy oil differential.

RESULTS OF OPERATIONS

PRODUCTION AND MARKETING

Production volumes for the three periods ended March 31, 2006 increased to 1,474 boe/d, which represents a 78% increase over the same period in 2005. The increase in volume is attributable to the integration of corporate and property acquisitions and new wells drilled during the year.

With the completion of the Tiverton Petroleums Inc. ("Tiverton") acquisition on March 14, 2006, Arsenal is producing approximately 2,000 boe/d with an approximately 250 boe/d behind pipe and will be brought into production after spring break-up. The Tiverton production is comprised of approximately 2.16 mmcf/d of natural gas, and approximately 240 bbl/d of light and medium crude and liquids. Arsenal is committed to decreasing its exposure to heavy oil, and has established a target of exiting 2006 with 50% of its production being comprised of natural gas and light oil.



Three Months Ended March 31
------------------------------------------------------------------------
2006 2005 % Change
------------------------------------------------------------------------
Crude oil (bbl/d) 1,333 758 76
NGL (bbl/d) 40 31 1,100
Natural gas (mcf/d) 600 231 1,267
------------------------------------------------------------------------
Total (boe/d) 1,474 828 78
------------------------------------------------------------------------
------------------------------------------------------------------------
Production split
------------------------------------------------------------------------
Oil & NGLs 93% 95% (2)
Natural Gas 7% 5% 46
------------------------------------------------------------------------
------------------------------------------------------------------------


COMMODITY PRICES

Commodity price realizations during the three month period ended March 31, 2006 increased 14% over the same period in 2005. The impact of favourable crude oil prices was partly offset by an 6% decline in the value of the US dollar relative to the Canadian dollar during the year, as well as the impact of the forward contract which expires September 2006.

The decrease is also reflective of the asset portfolio of Arsenal at March 31, 2006, with approximately 60% of its oil production comprised of lower gravity heavy crude oil. The heavy oil differential traditionally widens over winter, as demand for heavy crude is highest in the summer. The differential exceeded $25 per barrel for much of the first quarter, and has decreased starting in April reflecting historical seasonality. Arsenal expects the differential to return to the historical average of approximately 75% of WTI for the summer, and widening to less than 70% of WTI in winter.

Arsenal anticipates continued high commodity prices as supply issues continue to impact natural gas, while tensions in the Middle East, specifically Iran have resulted in the WTI price reaching record highs.



($Cdn.) Three Months Ended March 31
------------------------------------------------------------------------
Prices - Before Derivatives 2006 2005 % Change
------------------------------------------------------------------------
Total crude oil (bbl) 38.83 38.67 1
NGLs (bbl) 49.77 38.53 29
Natural gas (mcf) 9.00 7.46 21
------------------------------------------------------------------------
Total (boe) 44.02 38.59 14
------------------------------------------------------------------------
------------------------------------------------------------------------

Reference Pricing
------------------------------------------------------------------------
WTI ($U.S./bbl) 63.48 49.84 27
AECO gas ($Cdn./mcf) 8.79 6.63 33
NYMEX gas ($U.S./mmbtu) 9.08 6.53 39
Foreign exchange ($Cdn./$U.S.) 1.15 1.23 (6)
------------------------------------------------------------------------
------------------------------------------------------------------------


OIL AND GAS REVENUE

Net oil and gas revenue for the three month period ended March 31, 2006 was 99% higher than the comparable period in 2005, reflecting increased petroleum and natural gas production and commodity prices. Revenue per boe for the three month period ended March 31, 2006 increased 14% over the same period in 2005, as the impact of the hedged production was offset by higher commodity prices.



($Cdn.) Three Months Ended March 31
------------------------------------------------------------------------
2006 2005 % Change
------------------------------------------------------------------------
Crude oil sales 4,932,838 2,527,059 95
NGL sales 179,574 155,737 15
Natural gas sales 511,250 108,665 370
Other 61,800 93,613 (34)
Loss on forward contracts (404,134) (231,216) 75
------------------------------------------------------------------------
Gross oil and gas revenue 5,281,327 2,653,858 99

Per boe 39.77 34.86 14
------------------------------------------------------------------------
------------------------------------------------------------------------


ROYALTIES

Royalties as a percentage of gross oil and gas revenue were consistent with comparable period in 2005 at 23%. The production acquired from Tiverton has fewer burdens than the existing production held by Arsenal, management anticipates the royalty rate decreasing in upcoming periods.



($Cdn.) Three Months Ended March 31
------------------------------------------------------------------------
2006 2005 % Change
------------------------------------------------------------------------
Royalties 1,193,667 599,676 99
% of gross oil and gas revenue 23 21 1
Per boe 8.99 7.88 14
------------------------------------------------------------------------
------------------------------------------------------------------------


OPERATING COSTS

Operating expenses per boe for the three month period ended March 31, 2006 increased 24% over the same period in 2005. The increase is primarily attributable to record industry activity levels, which have resulted in oilfield service costs increasing more than 30% over the prior year. Costs have trended lower from the fourth quarter of 2005, when they averaged $17.54/boe. The Tiverton production acquired by Arsenal has historically been less expensive than the current production, reflecting the natural gas weighting of the assets. As the impact of the new Tiverton production is realized, Arsenal expects operating costs per boe to trend lower.



($Cdn.) Three Months Ended March 31
------------------------------------------------------------------------
2006 2005 % Change
------------------------------------------------------------------------
Operating expense 1,865,285 864,897 116
Per boe 14.05 11.36 24
------------------------------------------------------------------------
------------------------------------------------------------------------


PRODUCT NETBACKS(1)

Netbacks for the three month period ended March 31, 2006 increased 9% over the comparative period. Higher commodity prices were partially offset by increased royalties and operating costs experienced in the first quarter.




($Cdn. per boe) Three Months Ended March 31
------------------------------------------------------------------------
2006 2005 % Change
------------------------------------------------------------------------
Net revenue after derivatives 39.77 34.86 14
Royalties (8.99) (7.88) 14
Operating expenses (14.05) (11.36) 24
------------------------------------------------------------------------
Operating netback 16.74 15.62 7
------------------------------------------------------------------------
------------------------------------------------------------------------


GENERAL AND ADMINISTRATIVE EXPENSES

General and administrative costs per boe for the three month period ended March 31, 2006 decreased by 13% over the comparative period in 2005. Included in general and administrative costs for the first quarter is $275,000 relating to employee annual bonuses for 2005. Arsenal anticipates general and administrative costs to increase in absolute terms but decrease on a per barrel basis as the Company continues to grow production.



($Cdn.) Three Months Ended March 31
------------------------------------------------------------------------
2006 2005 % Change
------------------------------------------------------------------------
General and administrative 1,050,623 693,044 52
Per boe 7.91 9.10 (13)
------------------------------------------------------------------------
------------------------------------------------------------------------


FINANCE CHARGES

Finance charges for the three month period ended March 31, 2006 increased 21% over the comparative period as the Company drew on its credit facility to fund both drilling and acquisition activities during the first quarter.



($Cdn.) Three Months Ended March 31
------------------------------------------------------------------------
2006 2005 % Change
------------------------------------------------------------------------
Finance charges 78,286 64,730 21
Per boe 0.59 0.85 (31)
------------------------------------------------------------------------
------------------------------------------------------------------------


DEPLETION, DEPRECIATION, AND ACCRETION

Depletion, depreciation and accretion per boe increased 255% for the three month period ended March 31, 2006 compared to the same period in 2005. The increase is attributable to the higher production rates, significantly higher asset base in 2006 compared to 2005, and additional accretion incurred on the asset retirement obligation.



($Cdn.) Three Months Ended March 31
------------------------------------------------------------------------
2006 2005 % Change
------------------------------------------------------------------------
Depletion, depreciation and accretion 1,822,968 513,623 255
Per boe 13.73 6.75 103
------------------------------------------------------------------------
------------------------------------------------------------------------


TAXES

During the first quarter of 2006, Arsenal accrued current income taxes totalling $13,000 compared to $nil during the same period in 2005. Current taxes relate to Large Corporations Tax and Saskatchewan Capital Tax. During the first quarter, Arsenal recovered future income taxes totalling $392,859 compared to an expense $36,614 during the same period in 2005. A future income tax balance of $16,560,077 is recorded as a liability as at March 31, 2006 (March 31, 2005 - $5,632,396).



($Cdn.) Three Months Ended March 31
------------------------------------------------------------------------
2006 2005 % Change
------------------------------------------------------------------------
Current income taxes (13,000) - 100
Future income taxes (reduction) 239,859 (36,614) (755)
------------------------------------------------------------------------
226,859 (36,614) (720)
Per boe 1.71 (0.48) (455)
------------------------------------------------------------------------
------------------------------------------------------------------------

LIQUIDITY
Three Months Ended
($Cdn.) March 31, 2006
------------------------------------------------------------------------
Sources
Funds from operations 957,218
Issue of warrants 59,122
Change in non-cash working capital - operating items (2,482,394)
Change in non-cash working capital - investing items (957,863)
------------------------------------------------------------------------
Total sources of cash (2,423,917)

Uses
Plant, property and equipment additions (2,281,265)
Share issue costs (226,768)
Tiverton acquisition assumed debt (3,700,000)
------------------------------------------------------------------------
Total uses of cash (6,208,033)

Increase in bank debt (8,631,950)
------------------------------------------------------------------------
------------------------------------------------------------------------


OUTLOOK

STRATEGY

Arsenal's domestic production and cashflow has increased significantly over the past two years. The Company anticipates continued growth domestically both through the drill-bit and accretive acquisitions like Tiverton.

The Company remains committed to utilizing a portion of cashflows earned domestically to fund high impact international opportunities like the Nuqra concession in Egypt. The Company continues to search for other international opportunities with the following profile:

- Experienced and established international operator

- Considerable land acreage

- Pre-existing seismic or geological data establishing existence of source and reservoir rock.

Egypt

The 800 km seismic evaluation program is currently being completed in April 2006, and the reprocessing of 3,100 km of seismic acquired over the concession has confirmed thirteen leads ranging in size between 9.0 million original barrels in place and more than 100.0 million original barrels in place. The first two wells are scheduled to be drilled in the fourth quarter of 2006, subject to rig availability.

North America

Arsenal emphasises a full-cycle approach to its business and plans to continue with internal development opportunities as a means to enhancing its production base and creating value for shareholders. Consistent with its full-cycle approach, Arsenal actively added to its undeveloped land position through crown land sales during 2005 and 2006 in order to establish high-quality drilling prospects. The Company also obtained seismic options over considerable acreage in northern Alberta to further expand our core areas there.

The Company will continue to pursue acquisitions that will be accretive on a per share basis to cash flow, production, reserves and net asset value. One of the key components of the Tiverton acquisition is the existence of a high quality drilling inventory which Arsenal intends to quickly develop during this year. Arsenal believes that over the long term, outlook for both crude oil and natural gas pricing remains strong.



INTERIM CONSOLIDATED BALANCE SHEETS

As at March 31, 2006 December 31, 2005
------------------------------------------------------------------------
Unaudited Audited
ASSETS
Current assets
Accounts receivable 6,228,239 4,583,927
Reclamation bonds 203,291 203,291
Property, plant and equipment 87,393,829 44,578,604
Goodwill 18,363,990 4,791,561
------------------------------------------------------------------------
112,189,351 54,157,383
------------------------------------------------------------------------
------------------------------------------------------------------------

LIABILITIES
Current liabilities
Accounts payable and accrued liabilities 6,654,710 6,365,577
Revolving demand loan (note 3) 11,128,145 2,496,195
Deferred revenue 164,284 287,533
------------------------------------------------------------------------
17,947,139 9,149,305
Convertible debentures (note 8) 3,182,473 -
Future income taxes 16,493,897 7,509,044
Asset retirement obligations (note 4) 2,427,736 1,295,500
------------------------------------------------------------------------
40,051,246 17,953,849
------------------------------------------------------------------------

SHAREHOLDERS' EQUITY
Common shares (note 5) 72,582,023 36,514,809
Warrants (note 6) 303,731 303,731
Contributed surplus (note 7) 1,516,259 1,170,444
Common share conversion rights (note 8) 370,000 -
Deficit (2,633,908) (1,785,450)
------------------------------------------------------------------------
72,138,105 36,203,534
------------------------------------------------------------------------
112,189,351 54,157,383
------------------------------------------------------------------------
------------------------------------------------------------------------

Segmented information (note 10)
Subsequent event (note 11)

See accompanying notes to the interim financial statements.



INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS AND DEFICIT
(UNAUDITED)

For the three months ended March 31, 2006 March 31, 2005
------------------------------------------------------------------------

REVENUE
Oil and gas 5,281,327 2,653,858
Royalties expense, net of Alberta
Royalty Tax Credit (1,193,667) (599,676)
------------------------------------------------------------------------
4,087,660 2,054,182
------------------------------------------------------------------------

EXPENSES
Operating 1,865,285 864,897
General and administrative 1,050,623 693,044
Finance charges 78,286 64,730
Depletion, depreciation and accretion 1,822,968 513,623
Stock-based compensation expense (note 7) 345,816 37,535
------------------------------------------------------------------------
5,162,977 2,173,829
------------------------------------------------------------------------

Loss before income taxes (1,075,317) (119,647)
Income taxes
Current tax expense (13,000) -
Future income tax expense (recovery) 239,859 (36,614)
------------------------------------------------------------------------
Income taxes 226,859 (36,614)
------------------------------------------------------------------------
Net loss (848,458) (156,261)
Deficit - beginning of period (1,785,450) (685,026)
------------------------------------------------------------------------
Deficit - end of period (2,633,908) (841,287)
------------------------------------------------------------------------
------------------------------------------------------------------------

Loss per share - basic and diluted $ (0.02) $ (0.04)



INTERIM CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)

For the three months ended March 31, 2006 March 31, 2005
------------------------------------------------------------------------

Cash flows from operating activities
Net loss (848,458) (156,261)
Items not affecting cash
Depletion, depreciation and accretion 1,822,968 513,613
Future income tax expense (recovery) (239,859) 36,614
Stock-based compensation expense (note 7) 345,816 85,241
Deferred revenue (123,249) (30,179)
Unrealized foreign exchange - 37,535
------------------------------------------------------------------------
957,218 486,563
Change in non-cash working capital (note 9) (2,482,394) (485,797)
------------------------------------------------------------------------
Cash provided by (used in) operating
activities (1,525,176) 766
------------------------------------------------------------------------

Cash flows from investing activities
Corporate acquisitions (note 2) - (5,500,000)
Additions to property, plant and equipment (2,281,265) (1,546,532)
Change in non-cash working capital (note 9) (957,863) 42,574
------------------------------------------------------------------------
Cash used in investing activities (3,239,128) (7,003,958)
------------------------------------------------------------------------

Cash flows from financing activities
Issue of shares for cash upon exercise
of stock options - 193,784
Issue of shares for cash upon exercise
of warrants 59,122 2,909,332
Share issue costs (226,768) (174,728)
Revolving demand loan 4,931,950 3 ,857,731
------------------------------------------------------------------------
Cash provided by financing activities 4,764,304 6,786,119
------------------------------------------------------------------------

Change in cash during the period - (217,073)
Cash - beginning of period - 217,063
------------------------------------------------------------------------
Cash - end of period - -
------------------------------------------------------------------------
------------------------------------------------------------------------

Supplemental information (note 9)
Segmented information (note 10)


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. SIGNIFICANT ACCOUNTING POLICIES

The interim consolidated financial statements of Arsenal Energy Inc. ("Arsenal" or the "Company") have been prepared by management in accordance with accounting principles generally accepted in Canada. The interim consolidated financial statements have been prepared following the same accounting policies and methods of computation as the consolidated financial statements for the fiscal year ended December 31, 2005. The disclosures provided below are incremental to those included with the annual consolidated financial statements. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto in Arsenal's annual report for the year ended December 31, 2005.

2. BUSINESS ACQUISITION

On March 14, 2006 Arsenal acquired all of the issued and outstanding securities of Tiverton Petroleums Ltd. ("Tiverton"). On March 31, 2005 Arsenal acquired all of the issued and outstanding of IC Energy Inc. ("IC Energy"). The purchase method of accounting was used for both business combinations and the allocation of the purchase price and consideration for each acquisition is as follows:



Tiverton IC Energy
2006 2005
------------------------------------------------------------------------
Net assets acquired at assigned values:
------------------------------------------------------------------------
Working capital deficiency (2,085,000) -
Property, plant and equipment 42,740,000 10,243,000
Goodwill 13,572,428 2,665,198
Bank debt (3,700,000) -
Convertible debentures (3,182,473) -
Asset retirement obligation (1,095,000) (123,713)
Future income taxes (6,937,798) (2,784,485)
Common share conversion rights (370,000) -
------------------------------------------------------------------------
Net assets acquired 38,942,157 10,000,000
------------------------------------------------------------------------
------------------------------------------------------------------------

Financed by:
------------------------------------------------------------------------
Shares issued 38,342,157 4,500,000
Cash - 5,500,000
Acquisition costs 600,000 -
------------------------------------------------------------------------
Purchase price 38,942,157 10,000,000
------------------------------------------------------------------------
------------------------------------------------------------------------


The above amounts are estimates made by management based on currently available information. Amendments may be made to the purchase allocations as the cost estimates and tax balances are finalized.

3. REVOLVING DEMAND LOAN

At March 31, 2006, the Company has available a demand operating loan in the amount of $14.2 million (December 31, 2005 - $4.0 million) bearing interest at the bank prime rate plus 0.75% per annum and is secured by a fixed and floating charge debenture providing a fixed charge over certain petroleum and natural gas interests and a floating charge over all Canadian and U.S. assets.

On May 9, 2006, the Company's lending institution increased the total credit available under the demand operating loan to $16.0 million, bearing interest at the bank prime rate plus 0.75%.

4. ASSET RETIREMENT OBLIGATIONS

The following table presents the beginning and ending aggregate asset retirement obligations associated with the retirement of oil and gas properties:



Three Months Ended Year Ended
March December
31, 2006 31, 2005
------------------------------------------------------------------------
Asset retirement obligation - beginning
of period 1,295,500 780,889
Liabilities acquired 1,095,000 334,119
Liabilities incurred 17,000 114,808
Foreign exchange (6,764) (14,022)
Accretion expense 27,000 79,706
------------------------------------------------------------------------
Asset retirement obligation - end
of period 2,427,736 1,295,500
------------------------------------------------------------------------
------------------------------------------------------------------------


5. COMMON SHARES

Three Months Ended Year Ended
March 31, 2006 December 31, 2005
------------------------------------------------------------------------
Shares Amount($) Shares Amount($)
------------------------------------------------------------------------
Balance - beginning of
period 42,231,244 36,514,809 18,989,706 7,458,134
Issued to acquire Tiverton 23,237,671 38,942,157 - -
Issued to acquire IC Energy - - 3,000,000 4,500,000
Issued to acquire Quadra - - 4,088,292 5,483,014
Issued for cash - - 8,760,496 13,573,157
Cost of shares issued - (226,768) - (723,785)
Tax effect of flow-through
shares - (2,369,913) - (1,445,169)
Tax effect of share issue
costs - 83,000 - 247,000
Issued on exercise of
options - - 972,025 207,334
Issued on exercise of
warrants 59,960 59,122 6,745,725 6,133,159
Allocated from contributed
surplus - - - 93,205
Allocated from warrants - - - 988,760
------------------------------------------------------------------------
Shares issued 65,528,875 73,002,407 42,556,244 36,514,809
Shares held in escrow (325,000) - (325,000) -
------------------------------------------------------------------------
Balance - end of period 65,203,875 73,002,407 42,231,244 36,514,809
------------------------------------------------------------------------
------------------------------------------------------------------------


The per share calculations for the three month period ended March 31, 2006 was based on weighted average shares outstanding of 46,466,361 (March 31, 2005 - 20,134,963). In computing net loss per share - diluted, 1,132,046 shares (March 31, 2005 - 974,342) were added to the weighted average number of shares outstanding for the three month period, reflecting the dilutive effect of stock options and share purchase warrants.

6. WARRANTS

When share purchase warrants are exercised, the consideration paid is recorded to the shareholders' equity account along with an allocation for the deemed value of the warrants previously recognized in the warrants account. The following table details the changes in the warrant account balance:



Three Months Ended Year Ended
March 31, 2006 December 31, 2005
------------------------------------------------------------------------
Warrants Amount($) Warrants Amount($)
------------------------------------------------------------------------
Balance - beginning of
period 2,031,100 303,731 6,588,664 988,760
Private placement - - 2,031,100 303,731
Agents' warrants(1) 59,960 - 157,061 -
Allocated to common equity
upon exercise of warrants (59,960) - (6,745,725) (988,760)
------------------------------------------------------------------------
Balance - end of period 2,031,100 303,731 2,031,100 303,731
------------------------------------------------------------------------
------------------------------------------------------------------------
(1) During 2006 the Company's underwriters and agents exercised their
right to an additional 59,960 warrants pursuant to their respective
agency agreements relating to equity offerings completed in 2004
and 2005.


7. STOCK OPTIONS

A summary of the changes in the options outstanding under the Option Plan is as follows:



Three
Months
Ended Year Ended
March 31, December 31,
2006 2005
Weighted Weighted
Average Average
Options Price($) Options Price($)
------------------------------------------------------------------------
Balance - beginning of period 3,592,252 0.99 2,505,000 0.40
Granted 25,000 1.30 2,495,000 1.24
Exercised - - (972,025) 0.23
Cancelled - - (435,723) 0.59
------------------------------------------------------------------------
Balance - end of period 3,617,252 1.00 3,592,252 0.99
------------------------------------------------------------------------
Exercisable - end of period 2,627,252 0.90 1,977,259 0.90
------------------------------------------------------------------------
------------------------------------------------------------------------


The Company incurred non-cash compensation expense of $345,815 for the three month period ended March 31, 2006 (2005 - $37,535) related to vested options issued under the Option Plan with a corresponding increase to contributed surplus. When options are exercised by employees, contractors and directors of the Company, the consideration paid is recorded to the shareholders' equity account along with related non-cash compensation expense previously recognized in contributed surplus. The following table reconciles the movement in the contributed surplus balance:



Three Months Ended Year Ended
March December
31, 2006 31, 2005
------------------------------------------------------------------------
Balance - beginning of period 1,170,444 144,183
Issuance of stock options 345,816 1,119,466
Reclassification to common shares on
exercise of options - (93,205)
------------------------------------------------------------------------
Balance - end of period 1,516,259 1,170,444
------------------------------------------------------------------------
------------------------------------------------------------------------


8. CONVERTIBLE DEBENTURE

As outlined in Note 2, Arsenal completed the corporate acquisition of Tiverton effective March 14, 2006. A portion of Tiverton's capital structure was comprised of unsecured convertible debentures totalling $3,480,000. Interest accrues on the debentures at 8% on the debentures, payable semi-annually on June 30th and December 31st of each year. The debentures will mature on February 15, 2009 unless called for redemption earlier by Arsenal. After giving effect to the plan of arrangement, the debentures are convertible by the holders at any time prior to maturity into 1,539,170 shares of the Company, representing a conversion price of $2.26 per Arsenal share.

The Company can elect to prepay the debenture providing the Company's shares trade above $2.60 per share for 22 consecutive days. Interest is payable semi-annually on June 30th and December 31st of each year. The convertible debentures are a debt security with an embedded conversion option and were segregated into their debt and equity components based on their respective fair values at the date of acquisition. The $370,000 equity component represents the holder's conversion right and is included in Shareholders' Equity, the remaining balance of $3,110,000 has been classified as debt. If the holder exercises the conversion right, they will receive accrued and unpaid interest up to and including the conversion date.



9. SUPPLEMENTAL CASH FLOW INFORMATION

Three Three
Months Months
Ended Ended
March 31, March 31,
2006 2005
------------------------------------------------------------------------
Change in non-cash working capital items
Operating accounts receivable (1,644,313) (619,944)
Operating accounts payable (838,004) 134,147
------------------------------------------------------------------------
Amounts relating to operating activities (2,482,316) (485,797)
Amounts relating to investing activities (957,863) 42,574
------------------------------------------------------------------------
(3,440,179) (443,223)
------------------------------------------------------------------------
------------------------------------------------------------------------

Taxes paid 10,065 -
Interest paid 68,946 42,571
------------------------------------------------------------------------
------------------------------------------------------------------------


10. SEGMENTED INFORMATION

A significant portion of the Company's assets and revenues are earned in the United States and Egypt and are monitored as identifiable reporting segments by management. The remaining assets and associated revenues are earned in Canada by Arsenal Energy Inc. The following table outlines key operating results by entity:



2005
($ Cdn.) Canada U.S. Egypt Total
------------------------------------------------------------------------
Oil and gas revenue 3,141,274 2,140,053 - 5,281,327
Net loss before tax (815,863) (181,705) (77,826)(1,075,394)
Plant, property and equipment 77,391,835 4,641,762 5,360,232 87,393,829
Capital expenditures
(including acquisitions) 2,183,112 98,153 - 2,281,265
------------------------------------------------------------------------
------------------------------------------------------------------------

2004
($ Cdn.) Canada U.S. Egypt Total
------------------------------------------------------------------------
Oil and gas revenue 985,340 1,601,232 - 2,586,572
Net income (loss) before tax (352,646) 233,079 - (119,567)
Plant, property and equipment 24,521,453 6,456,801 - 30,978,254
Capital expenditures
(including acquisitions) 1,546,532 - - 1,546,532
------------------------------------------------------------------------
------------------------------------------------------------------------


11. SUBSEQUENT EVENT

Increase to credit facility

On May 9, 2006, the Company's lending institution increased the total credit available under the demand operating loan to $16.0 million, bearing interest at the bank prime rate plus 0.75%.

Certain statements in this material may be "forward-looking statements" including outlook on oil and gas prices, estimates of future production, estimated completion dates of acquisitions and construction and development projects, business plans for drilling and exploration, estimated amount and timing of capital expenditures and anticipated future debt levels and royalty rates. Information concerning reserves contained in this material may also be deemed forward-looking statements as such estimates involve the implied assessment that the resources described can be profitably produced in the future. These statements are based on current expectations, estimates and projections that involve a number of risks and uncertainties, which could cause actual results to differ from those anticipated by Arsenal. This news release is not for distribution in the United States.

The term barrels of oil equivalent ("boe") may be misleading, particularly if used in isolation. A boe conversion ratio of six thousand cubic feet per barrel (6mcf/bbl) of natural gas to barrels of oil equivalence is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead. All boe conversions in the report are derived from converting gas to oil in the ratio mix of six thousand cubic feet of gas to one barrel of oil.

The TSX and Frankfurt Exchange do not accept responsibility for the adequacy or accuracy of this release.

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