Arsenal Energy Inc.
TSX : AEI
FRANKFURT : A1E

Arsenal Energy Inc.

August 14, 2007 20:52 ET

Arsenal Announces Second Quarter 2007 Operating and Financial Results

CALGARY, ALBERTA--(Marketwire - Aug. 14, 2007) -

THIS NEWS RELEASE IS NOT FOR DISTRIBUTION IN THE UNITED STATES

Arsenal Energy Inc. ("Arsenal or the Company") (TSX:AEI) (FRANKFURT:A1E) is pleased to announce the results of operations for the three month and six month periods ended June 30, 2007.

SECOND QUARTER CORPORATE HIGHLIGHTS

- Cash flow of $1.1 million.

- Average production of 1,559 BOE/D.

- Sold Tower Creek for $14 million.

During the second quarter of 2007 Arsenal commenced a restructuring program. The goal of the program is to re-align Arsenal's cost structure, and position the company for future growth. Management and the Board of Directors are finalizing the plan and will roll it out in due course.



SELECTED FINANCIAL AND OPERATIONAL INFORMATION

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Three Months Ended Six Months Ended
FINANCIAL June 30 June 30
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2007 2006 2007 2006
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Financial
Funds from operations (1) 1,078,581 2,167,425 2,920,590 3,124,643
Per unit - basic 0.01 0.04 0.04 0.06
Per unit - diluted 0.02 0.04 0.04 0.05
Bank debt 9,086,009 18,748,615 9,086,009 18,748,615
Operating costs per boe 28.38 15.56 22.62 14.36
Operating netbacks per boe 18.42 22.98 19.19 19.43
Market
Shares outstanding
End of period 73,917,173 65,636,501 73,917,173 65,636,501
Weighted average - basic 73,798,006 65,205,504 73,720,090 56,088,944
Weighted average - diluted 74,043,577 66,165,023 73,965,661 57,048,463
Shares trading
High 0.73 1.88 0.99 1.88
Low 0.33 1.05 0.61 1.38
Close 0.48 1.30 0.61 1.41
Average daily volume 160,000 163,000 183,000 137,000
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OPERATIONS
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Daily production (average)
Crude oil (bbl) 1,166 1,239 1,330 1,284
NGLs (bbl) 46 56 45 48
Natural gas (mcf) 2,083 2,530 2,155 1,417
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Total (boe)(2) 1,559 1,717 1,734 1,568
Realized commodity prices
($Cdn.)
Total crude oil (bbl) 51.97 60.29 50.32 51.15
NGLs (bbl) 57.52 45.22 53.82 44.49
Natural gas (mcf) 6.44 5.35 6.52 6.44
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Average (boe)(2) 49.16 52.88 48.09 49.06
Reference pricing
WTI (U.S.$/bbl) 65.03 70.74 56.87 67.11
AECO gas ($Cdn./mcf) 6.99 6.04 6.89 7.41
Foreign Exchange ($U.S./$Cdn.) 1.10 1.12 1.13 1.14
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(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

EGYPT

Arsenal and its joint venture partner, Transglobe Energy, are awaiting results from a well drilled by Centurian closely offsetting the company's Egyptian concession. Preliminary indications are encouraging. Based on Centurian's preliminary information and the uphole shows encountered in Arsenal's two wells drilled in Q 1, the joint venture partners are mapping the Cretaceous geological section to evaluate shallower zones than those tested in March. Transglobe Energy has indicated their intention to drill sometime in 2008.

NORTH DAKOTA

Arsenal's geological and geophysical evaluation has confirmed a highly prospective Bakken target on its lands. Industry drilling activity continues to delineate Arsenal's land base with stabilized production rates of approximately 350 bbls/d/well. Arsenal has begun working with off setting mineral holders to build spacing units, with the goal of drilling in 2008.

EVI

Arsenal plans to drill 3 light oil wells in Q3, each targeting separate structural closures defined by 3D seismic. One well has a 100% WI and if successful will open up a new area for further exploration. Generally speaking, each well in Evi is deemed as "exploratory" by the EUB. As a result the capital cost tax write offs can be flowed through to investors and the production is eligible for the Alberta government royalty holiday program. This makes Evi an excellent play for small growing junior companies.

LLOYDMINISTER

Arsenal produces 600 bbls per day of heavy oil or roughly 1/3 of the overall production base from this area. During the first six months of 2007 the company restructured the operations of these fields. The restructuring included restarts of old wells, recompletions of new zones, changes to marketing and transportation and operating staff changes. These changes have begun to increase volumes and lower OPEX. Arsenal plans 4 new drills before year end and depending on results should have an expanded program in 2008.

PROVOST

Arsenal purchased 1 section of 100% WI land in 2005 and took assignment of a suspended well. In Q2 the company re-completed and swab tested the well at substantial rates. The well is currently being tied in and a 3D seismic program is shooting to delineate the discovery and outline further targets.

TOWER CREEK

The company agreed to sell its interest for $14 million effective June 1, 2007. The price equates to full value for the proven plus probable reserves in Arsenal's independent engineering report.

OPERATING EXPENSES

Arsenal is reporting OPEX for the quarter in excess of $28/BOE. In early 2006, Arsenal assumed control of Tiverton Petroleum. OPEX on the acquired properties was significantly higher than anticipated and as a result OPEX was chronically under accrued. The $28 OPEX for the quarter includes a large prior period adjustment to bring reporting current. OPEX on an activity basis ran at approximately $19/bbl through the three quarters following the Tiverton acquisition and has been dropping in Q1 and Q2 2007. Arsenal anticipates OPEX to range around $18/bbl going forward.

COMMODITY PRICING

Arsenal's commodity mix is approximately 50% heavy oil, 30% light oil and natural gas liquids, and 20% natural gas. In order of importance, posted prices for Canadian light, heavy oil differentials, and AECO posted natural gas prices are the relevant commodity prices which affect Arsenal's revenues.

Canadian light averaged approximately $75 Cdn/bbl in the second quarter vs. $69 Cdn/bbl in the first quarter. Forward strip pricing remains firm through to the end of the year. Heavy oil differentials rose from $22 Cdn/bbl in Q1 to $26 Cdn/bbl in Q2 and are forecasted in the $28 range through to year end. AECO gas averaged just over $6 Cdn/mef in Q2 vs $7.25 in Q1 and are anticipated to drop further in Q3 before recovering for the winter heating season starting in November.

OUTLOOK

Arsenal's emphasis over the last year has been on high risk, high reward exploration in Egypt. The stock price included a substantial premium on expectations from that program. Unfortunately, the Egyptian joint venture drilled two dry holes. Release of the drill results was followed by a substantial drop in the price of the stock. However, it should be noted that technical information from that program and from other operators drilling in the area has, in Arsenal's opinion, made the Egyptian concession more prospective than it ever has been.

In the short term, the company intends to focus on increasing our production and lowering our costs. In addition, the company plans to drill four small "e" exploration wells in core areas to fulfill flow through obligations. These activities deliver decent returns at relatively low risk. By next year, a new Egyptian program as well as some higher impact Bakken drilling in North Dakota and our ongoing development program should begin to bear fruit.

In July, Arsenal announced several changes to its boardroom and executive management. The company wishes to thank Mr. Errol Stewart, Alain Gaucher, Greg Belzberg, and Jesse Meidl for their contributions to the company and wish them much success in their future endeavors.

RESULTS OF OPERATIONS

PRODUCTION AND MARKETING

Production volumes for the three month period ended June 30, 2007 decreased 9% over the comparable period in 2006, owing to natural declines. Production volumes for the six month period ended June 30, 2007 increased 11% of the comparable period, attributable to the drilling program at Evi and Lloydminster completed in 2006.

Production volumes for the six month period ended June 30, 2007 increased 11% over the comparable period in 2006, reflecting the impact of the Tiverton acquisition which closed at the end of the first quarter of 2006.

Arsenal previously provided guidance of a 2007 exit rate of 2,500 boe/d, which was predicated on production from the Tower Creek project coming onstream in June 2007. On June 28th, 2007 the Company sold its interest in the Tower Creek project for gross proceeds of $14.0 million. As a result of this sale, Arsenal has revised its 2007 exit production guidance to a range of 1800 to 1900 boe/d.



Three Months Ended June 30 Six Months Ended June 30
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% %
2007 2006 Change 2007 2006 Change
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Crude oil (bbl/d) 1,166 1,239 (6) 1,330 1,284 4
NGL (bbl/d) 46 56 (17) 45 48 (6)
Natural gas (mcf/d) 2,083 2,530 (18) 2,155 1,417 52
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Total (boe/d) 1,559 1,717 (9) 1,734 1,568 11
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Production split
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Oil & NGLs 78% 75% 4 79% 85% (7)
Natural Gas 22% 25% (11) 21% 15% 38
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COMMODITY PRICES

Commodity price realizations during the three and six month periods ended June 30, 2007 decreased 7% and 2% respectively, over comparable periods in 2006. For the three months ended June 30, 2007, the Company experienced a 14% decrease in the crude oil price received over the prior period, consistent with the decline in the WTI reference price. The decrease is due to the impact of the heavy oil differential on the Company's heavy crude oil, comprising approximately 33% of oil sales during the period.

Natural gas prices received by the Company during the three month period ended June 30, 2007 increased 20% over the comparable period, consistent with the increase in the AECO and NYMEX reference prices. Arsenal anticipates continued historically high crude oil prices while inventory issues may continue to impact natural gas pricing.



($Cdn.) Three Months Ended June 30 Six Months Ended June 30
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Prices - Before % %
Derivatives 2007 2006 Change 2007 2006 Change
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Total crude oil (bbl) 51.97 60.29 (14) 50.32 51.15 (2)
NGLs (bbl) 57.52 45.22 27 53.82 44.49 21
Natural gas (mcf) 6.44 5.35 20 6.52 6.44 1
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Total (boe) 49.16 52.88 (7) 48.09 49.06 (2)
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Reference Pricing
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WTI ($U.S./bbl) 65.03 70.74 (8) 56.87 67.11 (15)
AECO gas ($Cdn./mcf) 6.99 6.04 16 6.89 7.41 (7)
NYMEX gas
($U.S./mmbtu) 7.56 6.83 11 6.52 7.95 (18)
Foreign exchange
($Cdn./$U.S.) 1.10 1.12 (2) 1.13 1.14 (0)
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OIL AND GAS REVENUE

Crude oil sales for the three month period ended June 30, 2007 were 13% lower than the comparable period in 2006, reflecting lower experienced price realizations and production. Natural gas sales for the three months ended June 30, 2007 increased 10% over the comparable period, as higher prices offset declining production. Other income is comprised of processing fees on facilities owned by the Company. Revenue per boe for the three months ended June 30, 2007 increased 17% over the comparable period in 2006, attributable to the production portfolio and the expiry of the forward contract in 2006.

Net oil and gas revenue for the six month period ended June 30, 2007 was 27% higher than the comparable period in 2006, reflecting the impact of the Tiverton acquisition which closed at the end of the first quarter of 2006.



($Cdn.) Three Months Ended June 30 Six Months Ended June 30
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% %
2007 2006 Change 2007 2006 Change
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Crude oil sales 5,945,993 6,797,251 (13) 12,103,473 11,730,089 3
NGL sales 254,415 230,447 10 445,483 410,021 9
Natural gas sales 1,501,972 1,232,818 22 2,927,786 1,744,068 68
Other 523,646 53,819 873 1,133,003 115,618 880
Loss on forward
contracts - (474,525) (100) - (878,659) (100)
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Net oil and gas
revenue 8,226,026 7,839,810 5 16,609,745 13,121,137 27

Per boe 57.97 49.64 17 53.21 43.58 22
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ROYALTIES

For the three months ended June 30, 2007, royalties as a percentage of gross oil and gas revenue decreased by 12% over the comparable period in 2006. The decrease is due to a royalty holiday received on production at Evi, for which the Company received $0.4 million (net) for 2006 and 2007 production. Arsenal expects the corporate royalty rate to return to the historical average of 22% of gross oil and gas revenue in future periods.



($Cdn.) Three Months Ended June 30 Six Months Ended June 30
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% %
2007 2006 Change 2007 2006 Change
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Royalties 1,584,257 1,752,513 (10) 3,558,543 2,946,180 21
% of gross oil and
gas revenue 19 22 (12) 21 22 (3)
Per boe 11.16 11.10 1 11.40 9.79 16
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OPERATING COSTS

Operating expenses per boe for the three and six month periods ended June 30, 2007 increased 82% and 58% respectively, over the same periods in 2006. The increase over the comparative periods is attributable to $0.9 million in non-recurring charges incurred for the reconciliation of non-operated processing fees payable to joint interest partners. Arsenal expects operating costs per boe to average between $17 and $18 per boe for the third and fourth quarter of 2007.




($Cdn.) Three Months Ended June 30 Six Months Ended June 30
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% %
2007 2006 Change 2007 2006 Change
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Operating expense 4,028,026 2,458,159 64 7,062,030 4,323,444 63
Per boe 28.38 15.56 82 22.62 14.36 58
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PRODUCT NETBACKS(1)

Netbacks for the three month period ended June 30, 2007 decreased 20% over the comparative period in 2006. Higher commodity prices were offset by increased royalties and operating costs experienced during the quarter compared to 2006. Netbacks for the six month period ended June 30, 2007 approximated netback in comparative period, as the 22% increase in revenues offset higher royalty and operating costs.



($Cdn. per boe) Three Months Ended June 30 Six Months Ended June 30
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% %
2007 2006 Change 2007 2006 Change
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Net revenue after
derivatives 57.97 49.64 17 53.21 43.58 22
Royalties (11.16) (11.10) 1 (11.40) (9.79) 16
Operating expenses (28.38) (15.56) 82 (22.62) (15.36) 47
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Operating netback 18.43 22.98 (20) 19.19 18.43 4
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GENERAL AND ADMINISTRATIVE EXPENSES

General and administrative costs per boe for the three and six month periods ended June 30, 2007 decreased by 38% and 17% respectively, over the comparative periods in 2006. The decrease is attributable to decrease in the absolute value in expenses, during 2006 the Company absorbed general and administrative costs relating to the acquisition of Tiverton. First quarter general and administrative expenses were $6.69 per boe. The first quarter charges were significantly impacted by costs incurred for the Egyptian drilling program. Arsenal anticipates general and administrative costs per boe to remain between $2.00 and $2.50 per boe for the remainder of 2007.



($Cdn.) Three Months Ended June 30 Six Months Ended June 30
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% %
2007 2006 Change 2007 2006 Change
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General and
administrative 694,047 1,085,309 (36) 1,830,004 2,135,932 (14)
General and
administrative per
boe 2.22 3.60 (38) 5.86 7.09 (17)
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FINANCE CHARGES

Finance charges per boe for the three and six month periods ended June 30, 2007 increased 106% and 103% respectively, over the comparative periods in 2006, as the Company drew on its credit facility to fund both drilling and acquisition activities in fall and winter of 2006 and during 2007. With the sale of Tower Creek on June 28, 2007, the draw on the Company's credit facility has been reduced to $9.1 million at June 30, 2007, which will significantly decrease interest per boe for the remainder of 2007.



($Cdn.) Three Months Ended June 30 Six Months Ended June 30
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% %
2007 2006 Change 2007 2006 Change
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Bank line interest 561,706 300,591 87 850,523 378,877 124
Per boe 3.96 1.92 106 2.72 1.34 103
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DEPLETION, DEPRECIATION, AND ACCRETION

Depletion, depreciation and accretion per boe increased 312% and 250% for the three and six month periods ended June 30, 2007 compared to the same periods in 2006. The increase is attributable to higher production rates, significantly higher asset base in 2007 compared to 2006, the write off of $6.3 million of drilling expenditures in Egypt incurred during the first and second quarters of 2007 and a $3.2 million ceiling test impairment of the Canadian cost centre. Proceeds from the sales of Tower Creek were used to reduce the Company's full cost pool for depletion purposes in accordance with CICA AcG-16, as a result, depletion rates per boe are forecast to decline in upcoming quarters assuming production remains consistent with the second quarter of 2007.



($Cdn.) Three Months Ended June 30 Six Months Ended June 30
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% %
2007 2006 Change 2007 2006 Change
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Depletion,
depreciation and
accretion 12,324,997 3,325,793 271 18,669,698 5,148,761 263
Per boe 86.85 21.06 312 59.81 17.10 250
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GOODWILL IMPAIRMENT

During the first quarter of 2007, Arsenal compared the deemed fair value of goodwill to the carrying value of goodwill. If the fair value of the Company is less than carrying value, the impairment loss is measured by allocating the fair value of the Company to the identifiable assets and liabilities at their fair values. The excess of the Company's fair value over the identifiable net assets is the implied fair value of goodwill. If this amount is less than the book value of goodwill, the difference is the impairment amount. As a result of this test, Arsenal wrote off $4.8 million in goodwill at March 31, 2007, resulting in a $nil balance in Goodwill at June 30, 2007.



($Cdn.) Three Months Ended June 30 Six Months Ended June 30
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% %
2007 2006 Change 2007 2006 Change
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Goodwill impairment - - 100 4,791,561 - 100
Per boe - - 100 15.35 - 100
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STOCK-BASED COMPENSATION

Stock-based compensation expense per boe for the three and six month periods ended June 30, 2007 decreased 7% and 13% respectively over the comparable periods in 2006, reflecting the lower number of options granted during the period.



($Cdn.) Three Months Ended June 30 Six Months Ended June 30
----------------------------------------------------------------------------
% %
2007 2006 Change 2007 2006 Change
----------------------------------------------------------------------------
Compensation expense 205,838 244,541 (16) 568,795 590,356 (4)
Per boe 1.45 1.57 (7) 1.82 2.09 (13)
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TAXES

During the three month period ended June 30, 2007, Arsenal reduced future income taxes by $2.2 million compared to a recovery of $2.3 million in 2006. During the six month period ended June 30, 2007, Arsenal reduced future income taxes by $3.9 million, compared to a recovery of $2.5 million in 2006. A future income tax balance of $7.3 million is recorded as a liability as at June 30, 2007.



($Cdn.) Three Months Ended June 30 Six Months Ended June 30
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% %
2007 2006 Change 2007 2006 Change
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Current income
taxes 210,000 (13,000)(1,715) 250,000 -
Future income tax
reduction (2,245,999)(2,300,138) (2)(3,929,155)(2,539,997) 55
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(2,035,999)(2,313,138) (12)(3,679,155)(2,539,997) 45
Per boe (14.35) (14.65) (2) (11.79) (9.00) 31
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CAPITAL EXPENDITURES

Capital expenditures and property acquisitions for the six month period ended June 30, 2007 totaled $8.7 million. Land costs relate to undeveloped lands acquired at Evi. Drilling costs were incurred in Egypt, Lashburn, Wildmere and House Mountain. Production facility costs were incurred at Tower Creek. Other costs include miscellaneous charges primarily attributable to Egypt.



($ Cdn.) Total
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Property acquisition 158,000
Land 376,227
Seismic 101,817
Drilling and completions 5,354,600
Production facilities 2,074,328
Other 615,458
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Total capital expenditures 8,680,431
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(1) Management's Discussion and Analysis contains the term funds from
operations, funds from operations per share, and operating netbacks,
which should not be considered to be an alternative to, or more
meaningful than net income as determined in accordance with Canadian
generally accepted accounting principles as an indicator of the
Company's performance. The company presents funds from operations per
share whereby per share amounts are calculated consistent with the
calculation of earnings per share.



INTERIM CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
As at June 30, 2007 December 31, 2006
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ASSETS
Current assets
Accounts receivable 4,553,861 7,282,175
Reclamation bonds 186,517 201,890
Property, plant and equipment (note 5) 59,005,421 83,186,918
Goodwill (note 6) - 4,791,561
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63,745,799 95,462,544
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LIABILITIES
Current liabilities
Accounts payable and accrued liabilities 6,096,410 4,643,907
Revolving demand loan (note 7) 9,086,009 21,822,985
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15,182,419 26,466,892
Convertible debentures (note 12) 3,314,473 3,263,473
Future income taxes 7,279,170 8,548,207
Asset retirement obligations (note 8) 2,763,083 2,638,520
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28,539,145 40,917,092
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SHAREHOLDERS' EQUITY
Common shares (note 9) 77,789,049 80,291,169
Warrants (note 11) - 303,731
Contributed surplus (note 10) 3,294,949 2,422,423
Common share conversion rights (note 12) 370,000 370,000
Deficit (46,247,344) (28,841,871)
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35,206,654 54,545,452
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63,745,799 95,462,544
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Future operations (note 2)
Supplemental information (note 13)
Segmented information (note 14)
Commitments and contingencies (note 15)

See accompanying notes to the interim consolidated financial statements.



INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS AND DEFICIT (UNAUDITED)

Three Months Ended Six Months Ended
June 30 June 30
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2007 2006 2007 2006
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REVENUE
Oil and gas 8,226,026 7,839,810 16,609,745 13,121,137
Royalties (1,584,257) (1,752,513) (3,558,543) (2,946,180)
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6,641,769 6,087,297 13,051,202 10,174,957
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EXPENSES
Operating 4,028,026 2,458,159 7,062,030 4,323,444
General and
administrative 694,047 900,461 1,830,004 1,951,084
Finance charges 561,706 300,591 850,523 378,877
Interest on long term
debt 69,410 138,056 138,056 138,056
Convertible debenture
accretion (note 12) 25,500 60,000 51,000 60,000
Depletion, depreciation
and accretion (note 5) 12,324,997 3,325,793 18,669,698 5,148,761
Goodwill impairment
(note 6) - - 4,791,561 -
Foreign exchange loss 174,693 184,848 174,164 184,848
Stock-based compensation
(note 10) 205,838 244,541 568,795 590,356
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18,084,217 7,612,449 34,135,831 12,775,426
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Loss before income taxes (11,442,448) (1,525,152)(21,084,629) (2,600,469)
Income taxes
Current income tax
reduction 210,000 (13,000) 250,000 -
Future income tax
reduction (2,245,999) (2,300,138) (3,929,155) (2,539,997)
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(2,035,999) 2,313,138 (3,679,155) (2,539,997)
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Net income (loss) (9,406,449) 787,986 (17,405,474) (5,140,466)
Deficit - beginning of
period (36,840,895) (2,633,908)(28,841,871) (1,785,450)
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Deficit - end of period (46,247,344) (1,845,922)(46,247,344) (6,925,916)
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Income (loss) per share
basic and diluted (0.13) 0.01 (0.24) (0.01)

See accompanying notes to the interim consolidated financial statements.



INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

Three Months Ended Six Months Ended
June 30 June 30
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2007 2006 2007 2006
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Cash flows from
operating activities
Net income (loss) (9,406,449) 787,986 (17,405,474) (60,472)
Items not affecting cash
Depletion, depreciation
and accretion 12,324,997 3,325,793 18,669,698 5,148,761
Goodwill impairment
(note 6) - - 4,791,561 -
Convertible debenture
accretion (note 12) 25,500 60,000 51,000 60,000
Future income tax
reduction (2,245,999) (2,300,138) (3,929,155) (2,539,997)
Stock-based compensation
expense (note 10) 205,838 244,541 568,795 590,356
Deferred revenue - (135,604) - (258,853)
Unrealized foreign
exchange loss 174,693 184,848 174,164 184,848
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1,078,581 2,167,426 2,920,590 3,124,644
Changes in non-cash
working capital
(note 13) 2,003,536 (932,489) 4,711,064 (2,994,499)
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Net cash provided by
operating activities 3,082,117 1,234,937 7,631,654 130,145
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Cash flows from
investing activities
Dispositions of
property, plant and
equipment 14,000,000 - 14,000,000 -
Additions to property,
plant and equipment (5,365,242) (3,537,385) (8,364,431) (5,818,650)
Changes in non-cash
working capital
(note 13) 126,198 504,989 (530,247) (452,874)
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Net cash used in
investing activities 8,760,956 (3,032,396) 5,105,322 (6,271,524)
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Cash flows from
financing activities
Issue of shares upon
exercise of warrants - - - 59,122
Issue of shares for cash
upon exercise of stock
Options - 59,000 - 59,000
Share issue costs - 90,606 - (566,546)
Revolving demand loan (11,843,073) 1,647,853 (12,736,976) 6,579,803
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Net cash provided by
financing activities (11,843,073) 1,797,459 (12,736,976) 6,141,379
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Change in cash during
the period - - - -
Cash - Beginning of
period - - - -
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Cash - End of period - - - -
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Supplemental information (note 13)

See accompanying notes to the interim consolidated financial statements.


NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. SIGNIFICANT ACCOUNTING POLICIES

The unaudited interim consolidated financial statements of Arsenal have been prepared by management in accordance with accounting principles generally accepted in Canada and following the same accounting policies and methods of computation as the consolidated financial statements for the year ended December 31, 2006. The disclosures provided below are incremental to those included with the annual financial statements. The interim financial statements should be read in conjunction with the consolidated financial statements and notes thereto in the Company's Annual Report for the year ended December 31, 2006. The preparation of financial statements in conformity with Canadian generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported period. Actual results may differ from these estimates.

2. FUTURE OPERATIONS

These financial statements have been prepared on a going concern basis, which assumes the Company will continue in operation in the foreseeable future and be able to realize assets and satisfy liabilities in its normal course of business. If this assumption were not appropriate, adjustments to the carrying of the assets and liabilities, revenues and expenses and the balance sheet classifications used might be necessary.

For the period ended June 30, 2007, the Company has incurred a loss due to goodwill impairment test and ceiling test write down. Arsenal believes that current working capital and cash flow from operations will be sufficient to meet its working capital requirements for 2007. Future operations depend upon the Company's continued ability to generate profitable operations and/or obtain additional financing to fund future operations and to generate positive cash flows from operating activities.

3. CHANGE IN ACCOUNTING POLICIES

Effective January 1, 2007, the Company adopted the new Canadian accounting standards for financial instruments - recognition and measurement; financial instruments - presentation and disclosure, hedging and comprehensive income. The Company has adopted these standards prospectively and as such the comparative interim consolidated financial statements have not been restated. The adoption of these standards had no impact on opening retained earnings or accumulated other comprehensive income.

a) Financial instruments - recognition and measurement

The new standard prescribes when a financial asset, financial liability or non-financial derivative is to be recognized on the balance sheet and at what amount, requiring fair value or cost-based measures under different circumstances. Financial instruments must be classified into one of the following five categories: held-for-trading, held-to-maturity, loans and receivables, available-for-sale financial assets or other financial liabilities. All financial instruments, including derivatives, are measured in the balance sheet at fair value except for loans and receivables, held to maturity investments and other financial liabilities which are measured at amortized cost determined using the effective interest rate method. Subsequent measurement and changes in fair value will depend on their initial classification, as follows: held-for-trading financial assets are measured at fair value and changes in fair value are recognized in net earnings; available-for-sale financial instruments are measured at fair value with changes in fair value recorded in other comprehensive income until the investment is derecognized or impaired at which time the amounts would be recorded in net earnings.

Under adoption of these standards, the Company classified its cash as held-for-trading, which is measured at fair value. Accounts receivable are classified as loans and receivables, which are measured at amortized cost. Accounts payable, revolving demand loan and convertible debentures are classified as other financial liabilities, which are measured at amortized cost.

b) Derivatives

All derivative instruments, including embedded derivatives, are recorded in the statement of earnings at fair value unless exempted from derivative treatment as a normal purchase and sale. All changes in the fair value of derivative instruments are recorded in earnings unless cash flow hedge accounting is used, in which case changes in fair value are recorded in other comprehensive income. Prior to adoption of the new standards, physical receipt and delivery contracts did not fall within the scope of the definition of a financial instrument and were also accounted for as executory contracts. For the six month period ended June 30, 2007, Arsenal did not enter into any derivative instrument contracts.

c) Other comprehensive income

The new standards require a new statement of comprehensive income, which is comprised of net earnings and other comprehensive income which, for the Company, related to changes in gains or losses on derivatives designated as cash flow hedges. The Company has combined this new statement with the statement of earnings.

d) Effective interest rate method

Transactions costs attributable to financial instruments classified as other than held for trading are included in the recognized amount of the related financial instrument and recognized over the life of the resulting financial instrument.

e) Accounting changes

The Company adopted Section 1506 - Accounting Changes, the only impact of which is to provide disclosure of when an entity has not applied a new source of GAAP that has been issued but is not yet effective. This is the case with Section 3862 - Financial Instruments Disclosures and Section 3863 Financial Instruments Presentations which are required to be adopted for fiscal years beginning on or after October 1, 2007. The Company will adopt these standards on January 1, 2008 and it is expected the only effect on the Company will be incremental disclosures regarding the significance of financial instruments for the entity's financial position and performance; and the nature, extent and management of risks arising from financial instruments to which the entity is exposed.



4. BUSINESS ACQUISITION

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

Tiverton
2006
----------------------------------------------------------------------------
Net assets acquired at assigned values:
----------------------------------------------------------------------------
Working capital deficiency (2,112,791)
Property, plant and equipment 42,740,000
Goodwil 13,572,428
Bank debt (3,700,000)
Convertible debentures (3,182,473)
Asset retirement obligation (1,095,000)
Future income taxes (6,937,798)
Common share conversion rights (370,000)
----------------------------------------------------------------------------
Net assets acquired 38,914,366
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Financed by:
----------------------------------------------------------------------------
Shares issued 38,314,366
Acquisition costs 600,000
----------------------------------------------------------------------------
Purchase price 38,914,366
----------------------------------------------------------------------------
----------------------------------------------------------------------------

5. PROPERTY, PLANT AND EQUIPMENT

June 30, 2007 December 31, 2006
----------------------------------------------------------------------------
Property, plant, and equipment 110,201,344 115,819,143
Accumulated depletion, depreciation,
and amortization (51,195,923) (32,632,225)
----------------------------------------------------------------------------
59,005,421 83,186,918
----------------------------------------------------------------------------
----------------------------------------------------------------------------


In Canada and the United States, all costs of unproved properties, net of any associated revenues, have been capitalized and depleted during 2007 and 2006. Future development costs totaling $2.9 million were included in the depletion calculation for the six months ended June 30, 2007. Depletion includes costs totaling $6.3 million relating to drilling activities completed and costs incurred to June 30, 2007 in Egypt, and $3.2 million relating to a ceiling test impairment of the Company's Canadian cost centre. Included in property, plant, and equipment at June 30, 2007 are asset retirement costs of $2.3 million. For the six months ended June 30, 2007, Arsenal capitalized general and administrative expenses of $0.6 million.

On June 28, 2007, the Company closed the disposition of its Tower Creek project for gross proceeds of $14.0 million which were applied against property, plant and equipment.

6. GOODWILL IMPAIRMENT

At March 31, 2007, Arsenal compared the fair value of goodwill to the carrying value of goodwill. As a result of this test, the Company recorded an impairment to goodwill of $4.8 million calculated as the excess of the Company's fair value over the identifiable net assets for its Canadian and Egyptian reporting units.

7. REVOLVING DEMAND LOAN

At June 30, 2007 the Company has available a demand operating loan in the amount of $23.0 million. The facility can be utilized in either Canadian or US dollars, bears interest on Canadian or US bank prime plus 0.25%, increasing to Canadian or US bank prime plus 0.40% if Net Debt to Annualized Cashflow exceeds 1.25:1. The facility 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.

The Company's lender has initiated the annual review of the demand operating loan, Arsenal expects the renewal to be completed during the third quarter of 2007.



8. ASSET RETIREMENT OBLIGATIONS

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

Six Months Ended Year Ended
June 30, 2007 December 31, 2006
----------------------------------------------------------------------------
Asset retirement obligations -
beginning of period 2,638,520 1,295,500
Liabilities acquired - 1,095,000
Liabilities incurred 30,300 128,100
Change in estimate (11,737) 11,920
Accretion expense 106,000 108,000
----------------------------------------------------------------------------
Asset retirement obligations - end of
period 2,763,083 2,638,520
----------------------------------------------------------------------------

9. SHAREHOLDERS' EQUITY

Six Months Ended Year Ended
Common shares June 30, 2007 December 31, 2006
----------------------------------------------------------------------------
Shares Amount ($) Shares Amount ($)
----------------------------------------------------------------------------
Balance - beginning of
period 73,642,173 80,516,169 42,556,244 36,839,809
Issued to acquire
Tiverton - - 23,237,671 38,314,366
Issued to acquire
property 275,000 158,000 - -
Issued for cash - - 7,328,148 7,960,963
Cost of shares issued - - - (1,131,708)
Tax effect of
flow-through shares - (2,660,120) - (2,369,913)
Tax effect of share issue
costs - - - 379,625
Issued on exercise of
options - - 350,000 206,501
Issued on exercise of
warrants - - 170,110 170,110
Allocated from
contributed surplus - - - 146,416
Shares held in escrow - (225,000) - (225,000)
----------------------------------------------------------------------------
Balance - end of period 73,917,173 77,789,049 73,642,173 80,291,169
----------------------------------------------------------------------------
----------------------------------------------------------------------------


The per share calculations for the six month period ended June 30, 2007 were based on weighted average shares outstanding of 73,720,090 (June 30, 2006 - 56,088,944). The per share calculations for the three month period ended June 30, 2007 were based on weighted average shares outstanding of 73,798,006 (June 30, 2006 - 65,205,504). In computing net loss per share - diluted, for the three and six months ended June 30, 2007, 4,087,252 options were excluded from the calculation as the effect would be anti-dilutive. For the three months ended June 30, 2006 shares 959,519 shares were added to the weighted average number of shares outstanding for the period, reflecting the dilutive effect of stock options. For the six months ended June 30, 2006, 4,127,252 options were excluded from the calculation as the effect would be anti-dilutive.



10. STOCK OPTIONS

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

June 30, December 31,
2007 2006
Weighted Weighted
Average Average
Options Price ($) Options Price ($)
----------------------------------------------------------------------------
Balance - beginning of
period 4,527,252 1.05 3,592,252 0.99
Granted - - 1,535,000 1.10
Exercised - - (350,000) 0.59
Forfeited (440,000) 1.20 (250,000) 1.13
----------------------------------------------------------------------------
Balance - end of period 4,087,252 1.03 4,527,252 1.05
----------------------------------------------------------------------------
Exercisable - end of
period 3,501,141 0.99 3,170,585 1.02
----------------------------------------------------------------------------
----------------------------------------------------------------------------


The Company incurred non-cash compensation expense of $568,795 for the six month period ended June 30, 2007 (2006 - $590,356) 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:



Six Months Ended Year Ended
June 30, 2007 December 31, 2006
----------------------------------------------------------------------------
Balance - beginning of period 2,422,423 1,170,444
Issuance of stock options 568,795 1,398,395
Reclassification to common shares on
exercise of options - (146,416)
Reclassification to contributed surplus
on expiry of warrants 303,731 -
----------------------------------------------------------------------------
Balance - end of period 3,294,949 2,422,423
----------------------------------------------------------------------------
----------------------------------------------------------------------------


11. WARRANTS

When share purchase warrants are exercised, the consideration paid is recorded to the shareholders' equity account along with an allocation for the fair value of the warrants previously recorded in the warrants account. Warrants issued during 2005 through private placement expired unexercised during the second quarter of 2007. The following table details the changes in the warrant account balance:





Six Months Ended Year Ended
June 30, 2007 December 31, 2006
----------------------------------------------------------------------------
Warrants Amount ($) Warrants Amount ($)
----------------------------------------------------------------------------
Balance - beginning of
year 8,606,715 303,731 6,588,664 988,760
Private placement - - 2,031,100 303,731
Agents' warrants (1) - - 157,061 -
Allocated to common
equity upon exercise of
warrants - - (170,110) (988,760)
Allocated to contributed
surplus expiry of
warrants (8,606,715) (303,731)
----------------------------------------------------------------------------
Balance - end of period - - 8,606,715 303,731
----------------------------------------------------------------------------
----------------------------------------------------------------------------

(1) During 2005 the Company's underwriters and agents exercised their right
to an additional 170,110 warrants pursuant to their respective agency
agreements. These warrants were exercised during 2006.


12. CONVERTIBLE DEBENTURE

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. 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 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.

For the six months ended June 30, 2007 Arsenal incurred $51,000.00 of accretion expense relating to the amortization of the discount of the debenture, and paid $0.14 million in interest on the debentures June 30, 2007.



13. SUPPLEMENTAL CASH FLOW INFORMATION

Three Three Six Six
Months Ended Months Ended Months Ended Months Ended
June 30, June 30, June 30, June 30,
2007 2006 2007 2006
----------------------------------------------------------------------------
Change in non-cash
working capital items
Operating accounts
receivable 2,151,639 (1,476,926) 2,728,314 (3,121,239)
Operating accounts
payable (148,103) 544,438 1,982,750 126,740
----------------------------------------------------------------------------
Amounts relating to
operating activities 2,003,536 (932,489) 4,711,064 (2,994,499)
Amounts relating to
investing activities 126,198 504,989 (530,247) (452,874)
----------------------------------------------------------------------------
2,129,734 (427,499) 4,180,817 (3,447,373)
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Taxes paid - - - 213,985
Interest and finance
charges paid 444,398 372,107 758,464 450,393
----------------------------------------------------------------------------
----------------------------------------------------------------------------


14. SEGMENTED INFORMATION

A portion of the Company's assets and revenues are earned in the United States and a portion of the Company's assets are located in 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:



2007
($ Cdn.) Canada U.S Egypt Total
----------------------------------------------------------------------------
Oil and gas revenue 11,939,053 4,670,692 - 16,609,745
Income (loss) before
income taxes (15,005,758) 552,983 (6,631,854) (21,084,629)
Operating income 3,983,953 2,005,219 - 5,989,172
Property, plant and
equipment (note 5) 53,111,698 3,489,542 2,404,180 59,005,420
Capital expenditures
(including acquisitions) 5,576,507 80,942 2,864,981 8,522,430
----------------------------------------------------------------------------
----------------------------------------------------------------------------

2006
($ Cdn.) Canada U.S Egypt Total
----------------------------------------------------------------------------
Oil and gas revenue 9,239,452 3,881,685 - 13,121,137
Loss before income taxes (2,532,537) 52,304 (120,236) (2,600,469)
Operating income 4,557,380 1,320,905 - 5,878,285
Property, plant and
equipment (note 5) 82,080,509 4,302,464 5,360,234 91,743,207
Capital expenditures
(including acquisitions) 5,720,497 98,153 - 5,818,650
----------------------------------------------------------------------------
----------------------------------------------------------------------------


15. COMMITMENTS AND CONTINGENCIES

Egyptian Concession

The Company's wholly owned subsidiary Quadra Egypt Ltd. entered into a concession agreement with the Egyptian government in 2004. The agreement requires gross expenditures of USD$11.0 million over an eight year period on seismic evaluation, exploratory drilling and developmental drilling. The two test wells drilled to date satisfy the current drilling requirements for the concession until July 2009 and the concession can be extended until July 2012 with an exploration commitment of two additional wells.

Flow-through shares

At June 30, 2007, the Company has a $6.5 million flow-through obligation which will be satisfied prior to December 31, 2007, through exploratory drilling and seismic shooting in Alberta and Saskatchewan.

Letter of Credit

During the second quarter, Arsenal provided a letter of credit to the Egyptian government for USD$1.6 million. The letter of credit is to be held until April 10, 2010, or until certain performance measures are achieved by Arsenal and its partners. Arsenal has obtained a Performance Security Guarantee ("PSG") from the Canadian government which guarantees Arsenal against the call of the bond by the Egyptian government. There is no impact to the existing credit facility of Arsenal from providing the letter of credit due to the PSG, however the Company incurred approximately $50,000 in stamping fees to obtain the PSG.

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.

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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