Arsenal Energy Inc.
TSX : AEI
FRANKFURT : A1E

Arsenal Energy Inc.

November 14, 2005 08:00 ET

Arsenal Announces Third Quarter 2005 Operating And Financial Results

CALGARY, ALBERTA--(CCNMatthews - Nov. 14, 2005) -

This news release is not for distribution in the United States.

Arsenal Energy Inc. (TSX:AEI) (FWB:A1E) ("Arsenal or the Company") is pleased to announce the results of operations for the three and nine month periods ended September 30, 2005.

THIRD QUARTER CORPORATE HIGHLIGHTS

- Production averaged a record 1,562 boe/d.

- Record funds from operations of $2.01 million, $0.06/share basic, $0.06/share diluted.

- Successful drilling of the first two wells at Evi in Northern Alberta. During completion, these wells swab tested at 390 bbl/d and 295 bbld/d, of high quality, 39 degree API oil, and were brought into production during October at a rate of 190 bbl/d and 155 bbl/d respectively. Three additional wells are planned in Northern Alberta during the fourth quarter.

- Drilling of eight oil wells at Lloydminster with an 88% success rate. An additional 10.0 gross (5.0 net) wells are planned on the lands during the fourth quarter.

- Completed the corporate acquisition of Quadra Resources Corp. ("Quadra"), an international oil and gas exploration Company for gross proceeds of $5.5 million. Quadra's principal asset was a 40% working interest in the 7.5 million acre Nuqra concession in the Komombo rift basis in Egypt. Quadra was a Canadian Public company which traded on the CNQ and Frankfurt Stock Exchange.

- Obtained listing on the Frankfurt Stock Exchange, trading under the symbol "A1E".



SELECTED FINANCIAL AND OPERATIONAL INFORMATION
------------------------------------------------------------------------
FINANCIAL Three Months Ended Nine Months Ended
September 30 September 30
------------------------------------------------------------------------
2005 2004 2005 2004
------------------------------------------------------------------------

Funds from operations (1) 1,835,348 131,527 3,193,209 126,247
Per unit - basic 0.06 (0.00) 0.12 0.00
Per unit - diluted 0.06 (0.00) 0.12 0.00
Bank debt 12,443,478 - 12,443,478 -
Operating costs per boe 13.70 16.49 14.19 2.19
Operating netbacks per boe 17.47 27.49 16.17 40.07
Market
Shares outstanding
End of period 33,400,567 11,591,875 33,400,567 11,591,875
Weighted average
- basic 30,942,600 11,396,541 25,915,932 11,375,898
Weighted average
- diluted 32,028,838 12,506,417 27,002,170 12,485,774
Shares trading
High 1.98 0.90 1.98 0.95
Low 1.21 0.58 0.88 0.60
Close 1.98 0.65 1.98 0.65
Average daily volume 99,000 15,500 67,000 14,200
------------------------------------------------------------------------

OPERATIONS
------------------------------------------------------------------------
Daily production (average)
Crude oil (bbl) 1,437 175 1,073 105
NGLs (bbl) 32 1 35 1
Natural gas (mcf) 562 6 463 6
------------------------------------------------------------------------
Total (boe)(2) 1,562 177 1,185 107
Realized commodity prices
($Cdn.)
Total crude oil (bbl) 44.56 54.23 41.79 45.09
NGLs (bbl) 51.78 52.38 43.40 38.01
Natural gas (mcf) 6.22 6.15 6.84 6.28
------------------------------------------------------------------------
Average (boe)(2) 44.81 53.53 42.53 44.09
Reference pricing
WTI (U.S.$/bbl) 63.19 43.88 55.40 39.10
AECO gas ($Cdn./mcf) 8.81 6.32 7.38 6.34
Foreign Exchange ($U.S./$Cdn.) 1.20 1.31 1.22 1.33
------------------------------------------------------------------------
------------------------------------------------------------------------

(1) This release 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.

(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

NORTHERN ALBERTA

The first two wells were successfully completed at Evi, and were brought into production during October at an average rate of 190 and 155 barrels of oil per day respectively. Arsenal has a 50% working interest in these wells. We are currently drilling 2.0 gross (1.0 net) wells in Northern Alberta, and will spud a third well during December. These wells all target Granite Wash, and Gilwood reservoirs, with high quality, light sweet oil, and if successful are anticipated to produce in excess of 150 boe/d. We continue to drill wells at this new core area in Northern Alberta by participating at land sales and pursuing additional farm-in opportunities.

NORTH DAKOTA

Optimization initiatives undertaken during the fourth quarter of 2004 produced superb results for the Company during 2005 as operation costs decreased by approximately $8.00 per barrel of oil equivalent over the prior year. Production for the quarter remained consistent at approximately 400 barrels of oil equivalent per day.

We are currently developing a 2.0 gross (2.0 net) well program in North Dakota, targeting the Red River, Winnipegosis and Bakken formations. We have obtained 3D seismic over the majority of our lands, and anticipate drilling during the summer of 2006, as there are no access issues in this area.

WESTERN SASKATCHEWAN

Arsenal drilled 8.0 gross (3.18 net) wells on these lands during the third quarter, achieving a 88% success rate. These wells came on stream with initial production rates ranging between 25 and 55 boe/d. We intend to drill an additional 10.0 gross (5.0 net) wells in this area during the fourth quarter. This drilling program will offset the production declines and wet weather issues faced earlier this year.

EGYPT

The operator of the Nuqra concession, is currently reprocessing the acquired seismic data on the concession, and has contracted a seismic crew to shoot an additional 800 km of seismic during the fourth quarter. The first exploratory wells are anticipated to be drilled during the third and fourth quarters of 2006. At this time, a three well exploratory program has been developed, with the preliminary locations to be chosen after the completion of the new seismic evaluation.

COMMODITY PRICING

Heavy oil pricing was significantly impacted by disruptions in the western Canadian synthetic crude oil and heavy crude markets during the first quarter of 2005. The heavy oil price differential has returned to historical averages of 30% of WTI, however diluent costs remain high. We anticipate that the differential will follow historical seasonality and widen during the fall and winter months, however it is unlikely the differential will be as large as it was during 2004 and early 2005.

Light sweet crude oil continues to set record highs with increasing demand from Asia, limited refining capacity, and stagnant global production. It is anticipated in the market that WTI will remain above $50 USD for the remainder of the year.

With the effects of Hurricane Katrina, natural gas recently set all time highs in excess of $14USD/mcf, however prices have declined sharply since the end of October, as inventories have risen in excess of expectations. As we enter into the winter months, we expect gas prices to increase as demand increases, consistent with historical seasonality.

OUTLOOK

We will continue to pursue acquisitions domestically and internationally while generating value through the drill bit on our lands in Canada. We will work along side our partners on the Nuqra concession in Egypt to develop and implement the drilling program there as quickly as possible.

With the completion of the two wells at Evi, we are currently producing approximately 1,800 barrels of oil equivalent per day, and target exiting the year in excess of 2,000 barrels of oil equivalent per day, comprised of 60% heavy oil and 40% light oil and natural gas.

RESULTS OF OPERATIONS

DRILLING ACTIVITY

Arsenal participated in 10.0 gross wells (5.18 net) during the third quarter, 2.0 gross wells (1.0 net) were drilled at Evi, and 8.0 gross (3.18 net) were drilled at Lloydminster. One dry hole was drilled at Lloydminster.



Three Months Ended September 30 Nine Months Ended September 30
------------------------------------------------------------------------
2005 2004 2005 2004
Drilling
Activity Gross Net Gross Net Gross Net Gross Net
------------------------------------------------------------------------
Oil 9.0 4.18 2.0 1.0 12.0 6.58 8.0 2.375
Gas 0.0 0.0 0.0 0.0 0.0 0.0 2.0 1.400
Dry and
abandoned 1.0 1.0 0.0 0.0 1.0 1.0 0.0 0.0
------------------------------------------------------------------------
Total 10.0 5.18 2.0 1.0 13.0 7.58 10.0 3.775
------------------------------------------------------------------------
------------------------------------------------------------------------


PRODUCTION AND MARKETING

Production volumes for the three and nine month periods ended September 30, 2005 increased to 1,562 boe/d and 1,185 boe/d, which represents a 783% and 1,008% increase respectively, over the same periods in 2004. The increase in volumes is attributable to the integration of corporate and property acquisitions and new wells drilled during the year.

For the three month period ended September 30, 2005, crude oil production increased 721%, attributable to the acquisition of properties in North Dakota and Lloydminister, and news drilled at Lloydminster, offsetting natural declines and losses from heavy oil wells shut in during the second quarter of this year. Natural gas production increased 3,067% and related natural gas liquids increased 9,262% over the prior year from properties acquired at Saskatchewan and North Dakota.

With the completion of the 4 well drilling program at Evi, Mitsue and Lubicon, Arsenal will be producing approximately 1,800 boe/d. These new wells produce high quality, light sweet oil, and have been swab tested between 250 and 390 bbl/d, with Arsenal holding a 50% working interest in the properties.



Three Months Ended Nine Months Ended
September 30 September 30
------------------------------------------------------------------------
% %
2005 2004 Change 2005 2004 Change
------------------------------------------------------------------------
Crude oil (bbl/d) 1,437 175 721 1,073 105 922
NGL (bbl/d) 32 1 3,067 35 1 1,100
Natural gas
(mcf/d) 562 6 9,262 463 6 1,267
------------------------------------------------------------------------
Total (boe/d) 1,562 177 783 1,185 107 1,008
------------------------------------------------------------------------
------------------------------------------------------------------------
Production split
------------------------------------------------------------------------
Oil & NGLs 94% 99% (5) 93% 99% (6)
Natural Gas 6% 2% 200 7% 1% 597
------------------------------------------------------------------------
------------------------------------------------------------------------


COMMODITY PRICES

Commodity price realizations during the three month and nine month period ended September 30, 2005 decreased 16% and 4% respectively, over the same periods in 2004. The impact of favourable crude oil prices was partly offset by an 8% 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 September 30, 2005, 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. Arsenal does not expect the differential to grow to the levels experienced last winter, however current forecasts are demonstrating this winter effect, which will continue to become more pronounced as the winter approaches.

Natural gas produced in North Dakota is high heat, and has historically achieved a price in excess of the NYMEX Henry Hub reference price.

Arsenal anticipates continued high commodity prices as supply issues continue to impact natural gas, while Indian and Asian demand in conjunction with ongoing tensions in the Middle East continues to put upward pressure on the WTI reference price.



Three Months Ended Nine Months Ended
($Cdn.) September 30 September 30
------------------------------------------------------------------------
Prices - Before % %
Derivatives 2005 2004 Change 2005 2004 Change
------------------------------------------------------------------------
Total crude oil
(bbl) 44.56 54.23 (18) 41.79 45.09 (7)
NGLs (bbl) 51.78 52.38 (1) 43.40 38.01 14
Natural gas (mcf) 6.22 6.15 1 6.84 6.28 9
------------------------------------------------------------------------
Total (boe) 44.81 53.53 (16) 42.53 44.09 (4)
------------------------------------------------------------------------
------------------------------------------------------------------------

Reference Pricing
------------------------------------------------------------------------
WTI ($U.S./bbl) 63.19 43.88 44 55.40 39.10 42
AECO gas
($Cdn./mcf) 8.81 6.32 40 7.38 6.34 16
NYMEX gas
($U.S./mmbtu) 10.24 5.84 75 7.80 5.83 34
Foreign exchange
($U.S./$Cdn.) 1.20 1.31 (8) 1.22 1.33 (8)
------------------------------------------------------------------------
------------------------------------------------------------------------


OIL AND GAS REVENUE

Net oil and gas revenue for the three month and nine month period ended September 30, 2005 was 564% and 881% higher respectively, than the comparable periods in 2004, reflecting increased petroleum and natural gas production. Revenue per boe for the three and nine month period ended September 30, 2005 decreased 25% and 11% respectively, over the same periods in 2004 reflecting the impact of heavy oil price realizations, and the loss on the forward contract of 180 bbl/d of oil in North Dakota.



Three Months Ended Nine Months Ended
($Cdn.) September 30 September 30
------------------------------------------------------------------------
% %
2005 2004 Change 2005 2004 Change
------------------------------------------------------------------------
Crude oil
sales 5,938,348 888,549 568 12,233,827 1,283,356 853
NGL sales 103,800 1,040 9,881 418,366 1,806 23,065
Natural gas
sales 368,937 8,977 4,010 862,050 11,445 7,432
Other 7,824 - - 195,387 - -
Loss on forward
contracts (450,199) - - (993,140) - -
------------------------------------------------------------------------
Gross oil and
gas revenue 5,968,709 898,566 564 12,716,490 1,296,607 881

Per boe 41.53 55.18 (25) 39.29 44.39 (11)
------------------------------------------------------------------------
------------------------------------------------------------------------



ROYALTIES

During the three and nine month period ended September 30, 2005, royalties as a percentage of gross oil and gas revenue increased 25% and 31% respectively, over the same periods in 2004 due to higher freehold royalties on the properties acquired in North Dakota and Canada during the year.



Three Months Ended Nine Months Ended
($Cdn.) September 30 September 30
------------------------------------------------------------------------
% %
2005 2004 Change 2005 2004 Change
------------------------------------------------------------------------
Royalties 1,489,165 182,380 717 2,891,924 62,037 4,562
% of gross oil
and gas
revenue 20 16 25 21 16 31
Per boe 10.36 11.20 (7) 8.94 2.12 321
------------------------------------------------------------------------
------------------------------------------------------------------------


OPERATING COSTS

Operating expenses per boe for the three month period ended September 30, 2005 decreased 17% over the same period in 2004. The decrease is attributable to workovers and optimization initiatives completed in North Dakota during the fourth quarter of 2004. Operating costs per boe have remained higher than anticipated, attributable to increased rig costs incurred to revive production that was shut in during the period as a result of the unseasonably warm and wet weather experience in Saskatchewan during the second quarter. Operating costs have declined from the second quarter when they averaged $16.39/boe, Arsenal expects operating costs to continue to trend lower as the additional optimization initiatives are completed during the fourth quarter.



Three Months Ended Nine Months Ended
($Cdn.) September 30 September 30
------------------------------------------------------------------------
% %
2005 2004 Change 2005 2004 Change
------------------------------------------------------------------------
Operating
expense 1,968,431 268,595 633 4,590,643 63,947 7,079
Per boe 13.70 16.49 (17) 14.19 2.19 548
------------------------------------------------------------------------
------------------------------------------------------------------------


PRODUCT NETBACKS(1)

Netbacks for the three and nine month period ended September 30, 2005 decreased 36% and 60% over comparative periods reflecting the impact of heavy oil price realizations during 2005. Third quarter royalties and operating costs were 7% and 17% lower than comparative periods respectively, reflecting operating efficiencies and lower royalty rates on wells acquired and drilled in Canada compared to the properties in North Dakota.



Three Months Ended Nine Months Ended
($Cdn. per boe) September 30 September 30
------------------------------------------------------------------------
% %
2005 2004 Change 2005 2004 Change
------------------------------------------------------------------------
Net revenue after
derivatives 41.53 55.18 (25) 39.29 44.39 (11)
Royalties (10.36) (11.20) (7) (8.94) (2.12) 321
Operating expense (13.70) (16.49) (17) (14.19) (2.19) 548
------------------------------------------------------------------------
Operating netback 17.47 27.49 (36) 16.17 40.07 (60)
------------------------------------------------------------------------
------------------------------------------------------------------------


GENERAL, ADMINISTRATIVE COMPENSATION EXPENSES

General and administrative costs per boe for the three and nine month periods ended September 30, 2005 decreased by 87% and 75% respectively over comparative periods in 2004. 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.

Stock-based compensation expense of $367,948 was accrued during the second quarter reflecting grants made during the period and amortization of compensation expense incurred for options which vested during the period.



Three Months Ended Nine Months Ended
($Cdn.) September 30 September 30
------------------------------------------------------------------------
% %
2005 2004 Change 2005 2004 Change
------------------------------------------------------------------------
General and
administrative 317,859 266,788 19 1,440,617 518,923 178
Compensation
expense 367,948 - 100 775,144 - 100
------------------------------------------------------------------------
685,807 266,788 157 2,215,761 518,923 327

General and
administrative
per boe 2.21 16.38 (87) 4.45 17.76 (75)
Compensation
expense per boe 2.56 - 100 2.40 - 100
------------------------------------------------------------------------
------------------------------------------------------------------------


FINANCE CHARGES

Finance charges for the three and nine month periods ended September 30, 2005 increased 95% and 434% respectively, over to comparative periods as the Company drew on its credit facility to fund both drilling and acquisition activities during 2005.



Three Months Ended Nine Months Ended
($Cdn.) September 30 September 30
------------------------------------------------------------------------
% %
2005 2004 Change 2005 2004 Change
------------------------------------------------------------------------
Finance charges 110,387 56,611 95 302,572 56,611 434
Per boe 0.77 3.48 (78) 0.93 1.94 (52)
------------------------------------------------------------------------
------------------------------------------------------------------------


DEPLETION, DEPRECIATION, AND ACCRETION

Depletion, depreciation and accretion per boe decreased 16% for the nine month period ended September 30, 2005 compared to the same period in 2004. The decrease is attributable to the significantly increased reserve base over the prior year.



Three Months Ended Nine Months Ended
($Cdn.) September 30 September 30
------------------------------------------------------------------------
% %
2005 2004 Change 2005 2004 Change
------------------------------------------------------------------------
Depletion,
depreciation
and accretion 1,440,866 163,105 783 2,601,853 278,548 834
Per boe 10.03 10.02 - 8.04 9.54 (16)
------------------------------------------------------------------------
------------------------------------------------------------------------


TAXES

During the first nine months of 2005, Arsenal accrued current income taxes totalling $213,468 compared to $nil during the same period in 2004. During the first nine months of 2005, Arsenal accrued future income taxes totalling $228,641 compared to $11,919 during the same period in 2004. A future income tax balance of $7,950,785 is recorded as a liability as at September 30, 2005 (September 30, 2004 - 113,509).



Three Months Ended Nine Months Ended
($Cdn.) September 30 September 30
------------------------------------------------------------------------
% %
2005 2004 Change 2005 2004 Change
------------------------------------------------------------------------
Current income
taxes 213,468 - 100 213,468 - 100
Future income
taxes 147,737 11,919 1,140 228,641 11,919 1,818
------------------------------------------------------------------------
361,205 11,919 2,930 442,109 11,919 3,609
Taxes per boe 2.51 0.73 243 1.37 0.41 235
------------------------------------------------------------------------
------------------------------------------------------------------------


SUMMARY OF QUARTERLY RESULTS

The following table highlights the Company's performance for the most recent eight quarters that comprise first three quarters of 2005 and the 2004 and 2003 fiscal years. Total revenue is primarily impacted by commodity prices, production volumes and royalties. Net income and net income per share are primarily impacted by operating, general and administrative costs, depletion, depreciation and accretion, and future income taxes.



($Cdn.) 2005
------------------------------------------------------------------------
Q3 Q2 Q1
------------------------------------------------------------------------
Total net revenue 4,479,544 3,290,840 2,054,182
Net income (loss) (200,436) (157,408) (156,261)
Per share - basic (0.01) (0.01) (0.02)
Per share - diluted (0.01) (0.01) (0.02)
Funds from
operations 1,835,348 871,288 486,573
Per share - basic 0.06 0.03 0.02
Per share - diluted 0.06 0.03 0.02
Total assets 48,955,973 38,308,547 30,978,254
Total bank debt 12,443,478 12,668,469 7,601,583
------------------------------------------------------------------------
------------------------------------------------------------------------


($Cdn.) 2004 2003
------------------------------------------------------------------------
Q4 Q3 Q2 Q1 Q4
------------------------------------------------------------------------
Total net revenue 1,802,339 894,574 181,270 220,763 286,736
Net income (loss) 45,846 (38,913) (77,695) (55,747) 56,633
Per share - basic - (0.01) (0.01) (0.01) 0.01
Per share - diluted - (0.01) (0.01) (0.01) 0.01
Funds from
operations 92,492 119,608 46,529 29,135 (77,159)
Per share - basic 0.01 0.01 (0.01) 0.01 (0.01)
Per share - diluted 0.01 0.01 (0.01) 0.01 (0.01)
Total assets 16,690,703 9,777,944 3,364,353 3,169,054 2,889,856
Total bank debt 3,743,852 3,700,000 - - -
------------------------------------------------------------------------
------------------------------------------------------------------------


LIQUIDITY

At September 30, 2005, the Company had a debt adjusted working capital surplus of approximately $1.3 million, compared to a debt adjusted working capital deficiency of approximately $1.5 million at December 31, 2004. The change in working capital subsequent to year end is attributable to cash flow generated from the assets acquired, drilling activities and private placements completed during the year.

CAPITAL RESOURCES

Revolving demand loan

At September 30, 2005, Arsenal has a revolving demand loan for $14.2 million (December 31, 2004 - $4.0 million) with a Canadian financial institution. The facility may be drawn down or repaid at any time and there are no scheduled repayment terms. The debt is secured by a demand debenture containing a first fixed charge on all crude oil and natural gas assets of Arsenal. At September 30, 2005, the interest rate was bank prime plus 0.75% (December 31, 2004 - bank prime plus 1.0%).

Private Placement

On October 27, 2005, Arsenal completed the first closing of a brokered private placement and has issued 3,855,500 units ("Units") at a subscription price of $1.60 per Unit for aggregate gross proceeds of $6,168,800. Each Unit consists of one common share ("Common Share") in the share capital of the Corporation and one-half of one common share purchase warrant ("Warrant"). Every one Warrant is exercisable into one additional Common Share of the Corporation at an exercise price of $2.50 per share on or before April 27, 2007. The Warrants contain a provision that should the Common Shares of Arsenal trade on the Toronto Stock Exchange or other recognized exchange at a price of $3.00 or higher for 20 non-consecutive trading days, the holder of such Warrants will have 10 business days in which to exercise such Warrants, and any Warrants not so exercised within such time shall be cancelled and void.

CAPITAL EXPENDITURES

Capital expenditures for the nine month period ended September 30, 2005 totalled $26.7 million. $10.0 million was spent for the acquisition of IC Energy which closed March 31, 2005, $6.9 million was spent on the property acquisition which closed June 29, 2005, and $5.5 million was paid for the acquisition of Quadra Resources Corp., which closed August 11, 2005. Land costs relate to undeveloped lands acquired in northwestern Alberta and at Maidstone, Saskatchewan. Drilling and facility costs were incurred at Evi, Mitsue and Lloydminister.




($ Cdn.) Total
------------------------------------------------------------------------
Corporate, property and land acquisitions 22,217,797
Seismic 335,351
Drilling and completions 3,026,600
Production facilities 1,125,220
------------------------------------------------------------------------
Total capital expenditures 26,704,969
------------------------------------------------------------------------
------------------------------------------------------------------------


COMMITMENTS AND CONTINGENCIES

Arsenal has contractual obligations in the normal course of operations including purchase of assets and services, operating agreements, transportation commitments and sales commitments. These obligations are of a recurring and consistent nature and impact cash flow in an ongoing manner.

With the corporate acquisition of Quadra Resources Corp. on August 11, 2005, Arsenal has acquired the Nuqra Concession in Egypt. The Concession Agreement signed with the Egyptian government requires gross expenditures of USD$11.0 million over an eight year period on seismic evaluation, exploratory drilling and developmental drilling. After completing a farm out agreement with a Canadian public company, Arsenal is responsible for incurring approximately USD$2.0 million of expenditures to maintain the Concession.

RISK MANAGEMENT

Business risks affecting Arsenal are unchanged from those disclosed in the December 31, 2004 Annual Report.

SIGNIFICANT ACCOUNTING POLICIES AND ESTIMATES

The interim consolidated financial statements dated June 30, 2005 have been prepared following the same accounting policies and methods of computation as the consolidated financial statements for the fiscal year ended December 31, 2004, with the addition of the policy outlined below.

GOODWILL

Goodwill is the residual amount that results when the purchase price of an acquired business exceeds the fair value of the net identifiable assets and liabilities of the acquired business. Net identifiable liabilities acquired include an estimate of future income taxes. In accordance with CICA Handbook Section 3062, "Goodwill and Other Intangibles", goodwill is tested at least annually for impairment. Impairment is charged to net income in the period in which it occurs.

The test for impairment is the comparison of the book value of net assets (assets less liabilities) to the fair value of the Company. If the fair value of the Company is less than its book 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.

FINANCIAL REPORTING UPDATE

COMPREHENSIVE INCOME

The CICA has issued Section 1530 "Comprehensive Income" which establishes standards for reporting and display of comprehensive income. This Section is effective for annual and interim periods beginning on or after October 1, 2006 with early adoption permitted for fiscal year ending on or after December 31, 2004. Arsenal has assessed that this guideline is unlikely to have a material effect on the financial statements and does not anticipate adopting the standard until October 2006.

OUTLOOK

STRATEGY

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 2004 and throughout 2005 in order to establish high-quality drilling prospects.

The Company mandate was to acquire inexpensive production to take advantage of current high commodity prices, and utilize those cashflows to develop high impact, high quality plays in Alberta. At the end of the third quarter the first of these high impact wells were successfully drilled and completed. Arsenal intends to further develop these key areas, and with our partners actively adding to our land base in Northern Alberta. 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.

Egypt

Reprocessing of the 3,100 km of seismic that was acquired from Quadra is currently being completed, and approximately 850 km of new seismic is planned to be shot during the fourth quarter. Once the new seismic has been processed, Arsenal and the operator of the Nuqra concession will establish preliminary drilling locations with the intent of drilling three wells during the third and fourth quarters of 2006.

SENSITIVITIES

The following table provides estimates for 2005 of the sensitivity of the Company's 2005 net income and cash flow to changes in commodity prices and the U.S./Cdn. Dollar exchange rate:



Variable Change Cash Flow
------------------------------------------------------------------------
Crude oil price $U.S. 1/bbl $ 350,000
Natural gas price $Cdn. 0.10/mcf $ 50,000
$U.S./$Cdn. exchange rate 0.01 $ 50,000
Interest rate 1.00% $ 60,000
Crude oil production 100 bbl/d $ 750,000
Natural gas production 100 mcf/d $ 125,000
------------------------------------------------------------------------
------------------------------------------------------------------------


CONSOLIDATED BALANCE SHEETS

September 30, December 31,
2005 2004
------------------------------------------------------------------------
Unaudited Audited

ASSETS
Current assets
Cash - 217,063
Accounts receivable (note 5) 3,157,936 582,762
------------------------------------------------------------------------
3,157,936 799,825
Reclamation bonds 215,145 210,960
Property, plant and equipment 40,791,331 15,679,918
Goodwill (note 3) 4,791,561 -
------------------------------------------------------------------------
48,955,973 16,690,703
------------------------------------------------------------------------
------------------------------------------------------------------------

LIABILITIES
Current liabilities
Accounts payable and accrued liabilities 3,742,519 2,265,903
Revolving demand loan (note 4) 12,443,478 3,743,852
Current portion of deferred revenue 352,650 352,650
------------------------------------------------------------------------
16,538,647 6,362,405
Deferred revenue 114,172 198,229
Future income taxes 7,950,785 1,443,129
Asset retirement obligation (note 6) 1,106,689 780,889
------------------------------------------------------------------------
25,710,293 8,784,652
------------------------------------------------------------------------

SHAREHOLDERS' EQUITY
Shareholders' equity (note 7) 23,433,661 7,458,134
Warrants (note 8) 185,027 988,760
Contributed surplus (note 9) 826,122 144,183
Deficit (1,199,131) (685,026)
------------------------------------------------------------------------
23,245,680 7,906,051
------------------------------------------------------------------------
48,955,973 16,690,703
------------------------------------------------------------------------
------------------------------------------------------------------------

Segmented information (note 11)
Commitments and contingencies (note 12)
Subsequent events (note 13)


CONSOLIDATED STATEMENTS OF OPERATIONS AND DEFICIT
(UNAUDITED)

Three Months Ended Nine Months Ended
September 30 September 30
----------------------- -------------------------
2005 2004 2005 2004
------------------------------------------------------------------------

REVENUE
Oil and gas 5,968,709 898,566 12,716,490 1,296,607
Royalties (1,489,165) (182,380) (2,891,924) (246,670)
------------------------------------------------------------------------
4,479,544 716,186 9,824,566 1,049,937
------------------------------------------------------------------------

EXPENSES
Operating 1,968,431 268,595 4,590,643 356,291
General and
administrative 685,807 266,788 2,215,761 518,923
Finance charges 110,387 56,611 302,572 56,611
Depletion,
depreciation and
accretion 1,440,866 163,105 2,601,853 278,548
Foreign exchange 113,285 - 185,733 -
------------------------------------------------------------------------
4,318,776 755,099 9,896,562 1,210,373
------------------------------------------------------------------------

Income (loss) before
income taxes 160,768 (38,913) (71,996) (160,436)
Current income taxes 213,468 213,468
Future income taxes 147,737 11,919 228,641 11,919
------------------------------------------------------------------------
Net income (loss) (200,436) (50,832) (514,105) (172,355)
Deficit
- beginning of period (998,695) (281,046) (685,026) (159,523)
Acquisition adjustment - (398,994) - (398,994)
------------------------------------------------------------------------
Deficit
- end of period (1,199,131) (730,872) (1,199,131) (730,872)
------------------------------------------------------------------------
------------------------------------------------------------------------

Income (loss)
per share
- basic and diluted $ (0.01) $ (0.01) $ (0.02) $ (0.02)



CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)

Three Months Ended Nine Months Ended
September 30 September 30
----------------------- -------------------------
2005 2004 2005 2004
------------------------------------------------------------------------
Cash flows from
operating activities
Net income (loss) (200,436) (38,913) (514,105) (172,355)
Items not
affecting cash
Depletion,
depreciation
and accretion 1,440,866 163,105 2,601,853 278,548
Future income taxes 147,737 11,919 228,641 11,919
Stock-based
compensation
expense (note 9) 367,948 25,645 775,144 38,364
Deferred revenue (34,051) (30,229) (84,057) (30,229)
Foreign exchange 113,285 - 185,733 -
------------------------------------------------------------------------
Funds from operations 1,835,348 131,527 3,193,209 126,247
Net change in
non-cash working
capital items
(note 10) 181,830 20,572 (1,667,299) (434,388)
------------------------------------------------------------------------
Net cash provided
by (used in)
operating activities 2,017,178 152,099 1,525,910 (308,141)
------------------------------------------------------------------------

Cash flows from
investing
activities
Corporate
acquisitions (note 3) - - (11,441,054) -
Additions to
property, plant
and equipment (3,219,160) (5,251,542) (6,034,030) (6,020,615)
Reclamation bonds - (223,340) - (223,340)
Changes in non-cash
working capital
- investing items
(note 10) 500,259 - 568,741 -
------------------------------------------------------------------------
Net cash provided
by (used in)
investing
activities (2,718,901) (5,474,882) (16,906,343) (6,243,955)
------------------------------------------------------------------------

Cash flows from
financing
activities
Issue of shares
for cash 305,184 1,026,380 1,977,694 1,665,041
Issue of shares for
cash upon exercise
of stock options - - 193,784 -
Issue of shares for
cash upon exercise
of warrants 695,266 - 4,551,016 -
Share issue costs (73,736) - (258,750) -
Deferred revenue - 735,529 735,529
Revolving demand loan (224,991) 3,700,000 8,699,626 3,700,000
------------------------------------------------------------------------
Net cash
provided by(used in)
financing activities 701,723 5,461,909 15,163,370 6,100,570
------------------------------------------------------------------------

Change in cash
during the period - 139,126 (217,063) (451,526)
Cash
- Beginning of period - 152,928 217,063 743,580
------------------------------------------------------------------------
Cash - End of period - 292,054 - 292,054
------------------------------------------------------------------------
------------------------------------------------------------------------

Supplemental information (note 10)
Segmented information (note 11)


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, 2004, with the addition of the policy outlined in note 2. 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, 2004.

2. GOODWILL

Goodwill is the residual amount that results when the purchase price of an acquired business exceeds the fair value of the net identifiable assets and liabilities of the acquired business. Net identifiable liabilities acquired include an estimate of future income taxes. Goodwill is tested at least annually for impairment. Impairment is charged to net income in the period in which it occurs.

The test for impairment is the comparison of the book value of net assets (assets less liabilities) to the fair value of the business unit, being the Company. If the fair value of the Company is less than its book 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.

3. BUSINESS ACQUISITON

Effective August 11, 2005 Arsenal acquired all of the issued and outstanding securities of Quadra Resources Corp. ("Quadra"). Effective March 31, 2005 Arsenal acquired all of the issued and outstanding shares of IC Energy Inc. ("IC Energy"). The purchase method of accounting was used for each business combination and the allocation of the purchase price and consideration for each acquisition is as follows:




------------------------------------------------------------------------
Net assets acquired at assigned values: Quadra IC Energy
------------------------------------------------------------------------
Working capital deficiency (500,000) -
Property, plant and equipment - 10,243,000
Undeveloped land 5,263,014 -
Seismic 720,000 -
Goodwill 2,126,363 2,665,198
Asset retirement obligation - (123,713)
Future income taxes (2,126,363) (2,784,485)
------------------------------------------------------------------------
Net assets acquired 5,483,014 10,000,000
------------------------------------------------------------------------
------------------------------------------------------------------------

Financed by:
------------------------------------------------------------------------
Shares issued (note 7) 5,233,014 4,500,000
Cash - 5,500,000
Acquisition costs 250,000 -
------------------------------------------------------------------------
Purchase price 5,483,014 10,000,000
------------------------------------------------------------------------
------------------------------------------------------------------------



4. REVOLVING DEMAND LOAN

At September 30, 2005, The Company has available a demand operating loan in the amount of $14.2 million (December 31, 2004 - $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.

5. RELATED PARTY TRANSACTIONS

At September 30, 2005, $218,037 is due from an officer and director of the Company relating to salary advances. These advances are anticipated to be paid in full by December 31, 2005.

6. ASSET RETIREMENT OBLIGATIONS

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




Nine Months Ended Year Ended
September 30, 2005 December 31, 2004
------------------------------------------------------------------------
Asset retirement obligation
- beginning of period 780,889 106,582
Liabilities acquired 242,159 609,300
Liabilities incurred 33,898 58,891
Foreign exchange (14,022) -
Accretion expense 63,765 6,116
------------------------------------------------------------------------
Asset retirement obligation
- end of period 1,106,689 780,889
------------------------------------------------------------------------
------------------------------------------------------------------------

7. SHAREHOLDERS' EQUITY

Nine Months Ended Year Ended
September 30, 2005 December 31, 2004
------------------------------------------------------------------------
Shares Amount ($) Shares Amount ($)
------------------------------------------------------------------------
Balance - beginning of
period 18,989,706 7,458,134 8,740,836 2,163,533
Issued to acquire IC
Energy 3,000,000 4,500,000 - -
Issued to acquire Quadra 4,088,292 5,483,014 - -
Issued to acquire Nahanni - - 1,000,000 750,000
Issued to acquire Orange - - 1,850,000 550,375
Issued for cash 1,254,710 1,977,694 7,298,870 4,270,532
Cost of shares issued - (258,750) - (493,306)
Tax effect of flow-through
shares - (1,445,169) - -
Tax effect of share issue
costs - 77,000 - 197,000
Issued on exercise of
options 904,277 193,784 100,000 20,000
Issued on exercise of
warrants 5,163,582 4,551,016 - -
Allocated from contributed
surplus - 93,205 - -
Allocated from warrants - 803,733 - -
------------------------------------------------------------------------
Balance - end of period 33,400,567 23,433,661 18,989,706 7,458,134
------------------------------------------------------------------------
------------------------------------------------------------------------


The per share calculations for the nine month period ended September 30, 2005 was based on weighted average shares outstanding of 25,915,932 (September 30, 2004 - 13,512,311). The per share calculations for the three month period ended September 30, 2005 was based on weighted average shares outstanding of 30,942,600 (September 30, 2004 - 13,688,148). In computing net income per share - diluted, 1,086,238 shares (June 30, 2004 - 1,806,645) were added to the weighted average number of shares outstanding for both the three and nine month periods, reflecting the dilutive effect of stock options and share purchase warrants.

8. 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 reconciles the movement in the warrant account balance:




Nine Months Ended Year Ended
September 30, 2005 December 31, 2004
------------------------------------------------------------------------
Balance - beginning of period 988,760 -
Warrants issued on acquisition
of Orange Exploration - 80,820
Private placement - 907,940
Reclassification to common
shares on exercise of warrants (803,733) -
------------------------------------------------------------------------
Balance - end of period 185,027 988,760
------------------------------------------------------------------------
------------------------------------------------------------------------

9. STOCK OPTIONS

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

Nine Months Ended Year Ended
September 30, 2005 December 31, 2004
Weighted Weighted
Average Average
Options Price ($) Options Price ($)
------------------------------------------------------------------------
Balance - beginning of
period 2,505,000 0.40 1,150,000 0.21
Granted 1,870,000 1.22 1,455,000 0.58
Exercised (904,277) 0.23 (100,000) 0.20
Cancelled (435,723) 0.59 - -
------------------------------------------------------------------------
Balance - end of period 3,035,000 0.91 2,505,000 0.40
------------------------------------------------------------------------
Exercisable - end of
period 1,512,501 0.77 1,125,833 0.26
------------------------------------------------------------------------
------------------------------------------------------------------------



The Company incurred non-cash compensation expense of $775,144 for the nine month period ending September 30, 2005 (2004 - nil) related to vested options issued under the Option Plan with a corresponding increase to contributed surplus. The Company incurred non-cash compensation expense of $ 367,948 for the three month period ending September 30, 2005 (2004 - nil) 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:




Nine Months Ended Year Ended
September 30, 2005 December 31, 2004
------------------------------------------------------------------------
Balance - beginning of period 144,183 59,990
Issuance of stock options 775,144 84,193
Reclassification to common
shares on exercise of options (93,205) -
------------------------------------------------------------------------
Balance - end of period 826,122 144,183
------------------------------------------------------------------------
------------------------------------------------------------------------

10. SUPPLEMENTAL CASH FLOW INFORMATION

Three Three Nine Nine
Months Months Months Months
Ended Ended Ended Ended
September June September September
30, 2005 30, 2004 30, 2005 30, 2004
------------------------------------------------------------------------
Change in non-cash working
capital items
Operating accounts
receivable (1,830,951) (86,454) (3,143,915) (367,809)
Operating accounts
payable 2,012,781 107,026 1,476,616 (66,579)
----------------------------------------------
Amounts relating to
operating activities 181,830 20,572 (1,667,299) (434,388)
Amounts relating to
investing activities 500,259 - 568,741 -
------------------------------------------------------------------------
682,089 20,572 (1,098,558) (434,388)
------------------------------------------------------------------------
------------------------------------------------------------------------

Interest paid 67,996 56,661 238,022 56,661
------------------------------------------------------------------------
------------------------------------------------------------------------



11. SEGMENTED INFORMATION

A significant portion of the Company's assets and revenues are earned in the United States and Egypt and are monitored as an identifiable reporting segment by management. The remaining assets and associated revenues are earned in Canada by Arsenal Energy Inc. Business risks and economic indicators are similar in Canada and the United States. There are no comparative figures as Arsenal acquired the United States properties August 31, 2004 and the Egyptian concession on August 11, 2005.




($ Cdn.) Canada U.S Egypt Total
------------------------------------------------------------------------
Oil and gas revenue 7,192,763 5,523,727 - 12,716,490
Net income before tax (488,446) 529,646 (113,196) (71,996)
Operating income 3,006,329 2,227,594 - 5,233,923
Capital assets 29,923,039 4,885,278 8,049,173 42,857,490
Capital expenditures
(including acquisitions) 17,376,931 98,153 - 17,475,084
------------------------------------------------------------------------
------------------------------------------------------------------------


12. COMMITMENTS AND CONTINGENCIES

With the corporate acquisition of Quadra Resources Corp. on August 11, 2005, Arsenal has acquired the Nuqra Concession in Egypt. The Concession Agreement signed with the Egyptian government requires gross expenditures of USD$11.0 million over an eight year period on seismic evaluation, exploratory drilling and developmental drilling. After completing a farm out agreement with a Canadian public company, Arsenal is responsible for incurring approximately USD$2.0 million of expenditures to maintain the Concession.

13. SUBSEQUENT EVENTS

Private Placement

On October 27, 2005, Arsenal completed the first closing of a brokered private placement and has issued 3,855,500 units ("Units") at a subscription price of $1.60 per Unit for aggregate gross proceeds of $6,168,800. Each Unit consists of one common share ("Common Share") in the share capital of the Corporation and one-half of one common share purchase warrant ("Warrant"). Every one Warrant is exercisable into one additional Common Share of the Corporation at an exercise price of $2.50 per share on or before April 27, 2007. The Warrants contain a provision that should the Common Shares of Arsenal trade on the Toronto Stock Exchange or other recognized exchange at a price of $3.00 or higher for 20 non-consecutive trading days, the holder of such Warrants will have 10 business days in which to exercise such Warrants, and any Warrants not so exercised within such time shall be cancelled and void. The private placement securities are subject to a hold period of four months, expiring February 28, 2006.

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 Exchange does not accept responsibility for the adequacy or accuracy of this release.

Contact Information