Arsenal Energy Inc.
TSX : AEI
FRANKFURT : A1E

Arsenal Energy Inc.

November 15, 2006 02:37 ET

Arsenal Announces Third Quarter 2006 Operating and Financial Results

CALGARY, ALBERTA--(CCNMatthews - Nov. 15, 2006) - Arsenal Energy Inc. ("Arsenal or the Company") (TSX:AEI)(FRANKFURT:A1E) is pleased to announce the results of operations for the three and nine month periods ended September 30, 2006.

THIRD QUARTER CORPORATE HIGHLIGHTS

- Cashflow of $2.01 million for the three months ended September 30th .

- Successful testing of deep gas well at Tower Creek.

- Drilled and cased 8 wells at Worsley, Evi, Lubicon and Wildmere.

- Selection of the first two drilling locations and one contingent location on the Nuqra Concession in Egypt.

SELECTED FINANCIAL AND OPERATIONAL INFORMATION



---------------------------------------------------------------------------
FINANCIAL Three Months Ended Nine Months Ended
September 30 September 30
---------------------------------------------------------------------------
2006 2005 2006 2005
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Financial
Funds from operations(1) 2,006,566 1,835,349 5,131,211 3,193,209
Per unit - basic 0.04 0.07 0.09 0.14
Per unit - diluted 0.03 0.07 0.09 0.13
Bank debt 20,535,965 7,601,583 20,535,965 7,601,583
Operating costs per boe 21.26 13.69 16.81 11.36
Operating netbacks per boe 18.85 17.47 19.26 15.62
Market
Shares outstanding
End of period 65,677,403 28,015,244 65,677,403 28,015,244
Weighted average - basic 65,656,022 26,601,305 59,312,943 23,531,894
Weighted average -
diluted 66,506,268 27,817,126 60,163,189 24,747,715
Shares trading
High 1.36 1.69 1.88 1.92
Low 0.09 1.00 0.89 0.88
Close 1.00 1.40 1.00 1.48
Average daily volume 122,700 51,600 145,000 51,100
---------------------------------------------------------------------------
---------------------------------------------------------------------------
OPERATIONS
---------------------------------------------------------------------------
Daily production (average)
Crude oil (bbl) 1,356 1,437 1,305 758
NGLs (bbl) 61 32 53 31
Natural gas (mcf) 2,149 562 1,650 231
---------------------------------------------------------------------------
Total (boe)(2) 1,775 1,563 1,632 828
Realized commodity
prices ($Cdn.)
Total crude oil (bbl) 57.06 44.56 47.28 38.67
NGLs (bbl) 57.05 51.78 48.57 38.53
Natural gas (mcf) 5.91 6.22 6.19 7.46
---------------------------------------------------------------------------
Average (boe)(2) 52.70 44.81 45.61 38.59
Reference pricing
WTI (U.S.$/bbl) 70.48 63.19 68.24 49.84
AECO gas ($Cdn./mcf) 5.71 8.81 6.85 6.63
Foreign Exchange
($U.S./$Cdn.) 1.12 1.20 1.13 1.23
---------------------------------------------------------------------------


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

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

OPERATIONS IN REVIEW

The third quarter of 2006 was the busiest in our history. We participated in 13.0 (7.925 net) wells resulting in 6 (3.775 net) oil wells, and 2 (1.15 net) gas wells and the remainder were either waiting on further evaluation or abandoned. As a result of the pipeline constraints and exceptionally wet weather, Arsenal's production for the quarter lagged forecasts to average 1,775 boe/d. The new wells at Evi have been put on more regular production subsequent to the quarter end. Commodity prices declined approximately 30% during the quarter, which negatively impacted our forecasted cashflows.

EGYPT

All three selected drilling locations are in the Nuqra sub basin in the central part of the 5.625 million acre Nuqra concession. The concession operator has located a suitable drilling rig and is currently in the process of preparing the necessary contracts and receiving government approvals. It is expected that the rig will be available to commence drilling in the first quarter of 2007.

TOWER CREEK

As announced in the second quarter of 2006, Arsenal participated in the successful drilling of a 4,900 meter exploratory Leduc well at Tower Creek, Alberta in which Arsenal holds a 14% working interest. This well was tested in the third quarter and the operator has indicated that raw gas production flow rates are expected to be in the 20 to 25 mmcf/d range. Arsenal expects to have net sales gas, after shrinkage, of 2.1 to 2.4 MMcf/d or 350 to 400 boe/d. Arsenal and partners have committed to drill a follow up location at 11-26-55-27 W5M and the operator has licensed the well and commenced preparing surface for a drilling rig which is expected to arrive in the first quarter 2007.

EVI

Arsenal drilled 3 (1.8 net) wells in the Evi area of Alberta. Of these wells, 2 wells (.8 net) were cased and completed and 1 well (1 net) was dry and abandoned. Initial production from each of these wells has been above 240 boe/d, however, a break in the third party oil shipper's pipeline has caused production from this area to be intermittent. Arsenal has a 50% working interest before payout and 30% after payout in one well, a 30% working interest in the second well and a 30% working interest in follow up locations on this property.

WORSLEY

Arsenal drilled 1 (0.6 net) well at Worsley, Alberta. This well is waiting on further evaluation.

LUBICON

Arsenal drilled 2 (0.75 net) oil wells at Lubicon, Alberta. Arsenal does not operate the wells but has a 37.5% working interest in one well and a 50% working interest before payout reverting to a 37.5% working interest after payout in one well. These wells were cased and completed during the quarter; however this property also had pipeline constraints. Arsenal expects that these wells will provide more stable production in November.

PRINCESS/ALDERSON

Arsenal and partners drilled 2 (1.15 net) wells at Princess/Alderson, Alberta. These wells are both cased as potential gas wells. Arsenal operates 1 well (0.75 net). Arsenal intends to complete the well during the fourth quarter.

WILDMERE

Arsenal drilled 3 (2.1 net) wells at Wildmere, Alberta. All of these wells were cased and are presently producing at rates averaging 15 boe/d. In October 2006 Arsenal acquired an additional property in the area and drilled a well which was subsequently cased as an oil well.

NORTH DAKOTA

Production has remained stable throughout the third quarter at 375 boe/d. The 180 boe/d hedge which was put in place upon the acquisition of the properties on September 1, 2004 expired on September 1, 2006. It is anticipated that this will add approximately $150,000 per month in cashflow to Arsenal for the next quarter based on the pricing received for the production from these properties in the first three quarters of 2006, assuming a WTI price of USD$60 per barrel.

COMMODITY PRICING

West Texas Intermediate crude oil prices declined approximately 20% from highs exceeding USD$75 per barrel of WTI in August to around USD$60 in November.

Natural gas prices were down significantly during the third quarter, as storage inventories neared capacity in Canada and the United States. Recent cold weather in the eastern states has resulted in natural prices recovering from September lows. Natural gas futures for winter 2006 and 2007 deliveries are presently around $8 US on the NYMEX exchange.

Heavy crude oil differentials remained seasonally strong during the third quarter. Arsenal believes that this is a result of the busy summer paving season and the benefit from pipeline reversals in the Midwestern United States during 2006, which now transport Canadian heavy crude oil to the US Gulf Coast.

OUTLOOK

We are providing exit guidance for 2006 of 2,000 boe/d and we are currently producing approximately 1,900 boe/d. Arsenal has initiated a five well drilling program at Wildmere, Lashburn, Hillmond and Dee Valley. Once the facility constraints are resolved at Evi/Lubicon, and with additional drilling, we are confident that this mark is achievable, and sustainable. The new management is continuing to grow its' inventory of quality prospects focusing on oil locations and reserving gas targets to be pursued when market conditions improve. Our recent success at Tower Creek will prove to be a key asset for Arsenal which will, when on-stream, provide stable production well into the future.

We have exited the busiest quarter in our history, and our drilling success will provide a strong platform from which we will continue to grow in 2007 and beyond. We look forward to continued growth in production in the fourth quarter, and with stable commodity prices we will achieve record cashflow.

RESULTS OF OPERATIONS

PRODUCTION AND MARKETING

Production volumes for the three and nine month periods ended September 30, 2006 increased 14% and 38% respectively over comparable periods in 2005. The increase in volume is attributable to the integration of corporate and property acquisitions and new wells drilled during the year.

Arsenal is currently producing approximately 1,900 boe/d, and has established a 2006 year end target exit rate of 2,000 boe/d. The increase in volume is attributable to our fourth quarter drilling program, and resolution of facility constraints which impacted production in Northern Alberta for September and October.



Three Months Ended Nine Months Ended
September 30 September 30
---------------------------------------------------------------------------
2006 2005 % Change 2006 2005 % Change
---------------------------------------------------------------------------
Crude oil (bbl/d) 1,356 1,437 (6) 1,305 1,073 22
NGL (bbl/d) 61 32 90 53 35 50
Natural gas (mcf/d) 2,149 562 282 1,650 463 256
---------------------------------------------------------------------------
Total (boe/d) 1,775 1,563 14 1,632 1,185 38
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Production split
---------------------------------------------------------------------------
Oil & NGLs 80% 94% (15) 83% 93% (11)
Natural Gas 20% 6% 237 17% 7% 159
---------------------------------------------------------------------------
---------------------------------------------------------------------------


COMMODITY PRICES

Commodity price realizations during the nine month period ended September 30, 2006 increased 7% over the comparable period in 2005. The impact of favourable crude oil and natural gas prices were partially offset by a 7% 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 expired September 2006.

The increase in commodity price realizations is reflective of the asset portfolio of Arsenal at September 30, 2006, with approximately 60% of our oil production comprised of lower gravity heavy crude oil, compared to more than 75% of corporate production in the third quarter of 2005. The heavy oil differential traditionally widens over winter, as demand for heavy crude is highest in the summer. The differential exceeded USD$25 per barrel for much of the first quarter, and has decreased starting in April reflecting historical seasonality. Arsenal will continue its plan to reduce the effects of this differential on its cash flows.

Arsenal anticipates continued historically high crude oil prices while inventory issues may continue to impact natural gas. It is anticipated that a colder than normal winter in North America could dramatically impact the North American gas price.



($Cdn.) Three Months Ended Nine Months Ended
September 30 September 30
---------------------------------------------------------------------------
Prices -
Before Derivatives 2006 2005 % Change 2006 2005 % Change
---------------------------------------------------------------------------
Total crude oil
(bbl) 57.06 44.56 28 47.28 41.79 13
NGLs (bbl) 57.05 51.78 10 48.57 43.40 12
Natural gas (mcf) 5.91 6.22 (5) 6.19 6.84 (10)
---------------------------------------------------------------------------
Total (boe) 52.70 44.81 18 45.61 42.53 7
---------------------------------------------------------------------------
---------------------------------------------------------------------------

Reference Pricing
---------------------------------------------------------------------------
WTI ($U.S./bbl) 70.48 63.19 12 68.24 55.40 23
AECO gas ($Cdn./mcf) 5.71 8.81 (35) 6.85 7.38 (7)
NYMEX gas
($U.S./mmbtu) 6.00 10.24 (41) 6.00 7.80 (23)
Foreign exchange
($Cdn./$U.S.) 1.12 1.20 (6) 1.13 1.22 (7)
---------------------------------------------------------------------------
---------------------------------------------------------------------------


OIL AND GAS REVENUE

Net oil and gas revenue for the three and nine month periods ended September 30, 2006 were 41% and 69% higher respectively, than comparable periods in 2005, reflecting increased petroleum and natural gas production and commodity prices. Revenue per boe for the three and nine month periods ended September 30, 2006 increased 24% and 23% respectively, over comparable periods in 2005, as the impact of the hedged production was offset by higher commodity prices.



($Cdn.) Three Months Ended Nine Months Ended
September 30 September 30
---------------------------------------------------------------------------
2006 2005 % Change 2006 2005 % Change
---------------------------------------------------------------------------
Crude oil
sales 7,040,383 5,938,347 19 18,770,471 12,233,827 53
NGL sales 314,968 103,800 203 724,989 418,366 73
Natural gas
sales 1,155,732 368,937 213 2,899,800 862,050 236
Other 251,753 7,824 3,118 367,371 195,387 88
Loss on
Forward
contracts (369,367) (450,199) (18) (1,248,026) (993,140) 26
---------------------------------------------------------------------------
Net oil and
gas
revenue 8,393,470 5,968,709 41 21,514,606 12,716,490 69

Per boe 51.40 41.52 24 46.41 37.78 23
---------------------------------------------------------------------------
---------------------------------------------------------------------------


ROYALTIES

Royalties as a percentage of gross oil and gas revenue were consistent with comparable periods in 2005 at 22%. Royalties per boe for the three months ended September 30, 2006 increased 9% over comparable periods in 2005, reflecting the changed asset portfolio of the Company, with a greater portion of corporate production coming from higher burden natural gas as a result of the Tiverton acquisition. Arsenal expects the corporate royalty rate to remain at 22% of gross oil and gas revenues for the remainder of the year.

OPERATING COSTS

Operating expenses per boe for the three and nine month periods ended September 30, 2006 increased 55% and 23% respectively over the same periods in 2005. The significant increase over prior periods is attributable to an extensive workover programs completed in Lloydminster, Galahad and Wildmere. Arsenal anticipates that these workovers will result in reduced operating costs from these properties in the future.



($Cdn.) Three Months Ended Nine Months Ended
September 30 September 30
---------------------------------------------------------------------------
2006 2005 % Change 2006 2005 % Change
---------------------------------------------------------------------------
Operating
expense 3,470,938 1,968,431 76 7,794,382 4,590,643 70
Per boe 21.26 13.69 55 16.81 13.64 23
---------------------------------------------------------------------------
---------------------------------------------------------------------------


PRODUCT NETBACKS (1)

Netbacks for the three and nine month periods ended September 30, 2006 increased 8% and 19% respectively, over the comparative periods in 2005. Higher commodity prices were partially offset by increased royalties and operating costs experienced during 2006.



($Cdn. per boe) Three Months Ended Nine Months Ended
September 30 September 30
---------------------------------------------------------------------------
2006 2005 % Change 2006 2005 % Change
---------------------------------------------------------------------------
Net revenue
after
derivatives 51.40 41.53 24 46.41 39.29 18
Royalties (11.30) (10.36) 9 (10.33) (8.94) 16
Operating
expenses (21.26) (13.70) 55 (16.81) (14.19) 18
---------------------------------------------------------------------------
Operating
netback 18.85 17.47 8 19.26 16.16 19
---------------------------------------------------------------------------
---------------------------------------------------------------------------


GENERAL AND ADMINISTRATIVE EXPENSES

General and administrative costs per boe for the three and nine month periods ended September 30, 2006 increased by 548% and 56% respectively over the comparative period in 2005. Included in general and administrative costs for the first quarter is $275,000 relating to employee annual bonuses for 2005. The increase in general and administrative costs is also reflective of increased staff over the prior year. Arsenal anticipates general and administrative costs to increase in absolute terms but decrease on a per barrel basis as the Company continues to grow production.



($Cdn.) Three Months Ended Nine Months Ended
September 30 September 30
---------------------------------------------------------------------------
2006 2005 % Change 2006 2005 % Change
---------------------------------------------------------------------------
General and
administra-
tive 725,525 317,858 128 2,676,608 1,440,617 86
Foreign
exchange (1,840) 113,285 (102) 183,009 185,733 (1)
---------------------------------------------------------------------------
723,685 431,143 27 2,859,617 1,626,350 84

General and
administra-
tive per boe 4.44 0.69 548 5.77 3.11 86
Foreign
Exchange
per boe (0.01) 0.79 (101) 0.39 0.55 (28)
---------------------------------------------------------------------------
---------------------------------------------------------------------------


FINANCE CHARGES

Finance charges for the three month and nine month periods ended September 30, 2006 increased 250% and 199% respectively over the comparative periods in 2005, as the Company drew on its credit facility to fund both drilling and acquisition activities during 2006. Included in finance charges for the nine months ended September 30, 2006 is $138,056 in interest relating to interest paid to the holders of the convertible debentures, and $70,000 in accrued interest charges for the three month period ended September 30, 2006.



($Cdn.) Three Months Ended Nine Months Ended
September 30 September 30
---------------------------------------------------------------------------
2006 2005 % Change 2006 2005 % Change
---------------------------------------------------------------------------
Bank line
interest 316,722 110,387 187 695,599 302,572 130
Convertible
debenture
interest 70,000 - 100 208,056 - 100
---------------------------------------------------------------------------
386,722 110,387 250 903,655 302,572 199
Per boe 1.94 0.77 153 1.50 0.90 67
---------------------------------------------------------------------------
---------------------------------------------------------------------------


DEPLETION, DEPRECIATION, AND ACCRETION

Depletion, depreciation and accretion per boe increased 143% for the three month period ended September 30, 2006 and 155% for the nine month period ended September 30, 2006 compared to the same periods in 2005. The increase is attributable to the higher production rates, significantly higher asset base in 2006 compared to 2005, and additional accretion incurred on the asset retirement obligation.



($Cdn.) Three Months Ended Nine Months Ended
September 30 September 30
---------------------------------------------------------------------------
2006 2005 % Change 2006 2005 % Change
---------------------------------------------------------------------------
Depletion,
deprecia-
tion and
accretion 3,979,771 1,440,866 176 9,128,532 2,601,853 251
Per boe 24.37 10.02 143 19.69 7.73 155
---------------------------------------------------------------------------
---------------------------------------------------------------------------


TAXES

During the nine month period ended September 30, 2006, Arsenal recovered future income taxes totalling $3.7 million compared to an expense of $0.4 million over the same period in 2005. Of this amount, $2.5 million is attributable to the reduction in the substantially enacted corporate income tax rates for oil and gas producers. A future income tax balance of $12.9 million is recorded as a liability as at September 30, 2006 (September 30, 2005 - $7.9 million).



($Cdn.) Three Months Ended Nine Months Ended
September 30 September 30
---------------------------------------------------------------------------
2006 2005 % Change 2006 2005 % Change
---------------------------------------------------------------------------
Current
income
taxes - (213,468) 100 - (213,468) 100
Future
Income
taxes
(reduction) 1,160,499 (147,737) (886) 3,700,496 228,641 1,518
---------------------------------------------------------------------------
1,160,499 (361,205) (421) 3,700,496 15,173 24,289
Per boe 7.11 (2.51) (383) 7.98 0.05 17,607
---------------------------------------------------------------------------
---------------------------------------------------------------------------


LIQUIDITY

Nine Months Ended
($Cdn.) September 30, 2006
---------------------------------------------------------------------------
Sources
Funds from operations 5,131,211
Exercise of warrants 98,142
Exercise of options 59,000
Change in non-cash working capital - operating items (399,042)
Change in non-cash working capital - investing items (1,205,987)
---------------------------------------------------------------------------
Total sources of cash 3,683,324

Uses
Plant, property and equipment additions (17,262,119)
Share issue costs (760,976)
---------------------------------------------------------------------------
Total uses of cash (18,023,095)

Increase in bank debt (14,339,770)
---------------------------------------------------------------------------
---------------------------------------------------------------------------


OUTLOOK

STRATEGY

Arsenal's domestic production and cashflow has increased significantly over the past two years. The Company anticipates continued growth domestically both through the drill-bit and accretive acquisitions. The addition of a new Vice President of Exploration, a geophysicist, and two engineers in our Operations group has already begun to provide results for shareholders.

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

- Stable Government and operating environment

- Significant upside relative to capital exposure

- Experienced and established international operator

- Considerable land acreage

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

Egypt

The 800 km seismic acquisition and processing program was completed in the second quarter. This data was included in the interpretation resulting from the reprocessing of the 3,200 km of seismic previously acquired over the concession. This combination of processed and interpreted data has confirmed several locations which we have high graded to allow us to select the first two drilling locations, and a third contingent location. The first two wells are scheduled to begin drilling during the first quarter of 2007, with the conditional well to follow immediately thereafter. The Egyptian government has granted approval of the first two locations, and we anticipate approval of the contingent location during the fourth quarter of 2006.

North America

Arsenal emphasises a full-cycle approach to its business and plans to continue to develop drilling opportunities as a means to grow its production base and creating value for shareholders. Consistent with its full-cycle approach, Arsenal added to its undeveloped land position through Crown land sales and private property acquisitions during the third quarter in order to establish high-quality drilling prospects. The Company also commenced an active evaluation of the seismic obtained in the Tiverton acquisition and has already identified several drilling opportunities on its existing land base and on open Crown lands.

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. Arsenal believes that over the long term, outlook for both crude oil and natural gas pricing remains strong.



INTERIM CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

As at September 30, 2006 December 31, 2005
---------------------------------------------------------------------------

ASSETS
Current assets
Accounts receivable 8,779,128 4,583,927
Reclamation bonds 195,027 203,291
Property, plant and equipment 94,984,133 44,578,604
Goodwill 18,369,093 4,791,561
---------------------------------------------------------------------------
122,327,380 54,157,383
---------------------------------------------------------------------------
---------------------------------------------------------------------------

LIABILITIES
Current liabilities
Accounts payable and accrued liabilities 10,648,234 6,365,577
Revolving demand loan (note 3) 20,535,965 2,496,195
Deferred revenue - 287,533
---------------------------------------------------------------------------
31,184,199 9,149,305
Convertible debentures (note 8) 3,302,473 -
Future income taxes 12,928,259 7,509,044
Asset retirement obligations (note 4) 2,592,597 1,295,500
---------------------------------------------------------------------------
50,007,528 17,953,849
---------------------------------------------------------------------------

SHAREHOLDERS' EQUITY
Common shares (note 5) 72,685,429 36,514,809
Warrants (note 6) 303,731 303,731
Contributed surplus (note 7) 2,007,244 1,170,444
Common share conversion rights (note 8) 370,000 -
Deficit (3,046,552) (1,785,450)
---------------------------------------------------------------------------
72,319,852 36,203,534
---------------------------------------------------------------------------
122,327,380 54,157,383
---------------------------------------------------------------------------
---------------------------------------------------------------------------

Contingency (note 3)
Segmented information (note 10)
Commitments (note 11)
Subsequent event (note 11 b)


INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS AND DEFICIT (UNAUDITED)

Three Months Ended Nine Months Ended
September 30 September 30
------------------------------------------------------
2006 2005 2006 2005
---------------------------------------------------------------------------
---------------------------------------------------------------------------
REVENUE
Oil and gas 8,393,468 5,968,709 21,514,605 12,716,490
Royalties (1,845,036) (1,489,165) (4,791,216) (2,891,924)
---------------------------------------------------------------------------
6,548,432 4,479,544 16,723,389 9,824,566
---------------------------------------------------------------------------

EXPENSES
Operating 3,470,938 1,968,431 7,794,382 4,590,643
General and
administrative 723,685 431,143 2,859,617 1,626,350
Finance charges 386,722 110,387 903,655 302,572
Convertible debenture
accretion 60,000 - 120,000 -
Depletion, depreciation
and accretion 3,979,771 1,440,866 9,128,532 2,601,853
Stock-based
compensation
(note 7) 288,444 367,948 878,801 775,144
---------------------------------------------------------------------------
8,909,560 4,318,775 21,684,987 9,896,562
---------------------------------------------------------------------------

Net income (loss)
before income taxes (2,361,128) 160,769 (4,961,598) (71,996)
Income taxes
Current tax expense - (213,468) - (213,468)
Future income tax
(expense)
(note 12) 1,160,499 (147,737) 3,700,496 (228,641)
---------------------------------------------------------------------------
1,160,499 (361,205) 3,700,496 (442,109)
Net loss (1,200,629) (200,436) (1,261,102) (514,105)
Deficit - beginning
of period (1,845,922) (998,695) (1,785,450) (685,026)
---------------------------------------------------------------------------
Deficit - end of
period (3,046,551) (1,199,131) (3,046,552) (1,199,131)
---------------------------------------------------------------------------
---------------------------------------------------------------------------

Loss per share -
basic and diluted $ (0.02) $ (0.01) $ (0.02) $ (0.02)

Segmented information (note 10)


INTERIM CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)

Three Months Ended Nine Months Ended
September 30 September 30
-------------------------------------------------------
2006 2005 2006 2005
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Cash flows from
operating activities
Net loss (1,200,630) (200,436) (1,261,102) (514,105)
Items not affecting
cash
Depletion,
depreciation
and accretion 3,979,771 1,440,866 9,128,532 2,601,853
Convertible debenture
accretion 60,000 - 120,000 -
Accrued interest
on convertible
debenture 70,000 - 70,000 -
Future income
taxes (reduction) (1,160,499) 147,737 (3,700,496) 228,641
Stock-based
compensation
expense (note 7) 288,444 367,948 878,801 775,144
Deferred revenue (28,680) (34,051) (287,533) (84,057)
Unrealized foreign
exchange loss (gain) (1,840) 113,285 183,009 185,733
---------------------------------------------------------------------------
2,006,566 1,835,349 5,131,211 3,193,209
Net change in
non-cash
working capital
(note 9) 2,595,457 181,830 (399,042) (1,667,299)
---------------------------------------------------------------------------
Net cash provided
by operating
activities 4,602,023 2,017,179 4,732,169 1,525,910
---------------------------------------------------------------------------
Cash flows from
investing activities
Corporate and
property acquisitions
(note 2) - - - (11,441,054)
Additions to
property, plant and
equipment (11,443,469) (3,219,160) (17,262,119) (6,034,030)
Changes in non-cash
working capital
(note 9) (753,112) 500,258 (1,205,987) 568,741
---------------------------------------------------------------------------
Net cash used in
investing
activities (12,196,581) (2,718,902) (18,468,106) (16,906,343)
---------------------------------------------------------------------------
Cash flows from
financing activities
Issue of shares for
cash - 305,184 - 1,977,694
Issue of shares
upon exercise of
warrants 39,021 695,266 98,143 4,551,016
Issue of shares for
cash upon exercise of
stock options - - 59,000 193,784
Share issue costs (204,430) (73,736) (760,976) (258,750)
Revolving demand
loan 7,759,967 (224,991) 14,339,770 8,699,626
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Net cash provided
by financing
activities 7,594,558 701,723 13,735,937 15,163,370
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Change in cash
during the period - - - (217,063)
Cash - Beginning of
period - - - 217,063
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Cash - End of
period - - - -
---------------------------------------------------------------------------
---------------------------------------------------------------------------

Supplemental information (note 9)


NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. SIGNIFICANT ACCOUNTING POLICIES

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

2. BUSINESS ACQUISITIONS

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



Tiverton IC Energy
2006 2005
---------------------------------------------------------------------------
Net assets acquired at assigned values:
---------------------------------------------------------------------------
Working capital deficiency (2,112,791) -
Property, plant and equipment 42,740,000 10,243,000
Goodwill 13,572,428 2,665,198
Bank debt (3,700,000) -
Convertible debentures (3,182,473) -
Asset retirement obligation (1,095,000) (123,713)
Future income taxes (6,937,798) (2,784,485)
Common share conversion rights (370,000) -
---------------------------------------------------------------------------
Net assets acquired 38,914,366 10,000,000
---------------------------------------------------------------------------
---------------------------------------------------------------------------

Financed by:
---------------------------------------------------------------------------
Shares issued 38,314,366 4,500,000
Cash - 5,500,000
Acquisition costs 600,000 -
---------------------------------------------------------------------------
Purchase price 38,914,366 10,000,000
---------------------------------------------------------------------------
---------------------------------------------------------------------------


3. REVOLVING DEMAND LOAN

At September 30, 2006, the Company has available a demand operating loan in the amount of $23.0 million (December 31, 2005 - $14.2 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.

At September 30, 2006, the Company is in breach of a covenant governing the Company's banking agreement. Management has informed the bank of the situation and the bank has indicated that they will review the financial statements in order to determine future covenant requirements.

4. ASSET RETIREMENT OBLIGATIONS

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



Nine Months Ended Year Ended
September 30, 2006 December 31, 2005
---------------------------------------------------------------------------
Asset retirement obligations -
beginning of period 1,295,500 780,889
Liabilities acquired (note 2) 1,095,000 334,119
Liabilities incurred 91,100 114,808
Change in estimate 29,997 (14,022)
Accretion expense 81,000 79,706
---------------------------------------------------------------------------
Asset retirement obligations - end of
period 2,592,597 1,295,500
---------------------------------------------------------------------------


5. COMMON SHARES

Nine Months Ended Year Ended
September 30, 2006 December 31, 2005
---------------------------------------------------------------------------
Shares Amount ($) Shares Amount ($)
---------------------------------------------------------------------------
Balance - beginning of
period 42,231,244 36,514,809 18,989,706 7,458,134
Issued to acquire Tiverton 23,237,671 38,914,366 - -
Issued to acquire IC Energy - - 3,000,000 4,500,000
Issued to acquire Quadra - - 4,088,292 5,483,014
Issued for cash - - 8,760,496 13,573,157
Cost of shares issued - (760,976) - (723,785)
Tax effect of flow-through
shares - (2,369,913) - (1,445,169)
Tax effect of share issue
costs - 188,000 - 247,000
Issued on exercise of
options 100,000 59,000 972,025 207,334
Issued on exercise of
warrants 108,488 98,143 6,745,725 6,133,159
Allocated from contributed
surplus - 42,000 - 93,205
Allocated from warrants - - - 988,760
---------------------------------------------------------------------------
Shares issued 65,677,403 72,685,429 42,556,244 36,514,809
Shares held in escrow(1) (325,000) - (325,000) -
---------------------------------------------------------------------------
Balance - end of period 65,352,403 72,685,429 42,231,244 36,514,809
---------------------------------------------------------------------------
---------------------------------------------------------------------------

(1) Included in accounts receivable is $225,000 from a former officer and
director of the Company pursuant to a share purchase loan for the
issuance of 325,000 common shares. The loan is unsecured and there are
no specified terms of repayment. At September 30, 2006 the fair value
of the shares held in escrow is $225,000.


The per share calculations for the nine month period ended September 30, 2006 were based on weighted average shares outstanding of 59,312,943 (September 30, 2005 - 25,915,932). The per share calculations for the three month period ended September 30, 2006 were based on weighted average shares outstanding of 65,656,022 (September 30, 2005 - 30,942,600). In computing net loss per share - diluted, 850,246 shares (September 30, 2005 - 1,086,238) were added to the weighted average number of shares outstanding for the three month period, reflecting the dilutive effect of stock options and share purchase warrants.

6. WARRANTS

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



Nine Months Ended Year Ended
September 30, 2006 December 31, 2005
---------------------------------------------------------------------------
Warrants Amount ($) Warrants Amount ($)
---------------------------------------------------------------------------
Balance - beginning of period 2,031,100 303,731 6,588,664 988,760
Private placement - - 2,031,100 303,731
Agents' warrants (1) 108,488 - 157,061 -
Allocated to common equity
upon exercise of warrants (108,488) - (6,745,725) (988,760)
---------------------------------------------------------------------------
Balance - end of period 2,031,100 303,731 2,031,100 303,731
---------------------------------------------------------------------------

(1) During 2006 the Company's underwriters and agents exercised their right
to an additional 108,488 warrants pursuant to their respective agency
agreements relating to equity offerings completed in 2004 and 2005.


7. STOCK OPTIONS

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

Nine Months
Ended Year Ended
September 30, December 31,
2006 2005
Weighted Weighted
Average Average
Options Price ($) Options Price ($)
---------------------------------------------------------------------------
Balance - beginning of
period 3,592,252 0.99 2,505,000 0.40
Granted 760,000 1.14 2,495,000 1.24
Exercised (100,000) 0.59 (972,025) 0.23
Cancelled (125,000) 1.23 (435,723) 0.59
---------------------------------------------------------------------------
Balance - end of period 4,127,252 1.02 3,592,252 0.99
---------------------------------------------------------------------------
Exercisable - end of
period 2,627,252 0.93 1,977,259 0.90
---------------------------------------------------------------------------
---------------------------------------------------------------------------


The Company incurred non-cash compensation expense of $878,801 for the nine month period ended September 30, 2006 (2005 - $775,144) 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, 2006 December 31, 2005
---------------------------------------------------------------------------
Balance - beginning of period 1,170,444 144,183
Issuance of stock options 878,801 1,119,466
Reclassification to common shares on
exercise of options (42,000) (93,205)
---------------------------------------------------------------------------
Balance - end of period 2,007,244 1,170,444
---------------------------------------------------------------------------


8. CONVERTIBLE DEBENTURE

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

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



9. SUPPLEMENTAL CASH FLOW INFORMATION

Three Three Nine Nine
Months Months Months Months
Ended Ended Ended Ended
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
2006 2005 2006 2005
---------------------------------------------------------------------------
Change in non-cash working
capital items
Operating accounts
receivable (1,073,963) (1,830,951) (4,195,202) (3,143,915)
Operating accounts payable 3,669,420 2,012,781 3,796,160 1,476,616
---------------------------------------------------------------------------
Amounts relating to
operating activities 2,595,457 181,830 (399,042) (1,667,299)
Amounts relating to
investing activities (753,112) 500,258 (1,205,987) 568,741
---------------------------------------------------------------------------
1,842,345 682,088 (1,605,029) (1,098,558)
---------------------------------------------------------------------------
---------------------------------------------------------------------------

Taxes paid - - 213,985 -
Interest paid 316,722 67,996 761,906 238,022
---------------------------------------------------------------------------
---------------------------------------------------------------------------


10. SEGMENTED INFORMATION

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



2006
($ Cdn.) Canada U.S Egypt Total
---------------------------------------------------------------------------
Oil and gas revenue 15,693,101 5,821,504 - 21,514,605
Income (loss) before income
taxes (4,941,333) 101,155 (121,419) (4,961,597)
Property, plant and equipment 85,123,670 4,312,511 5,547,952 94,984,133
Capital expenditures
(including acquisitions) 17,163,966 98,153 - 17,262,119
---------------------------------------------------------------------------

2005
($ Cdn.) Canada U.S Egypt Total
---------------------------------------------------------------------------
Oil and gas revenue 7,192,763 5,523,727 - 12,716,490
Income (loss) before income
taxes (488,446) 529,646 (113,196) (71,996)
Property, plant and equipment 29,923,039 4,885,278 5,983,014 40,791,331
Capital expenditures
(including acquisitions) 17,376,931 98,153 - 17,475,084
---------------------------------------------------------------------------


11. COMMITMENTS

(a) 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.

(b) Flow Through Shares

At September 30, 2006, the Company has satisfied its expenditure obligations for flow through share offerings completed in 2005. In addition, the Company completed a private placement of flow-through common shares on November 8, 2006 for gross proceeds of $8.0 million. The Company will renounce the appropriate tax pools, and will incur the qualifying expenditures during 2007.

12. FUTURE INCOME TAXES

During the nine month period ended September 30, 2006, the Company reduced its future income tax liability by $3.8 million. Of this amount, approximately $2.5 million of the reduction related to a change in the substantively enacted corporate tax rates for Canadian oil and gas producers.

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

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

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

Contact Information