Masters Energy Inc.
TSX : MSY

Masters Energy Inc.

October 26, 2006 17:33 ET

Masters Energy Inc. Reports Third Quarter 2006 Interim Results

CALGARY, ALBERTA--(CCNMatthews - Oct. 26, 2006) - Masters Energy Inc. (TSX:MSY) ("Masters" or the "Company") is pleased to report financial and operating results for the three and nine month periods ended September 30, 2006. Several significant accomplishments were achieved during the period;

- Issued 1,000,000 flow-through shares for total proceeds of $6.1 million.

- Increased the Company's productive capability to over 2,000 boe per day

- Tie-in of 15 natural gas wells has commenced in fourth quarter

- Sold non-core oil and gas interests for $6.2 million

- Shot and acquired 150 square kilometers of 3-D seismic and in excess of 100 kilometers of 2-D seismic



HIGHLIGHTS Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
---------------------------------------------------------------------------
(Unaudited)
Financial ($ thousands, except per
share amounts)
Gross revenue 5,971 7,175 18,304 16,021

Funds generated by operations 3,144 4,476 9,238 9,244
Per share - basic 0.20 0.31 0.61 0.64
- diluted 0.20 0.30 0.58 0.62

Net earnings 815 1,781 1,832 2,981
Per share - basic 0.05 0.12 0.12 0.21
- diluted 0.05 0.12 0.12 0.20

Capital expenditures 5,772 2,805 18,615 15,932

Working capital (deficiency) (1,904) 1,381 (1,904) 1,381

Long-term debt 14,467 11,911 14,467 11,911

Operations
Production
Crude oil (bbls/d) 791 688 795 694
NGL (bbls/d) 10 15 10 11
Natural gas (mcf/d) 2,897 3,872 3,439 3,160
Total production (boe/d at 6:1) 1,284 1,349 1,379 1,231

Average sales price
Crude oil ($/bbl) 58.03 56.92 52.42 45.62
NGL ($/bbl) 62.72 59.56 60.69 53.50
Natural gas ($/mcf) 5.61 9.09 6.38 7.93


To Our Shareholders

In the early part of 2006 Masters spent significant funds on acquiring undeveloped land and shooting 2D and 3D seismic in our core areas. The second and third quarter activities focused on drilling the opportunities identified with the new seismic. The program has resulted in considerable success and currently there is an estimated total of 750 boe per day to be tied-in. Approximately 500 - 650 boe per day is expected to be onstream by mid-November with the remainder to be tied-in later in 2006 and early 2007.

In addition to the activity conducted in our core areas, Masters has assembled several high impact exploration prospects. Each of these prospects has the potential to be a new core area. To the end of the third quarter of 2006, the Company has drilled on three of these prospects resulting in one prospect requiring follow-up drilling. We expect to evaluate two additional prospects prior to year-end and several others are scheduled for the early part of 2007.

For the fourth quarter of 2006, the Company plans to drill six to eight exploration and development wells. The drilling, along with the tie-in of the standing natural gas wells, will result in estimated capital expenditures of $4 - 6 million in the fourth quarter.

Oil and NGL prices have remained strong during the third quarter 2006. The wellhead price Masters received for crude oil in the third quarter of 2006 was $58.03 per bbl, which is close to the highest price we have received in a quarterly period, in the past two years. Natural gas on the other hand, at $5.61 per mcf, is the lowest price we have received in the past two years. We expect commodity prices to continue to be volatile and look forward to a recovery in gas prices.

In September 2006, the Company sold non-core oil and gas interests for cash proceeds of $6.2 million. The sale will have no impact on the Company's current production volumes, gross working interest reserves or available bank line. Proceeds from the disposition reduced bank debt, which provides Masters with greater flexibility to pursue growth opportunities.

Outlook

At the beginning of the fourth quarter 2006, Masters had approximately 750 boe per day of natural gas production capability behind pipe. With a majority of this capable production coming on stream during the fourth quarter, the Company forecasts an exit rate of 1,800 - 2,000 boe per day. The remaining behind-pipe production is expected to be tied-in during the early part of 2007. The exit forecast does not take into account any additional production which could be realized from the fourth quarter drilling program. The increased production is expected to significantly increase the Company's cash flow.

In addition to the ongoing exploration and development program, Masters has a strong desire to grow through acquisitions and will continue to pursue acquisitions that are strategic to the Company. We believe that the current commodity price weakness will increase the number of acquisition opportunities available to us. Proceeds from the $6.2 million divestment of non-core interests has reduced our debt levels and improved our ability to take advantage of those opportunities.

Masters is pleased that it will be able to show significant production growth within the next few months and remains optimistic about our ability to find new reserves with our exploration program.

On behalf of the Board of Directors,


Geoff C. Merritt, President and Chief Executive Officer

October 26, 2006


MANAGEMENT'S DISCUSSION AND ANALYSIS

ADVISORIES

Management's discussion and analysis ("MD&A") of Masters Energy Inc. ("Masters or the Company"), provided as of October 26, 2006, should be read in conjunction with the unaudited financial statements presented for the three and nine months ended September 30, 2006 and 2005 and the audited financial statements for the year ended December 31, 2005.

Basis of Presentation - The financial data presented below has been prepared in accordance with Canadian generally accepted accounting principles ("GAAP"). The reporting and the measurement currency is the Canadian dollar.

Non-GAAP Measures - The MD&A contains the terms 'funds generated by operations' and 'funds generated by operations per share', which should not be considered an alternative to, or more meaningful than net earnings or cash flow from operating activities as determined in accordance with GAAP as an indicator of the Company's performance. Masters' determination of funds generated by operations and funds generated by operations per share may not be comparable to that reported by other companies. Management uses funds generated by operations to analyze operating performance and leverage and considers funds generated by operations to be a key measure as it demonstrates the Company's ability to generate cash necessary to fund future capital investments and to repay debt. The reconciliation between net earnings and funds generated by operations can be found in the statements of cash flows in the financial statements. The Company presents funds generated by operations per share, which is prohibited under GAAP. Per share amounts are calculated using weighted average shares outstanding consistent with the calculation of earnings per share.

BOE Presentation - Masters bases calculations of barrels of oil equivalent ("boe") on a conversion rate of six thousand cubic feet ("mcf") of natural gas to one barrel ("bbl") of crude oil. The boe unit may be misleading, particularly if used in isolation. A boe conversion ratio of six mcf equals one bbl is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.

Forward-Looking Information - This MD&A contains forward-looking or outlook information with regard to Masters within the meaning of applicable securities laws. Forward-looking statements may include estimates, plans, expectations, forecasts, guidance or other statements that are not statements of fact. Masters believes the expectations reflected in such forward-looking statements are reasonable. However, no assurance can be given that such expectations will prove to be correct. These statements are subject to certain risks and uncertainties and may be based on assumptions that could cause actual results to differ materially from those anticipated or implied in the forward-looking statements. These risks include but are not limited to: crude oil and natural gas price volatility, exchange rate and interest rate fluctuations, availability of services and supplies, market competition, uncertainties in the estimates of reserves, the timing of development expenditures, production levels and the timing of achieving such levels, Masters' ability to replace and expand oil and natural gas reserves, the sources and adequacy of funding for capital investments, the Company's future growth prospects and current and expected financial requirements, the cost of future reclamation and site restoration, Masters' ability to enter into or renew leases and to secure adequate product transportation, changes in environmental and other regulations and general economic conditions. These statements speak only as of the date of this MD&A and Masters does not undertake an obligation to update our forward-looking statements except as required by law.



PRODUCTION

Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
---------------------------------------
Total Production
Crude oil (bbl) 72,815 63,334 217,134 189,431
Natural gas liquids ("NGL") (bbl) 938 1,370 2,863 2,955
Natural gas (mcf) 266,511 356,203 938,782 862,631
Total (boe) 118,172 124,071 376,461 336,158
Daily Production
Crude oil (bbl/d) 791 688 795 694
NGL (bbl/d) 10 15 10 11
Natural gas (mcf/d) 2,897 3,872 3,439 3,160
Total (boe/d) 1,284 1,349 1,379 1,231


Production volumes for the third quarter ended September 30, 2006 averaged 1,284 boe/d, a decrease of five percent in comparison with the third quarter of 2005. Oil and NGL production for the third quarter of 2006 increased 14 percent to 801 bbl/d from 703 bbl/d in the same period in 2005. Natural gas production for the third quarter ended September 30, 2006 decreased 25 percent to 2.9 mmcf per day from 3.9 mmcf per day for the three months ended September 30, 2005, as a result of production declines of mature fields and the temporary shut-in of production. Year to date equivalent production for the first nine months of 2006 was 1,379 boe/d, an increase of 12 percent in comparison to the same period for 2005. Production increased during 2006 as a result of successful wells being drilled and tied-in and the acquisition of producing properties in the Peace River Arch area during 2005.



PRICES

Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
---------------------------------------
Crude oil ($/bbl) 58.03 56.92 52.42 45.62
---------------------------------------
---------------------------------------
NGL ($/bbl) 62.71 59.56 60.69 53.50
---------------------------------------
---------------------------------------
Natural gas ($/mcf) 5.61 9.09 6.38 7.93
---------------------------------------
---------------------------------------


West Texas Intermediate ("WTI") is the benchmark for North American oil prices and is the crude type against which NYMEX futures contracts are priced. Canadian crude oil prices are based on refiners' postings at hubs such as Edmonton and Hardisty, Alberta. The basis for Canadian postings is the WTI price at Cushing, Oklahoma minus a transportation differential, adjusted for the US/Canadian currency exchange rate and for relative quality and regional market conditions.

During the third quarter of 2006, North America continued to see historically high price levels for WTI crude oil primarily due to concerns over supply. As a result, the average price for a barrel of WTI crude during the period increased over $7.30(US) to $70.48(US) from the third quarter of 2005. The average price for a barrel of WTI crude during the first nine months of 2006 increased $12.66(US) to $68.12(US) from the first nine months of 2005. The Canadian dollar strengthened relative to the US dollar during the course of the year. The average currency exchange rate for $1.00 Canadian increased from $0.817(US) in the first nine months of 2005 to $0.883(US) in the similar period of 2006. As a result, this lowered the effective price received for delivery of crude expressed in Canadian dollars. The quality price differential postings on medium type crudes also experienced a positive effect during the third quarter of 2006. The average differential between Edmonton light sweet crude postings and Hardisty Bow River medium crude was approximately $20.86 per bbl in the third quarter of 2006 versus $24.30 per bbl in the third quarter of 2005.

The Company's crude oil field price for the third quarter of 2006 increased two percent to $58.03 per bbl from the average price received in the third quarter of 2005. The narrowing differential has positively impacted Masters' oil revenues and cash flow, as the majority of the Company's crude oil production is medium gravity crude.

The Company's crude oil field price during the first nine months of 2006 was $52.42 per bbl versus $76.02 per bbl for light sweet postings at Edmonton, Alberta. The average differential for the 2006 period was approximately the same as 2005. For the first nine months of 2006 the crude field price increased 15 percent to $52.42 per bbl from the average price received during the comparable period in 2005.

US natural gas prices are typically referenced off NYMEX at Henry Hub, Louisiana while Canadian prices are referenced at Nova Inventory Transfer ("NIT") or the AECO Hub. Most of Masters' natural gas is sold to the spot market according to the AECO reference price. Masters did not enter into any fixed or hedged type gas sales contracts during 2005 or 2006. The average natural gas price received during the third quarter of 2006 was $5.61 per mcf, a decrease of 38 percent from the price received in the same period of 2005. The average natural gas price received for the first nine months of 2006 was $6.38 per mcf, a decrease of 20 percent from the average price received in the first nine months of 2005.



REVENUES

Three Months Ended Nine Months Ended
September 30, September 30,
($ thousands, except as indicated) 2006 2005 2006 2005
---------------------------------------------------------------------------
Crude oil revenue 4,226 3,605 11,382 8,642
NGL revenue 59 81 174 158
Natural gas revenue 1,496 3,237 5,994 6,838
---------------------------------------
Total petroleum and natural gas
revenue 5,781 6,923 17,550 15,638
Royalty and other revenue 190 252 754 383
---------------------------------------
Total revenue 5,971 7,175 18,304 16,021
---------------------------------------
---------------------------------------
Total petroleum and natural gas
revenue per boe ($) 48.92 55.84 46.62 46.54
---------------------------------------
---------------------------------------
Total revenue per boe ($) 50.52 57.83 48.62 47.67
---------------------------------------
---------------------------------------


Petroleum and natural gas revenues for the third quarter of 2006 decreased 16 percent to $5.8 million from the similar period in 2005 as natural gas prices and production volumes decreased during the period. The petroleum and natural gas revenue for the first nine months of 2006 was $17.6 million, an increase of 12 percent over the same period of 2005 as oil and NGL prices remained strong.

Royalty and other income for the third quarter of 2006 decreased 25 percent to $0.2 million as a result of lower natural gas prices received during the quarter. The royalty and other revenue for the first nine months of 2006 was $0.8 million, an increase of 97 percent as a large royalty interest was acquired with the purchase of the North Peace River Arch assets in June 2005.



ROYALTIES

Three Months Ended Nine Months Ended
September 30, September 30,
($ thousands, except as indicated) 2006 2005 2006 2005
---------------------------------------------------------------------------
Crown 835 1,186 3,238 2,716
Alberta Royalty Tax Credit ("ARTC") (125) (153) (375) (382)
---------------------------------------
Crown, net of ARTC 710 1,033 2,863 2,334
Freehold and gross overriding 17 238 384 545
---------------------------------------
Net royalties 727 1,271 3,247 2,879
---------------------------------------
---------------------------------------
Per boe ($) 6.15 10.25 8.63 8.57
---------------------------------------
---------------------------------------
Average royalty rate - net (%)(1) 12.8 18.4 18.5 18.4
---------------------------------------
---------------------------------------

(1) A percentage of total petroleum and natural gas revenue


For the three months ended September 30, 2006, royalties, net of Alberta royalty tax credit, totaled $0.7 million for an average royalty rate relative to oil and gas revenues of 12.8 percent. The decrease in the net average royalty rate is due to the decrease in natural gas production revenues. On a boe basis, royalties for the period were $6.15 per boe. For the similar period in 2005 the net royalty rate averaged 18.4 percent of oil and gas revenues or $10.25 per boe.

For the nine months ended September 30, 2006 royalties totaled $3.2 million for an average royalty rate of 18.5 percent or $8.63 per boe. For the comparable period in 2005 the royalty rate averaged 18.4 percent or $8.57 per boe.

Forecasted royalty rates for the balance of 2006, before ARTC, are anticipated to be consistent with the 2006 year to date rates. The Company anticipates maximizing its ARTC claim on Crown royalties during 2006. During the third quarter of 2006, the Alberta provincial government announced that the ARTC program would be terminated as of the end of the 2006 year.



OPERATING EXPENSES

Three Months Ended Nine Months Ended
September 30, September 30,
($ thousands, except as indicated) 2006 2005 2006 2005
---------------------------------------------------------------------------
Total operating expenses 1,463 1,000 3,758 2,697
---------------------------------------
---------------------------------------
Per boe ($) 12.38 8.06 9.98 8.02
---------------------------------------
---------------------------------------


Operating expenses for the three months ended September 30, 2006 were $1.5 million, an increase of 46 percent compared to $1.0 million during the same period in 2005, primarily as a result of higher processing fees, water hauling and annual maintenance performed on existing facilities during the period. On a boe basis, the 2006 third quarter operating expenses increased 54 percent, to an average cost of $12.38 per boe produced, from $8.06 per boe in the same period in 2005.

Operating expenses of $9.98 per boe in the first nine months of 2006 have increased 24 percent compared to the average boe operating expense for the similar period in 2005.

Operating expenses per boe for the balance of 2006 are anticipated to remain consistent with the year to date results.



Netback Analysis

Three Months Ended Nine Months Ended
September 30, September 30,
($ per boe) 2006 2005 2006 2005
---------------------------------------------------------------------------
Oil and gas revenues 48.92 55.84 46.62 46.54
Royalty and other revenue 1.60 1.99 2.00 1.13
------------------------------------
50.52 57.87 48.62 47.67
Royalties, net of ARTC (6.15) (10.25) (8.63) (8.57)
Operating expenses (12.38) (8.06) (9.98) (8.02)
------------------------------------
Operating netback 31.99 39.52 30.01 31.08
------------------------------------
------------------------------------


Operating income netback of $31.99 per boe for the third quarter of 2006 decreased 19 percent in comparison with the similar period in 2005. For the nine months ended September 30, 2006 the operating income netback was $30.01 per boe, a decrease of three percent in comparison to the same period in 2005.



GENERAL and ADMINISTRATIVE

Three Months Ended Nine Months Ended
September 30, September 30,
($ thousands, except as indicated) 2006 2005 2006 2005
---------------------------------------------------------------------------
Gross general and administrative 484 427 1,931 1,416
Operating recoveries (33) (28) (89) (64)
Capitalized expenses (166) (144) (639) (485)
------------------------------------
General and administrative expense,
before stock-based compensation 285 255 1,203 867
------------------------------------
Stock-based compensation expense 116 57 385 171
Capitalized stock-based compensation (148) - (148) -
------------------------------------
Net stock-based compensation expense (32) 57 237 171
------------------------------------
Total general and administrative
expense 253 312 1,440 1,038
------------------------------------
------------------------------------
General and administrative expense,
before stock-based compensation, per
boe ($) 2.41 2.06 3.20 2.58
------------------------------------
------------------------------------
Total general and administrative
expense per boe ($) 2.14 2.51 3.83 3.09
------------------------------------
------------------------------------


During the third quarter of 2006, net general and administrative costs before stock-based compensation increased over the third quarter 2005 as a result of annual salary increases awarded during 2006. The increase in the year to date 2006 general administrative costs compared to the first nine of 2005 is due to the awarding of short-term incentive bonuses.

General and administrative expenses per boe for the remainder of 2006 are anticipated to be similar to 2005. Based on forecasted production and capital spending, 2006 staff levels are anticipated to be similar to 2005.



INTEREST EXPENSE

Three Months Ended Nine Months Ended
September 30, September 30,
($ thousands except as indicated) 2006 2005 2006 2005
---------------------------------------------------------------------------
Total interest expense 292 135 742 268
------------------------------------
------------------------------------
Per boe ($) 2.47 1.09 1.97 0.80
------------------------------------
------------------------------------


Interest expense for the three months ended September 30, 2006 was $0.3 million, an increase of 116 percent compared to the same period in 2005, due to higher average debt levels and an increase in interest rates. On a boe basis, the 2006 third quarter interest expense increased 117 percent to an average cost of $2.47 per boe produced from $1.09 per boe in the same period in 2005. For the year to date period to September 30, 2006, interest expense increased 177 percent to $0.7 million in comparison to the similar period in 2005.



DEPLETION, DEPRECIATION and ACCRETION

Three Months Ended Nine Months Ended
September 30, September 30,
($ thousands except as indicated) 2006 2005 2006 2005
---------------------------------------------------------------------------
Depletion 1,998 1,697 6,797 4,352
Depreciation 3 4 8 8
Accretion on asset retirement
obligations 32 27 93 83
------------------------------------
Total depletion, depreciation and
accretion expense 2,033 1,728 6,898 4,443
------------------------------------
------------------------------------
Depletion, depreciation and accretion
expense per boe ($) 17.20 13.93 18.32 13.22
------------------------------------
------------------------------------


For the third quarter of 2006, depletion, depreciation and accretion expense increased 18 percent to $2.0 million from $1.7 million for the same period in 2005. The increase is due to higher exploration and development capital spending during the past year. On a boe basis, depletion, depreciation and accretion expense for the third quarter ended September 30, 2006 increased 23 percent to $17.20 from $13.93 in the same period in 2005.

For the nine months ended September 30, 2006, depletion, depreciation and accretion expense increased 55 percent to $6.9 million from $4.4 million for the same period in 2005. For the first nine months of 2006, the depletion, depreciation and accretion expense per boe increased 39 percent to $18.32 per boe.

At September 30, 2006, the ceiling test calculation indicated that the estimated undiscounted future cash flows from proven reserves exceeded the carrying values of producing petroleum and natural gas properties and therefore a ceiling test adjustment was not required.



INCOME TAXES

Three Months Ended Nine Months Ended
September 30, September 30,
($ thousands, except as indicated) 2006 2005 2006 2005
---------------------------------------------------------------------------
Future income taxes 382 948 387 1,716
--------------------------------------
--------------------------------------
Effective tax rate (%) 31.9 34.7 17.4 36.5
--------------------------------------
--------------------------------------


The future income tax expense provision for the three months ended September 30, 2006 decreased to $0.4 million from a future income tax expense of $0.9 million in the same period in 2005. For the nine months ended September 30, 2006, future income taxes decreased to $0.4 million from $1.7 million in the comparable period in 2005. The decrease in 2006 future tax expense is due to lower earnings before taxes and a reduction in the federal and provincial income rates that were substantially enacted during the second quarter of 2006.

As at September 30, 2006, the Company has approximately $46.4 million in tax pools to shelter taxable income in the future years.

NET EARNINGS and FUNDS GENERATED BY OPERATIONS

Net earnings decreased to $0.8 million for the three months ended September 30, 2006 compared to $1.8 million during the same period in 2005. The decrease was mainly due to lower revenues during the third quarter of 2006. Net earnings per basic and diluted share for the quarter was $0.05 compared to $0.12 per basic and diluted share during the same quarter in 2005.

For the nine months ended September 30, 2006, net earnings decreased 39 percent to $1.8 million compared to $3.0 million during the comparable period in 2005. The decrease was a result of higher depletion rates per boe over the same period in 2005, offset in part by lower future income tax expenses. Net earnings per basic and diluted share for the nine month period was $0.12, compared to $0.21 per basic and $0.20 per diluted share during the same period in 2005.

Funds generated by operations decreased 26 percent to $3.1 million for the three months ended September 30, 2006 compared to $4.5 million during the same period in 2005. The decrease for the third quarter of 2006 is primarily due to lower natural gas production and prices. For the first nine months of 2006, funds generated by operations were $9.2 million, which is comparable to $9.2 million during the first three quarters of 2005. The increase in 2006 revenues was offset in part by higher operating and interest expenses.

CAPITAL EXPENDITURES

During the first three quarters of 2006, the Company spent approximately $18.6 million in exploration and development capital expenditures compared to $8.7 million spent in the same period of 2005. In June and September 2005 the Company acquired properties in the North Peace River Arch area of Alberta for $7.8 million. For the nine months ended September 30, 2006, the Company drilled 26 wells (11.7 net) with a success rate of 50 percent, added over 11,000 net undeveloped acres and shot and acquired 150 square kilometers of 3-D and over 100 kilometers of 2-D seismic data. During the third quarter of 2006, the Company disposed non-core oil and gas interests for cash proceeds of $6.2 million.



Three Months Ended Nine Months Ended
September 30, September 30,
($ thousands) 2006 2005 2006 2005
---------------------------------------------------------------------------
Land 263 503 1,479 1,142
Geological and geophysical 458 202 2,998 525
Drilling and completions 4,133 1,088 9,358 5,129
Equipping and facilities 918 989 4,780 1,894
Other - 23 - 26
--------------------------------------
Total exploration and development
capital 5,772 2,805 18,615 8,719
Producing property acquisitions - 261 - 7,813
Disposal of property (6,200) (600) (6,200) (600)
--------------------------------------
(428) 2,466 12,415 15,932
--------------------------------------
--------------------------------------


Drilling Results

During the third quarter of 2006, the Company drilled eight wells resulting in five natural gas wells for a success rate of 63 percent. For the first nine months of 2006, the Company drilled 26 wells resulting in 13 natural gas wells and 13 dry and abandoned wells for an overall success rate of 50 percent.



Three Months Ended Nine Months Ended Nine Months Ended
September 30, September 30, September 30,
2006 2006 2005
(wells) Gross Net Gross Net Gross Net
---------------------------------------------------------------------------

Oil - - - - 3 3.0
Natural Gas 5 2.6 13 5.1 8 5.8
Dry 3 1.8 13 6.6 1 1.0
------------------------------------------------------
Total 8 4.4 26 11.7 12 9.8
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Success rate (%) 63 59 50 44 92 90
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CONTRACTUAL OBLIGATIONS

On April 18, 2006, the Company completed the issuance of 1,000,000 flow-through common shares for total proceeds of $6.1 million. The proceeds from the share issuance are to be spent on qualified exploration expenditures prior to December 31, 2007. As at September 30, 2006, approximately $1.9 million of exploration expenditure obligations remained outstanding.

There are no commodity hedge contracts outstanding as at September 30, 2006.

LIQUIDITY and CAPITAL RESOURCES

The Company's total capitalization at September 30, 2006 was $74.4 million with the market value of common shares representing 70 percent of total capitalization. Net debt represented 22 percent and asset retirement obligations and future income taxes accounted for six percent.



Total Market Capitalization
($ thousands except as indicated) 2006 %
---------------------------------------------------------------------------
Common shares outstanding (thousands) 15,570
Share price, September 30, 2006 ($ per share) 3.35
----------------
Total market capitalization 52,160 70
----------------
Working capital deficiency 1,904
Bank debt 14,467
----------------
Net debt 16,371 22
----------------
Asset retirement obligations 3,593 5
Future income taxes 2,252 3
----------------
Total capitalization 74,376 100
----------------
----------------
Net debt to total capitalization 22%
----------------
----------------


At September 30, 2006, the Company had borrowed approximately $14.5 million and had a working capital deficit of $1.9 million, totaling $16.4 million of total net debt. The net debt amount represents approximately 1.3 times the annualized third quarter 2006 funds generated by operations.

The Company has a bank revolving term facility to $22.0 million to fund future activities. The facility is a borrowing base facility that is determined by the Company's latest reserve assessment, results of operations, current and forecasted commodity prices and the prevailing market conditions. The facility is reviewed semi-annually with the next date being October 31, 2006. As at September 30, 2006, the Company had drawn $14.5 million of the revolving term facility.

The Company's future investing activities, which consist primarily of capital expenditures on oil and gas activities, will be funded with working capital, funds generated by operations and bank debt.

As at September 30, 2006, the issued and outstanding common shares of the Company were 15,569,979, options outstanding were 1,451,000 and there were performance warrants outstanding of 885,000.



SELECTED QUARTERLY INFORMATION

The financial data presented below has been prepared in accordance with
Canadian generally accepted accounting principles. The reporting and
measurement currency is the Canadian dollar.

--------------------------------------------------------------
2006 2005 2004
--------------------------------------------------------------
Operations Q3 Q2 Q1 Q4 Q3 Q2 Q1 Q4
---------- --------------------------------------------------------------
Production
Oil (bbl/d) 791 781 813 707 688 715 678 588
NGL (bbl/d) 10 13 9 10 15 11 6 13
Natural gas
(mcf/d) 2,897 3,543 3,888 3,619 3,872 3,055 2,538 2,406
Total (boe/d) 1,284 1,384 1,470 1,320 1,349 1,236 1,107 1,002
Pricing
Oil, before
hedging
($/bbl) 58.03 59.65 39.82 42.50 56.92 41.64 38.14 36.91
Hedging costs - - - - - - - (0.01)
--------------------------------------------------------------
Oil, after
hedging
($/bbl) 58.03 59.65 39.82 42.50 56.92 41.64 38.14 36.90
NGL ($/bbl) 62.71 61.62 56.87 60.85 59.56 49.56 46.12 50.72
Natural gas
($/mcf) 5.61 5.91 7.41 11.29 9.09 7.34 6.83 6.62
Total
($/boe) 48.92 49.34 41.97 54.18 55.84 42.71 39.28 38.09
Financial
---------
($ thousands,
except as
indicated)
Total
revenue 5,971 6,545 5,788 6,908 7,175 4,836 4,010 3,679
Funds
generated by
operations 3,144 3,553 2,542 2,915 4,476 2,699 2,069 1,676
Net earnings
(loss) 815 800 217 630 1,781 643 557 (124)
Per share
- basic 0.05 0.05 0.02 0.04 0.12 0.04 0.04 (0.01)
Per share
- diluted 0.05 0.05 0.01 0.04 0.12 0.04 0.04 (0.01)
Capital
spending
Exploration and
development 5,772 4,487 8,355 11,570 2,805 2,806 3,108 3,240
Acquisitions/
(dispositions)(6,200) - - 31 (339) 7,552 - -
Total assets 65,176 66,533 64,228 60,016 51,142 48,130 38,830 37,291
Working capital
(deficiency) (1,904)(1,496) (7,477) (5,013) 1,381 323 (5,155) (4,116)
Long-term
debt 14,467 18,584 17,442 14,093 11,911 13,137 - -
Shareholders'
equity 39,861 38,940 32,064 31,791 31,033 28,884 28,184 27,570
Common Shares
--------------
Weighted average
common shares
outstanding
(thousands)
- basic 15,570 15,356 14,523 14,491 14,462 14,364 14,364 14,364
- diluted 16,093 16,052 15,433 15,482 15,146 14,931 14,801 14,614
Trading
Activity
Volume
(thousands)
- total 773 804 1,757 2,351 2,467 3,096 4,149 2,858
- daily 12 13 27 38 39 48 67 45
Price ($ per
share)
- high 4.28 5.39 6.75 6.95 4.70 3.80 4.20 2.85
- low 3.25 3.56 4.25 4.60 3.62 3.05 2.31 2.30
- closing 3.35 3.80 4.89 6.47 4.55 3.64 3.40 2.60


Factors that caused variations over the quarters -

- The Company completed four acquisitions since its initial financing in the fourth quarter of 2003 which have impacted production growth:

-- The acquisition of the Little Bow property in Southern Alberta on December 22, 2003 added approximately 450 boe per day consisting of approximately 90 percent crude oil production. Proved and probable reserves acquired were approximately 1.4 million boe with an estimated reserve life index of 8.6 years.

-- The acquisition of Terraquest Energy Corporation on February 26, 2004 added production of approximately 400 boe per day consisting of approximately 60 percent natural gas. Proved and probable reserves acquired were approximately 1.1 million boe with an estimated reserve life index of 7.9 years based on the production at the time of acquisition.

-- The two acquisitions of producing properties in the Peace River Arch area of Northwest Alberta on September 3, 2005 and September 12, 2005 added approximately 160 boe per day consisting primarily of natural gas production. Proved and probable reserves acquired were approximately 0.5 million boe with an estimated reserve life index of 7.0 years.

- Production growth, other than the acquisitions, is a result of Masters' exploration, development and exploitation activities. Timing of production is subject to timing of drilling and facility construction.

- Growth in revenue and funds generated by operations is the combination of increased production and strong commodity prices. Oil prices for medium grade quality crude experienced a large drop in the latter portion of the fourth quarter 2004 due to wider than historical quality differentials. This impacted the prices received by Masters since that time as a majority of the crude production is of medium quality.

- The net earnings are impacted by depletion, depreciation and accretion and future income taxes. The Company estimates its reserves every quarter based on its acquisition and drilling activities. The annual reserves are determined by independent qualified reservoir evaluators, the results of which can affect fourth quarter reserve additions. Future income taxes have been impacted with the enacted changes to the federal and provincial income tax rates for the oil and gas industry.

- The development of future drilling prospects and seasonal field conditions influence capital spending. Funds generated by operations and bank debt primarily funded capital spending.



Masters Energy Inc.
Balance Sheets
---------------------------------------------------------------------------
($ thousands)

(unaudited)

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

Assets

Current assets
Accounts receivable $ 2,828 $ 3,608
Prepaid expenses and deposits 271 190
--------- ---------
3,099 3,798
Property and equipment (note 2) 62,077 56,218
--------- ---------
$ 65,176 $ 60,016
--------- ---------
--------- ---------
Liabilities

Current liabilities
Accounts payable and accrued liabilities $ 5,003 $ 8,811
--------- ---------

Long-term bank debt (note 3) 14,467 14,093

Asset retirement obligations (note 4) 3,593 3,316

Future income taxes (note 8) 2,252 2,005
--------- ---------
25,315 28,225
--------- ---------
Shareholders' Equity

Share capital (note 5) 33,394 27,469
Contributed surplus (note 6) 706 393
Retained earnings 5,761 3,929
----- -----

39,861 31,791
--------- ---------

$ 65,176 $ 60,016
--------- ---------
--------- ---------

See accompanying notes to the financial statements.


Approved on behalf of the Board,

William R. Stedman, Director Douglas H. Mitchell, Director


Masters Energy Inc.
Statements of Earnings and Retained Earnings
($ thousands except share and per share amounts, unaudited)

Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
---------------------------------------------------------------------------

Revenue
Petroleum and natural gas $ 5,781 $ 6,923 $ 17,550 $ 15,638
Royalty and other revenue 190 252 754 383
-------- -------- --------- ---------
5,971 7,175 18,304 16,021
Royalties, net of Alberta
Royalty Tax Credit (733) (1,271) (3,247) (2,879)
-------- -------- --------- ---------

5,238 5,904 15,057 13,142
-------- -------- --------- ---------

Expenses
Operating 1,463 1,000 3,758 2,697
General and administrative 253 312 1,440 1,038
Interest - long-term debt 292 135 742 178
- short-term debt - - - 90
Depletion, depreciation
and accretion 2,033 1,728 6,898 4,443
-------- -------- --------- --------
4,041 3,175 12,838 8,446
-------- -------- --------- --------
Earnings before taxes 1,197 2,729 2,219 4,697

Future income taxes (note 8) 382 948 387 1,716
-------- -------- --------- --------

Net earnings 815 1,781 1,832 2,981

Retained earnings,
beginning of period 4,946 1,518 3,929 318
-------- -------- --------- --------
Retained earnings, end of
period $ 5,761 $ 3,299 $ 5,761 $ 3,299
-------- -------- --------- --------
-------- -------- --------- --------

Earnings per share (note 7)

Basic $ 0.05 $ 0.12 $ 0.12 $ 0.21
-------- -------- --------- --------
-------- -------- --------- --------

Diluted $ 0.05 $ 0.12 $ 0.12 $ 0.20
-------- -------- --------- --------
-------- -------- --------- --------

Weighted average number
of shares outstanding

Basic 15,569,979 14,462,088 15,153,520 14,396,821
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------

Diluted 16,093,055 15,146,239 15,859,114 14,959,585
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------

See accompanying notes to the financial statements.


Masters Energy Inc.
Statements of Cash Flows
($ thousands, unaudited)

Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
---------------------------------------------------------------------------
Cash provided by (used for):

Operating activities
Net earnings $ 815 $ 1,781 $ 1,832 $ 2,981
Add non-cash items
Depletion, depreciation
and accretion 2,033 1,728 6,898 4,443
Future income tax expense 382 948 387 1,716
Stock-based compensation
expense (32) 57 237 171
Settlement of performance
warrants - - (52) -
Settlement of asset
retirement costs (54) (38) (64) (67)
-------- -------- --------- ---------
3,144 4,476 9,238 9,244
Changes in non-cash working
capital 635 308 (3,325) (1,557)
-------- -------- --------- ---------
3,779 4,784 5,913 7,687
-------- -------- --------- ---------

Financing activities
Increase (decrease) in
long-term bank debt (4,117) (1,226) 374 8,487
Proceeds on share issue - - 6,100 -
Proceeds on exercise of
options - 274 99 274
Share issuance costs (9) - (434) -
-------- -------- --------- ---------
(4,126) (952) 6,139 9,713
-------- -------- --------- ---------

Investing activities
Exploration and development (5,625) (2,805) (18,468) (8,719)
Producing property
acquisition - (261) - (7,813)
Disposal of property 6,200 600 6,200 600
-------- -------- --------- ---------
575 (2,466) (12,268) (15,932)
Changes in non-cash
working capital (228) (26) 216 824
-------- -------- --------- ---------
347 (2,492) (12,052) (15,108)
-------- -------- --------- ---------

Change in cash and cash
equivalents - 1,340 - 1,340
Cash and cash equivalents,
beginning of period - - - -
-------- -------- --------- ---------
Cash and cash equivalents,
end of period $ - $ 1,340 $ - $ 1,340
-------- -------- --------- ---------
-------- -------- --------- ---------

Supplemental Cash Flow
Information
Interest income received $ 1 $ 5 $ 1 $ 5
Interest paid $ 292 $ 135 $ 742 $ 268
Capital taxes paid $ - $ - $ 2 $ -
---------------------------------------------------------------------------

See accompanying notes to the financial statements.


Masters Energy Inc.
Notes to the Financial Statements
(Unaudited)


1. Accounting Policies

The interim financial statements of Masters Energy Inc. ("the Company") have been prepared following the same accounting policies and methods of computation as the audited financial statements of the Company for the year ended December 31, 2005. The disclosures provided below are incremental to those included with the annual financial statements. These interim financial statements should be read in conjunction with the financial statements and notes disclosed in the Company's annual report for the year ended December 31, 2005.

The Company is engaged in the exploration, development and production of petroleum and natural gas in Western Canada. The financial statements are stated in Canadian dollars and have been prepared in accordance with Canadian generally accepted accounting principles.



2. Property and equipment

($ thousands)
Accumulated
Depletion
and Net Book
As at September 30, 2006 Cost Depreciation Value
------------------------ ----------- ------------ --------
Petroleum and natural gas
properties and well equipment $ 79,656 $ 17,616 $ 62,040
Office equipment 73 36 37
----------- ------------ --------
$ 79,729 $ 17,652 $ 62,077
----------- ------------ --------
----------- ------------ --------

As at December 31, 2005
------------------------
Petroleum and natural gas
properties and well equipment $ 66,992 $ 10,820 $ 56,172
Office equipment 73 27 46
----------- ------------ --------
$ 67,065 $ 10,847 $ 56,218
----------- ------------ --------
----------- ------------ --------


The value of undeveloped lands excluded from costs subject to depletion was $8.5 million at September 30, 2006 ($8.7 million - December 31, 2005).

During the nine months ended September 30, 2006, $0.8 million ($0.4 million - September 30, 2005) of general and administrative costs were capitalized.

3. Bank debt

The Company has access to a revolving term credit facility with a Canadian chartered bank to a maximum of $22.0 million. The credit facility may be drawn with advances or bankers' acceptances or repaid. Direct advances bear interest at the bank's prime lending rate and the bankers' acceptances bear interest at the applicable bankers' acceptance rate plus a stamping fee.

The Company has available a $2.5(US) million demand swap facility, to assist in financing the contingent exposure of settlement for financial commodity swaps. The facility bears interest at a US base rate per annum on amounts drawn.

The revolving term credit facility is available for a period of 364 days until April 30, 2007. Up to 60 days prior to April 30, 2007 the Company may request an extension of the revolving facility for a period of another 364 days, subject to the bank's approval. If the Company does not request the extension or the bank does not agree to the extension, the credit facility principal borrowed will be repaid in full with a single payment 366 days subsequent to April 30, 2007. The repayment terms of the lending facility are such that it is recognized as a long-term liability.

As of September 30, 2006, $14.5 million ($14.1 million - December 31, 2005) has been drawn against the revolving term credit facility.

Security pledged for the facilities consists of a general assignment of book debts, a $40.0 million demand debenture, secured by a first floating charge over all the assets of the Company. The Company is not in breach of any covenants under its credit facility.



4. Asset retirement obligations

The following table summarizes changes in the asset retirement obligation
for the periods ended as indicated:

Nine Months
Ended Year Ended
September 30, December 31,
($ thousands) 2006 2005
---------------------------------------------------------------------------
Asset retirement obligations,
beginning of period $ 3,316 $ 3,044
Adjustments - (256)
Liabilities acquired - 305
Liabilities incurred 247 390
Asset retirement expenditures (64) (281)
Accretion expense 94 114
--------- ---------
Asset retirement obligations, end of
period $ 3,593 $ 3,316
--------- ---------
--------- ---------


The total estimated, undiscounted cash flows required to settle the obligations, before considering salvage, is $4.9 million as at September 30, 2006 ($4.6 million - December 31, 2005) which has been discounted using a weighted average credit-adjusted risk-free interest rate of 5.9 percent. The Company expects these obligations to be settled in approximately 1 to 14 years.

5. Share Capital

(a) Authorized

Unlimited number of voting common shares without nominal or par value.

Unlimited number of preferred shares issuable in series, with rights and privileges to be determined at the time of issuance by the Board of Directors.



(b) Common shares issued
($ thousands, except number of shares) Number Amount
---------------------------------------------------------------------------

Balance, December 31, 2005 14,523,313 $ 27,469
Issue of flow-through shares 1,000,000 6,100
Exercise of stock options 46,666 99
Transfer from contributed surplus from exercise of
options - 20
Share issue costs(net of future taxes of $140,000) - (294)
---------- ---------
Balance, September 30, 2006 15,569,979 $ 33,394
---------- ---------
---------- ---------


On April 18, 2006 the Company issued, through a private placement, 1,000,000 common shares on a "flow-through" basis at a price of $6.10 per share for net proceeds (after share issue costs of $434,000) of $5,666,000. The Company is obligated to incur $6.1 million of qualifying expenditures prior to December 31, 2007. As at September 30, 2006, the remaining obligation was approximately $1.9 million.



6. Stock-based Compensation

(a) Stock options

The following table sets forth a reconciliation of the stock option plan
activity for the nine months ended September 30, 2006:

Weighted
average
Number of exercise
options price
---------------------------------------------------------------------------
Balance, December 31, 2005 1,127,000 $ 2.28
Granted 404,000 4.62
Cancelled (33,334) 2.09
Exercised (46,666) 2.12

----------
Balance, September 30, 2006 1,451,000 $ 2.94
----------
----------


On May 3, 2006 at the annual and special meeting of the shareholders of the Company, the shareholders approved the amendment of the stock option plan, whereby, the maximum number of common shares reserved for the granting of stock options is limited to 10 percent of the issued and outstanding common shares of the Company. Previously, the maximum number of options reserved for future stock option grants was fixed at 1,435,042 common shares.

The fair value of the options and performance warrants granted during the period was estimated on the date of the grant using the Black-Scholes option pricing model with weighted average assumptions and resulting value for the grant as follows:



Options and
warrants Expected Risk-free Total fair
Grant date granted volatility interest rate value
---------------------------------------------------------------------------
(%) (%) ($ thousands)
April 10, 2006 150,000 42 3.7 266
May 11, 2006 319,000 44 4.0 578


(b) Performance warrants

Performance warrant plan activity for the nine months ended September 30,
2006 is as follows:

Number of Weighted
performance average price
warrants per warrant
---------------------------------------------------------------------------
Balance, December 31, 2005 870,000 $ 3.55
Granted 65,000 4.58
Settled (50,000) 3.66

-----------
Balance, September 30, 2006 885,000 $ 3.62
-----------
-----------


(c) Contributed surplus

The Company's contributed surplus activity for the nine months ended
September 30, 2006 is as follows:

($ thousands)
---------------------------------------------------------------------------
Balance, December 31, 2005 $ 393
Stock-based compensation expense 237
Capitalized stock-based compensation expense 148
Exercise of options (20)
Settlement of performance warrants (52)
------
Balance, September 30, 2006 $ 706
------
------


7. Per share amounts

Per share amounts have been calculated using the basic weighted average number of common shares outstanding of 15,569,979 and 15,153,520 during the three and nine month periods ended September 30, 2006, respectively (14,462,088 and 14,396,821 - three and nine month periods ended September 30, 2005, respectively). For the three month period ended September 30, 2006, a total of 523,076 common shares (684,151 - 2005) were added to the total to take into account the dilutive effect of the options and warrants for the period. A total of 705,594 common shares were added to take into account the dilutive effect during the nine month period ended September 30, 2006 (562,764 - 2005).

8. Future income taxes

(a) The provision for income tax expense differs from that which would be expected from applying the combined effective Canadian federal and provincial income tax rate of 34.5% (37.62% - 2005) to earnings before income taxes. The difference results from the following:





Three Months Ended Nine Months Ended
September 30, September 30,
($ thousands) 2006 2005 2006 2005
---------------------------------------------------------------------------
Expected income tax expense $ 413 $ 1,026 $ 766 $ 1,767

Increase (decrease) resulting from:
Non-deductible crown payments 86 126 350 504
Resource allowance (104) (269) (439) (15)
Stock based compensation expense 40 17) (321) (608)
Impact in effective tax rate applied (138) (35 133 60
Other 85 83 (102) 8

------- -------- ------- --------
Total future tax expense $ 382 $ 948 $ 387 $ 1,716
------- -------- ------- --------
------- -------- ------- --------

(b) The components of the future income tax liability are as follows:

As at As at
September 30, December 31,
($ thousands) 2006 2005
---------------------------------------------------------------------------
Carrying value of property and equipment
in excess of available tax deductions $ 3,732 $ 3,582
Asset retirement obligation (1,042) (1,076)
Share issuance costs (283) (286)
Attributed Canadian Royalty Income (155) (215)
--------- ---------
$ 2,252 $ 2,005
--------- ---------
--------- ---------


Masters Energy Inc. is an Alberta based corporation engaged in the business of acquiring or exploring for and developing oil and natural gas reserves in western Canada. Masters' common shares are listed on the Toronto Stock Exchange under the trading symbol "MSY".

ADVISORY

Certain information regarding the Company, including management's assessment of future plans and operations, may constitute forward-looking statements under applicable securities law and necessarily involve risks associated with oil and gas exploration, production, marketing and transportation such as loss of market, volatility of prices, currency fluctuations, impression of reserve estimates, environmental risks, competition from other producers and ability to access sufficient capital from internal and external sources: as a consequence, actual results may differ materially from those anticipated. The Company assumes no obligation to update the forward-looking statements or to update the reasons why actual results could differ from those contemplated by the forward-looking statements.

The Toronto Stock Exchange has neither approved nor disapproved of the information contained herein.

Contact Information

  • Masters Energy Inc.
    Geoff Merritt
    President and CEO
    (403) 290-1785
    or
    Masters Energy Inc.
    Randall Boyd
    Chief Financial Officer
    (403) 290-1785
    Website: www.mastersenergy.com