**UNITED
      STATES SECURITIES AND EXCHANGE COMMISSION**





**WASHINGTON,
      DC 20549**





**FORM
      10-QSB**




þ
            
            **QUARTERLY
                REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
                ACT OF
                1934**




**FOR
      THE QUARTERLY PERIOD ENDED September 30, 2007**




o
            
            **TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
                ACT OF
                1934**




**For
      the transition period from to** **** **to** ****





**Commission
      File Number: 001-32228**





**O2DIESEL
      CORPORATION**


(Name
      of
      small business issuer in its charter)




Delaware
              (State
                or Other
              Jurisdiction
                of Incorporation)
            
            91-2023525
              (IRS
                Employer
              Identification
                No.)




100
      COMMERCE DRIVE, Suite 301


NEWARK,
      DELAWARE 19713


(Address
      of Principal Executive Offices)





(302) 266-6000


(Issuer's
      telephone number)





Not
      Applicable


(Former
      name, former address and former fiscal year, if changed since last
      report)





Check
      whether the Issuer (1) filed all reports required to be filed by
      Section 13 or 15(d) of the


Securities
      Exchange Act during the past 12 months (or for such shorter period that the
      registrant was


required
      to file such reports), and (2) has been subject to such filing requirements
      for the past 90 days.


Yes þ No o





APPLICABLE
      ONLY TO CORPORATE ISSUERS





Indicated
      by check mark whether the registrant is a shell company (as defined in
      Rule 12b-2 of the Exchange Act).


Yes o No þ





APPLICABLE
      ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE
      YEARS:





Check
      whether the registrant filed all documents and reports required to be filed
      by
      Section 12, 13 or


15(d)
      of
      the Exchange Act after the distribution of securities under a plan confirmed
      by
      the court.


Yes o No o





State
      the
      number of shares outstanding of each of the issuer's classes of
      common


equity,
      as of the latest practicable date:





As
      of
      November 14, 2007, the registrant had 83,913,641 shares
      of Common Stock,


$0.0001
      par value per share, issued and outstanding





Transitional
      Small Business Disclosure Format (check one) Yes o No þ







O2DIESEL
      CORPORATION


FOR
      THE
      QUARTER ENDED SEPTEMBER 30, 2007


INDEX
      TO
      FORM 10-QSB


PART
      I
      FINANCIAL INFORMATION





Item 1.
                Financial Statements
            
            
            F-1Item 2.
                Management's Discussion and Analysis or Plan of Operation
            
            
            1Item 3.
                Controls and Procedures
            
            
            9PART
                II OTHER INFORMATIONItem 1.
                Legal Proceedings
            
            
            9Item 2.
                Unregistered Sales of Equity Securities and Use of
                Proceeds
            
            
            9Item 3.
                Defaults Upon Senior Securities
            
            
            10Item 4.
                Submission of Matters to a Vote of Security Holders
            
            
            10Item 5.
                Other Information
            
            
            10Item 6.
                Exhibits
            
            
            11Signatures
            
            
            12




NOTE
      REGARDING FORWARD LOOKING STATEMENTS





This
      quarterly report on Form 10-QSB contains forward-looking statements concerning
      O2Diesel Corporation (“O2Diesel,” the “Company” or the “Registrant”) and its
      future operations, plans and other matters. Any statements that involve
      discussions with respect to predictions, expectations, beliefs, plans,
      projections, objectives, assumptions or future events or performance (often,
      but
      not always, using phrases such as “expects”, or “does not expect”, “is
      expected”, “anticipates” or “does not anticipate”, “plans”, “estimates” or
“intends”, or stating that certain actions, events or results “may”, “could”,
“might”, or “will” be taken or occur or be achieved) are not statements of
      historical fact and may be “forward looking statements” which include statements
      relating to, among other things, the ability of O2Diesel to successfully compete
      in the fuel additive and fuel distribution business.





O2Diesel
      cautions readers not to place undue reliance on any such forward-looking
      statements, which speak only as of the date made. Such forward-looking
      statements are based on the beliefs of O2Diesel's management as well as on
      assumptions made by and information currently available to O2Diesel at the
      time
      such statements were made. Forward-looking statements are subject to a variety
      of risks and uncertainties which could cause actual events or results to differ
      from those reflected in the forward-looking statements, including, without
      limitation, the failure to obtain adequate financing on a timely basis and
      other
      risks and uncertainties. Actual results could differ materially from those
      projected in the forward-looking statements, as a result of either the matters
      set forth or incorporated in this report generally or certain economic and
      business factors, some of which may be beyond the control of O2Diesel. These
      factors include adverse economic conditions, entry of new and stronger
      competitors, inadequate capital, unexpected costs, failure to gain product
      approval in the United States or foreign countries for the commercialization
      and
      distribution of our products, failure to capitalize upon access to new markets
      and failure in obtaining the quality and quantity of ethanol necessary to
      produce our product at competitive prices. O2Diesel disclaims any obligation
      subsequently to revise any forward-looking statements to reflect events or
      circumstances after the date of such statements or to reflect the occurrence
      of
      anticipated or unanticipated events.











FINANCIAL
      INFORMATION


ITEM
      1.


**O2Diesel
                  Corporation****(A
                  Development Stage Company)****Consolidated
                  Balance Sheet****September
                  30, 2007**
  **ASSETS****CURRENT
                  ASSETS**Cash
              
              $
              650,626Restricted
                  cash
              
              
              2,898,550Accounts
                  receivable
              
              
              108,852Other
                  receivables
              
              
              251,127Unbilled
                  appropriations
              
              
              138,505Inventory
              
              
              201,716Prepaid
                  expenses, parts and deposits
              
              
              311,403Total
                  current assets
              
              
              4,560,779**PROPERTY
                  AND EQUIPMENT**Office
                  furniture and equipment
              
              
              262,824Fuel
                  and test equipment
              
              
              269,803Construction
                  in progress
              
              
              994,0081,526,635Less
                  accumulated depreciation
              
              
              (258,798
              )1,267,837**TOTAL
                  ASSETS**
              
              **$**
              **5,828,616****LIABILITIES
                  AND STOCKHOLDERS' EQUITY****CURRENT
                  LIABILITIES**Accounts
                  payable
              
              $
              1,594,709Accrued
                  expenses
              
              
              621,452Deferred
                  grants
              
              
              317,436Deferred
                  marketing program
              
              
              67,833Total
                  current liabilities
              
              
              2,601,430**TOTAL
                  LIABILITIES**
              
              
              **2,577,930****STOCKHOLDERS'
                  EQUITY**Preferred
                  stock: par value of $0.0001; 20,000,000 shares authorized; none
                  issued and
                  outstanding.
              
              
              -Common
                  stock: par value of $0.0001; 135,000,000 shares authorized; 83,286,786
                  shares issued;
                83,186,786
                  shares outstanding.
              
              
              8,329Additional
                  paid-in capital
              
              
              43,770,208Unearned
                  compensation
              
              
              (19,590
              )Accumulated
                  other comprehensive loss
              
              
              8,418Treasury
                  stock, at cost (100,000 shares)
              
              
              (40,100
              )Deficit
                  accumulated during the development stage
              
              
              (40,500,079
              )3,227,186**TOTAL
                  LIABILITIES AND STOCKHOLDERS' EQUITY**
              
              **$**
              **5,828,616**








See
      Notes
      to Financial Statements




F-1


**O2Diesel
                    Corporation****(A
                    Development Stage Company)****Consolidated
                    Statements of Operations**
  October
                    14, 2007(inception)Nine
                    months Ended
                
                Three
                    months Ended
                
                throughSeptember
                    30,
                
                September
                    30,
                
                September
                    30,2007
                
                2006
                
                2007
                
                2006
                
                2007**Revenue:**Additive
                    related sales
                
                $
                304,126
                
                $
                141,201
                
                $
                123,128
                
                $
                72,701
                
                $
                742,449Sponsorship
                    income
                
                
                21,375
                
                
                46,371
                
                
                1,875
                
                
                9,375
                
                
                169,248**Total
                    revenue**
                
                
                325,501
                
                
                187,572
                
                
                125,003
                
                
                82,076
                
                
                911,697Expenses:Cost
                    of Goods Sold
                
                
                227,421
                
                
                95,079
                
                
                81,910
                
                
                40,737
                
                
                553,728ProEco
                    operating expenses
                
                
                327,216
                
                
                -
                
                
                327,216
                
                
                -
                
                
                327,216Selling
                    and marketing
                
                
                1,145,391
                
                
                905,903
                
                
                439,753
                
                
                344,575
                
                
                8,992,245Product
                    testing and government grants, net
                
                
                449,316
                
                
                (196,832
                )
                
                259,651
                
                
                (356,607
                )
                
                1,427,099General
                    and administrative
                
                
                5,850,477
                
                
                6,158,235
                
                
                2,101,332
                
                
                3,010,524
                
                
                31,399,507**Total
                    operating expenses**
                
                
                7,999,821
                
                
                6,962,385
                
                
                3,209,862
                
                
                3,039,229
                
                
                42,699,795Operating
                    loss
                
                
                (7,674,320
                )
                
                (6,774,813
                )
                
                (3,084,859
                )
                
                (2,957,153
                )
                
                (41,788,098
                )Other
                    income (expense):Interest
                    expense
                
                
                (8,343
                )
                
                (6,392
                )
                
                (3,437
                )
                
                (2,300
                )
                
                (130,866
                )Interest
                    income
                
                
                37,697
                
                
                90,403
                
                
                9,603
                
                
                48,972
                
                
                233,063Foreign
                    currency gain/(loss), net
                
                
                230,297
                
                
                251,560
                
                
                148,759
                
                
                (28,897
                )
                
                729,080Other
                    income (expense), net
                
                
                1,030
                
                
                (4,920
                )
                
                1,420
                
                
                (1,392
                )
                
                311,100**Total
                    other income (expense)**
                
                
                260,681
                
                
                330,651
                
                
                156,345
                
                
                16,383
                
                
                1,142,377**Loss
                    before benefit for income taxes**
                
                
                (7,413,639
                )
                
                (6,444,162
                )
                
                (2,928,514
                )
                
                (2,940,770
                )
                
                (40,645,721
                )Benefit
                    for income taxes
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                145,642**Net
                    Loss**
                
                
                **(7,413,639**
                **)**
                
                **(6,444,162**
                **)**
                
                **(2,928,514**
                **)**
                
                **(2,940,770**
                **)**
                
                **(40,500,079**
                **)****Deemed
                    dividend to preferred stockholders**
                
                
                -
                
                
                (5,581,133
                )
                
                -
                
                
                -
                
                
                (6,200,005
                )**Net
                    loss allocable to common stockholders**
                
                **$**
                **(7,413,639**
                **)**
                **$**
                **(12,025,295**
                **)**
                **$**
                **(2,928,514**
                **)**
                **$**
                **(2,940,770**
                **)**
                **$**
                **(46,700,084**
                **)**Ner
                    loss per common share (basic and diluted)
                
                $
                (0.10
                )
                $
                (0.19
                )
                $
                (0.04
                )
                $
                (0.04
                )
                $
                (1.17
                )Weighted
                    average shares of common shares outstanding
                
                
                77,658,507
                
                
                62,822,036
                
                
                81,751,676
                
                
                73,734,522
                
                
                58,770,423Recapitalization
                    resulting from the AAE Technologies International PLC
                    acquisition
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                (18,926,524
                )Weighted
                    average shares of common shares outstanding - giving effect to
                    the
                    recapitalization
                
                
                77,658,507
                
                
                62,822,036
                
                
                81,751,676
                
                
                73,734,522
                
                
                39,843,899


See
      Notes
      to Financial Statements





F-2


**02Diesel
                  Corporation****(A
                  Development Stage Company)****Statement
                  of Changes in Stockholders' Equity (Deficit)****October
                  14, 2000 (Inception) through September 30,
                  2007**
  Common
              
              AdditionalPreferred
                  Stock
              
              Common
                  Stock
              
              Unearned
              
              Stock
              
              Paid
                  - InShares
              
              Amount
              
              Shares
              
              Amount
              
              Compensation
              
              Subscribed
              
              CapitalBalance
                  at October 14, 2000 (Inception)Common
                  stock issued in exchange for interest in wholly owned
                  subsidiaries
              
              
              -
              
              $
              -
              
              
              43,008,772
              
              $
              430,088
              
              $
              -
              
              $
              -
              
              $
              3,603,415Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Foreign
                  currency translation adjustment
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Comprehensive
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Common
                  stock issued on various dates during 2001
              
              
              -
              
              
              -
              
              
              24,181,038
              
              
              241,810
              
              
              -
              
              
              -
              
              
              1,268,031Balance
                  at December 31, 2001
              
              
              -
              
              
              -
              
              
              67,189,810
              
              
              671,898
              
              
              -
              
              
              -
              
              
              4,871,446Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Foreign
                  currency translation adjustment
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Comprehensive
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Common
                  stock issued at $0.225 per share on various dates during
                  2002
              
              
              -
              
              
              -
              
              
              703,282
              
              
              7,033
              
              
              -
              
              
              -
              
              
              515,657Balance
                  at December 31, 2002
              
              
              -
              
              
              -
              
              
              67,893,092
              
              
              678,931
              
              
              -
              
              
              -
              
              
              5,387,103Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Foreign
                  currency translation adjustment
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Comprehensive
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Common
                  stock issued on various dates during 2003
              
              
              -
              
              
              -
              
              
              555,556
              
              
              5,556
              
              
              -
              
              
              -
              
              
              119,444Common
                  stock issued for consulting services
              
              
              -
              
              
              -
              
              
              200,000
              
              
              2,000
              
              
              -
              
              
              -
              
              
              43,000Common
                  stock issued for remaining interest in subsidiaries on July 15,
                  2003
              
              
              -
              
              
              -
              
              
              4,356,200
              
              
              43,562
              
              
              -
              
              
              -
              
              
              46,323Common
                  stock issued upon exercise of stock options on various dates during
                  2003
              
              
              -
              
              
              -
              
              
              8,670,881
              
              
              86,709
              
              
              -
              
              
              -
              
              
              1,131,595Recapitalization
                  resulting from AAE acquisition on July 15, 2003
              
              
              -
              
              
              -
              
              
              (56,928,690
              )
              
              (814,283
              )
              
              -
              
              
              -
              
              
              814,283Common
                  stock issued at $1.50 per share on various dates during
                  2003
              
              
              -
              
              
              -
              
              
              3,333,333
              
              
              333
              
              
              -
              
              
              -
              
              
              4,999,667Expenses
                  related to 2003 issuance of common stock and
                  recapitalization
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (795,650
              )Subscriptions
                  for 754,900 shares of common stock at $1.50 per share on various
                  dates
                  during 2003
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              1,132,350
              
              
              -Balance
                  at December 31, 2003
              
              
              -
              
              
              -
              
              
              28,080,372
              
              
              2,808
              
              
              -
              
              
              1,132,350
              
              
              11,745,765Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Foreign
                  currency translation adjustment
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Comprehensive
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Common
                  stock issued at $1.50 per share on various dates in 2004
              
              
              -
              
              
              -
              
              
              1,070,451
              
              
              107
              
              
              -
              
              
              (1,132,350
              )
              
              1,535,770Preferred
                  stock issued on various dates during 2004
              
              
              1,550,000
              
              
              155
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              5,478,609Balance
                  at December 31, 2004
              
              
              1,550,000
              
              
              155
              
              
              29,150,823
              
              
              2,915
              
              
              -
              
              
              -
              
              
              18,760,144Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Foreign
                  currency translation adjustment
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Comprehensive
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Common
                  stock issued for consulting services
              
              
              -
              
              
              -
              
              
              63,750
              
              
              6
              
              
              -
              
              
              -
              
              
              63,094Warrants
                  issued for consulting services
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              135,000Common
                  stock issued at $0.70 per share on various dates in 2005
              
              
              -
              
              
              -
              
              
              7,515,981
              
              
              752
              
              
              -
              
              
              -
              
              
              4,832,439Common
                  stock issued at $0.7125 per share on various dates in 2005
              
              
              -
              
              
              -
              
              
              3,228,070
              
              
              322
              
              
              -
              
              
              -
              
              
              2,090,178Common
                  stock issued at $0.564 per share on various dates in 2005
              
              
              -
              
              
              -
              
              
              6,419,840
              
              
              642
              
              
              -
              
              
              -
              
              
              3,599,658Balance
                  at December 31, 2005
              
              
              1,550,000
              
              
              155
              
              
              46,378,464
              
              
              4,637
              
              
              -
              
              
              -
              
              
              29,480,513Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Foreign
                  currency translation adjustment
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Comprehensive
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Common
                  stock issued via exercise of warrants on various dates in
                  2006
              
              
              -
              
              
              -
              
              
              3,151,892
              
              
              315
              
              
              -
              
              
              -
              
              
              1,457,829Common
                  stock issued for consulting services
              
              
              -
              
              
              -
              
              
              56,250
              
              
              6
              
              
              -
              
              
              -
              
              
              50,994Conversion
                  of preferred stock into common stock on various dates in
                  2006
              
              
              (1,550,000
              )
              
              (155
              )
              
              15,500,000
              
              
              1,550
              
              
              -
              
              
              -
              
              
              (1,395
              )Common
                  stock issued at $0.75 per share in 2006
              
              
              -
              
              
              -
              
              
              8,666,666
              
              
              867
              
              
              -
              
              
              -
              
              
              6,256,282Common
                  stock issued at $0.729 per share in 2006
              
              
              -
              
              
              -
              
              
              1,371,742
              
              
              138
              
              
              -
              
              
              -
              
              
              979,367Fair
                  value of unvested stock options upon adoption of SFAS 123
                  R
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (376,031
              )
              
              -
              
              
              376,031Amortization
                  of unearned compensation
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              250,890
              
              
              -
              
              
              -Fair
                  value of stock options issued in 2006
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              1,476,684Balance
                  at December 31, 2006
              
              
              -
              
              
              -
              
              
              75,125,014
              
              
              7,513
              
              
              (125,141
              )
              
              -
              
              
              40,076,305Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Foreign
                  currency translation adjustment
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Comprehensive
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Common
                  stock issued to employee
              
              
              -
              
              
              -
              
              
              333,333
              
              
              33
              
              
              -
              
              
              -
              
              
              273,266Fair
                  value of unearned shares related to commitment shares
              
              
              -
              
              
              -
              
              
              805,987
              
              
              80
              
              
              -
              
              
              -
              
              
              668,889Unearned
                  common stock issued for commitment shares
              
              
              -
              
              
              -
              
              
              (561,888
              )
              
              (56
              )
              
              -
              
              
              -
              
              
              (466,311
              )Fusion
                  shares issued at various prices in 2007
              
              
              -
              
              
              -
              
              
              970,994
              
              
              97
              
              
              -
              
              
              -
              
              
              499,903Common
                  stock issued for consulting services
              
              
              -
              
              
              -
              
              
              490,000
              
              
              49
              
              
              -
              
              
              -
              
              
              239,951Common
                  stock issued at $0.405 per share in 2007
              
              
              -
              
              
              -
              
              
              5,823,346
              
              
              583
              
              
              -
              
              
              -
              
              
              2,189,702Repurchase
                  of shares for treasury
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Common
                  stock issued at $0.417 per share in 2007
              
              
              -
              
              
              -
              
              
              300,000
              
              
              30
              
              
              -
              
              
              -
              
              
              115,062Amortization
                  of unearned compensation
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              105,551
              
              
              -
              
              
              (24,727
              )Fair
                  value of stock options issued in 2006
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              198,168Balance
                  at September 30, 2007
              
              
              -
              
              $
              -
              
              
              83,286,786
              
              $
              8,329
              
              $
              (19,590
              )
              
              -
              
              $
              43,770,208




See
      Notes
      to Financial Statements




F-3


**02Diesel
                  Corporation****(A
                  Development Stage Company)****Statement
                  of Changes in Stockholders' Equity (Deficit)****October
                  14, 2000 (Inception) through September 30,
                  2007**
  DeficitCommon
              
              Accumulated
              
              
              
              Accumulated
              
              TotalStock
              
              Other
              
              
              
              During
                  the
              
              Stockholders'Subscriptions
              
              Comprehensive
              
              Treasury
              
              Development
              
              EquityReceivable
              
              Income
                  (Loss)
              
              Stock
              
              Stage
              
              (Deficit)Balance
                  at October 14, 2000 (Inception)Common
                  stock issued in exchange for interest in wholly owned
                  subsidiaries
              
              $
              -
              
              $
              -
              
              
              -
              
              $
              (4,138,684
              )
              $
              (105,181
              )Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              (1,406,709
              )
              
              (1,406,709
              )Foreign
                  currency translation adjustment
              
              
              -
              
              
              (4,476
              )
              
              -
              
              
              -
              
              
              (4,476
              )Comprehensive
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (1,411,185
              )Common
                  stock issued on various dates during 2001
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              1,509,841Balance
                  at December 31, 2001
              
              
              -
              
              
              (4,476
              )
              
              -
              
              
              (5,545,393
              )
              
              (6,525
              )Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              (1,712,803
              )
              
              (1,712,803
              )Foreign
                  currency translation adjustment
              
              
              -
              
              
              (74,085
              )
              
              -
              
              
              -
              
              
              (74,085
              )Comprehensive
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (1,786,888
              )Common
                  stock issued at $0.225 per share on various dates during
                  2002
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              522,690Balance
                  at December 31, 2002
              
              
              -
              
              
              (78,561
              )
              
              -
              
              
              (7,258,196
              )
              
              (1,270,723
              )Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              (4,230,296
              )
              
              (4,230,296
              )Foreign
                  currency translation adjustment
              
              
              -
              
              
              179,689
              
              
              -
              
              
              -
              
              
              179,689Comprehensive
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (4,050,607
              )Common
                  stock issued on various dates during 2003
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              125,000Common
                  stock issued for consulting services
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              45,000Common
                  stock issued for remaining interest in subsidiaries on July 15,
                  2003
              
              
              -
              
              
              -
              
              
              -
              
              
              (409,614
              )
              
              (319,729
              )Common
                  stock issued upon exercise of stock options on various dates during
                  2003
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              1,218,304Recapitalization
                  resulting from AAE acquisition on July 15, 2003
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Common
                  stock issued at $1.50 per share on various dates during
                  2003
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              5,000,000Expenses
                  related to 2003 issuance of common stock and
                  recapitalization
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (795,650
              )Subscriptions
                  for 754,900 shares of common stock at $1.50 per share on various
                  dates
                  during 2003
              
              
              (180,000
              )
              
              -
              
              
              -
              
              
              -
              
              
              952,350Balance
                  at December 31, 2003
              
              
              (180,000
              )
              
              101,128
              
              
              -
              
              
              (11,898,106
              )
              
              903,945Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              (6,728,014
              )
              
              (6,728,014
              )Foreign
                  currency translation adjustment
              
              
              -
              
              
              (97,446
              )
              
              -
              
              
              -
              
              
              (97,446
              )Comprehensive
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (6,825,460
              )Common
                  stock issued at $1.50 per share on various dates in 2004
              
              
              180,000
              
              
              -
              
              
              -
              
              
              -
              
              
              583,527Preferred
                  stock issued on various dates during 2004
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              5,478,764Balance
                  at December 31, 2004
              
              
              -
              
              
              3,682
              
              
              -
              
              
              (18,626,120
              )
              
              140,776Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              (6,852,165
              )
              
              (6,852,165
              )Foreign
                  currency translation adjustment
              
              
              -
              
              
              2,329
              
              
              -
              
              
              -
              
              
              2,329Comprehensive
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (6,849,836
              )Common
                  stock issued for consulting services
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              63,100Warrants
                  issued for consulting services
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              135,000Common
                  stock issued at $0.70 per share on various dates in 2005
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              4,833,191Common
                  stock issued at $0.7125 per share on various dates in 2005
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              2,090,500Common
                  stock issued at $0.564 per share on various dates in 2005
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              3,600,300Balance
                  at December 31, 2005
              
              
              -
              
              
              6,011
              
              
              -
              
              
              (25,478,285
              )
              
              4,013,031Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              (7,608,155
              )
              
              (7,608,155
              )Foreign
                  currency translation adjustment
              
              
              -
              
              
              (10,392
              )
              
              -
              
              
              -
              
              
              (10,392
              )Comprehensive
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (7,618,547
              )Common
                  stock issued via exercise of warrants on various dates in
                  2006
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              1,458,144Common
                  stock issued for consulting services
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              51,000Conversion
                  of preferred stock into common stock on various dates in
                  2006
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Common
                  stock issued at $0.75 per share in 2006
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              6,257,149Common
                  stock issued at $0.729 per share in 2006
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              979,505Fair
                  value of unvested stock options upon adoption of SFAS 123
                  R
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Amortization
                  of unearned compensation
              
              
              -
              
              
              -
              
              
              
              
              
              -
              
              
              250,890Fair
                  value of stock options issued in 2006
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              1,476,684Balance
                  at December 31, 2006
              
              
              -
              
              
              (4,381
              )
              
              -
              
              
              (33,086,440
              )
              
              6,867,856Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              (7,413,639
              )
              
              (7,413,639
              )Foreign
                  currency translation adjustment
              
              
              -
              
              
              12,799
              
              
              -
              
              
              -
              
              
              12,799Comprehensive
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (7,400,840
              )Common
                  stock issued to employee
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              273,299Fair
                  value of unearned shares related to commitment shares
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              668,969Unearned
                  common stock issued for commitment shares
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (466,367
              )Fusion
                  shares issued at various prices in 2007
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              500,000Common
                  stock issued for consulting services
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              240,000Common
                  stock issued at $0.405 per share in 2007
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              2,190,285Repurchase
                  of shares for treasury
              
              
              -
              
              
              -
              
              
              (40,100
              )
              
              -
              
              
              (40,100
              )Common
                  stock issued at $0.417 per share in 2007
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              115,092Amortization
                  of unearned compensation
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              80,824Fair
                  value of stock options issued in 2006
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              198,168Balance
                  at September 30, 2007
              
              $
              -
              
              $
              8,418
              
              $
              (40,100
              )
              $
              (40,500,079
              )
              $
              3,227,186
  See
          Notes
          to Financial Statements
  F-4


**02Diesel
                    Corporation****(A
                    Development Stage Company)****Consolidated
                    Statements of Cash Flows**
  October
                    14, 2007(inception)Nine
                    months Ended
                
                throughSeptember
                    30,
                
                September
                    30,2007
                
                2006
                
                2007**Cash
                    flows from operating activites****Net
                    loss**
                
                **$**
                **(7,413,639**
                **)**
                **$**
                **(6,444,162**
                **)**
                **$**
                **(40,500,079**
                **)**Adjustments
                    to reconcile loss to net cash used in operating activites:Depreciation
                
                
                69,922
                
                
                62,820
                
                
                353,686Amortization
                
                
                -
                
                
                -
                
                
                7,786Write
                    off of patent
                
                
                -
                
                
                -
                
                
                337,329Write
                    off of obsolete inventory
                
                
                -
                
                
                -
                
                
                5,925Loss
                    on sale/disposal of furniture & equipment
                
                
                -
                
                
                7,364
                
                
                8,528Non
                    cash contributions
                
                
                -
                
                
                1,564
                
                
                5,312Common
                    stock and warrants issued for consulting services
                
                
                240,000
                
                
                50,999
                
                
                494,100Common
                    stock issued to employee
                
                
                273,299
                
                
                -
                
                
                273,299Common
                    stock issued for commitment shares
                
                
                202,602
                
                
                -
                
                
                202,602Amortization
                    of unearned compensation
                
                
                278,992
                
                
                1,654,620
                
                
                2,006,566Changes
                    in operating assets and liabilities:Accounts
                    receivable
                
                
                (95,077
                )
                
                7,834
                
                
                (108,852
                )Other
                    receivables
                
                
                517,500
                
                
                (430,063
                )
                
                (251,127
                )Inventory,
                    prepaid expenses and other current assets
                
                
                (177,673
                )
                
                (91,895
                )
                
                (657,549
                )Accounts
                    payable
                
                
                903,656
                
                
                227,212
                
                
                1,594,709Accrued
                    expenses
                
                
                228,223
                
                
                488
                
                
                610,294Deferred
                    grants
                
                
                307,477
                
                
                254,756
                
                
                317,436Deferred
                    marketing program
                
                
                (166,667
                )
                
                (197,065
                )
                
                67,833**Cash
                    flows used in operating activities**
                
                
                **(4,831,385**
                **)**
                
                **(4,895,528**
                **)**
                
                **(35,232,202**
                **)****Cash
                    flows from investing activities**Restricted
                    cash
                
                
                745,877
                
                
                (128,918
                )
                
                (2,898,550
                )Purchase
                    of property and equipment
                
                
                (1,107,572
                )
                
                (121,552
                )
                
                (1,636,453
                )Proceeds
                    from sale of furniture & equipment
                
                
                -
                
                
                1,250
                
                
                13,150Purchase
                    of patent
                
                
                -
                
                
                -
                
                
                (345,115
                )**Cash
                    flows provided by (used in) investing activities**
                
                
                **(361,695**
                **)**
                
                **(249,220**
                **)**
                
                **(4,866,968**
                **)****Cash
                    flows from financing activities**Net
                    proceeds from issuance of preferred stock
                
                
                -
                
                
                -
                
                
                5,478,764Net
                    proceeds from private placement
                
                
                -
                
                
                -
                
                
                5,953,757Repurchase
                    of shares for treasury
                
                
                (40,100
                )
                
                -
                
                
                (40,100
                )Net
                    proceeds from issuance of common stock
                
                
                2,805,377
                
                
                7,715,293
                
                
                29,355,870**Cash
                    flows provided by financing activities**
                
                
                **2,765,277**
                
                
                **7,715,293**
                
                
                **40,748,291**Effect
                    of exchange rate changes on cash
                
                
                12,799
                
                
                (6,825
                )
                
                1,505**Net
                    (decrease)/increase in cash**
                
                
                (2,415,004
                )
                
                2,563,720
                
                
                650,626**Cash
                    at beginning of period**
                
                
                **3,065,630**
                
                
                **1,412,851**
                
                
                **-****Cash
                    at end of period**
                
                **$**
                **650,626**
                
                **$**
                **3,976,571**
                
                **$**
                **650,626**Cash
                    paid for interest
                
                $
                8,343
                
                $
                6,392
                
                $
                121,514Cash
                    paid for income taxes
                
                
                None
                
                
                None
                
                
                None
 Non-Cash
          Transactions: Conversion of bridge loan to common stock at 9/30/2003 -
          $2,322,500.


Conversion
      of preferred to common stock at various dates during 2006 -
      $1,550,000.




See
      Notes
      to Financial Statements





F-5





**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**Notes
      to Financial Statements**


**(Unaudited)**





**1.
      The Company and Basis of Presentation**





**The
      Company**





O2Diesel
      Corporation (“O2Diesel” or the “Company”) is in the development stage and has
      developed a proprietary additive product designed to enable distillate liquid
      transportation fuels to burn cleaner by facilitating the addition of ethanol
      as
      an oxygenate to these fuels. To date, the Company's operations have continued
      to
      be focused on raising capital, performing research and development, and bringing
      its product to market.





O2Diesel
      Corporation's predecessor, Dynamic Ventures, Inc., was incorporated in the
      State
      of Washington on April 24, 2000. Dynamic Ventures, Inc. changed its name to
      O2Diesel Corporation effective June 10, 2003, in contemplation of the
      reverse acquisition of AAE Technologies International Plc (“AAE”). On
      July 15, 2003, O2Diesel Corporation acquired all of the issued and
      outstanding shares of AAE in exchange for 17,847,039 shares of its common stock.
      As a result of this transaction, the former shareholders of AAE acquired control
      of the combined companies. The acquisition of AAE has been accounted for as
      a
      capital transaction followed by a recapitalization. AAE was considered to be
      the
      accounting acquirer. Accordingly, the historical financial statements of AAE
      are
      considered to be those of O2Diesel Corporation for all periods
      presented.





In
      conjunction with the reverse acquisition, the Company completed a private
      placement of its common stock whereby it issued 3,333,333 shares of common
      stock
      at $1.50 per share. Of the $5.0 million raised, approximately $800,000 was
      used
      to pay the costs of the reverse acquisition and private placement,
      $1.0 million was used to repay a bridge loan that was made in contemplation
      of the transaction, and the balance of $3.2 million was used to fund the
      ongoing developmental activities of the Company. Subsequent to its first private
      placement, the Company undertook to raise an additional $3.5 million
      through a follow-on private placement of our common stock (the “Follow-On
      Private Placement”). In the Follow-On Private Placement, we raised $1,535,770,
      before expenses, and issued 1,025,784 shares of our common stock at a price
      of
      $1.50 per share.





O2Diesel
      was reincorporated in the state of Delaware in a transaction that became
      effective on December 31, 2004.





On
      June 15, 2004, the American Stock Exchange (“AMEX” or “Exchange”) approved
      an application to list 46,518,898 shares of our common stock under the symbol
      OTD. Subsequent to this date, the Exchange has approved additional applications
      to list 72,830,013 shares of the Company's common stock so that the total number
      of shares approved for listing is now 119,348,911. Our shares began to trade
      on
      the Exchange on July 1, 2004.





**Basis
      of Presentation**





The
      Company's unaudited consolidated financial statements for the three and nine
      months ended September 30, 2007, have been prepared on a going concern basis,
      which contemplates the realization of assets and the settlement of liabilities
      and commitments in the normal course of business. We
      have
      reclassified certain prior-year amounts to conform to the current year’s
      presentation.




At
      September 30, 2007, the Company had working capital of $1,959,349 and had
      accumulated losses of $40,500,079. However, $2,898,550 of the working capital
      is
      restricted in use to operational costs associated with developing markets in
      Europe. The lack of adequate working capital and continuing losses, as well
      as
      the uncertain conditions regarding the Company’s AMEX listing status as stated
      below, create an uncertainty about the Company’s ability to continue as a going
      concern. However, as discussed below, management has developed a plan to bring
      the Company into compliance with AMEX standards and to commence profitable
      operations. The financial statements do not include any adjustments that might
      be necessary if the Company is unable to continue as a going concern.


The
        Company was notified by the AMEX in December 2004 that it was not in
        compliance with AMEX Company Guide Section 1003(a)(iii) which requires listed
        companies to have at least $6.0 million of stockholders' equity when it has sustained
        losses from continuing operations and/or net losses in its five most recent
        fiscal years .
        AMEX
        indicated that, in order to return to full compliance, O2Diesel needed to
        have
        stockholders' equity of $6.0 million by June 2006 and to maintain this
        level going forward.




In
      accordance with the procedures of the Exchange, we filed a plan (“Plan”) with it
      to demonstrate the steps we would take to return to full compliance. On
      February 15, 2005, the AMEX notified us that it had accepted our Plan, and
      that we would be given until June 2006 in which to regain compliance with
      the Exchange's listing rules. To achieve that level of stockholders' equity,
      we
      anticipated having to raise a total of approximately $10.0 million in new
      equity during 2005. In December 2005 the Company determined that it could
      not meet certain conditions of the Plan and met with representatives of the
      AMEX
      to discuss the need to develop an amended plan to demonstrate how the Company
      would be in compliance by June 2006.





The
      Company believed it needed to raise an additional $7.0 million in new
      capital prior to June 2006 to allow it to return to full compliance with
      the listing standards of the AMEX. In addition, the Company believed it needed
      to raise an additional $3.5 million in equity in the second half of 2006 to
      allow it to execute its business plan for the year and to remain in compliance
      with the AMEX standards.





The
      Company collected $592,692 (after expenses) and $865,452 (net of expenses)
      in
      two warrant exercises and closed three private placements totaling $7.5 million
      as part of this effort in 2006.




F-6





**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**Notes
      to Financial Statements**


**(Unaudited)**





On
      July
      17, 2006, the Company received a letter from the AMEX indicating that the
      Company had regained compliance with AMEX listing requirements. At December
      31,
      2006, the Company was in compliance with AMEX listing requirements but, for
      the
      period ended March 31, 2007, the Company was not able to meet the listing
      requirements. On June 29, 2007, the Company was notified by AMEX that it was
      not
      in compliance with the listing standards of the Exchange because it lacked
      the
      requisite amount of stockholders' equity. The Company was asked to submit a
      plan
      by July 27, 2007 advising AMEX of actions the Company would be taking to bring
      it into compliance with the continued listing standards by December 29,
      2008.





On
      July
      27, 2007, the Company filed a plan with the Exchange describing the steps it
      plans to take to return to full compliance. The Company has entered into a
      common stock purchase agreement with Fusion Capital Fund
      II,
      LLC to raise
      up to $10 million in new equity over a twenty-five month period starting on
      February 16, 2007. Also, the Company announced a private placement in which
      we
      raised an additional $2.52 million in July and August 2007. As noted below,
      the
      Company intends to raise additional new equity in conjunction with the
      acquisition of the ProEco Energy Company, Inc. (“ProEco”). We believe these
      actions will enable us to meet or exceed the equity requirements of the
      Exchange.




On
        September 13, 2007, the Company received a written notice from the AMEX
        indicating that AMEX had reviewed and accepted the Company’s plan to regain
        listing qualifications compliance. With the acceptance of the plan, the Company
        will be able to continue its listing during the plan period pursuant to an
        extension granted until December 29, 2008. The AMEX notice also advised the
        Company that, in addition to the previously disclosed deficiency with respect
        to
        Section 1003(a)(iii) of the AMEX Company Guide, it had triggered an additional
        deficiency with respect to Section 1003(a)(ii) of the AMEX Company Guide which
        requires listed companies to have at least $4.0 million of stockholders'
        equity
        when it has sustained
        losses from continuing operations and/or net losses in its four most recent
        fiscal years .





During
      the interim period until December 29, 2008, the Company must continue to provide
      AMEX staff with updates regarding initiatives set forth in its plan of
      compliance. The Company will be subject to periodic review by AMEX staff during
      the interim period. If the Company is not in compliance with the continued
      listing standards on December 29, 2008, or the Company does not make progress
      consistent with the plan during the interim period, the
      AMEX
      would likely initiate procedures to de-list the Company's common stock. If
      the
      Company's common stock were to be de-listed by the AMEX, its shares would
      continue to be traded as a bulletin board stock.





The
      consolidated financial statements in this report do not include any adjustments
      to reflect the anticipated private placements or the possible future effects
      on
      the recoverability and classification of assets or the amounts and
      classification of liabilities that may result should management be unsuccessful
      in obtaining financing on terms acceptable to the Company.





Since
      July 2003, the Company has raised approximately $36 million for its operations.





**2.
      Summary of Significant Accounting Policies**





**Principles
      of Consolidation**





The
      consolidated financial statements include the accounts of the Company and all
      affiliated subsidiaries. All significant inter-company balances and transactions
      have been eliminated in consolidation. Based on Financial Accounting Standards
      Board (“FASB”) Interpretation No. 46R, *Consolidation
      of Variable Interest Entities* ”
(“FIN
      46R”), the Company is the holder of the majority of the risks and rewards
      relating to ProEco Energy Company, Inc. (“ProEco”). As such, the Company is
      considered to be the “primary beneficiary” of ProEco, deemed to be a variable
      interest entity (“VIE”), and has included ProEco’s assets, liabilities and
      operating results in its consolidated financial statements.





**Variable
      Interest Entity (VIE)**





In
      general, a VIE is a corporation, partnership, limited-liability corporation,
      trust or any other legal structure used to conduct activities or hold assets
      that either (i) has an insufficient amount of equity to carry out its principal
      activities without additional subordinated financial support; (ii) has a group
      of equity owners that are unable to make significant decisions about its
      activities; or (iii) has a group of equity owners that do not have the
      obligation to absorb losses or the right to receive returns generated by its
      operations. Based on these guidelines, the Company has determined that ProEco
      is
      a VIE beginning with the third quarter of 2007. Prior to that period, activity
      with ProEco was not material.





**Cash
      and Cash Equivalents**





The
      Company considers all highly liquid instruments with a maturity of three months
      or less at the time of issuance to be cash equivalents. As of September 30,
      2007, cash deposits exceeded federally insured limits which are generally
      $100,000 per financial institution.





**Restricted
      Cash**





On
      December 16, 2005, the Company completed a private placement of its common
      stock, whereby it received approximately $3.6 million USD which is
      restricted to operational costs associated with developing markets in Europe.
      Prior to 2005, restricted cash consisted of cash held in the Company's bank
      account pursuant to the provisions set forth in documents to the acquisition
      of
      AAE on July 15, 2003. The restricted funds associated with the acquisition
      of AAE were released in equal amounts on October 15, 2003, and
      January 15, 2004.





**Fair
      Value of Financial Instruments**





The
      carrying amounts of cash and cash equivalents, accounts receivable, due to/from
      related parties, other receivables, accounts payable, accrued expenses and
      deferred grants approximate fair value because of their short-term
      nature.





**Concentration
      of Credit Risk and Allowance for Doubtful Accounts**





The
      Company provides an allowance for doubtful accounts for estimated losses
      resulting from the inability of customers to make required payments. The Company
      does not require collateral and it does not charge finance fees on outstanding
      trade receivables. The allowance is determined by analyzing historical data
      and
      trends, as well as specific customers' financial conditions. Past-due or
      delinquency status is based upon the credit terms for that specific customer
      from the date of delivery. Charges for doubtful accounts are recorded in selling
      and marketing expenses. Trade accounts receivables are written off against
      the
      allowance for doubtful accounts when collection appears unlikely.





F-7





**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**Notes
      to Financial Statements**


**(Unaudited)**





**Inventories**





Inventories,
      consisting of fuel additive held at third party locations, are stated at the
      lower of cost as determined using the first in, first out (FIFO) method, or
      market value.





**Furniture,
      Equipment, Construction in Progress** **and
      Depreciation**





Furniture
      and equipment are stated at cost, less accumulated depreciation. Depreciation
      is
      provided over the estimated useful lives of the assets using the straight-line
      method. Construction
      in progress primarily includes payments to third parties for land options,
      submission of permits for construction, negotiation of EPC, supply and
      transportation contracts, and the development of marketing agreements for sale
      of the ethanol to be produced at the Ethanol Plant. It also includes
      payroll-related costs attributable to personnel working directly on the project. The
      estimated useful lives of fixed assets are as follows:




Office
      furniture and equipment: 3 to 5 years


Fuel
      and
      test equipment: 5 years





Depreciation
      expense recorded in the accompanying Consolidated Statements of Operations
      was
      $21,124 and $62,820 for the three and nine months ended September 30, 2006,
      respectively, and was $20,713, $64,728 and $348,492 for the three and nine
      months ended September 30, 2007 and for the period October 14, 2000
      (inception) through September 30, 2007, respectively.





**Accounting
      for Impairment of Intangible and Long-Lived Assets**





The
      carrying values of intangible and long-lived assets are reviewed on a
      regular basis for the existence of facts or circumstances that may suggest
      impairment. The Company recognizes impairment when the sum of the expected
      undiscounted future cash flows is less than the carrying amount of the asset.
      Impairment losses, if any, are measured as the excess of the carrying amount
      of
      the asset over its estimated fair value.





**Revenue
      Recognition**





The
      Company sells its product directly to its customers and revenue is recognized
      and recorded upon the passage of title of the product to the customer and
      following confirmation that the customer is utilizing the final blended
      fuel.





The
      Company has developed the CityHomeTM program to serve as an
      important element of its sales/marketing and product demonstration
      strategy. This program involves the sale of our additive, the receipt of
      sponsorship fees and the potential sale of advertising space. As with other
      customers, revenue from the sales of product is recognized and recorded upon
      the
      passage of title of the product to the customer and following confirmation
      that
      the customer is utilizing the final blended fuel. Sponsorship fees will become
      additional revenue for us and will be recognized as such over the period of
      the
      contract when a sponsorship agreement is signed and the fees have been invoiced.
      Costs that are intended to be supported by the sponsorship fees are recorded
      separately in the related expense line in our statement of operations. With
      regard to the advertising space, since the CityHomeTM program is still in its
      beginning phase and since we have been unable to assess the fair market value
      of
      the advertising space received, we assign no value to the space at the time
      of
      receipt. We are recognizing the value associated with the advertising space
      when
      we enter into a contract arrangement with a third party. The Company will
      consider assigning a fair value to the advertising space received at the time
      of
      the initial sale when such fair value is more readily determinable, based upon
      a
      history of cash transactions.





The
      Company has supported certain fleet equipment conversion costs in these
      CityHomeTM initiatives and has also been required to bear the incremental costs
      of the blended fuel, where it is experienced. Whenever the expected costs of
      the
      program are determined to be in excess of the contracted sponsorship fees and
      related fuel additive revenue, the Company records the loss for the contract
      as
      an expense and a deferred liability to be amortized over the life of the
      contract. As of September 30, 2007, costs remaining to be amortized for
      CityHomeTM programs were recorded on the balance sheet as Deferred Marketing
      Program in the amount of $67,833. The Company recorded $23,779 and $112,532
      in
      costs for the CityHomeTM initiatives in excess of sponsorship fees during the
      three and nine months ended September 30, 2006 and ($22,497), $63,896 and
      $1,185,632 of costs in excess of sponsorship fees (fees in excess of costs)
      for
      CityHomeTM initiatives for the three and nine months ended September 30, 2007 and
      for the period October 14, 2000 (inception) through September 30,
      2007, respectively.





**Shipping
      and Handling Costs**





The
      Company classifies costs associated with shipping and handling activities within
      cost of goods sold in the consolidated statements of operations.





**Advertising
      Expenses**





Advertising
      costs are expensed as incurred. Advertising expense was $0 for the three and
      nine months ended September 30, 2007 and 2006, and was $450,000 for the period
      October 14, 2000 (inception) to September 30, 2007.





**Research
      and Development Costs**





Research
      and development costs are expensed as incurred.





**Product
      Test and Demonstration Appropriations**





The
      Company receives appropriations from U.S. governmental agencies to fund certain
      of its product testing and demonstration programs. The Company evaluates the
      conditions of the appropriation and either increases revenue, decreases expenses
      or reduces the cost of furniture and equipment depending upon the attributes
      of
      the underlying grant. Appropriations are not recognized until there is
      reasonable assurance that the Company will comply with the conditions of the
      grant and that the monies under the grant will be received.





**Net
      Loss Per Common Share (Basic and Diluted)**





Basic
      net
      loss per common share is computed by dividing the net loss available to common
      stockholders by the weighted average number of common shares outstanding during
      the period. Diluted net loss per share gives effect to all dilutive potential
      common shares outstanding during the period using the if-converted method.
      The
      weighted average number of shares used to compute basic and diluted loss per
      share is the same since the effect of the dilutive securities is
      anti-dilutive.





F-8





**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**Notes
      to Financial Statements**


**(Unaudited)**





**Accounting
      for Stock-Based Compensation**





Effective
      January 1, 2006, the Company adopted the fair value recognition provisions
      of Statement of Financial Accounting Standard ("SFAS") No. 123(R) *Share-Based
      Payment* ,
      using
      the modified prospective transition method. SFAS No. 123(R) requires all
      share-based payments to employees, including grants of employee stock options,
      to be recognized in the financial statements based on their fair values
      beginning with the first annual reporting period that begins after
      December 15, 2005, with early adoption encouraged.





The
      Company implemented a Stock Incentive Plan (the “Incentive Plan”) in 2004 for
      which the Board of Directors has authorized 9,750,000 shares of common stock
      to
      be reserved for future issuance under the Plan. Stock options generally vest
      over three years and will expire 10 years from the effective date. However,
      the Company has the latitude under the Incentive Plan to issue options at
      various stages of vesting.





Once
      these options are granted by the Board under the provisions of the plan, the
      Company records a compensation charge for the difference between the fair value
      of the common stock and the exercise price of the options on the date of
      issuance if the fair value of the common stock exceeds the exercise price of
      the
      option on that date. The fair value of each option granted is estimated on
      the
      date of grant using the Black-Scholes option-pricing model. There were no
      options granted by the Board in the nine months ended September 30, 2007. The
      assumptions used with this model for 2006 were an expected life of three years,
      a zero dividend yield, volatility ranging from 72% to 209% (depending on date
      of
      grant), and risk free interest rates ranging from 4.64% to 5.09% (depending
      on
      date of grant). The assumptions used with this model for 2005 were an expected
      life of 3 years, a zero dividend yield, volatility ranging from 59% to 120%
      (depending on date of grant), and risk free interest rates ranging from 3.39%
      to
      3.96% (depending on date of grant). The estimated fair value of an option is
      amortized over the option's vesting period. During the nine months ended
      September 30, 2007, no additional options were granted and 1,475,000 options
      expired unexercised.





**Income
      Taxes**





Income
      taxes are accounted for using the liability method in accordance with SFAS
      No. 109, *Accounting
      for Income Taxes* .
      Under
      SFAS 109, deferred tax assets or liabilities are computed based upon the
      difference between the financial statement and income tax bases of assets and
      liabilities using the enacted marginal tax rate applicable when the related
      asset or liability is expected to be realized or settled. Deferred income tax
      expense or benefits are based on the changes in the asset or liability from
      period to period. If available evidence suggests that it is more likely than
      not
      that some portion or all of a deferred tax asset will not be realized, a
      valuation allowance is recorded to reduce the deferred tax assets to the amount
      that is more likely than not to be realized. Future changes in such valuation
      allowance would be included in the provision for deferred income taxes in the
      period of change.





**Use
      of Estimates**





The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States requires management to make estimates
      and assumptions that affect the reported amounts of assets and liabilities
      and
      disclosure of contingent assets and liabilities at the date of the financial
      statements and the reported amounts of revenues and expenses during the
      reporting periods. Actual results could differ from those
      estimates.





**Foreign
      Subsidiaries**





The
      Company has foreign subsidiaries whose local currency has been determined to
      be
      the functional currency. For these foreign subsidiaries, the assets and
      liabilities have been translated using the period-end exchange rates, and the
      income and expenses have been translated using the weighted average of
      historical exchange rates during the reporting period. The adjustments resulting
      from translation have been recorded separately in shareholders' equity as “other
      comprehensive income (loss)” and are not included in determining the
      consolidated net loss. As of September 30, 2007, accumulated other comprehensive
      income included $8,419 of cumulative income from foreign currency
      translation.





The
      Company began operations in Brazil in March of 2004 by establishing a 75% owned
      subsidiary. The Brazilian subsidiary recognized revenue of $0 for the three
      and
      nine months ended September 30, 2006, and $0, $0 and $7,682 for the three and
      nine months ended September 30, 2007, and the period October 14, 2000
      (inception) through September 30, 2007, respectively. Brazil also had total
      assets less current liabilities (exclusive of intercompany amounts eliminated
      in
      consolidation) of $77,546 at September 30, 2007. Transactions in Brazil are
      denominated in, and the functional currency is, the Brazilian Real. Accordingly,
      no Brazilian operations currency exchange rate gains or losses are recorded
      in
      the accompanying consolidated statement of operations. At September 30, 2007,
      the Brazilian operation had aggregate losses of $1,932,556. The minority
      stockholder's portion of aggregate losses is not recorded in the consolidated
      balance sheet since reimbursement of this amount from the minority stockholders
      is not assured.





On
      December 31, 2004, the Company ceased operations at two of its wholly-owned
      subsidiaries in the United Kingdom. In connection with the cessation, the
      Company recorded an exchange gain in the 2004 consolidated statement of
      operations of $94,396 to recognize cumulative translation gains previously
      recorded in other comprehensive income (loss). The subsidiaries were primarily
      holding companies and had no assets or liabilities as of December 31, 2004.
      For the year ended December 31, 2005 and December 31, 2006 and for the three
      and
      nine months ended September 30, 2007, these subsidiaries incurred no activity
      and therefore had no profit or loss.





The
      company began operations in Spain in April of 2006 by establishing a 100%
      subsidiary. The Spanish subsidiary recognized $6,799 of revenue for the
      three and nine months ended September 30, 2007, and for the period of April
      2006 through September 30, 2007. At September 30, 2007 the Spanish subsidiary
      had total assets less current liabilities (exclusive of intercompany amounts
      eliminated in consolidation) of $91,279. Transactions in Spain are denominated
      in and the functional currency is the Euro. At September 30, 2007, the Spanish
      operation had aggregate losses of $1,414,104.





**Segment
      Reporting**





The
      Company is a development stage company and has not made sales of its products
      in
      commercial volumes. Management believes that the Company currently operates
      and
      manages the business as one business segment.





**Impairment
      of Intellectual Property Rights**





Prior
      to
      the fourth quarter of 2002, the Company was pursuing the marketability of a
      technology it had acquired for $424,659. In December, 2002, the Company
      determined that the related product was no longer commercially viable and would
      no longer be pursued. As a result of this decision, it was determined that
      the
      asset would not be recoverable as there was no alternative market for the
      technology. Accordingly, the net book value of $345,115 was charged to general
      and administrative expenses during 2002.




F-9




**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**Notes
      to Financial Statements**


**(Unaudited)**








**Interim
      Financial Statements**





The
      unaudited interim consolidated financial statements of the Company have been
      prepared in accordance with accounting principles generally accepted in the
      United States for interim financial information. In the opinion of management,
      all adjustments (consisting of normal recurring adjustments) considered
      necessary to present fairly the financial position of the Company as of
      September 30, 2007 and the results of operations and cash flows presented herein
      for the three and nine month periods ended September 30, 2007 and 2006 and
      from
      inception (October 14, 2000) through September 30, 2007 have been included
      in the financial statements. Interim results are not necessarily indicative
      of
      results of operations that may be expected for the year ending December 31,
      2007. It is recommended that this financial information be read with the
      complete financial statements included in the Company's Form 10-KSB dated
      December 31, 2006 previously filed with the SEC on March 27,
      2007.





**3.
      ProEco Transaction**




On
      January 12, 2007, the Company entered into a share exchange agreement (the
      “Share Exchange Agreement”) with ProEco and its shareholders (“ProEco
      Shareholders”) to acquire shares equal to 80% of the outstanding capital stock
      of ProEco in exchange for approximately 9.2 million shares of the Company's
      common stock (the “Transaction Shares”) valued at $0.872 per share for a total
      purchase price of $8.0 million.





ProEco,
      which has had limited operations to date, has been in the process of
      developing a new fuel-grade ethanol plant (the “Ethanol Plant”) with planned
      capacity of at least 100 million gallons per year to be built in two 50 million
      gallon trains (each a “Train”). Under the terms of the Shareholder Exchange
      Agreement, ProEco Shareholders would receive 60% of the Transaction Shares
      at
      the time of the closing and would receive the remaining 40% of the Transaction
      Shares in two equal installments upon the completion of construction of the
      first Train (20%) and the commencement of construction of the final Train (20%).
      The remaining 40% of the Transaction Shares would be held in escrow until the
      conditions for their release have been met. The parties intend the transaction
      to qualify as a tax-free reorganization under Section 368(a) of the U.S.
      Internal Revenue Code of 1986, as amended (the “Code”).





The
      Share
      Exchange Agreement requires ProEco to complete a number of steps toward
      completion of the Ethanol Plant project in order for the closing of the share
      exchange to occur. At the time of the closing, ProEco must have entered into
      a
      definitive engineering, procurement and construction (“EPC”) contract, with a
      reputable firm with extensive experience in implementing and completing projects
      similar to the Ethanol Plant project, and executed marketing agreements for
      the
      sale of the production of the Ethanol Plant. Under the terms of the Share
      Exchange Agreement, ProEco is responsible for having the Ethanol Plant
      designated as a facility nameplated, or certified, as producing ethanol at
      a
      level of at least 100 million gallons of production a year.





As
      a
      condition to the closing of the ProEco share exchange, the Company would
      be obligated to secure the financing necessary to complete the construction
      costs to build the Ethanol Plant. Accordingly, the Company would be required
      to
      raise $60 to $70 million in debt and between $30 and $40 million in equity
      in
      the first quarter of 2008 for each train.





Prior
      to
      closing, the Company and the ProEco Shareholders will enter into a stockholder
      agreement that will, among other things, impose restrictions on the transfer
      of
      the Transaction Shares.





The
      Common Stock will be issued to the ProEco shareholders in a transaction that
      will be exempt from the registration requirement pursuant to Section 4(2) of
      the
      Securities Act of 1933, as amended (the “Securities Act”) and under Regulation D
      promulgated under the Securities Act.




Under
      the
      terms of the letter of intent for the share exchange agreement, the Company
      agreed to enter into a secured loan agreement with ProEco for the purposes
      of
      financing the purchase options for the land to be used for the ethanol plant
      and
      certain engineering and permitting work required for the closing of the ProEco
      share exchange. The annual interest rate on the loan is 7% and the maturity
      date
      of the loan is December 15, 2007.





Current
      trends in the ethanol industry have seen increases in the price of corn and
      other feedstocks as well as a decline in the average selling price of ethanol.
      For a number of new plant construction projects, the lack of EPC contractor
      availability has resulted in increased costs and delays in completion dates.
      We
      are continuing our review of both the timing and scope of this project in light
      of the present industry environment. Our estimated timetable to obtain the
      financing and start construction has now shifted to the first half of
      2008.





Based
      on FIN
      46R,
      the Company is the holder of the majority of the risks and rewards relating
      to
      ProEco Energy Company, Inc. (“ProEco”). As such, the Company is considered to be
      the “primary beneficiary” of ProEco, deemed to be a VIE, and has included
      ProEco’s assets, liabilities and operating results in its consolidated financial
      statements. ( In
      general, a VIE is a corporation, partnership, limited-liability corporation,
      trust or any other legal structure used to conduct activities or hold assets
      that either (i) has an insufficient amount of equity to carry out its principal
      activities without additional subordinated financial support; (ii) has a group
      of equity owners that are unable to make significant decisions about its
      activities; or (iii) has a group of equity owners that do not have the
      obligation to absorb losses or the right to receive returns generated by its
      operations.) Based on these guidelines, the Company has determined that ProEco
      is a VIE beginning with the third quarter of 2007. Prior to that period,
      activity with ProEco was not material.





The
      following table summarizes the significant assets and liabilities of ProEco
      as
      of September 30, 2007:


Cash
              
              $
              35,554Construction
                  in progress
              
              
              994,008Accounts
                  payable
              
              
              341,904Accrued
                  expenses
              
              
              74,978




ProEco
      operating expenses of $327,216, after elimination of inter-company
      transactions,  are also reflected in the Company’s consolidated
      statements of operations.





F-10


**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**Notes
      to Financial Statements**


**(Unaudited)**





**4.
      Common Stock and Warrant Activity During 2007**





**$10.0
      Million Private Placement**





On
      February 16, 2007, the Company entered into a common stock purchase agreement
      (the “Purchase Agreement”) with Fusion Capital Fund II, LLC, an Illinois limited
      liability company (“Fusion Capital”). Pursuant to the Purchase Agreement, at the
      Company's discretion, the Company may sell up to $10.0 million of the Company's
      common stock to Fusion Capital from time to time over a 25-month period. The
      Company has reserved for issuance up to 12,000,000 shares of the Company's
      common stock for sale to Fusion Capital under this agreement. Subject to earlier
      termination at the Company's discretion, Fusion Capital's purchases commenced
      after June 8, 2007 when the Securities and Exchange Commission ("SEC") declared
      effective the registration statement related to the transaction. The Company
      has
      issued to Fusion Capital 805,987 shares of the Company's common stock as a
      commitment fee for entering into the Purchase Agreement.





Concurrently
      with entering into the Purchase Agreement, the Company entered into a
      registration rights agreement with Fusion Capital (the “Registration Rights
      Agreement”). Under the Registration Rights Agreement, the Company agreed to file
      a registration statement with the SEC covering the shares that have been issued
      or may be issued to Fusion Capital under the Purchase Agreement. After the
      SEC
      has declared effective the registration statement, generally the Company has
      the
      right but not the obligation from time to time to sell shares of the Company's
      common stock to Fusion Capital in amounts between $100,000 and $1 million
      depending on certain conditions. The Company has the right to control the timing
      and amount of any sales of the Company's shares to Fusion Capital. The purchase
      price of the shares will be determined based upon the market price of the shares
      of common stock without any fixed discount. Fusion Capital shall not have the
      right or the obligation to purchase any shares of the Company's common stock
      on
      any business day that the price of the Company's common stock is below either
      $0.50 or $0.60, depending on the transaction size of the purchase. The agreement
      may be terminated by the Company at any time at its discretion without any
      cost
      to the Company.





During
      the quarter ended September 30, 2007, the Company did not execute any
      transactions under this agreement. During the nine months ended September 30,
      2007, the Company executed five separate transactions under this agreement,
      selling a total of 970,994 shares of common stock at an average price of $0.515
      per share for total proceeds of $500,000.





**$2.52
      Million Private Placement**





Between
      June 26, 2007 and July 16, 2007, the Company entered into Agreements with five
      European institutional and private investors for the sale of 6,123,346 shares
      of
      the Company’s common stock at a purchase price of approximately $0.41 per share
      in a private placement, for total proceeds of $2,517,710 before commissions.
      As
      a condition to the enforceability of these agreements against the Company,
      the
      investors were required to fund the purchase price in an escrow account, which
      funds were received between June 19, 2007 and July 31, 2007.





As
      part
      of the sale, the Company issued warrants to purchase 1,530,827 shares of common
      stock at an exercise price of $0.62 per share during the period of six months
      to
      sixty-six months subsequent to issuance. The warrants expire sixty-six months
      after the date of issuance.





The
      Company was obligated to file a registration statement with the SEC including
      the common stock and the shares issuable upon exercise of the warrants within
      90
      days of the closing date. A Form S-3 registration statement, including these
      shares and shares issuable upon exercise of the warrants, was filed by the
      Company on October 18, 2007 and declared effective by the SEC on October 31,
      2007. All the costs and expenses incurred in connection with the registration
      of
      the common stock and warrants are paid by the Company. The Company closed this
      transaction on July 20, 2007 and August 20, 2007.





**Stock
      Repurchase**





On
      July
      17, 2007, the Company repurchased 100,000 shares of its common stock for
      treasury for an aggregate purchase price of $40,100. The purchase price was
      $0.401 per share, which was the daily volume weighted average for the five
      trading days prior to the day the Company’s board of directors approved the
      repurchase.




F-11





**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**Notes
      to Financial Statements**


**(Unaudited)**





**5.
      Government Appropriations**





**Appropriation
      from the U.S. Department of Energy (1)**





In
      2002,
      the Company received an appropriation of $1,107,734 from the U.S. Department
      of
      Energy (“DOE”) to test the Company's fuel additive as well as its blended fuel,
      O2DieselTM. The appropriation was increased to $2,039,651 as of
      September 15, 2004. This appropriation is managed for the DOE by the
      National Renewable Energy Laboratory (“NREL”) under a contract which, as
      amended, continued until June 30, 2007. As of September 30, 2007, NREL has
      not yet closed this contract. Under the terms of the contract, the Company
      is
      reimbursed by NREL for 80% of the costs incurred to complete the Statement
      of
      Work as set forth in the contract. The Company charges all expenses as incurred
      to operations and accrues all amounts receivable under the contract as a
      reduction to contract expenses when the Company is reasonably certain all
      conditions of the reimbursement are satisfied. As of September 30, 2007, the
      Company had incurred the full cumulative costs of $2,039,651 towards completion
      of the contract therefore leaving no balance of costs left to spend in order
      to
      complete the contract. From the inception of the contract in December 2002
      through September 30, 2007, the Company billed NREL $1,631,720 of which $23,924
      is included in other receivables as of September 30, 2007.





**Appropriation
      from the U.S. Department of Energy (2)**





In
      2003,
      the Company received an appropriation of $1,123,834 to test the Company's fuel
      additive under the California Air Resources Board (CARB) Diesel Emissions
      Control Strategy (DECS) verification rules. The Company is eligible to
      receive reimbursements of 80% of costs incurred under a contract up to the
      appropriation amount. This appropriation is managed for the DOE by NREL, the
      National Renewable Energy Laboratory. As of September 30, 2007, the Company
      had
      incurred cumulative costs of $921,609 towards completion of the contract,
      leaving a balance of $202,225 in costs to complete the contract. From the
      inception of the contract through September 30, 2007, the Company billed NREL
      $737,287 of which $173,493 is included in other receivables as of September
      30,
      2007.





**Appropriation
      from the U.S. Department of Energy (3)**





During
      2004 and 2005, Congress approved appropriations aggregating $1,000,000 for
      the
      purpose of continued testing and verification of our fuel additive. The Company
      will submit a proposal to NREL, and expects to have these funds under contract,
      by the end of the fourth quarter of 2007. These projects would be eligible
      for
      80% reimbursement.





**Appropriation
      from the U.S. Department of Defense (1)**





In
      2003,
      the Company received an appropriation of $1,000,000 from the U.S. Department
      of
      Defense (“DoD”) to test O2DieselTM fuel in non-strategic military vehicles
      operated by the U.S. Air Force at Nellis Air Force Base in Las Vegas, Nevada.
      Under the terms of this Appropriation, a third party is to be paid $200,000
      to
      administer this program on behalf of the Department of Defense. The remaining
      $800,000 is to be used to fund purchases of O2DieselTM fuel, certain capital
      equipment and to reimburse the Company for its labor, overhead and out-of-pocket
      costs required to complete this project. Under this program, the Company is
      required to meet certain milestones as a condition to receiving reimbursements
      for its costs. Thus, upon achieving a milestone, the Company accrues the amount
      due and submits an invoice for reimbursement. All amounts are expensed as
      incurred, and all amounts receivable for work completed are treated as a
      reduction to expense over the period earned. The period of performance for
      this
      program ran from October 7, 2003 to December 31, 2004. Through
      December 31, 2004, the Company had achieved five milestones and, since
      inception, has billed $360,000 related to this appropriation, of which $160,000
      was billed in January, 2005. By its terms, this contract expired on
      December 31, 2004 and will not be extended. No activity under this
      appropriation has taken place subsequent to March 31, 2005. The work
      required to achieve the milestones not completed as of December 31, 2004,
      has been included as part of the Statement of Work for Appropriation
      (2) from the DoD as is permitted under that contract. However, the funds
      from Appropriation (1) cannot be applied to Appropriation (2). Through
      December 31, 2005, the Company has received cash in excess of costs incurred
      of
      $296,097 and has recorded Deferred Grants at December 31, 2005 in the
      Consolidated Balance Sheet. All amounts billed had been received as of December
      31, 2005. No additional reimbursements are expected from this appropriation.
      During the fourth quarter of 2006 the Company was notified from the
      subcontractor that the contract was officially closed and O2Diesel has no
      further requirements. Based on this information, the Company applied the
      previously recorded liability of $296,097 for this contract as an offset to
      2006
      grant expenses for the year ended December 31, 2006.





**Appropriation
      from the U.S. Department of Defense (2)**





On
      January 11, 2005, the Company entered into a contract with a value of
      $1,085,000 with the DoD. Under this contract, the Company's O2DieselTM fuel is to
      be tested in a maximum of forty (40) non-tactical vehicles at US Air Force
      bases in Nevada for an 18 month period. Furthermore, the Company is to
      complete certain engine testing and other work required for the acceptance
      of
      O2DieselTM as a viable alternative fuel for use by the Air Force. Work on this
      contract commenced on November 1, 2004 and is to continue through
      November 30, 2006. Notwithstanding that the agreement for this contract was
      signed in January 2005, The
      Company was asked to begin work in 2004 and, by a letter from Innovative
      Technologies Corporation (ITC), was authorized to incur costs in an amount
      not
      to exceed $75,000. This is a time and materials contract that is administered
      for the DoD by a third party contractor. The Company charges




F-12




**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**Notes
      to Financial Statements**


**(Unaudited)**








all
      costs
      as incurred to expense and accrues all amounts receivable under the contract
      as
      a reduction to contract expenses. The contract amount was amended in May 2006
      to
      $1,012,564. The amount of the reduction will be added to a future contract
      through the Air Force. Billings under this contract are made monthly. As of
      December 31, 2006, costs totaling $1,011,215 had been incurred, billed, and
      received. As of September 30, 2007, there is a balance of $1,349 in the
      contract, but no further activity is expected. The contract will be officially
      closed out in the fourth quarter of 2007.





**Appropriation
      from the U.S. Department of Defense (3)**





The
      Company received a contract during 2005 of approximately $910,000 from the
      DoD.
      Concurrent Technologies Corporation (CTC) manages this appropriation on
      behalf of the Department of Defense. This contract contains a payment schedule
      based on meeting performance milestones. Six milestones were achieved by
      September 30, 2007. The primary objective of this contract is to create
      potential fuels using the Company additive that contain no more than 80%
      petroleum. If this project is successful, an application will be made to DOE
      for
“alternative fuel” status, creating an incentive for federal customers to use
      the fuel. Part of this research entails conducting demonstrations in various
      climates at three Air Force bases, including Nellis Air Force Base (expanded
      fleet) in Nevada. As of September 30, 2007, the Company has recorded expenses
      of
      $768,505 against this contract, leaving a balance of $141,495. The Company
      invoiced and collected $630,000 for the six milestones on this project through
      September 30, 2007. The Company also recorded $138,505 as an unbilled receivable
      under this appropriation as of September 30, 2007.





**Appropriation
      from the U.S. Department of Defense (4)**





Congress
      approved appropriations aggregating $1,100,000 in 2006 (DoD-4) and $1,000,000
      in
      2007 (DoD-5) for continued testing and verification of O2DieselTM. Instead of
      executing two separate contracts, DoD amended the funds and activities from
      DoD-5 into the existing DoD-4 contract. As of
      September 30, 2007, the Company has executed one contract for $1,106,895 to
      carry out theses activities. As of September 30, 2007, the Company has recorded
      expenses of $101,197 to this contract, leaving a balance of $1,005,698. The
      Company invoiced and collected $418,633 for four milestones on this project
      through September 30, 2007. In addition, the Company recorded $317,436 as a
      deferred grant on the balance sheet at September 30, 2007. Contract
      payments are based on milestones and do not require matching funds from
      O2Diesel. It is expected that approximately $168,000 will be added to this
      contract during the fourth quarter of 2007.





**6.
      Other Receivables**




Significant
      components of the Company’s Other Receivables at September 30, 2007 are as
      follows:




NREL
                Appropriation
            
            $
            197,417Reimbursement
                of expenses and services performed
            
            
            28,787Travel
                advances to employees
            
            
            24,923$
            251,127




**7.
      Accrued Expenses**




Significant
      components of the Company’s Accrued Expenses at September 30, 2007 are as
      follows:




Legal
                and professional fees
            
            $
            131,095Salaries
              and
              benefits
            
            
            38,978Investor
                relations fees
            
            
            10,000Severance
                payments
            
            
            282,604Minority
              interest
            
            
            35,000Other
            
            
            123,775$
            621,452




F-13





**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**Notes
      to Financial Statements**


**(Unaudited)**





**8.
      Deferred Financing and Business Acquisition Costs**





During
      2003, management began the public listing process on the Alternative Investment
      Market (AIM) in London, England. All legal, accounting, and other related costs
      incurred in connection with the AIM listing were capitalized as deferred
      financing costs. In December 2003, management determined that the Company
      would terminate its plan to seek an AIM listing. Accordingly, deferred financing
      costs of $517,000, were charged to expense for the year ended December 31,
      2003.





The
      Company records the cost of equity financings as a reduction of the associated
      proceeds.





**9.
      Income Taxes**





No
      provision for Federal and state income taxes has been recorded during the
      periods presented due to the Company's significant operating losses. The income
      tax benefit reflected in the accompanying consolidated statement of operations
      is the current benefit recognized in Ireland for the periods
      presented.





Deferred
      income taxes reflect the net tax effects of temporary differences between the
      carrying amounts of assets and liabilities for financial reporting purposes
      and
      the amounts used for income tax reporting purposes. Significant components
      of
      the Company's deferred tax asset as of September 30, 2007:




Net
                operating loss carryforwards
            
            $
            11,303,000Deferred
                revenue
            
            
            524,500Accrued
                expenses
            
            
            206,800Total
                deferred tax assets
            
            
            12,034,300Valuation
                allowance
            
            
            (12,034,300
            )Net
                deferred tax assets
            
            $
            --





Management
      has determined that a valuation allowance equal to 100% of the existing deferred
      tax assets is appropriate given the uncertainty regarding the ultimate
      realization of these assets. At September 30, 2007, the Company had Federal
      and
      state net operating loss carryforwards of approximately $27.5 million for
      income tax purposes. If not used, these carryforwards expire through 2021 for
      Federal and state tax purposes. Federal tax rules impose limitations on the
      use
      of net operating losses following certain changes in ownership. If such a change
      occurs, the limitation would reduce the amount of the benefits that would be
      available to offset future taxable income each year, starting with the year
      of
      ownership change. As of September 30, 2007, the Company had an Irish net
      operating loss carryforward of approximately $637,000 which can be carried
      forward indefinitely, cumulative Spanish losses of approximately $1,450,000
      and
      a Brazilian net operating loss of approximately $1,675,000 that may be carried
      forward indefinitely, but which is subject to annual usage
      limitations.





In
      July
      2006, the FASB issued FASB Interpretation No. 48, *Accounting
      for Uncertainty in Income Taxes* - *an
      interpretation of FASB Statement No. 109* ”
(“FIN
      48”). FIN 48 clarifies the accounting and disclosure for uncertainty in tax
      positions, as defined and prescribes the measurement process and a minimum
      recognition threshold, for a tax position taken or expected to be taken in
      a tax
      return, that is required to be met before being recognized in the financial
      statements. Under FIN 48, the Company must recognize the tax benefit from an
      uncertain tax position only if it is more likely than not that the tax position
      will be sustained on examination by the taxing authorities, based on the
      technical merits of the position. The tax benefits recognized in the financial
      statements from such a position are measured based on the largest benefit that
      has a greater than 50% likelihood of being realized upon ultimate
      resolution.





The
      Company is subject to the provisions of FIN 48 as of January 1, 2007, and has
      analyzed filing positions in all of the U.S. federal and state jurisdictions
      where it is required to file income tax returns, its federal and state tax
      returns in Ireland, Spain and Brazil and all open tax years in these
      jurisdictions. The Company has identified its U.S. federal tax return and its
      state tax returns in Delaware and California as “major” tax jurisdictions as
      defined. Based on the Company's evaluation, we have concluded that there are
      no
      significant uncertain tax positions requiring recognition in our financial
      statements. Our evaluation was performed for the tax years which remain subject
      to examination by the major U.S. tax jurisdictions (tax years ended December
      31,
      2003 to December 31, 2006) and for the tax years which remain open for
      examination in Ireland (December 31, 2006), Spain (December 31, 2006) and Brazil
      (December 31, 2006). Based on this evaluation, no reserves for uncertain income
      tax positions have been recorded pursuant to FIN 48 during the period ended
      September 30, 2007 and the Company does not anticipate that it is reasonably
      possible that any material increase or decrease in its unrecognized tax benefits
      will occur within twelve months. In addition, the Company did not record a
      cumulative effect adjustment related to the adoption of FIN 48.





Upon
      adoption on January 1, 2007 and as of September 30, 2007, the Company had no
      unrecognized tax benefits or accruals for the potential payment of interest
      and
      penalties. The Company's policy for recording interest and penalties associated
      with tax audits is to record such items as a component of income or loss before
      provision (benefit) for income taxes. Penalties are recorded in other expenses,
      and interest paid or received is recorded in interest expense or interest
      income, related to the settlement of tax audits for certain prior periods.
      For
      the period ended September 30, 2007, there were no penalties or interest
      recorded relating to the settlement of tax audits.




Federal
      tax rules under Section 382 of the Code impose limitations on the use of
      net operating losses following certain changes in ownership. If such a change
      occurs, the limitation would reduce the amount of the benefits that would be
      available to offset future taxable income each year, starting with the year
      of
      ownership change. In general, an ownership change, as defined by Section 382,
      results from transactions increasing the ownership of certain shareholders
      or
      public groups in the stock of a corporation by more than 50 percentage points
      over a there-year period. Since the Company's formation, the Company has raised
      capital through the issuance of capital stock on several occasions which,
      combined with the purchasing shareholders' subsequent disposition of those
      shares, may have resulted in a change of control, as defined by Section 382,
      or
      could result in a change of control in the future upon subsequent disposition.
      The Company has not currently completed a study to assess whether a change
      of
      control has occurred or whether there have been multiple changes of control
      since the Company's formation due to the significant complexity and cost
      associated with such study and that there could be additional changes in control
      in the future. If we have experienced a change of control at any time since
      the
      Company's formation, utilization of our NOL carryforwards would be subject
      to an
      annual limitation under Section 382. Any limitation may result in the expiration
      of a portion of the NOL carryforwards before utilization. Further, until a
      study
      is completed and any limitation is known, no amounts are being presented as
      an
      uncertain tax position under FIN 48.




F-14




**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**Notes
      to Financial Statements**


**(Unaudited)**





**10.
      Stockholders' Equity**





**Recapitalization**





On
      July 15, 2003, O2Diesel Corporation and AAE Technologies International Plc
      (“AAE”) entered into a merger transaction whereby O2Diesel acquired all of
      the issued and outstanding share capital of AAE in exchange for the issuance
      of
      17,847,039 shares of common stock of O2Diesel. Although O2Diesel was the legal
      acquirer, AAE was deemed to be the accounting acquirer. The transaction was
      accounted for as an AAE capital transaction, accompanied by a
      recapitalization.





As
      a
      result of the transaction, the historical financial statements of AAE are deemed
      to be those of the Company for financial reporting purposes. The equity accounts
      of AAE have been adjusted for the recapitalization to reflect the equity
      structure of O2Diesel, the legal acquirer. Specifically, the historical
      stockholders' equity of AAE prior to the transaction has been affected for
      the
      equivalent number of shares of O2Diesel common stock received in the
      transaction, with an offset to paid-in capital; the accumulated deficit of
      AAE
      was carried forward after the transaction; and the loss per share for all
      periods prior to the transaction was restated to reflect the number of
      equivalent common shares received by AAE in the transaction.





**Common
      Stock and Warrant Activity**





In
      connection with the merger between O2Diesel and AAE in July 2003, the
      Company completed a private placement of 3,333,333 shares of common stock at
      $1.50 per share. The private placement was partially effectuated through the
      issuance of a $4 million convertible note that was convertible into the
      Company's common stock at $1.50 per share. In October 2003, the Company
      repaid $1,677,500 of the note and the $2,322,500 balance was converted into
      1,548,333 shares of common stock. The remaining 1,785,000 shares of common
      stock
      issuable under the private placement were issued to other parties in exchange
      for cash proceeds of $2,677,500. The expenses associated with the merger and
      subsequent issuances of shares were $795,650 and have been reflected as a
      reduction of additional paid-in capital.





Subsequent
      to its first private placement in 2003, the Company undertook to raise an
      additional $3.5 million through a follow-on private placement of our common
      stock (the “Follow-On Private Placement”). In the Follow-On Private Placement,
      we raised $1,535,570, before expenses, and issued 1,025,784 shares of our common
      stock at a price of $1.50 per share. The Follow-On Private Placement was closed
      on March 31, 2004. There was no underwriter involved in the Follow-On Private
      Placement. Sales of common stock under the Follow-On Private Placement that
      were
      completed in non-U.S. transactions were exempt from registration pursuant to
      Regulation S promulgated under the Securities Act. The sales of common stock
      under the Follow-On Private Placement to accredited U.S. investors were exempt
      pursuant to Regulation D promulgated under the Securities Act.





On
      July
      17, 2007, the Company repurchased 100,000 shares of its common stock for
      treasury for an aggregate purchase price of $40,100. The purchase price was
      $0.401 per share, which was the daily volume weighted average for the five
      trading days prior to the day the Company’s board of directors approved the
      repurchase.





**$2.0
      and $3.0 Million Private Placements**





In
      a
      series of two private placements of the Company’s common stock in 2005, the
      Company raised $4,833,192 after payment of an 8% commission and other expenses,
      and issued 7,535,981 shares of common stock at a price of $0.70 per share.
      Subscribers to these private placements received for each two shares of common
      stock purchased one warrant to purchase one additional share of common stock.
      The warrant expires twenty-four months following the closing of the private
      placement. Each warrant is exercisable at a price of $0.70 per share during
      the
      first twelve months following the close of the private placement, or at an
      exercise price of $1.05 per share in the second twelve months following the
      close of the private placement. The total number of warrants issued was
      3,757,990. The common stock and the warrants were issued to the accredited
      investors in a transaction that will be exempt from registration pursuant to
      Section 4(2) of the Securities Act, and/or Regulation D promulgated under the
      Securities Act.




**$2.3
      Million Private Placement**





On
      October 24, 2005, the Company issued 3,228,070 shares of common stock at a
      purchase price of $0.7125 per share in a private placement for total proceeds
      of
      $2,300,000.





As
      part
      of this sale, the Company also issued warrants to purchase 1,614,035 shares
      of
      common stock at an exercise price of $1.425 per share during the period of
      six
      months to forty-two months subsequent to issuance or at a cashless exercise
      if a
      registration statement is not effective within one year of issuance. The
      warrants expire forty-two months after the date of issuance.





As
      part
      of the transaction, the Company agreed to sell up to an additional $700,000
      of
      its common stock to the Purchaser at a purchase price of $0.7125 per share
      for
      982,456 shares. The Company also issued warrants to purchase 491,228 shares
      of
      common stock at an exercise price of $1.425 per share during the period of
      six
      months to forty-two months subsequent to issuance or at a cashless exercise
      if a
      registration statement is not effective within one year of issuance. The
      warrants expire forty-two months after the date of issuance. The purchaser
      had
      180 days following the date of the Purchase Agreement to acquire additional
      shares. This offer expired unexercised on March 20, 2006.





The
      Company agreed to issue warrants to purchase 1,614,035 shares of common stock
      at
      an exercise price of $0.7125 per share to its advisor in connection with this
      transaction. The warrants expire forty-two months after the date of issuance.
      The common stock and the warrants were issued to the accredited investor in
      a
      transaction that will be exempt from registration pursuant to Section 4(2)
      of
      the Securities Act, and/or Regulation D promulgated under the Securities
      Act.





**$3.6
      Million Private Placement**





On
      December 16, 2005, the Company issued 6,419,840 shares of the Company's common
      stock in a private placement, for total proceeds of 3,000,000€, or approximately
      $3.6 million at the then current exchange rates.





As
      part
      of the transaction, the Company issued warrants to purchase 2,853,262 shares
      of
      common stock at an exercise price of $0.85 per share during the period six
      to
      forty-two months subsequent to the date of issuance or at an exercise price
      of
      $1.13 per share during the period forty-three to sixty-six months after the
      date
      of issuance. The warrants expire sixty-six months after the date of
      issuance.





F-15


**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**Notes
      to Financial Statements**


**(Unaudited)**





**$4.0
      and $2.5 Million Private Placements** ****





On
      April
      6, 2006, the Company entered into a Common Stock and Warrant Purchase Agreement
      (“$4.0 million Purchase Agreement”) with a UK investor (the “Investor”) for
      5,333,333 shares of common stock at a purchase price of $0.75 per share in
      a
      private placement for total proceeds of $4,000,000 (the “$4.0 million Private
      Placement”). As part of this sale, the Company also issued warrants to purchase
      2,666,667 shares of common stock at an exercise price of $0.825 per share during
      the period of six months to forty-two months subsequent to issuance. The
      warrants expire forty-two months after the date of issuance.





Also
      on
      April 6, 2006, the Company entered into a Common Stock and Warrant Purchase
      Agreement (“$2.5 million Purchase Agreement”) with a different European
      investor (the “2 nd Investor”) for 3,333,333 shares of common stock at a purchase price of $0.75 per
      share in a private placement for total proceeds of $2,500,000 (the “$2.5 million
      Private Placement”) before payment of a 9% commission and other expenses.
      As part of this sale, the Company also issued warrants to purchase 1,666,667
      shares of common stock at an exercise price of $0.825 per share during the
      period of six months to forty-two months subsequent to issuance. The warrants
      expire forty-two months after the date of issuance.





Subsequent
      to entering into these agreements, the Company entered into an identical
      amendment to each agreement which (i) modified the amount of liquidated damages
      to a maximum of 8% of the purchase price and (ii) added that shareholder
      approval will be obtained prior to the Company issuing the shares of common
      stock issuable upon exercise of the warrants. There were no other changes to
      either agreement. Both transactions closed and the warrants were issued on
      April
      27, 2006.





AMEX
      requires that shareholder approval be obtained by the Company for the sale
      of
      common stock in a transaction if the price of the shares to be sold is less
      than
      the greater of book or market value, and the number of shares is equal
      twenty-percent (20%) or more of the presently outstanding common stock. In
      order
      to comply with this requirement, the Company was required to obtain shareholder
      approval for the $4.0 and the $2.5 million Private Placements. Shareholder
      approval was obtained at the Company's annual shareholder meeting on July 6,
      2006.





**$1.0
      Million Private Placement**





On
      November 9, 2006, the Company issued 1,371,742 shares of the Company's common
      stock at a purchase price of $0.729 per share in a private placement for total
      proceeds of $1,000,000.





As
      part
      of the sale, the Company issued warrants to purchase 685,871 shares of common
      stock at an exercise price of $0.972 per share during the period of six months
      to sixty-six months subsequent to issuance. The warrants expire
      sixty-six months after the date of issuance.





The
      common stock and the warrants were issued to the accredited investor in a
      transaction that is exempt from registration pursuant to Section 4(2) of
      the Securities Act, and/or Regulation D promulgated under the Securities
      Act.





The
      transaction closed and the funds were received on November 22,
      2006.





**$10.0
      Million Private Placement**





On
      February 16, 2007, the Company entered into a common stock purchase agreement
      (the “Purchase Agreement”) with Fusion Capital Fund II, LLC, an Illinois limited
      liability company (“Fusion Capital”). Pursuant to the Purchase Agreement, at the
      Company's discretion, the Company may sell up to $10.0 million of the Company's
      common stock to Fusion Capital from time to time over a twenty-five month
      period. The Company has reserved for issuance up to 12,000,000 shares of the
      Company's common stock for sale to Fusion Capital under this agreement. The
      Company has issued to Fusion Capital 805,987 shares of the Company's common
      stock as a commitment fee for entering into the Purchase Agreement.





Concurrent
      with entering into the Purchase Agreement, the Company entered into a
      registration rights agreement with Fusion Capital (the “Registration Rights
      Agreement”). Under the Registration Rights Agreement, the Company filed a
      registration statement with the SEC covering the shares that have been issued
      or
      may be issued to Fusion Capital under the Purchase Agreement. Subject to earlier
      termination at the Company's discretion, Fusion Capital's purchases commenced
      after June 8, 2007 when the Securities and Exchange Commission ("SEC") declared
      effective the registration statement related to the transaction. Generally,
      the Company has the right but not the obligation from time to time to sell
      an
      aggregate of up to 12 million shares of the Company's common stock to Fusion
      Capital in amounts between $100,000 and $1 million depending on certain
      conditions. The Company has the right to control the timing and amount of any
      sales of the Company's shares to Fusion Capital. The purchase price of the
      shares will be determined based upon the market price of the shares of common
      stock without any fixed discount. Fusion Capital shall not have the right or
      the
      obligation to purchase any shares of the Company's common stock on any business
      day that the price of the Company's common stock is below either $0.50 or $0.60,
      depending on the transaction size of the purchase. The agreement may be
      terminated by the Company at any time at its discretion without any cost to
      the
      Company.




During
      the quarter ended September 30, 2007, the Company did not execute any
      transactions under this agreement. During the nine months ended September 30,
      2007, the Company executed five separate transactions under this agreement,
      selling a total of 970,994 shares of common stock at an average price of $0.515
      per share for total proceeds of $500,000.




**$2.52
      Million Private Placement**





Between
      June 26, 2007 and July 16, 2007, the Company entered into Agreements with five
      European institutional and private investors for the sale of 6,123,346 shares
      of
      the Company’s common stock at a purchase price of approximately $0.41 per share
      in a private placement, for total proceeds of $2,517,710 before commissions.
      As
      a condition to the enforceability of these agreements against the Company,
      the
      investors were required to fund the purchase price in an escrow account, which
      funds were received between June 19, 2007 and July 31, 2007.





As
      part
      of the sale, the Company will issue warrants to purchase 1,530,827 shares of
      common stock at an exercise price of $0.62 per share during the period of six
      months to sixty-six months subsequent to issuance. The warrants expire sixty-six
      months after the date of issuance.





The
      Company was obligated to file a registration statement with the SEC including
      the common stock and the shares issuable upon exercise of the warrants within
      90
      days of the closing date. A Form S-3 registration statement, including these
      shares and shares issuable upon exercise of the warrants, was filed by the
      Company on October 18, 2007 and declared effective by the SEC on October 31,
      2007. All the costs and expenses incurred in connection with the registration
      of
      the common stock and warrants are paid by the Company. The Company closed this
      transaction on July 20, 2007 and August 20, 2007.




F-16




**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**Notes
      to Financial Statements**


**(Unaudited)**





**Issuances
      of Preferred Stock**





**Series A
      0% Convertible Preferred Stock Private Placement**




Pursuant
      to a Convertible Preferred Stock Purchase Agreement between the Company and
      the
      purchaser named therein (the “Series A Purchaser”) dated as of
      March 3, 2004, the Company issued to the Series A Purchaser, 800,000
      shares of Series A 0% Convertible Preferred Stock, par value $.0001
      (“Series A Preferred Stock”). The offering resulted in gross proceeds of
      approximately $3,200,000 to the Company, prior to the deduction of fees and
      commissions. The sale of the Series A Preferred Stock was exempt
      from registration pursuant to Regulation S promulgated under the
      Securities Act.





The
      Series A Preferred Stock was initially convertible into the Company's
      common stock at a variable conversion ratio which was the lesser of (a) $4.00
      as
      adjusted as provided in the Series A Certificate of Designation (the
“Series A Fixed Conversion Price”) or (b) eighty percent (80%) of the
      lowest closing bid price for the Common Stock in the ten business days preceding
      the date of conversion, but, in no case, less than 50% of the Series A
      Fixed Conversion Price. In September 2004, we renegotiated the conversion
      formula with the holder of these shares. Thus, the minimum price at which the
      shares may be converted is equal to twenty-five percent (25.0%) of the Fixed
      Conversion Price, or $1.00 per share. Pursuant to the amended agreement, the
      Series A Purchaser may not convert Series A Preferred Stock into our
      common stock for a period of two (2) years following the closing date of
      this transaction. Under the revised agreement, in no event will the
      Series A Purchaser receive more than 8,000,000 or less than 2,000,000
      shares of the Company's common stock upon conversion of the Series A
      Preferred Stock.





The
      Series A Purchaser was granted an option to purchase additional shares of
      the Company's common stock equal to the difference between the number of shares
      of common stock actually received upon conversion and the number of shares
      that
      would have been received at a conversion price of $1.82. The exercise price
      shall be the Series A Fixed Conversion Price.





**Series B
      0% Convertible Preferred Stock Private Placement**




Pursuant
      to a Convertible Preferred Stock Purchase Agreement between the Company and
      the
      purchaser named therein (the “Series B Purchaser”) dated as of
      March 29, 2004, the Company issued to the Series B Purchaser, 750,000
      shares of Series B 0% Convertible Preferred Stock, par value $.0001
      (“Series B Preferred Stock”). The offering resulted in gross proceeds
      of approximately $3,000,000 to the Company, prior to the deduction of fees
      and
      commissions. The sale of the Series B Preferred Stock was exempt from
      registration pursuant to Regulation S promulgated under the Securities
      Act.




The
      Series B Preferred Stock was initially convertible into the Company's
      common stock at a variable conversion ratio which was the lesser of (a) $3.65
      as
      adjusted as provided in the Series B Certificate of Designation (the
“Series B Fixed Conversion Price”) or (b) eighty percent (80%) of the
      lowest closing bid price for the Common Stock in the ten business days preceding
      the date of conversion, but, in no case, less than 50% of the Series B
      Fixed Conversion Price. In September 2004, we renegotiated the conversion
      formula with the holder of these shares. Now the minimum price at which the
      shares may be converted is equal to twenty-seven and four tenths per cent
      (27.4%) of the Series B Fixed Conversion Price, or $1.00 per share.
      Pursuant to the amended agreement, the Series B Purchaser may not convert
      Series B Preferred Stock into our common stock for a period of two
      (2) years following the closing date of this transaction. Under the revised
      agreement, in no event will the Series B Purchaser receive more than
      7,500,000 or less than 2,054,795 shares of the Company's common stock upon
      conversion of the Series B Preferred Stock.




The
      Series B Purchaser was granted an option to purchase additional shares of
      the Company's common stock equal to the difference between the number of shares
      of common stock actually received upon conversion and the number of shares
      that
      would have been received at a conversion price of $1.82. The exercise price
      shall be the Series B Fixed Conversion Price.





In
      April
      2006, the holders of both the Series A and Series B Convertible Preferred Stock
      exercised all of their conversion rights and converted 1,550,000 shares of
      Convertible Preferred Stock into 15,500,000 shares of common stock.





**Warrants**





A
      wholly-owned subsidiary of the Company entered into a supply and distribution
      agreement (the “Distribution Agreement”) with a distributor dated July 10,
      2001 that granted the distributor the right to purchase up to 10% of the
      outstanding common stock of the Company for $1.00 per share should certain
      sales
      targets be achieved. The warrant was to expire on July 10, 2006. None of
      the sales targets have been achieved under the Distribution Agreement and as
      of
      December 10, 2004 this Distribution Agreement was terminated and replaced
      by a new supply and distribution agreement (the “New Agreement”). Under this New
      Agreement, the distributor received a warrant to purchase 600,000 shares of
      O2Diesel's common stock at a price of $2.00 per share, which expired on
      May 5, 2007.





On
      February 3, 2006, the Company offered existing warrant holders from the
      $2.0 million and $3.0 million Private Placements and the $2.3 million
      Private Placement an opportunity to exercise their warrants at the reduced
      price
      of $0.35 per share. On February 27, 2006, the Warrant Offering expired and
      the Company received proceeds of $592,692 (after expenses) for the exercise
      of
      warrants to purchase 1,864,035 shares of common stock. Between May 31 and June
      12, 2006, several other existing warrant holders elected to exercise their
      warrants at the contract price identified in their warrant documentation.
      Proceeds for these exercises were $865,452 (after expenses) for the purchase
      of
      1,287,857 shares of common stock.





On
      April
      27, 2007, the Company offered existing warrant holders an opportunity to
      exercise their warrants at the reduced price of $0.50 per share. If all eligible
      warrant holders were to exercise their warrants at the reduced price, the
      Company would receive proceeds of approximately $4.3 million. The warrant offer
      was originally set to expire on May 25, 2007, however on May 9, 2007, the
      Company extended this reduced price offer until June 8, 2007. As of May 15,
      2007, the Company amended the offer to grant the warrant holders, who tender
      their warrants, additional shares of Common Stock if the Company enters
      into any agreement for the sale of shares of Common Stock at less than $0.50
      per
      share prior to June 8, 2008. The offer expired on June 8, 2007, without any
      of the warrant holders exercising at the reduced price.




F-17




**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**Notes
      to Financial Statements**


**(Unaudited)**


**Options**





The
      Company implemented a Stock Incentive Plan (the “Incentive Plan”) in 2004 for
      which the Board of Directors has authorized 9,750,000 shares of common stock
      to
      be reserved for future issuance under the Incentive Plan.





The
      following table shows the outstanding options granted under the 2004 Stock
      Incentive Plan:


**Weighted
                  Ave****Remaining****Shares**
              
              **Weighted
                    Ave**
                  **Exercise
                    Price**
              
              **Contractual
                  Term**Outstanding
                  at January 1, 2004
              
              
              500,000
              
              $
              1.50
              
              
              -Granted
                  in 2005
              
              
              5,450,000
              
              $
              1.50
              
              
              7.9Exercised
                  in 2005
              
              
              -
              
              $
              -
              
              
              -Forfeited
                  or Expired
              
              
              -
              
              $
              -
              
              
              -Outstanding
                  at December 31, 2005
              
              
              5,950,000
              
              $
              1.50
              
              
              7.9Granted
                  During the Year Ended December 31, 2006
              
              
              1,350,000
              
              $
              1.28
              
              
              8.8200,000
              
              $
              1.50
              
              
              8.8100,000
              
              $
              0.71
              
              
              9.2Exercised
                  During the Year Ended December 31, 2006
              
              
              -
              
              $
              -
              
              
              -Forfeited
                  or Expired
              
              
              (100,000
              )
              $
              1.28
              
              
              -**Outstanding
                  at December 31, 2006**
              
              
              7,500,000
              
              $
              1.45
              
              
              8.2Granted
                  During the Nine Months Ended September 30, 2007
              
              
              -
              
              
              -
              
              
              -Exercised
                  During the Nine Months Ended September 30, 2007
              
              
              -
              
              
              -
              
              
              -Forfeited
                  or Expired
              
              
              (1,475,000
              )
              $
              1.50
              
              
              -**Outstanding
                  at September 30, 2007**
              
              
              6,025,000
              
              $
              1.44
              
              
              8.1**Exercisable
                  at September 30, 2007**
              
              
              5,265,000
              
              $
              1.46
              
              
              8.1




**Restricted
      Stock Awards**





On
      November 16, 2006, the Board of Directors approved the grant of 500,000 shares
      of restricted stock to Mr. Roger, pursuant to the terms of the Company's 2004
      Stock Incentive Plan and Mr. Roger's employment agreement. The terms of the
      award were that the shares were to be issued on January 1, 2007 with 166,667
      shares to vest on January 1, 2007, 166,667 shares to vest on January 1, 2008
      and
      166,666 shares to vest on January 1, 2009. The receipt of shares is contingent
      on Mr. Roger remaining employed by the Company on the date of vesting. In 2006,
      there was no FAS 123(R) expense for the grant of restricted stock.





On
      August
      1, 2007, the Company entered into a Separation Agreement with Mr. Roger. Mr.
      Roger will receive severance payments and health benefits from the Company
      in
      accordance with his Employment Agreement. Mr. Roger's Separation Agreement
      includes continuing obligations relating to confidentiality, non-competition
      and
      non-solicitation. The Separation Agreement also provides for a release by Mr.
      Roger of any and all claims he may have against the Company. In addition, all
      of
      Mr. Roger's options vested as of the date of the Separation Agreement and in
      accordance with the Incentive Plan, Mr. Roger had thirty days to exercise these
      options, which expired unexercised. Finally, 166,667 of the remaining shares
      of
      Mr. Roger's restricted stock vested on the date of the Separation Agreement
      and
      166,666 of the remaining shares will vest on July 31, 2008. Mr. Roger agreed
      not
      to sell or transfer these shares until after that date.




On
      May
      14, 2007, the Company entered into an investor relations consulting agreement
      for a term of two months. In exchange for services, the Company paid
      the consultant a fee of $10,000. In addition, the Company awarded the
      consultant 50,000 shares of restricted stock. In connection with the stock
      award, the Company recognized $0 and $27,000 of consulting expense during
      the three and nine months ended September 30, 2007,
      respectively.





On
      May
      16, 2007, the Company entered into a second investor relations consulting
      agreement for a term of six months. In exchange for services, the Company
      awarded the consultant 440,000 shares of restricted stock. In connection with
      the stock award, the Company recognized $96,400 and $213,000 of the
      consulting expense during the three and nine months ended September
      30, 2007, respectively. Pursuant to the terms of the consulting agreement,
      220,000 shares, 120,000 shares and 100,000 shares of the restricted stock were
      earned by the consultant on May 16, 2007, July 16, 2007 and September 17, 2007,
      respectively. As of September 30, 2007, the restrictions on 440,000 shares
      issued under this contract have lapsed and such shares were
      earned.


On
        November 4, 2004, the Company entered into a separate investor relations
        consulting agreement for a term of four years. In exchange for services,
        the
        Company awarded the consultant 50,000 shares of restricted stock as settlement
        of this agreement, effective November 9, 2007. In connection with this stock
        award, the Company has recognized $23,500 of consulting expense in the third
        quarter of 2007 and recorded this as an accrued expense.


The
      following schedule presents shares of common stock issued and outstanding and
      reserved for future issuance as of September 30,
      2007:




Common
                Shares Outstanding
            
            
            
            
            
            83,186,786Reserved
                For Future IssuanceOptions
                Granted to officers and directors
            
            
            6,025,000Unearned
                common stock issued for compensation
            
            
            166,666Unearned
                common stock issues for commitment shares
            
            
            561,888Treasury
                shares
            
            
            100,000Warrants
            
            
            9,486,502
            
            
            16,340,056Total
                shares issued and outstanding and reserved for future
                issuance
            
            
            
            
            
            99,526,842




F-18




**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**Notes
      to Financial Statements**


**(Unaudited)**





**11. Related
      Party Transactions**





A
      company
      controlled by the former Chairman of the Board provides office space, accounting
      and other services to the Company at a cost of approximately $2,500 per month.
      The Company paid $5,221 and $15,505 for the three and nine months ended September 30,
      2006, respectively, and paid $2,873, $27,744 (of which approximately $16,700
      relates to the first nine months of 2007) and $207,594 for the three and nine
      months ended September 30, 2007 and for the period October 14, 2000
      (inception) through September 30,
      2007, respectively, to the company controlled by the former Chairman.





Included
      in Other Receivables at September 30, 2007
      is $24,923 which is related to travel advances made to employees. Included
      in
      Accounts Payable at September 30, 2007
      is $139,839 which represents travel expenses reimbursable to employees and
      directors.





The
      Company has entered into two separate consulting contracts with two shareholders
      of its Brazilian subsidiary for the purpose of providing office rent and
      administrative services and in lieu of employment contracts with these two
      individuals. These two contracts provide support significant to the operation
      of
      the Brazilian subsidiary. The company incurred expenses of $37,352 and $137,060
      for the three and nine months ended September 30,
      2006, respectively, and $37,059, $107,735 and $581,119 for the three and nine
      months ended September 30, 2007
      and for the period October 14, 2000 (inception) through September 30,
      2007, respectively.





**12.
      Commitments**





**Operating
      leases**





The
      Company leases office space and certain office equipment under agreements that
      are accounted for as operating leases. As of September 30, 2007, future minimum
      lease payments under non-cancelable operating leases were as
      follows:





Operating
      Leases




2007
            
            $
            25,5062008
            
            
            89,779Thereafter
            
            
            -Total
            
            $
            115,285





Rent
      expense under the leases with unrelated parties was $26,798 and $79,896 for
      the
      three and nine months ended September 30, 2006
      and was $54,291, $140,361 and $436,836 for the three and nine months ended September 30, 2007
      and for the period October 14, 2000 (inception) through September 30,
      2007, respectively.





**13.
      Subsequent Events**





On
      October 17, 2007, the Company entered into a private financing agreement and
      a
      joint venture transaction with Energenics Holdings Pte Ltd (“Energenics
      Holdings”) to provide funding and commercial support to develop the Asian market
      for O2DieselTM, the Company's ethanol diesel fuel blend.





The
      parties entered into a Common Stock and Warrant Purchase Agreement (the
“Energenics Agreement”) pursuant to which Energenics Holdings agreed to purchase
      2,551,020 shares of the Company's common stock in a private placement, for
      total
      proceeds of approximately $1.25 million. As part of the transaction, the Company
      agreed to issue a warrant to purchase 1,275,510 shares of common stock at an
      exercise price of $0.50 per share, which warrant will be issued upon the closing
      of the transactions contemplated by the Energenics Agreement and shall be
      exercisable from the date that is six months following the date of issuance
      until October 17, 2012 (“Investment Warrant”).





The
      parties also entered into a Shareholders Agreement, in which Energenics Holdings
      and the Company will jointly develop the market for O2DieselTM in Asia through
      O2Diesel Asia Limited (“O2Diesel Asia”). Energenics agreed to pay the Company
      $750,000 for a fifty percent (50%) equity interest in O2Diesel Asia. The balance
      of the interest in O2Diesel Asia will be held by O2Diesel Europe Limited, a
      wholly-owned subsidiary of the Company. For the past year, pursuant to the
      Supply and Distribution Agreement, dated September 15, 2006, O2Diesel has
      supplied its additive to Energenics for the manufacture and distribution of
      O2DieselTM in the Asian Pacific and South Asia.





The
      parties also will enter into a License agreement whereby O2Diesel Europe Limited
      (formerly AAE Technologies International Plc) will license to O2Diesel Asia
      certain patents and know-how that are required to make and sell O2DieselTM in the
      territory in exchange for certain payments pursuant to the Shareholders
      Agreement. In addition, the Company will enter into a similar License agreement
      with O2Diesel Asia, pursuant to which the Company will pay to O2Diesel Asia
      a royalty based on sales of the Company's product in the Territory.





As
      part
      of the transaction, upon the purchase of a certain quantity of O2D05 or the
      equivalent, the Company will also issue a warrant to purchase 1,500,000 shares
      of common stock at an exercise price of $0.50 per share, which warrant shall
      be
      exercisable during the period from the date of issuance until October 17,
      2012 (“JV Warrant”).




Also,
      as
      part of the transaction, upon the achievement by Energenics Holdings of certain
      levels of additional purchases of O2D05 or the equivalent, the Company will
      issue additional warrants to purchase up to an aggregate of 6,500,000 shares
      of
      common stock at a price per share equal to the lesser of $0.50 or 106% of the
      closing price per share (rounded to the nearest cent) of the Company's common
      stock on the American Stock Exchange on the date such warrants are earned
      (“Market Development Warrants,” and, collectively with the Investment Warrant
      and the JV Warrant, the “Warrants”). The Market Development Warrants are
      exercisable from the date of issuance to October 17, 2012.





The
      parties expect to close the transaction in the fourth quarter
      of 2007.





The
      common stock and the Warrants will be issued to the accredited investor in
      a
      transaction that will be exempt from registration pursuant to Section 4(2)
      of
      the Securities Act and/or Regulation D promulgated under the Securities
      Act.




F-19





**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**September
      30, 2007**





**ITEM
      2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF
      OPERATION**





**OVERVIEW**





**Business
      Plan**





**Overview**





The
      Company is classified as a development stage company as shown on its unaudited
      consolidated financial statements for the period from inception
      (October 14, 2000) through September 30, 2007.





O2Diesel's
      predecessor, Dynamic Ventures, Inc., was incorporated in the State of Washington
      on April 24, 2000. Dynamic Ventures, Inc. changed its name to O2Diesel
      Corporation effective June 10, 2003, in contemplation of the reverse
      acquisition of AAE Technologies International Plc (“AAE”). On July 15,
      2003, O2Diesel acquired all of the issued and outstanding share capital of
      AAE
      in exchange for 17,847,039 shares of its common stock (the “Offer”). As a result
      of this transaction, the former shareholders of AAE acquired control of the
      combined companies. The acquisition of AAE has been accounted for as a capital
      transaction followed by a recapitalization as AAE was considered to be the
      accounting acquirer. Accordingly, the historical consolidated financial
      statements of AAE are considered to be those of O2Diesel for all periods
      presented.





In
      conjunction with the reverse acquisition, the Company completed a private
      placement of its common stock whereby it issued 3,333,333 shares of common
      stock
      at $1.50 per share. Of the $5.0 million raised, approximately $800,000 was
      used
      to pay the costs of the reverse acquisition and private placement,
      $1.0 million was used to repay a bridge loan that was made in contemplation
      of the transaction, and the balance of $3.2 million was used to fund the
      ongoing developmental activities of the Company.





Subsequent
      to the Offer and during 2003, the Company undertook an effort to raise an
      additional $3.5 million through a follow-on private placement. Pursuant to
      the follow-on financing, the Company issued 1,025,784 shares of its common
      stock
      at $1.50 per share for total proceeds of $1,535,877. The follow-on placement
      was
      closed as of March 31, 2004.




On
      December 29, 2004, the Company consummated a merger (the “Reincorporation
      Merger”) with and into its wholly owned subsidiary, O2Diesel Delaware
      Corporation, a Delaware corporation (“O2Diesel Delaware”), in order to
      reincorporate in the State of Delaware (the “Reincorporation”). The
      Reincorporation Merger was affected pursuant to an Agreement and Plan of Merger
      entered into between the Company and O2Diesel Delaware on December 29,
      2004. The Reincorporation was submitted to a vote of, and approved by, the
      Company's shareholders at its annual meeting held on August 16, 2004. As a
      result of the Reincorporation, the legal domicile of the Company is now
      Delaware. The merger became effective on December 31, 2004.





Since
      July 2003, the Company has raised approximately $36 million for its operations.





**Transactions
      During the First Nine Months of 2007**




**ProEco
      Transaction**





On
      January 12, 2007, the Company entered into a share exchange agreement (“Share
      Exchange Agreement”) with ProEco and its shareholders (“ProEco Shareholders”) to
      acquire shares equal to 80% of the outstanding capital stock of ProEco in
      exchange for approximately 9.2 million shares of the Company's common stock
      (the
“Transaction Shares”) valued at $0.872 per share for a total purchase price of
      $8.0 million.





ProEco,
      which has had limited operations to date, has been developing a new
      fuel-grade ethanol plant (the “Ethanol Plant”) with planned capacity of 100
      million gallons per year to be built in two 50 million gallon trains (each
      a
“Train”). Under the terms of the Shareholder Exchange Agreement, ProEco
      Shareholders would receive 60% of the Transaction Shares at the time of the
      closing and would receive the remaining 40% of the Transaction Shares in two
      equal installments upon the completion of construction of the first Train (20%)
      and the commencement of construction of the final Train (20%). The remaining
      40%
      of the Transaction Shares would be held in escrow until the conditions for
      their
      release have been met. The parties intend the transaction to qualify as a
      tax-free reorganization under Section 368(a) of the Code.





The
      Share
      Exchange Agreement requires ProEco to complete a number of steps toward
      completion of the Ethanol Plant project in order for the closing of the share
      exchange to occur. At the time of the closing, ProEco must have entered into
      a
      definitive engineering, procurement and construction (“EPC”) contract with a
      reputable firm with extensive experience in implementing and completing projects
      similar to the Ethanol Plant project and executed marketing agreements for
      the
      sale of the production of the Ethanol Plant. Under the terms of the Share
      Exchange Agreement, ProEco is responsible for having the Ethanol Plant
      designated as a facility nameplated, or certified, as producing ethanol at
      a
      level of at least 100 million gallons of production a year.




As
        a
        condition to the closing of the ProEco share exchange, the Company would
        be
        obligated to secure the financing necessary to complete the construction
        costs
        to build the Ethanol Plant. Accordingly, the Company would be required to
        raise
        $60 to $70 million in debt and between $30 and $40 million in equity in the
        first quarter of 2008 for each train.
 
 Prior
        to
        closing, the Company and the ProEco Shareholders will enter into a stockholder
        agreement that will, among other things, impose restrictions on the transfer
        of
        the Transaction Shares.
 
 The
        Common Stock will be issued to the ProEco Shareholders in a transaction that
        will be exempt from the registration requirement pursuant to Section 4(2)
        of the
        Securities Act and under Regulation D promulgated under the Securities
        Act.


1





**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**September
      30, 2007**




Under
      the
      terms of the letter of intent for the Share Exchange Agreement, the Company
      agreed to enter into a secured loan agreement with ProEco for the purposes
      of
      financing the purchase options for the land to be used for the Ethanol Plant
      and
      certain engineering and permitting work required for the closing of the ProEco
      share exchange. The annual interest rate on the loan is 7% and the maturity
      date
      of the loan is December 15, 2007.





Current
      trends in the ethanol industry have seen increases in the price of corn and
      other feedstocks as well as a decline in the average selling price of ethanol.
      For a number of new plant construction projects, the lack of EPC contractor
      availability has resulted in increased costs and delays in completion dates.
      We
      are continuing our review of both the timing and scope of this project in light
      of the present industry environment. Our estimated timetable to obtain the
      financing and start construction has now shifted to the first half of
      2008.





Based
      on FIN
      46R,
      the Company is the holder of the majority of the risks and rewards relating
      to
      ProEco. As such, the Company is considered to be the “primary beneficiary” of
      ProEco, and ProEco is deemed to be a VIE. Accordingly, the
      Company has included ProEco’s assets, liabilities and operating results in
      its consolidated financial statements. In
      general, a VIE is a corporation, partnership, limited-liability corporation,
      trust or any other legal structure used to conduct activities or hold assets
      that either (i) has an insufficient amount of equity to carry out its principal
      activities without additional subordinated financial support; (ii) has a group
      of equity owners that are unable to make significant decisions about its
      activities; or (iii) has a group of equity owners that do not have the
      obligation to absorb losses or the right to receive returns generated by its
      operations. Based on these guidelines, the Company has determined that ProEco
      is
      a VIE beginning with the third quarter of 2007. Prior to that period,
      activity with ProEco was not material.




The
        following table summarizes the significant assets and liabilities of ProEco
        as
        of September 30, 2007:
 
 Cash
              
              $
              35,554Construction
                  in progress
              
              
              994,008Accounts
                  payable
              
              
              341,904Accrued
                  expenses
              
              
              74,978
  ProEco
        operating expenses of $327,216, after the elimination of inter-company
        transactions, are also reflected in the Company’s consolidated statements of
        operations.
 **$10.0
        Million Private Placement**





On
      February 16, 2007, the Company entered into a common stock purchase agreement
      (the “Purchase Agreement”) with Fusion Capital Fund II, LLC, an Illinois limited
      liability company (“Fusion Capital”). Pursuant to the Purchase Agreement, at the
      Company's discretion, the Company may sell up to $10.0 million of the Company's
      common stock to Fusion Capital from time to time over a twenty-five month
      period. The Company has reserved for issuance up to 12,000,000 shares of the
      Company's common stock for sale to Fusion Capital under this agreement. The
      Company has issued to Fusion Capital 805,987 shares of the Company's common
      stock as a commitment fee for entering into the Purchase Agreement.





Concurrent
      with entering into the Purchase Agreement, the Company entered into a
      registration rights agreement with Fusion Capital (the “Registration Rights
      Agreement”). Under the Registration Rights Agreement, the Company filed a
      registration statement with the SEC covering the shares that have been issued
      or
      may be issued to Fusion Capital under the Purchase Agreement. Subject to earlier
      termination at the Company's discretion, Fusion Capital's purchases commenced
      after June 8, 2007 when the Securities and Exchange Commission ("SEC") declared
      effective the registration statement related to the transaction. Generally,
      the
      Company has the right but not the obligation from time to time to sell shares
      of
      the Company's common stock to Fusion Capital in amounts between $100,000 and
      $1
      million depending on certain conditions. The Company has the right to control
      the timing and amount of any sales of the Company's shares to Fusion Capital.
      The purchase price of the shares will be determined based upon the market price
      of the shares of common stock without any fixed discount. Fusion Capital does
      not have the right or the obligation to purchase any shares of the Company's
      common stock on any business day that the price of the Company's common stock
      is
      below either $0.50 or $0.60, depending on the transaction size of the purchase.
      The agreement may be terminated by the Company at any time at its discretion
      without any cost to the Company.





During
      the quarter ended September 30, 2007, the Company did not execute any
      transactions under this agreement. During the nine months ended September 30,
      2007, the Company executed five separate transactions under this agreement
      selling a total of 970,994 shares of common stock at an average price of $0.515
      per share for total proceeds of $500,000.




**Warrants**





On
      April
      27, 2007, the Company offered existing warrant holders an opportunity to
      exercise their warrants at the reduced price of $0.50 per share. If all eligible
      warrant holders were to exercise their warrants at the reduced price, the
      Company would receive proceeds of approximately $4.3 million. The warrant offer
      was originally set to expire on May 25, 2007, however on May 9, 2007, the
      Company extended this reduced price offer until June 8, 2007. As of May 15,
      2007, the Company amended the offer to grant the warrant holders, who tender
      their warrants, additional shares of Common Stock if the Company enters
      into any agreement for the sale of shares of Common Stock at less than $0.50
      per
      share prior to June 8, 2008. The offer expired on June 8, 2007, without any
      of the warrant holders exercising at the reduced price.





**$2.52
      Million Private Placement**





Between
      June 26, 2007 and July 16, 2007, the Company entered into Agreements with five
      European institutional and private investors for the sale of 6,123,346 shares
      of
      the Company’s common stock at a purchase price of approximately $0.41 per share
      in a private placement, for total proceeds of $2,517,710 before commissions.
      As
      a condition to the enforceability of these agreements against the Company,
      the
      investors were required to fund the purchase price in an escrow account, which
      funds were received between June 19, 2007 and July 31, 2007.





As
      part
      of the sale, the Company issued warrants to purchase 1,530,827 shares of common
      stock at an exercise price of $0.62 per share during the period of six months
      to
      sixty-six months subsequent to issuance. The warrants expire sixty-six months
      after the date of issuance.





The
      Company was obligated to file a registration statement with the SEC including
      the common stock and the shares issuable upon exercise of the warrants within
      90
      days of the closing date. A Form S-3 registration statement, including these
      shares and shares issuable upon exercise of the warrants, was filed by the
      Company on October 18, 2007 and declared effective by the SEC on October 31,
      2007. All the costs and expenses incurred in connection with the registration
      of
      the common stock and warrants are paid by the Company. The Company closed this
      transaction on July 20, 2007 and August 20, 2007.





2





**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**September
      30, 2007**





**Listing
      of Common Stock on AMEX**




On
      June 15, 2004, the AMEX approved an application to list 46,518,898 shares
      of our common stock under the symbol OTD. Subsequent to this date, the Exchange
      has approved additional applications to list 72,830,013 more shares of our
      common stock so that the total number of shares approved for listing is
      119,348,911. Our shares began to trade on the Exchange on July 1,
      2004.




The
      Company's audited consolidated financial statements for the year ended
      December 31, 2006, were prepared on a going concern basis, which
      contemplates the realization of assets and the settlement of liabilities and
      commitments in the normal course of business. Our independent registered public
      accounting firm included an explanatory paragraph in their report on the
      December 31, 2006 audited consolidated financial statements to highlight
      that the Company's accumulated losses and lack of available working capital
      raised substantial doubt about the Company's ability to continue as a going
      concern.





The
      Company's unaudited consolidated financial statements for the three and nine
      months ended September 30, 2007, have been prepared on a going concern basis,
      which also contemplates the realization of assets and the settlement of
      liabilities and commitments in the normal course of business. At September
      30,
      2007, the Company had working capital of $1,959,349, including $2,898,550 of
      restricted cash, and had accumulated losses of $40,500,079.




The
        Company was notified by the AMEX in December 2004 that it was not in
        compliance with AMEX Company Guide Section 1003(a)(iii) which requires listed
        companies to have at least $6.0 million of stockholders' equity when it has sustained
        losses from continuing operations and/or net losses in its five most recent
        fiscal years .
        AMEX
        indicated that, in order to return to full compliance, O2Diesel needed to
        have
        stockholders' equity of $6.0 million by June 2006 and to maintain this
        level going forward.





In
      accordance with the procedures of the Exchange, we filed a plan with it to
      demonstrate the steps we would take to return to full compliance. On
      February 15, 2005, the AMEX notified us that it had accepted our plan, and
      that we would be given until June 2006 in which to regain compliance with
      the Exchange's listing rules. To achieve that level of stockholders' equity,
      we
      anticipated having to raise a total of approximately $10.0 million in new
      equity during 2005. In December 2005, the Company determined that it could
      not meet certain conditions of the plan and met with representatives of the
      AMEX
      to discuss the need to develop an amended plan to demonstrate how the Company
      would be in compliance by June 2006. During 2006, as part of its efforts to
      meet these requirements, the Company closed an offer to existing warrant holders
      to exercise their warrants at a reduced price for proceeds of approximately
      $1.5
      million (after expenses) and three private placements totaling
      $7.5 million.





On
      July
      17, 2006, the Company received a letter from the AMEX indicating that the
      Company had regained compliance with AMEX listing requirements. At December
      31,
      2006, the Company was in compliance with AMEX listing requirements, but for
      the period ended March 31, 2007, the Company was not able to meet the
      listing requirements. On June 29, 2007, the Company was notified by AMEX that
      it
      was not in compliance with the listing standards of the Exchange because it
      lacked the requisite amount of stockholders' equity. The Company was asked
      to
      submit a plan by July 27, 2007 advising AMEX of actions the Company would be
      taking to bring it into compliance with the continued listing standards by
      December 29, 2008.





On
      July
      27, 2007, the Company filed a plan with the Exchange describing the steps it
      plans to take to return to full compliance. The Company has entered into a
      common stock purchase agreement with Fusion Capital Fund
      II,
      LLC to raise
      up to $10 million in new equity over a twenty-five month period starting on
      February 16, 2007. Also, the Company announced a private placement in which
      we
      raised an additional $2.52 million in July and August 2007. As noted below,
      the
      Company intends to raise additional new equity in conjunction with the
      acquisition of the ProEco Energy Company. We believe these actions will enable
      us to meet or exceed the equity requirements of the Exchange.




On
      September 13, 2007, the Company received a written notice from the AMEX
      indicating that AMEX had reviewed and accepted the Company’s plan to regain
      listing qualifications compliance. With the acceptance of the plan, the Company
      will be able to continue its listing during the plan period pursuant to an
      extension granted until December 29, 2008. The AMEX notice also advised the
      Company that, in addition to the previously disclosed deficiency with respect
      to
      Section 1003(a)(iii) of the AMEX Company Guide, it had triggered an additional
      deficiency with respect to Section 1003(a)(ii) of the AMEX Company Guide which
      requires listed companies to have at least $4.0 million of stockholders' equity
      when it has sustained
      losses from continuing operations and/or net losses in its four most recent
      fiscal years .




During
      the interim period until December 29, 2008, the Company must continue to provide
      AMEX staff with updates regarding initiatives set forth in its plan of
      compliance. The Company will be subject to periodic review by AMEX staff during
      the interim period. If the Company is not in compliance with the continued
      listing standards on December 29, 2008, or the Company does not make progress
      consistent with the plan during the interim period, the
      AMEX
      would likely initiate procedures to de-list the Company's common stock. If
      the
      Company's common stock were to be de-listed by the AMEX, its shares would
      continue to be traded as a bulletin board stock.





The
      consolidated financial statements in this report do not include any adjustments
      to reflect other anticipated private placements or the possible future effects
      on the recoverability and classification of assets or the amounts and
      classification of liabilities that may result should management be unsuccessful
      in obtaining financing on terms acceptable to the Company.




**Operations**





During
      the third quarter of 2007, we continued our efforts to generate sales to our
      targeted fleet customers in North America and Brazil, as well as our efforts
      to
      develop targeted demonstrations in Europe. At the same time, the Company
      continued its relationship with its Asian partner, Energenics Pte Ltd
      (“Energenics”) and expanded its sales in India.





In
      Canada, we intend to focus our efforts on the country’s large population centers
      in the Eastern and Western provinces, but until we have commercialized our
      technology in the U.S., no significant resources will be devoted to
      Canada.




3





**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**September
      30, 2007**





**United
      States:**





Our
      focus
      for the U.S. has been to target key geographical areas and specific diesel
      markets based upon:





**Ø**
            
            Current
                and projected quantity of diesel fuel consumption;**Ø**
            
            High-population
                centers under strict air quality regulations;**Ø**
            
            Municipal
                transit and school bus fleets with an emphasis on public policy and
                a
                positive environmental image;**Ø**
            
            Large
                concentrations of urban-based, centrally fueled fleets of trucks
                and
                buses;**Ø**
            
            Off-road
                construction equipment;**Ø**
            
            Diesel
                equipment used by port facilities and large-scale mining operations;
                and**Ø**
            
            Military
                installations in non-combat
                vehicles.





In
      the
      U.S., O2Diesel's third quarter sales and marketing efforts for fleet sales
      were
      focused in the state of California and in the Midwest. The Company maintained
      commercial activities at the Port of Long Beach and continued to pursue
      additional opportunities in this market segment. These efforts resulted in
      the
      addition of a third fleet operator at the Port. This customer is one of the
      largest at the Port and its fuel requirements are expected to double the sales
      of O2DieselTM at the Port. The Company had previously received a letter from the
      Port recommending the use of O2DieselTM in any of the existing centrally fueled
      fleets throughout the Port as part of its Green Port Policy and its Clean Air
      Action Plan. The Company also continued with the expansion of its successful
      test demonstration at a U.S. Air Force base in Nevada, both in the number of
      vehicles to be used and the length of time the demonstration will now be
      run.





The
      Company previously concluded a successful test demonstration in Clark County,
      Nevada which was devoted to documenting the reduced emission benefits of
      O2DieselTM over a range of temperatures and engine types as well as
      demonstrations at a large coal mining operation in Wyoming and a municipal
      waste
      fleet in California.





We
      also
      continued to devote resources to our CityHomeTM marketing program as a means of
      documenting operating performance data. CityHomeTM is a marketing and sales
      initiative directed at municipal transit agencies in the United States as an
      opportunity to improve air quality in urban locations. This program stresses
      the
      environmental benefits of our fuel and is designed to allow municipal transit
      authorities to convert their fleets to O2DieselTM without having to pay the
      higher costs of our fuel.





Through
      an innovative cost sharing concept with companies that wish to be good corporate
      citizens (sponsors), we have designed a program which permits the municipalities
      to purchase our fuel at costs which are the same as what they pay for regular
      diesel fuel. Corporate sponsors, generally with a national or international
      presence, will pay sponsorship fees to O2Diesel to take part in a clean air
      program for one or more of the communities participating in a CityHomeTM program.
      In return for sponsorship payments, each sponsor will be given access to
      currently unused advertising space on buses and other advertising assets owned
      by the municipality. Sponsorship fees will become additional revenue for us
      and
      will be recognized as such when the related advertising is displayed and all
      other criteria for revenue recognition have been met. Costs that are intended
      to
      be supported by the sponsorship fees are recorded separately in the related
      expense line in our statement of operations. With regard to the advertising
      space, since we have been unable to assess the fair market value of the
      advertising space received, we assign no value to the space at the time of
      the
      receipt. We are recognizing the value associated with the advertising space
      when
      we enter into a contractual arrangement with a third party. The Company will
      consider assigning a fair value to the advertising space received at the time
      of
      the initial sale when such fair value is more readily determinable, based upon
      a
      history of cash transactions.





In
      the
      third quarter of 2007, we had a CityHomeTM installation with one municipal bus
      fleet as well as several small school bus fleets in Chicago and South Dakota.
      To
      date, we have used this initiative as an important component of our
      test/demonstration strategy and have been successful in attracting fuel
      distributors to work with us in getting this initiative started. However, while
      we have received sponsorship funding for several CityHomeTM programs, the fleet
      demonstrations executed under this program have required significant financial
      support from the Company. As a result, we have limited new CityHomeTM programs to
      instances where we are assured of a level of sponsorship funding needed to
      cover
      all expenses of the demonstration. The Company’s future involvement with the
      CityHomeTM program has thus been reduced only to programs that can be consider to
      be cost neutral. During the third quarter of 2007, we concluded our
      demonstrations in Johnson County, Kansas and continued to run one CityHomeTM
fleet in Lincoln, Nebraska.





We
      have
      also expanded our efforts to establish and improve the logistics network
      required for the delivery of O2DieselTM to fleet and CityHomeTM customers in the
      third quarter of 2007. These efforts have centered on developing strategic
      relationships with ethanol producers and distributors in order to improve both
      quality consistency and price stability. As of September 30, 2007, the Company
      had supply agreements in place with two ethanol industry groups to obtain a
      supply of limited amounts of ethanol at preferential pricing for our Midwestern
      customers.





In
      addition, the Company continued to support its efforts to acquire an 80%
      ownership share in ProEco, which has been planning to build a 100 million gallon
      ethanol plant in South Dakota. Once this acquisition has closed and the plant
      is
      operational, it is expected that this facility will provide a reliable source
      of
      high quality, competitively priced ethanol for the Company to use in developing
      the U.S. market. During the third quarter of 2007, the Company expanded its
      support of ProEco to obtain options for land purchases, the submission of
      permits for construction, the negotiation of an EPC contract, the negotiation
      of
      supply and transportation agreements and the development of marketing agreements
      for sale of the ethanol to be produced at this facility.




During
      the third quarter, the U.S. ethanol industry experienced several economic and
      logistical challenges to the general expansion of production capacity. The
      prices of various ethanol feedstocks, most notably corn, have increased while,
      at the same time, ethanol prices have seen a general decline as new production
      capacity comes on line. In addition, the demands on experienced EPC contractors
      have increased, particularly with the need for qualified skilled labor to build
      new plants. As a consequence, many new projects have experienced increased
      construction costs and project delays at a time when the profitability of the
      industry is being tested. We
      are
      continuing our review of both the timing and scope of this project in light
      of
      the present industry environment. Our estimated timetable to obtain the
      financing and start construction has now shifted to the first half of
      2008.




4




**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**September
      30, 2007**


We
      are
      continuing a series of product tests and demonstrations that relate directly
      to
      obtaining regulatory approval forO2DieselTM and which are designed to meet the
      needs of our targeted customers. During the quarter ended September 30, 2007,
      the Company continued its efforts to register O2DieselTM fuel and fuel blends
      with the EPA and has decided to alter its regulatory approval strategy in
      California. The Company is now developing a revised series of tests to qualify
      O2DieselTM as a California Diesel Emissions Control Strategy only in conjunction
      with various exhaust after treatment devices, such as Diesel Oxidation Catalysts
      (DOC's) and Diesel Particulate Filters(DPF's), rather than as a standalone
      fuel.





In
      addition, we continued to develop a revised ballot for incorporation of
      ethanol-diesel fuel as an American Society for Testing and Materials (ASTM)
      specification. This revision is based on the results of the initial voting
      on
      the original ballot submitted in December 2006. A member of the Company serves
      as the chairman of the subcommittee tasked with revising this ballot and it
      is
      expected to be resubmitted during the second half of 2007 so that it can be
      discussed and voted on during the December 2007ASTM international
      meeting.





Finally,
      during the third quarter of 2007 we continued to develop contract proposals
      for
      submission to the DOE and the DoD to utilize the $2.0 million of available
      appropriations approved in prior years. These appropriations were awarded for
      the purpose of continued testing and verification of O2DieselTM, including the
      requirements of both DECS and the U.S.  military.





In
      September 2007, the Company announced that the Senate subcommittee had approved
      additional DoD funding to continue demonstration tests of O2Diesel’s O28 fuel
      blend at Nellis Air Force Base. The appropriations bill covering this funding
      has now been sent on to be reconciled with the House Defense Appropriations
      bill.




**Brazil:**





In
      Brazil, O2Diesel is targeting customers on a very focused basis. In general,
      these will be miller fleets (sugar and ethanol producers), municipal bus and
      other fleets, and to a lesser extent centrally fueled truck fleets. The roll
      out
      of our product has been much slower than planned. Obtaining government approvals
      and gaining market awareness has taken longer than we anticipated. In response
      to these matters, we have made a decision to reduce our overhead and our
      marketing plans until we have a solid base of customers in Brazil. During the
      third quarter of 2007, we continued our support of one test fleet and continued
      negotiations with a municipal bus fleet in Curitiba.





In
      April,
      2007, we announced the appointment of Fair Energy, S.A. as our distributor
      for
      several new markets in Central and South America. Demonstration programs in
      Columbia, Paraguay and Bolivia are targeted by the Company over the next several
      quarters. The first of these demonstrations will be initiated in the fourth
      quarter of 2007 in Asunción, Paraguay’s capital.





**Europe:**





During
      the third quarter of 2007, we pursued discussions and initiatives in Europe
      to
      test our fuel and to determine the market size and regulatory hurdles to be
      overcome to gain wider acceptance of our fuel in Europe. As of September 30,
      2007, the Company had identified two municipal transit fleets, a waste fleet
      and
      a port facility that were interested in evaluating O2DieselTM fuel. The Company
      recently announced that it had received regulatory approval in France to begin
      testing O2DieselTM in a large transit system in Angouleme in the Bordeaux region
      of France. This demonstration has now started and we expect these activities
      to
      develop into additional demonstration programs over the next several
      months.





In
      addition, the Company announced that it will commence its first demonstration
      in
      Spain with Tussam (Transportes Urbanos De Sevilla Sociedad Anonima Municipal),
      who operates the collective urban transport system in Seville.




**Asia:**





In
      Asia,
      the company that serves as our exclusive distribution agent announced that
      it
      had concluded a successful trial demonstration of the fuel and we commenced
      supplying the first 2,500 buses of a large municipal fleet in Karnataka, India.
      Expanded fueling of this fleet continued during the third quarter of 2007 and
      it
      is anticipated that all 17,000 buses in this fleet will be running on our fuel
      by the end of the second quarter of 2008. In addition, the Company recently
      announced that O2Diesel and Energenics have formed a joint venture to secure
      Energenics’ rights to our fuel technology in the Asian region and to expand the
      development of this market.





**Technical
      and Logistical Issues**





Significant
      technical and logistical issues continued to affect our ability to generate
      sales in the third quarter of 2007. While we have made substantial progress
      in
      addressing these challenges over the course of the year, they have continued
      to
      impede our efforts to commercialize O2DieselTM fuel. In general, these challenges
      fall into the following categories: (1) logistics of delivering and dispensing
      O2DieselTM, (2) obtaining consistent high quality fuel grade ethanol at
      competitive prices and (3) acquiring regulatory approval and an industry
      accepted specification for our “e-diesel” (ethanol-diesel) fuel. O2Diesel has
      devised several strategies to meet these challenges and has undertaken a variety
      of activities to overcome them and to position O2DieselTM as a premium
      clean-burning fuel.





**Logistics**





Under
      the
      first element of our strategy, we have signed distribution agreements with
      fourteen jobbers, who in turn have centrally fueled fleets as their customers.
      We sell additive to these jobbers and assist them in purchasing ethanol by
      either locating ethanol suppliers or purchasing and reselling ethanol to them.
      However, we will only purchase ethanol as an accommodation to a jobber, because
      we do not wish to tie-up our limited working capital to finance the purchases
      of
      ethanol. The jobbers blend our additive and ethanol with diesel fuel and then
      sell O2DieselTM to their customers. O2Diesel's sales force and technical staff
      work jointly with each jobber and the jobber's customers to assist in the
      transition from the use of regular diesel fuel toO2DieselTM. A key part of
      working with each jobber and its customers is to provide safety and training
      materials covering the use of the fuel. In addition, O2Diesel's technical staff
      works closely with each customer in the process of purchasing and installing
      flame arrestors and other devices for customer vehicles and storage facilities.
      In some cases, we are responsible for sourcing and installing these devices
      while, in other cases, our technical staff will only have an oversight role.
      Finally, our technical staff will work with the customer to insure that its
      storage facilities are clean and are compatible for storing and dispensing
      O2DieselTM.





5





**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**September
      30, 2007**





Our
      sales
      strategy is to market and sell O2DieselTM directly to companies, governmental
      port facilities and others that operate large centrally fueled fleets. These
      customers may include large truck and bus fleets, construction municipalities,
      and mining companies as well as port cargo handling facilities and agricultural
      users. To date, these customers have only included centrally fueled truck fleets
      and cargo handling facilities at a major port. In these transactions, the
      Company will maintain a similar working relationship with the customer's
      blending facilities and staff as it does with third party jobbers.





Secondly,
      as part of the process by which O2DieselTM was approved for sale in California,
      the California Air Resources Board set a number of conditions that we must
      adhere to on an ongoing basis. One of the conditions is that all storage tanks
      in which O2DieselTM is stored and all vehicles that use the fuel must be fitted
      with devices known as flame arrestors. Flame arrestors are safety devices which
      are intended to prevent a fire in case a spark or other type of ignition might
      inadvertently enter the fill inlet of a fuel tank. Imposing this requirement
      proved to be a serious issue prior to 2006, and was a serious challenge to
      our
      ability to effectively commercialize our technology in the U.S. Even though
      flame arrestor technology has been used for many years in other applications,
      flame arrestors in the required sizes and designs were not yet available as
      an
“off the shelf item” for use with O2DieselTM during this time. At the beginning
      of 2007, the flame arrestor challenge had been largely resolved for the vehicles
      within O2Diesel's target markets.





A
      third
      concern we have relates to the logistics and storage of O2DieselTM for fleets and
      other diesel equipment that may use the fuel. In particular, it is very
      important that storage tanks be cleaned prior to the introduction of O2DieselTM
into the customer's refueling station. We have made important strides in working
      with customers to insure that their storage facilities are compatible with
      O2DieselTM and have now included this step as a critical component of our
      implementation planning process.




The
      Company has taken several steps prior to 2007 to overcome these problems and
      to
      support the introduction of O2DieselTM fuel to new customer opportunities. First,
      we assembled our knowledge and documentation regarding the design requirements
      of flame arrestors in the market areas we served and developed a catalogue
      of
      flame arrestors and parts that can be used for a wide variety of engine/vehicle
      types and customer applications. Second, we developed a checklist of procedures
      to be used by our technicians (in conjunction with our customer) that enabled
      our technicians to prepare a comprehensive fleet profile of hardware
      requirements, tank cleaning procedures and the time required to perform the
      work
      necessary to bring a fleet on-line. Third, we have identified several equipment
      vendors who we plan to work with so that needed equipment can be delivered
      to
      customer locations quickly and at competitive prices. Fourth, we have developed
      a training program that will enable our technicians
      to teach our customers' fleet maintenance staff about handling and storing
      O2DieselTM fuel, fleet modification and maintenance issues that can be expected.
      Finally, we have developed a modest parts inventory at our laboratory facility
      so that in the event of an emergency, required parts can be supplied to our
      customers.





Our
      present planning methodology is based on a mutually agreed upon implementation
      time frame that requires the project to be a joint effort utilizing
      the  customer's
      employees and identifies the timing and costs that the customer can expect.
      During 2005 and 2006, we continued the research and development efforts begun
      in
      2004 to design and to identify flame arrestors, adaptors and other equipment
      for
      vehicles that use O2DieselTM. Where required, these devices have undergone and
      passed tests to insure that they are capable of complying with all required
      specifications. In addition, we have learned that certain engines require the
      fitting of a primer pump to insure that the vehicle starts and runs properly
      in
      hot weather. These devices are simple and readily available and the costs are
      known, but the necessity of adding these devices to certain vehicles has, in
      some cases, increased our costs as well as the time required to transition
      a
      fleet from using regular diesel fuel to the use of O2DieselTM.Lastly, in some
      buses, we have had to install safety fueling devices in the fuel inlet that
      serve the function of flame arrestors, but are generally more expensive. These
      particular devices are readily available in the market. To support our
      implementation efforts, we commissioned a third party engineering consulting
      firm to review our written safety training procedures as well as to conduct
      on-site reviews of four of our customer locations in order to evaluate the
      adequacy of the training and the quality of safety procedure implementation.
      The
      ensuing report from the consultant indicated that our safety program
      requirements were well conceived and were being followed quite closely at all
      locations. Additional safety procedures to enhance this program are currently
      being evaluated.





In
      the
      past, these issues have led to greater lead times than expected to convert
      fleets from using regular diesel to O2DieselTM. In fact, we have seen that the
      time it takes to do the conversion work can be the most important factor in
      bringing on more customers to use our fuel. As a means of mitigating the time
      required for converting a fleet, we have sought to have our customers complete
      much of this work under our direction. However, this policy is dependent upon
      obtaining an agreement from the customer to do the work. The actual time
      required to convert a fleet to use O2DieselTM may be further limited by the
      availability of the customers' vehicles to be in one place long enough to effect
      the required changes. In some cases for safety, insurance or union reasons,
      customers will require that they complete all of the work necessary for their
      vehicles and diesel powered equipment to use O2DieselTM, as well as arranging to
      insure that their storage and dispensing facilities are compatible with the
      use
      of the fuel.





The
      Company has made significant progress in addressing these key logistical issues
      over the past several years and we now feel that we can provide the necessary
      support to our customers both before and during implementation of our fuel
      in
      their fleets. The Company anticipates that the work achieved prior to 2007
      with
      all of these implementation factors will allow us to avoid the costs and delays
      we experienced in the past.





**Ethanol
      Supply**





Our
      experience has demonstrated that it is important to carefully select ethanol
      suppliers because there is a wide range of fuel grade ethanol in the
      marketplace. It is critical that the ethanol component of O2DieselTM be of a
      consistently high quality and that it meet certain other specifications.
      Selection of ethanol suppliers and creating a relationship with those that
      can
      provide the quality of product we require is a significant need, and is a task
      that we will devote more time to during the remainder of 2007. We are currently
      working closely with the industry to identify ethanol suppliers who meet
      our criteria. As of September 30, 2007, we had continued to maintain contracts
      with two ethanol industry groups to provide a supply of limited amounts of
      ethanol at preferential pricing for our Midwestern customers.





In
      order
      to insure fuel quality, we have developed a quality control function that
      constantly tests the ethanol used by all customers. In addition, we have learned
      that it is necessary to test the quality of diesel blended with our additive
      and
      ethanol. Establishing our own laboratory facility has been a significant help
      to
      us in developing quality control standards, and for carrying out the tests
      that
      are necessary in preparing a fleet for conversion to use O2DieselTM.
      Additionally, the Company has installed several testing devices in the field
      so
      that samples can be evaluated more efficiently than with a centralized
      laboratory alone. None of these tests are time consuming or technically
      difficult, but they are critical to ensuring that our product functions as
      intended. As we gain more experience, it may not be necessary to conduct the
      level and frequency of tests that we expect to do over this coming
      year.





The
      Company has seen that even with a reliable supplier, the price of ethanol can
      be
      volatile as a result of a number of factors, such as the overall supply and
      demand, the level of government support, and the availability and price of
      competing products. For example, many petroleum refiners have recently replaced
      methyl tertiary butyl ether (MBTE) in gasoline with ethanol during the second
      quarter of 2006. The replacement of this ingredient in gasoline has caused
      the
      demand for ethanol to increase dramatically, with a corresponding increase
      in
      its price. A benefit of this phenomenon has been to increase the availability
      of
      ethanol at petroleum terminals when compared to the recent past. However, the
      rise in the cost of ethanol has made the price of O2DieselTM fuel increase in
      relation to conventional diesel fuel during the first half of 2007. In the
      short
      term, it is the Company's strategy to contract with third parties to help
      control the costs of ethanol and reduce short-term exposure to price
      fluctuations by continuing our contracts with the ethanol industry groups for
      limited amounts of ethanol at preferred prices.





6





**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**September
      30, 2007**




In
      the
      longer term, the Company has seen the clear advantage represented by
      partnerships with distributors who have access to high quality, price
      competitive ethanol in the local market. In this regard, our partnership with
      Energenics in Asia, Abengoa in Europe and Fair Energy in South America have
      provided significant support to our efforts to blend O2DieselTM fuel at prices
      that are competitive with conventional diesel fuel in the markets we are
      entering. For this same reason, we have decided to acquire ProEco Energy so
      that
      we can have a similar quality and price advantage with our ethanol supply in
      the
      United States.





As
      a
      result of these efforts, the Company believes it has both an interim and
      long-term strategic opportunity to achieve a supply of high quality, price
      competitive ethanol among its key markets,





**Regulatory
      Approval**





As
      outlined in “Research and Development”, the Company must obtain regulatory
      approvals at a number of levels in order to be able to sell commercial
      quantities of O2DieselTM in the United States. These approvals involve the
      Environmental Protection Agency (EPA) at the federal level, the California
      Air
      Resources Board (CARB) at the state level and the American Society for Testing
      Materials (ASTM) at both a military and industry level. The process of acquiring
      these approvals requires significant testing for emissions, impact to the
      environment, safety, performance and engine warranty considerations among a
      broad range of engine types and ages. In some cases, existing regulations or
      the
      interpretation of the requirements to meet these regulations can change over
      the
      testing periods, either because of new legislation, additional technical data
      in
      the industry or the agencies' understanding of the technology they are
      evaluating. Such changes can add significant time to completing the required
      testing, either through changes in protocols or additional tests to be
      performed. While the Company has achieved important verification of its
      technology among these various agencies, the time and expense required to obtain
      final approval remains quite lengthy. Our experience in Europe has been similar,
      indicating that final regulatory approval here will also take additional time.
      In Asia and South America, similar approvals need to be obtained, but we are
      able to rely on our strategic partners in these areas to assist us in obtaining
      the appropriate regulatory permission to sell our fuel.





The
      technical challenges in the past year have presented significant hurdles to
      commercializing our technology. In most cases, we have overcome these obstacles
      by the application of technical resources, payments to support our customers
      and
      a high level of customer service. All of this has been time-consuming and has
      slowed our ability to bring our product to market. But it has also created
      a
      base of knowledge which is helpful as we continue our efforts to commercialize
      our technology. We have been encouraged by the fact that among our customers,
      we
      have a municipal bus fleet and a port facility that have been successfully
      utilizing the fuel for more than one year. Even though we have gained a
      significant amount of technical knowledge, we will continue to refine our
      efforts in this area in order to improve our ability to bring on greater numbers
      of customers and to better predict the cost and timing of the work required
      to
      have fleets conform to the requirements of using our product.





**Third
      Quarter Summary**





Operating
      results for the
      nine month period ended September 30, 2007 showed mixed results compared to
      those during the nine month period ended September 30, 2006. Sales in the
      first nine months of 2007 more than doubled to $304,126, from $141,201 in the
      comparable 2006 period, primarily due to several major shipments of additive
      to
      our Asian distributor. Cost
      of goods sold increased by $132,342 reflecting a combination of the increased sales activity
      and higher raw material costs causing the gross margin percentage to be
      approximately 7.4% lower compared to the nine months ended September 30, 2006. ProEco
      operating expenses increased by $327,216 as, pursuant to the requirements of FIN 46R discussed
      previously, ProEco was consolidated with O2Diesel beginning in the third quarter
      of 2007. Selling
      and marketing expenses
      for the nine months ended September 30, 2007 were $239,488 higher than the
      comparable 2006 period, primarily reflecting higher sales and marketing costs
      at
      the Spanish subsidiary which was in start-up mode in the latter half of last
      year. Product
      testing and government grant expenses (net) in the
      nine months ended September 30, 2007 were $646,148 higher than in the period
      ended September 30, 2006 due to the combination of a $209,113 increase in
      research and development costs associated with the Spanish subsidiary offset
      by
      the $437,035 decrease in net government contract billing activity. General
      and administrative expenses
      for the nine months ended September 30, 2007 were $307,758 lower than for the
      comparable 2006 period primarily due to a $1.4 million decrease in FAS 123(R)
      stock compensation expense attributable to a cumulative adjustment of $1.6
      million in 2006. These savings were largely offset by higher 2007 expenses
      related to share issuance costs for investor relations firms ($391,603),
      severance pay ($282,604), an officer’s restricted stock award ($273,299) and the
      use of additional accounting consultants related to the ProEco transaction
      ($267,901).





**Cash
      Requirements, Liquidity and Risk Factors**





Based
      on
      our projected level of expenses and the cash on hand as shown on our
      consolidated balance sheet at September 30, 2007, we will need to raise
      additional funds in 2007. Even with the capital raised in 2006 and 2007, we
      believe it will be necessary to raise additional funds in 2007 to allow us
      to
      execute our business plan and to be in compliance with the AMEX's listing
      standards.





To
      date,
      we have not had any bank trade facilities, except an overdraft line in the
      U.K.
      used to meet operating needs and a small vehicle loan. This overdraft facility
      was repaid and canceled during 2003 and the vehicle loan was paid off in
      November 2005. However if the Company achieves significant sales, we plan
      to apply for trading lines with banks in the U.S. and Brazil as a means to
      finance our working capital needs. In the third quarter of 2007, the Company
      continued to have favorable trade terms with its supplier, Cognis Deutschland
      GmbH (“Cognis”) for the supply of additive.





AMEX
      requires that minimum levels of stockholders' equity be maintained. In December,
      2004, the Company was notified that it was not in compliance because its
      stockholders’ equity had dropped below the required minimums, and it had
      experienced continuing losses for the past four years. In order to return to
      full compliance, O2Diesel needed to have stockholders' equity of
      $6.0 million by June 2006 and maintain this level going forward. In
      accordance with the procedures of the AMEX, we filed a plan (“Plan”) with it to
      demonstrate the steps we will take to return to full compliance. On
      February 15, 2005, the AMEX notified us that it had accepted our Plan, and
      that we would be given until June 2006 in which to regain compliance with the
      AMEX's listing rules. To achieve that level of stockholders' equity, we
      anticipated having to raise a total of approximately $10.0 million in new
      equity during 2005. In December 2005, the Company determined that it could
      not
      meet certain conditions of the plan and met with representatives of the AMEX
      to
      discuss the need to develop an amended plan to demonstrate how the Company
      would
      be in compliance by June 2006. During 2006, as part of its efforts to meet
      these requirements, the Company closed an offer to existing warrant holders
      to
      exercise their warrants at a reduced price for proceeds of approximately $1.5
      million (after expenses) and three private placements totaling $7.5
      million.





On
      July
      17, 2006, the Company received a letter from the AMEX indicating that the
      Company had regained compliance with AMEX listing requirements. At December
      31,
      2006, the Company was in compliance with AMEX listing requirements, but as
      of
      March 31, 2007, the Company was not able to meet the listing requirements.
      On
      June 29, 2007, the Company was notified by AMEX that it was not in compliance
      with the listing standards of the Exchange because it lacked the requisite
      amount of stockholders' equity. The Company was asked to submit a plan by July
      27, 2007 advising AMEX of actions the Company would be taking to bring it into
      compliance with the continued listing standards by December 29,
      2008.





On
      July
      27, 2007, the Company filed a plan with the Exchange to describe the steps
      to be
      taken to return to full compliance. The Company has entered into a common stock
      purchase agreement to raise up to $10.0 million in new equity over a
      twenty-five month period starting on February 16, 2007. Also, the Company
      announced a private placement in which we raised an additional $2.52 million.
      The Company intends to raise additional new equity in conjunction with the
      acquisition of ProEco. We believe these actions will enable us to meet or exceed
      the equity requirements of the Exchange.




7





**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**September
      30, 2007**





As
      a
      result of the lack of a sales history for our products, we do not have
      sufficient historical financial data for any periods on which to accurately
      forecast future revenues or operating expenses in connection with achieving
      such
      revenues. As such, we are not able to project with certainty the additional
      funds that may need to be raised. In 2005, we raised new equity of approximately
      $11.1 million, before payment of expenses. As stated previously, even with
      the fund raising completed in 2005, and the $8.7 million raised during 2006
      and
      the $2.8 million raised in the first nine months of the current year, we will
      need to raise additional equity in 2007. We continue to hold discussions with
      a
      number of potential investors and work with a professional investor relations
      service company to assist with these efforts. In connection with our efforts
      to
      attract new investment, there can be no assurance that we will be successful
      in
      doing so. Nor can there be any assurance that the Company will generate sales
      and sponsorship fees followed by the collection of cash to offset our operating
      expenses.





As
      shown
      in the consolidated statements of operations contained in this report, we have
      generated only $123,128 and $304,126 in sales and had sponsorship income of
      $1,875 and $21,375 associated with the CityHomeTM programs for the three and nine
      months ended September 30, 2007, respectively. As of the date of this report,
      excluding orders from Energenics, we have only minimal orders on hand for either
      O2D05 or O2DieselTM. Lastly, there can be no assurance that actual events will
      not differ from those anticipated, or that general economic conditions may
      not
      vary significantly in ways that could negatively impact our operations and
      cash
      position.





**Research
      & Development**





The
      Company has 81 patents granted or applications pending for nine different
      proprietary fuel and additive product inventions registered with the
      international WIPO (PCT) Registration System. Six inventions currently have
      38
      patents granted, and 22 applications pending, in 22 different countries in
      Europe, North America, South America and Asia. An additional three other
      inventions have 21 patent applications pending which are undergoing examination
      at the national level in 16 different countries. If patent applications for
      these latter three inventions are granted, we expect to immediately file related
      patent applications in several European, South American and Asian countries.
      During this period, O2Diesel's intellectual property rights over its additive
      products are protected through its registration with the WIPO (PCT) Registration
      System and its pending national patent applications.





As
      part
      of our cooperation agreement with Cognis, we, along with Cognis, are the joint
      owners of all patents covering both the use and composition of O2D05. All legal
      costs associated with preparing, filing and administering the jointly owned
      patents are shared equally by the Company and Cognis. We also have a number
      of
      patents that have been issued that relate to the predecessor technology of
      O2D05. As a strategic measure, we continue to fund all costs necessary to
      maintain some of these patents. O2Diesel is the sole owner of these latter
      patents, which in general cover the use and composition of its prior generation
      technology.





We
      have
      registered a trademark in the U.S. and the European Union for a mark which
      includes the words and numbers O2DieselTM as well as a figurative logo of the
      words. We also registered trademarks for “CityHome” (and design) in eight
      classes of goods and services, “TODAY'S CLEAN AIR SOLUTION TOMORROW'S BRIGHTER
      FUTURE” and “CITYHO2ME”, each covering one class of goods and
      services.





The
      Company has incurred substantial costs in carrying out tests to demonstrate
      that
      the use of our product will enable customers to comply with environmental laws
      and regulations. As of September 30, 2007, we incurred external expenses of
      $650,202 during 2007 in the U.S. in connection with governmental sponsored
      projects and tests. Most of the costs incurred in these government test
      programs will be reimbursed by appropriations from the U.S.
      Departments of Energy and Defense.





At
      the
      end of the third quarter of 2007, we had government test programs in progress
      with total remaining costs to complete of approximately $1.3 million. Under
      these programs, a wide array of engine tests and product demonstrations are
      to
      be conducted to further prove the emissions benefits of O2DieselTM and to show
      that the fuel performs well in specific applications.





Included
      in the foregoing programs are a number of emissions validation and verification
      projects as well as fleet demonstrations. All of the verification and validation
      programs are complicated and may take considerable time to complete. Finishing
      the protocols to allow O2DieselTM to be classified as a Diesel Emission Control
      Strategy fuel by the California Air Resources Board and registering the fuel
      with the EPA so that the emissions benefits can be quantified in their testing
      protocols are critical to our success. At this point, we are at an early stage
      so that it is not possible to predict when this work will be completed or if
      we
      will obtain the desired results once it is completed. We are also working with
      the military on a procurement specification for O2DieselTM alone or in
      combination with up to 20% biodiesel which should be completed this year. Based
      on the government funding in place, we believe that approximately 80% of the
      costs to conduct these tests and field demonstrations may be funded by
      appropriations from the U.S. Departments of Energy and Defense.





We
      have
      generated several successes in our fleet demonstration projects. These fleets
      are key to developing the no harm field experience necessary to demonstrate
      the
      commercial value of the fuel. Based upon its positive experience at Nellis
      Air
      Force base, the U.S. Air Force has expanded product demonstrations in Nevada
      to
      test O2DieselTM with 20% biodiesel in twice the number of non-tactical military
      vehicles that were used in the original test fleet. O2DieselTM is also conducting
      demonstrations with a number of school bus and transit agencies. In order to
      demonstrate the fuel’s capability in a broad array of conditions, O2DieselTM and
      O2DieselTM blended with up to 20% biodiesel are in fleets containing assorted
      engine types and uses and facing various weather conditions. We are continuing
      to refine our additive formulations in order to reduce their costs and increase
      their performance. In this regard, we have registered a second additive package
      with the Environmental Protection Agency that accomplishes both goals.
      Additionally we have formulated and field tested cold weather and detergent
      containing fuel formulations which are working as intended. We expect this
      work
      to continue in 2007 and 2008.





**Employees**





As
      of
      September 30, 2007, O2Diesel had fifteen full-time employees of which fourteen
      are in the U.S. and one is in Europe. We had one part-time employee. Currently,
      we rely on consultants to assist in commercializing our technology and to help
      us in key technical areas. At present, we employ seven consultants in the U.S.:
      three in marketing and business development; one laboratory technician, one
      chemist and two in regulatory affairs. The Company has entered into separate
      consulting contracts with two shareholders of its Brazilian subsidiary for
      the
      purpose of providing office rent and administrative services and in lieu of
      employment contracts with these two individuals. In Europe, we employ two
      consultants, one for general management and business development and one for
      regulatory affairs.





We
      will
      add new personnel in 2007 based on the pace of our commercialization. Under
      our
      business plan, we do not see the need to add employees in the U.S. or Brazil,
      but we do plan to add technical positions for our European market testing and
      development in 2007. We anticipate continuing to employ a total of eleven
      consultants serving in most of the same capacities in 2007.





8





**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**September
      30, 2007**





**ITEM
      3. CONTROLS AND PROCEDURES.**





EVALUATION
      OF DISCLOSURE CONTROLS AND PROCEDURES. O2Diesel's Chief Executive Officer and
      Chief Financial Officer have evaluated the effectiveness of O2Diesel's
      disclosure controls and procedures (as such term is defined in Rules13a-15
      and
      15d-15 under the Securities Exchange Act of 1934, as amended) as of the end
      of
      the period covered by this quarterly report (the “Evaluation Date”). Based on
      such evaluation, such officers have concluded that, as of the Evaluation Date,
      O2Diesel's disclosure controls and procedures are effective.





CHANGES
      IN INTERNAL CONTROLS OVER FINANCIAL REPORTING. During the most recent fiscal
      quarter, there have not been any changes in the Company's internal controls
      over
      financial reporting or in other factors that have materially affected, or are
      reasonably likely to materially affect internal controls over financial
      reporting.





**PART
      II. OTHER INFORMATION**




**ITEM
      1. LEGAL PROCEEDINGS.**





None.




**ITEM
      2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
      PROCEEDS.**





**Changes
      to Common Stock During the First Nine Months of 2007**





Pursuant
      to the $10.0 Million Private Placement transaction, the Company entered
      into a common stock purchase agreement (the “Purchase Agreement”) which allows
      the Company, at it’s discretion, to sell up to $10.0 million of the Company’s
      common stock from time to time over a twenty-five month period. The Company
      has reserved for issuance up to 12,000,000 shares of the Company’s common stock
      for sale under this Purchase Agreement. Subject to earlier termination at the
      Company’s discretion, Fusion Capital's purchases commenced after June 8,
      2007 when the SEC declared effective the registration statement related to
      the transaction. The Company issued 805,987 shares of the Company’s common stock
      as a commitment fee for entering into the Purchase Agreement. Fusion Capital
      is
      an “underwriter” within the meaning of the Securities Act.




During
        the quarter ended September 30, 2007, the Company did not execute any
        transactions under this agreement. During the nine months ended September
        30,
        2007, the Company executed five separate transactions under this agreement,
        selling a total of 970,994 shares of common stock at an average price of
        $0.515
        per share for total proceeds of $500,000





Between
      June 26, 2007 and July 16, 2007, the Company entered into Agreements with five
      European institutional and private investors for the sale of 6,123,346 shares
      of
      the Company’s common stock at a purchase price of approximately $0.41 per share
      in a private placement, for total proceeds of $2,517,710 before commissions.
      As
      a condition to the enforceability of these agreements against the Company,
      the
      investors were required to fund the purchase price in an escrow account, which
      funds were received between June 19, 2007 and July 31, 2007.





As
      part
      of the sale, the Company issued warrants to purchase 1,530,827 shares of common
      stock at an exercise price of $0.62 per share during the period of six months
      to
      sixty-six months subsequent to issuance. The warrants expire sixty-six months
      after the date of issuance.




The
        Company was obligated to file a registration statement with the SEC including
        the common stock and the shares issuable upon exercise of the warrants within
        90
        days of the closing date. A Form S-3 registration statement, including these
        shares and shares issuable upon exercise of the warrants, was filed by the
        Company on October 18, 2007 and declared effective by the SEC on October
        31,
        2007. All the costs and expenses incurred in connection with the registration
        of
        the common stock and warrants are paid by the Company. The Company closed
        this
        transaction on July 20, 2007 and August 20, 2007.





On
      July
      17, 2007, the Company repurchased 100,000 shares of its common stock for
      treasury for an aggregate purchase price of $40,100. The purchase price was
      $0.401 per share, which was the daily volume weighted average for the five
      trading days prior to the day the Company’s board of directors approved the
      repurchase.





**SUBSEQUENT
      CHANGES IN SECURITIES**





On
      October 17, 2007, the Company entered into a private financing agreement and
      a
      joint venture transaction with Energenics Holdings to provide funding and
      commercial support to develop the Asian market for O2DieselTM, the Company's
      ethanol diesel fuel blend.





The
      parties entered into a Common Stock and Warrant Purchase Agreement (the
“Energenics Agreement”) pursuant to which Energenics Holdings agreed to purchase
      2,551,020 shares of the Company's common stock in a private placement, for
      total
      proceeds of approximately $1.25 million. As part of the transaction, the Company
      agreed to issue a warrant to purchase 1,275,510 shares of common stock at an
      exercise price of $0.50 per share, which warrant will be issued upon the closing
      of the transactions contemplated by the Agreement and shall be exercisable
      from
      the date that is six months following the date of issuance until October 17,
      2012 (“Investment Warrant”).





The
      parties also entered into a Shareholders Agreement, in which Energenics Holdings
      and the Company will jointly develop the market for O2DieselTM in Asia through
      O2Diesel Asia Limited (“O2Diesel Asia”). Energenics Holdings agreed to pay the
      Company $750,000 for a fifty percent (50%) equity interest in O2Diesel Asia.
      The
      balance of the interest in O2Diesel Asia will be held by O2Diesel Europe
      Limited, a wholly-owned subsidiary of the Company. For the past year, pursuant
      to the Supply and Distribution Agreement, dated September 15, 2006, O2Diesel
      has
      supplied its additive to Energenics for the manufacture and distribution of
      O2DieselTM in the Asian Pacific and South Asia.





The
      parties also entered into a License agreement whereby O2DieselEurope Limited
      (formerly AAE Technologies International Plc) will license to O2Diesel Asia
      certain patents and know-how that are required to make and sell O2DieselTM in the
      territory in exchange for certain payments pursuant to the Shareholders
      Agreement. In addition, the Company entered into a similar License agreement
      with O2Diesel Asia pursuant to which the Company will pay to O2Diesel Asia
      a royalty based on sales of the Company's product in the territory.





As
      part
      of the transaction, upon the purchase of a certain quantity of O2D05 or the
      equivalent, the Company will also issue a warrant to purchase 1,500,000 shares
      of common stock at an exercise price of $0.50 per share, which warrant shall
      be
      exercisable during the period from the date of issuance until October 17,
      2012 (“JV Warrant”).




9





**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**September
      30, 2007**





Also,
      as
      part of the transaction, upon the achievement by Energenics Holdings of certain
      levels of additional purchases of O2D05 or the equivalent, the Company issued
      additional warrants to purchase up to an aggregate of 6,500,000 shares of common
      stock at a price per share equal to the lesser of $0.50 or 106% of the closing
      price per share (rounded to the nearest cent) of the Company's common stock
      on
      the American Stock Exchange on the date such warrants are earned (“Market
      Development Warrants,” and, collectively with the Investment Warrant and the JV
      Warrant, the “Warrants”). The Market Development Warrants are exercisable from
      the date of issuance to October 17, 2012.





The
      parties expect to close the transaction in the fourth
      quarter of 2007.





The
      common stock and the Warrants were issued to the accredited investor in a
      transaction that will be exempt from registration pursuant to Section 4(2)
      of
      the Securities Act and/or Regulation D promulgated under the Securities
      Act.




**ITEM
      3. DEFAULTS UPON SENIOR SECURITIES.**





Not
      applicable.




**ITEM
      4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.**





The
      Company's Annual Meeting of shareholders was held on September 20, 2007 in
      Montchanin, Delaware. Of the 83,915,341 shares of common stock outstanding
      as of
      the record date of August 16, 2007, 43,226,227 shares, or 51.5% of the Company's
      capital stock, were present or represented by proxy at the meeting, constituting
      a quorum.




The
      following proposals were approved by the shareholders:





1.
            Elect
                Mr. Alan Rae, and Mr. E. Holt Williams as Class C directors to hold
                office
                until the 2010 annual meeting of stockholders or until their respective
                successors are duly elected and
                qualified.




Votes
                Cast
            
            Rae
            
            WilliamsFor
            
            
            42,832,053
            
            
            42,870,307Against
            
            
            40,633
            
            
            2,379Abstain
            
            
            353,541
            
            
            353,541Not
                Voted
            
            
            -
            
            
            -Total
            
            
            43,226,227
            
            
            43,226,227





2.
            Ratify
                the appointment of Mayer Hoffman McCann P.C. to serve as the Company's
                independent registered public accounting firm for the fiscal year
                ending
                December 31, 2007.




AuditorVotes
                Cast
            
            AppointmentFor
            
            
            42,801,939Against
            
            
            251,442Abstain
            
            
            172,846Not
                Voted
            
            
            -Total
            
            
            43,226,227





**ITEM
      5. OTHER INFORMATION.**




*Election
      of Alan Rae as President*


On
      November 9, 2007, the Board of Directors of the Company appointed
      Mr. Rae as the President of the Company .





*Bylaws*


On
      November 9, 2007, the Board of Directors of the Company voted to amend Sections
      5.2, 5.4 and 5.5 of the Bylaws of the Company to allow for the issuance and
      transfer of uncertificated shares of the Company’s stock.  This amendment
      was adopted to allow the Company to participate in the Direct Registration
      System, which, effective January 1, 2008, will be required of all AMEX listed
      companies.  A copy of the Company’s amended Bylaws is attached hereto as
      Exhibit 3.1, and incorporated herein by reference.





10


**O2Diesel
      Corporation**


**(A
      Development Stage Company)**


**September
      30, 2007**





**ITEM
      6. EXHIBITS AND REPORTS ON FORM 8-K.**





The
      following exhibits are filed herewith.




ExhibitNumber
            
            Description3.1
            
            Amended
                  and Restated Bylaws (4)10.1
            
            Form
                of Common Stock and Warrant Purchase Agreement for $2.52 million
                private
                placement (1)10.2
            
            Form
                of Warrant for $2.52 million private placement (1)10.3
            
            Separation
                Agreement with Richard Roger* (2)10.4
            
            Employment
                Agreement with Richard Roger* (3)31.1
            
            Certification
                of the Chief Executive Officer pursuant to Rule 13a-14(a) or
                Rule 15d-14(a), as adopted pursuant to Section 302 of the
                Sarbanes-Oxley Act of 2002 (4)31.2
            
            Certification
                of the Chief Financial Officer pursuant to Rule 13a-14(a) or
                Rule 15d-14(a), as adopted pursuant to Section 302 of the
                Sarbanes-Oxley Act of 2002 (4)32.1
            
            Certification
                of the Chief Executive Officer and Chief Financial Officer pursuant
                to 18
                U.S.C. Section 1350, as adopted pursuant to Section 906 of the
                Sarbanes-Oxley Act of 2002 (4)








(1)
            Previously
                filed as an exhibit to the Company’s current report on Form 8-K/A on July
                20, 2007, and incorporated herein by reference.(2)
            Previously
                filed as an exhibit to the Company’s current report on Form 8-K on August
                3, 2007, and incorporated herein by reference.(3)
            Previously
                filed as an exhibit to the Company’s current report on Form 8-K on August
                3, 2005, and incorporated herein by reference.(4)
            Filed
                herewith.





* Indicates
      a management contract or compensatory plan.




11




**12. SIGNATURES**





Pursuant
      to the requirements of the Securities Exchange Act of 1934, as amended, the
      registrant has duly caused this report to be signed on its behalf by the
      undersigned hereunto duly authorized.


O2DIESEL
                CORPORATION
              (Registrant)Date:
                November 14, 2007
            By:
            /s/
                Alan RaeAlan
                RaeChief
                Executive Officer
              (Principal
                Executive Officer)





Date:
                November 14, 2007
            By:
            /s/
                David H. ShipmanDavid
                H. ShipmanChief
                Financial Officer
              (Principal
                Financial and Accounting
                Officer)







12