**UNITED
        STATES**
 **SECURITIES
        AND EXCHANGE COMMISSION**
 WASHINGTON,
        D.C. 20549
  **FORM
        10-QSB**
  (Mark
        One)
 x**QUARTERLY REPORT UNDER
        SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE** **ACT
        OF 1934**
  **FOR
        THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005**
  o**TRANSITION REPORT UNDER
        SECTION 13 OR 15(d) OF THE EXCHANGE ACT**
  For
        the
        transition period from ________________ to _______________
  000-51484
 (Commission
        file number)
  FORTUNE
        OIL & GAS INC.
 (Exact
        name of small business issuer as specified in its charter)
  NEVADA
                88-0393369(State
                    or other jurisdiction
                (IRS
                    Employerof
                    incorporation or organization)
                Identification
                    No.)
   **305-1676
        Martin Drive**
 **White
        Rock, British Columbia**
 **Canada
        V4A-6E7**
 (Address
        of principal executive offices)
 (604)
        531-0385
 (Issuer's
        telephone number, including area code)
  Check
        whether the issuer (1) filed all reports required to be filed by Section
        13 or
        15(d) of the 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
x
        No o
  The
        number of shares of common stock outstanding as of September 30, 2005 was 52,454,393.
   Transitional
        Small Business Disclosure Format (check one): Yes o No x
  The
        registrant is a shell copmany (check one): Yes o No x
  **Table
            of Contents**
 
 **FORTUNE
        OIL & GAS, INC.**
 Page
                    NumberPART
                      I. FINANCIAL INFORMATION
                  3Item
                      1. Interim Financial Statements
                  3Consolidated
                      Balance Sheet as of September 30, 2005 (unaudited)
                  3InterimConsolidated
                      Statements of Operations for the
                      three months and nine months ended September 30, 2005 and 2004
                      (unaudited)
                  4Interim
                      Consolidated Statement of Stockholders' Deficit for
                      the nine months ended September 30 , 2005 (unaudited)
                  5InterimConsolidated
                      Statements of Cash Flows for the
                      Nine months ended September 30, 2005 and 2004 (unaudited)
                  6Notes
                      to Interim Consolidated Financial Statements
                      (unaudited)
                  7Item
                      2. Management's Discussion and Analysis or Plan of
                      Operations
                  26Item
                      3. Controls and Procedures
                  45PART
                      II. OTHER INFORMATION
                  46Item
                      1. Legal Proceedings
                  46Item
                      2. Unregistered sales of Equity Securities and Use of
                      Proceeds
                  48Item
                    3. Defaults upon senior securities
                  48Item
                    5. Other Information
                  48Item
                      6. Exhibits
                  48SIGNATURES
                  49
 
 
 -2-
 **Table
            of Contents**
 
 **PART
        I**
 
 **FINANCIAL
        INFORMATION**
 
 **ITEM
        1 - FINANCIAL STATEMENTS**
 
 
 **FORTUNE
        OIL & GAS, INC.**
 **CONSOLIDATED
        BALANCE SHEET**
 **(UNAUDITED)**
 **September
                      30,**
                    **2005**
                  
                  **December
                      31,**
                    **2004****(Unaudited)****ASSETS****CURRENT
                      ASSETS**Cash
                      and cash equivalents
                  
                  $
                  6,905
                  
                  $
                  9,776Accounts
                      receivable
                  
                  
                  
                  
                  
                  –Taxes
                      receivable
                  
                  
                  2,678,629
                  
                  
                  3,135,471Joint
                      operating account
                  
                  
                  348,933
                  
                  
                  –Other
                      current assets
                  
                  
                  149,939
                  
                  
                  138,343Total
                      Current Assets
                  
                  
                  3,184,406
                  
                  
                  3,283,590**PROVEN
                      OIL AND GAS PROPERTIES, Net**
                  
                  
                  330,779
                  
                  
                  1,102,595**EQUIPMENT,
                      Net**
                  
                  
                  473,855
                  
                  
                  39,154**TOTAL
                      PROPERTY AND EQUIPMENT, Net**
                  
                  
                  804,634
                  
                  
                  1,141,749**RESTRICTED
                      CASH**
                  
                  
                  58,833
                  
                  
                  –**TOTAL
                      ASSETS**
                  
                  $
                  4,047,873
                  
                  $
                  4,425,339**LIABILITIES
                      AND STOCKHOLDERS’ DEFICIENCY****CURRENT
                      LIABILITIES**Accounts
                      payable and accrued liabilities
                  
                  $
                  5,598,126
                  
                  $
                  11,855,631Advances
                      payable to related parties
                  
                  
                  160,796
                  
                  
                  404,546Directors
                      fees payable
                  
                  
                  177,000
                  
                  
                  1,781,000Accrued
                      salaries and wages
                  
                  
                  177,473
                  
                  
                  464,775Short
                      term debt
                  
                  
                  5,120,496
                  
                  
                  6,522,603Taxes
                      payable
                  
                  
                  3,620,886
                  
                  
                  4,622,495Accrued
                      interest payable
                  
                  
                  932,331
                  
                  
                  1,277,725Total
                      Current Liabilities
                  
                  
                  15,787,108
                  
                  
                  26,928,775**STOCKHOLDERS’
                      DEFICIENCY**Common
                      stock, $0.001 par value, 100,000,000 authorized,52,454,393
                      at September 30, 2005 and 34,912,609 at December 31,2004
                  
                  
                  52,454
                  
                  
                  34,912Additional
                      paid-in capital
                  
                  
                  10,817,150
                  
                  
                  8,856,643Other
                      comprehensive loss
                  
                  
                  (28,019
                  )
                  
                  (24,250
                  )Accumulated
                      deficit
                  
                  
                  (22,580,820
                  )
                  
                  (31,370,741
                  )Total
                      Stockholder’s Deficiency
                  
                  
                  (11,739,235
                  )
                  
                  (22,503,436
                  )**TOTAL
                      LIABILITIES AND STOCKHOLDER’S****DEFICIENCY**
                  
                  $
                  4,047,873
                  
                  $
                  4,425,339
 The
        accompanying notes are an integral part of these accompanying interim financial
        statements
 
 
 -3-
 **Table
            of Contents**
 
 **FORTUNE
        OIL & GAS, INC.**
 **CONSOLIDATED
        STATEMENT OF OPERATIONS**
 **(UNAUDITED)**
 Three
                    months ended
                
                Nine
                    Months endedSeptember
                    30,
                  2005
                
                September
                    30,
                  2004
                
                September
                    30,
                  2005
                
                September
                    30,
                  2004**OIL
                    SALES**
                
                $
                –
                
                $
                –
                
                $
                –
                
                $
                3,069,747**EXPENSES**Production
                    Costs and taxes
                
                
                –
                
                
                64,944
                
                
                –
                
                
                3,085,952Depreciation
                    and depletion of oil and gas properties
                
                
                –
                
                
                29,838
                
                
                –
                
                
                340,738Total
                    Expenses
                
                
                –
                
                
                94,782
                
                
                –
                
                
                3,426,690**GROSS
                    LOSS**
                
                
                –
                
                
                (94,782
                )
                
                –
                
                
                (356,943
                )Selling,
                    general and administrative costs
                
                
                (616,963
                )
                
                (659,376
                )
                
                (2,860,030
                )
                
                (2,010,739
                )**LOSS
                    FROM OPERATIONS**
                
                
                (616,963
                )
                
                (754,158
                )
                
                (2,860,030
                )
                
                (2,367,682
                )Depreciation
                
                
                (27,886
                )
                
                –
                
                
                (81,428
                )Loss
                    on disposal of equipment
                
                
                –
                
                
                –
                
                
                –
                
                
                (765
                )Gain
                    on sale of oil rights
                
                
                –
                
                
                –
                
                
                9,712,950
                
                
                –Property
                    and equipment maintenance costs
                
                
                (191,942
                )
                
                –
                
                
                (554,398
                )
                
                –Gain
                    (loss) on settlement of vendor payables
                
                
                (10,679
                )
                
                –
                
                
                3,166,558
                
                
                –Foreign
                    exchange gain (loss)
                
                
                7,717
                
                
                (26,058
                )
                
                (85,241
                )
                
                (20,875
                )Legal
                    settlement costs
                
                
                (
                    90,000
                )
                
                –
                
                
                (
                    90,000
                )
                
                –Interest
                    Expense
                
                
                (295,675
                )
                
                (238,631
                )
                
                (418,490
                )
                
                (725,806
                )**NET
                    INCOME (LOSS) FOR THE PERIOD**
                
                $
                (1,225,428
                )
                $
                (1,018,847
                )
                $
                8,789,921
                
                $
                (3,115,128
                )**BASIC
                    NET INCOME (LOSS) PER****COMMON
                    SHARE**
                
                $
                (0.02
                )
                $
                (0.03
                )
                $
                0.21
                
                $
                (0.09
                )**DILUTED
                    INCOME (LOSS) PER****COMMON
                    SHARE**
                
                $
                (0.02
                )
                $
                (0.03
                )
                $
                0
                    .20
                
                $
                (0.09
                )**WEIGHTED
                    AVERAGE NUMBER OF****COMMON
                    SHARES OUTSTANDING****-
                    BASIC**
                
                
                52,454,393
                
                
                34,912,609
                
                
                41,038,688
                
                
                34,345,652**-
                    DILUTED**
                
                
                52,454,393
                
                
                34,912,609
                
                
                43,838,688
                
                
                34,345,652
 The
        accompanying notes are an integral part of these accompanying interim financial
        statements
 
 
 -4-
 **Table
            of Contents**
 
  **FORTUNE
        OIL & GAS, INC.**
 **CONSOLIDATED
        STATEMENT OF STOCKHOLDERS’
        EQUITY**
 FOR
        THE NINE MONTHS ENDED SEPTEMBER 30,
        2005
 **(UNAUDITED)**
 Common
                    Stock
                
                Additional
                
                OtherNumber
                    of
                
                
                
                Paid
                    In
                
                Comprehensive
                
                AccumulatedShares
                
                Amount
                
                Capital
                
                Loss
                
                Deficit
                
                TotalBalance
                    as of December 31, 2004
                
                
                34,912,609
                
                $
                34,912
                
                $
                8,856,643
                
                $
                (24,250
                )
                $
                (31,370,741
                )
                $
                (22,503,436
                )Stock
                    issued for payment of services
                
                
                50,000
                
                
                50
                
                
                4,950
                
                
                
                
                
                
                
                
                5,000Currency
                    translation adjustment
                
                
                
                
                
                
                
                
                
                
                
                (3,769
                )
                
                
                
                
                (3,769
                )Stock
                    issued in payment of director fees
                
                
                17,491,784
                
                
                17,492
                
                
                1,731,687
                
                
                
                
                
                
                
                
                1,749,179Stock
                    based compensation expense
                
                
                
                
                
                
                
                
                223,870
                
                
                
                
                
                
                
                
                223,870Net
                    income for the period
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                8,789,921
                
                
                8,789,921Balance
                    as of September 30, 2005
                
                
                52,454,393
                
                $
                52,454
                
                $
                10,817,150
                
                $
                (28,019
                )
                $
                (22,580,820
                )
                $
                (11,739,235
                )
 The
        accompanying notes are an integral part of these accompanying interim financial
        statements
   -5-
 **Table
            of Contents**
  **FORTUNE
        OIL & GAS, INC.**
 **CONSOLIDATED
        STATEMENT OF CASH FLOWS**
 **(UNAUDITED)**
 **Nine
                    Months**
                
                **Nine
                    Months****Ended**
                
                **Ended****September
                    30,**
                
                **September
                    30,****2005**
                
                **2004****CASH
                    FLOWS FROM OPERATIONS**Net
                    income (loss)
                
                $
                8,789,921
                
                $
                (3,115,128
                )Adjustments
                    to reconcile net income (loss) to net cash flowfrom
                    operating activities-
                    depreciation and depletion expense
                
                
                81,428
                
                
                340,738-
                    gain on settlement of vendor payables
                
                
                (3,166,558
                )-
                    stock issued in payment of interest
                
                
                
                
                
                119.988-
                    compensation expense - stock options
                
                
                223,870-
                    gain on sale of oil rights
                
                
                (9,712,950
                )-
                    legal settlement costs
                
                
                90,000Changes
                    in operating assets and liabilities, net of assets andand
                    liabilities acquired-
                    joint operating account
                
                
                (348,933
                )-
                    restricted cash
                
                
                (58,833
                )-
                    taxes receivable
                
                
                456,842
                
                
                (
                    16,950
                )-
                    other current assets
                
                
                (11,596
                )
                
                (65,497
                )-
                    accounts payable and accrued liabilities
                
                
                (3,175,948
                )
                
                430,576-
                    inventory
                
                
                
                
                
                1,403,552-
                    advances payable - related parties
                
                
                (243,750
                )
                
                (104,392
                )-
                    directors fees payable
                
                
                145,179
                
                
                531,000-
                    accrued salaries and wages
                
                
                (287,302
                )
                
                47,338-
                    taxes payable
                
                
                (1,001,609
                )
                
                (202,937
                )-accrued
                    interest payable
                
                
                (345,394
                )
                
                131,298**NET
                    CASH USED IN OPERATING ACTIVITIES**
                
                
                (8,565,633
                )
                
                (500,414
                )**CASH
                    FLOWS FROM INVESTING ACTIVITIES**Purchase
                    of property and equipment
                
                
                (531,362
                )
                
                (2,258
                )Proceeds
                    on sale of oil rights
                
                
                9,000,000**NET
                    CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES**
                
                
                8,468,638
                
                
                (2,258
                )**CASH
                    FLOWS FROM FINANCING ACTIVITIES**Short
                    term debt
                
                
                97,893
                
                
                491,014**NET
                    CASH PROVIDED BY FINANCING****ACTIVITIES**
                
                
                97,893
                
                
                491,014**EFFECTS
                    OF EXCHANGE RATE CHANGES**
                
                
                (3,769
                )
                
                7,745**INCREASE
                    (DECREASE) IN CASH**
                
                
                (2,870
                )
                
                (3,914
                )**CASH,
                    BEGINNING OF PERIOD**
                
                
                9,776
                
                
                12,037**CASH,
                    END OF PERIOD**
                
                $
                6,905
                
                $
                8,122**Supplemental
                    Disclosures with respect to cash flows-******Cash
                    paid for interest
                
                $
                498,586
                
                $
                –****Cash
                    paid for income taxes
                
                
                –
                
                
                –Cash
                    paid for other taxes
                
                $
                1,318,237
                
                $
                537,812
 The
        accompanying notes are an integral part of these accompanying interim financial
        statements
 
 -6-
 **Table
            of Contents**
  **FORTUNE
        OIL & GAS, INC.**
 **NOTES
        TO INTERIM CONSOLIDATED FINANCIAL
        STATEMENTS**
 SEPTEMBER
        30, 2005
 **(Unaudited)**
 
 **Note
        1 - Nature of Operations**
 
 Fortune
        Oil & Gas, Inc. (“Fortune”), a Nevada corporation, together with its
        subsidiaries, (the “Company”) is an independent energy company formed on January
        24, 1980 and is engaged in the exploration, development, exploitation and
        production of oil and natural gas. Its operations are focused in the North
        Java
        Sea, Indonesia. In May 2000, the Company acquired 100% of the issued and
        outstanding stock of Indo-Pacific Resources (JAVA) Ltd formerly GFB Resources
        (Java) Limited, an oil and gas exploration and production company which held
        a 100% interest in the Bawean Production Sharing Contracts (“Bawean PSC).
        The Bawean PSC covers two oil and gas blocks known as the Camar and Tuban
        fields. On January 14, 2005 the Company sold a 70% interest in the Bawean
        PSC to
        Camar Resources Canada Inc. (Refer Note 4). The Company is currently party
        to
        proceedings that may further dilute its interest in the Bawean PSC. (Refer
        note
        8).
 
 We
        operate our business through our wholly owned subsidiaries, Fortune Pacific
        Management Ltd., a British Columbia company (“FPM”), Fortune Ship Management
        Ltd., a Malta company (“FSM”) and Indo-Pacific Oil & Gas, Inc. a British
        West Indies company (“IPOG”) and through IPOG’s wholly owned subsidiary (our
        second tier subsidiary), Indo-Pacific Resources (JAVA) Ltd., a Barbados company
        (“IPR” or “IPRJ”) all of which we refer to collectively as “our subsidiaries”.
        The Company’s principal revenue producing asset is directly owned and operated
        by IPR. None of our other subsidiaries perform any operations that generate
        revenue.
 
 **Unaudited
        Interim Financial Statements**
 
 The
        accompanying unaudited interim financial statements have been prepared in
        accordance with United States generally accepted accounting principles for
        interim financial information and with the instructions to Form 10-QSB of
        Regulation S-B. They may not include all information and footnotes required
        by
        United States generally accepted accounting principles for complete financial
        statements. However, except as disclosed herein, there have been no material
        changes in the information disclosed in the notes to the financial statements
        for the period ended December 31, 2004 included in the Company’s Form 10-SB
        filed with the Securities and Exchange Commission. The interim unaudited
        financial statements should be read in conjunction with those financial
        statements included in the Form 10-SB. In the opinion of Management, all
        adjustments considered necessary for a fair presentation, consisting solely
        of
        normal recurring adjustments, have been made. Operating results for
        the nine months ended September 30, 2005 are not necessarily indicative
        of
        the results that may be expected for the year ending December 31,
        2005.
 
 **Note
        2 - Going Concern**
 
 These
        financial statements have been prepared on a going concern basis. However,
        the
        Company has suffered recurring operating losses and, during the three months
        ended September 30, 2005 and 2004, the Company incurred a net loss of
        $(1,225,428) and $(1,018,847),
        respectively. Although
        the Company realized non recurring gains on the sale of a 70% interest in
        its
        oil rights and settlement of vendor payables totaling $12,602,702 during
        the nine months ended September 30, 2005, the Company had a working capital
        deficiency of $12,543,868 and an accumulated deficit of
        ($22,580,820)  at
        September 30, 2005. During the nine months ended September 30, 2004, the
        Company
        had an operating loss of ($3,115,128), a working capital deficiency of
        $22,596,202 and an accumulated deficit of ($30,335,497). The Company requires
        additional capital to finance operations, current operating losses and to
        settle
        current debts in order to recommence oil production in Indonesia. The Company’s
        ability to continue as a going concern is dependent upon its ability to generate
        profitable operations in the future and/or to obtain the necessary financing
        to
        meet its obligations and repay its liabilities arising from normal business
        operations when they become due. The outcome of these matters cannot be
        predicted with any certainty at this time.
 
 On
        August
        26, 2005, the Company’s wholly owned subsidiary Indo-Pacific Resources (Java)
        Ltd. (“IPRJ”) filed a Request for Arbitration (the “Complaint”) against Camar
        Resources Canada Inc. (CRC), the operator and seventy percent owner of the
        Company’s oil and gas property at the Camar field, with the International Court
        of Arbitration (the “Court”) in Paris, France. IPRJ alleges CRC breached the
        Joint Operating Agreement (JOA), which regulates the operations of the Camar
        field, and also breached its
  -7-
 **Table
            of Contents**
  **FORTUNE
        OIL & GAS, INC.**
 **NOTES
        TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**
 SEPTEMBER
        30, 2005
 **(Unaudited)**
 
 fiduciary
        duty to IPRJ by failing to take all necessary acts to commence oil production
        in
        the Camar field. On October 7, 2005, CRC filed an Answer to IPRJ’s Request for
        Arbitration. CRC denies the breaches of the JOA alleged by IPRJ. In their
        Answer
        to IPRJ’s Request for Arbitration, CRC states that as operator under the JOA it
        is their duty to comply with laws of Indonesia. As part of such compliance,
        CRC
        should obtain
        approval from the government regulatory body overseeing the activities of
        the
        Oil and Gas industry of the budget and work program of the Camar field. CRC
        alleges that the government regulatory body has informed them it will not
        approve the budget and work program until such time as the Company has settled
        its various obligations to contractors and the Indonesian government. Without
        approval of the budget and work program, production at the Camar field would
        technically not be in compliance with Indonesian regulations. CRC alleges
        that
        if the Company does not satisfy its various debt obligations, the work approvals
        will not be issued. As a result, the Company may require additional capital,
        amounting to approximately $5 million, to settle current obligations, finance
        operations and current operating losses. The financing
        may be in the form of a sale of securities, the assumption of debt, or a
        combination thereof. In addition, the Company’s ability to continue as a going
        concern, in the long term, is dependent upon its ability
        to generate profitable operations. The outcome of these matters cannot be
        predicted with any certainty
        at this time.
 
 Since
        inception, the Company has satisfied its capital needs primarily by issuing
        equity securities, by incurring short and long term debt and the sale
        of a
        70% interest in its oil and gas property for $10.5 million. Management’s current
        plans are to ensure that sufficient capital will be available to provide
        for its
        capital needs with minimal borrowings and may issue equity securities to
        raise
        additional capital if available. However, there is no guarantee that the
        Company
        will be successful in obtaining sufficient capital through selling equity
        securities or other borrowings. All of the above raises substantial doubt
        as to
        the Company’s ability to continue as a going concern. These financial statements
        do not include any adjustments to the amounts and classification of assets
        and
        liabilities that may be necessary should the Company cease to continue operating
        as a going concern. See Note 8 - Subsequent Events.
 
 **Note
        3 - Summary of Significant Accounting Policies**
 
 **Principles
        of Consolidation**
 
 These
        consolidated financial statements are presented in accordance with generally
        accepted accounting principles in the United States. The consolidated financial
        statements include the accounts of the Company and its wholly owned subsidiaries
        (Fortune Pacific Management Ltd., Indo-Pacific Oil & Gas Inc., Fortune Ship
        Management Ltd., and Indo-Pacific Resources (Java) Ltd. (formerly GFB Resources
        (Java) Ltd.). All significant inter-company accounts and transactions are
        eliminated upon consolidation.
 
 **Estimates**
 
 The
        preparation of these consolidated financial statements requires the use of
        certain estimates by management in determining the Company's assets,
        liabilities, revenues and expenses. Actual results could differ from such
        estimates.
 
 Depreciation,
        depletion and amortization of oil and gas properties and the impairment of
        oil
        and gas properties are determined using estimates of oil and gas reserves.
        There
        are numerous uncertainties in estimating the quantity of reserves and in
        projecting the future rates of production and timing of development
        expenditures, including future costs to dismantle, dispose, and restore the
        Company's properties. Oil and gas reserve engineering must be recognized
        as a
        subjective process of estimating underground accumulations of oil and gas
        that
        cannot be measured in an exact way. Proved reserves of oil and natural gas
        are
        estimated quantities that geological and engineering data demonstrate with
        reasonable certainty to be recoverable in the future from known reservoirs
        under
        existing conditions.
 
 
 -8-
 **Table
            of Contents**
 
 **FORTUNE
        OIL & GAS, INC.**
 **NOTES
        TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**
 SEPTEMBER
        30, 2005
 **(Unaudited)**
 
 **Oil
        and Natural Gas Properties**
 
 Investments
        in oil and natural gas properties are accounted for using the full-cost method
        of accounting. All costs directly associated with the acquisition, exploration
        and development of oil and natural gas properties are capitalized. Such costs
        include lease acquisitions, seismic surveys, and drilling and completion
        equipment. Maintenance and repairs are expensed as incurred.
 
 Oil
        and
        natural gas property costs are depleted based on the unit-of-production method
        using estimates of proved reserve quantities. Investments in unproved properties
        are not amortized until proved reserves associated with the projects can
        be
        determined or until they are impaired. Unevaluated properties are assessed
        periodically for impairment on a country-by-country basis. If the results
        of an
        assessment indicate that
        the
        properties are impaired, the amount of the impairment is added to the proved
        oil
        and natural gas property
        costs to be amortized. The amortizable base includes estimated future
        development costs and dismantlement, restoration and abandonment costs, net
        of
        estimated salvage values. Depletion recorded in these financial statements
        is
        based upon a reserve report by Petroleum Geo-Services (UK) Ltd. dated March
        18,
        2005.
 
 Dispositions
        of oil and natural gas properties are accounted for as adjustments to
        capitalized costs with no gain or loss recognized, unless such adjustments
        would
        significantly alter the relationship between capitalized costs and proved
        reserves.
 
 The
        net
        capitalized costs of proved oil and natural gas properties are subject to
        a
“ceiling test” which limits such costs to the estimated present value,
        discounted at a 10% interest rate, of future net revenues from proved reserves,
        based on current economic and operating conditions. If net capitalized costs
        exceed this limit, the excess is charged to operations through depreciation
        and
        depletion. Because of the volatility of oil and natural gas prices, no assurance
        can be given that there will not be further write-down in future periods.
 
 **Oil
        and Natural Gas Reserve Estimates**
 
 Estimating
        quantities of proved reserves is a subjective process and involves estimating
        underground accumulations of hydrocarbons that cannot be measured in an exact
        manner. The reserve data included in these financial statements are estimates
        prepared by Petroleum Geo-Services (UK) Ltd. The process relies on
        interpretation of available geologic, geophysical, engineering and production
        data. The extent, quality and reliability of this data can vary. The process
        also requires certain economic assumptions regarding drilling and operating
        expenses, capital expenditures, taxes and availability of funds. The SEC
        mandates some of these assumptions, such as oil and natural gas prices and
        the
        present value discount rate.
 
 Proved
        reserve estimates prepared by others may be substantially higher or lower
        than
        the Company’s estimate. Because these estimates depend on many assumptions, all
        of which may differ from actual results, reserve quantities actually recovered
        may be significantly different than estimated. Material revisions to reserve
        estimates may be made depending on the results of drilling, testing, and
        rates
        of production.
 
 **Revenue
        recognition**
 
 Oil
        and
        natural gas revenues are recorded using the sales method, whereby the Company
        recognizes oil and natural gas revenue based on the amount of oil and gas
        sold
        to purchasers, when title passes, the amount is determinable, and collection
        is
        reasonably assured.
 
 **Inventory
        valuation**
 
 Oil
        inventories and material and supplies inventories are valued at the lower
        of
        average cost or net realizable value.
 
 -9-
 **Table
            of Contents**
  **FORTUNE
        OIL & GAS, INC.**
 **NOTES
        TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**
 SEPTEMBER
        30, 2005
 **(Unaudited)**
 
 **Cash
        and Cash Equivalents**
 
 For
        the
        purpose of the statements of cash flows, the Company considers all highly
        liquid
        investments purchased with original maturities of three months or less to
        be
        cash and cash equivalents.
 
 **Equipment**
 
 Equipment
        is stated at cost. For office furniture, equipment, computers and vehicles
        the
        Company provides for depreciation, in general, using the straight line method
        over the estimated useful lives of three to five years. Gains or losses on
        the
        sale of property and equipment are reflected in the statements of operations.
 
 **Impairment
        of Long-Lived Assets**
 
 Management
        evaluates long-lived assets for impairment whenever changes in circumstances
        indicate that the carrying value of an asset may not be recoverable. If the
        estimated future undiscounted cash flows from the use of an asset are less
        than
        the carrying value, impairment would be recorded to reduce the related asset
        to
        its estimated fair value.
 
 **Comprehensive
        Income**
 
 The
        Company utilizes SFAS NO. 130 “Reporting Comprehensive Income.” This statement
        establishes standards for reporting comprehensive income and its components
        in a
        financial statement. Comprehensive income as defined includes all changes
        in
        equity (net assets) during a period from non-owner sources. Examples of items
        to
        be included in comprehensive income, which are excluded from net income,
        include
        foreign currency translation adjustments, minimum pension liability adjustments,
        and unrealized gains and losses on available-for-sale securities.
 
 **Stock-Based
        Compensation**
 
 SFAS
        No.
        123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148,
“Accounting for Stock-Based Compensation - Transition and Disclosure,” defines a
        fair value based method of accounting for stock-based compensation. However,
        SFAS No. 123 allows an entity to continue to measure compensation cost related
        to stock and stock options issued to employees using the intrinsic method
        of
        accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25,
“Accounting for Stock Issued to Employees.” Entities electing to remain with the
        accounting method of APB No. 25 must make pro forma disclosures of net income
        and earnings per share as if the fair value method of accounting defined
        in SFAS
        No. 123 had been applied . The
        Company  has
        elected to account for its stock-based compensation to employees using the
        fair
        value method under SFAS No. 123. Due to the adoption of SFAS 123, no pro
        forma
        disclosures are presented as required by SFAS 148.
 
 Common
        stock issued for salaries and other services are recorded at the estimated
        fair
        value at the time of issuance.
 
 **Significant
        Customer**
 
 During
        the three and nine months ended September 30, 2005 and the three months ended
        September 30, 2004, the Company did not have any sales of oil. During the
        nine
        months ended September 30, 2004, sales to a Singaporean privately owned company
        accounted for 100% of revenues. The Company believes that there are numerous
        alternative buyers in the marketplace should this customer cease purchasing
        the
        Company’s oil.
 
 
 -10-
 **Table
            of Contents**
 
 **FORTUNE
        OIL & GAS, INC.**
 **NOTES
        TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**
 SEPTEMBER
        30, 2005
 **(Unaudited)**
 
 **Income
        Taxes**
 
 The
        Company accounts for income taxes under the liability method, which requires
        the
        recognition of deferred tax assets and liabilities for the expected future
        tax
        consequences of events that have been included in the financial statements
        or
        tax returns. Under this method, deferred income taxes are recognized for
        the tax
        consequences in future years of differences between the tax bases of assets
        and
        liabilities and their financial reporting amount at each period end based
        on
        enacted tax laws and statutory tax rates applicable
        to the periods in which the differences are expected to affect taxable income.
        Valuation allowances are established, when necessary, to reduce deferred
        tax
        assets to the amount expected to be realized.
 
 Significant
        components of the Company's United States provision for income taxes for
        the
        years ended December 31, 2004 and 2003 are:
 Three
                    Months Ended
                
                Nine
                    Months EndedSeptember
                    30,
                
                September
                    30,2005
                
                2004
                
                2005
                
                2004CurrentFederal
                
                $
                -0-
                
                $
                -0-
                
                $
                -0-
                
                $
                -0-DeferredFederal
                
                $
                -0-
                
                $
                -0-
                
                $
                -0-
                
                $
                -0-Provision
                    for Income Taxes
                
                $
                -0-
                
                $
                -0-
                
                $
                -0-
                
                $
                -0-
 
 For
        the
        three months ended September 30, 2005 and 2004, the Company incurred net
        losses
        of $1,225,428 and $1,018,847, respectively. For the nine months ended September
        30, 2005 and 2004, the Company had net income of $8,789,922 and net
        losses
        of $3,115,128, respectively.
 
 The
        Company is chartered in the State of Nevada which does not impose a State
        Income
        Tax. The Company does not engage in significant operation in North America.
        Currently its income from oil and gas operations will not be taxable
        by the
        Federal Government until the earnings are repatriated to North America.
 
 A
        reconciliation of the Company's United States expected income tax (benefit)
        computed using the federal statutory income tax rate to the Company’s effective
        income tax rate is as follows:
  Three
                    Months Ended
                
                Nine
                    Months EndedSeptember
                    30,
                
                September
                    30,2005
                
                2004
                
                2005
                
                2004Income
                    tax computed at the Federal Statutory rate
                
                
                34.0
                %
                
                34.0
                %
                
                34.0
                %
                
                34.0%-Changes
                    in valuation allowance
                
                
                (34.0
                )%
                
                (34.0
                )%
                
                (34.0
                )%
                
                (34.0
                )%Effective
                    Tax Rate
                
                
                0.0
                %
                
                0.0
                %
                
                0.0
                %
                
                0.0
                %
 
 
 -11-
 **Table
            of Contents**
  **FORTUNE
        OIL & GAS, INC.**
 **NOTES
        TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**
 SEPTEMBER
        30, 2005
 **(Unaudited)**
 
 
 Significant
        components of the Company’s deferred tax assets (liabilities) consist of the
        following:
 Nine
                    Months EndedSeptember
                    30, 2005
                
                December
                    31, 2004Net
                    operating loss carry forward
                
                $
                6,072,547
                
                $
                12,827,374Valuation
                    allowance
                
                $
                (6,072,547
                )
                $
                (12,827,374
                )Net
                    Deferred Tax Asset
                
                $
                -0-
                
                $
                -0-
 
 As
        of
        September 30, 2005, the Company has Net Operating Loss Carry forwards for
        federal income tax purposes of approximately $6,072,547, which expire through
        2019. The utilization of net operating loss carry forwards may be limited
        due to
        the ownership change under the provisions of the Internal Revenue Code Section
        382, or eliminated completely under Internal Revenue Code Section
        338.
 
 The
        entire deferred income tax assets of the Company have been offset by a valuation
        allowance since management does not believe the recoverability of the deferred
        income tax assets during the next year is more likely than not. In addition,
        due
        to the uncertainty of the Company to continue as a going concern, as discussed
        in Note 2, management believes that significant doubt exists as to the Company’s
        ability to realize any tangible value. Accordingly, a deferred income tax
        benefit for the period ending September 30, 2005 and the year ended December
        31,
        2004.
  **Risk
        Management**
 
 The
        Company is engaged in oil and gas production and manages related industry
        risk
        issues directly. The Company is at risk for environmental issues and
        fluctuations in commodity pricing. The Company is not exposed to significant
        credit concentration risk. The Company is not exposed to significant interest
        rate risk, hedging or other activities to manage this risk. The Company’s
        functional currency is the US dollar. All current oil production occurs within
        Indonesia and accordingly the Company is exposed to foreign exchange risk.
        The
        Company does not currently engage in derivatives.
 
 **Fair
        Value of Financial Instruments**
 
 The
        carrying value of cash, accounts receivable, joint operating account, other
        current assets, accounts payable and accrued liabilities, advances payable,
        director’s fees payable, accrued salary and wages, taxes payable, accrued
        interest payable and short term debt approximates their fair value because
        of
        the short maturity of these instruments. Unless otherwise noted, it is
        management’s opinion that the Company is not exposed to significant interest,
        currency or credit risks arising from these financial instruments.
 
 **Per
        Share Information**
 
 The
        Company presents basic earnings (loss) per share (“EPS”) and diluted EPS on the
        face of the statements of operations. Basic EPS is computed as net income
        (loss)
        divided by the weighted average number of common shares outstanding for the
        period. Diluted EPS reflects the potential dilution that could occur from
        common
        shares issuable through stock options, warrants, and other convertible
        securities which are exercisable during or after the reporting period. In
        the
        event of a net loss, such incremental shares are not included in EPS since
        their
        effects are anti-dilutive.
 
 -12-
 **Table
            of Contents**
 
 **FORTUNE
        OIL & GAS, INC.**
 **NOTES
        TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**
 SEPTEMBER
        30, 2005
 **(Unaudited)**
 
 
 The
        following table sets forth the computation of basic and diluted net income
        (loss) per share for the periods indicated:
 Three
                    months ended
                  September
                    30,
                
                Nine
                    months ended
                  September
                    30,2005
                
                2004
                
                2005
                
                2004Numerator:Net
                    Income (loss)
                
                $
                (1,225,428
                )
                $
                (1,018,847
                )
                $
                8,789,921
                
                $
                (3,115,128
                )Denominator:Denominator
                    for basic calculation weighted average shares
                
                
                52,454,393
                
                
                34,912,609
                
                
                41,038,688
                
                
                34,345,652Dilutive
                    common stock equivalents:Options
                
                
                
                
                
                
                
                
                2,800,000Denominator
                    for diluted calculation weighted average shares
                
                
                52,454,393
                
                
                34,912,609
                
                
                43,838,688
                
                
                34,345,652Net
                    income (loss) per share:Basic
                    net income (loss) per share
                
                $
                (0.02
                )
                $
                (0.03
                )
                $
                0.21
                
                $
                (0.09
                )Diluted
                    net income (loss) per share (1) (2)
                
                $
                (0.02
                )
                $
                (0.03
                )
                $
                0.20
                
                $
                (0.09
                )
 
 (1)
        The
        Company has issued stock for payment of debt and/or interest payments on
        short
        term debt during the nine months ended September 30, 2004. The effect of
        the
        issuances of shares was anti-dilutive. However, in the nine months ended
        September 30, 2005, the Company issued 17,491,784 shares of common stock
        to
        Messrs. Wensveen and Nunn, Chief Executive Office and President, respectively,
        for payment of accrued board of director fees. The effect of such issuances
        has
        been accounted for in the Basic and Diluted net income per share above. However,
        if the shares were treated as though they were issued as of the beginning
        of the
        nine months ending September 30, 2005, the diluted net income per share would
        have been $0.16 per share and the denominator for the dilutive calculation
        weighted average shares would have been 55,254,393.
 
 (2)
        The
        Company has secured the services of a law firm to assist them with the SEC
        filing requirements and, in payment thereof, has agreed to pay the firm a
        cash
        fee plus 1,000,000 shares of common stock with an effective date of July
        9,
        2004. Such payment will be made when the Company becomes trading on the OTCBB.
        If the shares were treated as though they were issued as of July 9, 2004,
        the
        Denominator would have been 38,825,652  for
        the
        three months ended September 30, 2004  and
        34,651,107  for
        the
        nine months ended September 30,  2004
        and
        they would have been anti-dilutive during the three months and nine months
        ended
        September 30, 2004. However, if the shares were treated as though they were
        issued as of the beginning of the periods for the three months and nine months
        ending September 30, 2005 the diluted net income per share would have been
        $(0.02) for the three months ended September 30, 2005 and $0.20 for the nine
        months ended September 30, 2005 and the denominator for the dilutive calculation
        weighted average shares would have been 56,254,393  for
        the
        three months ended September 30, 2005 and  44,838,688  for
        the
        nine months ended September 30, 2005.
 
 
 
 -13-
 **Table
            of Contents**
 
 **FORTUNE
        OIL & GAS, INC.**
 **NOTES
        TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**
 SEPTEMBER
        30, 2005
 **(Unaudited)**
 
 (3)
        If
        both (1) and (2) were considered issued as of the beginning of the three
        months
        and nine months ending September 30, 2005, the Dilutive net income per share
        would have been $(0.02) and $0.16, respectively and the denominator for the
        dilutive calculation weighted average shares would have been 53,454,393 and
        56,254,393 respectively.
  **Recent
        Accounting Pronouncements**
  In
        March
        2004, the FASB issued EITF No. 03-1, *The
        Meaning of Other-Than-Temporary Impairment and Its Application to Certain
        Investments* (“EITF
        03-1”). The objective of EITF 03-1 is to provide guidance for identifying
        impaired investments. EITF 03-1 also provides new disclosure requirements
        for
        investments that are deemed to be temporarily impaired. In October 2004,
        the
        FASB delayed the recognition and measurement provisions of EITF 03-1 until
        implementation guidance is issued. The disclosure requirements are effective
        for
        annual periods ending after June 15, 2004, and remain in effect. Management
        believes that the adoption of EITF 03-1 did not have a material impact on
        the
        Company’s financial condition or results of operations.
 
 In
        November 2004, the FASB issued SFAS No. 151, "Inventory Costs". SFAS 151
        amends
        the accounting for abnormal amounts of idle facility expense, freight, handling
        costs, and wasted material (spoilage) under the guidance in APB Opinion No.
        43,
        Chapter 4, "Inventory Pricing". Paragraph 5 of APB 43, Chapter 4, previously
        stated that ". . . under some circumstances, items such as idle facility
        expense, excessive spoilage, double freight, and rehandling costs may be
        so
        abnormal as to require treatment as current period charges. . . ." SFAS 151
        requires that those items be recognized as current-period charges regardless
        of
        whether they meet the criterion of "so abnormal". In addition, SFAS 151 requires
        that allocation of fixed production overheads to the costs of conversion
        be
        based on the normal capacity of the production facilities. This statement
        is
        effective for inventory costs incurred during fiscal years beginning after
        June
        15, 2005. Management does not expect adoption of SFAS 151 to have a material
        impact on the Company's financial statements.
 
 In
        December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets",
        and an amendment to APB Opinion No. 29, "Accounting for Nonmonetary
        Transactions". SFAS 153 eliminates certain differences in the guidance in
        APB 29
        as compared to the guidance contained in standards issued by the International
        Accounting Standards Board. The amendment to APB 29 eliminates the fair value
        exception for nonmonetary exchanges of similar productive assets and replaces
        it
        with a general exception for exchanges of nonmonetary assets that do not
        have
        commercial substance. Such an exchange has commercial substance if the future
        cash flows of the entity are expected to change significantly as a result
        of the
        exchange. SFAS 153 is effective for nonmonetary asset exchanges occurring
        in
        periods beginning after June 15, 2005. Earlier application is permitted for
        nonmonetary asset exchanges occurring in periods beginning after December
        16,
        2004. The adoption of FASB No. 153 did not have a material impact
        on
        the Company's financial statements.
 
 In
        December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment". SFAS
        123(R) amends SFAS 123 and APB 25. SFAS 123(R) requires that the cost of
        share-based payment transactions (including those with employees and
        non-employees) be recognized in the financial statements. SFAS 123(R) applies
        to
        all share-based payment transactions in which an entity acquires goods or
        services by issuing (or offering to issue) its shares, share options, or
        other
        equity instruments (except for those held by an ESOP) or by incurring
        liabilities (1) in amounts based (even in part) on the price of the entity's
        shares or other equity instruments, or (2) that require (or may require)
        settlement by the issuance of an entity's shares or other equity instruments.
        This statement is effective (1) for public companies qualifying as
        SEC
        small business issuers, as of the first interim period or fiscal year beginning
        after December 15, 2005, or (2) for all other public companies, as of the
        first
        interim period or fiscal year beginning after June 15, 2005, or (3) for all
 
 
 
 -14-
 **Table
            of Contents**
 **FORTUNE
        OIL & GAS, INC.**
 **NOTES
        TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**
 SEPTEMBER
        30, 2005
 **(Unaudited)**
 
 nonpublic
        entities, as of the first fiscal year beginning after December 15, 2005.
        Management intends to adopt
        this policy for the quarter ending March 31, 2006. Management is currently
        assessing the effect of SFAS 123(R) on the Company's financial statements.
 
 **Note
        4 - Sale of Oil Rights**
 
 On
        November 26, 2004, IPR entered into an Asset Purchase and Sale Agreement
        with
        CRC, for the sale of a 70% interest in the Bawean PSC dated February 12,
        1981
        rights in exchange for $10,500,000 as follows:
 
 ·
              $1,500,000
                  advance payment·
              $1,000,000
                  to be deposited in a Joint Operating Account·
              $4,500,000
                  to be deposited in a Trade Debt Settlement Account·
              $3,500,000
                  directly to the Company
 
 The
        required advance payments were made on November 19, 2003 and February 4,
        2004 in
        the amounts of $1,000,000 and $500,000 respectively. These payments were
        treated
        as short term debt pending the closing of the agreement and were secured
        by (i)
        inventory and equipment, (ii) a continuing right to all crude entitlements,
        and
        (iii) the 70% interest in the Bawean PSC noted in the Asset Purchase and
        Sale
        Agreement. The security interest was to be released upon repayment of the
        advance or execution of the Asset Purchase and Sale Agreement.
 
 The
        agreement completed on January 14, 2005 at which time the remaining $9,000,000
        was paid to the Company and the advance payments of $1,500,000 were applied
        to
        the purchase price.
 
 The
        properties sold had a net book value of $1,102,595 at December 31, 2004 and,
        at
        closing (January 14, 2005), the Company recorded a gain on the sale of
        $ 9,712,950.
        The Agreement called for the settlement of debts of the Company amounting
        to
        $9,862,622, and required that $4.5 million of the total purchase price of
        $10.5
        million be set aside for the purpose of settled amounts.
 
 Under
        the
        terms of the Asset Purchase and Sale Agreement, the Company agreed to endeavor
        to negotiate the settlement of outstanding trade debt with creditors, less
        the
        amount owed to the Indonesian Government for Value Added Tax (“VAT”), to an
        amount approximating the $4.5 million which has been deposited in a Trade
        Debt
        Settlement Account. The trade debt is unsecured obligations of the Company
        and
        do not encumber the assets of the Company or the Asset Purchase and Sale
        Agreement. As of December 31, 2004, the total amount owing for such debts
        was
        $9,826,622. If, after six months from the date of the Agreement, there remains
        a
        debt balance, the Company has the option of either paying off the remaining
        debt
        balance or having CRC pay off the remaining balance on behalf of the Company.
        If
        CRC pays off the remaining owing balances, IPR’s interest in the PSC will be
        reduced by one percentage point for every $150,000 remaining owing and paid
        by
        CRC, and such reduced interest will be transferred to CRC. If IPR’s interest is
        reduced to 5%, the maximum reduction per the Agreement, IPR shall have no
        obligation to fund future operations but shall be entitled to retain its
        5%
        ownership. CRC shall continue to have the right to recover the remaining
        debt
        balance paid on behalf of IPR. To September 30, 2005, CRC paid $1,122,580
        in settlement of the Company’s debts in terms of the Asset Purchase and Sale
        Agreement. See Note 8 - Subsequent Events.
 
 Pursuant
        to the Asset Purchase and Sale Agreement, CRC is required to pay the VAT
        amount
        owed to the Indonesian government in the amount of $2,808,448 at December
        31,
        2004 excluding any VAT receivable and all interest expense accrued on late
        payments, and IPR shall reimburse CRC for such payment within 6 months, from
        the
        date on which CRC paid the VAT, plus interest at 1.5% per month. Finally,
        if
        there is a judgment against IPR in the Enterprise lawsuit (see Note 6 -
        Litigation) in excess of $2,550,000, then IPR shall transfer to CRC percentage
        interests in the PSC accordance with the same formula stated above for trade
        debt settlement. At September 30, 2005, CRC, in accordance with the Asset
        Purchase and Sale Agreement, paid $1,142,159 of VAT taxes owed to the Indonesian
        government. (See Note 5 - Composition of Certain Financial Statement Captions,
        Note 5 - Litigation and Note 8 - Subsequent Events.)
 
 -15-
 **Table
            of Contents**
  **FORTUNE
        OIL & GAS, INC.**
 **NOTES
        TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**
 SEPTEMBER
        30, 2005
 **(Unaudited)**
 
 In
        addition to the Asset Purchase and Sale Agreement, the Company also entered
        into
        a Joint Operating Agreement ("JOA"). The purpose of the Joint Operating
        Agreement was to establish the rights and obligations of the parties with
        regard
        to operating activities including joint exploration, appraisal, development,
        production and disposition of hydrocarbons in the PSC. The parties to the
        agreement have the following percentage rights of net proceeds and expenses
        and
        liabilities: CRC - 70%; IPR - 30%, upon signing subject to the dilution clause
        discussed above. CRC is to act in the position of Operator of the project
        and
        shall be reimbursed by the Company for their proportionate share of expenses
        necessary to run the operations. As required by the Asset Purchase and Sale
        Agreement, $1.0 million of the gross sales price of $10.5 million was deposited
        directly into the Joint Operating Account as the Company’s proportional share of
        anticipated future operating costs of the Operator. The funds deposited in
        the
        Joint Operating Account are to be used by the Operator as the Company’s 30%
        ownership of operating expenses whereas the remaining 70% of operating expenses
        is to be paid by CRC as their share of operating expenses. The Joint Operations
        Account is replenished through quarterly cash-calls by the Operator of the
        Bawean PSC to the Joint Venture Partners. Should CRC elect to resign as
        Operator, it must give a 120 day notice; however, should CRC become insolvent
        or
        bankrupt it may be removed immediately.
 
 At
        September 30, 2005, the Company had a balance of $348,933  in
        the
        Joint Operating Account representing the unutilized portion of the $1.0 million
        sales proceeds deposited in this account and a balance of $58,833 in the
        Trade
        Debt Settlement Account representing the unutilized portion of the $4.5 million
        deposited in this account. The amount remaining in the Trade Debt Settlement
        Account has been recorded as Restricted Cash in the accompanying Balance
        Sheet.
 
 Should
        either party default from paying its share of the joint expenses, the
        non-defaulting party shall issue a Notice of Default in which the defaulting
        party shall have 5 days to cure the default. During the defaulting period,
        the
        defaulting party shall not be entitled to a right of Entitlement (quantity
        of
        hydrocarbons). The Operator can sell the entitlements and, after deducting
        expenses, pay the net proceeds to the non-defaulting party in proportion
        to the
        amounts they are owed by the defaulting party and apply any other proceeds
        to
        the establishment of a Reserve Fund. If the default is not cured within 30
        days
        of the Default Notice, the non-defaulting party may require the defaulting
        party
        to terminate the Agreement. If executed, the defaulting party’s interest shall
        be transferred to the non-defaulting party.
 
 If
        either
        party has a Change in Control (any direct or indirect change in control of
        a
        Party whether through merger, sale of shares or other equity interests) the
        non-acquired party shall have the right to acquire the other party’s
        participating interest as follows:
  ·
              The
                  acquired party shall determine and give the non-acquired party
                  a Notice of
                  Cash Value which
                represents
                  what the acquired party believes its participating interest is
                  worth.
 
 ·
              If
                  the parties cannot agree on a Cash Value within 15 days of the
                  Notice,
                  then the valuation shall be
                submitted
                  to an independent third party. If the independent third party’s valuation
                  is 5% or less than
                the
                  acquired party’s Cash Value, then the acquired party’s valuation shall be
                  accepted. If the independent
                third
                  party’s valuation is greater than 5% of the acquired party’s Cash Value,
                  then the independent
                party’s
                  valuation shall be accepted.
 
 Either
        Party has the right to withdraw from the Joint Operating Agreement. However,
        if
        so, the withdrawing Party may continue to be liable for certain expenses.
 
 
 -16-
 **Table
            of Contents**
 
 **FORTUNE
        OIL & GAS, INC.**
 **NOTES
        TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**
 SEPTEMBER
        30, 2005
 **(Unaudited)**
 
 **Note
        5 - Composition of Certain Financial Statement Captions**
 
 **Property
        and Equipment**
 
 Property
        and equipment consist of the following:
 September
                    30,
                  2005
                
                December
                    31,
                  2004Proven
                    oil and natural gas properties at cost, subject to depreciation
                    and
                    depletion
                
                $
                3,182,180
                
                $
                10,607,268Accumulated
                    depreciation and depletion
                
                
                (2,851,401
                )
                
                (9,504,673
                )Net
                
                $
                330,779
                
                $
                1,102,595Equipment
                
                $
                606,394
                
                $
                117,455Accumulated
                    depreciation
                
                
                (132,539
                )
                
                (78,301
                )Net
                
                $
                473,855
                
                $
                39,154Total
                    Property and equipment, net
                
                $
                804,634
                
                $
                1,141,749
 Equipment
        with a net book value of $429,146 at September 30, 2005 is held as assets
        for
        sale.
 
 **Accounts
        Payable and Accrued Liabilities**
 The
        Company’s accounts payable and accrued liabilities consisted of the following
        major payables:
 Vendor
                    name
                
                September
                    30,
                  2005
                
                December
                    31,
                  2004Haliburton
                    Services PT
                
                $
                –
                
                $
                1,055,012Patra
                    Drilling Contractor
                
                
                3,297,855
                
                
                3,297,855Prosafe
                    Production Services Pte. Ltd
                
                
                –
                
                
                1,581,387Others
                    under 10% of total
                
                
                2,300,271
                
                
                5,921,377Total
                    Accounts Payable and accrued liabilities
                
                $
                5,598,126
                
                $
                11,855,631
 
 The
        gain
        on the settlement of trade payables at less than recorded values results
        from
        negotiations with various unsecured creditors for the settlement and payment
        of
        the amounts owed at amounts less than that of the recorded liability. As
        of
        September 30, 2005, the Company settled the following debts:
 
 Vendor
                
                As
                    of
                  September
                    30, 2005
                
                As
                    of
                  December
                    31, 2004
                
                Payments
                  in
                    Cash
                
                Forgiveness
                    of Debt
                
                Increase
                    in PayablesHaliburton
                    Services PT
                
                $
                –
                
                $
                1,055,012
                
                $
                158,252
                
                $
                896,760
                
                $
                –Patra
                    Drilling Contractor
                
                
                3,297,855
                
                
                3,297,855
                
                
                –
                
                
                –
                
                
                –Prosafe
                    Production Services Pte. Ltd
                
                
                –
                
                
                1,581,388
                
                
                385,337
                
                
                1,196,051
                
                
                –Other
                    vendors (1)
                
                
                2,300,271
                
                
                5,921,376
                
                
                4,560,529
                
                
                1,073,747
                
                $
                2,013,171Total
                
                $
                5,598,126
                
                $
                11,855,631
                
                $
                5,104,118
                
                $
                3,166,558
                
                $
                2,013,171
 
 (1)
              Vendors
                  listed include those with a balance of 10% or greater of total
                  accounts
                  payable and accrued liabilities as of December 31,
                  2004.
 
 -17-
 **Table
            of Contents**
  **FORTUNE
        OIL & GAS, INC.**
 **NOTES
        TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**
 SEPTEMBER
        30, 2005
 **(Unaudited)**
 
 On
        August
        20, 2005, CRC, on behalf of the Company, paid $1,122,580 of vendor debts.
        The
        amount paid by CRC is included in short term debt as of September 30, 2005.
        The
        Company is continuing to negotiate and settle any debts that have not been
        settled as of September 30, 2005 with the anticipation that all negotiations
        will be completed by the end of the calendar year.
 
 During
        the period from January 14, 2005 through September 30, 2005, the Company
        negotiated the settlement of certain of its debts. As of September 30, 2005,
        the
        Company has settled approximately $6,126,000 of debts as of December 31,
        2004 in
        consideration of $2,959,000 of cash, which resulted in a gain of approximately
        $3,167,000. See Note 8 - Subsequent Events.
  **Taxes
        Payable**
 
 ***Value
        Added Taxes***
 
 Value
        Added Tax (“VAT”) is a tax assessed on certain products and services sold or
        purchased within Indonesia. The seller of the products assesses the tax against
        the buyer, collects the tax and remits it to the government. However, because
        the buyer of all of the petroleum of IPR is either the Government of Indonesia
        or State allowed companies, VAT is not calculated and included in the selling
        price of the petroleum. The Company, however, has recorded both the payable
        in
        respect of sales and the receivable in respect of purchases, as required
        by
        current Indonesian law. As a result, there remains at any time, a receivable
        and
        a payable of VAT. This law was changed in January 2004 eliminating the need
        to
        withhold any further VAT. Additionally, the law allows for the payment of
        a 2%
        per month interest factor on any accrued but unpaid VAT. Such interest is
        accrued for a period of two years after which no further interest is accrued.
        The VAT payable, receivable, interest and net VAT payable is as follows:
 As
                    at,
                  
                  VAT
                    Receivable
                  
                  VAT
                    Payable
                  
                  Accrued
                    InterestSeptember
                      30. 2005
                  
                  $
                  2,678,629
                  
                  $
                  1,196,729
                  
                  $
                  1,186,707December
                      31, 2004
                  
                  $
                  3,135,471
                  
                  $
                  2,808,448
                  
                  $
                  1,306,447
 
 Pursuant
        to the Asset Purchase and Sale Agreement, CRC is required to pay the VAT
        amount
        owed to the Indonesian government in the amount of $2,808,448 as of December
        31,
        2004, such amount excluding any VAT receivable and all interest expense accrued
        on late payments, and IPR shall reimburse CRC for such payment within 6 months
        from the date on which CRC paid the VAT, plus interest at 1.5% per month.
        The
        Company anticipates repaying CRC for the payment of the VAT, less related
        interest and penalties, from the VAT receivable of $2,678,629 at September
        30,
        2005 which becomes due and payable from the Republic of Indonesia upon the
        payment, in full, of the VAT payable. On the September 26, 2005, CRC
        paid
        the Indonesian government $1,142,159 of VAT payable. See Note 6 -
        Litigation and Note 8 - Subsequent Events.
 
 
 
 -18-
 **Table
            of Contents**
 
 **FORTUNE
        OIL & GAS, INC.**
 **NOTES
        TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**
 SEPTEMBER
        30, 2005
 **(Unaudited)**
  ***Income
        Withholding Taxes***
 
 Indonesia
        law requires companies to withhold a portion of the payments due to vendors
        for
        purchases and services for potential corporate income taxes that the vendor
        may
        owe the government. The withheld taxes are to be remitted to the government
        authorities. Remittance of withheld taxes, unless paid on a timely basis,
        is
        interest bearing to the entity collecting the taxes. The amount owing for
        taxes
        due at December 31, 2004 was paid in full during the nine month ended September
        30, 2005 and the remaining amount of $8,857 represents the current balance
        due
        for 2005 taxes.
 
 The
        withheld tax and related interest are as follows:
  As
                    at
                
                Taxes
                  Payable
                
                Accrued
                  InterestSeptember
                    30, 2005
                
                $
                8,857
                
                $
                1,228,594December
                    31, 2004
                
                $
                176,078
                
                $
                331,523
 
 **Short
        term debt**
 
 Short-term
        debt consisted of the following:
 
 September
                  30,
                2005
              
              December
                  31,
                2004Unsecured:Unsecured
                  short term loans
              
              $
              –
              
              $
              1,150,076Unsecured,
                  non interest bearing loans
              
              
              316,018
              
              
              188,220Secured:Canadian
                  Imperial Bank of Commerce
              
              
              –
              
              
              933,750RBM
                  Financial
              
              
              –
              
              
              210,820NOWMCO
              
              
              2,539,737
              
              
              2,539,737CRC
              
              
              2,264,741
              
              
              1,500,000Total short-term debt
              
              $
              5,120,496
              
              $
              6,522,603
 
 **Unsecured
        short term loans**
 
 Since
        the
        end of the calendar year December 31, 2000, various companies and individuals
        had advanced the Company short term funds which were used to finance operations.
        These loans bear interest at current market rates, as applicable to the Company,
        and are payable on demand. The loans were repaid on January 14,
        2005.
 
 **Unsecured
        non interest bearing loans**
 
 Since
        the
        end of calendar year ending December 31, 2000 through December 31, 2004,
        two
        related entities had advanced the Company short term funds which totaled
        $188,220 as of December 31, 2004 and $316,018 at September 30, 2005. There
        are
        no formal arrangements for repayment and no interest expense has been accrued
        for the loans. The loans were repaid on January 14, 2005.
 
 **Canadian
        Imperial Bank of Commerce (CIBC)**
 
 On
        May
        23, 2000, the Company borrowed $1,500,000, consisting of seventeen promissory
        notes, from CIBC for the purchase of GFB Resources (Java) Ltd. The notes
        were
        secured by a pledge of the shares in IPR. The notes bore interest at 6% per
        annum. The first note of $250,000 was due the earlier of five months after
        the
        start of production in the Camar field or eight months from the date
  -19-
 **Table
            of Contents**
  **FORTUNE
        OIL & GAS, INC.**
 **NOTES
        TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**
 SEPTEMBER
        30, 2005
 **(Unaudited)**
 
 of
        the
        agreement. Notes two to seventeen of $78,125 each become payable, at monthly
        intervals, starting the earlier of nine months after the start of production
        in
        the Camar field or twelve months from the date of the agreement. At December
        31,
        2004, the Company was in default on the CIBC loan and consequently the loan
        was
        classified as a current liability. The loan was repaid in full on January
        14,
        2005 and the security was discharged.
  **RBM
        Financial Inc. (“RBM”)**
 
 Between
        December 30, 2000 and February 21, 2001, the Company borrowed $620,000 from
        RBM.
        Since the date of the loans but prior to January 31, 2004, the Company made
        payments in the amount of $260,000 leaving a balance owed at January 31,
        2004 of
        $360,000 plus accrued interest of $111,600, for a total amount of $471,600.
        On
        June 30, 2004, the Company made a payment of $25,000 and on July 8, 2004,
        the
        Company made a payment of $150,000 leaving a balance at December 31, 2004
        of
        $226,000, inclusive of $15,180 of accrued interest. On December 30, 2004,
        RBM
        obtained an order for payment of $550,000 (Canadian) or $401,000 (US) which
        included the two payments totaling $175,000 made in 2004. The final payment
        of
        $236,000, pursuant to the order, was made on January 14, 2005.
  **NOWMCO
        Debt**
  On
        February 11, 2002 the Company and its wholly owned subsidiaries FSL and IPR
        entered into a $3,000,000 debt financing with National Oil Well Maintenance
        (NOWMCO) for the purpose of providing financing for the purchase and
        retrofitting of a vessel.
 
 The
        financing came in two deposits; $530,000 made on February 11, 2002 and
        $2,470,000 made on February 15, 2002. In addition, a related entity of NOWMCO
        advanced the Company $250,000 on July 17, 2002. As evidence of the debt,
        two
        promissory notes for $1,500,000 each were executed.
 
 Additionally,
        IPR granted NOWMCO a right of first refusal to provide IPR a program of
        analysis, remediation, production maximization and future development for
        IPR’s
        Camar Field Operation. In exchange for the right of first refusal, NOWMCO
        provided an additional $1,200,000 of debt financing. Gross funds of $1,200,000,
        less legal expenses amounting to $66,519 were received on June 6, 2002. As
        evidence of this debt, a promissory note for $1,200,000 was executed.
 
 The
        promissory notes were secured by 5,000,000 treasury shares of the Company’s
        common stock. Upon full payment of principal and interest of Promissory Note
        1,
        the common stock was to be released as security. Upon payment of Promissory
        Note
        2, NOWMCO was to deliver a registerable discharge of the Vessel Mortgage.
        The
        promissory notes were to be repaid based on IPR oil sales at the rate of
        $2.00
        for every barrel of the Camar Crude Oil sold plus an amount equal to the
        Discount Price defined as the prevailing market price less $2.00 per barrel.
        The
        5,000,000 treasury shares were never issued by the Company, but rather were
        secured by a Treasury Order dated February 11, 2002, which was irrevocable
        until
        the agreement was settled in accordance with the promissory note, or at its
        expiration date of December 31, 2003, which ever occurs first. The treasury
        order expired on December 31, 2003.
 
 On
        July
        11, 2002, NOWMCO assigned it rights under the Loan Agreement, including the
        irrevocable Treasury Order, to Enterprise Trading Limited. No payments were
        made
        against the outstanding loan nor were any demands made upon the Treasury
        Order.
        On August 19, 2004, Enterprise foreclosed on the loan and took ownership
        of the
        vessel.
 
 The
        Company recorded the net book value of the vessel, $1,910,262, as a reduction
        in
        the loan payable. The Company is currently in legal proceedings with NOWMCO.
        See
        Note 6 - Litigation.
 
 
 -20-
 **Table
            of Contents**
 
 **FORTUNE
        OIL & GAS, INC.**
 **NOTES
        TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**
 SEPTEMBER
        30, 2005
 **(Unaudited)**
 **CRC**
 
 In
        anticipation of an agreement between CRC and the Company (See Note 4) for
        the
        sale of a 70% interest in the oil rights of the Bawean PSC, CRC made two
        advance
        payments to the Company; $1,000,000 on November 19, 2003 and $500,000 on
        February 4, 2004. The advances were secured by (i) inventory and equipment,
        (ii)
        a continuing right to all crude entitlements, and (iii) the 70% interest
        in the
        Bawean PSC referenced in the Asset Purchase and Sell Agreement. The security
        interest was to be released upon repayment of the advance or execution of
        the
        Asset Purchase and Sale Agreement. The Agreement was executed on November
        26,
        2004 and funds, as described in the agreement, were transferred to the Company
        on January 14, 2005. The advance payments of $1,500,000 received in November
        2003 and February 2004 were applied against the total purchase price upon
        final
        execution of the agreement and the securities were released.
 
 On
        August
        30, 2005 and September 26, 2005, CRC paid, on behalf of the Company, $1,122,580
        for vendor related debts and $1,142,159 for VAT taxes due the Indonesian
        government, respectively. Advances made for tax liabilities and vendor
        obligations bear interest at the rate of 1 1⁄2% per month. During the three months
        ended September 30, 2005, the Company accrued $13,817 of interest payable.
        See
        Note 6 - Litigation and Note 8 - Subsequent Events.
 
 **Accrued
        interest payable**
 September
                    30,
                  2005
                
                December
                    31,
                  2004Canadian
                    Imperial Bank of Commerce
                
                $
                –
                
                $
                317,293RBM
                    Financial
                
                
                –
                
                
                15,180NOWMCO
                
                
                918,514
                
                
                763,959CRC
                
                
                13,817
                
                
                –Unsecured
                    short term loans
                
                
                –
                
                
                181,293Total interest payable
                
                $
                932,331
                
                $
                1,277,725
 
 **Note
        5 - Stockholders’ Equity**
 
 **Stock
        Issued**
 
 During
        the nine months ending September 30, 2005 and the year ended December 31,
        2004,
        the Company issued 17,541,784, and 1,199,900, shares of common stock
        respectively in payment of services or salaries provided/owed and for settlement
        debts and/or interest as follows:
 
 **Stock
        Issued in Payment of Services**
 
 On
        February 28, 2005, the Company issued 50,000 shares of common stock valued
        at
        $0.10 per share to its attorney as payment for legal services rendered.
 
 On
        June
        30, 2005, the Company issued 9,664,052 shares of common stock valued at $0.10
        per share to its Chief Executive Officer, Mr. Wensveen as payment for accrued
        salary and expenses in the amount of $966,405. On June 30, 2005, the Company
        also issued 7,827,732 shares of common stock valued at $0.10 per share to
        its
        President, Mr. Nunn as payment for accrued salary and expenses in the amount
        of
        $782,774.
 
 -21-
 **Table
            of Contents**
 
 **FORTUNE
        OIL & GAS, INC.**
 **NOTES
        TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**
 SEPTEMBER
        30, 2005
 **(Unaudited)**
 
 **Stock
        Issued in Payment of Debt and/or Interest**
 
 During
        the year ended December 31, 2004, 1,199,900 shares of common stock valued
        at
        $119,989 in payment of debt and accrued interest.
 
 **Stock
        Options**
 
 In
        January 2005, the Company granted options to purchase 1,400,000 shares of
        common
        stock to each of Mr. Wensveen and Mr. Nunn, at an exercise price of $0.07
        per
        shares. These options are fully vested. These options will expire on January
        1,
        2015. No portions of the options have been exercised. These options were
        not
        issued under our 2005 Equity Incentive Plan. In connection with these grants,
        the Company recorded compensation expense of $223,870 using the Black-Sholes
        valuation model (assuming volatility of 220%, a risk-free interest rate of
        4.22%, expected lives of 10 years and no dividend yield).
 
 The
        Company’s Board of Directors and our shareholders approved the Fortune Oil &
        Gas, Inc. 2005 Equity Incentive Plan (the “Plan”) which permits the Company to
        grant, for a ten year period, both stock purchase rights and stock options.
        The
        Plan reserved 10,000,000 shares of our Common Stock for issuance to our
        directors, employees and consultants under the Plan. The Plan is administered
        by
        the Board of Directors. As the administrator of the Plan, the Board of Directors
        has the authority and discretion, subject to the provisions of the Plan,
        to
        select persons to whom stock purchase rights or options will be granted,
        to
        designate the number of shares to be covered by each option or stock purchase
        right, to specify the type of consideration to be paid, and to establish
        all
        other terms and conditions of each option or stock purchase right. Options
        granted under the Plan will not have a term that exceeds ten years from date
        of
        grant.
 
 As
        of
        September 30, 2005, the Company has granted no awards of stock or options
        under
        the Plan and , during
        the year ended 2004, the Company did not grant any options or Stock Appreciation
        Rights.
 
 **Note
        6 - Litigation**
 
 **National
        Oil Well Maintenance (“NOWMCO”) and Enterprise Trading Limited (“Enterprise”)
        versus Fortune Oil & Gas, Inc. (the “Company”), Fortune Ship Management Ltd
        (FSM”) and Indo-Pacific Resources (Java) Ltd. (“IPR”)**
  On
        September 20, 2002, NOWMCO and Enterprise filed suit against the Company
        and its
        two wholly owned subsidiaries, FSM and IPR, for repayment of the total loan
        amount of $4,450,000 plus applicable interest and for the right to retain
        possession of the vessel currently in their possession. See Note 5 NOWMCO
        Debt.
 
 The
        Company contends that it relinquished possession of the vessel to Enterprise
        on
        August 14, 2004 and that the vessel should have been valued at $3,000,000
        based
        on an independent third party valuation of the scrap value of the vessel.
        The
        Company contends, based upon the belief that the credit is valid, that the
        outstanding loan amount should be reduced to $1,450,000 plus applicable
        interest.
 
 On
        December 2, 2002, the Company filed suit against NOWMCO and Enterprise alleging
        breach of contract for remediation work on the Camar Field oil wells and
        fraudulent and negligent misrepresentation as to the qualifications of skills
        of
        NOWMCO and Enterprise. The counterclaim asks for compensatory, consequential
        and
        punitive judgments, pre and post judgment interest, declaration of violation
        of
        the agreements between the parties, performance of contractual obligations
        and
        costs and expenses, including reasonable attorney fees.
 
 The
        Company has recorded the full amount of the loans, $4,450,000, less the net
        book
        value of the vessel, $1,910,262, plus accrued interest expense of $918,514
        for a
        balance owed of $3,458,252.
  -22-
 **Table
            of Contents**
  **FORTUNE
        OIL & GAS, INC.**
 **NOTES
        TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**
 SEPTEMBER
        30, 2005
 **(Unaudited)**
 
 **Glencore
        International AG (Glencore) versus Indo-Pacific Resources (Java) Ltd (“IPR”)**
 
 The
        Company had committed, by a sales contract dated March 3, 2003, to sell crude
        oil to Glencore. The Company was unable to meet the commitment and Glencore
        entered action against the Company on June 30, 2003 claiming damages for
        lost
        profits, indemnity, interest and legal costs of approximately $250,000.
 
 The
        Company filed a defense that based on unforeseen difficulties, as a claimed
        result of force majeure, it was not able to fulfill the sales contract. In,
        September  2005,
        the
        Company’s subsidiary, IPRJ and Glencore settled this matter and have entered
        into a settlement agreement whereby IPRJ shall pay to Glencore the sum of
        $290,000 in one lump sum on or before October 31, 2005. The Company has
        guaranteed this payment. The full amount of the settlement has been accrued
        as
        of September 30, 2005. The proceedings are currently on hold and would resume
        should settlement payment not be made or upon payment in full of the settlement
        amount, the case will be dismissed.  As
        of
        November 4 ,
        2005,
        the full amount of the settlement had not been made and the payment date
        for
        such settlement has been deferred to December 15, 2005 by verbal agreement
        between the parties.
 
 **Patra
        Drilling Contractor (“Patra”) and Somaser, S.N.C. (“Somaser”) versus
        Indo-Pacific Resources (Java) Limited (“IPR”)**
 
 Patra
        and
        Somaser claim breach of contract in the amount of approximately $2.7 million
        plus interest of approximately $800,000 under a contract for offshore oil
        and
        gas well drilling services. Patra and Somaser have requested that the dispute
        be
        settled by the Indonesian National Board of Arbitration (“BANI”). It is the
        position of the Company that BANI has no jurisdiction over the case. The
        outcome
        of this legal action is presently not determinable and the Company has recorded
        $3,297,855 as owing to Patra. See Note 8, Subsequent Events.
 
 **RBM
        Financial Inc. (“RBM”) versus Fortune Oil & Gas, Inc. (“the Company”)**
 
 RBM
        loaned the Company $620,000 between December 30, 2000 and February 21, 2001.
        The
        Company has made payments against this loan in the amount of $260,000 and,
        therefore owed RBM the principal sum of $360,000 plus $111,600 of accrued
        interest, for a total amount owed of $471,600. On January 2002, RMB filed
        an
        action for collection of amounts unpaid. On June 30, 2004 the Company made
        a
        payment of $25,000 and on July 8, 2004, the Company made a further payment
        of
        $150,000 leaving a balance at December 31, 2004 of $226,000, inclusive of
        $15,180 of accrued interest. On December 23, 2004, RBM obtained a court order
        for $550,000 (Canadian), or $401,000 (US), which included the two payments
        made
        in 2004. The final payment, pursuant to the order, was made on January 14,
        2005.
 
 **Singapore
        Technologies Marine Ltd. (“STM”) versus Fortune Ship Management LTD. (“FSM”) and
        the Company**
 
 STM
        performed conversion and repair work on a vessel to become a floating offshore
        storage vessel, pursuant to the terms of a contract dated January 9, 2002.
        The
        work was contracted for, performed but never paid for by the Company. STM
        claimed damages and accrued interest to which the Company filed a defense.
        On
        August 14, 2004, a Notice of Discontinuance was issued by the Court and there
        has not been activity since the filing. The Company has recorded
        $535,208  as
        owing
        to STM at September 30, 2005 and December 31, 2004.
 
 **Indo-Pacific
        Resources (JAVA) Ltd. versus Camar Resources Canada Inc. (International Chamber
        of Commerce, International Court of Arbitration, Paris,
        France**
 
 On
        August
        26, 2005, the Company’s wholly owned subsidiary Indo-Pacific Resources (Java)
        Ltd. (“IPRJ”) filed a Request for Arbitration (the “Complaint”) against CRC with
        the International Court of Arbitration (the “Court”) in Paris, France. The
        Complaint alleges CRC breached the Joint Operating Agreement and
 
 -23-
 **Table
            of Contents**
  **FORTUNE
        OIL & GAS, INC.**
 **NOTES
        TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**
 SEPTEMBER
        30, 2005
 **(Unaudited)**
 
 also
        breached its fiduciary duty to IPRJ by failing to take all necessary acts
        to
        commence oil production in the
        Camar
        field. The Company seeks a finding that such breaches constitute sufficient
        grounds for the removal of CRC as operator under the JOA and for the appointment
        of a new operator that IPRJ can choose without any input from CRC. IPRJ is
        seeking monetary damages including approximately $4,850,000 for lost profits
        that will increase at a net rate of $550,000 every month (based on current
        crude
        prices) for every month the Camar field is not put into production and also
        approximately $319,440 for the fixed charges related to the mooring system
        and
        which will also continue to accrue at an average monthly rate of $36,500.
        The
        Company commenced the Arbitration as means to compel CRC into proper action
        including the
        charter of a vessel that will culminate in reinstated production at the Camar
        field. The Company still believes
        that CRC is suited to operate the field and is a viable partner in the Joint
        Venture. However, the Company and its management believes that in order to
        protect the value of the Company and to protect its shareholders from further
        losses associated with the lack of production, it needed to instigate a
        proceeding that would force CRC to be responsive and move forward immediately
        to
        resume operations at the Camar field.
 
 On
        October 7, 2005, CRC filed an Answer to IPRJ’s Request for Arbitration an also a
        Counterclaim against IPRJ. CRC denies the breaches of the JOA alleged by
        IPRJ.
        CRC’s Counterclaim alleges IPRJ has breached the Asset Purchase and Sale
        Agreement (“PSA”) that the parties entered into on November 26, 2004 because
        IPRJ has failed to settle all of its trade debts and value added tax principal
        obligations (including
        tax penalties and associated interest charges owed to Indonesia) and hereinafter
        referred to as the “Settlement Obligations” under the Asset Purchase and Sale
        Agreement). As a result of IPRJ’s breach, CRC alleges that BPMIGAS, the
        Indonesian regulatory body that issues the work program and budget approvals
        in
        connection with oil production under the Bawean PSC, did not approve the
        2004
        and 2005 work programs and budgets for operation of the Camar Field. CRC
        is
        seeking monetary damages including $12,000,000 representing lost production
        suffered by CRC because of IPRJ’s failure to settle the Settlement Obligations,
        $1,000,000 per month commencing on the date of the filing of the Complaint
        for
        each month production is not obtained from the properties subject to the
        Bawean
        PSC, and an award of costs and interest on the damage amounts stated above.
        See
        Note 8 - Subsequent Events.
 
 **Note
        7 - Related Party Transactions**
 
 On
        January 1, 2005, the Company entered into Employment Agreements with the
        Chief
        Executive Officer and the President. Each of the Agreements are for a term
        ending on December 31, 2014 and commit the Company, for each of the executives,
        to an annual salary of $360,000 with annual salary increases of not less
        than 7%
        per year, incentive stock options of 1,400,000 shares exercisable at $0.07
        cents
        per share (or $100,000) which vest immediately and terminate 10 years from
        the
        date of the grant, health benefits provided by the Company, and annual vacation
        and sick leave allowances. In the event of a merger, selling of a controlling
        interest, or selling of a majority of its assets, the Company is obligated
        to
        pay each Executive three times his annual salary as is then in effect. In
        the
        event the Agreement is terminated prior to its expiration date, for any reason,
        the Executive shall receive the then current Base Salary and all accrued
        and
        earned, but unpaid bonuses or benefits described above. Additionally, the
        Executive shall have the right to retain all rights to shares and vested
        stock
        options as well as other granted equity rights, if any. If the Executive
        dies
        during the term of the agreement, the Executive’s estate shall be entitled to
        receive the Executive’s then current base salary for one year from date of
        death. However, the Company may terminate the Executive for “cause” as defined
        in the Agreement if (1) the Executive was given a minimum of thirty (30)
        days
        prior written notice of termination and (2) the Executive had one hundred
        twenty
        (120) days to correct any breach, default or causation. On January 1, 2005
        the
        stock options were granted in terms of the employment agreement.
 
 On
        January 14, 2005, the following payments for expenses and advances, which
        were
        all payable as of December 31, 2004 were made to the Company’s Chief Executive
        Officer and the Company’s President, $390,973 in respect of director fees which
        were accrued for periods prior to December 31, 2004; $229,455 in repayment.
  On
        June 30, 2005, the Company issued 9,664,052 shares
        of common stock valued at $0.10 per share to its Chief Executive Officer,
        Mr.
        Wensveen as payment for accrued salary and expenses in the amount of $966,405.
        On June 30, 2005, the Company also issued 7,827,732 shares of common stock
        valued at $0.10 per share to its President. Mr Nunn as payment for accrued
        salary and expenses in the amount of $782,774.
  -24-
 **Table
            of Contents**
  **FORTUNE
        OIL & GAS, INC.**
 **NOTES
        TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**
 SEPTEMBER
        30, 2005
 **(Unaudited)**
 
 of
        advances received from the Company’s subsidiaries; $17,279 in respect of accrued
        wages; $188,248 in respect
        of unsecured, non interest bearing loans; and $174,045 in respect of accrued
        expenses.
 
 Advances
        from related parties are unsecured, have no fixed terms of repayment and
        are
        interest free.
 
 **Note
        8 - Subsequent Events**
 
 **Transactions
        and events with CRC**
 
 **Request
        for Arbitration against CRC with the International Court of
        Arbitration**
 
 On
        October 3, 2005, CRC made a second payment of $981,733 of the VAT Payable
        to the
        Indonesian government on behalf of the Company leaving a balance due of
        $217,834. Once the VAT payable has been paid in the full, the Indonesian
        government is obligated to refund, to the Company the amount of the VAT
        receivable, amounting to $2,678,629 which will be assigned to CRC for their
        payments of the VAT payable and interest expense.
 
 On
        October 7, 2005, CRC filed an Answer to IPRJ’s Request for Arbitration an also a
        Counterclaim against IPRJ. CRC denies the breaches of the JOA alleged by
        IPRJ.
        CRC’s Counterclaim alleges IPRJ has breached the Asset Purchase and Sale
        Agreement (“PSA”) that the parties entered into on November 26, 2004 because
        IPRJ has failed to settle all of its trade debts and value added tax principal
        obligations (including
        tax penalties and associated interest charges owed to Indonesia and hereinafter
        referred to as the “Settlement Obligations” under the Asset Purchase and Sale
        Agreement). As a result of IPRJ’s breach, CRC alleges that BPMIGAS, the
        Indonesian regulatory body that issues the work program and budget approvals
        in
        connection with oil production under the Bawean PSC, did not approve the
        2004
        and 2005 work programs and budgets for operation of the Camar Field. CRC
        is
        seeking monetary damages including $12,000,000 representing lost production
        suffered by CRC because of IPRJ’s failure to settle the Settlement Obligations,
        $1,000,000 per month commencing on the date of the filing of the Complaint
        for
        each month production is not obtained from the properties subject to the
        Bawean
        PSC, and an award of costs and interest on the damage amounts stated
        above.
 
 On
        October 25, 2005, CRC paid $2,250,000 of the Patra Drilling Contractor payable
        on behalf of the Company and settled the total amount due at an amount
        $1,047,855 less than the recorded amount due.
 On
          October 26, 2005 the Company received a Notice of Dilution from CRC alleging
          that the Company has not discharged its requirement to settle and pay all
          outstanding vendor and VAT tax obligations and that CRC has settled and
          paid
          $3,402,580 of vendor obligations and $2,123,892 of VAT obligations. Under
          the
          terms of the Asset Purchase and Sale Agreement, the Company has 45 days
          to
          reimburse CRC for the payment of such non-settled vendor obligations and,
          if CRC
          is not reimbursed, is subject to a dilution in their ownership interest
          in the
          joint operations by a factor of one percentage point for each $150,000
          paid by
          CRC except that the Company ownership position shall not be diluted beyond
          5% of
          the joint operations. Per the Notice of Dilution, CRC claims that the Company’s
          ownership should be reduced to 7.12%. Under the terms of the Asset Purchase
          and
          Sale Agreement, the Company is entitled to reimburse CRC for the payment
          of such
          debts and avoid the dilution in the Company’s ownership interest. The Company
          intends to respond to the Notice of Dilution within the time frame permitted
          under the Asset Purchase and Sale Agreement. The Company does not believe
          that
          the payment of the debts by CRC was in accordance with the terms of the
          Asset
          Purchase and Sale Agreement and accordingly that the Notice of Dilution
          is not
          enforceable and the Company does not believe that CRC is entitled to reduce
          the
          Company’s ownership percentage in the Bawean PSC
 
 
 -25-
 **Table
            of Contents**
 
 **ITEM
        2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
        AND RESULTS OF OPERATIONS**
 
 **Forward
        Looking Statements and Safe Harbor**
 
 This
        Quarterly Report on Form 10-QSB contains “forward-looking statements”. These
        forward-looking statements are based on our current expectations, assumptions,
        estimates and projections about our business and our industry. Words such
        as
“believe,”  “anticipate,”  “expect,”  “intend,” 
“plan,”  “may,” and other similar expressions identify forward-looking
        statements. In addition, any statements that refer to expectations, projections
        or other characterizations of future events or circumstances are forward-looking
        statements. These forward-looking statements are subject to certain risks
        and
        uncertainties that could cause actual results to differ materially from those
        reflected in the forward-looking statements. Factors that might cause such
        a
        difference include, but are not limited to as the following:
 
 ·
              whether
                  or not we are able to successfully develop and market our concept,
 
 ·
              whether
                  or not we will be able to obtain the financial resources we need
                  to start
                  and continue our operations;
 
 ·
              whether
                  or not we will be able to compete successfully with others in our
                  industry;
 
 ·
              whether
                  or not we will continue to receive the services of our management
                  team;
 
 and
        other
        factors, some of which will be outside our control. You are cautioned not
        to
        place undue reliance on these forward-looking statements, which relate only
        to
        events as of the date on which the statements are made. We undertake no
        obligation to publicly revise these forward-looking statements to reflect
        events
        or circumstances that arise after the date hereof. You should refer to and
        carefully review the information in future documents we file with the Securities
        and Exchange Commission.
 
 Additional
        information of additional factors that could affect our business or financial
        results or condition is included in our Registration on Form 10 Report, as
        amended, and filed on October 18, 2005.
 
 **GENERAL
        OVERVIEW**
 
 The
        oil
        properties of the Company consist of the Bawean Production Sharing Contract
        (“PSC”) in the North Java Sea approximately 430 miles east of Jakarta, Indonesia
        and 50 miles north of the island of Java. The Bawean PSC consists of two
        offshore areas which include the Camar and Tuban Blocks. The petroleum lands
        had
        been under exploration and development since February 12, 1981 by predecessor
        firms granted by Pertamina, the government owned oil company in Indonesia
        with
        the authority to grant PSCs and similar agreements with operators. Predecessor
        firms include Kerr-McGee Corporation, Cities Service Oil Co. (“CITGO”) and
        Enterprise Oil plc (which was acquired by Royal Dutch Shell in 2002). The
        assets
        consist of all rights and entitlements relating to the 100% interest in the
        Bawean PSC and the South Camar Utilization and Unit Operating Agreement (“UOA”),
        all technical and proprietary information acquired pursuant to the Bawean
        PSC
        and Camar UOA, equipment and inventory.
 
 The
        Camar
        Block is operated under a production sharing contract. There is no royalty
        payable, although there is a “First Tranche Petroleum” provision (“FTP”), which
        is a percentage of the gross production revenue that is shared directly with
        the
        Indonesian government, before any cost of recovery or profit oil is taken.
        The
        FTP is 20% of the gross production revenue, and the Company is entitled to
        a
        45.45% share of it, up to a maximum of 89.09%. Allowable costs are recovered
        from the remaining 80% of the gross production, with any unused cost oil
        being
        shared with the government in the same proportions as the FTP. Because the
        field
        has not performed as well as the previous operator(s) had predicted, there
        is a
        large un-recovered cost pool, amounting to approximately $165,479,000 still
        associated with the Camar oil field, and consequently all of permitted cost
        oil
        allowances will revert to the contractor group. Therefore, the Company retains
        89.09% of the proceeds of all crude oil sales. We believe that our association
        with Camar Resources Canada, Inc (“CRC”), the sale of a 70% interest in the
        Bawean Block Production Sharing Contract to CRC, CRC acting as the Operator
        of
        the joint venture, and CRC’s production and management skills in oil production
        as well as the favorable relations with the Indonesian government will help
        to
        overcome the difficulties that prior operators of the field experienced.
        However, until a vessel is secured by purchase or lease, the production and
        off
        loading of oil cannot commence and thus revenues will not be realized. On
        September 27, 2005, CRC entered into an agreement for the use of a storage
        tanker at the Camar field with PT. Panji Adi Samudera (PAS) Maritne (“PAS”). The
        Company anticipates that the storage tanker will be in the field and operational
        by November 15, 2005.
 
 -26-
 **Table
            of Contents**
  On
        November 26, 2004, we entered into an Asset Purchase and Sale Agreement with
        Camar Resources Canada, Inc. (“CRC”) for the sale of a 70% interest in the
        Bawean Block Production Sharing Contract in exchange for $10,500,000. The
        purchase price was allocated between amounts to be placed in a Joint Operating
        Account ($1,000,000), amounts to be used for the settlement of trade debt
        ($4,500,000) and funds to the Company for general operations ($5,000,000).
        Under
        the terms of the agreement CRC is to act as the Operator of the project.
        The net
        proceeds from the operation are to be shared 70% by CAMAR and 30% by the
        Company. The transaction was completed on January 14, 2005 and all remaining
        funds due us were transferred as of that date. As a result of the above
        transaction, $9,712,950 was reported as a gain on the sale of oil rights
        during
        the quarter ended June 30, 2005.
 
 The
        funds
        deposited in the Joint Operating Account are to be used by the Operator as
        our
        30% of operating expenses whereas the remaining 70% of operating expenses
        is to
        be paid by CRC as their share of operating expenses. The Joint Operations
        Account is replenished through quarterly cash-calls by the Operator of the
        Bawean PSC to the Joint Venture Partners. As of September 30, 2005, we have
        a
        credit remaining of $348,933 in the Joint Operating Account for future
        expenditures.
 
 The
        $4,500,000 of funds deposited in the Trade Debt Settlement Account is to
        be used
        for the settlement of debt with creditors, less amounts owed to the Indonesian
        Government for VAT. As of December 31, 2004, the total amount owing for such
        debts was $9,826,622. As of September 30, 2005, we were successful in reducing
        the debt balance by $6,125,566 by negotiating favorable settlement agreements
        with creditors. Of the amount of debt balance reduce, $1,122,579 was a result
        of
        CRC paying the vendors directly. As a result of these settlement agreements,
        we
        recorded a gain, in other income, of $3,166,558  for
        the
        nine months ended September 30, 2005. It should be noted that if we are not
        able
        to settle the remaining amounts due, we could request CRC to pay off such
        amounts in exchange for a reduction in our remaining 30% share interest.
        Our
        agreement allows for the reduction of 1 percentage point of ownership for
        each
        $150,000 paid by CRC on our behalf.
 
 Additionally,
        under the terms of the agreement, CRC is to pay the gross VAT payable amount
        owing the Indonesian government, amounting to $1,196,729 as of September
        30,
        2005, net of all interest expense accrued as of the time of the payment by
        CRC.
        VAT paid by PSC’s in Indonesia is a refundable tax. We are to reimburse CRC for
        such payment, or for any part of such payment that has not been refunded
        by the
        Indonesian Government, within six months with interest at 1.5% per month.
 
 Finally,
        if there is a final settlement in the National Oil Well Maintenance Company
        and
        Enterprise Trading Limited versus Fortune Oil and Gas Inc, Fortune Ship
        Management Ltd and Indo-Pacific Resources (Java) Ltd. lawsuit that we are
        unable
        to satisfy, CRC will pay the short fall and we shall transfer to CRC percentage
        interests in accordance with the same formula as stated in the previous
        paragraph. As of September 30, 2005, the parties had not reached a settlement
        agreement.
 
 For
        the
        year ended December 31, 2004, we achieved revenues from oil properties of
        $3,069,747. Our oil production during the year was curtailed in April 2004
        due
        to production difficulties associated with pipeline blockage and equipment
        malfunctions complicated by cash flow shortfalls which further delayed repairs
        of the oil production capabilities. Finally, on August 19, 2004, the vessel
        used
        for the storage of produced crude oil was handed over to the debt holder
        of the
        vessel for non-payment of debt obligations. From the date of loosing the
        vessel
        used for storage we had no alternative arrangement for the use of a tanker
        for
        storage of oil produced at the Camar field. Therefore we suspended oil
        production and have not generated revenue from oil production since. As a
        result, we sold 96,940 barrels of oil during the year ended December 31,
        2004
        down from 134,894 barrels of oil sold during the year ended December 31,
        2003.
 
 -27-
 **Table
            of Contents**
  In
        the
        past we have experienced production delays due to mechanical malfunctions
        and
        cash flow difficulties. We believe that the joint venture agreement with
        CRC
        will assist in overcoming these difficulties. The production of oil in 2004
        was
        negatively impacted causing negative gross margins after production costs,
        net
        losses for the applicable years and negative cash flow from operations.
        Likewise, for the nine months ended September 30, 2005 there was not any
        production of oil. However, the past trend of negative operations will, we
        believe, reverse itself due to: the maintenance and operation of the oil
        fields
        being operated by CRC as the Operator; CRC being responsible for 70% of total
        operating costs while we will be responsible for 30% of the operating costs;
        securing of a vessel to off load the oil production and the ability to sell
        the
        oil to third parties and the general price increases in the price per barrel
        in
        the world markets. Once oil production is commenced, we believe that the
        gross
        oil revenues of the joint operations will increase and will produce profitable
        operations to the Joint Partners and thus to our 30% share of operational
        results.
 
 During
        the months of January through March, the geographical location of our oil
        properties often experiences storms and high seas. While such conditions
        make it
        difficult to impossible to off load oil production, it does not, in general,
        preclude us from producing oil and storing it in the moored vessel that will
        be
        used of storage. Once calm seas are returned, the production stored may be
        off
        loaded and sold.
 
 Our
        financial results are largely dependent on a number of factors, including
        commodity prices. Commodity prices are outside of our control and historically
        have been and are expected to remain volatile. Commodity prices are affected
        by
        changes in market demands, overall economic activity, weather, pipeline capacity
        constraints, inventory storage levels, basis differentials and other factors.
        As
        a result, we cannot accurately predict future crude oil prices and therefore,
        cannot accurately predict revenues. In the nine months ended September 30,
        2005,
        we did not realize any revenues from oil production due to the lack of a
        vessel
        to store oil production. In 2004, for the oil produced and sold, our realized
        oil price was 42.3% higher than in 2003.
 
 **Outlook**
 
 The
        following information summarizes management’s outlook for calendar year
        2005:
 
 ·
              We
                  expect that the Joint Venture Operation will have secured a vessel
                  to be
                  used for storing produced oil prior to sell to customers will be
                  secured
                  during the fourth quarter.
 ·
              We
                  expect that the Joint Venture Operation will commence oil production
                  approximately sixty to ninety days after a storage vessel is chartered,
                  although the production levels will be minor in
                  amount.
 ·
              We
                  do not expect that the oil production occurring during the quarter,
                  if
                  any, will be sold to customers and, therefore, the production will
                  be held
                  as inventories as of the end of the year.
 ·
              Once
                  production is resumed at the Camar field, we believe we will be
                  able to
                  produce approximately 1,500 barrels of processed oil per day over
                  the
                  balance of 2005.
 ·
              We
                  believe that as we continue to execute our strategy, we will see
                  improved
                  liquidity through cash generated by operating activities. We believe
                  that
                  we will need additional capital to finance operation, current operating
                  losses and to settle current debts. Our current working capital
                  deficit,
                  the anticipated sale of our mooring system, the credit balance
                  in our
                  joint operating account, and the continuing settlement of vendor
                  payables
                  at less than recorded values will not be sufficient to maintain
                  our
                  current operating levels without the additional
                  capital.
 
 
 -28-
 **Table
            of Contents**
 
 **Critical
        Accounting Policies**
 
 **Oil
        and Natural Gas Properties**
 
 Investments
        in oil and natural gas properties are accounted for using the full-cost method
        of accounting. All costs directly associated with the acquisition, exploration
        and development of oil and natural gas properties are capitalized. Such costs
        include lease acquisitions, seismic surveys, and drilling and completion
        equipment. Maintenance and repairs are expensed as incurred.
 
 Oil
        and
        natural gas property costs are depleted based on the unit-of-production method
        using estimates of proved reserve quantities. Investments in unproved properties
        are not amortized until proved reserves associated with the projects can
        be
        determined or until they are impaired. Unevaluated properties are assessed
        periodically for impairment on a country-by-country basis. If the results
        of an
        assessment indicate that
        the
        properties are impaired, the amount of the impairment is added to the proved
        oil
        and natural gas property
        costs to be amortized. The amortizable base includes estimated future
        development costs and dismantlement, restoration and abandonment costs, net
        of
        estimated salvage values. Depletion recorded in these financial statements
        is
        based upon a reserve report by Petroleum Geo-Services (UK) Ltd dated March
        18,
        2005.
 
 Dispositions
        of oil and natural gas properties are accounted for as adjustments to
        capitalized costs with no gain or loss recognized, unless such adjustments
        would
        significantly alter the relationship between capitalized costs and proved
        reserves.
 
 The
        net
        capitalized costs of proved oil and natural gas properties are subject to
        a
“ceiling test” which limits such costs to the estimated present value,
        discounted at a 10% interest rate, of future net revenues from proved reserves,
        based on current economic and operating conditions. If net capitalized costs
        exceed this limit, the excess is charged to operations through depreciation
        and
        depletion. Because of the volatility of oil and natural gas prices, no assurance
        can be given that there will not be further write-down in future periods.
 
 **Oil
        and Natural Gas Reserve Estimates**
 
 Estimating
        quantities of proved reserves is a subjective process and involves estimating
        underground accumulations of hydrocarbons that cannot be measured in an exact
        manner. The reserve data included in these financial statements are estimates
        as
        of December 31, 2004 and were prepared by Petroleum Geo-Services (UK) Ltd.
        The
        process relies on interpretation of available geologic, geophysical, engineering
        and production data. The extent, quality and reliability of this data can
        vary.
        The process also requires certain economic assumptions regarding drilling
        and
        operating expenses, capital expenditures, taxes and availability of funds.
        The
        SEC mandates some of these assumptions, such as oil and natural gas prices
        and
        the present value discount rate.
 
 Proved
        reserve estimates prepared by others may be substantially higher or lower
        than
        the Company’s estimate. Because these estimates depend on many assumptions, all
        of which may differ from actual results, reserve quantities actually recovered
        may be significantly different than estimated. Material revisions to reserve
        estimates may be made depending on the results of drilling, testing, and
        rates
        of production.
 
 **Revenue
        recognition**
 
 Oil
        and
        natural gas revenues are recorded using the sales method, whereby the Company
        recognizes oil and natural gas revenue based on the amount of oil and gas
        sold
        to purchasers, when title passes, the amount is determinable, and collection
        is
        reasonably assured.
 
 **Impairment
        of Long-Lived Assets**
 
 Management
        evaluates long-lived assets for impairment whenever changes in circumstances
        indicate that the carrying value of an asset may not be recoverable. If the
        estimated future undiscounted cash flows from the use of an asset are less
        than
        the carrying value, impairment would be recorded to reduce the related asset
        to
        its estimated fair value.
 
 -29-
 **Table
            of Contents**
  **Stock-Based
        Compensation**
 
 SFAS
        No.
        123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148,
“Accounting for Stock-Based Compensation - Transition and Disclosure,” defines a
        fair value based method of accounting for stock-based compensation. However,
        SFAS No. 123 allows an entity to continue to measure compensation cost related
        to stock and stock options issued to employees using the intrinsic method
        of
        accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25,
“Accounting for Stock Issued to Employees.” Entities electing to remain with the
        accounting method of APB No. 25 must make pro forma disclosures of net income
        and earnings per share as if the fair value method of accounting defined
        in SFAS
        No. 123 had been applied . The
        Company  has
        elected to account for its stock-based compensation to employees using the
        fair
        value method under SFAS No. 123. Due to the adoption of SFAS 123 no pro forma
        disclosures are presented as required by SFAS 148.
 
 Common
        stock issued for salaries and other services are recorded at the estimated
        fair
        value at the time of issuance.
 
 **RESULTS
        OF OPERATIONS**
 
 **Three
        Months Ended September 30, 2005 Compared to the Three Months Ended September
        30,
        2004**
 
 The
        following tables set forth the percentage relationship to total revenues
        of
        items included in the Company’s Consolidated Statements of Operations for the
        quarters ended September 30, 2005 and 2004.
 
 **Revenues**
 
 We
        did
        not have any revenues from oil production in the three months ended September
        30, 2005 as a result of not having a vessel available for the off loading
        and
        storage of produced oil. Additionally, there were not any revenues from oil
        production in the three months ended September 30, 2004 as a result of the
        discontinuance of oil operations on April 5, 2004, due to a mechanical
        malfunction in our largest producing well, CM-1. Additionally, on August
        14,
        2004, the vessel, into which the produced oil was to be stored, off loaded
        and
        brought to market, was handed over to the debt holder as partial payment
        for the
        loan secured by the vessel. The Company did not have an alternative method
        to
        store oil production thereafter.
 
 We
        do not
        presently have the ability to transport or store gas produced and consequently
        we derive no revenues from gas production. All gases are flared at the oil
        platform.
 
 **For
                  the three months ended September 30,**
              ****
              **$**
              ****
              **$**
              ****
              **$**
              ****
              **%****2005**
              
              **2004**
              
              **Change**
              
              **Change****Income
                  from Oil and Gas Properties**
              
              **$**
              –
              
              **$**
              –
              
              **$**
              –
              
              
              **N/A**
 
 The
        Company and CRC have identified a storage tanker for lease that can be used
        at
        the Camar field. CRC is in advanced discussions with PAS for the use,
        maintenance and staffing of the storage tanker “Fortuna Ayu” (which was
        previously owned by the Company and surrendered to NOWMCO) PAS acquired the
        ship
“Fortuna Ayu” from NOWMCO’s assignee, Enterprise, in September 2005 in
        anticipation of entering into the charter agreement for the ship for the
        Camar
        field with CRC. We believe chartering a storage tanker is a better approach
        for
        economic and operating reasons than attempting to acquire ownership of another
        storage tanker and obtaining the financing necessary to undertake that
        commitment. We anticipate the cost to charter the storage tanker will be
        approximately $10,750 per day. That cost will include all staffing, maintenance,
        upkeep and related items necessary to keep the storage tanker in continuous
        operations in the field. We anticipate that the storage tanker will be
        operational at the Camar field in December 2005.
 
 
 
 -30-
 **Table
            of Contents**
 
 **Expenses**
 
 **Production
        Costs**
 
 **For
                  the three months ended September 30,**
              
              **$**
              ****
              **$**
              ****
              **$**
              ****
              **%****2005**
              
              **2004**
              
              **Change**
              
              **Change****Production
                  Costs**
              
              **$**
              –
              
              **$**
              **64,944**
              
              **$**
              **(64,944**
              **)**
              
              **(100**
              **%)****Percentage
                  of Total Revenues**
              
              
              **N/A**
              
              
              **N/A**
 
 During
        the three months ended September 30, 2005, the production facilities were
        idle
        and, therefore, all cost incurred have been reported as Other Expense -property
        and equipment maintenance csosts. The total costs incurred in the three months
        ended September 30, 2004 were approximately $65,000 . Revenues  ceased
        on
        April 5, 2004. However, certain fixed and variable costs, such as payroll
        expenses, routine maintenance, and supervisory personnel costs, continued
        to be
        incurred. As a result, the Company generated a negative gross margin from
        operations of $65,000 due to continuing oil production related costs as the
        source of the well malfunction was investigated and attempts were made to
        solve
        the problems. On August 19, 2004, the vessel was handed over to the debt
        holder
        of the vessel as partial payment on the loan and, therefore, until a replacement
        vessel is secured, the Company does not have the ability to generate revenues.
        As a result of the equipment malfunctions and the loss of the vessel, the
        Company has not had production capabilities since April 5, 2004.
 
 **Depreciation
        and depletion of oil and gas properties**
 
 **For
                  the three months ended September 30,**
              
              **$**
              ****
              **$**
              ****
              **$**
              ****
              **%****2005**
              
              **2004**
              
              **Change**
              
              **Change****Depreciation
                  and depletion**
              
              **$**
              **27,886**
              
              **$**
              **29,838**
              
              **$**
              **(
                  1,952**
              **)**
              
              **(6.5**
              **)%****Percentage
                  of Total Revenues**
              
              
              **N/A**
              
              
              **N/A**
 
 Depreciation
        costs incurred in the three months ended September 30, 2005 have been classified
        as Idle Depreciation in Other Income and Expenses below. Depletion of the
        oil
        reserves was not charged to operations in the three months ended September
        30,
        2005 because the oil production facilities had been idle since August 19,
        2004
        when the owner of the vessel foreclosed on the loan, due to non-payment,
        and
        took possession of the vessel. Comments included in this section relate to
        the
        decrease in depreciation expense for the three month periods ending September
        30, 2005 and 2004.
 
 Depreciation
        of oil equipment and depletion of oil properties decreased by 6.5% for the
        three
        months ended September 30, 2005 from the three months ended September 30,
        2004.
        On February 18, 2005, the Company purchased a mooring system, which is required
        for vessel off loading of oil production, at a gross cost of approximately
        $500,000 and commenced depreciation during the period. Depreciation expense
        of
        $27,886 for the three months ended September 30, 2005 was included in Other
        income (expense) - idle production costs in the Statement of Operations for
        the
        period then ended as the Company was not facilitated for oil production during
        the period.
 
 
 -31-
 **Table
            of Contents**
 
 **Selling,
        general and administrative costs**
 
 **For
                  the three months ended September 30,**
              
              **$**
              ****
              **$**
              ****
              **$**
              ****
              **%****2005**
              
              **2004**
              
              **Change**
              
              **Change****Selling,
                  General and Administrative Costs**
              
              **$**
              **616,963**
              
              **$**
              **659,376**
              
              **$**
              **(42,413**
              **)**
              
              **(6.43**
              **)%****Percentage
                  of Total Revenues**
              
              
              **N/A**
              
              
              **N/A**
 
 Selling,
        general and administrative costs increased by $42,413 or 6.43% primarily
        due the
        addition of one accounting staff in the Corporate Office and consulting services
        in connection with financial reporting.
 
 **Other
        Income and Expense**
 
 Other
        income and expense consisted of the following items:
 
 **For
                  the three months ended September 30,****$**
              ****
              **$**
              ****
              **$**
              ****
              **%****2005**
              
              **2004**
              
              **Change****Gain
                  (loss) on settlement of trade payables at less than recorded values**
              
              **$**
              **(10,679**
              **)**
              **$**
              –
              
              **$**
              **(10,679**
              **)**
              
              **100.0**
              **%****Foreign
                  exchange gain (loss)**
              
              
              **7,717**
              
              
              **(26,058**
              **)**
              
              **33,775**
              
              
              **129.6**
              **%****Interest
                  expense**
              
              
              **295,675**
              
              
              **238,631**
              
              
              **57.044**
              
              
              **23.9**
              **%****Idle
                  depreciation**
              
              
              **27,886**
              
              
              –
              
              
              **27,886**
              
              
              **100.0**
              **%****Property
                  and equipment maintenance costs**
              
              
              **191,942**
              
              
              –
              
              
              **191,942**
              
              
              **100.0**
              **%****Legal
                  Settlement Costs**
              
              
              **90,000**
              
              
              –
              
              
              **90,000**
              
              
              **100.0**
              **%**
 
  The
        loss
        on the settlement of trade payables at less than recorded values results
        from
        negotiations with various unsecured creditors for the settlement and payment
        of
        the amounts owed at amounts less than that the recorded liability. During
        the
        three months ended September 30, 2005, debts were settled for less than the
        recorded value amounting to $55,129 offset by a new claim, which appeared
        valid,
        amounting to $65,808. As of September 30, 2005, the Company was successful
        in
        settling the following debts:
 Vendor
                
                As
                    of
                  September
                    30, 2005
                
                As
                    of
                  December
                    31, 2004
                
                Payments
                  in
                    Cash
                
                Forgiveness
                    of Debt
                
                Increase
                    in PayablesHaliburton
                    Services PT
                
                $
                –
                
                $
                1,055,012
                
                $
                158,252
                
                $
                896,760
                
                $
                –Patra
                    Drilling Contractor
                
                
                3,297,855
                
                
                3,297,855
                
                
                –
                
                
                –
                
                
                –Prosafe
                    Production Services Pte. Ltd
                
                
                –
                
                
                1,581,388
                
                
                385,337
                
                
                1,196,051
                
                
                –Other
                    vendors (1)
                
                
                2,300,271
                
                
                5,921,376
                
                
                4,560,529
                
                
                1,073,747
                
                
                2,013,171Total
                
                $
                5,598,126
                
                $
                11,855,631
                
                $
                5,104,118
                
                $
                3,166,558
                
                $
                2,013,171
 
 (1)
              Vendors
                  listed include those with a balance of 10% or greater of total
                  accounts
                  payable and accrued liabilities as of December 31,
                  2004.
 
 We
        are
        continuing to negotiate and settle any debts that have not been settled as
        of
        September 30, 2005 with the anticipation that all negotiations will be completed
        by the end of the calendar year. On October 25, 2005, CRC paid $2,250,000
        of the
        Patra Drilling Contractor payable on behalf of the Company and settled the
        total
        amount due.
 
 The
        net
        foreign exchange gain (loss) was due to gains realized from accounts payable
        recorded in foreign currencies and the related fluctuations of such currencies
        at the time of payment and unrealized gains or (losses) recorded for the
        change
        in the stated value of assets or liabilities as of the end of the quarter.
 
 -32-
 **Table
            of Contents**
  Property
        and equipment maintenance costs incurred during the three months ended September
        30, 2005 of $191,942, and idle depreciation expense of $27,886 relates to
        the
        fixed costs and continuing employee and related costs incurred during the
        period
        in which the Company had no production and all facilities were idle.
 
 Interest
        expense consists of interest on short term obligations, VAT taxes payable
        and
        withholding of corporate income taxes and personal income tax withholdings
        and
        the accrued interest related to the NOWMCO outstanding debt. The amount
        of
        interest expense for the three months ended September 30, 2005 decreased
        by
        $57,044 from the amount accrued during the three months ended September 30,
        2004
        due to the payment of approximately $2.0 million of interest bearing short
        term
        debt during the six months ended June 30, 2005. The remainder of the interest
        expense is for additional accrued interest on the NOWMCO debt, $42,741, and
        $13,817 of accrued interest for advances made by CRC for vendor obligations
        and
        VAT taxes payable.
 
 Income
        Taxes
 
 We
        account for income taxes under the liability method, which requires us to
        recognize deferred tax assets and liabilities for the expected future tax
        consequences of events that have been included in the financial statements
        or
        tax returns. As of September 30, 2005, the deferred tax assets related to
        our
        net operating loss carry-forwards are fully reserved. The Company has not
        provided an income tax provision for the three months ended September 30,
        2005
        due to the available federal tax loss carry forwards of $12,827,374 as of
        December 31, 2004, capital losses available to offset capital gains and because
        earnings will not be taxable by the Federal Government until the earnings
        are
        repatriated to North America
 
 **Nine
        Months Ended September 30, 2005 Compared to the Nine Months Ended September
        30,
        2004**
 
 The
        following tables set forth the percentage relationship to total revenues
        of
        items included in the Company’s Consolidated Statements of Operations for nine
        months ended September 30, 2005 and 2004.
 
 **Revenues**
 
 The
        Company did not have the ability to produce oil during the nine months ended
        September 30, 2005 as a result of not having a vessel to store production
        while
        awaiting the sale and off loading to a customer’s vessel. Revenues for the nine
        months ended September 30, 2004 are exclusively from oil production. We do
        not
        presently have the ability to derive production volumes from Natural gas
        and, as
        a result, all gases are flared.
 **For
                    the nine months ended September 30,**
                  
                  
                  **$**
                  
                  
                  **$**
                  
                  
                  **$**
                  
                  
                  **%****2005**
                  
                  
                  **2004**
                  
                  
                  **Change**
                  
                  
                  **Change****Income
                      from Oil and Gas Properties**
                  
                  **$**
                  –
                  
                  **$**
                  **3,069,747**
                  
                  **$**
                  **(3,069,747**
                  **)**
                  
                  **(100.0)**
                  **%****Average
                      Prices -****Oil
                      sales price (per Bbl)**
                  
                  
                  –
                  
                  **$**
                  **31.67**
                  
                  
                  **N/A**
                  
                  
                  **N/A****Oil
                      produced (Bbl’s)**
                  
                  
                  –
                  
                  
                  **96,940**
                  
                  
                  **N/A**
                  
                  
                  **N/A**
 
 Oil
        sold
        for the nine months ended September 30, 2004, amounting to 96,940 Bbls, ceased
        full operations on April 5, 2004 due to a mechanical malfunction in our largest
        producing well, CM-1. Additionally, on August 14, 2004, the vessel, into
        which
        the produced oil was to be stored, off loaded and brought to market, was
        handed
        over to the debt holder as partial payment for the loan secured by the vessel.
        The Company did not have a method to store produced oil production thereafter
        and, therefore, there was no further production throughout the year.
 
 **Operating
        Costs and Expenses**
 
 **Production
        Costs**
 **$**
                  
                  
                  **$**
                  
                  
                  **$**
                  
                  
                  **%****For
                    the nine months ended September
                    30,**
                  **2005**
                  
                  
                  **2004**
                  
                  
                  **Change**
                  
                  
                  **Change****Production
                      Costs**
                  
                  
                  **$**
                  **3,085,952**
                  
                  **$**
                  **(3,085,952**
                  **)**
                  
                  **(
                      100.0**
                  **)%**
 
 -33-
 **Table
            of Contents**
  During
        the nine months ended September 30, 2005 the production facilities were idle
        and, therefore, all cost incurred have been reported as Other Expense - Idle
        facilities.
 
 The
        total
        production costs incurred in the nine months ended September 30, 2004 were
        $3,085,952 which consisted of direct costs of oil production of approximately
        $2,599,044 and vessel related costs of $486,908.
 
 The
        direct costs of production of $2,599,044 consisted principally of -
 
 ·
              $1,252,000
                  of capitalized crude oil included in yearend inventories as of
                  December
                  31, 2003.
 ·
              $689,000
                  of rentals for supply charters and
                  generators
 ·
              $142,000
                  of production crew salaries
 ·
              $205,000
                  for expenditures related to oil lifting
                  costs
 ·
              $90,000
                  of insurance costs
 ·
              $78,000
                  of fuel costs
 ·
              $43,000
                  of communication costs
 ·
              $25,000
                  of food related costs for the production
                  crew
 ·
              $25,000
                  of storage and handling costs
 ·
              $50,000
                  of other miscellaneous costs.
 
 The
        vessel related cost of approximately $486,908, consisted principally of -
 ·
              $193,000
                  of vessel crew costs
 ·
              $124,000
                  of vessel related insurance costs
 ·
              $69,000
                  of vessel maintenance and upkeep
                  costs
 ·
              $47,000
                  of vessel crew living quarters
                  costs
 ·
              $54,000
                  of other miscellaneous costs
 
 We
        lost
        the use of the vessel on August 19, 2004 when the vessel was handed over
        to the
        debt holder of the vessel as partial payment on the loan.
 
 **Depreciation
        and depletion of oil and gas properties**
 $
                
                
                $
                
                
                $
                
                
                %**For
                  the nine months ended September
                  30,**
                
                
                **2005**
                
                
                **2004**
                
                
                **Change**
                
                
                **Change****Depreciation
                    and depletion**
                
                **$**
                **81,427**
                
                **$**
                **340,738**
                
                **$**
                **(
                    259,311**
                **)**
                
                **(
                    76.1**
                **%)****Percentage
                    of Total Revenues**
                
                
                **N/A**
                
                
                **11.1**
                **%**
 
 Depreciation
        costs incurred in the nine months ended September 30, 2005 have been classified
        as Idle Depreciation in Other Income and Expenses below. Comments included
        in
        this section relate to the explanation of the decrease in depreciation expense
        for the nine month periods ending September 30, 2005 and 2004.
 
 Depreciation
        of oil equipment and depletion of oil properties decreased by 76.1% for the
        nine
        months ended September 30, 2005 from the nine months ended September 30,
        2004.
        The principal reason for the decrease in depreciation expense was due to
        the
        loss of the vessel, which had a book value of $1,910,262 on August 19, 2004,
        the
        date the vessel was handed over to the debt holder due to non-payment of
        monthly
        debt payments.
 
 On
        February 18, 2005 the Company purchased a buoy mooring system, which is required
        for vessel off loading of oil production, at a gross cost of $500,000 and
        commenced depreciation during the period.  Depreciation
        expense of $81,427 for the nine months ended September 30, 2005 was included
        in
        Other income (expense) - property and equipment maintenance costs in the
        Statement of Operations for the period then ended as the Company was not
        facilitated for production during the period principally due to the lost
        use of
        the vessel.
 
 -34-
 **Table
            of Contents**
  Depreciation
        of oil equipment and depletion of oil properties decreased by 76.1%, or
        $259,311, for the nine months ended September, 2005 from the nine months
        ended
        September 31, 2004. Depletion of the oil reserves was not charged to operations
        in the nine months ended September 30, 2005 because the oil production
        facilities had been idle since August 19, 2004 when the owner of the vessel
        foreclosed on the loan, due to non-payment, and took possession of the
        vessel.
 
 **Selling,
        general and administrative costs**
 
 **For
                  the nine months ended September 30,**
              
              $
              
              $
              
              $
              
              %**2005**
              
              **2004**
              
              **Change**
              
              **Change****Selling,
                  General and Administrative Costs**
              
              **$**
              **2,860,030**
              
              **$**
              **2,010,739**
              
              **$**
              **849,291**
              
              
              **42.2**
              **%****Percentage
                  of Total Revenues**
              
              
              **N/A**
              
              
              **65.5**
              **%**
 
 Selling,
        general and administrative costs increased by $849,291or 42.2% due to
        -
 
 ·
              An
                  increase of $181,533 incurred in relation to consulting fees associated
                  with the VAT tax owed the Indonesian
                  government
 ·
              An
                  increase of $222,000 incurred in relation to accounting consulting
                  fees.
 ·
              An
                  increase of $158,000 incurred in relation to the employees who
                  were laid
                  off as a result of the 70% sale of our oil rights and CRC becoming
                  the
                  Operator of the oil field.
 ·
              An
                  increase of $223,870 for compensation expense recorded in connection
                  with
                  the granting of options.
 ·
              An
                  increase of $130,000 in legal expenses related to legal matters
                  and
                  lawsuits, the sale of the 70% interest in oil rights and general
                  corporate
                  matters.
 ·
              A
                  decrease of $64,000 for salary of an
                  expatriate.
 ·
              A
                  net decrease of $2,112 for other matters.
 
 **Other
        Income and Expense**
 
 Other
        income and expense consisted of the following items:
 
 **For
                  the nine months ended September 30,****$**
              
              **$**
              
              **$**
              
              **%****2005**
              
              **2004**
              
              **Change**
              
              **Change****Gain
                  on settlement of trade payables at less than recorded values**
              
              **$**
              **3,166,558**
              
              **$**
              –
              
              **$**
              **3,166,558**
              
              
              **100.0**
              **%****Foreign
                  exchange gain (loss)**
              
              
              **(85,242**
              **)**
              
              **(20,875**
              **)**
              
              **64,367**
              
              
              **308.3**
              **%****Interest
                  expense**
              
              
              **418,490**
              
              
              **725,806**
              
              
              **(307,316**
              **)**
              
              **(42.3**
              **)%****Gain
                  on sale of oil rights**
              
              
              **9,712,950**
              
              
              –
              
              
              **9,712,950**
              
              
              **100.0**
              **%****Idle
                  depreciation**
              
              
              **81,428**
              
              
              –
              
              
              **81,428**
              
              
              **100.0**
              **%****Legal
                  settlement cost**
              
              
              **90,000**
              
              
              
              
              
              **(90,000**
              **)**
              
              **(100.0**
              **)%****Property
                  and equipment maintenance costs**
              
              
              **554,398**
              
              
              –
              
              
              **554,398**
              
              
              **100.0**
              **%****Other
                  income (expense)**
              
              
              
              
              
              **(765**
              **)**
              
              **765**
              
              
              **100.0**
              **%**
 
 The
        gain
        on the settlement of trade payables at less than recorded values results
        from
        negotiations and payments with various unsecured creditors for the settlement
        of
        the amounts owed at amounts less than those recorded as a
        liability.
 
 -35-
 **Table
            of Contents**
  The
        net
        foreign exchange gain (loss) was due to gains realized from accounts payable
        recorded in foreign currencies and the related fluctuations of such currencies
        at the time of payment and unrealized gains or (losses) recorded for the
        change
        in the stated value of assets or liabilities as of the end of the quarter.
 
 The
        gain
        on the sale of oil rights pertains to the November 26, 2004 agreement, which
        was
        effective on January 14, 2005 which we entered into with CRC for the sale
        of a
        70% interest in the Bawean Block Production Sharing Contract in exchange
        for
        $10,500,000. The net gain amounted to $9,712,950. The basis of the oil rights
        was $1,102,595 at December 31, 2004.
 
 The
        legal
        settlement cost was a result of the settlement agreement reached in connection
        with the Glencore litigation.
 
 Property
        and equipment maintenance costs during the nine months ended September 30,
        2005
        of $554,398, and idle depreciation expense of $81,427  relates
        to the fixed costs and continuing employee and related costs during the period
        in which the Company had no production and all facilities were idle.
 
 Interest
        expense consists of interest on short term obligations, VAT taxes payable
        and
        withholding of corporate income taxes and personal income tax withholdings
        and
        the accrued interest related to the NOWMCO outstanding debt. The amount of
        interest expense for the nine month ended September 30, 2005 decreased by
        $307,316 from the amount accrued during the nine months ended September 30,
        2004
        due to the payment of approximately $2.0 million of interest bearing short
        term
        debt during the period. The majority of the interest expense,
        $165,580,  is
        additional accrued interest on the NOWMCO debt and $239,117 of additional
        accrued interest on unpaid VAT and withholding taxes due the Indonesian
        government and accrued interest of $13,817 for funds advanced by CRC in the
        payment of vendor debts and VAT taxes.
 
 **Income
        Taxes**
 
 We
        account for income taxes under the liability method, which requires us to
        recognize deferred tax assets and liabilities for the expected future tax
        consequences of events that have been included in the financial statements
        or
        tax returns. As of September 30, 2005, the deferred tax assets related to
        our
        net operating loss carry-forwards are fully reserved. The Company has not
        provided an income tax provision for the nine months ended September 30,
        2005
        and for the nine months ended September 30, 2004 due to the available federal
        tax loss carry forwards of $12,827,374 as of December 31, 2004, capital losses
        available to offset capital gains and because earnings will not be taxable
        by
        the Federal Government until the earnings are repatriated to North
        America.
 
 **LIQUIDITY
        AND CAPITAL RESOURCES**
 
 We
        have
        funded our business, to date, primarily from issuances of equity and debt
        securities as well as the sale of a 70% interest in the Bawean PSC dated
        February 12, 1981 rights in exchange for $10,500,000 which was effective
        as of
        January 14, 2005. Our sources of liquidity are cash flows which may be a
        result
        of the production and sale of oil through our joint venture with CRC. Since
        the
        completion of the Agreement, the joint venture has not produced and sold
        any
        oil. This is principally a result of the joint venture not having a vessel
        to
        off load the oil production. Although the joint venture continues to actively
        seek to contract for a vessel, there is not one in place to do so. Therefore,
        we
        are currently experiencing negative cash flow as a result of our requirement,
        by
        the Agreement, to fund 30% of the Operators expenses and our continuing
        obligations for general and administrative expenditures. We will attempt
        to sell
        the buoy mooring equipment to PT. Panji Adi Samudera (PAS) Maritime (“PAS”) the
        party to the vessel charter agreement in an attempt to provide positive cash
        flow to the Company. We believe that the Operator will be able to secure
        a
        vessel for off loading and to begin the production of oil before the end
        of the
        fourth quarter of 2005. Within six months after securing the vessel, we expect
        to be cash flow positive from operations.
 
 **For
        the Three Months Ended September 30, 2005**
 
 At
        September 30, 2005 our principal sources of liquidity consisted of
        $6,905  of
        cash
        compared to $8,122  at
        September 30, 2004. As of September 30, 2005 we were successful in reducing
        the
        trade debt balance by approximately $641,477.
 
 -36-
 **Table
            of Contents**
  Cash
        used
        in operating activities was $2,239,914 for the three months ended September
        30,
        2005 as compared to cash used in operating activities of $55,505 for the
        three
        months ended September 30, 2004. At September 30, 2005, we had a working
        capital
        deficit of $12,543,868. Operating cash flows for the three months ended
        September 30, 2005 reflect our net (loss) of $1,255,428.
 
 Cash
        used
        by investing activities of $22,967  for
        the
        three months ended September 30, 2005 consisted primarily of payments for
        purchases of property and equipment. There was no cash used or provided in
        investing activities the three months ended September 30, 2004.
  Cash
        provided by financing activities for the three months ended September 30,
        2005
        was $2,264,739 due to the advances made by CRC to us for the payment of certain
        vendor liabilities and payments of certain taxes due the Indonesian government.
  During
        the year ended December 31, 2004, our independent auditors have included
        an
        explanatory paragraph in their audit report issued in connection with our
        financial statements which states that our recurring operating losses raise
        substantial doubt about our ability to continue as a going concern.
  Based
        on
        our current plans, which includes the future operation of the joint venture
        with
        CRC, we believe that our cash, cash equivalents, prepaid joint venture operating
        expenses and anticipated sale of our buoy mooring system will be sufficient
        to
        enable us to meet our planned operating needs for at least the next 12 months.
        As of September 30, 2005, we had cash of approximately $6,905 and restricted
        cash of $58,833, a prepaid joint operating balance of approximately
        $348,933  which
        is
        the equivalent of approximately $1.2  million
        of total operating expenses because our contractually required share is 30%
        of
        total expenses, and are anticipating to sell the mooring system in a
        sale/leaseback transaction in which the Operator (CRC) would lease it on
        behalf
        of the joint venture.
 
 **For
        the Nine Months Ended September 30, 2005**
 
 Cash
        used
        in operating activities was $8,568,632 for the nine months ended September
        30,
        2005 as compared to cash used in operating activities of $500,414  for
        the
        nine months ended September 30, 2004. At September 30, 2005 we had a working
        capital deficit of $12,543,868. Operating cash flows for the nine months
        ended
        September 30, 2005 reflect our net profit of $8,789,922. Additionally, cash
        payments of interest during the nine months ended September 30, 2005 amounted
        to
        $498,586.
 
 Cash
        provided by investing activities of $8,468,638  for
        the
        nine months ended September 30, 2005 consisted primarily of the purchase
        of a
        buoy mooring system for $500,000 in anticipation of securing a vessel for
        oil
        off loading offset by the receipt of the final payment of $9,000,000 for
        the 70%
        sale of oil rights.
 
 Cash
        provided by financing activities for the nine months ended September 30,
        2005
        was $97,893. This consisted principally of the payoff of short-term debt
        totaling $307,666  and
        the
        issuance of common shares in payment of Directors Fee which had a book value
        of
        $1,754,178. During the period the following debts were paid; Asian Companies,
        companies controlled by Company’s directors, ($188,220), RBM ($210,820),
        Alislair MacLeannar ($125,000), Maraman Ltd. ($579,056), Michael Hendri
        ($130,000) CIBC ($933,750) and an advance of $2,264,739 to CRC was incurred.
 
 During
        the nine months ended September 30, 2005, we had a net profit of $8,789,922
        of
        which $9,712,950 consisted of net profits from the sale of the 70% % interest
        in
        the Bawean Block Production Sharing Contract for a gross purchase price of
        $10,500,000 and $3,166,558  from
        the
        settlement of outstanding debt at less than values recorded in prior periods.
        Offsetting the gains were expenses for general and administrative expenses
        and
        continuing expenses for the maintenance of property and equipment, depreciation
        expense and interest expense.
  During
        the year ended December 31, 2004, our independent auditors have included
        an
        explanatory paragraph in their audit report issued in connection with our
        financial statements which states that our recurring operating losses raise
        substantial doubt about our ability to continue as a going concern.
  -37-
 **Table
            of Contents**
  Based
        on
        our current plans, which includes the future operation of the joint venture
        with
        CRC, we believe that our cash, cash equivalents prepaid joint venture operating
        expenses and anticipated sale of our buoy mooring system September 30, 2005
        we
        had cash of approximately $6,905 and restricted cash of $58,833, a prepaid
        joint
        operating balance of approximately $348,933  which
        is
        the equivalent of approximately $1.2  million
        of total operating expenses because our contractually required share is 30%
        of
        total expenses, and are anticipating to sell the buoy mooring system in a
        sale/leaseback transaction in which the Operator (CRC) would lease it on
        behalf
        of the joint venture.
 
 **Changes
        in Working Capital between September 30, 2005 and December 31,
        2004**
 
 During
        the nine months ended September 30, 2005, the Company decreased its working
        capital deficit from $23,645,185 to $12,543,868, or an $11,101,317 decrease.
        The
        principal reasons for the decrease in negative working capital were as
        follows:
 
 ·
              Decrease
                  in accounts payable and accrued expenses by $6,257,505. During
                  the period
                  the Company received the remainder of the funds from the $10.5
                  million
                  sale of a 70% interest in oil rights, or $9,000,000, and used a
                  portion of
                  the funds received to pay down outstanding
                  payables.
 ·
              Decrease
                  in short term debt by $1,402,107. As noted above, the Company received
                  the
                  final payment on the sale of a 70% interest in its oil rights and
                  used a
                  portion of the funds received to pay down outstanding short term
                  debt.
 ·
              Advances
                  payable to related parties and accrued salaries and wages decreased
                  by
                  $243,750 and $287,302, respectively. As noted above, the Company
                  received
                  the final payment on the sale of a 70% interest in its oil rights
                  and used
                  a portion of the funds received to pay down outstanding these
                  obligations.
 ·
              Decrease
                  in Directors Fees by $1,604,000 which was paid by the issuance
                  of
                  17,491,784 shares of common stock.
 ·
              Other
                  current assets increased by $360,529 as a part of the requirements
                  of the
                  Agreement for the sale of a 70% interest in its oil rights wherein
                  we were
                  required to deposit $1,000,000 in the Joint Operating Account.
                  As of the
                  end of September 30, 2005, there remained a prepaid balance, for
                  future
                  operations of the Operator, of approximately $348,933 as our 30%
                  share of
                  future expenditures.
 ·
              Decrease
                  in taxes payable by $1,001,609 and increase of tax receivables
                  of $456,842
                  as a result of adjusted interest and payments made by CRC on behalf
                  of the
                  Company.
 ·
              Decrease
                  in interest payable of $345,394, principally related to interest
                  due the
                  Indonesian government on tax related
                  payables.
 ·
              Other,
                  net $52,516.
 
 **Off-Balance
        Sheet Arrangements**
 
 On
        November 26, 2004, we entered into an Asset Purchase and Sale Agreement with
        Camar Resources Canada, Inc. (“CRC”) for the sale of a 70% interest in the
        Bawean Block Production Sharing Contract. The contract became effective on
        January 14, 2005. As a part of the sale of the 70% interest and us becoming
        a
        30% sharing partner, we also entered into a Joint Operating Agreement. The
        purpose of the Joint Operating Agreement was to establish the rights and
        obligations of the parties with regard to the joint operations of the joint
        venture. CRC is to act in the position of Operator of the project and shall
        be
        reimbursed for all expenses necessary to run the operations. Should either
        party
        default from paying its share of the joint expenses and the default is not
        cured
        within 30 days of a default notice, the non-defaulting party may require
        the
        defaulting party to cease the Agreement. If executed, the defaulting party’s
        interest shall be transferred to the non-defaulting party. Therefore, we
        may be
        exposed to a financing, liquidity, market or credit risk that could arise
        from
        the Joint Operating Agreement
 
 -38-
 **Table
            of Contents**
  **Certain
        Business Risks**
 
 **Our
        Business Is Dependent Upon a Single Operating Asset; Our Operations are Not
        Diverse**
 
 Our
        sole
        operating asset is our 30% interest in the Bawean Production Sharing Contract
        (“Bawean PSC”), issued by an entity controlled by the Indonesian government,
        which gives us and our joint venture partner, Camar Resources Canada, Inc.
        (“CRC”), the right to develop and produce oil and natural gas in two petroleum
        blocks in the Java Sea, off the coast of Indonesia, known as the Camar and
        Tuban
        blocks. CRC owns the other 70% of the interests in the Bawean PSC and operates
        the day-to-day oil production at the Camar field, which is currently the
        only
        operation under the Bawean PSC. Revenues from our 30% interest represent
        not
        less than 100% of the revenues of the Company. All of our operations are
        focused
        upon and dedicated to our interests in the Bawean PSC and our joint venture
        with
        CRC. Should we or CRC become unable to operate the Camar field under the
        Bawean
        PSC due to regulatory, equipment, human resource or legal or business reasons,
        or should the Camar and Tuban fields cease to be exploitable for any other
        reason, or if the Indonesian government were to suspend or revoke the Bawean
        PSC, or if for any other reason this asset should cease to produce revenues
        or
        become impaired for a substantial period of time, our business would be
        materially harmed and you could lose the entire value of your investment
        in our
        common stock.
 
 **If
        the Bawean PSC Is Not Extended for Us in 2011, We May Have No Operations
        or
        Sources of Revenue At All**
 
 The
        Bawean PSC by its terms will terminate in February 2011. While we will attempt
        to have it extended for an additional term there can be no assurance that
        it
        will be extended to us or on terms acceptable to us. We can make no assurances
        that the Bawean PSC will be extended. As part of any extension negotiation,
        we
        may need to substantiate to the Indonesian government our ability to continue
        oil operations at the Camar field, our plans to develop the natural gas
        resources at the Camar field, and our plans to develop the oil and natural
        gas
        resources at the Tuban field. We do not presently have plans to develop the
        untapped natural gas and oil resources at the Camar and Tuban fields and
        there
        is a risk that we would be unable to develop such plans timely, or in a manner
        satisfactory to the Indonesian government prior to the expiration of the
        Bawean
        PSC. The Indonesian government may seek to grant the Bawean PSC contract
        rights
        to another party, if the Indonesian government determines that such a party
        is
        better able to develop the fields from a financial and operating perspective.
        We
        anticipate that the extension negotiations concerning the Bawean PSC may
        commence as early as 2009. In the event the Bawean PSC is terminated in 2011,
        we
        may have no other operating assets or sources of revenue at that time. If
        the
        Bawean PSC is terminated and we have no other operating assets or sources
        of
        revenues, our business would be materially impaired and you could lose the
        entire value of your investment in our common stock.
 
 **We
        are Dependent on the Services of Key Management and Employees**
 
 We
        are
        highly dependent on the services of our Chief Executive Officer and President.
        The loss of either of Mr. James Wensveen or Mr. David Nunn, our sole executive
        officers, could have a material adverse effect on our operations. We believe
        that Mr. Wensveen and Mr. Nunn have a well-developed understanding of the
        unique
        social and business cultures in Indonesia and as such are able to negotiate,
        manage and operate the Company’s business activities within Indonesian,
        including working with regulatory authorities and Indonesian business
        enterprises. We do not believe that such skills and unique qualities could
        be
        easily replaced, if at all.  Mr.
        Wensveen and Mr. Nunn are currently our sole directors. We have entered into
        employment agreements with each of them, but we cannot assure their continued
        services to the Company. We do not maintain key-man life insurance with respect
        to any of our officers or employees. Our success will be dependent on our
        ability to continue to employ and retain skilled operational and executive
        personnel including Mr. Wensveen and Mr. Nunn, especially individuals that
        possess the proven ability to penetrate the Indonesian oil and gas industry.
        The
        loss of our executive management or any key employees could have a material
        and
        adverse effect on our business and could harm the value of your investment
        in
        our common stock.
 
 
 
 -39-
 **Table
            of Contents**
 
 **Our
        Arbitration Case Against Camar Resources Canada, Inc. Could Remain
        Unresolved**
 
 On
        August
        26, 2005 we commenced an Arbitration case against our Joint Venture Partner,
        Camar Resources Canada, Inc. (“CRC”) alleging that CRC breached it duties and
        obligations under the Joint Operating Agreement concerning the operation
        of the
        Camar field. Since the filing of the Arbitration CRC has undertaken activities
        that will promptly lead to resuming oil production at the Camar field, including
        entering into the charter for a new oil storage tanker at the Camar field.
        While
        we are in active discussions with CRC concerning the operation of the field
        by
        them, and while we believe the Company and CRC will resolve all open items
        and
        matters in dispute, we can make no assurances that CRC will perform its
        obligations under the Joint Operating Agreement to our satisfaction, or that
        CRC
        will not present counter-claims in the Arbitration proceeding. CRC has filed
        a
        response to the Arbitration asserting claims and defenses. If the Arbitration
        proceeding is not resolved and we do not withdraw the Arbitration, our working
        relationship with CRC and Medco (CRC’s indirect owner and operator) could become
        strained. If that were to occur CRC might resign as operator and we would
        be
        forced to undertake operation of the Camar field independently. While we
        are
        able to operate the field independently, there can be no assurances that
        we can
        continue to operate the Camar field while the Arbitration is pending, or
        that
        the Arbitration will become too costly or distracting to maintain. In such
        event, the lack of operations at the field or the lack of clarity over the
        performance of the Joint Operating Agreement while the Arbitration is pending
        could have a material and adverse effect on our business and could harm of
        the
        value of your investment in our common stock.
 
 **We
        Could be Harmed by Possible Terrorist Events in Indonesia and/or by the
        Instability of the Indonesian Political System**
 
 The
        country of Indonesia is susceptible to terrorist attacks and organizations,
        due
        in part to its geographic location, its lack of strong central police and
        regulatory powers and the generally underdeveloped or “third world”
        infrastructure and government organization. Should Indonesia, or any aspects
        of
        Indonesia’s commerce or government, become the target of terrorist actions, our
        operations could be adversely affected. Should the government of Indonesia
        destabilize due to political uncertainty, our operations could be adversely
        affected. Any adverse affect on our operations due to terrorist activities
        or
        the instability of the Indonesian government could harm the value of your
        investment in our common stock.
 
 **There
        is Currently No Oil Production or Revenues from Operations; We May be Unable
        to
        Locate and Operate a Storage Tanker and Resume Oil Production and Generate
        Revenues in a Timely Manner**
 
 The
        operation of the Camar oil field and the production of oil from the active
        wells
        at that field requires the use of a moored storage tanker to hold the processed
        oil pending sale. We, and our joint venture partner, currently do not own
        or
        charter such a storage tanker and as such, we have suspended oil production
        at
        the Camar field. We are currently not producing oil or natural gas at the
        Camar
        field or the Tuban field. We are currently in the process of locating a suitable
        storage tanker for lease at the Camar oil field to hold the processed oil
        pending sale. In connection with the chartering of an oil storage tanker
        we, or
        our joint venture partner, would need to contract with a ship management
        company
        to staff, operate and maintain the storage tanker. While we are actively
        pursuing a charter agreement for an oil storage tanker, we can make no
        assurances that an oil tanker will be available on terms acceptable to us,
        and
        our joint venture partner, if at all. Until we are able to obtain the use
        and
        management of an oil storage tanker we will not be able to resume operations
        at
        the Camar field and as such, we will have no revenues until the production
        is
        resumed. Our continued lack of oil production and revenues would have a material
        adverse effect on the value of your investment in our common stock.
 
 **The
        Operation of the Camar and Tuban Oil and Gas Fields Requires Permits and
        Certifications of Our Equipment; We May Not be able to Maintain or Renew
        such
        Permits in the Future**
 
 In
        connection with the production of oil at the Camar field, we must utilize
        and
        maintain numerous pieces of equipment. Many such items of equipment, including
        the oil processing platforms, are subject to periodic safety and compliance
        certifications by Indonesian government agencies. Currently, our joint venture
        partner has been able to apply for and maintain all necessary certifications
        and
        operating permits with respect to the equipment in use at the Camar field
        and we
        have been able to maintain the mooring buoy we own and use at the Camar field.
        However, we can make no assurances that such certifications and permits will
        be
        reissued timely, if at all, as our equipment ages and the certifications
        and
        permits become due for renewal. If we are unable to obtain all necessary
        certifications and permits on a timely basis, our operations could be
        interrupted, which would be harmful to your investment in our common stock.
 
 -40-
 **Table
            of Contents**
  **We
        are Reliant on our Joint Venture Partner for the Direct Field Operation of
        the
        Camar and Tuban Oil and Gas Fields**
 
 Together
        with our joint venture partner, Camar Resources Canada, Inc. (“CRC”) we own 100%
        of the interests under a Bawean Production Sharing Contract, which gives
        us the
        right to operate the Camar and Tuban petroleum blocks in the Java Sea, off
        the
        shore of Indonesia. We originally owned 100% of the interests, but we sold
        70%
        of such interests to CRC in 2004. Under the terms of our agreements with
        CRC,
        CRC is the day-to-day operator of the Camar fields, and we have no direct
        operating responsibilities in the field. Accordingly, although we can operate
        the field independently, presently all of our revenues depend on the successful
        operation of the Camar field by CRC. While CRC operates the Camar field under
        our Joint Operating Agreement with them, we cannot exercise absolute control
        over CRC or the operations in the field. Should CRC fail to operate the Camar
        field in a profitable manner, or should CRC cause substantial liabilities
        to
        arise, or should CRC engage in criminal conduct, or should CRC terminate
        its
        commitments to us and cease its operations without prior notice, our business
        and operations would be adversely effected and the value of your investment
        could be harmed.
 
 **Debt
        Settlement and Reduction in Percentage Ownership under the Bawean PSC**
 
 Under
        our
        agreements with our joint venture partner, Camar Resources Canada, Inc.,
        if we
        are unable to settle and resolve certain liabilities for $4,500,000 or less,
        and
        if Camar Resources Canada, Inc. pays such liabilities on our behalf, we may
        be
        forced to forfeit some of our ownership interests in the Bawean PSC. These
        liabilities arise from our acquisition of GFB Java Resources, Ltd. and our
        settlement with Canadian Imperial Bank of Commerce. For every $150,000 in
        liabilities that CRC pays, in excess of $4,500,000, our percentage ownership
        interest in the Bawean PSC will be reduced by 1% unless we repay CRC for
        their
        advance payments within 30 days. In no event would our interest in the Bawean
        PSC be lower than 5%. However, any reduction in our ownership interest would
        result in less revenues to us, and as a result, the value of your investment
        in
        our common stock would be harmed.
 
 **Litigation
        Claims and Reduction in Percentage Ownership under the Bawean PSC**
 
 We
        are
        subject to various litigation claims and disputes in the ordinary course
        of our
        business and operations. We are presently a party to several material
        litigations. While we intend to vigorously defend such litigations, we cannot
        assure that we will be victorious and we cannot determine what damages, if
        any,
        we may be responsible to pay. Should any or all of the litigation matters
        we are
        a party to be determined against the Company, our business may be harmed
        and as
        a result your investment in our common stock could be negatively effected.
 
 In
        addition, under our agreements with our joint venture partner, Camar Resources
        Canada, Inc., if we are unable to resolve the NOWMCO litigation favorably,
        we
        may be forced to forfeit some of our ownership interests in the Bawean PSC.
        For
        every $150,000 in litigation judgments that we must pay in excess of $2,550,000,
        our percentage ownership interest in the Bawean PSC will be reduced by 1%.
        In no
        event would our interest in the Bawean PSC be lower than 5%. However, any
        reduction in our ownership interest would result in less revenues to us,
        and as
        a result, the value of your investment in our common stock would be harmed.
 
 **Our
        Reserve Data and Future Estimates Are Based on Assumptions that May be
        Inaccurate and Are Based on Existing Economic and Operating Conditions that
        May
        Change in the Future.**
 
 There
        are
        numerous uncertainties inherent in estimating oil and natural gas reserves
        and
        their estimated value, including many factors beyond the control of the
        operator. The reserve data set forth in this Registration Statement represents
        only estimates. Reservoir engineering is a subjective and inexact process
        of
        estimating underground accumulations of oil and natural gas that cannot be
        measured in an exact manner. The reserve data included in this Registration
        Statement represents estimates that depend on a number of factors and
        assumptions that may vary considerably from actual results, including:
 
 -41-
 **Table
            of Contents**
  -
        historical production from the area compared with production from other areas;
 
 -
        the
        assumed effects of regulations by applicable governmental agencies;
 
 -
        assumptions concerning future natural gas and oil prices;
 
 -
        future
        operating costs;
 
 -
        severance and other operating taxes;
 
 -
        development costs; and
 
 -
        remedial costs.
 
 For
        these
        reasons, estimates of the economically recoverable quantities of natural
        gas and
        oil attributable to any particular petroleum block, classifications of those
        reserves based on risk of recovery and estimates of the future cash flows
        expected from them may vary substantially with actual results. Accordingly,
        reserve estimates may be subject to upward or downward adjustment, and actual
        production, revenue and expenditures with respect to our reserves likely
        will
        vary, possibly materially, from estimates.
 
 Because
        most of our reserve estimates are calculated using volumetric analysis, those
        estimates are less reliable than estimates based on a lengthy production
        history. Volumetric analysis involves estimating the volume of a reservoir
        based
        on the net feet of pay of the structure and an estimation of the area covered
        by
        the structure based on seismic analysis. The actual amount of the reserves
        could
        differ materially from what our analysis shows. Should the reserves at the
        Camar
        field or the Tuban field be substantially less than our reports indicate,
        the
        long term operations of the Company could be harmed and the value of your
        investment could diminish over time.
 
 **Lack
        of Current Development Plans For the Camar Field and the Tuban Field**
 
 Historically,
        we have produced only oil from the Camar field. We believe, based on reserve
        data, that the Camar field also contains significant volumes of natural gas.
        We
        also believe, based on reserve data, that the Tuban field contains oil and
        natural gas. However, we have no current plans to develop and exploit the
        Camar
        field for natural gas production, or the Tuban field for oil or natural gas
        production. Accordingly, should the Camar oil production subside or cease,
        or
        should the oil reserves at Camar fall far short of our expectations, we would
        be
        forced to develop the Camar natural gas reserve and the oil and gas reserves
        at
        the Tuban field at substantial cost to our Company and the join venture with
        CRC. Because we have no current development plans, our ability to quickly
        exploit those resources in the event the Camar field ceased to be profitable,
        would be impaired. The capital required to develop and exploit the Tuban
        field
        for oil and gas, and the Camar field for gas, would be significant and above
        any
        amount the Company could presently afford without financing. There can be
        no
        assurances that the Company will ever develop the natural gas reserve at
        the
        Camar field, or the natural gas or oil reserve at the Tuban field. The lack
        of
        this planned development could harm your investment by not providing a strategy
        to continue operations in the event the Camar field oil production
        should
        terminate.
 
 **We
        May Depend on Successful Exploration, Development and Acquisitions of New
        Petroleum Blocks to Access New Reserves and Revenues in the Future.**
 
 In
        general, the volume of production from natural gas and oil properties declines
        as reserves are depleted, with the rate of decline depending on reservoir
        characteristics. Except to the extent we conduct successful exploration and
        development activities or acquire properties containing proved reserves,
        or
        both, our existing reserves will decline as reserves are produced. Our future
        natural gas and oil production is, therefore, highly dependent on our level
        of
        success in finding or acquiring additional reserves, even inside the Camar
        and
        Tuban fields. The business of exploring for, developing or acquiring reserves
        is
        capital intensive. Recovery of our reserves, particularly undeveloped reserves,
        will require significant additional capital expenditures and successful drilling
        operations. To the extent cash flow from operations is reduced and external
        sources of capital become limited or unavailable, our ability to make the
        necessary capital investment to maintain or expand our asset base of natural
        gas
        and oil reserves would be impaired. In addition, we may be dependent on finding
        partners for our exploratory activity. To the extent that others in the industry
        do not have the financial resources or choose not to participate in our
        exploration activities, we will be adversely affected.
 
 -42-
 **Table
            of Contents**
  **Oil
        and Natural Gas Prices are Volatile, and Lower Prices will Negatively Affect
        Our
        Financial Results.**
 
 Our
        revenue, profitability, cash flow, future growth and ability to borrow funds
        or
        obtain additional capital, as well as the carrying value of our properties,
        are
        substantially dependent on prevailing prices of natural gas and oil.
        Historically, the markets for natural gas and oil prices have been volatile,
        and
        those markets are likely to continue to be volatile in the future. It is
        impossible to predict future natural gas and oil price movements with certainty.
        Prices for natural gas and oil are subject to wide fluctuation in response
        to
        relatively minor changes in the supply of and demand for natural gas and
        oil,
        market uncertainty and a variety of additional factors beyond our control.
        These
        factors include:
 
 -
              the
                  level of consumer product demand;
 
 -
              overall
                  economic conditions;
 
 -
              weather
                  conditions;
 
 -
              domestic
                  and foreign governmental relations;
 
 -
              the
                  price and availability of alternative fuels;
 
 -
              political
                  conditions;
 
 -
              the
                  level and price of foreign imports of oil and natural gas; and
 
 -
              the
                  ability of the members of the Organization of Petroleum Exporting
                  Countries to agree upon andmaintain
                  oil price controls.
 
 Declines in
          natural gas and oil prices may materially adversely affect our financial
          condition, liquidity and ability to finance planned capital expenditures
          and
          results of operations.
 
 **We
        Face Competition from Other Natural Gas and Oil Companies As We Seek to Acquire
        Rights to New Petroleum Blocks.**
 
 We
        will
        encounter competition from other natural gas and oil companies in the
        acquisition of exploratory prospects and proven properties. Our competitors
        will
        include major integrated natural gas and oil companies and numerous independent
        natural gas and oil companies, individuals and drilling and income programs.
        Many of our competitors are large, well-established companies that have been
        engaged in the natural gas and oil business much longer than we have and
        possess
        substantially larger operating staffs and greater capital resources than
        we do.
        These companies may be able to pay more for exploratory projects and productive
        natural gas and oil properties and may be able to define, evaluate, bid for
        and
        purchase a greater number of properties and prospects than our financial
        or
        human resources permit. In addition, these companies may be able to expend
        greater resources on the existing and changing technologies that we believe
        are
        and will be increasingly important to attaining success in the industry.
        We may
        not be able to conduct our operations, evaluate and select suitable properties
        and consummate transactions successfully in this highly competitive environment.
 
 
 **We
        are Subject to Governmental Regulations and Environmental Risks.**
 
 Our
        operations are subject to various Indonesian regulations that may change
        from
        time to time. Matters subject to regulation include certification of equipment,
        oil export, oil storage, discharge permits for drilling operations, plug
        and
        abandonment bonds, reports concerning operations, the spacing of wells,
        unitization and pooling of properties and taxation. We also operate under
        regulations relating primarily to the protection of human health and the
        environment and to the development, production, handling, storage,
        transportation and disposal of natural gas and oil, by-products thereof and
        other substances and materials produced or used in connection with natural
        gas
        and oil operations. As a result, we may incur substantial liabilities to
        third
        parties or governmental entities and may be required to incur substantial
        remediation costs for any environmental hazards we cause. We also are subject
        to
        changing and extensive tax laws in Indonesia, the effects of which cannot
        be
        predicted. Compliance with existing, new or modified laws and regulations
        could
        have a material adverse effect on our business, financial condition and results
        of operations.
 
 -43-
 **Table
            of Contents**
  **We
        are Subject to Various Operating and Other Casualty Risks that Could Result
        in
        Liability Exposure or the Loss of Production and Revenues.**
 
 The
        natural gas and oil business involves operating hazards such as:
 
 -
              well
                  blowouts;
 
 -
              damage
                  to equipment due to marine and/or weather conditions;
 
 -
              mechanical
                  failures;
 
 -
              explosions;
 
 -
              uncontrollable
                  flows of oil, natural gas or well fluids;
 
 -
              fires;
 
 -
              geologic
                  formations with abnormal pressures;
 
 -
              pipeline
                  ruptures or spills;
 
 -
              releases
                  of toxic gases; and
 
 -
              other
                  environmental hazards and risks.
 
 Any
        of
        these hazards and risks can result in the loss of hydrocarbons, environmental
        pollution, personal injury claims and other damage to our properties and
        the
        property of others. Under Indonesian law, we would be responsible for the
        remediation costs of any environmental hazards caused by us. If such
        environmental hazard were to arise, and if the remediation costs were
        substantial, our remediation expenditures could negatively impact our operations
        and harm the value of your investment in our common stock.
 
 **We
        May Not Have Enough Insurance to Cover All the Risks That We and Our Joint
        Venture Partner Face.**
 
 In
        accordance with customary industry practices, our joint venture partner (the
        operator of the Camar and Tuban fields) maintains insurance coverage against
        some, but not all, potential losses in order to protect against potential
        risks.
        We do not carry business interruption insurance. We and our joint venture
        partner may elect not to carry insurance if we believe that the cost of
        available insurance is excessive relative to the risks presented. In addition,
        we, and our joint venture partner cannot insure fully against pollution and
        environmental risks. The occurrence of an event not fully covered by insurance
        could have a material adverse effect on our financial condition and results
        of
        operations.
 
 -44-
 **Table
            of Contents**
  **We
        Have Substantial Capital Requirements That, if Not Met, May Hinder Operations.**
 
 We
        and
        our joint venture partner have experienced and expect to continue to experience
        substantial capital needs as a result of our operations. We expect that
        additional external financing will be required in the future to fund our
        growth
        and our strategy to acquire new petroleum blocks for development, even if
        we
        resume oil production by the end of 2005. We, or our joint venture partner,
        may
        not be able to obtain additional financing on terms acceptable to us, if
        at all.
        Without additional capital resources, we may be forced to limit or defer
        our
        planned activities and development initiatives and thereby adversely affect
        the
        recoverability and ultimate value of our natural gas and oil properties,
        in turn
        negatively affecting our business, financial condition and results of
        operations. In addition, without adequate capital, we may not be able to
        pursue
        our growth strategy of acquiring new petroleum blocks or developing the Tuban
        field. Our failure to obtain adequate capital could harm the value of your
        investment in our common stock.
 
 **ITEM
        3 - QUANTITATIVE AND QUALTATIVE DISCLOSURES ABOUT MARKETY
        RISK**
 
 Our
        Indonesian operations and the operations of our Joint Operations Partner,
        CRC,
        are transacted, in part, in foreign currencies, which exposes us to financial
        market risk resulting from fluctuations in foreign currency exchange rates,
        particularly the Indonesian rupiah . In
        order
        to conserve cash,  we
        do not
        utilized hedging programs, currency forward contracts, currency options and/or
        other derivative financial instruments commonly used to reduce financial
        market
        risks. Should we decide to utilize hedging programs, currency forward contracts,
        currency options and/or other derivative financial instruments commonly used
        to
        reduce financial market risks, there can be no assurance that such actions
        will
        successfully reduce our exposure to financial market risks.
 
 **ITEM
        4 - CONTROLS AND PROCEDURES**
 
 **Evaluation
        of Disclosure Controls and Procedures**
 
 We
        carried out an evaluation, under the supervision and with the participation
        of
        our management, including our Chief Executive Officer, President and Chief
        Accounting Officer, of the effectiveness of our “disclosure controls and
        procedures” as of the end of the period covered by this report, pursuant to
        Rules 13a -15 (e) and 15d-15 (e) under the Securities Exchange Act of 1934,
        as
        amended. Based on that evaluation, our Chief Executive Officer, President
        and
        Chief Accounting Officer have concluded that, as of the end of the period
        covered by this report, these disclosure controls and procedures were effective
        to ensure that we are able to record, process, summarize and report the
        information we are required to disclose in the reports we file with the SEC
        within the required time periods.
 
 We
        are
        enhancing our internal control procedures in preparation of having to make
        the
        required management report on internal control over financial reporting required
        by Section 404 of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”). We enhanced
        our internal control procedures by engaging a financial consultant to ensure
        timely compliance with the requirements of the Sarbanes-Oxley.
 
 **Changes
        in Internal Control Over Financial Reporting**
 
 These
        has
        been no change in our internal control over financial reporting during our
        most
        recent fiscal quarter that has materially affected, or is reasonably likely
        to
        affect, our internal control over financial reporting.
 
 
 -45-
 **Table
            of Contents**
  **PART
        II**
 
 **OTHER
        INFORMATION**
 
 **Item
        1 - Legal Proceedings**
 
 ***Indo-Pacific
        Resources (Java) Ltd . v. Camar Resources Canada
        Inc.*** ***(International Chamber of Commerce, International Court of Arbitration, Paris,
        France)***
 
 On
        August
        26, 2005, the Company’s wholly owned subsidiary Indo-Pacific Resources (Java)
        Ltd. (“IPRJ”) filed a Request for Arbitration (the “Complaint”) against Camar
        Resources Canada Inc. (the Company’s joint venture partner and owner of the 70%
        working interest in the Bawean PSC) with the International Court of Arbitration
        (the “Court”) in Paris, France. No case number has been assigned to this matter.
        The Complaint alleges CRC breached the Joint Operating Agreement (the “JOA”)
        that the parties entered into on November 26, 2004 and also breached its
        fiduciary duty to IPRJ by failing to take all necessary acts to commence
        oil
        production in the Camar Field. Among other things, IPRJ alleges that CRC
        breached the JOA by failing to purchase, charter, or otherwise engage a sea
        vessel for the storage of oil produced from the Camar Field. IPRJ also alleges
        that an agreement, either express or implied, exists regarding the use of
        a
        mooring system at the Camar Field (the “Mooring System Agreement”) and for which
        CRC, as operator of the Camar Field, is obligated to pay a daily fixed-cost
        charge, which it has failed to do. IPRJ seeks a finding that such breaches
        constitute sufficient grounds for the removal of CRC as operator under the
        JOA
        and for the appointment of a new operator that IPRJ can choose without any
        input
        from CRC. IPRJ is seeking monetary damages including approximately $4,850,000
        for lost profits that will increase at a net rate of $550,000 every month
        (based
        on current crude prices) for every month the Camar field is not put into
        production, and also approximately $319,440 for the fixed charges related
        to the
        mooring system and which will also continue to accrue at an average monthly
        rate
        of $36,500.
  On
        October 7, 2005, CRC filed an Answer to IPRJ’s Request for Arbitration and also
        a Counterclaim against IPRJ. CRC denies the breaches of JOA alleged by IPRJ
        and
        also alleges that no agreement exists regarding the use of a mooring system
        at
        the Camar Field. Further, CRC claims that IPRJ’s claim for non-payment for the
        mooring system charge is not a claim subject to this arbitration because
        it is a
        collateral claim and does not arise under the JOA, and that a claim for unjust
        enrichment or quantum meruit is not a matter that falls under the jurisdiction
        of the arbitration proceedings. CRC’s Counterclaim alleges IPRJ has breached the
        Asset Purchase and Sale Agreement (“PSA”) that the parties entered into on
        November 26, 2004 because IPRJ has failed to settle all of IPRJ’s trade debts
        and value added tax principal obligations (including tax penalties and
        associated interest charges owed to Indonesia and hereinafter referred to
        as the
“Settlement Obligations”) under the PSA. As a result of IPRJ’s breach, CRC
        alleges that BPMIGAS, the Indonesian regulatory body that issues the
        work program and budget approvals in connection with production under the
        Bawean
        PSC, did not approve the 2004 and 2005 work programs and budgets for operation
        of the Camar Field. CRC is seeking monetary damages including $12,000,000
        representing lost production suffered by CRC because of IPRJ’s failure to settle
        the Settlement Obligations, $1,000,000 per month commencing on the date of
        the
        filing of the Complaint for each month production is not obtained from the
        properties subject to the Bawean PSC, and an award of costs and interest
        on the
        damage amounts stated above. The Company received notification for the approval
        of the 2004 work program from BPMIGAS dated July 19, 2005. The Company intends
        to vigorously defend CRC’s allegations.
 
 On
        October 26, 2005, the Company received a Notice of Dilution claiming that
        the
        Company has not discharged its requirement to settle and pay all outstanding
        vendor and VAT tax obligations and that CRC has settled and paid $2,967,021of
        vendor obligations and $2,123,892 of VAT obligations. Under the terms of
        the
        PSA, the Company has 45 days to reimbursement CRC for the payment of such
        non-settled vendor obligations and, if CRC is not reimbursed is subject to
        a
        dilution in their ownership interest in the joint operations by a factor
        of one
        percentage point for each $150,000 paid by CRC except that the Company ownership
        position shall not be diluted beyond 5% of the joint operations.
  
 -46-
 **Table
            of Contents**
 
 ***National
        Oil Well Maintenance Co. and Enterprise Trading Limited v. Fortune Oil &
        Gas, Inc., Fortune Ship Management Ltd. and Indo-Pacific Resources (Java)
        Ltd.***
 
 Fortune
        Oil & Gas, Inc. and its subsidiaries Fortune Ship Management Ltd. and
        Indo-Pacific Resources (JAVA) Ltd. are defendants and counterclaimants in
        an
        action pending in the United States District Court for the Southern District
        of
        New York captioned National
        Oil Well Maintenance Co. and Enterprise Trading Limited v. Fortune Oil and
        Gas,
        Inc., Fortune Ship Management Ltd. and Indo-Pacific Resources (JAVA) Ltd. ,
        Case No
        02 CV. 7666 (LBS), pending in the United States District Court for the Southern
        District of New York.  In this action, Plaintiffs seek to enforce
        promissory notes given by the Company in an approximate amount of $4.2 million
        dollars plus attorneys’ fees and interest.  On or about August 23, 2004,
        the Court granted Plaintiffs’ and Counter-defendants’ Motion for Summary
        Judgment on the promissory notes but did not fix an amount owed by the Company.
        The Company has asserted counterclaims against the Plaintiffs that greatly
        exceed the amount due under the promissory notes.  These counterclaims
        have
        survived Plaintiffs’ and Counter-defendants’ Motion for Summary Judgment and are
        scheduled to be tried on November 7, 2005. The Company intends to vigorously
        defend against this action. The Company, however, cannot control the outcome
        and
        cannot determine what losses may result from this, if any.
 
 ***Glencore
        International AG v. Indo-Pacific Resources (Java) Ltd.*** ****
 
 On
        March
        5, 2003, the Company’s wholly owned subsidiary Indo-Pacific Resources (Java)
        Limited (“IPRJ”) entered into a sales contract with Glencore International AG
        (“Glencore”) whereby the Company committed to sell crude oil to Glencore in
        exchange for cash payments to IPRJ (the “Sales Contract”). However, due to
        unforeseen difficulties and as a claimed result of force majeure, IPRJ was
        unable to fulfill the required sales under the contract. On June 30, 2003,
        Glencore filed a claim before a London Arbitration Tribunal (the “Tribunal”)
        constituted under the rules of the London Maritime Arbitrators' Association
        in
        London, England against IPRJ for breach of the Sales Contract. No case number
        was assigned to the arbitration matter. Glencore seeks damages including
        the
        $91,300 for lost profit, and/or a declaration that IPRJ must indemnify Glencore
        for any claim brought by the third party Glencore had agreed to sell the
        oil it
        would have purchased from IPRJ, and/or $184,000 in indemnity damages caused
        by
        the breach to third parties, and also interest and the costs of suit and
        defense
        of the indemnity claims. IPRJ subsequently secured permission to file a
        Counterclaim against Glencore and has filed a Counterclaim before the Tribunal
        against Glencore for breach of the Sales Contract. IPRJ is seeking monetary
        damages against Glencore for such breach in the amount of $133,000. The
        Company’s subsidiary, IPRJ and Glencore have settled this matter and are
        finalizing the terms of a settlement agreement whereby IPRJ shall pay to
        Glencore the sum of $290,000 in one lump sum on or before November 1, 2005.
        The
        Company has guaranteed this payment. Upon payment in full of the settlement
        amount, the case will be formally dismissed.  The
        Company is fully reserved for the sum of the settlement as of September 30,
        2005.
 
 ***P.T.
        Patra Drilling Contractor and Somaser, S.N.C. v. Indo-Pacific Resources (Java)
        Limited (formerly known as GFB Resources (Java) Limited) and related proceedings***
 
 On
        October 28, 2003, P.T. Patra Drilling Contractor (“Patra”) and Somaser, S.N.C.
        (“Somaser”) (collectively “Plaintiffs”) filed a Request for Arbitration (the
“Complaint”) against the Company’s wholly owned subsidiary Indo-Pacific
        Resources (Java) Limited (“IPRJ”) with the Indonesian National Board of
        Arbitration (“BANI”) in Jakarta, Indonesia, and the matter was assigned number
        184:X/ARB-BANI/2003. The Complaint alleges IPRJ breached the offshore oil
        and
        gas Jack-Up Drilling Rig services contract that the parties entered into
        on
        December 31, 1997 and a Joint Operating Agreement dated February 10, 1998
        by
        failing to make required payments under the contracts. Plaintiffs are seeking
        damages including approximately $2,698,074, interest of approximately $772,038
        plus all arbitration costs and expenses including legal fees. On August 24,
        2004, BANI rendered an interim award based on an exception (motion) by IPRJ,
        holding that there was no arbitration agreement between IPRJ and Somaser
        and
        ordering Somaser excluded from further participation in the arbitration
        proceedings. On February 17, 2005, BANI rendered a final award against IPRJ,
        granting Patra's petition and ordering IPRJ to pay Patra US$ 2,682,073.99
        and
        interest in the amount of US$ 772,037.26. BANI ordered IPRJ to comply with
        the
        final award within 30 days after the award was registered with the South
        Jakarta
        District Court (the “District Court”). On March 4, 2005, the clerk of BANI filed
        the final award with the District Court. On March 12, 2005, IPRJ filed a
        civil
        claim against Patra, Somaser and BANI in the District Court and the case
        was
        assigned Case No. 169/PDT/G/2004/PN.JKT.SEL. IPRJ alleged that Somaser and
        Patra
        violated Indonesian Laws by submitting the request for arbitration without
        a
        valid arbitration agreement made and signed by IPR, Somaser and Patra. On
        March
        14, 2005, the District Court’s panel of judges rendered a judgment, declaring
        that the District Court had no jurisdiction to try this case. IPRJ has filed
        an
        appeal contesting this judgment and it is currently pending. On March 14,
        2005,
        IPRJ also filed a Petition for Cancellation of the final arbitration award
        and
        it was assigned Case No. 73/PDT.P/2005/PN.JAK.SEL. On July 21, 2005, the
        District Court rejected IPRJ’s Petition for Cancellation of the final
        arbitration award. IPRJ then lodged a cassation with the Supreme Court to
        appeal
        the District Court’s judgment that rejected IPRJ’s Petition for Cancellation.
        IPRJ has also lodged a memorandum of cassation to the Supreme Court, through
        the
        District Court, and IPRJ’s cassation is currently pending. The Company believes
        that BANI has no jurisdiction over this case and intends to vigorously defend
        against the alleged claim and appeal the final arbitration award. The Company,
        however, cannot control the outcome and cannot determine what losses may
        result
        from this, if any.
 
 -47-
 **Table
            of Contents**
  On
        October 25, 2005, Patra Drilling Contractor was paid $2,250,000, in full
        payment
        of the amounts due, by CRC, the Company’s joint venture partner, on behalf of
        the Company.
 
 ***Singapore
        Technologies Marine Ltd., et al. v. Fortune Ship Management Ltd. and Fortune
        Oil
        and Gas, Inc***
 
 On
        or
        about May 28, 2003, Singapore Technologies Marine Ltd. (“STM”) filed a claim in
        the High Court of the Republic of Singapore against the Company and its
        subsidiary Fortune Ship Management, Ltd. (“FSM”) (collectively the
“Defendants”), and the case was assigned Suit No. 604 of 2003/P **.** The
        Complaint alleged the Defendants breached a contract to perform
        conversion/repair work on a vessel to become a floating offshore storage
        vessel
        by failing to make the required payments under the contract. STM claimed
        damages
        of $1,099,449 (Singapore Dollars) and accrued interest and costs of suit.
        On
        August 14, 2004, the parties filed a Notice of Discontinuance of this case
        with
        the Court, with each party bearing their own costs in the actions, and there
        has
        no been activity since that filing.
 
 **Item
        2 - Unregistered Sales of Equity Securities and Use of
        Proceeds**
 
 None
 
 **Item
        3 - Defaults Upon Senior Securities**
 
 None
 
 
 **Item
        5 - Other Information**
 
 None
 
 **Item
        6 - Exhibits and Reports on Form
        8-K**
 3.1*
                    Charter
                        of Fortune Oil & Gas, Inc. as filed in the State of Nevada3.2*
                    Bylaws
                        of Fortune Oil & Gas, Inc.10.1#
                    Bawean
                        Production Sharing Contract as amended dated February 12,
                        198110.2
                        #
                    Asset
                        Purchase and Sale Agreement - Indo-Pacific Resources (Java)
                        Ltd. and Camar
                        Resources Canada Inc. as amended dated November 26, 200410.3
                        #
                    Joint
                        Operating Agreement - Camar Resources Canada Inc. and Indo-Pacific
                        Resources (Java) Ltd. - Operating Agreement Covering: Bawean
                        Production
                        Sharing Contract dated November 26, 2004
 10.4
                        #
                    Sale,
                        Purchase and Settlement Agreement between ProSafe Production
                        Services PTE
                        Ltd. and Indo-Pacific Resources (Java) Ltd. dated February
                        8, 200510.5
                        #
                    Settlement
                        Agreement by and among Indo-Pacific Resource (Java) Ltd.,
                        Indo-Pacific Oil
                        & Gas, Inc., Fortune Oil and Gas, Inc., GFB Resources Limited,
                        Canadian Imperial Bank of Commerce, and CIBC Capital Partners,
                        dated
                        November 29, 200410.6
                        #
                    Lease
                        Agreement for British Columbia Offices dated September 27,
                        200010.7
                        #
                    Lease
                        Agreement as amended for Indonesian Offices dated March 15,
                        200510.8
                        #
                    Employment
                        Agreement with Mr. Wensveen dated January 1, 200510.9
                        #
                    Employment
                        Agreement with Mr. Nunn dated January 1, 200510.10
                        #
                    Fortune
                        Oil & Gas, Inc. 2005 Equity Incentive Plan10.11
                        #
                    Guarantee
                        Agreement between Medco International Ventures Limited and
                        Indo-Pacific
                        Resources (Java) Ltd. dated November 26, 200410.12*
                    Employment
                        Agreement with Mr.Yanianto11
                        *
                    Computation
                        of Per Share Earnings21
                        #
                    Subsidiaries
                        of the Registrant as of August 1, 200531.1
                    Rule
                        13a-14(a) Certification of Chief Executive Officer31.2
                    Rule
                        13a-14(a) Certification of Chief Accounting Officer32.1
                    Certification
                        of the Chief Executive Officer and Chief Accounting Officer
                        pursuant to 18
                        U.S.C. Section 1350 as adopted pursuant to Section 906 of
                        the
                        Sarbanes-Oxley Act of 2002
 
 #
              Exhibit
                  Filed on August 8, 2005 with the initial filing of the Registrant’s
                  Registration Statement on Form 10 and incorporated herein by
                  reference.
 *
              Exhibit
                  Filed on October 18, 2005 with Amendment Number 1 to Registrant’s
                  Registration Statement on Form 10 and incorporated herein by
                  reference.
 
 -48-
 **Table
            of Contents**
 
 **SIGNATURES**
  In
        accordance with the requirements of the Exchange Act, the registrant caused
        this
        report to be signed on its behalf by the undersigned, thereunto duly authorized.
  **FORTUNE
                  OIL & GAS, INC.**Date: November
                  16, 2005
              By:
              /s/ James
                  B. WensveenName:    
                  James B. Wensveen
                Title:      
                  Chief Executive Officer, Secretary and
                  Director
  Date:
                  November 16, 2005
              By:
              */s/ David
                  A. Nunn*Name:    
                  David A. Nunn
                Title:      
                  President and Director
  Date:
                    November 16, 2005
                By:
                /s/ Xin
                    FengName:    
                    Xin Feng
                  Title:      
                    Chief Accounting Officer
   -49-